Related News

DBS and IFC sign global trade deal for emerging markets

IFC joins Taulia as supply chain finance funder

WTO chief calls on development banks to help close trade finance gap

IFC kicks off supply chain finance initiative with Citi pilot

Sime Darby, MUFG close first Islamic green trade finance facility

Conventional banks are becoming capital constrained for trade finance, the Middle East is opening up to more regional trade:
Islamic trade finance should be enjoying a surge of interest. But why has the growth been relatively slow? Nick Lord reports.

Islamic trade finance volumes and lines should be experiencing a surge at the moment. The financial crisis and ongoing sovereign crises caused liquidity issues for many non-Islamic banks. These are now being compounded by regulators who want to make banks put away more capital for low-risk products like conventional trade finance.

However, the losses in the conventional world are not being replaced by growth in the Islamic world. According to figures from the Islamic Development Bank (IDB), the total trade of the 56 IDB member countries in 2009 was US$3.374tn. However, in the same year, the total trade funded through the IDB’s Islamic Trade Finance Corporation was only US$2.16bn. In 2011, it is expected to grow to only US$3bn. While not all Islamic trade finance goes through the ITFC, it is still an indication of the small percentage of the total trade financed using Islamic trade finance facilities.

Regional trade growth

One of the main problems for the growth of Islamic trade finance is that both sides of the trade need to agree to use it. This means that it has only really been applicable to intra-Islamic trading blocks. But most trade from and to Islamic countries in the Middle East and Asia has tended to be with non-Islamic countries: oil exports and consumer goods imports between the West and the Middle East; or commodities from Asia and finished goods into Asia. There has simply been very little intra-Islamic trade.

That is changing. As a result of the financial crisis, exporters in Islamic countries are looking to replace depressed markets in the West with markets closer to home. And despite the on-going political turmoil in the region, trade between members of the IDB has now reached 16.3% of their total trade. With the growth in the underlying trade, so the Islamic trade finance product should increase too.

The product does have its technical attractions, especially to banks that are facing unprecedented calls on their capital. Much Islamic trade finance can be funded from new sources of liquidity in the Middle East. Also, having subsidiaries that can be capitalised outside of the conventional markets would seem to be attractive. Islamic trade finance fits this bill easily. It is very easy to substitute a conventional trade finance asset for an Islamic trade finance asset and with that tap into Middle Eastern sources of liquidity to finance that asset. “Islamic trade finance and conventional trade finance do not differ a lot when it comes to financing,” says George Andraos, deputy head, international department at Fransabank in Beirut.

“Islamic institutions are very liquid and they could not access much in the developed markets before,”

Andraos believes that with the ease of attaching an Islamic trade finance capacity onto a conventional one, more banks will be offering this capability to their clients in coming years. “It was concentrated in a few countries before, but now it is in many more,” Andraos says. “There are clear rules and lots of banks are following them and looking to expand.”

New liquidity sources

Other banks point to the fact that there is a lot of spare liquidity sitting in Islamic countries that does not have anywhere to go. By setting up Islamic trade finance facilities, banks can tap into this liquidity. “Islamic institutions are very liquid and they could not access much in the developed markets before,” says Tariq Mateen Khan, head of financial institutions at Habib Bank in Karachi.

Many believe that the future of the product is bright for both the underlying trade reasons and the technical attractions of the product. “The outlook for Islamic trade finance is strong, given the demand for Islamic banking, and the total Islamic trade finance between the countries in the Organisation of Islamic Conference is expected to reach 20% of the total trade financing,” says Ghazanfar Naqvi, global head, Islamic origination and client coverage, at Standard Chartered Saadiq in Dubai.

Bankers believe that it is down to a question of familiarity. As customers become more aware of trade finance products from Islamic sources, so they will conduct more business. “Islamic trade finance is expanding across key markets in Mena and Asia as customers become more familiar with Islamic banking trade finance products and are able to convert their portfolio to Islamic banking,” says Naqvi at Standard Chartered.

“Furthermore, Islamic banks are an alternative source of liquidity for new customers who are looking at Islamic trade finance, to take advantage of the move towards asset-based financing.”

Sukuk competition

One difficulty is that Islamic trade finance actually competes with other forms of Islamic finance and that most of the famed Middle Eastern liquidity is going into the general Islamic finance market, rather than into the Islamic trade finance market. Sukuks are more attractive than murabaha, musharaka and wakhala.

Musharaka and wakhala are deemed more risky in that their repayment is subject to an individual guarantee; in other words there can be default. For murabaha paper, there is no default risk as the bank undertakes the transaction for both importer and exporter and takes the profit at the time of exchange. But that is essentially a fee business, which does not need much capital. And when it comes to liquidity, institutions need to put their money away for a term, rather than just indulge in fee business. As a result sukuk – or Islamic bonds – are proving more popular than murabaha, or Islamic trade finance deals.

“We have fewer products on the shelf at the moment than conventional banks,” says Muhammad Abdullah, head of treasury and financial institutions at Meezan Bank, the largest Islamic bank in Pakistan. “Islamic banks want to deploy their capital into sukuks or with the government.”

Other bankers disagree. They think that having control of the underlying asset actually makes for a better security than just traditional government-linked sukuks. “Islamic banking in general is a growing market and therefore Islamic trade finance is ideal, as it facilitates the trade of goods and services,” says Naqvi. “For example, through the Islamic trade finance product ‘goods murabaha’, a bank may have better control on the underlying assets.”

The question then becomes, if the banks are willing to provide the finance, why has it not happened? Potentially the biggest issue is that clients are not demanding the Islamic trade finance product. Bankers say that the products would be there if the customers were asking for them. “As with any industry that is growing, there is room for product development, however, this applies to conventional banking as well as Islamic,” says Naqvi at Standard Chartered. “Currently, Standard Chartered Saadiq offers a whole range of vanilla import and export products, as well as more structured solutions, customised to meet the needs of our customers. In addition, with the development of our Islamic hedging products we are now able to offer end-to-end shariah-compliant solutions for trade transactions.”

Growing appeal

One area that is growing fast, although from a small base, is Islamic export credit insurance. This product has been pioneered by the Islamic Corporation of the Insurance of Investments and Export Credit (ICIEC), which is part of the Islamic Development Bank. At the annual board of directors meetings of the IDB in March, it announced that in 2010 ICIEC saw growth of 91% in business insured to a level of US$1.97bn and an increase of 52% in new insurance commitments, which reached US$3.25bn. As a result of this, the board agreed to increase the capital of the institution from US$240mn to US$640mn.

Commenting on the increase in capital, Abdel Rahman El-tayeb Taha, the CEO of ICIEC says: “The approval to increase the capital resources of ICIEC will significantly enhance the insurance capacity of the corporation and enable it to meet the huge demand for ICIEC’s credit and country risk insurance services from exports and investors in member countries.”

However, despite the rapid growth in the business, the problem still seems to be one of general awareness of the product. The global financial crisis should have helped the product’s development. After all, in times of extreme stress, insurance tends to sell well.

Even if the overall product still has a long way to go before becoming dominant in its core home markets in the Middle East, there are signs that other countries are starting to see the risk mitigation and liquidity benefits of using Islamic trade finance. For instance, in March the ITFC signed a US$14mn export financing package with Gambia for the export of its groundnut crop. Similar deals are likely to follow in Senegal and Guinea Bissau.

In November 2010, the ITFC also signed a US$1.3mn credit line with Turan Bank in Azerbaijan, for the financing of non-oil exports. It is deals like these, on the fringes of the Islamic world, that show the benefits of tapping into this new market. Once it becomes standard practice in core trading nations, its time will have come.