Issue #4 summary

Satisfying customers globally
Success in business demands customers’ needs are met. Islamic finance has its own unique challenges that international banks must address if they intend to progress in this market, writes Stephen K Green
With a population of some 1.5 billion Muslims worldwide and an estimated industry size of US$250 billion, Islamic finance is a serious business for Muslims and non-Muslims alike. As a representative of the HSBC Group, I come to Islamic finance from the perspective of an international bank. With operations in 76 countries and territories around the world, HSBC has a naturally diverse customer base.
In any market, meeting the particular needs of our customers is both good etiquette and good business. Around one-quarter of the countries in which HSBC operates are Muslim, with significant Muslim minorities in many others. We need to provide these customers with products and services that fit their laws, customs and preferences. HSBC Amanah, our global Islamic financial services division, was created in 1998 to do precisely that.
Banking, like any other industry, has to respond to its customers’ needs—hence recent moves by international banks to follow their Muslim customers into Islamic finance. Experience and market research tell us that Muslims often hold distinctive views about money, banking and investment. When offered financial solutions that meet both their religious and financial needs, a significant number will opt out of conventional banking services.
This makes the rationale for market entry for an international bank compelling. First, our Muslim customers want us to create new products for them. Second, we can grow our business by offering Shariah-compliant products and services where others do not.
When we look at the Islamic finance industry, we see that very exciting things are happening. The Islamic retail sector is at an inflexion point. In Saudi Arabia, the industry’s largest domestic market, 95% of the recent growth in corporate and retail assets is in the Islamic finance sector. The development of sukuk instruments has brought sovereign issuers (Bahrain, Malaysia, Qatar) to a burgeoning global Islamic debt capital market. And in new markets, such as the UK and the US, Islamic financial providers have made early gains in personal banking, with home finance as the lead product.

Shaken to the foundations
A shallow adoption of Islamic contractual structures does not address the injustices of interest-based home finance, argues Tarek El Diwany
Gordon Brown is a little less vocal these days in his claim of having brought “an end to boom and bust” in the UK. One might wonder what radical policy the chancellor has implemented to achieve this goal but, in truth, reform has been superficial and the key drivers of the boom-bust cycle remain firmly in place.
Nowhere is this clearer than in the domestic property market, where a familiar tale is beginning to unfold. An ever more indebted nation is buying property for the economically inefficient reason that “prices are going up”, while older commentators worry that steep rises in interest rates will be required to “calm things down”.
Conveniently for the government, headline-inflation measures have been adopted that exclude asset prices, thereby allowing ministers to boast of achieving price stability in the middle of this roaring boom. Yet, the most expensive item most people ever buy is a house: so why aren’t houses included in measures of the cost of living?
Attention is now focusing on the ratio of average house price to average income in the UK, which is at an historical high. Received wisdom says that it will soon fall back to its longer term average, but how this will happen is difficult to predict. It is entirely possible that the adjustment in the price to income ratio will occur by means of a rise in incomes, most likely accompanied by a rise in the general level of inflation. On the other hand, a fall in nominal house prices could achieve the same result.
Meanwhile, lending institutions point to growing incomes, high employment, and a shortage of supply as factors that will spare us a sudden collapse. The motivation behind such arguments is probably a selfish one, given that lending against property has proved such a profitable endeavour over recent years. If an argument is needed to justify present prices, it would be more plausible to suggest that a low interest rate environment will become a feature of the British economy, similar to that which persisted in Germany for so many decades and allowed a much higher price to income ratio to become established there.
The more likely and worrying scenario is, however, that the Bank of England will in due course react by raising short-term interest rates. This is the same monetary orthodoxy that was unleashed on an unsuspecting population in the late 1980s. The results were disastrous. Typical was the case of a taxi driver who, in 1988, put £40,000 of his own money together with a further £20,000 of mortgage finance towards the cost of his first home. Within two years, interest rates almost doubled and his bank repossessed the property. Not long after, the house was sold at auction for not much more than the £20,000 that was secured on it.


Shariah-compliant crédit-bail immobilier
Michael JT McMillen discusses recent developments in French shariah-compliant real estate acquisition financing and focuses on the notarial approval of a structure and related documentation
Tradition, being the embodiment of wisdom and the muse, both cautions restraint and encourages innovative advancement. Tradition, in guiding our thinking in Islamic finance, as to both transactional implementation and new product development, implores us to consider the learning of the ages, the principles considered by the many exquisite minds that have proceeded us in our efforts.
Wisdom and the muse, restraint and innovation, are not contradictory; they are reciprocally interactive as applicable to our efforts in Islamic finance. They are also reciprocally interactive as applied to reportage of efforts to develop and implement new products and structures: generally we make no reports until after consummation of implementing transactions. Tradition supports the concept that the competitive advantage is rightfully with the developer of the new product or structure and should not be revealed until that developer has obtained a market lead by transactional consummation.
This article will honour these embodiments of tradition; although, a little in the breach. While recent developments in shariah-compliant real estate acquisition financing are discussed, particularly the notarial approval of a structure and related documentation, this is in advance of the implementation of the transaction. What is the justification for “early” reporting?
Islamic finance has grown rapidly in the last two decades, and the rate of growth seems to be accelerating. Shariah-compliant structures have been developed and implemented in an expanding universe of products. We have witnessed significant refinements and innovations in equity shares investing. Private equity investing techniques have been refined in the US, and major developments will soon occur in Europe. Sophisticated real estate investment funds and related financing structures are in widespread use in the US and Europe.
Structures have been developed for hedge funds to engage in the economic equivalents of short sales of securities and options trading. The International Swaps and Derivatives Association (ISDA) has established a working group to structure and implement Shariah-compliant equivalents to swaps and derivatives and to assure, with governmental bodies, an effective regulatory framework for implementation of those equivalents. Sukuk issuances have moved the industry towards efficient use of securitization and bond concepts and are becoming more sophisticated with each new issuance. The Islamic economy is taking shape.


What is Islamic banking worth?
High figures and growth rates purport to estimate the wealth of Islamic banks. But such calculations are difficult at best. The number crunching is not the same as in the West, writes Natalie Schoon
The growth of the Islamic banking services industry warrants a determination of the value of Islamic banks. According to Standard & Poor’s, the growth rate of Islamic banking services “outpaced that of conventional banking during the past decade, making it one of the most dynamic areas in international finance.
“The annual growth of Islamic financial institutions (IFI) has been an estimated 10% in the Gulf and almost 15% worldwide over the past 10 years,” the 2002 report says. “IFI’s assets and funds under management are estimated at about $200bn-$300bn. Islamic banking activities are expected to grow even more rapidly in the foreseeable future.”
To determine the value, it should be possible to make calculations applying a model similar to that used for western banks. Nevertheless, individual parameters need to be calculated differently because of contrasting structures and products.
Historically, Islamic and conventional finance are based on the same principle. Both originated to satisfy the need to provide funds for national and, later, international trade. The conventional banking industry has since developed from merchant banks to a more extensive banking industry, with a wide product range where returns are largely based on interest rates.
Islamic finance on the other hand operates on the basis of the Qur’an, which prohibits both interest (riba) as a means to generate wealth and speculation. However, as C Tomkins and RAA Karim state in “The Shari’ah and its Implications for Islamic Financial Analysis: An Opportunity to Study Interactions Among Society, Organisation, and Accounting,” The American Journal of Islamic Social Sciences, 4(1), 101-115, 1987—this does not imply wealth creation is prohibited. Islamic law does not advocate equalisation of wealth, they say, and it does recognise personal wealth creation is a motivator in the economic process. But it does require the wealthy to circulate their money to increase production for others as well as themselves.