Islamic Finance: A 'come together' consolidation?

| Tuesday, January 24, 2012

Will 2012 be the year of “come together” consolidation for Islamic banks?

Size is often the justification for achieving economies of scale, used to access deals for league table prominence, used as a buffer in a challenging environment, used as defensive measure to ward off unwanted suitors, and so on.

Islamic banks are very much like Islamic (equity) funds. There are hundreds of Islamic banks and funds, but the paid-up capital and assets under management, respectively, is too small to be meaningful. Yet, both, more so Islamic banks, present a unique situation (of an industry risk) of “too small to fail”.

Islamic finance is not only a niche industry today, but also an embryonic industry, where an Islamic bank failure may actually result in the “run on deposits” scenario due to contagion perception as no “Islamic lender of last resort”.

For example, when the industry had sukuk default, circa 2009, or comment by a leading scholar concerning syariah violation of a particular type of sukuk, the perception, fanned by certain media, was that “it’s the beginning of the end of Islamic finance”.

Obviously, the industry has not only survived but is said, by the likes of S&P, to be thriving on the march towards US$2 trillion (RM6.4 trillion).

Sub-Eco System

Islamic finance is a sub-eco system of the global economy, finance, and capital markets, hence, the hot winds of new world order, post- US sub-prime mortgage crisis and sovereign debt obligations of selected European countries, have made their way towards the base countries of Islamic banks.

The stakeholders of the Islamic finance industry, be it regulators, industry bodies or the banks themselves, have realised the new world order may just compress (or shorten) the industry development curve.

There is an implicit realisation that one does not need to have the “toxic assets” on the balance sheet to be collaterally damaged, as the financial economy (stage one) eventually impacts the real economy (stage two). Islamic banks finance the real economy.

Recent news and developments in Islamic finance include:
  • ISLAMIC Financial Services Board introducing Exposure Draft 13, Guiding Principles on Stress Testing Islamic Banks. This is one of the important developments in 2011, an attempt to better understand the soundness and stability of Islamic banks.
  • EMIRATES NBD, a conventional bank, acquired the struggling Dubai Bank (DB), an Islamic bank, at the behest of Sheikh Mohammed bin Rashid Al Maktoum, ruler of Dubai and prime minister of the United Arab Emirates. Emirates NBD also owns Emirates Islamic Bank (EIB), and we can expect to see integration between EIB and DB.
  • STANDARD & Poor’s a major rating agency, is reviewing the credit ratings on 50 banks in the Mena (Middle East North Africa) region under new criteria. It also classified Bahrain’s banks as the riskiest in the six-country GCC (Gulf Cooperation Council) region.
  • BAHRAIN’S central bank has “urged five of the Islamic banks to merge in early 2012 as it seeks to strengthen the banks’ capital bases …,” and it now pending shareholder approval.
  • QATAR’S central bank, which issued a directive early this year stating Islamic windows and subsidiaries of conventional banks need to be spun off, sold, closed, etc, by the end of the year, has hinted at giving the banks more time for implementation. The execution risk in these uncertain times may cause the law of unintended consequences to kick and cause more damage.

Central bank urging

The central bank of Bahrain, much like Bank Negara Malaysia, has brought much credibility (via regulations) and certainty to Islamic finance over last two decades. It can be said these two central banks have put Islamic finance on the global map, and, among the many benefits, have encouraged enlightened non-Muslim countries to establish themselves as Islamic finance hubs.

Thus, when the CBB encourages consolidation of Islamic banks in its home country, it may be just the necessary wake-up call for the industry to direct the conversation towards size, as it matters. Some may also say that it may be the by-product of the Arab Spring, more specifically, the situation in Bahrain.

The same “spring” that has brought real interest in Islamic finance in Oman, Egypt, Libya, and Tunisia.

What are the lessons from the present situation for Islamic banks in Malaysia?

At one level, Malaysian banks, Islamic or conventional, have not been directly impacted with crisis I or II, but anecdotal evidence suggests exporters (to the US and Europe) are been impacted. These same exporting companies are banking clients with working capital needs.

For Islamic banks in Malaysia, the options may include:
  • The often heard cry of consolidation to achieve the benefits of size. It may possibly be a better route to achieve size than establishing a newly licensed mega bank that will acquiring customers (is the retail pie expanding?), building/buying branch outlets, and so on.

Destructive competition in an overbanked market?
  • Spinning off and publicly listing the Islamic subsidiaries of conventional banks as the incubation testing market cycle period has been successfully completed. Islamic investors from, say, the GCC, are more interested in acquiring portfolio investment stakes in market share leading banks than their Islamic funds.

The restraint showed in Malaysia on not publicly commenting on the directive form the Qatar central bank shows the world-class leadership and stature of Bank Negara Malaysia.
  • Friendly/strategic or even bailout stakes in Islamic banks in the overbanked GCC generally, Bahrain and UAE, specifically. The GCC-based banks have been raising money in Malaysia, via sukuk and bonds. It shows the Malaysian money is not only welcomed, but also needed in the heart-land of the “petro-liquidity”.

Lessons?

Are there lessons from Qatar’s sovereign wealth fund (SWF), Qatar Investment Authority (QIA), for Malaysia’s SWF, Khazanah Nasional, concerning QIA’s investments in cash-strapped banks Britain’s Barclays, Brazilian unit of Spain’s Banco Santander, and Credit Suisse Group? In these cases, QIA was rewarded handsomely, where Credit Suisse and Barclays netted a US$2 billion profit.

The five Bahrain-based Islamic banks urged to merge by CBB include Bahrain Islamic Bank and Salaam Bank, and three-way combination Capivest, Elaf Bank and Capital Management House. The amounts involved here is not in the same league as Credit Suisse or Barclays, and the valuations are much lower than pre-crisis period.

Would a Malaysian Islamic bank or Khazanah be the welcomed figurative “white knight” that would provide not only a cash injection, but also the long sought after bridge between GCC and Malaysia?

The year 2012 could be the year for Malaysian Islamic banks to achieve size and spread their “welcomed wings” to new lands.

The writer is the global head, Islamic finance & OIC countries, Thomson Reuters

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