Islamic banks see Iran opportunities

Several foreign banks see huge untapped opportunities in Iran for Islamic finance, spurred on by hopes U.S. President Barack Obama's new approach toward the Islamic Republic will end years of sanctions hampering business.

Home to some 70 million people, Iran might become one of the hottest markets for the industry due to expected privatizations, a need for infrastructure projects and a young population, executives told the Reuters Islamic Banking and Finance Summit.

The U.N. Security Council has imposed three rounds of sanctions on Iran since late 2006 for refusing to halt sensitive nuclear enrichment activities, while the United States has added sanctions to curb business with the Islamic Republic.

But in a sharp change of U.S. policy, Obama has offered a new start in relations.

"I hope that the world leaders will embrace Iran because I think it's (got) great potential for our business," said Simon Eedle, managing director of Global Islamic Banking at France's Calyon.

"We've been present in Iran for many years and we've done business in Iran for many years. We are only constrained by international sanction agreements."

Islamic lenders in Bahrain, a regional center for Islamic finance located just across the Gulf from Iran, couldn't agree more.

"The minute you see a green light from the U.S., everybody will jump in," said Nabeel Kazerooni, head of private equity business at Bahrain-based Gulf Finance House (GFH) GFHB.BH.

MASSIVE MARKET

Majid al-Sayed Bader al-Refai, chief executive of investment bank Unicorn, took a similar view. "I think Iran is a massive market, it's huge, if you don't see that you just don't know the market ... I think President Obama has done a fantastic job so far. If he keeps this up we're on the right track."

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 estimated at between $700 billion and $1 trillion.

Iran's banking system adheres to Islamic rules that prohibit earning or paying interest. Iran uses what are officially termed "provisional" interest rates, as rates paid to depositors or received from borrowers should reflect the profits or losses of a business.

Granted, investing in Iran still presents problems. GFH's Kazerooni said legal and political uncertainties were an obstacle after past ownership deals or terms in privatizations were changed after being signed. "Iran doesn't have a good track record, people are a bit wary," he said.

While the Gulf Arab region has attracted many international banks seeking to tap opportunities in the world's top oil-exporting region, many Western banks have halted or reduced Iran-related business as a result of U.N. and U.S. sanctions.

Yet others still see ways in to a potentially major market.

"With the whole notion of Islam being inclusive, it is almost against the logic to exclude a country and a market of opportunity," said Knut Storholm, a partner at Boston Consulting Group.
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Derivatives dispute divides Islamic finance market

By Liau Y-Sing

KUALA LUMPUR (Reuters) - Islamic banks are struggling to develop hedging tools as religious differences cast doubt on the use of derivatives, exposing the industry to risks of increased volatility as markets deteriorate.

Strict rules on transparency and simpler deal structures saved sharia lenders from the worst of the current credit crisis, but their ability to survive future shocks is in question because they have few instruments to guard against wild swings in currency and interest rate movements.

"To the extent there are not enough sharia-compliant liquidity and risk management products, then clearly Islamic finance would be disadvantaged compared to conventional banks and would be less able to manage their liquidity risks," said Hussein Hassan, head of Islamic structuring at Deutsche Bank (DBKGn.DE).

The $1 trillion (694 billion pounds) industry bans banking structures that are vague or ambiguous to avoid exploitation -- a rule which some argue shuts out the use of common hedging instruments such as currency and interest rate swaps and futures contracts.

But as more markets embrace Islamic finance, and the need for risk protection increases, there are growing attempts to find sharia hedging tools.

More complex derivatives have come under widespread scrutiny by regulators and governments in the West for their role in the credit crisis. Some products have been blamed for spreading risks of bad assets rather than containing them, and amplifying the impact of losses in the financial slump.

Derivatives were a prickly issue in Islam even before the U.S. subprime mortgage market collapsed. Reflective of the diverse interpretations of Islamic law, the industry is divided over the use of derivatives -- and for different reasons.

This has left Islamic institutions with far fewer hedging devices than their conventional peers.

Conservative religious scholars reject derivatives because hedging practices are deemed speculative bets on currency and stock movements which violate the sharia ban on gambling.

These suspicions have deepened with derivatives having evolved from relatively simple contracts such as foreign-exchange forwards to complex tools like credit default swaps, over-the counter-contracts between two parties that bet on whether a company will default on its bonds within a certain time.

The conventional credit derivatives market alone was estimated to be worth some $55 trillion by last October.

With derivatives seen as a key trigger for the financial crisis and ensuring global economic downturn, opinion in Islamic finance may have now swung in favour of the conservative view.

"Just as there are fewer takers for conventional derivatives, fewer Islamic investors are biting at Islamic derivatives," said Hooman Sabeti, an Islamic finance lawyer with Allen & Overy.

"Similarly, new participants in Islamic derivatives with the fortitude to proceed are steering away from more controversial structures and embracing more conservative ones."

Some sharia advisers, however, permit derivatives as long as they are used to hedge risks on existing investments and not for speculation.

The difficulties with this argument are clear.

"Islam encourages you to manage your risk," said Agil Natt, chief executive of INCEIF, an Islamic university based in Kuala Lumpur. "But when does risk management end and gambling begin?"

Derivatives are also avoided as their underlying assets can be uncertain, as many loss-laden Western banks and investors have discovered.

"In Islamic law, there must be something tangible that you are selling," said Mohammad Akram Laldin, a sharia scholar who sits on various sharia advisory boards including HSBC Amanah.

"You cannot be selling something in which you do not know the status of the subject matter."

Last year, CIMB Islamic, the world's top arranger of Islamic debt, launched a forex hedging tool where investors enter into an Islamic transaction with the bank.

The net proceeds -- which are similar to the premium paid for conventional options -- gives investors the right to exercise the option at the agreed rate on the maturity date.

But some bankers say the industry is struggling to find enough Islamic contracts that can be used to create derivatives.

"Most of the contracts that we have today aren't entirely and immediately transferrable towards structuring derivatives products," said Deutsche's Hussein.

"Apart from 'arbun', which is the contract that is used mostly to do options, it's not immediately clear that we've got enough other contracts that can be used to do other things."

Under an arbun contract, a purchaser makes a deposit (which forms part of the purchase price) to buy particular assets at a later date. Should the sale not proceed, the seller keeps the deposit.

Another difficulty is that Islamic finance contracts are subject to varying interpretations due to different readings of the sharia.

The International Swaps and Derivatives Association is working on a template to standardise the main terms for over-the-counter sharia derivative contracts.

"In the Islamic market acceptance has to come from a wide range of independent sharia boards, which might be challenging," said Mahmoud Abushamma, HSBC's (HSBA.L) head of sharia division in Jakarta.
(To read more stories about the growing debate over how to manage derivatives in the West, click on)

(Additional reporting by Harry Suhartono in Jakarta)

Best Individual Islamic Banker Nomination (Islamic Finance News Poll 2008)

Achmad Riawan Amin is the president director of Bank Muamalat Indonesia (BMI) since 1999. He is also the director of International Islamic Financial Market (Bahrain), chairman of Indonesian Sharia Bank Association, and director of the General Council for Islamic Banks and Financial Institutions, Bahrain.

Achmad played an important role in reviving the bank from losses during the monetary crisis. BMI suffered losses of up to IDR105 billion (US$9.6 million), equity was only IDR39 billion (US$3.6 million), while non-performing financing drastically hiked by 65.5%.

Achmad — voted as Best CEO 2008 in Bisnis Indonesia — successfully maneuvered the bank through the difficult condition. In just the second year of his leadership, BMI reaped profits while assets hiked up to 3 times. Now BMI’s assets rose by 400 times to IDR12.6 trillion (US$1.1 billion) and total equity increased to IDR1.3 trillion (US$119 million). BMI possesses 40% of the total profit of the Shariah industry.

Innovation and alliance are Achmad’s keywords. Under his leadership, BMI has increased its outlets from a mere 58 outlets in 1998 to 222 outlets and 3,500 real time online service throughout Indonesia. BMI has an outlet operating in Malaysia. BMI’s innovative product, Shar-E, a Shariah investment was made available in every online post office all over Indonesia, possessesing 47% of the total Shariah savings account. Due to his role and service towards the development of the Shariah industry, he was awarded the Figure of Change 2008 by an author of a bestseller book ‘The Celestial Management and Satanic Finance’ published by Republika. Besides playing a vital role in the construction of the Shariah banking and Sukuk law in the country, Achmad also implemented the interconnection facility among Shariah banks via the Shariah Deposit Arrangement.

Banking with zero per cent interest

The U.S. Federal Reserve and the Bank of Japan have lowered interest rates to almost zero per cent. What is quite rare in conventional banking, however, is the norm in Islamic banks. But the Islamic Finance industry currently also finds itself hostage to the financial crisis.

'Fed cuts interest rates to near zero' - the latest headline triggered by the financial crisis triggered raised eye-brows throughout the world.

With one exception: In the Islamic world, banks working on the basis of Shariah aim to always operate without interest.

While conventional banks borrow at a lower interest rate than they lend out money to the public, Islamic banks aim to generate profit by establishing Profit-Sharing-Accounts, among other forms of financing.

Granting loans is haram in Islam, as is pooling credits and selling them to third-parties. By definition, an Islamic bank cannot hold hedge funds, sub-prime loans or junk bonds in its balance sheet.

Not immune to financial crisis

Is Islamic banking the solution to all the problems which came up in the financial crisis? Are they immune from default? 'Of course not', explains Fares Mourad, Head of Islamic Finance at Zurich-based Bank Sarasin.

'The entrepreneur who gets capital from the Islamic bank in a Mudharaba agreement can also fail, for whatever reason.'

Also, in reality, Islamic banks are unable to isolate themselves from the conventional world. Their size is still infinitely small compared to conventional finance houses.

The total volume of Islamic assets will soon reach $1 trillion, but US banks alone hold about $12.7 trillion. If a client of any Islamic Bank transfers money abroad to a conventional bank, the latter will charge interest. He will not find an Islamic bank in every market, although 500 banks in 75 countries offer banking according to Shariah.

The banking sectors of Sudan, Iran and Pakistan aim to be as close to an interest-free economy as possible. But again, if Pakistan is bailed out with a $5bn-loan granted by the IMF (as it happened on October 23 2008) the money will have to be paid back with interest, certainly.

Secondly, if risk-aversion is rising (as it is now), investors start hoarding cash instead of investing. This mentality affects the secondary Islamic market as well. Take the volume of Islamic Bonds (Sukuk); in 2008, it almost halved to $15.2bn. According to the IMF, the global market for structured finance suffered even more; it dipped by 80% to $387bn.

Saudi banking assets

Nevertheless, developments are also encouraging: Until 2010, $174bn, or half of Saudi-Arabia's banking assets, will be managed in line with Islamic law, according to Sarasin-Alpen, Dubai.

For the UAE and Malaysia, theses shares will be at 24% and a fifth, respectively. More and more non-Muslims are looking at Islamic finance as a non-interest, non-conventional, ethical-style of investment.

But Hari Bhambra, Senior Partner at Praesidum, a Dubai-based regulatory consultancy warns of a copy-and-paste mentality: 'The message of the financial crisis for Islamic banks is clear: Avoid placing conventional products in an Islamic dress with a 'halal'-label. A diluted Islamic finance industry will not only drive clients away, but also put Islamic banks in the same risk environment as conventional banks are.'
Source: ameinfo

Islamic finance: Size will matter in Islamic banking

By Chris Wright

THERE ARE 300 Islamic banks operating in the world today. But this statistic, ubiquitous in presentations about the growth of Islamic banking, is not an entirely positive number: it’s far too high. Islamic banking is enormously fragmented. At the top end, there are: Al Rajhi Bank, with $33.3 billion of total assets in 2007; Kuwait Finance House, with $32.1 billion; and Dubai Islamic Bank with $22.8 billion. But after that, there’s daylight, and you don’t have to go too far down the list to get to the minnows.

Numbers are notoriously tricky to pin down in this field, but in a January study the IMF put total Islamic banking assets at $250 billion, citing several other studies. That’s an average of less than $1 billion of assets for each bank, and with the best part of $100 billion accounted for by the top three alone, there are many banks with very little to their name. "They say that something like 65% to 70% of Islamic institutions are capitalized at less than $25 million," says Agil Natt, chief executive of Malaysia-based Islamic finance training organization Inceif, and formerly head of Aseambankers and deputy chairman of Maybank. "That’s nothing."

Natt continues: "Moving forward, not only do you need balance sheet, but you need reach and the power to distribute the various instruments that you come up with. My opinion is that there is a need for a few large Islamic financial institutions with global reach. But the industry has not reached that stage."

There are the earliest signs of consolidation. This year, Maybank bought a 20% stake in Pakistan’s MCB Bank for $686 million. However, MCB is not actually an Islamic bank: only eight of its 1,026 branches at the time of the acquisition were dedicated Islamic branches.

Consider also the full merger of National Bank of Dubai and Emirates Bank: although there is an Islamic entity in the group (Emirates Islamic Bank), and both banks sell Shariah-compliant mutual funds, this is again a merger of conventional entities that happens to have an impact on Islamic subsidiaries. Likewise Malaysia’s CIMB Islamic, which runs Islamic banking and asset management operations in Indonesia through Bank Niaga: a cross-border presence certainly, but one that sprang out of the 2002 purchase of one conventional institution by another, both banks happening to have Islamic subsidiaries or licences.

There have been signs of Islamic banks becoming more globally minded but they have tended to do this through organic expansion. The clearest example is Al Rajhi and Kuwait Finance House, which have taken advantage of Malaysia’s policy of opening its doors to foreign entrants to establish itself as the global hub for Islamic finance. KFH opened in February 2006, and Al Rajhi a year later. A third bank followed: Asian Finance Bank, which at the time of launch was owned 70% by Qatar Islamic Bank, 20% by Saudi Arabia’s RUSD Investment Bank, and 10% by Kuwait’s Global Investment House.

For KFH, the Malaysia expansion – which has been followed this year by the licensing of an Islamic asset management business – was in keeping with a long-standing and against-the-herd policy of global engagement. Until recently one could have argued that KFH was the only Islamic bank to have expanded cross-border. It holds a majority stake in Kuyevt Bank, an Islamic bank in Turkey, and has operations in Bahrain, Algeria, Saudi Arabia and Morocco and affiliates in the United Arab Emirates, Oman and Bangladesh. Its first participation in Malaysia came in 1995 when it set up a leasing joint venture with several Malaysian partners and the Islamic Development Bank; at the same time it applied for a full Islamic banking licence from Bank Indonesia, but the Asian financial crisis put that on ice.

But the fact is it could have been even more of a trailblazer if it had got its way last year, when it bid to buy a 33% stake in Malaysian financial services group Rashid Hussain. It got as far as striking a preliminary agreement with the seller, Utama Banking Group, and outlined plans to invest a total of M$12 billion ($3.3 billion) in the group and turn it into an Islamic banking powerhouse.

It didn’t happen: Utama opted instead for Malaysia’s key pension fund, the Employees Provident Fund. And so this is still the transaction Islamic banking is waiting for – a truly transformative, intercontinental acquisition to make a global Islamic banking leader. But it’s still possible that one will emerge, and when it comes it’s likely to be KFH that achieves it. The Malaysia managing director Dato’ K Salman Younis said last year that, in Indonesia, "we have identified some target banks where we know the owners desire to divest. There are four or five of them. Once we get the green signal from the parent company, we will be able to move."

KFH apart, though, most other Islamic banks are more sluggish. Al Rajhi’s expansion into Malaysia was all the more notable because it marked the first time it had ventured outside Saudi Arabia. Its behaviour in Malaysia suggests a more ambitious view of the world – it opened with 12 branches, quickly announced plans to get to 50 by 2010, and launched a blanket marketing campaign – but the bank looks less likely to expand by acquisition. Dubai Islamic Bank is growing with gusto – last year it said it aimed to open 70 branches in Pakistan – but again, it’s organic.

So why don’t mergers happen? There are several answers.

First, Islamic banks are just too busy. Most estimates (McKinsey is a frequently cited source) say that Islamic banking is growing by 15% to 20% a year. If you’re doing that, the challenge is finding enough people to run your own business. Why bother acquiring a whole other shop that would need integrating? With growth rates and margins like this, anyone new can set up a franchise from scratch without having to pay a premium for an acquisition.

This is an argument that relates to the maturity of the sector. For the moment, Islamic banks are opening branches and in some cases expanding overseas; the imperative isn’t, yet, to cut costs and improve profitability because margins have been so good. There has also been no need to look overseas when pickings have been so rich at home. But in time, that focus will undoubtedly shift, as the increasing competition from all these players starts to push margins down. That’s when mergers are likely to get more attention as an idea.

The second argument is regulatory, and this applies in particular to anything cross-border. Many Islamic countries have restrictions on foreign ownership, or limit the number of licences that can be awarded to foreign entities.

A third concerns Shariah interpretation. If KFH had succeeded in buying Rashid Hussain, there was much conjecture about how it would have integrated its assets. KFH is considered one of the most conservative institutions in the world in terms of Shariah compliance, and there are marked differences in interpretation between Malaysia and the Gulf, which makes cross-border acquisitions trickier.

For a long time there was a fourth argument: high equity valuations, particularly in the Gulf, made takeovers prohibitive. Still, that argument has gone out the window following the recent plunges in Gulf stock markets along with those everywhere else in the world.

Could the much tougher global environment be the catalyst for consolidation? Islamic banks by and large have come through the credit crunch in good shape, since many of the securities that triggered the sub-prime crisis in the first place are off limits to Shariah-compliant banks. But there’s no escaping the effects completely, and bank growth rates will surely slow. A 20% growth rate can’t last for ever anyway: it’s a function of starting from a low base, and maintaining that pace becomes more difficult with every passing year. Also, we have been in the midst of a period of asset transfer, as more funds have moved across from conventional to Islamic structures as awareness and regulation have permitted. That free kick to Islamic asset growth will be gone sooner or later, and asset gathering will have to come from other sources, perhaps acquisitions.

One possibility is that regulators will become agents for change rather than opponents of it. If they raise capital requirements, for example, or define a minimum scale for Islamic banks, they will drive consolidation; they can further enable it by being more accommodating to foreign buyers. Malaysia brought its domestic conventional banking sector down from more than 50 financial institutions to 10 banking groups in less than a decade.

Logically, mergers should come: this is how the conventional banking world has ended up and Islamic banking, when it reaches a greater degree of maturity, will likely do so too. "There are merits in growing organically, but that takes time," says Natt. "The future is for Islamic banks to look beyond their borders."

Source: Euromoney