Securing Funds During an Economic Downturn: Islamic Financing Another Option By Narita Naziree, Associate Director, PricewaterhouseCoopers Capital 10 August 2009
Explanatory Notice This document was prepared by PricewaterhouseCoopers Capital Sdn Bhd ( PwC Capital ) for the held on 10-11 August 2009 in Kuching, Sarawak, Malaysia ( the Conference ). In parts of this document, we may make reference to PricewaterhouseCoopers or PwC. PricewaterhouseCoopers or PwC is a general reference to the PricewaterhouseCoopers network of entities in Malaysia and the World. PricewaterhouseCoopers Capital is a separate legal entity within the PwC network in Malaysia. Apart from PwC Capital, the other Malaysian PwC entities include: PricewaterhouseCoopers, PricewaterhouseCoopers Advisory Services Sdn Bhd, PricewaterhouseCoopers Taxation Services Sdn Bhd and PricewaterhouseCoopers etax.com Sdn Bhd. This document is protected as an unpublished work under the copyright laws of Malaysia and of the other countries in which PwC entities operate. This document contains information drawn from publicly available sources, PwC information databases and PwC analysis that is intended to provide reference and insight to the participants of the Conference. Such information cannot be disclosed, used or duplicated in whole or in part by any party, unless prior consent has been obtained by PwC Capital. For further information, please contact: Narita Naziree PricewaterhouseCoopers Capital Sdn Bhd Level 10, 1 Sentral, Jalan Travers Kuala Lumpur Sentral, PO Box 10192 50706 Kuala Lumpur Malaysia Tel: +60(3)-2173-1188 Fax: +60(3)-2173-1288 Email: narita.naziree@my.pwc.com 2009 PricewaterhouseCoopers. All rights reserved. "PricewaterhouseCoopers" refers to the individual members of the PricewaterhouseCoopers organisation in Malaysia each of which is a separate legal entity or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.
Presentation Objectives 1 To introduce the key principles behind Islamic finance; To introduce the key principles behind Islamic finance; 2 To provide a snapshot of Islamic banking and finance in Malaysia today; and To provide a snapshot of Islamic banking and finance in Malaysia today; and 3 To Toshare sharesome some thoughtson onthe financing opportunitiesfor forsmes SMEsand corporates.
Part 1 Key Principles of Islamic Finance Valuation & Strategy
Part 1 - Key Principles of Islamic Finance Islamic finance is premised on Shariah principles and promotes ethical and socially responsible investments and financing. 1 Prohibition of Haram transactions Principles of Islamic Finance 2 3 Prohibition of Riba Prohibition on Gharah (uncertainty) 4 Prohibition on Maisir (gambling) 2
Part 1 - Key Principles of Islamic Finance Islamic finance transactions are backed by tangible assets, and promote productive trade. Real assets underlying any transactions Some Features of Islamic Finance Transactions Sellers own assets prior to sale Genuine trade transactions Higher level of disclosures 3
Part 1 - Key Principles of Islamic Finance The conventional financial system is observed to be more focused on transferring excess income generated from application of funds. Depositor Individuals with surplus funds Earns a premium on funds lent to a bank. Financial Institution Financial intermediary Uses interest rates to attract depositors and borrowers Credit focus vs Growth focus. Net interest income generated by appropriating depositor funds. Borrower Individuals with deficit funds Incurs an expense on funds borrowed from a bank. 4
Part 1 - Key Principles of Islamic Finance In Islamic finance, the concept of partnership is an important feature that is aimed at promoting wealth-creation. Depositor Individuals with surplus funds. Assigns funds for safekeeping in return for a gift (hibah) Shares the risks and profits on certain accounts. Financial Institution Financial intermediary / partner / asset owner Generates profits through commodity transaction (cost plus a mark-up) or partnership (profit sharing). Borrower Individuals with deficit funds Assumes payment on a deferred / rental basis or dividends. 5
Part 1 - Key Principles of Islamic Finance On the back of these principles, the Islamic finance sector has demonstrated some resilience in the current economic climate. Guidedby by Shariah principlesinin the the developmentof ofthe theislamic financial system, it it forms formsthe thevery foundationthat that contributes towardsits itsoverall stabilityand and resilience. The The Shariah injunctionsrequire requirethat thatislamic financial transactionsare are supportedby byan an underlying economic activity. This Thisresults resultsinin aclose closelink link between financialand and productiveflows, which whichinin turn, turn, shields shieldsthe theislamic financialsystem systemfrom excessive leveraging, imprudentrisk risktaking and and speculative activities. Tan Sri Dato Dr Zeti Akhtar Aziz Governor of Bank Negara Malaysia, February 2009 6
Part 2 An Overview of Islamic Finance in Malaysia Valuation & Strategy
Part 2 - An Overview of Islamic Finance in Malaysia Malaysia is the largest Islamic finance market outside the Middle East, as demonstrated by the size of its Shariah compliant assets. Country Total Shariah Compliant Assets (US$ mil) Iran $235,335.20 Saudi Arabia $88,847.90 Malaysia $66,676.20 Kuwait $63,137.90 UAE $49,082.60 Bahrain $37,405.20 Qatar $21,022.10 UK $17,485.20 Turkey $15,782.70 Pakistan $6,314.80 Bangladesh $5,706.90 Source: The Banker IFI Listing 2008 8
Part 2 - An Overview of Islamic Finance in Malaysia Malaysia s Islamic finance market is today made up of services in banking, capital market and non-banking financial services. TAKAFUL First takaful operator established in 1984, however market penetration is still low. PRIVATE EQUITY Low investment penetration but anticipated to grow. ISLAMIC FUNDS Funds have grown from 2 funds in 1993 to 149 in 2008. Focus on increasing international players. ISLAMIC FUNDS ISLAMIC BANKING / SUKUK ISLAMIC BANKING Islamic banking assets expected to represent at least 20% of total banking assets in the system by 2010. MICROFINANCE Low market penetration but potential growth area. MICROFINANCE TAKAFUL PRIVATE EQUITY SUKUK As at July 2009 Malaysia was largest issuer of sukuk globally with a 58% global market share. EMERGING GROWTH ESTABLISHED MATURE / SATURATION 9
Part 2 - An Overview of Islamic Finance in Malaysia Total Islamic financing recorded a CAGR of 16.3% between 2002 and 2008, in contrast with 5.9% for conventional financing. Total Financing (RM billion) 800 700 600 500 400 452 415 474 424 514 454 558 488 593 514 644 554 727 743 619 627 300 200 100-37 49 60 70 79 90 108 115 2002 2003 2004 2005 2006 2007 2008 June 2009 Conventional Banking Islamic Banking Total Banking Industry Source: Bank Negara Malaysia 10
Part 2 - An Overview of Islamic Finance in Malaysia Globally, Malaysia has been a market leader in sukuk issuance, representing 58% of total market share in terms of value in July. Sukuk issuance by country (Jan-Jul 2009) No. of issuances/value issued USD bil 25 22 20 15 10 5 0 USD4.12 bil 0 USD0 bil 1 USD1.33 bil 2 USD0.67 bil USD0.75 bil 1 1 Malaysia UAE Saudi Arabia Indonesia Bahrain Pakistan USD0.19 bil No. of issuances Value USD billion Source: Dealogic Islamic League Tables 11
Part 2 - An Overview of Islamic Finance in Malaysia However, among the issues the industry faces is differentiation from a customer perspective. Islamic financing by purpose (June 2009) Conventional financing by purpose (June 2009) Purchase of nonresidential property 4.0% Personal use 9.4% Purchase of residential property 18.2% Others 7.8% Source: Bank Negara Malaysia Working capital 25.7% Purchase of transport vehicles 32.0% Purchase of nonresidential property 10.3% Personal use 7.4% Others 13.3% Purchase of residential property 28.5% Purchase of transport vehicles 13.0% Working capital 27.6% 12
Part 2 - An Overview of Islamic Finance in Malaysia From a product perspective, products typically mirror conventional offerings. Cash line facility-i Contract financing-i Equipment financing-i Factoring facility-i Industrial hire purchase-i Land financing-i Leasing-i Term financing-i Shope house financing-i Working capital financing-i Bai Inah, Bai Bithaman Ajil, Murabahah Murabahah, Bai Bithaman Ajil, Istisna, Musyarakah, Mudharabah, Ijarah Bai Bithaman Ajil Bai Dayn Ijarah Bai Bithaman Ajil Ijarah Bai Bithaman Ajil, Variable Rate Bai Bithman Ajil Bai Bithaman Ajil istisna Variable, Rate Bai Bithaman Ajil Murabahah, Bai Bithaman Ajil, Tawarruq/Murabahah, Musyarakah, Mudharabah. 13 Source: MIFC, Bank Negara Malaysia
Part 2 - An Overview of Islamic Finance in Malaysia Another issue is the dominant use of debt-financing structures such as Bai Bithaman Ajil, which has met with some controversy. Islamic financing by concept (June 2007) Islamic financing by concept (June 2009) Istisna' 1% Mudharabah 0% Musyarakah 0% Murabahah 9% Others 18% Bai Bithaman Ajil 41% Istisna' 1% Mudharabah 0% Musyarakah 1% Murabahah 17% Others 14% Bai Bithaman Ajil 33% Ijarah 3% Ijarah Thumma Al- Bai 30% Ijarah 1% Ijarah Thumma Al- Bai 31% Source: Bank Negara Malaysia 14
Part 2 - An Overview of Islamic Finance in Malaysia Moving forward, there are underlying signs that a shift in concept will enhance the role of Islamic finance institutions. Core Areas of Islamic Financing Debt-Financing Equity-Financing Contracts include Murabahah, BBA and Ijarah. Dominant structures used in term-financing products. More easily assimilated in an environment accustomed to conventional financing. Main contracts are Mudarabah and Musharakah (profit / loss sharing basis) Oriented towards a bank focusing on equity-financing and asset-management operating models. 15
Part 3 Islamic Financing Opportunities Valuation & Strategy
Part 3 - Islamic Financing Opportunities SMEs are a prime segment for Islamic banking institutions, and stand to benefit from an alternative style of financing. Key Features of SME market Constitute 99.2% of total businesses in Malaysia Provides employment to 5.6 million people Contributes 32% to GDP Financing to Small / Micro Companies Financing penetration estimated at 13% Average financing size of RM10,000 Limited Islamic finance providers Fundraising challenges Limited track record to meet Bank s criteria Higher cost of borrowing Sources: SME Annual Report 2007, BNM Annual Report 2007, National SME Development Council 17
Part 3 - Islamic Financing Opportunities Government support for SME financing is evident, and Islamic SME financing is the fastest growing segment. Total Financing (RM billion) 140 120 100 80 60 40 20 - Islamic SME financing CAGR 2006-2008 20.5% (conventional = 10.1%) Islamic SME financing penetration was 12.4% of total SME financing (June 2009) 49 37 30 21 11 12 5 7 34 60 42 70 50 79 57 90 15 16 16 18 10 12 13 15 67 108 73 115 23 23 18 19 2002 2003 2004 2005 2006 2007 2008 June 2009 Islamic consumer financing Islamic commercial financing Note: Islamic commercial financing has been estimated using the penetration rate of SME financing to total business financing as a proxy Islamic corporate financing Total Islamic financing Source: BNM Monthly Statistical Bulletin, SME Annual Report 2007 18
Part 3 - Islamic Financing Opportunities However, Islamic equity-financing for SMEs and corporates can offer a new range of opportunities. Focus on company s potential Access to Liquidity Partnership support Investor s focus is on the potential of a company s venture, not solely on the creditworthiness of the company. Islamic funds are one of the fastest growing segments, and seek out projects and ventures with growth and economic potential. Some partnerships enable companies access to professionals and advisors to support the growth of the business/venture. 19
Part 3 - Islamic Financing Opportunities Islamic funds is a fast-growing segment of the financial services industry, with many funds listed under the equity-fund category. Net Asset Value of Mutual Funds in Malaysia and Islamic/Conventional Split Shariah based unit trust funds by category (June 2009) 180 160 17 80 70 67 RM billion 140 120 100 80 60 40 20-9 17 7 8 153 113 117 81 90 2004 2005 2006 2007 2008 Conventional Islamic No. of funds/nav 60 50 40 30 20 10-21 RM1.5 billion Balanced Fund 19 RM1.6 billion Sukuk Fund No. of funds RM12.0 billion Equity Fund 36 RM4.7 billion Others* Net Asset Value Sources: SC Annual Report 2008 20
Part 3 - Islamic Financing Opportunities Islamic private debt securities is one area where equity-financing contracts are evident. Notable Sukuk Approved in 2008 Issuer Danga Capital Bhd Plus SPV Bhd Dewa Ringgit Sukuk Limited The Export-Import Bank of Korea Industrial Bank of Korea National Bank of Abu Dhabi Seafield Capital Bhd Lingkaran Trans Kota Sdn Bhd UMW Toyota Capital Sdn Bhd Tadamun Services Bhd Rim City Sdn Bhd GS Galtex Corporation Source: Securities Commission Shariah Principle Musyarakah Musyarakah Ijarah Conventional & Sukuk Conventional & Sukuk Conventional & Sukuk Musyarakah Musyarakah Musyarakah Ijarah, Istisna & Murabahah BBA Conventional & Sukuk Nominal Value (RM million) 10,000 4,000 3,500 3,000 3,000 3,000 1,500 1,145 1,000 1,000 1,000 1,000 21
Part 3 - Islamic Financing Opportunities Islamic REITs also represent another area of growth Malaysian ireits ranked as top three REITs by annual dividend yield. Islamic REITs Dividend distribution to unit holders (on sen) ireits 2008 2007 2006 2005 Al-Aqar 8.1 7.32 2.72 n/a Earns income from rental income and capital gains on asset portfolio. Structurally similar to conventional REITs [differs in governance requirements] Al-Hadharah Axis 3.69 15.27 7.22 13.63 n/a 12.95 n/a 4.7 Source: Bursa Malaysia, ireits; The Real Deal, Islamic Finance Asia, June/July 2009 22
Part 4 Outlook for Islamic Finance Sharing PwC s Perspective on the Global Financial Crisis: The Day After Tomorrow Valuation & Strategy
Part 4 - Outlook for Islamic Finance Islamic finance has been an important mode in supporting capital flows between regions, a trend that is anticipated to continue. 1 Globalisation and transition to a multi-polar world will propel the development of Islamic finance Growing economic prominence of Asian countries such as China and India will see more trade and investments in the region. Emerging market countries will increasingly influence patterns of trade and investment to reflect their own natural resource requirements and the banking system will follow these flows. Islamic finance is primed to be a conduit to facilitate these capital flows. Alternative financial institutions such as Islamic financial institutions will emerge to challenge the hegemony of weakened Western banks. 24
Part 4 - Outlook for Islamic Finance As the industry relooks the operating models of conventional banks, Islamic banks can help to alleviate market gaps. 2 Global financial crisis has resulted in calls for reforms and the adoption of Nouveau Classic banking model Unsustainable, overleveraged structures will be replaced with simpler and more transparent forms of banking. Underlying values of Islamic finance promote such structures. Contraction in capital, credit and liquidity has created a monetary vacuum at the centre of the banking system. Islamic financial institutions have been well capitalised in the past and have not been as badly affected. 25
Part 4 - Outlook for Islamic Finance Islamic finance will be a viable and accessible avenue for fundraising in the future as the industry grows 3 Economic development in Malaysia will be less reliant on conventional sources of funds such as FDI Slowing foreign investment inflows to Malaysia means alternative funding will need to be sourced, either from the private sector or public sector to develop the economy. GLC s and Government bodies have played an instrumental role to sustain and develop corporates and SMEs by providing funds and incentives. Islamic finance is an avenue to tap these funding sources. Diversification and product innovation of Islamic financial institutions will see more choice for raising funds. 26
Part 4 - Outlook for Islamic Finance The Day After Tomorrow A PricewaterhouseCoopers perspective on the global financial crisis. Please visit the following site to access this document online: http://www.pwc.com/gx/en/financial-services/day-after-tomorrow/index_flash.html 27
Thank You For further information, please contact: Narita Naziree PricewaterhouseCoopers Capital Sdn Bhd Level 10, 1 Sentral, Jalan Travers Kuala Lumpur Sentral, PO Box 10192 50706 Kuala Lumpur Malaysia Tel: +60(3)-2173-1188 Fax: +60(3)-2173-1288 Email: narita.naziree@my.pwc.com Valuation & Strategy