Presentation to the International Center for Education in Islamic Finance, Kuala Lampur Malaysia, April 2012

1. Taking Islamic Finance to the Next Level:
Key Challenges and Opportunities
Mahmoud Mohieldin*
Managing Director
The World Bank
Presentation to the
International Center for Education in Islamic Finance
Kuala Lumpur, Malaysia
April 30, 2012
*Disclaimer: The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors
of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work.

2. Key questions
 Where is Islamic finance today?
 What role can Islamic finance play in economic
development?
 Where are the key opportunities?
 What are the main challenges?
 What is the contribution of the World Bank?
Introduction
2


3. Islamic Finance Today
3

0
200
400
600
800
1000
1200
2006 2007 2008 2009 2010
US$billions
Global Shariah-Compliant Financial Assets
Banking Assets (1) Sukuk Outstanding (2) Assets Under Management (3)
Sources: (1) Deutsche Bank 2010;(2) International Islamic Financial Markets database, March 2012; and (3) Ernst and Young 2011a.

4. Islamic Finance Today
4

19%
10%
33%
21%
27%
43%
24%
9%
5%
19%
13%
17%
32%
15%
Malaysia Indonesia Turkey Saudi Arabia UAE Qatar Median
Growth of Islamic Banking and Conventional Banking Assets in Selected Countries (2006-2010)
Islamic Banking Conventional Banking
22%
10%
31%
13%
20%
48%
21%
9% 4%
19% 14% 19%
26%
17%
Malaysia Indonesia Turkey Saudi Arabia UAE Qatar Median
Growth of Islamic Banking and Conventional Banking Deposits in Selected Countries (2006-2010)
Investmetns: Islamic Banking Deposits: Conventional Banking
Source: Deutsche Bank 2011, 8.

5. Islamic Finance Today
5

Malaysia
63%
United Arab
Emirates
16%
Saudi Arabia
8%
Bahrain
4%
Indonesia
3%
Others
2%
Qatar
2%
Pakistan
1%
Kuwait
1%
Cumulative Sukuk Issuances (1996-2010)
0
100
200
300
400
500
600
700
800
900
0
10
20
30
40
50
60
2006 2007 2008 2009 2010
US$billions
Global Sukuk Issuances (volume and number)
Sovereign Quasi Sovereign
Corporate Number of Sukuk Issuances
(right side vertical axis)
Source: Islamic Finance Information Services Database, October 2011.

6. The Role of Islamic Finance in Development
6

 Deepening financial intermediation
 Enhancing financial inclusion
 Strengthening financial stability

7. 7

 Deepening financial intermediation
(M2 as a share of GDP)
Source: World Development Indicators database, The World Bank, April 2012
The Role of Islamic Finance in Development
TajikistanChadGuineaNiger Turkmenistan
Azerbaijan
SudanCameroon
Kyrgyz
Republic GabonUgandaBurkina FasoNigeriaAfghanistanComorosMauritania KazakhstanMaliMozambiqueBeninTogoSenegalYemen, Rep.
Iran, Islamic
Rep. TurkeyIraqIndonesiaPakistanBangladesh
Tunisia
AlgeriaAlbania
Syrian Arab
RepublicDjibouti
Egypt, Arab
Rep.Morocco
Jordan Malaysia
Lebanon
0
100
200
300
400
500
600
700
0 2000 4000 6000 8000
Non-GCC OIC
M2 as a
% of
GDP
GDP per
Capita
(Current US$)PolandEstoniaHungarySlovenia
Slovak
Republic
Czech RepublicKorea, Rep. DenmarkSwedenUnited StatesAustraliaNew ZealandFinlandIsraelGreeceItaly
FranceBelgiumPortugal Canada
United
Kingdom
Spain
AustriaIrelandNetherlandsGermany
Japan
Luxembourg
0
100
200
300
400
500
600
700
0 20000 40000 60000 80000 100000
GDP per Capita
(Current US$)
M2 as a %
of GDP
OECDC

8. 8

 Deepening financial intermediation
(Credit to Private Sector as a share of GDP)
Jordan
Afghanistan
Albania
Indonesia
Pakistan
Bangladesh
Tajikistan
Turkey
Turkmenistan
Tunisia
Algeria
Iraq
Gabon
Gambia, The
Kazakhstan
Lebanon
Maldives
Mali
Malaysia
Egypt, Arab Rep.
Morocco
Niger0
20
40
60
80
100
120
140
160
180
200
0 1000 2000 3000 4000 5000 6000 7000 8000
Credit to Private
Sector
% of GDP
GDP per Capita
(Current US$)
Non-GCC OIC
Australia
Austria
Belgium
Canada
Czech Republic
Denmark
Estonia Finland
France
Germany
Greece
Hungary
Iceland
Ireland
Israel
Italy
Japan
Korea, Rep.
Luxembourg
Netherlands
New Zealand
Norway
Poland
Portugal
Slovak
Republic
Slovenia
Spain
Sweden
SwitzerlandUnited Kingdom
United States
0
20
40
60
80
100
120
140
160
180
200
0 20000 40000 60000 80000 100000
Credit to Private
Sector
% of GDP
GDP per Capita
(Current US$)
OECD
Source: World Development Indicators database, The World Bank, April 2012
The Role of Islamic Finance in Development

9. 9

 Enhancing financial inclusion
(Adults with an account at a formal institution)
Source: www.worldbank.org/globalfindex , World Development Indicators database, The World Bank, April 2012
The Role of Islamic Finance in Development
0
20
40
60
80
100
120
0 10000 20000 30000 40000 50000 60000 70000 80000 90000
Accountataformalfinancialinstitution(%age15+)
GDP per capita (current US$ - Average: 2000-2010)
OIC - Non GCC
countries
Non OIC countries

10. 10

 Enhancing financial inclusion
0.61%
0.79%0.78%
0.97%
0.92%
1.19%
Deposits: Value as
percentage of GDP
Loans: Value as
percentage of GDP
OIC countries
Developing
countries
Low-income
countries
Limited scale of Microfinance deposits and loans
The Role of Islamic Finance in Development
Economic development and growth, along with social
justice, are the foundational elements of an Islamic
economic system.
• Zakat
• Sadaqat
• Qard-al-Hassan
• Waqf
Distributive
and Re-
Distribution
Institutions
• Small-Medium Enterprises
(SME)
• Micro-Finance (MF)
• Micro-Insurance (Micro-
Takaful)
Risk-Sharing
or Hybrid
Alternatives
Source: Mohieldin et al., 2011.

11. 11

 Strengthening financial stability:
o Consistent evidence of higher capitalization of Islamic banks.
o Eliminates pure debt securities from the financial system.
o Calls for bank deposits to be collected on a profit/loss- (PLS)
sharing basis rather than fixed predetermined liabilities.
o Ensures a close link between the real economy and financial
sector.
o Affirms property rights and contract enforcement (honoring of
debt obligations).
o Emphasizes principles of morality and ethics in business conduct.
o Advocates the sharing of risk and reward between the rich and
poor.
The Role of Islamic Finance in Development

12. Opportunities
12

 Commodity boom
 Quality improvements
 Islamic finance windows at conventional financial
institutions
 Shariah compliant indexes

13. Opportunities
13

 The commodity boom has generated surpluses in some Muslim countries that
need to be allocated through financial intermediaries and sovereign wealth funds.
0
100
200
300
400
500
600
700
800
UAE
China
Singapore
China–HongKong
Australia
Kuwait
Russia
Algeria
Norway
SaudiArabia
Azerbaijan
Brunei
SouthKorea
Ireland
Kazakhstan
Libya
Qatar
Malaysia
SouthKorea
US–Alaska
USD billion Assets of Top 20 Global SWF
0
20
40
60
80
100
120
0
50
100
150
200
250
300
350
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
US$ / BarrelUSD billion
Current Account of GCC Vs. Oil Prices
Current Account Balance
(a) (left scale)
Crude Oil-Brent Dated Free
on Board U$/Barrel (b)
(right scale)
Source: Sovereign Wealth Funds Institute, March 2012
Source: (a) Institute of International Finance database, April 2012
(b) Reuters

14. Opportunities
14

 Quality improvements
o Quality has improved substantially over the years.
o New instruments have been developed.
o Islamic finance is increasingly being seen to offer
practical alternatives to conventional instruments for
savers and investors.

15. Opportunities
15

 Conventional financial institutions are offering Islamic
windows
o Over the past three years, ten major international
conventional financial institutions have opened Islamic
finance windows.
o This translates into Islamic finance products potentially
being available in an additional 44000 outlets/branches
across more than 70 countries.

16. Opportunities
16

 Shariah compliant indexes
0
20
40
60
80
100
120
140
Selected S&P – Shariah Compliant Stocks Indices
S&P DEV EX IS PROP HTL/RSRT & ENT $ - PRICE INDEX
S&P DEV EX IS PROP OFFICE SP-EQ $ - PRICE INDEX
S&P DEV EX IS PROP RETAIL-EQ $ - PRICE INDEX
0
500
1000
1500
2000
2500
3000
3500
Selected Dow Jones – Shariah Compliant Stocks
Indices
DJ ISLAMIC EUROPE TITANS 25 - PRICE INDEX
DJ ISLAMIC TECHNOLOGY - PRICE INDEX
DJ ISLAMIC US LARGE CAP - PRICE INDEX
Source: Reuters

17.  Improving regulatory oversight
 Rebalancing tax treatment
 Strengthening insolvency frameworks
 Promoting standardization
 Ensuring adequate liquidity for long term financing
 Establishing sound risk-management practices
Key Challenges
17


18.  Improving regulatory oversight:
Key Challenges
18

o Progress needs to be made on improving the regulatory framework
and strengthen regulations.
o International experience points to two approached:
 Minimal alterations: United Kingdom
 Dual approach: Bahrain and Oman
o Consensus remains to be established on a widely accepted and
comprehensive risk based supervisory approach , essential for
mitigating the risk of systemic failures.

19.  Rebalancing tax treatment:
Key Challenges
19

o Conventional debt often receives advantageous tax treatment (encouraging
leverage), while some Islamic finance products face double taxation.
o Malaysia and Thailand took fundamental steps to ensure that Islamic
financial transactions operate on a level playing field:
 In Malaysia, this principle has extended to ensuring that profits, asset
transfers, and expatriation of profits by foreigners are treated equally,
whether occurring under conventional or Islamic financial contracts.
 In Thailand, a package of proposed tax changes for Sukuk issuances is
making its way through the legislative process to address the main
hurdles faced by Sukuk issuers.

20.  Strengthening insolvency frameworks:
Key Challenges
20

o More work is needed to ensure convergence between best insolvency
practices on the conventional and Shariah-compliant sides.
o The need to establish reliable mechanisms for dealing with Sukuk
defaults, and addressing adverse outcomes, with special adaptations for
risk sharing.
o Setting up these mechanisms requires the specification of parties’
rights under Shariah-compliant finance, especially in the case of cross-
border transactions.

21.  Promoting standardization:
Key Challenges
21

o Lack of standardization and cohesion, especially in sukuk products,
hinders the growth potential of Islamic finance
o The industry would benefit from more widely accepted benchmarks
and indices.
o Innovation and knowledge sharing between various market players
are essential to facilitate the standardization and unification of global
markets for Islamic financial products.

22.  Ensuring adequate liquidity for long term financing:
Key Challenges
22

o The divergence between fully guaranteed Sukuk by sponsors, partially
guaranteed Sukuk, and those that are not covered by any guarantee.
o Uncommon and poor understanding of various Sukuk structures limits
diversification and hinders growth potentials of the industry.

23.  Establishing sound risk-management practices:
Key Challenges
23

o Basel III compliance and concerns about liquidity risk management
need to be addressed.
o Relying on equity-based finance, Islamic banks incur a higher cost
of capital, since by definition they hold more equity than
conventional banks.
o More work is needed to find a greater convergence on the rules
governing risk weighting and the treatment of investment accounts
in Islamic banks.

24.  Joining other MDBs in tapping Islamic financial markets
 Insolvency and Corporate governance frameworks
 Knowledge sharing and capacity building
Contribution of the World Bank
24


25.  Tapping Islamic financial markets
Contribution of the World Bank
25

o Financial products include the Multilateral Investment Guarantee Agency’s
(MIGA) transaction in Indonesia in FY11, using a murabaha instrument
involving exposure of some US$450 million to improve the quality of the
mobile network and increase population coverage.
o MIGA also had a US$ 27 million in guarantees supporting the construction
of the Doraleh Container Terminal in Djibouti in 2007.
o The International Bank for Reconstruction and Development (IBRD)
launched a five-year RM760 million Islamic bond in 2005.
o International Finance Corporation (IFC) recently issued a US dollars-
denominated 100 million - non-amortizing – Sukuk issue with a five-year
maturity against a portfolio of leases which was well-received in the market.

26.  Insolvency and Corporate governance:
Contribution of the World Bank
26

o Collaborating with IFSB to establish widely accepted Principles for Effective
Insolvency and Creditor Rights Systems – the essentials of an effective
insolvency regime.
o The World Bank is in the process of finalizing the Supplemental Corporate
Governance Guidelines for Islamic financial institutions .

27.  Knowledge sharing and capacity building.
Contribution of the World Bank
27

o Islamic Development Bank
o IFSB
o AAIOFI
o Collaboration with research centers and universities, including:
 INCEIF
 Oxford Center for Islamic Studies
 Harvard – Islamic Finance Project – Islamic Legal Studies Program

28.  Within a relevant framework of regulations, standards and
corporate governance, Islamic finance, based on its main
principles and through continued investment in human
capital can play an ever-more important role in ensuring
broadened financial access to support sustainable
development.
Conclusion
28


29. Thank You
29