Dealing with record profits

Record profits are all well and good, but they raise the question; what to do with it?
Go regional, argues Robin Wigglesworth

July and August are traditionally when banks report their first half profits, and they have generally made entertaining reading for shareholders and managers alike.

Islamic banks are no exception, having capitalised on the tremendous boom in the Middle East in general, and Islamic banking in particular. Take some of the larger players as examples: Qatar Islamic Bank (QIB) made $129 million, Dubai Islamic Bank (DIB) made $192 million, Kuwait Finance House (KFH) made $259 million, Bank AlJazira made $359 million, and Al Rajhi Bank made a staggering $941 million.

However, the banks are not resting on their laurels. All are aware that, as the recent stock market tumble showed, nothing can last forever, and to use a old clich‚, if you stand still you are moving backwards.

According to Adnan Yousif, CEO of AlBaraka Banking Group (ABG), Sheikh Saleh Kamel was the first person to raise the issue of the need for an Islamic 'megabank', a view he shares with his chairman. "The Islamic financial system needs a big banking institution, because truly to matter on the global stage you have to be big."

Most of the major Islamic banks in the region are investing tremendous resources into becoming regional, even international, banking players. Bahrain-based ABG is probably the most geographically diversified Islamic bank, with subsidiaries in Egypt, Lebanon, Sudan, Tunisia, Turkey, Jordan, Algeria, and South Africa, and has invested in the Islamic Bank of Britain and the European Islamic Investment Bank. It is all part of Sheikh Saleh's vision of a global Islamic bank, present in all predominantly Muslim countries.

ABG recently issued a $430 million IPO with the express intention of using the capital to bolster its subsidiaries, and expand internationally into new markets, particularly Malaysia, Indonesia, India and Syria, and "hopefully Europe soon", according to Adnan.

QIB has entered into a joint venture with Islamic investment banking big-hitters Gulf Finance House (GFH), based in Bahrain, and established Qatar Finance House (QFH), a Shari'ah compliant Qatari investment bank with $1 billion in authorised capital and $500 million in paid-up capital, with each bank owning 15%. QFH has already applied for a license to operate from the Qatar Financial Centre, and the board of directors is a veritable who's who of Qatari and Bahraini investors.

DIB, the world's first Islamic bank, has also spread its geographical wings, primarily in Sudan and Pakistan. Together with Abu Dhabi Islamic Bank, Sharjah Islamic Bank, and the Islamic Development Bank (IDB), DIB has taken over Al Khartoum Bank, Sudan's first bank, renamed it Emirates and Sudan Bank, and given it a paid-up capital of $113.5 million and an authorised capital of $200 million.

Interestingly, DIB also holds a significant stake in Bosna Bank in Bosnia, as does IDB. Though it is still a miniscule market, Bosna Bank could, with the right backing and economic conditions, potentially become a leading Islamic bank in Eastern Europe.

There are also reports that DIB is in the final stages of acquiring MNG Bank in Turkey for $160 million, and converting it into a fully Shari'ah compliant institution. Due to the secular constitution in Turkey, Shari'ah compliant banks must call themselves 'participation banks', but with a buoyant, thriving economy and an EU membership on the cards, a presence in Turkey is potentially extremely lucrative.

"DUE TO THE SECULAR CONSTITUTION IN TURKEY, SHARI'AH COMPLIANT BANKS MUST CALL THEMSELVES 'PARTICIPATION BANKS."

DIB's move into the Pakistani Islamic banking market is perhaps even more significant. In a Memorandum of Intent, DIB has committed to opening 70 branches across Pakistan over the next 18 months, making it one of the largest foreign banks in the Islamic republic. Explaining the move, Saad Abdul Razak, CEO of DIB, revealingly said that it would enhance DIB position "leading Islamic financial institution on the global scene".

It is a title that is likely to be contested, not least by KFH and Al Rajhi Bank. KFH in particular has a well-established pedigree outside the Kuwaiti borders. For many years, KFH was regulated directly by the Ministry of Economy, and was able aggressively to expand abroad, most notably in Turkey through its Kuveyt Turk subsidiary, Bahrain through KFH Bahrain, and the UAE through its 20% stake and management contract with Sharjah Islamic Bank.

It is also present in more far-flung areas, and not only through its real estate investments in the west. It operates in Malaysia through its wholly-owned subsidiary KFH Malaysia, which has a $100 million in paid-up capital. KFH Malaysia caught the attention of the Islamic financial world when it announced plans to bring a $200 million Islamic bond to the market, backed by Chinese energy infrastructure assets. It would be the first Chinese Sukuk, and KFH is also reportedly looking at issuing Sukuk on the behalf of Indonesia and the Philippines as well.

However, the largest Islamic bank in the world is predictably a Saudi one. Al Rajhi Bank is the second largest bank in the Middle East, and the largest Islamic one by some distance. Its sheer size allows it to take risks some smaller banks might shy away from, and uniquely for the largest Islamic banks, its focus is squarely on retail banking.

"This was our model from the very inception of the bank. We wanted to be the people's bank, and the strategy of the bank was built around this vision," says Saeed Mohammed Al Ghamdi, head of retail banking at Al Rajhi. It has announced plans to open 50 branches in Malaysia, arguably the world's most advanced country within Islamic finance, and as in Saudi Arabia, Al Rajhi's focus in Malaysia will be on retail.

The retail sector in Malaysia is very competitive, and Shari'ah boards in Malaysia are sometimes accused of taking a 'mercantile' approach to Shari'ah compliance. As Al Rajhi will still be relying on its own, Saudi board, this might disadvantage it vis-…-vis Malaysian competitors like RHB Islamic, Bank Islam, Bank Muamalat and CIMB. However, its venture into the Malaysian market should be applauded, and considering the tremendous financial backing and extensive retail experience accrued from years as a top player in Saudi Arabia makes it a well-calculated venture.

Saeed is certainly convinced that it will prove successful, and says once Al Rajhi are successfully established in Malaysia, it will use it as a springboard to other Muslim markets nearby. "We don't want to limit ourselves to one area or another, and all Muslim countries represent an opportunity for us. After we are successful in Malaysia we will closely study all the other regional markets, and determine the best way to expand in those in due course. We want to be a leading, global Islamic bank."

The larger players obviously have the advantage when it comes to expanding outside core markets, but wary of the dangers of standing still, smaller GCC Islamic banks are also looking around for opportunities. Often, their domestic markets are dominated by the larger banks, and though nimble, they cannot compete with their economies of scale, making regional expansion increasingly attractive.

Bank Boubyan in Kuwait has to face domestic giants KFH, and has decided to look abroad as well, having acquired a significant stake in Bank Muamalat Indonesia. "The bank has a very interesting history, has an excellent track record, good profitability over the past three years, and excellent future potential," says Fuad Al-Shehab, deputy general manager and head of investments, who wants to use the bank as a window into the Far East markets, particularly Malaysia and Japan.

"Malaysia is very advanced in terms of Islamic banking, but Japan has no knowledge of Islamic banking. Our investments in Japan are restricted to buying real estate, but we have found that Japan is very willing to entertain the concept of Islamic transactions," says Fuad. With Islamic banking and finance thriving in Malaysia, Singapore attempting to become an Islamic finance hub, and Indonesia the world's most populous Muslim country, Fuad thinks that South East Asia will attract a lot of attention from capital-rich Islamic banks in the GCC.

There are also many opportunities closer to home for more cautious banks. Take International Islamic in Qatar. It was a founding partner of Islamic Bank of Britain, is establishing a Takaful company in Pakistan, setting up an Islamic bank in Syria, and is in the early stages of setting up another bank in Morocco.

"BANK BOUBYAN IN KUWAIT HAS TO FACE DOMESTIC GIANTS KFH, AND HAVE DECIDED TO LOOK ABROAD AS WELL, HAVING ACQUIRED A SIGNIFICANT STAKE IN BANK MUAMALAT INDONESIA."

However, regional consolidation, whilst the good times are rolling, is all well and good, but some true Islamic 'megabanks', capable of competing with the multinationals, would be a boon to the industry, and help it move forwards. Ernst & Young did a survey with ABG, and found that 85% of all Islamic banks do not have capital exceeding $25 million, only 12% of Islamic banks have more than $100 million in capital, and despite abundant liquidity, there is not a single Middle East bank among the top 100 banks in the world, ranked by Tier 1 capital.

Perhaps the larger regional players, awash with budget surpluses, should rather look for merger and acquisition possibilities closer to home. There are several Islamic banks that, due to their size, look like ideal possibilities for an ambitious and capital-flushed bank, and due to the complicated ownership structure of Middle East companies, many banks are owned by the same government or family office.

Take for example Emirates Islamic Bank, wholly owned by the Emirates Bank International Group, in turn owned 76.8% by the government of Dubai, which also controls DIB. Furthermore, the government also owns Dubai Bank through Dubai Holding and Emaar Properties, and Dubai Bank is currently in the process of converting into a fully Shari'ah compliant institution.

There is also a case for cross-border consolidation in the Islamic financial sector. KFH could certainly afford fully to acquire Sharjah Islamic Bank, thereby getting a foothold in the lucrative UAE market, and a bank like Bahrain Islamic Bank has little chance of competing against the giants of Bahrain, and would have much to gain from, for example, a Saudi patron bank. Arab Islamic Bank's general manager Atiyeh Shananier certainly makes no secret of his desire to see an Islamic bank from the GCC investing in the Palestinian bank.

With most banks doing well, the price of consolidation might very well be extortionate, but the stock market downturn has made acquisitions a bit more palatable, with shareholders no longer asking for unrealistic valuations. As regional Islamic banks expand further, and become locked in increasingly tough competition, the smaller players will see their margins tighten, and an even stronger case might be made for M&As.