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Topic 2:An Introduction To Islamic Finance
& BankingESC Rennes School of Business
2009/2010
Dr Khalid ELBADRAOUI
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Learning Objectives
This course is designed to:
Help students consider in some detail the principles ofIslamic Banking and the differences between Islamicand conventional banking.
Equip students with a practical and detailedunderstanding of Islamic products and their use in abusiness context.
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References
Books: Iqbal Z. and Mirakhor A., “An Introduction to Islamic Finance: Theory and
Practice”, Hardcover, 2006.
Ayub M., “Understanding Islamic Finance”, Hardcover, 2007.
Khan M. and Mirakhor A., “Theoretical Studies in Islamic Banking andFinance”, Islamic Publications International, 2005.
Websites: http://www.islamic-finance.com
http://www.islamicfinancenews.com
http://www.aaoifi.com: Accounting & Auditing Organisation for IslamicFinancial Institutions (AAOIFI)
http://www.ifsb.org: Islamic Financial Services Board (IFSB)
http://www.iifm.net: International Islamic Financial Market (IIFM)
http://www.iirating.com: Islamic International Rating Agency (IIRA)
http://www.ibisonline.net: Islamic Banks and Financial InstitutionsInformation
http://www.islamic-banking.com: Institute of Islamic Banking
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Road Book
What is Islamic Finance?
History & development of Islamic Finance
Islamic Contracts & use of funds
Islamic Bond (SUKUK)
Islamic Insurance (Takaful)
Asset Management/Fund Management
Subprime crisis and Islamic Finance
Challenges facing Islamic Finance
Conclusion
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•Islamic banking has the same purpose as conventional bankingexcept that it claims to operate in accordance with the rules ofShariah, known as Fiqh al-Muamalat (Islamic rules ontransactions).
•The basic principle of Islamic banking is the sharing of profitand loss and the prohibition of riba (interest).
•Amongst the common Islamic concepts used in Islamic bankingare profit sharing (Mudharaba), safekeeping (Wadiah), joint
venture (Musharaka), cost plus (Murabaha) and leasing (Ijarah).
•The key Islamic contracts are described in more detail in the3rd section.
What is Islamic Finance and Banking?
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Shariah terms
Halal – that which is permitted or compliant
Haram – that which is not permitted
Riba – charging of interest or unjustified increase
Gharar – the taking of unreasonable risk; uncertainty
Maisir – reliance on chance or speculation, rather than effort
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Islam
Aqidah(Faith and Belief)
Shariah(Practices and Activities)
Akhlaq(Moralities and Ethics)
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Basis of Shariah Approval (At a Glance)
Considerationof
PrimarySource
Considerationof
SecondarySource
Considerationof
Local Laws
Quaran &Sunnah
IjmaIjtehadQiyas
Law ofCountry
AcceptableTo
Market
But Shariah principlesshall not be compromise
HolyQuran Thesacred text
of Islam
SunnahPractices
and sayingsof ProphetMuhammad
Ijtehad Reasoningapplied by
Scholars
IjmaaConsensus
of Ummah Qiyas
Analytical
comparison
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Banking and finance needs
Islamic finance is the outcome of religion inbanking
Shariah filter
Islamic banking and finance solutions
• Prohibition of:
Interest
Speculation
Gambling
– Quran
– Sunnah
– Ijma‟ (jurist
consensus)
– Qiyas (analogy)
– Ijtihad (reasoning)
– Musharaka - Partnership
– Mudaraba - Partnership
– Murabaha - Purchase-resale
– Ijara - Lease
– Istisna - Manufacturingcontract
– Salam - Forward sale
• Asset-backedtransactionswithinvestments inreal, durableassets
Fiqh al-Muamalaat contractsShariah sources
• Prohibition of certain investments:
Sectors (e.g.: alcohol,armaments, financial services,gambling, pork, pornography,tobacco)
Instruments (e.g. no forwardtransactions, limited option use,
no derivatives, short-selling)
• Credit anddebt productsare notencouraged
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Islamic Finance
Principles and Foundations laid down by Shariah (Islamic law)
Quran – Revealed word of God
Sunnah – Sayings and practices of the Prophet Mohammed
Moral guidance or set of principles practiced by muslims
Shariah Supervisory Board (SSB)
3-5 Islamic Scholars
Decide what is compliant or not
Interpret Islamic Jurisprudence (Fiqh)
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The Foundations of Islamic Finance
Avoid Interest (Riba)
Riba al Naseeyah or Riba al-Quran – excess resulting from apre determined interest
Riba al-Fadl or Riba al Hadith – Excess compensation withoutconsideration
Avoid Uncertainty/Deceit (Gharar)
Final result is uncertain
Short Selling
Fraud
Options
Avoid Gambling (Maysir)
Involvement In speculative and gambling transactions
No Derivatives
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Transactions should be backed by Tangible assets. Obligation to share to a certain extent profits and losses and in the
forms of buyer – seller (murabaha), lessor – leasee (ijarah),partnership (musyaraka), and or debtor – creditor (qard hasan)relationship.
Promote honesty, transparency justice and fairness in commercialdealings.
Charitable distributions:
Zakat (Mandatory) (2.5% Lunar or 2.5775% Solar Calendar)
Sadakat (Voluntary)
Gambling (Casinos)
Insurance
Pork
Weapons & Armaments
Adult Entertainment
Alcohol
Banking
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Bank Client
Money
Money + money (interest)
Bank Client Goods &Services
Money
CONVENTIONAL
ISLAMIC
CONVENTIONAL BANKING
•Is based on interest.•Deals in money or papers
•Is based on fixed return on bothSides of the balance sheet.
•Does not involve itself in tradeand business directly
Islamic BANKING
. Is based on profit or rent
. Deals in assets.
. Is based on profit sharing on .deposits side, and on profit onassets side.
. Actively participates in trade,production and valid servicesthrough valid contracts.
Islamic vs. Conventional
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Conventional Bank
Bank acts as a financialIntermediary
Maturity Transformation – Takes in long term financeand lends short term
Main income consists of
Interest Margin
Islamic Bank
Return must take the form ofa tangible asset
Bank acts a a fund/assetmanager (Mudarib)
Depositors are seen asinvestors (Rab al Mal)
Islamic vs. Conventional
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Expectations
More ethical business and economy.
Better governance, due to participation of investors (debtholders) in risk sharing.
Less uncertainty and less transaction costs.
Less speculation.
Shariah businesses deal only on real sector (goods and services),
so that it will add economic value.
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History and Development of Islamic
Finance and banking
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17Historical Background of IF&B
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1960‟s-1980New Concept,
Limited toCommercial
Banking
• New Concept, Limited to Commercial Banking
1980‟s-1990
• Expansion into Asian Markets
• Introduction of Islamic Insurance (Takaful) + Project Financing
1990‟s
• Oil shocks resulted in rapid growth• Birth of the Islamic bond (Sukuk)• Equities market• Leasing (Ijarah)
2000- Today
• Internationalization of Islamic Finance• Creation of Islamic Funds / Asset Management• Structured Products
Industry has developed a comprehensive productoffering over its young history
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Reach and richness
Niche presence
Mainstream relevance
Conceptual exploration
Engaging with regulators
Reach and richness
Source: HSBC
Amanah
Islamic finance industry is developing a globalreach…
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Singapore:
Active in
developing
Islamic
finance
Germany:
Saxony issues
E100m Sukuk (2004)
UK:
New legislation for
Islamic mortgages (2003)
UAE:
30% of retail banking
is Islamic (2005)
•Several institutions
have converted from
conventional to Islamic
Malaysia:
Islamic product and
industry, development
and sophistication lead
USA:
Harvard workshop
with six regulators
(1995)
China:
Active member
of Islamic
FinancialServices Board
(2004)
Bahrain:
Leading Islamicfinancial centre, and
housing regulatory
bodies
Saudi Arabia:
95%+ of new consumer
lending is Islamic (2006)
•Retail market rapidlyconverting to Islamic
(2006)
Source: HSBC Amanah, Press
Reviews
Japan:
JBIC explorin
Islamic
financingopportunities
(Dec. 2006)
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21Islamic Banking
KualaLumpur
Dubai Manama Doha London Singapore
Population 1.5m 1.3m 718,306 928,635 7.5m 4.6m
Muslims 40% 96% 81.2% 77.5% 8% 14.9%
Fin Sector
(Assets)
$387.5 B $340.0 B $251.1 B $81.3 B $19.1 Tr $276.5 B
Islamic $50.0 B $46.3 B $16.4 B $14.8 B $10.0 B $1.8 B
% 12.9% 13.5% 6.5% 18.2% 0.05% 6.5%
MajorPlayers
HSBC,Bank IslamMalayasia,Prudential
NoorIslamicBank,DIB,
EmiratesIslamicBank,
AcrapitaBank, Gulf
FinanceHouse,BahrainIslamicBank
AcrapitaBank, Gulf
FinanceHouse,BahrainIslamicBank
IslamicBank ofBritain,HSBC,
EuropeanFinanceHouse
StandardChartered,
Islamic Bankof Asia,
Malayan Bank
22N t d F t f th IF&B
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•1.6 Billion Muslims worldwide (24% of total world‟s population)
•10-20% annual growth rate
•Market of Shariah compliant assets approximately $800bn
•Islamic indexes on Dow Jones/FTSE//MSCI
0
500
1000
Islamic
Funds 2008
Islamic
Funds 2010
650950
Number of Islamic Funds
0
2
4
MuslimAUM 2008
MuslimAUM 2010
1.62.7
Assets held by musliminvestors in $trillions
Natures and Facts of the IF&B
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Conventional banks, including multinationals get into the
business, offering islamic financial products.
Grais & Pellegrini (2006) reported that the global Islamicfinancial services industry consisted of 284 institutions offeringIslamic financial services (IIFS) operating in 38 countries, bothMuslim and non-Muslim.
Solé (2007) identified that there were more than 300 Islamicfinancial institutions spread over 51 countries, plus well over 250mutual funds that comply with Islamic principles.
Assets held by fully Shariah-compliant banks or Islamic bankingwindows of conventional banks rose by 28.6% to $822bn from$639bn in 2008, compared to just 6.8% for that of conventionalbank (The Banker‟s Top 500 Islamic Financial Institutions Survey).
Natures and Facts of the IF&B
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The major contributors to asset growth for Islamic funds:
Gulf Cooperation Council (GCC) countries (US$262.7bil);
Asia (US$67.1bil);
Australia/Europe/the United States (US$35.3bil); and non-GCC Middle East countries, Middle East and North Africa(US$248.3bil).
The IF & B has involved in all of industries: energy, consumerdiscretionary, staples, financials, materials, informationtechnology, health care, telecommunication, utilities,education, etc.
IF & B also provides financing for large scale projects such asthose in energy and infrastructure through sukuk (asset based)financing.
Natures and Facts of the IF&B
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Global Islamic Banking Assets
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29Infrastructure Regulatory Framework and
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Infrastructure, Regulatory Framework andGovernance for If & B
Islamic law and regulatory framework exist, including those deal
with modern business. However, there are limitations in terms ofthe capacity of the jurists to deal with large scale economictransactions, and that there is no court of final appeal that resultin controversies (Monger and Rawashdeh 2008).
The most notable initiative is the establishment of Accounting andAuditing Organization of Islamic Financial Institutions (AAOIFI) =>to develop standards for accounting, auditing, governance, andethics to ensure Shariah compliance.
The Islamic Financial Services Board (IFSB) was created to set
standards for the industry, in which twenty-two agencies, includingseveral national central banks, International Monetary Fund andWorld Bank are members. The board intially focussed on riskmanagement and capital adequacy for islamic financial industry.
30Infrastructure Regulatory Framework and
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The IDB initiatives are also important to support the infrastructure
for operation and development of Islamic financial industry.
Other supporting structures, such as ratings, indexes, studies,
predictions and analysis for IF & B institutions are available andprovided by conventional and international institutions (such as
S&P, Dow Jones, etc.).
Infrastructure, Regulatory Framework andGovernance for If & B
31Self-regulatory organizations bring credibility
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GCIBFI
(2001)Bahrain
Promoting industry in theory and practice
− Disseminating Shariah concepts & multilateral understanding between IFIs and public− Improving IFI practices, cooperation, professionalism and transparency
IIFM (2001)
Bahrain
Development of global Islamic capital and money market
− Promoting active and regulated trading and capital flows
− Catalyzing trading infrastructure, product innovation and information flows
through standardization of practices
AAO-IFI (1991)
Bahrain
Benchmark of Islamic accounting standards
− 56 accounting, auditing, governance and Shariah standards− Enhancing clarity, transparency and harmonisation
IIRA (2005)
Bahrain
Reference point for IFI ratings
− Issuing sovereign, credit, Shariah quality and corporate governance ratings
− Providing effective tool for informed investment decision-making
IFSB (2002)
Malaysia
Standard-setting body of regulatory and supervisory agencies
− Complementing Basel II Capital Accord
− Key standards: risk management, capital adequacy & corporate governance
LMC (2002)Bahrain
Creation of active Islamic inter-bank market
− Creating secondary market for short-term Shariah-compliant treasury products
− Enabling IFI management of liquidity mismatch
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Islamic Banking Operating Structures
Islamic Windows
Branches
Subsidiaries
Fully fledged Islamic Banks
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Islamic Contracts & Use of Funds
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Sources & Uses of Client Funds
Sources
Deposit Accounts
Current account
Savings account
Investment account
Shareholders funds
Share Capital
Reserves
Other
Off balance sheet (specificaccounts)
Uses
Murabaha
Musharaka
Mudaraba
Ijara
Salam
Istisna
Off Balance sheet
Funds
Sukuk (Islamic Bond)
Reserves (general & statuary)
Type of Contracts
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l f C
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Elements of a Contract
Contracting parties Mature
Sane
Subject Matter
Valuable according to Shariah law Existence (material effect)
Must be owned
Ability to deliver
Specific Conditions & offer and acceptance
Acceptance must match offer
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Murabaha (Set Profit Sale)
Definition of Murabaha:
It is a sale contract, with a set increment on the original price,agreed upon by the two parties.
It is a particular kind of sale where the seller expressly mentionsthe cost of the sold commodity he has incurred, and sells it toanother person by adding some profit.
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Murabaha Financing
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Murabaha FinancingInstallment Credit Sale
Differed payment Sale/Installment Credit Sale + Profit Mark-Up
Closing & payment date must be clear
Bank can appoint client as agent (if bank is inexperienced)
Technical ownership of good remains with bank
Bank may request Collateral/Security/Guarantee
Buyer knows the original seller price
The banker in a Murabaha must have some form of actual ownership, registeredor not, constructive or physical
Bank Client
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Mechanics of Murabaha
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Mechanics of Murabaha
A typical Murabaha transaction as practiced today takes placebetween 3 players:
The financier or the Islamic bank
The vendor or the original seller of the product
The user of the product requiring the bank to purchase andfinance the product
The transaction is explained in detail in the following steps:
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Step 1
The bank‟s client seeking financing describes to the vendor the
goods they intend to obtain, and ask the vendor to quote theprice.
Client Trader/Vendor
Pricequote
PriceInquiry
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Step 2
The bank‟s client contacts the bank promising to buy the goods
from the bank if the bank buys the same from the vendor andresells them to the client at price inclusive of the original cost +profit to be agreed mutually.
Client Islamic Bank
Promise to buyat cost-plus-
profit
Price quote byTrader/Vendor
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Step 3
Client Islamic Bank
saleItem/Commodity
Trader/Vendor
saleItem/Commodity
PaymentCost-pluscontract
•The bank purchases the product from the vendor by making payment.•The Murabaha contract is drawn between the client and the bankindicating the profit or mark-up to be charged.
•The contract is finalized by agreeing on the mode of payment (lumpsum, installments).
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Step 4
Client Islamic Bank
Payments (Lumpsum/Installments)
•At the time of payments, the client makes the payment to thebank.
•This payment includes the cost of the product + profit margin tothe bank.
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Commodity Murabaha (Liquidity Management)
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Commodity Murabaha (Liquidity Management)
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F t d C diti f M b h
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Futures and Conditions of Murabaha
Murabaha must be based on a sale and should not be used forfinancing purposes.
In the case of default by the end used, the financier only hasrecourse to the items financed and no further mark-up or penalty
may be applied to the outstanding liability.
The mark-up rate charged is influenced by: the type of productfinanced, the credit worthiness of the client, the length of timefor which the financing takes place.
The financier is allowed to ask for security to protect itselfagainst any non-payment in the future (often an other asset istaken as security).
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Mudaraba (Partnership Contract)
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Definition
This is a kind of partnership where one partner gives money toanother for investing in a commercial enterprise.
The investment comes from the first partner who is called “Rab alMal” (Investor) while the management and work is an exclusive
responsibility of the other, who is called “Mudarib” ( WorkingPartner) and the profits generated are shared in a predeterminedratio.
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Mudaraba (Partnership Contract)
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Client (Rab al Mal) „deposits‟ (Invests) his money.
Bank (Mudarib) offers its skill/effort/knowledge.
Contracts between client & bank is a partnership contract.
Banks profit: share of investment profit instead of spread. (eventhough a profit margin is structured into the deal)
Mudarib could hold reserves so as to smooth out income/make itmore consistent.
Risk of loss lies with the client. (unless bank broke rules)
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FundManager/AssetManager (BANK)
(Mudarib)
$10,000 Profit
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Client C(Rab Al Mal)
Client A(Rab Al Mal)
Client B(Rab Al Mal)
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Client C(Rab Al Mal)
Client A(Rab Al Mal)
Client B(Rab Al Mal)
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54Types of Mudaraba
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Al-Mudaraba Al-muqayyadah (restricted Mudaraba):
Where Rab al Mal specifies aparticular business for themudarib, in which case heshall invest the money in thatparticular business only .
Al Mudaraba Al Mutlaqah (unrestricted Mudaraba):
Where Rab al Mal leaves thedoor open for the mudarib toundertake whatever businesshe whishes, the mudarib shallbe authorized to invest themoney in any business hedeems fit.
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Musharaka Contract (Sharing contract)
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Definition
Musharaka or Shirka can be defined as a form of partnershipwhere 2 or more people combine either their capital or labor,to share the profits and losses, and where they have similar
rights and liabilities.
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Musharaka Contract (Sharing contract)
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Client Enters Agreement with bank to Invest in a Project. Bankissues notes of participation.
Client invests $80,000, Bank Invests $20,000
Profit Share is Based on a 70%:30%
Client invests $80,000 Bank invests $20,000
$100,000Project
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Musharaka Project makes $30 000 profit
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Musharaka Project makes $30,000 profit.
Client receives 70% of profit $21,000
Bank Receives 30% of profit $9,000
Client receives$21,000
Bank receives $9,000
$30,000Profit
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Musharaka Project $50,000 loss, Project value=$50,000
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Losses are borne according to their initial capital contribution
Client receives proportion of investment (80% of $50,000) =$40,000
Bank receives proportion of investment (20% of $50,000) =$10,000
Client receives$40,000
Bank receives$10,000
Project makes lossof $50,000
50,000 remaining.
59
Difference between Musharaka and Mudaraba
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1. The investment in Musharaka comes form all the partners, while inMudaraba the investments comes from Rab Al Mal only. This meansthat the Musharaka is a partnership in profit and capital, whileMudaraba is a partnership in profit not in capital.
2. In Mushararka all the partners can participate in the managementof the business, and can work for it. While in Mudaraba the Rab AlMal has no right to participate in the management, which is carriedout by the Mudarib only.
3. In Musharaka all the partners share the loss. While in theMudaraba, only Rab Al Mal suffers the loss, while the Mudaribsuffers the loss of his labor.
60
Bai Al Salam or Salam
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•Bai Al Salam or as some call it 'Salam' means a contract in which anadvance payment is made for goods to be delivered later on.
•The seller undertakes to supply some specific goods to the buyer at a'future date' in exchange of an advance price fully paid at the time of
contract.
•The objects of this sale are goods and cannot be gold, silver orcurrencies, because these are regarded as 'monetary values exchange' ofwhich is covered under rules of Bai al Sarf (exchange of money for
money).
(Purchase with deferred delivery)
61
Bai Al Salam or Salam
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Purchase price(discounted)
CUSTOMER FINANCIER SUPPLIER
Purchase price(plus premium)
Sale of asset(delivery deferred)
Sale of asset(delivery deferred)
(Purchase with deferred delivery)
62
Istisna(Partnership in Manufacturing)
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• Seller agrees to manufacture a particular product with predetermined specifications and commits to deliver it to the buyer at apre determined price.
• Price can be paid in installments, or can even be deferred until theproduct is delivered
63
Features of Istisna
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Istitsna‟a is a pure sale contract and not a hire contract.
Commodity is non existing and is to be manufactured to bring it toexistence.
Does not include natural goods like fruits, cereals etc.
Quantity, Quality & Price are fixed at the time of signing thecontract.
Price need not be paid in advance. It can be either be paid ininstallments or can be partially deferred until delivery.
No fixed delivery date and no payment in full at outset required.
Advance funding of:
- Major industrial, construction and real estate development
- Large equipment e.g. ships, aircraft
64
Mechanism of Istisna
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CUSTOMER FINANCIER DEVELOPER/CONTRACTOR/
MANUFACTURER
Purchase price plus premium (deferred)
Sale of developed equipment/construction
Sale of developed equipment/construction
Purchase price
65
Ijara Contract (leasing)
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Similar to the a conventional lease contracts
A bilateral contract allowing the transfer of the usufruct
Rental could be fixed for the life of repayment or adjustedperiodically
Sub-leases are acceptable so long as lessor agrees Bank (lessor) & client (lessee) agree to the terms of lease.
(object/lease date/rent)
Additional security is acceptable (guarantees, collateral)
Title remains with bank until full repayment
Used for aircraft financing, ship financing and project financing
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67
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68
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69
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Islamic Bond (SUKUK)
70
Islamic Bond (SUKUK)
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• Bonds are important part of overall financial system.
• Well developed bond markets ensures stable financial system asit minimize over-reliance on financing from the banking sector.
• The development of the bond market allows for access tofunding with the appropriate maturities, thus avoiding thefunding mismatches. It also allows for the diversification of risksby issuers and investors.
71
Islamic Bond (SUKUK)
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Dealing in Bonds is not permissible according to Shariah
because of two aspects:
1. Firstly, they represent a portion of Debt payable by theissuer. Earning any kind of profit falls under the category ofRIBA as defined in the Hadith.
1. Second aspect pertain to the trading of Bonds. Shariahprohibits trading of debts (Bai Dayn) as it involves Gharar.
Trade of such Sukuks is permissible, because it will beequivalent to the sale/ purchase of holder‟s proportionate
share in the assets.However, trading of Murabaha and Salam Sukuks is notpermissible.
72
How is an Islamic Bond Different?
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Sukuk Sukuk are always linked to
underlying assets.
Sukuk are proof of ownershipor beneficial ownership of
the asset Sukuk holders have a right to
profits but also losses
Sukuk holders may dismisssukuk manager/issuer
Maturity is based onunderlying project/activity
Sukuk prospectus includes allshariah related rules
Conventional Bond
Bond holder does not incurdamages/loses suffered bythe company.
The security rights are notlinked to the company‟sassets
Represents a share in thefinancing process, it is not
directly linked to the project
No Shariah Constraints
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74
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75
50000
Global (Listed) Sukuk Issuance
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0
5000
10000
15000
20000
25000
30000
35000
40000
45000
U S $
M i l l i o n
Rest of World Middle East
76
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Islamic Sukuk-Types
Sukuk
Al Ijarah
Sukuk
Al Salam
Sukuk
Al Murabaha
Sukuk
Al Musharaka
77
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ABC Ltd. wishes to purchase a new asset and plan to raise finance throughissuance of Islamic Sukuk.
ABCLtd.
(Corporate)
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Supplier
ABC
Ltd.
Supplier of the Asset is identifiedand negotiations is finalized by
ABC Ltd.
79
S li
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Supplier
ABC
Ltd.
SPV is created by ABC Ltd. as a limited liability Company.
IssuerSPV
(LLC
100%
owned
ABC Ltd.)
80
Supplier
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SPV issues certificates and receives proceeds which are used topurchase asset from the supplier
Sukuks
Proceeds
Payment made to
SupplierTitle istransferred to
SPV
Supplier
IssuerSPV
(LLC
100%
owned
ABC Ltd.)
ABC
Ltd.
Investors
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ABC
Ltd.
SPV holds Asset as Trustee andleases the plant to ABC Ltd. as perrules of Ijarah
Issuer
SPV Investor
SPV holds
Plant/ Asset asTrustee
SPV leasesPlant to ABC
Ltd. on Ijarah
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ABC Ltd.
(Lessee)
Periodic Lease
RentalsSemi-annual coupondistribution amounts
Issuer
SPV
Investors
ABC Ltd. (Lessee) pays periodic rentals to SPV for tenors & amounts
matching the coupon & tenor of the Sukuks
83
Exercises the purchase undertaking. Asset transferred to ABC Ltd.
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Redeems
the TrustCertificatesatdissolution
Exercises the purchase undertaking. Asset transferred to ABC Ltd.
Pays theexercise priceat dissolution
•ABC Ltd (Lessee) give the SPV an irrevocable purchase undertaking topurchase the Asset at maturity.
•Exercise Price = Initial Purchase Price of Asset + service costs.
•Asset is transferred back on maturity, upon payment of the Exercise Priceto the SPV / Sukuk Holders.
ABC Ltd.
(Lessee)
Issuer
SPVInvestors
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Essential Condition
“It’s essential that the Ijarah Sukuks are designed to represent real ownership of the leased assets, and not only a right to receive rent.”
85Sukuk Al Salam
• so named because securities are based on the concept of Bai
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pSalam.
• Government of Bahrain first issued Salam Sukuks as an alternateto short term government treasury bill.
• Under the transaction Government took an advance payment
from the investors for a future delivery of Aluminum ingots. Apaper was issued as an acknowledgment of receipt which isknown as Salam Sukuk.
• Upon delivery of Aluminum ingots to the investors at the time of
completion of Salam contract, Government sold ingots to thirdparties as agent of the investors.
• The difference between Sale and Purchase price was the profit ofthe investors.
86
I C di i
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• Salam Sukuk represent investors shares in the Advance Pricepaid to the seller.
• Since its a dayn, it cannot be traded in the secondary market.
Important Conditions
87Sukuk Al Musharaka
• Musharaka is a mode of financing against which Sukuks can beissued.
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• If a comapany required financing for any of its project throughMusharaka it can issue Sukuks against which investors wouldprovide funding as per the rules of Musharaka.
• Every Sukuk would represent holder's proportionate ownership in
the assets of the Musharaka.
• Once the majority of the cash amount is converted into fixedassets, these Musharaka Sukuk can be treated as negotiableinstruments in the secondary market.
• Musharaka Sukuks can be used for number of purposes including:
Construction of Projects and factories
Expansion Projects
Working Capital Finance
88
P fit d b th M h k i h d di t
Important Conditions
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Profit earned by the Musharaka is shared according to anagreed ratio between the Issuer and Investors at an agreedratio.
Loss is shared on pro rata basis.
To ensure tradability of the Sukuks following condition
should be adhered to:
All the assets of the Musharaka should not be in liquidform.
At least 20% of the value of Portfolio should be investedin non-liquid assets.
89
Sukuk Al Murabaha
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Sukuks can also be issued against a Murabaha transaction. Underthe transaction investors would provide funding to purchase someassets for the issuer. Acknowledgment of their investment wouldbe regarded as Murabaha Sukuk.
The asset would be purchased from its supplier and would beimmediately sold to the issuer against deferred price.
Profit earned from the transaction would be distributed among theinvestor proportionately.
90
Important Conditions
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Murabaha Sukuk represent investors shares in receivable from thepurchaser.
Since its dayn, it cannot be traded in the secondary market.
91
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Islamic Insurance(Takaful)
92Islamic Insurance(Takaful)
Conventional Insurance means a way to provide security / and
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compensation of what is valuable in the event of its loss, damage or
destruction based on the principle of risk taking and speculation.
Islamic Fiqh (science of Shariah) Academy, meeting in its SecondSession in Jeddah, KSA, (Dec 1985) issued a Resolution which insummary stated the following:
• The commercial Insurance contract… is prohibited (Haraam) according to the Shariah.
• The alternative Takaful contract which conforms to the principles of
Islamic dealings is Halaal, being the contract of cooperativeinsurance, which is founded on the basis of charitable donation andShariah compliant dealings.
93Why conventional insurance is prohibited?
Scholars view the insurance contract as an exchange contract – moneyis being exchanged for money over time.
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Riba:
In the case of life insurance, policyholders get back the premiumsalong with interest in the case of survival and the insured amount inthe case of death before maturity of the policy.
Insurance funds are invested in financial instruments which containthe element of Riba.
Gharar (uncertainty): in the case of general insurance, thepolicyholders have to pay the premiums against unknown risks:
Whether the insured will get the compensation promised?
How much the insured will get?
When will the compensation be paid? Gambling: The insured loses the money paid for the premium when
the insured event does not occur.
The company will be in deficit if claims are higher than premium.
94
Definition for Takaful
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Takaful is an Arabic word that means "guaranteeing each other".
It is a system of Islamic insurance based on the principle of TA-AWUN (mutual assistance) and Tabarru (Voluntarily) where the riskis shared collectively by the group Voluntarily.
This is a pact among a group of members or participants who agreeto jointly guarantee among themselves against loss or damage toany of them as defined in the pact.
95
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96
Global Takaful premiums ($bn)
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1.41.7
2.02.5
3.0
3.6
4.3
11.0
0
2
4
6
8
10
12
20 04 2 00 5 200 6 20 07 2 00 8 20 09(f)2 010 (f) 2 015 (f)
97Basic Elements of Takaful
Mutuality and cooperation.
Takaful contract pertains to Tabarru’at as against mu’awadat in case
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Takaful contract pertains to Tabarru at as against mu awadat in case
of conventional insurance.
Payments made with the intention of Tabarru (contribution)
Eliminates the elements of Gharrar, Maisir and Riba.
Wakalah/Modaraba basis of operations.
Joint Guarantee / Indemnity amongst participants – sharedresponsibility.
Constitution of separate “Participants‟ Takaful Fund”.
Constitution of “Shariah Supervisory Board.”
Investments as per Shariah.
98
Main drivers of Takaful
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Piety (individual purification)
Brotherhood (mutual assistance)
Charity (Tabarru or contribution)
Mutual Guarantee
Community well-being as opposed to profit maximization.
99Comparing Takaful to ConventionalInsurance
Issue Conventional Insurance Takaful
O i ti P fit f h h ld M t l f ti i t
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Organization
Principle
Profit for shareholders Mutual for participants
Basis Risk Transfer Co-operative risk sharing
Value Proposition Profits maximization Affordability and spiritualsatisfaction
Laws Secular/Regulations Shariah plus regulations
Ownership Shareholders Participants
Management status Company Management Operator
Form of Contract Contract of Sale Cooperative,
Islamic contracts of Wakala or
Mudarba with Tabar’ru
(contributions)
Investments Interest based Shariah compliant, Riba-free
Surplus Shareholders’ account Participants’ account
100
ASSET/FUND MANAGEMENT
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101
4143 44
700
800
40
45
50
U S $ B n )
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20
23
29
34
0
100
200
300
400
500
600
0
5
10
15
20
25
30
35
2003 2004 2005 2006 2007 2008
N u m
b e r o f F u n d s
A s s e t s U n
d e r M a n a g e m e n t ( U
AUM Number of Islamic Funds
1Q 2009
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103
Type of Islamic Funds
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104
Stock Selection Process
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105
Subprime Crisis and IslamicFinance
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106
Making of the Crisis
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107From the Mortgage Crisisto the Global Economic & Financial Crisis
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108
Major Impacts
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109
Revisions by IMF for 2009 Growth Projections
Slowdown in Economic Growth
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3.0 -1.40.5 -3.86.1 1.5
110
Islamic Finance as aSolution
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111The Global Economic & Financial Crisis:The Real Causes
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111
112Implications for Islamic Banking
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113Islamic Finance as a Solution
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113
114
Islamic Theory of Finance
Islamic Theory of Finance andthe Global Financial Crisis
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Islamic Theory of Finance
115
Rules and Regulations
Islamic Theory of Finance andthe Global Financial Crisis
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115
Forbid
Stipulate
116
Islamic Theory of Finance
Islamic Theory of Finance andthe Global Financial Crisis
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117
Principles of Islamic Finance against the Crisis
Islamic Theory of Finance andthe Global Financial Crisis
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117
118
Principles of Islamic Finance against the Crisis
Islamic Theory of Finance andthe Global Financial Crisis
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119Challenges Facing Islamic Banking
In governance, independence of SSBs is being questioned, becausethey are part of management (paid by the banks).
Differences in practice and application of Shariah laws, that may
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e e ces p act ce a d appl cat o o S a a laws, t at ayresult in confusion in market. As an example, a practice ofguaranteeing profit in some institutions is against islamic lawssince it is similar to interest rate.
Studies (using Indonesian Islamic Index) indicate that speculationplays an influencial role in islamic market (Kurniawan 2008), and
there is moral hazard in Shariah based financing practices(Nasution and Wiliasih 2007).
Regulatory & tax issues
Shariah scholars & Shariah compliant products
Trained & Skilled Islamic Bankers
Understanding by its clients
Arabic Terminology
120
Conclusions
IF & B has been a choice of financial and banking services
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for Muslim and non-Muslim communities.
The size of their businesses and the asset managed growsignificantly.
To improve their role in global economy, IF & B need toimprove their infrastructure and governance, so that theislamic laws and values are consistently and essentiallyactually applied.
Islamic financial institutions are affected by the financialcrisis. They are not risk immune, however, during theeconomic crisis their growth is remained strong, and theyhave shown resilience to global market dislocation.