Islamic bonds

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Islamic bonds

  1. 1. Islamic Bonds
  2. 2. Sharia, the religious law of Islam. As Islammakes no distinction between religion andlife, Islamic law covers not only ritual butmany aspects of life.Islamic law is an important legal influence,to a greater or lesser degree, in nearly allnations with a Muslim majoritypopulation; the primary exception isTurkey, which has been a secular statesince Atatirk.
  3. 3. Islamic banking refers to a system of banking or bankingactivity that is consistent with the principles of Islamiclaw, Sharia.Sharia prohibits (Haram or forbidden) the payment oracceptance of interest fees for the lending and acceptingof money respectively, (called Riba or usury) for specificterms, as well as investing in businesses that providegoods or services considered contrary to its principles.Islamic banking is restricted to Islamically acceptabletransactions, which exclude those involving alcohol,pork, gambling, etc. Thus ethical investing is the onlyacceptable form of investment, and moral purchasing isencouraged
  4. 4. Islamic Banking is growing at a rate of 10-15% peryear and with signs of consistent future growth.Islamic banks have more than 300 institutionsspread over 51 countries, including the UnitedStates, as well as an additional 250 mutual fundsthat comply with Islamic principles.It is estimated that over US$822 billion worldwidesharia-compliant assets are managed according toThe Economist. This represents approximately0.5% of total world estimated assets as of 2005
  5. 5. MurabahaIn an Islamic mortgage transaction, instead of loaningthe buyer money to purchase the item, a bank mightbuy the item itself from the seller, and re-sell it to thebuyer at a profit, while allowing the buyer to pay thebank in installmentsThe fact that it is profit cannot be made explicit andtherefore there are no additional penalties for latepayment. In order to protect itself against default, thebank asks for strict collateral. The goods or land isregistered to the name of the buyer from the start of thetransaction.
  6. 6. This mortgage transaction allows for a floating rate in the form ofrental. The bank and borrower form a partnership entity, bothproviding capital at an agreed percentage to purchase the property.The partnership entity then rents out the property to the borrowerand charges rent. The bank and the borrower will then share theproceeds from this rent based on the current equity share of thepartnership.At the same time, the borrower in the partnership entity also buysthe banks share of the property at agreed installments until thefull equity is transferred to the borrower and the partnership isended.If default occurs, both the bank and the borrower receive aproportion of the proceeds from the sale of the property based oneach partys current equity
  7. 7. MusharakaThis approach is used in business transactions.Islamic banks lend their money to companies byissuing floating rate interest loans. The floatingrate of interest is pegged to the companysindividual rate of return. Thus the banks profiton the loan is equal to a certain percentage ofthe companys profits. Once the principal amountof the loan is repaid, the profit-sharingarrangement is concluded. This practice is called
  8. 8. Sukuk "legal instrument, deed, check") is theArabic name for a financial certificate but canbe seen as an Islamic equivalent of bond.Fixed income, interest bearing bonds arenot permissible in Islam, hence Sukuk aresecurities that comply with the Islamic lawand its investment principles.
  9. 9. A key technique to achieve capital protectionwithout amounting to a loan is a bindingpromise to repurchase certain assets, e.g. inthe case of Sukuk Al Ijara, by the issuer. In themeantime a rent is being paid, which is oftenbenchmarked to an interest rate like LIBORFor Islamic financial institutions the trading andselling of debts, receivables (for anything otherthan par), conventional loan lending and creditcards are not permissible.
  10. 10. Sukuk securities tend to be bought and held and,as a result, little of the securities enter thesecondary market.Only public Sukuk are able to enter this market, asthey are listed on stock exchanges.The secondary market is a niche segment withvirtually all of the trading done at the institutionlevel. The size of the secondary market remainsunknown, though LMC Bahrain state theytraded $55.5 million of Sukuk in 2007.
  11. 11. Sukuk offer investors fixed return on their investmentswhich is also similar in appearance to interest in thatthe investors return is not necessarily dependent onthe risks of that particular venture.Banks that issue Sukuk are investing in assets--notcurrency. The return on such assets takes the form ofrent, and is evenly spread over the rental period.The productivity of the asset forms the basis of the fixedincome stream and the return on investment.Given that there is an asset underlying the value of thecertificate, there is more security for the investorsinvolved, accounting for the additional appeal of Sukukas a method of financing for investors.

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