The growth of Islamic banking

Africasia:Islamic banking is steadily moving into the mainstream of conventional financial systems and has remained largely insulated from the global credit crisis.

It is expanding not only in the Muslim world, but also in other countries where Muslims are a minority, notably Britain, France, the US and even Japan. The industry has grown at a prodigious rate of 15-20% annually over the past decade; a trend that is likely to continue as the economic and construction boom in the Middle East and Asia regions will boost the value of Shariah assets.

There are now over 300 Islamic financial institutions (IFIs) spread over 75 countries and 300 Shariah-complaint mutual funds, whereas, just one Egyptian-based Islamic bank existed in 1975.

Currently, about $800bn is deposited in Islamic banks, mutual funds, insurance schemes and Islamic branches (windows) of conventional banks. By contrast, the market was valued at only $140bn in 2000. McKinsey & Co, the business consultants, estimates Islamic financial assets could reach $1 trillion by 2010.

Moody’s Investors Service, the ratings agency, is very bullish, predicting that a relatively young industry could boast worldwide assets of $4 trillion within five years. It notes: “Oil is creating liquidity and wealth through profits for companies and salaries for individuals. This finds its way through to the banks, whether it is in Shariah-compliant personal loans or from investors wanting to buy Sukuk bonds. A booming and profitable market attracts entrants because excess demand needs to meet additional supply.”

The US led sub-prime fiasco that wiped billions off balance sheets of western giants, or worse, the liquidation of Lehman Brothers, the fourth-largest US investment bank, underpins the benefits of Shariah law, which bans the trading of ‘toxic’ debt contracts and profit-sharing or leasing without underlying tangible assets. Those fashionable investment bandwagons, such as Collateralised Debt Obligations (CDOs), Asset-backed Securities Index - an index of credit default swaps referencing 20 bonds collateralised by sub-prime mortgages.

Leveraged bank loans (rated below investment grade) and Swaptions (options on interest rate swaps) are strictly forbidden, while lending must be prudent and linked to real economic activity. Thus, Islamic businesses offer a safety net against dubious or junk structured securities, which have triggered market turmoil since late 2007.

Of all the rapidly growing Shariah-compliant products none are gaining in popularity as much as Sukuk. The market for Islamic bonds has swelled in the past six years. According to the Islamic Finance Information Service (IFIS), over $43bn of Sukuks were issued in 177 deals last year. That total compares with $27.39bn in 2006 and $5.71bn in 2003. The bulk of Shariah securities originated in Asia (specifically Malaysia) and the Gulf Cooperation Council (GCC) states.

Savings and souls

The Economist :Muslims have a lot of money to invest. But it is a constant struggle to reconcile faith and finance

TO SEE Islamic finance in action, visit the mutating coastline of the Gulf. Diggers claw sand out of the sea off Manama, Bahrain’s capital, for a series of waterfront developments that are part-funded by Islamic instruments. To the east, Nakheel, a developer that issued the world’s largest Islamic bond (or sukuk) in 2006, is using the money to reorganise the shoreline of Dubai into a mosaic of man-made islands.

Finance is undertaking some Islamic construction of its own. Islamic banks are opening their doors across the Gulf and a new platform for sharia-compliant hedge funds has attracted names such as BlackRock. Western law firms and banks, always quick to sniff out new business, are beefing up their Islamic-finance teams.

Governments are taking notice too. In July Indonesia, the most populous Muslim country, said it would issue the nation’s first sukuk. The British government, which covets a position as the West’s leading centre for Islamic finance, is also edging towards issuing a short-term sovereign sukuk. France has begun its own charm offensive aimed at Islamic investors.

Set against ailing Western markets such vigour looks impressive. The oil-fuelled liquidity that has pumped up Middle Eastern sovereign-wealth funds is also buoying demand for Islamic finance. Compared with the ethics of some American subprime lending, Islamic finance seems virtuous as well as vigorous. It frowns on speculation and applauds risk-sharing, even if some wonder whether the industry is really doing anything more than mimicking conventional finance and, more profoundly, if it is strictly necessary under Islam (see article).

Sukuks in the souk

As the buzz around the industry grows, so do expectations. The amount of Islamic assets under management stands at around $700 billion, according to the Islamic Financial Services Board, an industry body. Standard & Poor’s, a rating agency, thinks that the industry could control $4 trillion of assets.

Others go further, pointing out that Muslims account for 20% of the world’s population, but Islamic finance for less than 1% of its financial instruments—that gap, they say, represents a big opportunity. With tongue partly in cheek, some say that Islamic finance should by rights displace conventional finance altogether. Western finance cannot service capital that wants to find a sharia-compliant home; but Islamic finance can satisfy everyone.

Confidence is one thing, hyperbole another. The industry remains minute on many measures: its total assets roughly match those of Lloyds TSB, Britain’s fifth-largest bank (though some firms that meet sharia-compliant criteria may attract Islamic investors without realising it). The assets managed by Islamic rules are growing at 10-15% annually—not to be sniffed at, but underwhelming for an industry that attracts so much attention. Most of all, the industry’s expansion is tempered by its need to address the tensions between its two purposes: to serve God and to make as much money as it can.

That is a stiff test. A few devout Muslims, many of them in Saudi Arabia, will pay what Paul Homsy of Crescent Asset Management calls a “piety premium” to satisfy sharia. But research into the investment preferences of Muslims shows that most of them want products that benefit their savings, as well as their souls—rather as ethical investors in the West want funds that do no harm, but are also at least as profitable as other investments.

A combination of ingenuity and persistence has enabled Islamic finance to conquer some of the main obstacles. Take transaction costs which tend to be higher in complex Islamic instruments than in more straightforward conventional ones. Sharia-compliant mortgages are typically structured so that the lender itself buys the property and then leases it out to the borrower at a price that combines a rental charge and a capital payment.

At the end of the mortgage term, when the price of the property has been fully repaid, the house is transferred to the borrower. That additional complexity does not just add to the direct costs of the transaction, but can also fall foul of legal hurdles. Since the property changes hands twice in the transaction, an Islamic mortgage is theoretically liable to double stamp duty. Britain ironed out this kink in 2003 but it remains one of the few countries to have done so.

However, just as in conventional finance, as more transactions take place the economies of scale mean that the cost of each one rapidly falls. Financiers can recycle documentation rather than drawing it up from scratch. The contracts they now use for sharia-compliant mortgages in America draw on templates originally drafted at great cost for aircraft leases.

Islamic financiers can also streamline their processes. When Barclays Capital and Shariah Capital, a consultancy, developed the new hedge-fund platform, they had to screen the funds’ portfolios to make sure that the shares they pick are sharia-compliant. That sounds as if it should be an additional cost, but prime brokers already screen hedge funds to make sure that risk concentrations do not build up. The checks they make for their Islamic hedge funds can piggyback on the checks they make for their conventional hedge funds.

Mohammed Amin of PricewaterhouseCoopers, a consulting firm, says the extra transaction costs for a commonly used Islamic financing instrument, called commodity murabaha, total about $50 for every $1m of business. That is small enough to be recouped through efficiencies in other areas, or to be absorbed in lenders’ profit margins. In addition, bankers privately admit that less competition helps keep margins higher than in conventional finance. “Conceptually, Islamic finance should cost more, as it involves more transactions,” says Mr Amin. “The actual cost is tiny and can be lost in the wash.”

The other area of substantive development has been in redefining sharia-compliance. New products require scholars to cast sharia in fresh, and occasionally uncomfortable, directions. Some investors express surprise at the very idea of Islamic hedge funds, for example, because of prohibitions in sharia on selling something that an investor does not actually own.

“You encounter a wall of scepticism whenever you do something new,” says Eric Meyer of Shariah Capital. “It is no different in Islamic finance.” He says that it took eight long years to bring his idea of an Islamic hedge-fund platform to fruition, applying a technique called arboon to ensure that investors, in effect, take an equity position in shares before they sell them short. Industry insiders describe an iterative process, in which scholars, lawyers and bankers work together to understand new instruments and adapt them to the requirements of sharia.

Differences in interpretation of sharia between countries can still hinder the economies of scale. Moreover, the scholars can sometimes push back. Earlier this year, the chairman of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), an industry body, excited controversy by criticising a common form of sukuk issuance that guarantees the price at which the issuer will buy back the asset underpinning the transaction, thereby enabling investors’ capital to be repaid. Such behaviour contravened an AAOIFI standard demanding that assets be bought back at market prices, in line with the sharia principle of risk-sharing. The sukuk market has enjoyed years of rapid growth (see chart), but early signs are that the AAOIFI judgment has dented demand.

Although Islamic finance has done well to reduce its costs and broaden its product range, it has yet to clear plenty of other hurdles. Scholars are the industry’s central figures, but recognised ones are in short supply. A small cadre of 15-20 scholars repeatedly crops up on the boards of Islamic banks that do international business. That partly reflects the role, which demands a knowledge of Islamic law and Western finance, as well as fluency in Arabic and English. It also reflects the comfort that this handful of recognised names brings to investors and customers.

There are plenty of initiatives to nurture more scholars but for the moment, the stars are pressed for time. That can be a problem when banks are chasing their verdict on bespoke transactions. It takes a scholar about a day to wade through the documentation connected with a sukuk issue, for example. But scholars are not always immediately available. “You’ve got to have the scholar’s number programmed into your mobile phone and be able to get hold of them,” says a banker in the Gulf. “That is real competitive advantage.”

Assets are another bottleneck. The ban on speculation means that Islamic transactions must be based on tangible assets, such as commodities, buildings or land. Observers say that exotic derivatives in intangibles such as weather or terrorism risk could not have an Islamic equivalent. But in the Middle East, at least, the supply of assets is limited. “Lots of companies in the Gulf are young and don’t have assets such as buildings to use in transactions,” says Geert Bossuyt of Deutsche Bank. This limits the scope for securitisation, a modern financing technique that is backed by assets and is thus seen by sharia scholars as authentically Islamic. There are not enough properties to bundle into securities.

Governments have more assets to play with. The Indonesians have approved the use of up to $2 billion of property owned by the finance ministry in their planned sukuk issuance later this year. But oil-rich governments in the Gulf have little need to issue debt when they are flush with cash. That is a problem. Sovereign debt would establish benchmarks off which other issues can be priced. It would also add to the depth of the market, which would help solve another difficulty: liquidity.

It may seem odd to worry about liquidity when lots of Muslim countries are flush with cash, but many in Islamic finance put liquidity at the top of their watchlist. The chief concern is the mismatch between the duration of banks’ liabilities and their assets. The banks struggle to raise long-term debt. In a youthful industry, their credit histories are often limited; they also lack the sort of inventory of assets that corporate sukuk issuers have.

Desert liquidity

As a result, Islamic banks depend on short-term deposit funding, which, as Western banks know all too well, can disappear very rapidly. “Lots of assets are generally of longer term than most deposits,” says Khairul Nizam of AAOIFI. “Banks have to manage this funding gap carefully.” If there were a liquidity freeze like the one that struck Western banks a year ago, insiders say that the damage among Islamic banks would be greater.

There are initiatives to develop a sharia-compliant repo market but for the time being the banks have only limited scope for getting hold of money fast. Loans and investments roll over slowly. The lack of sharia-compliant assets and a tendency for Islamic investors to buy and hold their investments have stunted the secondary market. The shortest-term money-management instruments available today are inflexible. Cash reserves are high, but inefficient.

Western banks with Islamic finance units, or “windows”, are just as troubled by tight liquidity as purely Islamic institutions are: their sharia-compliant status requires them to hold assets and raise funds separately from their parent banks.

There are other sources of danger, too. Because Islamic banks face constraints on the availability and type of instruments they can invest in, their balance-sheets may concentrate risk more than those of conventional banks do. The industry’s ability to steer its way through stormy waters is largely untested, although Malaysian banks do have memories of the Asian financial crisis in the 1990s to draw on.

None of these tensions need derail the growth of Islamic finance just yet. There is plenty of demand, whether from oil-rich investors, the faithful Muslim minorities in Western countries or the emerging middle classes in Muslim ones. There is lots of supply, in the form of infrastructure projects that need to be financed, Western borrowers looking for capital and ambitious rulers eager to set up their own Islamic-finance hubs. The industry is innovative; new products keep expanding the range of sharia-compliant instruments. And as in conventional finance, the economics of the Islamic kind improve as it gains scale.

But further growth itself contains a threat. The AAOIFI ruling on sukuk earlier this year neatly captured the contradictory pressures on the industry. On the one hand, bankers are worried that the narrow enforcement of sharia standards is liable to stifle growth; on the other some observers fear that Islamic finance is becoming so keen to drum up business that its products, with all their ingenuity, are designed to evade strict sharia standards. This presents a dilemma.

If the industry introduces too many new products, cynics will argue that sharia is being twisted for economic ends—the scholars are being paid for their services, after all. But if it fails to innovate, the industry may look too medieval to play a full part in modern finance.

Balancing these imperatives will become even harder as competition grows fiercer. Anouar Hassoune of Moody’s, a credit-rating agency, believes that unscrupulous newcomers could harm the reputation of the entire industry, “like the space shuttle undone by something the size of a 50 cent coin”. Islamic finance serves two masters: faith and economics. The success of the industry depends on satisfying both, even if the price of that is a bit more inefficiency and a bit less growth.

Islamic Banking in Numbers

Asharq Al-Awsat - Today Islamic banking is in its golden age since it is attracting the attention of some of the largest financial consultants, law firms and research and publishing institutions that frequently issue reports on the developments taking place in the industry. These include McKinsey & Company’s report on competition in Islamic banking, reports by Moody’s and Standard & Poor’s, which are amongst the most reputable credit rating institutions in the world as well as analyses by Bloomberg and the Financial Times.

The reason that Islamic banking is receiving so much attention is due to its increasing activity; the estimated number of Islamic banks around the world has reached 396 throughout 53 countries and the estimated volume of funds within the Islamic banking sector stands at US $442 billion, according to a report by the General Council for Islamic Banks and Financial Institutions [GCIBFI] in 2008.

The truth is that these figures, similar to what is mentioned in Moody’s report, indicate that the volume of funds managed by the Islamic banking industry stands at approximately US $700 billion globally with an average annual growth rate of 15 per cent.

According to the Moody’s report, sukuk is considered the fastest growing Islamic banking product and is estimated to increase annually at an average of 35 per cent. By the end of 2007, the volume of Islamic bonds reached US $97.3 billion, 26 per cent of which account for the issuance of sovereign sukuk whilst the remainder were issued by corporates. According to Standard & Poor’s, between 20 and 25 percent of all sukuk around the world are available for circulation in secondary markets.

The Moody’s report observed that the Arab Gulf states have become key players in the sukuk market and the total issuance of sukuk in 2007 was estimated at US$19 billion; 58 per cent of which came from the UAE, 30 per cent from Saudi Arabia, and the remainder from Kuwait, Bahrain and Qatar.

There has been an increase in investment funds in Islamic banking at an average annual growth of 22% with an estimated 700 Islamic investment funds around the world.

With regards to takaful insurance, in 2007, its premiums reached close to US $2.5 billion and are expected to reach $7.4 billion by 2015. Ninety percent of the takaful insurance market is in Malaysia, whilst the Kingdom of Saudi Arabia is expected to become more active in this field in light of new organization of the insurance sector.

Speaking of Saudi Arabia, I read a report on Islamic banking in Saudi that stated that the rate of Islamic finance in Saudi banks is estimated at 58 per cent of financial banking whilst the rate of Islamic investment funds stands at 77 per cent of all assets of investment funds. It is estimated that out of all active bank branches, 75 per cent are Islamic branches.

The growth of Islamic finance in Saudi Arabia over the last seven years is estimated at 430% and continues to increase since all banks in the Saudi market are seeking to provide Islamic banking services in order to stay in the race as many people see that there is no room for those who do not offer Islamic banking products.

Islamic finance growing, says UK bank chief

LONDON • Stable and conservative Islamic finance is attracting investors scared off by the global credit crisis, the chief executive of new UK Islamic bank Gatehouse said.

Islamic assets total around $1 trillion, the Asian Development Bank estimates, with annual growth of 10 to 15 percent a year.

Islamic bonds, or sukuk, are structured as profit-sharing or rental agreements which are underpinned by physical assets.

Islamic finance, which bans the payment of interest and restricts the use of some derivative instruments, has been growing rapidly in the past few years. The lack of exposure to some of the riskier markets of which investors have fallen foul in the past year makes Islamic finance attractive, and not just to those investors requiring Islamic Shariah-compliant transactions, Gatehouse CEO David Testa told Reuters in an interview.

“It’s actually quite old-fashioned banking. It’s asset-backed and asset-based, it’s not the infinitely leveraged model. It’s a good story in these stricken times.”

Gatehouse, a subsidiary of the Securities House of Kuwait, started operating in April and says it is the fifth Islamic bank to open in the UK, which market participants say has taken the lead in Europe in welcoming Islamic banking.

The bank has paid-in capital of £50m so far, and authorised capital of £225m.

It has a staff of 30, with plans to reach close to 40 by the end of the year, and has a global reach, Testa said, concentrating on capital markets, private equity, wealth management and real estate deals.

Testa, who joined the bank after 10 years with WestLB as executive director in its capital markets group, said Gatehouse would look for a public listing by 2012.

Gatehouse is targeting Islamic borrowers in the Gulf looking to raise money internationally, international borrowers tapping into Gulf investors, and Gulf investors looking to make acquisitions outside the local region.

There is also interest in Islamic finance from the UK, the United States and Europe including Turkey, as well as the Gulf, Testa said.

“Growth is coming out of a booming emerging market in the Gulf and very strong Southeast Asian markets. The opportunities are tremendous.”

Nearly two-thirds of the $100 billion worldwide sukuk market is based in Malaysia where the industry first took off.

But Testa said Malaysian sukuk deals were largely denominated in Malaysian ringgit and the global credit crisis, resulting in a weak dollar, had dented demand for hard currency sukuk deals. “At the moment, the appetite for sukuk instruments is very much for local currency.”

The sukuk market is encountering further difficulties after a major scholar last year said 85 percent of sukuk were not really Islamic, which caused many issuers to hold off debt sales.

Market participants are hoping for government sukuk issues to attract more international interest for sukuk from both borrowers and investors and to breathe life into the relatively illiquid secondary market.

Britain intends to issue its own sovereign sukuk debt in a rolling programme worth around 2 billion pounds, although it has said legal barriers still remain and a final decision will be made later in the year.

Japan, Thailand, Hong Kong and Singapore have also expressed interest in issuing sukuk.

“It is always helpful if we see government sukuk issuers come into the market. They are very eye-catching and bring some new investors in,” Gatehouse’s head of capital markets Anthony Saint said.

Centres fight for Islamic finance as oil booms

Reuters -- From Africa to Paris to Britain's former industrial heartland, Islamic law-compliant investment products are springing into existence as financial centres try to compete for a slice of the Middle East's colossal new oil revenues.

With conventional sources of cash depleted by the credit crunch and fears of recession around the developed world -- and with high oil and food prices limiting growth -- oil-rich Gulf markets are one of the few reliable sources of finance.
With dollar crude prices soaring to almost double their level of a year ago -- and Western financial woes seen deepening -- a new intensity has gripped Islamic finance growth.

Estimates of the total size of assets held under Islamic finance rules vary, but the Asian Development Bank estimates it at around $1 trillion, with growth of 10 to 15 percent a year.It is no surprise then that cities with substantial Muslim populations and connections as diverse as Singapore and Hong Kong, London and Birmingham and even Paris are vying to act as key centres of expertise in the new boom.

"The French have lagged the British...but recently the French government signalled a change in attitude," ratings agency Standard & Poor's said this week."By preparing the ground for Islamic finance, France can help financial innovation and benefit from the deep pockets of Middle Eastern investors as liquidity has dried up elsewhere in the global financial markets."

It is unclear to what extent, if at all, the vast sovereign wealth funds being built up by Gulf oil produces might be managed under the strictest principles of Islamic law, which prohibits the use of interest -- and therefore investment in conventional banks, alcohol or pornography producers.But more and more takers have been coming forward with products to target those who demand sharia products.

In June, investment bank Investec announced a partnership with a Saudi investment provider to produce the first sharia-compliant fund targeting Africa. Other funds are following.For now, two thirds of the worldwide Islamic sukuk bond market -- an estimated $100 billion -- is based in Malaysia where the industry first took off.

LONDON BOOMS

Singapore and Hong Kong are growing as are the emerging Gulf financial centres, where around a quarter of all banking is estimated to be managed according to sharia principles.

Outside Asia and the Middle East, Britain -- and London in particular -- is seen as by far the leader, with the London secondary sukuk market -- trading Islamic debt mainly issued by Asian and Middle Eastern firms -- worth some $6.5 billion.
"The UK government has done a far greater amount than any other Western government to aid Islamic finance," David Testa, chief executive of new UK Islamic bank Gatehouse said.

But other potential rivals are seen emerging.

"London might be the world's leading international financial centre -- but there are plenty of other cities that would like to be, or at least would like to take some of our business," said Britain's Economic Secretary to the Treasury Kitty Usher at the World Islamic Banking Conference in London earlier in the month.

"And that is as true in Islamic finance as it is in any other sector."
Partly as a result, Britain intends to issue its own sovereign sukuk debt in a rolling programme worth around 2 billion pounds -- although it said legal barriers still remained and a final decision would be made later in the year.

"LIKE SILICON VALLEY"

Britain's Treasury hopes that, if issued, a British sovereign sukuk would provide a benchmark to base other local products off. It has also moved to help standardise qualifications and training.But S&P says France looks to already be trying to close the gap with Britain, looking to reform its financial laws to allow easier issuance of Islamic financial instruments.

Regulatory and legal hurdles have dogged several countries trying to move into Islamic finance.Thailand had planned to issue its first $500 million Islamic sovereign bond this year but scrapped the plan because more preparation was needed
But it intends to push ahead with Islamic bonds from state enterprises such as the airline and power utility.

Britain's second largest city and one-time industrial centre Birmingham, home to a quarter of a million Muslims as well as the European Union's first stand-alone Islamic retail bank, is eagerly rebranding itself as a key European Centre for retail Islamic finance, targeting mainly local Muslims.

"It's like in America's Silicon Valley -- you will get clusters of expertise in certain areas," said Stephen Amos, spokesman for the Islamic Bank of Britain, which holds $256 million and is based on the outskirts of the city.
"The two areas of expertise are always going to be London... and hopefully Birmingham.

Western interest in Islamic banking is going beyond simply trying to attract wealthy Islamic investors. In the Gulf itself, Western institutions are emerging as the main buyers of Islamic instruments, keen to access the growth of Gulf firms.
Law firm Trowers and Hamlins said Islamic compliant sukuk bond issuance in the Gulf jumped 17 percent to a record $17 billion, increasing more than 20-fold over the last five years. Western investors made up 60 percent of the buyers.

New GCC Islamic banks target global growth

The increasing appeal of Islamic banking has prompted the establishment of sizeable new banks in the Gulf, which could soon head East. Acquisition opportunities in the Middle East are limited, and most of the Gulf countries are heavily banked – more than 50 banks, eight of them Islamic, compete for customers in the UAE.
This means that the new Islamic banks being established there are looking to Muslim countries abroad for much of their growth. So far, Kuwait Finance House and Saudi Arabia’s Al Rajhi Bank are the only Islamic banks in the Gulf to have built up a substantial presence in Asia, but that could be about to change.

Hussain Al Qemzi, group CEO of Dubai’s Noor Islamic Bank, which launched in January this year and is majority-owned by the government, says it aims to be the world’s largest Islamic bank within five years. Overtaking Bank Melli Iran, which has Shariah compliant assets of $35.5 billion, will require rapid expansion, so it is largely concentrating on acquisitions.

In addition to a network of branches in the UAE, Noor has opened a representative office in Tunisia and formed a bank in the Maldives in joint venture with the country’s government and an affiliate of the Islamic Development Bank. It aims to have a presence in three continents – Asia, Africa and Europe – and Al Qemzi says the bank is considering three acquisitions in Asia.

“Our timeframe is to sign at least one or two of them by the end of the year,” says Al Qemzi. “Two of them are Islamic banks and one is conventional, so we would have to work around converting it.” Al Qemzi also hints that Noor could move its IT operations from Dubai to a lower-cost location in Asia in the future.

Noor is competing for local market share with fellow newcomer Al Hilal Bank, which launched in June this year. Backed by the Abu Dhabi government, Al Hilal started life with $1.1 billion in capital, compared to Noor’s $1 billion, and is placing more focus on the domestic market.

“Our strategy for expansion is first to develop our banking model and entrench it into the local market,” says Al Hilal CEO Mohamed Jamil Berro. “That’s the priority for us.”

Al Hilal has a branch model which Berro believes is unique: customers will walk into a financial mall, segmented by demographics. There will be special branches with lower counters for children, areas for small business owners, as well as coffee shops and exhibitions of Islamic art. From Ramadan this year in September there will be car showrooms, where customers will be able to finance, register and insure their purchases before driving them out of the bank. Each customer will also be able to choose his own account number.

Berro is confident this model can be applied in other countries, but will not name his likely target markets, other than: “The world, in theory.” He says Al Hilal will begin planning its overseas expansion next year, and aims to be one of the top three banks in the region within five years. This year will be spent launching its takaful and real estate development subsidiaries.

Al Hilal’s model appears to be targeted at high-value customers, but Berro says that, as a universal bank, it has products for everyone.

Noor has launched an initiative specifically targeting low income customers. It has signed a memorandum of understanding with Emirates Post Authority which will see it use the post office network to offer banking services. Al Qemzi says he aims to reach the 50% of the UAE population that is currently unbanked.

“I think if this is a good model we might use the techniques learned from it in Asia, for example, or Africa,” says Al Qemzi. He aims to open at least two branches of the post office bank in the UAE this year.

Within the GCC, there are other large Islamic banks emerging. Masraf Al Rayan launched in Qatar in 2006 with capital of $2 billion, and has since opened a consumer finance unit in Saudi Arabia and a representative office in Libya.

Little is known about Alinma Bank, which is part-owned by the government of Saudi Arabia and held the Middle East’s second-largest IPO in June this year, but its $4 billion in capital should enable it to build a large presence. In Bahrain, Ummar Bank, backed by the head of the Albaraka banking group and other Gulf investors, is expected to launch next year with $11 billion of start-up capital.

Al Hilal’s Berro says that the public appetite for Islamic finance is growing so rapidly that there will be a large enough market for all of these banks.

“Any new Islamic bank on the market has a strong potential to grow,” says a Middle East-based banking analyst. “International expansion into Islamic banking in Asia, the Middle East and North Africa could be an interesting play.”

With powerful shareholders and no shortage of liquidity, one or two of these banks could become a global name in Islamic banking. Their combined entry to the market could also show whether the growth in demand for Shariah compliant finance shows any signs of slowing.

Islamic funds outperform conventional ones in 2007

Shariah-compliant investment funds outperformed conventional ones last year and totalled more than $19 billion (Dh70bn) in assets.

The Dow Jones Islamic Market (DJIM) World Index, for example, recorded a gain of 17.2 per cent in the third quarter of 2007 compared to DJIM US which rose by 15 per cent.

Islamic funds have escaped the worst of the economic turmoil that has left Western banks reeling from the credit crunch, high write-downs for bad debt, falling market valuations and bad decision-making.

That is because investing in banks is not considered halal under Shariah principles and is therefore largely prohibited.

“Overall Islamic funds have outperformed the conventional funds in 2007,” Mark Smyth, managing director of research firm Failaka, told Emirates Business.

“The Islamic fund market has tripled in size over the past five years with much of the growth coming from Gulf investors and directed towards funds investing in the GCC markets.

“More than 50 per cent of the funds are invested in the GCC, about 30 per cent are in Asia – primarily Malaysia – and the rest are sprinkled in the US and Europe.

“Funds investing in the GCC markets represent over half the entire Islamic equity fund industry. This is where the growth in the industry has come from. Five years ago there were only a few funds investing in the GCC but today there are more than 50."
Smyth said the numbers still told a relatively small story as Islamic funds were equal to less than one per cent of the total value of the world’s conventional investment funds.

“But the growth has been steady and gradual both in the number of funds and the amount of assets,” he added.Investment funds form only a part of the whole Islamic financial market, which has grown dramatically in recent years.

Uae And Saudi Firms Shine At Failaka Awards

Firms from the UAE and Saudi Arabia dominated the third Failaka Islamic Fund Awards held in Dubai last night.

The awards, presented for the best performance or the most noteworthy achievement, have been coveted by financial institutions and their fund managers as a high-water mark in their careers.

Out of the 21 categories, five firms from Saudi and four from the UAE went home with the laurels. This year’s awards saw the addition of new categories that include a one-year, three-year and in some cases a five-year performance award.

“This is a reflection of the increasing transparency and availability of information from fund managers and thus a reflection on the growth of the market generally,” a Failaka spokesman said.

The award for Best Islamic Fund Manager in the GCC was awarded to NCB Capital of Bahrain, while the title for the United States and Asia regions were awarded to Saturna Capital of the US and Public Mutual – Malaysia, respectively.

Islamic banks post 26.7% growth rate

The world’s 100 largest Islamic banks have outpaced conventional banks with an annual asset growth rate of 26.7 per cent, according to a new study.

The Islamic institutions reported a growth to nearly $350 billion (Dh1.28 trillion) in assets, beating the 19.3 per cent growth rate of mainstream banks, says the Asian Banker research group.

This growth rate is well above previous estimates of 15 to 20 per cent.“We’ve seen a rise in the number and size of Islamic banks across the world and they are growing popular in non-Muslim countries as well,” Asian Banker research manager Benny Zhang Wei told Emirates Business.

“I do not expect any slowdown in growth in the long term. There is enormous wealth coming from oil and gas in the Middle East and 1.5 billion Muslims worldwide make a good customer base.”

Dr Taha El Tayeb – who heads Mashreq’s Islamic banking division, Badr Al Islami, in the UAE – is a little cautious about the reported growth rate. “I’m a little surprised by the 26 per cent figure because I thought it was about 20 per cent,” he told Emirates Business.

“I believe this growth rate is sustainable in the short term but it may come down owing to the growing base of Islamic banking. Overall the prospects seem bright as a large number of corporates and family businesses in the region are moving to Islamic banking for religious reasons,” he added.

Zhang Wei said: “The potential [of Islamic banks] to eat into a conventional bank’s business model is huge and should not be underestimated. The threat will only get worse as Islamic banks grow organically or as a result of intensive mergers and acquisitions.”

Islamic banks’ expansion plans are paying off. The most successful international Islamic banking player, Albaraka Banking Group of Bahrain, is a good example. It has 11 Islamic banking licences in 10countries in the Middle East, North Africa, South Asia and Europe.

Albaraka sources more than 90 per cent of its revenue from overseas – a ratio even higher than Citi’s, said Zhang Wei.
An analyst at Standard & Poor’s in Singapore believes that Islamic finance has reached a critical mass and the level of interest means it makes sense to reach out beyond the predominantly Muslim countries.

Asia is a lucrative market for Islamic banks. According to Merrill Lynch and Capgemini the total wealth of high-net-worth individuals in the Asia-Pacific region may grow by 8.5 per cent a year to $12.7trn by 2011, the second-fastest increase after the Middle East, making it highly lucrative for Islamic banks.

Islamic banks are performing well in financial centres such as Singapore and London where they are trying to earn oil and gas dollars by encouraging the handling of cross-border financial deals through Shariah-compliant instruments.

But despite the impressive growth of Islamic banking in recent years it remains a niche segment in the global financial services industry. The largest company in the Asian Banker’s list of the top-100 Islamic banks is Iran’s state-owned BMI, which has total assets of $39.4bn.

This is equivalent to the size of Chang Hwa Bank in Taiwan, the 75th largest bank in the Asia-Pacific region and 395th in the world, said the report.

In Malaysia, where the number of Islamic banking players has almost doubled and their aggregate size has more than tripled in the last two years, Islamic banks account for only 5.2 per cent of the country’s banking assets.

Even if Islamic banking services offered by conventional Malaysian banks were included, the percentage of financial intermediations handled in a Shariah-compliant manner would not exceed 10 per cent.

And even in more developed Islamic banking systems such as the UAE, Bahrain, Saudi Arabia and Kuwait, intermediation through an Islamic bank or Islamic windows of a conventional bank accounts for less than 50 per cent of the total, said the report.

The Middle East is a major player in Islamic banking. Of the top-100 Islamic banks worldwide, Iran dominates with 14 players, followed by Saudi Arabia, Malaysia and the UAE.

Top-ranked BMI and the other 13 Iranian state-owned and privately managed banks in the list hold aggregate assets of $162.2bn, accounting for nearly 50 per cent of the world’s 100 largest Islamic banks’ assets. Saudi Arabia’s Al Rajhi Bank is in second place.

The story of Islamic banks in Iran differs from other countries as most banks there are state-owned. Government efforts to transform all financial institutions into Islamic ones drove the intense growth of Iran’s Islamic banking system.

Banks were nationalised as early as 1979 and regulations changed with the approval of an Islamic banking law. In 1983 the country made a wholesale switch to Shariah-compliant Islamic banking.

Sudan followed a similar policy, adopting Islamic banking practices as early as 1990. Today all banks are Shariah-compliant and despite their small scale, 19 of them figure in the top 100.

Pakistan is a mixed bag as the banking sector still runs on the dual system of both Islamic and conventional practices. The Islamic banking sector is driven by the government but at a relatively slower pace than elsewhere, even though 97 per cent of the population is Muslim.

Saudi Arabia, a big player in Islamic banking, has only three banks in the list that are wholly Shariah-compliant – Al Rajhi, Al Bilad and Al Jazira. With an aggregate 10 per cent of the total assets, they make it to the first quartile of the top 100. As many as eight Saudi commercial banks have begun to make their deposit taking and financing Shariah-compliant.

In the UAE, Dubai Islamic Bank was set up in 1975 to drive the sector’s growth and is in seventh place. Abu Dhabi Islamic Bank is ranked tenth. A lot is expected from Noor Islamic Bank, which was established recently.

With a paid-in capital of $1.09bn, the bank is expected to become the world’s largest Islamic player within five years by acquiring other institutions in countries such as Indonesia and Egypt.

Abu Dhabi plans to launch another Islamic bank, Al Hilal, in June, taking the number of dedicated Islamic banks in the UAE to seven.

“Consolidation could be a possibility,” says Zhang Wei.

Islamic Finance Expands as Wealth Grows in Oil-Rich Gulf

DUBAI, (AFP) - The market for Islamic finance and banking is growing rapidly in the oil-rich Gulf thanks to burgeoning wealth and attractive financial instruments.

Studies have put the total value of Islamic equity funds in the Gulf region at around 30 billion dollars (19.5 billion euros), said Khaled al-Masri, partner in asset management at Dubai-based Rasmala Investments.

"Investable wealth in the Gulf Cooperation Council is growing by one of the highest rates in the world ... This increase is being met with more product providers and products being launched in the GCC market," he said.

The Islamic finance industry worldwide is worth around 700 billion dollars, Moody's Investors Services estimated in a February report.

Economies of the six GCC member states -- Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates -- have been enjoying remarkable growth over the past few years on the back of record oil prices.

The robust economic performance has inflated local wealth in this Muslim region where many might prefer to seek profit through investments that do not contradict their beliefs.

The basic principle of Islamic finance is the prohibition of Riba (usury), which is correlated with interest in today's banking.

Islamic funds are also banned from investing in companies associated with tobacco, alcohol, pornography, pork or gambling, all considered taboo by devout Muslims.

Some 125 Islamic equity funds are based in the GCC out of around 320 globally, said Mark Smyth, UK-based managing director of Failaka Advisors, an Islamic fund research company.

"Increasing familiarity with Islamic products combined with the presence of longer and more established funds seems to be driving the current growth, combined with strong returns," Smyth told AFP.

Islamic finance provides a "solution for investors and consumers who want to adhere to sharia-compliant principles in their investment and consumption decisions," said Masri, referring to principles in line with Islamic law.

He also pointed out that the sukuk (Islamic bonds) have become appealing at the corporate and government levels as a tool to raise finance, which in turn increased the size of the sector.

A report by the US-based Morgan Stanley investment bank published by the local press in February put outstanding issued sukuk at more than 90 billion dollars worldwide.

Moody's report put this figure up at 97.3 billion dollars at the end of 2007, expecting the market of Islamic bonds to hit 200 billion dollars by 2010. It said that the majority of issued sukuks came from Malaysia, which is vying to promote itself as an Islamic finance centre, and the Gulf region.

The UAE had nearly 30 issues of sukuk in 2007 raising about 11 billion dollars, while Saudi Arabia came second with nearly six billion dollars raised with about 15 issues, it said.

"The growth of sukuk as a credible financing tool for regional corporate and state bodies is an important factor" in expanding the Islamic finance market in the GCC, Masri said.

In addition to sukuk, Islamic retail banking is flourishing in the GCC through the launch of full-fledged Islamic banks or the opening of Islamic windows in conventional retail banks.

Noor Islamic bank, which has a market capitalisation of 3.16 billion dollars, according to its chief executive officer Hussein al-Qemzi, was the latest to start operations in Dubai early this year.

"There are more than one and a half billion Muslims around the world, which contributes to the rising demand for banking institutions which offer sharia-compliant services," Qemzi told AFP.

These services include providing finance to consumers to buy assets ranging from cars to houses, through several schemes like lease-to-purchase and profit-sharing plans, which are presented as free of interest charges.

But these Islamic products, which were first sought to help pious Muslims in managing their wealth, are now being used by non-Muslim clients.

"This can particularly be seen in the UAE mortgage market where many of the important providers offer sharia-compliant products that are being consumed by a large expatriate population which is not necessarily a natural consumer of these products," Masri said.

Mortgaged assets in the UAE were valued at 12.6 billion dollars in mid-2007, according to a report by EFG-Hermes investment bank. Housing mortgages amounted to 4.9 billion dollars.

"Investors have strong faith in Islamic alternatives, which proved to be credible, steady and socially responsible, regionally and globally," Qemzi said, explaining the growth in this "lucrative" ma