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Saturday, 2 February 2008

Islamic banking booms, but faces challenges

MANAMA, Feb 1 (Reuters) - Islamic banking is poised to burst from its hubs in Malaysia and the Gulf and spread into regions which until now were unlikely hosts for the sector, but the booming industry now faces its greatest challenges yet.
As the industry expands into non-Muslim or secular states, Islamic lenders must pay greater attention to educating others about the sector, experts say. Meanwhile, banks are suffering a chronic shortage of staff with knowledge of Islamic finance.
Islamic bonds, the industry's hottest product, are under the spotlight after a top standards body said almost all do not comply with Islamic law, while controversy over the most common Islamic banking contract could shake the industry to the core.
Regulatory differences in different regions continue to plague efforts to build true cross-border Islamic banking, and links between the world's two biggest Islamic banking hubs in Malaysia and the Gulf are still at a nascent stage.
Next week, Reuters journalists in London, New York, Dubai, Bahrain, Geneva and Kuala Lumpur will bring together the industry's heavy hitters to ask them how they will overcome those challenges, and where they see future opportunity.
Interviewees at the Reuters Islamic finance summit include Malaysia's finance minister, Bahrain's central bank governor, Islamic banking experts from the world's top banks as well as regulatory and ratings agencies.
Demand from the world's 1.3 billion Muslims for investments that comply with their beliefs has soared, and assets that comply with Islamic law are set to hit $1 trillion by 2010 and are growing at a rate of about 15 percent a year, experts say.
Four out of eleven bankers and analysts polled by Reuters this week picked Indonesia, the world's most populous Muslim state, as the next big growth market for Islamic bonds.
Islamic law bans interest, and bond holders are paid returns derived from underlying assets. Investing in sectors such as alcohol, pornography and gambling is also prohibited, and deals must also be structured so that risk and reward is shared.
Pakistan came second to Indonesia, tied with the United Kingdom. Both countries have introduced legislation to encourage Islamic banking and the Islamic bond, or sukuk, market.
ISLAMIC IMAGE
Islamic and other Arab lenders are spending on expensive schemes to show they are not linked with militants, and also to reconcile an ethical image with the possibility of mortgage foreclosures, ratings firm Moody's said this week.
"It would be quite damaging for the Islamic financial institution's 'ethical' reputation to leave a Muslim family homeless for the sake of profit," Moody's said in a report.
"More broadly, reputation risk might stem from the misconception that Islamic financial institutions... might be close to violent militant groups," the report continued.
In a sign that cultural barriers may be coming down, some bankers are tipping North American firms, desperate for funds after defaults on subprime loans triggered a global credit crunch, as future sukuk issuers to tap huge Gulf liquidity.
Many bankers cite U.S. hostility to Arabs and Islam after September 11, 2001 as giving Islamic banking a boost, after many Muslims withdrew their investments from the United States.
"North American firms will be the new main issuers with large corporates always looking to tap any market liquidity, including Islamic markets. Those issuers...are confronted with home issues making them look for funding alternatives," Geert Bossuyt, head of Middle East structuring at Deutsche said.
HUNT FOR PRODUCTS
And as the popularity of Islamic banking grows, bankers are racing to find a greater range of products, both to meet consumer demand and that of Islamic scholars, who say decades-old Islamic banking practices are now due for a review.
In November, the head of Islamic law at one of the world's most important Islamic standards bodies said 85 percent of sukuk were not truly Islamic because they used repurchase agreements.
The agreement guarantees bondholders will be repaid the face value of the sukuk, which many scholars say contravenes the Islamic principal of sharing risk and reward.
Securitised mortgages and leases, which could be used instead of repurchase agreements, and other sukuk alternatives were tipped by bankers and analysts in the Reuters poll this week as this year's most important Islamic banking product.
"Innovative differentiation in sukuk, moving the classification from liabilities to capital will be a critical achievement," said Hissam Kamal, director of Islamic finance for HSBC in Saudi Arabia.
Meanwhile, a tool used by Islamic lenders to manage liquidity, commodity murabaha contracts -- the backbone of the Islamic banking industry -- are also drawing the ire of some scholars, prompting a race for an alternative.


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