By Richard Dean
Dubai, United Arab Emirates (Reuters) - Some Gulf Arab and Asian governments have begun diversifying reserves into Islamic financial assets, but a shortage of Islamic sovereign bonds will slow the process, a senior banker said on Sunday.
Iqbal Khan, Chief Executive of HSBC Amanah Finance, the Islamic banking unit of HSBC Holdings Ltd, said the shift was part of a wider trend among Asian governments to diversify their reserves away from U.S. dollar-based assets.
"Central banks in Muslim countries are investing into those (Islamic) instruments that are made available to them," he said on the sidelines of an Islamic finance conference in Dubai.
"As the Islamic finance industry expands and brings out institutional products, more and more reserves of Islamic countries will be invested Islamically," he told Reuters.
Khan said few governments have so far issued Islamic bonds, known as sukuks, restricting the ability of central banks in Muslim countries to hold them in reserve portfolios.
But he said the supply of sukuks is growing, albeit from a small base, and that he saw "big issuers who would want to tap this market."
Islamic bonds comply with sharia law that forbids interest payments. Instead, investors receive regular payments based on profits from approved investments.
Sukuks are normally priced in the same way as conventional bonds, with a spread based on an established interest rate benchmark such as London Interbank Offered Rate (LIBOR).
Malaysia and Bahrain were among the first governments to issue sovereign sukuks.
But in 2004, the German state of Saxony-Anhalt became the first non-Muslim government to tap the Islamic fixed income market. It raised 100 million euros ($134.3 million) through a five-year sukuk.
Khan said that as the legal structure for issuing sukuks becomes routine, rather than exceptional, more Muslim and non-Muslim governments will seek to tap the market.
"There is a demand and we have a proposition that is competitive and allows issuers to broaden and deepen their investor base."
Khan said 2005 would be "much, much busier" than 2004 for sukuk issues, with Islamic governments the main issuers, and Western governments a secondary source of issuance.
Gulf Arab states are often secretive about how they invest their surplus petrodollars, but analysts say that historically, Arab central banks and state investment funds have been significant buyers of U.S. assets, including government debt.
The government of Dubai, a trading hub in the oil-rich United Arab Emirates, wants to establish the emirate as a regional center for Islamic finance.
HSBC Amanah's global head office is based in Dubai, but analysts say Bahrain is currently the Middle East's Islamic finance hub.