Islamic finance a better risk than banks?

Islamic financing is a growing source of loans worldwide and is now a better way to fund huge Asian infrastructure deals than banks, S&P says in a new report.

“Although banks have dominated the financing landscape for Asian infrastructure projects over the past decade, we believe that Islamic finance may be a better match for the region’s infrastructure funding needs.”

Struggling to keep up with infrastructure demands posed by solid economic growth and surging population, Asia is faced with massive spending requirements on projects in the water, transport, energy and power sectors.

“With the outlook in global lending markets still uncertain, conventional financing such as bank funding might not be able to completely shoulder this huge financing task,” says Singapore-based S&P credit analyst Allan Redimerio in a statement.

“We believe alternatives, such as Islamic finance, could play a key role.”

The Sharia principles governing Islamic finance ban speculation and specify that income must come from shared business risk, S&P says in the report.

“What’s more, Islamic finance is based on the concept of asset-backing.”

Malaysia is leading the way in Islamic financing and other countries in the region could also provide the right regulatory and tax frameworks, S&P says in the report, titled: `Will Islamic Finance Play a Key Role in Funding Asia’s Huge Infrastructure Task?’

Large companies such as Malaysia’s state-owned oil and gas company Petroliam Nasional Bhd had taken part in corporate-related Islamic financing.

“The Islamic financing market is gradually expanding, and is now moving toward listed instruments both in international and local markets, including Dubai, Malaysia, and Saudi Arabia,” the report says.

Malaysia had created a very attractive environment for Islamic finance investors, including laws to provide favourable tax treatment for Shariah-compliant sukuk bonds (interest-free bonds which comply with Islamic law).

“We think other economies in the region can benefit from Malaysia’s example, especially some countries with large infrastructure requirements that do not have a developed local bond market, such as Indonesia, Philippines, Vietnam, and India,” the report says.

Indonesia was probably in the best position to benefit from Islamic finance, given that it had already put in place regulations for such transactions and issued a few sovereign sukuk bonds.

The Asian Development Bank (ADB) recently predicted that Asian economies require US$8 trillion over the next decade to fully address the region’s basic infrastructure needs.

Asian infrastructure projects such as power plants and toll roads benefited from long-term concession agreements of 15-to-20 years or beyond that usually offered stable and predictable cash flow.

“These are the sorts of traits that sukuk investors, which are typically buy-and-hold investors, tend to prefer,” the report says.

“On the other hand, bank loans typically have tenors of five-to-seven years, which in many cases translate to a poor match for infrastructure projects.

“Indeed, the short tenors of bank loans may introduce refinancing risk for these sorts of long-term developments.”

Governments across Asia had been making moves to create a more attractive investment climate for infrastructure-related investments, including promotion of Islamic financing, the S&P report said.

ASEAN had announced the creation of a new fund to help finance major infrastructure projects across the region, with the fund’s total lending commitment through to 2020 to be about US$4 billion.

This rises to more than US$13 billion when the 70 per cent co-financing from the ADB is included.

Regional governments had also channelled pension fund money into infrastructure funding and issued public bonds into the market backed by infrastructure projects.

The World Bank had launched “a hub for knowledge and financial activities” in Singapore to find solutions to infrastructure financing problems.

Governments across Asia had also been encouraging more access to local bond markets.

“In our opinion, Malaysia and Singapore are the two markets best-positioned to play the role of hubs for Islamic infrastructure investing and promotion.”