ISLAMIC BANKING, SHARIAH BOARDS, AND INVESTMENTS

S E C R E T SECTION 01 OF 06 MANAMA 000747

SIPDIS

STATE FOR NEA, NEA/ARPI, EB
STATE PASS USTR/J BUNTIN
STATE ALSO PASS TO OMB, COUNCIL FOR ECONOMIC
-- ADVISORS, OFFICE OF SCIENCE AND TECHNOLOGY
-- POLICY, AND NATIONAL ECONOMIC COUNCIL
USDOC FOR ITA/MAC/ONE
TREASURY FOR INTL AFFAIRS/G SILLS, TFI/A SZUBIN,
-- AND OFAC/R WERNER

E.O. 12958: DECL: 05/22/2015
TAGS: EINV ECPS EFIN ECON ETRD PREL BEXP BA
SUBJECT: ISLAMIC BANKING, SHARIAH BOARDS, AND INVESTMENTS
IN THE U.S.

REF: STATE 85235 (NOTAL)

Classified by Ambassador William T. Monroe for reasons 1.4
(b) and (d).

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Summary and Comment
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1. (U) Islamic banking is a growth industry worldwide and
represents a sector for which Bahrain holds a comparative
advantage and would like to expand and solidify as a regional
center in the Middle East. Bahrain has a strong reputation
for transparency and regulation of its financial sector in
general, and the Bahrain Monetary Agency (BMA) has endeavored
to establish the same stringent monitoring system for the
growing Islamic bank industry based in Bahrain. Among the
most prominent Islamic banks in Bahrain is Arcapita, formerly
First Islamic Investment Bank, because of its track record of
investment activity in the United States. Like all Islamic
banks, Arcapita's investments are reviewed by a Shariah
advisory board of Islamic scholars to ensure its operations
comply with Islamic principles. The pool of Shariah scholars
is very small; 40 individuals comprise the Shariah boards for
25 Bahraini and Gulf Islamic banks, and there are perhaps as
few as 100 of these experts worldwide.


2. (S) We are aware of concerns linking Arcapita advisors
and staff to questionable organizations, and that Washington
agencies are considering steps to block Arcapita's bid to
acquire an American telecommunications company and perhaps
other existing Arcapita investments. Action taken against
Arcapita could set a dangerous precedent, sending an
unfortunate message about U.S. attitudes towards Islamic
banking in general. Arcapita's Shariah advisors, for
example, sit on the boards of many Islamic banks, including
some that are American. We believe such a step in the
absence of specific and verifiable information directly
linking Arcapita and its investment to extremists could set
back United States interests in Bahrain and the wider Arab
and Islamic worlds. Most directly, such a step risks
undermining the positive benefits that we hope to reap from
ratification and implementation of the U.S.-Bahrain free
trade agreement. More broadly, it could send a message to
the Islamic world that their investments are unwelcome in the
U.S. at a time when the United States is working hard to open
markets around the world to American business people.
Finally, it could degrade our ability to win the war of ideas
in Arab and Muslim countries. Islamic banking is a reality;
it will increasingly attract funds from Muslim investors. It
is in our interest to support a well-regulated and
transparent Islamic banking industry.

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Strong Regulation, Supervision of Islamic Banks
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3. (U) Islamic banking is big business in Bahrain, with an
estimated $4.8 billion in assets in Bahrain as of July 2004.
Bahrain hosts 28 Islamic banks and financial institutions.
Given the emphasis on Islamic banking, the Bahrain Monetary
Agency (central bank) has developed a framework for
regulating and supervising the Islamic banking sector,
applying regulations and supervision, as it does with respect
to conventional banks. In early 2002, the BMA introduced a
comprehensive set of regulations for Islamic banks that is
designed to monitor capital requirements, governance, control
systems, and regulatory reporting, and it is now working
towards Basel II Accord compliance. Bahrain is home to the
Accounting and Auditing Organization of Islamic Financial
Institutions, an industry watchdog established in 1990 that
sets standards on accounting, auditing, governance, and
transparency, and the Middle East and North Africa Financial
Action Task Force, which sets standards for policies on
combating money laundering and terrorist financing.


4. (C) BMA Governor Rasheed Miraj told the Ambassador May 22
that the BMA has developed a very effective and strong
monitoring system for Islamic banks. What started as a niche
industry has grown tremendously in the last few years, said
Miraj, as Muslims demanded banking and investment instruments
in line with Islamic (Shariah) law, the region experienced
strong economic growth, and liquidity increased. He stated
that Bahrain and Malaysia are the global leaders in Islamic
banking. (Note: The BMA and the Malaysia-based Islamic
Financial Services Board work together on standards for and
regulation of the industry. End Note.) He expects continued
robust expansion in the industry as it develops a wider array
of financing and investment instruments to offer clients.
Miraj noted that he, along with a representative of the
Federal Reserve, had spoken at a session on Islamic banking
at the Arab Bankers Association of North America meeting in
New York in April and attendance -- some 150 people -- was
much larger than had been expected. He said that many
international banks in Bahrain, including Citibank,
BNP/Paribas, Barclays, Deutsche Bank, and UBS, now have
Islamic banking units, and HSBC and other banks are offering
Islamic products in the United States. Citibank Middle East
Regional Director Mohammed Al Sheroogi told the Ambassador
that Citibank established its Islamic banking facility in
Bahrain in 1996 because the BMA provides the best regulation
of Islamic banking. He considers BMA regulation of the
Islamic banking sector to be equal to its regulation of
conventional banks.

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Islamic Banking Bahrain's "Biggest Success Story"
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5. (C) Finance Minister (and until January, BMA Governor)
Shaikh Ahmad bin Mohammed Al Khalifa, in a May 18 discussion
with the Ambassador, characterized Islamic banking as
Bahrain's "the biggest success story." In response to the
Ambassador's question, he said Islamic banking does not pose
any special challenges with regard to money laundering and
terrorism financing. It does, however, require special
regulations to account for transactions due to the way risk
and profit are accounted for in Islamic banking. The BMA
publication "Islamic Banking Review" of April 2005 reported
that IMF experts, in Bahrain at the request of the
government, had met with representatives of Bahrain's Islamic
banking and finance industry as part of a Financial Sector
Assessment Program review. Miraj told the Ambassador that
the BMA would "come down hard" on any finance institution in
Bahrain that was not in compliance with international
standards. The stakes are simply too high and Bahrain's
future would be put in jeopardy, he said.


6. (U) The first International Islamic Financial Markets
(IIFM) Conference, held in Manama May 16-17, highlighted the
rapid growth of the sector and its increasing sophistication.
The headline announcement was the establishment of a new $2
billion wholesale Islamic bank due to open in June. The
initial paid-up capital will be $1 billion, rising to $2
billion in five years, said Izzadine Al Khoja, secretary
general of the General Council for Islamic Banks and
Financial Institutions. At the conference, Miraj stated that
the sovereign Islamic bond market ("sukuks") had expanded
across the Gulf and stood at about $4 billion at the end of

2004. Bahrain's sukuk program alone was over $1 billion.

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Arcapita Sets Up Shop In Atlanta
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7. (U) Among the most prominent Islamic banks in Bahrain,
because of its track record of investment activity in the
United States, is Arcapita, formerly First Islamic Investment
Bank (FIIB) of Bahrain. The bank has a solid reputation in
Bahrain's financial circles. According to its website,
Arcapita has paid-up capital of $154 million, of which just
under 90 percent is held by some 180 prominent individuals
and institutions, mostly from the Gulf region. (Note: The
largest shareholder in Arcapita is the General Motors dealer
in Saudi Arabia, from the Al Jomaih family. End Note.)
Arcapita has $1.2 billion on its balance sheet and an equity
capital base in excess of $300 million. The bank has
completed investments with a total transaction value of $7.8
billion. It has offices in Bahrain, Atlanta, and London.
Former Senator and Ambassador Wyche Fowler of Georgia and
Professor Samuel Hayes of Harvard Business School comprise
Arcapita's international advisory board. Members of the
bank's Shariah supervisory board are Shaikh Abdulla Sulaiman
Al Meneea (chair),Dr. Abdul Sattar Abdul Kareem Abu Ghuddah,
Justice Taqi Usmani, and Shaikh Essam Ishaq.


8. (U) As described on its website, Arcapita's investment
strategy is to act as a principal, utilizing its own funds to
complete investment transactions but with the ultimate
objective of placing a majority of the equity with its
investor base in the Gulf region. CEO Atef Abdulmalik said
in a press interview that he leveraged his experience at New
York's Investcorp to develop Arcapita into a "small to medium
size Islamic private equity player." The bulk of the bank's
business in the years following its establishment in 1996 was
located in the southeast of the United States.

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Arcapita: 14 Deals in Six Years in U.S.
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9. (U) An article in the February 7, 2005 edition of Fortune
magazine states that "a string of 14 deals over the past six
years has quietly made (Arcapita) the first and biggest
Middle East-based investment firm in the U.S. Through its
American subsidiary, Crescent Capital Investments, which
opened in Atlanta in 1997, (Arcapita) has poured about $2
billion into the U.S. market." The article notes that
Arcapita is one of only four private-equity firms conducting
investments in the U.S. in accordance with Shariah law. Some
of Arcapita's more prominent investments include Loehmann's
department stores, Sunrise Senior Living, Church's Chicken,
and Caribou Coffee.


10. (U) The bank's actions related to the Caribou Coffee
acquisition highlight just how business savvy it is. As
Middle East Banker reported in an early 2003 article,
Arcapita's investment in the Minnesota-based coffee company
attracted critical public attention and press commentary
because of the bank's association with controversial Muslim
cleric Yousuf Qaradawi. As a result of the uproar, Arcapita
dropped Qaradawi from its Sharia advisory board, satisfying
critics such as the Minnesota Jewish Community Relations
Council.

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Shariah Boards Far From Business Operations
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11. (C) BMA Governor Miraj told the Ambassador that Shariah
advisory boards are "not involved in operations or decision
making" of the banks they advise. Their role is to look at
whether a proposed transaction is compliant with Shariah law.
He said that Shariah boards are generally composed of 3-5
Islamic scholars who have expertise in banking and finance.
Dr. Hussein Hassan, a Shariah scholar and Islamic finance
expert, told us at the IIFM conference in Manama that Shariah
boards are not involved in day-to-day decision making. They
do an annual audit of contracts, randomly selecting various
contracts to ensure compliance with Shariah law. If there is
a new product, the Shariah board will issue a fatwa, or
religious ruling, on whether it is Shariah-compliant.
Citibank Regional Director Sheroogi said the same to the
Ambassador.


12. (C) A senior vice president of the Arab Banking
Corporation (ABC) told the DCM May 20 that ABC has an Islamic
banking arm, ABC Islamic Banking. The Shariah board is made
up of a number of Islamic scholars whose expertise is trade
and business within Islamic norms. The ABC Islamic Banking
Shariah board meets only once a year, and members each
receive $15,000 per year for their services. He noted that
there is a very limited pool of relevant experts, and the ABC
Shariah board members sit on several other boards. Within
the bank is a Shariah certification office that determines
whether a proposed business deal is in compliance with Islam.
This certifier handles almost all of the business-related
Islamic issues. Only in the case of a proposed deal being
unusual or non-routine does the certifier pass the proposal
to members of the Shariah board for their input.

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Very Small Pool of Islamic Finance Experts
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13. (U) Mohammed Tawfiq Kanafani, head of UBS's Islamic
banking facility Noriba Bank, told the DCM that he seriously
doubts whether the number of Shariah scholars who understand
banking is over 100. In an admittedly unscientific survey,
the Embassy has identified only 40 Islamic scholars who
comprise the Shariah boards of 25 Islamic banks based in
Bahrain or the Gulf region, including Arcapita. The four
members of Arcapita's Shariah board, Shaikh Abdulla Sulaiman
Al Meneea, Dr. Abdul Sattar Abdul Kareem Abu Ghuddah, Justice
Taqi Usmani, and Shaikh Essam Ishaq, either individually or
in some combination also sit on the boards of 18 of the 25
Bahrain- and Gulf-based banks. These include Citibank
Islamic Investment Bank, HSBC Islamic Finance, the
Saudi-American Bank, and the Saudi-British Bank. Abu Ghuddah
is also a member of the Shariah boards of the Dow Jones
Islamic Markets Indexes in New York and UBS in Switzerland;
Usmani is chair of the Shariah board for the Dow Jones
Islamic Market Indexes and for the Bahrain Monetary Agency;
and Ishaq is a director for the Al Baraka Islamic Bank,
Bahrain Development Bank, Discover Islam, Middle East
Traders, and the Islamic Education Society, all from Bahrain.


14. (S) Islamic banks are encouraged to give charitable
donations. (Note: This is different from "zakat," one of
the five pillars of Islam, which requires an individual to
donate a percentage of his wealth to charity. End Note.)
Arcapita reported giving a total $591,000 in 2003 and
$583,000 in 2002 to a variety of charitable organizations.
According to a board member of a charity in Bahrain that
receives donations from Arcapita, the Islamic Education
Society (Al Tarbiya Al Islamiya - Sunni Salafi) and the Al
Islah Society (Sunni Muslim Brotherhood) are the largest
beneficiaries of Arcapita's charitable giving, although the
contact did not have an idea about the amount of money
involved. As noted above, Shaikh Ishaq from Arcapita's
Shariah board is also director of the Islamic Education
Society. (Comment: Ishaq may be in a position to steer a
portion of Arcapita's charitable giving to the Islamic
Education Society. We have seen no evidence, however, that
he or other Shariah board members play any role in Arcapita's
business and investment decisions. End Comment.) The
Islamic Education Society and the Al Islah Society are the
most prominent and powerful Sunni charity organizations in
Bahrain and, according to contacts, it would not be unusual
for a large Sunni business to direct a portion of its
charitable donations to these Societies.

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Denying Deal Could Chill FTA Hopes...
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15. (S) We are aware of concerns linking Arcapita advisors
and staff to questionable organizations. Reftel describes
the status of the Committee on Foreign Investment in the
United States (CFIUS) case 05-17 on Arcapita. We understand
that one of the options under consideration by the CFIUS is
to block Arcapita's bid to acquire a U.S. telecommunications
company. Another option mentioned is investigating the full
array of Arcapita's holdings in the U.S. We are not in a
position to evaluate fully the information upon which these
possible measures are based. We can, however, comment on the
policy implications of possible action against Arcapita.


16. (C) United States relations with Bahrain are
characterized by the promotion and strengthening of U.S.
interests in Bahrain and region. The over 50-year military
relationship, best symbolized by NAVCENT headquarters in
Manama, has been the foundation of our bilateral relations.
The U.S.-Bahrain free trade agreement (FTA),however,
promises to be the catalyst for enhanced economic and
commercial relations. While the FTA will undoubtedly promote
bilateral trade, investment relations will also grow,
including those related to Islamic banking.


17. (S) Denying Arcapita's acquisition bid could have a
chilling effect on the FTA and undermine the positive
benefits that we hope to reap from ratification and
implementation of the agreement. It could harm the United
States' reputation for being open for investment. Such
action could be understood by our opponents in Bahrain as
blocking the single industry sector in which Bahrain has a
clear comparative advantage. It could lead to public calls
in Bahrain against the FTA.

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...Send Signal Islamic Banking Unwelcome in U.S...
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18. (S) The global presence of Islamic banking is a fact.
The industry has experienced strong growth since its
inception in the late 1970's. Many Western and American
banks have Islamic banking units or subsidiaries. A
fundamental requirement of the industry is guidance by
Islamic scholars. The pool of Shariah experts who have a
full understanding of complex financial and investment
instruments is very small, perhaps only 100 people worldwide.
Islamic scholars are, by definition, those who look to the
Koran for guidance on all aspects of life. Many of these
individuals have consorted in the past with those who have
descended into extremism and terrorism, but it is more
difficult to demonstrate where these ties contaminate
business decision-making in the banking sector. As troubling
as this association appears, the measures under contemplation
by the CFIUS are blunt instruments that may damage U.S.
interests without necessarily addressing the core of our
concerns. Additionally, action taken against Arcapita due to
its Shariah board members could require similar action taken
against many other banks, including American banks, because
the same individuals sit on the Shariah boards of a large
number of Islamic banks. Since 9/11, we have worked
diligently to demonstrate that our efforts to combat
terrorism financing were not seen as anti-Muslim. We risk
undercutting this message.


19. (S) How we react to Islamic banking's presence in the
United States will be watched very carefully. Islamic
banking is a new development that could prove to be a bridge
between Muslim and Western economies. There could be serious
consequences for U.S. decisions to prevent Islamic
investments into the country, with our enemies using these
moves to generate propaganda against us.

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...And Degrade U.S. Ability to Win War of Ideas
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20. (S) More broadly, a policy of stopping Islamic
investment in the U.S. would degrade our ability to win the
war of ideas in the Arab and Islamic worlds. We could be
accused of double-crossing, not practicing what we preach, or
being insincere about engaging seriously with Arabs and
Muslims. We should be encouraging the person-to-person
interaction and engagement that are the hallmarks of business
dealings as part of our strategy of promoting liberty and
freedom in Muslim countries.

MONROE