Cross-border sukuk on the rise

Cross-border sukuk originations into and out of Malaysia are set to increase as the global sukuk market continues its rebound. Investors are looking for better and more diversified returns, as the Malaysian government’s policy of encouraging government-linked companies (GLCs) and local financial institutions and corporates to increase their cross-border exposure to Islamic capital market instruments start to take effect.

Foreign issuers that have originated sukuk in Malaysia include the World Bank and its private sector funding arm, the International Finance Corporation (IFC), The Islamic Development Bank, Nomura and the National Bank of Abu Dhabi.

The Japan Bank for International Cooperation (JBIC) was on the verge of using a sukuk, only to be foiled by the onset of the global financial crisis and the credit crunch in 2008.

In the other direction, last year Khazanah Nasional Berhad, Malaysia’s sovereign wealth fund, issued its first cross-border sukuk in Singapore.

Indeed, Kuwait-based Gulf Investment Corporation (GIC), whose shareholders include the governments of the six Gulf Cooperation Council (GCC) states (Kuwait, Saudi Arabia, the United Arab Emirates, Qatar, Bahrain and Oman), is the latest Middle East institution to raise funds from the Malaysian market through a 600 million Malaysian ringgit ($196 million) local currency five-year Sukuk Wakala bi Istithmar issuance, which will be officially launched on March 1.

The issuance is the first tranche of a 3.5 billion Malaysian ringgit (RM) Sukuk Wakalah bi Istithmar Program planned by GIC.

Leading Malaysian rating agency, RAM Ratings, has assigned a long-term rating of AAA to the corporation’s RM3.5 billion sukuk program. Concurrently, RAM Ratings has also reaffirmed GIC's respective AAA and P1 long-and short-term financial institution ratings, and its AAA long-term ratings of the corporation's RM600 million conventional Senior Unsecured Bonds (2008/2013) and RM400 million Senior Unsecured Bonds (2008/2023). All the long-term ratings have a stable outlook.

In its ratings rationale, RAM Ratings stressed “GIC's ratings remain supported by its unique position within the GCC region, and the strong support from its shareholders. GIC's mandate is to support the development of private enterprises and economic growth within the GIC region. Given its strategic role, the corporation enjoys immunity and exceptions in terms of regional regulatory norms, including exemptions from asset nationalization, currency controls and taxes.”

The corporation reported a net profit of $129 million for the first nine months of 2010, surpassing the $91 million for the entire fiscal year 2009. RAM Ratings stressed that the performance of GIC’s key principal investments, particularly those in metal-and petrochemical-related industries, driven by the more encouraging economic outlook on the GCC, have improved.

While the corporation recorded a larger share of profits from its subsidiaries and associates in the same nine-month period, its dividend receipts for the year are expected to remain unchanged from historical levels given the nascent stage of its major principal investments.

The GIC sukuk issue was oversubscribed and the issuer decided to increase the size from RM500 million to RM600 million. It was jointly managed by Royal Bank of Scotland (RBS), who was also the adviser and book runner, and Maybank Investment Bank, and was priced at a yield of 5.25 percent.

The GIC sukuk follows the recent RM500 million 10-year sukuk issued by the National Bank of Abu Dhabi.

Malaysia originates more than 60 percent of global sukuk outstanding. This has generated significant cross-border flows as funds are raised from beyond domestic financial markets and as investors diversify their portfolios into assets from other jurisdictions. According to the Securities Commission, between January and September 2010, over 55 percent of all bonds approved by the commission were sukuk.

GIC, stressed RAM Ratings, is perceived to have a healthy liquidity position. At end-September 2010, its cash balances and available-for-sale securities amounted to $633 million and $2.5 billion respectively.

Contrasting against the corporation's $565 million of debt repayments due in December 2011, these are adequate. At the same time, GIC's overall risk-weighted capital-adequacy ratio (RWCAR) had increased to 30.23 percent at end September 2010 compared with 27.7 percent at end December 2009, backed by profit accumulation and revaluation gains on its equity investments.

At the same time, the de-leveraging of its balance sheet eased its leverage ratio (total assets/equity) from 3.5 times to 2.8 times.

While the expansion of the corporation's equity investment portfolio will elevate both its RWCAR and leverage ratios, the management, according to the Malaysian rating agency, will maintain a prudent near-term minimum RWCAR of 20 percent and a maximum leverage ratio of four times.

In his budget 2011 speech to the Malaysian Parliament late October, Prime Minister Mohd Najib Tun Abdul Razak emphasizes the transformation of Malaysia into a developed and high-income economy with inclusive and sustainable development, spearheaded by the private sector. A number of strategic high-impact projects are expected to involve both conventional and Islamic financing and investment.

To this end, government-linked investment companies (GLICs) will be allowed to increase investment in overseas markets to explore opportunities for better returns. For example, the Employees Provident Fund (EPF) will increase its investment overseas from the current 7 percent to 20 percent of the total assets managed, including in Islamic instruments such as sukuk.

“Efforts will be taken to strengthen Malaysia's position as a premier Islamic capital market,” said Najib. “Bursa Malaysia will develop an international board to enable foreign securities to be listed, including Shariah-compliant products. To further promote innovation in Islamic securities products, the government proposes that expenses for the issuance of Islamic securities which adopt the principles of Murabaha and Bai Bithaman Ajil based on Tawarru’ be given tax deduction. This will strengthen Malaysia’s position as the leading sukuk market and promote transactions in Bursa Suq al-Sila, the world’s first Shariah-compliant commodity trading platform. The government proposes that Takaful contributions for export credit be given double tax deduction.”

Bursa Malaysia, the national stock exchange, stresses that the global sukuk market saw a rebound in 2010 with total issuance outstanding reaching $30 billion, an increase of 20 percent on 2009 and double the volume of 2008, when the market hit an all-time low. Bursa Malaysia in fact attracted some $8.6 billion of sukuk listings in 2010, accounting for almost one-third of total global issuances.

The listings include Sime Darby Berhad’s RM4.5 billion Musyarakah Sukuk; the government of Malaysia’s $1.25 billion Global Sukuk Al-Ijarah and the Islamic Development Bank’s $3.5 billion sukuk. The total value of sukuk listed on Bursa Malaysia at Dec. 31, 2010 stood at $27.7 billion, thus retaining the exchange’s position as the leading sukuk listing destination in the world.

“[The] general consensus amongst industry players is that global sukuk issuances for 2011 will surpass the record high of $34.2 billion in 2007,” says Raja Teh Maimunah, global head of Islamic markets at Bursa Malaysia.

“As Malaysia has a well-established legal and regulatory framework to support sukuk issues, we are hopeful that 2011 holds greater promise in this space for us. We are seeing issuers more willing to list their issues and be subjected to reporting and disclosure requirements in order to attract investors, as the credit crisis have caused investors to be more aware of the importance of transparency and are thus demanding greater governance. We see this as a positive development as the industry steps to the next level in embracing higher governance standards.”

Arabnews.com

Amana Investments: The torchbearer of Islamic banking in Sri Lanka

Amana Investments Ltd. has been the torchbearer of Islamic banking in Sri Lanka for almost the last two decades. In that time the parent company also established a Takaful (Islamic insurance) subsidiary, Amana Takaful, in a joint venture with Syarikat Takaful Malaysia and Amana Capital. At the helm at Amana are Chairman Osman Kassim and Managing Director and CEO Faizal Salieh, arguably the two most seasoned Islamic bankers in the country. Years of lobbying finally paid off when the Sri Lankan government a few years ago amending its existing banking rules to facilitate the authorization of a Shariah-compliant commercial bank.

Last month, President and Finance Minister Mahinda Rajapakse and the Central Bank of Sri Lanka granted a full commercial banking license to Amana Investments Ltd. to set up Amana Bank, which is scheduled to start full operations later this year. The bank is headquartered in Colombo and has 13 branches in the west and east of the country as well as one in the south, in Galle, that are being converted into fully fledged branches of Amana Bank.

Salieh discusses with Arab News the core objectives of the bank; the potential and opportunities for Islamic finance in Sri Lanka’s development and economy; and the challenges and issues that remain.

What is the license status of Amana Bank?

Faizal Salieh: We have been granted a full commercial-banking license to establish Amana Bank. It was granted on Jan. 24, 2011. The authority is the Monetary Board of the Central Bank of Sri Lanka with the concurrence of the Minister of Finance Mahinda Rajapakse. The license was granted pursuant to Banking Act No. 30 of 1988.

What is the paid-up capital of the bank and who are the main shareholders?

The stated capital is 3.4 billion Sri Lankan rupees ($1 = Rs.110.87) which is what the bank has raised. The minimum required regulatory capital is Rs.2.5 billion. The main shareholders are Bank Islam Malaysia Berhad (with a 20 percent equity stake), Albaraka Bank of Bangladesh (with a 15 percent equity stake), the Jeddah-based Islamic Development Bank (with a 10 percent equity stake) and the local Akbar Bros. (with a 10 percent equity stake).

Which activities are you allowed to conduct under the provisions of the bank license and the law?

Amana Bank is allowed to conduct all commercial banking activities both domestic and offshore banking and Islamic banking products. Amana Bank will engage only in Shariah-compliant banking products and services. The license specifically requires us to assist the government of Sri Lanka to raise long-term funds through Islamic finance products.

What are your core business objectives and which products will you concentrate on?

Our core business objectives are to offer our customers a principled and attractive alternative to interest-based banking; infuse a new and innovative dimension to the country’s banking industry through our business model; and add value to the economy. In this process we aim to be among the top ten banks in the country in terms of brand equity in five years. We wish to touch the hearts and lives of many people as possible through our consumer-banking product offerings and also enable the corporations and small- and medium-sized businesses to access and benefit from our ethical financing products.

What is the potential for Islamic banking in Sri Lanka? Apart from Amana are their any other institutions that provide Islamic financial products, including through windows or ad hoc stand-alone products?

The potential market size for Islamic banking is estimated at $1.5 billion. There is growing awareness even among the non Islamic market segments. The other operators include two conventional banking Islamic windows, one of which is a wholly state-owned bank; two Islamic-leasing windows by a state-owned leasing company and a private sector leasing company; two Islamic windows by private finance companies; and a few small-time fund management entities.

What has been the support from the Sri Lankan government and its central bank in facilitating the introduction of Islamic financial products in Sri Lanka? Is it part of a financial inclusion policy?

The support from the government and the central bank has been essentially in response to Amana’s consistent lobbying efforts and continued dialogue with the regulators, which resulted in some significant amendments being made to the banking law in 2005; the articulation by the Ministry of Finance in the government’s budget proposals about the need to recognize Islamic finance for the purpose of tax neutrality in the country’s tax statutes in November 2010; and the issuance of the country’s first banking license to Amana Bank for the purpose of carrying on Islamic banking in January of this year. The government has recognized the global growth and value of Islamic finance and has expressed its desire to see the economy benefit from it. Yes, Islamic finance is now part of a financial-inclusion policy.

How can Islamic finance contribute to economic growth, infrastructure development and financial stability in Sri Lanka?

Islamic finance is ideally suited to participate in the long-term financing of the country’s infrastructure requirements as it has the right product structures for that purpose. The asset-based financing emphasis will be a positive factor in enabling real economic growth and promoting financial stability. Islamic financial institutions have been successful in tapping the informal sector and integrating it with the formal economy as demonstrated by Amana’s own business experience over the past 12 years. Islamic financial institutions that subscribe to good governance standards, best practices and compliance would by definition become formidable assets in ensuring true stability in the financial system.

Arabnews.com

(Source: Arab News, Jeddah, Saudi Arabia)By Md Rasooldeen, Arab News, Jeddah, Saudi Arabia

Feb. 06--RIYADH -- The Jeddah-based Islamic Development Bank (IDB) has taken a 10-percent stake in the first commercial Islamic bank in Sri Lanka, which is to be opened shortly in the island, a senior official from the Amana Bank Limited in Colombo told Arab News Saturday.

Amana Bank Limited, which obtained the provisional approval license from the central bank last year to become a bank, has got the green light from the island's Finance Ministry to operate as a commercial bank in the country.

According to the official, the new bank will start operations in the course of this year.

"Amana Bank will be Sri Lanka's first licensed commercial Islamic bank to conduct all its business operations in complete harmony with the principles of Islamic banking," he said.

Islamic banking is an emerging alternative to the interest-based banking practice and is gaining popularity across the world's communities.

The bank's shareholding amounts to 3.4 billion Sri Lankan rupees and constitutes both strategic and retail shareholders with the capital raised by a private placement of shares.

Its key shareholders are Bank Islam, Malaysia Berhad with a 20 percent stake, AB Bank, Bangladesh with 15 percent, Islamic Development Bank, (IDB) Saudi Arabia with 10 percent, and Sri Lankan tea exporter Akbar Brothers with 10 percent.

The bank has engaged KPMG Sri Lanka as its financial advisers to the capital raising.

Amana Bank will acquire the assets and liabilities of Amana Investments through an asset purchase agreement.

With the end of the ethnic conflict in all parts of Sri Lanka analysts predict good business for the newly set up bank.

Incorporated in 1997, Amana Investments Limited (AIL), being the investment and financing arm of the group, offers a range of Shariah-compliant financial solutions to its customers. Since its inception, Amãna has emerged as robust trendsetter in Sri Lanka's financial services sector and shown remarkable growth in business.

Its entire range of products are interest-free and structured on the principles of Shariah equity and fairness and available to all persons, irrespective of their ethnicity. All products are approved by its Ulema Supervisory Council and subject to regular Shariah audits

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To see more of the Arab News or to subscribe to the newspaper, go to http://www.arabnews.com.

Copyright (c) 2011, Arab News, Jeddah, Saudi Arabia

Afghan central bank sees Islamic banking law enacted in 2011

(Reuters) - Afghanistan's central bank expects an Islamic banking law to be enacted by September, drawing billions in deposits from citizens wary of the conventional banking system, a senior official said.

The central bank's sharia board will meet Sunday to finalize the law, said Muhammed Qaseem Rahimi, director general of the central bank's Financial Supervision Department. It will then go to the Justice Ministry and parliament for approval.

"Most of the people who can access banking services don't use them just because of the interest, which is not allowed in Islam," Rahimi told Reuters via email.

"The demand for Islamic bank services is very high in banked and unbanked populations of Afghanistan."

Of 17 banks in Afghanistan, six have Islamic banking windows. The central bank hopes to approve the creation of fully fledged Islamic banks after the law is passed, Rahimi added.

Total deposits stood at $3.58 billion as of August 2010, according to a central bank report. But bankers estimate that there is close to $30 billion in circulation that remains untapped by the banking sector.

An Islamic banking law could revive an industry hit by scandal in recent months.

The central bank took over Kabulbank in September, the country's largest private bank, after irregularities of about $579 million raised red flags with authorities.

The crisis added another layer of uncertainty for the country, which already struggles with record levels of military and civilian casualties as well as corruption concerns.

But Islamic banking could renew trust in the sector, said Alam Hamdard, Kabulbank's head of Islamic banking.

"The crisis showed Islamic banking provides more transparency," he said in a telephone interview. "We could show them that their money was safe and secure in tangible projects that were being developed."

Hamdard said Islamic bank customers at Kabulbank did not withdraw funds at the same level as conventional banking customers during the scandal.

SHAKING OUT PILLOWS

But reaching the conservative Muslim masses and educating them in how Islamic banking differs from the conventional system is a challenge, with some bankers taking to the airwaves or sitting down at religious gatherings in rural areas to preach Islamic finance.

"Our ultimate goal is to shake out all the money that is lying in pillows and not with the economy in order to contribute to the rebuilding of Afghanistan," Khan Afzal Hadawal, Chief Executive Officer of Bank-e-Millie Afghan, said by telephone.

Hadawal said Bank-e-Millie's Islamic banking business has $15 million in deposits and that is projected to rise to $50 million by the end of the year as demand grows.

The Islamic banking sector in Afghanistan could attract up to $6 billion in five years, he said, if the sector starts to offer products such as Islamic credit cards, debit cards and automated teller machine facilities. (Editing by Robert Birsel)

REUTERS

QCB's Islamic banking rule shocks banks

DOHA: Conventional banks are taken aback by the directive of the Qatar Central Bank (QCB) to close down their Islamic banking activities by the year-end.

Banking industry sources say more shocking is the suddenness with which the announcement has been made and it has not been made clear why the move was being made.

There are about 16 Islamic banking branches of commercial banks in the country with the largest lender, half state-owned Qatar National Bank (QNB), also having an Islamic banking outlet in Sudan.

It’s not clear what the QCB’s directives are regarding this overseas branch of the QNB, say industry sources.

What intrigues the banking industry more is the fact that barely seven months ago, the QCB Governor, H E Sheikh Abdullah bin Saud Al Thani, inaugurated HSBC’s Islamic bank branch with much fanfare.

“The same branch (and some 15 others) will now be closed down…Banking is serious business. It’s no gimmick,” said an industry source, criticising the QCB move.

He said he believed if such key policy decisions are taken ‘overnight and on ad-hoc basis’, they would spoil Qatar’s top ranking as far as ‘Transparency in Doing Business’ is concerned.

While the affected banks are left wondering how to recover their investments in Islamic banking activities and manage their long-term credit portfolios, experts say the QCB must review its decision.

“Qatar follows free market policy and its thrust is on ending monopoly and encouraging competition, but the QCB’s decision is against those principles,” banking expert Abdullah Al Khater told Al Sharq.

He said the move threatened to undermine the interests of both, the banks and their customers.

“We need to study the possible impact of the banking regulator’s move and see what viable alternatives we have so that we don’t lose our customers,” said Abdullah Al Raisi, deputy chief executive of Commercialbank, in remarks to the daily.

True. Since the QCB allowed commercial banks to open Islamic banking windows and branches in 2005, the ‘beneficiary’ banks have widened their customer base to some 80,000 individuals and corporate entities.

They have attracted billions of riyals in deposits and given away equally large sums as part of their medium and long-term credit portfolios.

“The time given to us to wind up our Islamic banking activities is so short that we can’t even imagine how to recover our investment and manage the credit portfolio,” said another industry source.

Islamic banking customers would at no cost accept doing transactions with the conventional banks due to the taboo of ‘riba’ (interest), and transferring their accounts to the full-fledged Islamic banks would choke up their limited networks and services.

“There has been a lot of improvement in Islamic banking services and products since 2005 thanks to QCB’s liberalised policy of permitting commercial banks to offer Shariah-compliant banking services,” said the source.

But with the monopoly returning, the services can only be expected to deteriorate rather than improve further.

The QNB is said to have no less than 45,000 customers of its Islamic banking services alone. The division netted profits to the tune of a whopping QR900m last year.

The division, additionally, employs scores of citizens and expatriates in its Islamic banking branches. The vast majority are nationals. “What would happen to these staff members—is a major question,” asks yet another banking source.

Then, there are other banks which face similar predicament.

“Frankly, nobody knows what’s going to happen to some of the Islamic banking experts, especially, those who are employed with these banks… They can’t work elsewhere, not even in commercial banking set-ups since they wouldn’t have Islamic banking operations,” said the source.

And if the government somehow allows the QNB to retain its Islamic banking services, the step would be impartial.

“Well, the Islamic banks could buy the 16 branches in question, but that wouldn’t be fair to the conventional banks who built the network and customer base with so much difficulty and over years,” he said.

Incidentally, the QCB’s move comes at a time Islamic banking is witnessing record growth in the country (which underlines the need to rather make Islamic banking more competitive).

Islamic banking is estimated to command a market share of around 20 percent.

Some experts say a much better option would be to ask the affected banks to declare their Islamic banking branches separate entities altogether so that the confusion between their conventional and Islamic banking activities are removed for ever.

“Since the main objection of the QCB is that conventional banks are messing up between their commercial and Islamic banking activities, it would be wise to make the two areas into separate entities,” said a banking industry source.

There are four Islamic banks in the country at the moment and the pace at which Shariah-compliant banking has been growing in the country, surely demands more banks in the arena, he argued.

Sources say if a bank or two have committed an error and that is why the QCB is clamping down on the entire conventional banking industry, the move should not be justified. Only the erring bank or banks must be punished. 

The Peninsula

Amana gets banking license - Sri Lanka

Amana Bank Limited, which obtained the provisional approval license from the Central Bank last year to become a bank have been granted the go-ahead of the Minister of Finance to operate as a commercial bank in the country. According to the senior officials of Amana, the new bank will start operations in the near future as Sri Lanka's first commercial Islamic Bank following the Shari code of ethics. Amana Bank last year raised 3,159 million rupees by selling 631.9 million 5.00 rupee shares in a private placement deal. The new bank will be backed by the Bank Islam Malaysia Berhard which currently holds a 10 percent stake in Amana Investment Limited, which is the parent company of Amana Bank.With the liberalization of the Eastern Province of the country, where a Muslim majority resides, analysts predict 'good business' for the newly set up bank.The minimum capital requirements needed to start operations as a commercial bank is Rs. 3.0 billion according to Central Bank Guidelines Amana Group has established itself as the pioneer in providing Islamic financial services, from merchant banking to insurance, to Muslims and non-Muslims alike. Incorporated in 1997, Amana Investments Limited (AIL), being the investment and financing arm of the Group, offers a range of Sharia-compliant financial solutions to its customers.

Dailymirror.lk

Islamic Finance gender gap closes as trends change

Kuala Lumpur: Asian Islamic financial institutions are attracting more women executives and scholars to fill a shortage of talent, setting a precedent for companies in the Middle East.

Malaysia's Sharia Advisory Council appointed a second woman scholar to its 11-member board in November.

Indonesia has six women on its panel of 35 experts, Ma'ruf Amin, chairman of the country's National Sharia Council, said in an interview December 30. Malaysia's central bank and the securities commission are both headed by women, while Liza Mohd Noor is chief executive officer at RAM Rating Services Bhd., which provides ratings for Islamic bonds.

"Previously, it was difficult for women to enter the industry; now people have broken that boundary, especially in Malaysia," Aznan Hassan, associate professor at the Kuala Lumpur-based International Islamic University Malaysia, said in a December 20 interview. "More women are coming in and this is good because we need people."

Encouraging women to work in Islamic finance will help meet demand for experts in an industry the Islamic Financial Services Board estimates has been growing 20 per cent annually since 2000, with assets exceeding $1 trillion (Dh3.67 trillion).

About 50,000 professionals will be needed globally over the next five to seven years to meet demand, Ishaq Bhatti, the director of Melbourne-based La Trobe University's Islamic banking and finance programme, said in a recent interview in Kuala Lumpur. The lack of prominent female banking executives stems from "history, culture and perceptions of women," said Nida Raza, senior vice president of capital markets at Unicorn Investment Bank BSC in Manama.

In Saudi Arabia, a Sunni Muslim-majority country where women are required to have a male guardian, about 15 per cent of the labour force was female in 2009, according to a report by the Geneva-based International Labour Organisation, a United Nations agency.

Barriers

"Getting a visa to Saudi is really difficult, and even when I'm there I face various challenges," Noripah Kamso, chief executive officer of Kuala Lumpur-based CIMB-Principal Islamic Asset Management Sdn. Bhd., a unit of CIMB Group Holdings Bhd., the world's biggest sukuk arranger, said in an interview. "I was once chased by a Saudi police officer because I entered from the wrong door, and travelling without a male colleague is impossible." As interest in the industry grows, women, including those from the Middle East, are likely to play a greater role, said Engku Rabiah Adawiah Engku Ali, the first female appointee to Malaysia's Sharia Advisory Council and an associate professor at the Ahmad Ebrahim Kuliyyah of Laws, International Islamic University.

A shortage of scholars increases the risk of conflicts of interest as many sit on various advisory boards at the same time, according to the Manama-based Accounting and Auditing Organisation for Islamic Financial Institutions, an industry standards setting body.

Shaikh Nizam Yaquby of Bahrain and Syria's Abdul Sattar Abu Ghuddah, who each serve on 85 boards of Islamic financial institutions, ranked first by the number of seats among the top 20 religious experts in an October report from Zawya, an online Middle East business news and directory, and Funds@Work AG, a Kronberg, Germany-based consulting company.

Prominent Saudi scholar warns on agenda against Shariah advisories

At a time when the global Islamic finance industry is debating whether Shariah advisory should be regulated and scholars restricted to advising only a small number of institutions, Malaysia almost in passing adopted on Jan. 1 a new Shariah Governance Framework (SGF) for Islamic financial institutions (IFIs) that supersedes the Guidelines on the Governance of Shariah Committees of IFIs introduced by Bank Negara Malaysia (BNM), the central bank, in 2004.

According to the Malaysian central bank, the primary objective of the SGF is to enhance “the role of the board, the Shariah committee and the management in relation to Shariah matters, including enhancing the relevant key organs having the responsibility to execute the Shariah compliance and research functions aimed at the attainment of a Shariah-based operating environment.”

One prominent international Shariah advisory to the Islamic finance industry, Muhammed Elgari of Saudi Arabia, who sits on several Shariah committees of such organizations as the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Dow Jones Islamic Market Indexes, and a number of banks, agrees that Malaysia’s Shariah Governance Framework for IFIs could become a blueprint for other countries to follow.

In an exclusive interview with the author, Elgari stressed that he can see the need for such a framework, which “most certainly” can be developed into a blueprint, even though he has yet to study the full details of the SGF.

Shariah advisory has been in the news in recent weeks following reports that the AAOIFI is in the process of drafting rules to regulate the shareholdings and the number of supervisory boards individual Shariah advisories can sit on. Market players have long been concerned by the small pool of experienced Shariah advisers serving the Islamic finance industry and that an elite few sit on multiple Shariah advisory boards, a practice which they claim could lead to conflicts of interest and is not consistent with best practice in terms of advisory.

Research by entities such as Funds@Work have added fuel to the fire, although the methodology of the research is not very detailed and transparent. According to Funds@Work, there are 1,141 overall Shariah advisory board positions available in 28 countries. The average board size is 3.33 scholars per board, across the entire universe. Perhaps more importantly, the Top 10 scholars hold 450 out of 1,141 board positions that are available and represent 39.44 percent of the universe. Two Shariah advisories sit on a staggering 85 boards while another on 79 boards.

Some of the top Shariah advisers, not surprisingly, have reportedly spoken out against any efforts to restrict their trade by restricting the number of boards on which they can sit.

“There is no justification in my mind to single out a profession to set rules that are not applied to any other. There is no dispute about the fact that a human being does have a limited capacity or let us say a finite one. But this can’t be measured by the number of boards. The real test is quality of work and ability to meet the expectations of the other party. It should be self evident that if one lacks both, it will not help him to have a limited number of boards,” said Elgari.

Elgari, who also has a doctorate in economics from the prestigious University of California in Berkeley, dismisses any suggestions that Shariah advisories “make too much money” and “they are monopolizing the trade” which he maintains are both lies and naive.

In his experience, none of the banks and organizations he serves as an advisory have expressed any concerns to him about the above issues. In fact, his relationship with his clients remains cordial and commands the utmost professionalism. As such, these supposed concerns are a smokescreen and are really serving the agenda of certain groups who are keen to get a slice of the Shariah advisory business in Islamic finance.

“What is being observed lately is that certain groups want to intermediate between banks and Shariah scholars. In other words they would like to ‘broker’ the Shariah advisory and they believe, correctly, that their negotiating power with the banks is much stronger than individual scholars. Hence they can extract much more from banks. They tell us why should you be concerned, you will not suffer any reduced income (negating the very argument that we make too much). But in principle we do not see it fitting to create an exchange where we sell our services to someone to sell them to a third party at a higher price,” he said.

Elgari, who is one of a very few number of foreign Shariah advisories registered with the Securities Commission Malaysia to give Shariah advisory to the Islamic finance industry in the south east Asian country, maintains that nobody is more concerned about bringing up the second generation of Shariah scholars in the global Islamic finance industry than the current scholars. As such, it is wrong to think that they are threatened by the thought of restrictions and regulation.

“On the contrary our nightmare is for Shariah boards to disappear when we cease to exist. We always request institutions to include in their Shariah board a younger scholar so that the next generation is brought up by the current generation. Recently, we met with the officials from the Waqf Fund (set up by Central Bank of Bahrain) to try to design a program that can be adopted by an academic institution for this purpose,” he said.

Some observers, including regulators, invoke the “conflict of interest” argument to support their desire to restrict the number of boards Shariah scholars can sit on. Elgari in fact believes this is a fair concern and in several instances he has emphasized that Shariah board members should be conscious of it and try to avoid it. He confirms that in several instances he was offered shares in companies he was giving Shariah advisory but he has always declined because he was always aware of a potential conflict of interest. He suggests greater transparency by fellow Shariah advisories, especially in showing their awareness of the issue of potential conflict of interest.

For Elgari, who has also been an economics don at King Abdul Aziz University in Jeddah for many years, the contemporary Islamic finance industry has witnessed over the last three decades the emergence the birth of a new discipline, which combines Shariah, economics and law. “Unless universities recognize this as a new discipline, not much will be done by them. If these professors themselves can’t do it, how can they teach it? The most effective way is apprenticeship, or a program for study designed by the current Shariah scholars,” he said.

The fact remains that the Shariah governance process in Islamic finance has been steadily evolving and gaining maturity. Last year, for instance, Elgari was the first prominent scholar to emphatically call for a scientific approach to Shariah compliance. This follows a similar call by another prominent Shariah scholar, Sheikh Esam Ishaq of Bahrain, that Shariah advisories serving the Islamic finance industry should be regulated.

Elgari then called on fellow Shariah advisories to adopt a scientific methodology in reaching their deliberations on Islamic finance. “To be respected,” said Elgari, “Shariah scholars should follow scientific methods to reach their conclusions. We have seen many mistakes where declarations have been issued. Only the correct resolutions will prevail. Shariah is not a group of infallible people. It is a science. It requires methodology, and resolutions require peer review and market consultation.”

He is also a big supporter of the codification of Fiqh Al-Muamalat, which could contribute immensely to clarifying the rubrics and the contentious issues relating to products and services in the nascent Islamic finance industry. Similarly, he believes that greater transparency in the Shariah governance process; more professional articulation of the resolutions and statements; and prior debate and consultation between scholars and other stakeholders in the industry, could go a long way in mitigating the misconceptions and confusion that has arisen as a result of some recent Shariah rulings.

Spread of Islamic banking can spur development in Muslim countries

There is evidence of close correlation between financial sector development and growth. Countries whose financial systems offer a variety of services—including banking and insurance— tend to grow faster. Banks, whether Islamic or traditional, play fundamental economic role as financial intermediaries and as facilitators of payments (King and Levine, 1993). They also help stimulate saving and allocate resources efficiently. Globally, the assets of Islamic banks have been expanding at double-digit rates for a decade, and Islamic banking is an increasingly visible alternative to conventional banks in Islamic countries and countries with many Muslims. 

The rise of Islamic banking: Four decades ago, Islamic banking emerged on a modest scale to fill a gap in a banking system not attuned to the needs of the devout two events were crucial to its development. First, the early 1960s appearance in rural Egyptian villages of microlending institutions following Islamic banking principles demonstrated the feasibility of Islamic banking. These experiments thrived and spread to Indonesia, Malaysia, and sub-saharan Africa. Second, top-down support following the 1975 establishment of the Islamic Development Bank in Jeddah, Saudi Arabia, further spurred diffusion of Islamic banking by centralising expertise. 

In its infancy, Islamic banking required much interpretation of shariah law by Islamic scholars. In the first few years, basic implementation tools—such as legislation allowing such banks to be set up and the training of staff—were key ingredients for the spread of Islamic banking. And the past few years have seen rapid innovation, most recently improved regulation of liquidity management and accounting. 

Similarly, the development of sukuk (Islamic bonds) has revolutionised Islamic finance in recent years: Islam prohibits conventional fixed income interest-bearing bonds. Harnessing sophisticated financial engineering techniques, sukuk is now a multibillion-dollar industry.

During the past decade, Islamic banking industry assets grew at an average 15 percent annually, and more than 300 Islamic institutions claim total assets of several hundred billion dollars. Two-thirds of Islamic banks are in the Middle East and North Africa, with the rest mainly in Southeast Asia and sub-saharan Africa. 

But even in countries with many Islamic banks, they are overshadowed by conventional banks. In the Gulf region, Islamic banks—in terms of their assets—account for one-quarter of the industry. Elsewhere, their share is in the single digits.

Islamic banking and development: The rise of Islamic banking has contributed to economic development in two main ways. One key benefit is increased financial intermediation. In Islamic countries and regions, large segments of the population do not use banks. The Islamic world, as a whole, has a lower level of financial development than other regions—in part because conventional banks do not satisfy the needs of devout Muslims. This ‘underbanking’ means savings are not used as efficiently as they could be.

Moreover, because Islamic banking requires borrowers and lenders to share the risk of failure, it provides a shock absorbing mechanism that is essential in developing economies. These economies—whether in the Middle East, Africa, or east Asia—are often large, undiversified commodity producers (mainly of oil) subject to boom-bust cycles and the vagaries of export and import price changes. In addition, most tend to have fixed or highly managed exchange rates, so the exchange rate is less able to absorb shocks. A mechanism that allows the sharing of business risk in return for a stake in the profits encourages investment in such an uncertain environment and satisfies Islam’s core tenet of social justice.

How Islamic banking spreads: Islamic banking is likely to continue to grow, because many of the world’s 1.6 billion Muslims are underbanked; understanding how Islamic banking spreads will help guide the formulation of policy recommendations. To that end, we estimated the factors behind the diffusion of Islamic banking around the world using a sample of 117 countries during 1992–2006. We also tested for whether it

substitutes for—or complements—conventional banking.

We found, unsurprisingly, that the probability of increased Islamic banking in a given country rises with the share of Muslims in the population, income per capita, the price of oil, and macroeconomic stability. Proximity to Malaysia and Bahrain (the two main Islamic financial centres) and trade integration with Middle Eastern countries also make diffusion more likely.

Interest rates negatively affect the diffusion of Islamic banking, reflecting the implicit benchmark they pose for Islamic banks. Although pious individuals may have accounts only with Islamic banks, other consumers allocate their savings based on interest rates set by conventional banks. High interest rates hinder the diffusion of Islamic banking by raising the opportunity cost for the less pious (and individuals from other denominations who are increasingly attracted to Islamic banking) to put their savings in Islamic banks. Some results, however, were unanticipated. 

First, Islamic banks spread more rapidly in countries with established banking systems. Islamic banks offer products not delivered by conventional banks and thus complement rather than substitute for conventional banks. Second, we found that the quality of a country’s institutions, such as the rule of law or the quality of the bureaucracy, was not statistically significant in explaining the diffusion of Islamic banking. This is not true for conventional banking.

Because Islamic banking is guided by shariah, it is largely immune to weak institutions: disputes can be settled within Islamic jurisprudence. 

Policy implications: During the past decade, Islamic banking has grown from a niche market into a mainstream industry, and has likely helped drive growth in the Islamic world by drawing underbanked populations into the financial system and allowing risk sharing in regions subject to large shocks. Even though our findings suggest little need for institutional reform, policy changes can still boost the spread of Islamic banking. Encouraging regional integration through free-trade agreements, maintaining a stable macroeconomic environment that helps keep interest rates low, and raising per capita income through structural reforms will lead to further expansion. the spread of Islamic banking is not, however, a panacea—it is merely one of many elements needed to sustain growth and development.

Will dawn of new year take Islamic finance to next level?

By MUSHTAK PARKER | ARAB NEWS

Published: Jan 3, 2011 00:42 Updated: Jan 3, 2011 00:42

The dawn of the new Hijrah year and 2011 could either signify more of the same as in the last year or a leap toward the first steps to taking the global Islamic finance industry to the next level as Malaysian Prime Minister Mohd Najib Tun Abdul Razak's government says it aspires to do.

In an entrenched interdependent world, the global economic recovery and financial sector stability remains fragile with much of the adoption of the new Basel III provisions relating to core capital strength, early warning systems, stress testing, risk management and financial stability still work in progress. Even where some of the above provisions have been adopted and applied, catastrophic bank failures continue to surface, which raises questions about the very validity and efficacy of some of these provisions.

In the case of Ireland, the Bank of Ireland indeed did apply the stress testing to the major Irish banks who incidentally passed the stress tests with flying colors, only to spectacularly fail shortly afterward and precipitating a multinational bail out of the Irish banking system with the help of the International Monetary Fund, the European Central Bank and the UK Treasury, who even had the audacity to borrow money from the markets and lend it to the Irish at a higher margin, albeit over a period of 25 years.

Islamic banking may have been relatively unscathed by the financial crisis but their business has been directly affected by the impact of the crisis on the real economies of the world especially in those countries in which their main business is located. As such, the challenges of the global economy and financial system are just as relevant to the Islamic finance sector both endogenously from a systemic and structural point of view and exogenously in terms of investment and other exposures in the global markets.

The feedback from the market on the prospects is mixed. There are the usual devoted diehard optimists for whom Islamic banking is more a conviction of faith as opposed to an alternative ethical system of financial management with all its attendant rigors.

Then there are the fair weather fellow travelers, whose nauseating platitudes will reverberate as long as the going is good and their renumeration packages stand out.

Finally there are the hard-working pragmatists who believe in Islamic finance not merely because of their faith traditions (not only Islam) but because they believe and have proven that Islamic finance is eminently workable, here to stay and a force for good in economic development, shareholder value and wealth creation and effecting socio-economic justice.

The reality probably will be that the global Islamic finance sector will embrace both scenarios in 2011 consolidating on the fragile recovery that started in 2010 and taking the initial steps in adding new value to the Islamic finance proposition.

At a micro level it will be business as usual with the industry continuing to grow impressively, with banks remaining cautious and concentrating on core business lines, which in turn will continue to put a brake on innovation, partly because innovation costs money and many banks remain cash-strapped or cautious in their lending and financing strategies.

The sukuk market, the flavor of the last three years, is bound to make a come back. Although its is dominated by sovereign and quasi-sovereign issuances, the market is seeing a small number of corporate issuances. "I am confident that we may see the volume of sukuk reaching $30 billion in 2011 - the same size as before the crisis, although the market will continue to be dominated by sovereign and quasi-sovereign issuances. Perhaps in 2012, corporate issuances will start equaling origination activity in the sovereign market. GCC markets suffered the most through defaults. The defaults awakened everybody - the regulators, Shariah boards and the investment bankers - all to do a better job. Whenever there was a sukuk default, the media immediately started to speculate about the future of the sukuk. But in the conventional bond industry there have been tens of defaults and the media never asked about the future of the bond industry. sukuk is a tool and an instrument. It is not a means by itself. It will continue forever as long as people need money and in the Islamic structure this will be the future trend. The sukuk structure is not responsible for the defaults. This was mainly due to the issuers having solvency problems or cash flow problems. It was a credit issue and nothing to do with the Shariah structures," stresses Jamil Jaroudi, CEO of Elaf Bank.

At a macro-level, it is a different story. This is the soft underbelly of global Islamic finance which has been largely ignored over the last 30 years. These are the debates and issues that exist in denial and are not discussed at the surfeit of global forums and conferences. Yes the geographic expansion will continue into markets that are not core because of the ultimate irony. They include Ireland, Luxembourg, the UK, South Africa, Australia, France, Russia, India, Ethiopia, Kenya, Japan, Singapore, Hong Kong, China, South Korea, the US and Canada. These countries are doing so either for financial exclusion policies (which is admirable); or to attract inward investment flows from capital-rich member countries of the Islamic Development Bank (IDB); or to promote their respective domiciles as hubs for Islamic finance or capital market products.

So what is this soft underbelly of the global Islamic finance industry? It is the absence of a systemic and structural approach to Islamic banking and finance - ranging from government policy, Treasury leadership, parliamentary ratification, financial inclusion to consumer education and protection. The notable exclusion is Malaysia and to a much lesser extent countries such as Bahrain, Turkey and perhaps Brunei.

Industry organizations such as the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) have done pioneering work in introducing prudential, supervisory and accounting standards for the global industry, but where they have been wanting is helping to suggest and develop policy, regulatory and legal frameworks for Islamic finance to create a level playing field in this respect.

At the moment these frameworks are at best ad hoc and piecemeal (except in Malaysia) which frankly is an embarrassment to any sector aspiring a role towards contributing to global economic growth and financial stability. How on earth can the sector move to the next level when the government and regulators of one of the most important Islamic finance markets does not see fit to introduce a separate regulatory, supervisory and legal framework for Islamic banking to encompass its special characteristics? This especially when the majority of its peer countries have or are in the process of adopting the dual model of banking where an Islamic system operates side-by-side a conventional one - cooperating but not inter-acting.

Taking Islamic finance to the next level is not merely about adopting policies that create a stake for the Islamic finance market in government and economic transformation programs, economic development programs, government-linked companies, sovereign wealth funds, pension and social security funds. It is also about giving Islamic financial institutions and their shareholders and their customers regulatory and legal certainty, protection and enforcement through recourse to the law of the land, which must not only work but perhaps equally importantly be seen to be working. Currently, only Malaysia and some of the industrialized jurisdictions offer this certainty. This should be the substantive debate in global Islamic finance today rather than reinventing the wheel with debate issues such as: Is riba interest or usury? or Is Islamic banking about equity or debt financing? or Should there be centralized Shariah board at the central bank or ad hoc boards in the industry?

The truth is that Islamic finance despite the impressive growth of the global industry over the last three decades, is still a highly parochial and insular one - still largely engrossed in talking to itself and to its principal immediate stakeholders - the shareholders, investors and its regulators. Outside this limited stakeholder paradigm, there is hardly much interaction with other equally important stakeholder groups - the government policy-makers, national Treasuries or finance ministries, parliamentary finance committees and consumer groups and watchdogs.

Whatever interaction there may be in the Islamic finance space is limited to the memorandum of understanding between regulators; or between governments in a general economic and financial framework; or cooperation between educational and training institutions. When last did a parliamentary delegation from an Islamic Development Bank (IDB) member country, discuss Islamic finance with a sister parliamentary group from another IDB member country, let alone with a non-IDB member country? How often is Islamic finance policy discussed as a banking and finance issue between intra-IDB member country policy makers and Treasuries?

Unfortunately, the sector is not used to thinking outside the black box which reflects its entrenched parochialism.

This parochialism is not confined at the industry level. It is also rampant very often in the manifestation of turf wars at an intra-national organizational level say between finance ministries and regulators; or between finance ministries and national assemblies; or even between governments and religious authorities as in the policy debacle by the unilateral and arbitrary imposition by Shariat Division of the Appellate Court in Pakistan of the Islamization of the banking system in the country a few years ago, which subsequently failed.

"I want to stress that it is not the Central Bank of Kuwait (CBK) that is delaying the introduction of sukuk and trust laws in the emirate. It is our political masters, the Ministry of Finance that can expedite the passing of the legislation," stressed an official of the CBK recently. Whatever the achievements the global Islamic finance industry has notched up in the last three decades - and some of them have been notable if not spectacular - they pale into insignificance compared with the failures of the industry to engage with arguably the four key stakeholders.

These are the heads of government of the member countries of the Islamic Development Bank (IDB); the Ministers of Finance or Treasury in these countries; the parliaments and national assemblies which debate, vote on and ratify any enabling legislation; and the consumer organizations and watchdogs.

This disconnect between policymakers and the Islamic finance industry is breathtaking.

Under-developed consumer awareness and market education reflects the paucity of the marketing policies and strategies of Islamic financial institutions, who unfortunately too seem to have fallen for the hype of the “Mad Men” of advertising and some of whom are not averse to paying for recognition and commercial awards.

The above shortcomings - in reality, government policy framework risk - are the issues that dare not speak their name. One way to start the ball rolling is for the OIC or the IDB or the IFSB to set up an Inter-Parliamentary Islamic Finance Sub-Committee to promote links and cooperation between parliamentary finance committees in both Muslim and non-Muslim countries in the field of socially responsible, ethical and Islamic finance. This could be an important stepping stone to other connectivities both in terms of the development of the global market and in dispelling misconceptions and fears about Islamic finance in both Muslim and non-Muslim countries.