Islamic Bond Market Revival

Sources:
Islamic Finance: Islamic Finance
Bloomberg Businessweek: End to Sukuk Freeze Spurs Pakistan Fund Buying: Islamic Finance
Asia Sentinel: Islamic Banking Back on Track
Bloomberg: Sudan, Albaraka, IDB, Pakistan, Thailand Plan Issuance: Islamic Bond Alert
Khaleej Times: GCC Sukuk Activity Rebounds

Islamic Governments and banks are once again issuing Islamic bonds, or sukuk, after a fourteen month hiatus. Sukuk are bonds in harmony with sharia, Islamic Law, which forbids lenders from charging interest rates on loans. However, Sukuk do provide the lender with payments similar to interest payments. The bank will invest money raised from the sukuk bonds in a company or homes, giving the mortgage payments to bond holders, instead of interest. Sukuk is thus similar to an asset backed security. The result is basically a bond with interest, but the mechanics are altered to satisfy sharia.

Sukuk were developed to allow pious Muslims to borrow but within the confines of their faith. The loans are issued and bought by banks and companies with Islamic values ( no pork, pornography, alcohol, or gossip).

The Islamic Development Bank is going to issue at least $500 million of sukuk in 2011 to achieve its funding needs of $1 billion annually. A similar amount was issued in October. The Islamic Development Bank will use the bond revenue to lend to various companies and projects across the Middle East. The largest Islamic bank in Bahrain, Albaraka Banking Group (“Albaraka”), expects to raise $200 million from issuing sukuk by the end of the year. The Albaraka sale presents a cultural fusion of the West and Islam. The bonds are Islamic, but Standard Chartered Plc, an English bank, will be one of the managers of the issuance.

Pakistan’s government will be issuing a sukuk sale worth $934 million to help cover its budget deficits. Other governments in the region will take similar steps. The Qatar Islamic bank issued $750 million sukuk and the bonds were given an “A” rating by Fitch, a rating agency, on the London Stock Exchange. The revival in Islamic Banking also represents the restoration of normalcy in the global financial system as a whole.

The fourteen month hiatus was a product of Dubai’s debt problems. From 2000-2006, Dubai greatly improved its cities and became a luxury destination for the world. Most of the developments were financed by borrowing, and Dubai still had extensive debts when the financial crisis hit. The entire region was affected, damaging economies and thus decreasing borrowing demand. Because sukuk are viewed as luxury bonds, their use is restricted by sharia, and, banks have to pay more “interest” to consumers to sell them, they were scarely used during the period of low demand when investors were looking for the safest, simplest bonds possible.

Discussion:
1.The Islamic Banks seem to use English banks and the London Stock Exchange. Why is there sukuk activity in England and not in the United States?
2. If governments need to borrow more because of deficits, then why use sukuk where it requires a higher interest rate than normal bonds?