GTR speaks with International Islamic Trade Finance Corporation (ITFC) acting CEO Hani Salem Sonbol about the need for greater development in the Islamic finance market.
GTR: What have been some of the biggest developments and innovations in shariah-compliant trade finance products and structures over the last year?
Sonbol: Most of the major developments and innovations in Islamic finance products (shariah-compliant finance products) are capital market tools, and most of the newly-developed products are tailored based on mudarabah, wakala and sukuk by structuring a certain transactional flow using one or more of these products aiming to liquidate assets and secure liquidity. However, it is rare to hear about new Islamic finance products introduced to the direct financing market: this could be due to the existing diversified financing products that are used to finance corporate clients directly, such as murabaha, musharaka, salam, istrisna’ and ijara. Another reason for the scarcity of new direct Islamic financing products is the risk appetite of the banks, as capital market tools are based on liquid assets and rated credit portfolios, while direct financing is associated with commercial transactions that could be affected by several risk elements, which could be beyond banks’ control in some cases.
GTR: What are some of ITFC’s opportunities for further expansion (whether geographically, or in terms of products) in the short term?
Sonbol: During the last year, ITFC saw its opportunities in extending trade solutions to more countries and clients. This in part is due to ITFC’s strategic drive for growing its presence and client proximity, which helped improve the overall business portfolio. ITFC started its push for regional presence in 2014; and in 2015 it successfully established field offices in Turkey, Indonesia and Senegal. Further expansion is expected: ITFC recently signed a host country agreement with the UAE government to establish a branch in Dubai. So far, the result is promising as we see the investment in regional presence paying off; we hope that by being closer to our member countries, the result will be more diversification and client proximity.
The corporation has developed new financing products during the last few years; most notably structured trade finance (STF), which has positively impacted trade finance volumes, contributing to the co-operation and integration of the member countries’ economies. Through STF, ITFC can provide funding to private-sector entities in member countries. This way, STF provides a win-win solution, allowing ITFC to deliver on its mandate while maintaining a portfolio with acceptable risk profile.
In the trade development domain, the Arab Africa Trade Bridge Programme is ITFC’s partnership development initiative, which is designed in consultation with some regional partners. It is aimed at supporting trade exchange between Africa and the Arab region.
GTR: What are the challenges to increasing the take-up of shariah-compliant trade finance products? Some banks, such as DBS in Singapore, recently closed down their Islamic business due to a lack of demand.
Sonbol: Shariah-compliant trade finance products, and more broadly Islamic finance, are driven by demand, just like any other economic activity. The demand comes from capital owners that view Islamic finance as a privileged mode of financing. They are mainly Organisation of Islamic Corporation (OIC) governments and populations. Their economies are driven by hydrocarbon rent, which is the origin of their monetary surplus invested, among other investment grades, in Islamic finance. Consequently, there is a strong probability of a positive correlation between oil prices and revenues and the development of the demand for Islamic finance. That said, so far no empirical studies have demonstrated this assumption.
The demand is developing with the emergence of more and more economic agents aligned with Islamic finance principles. Yet there is a need to grow public awareness of the advantages of shariah-compliant financing and correct the misperception that Islamic banks’ procedures are cumbersome.
In addition, there is a slow pace of product innovation and development. Islamic banks need to not only catch up on product development but also anticipate future needs and work towards fulfilling them. Islamic finance needs to become more resilient by diversifying its sources.
The obvious, and still untapped source, is capturing the savings of the millions of individuals keen to deposit their money in Islamic banks only. Therefore, the development of Islamic retail banking is key for the development of Islamic finance and products, including trade finance.
Moreover, the regulatory framework, which was built from the ground up around conventional banking, does not fully accommodate shariah-compliant financing.
Finally, Islamic financial institutions face a real challenge in going back to the basics of Islamic finance to find innovation as opposed to what is commonly referred to ‘shariah wrapping’ of conventional products.
GTR: How can Islamic trade finance stand alongside conventional trade finance to bring about broader access to trade finance (particularly with regards to SME financing)?
Sonbol: In general, SMEs are better served by conventional banks rather than Islamic banks, as their financing requirements are mainly for working capital and running expenses. Such financing needs can be served by loans and overdrafts, while Islamic financing is generally transaction or project-based financing. Nevertheless, and despite the market gap in providing special Islamic finance products to SMEs, Islamic banks are serving them – although on a small scale – and exploring ways to expand the scope of their services to SMEs.
As a multilateral development bank, ITFC is uniquely positioned at the crossroads of Islamic trade finance and development. Thus, the corporation is working with a variety of international and local partner financial institutions to give SMEs access to trade finance lines. For instance, the two-step murabaha is one of the modes of financing used to reach SMEs.
ITFC channels its intervention through a local FI, with better understanding of local market and companies, which distributes the financing into smaller amounts for SMEs.
GTR: What have been some of ITFC’s most groundbreaking Islamic trade finance transactions closed recently?
Sonbol: The year 2015 was challenging, with political upheavals and depressed commodity prices (including the steep decline in oil prices) affecting several member countries. Notwithstanding the difficult operating environment, ITFC, in response to the needs of its members countries, expanded its trade support interventions.
ITFC has a mandate to provide financing in countries where the interventions have strong potential to make a positive difference in the lives of the common people, particularly in rural communities. An example is to provide financing to create value for agricultural output in early stages of production, which is critical for food security in many less-developed countries going forward. This type of financing is often avoided by commercial banks but at the ITFC this ‘grassroot financing’ is central to our developmental role.
In addition, to ensure economic activity stability in countries like Comoros, Djibouti, Egypt, Mali, Mauritania, Morocco and others, ITFC financing is used to supply refined petroleum products, leading to stability in energy supply.
For example, one of the products financed is heavy fuel oil, which is used in electricity generation. Stability in electricity generation has a positive impact on the economy in terms of continued operation of social services (hospitals, schools), infrastructure, agriculture, main industries, as well as individual homes.
In Comoros, ITFC is successfully helping to secure and rationalise the cost of energy supply, improving at the same time the country’s macro-economic situation. The intervention has helped reduce costs directly and consequently the financing has led to increased competition between suppliers, resulting in competitive pricing.
As for Morocco, ITFC is supporting private-sector initiatives in the oil and gas industry for the provision of crude oil, refined petroleum products as well as liquefied petroleum gas for local consumption.
In Egypt, ITFC’s financing, which supported 13% of the country’s hydrocarbon imports, has helped the government in reducing the pressure on foreign currency reserves and has actually highlighted the corporation’s strength in mobilising considerable amounts from the international and regional market at critical times.