Elnamaki The Morning After May09

The Future of

Arab Banking By Dr. M S S El Namaki

28

globaleconomy

The credit crisis is upon us, and, with it, a dramatic economic decline, the likes of which has not been seen for decades. The outlook for Arab banking the morning after the credit crisis depends on a number of factors, each relevant to a specific segment of the industry.

Sovereign Wealth Arab sovereign wealth will have a field day in American and European markets and under certain conditions, the future could carry the potential for measurable portfolio enlargement. Sovereign wealth funds are strong in the Middle East, especially the Gulf states. They command massive resources and have strong capital clout. They could dictate the market structure and prices of financial assets for the coming years. Abu Dhabi’s Investment Authority, or “Mubadala,” is the largest, and the Qatar Investment Authority is possibly the smallest and youngest (established in 2005). Mubadala, which was created in 1976, is the largest sovereign fund in the globe, with near $875 billion in assets. Its investments are broad and scattered. It has bought a controlling stake in the Chrysler Building, an icon of the Manhattan skyline, and is planning to become one of the 10 biggest institutional investors in General Electric. Past Mubadala deals included a 5% stake in Ferrari, 7.5% equity in Carlyle Group and a 4.9% capital input in Citigroup. These moves highlight the growing selfconfidence and ambitions of Abu Dhabi’s sovereign investment vehicle and the effort by the emirate to develop a balanced and diversified economic growth model. Middle East sovereign wealth funds have recently played a leading role in helping to recapitalize the faltering U.S. banking industry, a risky endeavor in today’s volatile capital markets. These investments are not really performing. Worse still, they are leading to the question of who owns what and for what purpose. Put differently, there are those in the U.S. who are wondering whether government ownership of specific American assets is a good thing, especially if it is a Middle Eastern foreign government. There is the concern that this could jeopardize interests and undermine the traditional capital market fundamentals of the country.

Islamic Banking Islamic banking policies and practices will provide a benign alternative to the “malignant” and “greedy” practices of non-Muslim banking institutions. The basic principle of Islamic banking is the prohibition of riba, or interest. In Islamic banking, sharing of profits and losses replaces interest. A Shari’ah-compliant Murabaha mortgage transaction, to take the most common source of risk in the current Western economic crisis, is carried out through the intermediary role of a bank. The bank acquires the asset from the seller and sells it to the buyer, with the possibility of paying in installments. Profit may occur as a result of the buying and selling, and debtor default is nullified through collateral. This arrangement nullifies the malignant implications of securitization as it was done within the American mortgage and investment banking industry. Another innovative approach for home loans, called Musharaka al-Mutanaqisa, allows for the creation of a joint venture where capital is shared and returns from eventual rental are also divided. The bank and borrower form a partnership, with both providing capital at an agreed percentage to purchase the property. The partnership rents out the property to the borrower and charges rent that is shared between the two parties. The borrower remains entitled to the purchase of the bank’s equity share. Again, this is a far cry from the securitization practice in which the property subsides in layer upon layer of bonds created to exploit the purchase process. Dr. M S S El Namaki teaches and consults on strategic thinking, entrepreneurship and international business. He is past founder and dean of the Maastricht School of Management, Maastricht, The Netherlands (1984-2002). El Namaki has developed and introduced management degree programs into no fewer than 25 countries, including the Netherlands, China, Egypt, Brazil, Poland, Canada and Indonesia. He has held executive positions with Philips (Eindhoven), McKinsey (London and Dar es Salaam) and Time Inc. (Amsterdam). El Namaki’s book Strategy and Entrepreneurship in Arab Countries was published last year.

29

www.islamica-me.com • May 09

The Morning After

www.islamica-me.com • May 09

globaleconomy

www.islamica-me.com • May 09

globaleconomy

Private Equity The private equity industry will most likely face turbulence within Arab countries. The basic assumptions do not hold as strongly as they used to. Private equity players in the Middle East are few and far between today. Their size and scale of operations are modest by American standards. The majority cluster around the capital reserves of the GCC and Saudi Arabia and their presence in a country such as Egypt is sparse. Abraaj, the UAE operator, seem to be the undisputed leader and the one to survive the crisis. But all Arab private equity operators, including Abraaj, will face serious challenges in the coming years. Competition from sovereign wealth funds, the declining window of opportunistic deals, and the increasingly blemished face of leverage will all constrain operations. Sovereign wealth funds will be urged from a political standpoint to play a more pronounced role in reviving local economies, especially in the Gulf states, and this could happen at the expense of private equity. A reversal of free market thought on a global scale could reduce sources of private equity deals, be it privatized entities in countries such as Egypt and Syria or family firms in GCC countries. And leverage will prove more and more difficult under today’s credit decline and deleveraging crusades.

major barrier to their true entry into serious global mergers and acquisitions in the finance sector. Business as Usual Some Arab countries may experience little change in their structure or practice of banking. Their limited exposure to the credit crisis will render dramatic change superfluous. Among the Arab countries that escaped the most serious implications of the credit crisis is Egypt. The reasons are obvious: Banking institutions in Egypt abstained from drinking the toxic brew concocted by North America’s investment industry. Structured finance was too risky to contain within the traditional environment of those banking institutions. This might have also arisen from the simple inability of those institutions to deal with complex investment vehicles. Today, their toxic waste holdings are minor and their conservative approach may, after all, be worthy of praise! The near future may find growing interest in those countries, especially Egypt. They combine limited damage, safety and Islamic finance. Safety and Islamic finance might attract the attention of other Arab investors, especially in the Gulf. Those who have lost significantly as a result of recent events, as we have explained earlier, may seek the comfort of a traditional, admittedly non-innovative but safe banking and investment environment in countries such as Egypt, Libya or Syria.

Bank Management The management of banking institutions in Arab countries will likely demonstrate the same value shifts one will see in North America. Yet they will face another problem: talent. Talent is a core issue that is undermining the performance of the sector in Arab countries. This is not a short-term problem, but a long-term one. The volume and scale of banking talent leave a lot to be desired in almost every Arab country. Global supply is becoming abundant following massive layoffs in North America and Europe, but this may not provide a genuine solution, as those are the same people who have landed those institutions in the problems they have now. They may also be bringing with them the wrong culture, i.e., a focus on the short term and greed. The problem could be compounded if the level of policy making and control does not match the dynamic needs of the hour. China is a case in point. China’s massive reserves are not put to full use because of the talent problem. The Chinese authorities recognize this as a

Demonstrating Clout Discussion of the credit crisis cannot be stripped of its political dimension, especially when it comes to Arab banks and Arab economic management. Arab countries are substantial in capital resources but relatively weak in terms of political economic posture. One does not have to go far to substantiate this point. Arab countries’ representation in the G20 debates was modest. Arab influence on the ongoing debate around the restructuring of the global financial system is almost not there. Arab contribution to China’s call to replace the U.S. dollar with a global currency less susceptible to vagaries of U.S. economic forces is muted. Discrete measures might be there, but they do not reconcile with the volume and scope of possible Arab contribution. What is needed are two sets of measures, a professional and a political one. From a professional point of view, there is a need for a critical exchange of views on the position and future of the industry; a serious exchange of what the industry should do tomorrow and who should carry the mantel. From a political point of view, the need is there for an initiative that can coalesce and demonstrate the collective power of the Arab world when it comes to economic policy.

Arab sovereign wealth will have a field day in American and European markets and under certain conditions, the future could carry the potential for measurable portfolio enlargement.

30