15 per cent: The amount of Islamic finance accounted for in Qatar National Bank’s profits in 2010
December 2011: Date by which conventional banks have to shut Islamic banking windows in Qatar
When HSBC Amanah Qatar launched its elite personal banking service for upscale customers in August 2010, it could not have foreseen that a year later it would be preparing to shut down or sell off the business.
As one of the wealthiest societies in the Arab world, Qatar was an obvious target for the Islamic banking arm of the UK’s HSBC banking group, as it sought to expand its affluent customer base. But in February 2011, Qatar Central Bank announced that conventional banks would have to withdraw from the Islamic finance market by the end of the year. Even those groups with sharia-compliant services provided through distinct specialist subsidiaries would have to comply.
The new ruling came as a shock for conventional institutions, who had seen the provision of Islamic products as a valuable secondary line of business. In 2010, Islamic finance generated more than 15 per cent of profits for Qatar National Bank – the country’s largest commercial bank – and accounted for more than a tenth of the asset book at Doha Bank, the third largest.
The decision was all the more surprising, given the perception that, in terms of the service offered, sharia-compliant financial products are not radically different from conventional ones. Although the formal structures and securities underlying them may differ, many see Islamic finance as simply the provision of a banking service that satisfies the demands of religious principle.
Even as conventional banks active in Qatar prepare to dispose of their Islamic activities, the central bank has never fully explained the reasons for its policy change.
Several factors could lie behind the move – and these also highlight the extent to which, in both practise and principle, Islamic finance differs from conventional banking more generally.
The immediate spark for the Qatari decision seems to have been the country’s move to comply with principles set down by the Malaysia-based Islamic Financial Standards Board in its regulation of sharia-compliant products.
The board has been looking at how its principles should govern Islamic exposures and products to ensure these meet the risk control requirements of the Basel II prudential banking standards. The forthcoming Basel III regime will raise the bar even further.
From a business or personal consumer’s perspective, it is possible to provide sharia-compliant finance in such a way that it effectively offers funding on terms comparable with those available under conventional banking.
However, some of the actual risk and asset principles upon which Islamic products are based are fundamentally different from those of conventional finance. This makes for real differences in the nature of risk, how it is managed by finance providers and how it is supervised by regulators.
Sharia prohibits the collection and payment of interest (riba), but also forbids contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future (maysir) or speculation (gharar). Both principles are viewed as creating excessive risk and encouraging uncertainty and fraudulent behaviour; effectively excluding the use of conventional derivate instruments.
These lead to differences in the product structures through which Islamic institutions deliver services and, sometimes, differences in risk compared with conventional banks.
Islamic banks face the same categories of risk as conventional banks, in terms of the key categories governed by the Basel III standards, says Anouar Hassoune, general manager of Real Economy Partners, one of the first specialist Islamic finance houses to be set up in France.
“The main categories of risk are credit, market and operations, under [Basel] pillar one; macro-economy, concentration and price pillar two, together with liquidity risk, as defined by the new Basel III rules,” he says.
“However, Islamic banks are also subject to categories of risk specific to them, above all … reputational risk, inherent in that at any time customers can come to the view that their bank is not sufficiently sharia compatible. Moreover, Islamic banks fuel what experts call ‘displaced commercial risk’. With the return on deposits in mudharaba – profit-sharing investment accounts – there is a risk of clients voting with their feet and transferring their savings to another bank.”
Hassoune says Islamic banks also face a higher concentration of risks than conventional banks: “Because of the rarity of the asset classes they carry on their balance sheets, Islamic banks tend to be overexposed to the real-estate market. The same is true of their liabilities: they depend on too narrow a range of financing sources – essentially, deposits, their own funds and an inadequate number of sukuk issues. In reality, Islamic finance is finance within constraints.”
To trade in securities or provide derivatives, Islamic institutions have to engage in complex, lengthy and expensive structuring. They may also need more time, as potential deals may have to be reviewed by their sharia compliance board. It is, therefore, harder for them to provide services on a bulk, semi-automated scale and they face a risk of becoming obsolete in strategic terms because they cannot act quickly enough.
Qatar Central bank’s actions can be interpreted as levelling the playing field. Other countries may follow suit, leaving international banks with more risks to consider when going into Islamic banking territory.