Monday, July 07, 2008

RBC Plans to Enter Islamic Finance Market

  
The Globe and Mail, Sonia Verma, 7 July 2008

When Ford Motor Co. sold the iconic British Aston Martin luxury car maker to a consortium led by British racing entrepreneur David Richards last year, the deal hinged on some unusual conditions.

Mr. Richards' Kuwaiti partners, Investment Dar and Adeem Investment, would only back the $848-million (U.S.) deal if it were done according to Islamic principals. So, in accordance with the Koran, 40 per cent of the deal was structured to avoid directly paying interest on a loan.

But to do their deal, Mr. Richards and his partners didn't turn to a Middle Eastern bank with an extensive background in Islamic, or sharia, finance. Instead, the buyers of Aston Martin – most famous as James Bond's car – went to a German bank, WestLB AG, for $450-million in sharia financing, through a structure known as murabaha.

The Aston Martin deal, as the first sharia leveraged buyout in Britain, was a watershed for Islamic finance and highlighted the growing influence of sharia banking in Western finance.

After a few years of strong growth focused largely in the Middle East, a new generation of Islamic bank startups is setting its sights on the West.

And as the wealth of Gulf countries swells with skyrocketing oil prices, more Western banks, including some Canadian banks, are looking to those pools of capital. Banks such as Citigroup Inc., Lloyds TSB Group PLC, Deutsche Bank AG and Barclays PLC are now offering services along Islamic finance lines. In the Muslim world, some have partnered with local sharia banks to form joint funds. In the West, London ranks as the leading Islamic banking centre, with conventional banks, such as HSBC Holdings PLC, opening Islamic banking units.

“Islamic banking is growing faster than any other sector of the banking industry and the West is just starting to wake up to its potential,” says Anouar Hassoune, a Paris-based senior analyst with Moody's Investors Service who specializes in sharia banking.

In February, Royal Bank of Canada hired Zaher Barakat, who teaches Islamic banking and finance at Cass Business School in London, as head of financial products for the Middle East.

RBC is targeting a variety of clients in the region, including sovereign wealth funds, private banking arms of local banks and government pension funds. While the priority is to market the bank's existing services and products into the Middle East, RBC is planning to enter the Islamic finance market, Mr. Barakat said. “We are working now on one fund to transform it to be sharia-compliant,” he said.

Bank of Montreal, through its London institutional management group Pyrford International, manages sharia-compliant products for Middle Eastern clients and is expanding the offering, said BMO spokesman Paul Gammal.

Islamic banking forbids interest and obliges deals to be based on physical assets, not on speculation. Sharia-compliant products seek to replicate the structure of interest through cost-plus transactions, leasing arrangements, or by linking payments to returns on assets.

Iran leads all countries with the highest level of sharia-compliant assets, surpassing $150-billion, the chief operating officer of HSBC, David Hodgkinson, told an Islamic finance forum last fall. But flush with petrodollars, the Gulf has become fertile ground for Islamic bank startups.

The launches of three new state-owned Islamic banks – Abu Dhabi's Al Hilal Bank, Saudi Arabia's Alinma Bank and Dubai's Noor Islamic Bank – highlight the sector's rapid growth, and also its ambitions to export Islamic banking around the world and reap the profits.

Soon after it was launched last year, the chief executive officer of Noor Islamic Bank said he intended to go on a shopping spree for financial institutions in the West in an effort to become the world's largest sharia lender within five years.

The bank aims to gain a foothold in Europe – where demand for sharia-compliant services is growing – by acquiring controlling stakes in British banks. “We would like to take the Noor brand outside the [United Arab Emirates] by acquiring other financial institutions,” CEO Hussain Al Qemzi said in an interview.

For Al Hilal Bank, which has more than $1-billion in capital, “any place that has a strong Muslim population and presents an opportunity is motivation for us,” said CEO Mohamed Jamil Berro.

Mr. Berro rejects the criticism that Islamic finance structures lack transparency, and argues that Islamic banking is inherently less risky than Western finance, which has been battered by the subprime mortgage crisis.

“One of the things we don't do is subprime … because it's prohibited for us,” he said, referring to the Islamic banking principal that deals be based on tangible assets. “These [plans for expansion] are not meant with any political agenda or anything. More or less, it's just investing and creating a return,” he said.

The banking community at large could learn from sharia-compliant products, HSBC's Mr. Hodgkinson said. The products provide stability because of Islamic finance's emphasis on ethics and self-regulation.

Mr. Hassoune, the Moody's analyst, says Islamic financing is using the credit crisis in the West to its advantage, offering liquidity and security where conventional banks are coming up short.

However, the market is not without its problems.

Islamic banks are typically ruled by a board of religious scholars who determine whether particular deals are compliant with Islamic law. There are growing indications that these religious scholars are challenging Islamic banks' unprecedented growth, questioning whether their products truly comply with Islamic law.

Sheik Muhammad Taqu Usmani, an influential sharia scholar from Bahrain, recently sent shock waves through Islamic finance circles by warning that 85 per cent of Islamic bonds, or sukuk, do not truly comply with Islamic law, undermining public confidence.

“People are getting worried. Islamic banking is not just a business. It's ethics-based, so the opinion of these scholars matters,” Mr. Hassoune said.

Experts say standardized practices and industry-wide regulations could address those concerns, but could also stymie growth, because Islamic finance has to evolve based on its clients of any country where it takes root.

In Canada, sharia-based banking is available, but on a limited basis. The issue sparked controversy earlier this year when the Canada Mortgage and Housing Corp. launched a study on Islamic banking, as Ottawa considered its first applications to start up Canadian banks operating within Islamic law.

The proposals drew fire from the secular Muslim Canadian Congress, which argued that faith-based banking had no place in Canada, and the presence of Islamic banks would pressure Canadian Muslims to subscribe to costlier products.

Walied Soliman, a Toronto-based lawyer at Ogilvy Renault, said “Canadian banks haven't been as quick either on raising money from the Middle East for financial institutions in Canada or in terms of offering up structured products or issuers for investment in the Middle East.”

But that may be changing, he said. “Canada is very quickly getting onto the radar of [sharia] investors and other issuers looking to engage in M&A transactions with Canadian issuers, and as a result we're going to see growing interest in Canada and the bankers will adapt to that and learn more about the sector as the demand grows.”
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