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InterviewsMarch 15 2011

Saudi Arabian central bank seeks to meet sukuk challenge

Mohammad Al-Jasser, governor of Saudi Arabia’s central bank, discusses the huge potential of sukuk issuance in an interview with Stephen Timewell in Riyadh.
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Saudi Arabian central bank seeks to meet sukuk challengeMohammad Al-Jasser, central bank governor, Saudi Arabia collects his award as Central Bank Governor of the Year in the Middle East

As Saudi Arabia wrestles with the challenges of creating more employment for its youth and developing new growth areas in its economy, the governor of the Saudi Arabian Monetary Agency (SAMA), Mohammad Al-Jasser, is stressing the need for financial diversification and the move from traditional financing sources such as bank credit to corporate bonds and sukuk.

“The financial sector needs more legs,” says Mr Al-Jasser. “The corporate bond and sukuk markets need to develop here, corporates need to diversify their funding and the development of corporate bonds and sukuk will make the financial sector more robust.”

While in the past the Saudi authorities have appeared reticent to push Islamic finance, Mr Al-Jasser has actively encouraged the role of sukuk and the part the Islamic system of financial management can play in the future. Reflecting on core concepts of Islamic economics such as fairness and shared responsibility in risk-taking, Mr Al-Jasser noted in a recent speech in the UK: “Islamic financial institutions have been growing rapidly around the world and sharia-compliant banking products and services account for about 38% of the banking sector assets in Saudi Arabia. The challenge for SAMA is how to expand the role of Islamic financial institutions in the interbank money markets and to design tools that will be sharia-compliant, but at the same time allow SAMA to manage liquidity in the money market, especially repo agreements.”

Finding liquidity

Mr Al-Jasser, who recently won The Banker’s award for Central Bank Governor of the Year in the Middle East, admits that banks operating on sharia principles do not have the liquidity management tools used by traditional banks. While sukuk issues exist and are oversubscribed, he complains that most are held to maturity and there is no exit route to demonstrate real liquidity.  

“We need a liquid secondary market,” he insists, and analysts believe the absence of an interbank market in Islamic instruments is one of the major constraints to the development of an integrated Islamic financial system. But establishing a liquid secondary market in sukuk is easier said than done, and Mr Al-Jasser is well aware of the core supply-and-demand conflict and also a critical pricing issue. He acknowledges that the transition to corporate bonds and sukuk is more complex, especially when corporates have access to bank lending at a reasonable cost.

Nevertheless, the governor is confident that the process of improving liquidity management is moving slowly but surely, and is encouraged by the establishment, in October 2010, of the International Islamic Liquidity Management Corporation (IILM) in Kuala Lumpur, Malaysia. SAMA and Bank Negara Malaysia, the country's central bank, are the two largest subscribers to the IILM, each contributing $10m in equity out of the $80m paid in capital.

Lending limits

So what are the prospects for sukuk, especially in Saudi Arabia? According to the latest report by Standard & Poor’s, after two turbulent years global sukuk issuance reached a record high of $51.2bn in 2010, 78% attributed to issues in Malaysia. Although Saudi Arabia’s sukuk issuance was less than 10% of the global total in 2010, one of the world's leading manufacturers of chemicals, plastics and metals, SABIC, managed a $1.9bn issuance and Mr Al-Jasser believes there is huge potential for more sukuk in the country this year.

Analysts suggest that in 2011 corporates will look more to the capital markets and find bond and sukuk issuance more attractive as bank lending will be limited. For many Saudi corporates, borrowing from the international banking community is already constrained due to the effects of the global financial crisis. But while Saudi banks are showing an increasing willingness to lend, with bank lending to the private sector up 0.8% in January, according to the latest SAMA figures, there are concerns not only about banks hitting concentration limits but also about possible changing rules on bank lending limits.

Since the 1990s, banks have been able to lend clients up to 25% of capital but the rule may be changed this year, putting the squeeze on what banks can lend to many corporates. If banks can only lend up to 10% of capital to certain corporates, this could have a major impact on banks’ ability to lend and also corporates’ ability to borrow. So an inability to access bank funding may lead borrowers to the bond and sukuk markets. Given the market perception that there is a big appetite for sukuk as well as an increasing number of investment banks now offering services in the capital markets, the Saudi financial sector looks set for both an expansion and broadening of its core offerings.  

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