Islamic Bank Consolidation Faces Obstacles

Islamic banking looks ripe for consolidation. The sector is growing rapidly and is dotted with some 500 financial institutions, many ofthem very small and with highly localised offerings. Consolidation is, however, a path strewn with challenges. Islamic finance is, after

all, based around fitting in with religious beliefs.

And just as there are different shades of Islam, so there are different shades of Islamic finance. It ranges from Saudi Arabia’s strictWahabi interpretations of the Koran through to the much more liberalleanings seen in Malaysia and large parts of North Africa. The latter region is beginning to see the arrival of new Islamic banks.

Nonetheless, the will to make Islamic finance successful is there in spades. Middle Eastern countries are rushing to craft legal structures–as are many non-Muslim countries–to support Islamic finance. And some are going further. Recently, the National Bank of Kuwait declared its intention to buy 40% of Boubyan Bank, an Islamic lender, to give its chances a boost.

Malaysia has tackled the issue head-on and already has a fully functional two-tier banking system, one conventional and the other Islamic. It has emerged as a hotbed of innovation for Islamic financial products. Indeed, its ninth economic development plan (2006 to 2010) has as one of its goals to position Malaysia as a global hub for Islamic finance and capital markets.

Many investors also see it as a potential shelter from the recent financial crisis. Right now, basing finance and investment around real assets, sounder structures and conservativism holds a lot of appeal. It’s ethical stance and insistence on social sustainability is alsoin tune with the times.

“At the height of the crisis people preferred US Treasuries to Islamic investments as they’re safe and predictable,” says Ismael Erturk, a senior fellow in banking for the Manchester Business School. He feels that with its more conservative view of financing it should flourish in the long-term. Indeed, with fear from the credit crunch receding many investors seem to be coming to that conclusion.

Among the survivors

“The sector does look in generally better shape than its conventional peers, although some Islamic banks have been hit by problems withreal estate in Dubai,” says Bob McDowall, a banking analyst with consultancy Tower Group.

The sector is forecast to register strong growth of 10%-20% a year. According to Arthur D Little in a report called “Islamic Finance comes of age”, Sharia-compliant assets could reach $4UStrn by 2015, compared with about $800USbn now.

“Islamic finance is among the fastest growing financial industries,” says the consultancy. It goes on to note that the sector is being strengthened by various Gulf governments investing more in their regulatory processes, reorganising and consolidating their accounting standards.

The advent of more market research is also enhancing the attractiveness of Islamic finance, making it easier for investors to understand and evaluate.

“The industry has become a viable option for investors and a competitive form of financing for commercial enterprises,” says asset manager State Street in a report entitled “Islamic Finance–Opportunity for long-term growth”. However, what does all this translate into in terms of M&A?

“Islamic banks are still considered small compared with conventional banks. M&A is not happening yet and is not expected to in the nearfuture,” reckons Mohamed Roushdy, senior vice president, technology with Al Hilal Bank, a United Arab Emirates-based Islamic bank.

“However there were plans in the GCC [Gulf Cooperation Council] countries to create the biggest Islamic bank in the world, which would be similar in size to the major international banks,” he says. It is not clear yet after the crisis if this plan will continue or be postponed.”

In February, Bahrain along with a group of Gulf investors confirmed plans to create an Islamic super bank with $10USbn-$11bn in paid-upcapital. The idea is to create an Islamic bank big enough to generate the economies of scale to be competitive.

There are plans to list the bank in Bahrain and on Nasdaq Dubai with a $6US.5bn private placement to be supported by a $3US.5bn IPO, which is scheduled for the fourth quarter.

Some observers think this could spur consolidation among Islamic banks, especially if it proves to be a strong competitor. It would also enable “pure” Islamic banks to better compete with the Islamic windows set-up by the big global banks such HSBC with its Amanah subsidiary. Indeed, much of the Islamic product innovation actually comes from these hybrid banks.

Interestingly, the larger global banks are seen as unlikely to be acquirers of Islamic banks. Many prefer the route of Islamic windows–pursued by the likes of Citigroup, Deutsche Bank, UBS, Barclays and JP Morgan among others–so they can capitalise on the familiarity andprestige of their brand names.

But among Islamic banks, Roushdy points out that there have been very few acquisitions in recent years. And one of them was related to gaining a banking licence in Egypt since there were no more new licences being granted at that time.

“One of the major UAE Islamic banks acquired a conventional bank in Egypt and it is in the process of transforming the bank into an Islamic one,” says Roushdy. Abu Dhabi Islamic Bank along with the Emirates International Investment Company bought 51.3% of the National Bankof Development in Egypt last year.

Seeking acquisitions

Nonetheless, a number of Islamic banks are seeking acquisitions. Kuwait Finance House has been scouring Asia for investment opportunities. Its managing director, Salman Younis, has been quoted as saying that the sector is fragmented and there are too many small players in the market.

Bahrain-based Islamic lender Al-Baraka is also in the market for acquisitions, with $120USm pencilled for that purpose this year. It islooking to increase stakes in existing units in Turkey, Jordan and South Africa and to expand in France, India, China and Indonesia.

Another driver for consolidation is growth in the number of regulations and compliance obligations.

“Risk management will be another core focus area for the Islamic banking community,” says Mohamed Goneid, Islamic banking strategy manager, with IT solutions group Temenos. “They will be required to expand their compliance capabilities to cope with additional challenges dictated by the current status of the global business crisis,” he says.

This means expenditure on more sophisticated risk management systems. Indeed, there is some concern that Islamic banks have not been subjected to rigorous stress tests to discover their true liquidity positions. Many funded real estate and equity transactions. In places such as Dubai real estate values have fallen heavily as have equity markets, which are still below their peaks despite a recent recovery.

Analysts point out that the Islamic banking sector has seen a 40% drop in profits and that some Sharia-compliant firms such as Investment Dar, Islamic mortgage lenders Tamweel and Amlak Finance in Dubai are having to be restructured after suffering heavy losses.

All this is reinforcing calls for Islamic banks to implement more sophisticated risk management systems. And there are other reasons for consolidation:

“The sector could do with some standardisation. There are 13 different types of sukuk bond out there,” says Rod Ringrow, senior vice president with State Street. “Bigger Islamic banks would help bring about that standardisation.” He says more standardisation of Islamic products would lead to more liquidity, which in turn would see Islamic finance become more competitive.

Currently each bank has its own scholars who vet products to make sure they’re Sharia-compliant, at least from their own point of view.Though it hasn’t been an issue so far in terms of M&A, it could become one in some cases.

How would a Saudi-based Islamic bank merging with a Malaysian counterpart, probably with more liberal interpretations of the Koran, address those differences of interpretation? The deal probably wouldn’t get off the starting blocks.

It is possible that bigger players will be able to drive standardisation across sectors and that the industry will end up with several Sharia finance standards. In the meantime, there is still plenty of opportunity for Islamic finance to grow.

“While most of the current growth is coming from mainstream business like retail, corporate, etc … asset management is expected to boom, especially after the credit crunch, whereby Islamic banks are thriving in attracting wealth under management from both individuals andinstitutions,” says Goneid,

However, Ertuk feels that much of Islamic banking has been aimed at high-net worth individuals and wholesale capital markets.

Nonetheless, with its ethical emphasis and focus on customer care,Sharia-compliant banks should do well. He sees potential for Islamicfinance eventually to expand into areas such as micro-lending, whereit would well and truly fulfil its ethical bias.

In the end, the credit crunch may turn out to be a catalyst for bigger and better regulated Islamic banks and for improved supervision and regulation. After all, the last thing the sector needs is an Islamic banking crisis.

SOURCE: http://www.allbusiness.com/society-social/religion-spirituality-religion/12594535-1.html