US embassy cable - 05MANAMA747

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" 
--------------------------------------------- ---- 
 
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 
-------------------------------- 
 
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. 
---------------------------------------- 
 
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 
------------------------------------------- 
 
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... 
------------------------------------- 
 
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 
--------------------------------------------- -- 
 
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