ISLAMIC BANKS AND ARAB CAPITAL MARKETS
ALA KHANNAK
Islam is the main religion of the Arab world and it is important to note that the emergence of Islamic banking is not only due to the increased awareness of Islam in the Arab world, but is also a symbol of the economic success that was generated mainly from the oil wealth in this region. Practising Muslims are finding it necessary to invest their capital in Islamic financial instruments that are allowed by the Islamic Sharia.
Islamic financing provides for the fair distribution of income arising from the capital of the Arab and Islamic world. The Islamic financial market is a pool of money that has no geographical location, but has a common requirement or need to be looked after in a manner that is in line with the Sharia.
Fair distribution can be achieved by mobilising these funds and raising them from certain parts of the Ai-ab and Islamic world, then utilising them through Islamic banking and finance in other parts of the Arab and Islamic world by investing them in capital markets.
Over the past ten years, the Islamic banking industry has grown at a fast pace. Th e evolution of this sector has seen a transition from the early days of retail banking through to movements to more diverse arenas such as commercial banking and, recently, investment banking. Funds under management are presently about US$70 billion and are growing at approximately 15% per annum.
The dynamics of the movements within the Islamic financial world, the range of institutions operating under this umbrella, and the investors they attract, coupled with the volume and differentiation of the products provided, are strong indicators of its potential. Steps towards the establishment of regulatory bodies in Islamic countries according to the Sharia is a homage to the importance of this industry.
Continued sophistication and the diversity of the product offerings have transformed a collection of niche financial services into a whole-hearted market. More importantly, Islamic banks and financial institutions are fairly liquid, providing a potential appetite for investing in the capital markets of Arab and Islamic countries. This may also be a means to achieve economic development for these, so far, undeveloped economies.
Islamic investment banking is now a growing industry that is making major inroads into project-financing in the Islamic world. But in order to remain healthy, the industry must be discerning in its investments and, as such, there are several factors to be considered by the Islamic banking industry when investing in the capital market of an Arab, or, for that matter, any other Muslim country. Initially, the state of the local economy must be examined. To determine the type of operation and its size, a study of the following economic indicators essential:
• Rate of growth in real terms.
• Budget position and trade position with the rest of the world.
• The size and extent of external debt and local public debt.
• The stage of development of the country’s public infrastructure.
• The local strategy for macro-economic reform.
• The level of liquidity of the local market.
• The rate of inflation and devaluation in local currency.
A later stage in the process would be the assessment of the available opportunities for capital market investments, for example, the existence of a local stock exchange in the country and the size of the market capitalisation. Sometimes there are also opportunities for investing in initial public offerings, given the competitiveness of the local market returns. The introduction of privatisation schemes by some countries is another attractive avenue for investment.
The maintenance of tax incentive schemes where necessary, and the absence of exchange control regulations on repatriation of foreign capital on the part of host economies, can also help create a strong and stable capital market.
Aside from these factors, the existence of a strong legal and financial infrastructure, manifested by the existence of monitoring bodies, taking care of all aspects of local statutory requirements, including the stock exchange and Central Bank regulations, will always be an essential consideration for the users of capital markets in Islamic economies.
Socio-political considerations, as opposed to financial objectives, are contextually recognised by the level of political stability and technological sophistication of the necessary public services.
In order to provide an efficient medium of financial inter-mediation for Islamic countries, the capital markets of the host country should be able to uphold the basic concepts of Islamic financial teachings. Recommendations of local Islamic banks and financial institutions, based, on their respective religious boards, should eliminate the Riba impact from the income arising from capital market operations.
In spite of increased collaboration between Islamic banks and export credit agencies, the World Bank and the IPC’s funding of major projects, the Islamic banking industry will avoid investments in industries not allowed by the Islamic Sharia (e.g., gambling, alcohol and other non-Halal products).
To administer uniformity, the Arab capital markets must be provided with Islamic Sharia-compatible instruments, which need to be developed over time (e.g., through the Association of Islamic banks.)
Research and development are essential for future progress. The Religious Boards of the Islamic banks will have to show a greater understanding of the modern investors’ needs and find solutions within the realms of the Sharia to provide opportunity to the Islamic banks to compete at a superior level with the contemporary system in a more innovative fashion. Only after seeking the approval of its religious board may an Islamic bank obtain discretionary powers from its investors to allow, it to invest in specific capital market operations on a fiduciary basis.
The very nature and criterion upon which Islamic banking is based lends itself to being a competitive industry which has clearly demonstrated its ability to establish a leading position in its own markets against well-entrenched and well-established local competition.
Institutional demand for Islamic banking services and funding is primarily driven by the underlying faith of the investors in the system and their desire to abide by the ethical economic code of Islam.
The scope of involvement is sufficiently wide, and, subject to the approval of an Islamic bank’s religious board, includes trading in the local exchange and public offerings (particularly for industries that will be privatised, e.g., telecommunications, power, airlines and public infrastructure projects). Besides considering other public offerings, private placements and debt for equity swap transactions, and the creation of Islamic equity funds to be invested in Islamically compatible equities can be feasible operations.
The bottom line of these capital market operations depends upon revenue generation in the form of:
• Capital gains on equity trading or public offerings.
• Dividend income on equities.
• Management fees from capital market operations.
• Fees from corporate advisory services, public offerings and private placements; share valuation services; underwriting syndicated financial transactions; and nominee and custodian services.
There is a sizeable opportunity available for Islamic institutions’ operations in the global Arab and Islamic countries’ capital markets. Participation in this area of particular interest can be achieved through an investment banking subsidiary, or a branch, according to the regulations of the country concerned.
Joint ventures with local partners to invest in capital markets, as well as the launching of joint capital market products with local investment banking entities, may also be feasible routes of entry. An initial step may be to associate with one of the leading recognised global investment houses for a local capital market transaction on a deal-by-deal basis.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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