World Islamic Banking Competitiveness Report 2011-12.

A critical reference source for decision makers in the global Islamic � nance industry, providing strategic insights from Ernst & Young

Dear Banking & Finance Leader,

It is with great pleasure that we present to you the 8th annual edition of the World Islamic Banking Competitiveness Report 2011-12. This year’s original research project is developed in collaboration with leading global professional services and advisory fi rm, Ernst & Young. With a principal focus on “A Brave New World of Sustainable Growth”, the WIBC Competitiveness Report 2011-12 explores the key industry trends and the critical success factors guiding the global Islamic banking and fi nance industry to the next level of performance and growth.

The global Islamic fi nance industry has undergone major transformations in the last few years in its quest to boost international competitiveness and to build a sustainably profi table business model. There has been a focus on product innovation eff orts that aim to provide a more comprehensive array of Shari’ah-based products for the market. The global Islamic fi nance industry has also seen signifi cant developments in regulatory frameworks and Shari’ah standardization initiatives - making trans-jurisdictional market connectivity that much more achievable. However, both the challenge and the opportunity currently facing leading industry players is how will Islamic banks succeed in making the historical growth curve sustainable and profi table.

We would like to express our sincere gratitude to Ernst & Young and their world renowned Islamic Financial Services Team for investing their considerable talent and resources in developing the World Islamic Banking Competitiveness Report 2011-12. The Report is exclusively launched on-site at a special plenary session of the 18th Annual World Islamic Banking Conference (WIBC) where more than 1,200 industry leaders from over 50 countries gather to chart the future of Islamic fi nance.

Established as a critical reference resource for key industry players, thought leaders and policy makers in the global Islamic banking and fi nance industry, we hope that the analysis in this year’s Report will provide practical, constructive and valuable insights which will be useful in your own strategic planning activities and will assist your organization in its quest for success as the Islamic banking and fi nance industry enters the next phase of “Competing for Global Growth”. To fi nd out more on how your organization can play a part in this important research initiative in the future, please e-mail [email protected]

Yours sincerely,Yours sincerely,

David McLeanManaging DirectorThe 18th Annual World Islamic Banking ConferenceA MEGA Brand

A MEGA Brand: Shaping the Future of the Global Islamic Finance Industry Since 1993P.O. Box 72045, Dubai, UAE | t. +9714 343 1200 | f+971 4 343 6003MEGA Brands. MEGA Clients. Market Leaders.www.megaevents.net

18th Annual

World Islamic Banking Competitiveness Report 2011-12

‘A Brave New World of Sustainable Growth’

World Islamic Banking Competitiveness Report 2011-12

‘A Brave New World of Sustainable Growth’

Report Structure

Performance Analysis

Competitive Landscape

Competing to Win: The CEO

Agenda

Country Spotlight

Executive Brief

1

2 3

5 4

COMPETITIVENESS REPORT 2011-20122

A Brave New World of Sustainable Growth

Dear Executive,

The global economy, and the financial markets, are at a turning point. Fast growth economies in Asia, Middle East, Africa, Latin America and Eastern Europe now form almost half of global GDP and, in 2010, they contributed 70% to overall global growth. These trends are accelerating. The dramatic developments over the past twelve months – including Arab Spring, Eurozone crises and Occupy Wall Street movement – provide further impetus for the growth of Islamic banking.

Industry forecast suggest Islamic banking assets with commercial banks globally, will reach $1.1 trillion in 2012 (2010: $826bn). Now would be the opportune time to consider establishing Islamic sovereign wealth funds to champion the growing internationalization of the industry. The iSWF will further facilitate businesses across OIC markets seeking to transform to Shari’a compliant system and also help deepen the Islamic capital market, in our view.

As for MENA, Islamic banking assets increased to $416bn in 2010, representing a five year CAGR of 20% compared to less than 9% for leading conventional banks. As new geographies open up to Islamic banking, the MENA Islamic banking industry is expected to more than double to $990bn by 2015. However, there are significant performance variations across markets. In 2010, average ROE of leading Islamic banks declined to 10%. Also, market valuations appear to be converging to that of regional conventional peers.

Our clients agree that business models needed to shape and sustain success in this new landscape are evolving in a fundamental way. Ensuring sustainable growth will require brave, meaningful and decisive Performance Improvement initiatives. Two key themes are starting to emerge:

► Excellence in banking operations – by transforming to a customer centric, efficient and scalable operating model, driven by an enhanced risk and technology orientation; and

► Product innovation – to strengthen the Shari’a differentiation and provide greater integration with the real economy

A worrying concern though is the absence of an enabling legislative, regulatory, tax and legal environment in most OIC markets, which adds to the cost and complexity of Islamic banking operation. Where there are guidelines and standards issued by industry infrastructure institutions, their reach and enforceability remains a concern. These must be addressed as priority.

Our award-winning global Islamic Finance Center of Excellence continues to work with a diverse range of financial institutions helping them realize the true potential of their business. We trust you will find this report useful.

Ashar M. NazimIslamic Financial Services LeaderErnst and Young

Imtiaz IbrahimSenior Director, Islamic Financial ServicesErnst and Young

Islamic Banking Competitiveness Report 2011-12

Page 3

3COMPETITIVENESS REPORT 2011-2012

Key MessagesMENA Islamic banking assets reach $416bn in 2010, globally Islamic banking assets to cross $1.1t by 2012*

Expect a permanent change of play in the GCC – customer centric operating model to drive future (sustainable) growth

Topping CEOs agenda – Operational Transformation, Risk, Growth and Innovation

1

2

3

Executive Brief


Page 4

* Note: Islamic banking assets with commercial banks

One potential scenario shows global Islamic banking assets with commercial banks to reach $1.1 trillion in 2012

Global Islamic Banking Assets

2010GCC MENA

(ex GCC)Malaysia Rest of the

World

Source: IMF, The Banker, Central Bank Websites, EY perspective

Islamic Banking Asset Growth (US$bn)

826

12725

38114 1,130


2012e


Page 5


Key MessagesMENA Islamic banking assets reach $416bn in 2010, globally Islamic banking assets to cross $1.1t by 2012*

Expect a permanent change of play in the GCC – customer centric operating model to drive future (sustainable) growth

Topping CEOs agenda – Operational Transformation, Risk, Growth and Innovation

1

2

3

Executive Brief


Page 4


One potential scenario shows global Islamic banking assets with commercial banks to reach $1.1 trillion in 2012


2010GCC MENA

(ex GCC)Malaysia Rest of the

World

Source: IMF, The Banker, Central Bank Websites, EY perspective

Islamic Banking Asset Growth (US$bn)

826

12725

38114 1,130


2012e


Page 5


Analysis of leading Islamic commercial banks in the MENA region shows a large variation in the average ROE between 2006-10

Total Assets 2010 Average ROE (2006-2010)

Source: Annual Reports, Zawya, EY analysis (includes sample of leading banks across Middle East and North Africa (MENA) where published information was available)

MENA Conventional AverageUS$38bn 16%

MENA Islamic AverageUS$13bn 15 %

< 9%

> 20 %

Growth(3 Yr CAGR)

Steep Slide

Long Tail


Page 6

10.0%

0.20%

6.7%

7.4%

-1.9%

17.4%

12.6%

1.4%

-2.2%

0.1%

15.5%

12.2%

10.0%

11.6%

19.2%

8.5%

13.1%

15.2%

14.2%

26.0%

Bahrain

Bahrain

Kuwait

UAE

Kuwait

Qatar

Egypt

KSA

Bahrain

KSA

KSA

UAE

Qatar

Qatar

Bahrain

UAE

UAE

Kuwait

KSA

2,272

2,482

4,156

4,538

4,668

5,309

5,453

5,633

6,744

7,114

8,703

8,807

8,915

9,526

14,238

15,880

20,489

22,952

44,498

49,304

Kuwait


Analysis of leading Islamic commercial banks in the MENA region shows a large variation in the average ROE between 2006-10

Total Assets 2010 Average ROE (2006-2010)

Source: Annual Reports, Zawya, EY analysis (includes sample of leading banks across Middle East and North Africa (MENA) where published information was available)

MENA Conventional AverageUS$38bn 16%

MENA Islamic AverageUS$13bn 15 %

< 9%

> 20 %

Growth(3 Yr CAGR)

Steep Slide

Long Tail


Page 6

10.0%

0.20%

6.7%

7.4%

-1.9%

17.4%

12.6%

1.4%

-2.2%

0.1%

15.5%

12.2%

10.0%

11.6%

19.2%

8.5%

13.1%

15.2%

14.2%

26.0%

Bahrain

Bahrain

Kuwait

UAE

Kuwait

Qatar

Egypt

KSA

Bahrain

KSA

KSA

UAE

Qatar

Qatar

Bahrain

UAE

UAE

Kuwait

KSA

2,272

2,482

4,156

4,538

4,668

5,309

5,453

5,633

6,744

7,114

8,703

8,807

8,915

9,526

14,238

15,880

20,489

22,952

44,498

49,304

Kuwait

Libya

Banking industry to be made Shari’a compliant…

Oman

First two Islamic license awarded…potentially a 10% market share play by…

Tunisia

Central bank mulls Islamic banking regulations…

Egypt

Considering sovereign sukuk…

Hong Kong

HK legislating for Islamic banking…

Switzerland

Islamic Bank of Switzerland to open…

KenyaKenya to emerge as the Islamic finance gateway to East Africa…

CISFirst Islamic bank conversion…

Globally as mature markets press forward with banking reforms, many others are keen to explore an alternative Islamic finance option

Banks need US$ 106bn new tier 1 capital by 2012

Source: Published information.Image: Campaigner outside London Stock Exchange in Oct 2011 (Arab News)

by 20122012


Page 7


By 2015, the MENA Islamic banking industry is projected to be worth $990bn… a significant growth story (2010: $416bn assets)

MENA Islamic Banking Assets - 2015 Forecast (US$bn)

Saudi Arabia

Oman

UAEQatar

BahrainAlgeria

LibyaEgypt

Turkey

Tunisia

MoroccoLebanon

JordanIraq

Yemen

Syria

Kuwait

156

291

13

87

140

7920

104

GCC

North Africa

The Levant

7

7

5

34

12

13

10

8

5

Projected Islamic banking assets 2015 (US$bn) - the size of the circle denotes relative size

Key

Source: 2010 Company Reports, Global Insight, EY perspective


Page 8


Rediscovering profits - Operational efficiency can increase Islamic banks’ profitability by approximately 25%

Current Performance

(2010)1

Growth Momentum2

Potential Combined Islamic Banking Profit Pool (2015)

Operational Improvements

$5bn – $6bn

MENA Islamic Banking - 2015 Combined Net Profit Forecast (US$bn)

$7bn- $9bn

$3bn -$4bn

$15bn - $19bn

1- Based on ROA of 1.5%, 2 – Based on asset growth projections

Emerging Islamic geographies

Affluent retail proposition

Integration with real economy

SME banking

Further Potential Growth Opportunities

► Operational Transformation

► Risk Infrastructure

► Innovation

► Growth Play


Page 9


The CEO Agenda – There are four emerging trends that will permanently alter the Islamic banking play, especially in the GCC market

The CEO

Agenda

Operational Transformation

Risk & Compliance

Growth Play

Innovation

► Scalable, customer centric operating model, achieved through improved risk and technology orientation (winning back the profitability and valuation advantage)

► Economic capital, risk adjusted returns, funds transfer, pricing, regulations, and compliant products and systems to drive the change in business focus

► Shari’a compliant banking to stimulate financial access to previously unbanked – expect 100 plus new Shari’a compliant banks in MENA by 2020

► Embracing technology to deepen existing relationships and improve new customer acquisition rates

► Product research and structuring, while learning from past experiences (e.g. the sukuk market debacle)

► Having achieved 26% market share in GCC, future growth will come from mainstream customer segment; service model to be the primary proposition


Page 10


The CEO Agenda – There are four emerging trends that will permanently alter the Islamic banking play, especially in the GCC market

The CEO

Agenda

Operational Transformation

Risk & Compliance

Growth Play

Innovation

► Scalable, customer centric operating model, achieved through improved risk and technology orientation (winning back the profitability and valuation advantage)

► Economic capital, risk adjusted returns, funds transfer, pricing, regulations, and compliant products and systems to drive the change in business focus

► Shari’a compliant banking to stimulate financial access to previously unbanked – expect 100 plus new Shari’a compliant banks in MENA by 2020

► Embracing technology to deepen existing relationships and improve new customer acquisition rates

► Product research and structuring, while learning from past experiences (e.g. the sukuk market debacle)

► Having achieved 26% market share in GCC, future growth will come from mainstream customer segment; service model to be the primary proposition


Page 10

Report Structure




Agenda

Country Spotlight

Executive Brief

1

2 3

5 4


Page 11


Key MessagesGrowing asset market share – Shari’a compliant assets represent 14% share of MENA banking market, 26% in GCC*

Leading to repositioning – mergers, conversions, regional expansion, and changing business focus

But yet to achieve scale – $13bnaverage asset base for leading Islamic banks, a third of conventional banks

1

2

3



Page 12


Growth within the Muslim population throughout the emerging markets of MENA and Asia are key drivers behind increasing demand for Islamic financial services…

Source: Pew Research Center, Guardian, EY analysis

100m +

50 - 100m

10 – 50m

5 – 10m

1 – 5m

Muslim Population Density Indicator India

177mIndonesia

204m

Pakistan178m

Bangladesh148m

Turkey74m

Egypt80m

Nigeria75m

Algeria34m

Morocco32m

Iran74m

Global Estimated Muslim Populations – Selective Markets (2010)

Under 1m

China23m

Malaysia17m


Page 13


Growth within the Muslim population throughout the emerging markets of MENA and Asia are key drivers behind increasing demand for Islamic financial services…

Source: Pew Research Center, Guardian, EY analysis

100m +

50 - 100m

10 – 50m

5 – 10m

1 – 5m

Muslim Population Density Indicator India

177mIndonesia

204m

Pakistan178m

Bangladesh148m

Turkey74m

Egypt80m

Nigeria75m

Algeria34m

Morocco32m

Iran74m

Global Estimated Muslim Populations – Selective Markets (2010)

Under 1m

China23m

Malaysia17m


Page 13


The MENA region boasts macroeconomic synergies that bode well for future GDP growth

Source: Global Insight, EY analysis (includes Turkey; excludes Palestine due to lack of data)

Key Features► Total Population 374m (2010)► CAGR Population Growth 2.1% (2007-2010) (EU = 0.4%)► 61% and 45% of world oil and gas reserves respectively ► Nominal GDP US$2.6tn► GDP CAGR 6.3% (2007-2010) (EU = 4.3%)

Hydrocarbon Reserves Population Centers

The GCC, Iraq, Algeria, Libya all have large hydrocarbon reserves and accumulated wealth

Turkey, Egypt, Saudi Arabia, Algeria and Morocco have large population centers and human capital reserves

Saudi Arabia Oman

UAE

Kuwait

Qatar

BahrainAlgeria LibyaEgypt

Turkey

Tunisia

MoroccoLebanon

Jordan

Iraq

Yemen

GCC

North Africa

The Levant

Syria


Page 14


Governments are utilising their hydrocarbon revenues to stimulate, develop and sustain economic activity within the region

MENA Nominal Hydrocarbon GDP (US$bn) Cost of Arab Spring (US$bn)

592

374

494

738682

2008 2009 2010 2011f 2012f

Source: Geopolicity, IIF

21

Cost to GDP Cost to Public

Finance

Total Cost

35 56

Overall growth expected to moderate in 2012, still significantly higher than

levels seen in 2009-10

Finance

Many governments have responded by (i) committing to new spending and (ii) accelerating planned large

infrastructure spending


Page 15


0%

100%

200%

300%

400%

500%

600%

…but from a generally underpenetrated market position, the banking industry has considerable growth opportunities when compared to the more developed economies

Banking Asset / Nominal GDP (2010)

Average Penetration for Sample Countries1

Source: Central Bank Reports, Economist Intelligence Unit, Global Insight, EY analysis (average for EU)1 – Average Penetration for Sample Countries excludes US statistic to reduce skew.

MENA Rest of the world

1300%


Page 16

Within MENA, the GCC markets are generally more developed with greater lending/financing assets to GDP penetration

Total Bank Lending/Financing and Penetration (2010)

Source: Central Bank Reports, Global Insight, EY analysis

273 262

92 85

28

15

268

59

37 26

6

78

43

31

11

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

0

50

100

150

200

250

300

KSA UAE Kuwait Qatar Oman Bahrain Turkey Lebanon Jordan Syria Iraq Egypt Algeria Tunisia Libya

2008 2009 2010 Penetration

US$

bn


Page 17

0%

100%

200%

300%

400%

500%

600%

…but from a generally underpenetrated market position, the banking industry has considerable growth opportunities when compared to the more developed economies

Banking Asset / Nominal GDP (2010)

Average Penetration for Sample Countries1

Source: Central Bank Reports, Economist Intelligence Unit, Global Insight, EY analysis (average for EU)1 – Average Penetration for Sample Countries excludes US statistic to reduce skew.

MENA Rest of the world

1300%


Page 16


Within MENA, the GCC markets are generally more developed with greater lending/financing assets to GDP penetration

Total Bank Lending/Financing and Penetration (2010)

Source: Central Bank Reports, Global Insight, EY analysis

273 262

92 85

28

15

268

59

37 26

6

78

43

31

11

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

0

50

100

150

200

250

300

KSA UAE Kuwait Qatar Oman Bahrain Turkey Lebanon Jordan Syria Iraq Egypt Algeria Tunisia Libya

2008 2009 2010 Penetration

US$

bn


Page 17


Shari’a compliant assets represent a significant portion of the total banking system assets of the region

Banking Assets (US$bn) and Islamic Share (%) in 2010

Total banking assets 2010 (US$bn) - the size of the circle denotes relative size

Total Islamic banking assets as a % of total assets

Saudi ArabiaOman

UAEQatar

BahrainAlgeria

LibyaEgypt

Turkey

Tunisia

MoroccoLebanon

JordanIraq

Yemen

Syria

Kuwait

17%

438

XX

X%

Key

30%

8 35%

3774%

215

2%

1%109

1%

5%

546

25%269

22%15627%46

31%155

56

117

12%

49

4%135

42

46

0%

0%

Source: Central Bank Reports, Press Releases, The Banker - Top 500 Islamic Financial Institutions, EY perspective (Note: Shari’a assets with commercial banks)

41

0%

GCC

North Africa

The Levant


Page 18

MENA Islamic banking market share has reached 14%; in the GCC the Islamic banking market share has crossed the all important 25% threshold which means banks are competing in the conventional market as well

Size of circles denote the relative size of Islamic banking asset in 2010

Banking Asset Penetration (% of Nominal GDP) and Islamic Banking Market Share of Total Assets (%) in 2010

0%

80%

120%

160%

200%

240%

280%

320%

360% MENA Average Islamic Banking Market Share

Islamic Banking Market Share of Total Assets (2010)

Bank

ing

Pene

tratio

n (%

of N

omin

al G

DP)

40%

4% 8% 12% 20% 28% 36%32%24% 40%16%

UAE

KSA

Iraq

Qatar

Kuwait

Turkey

Bahrain

Egypt

Jordan

Yemen

Lebanon

Tunisia

AlgeriaSyria

Libya

Morocco

Oman

Source: Central Bank Reports, The Banker, Global Insight, EY perspective

GCC Average Islamic Banking Market Share


Page 19


Strong historical growth, driven by core Islamic segment; going forward expect change of play as Islamic banks begin to compete for mainstream customers who are open to Islamic or conventional banking

Source: Company Reports, EY analysis (sample includes selective Islamic and conventional banks based on asset size and published information)

19%

20%

16%

22%

39%

14%

13%

26%

7%

28%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Saudi Arabia

Kuwait

UAE

Bahrain

Qatar

Islamic Banks Conventional Banks

41%

235%

-38%

52%

40%

22%

26%

2008

2010

Asset CAGR (2006-2010)

Islamic Banking Market Share

Growth Relative to Conventional Banks


Page 20

Industry is still fragmented with most Islamic banks holding less than $13bn assets – yet to achieve scale, facing pressure on profitability

Source: Annual Reports, Analyst Briefings, EY analysis

Average Assets and ROE (2006-2010 Average)

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

80

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

2006

-201

0 Av

g As

sets

(US$

bn)

Avg ROE 2006-2010 (%)

Average ROE

Average Assets

Islamic Banks

Conventional Banks


Page 21


Industry is still fragmented with most Islamic banks holding less than $13bn assets – yet to achieve scale, facing pressure on profitability

Source: Annual Reports, Analyst Briefings, EY analysis

Average Assets and ROE (2006-2010 Average)

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

80

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

2006

-201

0 Av

g As

sets

(US$

bn)

Avg ROE 2006-2010 (%)

Average ROE

Average Assets

Islamic Banks

Conventional Banks


Page 21


The largest Islamic banks within the region are all leaders in their respective home markets and have expanded internationally to some degree

Source: Annual Reports, The Banker, EY analysis (where data was not available, calculation based on a 2 year average)

Shari’a Compliant Assets and ROA (2008-2010 Average)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

0% 0.5% 1% 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5%

Regional Full Fledged Islamic Bank

Regional with Islamic Operation

Global with Islamic Window

Assets US$m

Saudi Retail Banking Leader

Saudi Islamic Windows

Qatari Islamic Banks

UAE Market Leader

UAE Islamic Banks


Page 22

Kuwait Market Leader


The largest Islamic banks within the region are all leaders in their respective home markets and have expanded internationally to some degree

Source: Annual Reports, The Banker, EY analysis (where data was not available, calculation based on a 2 year average)

Shari’a Compliant Assets and ROA (2008-2010 Average)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

0% 0.5% 1% 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5%

Regional Full Fledged Islamic Bank

Regional with Islamic Operation

Global with Islamic Window

Assets US$m

Saudi Retail Banking Leader

Saudi Islamic Windows

Qatari Islamic Banks

UAE Market Leader

UAE Islamic Banks


Page 22

Kuwait Market Leader

Bank financing activity appears to be picking up, regulatory requirements may induce banks to raise higher-cost investment/ time deposits


Source: Company Reports, EY analysis (sample based on selective Islamic and conventional banks)

GCC Banks – Growth in Advances

22%

15%

35%

1%0%

5%

10%

15%

20%

25%

30%

35%

40%

2007 2008 2009 2010

GCC Banks - Net Financing / Deposits

108%

94%

87%

92%

70%

75%

80%

85%

90%

95%

100%

105%

110%

2006 2007 2008 2009 2010


Page 23


However, real estate concentration remains a concern for Islamic banks, may affect future growth

Conventional BanksIslamic Banks

Banks and FIs

Real Estate

Commercial

Others

35% 32%36%

33%

25%25%

20%

25%24%

11%18% 15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2008 2009 2010

Source: Company Reports, Zawya, EY analysis (sample based on selective Islamic and conventional banks) (rounded numbers)

39% 41% 40%

33% 32% 33%

12%16% 16%

16%11% 11%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2008 2009 2010


Page 24


Business repositioning - (M&A, conversions, changing business focus) appear to dominate MENA Islamic banking going into 2012

Bahrain Islamic and Al Salam Bank announce they are exploring merger

Goldman Sachs registers a $2bn Islamic bond programme with the Irish Stock Exchange

Global sukuk issuance surge to $63bn YTD, GCC a primary contributor after Malaysia

Qatar Central Bank announces Islamic banking windows to be prohibited by year end

$500m sukuk issue by HSBC Middle East

Merger - Al Baraka and Emirates Global announce merger - $582m asset base, 89 branches, 40 cities (Pakistan)

International Bank of Qatar announces the sale of its Islamic banking business to Barwa Bank

DECOCTMAYFEBNOVJULY2010 AUG

Source: The Banker, IFN, Maris Strategies, Analyst Briefing

2011

ENBD acquires Dubai Bank

Conversion of AmrahBank to Islamic

Royal Decree passed to allow Islamic finance industry to commence in Oman. First banking license granted in Q2

Formation of WarbaBank in Kuwait

Several countries across Africa announce plans to introduce Islamic banking; amend regulatory and legislative regimes


Page 25


Report Structure




Agenda

Country Spotlight

Executive Brief

1

2 3

5 4


Page 26


Key MessagesPainful decline in profitability – industry ROE now appears to be stabilizing around the 10% range (2006: 23%)

Structural advantage – better financing margins, higher deposit growth and higher proportion of free deposits

Operating model questioned –misaligned people-processes-systems, leading to high cost to income ratio

1

2

3



Page 27


ROE decomposition assists in understanding the key performance indicators of banks

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expenses

Provisions

X


Page 28


Islamic banks have experienced a more painful decline in profitability over recent years but this now appears to be stabilizing

Bahrain Kuwait

Qatar Saudi Arabia

United Arab Emirates

Net Income / Equity

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

23%

10%

13%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2006 2007 2008 2009 2010

11%-1%

13%

9%

-20%

0%

20%

40%

2006 2007 2008 2009 2010

19%

5%

27%

12%

-20%

0%

20%

40%

2006 2007 2008 2009 2010

16% 15%

22%20%

-20%

0%

20%

40%

2006 2007 2008 2009 2010

35%

13%

29%14%

-20%

0%

20%

40%

2006 2007 2008 2009 2010

17%

8%

10%

-20%

0%

20%

40%

2006 2007 2008 2009 2010




Page 29


2.8%

0.6%1.8%

2.2%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

Islamic banks are able to generate higher financing margins also because of their relatively stronger retail focus

Bahrain Kuwait

Qatar Saudi Arabia



Net Financing Income / Financing Assets

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

4.3%

3.7%

3.0%

2.8%

3.2%

2%

3%

4%

5%

2006 2007 2008 2009 2010

3.5%3.3%3.1%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

2.7%2.2%

3.8%

2.3%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

7.1%

4.9%3.7% 3.0%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

2.2%

3.3%2.3%

2.7%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

IB’s excluding KSA



Page 30


Equity multiplier suggest that Islamic banks have room for further expanding risk weighted assets

Bahrain Kuwait

Qatar Saudi Arabia


Assets / Equity

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

5.6

6.8

8.27.9

0

2

4

6

8

10

12

14

2006 2007 2008 2009 2010

Deposit CAGR = 13%

Deposit CAGR = 16%

4

811 9

0

4

8

12

2006 2007 2008 2009 2010

88

9

7

0

4

8

12

2006 2007 2008 2009 2010

3

5

7 8

0

4

8

12

2006 2007 2008 2009 2010

5

5

88

0

4

8

12

2006 2007 2008 2009 2010

8 8

68

0

4

8

12

2006 2007 2008 2009 2010



Mul

tiple


Page 31


Islamic banks benefit from a higher proportion of free customer deposits but there is a tendency that these are of a short term tenure



Other

Investment/ Time Deposit

Saving

Current

21%

47%

29%

2.6%

0.1%

2.6%

69.7%

47.7%

65.6%

6.8% 4.9% 3.0%

UAE KSA Qatar

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

2008-2010 Average

23%

78%

45.5%15%

5%

21.7%62%

17% 10.2%

UAE KSA Qatar


Page 32


5.5%

3.0%3.0%

2.6%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

2.6%

-0.2%1.1%

0.9%

-2%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

After a painful decline in profitability through the financial crisis the ROA appears to be stabilizing, but now lower than conventional banks

Bahrain Kuwait

Qatar Saudi Arabia


Net income / Assets

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

4.0%

1.5%

3.0%

1.6%

0%

1%

2%

3%

4%

5%

6%

7%

8%

2006 2007 2008 2009 2010

2.1%1.0%

2.6%1.2%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

7.2%

2.6%3.8%

1.8%0%

2%

4%

6%

8%

2006 2007 2008 2009 2010

2.5%0.7%

3.1%1.7%

0%

2%

4%

6%

8%

2006 2007 2008 2009 2010




Page 33


Higher provisions and operating costs have contributed to the steep decline in profitability of Islamic banks

ROA 3.2% 1.6% 1.5% 1.8% 1.6% 1.6%

Source: Company Reports, EY analysis (numbers rounded off)

Provisions

Operating Expenses

Other Income

Net Financing Income


ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

3.2% 3.4% 2.9%

2.5%1.5%

1.3%

-2.0% -2.0% -1.8%

-0.4%-1.4%

-1.0%

-4%

-2%

0%

2%

4%

6%

2006-2008 average

2009 2010

1.9% 2.1% 2.0%

1.1%1.1% 1.1%

-1.0% -1.0% -0.9%

-0.2%-0.6% -0.5%

-2%

-1%

0%

1%

2%

3%

4%

2006-2008 average

2009 2010

Provisions and operating expenses higher than conventional


Page 34


Higher provisions and operating costs have contributed to the steep decline in profitability of Islamic banks

ROA 3.2% 1.6% 1.5% 1.8% 1.6% 1.6%

Source: Company Reports, EY analysis (numbers rounded off)

Provisions

Operating Expenses

Other Income

Net Financing Income


ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

3.2% 3.4% 2.9%

2.5%1.5%

1.3%

-2.0% -2.0% -1.8%

-0.4%-1.4%

-1.0%

-4%

-2%

0%

2%

4%

6%

2006-2008 average

2009 2010

1.9% 2.1% 2.0%

1.1%1.1% 1.1%

-1.0% -1.0% -0.9%

-0.2%-0.6% -0.5%

-2%

-1%

0%

1%

2%

3%

4%

2006-2008 average

2009 2010

Provisions and operating expenses higher than conventional


Page 34

Higher cost to income ratio is a combined result of modest core banking revenues and a higher cost base due to misaligned processes and systems

Operating Cost / Operating Income

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

26%

40%

29% 35%

0%

20%

40%

60%

2006 2007 2008 2009 2010




Page 35


Performance culture – higher staff cost should translate into better performance but Islamic banks lag behind their conventional peers

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

58%

60%

57%

54%

51%

52%

53%

54%

55%

56%

57%

58%

59%

60%

2009 2010

3% 3%

0.9% 0.8%

0%

1%

1%

2%

2%

3%

3%

4%

2009 2010

Staff Cost / Operating Expenses Staff Cost / Deposits




Page 36


2.0%1.5%

1.3%

2.2%

0%

2%

4%

6%

2006 2007 2008 2009 2010

2.1%

3.8%

1.3%1.4%

0%

2%

4%

6%

2006 2007 2008 2009 2010

Operating costs are impacting Islamic banks across the region – operating models need to be made scalable

Bahrain Kuwait

Qatar Saudi Arabia


Operating Cost / Asset

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

2.2%2.1%

1.3% 1.5%

0%

1%

2%

3%

4%

5%

6%

2006 2007 2008 2009 2010

2.2% 2.1%

1.3%1.5%

0%

2%

4%

6%

2006 2007 2008 2009 2010

3.1%2.4%

1.6% 1.4%0%

2%

4%

6%

2006 2007 2008 2009 2010

1.6%1.6%

0.9%1.0%

0%

2%

4%

6%

2006 2007 2008 2009 2010




Page 37


2%

18%

5% 16%

-10%

10%

30%

50%

2006 2007 2008 2009 2010

Both Islamic and conventional banks have seen a deterioration in the provision to income ratio

Bahrain Kuwait

Qatar Saudi Arabia


Provisioning / Operating Income

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

3%

20%

6%

21%

0%

10%

20%

30%

40%

50%

2006 2007 2008 2009 2010

5%

32%

2%

16%

-10%

10%

30%

50%

2006 2007 2008 2009 2010

4%

25%

8%16%

-10%

10%

30%

50%

2006 2007 2008 2009 2010

3.7%

0.3%-2%

10%

-10%

10%

30%

50%

2006 2007 2008 2009 2010

3%

23%

13%

33%

-10%

10%

30%

50%

2006 2007 2008 2009 2010




Page 38


Leading GCC Islamic banks continue to grow deposit base at a faster pace

Money Supply

Islamic Deposit

Conventional Deposit

Money Supply Forecast

0%

5%

10%

15%

20%

25%

30%

35%

40%

2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Central Bank, Company Reports, EY analysis (sample based on selective Islamic and conventional banks)

Money Supply and Deposit Growth Rates

Ann

ual G

row

th R

ate While the bigger Islamic banks

have seen comfortable deposit growth, the smaller institutions have had to raise expensive investment

deposits to meet liquidity and regulatory requirements


Page 39


Average cost of customer funds is lower for Islamic banks, primarily due to high share of free deposits in the deposit mix

Average Return on Investment Account Holders Funds/ Deposits

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

3.0%

1.3%

3.8%

1.8%

5.0%

0.4%0%

1%

2%

3%

4%

5%

6%

2006 2007 2008 2009 2010


Source: Company Reports, EY analysis (sample based on selective Islamic and conventional banks), US$ LIBOR: global-rates.com

6 months US$ LIBOR (average)

However, cost of return-bearing customer deposits has been increasing relatively faster for a number of Islamic banks, compared to their conventional peers


Page 40


Average cost of customer funds is lower for Islamic banks, primarily due to high share of free deposits in the deposit mix

Average Return on Investment Account Holders Funds/ Deposits

ROE

Leverage

Return on Assets

Deposits

Cost of Funding

Operating Expense

Provisions

X

3.0%

1.3%

3.8%

1.8%

5.0%

0.4%0%

1%

2%

3%

4%

5%

6%

2006 2007 2008 2009 2010


Source: Company Reports, EY analysis (sample based on selective Islamic and conventional banks), US$ LIBOR: global-rates.com

6 months US$ LIBOR (average)

However, cost of return-bearing customer deposits has been increasing relatively faster for a number of Islamic banks, compared to their conventional peers


Page 40

Sharp correction in investment asset values, and emerging focus on core banking business has led to significant change in asset mix



22%

13%

24%

22%

10%

12%

14%

16%

18%

20%

22%

24%

26%

2006 2007 2008 2009 2010

Investment / Total Liabilities


Page 41


Islamic banks continue to hold more liquid assets than conventional banks in most markets across the region...

Saudi Arabia


Kuwait

Qatar

BahrainCash & Cash Equivalents / Total Liabilities

7%

16%

10%14%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

18%

19%

15% 14%

0%

5%

10%

15%

20%

25%

2006 2007 2008 2009 2010

17%

21%

8%0%

10%

20%

30%

2006 2007 2008 2009 2010

18%

12%12%

15%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

16%16%

14%

13%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

33% 29%

18%22%

0%

10%

20%

30%

40%

2006 2007 2008 2009 2010




Page 42


Islamic banks continue to hold more liquid assets than conventional banks in most markets across the region...

Saudi Arabia


Kuwait

Qatar

BahrainCash & Cash Equivalents / Total Liabilities

7%

16%

10%14%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

18%

19%

15% 14%

0%

5%

10%

15%

20%

25%

2006 2007 2008 2009 2010

17%

21%

8%0%

10%

20%

30%

2006 2007 2008 2009 2010

18%

12%12%

15%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

16%16%

14%

13%

0%

5%

10%

15%

20%

2006 2007 2008 2009 2010

33% 29%

18%22%

0%

10%

20%

30%

40%

2006 2007 2008 2009 2010




Page 42


... but as noted earlier, Islamic banks have limited long term liabilities

Long Term Liabilities

Short term Liabilities

Equity

Deposits

59%63% 66% 68% 69%

27% 22% 18% 17% 15%

13% 14% 14% 14% 14%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010

66% 62% 63% 63% 64%

13%12% 12% 13% 14%

16%20% 23% 19% 17%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010


As % of Total Liabilities & Equity

1% 1% 2% 1% 2% 5% 6% 2% 5% 5%


Page 43


Both Islamic and conventional banks have a negative liquidity gap for short term maturity band

-44%

72%

-36%

55%

-60%

-40%

-20%

0%

20%

40%

60%

80%

Less than one year Over 1 year

Net Liquidity Gap / Total Asset (selected maturity band)




Page 44


Both Islamic and conventional banks have a negative liquidity gap for short term maturity band

-44%

72%

-36%

55%

-60%

-40%

-20%

0%

20%

40%

60%

80%

Less than one year Over 1 year

Net Liquidity Gap / Total Asset (selected maturity band)




Page 44

Report Structure




Agenda

Country Spotlight

Executive Brief

1

2 3

5 4


Page 45


Key MessagesRebuild to last – operating model to be transformed for quality growth and to create sustainable shareholder value

Service driven culture – investing more in customer centric activities, with better use of technology and risk tools

Shari’a differentiation – acquire and build specialist product skills, ensure better integration with real economy

1

2

3

Competing to Win – The CEO Agenda


Page 46


Key MessagesRebuild to last – operating model to be transformed for quality growth and to create sustainable shareholder value

Service driven culture – investing more in customer centric activities, with better use of technology and risk tools

Shari’a differentiation – acquire and build specialist product skills, ensure better integration with real economy

1

2

3

Competing to Win – The CEO Agenda


Page 46

Several Islamic banks have initiated a comprehensive transformation agenda for sustainable growth

Risk and compliance • Risk, compliance and regulation to drive

change in business models• Capital management - substantive

reallocation involving tools such as risk adjusted returns, fund transfer pricing, economic capital etc.

The Search for A New Business Model

Operational efficiency and effectiveness

• Customer centric operating model• Improved data management • Updated Shari’a compliant systems

and processes

Innovation• Embracing new technology• Product research & structuring – while

minimizing reputation, regulatory and commercial risk

Growth• Emphasis on core businesses• Consolidation, conversions and new

start-ups – Next 100 in the making• Relationship growth with key clients,

vendors and partners


Page 47


Competing for customers who are not driven by Shari’a considerations only – service quality is likely to replace pricing as the primary proposition

Sales & channel management

Customer & market strategy

Customer service

management

Customer intelligence &

economics

Customer Rapid AssessmentC

usto

mer

Tra

nsfo

rmat

ion


Page 48


Competing for customers who are not driven by Shari’a considerations only – service quality is likely to replace pricing as the primary proposition

Sales & channel management

Customer & market strategy

Customer service

management

Customer intelligence &

economics

Customer Rapid Assessment

Cus

tom

er T

rans

form

atio

n


Page 48

New market strategy

►Understand the competitive landscape and assess customer trends

►Analysis of regulation, Shari’a, tax and legal requirements

Customer and market strategy (“the double compliant customer”)

Customer segmentation

►Specially designed tools to develop deep understanding of segment requirements

►Data analysis and modelling to develop logical segmentation models

Customer service improvement

►As-is and to-be analysis of customer experience to enhance customer engagement

►Develop the most important Customer moments of truth and develop service

Customer operating model review

►Development of organizational design and spans of control

►Shared service analysis

►Provide the linkage between employee, Shari’a & customer engagement

Customer service improvement

Bank’s need to review their customer and market strategies to help understand customer requirements and engagement tactics in the new competitive landscape


Page 49


Single customer view

Customer analytics and economics

Single customer view

►Developing an analytical single customer view to drive marketing activity

►Developing an operational single customer view to drive service experience

Customer data architecture

►Assist in the selection and implementation of CRM technology

►Assist in designing a customer data database

Customer retention

►Customer profitability and lifetime value analysis

►Cross sales and incentive schemes to assist in both retention and customer value management

Customer economics

►Development of actionable plans for improving margin or optimizing cost

►Diagnosis of key improvement initiatives to help sustain revenues, & reduce costs whilst improving customer service

Note: CRM (Customer Relationship Management)

Customer analytics – banks can identify trends in customer behavior and spending to provide suitable products in line with the customers needs –successful rollout has delivered increases in retention and profitability


Page 50


Customer loyalty management

Sales and channel management

Customer loyalty management

►Assess customer data to determine position in the customer lifecycle

►Analysis of customer needs and internal practices to help match customer expectations with service

Sales force effectiveness

►Planning sales activities/ deploying resources to develop an effective sales strategy

►Overhauling the sales process including pipeline management, tender management, risk & regulation

Channel strategy

►Use of data models for channel optimisation and defining incentive compensation for channel advocacy

►Smooth transition of customers between channels, efficient complaints handling process and effective use of channels

Product development

►Developing a product strategy based on Shari’a contracts to assist in revenue growth

►Product mix optimisation, margin improvement, consumer promotional effectiveness and competitor positioning

Effective and compelling marketing tactics can increase the customer’s consideration to buy. The region is already saturated with loyalty schemes so another new one needs to be carefully thought through


Page 51


Customer service management

Contact centre transformation

►Contact centre diagnostic and performance benchmarking

►Developing a detailed understanding of how contact centre fits into the overall service proposition

Service quality management

►Assess the impact of the move to self-service on the overall customer profitability

► Identify hot-spots and instigate process changes

Customer service effectiveness

►Assess service capabilities vs. competitors to identify gaps in the service proposition

►Map the high level processes and identify the key issues from a customer’s perspective

Service channel transformation

►Developing an integrated approach to servicing via multiple channels

►Determining the impact of service failures on customer experience

Contact centre transformation

Banks in the region often use costly incentives to attract customers but then spend little on service to retain them – this is unsustainable


Page 52


60%

30%

19%

11%

11%

8%

8%7%

5%

100%

Benefits

Typically three levers deliver the majority of the benefits

Structural Rationalisation

Process & Productivity

Improvement

Off shoring / Outsourcing

Business Portfolio

Rationalisation

Purchasing Compliance / Governance

Supplier Rationalisation

Demand Challenge

Infrastructure Rationalisation

& Efficiency

Total

In our experience, a customer-centric operating model which has processes built around the customer are the biggest drivers of benefits, as illustrated below


Page 53









and processes







Page 54

Reduced profits and valuations are amongst the biggest business risks facing Islamic banks

Top Risks for Islamic BanksManaging the transformation, to customer

centric business model

Reduced profits and valuations

Geopolitical, macroeconomic shocks

Human capital, including misaligned compensation structures

Product risk, balancing innovation, law of the land and Shari’a compliance

Technology risk, including absence of fully compliant/ certified systems

Liquidity and associated cost

Financial Compliance

Strategic Operational

5

Technology risk, incl. absence of fully compliant/ certified systems

Liquidity and cost

3

2

1

7

6

4

Product risk, balancing innovation, law of the land

and Shari’a compliance

Human capital, including misaligned compensation

structures


Managing the transformation, to customer




Page 55


Reduced profits and valuations are amongst the biggest business risks facing Islamic banks

Top Risks for Islamic BanksManaging the transformation, to customer




Human capital, including misaligned compensation structures

Product risk, balancing innovation, law of the land and Shari’a compliance

Technology risk, including absence of fully compliant/ certified systems

Liquidity and associated cost

Financial Compliance

Strategic Operational

5

Technology risk, incl. absence of fully compliant/ certified systems

Liquidity and cost

3

2

1

7

6

4

Product risk, balancing innovation, law of the land

and Shari’a compliance

Human capital, including misaligned compensation

structures


Managing the transformation, to customer




Page 55


Three way constraint on strategy – banking industry in general feeling the pressure, Islamic banks are no exception

Cost of more capital

Cost of liquid assets buffer

Leverageconstraint

► Business focus will have to change

► Spreads will need to rise

► Higher capital requirement for trading book

► Large, long-term corporate financing will need to be re-priced


Page 56


Three way constraint on strategy – banking industry in general feeling the pressure, Islamic banks are no exception

Cost of more capital

Cost of liquid assets buffer

Leverageconstraint

► Business focus will have to change

► Spreads will need to rise

► Higher capital requirement for trading book

► Large, long-term corporate financing will need to be re-priced


Page 56

Liquidity – challenges and needed improvements

Systems Process

Governance

Product innovation (e.g. credible, compliant

alternatives to Commodity Murabaha)

Contingent commitments

Funds transfer pricing

Enhanced analytic

capability

Collateral tracking systems

Better consolidated/ group wide

data

New data hubs needed


Page 57


As with conventional institutions, Islamic banks will find it challenging to return to pre 2007 profitability levels – question is how big will the cuts be?

Pre-crisis, 15 - 25%

Estimates of cut pre-mitigating actions –reduction around 5-9 percentage points

Components of the reduction

Capital quality 0.8 Capital increase 1.3Leverage ratio 0.1Liquid assets 0.6

Strategic issue for the banks – how much disclosure is needed to convince equity investors they are safer

Rate of return on

equity

ILLUSTRATION ONLY


Page 58


As with conventional institutions, Islamic banks will find it challenging to return to pre 2007 profitability levels – question is how big will the cuts be?

Pre-crisis, 15 - 25%

Estimates of cut pre-mitigating actions –reduction around 5-9 percentage points

Components of the reduction

Capital quality 0.8 Capital increase 1.3Leverage ratio 0.1Liquid assets 0.6

Strategic issue for the banks – how much disclosure is needed to convince equity investors they are safer

Rate of return on

equity

ILLUSTRATION ONLY


Page 58

It is now even more important to link remuneration code with institutions’ performance, and to retain scarce talent

Key challenges

► Talent retention► Corporate culture► Shares vs. cash/ deferrals► Data availability and quality

Current practices► Reviewing new rules and

guidance on remuneration► Revising compensation

policies, processes and systems

► Update balanced scorecards and new incentive plans

Remuneration Committee – Bank wide remuneration policy (NEDs + External Advisors)

Oversight of reward protocols + Reward framework

Bonus decision (form and amount)

“Golden handshakes” “parachute” payments

Payout decision (timing and amount)

► Human capital

► Risk► Tax

CRO

Board level executives Line Mgmnt/

HR Risk

“High end” employees

Individuals with significant influence on direction and risk profile

All other employees

Assessment

► Human capital

► Risk► Tax

Balanced Score Card

Salary

Short term incentive plans

Long term incentive plans

► Human capital

► Risk► Tax

People

Quality

Customer

Risk

Performance measurement framework

Salary / Bonus

Short term incentive plans

Long term incentive plans


Page 59


MI framework with risk adjusted performance tools will be central to directing quality growth

ValueDrivers

PerformanceMeasures

OperatingMeasures Action Plans

Business Strategy

ImproveEconomic Profit

Finance Income

Operating

Bad & Doubtful Debts

Cost of Risk Capital

Income per Account

Volume

Write -Offs

Recovery Revenue

Hurdle Rate

Risk Capital

Bad Debt Provision

Credit Risk Capital

Operational Risk Capital

Other Risks

Risk free rate

Beta

Market premium

Sales (# of New Accounts)

Number of Existing Account

Number of Closed Account

Net Profit Incomeper Account

Cost of Funding

Cure Rate

Value of Delinquency

Provision Estimate Probability of Default

Loss Given Default

Exposure at Default

Portfolio Diversification

# Fraudulent Accounts

# of Delinquent Account

# of Deceased Account

Expenses

InvestmentIncome

Long Term Embedded Value

Investment Return

Cost of Funding

Investment Impairment

Value Deterioration

FX Volatility

ILLUSTRATION ONLY


Page 60


One potential scenario shows that risk practices at Islamic banks need to evolve significantly to achieve sustainable growth

Business Strategy

Policies, Standards, People & C

ultureR

isk Organisation &

Governance

Data &

IT Infrastructure

Risk Appetite

Risk Universe

Liquidity Risk

Op’s Risk StrategicRisk

Credit Risk

MarketRisk

Profit Rate Risk

Catastro-phe

Risks

Risk Based Pricing

Active Portfolio

Management

Capital Planning and Management

Risk Adjusted Performance Measurement

Risk Monitoring & MI

Risk Control & Limit Setting

Scenario Analysis & Stress Testing

Risk Aggregation & Economic Capital

Risk Measurement

Risk Identification

Comparable to conventional

Need Enhancement

Weak

ERM FRAMEWORK


Page 61









and processes







Page 62


At current pace, MENA Islamic banking assets with commercial banks are set to grow by an additional $575 billion by 2015

2015 Forecast (US$b)

Source: Central Bank Reports, The Banker, Analyst Briefings, EY analysis

Saudi Arabia

Oman

UAEQatar

BahrainAlgeria

LibyaEgypt

Turkey

Tunisia

MoroccoLebanon

JordanIraq

Yemen

Syria

Kuwait

156

~ 291

13

87

140

7920

104

GCC

North Africa

The Levant

7

7

5

34

12

13

10

8

5

Total ISLAMIC banking assets 2015 (US$b) - the size of the circle denotes relative size

Key


Page 63


While most Islamic banks remain localized to their GCC base, there is potential demand for an estimated 100 new Islamic financial institutions across MENA by 2020

GCC Islamic Banks GCC Conventional Banks

America

1%

America

2%

Europe

8%

Europe

5%

Asia

1%

Asia

3%MENA

85%

MENA

87%



Page 64


However, a major impediment to growth is the weak Islamic finance enabling infrastructure in several OIC markets

Relatively Developed Infrastructure

Some Infrastructure

Weak or No Infrastructure OIC (Organization of Islamic Countries)

Enabling infrastructure would include legislative, regulatory, legal, accounting,

tax, human capital, and Shari’a business framework

Further, Islamic finance standard setting institutions have limited

geographic reach / enforceability remains a challenge

Bahrain, Malaysia and UAEare amongst the major Islamic finance centers


Page 65


Repositioning – through conversions and mergers – will be an important theme, in some instances driven by market pressures

Bahraini Saudi Bank Ahli United Bank -Egypt

Royal Bank of Scotland (UAE) (Retail

Banking business)

Islamic Bank of Britain Plc

Bahrain Egypt UAE UK

Al-Salam Bank Ahli United Bank Abu Dhabi Commercial Bank

Qatar International Islamic Bank

Bahrain Bahrain UAE Qatar

N/A 53 100 40

Al-Salam Bank acquired a 90.31%

stake in Bahraini Saudi Bank BSC. Salam

issued 227.8m new shares for BHD 0.112

each

Ahli United Bank -Egypt's 54.7% stake to

be acquired by Ahli United Bank in a share

swap transaction.*

Abu Dhabi Commercial Bank (ADCB), agreed to acquire the retail

banking business of Royal Bank of

Scotland (UAE).*

Qatar International Islamic Bank (QIIB) agreed to acquire

78.5% stake in Islamic Bank of Britain Plc.

Oct-09 Jan-10 Oct-10 Jul-10*Transaction announced date

Target company

Target country

Bidder company

Bidder country

Deal value ($ m)

Key details

Source: Mergermarket, Company annual reports, * Conventional banks


Page 66


In GCC, the pricing multiples of Islamic banks have converged over recent months – now broadly in line with conventional banks

Average P/E of Banks in GCC – Sep 2011 Average P/BV of Banks in GCC – Sep 2011

N/A

15.2

8.5

13.0

N/A

N/A

20.7

11.1

6.8

11.5

16.3

10.1

12.212.8

0

4

8

12

16

20

24

(tim

es)

Islamic Conventional

Avg. Islamic Avg. conventional

N/A

3.4

0.8

1.8

N/A

N/A

2.1

1.4

0.9

1.9

1.4 1.6

2.0

1.6

0

1

2

3

4

(tim

es)

Islamic Conventional

Avg. Islamic Avg. conventional

Banks include all listed retail banks excluding those having P/E of less than 0 or greater than 30; UAE banks include Dubai & Abu Dhabi based banks only; N/A – No bank with P/E within specified range in the respective country; Source: Bloomberg, OneSource & EY perspective


Page 67


…with Kuwait and UAE having the highest and lowest pricing multiples respectively

Kuwait KSA UAE

Qatar Oman Bahrain

P/BV (Sep 2011)P/E (Sep 2011)

Banks include all listed retail banks excluding those having P/E of less than 0 or greater than 30; UAE banks include Dubai & Abu Dhabi based banks only; Source: Bloomberg, OneSource & EY perspective


Page 68

27.4

14.0

20.7

2.4

1.9

2.1

10 0 10 20 30

Conventional

Conventional

Average Conventional

15.2

9.3

12.0

12.6

12.3

13.9

9.9

7.5

15.2

11.1

3.4

1.5

1.2

1.8

1.5

1.1

1.5

1.2

3.4

1.4

10 5 0 5 10 15 20

Islamic

Conventional

Conventional

Conventional

Conventional

Conventional

Conventional

Conventional

Average Islamic


7.4

6.0

8.4

7.0

8.5

5.1

8.5

6.8

0.6

0.9

1.2

0.9

0.8

0.7

0.8

0.9

10 5 0 5 10

Conventional

Conventional

Conventional

Conventional

Islamic

Conventional

Average Islamic


11.3

15.0

12.2

14.4

16.3

1.3

1.6

1.8

1.4

1.4

10 5 0 5 10 15 20

Conventional

Conventional

Conventional

Conventional


12.0

9.8

8.6

10.1

1.4

1.5

1.9

1.6

10 5 0 5 10 15

Conventional

Conventional

Conventional


10.0

11.1

11.1

10.9

14.4

13.2

13.4

14.0

13.0

11.5

2.0

1.5

1.9

1.2

2.4

1.8

1.8

2.4

1.8

1.9

10 5 0 5 10 15 20

Conventional

Conventional

Conventional

Conventional

Islamic

Islamic

Islamic

Conventional

Average Islamic



…with Kuwait and UAE having the highest and lowest pricing multiples respectively

Kuwait KSA UAE

Qatar Oman Bahrain

P/BV (Sep 2011)P/E (Sep 2011)

Banks include all listed retail banks excluding those having P/E of less than 0 or greater than 30; UAE banks include Dubai & Abu Dhabi based banks only; Source: Bloomberg, OneSource & EY perspective


Page 68

27.4

14.0

20.7

2.4

1.9

2.1

10 0 10 20 30

Conventional

Conventional


15.2

9.3

12.0

12.6

12.3

13.9

9.9

7.5

15.2

11.1

3.4

1.5

1.2

1.8

1.5

1.1

1.5

1.2

3.4

1.4

10 5 0 5 10 15 20

Islamic

Conventional

Conventional

Conventional

Conventional

Conventional

Conventional

Conventional

Average Islamic


7.4

6.0

8.4

7.0

8.5

5.1

8.5

6.8

0.6

0.9

1.2

0.9

0.8

0.7

0.8

0.9

10 5 0 5 10

Conventional

Conventional

Conventional

Conventional

Islamic

Conventional

Average Islamic


11.3

15.0

12.2

14.4

16.3

1.3

1.6

1.8

1.4

1.4

10 5 0 5 10 15 20

Conventional

Conventional

Conventional

Conventional


12.0

9.8

8.6

10.1

1.4

1.5

1.9

1.6

10 5 0 5 10 15

Conventional

Conventional

Conventional


10.0

11.1

11.1

10.9

14.4

13.2

13.4

14.0

13.0

11.5

2.0

1.5

1.9

1.2

2.4

1.8

1.8

2.4

1.8

1.9

10 5 0 5 10 15 20

Conventional

Conventional

Conventional

Conventional

Islamic

Islamic

Islamic

Conventional

Average Islamic


Islamic banks constitute approximately 9% of market capitalization in GCC

*Share of other financial sector estimated at December 2010 level; Source: Bloomberg, OneSource & EY analysis (rounded numbers)

Break-up of Total Market Capitalization of GCC indices (Sep 2011)

21%11%

4%12%

3% 9%

31%

14%

48% 29%

22%

34%30%

4%

5%

18%

6%

1%

35%

11%

43%

69%

30%

53%

77%

27%

50%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Kuwait KSA UAE Qatar Oman Bahrain Average

Non-financial sector Other financial sector Conventional retail banks Islamic retail banks


Page 69


M&A decision for Islamic banks come with certain motivations, and challenges

Buyers/ sellers considerations

► Aggressive due diligence

► Reverse due diligence

► Retention of key employees

► Potential synergistic

► Negotiation

► Regulatory approvals

► Willingness to accept transactions structured with significant contingent payment provisions

Key motivators

► Market pressure – threat of being left out in the new wave of M&A in some economies

► Internal &external efficiencies

► Business model transformation/ realignment

► Bigger scale – expansion to exploit upcoming infrastructure projects

► Inorganic growth – strategic mergers & acquisitions

ChallengesPricing – Difficulty in finding pricing benchmarks

Post integration issues


Page 70









and processes







Page 71


Customer adoption of digital technology is growing exponentially

1bn

10m

50m

10 Years2 Years 50 Years

Wor

ldw

ide

Audi

ence

of

2bn internet users globally

700m Facebook users

30bn iTunes downloads

8bn SMS send every day

7 hours per day spend using digital technology

$60bn peer-to-peer mobile payments by 2013


Page 72

Sources: www.internetworldstats.com; The World Factbook, CIA, EY perspectives


Customer adoption of digital technology is growing exponentially

1bn

10m

50m

10 Years2 Years 50 Years

Wor

ldw

ide

Audi

ence

of

2bn internet users globally

700m Facebook users

30bn iTunes downloads

8bn SMS send every day

7 hours per day spend using digital technology

$60bn peer-to-peer mobile payments by 2013


Page 72


Digital touchpoints are now critically important for engagement, sales & service delivery and retention strategies

Customer Expectations

PersonalisedExperience

Anytime, Anwhere

Security & Trust

Deeper Relationships

► Each customer will expect a bespoke service from their bank at whichever touchpoint they use

►With technology on handheld devices, customers will expect to undertake banking whenever and wherever they need

►Security and trust will be important factors customers will review when choosing which digital channels they will use

►Bank’s product and marketing teams need to maximiseintelligence gathered from all types of customer transaction data to forecast customer needs


Page 73


MENA wide, there has been a considerable increase in the number of users of smartphones and social media over the last 12 months. This bodes well for banks embracing digital technology….


Page 74


Population Users, in Internet Usage, % Population Facebook( 2011 Est. ) 2001 Latest Data (Penetration) Subscribers

Bahrain 1,214,705 30.4 40,000 649,300 53.50% 287,020Iran 77,891,220 27.6 250,000 36,500,000 46.90% n/aIraq 30,399,572 20.6 12,500 860,400 2.80% 860,400Jordan 6,508,271 21.8 127,300 1,741,900 26.80% 1,675,780Kuwait 2,595,628 26.4 150,000 1,100,000 42.40% 822,640Lebanon 4,143,101 29.4 300,000 1,201,820 29.00% 1,201,820Oman 3,027,959 23.9 90,000 1,465,000 48.40% 285,080Palestine (West Bk.) 2,568,555 20.9 35,000 1,379,000 53.70% 599,520Qatar 848,016 30.8 30,000 563,800 66.50% 245,580Saudi Arabia 26,131,703 21.6 200,000 11,400,000 43.60% 4,034,740Syria 22,517,750 21.5 30,000 4,469,000 19.80% n/aUnited Arab Emirates 5,148,664 30.2 735,000 3,555,100 69.00% 2,340,880Yemen 24,133,492 16.4 15,000 2,349,000 9.70% 329,040Gaza Strip 1,657,155 17.5 n/a n/a n/a n/a

Middle East 208,785,791 23.6 2,014,800 67,234,320 32.20% 12,682,500

Middle East Internet Usage and Population Statistics

Median Age of Population

Government stimulus packages & Nationalisation programmes

Wealth distribution & Wealth acquisition

A young population already inclined to use digital technology

Banks have a customer base that is ready to embrace the products and service offering’s that will meet their expectations of personalised experience, anytime anywhere, security and trust and deeper relationships.


MENA wide, there has been a considerable increase in the number of users of smartphones and social media over the last 12 months. This bodes well for banks embracing digital technology….


Page 74


Population Users, in Internet Usage, % Population Facebook( 2011 Est. ) 2001 Latest Data (Penetration) Subscribers

Bahrain 1,214,705 30.4 40,000 649,300 53.50% 287,020Iran 77,891,220 27.6 250,000 36,500,000 46.90% n/aIraq 30,399,572 20.6 12,500 860,400 2.80% 860,400Jordan 6,508,271 21.8 127,300 1,741,900 26.80% 1,675,780Kuwait 2,595,628 26.4 150,000 1,100,000 42.40% 822,640Lebanon 4,143,101 29.4 300,000 1,201,820 29.00% 1,201,820Oman 3,027,959 23.9 90,000 1,465,000 48.40% 285,080Palestine (West Bk.) 2,568,555 20.9 35,000 1,379,000 53.70% 599,520Qatar 848,016 30.8 30,000 563,800 66.50% 245,580Saudi Arabia 26,131,703 21.6 200,000 11,400,000 43.60% 4,034,740Syria 22,517,750 21.5 30,000 4,469,000 19.80% n/aUnited Arab Emirates 5,148,664 30.2 735,000 3,555,100 69.00% 2,340,880Yemen 24,133,492 16.4 15,000 2,349,000 9.70% 329,040Gaza Strip 1,657,155 17.5 n/a n/a n/a n/a

Middle East 208,785,791 23.6 2,014,800 67,234,320 32.20% 12,682,500

Middle East Internet Usage and Population Statistics

Median Age of Population

Government stimulus packages & Nationalisation programmes

Wealth distribution & Wealth acquisition

A young population already inclined to use digital technology

Banks have a customer base that is ready to embrace the products and service offering’s that will meet their expectations of personalised experience, anytime anywhere, security and trust and deeper relationships.

Product innovation - Shari’a structures are only now being tested (for example sukuk market)

Asset Based Structures

• Structured as a Musharaka (Partnership), a Wakala (Agency) or a Mudaraba (Fund Management)

• Allows for future asset creation from funds raised. Consequently, 33% tangible asset requirement does not apply

• Requires investment of funds according to an approved, Shari’a compliant investment plan

• Suitable structure for development projects where assets are to be developed in the future and are not immediately cash generative

Assets Backed Structures

• Typically structured as an Ijarah (sale and lease back) or a Sharikat al Melk (co-ownership)

• Involves a sales contract where a beneficial interest is acquired in certain assets

• Funds are immediately invested in Shari’a compliant assets

• Minimum requirement is to have at least 33% (increasingly 51%) tangible assets at the outset

Discussion on Sukuk Structures

• Provides the greatest discretion in use of proceeds as initial investment has already occurred

Source: Norton Rose


Page 75


Real life case study of a restructured sukuk issue

Sukuk Holders

Issuer as InvestorPartner/ Lessor/

Trustee

Obligor as Commercial Partner

Musharaka with Business Plan

Project Co as Lessee

Obligoras Manager

Musharaka Purchase Undertaking

Mushraaka Sale Undertaking

Contribution in kind (land)

Units

99%Profit1% Profit

Management AgreementRental Payment during Rental Period and Final Rental Payment

Cash contributions

Units

Lease of Issuer

Assets

Source: Norton RoseILLUSTRATION


Page 76


General stages of the sukuk restructuring exercise (see Appendix for detailed description)

► A thorough understanding of the underlying Sukuk structure together with the corresponding agreements is required

► Care shall be taken that the restructuring would not cause a cross default

Existing arrangement

1

► Sukuk holders have to be on board with respect to the key features of the restructuring, this shall also include a comparison of existing core provisions of the Sukuk structure with the restructured one

► Sukuk holder agreement shall be required for the revised structure

Sukuk holder accord

2

► Dissenting sukuk holders shall be provided with an exit route without any breach to the effective provisions of the existing sukuk structure

► Sukuk holders who opt to buy the portion of dissenting sukuk holders may be given some additional benefits

Exit option

3

► The revised structure shall benefit both parties for it to be economically efficient

► The revised documentation shall comply with existing laws and regulations

► The trail of restructuring shall be documented

Benefits & Compliance

4

Source: Norton Rose


Page 77


Report Structure




Agenda

Country Spotlight

Executive Brief

1

2 3

5 4


Page 78


Key MessagesMalaysia – significant budget incentives to develop capital market products, SME business and venture financing

Turkey – Unique participation banking model, $25bn value, growing at CAGR of 30% plus for 2006-2010

Oman – potentially a $6-10bn Islamic banking market over next five years, first two licenses awarded

1

2

3

Country Spotlight – Introducing selective Islamic banking markets


Page 79


Country focus - Salient features

Malaysia Turkey Oman

Banking Parameters► Total banking assets 2010: US$505bn

CAGR (06-10): 9.1%► Islamic banking market share 2010: 17.3%► Total banking deposits 2010: US$ 360bn

and CAGR [06-10]– 9.5%► Banking asset penetration 2010: 220%► Deposit penetration 2010 : 156%

Banking Parameters► Total banking assets 2010: US$ 652bn

CAGR (06-10): 25%► Islamic banking market share 2010: 4.3%► Total banking deposits for 2010: US$

399bn and CAGR [06-10] – 25%► Banking asset penetration 2010: 85%► Deposit penetration 2010: 52%

Banking Parameters► Total banking assets 2010: US$41bn

CAGR (08-10): 6.6%► Islamic banking market share 2010: 0%► Total banking deposits 2010: US$27bn

CAGR (06-10): 22%► Banking asset penetration 2010: 70%► Deposit penetration 2010: 47%

Islamic finance commentary► Regulators recognise the profit and loss

sharing concept of Islamic banks► There are currently 17 Islamic banks and

four international Islamic banks► Conventional banks are encouraged by

the Central Bank to establish Islamic windows

► Various incentives (legal & tax) are provided by the government (e.g. up to 100% foreign equity ownership for Islamic banks

Islamic finance commentary► Turkey has a total of 49 banks, and 4 of

them are Participation Banks► Currently a law is in place which

recognises the participation features of Islamic banks

► Total number of branches of Participation Banks has increased by 8% in 2010 to reach 607

Islamic finance commentary► Royal Decree to introduce Islamic banking► Central Bank of Oman expected to allow

full Islamic banks and Islamic windows, new regulatory regime for Islamic banking business expected

► Two licenses awarded for full Islamic banks; most conventional banks expected to compete for Shari’a banking business through window operation


Page 80


Malaysian Islamic banking sector registered a four year CAGR of 19.3% to reach US$ 87bn in 2010

43 51 63 76 87

0

0.05

0.1

0.15

0.2

0.25

0

100

200

300

400

500

600

2006 2007 2008 2009 2010

Total Banking Assets Total Islamic Banking Assets Islamic Banking Growth

83%

17%

US$bn

Source: BNM Annual Report 2010


Page 81


Islamic banking assets and deposits registered healthy growth rate

2629

35

44

53

0

10

20

30

40

50

60

2006 2007 2008 2009 2010

CAGR of 19.9%

Malaysia's Islamic Banking Sector Total Financing (US$ bn)

32

40

50

62

71

0

10

20

30

40

50

60

70

80

2006 2007 2008 2009 2010

CAGR of 21.6%

Malaysia's Islamic Banking Sector Total Deposits (US$ bn)



Page 82


The five largest banks in the country account for approximately 58% of the market share

Market Share 2010

Maybank Islamic

18%

CIMB Islamic

13%

Bank Islam12%

Public Islamic

9%AmIslamic

7%

Other41%

• Malaysia's long track record of building a successful domestic Islamic financial industry of over 30 years gives the country a solid foundation - financial bedrock of stability that adds to the richness, diversity and maturity of the financial system

• Islamic banks in Malaysia are regulated by the Islamic Banking Act of 1983 and are governed by the Central Bank of Malaysia, Bank Negara Malaysia (BNM)

• There are currently 17 Islamic banks and four international Islamic banks



Page 83


Household sector benefits the most from Islamic financing… whereas deposits are mainly generated from business enterprises and financial institutions

Financing by sector Deposit by customer


Household sector62%

Healthcare5%

Commercial5%

Trade4%

Construction4%

Real estate3%

Communications4%

Other13% Government

18%

Financial Institutions

30%Business

enterprises31%

Individuals21%


Page 84


Key messages

Liberal measures such as issuance of licenses and increased limits of foreign equity ownership for Islamic financial institutions will help to attract and create a diverse community of local and foreign Islamic financial institutions

1

The growth of halal food industry in Malaysia has positive implications for the Islamic banking and finance industry, as the source of financing for the halal food industry should be from a Shari’a-based source

2

The country’s large and young Muslim population (60.4% of the country’s total population) provides impetus for continued strong growth of Islamic banking

3


Page 85


Participation banking in Turkey has grown at a four year CAGR of 33% and now accounts for approximately US$ 25bn in asset

US$bn

Source: Company Reports, Analyst Briefings, Central Bank

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0

100

200

300

400

500

600

700

2006 2007 2008 2009 2010

Total Assets Islamic Assets Islamic Banking Growth4%

96%


Page 86


Healthy growth in participation banking assets and deposits

CAGR of 32.3%

Turkey Islamic Banking Sector Total Financing (US$ bn)

CAGR of 31.7%

Turkey Islamic Banking Sector Total Deposits (US$ bn)

69

11

15

19

0

5

10

15

20

25

2006 2007 2008 2009 2010

6

9

11

14

18

02468

101214161820

2006 2007 2008 2009 2010



Page 87


Participation branches increased by approximately 8% in 2007 alone

0

100

200

300

400

500

600

700

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2005 2006 2007 2008 2009 2010

BranchesEmployees

Employees Branches

0%

1%

2%

3%

4%

5%

6%

7%

2005 2006 2007 2008 2009 2010

Total Assets Funds Collected Funds Invested

Employees and Branches Market Share



Page 88


Key Messages

1 Participation banking is expected to more than double its market share to 10% in the next decade. A number of new applications have already been made with the Turkish banking authorities

2 The core Shari’a sensitive segment constitutes approximately 20% of the bankable market

3 Turkish National Assembly in February passed tax and other measures to facilitate the introduction of sukuk in Turkey


Page 89


With the exception of 2009, Oman’s banking sector has seen steady growth in total assets, deposits, credit and net profits between 2005 and 2010

Omani Banks – Key Indicators (2004-2010)

0

50

100

150

200

250

300

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

2004 2005 2006 2007 2008 2009 2010

Total assets Total deposits Total credit Net Profit



Page 90


Retail lending constitute 40% of total credit in 2010, personal loans grew at a CAGR of 24% between 2005 & 2010

0

2,000

4,000

6,000

8,000

10,000

12,000

2008 2009 2010

Other

Mining and Quarrying

Wholesale & Retail Trade

Import Trade

Manufacturing

Services

Construction

Personal Loans

Credit distribution by sector (RO million)

50%

41%

9%

Loan Segmentation (% of total loans) in 2010

Business

Personal

Government



Page 91


Bank deposits have grown at CAGR of 23% from 2005 to 2010

Bank Deposits (RO million) Deposit Split

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010

Demand Saving Time

3,762

4,685

6,491

8,579 9,091

10,517

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0

2,000

4,000

6,000

8,000

10,000

12,000

2005 2006 2007 2008 2009 2010

Total deposits y-o-y growth %



Page 92


Bank deposits have grown at CAGR of 23% from 2005 to 2010

Bank Deposits (RO million) Deposit Split

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010

Demand Saving Time

3,762

4,685

6,491

8,579 9,091

10,517

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0

2,000

4,000

6,000

8,000

10,000

12,000

2005 2006 2007 2008 2009 2010

Total deposits y-o-y growth %



Page 92

Key Messages

1

2

3

Central Bank has awarded two Islamic banking licenses, to Bank Nizwa and Bank Izz. Most ofthe conventional banks are expected to launch Islamic windows

Islamic banking could potentially gain up to 10% market share over next five years, alsofacilitating Shari’a compliant foreign investment

Islamic banking was introduced in Oman in 2010 through a Royal Decree


Page 93


Appendices


Page 94


The case study draws upon a real life restructuring involving an amendment of the terms and conditions of the sukuk certificates (the “Certificates”) and the underlying capital markets and Islamic documentation (the “Restructuring”). Below is a simplified diagram of the sukuk structure

Sukuk Holders

Issuer as InvestorPartner/Lessor/

Trustee

Obligor as Commercial Partner

Musharaka with Business Plan

Project Co as Lessee

Obligoras Manager

Mushraka Purchase Undertaking

Mushraka Sale Undertaking

Contribution in kind (land)

Units

99%Profit1% Profit

Management AgreementRental Payment during Rental Period and Final Rental Payment

Cash contributions

Units

Lease of Issuer

Assets

Source: Norton Rose


Page 95


Sukuk restructuring case study (cont’d)

The principal features of the structure are as follows:

1. On the issue date of the Certificates (the “Issue Date”), the Sukuk holders paid the issuance proceeds to the Issuer SPV, which in turn contributed such proceeds into a Musharaka in its capacity as Investor Partner (the “Issuer’s Contribution”). On the Issue Date, the Obligor contributed certain land in the Musharaka in its capacity as Commercial Partner (the “Obligor’s Contribution”), which together with the Issuer’s Contribution constituted the initial Musharaka assets, which were co-owned by the Issuer and the Obligor (as Musharaka partners) in the proportions in which each contributed capital to the Musharaka.

2. On the Issue Date, the Issuer as lessor and the Obligor as lessee entered into an agreement for the lease of the Issuer Assets to the lessee (the “Lease Agreement”). “Issuer Assets” were essentially the Issuer’s undivided share, rights, title, interests and entitlements in the Musharaka assets.

3. Pursuant to a Management Agreement, the Musharaka partners appointed the Obligor as manager to develop a certain project and conduct the Musharaka business on their behalf in accordance with the terms and conditions of the Musharaka Agreement and the Management Agreement. The objectives of the Musharaka included the development of the said project and the sale of the developed land in accordance with the musharakabusiness plan appended to the Musharaka Agreement.

4. Not withstanding the proportion in which each Musharaka partner made its respective contributions, the Musharaka Business Plan contemplated that the profit derived from the Musharaka assets would be distributed between the Musharaka partners in the proportions 99 per cent. to the Obligor and 1 per cent. to the Issuer. The profit derived from the Musharaka assets and the rental payments made under the Lease Agreement were used to fund payments of Periodic Distribution (profit) Amounts to Sukuk holders.

5. Pursuant to a Musharaka Purchase Undertaking, the Obligor irrevocably undertook to the Issuer that upon the Issuer exercising, at any time between the date of the undertaking and the expiry date of the Musharaka, its option to oblige the Obligor to buy all of the Issuer’s Musharaka units as a result of: (i) the occurrence of an event of default or (ii) on the expiry date of the Musharaka (being the scheduled dissolution date in respect of the Certificates), the Obligor would buy the Issuer’s units on an “as is, where is” basis for the Termination Sum (essentially, an amount representing the principal amount of the Certificates plus accrued but unpaid profit), on the terms and subject to the conditions of the Musharaka Purchase Undertaking. The Musharaka Purchase Undertaking operated in tandem with a Lease Purchase Undertaking such that exercise by the lessor of the Lease Purchase Undertaking automatically resulted in a deemed exercise by the Issuer of its rights under the Musharaka Purchase Undertaking. Payment by the lessee of the “Termination Sum” under the Lease Purchase Undertaking would be deemed to discharge the obligation of the Obligor to pay the Termination Sum under the Musharaka Purchase Undertaking.

6. A mortgage over the land (or certain parts thereof) in favour of a security agent was taken as security in respect of the Certificates. The ratio expressed (as a percentage) of the aggregate value as reasonably determined by the lessee of the assets subject to the trust constituted pursuant to the Trust and Agency Deed in respect of the Certificates, less any further permitted financial indebtedness (as defined in the Transaction Documents) incurred by the Obligor, to the aggregate of all amounts outstanding to the Sukuk holders at the corresponding point in time (the “Security Cover Ratio”) was set at a ratio equal to or greater than 150 per cent.

Source: Norton Rose


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Key terms of the restructuring / incentives offered to investors

The key elements of the Restructuring the proposals put forward to investors were as follows:

1. The Transaction Administrator (the de facto trustee acting on behalf of and in the interests of Sukuk holders) informed investors (via a series of notifications sent through the clearing systems and through publications in relevant local newspapers) that the ultimate obligor in the structure (the “Obligor”) and the Issuer SPV intended to restructure aspects of the Sukuk and amend the terms of the Certificates. A bank (the “Dealer”) was chosen to assist with and coordinate the implementation of the Restructuring. For the Restructuring to take place, it was necessary to amend certain key terms of the Certificates as well as the underlying documentation in respect of the Sukuk structure, more importantly the Musharaka Agreement and the Lease Agreement and the security documentation.

2. Sukuk holders were informed that the Obligor and the Issuer wished to extend, in whole or in part, the term of the Certificates. The Sukuk holders were also informed that the Obligor and the Issuer wished to increase the rate at which existing profit amounts (the “Periodic Distribution Amounts”) on the Certificates would be calculated to be equal to a fixed rate of 6 per cent. and that the Issuer was willing to pay to the Sukuk holders accepting to participate in the Restructuring an extraordinary (one-off) Periodic Distribution Amount equal to roughly between 1 and 2 per cent. of the principal amount of the Certificates held by the Sukuk holders. Finally, the Sukuk holders were informed that the Obligor and the Issuer were willing to enhance the security granted to the Sukukholders by increasing the Security Coverage Ratio to 200 per cent.. The increase in the collateral security package supporting the Certificates and consequent increase in the Security Coverage Ratio of the Certificates to 200 per cent. would be effected by authorising the Issuer to procure that the Obligor subdivided the existing mortgaged land and sold the subdivided plots to third parties while maintaining the Security Coverage Ratio to 200 per cent..

3. Sukuk holders were asked to approve a number of amendments relating to the Sukuk structure and the Certificates, including:

i. extending the original maturity by 3 years;

ii. approving the increase in Periodic Distribution Amounts as well as the offer of an extraordinary Periodic Distribution Amount (essentially, a restructuring fee) to those Sukuk holders who accepted the terms of the Restructuring of roughly between 100 and 200 basis points calculated on the principal amount of Certificates held by such investors following the Restructuring; and

iii. extending the Security Coverage Ratio in respect of the Certificates to 200 per cent..

4. The Sukuk holders were asked to vote, by way of signing an Extraordinary Resolution, in respect of the matters mentioned in the preceding paragraph. However, participation in the Restructuring was not compulsory. Sukuk holders were notified that if they chose not to participate in the Restructuring they would have the option to be repaid in full on the Scheduled Dissolution Date (the original maturity date). Dissenting Sukuk holders would be repaid at maturity through the exercise (in part) of the purchase undertakings in the structure and otherwise in accordance with the original terms and conditions set out in the Offering Circular prior to any amendments effected pursuant to the Extraordinary Resolution.

5. In addition, Sukuk holders were given the option, while agreeing to participate in the Restructuring, to increase their participations in the Sukuk and purchase Certificates from those Sukuk holders who wished to obtain full repayment on the scheduled dissolution date.

Source: Norton Rose


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Procedural aspects of the restructuring

6. Sukuk holders were asked to waive the requirements in respect of notice of time, place and purpose of Sukuk holders meetings set out in the terms and conditions of the Certificates and in the Trust and Agency Deed and to agree to the terms of the Restructuring by signing an extraordinary resolution of Sukukholders holding in aggregate 90 per cent. of the principal amount of the Certificates.

7. Sukuk holders were informed that a consultation period (the “Initial Consultation Period”) would be put in place (running from the effective date of the Extraordinary Resolution and expiring one week prior to the scheduled dissolution date) during which each Sukuk holder would be asked to return to the Issuer an extension subscription form substantially in the form prescribed in the Extraordinary Resolution indicating the number of the Certificates held by the Sukukholder and the aggregate principal amount thereof, and irrevocably confirming whether:

i. the Sukuk holder accepts the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it;

ii. the Sukuk holder rejects the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it and requests the payment to it of the scheduled dissolution amount (essentially, principal plus profit) on or before the original scheduled dissolution date;

iii. the Sukuk holder accepts the extension of maturity and the amendment with respect to a portion of the Certificates held by it and requests a repayment of the scheduled dissolution amount with respect to the remainder of the Certificates held by it; or

iv. the Sukuk holder accepts the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it and that the Sukukholder wishes to increase its participation in the Sukuk by purchasing additional Certificates and the principal amount of the increased participation which the Sukuk holder wishes to purchase.

8. The Sukukholders were informed and asked to agree that, following the expiry of the Initial Consultation Period, there would follow an optional participation increase period (lasting three days) (the “Optional Participation Increase Period”) during which the Dealer would match the Sukuk holders who, during the Initial Consultation Period, delivered an extension subscription form requesting repayment of their scheduled dissolution amount on or prior to the scheduled dissolution date (the “Exiting Sukuk holders”) and the Sukuk holders who during the Initial Consultation Period delivered an extension subscription form accepting the extension of maturity and amendment of the Certificates and requesting to purchase additional Certificates (the “Increasing Participation Sukuk holders”) in order to intermediate the transfer of the Certificates from the Exiting Sukuk holders to the Increasing Participation Sukuk holders. Following the expiration of the Optional Participation Increase Period, the Issuer and/or the Dealer would determine the “continuing principal amount”, being an amount equal to the aggregate principal amount specified by the Sukuk holders who, during the Initial Consultation Period, delivered the extension subscription form confirming their participation in the Restructuring plus the aggregate principal amount (if any) corresponding to the Certificates purchased by the Increasing Participation Sukuk holders from the Exiting Sukuk holders during the Optional Participation Increase Period.

9. In accordance with the terms and conditions of the Certificates, the Restructuring was approved by an extraordinary written resolution of the Sukuk holders who, in aggregate, held more than 90 per cent. of the principal amount of the Certificates.

Source: Norton Rose


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Procedural aspects of the restructuring

6. Sukuk holders were asked to waive the requirements in respect of notice of time, place and purpose of Sukuk holders meetings set out in the terms and conditions of the Certificates and in the Trust and Agency Deed and to agree to the terms of the Restructuring by signing an extraordinary resolution of Sukukholders holding in aggregate 90 per cent. of the principal amount of the Certificates.

7. Sukuk holders were informed that a consultation period (the “Initial Consultation Period”) would be put in place (running from the effective date of the Extraordinary Resolution and expiring one week prior to the scheduled dissolution date) during which each Sukuk holder would be asked to return to the Issuer an extension subscription form substantially in the form prescribed in the Extraordinary Resolution indicating the number of the Certificates held by the Sukukholder and the aggregate principal amount thereof, and irrevocably confirming whether:

i. the Sukuk holder accepts the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it;

ii. the Sukuk holder rejects the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it and requests the payment to it of the scheduled dissolution amount (essentially, principal plus profit) on or before the original scheduled dissolution date;

iii. the Sukuk holder accepts the extension of maturity and the amendment with respect to a portion of the Certificates held by it and requests a repayment of the scheduled dissolution amount with respect to the remainder of the Certificates held by it; or

iv. the Sukuk holder accepts the extension of maturity and the amendment of the Certificates with respect to all the Certificates held by it and that the Sukukholder wishes to increase its participation in the Sukuk by purchasing additional Certificates and the principal amount of the increased participation which the Sukuk holder wishes to purchase.

8. The Sukukholders were informed and asked to agree that, following the expiry of the Initial Consultation Period, there would follow an optional participation increase period (lasting three days) (the “Optional Participation Increase Period”) during which the Dealer would match the Sukuk holders who, during the Initial Consultation Period, delivered an extension subscription form requesting repayment of their scheduled dissolution amount on or prior to the scheduled dissolution date (the “Exiting Sukuk holders”) and the Sukuk holders who during the Initial Consultation Period delivered an extension subscription form accepting the extension of maturity and amendment of the Certificates and requesting to purchase additional Certificates (the “Increasing Participation Sukuk holders”) in order to intermediate the transfer of the Certificates from the Exiting Sukuk holders to the Increasing Participation Sukuk holders. Following the expiration of the Optional Participation Increase Period, the Issuer and/or the Dealer would determine the “continuing principal amount”, being an amount equal to the aggregate principal amount specified by the Sukuk holders who, during the Initial Consultation Period, delivered the extension subscription form confirming their participation in the Restructuring plus the aggregate principal amount (if any) corresponding to the Certificates purchased by the Increasing Participation Sukuk holders from the Exiting Sukuk holders during the Optional Participation Increase Period.

9. In accordance with the terms and conditions of the Certificates, the Restructuring was approved by an extraordinary written resolution of the Sukuk holders who, in aggregate, held more than 90 per cent. of the principal amount of the Certificates.

Source: Norton Rose


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Amendments to documentation

10. In order to give effect to the resolutions set out in the Extraordinary Resolution, the Sukuk holders were required to give their assent to the modification of the transaction documents, as well as to waive any potential breaches of the terms of the existing Certificates and thus waive the occurrence of an event of default.

11. The transaction documents that were amended and restated included the following:

i. the terms and conditions of the Certificates as well as the Trust and Agency Deed were amended and restated in order to give effect to the extension of the maturity and the changes to the Periodic Distribution Amounts payable to investors;

ii. the offering circular in respect of the Certificates was amended by a supplemental offering circular to reflect the new terms of the securities;

iii. the Musharaka Agreement and the Lease Agreement, together with the underlying Undertakings, were amended and restated in order to reflect theincreased profit payments derived from the Sukuk assets and to deal with the partial redemption of Certificates on the scheduled dissolution date;

iv. the Security Agency Agreement was amended and restated to reflect the increase in the collateral supporting the Certificates.

12. In addition, the Sukuk holders were asked to waive any potential breach of Condition 10 (the Condition specifying which events constitute dissolution events(events of default) in respect of the Certificates) occasioned by:

i. the proposals contained in the Extraordinary Resolution; and

ii. the extension, in whole or in part, of the scheduled dissolution date of the Certificates,

and any preliminary or incidental steps to the Restructuring.

13. Care was also taken to ensure that the Restructuring and the proposals contained in the Extraordinary Resolution would not in any way trigger any cross-default provisions contained in other unrelated financing agreements to which the Obligor was a party.

14. Finally, the Sukuk holders authorised and requested the Issuer to take all steps considered in its sole discretion to be necessary, desirable or expedient to carry out and give effect to the Extraordinary Resolution, acknowledged the limitation of liability provisions set out in the Trust and Agency Deed in respect of the Issuer and absolved the Issuer from any liability in respect of any act or omission for which it may have become responsible under the Trust and Agency Deed with respect to the proposals contained in the Extraordinary Resolution, save in respect of the gross negligence or wilful default of the Issuer.

* Note: the structure discussed above pre-dated the AAOIFI statement in 2008 in respect of the use of purchase undertakings in Sukuk structures. The Restructuring was conducted on the basis of the originally approved structure. Had the deal been structured afresh today, a different approach may have been taken in respect of the use of purchase undertakings.

Source: Norton Rose


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Agenda

Country Spotlight

Executive Brief

Team, Sources & Contributors


Page 100


Ernst & Young Leadership

Ashar NazimIslamic Finance [email protected]

Abid [email protected]

Sohaib [email protected]

Shahid [email protected]

Mustafa [email protected]

Islamic Financial ServicesCenter of Excellence

MENA Executives

Tariq SadiqAdvisory Leader

Noor AbidAssurance Leader

Sherif El-KilanyTax Leader

Phil GandierTAS Leader

Gordon Bennie FS Leader

Andrew BarstowFS Advisory Leader

Maged FanousPartner, Kuwait

Robert AbboudPartner, Qatar

Fawad LaiquePartner, Saudi Arabia

Nader RahimiPartner, Bahrain

Imtiaz IbrahimSenior Director, Bahrain

Sameer AbdiPartner, Qatar


Page 101

Ernst & Young Leadership

Ashar NazimIslamic Finance [email protected]

Abid [email protected]

Sohaib [email protected]

Shahid [email protected]

Mustafa [email protected]

Islamic Financial ServicesCenter of Excellence

MENA Executives

Tariq SadiqAdvisory Leader

Noor AbidAssurance Leader

Sherif El-KilanyTax Leader

Phil GandierTAS Leader

Gordon Bennie FS Leader

Andrew BarstowFS Advisory Leader

Maged FanousPartner, Kuwait

Robert AbboudPartner, Qatar

Fawad LaiquePartner, Saudi Arabia

Nader RahimiPartner, Bahrain

Imtiaz IbrahimSenior Director, Bahrain

Sameer AbdiPartner, Qatar


Page 101


Report methodology and our interviews

Survey Methodology► Our survey sought to identify key trends and business risks for the

Islamic banking industry through in-depth interviews with executives and industry observers.

► These discussions were used to gauge business sentiment and identify key areas for inquiry.

► The top Islamic and conventional banks in the region were selected for our sample with the break down of banks selected country wise being:

► Bahrain – 4 Islamic and 4 conventional banks► Saudi Arabia – 4 Islamic and 5 conventional banks► Kuwait – 4 Islamic and 3 conventional banks► Qatar – 3 Islamic and 3 conventional banks► UAE – 4 Islamic and 4 conventional banks► Egypt – 1 Islamic bank► Jordan – 1 conventional bank

Business Risk Ratings► Ernst & Young subject matter experts from the Middle East, Asia

and Europe developed a list of banking business risks and contributing factors.

► All interviewees were provided with a list of business risks and requested to rate each to reflect its severity to their respective business over the coming 12 months. Interviewees were also asked to add any additional risks they felt were important.

► The results of this rating process were tabulated and a relative ranking assigned to each. This rank formed the basis for our comparative.

Business Performance Indicator► The Performance Indicator is a simple device that allows us to

present how Islamic banks are faring in comparison to conventional banks

Business Risk Categories► The Performance Indicator is split into tree categories: ► Red Light denotes that Islamic banks are not on par with

conventional banks► Amber Light denotes that Islamic banks are on par with

conventional banks► Green Light denotes that Islamic banks are above par

Anonymity and Quotes► All interviewees were assured of anonymity and minutes

documented during our discussions► Quotations have been used to support arguments made in the

report.


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Sample of Islamic and conventional banks

Islamic banks that contributed data to our sample:Bahrain► Al Baraka Banking Group► Ithmaar Bank► Bahrain Islamic Bank► Al Salam Bank

Saudi Arabia► Al Rajhi Bank► Bank Al Jazira► Alinma Bank► Bank AlBilad

Kuwait► Kuwait Finance House► Ahli United Bank► Boubyan Bank► Kuwait International Bank

Qatar► Qatar Islamic Bank► Masraf Al Rayan► Qatar International Islamic Bank

UAE► Dubai Islamic Bank► Abu Dhabi Islamic Bank► Emirates Islamic Bank► Sharjah Islamic Bank

Egypt► Faisal Islamic Bank of Egypt

Conventional banks that contributed data to our sample:Bahrain► Arab Banking Corporation► Ahli United Bank► Bank of Bahrain and Kuwait► National Bank of Bahrain

Saudi Arabia► National Commercial Bank► Samba Financial Group► Riyad Bank► SABB► Arab National Bank

Kuwait► National Bank of Kuwait► Burgan Bank► Commercial Bank of Kuwait

Qatar► Doha Bank► Qatar National Bank► Commercial Bank of Qatar

UAE► Emirates NBD► Abu Dhabi Commercial Bank► National Bank of Abu Dhabi► First Gulf Bank

Jordan► Arab Bank


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References and acknowledgments

Sources► Global Insight - comparative world overview tables ► Zawya► Central bank reports► Economist intelligence unit► Maris Strategies► The Banker► Islamic Finance News► Morgan Stanley► Bank annual reports

Ernst & Young’s Project Team► Ashar Nazim► Abid Shakeel► Fawaz Siddiqui► Saad Qureshi► Mohammed Al Felaij► Mubashar Haroon► Assad Butt► Yasman Moghaddam► Mustaqim Zain

Contributions► Norton Rose► Alun Williams©

For questions or comments, please contact :Fawaz Siddiqui: [email protected] Qureshi: [email protected]

Our industry awards

Consistently ranked the best Islamic Advisory firm with awards every year since 2006

Best Islamic Advisory Firm/Best Islamic Research 2010CPI Financial Islamic Finance Award

Best Takaful Advisory Firm 2010, 2011International Takaful Summit, London

Best IFN Awards 2009/2010Best Islamic Consulting Firm 2006Sheikh Mohammed Bin Rashid Al Maktoum Award

WIBC Leading Islamic Financial Services Provider 2008World Islamic Banking Awards, Bahrain

Most Outstanding Business Advisory & Consulting Firm 2006/2007Kuala Lumpur Islamic Finance Forum, Malaysia

► Nader Rahimi► Imtiaz Ibrahim► Maged Fanous► Hammad Younas► Asad Jafree► Murat Hatipoglu► Merisha Kassie► Mohd Husin► Venkat Subramanian


Page 104


Ernst & Young

Assurance Tax Transactions Advisory

About Ernst & Young

Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 144,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

The Middle East practice of Ernst & Young has been operating in the region since 1923. For over 85 years, we have evolved to meet the legal and commercial developments of the region. Across the Middle East, we have over 4,200 people united across 20 offices and 15 Arab countries, sharing the same values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

© 2011 Ernst & Young.

All rights reserved.

www.ey.com

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.


Page 105



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MEGA BRANDS. MEGA CLIENTS. MARKET LEADERS.MEGA is the market leading business information firm focused on achieving business results for the global Islamic banking & finance industry since 1993.The portfolio of MEGA brands represents the landmark industry conferences and our clients are the leading players in the international financial markets.

World Islamic Banking Competitiveness Report 2011-12.

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Transcript of World Islamic Banking Competitiveness Report 2011-12.