An Islamic mega-bank

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Banker Middle East 2007 There has been a lot of talk lately about an Islamic mega-bank. Mike Gallagher reports. The idea of an Islamic mega-bank has been going around for years, mostly as a sort of Middle Eastern fantasy that had very little in common with reality. People would talk wistfully about Islamic mega-banks like they would about world peace. It sounds like a good idea, revolutionary even, but in practice impossible. Until recently that is. Then things began to happen across the wider financial spectrum. The price of oil more than doubled as war and surging Asian economies, notably those of China and India, created unprecedented demand and the countries that produced oil started seeing their budgets ballooning as the revenues kept coming in. The GCC banks were a natural deposit for all this cash, especially in the aftermath of 11 September as many Middle Eastern investors started looking at other places to invest their oil wealth. Banks started springing up around the Gulf and they, in turn, started investing this money for their clients in a wide range of ventures as the booming economies in turn created yet more demand for specialised banking products. People had fantastic amounts of money to invest and a small but growing number of Islamic banks started coming to the fore in the region. This quickly included many large international banks who saw which way the wind was blowing and decided to get in on the act by opening up Islamic windows in an attempt to gain a foothold in a lucrative market. Competition bred competition and international finance and banking centres sprang up right across the Gulf and Levant as everyone jockeyed for position. That is the history, but as usual, there is more to it than just simple figures. Geography is obviously a critical factor. Islamic banks exist across a wide range of countries and there are roughly 300 Islamic institutions worldwide, holding about $300 billion in deposits, with almost as much being held by conventional institutions with Islamic arms. Saudi Arabia, with 25 per cent of the world's oil reserves making up between 90 to 95 per cent of the country's revenues, and a population of around 27 million that has nearly tripled since 1980, is where a lot of attention was focused. The banks there started to capitalise on the oil boom, much as their neighbours had done around the Gulf and slowly the now plausible idea of an Islamic mega-bank began to emerge. Saudi banks are easily amongst the most profitable in the GCC and from there came Al Rajhi bank. All Saudi banks are Islamic and Al Rajhi, with more than 500 branches across the kingdom is easily the biggest Islamic bank in the world. Its return on assets was 3.5 per cent and its return on equity was in excess of 26 per cent. Kuwait had also been busy making the most of the windfall from yet another petrodollar driven boom and it was from there that Kuwait Finance House (KFH)Kuwait Finance House (KFH) materialised. KFHKFH, which is the third oldest Islamic bank in the world, is that rare thing in Islamic banking. It has cleverly managed to second guess all the major market movements over the years and has an uncanny knack of being able to position itself where the consumer is at his most willing. KFHKFH also recognized the impact of non-branch distribution of services, both in terms of customer service and reduced costs and the bank has become a leader in exploiting technology to serve business needs. The talk of expansion or consolidation has been on everybody's lips for quite some time and it goes without saying that if the idea of an Islamic mega-bank that could compete with the world's largest conventional banks was ever to be realised then it would be inevitable that at least one of the banks would have to break out of the GCC region and go overseas. Competing with the world's largest conventional banks is not going to be easy, especially when you look at the hard facts. UBS has total assets of around $1.5 billion while the four biggest Islamic banks have a sum total of just $8 billion between them. Mohammed Amin from PricewaterhouseCoopers put it in perspective when he said that "the reason why many conventional banks are very big is that you get economies of scale. But the theory is that as you get bigger, you are able to have lower costs of processing, in fact you are able to share information across countries, so that explains the rationale as to why many, many conventional banks have chosen to get big by a combination of expansion and acquisition. That same logic should apply to Islamic banking." "I do not see a fundamental reason why Islamic banks should not grow much larger than conventional banks. The banks will follow where the economic growth is and the fact that you are seeing significant economic growth in places like Malaysia, India and China so that explains why you should expect to see Islamic banks trying to grow in those areas." Mardig Haladjian from Moody's agreed and said that "if you look at conventional banks and global banks, you realise that there is a difference in scale. We have been criticising Islamic banks for being so fragmented in the sense of a limited scale and concentration of risk. The steps that we are seeing from the likes of Kuwait Finance House, Al Rahji and Al Baraka, who are what might be considered large players are quite positive in a sense that, on one hand they are diversifying their presence with the interest of gaining a foothold in the Asian markets where Islamic banking demand is high and they will have good opportunities to grow there. And on the other hand they are putting more capital behind their institutions and as a consequence this is increasing the prospects of them becoming major regional players." Al Rajhi BankAl Rajhi Bank decided to make its presence felt when it decided to embark on an ambitious expansion programme and open 50 branches in Malaysia. But Al Rajhi BankAl Rajhi Bank officials were coy when they were asked what kind of retail and corporate products they planned to offer, although word started leaking out that they planned to offer products like car and real-estate financing as well as mutual funds. Al Rajhi is one of three foreign Islamic banks in Malaysia, which also includes KFHKFH and HSBC AmanahHSBC Amanah. KFHKFH has also decided to further its ambitions and is currently negotiating to acquire Utama Banking Group's entire stake in the Rashid Hussian Berhad Group. KFHKFH has been battling EON Capital for control of RHB and many analysts seem to think that the Gulf house stands the best chance of doing so. The odds of this increased when the board of RHB approved a planned restricted offer for sale of the company's RHB Capital shares to RHB shareholders. KFHKFH further reinforced its intentions when it said that said that RHB would not be a foreign-controlled bank but operate as an Islamic brotherhood partnership. It also said that the group would support the Employees Provident Fund's (EPF) proposed restricted offer for sale of RHB Capital shares or any other proposals by the shareholders in dealing with RHB's debt as long as it would benefit all shareholders. Cheah King Yoong, the head of investment research for SJ Securities in Malaysia said that he believed that "KFHKFH has the upper hand because they have the commitment and they have said they are going to invest about $3.4 billion into transforming the RHB group and they are really sure of their game plan. They do have the financial capability if they really want to increase the bid and have already done their due diligence on the company." There is a common perception that being established in Malaysia is all about clever positioning for greater things further down the road in South East Asia, especially in Indonesia; and Malaysia has been described as a good foundation for those with ambitions for moving into Indonesia. However the growth of Islamic finance may not be all it has been hyped up to be, as a survey by the Islamic Financial Services Board, (IFSB) claimed that demand in the first half of 2006 was significantly slower than it had been in 2004 and 2005. The IFSB contacted nearly a dozen central banks and over 50 Islamic banks across Asia and the Middle East and suggested that there were no obvious indicators for any trends regarding asset growth for Islamic banks. Some of the bigger Islamic banks reported that growth by June of 2006 was below that of previous years. Islamic real estate finance appeared only to have increased in Qatar and Malaysia. Some commentators have suggested that the appeal of Islamic products may in some markets be overdone. Others have said that it is the quality of service that counts at the end of the day. Mohammed said "One of the comments I have heard many times from Iqbal Khan who used to run HSBC AmanahHSBC Amanah was that in Malaysia 70 per cent of the customers were ethnic Chinese, who are of course not Muslims. And they were simply going to HSBC, not because of any religious reasons, but because they were offering them better service and better products." "Islamic banking does not have to be directed exclusively at Muslims and this is important to remember for banks who are thinking of moving into parts of the world where there is no natural customer constituency of large Muslim populations. So there is no logical reason as to why Islamic banking should not expand into places like Latin America. It goes without saying that when you are expanding overseas, money always tends to go where it is easiest first, which is rational, hence the attraction of Malaysia." Haladjian said that "There are the other issues of differences of interpretation of Shari'ah law between the Islamic community in the Gulf and Asia. But that is something that may, or may not be bridged by moves towards a single authority." Malaysia has long been at the forefront when it comes to the issuance of Sukuk, but it has sold many of them using the bitamin ajiil rule of deferred payment which some say effectively makes it a form of debt payment but Haladjian says that "a scarcity of capital will determine where they make their move. These cross border moves by Islamic banks will also highlight the need to come up with a uniform industry regulation. That is the other dimension to Islamic banking. There is not a lot of uniformity, so as you see banks hopping from country to country, it should become much more relevant for the Islamic banking community to solve." So while it is probably safe to say that the dream of an Islamic mega-bank is now a little closer, much remains to be done. Whether one of these banks can ever hope to compete with the likes of Barclays or HSBC is probably a discussion for well into the future, but for now the next and more interesting step will be, from Malaysia to where? China, which is well on its way to becoming the next superpower, could be where the contest is decided. If an Islamic bank is successful there, then that could be where the definition of what constitutes an Islamic mega-bank is finally decided. Chinese government officials were recently in Jeddah, urging Saudi bankers to open branches there. "Chinese banks are willing to open branches here and we also invite Saudi banks to open branches in our country," Dr. Hu Wei former Chinese ambassador to Riyadh said. China has 23 million Muslims, mostly concentrated in the North-western province of Xingjian. Indonesia, another country that is also a natural next-step has a population of 250 million, most of them Muslims. Watch this space.