Islamic banking faces liquidity risk: Expert

Doha: Islamic banking sector is increasingly facing liquidity risk across all geographical regions. The situation is more challenging in the GCC region, said an expert.

He called for the industry leaders and the regulators to create new instruments and develop fresh policy tools for  the liquidity risk management in the Islamic industry sector.

Dr Salman Syed Ali of Islamic Research and Training Institute, Saudi Arabia, cautioned that the Islamic banking sector might also go the way of conventional banks, unless effective tools are not in place immediately.

Dr Salman, who was in Doha to attend the International Conference on Islamic Economics and Finance, told The Peninsula: “The structure of liquidity of Islamic banks have changed significantly over the years.  From an era of liquidity surplus in the beginning of the decade Islamic banks are now in the era of liquidity shortages. In general, the banks have moved from a position of positive gap to a negative one or from a negative gap to a more negative one.”

The level of liquidity in Islamic banking has been decreasing while liquidity risk has been increasing in all geographical regions over the past decade. The risk has further increased after the global financial crisis.

Contrary to the general perception, the liquidity of Islamic banking industry in the GCC is lowest with highest liquidity risk when measured by liquidity ratio and financing to deposit ratio.

There has been a major structural change in the maturity profile of assets and liabilities of Islamic banks between the years 2000 and 2009 from a position of positive short-term maturity gap to a negative gap.  This, according to Dr Salman, is a strong indication of a liquidity risk.

In comparison with the conventional banks, the Islamic banks, despite downward trend in their liquidity ratio, are holding much higher proportion of liquid assets.  Even during the financial crisis the liquidity in Islamic banks was more than twice the liquidity of conventional banks. This, among other factors, may have helped Islamic banks to ride out of the crisis.  But things are changing in the industry.

For want of updated Islamic instruments for liquidity management, the fully fledged Islamic banks face more difficulties compared to the conventional banks and the Islamic banking windows of conventional banks. A comprehensive review liquidity management practices and policies of Islamic industry is an urgent need.

“Out of the box thinking is needed to come up with solutions.  Researchers and policy makers need not confine their thinking within the present model of commercial banking and the set-up of the existing financial sector”, he said.

Among the GCC countries, Kuwait had consistently low liquidity ratio over the period. UAE is the country where liquidity ratio dropped most and remained lowest during the global crisis.  Among other countries, Jordan has the highest liquidity ratio consistently since 2004 followed by Malaysia.  The liquidity ratio in Sudan has been consistently showing a downward trend since 2004.

An important measure of liquidity risk is the Financing to Deposit Ratio – a situation that captures the relationship between changing nature of demand for financing and deposit gathering ability of banks to fund that demand.  This ratio is quite high in the GCC and Mena when compared to other regions,  Dr Salman said.

Qatari market over-banked, says HSBC MD

Doha: Although Qatar market looks very attractive it’s very difficult to penetrate, says a top banker.

“Business from London to Hong Kong works the same way, but not here. In Qatar it takes a longer time to build relations and you need to be very patient, things move slower here,” said Jody Sanderson, HSBC Managing Director and Head of Global Banking, who has been working in Asia, North America and in the Middle East.

One of the problems of the Qatari market and of the GCC in general is that it is over-banked.In the UK there are 4 banks serving 60 million people, while in the GCC there are 50 banks for 5-6 million people.

“This market is highly over-banked. For a consumer this is a great situation because there is a lot of competition, but at the end of the day you want a strong and healthy banking environment, and too much competition can lead in a negative situation, ending up with banks that can not invest properly because they are not profitable.

This is something that you wouldn’t want; a banking sector that is so competitive that the banks are unprepared to invest further to serve the customers the way they need to,” said Sanderson, categorising Qatar as one of the most competitive banking market in the world.

HSBC has been working in Doha for 60 years and now has 450 people operating in the country; these numbers give an idea of the stature of the presence of HSBC bank in Qatar and of the comprehensive knowledge that the bank now has of the local market.

The bank over-population is just one of the problems of the regional market.“There is still a need to improve a regulatory architecture, corporate governance, and reduce red tape and bureaucracy,” said Omar Mehanna, Managing Director, MENA Head of Advisory for HSBC.

The MENA market is relatively very small as it represents only 1 percent of the global market, but it has been penetrated by European banks.

“Twenty percent of the Middle East and North Africa syndicated loan financings are provided by European banks, but it’s still early to see the impact of the euro crisis in the Gulf,” said Mehanna.

In his opinion to recover from the eurozone crisis, the European Union should establish structural reforms as a fiscal union within the eurozone countries, and the European central banks should launch a comprehensive purchase bund programme.

He said that some argue that the global financial crisis could have been avoided if banks had abided by Islamic rules that forbid investment in collateralised debt obligations and other toxic assets.

“The proliferation of certain financial instruments, which existed pre-crisis, played a role in increasing the magnitude of the crisis, but Islamic financing has its issues and was not immune to the crisis,” said Mehanna.

The Peninsula

Islamic finance could be an answer to global economic problems

Adopting Islamic finance practices could lead to a more equitable global economic system, an Islamic finance expert told an AUB audience.

Sheikh Zaher Nsouli, chief of Sharia audits at the Lebanese Islamic Bank, added that methods applied in Islamic institutions could help prevent future economic meltdowns.

Nsouli, in the talk “Islamic Finance in the Midst of the Meltdown Crisis,” held at AUB’s Suliman S. Olayan School of Business, praised the Islamic Zakat system where a 2.5 percent of all revenue is continually redistributed to the poor.

“No economy is capable of doing or reaching such results except with Islamic finance, which is divine. As GDP increases, the Zakat increases and goes towards poverty alleviation,” he said.

Anwar Soubra, Sharia compliance officer at Elaf Bank, Bahrain, praised the Islamic finance system due to its refusal to allow speculation.

According to Soubra, 97 percent of all transactions done on the New York Stock Exchange were based on speculation.

“Nobody goes for real delivery and this is not acceptable in Islamic finance,” he said.

Speculation is an action that does not guarantee the safety or return of initial investment. It typically involves lending money or purchasing assets, equity or debt in an imprecise manner and is deemed to have a significant risk of the loss.

The end result, according to Soubra, is a worrying disparity in the value of the real economy and that created by speculation.

“We produce what is worth $60 trillion in the market but we buy and sell what is worth $2000 trillion,” he said.  “It is a very big bubble and when it burst it hurts everybody.”

Nsouli rounded on the greed of world finance, suggesting it was “malign neglect” which brought about the recent financial meltdown.

“According to (ratings agency) Fitch, $1.4 trillion of subprime mortgages originated from 2005 to 2007. The heart of the subprime meltdown rests with the default of these loans. This is inadequate and it is something that I refer to as a malign neglect,” he said.

A subprime mortgage is a loan granted to individuals with poor credit histories, who would not be able to qualify for conventional mortgages. Since subprime borrowers present a higher risk for lenders, subprime mortgages charge interest rates above the prime lending rate, something which Nsouli disapproved of.

“We actually have a crisis in the system,” Nsouli added.

He said that Adjustable Rate Mortgages – which charge repayment rates linked to financial indexes – comprised 80 percent of US mortgages and accused derivatives markets of helping bring down some of the world’s biggest banks.

“Derivates are estimated by the Bank of International Settlements to be $600 trillion, 10 times greater than the size of the world economy,” he said.

A derivative is a security whose price is dependent upon or derived from one or more underlying assets, he explained.

“Its value is determined by fluctuations in the underlying asset,” Nsouli said. “Derivatives are referred to by the American philanthropist Warren Buffett as being financial weapons of mass destruction.”

Nsouli said that the current world economic system led to the 2007 world food crisis.

“Food prices increased by 40 percent in 2007 and 50 percent in 2008,” he said.

He added that 850 million people went to bed hungry in 2008 but the number today reached 1 billion.

“To prevent the death of 50 million children it is estimated that $2.5 billion a year is needed, which is the same amount that a cigarette company spends on advertisements,” Nsouli said.

He added that the problem lay not in scarcity of food, but in reallocation of wealth.

“The GDP of 41 poor countries is less than the wealth of the richest seven persons combined,” he said.