Role of professional real estate firms in Islamic banking

Role of professional real estate firms in Islamic banking

In the region there have been challenges to Islamic banking due to the slump in real estate, however, advocates say the system has built- in protection when compared with the conventional financial institutions as excessive risk taking is banned

August 7, 2012 8:18 by kippreport

The decision to licence the operation of Islamic banking in the Sultanate has opened up windows of opportunities for the banking sector in Oman. The successful launch of “Bank Nizwa”, an exclusive Islamic bank and the opening of Islamic banking operations windows within conventional banks is evidence that the banks plan to capitalize on the opportunities presented by the new industry and meeting the increasing demand for Sharia-compliant finance.

Over the past two decades, Islamic finance has burgeoned into a $1 trillion global industry that, among other things, has served as a vital source of funding for real estate projects and developments around the world. Several modes of Islamic financing have been developed based on the primary tenet of Islamic financial intermediation that mandates the sharing of risk between the lender and the borrower.

Islamic banks have focused on real estate because it fits with Islamic principles, which require an underlying physical asset in all transactions. Many other investment classes are also off-bounds due to prohibition on gambling and interest.

Some institutions have relied heavily on real estate as the primary business model, investing in real estate, developing real estate and lending to activity around real estate. The real estate investment and finance products could involve the purchase of land, buying and selling, build and sell, build and lease and re-development.

In Oman, Islamic finance has the potential to, among other things, help the revival of the domestic real estate sector. This impending resurgence will help investor confidence in the local market and accelerate national economic growth as well.

In the region there have been challenges to Islamic banking due to the slump in real estate. However, advocates say the system has built- in protection when compared to the conventional financial institutions as excessive risk taking is banned. In addition to the market risks there are areas such as competencies and expertise to supervise risks effectively.

Islamic commercial banks have been conservative in lending and collateral valuations. Investors are being very cautious and asset prices are going down, so it is more challenging. The challenges are in identifying the quality of asset, asset price risk, rate of return risk, displaced commercial risk and equity investment risk.

The bank’s exposure for Islamic banks typically takes the form of a profit sharing contract; whereby the Islamic bank puts its own money at risk in the form, effectively, of an equity stake. The bank’s exposure depends on both the skill and honesty of its partner.

This potent mix of high risk and moral hazard is an area which needs greater scrutiny. In fact, as the real estate assets which banks are financing continue to be owned by their clients, much Islamic bank exposure to real estate risk may not appear on the sector’s balance sheets.

An experienced property management firm such as Cluttons has in-depth knowledge and experience to assist with critical risk management activities on individual opportunities such as condition surveys, purchase reports, valuations, and appraisals as well as strategic guidance on market opportunities and determinants of value of real estate income for investment decisions.

by Philip Paul, Head of Agency, Cluttons Oman