Economic woes, commodity slump could hit Islamic banks

By Y-Sing Liau - Analysis

SINGAPORE (Reuters) - Islamic banks have been barely bruised by the global credit crisis so far, but the worst is yet to come as falling property and commodity prices and slowing economies start to hit the sector.

As the global economy buckles, credit lines tighten and consumer confidence crumbles, Islamic institutions -- which manage an estimated $1 trillion worldwide -- will not escape the pain that is plaguing conventional lenders in the West.

Sliding commodity and property prices in predominantly Muslim countries in the Middle East and Southeast Asia are likely to have a particularly strong impact on the sharia market due to the industry's heavy reliance on those assets to support deals.

"Islamic banks are heavily exposed to real estate and private equity in many of these markets," said Abdulkader Thomas, chief executive of Kuwait-based sharia advisory firm Shape Financial.

"If these markets are overpriced -- which some of them are -- then Islamic banks could well be particularly exposed."

Strict lending requirements, insistence on transparency and requirements that physical assets underpin transactions helped the Islamic industry survive the first round of the U.S. subprime mortgage meltdown, which fueled a worldwide credit crunch.

But the global financial crisis has worsened dramatically in recent weeks, sparking heavy selling of stocks, commodities and oil and threatening to plunge developed and emerging economies alike into recession.

Many companies are freezing or slashing spending and cutting jobs, and consumers are reining in spending.

Prices for most commodities such as crude oil, metals and grains have fallen to multi-month lows as investors pulled billions of dollars from the sector. Bankers estimate that about $50 billion-$60 billion of value has been wiped off commodity markets in the last quarter.

The sharia bond market, one of the most popular segments of the industry, has been hit as companies from Japan to Kuwait and Malaysia cite tough market conditions and high borrowing costs as reasons for either aborting or delaying issue plans.

The launch of at least one sharia hedge fund has been shelved and even oil-rich Gulf economies, which are global hubs for Islamic finance, have not been spared.

The United Arab Emirates government agreed on Sunday to take measures to shield the economy, promising to protect banks from credit risks. Last month, the UAE central bank launched a $13.6 billion emergency facility to help keep interbank lending moving.

"The easing of oil and gas prices is unhelpful for the GCC (Gulf Cooperation Councils) economies where Islamic finance is most developed," said Rodney Wilson, an Islamic finance specialist at Durham University in the UK.

"Furthermore, governments have had to curtail capital spending due to inflationary pressures, and there are serious worries over the bubble in the property market in the GCC."

In Asia, where countries such as Malaysia and Singapore are vying to be Islamic finance hubs, once booming property sectors are slowing rapidly. CLSA estimates half the wealth of Malaysia, Singapore, South Korea and India are tied to property, making the region highly susceptible to a sharp brake in economic growth.  Continued...