LONDON, 15 December 2003 — The Murabaha, the Shariah-compliant commodity trade finance contract, for almost three decades the backbone of Islamic banking, is on the defensive. Some Gulf bankers such as Atif Abdulmalik, chief executive officer of Bahrain-based First Islamic Investment Bank, even suggest that its days are numbered, as pressure grows on Islamic banks to move away from the sector’s “Murabaha mentality”.
In recent months, German bank WestLB working together with Tricon Trade Management Ltd. launched the pioneering WestLB Tricon Forfaiting Fund (Shariah-compliant Share Class), whereby conventional forfaiting assets have for the first time been integrated with an Islamic commodity structure based on specially recognized accounts which separate the obligations and liabilities of the two.
Only a few days ago, Noriba Bank in Bahrain, the wholly-owned dedicated Islamic banking subsidiary of Switzerland’s UBS Group, took the market by storm with the launch of its Range Murabaha Investments (RaMI), which according to Noriba, is a “Shariah-compliant yield investment alternative (to the normal vanilla Murabaha) which provides investors with the potential to earn up to 10 percent per annum.”
Ironically, the pressure on the normal Murabaha has come from market dynamics. The Murabaha, akin to cost-plus or mark-up financing, normally uses LIBOR as a benchmark. Noriba’s RaMI moves away from LIBOR-fixing and is based on a commodity such as gold or a currency and allows investors to choose the spread and risk profile based on the performance of either the commodity or currency over the chosen price range and tenor.
The aim is to enhance investment returns; to move away from “LIBOR-fixing”; and to give clients control over their returns strategy. RaMI also promises capital preservation which is on the credit quality of the counterparty, the UBS Group — AA plus risk. With this sort of credit quality, investors do not risk their capital.
Investors, still smarting from a bear equities market, have in a difficult post 9/11 compliance and investment environment also sought refuge in cash and short-term instruments such as Murabaha. However, the Murabaha market itself has been depressed with yields currently generally below even LIBOR. And if Zakah is substracted, then the returns can effectively be negative. Islamic investors have put great pressure on their banks to come up with better-yielding Murabaha derivatives and products.
However, Islamic bankers are caught in a Catch 22 situation. Murabaha accounts for billions of dollars in Islamic investments. Yet the drivers of Murabaha are the investors themselves, who are risk-averse and are not prepared to go for medium-to-longer-term tenors. On the other hand the Islamic financial engineers must come up with structures which combine better yields with acceptable risks but with increasingly loner tenors. As such Islamic product structurers must be prepared to allocate more time and resources to R&D and financial innovation, still a poor relation in the sector in general. Unless this cycle changes dramatically, Islamic finance at least in the foreseeable future will continue to be stuck in its primary phase, which in turn will continue to stunt the development of secondary Islamic instruments and the development of a global Islamic capital market. Some Shariah advisories themselves have been putting pressure on islamic bankers to move away from the dominance of Murabaha and to structure products on other Islamic instruments.
The purists argue that Islamic finance is really about equity-based financing as opposed to debt financing, which Murabaha is.
However, in a modern financial system, this is highly unrealistic. In any case, the Murabaha and other debt instruments such as Bai Salam, Ijara (Leasing), and Istisna (construction financing) are legitimate Islamic financial instruments.
Noriba’s RaMI and WestLB Tricon Forfaiting Fund also attempts to push the boundaries of the tenors of Islamic financing. Islamic investors are notoriously risk-averse and short-term in their outlook. And this is the reason why still some 70 percent of Islamic financing is locked into short-term instruments, thereby stifling the development of the sector. Yes the normal vanilla Murabaha has a role but ideally as a short-term (overnight) liquidity management scheme, although this can be done using other structures such as Mudaraba.
The vanilla version of the international Murabaha, however, has over the last decade become an internationally-accepted trade finance instrument even in the conventional banking sector.
Not surprisingly, some $20 billion worth of Islamic trade finance is structured through banks in London every year. This finance is very often accessed by multinational companies including oil majors, car manufacturers, equipment suppliers, and airlines — all on the lookout for competitive short-term financing.
To enhance London’s status as a Murabaha capital, the Bahrain Monetary Agency (BMA), for instance, has recently signed an MoU (memorandum of understanding) with the London Metals Exchange (LME), through which many vanilla Murabaha transactions based on metal trades have been done over the last decade or so. Under the MoU, the LME will help structure documentation for value-added Shariah-compliant commodity contracts on the LME. The aim, according to the BMA, is to come up with internationalyy-standardized documentation enabling Islamic financial institutions to finance global commodity transactions.
London, of course, is the preferred jusrisdiction for international Murabaha deals. Two recent High Court judgments in favor of Islamic banks will give “Islamic financial institutions greater confidence.”
Of course Murabaha is prevalent in various local markets including Saudi Arabia, probably the largest single market for Murabaha, where banks such as National Commercial Bank (NCB) and Al-Rajhi Banking and Investment Corporation (ARABIC) are the two largest players. NCB’s Al-Ahli Saudi Riyal Trade is by far the single largest Islamic investment and commodity fund with assets under management in excess of SR10 billion. NCB’s total Islamic trade finance business is estimated at almost SR20 billion.
Abdulmalik, whose bank has pioneered Ijara-based leveraging for Islamic real estate transactions and private equity buyouts, stresses that although the Murabaha mindset of Islamic banking is still prevalent, the sector is moving away, albeit slowly, from this mentality. More importantly, “Islamic bankers are realizing that they need to be creative and have more products. Murabaha dominance will eventually go away.”