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Corporate Islamic Finance:
The Good News and the Bad News

Rafi-uddin Shikoh , Posted, July 20th, 2005

For those in the corporate world looking for Islamically or ethically correct business financing, the good news is that the Islamic Finance industry is booming with a suite of products that are fast maturing. The bad news however is that the most prevalent products are often the most controversial ones in terms of their Islamic adherence or ethical impact. In addition, these products are often far costlier than their conventional counterparts, while the least controversial ones, although available and growing, are least offered.

Growth & Potential:  

Whatever the issues may be, Islamic Finance is fast establishing itself as a major player in the global financial market. According to the IIIF (www.iiff.net), there are over 265 Islamic Banks or institutions operating in 40 countries with total assets estimated at US$262 billion. Some estimates put the growth annually at 15%.  

Western nations are taking serious interest in Islamic finance as well. Global players Citibank, HSBC and others are already tapping into the market while the British government has made legislative changes to allow Islamic banks to operate under Shari'ah law and the US is expected to provide a supporting regulatory framework as well. 

For the corporate market, Islamic finance now supports all major needs including leasing, project finance, asset financing, bond issuance, and insurance. IFIS (Islamic Finance Information Service), an information service provider providing proprietary tools and research to the industry, estimates that Islamic corporate bond issues (Sukuk's) so far in 2005 stand at US $5.48 billion, with the overall sector (corporate and sovereign) expected to grow by 33% by the end of 2005.

From a stability and credibility point of view, various regulatory measures and agencies are taking shape, and there is also a move by the Malaysian market to introduce international standards to ensure that Islamic banking products are compliant with Shari'ah principles. 

All these facts are signs of a maturing industry. However, total assets under Islamic Finance today are still a trickle within the global financial marketplace. The potential however is tremendous given a market of 1.4 billion Muslims and others seeking ethical financing options globally.  

Who's Who?

The industry is most mature in Malaysia and the Gulf countries of Saudi Arabia, Kuwait, the UAE and Bahrain. There is also a high degree of growth and maturity in Pakistan, Iran and Indonesia. Turkey's market meanwhile is in the infancy stage while Islamic Fianance is fast emerging in the Levant, as well as Britain, Singapore and the US.

Some of the leading IF market players include Al Rajhi Banking & Investment Corp (Saudi Arabia), Bank Melli (Iran), Kuwait Finance House (Kuwait), Bank Islam, and Bank Muamalat (Malaysia). (See the IFIS ranking of Islamic banks by shareholder equity)

Ranking of Islamic Banks BY IFIS - www.securities.com/ifis By Shareholders' Equity 2003 - USD$ '000 Ranking Commercial Islamic Banks Country Shareholders Equity 1 Al Rajhi Banking & Investment Corp Saudi Arabia 1,932,988 2 Bank Melli Iran 1,322,035 3 Bank Saderat Iran 1,032,859 4 Kuwait Finance House Kuwait 965,615 5 Bank Mellat Iran 499,729 6 Dubai Islamic Bank UAE 462,329 7 Abu Dhabi Islamic Bank UAE 381,264 8 Bank Islam Malaysia Malaysia 292,928 9 Shamil Bank Bahrain 281,980 10 Bank Tajerat Iran 260,184 11 Bank Sepah Iran 252,614 12 Bank Al Jazira Saudi Arabia 236,009 13 National Bank of Sharjah UAE 184,194 14 Al Amin Bank Bahrain 169,379 15 Qatar Islamic Bank Qatar 148,836 16 Bahrain Islamic Bank BSC Bahrain 106,070 17 Bank Muamalat Malaysia Malaysia 92,912 18 Qatar International Islamic Bank Qatar 85,920 19 Jordan Islamic Bank for Finance & Investment Jordan 80,371 20 AlBaraka Islamic Bank BSC. Bahrain 59,875 21 ABC Islamic Bank Bahrain 30,000 22 Bank Muamalat Indonesia Indonesia 29,553 23 Meezan Bank Pakistan 28,512 SOURCE: IFIS - Euromoney Institutional Investor Plc (www.securities.com/ifis)

Growing cross-regional Islamic banking is expected to improve efficiency and strengthen global integration of the Islamic banking systems. Recently, Malaysia issued banking license to three outside parties namely, Kuwait Finance House, Al Rajhi Bank (Saudi based) and a consortium led by Qatar Islamic Bank to compete in its market. This is also driving the development of cross-region industry regulations and standards. 

Corporate Offerings 

Islamic corporate finance offerings are based on various types of Islamic contracts that have usually been developed and endorsed by a bank's own Shari'ah board of Islamic scholars. This practice has resulted in certain contract types that have become common across the industry.  

Asset financing, working capital needs, and letters of credits are mostly based on the Murabaha (Cost plus profit) contract type. Corporate Bonds are based on Sukuks, Leasing is provided through Ijarah, Insurance/ Risk Management through Takaful, whereas, joint ventures or venture capital are facilitated through Musharakah or Mudarabah contracts.  

However, no standardization body yet exists to validate and set quality standards against an institutions contract designs. As a result perhaps, there are certain contract types that have many critics from amongst the Islamic scholars in relation to their adherence to the spirit of the Islamic law or their ethical impact, whereas there are certain others that are, for the most part, universally accepted. 

Prof Dr Saiful Azhar Rosly, an Islamic Finance expert and now the Director of Research at the Malaysian Institute of Economic Research, says that the most popular type of contracts being offered today are the Murabaha (almost 80% plus) and the least developed, although available, are the Musharakahs (Joint Ventures). He also points to the existing public unease with Islamic banks with credit-Murabahahs, where profits may be acquired on time value of money (a concept that money diminishes in value over time is argued by some scholars to contradict Islamic law). This shows that the risk appetites of Islamic banks are still on the low side - thus shunning Musharakah JV.  

Prof Rosly sighs, "This is rather sad."  

Key Challenges: Regulation, Cost, and, Perception 

Mr. Rushdi Siddiqui, Global Director, Dow Jones Islamic Indexes, says that Islamic corporate banking is still an emerging area.

As a recognized industry leader he sees improved Shari'ah structures [within a regulatory environment], lower costs and less paperwork as the key next areas of development of corporate Islamic Finance. He also points to massive training that's needed for corporate staff on various Islamic structures, as well as IT systems that must be in place to support them. Ultimately, he says the onus is on Islamic banks to convince clients to use Islamic contracts for corporate needs. "Islamic Finance has to prove itself, as it will be client driven," he says.  

The industry probably gets a low grade so far on building a convincing value proposition for corporate clients. As it is, the general public perception has been at best luke-warm when compared to the potential size of the market. Taking the market in the UK as an example, a survey conducted by the Department of Economics, Loughborough University, in which 503 Muslims in 10 English cities were questioned, concluded that only 5% of the 1.8 million UK Muslims are seriously interested in Islamic finance. Dr Humayon Dar, a lecturer in Islamic economics at Loughborough University, identified the main reasons for the lack of interest from Muslims as too little knowledge of Islamic finance; Islamic finance being more expensive than conventional instruments; and too few comparable products compared with conventional finance.  

Adding to the confusion to the poorly informed consumers are the critics of the Murabaha contract type who argue that the Murabaha contract is simply interest-based disguised and repackaged. Tarek El Diwany, an Islamic finance practitioner and author of The Problem With Interest and editor of Islamic-finance.com is one such critic.

This in affect has also diluted the acceptance of those contract types such as Musharakah and Mudarabah that are considered more pure to the spirit of the Islamic finance laws. 

Given the ideological basis of Islamic finance, which is in support of an ethical and a 'just' financial system that prohibits a culture of debt slavery and puts shared failure risk responsibilities on the borrower and the lender, the question is if the industry itself is part of the problem and might be disillusioned itself?  By not establishing clear integrity around its ethical and divine underpinning and not communicating its value proposition effectively to its market, the IF industry is in essence doing a disservice to its own potential.  

Building upon the successes

In the end, for those corporate customers seeking Islamically or ethically correct business financing, the good news is that there are a mature set of options including those that do not have any controversies associated with them. The drawback is, until the industry does a better job of communicating it to the masses, the customers have to do their own extra bit of figuring out how to evaluate and best integrate the options within their current environments. 

This puts a huge set of responsibility on today's Islamic Finance leaders, such as those gathering at the 8th International Islamic Finance Forum (IIFF) in Istanbul this fall, to continue to improve clarity and convincingly communicate the value proposition to the market.  

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