Islamic finance: safe haven or irrational exuberance?

Islamic finance: safe haven or irrational exuberance?

Global financial markets are in turmoil but in the strangely calm world of Islamic finance, no one looks like jumping out of a window any time soon.

As conventional credit markets seize up, forcing the world’s biggest banks to write off billions of dollars and panicking stock markets, Islamic lenders and underwriters continue to do brisk business.

New issues of Islamic bonds, or sukuk, have slowed down but growth remains close to vertical: in the third quarter, $37.3 billion in sukuk were issued, double the amount issued a year earlier, according to the Islamic Finance Information Service.

In the budding Islamic financial capitals of Dubai, Bahrain and Kuala Lumpur, bankers still have a spring in their step.

“It is a safe haven for investors,” Salman Younis, who heads the Asian operations for Kuwait Finance House, said when asked about the conspicuous calm in Islamic credit markets.

“We are investing in real assets, we are not investing in paper assets,” he told told Reuters in Malaysia after signing a deal to finance a luxury condominium project in the country.

Islamic law forbids payment of interest and requires transactions to involve a specific real asset, such as a property or a commodity. Sukuk-holders, unlike conventional bond-holders, are often technically owners of an asset, not lenders.

“When you securitise a trillion dollars worth of sub-prime mortgages, you don’t know which city, or which particular district, you are (invested) in,” Younis said.

“But here,” the ex-Citigroup executive added, referring to his condominium deal, “you can touch and feel the asset.”

Even so, there are doubts that the sukuk market can long remain an oasis from the turmoil in conventional credit.

IRRATIONAL EXUBERANCE?

One senior Islamic bank even wonders if the exuberance surrounding Islamic finance is becoming irrational.

“I think there’s a peculiar situation where there is too much liquidity in the market, arising from petro-dollars,” said Badlisyah Abdul Ghani, head of Islamic banking for Malaysia’s CIMB bank, one of the biggest deal-makers in sukuk.

“As far as the market is concerned, the impact of sub-prime is the same between Islamic and conventional. It’s just that the behaviour of market participants is somewhat irrational, given the fact there is this critical need to have Islamic assets.”

Badlisyah feels the storm in conventional markets will pass before it has time to shake the sukuk market, but he says sukuk have too many ties to regular credit markets to ever insulate them from a sustained global credit squeeze.

The major investors in sukuk are also the big buyers of conventional debt: in Malaysia, where there is more of a secondary market for Islamic paper, they include pension funds; in the Middle East, where secondary trading is scarce, the investors are banks, including the titans of finance.

Global banks such as Citigroup, HSBC, Barclays and Deutsche Bank are not only buying sukuk for institutional clients, they are also marketing sukuk issues.

“Logically there is a knock-on,” Badlisyah said.

“At the end of the day, credit is credit.”

CRISIS? WHAT CRISIS?

Already, some sukuk issues have been delayed or are fetching softer prices, Islamic banks say, but Kuwait Finance House points out that the credit squeeze is not entirely to blame.

The sagging U.S. dollar is also giving issuers of sukuk pause for thought. In the Gulf Arab states, companies issue sukuk in dollars as a hedge against their piles of dollar-based assets, but investors now want local currencies instead, Younis said.

But sukuk have three overwhelming advantages over conventional paper: religious belief, a tidal wave of oil money and a continuing shortage of high-quality sukuk.

There is an estimated $1.3 trillion looking for high-quality Islamic assets, Kuwait Finance House says. But only $41.9 billion in sukuk have been issued worldwide so far this year, according to the Islamic Finance Information Service.

The supply shortage is exacerbated by the fact that there is no liquid secondary market in the Middle East for this paper, said Baljeet Kaur Grewal, head of research in Kuwait Finance House’s Asian headquarters in Malaysia.

“It’s a captive market in the Middle East,” she said. “They are buy-and-hold people.”

Fitch Ratings, which assesses the risk of default for sukuk issues, agrees that the dynamics of the Islamic paper market shield it somewhat from the storm battering conventional markets but it says the sukuk market cannot insulate itself entirely.

Nor does Fitch view sukuk as inherently safer than bonds.

“It is a bit wishful to think that this is a safe haven of sorts and is totally insulated…,” said Ambreesh Srivastava, a Singapore-based senior director for Fitch.

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