Note that WestLB, one of the Ger­man state-owned Lan­des­banks, is in the midst of a major restruc­tur­ing, in keep­ing with the wave of merg­ers in the Lan­des­bank land­scape since 2007:

Doesn’t look like WestLB is under pres­sure to offload assets
Inter­na­tional financ­ing review
16 Feb­ru­ary 2012 | By Keith Mullin, Cap­i­tal City

Is WestLB’s restruc­tur­ing in good shape? I pose the ques­tion because even though the bank has opted to break up its busi­nesses into bite-sized units to max­imise sales poten­tial, it doesn’t seem to be that keen to deal.

...

What’s inter­est­ing about the WestLB restruc­tur­ing in a broader indus­try con­text is the spec­u­la­tion it kicked off about whether it would lead to fur­ther Lan­des­bank con­sol­i­da­tion. On that, I’m not so sure. In an extremely con­vo­luted takeover struc­ture, WestLB rival Helaba (Lan­des­bank Hessen-Thuringen) is acquir­ing between €40bn and €45bn of WestLB assets as a pre-arranged com­po­nent of the restruc­tur­ing plan, along with around 400 staff. This so-called Ver­bund­bank trans­fer takes effect on July 1. I think it’s clear that Helaba will prob­a­bly also end up acquir­ing SPM-Bank from the State of North Rhine-Westphalia, with most of the 1,000 legacy employees.

That leaves a rel­a­tively neat group of just six Lan­des­bank groups. Fol­low­ing a series of merg­ers in past years, the remain­ing LBs are Bay­erische Lan­des­bank (Bay­ernLB, which owns 49.9% of Lan­des­bank Saar); HSH Nord­bank (cre­ated out of merg­ers with Ham­bur­gis­che Lan­des­bank and Lan­des­bank Schleswig-Holstein); Lan­des­bank Baden-Wuerttemberg (LBBW, incor­po­rat­ing Baden-Wuerttembergische Bank, Sach­sen Bank and Rheinland-Pfalz Bank); NordLB (which owns 92.5% of Bre­mer Lan­des­bank); Lan­des­bank Berlin; and Lan­des­bank Hessen-Thuringen (Helaba, incor­po­rat­ing some/all of legacy WestLB). That’s a hell of a lot neater than in pre­vi­ous years. Now I’m no Lan­des­bank spe­cial­ist, but how much room in prac­tice does that leave for more con­sol­i­da­tion? I’m in the process of try­ing to find out. Watch this space.

...

Keep in mind that this lat­est wave of Lan­des­bank con­sol­i­da­tion was pre­ceded by decades of some­times aggres­sive over­seas invest­ments by the state-backed Lan­des­banks and Ger­man insur­ers, but that state back­ing was phased out start­ing in 2005(the state sup­port, it was argued, gave the Lan­des­banks an unfair com­pet­i­tive advan­tage). Iron­i­cally, the loss of state back­ing for debts issued sud­denly made the banks even more profit hun­gry in antic­i­pa­tion of the loss of state-backing:

Lan­des­banks and life insur­ers counter credit critiques

Orig­i­nal head­line: Credit risk

Risk mag­a­zine | 01 Jul 2003

Con­cerns about Lan­des­banks’ and Ger­man life insur­ers’ credit risk man­age­ment have grown in recent months, fol­low­ing reports from rat­ing agency Fitch Rat­ings ques­tion­ing their expo­sures. But the insti­tu­tions say the crit­ics are wrong.

On the debt syn­di­cate desks of the world’s lead­ing invest­ment banks, the phrase ‘Ger­man insti­tu­tions’ can get pulses rac­ing. Anec­do­tal evi­dence indi­cates that Lan­des­banks and life insur­ers snap up almost every­thing on offer, whether straight cor­po­rate bonds or the most sophis­ti­cated struc­tured prod­uct.

Ear­lier this year, Fitch Rat­ings inves­ti­gated the credit-worthiness of these insti­tu­tions. In reports on the Lan­des­banks and the insur­ance indus­try it focused atten­tion on their credit port­fo­lios and use of credit deriv­a­tives. The reports were poorly received by the insti­tu­tions involved, and many bankers have crit­i­cised the domes­tic media for regur­gi­tat­ing “ground­less non­sense” about Germany’s finan­cial institutions.

...

Helaba is one of the more con­ser­v­a­tive Lan­des­banks. “We are a risk-shy whole­sale bank,” says Andreas Petrie, head of credit prod­ucts at Helaba in Frank­furt. “On a scale of one to 10 we are a two in Ger­many and a three inter­na­tion­ally.” Most of its credit risk comes from the pub­lic sec­tor or the mort­gage mar­kets. It has around 40% of its mort­gage port­fo­lio out­side Ger­many – in the US, the UK, the Nether­lands and the rest of west­ern Europe – and it is a major lender to Germany’s 100 largest cap­i­tal mar­ket clients.

While Helaba is con­ser­v­a­tive, it is by no means atyp­i­cal. Until recently, Lan­des­banks oper­ated largely in the low-margin and low-risk envi­ron­ment of mort­gage assets, public-sector finance and ser­vic­ing the sav­ings bank mar­ket. The cat­a­lyst for a change in Lan­des­banks’ atti­tudes to risk was an agree­ment in July 2001 between the Ger­man author­i­ties and the Euro­pean Com­mis­sion, which removed the state guar­an­tee of Lan­des­banks by July 2005 – and effec­tively down­graded the banks from their cur­rent triple-A level. That action pushed up fund­ing costs, and the banks have been forced to seek ways to increase revenues.

One method – adopted by all the Lan­des­banks – has been to seek out instru­ments with poten­tially higher returns. Chris­t­ian Spieler, head of finan­cial insti­tu­tions deriv­a­tives mar­ket­ing at JP Mor­gan Chase, says there has been a steady – and sen­si­ble – growth in risk appetite among Lan­des­banks. “Most banks were focused on the low-risk end of the mar­ket in the mid-1990s, and started with bonds and then some asset-backed secu­ri­ties (ABS) and other lever­aged credit prod­ucts. Com­ple­ment­ing tra­di­tional oper­a­tions to a cer­tain degree by engag­ing in the inter­na­tional credit mar­kets is a very mean­ing­ful and risk-mitigating strat­egy for Lan­des­banks.” Lan­des­bank Baden-Württemberg, West LB and Lan­des­bank Sach­sen are known to have built up large ABS portfolios.

...

Not sur­pris­ingly, the Lan­des­banks like westLB that were instru­men­tal in fuel­ing euro­zone and US private-sector bor­row­ing binges bub­bles even­tu­ally found them­selves heav­ily invested in in soon-to-implode coun­tries:

The Local
Ice­land cre­ates bank­ing pain in told-you-so Germany

Pub­lished: 26 Oct 08 09:05 CET

Ger­man politi­cians were fast to blame “Anglo-Saxon” excesses for the finan­cial cri­sis but the country’s own banks, par­tic­u­larly state-owned lenders, have been any­thing but risk-averse.

Fig­ures this week from the Bank of Inter­na­tional Set­tle­ments showed that Ger­man banks were by far the most enthu­si­as­tic when it came to lend­ing money to Ice­land, the Nordic island state tee­ter­ing on the brink of finan­cial collapse.

Ice­land owed banks in Europe’s biggest econ­omy over $21 bil­lion (€16.5 bil­lion), almost a third of the island’s total lia­bil­i­ties and far more than any other coun­try, data from the cen­tral bank­ing body showed.

“This was a very sur­pris­ingly high num­ber ... Ice­land only has around 300,000 inhab­i­tants, the same as a town like Wup­per­tal,” said Kon­rad Becker, bank­ing ana­lyst at the pri­vate Merck Finck bank. “And no one is going to lend Wup­per­tal $21 billion.

“Ger­man banks, even state-owned ones, were not exam­ples of a pru­dent, con­ser­v­a­tive way of bank­ing,” Becker told AFP.

The North Atlantic island has been hit hard by the finan­cial cri­sis, with its gov­ern­ment forced to nation­alise its three largest banks and seek emer­gency bailouts from other coun­tries and from the Inter­na­tional Mon­e­tary Fund.

Germany’s loans to Ice­land were five times higher than those of banks in Britain, with regional Ger­man bank BayernLB’s lia­bil­i­ties alone exceed­ing those of all Italy’s main banks com­bined, accord­ing to the Han­dels­blatt daily.

...

And it is not just Ice­land. The data also showed that Ger­man banks have also been at the fore­front of invest­ing in other Euro­pean coun­tries offer­ing high returns — and high risks — most notably in Ire­land and Spain.

Ire­land last month became the first euro­zone mem­ber to be in reces­sion after years of break­neck growth, while the col­lapse of Spain’s once-booming prop­erty mar­ket has left many investors with their fin­gers badly burnt.

Ger­man banks have not yet given much detail but if the regional lender Bay­ernLB is any guide — it has writ­ten off as worth­less €800 mil­lion in loans to Ice­land — this is going to add con­sid­er­ably to the pain already being felt in other areas.

Bay­ernLB, one of Germany’s Lan­des­banks, this week became the first lender to seek help from the government’s €480-billion finan­cial res­cue pack­age. Hamburg-based HSH Nord­bank has since fol­lowed suit, and West LB is expected to take up the offer next week.

...

One of the prime sources of the trou­bles, it turns out, was cause by that some of the Landesbank’s US sub­sidiaries engag­ing in the high-risk prac­tice of short-term bor­row­ing from US munic­i­pal­i­ties and invest­ing the bor­rowed money in sub­prime mort­gage backed secu­ri­ties:

WSJ
April 21, 2010, 7:44 p.m. ET

Ger­man Bank: Vic­tim Or a Con­trib­u­tor?
IKB’s Invest­ments at the Heart of SEC’s Gold­man Probe

BY CARRICK MOLLENKAMP AND LAURA STEVENS

In 2006 and 2007, word spread around Wall Street about an unlikely investor: A little-known Ger­man bank that was will­ing to spend bil­lions of dollars—itself raised from U.S. municipalities—on new and risky credit instruments.

Now, those invest­ments made by IKB Deutsche Indus­triebank AG are cen­tral to the U.S. Secu­ri­ties and Exchange Commission’s case against Gold­man Sachs Group Inc.

In its com­plaint filed last week, the SEC alleged that Gold­man defrauded IKB by neglect­ing to dis­close that hedge-fund oper­a­tor Paul­son & Co. was help­ing to put together a mort­gage invest­ment vehi­cle known as Aba­cus. The SEC alleges that investors, includ­ing IKB,

...

“For a very, very long time the IKB was extremely sta­ble, but also very bor­ing,” said Kon­rad Becker, an ana­lyst with Munich-based pri­vate bank­ing firm Merck Finck & Co.

But by the end of the 1990s, the Duesseldorf-based bank was fac­ing lots of com­pe­ti­tion from other banks chas­ing the Mit­tel­stand sec­tor. It also was fac­ing pres­sure to increase profit—not an easy task when most of its busi­ness had extremely tight mar­gins, accord­ing to analysts.

In an effort to expand beyond Ger­man loans, IKB in 2001 brought in a for­mer State Street Corp. bond exec­u­tive named Dirk Roethig, who worked with an IKB team to dras­ti­cally increase the banks’s credit busi­ness, accord­ing to com­pany finan­cial doc­u­ments of the time.

Between 2002 and early 2007, an IKB unit called IKB Credit Asset Man­age­ment GmbH increased its assets under man­age­ment by nearly eight-fold to $23 bil­lion, accord­ing to finan­cial fil­ings. It did this by first sell­ing its own debt to invest­ment pools favored by U.S. munic­i­pal­i­ties. Those who invested with IKB included the state of Mon­tana, King County, Wash., and the city of Oak­land, Calif.

IKB then took that pot of short-term money and invested in bil­lions of dol­lars of secu­ri­ties backed by sub­prime loans as well as collateralized-debt oblig­a­tions con­tain­ing mort­gage secu­ri­ties. Accord­ing to an IKB annual report, 100% of the assets ini­tially were invest­ment grade.

Most of these deals were placed in IKB’s two big invest­ment vehi­cles: Rhineland Fund­ing Cap­i­tal Corp., founded in 2002, and Rhine­bridge PLC, founded in 2007, accord­ing to finan­cial filings.

IKB proved an avid buyer of much that Wall Street had to offer, includ­ing the Gold­man Aba­cus deal now under gov­ern­ment scrutiny. In 2007, its mar­ket­ing book for Rhineland touted the bank’s “strong record as a lead­ing investor in CDOs.”

Even though it received top rat­ings from the three main credit-ratings firms, Rhine­bridge launched on June 27, 2007, and was in receiver­ship by Octo­ber 2007. King County, Wash., which invested in Rhine­bridge debt as a cash man­ager for 100 other gov­ern­men­tal agen­cies, calls it, “per­haps the shortest-lived ‘Triple-A’ com­pany in the his­tory of cor­po­rate finance,” accord­ing to legal pro­ceed­ings the county has brought against IKB.

...

And yes, the invest­ment vehi­cle described above between IKB and Gold­man Sachs is, indeed, the very same noto­ri­ous “Aba­cus” prod­uct that came to epit­o­mize the fleece-the-sheep cul­ture that’s come to dom­i­nate the finan­cial industry.

So after all these ques­tion­able invest deci­sions led the Lan­des­banks to be amongst the first finan­cial insti­tu­tions to implode in the col­laps­ing hous­ing mar­ket, it’s inter­est­ing to recall that the favorite local to set up a “bad bank” (of junk assets) after the hous­ing col­lapse hap­pened to be Ire­land, a coun­try that was sent into the new euro­zone penalty-box pri­mar­ily because of its under-regulated, over­sized bank­ing sec­tor. While this fun-fact led to some soul search­ing in Dublin, keep in mind that these for­eign banks with dis­tressed assets in Irish sub­sidiaries weren’t get­ting directly bailed out by the Irish pub­lic dur­ing the bailout of the Irish bank­ing sec­tor. Indi­rectly bailed out on the other hand...:

Ire­land wants bank cred­i­tors to bear pain, ECB says no
By SHAWN POGATCHNIK, Asso­ci­ated Press
pdated 04/01/2011 02:17:28 PM

DUBLIN — Ire­land still wants to force for­eign bond­hold­ers to bear losses in debt-crippled banks but is being blocked by the Euro­pean Cen­tral Bank, which has the lenders on life sup­port, Finance Min­is­ter Michael Noo­nan said Friday.

Ireland’s bank-bailout bill offi­cially surged Thurs­day by 24 bil­lion euros to 70.5 bil­lion euros ($100 bil­lion) as part of a new round of ECB-ordered stress tests. Ire­land then unveiled plans to slash its largely nation­al­ized bank­ing sec­tor down to just two: Bank of Ire­land and Allied Irish Banks.

Rat­ings agency Stan­dard & Poor’s the next day said the tests’ assump­tions were robust, that the worst was over, and the econ­omy is now set to recover gradually.

Although it down­graded Ireland’s credit rat­ing by one notch, cit­ing increased risks for bond­hold­ers under new EU rules to come into effect in 2013, it expects the coun­try to recover faster than Greece or Por­tu­gal — Europe’s other two worst debt offenders.

It added it didn’t expect any more down­grades soon, though S&P rival Fitch warned soon after that it may cut its own BBB+ rat­ing on Ire­land soon as it assesses the stress tests and other devel­op­ments since its last down­grade in December.

But as experts digested the test results, the issue of how far to push losses on the banks’ bond­hold­ers remained the focus.

Noo­nan said Ire­land intends to force at least 5 bil­lion euros ($7 bil­lion) in losses on the most junior class of bank bond­hold­ers as part of the bailout bill. That rep­re­sents a small con­ces­sion by the ECB, which had until this week opposed such a move.

But Noo­nan said hopes of forc­ing bil­lions more in losses on senior bond­hold­ers — chiefly British, Ger­man and Amer­i­can banks — were again vetoed by a major­ity of ECB gov­er­nors dur­ing nego­ti­a­tions that ran right up to Thursday’s announcements.

Noo­nan said Ire­land would not act uni­lat­er­ally against the orders of the ECB, which along with the Euro­pean Com­mis­sion has been against forc­ing losses on bond­hold­ers since Ireland’s bank­ing cri­sis erupted in 2008. Euro­pean finan­cial chiefs made pro­tec­tion of senior bond­hold­ers a con­di­tion of its Novem­ber bailout agree­ment with Ireland’s pre­vi­ous gov­ern­ment, which was ousted from office three weeks ago amid voter fury over the terms of the deal.
...

Note that the Irish banks’ creditors/“junior bond­hold­ers” (mostly US, UK and Ger­man banks) were even­tu­ally forced to take a big hair­cut on their bad loans to Irish banks....oh wait never mind....

NYTimes
Bank Bond­hold­ers to Be Paid While Irish Pub­lic Howls
By DOREEN CARVAJAL
Pub­lished: Jan­u­ary 23, 2012

PARIS — Anglo Irish Bank is poised to pay more than a bil­lion euros on Wednes­day to unse­cured cred­i­tors, draw­ing crit­i­cism from Irish tax­pay­ers who are pay­ing the enor­mous bill for the country’s bank bailout.

The pay­ment is part of Ireland’s effort to shore up Anglo Irish, a state-owned bank now known as the Irish Res­o­lu­tion Bank Cor­po­ra­tion, in a res­cue that ulti­mately could top 47 bil­lion euros, or $61 billion.

The Euro­pean Cen­tral Bank put Ire­land on notice last week that default­ing on pay­ments to the bond­hold­ers could lead to dire finan­cial con­se­quences, the equiv­a­lent of a finan­cial “bomb” in the Irish econ­omy, accord­ing to Ireland’s trans­port min­is­ter, Leo Varad­kar, who made the com­ments over the week­end on an Irish tele­vi­sion program.

But that has not quelled a pub­lic debate about whether tax­pay­ers should pay bond­hold­ers who bet on invest­ments in a bank that was bailed out and nation­al­ized in 2009 after the col­lapse of the Irish real estate mar­ket. In gen­eral, unse­cured bond­hold­ers reap a higher return because the bonds are not guar­an­teed and there­fore carry a higher risk.

...

A year ago, David Nor­ris, an inde­pen­dent mem­ber of the Irish Sen­ate, used par­lia­men­tary priv­i­lege to read aloud the names of bond­hold­ers, includ­ing sev­eral Lon­don finan­cial insti­tu­tions, before he was ruled out of order. He had drawn his infor­ma­tion from Paul Staines, a for­mer bond trader who writes a blog from Lon­don under the name Guido Fawkes. Mr. Staines posted a list of bond­holder names on his blog, although he did not dis­close his source.

“My sense is that the hold­ers of these type of bonds are com­pletely dif­fer­ent now, with a much greater sense of risk,” Mr. Staines said.

Bond­hold­ers and invest­ment banks are reluc­tant to talk about Ireland’s repay­ment. The Insti­tute of Inter­na­tional Finance, the lead­ing global bank­ing lobby group, declined Mon­day to com­ment on the issue. The group is rep­re­sent­ing bond­hold­ers in nego­ti­a­tions in Greece for write-downs of its bonds.

Also Note that it’s not clear if WestLB, which did have junior Anglo Irish debt (see list at end of arti­cle), is amongst the Anglo Irish banks that will be part of the new ECB-enforced bailout, but some signs point in that direc­tion:

Busi­ness World
Who are the Anglo Bondholders?

Wednes­day, Jan­u­ary 25 10:48:11

The names of the organ­i­sa­tions hold­ing Anglo Irish bonds are con­fi­den­tial, how­ever past leaks reveal that the likes of Gold­man Sachs, Credit Suisse and a host of hedge funds are the prin­ci­pal holders.

The highly pop­u­lar Guido Fawkes blog this morn­ing re-published that first leaked in 2009 and, while out of date, shows that many of the world’s top finan­cial com­pa­nies have a stake in the bank that brought the Irish econ­omy to its knees.

The list shows that Ger­man finan­cial organ­i­sa­tion rep­re­sent the biggest block of own­ers with Deutsche Asset Man­age­ment, WEW and WGZ banks prominent.

Anglo — now the IBRC — could end up cost­ing the Irish tax­payer more than E47 bil­lion.
...

Any­ways, this is all a reminder of the Lan­des­banks’ impor­tant role in the finan­cial crises, as both a facil­i­ta­tors of bub­bles and bailout black holes for the pub­lic in the after­math. It’s a famil­iar story around the globe, but in the con­text of the eurozone’s cur­rent aus­ter­ity fetish and the bankster actions that destroyed the global econ­omy, the Landesbank’s chap­ter in the his­tory of the finan­cial cri­sis is pretty relevant.

Here’s a 2006 arti­cle about WestLB and Austria’s Raif­feisen Zen­tral­bank Oster­re­ich Aktienge­sellschaft (RZA) team­ing up to offer shariah-compliant invest­ments to the Gulf Finance House (GFH), high­light­ing WestLB’s early role in this fairly new seg­ment of the finan­cial indus­try:

Raif­feisen Zen­tral­bank Öster­re­ich and WestLB launch US$100 m Standby Com­mod­ity Murabaha Financ­ing for Gulf Finance House
ameinfo.com
Bahrain: Tues­day, Novem­ber 07 — 2006 at 13:34

Gulf Finance House [GFH] today announced the syn­di­cated launch of a 3-year US$100 mil­lion Standby Com­mod­ity Murabaha Financ­ing for GFH facil­i­tated by RZB and WestLB as joint lead arrangers, co-underwriters and joint book run­ners. WestLB will also act as the invest­ment agent.

This Murabaha trans­ac­tion sup­ports GFH’s efforts to cap­i­talise on the suc­cess of its invest­ment busi­ness model and widen its investor base in line with 7 years of steady growth and unin­ter­rupted profitability.

The Murabaha struc­ture is Sharia’a-compliant, hav­ing been approved by the inter­nal Sharia’a advi­sors of GFH. Trans­ac­tion dis­tri­b­u­tion has been geared towards a wide insti­tu­tional investor base both inside the Gulf region and out­side — par­tic­u­larly to Euro­pean and South East Asian investors.

...

On an ironic side-note, GFH just got a con­tract from Tunisia’s new post-Arab-spring gov­ern­ment to raise inter­na­tional funds for infra­struc­ture devel­op­ment. It’s an ironic con­tract given that GFH is based in Bahrain, not exactly an Arab-Spring-friendly loca­tion.

And here’s another arti­cle from 2006 dis­cussing WestLB’s under­writ­ing of a Sukuk (Islamic bond) that appears to emu­late put and call options. (and with shariah-compliant syn­thetic deriv­a­tives, mod­ern finance offi­cially jumps the shark). No doubt they’re some­how not spec­u­la­tive in nature, so it’s all good:

bankalkhair.com
Uni­corn Invest­ment Bank and WestLB close US$150m Sukuk for Invest­ment Dar

20 Sep­tem­ber 2006

Uni­corn Invest­ment Bank and WestLB Lon­don Branch have today suc­cess­fully closed the US$150 mil­lion Musharaka Trust Sukuk for Kuwait’s Invest­ment Dar.

This is the first Musharaka Sukuk struc­tured with a put option for the investors and a call option for the issuer. The put option allows each cer­tifi­cate holder (investor) to exit the trans­ac­tion at year three while the call option allows the issuer the same flex­i­bil­ity at the same date.

The Sukuk struc­ture is Shari’ah-compliant, hav­ing been approved by the Shari’ah Super­vi­sory Boards of Uni­corn and Invest­ment Dar.

Salim W. Abboud, Direc­tor of Cap­i­tal Mar­kets at Uni­corn, com­mented: “This Sukuk attests to the capa­bil­i­ties of Uni­corn in deliv­er­ing on the cap­i­tal mar­kets needs of its clients in Islamic finance. With this Sukuk we have added value to Invest­ment Dar by extend­ing their lia­bil­ity pro­file, low­er­ing their fund­ing cost and broad­en­ing their investor base, all through a Shari’ah-compliant struc­ture.

David Testa, Exec­u­tive Direc­tor of Asset Secu­ri­ti­sa­tion — Islamic Finance at WestLB, added: “As sole bookrun­ner, we were par­tic­u­larly pleased to bring in over 15 banks and insti­tu­tions into the trans­ac­tion, includ­ing investors in Europe and Asia”

The trans­ac­tion was launched on 6th June 2006 with Uni­corn and WestLB Lon­don Branch as joint-lead arrangers. Uni­corn also acted as the struc­tur­ing agent and WestLB’s Lon­don Branch was the sole under­writer and bookrunner.

...

Inter­est­ingly, in this snazzy new world of shariah-compliant inter­na­tional finance (which was set to sur­pass $1 tril­lion in 2010), it looks like process of get­ting of the shariah-compliant stamp of approval for these prod­ucts relies on a cou­ple dozen “schol­ars”:

Insight: “Rock star” schol­ars a risk for Islamic finance

By Anjuli Davies and Mirna Sleiman

LONDON/DUBAI | Thu Mar 1, 2012 8:14am EST

(Reuters) — Decades of pars­ing turgid legal doc­u­ments have not damp­ened the enthu­si­asm of octo­ge­nar­ian Islamic scholar Sheikh Hus­sein Hamed Has­san. He gets agi­tated as he searches for a paper among piles of doc­u­ments strewn across his posh Dubai office.

Wear­ing a dark grey suit with no tie, the Egyptian-born aca­d­e­mic talks to a vis­i­tor for almost two hours about Islamic bank­ing, which he has been instru­men­tal in devel­op­ing over half a cen­tury of writ­ing and lec­tur­ing.

“Lis­ten to me. You have to under­stand the basics of sharia, what’s allowed and not allowed in Islam. If you get it, then you’ll write it. And the whole world will under­stand,” he says.

Sheikh Hus­sein is one of the world’s most sought-after schol­ars in apply­ing sharia or Islamic law to finance, chair­ing no fewer than 22 of the boards which rule on whether prod­ucts and prac­tices in the indus­try obey reli­gious principles.

One posi­tion in par­tic­u­lar stands out. As chair­man of the sharia advi­sory board of Lon­don– and Dubai-based con­sul­tants Dar Al Istith­mar, he is hav­ing to answer some search­ing ques­tions on behalf of one of its most high-profile clients, U.S. invest­ment bank Gold­man Sachs.

Last Octo­ber Gold­man announced it would issue as much as $2 bil­lion in sukuk or Islamic bonds, mak­ing it one of the first top West­ern banks to raise money in that way. But the plan has run into con­tro­versy among poten­tial investors over whether it fol­lows Islamic prin­ci­ples, as Dar Al Istith­mar insists it does. There is also con­tro­versy over the fact that Gold­man pub­licly named at least three Islamic schol­ars as poten­tial advis­ers on the sukuk even though they had not even seen the prospectus.

“A copy of the Gold­man Sachs sukuk prospec­tus was sent to these schol­ars for con­sul­ta­tion but they never responded back,” Sheikh Hus­sein told Reuters. “They could be busy or did not approve the struc­ture, but we didn’t hear from them. Their approval is not nec­es­sary anyway.”

The con­tro­versy over the Gold­man sukuk illus­trates some of the weak­nesses of the Islamic finance indus­try. These are lead­ing to grow­ing pres­sure for reform of the scholar sys­tem, though the power of entrenched inter­ests, and the dif­fi­culty of coor­di­nat­ing pol­icy in an indus­try where author­ity is spread across the Mid­dle East and south­east Asia, may slow any change.

Schol­ars such as Sheikh Hus­sein com­mand great influ­ence but their opin­ions, lack­ing defin­i­tive legal sanc­tion, are often chal­lenged, cre­at­ing an uncer­tain reg­u­la­tory envi­ron­ment. And some schol­ars sit on scores of boards, leav­ing them open to charges of con­flict of inter­est and mak­ing it hard for them to keep up with all areas of their work.

“The big prob­lem is that there just aren’t enough of them,” said one Dubai-based banker in the indus­try, who declined to be named because of the sen­si­tiv­ity of the issue. “It’s a bit like being a rock star. They are dis­pro­por­tion­ately rec­og­nized, with peo­ple say­ing: ‘I want that name in Malaysia, I want that name in Bahrain.’”

CAPACITY

Islamic finance, based on prin­ci­ples such as bans on inter­est and pure mon­e­tary spec­u­la­tion, has grown rapidly over the last sev­eral years because it draws on pools of invest­ment money in the oil-rich Gulf and Asia that have been rel­a­tively untouched by the global finan­cial crisis.

The industry’s global assets are expected to rise 33 per­cent from 2010 lev­els to $1.1 tril­lion by the end of 2012, accord­ing to con­sul­tants Ernst & Young. Islamic finance will remain far smaller than con­ven­tional finance, with its tens of tril­lions of dol­lars, but the gap may con­tinue nar­row­ing; Ernst & Young expects Islamic bank­ing in the Mid­dle East and North Africa to expand over the next five years at a com­pound annual rate of 20 per­cent, ver­sus less than 9 per­cent for con­ven­tional banks.

Sharia schol­ars, with exper­tise in both reli­gious and con­ven­tional law, are key to this growth. Investors will not buy instru­ments with­out believ­ing they are reli­giously accept­able, so most wholly Islamic finan­cial firms have their own board of sharia schol­ars which cer­ti­fies prod­ucts and mon­i­tors the firm’s busi­ness. “Inde­pen­dent” sharia boards also exist, offer­ing their ser­vices to finan­cial firms for a price.

There are over 400 sharia schol­ars world­wide but only around 15 to 20 promi­nent and expe­ri­enced ones, which cre­ates demand for schol­ars to sit on mul­ti­ple boards. The top 20 schol­ars hold 14 to 85 posi­tions each, occu­py­ing a total of around 620 board posi­tions or 55 per­cent of the indus­try, data com­piled by invest­ment research firm Funds@Work show.

...

While the West­ern model finan­cial reg­u­la­tion has become sort of a joke in recent decades, the scholar-shopping model doesn’t appear to be an improvement.

Also, on an inter­est­ing side note, schol­arly sources indi­cate that tax shel­ter­ing is shariah-compliant:

Islamic Finance: Islamic Sukuk By Gold­man Sachs Causes Debate

First Posted: 02/23/2012 9:51 am Updated: 02/23/2012 11:55 am

By Anjuli Davies

LONDON, Feb 23 (Reuters) — A con­tro­ver­sial plan by Gold­man Sachs to issue an Islamic bond has ignited a wider debate on whether con­ven­tional banks in the West should be allowed to engage in Islamic finance.

At a major con­fer­ence of Islamic schol­ars and bankers in Lon­don this week, much of the pub­lic and pri­vate dis­cus­sion was devoted to whether grow­ing West­ern inter­est in Islamic finance could dam­age the indus­try by com­pro­mis­ing its reli­gious principles.

Some par­tic­i­pants argued invest­ment banks such as Gold­man should be banned from issu­ing Islamic bonds, or sukuk, because the funds they raised could help to finance other parts of their busi­ness that did not com­ply with sharia or Islamic law.

...

Aznan Hasan, one of the schol­ars who signed the Gold­man fatwa, said there were no sharia-related prob­lems with the sukuk. The inten­tion to list on the Irish exchange is purely for tax pur­poses, he said. But he added that Gold­man should con­sider more mea­sures to address doubts.

...

@Pterrafractyl–

Not an expert in sharia finance myself, I’d be very sur­prised if the shenani­gans engaged in by Gold­man Sachs and the rest of the major houses was in keep­ing with the prin­ci­ples of what Islamic invest­ment was SUPPOSED to be.

@Dave: Yeah, Gold­man Sachs seems to have the anti-Midas touch. Any­thing they touch turns to fools gold or some other scam.

It’s going to be really inter­est­ing to watch the impact that Gold­man Sachs and the other big banks have on this area of finances that’s still sort of in its infancy. One of the advan­tages Gold­man & friends seems to have in the debate is that there is no uni­form set of views because it all comes down to the opin­ions and inter­pre­ta­tion by a hand­ful of schol­ars. With around 20 “rock­star” schol­ars appar­ently run­ning the entire globe’s shariah-compliance racket there’s going to be an incred­i­ble amount of resources by all sorts of dif­fer­ent actors to influ­ence these guys. It sounds like there’s going to have to be a con­sen­sus view emerg­ing on what exactly con­sti­tutes shariah-compliance just to keep the grow­ing mar­ket func­tion­ing because there’s too much diver­gence in opin­ion amongst these schol­ars. That should be one inter­est­ing set of fatwas.

@Dave: Here’s a 2007 FT piece from the author of “Islamic Bank­ing: a $300 bil­lion decep­tion” that makes two reveal­ing obser­va­tions. First, the way Islamic finance is cur­rently prac­ticed is almost iden­ti­cal to the interest-based financ­ing that its sup­posed to be avoid­ing in the first place. Sec­ondly, the author asserts that the form of finance that most closely fol­lows the spirit of shariah would be ven­ture cap­i­tal (where the bank is actu­ally invest­ing in the busi­ness and shar­ing the prof­its and losses). Since the pur­pose of Islamic finance cur­rently seems to be find­ing the­o­log­i­cal cover for the Islamic banks to engage in Western-style lending/borrowing bank­ing, it’s not a per­spec­tive I’d expect to win out in the end:

Finan­cial Times
Jan­u­ary 18, 2007 8:44 pm
Islamic finance has much to learn from the west

By Muham­mad Saleem

Pro­po­nents of Islamic finance main­tain that as the Koran pro­hibits inter­est all financ­ing must be done on a profit and loss shar­ing basis. In spite of all the lofty rhetoric, in prac­tice no more than 5 per cent of Islamic financ­ing is done this way.

Instead, Islamic banks use a struc­ture called murabaha, or cost plus pre-determined profit, for the vast major­ity of their finance deals. Remark­ably, the “profit” for an Islamic bank in a murabaha trans­ac­tion and the inter­est a con­ven­tional bank would have charged on the same trans­ac­tion hap­pen to be exactly the same. Indeed, Islamic banks in deter­min­ing their “profit” even quote the rate as a mar­gin over Libor or other sim­i­lar indices.

Murabaha was a crude trad­ing prac­tice designed for trans­ac­tions between real sell­ers and real buy­ers involv­ing phys­i­cal goods. By struc­tur­ing a financ­ing trans­ac­tion while dis­guis­ing it as a trad­ing trans­ac­tion – and charg­ing inter­est con­cealed in Islamic garb – Islamic banks turn the entire enter­prise into a charade.

Other modes of financ­ing are just as dubi­ous. Take Islamic house finance, struc­tured as a lease: lease pay­ments are equal to inter­est that a con­ven­tional bank would charge on a home mort­gage loan. Sukuks, or Islamic bonds, are sim­i­lar in many respects to murabaha and just as tainted. Bran­dish­ing a fatwa from a scholar of sharia law (who, like mer­ce­nar­ies, are some­times for sale at the right price), bless­ing the struc­ture does not absolve the bankers from the respon­si­bil­ity of meet­ing the spirit of the sharia.

The real prob­lem with the Islamic finance indus­try is that despite a 30-year his­tory and cur­rent assets of about $300bn they have yet to add any value. Islamic banks have not cre­ated any new jobs (employ­ment at Islamic banks does not count), financed new inven­tions or inno­va­tions or made the Islamic com­mu­ni­ties more just and equi­table. The smoke and mir­rors Islamic finance indus­try appears to be all about cre­at­ing finan­cial struc­tures to com­ply with the let­ter of the law, not the spirit and intent of the Koran.

Islamic banks need to move away from the decep­tive modes of financ­ing they cur­rently use and step towards the Amer­i­can style of ven­ture cap­i­tal. This has two advan­tages. First, the stated prin­ci­ples of Islamic bank­ing – favour­ing profit and loss shar­ing over inter­est – are very sim­i­lar to the financ­ing tech­niques used by the ven­ture cap­i­tal indus­try, espe­cially in the US. These pri­vate equity groups are the real Islamic finance, the gen­uine arti­cle. Sec­ond, by pro­vid­ing funds to entre­pre­neurs with bright ideas, the banks can assist in pro­mot­ing inno­va­tion, inven­tion and cre­ation of new jobs and industries.

...

@ Ter­rafractyl and @ Dave: I am not an expert either on Sharia finance but I can’t help but to think that it looks just like another way of doing eco­nomic war­fare. Sharia finance won’t fund projects that are not com­pli­ant with sharia law, right? So all the projects and busi­nesses orga­nized and man­aged by Chris­tians, Jews, poly­the­ists, athe­ists, etc, in the Mid­dle East are vul­ner­a­ble to refusal. In other terms, with­out money to cap­i­tal­ize their enter­prises, these projects, busi­nesses and com­mu­ni­ties risk anni­hi­la­tion and dis­in­te­gra­tion, with­out Islamists and the like fir­ing a sin­gle shot. This could prove to be worse than Al-Qaeda.

@Claude: You may be right, I’m afraid. =(