As the largest market for Islamic finance, with assets growing over 30% a year, the scenario is attractive for Islamic wholesale, or commercial banking. CAMILLE KLASS looks at trends in the market and how these banks are priming themselves to gain a larger chunk of the market.

With economies around the world starting to experience some form of recovery from the recent debilitating crisis and signs that global trade is picking up, trade financing is expected to flourish again, helping to drive growth further in the Islamic wholesale banking sector.

The crisis, which caused trade to dip and credit to tighten, impacted Islamic wholesale trade and finance activities even though banks engaged in Islamic wholesale activities have enjoyed growth of around 30% annually, according to estimates by international management consulting firm Oliver Wyman.

“My view is that trade and term finance will be the one(s) to watch in terms of growth in the Islamic wholesale banking space,” said Musa Abdul Malek, executive director and CEO of HSBC Amanah in Malaysia. Trade, together with capital expansion or replacement, will be the key drivers of the positive growth that HSBC Amanah expects for wholesale banking, he added.

Sharing his view, Jacques Tripon, CEO of BNP Paribas Najmah in Bahrain, said: “Trade is going to be a major driver in the world and BNP Paribas wants to develop its trade business more. We have always been a strong player in trade finance and want to emphasize it and Islamic banking as part of it.”

The volume of world trade, which contracted by around 12.2% last year, is expected to rise by around 9.5% this year, according to estimates from the World Trade Organization. Last year, the value of world merchandise exports fell 23% to $12.15 trillion.

“Due to the recovering market conditions and (a) lift in international trade volumes, related products will see uplift in demand including trade products and term finance for capital expenditure,” HSBC Amanah’s Musa said. “These are both linked to treasury products for risk profile enhancement.”

Islamic trade finance products include letters of credit, trust receipts, accepted bills, export credit financing, working capital financing as well as bank and shipping guarantees.

BNP Paribas Najmah’s Tripon said the bank is “developing a trade financing offer that comprises LC import financing, export bill discounting and forfaiting to boost trade finance.”

BNP Paribas and HSBC aren’t the only banks looking to ramp up their business in trade finance. Standard Chartered Saadiq, the Islamic banking arm of Standard Chartered Bank, and CIMB Islamic are going in that direction, too. “We are looking at building up our Islamic trade finance offerings, as well as Islamic cash management services,” said Badlisyah Abdul Ghani, CEO of CIMB Islamic Bank in Malaysia.

At Standard Chartered Saadiq, which has experienced growth of between 70% and 80% for both consumer and wholesale businesses since it began its Islamic operations in Malaysia in 1993 and in the UAE, Pakistan and Bangladesh since 2003, head of product development Ghazanfar Naqvi said the bank is aiming to grow its trade business and customer base “at a faster pace.”

Together with trade finance products, bankers say wholesale clients will need hedging products, too, with the recovery in international trade. “As global trade picks up, trade finance and financing needs will rise again and hedging solutions (will) as well,” said Naqvi.

Bankers note that the need for hedging solutions is in line with a key trend — an increasing interest in Shariah compliant derivative products, adding that there is a real need in the market for risk management tools to mitigate currency, market and investment risks.

“The single most important trend in the Islamic wholesale banking market that is worth noting is the development of Islamic derivatives activities,” said Badlisyah. “As the industry grows, many of our wholesale banking customers need to have the ability to manage their risks effectively and efficiently. Islamic derivatives provide customers with a way to better manage these risks.”
Islamic hedging tools mainly consist of profit rate swaps, currency swaps, equity derivatives and arbun. Arbun is similar to an option in the conventional banking sphere in that it is a contract where a buyer puts a downpayment on a purchase for a later date and can choose not to go through with the transaction by forfeiting the downpayment.

Compared to the range and sophistication of hedging instruments available to clients in the conventional banking market, Islamic hedging instruments have been thin on the ground owing to divided opinions among Shariah scholars on whether they constitute speculation — a form of gambling, which is prohibited under Islamic law. Bankers say the lack of a wide range of derivatives products for hedging puts Islamic finance clients at a disadvantage when it comes to risk protection compared to conventional finance clients.

“If the Islamic finance industry wants to play a bigger role, then it needs the same tools as in conventional finance, because Islamic finance abides by the same regulations of central banks, and (international standards such as) Basel II, and Basel III in the future,” said BNP Paribas Najmah’s Tripon. “Otherwise, (the industry) is at a disadvantage.”

Citing the numerous projects in the GCC region which require financing of between 15 and 20 years, Tripon said it has been “impossible for Islamic banks to be very active in this area, the reason being the mismatch in their balance sheet.”

Bankers point to the recently introduced Tahawwut Master Agreement, created jointly by the International Islamic Financial Market and the International Swaps and Derivatives Association, as a significant milestone for the industry as it provides the industry with a framework for entering into hedging arrangements. “It’s an excellent initiative, but it doesn’t mean it will be accepted by all Shariah boards,” Tripon said. ”But it does give us more potential since the Tahawwut agreement implies less risk consumption.”

With its superior growth, Islamic wholesale banking is likely to attract increasing numbers of new entrants, especially as it develops and starts to move into the mainstream, making it imperative for existing players to devise effective strategies to grow their businesses. Deutsche Bank, which had already been involved in Islamic finance through its London, Middle East and Malaysian offices before it set up its Islamic banking branch in Malaysia to serve the rest of Asia, received an Islamic banking license from Bank Negara Malaysia in March. The bank is drawing on its success with conventional products to introduce its Islamic capabilities, expand its client base and solidify further its “global presence in Islamic products and services.”

The strategy banks seem to have in common is a focus on meeting and exceeding client expectations, providing a complete Islamic product range and ensuring that solutions are customized to clients’ needs. “As a bank we always make an effort to understand customer requirements, provide a whole range of solutions,” said Standard Chartered Saadiq’s Naqvi.

“We’ll continue to provide structured solutions, but these aren’t required on a daily basis,” he added. “We want to grow our normal financing solutions for foreign exchange, trade, financing — the kind of normal products customers need to employ to run their business because that’s where we think the real growth will come from.”

CIMB Islamic is also making sure it has its bases covered. “Our policy is to ensure that for every conventional wholesale banking product available in the market, we have an equivalent Islamic wholesale banking product solution for our customers where possible,” said CEO Badlisyah. “We develop all our products in-house, including our Islamic structured products, and we do and can tailor products for other banks and institutions. Where needed, we enter into joint ventures to provide certain services such as fund management.”

Well-known internationally for its leadership in the derivatives business, BNP Paribas is focusing on fixed income — profit rate swaps and currency swaps — for the year to come, said Bahrain-based Tripon. In terms of HSBC Amanah’s strategy for continued growth, Musa said: “The first port of call is to ensure that the customer experience is right for Islamic wholesale banking products and services. Conventional banking as we know it has been universally established for a long time, so there is a lot of ground to make up in Islamic banking to ensure that the product, service and ultimately customer experience is comparable,” he added.

His point strikes at the heart of an issue central to the Islamic finance market — the difficulty in penetrating markets that are used to conventional finance and ensuring that Islamic finance is a viable alternative in terms of cost, product features and processes. “The perception that Islamic finance solutions add more processes compared to conventional solutions needs to be managed and understood,” Standard Chartered Saadiq’s Naqvi said. “The process to give comfort to customers that it won’t disrupt the businesses activities is difficult but rewarding.”

In order to get the target market to accept Islamic solutions, countries involved in Islamic finance, excluding Malaysia, need to create an enabling legislative, regulatory, legal and Shariah governance framework, said CIMB Islamic’s Badlisyah. “Right now, it’s at a stage where we are in the education mode,” said Naqvi of Standard Chartered Saadiq. “Education and awareness are still a challenge.”

“Further client education efforts, particularly in the newer markets, would be helpful,” said Alhami Mohd Abdan, head of international finance and capital market at OCBC Al-Amin in Malaysia. “But in Malaysia, the market has grown to a certain level of maturity that Islamic finance is not so strange to a large number of clients because of the good examples set by the government benchmark issuances and Fortune 500 names such as Petronas, GE and other blue chip issuers both domestically and internationally.”

From a product perspective, “there are various factors that need to be ironed out with product developments” as “the market is growing and is still going through a rapid learning curve,” said Alhami. Certainty that an Islamic financial product or transaction is devoid of ambiguity, inconsistency and the risk of being declared void by a court of law for not being Shariah compliant is a major factor when it comes to developing products, he added. “Without certainty, it becomes very challenging for a bank to structure products,” he added.

A criticism leveled at the Islamic wholesale market is that there are insufficient products, and that most tend to be of the plain vanilla lending variety, even though demand is more and more from corporations to have products similar to conventional ones, not just plain vanilla but also more sophisticated ones.” BNP Paribas Najmah’s Tripon said banks should tread carefully in this area with regard to Shariah law.

But, does the market need more sophisticated and complicated products?

“As long as they don’t help or support the real economy, then no way. Islamic banking finances the real economy, so we deliver products that meet this requirement and not whether they can make more money,” Tripon emphasized.