It started with the
original objective of developing a secondary market in sukuk and to be a market
maker. In fact its original name was the cumbersome Sukuk Exchange Central
Bank. But the oncoming global financial crisis forced the bank to retreat into
more vanilla investment banking to generate enough income to cover its expenses
and to prepare for the recovery in the market in 2010-2011.
The CEO of Elaf Bank is Jamil El-Jaroudi, a seasoned Islamic
banker who previously worked for Shamil Bank of Bahrain, then a subsidiary of
the Dar Al-Maal Al-Islami (DMI) Group, and subsequently worked as CEO of Arab
Finance House in Lebanon. Here El-Jaroudi discusses with Mushtak Parker the
latest developments at Elaf Bank, the state of the sukuk market and why he is
optimistic about the future of the Islamic banking industry.

During the second half of 2007 we started noticing the
signals of the crisis to come in the global financial system. Many sukuk issues
that were scheduled to come to the market in the second half of 2007 were postponed
or canceled. Although the first half of 2008 was an excellent time for sukuk
issuance and showed an upward trend equal to that of the previous two years, we
felt that the market was getting difficult and most of the banks that held the
old sukuk issuance were holding on to them because they were getting good
returns.
We felt that to play only the market maker and to create a
secondary market would not be feasible under these circumstances. We
subsequently focused on all sorts of investment-banking activity — advisory
services, corporate finance, etc. We invested our capital in a way that would
allow us to invest in sukuk in the next few years. We are hoping the market
will recover and that is what is already happening.

We have a paid-up capital of $200 million and a nominal
capital $500 million. Before asking for a capital increase from our
shareholders, we are first creating more value for the present shareholders and
for those to come in the future. As such we are focusing on building our
infrastructure, team and networking. We are also building a good portfolio of
private equity investment. We have executed several investments which have
given us good returns to cover our expenses.
These investments cover several countries, mainly Turkey,
Sudan, Malaysia, the UK and Indonesia. In Turkey we have a leasing company and
we financed a development project in Istanbul. We are also looking at launching
a number of Islamic trade finance funds for the Turkish market. Turkey is a
very strong Islamic trade finance market especially for commodity Murabaha.
We are well positioned in Turkey, where we have the people
on the ground and the connections. This goes back to the days when I was at
Shamil Bank. I worked a lot with the Turkish banks at that time in 1999 and
2000, when the profit rates were very attractive in Turkey to everybody.
We are also in Sudan where we financed a cement factory and
where we established a leasing (Ijara) company. Both are doing very well. We
also have a leasing company in Indonesia. In the UK In the UK, we are investors
in the Bank of London and Middle East (BLME), one of the five Shariah-compliant
financial institutions authorized by the Financial Services Authority (FSA). The
bank is now on the right track and is doing well.
One of our strategic objectives is to create business and
value between the two Islamic financial hubs — Bahrain and Malaysia. In fact,
we have applied for a license to open a branch under the Malaysia International
Islamic Financial Center (MIFC) Initiative. We have also several deals in the
pipeline in Malaysia and Indonesia. In Malaysia we are involved in two projects
— a $1.3 billion toll road project and in a company servicing the oil sector.
We plan to issue a series of sukuk to finance the activities of this company.
We are looking at the possibility of originating the first issuance of $75
million out of Labuan. In Indonesia we are involved in two projects with a
collective value of $100 million — one a $75-million investment in a
hydroelectric project and the other a $25-million investment in a liquefied
natural gas plant. These are real economy activities which are what Islamic
finance is all about.
 

This fund could be a Wakala structure but we have the option
of several Shariah-compliant structures approved by our Shariah board.
Eventually it will depend on the legal aspects especially in Turkey. We expect
the size of the first fund to be around $15 million.

We hope to do things which would allow us to take sukuk into
the secondary market. Our original mandate is still very much alive. We are not
ignoring it. It is a question of market conditions and timing. We are
concentrating on primary issues which can lead themselves to the secondary
market later.
For instance, we have our own piece of land in Bahrain on
which we are going to build our own tower. We hope to generate an Ijara
portfolio by renting out much of the space. This will be a good source of
primary sukuk which can later be securitized and traded.

The sukuk market is coming back. Although its is dominated
by sovereign and quasi-sovereign issuances, we are seeing a small number of
corporate issuances coming to the market. We expect an improvement in the sukuk
market in the second half of this year into 2011. But the slight dip in the
market in first half of 2010 suggests that investors are still cautious.
I am confident that we may see the volume of sukuk reaching
$30 billion in 2011 — the same size as before the crisis, although the market
will continue to be dominated by sovereign and quasi-sovereign issuances.
Perhaps in 2012, corporate issuances will start equaling origination activity
in the sovereign market.

GCC markets suffered the most through defaults. The defaults
awakened everybody — the regulators, Shariah boards and the investment bankers
— all to do a better job. Whenever there was a sukuk default, the media
immediately started to speculate about the future of the sukuk. But in the
conventional bond industry there has been tens of defaults and the media never
asked about the future of the bond industry.
Sukuk is a tool and an instrument. It is not a means by
itself. It will continue forever as long as people need money, and in the
Islamic structure this will be the future trend. Whenever people decide to come
to the market they will do it primarily through a sukuk. The sukuk structure is
not responsible for the defaults. This was mainly due to the issuers having
solvency problems or cash flow problems. It was a credit issue and nothing to
do with the Shariah structures.

They seem to be now, but not in the past when they were
over-reacting in a self-defeating way. It takes time to develop a top
regulatory regime. Kuwait especially has not done much. The problem to tackle
the financial crisis was exaggerated because it was politicized especially in
the National Assembly. Also investment companies were in the last three years
behaving as if they were banks. The crisis has given the regulator the
opportunity to rein them in.