Islamic finance comes of age



Islamic finance is experiencing a growth spurt as new products and services come online to tap into nascent demand for Sharia-compliant products.

But as the trillion-dollar market starts to mature, many in the industry are wondering whether the industry is growing too fast and innovating faster than regulators can keep up.

Philippe de Backer, the global head of financial services at Bain and Company, says there is some doubt as to whether Islamic banking has enough momentum to move into the mainstream.

"There's a large number of Islamic banks, many part of universal banks," Mr de Backer says. "The issue is critical mass. That impacts the structural profitability of these banks."

He says the question is: "How do you manage to create a champion?"

The UAE is one of several countries playing a leading role in Islamic finance, which has traditionally been led by Asia.

National Bank of Abu Dhabi last week announced the launch of a Sharia-compliant repurchase agreement, the UAE's first, which it is hoped will allow Islamic banks access to fresh liquidity and spur lending in the economy.

A proposed Qatari superbank, which is expected to be formed from Islamic units spun off by the country's conventional lenders, may also give the industry a shot in the arm.

But more and more professionals are entering the industry, as clamour for Islamic financial services starts to build, according to Emad Mansour, the chief executive of the Sharia-compliant Qatar First Investment Bank.

"Demand for Islamic banks, as much as it is, is primarily driven by investor appetite," Mr Mansour says. "And another factor to this gap is the level and degree of sophistication of Islamic finance.

"More and more players are coming into this market. The more people that participate in the industry, the more sophisticated it gets."

But are participants in the industry equipped to cope with the breakneck speed of change? Sheikh Yusuf De Lorenzo, a Sharia scholar, thinks not.

Speaking at the Global Financial Markets Islamic Forum in Abu Dhabi, Sheikh Yusuf says: "It's no secret that as the industry expands its need for human capital increases. "The problem is and always has been that there's a lack of trained and educated and experienced professionals in the field.

"There was a period of getting to know one another, and getting acquainted with the basics and the rules. Now you've established international governing institutions, the focus needs to be on the development of human capital."

Sheikh Yusuf recommends a focus on the younger generation of professionals, including revolving membership of Sharia boards, so younger scholars are given the chance to gain experience alongside their more venerable counterparts.

"There's a great need within our industry for qualified people and people with new ideas," he says.

That would add rigour to the industry and allow for a more solid regulatory framework, drawing new investors, Sheikh Yusuf says. "To compete, we need people who are as good as, or better than, the people who work in conventional banks and asset houses."

As those international institutions pile into the sector, demand for Islamic market scrutiny is soaring. Standard & Poor's (S&P), the ratings agency, will tomorrow conclude consultations on proposed changes to the way it rates the Islamic financial sector worldwide as part of its all-reaching review after the global financial crisis.

Emmanuel Volland, an analyst at S&P, says the aim is to update its understanding of risks among conventional and Islamic banks.

"What we saw was that risks were more correlated across traditional silos than expected, leading to greater risk concentration and interconnectedness," Mr Volland says.

"The proposed criteria also differ from our current approach by proposing a more detailed and systematic framework for taking account of the potential for government support in bank ratings, which would allow for support to be included in certain ratings at all points of the cycle rather than just in downturns..

"We also propose to give less emphasis to unproven diversification benefits but place greater emphasis on risks resulting from the added complexity of off-balance-sheet derivatives and structured finance."

As more and more professionals demand information on the sector, Bloomberg News, the financial information provider, has become one of the latest companies to open a new suite of tools to analyse Islamic finance transactions. Functions include Sharia-compliant stock screening and a scholar search.

"Islamic finance is a marketplace that's growing and getting a lot of attention, but a lot of people don't fully understand it," says Max Linnington, the regional head for Middle East and Africa of Bloomberg News, adding that the new service is as much "designed to help educate" as analyse.

But Mr Linnington says the ability to analyse Islamic finance is of little use if it is not deployed. "The tools available to analyse Dubai World, for example, were there at the time that Dubai World came across financial difficulty," he says.

Abdulkader Thomas, the president and chief executive of Shape Financial Corporation and director of the American Journal of Islamic Finance, says problems remain in the sector despite lessons learnt from troubles at sukuk issuers such as Dubai World.

During the financial crisis, "the Islamic sector was lucky, as opposed to good", Mr Thomas says. "We have a lot of problems to solve."

He recommends regulation to take a more active role, ensuring businesses and regulators communicate more frequently.

"[Customers will not be concerned] whether you're Islamic or conventional," Mr Thomas says. "It's whether you're well governed or not." He adds "over-concentration in a single asset class", in most cases property, remains one of the most pressing worries for the industry.

Sheikh Yusuf agrees that Islamic finance needs to focus on business fundamentals. But he warns that regulators should be prepared to act in retrospect, rather than risk choking off innovation.

"Regulators tend to be reactionary and it's only natural," he says. "The market is what innovates and the regulators have to come along and deal with it." Mr Thomas says regulators of Islamic finance should nevertheless seek to avoid repeating mistakes of western markets.

"Another way to spell CDO [collateralised debt obligations] is s-u-k-u-k," he says. CDOs are the derivative products that wrought havoc on the American economy in 2007.

"They're fundamentally the same thing as many collateralised debt obligations. The difference should be that I cannot divide or tranche them the way my friends did in New York."

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