Iqbal Khan Presentation20070201

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  • Commonly accepted principles of corporate governance include: Rights and equitable treatment of shareholders : Organisations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. Interests of other stakeholders : Organisations should recognise that they have legal and other obligations to all legitimate stakeholders. Role and responsibilities of the board : The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of chairperson and CEO should not be held by the same person. Integrity and ethical behaviour : Organisations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that systemic reliance on integrity and ethics is bound to eventual failure. Disclosure and transparency : Organisations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organisation should be timely and balanced to ensure that all investors have access to clear, factual information.
  • The Islamic “Zone of Sustainability” is at the intersection of the economic and social imperatives. This is depicted by the shaded area in this graph. An organization that is to the far left on this chart would be unacceptable in Islamic Society, as would a for-profit organization that operates in the far right corner. It is worth mentioning that non-profit organizations such as NGOs are expected to operate in the right corner as they are not held under the rules of a commercial corporation. But they would be subject to all the prohibitions and guidelines mentioned earlier.
  • Beginning of Muslim-majority nation independence Pakistan 1947 Indonesia 1949 Malaysia 1956 Algeria 1963 GCC 1971 OIC establishment 1969 Consolidate economic cooperation among members Evolution of framework and strategic initiatives 1974: Islamic Development Bank 1977: Statistical, Economic and Social Research and Training Centre for the Islamic countries 1977: International Association of Islamic Banks 1981: Islamic Research and Training Institute 1983: Islamic Fiqh Academy IFI: laying country foundations 1971 Nasser Social Bank 1974 Islamic Development Bank 1975 Dubai Islamic Bank 1977 Faisal Islamic Bank of Egypt, and Sudan 1978 Al Rajhi 1978 Jordan Islamic Bank 1979 Bahrain Islamic Bank 1979 Kuwait Finance House
  • Tapping Muslim majority and minority markets 1. There are about 1.6 billion Muslims in the world today. In the next 8 to 10 yrs, it has been estimated tht half of the them will invest their savings in the Islamic finance sector 2. The growing Muslim population in G10 countries will increase for demand Islamic financial products 3. By 2015, it has been projected that 1 in every 4 graduates in London will be Muslim A source of funding 1. Islamic finance has gained acceptability in Muslim minority countrie 2. Issuance of first Islamic Eurosukuk by Saxony, Germany A source of liquidity 1. Islamic finance will allow OECD world to tap excess liquidity in the OIC world 2. Investment opportunities: Islamic finance institutions and projects can offer high risk-rated return for OECD investors Joint venture and market entry opportunities 1. bringing global expertise to attractive markets 2. This is particularly relevant as WTO takes effect in key Muslim markets
  • Islamic finance has grown considerably in the past few decades. It was already a promising industry when HSBC Amanah was established in 1998, but it has been gathering tremendous momentum since then. In key Muslim markets, the numbers speak for themselves. [CLICK] In Saudi Arabia, 95% of new consumer lending is now Islamic. [CLICK] In UAE, 30% of retail banking has turned Islamic in a few years. [CLICK] Bahrain has emerged as a hub of this industry. [CLICK] In Malaysia, more than half the Ringitt bonds that were issued last year were structured Islamically. Key markets outside the Muslim world are also taking notice. [CLICK] A Harvard workshop on Islamic finance just brought together the Fed, a number of state regulators and local Islamic banks to address the regulation of Islamic finance in the country. [CLICK] The UK, as you know, has already passed legislation to lower the barriers for Islamic banks to provide competitive mortgages. [CLICK] On of the German states, Saxony, has even issued the first sovereign Sukuk by a non-Muslim country. [CLICK] China has quickly become the most active member of the Islamic Financial Services Board, a consultative group that includes the IMF, World Bank and a number of Muslim regulators. [CLICK] Singapore, also a member of the IFSB, has just decided to go after Islamic finance in a big way by announcing friendly regulation.
  • World GDP 2006e growth = 4% GCC growth 06e = 7-10% Capital markets development: - Growing pool of liquidity with rising equity markets and growing debt markets - Saudi Arabia: implementing its Capital Market Law promulgated in 2005 - Malaysia: 42% of debt securities issued during 2004 were Islamic - UAE: expanding aggressively through listing in DIFX - Bahrain: leads the Islamic finance industry and actively promoting development of secondary market – Liquidity Management Centre (LMC), IIFM - Turkey: launched Shariah compliant exchange traded securities (ETS)
  • Iqbal Khan Presentation20070201

    1. 1. Islamic Finance: Relevance and Growth in the Modern Financial Age London School of Economics 1 February 2007 Iqbal Khan Founding ex-CEO, HSBC Amanah
    2. 2. Agenda <ul><li>What is Islamic finance? </li></ul><ul><li>What relevance does it have in the modern financial system? </li></ul><ul><li>What are the areas of current growth and initiatives? </li></ul><ul><li>What does the future hold? </li></ul>
    3. 3. Banking and finance needs Islamic finance is the outcome of religion in banking Islamic banking and finance solutions <ul><li>Prohibition on: </li></ul><ul><ul><li>Interest </li></ul></ul><ul><ul><li>Speculation </li></ul></ul><ul><ul><li>Gambling </li></ul></ul><ul><li>Quran </li></ul><ul><li>Sunnah </li></ul><ul><li>Ijma’ (jurist consensus) </li></ul><ul><li>Qiyas (analogy) </li></ul><ul><li>Ijtihad (reasoning) </li></ul><ul><li>Musharaka - Partnership </li></ul><ul><li>Mudaraba - Partnership </li></ul><ul><li>Murabaha - Purchase-resale </li></ul><ul><li>Ijara - Lease </li></ul><ul><li>Istisna’ - Manufacturing contract </li></ul><ul><li>Salam - Forward sale </li></ul><ul><li>Asset-backed transactions with investments in real, durable assets </li></ul>Fiqh al-Muamalaat contracts Shariah sources <ul><li>Prohibition of certain investments: </li></ul><ul><ul><li>Sectors (e.g.: alcohol, armaments, financial services, gambling, pork, pornography, tobacco) </li></ul></ul><ul><ul><li>Instruments (e.g. no forward transactions, limited option use, no derivatives, short-selling) </li></ul></ul><ul><li>Credit and debt products are not encouraged </li></ul>Shariah filter
    4. 4. <ul><li>Synthesis of Islamic law and contemporary finance </li></ul><ul><li>Community banking : serving communities, not markets </li></ul>Islamic finance is embedded within values Islamic finance is more than financial contracts Client affinity Fulfils aspirations <ul><li>Widens ownership base of society </li></ul><ul><li>Offers “success with authenticity” </li></ul>Alternative paradigm <ul><li>Stability from linking financial services to the productive, real economy </li></ul><ul><li>Moral compass for capitalism </li></ul>Responsible finance <ul><li>Builds systematic checks on financial providers </li></ul><ul><li>Restrains consumer indebtedness </li></ul>Inclusive proposition <ul><li>Open to all-faith clients </li></ul><ul><li>Available to Islamic and conventional issuers </li></ul>Parallel trends <ul><li>Ethical investment </li></ul><ul><li>CSR initiatives </li></ul>
    5. 5. Values of good governance are central to Islam Accountability to God raises level of awareness Quranic code of ethics Best practices of corporate governance <ul><li>Accountability and obligation to shareholders </li></ul><ul><li>Integrity and ethical behaviour </li></ul><ul><li>Fiduciary role and responsibility of board </li></ul><ul><li>Vicegerent concept of accountability (2:30) </li></ul><ul><li>Honest fulfilment of contracts (5:1) </li></ul><ul><li>Prohibition against betraying any trusts (8:27) </li></ul><ul><li>Prohibition against deriving income from cheating, dishonesty or fraud (4:29) </li></ul><ul><li>Prohibition against bribery (2:188) </li></ul><ul><li>Prohibition against concealing evidence (2:283) </li></ul><ul><li>Disclosure and transparency </li></ul>“ O ye who believe! Be ye staunch in justice, witnesses for Allah, even though it be against yourselves or (your) parents or (your) kindred…” (4:135)
    6. 6. prohibited sectors ECONOMIC IMPERATIVE <ul><li>Market-driven yet values-based </li></ul><ul><li>Gradualist and evolutionary nature </li></ul><ul><li>Symbiotic and synergistic relationship with mainstream finance </li></ul>Islamic Financial Institutions are positioned in a “zone of sustainability” Islamic finance characteristics: NGOs not-for-profits SOCIAL IMPERATIVE ZONE OF SUSTAINABILITY Islamic businesses
    7. 7. <ul><li>Growing at 15 to 20% per annum 1 </li></ul><ul><li>Within 8-10 years, industry estimated to capture half the savings of the 1.6 billion Muslim world 2 </li></ul>Industry has advanced from niche to critical mass <ul><li>Market size estimated at USD 750 billion globally 1 </li></ul><ul><li>Young industry </li></ul><ul><li>Mitghamr Savings Associations (1963) & Tabung Hajji Malaysia (1967) </li></ul><ul><li>Islamic Development Bank (1974) & Dubai Islamic Bank (1975) </li></ul><ul><li>Market-driven proposition </li></ul><ul><li>Retail customers historically the backbone of the industry </li></ul><ul><li>Tipping point in retail sector: Saudi Arabia, UAE, Bahrain and Kuwait </li></ul><ul><li>Self-regulating organisations, Standards bodies and Research and Training Institutes </li></ul><ul><li>Global scale </li></ul><ul><li>More than 250 Islamic banks worldwide operating in over 75 countries 3 </li></ul><ul><li>GCC accounts for two-thirds of global Islamic assets * </li></ul><ul><li>Malaysia leading industry maturity and sophistication </li></ul><ul><li>Islamic Development Bank: largest pan-OIC financial institution </li></ul>Industry is fragmented, with slowly internationalising players Source:1: S&P Report ( 31 Aug 2006); 2: IIR Middle East (Apr 2006); 3 Bursa Malaysia “The Islamic Capital Market” 2005; * HSBC analysis Islamic banking assets as proportion of total (%) * 40% 20% 12% 30% 66% growth 33% growth
    8. 8. Industry has developed a comprehensive product offering over its young history 1950s 60s 70s 80s 90s 00s <ul><li>Egypt and Malaysia pioneering institutions </li></ul><ul><li>Establishment of OIC (1969) </li></ul><ul><li>Development of theoretical framework </li></ul><ul><li>Muslim-majority nation independence </li></ul><ul><li>Islamic Development Bank (1974) and DIB </li></ul><ul><li>One country-one bank setup </li></ul><ul><li>Advancement of Islamic products </li></ul><ul><li>Full “Islamization” of Pakistan, Sudan and Iran </li></ul><ul><li>Entry of global institutions, e.g. HSBC </li></ul><ul><li>Tipping point reached in some markets </li></ul><ul><li>Development of industry-building institutions </li></ul>syndications structured and trade finance Evolving richness in products Development of industry Industry has near like-for-like parity with conventional offering 1970s commercial banking insurance 1980s 1990s equity private equity project finance debt issues 2000s structured products 1970s 1980s 1990s 2000s
    9. 9. Source: HSBC Amanah Islamic finance industry is developing a global reach…
    10. 10. … with worldwide momentum from retail to regulator involvement . Singapore: Active in developing Islamic finance UK: New legislation for Islamic mortgages (2003) <ul><li>UAE: </li></ul><ul><li>30% of retail banking </li></ul><ul><li>is Islamic (2005) </li></ul><ul><li>Several institutions have converted from conventional to Islamic </li></ul>Malaysia: Islamic product and industry, development and sophistication leader USA: Harvard workshop with six regulators (1995) China: Active member of Islamic Financial Services Board (2004) Bahrain: Leading Islamic financial centre, and housing regulatory bodies <ul><li>Saudi Arabia: </li></ul><ul><li>95%+ of new consumer </li></ul><ul><li>lending is Islamic (2006) </li></ul><ul><li>Retail market rapidly converting to Islamic (2006) </li></ul>Source: HSBC Amanah, Press Reviews Each region is contributing in a unique way Japan: JBIC exploring Islamic financing opportunities (Dec. 2006) Germany: Saxony issues E100m Sukuk (2004)
    11. 11. Self-regulatory organizations bring credibility through standardization of practices GCIBFI (2001) Bahrain <ul><li>Promoting industry in theory and practice </li></ul><ul><li>Disseminating Shariah concepts & multilateral understanding between IFIs and public </li></ul><ul><li>Improving IFI practices, cooperation, professionalism and transparency </li></ul>IIFM (2001) Bahrain <ul><li>Development of global Islamic capital and money market </li></ul><ul><li>Promoting active and regulated trading and capital flows </li></ul><ul><li>Catalyzing trading infrastructure, product innovation and information flows </li></ul>AAO-IFI (1991) Bahrain <ul><li>Benchmark of Islamic accounting standards </li></ul><ul><li>56 accounting, auditing, governance and Shariah standards </li></ul><ul><li>Enhancing clarity, transparency and harmonisation </li></ul>IIRA (2005) Bahrain <ul><li>Reference point for IFI ratings </li></ul><ul><li>Issuing sovereign, credit, Shariah quality and corporate governance ratings </li></ul><ul><li>Providing effective tool for informed investment decision-making </li></ul>IFSB (2002) Malaysia <ul><li>Standard-setting body of regulatory and supervisory agencies </li></ul><ul><li>Complementing Basel II Capital Accord </li></ul><ul><li>Key standards: risk management, capital adequacy & corporate governance </li></ul>LMC (2002) Bahrain <ul><li>Creation of active Islamic inter-bank market </li></ul><ul><li>Creating secondary market for short-term Shariah-compliant treasury products </li></ul><ul><li>Enabling IFI management of liquidity mismatch </li></ul>
    12. 12. Strong growth of OIC economies Retail customer commitment Institutional capital Liberalisation of capital markets Innovative product development Resurgence of Muslim cultural values EXPLOSIVE GROWTH OF ISLAMIC FINANCE Industry is driven by fundamental factors Why Islamic financing is flourishing
    13. 13. Multinational banks have gradually increased their focus on Islamic finance Mainstream institutions are embracing Islamic banking Ad hoc participation <ul><li>Correspondent banking for IFIs </li></ul><ul><li>Tailored Private Banking services for HNWIs </li></ul>Islamic client services <ul><li>Dedicated Relationship Managers for IFIs </li></ul><ul><li>Dedicated Private bankers for HNWIs </li></ul>Islamic window model <ul><li>Committed unit for Islamic financial services </li></ul><ul><li>Citi Islamic (1996), HSBC Amanah (1998) </li></ul>Dedicated Islamic subsidiary <ul><li>Islamic subsidiaries of conventional banks </li></ul><ul><li>Joint ventures and partnerships </li></ul>Market entry strategy Defensive strategy Proactive strategy <ul><li>Service and retain existing Muslim clients </li></ul><ul><li>Refine current proposition to reflect local needs </li></ul><ul><ul><li>Particularly important and economic clout of locals increased </li></ul></ul><ul><li>Protect and embed the brand </li></ul><ul><li>Acquire new customers, especially wealthy locals </li></ul><ul><li>Build a sustainable community banking proposition </li></ul><ul><li>Benefit from higher growth rates of emerging markets </li></ul><ul><ul><li>Crucial as developed market growth slows </li></ul></ul>Evolving commitment
    14. 14. Industry is reaching mainstream relevance in global financial system Relevance to non-OIC countries Relevance to OIC countries <ul><li>Reaching a broader market </li></ul><ul><ul><li>Muslim-minority populations become inclusive, economic, productive agents </li></ul></ul><ul><li>Alternative source of funding </li></ul><ul><ul><li>Debt issuance with the widest acceptance </li></ul></ul><ul><ul><li>Attract “new-to-industry” investors with Shariah-compliant funds and transactions </li></ul></ul><ul><li>Gateway to OIC markets </li></ul><ul><ul><li>Regional preference of Islamic investors </li></ul></ul><ul><ul><li>Infrastructure investment opportunities </li></ul></ul><ul><li>Fulfilment of financial needs of Muslims </li></ul><ul><ul><li>Islamic finance is the equilibrium choice </li></ul></ul><ul><li>Widens stakeholder base of society </li></ul><ul><ul><li>Increases bankable population of economy </li></ul></ul><ul><ul><li>Increases economic efficiency as a result of society’s increased engagement </li></ul></ul><ul><li>Enhances stability of financial model </li></ul><ul><ul><li>Asset-based framework links financial services to real economy </li></ul></ul>Islamic finance benefits are not exclusive to Muslims
    15. 15. <ul><li>Within 8 to 10 years, as much as half the savings of the world’s then 1.6 billion Muslims would be in Islamic banks 1 </li></ul><ul><li>The global Islamic insurance ( Takaful ) market is estimated to reach USD 14.4 billion by 2010 1 </li></ul><ul><li>Most Islamic financial institutions are highly liquid , and seek new asset classes and markets to diversify </li></ul><ul><ul><li>Project finance requirements of USD 500 billion in 5 years 2 </li></ul></ul><ul><ul><li>Capital markets developments: Malaysia – Sukuks account for 71% of 1H06 debt issues 3 </li></ul></ul><ul><li>Islamic finance has also gained popularity in Muslim-minority countries </li></ul><ul><ul><li>Germany issued the first Islamic Eurobond (2004) </li></ul></ul><ul><ul><li>UK’s first standalone Islamic bank (2004) </li></ul></ul><ul><li>Trends of convergence and conversion </li></ul><ul><ul><li>Ethical investing, community banking </li></ul></ul><ul><ul><li>Conversion of banks: e.g. National Bank of Sharjah, Bank al Jazira, Dubai Bank </li></ul></ul>The industry has not yet reached its potential Source: 1: IIR Middle East (Apr 2006); 2 Banker ME (June 2006); 3 RAM Islamic Ratings Services (2006)
    16. 16. Islamic framework provides solutions for key limitations of conventional banking system An ethical grounding prevents a wide set of problems IFI solutions Conventional banking issues <ul><li>Growing consumer indebtedness </li></ul><ul><ul><li>TSV maximisation ultimate goal </li></ul></ul><ul><ul><li>Systemic conflict between shareholders and credit-financed customers </li></ul></ul><ul><li>Speculation-fuelled crises </li></ul><ul><ul><li>1997 East Asia Crisis </li></ul></ul><ul><ul><li>1998 Russia </li></ul></ul><ul><ul><li>1999 Argentina </li></ul></ul><ul><li>Shariah-based IFI is Taqwa-based </li></ul><ul><ul><li>Regulation is reactive to corporate innovation </li></ul></ul><ul><ul><li>Shariah-based system prioritises God over regulators – (SRO) </li></ul></ul><ul><li>Check on profit-seeking alone as sole business motive </li></ul><ul><ul><li>Investment channels towards ethical activities </li></ul></ul><ul><li>Prevention of speculation </li></ul><ul><ul><li>Ownership is prerequisite of sale </li></ul></ul><ul><ul><li>Excessive risks are prohibited </li></ul></ul><ul><ul><li>The case for “Narrow Banking” </li></ul></ul><ul><li>Equitable distribution of risk and reward </li></ul><ul><li>Asset/need-based approach to financing </li></ul><ul><li>Regulation often reactive and lagging corporate misbehaviour </li></ul><ul><ul><li>Collusion between research and M&A teams </li></ul></ul><ul><ul><li>Enron, WorldCom, Arthur Anderson, Tyco and other collapses </li></ul></ul>
    17. 17. An alternative banking model in development Liabilities Assets Investments Deposits Profit, not interest, becomes the basis for financial intermediation Suppliers of capital Productive economic actors with capital needs Equity financing mudaraba & musharaka Debt financing ijarah, murabaha, salam, istisna‘ <ul><li>Reducing debt-based products </li></ul><ul><ul><li>Islam permits commercial debt for productive ends </li></ul></ul><ul><ul><li>Debt-based consumer products permitted on basis of need </li></ul></ul><ul><ul><ul><li>More the exception than the desired norm </li></ul></ul></ul><ul><li>Building income-sharing products </li></ul><ul><ul><li>Musharaka is true form of financing </li></ul></ul><ul><ul><li>Develop with “fixed” income payment profile </li></ul></ul><ul><li>Removing bias towards debt </li></ul><ul><ul><li>Current tax, accounting and regulatory systems and risk-weighting promote debt instruments </li></ul></ul>Key internal issues that need addressing…
    18. 18. Shariah-based mindset is crucial direction for product development Shariah-based industry is the new vision Shariah-compliant products Shariah-based solutions Savings & Investments Indebtedness x <ul><li>Income-sharing products </li></ul><ul><li>Shift from debt-based product offering </li></ul><ul><li>Letter of the law </li></ul><ul><li>Replicating conventional credit service offering </li></ul>
    19. 19. A number of factors need to be engaged to bring success Need for co-ordination to enable further development Key enablers <ul><li>Dedicated people </li></ul><ul><ul><li>Greatest intangible to enable Islamic finance and build its future </li></ul></ul><ul><ul><li>Human capital development: bankers and Shariah scholars </li></ul></ul><ul><li>Committed sponsorship </li></ul><ul><ul><li>Academic input to formulate visionary framework and development </li></ul></ul><ul><ul><li>Capital sponsorship to bring plans to life </li></ul></ul><ul><li>Change in mindset </li></ul><ul><ul><li>From Shariah-compliant to Shariah-driven products and services </li></ul></ul><ul><li>Education of all key stakeholders </li></ul><ul><ul><li>To build understanding and awareness </li></ul></ul><ul><li>Proactive engagement </li></ul><ul><ul><li>Regulators, practitioners and Shariah scholars to set a common agenda </li></ul></ul>
    20. 20. <ul><ul><li>We must preserve what is distinctive about Islamic finance </li></ul></ul><ul><ul><ul><li>Industry regulations and governance heading towards mainstream globalization </li></ul></ul></ul><ul><ul><ul><li>Balancing different elements of Shariah credibility </li></ul></ul></ul>Concluding remarks <ul><ul><li>Current expanding reach and richness of Islamic finance </li></ul></ul><ul><ul><ul><li>Despite the absence of an enabling framework </li></ul></ul></ul><ul><ul><ul><li>But at a cost: culture of exceptions, Shariah credibility, competitive disadvantages </li></ul></ul></ul><ul><ul><li>To build an enabling framework requires concerted efforts </li></ul></ul><ul><ul><ul><li>Collaboration between IFIs, endowed industry institutions and regulators </li></ul></ul></ul><ul><ul><ul><li>Exploration of narrow banking principles </li></ul></ul></ul>Imperative is for moving to Shariah-based services Japanese proverb: “ Vision without action is a daydream. Action without vision is a nightmare.”
    21. 21. Thank you Iqbal Khan Founding ex-CEO, HSBC Amanah

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