Few financial sectors have grown as quickly as the Islamic banking industry, whose religious precepts have struck a nerve with younger investors in particular across the Muslim world. The financial authorities in the Bahrain Monetary Agency (BMA – the central bank), the Bahraini government and Manama’s banking community understood the potential of this trend at an early stage, and sought to create the right conditions in which the nascent industry could thrive, based on the BMA’s rigorous rules-driven approach.
Bahrain is consolidating its position at the heart of the Islamic industry, providing a base for the majority of the sector’s banks, stimulating further growth by encouraging the development of new instruments and placing the sector within a well-regarded regulatory framework.
The industry’s early focus on short-term lending was dictated by the requirements of Islamic banking to balance liabilities against assets, which were mostly short-term deposits. Now, while that end of the market is still the most developed, a greater degree of sophistication has enabled Islamic finance to encompass longer tenors and more complex deals, such as syndications and securitisations, as well as the budding takaful insurance industry.
“With product lines such as project finance, we are seeing 15 to 18-year tenors, which is a good indication the market has moved on,” says Arul Kandasamy, the Manama-based head of Islamic banking at Calyon.
The Bahrain authorities have played an important part in these developments, encouraging Islamic finance to take a role in big-ticket projects in the island kingdom, as well as creating an extensive programme of short-term sukuk (Islamic) bond issuance, which now provides the bedrock for the industry internationally.
Landmark investments, such as the inclusion of a $55m Islamic finance tranche that was led by Kuwait Finance House and the Islamic Development Bank, in the $255m package for the local Al-Hidd power project have paved the way for other similar financings in Bahrain and elsewhere in the Gulf.
Crowded house
More than 25 banks and 10 insurance companies now run Manama-based, Sharia-compliant operations, making Bahrain the region’s main centre for Islamic finance. However, Manama has not been resting on its laurels, well aware that a vibrant Islamic sector bolsters the country’s reputation as a base for all types of banking – an important factor as Bahrain prepares to fend off stiff competition from rivals, such as the United Arab Emirates, bidding to become regional conventional banking centres.
The new all-embracing regulatory rule book framework for financial services companies granted licences by the BMA to operate in Bahrain includes a volume devoted specifically to Islamic institutions. This is intended to provide a rigorous and transparent framework, designed to enhance confidence in the sector and, in conjunction with other measures, to bring in new firms.
In the post-9/11 world, where many Arab banks and investors feel themselves to be victims of a politics of suspicion – and where an industry in carrying out due diligence on potential partners in the Muslim world is burgeoning arguably even faster than the Islamic financial industry itself – the BMA has for some time believed it was essential to create rules.
“We know that by playing to our strengths, through our reputation for playing by the book and implementing a body of clearly defined rules, Bahrain can maintain the confidence of western institutions and build up a leading, trusted position in this sector,” says one senior Bahraini official.
The policy seems to be working, with the BMA issuing several new licences in recent months. In December, it granted a licence to Islamic broking company the Global Islamic Clearing Company (GICC) – a venture between Bahrain-based Islamic Finance Consultants and UK-based financial services firm Dawnay Day Global Investment. By improving clearing procedures, this move fits in with the authorities’ drive to increase liquidity in Islamic paper, the BMA says.
The clearest manifestation of this strategy has been the creation of the Liquidity Management Centre (LMC), with BMA support, as a specialist bank with a brief to develop the secondary market in Islamic paper. A scarcity of primary issuance when the institution opened its doors in January 2003 hampered progress, but business is picking up.
“The LMC’s main objective was the secondary market trading but initially it found that it could not do that because there wasn’t much of a primary market,” Mr Kandasamy observes. “So it has been doing a great job with primary issuances and from that it is now able to build up secondary market trading.”
Among a growing list of innovatory moves designed to boost the market, the LMC led a $250m five-year sukuk for the Bahrain government in 2003 and led a rare Islamic euro issue – for First Islamic Bank in 2004. The LMC has also developed a Sharia-compliant lease buy-back structure. In 2005, it unveiled a sell/buy-back mechanism that permits investors to raise short-term funding using their sukuk bond holdings as security. This aims to plug a gap in Islamic finance structures by providing an equivalent to repo instruments in conventional banking, enabling holders of sukuks to borrow money against them without having to cash them in.
Business viability
The reward for these efforts – and a brightening economic picture across the Gulf – has been a rapid rise in the amount of money invested in the sector. By August 2005, Islamic finance institutions in Bahrain held $6.8bn in assets, up from $5.9bn six months earlier, according to BMA figures. That a large chunk of this was held by the Islamic finance units of the major western banks is indicative of the recognition that Islamic finance is seen as a viable business in its own right.
However, it also shows that the sort of financial clout that comes from Citicorp, HSBC, BNP Paribas, Calyon and others with Sharia-compliant operations in Bahrain is needed to fuel transactions in many parts of the Islamic finance market.
While the growth may be impressive, the Islamic sector is still dwarfed by conventional banking in the region and in Bahrain, with more than $130bn of assets in the banking system. Those in the market say that the region has yet to develop the sort of large-scale, long-term investors taken for granted in western economies, such as pension funds, insurance firms and big asset management companies, which would enable the Islamic sector to take off.
“Depending on the asset class, the bulk of the money does not come from the banks, so, as those other parts of the industry develop, that will produce demand for longer-dated instruments,” Calyon’s Mr Kandasamy concludes.
LONDON ADDRESS FOR ISLAMIC BANK
The extraordinary growth of Islamic banking across the globe in recent years has taken another significant step with the establishment of the European Islamic Investment Bank, which is set to become the first independent Sharia-compliant Islamic investment bank to be authorised and regulated by the UK’s Financial Services Authority (FSA).
The EIIB, which was granted authorisation in principle by the FSA in January, brings with it a diverse shareholding structure, a wealth of capital and a management structure that reads like a ‘who’s who’ of Gulf banking with experience in both Islamic and conventional banking. London will be the headquarters and hub for all activities but the bank also intends to have a representative office in Bahrain where the BMA has already given it a favourable response.
The new bank has 178 institutional and individual shareholders from both the Gulf and Europe and initially has a paid-up capital of £112m.
Managing director John Weguelin, who has more than 30 years’ banking experience, with the past 20 at Bank of America, most recently as chief operating officer in Europe, is bullish about the opportunities.
He says: “EIIB will seek to service a market niche in Europe that has only been lightly tapped by conventional and Islamic banks and by non-banking institutions, as well as becoming a major participant in the market for Islamic securities, treasury and investment products.”
Mr Weguelin sees huge opportunities in the sukuk (Islamic bond) market and in developing asset management capabilities among other areas such as advisory and corporate finance. “There is no one in London who can invest in a Sharia-compliant way,” he says.
Mr Weguelin says the bank has 20 members of staff but expects that to double to 40 by the end of the year. It is also planning to do an initial public offering (IPO) in the second quarter, boosting the capital to £300m and listing the company on the alternative investment market (AIM) at the London Stock Exchange.
The board, which will be chaired by the experienced Adnan Ahmed Yousif, a director of several Middle Eastern banks, has a distinct Bahraini flavour. Most of the board, including Mr Yousif, have spent the bulk of their banking careers in Bahrain, many at Arab Banking Corporation, and it also includes Khalid Abdulla Al-Bassam, a former deputy governor of the BMA and chairman of the Bahrain Islamic Bank.
Regulated by the FSA and focused on providing an Islamic financial services link between Europe and the Gulf, the EIIB is viewed by Mr Weguelin as a major milestone for Islamic finance and for London’s growing role as a natural centre for Islamic investment banking.
