Date: April 21st, 2003

Title: The implications of globalisation for Islamic finance

Author: Professor Rodney Wilson, University of Durham, UK

With its new Sukuk Al-Salaam Securities Bahrain has overcome this problem, by providing a fixed return, equivalent to 3.95 percent at an annualised rate for the first Islamic bill issue, which is not based on interest. The return has been calculated in relation to the real benefit the government expects to obtain on the funds, rather than with reference to market interest rates. The first securities matured on September 12th 2001, but this was only the first of many issues as the intention is to issue new Sukuk Al-Salaam every third month.

So far prospects for Sukuk Al-Salaam securities look encouraging, as the initial offer of bills in June 2001 worth $25 million was oversubscribed, with subscribers, mainly banks, offering $59.1 million. The minimum subscription was fixed at $10,000. This meant that relatively small financing houses could participate, as well as private investors seeking a non-banking home for their dollar denominated liquidity. The second issue in September 2001 was also oversubscribed, with banks offering $74 million for Sukuk Al-Salaam securities offering only 2.50 percent. The third issue in December was also oversubscribed, despite the rate being lowered further to 2.00 percent, but this may reflect the limited amount of the Sukuk Al-Salaam securities offered at $25 million. The success of this market in Islamic government securities has encouraged three Islamic banks to launch a liquidity management centre in Bahrain where Islamic corporate securities could be traded. The banks involved include the Kuwait Finance House, the Dubai Islamic Bank and the Bahrain Islamic Bank.

The launch of the Islamic money market in Bahrain has already resulted in the emergence of markets in longer-term Islamic securities, notably bonds, with Bahrain playing a similar role in the Gulf and West Asia to that of Kuala Lumpur in South East Asia. Bahrain government leasing securities worth $100 million were officially listed on the Bahrain stock exchange in September 2001 based on the ijara principle. These five-year Islamic bonds mature in September 2006 and offer a lease return of 5.52 percent paid twice each year in March and September. The rate was lowered for the second issue of the sukuk bonds, and the third issue, launched on 29th August 2002, pays a 4 percent annual return in two instalments every February and August until 2007. The third issue of for $80 million to fund infrastructure was oversubscribed by 211 percent, indicating excessively generous pricing. Although such disequilibrium pricing can be justified to increase market confidence, it arguably raises the cost of capital for essential projects needlessly.

In Malaysia there is a much longer history of the government issuing Islamic securities as the first non-interest bearing government investment certificates were issued in 1983. These were equivalent to certificates of deposit rather than bonds, although they were never described in these terms. However unlike bonds that have a fixed return, the Islamic securities issued in Malaysia had a variable return, with a dividend committee determining the rate based on macroeconomic and inflation indicators. Returns varied annually, but as the dividend committee had discretion over how to interpret macroeconomic and inflation data, simply looking at forecasts for these variables was not necessarily a good indicator of returns. There have been some calls for the dividend committee to publish the minutes of its meetings to increase transparency and accountability. These Islamic securities are not traded significantly, but when dealings occur prices remain close to redemption values in a similar manner to the value of certificates of deposits, rather than diverging markedly as is the case with bonds.

The more widely traded Islamic financial instruments in Malaysia are the mudarabah inter-bank investments that have maturities from overnight to twelve months and Al Bai Bithaman Ajil notes, with payment for the sale of goods providing the income stream. These have been traded since 1994, with most of the initial issues used to finance government borrowings. As with the Islamic securities started eleven years earlier, returns are variable rather than fixed, hence the instruments should be designated Islamic notes rather than Islamic bonds. By the late 1990s Islamic notes were issued for semi-state corporations in Malaysia as well as the government itself, and more recently Islamic commercial paper has been issued, usually in the form of notes.

In May 2002, for example, the TSH Resources Company of Malaysia issued murabahah commercial paper and medium term notes to cover refinance of corporate debt and the construction of a power plant in Sabah. The financing involved was RM 100 million ($ 26.3 million) over a seven year period with the murabahah commercial paper covering periods of up to one year and the notes that provide a variable return running from one to seven years. Similar facilities were provided the same month for the Malaysian Sunrise Corporation with RM 100 million ($26.3 million) being covered by an Al-Bai Bithaman Ajil facility and RM 70 million ($18.4 million) being provided through medium term notes. In Malaysia there are fund management groups that specialise in investing in such issues, notably the RHB Islamic Bond Fund, although it might be more accurately designated as an Islamic note fund.

The Islamic leasing sukuk issuance by Kumpulan Guthrie of Malaysia for $150 million to finance acquisitions in Indonesia was based on ijara leasing. This first foreign currency Islamic issue by a Malaysian corporation has been incorrectly described as a bond in some of the media, but as the return varies over the two and four year periods of the trust certificates, it would be better described as pertaining to notes. This also applies in the case of the sukuk al ijara issued in July 2002 by the government of Malaysia. This issue of $500 million was more than half subscribed by Islamic banks and investment companies in the Gulf in spite of some misunderstandings about the terms and how the rates of return were calculated.

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Institute of Islamic Banking and Insurance, New Horizon, November 2001, London, p. 18.
Institute of Islamic Banking and Insurance, New Horizon, February 2002, London, p. 17.
Institute of Islamic Banking and Insurance, New Horizon, March 2002, London, p. 17.
Institute of Islamic Banking and Insurance, New Horizon, December 2001 – January 2002, London, p. 27.
Bahrain Monetary Agency Press Release, www.bma.gov.ba
Islamic Banker, Issue 77, June 2002, p. 22.
Islamic Banker, Issue 76, May 2002, p. 31.
Institute of Islamic Banking and Insurance, New Horizon, February 2002, London, pp. 19-20.