islamic banking and finance

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Introduction to islamic banking and finance

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  • 1. ISLAMIC BANKING AND FINANCE: WHATS IN IT FOR CANADIAN COMPANIES? Mohammad Fadel Canada Research Chair in the Law and Economics of Islamic Law University of Toronto Faculty of Law October 16, 2006

2. OVERVIEW OF ISLAMIC BANKING SECTOR

  • Centers of Islamic Finance
      • Malaysia
      • Persian Gulf
        • United Arab Emirates (Dubai)
        • Bahrain
      • England ????

3. History of Islamic Banking

  • Local Islamic banks formed in the 1970s in Muslim countries such as Malaysia, Pakistan and Dubai
  • Originally emphasized joint-venture structures akin to private equity
  • Quickly evolved to provide short-term credit facilities by using themurbahastructure

4. History of Islamic Banking (II)

  • With increase in scale, Islamic banks began to branch out to more complex financing schemes, including:
    • Retail banking, including, deposit taking and consumer lending
    • Bonds ( sukk )
    • Medium- and Long-term leases(ijra)

5. History of Islamic Banking (III)

  • Impact of 9/11 Reverse Capital Flight
    • Perception of hostile climate in many Western jurisdictions, in particular, the United States, led to repatriation of dollars by Arab investors to Middle Eastern banks
    • Islamic banks, along with conventional banks in the region, benefited from this reverse flight of capital
    • Increase in Oil Prices Led to Dramatic Increase in Liquidity in the Gulf

6. History of Islamic Banking (IV)

  • Conventional Banks Open Islamic Windows
    • Conventional banks began to respond to requests from Muslim clients to offer products that complied with Islamic law
    • As the size of the potential market became clear, conventional banks responded with the creation of divisions dedicated to Islamic banking

7. History of Islamic Banking (V)

  • Conventional International Banks with Islamic Windows:
    • Citigroup
    • HSBC
    • Deutsche Bank
    • UBS
    • ABN AMRO
    • Standard Chartered Bank

8. History of Islamic Banking (VI)

  • Almost all regional banks have followed the international banks in creating Islamic windows and some have converted, or are in the process of converting, to the Islamic banking model

9. Size of Islamic Banking Sector

  • No precise measure of size of deposits held in Islamic banks or Islamic divisions of conventional banks
    • Ranges from a low of $250 billion to a high of $750 billion
    • As much as $300 billion held in Islamic investment funds awaiting investment opportunities
    • Arab investors hold approximately $800 billion of assets in European banks, with a growing trend to invest that money in Islamic products

10. Role of Islamic Finance in World Credit Markets

  • Demand Side
    • Sovereign Debt
    • International Agencies
    • Corporate Debt
    • Project Finance
    • Consumer Debt

11. Sovereign Islamic Debt

  • In recent years, several Islamic Countries and their instrumentalities, as well as non-Islamic countries, have issued sovereign debt in the form ofsukk :
    • Department of Civil Aviation, Dubai: $1 billion
    • Qatar: $700 million
    • Pakistan: $600 million
    • Malaysia: $600 million
    • German State of Saxony-Anhalt: 100 million
    • Bahrain: $79.5 million

12. International Agencies

  • International Agencies Have IssuedSukkin recent years:
    • Islamic Development Bank: $400 million
    • World Bank: $200 million

13. Islamic Corporate Debt

  • Private Issuances ofSukk :
    • DP World: $3.5 billion 7.5%sukk , convertible into equity at the time of a qualifying initial public offering
    • National Central Cooling Company: $200 million, rated BBB- by S&P
      • Listed on London Stock Exchange
      • Previous issuance by same issuer listed on Luxembourg Stock Exchange

14. Islamic Corporate Debt (II)

  • Global issuance ofsukkhas exceeded $20 billion
  • Dow Jones Citigroup SukkIndex
    • Comprised of sevensukk
    • $2.8 billion aggregate principal amount
    • Each issue rated at least A by S&P
    • Average tenor 3 years

15. Islamic Corporate Debt (III)

  • Biggest challenge thus far is limited secondary trading market forsukk
  • Demand forsukkhas far exceeded supply; offerings typically oversubscribed, even after substantial upsizing of the offering at times
    • DP World offering originally contemplated for $2.8 billion but was upsized to $3.5 billion to meet excess demand; no road show needed to market the offering

16. Islamic Finance and Project Finance

  • Infrastructure projects in the Gulf region largely financed on a corporate basis until the mid-1990s
    • Sadaf, a joint venture between Shell Oil and Saudi Arabian Basic Industries Corporation (SABIC), first important project finance transaction in Gulf region, closed in 1995
    • Project Finance now preferred structure for infrastructure investment

17. Islamic Finance and Project Finance (II)

  • Islamic sources of capital traditionally played minor role in project finance in Gulf
    • In recent years, however, no deal gets done without a substantial Islamic tranche
      • Financing needs exceed capacity of commercial banks and export credit agencies
      • Desire of project hosts to diversify sources of capital and take advantage of local capital to the extent feasible

18. Islamic Finance and Project Finance (III)

  • Rabigh Refinery and Petrochemicals Project, Kingdom of Saudi Arabia
    • $9.9 billion total cost, of which $5.8 billion was debt
    • $4.1 billion equity split 50-50 between Saudi Aramco and Sumitomo Chemical
    • $2.5 billion loan provided by Japan Bank for International Cooperation
    • $1 billion loan from Saudi Public Investment Fund
    • $1.7 billion commercial loan
    • $600 million Islamic tranche

19. Islamic Finance and Project Finance (IV)

  • YANSAB Project
    • $5 billion greenfield petrochemical project
    • $3.5 billion debt:
      • $1.067 billion, 13-year tranche from Saudi Public Investment Fund
      • $850 million, 12-year Islamic tranche
      • $700 million export credit agencies tranche
      • $533 million 12-year commercial bank tranche
      • $350 million working capital facility
    • ABN AMRO was sole arranger, underwriter and bookrunner on deal

20. Islamic Finance and Project Finance (V)

  • Future Demand for Project Finance
    • Last two years saw $40 billion of project finance in gulf region
    • Saudi Arabia estimates it will invest $90 billion in domestic power generation over the next fifteen years
    • Other states in the gulf also investing heavily in infrastructure projects, particular petrochemical
    • There will be a continuing demand in the region for capital to invest further expansion of the regions infrastructure

21. Opportunities for Canadian Banks

  • Deal flow shows no sign of abating
  • International banks have shown an ability to compete successfully
  • Because of the size of new deals, Islamic banks need to partner with international banks to take advantage of their larger distribution networ

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