Upload
teranet-europe
View
219
Download
0
Embed Size (px)
Citation preview
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
1/35
ROLE OF FINANCE AND FINANCIAL
MARKETS: STRUCTURE AND MANAGEMENTIN AN ISLAMIC PERSPECTIVE
DR. HUMAYON DAR
VICE-PRESIDENT, DAR AL ISTITHMAR, LONDONhttp://www.daralistithmar.com
http://www.daralistithmar.com/http://www.daralistithmar.com/8/3/2019 Lecture-5 (Nov 7, 2005)[1]
2/35
LECTURE OBJECTIVES
To introduce the participants to the role of finance and thetreatment of financial markets in the literature on Islamiceconomics and its off-shoot, Islamic banking and finance.
The lecture also aims at explaining some important Islamic
financial structures, institutions and markets. The primary objective of the lecture remains as discussing
the Islamic economic perspective on management, with aparticular reference to the emerging Islamic enterprise.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
3/35
LECTURE OUTCOMES
The participants must have an understanding of theimportance, Islamic economics tends to attach to finance andfinancial markets in building a distinct Islamic economy.
The participants must be able to evaluate the achievements
of Islamic economics in terms of its influence on thedevelopment of different financial structures, institutions andmarkets all over the world.
The participants must be aware of some key issues inmanagement of Islamic enterprises.
Finally, they must realise that a distinct Islamicmanagement style is imperative for running of Islamicenterprises in a successful and Islamic way.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
4/35
REFERENCES
IQBAL, Z. AND MIRAKHOR, A. (2001) Role ofStakeholders in Islamic Financial Institutions
Initially published as a World Bank Working Paper, but laterpublished in Islamic Economic Studies (2004?) available
from IRTI.LEWIS, M. K. (2005) Islamic Corporate Governance, Review
of Islamic Economics, 9(1), May 2005.
Available from MIHE
DAR, H. A. (2005) Principles of Islamic Management
(unpublished) Available from the author
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
5/35
LECTURE PLAN
Divided into four sections (excluding introduction andconcluding remarks):
Introduction (5 minutes)
Role of finance in Islamic economics (5 minutes)
Treatment of financial markets in Islamic economics (5minutes)
Islamic financial structures, institutions and markets (20minutes)
Islamic management: an emerging discipline? (20 minutes)
Summary and conclusions (5 minutes)
Questions and Answers (60 minutes)
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
6/35
INTRODUCTION
Islamic economics gave birth to Islamic banking and finance
The practice of Islamic banking and finance requires a distinctIslamic management style
The idea of sharing (gaining and losing together) should not
be restricted to shareholders, depositors and other clients Rather, it should encompass the whole organisation and itswider stakeholders
The notion of corporate governance
The doctrine of corporate social responsibility
Without managing an Islamic enterprise in an Islamic way, nocredible and socially acceptable Islamic structures, institutionsand markets possible
The need for Islamic management
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
7/35
ROLE OF FINANCE IN ISLAMICECONOMICS (1)
Emphasis on the prohibition of interest and the need foralternative modes of financing
Mudaraba and Musharaka emerged as alternative tointerest
Financing as opposed to lending PLS Profit Loss Sharing suggested as an alternative to
interest rate mechanism for the conduct of monetary policy(macro context), and a mode for banks to provide finance tobusinesses (micro context)
PLS was perceived as a more just and equitable relationshipbetween a financier and business being financed
Other modes of financing, like Murabaha, Ijara etc., are usedto provide financing for a real economic activity
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
8/35
ROLE OF FINANCE IN ISLAMICECONOMICS (2)
Emphasis on asset-based financing emerged
This, along with the prohibition of gambling and excessiverisk-taking (Gharar), ensured that Islamic financing was freeof unhealthy speculation adding to financial bubbles and
bursts Finance, in an Islamic economic framework, plays an
important role in fostering economic activity, withoutcontributing to large fluctuations in the performance of theoverall economic system
This is distinctively different from capitalism whereininterest-based financing may give rise to excessive risk-taking(on part of businesses) in times of low interest rates, andover-exposure to risk (of banks) in times of high interest rates
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
9/35
ROLE OF FINANCE IN ISLAMICECONOMICS (3)
In socialism, on the other hand, finance and financing wascentrally planned and organised no financial markets
In an Islamic economy:
Finance (and financial institutions) fosters economic growth
through contribution to the real economic activity Financing, as opposed to lending, is not interest-based
It is always asset-based
There is no concept of lending to businesses
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
10/35
TREATMENT OF FINANCIAL MARKETSIN ISLAMIC ECONOMICS
Financial markets must operate observing Islamic principlesof fair trade, information disclosure and transparency, usingSharia-compliant methods and structures
In the absence of interest rate mechanism, PLS ensuresstability of the overall financial system, and brings equity to
the transacting parties Mohsin Khan, Abbas Mirakhor, Wiqar Masood Khan,Nadeem ul Haq, etc.
Financial markets play a vital role in fostering economicgrowth
Habib Ahmad Financial markets in an Islamic economy also help the
government/central bank implement an Islamic monetarypolicy
Mohsin Khan, Abbas Mirakhor, Wiqar Masood Khan,Nadeem ul Haq, etc.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
11/35
ISLAMIC FINANCIAL STRUCTURES,INSTITUTIONS AND MARKETS
Structures
Contracts and products
Institutions
Banks
Finance houses Insurance companies (Takafol and re-Takafol)
Other financial institutions
Markets
Bahrain UAE
Malaysia
Qatar
Saudi Arabia
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
12/35
ISLAMIC FINANCIAL STRUCTURES (1)
Contracts and products
Murabaha, Ijara, Salam, Istisna, Mudaraba, andMusharaka etc.
Sukuk
Takafol Islamic mortgages
Islamic funds
Risk management in Islamic structures
Benchmarking
The role of promises, undertakings and options
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
13/35
ISLAMIC FINANCIAL STRUCTURES (2)
Role of benchmarking in mitigation of uncertainty and, hence,of risk
Most Islamic products are priced with reference to aninterest-based benchmark, e.g., LIBOR, KIBOR, KLIBOR etc.
Interest-based benchmarking allows Islamic banks and
financial institutions to manage deviations from the marketrates of return
The promises, undertakings and options are embedded inIslamic structures to manage risk
The most-widely used contract of Murabaha is, in fact, a
promise to purchase arrangementAAOIFI calls it an order to purchase
Without this promissory arrangement (the clientsundertaking to purchase the asset from the bank once it hasbought it from the market), Murabaha is not bankable
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
14/35
ISLAMIC FINANCIAL STRUCTURES (3)
In Sukuk al-Ijara, the master Ijara agreement allowsissuers to price Sukuk certificates in terms of LIBOR-linkedfloating rates
Investors actually receive a rate of return linked to amarket rate of return (LIBOR)
The master Ijara agreement is no more than:
An undertaking on part of the issuer to sell theunderlying asset to the initial owner of the asset for aknown price
An undertaking on part of the lessee to pay a rental tobe determined by the prevailing LIBOR at the time ofappraisal of the rent (normally quarterly)
We, at Dar Al Istithmar, have developed a technique thatallows the issuer of investment certificates to offer a rate of
return determined by performance of a chosen index
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
15/35
ISLAMIC FINANCIAL STRUCTURES (4)
Managing moral hazard in share contracts (like Mudaraba)
Mudaraba is inherently prone to moral hazard and adverseselection (the agency problem)
A fixed-return Mudaraba, or a benchmark-linkedMudaraba, manages the agency problem to make it bankable
This allows Islamic banks to charge a fixed return on theirMudaraba-based financing to businesses
How may it work?
Combining two conditions in a smart way
The business is allowed to retain profits beyond an
agreed profit level (allowed by all mainstream schools ofthought)
The bank may receive maximum of a fixed fee and aprofit share, whatsoever be greater, if the profit fallsshort of an agreed level (Hanafis permit it)
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
16/35
Condition 1
Banks profit share
Realised profitP0
Banks payoff
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
17/35
Condition 2
Banks profit share
Realised profitP0
Banks payoff
Fixed fee
Agreed profit ratio
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
18/35
Combing Conditions 1 and 2
Banks profit share
Realised profitP0
Banks payoffFixed fee
Agreed profit ratio
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
19/35
ISLAMIC FINANCIAL INSTITUTIONS
Banks retain their financial intermediary role in an Islamicframework; however, they must adhere to their socialresponsibility
Islamic structures like Sukuk are helping in developing Islamiccapital markets asset-based finance is at the heart of thismovement
Takafol companies are meeting insurance needs of Muslimcommunities by adhering to Islamic principles (of theprohibition of Gharar and gambling) by offering capitalprotection (effectively if not contractually) to their clients
Other institutions, like Liquidity Management Centre, havealso started emerging to deepen Islamic capital markets
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
20/35
ISLAMIC FINANCIAL MARKETS
Viable Islamic financial markets in different Islamic countries
Bahrain, Malaysia and Dubai fast emerging as dynamicIslamic financial markets
Trading in Islamic options to start soon at the newly opened
Dubai International Financial Exchange More sophisticated Islamic products and structures, larger
Islamic financial institutions (mega Islamic banks), and ever-expanding Islamic financial markets
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
21/35
ISLAMIC MANAGEMENT (1)
What do we mean by Islamic management?
Islamic management accounting (Malaysian contribution,AAOIFI)
Management of Islamic (voluntary) organisations (Rafik
Beekun)http://www.islamist.org Business management in Muslim countries
Managing an Islamic enterprise
Islamic management as a distinct management style
Islamic Perspectives on Management and Organisation by
Abbas J. Ali, published by Edward Elgar (2005)
http://www.islamist.org/http://www.islamist.org/8/3/2019 Lecture-5 (Nov 7, 2005)[1]
22/35
ISLAMIC MANAGEMENT (2)
Managing an Islamic enterprise
What is an Islamic enterprise?
The Islamic firm in Islamic economics
The Islamic firm is a nexus of Islamic contracts between
owners of factors of production, making them contractuallybound to cooperate within an organisation, and working withinthe legal limits imposed by the Islamic Sharia, to achieve awell-defined objective in terms of production of a good orservice.
Managing such a firm in an Islamic way is the subjectmatter of Islamic management
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
23/35
The Islamic firm
Unambiguous contracts
Owners of factors of production within an organisation
Definition of property rights
Objective function Legal system (Fiqh)
Specification of rights and responsibilities
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
24/35
ISLAMIC MANAGEMENT (3)
Role of contracts in Islamic management
Writing unambiguous (Gharar-free) contracts is a first steptowards managing an Islamic enterprise
Islam recognises that there is no such thing as a complete
contract it, therefore, emphasises on unambiguouscontracts
Unambiguous contracts minimise the occurrence ofdisputes and conflicts within organisations
A variety of contracts like agency (Wakala), profit sharing
(Mudaraba), partnership (Musharaka), promise of reward orbonus (Jiala) provide an array of incentives to different
parties within an organisation
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
25/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (1)
PRINCIPLE 1
Managers are required to identify and/or define objectivefunction of the firm to use for delineating consistent strategyfor operations.
Thus, adopting a mission statement is probably the mostimportant aspect of managing an Islamic enterprise
It should differentiate between an Islamic and aconventional business
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
26/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (2)
Mission statement of GFH
Our mission is to remain one of the regional leaders in
Islamic banking and participate in the economic,infrastructural and social development programmes of theGulf Cooperation Council, Middle East and North African
countries. Gulf Finance House aims to maximise clients and
shareholders value in accordance with the principles of
Shariah, contribute towards the global growth of Islamicbanking and provide a challenging environment to ouremployees encouraging innovation and realisation of
potential.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
27/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (3)
Mission statement of ABC
Our mission is to
Consistently generate increasing value for ourshareholders
Specialise in Arab-related activities across the world Invest in international financial institutions that diversify
and enhance shareholder value
Attract an retain high quality employees by providingrewarding careers
The two mission statements clearly differentiate between thetwo businesses
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
28/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (4)
PRINCIPLE 2
Clear and unambiguous definition of rights andresponsibilities of each group of actors within an organisationis essential for efficient and effective use of resources.
It helps in reducing moral hazard and slack in organisations
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
29/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (5)
PRINCIPLE 3
Devising incentive mechanisms like profit-relatedremuneration packages and performance-related bonuses,and effective monitoring are important for successfulmanaging.
It further helps in minimising the agency problem
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
30/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (6)
PRINCIPLE 4
Decision-making is a horizontal process in which those withright qualifications are consulted by the leader.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
31/35
Decision-making
Approval/Ratification
BOARD OF DIRECTORS
Owners and their representatives
EXECUTIVE BOARDA team of top management
Recommendations
SHRA BOARD
Representatives of workers, supervisorsand managers
Consultation
Recommendations
Supervisors ManagersWorkers
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
32/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (7)
PRINCIPLE 5
Improvement of quality of human resources primarily throughpersuasion, education and creation of a proper enablingenvironment within an organisation is fundamental to Islamicmanagement.
Islam recognises that there is no such thing as a completecontract it, therefore, emphasises on unambiguouscontracts
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
33/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (8)
PRINCIPLE 6
Improvement of quality of human resources primarily throughpersuasion, education and creation of a proper enablingenvironment within an organisation is fundamental to Islamicmanagement.
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
34/35
DERIVING PRINCIPLES OF ISLAMICMANAGEMENT (8)
PRINCIPLE 6
Improvement of quality of human resources primarily throughpersuasion, education and creation of a proper enablingenvironment within an organisation is fundamental to Islamicmanagement.
Islam recognises that there is no such thing as a completecontract it, therefore, emphasises on unambiguouscontracts
8/3/2019 Lecture-5 (Nov 7, 2005)[1]
35/35
SUMMARY AND CONCLUSIONS
The emergence of Islamic banking and finance requiresmanaging of the Islamic financial firm in accordance withIslamic principles of doing business
Although a distinct Islamic management style has yet toemerge, there is a growing awareness of the need for theIslamic way of managing Islamic firms
The literature on Islamic economics is sufficiently rich to offera starting point for developing an Islamic managementparadigm
A natural starting point is to look into the theory of the Islamicfirm to get implications for the development of principles ofIslamic management