FIBB, a commercial bank, is the only Islamic bank with overseas operations. A subsidiary headquartered in Karachi, Faysal Bank, in which FIBB has a 60 per cent stake, has 11 branches in Pakistan. Total funds under management at the end of last year declined 4.5 per cent from $1.51 billion at 1998-end to $1.44bn at last year-end, primarily due to a decrease in deposits of Pakistan by 12 per cent. This was, however, offset by an increase of 32 per cent in deposits in Bahrain. Total income declined by 17 per cent to $161m, from $193m in 1998. This reduction is primarily attributable to the negative impact on the banks operations in Pakistan, said Nassief.
Due to a prudent policy of building up provisions since 1998, an additional amount of $8.5m was set aside for non-performing financing and long term investment during last year in addition to the provision of $22.3m made in 1998. Management expect that, given the improving economic conditions in Pakistan, the banks operations in that country, under a new management team have reached a turning point and will show positive results for this year, said Nassief.
Islamic Mergers
The next few years will see mergers of Islamic banks as they try to compete in a global environment. Profiting from principal may once have been the core purpose of Islamic banks, but with the industry's growth to a point where some analysts value the Gulf business alone at $30bn, other factors have come into play.
Islamic investments have seen growth reflected in two recently launched indices of stocks compliant with the Islamic sharia law, which prohibits interest. The stocks have a combined capitalisation of $7,500bn.
The lure of the Islamic investment market has forced non-Islamic institutions to offer services which accord with the sharia. Last year, Citigroup's Global Islamic Finance Group, the US group's Islamic fund, reported a $5.9m net profit, while HSBC Investment Bank created a Global Islamic Finance department, to provide products and services compatible with the sharia.
The offer of such services by non-Islamic banks has intensified pressure on Islamic banks as they try to compete in an increasingly regulated global environment. This is proving as much of a test for them as it is for the often protected and poorly-regulated economies of the countries in which they are most active.
Central to the growth of the Islamic banking industry is the source of its wealth. With the oil wealth of the main shareholders of the leading Islamic banks less secure than at any time in the past, the viability of the institutions will come to rely increasingly upon their ability to offer services that can compete with non-Islamic banks. The next few years are therefore certain to see mergers of Islamic banks, as they attempt to consolidate their market share, improve efficiency and allow stricter regulation of their affairs. In doing so, the attraction of their service will come under close scrutiny.
“There is a growing segment of institutional clients demanding more Islamically-compatible products,” said Basil Al Ghalayini, head of the London office of The International Investor, a leading adviser on Islamic financial services.
For borrowers and depositors, the attraction of Islamic banking is clear. Negotiating loans based on expectations of profit coupled with the market cost of funds, rather than an agreed fixed interest rate, allows the borrower influence on the process of establishing the cost of borrowing. The careful allocation of loans to business has also encouraged the growth of large client depositor bases in the leading Islamic banks, lured by the prospect of a share in bank profits.
The success of the entire system depends vitally on the right investment decisions being made by the banks. The link between the borrower and the depositor is a direct one, heightening the need for high liquidity and careful regulation of the institutions.
This has led to concentration on investment banking at a time when non-Islamic commercial banks are looking to increase their retail business in response to the lower margins created by intense competition for business clients. The versatility of Islamic banks in changing market conditions has consequently been thrown into the spotlight, while they remain determined to retain the depositor base they have so far built up.
In many cases the Islamic banks, with large client bases, appear best prepared for a growth in retail banking, though they have yet to develop broadly in that area.
“We are depending on small savers. This is an advantage,” said Gamal Shaaban, general manager of the Faisal Islamic Bank of Egypt (Fibe), which has 400,000 individual accounts in Egypt and is seeking to open branches abroad. “Our strength lies in doing business in accordance with the Islamic sharia. But if at the end of the year I tell depositors that I didn't make a profit for them, they will go elsewhere.”
Mergers are widely discussed in Islamic banking circles, as a means of spreading risk to allow the banks to develop the retail side which their client base demands but which the banks largely fail to meet. Fibe has a mere 200 car loans outstanding, and does not even consider offering mortgages.
The opposite is true in much of the Gulf, where retail banking is an important aspect of the Islamic banking business. Even so, pressure for mergers has grown, in response to the over-reliance on oil wealth and the spate of bank mergers in Europe and the US in the past few years that have created megabanks.
Real Health?
But assessment of the industry's real health is complicated by the inconsistency of regulations governing the banks. While in Egypt all banks fall within the regulatory framework of the Central Bank of Egypt, ministries have control elsewhere.
The UAE Central Bank now regulates Abu Dhabi Islamic Bank and Dubai Islamic Bank, after the latter effectively lost $242 million in a scam.
“There are two Islamic banks in the United Arab Emirates but many traditional banks operate Islamic windows. Rendering Islamic services is not restricted to Islamic banks.”
There are 173 Islamic banks worldwide, 47 of which are in the Middle East. But at least half of the assets are in the Gulf Cooperative Council region which houses 22 banks. Research by Capital Intelligence, the Cyprus-based rating agency which currently rates nine Islamic banks, concludes that “Islamic banking, despite its shortcomings, is gradually gaining more credibility, playing an important role in the development of many Gulf countries, and is gaining wider acceptance in international markets”.
Historically, the banks asserted their independence from the non-Islamic institutions and regulators due to the non-interest-based nature of their operations. Now, pressure is mounting for Islamic banks to accept the central banks' protective and regulatory role.
Streamlined regulation of the Islamic banking industry is the likely outcome of the pressures on the industry. Islamic banks will face not only the need to develop ties with other banks which are bound by global standards of practice, but also to develop more sophisticated areas of business.
“In the coming period all the banks, not just the Islamic banks, will face problems,” said the senior official of one Gulf bank. “To survive we need to become bigger. It's not our problem alone. It's a problem for all small banks. We have got investment, and the market is big enough for us to survive in a changing global climate. But only if we become bigger.”