Tuesday, January 4, 2011

Islamic Finance - An open letter to Tun Dr Mahathir

As a visionary former prime minister, in forcefully addressing the currency crisis and now as a ‘global ambassador’ of Islamic finance, your words carry much weight across the Muslim world. A “keynote-cum-pep rally presentation,” as only you can deliver, is needed for Islamic finance to go from cheerleading to leading cheers in the Muslim countries and beyond.
Dr. Mahathir, some of your recent comments about Islamic finance are ahead of our time. Yes, Islamic finance may be seen as superior model to conventional finance and after a few more decades of operation , say, by 2030, will prove that you are right.

And it may also provide an opportunity for Muslim countries, all of them either frontiers or emerging markets, to become developed nations by financing real underlying assets contributing to gross domestidc product (GDP), from agriculture to industrial to service sector.

But, today’s Islamic finance is risk averse (Murabaha accounting for up to 85 per cent) and about bankable Muslims with nominal exposure to micro-finance, small and medium enterprise (SME) financing or venture capital, areas that contribute to financing/building knowledge base economies. The size of many Islamic banks is a rounding error or size of a transaction in the conventional space.

There is saying, a chain is only as strong as its weakest link, for Islamic banks, subset of Islamic financing, it is their lack of size. Many Islamic banks are privately held, have small free float, and their paid up capital is under US$500 million (RM1.53 billion). Yes, an Islamic mega bank, allowing for important functions like market making of Islamic instruments, will be a reality in Malaysia in 2011.

However, a newly licensed Malaysian Islamic mega bank is not the only route to ‘size matters’ banking environment. Today, the small Islamic banks are fragmented in overbanked markets, like the United Arab Emirates and Malaysia, and comments on consolidation will resonate when the source, like yourself, Dr Mahathir, having a proven track record, respect, and recognition as former leader of a country that is a leader in Islamic finance.


Dr Mahathir, Malaysia, as a table setter for Islamic finance, initially needs to look inward towards its overbanked Islamic banks and seriously think about “consolidation-cum-megabank.” The Malaysian Islamic banking subsidiaries, having spent enough time to grow and develop under their parent banking holding company, should be encouraged to merge, as part of the Economic Transformation Plan (ETP).

From the Pemandu website, on where we are today, “… the [financial] sector faces critical challenges, including lack of scale, lack of liquidity and diversity in the capital markets, low levels of financial literacy and competition from regional financial centre s such as Singapore, Hong Kong and increasingly Indonesia”.

Additionally, Malaysian bank holding companies should be encouraged to spin off their Islamic subs and list on Bursa Malaysia, hence, adding additional depth with syariah -based companies. As public listed, it opens up opportunities for (1) syariah- based indices , (2) stock options as part of compensation for attracting and retaining, (3) start process of Islamic shareholder activism, (4) acquisition currency, and so on.

Yes, there will be challenges, from desire to stay independent, especially for market share leaders, to political sensitivities to citing studies that mergers in the financial sector do not obtain the projected strategic efficiencies and so on. But, we have an example in Pakistan of two Islamic banks merging, Al Baraka Islamic Bank and Emirates Global Islamic Bank, to obtain strategic and financial efficiencies.

Size, especially horizontal mergers of commercial banks, allows for greater economies of scale, efficient use of distribution channels, better cost management, and ability to offer those products that are a function of size: project finance , debt underwriting , market making (all of which require a balance sheet).

Size also opens up many macro objectives of Islamic finance, like financially empowering Muslims, Organisation of Islamic Conference (OIC) countries and cross sell of Islamic finance, and sets an example for the fragmented Gulf Cooperation Council (GCC) market.

A mega Islamic bank needs to compete with the likes of CitiBank, HSBC, Standard Chartered, JP Morgan Chase, etc, and not their windows and subsidiaries for mega projects, advisory, underwriting, etc, in OIC and G20 countries. It is here and at this stage, where your comments about Islamic finance being a superior model and contributing to development of Muslim countries, etc, will be confirmed.

Existing situation

Dr Mahathir, today, Islamic finance is starting from a low base, 25 out the 57 OIC countries have some sort exposure, from nominal to established. Beyond the smaller reach, Islamic bank penetration, as a per centage of overall banking assets, is also at a low base, averaging 12 per cent Chart 1 shows a sample of OIC countries and market penetration.

At best, Islamic finance has reached 2 per cent to 3 per cent of the 1.6 billion Muslims, and, yet, the often ignored US$640 billion (RM1.96 trillion) Halal industry has not only better awareness and acceptance, but much greater market penetration.

Today, Muslim countries’ GDP, except Turkey’s and Indonesia’s, are smaller than large capitalis ed listed companies in the West. For example, Malaysia’s GDP for 2009, was about US$193 billion (RM591 billion), equal to the market capitalis ation of Google. Table 1 shows Top 10 OIC countries GDP (World Bank) to the market capitalisation of the 10 largest companies in the S&P BMI Global index.

Thus, the litmus test is twofold: First, If I’m an emerging market (Islamic) asset manager in the Gulf or EU/US and I want to invest in publicly listed (market share leaders) in Islamic banks (and not in their funds) where do I go? Is Bank Islam my preferred option over Dubai Islamic Bank, Kuwait Finance House or Al Rajhi?

Second, if I’m a Fortune 50 company and I want to retain a large balance sheet Islamic bank to expand my sources for efficiently raising capital, advisory, and distribution for US$1 billion to US$5 billion (RM3.07 billion to RM15.3 billion) sukuk or syndicated loans, where do I go?

Does Malaysia have the will and vision to be that one-stop destination answer today?

Thank you, Wasalaam and kind personal regards.
Rushdi Siddiqui
The writer is ThomsonReuters' Global Head of Islamic Finance based in New York

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