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A solution for sustainable economic development
of the Gulf Cooperation Council countries
Katarzyna Czupa
ISLAMIC FINANCE
Islamic finance. A solution for sustainable economic
development of the Gulf Cooperation Council countries
Katarzyna Czupa
Islamic finance. A solution for sustainable economic
development of the Gulf Cooperation Council countries
Centre for International Initiatives Warsaw 2015
The publication was issued within the project ‘Let’s talk about Islamic finance’.
Partners
Edition Katarzyna Czupa Cover project Katarzyna Czupa Language correction Aleksandra Radziwoń ISBN: 978-‐83-‐935548-‐0-‐5 Publisher Centre for International Initiatives Al. Waszyngtona 120/12, 04-‐074 Warszawa e-‐mail: [email protected] www.centruminicjatyw.org
About the author Katarzyna Czupa, Vice-‐President of the Centre for International Initiatives’ Management Board. She holds Master’s degree in international relations from University of Warsaw. She also studies Finance and Accounting (Master’s studies) at the Warsaw School of Economics. Between 2012 and 2014 she was a deputy of editor-‐in-‐chief of the student international affairs review Notabene. Her research interests include finance, Islamic finance, economic policy of the Gulf Co-‐operation Council’s member states as well as internal and foreign policy of the United Kingdom
Abstract The aim of this publication is to analyse the problem of sustainable economic development of the Gulf Cooperation Council (GCC) countries. The analysis focuses on the small and medium enterprises (SMEs), their development and use of financial instruments, especially Islamic financial instruments. It also discusses differences between Islamic and conventional theories of development. As it is proved, the GCC economies should not be perceived as truly and sustainably developed because they are based mainly on profits coming from oil and gas industry, which then are channelled through elaborated network of state-‐owned companies (SOEs). SMEs face many obstacles preventing development of their operations, e.g. financial exclusion. Taking into account the fact that religion plays a significant role in life of the Gulf inhabitants, Islamic finance, which is based on the prohibition on interest rate, may be used as a solution.
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Table of contents
Abbreviations .............................................................................................................................................................................. 4
Introduction ................................................................................................................................................................................. 5
1. Economic development in the GCC countries .......................................................................................................... 7
1.1. Introductory remarks. Defining development .............................................................................................. 71.2. Macroeconomic performance and development in the GCC countries ............................................. 11
2. Business environment in the GCC ............................................................................................................................... 19
2.1. The role of small and medium enterprises in the Gulf economies ...................................................... 23
2.2. Constraints for the Gulf SMEs’ operations .................................................................................................... 23
3. Financial inclusion as a precondition for development .................................................................................... 29
3.1. The role of finance in economy .......................................................................................................................... 293.2. Financial inclusion among the GCC SMEs ...................................................................................................... 31
4. Evolution and characteristics of Islamic finance .................................................................................................. 39
4.1. Main principles .......................................................................................................................................................... 394.2. Towards the Islamic banking .............................................................................................................................. 47
5. Islamic finance as a solution for development of the Gulf SMEs ................................................................... 53
Concluding remarks ............................................................................................................................................................... 61
References .................................................................................................................................................................................. 65
Appendix .................................................................................................................................................................................... 69
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List of figures
Figure 1 – GDP growth in the GCC member states and leading world economies, 2000-2012 (annual) ..................................................................................................................................................................................... 11
Figure 2 – Share of oil rents in the real GDP, 2000-2010 (percentage) ......................................................... 12
Figure 3 – GDP by economic sectors, 2011 ................................................................................................................. 13
Figure 4 – Share of state spending in non-oil GDP in the GCC and selected international cases, 2000 and 2008 .................................................................................................................................................................................... 14
Figure 5 – The GCC governments’ hydrocarbon revenues and total expenditure, 1980-2010 (real US dollars billions) ....................................................................................................................................................................... 16
Figure 6 – Private investment as a share of GDP, 1995 and 2006 (percentage) ........................................ 21
Figure 7 – The GCC employment in private and public sector, 2011 .............................................................. 22
Figure 8 – Distance to the frontier by region, 2013 ................................................................................................ 26
Figure 9 – Use of and access to financial services .................................................................................................... 30
Figure 10 – Credit growth, year over year, 2006-2011 ......................................................................................... 34
Figure 11 – SMEs loans as a percentage of total loans in selected economies in the MENA, 2009 .... 34
Figure 12 – Sources of working capital and investment finance, by firm size and country group, 2010 ............................................................................................................................................................................. 35
Figure 13 – Leasing volumes as a percentage of GDP in selected world regions, 2008 ......................... 36
Figure 14 – Results of survey on importance of obstacles to lending to SMEs, 2009 ............................... 37
Figure 15 – The mechanism of mudaraba ................................................................................................................... 41
Figure 16 – The mechanism of musharaka ................................................................................................................. 42
Figure 17 – The mechanism of asset-based sukuk .................................................................................................. 43
Figure 18 – The mechanism of asset-backed sukuk ................................................................................................ 44
Figure 19 – The mechanism of cash flow sukuk ....................................................................................................... 45
Figure 20 – The mechanism of ijarah ............................................................................................................................ 46
Figure 21 – Global Islamic banking assets growth trend, 2004-2012 ............................................................ 49
Figure 22 – Islamic banking market share by jurisdiction, 2011 ..................................................................... 50
Figure 23 – Average return on equity and return on assets for Islamic banks, 2008-2011 ................. 54
Figure 24 – Capitalization of Islamic and conventional banks, 2007 and 2011 .......................................... 55
Figure 25 – Issuance of Sukuk in the Gulf Cooperation Council, 2003-2009 ............................................... 56
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Figure 26 – Islamic Banking, religiosity, and Access of Firms to Financial Services ................................. 57
Figure 27 – Composition of financing modes in the Islamic banking sectors, 2008 ................................. 58
Figure 28 – Banking penetration and Islamic banking share, 2012 ................................................................. 59
List of tables
Table 1 – Financial inclusion indicators, 2011 ........................................................................................................... 33
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Abbreviations
E&Y Ernst and Young
HDI Human Development Index
GCC Gulf Cooperation Council
GDP Gross Domestic Product
IIBT International Islamic Benchmark Rate
MENA Middle East and North Africa
OECD Organisation for Economic Co-operation and Development
R&D Research and Development
ROA Return on assets
ROE Return on equity
SME Small and medium enterprise
SPV Special purpose vehicle
SOE State-owned enterprises
UAE United Arab Emirates
UK United Kingdom
US United States
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Introduction
On the surface, the Gulf Cooperation Council member states are one of the most developed countries in the world. They rank at the very top in terms of the gross domestic product (GDP) per capita – in 2012 the average value of the indicator in the region amounted to nearly 44,000 US dollars and was akin to those noted in Japan, Australia and Canada, which are the Organization for Economic Co-operation and Development members1. They are also in the group of countries with a high Human Development Index (HDI). As chart from the appendix 1 shows, since 1980 the indicator increased considerably among all the Gulf states and now its value is similar to these noted in the Central European countries2.
Recently, the Gulf has also become one of the main targets of global investors. Magnificent construction projects such as Burj Khalifa, the tallest building in the world, the 2022 FIFA World Cup in Qatar and numerous artificial private islands (the World archipelago is probably one of the most famous), attracted both international companies and individuals anxious for high profits’ rates. In 2007, before the outbreak of the financial crisis, the average market capitalization of listed companies measured as percentage of GDP in the region was nearly 87 per cent, compared to 63 per cent in Germany and 49 per cent in Poland. The indicator reached the higher values in Kuwait and Bahrain – 164 and 130 per cent respectively against 137 and 135 per cent noted in the United States (US) and the United Kingdom (UK). Although now market capitalization is far from this peak (in 2012 it was around 56 per cent), it is still relatively high and resembles patterns observed in the most dynamic economies in the world.
Given the fact that the GCC countries’ vast reserves of oil and gas3 generate a bulk of national income, those achievements should not come as a surprise. Most of the infrastructure projects as well as investments within the healthcare and education sectors are financed by profits coming from the extraction sector. This model cannot last forever, though, as natural resources are limited.
The aim of this study is to analyse the structure of the GCC companies’ ownership, their performance and contribution to GDP so as to examine patterns shaping particular economies. It describes the business environment in the region paying special attention to small and medium enterprises (SMEs), which in the West are deemed to be the cornerstone of a truly sustainable economy. It points out main obstacles towards enterprises development and discusses economic policies of the Gulf States in order to propose the best solutions facilitating SMEs’ operations, especially in the field of finance. Presenting characteristic features of Islamic finance, the main purpose of the analysis is to verify the hypothesis recommending this instrument as a tool that may help to satisfy financial needs of the small and medium business entities on the Gulf.
The first chapter discusses the issue of development. It shows evolution of the notion, points differences between conventional and Islamic approaches and introduces the concept of sustainable development. In the second part it describes the GCC economies from macroeconomic perspective as well as their performance in terms of human development.
The second chapter addresses the issue of business environment. By presenting contribution
1 Own calculation based on the World Bank data.2 In 2012 the average HDI in the region was 0.791 while in Belarus, Montenegro, Romania and Bulgaria it was 0.793, 0.791, 0.789 and 0.782 respectively. 3 According to BP Statistical Review of World Energy. June 2014, at the end of 2013, share of Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates reserves of total global reserves was 6, 0.3, 1.5, 15.8 and 5.8 per cent respectively. As for gas, shares were as follows 1, 0.5, 13.4, 4.4, 3.3 per cent and 0.1 per cent in Bahrain, which does not possess any oil reserves.
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of both SMEs and state-owned enterprises to employment, investment and GDP, it explains their role in the Gulf economies. It also analyses constraints for the Gulf SMEs’ operations and compares the operative solutions to those adopted in the most developed countries.
The third part of the study concerns financial inclusion and the role of finance in human and economic development. It discusses these issues from both conventional and Islamic perspective and provides various data in terms of individuals and business access to and use of finance.
The fourth chapter is thoroughly devoted to Islamic finance. The first section contains plentiful information on main principles of this unconventional finance and instruments used by SMEs. The second section shows evolution of this segment of finance both from the regional and global perspective.
The aim of the last part of the analysis is to establish whether Islamic finance is a plausible solution for the development of the Gulf SMEs. It presents current patterns in the use of this unconventional finance and points what risks and opportunities the prohibition of the interest involves. The final section describes actions that have been taken by the GCC incumbents in the past years and gives some recommendations in terms of policies relating to SMEs, finance and economy in general.
The research is based on reports published by global institutions and companies dealing with collecting data in the field of development, finance (both conventional and Islamic), entrepreneurship and macroeconomics, namely the World Bank, International Monetary Fund, United Nations, Organisation for Economic Co-operation and Development, Ernst&Young, Deloitte, British Petroleum, Islamic Service Board etc. Some statistics and figures come also from publications issued by renowned Western and Gulf universities, think tanks and governmental organizations (e.g. London School of Economics, Harvard University, Islamic Research and Development Institute, QFinance and Gulf Lead Consultants). All analyses were conducted with use of a variety of modern indicators measuring the GCC countries’ performance in the given fields and comparing results with those achieved by the most developed states. When it was possible, original documents were used. Given the fact that the author of this thesis does not speak Arabic, information was obtained only from the English and Polish references. So as to ensure high quality of the research the most up-to-date data was collected. Nonetheless, in some cases the author was not able to attain required sources, as in the GCC system of data collection is not sufficiently developed.
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1. Economic development in the GCC countries
1.1. Introductory remarks. Defining development
Defining development is considered as one of the most demanding tasks in the academic field. Scholars find establishing one and accurate definition particularly challenging due to the multidimensional nature of the phenomenon. Nonetheless, bearing in mind the scope of this study, it is necessary to describe the issue thoroughly lest cause any misinterpretations.
As of yet the most comprehensive definition of development has been presented in the Human Development Report 1990, according to which human development is ‘a process of enlarging people’s choices. The most critical of these wide-ranging choices are to live a long and healthy life, to be educated and to have access to resources needed for a decent standard of living. Additional choices include political freedom, guaranteed human rights and personal self-respect. (…) Human development thus concerns more than the formation of human capabilities, such as improved health or knowledge. It also concerns the use of these capabilities, be it for work, leisure or political and cultural activities. And if the scale of human development fails to balance the formation and use of human capabilities, much of the human potential will be frustrated’4.
The wealth of nations and its causes have been analysed for centuries. They were examined by such famous scholars as Adam Smith, David Ricardo and John Stuart Mill, representatives of so-called classical economics. Although while explaining disparities in particular countries’ development they focused on different aspects, they all pointed an unequal distribution of factors of productions (land, labour and capital), their values and thus different costs of production as primary causes of the problem5. Marxian model of economic growth put greater emphasis on the relations of production, referring to mode-specific ways of production in which human beings are joined in the production process, that is, the relations of production are concerned with class relations amongst members of society. In his view, development is a linear process and communism is its final stage6. Neoclassical school of thought tended to be resolutely micro-oriented. Its leading representatives, namely Alfred Marshall, Karl Menger and William Stanley Jevons, were concerned with conditions required for equilibrium in individual markets (e.g. the utility-maximizing behaviour of individuals and the profit-maximizing actions of the perfectly competitive firms)7.
Explanations and prescriptions were provided also by John Maynard Keynes, a strong advocate for state interventionism, Robert Solow, who proved that due to diminishing returns output growth is generated by technology changes rather than an increase in capital, and Walt Rostow, and author of stagesof growth theory8. Joseph Stiglitz and Gerald Meier, often pointed that issues such as macrostability, trade liberalization, property rights and poverty reduction are of utmost importance for economic development9.
4 UNDP, Human Development Report 1990 (New York: Oxford University Press, 1990), 1. 5 Ingrid Rima, Development of Economic Analysys (United Kingdom: Routledge, 2009), 196-197. 6 Danuta Drabińska, Miniwykłady z historii myśli ekonomicznej. Od merkantylizmu do monetaryzmu (Warszawa: Szkoła Główna Handlowa, 2007), 55. 7 Ingrid Rima, Development of Economic Analysys, 54, 283-285, 318. 8 Walt W. Rostow, Theorists of Economic Growth from David Hume to the Present. With a Perspective on the Next Century (New York: Oxford University Press, 1990), 281, 342, 374-380. 9 Gerald M. Meier and Joseph F. Stiglitz, Frontiers of Development Economics. The Future in Perspective, (New York: The World Bank and Oxford University Press, 2001), accessed 31.08.2014, http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2001/03/28/000094946_01032805420961/Rendered/PDF/multi0page.pdf.
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Until the publication of the Human Development Report it was generally assumed that the level of income is the best possible measure of welfare, since access to money provides a great deal of opportunities and permits the exercise of almost every option. However, it is true only up to a point. Income is a means, not an end. It may be used for many different purposes such as purchasing essential medicines or drugs. The well-being of a society depends on the uses to which its income is put, not on the level of income itself10. Human problems occur in many developed countries and no automatic link has been observed between the growth of income and human progress. Hence, it is essential to emphasize that income levels, by themselves, are no guarantee for prosperity and progress.
Due to the shift in the academic field towards a more complex approach focusing on the quality of human life11, for more than two decades human development has been measured not only by the yardstick of income, but also by a more comprehensive index known as the human development index (HDI) serving as a frame of reference for both social and economic development. This indicator consists of three main components: health, education and living standards, which are measured with the use of adequate indices. The first component is based on life expectancy at birth. The second one comprises the years of schooling for adults aged 25 years and expected years of schooling for children of school entering age. The decent standard of living component is measured by GNI per capita (PPP$) instead of GDP per capita (PPP$)12.
The significance of other factors does not mean that economic growth is irrelevant. A lack or at least shortage of necessary resources seriously impedes the realization of any development programs. Yet it must be also gauged whether people can lead long and healthy lives, whether they have the opportunity to be educated and whether they are free to use their knowledge and talents to shape their own destinies13. Taking all of that into account, the development analysis should discover how a link between growth and progress can be created and reinforced. In other words, it should focus on the issue known as sustainable development.
This concept was defined for the first time in the report entitled Our Common Future (also known as the Brundtland report), prepared by the United Nations’ Commission on Environment and Development. According to the document, sustainable development is ‘the development that meets the needs of the present without compromising the ability of future generations to meet their own needs. It encompasses two key concepts: the concept of ‘needs’, in particular the essential needs of the world’s poor, to which overriding priority should be given; and the idea of limitations imposed by the state of technology and social organization on the environment’s ability to meet the present and future needs’. As it was emphasized, development involves a progressive transformation of the economy and society. Physical sustainability cannot be secured unless development policies pay attention to such considerations as changes in access to resources and in the distribution of costs and benefits. Even the narrow notion of physical sustainability implies a concern for social equity between generations, a concern that must logically be extended to equity within each generation14.
According to Agenda 21, a roadmap to sustainable development containing ‘a comprehensive plan of action to be taken globally, nationally and locally, all countries should develop policies that improve efficiency in the allocation of resources and take full advantage of the opportunities offered by the changing global economic environment. In particular, wherever appropriate, countries should:
10 Gerald M. Meier and Joseph F. Stiglitz, Frontiers of Development Economics, 10.11 This change in approach is generaly ascribed to Amartya Sen, winner of the 1998 Nobel Prize in Ecnomics and co-creator of Human Development Reports and Mahbub-ul-Haq, game theorist and profesor at the University of Karachi.12 “Definition of Human Development Index,” UNDP, accessed 02.01.2014, http://hdr.und org/en/statistics/hdi.13 UNDP, Human Development Report 2010. 20th Anniversary Edition. The Real Wealth of Nations: Pathways to Human Development (New York: Palgrave Macmillan, 2010) IV. 14 “Report of the World Commission on Environment and Development. Our Common Future,” United Nations, accessed 25.04.2014, http://www.un-documents.net/our-common-future.pdf.
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(i) encourage the private sector and foster entrepreneurship by improving institutional facilities for enterprise creation and market entry; (ii) promote and support the investment and infrastructure required for sustainable economic growth and diversification on an environmentally sound and sustainable basis; (iii) provide scope for appropriate economic instruments, including market mechanisms, in harmony with the objectives of sustainable development and fulfilment of basic needs; (iv) promote the operation of effective tax systems and financial sectors; and (v) provide opportunities for small-scale enterprises, both farm and non-farm, and for the indigenous population and local communities to contribute fully to the attainment of sustainable development’15.
It has often been said that poor performance of developing countries in both social and economic field derives from the past institutional infrastructure, reflecting a belief system of beliefs that is difficult to change either because the needed changes, which are to enhance the economic performance of the country, conflict with the religion itself or pose a threat to the existing political or business leaders. The so-called developed world, also known as the North, envisaged an ideal political-economic institutional structure that has a potential for achieving a good economic performance and societal well-being as a framework of (i) an institutional matrix that defines and establishes a set of rights and privileges; (ii) a stable structure of exchange relationships in economic and political markets; (iii) a government that is credibly committed to a set of political rules and enforcement to protect individuals, organizations, and exchange relationships; (iv) rule compliance as a result of internalization of norms as well as coercive enforcement; (v) a set of economic institutions that create incentives for members of society and organizations to engage in productive activities; (vi) a set of property rights and an effective price system that lead to low transaction costs in production, exchange, and distribution16.
Stressing the importance of well-being rather than affluence, this approach is akin to the Islamic concept of development. The difference is that the Muslims care about social and economic justice, morality, compassion, generosity and charity even more than their Christian counterparts.
The essential framework for individual and collective human progress is presented in the Qur’an, and is, in turn, made operational by the traditions of the Prophet Mohammad. (…) The Qur’an provides the framework and specifies the rules (institutions) that are, to a degree, abstract, while the traditions of the Prophet articulate the operational form of these rules17. According to the Islamic school, prosperity is based on three pillars: individual self-development, physical development of the earth and the development of the community. Development is described as a sustainable process of human growth toward perfection with the use of natural resources, which leads to full integration and unity of society. These dimensions are connected to the point where balanced progress in all three areas is needed to achieve development.
Moral behaviour is the core of the Muslim tradition. It is also noticeable when it comes to organization of the economy. The underlying principles of Islamic economy are respecting property rights, commitment to contracts and market orientation, which are all to reduce uncertainty.
The Islamic doctrine recognizes property as a gift from Allah, which was given to humans to serve equal wealth creation. At the very beginning, property rights belonged to Allah, who in his graciousness transferred them to all of mankind upon the condition that the natural resources would be shared evenly and combined with the people’s labour would be used to produce goods and services. Individuals can gain legitimate property rights only through two ways: by their creative labour, and/or by transfers-exchange, contracts, grants, or inheritance – from those who have acquired the property rights title to an asset as a result of their own labour. Hence, work is perceived
15 “Agenda 21, United Nations Conference on Environment & Development,” United Nations, Sustainable Development Knowledge Platform, accessed 25.04.2014, http://sustainabledevelopment.un.org/content/documents/Agenda21.pdf.16 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance (Washington D.C.: International Bank for Reconstruction and Development, 2013), 156. 17 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 158.
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as the foundation of the property rights acquisition mechanism. It is prohibited to obtain property rights through gambling, theft, earning interest on money lent, bribery, or generally from any sources considered unlawful18.
The significance of property rights is strongly correlated with the commitment to contracts. The human fulfilment is contingent on patient and tolerant interaction and cooperation with other humans. Entrepreneurs of all kinds are subject to the rules of economic behaviour that forbid cheating, wasting (itlaf), overusing (israf), and causing harm to any trading partner. They must not do so both with respect to the Creator and other humans.
A contract is to be written and witnessed since there is a strong interdependence between contract and trust. Without trust, contracts become difficult to negotiate and conclude, as well as costly to monitor and implement. When and where trust is weak, complex and expensive administrative devices are needed to enforce contracts. Moreover, it is generally recognized that unambiguous contracts – the ones that foresee all contingencies – do not exist, as not all contingencies can be foreseen19.
It must be noted that markets play a crucial role in the Islam economy, but Muslim economic transactions differ considerably from the conventional ones. In the traditional capitalism the market norms are shaped by the notion of self-interest, which implies ’rational’ behaviour as maximizing the satisfaction that is utility or profit. In this concept individuals matter more. The community benefits chiefly thanks to self-realization of particular individuals and it is not itself a priority.
In Islam, by contrast, the market is only an instrument used in order to enhance extensive development. The principles shaping the pattern of preferences of entrepreneurs are constructed outside the market and they must learn them before engaging in any economic activity. The behaviour of consumers, producers, and traders, informed by their preferences, is subject to rules determined outside the market. In a market where there is full rule-compliance, the price that prevails for goods, services, and factors of production is considered just. The resulting incomes are considered justly earned. Therefore, the resulting distribution is just20.
The fact that interest rate based debt contracts of any type are deemed unlawful and as such are excluded from Islamic economy may provide an explanation of the specific shape of the Islamic economy. These contracts are replaced by the exchange ones, which, unlike the interest-based agreements21, entail a property claim on the principal and a portion of profits of the borrower before and after profits or losses are realized. In turn, parties willing to enter a contract must have the title to what they are going to exchange. They also need a place or a forum necessary for consummation of the exchange – that is a market – with rules ensuring its efficient operation (such as freedom of choice, freedom of contract, no restrictions on trade both international or interregional); free and transparent information concerning the price, quality, and quantity of goods; the specification of the exact date for the completion of transaction when it is to take place over time; the specification of the property and other rights of all parties in every contract.
In a nutshell, development means enhancing the quality of human lives understood as their capabilities. Both conventional and Islamic approaches focus on human empowerment understood as the ability to make their own and truly independent choices. The western countries accentuate the importance of education, health and decent level of income, while for the Muslim world justice, morality and the minimization of uncertainty are considerably more important. Notwithstanding differences, these concepts point to the necessity of providing people with even access to various 18 Any enterprises involving gambling, alcohol distribution, prostitution or pornography are banned in Islam. 19 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 172. 20 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 174. 21 According to Zamir Iqbal and Abbas Mirakhor, interest rate–based debt contracts do not result in exchange of full property claims. They only create a property claim for the lender on the property claims of the borrower in the amount of principal and interest, whether or not repayable ex post.
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resources, as it is the only proper means of improving their opportunities and thus ensuring sustainable development.
1.2. Macroeconomic performance and development in the GCC countries
The Gulf Cooperation Council is a political and economic organization comprising six countries located in the Middle East, namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE). It was established in 1981 in Riyadh, Saudi Arabia.
According to the Article 4 of the Charter, the GCC was created so as to effect co-ordination, integration and inter-connection between member states in all fields in order to achieve unity between them; to deepen and strengthen relations, links and areas of cooperation now prevailing between their peoples and to formulate similar regulations in various fields such as economic and financial affairs, education, culture, social and health affairs. The preamble of the Charter emphasizes the special relations, common qualities and systems founded on the creed of Islam, faith in a common destiny that bring these nations together22.
Figure 1 – GDP growth in the GCC member states and leading world economies, 2000-2012 (annual)
Source: Data from the World Bank database.
However, while analysing the development of the GCC countries, one should be aware, of the fact that they are not identical. Differences are especially noticeable in terms of territory and population. Saudi Arabia is by far the largest of the six countries with a territory covering 2 million sq. km, inhabited by over 28 million people. Then there is Oman with a territory of 309,500 sq. km and its 3.3 million inhabitants and the United Arab Emirates with a territory of 9.2 million sq. km and 83,600 people. Other countries are considerably smaller, as they are located on peninsulas or islands23. 22 “The Cooperation Council Charter,” The Cooperation Council for the Arab States of the Gulf, accessed 04.01.2014, http://www.gcc-sg.org/eng/indexfc7a.html?action=Sec-Show&ID=1.23 Data from the CIA World Factbook and the World Bank databases.
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Furthermore, although in all the GCC countries power is concentrated in the hands of the members of royal families, who are appointed to the most important state offices, particular political systems in the region have some specific features that make each of them unique. For instance, all states but Bahrain have legislative bodies, playing mostly an advisory role, whose deputies are chosen in general elections or are nominated by local communities. The Sharia law is the cornerstone of the GCC countries’ legal systems, yet the scope of citizens’ rights and freedoms is not identical24.
Notwithstanding some differences in the geographical and political field, the Gulf states resemble each other significantly in terms of economy. In 2012 the total value of the GCC’s GDP reached nearly 15,490bn US dollars25. For obvious reasons, the sizes of their economies vary considerably. Saudi Arabia, the biggest country in terms of both territory and population, produced the most (711bn US dollars, which is about 45 per cent of the total regional output). Yet the performance of its smaller neighbours was no less impressive. Total GDP of Qatar and Kuwait was 192 and 183bn US dollars respectively, accounting for 12 and 11.6 per cent of the regional production26.
Figure 2 – Share of oil rents in the real GDP, 2000-2010 (percentage)
Source: Data from the World Bank database.
Moreover, as figure1 shows, since the very beginning of the 21st century the yearly GDP growth among all the GCC members was almost constantly positive (on the account of the outbreak of the global financial crisis a drop was noted in 2008). In 2012 the average growth rate in this region exceeded 5 per cent, which compared to the US’s 2.8 per cent, Germany’s 0.7 per cent the UK’s 0.3 per cent is undoubtedly a remarkable feat. Only China’s GDP growth was higher (in the same period its GDP increased by nearly 8 per cent).
The GCC societies benefited from this outstanding economic performance. In 2012 an average GDP per capita in the region was nearly 44,000 US dollars (in Qatar it was 93,825 US dollars). This value is akin to those noted in the most developed countries. In the same period the US GDP per
24 Saudi Arabia is deemed to be the most conservative among the GCC members. 25 Data from the World Bank database.26 Own calculations based on The World Bank data.
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capita was 51,748 US dollars, while in Germany it was 42,624 US dollars27. A considerable improvement has also been noted in terms of quality of life. All the Council members are in high positions in the Human Development Report’s ranking. Qatar and the United Arab Emirates, placed in the group of countries with a very high HDI, are in the 36 and 41 places respectively. Bahrain, Kuwait, Saudi Arabia and Oman, which are in 48, 54, 57 and 84 places respectively, are marked as countries with a high HDI28.
A very important fact is that the GCC economies are driven by oil industry production. As figure 2 shows, oil rents contribute significantly to their real GDP. In 2010 profits coming from this sector accounted for nearly 50 per cent of Saudis and Kuwaiti revenues. Although the values noted in rest of the Council members were lower, they still exceeded the world average, which is well below 10 per cent. The yearly variations in the particular countries’ oil dependency stem from the volatility of oil prices that directly affect incomes.
Recently, each country has adopted a development strategy aiming at the economic diversification and creation of employment for nationals. Diversification may be defined in different ways depending on the field of application, yet on the whole it refers to ‘exports, and specifically to policies aiming to reduce the dependence on a limited number of export commodities that may be subject to price and volume fluctuations or secular declines’. (…) It also involves a shift from one sector or industry to another, and generally from the primary to the secondary and tertiary sectors’29.
Figure 3 – GDP by economic sectors, 2011
Source: Qatar National Bank SAQ, “GCC Economic Insight 2012,” Economic Insight Reports (2012):15, accessed 30.01.2014, http://www.qnb.com.qa/cs/.
One may wonder why, given the level of profits generated by the extraction sector, these policies have been launched before. As Atif Kubursi pointed out, ‘if oil supplies were everlasting, and the demand for oil strong and continuous, economic diversification would be pointless. (…) However, in the real world, oil resources are finite and experience shows that both the price of and the demand for oil have fluctuated considerably. Moreover, oil revenues quickly crowd out any other economic activity’30. That reasoning is the driving force behind all taken actions.
27 Data from the World Bank database. 28 UNDP, Human Development Report 2013. The Rise of the South: Human Progress in a Diverse World, (New York: United Nations Development Programme, 2013), 144-145. 29 Martin Hvidt, Economic diversification in GCC countries: Past record and future trends (United Kingdom: The London School of Economics and Political Science, 2013), accessed 30.01.2014, http://eprints.lse.ac.uk/55252/1/Hvidt_2013.pdf.30 Martin Hvidt, Economic diversification in GCC countries.
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The efforts aiming at creating a modern and fully sustainable economy date back to the wake of the so-called oil shocks that occurred in the 1970s. This goal has proven especially challenging, however, and a wide range of measures has been adopted since then.
Figure 4 – Share of state spending in non-oil GDP in the GCC and selected international cases, 2000 and 2008
Source: Steffen Hertog, The private sector and reform in the Gulf Cooperation Council (United Kingdom: London School of Economics and Political Science, 2013), accessed 01.02.2014, http://www.lse.ac.uk/IDEAS/programmes/kuwait/documents/The-private-sector-and-reform-in-the-GCC.pdf.
Saudi Arabia has the longest and most developed tradition of planning among the GCC member states, institutionalized in the Ministry of Economy and Planning. Since 1970, nine development plans have been implemented. The latest, the Ninth Development Plan, applies to the 2010-2014 period. In 2004 a Long-Term Strategy, which covers the years 2005-2024, was published31. In July 2008, Qatar published a long-term plan called Qatar National Vision 203032, which was followed by the Qatar National Development Strategy 2011-201633 in March 2011. In October 2008, Bahrain adopted the Economic Vision 2030 plan34, and a year later the National Economic Strategy35, which is a detailed and short-term spending plan (its implementation is to help to achieve the Vision 2030 goals). Similarly, in 2010 the National Assembly of Kuwait accepted the State Vision Kuwait 2035 and a five-year development plan, concerning the years 2010 to 2014, which were accompanied by the adoption of a detailed expenditure budget36. In February 2010, the UAE launched its Vision 202137 followed by the UAE Government Strategy (2011-2013)38. Oman’s the Eighth Five-Year Development Plan (2011-2015) was announced in January 201139.
31 Martin Hvidt, Economic diversification in GCC countries. 32 General Secretariat for Development Planning, Qatar National Vision (Doha: General Secretariat for Development Planning, 2008), accessed 30.01.2014, http://www.gsd gov.qa/portal/page/portal/gsdp_en/qatar_national_vision/qnv_2030_document/QNV2030_English_v2.pdf.33 General Secretariat for Development Planning, Qatar National Development Strategy 2011-2016, (Doha: General Secretariat for Development Planning, 2011), accessed 30.01.2014, http://www.gsd gov.qa/gsdp_vision/docs/NDS_EN.pdf.34 “Economic Vision 2030 for Bahrain,” Bahrain News Agency, accessed 30.01.2014. http://bna.bh/portal/en/news/428203. 35 “New Budget Process,” Ministry of Finance of Kingdom of Bahrain, accessed 30.01.2014, https://www.mof.gov.bh/topiclist.asp?ctype=budget&id=870.36 Tariq A. Aldowaisan, A Reconciliated Country Vision, September (2010), accessed 30.01.2014. http://glc-im.com/wp-content/uploads/2012/12/Reconciled.Kuwait.Vision.E.pdf.37 “UAE Vision.” Vision 2021, accessed 30.01.2014, http://www.vision2021.ae/.38 “UAE Strategy 2011-2013” The Cabinet of United Arab Emirates, accessed 30.01.2014, http://uaecabinet.ae/en/Strategies/Pages/20112013-Strategy.aspx#.UuqB8nd5M1g.39 “Sultanate of Oman Major Business Sectors,” Embassy of Switzerland, accessed 30.01.2014, http://www.s-ge.com/de/filefield-private/files/784/field_blog_public_files/4852.
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The purpose of these strategies is to enhance the competitiveness of the national economies in the global arena. All of them stress the need to boost productivity and competitiveness, and include promotion of a business environment conducive to growth. Targeted areas also include integrating the countries’ economies with the global knowledge economy, encouraging entrepreneurship, attracting foreign investment, fostering innovation and ensuring access to financing for small and medium-sized enterprises (SMEs). Other themes focus on recognition of the need to improve education and health outcomes, and the desirability of improving the efficiency of the public sector40. In short, the underlying goal of all these reforms is ‘to shift from an economy built on oil wealth to a productive, globally competitive economy, shaped by the government and driven by a pioneering private sector – an economy that raises a broad middle class that enjoy good living standards through increased productivity and high-wage jobs’41.
In the first decade of 21st century, all the GCC countries experienced an increase in the non-oil sectors’ contribution to the GDP growth. As set out in appendix 1, the services sector has played the central role in the diversification. Nonetheless, differences in shares of particular segments of the sector among the GCC countries can be observed. In the period 2000-2009, financial services grew rapidly in Bahrain, Kuwait, Qatar and the UAE, while the real estate services sector developed mostly in the UAE. Government services grew throughout the region, most markedly in Bahrain and the UAE. The construction boom was most pronounced in the UAE, with a significant growth in Qatar and Oman. Tourism is a rapidly growing sector in several countries, with Saudi Arabia – based on religious tourism – among the top 20 destinations in the world by the number of tourists42.
Nevertheless, as figure 4 shows the oil and gas sector still plays a major role in economy. In 2011 it accounted, on average, for the half of the GCC members’ GDP, while the government services, financial services, manufacturing and construction made for 12 per cent, 10 per cent, 9 per cent and 5 per cent respectively. On the whole, non-oil industry constituted only 16 per cent of the total production.
It must be noted that the share of state spending in the non-oil gross domestic product and of the government consumption in the total final consumption is considerably higher than in other parts of the world. Many of the 2000s booms, and thus a bulk of the diversification projects, were driven by state expenditures, which, as figure 5 shows, are strongly correlated with the hydrocarbon revenues. The GCC’s impressive results in terms of the HDI stem solely from government spending. What is more, an abnormally high share of private household consumption is financed through civil service wages, which dominate the total wage income of the GCC nationals (this issue will be explained more thoroughly in the second chapter).
As far as state spending and consumption patterns are concerned, Bahrain and the UAE seem to be more diversified than their neighbours. In the case of Bahrain, these figures seem to be explained by the fact that this country’s economy is dominatedby private service sector, financed, to a significant extent, by private capital from other GCC countries. Data concerning the UAE might understate the government’s role. It is because outside of Dubai the private sector activity is restricted, which makes unclear whether the United Nation’s figures for government spending and consumption include also ‘the emirate-level and public company activities’43.
Taking into account all presented information, the GCC countries have undoubtedly developed over the last few decades. Thanks to abundant oil and gas resources their economies have been
40 Samya Beidas-Strom et al., Gulf Cooperation Council Countries. Enhancing Economic Outcomes in an Uncertain Global Economy (International Monetary Fund, 2011), 2. 41 “Economic Vision 2030 for Bahrain,” Bahrain News Agency, accessed 30.01.2014. http://bna.bh/portal/en/news/428203.42 Samya Beidas-Strom et al., Gulf Cooperation Council Countries, 3. 43 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council.
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growing rapidly and as a result of the policymakers’ efforts, mostly taking the form of raising social expenditures, the quality of life of the Arab Peninsula inhabitants improved significantly. These impressive results may give the impression of prosperity and stability. Unfortunately, it is true only to some extent. Despite many diversification strategies, half of the GDP is still generated by the oil and gas sector, which is by no means a stumbling block to fully sustainable development.
Figure 5 – The GCC governments’ hydrocarbon revenues and total expenditure, 1980-2010 (real US dollars billions)
Source: Samya Beidas-Strom et al., Gulf Cooperation Council Countries. Enhancing Economic Outcomes in an Uncertain Global Economy, 36.
Firstly, oil prices are highly volatile and thus incur fluctuations of government revenues, what considerably impedes the implementation of proper economic policies44. Secondly, hydrocarbon
44 Volatility of the deficit is much lower than the volatility of revenues—the standard deviation of the growth in the former being just 30–55 per cent the standard deviation of the latter. Nonetheless a decrease in budged income triggers the necessary cuts in the fiscal policy in order to avoid the deficit.
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resources are not renewable, meaning that someday they will peter out and bring no more profits. Thirdly, the employment creation provided by the oil sector is limited it is assessed that it employs less than 3 per cent of the region’s labour force. This economic model simply cannot work forever and without a doubt will not ensure the development that ‘meets the needs of the present without compromising the ability of future generations to meet their own needs’45.
As Martin Hvid noticed, ‘the Gulf states’ drama is that it [oil extraction] is not simply another economic activity added to other existing productive sources within a viable and modern economy, as it is with the Netherlands or, for that matter, Canada, Australia, and the Scandinavian countries. In the Gulf, the oil sector dominates the economy; it is almost the unique source of wealth’46.
So as to examine the problem of the GCC economies more deeply and understand why the diversification efforts failed, an analysis of the GCC business environment and enterprises performance must be conducted.
45 “Report of the World Commission on Environment and Development. Our Common Future,” United Nations, 37.46 Martin Hvidt, Economic diversification in GCC countries, 4.
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2. Business environment in the GCC
2.1. The role of small and medium enterprises in the Gulf economies
It is a widely known fact that small and medium enterprises are a stepping-stone towards truly sustainable development, as they contribute significantly to job creation, economic growth and diversification. According to the OECD data, at the turn of 21st century SMEs contributed to over 55 per cent of GDP and over 65 per cent of total employment in high-income countries, over 60 per cent of GDP and over 70 per cent of total employment in low-income countries and 95 per cent of total employment and about 70 per cent of GDP in middle-income countries47.
The notion of entrepreneurship development as well as the SME term itself was conceived in the late 1940s along with the introduction of so-called targeted policies (grants, subsidized credits, special tax treatment etc.). Nonetheless, statistical definition of SMEs still considerably varies by country, generally comprising at least one of the following factors: the number of employees, the annual turnover and assets of a company. Given the relative ease of data collection, the most commonly variable used is the number of employees. The EU and a large number of the OECD, transition and developing countries set the upper limit of the number of employees in the SMEs between 200-250. In Japan and the USA the thresholds are 300 and 500 employees respectively48. At the lower end of the SME scale, many countries consider companies as small or the medium ones when they hire less than 10 employees49. It should be noted that irrespectively of the level of economic development, a considerable proportion of micro and (sometimes) small enterprises operate in the informal sector or the shadow economy.
As far as the GCC is concerned, there is also no common definition of SMEs that would be accepted and used by all the Council members. In Bahrain, an enterprise that is considered to be of micro size has up to 10 employees, while small and medium-sized ones have up to 50 and 150 employees respectively. In terms of investment levels the thresholds in each category are 53,000, 1.3 million and 5.3 million dollars. In Saudi Arabia, small businesses hire less than 60 people and their assets are worth up to 1.3 million dollars while the medium ones employ less than 100 and invest no more than 5.3million dollars. The UAE’s micro enterprises have less than 10 workers, while the small and medium ones have less than 25 and 100 employees respectively (in the latter case turnover cannot surpass 100 million Dirham per year, which is equivalent to 27 million dollars). In Oman, companies with up to 5 hired people are treated as micro ones, while small and medium entities employ 20 and 100 people respectively. Kuwaiti institutions use mainly financial criteria defining small and medium enterprises as projects with the capital between 500,000 and 520,000 dollars. Interestingly enough, in Qatar there seems to be no consensual definition pertaining to any of the types of enterprises50.
47 2nd OECD Conference of Ministers Responsible for Small and Medium Sized Enterprises, Promoting Entrepreneurship and Innovative SMEs in a Global Economy: Towards a More Responsible and Inclusive Globalisation (Istanbul: Organisation for Economic Co-Operation and Development, 2004), accessed 17.02.2014, http://www.oecd.org/cfe/smes/31919278.pdf. 48 2nd OECD Conference of Ministers Responsible for Small and Medium Sized Enterprises, Promoting Entrepreneurship and Innovative SMEs in a Global Economy: Towards a More Responsible and Inclusive Globalisation.49 As a result of a serious lack of cooperation between the government institutions the criteria differ also within the particular countries. 50 Steffen Hertog, Benchmarking SME Policies in the GCC: a survey of challenges and opportunities (Brussels: Eurochambres, 2010), accessed 17.02.2014, http://eprints.lse.ac.uk/29870/.
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On average, SMEs employ between 10 and 50 workers, so their impact on employment across the GCC is above 8.5 million jobs51.
The access to data concerning the SMEs’ share in the Gulf economies has improved over the years, however, specific figures are still scarce and often patchy, what often makes them incomparable across countries. The statistical data used in this paper were prepared by the EU-GCC Chamber Forum and are of the best possible quality accessible to a young researcher.
On the whole, SMEs constitute more than 90 per cent of enterprises in every GCC member country. In 2007 there were about 40,000 SMEs operating in Bahrain, indicating a high density of business – one company per 25 inhabitants of the country. Nearly 50 per cent of entire workforce was hired in micro-enterprises with up to 4 employees. In the same period in Kuwait the estimated number of SMEs amounted to ca. 33,000. According to the data from 2008, in Oman nearly 45,000 companies were considered as small or medium – 42.6 per cent were sole proprietorships while 37.2 per cent employed up to 5 workers. The same year in Saudi Arabia 785,000 enterprises were registered, 764,000 of which had only one employee, meaning that there was one SME per 25 inhabitants of the kingdom. As for Qatar, statistics about its private sector are divided into two groups: concerning entities with less than 10 employees, and those with 10 employees or more. In 2006 the number of companies employing less than 10 people exceeded 10,000, which constituted 75 per cent of all businesses. As far as the United Arab Emirates are concerned, the latest data that proves reliable comes from 1995. Back then, more than 92,000 companies were registered as having less than 100 employees. According to the EU-GCC Chamber Forum, till 2005 their number rose to about 157,00 and in 2007 there were 85,000 SMEs registered in the Dubai Chamber of Commerce and Industry alone52.
While analysing the sectoral breakdown of small and medium business entities, it is noticeable that they are a very heterogonous group. It is so due to the fact that these types of enterprises offer a chance of decent and, even more importantly, independent life to everybody, regardless of their profession. An enterprise of micro or small size may be established and run equally by a merchant, farmer, hairdresser as well as an engineer, artist, architect etc. They may operate both in the city and countryside, selling their products and services on the local, regional and sometimes even on the global market.
According to the Bahraini Ministry of Industry and Commerce, in 2007 more than a third of the SMEs dealt with manufacturing fabricated metal products, 16 per cent produced non-metallic mineral products, 15 per cent operated in chemicals and chemical products segment and 11 per cent dealt with food production53. In Kuwait, small and medium-sized business entities are concentrated in two sectors: in 2007 a third of the SMEs was active in the construction and industry segment and 40 per cent dealt with wholesale/retail trade and hotels and restaurants. As for Saudi Arabia, in 2008 almost a half of the SMEs operated in the commercial and hotel sector, a third dealt with construction and 12 per cent were active in industry. In 2006, about 65 per cent of Qatari small and medium businesses dealt with trade, almost 20 per cent operated in industry and 15 per cent ran hotels and restaurants. Merchants also dominate the United Arab Emirates’ market – 60 per cent of SMEs deal with trade, while 35 per cent of them operate in the services sector54. In the case of Oman, there are no available data in terms of sectoral breakdown. On the whole, in 2010 across the GCC region 47 per cent of SMEs were engaged in commercial, trading
51 Omar Fisher, “Small and Medium-Sized Enterprises and Risk in the Gulf Cooperation Council Countries: Managing Risk and boosting Profit,” QFinance, accessed 10.05.2014, http://www.financepractitioner.com/contentFiles/QF02/gwtb8s2b/10/0/small-and-medium-sized-enterprises-and-risk-in-the-gulf-cooperation-council-countries-managing-risk-and-boosting-profit.pdf. 52 Steffen Hertog, Benchmarking SME Policies in the GCC. 53 Venture Capital Fund Bahrain, Private Placement Memorandum, (Bahrain: Venture Capital Fund Bahrain, 2008), 22, http://www.lf.bh/docs/VCF-Private%20Placement%20Memorandum-En.pdf, accessed: 20.02.2014.54 Steffen Hertog, Benchmarking SME Policies in the GCC.
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and hotel businesses, 27 per cent in construction, 12 per cent in manufacturing, 6 per cent in social services and 8 per cent in sundry other sectors55.
Figure 6 – Private investment as a share of GDP, 1995 and 2006 (percentage)
Source: The World Bank, From Privilege to Competition. Unlocking Private-Led Growth in the Middle East an North Africa (Washington D.C.: The World Bank, 2009), 53.
Despite the large number of SMEs as well as the continuous efforts towards economic diversification aiming to develop the private sector, the GCC markets are dominated by huge state-owned enterprises (SOEs). It is hardly possible to find any truly private business among the top 100 GCC companies (not only in the energy sector) since the government is either a major shareholder or appoints its representatives as members of the board56. The Saudi Basic Industries Corporation, which ranked first on the list with the market capitalization of 75bn dollars, is controlled by the Saudi Arabian government owning 70 per cent of company’s shares57. The chairman of the enterprise is a member of the ruling family (curiously enough, he also acts as chairman of the Royal Commission for the Industrial Cities of Jubail and Yanbu). One current and one former deputy minister can be found among the other members of the board58. In the case of Etisalat, the situation looks oddly similar – 60 per cent of the telecommunication giant’s shares, whose market value is approximately 22bn dollars, are in the hands of the UAE government59. The situation of the Industries Qatar, the fourth biggest company in the region, which operates in the petrochemical, steel and fertilizers sectors is parallel, as the company is managed by the current Qatari Minister of Energy and Industry, who is also its Chairman and Managing Director60.
Given their size and abundance of capital stemming chiefly from state subsidies, the SOEs play a significant role in shaping the GCC economic environment. In 2006 the private sector investments constituted only 50 per cent of total investment in the oil-rich countries. This rate was considerably lower than that of East Asia and Pacific Europe (70 per cent), Europe and Central Asia (80 per cent) 55 Omar Fisher, “Small and Medium-Sized Enterprises and Risk in the Gulf Cooperation Council Countries: Managing Risk and boosting Profit.” 56 “Special Report Top 100 GCC Companies 2013,” Gulf Business, November 24, 2013, accessed 08.03.2014, http://gulfbusiness.com/2013/11/special-report-top-100-gcc-companies-2013/#.UxtOyud5PJA. 57 “Our company,” SABIC, accessed 08.03.2014, http://www.sabic.com/corporate/en/ourcompany/. 58 Steffen Hertog, “How the GCC did it: formal and informal governance of successful public enterprise in the Gulf Co-operation Council countries,” in Towards New Arrangements for State Ownership in the Middle East and North Africa, OECD, (OECD Publishing, 2012), accessed: 08.03.2014, http://dx.doi.org/10.1787/9789264169111-5-en.59 “History,” Etisalat, accessed 31.03.2014, http://www.etisalat.com/en/about/history/history.js. 60 “About us,” Industries Qatar, accessed 31.03.2014, http://www.iq.com.qa/IQ/IQ.nsf/en_Pages/en_AboutUs_BoardOfDirectors.
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and Latin America and the Caribbean (95 per cent) for 2006. Even in the non-oil-rich MENA economies the level of private investment was higher (62 per cent)61. As a result, the bulk of achievements in terms of diversifications result directly from the SOEs operation, which – being a kind of governmental tool – are commonly used to implement the government’s policies. Thanks to the sovereign backing them they are able to engage in longer-term strategies of research and product development, which are often too risky for private entities and do not yield sufficient profits. The enormous infrastructure investment activities conducted by Etihad (Abu Dhabi), Emirates (Dubai) and Qatar Airways (Qatar) 62, SABIC’s involvement in materials research and national human resource development, or the efforts of the Abu Dhabi’s ATIC to create a local semi-conductor industry thanks to large-scale local recruitment and training are perfect examples63.
Furthermore, the SOEs are the main source of employment for the nationals. As figure 7 shows, in 2011 about 90 per cent of citizens of Saudi Arabia, the UAE, Bahrain and Oman were employed in the public sector. In the case of Kuwait and Qatar this ratio was lower, about 75 and 55 per cent respectively. The private sector is literally dominated by expatriates. In the same period in Kuwait, Qatar and the UAE almost 100 per cent of employees came from abroad.In Saudi Arabia the ratio was 90 per cent, while in Bahrain and Oman it was 80 per cent.
Figure 7 – The GCC employment in private and public sector, 2011
Source: Pascal Devaux, “Economic diversification in the GCC: dynamic drive needs to be confirmed,” Conjoncture July-Au-gust (2013): 19-20, accessed 09.03.2014, http://economic-research.bnpparibas.com/Views/DisplayPublication.aspx?-type=document&IdPdf=22570.
This situation stems directly from a tremendous earnings gap between the public and private sectors. In 2008 the pay of an average UAE citizen working in a public institution or entity was generally 30 per cent higher than that of his counterpart in a private enterprise (on average they earned 5,500 and 3,700 dollars per month). In Saudi Arabia the combined share of expatriate and local private sector wages amounts to only 7 per cent of the GDP. In Bahrain, a country with a small government sector and a relatively developed private labour market, the private wage share accounts for 16 per cent of GDP. The wage gap in this country is about 30 per cent, while in Kuwait it exceeds 60 per cent 64.
Such a staggering over-employment derives from a very specific recruitment process. On the one hand, it is determined politically. People working in the public sector are generally selected
61 Duha Al-Kuwari, Mission impossible? Genuine economic development in the Gulf Cooperation Council countries (United Kingdom: London School of Economics and Political Science, 2013), 20, accessed 18.02.2014, http://eprints.lse.ac.uk/55011/1/__Libfile_repository_Content_Kuwait%20Programme_Al-Kuwari_2013.pdf. 62 Martin Hvidt, Economic diversification in GCC countries, 36.63 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council. 64 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council.
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not on the basis of their qualifications but rather thanks to their family connections65. On the other hand, working patterns are shaped by basic market forces. Most of the jobs in private enterprises – which are created mainly during periods of prosperity, meaning high energy sources prices – tend to go to foreign workers, as the price of this type of labour is simply lower. On the whole, the rise in the employment of nationals is noted solely after administrative interventions of forced ‘Saudi-zation’, ‘Kuwait-ization’ or ‘Oman-ization’. ‘Business for the most part has been fighting this nationalization agenda tooth and nail, as it increases costs and saddles them with more demanding employees who are much harder to dismiss66’.
One must be aware that the number of jobs created by the private sector in the GCC is significant. The fact that they are low-paid results from the factor-intensive growth approach that limits private-driven diversification and is politically as well as economically unsustainable in the long term (this issue will be discussed more deeply in the next section of the thesis)67. As a result, in spite of the increasing share of the private sector in GDP, generation of private demand remains quite limited. This means that in most GCC countries an untypically large part of consumer demand is, in fact, financed via state salaries and transfers – in Saudi Arabia, state salaries are twice the size of combined private salaries68.
Despite an undoubtedly significant role of the SOEs, the GCC governments have always pursued a pro-capitalist economic agenda. Unlike most of the republican regimes of the Arab region, local merchants never had to witness the waves of nationalization that crippled business classes in countries like Algeria, Egypt or Syria. One should be aware that the Gulf economies have never been particularly diversified. In the early oil era the actual productive capacities of the GCC entrepreneurs were particularly limited – they often operated as intermediaries and access brokers for international companies providing most of the actual goods and services that the rapidly growing GCC economies demanded. Now private business plays a more significant role in the sectors like education, health, telecoms, heavy industry and air transport, which until the 1990s were partly or completely state-controlled.
Nevertheless, aiming to create truly sustainable production patterns, the GCC incumbents should step up their efforts towards supporting the SMEs development (creating a business-friendly environment is one of the points of the Agenda 21). As it will be proved in the next section of the study, the SMEs’ small contribution to GDP and to job creation is not a result of their defective nature. They just face too many challenges precluding them from thriving.
2.2. Constraints for the Gulf SMEs’ operations
The existence SMEs is not a simple guarantee of growth and prosperity. It is merely a precondition. Undoubtedly, they facilitate economic growth inducing productivity, job creation and consumption. But it is not their quantitative development that ensures truly sustainable development. From the economic point of view, there is no big difference whether one hundred or two hundred merchants operate in a country barely making ends meet and who are thus unable to hire any extra employees. Small and medium entrepreneurs willing to innovate and advance are much more important. It is therefore the increase in the SMEs’ operations quality that truly matters.
65 It is essential to note that they very well educated because being born to affluent families can afford to pay for educations at foreign universities. 66 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council.67 Steffen Hertog, State and private sector in the GCC after the Arab uprisings (United Kingdom: LSE Research Online, 2014), accessed 10.05.2014, http://eprints.lse.ac.uk/54399/1/Hertog_state_private_sector_GCC_after_arab_uprising_final.pdf.68 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council.
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The Gulf economies combine features of developed and emerging markets in a very peculiar way. The income levels are high, infrastructure is well developed, national populations are well educated and large companies are generally professionally run. Furthermore, small and medium enterprises constitute a majority of business entities in the GCC countries. Yet they do not contribute to GDP and job creation as one may think, since wages offered in this segment are relatively low and employers favour hiring expatriates. It is so because they operate in a highly unfriendly environment constraining their genuine development. These include both universal problems that SMEs around the world struggle with, and numerous issues that are characteristic of the GCC states.
Firstly, there is the issue of modern technology and necessary infrastructure within companies. Technological innovation is undoubtedly a vital tool for enhancing efficiency and competitiveness. Thanks to the cutting edge innovations, it is possible to produce more using the same (or even lower) amount of resources. Such a process is called ‘intensive growth’. In factories, modern production lines streamline production, making it both faster and cheaper. In trade, better cars, well-equipped warehouses (such as cold stores with well-functioning cooling systems) improve merchants’ capabilities. The same happens with services where tools of higher quality help to save time and thus make it possible to serve more consumers.
Nevertheless, as far as the GCC countries are concerned, research and development (R&D) in the region is still a fledgling area. Technology clusters around specific industries and the links between business and the local universities are still very weak. In 2009, R&D expenditure constituted 0.11 per cent of GDP in Kuwait, 0.08 per cent in Saudi Arabia and less than 0.1 per cent in the UAE69.
Secondly, there is a problem with human resources. One does not need specialised knowledge to notice that educated staff facilitates daily operations. Not only are such employees able to use more advanced technology and solve problems quickly and easily, but they may also innovate and propose their own solutions. Well-qualified employees are not simply labour, they are human capital.
Yet again, plenty of problems appear. Companies operating in the Gulf region are considerably short of skilled human resources. Employees in the Arab SMEs are generally weak in terms of their knowledge and skills of market analysis, marketing and product innovation as well as business planning and financial management. Better-qualified people prefer to work in the SOEs where the wages are higher. The private sector is literally dominated by expatriates who often lack basic education. According to a study conducted by the SMEs Center at the Rihyadh Chamber of Commerce and Industry, 44 per cent of the SMEs’ managers see workforce issues as an important obstacle to their development70.
The contribution of production factors to GDP in the GCC varies from the one observed in developed countries. On the whole, economic growth has been significantly based on capital input71 – in the Gulf between 2000 and 2007 the average growth rate was 3.4 per cent, while in the USA it was only 1.2. Similarly, the average growth rate of labour volume used in production processes (2.03 per cent) exceeds the ones noted in the advanced economies (0.7 per cent, 0.5 per cent noted in the USA and Norway respectively). When it comes to human capital, the situation is better – 0.5 per cent in the GCC versus -0.3 in the USA and 0.7 per cent in Norway. We should remember, however, that it is an average growth rate of the contribution of particular factors, not their share in total GDP.
The average growth in total-factor productivity, an index including technological improvements, is less impressive. Its values in Oman, Qatar and Saudi Arabia were negative (about -1 per cent)
69 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council. 70 Steffen Hertog, Benchmarking SME Policies in the GCC: a survey of challenges and opportunities.71 The capital of the private sector has been generally put into housing, land and real estate infrastructure rather than into technology acquisition.
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and for the whole region it was only 0.43 per cent (in the USA and Norway it was 0.7 and 0.6 per cent respectively). This situation reflects the GCC growth patterns. For decades, development has been based on the extensive use of production factors rather than improvements in their productivity, let alone development of human capital. Apart from almost unlimited access to capital provided by the extraction sector as well as cheap labour, this situation also results from low user energy prices, which are immensely subsidised by the state. In these circumstances, entrepreneurs have simply no incentive to innovate. Instead of investing their money in research and development or organising trainings for their employee, they prefer to remain on a resource-intensive, low-to-mid-tech development path.
Dealing with national administration is not an easy task anywhere. Complicated procedures, concerning not only establishing companies but also their daily operations, sometimes demanding deep knowledge on law, high administrative fees and, most importantly, a great deal of wasted time are without doubt stumbling blocks to entrepreneurship. Doing Business, a report prepared by the World Bank, compares the ease of doing business between different countries. The index is calculated on the basis of the rankings of each economy in 10 fields: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and resolving insolvency. In the 2014 edition of the report the UAE, Saudi Arabia, Bahrain, Oman, Qatar and Kuwait ranked 23rd, 26th, 46th, 47th, 48th and 104th respectively. It may seem remarkable, yet we should bear in mind that the United States and Norway, which the GCC members where compared with in terms of productivity of production factors’, ranked 4th and 9th respectively72.
To complement ranking measuring the ease of doing business, in 2012 the report introduced another category – the distance to frontier, an absolute measure of business regulatory efficiency. By showing the distance of each economy to the ‘frontier’ – which represents ‘the best performance observed on each of the Doing Business indicators’ since 2003 or the year in which the data for the indicator were first collected – this measure ‘aids in assessing how much the regulatory environment for local entrepreneurs improves in absolute terms over time’. The measure is normalized in a range between 0 and 100, with 100 representing the frontier. The higher score indicates the more efficient business environment and the stronger legal institutions (for a detailed description of the methodology, see the chapter on the ease of doing business and distance to frontier)73.
As chart 8 shows, despite their high level of economic growth and development, the Middle East countries perform worse than their high-income OECD partners or countries in Europe and Central Asian do. The worst results are noted in terms of protecting investors, enforcing contracts, getting credit and resolving insolvency. An analysis of the particular components of the index helps to understand the roots of this situation.
As far as starting a business is concerned the UAE, Oman, Saudi Arabia, Bahrain, Qatar and Kuwait are in 37th, 77th, 84th, 99th, 112th and 152nd places respectively. The number of procedures that the beginner entrepreneurs have to face and the necessity of providing minimum capital, which is the share capital that must be deposited by shareholders before starting any business operations, are the two main obstacles. Overall, the inhabitants of the region are obliged to conduct 8 procedures. In Kuwait the bureaucracy is especially burdensome since 12 procedures must be carried out in the process of establishing a company (in Norway and the United States there are only 5 and 6 respectively). The average minimal capital, presented as a percentage of income per capita, is almost 100 per cent. In the UAE and Saudi Arabia no deposit is required, but in Oman and Bahrain it is obligatory to put 209.8 and 226 per cent of income per capita. As it is stated in the report, Bahrain
72 The World Bank, Doing Business 2014. Understanding Regulations for Small and Medium-Size Enterprises (Washington D.C.: The World Bank and the International Finance Corporation, 2013), 164, 171. 177, 203, 214, 215, 218, 221, 232, 233. 73 The World Bank, Doing Business 2014, 10.
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and Kuwait made starting a business even more difficult by increasing the cost of the business registration certificate and raising the minimum capital requirement respectively.
Figure 8 – Distance to the frontier by region, 2013
Source: The World Bank (2013), Doing Business 2014, 4.
It must be noted that the minimum capital requirement significantly impedes entrepreneurship. According to the report, there is a strong positive correlation between this factor and the percentage of companies saying that the informal economy severely constrains their growth. If entry costs are prohibitively high, entrepreneurs might be disinclined to formalize their businesses. There is also a strong negative relationship between the number of years for which companies operate without formal registration and the burden of the minimum capital requirements74.
Weak contract enforcement does not facilitate running a business either. In the ranking all of the GCC countries were far behind their Western counterparts. Qatar, the UAE, Oman, Kuwait Bahrain and Saudi Arabia ranked 93th, 100th 107th, 119th, 122th and 127th respectively while Norway and the United States were 4th and 11th places. The long process of property registration represents a similar obstacle – on average it takes 15 days (in Kuwait entrepreneurs must wait 47 days). This issue is particularly important, as unregistered property cannot be used as collateral by banks, limiting the financing opportunities for new businesses and expansion opportunities for the existing ones. Moreover, the already feeble perspectives for development are further undermined by poor investors protection. All the GCC members but Saudi Arabia, which is in the 22nd place, lag behind the countries that are at the similar level of development. Nevertheless, it is worth noting that some efforts to enhance business environment in the region have been made. The United Arab Emirates strengthened investor protection by introducing greater disclosure requirements for related-party transactions in the annual report and to the stock exchange, and by making it possible to sue directors when such transactions harm the company, while Kuwait made it possible for minority shareholders to request the appointment of an auditor to review the company’s activities75.
Undoubtedly, it is the access to financing that is the most important factor for development
74 The World Bank, Doing Business 2014, 44.75 The World Bank, Doing Business 2014, 164, 171.
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of a business, as no investment can be made without money. As Joseph A. Schumpeter put it, ‘the sole distinguishing characteristic of the entrepreneur is that he is an innovator’. In his view, so as to perform his economic function the entrepreneur requires technical knowledge, enabling him to produce new products or to combine factors in a different manner. Yet, adopting these new solutions demand capital. Raising the qualification of workforce, creating and implementing new solutions that enhance efficiency as well as buying assets entail significant expenses that are often far beyond the normal capabilities of companies (in most cases profits are not enough for necessary investment). ‘By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it’76. In other words, induces innovation and development, as enterprises do not have to save their money to ramp up their activities.
Over-expanded bureaucracy increases business demand for financing even more, since the interminable administrative procedures make daily operations more costly. Obviously, it matters for all types of firms, regardless of their size, yet this issue is particularly challenging for SMEs because they simply do not have such high incomes as the big enterprises do. In order to better understand the role of access to financing in the process of economic development the issue of financial inclusion must be introduced.
76 Irma Adelman, Theories of Economic Growth and Development (Stanford: Stanford University Press, 1961), 101-103.
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3. Financial inclusion as a precondition for development
3.1. The role of finance in economy
It is common knowledge that finance is the cornerstone of a market-based economy. Financial development and intermediation have been empirically proven to be key drivers of economic growth and development. A financial system provides income redistribution, as it motivates households and other entities to save. It does it in two simple ways. Firstly, it acts as an economic time machine, which helps savers transport today’s surplus income into the future and gives borrowers access to future earnings now. Secondly, it is also a sort of a safety net, insuring against floods, fires or illnesses. By providing these two kinds of services, a well-tuned financial system ‘smooths away life’s sharpest ups and downs, making an uncertain world more predictable. In addition, as investors seek out people and companies with the best ideas, finance acts as an engine for growth’77.
Healthy financial markets accelerate an economy, channelling credit to those that need it. They offer a wide range of instruments that fit their customers’ financial needs, broaden their investment opportunities, ameliorate risk sharing, increase growth of the real sector, enable individuals and companies to smooth income and consumption profiles over time. There is some evidence that through this process they not only leads to economic development, but they may also play a positive role in reducing poverty and income inequality78.
Finance serves households and businesses equally, as it enables people to take life in their own hands because they do not have to rely on their own limited savings. Individuals may borrow money to invest in income-enhancing assets, including human assets such as health and education, or/and set up their own enterprise. It also enables companies to grow – thanks to external capital more ambitious projects, which for example lead to ramping up production, may be realized.
Banks are those institutions that help economies thrive in a sustainable way. Being a kind of an intermediary they keep demand and supply for capital in balance. They take deposits from those who have more money than they need in their daily operations and ‘transform’ it into loans offered to those short of financial resources. In other words, banks, and the financial sector in general, alter the allocation of savings to various entities through loans and influence growth by raising domestic saving rates and attracting foreign capital79. They are also better at identifying creditworthy enterprises, leveraging savings, providing liquidity, facilitating transactions and pooling risk. As a result, funds are allocated to the most productive uses. These productive uses may be available in companies that have good growth opportunities and that need additional funds to finance the working capital and fixed asset investments. In addition, the financial sector enables those operating in the grey economy to channel their savings to the formal sector. It allows them to maintain bank accounts and other savings and insurance schemes, which enable them to establish a buffer against future shocks, thus reducing their vulnerability and exposure
77 “The slumps that shaped modern finance,” The Economist, April 12, 2014, 47. 78 Mahmoud Mohieldin et al., “The Role of Islamic Finance in Enhancing Financial Inclusion in Organization of Economic Cooperation (OIC) Countries,” Policy Research Working Paper 5920 (2011): 2, accessed 16.03.2014, http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-5920.79 Katherine Johnson, “The Role of Islamic Banking in Economic Growth,” CMS Senior Theses. Paper 642 (2013): 8, accessed 16.03.2014, http://scholarshi claremont.edu/cgi/viewcontent.cgi?article=1618&context=cmc_theses.
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to adverse events that otherwise would put under strain on their future income prospects80.
Nonetheless, a high degree of financial development in a country is not an indication of prosperity. The goal is to improve access to financing and make basic financial services available to everybody. An inclusive financial system is thus a precondition for truly sustainable economic development.
Initially, the concept of financial inclusion referred to the delivery of financial services to the low-income segments of society at an affordable cost. However, the notion has evolved over the years and currently encompasses the following four dimensions: (i) easy access to finance for all households and enterprises; (ii) sound institutions guided by prudential regulation and supervision; (iii) financial and institutional sustainability of financial institutions; and (iv) competition between service providers to bring alternatives to customers81.
According to a definition presented in the Global Financial Development Report 2014, financial inclusion is the proportion of individuals and firms that use financial services. It is quite a complex issue that reflects a variety of possible financial services, from payments and savings accounts to credit, insurance, pensions, and securities markets. It has been argued that more extensive availability of financial services allows individuals and companies to take advantage of business opportunities, invest in education, save for retirement and insure against risks82.
Figure 9 – Use of and access to financial services
Source: The World Bank Group, Global Financial Development Report 2014, 16.
Nevertheless, financial inclusion is not simply a use of finance. These issues, although connected, differ significantly. Some people may have access to financial services, but choose not to use them. The main problem is whether they do so because they want to (e.g. some prefer to pay by cash, have indirect access to banking system, or not use financial services at all due to cultural or religious reasons) or because they are forced to (e.g. cannot afford them or there is no bank infrastructure available). The key issue is the degree to which the lack of inclusion derives from the lack of demand for financial services and to which – from barriers that preclude individuals and businesses from accessing the services, thus rendering them financially excluded.
There is a great variety of causes of this phenomenon. Financial exclusion may result from a poor information environment in terms of banking services, shortcomings in contract
80 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 182.81 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 181. 82 The World Bank Group, Global Financial Development Report 2014. Financial Inclusion (Washington D.C.: The World Bank and the International Finance Corporation, 2014), 15.
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enforcement83 as well as mismatches between product features and customer preferences. It may also stem from high prices excluding large parts of the population from business activity. There might also exist discrimination against certain groups based on social, religious and ethnic grounds. Furthermore, some customers can be credit-constrained because they are subject to principal-agent problems. It means that a bank, not having adequate records and accounts, either cannot or is not willing to assess creditworthiness of some of its clients – they are considered unbankable. This group comprises both retail customers and companies that do not have sufficient level of documented income and thus present too high a lending risk84.
This problem is particularly noticeable when it comes to SMEs. It is so because they often do not have firm performance to apply successfully for a loan. Worse yet, some of them operate informally (mainly in the developing countries, but not only)85. Hence, they may not register with the government, or, if they are registered, they may not declare all their revenue, implying that they have no or inadequate official proof of income. This lack of documentation may be one reason why 12 per cent of the SMEs in the low-income countries state they did not apply for a loan because of the complex application procedures, that is, the application requires information that they cannot easily provide. To fill in for missing information, the lender may ask for additional collateral, but SMEs also often lack the adequate collateral. In the low-income countries, 7 per cent of SMEs state that the major reason why they have not applied for a loan are the high collateral requirements. Application procedures and collateral requirements appear to be less of an obstacle for large companies. Only 5 per cent of large firms in the low-income countries report they did not apply for a loan because of the complex application procedures (and 3 per cent say it was due to the collateral requirements)86.
3.2. Financial inclusion among the GCC SMEs
Measuring financial inclusion is not an easy task because of the multidimensional nature of the phenomenon. It is impossible to use only one index to check the level of inclusiveness of a particular system (another thing is that such an index does not exist). Fortunately, the Global Financial Inclusion (Global Findex) database provides a wide scope of indicators in this field (this databank contains over 500 indexes pertaining to both business and retail customers)87.
Given the topic of this study, the following indices concerning the use of financial services are selected: account at a formal financial institution (percentage age 15+), account used for business purposes (percentage age 15+), loan taken from a financial institution in the past year (percentage age 15+), loan taken from family or friends in the past year (percentage age 15+) and saved at a financial institution in the past year (percentage age 15+). The first of them denotes the percentage of respondents with an account at a bank, credit union or other financial institutions (e.g. cooperative, microfinance institution). The second indicator shows what part of respondents uses their accounts at a formal financial institution for business purposes only or for both business and personal transactions. The loan from a financial institution in the past year ratio measures the percentage of respondents who borrowed money from a bank, credit union, microfinance 83 This situation may be a result of a country’s underdevelopment or purely stem from the so-called transaction costs (reaching out to certain population groups is often too costly to be commercially viable). 84 The World Bank, Finance for all. Policies and Pitfalls in Expanding Access (Washington D.C., The International Bank for Reconstruction and Development, 2008), 29. 85 They do so because either the registration procedures are too complicated and too costly or because the tax rates are deemed to be too high. 86 The World Bank Group, Global Financial Development Report 2014, 117.87 According to the information from the World Bank’s website, the first set of data was released in April of 2012. They are collected in partnership with the Gallup World Poll and are based on interviews with more than 150,000 nationally representative and randomly selected adults in 148 economies, covering over 97 per cent of the world's adult population.
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institution or another financial institution such as a cooperative in the past 12 months, while the index pertaining to loan from family or friends denotes the percentage of respondents who report borrowing money from a family member or a friend within this period. ‘Saved at a financial institution in the past year’ indicates the percentage of respondents who report saving or setting aside any money by using an account at a formal financial institution such as a bank, credit union, microfinance, institution, or cooperative in the past 12 months88. When it comes to access to finance, an index measuring the number of branches of commercial banks (per 100,000 adults) is very commonly used.
As table 1 shows, financial inclusion in the GCC countries is decidedly lower than in the Western countries. On average, only 66 per cent of the inhabitants of the Gulf region have an account at a formal financial institution (in the United Kingdom over 97 per cent of people have their own accounts). The worst situation prevails in Saudi Arabia and the United Arab Emirates, whose ratios are only 46.4 and 59.7 per cent respectively. There are also far fewer branches per 100,00 adults than in the West – only 16.8 branches, compared to 35.4 in the United States and 29.6 in Australia. Again, the lowest values of the index are noted in Saudi Arabia and the United Arab Emirates – 8.7 and 14.5 respectively. In terms of loans from a financial institution in the past year the situation is slightly better. The values of this indicator in Bahrain and Kuwait are similar to the one noted in the United States (21.9 and 20.8 respectively compared to 20.1), but on average only 9.7 per cent of the people living in this region borrow money from financial institution (over 23 per cent of people living in the GCC look for capital among their friends and family). The case with saving is analogical. Over 40 per cent Kuwaiti and Omani save money with use of an account at a formal financial institution (in the United Kingdom and the United States the ratios are 44 and 50 per cent respectively), but for the entire region the value of the indicator is 26 per cent.
The share of private credit in GDP in the GCC is not impressive either (appendix 4). According to the World Bank’s estimations in 2009 it was only about 70 per cent, which is similar to developing countries (in East Asia and Central Europe it was about 60 per cent of GDP) rather than the most industrialized economies (140 per cent of GDP). Moreover, since 2008, mainly on account of the global financial crisis, the pace of credit growth (year over year) in all the member countries slowed down significantly. When in 2008 the average was about 50 per cent, in the first quarter of 2011 it barely reached 10 per cent.
As for enterprises, the available data is not very optimistic either. Only 2.8 and 4.3 of the Kuwaitis and Bahrainis use their accounts at a formal financial institution for business purposes. The average value of the index for the region is 22.6 per cent, which is considerably lower than in the most developed economies (in the United Kingdom and the United States it is 34 and 36 per cent respectively). Worse yet, in 2009 the credits granted to small and medium enterprises accounted for only 2 per cent of total lending. The GCC share of SMEs loans in the value of total loans is significantly lower than in the OECD countries (27 per cent) and even other, and less developed, Middle East states (in Morocco and Yemen it was 24 and 20 per cent respectively).
Furthermore, according to figure 12, internal finance is the main source of working capital and investment finance in the Middle East SMEs. It accounts for over 80 per cent of the SMEs working capital and investment finance, while the share of bank finance is about 5 per cent. The middle-income and OECD countries are less dependent on internal source of financing, as on average it accounts for 68 per cent of working capital finance and about 65 per cent of investment finance. They finance their investment activities mainly with the use of bank finance, whose average share in working capital finance and investment finance is 13 and 19 per cent respectively. What is noteworthy, large companies operating in the Middle East, although also internal finance reliant, use financial services more often.This situation is a perfect example of the principal-agent problem, when
88 “Global Findex Glossary,” The World Bank and Bill & Melinda Gates Foundation, accessed 20.04.2014, dohttp://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/Glossary.pdf.
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small entities are not able to take a loan due to their scant resources and patchy credit history. Furthermore, the respondents (representatives of commercial banks operating in the GCC countries) of the GCC 2015 Banking Survey indicated a preference to invest within their own countries in retail and SME banking (85 and 91 per cent respectively). This is quite meaningful and proves that small and medium enterprises suffer from a terrible insufficiency of financing.
Table 1 – Financial inclusion indicators, 2011
Source: Data from The Global Financial Inclusion Database.
Country IndicatorAccount at a formal financial institution (% age 15+)
Bahrain 64,51Kuwait 86,77Oman 73,60Qatar 65,88
Saudi Arabia 46,42United Arab Emirates 59,73
United Kingdom 97,20Account used for business purposes (% age 15+)
Bahrain 4,37Kuwait 2,84Oman 31,21Qatar 29,08
Saudi Arabia 8,45United Arab Emirates 59,73
United Kingdom 34,48United States 36,28
Loan from a financial institution in the past year (% age 15+)Bahrain 21,87Kuwait 20,80Oman 9,16Qatar 12,55
Saudi Arabia 2,14United Arab Emirates 10,78
United States 20,13Loan from family or friends in the past year (% age 15+)
Bahrain 20,65Kuwait 18,30Oman 20,65Qatar 30,57
Saudi Arabia 26,21United Arab Emirates 23,53
Saved at a financial institution in the past year (% age 15+)Bahrain 16,29Kuwait 40,35Oman 40,35Qatar 25,38
Saudi Arabia 17,24United Arab Emirates 19,16
United Kingdom 43,79United States 50,39
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Figure 10 – Credit growth, year over year, 2006-2011
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability: A road Map for the Middle East and North Africa (Washington D.C: The World Bank 2011), 54.
Unfortunately, leasing products, although offering potential advantages over bank lending89, are not very commonly used either. On average, leasing volumes in the GCC account for 1 per cent of GDP, which is only a third of the share noted in the economies in Central Europe. It is even lower than in Africa, which is the least developed continent in the world. The three top leasing centres of the region are located in the United Arab Emirates, Kuwait and Bahrain (together with Tunisia they constitute more than 60 per cent of the leasing market in the Middle East and Africa). The dominant types of lessors are banks and bank-related institutions. Their prevalence is partially a result of their easier access to funding. Stand-alone leasing companies often face difficulties financing their growth. Banks can rely on their deposit base, and bank-related institutions can rely on funding from their banks. By contrast, stand-alone companies must rely on equity or longer-term loans at market conditions to fund their portfolios, both of which are more costly than bank deposits90.
Figure 11 – SMEs loans as a percentage of total loans in selected economies in the MENA, 2009
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 105.
89 Leasing companies can overcome the effects of the weak creditor rights that hinder commercial bank lending to small and medium enterprises. It is so because they retain ownership of the leased asset and are in principle able to repossess it more easily in case of default. Furthermore, they are often established as joint ventures between equipment manufacturers and financial institutions and benefit from the technical support of their founders. Leasing companies also often benefit from the preferential tax treatment conferred on investments in fixed assets and equipment.90 Roberto R. Rocha, Zsofia Arvai, Subika Farazi, Financial Access and Stability, 209.
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While describing the financial environment of the GCC countries, it must be also noted that investment lending in this region is frequently provided by specialized state banks or institutions. Obviously, commercial banks also participate, through syndications, although the extent of their involvement is difficult to assess, because of the deficiencies in data reporting. Specialized state institutions do most of the long-term lending in the GCC. Private banks participate in loan syndications and usually benefit from some government guarantee. An accurate assessment of the maturity of investment loans is rendered difficult due to inaccurate data reporting, but most private banks do not seem to extend loans beyond five years. Many of these loans are provided at floating rates, exposing the borrower to interest rate risk. Some large institutions have issued corporate bonds, but they do not constitute a regular source of investment finance91.
Figure 12 – Sources of working capital and investment finance, by firm size and country group, 2010
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 98-99.
The patterns in enterprise financing obviously reflect the historical structure of the oil-based and government-driven economies, dominated by very large enterprises. The ease of doing business index is again a useful tool that helps to better understand the roots of this outstanding underuse of financial services.
This indicator comprises plenty of components, but given the topic of this thesis the most important ones are the strength of legal rights, credit bureau coverage and depth of credit information. The first of them, and probably the most important, indicates ‘a degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending’. It includes aspects related to legal rights in collateral law and bankruptcy law (e.g. allowing the parties
91 Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 110-111.
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to settle in a collateral agreement that the lender may enforce its security right out of court and ensuring secured creditors a right to be paid first when a debtor defaults outside an insolvency procedure or when a business is liquidated). The score of the index ranges from 0 to 10, with the higher mark indicating that domestic regulations are better designed to expand access to credit. The region’s average is 3.6, which compared to the result achieved by the US (10) looks rather woeful.
Figure 13 – Leasing volumes as a percentage of GDP in selected world regions, 2008
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 88.
The GCC lags behind other emerging regions in the introduction of effective collateral regimes that strengthen creditor rights and promote lending to underserved sectors. On average, more than 80 per cent of loans granted in MENA require some form of collateral. An in-depth analysis indicates that the source of the problem is not the availability of collateral but the ability to translate valuable assets into productive use. MENA lacks the legal framework that would allow enterprises to use their movable assets as collateral92.
When it comes to credit registry/bureau coverage, both private and public, it is even worse. These indices report the number of individuals and firms listed in the private and public credit bureau and the registry’s database respectively as of January 1, 2013, with information on their borrowing history from the past 5 years. The number is expressed as a percentage of the adult population (the population aged 15 and above in 2012 according to the World Bank’s World Development Indicators). These databases contain information on the creditworthiness of borrowers (individuals or companies) in the financial system and therefore facilitate the transfer of credit information between banks and other regulated financial institutions. If there is no public registry, the coverage value is 0 per cent. In Oman and Qatar data is collected only by public entities with coverage of 21 and 22,7 per cent respectively. In the rest of the Gulf states there are exclusively private bureaus. The coverage of the bodies operating in Kuwait, Bahrain, Saudi Arabia and the United Arab Emirates is 29, 26, 44.4 and 27 per cent respectively. Given the fact that private bureaus in the USA, Norway and Germany have 100 per cent coverage, it is noticeable that in the Gulf almost none of the information is collected by financial databases.
As it has been emphasized in many World Bank reports, the credit reporting in the Middle East and in Africa has improved in recent years. Private credit bureaus were launched in Bahrain, Kuwait, Saudi Arabia and in the UAE, increasing the total coverage and thus contributing to the increase in lending. Nevertheless, this region is still dependent on the traditional public credit registries, and both the coverage and the quality of information require improvement. Almost 60 per cent 92 Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 149.
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of MENA countries still rely entirely on the public credit registries, a much higher share than in all other regions except Africa. This reliance on the traditional public credit registries may be one reason that MENA still compares poorly with other regions when it comes credit information coverage93.
In this light, a close to maximum mark in terms of depth of credit information94, measuring ‘the scope and accessibility of credit information distributed by the public credit registries and private credit bureaus’, seems to be without significance, as distributing such a little amount of information has only a modest impact on lending (it simply does not have enough strength to stimulate it sufficiently)95.
Figure 14 – Results of survey on importance of obstacles to lending to SMEs, 2009
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 142.
Finance is a cornerstone of enterprises’ development, as every project enhancing productivity incurs expenses which are often far beyond the financial capacities of the particular business entities. This is especially noticeable in the case of SMEs that are generally run by few staff and whose operations do not yield outstanding incomes. Indeed, the dividing line between business finance and individual finance becomes cloudy in some cases, especially for small companies and the poorer segments of the population, the segments that the policies aimed at enhancing financial inclusion are often designed to reach. Frequently, the family is essentially a productive unit, that is, a company. The lack of access to finance is negatively correlated with the size of the company in both country-income types; a relatively higher share of smaller businesses identifies access to finance as a major constraint96.
93 Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 118-120. 94 The index analyses whether the data on both companies and individuals are distributed and if borrowers have the right to access their data in the largest credit registry or bureau in the economy. The scores range from 0 to 6. The average GCC score is 4.6.95 “Methodology of Doing Business Report,” Doing Business Report, accessed 21.04.2014, http://www.doingbusiness.org/methodology.96 The World Bank Group, Global Financial Development Report 2014, 26.
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Asked about the main obstacles to lending to small and medium enterprises, MENA banks complain chiefly about the quality of the SMEs transparency, lack of reliable collateral and weak credit rights (these issues are very important for 80, 35 and 31 per cent of the respondents). As it will be explained in the two following chapters, Islamic Finance may be a good solution to alleviating the GCC financial exclusion and thus ensuring sustainable development of the region.
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4. Evolution and characteristics of Islamic finance
4.1. Main principles
A proper scholarly analysis of the principles of Islamic finance ought to begin with the following remark: Islamic finance is nothing like the conventional one. It is necessary to keep it in mind in order to thoroughly understand the specifics of this particular segment of the financial market. The design and operation of the instruments, institutions, markets and infrastructure of this sector are based on contracts and governance arrangements that apply Sharia rules.
The core Sharia principles include: (i) the avoidance of riba (interest in all forms and intents), (ii) the avoidance of preventable uncertainty and ambiguity in contracts, and (iii) ethical principles of justice, fairness, transparency and public interest. These and other principles contained in the Islamic commercial jurisprudence are derived from the Qur’an, Sunnah (sayings of the Prophet), and the legal reasoning by Sharia scholars, and, in their entirety, constitute the foundations of Islamic finance97.
There have been many problems with establishing an accurate definition of riba, a cornerstone of Islamic finance. Due to the abundance and diversity of sources, there is no widely accepted equivalent in English. The Arabic core of this word, namely ‘rbw’, appears in the Qur’an many times and may be interpreted as ‘increase’, ‘growth’, ‘raising’ or ‘swelling’. Even though all these meanings have slightly different connotations they all pertain to growth. The main controversy is whether it is permissible or not98.
There are two main approaches that dominate in literature. The first one interprets riba as an interest, meaning a moderate, economically justified increase in capital, which is paid to the investor after a certain period of time. The second one, though, perceives it rather as a form of usury. Some scholars argue that a fixed, predetermined rate tied to maturity and principal impairs the position of the borrower and therefore must be prohibited. According to Hadith, there are two types of riba: riba al-fadl, which is the result of unlawful excess of one of the business partners, and riba al-nasia that is generated by delaying completion of the exchange of the counter values. Regardless of the interpretation, charging debtors or contractors with interest is not accepted within the Muslim community99.
As most of scholars claim, Mohammed’s view evolved from dislike for riba in his ‘Mecca period’ to absolute prohibition in his ‘Medina period’. The Qur’an declares that ‘those who disregard the prohibition of riba are at war with God and his Prophet’. The ban is included in four different revelations of the Qur’an (2:275-81, 3:129-30, 4:161 and 30:39), expressing the following ideas: ‘despite the apparent similarity of profits from trade and profits from riba, only profits from trade are allowed, when lending money, Muslims are asked to take only the principal and forego even the sum if the borrower is unable to repay; riba deprives wealth of God’s blessing to others; Muslims should stay away from it for the sake of their own welfare100’.
97 J. Ahmed and H. S. Kohli, Islamic Finance. Writings of V. Sundararajan, (SAGE Publications India Pvt Ltd, 2011), 9, 3. 98 Mateusz Bonca, Islamskie instrumenty finansowe, (Warszawa: Wydawnictwo Akademickie i Profesjonalne, Akademia Leona Koźmińskiego, 2010), 66-67. 99 Mateusz Bonca, Islamskie instrumenty finansowe, 70. 100 Ibrahim Warde, Islamic Finance in the Global Economy (Edinburgh: Edinburgh University Press, 2010), 58.
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The prohibition is based on the arguments of social justice, equality and property rights. Islam encourages the earning of profits, but forbids the charging of interest because profits, determined ex post, symbolize successful entrepreneurship and creation of additional wealth, whereas interest, determined ex ante, is a cost that is accrued irrespective of the outcome of a business operation and many do not create wealth in the event of business losses101. As a result, there is no pure debt security as well as Islamic finance products involving interests rates.
Condemnation of surcharging members of the ummah is the basis of another fundamental principle, namely the so-called ‘profit and loss sharing’. Riba is considered an instrument of transferring risk to those short of money who, being forced to ask for it, are in an inferior position. In conventional finance a debtor is the entity bearing the responsibility for failure of the project. The institutions offering capital do not engage in the operations of enterprises and earn only the fixed amount of money determined in the agreement. In Islamic finance, however, the borrower and the lender share rewards as well as losses in an equitable manner. If a company bankrupts, the creditor is also affected, they will not get their money back and have no right to demand any repayment whatsoever. This mechanism is to ensure social welfare, since it prevents financial exploitation and leads to wealth distribution within the society.
The prohibition of gharar, meaning deception, delusion and uncertainty as well as risk and hazard, is the last but not least core rule of Muslim finance. Although the word itself is not mentioned in the Qur’an, etymologically related words are. However, the condemnation of gharar can be found in a number of Hadiths102.
Similarly to riba, there are some controversies as to the extent of the activities that the definition of gharar encompasses. According to the Islamic doctrine, gharar pertains to two situations: highly uncertain conditions and hazard or fraud. On the whole, the term is applied to any form of dealings that involve hazard, benefiting from unjustified profits, deceiving business partners and uncertainty of particular projects. Any gain taken from chance, understood as undetermined causes, is here forbidden103.
Business partners must have equal access to all information since any asymmetry is considered to impair the position of the other party of the transaction. An agreement must be prepared thoroughly and accurately so as not to leave any doubt in terms of interpretation of the particular articles. Moreover, all contracts in the Islamic market must be based on real items. Financing must be linked directly with the underlying asset so that the financing activity is clearly and closely identified with the real sector activity. There are strong linkages between performance of the asset and the return on capital used to finance it104. Therefore, the subject of the transaction must be described in great detail – the quantity, quality, type and price of the product as well as all permissible actions to be taken in case it is destroyed must be determined.
It is necessary to note, however, that gharar and the broad concept of risk must not be interchanged. Neither the Qur’an nor Hadith clamours for avoidance of risk. Economic activities by their nature lack certainty to some extent and there is nothing to avert it. Profits and commercial risk are simply two sides of the same coin. The Islamic doctrine accepts it and encourages its community to engage in business, provided gains and losses are equitably shared105.
Bearing all of that in mind it is obvious that the Islamic financial instruments differ significantly from the conventional ones. There are no credit agreements with fixed interest rates. Furthermore, all products based on speculation and uncertainty as well as those not being based on assets, such as derivatives, are not permitted in the Muslim community either. 101 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 4. 102 Ibrahim Warde, Islamic Finance in the Global Economy, 59. 103 Mateusz Bonca, Islamskie instrumenty finansowe, 76-77.104 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 4. 105 Mateusz , Islamskie instrumenty finansowe, 78-79.
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Money is treated as ‘potential’ capital: that is, it becomes actual capital only when it joins with other resources to undertake a productive activity. Islam recognizes the time value of money, but only when it acts actively as capital, not when it is ‘potential’ capital106.
Islamic finance comprises a wide range of products offered both to individuals and companies. The market can be divided into several subsectors, which are similar to those existing in the traditional capitalist system: banking industry, capital market including asset management industry, insurance, nonbank financial services such as leasing, microfinance etc. and money market. Given the topic of this study, the following section deals only with those instruments that are used by business entities for investment purposes (insurance services and those used in trade operations are not included in the analysis).
On the whole, in Islamic banks there are three different categories of deposits: demand deposits, unrestricted investment accounts and restricted investment accounts. The deposits of the first category do not provide a depositor with any returns and can be withdrawn at any time. Safekeeping and facilitation of payments are the primary motives of the individuals and entrepreneurs for keeping this type of accounts (they are similar to current accounts in the conventional banking system). Funds on unrestricted investment accounts raise money that are used by the banks in their general investment and financing activities based on their own judgment – profits or losses are shared between the bank and the account holders, who do not give their banks any instructions in terms of investment.
Figure 15 – The mechanism of mudaraba
Source: “Mudaraba,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingmudarabah/index.htm.
The money on restricted investment accounts (so-called ‘special investment accounts’) is invested in ‘specific projects and sectors pre-agreed between the account holder and the bank’. Profits are shared with these account holders who are to keep the investment account until the end of its maturity. Given these features, the accounts of this type are not liabilities of the bank. They are rather ‘a kind of equity contribution to the bank, but with a provision that the shareholders do not have full voting rights’. What is important, the account holders can withdraw their funds at any time, but their proportion of profit share will thus be reduced. Given the unique combination of non-voting equity like characteristics (sharing profits and losses by the depositors and a free hand of the bank in its investment decisions) and debt like features (e.g. possibility of withdrawal),
106 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 4.
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these accounts are sometimes treated like quasi equities107.
Islamic finance encompasses a great deal of instruments that keep the needs of depositors and those short of capital (individuals, business entities and governments) in balance. The cornerstone of the Muslim finance is mudarabah. This type of contract was the first to define the rules pertaining to cooperation of partners whose contributions to the enterprise differs significantly. Mudarabah is a partnership agreement in which one party invests all the capital while the other brings the know-how and labour. The provider of capital is called Rabb-ul-Mall, while the entrepreneur who is exclusively responsible for management and work is known as Mudarib108.
The profits and losses from the business endeavour are shared between the partners at a certain ratio which should be determined strictly as a percentage and not as a lump sum (if necessary it may be revised at any moment). All parties must agree on a definite proportion of the actual profit to which they are entitled. If nothing is explicitly mentioned then it is assumed that all of them will get exactly the same amount of money. Apart from the agreed profit share Mudarib cannot claim any periodical salary, fee or remuneration for the work done109. Financial losses are bore solely by Rabb-ul-Mall. The principal of the loan is repaid to the investor at the end of the stipulated period, provided a surplus exists. The liability of the entrepreneur is limited to their time and efforts unless any negligence and misconduct can be proven.
This type of contract may be conducted between investment account holders, who in this way become fund providers, and an Islamic bank acting as the entrepreneur. It is also possible that the bank engages in a particular project as an investor on behalf of itself or on behalf of investment account holders.
Figure 16 – The mechanism of musharaka
Source: “Musharaka,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingmusharakah/.
The settlement should specify whether mudaraba is restricted or unrestricted. In the first case, the investor may request Mudarib to invest in a particular business, asset class or place. In the second one, though, Rabb-ul-Mall gives the entrepreneur full freedom in whatever business they deem appropriate to engage so as to maximize profits. 107 Salman Sayed Ali, “Islamic Banking in the Middle-East and North-Africa (MENA) Region,” Islamic Economic Studies, 20.1 (2012):6-7, accessed: 02.05.2014, http://www.irti.org/irj/go/km/docs/documents/IDBDevelopments/Internet/English/IRTI/CM/downloads/IES_Articles/Vol_20_No_1/MENA_Region_Islamic_Finance_Report.pdf.108 It is possible, however, to include special provision enabling Rabb-ul-Mall to participate in a decision-making process in terms of issues vital for entrepreneurship. 109 “Mudaraba.”
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The second main instrument is musharakah. Overall, it may seem quite similar to mudaraba since it enables different agents to involve in one entrepreneurship so as to gain profit or share losses (in case any occur) according to their proportionate ownership. Nevertheless, due to its specific features musharakah differs from the first model substantially. All partners put together their capital setting up a company or engaging in an already existing one. It may be either liquid or take a form of goods in kind. What is noteworthy, there is an obligation to qualify and specify all details of a contract, which should be accepted by all parties, lest any misunderstandings in terms of shares occur.
Contrary to mudarabah, in musharakah each partner has an equal right to participate in management. All participants are eligible to represent company in dealings with other entities. It is possible, however, to appoint a managing partner (or a number of them) but only with the consent of all parties involved. The partners may also decide to be so-called silent partners and not to conduct any business operations.
Figure 17 – The mechanism of asset-based sukuk
Source: “Asset-based sukuk,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingsukuk/index.htm.
The principles regarding profit and loss sharing are akin to those of the first contract. The basis for earnings distribution ought to be decided at the beginning of the partnership. It must be determined as a ratio of profit (not the capital contributed) and must not take the form of a fixed sum of money. The share of profit does not need to be in proportion with investment and may be later modified. If they wish, the partners may transfer a part of their profit to another partner. They may also resolve not to distribute the money in a given year retaining it within a venture, yet again the decision must be taken unanimously. All business associates incur losses proportionately to their contribution.
When it comes to the termination of the project, each participant is entitled to withdraw from the partnership with prior notice or when set conditions have been met. In the case of premature termination, the company ought to be liquidated and the settlement distributed pro-rata. Instead, the partners can choose to distribute all assets if possible. If one of the business associates is unwilling to proceed with the engagement they may withdraw, but only with the acceptance of all parties.
What is also worth noticing is the fact that none of the partners can request from another a provision of security in any form since they are equal in their rights and obligations. It is essential to adhere to rules mentioned above, otherwise there is high probability that the project is deemed invalid.
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Both these instruments may be used as a microfinance tool. According to the definition created during the Microcredit Summit in 1997, microfinance denotes a programme that extends small loans to very poor people for self-employment projects that generate income and thus allow them to take care of themselves and their families. The disbursement of small size loan to the recipients that are normally micro entrepreneurs and the poor is one of the features of microfinance. The loan is given for the purpose of a new income-generating project or business expansion110.
To simplify the process of acquiring capital, the loan is given without collateral or a guarantor, and is generally based on trust. This sector is considered an alternative for conventional banking because the financial institutions often recognize the poor as not creditworthy.
Figure 18 – The mechanism of asset-backed sukuk
Source: “Asset-backed sukuk,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingsukuk/index.htm.
In general, the Islamic and conventional microfinance are based on the same mechanism. Nonetheless, because of an obligation to comply with the Sharia law, the Islamic one has some distinctive characteristics. In non-Muslim countries, the institution offering services to the poor can directly give cash to its client as financing. In contrast, the Muslim entities are not allowed to do it111 and use PLS schemes instead. Moreover, conventional microfinance focuses mainly on women as their clients, while the scope of the activities of the Islamic institutions addressed rather to a family as a whole. Interestingly, not only the recipients are liable for aid repayment, but their spouses as well. Apart from business contracts, Muslim microfinance involves also other instruments such as micro-insurance and zakat that is a tax aiming at wealth redistribution.
Apart from the partnership contracts, companies may acquire the necessary capital by issuing investment certificates that to some extent resemble the conventional bonds. One of the most popular certificates is sukuk or the Islamic bond. Being a fixed income instrument, it is also a certificate of ownership of an asset that it is to finance. Sukuk is based on the concept of joint ownership of an asset by several financiers, which makes it similar to the securitized equity-type financing.
There are three types of Islamic bonds: asset-based, asset-backed and cash flow. They differ significantly in terms of the profits generation mechanism, yet they have one common feature. The investors or sukuk holders pay the issue price to a special purpose vehicle (SPV), established 110 Abdul Rahim, “Islamic Microfinance: A Missing Component in Islamic Banking,” Kyoto Bulletin of Islamic Area Studies, 1-2(2007): 38, accessed 30.12.2013, http://www.microfinancegateway.org/gm/document-1.9.50560/Islamic%20Microfinance.pdf. 111 Conventional loans are prohibited unless there is no interest or any incremental amount charge on that loan.
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in order to issue the Islamic bonds, and thus purchase the investment certificates. SPV is responsible for acquiring the assets that the bonds are based on and paying any due profit chiefly taking form of rentals112.
In the asset-based bonds, so-called sukuk al-ljarah, the principal is covered by the capital value of the assets but the returns and repayment of sukuk holders are not directly financed by these assets113. An SPV company buys the assets from a particular company willing to raise finance that is an obligor with all rights pertaining to it. Subsequently these assets are leased to the mentioned company obliged to pay rentals that are then periodically distributed to the investors via the SPV company as their profits. Furthermore, the investors obtain proportionate ownership of the asset and thus assume the rights and obligations related to the ownership. The instrument may be redeemed at a pre-agreed price.
Figure 19 – The mechanism of cash flow sukuk
Source: “Cash flow sukuk,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingsukuk/index.htm.
In the asset-backed bonds, while the principal is also covered by the capital value of the assets, the incomes are directly connected to these assets’ profitability. In this case the subject of a transaction is a portfolio of assets already generating profits that are bought by the SPV company from the issuing company. The returns that they yield are therefore transferred to the sukuk holders via the SPV company. Moreover, a complete or partial partnership is transferred to the investors and the relationship between the investor and the issuer is governed either through a partnership contract or a management one. The initial sale will preferably be on true sale basis, while redemption will only be possible at the market price of the assets.
When it comes to the cash flow bonds, sufficient assets necessary to cover the principal do not exist and financing is extended on the basis of strong cash flow. In this example, the entity requiring finance contributes assets in kind to the SPV company that will be pursuing the specific venture. The sukuk holders engage in a particular project after conducting a due diligence on its projected returns which are paid from the generated cash flows. It is possible to create a sort of a reserve fund to smooth the returns to the bondholders. The redemption of capital is made at market value.
Sukuks have a great deal of advantages, making them attractive to investors, corporations and Islamic financial institutions. Considering the first group, Islamic bonds are Sharia complaint
112 Investors may also participate in project’s final settlement or when it is sold. 113 “Sukuk,” Delotitte Islamic Finance Glossary, accessed 29.12.2013, http://www.deloitte.com/view/en_XD/xd/glossary/understandingsukuk/index.htm.
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products facilitating investment in this part of the market. They are also more liquid than companies’ shares which contribute to money and capital market development. Giving the operations of enterprises and institutions, they smooth liquidity and balance sheet management processes as well as help to raise the necessary funds.
Despite some controversies114, stocks are also included in the Islamic financial market. It must be emphasized, though, that it is permissible to invest only in the companies whose operations comply with the Sharia principles. Moreover no transaction can have a short-term character since it is deemed speculative.
Figure 20 – The mechanism of ijarah
Source: “Ijarah,” Delotitte Islamic Finance Glossary, accessed 04.05.2014, http://www.deloitte.com/view/en_XD/xd/glossary/understandingijarah/.
Stocks are purchased with the use of the Islamic mutual funds that permit to invest in a wide range of securities e.g. bonds, investment certificates and stocks115. They are managed by well-qualified specialists, who, by offering their advice, help to enhance the profitability of particular companies. Because of the relative ease of withdrawal by selling shares, these funds are perceived as especially convenient to engage in.
In order to help the investors choose the most profitable Sharia complaint enterprises, facilitate monitoring their performance and thus reduce costs of transaction stock market many indexes have been introduced worldwide.
Apart from the instruments used for generating raising capital, there is a great deal of products facilitating the sale and purchase of goods. Given the subject of this analysis that concerns the development of SMEs not their daily operations, only ijarah, that is Islamic leasing, will be discussed.
Ijarah is a contract where a bank purchases an asset and as its owner transfers it to a third party for an agreed period, at an agreed consideration, in return for periodic rental payments. It is possible to transfer the right over the asset at the end of the agreement for a mutually agreed price. This instrument is very similar to the conventional leasing, yet it has some distinctive features. Firstly, it may relate to the provision of services (ijarah tul-amal). Secondly, and even more importantly, as all 114 There is no agreement whether stocks breach Sharia or not. Some consider them as a kind of tool enabling investors to contribute to particular enterprises’ development while others perceive it as an instrument used to profit only by speculating. They argue that investing in stocks involve use of leverage that is prohibited in Islam. 115 The first Islamic mutual fund was created in 1996 in Bahrain and was set up by Citigroup.
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Islamic financial services, it should comply with Sharia in terms of parties, subject, rent and termination of a contract.
In ijarah the lessee can be the one who sold the asset to the bank in the first transaction and then leases the asset back. The only condition is that both these transactions are independent. The lessee can be also a co-owner of the asset with the lessor. As for the leasing subject, it must be valuable, identified and quantified. Moreover, the corpus of the leased asset should remain in the ownership of the lessor and should exist at the expiry of the lease. The lessor bears all costs related to the asset such as its registration with the relevant authorities before use, its insurance, should that be required, as well as its maintenance and repairs (unless they are the result of the lessee’s misuse or misconduct)116.
As far as rent is concerned, it should be clearly stated in the contract and can be changed unilaterally neither by the lesser nor the lessee. It may be paid in cash or take a form of benefit in kind. A part of the payment can also be received in advance, before the delivery of the asset, and set against future instalments. It is also permissible to fix different rentals for different periods. For floating rental, it is necessary to be specified for the first period and to be subject to a certain benchmark, based on a clear formula, for subsequent periods.
The period of a contract should be clearly specified at the outset (it may be changing only when all parties agree to do so). The lease will be effective upon the delivery of the asset. As with rent, no party has the right to terminate the lease agreement prior to its maturity without mutual consent. Ijarah expires only with a total destruction of the leased asset or complete hindrance in the intended use. It may be stipulated in the contract, though, that a transaction will be terminated if the rents are not paid on time.
The obvious benefit of such an arrangement is that the lessor does not have to wait for a buyer to accumulate enough money to purchase their product. They can simply settle for a breakup of the total cost of the asset and an agreement that states that they will receive money against their asset in instalments from the lessee. Also, that the lessee would be bound to ‘purchase’ the asset at the end of the contract with the residual value of the asset being paid like in a normal transaction, i.e. in full. This also benefits the lessor in the sense that they receive a stream of finance without having to wait for it over a long time, since fixed assets require a lot of payment to secure full ownership, an ability not shared by every buyer in the market117.
Given all presented information it is apparent that Islamic finance comprises a wide range of instruments encompassing partnership agreements, Islamic bonds, leasing and stock exchanges. On the one hand, they enable the depositors to invest their money in profitable projects, on the other though, they provide companies with the financing necessary for developing their operations. The next chapter shows what is the market share of these instruments and how it has changed over the years.
4.2. Towards the Islamic banking
Commerce is a cornerstone of the Islamic tradition. The Prophet Mohammad was a merchant himself, as were most of the population of the Arab Peninsula. In hadith, the Prophet clearly disapproves of barter and orders Muslims to resort to trade instead118. For ages, people from Europe, Asia and Africa travelled to the Middle East to buy some luxury goods, such as spices and textiles. The development of international trade simply demanded a creation of financial instruments. Since
116 “Ijarah,” Financial Times Lexicon, accessed 04.05.2014, http://lexicon.ft.com/Term?term=ijarah. 117 “Special Report Top 100 GCC Companies 2013.” 118 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 137.
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the bills of exchange, letters of credit, promissory notes, ordinary checks, and double-entry bookkeeping were all know to Muslims, there is a general agreement among historians that medieval Europe simply borrowed these instruments from the inhabitants of the Arab Peninsula119.
Yet, the centuries of conflict starting from the series of Crusades brought the Islamic prosperity the to an end. On account of remaining hostilities and continuous military actions, the volume of trade fell drastically as did the revenues. Impoverishment and disparities replaced the formerly ubiquitous prosperity. The well-developed Islamic financial market ceased to exist.
The Ottoman rule along with the expanding colonialism, which were characterized respectively by proto-quasi socialism and outright exploitation, also had their impact and contributed to reshaping of the financial reality of the region120. Modern finance entered the Islamic world alongside the Western colonial expansion. Foreign banks financed trade and development (…) Since 1840 the Ottoman Empire had been issuing interest-bearing Treasury Bonds, but it is in Egypt where foreign bankers played a truly significant role, as it was the first Islamic country that possessed indigenously controlled banks. The National Bank of Egypt was set up in 1898 and has mixed capital121. All institutions established at that time operated in line with the traditional, European model, which involved interest rates and did not comprise any restrictions in terms of the character of the activities.
Gaining independence in the 1950s and 1960s, the Arab states came to reassess their economic policies, also in the finance field. The concept of a system that would comply with the religious precepts and, at the same time, be viable in a modern economy grew in popularity122. Islamic banking was considered an important mode of getting control over the political and economic destiny of the Muslim world. But it was not until some political and economic factors occurred, more specifically the advent of pan-Islamism and the rise in oil prices, that such ideas were put into practice. The fourfold rise in the price of resources at the beginning of 1970s123 provided the Gulf countries with extra revenues (the so-called petrodollars). This money was supposed to be used to fund development of the region by funnelling it through a brand-new system of financial institutions. This moment was acclaimed as the turning point in the New International Economic Order or at least in the North-South relations.
In 1974, during the summit of the Organization of the Islamic Conference in Lahore, the Islamic Development Bank (ISD) was created. Its purpose is ‘to foster economic development and social progress of the member countries and Muslim communities individually as well as jointly in accordance with the principles of Sharia law’. The functions of the Bank are to participate in equity capital and grant loans for productive projects and enterprises besides providing financial assistance to member countries in other forms for economic and social development. It is also required to establish and operate special funds for specific purposes including a fund for assistance to Muslim communities in non-member countries, in addition to setting up trust funds124. The institution has become a foundation of the Islamic banking system.
Since then Muslim finance has been reshaped significantly. While at the very beginning of their existence, the banks complied with the International Association of Islamic Banks (IAIB)
119 Zamir Iqbal and Abbas Mirakhor, Economic Development and Islamic Finance, 140. 120 It must be noted that the GCC countries neither had been part of the Ottoman Empire nor had been French or British colonies. Nevertheless, due to some specific bonds all erstwhile powers influenced the political and economic situation in the Gulf. 121 Ibrahim Warde, Islamic Finance in the Global Economy, 49.122 The idea was present in the Arab political discourse since the early 1930s. The Muslim Brotherhood was a group that particularly clamoured for a change of the financial status quo. 123 According to BP Statistical Review of World Energy. June 2013, between 1973 and 1974 crude oil prices increased from about 4 dollars per barrel to about 12 dollars per barrel. 124“About IDB,” Islamic Development Bank, accessed 30.11.2013, http://www.isdb.org/irj/portal/anonymous?NavigationTarget=navurl://24de0d5f10da906da85e96ac356b7af.
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and the IDS guidelines, now they operate rather under the instructions of particular countries125. Specific domestic factors (including the indigenous forms of Islam) have added to the differences across countries126.
Figure 21 – Global Islamic banking assets growth trend, 2004-2012
Source: Islamic Financial Services Board, Islamic Financial Services Industry. Stability Report 2013 (Kuala Lumpur: Islamic Financial Services Board, 2013), accessed 1.12.2013, http://ifsb.org/docs/IFSB%20-%20IFSI%20Stability%20Report%20TEXT%20FINAL%20(OUTPUT).pdf.
Shortly after the creation of the Islamic Development Bank some commercial Islamic banks were set up. The Dubai Islamic Bank, established in 1975, is deemed to be the first of them. In the following years plenty of similar banks emerged in the Middle East. The Kuwait Finance House (1977), Bahrain Islamic Bank (1978) and Qatar Islamic Bank (1982) are those created in the GCC region. Saudi Arabia and Oman remained surprisingly unenthusiastic about Islamic finance. The Saudi authorities were reluctant to provide the Al Rajhi Bank, today the world’s largest listed Islamic bank, with a banking license, as they fret that this might increase the interest transactions of the conventional banks in the kingdom. The Al Rajhi Bank was finally given a banking license in 1987, largely due to the fact that it already had significant deposits, and it was felt that it would be preferable to have it regulated127. Oman for political reasons (the incumbents were concerned with limiting the influence of the Ibadi sect) refused to award licenses to any Islamic banking. It was not until May 2011 that this country decided to permit Islamic banking128.
Some legislation facilitating the operations of these institutions has been adopted in the recent years. For instance in Kuwait, which in 2004 passed an amendment to the Central Bank Law 32 of 1968, bringing the Kuwait Finance House under the regulatory authority of the Central Bank of Kuwait. This step aimed to ensure that the competition within the Islamic financial sector was open, with other banks allowed to apply for the Islamic banking licenses129. Furthermore, in 2011 the International Islamic Benchmark Rate (IIBR), the world’s first Islamic interbank rate, was launched. It was created by Thomson Reuters, the Islamic Development Bank, the Statistical, Economic and Social Research and Training Centre for Islamic Countries and the Accounting and Auditing Organization for Islamic Financial Institutions together with a consortium of the world’s largest Islamic banks. It was a momentous step towards achieving a fully Islamic capital market and decoupling Islamic finance industry from the conventional system. Since the establishment 125 According to Ibrahim Warde, in the early days of Islamic banking it was assumed that there was a unique model transposable to all members of the ummah, designed by IAIB and IDS that would serve as a basis of greater economic and political integration. 126 Ibrahim Warde, Islamic Finance in the Global Economy, 85.127 Rodney Wilson, The development of Islamic finance in the GCC (United Kingdom: London School of Economics, 2009), accessed 10.05.2014, http://eprints.lse.ac.uk/55281/1/Wilson-2009.pdf.128 Organization for Islamic Cooperation, Statistical, Economic and Social Research and Training Centre for Islamic Countries, “Islamic Finance in OIC Member Countries,” OIC Outlook Series May (2012): 7, accessed 10.05.2014, http://www.sesrtcic.org/files/article/450.pdf.129 Rodney Wilson, The development of Islamic finance in the GCC.
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of the first Islamic commercial bank in the mid-70s, the Islamic finance industry has been trying to create an appropriate yardstick that can be used to value a spectrum of the unconventional financial products. IIBR is believed to fill this gap by providing the Islamic financial institutions with a reliable alternative to conventional benchmarks such as the London Interbank Offered Rate (LIBOR)130.
Figure 22 – Islamic banking market share by jurisdiction, 2011
Source: Organization for Islamic Cooperation, Statistical, Economic and Social Research and Training Centre for Islamic Countries, “Islamic Finance in OIC Member Countries,” 4.
Moreover, the conventional financial institutions have been permitted to open their subsidiaries (they operate in the so-called ‘Islamic windows’) offering customers a choice between the Islamic and conventional products (e.g. HSBC, Citicorp, Goldman Sachs). A growing number of Muslim banks have been established around the world so as to facilitate the activities of the local Islamic communities.
As figure 21 shows, since 2004 the assets of the Islamic banks have grown rapidly. In 2011 their value reached 1 trillion dollars with the average annual growth rate of 19 per cent. This segment of banking has been developing 50 per cent faster than the overall banking sector131. According to Ernst & Young estimations, this segment of finance hit 1.7trillion dollars in 2013132.
Over the years, the Islamic banking gained outstanding popularity and increased its market share significantly. According to figure 22, in 2011 Sharia complaint assets constituted nearly 36 per cent of total assets in Iran, about 14 per cent in Saudi Arabia, 9 per cent in the UAE, 7 per cent in Kuwait and about 5 per cent in Bahrain and Kuwait (reliable data concerning Oman are not available). The GCC countries are the main centres of Islamic finance, as in total they make for 40 per cent of world Islamic assets133.
The performance of the sukuk market has been particularly impressive. Its issuances amounted to 50 per cent of total GCC stock in 2009. A significant part of those issues financed real estate
130 Organization for Islamic Cooperation, Statistical, Economic and Social Research and Training Centre for Islamic Countries, “Islamic Finance in OIC Member Countries,” 7.131 Ernst&Young, The World Islamic Banking Competitiveness Report 2012-2013, accessed 1.12.2013, http://www.ey.com/Publication/vwLUAssets/The_World_Islamic_Banking_Competitiveness_Report/$FILE/World%20Islamic%20Banking%20Competitiveness%20Report%202012-13.pdf.132 Ernst & Young, The World Islamic Banking Competitiveness Report 2012-2013.133 Organization for Islamic Cooperation, Statistical, Economic and Social Research and Training Centre for Islamic Countries, “Islamic Finance in OIC Member Countries,” 4.
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development projects and banking operations in the United Arab Emirates. By contrast, most of the Kuwait’s issues were government bonds, which were issued regularly for the central bank’s open market–type operations to drain liquidity from the banking system. The Qatari government large issues with maturities of 5, 10, and 30 years totalled 7 billion US dollars, putting it in the third place in 2009134.
As a result of robust economic growth since late 1980s, the need for yet another channel of acquiring capital necessary for the development of companies emerged, namely stock exchange. The first one, Kuwait Stock Exchange, was established in 1983. Four years later Bahrain decided to follow the suit and created the Bahrain Stock Exchange (currently known as Bahrain Bourse). But it was not until the beginning of 21st century that Islamic stock trading became a fully-fledged segment of the financial market. In 2000 the Dubai Financial Market and Abu Dhabi Securities Exchange were set up. The Saudi Arabian and Qatari stock exchanges came into operation in 2007 and 2009 respectively135.
In 1999 the Dow Jones Marker Index was created. It comprises thousands of broad-market, blue-chip, fixed-income and strategy and thematic indices that have passed rules-based screens for Sharia compliance. The indices are the most visible and widely used set of Sharia-compliant benchmarks in the world136. Similarly, FTSE also introduced its Sharia indices in 2006, starting with the FTSE Global Sharia countries and Arabian markets137.
Also, the London Stock Exchange informs its customers which enterprises adhere to the Islamic law. It comprises seven Sharia-compliant Exchange Traded Funds based on the Islamic indices as well as shares of four Sharia-compliant institutions: Islamic Bank of Britain plc, European Islamic Investment Bank plc, The Family Sharia Fund Ltd. and Sharia Capital Inc listed on the AIM market devoted to smaller but growing entities. Moreover, in November 2013 the British Prime Minister David Cameron promised ‘to establish a new Islamic index on the London Stock Exchange138’.
At the turn of 21st century, the Dow Jones World Index and the MSCI World Index, noted significant growth. The first one increased by 14 per cent since 2004, while the second one grew by nearly 8 per cent since August 2007. Furthermore, constituents with more than 10bn dollars in market capitalisation take a larger share in the Islamic index as compared to the conventional index in terms of both their number and total market capitalisation (as a percentage of the total) 139.
134 Islamic Financial Services Board, Islamic Financial Services Industry.135 All detailed information about these institutions’ operation is available on the particular websites. 136 “Islamic finance,” London Stock Exchange, accessed 30.12.2013, http://www.londonstockexchange.com/specialist-issuers/islamic/finance.htm.137 Islamic Financial Services Board, Islamic Financial Services Industry.138 More information Nigel Morris, “Islamic investment: David Cameron moves to make London a Mecca for Middle East wealth” Independent, October 29, 2013, accessed 30.12.2014, http://www.independent.co.uk/news/uk/politics/islamic-investment-david-cameron-moves-to-make-london-a-mecca-for-middle-east-wealth-8909570.html. 139 Islamic Financial Services Board, Islamic Financial Services Industry.
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5. Islamic finance as a solution for development of the Gulf SMEs
As it was proved in the third chapter, the small and medium enterprises operating in the GCC member countries, seriously lag behind other states in terms of use of the financial services - loans granted to small and medium companies accounted for only 2 per cent of total lending, while leasing volumes accounted for 1 per cent of GDP. Given the enormous rise in popularity of Islamic finance in the region, it is often said140 that these unconventional services may come as a solution. Obviously, it is not due to the growth of the assets alone. There are some specific features of the Islamic financial products that make them particularly suitable to SMEs. There are also some mechanisms that are considered to lead to sustainable economic growth and development.
Undoubtedly, the most important issue is profit and loss sharing instead of interest rate, known as a riba in Islam. Unlike the conventional ones, the Islamic financial services are purely asset-based. Islamic banks do not just lend money to their customers. They invest in particular projects, which means that loans are rather share instruments than debt ones. As a result their remuneration takes a form of profits generated by an enterprise, and not simply of credit instalments like in the conventional banks. It may seem preposterous – why to engage in some uncertain projects, which may never succeed, and wait months until they generate profits? Yet the explanation is very reasonable: if you want to gain the benefits, you have to share the risk.
In conventional finance, banks earn by charging their clients with interest, which is a kind of a compensation for lending money. The only effort that creditors make is to assess whether the customers are able to pay it back (the so-called ‘creditworthiness’). In order to reduce a risk of loss, they sometimes require a collateral. In other words, banks earn money from offering money to someone else. The real economy does not matter.
In Islamic finance it is quite the opposite. As it was mentioned before, in accordance with the profit and loss sharing principle, banks earn only when the particular projects turn out to be profitable. Given that they bear the risk of the project’s success, they check very carefully what to invest in and choose only those ventures that are sound and promising. The risk-sharing aspect of Islamic finance incentivizes banks and private lenders to be more prudent with their funds and in turn allocate liquidity more optimally than the conventional banks do. Since the lenders have a personal stake in the success of the project, any risk they undertake reflects their true belief about the success of the borrowers’ endeavors, in contrast with the conventional lending in which the risk can be easily bought and sold for profit primarily through credit default swaps141.
The untypical mechanism of the Islamic finance products also aligns with the payment obligations of the companies. Entrepreneurs are not obliged to repay their debt until they make profits. Additionally, if any losses occur they accrue equally to all partners. This undoubtedly reduces the external financing burden, as its cost are born only when the projects turn out to be successful. It matters especially in the case of start-ups and SMEs, for whom even the smallest reduction in charges facilitates the daily operations and helps them develop.
Moreover, as a kind of a shareholder, the financial institutions are not simply ‘passive capital providers’. For example, in musharakah each partner, including the bank, is entitled to take part
140 Recently, plenty of institutions (e.g. the World Bank, Harvard Kennedy School, University of Warsaw, Warsaw School of Economics) have published papers and reports concerning Islamic finance role in boosting financial inclusion. Most of these publications are used in this dissertation. 141 Katherine Johnson, “The Role of Islamic Banking in Economic Growth,” 10.
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in management and to represent company in dealings with other entities. This mechanism discourages the financial institutions from engaging in some uncertain projects as well as creating credit bubbles, which lead to economic crises142. What is important, Islamic finance offers a wide range of products whose extent of involvement in the operations of the companies is different in order to enable investors to choose the most suitable one.
The actions of the Islamic banks are directly connected to the production and service sectors and therefore contribute to stimulating business growth and creating a healthy and sustainable economy. The prohibition of gharar that poses a ban on highly uncertain conditions and hazard or fraud also helps the economies grow. Under the Sharia law no money can be wasted on ventures that are deemed immoral. As a result, all resources are allocated in projects that contribute to economic and social development.
Figure 23 – Average return on equity and return on assets for Islamic banks, 2008-2011
Source: Ernst&Young, The World Islamic Banking Competitiveness Report 2012-2013.
This model works not only in theory, but also in practice, as over the years Islamic finance has proved to be very profitable. In 2008 the average return to equity (ROE) of the Islamic banks, measured by net profit to total equity, was 17 per cent143. In the GCC alone it was close to 15 per cent. Although values varied among particular institutions, in general they remained high even during the global financial crisis, when the conventional banks around the world were severely affected. In 2008 an average ROE for the Islamic banks in the UAE was above 15 per cent. In Bahrain it was 7.2
142 So-called subprime loans, granted to clients without sufficient income levels, led to bankruptcies of financial institutions around the world and thus caused the recent global financial crisis. The most famous, and inglorious, case was this of the Lehman Brothers, which went bust in the late 2008.143 Value of the index is calculated for Islamic banks operating around the world, not only in the Gulf region.
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per cent, Kuwait 8.2 per cent, Qatar 11.9 per cent and 10.7 per cent in Saudi Arabia144. The values of the return on asset (ROA), which is measured by net profit to total assets, were similarly high. In 2008 ROA of the Islamic banks operating in the GCC was nearly 2.5 per cent compared to 1.6 per cent achieved by the conventional ones.
This situation may be explained by the fact that the Islamic banks operate predominantly within their domestic markets, which were relatively less affected by the global crisis and hence were able to preserve profitability to an extent, whereas the global conventional banks were subject to deleveraging compounded by such factors as contracting economies in the crisis epicentre.
Figure 24 – Capitalization of Islamic and conventional banks, 2007 and 2011
Source: Islamic Financial Services Board, Islamic Financial Services Industry.
Obviously, the banks’ performance was impacted by the turmoil on the financial markets as well as the global economic downturn. They also suffered from the limitations in risk management capabilities (operations of some of them were excessively concentrated on real estate boom in the GCC) as well as a significant exposure to large single-customer accounts. The larger Islamic banks were more profitable, as indicated by their ROE, than the smaller ones, mainly due to the broader diversification of financing and investing portfolios of the larger banks, the result of economies of scale, and stronger franchise value. On the whole, the Islamic banks contributed to the financial and economic stability during the global financial crisis, given that their credit and asset growth was for the most part directed towards the retail sector, whereas corporates suffered the direct brunt of the global financial and economic crisis.
When the crisis subsided, profitability reverted to its previous levels and was very close to this of the conventional banks. In 2011 the average ROE recorded by the Islamic banks was 12 per cent, compared to about 15 per cent noted by the conventional banks. ROE of Islamic banks operating in the GCC was close to 10 per cent, while this of the conventional ones reached 13 per cent. The Islamic banks also performed well in terms of returns on assets. In 2011 the value of the index was 1.3 per cent. In the same period the conventional institutions noted ROA of 1.7 per cent. The Islamic financial institutions operating in the GCC member countries recorded ROA of 1.5 per cent, while this of the conventional ones was about 1.8 per cent145. It must be noted that the relatively lower profitability stems mainly from the high operating expenses being a result of infrastructure development, necessary market expansion as well as a more cautious approach to real estate investment after the property bubble bust in 2008 and 2009.
144 Salman Sayed Ali, “Islamic Banking in the Middle-East and North-Africa (MENA) Region,” 29. 145 Ernst&Young, The World Islamic Banking Competitiveness Report 2012-2013.
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Figure 25 – Issuance of Sukuk in the Gulf Cooperation Council, 2003-2009
Source: Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 223.
The capitalization of the Islamic banks is also deemed to be solid. Given the fact that the Islamic banks operate under the Shariah law, the quality of their capital has usually been better than that of the conventional banks. It results from the higher capital adequacy ratio (CAR) requirements in many GCC countries. Being predominantly equity-based, the majority of the capital of the Islamic banks has been at an elevated level, since there are minimal debts raised for capitalization purposes. The average total CAR of a sample of the Islamic banks at end-2011 stood at 17 per cent, compared to around 15 per cent of conventional banks. Although this level was somewhat lower compared to the pre-financial crisis level of 21 per cent noted in 2007, it demonstrates that the capital of the Islamic banks is overwhelmingly denominated by common equity146.
Sukuk, the Islamic bonds, have proved to be even more successful. Between 2004 and 2013 the value of sukuk issuances has increased by 45.2 per cent, from 6.6bn US dollars to 131.2bn dollars. Despite a slump of 54.1 per cent in 2008 due to the global financial crisis, the growth momentum rebounded from 2009 onwards, growing at a rate of 60.1per cent until end-2012147. Such a rapid growth is a result of the rising demand for the Islamic bonds. According to the Earnst&Young estimations, by 2015 the global sukuk demand could excess 600bn US dollars148.
Since the very beginning the governments have been the main issuers of the Islamic bonds.Nevertheless, as figure 25 shows, except from 2008, the supply of the corporate Islamic bonds has been rising. While in 2003 the corporate sukuk issuance in the GCC was about 0.7bn US dollars, in 2009 it surpassed 20bn US dollars. Given the fact that the sukuk market is still nascent in comparison to the global bond markets, this trend seems particularly promising.
Such impressive results may be taken as a proof that engaging in the real economy is beneficial not only for entrepreneurs, but for banks as well. It also proves that sharing risk between the companies and financial institutions is a good incentive for the latter ones to search for the most promising and sound projects that would yield reasonable returns. Apart from that, there is yet one more important factor making Islamic finance a useful tool for the SMEs development. That is a high demand for these unconventional financial services.
146 Islamic Financial Services Board, Islamic Financial Services Industry. 147 Islamic Financial Services Board, Islamic Financial Services Industry. 148 Ernst & Young, The World Islamic Banking Competitiveness Report 2012-2013.
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For obvious reasons Islamic finance is addressed to the Muslims. The fact that countries, where Islam is a dominant religion witness a rapid populations growth149 is one of the main drivers of the demand for these services. In a World Bank survey 45 per cent of the respondents reported a preference for a Sharia-compliant banking product over a less expensive conventional banking product. However, 37 per cent of the respondents preferred a conventional product or have no preference, which suggests that the demand for the Sharia-compliant products is not immune to cost concerns. It was noted, tough, that the lack of standardized survey methodologies and questions in the current literature make it difficult to draw broad-based conclusions about the demand and the use of financial services among the Muslims150.
Figure 26 – Islamic Banking, religiosity, and Access of Firms to Financial Services
Source: The World Bank Group, Global Financial Development Report 2014, 38.
The Global Financial Development Report 2014 seems to confirm these findings. The financial exclusion in the MENA region ‘relates to the fact that many Muslim-headed households and micro, small, and medium enterprises may voluntarily exclude themselves from the formal financial markets because of the Sharia requirements’. Based on a 2010 Gallup poll, about 90 per cent of the adults living in the member states of the Organization of Islamic Cooperation (OIC) perceive religion an important part of their daily lives. This fact may help explain why only about 25 per cent of adults in the OIC member countries have an account in the formal financial institutions (this values is far below the global average of about 50 per cent). Also, while 18 per cent of non-Muslim adults in the world have formal saving accounts, only 9 per cent of Muslim adults have these accounts. Moreover, 4 per cent of the respondents without a formal account in the non-OIC countries cite religious reasons for not having an account, compared with 7 per cent in OIC countries and 12 per cent in the MENA151.
The situation is similar when it comes to the use of financial services by enterprises. The number of Islamic banks per 100,000 adults is negatively correlated with the proportion of the companies identifying the access to finance as a major obstacle to their development. The negative correlation
149 It is also noticeable in the GCC region, where the average population growth rate in 2012 was 4.5 per cent. 150 Asli Demirgus-Kunt, Leora Klapper and Douglas Randall, “Islamic Finance and Financial Inclusion. Measuring Use and Demand for Formal Financial Services among Muslim Adults,” A Policy Research Working Paper 6642, October (2013): 5, accessed 03.05.2014, http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-6642.151 The World Bank Group, Global Financial Development Report 2014, 36.
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is greater in the OIC countries and even bigger in the OIC countries with a religiosity index152 above 85 per cent. These findings, which mainly refer to small enterprises, suggest that a rise in the number of the Sharia-compliant financial institutions can enhance the operations of small firms (0-20 employees) in the Muslim-populated countries by ‘reducing the access barriers to formal financial services153’.
Figure 27 – Composition of financing modes in the Islamic banking sectors, 2008
Source: Salman Sayed Ali, “Islamic Banking in the Middle-East and North-Africa (MENA) Region,” 18.
Moreover, as the Report shows, a considerable part of the GCC populations decided not to use any financial services on account of religious reasons. On average, 1 600 000 inhabitants of the region resigned from having an account at a formal institution because their operations were not Sharia-complaint (in Saudi Arabia the value of this index was 2 540 000).
Notwithstanding the obvious benefits, the process of Islamic finance development and its use in SMEs operations may face serious challenges. The most important ones relate to the unique features of these unconventional instruments. In principle, the prohibition of riba is supposed to eliminate the asymmetry between the lender and the borrower, as banks profits take a form not of the interest rate, but the incomes generated by successful enterprises. This approach is deemed fairer in comparison to conventional finance, as it is a partnership rather than a simple lending agreement. Nevertheless, the fact that in case of a business failure the bank may be perceived as a serious obstacle to a credit action. Default risk covers more than three quarters of the risks in the asset portfolio of an average Islamic bank in the banking book, while credit risk causes more than three quarters of the Islamic bank failures154. In order to limit the risk of default some institutions may refuse to grant loans to companies without sufficient (in their consideration) credit history. In the case of small entities the process of assessing creditworthiness may also be deemed too costly to conduct. This situation may result in an excessive involvement of the Islamic banks in huge, and often public, projects instead of the SMEs development.
Furthermore, Islamic finance is based on trust and confidence, resulting from personal relationships, and therefore it takes time for it to be established. As Nirvana Abou-Gabal, Asim Khwaja and Bailey Klinger emphasised ‘in today’s modern financial system,
152 Religiosity is measured by a percentage of adults in a given country who responded affirmatively to the question, “Is religion an important part of your daily life?”. According to the Global Financial Development Report 2014, in the GCC member countries an average value of the index in 2010 was 93.4 per cent. 153 The World Bank Group, Global Financial Development Report 2014, 37. 154 Hamid A.H. Al.-Wesabi and Nor Hayati Ahmad, “Credit risk of Islamic banks in GCC countries,” International Journal of Banking and Finance, 10.2 (2013): 5, accessed 03.05.2014 http://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1350&context=ijbf.
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building these relationships requires significant investments, which often make it financially inefficient. For example, in mudaraba contracts, where the Islamic finance institution has to bear all of the losses in case of a negative outcome, it is difficult for the financer to force the client to exert the efforts necessary to secure the success of a business. Moreover, in mudaraba contracts the bank does not have the right to monitor or participate in the management of a project and hence may lose its principal investment in addition to its potential profit if the entrepreneurs’ books show a loss155’. For these reasons most of the GCC Islamic banks prefer fixed return modes, especially murabahah modes156, which represent the leading form of financing (figure 27). In 2008 Musharakah and mudarabah represented only about 10-20 percent of total assets of the Islamic banks.
Figure 28 – Banking penetration and Islamic banking share, 2012
Source: Ernst&Young, The World Islamic Banking Competitiveness Report 2012-2013.
Another problem is the relatively low market penetration. Despite the outstanding growth of Islamic finance, the services of the conventional banks still dominate in the GCC region. As figure 28 shows Saudi Arabia is a country with the biggest share of Islamic banking in the market, but it is only about 53 per cent. As far as the rest of countries are concerned it is even worse. In Kuwait the value of the index is 33 per cent, while in the case of Bahrain157, Qatar and the UAE it is 27, 24 and 17 per cent respectively. On the other hand, such a low market share is a unique opportunity for Islamic finance to grow and make profits.
155 Nirvana Abou-Gabal, Asim Ijaz Khwaja and Bailey Klinger, “Islamic Finance and Entrepreneurship: Challenges and Opportunities Ahead,” EFLIR Islamic Finance Whitepaper, January (2011): 4, Harvard University, accessed 03.05.2014, http://belfercenter.ksg.harvard.edu/publication/21304/islamic_finance_and_entrepreneurshi html 156 Murabaha is an Islamic financing structure, where an intermediary buys a property with free and clear title to it. The intermediary and prospective buyer then agree upon a sale price (including an agreed upon profit for the intermediary) that can be made through a series of instalments, or as a lump sum payment. 157 Ernst&Young, The World Islamic Banking Competitiveness Report 2012-2013.
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Concluding remarks
Despite high rates of economic growth the GCC states are far from being developed. Granted, the level of GDP per capita in the region is close to this in the OECD member countries, yet most of the income comes from the extraction sector. Some attempts towards diversification have been taken over the years, nevertheless non-oil industry and services still play a significant role in neither domestic production nor employment. What is more, state-owned companies dominate the Gulf markets in terms of investment and employment of nationals. The private sector operates on the fringes of the economy and mainly hires the poorly paid and low-qualified expatriates. Although there are thousands of small and medium enterprises, their market share is rather insignificant. This model can scarcely be called sustainable, especially given the fact that oil prices are highly volatile and thus incur fluctuations of profits generated by oil and gas industry.
As it was presented in the second chapter, the business environment in the region is not entrepreneur-friendly. Those running or willing to run their own businesses face many challenges in terms of financing and bureaucracy. Various procedures that the beginner entrepreneurs have to face and the necessity of providing a minimum capital are just two of many obstacles. Research and development in the region is still a fledgling area and companies are considerably short of skilled human resources. This situation is reflected in the very poor performance in the distance to the frontier indicator, which shows that the GCC seriously lag the OECD members in terms of protecting investors, enforcing contracts, getting credit and resolving insolvency.
The most serious obstacle to the development of the Gulf SMEs is the financial exclusion. On average, only 22.6 per cent of SMEs operating in the region use their accounts at a formal financial institution for business purposes. Worse yet, in 2009 the credits granted to small and medium enterprises accounted for only 2 per cent of the total lending. The GCC share of SMEs loans in the value of total loans is significantly lower than in the OECD countries (27 per cent) and even other, and less developed, Middle East states (in Morocco and Yemen it was 24 and 20 per cent respectively. The lack of capital precludes companies from investing and thus facilitating their operations. Obviously, the existence of SMEs is not a simple guarantee of growth and prosperity. It is merely a precondition. From the economic point of view, there is no big difference whether one hundred and two hundred merchants operate in country barely making ends meet and thus unable to hire any extra employees. Small and medium entrepreneurs, willing to innovate and advance, are much more important and it is the increase in the quality of the SMEs operations that truly matters.
Aiming to create truly sustainable production patterns (it being one of the points of Agenda 21), the GCC incumbents should step up their efforts towards supporting these enterprises. Since they are less prone to volatility on the global markets and contribute to job growth ensuring stable sources of income for proprietors as well as employees they are a vital source to diversification. The SOEs, no matter how efficient, cannot play the leading role in an economy since they simply do not offer as many opportunities to the society as the SMEs.The private sector has been central in all the countries that have grown strongly over long periods. International experience indicates that relying on state-owned enterprises to create jobs and investment has never been a sustainable substitute for investment by privately owned companies – because no government has been able to expose firms that it owned to real competition and hard budget constraints (especially when the natural resources finally run out)158.
158 The World Bank Group, Global Financial Development Report 2014, 1.
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Due to the small size of the indigenous populations, except for Saudi Arabia, the aim of adopted economic policies should be creation high-value-added jobs offered by private entities. This is primarily because such jobs are well-paid and therefore can support high living standards, but also because they meet expectations of the Gulf citizens in terms of desired work, as they are not particularly willing to do jobs in the field of administration or consumer service. Nevertheless, such jobs are characterized by specific knowledge and technological content, which again requires a high level of investment159. Given the fact that the GCC SMEs are seriously cash-strapped, government actions should be directed to this area.
It must be noted, however, that providing cheap loans to private enterprises via the public funding agencies such as the Emirates Industrial Bank, the Kuwait Industrial Bank, the Qatar Development Bank or the Saudi Industrial Development Fund, which have recently been joined by government funding agencies offering support for small and medium enterprises, may be quite a problematic solution. Undoubtedly, money from such bodies has helped to create numerous prosperous private businesses within just a few decades. They have, however, also crowded out private funding and have been a weak incentive for a technological upgrade, as the state support has not been contingent upon achieving any targets in this field160.
Bearing all these facts in mind, the GCC officials should focus on the development of the finance sector. The challenge for the public policy is to ensure that enhancements in access are achieved through a removal of market and regulatory distortions rather than through a price regulation or other anticompetitive policies that may exacerbate distortions and threaten the financial stability. Policies can improve financial inclusion by addressing the imperfections in the supply of financial services (e.g. through modern payment and credit information systems or the use of new lending technologies) and in the demand for financial services (e.g. by launching financial literacy initiatives that raise awareness and lead to a more responsible use of finance). The policies to support financial inclusion should also remove non-market barriers that prevent an equitable access to financial services (e.g. antidiscrimination laws). More generally, the aim of all actions is to guarantee that the financial service providers are delivering their services as widely and inclusively as possible and to ensure that the use of such services is not impeded by inappropriate regulatory policies or nonmarket barriers limiting the use of financial products161.
The rapid growth in the Islamic finance assets in recent decades has prompted many to believe that these unconventional banking services may play an important role in enhancing the GCC business performance. In 2007 the average ROE of the Islamic banks, was 17 per cent and in the GCC alone it was close to 15 per cent. The values of ROA were similarly high162. Furthermore, operating under the Sharia law Islamic banks keep capitals of a better quality than their conventional counterparts do. As a result of a rising demand, between 2004 and 2013 the value of sukuk issuances has increased by 45.2 per cent. Although since the very beginning the governments have been the main issuers of the Islamic bonds, the supply of the corporate Islamic bonds has been constantly rising. While in 2003 total value of corporate sukuk issuance in the GCC was about 0.7bn US dollars, in 2009 it surpassed 20bn US dollars163.
Islamic finance seems to be particularly suitable for the GCC small and medium companies. Firstly, there is the issue of religiosity. The value of the religiosity index in this region is one of the highest in the world. On account of the still limited supply of the Sharia-complaint products many people, some of them entrepreneurs operating in the informal sector, resign from using bank 159 Martin Hvidt, Economic diversification in GCC countries: Past record and future trends. 160 Steffen Hertog, The private sector and reform in the Gulf Cooperation Council. 161 The World Bank Group, Global Financial Development Report 2014, 47.162 Salman Sayed Ali, “Islamic Banking in the Middle-East and North-Africa (MENA) Region,” 29. 163 Islamic Financial Services Board, Islamic Financial Services Industry.
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services at all. Islamic finance will certainly give them a chance to develop. Secondly, the nascent enterprises will undoubtedly benefit from the lack of interest rates and risk sharing. Repaying the debt only when the business starts to bring profits lessens the costs and stimulates business (it is also an advantage for the creditor, as it increases the probability of repayment). Some may compare it to private equity investing, which can encourage companies to make bold investments because it allows them to share the possible losses with a private equity investor. Furthermore, this unconventional finance, despite its relatively short history, offers a wide range of products which encompass such instruments as partnership contracts (musharakah and mudarabah), bonds (sukuk) and leasing (ijarah). The last one should be particularly attractive for the SMEs, especially those that do not have a long credit history or a significant asset base for collateral, as the lack of a collateral requirement offers them an opportunity to acquire assets at a relatively low cost164.
Nevertheless, the Islamic banking faces some problems that the governments should help overcome, namely encouraging the financial institutions to turn towards the needs of the SMEs and creating such an environment that would facilitate development of this unconventional finance.
The path to success in the Islamic banking is to ensure regulatory clarity at the outset through a distinct Islamic banking regulatory framework. For a highly regulated sector like banking, the link between regulatory clarity and industry performance should not come as a surprise. The economy loves the certainty that comes with setting clear rules of the game. It is also easier for bankers who have to implement the rules (especially in the case of default)165. Given the fact that the principal-agent problem is especially dire in terms of the SMEs lending, some regulations ought to be implemented in this area as well.
Furthermore, the business model of the Islamic banks needs to provide more efficient intermediation of funds demanded and supplied by the key segments of the market – the households and businesses. Stronger linkages between the financial and real economic sectors must be established. A natural outcome will be a more direct ‘match-making’ equation between the (long-term) savers and borrowers, thus delivering meaningful and reliable returns to the account holders. Higher cost of funds in the short term must get offset against a proportionate lower regulatory cost relating to capital and liquidity over the medium term. Raising the qualifications of the bank officers plays a key role in achieving this goal. The lack of coherent knowledge and a comprehensive perspective on the financial aspect of the Islamic economic system is a primary limitation today. The governments, regulators and industry leaders in influential positions need to promote the emerging class of professionals who understand and possess substantive knowledge of the Sharia and modern economics and banking systems in order to promote financial services among the Gulf inhabitants166.
The GCC incumbents seem to be aware of that. In 2002 the Mohammed Bin Rashid Establishment for SME Development was incorporated into the Department of Economic Development as an agency aiming to nurture business leadership through entrepreneurial spirit. In 2006 the Bahraini government set up Tamkeen, a governmental institution with a purpose to support Bahrain’s private sector, and positioned it as the key driver of economic growth. Offering support programs for the private sector, Tamkeen helps the SMEs to hire well-trained locals, to obtain and implement sophisticated financial management systems, technological developments and to improve its access to finance. Tamkeen co-operates closely with banks, financial consultants and training institutions so as to fulfill its mandate. As far as Qatar is concerned, the Qatar Authority for the Development of SMEs was created in 2011. Its responsibility is to encourage the development of the SME sector and create a strategy to induce growth for these enterprises by offering them technical assistance 164 Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 209. 165 Ernst & Young, World Islamic Banking Competitiveness Report 2013-2014. The transition begins, accessed 1.12.2013, http://emergingmarkets.ey.com/world-islamic-banking-competitiveness-report-2013-14/.166 Ernst & Young, World Islamic Banking Competitiveness Report 2013-2014. The transition begins.
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and working with banks and governmental institutions in order to facilitate financing process. In June 2012, the Shoura Council in the Kingdom of Saudi Arabia unanimously approved a set of draft regulations for a separate authority for the SMEs. As for Oman, it was announced that a National Business Center would be set in the first quarter of 2013, which would be a center acting as a premier platform for developing and supporting Omani entrepreneurs167.
In order to broaden the SMEs investment opportunities those initiatives should also include Islamic finance. Fortunately, there is hope for that. In march 2014 Ahmad Ali Al Madani, the President of the Islamic Development Bank in Saudi Arabia said that the Islamic governments ‘should work hard to escalate the environment of the Islamic businesses trying to attract different investments and eliminate all obstacles in the face of Islamic industry’. He also addressed the problem of the unwillingness of the banks to engage in long-term projects and the underuse of profit and loss sharing168. Such initiatives have been organized relatively often in recent months, which shows that the GCC officials are willing to use Islamic finance to increase their the Gulf citizens investment opportunities.
167 Rushid Kikhia, “Is small more beautiful?,” in The Middle East Point of View Magazine, Winter (2013): 2, accessed 10.05.2014, http://www.deloitte.com/view/en_LB/lb/insights-ideas/e3289461a7d6d310VgnVCM2000003356f70aRCRD.htm. 168 Nigel Morris, “Islamic investment: David Cameron moves to make London a Mecca for Middle East wealth” Independent, October 29, 2013, accessed 30.12.2014, http://www.independent.co.uk/news/uk/politics/islamic-investment-david-cameron-moves-to-make-london-a-mecca-for-middle-east-wealth-8909570.html.
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Appendix 1 – Average contribution to growth by sector in the GCC countries, 1991–2009
Source: Samya Beidas-Strom et al., Gulf Cooperation Council Countries. Enhancing Economic Outcomes in an Uncertain Global Economy (International Monetary Fund, 2011), 12.
Appendix 2 – HDI trend for the GCC countries, 1980-2012
Source: Own calculations based on the UNDP data.
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Appendix 3 – Various production factors’ contribution to GDP growth in the GCC and selected international cases (IMF estimates), average growth rates, 2000–2007
Source: Steffen Hertog, The private sector and reform in the Gulf Cooperation Council.
Appendix 4 – Private credit as a Percentage of GDP in Selected World Regions, 2009
Roberto R. Rocha, Zsofia Arvai and Subika Farazi, Financial Access and Stability, 78.
Katarzyna Czupa
A solution for sustainable economic development
of the Gulf Cooperation Council countries
ISLAMIC FINANCE
Centre for International Initiatives (CII) is a non-profit, non-governmental organizationfocusing its work on research and analysis of issues related to the international relations.The aim of the CII is to promote knowledge of international affairs, to participatein the public debate on issues relevant to the Poland's foreign policy and to co-createa civil society on a national and European level.
The CII carries out the following activities: publishing articles, analyses and reportsthat concern international issues, organizing conferences, debates and seminars relatedto gaining and broadening knowledge in that area.
www.centruminicjatyw.org
The publication was issued within the project 'Let's talk about Islamic finance'.The initiative aimed to broaden the understanding of Islamic finance. It encompassed:series of articles concerning Islamic finance and economic situation in the leadingeconomies of the Middle East; the conference ‘Islamic finance. A new solutionfor entrepreneurs and investors?’and the post conference publication.The projectwas organized by the Centre for International Initiatives, the Polish Forum of YoungDiplomats and Notabene - the International Affairs Review under the patronage of Centerfor Social and Economic Research, the Polish Chamber of Commerce and debaty.org.pl.
ISBN 978-83-935548-0-5
