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Islamic finance 2012

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Islamic finance; Introduction, challenges and opportunities

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Islamic finance 2012

  1. 1. Presented  to:  Dr.  Abeer  Zein   Presented  by:  Ahmed  El-­‐Sayed                                                    ESLSCA  37B                                                    Mohamed  Abdou                                                    Sameh  Ali                                                    Mostafa  Younis  
  2. 2. Contents  •  Major  Economic  Systems.  •  Islamic  Finance:  Moral   ProhibiFons.  •  Permissible  financing  methods.  •  Permissible  Investment  Vehicles.  •  Permissible  Insurance   AlternaFves.  •  Shariah  Governance  Framework   for  Islamic  Financial  InsFtuFons.  •  Value  of  Money  in  Islamic  finance  •  Islamic  Finance:  Challenges  and   opportuniFes  
  3. 3. Economic  Systems  •  Humans  indeed  made  systems  and  who  can  change  them  for   bePer  •  Systems  do  not  need  to  be  modified  or  altered  unless  it  is  not   longer  providing  the  desired  results  •  Economic  System  is  a  set  of  principles  on  which  an  economy   can  run  and  make  decisions  about  the  central  problems  it  faces   in  the  form  of  scarcity  of  resources  and  unlimited  wants.  
  4. 4. Major  Economic  Systems  •  Capitalism  •  Socialism  •  Mixed  Economy  •  Islamic  Economic  System  
  5. 5. Capitalism  •  Economic  system  based  on  the   private  ownership  of  the  means   of  producFon,  distribuFon,  and   exchange,  characterized  by  the   freedom  of  capitalists  to  operate   or  manage  their  property  for   profit  in  compeFFve  condiFons.  •  It  shiTs  the  break  even  line   further  away  from  the   entrepreneur  and  crowds  out   entrepreneurs  who  cannot  afford   to  keep  feeding  capitalists.  
  6. 6. Capitalism  Fundamental    •  Right  of  Private  Property  •  No  Government  IntervenFon  •  Freehand  to  Market  Forces  •  Dependence  on  Invisible  hand  •  Freedom  of  Choice  in  ProducFon  •  Freedom  of  Choice  in  ConsumpFon  
  7. 7. Capitalism  CriFcal  Analysis  •  Issues  of  Equity   –  unscrupulous  consumpFon  and  imposing  externaliFes  on  society.   –  precedence  of  self  interest  over  social  prioriFes.   –  unequal  distribuFon  of  income       –  Prices  not  reflect  urgency   –  Social  Darwinism    •  Need  for  Redefining  PrioriFes   –  Growth  Vs  Development   –  Profit  OpFmizaFon  Vs  Social  OpFmizaFon   –  What  goes  around  comes  around!  •  Interest  Dilemma     –  Interest  is  the  price  of  risk   –  Share  in  the  profit  of  the  borrower   –  Interest  is  a  rent  on  money  
  8. 8. Socialism  •  Socialism  was  to  act  as  a  pre-­‐cursor  to   Communism.                (Robert  Owen,  Charles  Fourier,  Pierre-­‐Joseph  Proudhon,   Louis  Blanc,  Charles  Hall  and  Saint-­‐Simon)  •  socialism  as  a  specific  historical  phase   that  will  displace  capitalism  as  a   precursor  to  communism.   (Karl  Marx  )  
  9. 9. Socialism  Fundamental  •  CollecFve  property  •  Planned  Economy  •  Decisions  in  CollecFve  Interest  •  Reduced  Income  Inequality  •  RestricFon  on  Market  forces  •  Centralized  Economy  •  Non-­‐existence  of  Private  sector  
  10. 10. Socialism  CriFcal  Analysis  •  government  is  only  the  big  capitalist   accredited  with  the  responsibility  to   operate,  manage  and  administer  the   overall  economy  without  giving  society   and  individuals  any  recourse  to  challenge   the  government.  •  The  problem  in  distribuFon  of  income    •  Land  has  an  intrinsic  value  and  its  owners   receive  rent  on  land.    •  Labor  also  earns  wages  even  when  the   entrepreneur  suffers  loss.    •  Value  of  producFon  i.e.  prices  of  goods  is   not  always  sufficient  to  create  surplus   aTer  paying  wages,  rent  and  interest.    
  11. 11. Hybrid  Economic  System  •  Mixed  economy  is  a  compromise  between  capitalism  and  socialism.    •  A  mixed  economy  takes  the  valuable  features  of  both.    •  Most  countries  can  be  classified  as  mixed  economies  in  the  real   world.    
  12. 12. Hybrid  System  Fundamental  •  Coexistence  of  Public  and  Private  Sector  •  Government  RegulaFon  and  Prices  •  Government  RegulaFon  and  Market  ImperfecFon  •  Government  IntervenFon  and  Income  distribuFon  •  Public  Sector  and  Social  ObjecFves  •  PromoFon  of  Private  Sector  •  DeregulaFon,  LiberalizaFon  and  PrivaFzaFon  
  13. 13. CriFcal  Analysis  •  It  sFll  lacks  an  ethical  foundaFon  to  foster  social  opFmizaFon   and  development  at  a  grand  scale  to  influence  social  and   human  development.    •  It  has  retained  interest  free  financial  system  which  has  created   at  least  two  havocs  i.e.  one  in  East  Asia  in  1990s  and  the  Great   Recession  since  2007.  Therefore,  much  of  the  criFcism  that  is   made  on  Capitalism  holds  true  for  Mixed  economy  as  well.  
  14. 14. Islamic  System  •  Islamic  economic  system  in  its  true   sense  is  not  present  in  any  country.    •  It  is  a  blend  of  natural  features   present  in  Capitalism  such  as  right   to  private  property,  private  pursuit   of  economic  interest,  use  of  market   forces  etc.  •  Interest  free  economy,  moral  check   on  unbridled  self-­‐pursuit  and   provision  of  socio-­‐economic  jusFce   to  achieve  the  goals  of  Socialism  as   far  as  is  naturally  possible  without   denying  individual  freedom  and   incenFves.    
  15. 15. Islamic  System  Fundamental    •  Equitable  distribuFon  of  Income  •  ProhibiFon  of  Interest  •  Spending  in  the  way  of  Allah  •  ProtecFon  of  Rights  •  Provision  of  JusFce  •  Equality  of  OpportuniFes  •  No  Gender  and  Ethnic  DiscriminaFon  
  16. 16. Dealing  with  Scarcity  of  Capital  in  an  Islamic   Economy  •  Business  Cycles  will  conFnue  to  exist  as  they  are  natural,  but  the   loss/profit  would  be  shared.  •  An  imposiFon  of  wealth  tax  (Zakah)  would  ensure  that  loanable   funds  increase  even  when  there  is  no  interest.  •  Tax  exempFon  would  also  ensure  the  availability  and  supply  of   loanable  funds.  •  ExempFon  of  investment  in  income  bonds  would  also  ensure  the   availability  and  supply  of  loanable  funds  in  income  bonds  market.  •  corporaFons  will  no  longer  be  able  to  generate  finance  through   interest  based  debt.  Therefore,  increase  in  listed  companies  will   expand  the  market  and  diversify  trading  opportuniFes  for   investors.  
  17. 17. Islamic  System  CriFcal  Analysis  •  Comparing  Islamic  ideals  with  pracFced  capitalism:   Making  that  systems  cannot  be  analyzed  judicially  with  taking   ideals  of  one  and  the  pracFce  of  the  other.  
  18. 18. ISLAMIC  FINANCE  MORAL  PROHIBITIONS   •  Shariah’ah;  comprises  two   sources;   – Quran     – Sunna   •  Fiqh;  body  of  laws  deducted   from  Shariah’ah   •  SePled  2  Major   principles;   – Halal;  permiPed  acFviFes   – Maslaha;  public  goods  
  19. 19. ISLAMIC  FINANCE  MORAL  PROHIBITIONS  (cont,)  –  riba:           interest  earnings  or  usury  and  money  lending  –  Haram:         such  as  direct  or  indirect  associaFon  with  lines  of   business  involving    alcohol,  pork  products,  firearms,   tobacco,  and  adult  entertainment  –  Maisir:         speculaFon,  bekng,  and  gambling,  including  the   speculaFve  trade  or     exchange  of  money  for  debt   without  an  underlying  asset  transfer  –  bay’  al  inah:         the  trading  of  the  same  object  between  buyer  and  seller    –  gharar:         preventable  uncertainty;  such  as  all  financial   derivaFve  instruments,     forwarding  contracts,  and   future  agreements  
  20. 20. Permissible  financing  methods   SUKUK  •  In  the  modern  Islamic  perspecFve,  sukuk  lies  in  the            concept  of  asset  moneFzaFon  ,  or  also  called  securiFzaFon    •  to  enable  organizaFons  (1)  to  raise  capital  in  a  Shariah-­‐compliant  fashion,    (2)  expanding  the  investor  base    (3)  offering  investment  opportuniFes  to  new  groups.    •  While  a  convenFonal  bond  is  a  promise  to  repay  a  loan,  sukuk   consFtutes  parFal  ownership  in  a  debt  (Sukuk  Murabaha),   asset  (Sukuk  Al  Ijara),  project  (Sukuk  Al  IsJsna),  business   (Sukuk  Al  Musharaka),  or  investment  (Sukuk  Al  IsJthmar).  
  21. 21. Sukuk  –  Guiding  principles  •  Islamic  cerFficates  of  investment  referred  to  as  Sukuk  involve  structuring  of  pools  of  Shariah   compliant  assets  •  Investors  have  an  undivided  interest  in  the  underlying  assets  and  are  therefore  enFtled  to   share  jointly  the  related  returns  •  Could  take  place  through  applicaFon  of  various  Shariah  principles  such  as  Ijarah,  Salam,   Musharakah,  Mudaraba  and  mixed  pools.  •  From  credit  perspecFve,  investors  expect  the  Sukuk  issue  to  represent  the  same  credit  risk   as  that  of  the  ulFmate  issuer/guarantor.  
  22. 22. Cost-­‐plus  sales  (Murabaha)  •  In  this  sale,  the  buyer  knows  the  price  at   which  the  seller  obtained  the  object  to   be  financed,  and  agrees  to  pay  a   premium  over  that  iniFal  price  Ex.  purchase  this  item  on  my  behalf  at  this   price,  and  I  shall  give  you  a  profit  margin  
  23. 23. Credit  sales  (bay  bi-­‐thaman  ajil)   •  When  a  customer  approaches  an   Islamic  bank  to  finance  a  purchase   through  mur ̄abaha  the  payment  of   the  price  is  usually  deferred,  and   most  commonly  paid  in  installments.   •  rate  of  return  is  thus  guaranteed  (up   to  the  risk  of  default  on  payments  by   the  buyer)  over  a  fixed  period  of  Fme  
  24. 24. Leasing  (ijarah)  •  the  lease  contract  is  not  a  sale  of  the  object,  but  rather  a  sale   of  the  usufruct  (the  right  to  use  the  object)  for  a  specified   period  of  Fme.  •  The  most  important  financial  difference  between  Islamically   permiPed  leasing  and  convenFonal  financial  leasing  is  that  the   leasing  agency  must  own  the  leased  object  for  the  duraFon  of   the  lease  
  25. 25. Salam  &  IsFsna´a    •  Bai  As-­‐salam  or  Salam  means  a  contract  in  which  advance  cash  payment  is  made  for   goods  to  be  delivered  later  on.    •  The  seller  undertakes  to  supply  some  specific  goods  to  the  buyer  at  a  future  date  in   exchange  of  an  advance  price  fully  paid  at  the  Fme  of  contract.  •  Salam-­‐  also  know  as  sales  by  order.  •  IsFsna    is  almost  the  same  ,  it  can  be  used  for  financing  the  manufacture  or   construcFon  of  houses,  plants,  projects,  bridges,  roads  and  highways.  By  way  of   parallel  IsFsna  contract  with  subcontractors,.    •     
  26. 26. Partnerships  (musharaka  and  mudaraba)   •  where  the  financing  agency   and  the  customer  share  the   ownership  of  real  estate.   •  Mudarabah  cerFficates  or   Sukuk  represent  projects  or   acFviFes  managed  on   Mudarabah  principle  by   appoinFng  any  of  the  partners   or  any  other  person  as   Mudarib  
  27. 27. Permissible  Investment  Vehicles  •  InvesFng  in  equiFes   – Common  stocks  are  Islamically  permiPed.   – Possible  to  create  mutual  funds  in  such  stocks  invesFng  in  a   porqolio  of  permiPed  stocks   •  some  Islamic  countries,  some  “Islamic  mutual   •  funds”  also  calculate  and  pay  the  appropriate  Zak¯ˉah  on   shares  on  behalf  of   •  their  investors.   •  companies  which  neither  pay  nor  receive  interest  (difficult  to   control  )  
  28. 28. Secondary  Market  of  Sukuk  •  Shirkah  based  and  Ijarah  Sukuk;  MarkeFng  based  on  the  market  signals   and  forces.  •  Murabaha,  Salam  and  IsFsna´a  Sukuk  only  at  face  value  (Hawalah  rules)  
  29. 29. The  Dow  Jones  Sukuk  Index    hPp://www.djindexes.com/sukuk/  •  Different criteria to satisfy: – Comply with both Sharia Law and the standards of the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) for tradable sukuk. – Must have a minimum maturity of one year – Minimum issue size of US$200 million – Minimum rating of at least BBB-/Baa3 by leading rating agencies.
  30. 30. Permissible  Investment  Vehicles  •  “Fixed  income”  funds   – Majority  of  convenFonal  fixed  income  investments  (e.g.  CDs,   government  bonds,  money  market  accounts,  etc.)  include   forbidden  Rib¯ˉa   – Do  we  have  islamic  fixed  income  funds  ?   • Consider  Real  estate  Ijarah  in  a  porqolio  
  31. 31. Permissible  Insurance   AlternaFves  •  Thinking  about  reducing  certain  types  of  risk  •  The  majority  of  Islamic  jurists  have  concluded   that  regular  insurance  contract  is  invalid  based   on  the  prohibiFon  of  Gh¯ˉarar.  •  insurance  companies’  investments  in  interest-­‐ bearing  bonds  render  such  contracts  invalid   based  on  the  prohibiFon  of  Rib¯ˉa  •  Why  is  convenFonal  insurance  not  permissible   in  Islam?   •  Uncertainty  (Gharar)   •  Gambling  (Maisir)   •  Interest  (Riba)  
  32. 32. Permissible  Insurance   AlternaFves  •  CooperaFve  insurance   – group  of  subscribers  contribute  to  a  pool  of  funds.   Whenever  one  of  the  members  makes  a  legiFmate  claim  ),   they  draw  money  out  of  the  pool   – funds  in  the  pool  are  invested  in  an  Islamic  manner  without   exposing  the  policy  holders  to  any  extra  significant  risk  
  33. 33. Shariah  Governance  Framework  for  Islamic  Financial   InsJtuJons ObjecJves:  • Set  out  the  expectaFons  of  the  IFI.    • Provide  a  comprehensive  guidance  to  the  key  organs.    • Outline  the  funcFons  relaFng  to  Shariah  review,  Shariah  audit,  Shariah  risk  management  and  Shariah    research.  
  34. 34. Approach:  •  General  requirements  of  the  Shariah  governance  framework.  •  Oversight,  accountability  &  responsibility.  •  Independence.  •  Competency.  •  ConfidenFality  &  consistency.  •  Shariah  compliance  &  research  funcFons.
  35. 35. key  organs  in  the  IFI’s  Shariah  governance  framework
  36. 36. Value  of  Money  
  37. 37. The  people  not  conversant  with  the  principles  of  Shari‘ah  and  its  economic  philosophy    someFmes  believe  that  abolishing  interest  from  the  banks  and  financial  insFtuFons  would    make  them  charitable,  rather  than  commercial,  concerns  which  offer  financial  services    without  a  return.    
  38. 38. The Islamic Shari‘ah has a differentset-up for the purpose of profit, Theprinciple is that the person extendingmoney to another person must decidewhether he wishes to help theopposite party or he wants to share hisprofits. If he wants to help theborrower, he must rescind from anyclaim to any additional amount. Hisprincipal will be secured andguaranteed, but no return over andabove the principal amount islegitimate. But if he is advancingmoney to share the profits earned bythe other party, he can claim astipulated proportion of profit actuallyearned by him, and must share his lossalso, if he suffers a loss.
  39. 39. It is thus obvious that exclusionof interest from financial activitiesdoes not necessarily mean thatthe financier cannot earn a profit.If financing is meant for acommercial purpose, it can bebased on the concept of profitand loss sharing, for whichmusharakah and mudarabah havebeen designed since the veryinception of the Islamiccommercial law.

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