Islamic Banking Trade Finance
Mature as they are, conventional trade finance vehicles in most of the world remain locked into documentary credits, collections and open account transactions. However, the social culture of the Gulf countries has led to the evolution of a new Islamic trade finance.
Once again, the operational risk management in trade finance is a complex issue that requires specialized knowledge not only of trade finance rules of practice, but also of various aspects related to the transaction itself whether it is under conventional or Islamic banking trade finance. But since we are discussing trade finance in the Islamic context, this article will focus on Islamic trade finance.
Islamic Banking is a financial field based on Islamic legal concepts (Shari'a). The term, evolved since the first decades of Islam, depends on risk-sharing as a prerequisite to initiating the credit facility whilst prohibiting financing based on a fixed pre-determined return.
In the credit side of Islamic Banking, the principles of risk and reward were formulated into a new bond of partnership between the parties to the banking contract as opposed to the debtor - creditor relationship in traditional banking. In simple words, the bank enters into a partnership with its customers; its revenue is proportional to its shares. Conversely, the bank receives no profits if the deal it is financing doesn’t generate any. Distinctively unique, Islamic Banking is a very popular method in countries like Saudi Arabia. Some Saudi Banks, like Al Ahli are even planning to completely turn into Islamic Banking. Whilst Al Rajihi Group is another important bank that focuses on introducing Islamic banking trade finance around the ME, the Islamic Development Bank, or IDB, continues to expand its operations within Saudi Arabia and it is currently setting up a new trade finance corporation in Jeddah with a staggering capital of $3 billion. The IDB celebrated its 30th anniversary in January with a gala invitation-only dinner at the St. James Palace in London hosted by Prince Charles. Of course their mission is a tough one especially that they have to compete against the world’s trade finance giants such as the HSBC, CitiBank, ABN Amro Bank and the Standard Chartered who operate aggressively in Saudi Arabia and other Gulf countries. As a highly profitable domain, and a fairly secured one as local and regional competition does not exist, Islamic banking remains an attractive pursuit for global banks. It is a rich source of low cost deposits and the perfect method to boost ROAA and ROE ratios for based on the Sharia’s principles, Muslim depositors do not accept credit interest on their deposits. This also explains the reason behind vigorously promoting the concepts of Islamic banking by western banks, journalists and politicians.The total assets of Islamic banks that confront to the Sharia’s requirements has recorded a staggering $400 billion, according to Standard & Poor's Ratings Services.
In financing trade, Islamic banking is mainly based on two major principles i.e. musharakah and mudarabah. The dictionary meaning of the Arabic word Musharakah is partnership or contribution in a venture where both the buyer and the bank put up capital. The dictionary meaning of the Arabic word Mudarabah is plunge and it is a technical term used to describe the situation where the bank provides the technical skills and management needed to conclude the transaction accurately whilst the customer provides the investment.The market for listed Sukuk is approximately equal to 9.5 Billion Dollars of which over 5 Billions Dollars are actually rated by the Standard & Poor. In view of the changing social and economic environment in the gulf, it would be extremely difficult to anticipate the rates at which the market would grow during the next decade.
Illustrating the interest of the European banks in Islamic Trade Finance as a profitable domain of banking, Britain has established it first fully conforming Shariah bank back in August 2004 under the name of the Islamic Bank of Britain. It is based in Birmingham where the largest Muslim population is situated. It has several branches, including four in London and it offers traditional and Islamic banking products at the same time, including savings accounts, term deposits, personal finance, home mortgages and business banking. Its shareholders comprise leading Islamic banks, including Qatar International Islamic Bank.
The leading centers of Islamic banking in the world are Riyadh and Kuala Lumpur are liaising with each other to unite their principals and possibly procedures so that they strengthen the development of Islamic banking around Asia and Africa including the Gulf.
Several Arabian Islamic banks based in the Gulf have recently expanded their networks to include Malaysia, Thailand, Philippines, China and India.
In essence, the Islamic banking trade finance services are traditional banking products redesigned in a way to conform with the rules and principles of the Sharia. Murabaha is the most commonly used form of Islamic trade financing, which as explained earlier, is a form of partnership where the bank pays in full or part the value of the goods for its customer who in turn agree to share the profits generated from sales with the financier, in simpler words, the bank purchases the goods and the borrower sells them. Of course the bank would allow the borrower a grace period adequate for the borrower to sell the goods and repay the bank’s dues which obviously do not include interest on the loan as interest is totally forbidden in Islamic Banking.
Islamic banking is mainly based on profit- and loss-sharing partnerships; the essence of musharakah and mudarabah, to finance trade. Under musharakah, the bank pays part of the capital. One partner buys out the other partner's share over time. Under Mudarabah the client provides the capital and the bank contributes the skill and efforts to make the transaction a success. The distinctive feature of these types of financing is that the financier becomes a trader as well and takes possession of goods, something that traditional bankers prefer not to do.The first global bank to introduce Islamic Banking trade services was the HSBC Bank Middle East back in 1998 when it launched a series of murabahah products, branded as HSBC Amanah, replicating all conventional services.
Whilst Riyad Bank continues to lag behind with its never ending operational problems, Citi Financial Group (Samba), another major player in the Islamic banking market in Saudi Arabia, has a top-three market share in the kingdom. They have three main trade operations centers, in Riyadh, Jeddah and Khobar. By offering both Islamic banking as well as conventional trade products, Samba Financial is able to meet the specific needs of its customers and offer them a wider choice. Local banks that have a deeper understanding of the sensitivities and requirements of their specific market claim to have an advantage over the international banks in introducing new Islamic financial products.
Al Rajhi Bank, also based in Riyadh, is the worlds largest and most respected Islamic bank. It has more than 500 in Saudi Arabia and it is the first Saudi bank to operate in Malaysia. The bank is expanding its network to include the Levant as well. From a similar article on Islamic Trade Finance, I quote the following paragraphs:“Founded in 1970, Dubai Islamic Bank, based in the United Arab Emirates, is the first fully fledged Islamic bank. In December 2006 it launched Al Islami Land Trading Finance, a Shariah comforming structured finance service designed for Emirates national dealing with real estate. Dubai Islamic Bank has issued a $3.5 billion sukuk bond for the Nakheel Group (a governmental emirates organization). Sukuk are financial participation certificates that do not offer interest payment rather provides for paying a fixed return.
Islamic bonds recorded a volume of more than $7.3 billion in the year-to-date through December 19,2006, an increase of about 12% from the same period a year earlier, according to Dealogic. Abu Dhabi Islamic Bank's $800 million sukuk, priced on November 30, 2006, through HSBC Amanah, was the third-largest Islamic bond on record. The issue was originally planned for $400 million to $500 million but was increased due to strong demand from investors, nearly 40% of whom were based in Europe.
Malaysian issuers dominated the Islamic bond market last year, with $5.6 billion of volume as of December 19, an increase of 31% from the same period of 2005, Dealogic says. CIMB Islamic, based in Kuala Lumpur, led the 2006 year-to-date bond volume and revenue rankings, according to Dealogic.
The Malaysian subsidiary of Bank of Tokyo-Mitsubishi UFJ, part of Mitsubishi UFJ Financial Group, is teaming up with CIMB to offer a range of financial services, possibly including sukuk for Japanese corporations. The strategic alliance covers broad collaboration, including conventional and Islamic investment banking and cash-management services.
Kuwait Finance House, one of the world's largest Islamic banks, has recently launched a $200 million Islamic bond issue for a Chinese power company. It also is arranging financing for infrastructure projects in India, Indonesia and Pakistan.”The modern conventional banking has developed over long historic periods of time as a consequence of changing social and economic needs of people. It is based on laws and rules of economics and finance where the management of value is in the heart of the decision on the sort of banking services to choose. For example interest rates on deposits are correlated to annual inflation rate which in turn is the result of interacting factors of production and market forces (demand and supply). Hence banking is an advanced science based on solid laws rather than theories. For Islamic banking to blossom solidly, there has to be a mechanism that takes into account all such factors and soundly convert the traditional interest rates into equivalent fixed fees to ensure that the value of the investment is maintained undiminished. Many Muslim bankers actually argue that the current principles of Sharia are not fixated and may change with the changing global financial environment. Hence an adoption of traditional banking principles by Islamic bank is not only possible, but is actually perceived by the majority of the Muslims in the Arab world.
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