Your SlideShare is downloading. ×

Islamic Finance

1,419

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
1,419
On Slideshare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
89
Comments
0
Likes
0
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. PROJECT TITLE ISLAMIC FINANCE ORGNISATION/COMPANY NAMEINVESTMENT & DEVELOPMENT OFFICE GOVERNMENT OF RAS AL KHAIMAH UAE PROJECT SUMITTED BY KHURRUM IQBAL EXECUTIVE MBA (FINANCE) PROJECT GUIDE DR. RAJESH PUARKAR DIRECTOR UOP UAE – RAK CAMPUS PROJECT SUBMITTED TO UNIVERSITY OF PUNE UAE CAMPUS RAS AL KHAIMAH ACADEMIC YEAR 2009-2011
  • 2. ACKNOWLEGEMENTS In the name of Allah the most gracious & merciful.I dedicate this project to my parents, my wife who give me the real insight and thoughtabout Islam & and to my office colleagues, friends and honorable teachers who make this possible for me. i
  • 3. ContentsCertificate from the Company.................................................................................................................... iiiCertificate of University .............................................................................................................................. ivList of Figures ............................................................................................................................................... vEXECUTIVE SUMMARY ............................................................................................................................ 1VISIT & SURVEY OF FINANCIAL INSTITUTIONS ................................................................................ 4SCOPE .......................................................................................................................................................... 5DATA ANALYSIS ......................................................................................................................................... 6 Non-Banking Islamic Products ...............................................................................................................6 Islamic Investment Funds .....................................................................................................................14 Banking Institutions ................................................................................................................................19 Conventional Banks versus Islamic Banks ........................................................................................20FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCE ................................................... 25 Human resource for Shariah compliance ...........................................................................................27 Unresolved Fiqh Issues .........................................................................................................................27 Legal framework .....................................................................................................................................27 Excess Liquidity ......................................................................................................................................27 Technology ..............................................................................................................................................27 Islamic Banking — Possible solutions ................................................................................................28CONCLUSIONS ......................................................................................................................................... 29Annexure/Appendix .................................................................................................................................... 30 Islamic Economic Fundamentals .........................................................................................................30 Islamic Financial Terminologies ...........................................................................................................31 Islamic Shariah Board ...........................................................................................................................33 Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) ......................34 Top 10 Islamic funds by key Performance statistics .........................................................................35Bibliography ................................................................................................................................................ 37 ii
  • 4. Certificate from the Company iiiCertificate from the Company C E R T I F I C A T EThis is to certify that Mr. Khurrum Iqbal holder of Pakistani passport number AR1336642, Executive MBA (Final Year) student of University of Pune – UAE campus RAK, is our employee working in a capacity of Office Accountant. He has submitted this report to his own research, Investment & Development Office, Government of Ras Al Khaimah has no obligation and responsibility for the outcome of this report. Certified by: _________________________ Jim Stewart Chief Executive Officer iii
  • 5. Certificate of University ivCertificate of University CERTIFICATEThis is to certify that Mr. Khurrum Iqbal (Permanent Registration No. 2120801009) holder of Pakistani passport number AR1336642, Executive MBA (Final Year) student of University of Pune, UAE Campus RAK, has worked on the Project Title ISLAMIC FINANCE during the period from 1st October 2010 to 10th December 2010. He hascarried out the above project work as per the University guidelines and worked sincerely. …………………………………………. Signature & name of the Student Name of the Project Guide: Dr. Rajesh Puharkar Signature of the External Examiner………………………………………. Date: 17th December 2010 Place: Ras Al Khaimah - UAE iv
  • 6. vList of Figures Figure Description Page Ref. 1 Stages of Evolution of Islamic Finance 1 2 Global Sukuk Issuance 6 3 Sukuk Issuance by Type 7 4 Islamic Funds Launched by Assets Class 9 5 Global Takaful Contribution 10 6 Takaful Mechanism 12 7 Mechanism of Murabahah Fund 18 8 Key Players in Islamic Banking Market 19 Percentage of Market Share and Growth in Assets of Islamic Banks 9 20 and Conventional Banks 10 Impact of Global Crises on Islamic Finance 21 11 Market Share of Islamic and Conventional Bank Assets in 2008 23 12 Market Penetration of Islamic Banks in GCC 24 13 GCC’s Breakdown of Total Banking Assets 24 14 Top 10 Countries by Value of Shariah-Compliant Assets, 2009 26 15 Geographical Distribution of Reported Shariah Assets, GCC, 2009 26 v
  • 7. EXECUTIVE SUMMARY 1EXECUTIVE SUMMARYThe Islamic Finance (IF) is not at all a new concept. It is a concept which is addressedby many in the changing world order. The economy is diversified from culture to culturefrom Europe to Asia, and from one religious believes to another.In early 1970s (Figure 1) when the concept of banking without interest was introduced,the majority of people considered it a novelty. It took almost thirty years to implementIslamic banking in practice, with the Dubai Islamic Bank becoming the first full-fledgedIslamic finance bank (UAE perspective).Figure 1: Islamic Financial Services: Stages of Evolution in Islamic Finance Institutions Products Area Commercial Islamic Banks Commercial Islamic banking products Gulf/Middle East 2000s Takaful Takaful Asia Pacific Islamic investment companies Mutual funds/unit trust Europe/Americas Islamic investment banks Islamic Bonds Global/Offshore Market Asset management companies Shariah – compliant stocks e-commerce Islamic stock broking Broker/bankers Commercial Islamic Banks Commercial Islamic banking products Gulf/Middle East 1990s Takaful Takaful Asia Pacific Islamic investment companies Mutual funds/unit trust Broker/bankers Islamic Bonds Shariah – compliant stocks Islamic stock broking Commercial Islamic Banks Commercial Islamic banking products Gulf/Middle East 1980s Takaful Takaful Asia Pacific Islamic investment companies Commercial Islamic Banks Commercial Islamic banking products Gulf/Middle East 1970sSource: World Islamic Funds and Capital Markets Conference, May 2006, Bahrain 1
  • 8. EXECUTIVE SUMMARY 2There are shariah scholars who provide the religious foundation based on IslamicJurisprudence and the practices instituted by earlier scholars. They endeavor to translateand rationalize the long-standing practices into contemporary usage. Islamic finance isunique because of its interdisciplinary nature.Islamic finance is one of the fastest growing segments of global financial industry. Insome countries, it has become systemically important and, in many others, it is too big tobe ignored. Several factors have contributed to the strong growth of Islamic finance,including: i. strong demand in many Islamic countries for Shariah-compliant products;ii. progress in strengthening the legal and regulatory framework for Islamic finance;iii. growing demand from conventional investors, including for diversification purposes; andiv. The capacity of the industry to develop a number of financial instruments that meet most of the needs of corporate and individual investors.It is estimated that the size of the Islamic banking industry at the global level was closeto US$820 billion at end-2008 according to International Finance Supervisory Board2010.The area of research is Islamic Finance, which mainly focuses on the establishment andimplementation of Islamic Financial System in the economy, as per the principals led byShariah (Islamic Jurisprudence) in the light of Quran & Sunna, proposed by IslamicJurists and Scholars. Under the Islamic system ‘Riba’ (interest) is haram (prohibited),unlike in conventional financial system.Project ScopeThe scope of the project to oversee the current trends of Islamic and Non Islamic(conventional) products, key players in both Banking & Non-Banking FinancialInstitutions and countries promoting Islamic Finance. 2
  • 9. EXECUTIVE SUMMARY 3Research MethodologyThe methodology for primary research is based on currently available past data ofIslamic and Non Islamic Financial Institutions. The sample size taken in this research islimited to 10 leading Islamic countries, promoting Islamic Finance in particular and non-Islamic products and services in general.For secondary research and in-depth analysis, 5 leading banking and non-bankingfinancial institutions have been taken, while discussing their product base, and marketcapitalization and competition, in comparison to Islamic & Non Islamic products.Risks & LimitationThe sub-prime limitation of the project is non-availability of current consolidated data andstatistics, of both Islamic & Non Islamic Financial Institutions from authentic and non-speculative market source.Since Islamic Finance is in its emerging phase, it is hard to avoid associated risks; one ofthe major risks is market acceptability and challenges to compete with conventionaleconomic system.To mitigate these risks some leading Islamic Finance Professionals have posted theirSpeeches and Scholarly articles on various websites.ObjectivesThe main objective of the project is to highlights the global impact on the Islamic Systemand the economic challenges to be faced in transforming conventional financial systeminto Islamic Financial System.Conclusion & OutcomeThe outcome of the research to evaluate future market demand for Islamic products andservices in the economy. 3
  • 10. VISIT & SURVEY OF FINANCIAL INSTITUTIONS 4VISIT & SURVEY OF FINANCIAL INSTITUTIONSPrimary Research & SurveyThe purpose of the visit of the following financial institutions to know about currentmarket trends and products offering from conventional (Non-Islamic) to Islamic Productsand services.Abu Dhabi Islamic Bank (UAE)National Bank of Abu Dhabi (UAE)Emirates Islamic Bank (UAE)Oman Insurance (Takaful)Noor Islamic Bank (Wakala Deposits)Secondary Research & SurveyThe secondary research is based on internet blogs and research articles posted thevarious websites.Dubai Islamic Bank 4
  • 11. SCOPE 5SCOPEThe scope of the project is comprised of banking and non-banking financial institutions ofboth Islamic Finance and non-Islamic and conventional financial institutions. The periodcoverage for the analysis purposes is starting from 2004 to 2010.The project is limited to UAE in particular and other Islamic countries in general.The Islamic Countries which are discussed in this report are: Gulf Region Levant South East Asia  Bahrain  Jordan  Pakistan  UAE  Turkey  Malaysia  Kuwait  Saudi Arabia  Oman  QatarIslamic Finance Institution have taken the form of commercial banks, investment banks,insurance companies, funds management companies and other financial servicescompanies. Current estimates of the total number of IFIs world-wide range from 400 to600.In Asia, the most prominent IFIs are currently found in Malaysia, such as Bank Rakyat,Maybank Islamic Berhad, BIMB Holdings, CIMB Islamic Bank Berhad and Public BankIslamic Berhad. Of the global conventional banks operating in Asia, HSBC Amanah, theIslamic finance division of HSBC established in 1998, has a high profile operation asdoes Standard Chartered Bank through Standard Chartered Saadiq. 5
  • 12. DATA ANALYSIS 6DATA ANALYSISNon-Banking Islamic ProductsISLAMIC BOND (SUKUK)In 2009, according to S&P, the ratio rose even more and is likely to do so again this year.Those in the capital markets may have drawn solace from the fact that the value ofsukuk, or Islamic bonds, issued worldwide during 2009 rebounded to $23.3 billion, upfrom a paltry $14.9bn the year before. The total was still short of the record value of$34.3bn seen in 2007. (Figure 2)Figure 2: Global Sukuk IssuanceAsian issuers accounted for more than 60 per cent of the total value of sukuk issuedaround the world in 2009, with Malaysia alone making up just over half of the total. Lastyear’s partial revival in the market brought the total value of Islamic bonds issued so farto $100 billion, a landmark of significance to be sure.About $20 billion-worth of sukuk are reckoned to be in the pipeline, with a further $10billion or so being talked about if the market keeps its calm. If so, that could bring thetotal value of bonds issued this year close to the record achieved in 2007. The default oftwo sukuks issued by Saad Group of Saudi Arabia and Kuwait’s Investment Dar – 6
  • 13. DATA ANALYSIS 7unsettled issuers and investors alike. A third issue – by Nakheel of Dubai – was rescuedat the last minute by the federal government in Abu Dhabi.Figure 3: Sukuk Issuance by TypeIt is worth noting, too, that governments and entities related to governments, accountedfor most of the issuance of Islamic bonds during 2009. This is good in one way becauseit gives the market more breadth and depth. The more sukuk that governments issue, theeasier it is for riskier borrowers to price their own issues thanks to the benchmarkestablished by the sovereign or quasi-sovereign sukuk. 7
  • 14. DATA ANALYSIS 8ISLAMIC INVESTMENT EQUITY FUNDSIslamic investment equity funds market is one of the fastest-growing sectors within theIslamic financial system. Currently, there are approximately 100 Islamic equity fundsworldwide. The total assets managed through these funds currently exceed US$5 billionand is growing by 12–15% per annum. With the continuous interest in the Islamicfinancial system, there are positive signs that more funds will be launched.Despite these successes, this market has seen a record of poor marketing as emphasisis on products and not on addressing the needs of investors. Over the last few years,quite a number of funds have closed down. Most of the funds tend to target high networth individuals and corporate institutions, with minimum investments ranging fromUS$50,000 to as high as US$1 million. Target markets for Islamic funds vary; some caterfor their local markets, e.g., Malaysia and Gulf-based investment funds. Others clearlytarget the Middle East and Gulf regions, neglecting local markets and have beenaccused of failing to serve Muslim communities. 8
  • 15. DATA ANALYSIS 9Figure 4: Islamic Funds launched by Assets ClassIslamic asset managers have to learn to adapt to survive, amid stagnating asset pools,investor risk aversion and crimped liquidity. The past year has been tough for the MiddleEast’s asset management industry generally, and the Sharia-compliant sector has notbeen spared the pain. If anything, asset management is the sector that has been hitharder than others in the Sharia-compliant sphere. According to the Ernst & YoungIslamic Funds & Investment Report 2010, released in May, global Islamic fund assetsstagnated at $52.3 billion in 2009, barely registering an increase on the $51.4bn postedin 2008. In contrast, the global conventional mutual fund assets under managementexhibited signs of recovery from their lows of $19 trillion in 2008, reaching $22 trillion in2009. The research reveals that only 29 new Islamic funds were launched in 2009,almost offsetting the 27 Islamic funds that were liquidated during the same period. Thiscompares to 173 that were launched in the market’s 2007 peak. 9
  • 16. DATA ANALYSIS 10ISLAMIC TAKAFULAs a nascent, specialized sector in its first years of significant growth, the takafulindustry, one might think, had particular reason to fear the global economic downturn.However, almost two years since the collapse of US investment bank Lehman Brotherssparked the credit crunch, the global value of takaful contributions continue to showdouble digit growth, and according to consultants Ernst & Young will reach almost $9billion this year.Figure 5: Global Takaful ContributionBullish growth in the number of firms offer takaful and re-takaful – insurance and re-insurance which complies with Sharia seems to support the idea that the sector has abright future in an Islamic world which remains severely underinsured. Perhaps theclosest conventional corollary to the takaful industry is that of the co-operative insuranceindustry. In common with that branch of the insurance sector, takaful sees participantspool their funds together to insure one another. Liability is spread among the funds policyholders and any losses divided between them meaning, in the words of Ernst & Young 10
  • 17. DATA ANALYSIS 11that ‘policyholders are both the insurer and the insured’. The structure of a takaful fundadheres to the Islamic principle of Ta’awun (mutual assistance) and all investments mustuse instruments free of Riba, or interest. However, the tumultuous events of the last twoyears have left the industry far from unscathed, and it now must meet the challenges ofany embryonic enterprise building scale, establishing an identity, and achievingsustainable profits – against an economic backdrop which is likely to remain difficult inthe near term.Takaful companies may have been prohibited from investing in the toxic financialderivatives which humbled conventional giants like AIG, but the resultant fall in assetprices caused by the downturn has negatively affected the investment portfolios of manyfirms. With this, the onus is now on firms to find operating efficiencies, and even morepressingly, build scale – something which will likely only be achieved by mergers andacquisitions. This will likely be complicated by the fact that different regulatoryenvironments in different countries both within and outside the Gulf Co-operation Council(GCC) add an added layer of difficulty to cross-border transactions.The way that different regulations have given rise to different operating models in thetakaful industry is most apparent when one contrasts the way the industry has developedin the GCC, with the path taken by Malaysian takaful operators. There are severalsignificant differences between the two jurisdictions in the way that takaful operatorsconduct their business.Ernst & Young’s World Takaful Report 2010 finds GCC takaful operators have been hitharder by the financial crisis than their Malaysian counterparts. Its data shows thatwhereas a sample of Gulf takaful operators could point to an average return on equity(ROE) of 10 per cent in 2005, by 2009 that figure was minus 6.5 per cent. Over the sameperiod, a sample of Malaysian operators saw their ROE rise from 1.6 per cent to 7.6 percent. While Malaysian firms can take heart from their resilience during the globalfinancial crisis, the results of several GCC firms leave more to be desired, in no smallpart due to operating models which has prioritized the investment side of insurance over 11
  • 18. DATA ANALYSIS 12developing expertise in the underwriting skills which are the cornerstone of the business.In recent years GCC takaful companies have been heavily reliant on income from theirinvestments, but an exposure to asset classes badly affected by the downturn until 2009two thirds of investments were in real estate has seen the average yield on investmentsfall from 35.1 per cent in 2005 to just 3.5 per cent in 2009.Figure 6: Takaful Mechanism Expenses Claim RetakafulTheir rush to acquire market share in the face of growing regional contribution has alsoseen Gulf companies look to undercut rivals, with the result that questions have beenraised about the quality of their customer base.Meanwhile, takaful operators in Malaysia have focused on developing a strongunderwriting capacity and with it the ability to better gauge the risks presented by eachparticular customer. As a result, Malaysian takaful firms are increasingly confident aboutretaining a larger proportion of their actual business on their own books. In contrast,Ernst & Young found that GCC operators cede between 30 and 50 per cent of their grosspremiums to re-takaful companies – the Sharia compliant equivalent of conventional re- 12
  • 19. DATA ANALYSIS 13insurance companies. Insurers look to reduce their exposure to losses by transferringrisk to such firms.However, the fact that takaful operators in the Gulf cede such a high proportion of theirpremiums to retakaful companies reduces their ability to generate strong income fromunderwriting and has left them overly reliant on investment returns to generateprofitability. With investment returns under real pressure in these straitened times, thedevelopment of underwriting skill sets would avoid GCC-based takaful companieseffectively handing such a large proportion of their potential returns to a re-takaful firm.By way of comparison, in Malaysia operators generally cede less than 15 per cent oftheir gross premiums to the re-takaful sector. By keeping most of the risk on their ownbooks, Malaysian operators have had to develop stringent underwriting techniques toavoid damaging losses. They have been rewarded for this with an average claims ratioof between 25 to 35 per cent – compared to a GCC average which ranges between 40and 60 per cent.Gulf takaful firms have focused on the investment returns side of the business at theexpense of the underwriting side in part to satisfy shareholder expectations. As theindustry moves forward, managing such expectations will be a crucial part of the jobdescription of the executive management of those firms who aspire to lead the pack. Thedays of 20 per cent returns are not likely to come back any time soon.But if firms must be frank with shareholders, they must also maintain theircommunication with potential customers, and the suspicion lingers that the industry isstill grasping for an identity, and a simple way of presenting the tangible benefits of itsSharia-compliant practices to those either oblivious to the benefits of insurance, or usedto dealing with conventional operators. The future for the industry will require, perhapscounter-intuitively, both further diversification and specialization. Takaful firms haveconcentrated heavily on the industry’s low hanging fruit, with analysts warning that atsome firms a single sector, such as motor takaful, accounts for 80 per cent of theirpremiums. As companies look to achieve a better business mix, sectors such as lifecoverage, and products serving the construction industry, including covering contractorsand customers against financial losses incurred when projects are delayed or cancelled 13
  • 20. DATA ANALYSIS 14offer new opportunities. Equally, while in the conventional markets specialist operatorsfocus on particular segments, such as, for example, only catering to female customers,such firms are conspicuous by their absence in the takaful sector. By focusing on aparticular type of customer believed to carry lower risk than others, firms may beconfident they can achieve better underwriting results.Islamic Investment FundsThe term "Islamic Investment Fund" means a joint pool wherein the investors contributetheir surplus money for the purpose of its investment to earn halal profits in strictconformity with the precepts of Islamic Shariah. The subscribers of the Fund may receivea document certifying their subscription and entitling them to the pro-rated profits actuallyaccrued to the Fund. These documents may be called "certificates" "units" "shares" ormay be given any other name, but their validity in terms of Shariah, will always besubject to two basic conditions:1. Instead of a fixed return tied up with their face value, they must carry a pro-rated profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. If the Fund earns huge profits, the subscribers will earn profits to according to the proportion of Investment however, in case the Fund suffers loss, they will have to share it also, unless the loss is caused by the negligence or mismanagement, in which case the management, and not the Fund, will be liable to compensate it.2. Second, the amounts so pooled together must be invested in a business acceptable to Shariah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.Keeping these basic requisites in view, the Islamic Investment Funds may accommodatea variety of modes of investment which are discussed briefly in the following paragraphs. 14
  • 21. DATA ANALYSIS 15Equity FundIn an equity fund the amounts are invested in the shares of joint stock companies. Theprofits are mainly achieved through the capital gains by purchasing the shares andselling them when their prices are increased. Profits are also achieved by the dividendsdistributed by the relevant companies.It is obvious that if the main business of a company is not lawful in terms of Shariah, it isnot allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entailthe direct involvement of the shareholder in that prohibited business.Similarly the contemporary Shariah experts are almost unanimous on the point that if allthe transactions of a company are not in full conformity with Shariah, which includes thatthe company borrows money on interest nor keeps its surplus in an interest bearingaccount, its shares can be purchased, held and sold without any hindrance from theShariah side.Ijarah FundAnother type of Islamic Fund may be an Ijarah fund. Ijarah means leasing. In this fundthe subscription amounts are used to purchase assets like real estate, motor vehicles, orother equipment for the purpose of leasing them out to their ultimate users. Theownership of these assets remains with the Fund and the rentals are charged from theusers. These rentals are the source of income for the fund which is distributed proratedto the subscribers. Each subscriber is given a certificate to evidence his subscription andto ensure his entitlement to the pro-rated share in the income. These certificates may bepreferably called "Sukuk" -- a term recognized in the traditional Islamic jurisprudence.Since these sukuk represent the pro-rated ownership of their holders in the tangibleassets of the fund, and not the liquid amounts or debts, they are fully negotiable and canbe sold and purchased in the secondary market. Anyone who purchases these sukukreplaces the sellers in the pro-rated ownership of the relevant assets and all the rightsand obligations of the original subscriber are passed on to him. The price of these sukukwill be determined on the basis of market forces, and are normally based on theirprofitability. 15
  • 22. DATA ANALYSIS 16However, it should be kept in mind that the contracts of leasing must conform to theprinciples of Shariah which substantially differ from the terms and conditions used in theagreements of the conventional financial leases. The leased assets must have someusufruct, and the rental must be charged only from that point of time when the usufruct ishanded over to the lessee.1. The leased assets must be of a nature that their halal (permissible) use is possible.2. The lessor must undertake all the responsibilities consequent to the ownership of the assets.3. The rental must be fixed and known to the party’s right at the beginning of the contract. In this type of the fund the management should act as an agent of the subscribers and should be paid a fee for his services. The management fee may be a fixed amount or a proportion of the rentals received.Commodity FundAnother possible type of Islamic Funds may be a commodity fund. In the fund of this typethe subscription amounts are used in purchasing different commodities for the purposeof the resale. The profits generated by the sale are the income of the fund which isdistributed pro-rated among the subscribers. In order to make this fund acceptable toShariah, it is necessary that all the rules governing the transactions and fully compliedwith. For example:1. The commodity must be owned by the seller at the time of sale, therefore, short sales where a person sells a commodity before he owns it are not allowed in Shariah.2. Forward sales are not allowed except in the case of salam and istisna3. The commodities must be halal, therefore, it is not allowed to deal in wines, pork, or other prohibited materials.4. The seller must have physical or constructive possession or the commodity he wants to sell. (Constructive possession includes any act by which the risk of the commodity is passed on to the purchaser).5. The price of the commodity must be fixed and known to the parties. Any price which is uncertain or is tied up with an uncertain event renders the sale invalid. 16
  • 23. DATA ANALYSIS 17In view of the above and similar other conditions, it may easily be understood that thetransactions prevalent in the contemporary commodity markets, especially in the futurescommodity markets do not comply with these conditions. Therefore, an IslamicCommodity Fund cannot enter into such transactions. However, if there are genuinecommodity transactions observing all the requirements of Shariah, including the aboveconditions, a commodity fund may well be established. The units of such fund can alsobe traded in with the condition that the portfolio owns some commodities at all times.Murabahah Fund"Murabahah" is a specific kind of sale where the commodities are sold on a cost-plusbasis. This kind of sale has been adopted by the contemporary Islamic banks andfinancial institutions as a mode of financing. They purchase the commodity for the benefitof their clients, and then sell it to them on the basis of deferred payment at an agreedmargin of profit added to the cost. If a fund is created to undertake this kind of sale, itshould be a closed-end fund and its units cannot be negotiable in a secondary market.The reason is that in the in the case Murabahah, as undertaken by the present financialinstitutions, the commodities are sold to the clients immediately after their purchase fromthe original supplier, while the price being on deferred payment basis becomes a debtpayable by the client. Therefore, the portfolio of Murabahah does not own any tangibleassets, rather it comprises of either cash or the receivable debts, and both these thingsare not negotiable, as explained earlier. If they are exchanged for money, it must be atpar value. 17
  • 24. DATA ANALYSIS 18Figure 7: Mechanism of Murabahah FundMixed FundAnother type of Islamic Fund maybe of a nature where the subscription amounts areemployed in different types of investments, like equities, leasing, commodities, etc. Thismay be called a Mixed Islamic Fund. In this case if the tangible assets of the Fund aremore than 51% while the liquidity and debts are less than 50% the units of the fund maybe negotiable. However, if the proportion of liquidity and debts exceeds 50%, its unitscannot be traded in according to the majority of the contemporary scholars. In this casethe Fund must be a closed-end Fund. 18
  • 25. DATA ANALYSIS 19Banking InstitutionsThe countries of the Gulf Cooperation Council (GCC) have the largest Islamic banks (IBs).The market share of Islamic finance in the banking systems of the GCC countries at end-2008 was in the range of 11−35 percent, compared with 5−24 percent in 2004. While Islamicbanking remains the main form of Islamic finance Islamic insurance companies (Takaful),mutual funds and the sukuk have also witnessed strong global growth.• Islamic banking is one of the fastest growing industry segments in the Financial Services sector• Growth momentum, both in the Arab world and globally, estimated at plus 20% p.a.• Approximately 400 Islamic institutions globally with assets in excess of US$ 500 billion• More than US$ 20 billion in international Islamic bond issuance to date• Targeted regions include GCC, South Asia, South East Asia and select niche markets• Entry by Global Commercial/ Investment banks in this sectorFigure 8: Key Players in Islamic Banking MarketStandard & Poor’s (S&P), notes that the weighted average of non-performing facilities(mostly murabaha and ijara transactions) to total financing of the five largest Islamicbanks in the Gulf was just over 5% at the end of 2008, up from 3% the year before. 19
  • 26. DATA ANALYSIS 20Conventional Banks versus Islamic BanksThe countries of the Gulf Cooperation Council (GCC) have the largest Islamic banks(IBs). The market share of Islamic finance in the banking systems of the GCC countriesat end-2008 was in the range of 11−35 percent, compared with 5−24 percent in 2004.While Islamic banking remains the main form of Islamic finance Islamic insurancecompanies (Takaful), mutual funds and the sukuk have also witnessed strong globalgrowth.Figure 9: Percentage of Market Share and Growth in Assets of Islamic Banks and Conventional BanksThe recent global crisis has renewed the focus on the relationship between Islamicbanking and financial stability and, more specifically, on the resilience of the Islamicbanking industry during crises. Industry specialists and academics have taken note ofthe strong growth in Islamic banking in recent years. Some have argued that the lack ofexposure to the type of assets associated with most of the losses that many conventionalbanks (CBs) experienced during the crisis and the asset-based and risk-sharing natureof Islamic finance have shielded Islamic banking from the impact of the crisis. Othershave argued that IBs, like CBs, have relied on leverage and have undertaken significantrisks that make them vulnerable to the second round effect of the global crisis. 20
  • 27. DATA ANALYSIS 21Figure 10: Impact of Global Crises on Islamic FinanceComparing the performance of IBs to CBs globally would suggest that IBs performedbetter, given the large losses incurred by CBs in Europe and the US as a result of thecrisis. However, such a comparison would not lead to reliable conclusions about financialstability and the resilience of the Islamic banking sector because it would not allow forappropriate control for varying conditions across financial systems in countries where IBsoperate. For example, this comparison might not reflect the moderate impact of the crisison the GCC, Jordan, and Malaysia.To assess the impact of the crisis, the paper uses bank-level data covering 2007−10 forabout 120 IBs and CBs in eight countries Bahrain (including offshore), Jordan, Kuwait,Malaysia, Qatar, Saudi Arabia, Turkey, and the UAE. These countries host most IBs(more than 80 percent of the industry, excluding Iran) and have a large CB sector. Thekey variables used to assess the impact are the changes in profitability, bank lending,bank assets, and external bank ratings.The evidence shows that, in terms of profitability, IBs fared better than CBs in 2008.However, this was reversed in 2009 as the crisis hit the real economy. IBs‘ growth incredit and assets continued to be higher than that of CBs in all countries, except theUAE. Finally, with the exception of the UAE, the change in IBs‘ risk assessment, asreflected in the rating of banks by various rating agencies, has been better than or similar 21
  • 28. DATA ANALYSIS 22to that of CBs. Hence, IBs showed stronger resilience, on average, during the globalfinancial crisis.Factors related to IBs‘ business model helped contain the adverse impact on profitabilityin 2008, while weaknesses in risk-management practices in some IBs led to largerdeclines in profitability compared to CBs in 2009. Thanks to their lower leverage andhigher solvency, IBs were able to meet a relatively stronger demand for credit andmaintain stable external ratings.To address the lack of adequate information, bank-level data were collected for CBs andIBs in Bahrain (including offshore), Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia,Turkey, and the UAE. These countries were chosen because of the importance of IBs intheir banking systems and data availability. The database includes about 120 CBs andIBs, of which about one-fourth are Islamic. The sample covers over 80 percent of IBsglobally if Iran is excluded.Countries differ in terms of Islamic banking model and market structure. For example, inJordan, Kuwait, and Turkey, CBs do not have Islamic windows. The Bahraini wholesale(offshore) banks are largely involved in investment activities and are not regulated asrigorously as domestic (retail) banks. Indeed, by covering Bahrain offshore activities, thesample includes an important part of investment banking. The Malaysian IBs included inthe sample are all subsidiaries of CBs. Five countries (Turkey, Saudi, the UAE, Malaysia,and Kuwait) represent about 85 percent of the sample total assets and about 77 percentof the IB market shares (Figure 12). Islamic banking activities conducted by CBs are notcaptured in sample due to lack of reliable data.The assets (loans) boasted by the world’s top 500 Islamic banks rise to a total of $822billion during 2009, compared with $639 billion the year before. The value of those ofbanks in the six countries of the Gulf Co-operation Council (GCC) reached a total of$285 billion at the last count. That gives them 22 per cent of the worldwide market forIslamic finance, more than double the total five years earlier. 22
  • 29. DATA ANALYSIS 23Figure 11: Market Share of Islamic and Conventional Bank Assets in 2008More important still is the fact that banks complying with Sharia now account for just overa quarter of all banking assets within the GCC. Yet this is still less than the share ofIslamic assets accounted for by the Islamic windows of conventional banks.This is the certainly true for asset management. According to consulting firm Ernst &Young most new products and services unveiled recently by asset managers complyingwith Sharia were aimed at institutional, not retail, customers. Either Islamic fundmanagers have yet to find the right formula or retail customers are reluctant to part withtheir cash. The result is that Islamic funds under management still account for a mere 5.5per cent of the total market for finance complying with Sharia. 23
  • 30. DATA ANALYSIS 24Small wonder then that the value of assets worldwide held by funds complying withSharia, at $52 billion, remained more or less flat during 2009. Or that the industry itselffaces difficult choices. Some 70 per cent of firms managing Islamic funds have less than$100 million under their charge.Figure 12: Market penetration of Islamic Banks GCC Figure 13: GGC’s Breakdown of Total Banking Assets 24
  • 31. FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCE 25FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCEDynamic growth in Islamic finance will be driven by the following.Rising oil revenue and strong economic growth of the Gulf: In the past few years,economic growth in the GCC has been robust on the back of higher oil prices. The GCCholds around half of the world’s known oil reserves, and oil earnings account for 70 percent of the GCC’s exports and revenues.The substantial petrodollar liquidity in the Gulf economies has meant that petrodollarinvestors are increasingly seeking to invest in offshore assets, a proportion of which issought in the form of Shariah-compliant financial assets. In addition, the GCC is planningmassive infrastructure and construction spending of US$1.4 trillion from 2009-2015which will require financing.Demand from Muslim and non-Muslim investors: Investors from the Middle East andAsia are increasingly seeking to invest in products that are compliant with their religiousbeliefs. Surveys suggest that half of the Muslims world-wide would opt for Islamic financeif given a competitive alternative to conventional services.Low penetration levels: In spite of the growth in the Islamic banking and financeindustry, there remains a lack of depth across asset classes and products, signifyinguntapped potential. In particular, countries such as Indonesia, India and Pakistan whichhave the largest Muslim populations in the world are not considered to have well-developed Islamic banking and finance industries.Ethical character and financial stability of products: Islamic finance is attractingattention in a world of increasing corporate social responsibility. IFIs have not invested inimpaired asset classes that have hampered many conventional banks’ financial profilesand performance recently. According to Standard & Poor’s, Islamic commercial banksrecorded a ratio of liquid assets to total assets of 19.9 per cent at 30 September 2008,and although this ratio declined in the first quarter of 2008, it remained adequate. 25
  • 32. FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCE 26Key countries for Islamic capitalOn a regional basis, the Middle East and Asia are the primary locations for Islamiccapital. In particular, the UAE, Bahrain and Malaysia are seen as the main canters ofIslamic finance, with significant activity also taking place in London.FIGURE 14: TOP 10 COUNTRIES BY VALUE OF SHARIAH-COMPLIANT ASSETS 2009FIGURE 15: GEOGRAPHICAL DISTRIBUTION OF REPORTED SHARIAH ASSETS, GCC, 2009 26
  • 33. FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCE 27ISLAMIC BANKING ISSUESHuman resource for Shariah complianceUsers of Islamic financial services assign primary importance to Shariah compliance ofthe services they use. It is understandable that Shariah noncompliance entails a seriousoperational risk and can result in withdrawal of funds from and instability of an Islamicbank, irrespective of its initial financial soundness. Shariah compliance is hence aserious matter for an Islamic bank, in addition to its compliance with other regulatoryrequirements.Unresolved Fiqh IssuesLack of standard financial contracts and products can be a cause of ambiguity and asource of dispute and cost. In addition, without a common understanding of certain basicfoundations, further development of banking products is hindered.Legal frameworkAn appropriate legal, institutional and tax framework is a basic requirement forestablishing sound financial institutions and markets. Islamic jurisprudence offers its ownframework for the implementation of commercial and financial contracts andtransactions. Nevertheless, commercial, banking and company laws appropriate for theenforcement of Islamic banking and financial contracts do not exist in many countries.Excess LiquidityIslamic banks have over 60 % excess liquid funds which cannot be properly utilized dueto non-availability of Shariah Compliant products and instruments.The competitiveness and soundness of financial institutions depend on the availability ofefficient financial products. Islamic banks urgently need Shariah compliant products tomeet a number of pressing needs.TechnologyDesigning technological solutions around a concept requires extensive knowledge of thedomain. Conventional banking today is technologically advanced; however, for craftingIslamic financial solutions, considerable time and expertise are required. 27
  • 34. FACTORS DRIVING FUTURE GROWTH OF ISLAMIC FINANCE 28Islamic Banking — Possible solutions Establishment of Shariah Governance Systems Settling unresolved Fiqh Issues A sufficient number of well-trained, competent, high-caliber Islamic finance professionals and management teams with the required expertise Well-informed individual and corporate consumers, knowledgeable about Islamic banking and takaful The availability of Shariah compliant products (Shariah Compliant Stocks, Sukuks, etc.) Development of a Legal, Regulatory, and Institutional Framework complying with Shariah Advanced technology solutions designed to support Islamic Finance 28
  • 35. CONCLUSIONS 29CONCLUSIONSAs one of the fastest growing segments in global financial services, Islamic finance hasbecome systemically important in many markets and too big to ignore in others. Whileconventional intermediation is largely debt-based and allows for risk transfer, Islamicintermediation, in contrast, is asset-based, and centers on risk sharing. In addition toproviding IBs with additional buffers, these features make their activities more closely relatedto the real economy and tend to reduce their contribution to excesses and bubbles.Our analysis suggests that IFs fared differently than did CF (conventional Finance) duringthe global financial crisis. Factors related to IBs‘ business model helped contain the adverseimpact on profitability in 2008, while weaknesses in risk management practices in some IBsled to larger decline in profitability compared to CBs in 2009. In particular, adherence toShariah principles precluded IBs from financing or investing in the kind of instruments thathave adversely affected their conventional competitors and triggered the global financialcrisis. The weak performance in some countries was associated with sectorial/nameconcentration and, in some cases, was facilitated by exemptions from concentration limits,highlighting the importance of a neutral regulatory framework for IBs and CBs andstrengthening risk management in some banks.Despite higher profitability during the pre-global crisis period (2005–07), IBs‘ averageprofitability for 2008–09 was similar to that of CBs, indicating better cumulative (pre- andpost-crisis) profitability and suggesting that higher pre-crisis profitability was not driven by astrategy of greater risk taking. Large IBs have fared better than small ones. Betterdiversification, economies of scale, and stronger reputation might have contributed to thisbetter performance. This suggests that developing the industry and increasing competitionshould be achieved through establishing large and well managed IBs that can compete withexisting banks.IBs‘ credit and asset growth were at least twice higher than that of CBs during the crisis,suggesting a growing market share going forward and larger supervisory responsibility.External rating agencies’-assessment of IBs’ risk was generally more favorable or similar tothat of CBs. Higher solvency has facilitated meeting the relatively more robust demand forIslamic banking finance and maintaining stable external ratings. Lending to the less affectedconsumer sector has helped support strong credit and asset growth. 29
  • 36. Annexure/Appendix 30Annexure/AppendixIslamic Economic FundamentalsThe definition of riba in a classical Islamic jurisprudence was "surplus value withoutcounterpart, or to ensure equivalency in real value, and that "numerical valuewas immaterial." During this period, gold and silver currencies were the benchmarkmetals that defined the value of all other materials being traded.The Quran prohibits gambling (games of chance involving money) and insuring oneshealth or property (also considered a game of chance). The hadith, in addition toprohibiting gambling (games of chance), also prohibits bay al-gharar (trading in risk,where the Arabic word gharar is taken to mean "risk" or excessive uncertainty).There are four schools (or Madhhab/factions) of Sunni Muslims are each named bystudents of the classical jurist who taught them. The Sunni schools are: Schools Scope & thought These are comprise of Levant, Turkey, the Balkans, Central Asia, Indian subcontinent, Iran, Afghanistan, China and Egypt. The Hanafi School in Islam Hanafi defines gharar as "that whose consequences are hidden." Ibn Hazm (Founder of Hanafi school) wrote "Gharar is where the buyer does not know what he bought, or the seller does not know what he sold." Followers of Shafi’i school are found in Yemen, Somalia, Djibouti, Eritrea, Ethiopia, Southern Iran, Muslim Southeast Asia, Egypt, Swahili Coast, Maldives and southern Shafii parts of India. The Shafi’i school defined gharar as "that whose nature and consequences are hidden" or "that which admits two possibilities, with the less desirable one being more likely." Maliki North Africa, the Muslim areas of West Africa, Kuwait, the United Arab Emirates and Bahrain. According to Hambali school, gharar as "that whose consequences are unknown" or Hambali "that which is undeliverable, whether it exists or not." Saudi Arabia and Qatar. 30
  • 37. Annexure/Appendix 31Islamic Financial TerminologiesTerm Explanation Gharar is the sale of probable items whose existence or characteristicsGharar are not certain, due to the risky nature that makes the trade similar to gambling. It is a financing facility with the underlying buy and sells transactions between the financier and the customer. The financier buys an asset fromBai Al Inah the customer on spot basis. The price paid by the financier constitutes the(sale and buy-back disbursement under the facility. Subsequently the asset is sold to theagreement) customer on a deferred-payment basis and the price is payable in installments. The second sale serves to create the obligation on the part of the customer under the facility.Bai Bithaman Ajil Sale of goods on a deferred payment basis at a price, which includes a(deferred payment profit margin agreed to by both parties. Interest payment can be avoidedsale) as the customer is paying the sale price which is not the same as interest charged on a loan.Bay mu’ajal The seller can sell a product on the basis of a deferred payment, in(Pre-delivery, installments or in a lump sum. The price of the product is agreed upondeferred payment) between the buyer and the seller at the time of the sale, and cannot include any charges for deferring payment.Bay salam The buyer pays the seller the full negotiated price of a product that the(Pre-payment, seller promises to deliver at a future date.deferred delivery)Ijara A party leases a particular product for a specific sum and a specific time(Lease, lease period. In the case of a lease purchase, each payment includes a portionpurchase) that goes toward the final purchase and transfer of ownership of the product. A manufacturer (contractor) agrees to produce (build) and to deliver aIstisna certain good (or premise) at a given price on a given date in the future.(Deferred payment, The price does not have to be paid in advance (in contrast to bay salam).deferred delivery) It may be paid in installments or part may be paid in advance with the balance to be paid later on, based on the preferences of the parties. It is a pledge given to a creditor that the debtor will pay the debt, fine orKifala liability. A third party becomes surety for the payment of the debt if unpaid by the person originally liable. 31
  • 38. Annexure/Appendix 32Islamic Financial Terminologies Mudaraba Rabb -ul- mal (capital’s owner) provides the entire capital needed to finance a (Trustee finance project while the entrepreneur offers his labor and expertise. Profits are shared contract) between them at a certain fixed ratio, whereas financial losses are exclusively borne by rabb -ul- mal. The liability of the entrepreneur is limited only to his time and effort. Murabaha The seller informs the buyer of his cost of acquiring or producing a specified (Mark–up financing) product. The profit margin is then negotiated between them. The total cost is usually paid in installments. The bank enters into an equity partnership agreement with one or more partners Musharaka to jointly finance an investment project. Profits (and losses) are shared strictly in (Equity participation) relation to the respective capital contributions. These are zero-return loans that the Qur’an encourages Muslims to make to the Qard Hassana needy. Banks are allowed to charge borrowers a service fee to over the (Beneficence loans) administrative expenses of handling the loan. The fee should not be related to the loan amount or maturity. Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may Musawamah not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah (gift) Hibah usually arises in practice when Islamic banks voluntarily pay their customers a gift on savings account balances, representing a portion of the profit made by using those savings account balances in other activities. Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes. Takaful is based on the idea that what is uncertain Takaful (Islamic with respect to an individual may cease to be uncertain with respect to a very insurance) large number of similar individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of large numbers. In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the Wadiah (safekeeping) deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the banks discretion, may be rewarded with Hibah (see above) as a form of appreciation for the use of funds by the bank. Sukuk, is the Arabic term for financial certificates that are the Islamic equivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Sukuk Islam. Hence, Sukuk are securities that comply with the Islamic law (Shariah) and (Islamic bonds) its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets. 32
  • 39. Annexure/Appendix 33Islamic Shariah BoardIslamic banks and banking institutions that offer Islamic banking products and services (IBSbanks) are required to establish a Shariah Supervisory Board (SSB) to advise them and toensure that the operations and activities of the banking institutions comply with Shariahprinciples. On the other hand, there are also those who believe that no form of banking thatinvolves interest payments can ever comply with the Shariah.The Shariah board is a key element of the structure of an Islamic financial institution, carrying theresponsibility of ensuring that all products and services offered by that institution are fullycompliant with the principles of Shariah law.The role of the board also involves the reviewing and overseeing of all potential new productofferings. Additionally, the board may be called on to make a judgment on individual casesreferred to it, relating to whether specific customer business requests are acceptable to theinstitution.Shariah law is derived from studies of both the Quran and the Sunna; with slight modificationsoccur in the interpretations of precisely where the boundaries of compatibility lie, with the resultthat some Shariah boards may deem unacceptable proposals that may be approved by otherboards.With demand for shariah-compliant financial services growing at a faster rate than mainstreambanking, the board can also play a vital role in helping to develop new procedures and productsto position the institution to adapt to industry trends, and customers’ expectations. The boardshould also be closely involved in overseeing Shariah-compliant training programs foremployees. Board members also participate in the preparation of an annual investors’ report onthe bank’s balance sheet, with particular reference to its compliance with Shariah principles.Given the importance of the role of the Shariah boards in ensuring the conformity of theinstitution’s offerings, boards typically include acknowledged experts, such as contemporaryIslamic scholars. It is common for such scholars to sit on the shariah boards of multipleinstitutions; some senior scholars may sit on the boards of 15 or more institutions. 33
  • 40. Annexure/Appendix 34Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)The AAOIFI was established in 1990 and is headquartered in Bahrain. Its main purposeis to issue accounting and auditing standards and governance norms within the Islamicfinance sector.As an independent international organisation, the AAOIFI is supported by institutionalmembers (200 members from 45 countries) including central banks, IFIs and otherparticipants in the international Islamic banking and finance industry.AAOIFI standards have now been adopted by IFIs in many countries such as Bahrain,UAE-Dubai, Jordan, Lebanon, Qatar, Sudan and Syria. The standards cover accounting,auditing, corporate governance, capital adequacy and ethics. Future standards willinclude corporate social responsibility and presentation and disclosure.While the AAOIFI has introduced a range of accounting standards, many IFIs arerequired to report to the market in accordance with local Generally Accepted AccountingPrinciples (GAAP) or International Financial Reporting Standards (IFRS).The treatment of Islamic products under local GAAP or IFRS may well differ from theirtreatment under Islamic principles.An external auditor of IFIs requires skill sets and experience that some accountingorganizations may not possess. 34
  • 41. Annexure/Appendix 35Top 10 Islamic funds by key Performance statistics 35
  • 42. Annexure/Appendix 36TOP 10 ISLAMIC FUNDS BY KEY PERFORMANCE STATISTICS – (Continue) 36
  • 43. Bibliography 37Bibliographya. Annual Review of Islamic Banking & Finance – The Gulf Analysis of Banking & Finance November 2010.b. The Effects of the Global Crisis on Islamic and Conventional Banks, A Comparative Study, by Maher Hasan and Jemma Dridi – International Monetary Fund Paper, September 2010c. Islamic Finance – Austrade, Australian Government January 2010d. Islamic Finance at a Crossroad (by Andrei Juravliov) International Conference Islamic Banking: specifics and prospects March 17 -18, 2009, Moscow.e. Standard & Poors Islamic Finance Report 2008, Earnst & Young Islamic Finance & Banking Report 2009.f. PriceWaterhouseCoopers Ireland (Sukuk - A Catalyst for growth of Islamic Finance) 2009, by Omer Khan (Manager) & Ken Ovens (Partner).g. Islamic Terminologies explanation http://en.wikipedia.org/wiki/Islamic_bankingh. Top 10 Islamic Funds by performance Statistics, Islamic Finance news Guide 2008 http://www.eurekahedge.com 37

×