Islamic Banking and Finance

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islamic 521 financial 195 shariah 174 finance 169 products 101 banking 96 conventional 83 banks 82 funds 80 investment 76 sukuk 76 muslim 74 population 67 compliant 65 institutions 65 services 64 assets 57 countries 57 based 45 europe 43

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we would very much like to thank in particular ms segolene ede bpce former cnce director of international relations who provided useful information related to the latest developments in the french regulatory framework and mr azim zabidi chairman of bank simpanan nasional of malaysia who very kindly agreed to revise the content of the report and contributed added value information regarding islamic finance in malaysia
acknowledgements the wsbi esbg business cooperation department wishes to thank the members of wsbi esbg s coordination committee for their inputs suggestions and information provided regarding their national regulatory frameworks

the principles of islamic banking and finance
the role of the supervisory authorities

this area of finance is composed of practices which are consistent with the beliefs of islam a characterised by an emphasis on socially responsible investment and the prohibition against what is called riba or usury a including any form of guaranteed interest on a loan

it simply aims to provide a closer examination of islamic finance analysing objectively the opportunities and challenges that islamic finance can offer to savings and socially committed retail banks
once again this study describes the current panorama of islamic finance for the attention of the members of wsbi esbg

spotlight on the market this document provides an overview of the islamic finance sector worldwide presenting first of all a brief analysis of the islamic offer in the middle east and africa

this research document aims to shed some light on the abovementioned issues for the attention of the wsbi esbg members and the general community of those interested in finance issues in europe

islamic finance growth has become particularly visible since mainly due to the evolution of oil prices and the massive repatriation of capital to the persian gulf region from muslim countries around the world after the attacks of september
according to the international monetary fund imf it has risen from one institution in one country in to more than institutions operating in more than countries in

within retail banking some british banks offer products and services in the domestic market presumably due to the fact that it is so far the only country in europe where the financial services regulator adapted the supervisory framework to allow an offer of sharia compliant financial products and services
in some countries such as libya and morocco islamic banks are considered by some to be tied to islamic political parties and consequently have been refused licenses

conservatorship is a legal concept to be found in the law of many states of the us whereby an entity is established by court order or in the case of regulated business enterprises via statutory or regulatory authority that some property person or entity be subject to the legal control of another person or entity known as a conservator

while the sunni group comprises the majority of muslims the exact percentage of the world s muslim population that adheres to the various shia schools is difficult to estimate
the most popular are musharakah which is a partnership where all partners contribute and pool their resources together to run a business and murabaha which is a contract where a financial institution buys an asset and resells it to the client at a higher price on a cost mark up basis

instead of money the client can receive the return in the form of gifts vouchers or donations made in the name of the client

it must have use according to shariah must not be too little to be of use must not distract from remembering allah must not be used to propogate haram activities such as gambling and riba

the detailed operation of these fixed deposit accounts is described as follows n the bank accepts deposits from its customers who are looking for investment opportunities for their funds in the form of general investment accounts based on the principle of mudaraba

thus the term mortgage is used here in the sense of collateral and the title to the property is in the name of those that provide the funds ie the banks
v islamic mortgages the most characteristic feature of an islamic mortgage is that instead of lending to muslim businesses and families for property purchase mortgage providers buy the property and re sell it to them in instalments for a higher price

under a musharaka agreement the client s first capital repayment as part of the regular monthly repayments to the islamic mortgage provider becomes their first share albeit small in the property
n murabaha mortgages with a murabaha mortgage the would be buyer locates a property that s he would like to purchase and agrees upon a price with the vendor a as they would for an ijara or musharaka mortgage

the following criteria are used when calculating the higher price that the homeowners must pay and hence the monthly repayments that they will be required to make throughout the mortgage term the balance owed on the property after the client s original down payment usually around the length of the murabaha mortgage term the size of the financial institution s agreed return ie expected return on investment over the mortgage term
islamic microfinance microfinance is considered a very effective development tool that can be adapted to the local needs of low income people to help them engage in productive activities in every environment

some studies carried out on islamic microfinance reveal the following common features among the current islamic microfinance products and services n the supply of islamic microfinance is very concentrated in a few countries with three top countries a indonesia bangladesh and afghanistan accounting for of global demand
karim tarazi and reille includes gcap survey results on islamic microfinance collecting information on over institutions and contacting experts from muslim countries

the essential concepts of a sukuk are n transparency and clarity of rights and obligations n income from securities must be related to the purpose for which the funding is used and n securities should be backed by real underlying assets and not simply paper derivatives
however the sukuk market is not connected with subprime mortgages or with interest rates because sukuk is backed by real assets and as such avoids the securitization chains as in collateralized debt obligations cdos that have other cdos or asset backed security abs products

the majority of islamic financial institutions and their shariah committees agreed on the following compliance rules for a sukuk n any collection of assets can be represented in a bond and n this bond can be sold at a market price provided that the composition of the group of assets represented by the security consists of a majority of physical assets and financial rights

takaful in process of region companies establishment total middle east africa asia pacific rest of the world total source esbg s elaboration based on data from banque strategie takaful is an alternative form of coverage that a muslim can take to guard against the risk of loss due to misfortune

the contract specifies how the return from the operations of takaful managed by the takaful operator is to be shared in accordance with the principle of mudarabah between the participants as the providers of capital and the takaful operator as the entrepreneur
by this principle the entrepreneur or mudharib takaful operator accepts payment of the takaful installments or takaful contributions premiums termed as ra s ul mal from investors or providers of capital or funds takaful participants acting as sahib ul mal

the powers of the shariah board differ from one islamic financial institution to another but the objective of complying with islamic law for the offer of financial products is common to all islamic financial institutions
the shariah board members must have an understanding of shariah rules accompanied by a reasonable knowledge of the business environment the nature of investments the client base investor tastes and the culture in which business is being run

at the inception of the islamic service the products typically offered are deposits on the liability side of the bank and islamic trade finance products for small and medium sized companies on the asset side of the bank

the use of islamic windows as a take off platform for moving into the islamic financial industry has been a more common practice in south east asia and western countries than in the middle east where the tendency has been to establish stand alone islamic banks
establishing an islamic bank once a conventional bank has operated an islamic window for some time and has gathered a sizeable customer base for its islamic activities it may decide to establish an islamic subsidiary or even convert into a fullyfledged islamic bank

normally in the case of islamic windows the treasury department of the parent bank is typically in charge of managing the liquidity requirements of the bank as a whole which poses the threat of mixing conventional and islamic funds
probably it will be necessary to transform all of its loans and deposits into non interest bearing assets and liabilities such as murabaha contracts in the case of assets or mudarabah deposits in the case of liabilities

it is in the process of embracing islamic financial techniques by introducing new laws to facilitate further market entry and practice of islamic finance in the uk
table the population of muslims in various european countries population muslim population country millions millions percentage austria

according to the office of national statistics the uk muslims within the uk have the following countries of origin pakistan bangladesh india other asian other according to research carried out by the runnymede trust the muslims from middle east and africa represent of the total muslim population in the uk
the uk already has five licensed islamic banks including the islamic bank of britain which was formed by a group of investors from the middle east and the european islamic investment bank eiib which is the first investment bank in europe that offers shariah compliant investment banking products and services

in the uk the hsbc amanah finance uk is the division which provides a wide range of islamic financial products developed in consultation with independent sharia scholars such as current accounts for private and business customers as well as mortgages chequing facilities investment opportunities personal and corporate financial solutions
furthermore the uk government is determined to maintain its momentum on work on islamic finance and to make clear to stakeholders its commitment to this industry

in april the french government asked to the paris europlace the paris financial markets organisation to produce a report analysing the necessary measures in order to make this marketplace a competitive one worldwide in the provision of islamic products and services
finally in france announced reforms to adapt its banking legislation to allow more traditional banks to engage in islamic products

the main conclusions of this study state that islamic finance represents an opportunity for france and it is necessary to make some refor miss these reforms include the enactment of a law modifying the french monetary and financial code and to include adequate regulatory provisions in the next finance bill and the enactment of appropriate tax instruction
as a result of the abovementioned studies conclusions three measures were adopted in related to the conditions for issuing sukuk in euronext paris a the french securities market the elimination of double taxation on registration rights in murabaha contracts and implementation of the tax deduction on capital earned from sukuk

negotiations began at the end of and it should be operational after the french government carries out the necessary regulatory refor miss at the end of qatar islamic bank kuwait finance house and al baraka islamic bank bahrain requested licenses to operate in france which could be possible before the end of

first the spanish retail banking sector could diversify their business and find new commercial opportunites thanks to the economic relationship of spain with the magreb northwest africa region and also because these countries financial markets have a low correlation with the international financial markets

the feedback from the first consultation was very positive and the mfsa envisages a number of opportunities for the setting up of malta based islamic financial institutions as fully fledged banking institutions as well as a number of opportunities for the setting up of shariah compliant funds in malta

related to switzerland in the islamic bank of britain ibb announced a plan to capture part of the european market through the opening of branch offices in germany and switzerland
the netherlands belgium and italy are examples of countries where the financial regulatory framework has not been adapted to allow for the offer of islamic products and services

in and until the boom of the subprime crisis freddie mac reportedly purchased more than usd million in islamic home loans a a small but notable fraction of the enterprise s usd
since the federal national mortgage association fannie mae and the federal home mortgage corporation freddie mac have purchased shariah compliant mortgage contracts from financial intermediaries allowing providers to originate further mortgages

shariah compliant mutual funds are offered by intermediaries such as the amana mutual funds trust azzad funds and the dow jones islamic fund
islamic investors from the countries of the gulf cooperation council gcc have sought to diversify their financial portfolios geographically and to invest their oil wealth in u

the shariah board the role to be played by the shariah board in an islamic financial institution is two fold on the one hand there is the traditional prudential supervision aspect but there is also a vital developmental role that is equally important
in addition other international islamic institutions are the general council for islamic banking and finance institutions gcibfi bahrain the islamic international rating agency iira bahrain and the islamic liquidity management center ilmc bahrain

the islamic financial services board ifsb the islamic financial services board ifsb is an international standard setting organisation that promotes and enhances the soundness and stability of the islamic financial services industry by issuing global prudential standards and guiding principles for the industry a broadly defined to include the banking capital markets and insurance sectors

as of january the members of the ifsb included n regulatory and supervisory authorities n the international monetary fund n the world bank n the bank for international settlements n the islamic development bank n the asian development bank and n market players and professional firms operating in countries

the accounting and auditing organisation for islamic financial institutions aaoifi islamic financial institutions that wish to comply with the general international standard must publish regular financial statements in accordance with financial accounting standards fas issued by the accounting and auditing organisation for islamic financial institutions aaoifi
in its efforts to enhance the industry s human resources base and governance structures aaoifi now offers professional qualification programs notably cipa the certified shariah adviser and auditor csaa and the corporate compliance program

this activity is intended both to enhance the confidence of users of the financial statements of islamic financial institutions in the information that is produced about these institutions and to encourage these users to invest or deposit their funds in islamic financial institutions and to use their services
aaoifi carries out these objectives in accordance with the precepts of islamic shariah which represent a comprehensive system for all aspects of life in conformity with the environment in which islamic financial institutions have developed

n if the firm has close links with another firm these should not prevent the effective supervision of the firm n the firm has adequate resources both financial and non financial for the activities which it seeks to carry on

in general terms a financial institution wishing to open an islamic bank window should consider the following issues related to corporate governance and regulatory requirements in order to ensure compliance with shariah and national rules n corporate governance issues establishment of a shariah board internal coordination of the administrative board s work with the new supervisory shariah board rewording of the financial institution objectives including clear definition in the case of an islamic bank or segregation in an islamic windows structure of the bank s funds and of its uses integration of shariah standards e
to fulfill the capital adequacy requirements national and international requirements suggested by the ifsb to fulfil liquidity requirements subsequent to national regulation see islamic banking issues in prudential regulation and supervision by errico luca and mitra farahbaksh

rating analysis of shariah compliant assets may differ from analysis of conventional assets both in terms of the general principles that govern shariah compliant finance for example the concept of default and in terms of the features of specific financial instruments for example the concept of displaced commercial risk dcr when dealing with returns on investment accounts that are based on a mudarabah contract

in terms of capital adequacy calculations the principal areas where shariah compliant finance may differ from conventional finance include though are not limited to the following a different meanings of ratings and the concept of default as a result of the different natures of default considered the meaning of ratings may differ depending on the type of instrument being rated
f trading in sukuk does not involve trading in debt unlike conventional bonds sukuk holders derive their returns either from an underlying real asset s or the usufruct of such assets which is fractionally owned by the sukuk holders rather than being collateral for a debt as with conventional asset backed securities or from a securitised partnership in an underlying business venture

this may put investors in a stronger position to attach assets in the event that the issuer defaults than the investor would be if they were holding conventional instruments
for example a murabahah contract requires an islamic financial institution to have ownership of assets as part of asset based financing activities on its balance sheet for a short period of time pending resale

the market continues to flourish around the world and there are sufficient muslim investors and borrowers in both islamic and non islamic countries to warrant the attention of traditional banks that seek to serve such clients and capture a potentially profitable slice of a still relatively untapped market
however to achieve this objective has been quite difficult because despite being the fastest growing component of the financial services industry islamic finance presents some challenges that could threaten a path of sustainable growth

figure challenges for islamic finance islamic finance challenges lack of standard excess liquidity regulatory and tax issues accounting system internal product configuration excess shortage of shariah documentation asset challenges expertise segregation kyc know your customer nor miss islamic banking control external contracts type lack of trained skilled by regulators fund mobilisation islamic staff shariah governance the two most important challenges are in a darker blue then the additional challenges
the most important are produced by the international accounting standards ias and by the accounting and auditing organisation for islamic financial institutions aaoifi but there are also other standards

challenges internal to the institution n it product configurations require customisation it is a challenge to create and maintain it systems in such a manner that they continuously support the current products and also implementation of new product innovations on an end to end basis
there is a need to establish one international central shariah board and one external audit committee n excess liquidity about of shariah compliant funds are invested on a shortterm basis there is about more liquidity in islamic banking and finance institutions than in traditional banking

n the different nature of contracts will require new practices the use of non conventional contracts to offer products for financial services can create a whole range of issues concerning corporate governance standards sources of new risks and how to manage them as well as how to make islamic banks conform to the market discipline already created for conventional banks

these opportunities have been mentioned along this report and are summarised in the figure below figure opportunities related to islamic finance islamic finance challenges new customer base integration of muslim diversification and population in the country new business of residence opportunities opportunities low correlation products considered with international as ethical financial markets new tools for financing banking activities the two most important opportunities are in a darker blue then the additional opportunities
the dynamism of the islamic financial services industry is being felt in both traditional islamic financial centres and other markets however none of these new markets are yet located in europe with the exception of the uk

it is possible to say that the interest in islamic finance is blossoming in europe and many european banks perceive it as a profitable opportunity to generate or to broad new business rather than a threat to existing business
thus any islamic banking product or service that may be introduced by a conventional european bank will have to be more attractive than the equivalent product offered by conventional european banks to ensure up take

annexes annex sources of shariah and the schools of thought the basic pillars of islamic finance are sources of shariah the primary sources accepted universally by all muslims are derived from the holy qur an and the sunnah of the holy prophet pbuh
during his lifetime the prophet s family and companions observed him and shared with others exactly what they had seen in his words and behaviours

ijmah means consensus among the jurists in situations when muslims have not been able to find a specific legal ruling in the qur an or sunnah the consensus of the community is sought or at least the consensus of the legal scholars within the community
to become a mujtahid in theological terms is similar to having a doctorate in divinity in islamic kalam or a in legal terms a equivalent to reaching the status of a high or supreme court judge

schools of thought the historical circumstances of the emergence of islamic law in the seventh century ad continue to determine the essential features of islamic law today
these centres of learning consisted of groups of religious persons who surveyed the existing law and engaged in fiqh ie the science of law

it includes the percentage of muslims to the total population and the percentage of shia and sunni population to the total of muslim population
as noted within the table the source for many of these percentages is which is not a scientific source a though the source is well cited a so there is potential for the percentages to be inaccurate

table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population gabon gambia the gaza strip
the cia lists the muslim population for france as

table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population iran iraq ireland
jordan kazakhstan kenya korea south

table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population morocco
ibadi muslims make up of population cia

table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population qatar
the cia lists the muslim population for russia as

table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population sudan suriname
in tanzania of the mainland is muslim while more than of zanzibar is muslim cia

total unavailable unavailable unavailable unavailable in the west bank the predominance of muslims are sunni but exact percentages were unavailable cia
table continued muslims shia to shia sunni to sunni country population muslim approximate muslim population muslim population uganda

sources n principal source cia central intelligence agency
https muslim distribution map

below are only the basic outlines of these contract types ijara a form of leasing whereby the property owner transfers the usufruct the right to benefit from the use of the property to a person in exchange for an agreed upon rent
diminishing musharaka means that the bank reduces its equity in an asset with any additional capital payment that the client makes over and above his her rental payments

the bank may use it for its large deposit accounts the client owns the capital invested appoints the bank as his her agents and pay a fee for the bank s expertise
murabaha also known as murabha is a trading arrangement where a financial institution acquires an asset and then resells it to a client at a higher price effectively cost price plus a mark up to give a return on investment which the client repays over an agreed upon term

expenses related to the operation of a leased asset are however the responsibility of the lessee such as fuel in the case of a leased vehicle or aircraft or fertiliser and seeds in the case of leased land
where a leased asset is accidentally destroyed or its usufruct value reduced as in the case of leased farmland during periods of prolonged drought then ijarah contracts can be cancelled by the lessee but in modern practice leased assets usually are insured against such contingencies

an ijarah contract is for a predetermined period as the rent provides a regular income therefore it is well suited to be covered by the issue of securities that have many of the characteristics of bonds
n sukuk istisna islamic investment certificate in a project project financing can be undertaken through an istisna contract whereby funds are advanced to pay for the supplies and labour costs by an islamic bank

annex the sukuk debate from a shariah perspective certificates of debt are not tradable and certain structuring elements for sukuk based on a debt sukuk murabaha business sukuk musharaka or investment sukuk istithmar faced severe critics in by sheikh muhammad taqi usmani in a meeting of the accounting and auditing organisation for islamic financial institutions aaoifi

the recommendations of the aaoifi shariah committee agreed upon in a series of meetings in and are n tradable sukuks must represent ownership for sukuk holders with all of the rights and obligations that accompany ownership in real assets whether tangible or usufructs or services that may be possessed and disposed of legally and in accordance with the shariah

islamic equity funds the islamic investment equity funds market is one of the fastest growing sectors within the islamic financial system with a growth of around usd billion in assets under management
most equity funds bring diversification and benefits and for those considerations they charge a fee management and load fees and some charge a redemption penalty

similarly to conventional equity funds the shariah s board acts in a manner similar to the board of directors which assess the management of the fund evaluate the investment strategies establish orientations and possibly order the liquidation of positions
information reporting in their moral function the shariah board ensures consumers have at their disposal sufficient information regarding the fees the fund s performance portfolio diversification the purification process and the charities which benefit from it

the key reason for the growing interest in shariah compliant private equity in the last years is the sheer size of the current pool of available islamic capital
this is a trend that is perceptible across islamic products globally and is evident in both real estate and private equity launches only a minority of funds being denominated in local currencies

an indication of the acceptance of these vehicles for making islamic compliant investments is the number of conventional private equity and venture capital funds that have passed shariah compliance tests with only minor adjustments made to the investment policies of the funds themselves
for this purpose total debt includes interest bearing debt which comprises short term and long term conventional debt convertible bonds preference shares offbalance sheet debt and similar instruments

it must be noted in this context that some shariah advisers insist that if an islamic private equity fund acquires control over a leverageburdened target company the fund must promptly pay off the conventional debt even if the percentage of such debt to the total assets of the company is less than or subject to strict repayment plans and schedules undertake to pay off the conventional debt within a limited period of time up to three years in most cases
n income from interest and unpermissible activities under shariah precepts non operating interest income and the income from incidental unpermissible activities by the target company cannot exceed of the total income of that company

if the basket of shares subject to the bai al arboon depreciates the fund manager will not exercise the option and the price of the option ie the bai al arboon advance payment will be lost
promoters of islamic funds and issuers of islamic instruments including conventional banking institutions should develop a generalised understanding of islamic law and work closely with shariah advisers to ensure that they have a sufficient understanding of islamic investment structures

arboun on the other hand entitles the investor to purchase an asset at an agreed price at any time up to the maturity of the contract a effectively an option
figure arboun murabaha structure variable arboun maturity value arboun initial capital of original asset with capital fixed fixed maturity value minimum return issue date maturity date note this structured contract offers capital security and equity pay out

figure estimated growth of assets net asset flow in equity hedge funds a q number of funds q q n hedge funds n fund of funds source hedge fund research barclays bank plc
the task of structuring islamic structured products is one of the most controversial areas in islamic finance but increasingly structured products are gaining acceptance in the market and new products are being approved by eminent shariah scholars

hedge fund managers can still replicate some of the conventional hedge fund strategies by employing some of the already accepted concepts in islamic finance

in repayment for the bank s purchase of the commodities the customer will include in the installment payments to the bank an amount commensurate with the forgone interest on the loan
annex example the use of tawarruq to make the transition from conventional to islamic balance sheets when a conventional bank decides to fully convert into an islamic institution it must ensure that all the items on its balance sheet are compatible with the shariah

the performance of islamic equity funds a comparison to conventional islamic and ethical benchmarks
annex bibliography works cited aaoifi accounting and auditing organisation for islamic financial institutions

islamic credit cards getting noticed
http mdsidx downloads delorenzo

hedge funds review access to islamic hedge funds supplement november
cited in barclays bank plc

communique de presse remise du rapport jouini a pastre a paris europlace enjeux et opportunites du developpement de la finance islamique pour la place financiere fran aise propositions pour attirer milliards d euros d epargne
oecd organisation for economic cooperation and development

islamic financial institutions and products in the global financial system key issues in risk management and challenges ahead
rscas policy papers rscas pp musminemuslim minorities in europe islamic finance in europe

so many jobs so few experts for islamic finance
shariah compliant financial services a guide to products markets and trends

wsbi a esbg a the global voice of savings and retail banking wsbi world savings banks institute is one of the largest international banking associations and the only global representative of savings and retail banking
esbg european savings banks group is an international banking association that represents one of the largest european retail banking networks comprising about one third of the retail banking market in europe with total assets of over a billion january

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AlHuda Material\islamic banking

KeyWords

islamic banks banking financial finance investment conventional institutions funds risk financing deposits assets services management international countries equity profit products

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Number of Pages

100

Published Date

2009-10-08 17:30:59

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Islamic Banking and Finance

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