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Monday, 4 February 2008

Key facts about Islamic finance

(Reuters, 3 Feb 08)- Islamic banking is poised to spread beyond its hubs in Malaysia and the Gulf into regions which until now were unlikely hosts for the sector, but the booming industry faces its greatest challenges yet.
The fledgling sector has grown at a rate of about 15 percent a year and assets managed by Islamic lenders are set to hit $1 trillion by 2010 as demand from the world's 1.3 billion Muslims for banking that complies with their faith grows, experts say.
The following are some key facts about the Islamic finance industry:
WHAT IS ISLAMIC FINANCE?
* Islamic banking institutions say they operate in compliance with sharia, or Islamic law. A ban on charging interest and investing in prohibited industries such as alcohol, pornography and gambling, are among features that distinguish it from conventional banking.
* Islam also stipulates that risk and reward should be shared among all participants in a business venture.
* Malaysia and the states that make up the Gulf Cooperation Council -- Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates -- are the world's Islamic banking hubs. However, Islamic banks are opening elsewhere in the Middle East and further afield, including in Britain, Turkey, Indonesia, Singapore, South Africa and Pakistan.
* Islamic bonds, or sukuk, are one of the Islamic banking's highest profile products and are backed by physical assets from which returns are paid to bondholders rather than interest.
HOW BIG IS THE INDUSTRY?
* There are more than 300 Islamic banks and investment firms spread among some 75 countries, against almost none 30 years ago, Kuwait's Global Investment House said in a January report.
* The value of assets managed by Islamic banks will grow 33 percent to $1 trillion by 2010, management consultants McKinsey & Co said in a December report.
* By the end of July last year, the total value of sukuk outstanding globally totaled $82.4 billion, of which about 62 percent was denominated in Malaysian ringgit, ratings firm Moody's said in an August report.
* Gulf Arab sukuk sales overtook those in Malaysia on an annual basis for the first time last year, Moody's said in September. Gulf Arab sales totaled about $12 billion in 2007, up from $9 billion a year earlier, Moody's said in January.
* The UAE was the world's top issuer of Islamic bonds during the last seven years, contributing 36.2 percent of global sale value, Kuwait's Global Investment House said in the report. Malaysia was second at 32.1 percent.
SOME OBSTACLES
* Differing interpretations of Islamic law are hindering the growth of the industry by making it difficult to standardize products across markets, though some argue too much standardization would hinder innovation.
* Some Gulf investors disagree with the Malaysian interpretation of Islamic law, stifling cooperation between the two regions. The Malaysian policy of allowing debt to be traded in some Islamic transactions is a key bone of contention.
* Malaysian Islamic finance deals are typically valued in ringgit, making them less attractive to Gulf investors, who prefer U.S. dollars. Malaysia's capital markets are deep and liquid enough to easily sell products in the local currency, unlike the Gulf, where dollars are used to widen appeal.
* The head of the board of scholars at the Accounting and Auditing Organization for Islamic Financial Institutions in November said 85 percent of sukuk did not comply with Islamic law. Scholars and bankers are now trying to fix the problem.
* A growing number of scholars and bankers say the way in which the most common Islamic banking contract -- commodity murabaha -- is often used either does not comply with Islamic law, or no longer suits the needs of the industry, prompting a search for alternatives.
* Some Islamic financial institutions have launched hedge funds that they say adhere to Islamic law, but others say short selling, a common hedge fund strategy used to speculate on currency and stock moves, breaks Islam's law against gambling.
SOME DEFINITIONS
* Widely used structures for Islamic deals include:
Murabaha -- a financier, such as a bank, buys a commodity and sells it to the purchaser at a higher price on a deferred basis. Purchasers have often used murabaha as a tool to secure indirect loans by selling the commodity immediately, an issue that has caused controversy.
Mudaraba -- the bank provides funding to entrepreneurs, who share the profits of any venture. The entrepreneurs do not put up any capital.
Musharaka -- the bank provides funding to entrepreneurs, who also contribute capital. Profits from the venture are shared.
Ijarah -- an agreement in which banks lease an asset to a client for a specific time at a specific price. At the end of the leasing period, the client may or may not own the asset
Istisna -- the purchaser asks the seller to create a product, which is then sold to the purchaser at a given price. Istisna allows parties to contract the sale of something that does not exist at the time of the agreement.
Takaful -- Islamic insurance. Risk and reward are shared between the customer and the insurer, unlike in conventional insurance where the insurer takes on all the risk and receives a premium.
(Compiling by Mohammed Abbas; Editing by Inal Ersan and David Holmes)

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