islamic finance: standard & poor’s general views and ratings approach

33
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright (c) 2006 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. Islamic Finance: Standard & Poor’s General Views and Ratings Approach Dr. Mohamed Damak Associate -- Co-Chair of Islamic Finance Workgroup Standard & Poor’s Financial Services Osservatorio Del Mediterraneo Ministry of Foreign Affairs Roma, Nov. 4, 2009

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Osservatorio Del Mediterraneo Ministry of Foreign Affairs Roma, Nov. 4, 2009. Islamic Finance: Standard & Poor’s General Views and Ratings Approach. Dr. Mohamed Damak Associate -- Co-Chair of Islamic Finance Workgroup Standard & Poor’s Financial Services. Agenda. 1- Introduction - PowerPoint PPT Presentation

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Page 1: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.Copyright (c) 2006 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

Islamic Finance: Standard & Poor’s General

Views and Ratings Approach Dr. Mohamed Damak

Associate -- Co-Chair of Islamic Finance Workgroup

Standard & Poor’s Financial Services

Osservatorio Del MediterraneoMinistry of Foreign Affairs

Roma, Nov. 4, 2009

Page 2: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

2.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

Agenda

1- Introduction

2- Impact of the crisis on Islamic Finance and Sukuk market

3- The European experience

4- Sukuk market at a glance

5- Standard & Poor’s approach to rating Islamic Financial

Institutions and Sukuk

Page 3: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

3.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

Introduction

Page 4: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Islamic Finance At A Glance

Date and place of first emergence Begining of the 60ies in Egypt and MalaysiaEmergence of the first universal Islamic Bank 1975Market size (estimated - mid-year 2009) About $800 billionAnnual Growth Rate (estimated - over the last decade) 10-15% (depending on asset class)Geographic Spread 60% in the Gulf - 20% in Asia - 20% Other countriesSukuk market size (Sept. 30, 2009) $92 billion compared with $500 million in 2001Sukuk issuance (Sept. 30, 2009) $15.3 billionSukuk issuance (2008) $14.8 billion

Date and place of first emergence Begining of the 60ies in Egypt and MalaysiaEmergence of the first universal Islamic Bank 1975Market size (estimated - mid-year 2009) About $800 billionAnnual Growth Rate (estimated - over the last decade) 10-15% (depending on asset class)Geographic Spread 60% in the Gulf - 20% in Asia - 20% Other countriesSukuk market size (Sept. 30, 2009) $92 billion compared with $500 million in 2001Sukuk issuance (Sept. 30, 2009) $15.3 billionSukuk issuance (2008) $14.8 billion

Total assets of Islamic Banks in the GCC

0

50

100

150

200

250

300

350

2003 2004 2005 2006 2007 2008

$.

Bill

ion

Total assets of Islamic Banks in the GCC

Page 5: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Islamic Finance At A Glance

Islamic Finance is rapidly emerging in new territories!

Geographic expansion of Islamic Finance

Page 6: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

6.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

What makes Islamic finance different?

The Five Pillars of Islamic Finance

1- Prohibition of interest

2- Prohibition of speculation

3- Prohibition of the financing of illicit sectors (pork, weapons, alcohol,

…)

4- Profit & Loss sharing principle

5- Asset backing principle

Islamic finance is not restricted to Muslims (the “natural” clients) as

some of its principles may attract non-Muslim clients.

Islamic Finance At A Glance

Page 7: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Impact of the crisis on Islamic Finance and Sukuk market

Page 8: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Impact of the crisis on Islamic Finance and Sukuk market

• We note that Islamic banks have no exposure to structured investment products (CDOs, SIVs and ABS…) and have not been directly affected by the decline of the value of these products.

• We note that Islamic banks are not risk free, however, as one of the principles of Islamic Finance requires that participants in each transaction share risks and rewards (profit & loss sharing principle).

• In our view, one of the main sources of risk for Islamic banks in the Gulf stems from their high exposure to the real estate sector (Dubai, in particular).

• Given the outlook for real estate sector in Dubai, for example, Standard & Poor’s took rating actions on Dubai-based banks, including the downgrade and the change of outlook to negative from stable on Dubai Islamic Bank (BBB+/Negative/A-2).

• Some Islamic banks are also under pressure due to: 1- Liquidity drying-up and their reliance on wholesale funding; and 2- Their exposure to the U.S and Europe through private equity, real estate, and asset-based investments.

Page 9: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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S&P’s expectations for rated Islamic banks (2009-2010)

1- Weaker financial performance as the economic environment

has deteriorated (slowdown in business volumes, lower fees

and commissions, higher price competition, higher provisioning

needs…).

2- Weaker asset quality indicators.

3- More conservative approach toward growth, as liquidity is

scarce and more expensive.

Standard &Poor’s Observations on how the crisis has affected Islamic Finance and the Sukuk market

Page 10: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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• The Sukuk market experienced a sharp slowdown in 2008 compared with 2007. However, recovery appears to have started in the second half of 2009.

• Total issuance reached $15.3 billion during the first nine months of 2009 compared with $14.9 billion in 2008 and $34.3 billion in 2007.

Main drivers for the slowdown

• Liquidity dry-up on international markets;

• Widening of spreads;

• Investors “wait and see” attitude; and

• Intrinsic challenges (comments on Sharia compliance, the low liquidity of sukuk, etc…).

A more positive trend in the recent past

Standard & Poor’s believes that the market is picking up again as market conditions begin to improve and stakeholders are deploying efforts to overcome the intrinsic challenges related to Sukuk market.

Reported pipeline of more than $50 billion?

Standard &Poor’s Observations on how the crisis has affected Islamic Finance and the Sukuk market

Page 11: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

Page 12: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Islamic Finance At A Glance

Initiatives in European countries

• UK: Five Islamic banks, one Takaful company, more than 15 conventional financial institutions offering Islamic financial products.

• France: Discussion at the highest level of the state on the strategy and the necessary steps to introduce Islamic finance. Talks about the licensing of an Islamic bank by the end of the year.

• Italy: Conference organized by the Osservatorio Del Mediterraneo focusing on the opportunities for Italy.

• Germany: €100 million Sukuk issued by the State of Saxony-Anhalt rated «AA-» and matured on Aug. 13, 2009.

• Switzerland: several Swiss banks offering private banking and Sharia compliant wealth management (local banks and affiliates of Gulf banks).

• A significant number of European banks are active in the structuring of Sharia compliant transactions In the Gulf Cooperation Council countries and Asia.

Page 13: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience of Islamic Banking

Three apparent strategies:

1- Retail and private banking: local Muslims, recycling of

immigration funds, private banking (local and foreign Muslim

customers).

2- Wholesale banking: corporate, project financing, private equity.

3- Access to Islamic capital markets (Sukuk market).

Page 14: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

1- Retail and private banking

- Islamic Bank of Britain

- Launched in 2004 as the first retail Islamic bank in the U.K.

- Main indicators as of Dec. 31, 2008

Total assets: £180.8 million

Total financing: £23.4 million

Total deposits: £153.3 million

Net income: £(5.9) million

Page 15: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

Specialized private bank

Diversified retail bank

Diversified private bank

Price

Operational diversification

Niche operational strategyin less competitive markets

Diversified player in competitive markets

Diversified offering in lesscompetitive markets

+

-

-

+ Specialized retail bank

Niche player in competitivemarkets

Sharia compliant retail banking products (home and auto financing)

Sharia compliant private banking, wealth management

Page 16: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

Target Market: Muslim population in Selected European Countries

Total population Mil.

(2008)% of Muslim population

(Est.)Total Muslim population Mil.

(Est.) GDP Per capita $ Est. (2009)

Belgium 10.7 3.6 0.4 42,965

France 62.0 10.0 6.2 42,091

Germany 82.2 3.7 3.0 39,442

Netherland 16.4 5.4 0.9 47,042

Switzerland 7.6 3.1 0.2 66,127

Italy 59.9 2.4 1.4 34,955

Spain 46.5 1.2 0.6 31,142

United Kingdom 61.3 2.8 1.7 35,728

- More than 14 million potential customers in the selected

countries sample.

- Average GDP per capita of $42 K in 2009.

- Islamic Finance is not restricted to Muslims!

Page 17: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

2- Wholesale banking: corporate and project financing

- SMEs financing, large corporate financing, foreign direct

investment in Europe, private equity. Example: Viridian PLC

acquired by Arcapita in the U.K. ($4.2 billion); CEPL acquisition in

France by Arcapita ($450 million), etc.

3- Access to Islamic capital markets

U.K. government plan to issue Sukuk, “rumors” on Sukuk

issuance out of France, Switzerland…

Investor base diversification and attraction of institutional

investors (incl. Sovereign Wealth Funds).

Page 18: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

• Major hurdles/unanswered questions

1- Demand quantification: in the GCC, the offer created its own demand, is it replicable in Europe?

2- Regulatory environment: tax neutrality of Sharia compliant transactions, regulation of Islamic banks...

3- Political environment: launch of Sharia compliant operations in secular countries for example; necessity of political stakeholders’ support.

4- A common strategy for the E.U.?

5- Specific weaknesses of Islamic finance: standardization of products, Sharia interpretation, lack of qualified human resources, lack of liquidity instrument management, small size of the Sukuk market...

• Observations

1- IFOP : 47% of the sample are interested in Sharia compliant saving products; 55% in Sharia compliant financing.

2- Efforts deployed by U.K. and French regulators to render the environment more friendly.

3- France and U.K. communication from the top level of the state in favor of the development of Islamic Finance.

5- Efforts being deployed by stakeholders to overcome these hurdles.

Page 19: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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The European Experience

• Our opinions

1- Islamic finance development is expected to be gradual starting

with wholesale activities and possibly retail offering in a second

step (including the recycling of immigrants deposits and funds

transfers as Islamic finance begins to emerge in home

countries, mainly in Africa).

2- More private equity and FDI transactions from the Gulf states

and other Muslim countries to Europe (mature economies,

strong legal environment, still untapped opportunities...).

3- European banks to continue playing an important role in

complex financial transactions and Sukuk structuring.

Page 20: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

Page 21: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

• A sukuk is a Sharia compliant debt instrument that allows an

entity to raise funds.

• Main reasons for Sukuk issuance:

- Size: limited access to bank financing (regulation limiting

concentration, loan to deposit ratio limits).

- Cost of funding: desintermediated financing.

- Maturity: longer than bank loans.

- Sharia compliance: Sharia-compliant financing (if the structure

is approved by Sharia board).

Page 22: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

Sukuk Market (2001-2009*)

0

10

20

30

40

50

60

70

80

90

100

2001 2002 2003 2004 2005 2006 2007 2008 2009*

$ b

illi

on

Cumulative Total Sukuk

Total Sukuk Issued

• Significant slowdown of Sukuk issuance in 2008 because of market conditions.• Apparent recovery in the recent past• Reportedly healthy pipeline

Page 23: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

Sukuk Issuance by Country 2009*

9.2% 0.4%

0.1%

9.8%

56.4%

2.4%

19.1%

2.6%

Bahrain

Brunei Darussalam

Gambia

Indonesia

Malaysia

Pakistan

Saudi Arabia

United Arab Emirates

• Malaysia has taken the lead but GCC is still contributing significantly.• No Sukuk issued out of Europe in 2009*.

Page 24: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

Sukuk Issuance by Currency In 2009*

27.1%

13.5%

2.4%

46.6%

5.6%

0.1%

0.4%

4.3%

USD

SAR

PKR

MYR

IDR

GMD

BND

BHD

• The US$ is slowly recovering its position as the currency of choice for Sukuk.• More than 70% of issuance where done in local currencies in 2009*.

Page 25: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Sukuk Market At A Glance

Total Issuance by Issuer Type 2009*

79%

19%2%

Governments andrelated entities

Corporates

Financials

• Government and related entities are driving the growth of the market compared with FI and corporates in the past.• This trend should help the construction of a yield curve against which issuers can benchmark themselves.

Page 26: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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S&P’s Views of the Sukuk Market

• Main developments/Hurdles

1- Sukuk default (The Investment Dar,

East Cameron Gas, Golden Belt…).

2- Comments made by AAOIFI

regarding the Sharia compliance of

sukuk issued so far and lack of

standardization.

3- Low liquidity of the sukuk market

(mostly OTC instruments)

• Efforts deployed/Conclusions

1- Default is providing the market with

interesting information on Sukuk

resolution (access to the underlying

assets; guarantee enforcement, etc.)

2- AAOIFI will screen products for

Sharia compliance and the National

Sharia Advisory Council of Bank

Negara Malaysia have the status of

final arbiter for Sharia compliance.

3- Creation of Saudi Sukuk and bond

market (might help improving the

liquidity of sukuk listed there).

Page 27: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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S&P’s Views of the Sukuk Market

• Our expectations for 2009-2010

- The Sukuk market is slowly reviving but issuance volume will continue to depend on market conditions (market are reopening at least for good names).

- Sovereign issuers are expected to continue driving the market upward. From 2010, more corporate issuers and FI to re-enter the market. The construction of a yield curve will be helpful.

- Our expectations in the longer-term

- Prospects remain positive in our view (more than $50 billion of Sukuk were either announced or talked about in the market)

- Investors are increasingly seeking to invest in products that are compliant with their beliefs.

- Infrastructure projects in the GCC require a huge amount of financing.

- Asset and liability mismatch management for financial institutions.

- Non-Muslim countries/issuers looking to diversify their investors base.

Page 28: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Standard & Poor’s approach to rating Islamic Financial

Institutions and Sukuk

Page 29: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Standard & Poor’s has covered Islamic Finance for more than a decade and has developed a

recognized expertise in this field.

Standard & Poor’s is active in:

1- Rating Islamic banks, Takaful companies, Sukuk issued by corporates and sovereigns; and

2- Launching Sharia compliant indices.

Standard & Poor’s does not:

1- Comment on the Sharia compliance of a specific issue or issuer; or

2- Provide consultancy or advisory services (ex. structuring sukuk.)

• The need for independent research is high in Islamic Finance! Standard & Poor’s has

published numerous articles on Islamic Finance and frequently participates in seminars to

communicate its views.

• Standard & Poor’s is in regular contact with different market participants (issuers, investors,

regulators, press...)

Standard & Poor’s approach to rating Islamic Financial Institutions and Sukuk

Page 30: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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AssetsCurrent accountsInterbank deposits STInterbank deposits LTPSIASukukPER and IRRCapital and reserves

Liabilities

Banking Assets

Classic liabilities

Specific liabilities

Equity

Islamic Bank Balance Sheet

1

2

1 Classic Rating Methodology

Specific Rating Methodology2

Standard & Poor’s approach to rating Islamic Financial Institutions and Sukuk

Page 31: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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• In rating Sharia compliant issuers, Standard & Poor’s applies

the same methodology as for conventional issuers but takes

into consideration the specificities related to operating in

compliance with Sharia.

• Standard & Poor’s has developed a specific methodology for

rating Sukuk.

• For some instruments, Standard & Poor’s has developed a

specific methodology (Stability ratings for Islamic Financial

Institutions offering Profit Sharing Investment Accounts) that

takes into account the differences between these instruments

and their equivalent in conventional finance.

Standard & Poor’s approach to rating Islamic Financial Institutions and Sukuk

Page 32: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Selected publications

1- The Sukuk market has continued to progress in 2009 despite some roadblocks - Sept. 2009.

2- Rated Gulf Islamic financial institutions and takaful companies have shown resilience to global market dislocations but they are not immune – Feb 2009

3- Sukuk Market Declined Sharply In 2008, But Long-Term Prospects Remain Strong – Jan 2009.

4- The Sukuk market continues to grow despite global gloomy market conditions - Sept. 2008.

5- The Sukuk market continues to soar and diversify, held aloft by huge financing needs - March 2008

6- Risk management for Islamic Financial institutions: A rating perspective – Jan. 2008

7- S&P’s Approach to Rating Sukuk - Sept. 2007

8- S&P Launches Stability Ratings For Islamic Banks Offering Profit-Sharing Investment Accounts - Sept. 2007

9- Islamic finance in France: Paris tries to reduce the gap with London - July 2007

10- Key Business Drivers Of Global Islamic Finance - April 2007

11- Islamic Finance Expands Slowly But Surely In The Maghreb, April 2007

12- Takaful: A New And Viable Insurance Business Model Or Just A Marketing Opportunity? April 2007

Page 33: Islamic Finance:  Standard & Poor’s General Views and Ratings Approach

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Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.

www.standardandpoors.com