Are Islamic syndicated financings different from conventional syndicated loans?

University of Maastricht Faculty of Economics and Business Administration Maastr

icht, 03.08.2009 Farbood, Hutan (I229830) Master of Science in International Bus
iness Concentration: Finance Supervisor: Professor Dr. S. Kleimeier Final Master
Thesis
Table of Contents
Page 1. Introduction…………………………………………………………………… 2 2. Islamic Financing ………………………………………………………
odes …………………………………. …… 2.2.2. The Mark-up Modes……………………………………… ……………….. 2.2.3. Sukuk…………………
3. Descriptive Research Questions …………………………..…………………. 15 4. Analysis on Loan Spreads of Ma
.1. The Banking System in Malaysia…………………………………………...... 25 5. Data Selection……………………………………
stions………………...…..... 5.2. Sample Characteristics for the Descriptive Research Questions...
3. Data Selection & Sample Characteristics for the Loan Spread Analysis of Malay
sian Syndications ……………………………………………......…...... 27 27 28 29
6. Empirical Results…………………………………………………………..….. 31 6.1. The source of funds for Islamic Syn
ceivers of Islamic syndicated financings………………………..……… 34 6.3. Industries towards which Isl
ed financing are directed to …...…. 37 6.3.1. Changes of Islamic syndicated deals fo
r different industries over time…..… 44 6.4. Shares of lead banks: Islamic syndicati
ons vs. conventional syndications….... 46 6.5. Maturities of Islamic syndicated fi
nancings versus conventional syndications. 47 6.6. Financial debt covenants: Isl
amic syndications vs. conventional syndications. 49 6.7. Participating banks: Is
lamic syndications vs. conventional syndications…….. 49 6.8. Deal Size: Islamic synd
ications vs. conventional syndications……………..... 50 6.9. Differences in the Spread………………………
itations………………………………………………....... 56 References……………………………………………………………………....… 60 Appendix…
1
1. Introduction:
Islamic finance has become a widespread hot topic, and even more heard since the
storm of financial and economic crisis erupted in the end of 2007. Financial In
stitutions in the oil rich states at the Persian Gulf, thriving emerging nations
in South-East Asia and African nations, with their large Muslim populations, bu
t also financial centers in the Western World rush to take part at the phenomena
l 15-20% growth of Islamic financial products even in the wake of the recent fin
ancial crash. Even banks which are laying off their workforce on a large scale a
re still looking to increase their workforce in the Islamic financing business a
s they hope to tap into this promising niche market. The Islamic financial asset
s size is expected to be between $700bn and $1tn in spring 2009 (Reuters, 2009).
Indeed Islamic finance has seen fast growth since 1975, when the first Shariah-
compliant bank in the world was set up.1 Islamic financial institutions in the l
ast three decades grew faster than their conventional counterparts in Muslim nat
ions. The number of Shariahcompliant financial institutions has risen to more th
an 300 institutions operating in 75 countries till 2008 (Hasan, 2008). A determi
nant factor for the growth of the Islamic finance industry is because it complie
s with the religious beliefs and also the cultural characteristics of societies
in Muslim nations (Hamwi & Aylward, 1999). Furthermore, the rise in Islamic fina
nce can also be attributed to the rise of the petrodollar income in the Middle E
ast (The Boston Consulting Group, 2008). But next to the growth of Islamic finan
cial institutions in Islamic countries, Islamic finance has gained ground in pre
dominantly non-Muslim nations as well. The United Kingdom and Singapore for exam
ple opened their doors to become centers for Islamic finance (Akhtar, 2007). The
re it has been noticed that mostly conventional banks have opened Islamic window
s, in contrast to the Middle-East where there is the tendency to establish stand
-alone Islamic institutions. The growth of Islamic finance also in non-Muslim co
untries is due to the rising demand of the Muslim population in Western countrie
s and the desire of Islamic
1
Islamic financing, lead to sustained economic development throughout the Islamic
world already during the Middle Ages (Grais & Pellegrini, 2006).And in 1963, a
small Islamic savings fund started operations in Malaysia. This Islamic institut
ion managed funds for pilgrimages to Mecca (Solé, 2007). Also in 1963 a savings ba
nk, working in line with Islamic principles, in Mit Ghamr in Egypt was founded.
But this bank did not include any reference to Islam or the Shariah in its chart
er (Chong & Liu, 2007).
2
investors, especially Investors from the Persian Gulf, to diversify their invest
ment portfolio geographically while complying with Islamic jurisprudence (Solé, 20
07). But also more and more non-Muslims find the philosophy of Islamic banking d
esirable (The Boston Consulting Group, 2008). Another argument accrues as well,
namely the uneven performance of the conventional financial markets, especially
in the West (Grais & Pellegrini, 2006). Therefore non-Muslim European investors
use Islamic financial products to diversify their investment portfolio (Oakley,
2009). On the one hand it is expected that Islamic finance is going to continue
its growth path, as Islamic financial institutions will attract 40 to 50% of the
total savings of the population in the Muslim World already in some years (Dahl
ia El, Wafik, Zamir, 2004). The European Islamic Investment Bank even believes t
hat about 60% of Muslim investors will turn to Islamic financial products in the
future, compared with 20% in 2009 (Financial Times, 2009). But on the other han
d, further growth may be hindered by uncertainty on scholarly views2 on the comp
liance of Islamic financial products and a lack of standardization, which is bel
ieved to make Islamic financial products more timeconsuming to construct and the
refore also more expensive (Reuters, 2009). Furthermore, agency problems at Isla
mic financial institutions do deserve separate and special attention to enable f
urther growth in the future. Reasons for this special attention arise due to the
fact that the bankers in Islamic financial institutions are entrusted to maximi
ze shareholder value in a Shariah conform way. Islamic financial institutions ha
ve different operations dynamics and the relationships between the parties invol
ved are different. Another reason why agency problems at Islamic financial insti
tutions deserve separate and special attention is because of the incredible grow
th of Islamic financial institutions. Also the fact that little empirical resear
ch has been done on this subject can be seen as a reason why agency problems des
erve special attention at Islamic financial institutions (Safieddine, 2008). Thi
s paper takes into account these considerations, particularly of the special age
ncy challenges at Islamic financial institutions. Empirical research is conducte
d on Islamic
2
Supervisory boards of Islamic financial institutions rely on their own Shariah e
xperts. This may lead to contradictions of the permissibility of financial instr
uments in different countries. And this in turn can hamper the cross-border use
of Islamic financial products and the growth potential of this industry (Solé, 200
7).
3
syndicated financings and compared with conventional financings. Differences in
the structure of Islamic and conventional syndicated loans are researched to fin
d out what influences agency effects have. This enables to make conclusions on t
he dimension of the agency problematic. Furthermore a model is built to find out
whether Islamic syndicated financings are more expensive than their conventiona
l counterparts, by taking into account the special structural differences betwee
n Islamic syndicated financings and conventional syndicated loans. As there is n
o paper, to the knowledge of the author, which conducts empirical research on Is
lamic syndications, this paper will contribute to new insights into Islamic synd
icated financings. The aim is to show differences which exist between Islamic sy
ndicated financings and conventional syndicated loans. This paper will also add
value, by finding out how far Islamic syndications are affected by the agency pr
oblematic, as the empirical findings will hint the truth of the agency conflict
at Islamic syndicated financings. This paper starts by introducing the concepts
of Islamic financing and how the different Islamic financing modes are structure
d. Then, the concept of Islamic syndications is elaborated. Next, the descriptiv
e research questions on Islamic syndications and the hypothesis for the analysis
of Malaysian loan spreads are formulated. These include research questions abou
t which countries are the source of Islamic syndications and which countries are
the benefiters. Afterwards the industries which receive financings via Islamic
syndications are researched. Differences over time in the financings of the bene
fiting industries are researched as well. In regard to the agency problematic, t
he size and maturity of the Islamic syndicated financings, the existence of debt
covenants at Islamic syndications, the number of participating banks at Islamic
syndications and the share of the lead banks at the Islamic syndication are res
earched and compared to empirical data on conventional syndications. Finally a h
ypothesis test for the analysis of Malaysian loan spreads is conducted, to find
out whether there are differences in the spread of Islamic syndicated financings
and conventional syndications in Malaysia. The hypothesis test further investig
ates the influence of borrower characteristics, contract characteristics and the
syndicate structure on the spread. The following paragraph starts with an intro
duction to the concepts of Islamic financing.
4
2. Islamic Financing: “Shariah compliant” finance is a system of prudent lending to
reduce risks, to share profits and to ban speculations such as the short selling
of stocks (Hasan, 2008). The Shariah is based on rules by the Quran and the Sun
nah, which entails explanations and practices rendered by the Prophet Muhammad (
Iqbal, 1997). The Islamic financial systems are complemented by the explanations
of scholars in Islamic jurisprudence within the laws and rules set by the Quran
and the Sunnah.
2.1 The Principles of Islamic Financing
The Islamic financial systems are different in regard to conventional financial
systems by the means that they entail special principals (Iqbal, 1997). The most
widely known principal is the “prohibition of interest”, which rules out the use of
debt-based financial instruments. Any positive, predetermined and fixed rate th
at is fixed to the maturity and the principal is believed to be “riba”, which means
excess and is therefore prohibited. As interest is seen as a cost that is not ti
ed to the achievements in the business it is not seen as social, as social justi
ce would mean that rewards and losses would be divided in an equitable fashion.
This leads to the next principal, the “risk sharing”. This principal is a result of
the first principal, the prohibition of interest. As the lenders become investor
s, because they cannot charge interest, they join the productive business. There
fore they share risks of the business for the share at the profits. The next pri
ncipal describes money as “potential capital” as long as it is not invested in produ
ctive businesses and therefore it is not entitled to the time value of money. Th
e Islamic financial systems recognize the time value of money only when money ac
ts as capital at productive activities. “Materiality” is another principle in the Is
lamic financial system and means that financial transactions have to lead to a r
eal economic transaction (Dahlia El, Wafik, Zamir, 2004). In addition, Islamic f
inancial systems prohibit “gharar”3, or speculative behavior, which
3
“Gharar” means, not knowing the value of the good purchased. Terms of a contract sha
ll be well defined and leave no ambiguity to avoid gharar (Chong & Liu, 2007).
5
incorporates transactions that involve extreme uncertainties and risks. Conseque
ntly gambling, “maysir”, for example is forbidden. Another principle is the “sanctity
of contracts”. This means that it is a religious duty to stick to contractual obli
gations and to disclose information. This principle has the mean to reduce asymm
etric information and the moral hazard problem. The next principle is the “prevent
ion of exploitation” of any of the parties involved in a transaction. And as a las
t principle, the financing deals shall not finance “sinful activities” such as the p
roduction of alcoholic beverages. Finally, only those investment activities can
qualify to be “Shariah compliant” which comply with the above mentioned laws and rul
es of the Shariah and the Sunnah. The difference of an Islamic financial system
to a conventional financial system is that equal emphasis is placed on ethics, m
oral, social and religious dimensions contrary to the sole focus on economic and
financial aspects (Iqbal, 1997). So the Islamic financial system has the noble
goal to foster fairness and equality in the society. And this Islamic system act
s for risk sharing, entrepreneurship, individuals’ rights and duties, property rig
hts and the importance of contracts while discouraging speculative behavior (Iqb
al, 1997). But it has to be mentioned that there is no uniform Islamic financial
system. The explanations of scholars in Islamic jurisprudence within the laws a
nd rules set by the Quran and the Sunnah differ enormously. The al-Azhar Univers
ity, the well respected theological centre for Sunni-Islam in Egypt, for example
has issued a fatwa which states that interest is not always “riba” or usury (Tripol
ipost, 2008). Returns which are not excessive but prespecified by lenders are pe
rmissible if there is a mutual agreement and if it brings in the advantage to re
duce uncertainty. But this argument is of course very disputed, as a fixed retur
n for the financier is much disputed under Islamic law. And nor do common Islami
c financial instruments conform to the principle of profit-and loss-sharing (Raj
esh, Amos, Tarik, 2000). Islamic financial products are mostly very debt like in
essence and based on the markup principle. This is seen as rational responses o
f the Islamic financial institutions to the environments in which they operate,
which are financial markets that are characterized by high degrees of imperfect
information and rent-seeking behavior. Financings according to the profit-and-lo
ss-sharing principle would entitle the financing provider to be compensated at t
he profits but also the losses of
6
the project. Some scholars don’t interpret it too squeezed, and advice just to avo
id Islamic financial instruments based on the markup principle, while they see t
hese financial products as permissible under Islamic law. In the next paragraph,
the most common Islamic financing methods are introduced.
2.2 Islamic Financing Methods
Under the teamwork of scholars, bankers and lawyers, modern Islamic banking has
invented a multitude of Islamic financing products, which shall conform to the S
hariah and the Sunnah (Wigglesworth, 2009). All basic Islamic financial instrume
nts can be used for Islamic syndicated financings as well. These Islamic financi
al instruments can be based on the profit-and-loss-sharing principle or the mark
up principle and comprise amongst others the following financing modes:
Profit-and-losssharing principle:
Markup principle:
“Mudarabah” (Venture capital financing, limited partnership) “Musharaka” (Partnership wi
th right of control),
“Murabaha” (Cost-plus financing, trade financing) “Ijara” (Leasing),
“Sukuk“ (Bond)
Table 2.1: Examples of Islamic financing instruments
7
The examples of Islamic financial instruments in table 2.1 are not full fledged.
Islamic financings entail the freedom of contracts, which enables almost infini
te forms of financial instruments and transactions (Khan & Mirakhor, 1990).
2.2.1. The Profit-and-Loss-sharing Modes
Mudarabah and Musharaka financing can be seen as equity investments and therefor
e represent the profit-and-loss-sharing principle. The financiers are entitled t
o share profits (or losses) of the borrowers business, settled on a ratio based
on the contractual agreement. The rate of profit is determined as a percentage a
nd not as a lump-sum payment. Financings based on the profit-and-loss-sharing mo
de cannot claim collateral or other guarantees that would reduce the credit risk
for the lender (Sundararajan, V. & Errico, L., 2002). But banks, even though th
ey have no legal means, have direct and indirect control over the borrower. Furt
her credits could be declined in the future and the credibility and reputation o
f the borrower is at stake, which is a strong point in Islamic ethics (Khan & Mi
rakhor, 1993). The main problem for profit-and-loss-sharing instruments is how t
o hold the borrowers accountable to the Islamic lender, while maintaining the bo
rrower’s freedom, incentives and the control over the business project (Dar & Pres
ley, 2000). On the other side, profit-and-loss-sharing instruments are generally
seen as stable. This is due to the reason that the term and structure of the li
abilities and the assets are systematically matched through profit sharing arran
gements and since no fixed interest rates mount up and as no refinancing via deb
t is possible (Iqbal, 1997). Furthermore, allocations are supposed to be efficie
nt as the investment possibilities are scrutinized on their productivity and the
rate of return. Under the Mudarabah financing mode, the sole capital provider t
o finance a project is the bank. So in case of a financial loss the financial in
stitution bears all losses. The borrowing company on the other side offers its l
abor and expertise. So the managing
8
company has complete freedom to manage the business.4 Only in case of negligence
or mismanagement, the borrowing company can be made responsible for the resulti
ng financial losses. However the capital provider is permitted to supervise the
businessproject (Sundararajan, V. & Errico, L., 2002). The borrowing company is
compensated by a stake in the profits of the project (Hamwi & Aylward, 1999). Us
ually Mudarabah modes are utilized to finance projects with a short duration in
trade and commerce. The Musharaka mode of financing resembles venture capital. T
he financial institution is not the sole provider of the investment. Other partn
ers, such as the borrowing company for example who form the partnership, provide
capital to finance the project as well. The profits are shared in the relation
to the capital contribution. Lenders can participate in the management of the bo
rrowing company. Voting rights can also be exercised according to the share at t
he borrowing company’s equity capital. The Musharaka mode of financing is more uti
lized to finance projects with a long duration (Sundararajan, V. & Errico, L., 2
002). Profit-and-loss-sharing contracts in general need special risk considerati
ons from the investor side, as the credit risk is shifted from the Islamic finan
cial institution to the investment depositor. The profit-and-loss-sharing contra
cts are more complex and need to determine the profit-and-loss-sharing ratio. Mu
darabah contracts for example give the financiers no possibility to control the
borrower-agent who manages the business. The borrowing company has free hands to
run the business to their best judgment. Musharaka contracts enable the financi
ers better monitoring opportunities of the borrowing entity, as they have more i
nfluence on the management and may exercise voting rights. In addition it should
be noted that in case of losses, part of the loss is absorbed by the borrower.
Also the interest rate risk does not apply for profit-and-loss-sharing financing
modes. But the question is whether this can absorb the special risks of this mo
de of financing. Another risk is the operational risk which becomes crucial for
investments based on the profitand-loss mode. This is due to the special activit
ies that the Islamic financial institution has to perform internally to ensure t
he monitoring of the investment process and the compliance to the institutions I
slamic investment policy. Operational risk may also arise
4
Mudarabah financings are structured usually as unit trusts, limited partnerships
or as limited liability companies (Hamwi & Aylward, 1999). Venture capital fina
ncing represents a modern example of Mudarabah in the Western world (Dar & Presl
ey, 2000).
9
due to the non-standardization of Islamic financial products and due to the lack
of a reliable and efficient Shariah litigation system that enforces financial c
ontracts. Dar and Presley (2000) mention that laws in most Muslim nations hinder
the adaption of profitand-loss sharing modes by prohibiting Islamic banks to ta
ke controlling rights in borrowing firms in two ways: First, by making controlli
ng very costly, second, the controlling blocks in the borrowing firms in Muslim
nations are structured so that the managers of the borrowing company control the
decision making. In addition, Mudarabah contracts are in general hostile toward
s investors. Therefore reforms in the banking regulations would be required to b
alance the control between financiers and managers.
2.2.2. The Mark-up Modes
Financing modes under the markup principle allow in contrast to financings accor
ding to the profit-and-loss-sharing modes to calculate the return as a fixed per
centage of the total investment. But legally even the markup mode contracts do n
ot exhibit a fixed negotiated rate of return, as guaranteed returns are un-Islam
ic. Markup financing modes even give the possibility to request a pledge for col
lateral from the borrower. Generally, markup instruments of Islamic financial in
stitutions resemble instruments of conventional financial institutions most of a
ll (Dhumale, R., & Sapcanin, A., 1998). Murabaha and Ijara are based on the mark
up principle and are historically based on commercial trade activities. In the M
urabaha mode of financing a markup is negotiated between a buyer and a seller, w
hereby the seller informs the buyer about the true cost for acquiring or produci
ng the specified product. The agreed sum is usually paid in installments. The Ij
ara mode of financing can be translated as Leasing. So a product is leased for a
specified time and a specified sum. Also a lease purchase mode exists which is
called “Ijara wa Iqtina”. Here the installments include a portion toward the final p
urchase of the product and consequently the transfer of ownership of the product
(Sundararajan, V. & Errico, L., 2002). Payments to the investors generally depe
nd on the rent or profits of the leaseholder (Oakley, 2009). This is an importan
t point, which gives
10
Ijara financings its Islamic credibility. Advantages of Ijara financings are the
access to finance with low credit requirements. Furthermore, no collateral is r
equired, as the ownership of the leased assets is initially not transferred to t
he borrower. In addition the transaction costs are low. So Ijara provides a sour
ce for long-term financings (Hamwi & Aylward, 1999). Another advantage of Ijara
financing is that the client doesn’t need an initial large capital, and can pay fo
r the services of the asset by its operating income (Ebrahim, 1999). Islamic Inv
estment modes based on the markup principle are more similar to conventional fin
ancing modes, but entail also special risks. But generally financings based on t
he markup principle carry less risk than financings which are based on the profi
t-and loss-sharing principle. The interest rate risk affects only indirectly thr
ough the mark-up. Ijara contracts for example do not allow the Islamic financial
institution to transfer substantial risks and rewards of the ownership to the l
easeholder, because the Islamic financial institution has to hold the leased ass
ets on its balance sheet for the time of the lease (Sundararajan, V. & Errico, L
., 2002).
2.2.3. Sukuk
The Sukuk is an Islamic bond which is asset based. This means that the investor
owns an undivided interest on a real tangible asset and receives a proportionate
investment return on that asset. The Sukuk can be designed as a profit-and-loss
-sharing instrument or a markup instrument (Iqbal, 2007). But Sukuks have turned
to be mainly an Ijara structure. Scholars from the Bahrain-based Accounting and
Auditing Organisation for Islamic Financial Institutions have banned Musharaka
and Mudarabah modes as structures for Islamic bonds. In February 2008, these two
structures were declared to break Islamic law, as investors were offered the po
ssibility of a repurchase undertaking under these structures. This means that th
e issuer had to guarantee to pay back the face value of the bond when it matured
or in case of default (Oakley, 2009).
11
2.3. Islamic Syndicated Finance
In this paragraph, first a general introduction on syndicated loans is provided,
and then the concept of Islamic syndicated financings and differences to conven
tional syndicated loans are explained. Finally the structure, how the parties in
volved in an Islamic syndication deal with each other is elaborated. The basic i
dea of syndicated loans is to pool resources to finance large transactions, whil
e reducing the risks for the finance providers. Therefore a group of banks joint
ly arrange a loan. The risk reduction is due to the ability of the financiers to
invest in more projects as the investment size is reduced, whereby they can div
ersify their investments more effectively. A syndicate typically includes one or
a few lead banks, which assess the borrower quality and which negotiate the ter
ms and conditions of the contract. Furthermore the lead banks prepare the inform
ation memorandum for the participating banks, which have to decide then how much
of the syndicate loan to invest in. After the deal is signed, the deal agent, w
hich is often one of the lead banks, has the responsibility to monitor the borro
wer, whether the borrower complies with the loan covenants and to negotiate with
the borrower and the lenders in case of default. To retain the incentives of th
e lead banks to properly monitor post-signing the contract, the lead banks usual
ly retain a share of the loan in order to signal the quality of the specific syn
dicated loan. (Giannetti & Yafeh, 2009). Islamic syndicated financings are based
on Islamic rules and laws which are referred to as “Shariah compliant”. The syndica
ted Islamic finance market has seen noticeable growth in the last years. In 2007
there were about 28 syndicated Islamic finance deals which summed up to a total
value of $15.2 billion (Iqbal, 2007). It is also often the case that Islamic fi
nancing is pooled in alongside conventional finance and is pari passu with other
senior debt (Akhtar, 2007). The main distinguishing features of Islamic syndica
tions are that the returns are not structured as interest income and that genera
lly returns to the investors are not guaranteed as it is required by the Shariah
. The conformity of syndicated financing deals to the Shariah is ensured by usin
g eligible Islamic financing modes, as described in the paragraphs above. Most I
slamic financial instruments are qualified for syndications, but Murabaha and Su
kuk are the most widely used ones.
12
Another distinguishing point between Islamic syndications and conventional syndi
cations is that in the opinion of many Islamic scholars the lead arranger has to
sell the “debt” down at par and not at discount or at a premium. In conventional sy
ndicated loans, the lead bank sells the debt further to other banks and this mig
ht also be at a discount or at a premium. But the lead arranger for an Islamic s
yndication is allowed to take an administration or management fee for the arrang
ement of the syndication process. Except for the distinguishing points explained
above, syndicated Islamic financings are very similar to their conventional cou
nterparts. A detailed description of how the different stakeholders of Islamic s
yndications are involved with each other follows next.
Obligor
Wakeel (Lead Bank)
Muwakkil
Muwakkil
………
Muwakkil
Graph 2.3: Syndicated Islamic Finance (Source: Iqbal, 2007)
The Islamic financial instrument for an Islamic syndicated financing is provided
by the lead bank to the obligor (Graph 2.3). The lead bank will set up an inves
tment agency agreement (IAA) with the participating banks in the syndicate. Usua
lly the lead bank is
13
part of the syndicate as well. The lead bank acts as a “Wakeel” or agent, the partic
ipating banks in the syndicate are called the “Muwakkils” or principals. While the M
uwakkils provide the funds, the Wakeel is the managing agent of the funds. The W
akeel has the obligation to monitor and manage the transaction and to keep the d
irect contact with the obligor, as the Muwakkils only have a direct relationship
with the Wakeel and not the obligor. The IAA specifies the conditions for the p
articipation in the syndication, but stipulates also the purpose for which the c
apital provided by the Muwakkils can be used. So the IAA determines the rights a
nd obligations of the parties involved in the syndication (Iqbal, 2007).
14
3. Descriptive Research Questions:
This paper has the objective to fill the empirical gap on Islamic syndicated fin
ancings, as Islamic financings in larger dimensions are relatively young. Theref
ore, first a descriptive research on the characteristics of the Islamic financin
gs, based on the data of all syndicated loans from the time period between Janua
ry 1995 and October 2006 will be conducted.5 These characteristics will then be
compared with conventional syndicated loans. Also differences in between this ti
me period will be researched. The results on the structural characteristics of I
slamic syndicated financings provide answers on the true dimension of the agency
conflict and the structural tools used to reduce agency costs. The following pa
rt will discuss research results of different authors on general Islamic financi
al instruments or general syndicated loans. These discussions might hint what re
search results to expect for Islamic syndicated financings and help to formulate
the research questions on Islamic syndicated financings. First, this article wi
ll conduct a descriptive research on multiple features of Islamic syndicated fin
ancings. The first characteristics which will be evaluated for the descriptive r
esearch are based on the lenders and the borrowers of Islamic syndicated financi
ngs. Where are the funds of Islamic syndicated financings coming from? Are the o
il rich Persian Gulf states the source of Islamic syndicated financings? The Bos
ton Consulting Group (2008) argues that the growth of Islamic finance can be att
ributed to the accelerating wealth of the petrodollar-rich Persian-Gulf states.
And which countries are receiving these funds? It seems most probable that count
ries with Muslim populations are the main target for Islamic syndicated financin
gs. The article “Turning towards Mecca” (Economist, 2008) argues for example that Is
lamic finance with funds from the Persian Gulf states is also flowing towards Is
lamic countries in Africa. But funds might also flow towards Western countries,
to enable Persian Gulf investors to diversify their investment portfolio geograp
hically while complying with Islamic jurisprudence (Solé, 2007). These thoughts le
ad to the following research questions:
5
This time period starts with the emergence of the first Islamic syndicated finan
cings and ends before any effect of the financial crisis, which emerged in 2007,
to affect the research.
15
1) Research Question: Where are funds of Islamic syndicated loans coming from?
2) Research Question: Which countries are receiving the funds of Islamic syndica
ted financings?
The next characteristic which is to be explored is the industrial distribution o
f the Islamic syndicated financings. Generally, the majority of Islamic financia
l transactions are directed away from agriculture and industry towards retail an
d trade finance (Rajesh, Amos, Tarik, 2000). This is because these involve fewer
risks for the lending institutions. Islamic financings have the characteristic
to be concentrated on short-term trade, retail, finance and service sector finan
cings than on the capital intensive industrial sector (Hamwi & Aylward, 1999). B
ut as Islamic financings are expected to profit emerging nations in Muslim natio
ns, the financing of infrastructure projects should see a rising trend as the pa
per “Infrastructure project finance and capital flows: A new perspective” (Dailami a
nd Leipziger, 1998) would suggest. There are opportunities for Islamic infrastru
cture financings, especially in power and telecommunications projects. But also
projects in transportation and utilities are becoming more important. The growth
in demand for investments in these sectors has increased due to the privatizati
on drive of many governments and the difficulties these large projects face to m
obilize funds for these large-scale projects. Traditionally governments had been
the source of funds for infrastructure projects, but governments have to adapt
to tighter budget constraints. Furthermore the limited recourse project financin
g structures fit well in the Islamic financing modes as they are in line with Is
lamic law at a general level because they are asset based and socially valuable
(Hamwi & Aylward, 1999). This paper will research the business areas where Islam
ic syndicated financings have been provided for in the time between January 1995
till October 2006 and whether there are changes during time.
3) Research Question: Towards which industries are Islamic syndicated financings
directed to? And are there changes over time?
16
Next, the structure of Islamic syndicated financings shall be researched. For th
e structure of syndications, the agency problem and information asymmetries play
an important factor. In general, Islamic financing is different than convention
al financing as the lenders face different risks, even though Islamic financing
resembles conventional lending (Chong & Liu, 2007). Grais & Pellegrini (2006) ar
gue that the agency problem for Islamic financial institutions is not only due t
o the separation of ownership and control, which is the common agency problem th
at conventional syndicated loans face, but agency problems hit Islamic financial
institutions also due to the separation of depositor’s and investor’s cash flows an
d control rights (Grais & Pellegrini, 2006). Agency problems for Islamic financi
al instruments, resulting from non-compliance to Shariah regulations and resulti
ng from poor transparency, can affect Islamic banks credibility and its ability
to attract investors (Chapra and Ahmed, 2002). Safieddine (2008) states that mos
t Islamic banks understand the importance of incorporating corporate governance
mechanisms. But deficiencies in the actual corporate governance system are obser
ved.6 Especially profit-and-loss-sharing instruments are exposed to agency probl
ems. Compared to a self-financed manager, borrowers of profit-and-loss-sharing i
nstruments have less incentive to bring in effort and have more incentive to rep
ort less profit. In addition, the lenders’ role in the management is restricted an
d doesn’t facilitate participation in the management (Dar & Presley, 2000).7 To mi
tigate agency problems for syndicated loans, there are specificities in the stru
cture of these loans. Sufi (2007) finds out that the lead banks hold a larger sh
are of the syndicated loans and that the syndicate is more concentrated, when in
formation asymmetry requires more intensive monitoring and due diligence of the
borrower. Sufi (2007) also finds out that in case that the information asymmetri
es are very large, if the
6
It is for example not common yet for Islamic banks to have a governance committe
e, an audit committee or clear internal audit functions. As this leads to a fina
ncial reporting process which is not sufficiently monitored, this leads to agenc
y problems (Safieddine, 2008). 7 There are also other reasons, which are not rel
ated to the agency problem, why Islamic markup modes are preferred to profit-and
-loss sharing modes of Islamic financings: Financings which are more debt-like e
njoy tax advantages. Profits are taxed, but interest (regarded as a cost) is exe
mpted. Furthermore, property rights are often not well defined and protected in
many Muslim nations. But well-defined property rights are an inalienable require
ment for profit-and-loss-sharing contracts. Another reason is that financial pro
ducts which are based on the profit-and-loss-sharing mode have the disadvantage
that there is no secondary market to enable financial institutions to trade thos
e (Dar & Presley, 2000).
17
borrower is informationally opaque, participant banks are closer to the borrower
, by geographical means and by the means of previous lending relationships. Gian
netti & Yafeh (2009) have evaluated how cultural differences affect syndicated l
oans. They find out that the share of participant banks are smaller as the cultu
ral distance is higher. In addition, the larger the cultural distance between th
e lead bank and the borrower, the larger the share of the lead bank, as cultural
differences reduce risk sharing within the syndicate.8 There are several reason
s for these results. The first one is information asymmetry. The closer the cult
ure is, the lower the cost of information gathering, as lenders consider borrowe
rs from a distant culture more risky. Another reason might be the higher transac
tion costs for culturally distant lenders.9 And finally another argument might b
e a taste-based discrimination which arises due to a negative perception because
of the cultural differences between borrowers and lenders (Giannetti & Yafeh, 2
009). These considerations on the one hand mean that Islamic syndicated financin
gs should exhibit larger shares of the lead banks, as their agency conflicts see
m especially great. On the other hand the gap of cultural differences between Is
lamic borrowers and lenders is not very clear until now. Cultural closeness betw
een lenders and borrower could mean that a larger share of the lead banks is not
required anymore. Cultural distance between lenders and borrower could lead to
even increased shares of the lead banks. These considerations lead to the follow
ing research question, which might hint about the urgency of the agency problem
and the gap of cultural differences between borrowers and lenders at Islamic syn
dicated financings.
4) Research Question: Are the shares of lead banks at Islamic syndicated financi
ngs larger than in conventional syndicated loans?
In the context of Islamic syndicated financings, the loan maturity is an importa
nt measure of the agency problem and the perceived asymmetric information. A sho
rter maturity can
8
Regarding the quality of the borrower there is an information asymmetry between
the lead banks and the participating banks. The more severe the information asym
metries and the agency problems the larger the share of the loan, the lead banks
have to retain. This in turn limits the lead banks ability to diversify their i
nvestments (Giannetti & Yafeh, 2009). 9 The higher transaction costs may arise d
ue to difficult communication, from difficult co-ordination between individuals
of different cultural backgrounds and from conflicts that arise due to the diffe
rences in national cultures (Giannetti & Yafeh, 2009).
18
be interpreted as a contracting tool, in case the borrower is perceived to have
high default probability (Giannetti & Yafeh, 2009). Moreover, Islamic financial
institutions do have a preference to finance short-term investments due to the r
egulations of Islamic financial systems or the practice of Islamic financial ins
titutions (Rajesh, Amos, Tarik, 2000). Islamic financial institutions haven’t had
the abilities to develop well-functioning secondary markets for long-term Islami
c financial products and the missing of qualified market makers are also reasons
why Islamic financial institutions have been limited to invest in long-term pro
jects (Dahlia El, Wafik, Zamir, 2004). Therefore, the next research question is
concerning the maturity of Islamic syndications in comparison to conventional sy
ndication. All arguments hint that the Islamic syndications should exhibit short
er maturities than their conventional counterparts.
5) Research Question: Do Islamic syndicated financings exhibit shorter maturitie
s than conventional syndicated loans?
And also loan covenants are important measures of the agency problem and the per
ceived asymmetric information. As Islamic financing involves risk sharing, there
are tighter controls from the side of the Islamic financial institutions. And b
ecause Islamic syndicated financings are mostly structured as markup-modes and l
ess as profit-and-losssharing modes, there is no right of control, which might s
trengthen the requirement for debt covenants, especially for financial debt cove
nants. This leads to the next research question, which explores whether more Isl
amic syndications exhibit financial debt covenants than conventional syndication
s.
6) Research Question: Do more Islamic syndicated financings exhibit financial de
bt covenants than conventional syndicated loans?
Information asymmetry can also mean that the syndicate is more concentrated to b
e better able to monitor the borrower. As the Islamic financial system is not as
developed as the conventional banking system and as the number and size of Isla
mic financial institutions is limited, it seems also probable that there are few
er banks engaged in Islamic syndicates
19
than in conventional ones. Therefore the next research question is concerning th
e number of participating banks in an Islamic syndication in comparison to a con
ventional syndication.
7) Research Question: Are there fewer participating banks in Islamic syndication
s than in syndicated loans?
Another tool to limit effects of agency problems and information asymmetry is th
e limitation of the size of the loan. Giannetti & Yafeh (2009) for example, find
out that culturally distant borrowers are offered smaller loans, as they exhibi
t larger agency problems and information asymmetries compared to culturally clos
er borrowers. Therefore the next research question examines the size of the Isla
mic syndicated financings in comparison to the conventional syndicated loans.
8) Research Question: Are Islamic syndicated finances smaller than conventional
syndicated loans?
20
4. Analysis on Loan Spreads of Malaysian Syndications:
In this section, an OLS regression model with determinants of loan pricing for I
slamic and non-Islamic loans in Malaysia is built to find out whether Islamic sy
ndicated financings are more expensive than conventional syndications and whethe
r specific attributes of Islamic and non-Islamic syndicated loans influence cred
it spreads. This analysis is based on the model used by Ivashina (2009) in her a
rticle “Asymmetric information effects on loan spreads”. The time period evaluated i
s again, as it is the case for the descriptive research, between 1995 and Octobe
r 2006. The research will focus on Malaysia, one of the most developed markets f
or Islamic banking products, which exhibits an Islamic banking system next to th
e existence of the conventional banking system. The choice for one single countr
y allows for a more accurate comparison between Islamic syndicated financings an
d conventional syndicated loans. Empirically, to the knowledge of the author, th
ere is no literature on the research question, whether the spreads on Islamic sy
ndicated financing are priced differently than conventional syndicated loans. Bu
t there is literature on the pricing of Islamic financial instruments in general
. This question entails the important issue of corporate governance. In the disc
ussion of corporate governance, the fundamental problem is concerning the agency
problem, which results from the separation of ownership and finance or control
(Shleifer & Vishny, 1997). Therefore the main objective of shareholders’ value bas
ed corporate governance is to develop incentives for managers to pursue the ince
ntives of the shareholders (Grais & Pellegrini, 2006). When there is a shift fro
m shareholder value maximization to aggregate welfare maximization of stakeholde
rs, as is the case for Islamic financings, the managerial incentives are difficu
lt to design (Tirole, 1999). Reputational risk evolves for the whole Islamic fin
ancial industry if individual Islamic institutions do not comply with the Islami
c jurisprudence. Therefore, Islamic financial institutions incorporate corporate
governance structures and processes which shall ensure the Shariah compliance t
o reassure all the stakeholders (Grais & Pellegrini, 2006).10
10
The most applied method for Shariah compliance reassurance are certifications by
independent bodies. Furthermore a Shariah Supervisory Board is part of the inte
rnal corporate governance structure of the Islamic financial institutions to giv
e advice on Shariah conformity. Shariah Supervisory Boards deal with five corpor
ate governance issues, namely the independence, confidentiality, competence, con
sistency and
21
Islamic financial institutions are exposed to cash-flow risk that might erode th
e capital base of Islamic banks. Negative deviations from promised liability at
a conventional bank are absorbed by its equity. In Islamic banks depositors are
not guaranteed their deposits or any profit (Ebrahim, 1999). This might lead dep
ositors to take away their money when markets are not promising. Therefore Islam
ic financial institutions and Islamic financial instruments have a different ris
k pattern than conventional financial institutions and instruments (Ariss, 2009)
. Syndicated loan lenders, as described by Giannetti & Yafeh (2009), are associa
ted with asymmetric information and moral hazard problems. All these research re
sults therefore hint that Islamic syndicated loans are priced differently than c
onventional syndicated loans. Better corporate governance enables corporations t
o extend financing to a business and enables a lower cost of capital. Islamic sc
holars might argue that Islamic financial instruments enable better corporate go
vernance, as Islam obliges stakeholders to engage ethically. But the sticking of
stakeholders to Islamic ethically correct principles cannot be taken for grante
d. Islamic financial institutions suffer from breaches of fiduciary responsibili
ties and from effects of asymmetric information as much as conventional banks do
. Scandals in Islamic banking look very much the same as for conventional bankin
g scandals, such as audit failure, collusion of the board with the management, e
xcessive risk taking or imprudent lending. Furthermore the Islamic financial ind
ustry does raise specific challenges for the corporate governance, which do not
hold for the conventional financial industry. One example is the confidence keep
ing of the stakeholders of the compliance of the institutions activities with th
e Islamic rules and ethics (Grais & Pellegrini, 2006). But the more perceived ag
ency problems are, the larger their effects on the Islamic syndicated financing
contract, entailing the cost of the financing. Differences in perceived risk can
also be attributed to cultural differences between borrowers and lenders, which
lead to differences in the spread of Islamic and conventional syndicated loans.
The loan spread is in general lower if borrowers and lenders share the same
disclosure. Except for Iran, where the Shariah compliance is monitored and guara
nteed by the central bank, Shariah Supervisory Boards exist in all Islamic count
ries. Further, centralized Shariah Supervisory Boards are used in many Islamic c
ountries for ex-ante monitoring, which develops further the standardization of S
hariah operations, and ex-post monitoring of the Shariah conformity (Grais & Pel
legrini, 2006).
22
religion and are culturally closer (Giannetti & Yafeh, 2009). So this would mean
that syndicated Islamic financings should be more expensive for a borrower in t
he Middle East, if the lead lender of the syndicate is a Western bank than compa
red to an Islamic financial institution from the Middle East as a lead lender. S
afieddine (2008) points out that there are also conflicts between some agency mi
tigating mechanisms and the Shariah law. This could lead to higher costs for Isl
amic financial instruments. Others argue that the margins for Islamic banks woul
d be larger, due to the “piety premium” which also other ethical investment products
possess (Hasan, 2008). Also the Tripolipost (2008) mentions, that Islamic produ
ct are regarded as more expensive, as clients have to pay a premium on Islamic f
inancings. But Akhtar (2007) mentions that tranches of Islamic financings, which
are incorporated within a multi-sourced financing offering, are priced competit
ively. This paper will research whether Islamic syndicated financings are more e
xpensive, based on the credit spreads founded on data of syndicated loans for Ma
laysian borrowers. Since there is a huge difference in the risk pattern, which c
an enhance information asymmetries and the agency problems and because there mig
ht be a cultural distance between borrowers and lenders and since Islamic syndic
ated financings might include a “piety premium”, it is hypothesized that the spreads
for Islamic syndicated financings are higher than for conventional syndicated l
oans.
Hypothesis:
Islamic syndicated financing spreads are higher than spreads for
conventional syndicated loans.
The method to test this hypothesis will be based on the model used by Ivashina (
2009) in her article “Asymmetric information effects on loan spreads”. As in the art
icle of Ivashina (2009), the determinants of the loan pricing in this statistica
l test are based on borrower characteristics, contract characteristics and the r
elevant characteristics of the syndicate structure. The borrower characteristics
are determined by the respective credit ratings.11 Contract characteristics mig
ht include the maturity, the deal size and the existence or not-existence of fin
ancial covenants. Characteristics of the syndicate
11
Borrowers which do not exhibit a published rating will be classified as “Not-Rated”.
23
structure might be the size of the lead-banks share or the number of participati
ng banks. Furthermore the source of the funds may play a relevant role, as cultu
ral distance might have a negative effect. Relevant contract characteristics and
characteristics of the syndicate structure for the statistical test are determi
ned in the descriptive research. Since financings according to the profit-and-lo
ss sharing principle do not exhibit fixed spreads, the research can only take in
to account data given from deals based on the markup-pricing principle. But it i
s important to note again that Islamic financial instruments exhibit skewness to
wards markup pricing instruments. According to the article “Islamic Banks and Inve
stment Financing” (Rajesh, Amos, Tarik, 2000), the markup-principle is the most wi
dely used financing structure in Malaysia and other Muslim countries with a dual
banking system, such as Egypt or Jordan. And also in Iran, where the banking sy
stem is entirely Islamic the majority of Islamic financial instruments are based
on the mark-up principle. Furthermore, this trend has even increased for all th
ese countries over time. Markup-pricing in this research is determined for syndi
cated financings where the base rate & markup is either fixed or based on the LI
BOR plus a markup. The pricing difference will be based on the difference of the
markup on the base rate or the LIBOR. Of course there are also other factors th
an the spread which will determine the total cost of the financing. The comprehe
nsiveness of the regulatory framework and the provision of the necessary legal f
ramework could be reasons why Islamic financing becomes more or less expensive t
han conventional financing. The provision of tax exemptions and the provision of
complete value chains of Islamic financial products in the markets can have an
important effect on the total Islamic financing costs (islamicfinanceasia.com, 2
008). But it is assumed that there are no disadvantages for Islamic syndicated f
inancings compared to their conventional counterparts in Malaysia, as the Islami
c banking industry tends to appear and grow there, where legal and tax hurdles a
re paved, as it happened in Malaysia. Furthermore, the considerations about diff
erences of the regulatory and legal framework are less important in this paper,
as this research is conducted on a single country, namely Malaysia and as all Is
lamic syndicated financings have to cope with the same regulatory and legal fram
ework.
24
The consideration to conduct this research only on Islamic syndicated financings
and conventional syndicated loans from Malaysia has several reasons. The first
reason is that Malaysia exhibits the conventional and the Islamic banking system
, which makes an accurate comparison between the two systems possible. The artic
le of Ainley, M. &
Mashayekhi, A. & Hicks, R. & Rahman A. & Ravalia, A. (2007) points out, that the
re is variation in Islamic banking practices among countries and jurisdictions.
And these differences are not only due to differences of interpretation of Islam
ic scholars but also the level of industry development and the regulatory framew
ork. This means that comparable differences in Islamic banking are better done b
etween very similar countries, which would increase the difficulties to compare
the results among different Islamic nations. Furthermore,
Malaysia exhibits one of the most developed banking systems in the Islamic World
and also in the database used for this research, Malaysia is found to be by far
the largest market for Islamic syndicated financings. As this research is done
on Malaysian Islamic syndicated financings, the next paragraph shortly introduce
s the banking system in Malaysia.
4.1 The Banking System in Malaysia
Malaysia with its dual banking system, which facilitates the co-existence of Isl
amic and conventional banking systems, provides a unique opportunity to compare
Islamic financing with conventional financing. Malaysia is reportedly one of the
largest Islamic financing hubs in the world (Solé, 2007). To achieve this positio
n, regulatory premises were set with the establishment of the Islamic Banking Ac
t in 1983 (Chong & Liu, 2007). So for example, the central bank of Malaysia give
s tax breaks for Islamic products. Furthermore rules were relaxed to allow comme
rcial and investment banks to carry out Islamic business transactions in foreign
currencies. Malaysia, like several other countries has introduced a central Sha
riah board in its regulatory systems (Hamwi & Aylward, 1999). Today there are 17
Islamic banks in Malaysia, including the Islamic windows of large conventional
banks, such as HSBC Holdings Plc, Oversea-Chinese Banking Corp. and
25
Standard Chartered Plc (Bloomberg, 2009). Islamic banking modes have often been
criticized to resemble debt, especially in countries with a dual banking system.
Chong & Liu (2007) argue, especially in the case of Malaysia, that next to the
severe agency problems which Islamic financing modes create, competition from co
nventional banking might be a reason why Islamic financing modes resemble debt i
nstruments.12 The ability to maximize the risk-adjusted returns on investment an
d the ability to sustain stable and competitive returns, ensure that Islamic fin
ancial institutions stay competitive against their conventional peers (Chong & L
iu, 2007).
12
Islamic banks, sticking to the profit-and-loss sharing principle, would face „with
drawal risk“ as a result of a lower rate of return for depositors than the rate of
return competitors pay (Chong & Liu, 2007).
26
5. Data Selection:
The data source for this Master thesis stems from the LoanAnalytics (former Loan
ware) database, which contains detailed information on the whole population of l
oan facilities. The data population from 1995 up to October 2006 was kindly plac
ed at the disposal of mine by Dr. Stefanie Kleimeier, Associate Professor of Fin
ance at Maastricht University, as the research source for this Master thesis.
5.1 Data Selection for the Descriptive Research Questions
For the descriptive research questions all worldwide Islamic syndicated financin
gs from 1995 till October 2006 were selected. Islamic financings were separated
from the other financing facilities by two ways. First all facilities which were
described as Islamic financings by the information contained in the LoanAnalyti
cs database on the loan facilities. Second, facilities which have no remarks to
be Islamic financings were treated as Islamic financing facilities if the facili
ty contained at least one participating financial institution which conducts its
business exclusively in an Islamic compliant manner.13And also if the borrower
is a solely Islamic financial institution, the facility is treated as an Islamic
financing facility. The reason is that Islamic financial Institutions are only
allowed to lend and borrow in an Islam compliant way (Chong & Liu, 2007). Furthe
rmore the question arises whether loans to Iranian companies in Iran, the only c
ountry in the database which exhibits a solely Islamic banking system14, by fore
ign financial institutions are automatically Shariah compliant. But even though
the borrowing companies are mostly state owned enterprises, the loans from abroa
d are not
13
Especial attention has to be paid to Iranian banks, as they are often seen as Is
lamic financial institutions, as the Islamic banking regime in Iran may induce.
But the LoanAnalytics dataware shows that often Iranian banks, which lend money
from branches abroad to international borrowers, do mostly not follow Islamic fi
nancing modes. 14 Only Sudan had introduced a wholly Islamic banking system as w
ell. Sudan promulgated the full Islamization of its financial system in 1992. Bu
t since January 2005, the time when the Sudanese government and the former Chris
tian opposition group Sudan People’s Liberation Movement (SPLM) have signed a peac
e agreement, conventional banks are allowed to work in Sudan again (Solé, 2007).
27
automatically Shariah compliant (Shafizadeh, 2008).15 Therefore in this research
, borrowings by Iranian companies from foreign financial institutions (if the de
al is arranged at least by one foreign financial institution) are only assumed t
o be Shariah compliant if this information is contained in the LoanAnalytics dat
abase. But for Iranian banks, not borrowing via a branch abroad, any borrowing i
s assumed to be Shariah compliant, as these institutions have to comply with the
Islamic banking system inside the country.
5.2 Sample Characteristics for the Descriptive Research Questions
The sample includes all worldwide syndicated Islamic financings. The final sampl
e size consists of 175 Islamic syndicated financing deals from 1995 till October
2006. For some of the descriptive research results the sample size is lower, as
specific information required is missing on the dataset. But the exact number o
f deals is given for every descriptive research result. The time span ends in Oc
tober 2006, not to include any effect of the credit crisis which followed the fo
llowing year. The total facility amount of these deals in this time span totals
about $28.55bn. There is generally an increasing trend visible, but there are al
so several drawbacks visible in the generally positive trend for Islamic syndica
ted financings (Chart 4.2). These drawbacks coincide with the periods of the Asi
an Crisis in 1997, the bust of the economic bubble in the end of 2000 and the st
art of the Iraq War in 2003. The year 2006 exhibits the highest amount ever, inv
ested in syndicated Islamic financings, with a record of more than $9.38bn in in
vestments till October 2000.
15
After many years of discussion, foreign lenders, who lend money to borrowers in
Iran, have to pay taxes on their interest income. But most financial facilities
of foreign lenders entail provisions which require any payments by the borrower
back to the lender to be grossed up of any tax payments attributable to it (Shaf
izadeh, 2008).
28
Chart 4.2: Investments in Islamic Syndicated Loans from 1995 till October 2006
5.3 Data Selection & Sample Characteristics for the Loan Spread Analysis of Mala
ysian Syndications
In order to select the data for the hypothesis test, first all Malaysian borrowe
rs of Syndicated loans, Islamic and conventional ones, were selected. As for the
descriptive research, the LoanAnalytics database is used as the data source. Th
e sample includes all Malaysian borrowers from the time period between 1995 and
October 2006, where the all-in spread was given in the database. In a few cases
other important information in regard to the determinants of loan pricing, such
as the name of the lenders or the maturity date of the deal are missing in the d
atabase as well. These few cases were excluded too. Furthermore the borrower cha
racteristics, which are determinants of the loan pricing, are measured by the re
spective credit ratings of the borrowers. The credit ratings for the Malaysian b
orrowers were found on the websites of the two credit rating agencies in Malaysi
a, Ram Ratings Services Berhard (RAM) and Malaysian Rating Corporation Berhard (
MARC). If the borrowing company doesn’t have a credit rating, it was researched wh
ether this company has a mother company which was rated, to eventually include t
his rating as a proxy. Furthermore, it is not always possible to find credit rat
ings for the borrower for the specific year, when the syndicated loan deal was s
igned. In case
29
there is no credit rating for the time of the deal signing, the credit rating wh
ich is closest in time is chosen. If there is no credit rating found, the deal i
s classified as “Not Rated” in the analysis. Data on the syndicate structure and the
contract characteristics were found on the LoanAnalytics database. The sample f
inally includes a total of 420 Islamic and non-Islamic syndicated loan deals. Of
these, 32 syndications are Islamic financings. As there are 57 Malaysian Islami
c syndications for this time period in total, this means that the final sample i
ncludes 56% of them. Not all of the syndications could be included, as data on t
he spread was missing in these cases. It is important to mention that the 57 Mal
aysian Islamic syndicated financings count for about a third of all 175 Islamic
syndications worldwide in the researched time period.
30
6. Empirical Results:
This paragraph presents the results for the descriptive research questions and t
he outcome of the loan spread analysis for the Malaysian syndicate borrowers. Fi
rst the results of the descriptive research questions are presented, and then th
e results of the regression model for the loan spread analysis are provided. For
the descriptive research results, countries except for Malaysia, which has a ve
ry dominant share, are also added up to regions to emphasize the dominance of sp
ecific regions for Islamic syndications. Furthermore the exceptional role for Ma
laysia continues as Malaysian syndications are taken for the loan spread analysi
s.
6.1 The receivers of Islamic syndicated financings:
The first research question investigates the receivers of Islamic syndicated fin
ancings. In table 6.1.1 the benefiters are categorized in countries. The total t
ranche amounts for all Islamic syndicated financings worldwide, for the time per
iod between 1995 and October 2006, add up to $28.55bn. The deal count totals 175
Islamic syndicated financings. In respect to the tranche amounts, Saudi Arabian
borrowers have the lead with $6.67bn of Islamic syndicated financings, which me
ans that more than 23% of all the financings have been received by Saudi Arabian
borrowers. The United Arab Emirates follows with $5.90bn of Islamic syndicated
financings, which shows that borrowers in the United Arab Emirates have gained a
lmost 21% of all the Islamic syndicated financings. Malaysia is next with $5.02b
n of Islamic syndicated financings which is equal to a share of almost 18% for M
alaysia. Borrowers from Kuwait and Iran are also important benefiters of Islamic
syndicated financings, and their share of all the Islamic syndicated financings
is about 12% and 9% respectively. Companies from predominantly non-Islamic nati
ons, such as the Netherlands, Kazakhstan, Brazil, the United Kingdom, South-Kore
a, Italy, France, Singapore and the United States have benefited from Islamic sy
ndicated financings as well.
31
Tranche amount Tranche Amount in Percent of ($) Total Bahrain 1.065.167.800 3,73
% Brazil 85000000 0,30% France 54.300.400 0,19% Indonesia 370.000.000 1,30% Iran
2.630.812.904 9,21% Italy 100.000.000 0,35% Jordan 15.000.000 0,05% Kazakhstan
250.000.000 0,88% Korea (South) 130.000.000 0,46% Kuwait 3.475.000.000 12,17% Ma
laysia 5.016.268.305 17,57% Netherlands 750.000.000 2,63% Oman 260.000.000 0,91%
Pakistan 450.005.580 1,58% Qatar 139.590.000 0,49% Saudi Arabia 6.667.200.000 2
3,35% Singapore 85.000.000 0,30% Turkey 834.500.000 2,92% United Arab Emirates 5
.902.000.000 20,67% United Kingdom 228000000 0,80% USA 45.000.000 0,16% Total 28
.552.844.989 100,00% Table 6.1.1: Receivers of Islamic syndicated financings Cou
ntry
Deal Count 8 2 5 3 22 1 1 3 3 8 57 1 1 9 3 11 1 15 17 3 1 175
Chart 6.1.1 shows the borrowers of Islamic syndicated financings added up in reg
ions, to emphasize the most important benefiting regions. Malaysia as explained
already above is exceptionally left as a single country. The regions consist of
the West 16, the Middle East17, Malaysia and Others18. The chart (6.1.1) shows t
hat 75% of the borrowers of more than $28.55bn of investments in syndicated Isla
mic financings are located in the Middle East. Malaysia, as the largest hub for
Islamic financings in South-East Asia comprises about 18% of all the Islamic syn
dicated financings in the world. The absorption of capital by the West is very l
imited, but still not neglectable at about 4%. Other borrowers comprise 3 % of a
ll Islamic syndicated financings.
16 17
The West is defined to entail France, Italy, the Netherlands, the United Kingdom
and the United States. In this paper, the Middle East is defined as the Greater
Middle East which includes Bahrain, Iran, Jordan, Kuwait, Oman, Pakistan, Qatar
, Saudi Arabia, Turkey, and the United Arab Emirates. 18 The Others entail Brazi
l, Indonesia, Kazakhstan, South Korea and Singapore.
32
Chart 6.1.1: Receivers of Islamic syndicated financings in % of the total Islami
c syndicated financings
In regard to the deal counts, Malaysia has the lead with 57 out of 175 Islamic s
yndicated financing deals (Table 6.1.1). Iran and the United Arab Emirates follo
w with 22 and 17 deals respectively. Saudi Arabian borrowers exhibit only 11 dea
ls, even though they have the largest share in Islamic syndications in total amo
unts. The number of deals therefore does not reflect the same outcome as the res
pective percentages of the investments. Table 6.1.2 shows well, that comparably
loans to Malaysian borrowers are smaller than to borrowers in the Middle East. W
hile the average deal size for Malaysian Islamic syndicated financings is about
$88.0 million, the average deal size for Middle Eastern borrowers is about $225.
7 million. The average deal size for all Islamic syndicated financings is $163.2
million. Western and Other borrowers have average deal sizes of $107.0 million
and $76.7 million respectively. The reason for these significant differences mig
ht be the industries that profit from Islamic syndications in the respective cou
ntries. Malaysian deals for example, overhelmingly invest in the construction in
dustry, while Islamic syndications in the Middle East are mostly on very capital
intensive industries, such as the oil and gas sector, or the utilities sector.
A more detailed description of the industrial distribution can be found in parag
raph 6.3.
33
Number of Deals Total Deal Sum ($) Average Deal Size ($) 11 1.177.300.400 107.02
7.309 West 95 21.439.276.284 225.676.592 Middle East 57 5.016.268.305 88.004.707
Malaysia 12 920.000.000 76.666.667 Others 175 28.552.844.989 163.159.114 All Ta
ble 6.1.2: Receivers of Islamic syndicated financings in total numbers for regio
ns
6.2 The source of funds for Islamic Syndicated financings:
The second research question investigates where funds of Islamic syndicated fina
ncings come from. In order to do this, the lending institutions are explored. Th
e place of the headquarters of the lending institutions is taken as the source f
or the countries, from where the funds of Islamic syndicated financings are comi
ng from. Again these countries are added up to regions as in the paragraph befor
e. And as before, the regions consist of the West19, the Middle East20, Malaysia
and Others21. As expected, the Middle East contributes a large share of the inv
estments in Islamic syndicated financings (Chart 6.2). But surprisingly, Western
lenders exhibit an even larger share of investments in Islamic syndicated finan
cings then Middle Eastern lenders. While Western lenders have contributed about
50% of the funds for Islamic syndicated financings, Middle Eastern lenders have
provided 34%. Malaysia as a financial hub for Islamic financings alone provided
11% of the funds of all Islamic syndications. 5% of the funds are from other len
ders, such as from Japan or Singapore.
19 20
The West is defined to entail France, Italy, the Netherlands, the United Kingdom
and the United States. In this paper, the Middle East is defined as the Greater
Middle East which includes Bahrain, Iran, Jordan, Kuwait, Oman, Pakistan, Qatar
, Saudi Arabia, Turkey, and the United Arab Emirates. 21 The Others entail Brazi
l, Indonesia, Kazakhstan, South Korea and Singapore.
34
Chart 6.2: Source of funds of Islamic syndicated financings
Next, it seems also very interesting to find out which fund providers are the mo
st important for which Islamic syndicated financing receiver. As can be seen in
table 6.2.3, Western Lenders are focused on the Middle East, as 79% of all inves
tments in Islamic syndications by Western financial institutions are absorbed by
borrowers in the Middle East. Malaysian borrowers are also paid attention to, a
s 14% of all investments in Islamic syndications by Western financial institutio
ns are absorbed by borrowers in Malaysia.
Western Middle Eastern Malaysian Borrowers Borrowers Borrowers Western Lenders 2
,3% 79,0% 14,0% Middle Eastern Lenders 7,7% 89,6% 0,3% Malaysian Lenders 0,0% 5,
4% 94,6% Other Lenders 6,9% 89,3% 3,8% Table 6.2.3: Lenders and borrowers of Isl
amic syndicated financings in % terms in % of Lenders
Other Borrowers 4,7% 2,5% 0,0% 0,0%
35
Western Middle Eastern Malaysian Other Total Borrowers Borrowers Borrowers Borro
wers 337 11.355 2.006 680 14.379 Western Lenders 750 8.753 28 240 9.770 Middle E
astern Lenders 0 167 2.932 0 3.099 Malaysian Lenders 90 1.164 50 0 1.304 Other L
enders 1.177 21.439 5.016 920 28.553 Total Table 6.2.4: Lenders and borrowers of
Islamic syndicated financings in absolute numbers in million-$
In absolute numbers, $11,355 million and $2,006 million of investments in Islami
c syndications by Western financial institutions were absorbed by borrowers in t
he Middle East and Malaysia respectively (Table 6.2.4). Middle Eastern lenders f
ocus almost purely on their region, as 89.6% of their investments in Islamic syn
dications stay in the region. But 7.7% of the funds flow to Western borrowers (T
able 6.2.3). Again in absolute numbers this means that $8,753 million of Islamic
syndications from Middle Eastern lenders have been absorbed by Middle Eastern b
orrowers, while also $750 million have reached borrowers in the West (Table.6.2.
4). Malaysian lenders are also very focused on their home market, as 94.6% of th
e Malaysian funds flow to Malaysian borrowers (Table 6.2.3). But there are also
investments done in the Middle East. 5.4% of the Malaysian investments in Islami
c syndications are absorbed in the Middle East. In absolute numbers these invest
ments total $2,932 million and $167 million for Malaysian and Middle Eastern bor
rowers respectively (Table.6.2.4).Lenders, other than Western, Middle Eastern an
d Malaysian focus their investments on the Middle East. The Middle East absorbs
89.3%, of the total investments in Islamic syndications. And also Western countr
ies absorb 6.9% of the funds of the other lenders (Table 6.2.3). In absolute num
bers these investments have a size of $1,164 million and $90 million for Middle
Eastern and Western borrowers respectively (Table 6.2.4). To sum up these result
s, the Middle East absorbs most Islamic syndicated financings from Western lende
rs and Middle Eastern lenders. Malaysian borrowers receive most of the Islamic s
yndicated financings from Malaysian lenders. But Malaysian borrowers also obtain
a respectable share from Western lenders. Western borrowers receive a respectab
le share of Islamic syndicated financings from Middle Eastern lenders. Other len
ders focus on Middle Eastern borrowers.
36
6.3 Industries towards which Islamic syndicated financings are directed to:
The next descriptive research question investigates the industries which profit
from Islamic Syndicated financings the most. Then, a more detailed look is done
on each of the most important borrowing industries and the distribution among co
untries. But first the industries which profit from Islamic Syndicated financing
s the most are researched.22 As can be seen in chart 6.3.1, the oil and gas sect
or, financial services and telecommunications received the bulk part of about 59
% of all the financings in Islamic syndications.
Chart 6.3.1: Industrial distribution of Islamic syndicated financings
The oil and gas sector alone has received about 27% of all the Islamic syndicate
d funds, the financial services follow with 18% and then telecommunications with
14%. Utilities and construction follow with each 9% of the total investments. G
overnment borrowings constitute another 7%. These results are in line with the r
esults of the borrowers of Islamic syndicated financings, which are to the large
st part situated in the Middle East.
22
A detailed list of the industrial distribution of the investments by syndicated
Islamic financings can be found in Appendix 6.3.0
37
Borrowers in the Middle East have used these financings for typical industries f
or this region, which require large investments, such as oil and gas. But also f
inancings which are required to cope with the economic boom and population growt
h, such as the financial sector, telecommunications, the utility and constructio
n sector, were taken in form of Islamic syndication. In the following part, the
borrowers of the above elaborated main sectors, which profit most from Islamic s
yndicated financings, are examined. These sectors include the oil and gas indust
ry, financial services, telecommunications, utilities, construction and governme
nt. The borrowers are sub-divided into countries where they are based in. The re
search results of the share of the countries, in which the borrowers are based i
n, are listed detailed in tables. Pie charts are used to give emphasis to the mo
st important borrowers. The oil and gas industry is the biggest profiteer of Isl
amic syndicated financings with about $7.7bn of total investments. Especially th
e energy rich Persian Gulf nations, Saudi Arabia, United Arab Emirates and Kuwai
t use Islamic syndications to finance their oil and gas industries (Chart 6.3.2)
.
Islamic Syndicated Financings in Oil and Gas
0% 1% 7% 4% 4% Saudi Arabia 38% United Arab Emirates Kuwait Malaysia Bahrain 20%
Indonesia Pakistan Iran 26%
Chart 6.3.2: Distribution of Islamic syndicated financings in the oil and gas se
ctor by borrowing country
38
Their share constitutes already about 84% of all the Islamic syndicated investme
nts in the oil and gas sector. Other important borrowers in the oil and gas sect
or come from Malaysia (7%), Bahrain (4%) and Indonesia (4%).
Oil and Gas Amount of Investments ($) Percentage of Total Saudi Arabia 2.913.200
.000 37,89% United Arab Emirates 2.000.000.000 26,01% Kuwait 1.500.000.000 19,51
% Malaysia 524.500.000 6,82% Bahrain 330.000.000 4,29% Indonesia 322.000.000 4,1
9% Pakistan 75.000.000 0,98% Iran 23.730.252 0,31% Total 7.688.430.252 100,00% T
able 6.3.2: Borrowers of Islamic syndicated financings for the oil and gas secto
r
The second biggest profiteer of Islamic syndicated financings with more than $5.
2bn of the total investments is the financial services sector. The most importan
t borrowers of Islamic syndicates, working in the financial sector, are all plac
ed in the Middle East (Chart 6.3.3).
Chart 6.3.3: Distribution of Islamic syndications in the financial services sect
or by borrowing country
39
The borrowers are placed in Iran (34%), Kuwait (23%), Bahrain (14%) and Saudi Ar
abia (11%) according to the share of the syndicate investments in relation to th
e total investment in this industry sector.
Financial Services Amount of Investments ($) Percentage of Total 1.777.082.652 3
3,98% Iran 1.225.000.000 23,42% Kuwait 735.167.800 14,06% Bahrain 584.000.000 11
,17% Saudi Arabia 250.000.000 4,78% Kazakhstan 210.526.319 4,03% Malaysia 180.50
0.000 3,45% Turkey 100.000.000 1,91% Italy 85.000.000 1,63% Singapore 63.000.000
1,20% United Kingdom 20.000.000 0,38% United Arab Emirates 5.230.276.771 100,00
% Total Table 6.3.3: Borrowers of Islamic syndicated financings for financial se
rvices
The third biggest borrower of Islamic syndicated financings with more than $4.1b
n of total investments is the telecommunications sector. Here the borrowers in t
he kingdom of Saudi Arabia are the most important borrowers and absorb 57% of al
l Islamic syndicated investments in the telecommunications sector (Chart 6.3.4).
The Netherlands is the second biggest profiteer of Islamic syndicated financing
in the telecommunications sector. With $750 million in investments or a share o
f about 18%, the telecommunication sector shows how Islamic financings can be us
ed in predominantly non-Muslim Western states as well. Kuwait receives the same
size of Islamic syndicated financings of 18% for the telecommunications sector,
like the Netherlands.
40
Chart 6.3.4: Distribution of Islamic syndications in the telecommunications sect
or by borrowing country
Other benefiters of Islamic syndicated financings in the telecommunications sect
or are Malaysia and Turkey, with a share of 4% and 2% respectively. In total num
bers, these amounts to $171 million and $100 million of investments for Malaysia
and Turkey (Table 6.3.4).
Telecommunications Amount of Investments ($) Percentage of Total 2.350.000.000 5
7,02% Saudi Arabia 750.000.000 18,20% Netherlands 750.000.000 18,20% Kuwait 171.
052.632 4,15% Malaysia 100.000.000 2,43% Turkey 4.121.052.632 100,00% Total Tabl
e 6.3.4: Borrowers of Islamic syndicated financings for the telecommunications s
ector
Another important borrower of Islamic syndicated financings with about $2.6bn of
total investments is the utilities sector. The borrowers in the United Arab Emi
rates are the biggest receivers of Islamic syndicated financings in the utilitie
s sector with the absorption of about 80% of all the investments of this sector
(Chart 6.3.5). Malaysia is the second biggest borrower, with a share of 10%. Sau
di Arabia and Pakistan follow with 8% and 2% respectively. 41
Islamic Syndicated Financings in Utilities
8% 10%
2%
United Arab Emirates Malaysia Saudi Arabia Pakistan
80%
Chart 6.3.5: Distribution of Islamic syndicated financings in the utilities sect
or by borrowing country
In absolute numbers, borrowers from the United Arab Emirates exhibit $2.04bn of
Islamic syndicated financings in the utilities sector (Table 6.3.5). Malaysia an
d Saudi Arabia follow with $245 million and $210 million. Borrowers from Pakista
n have received more than $61 million of Islamic syndicated financings for the u
tilities sector.
Utilities United Arab Emirates Malaysia Saudi Arabia Pakistan Total
Amount of Investments ($) 2.040.000.000 244.769.049 210.000.000 61.319.766 2.556
.088.815
Percentage of Total 79,81% 9,58% 8,22% 2,40% 100,00%
Table 6.3.5: Borrowers of Islamic syndicated financings for the utilities sector
The next important borrower of Islamic syndicated financings with about $2.5bn o
f the total investments is the construction sector. In this sector, Malaysian bo
rrowers are the stunning majority, with a share of close to 96% (Chart 6.3.6). T
urkey and France follow with a share of 2% each.
42
Chart 6.3.6: Distribution of Islamic syndicated financings in the construction s
ector by borrowing country
The absolute total amount of Islamic syndicated financings for the construction
sector totals $2.38bn for Malaysia. The financing amount totals $62 million and
$54 million for Turkey and France respectively (Table 6.3.6).
Construction Amount of Investments ($) Percentage of Total 2.379.522.670 95,34%
Malaysia 62.000.000 2,48% Turkey 54.300.400 2,18% France 2.495.823.070 100,00% T
otal Table 6.3.6: Borrowers of Islamic syndicated financings for the constructio
n sector
Other important borrowers of Islamic syndicated financings with more than $2bn o
f the total investments are governments. The United Arab Emirates enjoys the lar
gest chunk of these financings, with a share of 49% (Chart 6.3.7). Iran follows
with a share of 25% and then Turkey and Pakistan with 16% and 10% respectively.
43
Islam ic Syndicated Financings in Governm ent
10% 16% 49% United Arab Emirates Iran Turkey Pakistan 25%
Chart 6.3.7: Distribution of Islamic syndicated financings received by governmen
ts by borrowing country
In total absolute amounts, the United Arab Emirates has received $1bn of Islamic
syndicated financings. Iran follows with $500 million. And the governments of T
urkey and Pakistan have received $332.5 million and $200 million in Islamic synd
icated financings respectively.
Government Amount of Investments ($) Percentage of Total 1.000.000.000 49,20% Un
ited Arab Emirates 500.000.000 24,60% Iran 332.500.000 16,36% Turkey 200.000.000
9,84% Pakistan 2.032.500.000 100,00% Total Table 6.3.7: Governments as borrower
s of Islamic syndicated financings
6.3.1 Changes of Islamic syndicated deals for different industries over time:
In the following paragraph, the research results for changes in the Islamic synd
icated financing deals for major industry groups are depicted (Graph 6.3.1).23 G
enerally, the number of syndication deals that include Islamic tranches is very
volatile. It is also very noticeable that the Islamic syndicated financings have
begun in the middle of the 90s and
23
A detailed list of the changes of the industrial distribution over time, of the
investments by syndicated Islamic financings can be found in Appendix 6.3.1
44
that there is a general increase in the deal counts over the years, except for t
he year 2003. Remarkable is the surge in the Islamic syndicated financing deals
in the construction sector in the time period between 2003 and 2005. The financi
al services sector has especially profited from Islamic syndication deals in the
time period between 1999 and 2002. And compared to 2005, the financial services
sector has seen high growth in Islamic syndication deals for this sector again
in 2006. The utilities sector has seen the highest number of deals in 2001. The
transportation sector was most successful between 2000 and 2002 to attract Islam
ic syndicated financings. The oil and gas sector has seen growth in the absorpti
on of Islamic syndication deals since 2004.
Graph 6.3.1: Industrial distribution of Islamic syndications over time
45
6.4 Shares of lead banks: Islamic syndications vs. conventional syndications:
In case of more intense information asymmetries and to mitigate agency problems
for Islamic syndicated financings, lead banks are expected to hold a larger shar
e of the syndicated financing. This enforces more intensive monitoring and due d
iligence of the borrower. Furthermore, do lead banks hold larger shares if there
is a cultural gap between lenders and borrowers. But do lead banks hold larger
shares of Islamic syndicated financings than for conventional syndicated loans,
to confront the expected larger agency problems and information asymmetries?
Participation Numer of Average Median Minimum Maximum of Lead Banks observations
52% 0% 100% Islamic 55% 68 50% 0% 100% Non-Islamic 56% 22.944 Table.6.4: Averag
e and Median share of lead banks at Islamic and Non-Islamic Syndicated loans
As can be seen in table 6.4, the average shares of lead banks at Islamic and Non
-Islamic syndications are almost the same. The share of lead banks at Islamic sy
ndications is on average about 55% of the syndicated financings, while the share
of lead banks at nonIslamic syndications is about 56%. And there is also not a
large difference between the median numbers. Islamic as well as non-Islamic deal
s have very different deal structures in regard to the participation of lead ban
ks, as the minimum and maximum numbers show. This hints that the share of lead b
anks might be increased in case the borrower is perceived as more risky. But the
results show that the share of the lead banks is not increased to lessen inform
ation asymmetries and agency problems specifically for Islamic syndicated financ
ings. But there are other contracting tools, which might be used in order to les
sen agency problems perceived with Islamic financial instruments. Such an instru
ment is the maturity of the Islamic syndicated financings, which is explored in
the following paragraph.
46
6.5 Maturities of Islamic syndicated financings versus conventional syndications
:
Comparing the maturities of Islamic and conventional syndicated loans, the matur
ities, as can be seen in table 6.5.1 show certainly differences. On average Isla
mic syndicated financings do have a maturity of 5.35 years compared to 4.44 year
s for conventional syndications. Thus on the first sight, this would mean that t
he maturity is not used as a contracting tool against probable agency problems a
nd information asymmetries of Islamic syndicated financings.
Average Median Number of Observations Maturity (Years) 5,35 5,00 143 Islamic 4,4
4 4,50 94.318 Conventional Table 6.5.1: Maturity of Islamic and conventional syn
dications
But the maturity needs a more differentiated analysis. In graph 6.5.1, the matur
ities of all Islamic and conventional syndication deals are depicted in the perc
entage of all respective deals per year. And indeed, more Islamic syndicated loa
ns have a shorter maturity than their conventional counterparts in the first thr
ee years. This is especially true for the part of the loans with a maturity of 1
– 2 years. While 14% of the Islamic syndications have a maturity of 1-2 years, on
ly 7% of the conventional syndications exhibit a maturity of 1-2 years (Table 6.
5.2).
Maturity: Islamic vs Conventional Syndications
% of All Islamic or Conventional Syndications
35% 30% 25% 20% 15% 10% 5% 0%
<= 1 1-2 2-3 3-5 5-7 7-9 9 - 11 11 - 13 13 - 15 >= 15
Non-Islamic Syndications Islamic Syndications
Years
Graph 6.5.1: Maturity of Islamic and conventional syndication deals in % of all
deals per year
47
But more conventional syndications exhibit maturities higher than three years th
an Islamic syndications. This gap holds for the syndicated loans with maturities
up to nine years (Graph 6.5.1). Accordingly more Islamic syndicated financing d
eals have maturities lower than three years or higher than nine years, compared
to conventional syndications. A lower loan maturity is an important tool against
agency problems. This means that the maturity might be used to lessen the agenc
y conflicts of Islamic syndicated financings, as there are more Islamic syndicat
ion deals which have a lower maturity in the first three years. Other reasons mi
ght be the preference to finance shortterm investments due to the regulations of
Islamic financial systems or the practice of Islamic financial institutions (Ra
jesh, Amos, Tarik, 2000). Another explanation could be the differences between t
he industries which receive the financings, which might enforce different maturi
ties between Islamic and non-Islamic syndicated financings. So the industries wh
ich receive the Islamic syndications might explain the larger amount of deals wi
th lower maturities in the first three years compared to conventional syndicatio
ns in the same time period. But as it is researched in paragraph 6.3, Islamic sy
ndications are mostly invested in industries which exhibit larger investment nee
ds and have usually more long-term financing requirements, such as the oil and g
as industry, telecommunications or the utilities sector. This explains also why
there are also more Islamic syndicated financing deals which exhibit maturities
higher than nine years (Table 6.5.2). While about 5% of all conventional syndica
tions have maturities longer than nine years, about 18% of all Islamic syndicati
ons have a maturity of more than nine years.
Non-Islamic Syndications Islamic Syndications 19% Maturity <= 1 Year 17% Maturit
y <= 1 Year 7% Maturity 1 - 2 Years 14% Maturity 1 - 2 Years 16% Maturity 2 - 3
Years 15% Maturity 2 - 3 Years 31% Maturity 3 - 5 Years 20% Maturity 3 - 5 Years
17% Maturity 5 - 7 Years 9% Maturity 5 - 7 Years 5% Maturity 7 - 9 Years 6% Mat
urity 7 - 9 Years 2% Maturity 9 - 11 Years 6% Maturity 9 - 11 Years 1% Maturity
11 - 13 Years 7% Maturity 11 - 13 Years 1% Maturity 13 - 15 Years 2% Maturity 13
- 15 Years 1% Maturity >= 15 Years 3% Maturity >= 15 Years Table 6.5.2: Maturit
ies of Islamic and Conventional Syndications in %
48
And as the Islamic syndicated financings for these large projects are mostly for
stateowned enterprises, the higher perceived agency conflict for Islamic syndic
ated financings diminishes, as the state acts as a kind of guarantor.
6.6 Financial debt covenants: Islamic syndications vs. conventional syndications
:
Loan covenants are important measures of the agency problem and the perceived as
ymmetric information. Interestingly, the results show that only 7% of Islamic
syndicated financings exhibit financial debt covenants, compared to 31% of conve
ntional syndicated loans (Table 6.6).
Number of Observations Debt Covenants Yes No 175 Islamic 7% 93% 111.768 Conventi
onal 31% 69% Table 6.6: Percentage of deals with or without financial debt coven
ants
This is the opposite of the result expected, as Islamic financing involves risk
sharing. Therefore it is clear that financial debt covenants are not used as a t
ool against information asymmetries and agency problems.
6.7 Participating banks: Islamic syndications vs. conventional syndications:
Another mean to reduce information asymmetry, is to concentrate the number of th
e lenders in the syndicate, to be better able to monitor the borrower.
Number of Lenders Average Median Number of Observations 175 Islamic 6,78 5,00 11
0.588 Conventional 6,81 4,00 Table 6.7: Number of lenders in Islamic and convent
ional syndications
49
As can be seen in table 6.7, this tool is also not used more predominantly for I
slamic syndicated financings. The average number of lenders in Islamic and conve
ntional syndications is just marginally different. The average number of lenders
in an Islamic syndicate is 6.78, while it is 6.81 for conventional syndicated l
oans. The median number of lenders is even higher for Islamic syndications, with
an average of 5 lenders, while conventional syndicated loans exhibit a median n
umber of 4 lenders.
6.8 Deal Size: Islamic syndications vs. conventional syndications:
The effects of agency problems and information asymmetries can also be limited,
by limiting the size of the Islamic syndicated financing. And indeed, the size o
f conventional syndicated loans is on average 36.6% larger than the average Isla
mic syndicated financing deal size. And also the median deal size is significant
ly lower for Islamic financings than for their conventional counterparts. Theref
ore, these results might hint, that the limitation of the deal size is a tool to
limit information asymmetries and agency problems. And this result might not be
due to the industries in which the financings flow in. As seen in paragraph 6.3
, Islamic syndicated financings are to the largest part invested in capital-inte
nsive industries, such as oil and gas industries, telecommunication and utilitie
s. Furthermore, the reason cannot be due to Islamic financial institutions which
do not have the capabilities for larger financings. As seen in paragraph 6.2, W
estern lenders and cash-rich Middle Eastern lenders constitute the overwhelming
majority of Islamic syndicated financings.
Average Median Number of Observations Deal Size (in $) 168 Islamic 169.957.411 6
1.659.883 111.069 Conventional 232.189.860 77.848.549 Table 6.8: The average and
median deal size of Islamic and conventional syndications
50
6.9 Differences in the Spread
Agency problems have a larger effect on the syndicated loan contract, the more t
hese problems are perceived. The difference in the risk pattern of Islamic syndi
cations could yield different agency problems. Islamic syndicated financings cou
ld face agency problems because some agency mitigating techniques might have con
flicts with the Shariah law. Cultural differences between borrowers and lenders
can increase the perceived risk. And the higher the actual or perceived risk of
the agency problems, the higher the loan spread. Also a piety premium could lead
to a higher loan spread. The OLS regression model, with determinants of loan pr
icing for Islamic and non-Islamic loans in Malaysia, is built to find out whethe
r Islamic syndicated financings are more expensive than conventional syndication
s, as explained in paragraph 4. Furthermore it is researched whether specific at
tributes of Islamic and non-Islamic syndicated loans influence credit spreads. A
t first, one dummy variable states whether a syndicated deal is Islamic or conve
ntional. Then determinants of the loan pricing are added as dummy variables as w
ell. As stated in paragraph 5.3, determinants of the loan pricing in the statist
ical model are based on borrower characteristics, contract characteristics and t
he characteristics of the syndicate structure. It is decided to include only tho
se variables as determinants of the loan pricing, which have shown differences f
or Islamic and conventional syndications in the descriptive statistics, as these
variables which show up differences are probably active tools to lessen agency
conflicts. The credit ratings of the Malaysian borrowers are taken as the determ
inant for borrower characteristics. In order to accomplish this, dummy variables
are created, indicating the credit ratings, namely “AAA”, “AA”, “A”, “BBB”, or “BB and bel
any borrowers do not have a rating, a dummy variable would indicate that the spe
cific borrower is not rated. For the contract characteristics, the maturity, the
deal size and the existence or not-existence of financial covenants are include
d, as these were found out to be different for Islamic syndicated financings. In
case of the maturity and the deal size, the dummy variables hint whether a synd
icated deal is bigger or equal to the median size of Islamic or conventional syn
dications, depending whether the deal is Islamic or conventional. For the charac
teristics of the syndicate structure, the size of the lead banks share and the n
umber
51
of participating were found out to be not different for Islamic syndications tha
n for conventional syndications. But the differences of the origin of the lendin
g banks are taken as dummy variables for the syndicate structure. The dummy vari
ables include whether a lending bank is Western, Middle Eastern, Malaysian or Ea
st Asian. As dependent variable for this model, the all-in spread for the deals
is taken. The all-in spread is given for most of the syndications in the LoanAna
lytics database. Those deals which had no spread given were excluded from the mo
del. The sample for the regression model finally includes a total of 420 Islamic
and non-Islamic syndicated loan deals with Malaysian borrowers. Of these, 32 sy
ndications are Islamic financings, which constitute 56% of all Islamic syndicate
d financings for Malaysian borrowers. Obviously it is impossible to include all
the variables in the OLS regression equation, as this would create a nearsingula
r matrix. In the regression, one of the variables is left out. At random, the du
mmy variable “BB and below” is left out. The first regression results can be seen in
table 6.9.1. There is a trend visible for the borrower characteristics, as the
rating coefficients have a decreasing trend, the higher the credit rating. Howev
er, the t-statistics indicate that the variables selected so far are not all ver
y significant on their own. For the contract characteristics, the “Deal Size” is sig
nificant, which means that if the syndicated deal has a larger deal amount than
the median deal size of all Malaysian syndications, the spread would decrease by
0,38%. For the syndicate structure, the variable “Conventional” is highly significa
nt. This means that the model predicts that conventional syndicated loans have a
1.46% lower spread than Islamic syndicated financings. Furthermore, in case the
lending bank is Malaysian, the spread significantly increases by 0.5%. But if t
he lending bank is East Asian, the spread significantly decreases by 0.33%.
52
Coeff. t-stat Borrower Characteristics: Rating: AAA Rating: AA Rating: A Rating:
BBB Not Rated Contract Characteristics: Maturity Deal Size Financial Covenants
Syndicate Structure: Conventional Lending bank Western Lending bank Middle Easte
rn Lending bank Malaysian Lending bank East Asian Observations R-squared
*** Indicates p value of 1% ** Indicates p value of 5% * Indicates p value of 10
%
-0,65 -0,33 -0,47 -0,36 -0,19
-2,51 -1,30 -1,92 -1,39 -0,83
** *
0,03 -0,38 -0,03
0,24 -3,16 -0,22
**
-1,46 0,02 -0,44 0,50 -0,33
-6,68 0,17 -0,54 3,68 -2,62 420 0,25
***
*** ***
Table 6.9.1: First regression results
But there are also many variables in table 6.9.1, which seem not to be significa
nt. To improve the model, those variables are iteratively removed from the model
. Thus in order to improve the model, the variable with the highest p-value is d
eleted as the chance of this variable to be not significant is very high. Then t
he regression is run again and then the variable with the highest p-value is rem
oved again. This procedure is done till all remaining variables are significant.
This leads to the removal of “Lending bank Western”, “Maturity”, “Financial Covenant”, “Le
ng bank Middle Eastern”, “Not rated”, “Rating: AA”, “Rating: BBB”, “Rating A”. Table 6.9.2
he regression results after the removal of the last insignificant variable.
53
Coeff. t-stat Borrower Characteristics: Rating: AAA Contract Characteristics: De
al Size Syndicate Structure: Conventional Lending bank Malaysian Lending bank Ea
st Asian Observations R-squared
*** Indicates p value of 1% ** Indicates p value of 5% * Indicates p value of 10
%
-0,35
-1,96
*
-0,41
-3,60
***
-1,41 0,51 -0,35
-6,68 4,36 -3,08 420 0,24
*** *** ***
Table 6.9.2: Final regression results
In table 6.9.2, all variables, except for “Rating: AAA” are significant at a 1% sign
ificance level. The variable of the borrower characteristic “Rating: AAA” predicts t
hat a Malaysian syndicated borrower with AAA-rating is expected to pay 0.35% les
s spread than if it would not have the AAA-rating. This is in line with common s
ense, as less risky borrowers have to pay lower risk compensation. The remaining
variable “Deal Size” means that if the Islamic or conventional syndicated deal has
a larger deal amount than the median deal size of all Islamic or conventional Ma
laysian syndications respectively, the spread would decrease by 0.41%. The reaso
n might be that larger syndicated financings are assured by more credible compan
ies, which might be even state owned. Large industries, such as oil and gas, tel
ecommunications or utilities are not very unlikely to be government owned or ver
y large and therefore more credible for the lenders. For the syndicate structure
, there are three significant variables in the regression results. Based on the
coefficients of the variable “Conventional”, the model predicts that conventional sy
ndicated loans have a 1.41% lower spread than Islamic syndicated financings. Thi
s might confirm that Islamic syndicated financings face a piety premium. Especia
lly, as not all tools to lessen information asymmetries and agency problems are
used, such as to increase the share of lead banks, to include financial debt cov
enants or to reduce the number of lending institutions, this indicates that the
piety premium might be the reason
54
for the higher spread. Another reason might be a higher perceived agency problem
for Islamic syndicated financings, which would even not be reduced by introduci
ng further tools to limit its effect, and which yields therefore a higher spread
. Another interesting finding is that the variable “Lending bank East Asian” has a n
egative effect on the spread. As soon as the lending bank is East Asian, the mod
el predicts that the spread is 0.35% lower than if the lending bank is not East
Asian. Furthermore, the last variable, namely the variable “Lending bank Malaysian”
is positive at 0.51%. Thus when the lending bank is Malaysian, the interest rate
is expected to be 0.51% higher, than in the case when the lending bank is not M
alaysian. These findings are in opposite of the arguments of Giannetti and Yafeh
(2009), who find that loan spreads are lower, if borrowers and lenders are cult
urally closer.
55
7 Conclusion and Limitations:
Islamic syndicated financings have seen a surge since their appearance in the mi
d 90s and constituted more than $28.55bn of financings worldwide in the time per
iod of 2005 till October 2006. The aim of this paper is to find out differences
between Islamic syndicated financings and conventional syndicated loans. Further
more, the research results hint by how far Islamic syndications are affected by
the agency problem. The research was conducted in two parts. First, descriptive
research was carried out to find differences in the contract characteristics and
syndicate structure of Islamic syndicated financings and conventional syndicate
d loans. Then a regression analysis on the loan spreads of Malaysian syndicated
borrowers was conducted to find out whether Islamic syndicated financings have a
higher spread, or in other words, if they are more expensive than conventional
syndications. Furthermore, determinants of the loan pricing were added to the re
gression model to research their effects on the credit spread. The determinants
of the loan pricing in the regression model are based on borrower characteristic
s, contract characteristics and the characteristics of the syndicate structure.
Only those variables are included as determinants of the loan pricing, which hav
e shown differences for Islamic and conventional syndications in the descriptive
statistics researched before, because these variables which show up differences
are most likely active tools to lessen agency conflicts For the descriptive res
earch, first borrowers and lenders were researched. It is confirmed in this rese
arch that Muslim borrowers are the main benefiters of Islamic syndicated financi
ngs. But also Western borrowers received Islamic syndicated financings, a tool t
o attract investments from Islamic investors. 75 % of all Islamic syndicated fin
ancings were received by borrowers that are located in the Middle East. Malaysia
n borrowers follow with 18%. Western borrowers have a share of 4%. On the lender
s side, the West uses its banking experience and the attractive markets, especia
lly in the Middle East, and contributes 50% of all Islamic syndicated financings
. Middle Eastern lenders have provided 34% of the funds. But these funds are to
the largest part lent to Middle Eastern borrowers. The share of Malaysian lender
s is at 11%. And also Malaysian lenders lent almost all of their funds to Malays
ian borrowers of Islamic syndicated financings.
56
Furthermore the industries which receive these financings are researched. Islami
c syndications are mostly invested in industries, which are typical high-growth
or cash-rich industries of its lenders, such as the oil and gas industry, teleco
mmunications, financial services, or the utilities sector. To continue with the
descriptive research, differences in the syndicate structure were researched. Fi
rst differences of the share size of Islamic and conventional syndications are i
nvestigated. The results show that the share of lead banks at Islamic syndicatio
ns is on average about 55% of the syndicated financings, while the share of lead
banks at nonIslamic syndications is about 56%. As the minimum and maximum numbe
rs show that Islamic and conventional syndications can have very different deal
structures in regard to the participation of lead banks, this hints that the sha
re of lead banks might be increased in case the borrower is perceived as more ri
sky. But the results show that the share of the lead banks is not increased to l
essen information asymmetries and agency problems specifically for Islamic syndi
cated financings. Another factor for the syndicate structure is the concentratio
n of the number of lenders in the syndicate. And also this tool to better monito
r the borrower to lessen agency problems is not used more predominantly by Islam
ic syndicated financings. Next the differences in the contract characteristics w
ere researched as well. One factor of contract characteristics is the maturity.
The research results show that more Islamic syndicated financing deals have matu
rities lower than three years or higher than nine years, compared to conventiona
l syndications. A lower loan maturity is an important tool against agency proble
ms. Therefore the results suggest that the maturity might be used to lessen the
agency conflicts more often for Islamic syndicated financings than for conventio
nal syndicated loans. But also other reasons such as regulatory factors for Isla
mic syndicated loans might explain the higher percentage of Islamic syndicated f
inancings that have a maturity of up to three years. The higher percentage of Is
lamic syndicated financings with maturities above nine years can be explained by
the industries in which Islamic syndicated financings are sourced to. Large ind
ustries in the gas and oil industry or the utilities sector require longer matur
ities. Agency problems, due to the higher maturity for these financings, are les
sened by the fact that the borrowing companies are often large, therefore more c
redible and many times even state owned.
57
Another factor for contract characteristics is the limitation of the size of the
syndication deals. The effects of agency problems and information asymmetries c
an be reduced, by limiting the size of the Islamic syndicated financing. The res
earch results show that the size of conventional syndicated loans is on average
36.6% larger than the average Islamic syndicated financing deal size. While the
size of an average Islamic syndicated financing is about $170 million, it is abo
ut $232 million for conventional syndicated loans. The research results of the r
egression analysis on the loan spreads of Malaysian syndicated borrowers signifi
cantly show that conventional syndicated loans have a 1.41% lower spread than Is
lamic syndicated financings. This might confirm that Islamic syndicated financin
gs face a piety premium. Especially, as not all tools to lessen information asym
metries and agency problems are used, such as to increase the share of lead bank
s, to include financial debt covenants or to reduce the number of lending instit
utions, this indicates that the piety premium might be the reason for the higher
spread. Furthermore the variable “Credit rating: AAA” for the borrower characterist
ics predicts that a Malaysian syndicated borrower with AAA-rating is expected to
pay 0.35% less spread than if it would not have the AAA-rating. Another signifi
cant variable is the variable “Deal Size” which shows that in case the Islamic or co
nventional syndicated deal has a larger deal amount than the median deal size of
all Islamic or conventional Malaysian syndications respectively, the spread wou
ld decrease by 0.41%. The reason for this result might be again that larger deal
s are predominantly done with larger and therefore more credible borrowing compa
nies. Another interesting finding is that the variable “Lending bank East Asian” has
a negative effect on the spread. As soon as the lending bank is East Asian, the
model predicts that the spread is 0.35% lower than if the lending bank is not E
ast Asian. In addition, the variable “Lending bank Malaysian” is positive at 0.51%.
Thus when the lending bank is Malaysian, the interest rate is expected to be 0.5
1% higher, than in the case when the lending bank is not Malaysian. These findin
gs oppose the findings of Giannetti and Yafeh (2009), that loan spreads are lowe
r, if borrowers and lenders are culturally closer. It has to be cautioned that t
he data on Islamic financing, and more precisely Islamic syndicated financings,
are still scarce. The research results of the regression analysis should be caut
ioned to be true for all Islamic syndicated financings worldwide, as it
58
contained only 32 Islamic syndicated financing deals with Malaysian borrowers. B
ut for Malaysia, the regression results are significant and entail 56% of all Is
lamic syndicated financings. But taking all these results together, one can say
that Islamic syndicated financings are only slightly different than conventional
syndicated loans. For sure the ethical and religious specificities of Islamic s
yndicated financings play an important role and may attract specific investors o
r lead to new opportunities for Western banks to conduct business in the Islamic
world. But in regard to the structure and contract specificities of Islamic syn
dicated financings, one can say that there are only minor differences. Some agen
cy mitigating tools might be used for Islamic syndicated financings, but many to
ols are not used. Therefore one can say that Islamic syndicated loans do not suf
fer immensely more from the agency problem than conventional syndicated loans. T
he higher spread costs for Islamic syndicated financings in Malaysia can be ther
efore regarded more as a piety premium. As a research suggestion, it would be in
teresting to find out what the effects of the credit crisis were on Islamic synd
icated financings and specifically on its spread. This might give new insights b
y how far Islamic borrowers are indirectly affected by the credit crisis, as Isl
amic financial institutions did not suffer from the international crisis directl
y (Wigglesworth, 2009).
59
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Appendix:
Industry Agriculture Automotive Beverage, Food, and Tobacco Processing Business
Services Chemicals, Plastics & Rubber Manufacturing Construction Financial Servi
ces General Manufacturing Government Hotel & Gaming N/A Oil and Gas Real Estate
Retail & Supermarkets Technology Telecommunications Transportation Utilities Who
lesale Total Appendix 6.3.0
Industry Tranche Amounts / Total Tranche Amount 2,50% 0,28% 0,35% 0,54% 1,95% 8,
67% 18,18% 2,53% 7,06% 0,22% 2,00% 26,72% 1,50% 0,27% 0,16% 14,32% 2,84% 8,88% 1
,02% 100,00%
65
Changes of Islamic syndicated financings in different industries over time Agric
ulture Automotive Beverage, Food, and Tobacco Processing Business Services Chemi
cals, Plastics & Rubber Manufacturing Construction Financial Services General Ma
nufacturing Government Hotel & Gaming N/A Oil and Gas Real Estate Retail & Super
markets Technology Telecommunications Transportation Utilities Wholesale Total A
ppendix 6.3.1
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 0 0 0 0 0 0 0 0 2 0
0 0 0 0 0 0 0 0 0 2 0 0 0 0 0 3 0 2 0 0 2 2 0 0 0 0 0 0 0 9 1 0 0 0 0 0 0 0 2 0
3 0 0 0 0 0 0 0 2 8 0 0 0 0 0 0 0 0 0 0 4 2 0 0 0 0 0 1 0 7 2 2 0 0 0 6 6 0 0 0
3 2 2 0 0 0 0 0 2 25 2 0 0 0 0 4 4 0 0 0 0 0 0 0 0 0 3 0 1 14 2 0 0 0 0 3 3 0 0
0 0 0 0 0 1 0 2 4 1 16 0 0 1 0 0 1 7 0 1 0 1 2 1 0 0 1 2 3 2 22 0 0 0 1 0 0 0 0
0 0 0 0 0 2 0 0 1 1 0 5 0 0 0 0 0 5 3 1 0 0 0 3 1 0 0 3 1 1 1 19 1 0 0 0 0 16 0
2 0 1 2 3 0 0 0 0 0 0 0 25 0 0 1 1 2 0 7 2 1 0 0 6 0 0 0 2 0 1 0 23
66