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Islamic Banking and Finance

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Introduction to islamic banking and finance

Introduction to islamic banking and finance

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  • 1. ISLAMIC BANKING AND FINANCE: WHAT’S IN IT FOR CANADIAN COMPANIES? Mohammad Fadel Canada Research Chair in the Law and Economics of Islamic Law University of Toronto Faculty of Law October 16, 2006
  • 2. OVERVIEW OF ISLAMIC BANKING SECTOR
    • Centers of Islamic Finance
        • Malaysia
        • Persian Gulf
          • United Arab Emirates (Dubai)
          • Bahrain
        • England ????
  • 3. History of Islamic Banking
    • Local Islamic banks formed in the 1970s in Muslim countries such as Malaysia, Pakistan and Dubai
    • Originally emphasized joint-venture structures akin to private equity
    • Quickly evolved to provide short-term credit facilities by using the murâbaha structure
  • 4. History of Islamic Banking (II)
    • With increase in scale, Islamic banks began to branch out to more complex financing schemes, including:
      • Retail banking, including, deposit taking and consumer lending
      • Bonds ( sukûk )
      • Medium- and Long-term leases (ijâra)
  • 5. History of Islamic Banking (III)
    • Impact of 9/11 – Reverse Capital Flight
      • Perception of hostile climate in many Western jurisdictions, in particular, the United States, led to repatriation of dollars by Arab investors to Middle Eastern banks
      • Islamic banks, along with conventional banks in the region, benefited from this reverse flight of capital
      • Increase in Oil Prices Led to Dramatic Increase in Liquidity in the Gulf
  • 6. History of Islamic Banking (IV)
    • Conventional Banks Open “Islamic Windows”
      • Conventional banks began to respond to requests from Muslim clients to offer products that complied with Islamic law
      • As the size of the potential market became clear, conventional banks responded with the creation of divisions dedicated to Islamic banking
  • 7. History of Islamic Banking (V)
    • Conventional International Banks with Islamic Windows:
      • Citigroup
      • HSBC
      • Deutsche Bank
      • UBS
      • ABN AMRO
      • Standard Chartered Bank
  • 8. History of Islamic Banking (VI)
    • Almost all regional banks have followed the international banks in creating “Islamic” windows and some have converted, or are in the process of converting, to the Islamic banking model
  • 9. Size of Islamic Banking Sector
    • No precise measure of size of deposits held in Islamic banks or Islamic divisions of conventional banks
      • Ranges from a low of $250 billion to a high of $750 billion
      • As much as $300 billion held in Islamic investment funds awaiting investment opportunities
      • Arab investors hold approximately $800 billion of assets in European banks, with a growing trend to invest that money in Islamic products
  • 10. Role of Islamic Finance in World Credit Markets
    • Demand Side
      • Sovereign Debt
      • International Agencies
      • Corporate Debt
      • Project Finance
      • Consumer Debt
  • 11. Sovereign Islamic Debt
    • In recent years, several Islamic Countries and their instrumentalities, as well as non-Islamic countries, have issued sovereign debt in the form of sukûk :
      • Department of Civil Aviation, Dubai: $1 billion
      • Qatar: $700 million
      • Pakistan: $600 million
      • Malaysia: $600 million
      • German State of Saxony-Anhalt: €100 million
      • Bahrain: $79.5 million
  • 12. International Agencies
    • International Agencies Have Issued Sukûk in recent years:
      • Islamic Development Bank: $400 million
      • World Bank: $200 million
  • 13. Islamic Corporate Debt
    • Private Issuances of Sukûk :
      • DP World: $3.5 billion 7.5% sukûk , convertible into equity at the time of a qualifying initial public offering
      • National Central Cooling Company: $200 million, rated BBB- by S&P
        • Listed on London Stock Exchange
        • Previous issuance by same issuer listed on Luxembourg Stock Exchange
  • 14. Islamic Corporate Debt (II)
    • Global issuance of sukûk has exceeded $20 billion
    • Dow Jones Citigroup ® Sukûk Index
      • Comprised of seven sukûk
      • $2.8 billion aggregate principal amount
      • Each issue rated at least A by S&P
      • Average tenor 3 years
  • 15. Islamic Corporate Debt (III)
    • Biggest challenge thus far is limited secondary trading market for sukûk
    • Demand for sukûk has far exceeded supply; offerings typically oversubscribed, even after substantial upsizing of the offering at times
      • DP World offering originally contemplated for $2.8 billion but was upsized to $3.5 billion to meet excess demand; no road show needed to market the offering
  • 16. Islamic Finance and Project Finance
    • Infrastructure projects in the Gulf region largely financed on a corporate basis until the mid-1990s
      • Sadaf, a joint venture between Shell Oil and Saudi Arabian Basic Industries Corporation (SABIC), first important project finance transaction in Gulf region, closed in 1995
      • Project Finance now preferred structure for infrastructure investment
  • 17. Islamic Finance and Project Finance (II)
    • Islamic sources of capital traditionally played minor role in project finance in Gulf
      • In recent years, however, no deal gets done without a substantial Islamic tranche
        • Financing needs exceed capacity of commercial banks and export credit agencies
        • Desire of project hosts to diversify sources of capital and take advantage of local capital to the extent feasible
  • 18. Islamic Finance and Project Finance (III)
    • Rabigh Refinery and Petrochemicals Project, Kingdom of Saudi Arabia
      • $9.9 billion total cost, of which $5.8 billion was debt
      • $4.1 billion equity split 50-50 between Saudi Aramco and Sumitomo Chemical
      • $2.5 billion loan provided by Japan Bank for International Cooperation
      • $1 billion loan from Saudi Public Investment Fund
      • $1.7 billion commercial loan
      • $600 million Islamic tranche
  • 19. Islamic Finance and Project Finance (IV)
    • YANSAB Project
      • $5 billion greenfield petrochemical project
      • $3.5 billion debt:
        • $1.067 billion, 13-year tranche from Saudi Public Investment Fund
        • $850 million, 12-year Islamic tranche
        • $700 million export credit agencies tranche
        • $533 million 12-year commercial bank tranche
        • $350 million working capital facility
      • ABN AMRO was sole arranger, underwriter and bookrunner on deal
  • 20. Islamic Finance and Project Finance (V)
    • Future Demand for Project Finance
      • Last two years saw $40 billion of project finance in gulf region
      • Saudi Arabia estimates it will invest $90 billion in domestic power generation over the next fifteen years
      • Other states in the gulf also investing heavily in infrastructure projects, particular petrochemical
      • There will be a continuing demand in the region for capital to invest further expansion of the region’s infrastructure
  • 21. Opportunities for Canadian Banks
    • Deal flow shows no sign of abating
    • International banks have shown an ability to compete successfully
    • Because of the size of new deals, Islamic banks need to partner with international banks to take advantage of their larger distribution networks
    • Success of sukûk issues means that conventional market investors have grown comfortable with their structure and will invest in them so long as credit profile meets investors’ needs
  • 22. Opportunities for Canadian Banks (II)
    • Success in penetrating markets for arranging credit could lead to mandates in upcoming equity offerings
    • Future opportunities to advise in connection with an inevitable consolidation of banks in the Gulf region
    • Opportunities for wealth management of wealthy Islamic investors
      • Merrill Lynch identified 300,000 U.S. dollar millionaires in the Middle East
  • 23. Opportunities for Canadian Issuers
    • Canadian Issuers, public and private, may consider tapping the Islamic capital markets
      • Because of Islamic finance is asset-based, Canada’s mining industry is a natural fit with the structures so far developed in Islamic finance
      • Because of high-liquidity of Islamic banks and Islamic investment funds, issuers who tap this market may be able to obtain relatively favorable pricing relative to the conventional market
  • 24. Opportunities for Canadian Infrastructure Firms
    • Because of infrastructure boom in Gulf region, large premiums have been paid on Engineering, Procurement and Construction contracts
    • Successful competition for infrastructure projects inevitably requires support of export credit agency
    • Export Development Canada would have an important role to play in promoting Canadian firms’ expertise in the region
  • 25. Conclusion
    • Islamic finance and conventional finance are quickly converging in the Gulf region
    • As conventional investors gain more comfort with Islamic structures, cost differential between Islamic products and conventional products have almost disappeared
    • As a result, Islamic products may be more practical because they appeal to both Islamic and conventional investors
  • 26. Conclusion (II)
    • It is not too late for Canadian banks to compete for business in the Islamic finance arena
    • To do so successfully, they will need to establish a presence in the region, as have their competitors