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REGULATION

Special Report

Engaging with the economy

July 2012

Islamic banks must overcome a number of cross-border regulatory and cultural hurdles if they are to capitalise on the massive opportunities in Gulf infrastructure



Critics have frequently charged that Islamic banks need to more actively engage with the general economy, rather than simply conduct financial engineering in a Shari’a compliant way.

Yet given the economic, political and religious headwinds they continue to face, such an undertaking is easier said than done, even if these institutions are becoming increasingly active.

Whether it is financial products aimed at institutional clients, consumer/business loans, or even project finance in a wider regional context, the common thread running through all is that banks are impacted to varying degrees by the prevailing political and/or religious climate in the states in which they operate.

At the local level this may not be a major issue. Faisal Aqil, general manager of consumer wealth management at Emirates Islamic Bank in Dubai, whose customers are a cross-section of small, mid and large-sized corporates, makes the point that the UAE Central Bank has, for example, “played a pivotal role in ensuring that all Islamic banks operating in the country work within a set framework to ensure transparency.”

That said, regulations differ from state to state across the Gulf Co-operation Council (GCC) and compliance can often be a lengthy and expensive process. It is also counter intuitive, since the objective for all parties concerned should be to reduce expenses, increase product availability and generate more competition for the benefit of investors.

Given also that different Shari’a boards may choose to interpret contracts differently, greater input from Shari’a experts under the guidance of the Organisation of the Islamic Conference (OIC) Fiqh Academy (Islamic jurisprudence) and AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions), is required.

In theory, a region-wide regulatory framework, overseen by a centralised agency tasked with interpreting the legislations regarding Shari’a investments, could then be set up.

“In order to ensure an orderly evolution of Islamic finance from a niche segment into the mainstream international financial markets, it is vital to further enhance the industry’s capabilities for cross-border activities, which in turn will encourage innovative product development, robust and standardised regulatory frameworks and the long term stability of the industry,” says Hussain al Qemzi, chief executive of Dubai-headquartered Noor Islamic Bank.

“What the industry lacks at the moment is the breadth and depth that investors enjoy in the conventional market. An inter-linkage between the key Islamic financial centres will facilitate investor access to a wider range of Shari’a-compliant products beyond those available in their domestic market,” he adds.

From a legislative perspective the regional mortgage market is a case in point.

More than a year after Saudi Arabia’s Shura Council agreed final amendments to a package of measures aimed at boosting the kingdom’s private mortgage lending, the market there remains woefully underdeveloped due to delays in implementation – mortgage lending still represents a paltry two per cent of gross domestic product (GDP), compared to the more developed markets of the United Arab Emirates, Kuwait and Qatar where, according to international property advisors, Jones Lang LaSalle, it is 17 per cent, 14 per cent and 12 per cent respectively.

Meanwhile, with government lenders across the region recording relatively high volumes of loans in arrears in the recent past, addressing the issue of foreclosure remains a major priority.

In the wider sphere, project finance offers significant business potential for Islamic institutions, and it is not difficult to see why.

European banks have recently been in retreat from the Gulf region as they look to rebuild their balance sheets and ensure they meet the capital adequacy requirements of the Basel III Framework. Hence, the opportunity for Islamic institutions to bridge a burgeoning funding gap, as governments continue to invest in major infrastructure projects, has never been greater.

European banks lent approximately $237 billion into the GCC region in the first nine months of 2011, according to a March 2012 report by Moody’s Investors Service.

But the ratings agency added it now expects to see “a sustained reduction of lending at a time when the GCC faces sizable funding requirements.”

And for good reason, with the GCC having an estimated $1.8 trillion of capital investments underway or planned over the next 15 years, Moody’s says.

Unsurprisingly, demand for Islamic financing has been increasing. Data from Dubai bank Emirates NBD shows $6 billion-worth of sukuk sales in the GCC in the first quarter of this year, against the $7.3 billion issued in the whole of 2011.

Much of the impetus has come from the limited supply of sukuk and many financial institutions looking to put money into new investment channels.

Elsewhere, the proposed Qatar megabank earmarked for Doha – the result of an agreement between the Qatari government, the Islamic Development Bank and Riyadh-based Islamic banking and financial services provider Dallah Albaraka Group, will provide the needed balance sheet, capital and underwriting capabilities to target projects of size. The venture is set to be initially funded through the issuance of $1 billion of sukuk.

In its April 2012 report, Citigroup said Saudi Arabia currently heads construction activity in the Middle East and North Africa (MENA) region with $750 billion-worth of new projects in the pipeline, making up 31 per cent of the entire market.

As of January 2012, the total value of GCC projects planned and underway crept up 2.5 per cent, by Citigroup’s estimate, to $1.96 trillion – the value of projects in Kuwait, for example, growing 10 per cent to $200 billion.

The value of cancelled and delayed projects in the region meanwhile remained stable at approximately $719 billion, the lender’s latest construction project tracker showed.

However, 57 per cent of cancelled or delayed projects were in the UAE – the value of such projects rising two per cent since the bank’s previous report.

The story was significantly more upbeat in Saudi Arabia though, where the value of cancelled and delayed developments fell by eight per cent to $316 billion.

What is clear is that Shari’a-compliant structures available for project financing, general construction projects and asset financing, now see Islamic banks well placed to participate in the massive economic and social spending programmes governments are now embarking upon, as they look to improve infrastructure and diversify away from their oil-based economies.

The onus is now firmly on the ?banks to exploit these growing opportunities.

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