The seven years between September 1980 and December 1987 were the most intellectually creative years of my career. I was given the opportunity by the Alrajhi Company for Currency Exchange and Commerce (ARCCEC) of Saudi Arabia to create the first short-term trade-related Islamic financing instrument and market it around the world as an alternative to conventional bank loans.
In what follows, I will describe the circumstances and the processes that led to the conversion of ARCCEC’s billions of dollars in customers’ deposits to an Islamic bank, the Alrajhi Bank.
Alrajhi and Unregulated Money Changing in Saudi Arabia in the 1980s
In 1980, ARCECC, was possibly the largest privately owned company in Saudi Arabia. It had SR600 million (SR 3.75 = $1) in paid-up capital and 150 money changing and general trading branches, mainly in building materials. It was owned by four Alrajhi brothers, in order of age, Saleh (Chairman), Abdullah, Sulaiman (Managing Director and majority shareholder with 42% of the equity), and Muhammad. The company took customer deposits and transferred money around the world through a network of correspondent banks. To comply with Shari’a Laws, customer deposits did not earn interest. ARCCEC deployed its liquidity in precious metals and currency trading. It also placed funds in bank deposits with the interest given to charity. Since the Company was not a bank, it was outside the supervision of the Saudi Arabian Monetary Agency (SAMA), Saudi Arabia’s Central Bank.
The 1973 increase in oil prices created an enormous economic boom. Saudi Arabia became host to millions of workers from Arab countries, Bangladesh, India, Indonesia, Pakistan, the Philippines, among others. Remittances from expatriate workers to their home countries became a massive business. By the early 1980s, dozens of money changers had sprung up. ARCCEC’s reputation for safety, efficiency, and competitive pricing was dominant and led to a balance sheet in billions of dollars.
Concerned over an important unregulated financial industry, the Saudi government had started in the late 1970s a process to regulate the money changers. The process became urgent in 1982, after the money changing business of Abdullah Saleh Alrajhi, a son of ARCCEC’s Chairman, had failed. The son had created a sizeable network of 40 branches in competition with the company of his father and uncles. The failure was caused by speculation in silver. It resulted in default of over $250 million to precious metals dealers in European banks and to tens of thousands of expatriate workers who remitted their wages through the failed company. The failure caused a huge stir in banking circles in Saudi Arabia, Europe, and the home countries of the remitters. It tarnished the reputation of Saudi money management. I remember visiting ARCCEC’s correspondent banks around the world with Sheikh Sulaiman Alrajhi to explain the difference between ARCCEC and the other businesses carrying the Alrajhi name.
Advising Sheikh Sulaiman Alrajhi
Regulating the money changers included banning them from taking customers’ deposits. As for ARCCEC, it had to separate its general trading business from money changing and turn the latter into a bank under SAMA’s supervision. Sheikh Sulaiman did not want the new bank to be the 10th conventional bank in Saudi Arabia. He wanted an Islamic bank, the first in the country.
During the 1970s a handful of small Islamic banks and finance companies were formed in the Middle East. ARCCEC, in terms of balance sheet totals, was several times the size of the Islamic finance market combined.
To operate in an interest-free environment, Sheikh Sulaiman had to convince SAMA that the future bank would have the capacity to create safe Islamic assets. It was in May 1980, during a visit to Riyadh that Sheikh Sulaiman introduced me to his strategy. He asked me to think of ways to create Islamic assets.
Setting Up an Advisory Company in London
Back in London, it was a life-time opportunity and a unique privilege to work on introducing a new banking instrument to the market. Many challenging issues had to be considered: How to convert an interest producing transaction to a non-interest Shari’a compliant return? Should the transaction be booked in a bank or a finance company? Where? In Riyadh? In London? In New York? In a tax haven? What are the tax implications in each location? Etc…
With help from an accomplished Arthur Young tax specialist, Larry Chrisfield, it was decided that an advisory company in London would be the most efficient structure. It would create a non-interest-bearing legal contract, market the product, and assess the commercial risk of counterparties. The London company would then recommend to the ARCCEC Credit Committee the establishment of credit limits and the contracts. Paying and receiving of funds and booking transactions would be done in in Riyadh in the normal course of ARCCEC’s procedures.
The London operation did not need much capital, just enough for desks, word processors, an IBM 36, and Telex machines. Its tax bill in the UK would be rather small. Indeed, such a function could have been placed in Riyadh, but London was better suited to access lawyers, tax specialists, risk analysts, and to market the new products to companies in Europe and beyond.
A meeting with Sheikh Sulaiman was held in the Hilton Hotel in Bahrain one Friday in July 1980. We spent hours discussing the proposed structure. I was given the green light to form the London company.
Arthur Young produced the Memorandum and Articles of Association of the new company, which I translated into Arabic. Another meeting with Sheikh Sulaiman was held a few weeks later in his Riyadh office. With phone calls diverted and a cleared diary, we spent all day going over every word and comma of the incorporation documents, after which he approved the formation of the Alrajhi Company for Islamic Investments Limited. The directors were to be the four Alrajhi brothers and myself.
Implementation
A 3,000 square-foot space was rented in the just completed J. P. Morgan building complex at 2 Copthall Avenue in the City of London. Incorporation of the new company, furnishing the new office and staffing were completed during the fourth quarter of 1980. We began operations on January 1, 1981.
A liaison office was established in Riyadh as part of ARCCEC’s International Division to approve London’s credit-line recommendations, sign contracts, pay and receive funds, and book transactions. The International Division was headed by Abdullah, the competent son of Sheikh Sulaiman.
Creating a Shari’a-Compliant Lending Structure
The Quranic Verse 2:275: “God sanctioned trade and prohibited usury”. A Shari’a compliant return cannot accrue through the mere passage of time. Capital must be put to work to generate profit, from buying and selling goods; rent, from leasing real estate, equipment, or other assets; and dividends or capital gains from owning assets. Safety of principal and return were paramount. Any loss would have jeopardized the viability of the new concept.
Since rental income and dividends involve long-term risk exposure, they were ruled out. Short-term trading was the choice. To illustrate, while a customer would typically borrow, say, $30,000 from a bank to purchase a car, ARCCEC would purchase the car from a supplier and sell it to the customer at a higher price on a deferred settlement of, say, twelve months. Called Murabaha, the difference between the purchase and sale prices represents trading profit.
The task was now to develop a contract that would protect ARCCEC’s legal rights and:
1. Comply with Shari’a laws. A Murabaha contract should have three parties: A seller, ARCCEC, and a buyer. Conventional lending contracts have only two parties, a lender and a borrower. Furthermore, trading in certain goods is prohibited, such as, alcohol, pork-related products, tobacco, and weapons. Also, forward dealing in currencies and precious metals is not allowed—the difference between their spot and forward prices represents interest. These parameters were approved by Sheikh Sulaiman and his Shari’a adviser.
2. Be legally acceptable to international corporate customers and be simple to implement. To this end, I received considerable guidance from the treasurers of two of the largest companies in the UK and Japan.
I had meetings with a major law firm to help construct such a document, but the staff was not sufficiently creative. I changed to a smaller law firm, Bischoff & Co. I worked with a brilliant lawyer, Jamie Jowitt. After many meetings, we concluded that the new contract should be under English Law, along the lines of a Banker’s Acceptance (BA), with a twist. The twist is to own the goods involved in the transaction by taking title to the goods. While a conventional BA does not take title to the goods, Murabaha must. A 15-page agreement was produced. We called it the General Trading Agreement (GTA).
Taking title to goods can be risky. If a serious accident were to cause damage to life and property while ARCCEC held the title, we would be pursued in the courts for compensation. So, the GTA specified that once title passes to ARCCEC from a supplier, it would immediately (scintilla temporis) pass to the buyers. I am pleased to say that the GTA guided other Islamic banks into documenting their own short-term trade-related financing.
Communicating with Bank of England and SAMA
Although the London company was not a bank, I kept the Middle East staff at the Bank of England informed of Alrajhi’s activities. They knew our tax advisors and law firm. They had a copy of the GTA, along with a regularly updated list of customers with the amount of each facility. I also shared, discreetly, with SAMA, through a senior official I had known from my days at Philadelphia National Bank, the same information submitted to the Bank of England.
Marketing the New Product
ARCCEC had several billion dollars to deploy. It was necessary to engage with large global companies in high commodity-linked sectors like oil, mining, chemicals, trading, manufacturing, among others.
Before approaching a potential customer, the tax implications in the specific country had to be examined carefully. While the GTA was considered a trading activity by one taxing authority, in others, it was viewed as financing. Trading or financing have very different tax implications. The Arthur Young network provided guidance in every jurisdiction.
To market the GTA, ARCCEC’s correspondent banks were often helpful with introductions to certain companies. The GTA had two advantages:
The first was balance sheet attraction. Although the accounting treatment was left to the customer, the obligation to pay for the goods under a GTA could be booked on the liabilities side of the balance sheet as account payable instead of bank borrowing. An account payable entry improves balance sheet ratios.
The second advantage was pricing. A GTA transaction saved a customer a quarter to a half percent in financing cost. A loan was typically priced at the London Interbank Offered Rate (LIBOR) plus a spread. ARCCEC’s pricing was based on the London Interbank Bid Rate (LIBID) without a spread.
By the end of 1987, among ARCCEC’s customers list were 30 of the 50 largest corporations in Europe, and Japan’s biggest trading companies. Credit facilities were $6 billion with outstanding balances more than $3 billion. With gratification, I state that during these years, thousands of transactions were completed without a penny lost. Behind the numbers stood three seasoned banker colleagues: Peter Butler, John Carney, and Barry Noton.
The Next Chapter
With the formation in 1988, of alrajhi Banking and Investment Corporation, renamed in 2006 as alrajhi bank, my task was complete. On January 1, 1988, I returned to conventional banking at the London Branches of Arab Bank of Jordan. My Alrajhi years were the most intellectually exciting and exhilarating years of my career.
Sheikh Sulaiman passed away in 2020. He was an extraordinary self-educated and self-made giant of a man. He was visionary, decisive, thoughtful, and modest.
Led by Sheikh Sulaiman’s son Abdullah, alrajhi bank had on December 31, 2023, a balance sheet total of $215 billion, equity of $29 billion, 500 branches, and 150 remittance centres. In 2023, the global Islamic finance market was estimated at more than $3 trillion.
Note: This article was an interview conducted with Elie Elhadj by the Association of Arab Bankers in London on 07/10/24.