Islamic Bonds Provide Debt Relief for German State

With €16 billion ($19.5 billion) in debt, the eastern German state of Saxony-Anhalt is one of the poorest regions in Germany.

In order to help get its debt under control, state leaders are expected to issue Europe's first Islamic bond within the next few months. Should they succeed, Saxony-Anhalt will be among the increasing number of Western borrowers looking to cash-rich Muslim investors as a source of funds.

Islamic bonds differ from regular bonds in that they pay no direct interest, which is forbidden under Sharia law. Instead, they make regular payments based on profits from approved investments.

Profits from leasing

Saxony-Anhalt expects to issue around €100 million worth of debt in a bond adapted to meet the requirements of Sharia law. The profits for investors would come from leasing transactions. The state government would transfer the rights for the use of some state properties, such as the Finance Ministry, to a Dutch foundation authorised to issue Islamic bonds.

Saxony-Anhalt would continue to use the properties by paying leasing fees, meaning that the holders of the bonds receive rent from the properties instead of interest. After five years, the state would buy back the rights to its properties. Axel Guehl of Saxony-Anhalt's finance ministry predicts a 3.8 to 4 percent rate of return to investors after the five year period.

The idea to issue Islamic Bonds developed out of conversations with Arab investors, said Guehl. Saxony-Anhalt has never been dependent on Muslim investors before,"but why should the state ignore a market that is growing so strongly each year?" Guehl told DW-WORLD.

He added that it's not just about getting funds for the state coffers. "We want to send this market a message, to say, 'Look, here's a region that's openly considering issuing securities that are compatible with another legal culture and another financial culture. We're prepared to strengthen trade and cooperation with your region.' I think it's a really integral way of doing business."

No financial links to porn, gambling, alcohol or pork

Before the Islamic bonds can go on the market, a "Sharia-board" -- a group of Islamic experts -- has to check if the investment opportunity is in accordance with Islamic law. Not only does it forbid interest payments, it also bars financial links to industries involving alcohol, gambling, pornography, weapons or pork.

Even though Saxony-Anhalt is highly in debt, the state has received positive ratings as a borrower from investment companies. Non-muslims have also expressed interest in the bonds, according to Guehl.

Saxony Anhalt is breaking new ground with its interest in Islamic bonds, and that has also meant a degree of skepticism. Guehl said he's faced repeated questioning about the possibility that Islamic organizations could use the scheme for money laundering purposes. But he said that's an unfounded concern.

"We always refer to the fact that the Arab capital market has strict regulations on money laundering, and that, in addition to this, the U.S. bank Citigroup, which is bringing the bonds onto the market, also has a precautionary strategy, so we feel that we're in good hands," Guehl said.