The UK Treasury's £200 million sterling issue is designed to provide a benchmark borrowing rate for British bank/corporate issuers and to reinforce London's claim as the debt issuance, banking, sukuk trading and asset management hub of global Islamic finance.
Islamic banking and finance is a $1.3 trillion asset industry in the world money and capital markets, though its focal point remains the Gulf states and Malaysia. A former East German state (Saxony Anhalt) has issued sukuk (Shariah-compliant, asset backed debt) as have major Western multinational corporations like Tesco and HSBC. The UK Treasury's £200 million sterling issue is designed to provide a benchmark borrowing rate for British bank/corporate issuers and to reinforce London's claim as the debt issuance, banking, sukuk trading and asset management hub of global Islamic finance.
Bahrain and Dubai have both emerged as Islamic capital markets centres in the Middle East while Kuala Lumpur is the Shariah-compliant hub of Southeast Asia, with a vibrant ringgit denominated sukuk money markets. Though Islamic finance (IF) was used centuries ago to finance trade between Arabia and the Byzantine Empire, the first modern Shariah-compliant bank was the Dubai Islamic Bank.
Islamic finance has the potential to transform the banking systems and a capital markets of the Arab world, Iran, Turkey, Pakistan, West Africa and Southeast Asia. Its basic element include risk sharing, prohibition of interest, profit sharing and socially beneficial financing and ethical investments. There is no room in Islamic finance for excessive leverage, speculative gambling or socially destructive financing. After Lehman, Ireland, Spain, Iceland, Beat Steams etc, the world has learnt the high cost of banking's "casino capitalism" culture.
Islamic finance has evolved in sophistication and scale far beyond the commodity finance money market transactions of its early decades. Sukuk, ijara (leasing), mubaraba (profit sharing), anboun (derivatives) are now traditional international capital markets products. Islamic finance enables more than a billion Muslims to save, invest and borrow without violating their ethical and religious belief systems. It also helps finance trade and therefore boosts economic integration among Muslim countries, who are often desperate for investment capital.
There is now even a Shariah-compliant insurance (Takaful) and a reinsurance (Retakaful) industry in the Middle East.
There are now thousands of Islamic financial institutions in more than 50 countries. Islamic banking and finance critics who argue that it does not eliminate the role of interest but merely camouflage it and therefore mimics Western finance.
Shariah boards are also inconsistent. In their rulings and interpretations. There have also been failures of Islamic finance companies in Egypt and Pakistan as well as defaulted investment banking's sukuks in Kuwait after failed speculation in the money markets. This would be impossible in the classic, interest free model of Islamic finance. While Islamic banks avoided subprime lending and toxic derivatives, they suffered losses in the Gulf's property crash.
The Islamic Development Bank (IDB) in Jeddah, Saudi Arabia has played a major role in the evolution of infrastructure finance and long term capital markets in dozens of Muslim countries. The IDB is the World Bank of the Islamic world and is backed by Saudi Arabia, the birthplace of Islam and the financial superpower of the Arab world. International banks as varied as HSBC (Amanah), Standard Chartered Bank, BNP and Societe Generale have created Islamic banking subsidiaries and celfiliates. There are now five Islamic banks and Shariah-compliant trusts listed on the London Stock Exchange.
Sukuks are the growth engine of global Islamic finance since they enable long term debt finance against the collateral of specific assets. This reduces default risk for an investor but some sukuk structures were tested and found inadequate during the 2008 global financial crisis, when investors found that sukuk contracts did not enable them to gain control of assets in the event of default.
Two thirds of all sukuk outstanding were issued by Malaysian banks, corporate and government agencies. It is possible that the governments of South Africa, Nigeria and Hong Kong will issue sukuk in 2014 to attract investors from the Gulf. While Islamic finance is $1 trillion in assets, each of single US and Chinese banks (JP Morgan, Citigroup, Bank of America, ICBC, Bank of China etc) has amassed $2 trillion in assets. However, Islamic finance is growing at 15 per cent a year, far higher than conventional banking. The two biggest future challenges for Islamic banking will be adequate cross border central bank regulation and the creation of liquid, marketable, secondary market instruments.
The writer is a Dubai-based ?research analyst in energy and ?GCC economics.