Introduction
This article was first published in Quantum magazine.
Islamic infrastructure finance is likely to be among alternative funding models to benefit from investors seeking to construct more varied project finance packages.
Returning Demand
As the infrastructure finance market starts to recover, it is becoming clear that conventional banks, whose lending capacity is being limited by tighter regulatory controls, will be under pressure to meet all the demand. Consequently, borrowers and their advisers are looking more closely at alternatives—and this will give opportunities to sectors including Islamic finance.
This will enable Islamic investment banking to build on the current position, where its involvement is largely restricted to the Middle East and Asia—and even in this region its participation is limited by the small asset base.
The Middle East is still the dominant region, with the main focus on the Gulf states, although there is increasing demand in other areas such as north Africa. But that balance may soon change. Beyond the Middle East and Asia, concession-holders and banks are starting to consider including Islamic financial tranches in their project finance structures, which would enable them to diversify their sources of funding by accessing Middle Eastern capital.
Islamic infrastructure finance should thus regain some of the momentum that it had before the financial crisis struck in 2008. At that time, there was real confidence that the number of projects would continue to expand rapidly, with Islamic financial structures taking an increasingly large role in the financing of these projects both inside and outside the Gulf Cooperation Council.
Historical Perspective
A number of projects had started to explore the use of Islamic financial structures, if not for the whole project then at least for a tranche of the total financing requirement. The most commonly used vehicle today for project finance is a combination of istisna’a (financing of a large asset during production) and ijarah (lease). The easiest transactions to structure Islamically are those with specific identifiable assets, such as a power station or petrochemical plant, although there is no reason why infrastructure-related assets such as roads should not also be financed in this way.
The need for capital from the market to finance this type of project is certain to grow. Historically, all types of projects—ranging from railways to roads, bridges, power plants, ports, waterworks, and gas distribution systems—were built across the world by private entrepreneurs. They were largely financed by private capital, provided by risk-takers in the hope of high returns. Some were profitable, others were not.
Over time, the number of such entrepreneurs declined, and projects were financed through public-sector borrowing, with the state and public-utility organizations as the main clients. After World War II, most infrastructure projects in industrialized countries were built under the supervision of the state and funded out of sovereign borrowings and tax revenues.
Modern infrastructure finance marks the third phase of financing projects. Its use is likely to become more significant as governments are less able to fund projects from their own balance sheets, due to the massive deficits in most developed countries. Islamic infrastructure finance is an excellent vehicle for the latest process: the construction phase is backed by investors who realize a return in the form of, for example, toll monies or leasing rentals for a given period of time.
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