Are Islamic syndicated financings different from conventional ...

Are Islamic syndicated financings different

from conventional syndicated loans?

University of Maastricht

Faculty of Economics and Business Administration

Maastricht, 03.08.2009

Farbood, Hutan (I229830)

Master of Science in International Business

Concentration: Finance

Supervisor: Professor Dr. S. Kleimeier

Final Master Thesis

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Table of Contents

Page

1. Introduction…………………………………………………………………… 2

2. Islamic Financing …………………………………………………………….. 5

2.1. The Principles of Islamic Financing ………………………………….……... 5

2.2. Islamic Financing Methods ……………………………. …………………… 7

2.2.1. The Profit-and Loss-sharing Modes …………………………………. …… 9

2.2.2. The Mark-up Modes……………………………………… ……………….. 10

2.2.3. Sukuk……………………………………………………………………….. 11

2.3. Islamic Syndicated Finance………...………………………………………… 12

3. Descriptive Research Questions …………………………..…………………. 15

4. Analysis on Loan Spreads of Malaysian Syndications ………….………... 21

4.1. The Banking System in Malaysia…………………………………………...... 25

5. Data Selection………………………………………………………………...... 27

5.1. Data Selection for the Descriptive Research Questions………………...…..... 27

5.2. Sample Characteristics for the Descriptive Research Questions...………...…. 28

5.3. Data Selection & Sample Characteristics for the Loan Spread Analysis of

Malaysian Syndications ……………………………………………......…...... 29

6. Empirical Results…………………………………………………………..….. 31

6.1. The source of funds for Islamic Syndicated financings...……………...……... 31

6.2. The receivers of Islamic syndicated financings………………………..……… 34

6.3. Industries towards which Islamic syndicated financing are directed to …...…. 37

6.3.1. Changes of Islamic syndicated deals for different industries over time…..… 44

6.4. Shares of lead banks: Islamic syndications vs. conventional syndications….... 46

6.5. Maturities of Islamic syndicated financings versus conventional syndications. 47

6.6. Financial debt covenants: Islamic syndications vs. conventional syndications. 49

6.7. Participating banks: Islamic syndications vs. conventional syndications…….. 49

6.8. Deal Size: Islamic syndications vs. conventional syndications……………..... 50

6.9. Differences in the Spread……………………………………………………... 51

7. Conclusion and Limitations………………………………………………....... 56

References……………………………………………………………………....… 60

Appendix……………………………………………………………………...…... 65

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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 Institutions in the

oil rich states at the Persian Gulf, thriving emerging nations in South-East Asia and

African nations, with their large Muslim populations, but also financial centers in the

Western World rush to take part at the phenomenal 15-20% growth of Islamic financial

products even in the wake of the recent financial crash. Even banks which are laying off

their workforce on a large scale are still looking to increase their workforce in the Islamic

financing business as they hope to tap into this promising niche market. The Islamic

financial assets 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 last three decades grew

faster than their conventional counterparts in Muslim nations. The number of Shariah-

compliant financial institutions has risen to more than 300 institutions operating in 75

countries till 2008 (Hasan, 2008). A determinant factor for the growth of the Islamic

finance industry is because it complies with the religious beliefs and also the cultural

characteristics of societies in Muslim nations (Hamwi & Aylward, 1999). Furthermore,

the rise in Islamic finance can also be attributed to the rise of the petrodollar income in

the Middle East (The Boston Consulting Group, 2008). But next to the growth of Islamic

financial institutions in Islamic countries, Islamic finance has gained ground in

predominantly non-Muslim nations as well. The United Kingdom and Singapore for

example opened their doors to become centers for Islamic finance (Akhtar, 2007). There

it has been noticed that mostly conventional banks have opened Islamic windows, 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 countries is due to the

rising demand of the Muslim population in Western countries 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 institution managed funds for pilgrimages to Mecca (Solé, 2007). Also in 1963 a

savings bank, 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 charter (Chong & Liu, 2007).

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investors, especially Investors from the Persian Gulf, to diversify their investment

portfolio geographically while complying with Islamic jurisprudence (Solé, 2007). But

also more and more non-Muslims find the philosophy of Islamic banking desirable (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 (Dahlia El, Wafik, Zamir, 2004). The

European Islamic Investment Bank even believes that 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 hand, further growth may be hindered by

uncertainty on scholarly views2 on the compliance of Islamic financial products and a

lack of standardization, which is believed to make Islamic financial products more time-

consuming to construct and therefore also more expensive (Reuters, 2009). Furthermore,

agency problems at Islamic financial institutions do deserve separate and special attention

to enable further growth in the future. Reasons for this special attention arise due to the

fact that the bankers in Islamic financial institutions are entrusted to maximize

shareholder value in a Shariah conform way. Islamic financial institutions have different

operations dynamics and the relationships between the parties involved are different.

Another reason why agency problems at Islamic financial institutions deserve separate

and special attention is because of the incredible growth of Islamic financial institutions.

Also the fact that little empirical research has been done on this subject can be seen as a

reason why agency problems deserve special attention at Islamic financial institutions

(Safieddine, 2008).

This paper takes into account these considerations, particularly of the special agency

challenges at Islamic financial institutions. Empirical research is conducted on Islamic

2 Supervisory boards of Islamic financial institutions rely on their own Shariah experts. This may lead to

contradictions of the permissibility of financial instruments 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,

2007).

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syndicated financings and compared with conventional financings. Differences in the

structure of Islamic and conventional syndicated loans are researched to find out what

influences agency effects have. This enables to make conclusions on the dimension of the

agency problematic. Furthermore a model is built to find out whether Islamic syndicated

financings are more expensive than their conventional counterparts, by taking into

account the special structural differences between Islamic syndicated financings and

conventional syndicated loans.

As there is no paper, to the knowledge of the author, which conducts empirical research

on Islamic syndications, this paper will contribute to new insights into Islamic syndicated

financings. The aim is to show differences which exist between Islamic syndicated

financings and conventional syndicated loans. This paper will also add value, by finding

out how far Islamic syndications are affected by the agency problematic, 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 structured. Then, the concept of Islamic syndications is

elaborated. Next, the descriptive research questions on Islamic syndications and the

hypothesis for the analysis of Malaysian loan spreads are formulated. These include

research questions about 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

benefiting industries are researched as well. In regard to the agency problematic, the 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 researched and compared to

empirical data on conventional syndications. Finally a hypothesis 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 investigates the influence of borrower characteristics, contract

characteristics and the syndicate structure on the spread. The following paragraph starts

with an introduction to the concepts of Islamic financing.

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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 Sunnah, 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 that 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 tied to the achievements in the business it is not seen

as social, as social justice 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 investors,

because they cannot charge interest, they join the productive business. Therefore they

share risks of the business for the share at the profits. The next principal describes money

as “potential capital” as long as it is not invested in productive businesses and therefore it

is not entitled to the time value of money. The Islamic financial systems recognize the

time value of money only when money acts as capital at productive activities.

“Materiality” is another principle in the Islamic financial system and means that financial

transactions have to lead to a real economic transaction (Dahlia El, Wafik, Zamir, 2004).

In addition, Islamic financial systems prohibit “gharar”3, or speculative behavior, which

3 “Gharar” means, not knowing the value of the good purchased. Terms of a contract shall be well defined

and leave no ambiguity to avoid gharar (Chong & Liu, 2007).

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incorporates transactions that involve extreme uncertainties and risks. Consequently

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 obligations and to

disclose information. This principle has the mean to reduce asymmetric information and

the moral hazard problem. The next principle is the “prevention of exploitation” of any of

the parties involved in a transaction. And as a last principle, the financing deals shall not

finance “sinful activities” such as the production of alcoholic beverages. Finally, only

those investment activities can qualify to be “Shariah compliant” which comply with the

above mentioned laws and rules 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, moral, 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 acts for risk sharing, entrepreneurship, individuals’ rights and duties, property

rights and the importance of contracts while discouraging speculative behavior (Iqbal,

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 and rules set by the

Quran and the Sunnah differ enormously. The al-Azhar University, 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 (Tripolipost, 2008). Returns which are not

excessive but prespecified by lenders are permissible if there is a mutual agreement and if

it brings in the advantage to reduce uncertainty. But this argument is of course very

disputed, as a fixed return for the financier is much disputed under Islamic law.

And nor do common Islamic financial instruments conform to the principle of profit-and

loss-sharing (Rajesh, 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 of

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-loss-sharing principle

would entitle the financing provider to be compensated at the profits but also the losses of

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the project. Some scholars don’t interpret it too squeezed, and advice just to avoid Islamic

financial instruments based on the markup principle, while they see these 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 Shariah

and the Sunnah (Wigglesworth, 2009). All basic Islamic financial instruments can be

used for Islamic syndicated financings as well. These Islamic financial instruments can

be based on the profit-and-loss-sharing principle or the markup principle and comprise

amongst others the following financing modes:

Table 2.1: Examples of Islamic financing instruments

Profit-and-loss-

sharing principle:

Markup principle:

“Mudarabah”

(Venture capital

financing, limited

partnership)

“Musharaka”

(Partnership with

right of control),

“Murabaha”

(Cost-plus

financing, trade

financing)

“Ijara” (Leasing),

“Sukuk“ (Bond)

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The examples of Islamic financial instruments in table 2.1 are not full fledged. Islamic

financings entail the freedom of contracts, which enables almost infinite 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 therefore

represent the profit-and-loss-sharing principle. The financiers are entitled to 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 and not as a lump-sum

payment. Financings based on the profit-and-loss-sharing mode cannot claim collateral or

other guarantees that would reduce the credit risk for the lender (Sundararajan, V. &

Errico, L., 2002). But banks, even though they have no legal means, have direct and

indirect control over the borrower. Further credits could be declined in the future and the

credibility and reputation of the borrower is at stake, which is a strong point in Islamic

ethics (Khan & Mirakhor, 1993). The main problem for profit-and-loss-sharing

instruments is how to hold the borrowers accountable to the Islamic lender, while

maintaining the borrower’s freedom, incentives and the control over the business project

(Dar & Presley, 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

liabilities and the assets are systematically matched through profit sharing arrangements

and since no fixed interest rates mount up and as no refinancing via debt is possible

(Iqbal, 1997). Furthermore, allocations are supposed to be efficient as the investment

possibilities are scrutinized on their productivity and the rate of return.

Under the Mudarabah financing mode, the sole capital provider to finance a project is the

bank. So in case of a financial loss the financial institution bears all losses. The

borrowing company on the other side offers its labor and expertise. So the managing

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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 resulting

financial losses. However the capital provider is permitted to supervise the business-

project (Sundararajan, V. & Errico, L., 2002). The borrowing company is compensated

by a stake in the profits of the project (Hamwi & Aylward, 1999). Usually Mudarabah

modes are utilized to finance projects with a short duration in trade and commerce. The

Musharaka mode of financing resembles venture capital. The financial institution is not

the sole provider of the investment. Other partners, 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 borrowing company. Voting rights can also be exercised according to

the share at the borrowing company’s equity capital. The Musharaka mode of financing is

more utilized to finance projects with a long duration (Sundararajan, V. & Errico, L.,

2002).

Profit-and-loss-sharing contracts in general need special risk considerations from the

investor side, as the credit risk is shifted from the Islamic financial institution to the

investment depositor. The profit-and-loss-sharing contracts are more complex and need

to determine the profit-and-loss-sharing ratio. Mudarabah 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 financiers better monitoring opportunities of the borrowing entity, as

they have more influence 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 mode of financing. Another

risk is the operational risk which becomes crucial for investments based on the profit-

and-loss mode. This is due to the special activities that the Islamic financial institution

has to perform internally to ensure the monitoring of the investment process and the

compliance to the institutions Islamic 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 financing represents a modern example of

Mudarabah in the Western world (Dar & Presley, 2000).

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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 contracts. Dar and

Presley (2000) mention that laws in most Muslim nations hinder the adaption of profit-

and-loss sharing modes by prohibiting Islamic banks to take controlling rights in

borrowing firms in two ways: First, by making controlling 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 towards investors. Therefore reforms in the

banking regulations would be required to balance the control between financiers and

managers.

2.2.2. The Mark-up Modes

Financing modes under the markup principle allow in contrast to financings according to

the profit-and-loss-sharing modes to calculate the return as a fixed percentage of the total

investment. But legally even the markup mode contracts do not exhibit a fixed negotiated

rate of return, as guaranteed returns are un-Islamic. Markup financing modes even give

the possibility to request a pledge for collateral from the borrower. Generally, markup

instruments of Islamic financial institutions resemble instruments of conventional

financial institutions most of all (Dhumale, R., & Sapcanin, A., 1998).

Murabaha and Ijara are based on the markup principle and are historically based on

commercial trade activities. In the Murabaha mode of financing a markup is negotiated

between a buyer and a seller, whereby the seller informs the buyer about the true cost for

acquiring or producing the specified product. The agreed sum is usually paid in

installments. The Ijara 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

purchase of the product and consequently the transfer of ownership of the product

(Sundararajan, V. & Errico, L., 2002). Payments to the investors generally depend on the

rent or profits of the leaseholder (Oakley, 2009). This is an important point, which gives

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Ijara financings its Islamic credibility. Advantages of Ijara financings are the access to

finance with low credit requirements. Furthermore, no collateral is required, as the

ownership of the leased assets is initially not transferred to the borrower. In addition the

transaction costs are low. So Ijara provides a source 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 for the services of the asset by its operating income

(Ebrahim, 1999).

Islamic Investment modes based on the markup principle are more similar to

conventional financing modes, but entail also special risks. But generally financings

based on the markup principle carry less risk than financings which are based on the

profit-and loss-sharing principle. The interest rate risk affects only indirectly through 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 leaseholder, because the

Islamic financial institution has to hold the leased assets 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 possibility of a repurchase undertaking under these

structures. This means that the issuer had to guarantee to pay back the face value of the

bond when it matured or in case of default (Oakley, 2009).

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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 conventional syndicated

loans are explained. Finally the structure, how the parties involved in an Islamic

syndication deal with each other is elaborated.

The basic idea of syndicated loans is to pool resources to finance large transactions, while

reducing the risks for the finance providers. Therefore a group of banks jointly 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 diversify their investments more

effectively. A syndicate typically includes one or a few lead banks, which assess the

borrower quality and which negotiate the terms and conditions of the contract.

Furthermore the lead banks prepare the information 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, which is often one of the lead banks, has the responsibility

to monitor the borrower, 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

the lead banks to properly monitor post-signing the contract, the lead banks usually retain

a share of the loan in order to signal the quality of the specific syndicated loan. (Giannetti

& Yafeh, 2009).

Islamic syndicated financings are based on Islamic rules and laws which are referred to as

“Shariah compliant”. The syndicated 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 financing is pooled in alongside conventional finance and is pari passu with other

senior debt (Akhtar, 2007). The main distinguishing features of Islamic syndications are

that the returns are not structured as interest income and that generally 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 using eligible Islamic financing

modes, as described in the paragraphs above. Most Islamic financial instruments are

qualified for syndications, but Murabaha and Sukuk are the most widely used ones.

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Another distinguishing point between Islamic syndications and conventional syndications

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 syndicated loans, the

lead bank sells the debt further to other banks and this might also be at a discount or at a

premium. But the lead arranger for an Islamic syndication is allowed to take an

administration or management fee for the arrangement of the syndication process. Except

for the distinguishing points explained above, syndicated Islamic financings are very

similar to their conventional counterparts. A detailed description of how the different

stakeholders of Islamic syndications are involved with each other follows next.

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 investment agency

agreement (IAA) with the participating banks in the syndicate. Usually the lead bank is

Wakeel

(Lead Bank)

Muwakkil

Muwakkil

………

Muwakkil

Obligor

14

part of the syndicate as well. The lead bank acts as a “Wakeel” or agent, the participating

banks in the syndicate are called the “Muwakkils” or principals. While the Muwakkils

provide the funds, the Wakeel is the managing agent of the funds. The Wakeel has the

obligation to monitor and manage the transaction and to keep the direct 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 participation in the syndication, but

stipulates also the purpose for which the capital provided by the Muwakkils can be used.

So the IAA determines the rights and obligations of the parties involved in the

syndication (Iqbal, 2007).

15

3. Descriptive Research Questions:

This paper has the objective to fill the empirical gap on Islamic syndicated financings, as

Islamic financings in larger dimensions are relatively young. Therefore, first a descriptive

research on the characteristics of the Islamic financings, based on the data of all

syndicated loans from the time period between January 1995 and October 2006 will be

conducted.5 These characteristics will then be compared with conventional syndicated

loans. Also differences in between this time period will be researched. The results on the

structural characteristics of Islamic syndicated financings provide answers on the true

dimension of the agency conflict and the structural tools used to reduce agency costs. The

following part will discuss research results of different authors on general Islamic

financial instruments or general syndicated loans. These discussions might hint what

research results to expect for Islamic syndicated financings and help to formulate the

research questions on Islamic syndicated financings.

First, this article will conduct a descriptive research on multiple features of Islamic

syndicated financings. The first characteristics which will be evaluated for the descriptive

research are based on the lenders and the borrowers of Islamic syndicated financings.

Where are the funds of Islamic syndicated financings coming from? Are the oil rich

Persian Gulf states the source of Islamic syndicated financings? The Boston Consulting

Group (2008) argues that the growth of Islamic finance can be attributed to the

accelerating wealth of the petrodollar-rich Persian-Gulf states. And which countries are

receiving these funds? It seems most probable that countries with Muslim populations are

the main target for Islamic syndicated financings. The article “Turning towards Mecca”

(Economist, 2008) argues for example that Islamic finance with funds from the Persian

Gulf states is also flowing towards Islamic countries in Africa. But funds might also flow

towards Western countries, to enable Persian Gulf investors to diversify their investment

portfolio geographically while complying with Islamic jurisprudence (Solé, 2007). These

thoughts lead to the following research questions:

5 This time period starts with the emergence of the first Islamic syndicated financings and ends before any

effect of the financial crisis, which emerged in 2007, to affect the research.

16

1) Research Question: Where are funds of Islamic syndicated loans coming from?

2) Research Question: Which countries are receiving the funds of Islamic syndicated

financings?

The next characteristic which is to be explored is the industrial distribution of the Islamic

syndicated financings. Generally, the majority of Islamic financial transactions are

directed away from agriculture and industry towards retail and 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 financings than on the capital intensive industrial sector

(Hamwi & Aylward, 1999). But as Islamic financings are expected to profit emerging

nations in Muslim nations, the financing of infrastructure projects should see a rising

trend as the paper “Infrastructure project finance and capital flows: A new perspective”

(Dailami and Leipziger, 1998) would suggest. There are opportunities for Islamic

infrastructure 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 privatization drive of

many governments and the difficulties these large projects face to mobilize 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 financing structures fit well in the Islamic

financing modes as they are in line with Islamic law at a general level because they are

asset based and socially valuable (Hamwi & Aylward, 1999). This paper will research the

business areas where Islamic 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?

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Next, the structure of Islamic syndicated financings shall be researched. For the structure

of syndications, the agency problem and information asymmetries play an important

factor. In general, Islamic financing is different than conventional financing as the

lenders face different risks, even though Islamic financing resembles conventional

lending (Chong & Liu, 2007). Grais & Pellegrini (2006) argue that the agency problem

for Islamic financial institutions is not only due to the separation of ownership and

control, which is the common agency problem that conventional syndicated loans face,

but agency problems hit Islamic financial institutions also due to the separation of

depositor’s and investor’s cash flows and control rights (Grais & Pellegrini, 2006).

Agency problems for Islamic financial instruments, resulting from non-compliance to

Shariah regulations and resulting from poor transparency, can affect Islamic banks

credibility and its ability to attract investors (Chapra and Ahmed, 2002). Safieddine

(2008) states that most Islamic banks understand the importance of incorporating

corporate governance mechanisms. But deficiencies in the actual corporate governance

system are observed.6

Especially profit-and-loss-sharing instruments are exposed to agency problems.

Compared to a self-financed manager, borrowers of profit-and-loss-sharing instruments

have less incentive to bring in effort and have more incentive to report less profit. In

addition, the lenders’ role in the management is restricted and doesn’t facilitate

participation in the management (Dar & Presley, 2000).7

To mitigate agency problems for syndicated loans, there are specificities in the structure

of these loans. Sufi (2007) finds out that the lead banks hold a larger share of the

syndicated loans and that the syndicate is more concentrated, when information

asymmetry requires more intensive monitoring and due diligence of the borrower. Sufi

(2007) also finds out that in case that the information asymmetries are very large, if the

6 It is for example not common yet for Islamic banks to have a governance committee, an audit committee

or clear internal audit functions. As this leads to a financial reporting process which is not sufficiently

monitored, this leads to agency problems (Safieddine, 2008). 7 There are also other reasons, which are not related 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

enjoy tax advantages. Profits are taxed, but interest (regarded as a cost) is exempted. Furthermore, property

rights are often not well defined and protected in many Muslim nations. But well-defined property rights

are an inalienable requirement for profit-and-loss-sharing contracts. Another reason is that financial

products 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 those (Dar & Presley, 2000).

18

borrower is informationally opaque, participant banks are closer to the borrower, by

geographical means and by the means of previous lending relationships. Giannetti &

Yafeh (2009) have evaluated how cultural differences affect syndicated loans. They find

out that the share of participant banks are smaller as the cultural distance is higher. In

addition, the larger the cultural distance between the 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 reasons for these results. The first one is information

asymmetry. The closer the culture is, the lower the cost of information gathering, as

lenders consider borrowers from a distant culture more risky. Another reason might be

the higher transaction costs for culturally distant lenders.9 And finally another argument

might be a taste-based discrimination which arises due to a negative perception because

of the cultural differences between borrowers and lenders (Giannetti & Yafeh, 2009).

These considerations on the one hand mean that Islamic syndicated financings should

exhibit larger shares of the lead banks, as their agency conflicts seem especially great. On

the other hand the gap of cultural differences between Islamic borrowers and lenders is

not very clear until now. Cultural closeness between 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 following research question, which might hint about the

urgency of the agency problem and the gap of cultural differences between borrowers and

lenders at Islamic syndicated financings.

4) Research Question: Are the shares of lead banks at Islamic syndicated financings

larger than in conventional syndicated loans?

In the context of Islamic syndicated financings, the loan maturity is an important measure

of the agency problem and the perceived asymmetric information. A shorter 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 asymmetries 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

investments (Giannetti & Yafeh, 2009). 9 The higher transaction costs may arise due to difficult communication, from difficult co-ordination

between individuals of different cultural backgrounds and from conflicts that arise due to the differences in

national cultures (Giannetti & Yafeh, 2009).

19

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 regulations of Islamic financial

systems or the practice of Islamic financial institutions (Rajesh, Amos, Tarik, 2000).

Islamic financial institutions haven’t had the abilities to develop well-functioning

secondary markets for long-term Islamic financial products and the missing of qualified

market makers are also reasons why Islamic financial institutions have been limited to

invest in long-term projects (Dahlia El, Wafik, Zamir, 2004). Therefore, the next research

question is concerning the maturity of Islamic syndications in comparison to

conventional syndication. All arguments hint that the Islamic syndications should exhibit

shorter maturities than their conventional counterparts.

5) Research Question: Do Islamic syndicated financings exhibit shorter maturities than

conventional syndicated loans?

And also loan covenants are important measures of the agency problem and the perceived

asymmetric information. As Islamic financing involves risk sharing, there are tighter

controls from the side of the Islamic financial institutions. And because Islamic

syndicated financings are mostly structured as markup-modes and less as profit-and-loss-

sharing modes, there is no right of control, which might strengthen the requirement for

debt covenants, especially for financial debt covenants. This leads to the next research

question, which explores whether more Islamic syndications exhibit financial debt

covenants than conventional syndications.

6) Research Question: Do more Islamic syndicated financings exhibit financial debt

covenants than conventional syndicated loans?

Information asymmetry can also mean that the syndicate is more concentrated to be 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 Islamic financial institutions

is limited, it seems also probable that there are fewer banks engaged in Islamic syndicates

20

than in conventional ones. Therefore the next research question is concerning the number

of participating banks in an Islamic syndication in comparison to a conventional

syndication.

7) Research Question: Are there fewer participating banks in Islamic syndications than in

syndicated loans?

Another tool to limit effects of agency problems and information asymmetry is the

limitation of the size of the loan. Giannetti & Yafeh (2009) for example, find out that

culturally distant borrowers are offered smaller loans, as they exhibit larger agency

problems and information asymmetries compared to culturally closer borrowers.

Therefore the next research question examines the size of the Islamic syndicated

financings in comparison to the conventional syndicated loans.

8) Research Question: Are Islamic syndicated finances smaller than conventional

syndicated loans?

21

4. Analysis on Loan Spreads of Malaysian Syndications:

In this section, an OLS regression model with determinants of loan pricing for Islamic

and non-Islamic loans in Malaysia is built to find out whether Islamic syndicated

financings are more expensive than conventional syndications and whether specific

attributes of Islamic and non-Islamic syndicated loans influence credit spreads. This

analysis is based on the model used by Ivashina (2009) in her article “Asymmetric

information effects on loan spreads”. The time period evaluated is again, as it is the case

for the descriptive research, between 1995 and October 2006. The research will focus on

Malaysia, one of the most developed markets for Islamic banking products, which

exhibits an Islamic banking system next to the existence of the conventional banking

system. The choice for one single country allows for a more accurate comparison

between Islamic syndicated financings and conventional syndicated loans.

Empirically, to the knowledge of the author, there is no literature on the research

question, whether the spreads on Islamic syndicated financing are priced differently than

conventional syndicated loans. But there is literature on the pricing of Islamic financial

instruments in general. This question entails the important issue of corporate governance.

In the discussion 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 based

corporate governance is to develop incentives for managers to pursue the incentives of

the shareholders (Grais & Pellegrini, 2006). When there is a shift from shareholder value

maximization to aggregate welfare maximization of stakeholders, as is the case for

Islamic financings, the managerial incentives are difficult to design (Tirole, 1999).

Reputational risk evolves for the whole Islamic financial industry if individual Islamic

institutions do not comply with the Islamic jurisprudence. Therefore, Islamic financial

institutions incorporate corporate governance structures and processes which shall ensure

the Shariah compliance to 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 internal corporate governance structure of the

Islamic financial institutions to give advice on Shariah conformity. Shariah Supervisory Boards deal with

five corporate governance issues, namely the independence, confidentiality, competence, consistency and

22

Islamic financial institutions are exposed to cash-flow risk that might erode the 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 depositors to take away their money when

markets are not promising. Therefore Islamic financial institutions and Islamic financial

instruments have a different risk pattern than conventional financial institutions and

instruments (Ariss, 2009). Syndicated loan lenders, as described by Giannetti & Yafeh

(2009), are associated with asymmetric information and moral hazard problems. All these

research results therefore hint that Islamic syndicated loans are priced differently than

conventional syndicated loans.

Better corporate governance enables corporations to extend financing to a business and

enables a lower cost of capital. Islamic scholars might argue that Islamic financial

instruments enable better corporate governance, as Islam obliges stakeholders to engage

ethically. But the sticking of stakeholders to Islamic ethically correct principles cannot be

taken for granted. Islamic financial institutions suffer from breaches of fiduciary

responsibilities and from effects of asymmetric information as much as conventional

banks do. Scandals in Islamic banking look very much the same as for conventional

banking scandals, such as audit failure, collusion of the board with the management,

excessive risk taking or imprudent lending. Furthermore the Islamic financial industry

does raise specific challenges for the corporate governance, which do not hold for the

conventional financial industry. One example is the confidence keeping of the

stakeholders of the compliance of the institutions activities with the Islamic rules and

ethics (Grais & Pellegrini, 2006).

But the more perceived agency 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 guaranteed by the central bank,

Shariah Supervisory Boards exist in all Islamic countries. Further, centralized Shariah Supervisory Boards

are used in many Islamic countries for ex-ante monitoring, which develops further the standardization of

Shariah operations, and ex-post monitoring of the Shariah conformity (Grais & Pellegrini, 2006).

23

religion and are culturally closer (Giannetti & Yafeh, 2009). So this would mean that

syndicated Islamic financings should be more expensive for a borrower in the Middle

East, if the lead lender of the syndicate is a Western bank than compared to an Islamic

financial institution from the Middle East as a lead lender. Safieddine (2008) points out

that there are also conflicts between some agency mitigating mechanisms and the Shariah

law. This could lead to higher costs for Islamic financial instruments. Others argue that

the margins for Islamic banks would be larger, due to the “piety premium” which also

other ethical investment products possess (Hasan, 2008). Also the Tripolipost (2008)

mentions, that Islamic product are regarded as more expensive, as clients have to pay a

premium on Islamic financings. But Akhtar (2007) mentions that tranches of Islamic

financings, which are incorporated within a multi-sourced financing offering, are priced

competitively.

This paper will research whether Islamic syndicated financings are more expensive,

based on the credit spreads founded on data of syndicated loans for Malaysian borrowers.

Since there is a huge difference in the risk pattern, which can enhance information

asymmetries and the agency problems and because there might be a cultural distance

between borrowers and lenders and since Islamic syndicated financings might include a

“piety premium”, it is hypothesized that the spreads for Islamic syndicated financings are

higher than for conventional syndicated loans.

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 article of

Ivashina (2009), the determinants of the loan pricing in this statistical test are based on

borrower characteristics, contract characteristics and the relevant characteristics of the

syndicate structure. The borrower characteristics are determined by the respective credit

ratings.11

Contract characteristics might include the maturity, the deal size and the

existence or not-existence of financial covenants. Characteristics of the syndicate

11

Borrowers which do not exhibit a published rating will be classified as “Not-Rated”.

24

structure might be the size of the lead-banks share or the number of participating banks.

Furthermore the source of the funds may play a relevant role, as cultural distance might

have a negative effect. Relevant contract characteristics and characteristics of the

syndicate structure for the statistical test are determined in the descriptive research.

Since financings according to the profit-and-loss sharing principle do not exhibit fixed

spreads, the research can only take into account data given from deals based on the

markup-pricing principle. But it is important to note again that Islamic financial

instruments exhibit skewness towards markup pricing instruments. According to the

article “Islamic Banks and Investment Financing” (Rajesh, Amos, Tarik, 2000), the

markup-principle is the most widely 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 system is entirely Islamic the majority of Islamic financial instruments

are based on the mark-up principle. Furthermore, this trend has even increased for all

these countries over time.

Markup-pricing in this research is determined for syndicated financings where the base

rate & markup is either fixed or based on the LIBOR 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 than the spread which will determine the total cost

of the financing. The comprehensiveness of the regulatory framework and the provision

of the necessary legal framework could be reasons why Islamic financing becomes more

or less expensive than 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, 2008).

But it is assumed that there are no disadvantages for Islamic syndicated financings

compared to their conventional counterparts in Malaysia, as the Islamic banking industry

tends to appear and grow there, where legal and tax hurdles are paved, as it happened in

Malaysia. Furthermore, the considerations about differences 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 Islamic syndicated financings have to cope with the

same regulatory and legal framework.

25

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 article of Ainley, M. &

Mashayekhi, A. & Hicks, R. & Rahman A. & Ravalia, A. (2007) points out, that there is

variation in Islamic banking practices among countries and jurisdictions. And these

differences are not only due to differences of interpretation of Islamic scholars but also the

level of industry development and the regulatory framework. This means that comparable

differences in Islamic banking are better done between 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 introduces the banking system in

Malaysia.

4.1 The Banking System in Malaysia

Malaysia with its dual banking system, which facilitates the co-existence of Islamic 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 position, regulatory premises

were set with the establishment of the Islamic Banking Act in 1983 (Chong & Liu, 2007).

So for example, the central bank of Malaysia gives tax breaks for Islamic products.

Furthermore rules were relaxed to allow commercial and investment banks to carry out

Islamic business transactions in foreign currencies. Malaysia, like several other countries

has introduced a central Shariah 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

26

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 conventional banking

might be a reason why Islamic financing modes resemble debt instruments.12

The ability

to maximize the risk-adjusted returns on investment and the ability to sustain stable and

competitive returns, ensure that Islamic financial institutions stay competitive against

their conventional peers (Chong & Liu, 2007).

12

Islamic banks, sticking to the profit-and-loss sharing principle, would face „withdrawal risk“ as a result

of a lower rate of return for depositors than the rate of return competitors pay (Chong & Liu, 2007).

27

5. Data Selection:

The data source for this Master thesis stems from the LoanAnalytics (former Loanware)

database, which contains detailed information on the whole population of loan facilities.

The data population from 1995 up to October 2006 was kindly placed at the disposal of

mine by Dr. Stefanie Kleimeier, Associate Professor of Finance 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 financings 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 LoanAnalytics database on the loan

facilities. Second, facilities which have no remarks to be Islamic financings were treated

as Islamic financing facilities if the facility contained at least one participating financial

institution which conducts its business exclusively in an Islamic compliant manner.13

And

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).

Furthermore the question arises whether loans to Iranian companies in Iran, the only

country in the database which exhibits a solely Islamic banking system14

, by foreign

financial institutions are automatically Shariah compliant. But even though the borrowing

companies are mostly state owned enterprises, the loans from abroad are not

13

Especial attention has to be paid to Iranian banks, as they are often seen as Islamic 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

financing modes. 14

Only Sudan had introduced a wholly Islamic banking system as well. Sudan promulgated the full

Islamization of its financial system in 1992. But since January 2005, the time when the Sudanese

government and the former Christian opposition group Sudan People’s Liberation Movement (SPLM) have

signed a peace agreement, conventional banks are allowed to work in Sudan again (Solé, 2007).

28

automatically Shariah compliant (Shafizadeh, 2008).15

Therefore in this research,

borrowings by Iranian companies from foreign financial institutions (if the deal is

arranged at least by one foreign financial institution) are only assumed to be Shariah

compliant if this information is contained in the LoanAnalytics database. But for Iranian

banks, not borrowing via a branch abroad, any borrowing is 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 sample 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 of deals is given for every

descriptive research result. The time span ends in October 2006, not to include any effect

of the credit crisis which followed the following 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 also several drawbacks visible in the generally positive trend for

Islamic syndicated financings (Chart 4.2). These drawbacks coincide with the periods of

the Asian Crisis in 1997, the bust of the economic bubble in the end of 2000 and the start

of the Iraq War in 2003. The year 2006 exhibits the highest amount ever, invested in

syndicated Islamic financings, with a record of more than $9.38bn in investments 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

(Shafizadeh, 2008).

29

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

Malaysian Syndications

In order to select the data for the hypothesis test, first all Malaysian borrowers of

Syndicated loans, Islamic and conventional ones, were selected. As for the descriptive

research, the LoanAnalytics database is used as the data source. The 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 database as well. These few cases were excluded too.

Furthermore the borrower characteristics, which are determinants of the loan pricing, are

measured by the respective credit ratings of the borrowers. The credit ratings for the

Malaysian borrowers were found on the websites of the two credit rating agencies in

Malaysia, Ram Ratings Services Berhard (RAM) and Malaysian Rating Corporation

Berhard (MARC). If the borrowing company doesn’t have a credit rating, it was

researched whether this company has a mother company which was rated, to eventually

include this rating as a proxy. Furthermore, it is not always possible to find credit ratings

for the borrower for the specific year, when the syndicated loan deal was signed. In case

30

there is no credit rating for the time of the deal signing, the credit rating which is closest

in time is chosen. If there is no credit rating found, the deal is classified as “Not Rated” in

the analysis. Data on the syndicate structure and the contract characteristics were found

on the LoanAnalytics database.

The sample finally includes a total of 420 Islamic and non-Islamic syndicated loan deals.

Of these, 32 syndications are Islamic financings. As there are 57 Malaysian Islamic

syndications for this time period in total, this means that the final sample includes 56% of

them. Not all of the syndications could be included, as data on the spread was missing in

these cases. It is important to mention that the 57 Malaysian Islamic syndicated

financings count for about a third of all 175 Islamic syndications worldwide in the

researched time period.

31

6. Empirical Results:

This paragraph presents the results for the descriptive research questions and the outcome

of the loan spread analysis for the Malaysian syndicate borrowers. First the results of the

descriptive research questions are presented, and then the results of the regression model

for the loan spread analysis are provided. For the descriptive research results, countries

except for Malaysia, which has a very dominant share, are also added up to regions to

emphasize the dominance of specific regions for Islamic syndications. Furthermore the

exceptional role for Malaysia continues as Malaysian syndications are taken for the loan

spread analysis.

6.1 The receivers of Islamic syndicated financings:

The first research question investigates the receivers of Islamic syndicated financings. In

table 6.1.1 the benefiters are categorized in countries. The total tranche amounts for all

Islamic syndicated financings worldwide, for the time period 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 means 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 almost 21% of all the Islamic syndicated financings. Malaysia is

next with $5.02bn of Islamic syndicated financings which is equal to a share of almost

18% for Malaysia. 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 nations,

such as the Netherlands, Kazakhstan, Brazil, the United Kingdom, South-Korea, Italy,

France, Singapore and the United States have benefited from Islamic syndicated

financings as well.

32

Country Tranche amount

($) Tranche Amount in Percent of

Total Deal

Count

Bahrain 1.065.167.800 3,73% 8

Brazil 85000000 0,30% 2

France 54.300.400 0,19% 5

Indonesia 370.000.000 1,30% 3

Iran 2.630.812.904 9,21% 22

Italy 100.000.000 0,35% 1

Jordan 15.000.000 0,05% 1

Kazakhstan 250.000.000 0,88% 3

Korea (South) 130.000.000 0,46% 3

Kuwait 3.475.000.000 12,17% 8

Malaysia 5.016.268.305 17,57% 57

Netherlands 750.000.000 2,63% 1

Oman 260.000.000 0,91% 1

Pakistan 450.005.580 1,58% 9

Qatar 139.590.000 0,49% 3

Saudi Arabia 6.667.200.000 23,35% 11

Singapore 85.000.000 0,30% 1

Turkey 834.500.000 2,92% 15

United Arab Emirates 5.902.000.000 20,67% 17

United Kingdom 228000000 0,80% 3

USA 45.000.000 0,16% 1

Total 28.552.844.989 100,00% 175

Table 6.1.1: Receivers of Islamic syndicated financings

Chart 6.1.1 shows the borrowers of Islamic syndicated financings added up in regions, to

emphasize the most important benefiting regions. Malaysia as explained already above is

exceptionally left as a single country. The regions consist of the West16

, the Middle

East17

, Malaysia and Others18

. The chart (6.1.1) shows that 75% of the borrowers of more

than $28.55bn of investments in syndicated Islamic 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 syndicated financings in the world. The absorption of capital

by the West is very limited, but still not neglectable at about 4%. Other borrowers

comprise 3 % of all Islamic syndicated financings.

16

The West is defined to entail France, Italy, the Netherlands, the United Kingdom and the United States. 17

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 Brazil, Indonesia, Kazakhstan, South Korea and Singapore.

33

Chart 6.1.1: Receivers of Islamic syndicated financings in % of the total Islamic syndicated financings

In regard to the deal counts, Malaysia has the lead with 57 out of 175 Islamic syndicated

financing deals (Table 6.1.1). Iran and the United Arab Emirates follow with 22 and 17

deals respectively. Saudi Arabian borrowers exhibit only 11 deals, even though they have

the largest share in Islamic syndications in total amounts. The number of deals therefore

does not reflect the same outcome as the respective 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. While 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 might be the industries that profit from Islamic syndications in the respective

countries. Malaysian deals for example, overhelmingly invest in the construction

industry, 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 paragraph 6.3.

34

Number of Deals Total Deal Sum ($) Average Deal Size ($)

West 11 1.177.300.400 107.027.309

Middle East 95 21.439.276.284 225.676.592

Malaysia 57 5.016.268.305 88.004.707

Others 12 920.000.000 76.666.667

All 175 28.552.844.989 163.159.114

Table 6.1.2: Receivers of Islamic syndicated financings in total numbers for regions

6.2 The source of funds for Islamic Syndicated financings:

The second research question investigates where funds of Islamic syndicated financings

come from. In order to do this, the lending institutions are explored. The place of the

headquarters of the lending institutions is taken as the source for the countries, from

where the funds of Islamic syndicated financings are coming from. Again these countries

are added up to regions as in the paragraph before. 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 investments in Islamic

syndicated financings (Chart 6.2). But surprisingly, Western lenders exhibit an even

larger share of investments in Islamic syndicated financings 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 lenders, such as from Japan or Singapore.

19

The West is defined to entail France, Italy, the Netherlands, the United Kingdom and the United States. 20

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 Brazil, Indonesia, Kazakhstan, South Korea and Singapore.

35

Chart 6.2: Source of funds of Islamic syndicated financings

Next, it seems also very interesting to find out which fund providers are the most

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 investments in Islamic

syndications by Western financial institutions are absorbed by borrowers in the Middle

East. Malaysian borrowers are also paid attention to, as 14% of all investments in Islamic

syndications by Western financial institutions are absorbed by borrowers in Malaysia.

in % of Lenders Western

Borrowers Middle Eastern

Borrowers Malaysian Borrowers

Other Borrowers

Western Lenders 2,3% 79,0% 14,0% 4,7%

Middle Eastern Lenders 7,7% 89,6% 0,3% 2,5%

Malaysian Lenders 0,0% 5,4% 94,6% 0,0%

Other Lenders 6,9% 89,3% 3,8% 0,0%

Table 6.2.3: Lenders and borrowers of Islamic syndicated financings in % terms

36

in million-$ Western

Borrowers Middle Eastern

Borrowers Malaysian Borrowers

Other Borrowers

Total

Western Lenders 337 11.355 2.006 680 14.379

Middle Eastern Lenders 750 8.753 28 240 9.770

Malaysian Lenders 0 167 2.932 0 3.099

Other Lenders 90 1.164 50 0 1.304

Total 1.177 21.439 5.016 920 28.553

Table 6.2.4: Lenders and borrowers of Islamic syndicated financings in absolute numbers

In absolute numbers, $11,355 million and $2,006 million of investments in Islamic

syndications by Western financial institutions were absorbed by borrowers in the Middle

East and Malaysia respectively (Table 6.2.4). Middle Eastern lenders focus almost purely

on their region, as 89.6% of their investments in Islamic syndications stay in the region.

But 7.7% of the funds flow to Western borrowers (Table 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 borrowers, 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 the 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 Islamic syndications are absorbed in the Middle East. In absolute numbers

these investments total $2,932 million and $167 million for Malaysian and Middle

Eastern borrowers respectively (Table.6.2.4).Lenders, other than Western, Middle

Eastern and Malaysian focus their investments on the Middle East. The Middle East

absorbs 89.3%, of the total investments in Islamic syndications. And also Western

countries absorb 6.9% of the funds of the other lenders (Table 6.2.3). In absolute numbers

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 results, the Middle East absorbs most Islamic syndicated financings

from Western lenders and Middle Eastern lenders. Malaysian borrowers receive most of

the Islamic syndicated financings from Malaysian lenders. But Malaysian borrowers also

obtain a respectable share from Western lenders. Western borrowers receive a respectable

share of Islamic syndicated financings from Middle Eastern lenders. Other lenders focus

on Middle Eastern borrowers.

37

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 countries.

But first the industries which profit from Islamic Syndicated financings the most are

researched.22

As can be seen in chart 6.3.1, the oil and gas sector, 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 syndicated funds,

the financial services follow with 18% and then telecommunications with 14%. Utilities

and construction follow with each 9% of the total investments. Government borrowings

constitute another 7%. These results are in line with the results of the borrowers of

Islamic syndicated financings, which are to the largest 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

38

Borrowers in the Middle East have used these financings for typical industries for this

region, which require large investments, such as oil and gas. But also financings which

are required to cope with the economic boom and population growth, such as the

financial sector, telecommunications, the utility and construction 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 syndicated financings, are examined. These sectors include the oil and

gas industry, financial services, telecommunications, utilities, construction and

government. The borrowers are sub-divided into countries where they are based in. The

research results of the share of the countries, in which the borrowers are based in, are

listed detailed in tables. Pie charts are used to give emphasis to the most important

borrowers.

The oil and gas industry is the biggest profiteer of Islamic syndicated financings with

about $7.7bn of total investments. Especially the energy rich Persian Gulf nations, Saudi

Arabia, United Arab Emirates and Kuwait use Islamic syndications to finance their oil

and gas industries (Chart 6.3.2).

Islamic Syndicated Financings in Oil and Gas

38%

26%

20%

7%4% 4%

1%

0%

Saudi Arabia

United Arab Emirates

Kuwait

Malaysia

Bahrain

Indonesia

Pakistan

Iran

Chart 6.3.2: Distribution of Islamic syndicated financings in the oil and gas sector by borrowing country

39

Their share constitutes already about 84% of all the Islamic syndicated investments in the

oil and gas sector. Other important borrowers in the oil and gas sector 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 4,19%

Pakistan 75.000.000 0,98%

Iran 23.730.252 0,31%

Total 7.688.430.252 100,00%

Table 6.3.2: Borrowers of Islamic syndicated financings for the oil and gas sector

The second biggest profiteer of Islamic syndicated financings with more than $5.2bn of

the total investments is the financial services sector. The most important borrowers of

Islamic syndicates, working in the financial sector, are all placed in the Middle East

(Chart 6.3.3).

Chart 6.3.3: Distribution of Islamic syndications in the financial services sector by borrowing country

40

The borrowers are placed in Iran (34%), Kuwait (23%), Bahrain (14%) and Saudi Arabia

(11%) according to the share of the syndicate investments in relation to the total

investment in this industry sector.

Financial Services Amount of Investments ($) Percentage of Total

Iran 1.777.082.652 33,98%

Kuwait 1.225.000.000 23,42%

Bahrain 735.167.800 14,06%

Saudi Arabia 584.000.000 11,17%

Kazakhstan 250.000.000 4,78%

Malaysia 210.526.319 4,03%

Turkey 180.500.000 3,45%

Italy 100.000.000 1,91%

Singapore 85.000.000 1,63%

United Kingdom 63.000.000 1,20%

United Arab Emirates 20.000.000 0,38%

Total 5.230.276.771 100,00%

Table 6.3.3: Borrowers of Islamic syndicated financings for financial services

The third biggest borrower of Islamic syndicated financings with more than $4.1bn of

total investments is the telecommunications sector. Here the borrowers in the kingdom of

Saudi Arabia are the most important borrowers and absorb 57% of all 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 of about 18%, the telecommunication

sector shows how Islamic financings can be used 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.

41

Chart 6.3.4: Distribution of Islamic syndications in the telecommunications sector by borrowing country

Other benefiters of Islamic syndicated financings in the telecommunications sector are

Malaysia and Turkey, with a share of 4% and 2% respectively. In total numbers, 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

Saudi Arabia 2.350.000.000 57,02%

Netherlands 750.000.000 18,20%

Kuwait 750.000.000 18,20%

Malaysia 171.052.632 4,15%

Turkey 100.000.000 2,43%

Total 4.121.052.632 100,00%

Table 6.3.4: Borrowers of Islamic syndicated financings for the telecommunications sector

Another important borrower of Islamic syndicated financings with about $2.6bn of total

investments is the utilities sector. The borrowers in the United Arab Emirates are the

biggest receivers of Islamic syndicated financings in the utilities 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%. Saudi Arabia and Pakistan follow with

8% and 2% respectively.

42

Islamic Syndicated Financings in Utilities

80%

10%

8% 2%

United Arab Emirates

Malaysia

Saudi Arabia

Pakistan

Chart 6.3.5: Distribution of Islamic syndicated financings in the utilities sector 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 and Saudi

Arabia follow with $245 million and $210 million. Borrowers from Pakistan have

received more than $61 million of Islamic syndicated financings for the utilities sector.

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 of the

total investments is the construction sector. In this sector, Malaysian borrowers are the

stunning majority, with a share of close to 96% (Chart 6.3.6). Turkey and France follow

with a share of 2% each.

Utilities Amount of Investments ($) Percentage of Total

United Arab Emirates 2.040.000.000 79,81%

Malaysia 244.769.049 9,58%

Saudi Arabia 210.000.000 8,22%

Pakistan 61.319.766 2,40%

Total 2.556.088.815 100,00%

43

Chart 6.3.6: Distribution of Islamic syndicated financings in the construction sector 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

Malaysia 2.379.522.670 95,34%

Turkey 62.000.000 2,48%

France 54.300.400 2,18%

Total 2.495.823.070 100,00%

Table 6.3.6: Borrowers of Islamic syndicated financings for the construction sector

Other important borrowers of Islamic syndicated financings with more than $2bn of the

total investments are governments. The United Arab Emirates enjoys the largest 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.

44

Islamic Syndicated Financings in Government

49%

25%

16%

10%

United Arab Emirates

Iran

Turkey

Pakistan

Chart 6.3.7: Distribution of Islamic syndicated financings received by governments 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 Turkey

and Pakistan have received $332.5 million and $200 million in Islamic syndicated

financings respectively.

Government Amount of Investments ($) Percentage of Total

United Arab Emirates 1.000.000.000 49,20%

Iran 500.000.000 24,60%

Turkey 332.500.000 16,36%

Pakistan 200.000.000 9,84%

Total 2.032.500.000 100,00%

Table 6.3.7: Governments as borrowers 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 syndicated

financing deals for major industry groups are depicted (Graph 6.3.1).23

Generally, 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

45

that there is a general increase in the deal counts over the years, except for the 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 financial 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 Islamic syndicated financings. The oil and gas sector has seen

growth in the absorption of Islamic syndication deals since 2004.

Graph 6.3.1: Industrial distribution of Islamic syndications over time

46

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 share of the

syndicated financing. This enforces more intensive monitoring and due diligence 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 of Lead Banks

Average Median Minimum Maximum Numer of

observations

Islamic 55% 52% 0% 100% 68

Non-Islamic 56% 50% 0% 100% 22.944

Table.6.4: Average 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 syndications is on

average about 55% of the syndicated financings, while the share of lead banks at non-

Islamic syndications is about 56%. And there is also not a large difference between the

median numbers. Islamic as well as non-Islamic deals have very different deal structures

in regard to the participation of lead banks, as the minimum and maximum numbers

show. This hints that the share of lead banks 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 information asymmetries and agency problems specifically for Islamic

syndicated financings. But there are other contracting tools, which might be used in

order to lessen agency problems perceived with Islamic financial instruments. Such an

instrument is the maturity of the Islamic syndicated financings, which is explored in the

following paragraph.

47

6.5 Maturities of Islamic syndicated financings versus conventional syndications:

Comparing the maturities of Islamic and conventional syndicated loans, the maturities, as

can be seen in table 6.5.1 show certainly differences. On average Islamic syndicated

financings do have a maturity of 5.35 years compared to 4.44 years for conventional

syndications. Thus on the first sight, this would mean that the maturity is not used as a

contracting tool against probable agency problems and information asymmetries of

Islamic syndicated financings.

Maturity (Years) Average Median Number of Observations

Islamic 5,35 5,00 143

Conventional 4,44 4,50 94.318

Table 6.5.1: Maturity of Islamic and conventional syndications

But the maturity needs a more differentiated analysis. In graph 6.5.1, the maturities of all

Islamic and conventional syndication deals are depicted in the percentage of all

respective deals per year. And indeed, more Islamic syndicated loans have a shorter

maturity than their conventional counterparts in the first three 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, only 7% of the conventional syndications

exhibit a maturity of 1-2 years (Table 6.5.2).

Maturity: Islamic vs Conventional Syndications

0%

5%

10%

15%

20%

25%

30%

35%

<= 1 1 - 2 2 - 3 3 - 5 5 - 7 7 - 9 9 - 11 11 - 13 13 - 15 >= 15

Years

% o

f A

ll

Isla

mic

or

Co

nven

tio

nal

Syn

dic

ati

on

s

Non-Islamic Syndications

Islamic Syndications

Graph 6.5.1: Maturity of Islamic and conventional syndication deals in % of all deals per year

48

But more conventional syndications exhibit maturities higher than three years than

Islamic syndications. This gap holds for the syndicated loans with maturities up to nine

years (Graph 6.5.1). Accordingly more Islamic syndicated financing deals 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 agency conflicts of Islamic

syndicated financings, as there are more Islamic syndication deals which have a lower

maturity in the first three years. Other reasons might be the preference to finance short-

term investments due to the regulations of Islamic financial systems or the practice of

Islamic financial institutions (Rajesh, Amos, Tarik, 2000). Another explanation could be

the differences between the industries which receive the financings, which might enforce

different maturities between Islamic and non-Islamic syndicated financings. So the

industries which receive the Islamic syndications might explain the larger amount of

deals with lower maturities in the first three years compared to conventional syndications

in the same time period. But as it is researched in paragraph 6.3, Islamic syndications are

mostly invested in industries which exhibit larger investment needs and have usually

more long-term financing requirements, such as the oil and gas 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 syndications have maturities longer than nine

years, about 18% of all Islamic syndications have a maturity of more than nine years.

Non-Islamic Syndications Islamic Syndications

19% Maturity <= 1 Year 17% Maturity <= 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% Maturity 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: Maturities of Islamic and Conventional Syndications in %

49

And as the Islamic syndicated financings for these large projects are mostly for state-

owned enterprises, the higher perceived agency conflict for Islamic syndicated 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

asymmetric information. Interestingly, the results show that only 7% of Islamic

syndicated financings exhibit financial debt covenants, compared to 31% of conventional

syndicated loans (Table 6.6).

Debt Covenants Yes No Number of Observations

Islamic 7% 93% 175

Conventional 31% 69% 111.768

Table 6.6: Percentage of deals with or without financial debt covenants

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 tool 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 the

lenders in the syndicate, to be better able to monitor the borrower.

Number of Lenders Average Median Number of Observations

Islamic 6,78 5,00 175

Conventional 6,81 4,00 110.588

Table 6.7: Number of lenders in Islamic and conventional syndications

50

As can be seen in table 6.7, this tool is also not used more predominantly for Islamic

syndicated financings. The average number of lenders in Islamic and conventional

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 loans. The median number

of lenders is even higher for Islamic syndications, with an average of 5 lenders, while

conventional syndicated loans exhibit a median number 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 of conventional

syndicated loans is on average 36.6% larger than the average Islamic syndicated

financing deal size. And also the median deal size is significantly lower for Islamic

financings than for their conventional counterparts. Therefore, 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-intensive industries, such as oil and gas industries, telecommunication and

utilities. 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, Western lenders

and cash-rich Middle Eastern lenders constitute the overwhelming majority of Islamic

syndicated financings.

Deal Size (in $) Average Median Number of Observations

Islamic 169.957.411 61.659.883 168

Conventional 232.189.860 77.848.549 111.069

Table 6.8: The average and median deal size of Islamic and conventional syndications

51

6.9 Differences in the Spread

Agency problems have a larger effect on the syndicated loan contract, the more these

problems are perceived. The difference in the risk pattern of Islamic syndications could

yield different agency problems. Islamic syndicated financings could face agency

problems because some agency mitigating techniques might have conflicts 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 pricing for Islamic and non-Islamic

loans in Malaysia, is built to find out whether Islamic syndicated financings are more

expensive than conventional syndications, as explained in paragraph 4. Furthermore it is

researched whether specific attributes of Islamic and non-Islamic syndicated loans

influence credit spreads. At first, one dummy variable states whether a syndicated deal is

Islamic or conventional. Then determinants of the loan pricing are added as dummy

variables as well. As stated in paragraph 5.3, determinants of the loan pricing in the

statistical model are based on borrower characteristics, contract characteristics and the

characteristics of the syndicate structure. It is decided to include only those variables as

determinants of the loan pricing, which have shown differences for 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 determinant for borrower characteristics. In order to

accomplish this, dummy variables are created, indicating the credit ratings, namely

“AAA”, “AA”, “A”, “BBB”, or “BB and below”. As many borrowers do not have a

rating, a dummy variable would indicate that the specific borrower is not rated. For the

contract characteristics, the maturity, the deal size and the existence or not-existence of

financial covenants are included, 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 syndicated deal is bigger or equal to the median size of Islamic or conventional

syndications, depending whether the deal is Islamic or conventional. For the

characteristics of the syndicate structure, the size of the lead banks share and the number

52

of participating were found out to be not different for Islamic syndications than for

conventional syndications. But the differences of the origin of the lending banks are taken

as dummy variables for the syndicate structure. The dummy variables include whether a

lending bank is Western, Middle Eastern, Malaysian or East 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 LoanAnalytics database. Those deals which had no

spread given were excluded from the model. 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 syndications are Islamic financings, which constitute 56% of all

Islamic syndicated financings for Malaysian borrowers. Obviously it is impossible to

include all the variables in the OLS regression equation, as this would create a near-

singular matrix. In the regression, one of the variables is left out. At random, the dummy

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. However, the t-statistics indicate that the variables selected so far are not all

very significant on their own. For the contract characteristics, the “Deal Size” is

significant, 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 significant. 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 the lending bank is East Asian, the spread

significantly decreases by 0.33%.

53

Coeff. t-stat

Borrower Characteristics:

Rating: AAA -0,65 -2,51 **

Rating: AA -0,33 -1,30

Rating: A -0,47 -1,92 *

Rating: BBB -0,36 -1,39

Not Rated -0,19 -0,83

Contract Characteristics:

Maturity 0,03 0,24

Deal Size -0,38 -3,16 **

Financial Covenants -0,03 -0,22

Syndicate Structure:

Conventional -1,46 -6,68 ***

Lending bank Western 0,02 0,17

Lending bank Middle Eastern -0,44 -0,54

Lending bank Malaysian 0,50 3,68 ***

Lending bank East Asian -0,33 -2,62 ***

Observations 420

R-squared 0,25

*** Indicates p value of 1%

** Indicates p value of 5%

* Indicates p value of 10%

Table 6.9.1: First regression results

But there are also many variables in table 6.9.1, which seem not to be significant. 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 deleted as the chance of

this variable to be not significant is very high. Then the regression is run again and then

the variable with the highest p-value is removed again. This procedure is done till all

remaining variables are significant. This leads to the removal of “Lending bank

Western”, “Maturity”, “Financial Covenant”, “Lending bank Middle Eastern”, “Not

rated”, “Rating: AA”, “Rating: BBB”, “Rating A”. Table 6.9.2 shows the regression

results after the removal of the last insignificant variable.

54

Coeff. t-stat

Borrower Characteristics:

Rating: AAA -0,35 -1,96 *

Contract Characteristics:

Deal Size -0,41 -3,60 ***

Syndicate Structure:

Conventional -1,41 -6,68 ***

Lending bank Malaysian 0,51 4,36 ***

Lending bank East Asian -0,35 -3,08 ***

Observations 420

R-squared 0,24

*** Indicates p value of 1%

** Indicates p value of 5%

* Indicates p value of 10%

Table 6.9.2: Final regression results

In table 6.9.2, all variables, except for “Rating: AAA” are significant at a 1% significance

level. The variable of the borrower characteristic “Rating: AAA” 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. This is in line with common sense, 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 Malaysian syndications respectively,

the spread would decrease by 0.41%. The reason might be that larger syndicated

financings are assured by more credible companies, which might be even state owned.

Large industries, such as oil and gas, telecommunications or utilities are not very unlikely

to be government owned or very 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

syndicated loans have a 1.41% lower spread than Islamic syndicated financings. This

might confirm that Islamic syndicated financings face a piety premium. Especially, 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 covenants or to reduce the

number of lending institutions, this indicates that the piety premium might be the reason

55

for the higher spread. Another reason might be a higher perceived agency problem for

Islamic syndicated financings, which would even not be reduced by introducing 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 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 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 Malaysian. 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 culturally closer.

56

7 Conclusion and Limitations:

Islamic syndicated financings have seen a surge since their appearance in the mid 90s and

constituted more than $28.55bn of financings worldwide in the time period of 2005 till

October 2006. The aim of this paper is to find out differences between Islamic syndicated

financings and conventional syndicated loans. Furthermore, 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 syndicated 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 regression model to research their effects on the credit spread. The determinants of

the loan pricing in the regression model are based on borrower characteristics, contract

characteristics and the characteristics of the syndicate structure. Only those variables are

included as determinants of the loan pricing, which have 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 research, first borrowers and lenders were researched. It is confirmed

in this research that Muslim borrowers are the main benefiters of Islamic syndicated

financings. But also Western borrowers received Islamic syndicated financings, a tool to

attract investments from Islamic investors. 75 % of all Islamic syndicated financings

were received by borrowers that are located in the Middle East. Malaysian borrowers

follow with 18%. Western borrowers have a share of 4%. On the lenders side, the West

uses its banking experience and the attractive markets, especially 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 lenders is at 11%. And also Malaysian lenders lent

almost all of their funds to Malaysian borrowers of Islamic syndicated financings.

57

Furthermore the industries which receive these financings are researched. Islamic

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, telecommunications, financial

services, or the utilities sector.

To continue with the descriptive research, differences in the syndicate structure were

researched. First differences of the share size of Islamic and conventional syndications

are investigated. The results show that the share of lead banks at Islamic syndications is

on average about 55% of the syndicated financings, while the share of lead banks at non-

Islamic syndications is about 56%. As the minimum and maximum numbers show that

Islamic and conventional syndications can have very different deal structures in regard to

the participation of lead banks, this hints that the share of lead banks 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 information asymmetries and agency problems

specifically for Islamic syndicated financings. Another factor for the syndicate structure

is the concentration of the number of lenders in the syndicate. And also this tool to better

monitor the borrower to lessen agency problems is not used more predominantly by

Islamic syndicated financings.

Next the differences in the contract characteristics were researched as well. One factor of

contract characteristics is the maturity. The research results show that more Islamic

syndicated financing deals 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. Therefore the results suggest that the maturity might be used to

lessen the agency conflicts more often for Islamic syndicated financings than for

conventional syndicated loans. But also other reasons such as regulatory factors for

Islamic syndicated loans might explain the higher percentage of Islamic syndicated

financings that have a maturity of up to three years. The higher percentage of Islamic

syndicated financings with maturities above nine years can be explained by the industries

in which Islamic syndicated financings are sourced to. Large industries in the gas and oil

industry or the utilities sector require longer maturities. Agency problems, due to the

higher maturity for these financings, are lessened by the fact that the borrowing

companies are often large, therefore more credible and many times even state owned.

58

Another factor for contract characteristics is the limitation of the size of the syndication

deals. The effects of agency problems and information asymmetries can be reduced, by

limiting the size of the Islamic syndicated financing. The research 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 about $232 million for conventional syndicated loans.

The research results of the regression analysis on the loan spreads of Malaysian

syndicated borrowers significantly show that conventional syndicated loans have a 1.41%

lower spread than Islamic syndicated financings. This might confirm that Islamic

syndicated financings face a piety premium. Especially, 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 covenants or to reduce the number of lending

institutions, this indicates that the piety premium might be the reason for the higher

spread. Furthermore the variable “Credit rating: AAA” for the borrower characteristics

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 significant variable is the

variable “Deal Size” which shows that in case the Islamic or conventional syndicated

deal has a larger deal amount than the median deal size of all Islamic or conventional

Malaysian syndications respectively, the spread would decrease by 0.41%. The reason for

this result might be again that larger deals are predominantly done with larger and

therefore more credible borrowing companies. 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 East 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 0.51% higher, than in the case when the lending bank is not Malaysian. These

findings oppose the findings of Giannetti and Yafeh (2009), that loan spreads are lower,

if borrowers and lenders are culturally closer.

It has to be cautioned that the data on Islamic financing, and more precisely Islamic

syndicated financings, are still scarce. The research results of the regression analysis

should be cautioned to be true for all Islamic syndicated financings worldwide, as it

59

contained only 32 Islamic syndicated financing deals with Malaysian borrowers. But for

Malaysia, the regression results are significant and entail 56% of all Islamic 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 syndicated financings play an important role and may

attract specific investors or 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 syndicated financings, one can say that there are only minor differences. Some

agency mitigating tools might be used for Islamic syndicated financings, but many tools

are not used. Therefore one can say that Islamic syndicated loans do not suffer

immensely more from the agency problem than conventional syndicated loans. The

higher spread costs for Islamic syndicated financings in Malaysia can be therefore

regarded more as a piety premium.

As a research suggestion, it would be interesting to find out what the effects of the credit

crisis were on Islamic syndicated financings and specifically on its spread. This might

give new insights by how far Islamic borrowers are indirectly affected by the credit crisis,

as Islamic financial institutions did not suffer from the international crisis directly

(Wigglesworth, 2009).

60

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65

Appendix:

Industry Industry Tranche Amounts / Total Tranche

Amount

Agriculture 2,50%

Automotive 0,28%

Beverage, Food, and Tobacco Processing 0,35%

Business Services 0,54%

Chemicals, Plastics & Rubber Manufacturing 1,95%

Construction 8,67%

Financial Services 18,18%

General Manufacturing 2,53%

Government 7,06%

Hotel & Gaming 0,22%

N/A 2,00%

Oil and Gas 26,72%

Real Estate 1,50%

Retail & Supermarkets 0,27%

Technology 0,16%

Telecommunications 14,32%

Transportation 2,84%

Utilities 8,88%

Wholesale 1,02%

Total 100,00%

Appendix 6.3.0

66

Changes of Islamic syndicated financings in different industries

over time

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Agriculture 0 0 1 0 2 2 2 0 0 0 1 0

Automotive 0 0 0 0 2 0 0 0 0 0 0 0

Beverage, Food, and Tobacco Processing

0 0 0 0 0 0 0 1 0 0 0 1

Business Services 0 0 0 0 0 0 0 0 1 0 0 1

Chemicals, Plastics & Rubber Manufacturing

0 0 0 0 0 0 0 0 0 0 0 2

Construction 0 3 0 0 6 4 3 1 0 5 16 0

Financial Services 0 0 0 0 6 4 3 7 0 3 0 7

General Manufacturing 0 2 0 0 0 0 0 0 0 1 2 2

Government 2 0 2 0 0 0 0 1 0 0 0 1

Hotel & Gaming 0 0 0 0 0 0 0 0 0 0 1 0

N/A 0 2 3 4 3 0 0 1 0 0 2 0

Oil and Gas 0 2 0 2 2 0 0 2 0 3 3 6

Real Estate 0 0 0 0 2 0 0 1 0 1 0 0

Retail & Supermarkets 0 0 0 0 0 0 0 0 2 0 0 0

Technology 0 0 0 0 0 0 1 0 0 0 0 0

Telecommunications 0 0 0 0 0 0 0 1 0 3 0 2

Transportation 0 0 0 0 0 3 2 2 1 1 0 0

Utilities 0 0 0 1 0 0 4 3 1 1 0 1

Wholesale 0 0 2 0 2 1 1 2 0 1 0 0

Total 2 9 8 7 25 14 16 22 5 19 25 23

Appendix 6.3.1