Interview: Adnan Chilwan
How strongly held is the view in the industry that trade finance remains a largely untapped sector?
ADNAN CHILWAN: If you look at statistics such as the contribution to global trade volumes of Organisation of Islamic Cooperation (OIC) countries, trade originating from the 57 member countries makes up 11% of the total, though only 10% of that share is conducted under Islamic principles. Considering that inter-OIC trade is only 18% of their total trade, and there is a strong leaning towards Islamic structures, there is huge potential to grow Islamic trade within OIC alone. The main challenge is that Islamic banks do not have the sophisticated trade products needed to tap this opportunity. Clients, be they consumers or corporations, are seeking offerings that are aligned to their requirements. Sure, beliefs are a factor, but no one wants to compromise on quality. The market is untapped, mostly from a lack of Islamic banking products for trade. Banks have the liquidity, systems and technology to support trade, but not the structures.
BIN GHALAITA: Revenues from global trade finance are estimated at more than $30bn, and of this, only a very small percentage is conducted through Islamic financial instruments, so opportunity is definitely huge. The challenges to Islamic banks increasing their share lie mainly on three fronts: to strengthen product offerings, widening coverage to accommodate the clients’ needs, where clients still find a richer offering with conventional banks; to expand their global network, as the industry still lacks the large international champions that conventional banks have; and last but not least, to increase customer awareness of Islamic product offerings, requiring strong efforts on the part of banks. I am confident that all three of these fronts are advancing, to the betterment of Islamic banks. We are further helped along by strong growth in trade among developing countries, where there is stronger preference for Islamic offerings. As a percentage of global trade, their share has grown from about 13% to over 25% in the last decade.
AL QEMZI: This market is vastly underserved. Islamic banking came about through murabaha – sharia-compliant transactions where the seller reveals to the buyer what portion is his profit – as a short-term instrument to encourage trade, and in a sense we have lost our way. Islamic banks slowly evolved into commercial banks. As Islamic finance grew, we examined the products on the market, compared them to products offered by conventional banks and created new ones where we were deficient. In trying to cover every customer need we ended up with a universal Islamic banking model. The trade finance segment is worth over $1trn in the UAE alone, and it is a shame Islamic finance is not servicing a larger portion of that trade. We do not have specialist models or Islamic banks that deal exclusively in trade finance, and there is still a huge market left to be serviced.
I think we need to move towards specialised houses more capable of catering to small and medium-sized enterprises (SMEs), and more trade finance to fit the commercial cycles unique to this segment.
What obstacles do you see arising in standardising sharia compliance on a national scale?
BIN GHALAITA: As with any standardisation, the main challenge is aligning different views across the industry. Until now, the sector has operated under stand-alone sharia boards, allowing standards for each bank to vary with the views of its board. Unifying these views into a single system is always challenging. However, given how critical it is to the sector’s development, I am confident the UAE Central Bank will be able to push through plans for unified sharia regulation.
The benefits would be many. From the industry’s perspective, a unified board will support the provision of all products across all Islamic institutions within the country, thus helping enrich offerings across the industry and forcing Islamic banks to improve overall service propositions rather than reinventing product structures. From the customer’s perspective, it presents a relief from worrying about the degree of sharia compliance at different banks.
AL QEMZI: A national standardisation of our services and products is crucial to growth. If we want to compete as an international – and eventually global – industry, the inconsistencies must be eliminated. For example, we have found ourselves in situations where we enter a syndicated corporate loan with four other Islamic banks in Dubai, but then are able to gain approval from only three of the four banks’ sharia boards. Stories of this sort make companies uneasy when considering Islamic, compared to conventional, financing. The industry is still in a nascent stage, and we have functioned quite well without national standardisation for some time. But now is the time.
We need to put more pressure on sharia scholars for consistency. It is unsustainable to use contrasting standards between Saudi, Malaysian, and UAE models. For the sake of our business, we should have a standard and consistent model similar to that of traditional commercial banks. We have not seen resistance. We may lack a global or international body pushing for standardisation, but we believe it is inevitable. First there will be standardisation by country, as we have seen in Bahrain and Malaysia, then more cooperation between countries, and at last international boards will unify globally. Until this happens, we will not be taken seriously, and our ability to compete with traditional banks will be handicapped.
CHILWAN: I do not necessarily subscribe to the belief that Islamic banking regulation needs to be internationally standardised. Setting up a unified sharia supervisory board would eliminate competition, with no variation in product offerings.
The UAE has 52 banks, five of them established Islamic banks and nine others involved in Islamic banking. All others are conventional, and do not have a standardised board governing and directing product and business offerings because that would prohibit individual strategies being implemented. Difference of opinion on Islamic principles enhances competition and the range of products as it promotes innovative thinking. The myth that the lack of a unified sharia board is an impediment to Islamic banking’s success is a miscalculated theory. However, standardisation of overall rules and policies are still key towards the globalisation of Islamic finance. Any form of standardisation is impossible without the support of a regulator. Once a regulator has shown progress, established Islamic banks must form a task force to promote the industry. Islamic banks in the UAE are not unified, and each plays its cards close to its chest. A further impediment to unification on a national level is difference of opinion among the sharia boards of Islamic banks in the UAE. Because unification is bound to put downward pressure on profits, the only way it will move forward is if one regulator mandates a single sharia supervisory board with which all banks must comply.
What changes do you see in the options Islamic banks have to manage their liquidity?
AL QEMZI: After standardisation, liquidity management is the biggest challenge for Islamic finance. There is no well-developed money market such as conventional banks have, and this is a major issue. An Islamic bank is like any other in that it needs to gain a certain amount of its earnings from liquidity, playing the margins between savers and borrowers. Products such as sukuk (Islamic bonds) help meet shortterm liquidity requirements, but we still need to invest in designing more tools to create a real money market – especially for short-term liquidity.
The size of the market as it stands is not sufficient, and this impacts business heavily, both in the services it can offer and in the cost it bears in providing them. Perhaps this is merely because there are too few products available, but there is a positive trend toward change. After more than 35 years in operation, it is essential that we create an Islamic money market so that liquid assets can be treated as such.
CHILWAN: Because there are few avenues for investment that Islamic banks can use to deploy their liquidity, liquid assets tend to stay on local banks’ balance sheets. In the past four years, we have seen the UAE market take steps in the right direction by creating liquidity-management tools such as Islamic certificates of deposit and a repurchase, or repo, market. There is clear intent by regulators to bring more sophisticated tools to the UAE market, but it remains a very nascent one. There are many unique Islamic liquidity solutions used elsewhere, such as in Malaysia, that would be very beneficial to UAE, but currently the focus is converting conventional instruments to Islamic ones. Differences in interpretation of sharia will slow the adoption of these tools.
BIN GHALAITA: An Islamic money market is indeed another long-overdue requirement for boosting Islamic banks. In general, Islamic banks in the UAE have historically been more liquid than conventional ones, but with fewer placement options. The recent boost sukuk market has given Islamic banks another option for short-term liquidity placements, but many more are needed. This is a challenge for Islamic banks globally, not just in the UAE. Fortunately, the Central Bank of the UAE has already taken several steps to develop an Islamic money market, introducing several tools in the past few years. Thus, I am confident we will see further developments on this front. This will also help boost the liquidity of the banking market at large, as Islamic banks typically have more “asset heavy” portfolios that can be securitised in global market to attract further liquidity into the UAE.
What should bankers bear in mind as they provide sharia-compliant tools and financing to SMEs?
CHILWAN: Islamic banks need to reprioritise and focus their SME lending efforts on trade, manufacturing and retail rather than real estate, as these activities are the real engine of growth. Further, banks need to focus more on SMEs in the incubation stage rather than on established enterprises. Many lament a lack of products customised for SMEs, but we believe the proper products are available, as we find their needs largely in line with those of the corporate market. Most important is to create a standardised definition of SME. Lacking one, it is unclear whether banks truly have the risk appetite for SME lending or are merely paying lip service to them.
BIN GHALAITA: The global financial crisis has uncovered a number of myths. Among other revelations, banks have started to see that SMEs can be as resilient to economic shock as large corporations can, if not more so. Banks’ diversification into SME exposure, instead of concentrating largely on big corporations, has been seen as an important change to their balance sheets. Thus one sees many banks starting to build their SME portfolio, especially locally. The challenge for Islamic banks, though, is that most SME needs relate to simply financing their working capital, and products for this are less developed in Islamic banks than in conventional ones. Islamic banks have typically focused more on asset-based financing such as ijara (Islamic lease contracts) and murabaha. If they are to support and cater to SMEs, Islamic banks must make capital financing solutions a core focus.
AL QEMZI: It is time the industry shift its focus and steer more lending towards SMEs. Trade is becoming increasingly local, and SMEs are the seeds to grow this market. Products do exist for smaller entities, but there needs to be more of them and more focus on them. SMEs operate in a very different environment than big companies do – one that falls somewhere between corporate and personal financing. By nature, they have a higher rate of failure and thus require a more tailored approach. Like the credit card business, it has high risk with high reward, where up to 7% of loans could fail. With high enough earnings, though, it can still make business sense. The outlook for this type of risk differs, and it is a business of great potential if we can devise appropriate services to bolster it.
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