Working out the Islamic Banking Knots

The latest initiative of the Islamic Development Bank (IDB), working jointly with the Asian Development Bank (ADB), to set up Asia’s first major multi-country Islamic infrastructure support fund is a good step forward. But in Indonesia and other Asian countries there are obstacles. Lack of access to finance is not the main problem. Projects are frequently blocked by lack of project preparation capacity, poor regulatory frameworks, lack of functioning deal-structuring models, bureaucracy and corruption.

The new Asian Islamic infrastructure fund will start at US$500 million, and then attract more funds, contributing sharia-compliant equity investments to projects in 12 Asian countries (Afghanistan, Azerbaijan, Bangladesh, Indonesia, Kazakhstan, Kyrgyz Republic, Malaysia, Maldives, Pakistan, Tajikistan, Turkmenistan and Uzbekistan).

There are several reasons why the initiative is welcome and timely.

First, the Organization of Islamic Conference (OIC) and the World Islamic Economic Forum (WIEF) have encouraged such initiatives, promoting South-South investment and trade, especially between Muslim countries and member states of OIC.

Second, with the Western banking and financial crisis and global liquidity shortage, this IDB-ADB strategic partnership opens access to Gulf and Islamic liquidity, whilst open to other contributions.

Third, Islamic banking and finance cannot take off in countries like Indonesia, in high population and high poverty Muslim countries, unless the range of banking and financial instruments deployed are diversified to facilitate volume, including bonds and targeting consumer lending, SMEs, private companies and infrastructure.

Robert van Zwieten, the director of ADB’s capital markets and financial sectors division commented that “In Indonesia, only 39 percent of urban dwellers have access to piped water, only 9.5 percent of roads in Afghanistan are paved and only 42 percent of Bangladesh’s population has access to electricity. “

But there are major obstacles to infrastructure projects. Although Malaysia has far better infrastructure and Islamic banking than most of the 12 target countries, the problems in Indonesia, despite its relative economic success, may be similar to some of the 12 target countries.

It comes down to three basic issues: lack of capacity in project preparation; lack of functional deal-structuring arrangements to help make projects viable and manageable backed by adapted regulatory frameworks; and problems of bureaucracy and corruption, especially affecting public-private partnerships.

In Indonesia previous government backed Infrastructure Investment Summits prioritizing public-private partnership projects were not very successful, with investors unimpressed by poor project preparation. Now ADB, Australia, Germany and others have worked with government upgrading project preparation capacity. But Indonesia still lacks pre-feasibility and feasibility study support to help launch and fast-track priority infrastructure projects.

The problem is also how to modernize deal structuring and joint venture design, and adapt regulatory frameworks to share risks and make projects bankable. Despite improvements to Power Purchase Agreements (PPAs), implementation of Independent Power Producer (IPP) models has been slow and extension to Small Power Projects (SPPs) under 10 megawatts of electrical output often impossible. The water sector is in a much worse position. There are almost no water projects without restructuring bankrupt and badly-managed host water authorities.

European Union studies previously warned investors to avoid public-private partnership projects where state companies can propose joint ventures but control revenue streams. Corruption and anti-corruption campaigns have slowed projects, leaving development funds stuck in bonds and banks, alongside undisbursed budget and stimulus funds. An IDB-ADB task force is needed to shift this money to projects, using the new fund as a lever.

So the joint IDB-ADB initiative is really welcome. But the devil is going to be in the details. Despite 4.5 percent growth and economic successes, the big challenge for the next Indonesian government, probably to be led again by President Susilo Bambang Yudhoyono after elections on July 8th, will be reform of public administration. Across Asia the clock is ticking to get infrastructure projects moving and overcome bureaucratic obstacles.

A famous Gilbert and Sullivan comic opera included the chorus “A policeman´s lot is not a happy one”. Asia needs happy bankers, pushing their money out to infrastructure projects to help the people, instead of it being stuck in the bank, in case somebody steals it.

Terry Lacey is a development economist who writes from Jakarta on modernization in the Muslim world, investment and trade relations with the EU and Islamic banking.