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ISLAMIC BANKING

ISLAMIC BANKING
INTRODUCTION:
The evolution of Islamic banks from their
modest ancestry in the early 1970s into a
multi-billion dollar industry has been
unprecedented in modern financial
history. Not only has Islamic banking
been identified as a potentially lucrative
business of rising importance in our
primary markets, but the surge of interest
in Islamically acceptable financial
instruments has also encouraged
conventional banks, including those in the
west, to vigorously take part in the
Islamic banking system.
Despite
the significant expansion of the Islamic
banking market, supported by the
innovative financial engineering, to
include almost all conventional banking
products, which were adapted to comply
with the Islamic law, there is still a
huge pool of untapped assets in Muslim
countries and among Muslim minorities in
Europe, the Far East and the USA.
This
study is intended to evaluate the expected
benefits to the Arab Bank group via
venturing into the Islamic Banking line of
business in view of the strategic
direction of the bank.
THE
MARKET:
The size
of the global Islamic banking market,
comprising the financial and capital
market sectors, is now estimated between
US$ 150 – 200 billion, with more than 200
Islamic financial institutions, managing
funds about the same size, and spreading
in over 50 countries. For much of the
past decade, this market has experienced a
growth rate exceeding 15% p.a.,
outstripping that of the conventional
banking industry.
The latest available official statistics
on this market are as follows:
US$
Million
|
|
#
of Banks |
Capital |
Assets |
Funds Managed |
Reserves |
Net Profits |
|
1993 |
100 |
2,390 |
53,815 |
41,587 |
n.a. |
n.a. |
|
1994 |
133 |
4,954 |
154,567 |
70,044 |
2,383 |
809 |
|
1995 |
144 |
6,308 |
166,053 |
77,516 |
2,939 |
1,245 |
|
1996 |
166 |
7,271 |
137,132 |
101,163 |
5,746 |
1,684 |
|
1997 |
176 |
7,333 |
147,685 |
112,590 |
3,076 |
1,238 |
While the number of Islamic banks has
increased by more than 76% between 1993
and 1997, their assets have increased by
three folds. The total deposits of
Islamic banks are now valued at
approximately US$ 150 million. Deposits
of the Islamic banks operating within the
Gulf region do account for 10% of the
total banking deposits. In Kuwait,
Islamic institutions have successfully
managed to capture 20% of the domestic
deposits market.
The Islamic banks’ consolidated net profit
for 1996 stood at US$ 1.7 billion, a
figure which excludes sizeable returns
realized by Arab and western conventional
banks that also invest in accordance with
Islamic law. This gave a return of 23%
and 1.24% on capital and total assets in
respective terms, which compares
favourably with conventional banks.
Trade financing, which captured 32% of
Islamic financing in 1997, continues to be
the most popular sector due to the high
volume of trade within countries of the
region in addition to the relatively short
term nature of this form of financing.
The real estate sector appears to be the
sector gaining higher momentum and
popularity.
|
|
|
|
Sectoral Financing of Islamic Banks
(%) |
|
|
|
|
|
Trading |
Agricul-ture |
Industry |
Services |
Real Estate |
Others |
|
1993 |
30.5 |
13.3 |
30.1 |
11.4 |
n.a. |
14.7 |
|
1994 |
27.0 |
13.3 |
27.5 |
14.8 |
5.4 |
12.0 |
|
1995 |
29.8 |
8.5 |
18.9 |
13.1 |
12.1 |
17.1 |
|
1996 |
31.2 |
7.5 |
18.8 |
13.2 |
11.7 |
17.7 |
|
1997 |
32.0 |
6.0 |
17.0 |
12.0 |
16.0 |
16.0 |
| |
|
|
|
|
|
|
|
|
|
|
|
The assets under the Islamic banks’
management are used in different ways.
While the bulk is still used in Murabaha
(trade finance), which is attributed to
the short tenor of the transaction, other
activities are rapidly developing, such as
Musharaka (equity participation).
|
|
|
|
Modes of Finance Used (%) |
|
|
|
|
Murabaha |
Musharaka
|
Mudaraba |
Ijara |
Others |
|
1994 |
41.5 |
8.2 |
12.6 |
8.7 |
26.8 |
|
1995 |
45.6 |
8.7 |
15.3 |
9.7 |
21.1 |
|
1996 |
40.3 |
7.2 |
12.7 |
11.5 |
28.3 |
|
1997 |
37.0 |
19.0 |
6.0 |
9.0 |
29.0 |
| |
|
|
|
|
|
|
|
|
|
BUSINESS LINES (PRODUCTS):
Although
a whole range of Islamic products, that
are comparable to those of the
conventional banking system, is available,
only few products have proved to be
popular and are widely used by Islamic
banks. This can be attributed to the
short term nature of deposits at the
Islamic institutions in addition to some
technical difficulties embodied into a
number of Islamic modes of finance. This
in fact reflects very high potentials for
the Islamic institutions that are capable
of developing and structuring new Islamic
banking products.
Some of
the major Islamic products, available to
Islamic institutions, can be outlined as
follows:
³
Murabaha (mark up or cost plus financing).
³
Mudaraba (profit or loss sharing
financing).
³
Musharaka (equity participation finance).
³
Ijara (leasing).
³
Istisna’.
³
Islamic funds.
³
Muqarada.
³
Commercial products (L/Cs, L/Gs, … etc.).
CLIENTS:
The
potential client base for Islamic banking
is any individual or institution,
including corporates, with an interest in
Islamic banking products. High net worth
individuals, who reside within the Gulf
region and own approximately US$ 800
billion, do represent a targeted group of
customers for the Islamic banks’ funds.
Retail clients, on the other hand, are
gaining more magnitude and share of the
Islamic banking customer base. In all
cases, some clients have a strong desire
for Islamic banking products due to
religious reasons, while others deal in
such products for the purpose of
diversifying their financial products and
services and / or acquiring other indirect
benefits; i.e., taxes … etc.
GEOGRAPHICAL DISTRIBUTION:
The Middle East and the Arabian Gulf
region constitute more than two thirds of
the Islamic banking market. The assets
growth rate of Islamic banks has
outstripped that of the conventional
counterparts during the 1990s in light of
the booming demand for Islamic banking
facilities, especially within the GCC
states.
The client base of Islamic banks is not
confined to Muslim countries alone, but is
spread all over Europe, the Far East and
the USA, evidenced by the geographical
distribution of these institutions.
|
|
Banks |
|
Capital |
|
Ass-
ets |
|
Depo-sits |
|
Reservs |
|
N. Profit |
|
|
|
No. |
% |
Amnt |
% |
Amnt |
% |
Amnt
|
% |
Amnt |
% |
Amnt |
% |
|
S. Asia |
51 |
29 |
884 |
12 |
39273 |
26 |
25665 |
23 |
1077 |
35 |
250 |
20 |
|
Africa |
35 |
20 |
202 |
3 |
1574 |
1 |
730 |
1 |
82 |
3 |
20 |
2 |
|
S.E.
Asia |
31 |
18 |
150 |
2 |
2332 |
2 |
1888 |
2 |
160 |
5 |
46 |
4 |
|
M.E. |
26 |
15 |
3684 |
50 |
83136 |
56 |
69076 |
61 |
382 |
12 |
252 |
20 |
|
GCC |
21 |
12 |
1787 |
24 |
20450 |
14 |
14089 |
12 |
1353 |
44 |
604 |
49 |
|
Europe
/ America |
9 |
5 |
617 |
9 |
909 |
1 |
1140 |
1 |
21 |
1 |
67 |
5 |
|
Asia |
2 |
1 |
3 |
0 |
6 |
0 |
3 |
0 |
0 |
0 |
0 |
0 |
|
Australia |
1 |
0 |
5 |
0 |
6 |
0 |
n.a. |
0 |
0 |
0 |
0 |
0 |
|
Total |
176 |
100 |
7333 |
100 |
147685 |
100 |
112590 |
100 |
3076 |
100 |
1238 |
100 |
P.S.: Pakistan & Iran are included in the
S. asia & M.E. groupings respectively.
ISLAMIC BANKS IN THE GCC:
The following section will cover Islamic
banks in each country within the GCC
market, their activities and the future
prospects of the Islamic banking industry
in this area. This section has been
incorporated since Islamic banks operating
in the GCC region have currently the
fastest growth rates among other financial
institutions with the highest
profitability ratios.
1)
Bahrain:
Islamic
Banks:
Bahrain
is rapidly developing into a major hub for
Islamic banks in the region. Within this
context, Bahrain Monetary agency (BMA) has
been encouraging finance houses to set up
subsidiaries to undertake their
non-conventional banking activities.
Accordingly, Bahrain currently plays host
to 18 Islamic banks and financial
institutions, of which two are commercial
banks, while the rest are mainly
investment banks. Most of the banks are
medium sized, capitalized at between US$
70 – 200 million.
Gulf
Finance House and Al Khaleej are the
latest Islamic institutions being granted
license to operate in Bahrain. However,
consolidation is expected in this sector
as many of the working Islamic banks are
small compartments, which need to merge in
order to strengthen their lending
capabilities and compete in a difficult
and challenging environment. An example
of this is the emergence of the Shamil
Bank of Bahrain, which emerged as the
fruit of the union of Faysal Islamic Bank
of Bahrain and Islamic Investment Company
of the Gulf and is already in negotiations
for a further merger with Bahrain Islamic
Bank.
Going forward, and in an effort to
strengthen Bahrain’s position as a major
center for Islamic banks, BMA has been
closely coordinating with major Islamic
banks in the region, including Islamic
Development Bank, to find convenient
solutions to overcome the problems that
are facing this industry and hampering its
potentials for further development.
Islamic inter-bank money market, liquid
tradable financial and short-term
instruments, and unified accounting
standards that are acceptable to different
Sharia boards are some of the serious
problems currently encountered by Islamic
banks. Accordingly, BMA, in collaboration
with the Accounting & Auditing
Organization for Islamic Financial
Institutions, have been working to
formulate new regulations for Islamic
banks so that they may comfortably fit
into the global financial system.
In addition, BMA is planning to start
issuing Islamic government bonds and
treasury bills that will be commodity
backed, either by aluminum or oil. The
purpose of these bonds is to absorb
Islamic banks’ surplus liquidity by
developing active and liquid secondary
market that will help Islamic banks manage
their assets efficiently on one hand, and
meet the government requirements on the
other.
Characteristics:
Islamic
banks in Bahrain can be divided into local
banks, subsidiaries of foreign or regional
banks, and specialized divisions within
offshore foreign banks. They all focus on
corporate finance and investment banking
services in order to tap the deposits of
high net worth individuals in addition to
Islamic mutual funds. First Islamic
Investment Bank focuses on private equity
deals in the USA, while others, like ABC
Islamic & Citi Islamic investment Bank,
concentrate on structured transactions and
project finance deals. The money, raised
by the last group of banks through their
Islamic funds, is usually channeled to
large investment groups, which manage this
money on the banks’ behalf.
Surprisingly, retail banking, which
usually provides attractive returns has
not been tapped by many Islamic banks.
This could be attributed to the youthful
nature of the Bahraini population, whose
financing needs have been met by the
various kinds of loans offered by
conventional banks. However, there is a
plenty of room for this business to
prosper if proper marketing and promotion
strategies could be formulated.
Major
Players:
ABC
Islamic, Citi Islamic Investment Bank, Al
Baraka Holding Co., Shamil Bank (outcome
of the merger between Faysal Islamic Bank
of Bahrain & Islamic Investment Co. of the
Gulf) and Bahrain Islamic Bank. United
Bank of Kuwait (UBK) has extended its
Islamic Investment Unit in UK and
establish an Islamic joint venture
enterprise early 2001 in Bahrain.
2)
Kuwait:
Islamic
Banks:
The
prominent players in the Islamic field in
Kuwait can be narrowed to include two
names only: Kuwait Finance House (KFH) and
The International Investor (TII). Both
names are large and well established in
terms of human and financial resources,
and do control a major share of the local
market. Also, KFH & TII have both
extended their presence to neighboring
markets by establishing various
subsidiaries in Bahrain, Qatar and UAE,
whereas TII has extended its presence
further to Switzerland. The two players
are active in retail banking as well as
regional structured transactions and
funds.
Characteristics:
KFH &
TII
have been regarded as two of the most
innovative wholesale and investment banks
in the region. KFH provides a full
spectrum of retail products ranging from
car loans with different schemes to more
complex mutual funds with various
integrated instruments. Additionally, KFH
is an active player in the syndicated
market and has helped in raising funds for
various corporate borrowers in the region.
TII
is considered more advanced than KFH in
the fields of structured finance and
advisory services. Within this context,
TII is responsible for restructuring the
diverse banking activities of Dallah al
Baraka group. Besides, TII has been one
of the only two institutions in the world
to launch an Islamic equity index. Arab
Bank, as a new venturer into this market,
can liaise with either KFH or TII in
introducing any of the Islamic products
and/or benefit from their experience.
Major
Players:
KFH & TII
3)
Oman:
Islamic
Banks:
Practically speaking, Islamic banking
institutions do not exist in Oman. All
previous Islamic deals that were
undertaken within the Omani market were
mainly initiated by Citi Islamic
Investment Bank.
Islamic
products do have a market in Oman and can
be marketed with relative ease to both
individual and corporate customers, whom
we should concentrate on through Arab Bank
Oman. The consumer market, on the other
hand, is saturated and faces fierce
competition, and therefore should be
avoided.
4)
Qatar:
Islamic
Banks:
The
Islamic banking system in Qatar is
represented by Qatar Int’l Islamic Bank (QIIB)
and Qatar Islamic Bank (QIB). It is
believed that these two banks are not well
developed when compared to their peers in
other GCC states as most of their assets
are held in trade financing (Morabaha),
government investments or its various
local entities as well as in real estate.
Both
banks are minor players in the regional
Islamic banking industry and their names
are rarely heard in syndicated Islamic
transactions. The idea of introducing
Arab Bank in the local market of Qatar for
the purpose of providing Islamic products
needs careful and thorough evaluation of
the legal system, related regulations, and
the size of the market.
5)
Saudi Arabia:
Islamic
banks:
Islamic
banks in Saudi Arabia can be categorized
into the following: Islamic banks with
commercial banking Iicensing like Al Rajhi;
Islamic banks that are owned by several
governments like Islamic Development Bank
(IDB); and Islamic banks that conduct
their activities with no formal existence
like Faisal Islamic Bank.
Saudi
Arabia is the largest as well as the
wealthiest Islamic country in the Middle
East. According to estimates, there are
200,000 high net worth individuals in the
GCC who own about US$ 800 billion of
liquid assets, of which Saudi Arabia’s
share is US$ 500 billion. Based on this,
Islamic products are smoothly marketed in
the wealthy kingdom.
Local
banks have established specialized Islamic
divisions to meet the accelerating demand
for and growth of Islamic products
market. These divisions have succeeded in
introducing many mutual funds and using
new techniques and instruments in reducing
investment risks to investors. Some of
the innovative tools were the launching of
capital guaranteed funds Launched by
National Commercial Bank and Life
Insurance funds by Bank Al Jazira.
Moreover, the Islamic divisions of local
banks have strated to concentrate their
efforts and resources on Islamic retail
products that are gaining momentum in the
local market; i.e., car loans and real
estate loans. Investment bankers also
found a great potentiality in routing many
of their funds to Saudi citizens, and
eventually channeling money raised into
the global financial system .
Offshore
banks, especially in Bahrain, have
successfully managed to get a good slice
of the cake by pooling for Islamic banks’
excess liquidity at a cost lower than
those predominant within the money markets
through Murabaha transactions. Foreign
banks as well have secured a place for
themselves in this giant market by either
structuring a fund and/or dealing for
local banks or investing directly in the
domestic market. In summary, the Saudi
market is quite big allowing for easy
absorbtion of all the possible products
and services launched.
Characteristics:
Due to
the huge size of the Saudi market, the
wealth of its people and the complexity of
its banking system as well as its legal
framework, no specific features can be
linked to Islamic banks or those investing
in their products. Nonetheless, the
growth and complexity of the market are
accelerating rapidly allowing for the
introduction of products that were
unacceptable in the past.
The
growing number of market players and the
sophistication of products offered are
indicative of the increasing appetite for
Islamic banking. The Saudi market is too
big to ignore or overlook and there exist
very high potentials in this market.
Major
Players:
Al Rajhi, IDB, National Commercial Bank,
Saudi American Bank.
5)
United
Arab Emirates:
Islamic
Banks :
Abu
Dhabi Islamic bank (ADIB) is head
quartered in the emirate of Abu Dhabi, the
capital and the wealthiest emirate among
the UAE. Dubai Islamic bank (DIB), on the
other hand, is stationed in the trading
center of UAE,Dubai. The problems faced
by DIB have negatively influenced the
growth of the Islamic banking in the
country as a whole and paved the way for
foreign banks to step in and take hold of
the existing opportunities. The practice
of Islamic banking in the UAE took
advantage of the advanced foreign banks as
ADIB & DIB are considered relatively small
to their rivals in terms of experience and
products range.
However,
faced with the new competition, both ADIB
& DIB have started to move in a different
direction and focus on their activities.
DIB is upgrading its IT system and
planning to offer internet services to its
customers to enable them monitor their
investments. ADIB, which is more active
than DIB in syndicated transactions
particularly for Gulf borrowers, is now
cooperating with DIB in setting up two
insurance and real estate subsidiaries.
In
addition, the bank is planning for future
expansion, with targeted markets in India
and other Gulf states. Both ADIB and DIB
are expected to play a greater role in the
local market and control a higher share of
domestic deposits and broaden the range of
the Islamic products and instruments
available to investors.
Characteristics :
The
focus of Islamic banking in the UAE has
been on trade finance, which is clearly
demonstrated in the case of DIB, whose
activities are mainly concentrated on
Murabaha contracts. ADIB, on the other
hand, has been trying to build long-term
assets in its balance sheet by
participating in various Islamic
syndicated transactions, especially for
the GCC region.
However, efforts ADIB are constrained by
small size of transactions and the limited
number of Islamic syndicated transactions
available. Both banks (ADIB & DIB) are
rich in cash and highly liquid, whereas
the basic channel for this excess
liquidity is Murabaha, where returns are
not highly attractive.
Major Players:
DIB, ADIB and foreign banks.
Ranking of Islamic Banks in the GCC:
Middle East Economic Digest (MEED) has
recently published a ranking of banks in
the GCC. The following listing shows the
ranking (by assets) of Islamic banks among
the top 65 GCC banks:
US$ Million
|
1999 |
|
Total |
Client |
Net |
Net |
1999 (%) |
|
|
Rank |
Bank |
Assets |
Deposits |
Worth |
Profit |
ROAA |
ROAE |
|
7 |
Al Rajhi |
11435 |
8049 |
1517 |
400 |
3.81 |
27.68 |
|
16 |
KFH |
5745 |
4334 |
624 |
144 |
2.66 |
26.2 |
|
40 |
QIB |
1094 |
902 |
81 |
15 |
1.89 |
25.31 |
|
41 |
FIBB |
4092 |
805 |
116 |
4 |
n.a. |
n.a. |
|
46 |
ADIB |
726 |
408 |
305 |
5 |
0.89 |
1.65 |
|
51 |
Invest Bank |
608 |
476 |
106 |
16 |
2.78 |
14.99 |
|
52 |
First Gulf Bank |
557 |
393 |
123 |
-13 |
-2.77 |
-10.4 |
|
60 |
BIB |
415 |
365 |
40 |
5 |
1.15 |
12.04 |
|
63 |
FIIB |
171 |
n.a. |
120 |
16 |
10.7 |
12.01 |
|
64 |
GIH |
107 |
n.a. |
n.a. |
n.a. |
n.a. |
n.a. |
|
65 |
TH |
94 |
n.a. |
72 |
16 |
17.67 |
21.55 |
|
|
|
|
|
|
|
|
|
|
|
IIAB |
305 |
|
58 |
2 |
0.82 |
3.50 |
|
|
Arab Bank PLC |
17793 |
12355 |
1289 |
170 |
0.99 |
13.90 |
| |
|
|
|
|
|
|
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CRITICAL SUCCESS FACTORS:
³
Ability to develop / structure genuine
Islamic products.
³
Build strategic alliances (with users of
funds outside the Arab World).
³
Focus on Investment Banking in the
wholesale business and on Commercial
Banking in the retail business.
³
Hire skilled and experienced staff since
Islamic banking, in particular, is more
sophisticated than conventional banking as
it combines commercial and investment
banking. This puts more pressure on
Islamic banks to have staff with better
skills, competency and experience.
³
Sophisticated banking services and
products require certain types of
infrastructure, all of which require
financial resources, which perhaps, are
beyond the means of smaller entities.
³
Deep and thorough knowledge of the
business.
CONCLUSION:
The Islamic banking industry is most
definitely on the path of high growth,
evidenced by the healthy growth rate of
15% p.a. This occurrence has resulted due
to the increasing demand for Islamic
finance across all market segments, which
include retail, high net worth
individuals, corporate, industrial,
institutional, and government entities.
Observers predict that the Islamic banking
market will account for at least 50% of
the total savings of Muslims by the end of
this decade. On the other hand, Islamic
bankers, keeping pace with sophisticated
techniques and latest developments, have
evolved investment instruments that are
not only profitable but re also ethically
motivated.
In essence, major banks seeking
opportunities in the Muslim world cannot
afford to ignore or overlook this growing
and lucrative market. And if we are keen
to be a major player serving the Arab
people, Islamic banking should be
vigorously ventured in light of the
following:
³
It would be a valuable source of low-cost
deposits.
³
It also goes well with other businesses,
such as trade finance, project finance and
assets management.
|