ISLAMIC BANKING AND FINANCE

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Today An Introduction To New Emerging System

OVERVIEW OF ISLAMIC BANKING SECTOR

Centers of Islamic Finance
Malaysia, Pakistan, Iran, Jordan, Saudi Arabia United Arab Emirates, Bahrain, Kuwait, Qatar, Oman, England, Sudan, Egypt, Syria, Philippines, Sri Lanka, India, USA, Denmark, Switzerland, Luxembourg, Australia, Indonesia, Singapore, Hong Kong, Maldives,

History of Islamic Banking
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Islamic Banking movement started 1958 in the city of Egypt. 2nd attempt was made in the City of Karachi in Pakistan when Interest Free Bank Launched in 1963 Islamic Development Bank was established in 1966 base at Jeddah, Saudi Arabia From 1970 in International Association of Islamic Bank was formed and first commercial bank Dubai Islamic Bank was establish in 19712 at Muslim countries such as Egypt, Malaysia, Pakistan and Dubai UAE

In the Year 1982 a Pan Islamic Financial Group establish in the City of Geneva, Switzerland The DMI Group (Dar-Al-Maal-Al- Islami) This group followed by 2nd largest Financial & Commercial Group Dhallah Group from Geneva, Switzerland by the name Al-Barka Bank. Both the Financial Group were registered in the City of Nassau, Bahamas

Originally emphasized joint-venture structures similar to private equity through Musharaka form of Financing  Quickly evolved to provide short-term credit facilities by using the Morabaha structure for Trade financing.  Started accepting the deposit under Modaraba form of financing

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 (Ijara)

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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

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

History of Islamic Banking (V)

Conventional International Banks with Islamic Windows:
Citigroup  HSBC  Deutsche Bank  UBS  ABN AMRO  Standard Chartered Bank

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

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

Role of Islamic Finance in World Credit Markets

Demand Side
 Sovereign Debt  International Agencies  Corporate Debt  Project Finance  Consumer Debt

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

International Agencies

International Agencies Have Issued Sukûk in recent years:
 Islamic Development Bank: $400

million  World Bank: $200 million

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 million, rated BBB- by S&P  Listed on London Stock Exchange  Previous issuance by same issuer listed on Luxembourg Stock Exchange

 National Central Cooling Company: $200

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

Islamic Corporate Debt (III)
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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

Islamic Finance In Project

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

Islamic Finance and Project Finance (II)

Islamic sources of capital traditionally played minor role in project finance in Gulf In recent years, no deal gets done without

a substantial Islamic trenches

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

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 Armco 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 trenches

Islamic Finance and Project Finance (IV)

YANSAB Project
$5 billion Greenfield petrochemical project  $3.5 billion debt:

$1.067 billion, 13-year trenches from Saudi Public Investment Fund  $850 million, 12-year Islamic trenches  $700 million export credit agencies trenches  $533 million 12-year commercial bank trenches  $350 million working capital facility

ABN AMRO was sole arranger, underwriter and book runner on deal

Islamic Finance & 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

Opportunities for Banks
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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

Opportunities for 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

Opportunities for Issuers

Issuers, public and private, may consider tapping the Islamic capital markets Because of Islamic finance is asset-based, 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

Opportunities for 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

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

Conclusion (II)
It is not too late for 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

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