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Tuesday, 9 October 2012

Global Islamic finance witnesses newcomers, boom and old hurdles

DUBAI, Oct. 8 (Xinhua) — As banking in line with Islamic law matures, partnerships rather than rivalry feed the industry’s comeback.
According to global consultancy Ernst and Young, there are more than 390 Islamic banks and financial institutions based in 75 countries. The emirate of Dubai will soon have a new player in the field of banking in line with Islamic law or Shari’ah.
Earlier this month H. H. Sheikh Maktoum bin Hasher Al Maktoum, executive chairman of the United Arab Emirates’ (UAE) oldest investment bank, Shuaa Capital, said on request by Xinhua that his bank applied for an Islamic banking license. “We plan to launch Islamic banking in the first quarter of 2013,” he said.
Shuaa was hit badly by the financial crisis as trading volumes at capital markets plummeted. In 2011, the bank reported a eyebrow- raising return of equity of minus 19.9 percent.
Consequently, Shuaa, whose shares are traded at the Dubai Financial Market, aims to explore new markets.
“We target the market for Shari’ah-compliant financing for small and medium enterprises (SMEs) as in the UAE only four percent of SME financing comes today from banks,” said Sheikh Maktoum, who is a member of Dubai’s ruling family Al-Maktoum.
Because Shari’ah forbids interest, banks become partners of those businesses they finance and share profits, instead of lending money with interest.
It is of no coincidence that Shuaa opts to enter Islamic finance now. The market celebrates a strong comeback. The impressive growth in Islamic bonds, known as sukuk, has moved banking in line with Islamic law or Shari’ah back into the spotlight of global finance.
According to Kuwait’s largest Islamic financial institution Kuwait Finance House, the market for Islamic bonds grew to 210.8 billion U.S. dollars, up by a whopping 40.1 percent year-on-year.
Forgotten are the woes when Dubai state-owned developer Nakheel almost defaulted on a 3.52 billion dollars sukuk in November 2009 (only a guarantee worth 10 billion dollars issued by oil-rich emirate Abu Dhabi saved Nakheel and Dubai from an embarrassing oath of disclosure).
The positive trend is expected to continue. “This is the biggest year for sukuk simply because supply is finally catching up to demand,” said John Sandwick, wealth manager at Safa Investment Services in Geneva, Switzerland.
He added that “2013 we expect issuances to be even bigger. The sukuk market is finally hitting its stride since substantial standardization by Islamic finance organizations such as AAOIFI, the Accounting and Auditing Organisation for Islamic Financial Institutions.”
Ample demand has pulled the yield for sukuk to a historic low, as the HSBC/NASDAQ Dubai US Dollar Sukuk Index (SKBI) indicates.
Attracted by the impressive petro-dollars fuelled growth in the Gulf Arab region, Sandwick decided to expand to the region. On Oct. 8, Sandwick launched Safa Investment Services’ branch in Riyadh, Saudi Arabia, with a grand opening.
In the wake of the financial crisis, Islamic banking went through choppy years.
Germany’s largest lender Deutsche Bank and Swiss private bank Pictet closed their Islamic investment funds due to a lack of demand; conferences on Islamic finance were cancelled; Islamic financial institution Dubai Bank, launched in 2007 as a bank which aimed to make a difference in service, had to be saved from collapse, first in May 2011 by the Dubai government, then a year ago by the UAE’s largest lender Emirates NBD, who took over Dubai Bank.
Meanwhile, Islamic finance has reached the volume of some 1.1 trillion dollars, according to Ernst and Young.
Besides new players entering the scene, like Shuaa or Safa, consolidation is also on the move, giving proof of that industry’s maturity.
On Tuesday, Bahrain’s Islamic lender Ithmaar Bank’s negotiations on a proposed merger with First Leasing Bank, one of its Bahrain-based associates, have reached an advanced stage.
But one of the most significant joint ventures in the industry has happened last summer and was almost unnoticed. Dow Jones Indexes and Standard and Poor’s (S&P) Indices, once rivals in providing indexes for the financial industry, joined forces.
Dow Jones Indexes developed and launched in 1998 the first market index which measures the performance of listed firms whose business does not contradict to Islamic principles, the Dow Jones Islamic Market (DJIM) Index.
Entities which produce alcohol, weapons, pork products and interest-bearing financial products are excluded from any Islamic market measure, as well as highly indebted firms.
After Dow Jones started to develop Shari’ah-compliant indexes for different regions, countries and industries, more providers jumped on the Islamic bandwagon, such as S&P, FTSE or Russell Indexes, to mention a few.
“The joint venture in July 2012 between S&P Indices and Dow Jones Indexes has led to the creation of the world’s largest provider of financial market indices,” said Tariq Al-Rifai, director of Index Investment Strategy, S&P Dow Jones Indices, in an e-mailed interview with Xinhua.
“The new entity, S&P Dow Jones Indices, is able to deliver index-based investment solutions across a wider range of asset classes and regions,” he said.
The joint venture is that huge that it is too early to disclose figures on how many funds have licensed an Islamic gauge from the S&P Dow Jones Indices family. “S&P Dow Jones Indices is currently in the process of recalculating the AUM post merger for both families of Islamic indices,” Al-Rifai explained.
However, the boom in sukuk is also mirrored in the Dow Jones Citigroup Sukuk Index. “When we launched the first global, rated, U.S. dollar-denominated sukuk index in 2006, there were only 11 sukuk issues in the index,” Al-Rifai said. “Our Dow Jones Sukuk Index has since then become the leading benchmark in the world and includes 31 sukuk issues as of today. While still small on a global scale, the sukuk market continues to grow at a rapid pace.”
Nevertheless, the index family also reveals a tenacious deficit in Islamic capital markets. “Islamic countries currently have a weighting of only 1.3 percent in the DJIM World Index and there are several reasons for this. First, the largest stock market in the Middle East, Saudi Arabia, is not included in the index because it is not investible by foreign investors.”
“Second, countries with small market capitalizations, such as Pakistan and Lebanon, are dropping off because of their size. Third, it is important to note that many other Islamic countries do not have stock exchanges or do not allow foreign investors,” said Al-Rifai.
Such indications of isolation in times of growing interconnected markets prove that the Islamic finance industry, albeit celebrating an impressive comeback this year, is only in the first stage of becoming a mature market with culture for investing in the Muslim world.
( (Xinhua 08 Oct 2012)

--- Alfalah Consulting - Kuala Lumpur: Consultant-Speaker-Motivator: Islamic Investment Malaysia:

Can Islamic finance provide salvation for the banking sector

Islamic finance has grown and expanded rapidly in recent years. It was recently announced that, following in the footsteps of some of its European neighbours, Germany will soon have its first Islamic bank — which is ironic if you think about the history of the country. Ireland, a country of arguably staunch Catholics, is also making a bid to be a global hub for Islamic finance.
The global growth of Islamic finance in recent years is, in part, a response to the demand for a more ethical financial system. But is Islamic finance just an ethical “spin” on “conventional” finance? Or can it offer more tangible solutions beyond the Muslim community?
What is Islamic finance?
Just like ethical investment in the standard financial sector, Islamic finance prohibits the use of funds for certain purposes. For example, no investment in activities that deal with alcohol, pornography, gambling and so forth.
The basis for Islamic finance’s code of ethics comes from religious texts and is less arbitrary than secular ethical investment. Admittedly, these texts have to be interpreted, and this can lead to vigorous debates and disagreements. But compared to standard ethical investment, the religious texts serve as a relatively more permanent anchor to guide behaviour.
Islamic finance goes much further than standard ethical investment. Not only does Islamic finance prohibit funding for “unethical” activities, it also bans transactions where people share risks and uncertainty in a disproportionate manner. This is why the use of interest is prohibited.
As you know, if you borrow money from a “standard” bank to run a business, the bank is guaranteed a return (the interest) while you, the borrower, will bear all the risks of making or losing money from the business operation. Islamic finance prohibits such arrangements. Instead of an interest-based banking system, Islamic finance prefers a system where profits and losses are shared. So, instead of lending money in return for interest payments, Islamic banks would lend money in return for an eventual share of the profits or loss generated from the business.
No speculation
The standard financial system permits speculative activity. In fact, this is encouraged as a way to keep the market “efficient”. Unfortunately, speculative activity can also have unwelcome effects, such as when financial bubbles are created and then burst.
Unlike the standard financial system, Islamic finance prohibits financial transactions that involve speculation. According to Islamic texts, financial transactions must have a clear link to an underlying “real” activity. So, you can buy and sell financial assets if you have a genuine interest in its underlying value, not because you want to gamble on changes in its price. [See the paper (paywalled) by Shahnaz and Tony Naughton for a clear and detailed discussion on this point.]
As such, Islamic finance is about more than just ethical investment. It challenges the increasing “gap” that has emerged since the 1990s between the financial sector and what economists call the “real” economy: the part of the economy that is concerned with producing goods and services, as opposed to the financial sector which is less tangible. It seeks to take us back to the days when the role of the financial sector was to serve the “real” economy.
In emphasising the need for financial transactions to have a link to a “real” activity, Islamic finance limits the amount of debt in the system, creates fewer opportunities for speculation and, as a result, minimises the chances of the financial system becoming unstable. Islamic finance would have prohibited the type of products that contributed to instability in the American financial system in 2007.
By prohibiting the use of interest while encouraging the sharing of profit and loss, the approach adopted by Islamic finance will shift some of the risks shouldered by consumers on to financial institutions. Supporters of Islamic finance argue that it offers a safer and more equitable approach to the organisation of finance than the standard system.
A way to a more equitable financial system?
In practice, Islamic finance has so far not been able to perfectly follow what it preaches. Even though interest is prohibited and banks should share in profits and losses, Islamic banks tend to intentionally structure the products they sell so that they achieve outcomes that are very similar to interest-based products. As a result, Islamic financial institutions get more certain outcomes instead of bearing the risks profit and loss-sharing arrangements.
Until now, supporters of Islamic finance have argued that these choices have been necessary in order to compete with the “standard” sector, and that they would be abandoned once Islamic finance becomes more established and sophisticated. But, in mimicking the “standard” financial sector, Islamic finance risks betraying its roots. Such an approach undermines its claims to offer an important and substantially different system.
Despite these criticisms, Islamic finance can still reframe the debate about the role of the financial sector in modern society. It forces us to question our current relationship with finance: should finance be used for speculation, or should it only be used to fund “real” activities?
Given the global financial crisis and the debate about reforming financial sectors, the approach of Islamic finance offers us one way to think about how the financial sector might be reformed to better serve society’s needs.

( The Conversation / 09 Oct 2012)

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