Size will matter in Islamic banking

Euromoney, December 2008

Author’s note: to see the published article, including tables and data, follow this link: http://www.euromoney.com/Article/2060579/BackIssue/65745/Islamic-finance-Size-will-matter-in-Islamic-banking.html

As you read this, someone, somewhere, will be addressing an Islamic finance conference and stating with pride that there are 300 Islamic banks operating in the world today. But this statistic, ubiquitous in presentations about the growth of Islamic banking, is not an entirely positive number: it’s far too many.

Islamic banking is enormously fragmented. At the top end, there are a handful of institutions of truly significant scale: Al Rajhi Bank, with US$33.3 billion of total assets as of 2007; Kuwait Finance House, with $32.1 billion; and Dubai Islamic Bank with $22.8 billion. (See the attached data from IFIS for a more detailed breakdown.) But after that, there’s daylight, and you don’t have to go too far down the list to get to the minnows.

Numbers are notoriously tricky to pin down in this field but in a January study the IMF put total Islamic banking assets at $250 billion, citing several other studies. That’s an average of less than $1 billion of assets per bank, and with the best part of $100 billion taken out of the picture by the top three alone, one can see that there are a large number of banks with very little to their name. “They say that something like 65 to 70% of Islamic institutions are capitalised at less than US$25 million,” says Agil Natt, CEO of the Malaysia-based Islamic finance training organisation INCEIF, and formerly head of Aseambankers and deputy chairman of Maybank. “That’s nothing.”

“Moving forward, not only do you need balance sheet, but you need reach and the power to distribute the various instruments that you come up with,” Natt says. “My opinion is there is a need for a few large Islamic financial institutions with global reach, but the industry has not reached that stage.”

There are the earliest signs of consolidation taking place. This year Maybank bought a 20% stake in Pakistan’s MCB Bank for US$686 million. However, despite the name (MCB stands for Muslim Commercial Bank), it is not actually an Islamic bank: in fact, only 8 of MCB’s 1026 branches at the time of the acquisition were dedicated Islamic branches. Parties on both sides of the deal talked about working closely on Islamic banking, but this was more of a conventional tie-up with Islamic side-effects.

One could say the same of the full merger of National Bank of Dubai and Emirates Bank: while there is an Islamic entity within the group (Emirates Islamic Bank), and both banks sell Shariah mutual funds, this is again a merger of conventional entities which happens to have an impact on Islamic subsidiaries. Likewise Malaysia’s CIMB Islamic, which runs Islamic banking and asset management operations in Indonesia through Bank Niaga: a cross-border presence, certainly, but one which sprung out of the 2002 purchase of one conventional institution by another, both of which happened to have Islamic subsidiaries or licences.

Without question, there have been signs of Islamic banks becoming more globally minded, but they have tended to do this through organic expansion. The clearest example is in Middle Eastern institutions heading to Malaysia, notably the big two of Al Rajhi and Kuwait Finance House. They have taken advantage of Malaysia’s policy to open its doors to foreign entrants in order to establish itself as the global hub for Islamic finance, with KFH opening officially in February 2006, and Al Rajhi a year later. A third bank followed: Asian Finance Bank, which at the time of launch was owned 70% by Qatar Islamic Bank (the fourth largest Islamic bank in the world, according to IFIS data), 20% by Saudi Arabia’s RUSD Investment Bank, and 10% by Kuwait’s Global Investment House.

For KFH, the Malaysia expansion – which has been followed this year by the licensing of an Islamic asset management business – was in keeping with a long-standing and against-the-herd policy of global engagement. Indeed, until recently one could have argued that KFH was the only Islamic bank anywhere to have expanded cross-border to any meaningful degree. It holds a majority stake in Kuyevt Bank, an Islamic bank in Turkey, and has operations in Bahrain, Algeria, Saudi Arabia and Morocco and affiliates in the United Arab Emirates, Oman and Bangladesh. Its first participation in Malaysia came back in 1995 when it set up a leasing joint venture with several Malaysian partners and the Islamic Development Bank; around the same time it applied for a full Islamic banking licence from Bank Indonesia, although the Asian financial crisis put that on ice.