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Tuesday, 19 February 2008

Instrument in the news: Islamic finance

by Alan Shipman

Islamic banks have weathered the global financial turmoil more effectively than most western counterparts, and Islamic bonds and debt securitisations are rising in popularity while those in Europe and America fall away. UK financial institutions have piled into new forms of sharia-compliant lending, at home and abroad, building a market that could be worth one trillion dollars worldwide by 2010. But sceptics outside the Islamic community say the boom is more to do with Oil than Allah – and some within it are uneasy at the way London and New York based institutions are cashing in.

While Britain’s religious institutions have run into controversy over Sharia law, its financial establishment has few such problems. Creating products that reward the sources of capital fairly, without charging interest, is a task of financial engineering fully compatible with UK financial law. With Muslim countries in South. South-East and Central Asia and the Middle East now among the world’s fastest growing, and over 100,000 Muslim-headed business in the UK, there’s also a growing financial incentive to keep on the right side of Islamic financial law.
Perennial gong-giver Euromoney now includes an 'Islamic finance deal of the year' award, and has just awarded it for 2007 to United Arab Emirates property investment house Tamweel, for the world’s first Sharia-compliant residential mortgage backed securitisation.
The $210m deal was also the first asset-backed securitisation from a Middle Eastern country – and was snapped up by mainly European investors, even as they were fleeing from similar securitisations of mortgage debt from house-buyers in America and Britain. Those countries’ financial institutions have been quick to team up with their Islamic counterparts, and the Chartered Institute of Management Accountants has become the first in the world to offer a Certificate in Islamic Finance. Trade minister Lord Jones last week hailed the City of London as "the premier Western centre and partner of choice for Islamic finance."What it consists ofAmong already-established Islamic financial products already enjoying fast growth, in the Muslim world and further afield:
Islamic banking: At a time when many US banks are having trouble collecting their interest, the economics of banks that don’t charge it are being assessed in a better light. Islamic banking assets were calculated at $750bn (£370bn) worldwide in 2006, and are estimated to have grown another 10-15% last year. McKinsey forecasts they will reach $1,000bn by 2010. Malaysia and other Islamic financial centres say their banks have avoided suffering serious fallout from the American sub-prime borrowing crisis, or creating their own, largely because sharia constrains them to secure loans against real assets and avoid excessive leverage. The belief in sharing risks and rewards across all participants in a venture, something only achieved in western banking relationships after complex and expensive rescheduling battles, is also seen as a source of strength, notably exploited by micro-finance pioneers in Bangladesh. Others say Islamic banks are strong because they’re in economies that have sustained 5-10% growth rates which western counterparts only dream of – but UK lenders that have engaged with the Muslim community, such as Lloyds-TSB, say it’s brought them one of the country’s most dynamic client bases, with a high savings rate and low defaults
Islamic bonds: interest-free bonds (sukuk) have long been issued by governments and state-backed entities on Islamic countries’ exchanges, paying a return which is derived from the asset the funds are invested in. Western investment funds, especially hedge funds, are now tapping into them as a way to access some of the world’s fast-growing economies, avoiding its exchange controls (and, at present, eyeing a further capital gain as oil states’ external surpluses force their exchange rates to rise against the dollar). Worldwide, sukuk issuance rose by 73% to $47.1bn in 2007, according to Euromoney’s Islamic Finance Information Service (IFIS). Ratings agency Moody’s calculates that issuance by Gulf states rose over 30% to $12bn in 2007, overtaking pioneering Malaysia, whose corporate issuance has slowed by where secondary trading in sukuk was worth $25bn last year. From a smaller base, Pakistan was the fastest-growing market last year, according to IFIS. Alistair Darling’s budget on 12 March is expected to include the UK’s first sukuk, to set a benchmark for the City and allow the government to tap into the savings of Britain’s estimated 2.5 million Muslims
Islamic mortgages: Instead of lending to Muslim businesses and families for property purchase, mortgage providers buy the property and re-sell it to them in instalments for a higher price. The UK market could be worth £1bn by 2009, according to forecasts by the Islamic Banking Corporation
Leasing and financing: Large purchases other than property – such as cars and industrial machinery – can also be financed on a similar form of ‘murabaha’, the buyer enjoying immediate use of the asset and gradually paying off its owner, who gets a pre-agreed profit
Ethical investment: Sharia-compliant investment funds must avoid exposure to armaments, alcohol, gambling, pornography, pork production and other Islamically proscribed activities. This is attractive to some of the same investors who have recently promoted the fast growth of ethical funds in Europe and America, which steer clear of products that injure personal or planetary health
What could go wrong?The instruments and regions into which Islamic finance is drawing western capital have raised alarm amongst one investment analysts, on purely economic grounds. The fastest-growing issuers are Middle Eastern states with restricted forms of democracy and much-criticised human rights records, which raises questions over their long-term political stability. Present rapid growth in the Gulf region is heavily reliant on strong world oil and gas prices, which may actually prevent the growth of other industrial and service activities by keeping exchange rates strong and imports cheap.
Oil revenue inflows and rapidly rising demand have already unleashed a serious surge of inflation in the Gulf region, a situation that is bad for yields on traditional bonds and may be no kinder to those on Islamic bonds.
Despite their appeal beyond the Muslim world, two types of backlash may also prevent Islamic financial instruments getting as wide a following as the mainstream variety. Investors of other religious persuasions may feel disinclined to assist the uptake of sharia-compliant products, and some governments of predominantly non-Muslim nations will resist the regulatory changes needed to market them.
Equally seriously, some Muslims dislike the implication of being sidelined into a small, specifically Islamic investment and savings pool; and then more secularly inclined Islamic states, such as Turkey, are wary of allowing sharia to influence financial markets when their governments have traditionally worked to keep it out of the political lawmaking process.
There have also been reactions from some religious Muslims against financial institutions labelling as Islamic certain products that differ only marginally from western equivalents. Islamic banks submit their products to independent panels of Islamic scholars, but these can give widely differing judgements on what first under the law.
Some Muslims observe uneasily that, when they sell to international investors, Islamic institutions usually team up with American and European ones: for example, Tamweel’s award-winning bond issue used Morgan Stanley and Standard Chartered as joint managers and bookrunners. Far from providing an alternative set of values not dominated by capitalist profit orientation, Islamic finance appears to have created yet another channel for this, yielding a new source of business with which western banks can replace their flagging old ones.
A final worry is simply the speed with which Islamic financial institutions and their operations are growing. None of the 300 banks in 75 countries identified by the Kuwaiti Global Investment House in January is more than thirty years old, and most of their clients have even shorter commercial track records. Whenever banks and other finance companies grow fast, some will launch into the market with insufficient capital, and take on clients whose appetite for spending outruns their ability to repay.
Devout Muslims worry that Islamic financial institutions are springing up more rapidly than the scholars they need to monitor their sharia compliance. Worshippers of Mammon express concern, just as fervently, that they and their customers’ financial compliance will break down of the present pace of growth is kept up.--(FinanceWeek)

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