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Takaful industry faces slower growth, unstable returns study

Oct 21 Expansion of the takaful (Islamic insurance) industry is slowing as firms struggle for scale and face growing competition, but the sector is still poised to sustain double-digit growth, according to a report by Ernst & Young. Takaful, an industry which attracted $10.9 billion in gross contributions worldwide last year, has its core markets in the Gulf and southeast Asia and serves as a bellwether of consumer appetite for Islamic finance products. Driven largely by Saudi Arabia and Malaysia, takaful globally is expected to grow by 16 percent annually in coming years compared to an average 22 percent rate between 2007 and 2011, said Ashar Nazim, Islamic financial services leader at consultants Ernst & Young. That would see the industry edge close to $17 billion in annual gross contributions by 2015, with Saudi Arabia making up almost half of that figure, the report showed. But firms have expanded in narrow product segments such as auto insurance which are saturated by competitors, sparking price competition to gain market share, Nazim added."Unless serious thinking goes into strategising the model and structures, you'll grow your market share at the expense of profitability."A shift from general insurance to more profitable life business remains unlikely in the Gulf because of comfortable government-funded safety nets, with general business commanding a market share of as high as 96 percent in Saudi Arabia. Takaful firms have struggled to control costs because of expanding workforces, and they have lost business to conventional rivals which can underwrite larger risks more efficiently.

Lopsided portfolio allocation is a key problem, especially in the Gulf outside Saudi Arabia where firms invest 25 percent in equities but just 2 percent in the more stable sukuk asset class, the report showed. Saudi takaful firms allocate more to sukuk, 25 percent, but 44 percent is held in low-yielding cash deposits because of regulatory requirements. This means profits can swing widely. Return on equity for a sample of Gulf firms reached 0.4 percent in 2012, up from minus 7 percent in 2011 and minus 4 percent in 2010, the report said. In Saudi Arabia, return on equity jumped to 4 percent last year from minus 6 percent in 2011 and minus 1 percent in 2010. Such volatility requires greater use of reinsurers, which in turn erodes profits: reinsurance ratios for takaful firms are as high as 38 percent in the Gulf and 31 percent in Saudi Arabia, with Malaysian firms at 14 percent.

CROSS-BORDER Geographical expansion is one way out, but this is difficult because of expensive regulatory requirements and the lack of a standard approach to sharia-compliance across the world - two major barriers which remain unadressed, Nazim said."Unless there is regulatory clarity across borders, and a certain level of convergence, we believe this is holding back the internationalisation of the industry."Aside from a few operators in Saudi Arabia and Malaysia, most takaful firms lack the balance sheets necessary to explore markets such as Indonesia, Turkey, Egypt and Qatar, which offer strong potential because of their demographics.

Although scale is a priority and there are 77 operators in the Gulf and 36 in Africa, consolidation looks unlikely."We do not see consolidation as a major theme in the near future. For this to happen there needs to be good value in the business. It's still a very young industry and it needs to be given the room to proliferate and grow in a more entrepreneurial way," Nazim added. Clearer distinctions between takaful firms and conventional insurers are poised to change the sector in countries such as Malaysia and Indonesia. Malaysia's Islamic Financial Services Act, introduced in July, requires the separation of life and general business lines; firms with composite licences that cover both sectors have five years to separate them. Indonesia, which has 46 takaful operators, is poised to move away from allowing takaful windows, through which takaful services are offered by conventional insurers, Nazim said."This will create greater clarity and focus in business models, a good thing for the industry. In the near term, it'll require some operators doing composite business to reposition themselves," said Nazim."Only once there is clarity, then operators can understand what kind of consolidation can create or destroy value."

Update 2 chinas wen govt debt risk controllable, sets reforms

* Premier Wen says nation's govt debt at controllable level* Vows economic management won't cause risks to financial system* Comments from speech to financial work conferenceBy Aileen Wang and Chris BuckleyBEIJING, Jan 30 China's Premier Wen Jiabao said the nation's government debt is at an "overall safe and controllable" level, that funding for key projects would be ensured and that applying the brakes to the problem would be done in a way to avoid systemic risks. Investors have been worried by the scale of the debts built up by China's local governments, which some fear could threaten the stability of the banking system. Wen's comments, reported in the official People's Daily on Monday, were made in a speech dating back to early January at the government's flagship financial work conference. Wen pledged to contain and defuse local government debt risks and avoid the spread of financial risks."Currently, our government debt is overall safe and controllable," he said."We are taking the issue of managing local government debt very seriously. Through clean-ups and regulation, the trend of expanding investment vehicles has been effectively contained."China's state audit office said earlier this month it had uncovered 530 billion yuan ($84 billion) worth of irregularities involving local government debt. But the figure is a fraction of the 2 trillion-3 trillion yuan of sour loans economists believe are buried in the 10.7 trillion yuan of debt local governments had at the end of 2010.

ACTIVELY, APPROPRIATELY EASE RISKS Wen said China "must both actively and appropriately ease financial and fiscal risks, and also ensure the funding needs of key construction projects approved by the government". But he warned against a simplistic approach to local government investment."We cannot simplistically hit the brakes and use a one-size-fits-all approach, and must avoid turning localised risks into comprehensive, systemic risks," he said. Wen also urged greater attention and controls on systemically important financial institutions.

"We must study standards for determination and a framework for assessing our country's systemically important financial institutions, and we must adopt more stringent oversight standards towards these institutions, enhancing external constraints on them," he said. Wen also vowed to "break monopolies" against private capital participation in the financial sector, promising broad reforms to ownership and capital structures in banking, equities, insurance and other financial institutions that would encourage more private capital to flow into the financial services sector."Improving financial services for small businesses requires the reform, innovation and regulated development of financial institutions that come in different types and different sizes," he said, making clear there was a role for private credit in the economy, providing it was properly regulated. In addition, Wen made the case for more market-based reforms to interest rates and credit pricing to enhance their roles, along with exchange rates, as price levers. Wen said China should "accelerate nurturing of a market system for benchmark interest rates, guide financial institutions towards enhancing their risk price-setting capacities, and steadily advance marketising reform of interest rates". And he repeated the long-standing commitment to "further improve the renminbi exchange rate formation mechanism, strengthen the flexibility of the renminbi exchange rate in both directions, maintaining a basically stable renminbi exchange rate at a reasonable and balanced level".

China would push forward with yuan convertability in an orderly manner and broaden the use of the currency in cross-boarder trade settlement, he added. And Wen reiterated that the government would further diversify its huge $3.18 trillion foreign exchange reserves."We should explore a multi-layer investment channel for our foreign exchange reserves and further improve the skill of managing the reserve assets by steadily diversifying the investment to maintain safety, liquidity and preserve and increase its value," he said. SUPPORT FOR ECONOMIC INNOVATION The Premier said China's financial institutions must step up support for key areas of economic structural adjustment, for projects aimed at saving energy and reducing pollution, and for indigenous innovation. Beijing has unveiled a slew of tax breaks to help cash-strapped small firms cope with rising costs and has also allowed them to issue more bonds and tap other sources of financing to ease the funding squeeze. China's big four state-backed lenders are criticised by small and medium-sized business owners for directing the bulk of their lending capacity to major state-owned enterprises. Bank lending in China is essentially rationed by the government, which sets an annual lending target and decides how much credit can be created in the economy. China has set a target of 8 trillion yuan ($1.27 trillion) in new local-currency bank loans and 14 percent growth in broad M2 money supply for 2012, three sources familiar with government plans told Reuters earlier this month. That marks a rise from 7.47 trillion yuan in new bank loans and annual M2 growth of 13.6 percent achieved in 2011, implying a further loosening of policy by the People's Bank of China to support the economy as growth loses steam and inflation cools.