Trade Finance, The Islamic Way

Islamic lenders need to improve their efficiency and increase penetration in predominantly Muslim markets to be big players in global trade finance.

Located at the crossroads of Asia and Europe while at a favourable proximity to Africa, Dubai and the UAE have been well positioned to capitalise on the large trading volumes that pass through the region.

In line with the growing volumes, trade financing, which is a specialised area of finance dealing with short term funding of import and export transactions, too has grown over the last few years. The global trade finance market is forecast to be worth $38 billion by 2015, according to a report by the UAE-based investment firm Al Masah Capital that quoted management consultant Oliver Wyman.

Meanwhile, trade in the MENA region is expected to surge by 131 per cent by 2026, a previous HSBC study forecast, widening the potential for trade finance in the regional market. This has drawn the interest of Islamic banks and financial institutions, which are now looking to take a cut from the lucrative pie, after failing to tap into the sector previously.

Islamic trade finance has strong growth potential, especially in the emerging rapid growth markets (RGMs) that include turkey, Indonesia, Malaysia, Qatar, Saudi Arabia and the UAE, according to a report by advisory firm EY. “The increase of trade flows to the east and within emerging economies combined with growing interest in Islamic finance, means that Islamic trade finance is now a serious alternative,” said Ashar Nazim, partner, Global Islamic Banking centre of excellence at EY. Local Islamic lenders in the GCC are among those taking note of this shift, readying to cash in.

“There is a significant increase in trade movement within the Middle east and the emerging economies as well as in Islamic growth markets such as Turkey, Malaysia, Indonesia, the UAE, Saudi and Qatar.

“For three or four years, Islamic finance was less receptive to trade finance. However that is fast dissipating,” said Hussain Al Qemzi, board member of the Dubai Islamic Economy Development Centre and CEO of Noor Bank in his keynote address at the World Islamic Economic Forum, held in Dubai.

“Today, the exponential global growth in Islamic financing has meant that sharia compliant trade financing is a viable solution for businesses.” But some corridors are more active than others, Al Qemzi noted. “For instance, significant growth is coming into Africa from China and any bank, from whichever geography, helping to mediate this flow is facilitating global trade. Middle East banks and within that space, Islamic banks are increasingly playing an important role.”

OIC – A PLACE TO BEGIN

Despite the strong growth that Islamic banking has registered over the last few years, the share of Islamic trade finance globally is still painfully low. “At the start of 2014, Islamic trade finance transactions totaled only a negligible 1.5 per cent of the total global trade finance transactions,” Al Qemzi said.

Industry experts argue that if lenders want to raise their share, they should begin with members of the Organisation of Islamic Cooperation (OIC), where there is a relatively untapped opportunity in the large Muslim population.

“There is huge potential for Islamic finance both in the intra – OIC trade market as well as globally,” said Ashruff Jammall, consulting firm PwC’ s global Islamic finance leader. “In 2011, intra-OIC trade accounted for only 17.8 per cent of global trade of $2.1 trillion undertaken by OIC member states and only 1.5 per cent of world trade finance flows using Sharia compliant instruments.”

Growth of 131 per cent in trade happening in the MENA region highlighted the potential of trade finance, he said; offering an opportunity for Islamic lenders to grow their market share. However, lower Islamic finance penetration levels in OIC markets put a dampener on proceedings.

“In OIC countries, where the population is predominantly Muslim, Islamic finance has still not penetrated fully let alone in world trade,” said Adnan Chilwan, CEO of Dubai Islamic Bank (DIB) during a panel discussion at WIEF. “Islamic finance and Islamic trade go hand-in-hand and the latter will automatically increase if there is more penetration of Islamic finance.”

The CEO called for other lenders to widen their reach in order to increase Islamic finance penetration from the current four to five per cent in most OIC countries. “Once Islamic finance penetrates into these markets, the next step is to ensure all structures follow the Islamic finance model, trade being one of them,” said Chilwan.

CHARTING REGIONAL GROWTH

Islamic trade finance could also grow in the regional market through forming partnerships with conventional banks, which have a more developed system of trade finance.

“Rather than competing with major international banking institutions, Islamic financial institutions should be looking to cooperate and form alliances with these banks in order to increase their footprint in the regional trade finance market. A case in point would be DIB’s announcement last year that it would work with Deutsche Bank to bring its letters of credit to Europe,” said PwC’s Jammall.

But just collaborating with conventional banks will not ensure the growth of Islamic trade finance in the region, he noted. “They (Islamic banks) need to achieve economies of scale in order to become more price-competitive with their conventional counterparts. Islamic financial institutions also need to improve their efficiency levels in order to improve their product and services’ delivery capabilities.”

Issues of complex documentation and low awareness among customers also need to be tackled, but if the correct framework is used and awareness of sharia compliant initiatives continues to grow, MENA markets will be able to strengthen their trade focus on the growing Muslim populations in emerging economies, argued EY’s Nazim.

“These initiatives have the potential to significantly increase the value and volume of trade of these expanding markets. This is an opportunity that should not be overlooked.”

Originally published on www.gulfbusiness.com