Shariah Finance ‘Transforming Business Banking Horizons’

Asian financial markets can benefit from a new wave of opportunities developing through the growth of Shariah financial products, according to a research note issued by East & Partners Asia.

The market researcher says that oft-overlooked Shariah-compliant financial markets are firming as a reliable foundation for further economic growth that can be sustained and quantified.

Islamic business banking markets are flourishing across Asia, offering valuable new growth opportunities to incumbent banks while providing a lucrative market-entry vehicle for new rivals.

Assets of Islamic finance related investments are forecasted to exceed US$2 trillion by the end of 2014 following an extended period of double digit growth. Shariah-compliant investments are defined by their compliance with the principles of Islam. The word ‘Shariah’ translated means ‘the way’.

Investments in funds associated with alcohol or gambling are prohibited as they are deemed morally deficient, referred to as ‘Qimar’ (speculation), ‘Maysir’ (gambling) and ‘Gharar’ (unfairness).

Islamic finance strictly avoids any form of exploitation, therefore limiting the charging of interest, short selling and many other conventional banking processes.

Shariah-compliant markets issue ‘Sukuk’; bond-like products literally translating to ‘certificates’. Given interest bearing transactions are banned, Sukuk are used to raise funds using permitted contracts of this type.

A Sukuk holder is able to collect rental payments from the leasing of an asset but may not lend capital to a leasing company. There are several types of Sukuk however the most popular type are leasing based and applied to real estate, referred to as ‘ijarah’.

No-go areas

East’s research note cites Standard & Poor’s (S&P) estimate that global Sukuk issuances will exceed US$100bn by the beginning of 2015 thanks to greater demand in traditional markets, particularly Malaysia where most Sukuk are raised.

Ventures involving highly leveraged companies are not pursued by Shariah-compliant investment funds. Entrepreneurship is actively encouraged, although not without an active focus on the sharing of risk and execution of the sanctity of contracts.

For these reasons derivatives such as options, forwards and futures generally do not feature in Shariah-compliant funds however a variety of creative financial structures effectively replicate these functions using alternative but accepted methods.

‘Bai Salam’ commodity market contracts mimic forwards yet remain compliant by ensuring the seller’s position is protected. This is carried out by extending payment to the provider following contract agreement in contrast to the conclusion of the contract.

Absolving the seller of the underlying risk results in compensation to the buyer in the form of a fixed delivery price set without a premium on the spot price.

Shariah business banking growth is underpinned by a number of influential factors including greater international trade flows, Islamic government infrastructure development and a broadening interest in fostering social responsibility – not at all dissimilar to investments in western ‘green’ funds seeking to generate positive externalities in the form of an emphasis on environmental or community development.

Islamic banks have grown by 15% to 20% on average in traditional markets including Malaysia, Indonesia and the Middle East with significant further growth to be derived from new markets in Africa, the US and Europe. UK prime minister David Cameron recently stated “I want London to stand alongside Dubai and Kuala Lumpur as one of the great capitals of Islamic finance anywhere in the world”.

Challenges to greater proliferation of Shariah compliant investments include price pressure, administrative burdens borne by the maintenance of strict adherence to Islamic principles, underlying risk framework costs and the relative lack of talented individuals well trained in the specific processes of structuring Islamic finance investments.

A glaringly deficient understanding of new demand for Islamic finance solutions in business banking markets has resulted in the establishment of the first ever demand-side Shariah compliant finance research programme, which East has developed by East & Partners in conjunction with REDmoney.

The report will be released in September and every six months thereafter to provide a regular monitor of Shariah-compliant business banking markets in Malaysia and Indonesia.

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