16th WBD Executive Session IBF

Islamic Finance as an Alternative
Banking Business Model
Executive Session – 16th World Business Dialogue

Kevin Gilhawley

Why should you care about Islamic Finance?

Market Size and Need for Change in the
1 2 Business Opportunities 3
Growth Rate Financial System

16th World Business Dialogue 130314_WBD_IBF_v01.pptx
1

Market Overview
Islamic Finance Fundamentals
Comparison to Conventional Finance
Case Studies
Islamic Finance as an Alternative System
Discussion

2

1 Market Overview

Islamic Finance has received positive comments from
influential individuals in the last decade

“The ethical principles on
which Islamic finance is based „We need to make Britain the
may bring banks closer to global centre for Islamic
their clients and to the true finance to participate in the
spirit which should mark industry’s promising future“
every financial service”
Gordon Brown, Former Prime
Benedict XVI Minister of the United
Kingdom

„The rapidly growing Islamic
Finance sector contributes
significantly to a broadening
of our funding-structure“
Dr. Josef Ackermann, Former
CEO Deutsche Bank

3

1 Market Overview

More than one quarter of the world population are Muslims

Global Estimated Muslim Populations – Selective Markets (2010)

Share of Muslims in % of Population
<5 5-14 15-49 50-89 90-100

Source: Booz & Company Analysis

4

1 Market Overview

The penetration of Islamic banking is growing on the back of
a number of new institutions in traditional markets
Selected Islamic Banks (excluding Banks with Islamic windows)
Syria Kuwait
 Syria International Islamic Bank  Kuwait Finance House
(September 2007)  Kuwait International Bank*
 Cham Bank (October 2006) Bahrain
 Boubyan Bank (January 2006)
 Albaraka Bank Syria (January 2008)  Bahrain Islamic Bank
 Warba Bank (March 2010)
 Shamil Bank
 Khaleeji Commercial Bank
 Al Baraka Islamic Bank
Indonesia
 Al Salam Bank (April 2006)
 Bank Syariah Mandiri
 Al Masref Bank (March 2006)
 PT Bank Muamalat Indonesia
 UUS BNI Syariah
 PT Bank Syariah Mega Indonesia
Qatar
 PT BRI Syariah (2008)
 Qatar Islamic Bank
 PT Bukopin Syariah (2008)
 Qatar International Islamic Bank
 Masraf Al Rayan (October 2006)
 Barwa Bank (June 2007)
Malaysia
 Bank Islam Malaysia Berhad
 Bank Muamalat
UAE  Asian Finance Bank (January 2007)
 Dubai Islamic Bank  KFH Malaysia (February 2006)
 Abu Dhabi Islamic Bank  Al Rajhi Bank Malaysia (October 2006)
Saudi Arabia  National Bank of Sharjah
 Al Rajhi Bank  Emirates Islamic Bank
 Bank Al Jazira  Sharjah Islamic Bank*
 Bank Al Bilad (2006)  Dubai Bank*
 Bank Al Inma (October 2008)  Noor Islamic Bank (January 2008)
 Al Hilal Bank (June 2008)
 Ajman Bank (June 2008)

Note (*) Conversions of conventional banks to Islamic banks
Source: Central Banks, The Banker, Islamic Business and Finance Network, Islamic Development Bank

5

1 Market Overview

We‘ve experienced some Islamic banking activity in Europe,
but everybody is still waiting for the major breakthrough
Islamic Banking in Europe

United Kingdom Germany

 5 Islamic Banks – only one  First institutional
with focus on retail banking transactions
(Islamic Bank of Britain)  Limited retail offering
 High Street Banks setting up
Austria
Islamic Windows
 Islamic Banking-
Concepts in
development
Luxembourg

 Popular location for
Islamic investment funds France
due to regulatory  Expected market entry
adjustments of several Islamic Banks Switzerland Turkey

 Numerous Islamic  Currently four purely
Wealth Management- Islamic Banks
Offerings On- and (Participation Banks),
Offshore mostly founded by Arab
banks

16th World Business Dialogue 130314_WBD_IBF_v01.pptx 6

1 Market Overview

Especially Swiss Banks recognized the potential of Islamic
Finance and strengthend their position in the GCC-countries
Swiss banks in Muslim countries (Onshore)

Lebanon

Indonesia,
Malaysia,
Singapur

GCC (Saudi-Arabia, United Arab Emirates
Kuwait, Qatar, Bahrain, Oman)


7

1 Market Overview

Islamic Finance grows at a higher pace than conventional
finance and continually gains more market share
Worldwide banking assets Islamic Banks’ Market Share
USD trillion 2008 vs. 2003
CAGR
5.1% 34.5%
105.3 Kuwait
98.6 101.1
CAGR 90.8 16.0%
9.5%
77.5
63.2 65.5 38.0%
56.0 KSA
47.4 21.0%
40.1 40.8 41.8 41.5

16.0%
UAE
1998 2000 2002 2004 2006 2008E 2010E 9.0%
Worldwide Islamic banking assets*
USD trillion 14.0%
Malaysia
CAGR 9.0%
22.1% 1.00
0.87
0.75 9.0%
Bahrain
CAGR 0.55 4.0%
16.4%
0.37 0.40
0.31 0.33 4.0%
0.26 0.28
0.23 Indonesia 2009
0.14 0.16
0.7%
2003
1998 2000 2002 2004 2006 2008E 2010E
* Estimated based on publicly available data and forecast; years for which no data was available have been extrapolated based on the average growth rate for the period
Source: Council for Islamic Banks, Press Releases, Standard & Poor’s, Economist Intelligence Unit; Booz & Company analysis

8

Market Overview
Case Studies
Discussion

9

4 Case Studies

Introducing Islamic Banking and Finance
http://www.youtube.com/v/M7kiLLlwbuQ EXAMPLE

10

2 Islamic Finance Fundamentals

Islamic Finance describes financial services which are
conducted according to Islamic Law
Shari’ah-Restrictions for Financial Services

Prohibition of Usury Prohibition of Speculation Prohibition of Gambling Shari’ah Board

‫“ ﻱ‬The trade of the petty usurer is hated with most reason: it makes a profit
from currency itself, instead of making it from the process which currency
was meant to serve.”

Aristotle

11


In Islam activities can be classified as haram (prohibited) or
halal (lawful)
Permissibility of Things in Islam

Halal Haram

12


Islamic principles embrace risk sharing and have a strong
focus on productive activities
Key Principles of Islamic Finance

Overarching principles founded in Shari’ah objectives aiming at the protection of individuals’ personal and
religious rights, upholding of high ethical standards and higher equality of wealth distribution

Transaction requirements Risk sharing requirements
‫ ﻱ‬Underlying activities based in real economy ‫ ﻱ‬Earning of legitimate profits requires sharing of
‫ ﻱ‬Actual trade or business activities (not pro- risks as well (e.g. in Mudaraba or Musharaka
forma) structures)
‫ ﻱ‬No speculative transactions ‫ ﻱ‬Not only form, but substance of contract have
to be honoured at all times
‫ ﻱ‬No interest-based deals
‫ ﻱ‬No business involving illegal or unethical
activities not complying with Shari’ah

‫ ﻱ‬Shari’ah law do not allow the detachment of the financial sector from productive activities, thus Islamic assets
can be expected to grow in line with real economy and usage of excessive leverage is avoided
‫ ﻱ‬Speculation is forbidden and excessive risk taking is discouraged by the risk sharing nature of many contracts
‫ ﻱ‬Upholding of Shari’ah principles reduces risk of financial unrest and promotes stability

Source: Islamic Finance and Global Financial Stability Report (April 2010), Booz & Company analysis

13


Participatory profit and risk sharing contract structures play a
key role for the generation of funds in Islamic banks
ILLUSTRATIVE
Financing Structure of Islamic Banks

Assets Liabilities
Inventory Current / Demand Deposits
 Real estate  Wadiah (Safe custody) /
 Automobiles  Ward (loan)
Asset-backed Transactions Unrestricted Investment
Similar to conventional  Murabaha (cost plus) Accounts
loans, however, legal  Ijara (leasing)
 Mudarabah (profit sharing, loss Similar to fixed deposits, but
positions of both parties  Istisna’ (manufacture)
bearing)
based on different  Salam (forward delivery) returns to depositors are set
contract forms Restricted Investment Accounts as a fixed ratio of returns
earned on the asset side,
Profit Sharing Transactions  Mudarabah (profit sharing, loss while losses are borne by the
Investor - Entrepreneur bearing)
relationship between bank  Mudaraba (profit sharing, loss client alone
and client bearing)
 Musharaka (profit and loss
sharing) Profit Equalization Reserves Building of reserves for
losses on profit and loss
Fee Based Services sharing accounts as
Equity prudential measure


14

Market Overview
Case Studies
Discussion

15

3 Comparison to Conventional Finance

There are significant differences between Islamic Finance
and conventional Finance
Conventional Banking Islamic Banking

‫ ﻱ‬No explicit values associated ‫ ﻱ‬Normative banking system
‫ ﻱ‬Strong emphasis on debt financing ‫ ﻱ‬Strong emphasis on equity financing
‫ ﻱ‬Sophisticated product offering ‫ ﻱ‬Basic banking service offering
‫ ﻱ‬Making money from money is possible ‫ ﻱ‬Transactions must be tied to real assets
‫ ﻱ‬Risk is shifted/transferred to the client ‫ ﻱ‬Risk is shared between bank and client

16


The global financial crisis has its roots in a dangerous
mixture of developments in the conventional banking system
Origins of Financial Crisis ‫ ﻱ‬Short-term profits as sole
rewarded goal
‫ ﻱ‬No consideration for other
stakeholders’ objectives
build into compensation
Misaligned
‫ ﻱ‬Increasingly complex schemes
Incentive Structures
financial engineering ‫ ﻱ‬No regard for system
techniques employed stability encouraged
‫ ﻱ‬Risks separated from actual
underlyings
‫ ﻱ‬Encouraged excessive
lending and risk taking ‫ ﻱ‬Looser underwriting and
‫ ﻱ‬Development was not risk management
Uncontrolled standards allowed in
accompanied by similar Erosion of
Financial exchange for short-term
advances in governance Prudency
Innovations gains
processes and risk
management ‫ ﻱ‬Uncritical and passive
regulators interfering too
late too little to prevent
crisis

17


Islamic banks have proven more resilient during the financial
crisis than conventional banks..
Key Financial Indicators
Performance of Top10 Conventional vs. Top10 Islamic Banks during Crisis

36%
55% Explanations for Superior Performance
9% 24% 36%
 Shari’ah principles as outlined above
-9%
-43% require, among other things, prudency due
to risk sharing, prohibit speculation and
-136% limit risks through close links to real
Change in Change in Change Change economy
market net profits in assets in equity  Particularly, conventional derivative
capitalization
instruments, a main facilitator for the
emergence of the crisis, are banned
Leverage Ratio
Top10 Conventional vs. Top10 Islamic Banks entirely
16.6x 18.2x  Significantly lower leverage ratios reflect
5.8x 6.6x this lower risk appetite and more
conservative business practices of Islamic
banks
2006 2008
Conventional
Islamic

18


..Islamic equity markets have also survived the financial
crisis better than conventional indexes
Shari’ah Restrictions Performance-Comparison Total Market vs.
Shari‘ah-Compliant Index
Performance
Capital investment and financing restrictions (indexed) Beginning of Financial Crisis
‫ ﻱ‬General prohibition of interest (riba), gambling (maisir) and
uncertainty (gharar)
‫ ﻱ‬Restrictions for capital investments in and financing of certain
industries, e.g.:
‫ ﻱ‬Alcohol fabrication and distribution
‫ ﻱ‬Casinos and hotels (if alcohol is served)
‫ ﻱ‬Banks and insurance companies
‫ ﻱ‬Tobacco industry, etc.

Compliance with key financial ratios

‫ ﻱ‬Investments in businesses that have bonded capital or cash +
interest bearing bonded capital of more than 33% of the market
value of the equity are prohibited
‫ ﻱ‬Accounts payable are not allowed to cross 49% of the market
value of the equity
‫ ﻱ‬Revenues from prohibited industries have to be less than 5% Shari‘ah compliant investments significantly outperformed
conventional ones due to Shari‘ah restrictions

Source: S&P, Dow Jones, Bloomberg, Booz & Company Analysis

19

Market Overview
Case Studies
Discussion

20

4 Case Studies

A typical example for an Islamic financial product is a car
financing according to the so-called Murabahah concept
EXAMPLE
Murabahah-Structure

Vendor Purchaser

1
Transfer of Ownership 2 Purchasing price plus
Purchasing price
profit margin

Islamic Bank

Source: Gassner/Wackerbeck, Islamic Finance 2007

21

4 Case Studies

Islamic Mortgage Financing via co-ownership has been
copied by conventional financial instituitions
http://www.youtube.com/v/SmROuXO4lD0 EXAMPLE

22

4 Case Studies

Many companies in the GCC countries finance themselves
increasingly Shari‘ah-compliant Islamic bonds
EXAMPLE
Islamic Finance-Strategie Emirates Airlines

Financing Objects Transaction Details Rationale

‫ 562 ﻱ‬Mio. USD for financing two new ‫ ﻱ‬The Emirates-Management decided
Boeing 777-300 ER airplanes to use Islamic Finance as a strategic
source of financing to help finance
‫ ﻱ‬Shari’ah-compliant Leasing over 12
the company‘s growth plan
years
‫ ﻱ‬In total Emirates have already taken
over 1.3bn USD in Shari‘ah-compliant
loans
‫ ﻱ‬In 2005 Emirates took a 550 Mio. USD
loan for the construction of their new
headquarters
‫ ﻱ‬Financing via Islamic bond (Sukuk)
based on a Musharakah-Structure

Nice to know: The German Federal Land Sachsen-Anhalt was 2005 the first western issuer of an
Islamic bond (Sukuk)
16th World Business Dialogue 130314_WBD_IBF_v01.pptx 23

Market Overview
Case Studies
Discussion

24

5 Islamic Finance as an Alternative System

The Islamic Finance Industry still has many obstacles to
overcome
Growth Constraints in Islamic Finance

‫ ﻱ‬Lack of Standardization
‫ ﻱ‬Lack of Human Capital
‫ ﻱ‬Lack of Money Market Instruments
‫ ﻱ‬Lack of Awareness and Trust
‫ ﻱ‬Lack of Economies of Scale
‫ ﻱ‬Lack of Shari‘ah Scholars

25


The availability of Shari’ah scholars is one of the most
significant bottlenecks in Islamic Finance
Informal Standardization of Shari’ah Standards
Board Memberships of Top 5 Scholars GCC Network Analysis of Top 15 Scholars’ Board Memberships
Board
Rank Scholar
Memberships
1 Shaikh Nizam Mohammed Saleh Yaquby 77
2 Shaikh Dr. Abdul Satar Abdul Karim Abu Ghuddah 72
3 Dr. Mohammed Eid Elgari 64
4 Sheikh AbdullahSulaiman Al Manee’a 37
4 Dr. Abdulaziz Khalifa Al Qassar 37

‫ ﻱ‬Top 5 out of 176 scholars in the GCC are
members in almost a third (30.1%) of entire
universe of ~956 GCC Board positions

‫ ﻱ‬Top 6 scholars in Kuwait (out of 45) make
48.3% of all (226) Board positions - local
Boards dominated by local scholars

Source: Funds@work, Booz & Company analysis

26


I believe a number of factors are likely to fuel the growth of
Islamic banking going forward
Key Drivers for Growth in Islamic Finance

Demografic
Financial Inclusion Innovation
Change

Islamic
Demand/ Wealth LOHA
Movements
27


A great example for innovative business models in Islamic
Finance is the Kuwait Finance House (1/2)
Car Sale in the Kuwait Finance House

28


A great example for innovative business models in Islamic
Finance is the Kuwait Finance House (2/2)
Positioning of Car Sale Islamic Banking and Takaful-Services

Murabahah-Boxes
Advisory Offices
and Sales Offices

Insurance Counter Cash Register

29

Market Overview
Case Studies
Discussion

30

Do you think Religion and Finance should be strictly
separated?

+

31

Which is the right approach: Trying to prevent financial crises
with regulatory measures or by promoting ethical behavior?

vs.

32

What do you think about Dr. Tomáš Sedláček’s argument?
Is Islamic Finance a possible solution?

„Our problem is not lack of
growth but too much of it “
Dr. Tomáš Sedláček, Chief
Macroeconomic Strategist

33

Could Islamic Banking be the next generation of Socially
Responsible Investments?

34

What role does sustainable economic growth in the MENA
region play for the future of Islamic Finance?

35

Islamic Banking – Backward Banking or Next Generation
Business Strategy?

or

36

Wrap-Up

37

List of other student conferences
‫ ﻱ‬South American Business Forum (SABF) The SABF is an event that takes place annually in Buenos Aires for 3 days in the month of August. Each
year the forum invites 100 outstanding university students from around the globe together with 40 leaders in business, politics and academics.
‫ ﻱ‬Harvard Project for Asian & International Relations (HPAIR) Harvard’s largest annual student connection in Asia: The Harvard Project for
Asian and International Relations creates a forum of exchange and facilitates discussion of the most important economic, political, and social
issues relevant to the Asia-Pacific region. Applications are closed for 2012.
‫ ﻱ‬Kairos Global Summit 2013 The Kairos Global Summit in partnership with the United Nations and New York Stock Exchange, brings together
350 innovative and entrepreneurial students from around the world to meet 150 of today’s influential leaders.
‫ ﻱ‬St. Gallen Symposium The St. Gallen Symposium aims to foster the intergenerational and intercultural dialogue between the Leaders of Today
and the Leaders of Tomorrow. The 43rd symposium will take place from 2nd–3rd May 2013 at the University of St. Gallen.
‫ ﻱ‬International Development Conference at Harvard 2013 A yearly student-organized conference dedicated to fostering a constructive dialogue
between leading academics, practitioners, policy makers and students, concerned with creating a better world. Applications will open at the
end of the year.
‫ ﻱ‬United Nations International Student Conference Amsterdam 2012 (UNISCA) UNISCA is a Model United Nations (MUN) organised by the
University of Amsterdam. It is a program which consists of a two week long summer course, in which a simulation of an United Nations
Conference takes place.
‫42 ﻱ‬th International Youth Leadership Conference The one week-long youth forum on world politics, international relations and justice will take
place in Prague. It gives you an opportunity to test your leadership skills, debate current issues, deliver speeches, draft resolutions, make
executive decisions, and experience the complexities of international relations.
‫ ﻱ‬International Youth Forum Seliger 2012 1,000 young leaders meet in Russia to build an international youth community based on the principles
of peaceful coexistence, the promotion of personal and democratic liberties and recognition cultural diversity. Applications are closed for
2012.

38

Contact Information

Kevin Gilhawley
about.me/kevingilhawley

Private: kevin.gilhawley@gmail.com
Aiducation: kevin.gilhawley@aiducation.org
zig: kevin.gilhawley@project21.ch

About :
Kevin Gilhawley is currently interning at the strategy consulting firm Booz & Co. He holds a Bachelor‘s degree in banking and
finance from the University of Zurich. After having worked in the wealth management division of UBS for a few years, he
held different part-time positions in the financial industry. Kevin is also active as a volunteer in sales development in the for-
impact organization Aiducation. In addition, he co-founded the time-sharing platform ZIG in 2012. Kevin’s research focus is
on responsibility in finance and Islamic Finance. He gained first practical experience in Islamic Banking while working with
clients from the GCC countries at UBS. Going forward he is going to intern at Credit Suisse’s IBD and complete his Master‘s
degree in Finance at the London School of Economics thereafter.

39

16th WBD Executive Session IBF

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