It happened at an international conference promoting Islamic real estate financing last month in Amman. After a session detailing product trends in real estate financing that meet the requirements of shariah, an American listener working in a real estate business in Jordan stood up and said, “I am completely confused about the products you have, but it sounds all very interesting.”
The man was not alone. Panelists presenting the latest models for Islamic real estate financing at the event said apologetically at several points that their explanations would “increase the confusion” of listeners, especially when questions ventured into the ethical underpinnings of specific Islamic products. Instead of trumpeting new flashy deals between Islamic bankers and regional real estate investors, speakers overall had their hands full with building awareness in a meeting that showed how the complexity of Islamic financial concepts in the past five years has grown faster than the corresponding knowledge base in the regional investor community.
As one example, sukuk—asset-backed securities that are employed in growing numbers for securitization operations with real estate as underlying assets—have ballooned into 17 different varietals on record with the Accounting & Auditing Organization for Islamic Financial Institutions (AAIOFI). The first modern sukuk was issued as simple arrangement but five years ago by the government of Malaysia.
In the retail market, the contracts and models for Islamic real estate finance have sprouted from relatively simple mudaraba transactions (in which a bank purchases a property and resells it to its client at a fixed higher price payable in installments) to multi-layered deals that include leasing (ijara), diminishing joint ownership (diminishing musharaka), and parallel and mixed leasing agreements.
The United Kingdom has acted as center for developing these shariah-compliant products, said Tariq Hameed, a partner in British law firm Norton Rose. However, when pressed for numbers and the UK market size for the Islamic product marvels, he estimated the number of existing contracts at 5,000 home finance deals—out of 410,000 Muslim households in the country. “Many Muslim families in the UK don’t trust that the contracts really are shariah-compliant,” he offered as explanation.
Lots of room for growth
In Jordan, the size of the Islamic housing market also has a lot of room for optimists. Jordan Islamic Bank (JIB), one of two shariah-compliant banks in the Hashemite Kingdom, has records of $700 million worth of home finance agreements—but that is a lifetime achievement of the bank in the past quarter century. The numbers for 2006 are a modest $45 million for JIB out of an estimated $70 to $80 million in Islamic house finance deals by all Jordanian providers last year, an advisor to JIB told Executive.
And for sukuk, while the papers are growing impressively in issue size and total numbers, the majority of investors come from a conventional background, with interests that are not driven by the Islamic aspect of the complex structures.
Islamic finance is, by definition, a practice of business which adheres to rules that transcend the mere mechanisms of the markets. Drawing strength from its roots and the blessings of wealth in Muslim societies, Islamic finance took shape between the early 1960s and late 1980s and has gained greatly in international stature since the mid 1990s. As such, modern Islamic finance for the past decade or so has with increasing vigor addressed the formidable challenge of conducting business activity in a manner that is satisfactory through both its economic rewards and its religious purity.
A very big part of this process has been and still is to set standards that meet the requirements of two very complex and inherently demanding systems: shariah law and the latest economic science. Creating standards that fuse these two realms into a winning partnership is the chosen task of organizations such as the Islamic Financial Services Board (IFSB), which was established in 2002 in Malaysia as international body of regulators and Islamic financial institutions.
The IFSB hosted a seminar on real estate financing standards back to back with the Amman conference last month and is generally very busy this year, with eight major event packages that discuss topics from legal issues to the “European challenge” for the industry.
This standard-setting and dissemination enthusiasm goes hand in hand with the growing awareness and expansion of Islamic financial services to highly developed conventional financial markets in Japan, where the central bank has shown interest in the specialty, and Europe, where the UK authorities have been taking steps to ease the facilitation of Islamic finance and where France recently has started considering a regulatory framework that will accommodate Islamic banking.
But there are signs suggesting that the course of Islamic finance is entering another phase of its development. In the past three years, more and more financial firms and general corporations in the Gulf region have been converting their operations to become shariah-compliant. However, as a survey by the IFSB showed last month, the growth rates of Islamic banks in many Muslim countries have dropped from exponential between 2003 and 2005 to more normal in 2006.
Islamic assets in the banking sectors of countries like Bahrain, Qatar, Jordan and Malaysia represent between 10% and 15% of total banking assets, with no significant increase in the percentage share in the first half of 2006. While Brunei was the only upward outlier with more than 40% of assets being Islamic, Lebanon joined Indonesia and Pakistan at the low end of the scale with no more than 2% of Islamic banking assets. According to the survey, Islamic finance is still growing in the Middle East but so is conventional banking, and the strongest growth rates are usually not on the side of Islamic banks.
For banks, specialization in Islamic real estate finance can be attractive in two ways, as facilitators of home or commercial property purchases by their customers, and as means for their own investments. While conventional banks are largely excluded from using real estate for profit-oriented own investments, the operating mandate of Islamic institutions has led regulators in several countries to allow these banks to include property in their investment portfolios.
Different jurisdictions, different regulations
However, the banks are facing different restrictions in different jurisdictions, as some regulators put limits on Islamic banks’ real estate investments and others don’t. In Europe, the practitioners also still face cost issues in home financing. These originate from tax laws that make no provisions for the special processes of Islamic finance, such as double transfer of deeds in a mudaraba structure. Only the UK has taken steps toward removing these cost barriers.
All this underpins the case made by the Islamic finance protagonists that the playing field for real estate finance by Islamic institutions should be made more level, beginning with continued standardization initiatives of central banks and regulators in Muslim countries.
Cost barriers and overly complex structures of Islamic products can be impediments for the growth of Islamic finance beyond sitting on a ledge as niche operators that address customers who will not enter the realm of conventional banking. While this target group is important, especially in developed countries, the ethics aspirations involved in the drive to expand Islamic finance extend into creating a humane economic realm, which will appeal to wide population groups—which as a larger aim underscores again the need for comprehensive standards.
And while the buzz of abundant liquidity by shariah-compliant investors and financial institutions in the Gulf certainly is no myth, the security and business convenience environment in the Levant has yet to infuse managers with more confidence. Take the example of Kuwait Finance House, a big player in channeling funds into real estate investments under observance of shariah, which has nearly $7.5 billion in property assets and funds.
KFH wants to expand in the Middle East, but for the time being, its property portfolio is invested in Europe, the Americas, and Asia. Said the manager of KFH’s international real estate department, Ali Al-Ghannam: “We have received many proposals for projects in Syria, Jordan, Lebanon, and North African countries, but so far we have no concrete projects.”