Islamic finance and China

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China has become the world’s fastest growing energy consumer in the world. As the country develops, and the need for energy – specifically oil – grows, China wiill look to deepen strategic relationships with oil rich Gulf states. A result of that will be the opening of China’s banking sector to Middle East investors who follow Islamic finance standards.

A recent cover story in FinanceAsia on Islamic finance pointed out that “the Islamic finance business is growing at twice the rate of conventional financial services.” And Nora Salim of Islamic Finance News concluded in her January 26 article “China’s scope for Islamic finance” that Islamic finance players do have a place in China. Here is a bit of what she had to say:

The year 2006 started with Bahrain-based Shamil Bank launching its US$100 million Shamil China Realty Mudarabah. This was the first-ever Islamic property fund for investment in the Chinese real estate market. The four-year Mudarabah invests in the Xuan Huang China Realty Investment Fund, a joint venture between Shamil Bank and state-owned Chinese conglomerate CITIC Group. The fund undertakes Shariah-compliant, high quality investments in land development projects, residential, commercial and industrial properties. Institutional investors and high net worth individuals in the GCC were the target.

Deutsche Bank, through its global mutual fund arm DWS Investments, launched its first Shariah-compliant mutual fund capability in December. Within this range – marketed as DWS Noor Islamic Funds – it includes the DWS Noor China Equity Fund.

Another player is Gulf Finance House (GFH), which plans to invest at least US$1 billion in China. Esam Janahi, CEO of the Islamic finance house, stated that the bank is seeking to establish direct investments in infrastructure projects through the development of business hubs for energy companies, ports or roads in the country. Esam also added: “If you look at the growth in the utilisation of energy over the next five years, most of it comes from China and India. You have to be part of that market.”

So what exactly is Islamic finance? FinanceAsia had an excellent Islamic finance 101 in their May issue, the basics are as follows:

  • Under Shari’ah  law, making money from money, such as charging interest (riba) is prohibited
  • Financial speculations (gharar) is also not permissible
  • Companies should also avoid business related to obvious vices that aren’t in keeping with Islamic practice – alcohol, gambling, pork and entertainment businesses that are averse to Islam

So if you can’t receive payments of interest, how do Islamic bonds (sukuks) work? According to FinanceAsia it’s quite simple:

The issuer enters money, which is paid to the investor. For example, Pakistan issued a sukuk that uses toll receipts from state roads to pay investors holding government bonds.

How can you make a loan if you can’t charge interest?

You follow the murabaha principle and sell a commodity. Rather that loaning money to a borrower, as you would in a conventional loan, under murabaha a bank will buy a commodity from a third party and sell it to the customer for a pre-agreed upon price.

This is part of the concept of musharakah, which literally means sharing. The most frequently seen product is “diminishing musharakah,” which is principally used for home loans. A financier and the customer agree to joint ownership in a property. The client pays 20 percent of the price and the financier pay 80 percent. The client then moves into the house and pays rent that is agreed upon in a deal. The financier’s share of the house may be broken down into eight equal units, each representing 10 percent ownership of the house. The client may then promise to pay for one unit every three months. So after three months he purchases one unit of the share from the financier by paying 1/10 of the price of the house. That reduces the share of the financier from 80 percent to 70 percent and thus reduced the rent owed to the financier. At the end of the second term, the client purchases another unit increasing his share in the property to 40 percent and reducing the share of the financier to 60 percent and consequently reducing the rent to that proportion.

As Asia is home to at least half of the world’s 1.6 billion Muslims, concentrated largely in Malaysia and Indonesia, opportunities for Islamic banking products are huge. Asia’s emerging economies will expand 8.4 percent this year compared with U.S. growth of 2.2 percent, according the International Monetary Fund.

Just how much China’s new banking regulations – the lifting of restrictions on RMB and foreign currency transactions by solely foreign-funded banks and Sino-overseas joint venture banks – affects Islamic financing in China remains to be seen, but with China in need of more and more oil to power its economic machine, this finance practice will surely become an integral part of the financial scene on the mainland.