Randy
Islamic Finance Becomes Growth Market for Banks
3/12/03
By PHILLIP DAY and S. JAYASANKARAN Staff Reporters of THE WALL STREET JOURNAL
Most investment bankers don't spend a lot of time worrying about the religious implications of their work. But Western banks seeking to tap a blossoming market for Islamic financial instruments are adapting to a system where religious law is as important as anything written in an economics textbook.
"Religious law goes all the way; we have to make sure all the features and concepts involved in what the banks are trying to do are acceptable," says Mohamad Daud Bakar, deputy rector of Malaysia's International Islamic University.
Malaysia's central bank and some Western bankers estimate that Muslims currently hold about $180 billion in funds in international banks around the world -- money that could be lured into Islamic financial products. But first Muslim scholars must decide what banks can offer and what Muslim investors can buy. That's no small task considering that Islam prohibits some key elements of Western banking, notably interest payments. So big Western banks that want to market Islamic mortgages or savings accounts, or set up mutual funds that invest in companies that comply with Islamic law, are hiring or consulting experts such as Dr. Daud to guide them.
As revenues from traditional deal-making dwindle, Western investment banks -- including Citigroup Inc., HSBC Holdings PLC, Standard Chartered PLC and Deutsche Bank AG -- are all listening to religious scholars to reach a market that some bankers expect to grow 12% to 15% a year over the next few years.
"You can't go wrong with over a billion" Muslims, says Zarir Cama, who set up HSBC's global Islamic department in Dubai and is now the bank's chief executive in Malaysia.
But reaching those customers requires leaping a few hurdles. In addition to banning interest, Islamic law prohibits Muslims from investing -- directly or indirectly -- in companies with interests in gambling, pornography or liquor, or that are involved in the production or sale of pork products. Islamic law also frowns on deals that have an element of uncertainty in their returns, since such investments can be viewed as akin to gambling.
"You don't want to go and finalize a structure and spend $250,000 or whatever setting it up, only to find out what you've done isn't compliant," says London-based Saad Ashraf, a senior Islamic banker at Citigroup.
Malaysia, a majority-Muslim nation with ambitions to become a global hub for Islamic finance, has been particularly aggressive in promoting itself as a banking base for the Muslim world. To help banks -- local and foreign -- win religious approval for their products, the government has set up a standards board with international Islamic experts.
It is also pushing local companies to arrange their financing through Islamic instruments. Most of the corporate debt issued in Malaysia last year was arranged in compliance with Islamic rules.
Malaysia's effort to go global has required more coordination between Malaysian Muslim scholars and their counterparts in the Middle East. In the past, some efforts in Malaysia and elsewhere to sell products throughout the Muslim world failed because of disagreements between scholars in different countries over what is and isn't proper. "It used to get very, very heated," says Dr. Daud, who has worked as a consultant to HSBC and other Western banks. "Four or five years ago people in one place just wouldn't listen to what the people elsewhere were saying. Nowadays, people want to get to know each other and work toward harmony of the laws."
So when HBSC won the mandate last year to lead a $600 million Malaysian government global Islamic bond issue, the bank was careful to get approval in advance for the complex arrangement it had in mind. HBSC proposed a lease-type structure that called for Malaysia's federal land commission to sell property (including the building housing the Ministry of Finance) to a special-purpose company, which would then lease the property back to the government. Investors in the bond would buy the land from the special-purpose company and were to be paid the lease proceeds every six months. The lease payment was to correspond to the interest rate London banks use to lend each other money, a common benchmark for interest-bearing bonds. Upon the bond's maturity, the bond investors would sell the land back to the special-purpose company and get back their principal, while the special-purpose company would sell the land back to the government.
Because of the link between lease payments and London lending rates, HSBC's proposed structure came very close to involving an interest payment, which Islamic law forbids. It appeared for a time that the link could be a sticking point for the deal. But the Islamic scholars who ruled on the bond "were very pragmatic about it," says a banker involved in the deal. "They took the view that too strict a perspective could throttle Islamic finance at birth."
In all, four groups of scholars -- one each in Dubai and Bahrain and two in Malaysia -- were asked to approve the bond's structure before it was finally cleared to market internationally.
The Malaysian bond met the approval of most of the Muslim investors targeted and was two times subscribed. But there are still financial instruments used some places in the Muslim world that aren't accepted in others. "There are times when we've gone through significant refinements," says Mr. Ashraf, unit head for Citigroup's global Islamic finance team. "They do say no."
To minimize such rejections Citigroup set up Citi Islamic Investment Bank in Bahrain in 1996 -- the first Islamic bank founded by a Western investment bank -- and recruited a board of Islamic scholars to oversee its operations. Now, each of the scholars who sit on the bank's religious board also advises other companies, including the same investors that Citigroup hopes will buy its Islamic products. If he can get a product approved by Citigroup's in-house religious board, acceptance by big Middle Eastern investors is almost guaranteed, says Mr. Ashraf.
Citigroup has found that, once financial products are approved by the religious scholars, it opens up a whole range of Muslim investors for companies that aren't Muslim-owned.
For example, the bank's Islamic finance team has convinced borrowers in Brazil, Hungary, Italy and South Korea to raise money using Islamic instruments.
Some companies have become important repeat customers. In 1998, for instance, Citigroup bankers suggested that Petrobras, the Brazilian national oil company, use an Islamic instrument to raise money after more traditional lenders had soured on Brazil. "We've done four or five trades for them since and they still look to that Islamic liquidity when they are considering raising funds," says Mr. Ashraf.