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Rabu, 10 Maret 2010

THE IMPLICATIONS OF GLOBALISATION FOR ISLAMIC FINANCE

RODNEY WILSON*

ABSTRACT
How should Islamic banks respond globalization? This paper suggests that there are threats, but also opportunities. Globalization involves not merely freer trade and capital movements, but also the communication of ideas. Islam, and Islamic finance in particular, has a message to spread, and global networks are arising for this purpose.

The paper contains a review of previous studies on Islam and globalization and work on Islamic finance undertaken by international financial institutions. An examination is made of the implications for Islamic finance of the opening up of domestic retail and investment banking markets. The Basel Accords, the rating of Islamic banks and international financial monitoring are considered. The attempt to create a global market in Islamic securities is discussed. The conclusion is that Islamic finance has an important role to play in a pluralist international financial and trading system.

INTRODUCTION

Islamic finance has become a worldwide industry, with assets under management in accordance with the Shari[ah law valued at over $200 billion. Within individual countries, especially in the Muslim world, Islamic finance plays a significant role, with the financial systems of countries such as Iran and the Sudan operating under the Shari[ah law. Other countries such as Pakistan are preparing to implement laws on riba free banking, while in the Gulf states Islamic banking is playing an increasingly significant role, accounting for over 20 percent of deposits in Kuwait and Qatar. Bahrain has become a major regional centre for Islamic finance. At the same time many major multinational banks including Citibank, HSBC, ABN-AMRO and Deutsche Bank are offering Islamic financial products, while in Malaysia a sophisticated market in Islamic securities has developed, and Bahrain is providing money management instruments that comply with the Shari[ah law.

In global terms Islamic finance is a limited niche activity however, while international financial markets are dominated by riba based activity. There are significant pressures from international organizations such as the IMF and the WTO for Muslim countries to open up their financial markets to multinational banks. International rating agencies such as Moodys and Standard and Poor classify Muslim government debt and rate commercial banks, and even some Islamic banks, which affects the terms on which they can conduct their business. The Basle based Bank for International Settlements has capital adequacy guidelines that pose significant challenges for Islamic banks and Islamic finance more generally.
How great a threat is globalization to Islamic finance, and how should Islamic banks respond? This paper suggests that there are threats, but also opportunities. Furthermore globalization is not a new phenomenon, nor does it necessarily imply westernization. The Muslim world was exploited in the 19th century and for much of the 20th century with the penetration of western capital, but in its early years, Islam itself promoted globalization through the transmission of its value system, a process that has been reinvigorated in recent decades. Contemporary globalization involves not merely freer trade and capital movements, but also the communication of ideas by new methods including the Internet. Indeed it is the advance in information and computer technologies that is one of the major forces driving globalization, which makes it possible for market participants and regulatory bodies to collect and process the information they need to measure, monitor and manage financial risk and to price and trade complex new financial instruments. Islam, and Islamic finance in particular, has a message to spread, and global networks are arising for this purpose. It is the spread of ideas rather than mere money that is the greatest challenge, but one that presents hope for Muslims.

The paper will be organized into sections:

A review of previous studies on Islam and globalization and work on Islamic finance undertaken by international financial institutions

GATS and the opening up of domestic retail and investment banking markets

THE BASEL ACCORDS, THE RATING OF ISLAMIC BANKS AND FSAP FINANCIAL MONITORING
Differentiating Islamic financial instruments by global product rather than national segmentation

Creating a global market in Islamic securities
Towards a pluralist international financial and trading system
Previous studies

There is an extensive literature on Islam and globalization, usually adopting a political economy approach. Some authors, notably Ali Mohammadi, take a negative stance viewing globalization as a type of economic re-colonization. Others have taken a more positive view, notably the economists and finance specialists attending a conference in Malaysia the proceedings of which have been published in a book edited by Mustapha Nik Hassan and Mazilan Musa. To some extent these views of globalization may reflect disciplinary biases rather than different strands of Muslim thought, this in itself demonstrating the dynamic interaction of western ideas with modern Islamic scholarship.

Leslie Armour, a social economist, has suggested one way forward. Although he sees globalization reducing the powers of government and threatening cultures with homogenization, this process occurs through individual empowerment, usually associated with the accumulation of riches. Faith communities through their strengthened social interaction can resist homogenization, and use globalization for their own purposes, including disseminating their religious values. Armour distinguishes between wealth, which is social, and riches, which are personal. Accumulation of riches builds personal barricades that divide society. Accumulation of wealth strengthens civil society and results in increasing power and influence by collective groups.

These ideas can be applied to Islamic finance, which facilitates the creation of Muslim wealth that can be used for social purposes. The role of Islamic banks and financial institutions can be to enable this process. In contrast the hoarding of personal riches, even in Muslim countries, makes those that hoard subservient to and dependent on global secular capitalism with its corrupting influences.

In addition to the more general theoretical literature, there are some more specific articles, often containing empirical material, on the impact of globalization on Muslim trade and investment. Much less has been written specifically on Islamic finance and globalisation. Ibrahim Warde’s book on Islamic Finance in the Global Economy is the most important contribution to date, but it is in the field of political economy rather than economics and finance, and is more about, as its title implies, the position of Islamic finance internationally, rather than the impact of globalization on Islamic finance. The difference with this paper concerns causation, the concern here being with the latter, specifically the response of Islamic financial institutions to global competition and the opening up of financial markets in Muslim countries, especially those who are members of the World Trade Organization (WTO) and signatories to the General Agreement on Trade and Services. (GATS).

Within international financial organizations there is considerable interest in Islamic banking, and it would be wrong to see those organizations associated with the “Washington consensus”, notably the IMF and World Bank, as being antagonistic to Islamic economic ideas. Indeed the IMF sponsored a study back in the 1980s on Islamic banking that was seen by many as an important contribution to the growing literature at that time, and a work that helped bring Islamic finance to the attention of a wider non-Muslim readership. Since then there have been further major studies undertaken by research economists working at the IMF, notably the working paper by Luca Errico and Mitra Farahbaksh on the regulation and supervision of Islamic banks, a summary of which appeared in the IMF Survey. At the macroeconomic level there has also been a willingness by the IMF to encourage investigation of how monetary policy can operate and debt management handled in compliance with Islamic principles. This has resulted in a useful exploration of the issues by V. Sundararajan, David Marston and Ghiath Shabsigh, all of whom are researchers at the IMF.

The World Bank has long had close relations with the Islamic Development Bank and both organizations have co-funded projects in a number of Muslim countries. There are also a number of Muslims working for the World Bank who are enthusiastic about Islamic finance, and keen to point out the merits of such a system. Zamir Iqbal in a widely read article emphasized that Islamic banking not simply about interest free financing, a source of confusion in the West, but rather has to be understood “in the context of Islam’s teaching on the work ethic, wealth distribution, social and economic justice, and the role of the state”. Iqbal points out the virtues of Islamic finance as it “encourages risk-sharing, promotes entrepreneurship, discourages speculative behaviour and emphasizes the sanctity of contracts”. This positive stance on Islamic finance by IMF and World Bank researchers has undoubtedly helped to break down barriers to the acceptance of Islamic banking in the Muslim world itself.

GATS AND THE OPENING UP OF DOMESTIC RETAIL AND INVESTMENT BANKING MARKETS

Although Nabil Hashad has written about the implications of GATS from an Arab banking perspective, within the Islamic financial community only limited attention has been paid to the issues of international banking competition. Yet the majority of middle and high-income Muslim states are WTO members, including Malaysia, Turkey, Egypt, Jordan, Tunisia, Morocco and five of the six GCC states. This membership not only has implications for trade, but for financial services through the GATS provisions for the opening up of markets for banking and insurance. In some Muslim states such as Egypt and Syria the banking system is largely state owned, while in other states, notably Kuwait and Saudi Arabia, there are limitations on the share that foreign institutions can hold in the ownership of local banks. Privatization of the state owned banks, and the removal of ownership restrictions is likely to result in the take-over of local banks by multinationals.

The issue for Islamic banks is whether they are also vulnerable to foreign take-overs, especially as most are relatively small in size. There have already been some attempts at consolidation in Islamic banking, notably the proposed merger of the Institutional Investor of Kuwait and the Al Baraka Islamic Bank in Bahrain although negotiations were suspended in 2002. The Faysal Bank in Bahrain was merged with other group affiliates to form the more adequately capitalized Shamil Bank. The Al Ahli Bank of Bahrain merged with the London based United Bank of Kuwait, including the Islamic banking unit. So far however no major multinational providing Islamic treasury or asset management facilities for Islamic banks or high net worth individuals has shown much interest in getting involved in Islamic banking at retail level in the Muslim world, although HSBC seems to have ambitions in this respect. Even if the markets for financial services are opened up in Muslim countries as a consequence of GATS, the Islamic banking sector may still be protected by its knowledge of Muslim clients and its unique product offerings.

Muslim countries can open up their conventional banking sector under GATS while still protecting their Islamic finance sector using infant industry arguments. In the January 2002 Trade Policy Review of Pakistan, the review team noted Pakistan’s commitment to liberalization under GATS in forty seven activities including banking, insurance, business and communications. Pakistan requested and received GATS exemptions under the most favoured nation clause (MFN) in financial services where there were reciprocity agreements and in Islamic financing transactions. This ruling by the WTO should help the position of Islamic banks in Pakistan, demonstrating that a sympathetic treatment of globalization issues can prove beneficial to those seeking to ensure Shari[ah compliant financing facilities are offered to potential Muslim clients.

As financial systems become more open, national discretion in the determination of interest rates is reduced, as if money flows freely, differentials in inter-bank rates between currencies will largely reflect exchange rate expectations in relation to a dominant currency, usually the United States dollar. If expectations remain unchanged, and dollar interest rates rise, local inter-bank rates will also rise. The close correlation between the London Inter-bank Offer Rate (LIBOR), which refers to Euro-dollar transactions, and for example, the Saudi Inter-bank offer rate on riyals (SIBOR), is not surprising given that the exchange rate between the dollar and the riyal is fixed and that international inter-bank transactions can be freely substituted for domestic transactions. As returns on Islamic investment deposits and the costs of Islamic financing in Saudi Arabia are related because of competitive pressures and client expectations to SIBOR, it could be argued that Islamic banking activities are indirectly affected by what is happening in western, secular money markets. Hence Islamic financial institutions, and even less the Islamic branches, counters and windows of conventional banks, are not seen as autonomous.

Does globalization of financial markets therefore undermine the legitimacy of Islamic finance if the price of money is similar to that which is conventionally determined? Should the economies of the Muslim world impose capital controls and introduce regulations preventing domestic banks from dealing with foreign banks, with perhaps limited exceptions for trade financing? Responses are more likely to reflect political ideology, whether favouring freer markets, or a greater role for the state, rather than religious piety. It can be argued it is not the rate of return or the cost of financing that makes Islamic finance distinctive, but rather the nature of the facilities and products offered.

Most Muslim countries apart from the GCC member states maintain controls over capital movements and some payments restrictions for import transactions. IMF structural adjustment policy encourages member states to eliminate multiple exchange rates and float currencies so that an equilibrium currency rate can be determined in the foreign exchange market, potentially facilitating the reduction of external deficits. In practice the results of such policies have been mixed in the Muslim world, but in the longer term the dismantling of foreign exchange controls seems likely for most countries. This will create additional opportunities for Islamic banks to offer murabahah trade financing facilities as well as leasing, ijarah, and project financing, istisna[. With foreign exchange liberalization the pricing of Islamic financing products has to be internationally rather than simply nationally competitive.

The Basel Accords, the rating of Islamic banks and FSAP financial monitoring

Like conventional banks Islamic banks are not only regulated by the central banks of the countries in which they are based, but they are also potentially subject to the scrutiny of international monitoring agencies, notably the Bank of International Settlements (BIS) in Basel. National regulation by central banks is also subject to international inputs, an example of this being the IMF and World Bank intervention through the Financial Sector Assessment Program (FSAP), which was started as a response to some of the issues raised by the Asia financial crisis of 1997. The annual reports of Central Bank Governors of Asian countries such as Malaysia and Indonesia are monitored and disseminated by the BIS, including their reviews of Islamic banking developments. In addition there is also continuing assessment of both Islamic and conventional banks by other commercial financial institutions, a process facilitated by the work of the ratings agencies.

Although there is no obligation to adhere to the BIS minimum requirement of 8 percent of capital to risk weighted assets, Islamic banks that are seen as being adequately capitalized are more likely to have their trading instruments recognized, and can negotiate better terms for their assets which are managed by other banks. Capital therefore can be a constraint on Islamic bank growth, especially when the bank has been successful in rapidly building up its deposit base. Often it has taken longer for Islamic banks to identify profitable lending opportunities than build up their deposit base, which implies lower initial profitability. This may delay stock market quotation to increase the capital base, or where the bank is already a quoted company, it may preclude rights issues to raise additional capital.

Arguably given the stable characteristics of their deposit base, Islamic banks could afford to be more venturesome in their financing activities, despite the constraint of having to follow central bank directives, and the pressure to adhere to BIS capital adequacy requirements. Although some conventional bankers view the new Basel Capital Accords that will be implemented from 2004 with trepidation, the replacement of the 1988 Accord should allow Islamic banks greater flexibility, as there is a menu of approaches to risk management, rather than one size fits all, and a greater sensitivity to different types of risk.

Corporate lending at present carries a risk weight of 100 percent, but under the new Accord there will be four categories, 20, 50, 100 and 150 percent. The risk weights will be refined with reference to the external risk assessments by rating agencies. This could enhance the role of Capital Intelligence, the major ratings agency for Islamic banks and financial institutions in the Arab World and Pakistan, and the Malaysian Rating Corporation, a domestic agency. As the table shows, the Al Rajhi Banking and Investment Corporation and the Kuwait Finance have the most favourable long-term ratings for foreign exchange (FX), and the later enjoys the highest domestic strength. The Islamic banks in Bahrain, Jordan, Qatar and Saudi Arabia are assessed as having the greatest support from their central banks.

Table 1
Capital Intelligence Islamic Bank Ratings

FX long FX short Domestic strength Support
Al-Baraka Bahrain BB+ A3 N/A 2
Al-Rajhi Saudi Arabia BB+ A3 A- 3
Bahrain Islamic Bank BB+ A3 BBB- 3
Bank Islam Malaysia BB+ A3 BB+ 2
Dubai Islamic Bank BB+ A3 BBB- 2
Faysal Bank Pakistan C C B- 2
Jordan Islamic Bank BB- B BB 3
Kuwait Finance House A- A2 BBB+ 2
Qatar International Islamic Bank BB+ A3 BB+ 3
Qatar Islamic Bank BB+ A3 BB+ 3
Shamil Bank (Bahrain) BB+ A3 BB+ 3
Source: New Horizon, London, September 2002, p. 8.

Compliance with BIS requirements and aspiring towards higher ratings are two aspects of the FSAP being developed by the IMF and World Bank. By the end of 2001 over one third of the 183 member states of the IMF were already involved in FSAP or volunteered to be included in the future. Already a number of Muslim countries, including Lebanon and Jordan, have been involved, while others, such as Yemen, have made formal commitments to participate. The IMF for its part tries to help participating countries to carry out assessments of financial sector vulnerabilities and developmental needs. It also encourages strengthening of the national institutional capacity to monitor financial activity and promote transparency and integrity in financial reporting. A code of good practice on transparency has been developed by the IMF in the expectation of it being implemented by all member states.

Even the Islamic Development Bank (IDB) has increased its subscribed capital to meet the requirements of the BIS and to ensure favourable ratings. In 2001 the subscribed capital was almost doubled to eight billion Islamic dinar. As a result its long-term rating became A-, which meant it had more favourable access to co-financing in international markets than might otherwise have been the case. Most Islamic commercial banks have more than adequate capital asset ratios according to BIS criteria, the Jordan Islamic Bank ratio for 2000 being almost 16 percent for example, while that for the Bahrain based Al Baraka Islamic Bank was 25 percent. Changes in the value of shareholder equity in these quoted banks depends on stock market developments, but despite the volatility of the 1999-2002 period and depressed stock prices, the BIS minimum has been exceeded.

Arguably because investment deposits with Islamic banks are not guaranteed, they have to be treated differently from conventional bank liabilities, necessitating less capital cover. The Bahrain based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) takes this more favourable position into account when calculating capital adequacy ratios, with that for the Jordan Islamic Bank calculated at over 35 percent, more than double the ratio using conventional BIS methods of calculation. A dialogue between AAOIFI and the BIS could be helpful for the Islamic banking industry, with perhaps some of the major global accounting firms participating, especially their partners with responsibility for the auditing of Islamic banks. Useful lessons could perhaps be drawn from the experience of the Central Bank of Malaysia (Bank Negara Malaysia) which has developed a Risk Weighted Capital Ratio (RWCR) and a Rate of Return (ROR) framework for the regulation of the Islamic banking industry.

It is clear that Malaysia with its outward looking stance and its innovative interpretation of Shari[ah laws on finance is destined to play a growing role in Islamic banking globally, and can to some extent intermediate between the Islamic finance industry and international financial institutions, notably the IMF. Kuala Lumpur is the location for the headquarters of the Islamic International Services Board (IFSB) which was established on 3rd November 2002 following an earlier meeting at the IMF in Washington attended by the governors of the central banks of a number of Muslim countries, including Iran, Kuwait, Pakistan, Saudi Arabia, Sudan and the UAE, and representatives of the IDB, together with Professor Rifaat Karim representing AAOIFI. This Washington meeting had been preceded by a conference in February 2000 organized jointly by the IMF, the IDB and AAOIFI, and a session at the Annual Meeting of the IMF and World Bank in September 2000 in Prague attended by the governors of central banks from several Muslim countries.

The IFSB is to serve as an association of institutions that have responsibility for the regulation and supervision of the Islamic financial services industry. The aim is to set and disseminate standards and core principles as well as adapt existing, mainly AAOIFI, standards. Adoption of the standards will be voluntary, but banks and countries that adhere to the standards are likely to be more favourably rated. The IFSB is also responsible for liaison and cooperation with other standard setters, including central banks and security market regulators, in the area of monetary policy and financial stability, opening up the possibility of the adoption of Shari[ah law in this area for the first time. In addition the IFSB is responsible for the promotion of good practice in the area of risk management through research, training and technical assistance.

At the inaugural council meeting of the IFSB it was announced that Dr Rifaat Karim had been appointed as Secretary General of the organization for a period of three years until 2005. A technical committee was established of representatives of the Bahrain Monetary Agency, the Islamic Research and Training Institute of the Islamic Development Bank, Bank Markazi of Iran, the Central Bank of Kuwait, the Banque du Liban, Bank Negara Malaysia, the State Bank of Pakistan, the Saudi Arabian Monetary Agency and the Bank of Sudan. Annual subscriptions were set at a modest $30,000 for full members, $20,000 for associate members and $10,000 for observers. The membership application by Qatar was approved at the inaugural meeting.

Dr Zeti Akhtar Aziz, the Chairman of the Steering Committee of the IFSB and Governor of Bank Negara Malaysia, stressed at the inaugural meeting how Shari[ah injunctions “interweave Islamic financial transactions with genuine productive activities and prohibit involvement in illegal and unethical activities.” He stressed how “this intrinsic principle of governance contributes towards insulating the Islamic financial system from the potential risks of financial stress triggered by excessive leverage and speculative financial activities.”

In practice the major challenges facing the IFSB are likely to involve benchmarking. The differences between Fiqh scholars in the Gulf and Malaysia over what constitutes the acceptable working of financial instruments are difficult to resolve. Malaysia’s pragmatic attitude to Islamic banking is in part driven by the objective of Bank Negara to see Islamic assets account for 20 percent of all bank assets in the country by 2010. This is encouraging conventional banks to offer Islamic financing facilities that conform to the letter of local Shari[ah interpretation by devising products with Islamic names. The actual working of the products is little different from their conventional equivalents however, raising doubts about the meaningfulness of the exercise. Malaysia, for example, has an inter-bank market in Islamic debt securities but the returns in the market move in line with interest rates. The Public Bank’s Islamic overdraft scheme seems to differ little from conventional overdrafts, and its offer of long term housing finance through al bay[ bi thaman [ajil rather than ijarah leasing seems questionable.

AmBank of Malaysia, another primarily conventional Malaysian bank, has been offering designated Islamic products since 1994. Its chairman, Ahmad Zani Othman, speaks of raising capital by “structuring the same deal but with Islamic principles in it. It is not about reinventing the wheel but modifying what has existed in the market.” Such a methodology is arguably flawed however, as Islamic finance should be about new product innovation from basic Shari[ah principles rather than simply re-engineering conventional products. The Securities Commission rather than Bank Negara regulates most Islamic instruments in Malaysia, but as the former is not a member of IFSB, this raises additional questions.

DIFFERENTIATING ISLAMIC FINANCIAL INSTRUMENTS BY GLOBAL PRODUCT RATHER THAN NATIONAL SEGMENTATION

Globalization can facilitate standardization of financial instruments so that national differences become less pronounced or even cease to exist. This not only applies to conventional finance but also to Islamic finance, despite differences in Shari[ah interpretation between Muslim countries. Even when foreign exchange restrictions and capital controls are removed, markets may remain segmented by different national legal systems and differentiated financial products which potential foreign users find it hard to understand and appreciate. As Islam is a universal religion, financial products designated as Islamic should arguably reflect the Muslim value systems rather than national characteristics.

Standardization of Islamic financial products can come about by adhering to international regulations, whether from secularist institutions such as the IMF or BIS or from designated Islamic international institutions such as the IDB, AAOIFI or the IFSB. It can also result from the interchange of ideas by national Islamic banks at international conferences, which encourages the spread of “best” practice. Even more influential in standardization has been the emergence of major multinational banks and fund management groups as providers of Islamic financial products either directly to their own clients, or indirectly to those of the national Islamic banks. As HSBC Amanah Finance typifies this type of initiative by a major multinational bank, it is perhaps instructive to examine its experience.

Despite its size as the largest United Kingdom based bank, with a significant presence in many Muslim countries from the Middle East and the Gulf to Malaysia, HSBC was a relatively late entrant to Islamic finance. Banks such as Citicorp, ABN AMRO, Deutsche Bank and some of the British merchant banks were involved from the 1980s, but HSBC only established its Amanah Finance division in 1998. In its mission statement HSBC Amanah Finance stresses its respect for the sanctity of the Shari[ah, its professionalism, uncompromising integrity and strong customer focus. The aim is to build Amanah’s reputation amongst Muslim clients of HSBC who already use its financial products and potential internal and external clients. Initially the emphasis has been on cross selling Amanah products to existing HSBC Muslim customers who use its conventional financing facilities, the internal clients, rather than reaching external clients of other banks through marketing and advertising the Islamic products. Direct cross selling is cheaper, and usually more effective given the captive nature of the market.

For an international bank such as HSBC, product development is usually undertaken centrally, and then the products distributed through national subsidiaries. In the case of Amanah finance, the initial offerings were developed in London where the bank was based, but the intention was always to focus on HSBC clients in Malaysia and Saudi Arabia where the Saudi British Bank is 40 percent HSBC owned. For Malaysian and Saudi Arabian retail clients the leading products are those involving wealth management, in practice Islamic managed funds. Three Saudi British Bank branches have been initially designated as outlets for Amanah products, with local staff given appropriate training. For the United Kingdom and the United States the leading products are Islamic mortgages, but in 2002 the programme had only just started in the United States, and in the United Kingdom, because of the unfavourable tax treatment of Islamic mortgages and capital adequacy issues, the program was still to be launched.

Credibility with Muslim communities internationally rather than within single countries is important for multinational banks such as HSBC. Reputations can be enhanced internationally by having Shari[ah committee members from different Muslim countries. In the case of Amanah finance the advisors are Muhammed Taqi Usani of Pakistan, Shaikh Nizam Yaquby of Bahrain and Mohamed Ali Elgari of Saudi Arabia. All three are University Professors who combine academic scholarship with practical work on the Shari[ah committees of a number of several banks, including in the case of Usani and Yaquby the Abu Dhabi Islamic Bank and Citi Islamic Investment Bank and in the case of Elgari the National Commercial Bank of Saudi Arabia, the Saudi American Bank and the Saudi French Bank. This multiple membership of Shari[ah committees itself contributes to product standardization.

The flagship Islamic wealth management product offered by HSBC is its Amanah Fund, which invests in equities globally subject to Shari[ah screening. HSBC also acts as a third party distributor of other Islamic funds including the Al Ahli Global Trading Equity Fund and the Al Ahli Small Cap Trading Equity Fund offered by the National Commercial Bank of Saudi Arabia. For corporate clients leasing ijarah finance is offered, deals in 2001 including $60 million for Malaysia Telekom Berhad, $61 million for Airbus Industry for aircraft for Emirates and £50 million for Hartwell Finance, a British vehicle leasing company. Murabahah trade financing in 2001 included $26 million for Vestel Dayanikli and DM 30 million for Vestel DIS Ticaret, both Turkish companies. Deals such as these have helped convince international companies of the viability and merits of Islamic financial products.

CREATING A GLOBAL MARKET IN ISLAMIC SECURITIES

An important aspect of globalization of finance has been the emergence of offshore financial centres that by definition serve international clients. In the case of Islamic finance, Bahrain has emerged as the leading offshore centre, a role that has been enhanced with the instigation of its Islamic money market. On June 13th 2001 the Bahrain Monetary Agency offered for the first time in the Gulf government bills that were structured to comply with the Shari[ah Islamic law. The bills were worth $25 million, and were in the form of three-month paper, referred to as Sukuk Al-Salam Securities.

Although the Malaysian government has offered Islamic bonds for over ten years, governments in the Gulf have been forced to borrow in international markets rather than locally because of Islamic objections to trading in debt and interest based securities. Governments have issued paper that the local commercial banks have held to maturity, but not traded. This however restricts the liquidity of bank assets, and makes it more difficult for the government to raise finance directly from the public.

With its new Sukuk Al-Salam Securities Bahrain has overcome this problem, by providing a fixed return, equivalent to 3.95 percent at an annualized rate for the first Islamic bill issue, which is not based on interest. The return has been calculated in relation to the real benefit the government expects to obtain on the funds, rather than with reference to market interest rates. The first securities matured on September 12th 2001, but this was only the first of many issues as the intention is to issue new Sukuk Al-Salam every third month.

So far prospects for Sukuk Al-Salam securities look encouraging, as the initial offer of bills in June 2001 worth $25 million was oversubscribed, with subscribers, mainly banks, offering $59.1 million. The minimum subscription was fixed at $10,000. This meant that relatively small financing houses could participate, as well as private investors seeking a non-banking home for their dollar denominated liquidity. The second issue in September 2001 was also oversubscribed, with banks offering $74 million for Sukuk Al-Salam securities offering only 2.50 percent. The third issue in December was also oversubscribed, despite the rate being lowered further to 2.00 percent, but this may reflect the limited amount of the Sukuk Al-Salam securities offered at $25 million. The success of this market in Islamic government securities has encouraged three Islamic banks to launch a liquidity management centre in Bahrain where Islamic corporate securities could be traded. The banks involved include the Kuwait Finance House, the Dubai Islamic Bank and the Bahrain Islamic Bank.

The launch of the Islamic money market in Bahrain has already resulted in the emergence of markets in longer-term Islamic securities, notably bonds, with Bahrain playing a similar role in the Gulf and West Asia to that of Kuala Lumpur in South East Asia. Bahrain government leasing securities worth $100 million were officially listed on the Bahrain stock exchange in September 2001 based on the ijarah principle. These five-year Islamic bonds mature in September 2006 and offer a lease return of 5.52 percent paid twice each year in March and September. The rate was lowered for the second issue of the sukuk bonds, and the third issue, launched on 29th August 2002, pays a 4 percent annual return in two installments every February and August until 2007. The third issue of for $80 million to fund infrastructure was oversubscribed by 211 percent, indicating excessively generous pricing. Although such dis-equilibrium pricing can be justified to increase market confidence, it arguably raises the cost of capital for essential projects needlessly.

In Malaysia there is a much longer history of the government issuing Islamic securities as the first non-interest bearing government investment certificates were issued in 1983. These were equivalent to certificates of deposit rather than bonds, although they were never described in these terms. However unlike bonds that have a fixed return, the Islamic securities issued in Malaysia had a variable return, with a dividend committee determining the rate based on macroeconomic and inflation indicators. Returns varied annually, but as the dividend committee had discretion over how to interpret macroeconomic and inflation data, simply looking at forecasts for these variables was not necessarily a good indicator of returns. There have been some calls for the dividend committee to publish the minutes of its meetings to increase transparency and accountability. These Islamic securities are not traded significantly, but when dealings occur prices remain close to redemption values in a similar manner to the value of certificates of deposits, rather than diverging markedly as is the case with bonds.

The more widely traded Islamic financial instruments in Malaysia are the mudarabah inter-bank investments that have maturities from overnight to twelve months and Al Bay[ Bi thaman [ajil notes, with payment for the sale of goods providing the income stream. These have been traded since 1994, with most of the initial issues used to finance government borrowings. As with the Islamic securities started eleven years earlier, returns are variable rather than fixed, hence the instruments should be designated Islamic notes rather than Islamic bonds. By the late 1990s Islamic notes were issued for semi-state corporations in Malaysia as well as the government itself, and more recently Islamic commercial paper has been issued, usually in the form of notes.

In May 2002, for example, the TSH Resources Company of Malaysia issued murabahah commercial paper and medium term notes to cover refinance of corporate debt and the construction of a power plant in Sabah. The financing involved was RM 100 million ($ 26.3 million) over a seven year period with the murabahah commercial paper covering periods of up to one year and the notes that provide a variable return running from one to seven years. Similar facilities were provided the same month for the Malaysian Sunrise Corporation with RM 100 million ($26.3 million) being covered by an Al-Bay[ Bi thaman [ajil facility and RM 70 million ($18.4 million) being provided through medium term notes. In Malaysia there are fund management groups that specialize in investing in such issues, notably the RHB Islamic Bond Fund, although it might be more accurately designated as an Islamic note fund.

The Islamic leasing sukuk issuance by Kumpulan Guthrie of Malaysia for $150 million to finance acquisitions in Indonesia was based on ijarah leasing. This first foreign currency Islamic issue by a Malaysian corporation has been incorrectly described as a bond in some of the media, but as the return varies over the two and four year periods of the trust certificates, it would be better described as pertaining to notes. This also applies in the case of the sukuk al ijarah issued in July 2002 by the government of Malaysia. This issue of $500 million was more than half subscribed by Islamic banks and investment companies in the Gulf in spite of some misunderstandings about the terms and how the rates of return were calculated.

Regulators from five Islamic countries, Bahrain, Malaysia, Indonesia, Brunei and Sudan, as well as the Jeddah based Islamic Development Bank, agreed on the establishment of an International Islamic Financial Market. It started operations from Bahrain in August 2002 following the passing of a decree by the King, Sheikh Hamad bin Isa Al Khalifa. The market provides a venue where both Islamic bills and bonds can be traded. Malaysia had promoted its offshore financial centre, Labuan, as its preferred location for the venture but as the Gulf states agreed that the IFSB should be located in Kuala Lumpur, Bahrain’s case for hosting the market was seen as part of a wider settlement. As Bahrain has four Islamic commercial banks, three Islamic offshore banking units, fifteen Islamic investment banks and an Islamic finance consultancy firm, it had a strong case for being the centre for global dealings in Islamic securities. The Islamic International Rating Agency that was established in Bahrain on 29th October 2002 should also help the market by providing evaluations of Islamic financial institutions and Islamic securities. The Islamic Development Bank is the major shareholder in the new ratings agency. Its inauguration may undermine the position of Capital Intelligence, the agency that hitherto specialized in Islamic finance from its base in Cyprus. Confidence in Bahrain has prompted the Islamic Development Bank to locate its Infrastructure Fund on the island, a private equity fund that is being managed by the Emerging Markets Partnership of Bahrain.

Although Bahrain and Malaysia are rivals in some respects, both stand to gain from co-operative ventures. Maybank, Malaysia’s leading commercial bank, received approval in June 2001 to open an Offshore Banking Unit in Bahrain. Although this is primarily involved in conventional interest based banking, it will have an Islamic banking window in Bahrain, which will complement the group’s other offshore Islamic banking operation in Labuan. The OBU in Bahrain acts as a distributor of Islamic banking products offered by Maybank, and provides investors in the Gulf with access to expertise on the Malaysian market.

The favourable environment in Bahrain has also helped the Arab Banking Corporation which is based on the island achieve a ratings gain from Standard and Poor’s. The rating is now positive rather than stable, based on the bank’s strong Arab business franchise, its stable capitalization, calming financial profile and supportive shareholders who include the Libyan Central Bank, the Abu Dhabi Investment Authority and the government of Kuwait. With assets of $26 billion, ABC has become the largest Arab bank. Its rival the Gulf International Bank is also faring well, and has established an Islamic Aircraft Leasing Company in Bahrain. This is to build up a portfolio of 20 aircraft for leasing to regional carriers, the local sponsors being Shaikh Abdulaziz Al Sulaiman and Shaikh Hamad Al Sulaiman, with Novus Management of Geneva managing the venture.

TOWARDS A PLURALIST INTERNATIONAL FINANCIAL SYSTEM

Far from being a threat to Islamic finance, globalization provides an opportunity. Islamic finance extends choice, and enables Muslims internationally to conduct their financial affairs in a manner that is consistent with their beliefs and values. Many non-Muslims are concerned with the ethics of how their money is utilized and their financing derived, hence the rise of the ethical finance industry encompassing some western banks and many mutual funds. Western and Eastern non-Muslim clients have shown their willingness to use Islamic financing when it is attractive. HSBC Amanah financing, for example, have found that 20 percent of their Malaysian clients are non-Muslim Chinese. Islamic finance adds value to the international financial system and encourages non-Muslims to think more seriously about debt issues, from the injury caused by lending sharks in the consumer loan market to the issue of developing country debt.

The challenge of globalization is both to regulation and to markets, with a widening in the remit of the former and in the breadth and depth of the latter. Islamic finance should not only be judged by its quantitative impact on global markets, which though increasing, remains small, but more importantly by the quality of the service and its effect on the perceptions and thinking of global financial players. Ultimately finance is more about values than the mere accumulation of money. Finance is also concerned with social responsibilities, including that of the wealthy towards the less fortunate in an often too selfish global economic order based on greed rather than economic justice.

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