Oral History

Today, the global Islamic financial services industry is estimated to be worth $3.88 trillion, with some predicting its value will increase to as much as $7.5 trillion by 2029. The field is dominated by the Kingdom of Saudi Arabia which hosts the world’s largest Islamic finance market, worth an estimated $826 billion.

As part of our series of oral history interviews with significant figures from the ABA’s past, founding member of the ABA and former Arab Banker Magazine Editor, Elie Elhadj, (1980 - 1986) recalls the formative part that he played in establishing the first Islamic banking institution in Saudi Arabia, Alrajhi Bank.

The 1973 increase in oil prices created an enormous economic boom in Saudi Arabia. The country 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.

In 1980, Alrajhi Company for Currency Exchange and Commerce (ARCECC), was possibly the largest privately owned company in Saudi Arabia. It had $160 million in paid-up capital and 150 money changing and general trading branches.

The company was owned by four Alrajhi brothers, in order of age, Saleh (the chairman), Abdullah, Sulaiman (the 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. ARCCEC’s reputation for safety, efficiency, and competitive pricing was dominant and led to a balance sheet in billions of Riyals. But since the company was not a bank, it was outside the supervision of Saudi Arabia’s Central Bank, the Saudi Arabian Monetary Agency (SAMA).

The Saudi government was concerned that an important financial industry was largely unregulated and had started a process to regulate the money changers in the late 1970s. This 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 and 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. It caused a huge stir in banking circles in Saudi Arabia, Europe, and the home countries of the remitters and tarnished the reputation of Saudi money management.

Advising Sheikh Sulaiman Alrajhi

Regulating the money changers involved banning them from taking customers’ deposits. As a result, ARCCEC, was required to separate its general trading business from money changing and turn the latter into a bank under SAMA’s supervision.

I was working at the London office of Philadelphia National Bank at the time and Sheikh Suleiman was one of my customers. I’ve never met anyone quite like Suleiman Al Rajhi. He was an extraordinary self-educated and self-made giant of a man.

Sheikh Sulaiman did not want this new bank to be just one more conventional bank in Saudi Arabia. He wanted an Islamic bank. But to operate in an interest-free environment, he had to convince SAMA that the future bank would have the capacity to create safe Islamic assets. In May 1980, during a visit to Riyadh he revealed to me his strategy and asked me to think of ways to create Islamic assets.

I said to myself, when was the last invention in banking? Probably when the Italians invented the bankers draft! Commercial banking is conservative and rather unimaginative. You can't be too creative in banking, because if you are, you risk losing the sacred trust of your depositors. So this felt like a life-time opportunity for me – and a unique privilege to work on introducing a new banking instrument to the market. But there were many challenging issues to be considered.

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 prepare the contracts for signing by the ARCCEC in Riyadh. 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 for marketing the new products in Europe and beyond.

Arthur Young produced the memorandum and articles of association of the new company, which I translated into Arabic and a few weeks later I met with Sheikh Sulaiman in his Riyadh office. 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.

Creating a Shari’a-compliant lending structure

We rented a 3,000 square-foot space in the just completed J. P. Morgan building complex at 2 Copthall Avenue in the City of London and 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, Sheikh Sulaiman’s competent son.

But a Shari’a compliant return cannot accrue from the mere passage of time. Capital must be put to work to generate profit. Of course, 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. While a customer would typically borrow, say, $10,000 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 comply with Shari’a laws. A Murabaha contract should only have three parties, a seller, ARCCEC, and a buyer. Furthermore, trading in certain goods, namely alcohol, pork-related products, tobacco, or weapons, is prohibited. Also, forward dealing in currencies and precious metals is not allowed since the difference between their spot and forward prices represents interest. These parameters were all approved by Sheikh Sulaiman and his Shari’a adviser.

The contract also had to be legally acceptable to international corporate customers and be simple to implement. I worked with a brilliant lawyer named Jamie Jowitt, of London law firm, Bischoff & Co. After many meetings we concluded that the new contract should be drawn up under English Law, along the lines of a Banker’s Acceptance (BA), but with a twist. The twist was for ARCCEC to own the goods involved in the transaction by taking title to them. 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).

But taking title to goods was also potentially 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 passed 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.

Marketing the new product

ARCCEC had several billion dollars to deploy, so we were looking for engagement with large global companies in high commodity-linked sectors like oil, mining, chemicals, trading, and manufacturing, among others.

But 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 other jurisdictions it was viewed as financing. Trading or financing would mean different tax treatment for Alrajhi. For the counterparties, the GTA had two important 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 bank 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. A GTA transaction saved the customer around a quarter of one percent in financing costs.

Seven years later, by the end of 1987, ARCCEC’s customers list included 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. 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.

With the formation in 1988, of Alrajhi Banking and Investment Corporation, renamed as Alrajhi Bank in 2006, my task was complete. My years with Alrajhi were the most intellectually exciting and exhilarating of my career.