islamic banks in the gcc -...

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Banking Moody’s Global

Special Comment

Table of Contents: Summary Opinion 1

Three Distinct Islamic Banking Business Models Have Emerged 3

Credit and financial leverage: the first line of differentiation 3 Relative profitability measures diverge accordingly 4

Robust Financial Fundamentals Support Islamic Banks’ Stand-alone Ratings in the GCC 5 Imperfect Risk Positioning and Constrained Operating Environments Weigh on Islamic Banks’ BFSRs in the GCC 9 Expectations of Likely External Support Help Uplift Ratings for GCC-Based Islamic Banks 12 Appendix 1 13 Appendix 2 17 Moody’s Related Research 21

Analyst Contacts:

Paris 33.1.53.30.10.20

19 Anouar Hassoune Vice President - Senior Credit Officer

London 44.20.7772.5454

13 Adel Satel Managing Director

March 2008

Islamic Banks in the GCC: a Comparative Analysis

Summary Opinion

Islamic banking in the six countries constituting the Gulf Co-operation Council (GCC) – namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE) – has been expanding at double-digit annual growth rates over the past decade. Today, Islamic banks in the Gulf control a market share close to 15% of the regional banking system’s assets, and have become part of mainstream financial intermediation in this part of the world. At the same time, Islamic banks in the GCC have also become more diverse: large pioneers established in the 1970s co-exist with new entrants, former conventional financial institutions recently converted into fully fledged Shari’ah-compliant banking entities and the Islamic windows of still-conventional banking providers. Competition has been heating up, forcing Islamic banks to enhance their commercial entrenchment, develop relevant business models, strengthen their brands and reputation and provide innovative solutions to a growing number of clients attracted by the concept of interest-free banking.

In such a context, Moody’s draws in this report a comparative analysis of 23 leading Islamic banks operating in the GCC, seven of which we rate (see Figure 1). Together, these banks account for total assets in excess of US$125 billion, or 25% of Shari’ah-compliant assets globally.

The purpose of this report is to:

Identify the various business models that are emerging and enriching the Islamic financial industry in terms of product supply;

Deconstruct the financial performance of GCC-based Islamic banks;

Determine the structural constraints Islamic banks face in terms of risk positioning; and

Ultimately, clarify the main drivers of Islamic banks’ credit ratings, where applicable.

2 March 2008 Special Comment Moody’s Global Banking - Islamic Banks in the GCC: a Comparative Analysis

Special Comment Moody’s Global Banking


The main conclusions of this report are that:

The pure commercial-banking model in GCC Islamic banking, although still dominant, is being increasingly complemented by other, recently developed forms of more specialised Shari’ah-compliant financial intermediation.

Islamic banks’ ratings in the Gulf are usually driven by robust financial fundamentals, and benefit from external support.

Maturing operating environments and imperfect risk positioning tend to weigh on Islamic banks’ risk profiles, and ultimately on their stand-alone credit ratings.

Figure 1:

GCC-Based Islamic Banks Included in the Sample

Bank full name Bank short name [1] Domicile Business model

Moody's issuer ratings

Total assets (US$ mil.) at 31 December 2006

Abu Dhabi Islamic Bank ADIB UAE Retail banking A1/P-1 9,888

Al Rajhi Bank Al Rajhi Saudi Arabia Retail banking A1/P-1 28,056

Albaraka Banking Group ABG Bahrain Commercial banking N/R 7,626

Amlak Amlak UAE Specialised finance N/R 1,375

Arcapita Bank Arcapita Bahrain Investment banking N/R 2,708

Bahrain Islamic Bank BIB Bahrain Commercial banking N/R 1,162

Bank Albilad Albilad Saudi Arabia Retail banking N/R 3,008

Bank Al-Jazira BaJ Saudi Arabia Commercial banking A3/P-2 4,190

Boubyan Bank Boubyan Kuwait Commercial banking Baa2/P-2 1,847

Dubai Bank DB UAE Commercial banking N/R 1,515

Dubai Islamic Bank DIB UAE Commercial banking A1/P-1 17,557

Emirates Islamic Bank EIB UAE Retail banking N/R 2,854

Gulf Finance House GFH Bahrain Investment banking N/R 1,501

Kuwait Finance House KFH Kuwait Commercial banking Aa3/P-1 23,128

Kuwait International Bank KIB Kuwait Specialised finance N/R 2,945

Masraf Al Rayan Rayan Qatar Commercial banking N/R 1,188

Qatar International Islamic Bank QIIB Qatar Commercial banking N/R 2,308

Qatar Islamic Bank QIB Qatar Commercial banking N/R 4,092

Shamil Bank of Bahrain SBB Bahrain Commercial banking N/R 1,693

Sharjah Islamic Bank SIB UAE Commercial banking N/R 2,082

Tamweel Tamweel UAE Specialised finance A3/P-2 889

The Investment Dar TID Kuwait Investment banking N/R 3,883

Unicorn Investment Bank UIB Bahrain Investment banking N/R 293

TOTAL 125,789

[1] For the purpose of listing the banks in Figure 2 and Figure 3.




Three Distinct Islamic Banking Business Models Have Emerged Business diversification in Islamic banking and finance started about a decade ago. Up to the mid-1990s, Islamic banking institutions in the Gulf were mainly handling plain-vanilla financial intermediation, raising deposit-like liabilities (in the form of current accounts and profit-sharing investment accounts or PSIAs) to recycle them into Shari’ah-compliant credit exposures. Both fully fledged IFIs and the Islamic windows of conventional banks have been controlling the Shari’ah-compliant banking intermediation market so far. Having said that, this commercial-banking business model, dominated by both the corporate and retail business lines, is now being enhanced by the emergence of two new activities: on the one hand, Shari’ah-compliant investment banking has grown as a viable, profitable and successful way to manage alternative Islamic asset classes; and on the other hand, specialised financial institutions focusing on mortgage, housing and consumer banking have been providing financing solutions to households facing unprecedented needs in terms of accession to consumption and property.

Credit and financial leverage: the first line of differentiation

Figure 2:

Credit vs. Financial Leverage Ratios for Islamic Banks Under Review (2006)

ALL

KIBABG

KFH

Tamweel

Amlak

Albilad

Al Rajhi

EIBADIB

SIBQIB

SBB

DIB

QIIB

BaJ

DB

BIB

Boubyan

TID

Arcapita

GFH

UIB

Rayan

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Credit leverage = Net credit portfolio/Total assets

Fina

ncia

l lev

erag

e =

Equi

ty/T

otal

ass

ets

At Dec. 31, 2006

Islamic Commercial Banks

Islamic Retail & Specialised Banks

Islamic Investment Banks

As shown in Figure 21, Shari’ah-compliant commercial banks, investment banks and retail/specialised banks tend to display different profiles when it comes to their respective use of leverage. Commercial banks generally have average credit leverage (defined as the proportion of credit exposures in total assets), as well as average financial leverage (defined as the proportion of equity in total assets). As far as retail/specialised banks are concerned, credit leverage is materially higher. These banks are also more capital intensive due to the greater capital demands from lower liquidity, the banks’ quasi-monoline status (bringing less operating diversification to their business model) and their tendency towards geographic concentration. In addition, their funding is generally retail based, and therefore less expensive than wholesale refinancing, which in turn makes the average cost of funds and thus the relative cost of equity lower than for their commercial peers. Investment banks, conversely, do not use credit leverage. Their purpose is not to extend credit, with the exception of the funding requirements of their investee companies, but rather to allocate the excess liquidity of their customer base (usually institutional investors and high-net-worth individuals) to private equity transactions, mainly in four preferred areas (unlisted growth and value stocks, infrastructure projects, development and rental properties, venture capital in innovative young companies with high technological content). Consequently, the bulk of their intermediation endeavour finds its way through to off-balance-sheet assets under management, taking the form of more or less diversified funds. Islamic private equity houses receive remuneration, for their service as

1 Tables and charts in this report are extracted from the comparative, summarised financial tables and ratios reported in Appendix 1.




project managers, in the form of both management (wakala) fees and performance (mudharaba) fees, in the time span that runs from the investment date to the exit date (usually equivalent to an investment horizon of three to five years).

Relative profitability measures diverge accordingly

Figure 3:

ROA vs. ROE for Islamic Banks Under Review (2006)

SIB

AmlakBoubyan

Albilad

KIB

ABGEIB

Rayan

DB BIB

DIBADIB KFH

SBB

Tamweel

ALL

QIIB

Arcapita

QIB

Al Rajhi

TID

UIB

GFH

BaJ

0

0.1

0.2

0.3

0.4

0.5

0.6

0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16

ROA

RO

E

As at Dec. 31, 2006, excluding extraordinary income

Given that Islamic investment banks offload investments from their balance sheets and that their risk profile is higher, it is not surprising that their ROAs are the most spectacular, as suggested in Figure 3. Specialised and retail banks also record high ROAs as they benefit from both credit volumes and wide margins (thanks to rather lucrative consumer and housing yields, and relatively low retail-based funding costs). Usually, their ROEs tend to be penalised by the higher capital base they keep on their balance sheets. Commercial banks tend to have lower ROAs because of the price-competitive nature of corporate banking business, but robust ROEs because their relatively better diversified business model and asset classes allow for tighter capital management approaches.

Some interesting outliers emphasise the fact that Islamic business models are evolving and dynamic components of strategy

Islamic banks’ business models are not cast in stone. In Saudi Arabia, Bank Al-Jazira (BaJ) used to be a traditional commercial bank, raising deposits and extending credit to both its retail and corporate franchise. With competition heating up in the Kingdom in the field of credit, from both established Islamic banks and the Islamic windows of conventional institutions, BaJ has diversified into brokerage, margin lending and leveraged finance on behalf of customers. In 2006, BaJ’s operating income was more than five times higher than its net intermediation income (NII), reflecting the very large revenues derived from fees and commissions, themselves a function of BaJ’s appetite for brokerage and funding borrowers’ investments in stocks. Al Rajhi Bank (Al Rajhi), also headquartered in Saudi Arabia, remains a mass-market, retail-oriented Islamic bank, benefiting from the funding advantage of a very cheap and large customer deposit base. In 2006, Al Rajhi recorded a 1% funding cost, compared to 3% on average for all the Islamic banks included in the comparative panel. Given its robust profitability and comfortable capitalisation, Al Rajhi has been diversifying its asset allocation into corporate lending in recent years, and building the platform for enhanced asset management capabilities. Qatar Islamic Bank (QIB) has been following the same path to seek a universal banking status built on core commercial intermediation, but augmented by other business lines in investment banking and asset management. Dubai Islamic Bank (DIB) has also dramatically enhanced its Islamic investment banking business through its powerful Millennium brand established under a separate legal entity handling advisory, listing, private equity and fund and asset management.




Although commercial banking in the Islamic financial industry is expected to remain dominant, specialised and investment houses will continue to grow, as the financing and investment needs of regional clients are getting more specific. Given the successful evolution of the industry as a whole, newcomers (such as Masraf Al Rayan, with its equity base in excess of US$1 billion after just 18 months of operation) will intensify competition, forcing established players to seek opportunities in non-core, non-traditional business lines and to explore new territories outside home markets. Kuwait Finance House (KFH), Al Rajhi and QIB have already crossed the line by establishing operations in the Malaysian hub, seeking a wider audience in a larger part of Muslim Asia. Several GCC-based financiers are also sponsoring the recent foray of Islamic finance in the UK: both European Islamic Investment Bank and Europe Finance House have Gulf banking investors as reference shareholders. Even Shari’ah-compliant investment banks such as Gulf Finance House, Arcapita Bank and Unicorn Investment Bank have been structuring transactions outside their regional Gulf markets, both in the Western hemisphere and Asia.

Robust Financial Fundamentals Support Islamic Banks’ Stand-alone Ratings in the GCC Strong profitability ratios are not derived from excessive financial leverage

It is interesting to note that the robust returns of the 23 Islamic banks included in the comparative panel were not achieved by using excessive leverage: although aggregated ROE for fiscal year 2006 was 24.3%, total reported equity accounted for 18.4% of total assets, or financial leverage of 5.4x (see Figure 4). Therefore, the explanation must lie elsewhere.

Figure 4:

Detailed Aggregated Profitability Analysis and Capital Ratios for Islamic Banks Included in the Comparative Panel (2006) Net income components (as a % of NII)

Net Intermediation Income (NII) 100.00%

+ +

Gross operating income/NII (incl. extraordinaries) 223.80%

- -

Operating expenses/NII 69.20%

- -

Provisions/NII 10.10%

- -

Taxes/NII 1.90%

= =

Profit margin (net income/NII) 142.50%

DuPont ROE components

Profit margin (net income/NII) (%) 142.50%

x x

Net asset margin (NII/total assets) (%) 3.10%

x x

Financial leverage (total assets/equity) (x) 5.4

= =

ROE 24.30%

Capital ratios

Equity/total assets 18.40%

Net credit portfolio/equity 3.0x

Total capital adequacy ratio 27.60%




To determine the drivers of the banks’ strong returns, we use a DuPont-type decomposition of ROE – i.e. ROE is the product of the profit margin (defined as net income/NII), the net asset margin or NAM (NII/total assets) and financial leverage (total assets/equity). As the banks’ aggregated financial leverage (5.4x) is low by international standards, strong ROE must be derived from either wide NAMs or robust profit margins – or both. Based on Figure 4, it appears that both NAMs and profit margins are high at GCC-based Islamic banks. Each component is explored in more detail in the following sections.

Solid NAMs derive from the combination of high asset yields and low funding costs

The NAM is defined as the ratio of net intermediation income (NII) to total assets. NII is the net amount of gross yields on credit-like assets (typically murabaha,2 ijara3 and certain mudharaba and musharaka4 contracts displaying credit-like features rather than investment-like characteristics) minus all funding costs, including payments to unrestricted PSIA-holders.

As shown in Figure 5, Islamic banks generated an average asset yield of 5.6% in 2006, but their funding cost was capped at 3.0%. This translates into a NAM of 3.1% for the year, which is robust by international, and even regional, standards.

Figure 5:

Selected Profitability Ratios for Islamic Banks Included in the Comparative Panel (2006); Focus on Intermediation Income Net intermediation income

NII/total assets 3.10%

Gross intermediation income/total assets 5.60%

Cost of funds/total liabilities (excl. equity) 3.00%

Cost of funds/[total liabilities (excl. equity) - customer deposits] 5.00%

Four components, summarised in Figure 6, explain why NAMs tend to be wide at Islamic banks. First, Islamic products are usually more expensive than their conventional equivalents because a number of customers of Islamic banks are not price-sensitive and loyal and are more attracted by the religious identity of their banking service provider. Second, thanks to their strong entrenchment in the retail market, Islamic banks have a natural advantage in serving the higher yielding, and often lower risk, household market in the GCC. Third, Islamic banks have a tendency to book a higher proportion of credit exposures onto their balance sheets, translating into higher credit leverage than conventional peers. Whereas conventional peers can and do allocate a portion of their funds to fixed-income securities, Islamic banks, in line with the prohibition of riba,5 have a dual approach to balance sheet management: core liquidity based on short-term commodity murabahas are booked along with large illiquid credit portfolios, with small investment portfolios in between these two sizeable asset classes. Finally, Islamic banks have mainly two dominant funding sources: unremunerated qardh hassan6 deposits, and remunerated PSIAs. Whenever possible, Islamic banks resort to cheap qardh hassan deposits, which ultimately account for about 40% of their liabilities (excluding equity). The average funding cost is therefore relatively low, as opposed to very attractive asset yields. Consequently,

2 A contract of sale with an agreed profit mark-up on the cost. There are two types of murabaha sale: in the first type, the Islamic bank purchases the

goods and makes them available for sale without any prior promise from a customer to purchase them, and this is termed a normal or spot murabaha; the second type involves a promise from a customer to purchase the item from the bank, and this is called murabaha to the purchase order. In this latter case, there is a pre-agreed selling price that includes the pre-agreed profit mark-up. Normally, it involves the bank granting the customer a murabaha credit facility with deferred payment terms, but this is not an essential element.

3 The lease, hire or transfer of ownership of a service for a specified period for an agreed lawful consideration. This is an arrangement under which an Islamic bank leases equipment, a building or other facility to a client for an agreed rental.

4 An agreement under which the Islamic bank provides funds that are mingled with the funds of the business enterprise and possibly others. All providers of capital are entitled to participate in management, but are not necessarily obliged to do so. The profit is distributed among the partners in a pre-determined manner, but the losses, if any, are borne by the partners in proportion to their capital contribution. It is not permitted to stipulate otherwise.

5 Interest. Sometimes equated with usury, but its meaning is broader. The literal meaning is an excess or increase, and its prohibition is meant to distinguish between an unlawful exchange in which there is a clear advantage to one party in contrast to a mutually beneficial and lawful exchange.

6 A virtuous loan in which there is no interest or mark-up. The borrower must return the principal sum in the future without any increase.




asset margins are usually in excess of 250 basis points across the credit cycle in the region. This is particularly true for commercial and retail banks, whose access to cheap funding on the liability side of their balance sheet, and to lucrative retail lending on the asset side, is far stronger than Shari’ah-compliant investment banks, which are not in the business of credit.

Figure 6:

Increasing earning diversification, limited operating charges, cost of risk under control and no taxes make a heady cocktail, but is this sustainable?

The last component of ROE decomposition expressed in Figure 4 is the profit margin, or net income as a proportion of NII. This ratio was a strong 142.5% at year-end 2006, reflecting the fact that, despite solid intermediation revenues, Islamic banks in the Gulf manage to extract non-intermediation earnings capable of more than offsetting the sum of all their charges. In particular, non-intermediation gross revenues were twice the size of NII, mainly driven by brokerage fees and credit-related commissions, as well as investment income. Islamic banks tend to trade in assets, particularly real estate, stocks and projects, bringing sizeable amounts of investment-related mark-ups. Having said that, 2006 was a particular year: despite the deterioration in regional stock markets from the second quarter, the first quarter registered unprecedented trading volumes in equities, generating large amounts of brokerage fees for Islamic and conventional banks alike.

Altogether, the size of non-intermediation revenues, although unsustainable in the long term, reflects a positive development in that Islamic banks are no longer pure commercial banks. Business diversification into investment banking (including private equity), brokerage and fund and asset management has grown to the point where, if sustained, these sources of income might represent about half of gross operating income (as opposed to the inflated two-thirds recorded in 2006). Such revenues more than cover a limited cost base overall: operating expenses account for less than 70% of NII, translating into a cost-to-income ratio barely exceeding the 30% mark, which is very strong by any standard (see Figure 7). This stems from the fact that labour is still a cheap resource in the GCC, despite increasing tension on the labour market when it comes to hiring skilled and experienced professionals familiar enough with the subtleties of the Islamic banking industry. Credit and investment provisions absorb only an additional layer of expenses of about 10% of NII, translating into a cost of risk (defined as provisions/net operating income before provisions) of just 6.8% in 2006. Such a reasonable level of provision charges does not reflect under-provisioning at Islamic banks, as at year-end 2006, NPLs were covered by credit loss reserves by 112%. Finally, Islamic banks – just like their conventional peers – do not pay income taxes. Some of them, depending on the jurisdictions they operate in, are subject to

Access to a large

base of cheap and stable

retail deposits

Islamic products relatively expensive

Low funding costs

The Four Components of Islamic Banks’ Wide Intermediation Margins Summarised

Strong entrenchment in the retail market

Relatively high credit leverage

High gross yields

on assets

WIDE INTERMEDIATION MARGINS

Assets Liabilities




zakat7 and other small social contributions, whereas for the vast majority of others, zakat is paid directly at the level of shareholders.

Figure 7:

Selected Profitability Ratios for Islamic Banks Included in the Comparative Panel (2006); Focus on Expense Ratios Expense ratios 2006

Net income/RWAs 6.70%

Cost/income ratio 31.60%

Provisions/net operating income before provisions 6.80%

Overall, net income (in excess of US$5.6 billion for the 23 Islamic banks included in the comparative panel) was 6.7% of risk-weighted assets in 2006, which we consider very strong, but probably beyond the long-term potential of the industry. Not only are fees and commissions as well as investment income expected to slow down in relative, if not in absolute terms, going forward, but also a large portion of current exposures have never been tested by a sharp economic downturn. Therefore, past provisioning charges might not be good indicators of future write-downs, and thus of overall profitability.

Rating implications: high scores for quantitative financial factors in our BFSRs for Islamic banks in the Gulf

Notwithstanding the necessary caveats attached to any analysis of the 2006 figures, Islamic banks in the GCC are structurally profitable, and their business model robust enough to weather credit cycles. This is reflected in our Bank Financial Strength Ratings (BFSRs), which are Moody’s assessments of Islamic banks’ stand-alone creditworthiness, irrespective of any external support. Our BFSRs are largely, although not exclusively, based on scorecards, which we publish for each rated bank within our Credit Opinion reports. The comparative scorecards of the seven Islamic banks we rate in the GCC are summarised in Appendix 2. Scores range from A to E, for the various rating factors, themselves sub-divided into two broad categories of qualitative vs. financial factors. The scorecard serves as a guideline for assigning BFSRs, which translate into unsupported Baseline Credit Assessments (BCAs). BCAs can be interpreted as Moody’s opinion on a bank’s creditworthiness absent any shareholder or systemic support. BFSRs map to BCAs as shown in Figure 8.

7 A tax that is prescribed by Islam on all persons having wealth above an exemption limit at a rate fixed by the Shari’ah. Its objective is to collect a portion

of the wealth of the well-to-do and distribute it to the needy. The way it is distributed is set out in the Qur’an. It may be collected by the state, but otherwise it is down to each individual to distribute the zakat.




Figure 8:

BFSR/BCA Mapping BFSR BCA

A Aaa

A- Aa1

B+ Aa2

B Aa3

B- A1

C+ A2

C A3

C- Baa3

C- Baa2

D+ Baa3

D+ Ba1

D Ba2

D- Ba3

E+ B1

E+ B2

E+ B3

E Caa1

E Caa2

E Caa3

All seven Shari’ah-compliant financial institutions we rate in the GCC score highly in terms of quantitative financial fundamentals. Not surprisingly, GCC-based Islamic banks’ overall scores for (quantitative) financial performance are in the B category, which is equivalent to financial profiles of Aa-rated or A-rated banks globally. However, assigned BFSRs for these seven banks ultimately range from D to C, meaning that other factors, based on more qualitative assessments, are driving down the stand-alone ratings. These mitigants are explored more extensively in the following section.

Imperfect Risk Positioning and Constrained Operating Environments Weigh on Islamic Banks’ BFSRs in the GCC

Asset quality: reported numbers do not tell the whole credit story

From a quantitative perspective, Islamic banks in the GCC display adequate asset quality ratios. With NPLs limited to 3.4% of gross credit exposures at year-end 2006 and provision coverage in excess of 100% (see Figure 9), Gulf Islamic banks are in line with the region’s average, and compare favourably to banks in other emerging countries. Asset quality at this point in time does not weigh on capital positions.




Figure 9:

Asset Quality Indicators for Islamic Banks in the GCC (2006) Asset quality ratios

NPLs/gross credit portfolio 3.4%

CLRs/NPLs 112.3%

CLRs/gross credit portfolio 3.8%

NPLs/equity 10.4%

CLR = Credit loss reserves

Nevertheless, on closer inspection it becomes apparent that portfolios tend to be concentrated, with very few exceptions (those of the largest Islamic banks operating in the Gulf, such as Al Rajhi, KFH and DIB). First, concentration risk arises from the banks’ limited geographic reach, as most Islamic banks in the region are domestic players and only very few have material operations outside their home country. One interesting exception is Albaraka Banking Group, which has a material presence in more than a dozen jurisdictions across the Muslim world, from Algeria to Pakistan, bringing a good amount of de-correlation between sub-portfolios. Second, Islamic banks in the Gulf also face concentration by name and sector. The granularity of credit portfolios is usually weak, with few large obligors accounting for large proportions of banks’ equity bases. Given the lack of economic diversification of their operating environments, Islamic banks also face the drawback of being exposed to a limited number of borrowing industries. Finally, only business diversification out of pure lending is improving, although its sustainability remains questionable.

As a consequence, current asset quality indicators are not sufficiently good proxies of Islamic banks’ genuine asset quality through a full credit cycle. This is all the more relevant as Islamic banks only discovered the merits of retail banking little more than a decade ago. A large number of new customers have been fuelling very rapid credit growth, and portfolios remain largely untested. Therefore, the current coverage of NPLs by loan loss reserves, although in excess of 100%, could prove insufficient should the credit cycle worsen suddenly, although this is not expected in the medium term. Concentration and potential volatility in the credit quality of portfolios have made it necessary for Islamic banks to maintain strong capitalisation despite rapid growth. This has in turn put pressure on dividend payouts, and sometimes also on shareholders to inject fresh capital despite spectacular returns on their investments.

Risk management architectures are evolving to better cope with structural threats

Capital is the ultimate buffer against unexpected losses. As risk management frameworks in the region are still evolving, Islamic banks’ management teams have not given credit to computations of economic capital beyond what models can tell. Indeed, reliable default and loss data are scarce in the GCC banking systems, and therefore qualitative and intuitive judgment has been driving more conservative capital policies than would be suggested by the quantitative results of credit portfolio models. The fact that risk is still difficult to quantify in a regional market subject to recurring volatility constitutes a material mitigating factor to strong financial performance.




As stated in a previous report published recently,8 Islamic banks face a number of challenges in terms of risk management. The entanglement of credit, market and operational risk in each contract type used by Islamic banks in their daily operations, as well as displaced commercial risks attached to the incentive to serve PSIA-holders with returns at least comparable to similar conventional deposits, are two of the constraints Islamic banks need to cope with. In addition, absent a wide pool of Shari’ah-compliant, sufficiently liquid investment vehicles (especially in fixed income), Islamic banks find it difficult to manage their balance sheet from an asset-liability management perspective, especially liquidity and margin-rate risk. Finally, Islamic banks’ funding mix tends to be imbalanced (see Figure 10), with the dominance of deposits, PSIAs and equity making Islamic banks’ funding profile predominantly short-term at a time when the maturity of their asset classes is widening. To mitigate nascent maturity mismatches, some Islamic banks have started issuing medium-term Sukuk (Islamic notes) to lengthen the maturity profile of their funding, but at year-end 2006, Sukuk accounted for only 1.6% of total liabilities (excluding equity). Subordinated Sukuk and hybrid instruments have not been used yet; these are more expensive funding sources and incentives to issue them are limited given the abundance of capital in the region.

Figure 10:

Funding and Liquidity Ratios of Islamic Banks Included in the Comparative Panel (2006) Cash and money market/bank deposits 2.7x

Cash and money market/(total deposits + PSIAs) 33.20%

(Cash and money market + investments and participations)/(total deposits + PSIAs) 55.00%

PSIAs/total liabilities (excl. equity) 40.60%

(PSIAs + customer deposits)/total liabilities (excl. equity) 79.70%

Rating implications: lower scores for qualitative factors in our BFSRs for Islamic banks in the Gulf

Taking into account these constraints, the scorecards supporting GCC-based Islamic banks’ BFSRs display more modest performances for qualitative factors. Qualitative scores range from D- to D+. As qualitative scores are given more weight in emerging markets than in more mature banking environments, the weighted-average score for Islamic banks tends to be even lower than a simple arithmetic mean between scores assigned to financial fundamentals and qualitative factors would suggest. Weighted BFSRs implied by the scorecards therefore range from D+ and C-, but are further adjusted by the rating committee to better reflect a higher risk profile than the scores would suggest. Four out of the seven rated GCC Islamic banks have been assigned final BFSRs lower than the outcome of their scorecards, precisely to capture volatile business environments, unsustainable profitability, low earning quality relative to that of peers, limited diversification and imperfect corporate governance frameworks.

In turn, BFSRs translate into stand-alone credit ratings, or BCAs, ranging from Ba2 to A3. However, the final ratings have all been uplifted by several notches to reflect our support expectations.

8 See Moody’s report entitled “Risk Issues at Islamic Financial Institutions”, published in January 2008 (107175). A complete list of related reports can be

found at the end of this report.




Expectations of Likely External Support Help Uplift Ratings for GCC-Based Islamic Banks

Government ownership and systemic importance are two critical rating drivers for Islamic banks in the Gulf

Out of the seven Islamic banks we rate in the GCC, five have some form of direct government ownership, in material amounts. Government shareholding provides us with additional comfort that support would be made available to those institutions should the need arise. In addition, all six states constituting the GCC are considered, under our methodology, as high-support countries. This means that even without material government ownership, the banks might benefit from system support, the relevant cap being our assessment of country ceilings, as they would apply to local and foreign currency deposits, and foreign currency bonds and notes. In this respect, two private-sector Islamic banks, Al Rajhi and BaJ (both headquartered in Saudi Arabia), benefit from rating uplifts, absent government ownership, in order to reflect their systemic importance to the Kingdom’s banking sector.

Rating implications: ultimately, Islamic banks’ final issuer and deposit ratings tend to be materially uplifted from BCAs

Rating uplifts for Islamic banks in the GCC range from two to six notches. Not surprisingly, those Islamic banks with some form of direct sovereign shareholding benefit from higher uplifts, ranging from three to six notches, whereas private-sector banks benefit from Joint Default Analysis-driven uplifts of two to three notches. This translates into final ratings ranging from Baa2 to Aa3, all in the investment-grade category. Rating uplifts beyond standalone BFSRs is not a feature specific to Islamic banks: most conventional banks’ ratings in the GCC also extensively benefit from external support.

For conventional banks, Moody’s rates long- and short-term deposits of both foreign and domestic currency with the emphasis being on wholesale deposits. These ratings act as good proxies for issuer, or overall, ratings of the bank. We are rating relative creditworthiness as captured by an assessment of expected losses to depositors and other creditors. For Islamic banks, we will generally use issuer ratings and BFSRs to describe the overall creditworthiness of the bank and focus on the expected loss that might be incurred by a fund provider. In some circumstances, where the funding of the Islamic bank is similar to that of a conventional bank in its own market, we will issue deposit ratings to allow easy comparison of creditworthiness among peers. It is our intention that any credit ratings assigned to Islamic financial institutions be comparable to ratings assigned to conventional banks.




Appendix 1

Financial Statistics of the 23 Islamic Banks Included in the Comparative Panel As at Dec. 31, 2006 ($ million) ADIB

Al Rajhi ABG Amlak Arcapita BIB Albilad BaJ Boubyan DB DIB EIB GFH KFH KIB Rayan QIIB QIB SBB SIB Tamweel TID UIB TOTAL

Balance sheet

Assets

Cash & money market 3,261 2,852 2,544 73 311 520 221 1,972 1,100 918 5,044 456 703 4,700 952 1,093 1,055 1,166 572 469 104 652 105 30,841

Investment portfolio & participations 896 2,525 928 154 1,748 277 44 351 214 136 3,661 514 463 4,366 161 38 214 809 211 188 19 2,238 152 20,309

Credit portfolio (gross) 5,636 22,472 3,957 1,136 512 328 2,578 1,767 458 420 8,283 1,906 135 13,198 1,923 51 1,023 2,043 859 1,286 704 795 28 71,498

Credit loss reserves (CLRs) 67 922 159 12 0 6 2 95 8 10 248 107 0 648 154 0 21 76 45 51 0 77 0 2,707

Credit portfolio (net) 5,569 21,550 3,798 1,124 512 322 2,576 1,672 452 410 8,035 1,799 135 12,549 1,769 51 1,003 1,967 814 1,235 704 718 28 68,792

Fixed assets 58 539 131 2 62 27 148 109 13 10 135 18 4 1,044 51 3 9 30 6 34 9 22 3 2,466

Other assets 105 589 225 22 75 17 20 86 68 41 682 67 196 469 11 3 27 120 90 157 53 253 5 3,380

Total assets 9,888 28,056 7,626 1,375 2,708 1,162 3,008 4,190 1,847 1,515 17,557 2,854 1,501 23,128 2,945 1,188 2,308 4,092 1,693 2,082 889 3,883 293 125,789

Liabilities

Bank deposits 1,457 926 115 0 1,342 0 19 46 759 69 1,267 15 341 3,956 136 0 28 315 301 24 25 77 0 11,218

Customer deposits 4,902 19,494 1,334 0 0 136 1,293 1,705 330 351 4,087 784 356 3,416 139 7 466 664 112 583 28 0 10 40,196

Profit-sharing investment accounts (PSIAs) 1,589 650 4,698 614 158 810 784 1,206 287 869 8,919 1,680 59 10,247 1,927 55 1,374 1,750 838 622 282 2,190 0 41,609

Long-term funds (excl. Sukuk) 0 500 0 69 0 0 0 0 0 0 0 0 0 0 154 0 0 0 0 0 0 0 0 723

Sukuk funds 801 0 0 190 215 0 0 0 0 0 0 0 0 0 0 0 0 0 0 225 0 242 0 1,672

Other liabilities (incl. proposed dividend) 429 1,371 301 19 71 43 106 173 30 51 1,200 111 77 2,414 70 6 47 400 61 55 113 4 29 7,180

Total liabilities excl. equity 9,177 22,941 6,448 893 1,786 989 2,202 3,130 1,407 1,340 15,473 2,591 833 20,033 2,425 67 1,916 3,130 1,312 1,508 447 2,513 39 102,599

Equity (excl. proposed dividend) 711 5,115 1,178 482 922 173 806 1,060 441 174 2,084 263 668 3,095 520 1,121 392 962 381 575 441 1,370 254 23,190

Total liabilities and equity 9,888 28,056 7,626 1,375 2,708 1,162 3,008 4,190 1,848 1,515 17,557 2,854 1,501 23,128 2,945 1,188 2,308 4,092 1,693 2,082 889 3,883 293 125,789

Note 1: Nonperforming credit exposures (NPLs) 50 685 192 5 0 15 6 55 0 8 345 114 0 449 168 0 27 93 42 74 0 81 0 2,410

Note 2: Risk-weighted assets (RWAs) 5,726 21,257 N/A 1,299 2,302 456 1,485 2,782 1,352 923 13,159 1,839 1,452 16,026 2,240 423 1,369 2,882 1,445 1,205 640 3,426 220 83,908






Income statement

Gross intermediation income 561 2,042 614 82 65 66 100 200 68 76 820 88 39 1,201 214 1 104 172 116 90 38 301 7 7,066

- Funding cost 368 222 374 47 72 53 4 73 29 29 479 65 24 762 119 0 49 71 68 31 17 150 1 3,107

= Net intermediation income (NII) 193 1,820 240 35 -7 13 96 127 39 47 341 23 15 440 95 0 55 101 48 60 21 151 6 3,959

+ Net commissions 29 399 124 9 32 20 68 501 24 20 237 24 24 161 11 0 19 116 22 22 13 103 19 1,998

+ Income from investments & participations, others 54 316 82 15 253 25 11 69 17 23 190 39 283 758 28 49 63 144 27 11 22 192 41 2,713

= Gross operating income 276 2,536 446 59 278 58 175 697 80 90 768 86 322 1,359 134 49 138 362 97 93 57 445 66 8,670

- Operating expenses 103 521 273 18 116 22 125 141 33 54 316 44 103 535 45 18 25 57 32 38 15 71 36 2,741

= Net operating income (NOI) before provisions 172 2,015 173 41 162 35 49 557 47 36 453 42 219 824 89 31 113 305 65 55 42 375 30 5,929

- Provision charges 17 67 33 5 25 1 2 4 8 7 21 10 7 99 52 0 3 19 1 0 0 19 0 401

= Net operating income (NOI) after provisions 156 1,947 140 35 137 35 47 553 39 29 432 32 212 725 37 31 110 286 64 55 42 355 30 5,528

+ Exceptional items 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 190 0 0 190

- Zakat & other taxes 0 0 16 0 0 0 0 27 1 0 2 0 0 18 2 0 0 0 1 0 0 10 0 76

= Net income 156 1,947 124 35 137 35 47 526 38 29 430 32 212 707 35 31 110 286 63 55 232 345 30 5,642

Key ratios

Asset leverage ratios

Credit leverage = Net credit portfolio/total assets 56.3% 76.8% 49.8% 81.8% 18.9% 27.7% 85.6% 39.9% 24.5% 27.1% 45.8% 63.0% 9.0% 54.3% 60.1% 4.3% 43.4% 48.1% 48.1% 59.3% 79.2% 18.5% 9.6% 54.7%

Net credit portfolio/total liabilities (excl. equity) 60.7% 93.9% 58.9% 125.9% 28.7% 32.5% 117.0% 53.4% 32.1% 30.6% 51.9% 69.4% 16.2% 62.6% 73.0% 76.3% 52.3% 62.8% 62.0% 81.9% 157.4% 28.6% 71.8% 67.0%

Investment leverage = Investments & participations/total assets 9.1% 9.0% 12.2% 11.2% 64.5% 23.9% 1.5% 8.4% 11.6% 9.0% 20.9% 18.0% 30.8% 18.9% 5.5% 3.2% 9.3% 19.8% 12.5% 9.0% 2.2% 57.6% 51.9% 16.1%

Net credit portfolio/customer deposits 113.6% 110.5% 284.7% N/M N/M 236.7% 199.2% 98.1% 136.8% 116.9% 196.6% 229.3% 37.9% 367.4% 1271.1% 779.2% 215.0% 296.1% 726.8% 212.0% 2558.4% N/M 280.0% 171.1%

Net credit portfolio/(customer deposits+PSIAs) 85.8% 107.0% 63.0% 183.1% 324.1% 34.0% 124.0% 57.4% 73.2% 33.6% 61.8% 73.0% 32.5% 91.8% 85.6% 83.5% 54.5% 81.4% 85.7% 102.5% 227.5% 32.8% 280.0% 84.1%

Investments & participations/equity 126.0% 49.4% 78.8% 31.9% 189.6% 160.0% 5.5% 33.1% 48.6% 78.1% 175.7% 195.3% 69.3% 141.1% 31.0% 3.4% 54.6% 84.1% 55.4% 32.8% 4.4% 163.4% 59.8% 87.6%






Funding and liquidity ratios

Cash & money market/bank deposits (x) 2.24 3.08 22.12 N/M 0.23 N/M 11.65 42.51 1.45 13.37 3.98 29.89 2.06 1.19 7.03 N/M 37.62 3.70 1.90 19.77 4.09 8.48 N/M 2.7

Cash & money market/(total deposits + PSIAs) 41.0% 13.5% 41.4% 11.9% 20.7% 54.9% 10.5% 66.7% 79.9% 71.2% 35.3% 18.4% 93.0% 26.7% 43.3% 1775.9% 56.4% 42.7% 45.7% 38.2% 30.9% 28.8% 1050.0% 33.2%

(Cash & money market + investments & participation)/(total deposits + PSIAs) 52.3% 25.5% 56.5% 36.9% 137.3% 84.2% 12.6% 78.5% 95.4% 81.8% 61.0% 39.1% 154.2% 51.5% 50.6% 1837.9% 67.9% 72.4% 62.6% 53.5% 36.7% 127.5% 2570.0% 55.0%

PSIAs/total liabilities (excluding equity) 17.3% 2.8% 72.9% 68.8% 8.8% 81.9% 35.6% 38.5% 20.4% 64.9% 57.6% 64.9% 7.1% 51.2% 79.5% 81.6% 71.7% 55.9% 63.9% 41.2% 63.0% 87.2% 0.0% 40.6%

(PSIAs + customer deposits)/Total liabilities (excluding equity) 70.7% 87.8% 93.5% 68.8% 8.8% 95.7% 94.3% 93.0% 43.9% 91.0% 84.1% 95.1% 49.8% 68.2% 85.2% 91.4% 96.1% 77.1% 72.4% 79.9% 69.2% 87.2% 25.6% 79.7%

Asset quality ratios

NPLs/gross credit portfolio 0.9% 3.0% 4.9% 0.5% 0.0% 4.7% 0.2% 3.1% 0.0% 1.9% 4.2% 6.0% 0.0% 3.4% 8.8% 0.0% 2.6% 4.5% 4.9% 5.8% 0.0% 10.1% 0.0% 3.4%

CLRs/NPLs 133.5% 134.6% 82.8% 215.0% N/M 37.9% 33.3% 172.8% N/M 120.0% 71.8% 94.3% N/M 144.5% 91.3% N/M 76.1% 81.7% 107.1% 69.2% N/M 95.5% N/M 112.3%

CLRs/gross credit portfolio 1.2% 4.1% 4.0% 1.0% 0.0% 1.8% 0.1% 5.4% 1.7% 2.3% 3.0% 5.6% 0.0% 4.9% 8.0% 0.0% 2.0% 3.7% 5.2% 4.0% 0.0% 9.7% 0.0% 3.8%

NPLs/equity 7.1% 13.4% 16.3% 1.1% 0.0% 8.9% 0.7% 5.2% 0.0% 4.7% 16.6% 43.3% 0.0% 14.5% 32.4% 0.0% 6.9% 9.7% 11.0% 12.9% 0.0% 5.9% 0.0% 10.4%

Profitability ratios

ROA 1.6% 6.9% 1.6% 2.6% 5.1% 3.0% 1.6% 12.6% 2.1% 1.9% 2.4% 1.1% 14.1% 3.1% 1.2% 2.6% 4.8% 7.0% 3.7% 2.6% 26.1% 8.9% 10.2% 4.5%

ROE 21.9% 38.1% 10.5% 7.3% 14.9% 20.0% 5.9% 49.6% 8.7% 16.4% 20.6% 12.1% 31.7% 22.8% 6.7% 2.8% 28.1% 29.7% 16.5% 9.5% 52.6% 25.2% 11.8% 24.3%

Net income/RWAs 2.7% 9.2% N/A 2.7% 6.0% 7.6% 3.2% 18.9% 2.8% 3.1% 3.3% 1.7% 14.6% 4.4% 1.6% 7.3% 8.0% 9.9% 4.4% 4.5% 36.3% 10.1% 13.7% 6.7%

Cost/income ratio 37.5% 20.6% 61.2% 30.9% 41.7% 38.9% 71.8% 20.2% 41.6% 60.1% 41.1% 51.4% 32.0% 39.4% 33.6% 36.5% 17.9% 15.7% 33.0% 40.6% 26.4% 15.9% 54.5% 31.6%

Provisions/NOI before provisions 9.6% 3.3% 19.1% 13.3% 15.4% 1.5% 3.8% 0.8% 16.4% 20.5% 4.6% 23.5% 3.2% 12.0% 58.8% 0.0% 2.7% 6.3% 1.5% 0.5% 0.0% 5.2% 0.0% 6.8%

NII/total assets 1.9% 6.5% 3.1% 2.5% -0.3% 1.1% 3.2% 3.0% 2.1% 3.1% 1.9% 0.8% 1.0% 1.9% 3.2% 0.0% 2.4% 2.5% 2.8% 2.9% 2.4% 3.9% 2.0% 3.1%

Gross intermediation income/total assets 5.7% 7.3% 8.1% 6.0% 2.4% 5.7% 3.3% 4.8% 3.7% 5.0% 4.7% 3.1% 2.6% 5.2% 7.3% 0.1% 4.5% 4.2% 6.9% 4.3% 4.3% 7.8% 2.4% 5.6%

Cost of funds/total liabilities (excluding equity) 4.0% 1.0% 5.8% 5.3% 4.0% 5.4% 0.2% 2.3% 2.1% 2.2% 3.1% 2.5% 2.9% 3.8% 4.9% 0.4% 2.6% 2.3% 5.2% 2.0% 3.7% 6.0% 2.6% 3.0%

Cost of funds/[total liabilities (excluding equity) - customer deposits] 8.6% 6.4% 7.3% 5.3% 4.0% 6.3% 0.4% 5.1% 2.7% 2.9% 4.2% 3.6% 5.0% 4.6% 5.2% 0.4% 3.4% 2.9% 5.7% 3.3% 4.0% 6.0% 3.4% 5.0%






Detailed profitability analysis

Net income components (as a % of Net intermediation income or NII)

Net intermediation income (NII) 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

+

Gross operating income/NII (including extraordinaries) 143.1% 139.3% 185.8% 169.5% N/M 459.6% 182.5% 548.2% 204.7% 191.3% 225.0% 370.6% 2146.7% 309.2% 140.8% 12707.1% 249.8% 357.6% 202.1% 155.3% 1162.8% 295.1% 1100.0% 223.8%

-

Operating expenses/NII 53.6% 28.6% 113.8% 52.3% N/M 178.7% 131.1% 110.5% 85.0% 115.0% 92.4% 190.6% 686.7% 121.7% 47.3% 4642.9% 44.8% 56.3% 66.7% 63.0% 70.5% 46.8% 600.0% 69.2%

-

Provisions/NII 8.6% 3.7% 13.8% 15.6% N/M 4.3% 2.0% 3.4% 19.6% 15.6% 6.1% 42.4% 46.7% 22.5% 55.0% 0.0% 5.5% 19.0% 2.1% 0.5% 0.0% 12.9% 0.0% 10.1%

-

Taxes/NII 0.0% 0.0% 6.7% 0.0% N/M 0.0% 0.0% 21.0% 2.5% 0.0% 0.5% 0.0% 0.0% 4.2% 1.9% 0.0% 0.0% 0.0% 2.1% 0.0% 0.0% 6.6% 0.0% 1.9%

=

Profit margin (net income/NII) 80.9% 107.0% 51.7% 101.6% N/M 276.6% 49.5% 413.4% 97.5% 60.7% 125.9% 137.6% 1413.3% 160.8% 36.5% 8064.3% 199.5% 282.3% 131.3% 91.8% 1092.3% 228.9% 500.0% 142.5%

Du Pont ROE components

Profit margin (net income/NII) (%) 80.9% 107.0% 51.7% 101.6% N/M 276.6% 49.5% 413.4% 97.5% 60.7% 125.9% 137.6% 1413.3% 160.8% 36.5% 8064.3% 199.5% 282.3% 131.3% 91.8% 1092.3% 228.9% 500.0% 142.5%

x

Net asset margin (NII/total assets) (%) 1.9% 6.5% 3.1% 2.5% -0.3% 1.1% 3.2% 3.0% 2.1% 3.1% 1.9% 0.8% 1.0% 1.9% 3.2% 0.0% 2.4% 2.5% 2.8% 2.9% 2.4% 3.9% 2.0% 3.1%

x

Financial leverage (Total assets/equity) (x) 13.9 5.5 6.5 2.9 2.9 6.7 3.7 4.0 4.2 8.7 8.4 10.8 2.2 7.5 5.7 1.1 5.9 4.3 4.4 3.6 2.0 2.8 1.2 5.4

=

ROE 21.9% 38.1% 10.5% 7.3% 14.9% 20.0% 5.9% 49.6% 8.7% 16.4% 20.6% 12.1% 31.7% 22.8% 6.7% 2.8% 28.1% 29.7% 16.5% 9.5% 52.6% 25.2% 11.8% 24.3%

Capital ratios

Equity/total assets 7.2% 18.2% 15.4% 35.1% 34.0% 14.9% 26.8% 25.3% 23.9% 11.5% 11.9% 9.2% 44.5% 13.4% 17.7% 94.3% 17.0% 23.5% 22.5% 27.6% 49.7% 35.3% 86.7% 18.4%

Net credit portfolio/equity (x) 7.83 4.21 3.22 2.33 0.56 1.86 3.19 1.58 1.02 2.35 3.86 6.83 0.20 4.05 3.40 0.05 2.55 2.05 2.14 2.15 1.60 0.52 0.11 3.0

Total capital adequacy ratio 12.2% 26.5% 14.5% 37.1% 32.0% 35.2% 54.3% 41.5% 32.6% 18.9% 15.6% 14.3% 46.0% 18.9% 23.3% 265.0% 28.7% 33.4% 26.4% 47.7% 68.9% 40.0% 115.7% 27.6%

Tier 1 capital adequacy ratio 11.2% 25.3% N/A N/A N/A N/A 54.3% 40.1% 32.6% N/A 15.6% 14.3% 46.0% 18.4% 21.2% 265.0% N/A N/A 21.7% 47.7% N/A N/A N/A N/M




Appendix 2

Comparative Scorecards of the Seven Islamic Financial Institutions Rated by Moody’s in the GCC

Abu Dhabi Islamic Bank

Al Rajhi Bank Bank Al-Jazira Boubyan Bank Dubai Islamic Bank Kuwait Finance House Tamweel

Rating Value Trend Rating Value Trend Rating Value Trend Rating Value Trend Rating Value Trend Rating Value Trend Rating Value Trend

Country U.A.E. SAUDI ARABIA SAUDI ARABIA KUWAIT U.A.E. KUWAIT U.A.E.

Sovereign FC long-term rating Aa2 A1 A1 Aa2 Aa2 Aa2 Aa2

Sovereign rating outlook Stable Positive Positive Stable Stable Stable Stable

Systemic support category HIGH HIGH HIGH HIGH HIGH HIGH HIGH

Qualitative Factors D- D+ D+ D- D- D+

Factor 1: Franchise Value D B- D E+ D+ C

Market share and sustainability D A C D B A

Geographical diversification D D D E D E

Earnings stability D B E E E C

Earnings diversification

Factor 2: Risk Positioning (21%) E D D+ E E D

Corporate governance E D D E E D

- Ownership and organizational complexity D D D E

- Key man risk D

- Insider and related-party risks E D

Controls and risk management D D C C C D

- Risk management E D D D D E

- Controls B C B B B C

Financial reporting transparency C C C C C C

- Global comparability A A A A A B

- Frequency and timeliness B A A B A A

- Quality of financial information D D D D D D

Credit risk concentration

- Borrower concentration

- Industry concentration

Liquidity management D C C C C C

Market risk appetite C C C B B C

Factor 3: Operating Environment D+ D D D D+ D

Economic stability D D D E D E

Integrity and corruption C D D C C C

Legal system D D D D D D

No scorecard available: Tamweel is a non-bank

financial institution, and scorecards are applied only

to bank ratings




Abu Dhabi Islamic Bank Al Rajhi Bank Bank Al-Jazira Boubyan Bank Dubai Islamic Bank Kuwait Finance House Tamweel


Financial Factors B+ B+ B+ B+ B B

Factor 4: Profitability A A A A A A

PPP % Avg RWA A 3.94% A 8.64% A 12.21% A 4.21% A 3.84% A 4.83%

Net Income % Avg RWA A 2.93% A 7.70% A 10.55% A 3.54% A 3.44% A 4.77%

Factor 5: Liquidity C+ B B B B C+

(Market Funds-Liquid Assets) % Total Assets A -24.37% A -25.12% A -45.69% A -28.33% A -19.59% B -8.82

Liquidity Management D C C C C C

Factor 6: Capital Adequacy A A A A A A

Tier 1 ratio (%) A 14.47% A 19.57% A 29.05% A 32.03% A 10.60% A 17.06%

Tangible Common Equity % RWA A 14.44% A 19.57% A 24.18% A 33.97% A 12.19% A 15.48%

Factor 7: Efficiency A A A A A A

Cost/income ratio A 38.23% A 22.58% A 28.73% A 36.90% A 37.86% A 41.19%

Factor 8: Asset Quality (4.7%) A B B A C C+

Problem Loans % Gross Loans A 0.56% B 2.42% C 3.18% A 0.00% C 4.90% C 3.82%

Problem Loans % (Equity + LLR) A 3.41% A 8.50% A 7.48% A 0.00% C 27.87% B 16.22%

Lowest Combined Score C+ B B B C C+

Economic Insolvency Override




Abu Dhabi Islamic Bank Al Rajhi Bank Bank Al-Jazira Boubyan Bank Dubai Islamic Bank Kuwait Finance House Tamweel


Total Scorecard Implied BFSR (a) C- C C D+ D+ C N/A

Assigned BFSR (b) D C D+ D D+ C- D

If (a) different from (b), why?

-2 notches because of: fast credit growth, constrained liquidity management, and

unsustainable financial performance

N/M

-2 notches because of: unsustainable business

conditions and low earning quality

-1 notch because of: perfectible corporate

governance, disclosure, and diversification

N/M

-1 notch because of: perfectible corporate

governance, disclosure, and diversification

N/M

Baseline Credit Assessment (BCA) Ba2 A3 Baa3 Ba2 Baa3 Baa1 Ba2

Main shareholder & FC long-term rating Government of Abu Dhabi (Aa2) and Abu Dhabi ruling

family (NR) Al Rajhi family (NR) Rashed family, Saleh Kamel

(NR) State of Kuwait (Aa2) Government of Dubai (NR) State of Kuwait (Aa2) Istithmar (NR), Dubai Islamic

Bank (A1), Dubai Holding (NR)

JDA Notching +6 +2 +3 +3 +5 +4 +5

LCDR/LCIR (long-term) A2 A1 A3 Baa2 A1 Aa3 A3

LCDR/LCIR (short-term) P-1 P-1 P-2 P-2 P-1 P-1 P-2

Outlook Stable Stable Stable Stable Stable Stable Stable

LCDC Aa2 Aa3 Aa3 Aa2 Aa2 Aa2 Aa2

Total Scorecard Implied BFSR (a) C- C C D+ D+ C N/A

Assigned BFSR (b) D C D+ D D+ C- D*

If (a) different from (b), why?

-2 notches because of: fast credit growth, constrained liquidity management, and

unsustainable financial performance

N/M

-2 notches because of: unsustainable business

conditions and low earning quality

-1 notch because of: we expect some of the bank's

metrics, in particular its asset quality and capital adequacy, to deteriorate somewhat as

the bank expands. The scorecard outcome was also

negatively affected by corporate governance concerns, disclosure standards and credit

concentrations and by the regulatory environment score

for Kuwait.

N/M

-1 notch because of: corporate governance concerns, disclosure standards and credit

concentrations. KFH's score was also negatively affected by the regulatory score for

Kuwait, because the Kuwaiti supervisory authority applies a different regulatory regime to the country's Islamic banks than to its commercial banks

N/M

Baseline Credit Assessment (BCA) Ba2 A3 Baa3 Ba2 Baa3 Baa1 Ba2

Main shareholder & FC long-term rating Government of Abu Dhabi (Aa2) and Abu Dhabi ruling

family (NR) Al Rajhi family (NR) Rashed family, Saleh Kamel

(NR) State of Kuwait (Aa2) Government of Dubai (NR) State of Kuwait (Aa2) Istithmar (NR), Dubai Islamic

Bank (A1), Dubai Holding (NR)

Uplift due to external support +6 +2 +3 +3 +5 +4 +5

LCDR/LCIR (long-term) A2 A1 A3 Baa2 A1 Aa3 A3

LCDR/LCIR (short-term) P-1 P-1 P-2 P-2 P-1 P-1 P-2

Outlook Stable Stable Stable Stable Stable Stable Stable

LCDC Aa2 Aa3 Aa3 Aa2 Aa2 Aa2 Aa2

FCDR A2 A1 A3 Baa2 A1 Aa3 A3

CCFCBD Aa2 A1 A1 Aa2 Aa2 Aa2 Aa2

FCIR A2 A1 A3 Baa2 A1 Aa3 A3

CCFCBN Aa2 Aa3 Aa3 A2 Aa2 Aa2 Aa2

Sub debt rating A3 NR NR NR NR NR NR

Latest Credit Opinion published November 2007 September 2007 December 2007 December 2007 November 2007 May 2007 November 2007

Latest Analysis published November 2006 September 2007 June 2007 December 2007 November 2007 December 2006 November 2007




Confidential

Blank box, no input

Notes: * Tamweel has been assigned a standalone rating, not a BFSR, as it is not classified as a bank. FC: Foreign Currency PPP: Pre-Provision Profit RWA: Risk-Weighted Assets LLR: Loan Loss Reserves

: Improving : Weakening : Neutral

JDA: Joint Default Analysis NR: Not Rated BFSR: Bank Financial Strength Rating LCDR: Local Currency Deposit Rating LCIR: Local Currency Issuer Rating LCDC: Local Currency Deposit Ceiling FCDR: Foreign Currency Deposit Rating CCFCBD: Country Ceiling for Foreign Currency Bank Deposits FCIR: Foreign Currency Issuer Rating CCFCBN: Country Ceiling for Foreign Currency Bonds and Notes




Moody’s Related Research

Special Comments:

The Benefits of Ratings for Islamic Financial Institutions and What They Address, February 2008 (107502)

Risk Issues at Islamic Financial Institutions, January 2008 (107175)

Understanding Moody’s Approach to Unsecured Corporate Sukuk, August 2007 (103919)

Asian Sukuk Poised for Fast Growth: Market Review and Introduction to Moody’s Rating Approach, August 2007 (104446)

Moody's Approach to Analysing Takaful Companies, May 2007 (102910)

Takaful: A Market with Great Potential, October 2006 (98913)

Shari’ah and Sukuk: A Moody’s Primer, May 2006 (103338)

A Guide to Rating Islamic Financial Institutions, April 2006 (97226)

Moody's Involvement in Rating Islamic Financial Institutions, April 2006 (97113)

Regulation and Supervision: Challenges for Islamic Finance in a Riba-Based Global System, January 2004 (81128)

Culture or Accounting: What Are The Real Constraints for Islamic Finance in a Riba-Based Global Economy?, January 2001 (63369)

Selected Sukuk Rating Actions:

Moody's rates Abu Dhabi Islamic Bank's Trust Certificate Issuance Programme, November 2006

Moody's assigns (P)A1 ratings to DP World's proposed EMTN Programme and Sukuk, June 2007

Moody's affirms Dubai Islamic Bank's A1 Sukuk Trust Certificates rating, March 2007

Moody's rates Saad's Sukuk Issuance (P)Baa1, April 2007

Moody's rates Maybank's Subordinated Sukuk Certificates ("Certificates") Baa1, April 2007

Moody's rates DIFC Investments' Sukuk Issuance (P) A1, May 2007

Moody's assigns A1 rating to Emirates Islamic Bank's Sukuk Trust Certificates, May 2007

Moody's assigns (P)A1 ratings to Jebel Ali's proposed GMTN Programme and Sukuk, November 2007

Moody's assigns (P)Baa2 rating to NIG's proposed Sukuk, July 2007

Moody's assigns (P)A2 rating to Qatar Real Estate's proposed Sukuk , July 2007

Moody's affirms Baa1 ratings for Sarawak Corporate Sukuk Inc certificates, September 2006

Moody’s upgrades Malaysia Global Sukuk Inc.'s Trust Certificates to A3 from Baa1, December 2004

Moody's assigns definitive ratings to Floating Rate Secured Sukuk Notes issued by Tamweel Residential ABS CI (1) Ltd, July 2007

http://www.moodys.com/cust/getdocumentByNotesDocId.asp?criteria=PBC_107502














http://www.moodys.com/moodys/cust/research/MDCdocs/10/2006100000428126.asp?doc_id=2006100000428126&frameOfRef=corporate&namedEntity=Rating+Action











http://www.moodys.com/moodys/cust/research/MDCdocs/15/2003000000442220.asp?doc_id=2003000000442220&frameOfRef=structured&namedEntity=Rating+Action






Selected Islamic Bank Reports:

Abu Dhabi Islamic Bank, Credit Opinion, November 2007

Al Rajhi Bank, Credit Opinion, September 2007

Asya Katilim Bankasi A.S., Analysis, September 2007

Bank Al-Jazira, Credit Opinion, December 2007

Boubyan Bank, Analysis, December 2007

Dubai Islamic Bank PJSC, Credit Opinion, November 2007

Kuwait Finance House, Credit Opinion, May 2007

Tamweel PJSC, Analysis, November 2007

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

© Copyright 2008, Moody’s Investors Service, Inc. and/or its licensors and affiliates (together, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided “as is” without warranty of any kind and MOODY’S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling.

MOODY’S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY’S have, prior to assignment of any rating, agreed to pay to MOODY’S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody’s Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody’s Investors Service (MIS), also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody’s website at www.moodys.com under the heading “Shareholder Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”

Report Number: 107856

Author Production Associate Anouar Hassoune

Martina Reptova

http://www.moodys.com/cust/getdocumentByNotesDocId.asp?criteria=COP_809579906








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