The shariah-compliant investment banking sector (SCIB) concept – originally conceived as boutique investment houses created by individual investment bankers – had suffered considerably during the crisis, but would likely evolve as part of larger Islamic banking groups that are seeking to diversify, says Anouar Hassoune, Moody’s Vice President-senior credit officer and lead analyst for Islamic banks.
Development plans for the creation of a full-fledged SCIB sector had to be put on a back burner following the onset of the global financial crisis, which undoubtedly stunted growth in the banking and finance industry worldwide.
“The speed at which the SCIB model failed was alarming: the most innovative and in-demand concept since the birth of modern Islamic finance around 40 years ago was wiped out in just a few months,” Hassoune wrote in Moody’s Investor Service’s report published on Wednesday.
The report cited regional investment banks such as Gulf Finance House, Arcapita Bank, Unicorn Investment Bank and Investment Dar as major players in the GCC region’s financial landscape before they fell into murky waters after receiving a blow from the financial crisis.
“Some time before the crisis, these institutions were among the most profitable, innovative, dynamic and attractive wholesale institutions within the booming Islamic finance industry. They diversified the sector by moving away from pure banking intermediation and into more sophisticated investment/merchant banking lines of business like private equity, asset management, brokerage, infrastructure and structured real-estate finance, as well as advisory, corporate and project finance – thereby laying the groundwork for an SCIB sector,” the report explained.
SCIB’s “profitable and robust” concept, however, was no match for one of the worst economic crises the world has ever witnessed.
By 2009, nearly two years after the global financial crisis hit the markets, the Bahrain-based Gulf Finance House had already incurred a net loss of $728 million (Dh2.67 billion) against a profit of only $262m in 2008. Early this year, it narrowly avoided defaulting on a tranche of $300m murabaha facility after a series of negotiations.
Kuwait’s Investment Dar, a major stakeholder in luxury sports carmaker Aston Martin, also defaulted on loans and is in the process of restructuring $3.49bn of debt. Media reports suggested that its losses for 2009 had reached $416m.
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Moody's report said that Arcapita Bank and Unicorn Investment Bank, both also based in Bahrain, managed to dodge defaulting on their obligations, but their “liquidity, financial performance and capital base were put under tremendous pressure.”
Islamic finance ‘not risk-free’
Hassoune was quick to point out that while the Islamic financial industry may have been resilient to the impact of the crisis, it is not totally immune and far from being considered a risk-free segment.
“As a whole, Islamic banking has been one of the most resilient niches of the global financial industry, and yet its investment banks have been suffering more so than any other sector in the GCC region,” he said.
The report noted that until 2007, SCIBs were portrayed as having significant potential, benefiting from cheap funding, high liquidity, exceptional profits and robust capitalisation. These factors led industry players to dip their hands deeper into riskier investments and asset classes such as private equity and real estate.
And then the unthinkable happened. The “illiquid nature” of SCIBs’ investments, such as the property sector, contributed to rapid asset-value declines of their already damaged liquidity profile due to wholesale and short-term funding concerns.
The crisis offered a very bitter pill for the industry to swallow. Thus, Moody’s highlighted the need to improve risk management as the top lesson that should be learned from the meltdown.
Demand overshadows uncertain future for SCIB
The ratings agency believes that the outlook for Islamic investment banking is not bleak despite the recent developments in the sector because a growing demand for shariah-compliant financial services will likely keep it afloat.
“Demand for investment banking services in the GCC remains robust, especially for those that are shariah-compliant. The GCC economies still have an appetite for ambitious investments in infrastructure, and especially in the energy, logistics, communication and transport sectors,” the report said.
In addition, SCIBs’ future is seen to be “deeply correlated to that of the whole Islamic financial industry,” which is expanding at a very impressive rate and is expected to reach a hefty value of $1 trillion in the near-term.
“As a proficient vector of innovation and sophistication, SCIBs remain vital components for the modernisation of Islamic finance as a credible alternative to conventional solutions,” the Moody’s report mentioned.
Consider also reading:
Default woes may transform Islamic finance
Islamic asset management to be worth $125bn
Islamic finance mulls global shariah advisers
Islamic finance body to overhaul scholar rules
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