Ram Bulletin 0608

7/31/2019 Ram Bulletin 0608

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Islamic FinanceBulletin

. . .

Towards an informed market

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M E SSAGE FROM RAM RAT INGS

Dear Readers

The Islamic Finance Bulletin marks another cornerstone in

2008, with the start of a partnership between RAM Rating

Services Berhad (RAM Ratings) and our new joint publisher,

Islamic Banking and Finance Institute Malaysia (IBFIM). As

part of this strategic partnership, RAM Ratings will work withIBFIM on a variety of initiatives involving content sharing.

Along with this collaboration, we are also proud to announce

that the Islamic Finance Bulletin will be moving on to an

electronic platform. This move is to align our information

services with the changing times and new methods of delivery.

This is also to improve the publications time to market. As we

strive to improve our information services, an online network

will undoubtedly improve the flow of information to the market.

Irrespective of our evolution, we wish to assure our readers of

our continued commitment to delivering timely and value-added

information on the developments within the Islamic finance

market. We would also like to thank you for your firm support

since the debut of the publication in 2003, and look forward to

your continued patronage.


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Islamic Banking and Finance Institute Malaysia Sdn Bhd

usharakah is a contract that is

applicable for a joint venture

business. It is a partnership

arrangement between the Bank and the

customer, each contributing certain

capital. Any profit or loss arising from the

venture will be shared among them as

agreed at the inception of the partnership.

Musharakah financing can be granted

through the following arrangements:

a. On joint-venture or partnership

basis which is based on Joint-

account and without formation of

any separate entity.

b. Through equity participation which

involves the incorporation of a

joint-venture limited companyunder the Company Act, 1965

Normally, it is the Bank who seeks the

opportunity to invest in new or growing

or struggling business.

Before the Bank invest in the company,

by way of injecting capital, the Bank shall

perform some necessary financial test in

order to test the project viability. The

Bank shall have a representative in the

management of the company to monitor

the progress of the project. The

representative has some power in the

management of the company.

The profit made during the period shall be

shared between the two parties according

to the pre-agreed profit sharing ratio.

However, should there be any loss, it will

be shares between them based on the

capital contribution ratio. Apart from that,

the Bank shall also receive a certain sum

of money from the Company as

management fee for the project.

Once the company is already viable, the

Bank shall withdraw his capital from thecompany. The company shall buy back all

the shares held by the Bank, in the terms

agreed by both parties as per in the

Partnership Agreement.

M


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33

The Bank Customer

Project

Capital

Profit / Loss

1

2

Illustration

Description

1 The Bank injects some capital into the project, along with the Customer.2 The money will be invested in the project

3 The profit will be distributed according to pre-agreed ratio while the loss will be

distributed according to capital contribution ratio.

Musharakah literally means sharing.

Musharakah Financing refers to financing

given by a Financial Institution to itscustomer based on a partnership

arrangement. Both parties will share the

profit and loss of a project and both

parties will contribute capital on a pre-

agreed ratio. The partnership arrangement

referred to in this section is based on

Shirkah al-Amwal where partners or

parties contribute some capital into the

partnership.

The legality of partnership contracts was

established in the Quran, Sunnah and

consensus of the Muslim scholars and

community:

Proofs are derived from the Quranic

verses :

If more than two, then they share in

third (4:12)

Truly many are the partners (in

business) who wrong each other: not

to do those who believe and work

deeds of righteousness (38:24)

Proof of legality of partnership is

found in the Hadith Qudsi where

Allah SWT says : I am the third of

every two partners as long as neither

one betrays the other. However, if

one betrays the other, I leave theirpartnership. This Hadith Qudsi was

narrated on the authority of Abu

Hurairah who validated its chain of

narration.


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The Prophet (pbuh) found the people

using the partnership contract and did

not question this behavior, and there

are many Hadiths that indicate his

approval of the contract. One suchHadith is: Allah supports the

partners as long as they do not betray

one another. In general, Muslims

have approved the legality of

partnership, with the differences in

opinion only existing over specific

types that we shall discuss below.

The wisdom in permitting partnerships is

clear. The contract allows individuals to

combine their properties in manner that

allows them to produce more wealth than

they could each produce individually.

!"!"!"!"

Any Musharakah arrangement needs to

fulfill the following rukun:

1. Owner of capital

The arrangement is carried outbetween individuals and/or legal

entities.

All partners have right over the

management of the project and

may designate an independent

management team which is paid

for its service or designate a

management team with which the

partners have entered into a

Mudharabah contract.

Any of the partners may be only a

sleeping partner.

2. Capital

The contributed capital can be either

in the form of cash or assets with an

ascribed monetary value. It isnoteworthy to point out that while the

majority of Islamic scholars insist

that capital must be in cash, Imam

Malik allows assets to be considered

as capital. Imam Shafie further allows

commodities of similar features in

quantity and quality to be considered

as capital.

3. The ownership of the capital is

transferable.

The contributed capital by the

partners need not be on equal basis.

However, the ownership of the capital

will then belong to the partnership.

4. Project

The contract and project must be

halal or permissible in Islam such as

construction of buildings, houses,

highways and even supply of goods

and equipment.

5. Profit

The basis for dividing profit should

be predetermined at the time of the

Musharakah aqad is being performed.

It must be based on either a

percentage or a ratio of the profit.

Under Mazhab Shafie and Maliki, the

profit ratio must be proportionate tothe capital investment. Any

agreement other than that basis, will

render the Musharakah contract

invalid. Under Mazhab Hambali and


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Hanafi, the profit ratio is negotiable.

However, Hanafis do not allow the

profit ratio of a sleeping partner to

exceed the ratio of an active partner.

All scholars, however, are in

consensus that any losses incurred by

the project must be shared based on

the capital contribution ratio.

However, if the loss is due to the

negligence of the managing partner or

management team, then the partner or

the team shall bear the loss.

6. Offer and Acceptance (Ijab Qabul)

The Musharakah terms must be

voluntarily accepted by both parties.

The termination of the arrangement

needs to be spelled our together with

the distribution of the remaining

capital.

The Musharakah can be terminated in

any of the following events:

at any time after giving the other

partner a notice to this effect.

If any of the partners die.

However, the heirs will have the

option to either continue with the

Musharakah or to draw the share

of the deceased.

If any of the partners becomes

incapable to effect commercial

transactions such as insane or

comatose.

The distribution mode of the remaining

capital will depend on the following

scenarios:

If the remaining capital and/or profit

is in cash, the net amount (after

deducting expenses) will be

distributed amongst the partners as

per the predetermined ratio.

If the remaining capital is not in a

liquid form, the partners shall sell the

assets. The sale proceeds will then be

distributed as per the predetermined

ratio. A prior agreement to this effect

could also be arranged to solve this

issue.

Partnerships are of two types: holding

partnership and contract partnership.

A holding partnership is created by means

of inheritance or wills or other

circumstances resulting in the holding by

two or more persons of an asset in

common.

A contract partnership is created by

means of an agreement whereby two or

more persons agree that each of them

contributes to the capital of the

partnership and shares in its profit or loss.

Contract partnerships are divided into:

mufawada, al-inan, alamaal and al-

wojooh. Fuqaha (jurists) have differed on

whether Mudaraba is a partnership in this

sense or not. Some Fuqaha consider

Mudaraba to be such a partnershipbecause in general it fulfils the elements

and terms of a partnership contract.

Others, however, do not consider


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Mudaraba to be one of the types of

contract partnership.

Following is a brief definition of each of

the above types in light of what isreported in Fiqh texts.

1. Shirkah al-Mufawada

It is a contract between two or more

persons. Each of the two parties

contributes a portion of the overall

fund and participates in work. Both

parties equally divide profit or loss. It

is a condition of this type of

partnership that contributed funds,work, mutual responsibility and

liability for debts be equally shared

by the parties. Both Hanafis and

Malikis have permitted this type of

partnership but have stipulated many

restrictions for it.

2. Shirkah Inan

lt is a contract between two or more

persons. Each of the parties

contributes a portion of the overall

fund and participates in work. Both

parties share in profit or loss as

agreed between them, but equality is

not required either in the contribution

to the fund or in work or in sharing of

profit (these being subject to

agreement between the parties). This

type of partnership is approved by all

Fuqaha.

Hanafis and Hanbalis allow any ofthe followings. Profits of the two

parties to be divided in proportion to

their contributed funds; profits may

be divided equally but contributed

funds may be different; and profits

may be unequally divided, but

contributed funds are equal. lbn

Qudamah said: preference in profit

is permissible with the existence ofwork, as one of them may be more

knowledgeable in trade than the other

and he may be stronger than the other

in doing the work, and thus he is

allowed to make an increase in his

profit. share a condition of his work.

It is permissible for one of the

partners to propose that if profits

exceed a certain amount, such excess

or a percentage of it will be credited

to him. It is stated in Al-Bahr AI-

Zukhar Al-Gami Lema thahib

Ulamma Al-Absar that if one of

them (partners) says that I will have

ten if we gain more than that then this

will be valid and the condition will be

binding as there is no exigency of

revocation

3. Shirkah al-Amal

It is a contract between two personswho agree to accept work jointly and

to share the profit from such work.

For example, two persons of the same

profession or craft may agree to work

together and to divide the profit

arising from such work on an agreed

basis. It is sometimes called abdan or

sanaie partnership.

An amaal partnership is considered

permissible by Hanafis, Malikis,

Hanbalis. It is considered valid within

the same profession or otherwise. Its

permissibility is based on much

evidences including explicit approval


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! &

thereon by the Prophet, prayers and

peace be on him. In addition, it is

based on agency which is

permissible.

4. Shirkah Al-Wujooh

It is a contract between two or more

persons who have good reputation

and prestige and who are expert in

trading. Parties to the contract

purchase goods on credit from firms,

depending for that on their reputation,

and sell the goods for cash. They

share profit or loss according to the

guarantee to suppliers provided by

each partner. Accordingly, this type

of partnership does not require capital

since it is based on credit backed by

guarantee. Hence, it is sometimes

called a receivables partnership.

A wojooh partnership is considered

permissible by Hanafis and Hanbalis.

Those who support its permissibility

argue that it includes an agency

guarantee which is also acceptable. It

has been used throughout withoutbeing disapproved of.

In general, the partnership shall be

terminated if one of the partners

terminates the contract, or dies, if his

legal competency ceases or if the

partnership capital is lost.

The majority of Fuqaha, except for

Malikis, are of the opinion that as

partnership is one of the permissible

forms of contract, each of the partners is

entitled to terminate it whenever he

wishes, as is the case with agency

contracts.

The partnership is based on agency and

probity. Each of the partners is a proxy

for the others and a principal at the same

time.

He acts in respect of his share as a

principal and in respect of his partners

shares as a proxy, i.e., as an agent. In

principle, agency is one of theunanimously permissible contracts and no

one party is forced to proceed with it

against his will. The partnership, too,

should start with an agency relationship

between the partners, and this relationship

provides the basis for its continuity. If the

agency reltionship is severed by

termination on the part of one of the

partners, the legal basis upon which they

acted in respect of each others funds will

be eliminated In the case of death, one of

the heirs, if he is of sound mind, mayreplace the deceased provided that the

other heirs and the other partners agree to

that. This shall also be applicable in case

one of the partners loses competency.

####

Due to the nature of Musharakah which is

of no exact comparison with any of the

conventional banking loan, there are

several issues that need to be addressedbefore it can be widely offered to

customers.


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a) Third Party Guarantee

Under Musharakah, there cannot be

any security or collateral to the

financing. For a project financingwith a possible cost overrun and

unexpected delay in works or

collection, the risks faced by

Financial Institutions are great.

There are Islamic scholars who allow

a third-party guarantee or collateral to

secure the return of the contributed

capital in a Musharakah arrangement

in the event of fraud or negligence of

the other party. Some scholars require

that the third party should not have adirect interest to the partners. An

example of the third party is the

Government or the project awarding

party.

In Jordan, the Government of Jordan

has acted as a guarantor in one of the

Musharakah arrangement. In Sudan,

the Sudanese Islamic Bank accepts

the customers own property as

collateral against negligence or

misuse of fund.

b) Shared Liability

Under JV type of Musharakah, the

Financial Institution and customer

will share any liability to the project.

Even though legally, the Financial

Institution can request for an

Indemnity Letter from the customer

to indemnify the former from anyclaim or suit on the project (eg. Injury

or non-completion of project), under

Syariah, the Financial Institution

cannot absolve its liability to the

project.

However, if the partnership

arrangement is not based on completeequality between the partners (where

the capital contribution and profit

distribution ratios are not 50 : 50) the

agreement can exclude a contract of

suretyship. Thus arrangement, called

shirkah man, only contains a contract

of agency. Consequently, the partners

are not sureties the one for the other.

(The Mejelle, Chapter 6, Section 11).

However, shall there be any claim on

the project itself - not due to the actof the customer, the Financial

Institution still has to share that

liability. This is not the case in an

equity participation Musharakah

where the Financial Institution does

not take part in the running of the

business or represent the others as

agent.

c) Accounting Requirement on Equity

Participation

Under the International Accounting

Standard (lAS) 28, an investor is

required to classify its investment in

an associate as a long term assets and

is disclosed as a separate item in the

balance sheet (usually under

Investment in Associate). An

associate is generally defined as an

enterprise in which the investor has

significant influence with direct or

indirect 20% or more equity of thecompany.


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$%&$%$%&$%$%&$%$%&$%

As earlier stated, this section will propose

a model of Musharakah for equity

financing. In reality, the Musharakah

financing is applicable, but not limited, to

any of the following sectors:

Real estate

Property development

Trading

Manufacturing

Infrastructure

The information herein has been obtained from

sources believed to be reliable but cannot be

guaranteed. The views or opinions expressed are

subject to change at any time. Neither the

information nor any opinion expressed is to be

construed as a solicitation for the purchase or sale

of any securities. Islamic Banking and Finance

Institute Malaysia Sdn Bhd do not assume any

responsibility whatsoever in this respect.

The article has not been edited by RAM Ratings in

the interest of presenting originality in content and

presentation.

ISLAMIC BANKING AND FINANCE

INSTITUTE MALAYSIA SDN BHD

Islamic Banking and Finance InstituteMalaysia Sdn. Bhd. (IBFIM) is an institutededicated to produce well-trained, highcalibre individuals and management teamswith the required expertise in the Islamicfinance industry.

Based on the industrys demands andcustomers needs, we provide completeassistance to our clients through a widespectrum of inter-related services: training

and education, advisory and consultancy, andresearch and development in Islamic finance.

Our close relationship with the industry givesus the opportunity to share knowledge and

resources. We also enjoy a strong networkwith local and international authorities andfinancial institutions. Having assistednumerous governments, financial institutions,and other organisations in this arena, we arepropelled to serve the need for furtherenhancement and development of the industryin years to come.

For more information, please contact:

Islamic Banking and Finance Institute

Malaysia Sdn Bhd (340040-M)

Level 3, Dataran Kewangan Darul TakafulJalan Sultan Sulaiman50000 Kuala Lumpur, MalaysiaTel: +603-2031 1010Fax: +603-2031 9191E-mail: [email protected]: www.ibfim.com.my


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''''((((

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****

Dr. Mokhrazinim Mokhtar

Bank Kerjasama Rakyat Malaysia Berhad

Possible Solutions

his section proposes possible

solutions to overcome the Shariah

issues and technical issues. The

section begins with firstly, the issue of

ownership, secondly, the trading of debt

and thirdly credit enhancement. Finally, it

analyses the technical issue on the rating

of Islamic banks.

++++

,-,-,-,- $.$.$.$.

It has already been mentioned in section

2.3.1 that even though with regular cash

flows, assets that are based on cost-plus

(debt) mode of financing are difficult to

securitize because Islamic banks do not

have the ownerships of these assets. Thisis because once the asset is sold to the

customer; the ownership is also

transferred even though the customer may

have not paid the entire purchase price. In

addition to this, assets based on cost-plus

(debt) mode of financing can only be

traded at face value. They cannot be

discounted.

In Islam there is a contract called Hawala.

Hawala means transferring debt. Islamic

banks can use the contract of Hawala to

transfer assets based on cost-plus to

another party thus overcoming the

problem of the ownership of asset. The

rules of Hawala works as below (www.al-

islam.org/laws/transactions3)

2390. If a debtor directs his creditor to

collect his debt from the third

person, and the creditor acceptsthe arrangement, the third person

will, on completion of all the

conditions to be explained later,

become the debtor. Thereafter,

this creditor cannot demand his

debt from the first debtor.

2391. The debtor, the creditor and the

person to whom collection is

referred, should be adult and

sane, none should have coerced

them, and they should not be

feeble-minded, that is, those who

squander their wealth. Also, if a

bankrupt person is barred from

the right of discretion over his

property by a fully competent

Mujtahid, cannot be asked to get

his debt from others and others

T


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cannot transfer their debt to him,

but he may transfer his debt to a

person who does not owe him

anything.

2392. As an obligatory precaution,

transferring the debt to a person

who is not a debtor will not be

correct, unless he accepts it. And

if a person wishes to affect a

transfer to a debtor for a

commodity other than that for

which he is indebted (for

example, if he transfers the debt

of wheat while he is indebted to

him for barley), the transfer will

not be in order, unless he accepts

it.

2393. It is necessary that a person

should actually be a debtor at the

time he transfers the debt.

Therefore, if he intends taking a

loan from some one, he cannot

transfer the prospective debt in

advance to another party, telling

the would-be creditor to collectthe debt from the party.

2394. The debtor must specify exactly

the category and the quantity of

the debt he transfers to another

party. For example, if his debt

comprises of ten kilos of wheat

and 10 dollars owned to one

person, and he tells him to go and

collect either of the two debts

from a certain party, that transfer

will not be valid.

2395. If the debt is fully identified, but

the debtor and creditor do not

know its quantity and category at

the time of assigning the transfer,

the transaction is in order. For

example, if a person who has

recorded the debt he owes to

someone in his books, assigns a

Hawala or transfer of debt before

referring to the books, and later,

after consulting his record,informs the creditors about the

quantity of his debt, transfer is in

order.

2396. The creditor may decline to

accept the transfer of debt,

although the person in whose

name the assignment has been

given may be rich, and may not

fail to honor the Hawala.

2397. If a person accepting the Hawala

is not a debtor to the person

giving the Hawala, he can

demand the amount of the

Hawala from the person who

gave it, before honoring the

Hawala. And if the creditor

compromises for a lesser amount,

the person honoring the Hawala

should demand only that sum

which he has paid.

2398. When the conditions of the

transfer of debt or Hawala have

been fulfilled, the person

affecting the Hawala and the

person receiving it cannot cancel

the Hawala, and if the person

receiving the Hawala was not

poor at the time the Hawala was

issued, the creditor cannot cancel

the Hawala, even if the recipient

becomes poor afterwards. The

same will apply if the recipient ofthe Hawala was poor at the time

it was issued, and the creditor

knew about it. But if the creditor

did not know that the person to

whom the Hawala has been

issued is poor, and when he

comes to know of it, the recipient

is still poor, then the creditor can


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! "

and the buyer is getting a share in

the profit and not the interest. (This

is further explained in 4.4.3).

3. The SPV will then issue

mudharabah (profit and loss

sharing) securities and interested

investors amounting the value that

is needed to pay to the bank. For

example RM 80 million as earlier

explained in paragraph 2. Interested

investors could purchase these

notes. These notes represent the

participation of the investors in the

shareholding of the SPV.

4. In the Hawala there is a

requirement that all parties involves

in the transaction should not be a

bankrupt. If any of the party is

bankrupt, debt cannot be

transferred to him or her and he

cannot ask others to get his debts

from some one else but he can

transfer his debt to others. In

relation to the securitization

structure, the SPV must be

bankruptcy remote. Otherwise, debtcannot be transferred to it. This

coincides with the requirement that

an SPV should be a bankruptcy

remote entity. This requirement

also ensures that the pool of loans

must be of a good quality.

5. The bank collects and pays periodic

installments of RM100 million

owed by the borrowers to the SPV.

The SPV will then forward them to

the investors. The RM20 million is

the profit that the investors will

make for the investing in the SPV.

The operation of this is illustrated in

Diagram 3.


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! "#

Diagram 3: Structure of an Islamic Asset- Backed Securitization for Debt-based Mode of Assets Using Hawala

1. The borrowers debts are

transferred to SPV using

HAWALA arranged by the bank as

originator

2. SPV accepts the debt and pays the

bank the debts of the borrower

3. Since the SPV is not a debtor to the

borrowers, the borrowers continue

paying the bank installments oftheir debts as the SPV is not

indebted to the borrowers. The

bank will monitor the servicing of

the debts on behalf of the SPV. The

bank can charge the SPV a fee for

this.

4. The Islamic bank will forward the

payment of debts to the SPV

5. The SPV then issues securities of

itself. The securities will be rated

and also approved by an

internationally recognized Shariah

Board. The securities will be tradedin the Secondary Market through

appointed market makers. At

maturity the SPV will be abolished

Originator (Islamic bank)

Special Purpose Vehicle Securities

Investors

Borrowers of an

Islamic Bank

1 23

5

4


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! "$

//// 0000

As mentioned in section 2.3.2, trading

debt at must be at face value. In diagram

3, the SPV issues zero coupon securitiesto investors. The discount offered by

Islamic bank to the SPV for paying of its

debts earlier should be looked the banks

relinquishing some of its share in profit in

the contract. Chapra and Khan (2000)

argue that the selling price under the

Murabaha contract includes the profit on

the transaction. Therefore, when the bank

sells debt at a discount, the bank is

actually relinquishing its share in the

profit.

Another reason for discounting can be the

fact that there is immediate payment of

the debt thus discharging the debtor from

liability and earlier recovery of the debt.

Both parties benefit from the transaction

without any loss or damage. This is

different than interest that is prohibited

because it is damaging the debtor who has

to suffer losses from the interest. In a

hadith1 narrated by Ibn Abbas, that when

the Nadhir tribe was ordered to leaveMedina (for violation of a peace treaty),

they approached the Prophet (pbuh) and

said: O messenger of God, you have

ordered your people to expatriate us and

we have debts against some people that

are yet to fall due. The Prophet (pbuh)

said: discount the debts for payment2 .

Ibn Abbas was asked about a creditor

1 Words from the Prophet (pbuh)2 Many hadith reporters report this hadith.

However some scholars classify this hadith asweak due to Muslim ibn Khalid who is in the

chain of the hadith, nevertheless Muslim is

trustworthy and a reliable jurist as Imam Shafii

has reported hadiths through him and regard his

view as authoritative.

whose debt is yet to fall due and he

suggested a discount to the debtor for

immediate payment. Some of the Muslim

jurists including some of the school of

jurisprudence

3

do not allow it. Themajority of the Muslim jurists do not

accept this hadith as authentic and this

hadith is considered as a weak narration.

However, in Malaysia, where the Shafi

School of jurisprudence is practiced, there

is acceptance of securitised Murabahah-

based assets. Most of the Islamic debt

papers issued to date have been based on

the principles of Murabahah and Bai

Bithaman Ajil.

1111

Credit enhancement is provided in order

to increase the marketability of an asset

backed securitization. The types of credit

enhancement in conventional ABS can be

divided into:

1. external enhancements

2. internal enhancements

Examples of external enhancements are;cash-collateral-account method, currency

exchange agreement, direct credit

substitution, guarantee, guaranteed

investment contract, insurance, standby

letter of credit and swap arrangement.

Examples of internal enhancements are

overcollateralisation of the loan pool

method, senior/subordinated structure

(tranches) method and spread account.

The type credit enhancement offered must

comply with the Shariah requirements.

3 There are four well-known schools of Islamic

jurisprudence, namely Hanafi, Maliki, Shafi and

Hanbali.


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! "%

Interest is strictly prohibited and return or

fixed return cannot be guaranteed. There

must be an element of the sharing of risk

in return for a gain.

The type of credit enhancement must

show that there is some form of sharing in

the profit and loss of the securitization

structure. A credit enhancement that acts

as a form of guarantee for investment

made by investors would not be

appropriate as there is no form of risk in

their investments. Their profits in the

investments are guaranteed. A cash

collateral account method whereby a loan

is made to the SPV by the originator or a

specific amount of liquidity is put aside inan account may not be appropriate, as this

resembles a guaranteed. Clearly, credit

enhancement in the form of a guarantee,

either conditional or unconditional

guarantee by the originator or third party

of the performance of the asset is also not

suitable for an Islamic securitization as it

is clearly stated that it is a guarantee. A

standby letter of credit where a financial

institution promises to provide the SPV

with a loan in the event of income

shortfall may not be appropriate as this

will reflect that there is no sharing of loss

by the investors. A guaranteed investment

contract where a financial institution in

example a bank or an insurance company

guarantees a fixed return on any funds

invested by the SPV is also not

appropriate for Islamic ABS.

Based on the Shariah requirements of

profit and loss sharing, the most suitable

form of credit enhancement where theinvestors can actually participate in the

sharing of profit and loss would be

insurance. In Islam, insurance is seen as a

mutual help. Islamic jurists acknowledge

insurance as shared responsibility. The

concept of insurance is acceptable in

Islam because;

the policy holders would cooperate

among themselves for theircommon good;

every policyholder would pay his

subscription in order to assist those

of them who need assistance;

it falls under the donation contract

which is intended to divide losses

and spread liability according to

the community pooling system;

the element of uncertainty will be

eliminated insofar as subscription

and compensation are concerned;

it does not aim at derivingadvantage at the cost of other

individuals.

Source: BIMB Institute of Research and

Training Sdn. Bhd., 1996

The contract of Islamic insurance is based

on the Islamic profit-sharing principle. By

this principle, the entrepreneur will accept

payment of the insurance installments or

contributions from investors. The contract

specifies how the profit from operations

of the insurance managed by the

insurance operator is to be shared, in

accordance with the principle of profit

sharing between the participants. In

Islamic insurance, the participant shall

agree to relinquish certain proportion of

his insurance installments or

contributions that he agrees to pay should

any of his fellow participants suffer a

defined loss. This way, the participant is

fulfilling his obligation of mutual help

and joint guarantee, helping otherparticipants who might suffer loss or

damage due to catastrophe or disaster.


18/44


19/44

! "'

the securities looks at the quality of the

originator. What sort of loans does the

originator have? What risk management

policy does it use? How does it manage

its non-performing loans? How is thepolicy on recovery of non-performing

loans? All these will determine the

quality of the pool of loans.

Rating agencies have their own way of

issuing a rating. For example, Moodys

Bank Financial Strength Ratings (BFSRs)

represent Moodys opinion of a banks

intrinsic safety and soundness and, as

such, exclude certain external credit risks

and credit support elements that are

addressed by Moodys Bank DepositRatings (Moodys Investors Service,

www.moodys.com). In addition to

commercial banks, Moodys BFSRs may

also be assigned to other types of

financial institutions such as multilateral

development banks, government-

sponsored financial institutions and

national development financial

institutions. Bank Financial Strength

Ratings do not address the probability of

timely payment. Instead, Bank Financial

Strength Ratings can be understood as a

measure of the likelihood that a bank will

require assistance from third parties such

as its owners, its industry group, or

official institutions.

Moodys BFSRs do not take into account

the probability that the bank will receive

such external support, nor do they address

risks arising from sovereign actions that

may interfere with a banks ability to

honour its domestic or foreign currencyobligations.

Factors considered in the assignment of

Moodys BFSRs include bank-specific

elements such as financial fundamentals,

franchise value, and business and asset

diversification. Although Moodys

BFSRs exclude the external factors

specified above, they do take into accountother risk factors in the banks operating

environment, including the strength and

prospective performance of the economy,

as well as the structure and relative

fragility of the financial system, and the

quality of banking regulation and

supervision.

According to Hassoune, Volland and Al-

Yousouf (2002) the problem with rating

Islamic banks is that compared to non-

Islamic banks it is difficult to judgewhether an Islamic banks asset portfolio

is of higher or lower quality than that of

the non-Islamic banks. This is due to the

limited disclosure relating to asset

quality. This hampers the comparison.

Furthermore, in the case of impaired

financing, financial instruments like

mudharabah and musyarakah can only be

assessed at the end of a contract.

According to Standard and Poors,

Islamic financial institutions have a weak

track record of high, consistent and

exhaustive financial disclosure. This view

is shared by Willis (2000,

www.gtnews.com) who suggests that

Islamic banks will need to provide a far

greater level of transparency because so

far they have done very little to provide a

clear picture of their general activities,

asset quality or management policies.

Furthermore, rating agencies are

concerned with the asset quality.

Recurrent weaknesses in disclosure relate

to volumes of non-performing assets,

internal classification rules concerning

impaired assets, provisioning policies,


20/44

! "

and the breakdown of deposits between

savings accounts and investment accounts

and capital adequacy ratio. Also,

information provided to investors

regarding these issues is generallyinsufficient, while there remain large

differences between Islamic financial

institutions in terms of practices and

disclosure. The problems in rating Islamic

financial institutions only add to the

importance of an appropriate policy of

measurement and management of non-

performing loans for Islamic banks and

adequate information disclosure in an

Islamic bank. Therefore the problem of

rating actually lies in the Islamic financial

institutions themselves. If they can betransparent by making adequate

disclosures then there should be no

problem in rating Islamic financial

institutions.

The suggestion that an Islamic rating

agency should be established because

current rating agencies have taken a

varied approach in analyzing Islamic

financial institutions resulting in

inconsistent rating is arguable.

International rating agency for example

Moodys has made an effort of

understanding the operations of Islamic

financial institutions (Cunningham,

2000). Moodys are aware that the

instruments they used are different from

interest-based bank. Fitch IBCA rating

agency is also coming up with their rating

of Islamic financial institutions. In

conclusion, international rating agencies

are making an effort to understand the

operations of Islamic banks.

If Islamic banks can disclose the quality

of its assets, its policy on the risk

management and its policy on non-

performing assets, then there would be no

problem of getting a good rating.

Disclosure is very important, as it is a

source of information for public.

Information that includes themanagement policies, risk exposures and

risk management practices helps to

enhance the transparency and efficiency

of the financial markets thus promoting a

greater stability to the financial systems

of any country. Disclosure of credit risk,

market risk, liquidity risk helps investors

and other parties to assess the risk and the

return of their investments should they be

interested to purchase the securities.

The Islamic banking system involves

some sharing or distribution of risk in the

operation of an Islamic bank.

Understandably, this would require

Islamic banks to have a conducive and

supportive environment in the form of

jurisdiction and framework that facilitate

the development of appropriate systems.

There should be development that can

help Islamic banks to improve theirposition in the banking system. There is

tough competition from conventional

banks that have experience and

technology on their side. The

conventional banks are finding it easier to

provide the same products as Islamic

banks. Islamic banks should meet this

challenge through product innovation and

liquidity management. Banks and

financial markets are becoming more

sophisticated and competitive and Islamic

banks must exploit this opportunity.Asset-backed securitization is an

important development for banks. More

illiquid loans can be transformed into


21/44

! "(

securities that are liquid. However,

Shariah rules must also be observed.

As mentioned in the introduction, like

conventional banks, Islamic banks arealso exposed to banking risks especially

credit risks. They are also subject to

capital adequacy ratio and reserve

requirements by regulatory bodies. Most

importantly, their special characteristics

whereby the principle of profit and loss

sharing is used in their relationship

between depositors and in extending

financings makes them more vulnerable

to losses therefore making risk

management very important in Islamic

banks. Islamic banks also face theproblem of non-performing loans that can

affect their performance. In addition,

Islamic banks have been facing a liquidity

issue that is created by the mismatch of

deposits tenure and financing tenure.

There is either surplus idle cash position

to be invested or shortage cash position to

be funded immediately. The limited tools

in liquidity management in Islamic banks

make them vulnerable. The predominance

of debt-based financial modes is a

weakness as it is difficult to transform

these into negotiable financial

instruments.

ABS has offered a way for conventional

banks to overcome the issues above.

Islamic banks on the other hand have had

some problems in implementing Islamic

securitization. The issues of ownership,

trading of debt, credit enhancement and

rating of Islamic bank has impeded the

development of Islamic securitization.Several scholars like Dualeh (1998),

Thomas (2001) have highlighted the

potential of Islamic ABS without

analyzing the issues that might arise from

the structuring of the ABS. This paper

analyses the problems in implementing

the Islamic ABS and also suggests

solutions to overcome the problems in

structuring Islamic ABS.

The issuance of $500 million floating rate

sukuk by Islamic Development Bank

(IDB) is a major leap in Islamic banking

development as the assets are of Ijara

contracts and installment payments under

the Murabahah and Istisna contracts. The

sukuk is AAA rated and was

oversubscribed of $780 million that it had

to be closed quickly as orders were still

coming in. The sukuk are a ring fenced

portfolio of IDB assets. They areseparated from other assets of the banks

multilateral assets. The assets consist of

not less than 30% of its total value, assets

under the Ijara contracts with rentals

consisting of the unamortized portion of

the acquisition with fixed or variable

profit portion. In addition to this assets,

installment payments under Murabahah

and Istisna contracts that IDB has entered

into with some of its clients also forms

part of the assets. The IDB also retains

the risk of default on the sukuk assets

whereby it acts as a liquidity provider to

cover costs and expenses and periodic

distribution payments to sukuk holders.

The problem of ownership can be

overcome using the principles of Islam

itself. The assets based on the cost plus

(debt) mode of financing can be

securitized using Hawala. Hawala was

used when the Prophet (pbuh) was alive

and should not be an issue. Thediscounting of the value of debt should

not be likened to interest. Instead it

should be likened to capital appreciation.

Furthermore, the practice of discounting


22/44


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! "

2#2#2#2#

RHB Islamic Bank Berhad

ne of the clear differences

between Islamic banking and

conventional banking

transactions is that Islamic banking

transactions are predominantly based on

buying/selling or exchanging contracts

whereas conventional transactions are

based on lending contracts.

This clear distinction is based on the

foundation of Islamic banking as stated in

the Quran verse 2:275, "Trade is like

usury". But Allah SWT hath permitted

trade and forbidden usury. The Quranic

foundation has resulted in one of the most

important characteristics of Islamic

financing where it is based on asset-

backed financing and it places the

importance of underlying assets in thecontract.

The conventional banking financing

approach, on the converse, merely deals

in money and monetary papers only.

Islamic banking promotes the trading and

sale of real goods, assets and

commodities, thus enabling Islamic banks

to derive profit from it whereas interest,

which is forbidden in Islam, is obtained

through the lending of money byconventional banks.

In an Islamic contract, such as Murabahah

contract (mark-up sale) and Ijarah

(leasing), the underlying asset must be of

value, in existence at the time of the

sale/lease and the seller must have the

physical or constructive possession of the

goods and the goods must not be used for

purposes not allowed under Shariah.

In conventional banking, the lender gives

the client an interest-bearing loan, after

which the client may make use of it

(notwithstanding what may have been

described under the purpose of the loan)

for his own needs, which may or may not

be productive in nature.

In a conventional loan, the money is

advanced for profitable purposes which

may not be socially ethical, i.e. gambling

and liquor businesses.

In financing underlying assets, Islamic

banking can ensure that only goods and

commodities that are allowed under

Shariah will be purchased by the client.

The next question is: what if there is no

underlying asset at the point of contract?

Can it still be financed under Islamic

banking? The answer is definitely, Yes.

For example, through contract of Salam

(forward sale) and Istisna (contract tomanufacture) - contracts which are not

commonly used in this country but well

accepted and practised in the other parts

of the Islamic banking world.

O


24/44

!

From the above discussion, it is evident

that Islamic banking is deeply involved in

financing underlying assets, which

promotes the creation of real trade, realgoods, production and services, as

opposed to the increase in money supply

under conventional loans for which the

supply may or may not enhance the

creation of real assets or at worst fuels

inflation.

In placing the importance of underlying

assets, Islamic bankers analyse clients

differently from their conventional

counterparts.

Conventional bankers evaluate credit

quality as the ultimate test in determining

how much loan to give out but Islamic

bankers will have to go deeper into other

risk factors such as construction risk,

project financing risk under Istisna

contract, performance risk of producer

and commodity supply risk under Salam

contracts, and risks associated with the

asset under Murabahah and Ijarah

contracts.

This is evident as Islamic bankers directly

and indirectly act as traders, sellers,

contractors, producers and suppliers of

real goods and services as opposed to

conventional bankers who act as mere

lenders.

Islamic bankers in this case, are more

engaged and involved with the clients in

the trading activities and the risks

associated with the clients' trade.

The need for underlying assets has also

enhanced the credibility and transparency

to the transaction where the price of the

assets to be transacted must be made

known and the mark-up is determined at

the point of the contract in all the said

Islamic contracts.

This is certainly a great shift from a

conventional loan transaction where the

bank is only interested in the loan pricing

to customer.

There still is this issue of monies required

to start off a business in the form of

capital injection or funds required for the

acquisition of shares in a company. In

such a situation, where is the underlying

asset to start with?

Shares, in this case shares allowed under

Shariah, are a form of asset that can be

transacted upon and financed under

Islamic financing contracts such as

Murabahah, thus dispelling the notion

that we only transact in physical assets.

To go further, the underlying asset could

be in the form of systems software that is

of value and can be bought and sold in the

market.

Time has also come for us to broaden the

scope and further explore structuring

Musharakah (partnership) and

Mudharabah (profit and loss sharing)

contracts to address the capital injection

financing requirement, and packaging it

together with the earlier contracts of

exchange, thus providing the working

capital in delivering productive assets and

commodities into the market.

To achieve this ideal scenario, all

interested parties, especially the

regulatory bodies, must come together

firstly in appreciation of the peculiar


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26/44

! $

Prof. Datuk Dr. Syed Othman Alhabshi

International Centre for Education in Islamic Finance

&&&&

Stock screening is a process ofdetermining whether a stock or security isShariah-compliant or not. It consists ofvarious Shariah principles that form thecriteria which should be used to

determine whether the stock or security isShariah-compliant or not.

$034$034$034$034

The main objective of screening the stockis to ensure that the stock or security thatone purchases or invest in does notcontain any prohibited elements thatmake it Shariah non-compliant. ForMuslims, it is a grave sin to consume

something that is unlawful or prohibited.

According to a hadith of the Holy Prophet(peace and blessings of Allah be uponhim) as reported by Jabir (may Allah bepleased with him), the Messenger ofAllah said: The flesh grown fromunlawful provisions shall not enterParadise, and every flesh grown fromunlawful provisions deserves to bethrown in the Hell fire (Ahmad). Fromthe hadith, it is clear that Muslims need tobe very careful not to consume or feed his

family with food that originates fromunlawful income. In fact it is not just foodthat we consume must be permissible, itis all that we consume in the generalsense should be pure and clean.

This paper will confine discussion onlyon the stock screening processes asadopted by the Securities Commission ofMalaysia (SC) and the Dow Jones IslamicMarket Index (DJIM).

To ensure that we consume only what ispermitted, we have to ensure that theincome that we earn and the resultingwealth that we generate and accumulatemust have been done through lawfulmeans. To help us ensure this, the Shariahhas laid down the basic principles that

should be followed in our business orcommercial transactions.

The Holy Quran also states, O ye whobelieve! Eat not up your property amongyourselves in vanities; but let there beamongst you traffic and trade by mutualgoodwill: Nor kill (or destroy)yourselves: for verily God hat been to youMost Merciful [An-Nisaa (4):29]

From the above verse, it is clear that weshould not take each others wealth or

property through vain means. But thereshould be proper, transparent, fair andjust exchange or transactions which aremutually agreed by both parties. At theend of the verse, it says about killing or


27/44

! %

destroying oneself which implies that bycheating or forcing one to give up hisproperty you are in fact killing hislivelihood although he may not die. Basedon such interpretations of the verse, the

scholars have outlined the principles ofIslamic transactions as follows:

Willing buyer

Willing seller Well defined or specified good,

commodity or product

Agreed price

Offer and acceptance

The following can be derived from theabove list of requirements:

First, the participants in transactions mustbe of age, free man, represented if blindand sane individual. Underage person isnot allowed to transact unless permittedby the guardian or parents.

Second, the good or commodity orproduct must be well defined or specifiedto avoid any ambiguity or uncertainty(gharar) which is prohibited. The goodmust be owned by the seller and can bedelivered at the appointed time.

Third, both parties need to agree on theprice.

Fourth, the offer and acceptance can beverbal or in writing which acts as theconclusion of the agreement by bothparties to the transaction.

The Holy Quran has addressed mankindthus: O ye people! Eat of what is onearth, lawful and good and not follow thefootsteps of the evil one, for he is to you

an avowed enemy [Al-Baqarah (2):168].

The verse clearly states two basic criteriain selecting food for our consumption,

namely, they should first be lawful andsecondly they should be good. From thescience of the Holy Quran, the order ofthe words in the verse implies that weshould choose food that is lawful first.

Among the lawful food we should thenchoose those that are good for us. Thereare two implications here: First, it impliesthat what is lawful must be good.However, what is good may not be lawfulsuch as strong drinks. Secondly, what isgood for someone may not be good foranother. Hence, one should be selective inchoosing among the lawful what is goodfor him.

While the first verse outlines the basicprinciples of Islamic transactions ingeneral, the second provides the basis forstock screening. This does not mean thatthe basic principles of Islamictransactions do not apply in the stockscreening process. In fact, the thirdprinciple of Islamic transactions whichpertains to good or product to betransacted is further clarified by thesecond verse quoted above. In otherwords the stock cannot contain anyprohibited elements whether by action orby contents. Stock screening therefore

entails the scrutiny of the good or productof the company and the manner it is beingproduced, particularly in terms offinancing.


28/44

! &

#4 #4 #4 #4

,,,,

The universe for Securities Commission

(SC) of Malaysia is limited only to thosestocks or securities that are listed in BursaMalaysia. This includes those securitieslisted in the First and Second Boards aswell as in MASDEQ.

The universe for Dow Jones IslamicMarket Index (DJIM) is based on globalmarkets.

The DJMI include stocks from 34countries and cover 10 economic sectors,18 market sectors, 40 industry groups and

70 subgroups. Currently, the Dow JonesIslamic Market family of indices consistsof the broad DJ Islamic Market Index, theDJ Islamic Market Canadian Index, theDJ Islamic Market UK Index, the DJIslamic Market Europe Index, and the DJIslamic Market Asia/Pacific Index.

Both the Securities Commission (SC) ofMalaysia and Dow Jones Islamic MarketIndex (DJIM) have the same approach tothe first level of screening which is basedon core business. The core business is

considered permissible as long as they donot belong to any of those businesses thatare listed as non-permissible.

The SC listed the non-permissible corebusinesses as follows:

Financial services based on riba(interest);

Gambling and gaming;

1 This section onwards has made reference to

Securities Commission booklet on List ofShariah-Compliant Securities by the Shariah

Advisory Council of the Securities Commission

dated 25 May 2007 and the Dow Jones Islamic

Market Index website

Manufacture or sale of non-halalproducts or related products;

Conventional insurance;

Entertainment activities that arenon-permissible according toShariah;

Manufacture or sale of tobacco-based products or related products;

Stock broking or share trading inShariah-non compliant securities;and

Other activities deemed non-permissible according to Shariah

For DJIM most Shariah boards haveadvised against investment in companiesinvolved in the following activities:

Alcohol

Tobacco

Pork-related products Conventional financial services

(banking, insurance, etc.)

Weapons and defense

Entertainment (hotels,casinos/gambling, cinema,pornography, music, etc.)

Shariah-compliant securities includeordinary shares, warrants and transferablesubscription rights (TSRs). This meansthat warrants and TSRs are classified asShariah-compliant securities provided theunderlying shares are also Shariah-compliant. On the other hand, loan stocksand bonds are Shariah non-compliantsecurities unless they are issued based onShariah principles


29/44

! '

2 2 2 2

(A) By the Securities Commission of

Malaysia

Having got the universe of securitieswith permissible core business, theShariah Advisory Committee (SAC)of SC also scrutinizes the level ofcontribution of interest incomereceived by the company fromconventional fixed deposits or otherinterest bearing financialinstruments. In addition, dividendsreceived from investment in Shariah-non compliant securities are also

considered in the analysis carried outby the SAC

For companies with activitiescomprising both permissible andnon-permissible elements the SACconsiders two additional criteria:

the public perception or image ofthe company must be good; and

the core activities of the companyare important and consideredmaslahah (benefit in general) to

the Muslim ummah (nation) andthe country and the non-permissible element is very smalland involves matters such asumum balwa (common plight anddifficult to avoid) uruf (custom)and the rights of the non-Muslimcommunity which are accepted byIslam

(B) By the Dow Jones Islamic MarketIndex (DJMI)

During the component selectionprocess, each company in the indexuniverse is examined based on itsrevenue allocation. If the companyhas business activities in any one of

the following sectors defined by theIndustry Classification Benchmark(ICB), it is considered inappropriatefor Islamic investment purposes andis excluded from the index.

DefenseBanksDistillers & VintnersFull Line InsuranceFood ProductsInsurance BrokersRecreational ProductsProperty and Casualty InsuranceTobaccoReinsuranceFood Retailers & WholesalersLife InsuranceBroadcasting & EntertainmentReal Estate Holding & DevelopmentMedia AgenciesConsumer FinanceGamblingSpecialty FinanceHotelsInvestment ServicesRecreational ServicesMortgage FinanceRestaurants and Bars

0 4 %0 4 %0 4 %0 4 %''''

0000

(A) By the Securities Commission ofMalaysia

To determine the tolerable level ofmixed contributions from permissibleand non-permissible activitiestowards turnover and profit beforetax of a company, the SAC hasestablished several benchmarks

based on ijtihad(reasoning from thesource of Shariah by qualifiedShariah scholars). If the contributionsfrom non-permissible activitiesexceed the benchmark, the securities


30/44

!

of the company will be classified asShariah-non compliant.

The benchmarks are:

The five-percent benchmark

It is used to assess the level of mixedcontributions from the activities thatare clearly prohibited such as riba,(interest-based companies likeconventional banks), gambling,liquor and pork

The 10-percent benchmark

It is used to assess the level of mixedcontributions from the activities thatinvolve the element ofumum balwawhich is a prohibited elementaffecting most people and difficult toavoid. An example of such acontribution is the interest incomefrom fixed deposits in conventionalbanks. This benchmark is also usedfor tobacco-related activities


It is used to assess the level ofcontribution of mixed rental paymentfrom Shariah non-compliantactivities, such as rental paymentsfrom premises used in gambling, saleof liquor, etc.


It is used to assess the level of mixedcontributions from the activities thatare generally permissible accordingto Shariah and have an element of

maslahah to the public, but there areother elements that may affect theShariah status of these activities.Among the activities that belong tothis benchmark are hotel and resort

operations, share trading, stockbroking and others as these activitiesmay also involve other activities thatare deemed non-permissibleaccording to the Shariah.

(B) By the Dow Jones Islamic MarketIndex (DJMI)

For DJIM, after removing companieswith unacceptable primary businessactivities, the remaining stocks areevaluated according to severalfinancial ratio filters. The filters arebased on criteria set by the Shariahsupervisory Board to removecompanies with unacceptable levelsof debts or impure interest income.

All of the following must be less than33%:

Total debt divided by trailing 12-month average marketcapitalization

The sum of a companys cash andinterest-bearing securities dividedby trailing 12-month average

market capitalization Accounts receivables divided by

12-month average marketcapitalization

''''

As a guide to investors, the SAC wouldlike to advise investors on the timing forthe disposal of securities which have beenclassified as Shariah non-compliant.

Shariah-Compliant Securities Which

Are Subsequently Considered Shariah

Non-Compliant


31/44

! (

This refers to those securities which wereearlier classified as Shariah-compliantsecurities but due to certain reasons, suchas changes in the companies operations,are subsequently considered Shariah non-

compliant. In this regard, if on the datethe updated list takes effect (e.g. 25 May2007), the value of the securities heldexceeds the original investment cost;investors who hold such Shariah non-compliant securities must liquidate them.Any capital gain arising from the disposalof the Shariah non-compliant securitiesmade at the time of the announcement canbe kept by the investors. However, anyexcess capital gain derived from thedisposal after the announcement day at amarket price that is higher than theclosing price on the announcement dayshould be channeled to charitable bodies.

On the other hand, investors are allowedto hold their investment in the Shariahnon-compliant securities if the marketprice of the said securities is below theoriginal investment cost. It is alsopermissible for the investors to keep thedividends received during the holdingperiod until such time when the totalamount of dividends received and the

market value of the Shariah non-compliant securities held equal theoriginal investment cost. At this stage,they are advised to dispose of theirholding.

In addition during the holding period,investors are allowed to subscribe to:

any issue of new securities by thecompany whose Shariah non-compliant securities are held by theinvestors, for example rights issues,

bonus issues, special issues andwarrants [excluding securitieswhose nature is Shariah non-compliant, e.g. irredeemable

convertible unsecured loan stock(ICULS)]; and

securities of other companiesoffered by the company whoseShariah-non compliant securitiesare held by the investors

on condition that they expedite thedisposal of the Shariah non-compliantsecurities. For securities of othercompanies [as stated in (b) above], thymust be Shariah-compliant securities.Shariah Non-Compliant Securities

The SAC advises investors who investbased on Shariah principles to dispose ofany Shariah non-compliant securitieswhich they presently hold, within a monthof knowing the status of the securities.Any gain made in the form of capital gainor dividend received during or after thedisposal of the securities has to bechanneled to charitable bodies. Theinvestor has a right to retain only theoriginal investment cost.

Note: Original investment cost may

include brokerage cost or other

related transaction cost.

Purification or cleansing is normally donewhen we know for sure that part of theincome or revenue of the company that isShariah compliant

derives from non-permissiblesources such as interest onconventional fixed deposits; or

contributed by a portion of capitalthat is obtained throughconventional loan; or

some other sources that are Shariahnon-compliant


32/44


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! #"

strategic relationships with renowned

local and international organisations. This

will accelerate our endeavor in delivering

the best human capital solution for the

global Islamic finance industry

For more information, please contact:

International Centre for Education in IslamicFinance

2nd Floor, Annexe Block,Menara Tun Razak, Jalan Raja Laut50350 Kuala LumpurMalaysiaTel: +603-2781 4000Fax: +603-2692 4094E-mail: [email protected]: www.inceif.org


34/44

! #

5555&&&&

,/667,/667,/667,/667

RAM Rating Services Berhad

total of 34 new sukuk deals,

with a combined issuance value

of RM14.5 billion, were

successfully closed in 1H 2008. Although

less than half that of the previous

corresponding period, this is still

respectable considering the jittery marketand widening bond spreads amid the

ongoing credit crisis, mounting

inflationary pressures and continued

concerns about flagging global economic

growth. RAM Ratings notes that sukuk

issues accounted for about 34% of the

domestic markets RM43.4 billion of

rated corporate bond issues in the first

half of this year.

Big Boys Club: The sukuk market is still

the domain of infrastructure issues. Eight

corporates from this sector entered themarket with some RM8.16 billion of

sukuk programmes in 1H 2008,

accounting for 56% of the total sukuk

market. This was followed by the real

estate and construction sector, with a

12%-share.

A

ABS / StructuredFinance

10%

Finance7%

Industrial4%

Infrastrutcure56%

Oil & Gas6%

Plantation1%

Real Estate &Construction

12%

Services1%

Trading3%

Sukuk Programme by Economic SectorTotal Rated Facility Programme = RM14.50 Billion

as at End-June 2008

!"#$%$


35/44

! ##

The more notable sukuk programmes that

were closed between January and June

this year included those by PLUS SPV

Berhad (PLUS SPV), Menara ABS

Berhad (Menara ABS) and Al-AqarCapital Sdn Bhd (Al-Aqar Capital).

The RM4.0 billion (nominal value) sukuk

programme by PLUS SPV represents the

markets largest year-to-date sukuk deal.

PLUS SPV is an independent special-

purpose company through which PLUS

Expressways Berhad (PEB) had issued

sukuk to meet its funding requirements.

PEB is an investment-holding company,

and is primarily involved in the operation

of tolled roads, both in Malaysia andabroad. Its stable of domestic toll-road

concessionaires includes Projek

Lebuhraya Utara-Selatan Berhad

(PLUS), Expressway Lingkaran

Tengah Sdn Bhd (ELITE), Linkedua

(Malaysia) Berhad (LINKEDUA) and

Konsortium Lebuhraya Butterworth

Kulim (KLBK) Sdn Bhd (KLBK). In

addition, PEB has ventured into India and

Indonesia, with stakes in 3 toll-road

concessionaires.

Meanwhile, the RM1.0 billion Sukuk

Ijarah by Menara ABS, a real-estate-

backed transaction involving the

securitisation of properties with a

combined value of RM1.03 billion, is

Malaysias largest securitisation of

property assets executed to date. Menara

ABS is a special-purpose vehicle,

incorporated for the purpose of

undertaking a sale-and-leaseback

transaction involving 4 properties owned

by Telekom Malaysia Berhad.

Despite its relatively small offering, Al-

Aqar Capitals RM300 million SukukIjarah is noteworthy as the first domestic

commercialreal-estate-backed ransaction

involving hospital properties. Under this

transaction, Al-Aqar Capital had issued

medium- and short-term Sukuk Ijarah to

acquire the beneficial interests in 6

hospitals from Al-Aqar KPJ Real Estate

Investment Trust (Al-Aqar REIT). The

KPJ Group - the largest provider of

private healthcare services in Malaysia -

is also the largest shareholder of Al-Aqar

REIT and has a vested interest in theoperational and financial stability of Al-

Aqar REIT, i.e. the lessee under the

Ijarah Agreement (lease agreement). Al-

Aqar Capital, a special-purpose vehicle,

is wholly owned by Amanah Raya

Berhad - the REIT Trustee for Al-Aqar

REIT.

Credit Concentration: In 1H 2008,

RAM Ratings published the ratings of 22

new corporate sukuk issues, with an

aggregate issuance value of RM11.2

billion; about 46% or RM5.1 billion of

this had already been issued by end-June

2008. This constituted about 70% of the

entire markets RM7.3 billion of sukuk

issued as at the same date.

Rated Sukuk Market As At June 2008 (RM) Facil ity Programme Issued Amount

Source: RAM Ratings / FAST

RAM Ratings-Rated 11,239,000,000 5,119,000,000

MARC-Rated 3,265,000,000 2,223,000,000

Total Rated Sukuk Market 14,504,000,000 7,342,000,000

Total Rated Corporate Bond Market 43,354,000,000 23,162,000,000


36/44


37/44


38/44

! #&

)*+,-).*!#

,,-//

0,* 1

"&$'""()* +,-./,000,000 12345

$'%"($67$!)* 2,2+8,000,000 -83+5

'"&$'""()* -,-00,000,000 43+5

"(967$!:)* 8.0,000,000 13-5

'")"&$'""()* 8/8,000,000 1305

"(67$!)* ;1/,000,000 2315

"&$'""()* ;1/,000,000 2315

"&$'""()* /00,000,000 8385

!!%"()* 880,000,000 ;3/5

"(967$!:)* 800,000,000 ;315

"#"#"()* 800,000,000 ;315

"($6'67$!)* 280,000,000 -345

?!!""$967$!:)* 280,000,000 -345


39/44

4 #'(!$!$

Malaysian Islamic

Capital Market


40/44

4 #(!$!$

Malaysian Islamic

Capital Market


41/44


42/44

4 $(!$!$

RAM Ratings-Rated

Islamic BondsRAM Ratings-Rated Islamic Bonds (long-term)

as at June 2008

A

31%

AA A

23.4%

AA

34.8%

BBB

6.2%

BB

0.3%

B

1%C

0.7% D

2.4%

Total number of issues = 290

Source: RAM Ratings

RAM Ratings-Rated Islamic Bonds (long-term)

as at June 2008

AA A

33.5%

AA

49.9%

A

13.3%

BBB

0.9%

BB

0.1%

B

1.3% C

0.2% D

0.7%

Total value = RM173.30billion

Source: RAM Ratings

RAM Ratings-Rated Islamic Bonds (long-term)

as at June 2008

A

31%

AA A

23.4%

AA

34.8%

BBB

6.2%

BB

0.3%

B

1%C

0.7% D

2.4%


Source: RAM Ratings

RAM Ratings-Rated Islamic Bonds (short-term)

as at June 2008

P1

73.5%

P2

13.3%

P3

10.8%

NP

2.4%


Source: RAM Ratings


43/44

4 $"(!$!$

Malaysian Islamic

Banking MarketIslamic Asse ts in the Banking Sector

Source: Bank Negara Malays ia

3.37%

5.44%

6.91%

8.23%8.93%

11.35%

10.45%

9.72%

12.18%

13.66%13.08%

12.80%

-

200,000

400,000

600,000

800,000

1,000 ,000

1,200 ,000

1,400 ,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 M ar-08 Jun-08

RMm

illio

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

Is lam ic A ssets To tal A ssets in B anking Sys tem M arket share o f Is lam ic B anking assets (%)

Islamic Banking by Financing Contract

as at June 2008

Istisna, 1.5%

Others, 16.0%Mudharabah,

0.2%

Musyarakah,

0.8%

Murabahah,

15.7%

Ijarah Thumma Al-

Bai', 30.6%

Ijarah, 1.8%

Bai Bithaman Ajil,

33.6%

Tot al Financing : RM93.8 billion

Source Bank Negara Malaysia


44/44

Information contained in this publication is obtained from sources

believed to be reliable and correct at the point of writing; however, its

accuracy or completeness cannot be guaranteed. Opinions in this

publication are expressed from the point of view of the writers and are

not necessarily those of the Publisher. The views or opinions

expressed are subject to change at anytime. No statement in this

publication is to be construed as a recommendation to buy, sell or hold

securities.

All rights reserved. No part of this publication may be copied or

otherwise reproduced, repackaged, further transmitted, transferred,

disseminated, redistributed or resold or stored for subsequent use for

any such purpose, in whole or in part, in any form or manner or by

any means whatsoever by any person, without prior written consent

from the Publisher and / or writers.

'!"#&!$)*! 20 0- &6 20

;*6,"?"#"6(6"6"6!'"800006'@

Documents

Ram Bulletin 0608