While some of the problems faced by the above banks were due to the impact of the global financial crisis and the credit crunch, the fundamental problem in some cases lay with flawed business, strategy and marketing plans and in one or two cases with mismatched senior management with minimal experience in Islamic finance. With the departure of at least three inaugural CEOs and restructuring at all five banks over the last year, some of the institutions seem to be emerging with a new found purpose, focus and cautious optimism.

First it was the shareholders of Islamic Bank of Britain (IBB) at their general meeting in August 2010 approving a 20 million pounds capital injection from founding shareholder Qatar International Islamic Bank (QIIB). This was an effective bailout of IBB which gives the UK's only dedicated Islamic commercial bank some much-needed breathing space.

Perhaps, more importantly, a few days ago, BLME, the wholesale Islamic bank which claims to be the largest Islamic bank in Europe, was the first of the five Islamic banks in the UK to report "a healthy return to profitability" for the first half of 2010. According to a BLME statement, the bank reported profit before tax of 3.6 million pounds for the first six months of 2010, showing a swift recovery from the loss before tax of 9.8 million pounds for the first 6 months of 2009.

Similarly, BLME total operating income increased to 19.2 million pounds for the first 6 months of 2010, compared with 17.6 million pounds for the same period in 2009; and net fee income increased by 171 percent year-on-year for the same period.

The bank's turnaround was spearheaded by a strong performance by the markets division, particularly the management of the Bank's investment portfolio and capital; continued top quartile performance of the US Dollar Income Fund; cash recoveries from assets that were subject to credit impairment provisions in 2009; and by strengthening of the corporate banking team, resulting in a steady acceleration in earnings and improved contributions from the three financing areas: Property, leasing and trade finance.

"The market remains a challenge to all financial institutions," explained Humphrey Percy, chief executive officer of BLME. "However we feel confident that the robust financial performance of BLME is testament to the increasing diversity, cost management, conservative risk management practices and client led recognition of our business model and product offering."

One area in which BLME is setting the pace is Islamic trade finance and structured trade finance. According to Massoud Janekeh, director of Islamic Capital Markets at BLME trade finance should be a natural home for Islamic finance funded either through a Murabaha sale or a Tawarruq structure (Tawarruq overcomes the taxation issues such as VAT relevant to some tax jurisdictions such as the UK).

Most observers and practitioners of Islamic finance agree that many features of trade finance such as its liquidity (many trades have short term maturity type less than 1 year, average 180 days) and asset backed structure suit the industry. "Certainly BLME is a strong advocate of growth in the Islamic trade finance flow. The demand is certainly there as many countries practicing Islamic finance such as the GCC block and Malaysia are trading nations and have large trade flows. Yet in BLME's experience, Islamic trade finance has not matched this demand and we see very little international Islamic trade finance flow in what is otherwise a very mature market," he explained.

BLME however does have an established network of trade finance counterparties mostly based in Europe. The international market potential also remains untapped due to a lack of connectivity between Islamic Financial Institutions.

The potential for Islamic finance going forward is huge, according to Janakeh but to have any substitution effect, the service delivery has to match trade finance offered through conventional banks. "Many Islamic banks are still relatively young: very few are more than five years old, and fewer still have an international footprint and correspondent banking relationships to offer true international trade finance," he maintained.

While there has been an over-concentration on financing short-term commodity Murabaha mainly through LME warrants in the past, Janakeh believes that this was forced partly because of the growing Tawarruq trade which is done through LME warrants. In GCC where tax is not an issue, Tawarruq is not necessary for trade finance.

But surely the opportunities lie with financing real world trade flows, especially oil and gas, metals, soft commodities? The issue, says Janakeh, is the ticket size rather than the trade flow. An oil tanker could typically carry around $30 million oil. A sugar shipment on a dry bulk carrier could have $15 million value. Many Islamic banks are not large enough to take such exposure by themselves and are not sophisticated enough to do these transactions on a club or syndicated basis. The one institution that handles such trade business is ITFC which is part of IDB, which Janakeh feels can play a very important role in expanding the Islamic trade finance flow.

He stresses that the sector is starting at such a small base that there is room for growth in both structured trade funds and individual transactions. The important factor is to get more primary origination in the Islamic trade finance, which will feed the funds too. Islamic banks cannot build a portfolio by buying debt obligations in the conventional trade flow (which is common in conventional trade finance). Therefore much of the growth will need to be originated from trade finance desks in Islamic banks.

Conventional trade finance declutter and deleverage assets off the balance sheet. Islamic trade finance on the other hand bring them on the balance sheet. BLME does not see this as a limiting factor for growing its Islamic finance business.

"It is true that there is fee income in trade finance and that some of the exposure can be treated as contingent liability. But this can also be accommodated within Islamic finance structures too," explained Janakeh.

The preferred structure for BLME is for the trade finance fund to enter into a wakala with the originator (e.g. the trade finance desk), and the originator to invest in murabaha on behalf of the fund. Under this structure the fund can appoint the originator to manage the day to day activities for procuring the investment, yet from accounting perspective retaining an exposure to the underlying risk. — M.P.