Islamic banking in Germany: opportunities and potential aspects

Uploaded on

The purpose of this thesis is to examine the German market and to investigate …

The purpose of this thesis is to examine the German market and to investigate
whether it is potential for Islamic banking or not. It will further highlight the main
opportunities for the future growth of the business, as well as the main challenges
facing Islamic banks in the country.

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Be the first to comment
    Be the first to like this
No Downloads


Total Views
On Slideshare
From Embeds
Number of Embeds



Embeds 0

No embeds

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

    No notes for slide


  • 1. Islamic Banking in Germany: Opportunities and Potential Aspects MASTER – THESIS Adviser: Prof. Dr. Lars Jäger Co-Adviser: Dr. Johannes Engels Course of Studies: International Business Administration and Foreign Trade UNIVERSITY OF APPLIED SCIENCES WORMS Submitted by: Islam Hamed Gabriel-von-Seidl-Straße 75 67550 Worms Matriculation no.: 666149 Winter Term 2013/2014 Worms, October 19th, 2013
  • 2. In The Name of Allah, The Most Beneficent, The Most Merciful Dedicated to my father’s soul, Fathy Abd-elaziz Hamed
  • 3. Acknowledgements Acknowledgements First of all, I would like to thank Almighty Allah for everything in my life, Without his guidance I would never be able to accomplish anything in my whole life. I would like also to thank my mother who has supported me with her prayers, as well as her best dedication. I cannot forget my sister and my brother who had been always beside me. I am further grateful to thank all my family members, as well as my friends for their support, without you it would be very difficult to overcome all the challenges. I cannot say thanks enough to my beloved fiance, Sarah El-sadany, who has inspired me with her hope, love and support. Finally, I would like to offer my gratitude to my supervisors Dr. Jäger and Dr. Engels for their support and guidance through this thesis.
  • 4. Student’s Declaration Student’s Declaration I hereby declare that this thesis is my own original work and that no other than the listed references have been used as sources of information. I further declare that no part of this thesis has been previously submitted to this or any other institution. Worms, October 19th , 2013 Islam Hamed Signature
  • 5. Abstract Abstract The Islamic banking sector has grown rapidly with double digit rates in the past decades. It is further considered the fastest growing segment in the global financial system. Hence, several countries were attracted by the business around the globe. In particular, several western countries who started to realize the potential of its Muslim minorities, and started to open doors for Islamic banks. In consequence, Islamic banks started to spread in several western countries. On the contrary, other European countries with a large group of Muslims did not launch the business yet, such as Germany. The purpose of this thesis is to examine the German market and to investigate whether it is potential for Islamic banking or not. It will further highlight the main opportunities for the future growth of the business, as well as the main challenges facing Islamic banks in the country. Key words: Islamic banking, Islamic finance, Islamic banks, Market potential, German banks and regulatory framework. IV | P a g e
  • 6. Table of Contents Table of Contents Acknowledgements ................................................................................................... II Abstract ................................................................................................................... IV List of Figures ......................................................................................................... VIII List of Abbreviations ................................................................................................. IX Glossary ................................................................................................................... XI 1. Research Overview ............................................................................................. 1 1.1. 1.2. Purpose ............................................................................................................... 3 1.3. Research Design & Methodology ....................................................................... 3 1.4. 2. Introduction ........................................................................................................ 1 Thesis Structure .................................................................................................. 4 Islamic Banking: Introduction and Overview ....................................................... 6 2.1. History & milestones .......................................................................................... 6 2.2. Evolution of Islamic banking ............................................................................... 8 2.3. Shariah & Fiqh..................................................................................................... 9 2.3.1. The sources of Shariah.............................................................................. 10 2.4. 2.5. The Prohibition of Gharar and Maysir .............................................................. 14 2.6. Halal and Haram concept ................................................................................. 15 2.7. 3. The Prohibition of Riba ..................................................................................... 13 Zakat ................................................................................................................. 16 Islamic Modes of Finance.................................................................................. 17 3.1. Profit -and -Loss Sharing Instruments .............................................................. 17 3.1.1. Mudaraba ................................................................................................. 18 3.1.2. Musharaka ................................................................................................ 19 3.2. Deferred Sales Contracts .................................................................................. 21 3.2.1. Murabaha ................................................................................................. 21 3.2.2. Forward Sales: Salam and Istisna‘a ........................................................... 22 3.3. Ijarah - Leasing .................................................................................................. 25 3.4. Qard Hasan ....................................................................................................... 27 3.5. Retail Banking: Funding Accounts .................................................................... 27 3.5.1. V|Page Current Accounts ...................................................................................... 28
  • 7. Table of Contents 3.5.2. 3.6. Sukuk ................................................................................................................. 29 3.6.1. 3.7. 4. Saving & Investment Accounts ................................................................. 28 Ijarah Sukuk .............................................................................................. 30 Takaful .............................................................................................................. 32 Corporate Governance In Islamic Banks ............................................................ 36 4.1. The Shariah Supervisory Board (SSB) ............................................................... 37 4.1.1. Functions and Responsibilities.................................................................. 37 4.1.2. The Issue of Fatwa .................................................................................... 38 4.1.3. Characteristics of The Board Members .................................................... 39 4.1.4. Shariah Supervisory Boards & Western Regulators ................................. 41 4.2. International Islamic Financial Infrastructure................................................... 42 4.2.1. 4.2.2. IFSB ........................................................................................................... 42 4.2.3. IDB............................................................................................................. 43 4.2.4. 5. AAOIFI ....................................................................................................... 42 LMC ........................................................................................................... 43 Islamic Banking & the German Market .............................................................. 44 5.1. Muslims in Germany ......................................................................................... 44 5.2. Financial Behavior of the Muslim population in Germany ............................... 48 5.2.1. Current Trends .......................................................................................... 48 5.2.2. Market potential for Shariah-compliant products in Germany................ 50 5.3. Regulatory Framework of The Financial Entities in Germany .......................... 54 5.3.1. Banking Supervision in Germany .............................................................. 54 5.3.2. Licensing of theIslamic Financial Entities in Germany .............................. 55 5.4. Feasible key players in the German market ..................................................... 59 5.4.1. 5.4.2. Commerzbank ........................................................................................... 60 5.4.3. 6. Deutsche Bank AG .................................................................................... 59 Kuveyt Türk Participation Bank................................................................. 62 Conclusion ....................................................................................................... 63 6.1. Opportunities for the Islamic Banking industry in Germany ............................ 63 6.2. Challenges Facing the Islamic Banking Industry in Germany ........................... 64 References ................................................................................................................. i APPENDIX 1 ............................................................................................................ viii APPENDIX 1.1 ................................................................................................................ viii VI | P a g e
  • 8. Table of Contents APPENDIX 1.2 .................................................................................................................. ix APPENDIX 1.3 .................................................................................................................. xi Appendix2 ............................................................................................................... xii VII | P a g e
  • 9. List of Figures List of Figures Figure 1 Thesis Structure .................................................................................................... 4 Figure 2 Trend in Global Islamic Banking Assets ................................................................ 8 Figure 3 Geographical Breakdown of Total Global Islamic Financial Assets ...................... 9 Figure 4 Mudaraba Model ................................................................................................ 19 Figure 5 Diminishing Musharaka Model ........................................................................... 20 Figure 6 Murabaha Model ................................................................................................ 22 Figure 7 Bai'salam Model.................................................................................................. 24 Figure 8 Istisna'a Model .................................................................................................... 25 Figure 9 Ijarah - Leasing Model......................................................................................... 26 Figure 10 Sukuk issuance .................................................................................................. 30 Figure 11 Structure of a generic ijarah sukuk .................................................................. 31 Figure 12 The global gross Takaful contributions ............................................................. 33 Figure 13 Takaful Mudarbah Model ................................................................................. 35 Figure 14 Muslims According to Region of Origin ............................................................ 46 Figure 15 Muslims according to denomination ................................................................ 46 Figure 16 Age Structure of Muslims According to countries of Origin ............................. 47 Figure 17:Bank preferences for Muslims in Germany with Turkish Background ............. 50 Figure 18 Attitude on Banks in Germany……………………………………………………………………… 51 Figure 19 Relevance of Shariah Compliance and Adherence of Islamic principles .......... 52 Figure 20 Importance of Islamic Investments by Religiousness ....................................... 53 VIII | P a g e
  • 10. List of Abbreviations List of Abbreviations A AAOIFI Accounting and Auditing Organization for Islamic Financial Institutions. ARCIFI Arbitration and Reconciliation Centre for Islamic Financial Institutions. B BaFin Bundesanstalt für Finanzdienstleistungs-aufsicht (the Federal Financial Super-visory Authority). BOT Build–operate–transfer. C CIBAFI Council for Islamic Banks and Financial Institutions G GCC Gulf Cooperation Council. I ICD Islamic Corporation for the Development of the Private Sector. ICIEC Islamic Corporation for the Insurance of Investment and Export Credit. IDB Islamic Development Bank. IFIs Islamic financial instutions. IFSB Islamic Financial Services Board. IIFM International Islamic Financial Market. IRTI Islamic Research and Training Institute. IX | P a g e
  • 11. List of Abbreviations K KFH Kuwait financial house. KTP Kuvyet Türk participation bank. KWG Kreditwesengesetz (the German Banking Act). L LIBOR London interbank offered rate. LMC Liquidity Management Centre. P PBUH Peace be upon him. PLS profit and loss-sharing. R ROE Return on equity S SDLT Stamp Duty Land Tax. SPV special purpose vehicle. SSB The Shariah Supervisory Board. X|Page
  • 12. Glossary Glossary1 Allah Amana is trust; the contract of amana gives rise to fiduciary relationships and duties. Bay (bai) a comprehensive term that applies to the sale transactions, exchange. Bai bi-thamin ajil a deferred payment sale by installments Bai’muajjal a deferred-payment sale. Bai’salam a pre-paid purchase. Fatawa (sing. fatwa) legal decisions or opinions rendered by a qualified religious leader (mufti). Fiqh Islamic jurisprudence, the science of religious law, which is the interpretation of the Sacred Law, Shariah. Fuqaha (sing. faqih) Muslim jurisprudents who have religious authority. Gharar uncertainty, speculation. Hadîth (plural ahadith) the technical term for the source related to the Sunna; the sayings - and doings of the Prophet (PBUH), his traditions. Hajj The pilgrimage to Mecca. Halal means permitted according to the shariah. Haram 11 The Arabic word for God. means forbidden according to the shariah. The definantions are according to the glossary from Lewis & Algaoud ( 2001) and Ayub (2007). XI | P a g e
  • 13. Glossary Ijara contract a leasing contract. Ijara wa iqtina a lease-purchase contract, whereby the client has the option of purchasing the item. Ijma means consensus among jurists based on the Holy Qur’an and Sunna, and one of the four sources of law in Sunni Islam. Ijtihad means the act of independent reasoning by a qualified jurist in order to reach new legal rules. Islam is submission or surrender to the will of God. Istisnaa a contract to manufacture. Maysir means gambling, from a pre-Islamic game of hazard. Mudaraba contract is a trustee financing contract, where one party, the financier, entrusts funds to the other party, the entrepreneur, for undertaking an activity. Mufti is a jurist who is authorised to issue a fatwa or legal decision on a religious matter. Murabaha is resale with a stated profit, for example the bank purchases a certain asset and sells it to the client on the basis of a cost plus mark-up profit principle. Musaqah is a contract for the lease of agricultural land with profit-sharing. Musharaka contract is an equity participation contract, whereby two or more partners contribute with funds to carry out an investment. Qard hasan a benevolent loan (interest free). XII | P a g e
  • 14. Glossary Qiyas means analogical deduction. Qur’an is the Holy Book, the revealed word of God, followed by all Muslims. Rabb al-mal refers to the owner of capital or financier in a mudaraba partnership agreement (also sahib al-mal). Riba is literally ‘excess’ or ‘increase’, and covers both interest and usury. Shariah is Islamic religious law derived from the Holy Qur’an and the sunna. Sukuk Certificates of equal value representing undivided share in ownership of tangible assets of particular projects or specific investment activity, usufruct and services. Takaful refers to mutual support which is the basis of the concept of insurance or solidarity among Muslims. Zakat is a religious levy or almsgiving as required in the Holy Qur’an and is one of Islam’s five pillars. XIII | P a g e
  • 15. Research Overview 1. Research Overview 1.1. Introduction The negative consequences of the global financial crisis have made both investors and experts rethink the current financial system. Speculation schemes, as well as sub-prime loans, drove the global economy to the so called “black hole”. Several banks have gone bankrupt and as a result, customers started to lose trust in the current financial system, particularly, in the banking sector (Ernst & Young, 2011). Despite the fact that governments began to pursue restrictive schemes against speculations and credit lending, the situation was beyond recovering. The Eurozone crisis has hit the financial system again, resulting with an ongoing financial crisis, and the reason was still the same. On the other side, the consequences were slightly lighter across the majority of the Muslim countries, especially the ones that are operating according to the Islamic financial system. The Islamic-financial system which based on the elimination of both interest rates (riba) and speculation (gharar & maysir), has been very stable against the global financial crisis. Following the crisis, some Investors started to search for other alternatives than conventional banks. As a result, many investors have switched to Islamic banks, as they could structure profitable products, with a lower risk. Furthermore, Investors started to orient their investments into ethical products, which could be found only in Islamic banks. In 2009, The Vatican announced officially in its newspaper, that banks should learn from the Islamic banking procedures in order to retrieve customers’ confidence. All the above reasons and more have elaborated to make Islamic banking and finance a hot topic among researchers and experts. Despite the fact that the principles of Islamic banking and finance were set in the 7th century (the Muslims’ golden age), the phenomenon began to evolve in the past 30years. In particular, in the 1970s , with the rise of the Islamic banks in the GCC area. The sector started to grow rapidly with double digit rates. According to the European central bank (2013, p. 19), Islamic banking has shown annual sustainable growing 1|Page
  • 16. Research Overview rate by 15-20percent over the past five years, the handled assets by the Islamic banks have reached $1.3 trillion at the end of 2012. Western banks were also attracted by this profitable business. Hence, several banks started to launch “Islamic windows” in many Arab countries, by offering Islamic financial products through its subsidiaries (mainly GCC region). Moreover, some western countries started to realize the potential of its Muslim minorities, and thus started to launch Islamic financial banks in their countries. The United Kingdom, with a potential market of more than 2 million Muslims, was one of the leaders in Islamic finance and banking business in Europe since 1980s. It was the first Western country to open the doors for Islamic banking with the first established Islamic bank in 1982 (Wilson, 2007, p. 420). Currently, the UK is the centre of Islamic finance in Europe, with $19 billion of reported assets and various banks delivering Shariah-compliant products (UKTI, 2013). Other European countries have also a large group of Muslims as the UK or maybe more; however, Islamic banking did not penetrate its markets yet, such as Germany. The success of the UK raised the question of whether Germany can be also a potential market for Islamic financial products or not. Despite its large Muslim population and its strong economy, no serious actions have been taken to launch the Islamic business till now. Several Islamic banks showed a real interest in launching a subsidiary in Germany, however, regulatory and legal issues are still the major constraints facing the implementation of this business. The Kuveyt Türk Participation Bank was the first bank to take a serious step in the Islamic banking business in Germany. The new Islamic bank has opened its first branch in Mannheim, in 2010, with a limited license issued by BaFin (the Federal Financial Super-visory Authority). However, the bank did not obtain the Full license yet, due to the different regulatory constraints. In this regard, many questions have been raised, such as is Germany really a potential market for this business? What are the opportunities & challenges? This paper will try to investigate about these questions. 2|Page
  • 17. Research Overview 1.2. Purpose The purpose of this thesis is to examine the German market and to investigate whether it is a potential market for Islamic banking or not. In this context, the paper will scrutinize the financial behavior of the German Muslim population. In addition, the anticipated key players in the domestic market will be outlined. The dissertation will further highlight the main opportunities for the future growth of the business, as well as the main challenges facing the business. In this regard, the regulatory restrictions as well as the other implications facing the business will be discussed. It is important to note that the paper will not discuss further any legal issues. 1.3. Research Design & Methodology The research relied mainly on two methods. First, secondary data available through the conducted research papers as well as authorized publications and online sources. Secondly, Interviews with the Islamic finance experts which are located in Germany. Therefore, several experts and banks' representatives across Germany have been contacted via email. Unfortunately, there was no answer from almost all of them, except Dr. Johannes Engels2 from the federal financial supervisory authority (BaFin). For these reasons, the majority of the data in this thesis is mainly based on the working papers, market surveys and other online researches. 2 Dr. Johannes Engels is a Senior Advisor at The Federal Financial Supervisory Authority (BaFin) – Germany. He has studied General Economics in Aachen and Cologne; he finished in at University of Cologne with Doctor Degree. He has been working for the Federal Financial Supervisory Authority for twenty two years, in the international dept. for eight years. Since October 2012 he has been the lecturer for Corporate Governance at University of Applied Sciences in Mainz. He has written several publications in the field of Islamic finance. 3|Page
  • 18. Research Overview 1.4. Thesis Structure The disposition of the Thesis chapters is illustrated in figure1 and followed by a summary of the chapters’ content. Research Overview Introduction & Overview Islamic Modes of Finance Corporate Governance In Islamic Banks Islamic Banking & The German Market Conclusion Figure 1 Thesis Structure This paper is divided into six chapters. This first chapter, is an introductory chapter, which outlines the research objective as well as the methodology and the chapters’ contents. The second chapter gives a brief overview of the history and the evolution of the Islamic banking, as well as the Islamic legal system (Shariah and Fiqh). In this regard, the main principles of the Islamic finance and banking will be discussed. The chapter is geared to provide the reader with the basic knowledge of the Islamic finance & banking principles for a better understanding of the following sections and chapters. The third chapter introduces the main financial instruments offered by Islamic banks. In this context, the structure of the several products and services will be explained with practical examples presented graphically for understanding their concepts better. Moreover, the chapter discusses other Islamic financial alternatives, such as the Islamic insurance (Takaful) and Islamic bonds (sukuk). Compliance structure and governance of Islamic banks will be discussed in chapter four. The first section will be about the Shariah supervisory board in the Islamic banks and its central role in assessing and monitoring the Islamic banking business. The second section will examine the International Islamic financial infrastructure. In this respect, the most important Islamic international organizations will be addressed. In order to investigate whether the German market has potential for Islamic banking or not, this matter will be analyzed in chapter five. This 4|Page chapter
  • 19. Research Overview scrutinizes the Muslim populations in Germany and its financial attitudes and behaviors. In addition, the chapter will highlight the main key players in the domestic market. Finally, the major regulatory and taxation issues facing the implementations of this sector will be discussed. In the last chapter, the research conclusion will be outlined. 5|Page
  • 20. Islamic Banking : An Introduction & Overview 2. Islamic Banking: Introduction and Overview Following the birth of Islam, almost 1400 years ago, new financial principles were introduced by prophet Mohamed (PBUH), the prophet of Islam. This was mainly based on the prohibition of riba (usury) and the reliance on the profit-sharing concept (Lewis & Algaoud, 2001, p. 4), which modernly known as Islamic finance. Approximately 40 years ago, the concept was absorbed by the modern financial institutions, as they started to design products and services in compliance with the Islamic law (Shariah). In consequence, a new banking system has emerged, which is known as “Islamic Banking”. The new banking system has expanded across both the Muslim and non Muslim countries, currently there are more than 500 IFIs (Islamic Finance Institutions) and the number is expeditiously increasing (Etzold, 2011). In spite of this wide expansion, Many Muslims and non Muslims nowadays have a poor understanding of this field concepts and practices (Lewis and Algaoud 2001, p. 1). The following chapter will outline the Islamic banking history with its major milestones. Furthermore, it will discuss the main sources of the Islamic law (Shariah), as well as the main principles of that business. 2.1. History & milestones The interest-free concept, which was introduced by prophet Mohamed, in the seventh century, has declined over the years and was decimated after the World War I, in particular, after the collapse of the Ottoman Empire. Consequently, the interest –based concept dominated the new economic system and spread rapidly in the western world. As a result of the World War I, Britain and France occupied most of the Muslims countries (Abdul-Rahman, 2010, p. 191). Accordingly, the British established the first commercial bank in the Muslim world in 1890s, in Egypt. The main purpose was to manage the financial transaction regarding the Suez canal construction. Nevertheless, the existence of the latter bank had faced a wide rejection from the Muslim scholars at that time (IRTI &IFSB, 2007). 6|Page
  • 21. Islamic Banking : An Introduction & Overview Between 1990-1950s, the interest-based banking system spread rapidly in the Arab regions as well as the Indian sub-continent. Hence, Islamic economists had to put an effort to design alternatives in the scope of Islamic Shariah. The first practical model was introduced by Dr. Ahmed Al Naggar in Egypt in the early 1960s. The young German-educated Egyptian established a small bank in Zefta/Mit Ghamr, in order to finance the basic needs of the poor farmers. The bank showed a great success over the agriculture industry until it was nationalized by president Nasser3 under the name of “Nasser Social Bank” (Abdul-Rahman, 2010, p. 192). Another essential milestone was the Arab-Israeli war in, 1973; it pushed tremendously the oil prices which created the first oil crisis. Subsequently, massive cash flows entered the gulf area introducing a new class of dollars, the petro-dollars. As a result, King Faisal of Saudi Arabia established the Islamic Development Bank, IDB, which aimed to develop a new vision for the Islamic banking system. Simultaneously, The establishment of the Islamic bank in Dubai and the Kuwait financial house (KFH). Later in Egypt, the Faisal Islamic bank was established by the King’s Faisal son, prince Mohamed Al Faisal. The bank has grown rapidly in Egypt with many branches serving more than 700,000 customers. In addition, Sheikh Saleh Kamel established the Egyptian Saudi Finance Bank (Bank Al Tamweel Al Misry Al Saudi) (Abdul-Rahman, 2010, p. 193). It is one of the major Islamic banks in Egypt with 22 branches.currently the bank’s name has changed to “alBaraka Bank Egypt” (alBaraka, 2013). In 1980s the scheme continued to spread in many countries with the existence of new Islamic Banks and academic institutions. Pakistan , Iran, and Sudan announced the intention to transform their financial system to be governed by Shariah . Additionally, the establishment of the Islamic Research and Training Institute (IRTI) in 1981. Consequently, the IMF started to publish many research papers on the topic, as it became a rapidly grown business. During the 1990s, the Islamic banking business became a hot topic in the western academic world. Moreover, commercial events on the topic took place in several countries. Most 3 President of Egypt (1956-1970), a leader of the Egyptian free officers revolution of 1952. 7|Page
  • 22. Islamic Banking : An Introduction & Overview importantly, the establishment of The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) (IRTI &IFSB, 2007). The duration between 2000 and 2006 witnessed the real establishment of the Islamic financial infrastructure which is considered as the backbone of the Islamic Financial system. Specifically, the establishment of the Islamic Financial Services Board (IFSB), the International Islamic Financial Market (IIFM), the General Council for Islamic Banks and Financial Institutions (CIBAFI) and the Arbitration and Reconciliation Centre for Islamic Financial Institutions (ARCIFI) (IRTI &IFSB, 2007). Recently, Islamic banking business has spread rapidly through the European countries to serve the Muslim minorities. The Islamic Bank of Britain (IBB) is one the main players in this business in Europe. It is worth pointing out that the first customer in the Leicester branch of IBB travelled over 100 miles to open an account , which reflects a high degree of service transparency (Ayub, 2007, p. 16). 2.2. Evolution of Islamic banking The Islamic banking industry has shown substantial growth in the past decade. As part of the Islamic finance industry, Islamic banking accounted for almost 80 percent of the Islamic financial assets with $1.3 trillion assets in 2012 (figure 2), and with 15-20 percent annual growth for the past 5 years (ECB, 2013, p. 19). Figure 2 Trend in Global Islamic Banking Assets (ECB, 2013, p. 20) 8|Page
  • 23. Islamic Banking : An Introduction & Overview The industry trend is expected to continue growing with a constant rate, which made this industry the fastest growing segment of the entire global financial system. The industry started to compete with the conventional banking industry. In terms of profitability, Islamic banking average ROE in 2011 was 12 percent compared to 15percent in conventional banking (Ernst & Young 2012). The industry is mainly focused in the GCC region (i.e. Saudi Arabia, the United Arab Emirates, Kuwait, and Qatar) as well as in South-East Asia ( i.e. Malaysia and Indonesia) ( figure 3) (ECB, 2013, p. 19). Figure 3 Geographical Breakdown of Total Global Islamic Financial Assets (ECB, 2013, p. 19) 2.3. Shariah & Fiqh In the religion of Islam, Allah (the Arabic word for God) is the creator and the owner of everything, it is He only who has the ultimate right to establish the right path for the mankind. Therefore, Muslims believe that following Allah’s law is essential, as it is established and ordained only by Him and not with a human lawmaker (Kettell, 2010, p. 84). 9|Page
  • 24. Islamic Banking : An Introduction & Overview In fact, the term Shariah literally means ‘the way to the source of life’ (Algaoud & Lewis, 2007, p. 38), ‘the way to a watering place’ (Kettell, 2010, p. 84), it can be also translated as ‘the law’ (Abdul-Rahman, 2010, p. 63). Shariah represents a set of duties which governs the whole Muslims life including. It regulates the relationship between man and Allah (Fiqh Ibadah) concerning worship duties and activities (prayers, fasting, pilgrimage, etc.). On the other hand, it regulates the relationship among people in the society (Fiqh muamlat) (Millar, 2008, p. 5), such as manners and morals, crime and commercial transactions. In the latter case, in business transactions, Shariah acts as a regulator between the seller and the buyer. In this context, business transactions can be divided into four classes: first, sales (bay), the transfer of a property’s ownership to another entity with a beneficial value. Second, hire (ijara), the transfer of the usufruct of certain property to another entity with a beneficial value. Third, gift (hiba), a gratis transfer of the property. Fourth, loan (ariyah), a gratis transfer of the usufruct (the right to use) of the property. Based on this, almost all financial transactions fall in the context of the latter cases, for instance, deposits, partnerships, guarantee, agency, etc. (Algaoud & Lewis, 2007, p. 38). 2.3.1. The sources of Shariah The scope of Shariah is relatively wider than any other legislative system; it is a unique legislative system that governs the relationship between man to Allah and man to man. In fact, Shariah has two main sources, primary and secondary (Kettell, 2010, p. 86). The Quran and the Sunna are the primary sources , whereas Ijma (consensus) and Qiyas (analogy) are the secondary sources, as illustrated below. (Visser, 2009, pp. 10-12). The Qur’an The Qur’an is believed to be a revelation from Allah to his last prophet Mohammed (PBUH) by the angel Gabriel in the city of Mecca. The Qur’an is considered to be a verbal miracle to prophet Mohammad (PBUH) and an evidence of his Prophecy. The literal meaning of the word Qur’an is ‘reading’ or 10 | P a g e
  • 25. Islamic Banking : An Introduction & Overview ‘recitation’; it was revealed in the Arabic language approxmaitely1400 years ago. In fact, the Qur’an was revealed gradually based on certain situations over a period of time. It contains 114 Suras (chapters) and 6235 ayat (verses) differed in length (Kettell, 2010, pp. 87-88). It confirms the sequence of both prophets and their revelations as stated in many verses of it (Abdul-Rahman, 2010, pp. 65-66). In fact, approximately 500 verses of the Qur’an dealt with legal injunctions, these cover marriage, rights and obligations, divorce, loans, punishment, inheritance, etc. Therefore, it is the first primary source of Shariah (Kettell, 2010, p. 86). The Sunnah Sunnah is the second primary source of Shariah. It means a path, or an example, it refers to the way of prophet’s Mohammad life as it is practiced in the light of the Qur’an. Sunnah represents the prophet’s life on the basis of the sayings, comments and actions approved or done by him (Abdul-Rahman, 2010, p. 66). In fact, the Qur’an was written and preserved in the life of the prophet Mohammad. The Sunnah on the contrary, was recorded directly after his death by his companions. They started to record all the prophet’s sayings ( Ahadith, the plural of Hadith ) and doings . In addition, Sunnah is very important to understand the context of the Qur’anic verses, whereas the verses were revealed based on a certain situations during the life of the prophet (Kettell, 2010, pp. 89-91). Ijma (Consensus) Apart of the confirmed primary sources of Shariah , the Qur’an and the Sunnah, there are two secondary sources Ijma and Qiyas. The word Ijma derived from the Arabic verb ajma’a, which means ‘to determine and to agree upon something’. Thus, Ijma refers to a consensus on a certain opinion of the prophet’s early companions and the followed Muslims jurists on a various Islamic matters (Kettell, 2010, p. 92). Actually, Ijma applies just in cases where there is no explicit or clear solution for a certain problem from the Qur’an or the Sunnah. The process is only done by the Muslim jurists (fuquahaa ) and not by the individuals (Abdul-Rahman, 2010, p. 68). Indeed , Ijma can just occur after the death of the 11 | P a g e
  • 26. Islamic Banking : An Introduction & Overview prophet and not in his lifetime, as he was the highest authority on Shariah. The process began when several problems arose after his death, the companions started to consult each other until they agree on one solution, the process passed through the following generation and so on. Hence, once Ijma is settled, it became an authority which cannot be rejected by anyone (Kettell, 2010, p. 93). Qiyas (analogical reasoning) Qiyas is the second secondary source of Shariah. It means literally ‘measuring’, and can also refer to a comparison to asses equality or similarity between two things (Kettell, 2010, p. 94). In the Islamic context, qiyas is an analogical approach done by Jurists on an original case in order to extract the rules from it, and practice these rules on a new case. Usually, this new case does not have a clear conclusion from the Qur’an or the Sunnah, and there is no Ijma on it (AbdulRahman, 2010, p. 68). For instance, the use of wine is considered to be strictly condemned according to the Qur’an, similarly, the use of any other toxicants can fall under the same prohibition as well (Visser, 2009, p. 12). Ijtihad Ijtihad is considered to be an important source when developing new Shariahcompliant products. In fact, it took over an effective role in developing the Islamic Banking and finance industry. Ayub ( 2007, p. 489) defined Ijtihad as : [a]n endeavor of a qualified jurist to derive or formulate a rule of law to determine the true ruling of the divine law in a matter on which the revelation is not explicit or certain, on the basis of Nass or evidence found in the Holy Qur’an and the Sunnah. Indeed, there are strong debates about ijtihad, which is mostly concerned about who can perform ijtihad, as he should be a very qualified scholar (Millar, 2008, p. 5). Ayub ( 2007, p. 441) further argues that ijtihad is the main cause for the non standardized products across the IFIs, due to the different Shariah interpretation. 12 | P a g e
  • 27. Islamic Banking : An Introduction & Overview 2.4. The Prohibition of Riba The prohibition of riba (usury) is one of the main principles of the Islamic financial system. The term riba literally means “increase” or “addition” or “surplus”(Visser 2009, p. 31). Generally, it refers to an addition cost imposed on the borrower at the maturity date (Kettell 2010, p. 13). The Holly Qur’an and the Sunnah strongly condemn riba in many places (Appendix 1.1 & 1.2). In fact, Riba was also condemned in all of the revealed religions, such as Christianity and Judaism. With regard to riba in Islam, there are no debates among Muslims about the prohibition of riba, as almost all Muslims regard it as a great sin (Ayub, 2007, p. 44). However, Muslim scholars have been arguing about its frame in the modern life and particularly in business activities. On that basis, Muslim scholars argued that the concept of riba is wide and can take different forms other than interest rates. In this regard, Muslim scholars have divided riba into two categories (Kettell 2010, p.13): 1- Riba al-nasia, where an increase imposed on the loan by the case of deferment (conventional banking interest rate). 2- Riba al-fadl, where unequal exchange takes place between two commodities (e.g. good quality dates for less quality dates). It can be obviously concluded that the ban on riba is not limited just to money; it is also over the exchange of goods (Visser 2009, p. 34). The conventional banking system which is based on the credit lending falls in the first category (Riba alnasia). One might think that the Islamic rejection of interest neglects the time value of money. However, the time value is widely recognized in the case of credit sales as it is permitted in Islam. It was explicitly stated in Sura 2:275, trade is permitted but riba is not (Visser, 2009, pp. 36-37). In other words, credit sales and interest rates may have the same mechanism, but one is allowed, and the other is forbidden. The reason behind the latter case, the money itself does not have value (not a commodity) (Ayub, 2007, p. 52). Money has only one function, which is “ medium of exchange”, unlike any commodity which has value and can be traded. This will lead to further discussion about the reasons behind the 13 | P a g e
  • 28. Islamic Banking : An Introduction & Overview prohibition. The Qur’an and the Sunnah did not provide a clear justification about its reasons. However, Muslim scholars have provided different reasons concerning the condemnation. The unfairness of the loan contract is one of the major reasons,where one party (the borrower) takes over the risk of losing its money and effort in the case of project failure. On the contrary, the other party (the creditor) will receive the principal plus the interest at any case (Kettell 2010, p.16). Another reason, riba increases the gap between rich and poor in the society by transferring wealth from poor to rich people. In addition, it drives people in the society to be non productive relying on their interest returns (Visser 2009, p. 38). 2.5. The Prohibition of Gharar and Maysir There are other prohibitions governing the business activities side by side with riba, such as gharar (uncertainty) and maysir (gambling) (Visser 2009, p. 45). The latter type, maysir, is derived from the Arabic word usr (ease and convenience), which refers to “mass wealth without effort” (Algaoud and Lewis 2007, p. 39 ). The prohibition of maysir is to be found in the Holy Quran in many verses, for instance, ‘O you who believe! Khamr, Maysir, Ansab, and Azlam are a filth of Shaytan’s handiwork. So avoid that in order that you may be successful’(Holy Quran, 5:90). In this context, any form of gambling is forbidden in Islam, as it is based on hazards and speculation. Moreover, it is against the concept of fairness in Islamic law (Algaoud and Lewis 2007, p. 39 ). Therefore, Islamic banks are not allowed to engage in any gambling games, lotteries, disproportionate prizes as well as conventional insurance (Ayub, 2007, p. 76). The other type is gharar, which literally means “risk” or “deception”( Visser 2009, p. 45). This ban implies that both commercial parties should have a fair deal and to be aware of the real counter value of the business transaction. Professor Mustafa Al-zarqaa defined the forbidden gharar as ‘the sale of probable items whose existence or characteristics are not certain, the risky nature of which makes transactions akin to gambling’ (Abl-rahman 2010, p.43). 14 | P a g e
  • 29. Islamic Banking : An Introduction & Overview In fact,the ban on gharar was not explicitly mentioned in the Holy Quran, however, it is against the Quranic terms of fairness and contract information disclosure (verses 6:159, 17:35, 83:1-6 ) (Abl-rahman 2010, p.43). The condemnation is mainly relied on the Ahadith (the sayings - and doings - of the Prophet) which condemn the sale of the “uncertain outcome”. For instance, ‘the sale of the birds in the sky or the fish in the water’ and ‘ the sale of the unborn calf in his mother’s womb’ (Visser 2009, p. 45). The latter cases dealt all with the risk of uncertainty and/or the risk of deception. Avoiding risk in contracts is indeed impossible, since the risk margin cannot be avoided. Therefore, Muslim scholars separated between excessive gharar which violates the contract, and minor gharar which cannot be avoided (El-Gamal 2006, p.58). Professor Al-Darir identified significant reasons for a forbidden gharar (El-Gamal 2006, p.58). First, the risk of uncertainty must be extremely high, in other words, cannot be anticipated. Second, it must affect a financial contract between two parties (e.g. sales). Finally, if it affects the primary components of the sales contract (e.g. the price or object of sale). In this regard, selling a pregnant cow with a higher price is permitted, whereas selling unborn calf in his mother’s womb is forbidden. In the latter case, a primary object of the sales contract does not exist yet; therefor, it encounters a great risk . Typical gharar contracts examples in the modern economy can apply for the book-out contracts. In the latter type, the customer purchases and sells the asset without any physical ownership or possession. This applies for commodities and stocks in foreign exchange markets, which involves excessive speculative activities. The majority of Muslim scholars rejected the concept of these contracts as well as the concept of unknown risk ( the case of conventional insurance) (Ayub, 2007, p. 144; Algaoud and Lewis 2007, p. 40 ). 2.6. Halal and Haram concept As previously discussed, Shariah rules promote ethical manners, mainly in business activities. Thus, all the financial products and investments must be in the context of “ethical investment” (Algaoud & Lewis, 2007, p. 39). The commonly 15 | P a g e
  • 30. Islamic Banking : An Introduction & Overview used terms when describing the situation of transactions or activities, are halal for permitted actions and haram for forbidden actions. Accordingly, both investors and financial institutions are not allowed to deal or invest in any type of haram business. For instance, ‘alcohol, tobacco, pork, pornography, gambling, illegal drugs, and other harmful products’ (Samad, et al., 2005, p. 74). Moreover, the main concern is to satisfy the factual needs of the Muslim society. In this regard, Producing and marketing of the luxury goods over the essential goods and services such as clothing, health and education is rejected from the Jurisprudence point of view (Algaoud & Lewis, 2007, p. 39). 2.7. Zakat According to the Islamic faith, Allah owns all wealth and property (Holy Quran, 31:26), private property is given by Allah’s trustee to people in order to achieve integration and prosperity in the community (Abl-rahman 2010, p. 32). Justice and equality in the society are major concerns in Islam, everyone should have equal rights, irrespective of their positions, rich or poor (Algaoud & Lewis, 2007, p. 40). Accordingly, Islam designed a new system called “Zakah” which allows a fair transfer of wealth from the rich to the poor. Zakah literally means “purity”and “cleanliness” (Visser 2009, p. 27), it is considered to be one of the five pillars of Islam (Appendix 1.3), which guarantees a fair redistribution of wealth (Algaoud and Lewis 2007, p. 40). It is an obligation for every adult Muslim to pay a percentage of 2.5 per cent on any assets held for one year if it reached a specific agreed amount of money ( nisab in the Arabic language) (Algaoud and Lewis 2007, p.40). Islamic banks are obligated as well for paying zakah in addition to regular income taxes. In consequence, the proceeds from the bank and individuals are to be transferred to special zakah funds established by each bank (Samad, et al., 2005, p. 74). 16 | P a g e
  • 31. Islamic Modes of Finance 3. Islamic Modes of Finance Apparently, there is no difference in the concept of funding in both Islamic and conventional banks, whereas, the main purpose is to generate profits. However, Islamic financial systems are governed by Shariah rules which imposes main restrictions on the financial products. Most significantly, the rejection of “making money out of money” concept, as it is considered a medium of exchange, which has no value in it (kettle 2010, p. 7). In addition, the rejection of the predetermined “fixed return” concept (kettle 2010, p. 5). Islamic economists have developed special financial techniques with regard to Shariah. The techniques are divided into two main groups (kettle 2010, p. 24-25). The first group is the“profit and loss share contracts”, where the bank invests with another partner in a certain business and shares profit and losses (based on the mode of finance). This type is used normally for equity finance. The second group is the “deferred sale contracts” (also known as markup), this technique is similar to the conventional debt-financing schemes. Whereas the customer purchase a commodity from the bank with an agreed mark-up percentage to be paid in periodical installments. The following sections will briefly examine the two groups in practice with a focus on the main Shaiah-compliant products (the most popular). It is worth mentioning that some of the following products can be named differently in other literature; however, there is no difference. 3.1. Profit -and -Loss Sharing Instruments PLS instruments are simply based on equity-finance modes. In fact, they represent the ideal forms of finance with regard to Shariah. In PLS contracts, the capital provider and the borrower share not only profits but also losses with an exception in some cases (Visser 2009, p. 53). The most common techniques under this method are “Mudaraba” and “Musharaka”, as presented in the following sections. 17 | P a g e
  • 32. Islamic Modes of Finance 3.1.1. Mudaraba Mudaraba is a form of business agreement between two parties, the capital owner and the entrepreneur. The capital owner (also called rabb al-mal ) provides the needed capital, while the other party, the entrepreneur (mudarib) brings the knowhow and the labor needed for the project. In fact, mudaraba is a form of sleeping partnership, in other words, the capital provider does not have the right to interfere in any of the management decisions. However, the financier has all the rights to guarantee that his money is well managed and invested properly. Islamic banks use this technique as a term of finance, where the bank acts as “rabb al-mal” and the agent as “mudrib” (figure 4). Profits are shared based on a pre agreed ratio, in contrast, losses are endured just by the capital provider (kettle 2010, pp. 36-37). In the latter case, the main cause is that according to Shariah ‘one cannot lose what he does not contribute’(Visser 2009, p. 54). There are two types of mudaraba, “Al Mudarabah Al Muqayyadah” (restricted mudarabah) and “Al Mudarabah Al Mutlaqah” (unrestricted mudaraba) (Usmani 2002, pp. 98-99). Under the restricted Mudaraba, the capital provider (rab al-mal) has the right to choose a specific agent (mudarib) with a specific type of business. In contrast, under the unrestricted mudaraba, the agent is free to launch any type of business, however, there are several restrictions governing the rights of the owner. For instance, engaging other mudarib in the business and/or mixing the investment with others without permission from rab al-maal. 18 | P a g e
  • 33. Islamic Modes of Finance Customer (Mudarib) Know-How Business Activity Kmk;lk; Kmk;lk; Islamic Bank (Rab-al-mal) Kmk;lk; Negative e.g. 60% from profits e.g. 40% from profits Outcome Positive Figure 4 Mudaraba Model (iFIS, n.d.) 3.1.2. Musharaka Musharaka is a form of financial partnership, where two parties or more agree on launching a set of business, in order to generate profit. Unlike mudaraba, the parties contribute either with equity or labor together, in other words, it is a similar form of a joint venture where the parties have the same rights. Accordingly, they share both profit sand losses based on the equity contribution (Visser 2009, pp. 55-56). Another type of musharaka is “Diminishing Musharaka” which was developed recently. This mode of finance is used mainly in financing the various types of fixed assets. Under this scheme, both financier and client are participating in the ownership of certain asset with a predetermined equity percentage. The share of the financier is split into a number of units, and the client will purchase unit after unit periodically based on a former agreement. In this sequence, the share of the financier will decrease, whereas the share of the client will increase until he acquires all financier’s shares (became the ultimate owner of the asset) (Usmani, 2002, p. 108). For further understanding of the mechanism, an example of diminishing musharaka model from Ayub ( 2007, p. 341) will be explained. Under the latter 19 | P a g e
  • 34. Islamic Modes of Finance model, the Islamic bank will finance a house for a client; both parties agree on the equity percentage, as 20 percent for the client and 80 percent for the bank (figure 5). The finance duration is 10 years with 7 percent as a return rate (benchmarked). The bank will lease his share (80 percent) to the client for a return of 7 percent, in addition, the bank’s share is divided into 120 equal units (equal to the number of months). The client will have to pay monthly payments divided into two parts, firstly the rental payment, secondly, an amount of one share. Under this process, the rental payment will decrease each month as the bank’s share is decreasing. At the end of the ten years, the financier’s shares will be fully purchased by the client, and in consequence, the client will become the owner of the house. Islamic Bank Payments to increase Customer ownership 20% of the payment 80% of the payment Asset Figure 5 Diminishing Musharaka Model (Own illustration) Even though it seems that interest-based and PLS systems are looking alike, there is a significant difference between their mechanisms. Under the latter system, there is no fixed yield, or maybe there is no yield based on the profit, whereas, under the former there is a fixed yield translated into a form of a predetermined interest rate. Moreover, PLS systems represent a physical share of profits and losses, which indicates a strong concern from the both sides in terms of project profitability. In contrast, the interest-based system is just concerned about the default of the loan, in other words, the periodical interest payment regardless of the profit or loss of the other party. For this and other reasons, Scholars asserted that PLS contracts aim to develop and sustain the financial market, as it 20 | P a g e
  • 35. Islamic Modes of Finance encourages banks to focus more on long term projects instead of the short term lending techniques. In addition, banks will be obliged to monitor the ongoing projects with its clients as it became a real partnership and not equity finance. Indeed, this will increase the overall cost; however, it will develop the investments in the financial markets (Mirakhor & Zaidi, 2007, pp. 49-50). 3.2. Deferred Sales Contracts The second financing technique is the “Deferred sales contracts”, this type is accepted by the Islamic jurists and widely used by the different Islamic banks. These contracts are based mainly on selling an object with a markup percentage (as a compensation to the seller ), which will be paid back in the future in a form of periodical installments. The main contracts for this type are “Murabaha”, “Salam”, “Istisna’a” and “Ijara”( Kettell 2010, p. 24). These instruments will be successively discussed in the following sections. 3.2.1. Murabaha Murabaha is derived from the Arabic word ‘ribh’, meaning profit. It is a commonly used instrument by the Islamic financial institutions. In Islamic banks, murabaha is a trade contract between the bank and the client, where the bank purchases a certain good from a third party and resell it to the client with a markup margin. murabaha contracts are commonly used for the financing of ‘machinery, consumer durables, trade supplies and means of transport’ (Visser 2009, p.57-58). In fact, there are two types of murabaha. Under the first type, the bank purchases the assets/goods and makes them available for sale. Similarly, the second type, also called “ Murabaha to purchase order”, the bank purchases the asset on behalf of the customer based on an agreed promise. The most important concept in this formula is that the bank commits to reveal the original cost of the purchased goods to the client. In addition, both parties must agree on the mark-up margin (figure 6) (Kettell 2010, p. 26-27). In fact, Banks commonly use the London interbank offered rate (LIBOR) as an indicator for the mark-up percentage (Visser 2009, p. 57). 21 | P a g e
  • 36. Islamic Modes of Finance ownership transfer to the customer Ownership transfer to the bank Seller Payment of the purchase price Islamic Bank Payment of the purchase price + profit margin Customer Kmk;lk; Kmk;lk; Figure 6 Murabaha Model (iFIS, n.d.) In fact, It can be seen that the respective model operates similarly as the interestbased model, however, several reasons contradict this argument. First, the markup margin is for a service done by the bank (intermediary service), which stands for a certain effort. Second, in contrast with the interest based model, the mark-up is a pre-agreed ratio which not linked to a certain time factor. Therefore, it will not increase if the customer fails to pay in the case of deferred payment. Finally, all risks which might occur before the possession by the customer will be borne by the bank, as he is the owner of the goods (Mirakhor & Zaidi, 2007, p. 52). 3.2.2. Forward Sales: Salam and Istisna‘a According to Shariah, there are basic terms govern any sales contract and prevent any occurrence of gharar. First, The commodity must exist at the time of the sale. Second, the commodity must be owned by the seller at the time of the sale. Finally, after the execution of the contract, there must be a physical transfer of the commodity’s ownership from the seller to the buyer as well as the associated risks. However, Some contracts do not fulfil all the latter criteria; nevertheless, they are still accepted by the Islamic Shariah (Ayub, 2007, p. 241). The following will discuss two examples of these contracts, which are Salam and Istisna‘a contracts (Ayub, 2007, p. 241). 22 | P a g e
  • 37. Islamic Modes of Finance Bai’salam Bai’salam or salam (also known as forward sale contract) is a trade contract, whereby the seller agrees to deliver a certain commodity in the future with an immediate payment of the buyer. As a result , both parties can benefit from this transaction. The seller covers any liquidity shortage, whereas the buyer gets a cheaper price of the goods, as the price is always cheaper than the market price (Usmani, 2002, p. 126). In fact, Salam has been permitted by the holy Prophet (PBUH) himself under certain terms to prevent any excessive gharar. The main terms are:a specific measure and weigh; a known quality; agreed price with a specific delivery time (Ayub, 2007, p. 242). Bai’salam can be used as a way to finance agricultural products and fungible manufactured goods, as well as for small traders as a form of working capital finance (Visser, 2009, p. 61). On the contrary, salam finance is not permitted in the case of gold, silver, and currency trading (Ayub, 2007, p. 244). In practice, the Islamic bank acts as the ultimate buyer (the financier) and the client as the seller. In this sequence, the Islamic bank can practice salam finance in two ways. Firstly, the banks can get a promise from a third party to purchase the commodity with a predetermined price. In this respect, the bank pays a full payment for the first seller, later on when the bank receives the commodity, he will deliver it to the third party with a higher price (figure 7). Alternatively, The bank can enter a parallel salam contract. Parallel salam is two independent contracts which are not linked to each other, whereby, the bank acts as a buyer in the first one and a seller in the other one. In this case, the bank delivers the received goods from the first contract to the buyer of the second contract with a higher price (Usmani, 2002, pp. 128-129). Indeed, guarantees are important in the case of Salam. Therefore, the bank may ask for a specific security or mortgage which can be delivered to the buyer in the case of default (Kettell 2010, p. 76). 23 | P a g e
  • 38. Islamic Modes of Finance Delivery of the goods on schedule Seller Advanced payment of the purchase price Kmk;lk; Islamic Bank Kmk;lk; Payment of the purchase price upon delivery Delivery of the goods on schedule Customer Kmk;lk; Figure 7 Bai'salam Model (iFIS, n.d.) Ayub (2007, p. 243) argues that Salam contracts are an effective way to stabilize the price in the market as well as protecting both buyer and seller from any speculative transaction. The argument is based on the fact that Shariah prohibits any reselling of Salam contracts before maturity; thus, there will not be any room for speculative actions. Istisna’a Istisna’a is a trade contract whereby the buyer requires the seller to manufacture a specific item for him. In this context, both parties agree on the price and the delivery date. In principle, the item will be manufactured from the seller’s raw material and the payment method can be either lump amount or instalments. Istisna’a is similar to salam contract, as the product does not exist at the time of the contract. However, the payment can be deferred based on the contract agreement, unlike salam (Kettell 2010, p.66). Istisna’a contracts can be used for different modes of finance, for example, house finance, constructing buildings and plants as well as BOT arrangements (Usmani, 2002, p. 134). In theory, both Manufacture (seller) and the buyer can go together in a direct istisna’a contract. However, in practice, the Islamic bank takes over the mediator 24 | P a g e
  • 39. Islamic Modes of Finance role by entering in back-to-back istisna’a contract, or Parallel contract. In essence, istisna’a parallel contract does not substantially differs from the salam parallel contract. The bank will first make an agreement with the customer where the customer provides all the details about the desired constructed item and the payment method, either lump or installments. Upon approval, the bank simultaneously enters a second agreement with the supplier, or the manufacture. The desired specification from the customer will be handed to the manufacture by the agreed date, and the bank will pay the manufacture directly all the cost. Upon completion of the constructed item, the bank will deliver it to the customer as agreed, then the customer will pay the agreed price based on the agreed method (figure 8). The bank will profit from the differences between the two contract prices (Kettell, 2010, pp. 67-68). Delivery of the goods on schedule Manufacturer Advanced payment of the purchase price Islamic Bank Kmk;lk; Payment of the purchase price upon delivery Delivery of the goods on schedule Customer Figure 8 Istisna'a Model (iFIS, n.d.) Kmk;lk; 3.3. Ijarah - Leasing Ijarah is one the major financial schemes in the Islamic financial system. The term is permitted by the majority of Islamic scholars as it was viewed in both the Quran and the Sunnah. Literally, ijarah is derived from the Arabic word “al-‘Ajr” which means compensation (Ayub, 2007, p. 279). Ijarah or leasing is a contract 25 | P a g e
  • 40. Islamic Modes of Finance between two parties, the lessor and the lessee, where the lessor transfers the usufruct (the right to use) of a particular asset to the lessee for an agreed periodical rent amount (Kettell, 2010, p. 54). The latter is the first type of ijarah, where the transaction is based just on the transfer of the usufructs of a certain asset. This type is similar to the operating lease in the modern finance, however, ijarah is based on shariah principles (the prohibition of Riba and Gharar). Under this ijarah type, The bank (lessor) will purchase the required item for the client (lessee) directly from the supplier and lease it back to the client after adding a profit margin. All risks associated with the ownership of the asset shall be borne by the bank during the time of the contract,. Upon the end of the lease contract, the bank will retrieve the asset again (Kettell, 2010, p. 55; Ayub, 2007, p. 289). In order to determine the profit margin, The Islamic bank can use LIBOR interest rate as a benchmark (Usmani, 2002, pp. 140,145). There is another type of ijarah similar to the conventional finance lease. This type is called “Ijarah Wa Iqtina”(leasing and promise to gift) (Usmani, 2002, p. 151). Under this type, the agreement between the lessor and the lessee is similar to the normal ijarah, however, the lessor is obliged to transfer the ownership of the asset at the end of the lease period (figure 9). In practice, the bank amortizes the cost of the asset, in addition to a profit margin over a certain period (based on an agreement between the two parties), in a way that he receives the principle and transfer the asset to the lessee at the end of the lease period (Ayub, 2007, pp. 289,291-292). Ownership transfer under “Ijarah Wa Iqtina” Ownership transfer to the bank Payment of the purchase price Seller Kmk;lk ; Lease payments Islamic Bank Kmk;lk; Customer Kmk;lk; Figure 9 Ijarah - Leasing Model (iFIS, n.d.) Both ijarah and Ijarah –Wa- Iqtina are widely practiced by the Islamic banks; several assets can be leased under this mode of finance, for example, aircrafts 26 | P a g e
  • 41. Islamic Modes of Finance building, cars and machinery. It is worth pointing out that the first Islamic lease in the modern history was between the AL Rajhi Banking and investment corporation (ARBIC) and the Bubai-based Emirates Airline, where the former leased the latter an A310-300 Airbus with an amount of $US 60 (Kettell, 2010, p. 61) . 3.4. Qard Hasan Qard hasan is a financial instrument without any intention to generate profit, it means literally “good loan”, and also called a zero-return instrument. Normally, qard hasan is offered as financial assistance for solidarity intentions and social activities. For example, poverty projects and health care projects which mostly run through governments in the Muslim countries. In fact, qard hasan’s providers are seeking the reward in the hereafter; therefore, there is no intention to make profit out of their deposits. Normally, Full repayment of the loan at the face value is guaranteed by the government (Khan, 2007, p. 294). Islamic financial institutions can also provide qard hasan to individuals; this will be also for social activities and training programs for students who cannot afford studying expenses. For instance, the Islamic development bank offers several academic scholarship programs for students; the repayment of the loan would be in easy installments and after graduation and gainful employment (IDB, 2013). 3.5. Retail Banking: Funding Accounts Retail banking business is one of the major funding techniques for the conventional banks. Recently, Islamic banks adapted the phenomena to offer Islamic retail banking products in accordance to Shairah. The following sections will briefly explain some Islamic retail banking products such as the current, saving and investment accounts. 27 | P a g e
  • 42. Islamic Modes of Finance 3.5.1. Current Accounts The Islamic current accounts are way similar to the conventional accounts. The main benefit from these accounts, is to build an effective relationship with the customer in order to gain his trust and to profit from his/her investments in the future. These types of accounts are held by the trustee of the bank without any interest charges at any level. However, the Islamic bank can charge an administration fee to cover its cost, as well as a penalty fee in case of overdraft. Furthermore, the deposits amount support and strength the bank’s balance sheet in order to meet the regulatory requirements (Millar, 2008, p. 32). The Islamic current accounts are justified by the Islamic Shariah based on the concept of al-wadiah (trust or safekeeping). Wadia can be defined as ‘setting up an agency contract for the purpose of protecting one’s wealth’ (Lewis & Algaoud, 2001, p. 47). In other words, the bank does not have the right to invest these accounts at any type of investment. 3.5.2. Saving & Investment Accounts Both conventional and Islamic saving and investment accounts are equal in their nature, but are way different in their mechanism. Under the Islamic saving accounts, the bank guarantees a full repayment of the deposits’ nominal value with a small return (based on the applied method ). Whereas under the investment accounts, the full repayment of the deposits’ nominal value is not guaranteed, and the return is higher. The return on the both former types of deposits is not fixed; otherwise it would endure a sort of riba transaction such as in the conventional system. The Islamic saving accounts can operate under several methods. The first method is according to al-wadiah principle (please refer to 3.5.1.), under this scheme the bank invests the deposits in a Shariah complaint business with a pre-permission from the depositors. In return, the bank guarantees a full return of the value with a shared profit. The second method is to deal with the saving deposits as a qard 28 | P a g e
  • 43. Islamic Modes of Finance hasan ( please refer to 3.4.) from the depositors. The third method is to deal with the saving deposits as investment deposits, in other words, the depositors will permit the bank to invest their deposits in an investment pool, and they will agree to share profits and losses on the basis of mudaraba (Lewis & Algaoud, 2001, p. 47). The Islamic Investment accounts are subjected to al mudaraba al mutlaqa principles (please refer to 3.1.1.), as its main purpose is to earn profit. The mechanism is similar to the third method of the saving accounts (illustrated above), however, other requirements will apply such as higher fixed minimum amount, longer duration of deposits and most importantly the possibility of losing some funds in case of loss occurrence (Lewis & Algaoud, 2001, p. 47). 3.6. Sukuk The Islamic capital market has grown expeditiously after the 1990s; it started in the GCC region and spread across Europe and Asia. Several products have been introduced as an alternative to the conventional financial instruments; indeed, the new Islamic products had attracted the worldwide investors. The most famous type of these Islamic instruments is the Islamic bonds, or sukuk. The new sukuk market has been the fastest growing market after Islamic banking. Sukuk refers to ‘certificates of equal value representing undivided share in ownership of tangible assets of particular projects or specific investment activity, usufruct and services’ (Ayub, 2007, p. 494). At the end of 2012, the value of the outstanding global sukuk recorded $229.4 billion. The latter number has increased due to the new issuances by $131.2 billion (figure10 a). The GCC countries, as well as Indonesia have been the major players in the growth of the sukuk primary market (figure10 b). In fact, it is expected that the demand for sukuk will grow by significant numbers in the next decades (ECB, 2013, pp. 20-22). Sukuk were developed by Shariah scholars as a substitute for the conventional bonds. In essence, Shariah does not reject the idea of bond investment itself; however, the rejection is related to its mechanism, as it relies mainly on interest 29 | P a g e
  • 44. Islamic Modes of Finance rates. Equally important, the investor does not care about the company that owns this bond, as he cares more about the profit. In consequence, the investor might invest in a company which produces any products related to haram activities (please refer to 2.6.). Figure 10 Sukuk issuance (ECB, 2013, p. 21) In contrast, the mechanism of the Islamic sukuk is based on ‘the exchange of an approved asset (for example, the underlying assets could include buildings, hire cars, oil and gas pipelines and other infrastructure components) for a specified financial consideration’ (Mirakhor & Zaidi, 2007, p. 53). In this regard, Islamic sukuk are based on the several Islamic financial contracts such as mudaraba, murabaha, ijara, etc.. The following section will briefly explain the mechanism of the most famous and important type of sukuk, ijara sukuk . 3.6.1. Ijarah Sukuk This type of sukuk has gained wide acceptance in the market among both scholars and investors. Several governments and corporate entities have used this type as a strategy to raise funds, as well as for long-term project finance. Its mechanism is based on the ijarah finance contract (please refer to 3.3.), in which the structure is based on three parties (figure 11), the originator (beneficiary), the special purpose 30 | P a g e
  • 45. Islamic Modes of Finance vehicle (SPV) with an independent legal structure, and the investors (sukuk holders) (Ali, 2005, p. 3). Figure 11 Structure of a generic ijarah sukuk (Ali, 2005, p. 5) For better understanding of the mechanism, an example from Mirakhor & Zaidi ( 2007, p. 54) will be illustrated. A corporation wants to raise funds with $50 million for the purchase of a piece of land. The corporation (originator) starts the process through the SPV by issuing sukuk with small denominations (e.g. $10000 each) totalling $50 million. In this respect, the corporation transfers the ownership of the land to the SPV, which will then securitize the asset by issuing certificates to the investors. Consequently, the investors became the real owners of the acquired asset. The funds generated from the sales proceeds will then be transferred to the SPV and further to the corporation. The asset now is leased back to the originator, in other words, the investors became the lessor, whereas the corporation became the lessee. Afterwards, The rent proceeds from the originator is divided between the investors through the SPV. Apart from GCC sukuk market, sukuk had penetrated the western capital markets as well. Germany was the first European country to introduce Ijarah sukuk to the 31 | P a g e
  • 46. Islamic Modes of Finance Western market. Saxony-anhalt issued the first ijarah sukuk in 2004 by total amount of €100 million. The respective sukuk were designed to target investors from gulf area as well as from Europe. Finally, 60 percent of the issue was acquired by investors from Bahrain and the UAE, the remaining 40 percent were acquired by investors in France and Germany. The sukuk amount was fully redeemed in 2009 (ECB, 2013, p. 26). 3.7. Takaful The need for insurance coverage by individuals and institutions arose over time. It became the only way to mitigate the several types of risks associated with their wealth and lives. Despite the fact that, the conventional type of insurance is rejected from the Shariah point of view, the IFIs had to find other alternatives in order to fulfil this needy gab. The new Islamic insurance (Takaful) system has been developed over several decades in accordance with Shariah principles. Currently, large number of financial institutions are providing the service with wide acceptance from customers in the Muslim communities (Ayub, 2007, p. 417).The following will briefly discuss the new scheme and its mechanism; furthermore, it will highlight the main differences between takaful and conventional insurance system. Takaful industry which started in Sudan in 1979 has evolved over decades to spread across the Arab and Muslim countries. The rapid growth and success in the Muslim countries made it an attractive investment for the western world as well. Several non Muslim countries started to launch takaful in their countries, such as Germany (Hannover-Re entered both Takaful & re-Takaful insurance in 2007 & 2010 respectively), Britain (the establishment of Salam insurance in 2008) and Switzerland (Swiss-Re in 2009) (E&Y, 2012). According to Halim (2012), The main takaful business is to be found in the GCC region and southeast Asia. Saudi Arabia considered to be the largest takaful market with approximately US$4.3 billion and 51.8 percent of the whole industry. Malaysia contributes with US$1.4 billion while UAE contributes with US$818 32 | P a g e
  • 47. Islamic Modes of Finance million. In addition , Sudan is the main player in Africa with contributions of US$363 million. The Ernst & Young takaful report 2012 shows a relatively lower increase with 19 percent in 2011 in comparison with 2010 in the takaful business. Nevertheless, the industry curve continues to grow with a double digit as in figure 12. Figure 12 The global gross Takaful contributions (E&Y, 2012) The new insurance Scheme differs substantially from the conventional insurance in terms of concept and mechanism. Khan & Coopers (2008, p. 23) define conventional insurance as ‘an agreement whereby an insurer undertakes (in return for the agreed premium) to pay a policyholder a sum of money (or its equivalent) on the occurrence of a specified event’. Even though that Islamic Shariah does not reject the idea of risk mitigation, the rejection of the conventional insurance has been debated between Muslim scholars for other reasons (Hussain & Pasha, 2011). The rejection is based on the idea that conventional insurance involves all prohibited transactions; this includes riba, maysir and gharar ( please refer 2.3. & 2.4.) (Visser, 2009, pp. 102-104). With regard to the involvement of riba, it is directly involved as a result of any excess between the amount of paid premiums and the sum insured, moreover, it is involved indirectly as the insurer normally invest the money in an interest-based business. Concerning gharar and maysir, 33 | P a g e
  • 48. Islamic Modes of Finance the uncertainty about the subject matter involves a high degree of risk, for instance, in life insurance whereby the policyholder receives a sum of money in case of death, this is seen by scholars as a sort of gambling as well as gharar (Ayub, 2007, p. 419). On the contrary, takaful system is based on the basis of Islamic principles which promote solidarity and mutual cooperation (Ayub, 2007, p. 421). Under the takaful system, policy holders can share both profits and losses. This idea is based on the concept of donation rather than investments, ‘whereby policy holders agree to pool their contributions and share the liability of each policyholder. So if one policyholder has to be paid a claim, this is paid out of the combined pool’ (Khan & Coopers, 2008, p. 129).Thus, the new system has eliminated any sort of gharar and/or gambling as it became risk sharing system under a voluntary contribution (Visser, 2009, p. 105) . Several models of takaful have evolved over time, the commonly used models by the IFIs are : Wakalah4(practiced mainly in the Middle east), mudaraba (practiced mainly in Asia), waqf (a kind of endowment) or wakalah with waqf (Ayub, 2007, p. 423) . For further understanding of the mechanism, an example of mudaraba model from Akhter (2010, pp. 3-4) will be explained. The takaful mudaraba model is based on the principles of mudaraba contract (please refer to 3.1.1.), where participants act as rab-almal who provides capital and the takaful operator acts as mudarib who provides expertise and know-how. The takaful fund under this model is divided into two accounts (figure13), the first account called “Participants Account” (PA) where the majority of the participants’ contributions is deposited. The second account called “Participants Special Account” (PSA) where small portion is deposited and used to pay claims and underwriting costs (risk management account). The contributions from the participants are divided between the two accounts with a higher percentage to PA 4 Wakala: the term means agency and refers to the absolute power of attorney where a representative is appointed to undertake trasactions on another person’s behalf (Kettell, 2010, p. 232) 34 | P a g e
  • 49. Islamic Modes of Finance over PSA (as in figure13, 80 percent and 20 percent respectively). Both accounts are invested in Shariah based instrument(s), in case of surplus after deducting any claims, both of the participants and operator share the profit based on a pre-agreed percentage. On the other hand, in case of loss which exceed the amount in the PSA, the loss is borne just by the participants and not by the operator. In this context, shareholders can provide a form of qard hasan (please refer to section 3.4.), in order to compensate the loss. In fact, several scholars have criticized the mechanism of the several takaful models. For instance, In the case of mudaraba model, neither the participant’s nor the operator has the right to profit from a donated contributions, as it is a form of tabaruu ( voluntary donations). While according to Shariah, the nature of tabaruu is not complying with profit purposes (Akhter, 2010, p. 15). However, the different issues from some scholars do not affect the business, as it is approved from the wide variety of scholars from the different fiqh schools. In addition, the business of each takaful organization is monitored by an independent SSB. Figure 13 Takaful Mudarbah Model (Akhter, 2010, p. 4) 35 | P a g e
  • 50. Corporate Governance In Islamic Banks 4. Corporate Governance In Islamic Banks The need for governance arose over time as a result of the separation between management and ownership. Nienhaus (2007, p.128 ) stated that ‘[t]he core issue of governance of a corporation is how to ensure that managers will use a company’s resources in the interest of the shareholders’. In the banking sector, governance differs than other sectors. The root cause is that information asymmetries between insiders and outsiders are relatively hard due to the nature of the business (risky business). In conventional banks, depositors (financiers) share part of the risk with shareholders, especially in the case of insolvency, which can be hedged by typical insurance schemes (Nienhaus, 2007, p. 128). On the contrary, in Islamic banks, depositors bear higher risks comparing to conventional banks. The reason is in the mechanism of the Islamic deposits, which differ substantially from conventional deposits. According to Islamic banking principles, deposits (saving and investment accounts) are subjected to mudaraba rules (please refer to 3.5.), in other words, the principal amount is not guaranteed for full repayment . Therefore, depositors and shareholder are likely to share an equal risk (Nienhaus, 2007, p. 129). For these reasons, the corporate governance in Islamic system is different from the conventional system. In Islamic Banks, Stakeholders’ confidence is a major aspect for the success of the business; thus, the bank must gain trust of its stakeholders and customers. In particular, they must be assured that all products are compliant to Shariah rulings (Grais & Pellegrini, 2006). Hence, IFIs tend to pursue an independent ‘legitimate control body’ in order to supervise the business from a religious point of view, which is known as the Shariah Supervisory Board (SSB) (Rammal, 2006). The following sections will discuss the governance and the compliance structure of the Islamic banks. The first section will discuss the SSB and its main duties, moreover, it will highlight the main constraints facing the SSBs in the western 36 | P a g e
  • 51. Corporate Governance In Islamic Banks world. The second section will highlight the main Islamic international organization, additionally; it will discuss its major role in setting standards and regulations for the IFIs. 4.1. The Shariah Supervisory Board (SSB) The Shariah Supervisory Board (SSB) (also known as Shariah Committee) is a form of religious supervision in the IFIs. The SSB members are a group of authentic Islamic Scholars who are highly credible in the society. The board undertakes an important role in the process of examining the financial products in order to certify that the issued products are conducted according to shariah principles (Kettell, 2010, p. 102). Almost all the Islamic financial institutions have or deal with a Shariah committee, moreover, the admission of some international Islamic organizations strictly requires an active SSB (Rammal, 2006). Rammal (2006) pointed out in his research regarding the different SSBs that some institutions neither have a Shariah adviser nor a full board. However, they rely on fatwas (religious opinions) issued by the leading Islamic organizations like “Al Azhar” university in Egypt. On the other hand, other institutions (e.g. Meezan Bank in Pakistan) rely on other type of SSB whose members are located in different boards around the world. 4.1.1. Functions and Responsibilities The SSB has several responsibilities regarding monitoring and assessing the business in the light of Shariah. According to Abdul-Rahman (2010, pp. 77-78), the main functions and responsibilities of an active SSB are:  Study and analyze the previous fatawa concerning the current business transactions, in addition, issuing new fatawa based on banking and financial questions.  Supervision of the banking day-to- day operation to insure that Shariah principles are fully implemented. 37 | P a g e
  • 52. Corporate Governance In Islamic Banks  Assist in the product manufacturing process in accordance with developing new products with the banking professionals to increase its competitiveness.  Assist in designing the product manuals which contain detailed procedures for the operation process.  Review and monitor any agreements or contracts related to any conducted business inside or outside the bank to guarantee that they are complying with Shariah.  Participate in the bank’s training programs. In this context, employees learn the main aspects of the Islamic finance principles and the Islamic ethics of business transactions (Fiqh Muamlat). In principle, if the SSB has any doubt regarding a specific product or transaction(s), which might not be fully bound by Shariah, the board will try to find other alternative in order to execute the transaction; otherwise it will not processed. In case of any deception from the financial institution, the board will take a serious action towards the underlying transaction. In this regard, any profit generated from the underlying transaction will be transferred to the charity account, in addition, financial penalty will take place for non-compliance as well as adverse publicity (Rammal, 2006). Equally important, at he end of the financial year, the SSB submits an annual report to the bank’s directors. The report should summarize the board’s opinion over the bank’s business transactions as well as the financial products (AbdulRahman, 2010, p. 78). 4.1.2. The Issue of Fatwa A fatwa (the plural is “fatawa”) is an Islamic religious opinion, which has to be issued by a recognized religious authority, or alternatively by a Muslim scholar whose knowledge is based on wisdom and honesty (Kettell, 2010, p. 205). 38 | P a g e
  • 53. Corporate Governance In Islamic Banks Issuing fatawa is one of the primary roles of the SSB, once a fatwa is issued; it is considered binding and became an authentic guarantee for a Shariah compliant service. However, the process of issuing any fatwa is a bit complicated which endures significant challenges. The reason is that a fatwa is a juristic opinion based on a particular Shariah school, and due to the existence of different Shariah schools , some conflicts might take place. As a result, different debates and disagreements sometimes takes place when developing Shariah compliant products due to the different views in each Shariah school .This lead in some cases to Inconsistency of fatawa (Belder & Sapte, 2008, pp. 186-187). Nevertheless, the CIBAFI (General Council for Islamic Banks & Financial Institutions) sampled about 6000 SSB’s fatawa across different banks, and found that 90% of them were consistent (Grais & Pellegrini, 2006). 4.1.3. Characteristics of The Board Members As one of the main components of the Islams banking structure, SSB members are chosen based on specific criteria. The AAOIF’s Governance standard No. (1) pointed out that the board must contain at least three members, and should have a high expertise members in economics, and/or law, and/or accounting, etc.. Most importantly, the board must not include any influential person from the institution administration or the shareholders (Al-Qattan, 2008). The IFSB (2009, p. 5) has issued guidelines to strengthen the governance structure of the Islamic financial institutions. In particular, it includes a specific criteria concerning the selection of the SSB members in order to ensure a high level of expertise. The main criteria are summarized in the qualification (competence) and independence of the board members. 39 | P a g e
  • 54. Corporate Governance In Islamic Banks Qualification Any SSB member who is responsible for issuing a fatwa is considered to be a mufti5. According to Al-Qattan (2008), such an important role as mutfi requires a high level of qualification on both educational and expertise levels. In particular, he must be a Muslim, adult, pious and knowledgeable person with high capability of Ijtihad (please refer to In addition, he must be an intelligent character, who can interact with different people and deal with cases of cheating and deceiving. Furthermore, he must be cooperative as he should consult with the other members . Equally important, he must be aware of the societal conditions in general and the country condition in particular, for a better understanding of the several fatwa conditions. The IFSB (2009, p. 13) pointed out that the Islamic financial institutions must provide the SSB members with special training programs mainly in the business and financial transactions. In consequence, the member will be aware of any case from the technical aspect as well as the religious aspect. These factors will contribute to a continuous professional development of the board members (AlQattan, 2008). Independence According to the AAOIF’s Governance Standard No. 1, ‘Sharia’a Supervisory Board is an independent body of special jurists in fiqh almua’malat,and can issue fatwas and rulings which shall be binding on the Islamic financial institution’ (Nienhaus, 2007, p. 136). However, the board independence can be affected by its dual rule, as it acts as an auditor and an employee at the same time. In other words, the dual relationship might lead to a possible conflict of interest. The conflict can be represented in a way that the board will not take any strict opinion against a profitable transaction 5 A mufti is one who reports the rule of Allah on His behalf, or he is the one who is capable of knowing the Sharia’a rulings for events with their evidence and who has memorized most fiqh issues. 40 | P a g e
  • 55. Corporate Governance In Islamic Banks (haram transaction ) in order to maintain the profitability curve of the financial institution . Nevertheless, such a risk in practice can be mitigated by the ethical standards of the SBB members. In fact, the SBB members are mostly scholars with high reputation, therefore, such any conflict action would inflict the scholar’s reputation as well as the financial institution. Equivalently, any management intervention in the SSB’s compliance work will negatively affect the stakeholders’ confidence. For these reasons, the dual relation of the SSB is likely not to affect the board’s independence as well as the quality of the competence job (Grais & Pellegrini, 2006). 4.1.4. Shariah Supervisory Boards & Western Regulators There are serious challenges facing the implementation of the SSBs across the western region. Abdul-Rahman (2010, pp. 117-118) stated three main issues facing the implementation of the SSBs in the western countries. 1- In the majority of the western countries, there is a strong separation between church and state across the different sectors. Hence, it is quite sensitive to implement any religious laws at any financial institution, as it might lead to religious discrimination for customers from other religions. 2- The fact that there will be two supervisory boards, where one can be superior over the other, may lead to ultimate conflict. In consequence, it will negatively impact the bank’s safety and performance. 3- The majority of the scholars do not have professional expertise in the banking operation, however, Islamic banks can offer an intensive training for this issue (please refer to Other issues, that some scholars are located in different countries, which is nearly difficult to meet the local challenges. 41 | P a g e
  • 56. Corporate Governance In Islamic Banks 4.2. International Islamic Financial Infrastructure Generally, International Financial infrastructure is essential for an effective legal and regulatory framework. Hence, it was mandatory for Islamic banks to have a set of supporting institutions in order to facilitate monetary and financial policymaking at a national level. Furthermore, to coordinate and develop a set of guidelines and best practices to achieve the financial integration. In the following section, the main Islamic international organisations will be successively discussed. 4.2.1. AAOIFI The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic-nonprofit organization that aims to develop standards in accounting, auditing, governance, ethics and Shariah for the IFIs. AAOFI plays a major role in enhancing the industry’s human resource by providing professional qualification programs. The organization was founded in 1990 and was officially registered in 1991 in the state of Bahrain. The present membership is 200 members from 45 countries including different participants from the Islamic finance industry regionally and worldwide (AAOIFI, 2010). 4.2.2. IFSB The Islamic Financial Service Board (IFSB) is an international Islamic organization started its operations in 2003, and based in Kuala Lumpur, Malaysia. The main objective is to promote the Islamic financial system stability through issuing guiding standards to the different sectors of the financial system including banking, capital markets and insurance sectors. The process is mainly conducted through researches in addition to organizing seminars and conferences with the main market players. Moreover, IFSB participates in developing instruments for efficient operational and risk management. IFSB’s members are gradually 42 | P a g e
  • 57. Corporate Governance In Islamic Banks increasing; the present membership is 187 members including supervisory authorities, inter-governmental organizations and market players (IFSB, 2010). 4.2.3. IDB The Islamic Development Bank (IDB) is an international financial institution and part of the IDB group, it was founded in 1973 and started officially in 1975. The bank plays an important role in the economical and social development of its member countries and the Muslim communities, according to Shariah principles. In this regard, the bank provides financial assistance in the form of loans and equity capital participation for the productive projects in the repective countries. The present membership is 56 countries, the Bank’s head office is in Jeddah in the Kingdom of Saudi Arabia, furthermore, the bank has four regional offices (IDB, 2013). IDB group involves 4 main organizations: The Islamic Development Bank IDB, the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), the Islamic Corporation for the Development of the Private Sector (ICD) and the Islamic Research and Training Institute (IRTI) (Iqbal, 2007, p. 361). 4.2.4. LMC The Liquidity Management Center B.S.C was established in the Kingdom of Bahrain in 2002 (Kettell, 2010, p. 181). The main purpose is to provide liquidity assistance to the Islamic financial institutions. In other words, LMC plays an effective key role in the interbank market by facilitating the surplus funds of the Islamic financial institutions into short and medium term financial instruments. Furthermore, it provides Islamic advisory services as well as sourcing assets from both private and public sectors and transform them to innovative investment instruments (LMC, 2009). 43 | P a g e
  • 58. Islamic Banking & The German Market 5. Islamic Banking & The German Market With approximately 38 million Muslim citizens across Europe (Including Russia & Ex. Soviet Union), Muslims constitute the largest minority in Europe. In fact, the European Muslims Origins go back to several centuries, as they used to live in the Baltic and Balkan countries, as well as Cyprus and Sicily. In Germany, the Muslim population trend increased between the 1960s and 1990s as a result of the foreigner workers' immigration (Farhoush & Schmidt, 2011, p. 236). Currently, Germany contains the largest Muslim population in Europe (approximately 4 million), Moreover, it is the fifth largest economy in the world. For these reasons, Germany seems to be a very potential market for Islamic banking and finance. This chapter will examine the potential aspects of the Islamic banking in Germany as well as the major obstacles facing the business. In this regard, the Muslim population in Germany will be scrutinized as well as its financial behaviour and demands. It will further highlight the main key players in the domestic market. 5.1. Muslims in Germany As Christianity (mainly Protestant and Roman catholic confessions) is the major religion in Germany, Islam represents the second major religion, and the largest minority in the country. In fact, the first Muslims incomers were in the 18th century as a result of military and economic agreement between Germany and the Ottoman empire (Yorulmaz, n.d.). Two centuries after, particularly from 1960s1990s, immigrant waves of “guest workers” started to enter Germany from several Muslim countries. The immigrants from Turkey, Morocco, Tunisia and Yugoslavia, were expected to stay for a limited time, but they could settle down their conditions to stay in Germany and not to go back to their countries. In fact, there was and still a lack of research concerning the Muslim population in Germany. After 11 September 2001, the German government started to take critical steps in order to analyse the structure of its Muslim population. The 44 | P a g e
  • 59. Islamic Banking & The German Market creation of the DIK (Deutsche Islam konferenz), the German conference of Islam, in September 2001, was one of the positive results (Farhoush & Schmidt, 2011, p. 242). The DIK was established in order to create a dialogue between the state and the Muslim citizens, moreover, to eliminate any conflicts and to promote the common ideas and thoughts (DIK, 2010). The first accurate representative study over the Muslims in Germany was conducted on behalf of the DIK and presented to the Federal office for migration and refugees (DIK, 2007). In the context of the latter study, approximately 6000 persons were interviewed from 49 Islamic countries. Indeed, the research was not limited to find the accurate Muslim population number in Germany, the scope was larger to discover education, behaviours and social integration of the Muslim citizens. The estimated numbers of the Muslim population before the study was ranged from 3.1 to 3.4 million citizens, whereas the study finding puts the number between 3.8 and 4.3 in a country with 82 Million citizens. The percentage of Muslims in Germany is between 4.6 and 5.2 percent of the total population. In fact, people of Turkish origin constitute approximately 63 percent of the total Muslim population in Germany (figure 14). The second largest group is people from Southeast Europe by approximately 14 percent, followed by Muslims from South Asia, North Africa and the middle east, which account for 5-8 percent of the Muslim population. People of Iranian origin and other parts of Africa account only for approximately 2 percent, and the minority are Muslims from central Asia/CIS with less than 1 percent. In this context, it is worth mentioning that there are approximately 1.7 to 2.0 million German Muslims. 45 | P a g e
  • 60. Islamic Banking & The German Market Muslim Population in Germany (in percent) Turkey Southeast Europe 13.6 Middle East 1.4 North Africa 1.2 4.6 South/Southeast Asia 1.7 63.2 Iran 1.5 Other Parts of Africa 0.4 Central Asia/CIS Figure 14 Muslims According to Region of Origin (DIK, 2007) With regard to the religious affiliation (figure 15), the majority of Muslims from all origins tend to follow the Sunni faith with approximately 74 percent from all origins, except Iranians who are from the Shiite faith. In addition, there are nearly 13 percent following the Alevi faith and 7 per cent following the Shiite faith. The minority of the Muslims group in Germany are following other faiths like Ahmadi, Sulfis/Mystics, Ibadis and other Muslim faiths. Muslims According to Denomination (in percent) Sunni 7.1 Shiite Alevi 12.7 Ahmadi 1.7 74.1 Sufis/Mystics 0.1 4.0 0.3 Ibadis Other Figure 15 Muslims According to Denomination (DIK, 2007) 46 | P a g e
  • 61. Islamic Banking & The German Market The study further examined the Muslims age structure according to the country of origin, which can provide a clear vision of the different target groups when adopting any Islamic financial products in the future. Figure16 shows a quite large number of children and young adults across the different country of origins. In addition, a relatively high percentage of the group between 25 to 64 years old who are still in the working age. On the contrary, people who are 65 years old and older account for a small percentage ranges between 2 to 4 per cent. Age Structure of Muslims According to Countries of Origin (In percent) Southeast Europe 31.0 Turkey Central Asia/CIS 13.4 23.0 6.4 Iran 17.5 14.7 19.5 26.1 Other parts of Africa Total 0 to 15 years old 10% 48.0 17.1 2.6 3.2 55.4 1.7 10.6 20% 58.7 1.8 16.9 24.8 0% 3.2 49.9 16.6 28.8 0.0 63.2 31.7 North Africa 4.2 70.2 28.0 Middle East 0.6 55.3 23.4 18.9 South/Southeast Asia 55.0 54.8 3.5 30% 16 to 24 years old 40% 50% 60% 25 to 64 years old 70% 80% 90% 100% 65 years old and older Figure 16 Age Structure of Muslims According to Countries of Origin (DIK, 2007) Indeed, it is essential to analyze the different group religiousness. Based on the study, it can be concluded that religion takes over an important role in the life of the Muslim in Germany. However, it cannot apply equally across the respective groups, for instance, a substantial percentage from origins like Iran and central Asia/CIS identify themselves as not particularly devoted or not devoted at all to religion. Nevertheless, the percentage of people who are devoted to religion is relatively high, 36 percent regard themselves as “very strongly religious”, whereas 50 percent are “quite religious”. With reference to the religious activities, one third of the Muslims tend to pray, almost 50% are observing fasting rules and 70 percent are celebrating religious festivals and holidays. 47 | P a g e
  • 62. Islamic Banking & The German Market 5.2. Financial Behavior of the Muslim population in Germany Muslims in Germany as the largest Muslim population in Europe has attracted many researchers to analyze their financial attitudes and behaviour. However, the majority of the researchers had just focused on Muslims of Turkish origin, as they stand for the largest group of the Muslim community (please refer to section 5.1.). Nevertheless, the rest groups which stands for approximately 37 percent of the Muslim population will be neglected. The following section will analyse the financial behaviour of the Muslim population in Germany who are mainly from Turkish origins. 5.2.1. Current Trends Figures and numbers about Muslims with Turkish background indicate a potential target group. According to Chahboune & el-Mogaddedi (2008), Muslims of Turkish origin in Germany accounts for 720,000 households with an average of 3,8 persons. Whereas, the average in the German households is 1.8 persons. In this context, the Turkish average net household income is estimated by €1917, while the average for the German household net income is €2596. Furthermore, Turks tend to save as double as Germans with 18 percent saving rate in comparison with 10 percent for Germans. The saving capacity of the Turks accounts for €2.2 billion with €25 billion as an estimated total Muslim wealth (Nienhaus, 2012). Evers & Jung (Hayen, et al., 2005) conducted a study over the Turkish community in Germany, in order to investigate their financial behaviours and demands. In this regard, the research classified the Turkish community into 4 main generations and highlighted the preference of each generation. The first generation who came to Germany between 1960-1973 as “guest workers”, the rest generations are their children and grandchildren. In fact, the first two generations are likely to preserve their culture and traditional mentality, on the contrary, the third and the fourth absorbed more the German culture equal to their own culture or maybe more. 48 | P a g e
  • 63. Islamic Banking & The German Market Representatives from each generation were interviewed in the course of the respective research, in order to understand their investment preferences. The results indicated that one of the main reasons for saving and investing, is for mutual and solidarity issues (mainly for the first generation). The study further showed that the majority Turks are risk-averse, who prefer to invest in secure investments. This reflected on their investment preferences, which were mainly directed to real estate investments in Germany and Turkey, as well as investments in gold and jewellery. Moreover, a deep interest in long term fixed rate investments. On the other hand, unwillingness for mutual funds and securities investments. In essence, several researches supported the previous analysis, as real estate investment trends recorded an increase from 1.8 percent in 1980 to 7.6 percent in 2001 (Gassner, 2004). Furthermore, Turks deposits in the German banks are between EUR15 and 25 billion (Farhoush & Schmidt, 2011, p. 239). Hayen, et al.( 2005) finding further showed a poor knowledge regarding the various financial products. In fact, language barriers can be the main cause for this problem, as approximately 43 percent of the study sample stated that they would prefer to be consulted in their language. Similarly, Gleisner, et al. (2010) advised in their study over 1000 immigrants in Germany with a Turkish background, that banking products and services should be offered in the immigrants’ native language. Gleisner, et al. (2010) further studied the immigrants’ bank of choice, as a result, host nation's banks (the German banks) tend to be the first choice for the Turkish immigrants over home nation's banks (Turkish banks operate in Germany) and third nation's banks (international banks operate in Germany e.g. Citibank) . The results showed that approximately 76 percent of the respondents had at least one account in a German bank, whereas 20 percent deals with a subsidiary of a Turkish Bank. The last group who deals with a third nation's bank account for almost 4 percent (figure 17). 49 | P a g e
  • 64. Islamic Banking & The German Market Bank Preferences for Muslims in Germany with Turkish Background Turkish immigrants' Bank preferences Home Nation Bank (German Banks) 1% 0% 8% 0% 1% 7% 20% 45% 9% 76% 10% 4% 19% Spakasse/Volksbank Commerzbank Postbank Comdirect Bank Hypovereinsbank DAB Bank Third nation bank Host nation bank Dresdner Bank BMW Bank Home nation bank Deutsche Bank Other Banks Figure 17:Bank preferences for Muslims in Germany with Turkish Background (according to Gleisner, et al., 2010) 5.2.2. Market potential for Shariah-compliant products in Germany Despite the fact that, there is neither a full operated Islamic bank in Germany nor typical Islamic retail banking products or services, the different sectors across Germany have designed special products to attract the country Muslim community (mainly Turks). Different stages have been taken; different marketing campaigns took place across Germany held by Turkish representatives offering materials in the Turkish language. With regard to the telecommunication industry, one of the big companies, E Plus has launched a special mobile service between Turkey and Germany. In the financial service industry, Deutsche bank has offered special branches called “Bankamiz”. The main purpose is to consult Turkish customers in their language as well as offering free money transfer service to Turkey. Other banks such as HypoVereinsbank (HVB) has served customers in Turkey with the cooperation of the YapiKredi bank. Furthermore, Allianz and 50 | P a g e
  • 65. Islamic Banking & The German Market Helvetia have been offering services in the Turkish languages (Farhoush & Schmidt, 2011, p. 240). Based on the above information, as well as the presented trends and figures in section 5.2.1. & 5.2.2, it can be assumed that the German Market appears to be potential for Shariah-compliant products. However, a relatively low number of researchers did not support this assumption. The following will highlight the several researchers' findings regarding the potentiality of the German market with respect to the Islamic banking business. The survey results from Farhoush & Schmidt (2011) has supported the assumption. The study was conducted among 373 Muslim participants from Germany, Turkey, Morocco, and Iran. With regard to the religiousness, the results showed that approximately 70 percent of the participants regarded themselves as “religious practising Muslims”. In consequence, when asking about the banking attitudes (whether following Islamic Shariah or not), more than 50 percent have a deep trust in banks which tend to follow Shariah principles (figure 18). Furthermore, more than 70 percent of the participants confirmed that following Shariah rules (regarding the prohibition of riba and gharar ) is very important. In this respect, It is worth mentioning, that the respective participants are willing to receive lower returns on their investments, in order to be compliant with Shariah (figure 19). Attitude on banks in Germany Answer Scales (1= Agree … 6=Disagree) I trust in banks and finincial institutions more, that follow Islamic principles, than banks and financial institutions, that do NOT follow the principles. 30.8% For me, it is important that my bank in Germany adheres rules and principles of Islam. 23.6% 44.2% 0% 20.0% 17.2% 20% 1 40% 2 3 7.6%5.9% 12.1% 13.0% 7.6%5.4% 12.6% 60% 4 5 80% 100% 6 ` Figure 18 Attitude on banks in Germany (according to Farhoush & Schmidt 2011 (p. 251)) 51 | P a g e
  • 66. Islamic Banking & The German Market Relevance of Shariah compliance and adherence of Islamic Answer Scales (1= Agree ... 6=Disagree) It is very important to me, to obey prohibition of interest. 56.8% 8.3% 3.8% 12.3% 3.0% 15.8% It is very important to me, to obey prohibition of speculation. 54.4% 17.4% It is very important to me, to follow rules and principles of Sharia’a regarding investments. 53.6% 17.2% 0% 20% 40% 1 2 11.5%3.0% 9.7% 4.0% 9.8% 3.2% 13.7% 2.5% 60% 3 4 5 80% 100% 6 Figure 19 Relevance of Shariah Compliance and Adherence of Islamic principles (according to Farhoush & Schmidt 2011 (p. 255)) The study further investigated the anticipated demand, in case of a future existence of Shariah-compliant products in Germany. The analysis showed a potential demand for the several types of investments. For instance, demand for saving accounts will increase from 46 percent to 75 percent, in case of following Shariah principles. Strong effect will hit the Stock investments from 25 percent to 50 percent. Likewise, investments in mutual funds will increase from 25 percent to 52 percent, as well as for other investments. In short, the finding of this study suggests that there is a potential demand for Shariah-compliant products in Germany and that the Muslim community is an attractive target group. On the contrary, The conducted survey results by Evers & Jung (Hayen, et al., 2005) rejected the above assumption. Despite the fact that approximately twothirds of the participants defined themselves as “very religious” or “quite religious”, the majority of them saw that it is not important to hold Islamic investments (figure 20). In addition, less than 1 percent of the participants reported that they currently hold an Islamic investment. Similarly, less than 1 percent plan to invest in such a service in the future. In fact, the negative experience of the so-called “ Islamic holdings” in the 1990s, can be the cause of the previous result. These holdings (e.g kombassan and Yimpas) attracted a quite big number of the Turkish community in Germany estimated between 200,000 to 52 | P a g e
  • 67. Islamic Banking & The German Market 300,000 with investments exceeded €5 billion. At the beginning , the business was quite successful, but it last with a huge loss for both of German and Turkish investors. Importance of Islamic Investments by Religiousness Highly religious 29.1% Rather religious 9.6% Rather not religious 25.5% 16.2% 5.4% 1.6% 16.3% Very important 5.4% 18.4% 4.8% 64.9% 9.7% 91.3% 10.2% 0% 27.3% 53.1% Not religious 1.0% 1.9% 1.0% Total 12.7% 10% 12.5% 14.4% 20% Rather important 30% 4.8% 56.7% 40% 50% Rather not important 60% 70% 6.2% 80% Not important 90% 100% No comment Figure 20 Importance of Islamic Investments by Religiousness (according to Hayen, et al., 2005) On the other hand, Experts such as Zaid el-Mogaddedi (2007) stated that ‘the experience of so-called Islamic holding in Germany must be taken into account when trying to give a correct answer to the question on the market potential for Islamic financial products in Germany’. Mr. el-mogaddedi further argues that this experience has demonstrated the financial power of the Turkish community in Germany. Furthermore, it has indicated a strong willingness to invest in such an Islamic products, if structured and marketed correctly. Mr. Nienhaus (2012) also reported that all numbers and figures about Muslims in Germany indicates a potential market for Islamic Banking; however, the unsolved problems of legal, regulatory, taxation and accounting issues are the main problem (please refer to section 5.3.2 ). To sum up, all figures and numbers about the Muslim population in Germany as well as their financial attitudes and demands indicates a potential market for Islamic banking. There might be a doubt from some researches about the expected demand; however, the issue cannot be determined before structuring the right products which can be marketed efficiently. 53 | P a g e
  • 68. Islamic Banking & The German Market 5.3. Regulatory Framework of The Financial Entities in Germany 5.3.1. Banking Supervision in Germany The strong integration of the financial markets with the gradual evolution of the financial products across the different sectors in Germany has eliminated the typical variances between banking, financial services and insurance business. For instance, insurance companies started to offer banking products; likewise, financial institutions started to develop new products in accordance with insurance companies. Equally important, the electronic business evaluation made the client cares more about the product regardless of its source, whether a bank or insurance company (Engels, 2010, p. 175). For these reasons, creating a single regulator that supervises the different financial businesses including banking, financial service institutions and insurance companies, was a mandatory action. The new entity, the Federal Financial Super-visory Authority (Bundesanstalt für Finanzdienstleistungs-aufsicht – BaFin) was established in 2002, in order to take over the roles of the three former supervisory agencies, the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred), the Federal Securities Supervisory Wertpapierhandel – BAWe) and Office (Bundesaufsichtsamt für den the Federal Insurance Supervisory Office (Bundesaufsichtsamt für das Versicherungs-wesen – BAV). BaFin aims to ensure market stability and to increase both investors and consumers trust in the financial system. Currently, 1.854 banks, 681 financial services institutions, 592 insurance companies, 30 pensions funds, 6069 domestic investment funds and nearly 78 asset management companies fall under the supervision of BaFin (BaFin, 2013). With regard to the banking supervision, both BaFin and the Bundesbank are collaborating together under the financial stability Act (Finanzstabilitätsgesetz – FinStabG). Since January2013, the Bundesbank has taken over the role of 54 | P a g e
  • 69. Islamic Banking & The German Market “macroprudential supervision” in order to identify the dangerous issues and to maintain financial stability. On the other hand, BaFin took over the role of “microprudential supervision”. According to the Banking Act (Kreditwesengesetz – KWG), section 7 (1), The Bundesbank assesses and analyses the financial documentation (annual reports& financial statements) submitted by the financial institutions, in order to evaluate the capital adequacy and risk management procedures. Based on the Bundes Bank evaluation, BaFin decides whether the financial institution took over the appropriate risk measures, and if its risks are covered with sufficient liquidity and capital resources.Finally, the final assessment on all supervisory measures shall rest with BaFin (BaFin, 2013). 5.3.2. Licensing of theIslamic Financial Entities in Germany As previously discussed, Germany with its largest Muslim population as well as its strong economy, assumed to be an attractive market for Islamic Banking business. According to Engels (2010, p. 174), During the past15 years, some parties had opened preliminary talks with the BAKred/BaFin in order to set up an Islamic bank in Germany. The respective parties were both residence Muslim groups and Islamic financial institutions operating in the Muslim countries, who intend to open a subsidiary in Germany. Currently, there is no Islamic bank that operates in Germany, with an exception to the Kuveyt Türk bank, which currently operating with a limited license (still waiting for the full license) ( please refer to 5.4.3 ). In fact, major obstacles are facing the implementation of the business till now; most of the concerns are legal and regulatory issues. The following will highlight the main regulatory concerns regarding the implementation of the Islamic banking business in Germany. 55 | P a g e
  • 70. Islamic Banking & The German Market Regulatory Concerns According to the German Banking Act (Kreditwesengesetz – KWG), in particular section 39, the use of the term ‘Bank’ is just for a credit institution holding a license in conformity with section 32. Section 1 further defines the main transactions which shall be conducted by the credit institution, nine types of banking transactions were listed as follows: 1- Deposit business, 2- Lending business, 3- Discount business, 4- Principal broking services, 5- Safe custody business, 6- Guarantee business, 7- Giro business, 8- Underwriting business, 9- E-money business. Based on the latter criteria, some had argued that the Islamic banking business is not engaged in all of the above transactions. However, such an argument is relatively weak, as the law did not explicitly states whether the bank must fulfil all the above transaction, or must not perform any other type of transactions. Moreover, from commentaries and legal practices, performing at least one or some of the above transactions is enough for qualifying the entity as a bank (Engels, 2010, p. 181). The second major concern relies on the concept of “ investor protection”. In fact, no legal definition was given to the term ‘deposits’, deposits were explained by the Banking Act section1 as the receipt of funds from others regardless of the actual repayment of interest. In this respect, the current accounts in the Islamic banks conform to this definition. However, the investment accounts which are 56 | P a g e
  • 71. Islamic Banking & The German Market subjected to the profit and loss concept can be different, especially in cases of loss. As a result, the principle amount will not be fully repaid, and thus, an essential deposit’s feature will be missing. Dr. Engels, who was interviewed in the course of this research (Appendix 2), has stated that the latter issue of deposits is the main constrain from the regulatory point of view. The reason is that according to the EU regulation, each deposit up to 100,000 euros must be fully protected; otherwise it will be hard to be accepted by the German regulators. However, Islamic banks can still perform deposits business, as not all of its deposits are subjected to mudaraba principles (not guaranteed for full repayment) (please refer to 3.5.1. & 3.5.2.) (Engels, 2010, p. 182). Dr. Engels further argues that the role of the SSB is very important for Islamic banks. However, in some Islamic banks, the SSB can be also included with the board directors of the bank, and it can intervene in the banks’ decisions. The latter concept is rejected in Europe as well as in Germany, as only CEOs are responsible for heading the bank, and any supervisory board can only act as a consultant. Another issue stands against the Islamic business in Germany, is the German respective European accounting, reporting, auditing and monitoring techniques. As the matter of fact that the particular techniques were designed for the conventional financial institutions such as the conventional banks, which cannot be applied to the Islamic Banks. Therefore, there should be a serious amendments in the whole accounting and reporting system, which indeed, hard step to be taken by the European authorities (Engels, 2010, pp. 180-181). When asking Dr. Engels about the solution of these problems, he mentioned that these challenges can be overcome in the future, but it needs time and efforts. Dr. Engels further mentioned that Islamic banks must offer some compromises in order to ease the process as in the case of the SSB. 57 | P a g e
  • 72. Islamic Banking & The German Market Taxation Issues The German tax regulation is also a major challenge facing the Islamic banking business in Germany. In fact, Based on the current taxation system, any Shariah compliant product will be exposed to different types of taxes. In addition, the possibility for any cost efficiencies will be very hard in comparison with conventional banks (Klein, 2012). The following will focus on one of the main taxation problems, “the double taxation treatment”. The double taxation problem is mainly facing Islamic banks across the western countries, particularly, in mortgage finance under murabaha mode of finance. Taking the example of mortgage finance, in the conventional banking system, the bank takes over the role of “external creditor”, where the bank does not acquire the underlying asset at any stage until the final delivery to the customer. In consequence, the underlying process will be taxed just one time (stamp duty tax). On the contrary, Under murabaha finance, in the Islamic banking system, the bank takes over the role of the intermediary between the buyer and the seller. In this respect, two steps will take place. Firstly, the acquisition of the underlying asset from the seller by the bank, Secondly, reselling the asset to the customer (the buyer) with a profit mark-up. In consequence, the latter transaction will be taxed twice (stamp duty tax) at the two steps, which will impose higher costs on Islamic banks (Klein, 2012). Several western countries have tried to solve this problem, in order to attract Islamic banks. One concrete example is the United Kingdom. The UK has taken major steps in terms of tax regulations, in order to ensure that Islamic finance investors have similar tax treatment as conventional investors. For instance, in the case of double taxation issue under the murabaha finance, the legislator considered the latter finance scheme as “alternative finance arrangement”. In this regard, the bank will be subjected to the stamp duty land tax (SDLT) only once at the acquisition step, whereas, in the second step the mark-up will be regarded as deemed interest (Butt, 2012; PWC 2008). 58 | P a g e
  • 73. Islamic Banking & The German Market On the contrary, in the case of Germany, tax regulation is more complicated and would be very hard to accept any changes or amendments. Dr. Engels in the course of this research clarified the latter statement, as the taxation treatment (mortgage tax) is changing from one state to another (e.g. 2.5% in Hessen region, whereas, 5% in Rheinland pfalz region). Hence, this difference can impose higher cost when acquiring expensive assets in different regions. Nevertheless, Ernst & Young has proposed such an intelligent idea which can solve the double taxation issue. Ernst & Young advised that Islamic banks should take over the role of “silent partnership” in mortgage finance. In this respect, the client will be registered in the first stage as the owner, whereas the bank is documented in the next chapter as a silent partner (has all rights to use the underlying asset). Afterwards, at the repayment of the debt, the bank can transfer the juridical title to the client. Under this method, the Islamic bank can offer halal mortgage based on murabaha finance. 5.4. Feasible key players in the German market The Islamic banking business has attracted many German banks over the past decade. Several German banks started to launch the so called “ Islamic window” across the Muslims countries (mainly GCC region). In fact, they have been very active and successful in this type of business. Thus, In case of Islamic banking implementation, these banks can be major players in the market. The following will highlight the main German banks which operate with an Islamic window across the Muslims countries. 5.4.1. Deutsche Bank AG Deutsche Bank AG is one of the leading banks in Germany and Europe, the bank was founded in 1870 with its headquarter now in Frankfurt. According to the Bank’s figures in 2012, the bank has achieved a net profit of approximately 291 million euros wit A+ rating by Fitch and Standard & Poor’s ( Deusche bank, 2013). Over a decade, the bank has been a major player in the Islamic finance 59 | P a g e
  • 74. Islamic Banking & The German Market industry, with sources in different countries mainly in the middle east region as well as in London and Kula Lumpur . In fact, the bank was active in developing innovative Islamic financial products across the different asset classes, liabilities and derivatives. Therefore, it was honoured many times for its outstanding performance with several rewards. For instance, “Best Islamic Trustee/Custodian 2011,2012”, “IPO Deal of the year 2012” as well as “Best Fund Administrator Mutual Funds” and “Best Fund Administrator – Shariah Compliant Funds” in 2013 (Deutsche Bank, 2013). Deutsche Bank owns the DWS, the largest mutual fund in Germany, which ranked among the top 10 in the world. The DWS company with €283 bn assets, considered to be the arm of the Deutsche bank in terms of asset management (Deutsche Asset & Wealth Management 2013). Since 2007, DWS investments have expanded its business in Dubai and Bahrain, to offer a special fund range in compliance with Shariah. The special fund was named as “DWS Noor Islamic Funds” and had various investments in China, Japan and Asia Pacific’s emerging economies. (Deutsche Bank 2006). In short, Deutsche bank has been a major player in Islamic finance in the GCC area, as well as in other regions. The bank expertise in Islamic finance will elaborate to make him a strong player in the German market in case of the business existence in the future. 5.4.2. Commerzbank Commerzbank is one of the leading banks in Germany with approximately 1200 branches across the country. The bank has started to establish a regional footprint in the Islamic finance business since more than one decade. In 1999, Commerz international capital management (CICM), the owned subsidiary by the Commerzbank has launched a new equity fund under the rules of Shariah. “AlSukoor European Equity Fund” was launched with 100 percent focus on the European equities, in order to attract investors from the middle east. In fact, it was only for institutional investors from the middle east area, however, since 2000 it became accessed by private clients in Germany. Commerezbank searched a 60 | P a g e
  • 75. Islamic Banking & The German Market partner for a better sales record,and due to the strong presence in the middle east, the bank had already many contacts with several banks. Finally, the Al - Tawfeek group was selected , a subsidiary of the “Dalla Albraka group”. Indeed, it was a perfect choice as an AL-Tawfeek group managed nine funds from this type before (Geyer, 2002, p. 263). Alsukoor equity fund was monitored by SSB consists of five scholars. The board was strict and working according to Shariah rules without any exceptions. Several incidents occurred where the board refused to invest in some types of business, for instance; the board rejected an approval by the fund manager to invest in Lufthansa airlines as their business is engaged with serving alcoholic drinks (Geyer, 2002, p. 264). Unfortunately, in 2005, the fund had to be closed with just 4 million Euro assets. In fact, the failure of the fund was due to several reasons. Firstly, the fund was targeted to GCC region where real estate investment was the most attracting type and not equity investments. Secondly, it was not well targeted to the German investors. Finally, the negative consequences on the stock markets after the September 11th attacks, was a strong hit to the fund (Chahboune & ElMogaddedi, 2008). Commerzbank continued in the Islamic finance business across the GCC region. Indeed, the bank has been concerned about the sukuk markets, in 2011 Commerzbankbank undertook the role of the joint lead manager for the Kuveyt Türk Bank’s sukuk issuance. The $350 million 5year ijarah sukuk were issued to attract investors across the Middle East, Asia and Europe. Commerzbank presented the issue through its international network , Indeed, the issue was quite successful and was rated at “BBB” by Fitch rating (Commerzbank, 2012). Commerzbank can be also a critical player in this business in the future, especially in the sukuk sector. In case of launching Islamic banking in Germany, The bank experience in Islamic finance will be a major asset for him in the market. 61 | P a g e
  • 76. Islamic Banking & The German Market 5.4.3. Kuveyt Türk Participation Bank The Kuvyet Türk participation bank, a Turkish-Kuwaiti bank, has taken critical steps in order to establish the first Islamic bank in Germany. The proactive bank applied for a full banking licence to establish an Islamic bank in Germany. However, The German banking regulator, the Federal Financial Services Authority (BaFin), has just issued a limited banking licence to the respective bank. In consequence, the bank opened its first branch in Mannheim in 2010 (Farhoush & Schmidt, 2011). The limited licence allowed the bank to collect deposits from investors in Germany to be transferred to a PLS accounts in Turkey (GIF magazine, 2013). The bank has been active across the sukuk markets, the first sukuk issuance was in 2010, KTB has issued a US$100 million three-year sukuk wakalah. The second big issuance was in 2011 as mentioned above, The US$350 five-year sukuk Ijarah were managed by different banks and corporations. According to Mr. Uyan, the chief executive of the bank, the bank is planning to open several branches in Germany, in case of full license issuance. Mr Uyan further stated “We plan to open branches in Germany, and if this model becomes successful, we could consider going to other European countries”. Furthermore, the bank is planning to invest an initial capital of 45 million. The bank is also planning to target the small-medium size enterprises (Sezer & Tuncay, 2012). The bank’s full license application is still under review with BaFin, however, no decision has been taken till now. Dr. Engels stated that the regulatory concerns regarding the deposit taking as well as the role of SSB are the major causes. However, it will be solved in the long run. 62 | P a g e
  • 77. Conclusion 6. Conclusion There is no doubt that Islamic banking is a fast growing industry in the world. The overview presented in chapter 2 reflects a stable growth for the future of this business. This is supported by its new approach in doing the banking business, therefore, it has attracted both Muslim and non Muslim investors. The cause is that investors can earn high profits with lower risks, in comparison with conventional banking. Moreover, consumers now are tending to invest more in ethical products, which could be found in the Islamic banking principles as discussed in chapter 2 and 3. With regard to the German market, the Muslim population in Germany is the largest in Europe, and the second largest minority in the country. The different industries across the country have been trying to target the Muslim population, as they believe that it is a potential group. As discussed in chapter 5, religion takes over an important role in the life of the Muslims in Germany. Nearly two –thirds of the Muslims have identified themselves as devoted to religion. As a result, this will be a positive trend for accepting Shariah-compliant products in the future. Below are the main opportunities as well as the main challenges for the Islamic banking business in Germany. 6.1. Opportunities for the Islamic Banking industry in Germany  The country has the Largest Muslim population in Europe, with a quite large population between 25-64, who are still in the working age .  Muslims with Turkish background account for almost 63 percent of the Muslim population, and represent 720,000 households, with €1917 as the average net salary for the household. In addition, they have high savings in comparison with the Germans, with a capacity of €2.2 billion.  The market is already ready to offer special products to Muslims, as several industries have been designing particular services to the Turkish 63 | P a g e
  • 78. Conclusion Muslims. With regard to the Financial industry, Deutsche bank as well as other banks has already offered private services to the Turkish Muslims (please refer to 5.2.2.).  Results and finding from the conducted researches have shown a keen desire to follow Shariah rules from a higher percentage of the Muslim population.  Several German banks have been running Islamic windows in the GCC region; hence, they had gained wide expertise in the Islamic finance and banking industry.  Indeed, any Islamic bank who will be able to structure the right products for the market, will definitely acquire an appropriate market share (around 5%), away of the competitors.  Launching the business will further tie the trade business between Germany and Turkey as well as the other Muslim countries, Moreover, it will provide funding alternatives for the investors. 6.2. Challenges Facing the Islamic Banking Industry in Germany  The negative experience of the so-called “ Islamic holdings” in the 1990s has negatively affected the customer trust in the Islamic product investments. As a result, Turks in Germany lost their trust in this type of investments, this can be reflected in their trust in the German banks, over home national banks (76 percent have at least one bank account in the German banks, for only 20 percent in the national banks).  The German regulations reject the concept of Islamic deposits (in particular saving deposits), as it does not guarantee full repayment of the deposits’ principle. Therefore, it is against the Investor protection in the EU as well as German regulation.  The role of the Shariah Supervisory board is not compatible with the regulation, as the board might intervene in the banks’ decisions. Equally important is the strong separation between religion and business across the western countries. 64 | P a g e
  • 79. Conclusion  Islamic banks will have a significant problem with the German respective European accounting, reporting, auditing and monitoring techniques. In fact, amending or changing the respective system will be very hard.  The double taxation treatment for mortgage finance has been one of the main challenges, however, the excellent idea of the “silent partnership” by Ernst & Young , has solved this issue. To sum up, the paper has highlighted the main opportunities as well as the main challenges for this industry in Germany. It can be concluded that there is a huge potential for the business in the country, as illustrated in 5.1 & 5.2. The majority of Muslims are keen to invest in Shariah-compliant products. However, the negative impact of the Islamic-holding still an obstacle. Therefore, any Islamic bank must take necessary steps before launching any Shariah-compliant products. Firstly, the bank must change the negative idea about Islamic banking to attract more customers (Muslims and non Muslims). This can be done through implementing different campaigns and conferences across the country, in order to illustrate the mechanism of this new phenomena and the mechanism of the different modes of finance. Equally important, the majority of the latter campaigns should be offered in the customers' native language. Secondly, any bank must understand first the needs of the customers, in order to structure the right products for them. In this regard, the bank must take effective marketing strategies as well as extensive analysis work. Finally, Islamic banks must try to find solutions to settle down all the regulatory issues with the country regulators, in order to start launching the business as soon as possible. Germany as a country still needs to take further steps towards the Islamic banking business, as it will be beneficial for the economy, especially after the European financial crisis. Starting that business in the country will attract more investors who are keen to follow Shariah. Furthermore, it will be the first step to launch other profitable Islamic financial products, such as sukuk, which can further strength the capital market. In fact, German regulators should try to come to a common point with Islamic banks to ease this process. Indeed, The current challenges can be easily solved if the country decided to give this business a 65 | P a g e
  • 80. Conclusion chance. However, Experts are sure that the business will start in the near future and will be indeed positive for investors as well as for the country. 66 | P a g e
  • 81. References References Abdul-Rahman, Y., 2010. The Art of Islamic Banking and Finance Tools and Techniques for Community-Based Banking. New Jersey: John Wiley & Sons, Inc. Akhter, W., 2010. Takaful Models and Global Practices. [Online] Available at: [Accessed 27 September 2013]. Al Baraka, 2013. About Al Baraka. [Online] Available at: [Accessed 12 July 2013]. Algaoud, L. M. & Lewis, M. K., 2007. Islamic critique of conventional financing. In: K. M. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. Ali, S. S., 2005. Introduction To Ijarah Sukuk: Current Structures And Future Prospects.. [Online] Available at: [Accessed 6 October 2013]. Al-Qattan, M. A. A., 2008. Shari'ah Supervisory Boards: Selection of Their Members. [Online] Available at: [Accessed 25 July 2013]. Ayub, M., 2007. Understanding Islamic Finance. West Sussex: John Wiley & Sons Ltd. BaFin, 2013. Financial Stability Act expands cooperation between BaFin and Bundesbank. [Online] Available at: _2013_08_interview_hufeld_dombret_en.html [Accessed 29 August 2013]. BaFin, 2013. Functions & History. [Online] Available at: [Accessed 30 August 2013]. i|Page
  • 82. References Belder, R. T. d. & Sapte, D. W., 2008. Shari’a Supervisory Boards and Shari’a Compliance. In: R. Millar & H. Anwar, eds. Islamic Finance: A Guide for International Business and Investment. London: GMB Publishing Ltd.. Butt, I., 2012. Islamic Finance Tax Considerations Around the World. [Online] Available at: [Accessed 3 October 2013]. Chahboune, J. & El-Mogaddedi, Z., 2008. Kreditwesen, Islamic Bankning- das Marktpotenzial in Deutschland. [Online] Available at: ert.pdf [Accessed 2 September 2013]. Commerzbank, 2012. Kuveyt Turk Bank:A USD350mn 5year sukuk issue in Turkey attracts an international market. [Online] Available at: [Accessed 8 October 2013]. Deutsche Asset & Wealth Management, 2013. Company profile. [Online] Available at: [Accessed 1 September 2013]. Deutsche Bank, 2013. Deutsche Bank Middle East & North Africa, Islamic Finance. [Online] Available at: [Accessed 1 September 2013]. Deutsche Bank, 2013. Facts and Figures. [Online] Available at: [Accessed 1 September 2013]. Deutsche Islam Konferenz, 2007. Muslim life in Germany. [Online] Available at: [Accessed 01September 2013]. Deutsche Islam Konferenz, 2010. What is the DIK? [Online] Available at: http://www.deutsche-islam [Accessed 28 August 2013]. ii | P a g e
  • 83. References el-Mogaddedi, Z., 2007. Islamic Banking in Germany, Islamic Finance News. [Online] Available at: nking091107.pdf [Accessed 2 October 2013]. Engels, 2013. Germany & Islamic banking [Interview] (29 October 2013). Engels, J., 2010. German banking supervision and its relationship to Islamic banks. In: M. F. Khan, M. Porzio & E. Elgar, eds. Islamic Banking and Finance in the European Union. Cheltenham: Edward Elgar Publishing Limited. Ernst & Young, 2011. A new era of customer expectation, Global Consumer Banking Survey. [Online] Available at: [Accessed 22 October 2013]. Ernst & Young, 2012. The World Takaful Report. [Online] Available at:$ FILE/Ernst%20&%20Young's%20The%20World%20Takaful%20Report%20201 2.pdf [Accessed 15 October 2013]. Ernst & Young, 2012. World Islamic Banking Competitiveness Report 2012-2013. [Online] Available at: petitiveness_Report/$FILE/World%20Islamic%20Banking%20Competitiveness% 20Report%202012-13.pdf [Accessed 17 November 2013]. European Central Bank, 2013. Islamic Finance in Europe. [Online] Available at: [Accessed 6 October 2013]. iii | P a g e
  • 84. References Farhoush, A. & Schmidt, N., 2011. Islamic Finance in Germany: Trends, opportunities, and Potential. In: Islamic Capital Markets Products and Strategies. West Sussex: John Wiley & Sons, Ltd. Gassner, M. S., 2004. Regulatory Framework of Germany - Opportunities for Structuring Shari'a compliant Financial Products, s.l.: Harvard Law School. Geyer, R., 2002. Mit Allahs Segen Entwicklung und Marktstellung islamischer Investmentfonds. [Online] Available at: [Accessed 2 September 2013]. Global Islamic Finance magazine, 2013. Germany to welcome Islamic banking. [Online] Available at: [Accessed 8 October 2013]. Gleisner, F., Hackethal, A. & Rauch, C., 2010. Migration and the retail banking industry: an examination of immigrants' bank nationality choice in Germany. The European Journal of Finance, 16, No.5 (Taylor & Francis), pp. 459-480. Grais, W. & Pellegrini, M., 2006. Corporate Governance and Shariah Compliance in Institutions Offering Islamic Financial Services . [Online] Available at: [Accessed 21 July 2013]. Halim, N., 2012. Islamic FInance News Supplements. [Online] Available at: [Accessed 26 September 2013]. Hansen, R., 2003. Migration to Europe since 1945: its History and its Lessons, Oxford: Blackwell Publishing Ltd. Hayen, D. et al., 2005. Migranten und Finanzdienstleistungen, Studie im Auftrag des Bundesministerium für Ernährung, Landwirtschaft und Verbraucherschutz (BMELV), Hamburg: Evers & Jung GbR. Hussain, M. M. & Pasha, A. T., 2011. Conceptual and Operational Differences Between General Takaful and Conventional Insurance. Australian Journal of Business and Management Research, Volume Vol.1 No.8 , pp. 23-28. iv | P a g e
  • 85. References iFIS, n.d. Islamic Finance Glossary. [Online] Available at: [Accessed 12 November 2013]. Iqbal, M., 2007. International Islamic Financial Institutions. In: M. K. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. Islamic Development Bank, 2013. About IDB. [Online] Available at: da906da85e96ac356b7af0 [Accessed 13 July 2013]. Islamic Development Bank, 2013. Scholarship & Assistance. [Online] Available at: 1c15795d5f2450c1099bfb [Accessed 3 September 2013]. Islamic Development Bank, Institute of Islamic Research &Training, International Financial Services Board, 2007. Islamic Financial Services Industry Development - Ten-Year Framework and Strategies. Joint initiative, Kuala Lumpur: International Financial Services Board. Islamic Financial Service Board, 2009. Guiding Principles On Sharī`Ah Governance Systems For Institutions Offering Islamic Financial Services. [Online] Available at: [Accessed 1August 2013]. Islamic Financial Service Board, 2010. Objectives. [Online] Available at: [Accessed 14 July 2013]. Kettell, B., 2010. Islamic Finance in a Nutshell: A Guide for Non-Specialists. West Sussex: John Wiely & Sons ltd. Khan, M., 2007. Islamic methods for government borrowing and monetary management. In: M. K. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. v|Page
  • 86. References Khan, M. & Coopers, P., 2008. Takaful. In: R. Millar & H. Anwar, eds. Islamic Finance: A Guide for International Business and Investment. London: GMB Publishing Ltd.. Khan, M. & Coopers, P., 2008. Takaful vs. Conventional Insurance. In: R. Millar & H. Anwar, eds. Islamic Finance: A Guide for International Business and Investment. London: GMB Publishing Ltd.. Klein, O., 2012. Islamic Finance Tax Considerations Around the World. [Online] Available at: [Accessed 3 October 2013]. Lewis, M. K. & Algaoud, L. M., 2001. Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. Millar, R., 2008. Religious Foundations of Islamic Finance. In: R. Millar & H. Anwar, eds. Islamic Finance: A Guide for International Business and Investment. London: GMB Publishing Ltd.. Millar, R., 2008. Retail Banking: Current and Savings Accounts and Loans. In: H. Anwar, ed. Islamic Finance: A Guide for International Business and Investment. London: GMB Publishing Ltd.. Mirakhor, A. & Zaidi, I., 2007. Profit-and-loss Sharing Contracts in Islamic Finance. In: M. K. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. Nienhaus, V., 2007. Governance of Islamic Banks. In: M. K. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited. Nienhaus, V., 2012. Germany: More talks, little action. [Online] Available at: hid=23351 [Accessed 29 September 2013]. PricewaterhouseCoopers, 2008. Islamic finance – UK tax aspects an extract from UK real estate insights - Issue 10. [Online] Available at: [Accessed 03 October 2013]. Rammal, H. G., 2006. The Importance of Shari’Ah Supervision in Islamic Financial Institutions. Corporate Ownership and Control, 3 (3), pp. 204-208. vi | P a g e
  • 87. References Samad, A., Gardner, N. D. & Cook, B. J., 2005. Islamic Banking and Finance in Theory and Practice: The Experience of Malaysia and Bahrain. The American Journal of Islamic Social Sciences, Volume 22:2, pp. 71-86. Sezer, S. & Tuncay, E., 2012. Reuters, Kuveyt Turk aims to be Germany's first Islamic bank. [Online] Available at: [Accessed 15 November 2013]. The Accounting and Auditing Organization for Islamic Financial Institutions, 2010. About AAOIFI. [Online] Available at: [Accessed 13 July 2013]. The Liquidity Management Center, 2009. Vision & Role. [Online] Available at: [Accessed 15 July 2013]. UK Trade & Investment, 2013. UK Excellence in Islamic Finance. Available at: 791/UK_Excellence_in_Islamic_Finance_2013.pdf [Accessed 19 October 2013]. Usmani, M., 2002. Meezan Bank’s Guide to Islamic Banking.Karachi: DarulIshaat Urdu Bazar. Visser, H., 2009. Islamic Finance Principles and Practice. Cheltenham: Edward ELgar. Wilson, R., 2007. Islamic banking in the West. In: M. K. Hassan & M. K. Lewis, eds. Handbook of Islamic Banking. Cheltenham: Edward Elgar Publishing Limited, pp. 419-432. Yorulmaz, N., n.d. Ottoman Empire and Germany (1871-1908) Militaryeconomic relationship Trade Activities of German Armaments Industry In the Ottoman Market, Berlin: s.n. vii | P a g e
  • 88. Appendices APPENDIX 1 APPENDIX 1.1 The prohibition of Riba in the Quran6 • Surah al-Rum, verse 39 “That which you give as Riba to increase the people’s wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold.” (30: 39) • Surah al-Nisa’, verse 161 “And for their taking Riba although it was forbidden for them, and their wrongful appropriation of other people’s property. We have prepared for those among them who reject faith a grievous punishment.” (4: 161) • Surah Al-e-Imran, verse 130 “O believers, take not doubled and redoubled Riba, and fear Allah so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey Allah and the Prophet so that you may get mercy.” (3: 130) • Surah al-Baqarah, verses 275–281 — “Those who take Riba shall be raised like those who have been driven to madness by the touch of the Devil; this is because they say: ‘Trade is just like interest’ while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to God; but those who revert, shall be the inhabitants of the fire and abide therein forever.” (275) — “Allah deprives Riba of all blessing but blesses charity; He loves not the ungrateful sinner.” (276) 6 These are not the only the versus dealing with Riba in the Quran, Riba was mentenioed explicitly in other versus as well. viii | P a g e
  • 89. Appendices — “O, believers, fear Allah, and give up what is still due to you from Riba if you are true believers.” (278) — “If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.” (279) — “And if the debtor is in misery, let him have respite until it is easier, but if you forego it as charity, it is better for you if you realize.” (280) — “And be fearful of the Day when you shall be returned to the Allah, then everybody shall be paid in full what he has earned and they shall not be wronged.” (281) APPENDIX 1.2 The prohibition of Riba in the Sunnah (Ahadith)7 1. From Jabir (Gbpwh): “The Prophet (pbuh) cursed the receiver and the payer of interest, the one who records it and the witnesses to the transaction and said: ‘They are all alike [in guilt]’.” 2. From Anas ibn Malik (Gbpwh): “The Prophet said: ‘When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually’. 3. Zaid B. Aslam reported that interest in pagan times was of this nature: “When a person owed money to another man for a certain period and the period expired, the creditor would ask: ‘you pay me the amount or pay the extra’. If he paid the amount, it was well and good, otherwise the creditor increased the loan amount and extended the period for payment again.” 7 The Ahadith are according to Ayub (2007, pp. 46-47). ix | P a g e
  • 90. Appendices 4. The holy Prophet (Pbuh) announced the prohibition of Riba in express terms at the occasion of his last Hajj, which was the most attended gathering of his Companions. The Prophet said: “Every form of Riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting Riba. I start with the amount of Riba which people owe to my uncle Abbas and declare it all cancelled”. He then, on behalf of his uncle, cancelled the total amount of Riba due on his loan capital from his debtors. 5. The holy Prophet (Pbuh) said, “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt – like for like, equal for equal, and hand to hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand to hand.” 6. Bilal (Gbpwh) once visited the Messenger of Allah (pbuh) with some high quality dates, the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of that of the higher quality. The Prophet (pbuh) said: “This is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the others.” 7. A man deputed by the holy Prophet (pbuh) for the collection of Zakat/Ushr from Khyber brought for him dates of very fine quality. Upon the Prophet’s asking him whether all the dates of Khyber were such, the man replied that this was not the case and added that he exchanged a Sa‘a (a measure) of this kind for two or three (of the other kind). The holy Prophet replied: “Do not do so. Sell (the lower quality dates) for dirhams and then use the dirhams to buy better quality dates. (When dates are exchanged against dates) they should be equal in weight.” x|Page
  • 91. Appendices APPENDIX 1.3 The Five Pillars of Islam8 1. Acceptance of the shahada or witness of faith which consists of reciting the sentence ‘la ilaha illa llah, Muhammadu rasulu llah’ (in its alternative translation, ‘There is no God but the God and Muhammad is his Prophet’). Anyone who utters the shahada in full faith must be regarded as a Muslim. 2. Prayer, or salat, is prescribed to be performed five times per day (at dawn, around midday, in the afternoon, at sunset, and at night before going to bed), preceded by self-purification through ritual washing, performed facing in the direction of the Holy Mosque in Mecca, demonstrating ‘submission to God’s will’ by word of mouth and physical gesture. 3. Alms, or zakat (a term derived from the Arabic zaka, meaning ‘pure’). The Holy Qur’an stresses that the giving of alms is one of the chief virtues of the true believer, the generally accepted amount being onefortieth of a Muslim’s accumulated personal or business wealth. Because all such revenue benefits the poor and pays for certain activities within a 19 Islamic banking community, the very act of giving shows the believer’s sense of social responsibility, thus leaving acquired wealth free of disrepute. 4. Fasting or sawm. All believers are required to observe the ninth lunar month of the Muslim year, Ramadan, as a period of fasting in which they abstain from eating, drinking, smoking and sexual relations from sunrise to sunset (Holy Qur’an 2:185-6). The purpose is to subjugate the body to the spirit and to fortify the will through mental discipline, thus helping the believer to come nearer to God. 5. Pilgrimage. The hajj, or pilgrimage to Mecca must be performed at least once in the life of every Muslim, health and means permitting (Holy Qur’an 3.97). 8 According to (Lewis & Algaoud, 2001, pp. 19-20) xi | P a g e
  • 92. Appendices Appendix2 In the course of this research, several experts in the field of Islamic finance as well as banks’ representatives were contacted via email, in order to perform an interview about the respective topic. However, there was no answer from all of them except Dr. Johannes Engels. Dr. Johannes Engels is a Senior Advisor at The Federal Financial Supervisory Authority (BaFin) – Germany. Dr. Engels has studied General Economics in Aachen and Cologne; he finished in at University of Cologne with Doctor Degree. He has been working for the Federal Financial Supervisory Authority for twenty two years, in the international dept. for eight years. Since October 2012 he has been the lecturer for Corporate Governance at University of Applied Sciences in Mainz. He has written several publications in the field of Islamic finance. The below interview took place on October 29th, 2013 at Dr. Engels’ office. 1- As the matter of fact that Islamic banking became a hot topic in Germany for the past years, do you think that Germany will benefit from this business? I can really imagine it, we have several million Muslim citizens in Germany , and that is indeed reflected a great market. There are important Shariah principles which must be followed in Islamic banking (riba, maysir, gharar). Indeed, if we have operated financially according to these principles, we would never experience the different financial crisis. 2- Facts and figures about the Muslim population in Germany have reflected a potential group for Islamic banking, Do you think that Germany can be really a potential market for Islamic banking? Indeed, from the quantity, there is a potential for this business. However, when I look to one bad experience which occurred in the 1990s, where bad Turkish Muslims cheated other Muslims after Friday prayers, in the so-called Islamic holding. As a result, these Muslims had lost their money, and consequently, this bad experience still constitutes a problem . On the other hand, the majority of Muslims in Germany is from Turkey, and from this point, it is still today, not religiously based country. Therefore, Turkish Muslims feel home in our regional banks which are highly preferred more than their home banks. Therefore, I think that, in the short run, it will be possible that an Islamic bank will offer a trading xii | P a g e
  • 93. Appendices business (e.g. import and export business). Indeed, there will an economic niche. Later on, it might a room for retail banking business; however, it should be taken step by step. 3- Several German Banks have launched the so-called “Islamic Windows” in the GCC region, Do you think that these banks can be key players in this business, In case of further implementation? I think in the long run, if the business shows a successful trend in the market; the German banks will try to play such a similar role. However, I think it will not be in the retail business, except for important clients, where they deal with them in Kuala Lumpur or Dubai. 4- With regard to the regulatory issues, what are the major challenges facing the business implementation? And how can Germany overcome it? We have no general line, when we look at the German banking act (KWG), there is no explicit forbiddance for Islamic banking. In my opinion, the thing is possible when it is not strictly forbidden. I think it is only a different type of calculation in Islamic banking, for instance, deposits and lending mechanism. It is another way to do this business and not forbidden in the KWG. My opinion, it will be possible. There is no general line till now, still there is no final decision about it. I think it will be a soon a final decision , as there is already a full licence application from the Kuveyt Türk bank, which located in Mannheim. There are indeed other concerns which related to the Islamic deposits. According to the EU regulation, each deposit up to 100,000 euros must be fully protected, and this type of deposit insurance system is against Shariah rules. Any Islamic bank must follow these rules, otherwise it will be hard to obtain a banking license. Another issue is the role of the Shariah board (SSB), it is absolutely a need to have a qualified Shariah board. As a supervisor, I highly welcome it when there is a qualified Shariah board. However, I know that in several countries, the SSB is as well included in heading the bank , and it can intervene in the banks’ decisions. In the European Union as well as in Germany, Only CEOs are responsible for heading the business, and SSB can take over the role of a Consultant. 5- The Kuveyt Türk bank has entered the market as an Islamic bank, however, it has obtained only a limited license, What are the main reasons for this? And can the bank get a full banking license in the future? The Kuveyt Türk bank is a well known bank in Turkey and operates through highly qualified managers. However, the main issues previously discussed xiii | P a g e
  • 94. Appendices (deposits issue & SSB role) are the main reason for not getting a full license till now. Indeed, I hope that it will be successful in the future, in my opinion; it is just a new business in the country, which might face some resistance. However, I am sure that they will get a full license in the future, but it will take some time. Indeed, there should be some compromises from the Islamic banks' side to overcome these issues. For instance, the SSB can be equal to the role of the supervisory boards in the conventional banks, but not more. 6- Tax conditions in Germany also impose some restrictions to Islamic banks? Are there any current solutions for this issue? Under the current taxation system, Islamic banks will be exposed to double taxation treatment in the case of Islamic mortgage finance. In addition, Germany has a different level of taxes according to each region (e.g. 2.5% in Hessen region, whereas 5% in the Rheinland Pfalz region). In fact, it will very difficult to change the taxation system, such as in the UK (one time treatment) and France (double taxation but with a lower level of taxes). However, Ernst & Young has proposed an excellent idea, “the silent partnership”. In consequence, the bank will only be registered only one time in this process as he acts as a sleep partner. This is simply the solution for the double taxation problem, without changing anything the taxation regulation. 7- Finally, what do you think about the future of the Islamic banking business in Germany? I think in the long run; it will be very successful, as we will have another generation than the one who experienced the Islamic holding in the 1990s.On the other hand, the success of Islamic finance in London (new sukuk issuance ) as well as in Luxemburg, will positively affect the European market. Hence, in the near future, first with a trading business (Import and export), then step by step it will further develop to offer Islamic products and services. I think also that we will see an Islamic index in the stock market in the future. It is not impossible; there are several companies which don’t engage with haram business (gambling, pork, weapons, etc.). P.S. “The above mentioned interview reflects only the private opinion of Dr. Johannes Engels and does not automatically display the position of German Federal Financial Supervisory Authority”. xiv | P a g e
  • 95. Europass Curriculum Vitae Personal information Surname(s) / First name(s) Address Mobile E-mail(s) Nationality Gender Islam Hamed Gabriel-von-Seidl-Straße 75, 67550 Worms (Germany) 004917671298135 Egyptian Male Work experience Dates Occupation or position held Main activities and responsibilities Name and address of employer Type of business or sector Dates Occupation or position held Main activities and responsibilities Name and address of employer Type of business or sector Dates Occupation or position held 17/09/2012 - 12/02/2013 Lean Coordinator-Intern (Product Development Department) • Implement lean tools in the PD department (e.g. Lean meetings, visual boards, 5S and VSM). • Monitor PDP/APQP running projects. • Support top management in presentations preparation and workshops organization. • Coordinate RFQ value stream mapping/analysis project. • Development of standards in Project Management. SKF Schweinfurt (Germany) Engineering 03/03/2008 - 31/05/2010 Credit Analyst (Credit Department, retail Banking & SMEs) • Manage, direct, and coordinate all activities to implement bank policies, procedures and practices concerning underwriting, applications, and granting or extending / enhancing loans. • Analyze customer’s financial history to grant loans in accordance with risk management in the different products. • Assist and support the lending staff with matters of credit policy, guidelines and procedures. • Monitor the quality of the loan portfolio. • Assist top management in preparing manuals for new credit products. • Prepare internal and external reports. • Answer branches inquires and dealing with complex issues. Banque Misr Cairo (Egypt) Financial and insurance activities 08/07/2007 - 01/03/2008 Accountant (Engineering Department) Main activities and responsibilities • Prepare journal entries. • Complete general ledger operations. • Prepare monthly financial reports. Name and address of employer Banque Misr Cairo (Egypt) Type of business or sector Page 1 / 3 - Curriculum vitae of Islam Hamed Financial and insurance activities For more information on Europass go to © European Union, 2002-2010 24082010
  • 96. Education and training Dates Title of qualification awarded Grade Principal subjects / occupational skills covered Name and type of organisation providing education and training Dates Title of qualification awarded Grade Principal subjects / occupational skills covered Name and type of organisation providing education and training Dates Title of qualification awarded Principal subjects / occupational skills covered Name and type of organisation providing education and training Dates Title of qualification awarded Name and type of organisation providing education and training 14/03/2011 – 14/02/2014 Master of Arts (International Business Administration and Foreign Trade) 1.7 (scale: 1 – 5, with 1 being the highest) • Advanced Corporate Finance and Value Investing. • International Project Management. • Strategies of Internationalisation. • International Logistics & Transportation Management. University of Applied Sciences Worms Worms (Germany) 01/10/2007 - 20/08/2009 MBA (Financial Management) Excellent • International Finance. • Advanced Financial Management. • Investment Management. Arab Academy for Banking & Financial Sciences Cairo (Egypt) 15/09/2002 - 30/05/2006 Bachelor of Arts (Accounting) • Accounting. • Economics. • Financial management. Ain Shams university Cairo (Egypt) 15/09/1999 - 20/06/2002 Secondary school Shobra Elthanawya Cairo (Egypt) Personal skills and competences Mother tongue(s) Arabic Other language(s) Understanding Self-assessment European level (*) English German Listening Reading Proficient user Speaking Spoken interaction Page 2 / 3 - Curriculum vitae of Islam Hamed Spoken production C2 Proficient user C2 C2 Proficient user C2 C1 Proficient user B2 Independent user C1 Proficient user B2 Independent user B1 Independent user (*) Common European Framework of Reference (CEF) level Social Engagement Writing Volunteer at Misr El Kheir foundation. For more information on Europass go to © European Union, 2002-2010 24082010 Proficient user C1 Proficient user
  • 97. Social skills and competences • Strong sense of creativity. • Critical thinking. • Goal-oriented. Computer skills and competences • MS Office. • Mind Manager. • Project Link. • Lotus Notes. Page 3 / 3 - Curriculum vitae of Islam Hamed For more information on Europass go to © European Union, 2002-2010 24082010