Frontiers in Islamic Finance       Muhammad Hanif         Fellow CMA
Why Islamic Finance• About 1,500 Billions (25% of Global  Population) is Muslim• Riba (Usury & Interest) which is foundati...
Why Islamic Finance• Conventional Banking led to Financial crisis  due to lack of support from real assets• Islamic Bankin...
Principles of Islamic Finance• Prohibition of interest and usury in financial  dealings. Al-Qura’n (30:39, 4:161, 3:130, &...
Principles of Islamic Finance• Profit and loss sharing. According to this  principle capitalist demanding profit on capita...
Features of Islamic Banking• The principal activity of customer of Islamic  financial institutions (IFIs) must not be  pro...
Features of Islamic Banking• Islamic banks cannot service depositors like  conventional banking with a predetermine  retur...
Features of Islamic Banking• Under partnership business IFIs cannot limit  their share in profit only also loss in  partne...
Historic Development• First ever objection on receipt of interest from  banks was raised by Syed Abul Aala Modoodi• Object...
Historic Development• Article 37 dealing with principles of policy  enjoins upon the state to eliminate riba as  early as ...
Historic Development• Revolution of Iran 1979 which eliminated interest  from economy• Interest free banking economy-wide ...
Historic Development• Raja Zafar Ul Haq Commission Report in 1997• Supreme Court decision (1999) [Justice retd  Taqi Usman...
Industry Overview• By the end of 2011, Global Volume US $1,289  Billions in more than 50 countries with above  300 Institu...
Industry Overview US $ Billions1400                                                             12891200                  ...
Industry Overview-Y-o-Y Growth35%30%25%20%15%10%  5%  0%            2007   2008             2009        2010   20112/12/20...
Industry Overview• By the end of Sept; 2012, in Pakistan Volume  of Assets is PKR Billions 741; Deposits 627;  Investment ...
Industry Overview-PKR Billions 800                                                              741 700                   ...
Industry Overview-Growth YoY74%72%70%68%66%64%62%60%58%            Deposits   Financing         Branch network   Overall2/...
Comparative Performance• Hanif et.al 2012• Study period 2005-09• Sample includes 22 conventional banks and 05  Islamic ban...
Comparative Performance-ProfitabilityPerformance   Conventional Banks Islamic Banks   CommentsMeasureROA           1.44%  ...
Comparative Performance-LiquidityPerformance          Conventional Banks Islamic Banks   CommentsMeasureNet Loans/        ...
Comparative Performance-Credit RiskPerformance     Conventional Banks Islamic Banks   CommentsMeasureComn Equity/    10.10...
Comparative Performance-SolvencyTo measure Solvency following model was usedS = 1.5* CA+1.2*EA +3.5* CAR+0.6*NPL+0.3*CI+04...
Products-Financing Tools• Deposits-Liabilities & Equity            • Musharaka            • Mudaraba            • Loans• F...
Products-Financing Tools• Musharaka            is a partnership in capital; management by all or any    one of the partner...
Products-Financing Tools• Murabaha            is a selling mode of financing where by cost and profit,    both are disclos...
Products-Financing Tools• Ijarah       is a rental based mode of financing whereby asset is purchased    by bank to delive...
Portfolio Make up [July-06 to Sep 10]45%40%35%30%25%20%15%10%  5%  0%2/12/2013                Muhammad Hanif ACMA        28
Capital Market• Equity Investments                   Equity shares are Musharaka based    investment Instruments with vari...
Capital Market• Equity Investments                Although investment in equities is allowed,    however in order to inves...
Capital Market- Screening Criteria KMI-30• Halal Business of the Investee Company• Interest Based Financing: Interest base...
Global Impact of Islamic Finance•   Opportunity of Shari’a compliant financing•   Petro dollars•   Study of Islamic teachi...
Challenges• Use of Kibor as bench mark for profit• Use of par value in selling of shares of IFI in House financing• Use of...
How to overcome Challenges            Answer is well educated and trained Human Resource                                Yo...
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Frontiers in islamic finance

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presentation on Islamic Banking, its future, opportunities, challenges and solutions.

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Frontiers in islamic finance

  1. 1. Frontiers in Islamic Finance Muhammad Hanif Fellow CMA
  2. 2. Why Islamic Finance• About 1,500 Billions (25% of Global Population) is Muslim• Riba (Usury & Interest) which is foundation of modern conventional banking is Prohibited for Muslims• There are four sets of verses in Holy Qura’n about Riba [Ar-Rum 30:39] [An-Nisaa 4:161] [Al-i-Imran 3:130] [Al- Baqarah 2:275-281]2/12/2013 Muhammad Hanif ACMA 2
  3. 3. Why Islamic Finance• Conventional Banking led to Financial crisis due to lack of support from real assets• Islamic Banking is asset based financing, hence can serve as hurdle in the way of financial crisis• Islamic Banking is equity based financing which discourage the passive behavior of Investors2/12/2013 Muhammad Hanif ACMA 3
  4. 4. Principles of Islamic Finance• Prohibition of interest and usury in financial dealings. Al-Qura’n (30:39, 4:161, 3:130, & 2:275-281).• Avoidance of Gharar (uncertainty) in a business transaction (Ayub 2007,page 57; Mansoori 2007, page 179; Ghazi 2010, page 237).• Avoidance of Myser and Qimar (speculation) or any game of chance (Ghazi 2010, Ayub 2007). Myser is prohibited by Holy Qura’n [ 2: 219 and 5: 90]2/12/2013 Muhammad Hanif ACMA 4
  5. 5. Principles of Islamic Finance• Profit and loss sharing. According to this principle capitalist demanding profit on capital should also participate in loss as well (Khan 1989, page 71; Usmani 2002, page 87; Ghazi 2010, page 386; Khan 2007, page 307 & Shari’a standard 12).• Financing for only Halal (permitted) businesses.2/12/2013 Muhammad Hanif ACMA 5
  6. 6. Features of Islamic Banking• The principal activity of customer of Islamic financial institutions (IFIs) must not be prohibited by Islamic Shari’a.• Islamic banks have to follow the principles of sales and purchase as given by Shari’a including five khiyars (stipulations).• Islamic bank cannot claim additional amount from customer in case of default2/12/2013 Muhammad Hanif ACMA 6
  7. 7. Features of Islamic Banking• Islamic banks cannot service depositors like conventional banking with a predetermine return.• Islamic banks cannot avoid Shari’a compliance in their operations on the excuse of non conduciveness of existing legal & business framework.• Islamic banks cannot enter into transactions of futures and forwards; gambling etc.2/12/2013 Muhammad Hanif ACMA 7
  8. 8. Features of Islamic Banking• Under partnership business IFIs cannot limit their share in profit only also loss in partnership must be shared according to equity stake;• IFIs cannot extend loans except Qarz e Hasna (charity loans)2/12/2013 Muhammad Hanif ACMA 8
  9. 9. Historic Development• First ever objection on receipt of interest from banks was raised by Syed Abul Aala Modoodi• Objective resolution was passed in 1949 (Article 2-A)• First bank on Islamic Principles was established in 1963 in Mitghamer (Egypt) and Tabong Hajji program of Malysia• Elimination of interest from economy found place in 1973 Constitution (Aticles 2, 31, 37,227)2/12/2013 Muhammad Hanif ACMA 9
  10. 10. Historic Development• Article 37 dealing with principles of policy enjoins upon the state to eliminate riba as early as possible.• Conference of Foreign Ministers of OIC in 1973 in Jeddah & Establishment of IDB• Council of Islamic Ideology Issued a comprehensive report on “Elimination of Riba from economy”in 19802/12/2013 Muhammad Hanif ACMA 10
  11. 11. Historic Development• Revolution of Iran 1979 which eliminated interest from economy• Interest free banking economy-wide in Pakistan 1985, however optimism failed very badly• Great research work done by IIU and IPS• Decision of Federal Shari’a court (Justice Rtd Tanzeel ur Rehman) in 1991• AAOIFI 1991 (By Nov 2007, 30 Shari’a standards and by June 2008, 23 accounting standards, 5 auditing standards, 6 governance standards and 2 codes of ethics were issued).2/12/2013 Muhammad Hanif ACMA 11
  12. 12. Historic Development• Raja Zafar Ul Haq Commission Report in 1997• Supreme Court decision (1999) [Justice retd Taqi Usmani & Coaleagues; a land mark]• Establishment of Islamic Banking Department in early 2000• Establishment of Meezan Bank (2003), BankIslami (2006) Burj Bank; Albaraka; Emirates Global; Dubai Islamic; HSBC2/12/2013 Muhammad Hanif ACMA 12
  13. 13. Industry Overview• By the end of 2011, Global Volume US $1,289 Billions in more than 50 countries with above 300 Instituions [IFSL-2012]• Share of Middle East 80% followed by South and Far East Asia region 15% and balance 5% from rest of the world [Hanif 2012]• Islamic Finance shown growth and resilience during world financial crisis of 2007-082/12/2013 Muhammad Hanif ACMA 13
  14. 14. Industry Overview US $ Billions1400 12891200 11301000 933 861 800 677 600 509 400 200 0 2006 2007 2008 2009 2010 20112/12/2013 Muhammad Hanif ACMA 14
  15. 15. Industry Overview-Y-o-Y Growth35%30%25%20%15%10% 5% 0% 2007 2008 2009 2010 20112/12/2013 Muhammad Hanif ACMA 15
  16. 16. Industry Overview• By the end of Sept; 2012, in Pakistan Volume of Assets is PKR Billions 741; Deposits 627; Investment & Financing 571 [SBP-2012]• No of Banks 18 (5+13) with branch network of 977 [SBP-2012]• Islamic Finance has shown tremendous growth in Pakistan during last nine years (04- 12) at an average annual rate of 65% (Y-O-Y) [Hanif -2012]2/12/2013 Muhammad Hanif ACMA 16
  17. 17. Industry Overview-PKR Billions 800 741 700 641 627 Assets 600 521 500 477 366 390 400 Deposits 300 276 283 206 202 200 147 119 Financing 100 71 84 50 & 0 Investme Dec.05 Dec.06 Dec.07 Dec.08 Dec.09 Dec. 10 Dec. 11 Sep. 12 nts2/12/2013 Muhammad Hanif ACMA 17
  18. 18. Industry Overview-Growth YoY74%72%70%68%66%64%62%60%58% Deposits Financing Branch network Overall2/12/2013 Muhammad Hanif ACMA 18
  19. 19. Comparative Performance• Hanif et.al 2012• Study period 2005-09• Sample includes 22 conventional banks and 05 Islamic banks• Areas studied profitability, liquidity, credit risk and solvency• All figures are based on Industry Averages2/12/2013 Muhammad Hanif ACMA 19
  20. 20. Comparative Performance-ProfitabilityPerformance Conventional Banks Islamic Banks CommentsMeasureROA 1.44% 0.26% Conventional Banking is dominating inROE 14.26% 1.73% profitabilityCSR 52.80% 97.63%2/12/2013 Muhammad Hanif ACMA 20
  21. 21. Comparative Performance-LiquidityPerformance Conventional Banks Islamic Banks CommentsMeasureNet Loans/ 53.65% 91.30% ConventionalAssets Ratio banking isLiquid Assets/ 96.00% 82.17%Customer deposits dominating in& Short term fundsRatio liquidityNet Loans/ 58.49% 86.84% managementDeposits &Borrowings2/12/2013 Muhammad Hanif ACMA 21
  22. 22. Comparative Performance-Credit RiskPerformance Conventional Banks Islamic Banks CommentsMeasureComn Equity/ 10.10% 14.81% IslamicAssets Ratio Banking isTotal Equity/ 18.72% 16.22%Net Loans dominatingImpairedLoans 10.64% 00.65% in credit risk/ Gross Loans management2/12/2013 Muhammad Hanif ACMA 22
  23. 23. Comparative Performance-SolvencyTo measure Solvency following model was usedS = 1.5* CA+1.2*EA +3.5* CAR+0.6*NPL+0.3*CI+04*LA Performance Conventional Banks Islamic Banks Comments Measure Solvency 56.36% 91.95% Islamic Banking Result is dominating in Solvency management2/12/2013 Muhammad Hanif ACMA 23
  24. 24. Products-Financing Tools• Deposits-Liabilities & Equity • Musharaka • Mudaraba • Loans• Financing-Assets • Selling [Murabaha, Salam, Istisna’a] • Rentals [Ijarah] • Partnership [Musharaka, Mudaraba, Diminishing Musharaka] • Investments in Skuk and Marketable securities2/12/2013 Muhammad Hanif ACMA 24
  25. 25. Products-Financing Tools• Musharaka is a partnership in capital; management by all or any one of the partner; No salary to a partner; Profit as per agreement, however share of sleeping cannot be more than active; loss must be shared according to equity stake; Very fruitful for cash financing to business and industry [Shari’a Standard 12]• Mudaraba is a partnership between capital and skill; Profit sharing as per agreement, however loss is of financier; very fruitful for small businesses and self employment generation [Shari’a Standard 13]2/12/2013 Muhammad Hanif ACMA 25
  26. 26. Products-Financing Tools• Murabaha is a selling mode of financing where by cost and profit, both are disclosed to customer; very useful in short term financing especially overdraft facility [Shari’a Standard 8]• Salam is a selling based mode of financing especially usefel for agricultural financing; Cash is provided to farmer in advance as a purchase price of produce to be delivered to bank later on [Shari’a Standard 10]• Istisna’a is also selling based mode of finance designed for industrial financing; cash is provided in advance in return of goods to be delivered at completion to bank [Shari’a Standard 11]2/12/2013 Muhammad Hanif ACMA 26
  27. 27. Products-Financing Tools• Ijarah is a rental based mode of financing whereby asset is purchased by bank to deliver to customer on rent; end of Ijarah may be in transfer of asset from bank to customer; Practically it is used in auto-financing [Shari’a Standard 9]• Diminishing Musharaka is a mixture of Musharaka and Ijarah where by asset is purchased in joint ownership of bank and customer; Bank rent out his share to customer and receives rent proportionally; customer purchases share of bank in installments and finally asset is transferred to customer; Practically it is used for house financing [Shari’a Standard 12]2/12/2013 Muhammad Hanif ACMA 27
  28. 28. Portfolio Make up [July-06 to Sep 10]45%40%35%30%25%20%15%10% 5% 0%2/12/2013 Muhammad Hanif ACMA 28
  29. 29. Capital Market• Equity Investments Equity shares are Musharaka based investment Instruments with variable returns, hence allowed under Islamic financial system, while conventional bonds and Government securities are interest based with predetermined fixed return and prohibited [Shari’a Standard 12, 21].• Skuk is an Islamic bond designed to meet the need of ready market liquidity instrument; These are different from conventional bonds as return is not absolutely fixed. [Shari’a Standard 17] According to ISI Emerging Markets, approximately 2000 issues of Skuk were held with Global volume of around US $200 Billion by the end of June 2010.• In addition to corporate Skuk, Sovereign Skuk are also issued by the governments including Pakistan, Jordan, UAE, Thailand, Malaysia, Turkey, Indonesia, Bahrain, Qatar, Cayman Islands, Singapore, Germany, Brunei, Gambia and Kuwait. (www.123 accessed on 5th July, 2010).2/12/2013 Muhammad Hanif ACMA 29
  30. 30. Capital Market• Equity Investments Although investment in equities is allowed, however in order to invest in shares of a company certain tests (of Shari’a compliance) must be qualified.• There are about nine Islamic indexes globally engaged in screening of companies by applying Shari’a Compliance tests including DJIM, FTSE, S&P, MSCI, HSBC, Ameri, BID, Azzad and KMI(Derigs & Marzban, 2008).• In Pakistan KSE-Meezan Index (KMI-30) was launched in 2008. It is revised semi-annually in May and Nov based on Dec and Jun Positions• There are above 30 mutual funds working in Pakistan2/12/2013 Muhammad Hanif ACMA 30
  31. 31. Capital Market- Screening Criteria KMI-30• Halal Business of the Investee Company• Interest Based Financing: Interest based debts to asset ratio should be less than 40%.• Shari’a Non-compliant Investments: The ratio of non compliant investments to total assets should be less than 33%.• Purification of Shari’a Non-complaint Income: The ratio of Shari’a non- compliant income to total revenue should be less than 5%.• Net Liquid Assets to Share Price: The market price per share should be greater than the net liquid assets per share calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number of shares.• Illiquid Assets to Total Assets: The ratio of illiquid assets to total assets should be at least 20%.2/12/2013 Muhammad Hanif ACMA 31
  32. 32. Global Impact of Islamic Finance• Opportunity of Shari’a compliant financing• Petro dollars• Study of Islamic teachings by wider audience• Promotion of commonalities in Muslim Communities• Leadership role in global affairs• Wider participation of masses in financial system• Stability in financial system if get dominance2/12/2013 Muhammad Hanif ACMA 32
  33. 33. Challenges• Use of Kibor as bench mark for profit• Use of par value in selling of shares of IFI in House financing• Use of par value in purchase of skuk at the time of redemption• Use of financial penalty in case of default by customer• Use of independent party guarantee of capital in case of skuk• Use of time value based computer softwares in calculation of installments• Very minor use of profit and loss sharing, salam and Istisna’a modes of financing• Non availability of cash financing for day to day operations except through Musharaka2/12/2013 Muhammad Hanif ACMA 33
  34. 34. How to overcome Challenges Answer is well educated and trained Human Resource YouResearch2/12/2013 Muhammad Hanif ACMA 34

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