Increasingly too, demand for Islamically-structured finance is not confined to Muslim investors and institutions. Providers of Sharia-compliant products, whose confidence has grown with their industry, boldly state their aim to compete on wider terms, punching their weight with conventional counterparts in the competition for custom. And investors have responded positively, welcoming the new kids on the financial block.
The GCC has emerged as the capital of the booming world of Islamic finance, rivalled only by Malaysia. Only Oman continues to resist the trend. At first glance this should come as no surprise, given the happy combination of wealth and overwhelmingly Muslim populations. Yet Islamic banking has been around for more than three decades without previously threatening to shed its niche status. The question is not why, but why now?
The industry's ascent is being driven by a number of related factors, external and internal. Among the former is the sustained high oil price since 1998, which has created a surge of liquidity and boosted the balance sheets of all GCC banks, Islamic and conventional alike. The continuing bounty has driven the appetite for development on both supply and demand sides. The Islamic financial institutions have been confronted with ballooning liabilities and the problem of sourcing assets quickly enough to keep up. Their response has been innovation. New vehicles and structures have been developed to create new outlets for this liquidity: the rise of the regional sukuk market and the evolution of Islamic project finance, for example, have been rapid.
The rapid expansion of the Islamic liquidity pool has made it an increasingly important source of finance. It has grown too large to be ignored. With size, it has become more sophisticated and better able to meet the needs of those seeking access to it. In short, surging liquidity has brought the sector to maturity.
In response, a number of the GCC's Islamic institutions have been expanding their activities at home and abroad. Global banks, never slow to notice money seeking a resting place, have set up Gulf-based Islamic units to cater for increasing demand. The sight of international giants CitiGroup, UBS and HSBC involving themselves in Islamic finance has both demonstrated and accelerated its move into the mainstream.
As Sharia-compliant structures and instruments have become more widely understood and accepted, so investors and borrowers have recognised the potential they offer to diversify portfolios and funding streams. In project finance this is particularly evident. Again, the increase in the inclusion of Islamic tranches has not been a steady flow, but rather a trickle followed by a flood. There was a three-year lull between a groundbreaking $200 million Islamic facility from Kuwait Finance House (KFH) to fund the local Equate petrochemicals complex in 1996, and a $100 million Islamic tranche from KFH and Abu Dhabi Islamic Bank (ADIB) for the Thuraya satellite telephony project. Still an Islamic component was regarded as exotic. Financiers feared expanding their risk profiles by venturing into uncharted waters, and unfamiliar legal documentation was expected to create delays.
The tipping point came in 2001, with the financing of the Shuweihat independent water and power project (IWPP) in Abu Dhabi. The $1,600 million deal was arguably saved by the inclusion of a $250 million Islamic tranche, the success of which prompted the inclusion of a similarly structured facility as a matter of course when the Umm al-Nar IWPP financing was being arranged. Hard on Shuweihat's heels, in Bahrain, came Islamic elements in the funding of both the Hidd power and water plant and Aluminium Bahrain (Alba) expansions. In the long drawn out Alba deal, the Islamic tranche stood out for the ease with which it was signed off. Islamically-structured project finance no longer raises eyebrows. Indeed, a major Gulf project finance deal without it is becoming more unusual. And for the industry itself, the change marks a coming of age and a move upmarket from its traditional retail focus.
Corporate borrowers have also jumped on the Islamic bandwagon. Aircraft finance is particularly well-suited to the leasing structures used to meet the requirement that borrowings should be backed by an underlying asset. In November, Dubai-based Emirates staged the latest in a line of Islamically-structured borrowings. The stated aim is to diversify revenue streams, as the airline undertakes a $26,000 million fleet expansion. That the $112 million transaction was entirely undertaken by Dubai Islamic Bank (DIB) and ADIB again highlights the growing confidence of the GCC's Islamic financiers.
Sovereign diversification into Sharia-compliant finance has cemented its respectability and fuelled its appeal. Bahrain, the industry's regional hub, blazed the trail. The Bahrain Monetary Agency (BMA - central bank) began issuing sukuk al-ijara instruments - Islamic securities with three to five-year tenors - in 2001. A further $300 million worth of the paper is set to come to market by early 2004. The decision to mandate Citi Islamic Investment Bank, Citigroup's Islamic window, to arrange a $250 million issue was billed as an effort to spread the word to a wider circle of investors. When Doha launched its debut sukuk in September, arranged by HSBC, almost half the subscription came from conventional investors and a significant proportion came from outside the region. The value of the issue was lifted from $500 million to $700 million on account of heavy oversubscription.
Doha's stated aim was to diversify revenue streams. However, the government also wanted to create a benchmark for future corporate borrowings by means of the sukuk. It may not be long before heavyweights such as Qatar Petroleum - and its subsidiaries - start tapping the market.
Elsewhere in the Gulf the fourth quarter of 2003 has seen the floodgates opening. Bahrain-based Liquidity Management Centre (LMC) has burst on to the scene by winning the mandates to arrange a string of sukuks: for Dubai-based real estate developer Emaar Properties, Bahrain Specialist Hospital and - the largest and most recent - a BD 100 million ($263 million) issue to fund the Durrat al-Bahrain resort, part-owned by KFH. The UAE's National Central Cooling Company (Tabreed) is looking at a $100 million sukuk issue in early 2004, to be arranged by Abu Dhabi-based National Investor. In Mecca, the Zamzam tower project is being financed by a $390 million sukuk, uniquely structured as a timeshare lease. In April, Bahrain-based First Islamic Investment Bank (FIIB) became the first Islamic bank in the Gulf to issue a sukuk, worth $75 million.
Increasing demand for Islamic finance tells only half the story. The appetite is fed by the increasing number and sophistication of its products and providers. In October, the newly created International Islamic Investment Bank was granted a BMA licence to begin operations. Bank of Bahrain & Kuwait is considering reviving its Sharia-compliant subsidiary, Al-Khaleej Islamic Bank. National Bank of Sharjah has converted to a wholly Islamic bank and Bank al-Jazira is looking at doing so. Conventional banks, both regional and international, are broadening their Islamic offerings. The increasingly crowded marketplace forces providers into making their products competitive against a tougher benchmark: customers will not be lured by Sharia compliance alone.
GCC institutions are also demonstrating their growing confidence by spreading their wings. Qatar International Islamic Bank (QIIB) is planning to establish an Islamic bank in Libya. Gulf Finance House and Qatar Islamic Bank are doing the same in Lebanon. Shamil Bank now has operations in Bangladesh, Pakistan, Switzerland and Yemen. FIIB has diversified from its US direct investment and real estate businesses into European real estate, and is considering a move into European private equity. In October, the bank staged its most successful divestment, selling US healthcare software provider Medifax for $325 million, having paid less than half that two years before.
Gulf Islamic banks also predominate among the shareholders in a groundbreaking venture to set up Europe's first wholly Islamic bank, in the UK. ADIB chief executive Abdulrahman Abdulmalik will serve as chairman of Islamic Bank of Britain (IBB), if and when it receives regulatory approval, which is expected in the first quarter of next year. Justifying their confidence in receiving a licence, the bank's backers cite the growing recognition and understanding of Islamic finance in the West. Historically, the sticking point has been the notion that depositors can lose as well as gain on their capital. Another young institution, Bahrain-based Islamic Joint Venture Partners (IJVP), raised IBB's seed capital. Part of IJVP's stated mandate is to enhance the understanding and acceptance of Islamic finance among conventional investors and Western regulators. The ground is increasingly fertile.
At home, regulators are playing a positive role. In Kuwait, an Islamic banking law was finally passed in July, clarifying KFH's anomalous status and prompting Kuwait Real Estate Bank to plump for Islamicisation. Local investors are working on setting up a third Islamic bank. The BMA's widely admired regulatory regime has succeeded in making it the location of choice for Islamic financial institutions. When Saudi-based conglomerate Dallah AlBaraka Group decided to consolidate the operations of nine of its Islamic banks under the AlBaraka Banking Group umbrella, Manama was its chosen home (see pages 33-34). And the central bank is committed to developing the industry further, both locally and internationally. The BMA-backed LMC was set up with a mandate to devise tools to ease the chronic liquidity management problems that have hindered the growth of Islamic finance. Large volumes of short-term funds lack a profitable outlet because of the prohibition on money earning a return on itself - hence the creation of Islamically-structured securities such as the sukuk. The point of critical mass, where secondary trading of these instruments takes off, has yet to be reached, but if the frenetic activity of the past few months is anything to go by, the day is not far off.
In fact, such is the acceleration of the deal flow that this aspect of the Islamic financial market is set to overtake its conventional equivalent. Regional bond markets are woefully underdeveloped and are in danger of being superseded by the sukuk. It is significant that sizeable proportions of recent issues have been subscribed to by conventional investors.
Manama is also at the forefront of efforts to resolve the other great problem constricting Islamic finance - that of standardisation. Each bank's Sharia board has its own interpretation of what is and what is not Islamically acceptable. Here, there has so far been less success. The international Islamic ratings agency, set up in Bahrain in 2002, has yet to take off.
And there is still a bewildering array of products on the market based on different Sharia readings, welcomed by some investors, rejected by others. On the other hand, the almost universal acknowledgement on the part of Islamic bankers and regulators that standardisation is an issue urgently in need of address bodes well for progress. Regulators from the GCC and Asia gather frequently to discuss this and other issues confronting the industry. And barely a month goes by without an international conference on Islamic bankers' agendas.
As Sharia-compliant finance has moved away from the fringes, enormous new potential has opened up for the GCC's Islamic banks. Growing recognition from Western regulators offers the possibility of winning the overseas Muslim market, previously starved of a religiously acceptable form of finance. The 15 million-18 million Muslims in Europe spring to mind. But as competition in the industry hots up and conventional institutions wake up to Islamic structures, Islamic financial products are marketed more and more on their own merits: 'This is a quality product' as opposed to 'this is a Sharia-compliant product'. Islamic institutions are bringing conventional investors into their sights. And while the idea of Islamicising the entire global financial system appears as fanciful as ever, things are at least moving in the right direction.
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