Malaysia : The benchmark for Islamic Finance

Malaysia presents a particularly interesting case. Although it has a completely secular financial system in place, the country claims to have the highest Islamic banking growth rate in the world. The government is reportedly aiming at increasing the share of Islamic financial services providers to 20 per cent of the banking and insurance (or Takaful) industry by 2010.

Malaysia has a good chance to be an international Islamic financial centre, Bank Negara Malaysia Governor, Tan Sri Dr Zeti Akhtar Aziz, recently said in Malaysia after launching AmIslamic Bank Bhd, AmBank Group’s Islamic banking subsidiary.

Recent reports have pointed out Malaysia might just lose its status as the world’s second largest Islamic banking hub after Bahrain to Singapore as the island state was actively pursuing this interest by capitalising on its status and strength as a major Asian financial centre.

The Singapore Government also announced two new tax incentives for Islamic finance in its fiscal budget announcements, in order to attract more foreign investors into its Islamic financial system.

Singapore does have an edge because of the progressive methods incorporated by the Islamic scholars there.

“The shift in thinking among the scholars who were able to keep up with modern times and the contemporary requirements and approved novel ‘asset migration’ techniques played a key role in the development of Islamic financing,” according to Mohd Alami Musa, President, the Majlis Ugama Islam Singapura – Islamic Religious Council of Singapore (MUIS).

Singapore has over 100 wakafs, which have more than US$250 million in assets.

The MUIS received recently the Sheikh Mohammed Bin Rashid Al Maktoum Islamic Finance Awards in Dubai for the Musharaka bonds through which the Bencoolen Mixed Development project was successfully executed.

However, even though the global environment is competitive, Malaysia’s Islamic banking is well supported by the people as well as the regulatory infrastructure, which is already in place.

Dr Zeti Akhtar Aziz says Malaysia still has the competitive edge to become the international Islamic financial centre due to the country’s comprehensive Islamic financial system.

Islamic banking assets in Malaysia amount to US$31.37 billion (RM113.5 billion), the takaful assets, US$1.63 billion (RM5.9 billion), the approved Islamic bonds in 2005, over US$11.05 billion (RM40 billion), and the Islamic money market recorded a sizeable monthly turnover of US$37.36 billion (RM135.2 billion).

With two full-fledged Islamic banking institutions and the three new foreign Islamic banking players, Malaysia now has 12 Islamic banking institutions operating under its Islamic Banking Act.

‘10-15 per cent growth is anticipated’

Citibank has been in Islamic financing for over 25 years. The bank’s London operations were set up way back in 1981. Citigroup was also the first international institution to set up a separately capitalized Islamic bank. Citi Islamic Investment Bank E. C. (CIIB) was incorporated in July 1996 in Bahrain, as a 100 per cent owned subsidiary of Citigroup. Usman Ahmed, Deputy CEO of CIIB tells Michael Clarence in Dubai how Citi views the future of Islamic Finance. Excerpts:

What prospects does Citi see in Islamic finance?
We have long-term commitment to Islamic banking. The industry continues to grow from a geographic as well as product perspective.

At what rate do you think Islamic financing will grow worldwide?
Currently, Islamic financing is estimated to be in the region of US$300 billion to US$350 billion. While the industry size and historical growth has not been precisely documented, it is expected to continue growing at the estimated historical rate of 10-15 per cent per annum in the foreseeable future.

How difficult it was for a global bank like yours to ease into Islamic financing?
As mentioned, Citigroup has longstanding involvement and commitment to Islamic banking. More and more international banks are offering Islamic financing instruments through Islamic windows as the industry gets increasingly integrated with mainstream capital markets. There are no significant barriers to entry for an international bank to venture into Islamic banking.

What Islamic financing products do you currently offer? Is the demand for your products increasing in the Arab world?
Historically, we have focused on Islamic corporate and project finance, capital markets, advisory and derivative products. Citigroup has been a leader in Islamic structured debt transactions and has played a pioneering role in the development of the Sukuk Market.

Can you point out major Shariah-compliant deals led by Citi Islamic in the past few years?
With CIIB’s active involvement, Citigroup was lead-manager and bookrunner on four out of five sukuk offerings in 2004, including the Dubai Civil Aviation US$1 billion debut sukuk offering, the Bahrain Monetary Agency (BMA) US$250 million issue, the Saxony-Anhalt Euro 100 million debut offering and the Government of Pakistan US$600 million Sukuk.

We have also arranged for a US$260 million Islamic component for Sohar Aluminium last year out of a total financing facility of US$1.58 billion. In 2005, CIIB was the mandated lead arranger and bookrunner for US$1 billion Islamic loan for Dolphin Energy Ltd. While the general syndication was done last year, some parts of it were completed during the first quarter of 2006.

Which countries in the Arab world have the potential to become like Malaysia in Islamic financing?
We are talking about slightly different market dynamics here. In Malaysia, there is a regulatory focus on increasing the share of Islamic banking assets to 20 per cent by the year 2010. And Malaysia has a large domestic capital market. The Middle East is largely US Dollar-denominated, as most regional currencies are pegged to the dollar. The domestic capital market is therefore not as large as that of Malaysia where most Islamic issuance is Ringitt denominated under regulatory encouragement and supervision. The Bahrain Monetary Authority (BMA) for a long time, and, of late, the Dubai International Financial Centre (DIFC) are playing important roles in developing Islamic capital markets and encouraging the setting up of new Islamic banks and windows.

What is Oman’s status in the Islamic financing world?
We have recently closed the first Islamic tranche for an Omani issuer – this is a US$ 260 million Islamic facility for the Sohar Aluminium project. It is part of an overall deal of US$ 1.58 billion.

Has the Citigroup Dow Jones Islamic bond index been successful so far in helping create a benchmark for sukuks?
The index was established to promote secondary market liquidity of existing Sukuk issues and encourage future issuance. It will also serve as a benchmark for measuring and tracking performance as well as a reference point for developing Islamic derivative and investment products.

Even though the Sukuk market has made great strides in the recent past, it still has a long way to go and such initiatives will serve to accelerate the pace of integration of Islamic finance with mainstream capital markets.

There is an opinion that most of the time, Sukuks are 5-year floating rate notes (FRNs). Fixed coupon and government Sukuks are rare. Thus, a benchmark all across the yield curve is not possible yet. What is your view on this?
It is true that most Sukuk issuance to date has been on a five-year, FRN format. However, in future, we do anticipate issuance across the yield curve as the scope of the Sukuk product expands. The recent US$3.5 billion PCFC Sukuk has a tenor of two years. We can also expect to see real estate and project financing Sukuk issues with longer tenors in the imminent future.

Talent Hunt: A Challenge

Western investment bankers, according to recent media reports, are on a talent hunt. They are scouting for financially-literate Islamic scholars. Leading banks in the West, say reports, are moving quickly to locate Islamic experts who can issue religious edicts approving new financial products, such as “Islamic” bonds, loans or hedge funds.

One of the key challenges with Islamic finance or banking is that there are very few Islamic scholars who command enough religious respect to issue fatwas, understand the complexities of global structured financial products, and have the kind of language skills required to read the necessary market documentation in both Arabic and English.
Finding qualified personnel to create, monitor, and administer Shariah-compliant products and services often means training conventional bankers (they may not even be Muslims).

Although a number of universities in Muslim countries offer business courses guided by Islamic principles, the industry stills lacks widely recognized certification programs.

This shortcoming, coupled with the fact that investment bankers are rushing to expand their business in the Middle East amid an oil price boom, ensured a real shortage of Islamic scholars, who are hard to get. Being short in supply, they are reportedly being constantly whizzed around the world in planes.

According to Humayon Dar, managing director of the Dar Al Istithmar insitute, a London-based Shariah consultancy, “There are perhaps 150 (such scholars) worldwide who are involved with Islamic finance but only 20 are internationally recognized.”

Islamic Finance: Some Key Concepts

The Principle Of Mudarabah
Mudarabah is a profit-and-loss-sharing contract whereby a professional manages the capital of a group of investors. In Islamic banking, the bank acts as a mudarib (entrepreneur-borrower) and manages the funds of the depositors in order to generate profits, in which the depositors share. The bank uses the depositors’ funds on a mudarabah (profit-sharing) basis. That is, the bank acts as both the entrepreneur-borrower on the saving side of the equation and as the rabbul-mal (owner of capital) on the bank’s investment, or asset portfolio, side.

The Principle Of Musharakah
The second pillar of Islamic finance, Musharakah, is similar to the conventional concepts of partnership and joint stock ownership. For example, Muslims seeking home financing at Shariah-compliant banks enter into contracts incorporating musharakah structures. The three most popular are declining-balance co-ownership, lease to own, and instalment credit.

In Islamic law, Riba is defined as excess, either in quantity or term, in the counter-values of whatever is exchanged—currency, commodities, goods, or anything else — in a variety of sales, purchases, swaps, or loans. In one explanation, riba is forbidden because it is predatory or exploitative, and produces profit at another person’s expense.

Risk Sharing
Contrary to popular perception, Islamic banking is not monolithic, nor can Islamic finance be neatly summed up as a prohibition against charging interest (riba), as it is often portrayed in the media. Riba, as described in Islamic jurisprudence, is a forced, or demanded, exchange of quantities that gives one party an advantage over another. Because it can be predatory, riba is considered unjust. For example, riba in a loan is prohibited because the lender is guaranteed a profit whether the borrower has gained or lost on the transaction. Conventional mortgages are regarded as exploitative in part because the mortgage-holder does not share in the homeowner’s risk.

IF: Key Facts

• A multi-billion dollar global industry
• Assets estimated in excess of US$400 billion worldwide
• Expected to witness double-digit growth in coming decades
• Presence in over 75 countries
• Over 300 Islamic financial institutions in the world
• Muslims (and non-Muslims) can now obtain Islamic credit cards
• Muslims (and non-Muslims) can insure themselves and their property Islamically
• Muslims (and non-Muslims) can invest on line in Islamic funds
• Muslims (and non-Muslims) can now track their investments Islamically
• Muslims (and non-Muslims) can even get a Sharia-compliant mortgage from a US firm

Expensive Affair

Not many know that Islamic Finance is more expensive compared to its conventional counterpart, says Rajeev Singh, Partner, Ernst & Young, Oman. “A couple of clients in Oman have chosen to have financing with Islamic banks. The most recent is the case of a client who is paying 3-4 per cent higher finance charges only because he wants to have IF as part of his portfolio,” he adds.

According to Farmida Bi, a partner at the Denton Wilde Sapte law firm in the UK, “It’s hard to get hold of Islamic scholars and their fees are getting higher.”

The fees charged for Shariah advice are a closely guarded secret. However, some investment banks say they have paid up to US$500,000 for advice on large capital markets transactions, a dramatic increase from the levels seen a few years ago.

source : oer

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