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East looks West for increased market share.

The Islamic financial industry has over the past two decades developed into a growing and important global niche market. International banks seeking high-growth opportunities in the Middle East, North Africa, and Southeast Asia cannot ignore this market without suffering a loss of competitive edge and potential loss of market share in the Muslim countries as MOIN A. SIDDIQI reports.

Growing interest by proactive foreign banks is adding credibility and sophistication to the Islamic financial market, which is expanding at between 10-15 per cent per annum. Competition is rife among leading international banks and western fund managers hoping to capture Islamic business. As a result, bankers and portfolio managers are devising innovative product-lines, with a view to integrating Islamic and conventional finance, thereby providing a new source of funding.

A number of western institutions, such as Citibank, HSBC, Societe Generale, Chase Manhattan, Bankers Trust, Swiss Bank Corp., Union Bank of Switzerland, Girozentrale of Austria, Indosuez (France), Goldman Sachs, ABN AMRO, ING (Netherlands), NatWest Markets (UK), ANZ Grindlays, Nomura Securities (Japan), J.P.Morgan, and Kleinwort Benson, which is owned by Dresdner Bank (Germany), have developed close relationships with Islamic financial institutions. These banks have formed special Islamic Banking Units, which comply with the Sharia law, and seek to generate incremental growth by attracting a new wealthy (but untapped) client base.

In essence, for conventional banks, Islamic banking serves as a powerful sign of differentiation. ABN AMRO is following Citibank's lead by setting up an Islamic Bank in Bahrain this year. In fact, Citicorp was the first western bank, in April 1996, to establish an Islamic subsidiary, Citi-Islamic Investment Bank (capitalised at $20 million) in Bahrain, and with a separate board.

International banks enjoy a competitive edge in international trade, and asset portfolio management, which benefits Islamic banks. Major foreign banks can draw on their international networks to invest Islamic funds (with duration periods of 3-12 months) in mostly Murabaha (trade or commodities deals) and split the profits with the Islamic banks. Foreign banks' business also includes arranging and structuring portfolios of Ijaras (leasing funds) and/or equity funds, with heavy exposures in the hydrocarbon, transportation and real estate sectors (traditional outlets for Islamic equity investments). The portfolios are then sold to Islamic banks as a Mudaraba (or fund management investment).

In recent years, Citibank, ANZ Grindlays and Kleinwort Benson have been among the most visible arrangers of Islamic deals. Citibank is estimated to manage about $12 billion in short-term Islamic trade finance and private investments. ANZ Grindlays has arranged $2 billion worth of structured Islamic cross-border trade, over the past four years.

Investment banks such as SBC Warburg, Goldman Sachs, Robert Flemings, & Boston asset manager, Wellington, can draw on their diversified financial expertise to offer added-value services for their Muslim clientele, as they have resources that some conventional Arab and smaller Islamic banks lack. Kleinwort Benson has over $1 billion worth of Islamic funds under management. It has marketed an Islamic unit trust in the Gulf and has also issued a floating Islamic bond and a Mudaraba fund registered in Guernsey. The International Investor (Kuwait) has formed strategic alliances with the Swiss Bank Corporation and Nomura Securities.

There remains considerable scope for western banks (with long-established presence in the Middle-East) to tap sizeable inter-Islamic banks' deposits, as well as short-term cash deposits of private Muslim investors, whose volume worldwide is estimated at over $50 billion. After making heavy provisions in 199192 against exposures to the collapsed BCCI, Islamic banks are now selective in the placements of their liquid reserves with other Arab-based banks. Inter-Islamic bank deposits are mostly maintained with the top 20 Arab banks, as well as some major US and European banks. Islamic funds must be 'ringfenced' to ensure there is no 'contamination' by fixed-interest deposits on the inter-bank markets.

Thus due to a lack of Islamic securitisation, i.e. limited short-term outlets for excess Islamic liquidity, conventional banks, including non-Arab banks, will continue to play an important role in the placements of funds, until Islamic capital markets become more developed.

Another area for close cooperation between conventional and Islamic banks is in syndications. Faysal Islamic Bank of Bahrain frequently wins mandate to arrange six-month pre-export financings for the cotton and rice corporations of Pakistan, usually for about $50-$100 million. The syndication list includes some major western and Gulf based Islamic and conventional banks.

In recent years, a number of global blue-chip companies have tapped Islamic capital, especially for leasing & project finance deals. IBM, General Motors, Alcatel (France) and Daewoo (Korea) have raised finance through an Islamic Ijara fund, set up in the US by United Bank of Kuwait.

Islamic investment banking is also making an inroad, albeit modestly, into project financing, thereby providing both equity and debt for some capital projects within the Muslim countries. Last year, Islamic Investment Company of the Gulf (Bahrain) put together $70 million in project loan syndication for Saudi Arabia's Holy Sites project to develop pilgrim shelters and roads between Medina and Mecca.

Islamic finance is expected to constitute an important source of funding for infrastructural projects in the Gulf and Southeast Asia, over the medium-term. Experts say about 50 per cent of deals in the Middle East could be in line with Islamic principle in future. Gulf governments are showing a preference for using the project finance market. Infrastructural funding requirements in the GCC region are projected to total $40 billion over the next decade and bankers say sophisticated financial packages will be required. Project sponsors in the region are keen to tap Islamic savings monetized in banks worldwide.

Major Islamic banks such as Al Rajhi Banking & Investment Corporation, ARBIC of Saudi Arabia, International Investor, Kuwait Finance House and Islamic Investment Company of the Gulf are diversifying their asset base in order to invest more funds in medium/long-term instruments. Thus through innovation, Islamic banks are participating in asset-backed investments, that involve Ijara (leasing) and Istisna (project financing) structure.

These instruments can be adapted to a wide range of transactions involving aircrafts, ships and capital equipment, and yield higher returns, compared with short-term Mudaraba trade facilities. However, the asset building side of Islamic banks' balance sheets will require continuous technical expertise of major foreign banks. Islamic banks are actively seeking partners to co-finance and co-manage their long-term projects. Last year the Kuwait Finance House won a mandate to manage a $200 million tranche of Islamic leasing for the $1.2 billion petrochemical complex in Shuaiba, Kuwait and the deal was completed in September 1996 with help of conventional funds.

Conventional Arab banks are also strengthening their Islamic operations. The Arab Banking Corporation, National Bank of Kuwait, National Commercial Bank, Saudi British Bank and Riyad Bank, are amongst major providers of Islamic trade and portfolio services for mostly high net worth clients. Such developments are narrowing the distinction between commercial banks and fully fledged Islamic banks.

In essence, conventional and Islamic banking are converging towards a direction that promotes cooperation. There are potential opportunities in niche markets, such as aircraft leasing, countertrade, medium/long-term project financing for residential & commercial property sectors, providing banks are willing or able to accept project as well as country risks.

Islamic banks can utilise the international connections and credit-risk analysis skills of major foreign banks, while Western banks can draw on the religious expertise of the Islamic banks. A combination of both knowledges are crucial for successful Islamic deals.

The prospects for Islamic banking over the long-term appear bullish. The past decade has witnessed a resurgence of Islam in a number of countries. Thus the market for the services of Islamic banks is far larger now than it was a few years ago. Mr Adnan Al Bahar, Chairman of the International Investor estimates this market could tap 40-50 per cent of the total savings of Muslims worldwide within eight to 10 years.
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Author:Siddiqi, Moin A.
Publication:The Middle East
Date:Sep 1, 1997
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