THE ISLAMIC FINANCIAL AND CAPITAL MARKET DEVELOPMENTS
JASSAR AL JASSAR
The Islamic financial market is a pool of money that has no geographical location but has the common requirement or need that it is looked after in a manner that is in line with the Islamic Sharia. It has, however, important penetration in some markets, where it commands a market share of up to 30%.
This is the case today primarily in countries of the Arabian Gulf, which means they are the major contributors to this market where growth has been predominantly the result of increasing market share. However, considerable growth is coming gradually from other markets, such as Malaysia, Egypt and Pakistan, as a result of the general growth of private wealth in these markets.
The Market and its Development
Islamic banking is an industry that has evolved, developed and grown, and is here to stay. The industry is about 15 years old, manages approximately $50 to $80 billion dollars and is growing at approximately 10% to 15% per annum. It is my belief that Islamic banking will be responsible for managing up to 50% of the savings of the Islamic world in the coming five to ten years.
The growth of Islamic banking is not a reflection of the growing awareness of Islam. It is the result of economic growth in the Islamic world, fuelled primarily by oil wealth. This growth created a growing middle-wealth segment and hence made banking a necessary service to the larger segment of the population rather than a service for the few, as had been the case some 10 to 15 years earlier.
In this case, with banking becoming a necessary service for the majority, it became inevitable that the problems of conventional banking and its conflicts with Islamic values came to the surface, leading to attention and research being directed to redress the issue.
This can be clearly noticed by the fact that Islamic banking is most advanced, and has achieved the largest penetration, in those Islamic countries or societies that have achieved a higher level of per capita income which is reasonably better distributed, i.e., markets that have a large and reasonably well-off middle-income group. (Examples are Kuwait, Malaysia, and Egypt).
• Th e different types of financial institutions operating in this market.
• Th e entry of institutional investors.
• Th e increasing number of instruments and products.
• The way regulatory bodies are dealing with the market.
• The way financial authorities are targeting to attract it.
A number of developments will continue to feed this growth, the chief among these being:
1 Continued economic growth in some parts of the Islamic world and the growing size and wealth of middle-income groups in these countries.
2 Transfer of wealth, especially in the oil producing countries, from the state to the private sector This is very much the case today, with most governments running major deficits, and wealth becoming predominantly privately owned.
3 Institutional demands for Islamic banking services are driven primarily by the underlying demand of clients. A clear example of this is pension funds, where subscribers are demanding that their long-term savings be invested in an Islamically acceptable manner
4 Growing support to the industry by monetary authorities as a result of the growing realisation of the value of Islamic banking as both:
(i) A competitive and growing local industry that is being attracted to base itself in these markets; and a highly differentiated local and regional industry that can survive an open competitive market in the face of international competition.
This is clearly demonstrated in the industry’s ability to establish a leading position in its own markets against entrenched and well-established local competition and the experience in Turkey of a few GCC financial institutions that were able to establish a local presence profitably in an over-banked market, and a market where all major international players were present and competing.
(ii) An efficient financial inter-mediation and increased collaboration between Islamic banks and export credit agencies, the World Bank, and the IFC, into funding of major projects.
4 Islamic banks are becoming some of the largest private sector financial institutions, with growing networks (through branches and/or subsidiaries) within the Islamic world.
5 Last but not least, this market is also developing its own inter-regional export finance, investment, insurance and development finance schemes.
Future Focus
Looking into the near future, the key focus is on the development and expansion of the long-term funding capability of the Islamic market and encouraging the development of a reasonable inter-bank market.
1. A Long-Term Capital Market
As the market gets more competitive, the industry is forced to go towards project finance, which is mainly medium- and long-term in nature. This is currently being funded through the commercial banks’ balance sheet and has reached, or will soon reach, saturation.
However, the recent entry of institutional investors such as pension funds and insurance companies has brought new sources of long-term funding. This too will start to dry up and the industry will have to revert to innovation in products to expand the market further. There are two key risks that, if dealt with well, can increase the availability of long-term funding from all its original sources (commercial Islamic banks and institutional investors). These are:
a) Liquidity Risk
Institutional investors and Islamic banks can provide more long-term funding if these investments or transactions can be liquidated when needed. For equity investments, this is straightforward because under the Islamic Sharia debt can only be traded at face value, which gives no incentives to buyers, and since most Islamic financing instruments (Murabaha, Istisna, Salam, etc.) end up with future cash flow in the form of receivables, they do not lend themselves readily to secondary trading.
However, leasing, one of the most flexible Islamic financing structures, does allow for the trading of future cash flow at any price that is agreed between seller and buyer This is because one is selling an asset (the leased asset) with its associated cash flow and not the cash flow itself.
b) Return Risk (interest rate risks)
Another key concern with providers of funds, which if addressed properly can help them allocate more funds to longer-term investments, is their need to keep their earnings current with market returns, otherwise if the returns to their investors drop below that of their competitors, they risk losing their clients to competition and are faced with liquidity risks, and this is especially true with the commercial banks.
Here again, the only instrument that can solve that is leasing, if one could enter into a lease that is re-priced annually, something that one cannot do with a receivable under the Islamic Sharia.
This is why one can expect further growth in leasing, securitisation and listing of leasing transactions. Others, where these transactions are pooled, are in a vehicle with receivables generated from the other modes of financing after which the pool is securitised and traded.
Inter-Bank Market (placement and funding)
The development of an active inter-bank market still needs some time but will revolve primarily around three key solutions:
1. Short term deposits by one bank with the other bank, which is the easiest concept but will not really take off because it is difficult to determine the potential return to the investing bank by analysing the profitability of the other bank. This requires information that is rarely available.
2. The investment in securitised paper that is listed and traded in the market, and where banks that need further funding will securitise more of what they generate in business. Those that have surplus liquidity will buy. To enhance the sale of these instruments and their pricing, the selling bank can add its guarantee on the receivables that the securitised pool is made up of.
3. The trading of securitised government receivables generated by the Islamic banking industry.
The Islamic market has grown to a substantial size and is today an important and useful part of the global market. Although different in a number of ways, it is these differences that, in my view, make it of interest. The key features that this market offers, and that are special and complementary to the global market, include the following:
1. A Different View to Risk
Risk is very much a perception, which results from a better understanding and ability, or capability, to deal with different types of risk. Distancing oneself from the risk itself, while decreasing the first-hand knowledge and its understanding, increases one’s perception of that risk.
This is clearly evident in the fact that the Northern American market is the most competitive provider of capital to Eastern Europe and similarly Japan to Asia etc. This is also true of the Islamic market and the Middle East, North Africa and the Near East.
As such, for those regional and multinational players operating in this part of the world, having access to the Islamic market is important from a competitive point of view and sometimes the only source of capital for some regional risks.
Interestingly, the Islamic market is growing, and as it does, what it considers local and hence lower in risk will include a larger part of the globe. Islamic banking began as a geographic phenomenon, predominantly in the Gulf countries and Egypt. It now covers most of the Islamic world, from North Africa to Turkey, across Pakistan, all the way to Malaysia, Indonesia and Brunei.
By the end of this century Islam is predicted to become second only to Christianity in the USA, in terms of numbers of adherents. If one also thinks of Europe, one gets a feel of where the growth to this market might come from, and how this market will be perceiving risk that it may now be considering as foreign.
A Different Risk Book
The Islamic market does not participate in internationally distributed financial transactions and hence, might have more demand for investment-grade types of risk that it likes but does not hold enough of on its books. This will result in more aggressive pricing by the Islamic market for these risks when they are structured to allow it to invest. In such a case, a corporate can improve its cost of funding and spare its conventional funding sources.
Difference in Growth Patterns
The Islamic market has different growth patterns, and while, during the last few years, the conventional banking industry was consolidating and healing its wounds, the Islamic market was growing and seeking new business. Corporates that have had access to the Islamic market have been able to reduce the impact of the tighter lending policies of the conventional market. This makes the Islamic market a good diversification tool.
Different Structures
Although, in many ways, achieving the same financial results. Islamic financial solutions follow different structures (some more familiar than others) to achieve the same result. These different structures sometimes offer a more favourable accounting treatment on the books of the borrowers, or structures that can sometimes solve more efficiently certain needs.
Better Harmony with the Local Market
For corporates doing business or managing ventures in the Islamic world, Islamic banking offers opportunities to global players to work locally and remain in harmony with local environments.
For those contemplating direct investment in the Islamic market, there are sometimes regional investment insurance schemes available. For those targeting to sell to countries in the Islamic world, where the competitive edge lies with those that are able to supply export credit, the answer might be in setting up ventures in some Islamic countries and adding some value to the product locally.
For those contemplating direct investment in the Islamic market, there are sometimes regional investment insurance schemes available. For those targeting to sell to countries in the Islamic world, where the competitive edge lies with those that are able to supply export credit, the answer might be in setting up ventures in some Islamic countries and adding some value to the product locally.
The Islamic market is a fast-growing and sizeable niche of the global capital market. It is different in its approach, but it is these differences that make it so much more interesting in many ways and it is important for all regional and multinational players to develop a capability to tap this market.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
Comments
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.