The Growing Importance of Islamic Finance

JBIC TODAY JULY 2007 2

JULY

The Growing Importance of Islamic FinancePetrodollars Begin Recycling in Asian Markets —

Strengthening Relations with Middle Eastern Countries

The Future for Japanese ODA loans:

More Advantageous Conditions, More Effective AssistanceApplying Japan’s Development Experience and Expertise

2 JBIC TODAY JULY 2007


Bahrain Malaysia

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Islamic financial assets of the banking sector, Bahrain and Malaysia, 1998-2006

Crude oil prices and Middle Eastern petrodollars, 2001-2006

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Crude oil prices

Middle Eastern petrodollars

Source: Datastream, Bloomberg. Graph compiled by JBIC. Source: Bank Negara Malaysia (Central Bank of Malaysia) and Bahrain Monetary AgencyNote: 2006 data for Malaysia not available.

US$ BillionUS$ Billion

to different estimates by the International IslamicFinance Forum, are worth either upward of US$260billion or upward of US$400 billion.

This rapid expansion has been driven by thegrowing investment needs of Middle Eastern oil pro-ducing countries awash in petrodollars as a result ofthe steep global rise in crude oil prices. Meanwhile,other countries, mainly in the West, have stepped upefforts oriented toward Islamic finance, eager to wel-come new investment capital. In the 1980s, the U.K.gained successful experience in the global recyclingof petrodollars through eurodollar markets. Britainenvisions the City of London as the gateway forIslamic finance, and recently, with this goal in mind,it wasted no time in granting commercial bankinglicenses to banks that specialize in Islamic financialservices. Parallel to this development, U.S. financialinstitutions established financing subsidiaries inBahrain in the 1990s, and this spurred the entry ofmajor international commercial banks into the worldof Islamic finance.

The Globalization of Islamic FinanceWith Islamic finance now strengthening its presencein international finance, there is a growing need toensure transparency, harmonize standards for suchservices (which have unique features originallydeveloped to serve local markets), and ensure con-cordance with conventional financial systems. Topromote these goals, in 2002 the central banks of anumber of Muslim countries were the main partici-pants in the establishment, as founding members, ofthe Islamic Financial Services Board (IFSB). Hopesare high that these goals will be met through theefforts of organizations such as the IFSB. (For furtherinformation on the IFSB, see pages 4 and 9.)

1. Islamic Financial Markets Today

Essential Features of Islamic FinanceToday’s Islamic finance has roots that go back toaround 1980, when Islamic financial instrumentswere used primarily in Malaysia and Bahrain to pro-mote the acquirement of relatively small assets suchas motor vehicles, precious metals and housing.Islamic finance is based on Shari’ah (Islamic law),which in turn is based on teachings in the Qur’an,the sacred book of Islam. Islamic banking practicesprohibit the financing of businesses violating reli-gious precepts (for example, alcohol, gambling andhog farming), the taking of interest, and speculation.Lenders and borrowers conduct transactions in realassets and share the resulting profit or loss. (Seepages 7 and 8 for a further explanation of Islamicfinancing methods.)

Expansion into Global MarketsIslamic finance slowly but surely gained momentumand experience in the 1980s. Its opportunity forlarge-scale expansion came at the beginning of thiscentury, after the issuance of Islamic bonds (sukuk)and the development and promotion of markets fortrading in these bonds. Governments and govern-ment institutions in Muslim countries, notablyBahrain and Malaysia, have launched major sukukissues, and even the World Bank has raised fundsthrough sukuk in Malaysia. Malaysia and Bahrainare currently the two largest centers for the Islamicfinancial market — in Malaysia, where the govern-ment takes an active role in Islamic finance, Islamicfinancial assets are now about 10% of total assets.Islamic financial services are now offered in morethan 75 countries by more than 250 financial institu-tions. Assets under management are growing atannual rates of between 10 and 15%, and, according

Keys to understandingIslamic finance

Islamic Financial Services Board (IFSB)

One of the IFSB’s functions is to explore ways to harmonize rules and standards governing Islamic finance. It was inaugurated in 2002 by institutions in Muslim countries, most located in the Middle East. The Secretariat is in Malaysia. There are currently 20 full members, many of them central banks of Muslim countries. There are 15 associate members, including the International Monetary Fund and the World Bank. JBIC is one of 90 observer members.

Petrodollars

Surplus foreign currency assets that have their source in the net petroleum profits of oil-producing countries.

The Growing Importance of Islamic Finance Petrodollars Begin Recycling in Asian Markets — Strengthening Relations with Middle Eastern Countries


Islamic finance while strengthening its relations withrelevant institutions. It frequently shares informationwith the IFSB, which was established in 2002. TheIFSB recommended that JBIC join it as an ObserverMember, and in January 2007 JBIC became the firstJapanese financial institution to do so. JBIC’sobserver status permits it to attend IFSB meetingsand access Islamic finance information compiled formembers. Observer status therefore offers extremelyvaluable opportunities to explore and developfinancing programs using Islamic funds.

(2) Seminar on Islamic Finance Held at JBIC HeadquartersThe IFSB and JBIC organized a Seminar on IslamicFinance in January 2007 to facilitate Japanese under-standing of the Islamic financial services industry. Thetwo-day seminar, held at JBIC headquarters, was thefirst of its kind in East Asia. After keynote addresses bythe IFSB Secretary General and the Governor of theCentral Bank of Malaysia, specialists spoke on sub-jects such as the supervision and regulation of Islamicfinance, legislation, market perspectives, and Islamicfinancial services in Japan. Seminar participants filledthe hall and asked pertinent questions.

2. Recycling Petrodollars in Asian Markets: The Part JBIC Plays in Japan’s Initiative

The Flow of Petrodollars into Asian MarketsRamifications from the terrorist attacks in the UnitedStates in 2001 led to a stronger tendency amongMiddle Eastern oil producing countries to investtheir petrodollars in their own region. But by the fol-lowing year those petrodollars were once againbeing recycled to an increasing degree — althoughindirectly — in Western securities markets, whichwere viewed as places where continually expandingassets would be managed effectively. But there arenow signs of a growing eagerness to invest in Asianmarkets where the potential for future economicgrowth appears strong, and this tendency is especiallyprevalent in Malaysia, which is energetically promotingIslamic financial practices. The challenge is to seizeevery opportunity to recycle those petrodollars inAsian markets, and to use their potential to effectivelypromote economic and social development in Asia.

The Positive Role Japan Can PlayThe Japanese government, now interested in thepotential of Islamic finance, is collaborating with theFinancial Services Agency, the Bank of Japan andJBIC to promote stronger relations with IFSB and toobtain more information on Islamic finance. It isimportant that Japan make optimum use of its expe-rience, knowledge and credit-worthiness to establishties with countries such as Malaysia that aim tobecome global Islamic financial centers. By promot-ing Islamic finance in the Asian market as a whole,Japan would encourage Middle Eastern petrodollarinvestors to recognize the advantages of Asia as aninvestment destination.

JBIC: Becoming Japan’s Expert on Islamic Finance(1) JBIC: Becoming Japan’s Center for Information on

Islamic FinanceJapan is home to the largest financial trading marketin Asia, but it has almost no experience in Islamicfinance. As a first step to changing this, JBIC is gath-ering information and conducting research on

Left: The Governor of theCentral Bank of Malaysia,speaking at the seminar. Below: The seminar wasvery well attended.

Islamic Finance Study Group

JBIC established the Islamic Finance Study Session in May 2006, after signing Memorandums of Understanding to that effect with private financial institutions (Sumitomo Mitsui Banking Corporation, Mizuho Corporate Bank and Bank of Tokyo-Mitsubishi UFJ).


(3) JBIC To Share Information with Private Financial Institutions

Japanese financial institutions do not yet have expe-rience with Islamic finance, so they are not veryfamiliar with its distinctive approach.

It is customary for financial institutions thatconduct Islamic financial transactions on a regularbasis to establish advisory boards composed ofIslamic legal scholars to help them ensure that theirmethods and systems conform to Shari’ah. ButJapanese financial institutions have had little oppor-tunity to come in contact with Islamic legal scholars,because of their lack of experience in Islamicfinance.

Therefore, in May 2006 JBIC established aShari’ah Advisory Group composed of Islamic legalscholars. This was the first such step taken in Japan.JBIC has signed Memorandums of Understanding(MOUs) on business cooperation with private finan-cial institutions who are convinced that Islamicfinance offers significant business opportunities.Under the MOUs, Islamic Finance Study Groups willbe held when appropriate, to disseminate the knowl-edge gained from the Shari'ah Advisory Group.

(4) JBIC Making Tangible Progress on IntroducingIslamic Finance

JBIC co-hosted the Seminar on Islamic Finance inearly 2007, and has signed a Memorandum ofUnderstanding on Islamic finance with the CentralBank of Malaysia.

JBIC is considering issuing Islamic bonds(sukuk) after conducting studies, in order to promotethe development of Islamic finance in Asia and betterserve local capital needs. The Central Bank ofMalaysia leads the Islamic finance sector in Asia, andthe stronger cooperative relationship that JBIC hasnow established with the Bank is highly significant.

JBIC intends to continue gaining and sharingknowledge and concrete experience in matters ofIslamic finance, so that it can better contribute to thefurther development of Islamic financial services inAsia and the recycling of petrodollars within Asia.

I believe that the Islamic community from the East tothe West has warmly welcomed the interest shown bythe Japanese government, Japanese governmentalinstitutions, especially JBIC, Japanese financial insti-tutions, and Japanese enterprises and individuals inIslamic Finance.

Islamic finance relates to all financial activitieswhich are conducted in accordance with Islamic Law,known as Shari’ah. The most unique characteristic ofIslamic finance is that all products offered by Islamicfinancial institutions must be Shari’ah compliantthrough review by a Shari’ah Advisory Board whichis established in each Islamic financial institution.Although it is possible that interpretations of theShari’ah by Shari’ah Advisory Boards may be differamongst Islamic financial institutions, the Islamicfinance community is making efforts to harmonizethe interpretation of the Shari’ah amongst Islamicfinancial institutions and also to harmonize that commoninterpretation of the Shari’ah with conventionalfinance.

A feature which distinguishes Islamic financefrom conventional finance which I would like to mostemphasize is that conventional banking pricesmoney (in the form of interest), whereas Islamicfinance prices goods and services which promotesentrepreneurship, wealth creation and economicwell-being. The profit and loss sharing and partnershipmodels featured in Islamic finance products meansthat financial institutions become investors ratherthan creditors which encourages a fairer distributionof wealth in the society which is also representativeof true productivity.

I hope that Japanese institutions and enterpriseswill become more interested in Islamic finance as thefuture cooperation between Islamic and Japanesefinancial institutions will lead to a deeper under-standing and appreciation of the societies which theyrepresent, and also opportunities to create wealthwhich will be mutually beneficial.

Cooperation Will Lead to MutualUnderstanding Between MuslimSocieties and JapanMuhammad Imran Usmani, Ph.D.,Member of the JBIC Shari’ah Advisory Group, and memberof the Shari’ah Board of the Meezan Bank (Pakistan)

The Growing Importance of Islamic Finance Petrodollars Begin Recycling in Asian Markets — Strengthening Relations with Middle Eastern Countries


BAPCO refinery

PETRORabigh oil refinery and petrochemical plant

Bahrain government. Funds required for the construc-tion and equipping of the environmental conservationproject were procured using the Islamic financingtools of overseas financial institutions, and this hascreated a model for programs cofinanced withIslamic financial instruments.

Saudi Arabia: Project Financing for an OilRefining and Petrochemical Project (2006) Saudi Arabia’s Saudi Aramco, the world’s largestpetroleum company, and Sumitomo Chemical Co.,Ltd., have decided to establish a refining and petro-chemical company called PETRORabigh with equalcapital investments. The new company will acquireand improve an existing Saudi Aramco oil refinery,and construct new facilities for the production ofrefined petroleum products and petrochemical prod-ucts such as polyethylene. JBIC is providing SaudiAramco and PETRORabigh with loan in projectfinancing.

The project financing, the first from JIBC toSaudi Arabia, will support that country’s efforts todiversify its petrochemical industry, give addedvalue to its petrochemical products, and create morejobs. Use of Japan’s advanced technology willensure the stable, low-cost production of products ata time when crude oil prices are spiraling upward.The project financing will promote friendly relationsbetween both countries, and represents a cofinancingarrangement that involves Islamic financialresources from overseas financial institutions.

3. Projects Cofinanced with Islamic Finance Partners

JBIC’s Experience with Islamic Finance inMiddle Eastern ProjectsFulfilling its role as a policy-oriented financial institutionmandated to harmonize Japan’s external economicpolicies with its economic cooperation programs, JBIChas offered financial assistance to many projects indifferent parts of the world. A number of investmentprojects and large infrastructure projects in whichJapanese corporations have participated have recentlybeen cofinanced with Islamic finance partners, particu-larly in the Middle East. This shows that, even incases of direct corporate participation, Islamicfinance is taking on greater importance in the worldof international finance.

In the Middle East and the Persian Gulf region,conventional and Islamic financial systems are oftenblended to support project financing schemes. Thereis every reason to assume that this type of blend willcontinue to be used for major infrastructure projectsthere, such as petrochemical and LNG plants, powergeneration facilities and desalination plants.

Bahrain: Buyer’s Credit for a PublicPetroleum Company (2005)In response to the worldwide trend toward tighterenvironmental regulations, the Bahrain PetroleumCompany (BAPCO) decided to purchase advancedenvironmental conservation equipment from Japan,primarily a desulphurization unit, in order to lowerits refinery’s diesel fuel sulfur content to 10ppm, alevel that meets the environmental standards ofadvanced countries.

JBIC extended buyer’s credit to BAPCO for aloan for JGC Corporation to export the equipment asa set. This was the first direct loan commitment thatJBIC provided Bahrain. The loan was arranged sothat revenues from the sale of petroleum productsare set aside for the purpose of repayment, therebyavoiding the need for a loan guarantee from the

Car retailer Islamic bankPays lump sum

Resells car at a higher price,the difference being comparable

to interest

Sells car

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Islamic financing methods

Typical contractual arrangement: Cost-plus loan

(murabahah)

This method, applied since the early days of Islamic finance, is often used for individuals acquiring a relatively small material asset, such as a car or house. In Islamic finance, about 70% of all capital management schemes follow this method.

A similar method, called istisna’a, is applied when there is no material asset at the time of the contract (for example, a house purchased before it is built).

Islamic financial instruments

for project loans

Global Islamic Project Loans (IPLs)

IPLs use Islamic finance methods to finance a project.

IPL financing has soared recently — the total amount provided in the first seven months of 2006 exceeded the total value of loans in 2004 and 2005. The number of loans is also increasing sharply. Contrasted to this, the average amount of loans provided during 2006 was less than for 2005, thereby actually demonstrating again that IPLs are gaining favor.

Project financing through IPLs is often a blend of Islamic financing with conventional financing methods. It is anticipated that cofinancing with an Islamic finance component will rise even higher, especially for private-sector water and power producers (IWPP*) in the Middle East and Persian Gulf region.

What is Islamic finance?

Islamic finance is also called Shari’ah-compliant finance, because its financial and commercial affairs conform to Shari’ah (Islamic law). These financial services abide by two major sources of inspiration: the Qur’an (the sacred book of Islam), and the Sunna (practices and traditions from the time of the Prophet Muhammad). Islamic finance is practiced by Muslims in the Islamic world, of course, but it is also expanding as an international financing practice in the global market.

The most distinguishing features of Islamic finance are: (1) riba (interest) is prohibited; (2) profits and losses are shared by the capital provider and the entrepreneur; (3) transactions are backed up by material, not intangible, assets; and (4) financing for businesses violating religious precepts (for example, alcohol or gambling) is prohibited.

Murabahahcontract

Installment payments

End purchaser

(Example: An individual needing a loan to purchase a car)

* An IWPP (Independent Water and Power Producer) builds and operates power generation and water desalination plants on its own, and sells the electricity and water.

IPLs: Total amounts, 2004 – July 2006

IPLs: Average amount per loan, 2004 – July 2006

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Islamic financial services is without doubt rising to greater prominence inthe global financial system, and over the last decade or so has rapidlyextended beyond predominantly Muslim emerging economies to majordeveloped economies. This growing significance demonstrates the viabilityof Islamic finance as a basis for financial intermediation that supports economicgrowth and national development.

While initially developed to fulfill the needs of Muslims, Islamic financialservices have now gained universal acceptance, and the appreciation oftheir potential has motivated international financial institutions to ventureinto this fast expanding market. Financial institutions now offering Islamicfinancial services are constantly developing and innovating Shari’ah compliantproducts to suit market demands. While it can be seen as a significant andpositive development in the global financial system, this extreme growthposes a major challenge both to regulators and international inter-govern-mental organisations that are entrusted with the task of monitoring thesoundness and stability of the financial systems in various jurisdictions, andto the market players themselves.

The two fundamental challenges facing the Islamic financial servicesindustry are to ensure that the industry operates (1) as an integral part of theinternational financial system; and (2) on a sound and stable basis.

The integration of the Islamic financial services industry into the globalfinancial system will to a large extent be facilitated by high quality prudentialstandards which, while complementing existing international standards, alsoaddress the specificities of Islamic finance. We believe that the IFSB has asignificant role to play in promoting and facilitating this integration.

Role of the Islamic Financial Services BoardThe IFSB was officially inaugurated on 3rd November 2002 with nine foundingmembers — the Central Banks of Bahrain, Indonesia, Iran, Kuwait, Malaysia,Pakistan, Saudi Arabia and Sudan as well as the Islamic Development Bank.Malaysia, the host country of the IFSB, has enacted a law known as theIslamic Financial Services Board Act 2002, which gives the IFSB privilegesand immunities that are reserved for international organisations and diplo-matic missions.

The membership of the IFSB (as at March 2007) is 126 organisationscomprising regulatory and supervisory authorities, international inter-govern-mental organisations such as The World Bank, International Monetary Fund(IMF), Bank for International Settlements and Asian Development Bank as wellas market players and financial institutions operating in over 22 jurisdictions.

It is worth noting the increased interest in the Islamic financial serv-ices industry, especially from non-traditional Muslim markets. In the pastyear, we admitted regulatory authorities and financial institutional membersfrom Japan, Hong Kong, Singapore, Germany, Turkey and the UnitedKingdom. Japan Bank for International Cooperation joined the IFSB as anObserver member in January 2007.

Since its inception, the IFSB has issued three standards and guidingprinciples for the Islamic financial services industry focusing on RiskManagement, Capital Adequacy and Corporate Governance. Two furtherstandards on Supervisory Review Process and Transparency and MarketDiscipline are scheduled for adoption by the IFSB Council by end of 2007.They are currently being issued as exposure drafts, as part of a public con-sultation process. The IFSB is also working on three new standards andguidelines on Special Issues in Capital Adequacy, Governance of InvestmentFunds and Corporate Governance in Takaful Operations.

In developing its standards and guidelines for the Islamic financial

services industry — broadly defined to include banking, capital markets andinsurance - the IFSB does not attempt to reinvent the wheel. Rather, it compli-ments the standards and guidelines issued by its international counterparts.

It has to be noted that similar to other international standard-settingorganisations, the IFSB does not have the power to enforce the implementationof the standards and guidelines it promulgates. In this respect, the IFSBendeavours to develop high quality standards and guidelines while workingtogether with regulatory and supervisory authorities in member countries as wellas other relevant international organisations to conduct awareness programmessuch as workshops and seminars so as to facilitate the implementation of itsstandards and guidelines.

Cross-Sectoral Approach to Supervision of IslamicFinancial ServicesThe scope of financial services for the IFSB includes banking, capital mar-kets and takaful segments of the Islamic financial services industry. Whileeach sector is constantly innovating and developing new Shari'ah compliantproducts and services, the role of the IFSB is to assist and facilitate theindustry to operate on a sound and stable basis.

The forthcoming IFSB Summit on 15 - 16 May 2007, which will be heldin Dubai, will focus on “The Need for A Cross-Sectoral Approach to theSupervision of Islamic Financial Services”. The Central Bank of the UAE ishosting the Summit, and it will be held under the Royal Patronage of the HisHighness Sheikh Mohammed bin Rashid Al Maktoum, Vice President andPrime Minister of the UAE and Ruler of Dubai. Among the distinguishedchairpersons and speakers who have confirmed their participation are theManaging Director of the IMF and the former Prime Minister of New Zealandtogether with 12 Governors of Central Banks and Chairmen of Securities andInsurance Commissions. The Summit will discuss alternative regulatorystructures for effective supervision, the relevance of a cross-sectoralapproach of supervision for Islamic financial services, the approach from thestandard-setters’ and market players’ perspectives as well as challengesand opportunities that lie ahead for cross-sectoral supervision.

The 4th IFSB Summit aims to facilitate constructive discussion andexchange of ideas on an approach which may prove relevant at a time manystakeholders are watching further developments within the industry, devel-opments that will further the position of Islamic finance as an integral part ofthe global financial system.

Potential benefits of JBIC's proposed sukuk issueJBIC is considering issuing sukuk (a type of bond) in Malaysia. If it does so,we hope that Japanese government institutions and private companies willactively explore ways to use the sukuk market as a way to raise funds.

The proposed sukuk would be the first ever issued by a governmentor government institution of a G8 country, and would represent an importantstep toward the involvement of Islamic financial services in the global finan-cial system. International credit rating institutions would probably assign asovereign credit rating of AA or even higher to quality sukuk issued by aJapanese government institution. It is expected that repeated issues wouldestablish global benchmarks, Islamic capital markets would secure astronger position for themselves in Asia, and the day would soon come whenpetrodollars would be recycled within the Asian market.(The above text is an article submitted by Professor Karim in the end ofMarch 2007, with the addition of some of his remarks at the January 2007Seminar on Islamic Finance.)



The Future for Japanese ODA loans: The Future for Japanese ODA loans: More Advantageous Conditions, More Advantageous Conditions, More Effective AssistanceMore Effective Assistance

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Applying Japan’s Development Experience and Expertise The environment in which Japan's Official Development Assistance (ODA) programs operate is

dramatically changing. The world's assistance needs are greater, as is evident from the challenges

posed by the United Nations' Millennium Development Goals (MDGs), and developing countries still

have strong expectations of Japan. The Japanese government, however, is now in a difficult fiscal

situation, and Japan's ODA has slipped from second to third place. Meanwhile, South Korea, China and

other emerging donors have arrived on the scene. These and other changing trends are affecting

international assistance. The best approach for more impressive Japanese ODA is to fully utilize the

experience and expertise gained through its own development, and through its development

assistance programs.

Japanese ODA loans through the Japan Bank for International Cooperation (JBIC) must offer even

more advantageous conditions and be even more effective, in order to better contribute to sustainable

development and the self-help efforts of recipient countries. JBIC promotes the development of both

infrastructure and social sector, and is strengthening its ties with the Japan International Cooperation

Agency (JICA) and other organizations that are active in development assistance.

The Future for Japanese ODA loans: More Advantageous Conditions, More Effective Assistance

(million dollars)

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(preliminary figures; calendar years)

Photos: Delhi Mass Rapid Transport System Project (India)


ing the eradication of extreme poverty. The Goals areextremely ambitious, and more assistance is requiredto achieve them.

Japan’s ODA was the highest in the world duringthe 1990s, but began shrinking in 2000 due to thedifficult fiscal situation faced by the Japanese govern-ment. On the other hand, developed countries in theWest scaled up their assistance budgets, spurred on bythe 2002 UN International Conference on Financing forDevelopment in Monterrey, where it was affirmed thatdeveloped countries would need to double their ODAfor the MDGs to be achieved. Japan’s ODA fell behindthat of the United States, and in 2006 slipped again tothird place, behind that of the United Kingdom as well.The OECD Development Assistance Committee (DAC)released estimates indicating that if present trends con-tinue, Japan’s ODA will fall to fifth place in severalyears. International development assistance is seeingother significant changes as well, notably the entry ofemerging donors such as South Korea and China.

Japan depends on other countries for much ofits energy resources and food, and its corporationsare pursuing businesses around the world. For thesereasons, too, it is crucial that Japan promote globalstability and maintain friendly relations with othercountries. In pursuit of these goals, Japan needs tofulfill its due role in development assistance. Moreattractive and more effective assistance programs thatplace a lighter burden on the Japanese people willbecome important “to help ensure Japan’s ownsecurity and prosperity,” an objective stressed inJapan's ODA Charter. Japanese ODA loans are potentinstruments for achieving these aims. There are indeedcauses for optimism, since Japan implements the pro-grams with experience and expertise gained through itsown economic development and through the success-ful assistance projects carried out for years in Asia.

Japanese ODA loans: Optimizing Japan’s Experiencein Its Own Development and Its Assistance Programs

Infrastructure Projects for EconomicDevelopmentThe fourth Tokyo International Conference on AfricanDevelopment (TICAD-IV) will be held in 2008 in Tokyo,and right after that Japan is scheduled to host the G8Summit in Hokkaido. For these reasons, too, attention isalready focusing on 2008 as the year of official develop-ment assistance (ODA).

Japan’s ODA programs began in 1954, and havesince provided assistance in the form of technicalcooperation, loans, and grants facilitating the advance-ment of developing countries. Aid from Western countrieshas tended to prioritize direct assistance to the poorthrough, for example, health and medical programs. Onthe other hand, Japan, while also offering this type ofassistance, has focused its energies on economicgrowth through Japanese ODA loan support for theconstruction and improvement of socioeconomic infra-structure. This approach raises living standards andreduces poverty in recipient countries. Japanese ODAloans and other forms of assistance provide backupsupport for the self-help efforts of developing countries,especially in Asia, and it is often said that they haveplayed a key role in the ”East Asian miracle” of eco-nomic development seen today.

More Attractive Conditions, MoreEffective Assistance — WithoutOverburdening Japanese TaxpayersReports indicate that despite years of continued develop-ment assistance, about 1.2 billion people worldwidestill live on less than a dollar a day — a figure thatrepresents one-fifth of all humanity.

The UN Millennium Development Goals (MDGs)are inspired by the Millennium Declaration adopted in2000, and set down specific actions and targets, includ-

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Role of Japanese ODA loans in East Asia’s economic development

(US dollars) (Billion yen)

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Per capita GDP (East Asia)

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Value of approved Japanese ODA loans to East Asia (scale on right)

Keys to understanding opportunities to make ODA loans more advantageous and effective

Millennium Development Goals (MDGs)

The MDGs were inspired by the United Nations Millennium Declaration issued at the UN Millennium Summit in September 2000. The following year, they became shared development targets for the international community in the 21st century. The MDGs set specific quantifiable targets to be achieved by 2015 in eight thematic areas, including eradication of extreme poverty and hunger, achievement of universal primary education, improvements in healthcare and medical treatment, and environmental sustainability.

The Future for Japanese ODA loans: More Advantageous Conditions, More Effective Assistance Applying Japan’s Development Experience and Expertise


Japanese ODA loans: Effective Use inMore Parts of the WorldThe Japanese government intends to implement ODAprojects strategically at a time when it faces a difficultfiscal situation. Within the government, discussionsare continuing on how Japan can improve the qualityof its ODA projects while at the same time meeting theinternational commitment made at the G8 Summitin Gleneagles in 2005 to increase the value of ODAassistance by US$10 billion over the subsequent fiveyears. Policy-related matters discussed during a January2007 government meeting on overseas economiccooperation included the increase in the number ofdonor countries, facilitating Japanese ODA loansthrough faster decision-making and implementationprocesses, and seamless ties linking the efforts of JICAand JBIC in the field.

Against this backdrop, JBIC substantiallyincreased the value of newly committed Japanese ODAloans for fiscal 2006 by 34% over the previous year, to763.7 billion yen.

At 84.3%, Asia still accounts for a major share ofJapanese ODA loans. Africa dramatically increased itsshare over fiscal 2005 from 8.9 to 14.9%, with total loanvalue jumping from 50.7 billion yen to 113.7 billion. Thisincrease was due to a number of factors, including: (1)Tanzania received its first Japanese ODA loan in 25years, after achieving strong results from its manyyears of structural reform aimed at resolving debtissues; and (2) private sector assistance financinginvolving the participation of the African DevelopmentBank. In addition, two Sub-Saharan countries, Namibiaand Mozambique, have recently been added to the listof Japanese ODA loan beneficiaries.

In Asia, JBIC will continue to support infrastruc-ture projects, which have tremendous capital needs,and will enhance its support for countries in Sub-Saharan Africa. JBIC also intends to carefully promoteODA projects in countries in other parts of the worldwhere expectations for economic development arehigh, using the expertise it has gained through supportprograms in Asia, and showing consideration for eachcountry's circumstances and respect for their self-helpefforts, all the while accurately ascertaining what typesof assistance are truly required.

Effective ODA loans to Facilitate DevelopingCountries’ Own Initiatives

Solid Results in Many FieldsThe basic philosophy behind Japan’s assistance issupport for self-help efforts that depend on the initiativeof developing countries themselves. Japanese ODAloans are financing instruments, of course, but they arealso an expression of respect for the self-helpendeavors of other countries, and they representpractical support measures that embody Japan’sexperience and expertise.

Japanese ODA loans provided through JBIC haveroots going back to 1958, and since then Japan hasbuilt up, primarily in Asia, a wealth of developmentsupport experience in many sectors, including electricpower, transportation, telecommunications, irrigation,water supply and sewerage systems, and environmentalprotection.

These programs have clearly been a factor in thestrong economic growth and impressive reduction ofpoverty in Asia. JBIC employs a wide range of process-related tools, from project formation to post evaluation,and will use the experience and skills it has gained in thefield to make these tools even more useful and practi-cal, and to prioritize efforts to raise the capacities ofdeveloping countries. JBIC continues to be involvedin policymaking, human resource development andsustainable initiatives fostering citizen participation indeveloping countries, while strengthening its ties withJICA, which is mandated to link capital aid coopera-tion with technical cooperation beginning in 2008, andwith local governments, universities, NGOs and otherorganizations.

Value of Japan’s approved ODA loans, 1990 - 2006

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Tokyo International Conference on African Development (TICAD)

These international conferences are held in Tokyo under the co-organization of the Japanese government, the United Nations, the Global Coalition for Africa (GCA), and the World Bank, to examine policy guidelines on African development. The first Conference was held in 1993, and the fourth is scheduled for 2008.

Private Sector Assistance Loan under the joint initiative titled Enhanced Private Sector Assistance for Africa with the African Development Bank

At the G8 Summit in 2005, then-Prime Minister Junichiro Koizumi announced a joint initiative with the African Development Bank (AfDB), entitled Enhanced Private Sector Assistance (EPSA). Under this initiative, Japan is able to provide ODA loans to the AfDB up to a limit of 11.5 billion yen, to be used to foster local small and micro enterprises and private financial institutions.


In 2005, JBIC partnered with Hikone City and theUniversity of Shiga Prefecture to hold a workshop inHyderabad and demonstrate this experience and know-how to local people involved in the issue. In March 2006,JBIC decided to provide an ODA loan for the HussainSagar Lake and Catchment Area Improvement Project,and in May 2006 people from Hyderabad participated intraining sessions in Hikone. The collaboration is ongoing.

Case Study 2: China — Trainees from China—Tie-ups with Yamaguchi University, Shimane University,

Shimane Prefecture, Fukuoka City and Kita Kyushu City

Japanese ODA loans for China now prioritize humanresource development and environmental projects inthe interior, since the more coastal areas have seengreater economic development. The support is wide-spread, encompassing not only improvements in physicalfacilities but also the human resources, inviting traineesto Japan and sending experts to China through tie-upswith local governments and universities.

One such endeavor, the Inland Higher EducationProject in Guizhou Province fostered a tie-up betweenYamaguchi University in Japan and a university inGuizhou Province. This led to the creation of a humanresources development program for environmentaleducation, which will form the basis for an environmentaleducation handbook for senior high school students inGuizhou. The Yamaguchi prefectural government plansto invite government officials and senior high schoolteachers from China to attend a training session that itwill organize.

As part of the Ningxia Water EnvironmentImprovement Project, Shimane University providedbackup for local research into the use of reclaimedwastewater and the development of a related trainingprogram. When the project reaches the implementationstage, the governmentsof Shimane Prefecture,Fukuoka City and KitaKyushu City plan toinvite trainees fromChina to examine waterconservation measuresand the use ofreclaimed wastewaterin Japan.

Recent Practices Using Japan’s DevelopmentExperiences

Partnership with Local Governments andUniversitiesCase Study 1: India — Hussain Sagar Lake andCatchment Area Improvement Project— Tie-ups with Hikone City and the University of Shiga

Prefecture to use their experience and know-how in lakewater purification

Hyderabad, the capital of the state of Andhra Pradesh insouthern India, is attracting worldwide attention as acenter for software development. Companies there arecontributing to the development of systems forJapanese corporations as well. Against this backdrop ofeconomic development, the water quality of HussainSagar Lake in the center of the metropolitan area hasdeteriorated, creating a need for improved sewagetreatment facilities.

In the 1960s, Lake Biwa in Shiga Prefecture,Japan, was polluted by industrial and household waste-water and the inflow of pesticides and fertilizers.Citizens joined hands with the local governments ofHikone City and the prefecture to improve water quality,and eventually succeeded in halting the pollution.Capitalizing on this shared experience, internationalassociations in Hyderabad and Hikone formed a partner-ship that was augmentedthrough grass-root exchanges,creating opportunities forHikone to demonstrate toHyderabad the experience andknow-how it had gained byimproving Lake Biwa’s waterquality. Hussain Sagar Lake in Hyderabad

is in urgent need of measures toimprove water quality

Hyderabad is experiencing dramatic economic growth

Exchanging ideas at a Chinese university spe-cializing in science and technology: participantsin a human resources development project

Keys to understanding opportunities to make ODA loans more advantageous and effective

Special Terms for Economic Partnership (STEP)

Although the STEP program requires that equipment and materials are procured from Japanese companies, preferential interest rates, repayment periods and other favorable conditions apply. The loans facilitate the transfer of advanced Japanese technologies and know-how to developing countries.



all factors hindering socioeconomic development.To promote Ho Chi Minh's economy and

improve the urban environment, JBIC has agreed toprovide Japanese ODA loan for the Ho Chi Minh CityUrban Railway Construction Project, which envisageshigh-speed operations on underground and elevatedtrack for Line 1 (from Ben Thanh to Suoi Tien). This isthe first full-scale urban railway project in the country,and because Japan's rail technology is expected to beintroduced, Special Terms for Economic Partnership(STEP) will be applied.

The advanced technology of Japanese compa-nies in the railway sector will be used for this projectin response to Vietnam's request, as it has for otherurban rail projects financed through Japanese ODAloans. The positive results of such projects canalready be seen in Bangkok, Thailand and Delhi, India.

JBIC is transferring Japan’s advanced technolo-gy to Vietnam through strong support of other proj-ects as well, including highly efficient electric powerplant technology, and environmental protection tech-nology to halt pollution.

Support for Disaster Management andEnergy ConservationCase Study 5: Countries prone to natural disasters —Exploring disaster risk management issues—Discussing Japan’s experience after the Great Hanshin-

Awaji Earthquake

The world still remembers the tsunamis that causedso much damage after undersea seismic activity offSumatra in 2004. Japan has built up considerableexpertise in mitigating the effects of earthquakes,typhoons, floods, volcanic eruptions and other natural

Case Study 3: India — Gujarat Forestry DevelopmentProject Phase 2—JBIC joins forces with the University of the Ryukyus and Okinawa

Prefecture for mangrove reforestation and conservation

The mangrove swamps in the coastal regions of thestate of Gujarat in western India are the secondlargest in the country. Mangroves protect shores fromwave and tidal erosion, but in Gujarat, 79% of themangrove cover has deteriorated. In 2007, a refor-estation project financed with an ODA loan fromJapan was launched with local citizen participation torestore mangrove swamps, raise local incomes andimprove the environment.

During the project formation stage, JBIC partneredwith the University of the Ryukyus and the Okinawaprefectural government to organize workshops fororganizations in Gujarat, to demonstrate Japan’sknow-how and experience in planting and protectingmangroves. This expertise holds promise for a success-ful outcome to the project.

Infrastructure Projects Applying Japan’sAdvanced TechnologyCase Study 4: Vietnam — Ho Chi Minh City UrbanRailway Construction Project—Taking advantage of the advanced technology of Japanese

companies

In Ho Chi Minh, Vietnam's largest city, traffic isbecoming heavier as the economy grows. This hascreated serious problems, especially a sharp increasein traffic accidents, road congestion and air pollution,

Workshops in India offer guidelines in mangrove swamp conservation

Traffic is heavy in Ho Chi Minh City, Vietnam

Japanese ODA loan project evaluations

JBIC evaluates all projects to enhance the effectiveness and efficiency of ODA operations, and to ensure full accountability. Post-project evaluations are based on international evaluation criteria. Projects are evaluated on an individual basis, and impact analysis is also made to examine the effect of Japanese ODA loan operations on specific countries and on specific themes. Results of all project evaluations are made public.


Making the Most of JBIC’s AssistanceExperience in Partnership with OtherCooperation OrganizationsCase Study 6: Operations agreements with Export—Import Bank of Thailand, Neighboring Countries EconomicDevelopment Cooperation Agency and EconomicDevelopment Cooperation Fund of the Export-Import Bankof Korea— Partnerships with emerging donors for more effective

support programs

In 2006, JBIC signed memorandums of understanding(MOU) with the Export-Import Bank of Thailand(TEXIM) and the Neighboring Countries EconomicDevelopment Cooperation Agency (NEDA), to facili-tate more partnering for development of the GreaterMekong Subregion.

The objective of the MOU with TEXIM is toexchange information that will be used when provid-ing cooperative support for Japanese and Thai busi-nesses expanding into the Greater MekongSubregion (GMS). This will promote investment inthe region. The MOU with NEDA will strengthenJBIC's partnership with that organization, which hasbegun financial cooperation with Cambodia and Laos.JBIC has sent a expert to NEDA to conduct trainingprograms, and assist NEDA as it enhances its organi-zational capacity, drawing on the expertise JBIC hasgained in project implementation and evaluations.JBIC intends to strengthen its ties with TEXIM andNEDA, and will offer effective support for sustainabledevelopment, nature conservation and poverty reduc-tion in the GMS.

JBIC has also signed an ODA operations agree-ment with the Economic Development CooperationFund (EDCF) of the Export-Import Bank of Korea. JBICintends to continue actively promoting partnershipswith emerging donors in Asia.

disasters, and JBIC isteaming up with govern-ments, citizens’ groupsand NGOs to support dis-aster risk managementand reconstruction.

In May 2007, JBICheld a seminar on disas-ter risk management inKobe, Japan, with coop-eration from the Kobemunicipal government and the Asian DisasterReduction Center. The keynote speech, given by aKobe City official, focused on the region’s experienceafter the Great Hanshin-Awaji Earthquake. The speechwas followed by discussions and presentations fromexperts involved in disaster risk management andresearch in countries prone to natural disaster, includingBangladesh, Pakistan, the Philippines and Indonesia.

JICA and JBIC representatives joined in thepanel discussion that examined what kind of assis-tance is truly necessary for community residents, howgovernment activities can be linked with local com-munity needs, and how important the roles of educa-tion for disaster risk management are.

This type of seminar approach is used toexpand knowledge in other fields as well, such asenergy conservation and pollution prevention.

Tsunami damage in Sri Lanka after a massive earthquake off Sumatra

Villagers taking action to prevent floodingin the Philippines: One activity presented atthe seminar on disaster risk management

Ceremony marking the signing of an ODA operations agree-ment with the Economic Development Cooperation Fund(EDCF) of the Republic of Korea


in the fall of 2008 the Japanese government willintegrate JBIC’s Overseas Economic CooperationOperations (which include ODA loan programs),technical assistance operations managed by JapanInternational Cooperation Agency (JICA), and manyof the grant aid programs that now fall under thepurview of the Ministry of Foreign Affairs. The “newJICA” will bring all three roles under a singleumbrella.

JBIC has partnered with JICA to pursue proj-ects in many sectors in the past, and will put itsweight behind the goals driving this integration inorder to improve the quality of Japan's assistanceand raise the international competitiveness ofJapanese ODA. In doing so, JBIC will meet theexpectations of the Japanese people, who expectthat Japan’s aid programs will be carried out underODA policies and strategies that suit the new age.

Japanese ODA loans: More Advantageous Conditions

The capital needs of developing countries will mostlikely remain great for many years. For one thing,poverty reduction and other efforts to achieve theMillennium Development Goals will continue forsome time in Africa and elsewhere in the world. Inaddition, developing countries in Asia that are nowenjoying economic expansion will require more cap-ital investment to maintain growth rates. The gov-ernments of developing countries have limited capi-tal resources, and this means that private invest-ment must be encouraged. To improve the invest-ment climate, there is an urgent need to build insti-tutional systems, raise capacity, improve gover-nance, and develop basic infrastructure. Japan’sODA can play a very important role in achievingthese objectives.

To enhance the effectiveness and efficiency ofJapan’s ODA operations and improve their quality,

In response to enormous development needs, theJapanese government has confirmed that it aims toincrease the aggregate value of Japan’s ODA assistanceby US$10 billion during the five year period beginning in2005, and that it will therefore place even greater priorityon Japanese ODA loans.

In April 2007, the government of Japan and JBICbegan lowering ODA loan interest rates and modifyingthe fee system to further promote the use of such loansand speed up the project implementation more. The goalhere is to promote project implementation by reducingthe burden on borrowing countries and levying a com-mitment charge of just 0.1% per annum on undisbursedamounts of Loans (the portion of approved loans still notdisbursed).

Also, the interest rate on consulting services wasreduced to almost zero (the rate is now 0.01%). This wasdone to strengthen the soft component assistance, toensure a higher level of quality in the projects, and tospeed implementation.

Conditions are also better for upper-middle income

Japanese ODA loanTerms Becoming MoreFavorableKeiichiro Nakazawa,Director, Project Development Department

countries, including substantially lower interest rates,widening the coverage of project candidates, and greateremphasis on ease of use. For example, assistance forearthquake-related measures has been expanded toinclude disaster risk management and post-disasterrecovery measures, and assistance to reduce income dis-parities in lagging rural regions has been expanded toinclude measures to raise the living standards of theurban poor. These steps are being taken to promoteimprovements in social infrastructure.

In addition, interest rates have been made even morefavorable for the Special Terms for Economic Partnership(STEP) program, which requires that equipment andmaterials be procured from Japanese companies as away to introduce Japan’stechnology and know-how.On another front, the interestrate on loans to finance emer-gency post-disaster recoveryefforts — a program whereJapan’s international contri-butions are much admired —has been reduced to almostzero (the rate is now 0.01%).

JBIC is keen to continuepromoting policies such asthese, as they will lead togreater use of Japanese ODAloans.

Second Bosphorus Bridge(Turkey) constructed with supportfrom Japanese ODA loan

No part of this magazine may be reproduced without the written permission of JBIC.

For inquiries, please contact:JBIC Public Relations Office4-1, Otemachi 1-Chome, Chiyoda-ku, Tokyo, Japan 100-8144Tel. +81-3-5218-3101 URL http://www.jbic.go.jp/english/index.php

This magazine is printed on recycled paper using environmental-friendly soy ink.

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Cover: Tubbataha Reef Marine Park, the Philippines

The Growing Importance of Islamic Finance

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