Unaffected by the banking crises stalking the US and Europe, and despite the massive structural changes taking place in the global economy, financial services in the oil-rich Gulf states are booming. As record profits in the Gulf contrast sharply with losses in the West, Islamic finance is providing a huge new stimulus to one of the world’s fastest growing financial regions. As the world’s top banks, such as Citigroup, look to the Gulf states for financial support, Gulf investors are looking to Islamic banking to provide new growth opportunities. In the past year or so, a plethora of new Islamic financial institutions, both retail and investment banks, have sprung up from Bahrain to Dubai and Abu Dhabi. Even traditional banks are jumping on the Islamic bandwagon with new Islamic windows and products.
Critical mass
From a virtual concept 20 years ago, Islamic finance has now achieved a critical mass. According to The Banker’s Top 500 Islamic Financial Institutions listing last November, the global total of sharia-compliant assets grew by 29.7% in the previous year to reach $500.5bn. Make no mistake, Islamic finance is still in its infancy, its assets are still relatively tiny compared with those of traditional finance. And the Islamic financial industry is not only fast becoming a key component within Muslim economies but is also developing – especially through sukuks (Islamic bonds) – a distinct new asset class in non-Muslim markets.
The surge in new Islamic institutions comes at a time when the economic boom of the six states of the Gulf Co-operation Council (GCC) is likely to be sustained well into the medium term. The January report on the GCC by Washington-based think tank the Institute of International Finance (IIF) says: “High oil prices are facilitating a surge in investment and the significant number of major projects underway will provide momentum for robust non-hydrocarbon growth (notably real estate, trade and finance and tourism) for several years to come.
We estimate that the GCC’s non-hydrocarbon sector will grow by about 14% in nominal terms this year, mirroring the rise in overall gross domestic product (GDP) growth. At around $900bn, the area’s 2008 nominal GDP will be more than double that recorded as recently as 2003.”
The explosion in growth in the region is clearly being reflected in Islamic finance, where well-established local players, such as Dubai Islamic Bank, have grown their businesses tenfold in the past six years. The coming of age and the prospects for Islamic finance are well summed up by new Dubai Islamic Bank group managing director Khaled Al Kamda: “Today, Islamic finance accounts for 12% to 13% of the United Arab Emirates (UAE) financial sector but we expect that figure to grow to between 20% and 25% in two to three years.”
Growth prediction
Michael Tomalin, chief executive of National Bank of Abu Dhabi, the UAE’s biggest bank prior to the merger of two Dubai banks last year to form Emirates NBD, has recently established an Islamic window and is about to set up an Islamic finance company at his bank. He believes that Islamic finance could account for 25% to 30% of the market in five years, nearly double its share today.
“Growth will go through the roof,” says Asif Mumtaz, regional head of HSBC Amanah, the global Islamic banking division of HSBC Group. Emphasising the strong market support at all levels, he adds: “Islamic institutions are growing at twice the rate of conventional [banking] businesses; basic growth of Islamic firms over the last four years has been 20% to 22% compared with 11% for conventional banking business.”
HSBC aims to be the leading provider of Islamic banking worldwide and HSBC Amanah was ranked 14th in The Banker’s recent Top 500 Islamic listing with $9.7bn in sharia-compliant assets, 17.2% up on the previous year.
Although HSBC Amanah and other international banks, such as Standard Chartered, are keen to carve out a piece of this new expanding market, the key drivers are the already established Gulf institutions. It is those institutions that are seizing the opportunities available in the region, along with a host of dynamic new institutions that feel that there is still a huge gap in the market for Islamic financial services.
In January a new giant was launched in Dubai with huge global ambitions. Starting big with a paid-up capital of Dh3.6bn ($1bn) and a staff of 400, Noor Islamic Bank represents another formidable initiative from the Dubai government which holds, through Dubai Group and Dubai Investment Corporation, 50% of the new full-service bank that will initially focus on consumer and corporate banking.
Noor Islamic’s aim is not modest. As group chief executive Hussain Al Qemzi says: “Our strategy is to become the largest global Islamic bank.”
International footprint
Initially, Noor is offering its services through a 10-branch UAE network, with plans to expand to 20 branches this year. But in time it intends to extend its footprint in the region and in Europe, Asia and north Africa. “The board has a remarkable vision to position the bank as the world’s leading Islamic financial institution, focusing on sharia-compliant financial services that are complemented by a solid customer-centric approach,” he says.
Mr Al Qemzi, an experienced banker who was previously at Sharjah Islamic Bank, is bullish about opportunities in China (with more than 50 million Muslims), Pakistan and Indonesia. “China has high potential and Pakistan is a large market that we cannot ignore but we have not yet applied for a licence in Pakistan,” he says.
Noor is looking to expand both organically and through acquisitions and Mr Al Qemzi says that he expects to see the GCC market open up more, which will help the bank’s expansion.
With cutting-edge IT infrastructure developed in record time with iFlex systems, Noor is well placed for expansion and has started with a widespread range of 41 financial products. But although Mr Al Qemzi is long on ambition, he is short on specific growth plans or acquisition strategy. How such a large start-up can meet its expectations, even with huge growth in the region, remains to be seen. Nevertheless, retail is expected to maintain a 50% to 60% business share in the coming years, and as Mr Al Qemzi concludes: “It is all about mass.”
New Abu Dhabi giant
On the subject of mass, the Abu Dhabi government has launched plans for another new Islamic giant, the $1.1bn Al Hilal Islamic Bank. Details of this move are not yet clear but a long-established Abu Dhabi bank, Al Masraf (formerly called Arbift), is adamant that it wants to follow the regional trend and move in the Islamic direction. Al Masraf, which is owned by the governments of the UAE, Libya and Algeria, is planning to establish an Islamic subsidiary to enable it to do Islamic business. With the growth of the sukuk market and the highly competitive UAE banking market, traditional banks, such as Al Masraf, are feeling the market pressure and want to offer an increasing range of Islamic products or even take a bigger step and turn themselves into Islamic banks.
With Al Hilal, the number of Islamic banks in the UAE has increased to seven. Emirates Post has become the latest to join the fray, announcing plans to apply for a banking licence to create a postal Islamic bank this year.
Healthy gains in Bahrain
Bahrain, which vies with Dubai for leadership in Islamic finance, is also forging ahead with new players, especially in the investment banking arena. The country’s Islamic banks are also posting healthy gains, according to a recent Central Bank of Bahrain report, with consolidated on-balance sheet assets totalling nearly $18.8bn in October 2007, a year-on-year increase of a significant 85%.
Last June, a new Islamic investment bank, Global Banking Corporation (GBCorp), was set up in Bahrain by a group of Saudi investors with a large paid-up capital of $250m and a vision to be the leading investment bank in the GCC. With 52 staff at the end of January, GBCorp hopes to use its unique group of shareholders to create superior access to deal flows and to focus on core business areas of private equity and venture capital, real estate and infrastructure development, asset management and advisory services.
The bank’s chief executive, Mark Hanson, formerly at Saudi Hollandi Bank in Riyadh, sees GBCorp as a bridge bank, not only in the GCC but also in Europe and Asia, China in particular.
The bank’s first major deals were the sale of the prestigious Aston Martin car company and more recently the purchase of its headquarters building in the new Bahrain Financial Harbour complex. Why did GBCorp choose an Islamic path through Bahrain instead of Dubai? Mr Hanson cites the good regulatory environment in Bahrain and shareholder preferences.
Although Dubai creates considerably more financial noise, many still view Bahrain as the prime Islamic financial centre with its strong regulatory history and the presence there of key Islamic financial organisations, such as the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the Islamic International Rating Agency, which strengthen its Islamic credentials.
Another relatively new Islamic investment bank in Bahrain has recently been instrumental in some ground-breaking deals that emphasise the growing strength and importance of Islamic finance both in the region and elsewhere.
Unicorn Investment Bank, founded in 2004, was structuring adviser and joint lead manager last July on a landmark $1bn sukuk issue for Dar Al-Arkan Real Estate Development Company in Saudi Arabia. The deal was significantly oversubscribed, raising $1.5bn, and its success represents the demand that exists globally for well-structured sharia-compliant investments.
Unicorn expands
More recently, Unicorn announced the acquisition of major equity stakes in two electronics and microchip manufacturers in California, as well as the creation of a $350m strategic acquisition fund. In January, Unicorn closed a $125m, three-year syndicated commodity murabaha facility arranged on its own behalf by Dubai Bank and Austria’s RZB. Significantly oversubscribed and raised from $100m, the facility attracted 50% of subscriptions from non-GCC institutions.
Unicorn CFO David Pace said: “The overwhelming success of this syndication, given the current global liquidity squeeze, and the participation of such a broad range of institutions, both regionally and internationally, attest not only to the strong reputation that Unicorn enjoys but also to the growing international importance of Islamic finance.”
In further significant developments, another established Bahrain Islamic investment bank, Gulf Finance House (GFH), has just announced its most profitable year ever with a net profit in 2007 of $340m, a 61% increase on the previous year. GFH, with a return on equity of 44% and a return on assets of 18% in 2007, has succeeded in maintaining its focus on creating real value from infrastructure projects in the Gulf and elsewhere.
Growth strategy
Projects such as the $10bn Mumbai Economic Development Zone, which includes Energy City India, and the $3bn Tunis Financial Harbour at Tunis Bay, the site of north Africa’s first offshore financial centre, are key parts of GFH’s growth strategy. “The concept and ethos of Islamic banking dovetails very nicely with the needs of the region to develop its economic infrastructure,” says Peter Panayiotou, acting chief executive of GFH.
GFH is also active in projects in Dubai, Qatar, Saudi Arabia, Libya and Algeria. Mr Panayiotou says that the risk-sharing principles behind Islamic banking can have broad appeal. “There is a paradox as the ethos behind Islamic banking and the sharing of risk and reward is more aligned to US business attitudes than to those in Europe. Think of the possibilities if Islamic banking was let loose in the US.”
Making marks
Some relatively new Bahrain Islamic investment banks are trying to make their mark on the international arena, too, especially in areas such as private equity, real estate and wealth management. Capivest, formerly known as Khaleej Finance & Investment, is targeting the GCC states and the major emerging economies, in particular India.
Chief investment officer Mohamed Hassan is proud of Capivest’s new $110m First India Private Equity Fund. For Capivest and International Investment Bank, which recently more than doubled its paid-up capital to $110m, the opportunities in the Gulf and outside appear boundless. “2008 will be the year when we will harvest our alliances,” says Mr Hassan.
Ripple effect
Elsewhere, the euphoria in the Islamic sector continues. Dubai Islamic Bank, the third largest Islamic bank in the GCC, posted a 61% increase in net profits in 2007 to $681m, with total revenues up 46% and further expansion expected. The boom in the Gulf is also extending to London, where last month European Finance House (EFH), a subsidiary of Qatar Islamic Bank, received authorisation from the Financial Services Authority (FSA) to operate as an Islamic investment bank in the UK.
EFH, the fourth Islamic financial institution to be licensed in the UK, has a paid-up capital of £25m and wants to become the leading sharia-compliant financial institution in Europe. It will focus on wholesale activities and, according to chief executive Michael Clark, previously at Saudi International Bank and Arab Bank, will own 20% of the prestigious Shard London Bridge building, a £1.4bn project in the City of London.
EFH expects to participate in the growing sukuk market, in which the UK government is likely to issue a sovereign sukuk in the coming months, and to help establish London as the prime international hub for Islamic banking. The bank also plans to establish operations in Paris and Frankfurt within three years, and to help build two-way investment opportunities between the UK and the Middle East.
Bullish outlook
The outlook for Islamic banking in the Gulf looks promising, with big players such as Dubai Islamic hitting record profits and new institutions and investment banks setting up to seize the opportunities available in a region untainted by the subprime crisis. Also, according to Bloomberg, international sukuk issuance rose to $19.4bn in 2007, a rise of more than 60% on the $12bn issued in 2006. And, according to a Moody’s report, corporate bond issuance in the cash-rich Gulf could double in 2008 to reach about $50bn, again providing huge opportunities for Islamic institutions.
Are any clouds hanging over this Islamic boom? For most institutions in the Gulf, real estate occupies a significant part of their portfolio, with some believed to be as high as 80%. Could the underlining property boom turn sour and take the infant financial industry with it? DIB’s CEO, Khaled Al Kamda acknowledges that real estate represents his largest portfolio but defends his strategy. “Property is not a bubble, demand is outstripping supply. Demand is coming from expatriates and foreign investors not just locals. Dubai’s biggest attraction is real estate and Dubai prices are lower than those in Tehran and Mumbai.”
Risk exposure
Real estate exposure, however, represents a key concern in some areas. In December, the Central Bank of Bahrain put out proposals to limit banks’ exposure to the real estate market and proposed capping the value of the mortgages that banks can offer at 25% of total loans. While the central bank would see this as establishing best practice and avoiding over- concentration, it may prove to be a difficult pill to swallow for many Islamic institutions, which lack the diversity and product range of many conventional banks. This potential limiting of exposure to the real estate sector may be a prudent regulatory safeguard but could also be crippling to an industry that is yet to develop fully.
This exposure issue is one of a number of concerns facing Islamic financial institutions (IFIs). In a recent report on risk issues by Moody’s, two key conclusions were:
- In IFIs’ financing and investment contracts, risk categories of different natures are often entangled, a constraint mitigated by the naturally strong asset collateralisation of their portfolios;
- Balance-sheet management – including liquidity, investment, asset-liability management and capital management – constitutes a critical field where IFIs face a series of specific challenges that are difficult to cope with.
In commenting on the difficult task of liquidity management, Moody’s noted: “Despite the efforts of the Central Bank of Bahrain and others to provide a range of liquid instruments in which Islamic banks can place their surplus cash, there is still a great shortage of liquid instruments, which means IFIs tend to be more illiquid than their conventional peers and have more non-earning assets on their books.
“Indeed, most instruments used for liquidity management purposes are interest based. Typically, Islamic banks would place their excess cash reserves into short-term interbank murabaha, at more cost compared to conventional banks. Indeed, short-term murabaha resemble money-market interbank placements, but, as murabaha contracts make it necessary for commodity brokers to be involved, costs for managing liquidity might be high.”
Vulnerabilities
A limited range of possible funding sources leads to concentrated liabilities, imbalanced funding mixes and stretched capital management strategies. In a boom, all of these factors can be accommodated, as is happening at present in the Gulf, but that may not always be the case – as the subprime crisis in the West readily shows. IFIs, for all their positive developments at both a retail and wholesale level, are not without their vulnerabilities.
Islamic banking may represent a new dawn for financing in the Gulf and elsewhere across the globe as the sector blossoms with record growth and new institutions. But IFIs need to take a long, hard look at the current crises facing conventional banks and realise that their own Islamic products and risk management structures have considerable room for improvement and, like it or not, Islamic finance is not a one-way play.
