Private banking is growing as a distinct discipline within Islamic finance. Both within the Islamic world, and among international banks, the need to provide Shariah-compliant offerings to high net worth individuals is going to become steadily more important.

Partly, this is a function of demographics: the rising wealth of the Muslim world. It is hard to put precise figures for the world’s 1.6 billion Muslim population, but Cap Gemini and Bank of America Merrill Lynch reported in their most recent World Wealth Report in June that the number of high net worth individuals in the Middle East stood at 400,000, representing a 10.4% increase during 2010. Between them they had combined wealth of US$1.7 trillion at the time of the survey, up 12.5% year on year.

“The Islamic world has experienced superior growth rates in terms of wealth generation, especially during the last two years,” says Stefan Leins, thematic research analyst at Credit Suisse. He notes that the largest part of the global Muslim community is in Asia, where wealth grew at an average of 5% a year from 2000 to 2009 before leaping 15% from 2010 to 2011. “Much of the Islamic world’s new wealth has been created by the emergence of a growing middle class in large parts of Asia and the Middle East. This leads us to the assumption that wealth generation in the Islamic world is not only superior but also sustainable.”

On top of that, Islamic banks themselves are becoming more sophisticated, and clearly see high net worth advice as a vital source of revenue, particularly as more and more mass market Muslims achieve greater wealth. In Malaysia, Islamic private banking has been a discrete field of finance for years, and it continues to grow. “Moving forward you will see a lot more momentum in Islamic private banking,” says Badlisyah Abdul Ghani, CEO of CIMB Islamic in Kuala Lumpur. And it’s not just because of demographics, but because of the sense that Islamic finance – tied as it is to real, tangible assets – is increasingly seen as resilient in an economic downturn. “Arising from the recent crisis, much of the wealth that used to be managed by conventional private bankers is now coming into the hands of Islamic private banks,” he says. “Islamic banks are now forced to come up with a framework that would be able to facilitate the needs of these high net worth individuals.” Because it is perceived as being more safe? “One of the reasons is that perception,” he says. “The other is centred on pure diversification of exposures, and who manages their funds. They want to be able to spread out a bit in terms of who is managing their wealth.”

CIMB has had a distinct Islamic private banking business for several years; at Maybank, executive vice president Choong Wai Hong says that “establishing an Islamic private bank brand is something we’re exploring right now.” For him, part of the prompt is the fact that Middle Eastern money is becoming increasingly prominent in Malaysia. “Some of these customers are more discerning in what they expect,” he says.

International banks, too, see private banking as an increasingly vital part of an Islamic offering. “It is an area which is getting to be very important,” says Wasim Saifi, global head of Islamic and consumer banking at Standard Chartered. “You’ve got customers who are quite sophisticated. Shariah compliance is an important need, but on top of that they need to balance it with the commercial aspects of that proposition. Unless and until you have a Shariah compliant range of products available, your appeal is not to the entire market.” He says it has become an especially important focus for Standard Chartered in the Middle East, particularly in Saudi Arabia, Qatar, Kuwait and parts of the UAE. “These are places where having a Shariah range of products is becoming a very important plus for a private bank.”

Leins at Credit Suisse says Islamic private banking has “absolutely” emerged as a new discipline. “Many global banks that are active in private banking, such as Credit Suisse, have started to structure a whole range of private banking services in a Shariah compliant way in order to meet Islamic clients’ demands.”

At Citibank, Ahmad Shahriman Mohd Shariff, Islamic banking head in Malaysia, adds: “A separate discipline is required if one considers all the additional obligations and considerations an Islamic investor would have with regards to his wealth.” These aren’t as straightforward as one would think: for example, Shariff points to zakat, a pillar of Islam you can roughly translate as philanthropy, which has quite specific rules for calculation that must be adhered to (see box). “While in the past, these needs were met by Islamic investors privately, there is an opportunity for Islamic financial institutions to offer commercial solutions that will help Islamic investors to meet these needs.”

Clearly, the available product suite to sell to Islamic HNW investors has improved considerably over the years, and continues to do so with every new sukuk. “The most popular instruments in Islamic investing would be the sukuks, especially in the MENA region and Malaysia,” says David Pinkerton, chief investment office of Falcon Private Bank, which is owned from the Middle East. “They have become fairly liquid, and provide investors with fixed income, which is very popular among Islamic HNWIs.” It is common for bankers to insist that Shariah compliance is not a constraint but an opportunity. “Restrictions imposed by the Shariah on investments that are available for Islamic investors should not be seen as a disadvantage,” says Shariff. “The financial crisis in 2008 has shown that there is wisdom in the restrictions imposed, and that Islamic investors who followed the restrictions saw their wealth protected during the crisis.” Shariff would like to see more product development in Shariah-compliant risk management tools, and broader wealth management solutions, but in terms of investment products, that is rarely raised as a problem these days.

But not everyone agrees with that assessment. John Sandwick, a Californian who spent much of his youth living in the Gulf before becoming a Swiss private banker tasked to bring in Arabian private clients, started his own advisory business, called Islamic Wealth & Asset Management, seven years ago in Geneva. He did so partly because his clients were asking for investments that were halal, yet in fact within the private bank many of the assets in their private banking accounts were actually haram, illegal under Shariah, because they were interest-bearing, which is prohibited.

To his mind, most of the process of asset management under Islam ought to be the same as conventional: you start with a client profile, evaluating risk appetite and investment objectives; then you create an investment strategy to fit, typically in an income, balanced or growth strategy; and then you go and buy the appropriate securities. Since it’s only the last of those processes that is any different in Islam, he set about building his approach to asset management the same way, and to do that, he decided he needed a comprehensive database of Shariah-compliant securities, or at least funds. “An asset manager has to examine all the possible securities in the investable universe,” he says. “If he doesn’t, then he is driving blind, and he is not doing his job.”

The first surprise he got was to learn that no such database existed, so with the help of some graduate students in the UK, he set about building one. The next surprise was that the resulting universe was small: 850 Islamic products. And when he filtered out funds that were too small, new, opaque, illiquid, or didn’t have a suitably robust fatwa to assert their Islamic compliance, that number shrank to 150. “It’s pathetic,” he says. “There are 66,000 suitable funds in the conventional universe.” Be that as it may, 150 has proven sufficient to build the sorts of growth, balanced and income portfolios he believes should be widely available for Islamic investors, and he says they have performed exceptionally well, not just in terms of returns but the various measures of the risk involved to get them. “While there are only really 10 fixed income funds to examine, and I would much prefer there to be 2,000, it so happens that 10 does the job. It’s an awful situation to have so few Islamic funds but we have reached the point where there are enough to achieve investment goals in a professional manner.”

Sandwick’s broader objection, though, is that if nobody else really has the database that he has, then how are they conducting asset management? “If you do not have full information on your investable universe, you cannot do asset management,” he says. “People tell me they do Islamic asset management. I say: no you don’t, you do random product sales. If you don’t have the entire universe to select from, I don’t know what you’re doing but it’s not asset management.”

Sandwick’s assertion rests on the assumption that other banks have not done the same level of research that he has, but nevertheless he has a point. There is a dearth of the sort of fund-of-fund or multimanager diversified investment products that are commonplace in the conventional mainstream. What one has instead, particularly from the international banks, is a slew of structured products underpinned, at some level, by derivatives. “Derivatives are the garbage of the professional asset management universe,” he says. “The Bill and Melinda Gates Foundation manages $36 billion. Go find me a single derivative position in there. Go to Calpers; there’s a modest amount, but only when it meets specific investment objectives. Professionals don’t buy this crap. Muslims are told it’s all they’ve got. It’s shameful.” Where, he asks, are the straightforward balanced portfolios? “If I go to [an international banker in the Middle East] and say: show me your conventional US dollar balanced portfolio, he’ll reach on his shelf and get something right away,” says Sandwick. “If I say: give me the same thing – back-tested, optimized, with all your global sorting and filtering – but with fatwa, he can’t do it.”

This touches on another point: private banking is often seen as a source of innovation in Islamic finance, in order to create equivalents to conventional world securities. It is impossible to spend more than an hour at an Islamic finance conference without hearing someone call for more and faster innovation, but a counter-argument runs that the real priority should be doing the simple things right.

On top of that, the differences in Shariah interpretation, particularly between Malaysia and the Gulf, make it difficult to think of a single investment universe that applies to the whole Islamic faith. “It’s a challenge everyone faces,” says Choong at Maybank. “When customers come from the Middle East, we have to be very sensitive about how the same principles of fatwa are interpreted there and here. It’s quite tricky.”

Beyond investment, Islamic private banking is undergoing the same transition as its conventional equivalent in Asia: a shift from pure investment advice to true wealth management. “The special needs of Islamic HNW investors have progressed from finding good Shariah compliant investment opportunities, to having a comprehensive Shariah-compliant wealth management solution,” says Shariff. That includes Shariah-compliant estate planning, takaful (insurance) and zakat (see box).

Pinkerton says that beyond selection of compliance securities, this largely mirrors the conventional world. “Shariah-compliant high net worth individuals have the same basic needs as the conventional investors in terms of capital preservation and income generation.”

But here, too, there are distinct differences. Choong at Maybank points to the concept of faraid, or wealth distribution; this governs the treatment of inheritance under Muslim law. “It is quite specifically governed by Islamic laws,” he says. “How you distribute, to whom – there is no conventional option that a customer can opt for. It is very clearly defined.” Maybank has built the capability within its trustee business to deal with this Islamically, and Choong thinks this will be “one of the anchors” of an Islamic private banking offering.

Whatever form it takes, private banking is going to continue to grow within Islamic finance, simply because every relevant factor is growing: Muslim world wealth; investor sophistication; acceptance of Islamic finance; and availability of investments. There is, quite simply, no reason for it to do anything but grow.

BOX: Islamic philanthropy

The Muslim principle of zakat requires believers to give a fixed proportion of their wealth to charity, although the proportion given – and what constitutes wealth – is widely debated. Additionally, Muslims are encouraged to make voluntary contributions, or sadaqat. Consequently philanthropy is an enormously important part of Islamic wealth management.

“The pattern of giving is not much different from the conventional world, but I think there is more giving among the Islamic high net worth than the conventional, because they see other benefits over and above what they get in this world,” says Badlisyah Abdul Ghani at CIMB Islamic. “Not necessarily the volume but the number of times that they do such giving is more, and they don’t announce it.”

Shariff at Citibank Malaysia agrees. “In general, from an Islamic perspective, philanthropy should be done discreetly with no publicity.” He says Islamic investors approach philanthropy first by calculating their zakat obligations, then adding voluntary donations. “In certain countries, Islamic investors have the option of fulfilling zakat obligations either privately or through a state appointed organization,” he says. “Regardless of the option chosen, an Islamic investor would require good advice on how to calculate the amount of zakat payable, and where possible to tie payment of zakat to tax planning as well.” This, he says, is an area where Islamic financial institutions need to do more to work out how they can provide appropriate solutions to investors.

The requirement for philanthropy has also found application in the fund management world. Last year Maybank’s Islamic banking arm created a fund through which parts of the returns go to a particular Shariah-approved charity; it represented an easy and compliant way to fulfill philanthropic duties.

In 2001, Malaysia set an ambitious target for Islamic finance. Back then, Islamic banking accounted for 6% of the overall Malaysian banking system; the target was for the figure to hit 20% by the end of the decade. But Malaysia didn’t make its target. It beat it.

Today, Islamic banking is 22% of the national market and continuing to grow steadily. Malaysia has fostered the most complete and sophisticated environment for Islamic finance worldwide, with a clear agreement between government, regulator and central bank about what needs to be done to encourage it. The legal and regulatory environment is supportive, there are entrenched Islamic industries from banking to the capital markets, asset management and takaful (insurance), and today the focus is on bringing international Islamic capital into the country through the Malaysia International Islamic Finance Centre (MIFC).

The importance of this may soon become especially clear. It is often said that Islamic finance, being linked to tangible assets, came through the global financial crisis relatively unscathed, since its banks could not have been involved in complex derivatives even if they had wanted to. It may well be that Islamic finance will have to prove its worth again as Europe drags the world into another financial malaise.

“Islamic finance is insulated from the first round effects” of a crisis, Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, tells Institutional Investor. “That is because it is closely linked to the real economy, has built-in checks and balances, profit sharing, and more responsible lending. But of course as the economies slow down, as financial markets get corrected, it will impact our financial institutions. That’s why it is so important to have capital buffers, risk management and sound governance practices; these are equally important for Islamic finance as conventional.”

Governor Zeti was at the heart of initiatives after the global financial crisis to examine how Islamic finance had fared, and to work out what would be needed to strengthen the system for any subsequent crash. One of the key areas was a need for inter-bank liquidity. As a consequence the International Islamic Liquidity Management Corporation was launched by the Islamic Financial Services Board in October 2010 as a vehicle to issue Shariah-compliant financial instruments so as to improve liquidity management for Islamic banks. Kuala Lumpur is the host to this institution.

At the time of writing, IILM has a chief executive and is more or less ready to start issuing securities, which are expected to come early next year. Surely nobody could have expected it would be called upon so quickly, but its success is likely to be vital if the Eurozone situation gets any worse and European banks pull back their lending further. “We saw during the crisis that liquidity became an important issue,” says Zeti. “With the internationalization of Islamic finance, cross-border flows require short-term instruments to effectively manage – not only in stressful conditions but in normal times.” Several issues are expected to be launched each year, typically around $2-3 billion apiece; shareholders in the institution are several of the Islamic world’s major central banks and the Islamic Development Bank and its investment arm.

Current travails notwithstanding, Malaysia’s focus for Islamic finance is international. The award of a so-called megabank Islamic licence is expected shortly, with the specific aim of bringing international Islamic expertise and capital into the country. And the capital markets – Malaysia already having the most vibrant and high-volume domestic sukuk market in the world – will be increasingly cross-border too. “What has been important for us is that we have become more multi-currency,” Zeti says. “We have had a Singapore dollar sukuk this year, then RMB, as well as the dollar sukuks being issued out. We want to develop Malaysia as a centre of origination of sukuks: a meeting place for those who have funds to raise and surplus funds to invest. This is where we are.”

INDONESIA

Indonesia dominated the Asian dollar capital markets this week, with a well-received $1 billion sovereign sukuk rapidly (some would say alarmingly so) followed by another $1 billion benchmark from state electricity company Perusahaan Listrik Negara (PLN).

The seven-year sukuk was priced on Tuesday morning Asia time and gave a clear demonstration of how positively Indonesia is now seen in world markets. It priced at 4% (strictly speaking this is a profit rate rather than a yield, since this is an Islamic security), the tight end of 4-4.125% guidance. It was widely agreed that the tight pricing reflected an assumption that Indonesia, rated Ba1/BB+/BB+, with a positive outlook in Fitch and S&P’s cases, will be upgraded one more notch to investment grade. It formed a sharp contrast with the 6.29% Italy paid for a Eu3 billion five-year bond on Monday – Italy is rated A2 by Moody’s.

“The good news is in the price with regards to the rating,” said one banker. “Indonesia certainly trades like an investment grade sovereign. People feel very positive about how the future looks down there. But an upgrade is not going to result in a dramatic tightening of yields again; ratings need to catch up with reality.”

Those close to the deal say it attracted a $6.5 billion order book. “4% was an excellent outcome for them considering their last deal was 8.8% in 2009,” said one. “Seven years is a respectable maturity profile. Everybody is pretty happy with that.” The choice of maturity reflects the fact that Middle East investors, who were key to the transaction, prefer shorter-dated bonds, ideally five years; since the issuer wanted funding of up to 10 years, seven was seen as a sensible compromise. Middle East investors accounted for 30% of the deal, and had been a clear target, with a roadshow that visited Riyadh, Doha, Dubai and Abu Dhabi. Indonesian investors took 12%, the rest of Asia 32%, the US8% and Europe 18%. Funds took 59% of the deal. Citi, HSBC and Standard Chartered were lead managers.

It is harder to demonstrate that the deal’s success was down to a growing conventional investor appetite for sukuk, though some believe that it was a contributory factor. “There was a strong bedrock of interest from Middle East and Asian sukuk-specific funds, but conventional players also recognised the quality of the issuer,” said one person close to the deal, who estimated that 40% of the book were conventional investors but stressed there was some guesswork in that number.

The PLN deal was a $1 billion 10-year offer which priced on Wednesday morning Asia time, led by Barclays Capital and Citi as joint bookrunners. It priced at a yield of 5.625%, the tight end of 5.625%-5.75% guidance (a coupon of 5.5% with notes reoffered at 99.054). Some in the market considered this cheap, particularly in light of the sovereign sukuk; but S&P rates it one notch below the sovereign at BB (unlike Moody’s and Fitch, who have it at Ba1 and BB+ respectively), suggesting a slightly weaker credit than the sovereign, in addition to which the PLN deal carried a longer tenor. It is the lowest coupon PLN has ever paid for a dollar bond and represents a 150 basis point spread over comparable-tenor conventional sovereign debt.

Despite its proximity to the sovereign deal – something another banker in the market described as “breathtaking arrogance in timing” – it attracted considerable interest, with $5.5 billion of orders from more than 200 accounts. Those close to the deal say it was not simply a method of mopping up excess demand from the sukuk, since the two were marketed in very different ways as reflected in PLN’s final distribution: European investors took 21% and US investors 35%, far higher than in the sukuk, while the Middle East was not a significant source of demand for PLN. Fund managers accounted for 64%, insurers and pension funds 19%, banks 7%, private banks 6%, and central banks and others 4%.

Those close to the deal say the timing was partly coincidence; a necessary revision to the documentation had only come through late on Monday New York time, and the bond was issued swiftly thereafter to take advantage of a brief window. It did, though, probably have an impact on the aftermarket performance of the sukuk, which started out trading up and dropped below par in the wake of the PLN issue (which traded up).

Structurally, the deal was interesting because it did not use a special purpose vehicle, as most Indonesian companies do and as PLN previously has. The SPV structure avoids a withholding tax charge, but PLN’s government ownership rendered that somewhat irrelevant. Ditching the SPV opened it up to a greater range of investors, according to people close to the deal.

IILM

The International Islamic Liquidity Management Corporation, a body designed to issue short term Shariah-compliant instruments to foster better liquidity management among Islamic banks, will issue its first bonds within “the first six months” of 2012, according to Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia.

Dr Zeti was interviewed on Tuesday in Kuala Lumpur, one day before a crucial IILM board meeting that was expected to move the body closer to its first issuance. She said the meeting should approve the parameters for issuance, including allocation of assets against which the issuance will take place, and the appointment of primary dealers who will make the market. “We are very close,” she said.

In the wake of the financial crisis, many Islamic finance leaders – Zeti prominent among them – conducted a study of the industry to establish what risks it faced and what to do about them. The lack of liquidity was one of the main findings and led to the formation of the IILM in late 2010. “We saw during this crisis that liquidity became an important issue,” she said. “With the internationalization of Islamic finance, cross-border flows require short term instruments to effectively manage, not only in stressful conditions but in normal times.”

Zeti said there will be a program of issues like to be around $2 billion to $3 billion apiece, with regular issues through the year. A first issue will be smaller, “to test the system”. Issues can come in a number of currencies but are initially expected to be in dollars; the first, pilot issue, is certainly expected to be in the US currency. “They will be high quality short-term liquid instruments and will be in demand by other funds managing portfolios – even conventional,” she said.

Issuance will be from IILM itself, which is a corporation established and backed by 12 central banks (Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE) and two multilaterals (the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector) as shareholders. It is understood that a formal rating will soon be announced for IILM, a vital precursor to issuance and something Zeti described as “a long process”.

The need for IILM is likely to become particularly acute if world capital markets lock up in the wake of problems in Europe. “Almost the entire world uses Treasury bills: they are highly traded and can be used to manage the liquidity of any portfolio or any financial business,” she said. “For Islamic finance, there is no sovereign that issues short term paper of that nature, and therefore IILM was established. It took us two years of work.”

Other founders agree the start line is near but that there is more to be done. “We are still crossing the Ts and dotting the Is,” said Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria. “There are still issues in terms of the rulings of the Shariah Council on what we can and can’t do and how it will be structured. We’re still going through the process of structuring IILM to get the kind of rating we would like to have. It will take a little time for us to be out there.”

NIGERIA

Nigeria is set to become a fixture in the Asian debt capital markets with plans for a Malaysia-domiciled benchmark sukuk and possibly a dim sum bond next year.

In an interview in Kuala Lumpur, Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, said the country had been receiving advice from HSBC and CIMB on a sukuk, although the banks had not been formally appointed onto a deal. “We would like to see if we can issue a sukuk next year,” he said, probably in the second half. “We think that anything from five to seven years should be good for an initial offering, with the amount $700 million to a billion. That gives the kind of liquidity you want, and it also fits the tenor for most of the Arab funds who are not interested in 10-year instruments” – a consideration which also affected the choice of tenor in this week’s Indonesian sukuk (see separate story).

“The European funds tend to go for longer tenors, the Arabs for shorter, but given where Europe is, it makes a lot of sense to structure something to the areas that have a lot of liquidity,” he said.

But although Middle East investors would be targeted, Sanusi said the sukuk would “most likely” be issued out of Malaysia. “The central bank of Nigeria has had a very strong relationship with Bank Negara since I became governor,” he said, partly because Nigeria had recovered from a domestic banking crisis by studying Asian responses to the financial crisis there and had decided Malaysia was the best role model. “The Malaysian Islamic finance market is obviously the most advanced at the moment in terms of product, size and innovation, and the natural place to be.”

As with many sovereign sukuks, the hope in Nigeria is that it would prompt corporate issuers to follow. “Capital markets generally work better if you have a sovereign benchmark, that’s my view.” He also said that sukuk markets appeared to show better pricing than conventional finance. “Italy is paying 7%, so if Indonesia can raise at 4.125%, that’s a reflection of the liquidity in the sukuk markets. There is increasing interest: once conventional fund managers accept sukuk it is almost a no-brainer, as a sukuk targets both conventional and Islamic investors so you’ll probably have tighter pricing.”

He said the likely projects that would underpin the sukuk would be infrastructure, and could include aviation assets.

Sanusi also said that Nigeria’s recent decision to put 5-10% of its reserves into RMB could pave the way to a dim sum bond. The shift in reserves, he said, “is a strategic decision and recognizes the fact that China has become a major trading partner for us. It recognizes the possibility of Chinese investments in infrastructure coming in to Nigeria, and opens up for me, from a central bank perspective, the possibility of coming to the RMB market for dim sum borrowing.”

He said there was a natural argument for RMB funding. “Think of it theoretically. If we agree to accept RMB in payment for oil sales to China, you immediately generate RMB cash flows. If you have long term contracts to supply crude oil to China, you could securitize those, and raise dim sum bonds; that pays for what infrastructure investments you require from China.

“You hedge the currency risk, you get finance, and come to a very liquid market where the yields are lower and the spreads tighter than you would get in Europe at this point in time.”

A wish to avoid risk-averse European investors as a source of funding appears to be driving these moves towards Asian markets. “It is extremely important for the country to look to Asia as one likely source of borrowing,” he added. “That’s why the sukuk market in Malaysia and dim sum market in Hong Kong are markets we believe Finance [the Ministry of Finance] should be looking at.”

BEA

The Bank of East Asia’s China subsidiary has issued RMB3 billion of financial bonds in China’s interbank bond market – the second tranche in a RMB5 billion program, following a RMB2 billion launch in March.

The interest rate was set at 4.81% for the two-year bonds, which provides a reflection of how market sentiment has changed through the year; the first tranche, with the same tenor, priced at 4.39%, albeit for a larger volume.

The joint lead managers on the deal were ICBC, CICC, UBS Securities and Bank of Communications, with CICC as bookrunner. They sold the bonds only to institutional investors.

On first glance, the dynamics supporting the Islamic fund management industry look very strong. In the GCC markets of the Middle East in particular, the region is galvanized by high oil prices so that at both an institutional and an individual level, wealth is growing. As that wealth requires a greater range of products to be invested in, and since these are all Muslim countries, shouldn’t that be the spur to a dramatic increase in Islamic asset management?

Well, yes and no. It’s true that retail investors in the Middle East and in Malaysia have firmly embraced Islamic funds. This is nowhere more true than in Saudi Arabia, where the mutual fund industry is overwhelmingly Islamic: about 80% of funds sold in the country are Shariah-compliant. The degree of penetration varies elsewhere from market to market – entrenched in Kuwait, popular but not dominant in Malaysia (where Islamic unit trusts are 10.6% of the market in volume terms) and Bahrain, limited in the United Arab Emirates – but it is certainly true to say that many individual investors have welcomed the opportunity to invest in a way consistent with their faith.

For institutions, though, it’s a different story. The Middle East is best known, in institutional terms, for its vast sovereign wealth funds: the Abu Dhabi Investment Authority, believed to be easily the biggest of them all; the Kuwait Investment Authority; the Qatar Investment Authority; the parts of the Saudi Arabian Monetary Agency that fulfill sovereign wealth duties; and several other smaller funds. But none of these invests in a Shariah-compliant way. They might well consider Shariah-compliant mandates if there was a demonstrable advantage in doing so in terms of returns or risk diversification. But just for the sake of religion? Not at all.

Even in the strictest Islamic country of them all, Saudi Arabia, one could not say that SAMA is Shariah compliant. It’s true that it tends to invest with elements of Islamic principles in its mandates, such as avoiding investments in alcohol and gaming. But one of the central tenets of Islamic finance – the biggest, really – is that the idea of interest is prohibited. Money cannot turn into more money without performing some purpose along the way, such as trade. Now, for a central bank, that’s clearly implausible: the vast majority of many central banks’ holdings, including Saudi’s, are US Treasuries or similar securities – which, very obviously, pay interest.

There are modest signs of growing institutional interest in Islamic asset management. Several Saudi fund managers say they do have some Shariah-compliant mandates from institutions in the country, although all say that at this stage Islamic finance is to a very large extent just a retail story. And in Malaysia, there have been steps towards greater Islamic investment among institutions, notably Khazanah, the state investment arm which holds stakes in many of Malaysia’s largest corporate enterprises; it conducts all of its fundraising in a Shariah-compliant way through the sukuk markets.

In between retail and institutional, the ground is muddier. High net worth individuals and family offices are a very important part of Gulf wealth, and it is very difficult to generalize about their own investment preferences since they are so individual. But this is perhaps an area within which Islamic asset managers can start to bridge the divide between the low average investment volumes of retail and the high volume but disinterested masses of institutions.

Global fund managers have, by and large, been happy to watch and wait before launching Islamic funds. In the Gulf, for example, a rule of thumb is that many managers will want to be pretty sure of getting $50 million of assets in the door – in some cases $100 million – before it seems a good idea to launch a new fund. Going Islamic requires an infrastructure: most obviously, you need Shariah advisors, who are far from cheap, to endorse your products as Shariah compliant.

And while it might seem straightforward to simply launch an Islamically compliant version of an existing fund, it’s not actually that simple. Let’s say you have a US equities fund, and you want to put a Shariah screen over it. That’s easily done. But given that you’ve now removed all the financial institutions, don’t you want to have a rethink about the rest of the portfolio too? Everything about it has changed – its overall risk profile, the weighting of various sectors – and a diligent portfolio manager is likely to want to start from scratch rather than just accept what the overlay has come up with. It’s clearly easier for passive funds, but as a general comment launching an Islamic range is not as straightforward as it might at first appear.

Also, the available assets to underpin Islamic funds could be more widespread. Equities are easy enough: a simple screening service can help to find which stocks are compliant and which not, and in Malaysia, some 88% of total listed securities are Shariah-compliant (63.83% by market cap). In sukuk, though, the supply is more limited: Malaysia, where there were 181 outstanding sukuk in December 2010 worth RM319 billion and representing 57% of the total bond market, is really the only place with any secondary market liquidity in sukuk, and even there it’s modest. Beyond that, real estate is inherently suited to Islamic finance, but only if the tenants and the property’s financing are compliant.

Probably more international managers would have launched Islamic ranges had the financial crisis not, belatedly, hit the Gulf so hard. Gulf states were about a year behind the rest of the world in entering the financial crisis, and are correspondingly slow to emerge from it again, a process complicated by social unrest in the region. Many stock markets, notably Saudis, remain considerably below their pre-crisis highs, which in turn has meant that the willingness of individual capital to seek new investments has diminished too. If international fund managers didn’t think it made sense to launch Shariah ranges of funds in 2007, it certainly doesn’t make any greater sense now.

That said, there is a counterpoint to that argument. Islamic finance itself escaped the financial crisis very well, even if the economies in which it is prevalent did not. Islamic finance insists on tangible assets performing a real function; that counted out many of the derivative products that brought western institutions unstuck. There is, perhaps, a greater appreciation among mainstream investors, for whom religion is not a consideration, that an Islamic fund constitutes a useful diversifier in risk terms.

One exception to the reticence of foreign houses to go Islamic is Saudi Arabia, where the picture looks slightly different. Many of the biggest houses in Saudi have long-standing foreign involvement – HSBC in Saudi British Bank (now SABB), for example, or more recently Goldman Sachs in NCB Capital, which is the biggest issuer of Islamic mutual funds in the world. All of these institutions have widespread Islamic fund ranges, but they are basically domestic.

And another exception may prove the way forward. When Malaysia launched the Malaysia International Islamic Financial Centre (MIFC), it sought to attract foreign fund managers to set up Islamic ventures in Malaysia, aiming to make them a hub for global Islamic capital. Several, among them Nomura, Aberdeen, BNP Paribas, Principal (through a joint venture with Malaysia’s CIMB), Franklin Templeton, Prudential and India’s Reliance have gone ahead and launched such ventures, attracted in part by seed capital from Malaysia’s key institutional investor, the Employee Provident Fund. It’s not yet clear whether any of these are actually sourcing new money into Malaysia, which was MIFC’s intended goal; but it does demonstrate that in order to get internationals to take the Islamic route, they first need to see some money committed.

Best bank in the Asia region: CIMB Islamic

With activity in the Gulf having been so subdued since the Dubai near-default in 2009 – and, more recently, upheaval in the Middle East – the bank that leads the way in Asia has its strongest ever claim to be leading the way worldwide too. Step forward CIMB Islamic, whose market share as an underwriter of global Islamic sukuk, based on Dealogic’s numbers, hit a remarkable 24.2% in the 2010 calendar year.

Sukuk are clearly not the only way one should judge an Islamic bank, but they provide the most international comparable criterion for influence in the global Islamic markets. And apart from being pm the most deals, and dominating global volume, it was on the deals that mattered. It was, for example, the only regional lead manager (the others were Barclays Capital and HSBC Amanah) on the pivotal US$1.25 billion five-year sovereign sukuk from Malaysia in May, which was the largest ever dollar sovereign to issue Islamically, and came in the middle of the sovereign debt crisis in Europe, hitting a $6 billion order book with more than a quarter of demand coming from the Middle East.

CIMB Islamic is full service, from investment banking to consumer banking and asset management, discussed in more detail in the Malaysia award. But the asset management arm in particular cements the sense of an institution that is regional more than local. CIMB’s Islamic asset management offering runs alongside the CIMB-Principal Asset Management business, jointly owned by CIMB and the vast 130-year-old US house. And almost everything it announces these days has a regional bent: the absorption of Thailand’s BT Asset Management into the CIMB-Principal business in August, allowing CIMB to sell a full range of mutual funds into Thailand, including Islamic; the launch of the CIMB Islamic Global Commodities Equity Fund last year, which gave exposure to Shariah-compliant global equities benefiting from commodity demand. It is one of the world’s leading Islamic asset managers.

While many of its most notable efforts have been domestic, some of them have a global impact. CIMB Islamic CEO Badlisyah Abdul Ghani was instrumental in the development of the Bursa Suq Al-Sila’, the world’s first Shariah-compliant commodity trading platform, which is attempting to streamline commodity trading – and, through it, bank liquidity – across the Islamic world. As a lender, some of its most significant deals have been for multinationals, notably a 12-year $100 million loan, structured around the bai’ al-inah form, for Hewlett Packard in October. And then there are the bricks-and-mortar investments CIMB has built in the Islamic world, from its Bank Niaga stake in Indonesia to its ventures in Bahrain and Brunei. Malaysia wants to be a global hub for Islamic capital, and CIMB more than any other Malaysian bank is its flag-bearer.

Best bank in Malaysia: CIMB Islamic

CIMB Islamic continues to impress in domestic Islamic banking in Malaysia. There are banks that can compete on branches, or assets, or number of mutual funds, or research, or advisory, but it would rarely be the same bank twice. What stands apart with CIMB Islamic is that it is either the leader or a close second in every area from investment banking to consumer and asset management.

We don’t yet have the 2010 full-year numbers, but as of September 30 CIMB Islamic had RM34.8 billion in total assets, a 27.4% increase in just nine months, and entirely in keeping with the stellar growth of a business that had just RM0.5 billion as recently in 2005. Deposits (R0.4 billion in 2005, RM21.25 billion in September) tell a similar story, but actually one can look at any metric in the business – total gross financing, home financing, hire purchase – and see the same picture. And that’s just the consumer side.

In investment banking, CIMB clearly stands supreme in sukuk – with its role on the US$1.25 billion sukuk for the Malaysian sovereign, discussed above, the clear standout – but is also powerful on the equity side, with Shariah-compliant deals including Petronas Chemical Group and JCY International during 2010. It continues to win the important domestic sukuk deals too: a bookrunner role on a RM1.1 billion sukuk for Pembinaan BLT, a state-backed issuer, in January is illustrative.

Whether in esoteric capital markets or mum-and-dad personal finance, CIMB continues to innovative. The ijarah concept is gaining in popularity in Malaysia – previously it was mainly a Gulf staple – and in 2010 CIMB applied it to home financing for the first time in Malaysia, through its Ijarah Property Financing-I product. Its RC-I CM product is a Shariah-compliant revolving credit facility based on commodity murabaha. And then there’s the excellence in Islamic asset management, discussed in more detail in the regional award, as is the bank’s support for the Bursa Suq Al-Sila’ commodity trading platform. In credit cards, financing, wealth management, transaction banking and treasury there is a full-service range of products available and most of them have included some market firsts.

For all that, investment banking is still seen as CIMB Islamic’s strongest suit, and in that respect its immediate prospects are somewhat dependent on both the debt and equity markets, and their appetite for new issuance. But Badlisyah Abdul Ghani runs a business that has consistently stayed ahead through innovation and steady growth, and has seen off tougher markets than this one.

Best bank in the Middle East; Best bank in Saudi Arabia: Al Rajhi Bank

The world’s biggest Islamic bank, Al Rajhi continues to be considered the leader not only in Saudi Arabia but the Middle East region. It is, by Islamic banking standards, vast: at the end of 2010 it had total assets of SR184 billion, upon which it generated profits of SR5.1 billion for the first three quarters of its 2010-11 financial year. Its three million customers give it half of the national consumer finance market in Saudi Arabia.

Al Rajhi was, until very recently, just a Saudi Arabian story, but that changed in 2006 when it moved into Malaysia. It did so in a big way, and has 20 branches already, with plans to open many more. Unlike Kuwait Finance House – its obvious rival for the title of best bank in the Middle East – Al Rajhi opted to go into Malaysia with a full service offering, with all of its core banking products including retail. It is a grand ambition that can only be attempted with deep pockets.

With critical mass attained in Malaysia, Al Rajhi has now turned its attention to its own region, with approval gained in 2009 to open branches in Kuwait and Jordan. Kuwait has been the first to get underway, and again Al Rajhi says it has gone in to “serve all the needs of its retail and corporate clientele,” suggesting a full service offering in due course. In 2010 Al Rajhi announced plans to open five branches in Jordan within a year.

Still, there’s no question Al Rajhi is chiefly a Saudi story; the reason it qualifies for a regional award is in large part because Saudi matters more than almost all other Middle Eastern markets put together. Within that market, Al Rajhi excels on every metric: assets, profitability, headcount, customer base, branches, points of sale and lending.

More than sheer scale, it continues to launch new products and be innovative. Cash management and trade finance services, both undergoing electronic revamps, had excellent years in 2010. And the bank led a new Shariah-compliant bond, sukuk al-amanah Li al-Istithmar, in Malaysia. This is worth looking at in some detail: Al Rajhi was a lead manager on this RM5 billion debt programme by Cagamas, the Malaysian national mortgage company, starting with a RM1 billion print. It was structured in such a way as to be tradable in the Middle East, which generally takes a more conservative stance towards sukuk than do the Malaysian markets. Correspondingly, 33% of the deal went to the Middle East, much higher than usual. This raises big possibilities for further cross-border, cross-tradable deals.

Al Rajhi is, too, one of the strongest players in asset management in Saudi Arabia, although the stand-out in that area is NCB Capital and its Al-Ahli range.

Best bank in Qatar: Qatar Islamic Bank

QIB is the clear leader in Islamic banking in Qatar: impeccably connected to the state and top institutions, and with a critical mass that is going to be tough for anyone to compete with domestically.

Islamic banking is relatively powerful in Qatar: 31% of the total market, accounting for QR149 billion in total assets as of December 2010. Within that, QIB accounts for 35% of the Islamic pool, and 11% of the total banking assets of Qatar overall (and 30% of financing).

The bank has built its name on project and real estate financing, both in the public and private sector. It has funded many of the significant infrastructure and real estate projects in Qatar in recent years, including a record QR4 billion syndicated Islamic facility for the Qatari Diar development group; financing for Qatar Airways; a 25-year US$250 million facility to build a power and desalination plant, and US$150 million on a similar financing for the construction of the RAF A1 desalination project; financing for Qanat Quartier, within the landmark Pearl development; and The Gate construction project, a mixed use real estate project in Doha’s West Bay.

But in recent years it has grown considerably in consumer business too, having moved from one branch in 1983 and eight in 2005 to 28 today and 35 by 2012.  A recent example of innovation in this area was its Hemaya investment product, a Shariah compliant investment vehicle that has proven enormously successful in Qatar.

Like several other of the bigger Gulf institutions, QIB has sought to expand beyond its home boundaries in recent years. It is the key shareholder in Asian Finance Bank, one of the three Gulf institutions that went into Malaysia with full-service licences in the middle of the last decade (the others are KFH and Al Rajhi); it is also a key shareholder in Arab Finance House, in Lebanon; and has interests in Indonesia, Yemen, Syria and the UK, as well as plans in France, Turkey and Kazakhstan. It has also signed a memorandum of understanding with Woori in Korea and BPCE in France.

QIB has the best possible local backers, since the QIA – the country’s sovereign wealth fund – is now the bank’s largest shareholder. This will help strategically and in expansion. It also has muscle: authorized capital of QR2.1 billion at the end of 2010; QR51.8 billion of assets (32% year on year growth); customer deposits and absolute investment deposits of QR30.3 billion (up 49%); and a financing portfolio of QR29.3 billion, up 30%. Return on average equity was 17.9% in 2010, and capital adequacy stands at 17.4%.

This strength helped QIB launch its debut international sukuk in 2010, a US$750 million deal that attracted some US$6 billion of demand.

Best bank in United Arab Emirates: Dubai Islamic Bank

You wouldn’t call Dubai Islamic Bank a business that is shooting the lights out, but it’s still the obvious leader in UAE Islamic banking. Where other Islamic banks around the world boast double digit growth rates, often more than 20%, DIB’s deposits are steady and assets (at just under AED90 billion) growing around the 7% mark annually. But then again, this is the first true fully-fledged Islamic bank, formed back in 1975, so perhaps it’s unreasonable to expect lung-busting growth every year.

It tells you something that, after the AED806 million profit number, the first figure DIB highlights in its 2010 results announcement is provisions, bulked up by AED864 million over the year. That’s a reflection of a crushingly difficult business environment in Dubai, though most in business there feel is a feeling the worst is over. Still, in that environment DIB logged a net operating income (before those provisions) of just under AED 1.9 billion, showing that the well-established core businesses continue to do what they’re meant to.

The simple things worked for DIB in 2010: a focus on balance sheet strength and growth in the retail franchise. DIB upped its presence to 68 branches nationwide in 2010, with six new ones during the year, serving 1.2 million customers in a country whose rather fluid population is usually around the four million mark. Retail accounted for 49% of group revenues in 2010. Perhaps the most salient figure on the whole DIB balance sheet at the moment is the capital adequacy ratio of 17.8% under Basel II, a key differentiator in these uncertain times. Both Moody’s and Fitch upgraded their outlooks on the bank in 2010 (it publicly parted ways with S&P) and at the time of writing it was believed to be the only major bank in Dubai with a stable outlook from both.

Like many of the highlighted Middle East banks in this report, DIB has impeccable connections: its chairman is Mohammed Ibrahim Al Shaibani, whose day job is director-general of His Highness The Ruler’s Court of Dubai. And it’s also in a position to take advantage of lower asset valuations and grow where prudent, which it did in 2010 by increasing its stake in Tamweel, the Islamic home finance provider, to 58%, becoming the majority shareholder. And even in a conservative year, there was still scope for innovation: DIB was behind Emirates REIT, Dubai’s first real estate investment trust, and launched a new personal financing product, Al Islami Salam Finance, and a host of takaful products. Finally, its Dar Al Sharia consultancy and advisory subsidiary has gone from strength to strength, under the guidance of UAE uber-scholar Hussain Hamed Hassan.

Best bank in Kuwait: Kuwait Finance House

By far the biggest Islamic institution in Kuwait, KFH is also one of the Middle East’s few true international players. The regional award is always a choice between KFH and Al Rajhi.

KFH has grown steadily over the last decade, outpacing its native Kuwait. Its asset base, which stood at KD2.4 billion in 2001, was KD12.5 billion by the end of 2010, making for an annual average growth rate of 18.1%. Deposits are up fourfold, to KD7.6 billion, over the same period, and shareholders’ equity six times over to KD1.29 billion, an 18.3% annual growth rate. Net profits have been less dramatic in their growth rate, but have nevertheless doubled over the last decade and stood at KD106 million in 2010.

Bader Abdul Muhsen Al-Mukhaizeem, the chairman and MD, described 2010 as a year of “consolidation and cohesion” for KFH, as it was for many in the Gulf. It shifted investment – both in terms of its own portfolio and its offerings to customers – towards fixed income, low risk, high-liquidity opportunities; it continues to build its consumer business, launching a new family card, the Al-Ousra, in 2010; and it is a long-standing leader in real estate and aviation finance. It is considered to have one of the best electronic systems in the region, manifesting itself both at the treasury level and the individual, with various new smart mobile offerings launched during the year; it’s also evident in revamped credit procedures, anchored around a new documentary credit system called Trade Wind.

Just as Al Rajhi has opened in Kuwait in 2010, so its regional rival is doing the same in reverse. Saudi Kuwait Finance House is up and running and has received a licence to provide a SR500 million real estate investment fund. KFH has long-standing strength in Turkey, which it continues to build upon, launching a new gold investment fund through the Istanbul stock exchange during 2010. It also has branches in Germany and Dubai, as well as its KFH Malaysia and Bahrain businesses, which have eight branches apiece.

KFH is the second-largest Islamic bank worldwide by assets, and continues to impress in the region for its financial strength. Fitch gives it an A+ long-term rating, S&P A-, and Moody’s Aa3. Capital adequacy ratios (14.22% total, and 14.15% tier one, as of December 2010) are down slightly from 2009 but still well above the regulatory minimum of 12%.

BRUNEI: Bank Islam Brunei Darussalam

Competition is not especially fierce in Brunei, the less so since two of the main Islamic banks in the country, Islamic Bank of Brunei and Islamic Development Bank of Brunei, merged to form Bank Islam Brunei Darussalam. BIBD wins the title: in a small country, 14 branches and 600 staff is plenty enough to be dominant. Add its two subsidiaries – Takaful BIBD, which offers Islamic insurance, and BIBD Al-Tamwil, which offers hire purchase financing for vehicles and consumer products – and the group has more or less cornered the market.

For a modest domestic customer base, BIBD is pretty much full service. Its BIBD Securities arm handles brokerage to help its nationals invest in Shariah-compliant equities in Kuala Lumpur and Singapore; its investment banking division has been building an asset and fund management team steadily since the merger; and it offers corporate advisory, wealth management, investment and retail services.

There are more dynamic institutions in the Islamic world than BIBD: the most recent financial statements on its web site date from 2008 and its news section is a host of releases on blood donation campaigns and Toy Story 3 promotions. But still, BIBD is in an interesting place. Brunei has long since wished to diversify away from oil, and set up its Brunei International Financial Centre in 2000, where growth has been modest but the penetration of Islamic banking has been around 40% of total assets – much higher than most other nations. Since the announcement of a banking and insurance order in 2006, and a takaful order in 2008, the legislative environment is now in place, and there is a Shariah financial supervisory board now established at a state level. If Brunei does succeed in making itself a hub for Islamic capital, then nobody is better placed for the opportunities than BIBD.

The bank is also growing steadily. In January it reported a 14.8% rise in profits for the previous financial year to B$101.99 million (though it tells you something that the figures from that January AGM were from 2009). It has B$4.42 billion in total assets, and it has been appointed as a joint lead on some significant sukuk issues by issuers including Islamic Development Bank and General Electric Capital Corporation.

Pakistan: Meezan Bank

Meezan Bank, the first and largest Islamic bank in Pakistan, consolidated its hold on this award over the last 12 months. Firstly, it makes a compelling case based on scale: in January it announced its 222^nd branch across 63 cities in Pakistan. Irfan Siddiqui, president and CEO, has always talked of providing quality Shariah-compliant banking “to every citizen of Pakistan at their doorstep”, and that vision moves closer by the day; some achievement, since when he started saying it eight years ago, it was the smallest bank in the country. It also has the best (local) rating among Islamic banks in the country, at AA.

Secondly, its results are consistently strong. In February it announced its full-year results for 2010, with 61% growth in net profit for the year to Rs1.65 billion. Earnings per share were comfortably up, deposits grew 31% to Rs131 billion, and investments increased 139% to Rs 55 billion. Shareholders received 15% bonus shares in an effort to boost paid-up capital to Rs8 billion (the State Bank of Pakistan had earlier declared a Rs7 billion minimum, a requirement Meezan has now met a full year earlier than scheduled).

Other developments during the year included setting up a new car financing partnership with Indus Motor Company, and the launch of a new Mudarabah-based business account called Meezan Business Plus. It is also an increasingly successful asset manager.

There is huge opportunity in being the biggest Islamic bank in Pakistan. The country has one of the biggest domestic Muslim populations in the world, interest in Islam is clearly increasing – with more and more people wanting to invest their money in keeping with their faith – and individual wealth is climbing too. As more and more people shift from conventional to Islamic banking products, Meezan is ideally placed to benefit.

Indonesia: Bank Syariah Mandiri

The market for Islamic finance in Indonesia, while little developed, is becoming extremely competitive, with five new commercial Islamic banks licensed over the last 18 months in addition to the entrenched players. Of those who have been here longer, two compete in terms of assets, brand and overall standing: the Shariah versions of Bank Mandiri and Bank Muamalat.

A case can be made for both, but we have opted for Mandiri, which is starting to bring the strength of the conventional parent into its Islamic operations too. It is the national leader in assets – in the third quarter of 2010, it had Rp28.05 trillion in assets, up from Rp22.04 trillion at the end of 2009. Profits are still modest, at Rp291 billion in 2009 (the most recent full-year figure yet disclosed), but that’s still a fourfold increase since 2006 and the trajectory is encouraging. It had already beaten that figure in the first nine months of 2010, earning Rp320 billion.

Mandiri has had time on its side: it has had a designated Shariah team ever since the merger that created the overall Bank Mandiri back in 1999, and Bank Syariah Mandiri was formed the same year. It claims some 513 offices operating in 33 Indonesian provinces – one would imagine this involves some overlap with the broader network, but it’s not simply a statement of the overall Mandiri branch count, which is over 900. As a free-standing Islamic entity it has, for example, 220 ATMs in its own right, and claims a staff headcount of some 7,000 in September 2010, although again it seems likely there must be some overlap with the parent in that number.

BSM was upgraded by Fitch in early January to AA(idn); Fitch also upgraded its subordinated Islamic bond from 2007. These upgrades were chiefly predicated on the support from Bank Madiri itself, which put in Rp200 billion over 2008 and 2009 and is believed to be adding an additional Rp400 billion this year in order to bolster the Shariah bank’s capital adequacy ratio to 12%.

Like Islamic finance more broadly in Indonesia, BSM hasn’t done a whole lot so far but shows potential. Fitch, in its upgrade, noted robust financing growth, higher financing yields, a satisfactory deposit mix, and a falling (but still high) non-performing financing ratio (4.2%). It also has a healthy 117.5% provision cover. In the year ahead the bank is expected to expand its micro and SME portfolio in order to lower the concentration risk it faces through corporate financing.

Bahrain: Al Baraka Banking Group

At a time when one of Bahrain’s biggest and oldest Islamic banks, Bahrain Islamic, was announcing a BD39.7 million (US$105 million) loss for 2010, its rival Al Baraka was announcing a $193 million net profit, up 15% year on year. While other banks in the increasingly troubled kingdom have shrunk, Al Baraka’s total assets went up 21% to $16 billion. While others have stopped lending and investment, finance and investments at Al Baraka rose 21% to $11.4 billion.

Customers are getting the message too. Deposits and investment accounts were up 23% to $13.6 billion at the end of 2010, a clear sign of confidence.

Al Baraka chairman Shaikh Saleh Abdullah Kamel attributes the relative strength of Al Baraka to “a model that reflects the true values of Islamic banking and far-sighted business strategies,” which may or may not be a suggestion that not everyone has stuck to those true values and is now suffering accordingly. But it certainly hasn’t come at the cost of expansion: Al Baraka is arguably Bahrain’s most outwardly ambitious Islamic group, and now has 370 branches across 13 countries. In 2010 it opened a new commercial bank in Syria, and launched a new head office for its Turkish business. In October, it completed a merger with Emirates Global Islamic Bank Pakistan and so was able to turn its existing Pakistan branches into a local commercial bank, creating an entity with US$710 million of assets and 89 branches across the country. Next up: Libya – although it’s possible that might now be on hold for a while. Nevertheless, it expects the total number of branches worldwide to hit 500 within the next three years.

Back home, it remains a powerful and comprehensive bank with a full range of operations on the retail and commercial side. It has revamped HR, technical and operational infrastructure, and is working on joint financing of new projects with the Islamic Development Bank.

At the time of writing, with the Saudi army crossing the causeway to Manama, it was not clear just how events were going to pan out in Bahrain. “Not now,” said one person in Bahrain when asked for their opinion on the best Islamic bank. “There are gunshots in the back garden.” Bahrain has built itself on being a hub of stability and reason, and a loss of that status would have an immense impact on businesses there. But, set up in Bahrain in 1984, Al Baraka continues to look one of the strongest names in the country and the region.

South Korea’s National Assembly has blocked a proposed new law that would have smoothed the way for a sovereign sukuk issue. Local reports suggest that lawmakers objected to the bill – a piece of tax equalisation common in any countries seeking to streamline sukuk issues – on religious grounds.

Under Korean tax laws, companies have to pay between 1.5 and 3.5 percentage points more in tax for an Islamic issue than a mainstream one, an imbalance that the government has been pledging to correct since 2009. The new sukuk law would have provided new tax breaks to create a level playing field with mainstream issuance.

While it is not uncommon for tax laws to take time to clear parliament, Islamic practitioners may be concerned to find that religious objection appeared to be the main reason for blocking the new legislation. In particular, Lee Hye-hoon, who is a congresswoman within the Grand National Party and a committed Christian, has been quoted in local media saying: “It is possible that 2.5% of the proceeds from the bond issuance are given to Islamic missionaries,” and “acknowledging the religious restrictions on charging interest is against the Korean constitution that stands for capitalism.”

The government had hoped that the new law would help it to diversify sources of income and attract capital from the Middle East. While the sovereign itself had been expected to issue a sukuk, many other South Korean companies had also expressed interest, including oil refiners, airlines and construction companies. Despite objection, they had been confident about getting the tax change through: as recently as December, the ruling Grand National Party had said it expected the bill to pass within a week. It was recommended by the legislature’s taxation sub-committee, but then blocked at the overall level. Minister of Strategy and Finance Yoon Jeung-hyun is among those who had hoped the bill would go through: he has spoken of a need to “diversify the sources of foreign borrowing. When economic cooperation with the Middle East is important, there is no reason to discriminate against Islamic bonds.”

The news was greeted with some alarm in the Middle East, where Arab News devoted a 1,300-word editorial to it, calling it “a wake-up call for the global Islamic finance industry” and bemoaning “Islamophobic lobbying from powerful Christian evangelical groups”.

It is not clear if Korea will attempt to pass the bill once again, since there is little that can be done in terms of technical modification that would get it past the religious objections that have stymied it so far. In its absence, it is highly unlikely Korean issuers will bother to launch sukuk issues.

The first chief executive of the International Islamic Liquidity Management Corporation, the new post-financial crisis body designed to ensure short-term liquidity in Islamic finance, has been appointed. Mahmoud AbuShamma, previously head of HSBC Amanah Coverage in Dubai, will take the top role.

The appointment marks a crucial step in the development of a significant new multilateral. Legally founded on October 10, it has 14 founding shareholders: 12 central banks or monetary authorities, including Indonesia, Malaysia, the UAE, Saudi Arabia, Kuwait, Iran and Turkey; and two multilaterals, the Jeddah-based Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector.

It will issue short-term Shariah-compliant financial instruments in order to help with efficient liquidity management for Islamic banks, particularly around cross-border transactions. It came about as part of a collective effort by the Islamic financial industry globally to take a close look at the financial crisis and work out what had been learned from it. It will issue in a range of major reserve currencies, with the distribution of the Islamic paper through agencies licensed by the shareholders – that is, banks approved by the central banks and monetary authorities.

Mahmoud’s job at HSBC was to take charge of the bank’s key Islamic relationships, which varied from governments to high net worth individuals as well as banks and corporations. Appointing a coverage man to such a position is an interesting move, and perhaps reflects the delicate nature of streamlining the approaches of 12 countries and two powerful multilaterals. He will take a three-year term beginning February 1 2011.

Like so many other pieces of global Islamic infrastructure, IILM will have a head office in Kuala Lumpur, perhaps reflecting the pivotal role that Malaysia’s central bank governor, Dr Zeti Akhtar Aziz, played in setting in up (see profiles in this edition). Indeed, Zeti will be the first chairperson of the governing board, with Yves Mersch, governor of the Central Bank of Luxembourg, as her deputy. Malaysia is trying to push through legislation that will give IILM special status, privileges and immunities.

The board has also announced the scholars who will sit on the IILM’s Shariah committee, all of them on three-year terms. They include some very familiar names who serve widely on international Shariah boards, most notably Malaysia’s Mohd Daud Bakar and Saudi Arabia’s Mohamed Ali Elgari (but not, notably, Bahrain’s Nizam Yaquby), alongside Ahmed Ali Abdalla Hamad, Cecep Maskanul Hakim, Umar Bashir Aliyu and Waleed Bin Hady Al Mullah.

It’s hard to think of any woman, or any person at all, who has had a greater impact on the development of the industry than Dr Zeti. Governor of the central bank since 2000, and a staffer since 1985, she has consistently piloted Malaysia towards a pivotal role in international Islamic finance, first by helping to nurture a strong domestic industry, and then by developing the infrastructure to make the country a global hub.

Throughout, the sense of common ground shared between her, the Securities Commission (also headed by a woman, Zarinah Anwar) and the government has been vital, but Zeti and Bank Negara have consistently been seen as the spearhead of Islamic finance development in Malaysia. The Malaysia International Islamic Finance Centre, which seeks to bring international Islamic capital into Malaysia, is chiefly a Bank Negara (and Zeti) initiative; the redevelopment of the domestic Islamic banking industry into fully fledged independent banks rather than subsidiaries or Islamic windows has come under her watch, building a sector strong enough to survive the global financial crisis largely unscathed; and the growth of the world’s largest sukuk market, with the only secondary market that trades in any meaningful way, must in part be attributed to her. She has been instrumental in a host of educational institutions that have sprung up in Kuala Lumpur, including efforts to increase the pool of Shariah scholars, a key bottleneck.

Today Islamic finance is 21% of the Malaysian banking sector – beating a national target set for the end of 2010 some years back – while more than half of bond issuance in Malaysia is Islamic. The sector has thrived in an environment that has emphasised enablement, stability and learning, and she has been a large part of all three attributes.

A private woman, surprisingly understated in speech, she will not be drawn on her own career or the role of women in Islamic finance, but instead prefers to talk about her industry, how it has arrived where it is and where it is going. “We drew a lot of lessons from the Asian financial crisis,” she says. “And following that we moved to strengthen our financial system to give it the resilience it has now. As a result we can focus on long-term issues like developing our sukuk market and building the financial infrastructure for our system, because we don’t have to spend our time fire-fighting on failed financial institutions.”

Today her favourite subject is the International Islamic Liquidity Management Corporation, an international initiative spawned by the financial crisis in order to improve liquidity in Islamic banking. Zeti was part of the team pulled together to develop the system, which draws on the lessons she learned domestically in Malaysia. “We already have a well-functioning Islamic money market to facilitate liquidity management, but it is only in the ringgit market,” she says. “In a crisis, liquidity gets evaporated,” she says, and IILM will therefore make a contribution to global financial stability.

Zeti’s watchwords are stability and governance, and she is a strong believer in the role Islamic finance can play not just for Muslims but for world financial markets. “I believe Islamic finance has been able to offer tremendous benefits, and will continue to grow at a very strong rate in the future.”

Malaysia has an uncommonly high representation of women at senior levels in Islamic finance. In addition to the heads of the central bank and securities commission, one could point to Noripah Kamso, head of the biggest Islamic fund manager, CIMB-Principal; Jamelah Jamaluddin, now head of Kuwait Finance House for Asia and previously MD of RHB Islamic Bank; Fozia Amanulla, head of Eoncap Islamic Bank; Engku Rabiah Adawiah, probably the most senior female Shariah scholar; and Nor Rejina Abdul Rahim, who heads Nomura Asset Management in Malaysia, among the most active foreign fund managers in Malaysian Islamic finance.

One of the younger members of this successful group is Raja Teh Maimunah, who followed a career in investment banking, including stints at UIB Capital, CIMB, RHB Sakura (now RHB Islamic) and KFH, with her current role at the stock exchange, spearheading Islamic finance product development and market policy. She argues that the prominence of women in the industry in Malaysia is partly that, “from a gender point of view, I’ve never had a glass ceiling,” and is partly more practical. “In Asia you live as extended families: it’s easy to drop each other’s children off with one another to help out. And the more critical element is the availability and affordability of helpers.” She has three children.

A frequent ambassador for Malaysia elsewhere in the Islamic world, she is under no illusion that the same opportunities exist for women elsewhere. On a trip to Saudi Arabia, with a perfectly valid business visa, she was refused entry to the country because she was not travelling with her husband, “accompanied with a few comments on how shamefully I was behaving.” On another more recent visit to Riyadh, she was not permitted, as a woman, to enter a building for a meeting.

Bursa presented her with the opportunity to jump from deal-making to the other side of the fence, a move she has found rewarding. “I wanted to contribute and make a difference, to push through changes in industry, and this gave me the platform,” she says. Among the most significant developments closely associated with her has been the development of Bursa Suq al-Sila, the first Shariah-compliant commodity trading platform. “This is an industry where everybody has got to help to build it,” she says. “It’s not like a conventional bank where it is just about your bottom line. In this industry, to get to a bottom line, you have to build something, and then earn something from it.” The structure of Bursa has also allowed her to be involved in regulatory development as well as product, and has led to lengthy dialogue with other standard-setting bodies around the world.

Though a thoughtful interviewee on Islam itself, she is also vocal on the importance of Islamic finance beyond its religious relevance. “Being on this side has helped me to articulate that this is not just about social inclusion or a faith-based agenda. It’s really about a financial alternative that is viable following the crisis, and it should be made more available whether you believe in the religion or not.”

For as long as Islamic finance has been discussed internationally, practitioners have been talking about convergence. No conference is complete without a panel on it; no discussion about global growth in Islamic finance can take place without addressing it. But what does convergence really mean, and how much progress has been made?

The most important distinction to make when talking about convergence is between Shariah opinion, and other standards related to Islamic finance such as regulatory frameworks, tax and accounting treatment. In a nutshell, the first camp will never reach full standardisation, and arguably would be much worse off if it ever did so; the second is where efforts are directed today and where progress is more vital in bringing Islamic finance into the global mainstream.

“We’ve got an opportunity to take Islamic finance to the global stage, and in order to do that we do need to have a great deal more convergence around standards – not just Shariah but tax, legal and accounting,” says Daud Vickery Abdullah, global Islamic finance leader at Deloitte. For Vickery, this means, for example, streamlining Islamic accounting standards in order to dovetail them with International Financial Reporting Standards (IFRS), so that “IFRS understands what Islamic is, and vice versa. There are global standards, everybody understands what they are, and they can accommodate as far as is possible Islamic standards.”

“In order to globalise we need to standardise – but in a rational way,” Vickery says. “Global accounting standards and tax standards: good. More legal definitions and congruence would be good. Greater standardisation on the definition of terminology: what does an ijarah mean, in Malaysia or in Kuwait?”

Several organisations are already involved in trying to make these things happen. Three stand out.

One is the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), a Bahrain-based non-profit body supported by a global institutional membership of 200 members from 45 countries. AAOIFI exists to prepare accounting, auditing, governance, ethics and Shariah standards for the industry, and dates from 1990; its standards have been adopted in Bahrain, the Dubai International Financial Centre, Qatar and several other Middle Eastern and African nations, while some other countries, most notably Malaysia, Indonesia, Pakistan and Saudi Arabia, have issued their own guidelines that closely follow AAOIFI standards. It is a busy organization: its Shari’a Standards 2010 publication contained 41 standards, and its Accounting, Auditing and Governance Standards 2010 report a further 40.

Another is the Islamic Financial Services Board, again a multilateral with widespread participation across the Islamic world, but headquartered in Kuala Lumpur. This is also a standard-setting body, but chiefly concerned with global prudential standards and principles and with a mandate to help promote soundness and stability in the system.

And on the markets side, the key institution for developing standardisation is the Islamic International Financial Market, based in Bahrain and founded collectively by central banks and ministries in Bahrain, Indonesia, Sudan, Labuan (Malaysia), Brunei and the Islamic Development Bank. Its mandate is to standardize Islamic products, documentation and processes.

One could argue IIFM has had the most momentous year of the three. Most practitioners know it for its work around hedging. “What banks need to hedge is currency risk, and fixed to floating [rate risk], because they have mismatches,” says Ijmal Alvi, CEO of IIFM in Bahrain. It achieved a breakthrough in March with the launch of a new master agreement document, called Tahawwut, launched jointly (and crucially so) with the International Swaps and Derivatives Association (ISDA). The document marked the first globally standardized documentation for privately negotiated Islamic hedging products – that is, derivatives such as profit-rate and currency swaps.

There is nothing straightforward about getting something like this to the finish line, and Alvi says it went through 24 drafts as the document passed through industry consultation and Shariah guidance. The endorsement of ISDA, whose conventional master agreement the Tahawwut template closely resembles in structure, was vital in bringing international validation to it. But the work continues, even within this narrow field: IIFM is now working with regulators in jurisdictions around the world to improve the local legal frameworks for hedging products and for close-out netting provisioning, and to develop insolvency laws around the Islamic world accordingly.

Alvi sees that the enabling environment is the key to a market. “With architecture, you create the agreement first, and then you bring the product,” he says. So the next step now is to provide standardising agreements at a product level, around FX forwards and profit-rate swaps, for example, below the overarching Tahawwut framework. As with the master agreement, these documents are going through lengthy consultation both with industry and Shariah advisors; he is reluctant to commit to a timeline beyond “we are trying our best to complete it during 2011, and if we do it earlier it is better for everybody, but we cannot bypass the processes.” When it’s done, he says, “it will provide the whole suite to the industry.” Additionally, banks have to go through their own internal processes with documents, which also takes time.

Alvi and his team continue to work on a host of other standards – in July it launched a paper on I’aadat Al Shira’a, a repo alternative, to help with liquidity management challenges, and it has also been looking at issues around sukuk, although Alvi says they are in too early a stage to be discussed in detail now. But Alvi is also interesting in that he sees that there are limits to beneficial standardisation.

“I often say: we are not supposed to standardise each and every aspect of the industry,” he says. “We are driven by requirements of the industry. It is good to have templates for common kinds of structures, like ijarah. But you cannot put every structure in a standardised form. Each sukuk has certain particular things within it, and within its packaging.”

Another example of, if not convergence, than a common approach to a problem, is the International Islamic Liquidity Management Corporation being built by a collective of Islamic country regulators and central banks, among them Bank Negara Malaysia. “This will issue triple A or double A rated paper, and the shareholders [the countries who back the system] can then nominate any entity within their system to allocate and monetize the assets,” explains Zeti Akhtar Aziz, governor of BNM and one of the drivers behind the new system. “We will have primary dealers identified by shareholders from their financial system, and they will create a market. These instruments will be highly liquid and attractive, and will be issued periodically throughout the year in different reserve currencies.” When interviewed in late October, Zeti said the team had made an offer to a potential CEO and was in the process of “mobilising the team”.

This venture grew out of a financial crisis response in which several groups were tasked to produce a global financial stability report, which generated eight areas within Islamic finance where it was important to put new standards in place. The feeling was that a liquidity framework was so important “we didn’t wait for the report to be finished before we implemented one or two recommendations, and one was the liquidity infrastructure mechanism.” The other was the development of a financial stability board distinct to Islamic finance, “where the regulators discuss possible risks to financial stability in the Islamic financial system.”

Measures like this, by definition, ought to bring a measure of convergence. They demonstrate the industry working together in a way it has never done before; one can argue, in fact, that the financial crisis was the biggest and most important spur towards Islamic financial convergence to date, particularly since Islamic structures fared better than conventional ones in the crisis and now have an opportunity to present more of a case to the financial mainstream.

But that’s all on the prosaic side of regulation, accountancy, tax and law. It’s on the other area, Shariah itself, where things become more complicated.

“Personally, I am not a proponent of Shariah harmonization,” says Raja Teh Maimunah at Bursa Malaysia. “What I would propagate is regulatory harmonization. The world must acknowledge there are two parts to any contract with Islamic banking: one is the legal framework and the other is Shariah compliance. Legal is man’s obligation to another man. Shariah compliance is man’s obligation to God. And a failure to meet your obligations to God does not make your obligation to man invalid.”

It’s a vital distinction, in her view. “In the capital markets, you have a basic framework and then the Shariah compliant elements of it. So with REITs, there can be rules on who the tenants are, how to manage the money – those are things we ought to agree from a regulatory perspective. We can all agree arms and alcohol are not compliant. But in terms of interpretation between contracts, I believe we should allow for differences. It’s OK to have those differences. It provides choice, it gives you options, and it has promoted innovation.”

She cites the recent Islamic RM1 billion debt programme set up by Cagamas, the Malaysian national mortgage company, as an example of this. The deal, lead managed by Saudi Arabia’s Al Rajhi bank, uses a structure called sukuk al-amanah li al-isthithmar, or sukuk ALIm, which incorporates principles of structures such as al-iljarah and al-wakalah in order to make it tradable in more conservative Middle East markets, which are normally off limits to more liberally-structured Malaysian securities. Cagamas itself said the issue was a contribution to harmonization, and it also shows how Shariah differences breed innovation. “They came up with it because their Shariah [advisors] weren’t comfortable with the structures we have in the market,” Maimunah says. “We need diversity.”

But for regulation – that’s different. “The world has gone through a terrible crisis,” she says. “Lots of businesses that survived two world wars did not survive, and we as an industry must come up and make sure we have tightened our practices in risk management, providing liquidity, encouraging cross-border trade. And for that to happen, we need convergence on a regulatory framework.”

Many others agree that diversity of Shariah opinion is a good thing. “I’m firmly of the view that the different schools of thought in Shariah are very good, because they drive discussion and product innovation,” says Vickery. “That should be encouraged and should continue.” But that doesn’t mean there’s nothing to be done. “Where we need to standardise is around the process by which a decision is made. Publish the fatwa, have a database: who was involved? What did they look at? How did they reach their conclusion? A lot of the confusion arises from the fact that you’ve got Shariah scholars sitting on multiple boards, and it appears to the man on the street that they have said yes at Bank A and no at Bank B, but the process of making that decision has not been published.” We could, Vickery says, eventually end up with “a sort of book of common law in place, where people say there was a similar situation and this was the conclusion.”

Zeti argues that, in Malaysia at least, this is already happening. “We have a Shariah advisory board in Bank Negara and when they announce their rulings, it is in great detail, providing the rationale for the ruling,” she says. This, too, might lead to some convergence. “There is discussion on parameters and guidelines, so there will be mutual recognition if they comply with these parameters.”

An important spur for convergence has been that scholars, put simply, talk to each other a lot more. “More international scholars of different backgrounds are on the same panels now, exchanging views and ideas and reaching a kind of common congruence on Shariah,” Vickery says. “They may have differences of opinion, but they’re mainly in a minority.”

Zeti agrees. “Scholars in the Middle East and Asia have been discussing the fundamental differences that exist in different jurisdictions,” she says. “Previously there was no such dialogue so there was no convergence.” Bank Negara allocated around RM200 million of funds to facilitating this dialogue and research. “We believe, with dialogue, we will move to greater convergence.”

It is commonplace to say that most Shariah standards are the same anyway, although it’s interesting how widely this number varies: Vickery talks of scholars saying they agree “90 to 95% of the time”, Zeti says there “has been a convergence on 80% of the issues”, and Maimunah says “from where I stand, the differences are only 5%. 95% of the time, we get along.”

But whatever the true number is, that’s not bad. “The 80/20 rule is a good example,” Vickery says. “If you get 80% agreement you’ve got an international standard, as far as I’m concerned. In the conventional world, if you’re trying to agree on how to account for a derivative transaction, we still haven’t decided how to account and accrue income on it, but 80% of the world has agreed. That is critical mass.”

All these issues are becoming increasingly important as Islamic finance becomes more cross-border. Bankers expect further closeness. “From a commercial standpoint, if you are doing a cross-border deal, then the objective must be to be able to reach out to the maximum pool of investors, and the only way to do that is to go for the standard that will clear the majority,” says Tan Jeh Wuan, managing director of the Islamic Bank of Asia in Singapore. “As we see more and more cross-border deals happening, convergence has to take place.” Asked if this is more likely to be towards more rigorous GCC standards or less onerous ones in Malaysia, he says “somewhere in between, but more leaning towards GCC standards.”

For Vickery, a key challenge is improving international perceptions of Islamic finance. “There is still a view out there that this is terrorist financing and they stone women.” But it’s changing. Before speaking to II, Vickery has been working on a proposal on developing interest in Islamic finance in Azerbaijan, Italy, Brazil, South Africa and India. “It’s because these guys are recognising it’s an international phenomenon, a way of tapping liquidity in the GCC, and it’s good for business. And the more international standardisation and transparency there is, the better it is going to be.”