Private banking, Islamic-style

Asiamoney, December 2011

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.