Islamic finance; Introduction, challenges and opportunities

1. Presented
to:
Dr.
Abeer
Zein
Presented
by:
Ahmed
El-­‐Sayed
ESLSCA
37B
Mohamed
Abdou
Sameh
Ali
Mostafa
Younis

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. 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. Major
Economic
Systems
• Capitalism
• Socialism
• Mixed
Economy
• Islamic
Economic
System

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. ISLAMIC
FINANCE
MORAL
PROHIBITIONS
• Shariah’ah;
comprises
two
sources;
– Qur'an
– Sunna
• Fiqh;
body
of
laws
deducted
from
Shariah’ah
• SePled
2
Major
principles;
– Halal;
permiPed
acFviFes
– Maslaha;
public
goods

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Approach:
• General
requirements
of
the
Shariah
governance
framework.
• Oversight,
accountability
&
responsibility.
• Independence.
• Competency.
• ConfidenFality
&
consistency.
• Shariah
compliance
&
research
funcFons.

35. key
organs
in
the
IFI’s
Shariah
governance
framework

36. Value
of
Money

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. The Islamic Shari‘ah has a different
set-up for the purpose of profit, The
principle is that the person extending
money to another person must decide
whether he wishes to help the
opposite party or he wants to share his
profits. If he wants to help the
borrower, he must rescind from any
claim to any additional amount. His
principal will be secured and
guaranteed, but no return over and
above the principal amount is
legitimate. But if he is advancing
money to share the profits earned by
the other party, he can claim a
stipulated proportion of profit actually
earned by him, and must share his loss
also, if he suffers a loss.

39. It is thus obvious that exclusion
of interest from financial activities
does not necessarily mean that
the financier cannot earn a profit.
If financing is meant for a
commercial purpose, it can be
based on the concept of profit
and loss sharing, for which
musharakah and mudarabah have
been designed since the very
inception of the Islamic
commercial law.