NEW Muharram–Rabi Al Awwal 1428 ISSUE NO. 163 HORIZON JANUARY–MARCH 2007 MUHARRAM–RABI AL AWWAL 1428

PUBLISHED SINCE 1991 GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

BAHRAIN: MIDDLE EASTERN PROMISE

INNOVATIONS IN ISLAMIC FINANCE

ISLAMIC BANKING AND TAKAFUL IN RUSSIA

SUKUK: MANAGING LIQUIDITY ISSUES

TAKAFUL AT BANK AL JAZIRA

CREDIT RISK MANAGEMENT IN ISLAMIC FINANCE

www.islamic-banking.com IIBI 1 NEWHORIZON January–March 2007

2 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 CONTENTS

Features 12

12 Islamic banking and takaful in Russia: What the future holds Today’s challenges and the future prospects of the industry in the world’s largest country with over 15 million Muslim population.

22 The London Islamic Financial Services Summit Discussing London’s role in the Islamic banking industry.

25 Bahrain: Middle Eastern promise A country focus on Bahrain’s financial services market and its main regulator, the Central Bank.

32 First line of protection Bank Al Jazira introduces takaful ta’awuni, the first and only Islamic protection savings plan in Saudi Arabia.

32 38 The role of the sukuk in managing liquidity issues An interview with Stella Cox, managing director of the UK-based DDGI Ltd, one of the leading Islamic asset investment companies.

40 Innovations in Islamic finance Dr Humayon Dar, CEO of Dar Al Istithmar, gives his view on what is the next big thing in Shari’ah-compliant finance. Regulars

05 NEWS 23 RATINGS AND INDEXES 43 APPOINTMENTS A round-up of the important stories from the last quarter around the globe. 36 ACADEMIC ARTICLE 44 ACADEMIC ARTICLE Credit risk management in The time value of money in 18 IIBI NEWS Islamic finance. Islamic banking.

19 IIBI LECTURES 42 ANALYSIS 48 DIARY January, February and March lectures Healthy Islamic banking sector reaches reviewed; April lecture preview. new heights in Pakistan. 50 GLOSSARY

www.islamic-banking.com IIBI 3 EDITORIAL NEWHORIZON January–March 2007

Editor’s Note

NewHorizon is possibly the oldest magazine published in English on Islamic banking and insurance. It has been in publication for over 15 years, and is the official journal of the Institute of Islamic Banking and Insurance (IIBI), an independent not-for-profit organisation. Founded EXECUTIVE EDITOR Mohammad Ali Qayyum, in London back in 1991, it is now one of the world's Director General, IIBI leading independent education, training and research

EDITOR organisations dedicated solely to the promotion and Tanya Andreasyan implementation of Islamic finance in the UK and globally. CONTRIBUTING EDITORS Tom Alford Don Brownlow NewHorizon publishes in-depth articles on various James Ling aspects of Islamic banking and insurance and also IIBI EDITOR reports on events and developments from around Mohammad Shafique the world. The magazine enjoys a wide readership

IIBI EDITORIAL PANEL in around 105 countries. Mohammad Amin Stella Cox Over the years the look and contents of NewHorizon Dr Humayon Dar Iqbal Khan have evolved to reflect the times. IIBI is now working Richard Thomas with IBS Publishing, a UK-based company, to produce Dr Imran Ashraf Usmani the magazine, with the first issue of this quarterly journal DESIGN CONSULTANT covering the period from January to March 2007. Becky Ellison

PUBLISHED BY NewHorizon embraces challenges facing the IBS Publishing Ltd Islamic financial sector right across the globe, from 8 Stade Street the developments in the well-established Islamic Hythe, Kent, CT21 5DT United Kingdom banking markets in the Middle East, through the Tel: +44 (0) 1303 262 636 growing markets of Pakistan, UAE and the UK, to the Fax: +44 (0) 1303 262 646 Email: [email protected] attempts to introduce this industry in Russia. African Web: www.ibspublishing.com developments continue at pace with Kenya becoming one of the latest countries to provide its citizens with CONTACT Advertising Islamic financial services. IBS Publishing Ltd Paul Minister Advertising Manager The range of such services continues to expand. Shari’ah- Tel: +44 (0) 1303 262 636 compliant credit cards and personal loans are amongst Fax: +44 (0) 1303 262 646 the newcomers. Sukuk (government bonds) are becoming Email: [email protected] more prominent in the Islamic banking market. This SUBSCRIPTION issue of NewHorizon also tackles the subject of takaful Institute of Islamic Some previous (Islamic insurance) with further in-depth analysis of Banking & Insurance (IIBI) NewHorizon issues 12–14 Barkat House this matter to come in our future publications. 116–118 Finchley Road London NW3 5HT United Kingdom Whether you are already an Islamic finance specialist, Tel: +44 (0) 207 245 0404 about to enter the world of Islamic banking and Fax: +44 (0) 207 245 9769 insurance or just interested in this subject, we hope you Email: [email protected] Web: www.islamic-banking.com find the magazine interesting, cognitive and educational.

©Institute of Islamic Banking and Insurance ISSN 0955-095X

Views expressed in this magazine are not Mohammad Ali Qayyum necessarily those of the Publisher Director General IIBI

4 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 NEWS

Bank and real-estate developer sign Memorandum of Understanding

Islamic bank, Masraf Al Rayan, The Lusail Corniche Project is and real-estate developer, part of the waterfront district Qatari Diar, have signed a of the Lusail development. Memorandum of Understanding Consisting of two small islands, worth $2.25 billion for the the Corniche district will have development of the Lusail around two and a half Corniche Project in Qatar. kilometres of waterfront Under the terms of the promenade made up of retail agreement, Masraf Al Rayan and restaurant outlets. Qatari will take the primary role in Diar, a real-estate company arranging and managing the wholly owned by the Qatar mobilisation of funds to finance (above). Both men were happy of local financial institutions’. Investment Authority, is the the project. However, the bank with the agreement and saw it as company behind the Lusail is not only limited to a financial a step forward for their relative Masraf Al Rayan is the only development. The waterfront role within the project, it will institutions. Al-Abdulla fully-fledged Islamic commercial district looks to be a popular also be working with Qatari described the agreement as one and investment bank in Qatar, area for the developers; recently Diar to develop the project that will ‘strengthen our position and has an entirely Shari’ah- all 46 plots within the district through an investment fund. in the local market and help us compliant portfolio of products. were sold to investors within to achieve our goals of being This deal will come as no hours of going on sale. The agreement was signed a truly progressive force in surprise; the bank has been Development of the Corniche by Dr Hussain Al-Abdulla, the banking world’. Al-Ansari heavily involved with the Project is planned to start by chairman and managing director saw the deal as ‘part of our financing of new real estate the end of this year, with a of Masraf Al Rayan, and Nasser strategy in developing projects developments in Qatar since its completion date set for the Al-Ansari, CEO of Qatari Diar in partnership with and support inception in October last year. end of 2009. Maybank tops The Government of Abu Dhabi Asian Banker survey sets up Al Hilal Bank

Maybank has been ranked as the standalone Islamic bank was The government of Abu Dhabi been designed to cater to largest Islamic banking service Bank Islam Malaysia; this had is setting up an Islamic bank project-related requirements provider in the Asia Pacific about half as many Shari’ah- with $1.1 billion in authorised and provide credit facilities region by The Asian Banker compliant assets as Maybank capital. The new bank, called for the private sector, which Islamic Bank 40 survey. The and was ranked number two Al Hilal Bank, will operate will be the backbone of the annual study identifies the 40 in the region. under the provisions of Islamic economic development of key players in the Asia Pacific Shari’ah while rendering all the country’. banking sector, and ranks them The study also revealed that modern services required for according to the size of their Malaysia was leading the way the business sector, as well as The bank will deal with Shari’ah-compliant products. for Islamic financial services investment in the industrial, corporate and retail banking, industry in the region. It agricultural and real estate consultancy services, funds The inaugural study has showed the country to have sectors. management and will invest revealed that Maybank, which 17 institutions which hold customer funds in Shari’ah- is not a standalone Islamic bank, 73 per cent of the top 40’s The bank will be aimed at the compliant financial currently holds over $6.4 billion total assets. private sector. The Founders’ instruments. in assets through its Islamic Committee says, ‘the bank has banking window. The largest www.islamic-banking.com IIBI 5 NEWS NEWHORIZON January–March 2007

UK to become global centre Global House to establish for Islamic finance Islamic bank in Syria

Plans to establish the UK as a capital gains and capital The Bahrain-based investment year, since the country became leading global centre for Islamic allowances will be published, banking group Global House is more open to international finance have been announced to provide certainty of to launch a new Islamic bank in investors. It concluded that by economic secretary, Ed Balls interpretation. In his speech, Syria. The new bank will be set it would be feasible for Global (below). In his speech to the Balls also announced the plans up with an initial capital of House to invest in more than Euromoney Annual Islamic to publish guidance on how $500 million; so far half of this one Syrian city. Al-Dawsary Finance summit, Balls takaful products will be taxed figure has been put up by the says, ‘The creation of an Islamic announced plans for new within current rules; it is hoped banking group. Dr Ahmed Bin bank in Syria had for a long legislation to facilitate the that this guidance will clarify the Hussein Al-Dawsary, chairman time been on the cards for the issuance and trading of sukuk, uncertainty in the market over of Global House, says the group group, as the country itself is yet and guidance on diminishing treatment of these products. ‘will be a partner in the new to benefit from Islamic finance’. musharakah and takaful. bank’ with the initial The government hopes that contribution that it makes The group plans that The market for Islamic these new measures will ensure dependent on other key preliminary operations for finance products in the UK has that the tax and regulatory shareholders. the bank will begin in the next shown strong growth since the system will encourage the few months, depending on government started shaping the development of Shari’ah- The group has been studying the completion of the required tax and regulatory framework, compliant products, and Syrian market for well over a paperwork. and it hopes that these new will cement Britain’s role measures will help to make as a global centre for Islamic Britain the financial partner finance and trade. of choice for Muslim countries Emirates Global Islamic Bank all over the world. Balls said, ‘As Islamic finance grows in launched in Pakistan importance, we want to see more of this business coming to the UK.’ A new six-branched Islamic and Saudi Arabia, has opened bank has been set up in with five branches in Karachi In his speech, Balls announced Pakistan. Emirates Global and one in Lahore. However, it that the Treasury will set out Islamic Bank Ltd (EGIBL) is a is looking to extend its branch in the Budget what the tax dedicated commercial Islamic network to gain access to more framework for sukuk will look bank and, according to president people. EGIBL chairman, Sheikh like, and that detailed legislation and CEO Syed Tariq Husain, Tariq Bin Faisal Al-Qassimi says, will follow in the Finance Bill. it plans to become ‘a leading ‘The Pakistani market offers He also indicated that guidance Islamic commercial bank in tremendous potential and the on how diminishing musharakah Pakistan’. finance sector has been doing products will be treated for exceptionally well. We are The bank aims to capture confident we can build upon the market share by offering work already being done here to Shari’ah-compliant competitive develop the sector even further.’ Three banks in dual tranche deal banking products. EGIBL will offer Shari’ah-compliant savings The bank has big plans for the Asya Katilim Bankasi of Turkey Banking. It has been structured and current accounts, as well as future. It plans to establish an has mandated three banks to as a one- and two-year dual term deposit schemes, and trade, asset management company and arrange a $50 million murabaha tranche facility, with the ijara, murabaha, and consumer launch Shari’ah-compliant funds financing facility. The mandated proceeds being used to finance financing. this year. It is also looking to be banks are ABC Islamic Bank, the Turkish bank’s Shari’ah- listed on the stock exchange Standard Chartered Bank and compliant trade finance The bank, which is sponsored by through an IPO (Initial Public Unicredit Markets & Investment activities. leading investors from the UAE Offering) in 2008.

6 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 NEWS

RHB takeover rumbles on CIMB goes global March has been an interesting have a role to play in the director of KFH (Malaysia) month in the ongoing takeover new development to create Bhd, K. Salman Younis told of Malaysia’s fourth largest the world’s largest Islamic reporters that the bank would lender Rashid Hussain Behad bank. EPF seemed to confirm be ‘interested’ in taking a 49 (RHB). It was originally this; the pension fund plans per cent stake in RHB Islamic thought that the Kuwait to cut its stake in the bank Bhd, but as yet had not been Finance House (KFH) would to around 35–40 per cent and offered the opportunity. be successful with its bid for is looking for two or three the debt-ridden institution, and strategic partners in order to EPF is looking to cut costs at that it would go on to form the achieve this. In an interview RHB in order to clear some of world’s largest Islamic bank. with Bernama, EPF’s CEO the banks debts. It has decided Datuk Azlan Zainol said that to sell the bank’s non-core This plan was shattered it would consider KHF as a assets, such as Vision City, and when Malaysia’s state pension strategic partner in RHB due even hinted that the RHB head fund company, the Employees to its extensive expertise in office could be sold off. The IT Provident Fund (EPF), outbid Islamic banking. Speaking systems at the bank will be KFH to buy the Utama about KHF as a potential looked at. Zainol told Bernama Banking Group’s (UBG) 32 partner, Zainol said ‘it will that improvements here would per cent stake in RHB, taking augur well in helping Malaysia ‘bring down the cost of doing CIMB Islamic Bank plans its overall stake in the banking become an Islamic finance business and increase market to take its Shari’ah-compliant group to about 64 per cent. hub’. share’. The branch network is finance products into the global The deal was initially also under consideration; the market. Executive director welcomed by KFH – in There seems to have been no bank currently has around 200 Badlisyah Abdul Ghani (above) a statement to Bernama progress on a deal between the branches in Malaysia, which explains, ‘We have various (Malaysian National News two companies since this point. will be restructured to better financing products available Agency) it said it was confident Speaking at the Invest Malaysia position the firm in the for local and foreign players the consortium it led would 2007 conference, managing banking business. in the halal industry’.

Speaking at the World Halal Forum in Kuala Lumpur, Securing future of Islamic finance market Ghani told reporters that the global halal and Islamic finance industry is estimated to be A landmark agreement has focused work on the sukuk agreement will ‘enable the IIFM worth $1.5 trillion, which means been reached between the market, now worth over $40 and ICMA to address critical there is enormous potential for International Capital Market billion, which is increasingly market issues, through shared partnerships. ‘Players should Association (ICMA) and the attracting non-Islamic financial expertise and through consider using Islamic financing International Islamic Financial institutions and firms. Khalid consultation with industry’. as an option to raise funds as Market (IIFM) to sign a Hamad, vice chairman of the the cost is lower compared with Memorandum of Understanding IIFM (below), said that the The Memorandum of conventional banking,’ he said. that it is hoped will help secure Understanding will establish the long-term future of the a joint working group between Ghani also announced the Islamic finance market. the ICMA and the IIFM. This bank’s plans to expand its group will develop standardised Malaysian operations. The The agreement, signed on 30th contracts, language and bank plans to open 320 January at the Annual Islamic practices for secondary market branches across Malaysia Finance Summit in London, transactions and will also by June this year, says Ghani. is a significant step in the develop standardised practices ‘These branches will contribute development of a key section for the trading of sukuk and toward making our products of the global Islamic financial other Islamic financial and services more accessible services industry. It will allow instruments. to the market.’ www.islamic-banking.com IIBI 7 NEWS NEWHORIZON January–March 2007

Dubai Bank launches new Credit Suisse expands its Shari’ah-compliant Islamic banking product range

finance products Credit Suisse is set to expand do not involve profiting from its Shari’ah-compliant range investments in interest-based of banking products. The bank assets, or in businesses Dubai Bank has launched a new electronics or air tickets to every entered the market in March involved with alcohol, Islamic finance product range. customer. this year with a Shari’ah- gambling, weapons, The bank started its Shari’ah- compliant fund, and has entertainment or non-halal compliant operations in January, The next wave of the new quickly decided to expand meat. Murad believes that this and a series of announcements product range was released in its offering. There was no will mean that, in terms of in March has seen four new mid-March. The bank launched specified amount assets, the Islamic products become available in its markaba auto finance and that the Swiss bank banking sector could the UAE. The first new offerings souk goods finance products. planned to raise overtake the were launched in the first week These products have been with the initial fund, conventional banks. of March. The most interesting designed to aid the purchase of but it did announce ‘The possibility is of these new lines were a mulki cars and goods within the UAE. that up to 20 there. Islamic banks property financing product With both new products, the per cent of the in the region are very designed to facilitate the bank will purchase the goods amount raised active and innovative purchase of properties in the requested by the customer will be invested in and they are eager to UAE, and a sanad personal and then sell them on to the emerging economies. grow,’ explained finance product. The mulki customer at an agreed profit. Murad. product has a financing structure The bank is expecting to based on those of murabaha or The product launches have been see a continued demand for The Islamic banking sector ijara, and is available to UAE a success for the bank. Head of investments that conform to in the Gulf is believed to hold nationals and expatriates distribution, Mohammad Al- Islamic principles in the global around half of the assets of the living in the UAE. Nahdi, said the products had market. ‘I have not witnessed entire Islamic financial sector. received ‘a tremendous response’ a banking activity that has This works out to about $200 The sanad was designed to help and had ‘increased the inflow shown such sustained growth billion and is still growing. customers meet their personal of traffic at our branches’. The for two decades,’ global head Murad does not believe that finance needs or transfer their bank has also increased its of Credit Suisse Islamic the reasons for this are entirely existing liabilities from other branch footprint, opening five investments, Fares Murad to do with oil. ‘There are many banks. In an attempt to boost new branches across the UAE (above), told Gulf News. socio-political factors that are the uptake of the offering, the on 1st April. It has also opened driving this growth. To say bank promised a gift voucher three new branches in Dubai, There is currently an increasing that Islamic finance is growing worth between $136 (AED500) as well as one in Ras Al Kaimah demand from Arab investors in because of petro-dollars is and $1089 (AED4000), and one in Al Ain, in an attempt the Gulf for opportunities that simplistic.’ which could be redeemed for to enhance its customer reach.

First Islamic bank to open in Kenya

A consortium of investors is set Islam, but until now they have International, the Dubai Nairobi, Kenya to open Kenya’s first Shari’ah- not had a dedicated Islamic government investment agency compliant bank, Gulf Africa financial service. Isithmar and The World Bank Bank. The setting up of the Group International Finance bank is good news for Kenya’s The consortium is made up of Corporation. The bank will start Muslim community. Around a collection of investors from with $25 million in capital and 26 per cent of the Kenyan around the financial industry. aims to become a domestic bank population are followers of They include BankMuscat with a regional presence.

8 IIBI www.islamic-banking.com

NEWS NEWHORIZON January–March 2007

Islamic Islamic banks growing rapidly ICCI to home finance Islamic banks are growing at of the world’s Islamic funds in set up 200 more than twice the rate of as little as a decade. products conventional banks according companies to Ahmed Darweesh Bin The research that led to these in Egypt Dagher Al Marar, managing results has been carried out by in ten years director of Abu Dhabi Islamic ADIB for the Oxford Business Bank (ADIB). Globally the Group (OBG), a UK-based Amlak Finance and Real Estate growth rate of Islamic banks is publishing, research and The Islamic Chamber of Investment, a company offering 23 per cent, more than double consultancy conglomerate. Commerce and Industry (ICCI) Islamic home finance products, the ten per cent growth rate of OBG is preparing its new has announced that, through its has been launched in Egypt. It conventional banks. Islamic guide to doing business in Abu subsidiary the Foras Investment is the first to offer Islamic home deposits in Gulf investment Dhabi and this research will go Company, it will help to set finance products to the local accounts have more than into a chapter dedicated to the up 200 companies in the next market. doubled in the last five years, Islamic financial services industry. five years in the 57 member and Al Marar believes that The guide will be available in the countries of the Organisation ‘With growth of over 1.5 per Islamic banks will attract half second quarter of this year. of the Islamic Conference (OIC). cent annually, and a current The announcement is part of a shortfall of approximately ten-year development plan and, 145,000 houses per year, the according to Foras CEO Hatim real-estate industry has been Two deals for the European Jamil Mukhtar, it has been set highlighted by the current up ‘to accelerate the process of government as an area for Islamic Investment Bank economic development across development in 2007,’ says the Muslim Ummah’. Mukhtar Shahil Akram Juma, CEO of made this announcement to a Amlak Finance and Real Estate The European Islamic the deal was ‘a key addition to select gathering of businessmen Investment in Egypt. Added Investment Bank (EIIB), the first our funding base which has in Lahore. to this, the government has Shari’ah-compliant Islamic traditionally been provided by introduced the mortgage finance investment bank to be Middle Eastern institutions’. Foras currently has a paid up law, enabling individuals across authorised and regulated by the capital of $100 million and it is the country to own a home Financial Services Authority in In the second deal, EIIB has hoped that this will soon double. within a well regulated system the UK, has announced the signed a committed standby The company will set up five headed up by the Mortgage completion of two deals. facility with the Islamic Bank of sub-holding entities in Pakistan, Finance Authority (MFA). Britain (IBB). The facility is Malaysia, Turkey, Egypt and Chairman of the MFA, Osama The first is a structured trade structured as an undrawn Senegal, which it is hoped will Saleh, says ‘As we work to finance facility with trade revolving commodity murabaha help speed up the process of provide physical housing for all finance group CCH and is designed to assist IBB in company formation across the sectors of society, it is right that International (CCH). Under the managing its liquidity profile. Muslim world. According to people should have the ability to deal, EIIB has signed an Mukhtar, the companies will choose a financing solution that agreement with CCH and its be set up ‘for the promotion is in line with their beliefs’. subsidiaries for a sterling- of diverse fields ranging from denominated revolving financing bio-technology to IT and When this backdrop is combined facility. The proceeds of the infrastructure’. with Egypt’s largely Muslim facility will be used according to population, it is no wonder that the principles of Shari’ah to Foras has already begun its the parent company Amlak finance UK-based supplier of work with the preparation Finance has decided the time steel products, Alphasteel. This of investment road maps for is right to enter the Egyptian deal is the sixth structured trade ten Muslim countries, such as market. Initially, customers finance transaction to be signed Pakistan. It is hoped that these will be able to purchase any by EIIB and the first in the UK steps will lead to the formation completed property, with long- for CCH. Managing director of of an economic consortium of term tenures of up to 20 years. CCH, Eren Nil (right), said that the Islamic world.

10 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 NEWS

Islamic business banking Islamic banks support on the UK high street Sharjah Electricity and Water Authority Lloyds TSB (below) has all the other services available launched the first high-street to traditional business and Islamic business accounts in the corporate account holders. Sharjah Electricity and Sharjah, is the first entity owned UK. The Shari’ah-compliant Water Authority (SEWA) has by the government of Sharjah to accounts have been split into The launch of these new successfully closed its $350 approach the syndication market two categories. If the turnover accounts establishes Lloyds TSB million sukuk al ijara facility. for a long-term Islamic financing of a business is under £2 million as the largest provider of Islamic It received strong interest from facility. The financing was ($3.9 million) it will be eligible banking across the UK. Truett regional banks in the general provided by a total of twelve for the Islamic Business account. Tate, group executive director syndication, and was over- banks including ABC Islamic If a business has a turnover for wholesale and international subscribed. SEWA, the Bank, Gulf International Bank, greater than this it will be banking, says: ‘We’re monopoly supplier of electricity, Kuwait Finance House and eligible for the Islamic Corporate consolidating our position as water and gas to the Emirate of Sharjah Islamic Bank. account. Both accounts comply the UK’s leading provider of with Shari’ah law and, as such, Islamic financial services and offer no credit interest and no making it possible for Britain’s overdraft facility, but still offer Muslim businesses and aspiring Malaysia International Islamic entrepreneurs to bank according to their principles’. Financial Centre initiatives

This is the latest addition to strengthened with MOU the bank’s Islamic finance range. The range was developed after a survey last year revealed that A Memorandum of operation on capacity three quarters of the UK’s Understanding (MOU) has building and human capital Muslim population were been signed between Bank development in Islamic finance. interested in Islamic finance. Negara Malaysia, Qatar The second is a mutual co- The new business accounts are Financial Centre Regulatory operation on the development available across the bank’s 2000 Authority and Dubai Financial of international Islamic strong branch network, and the Services Authority. The deal finance, and the third includes bank is hoping that it will mean has been signed as part of the Shari’ah harmonisation and that Muslims will not have to Malaysia International Islamic strategic promotion initiatives. compromise their principles Financial Centre initiatives. when it comes to their It is hoped that this MOU, business finance. The initiatives aim to establish signed between East and West collaborative relationships Asia, will mutually strengthen with strategic partners towards the inter-linkages amongst the the development of Islamic Islamic financial centres, and New Islamic investment fund finance, and are based around reinforce trade and investment launched in Saudi Arabia three themes. The first is co- flows between the regions.

Saudi Arabia’s National for International Stock Trade D in an international stock folder investment channels compliant Commercial Bank (NCB) has will allow investors to invest in that is compliant with Islamic with Islamic principles and launched a new investment international corporations that principles. Sami Abdo, head of invest in large international fund for individuals to invest are leaders in their field. The NCB’s Investment Services corporations that enjoy strong in international corporations. two-year fund will also protect Division, said, ‘The new fund and stable growth averages’. The Al-Ahli Ma’moun Fund the investor’s capital by investing will provide alternative www.islamic-banking.com IIBI 11 COUNTRY FOCUS: RUSSIA NEWHORIZON January–March 2007

Islamic banking and takaful in Russia: What the future holds

With over 15 million Muslims living in Russia today, the domestic introduction of Islamic financial services has been discussed and attempted by both businessmen and scholars. But is the country ready for it? Renat Bekkin, Moscow State Institute of International Relations lecturer, talks to Tanya Andreasyan about the challenges facing Islamic banking and insurance in Russia.

In recent years, the Russian banking market Mosque in St Petersburg, Russia has been developing at a rapid pace. As the country’s economy is stabilising and taking a definitive shape, so is its financial services industry.

In typically dramatic Russian style, recent events within the Russian banking sector have attracted attention on a worldwide scale, not always in a positive way. The murder of the Central Bank’s vice chairman, Andrei Kozlov; the revoking of banking licences; the control of many domestic banks by foreign investors; and the upcoming changes connected with the Russian Federation joining the World Trade Organisation (WTO) are contributing to the shape of the Russian banking sector today.

Currently, there are around 1200 banks operating in Russia, with Sberbank (Savings Bank of the Russian Federation) having the largest share and the widest spread over all eleven time zones of the country. The rest are a pretty mixed bunch, but there are some strong and growing players. Regional expansion is high on the banks’ agenda and retail banking services are of the utmost importance in capturing the largest market share.

However, having suffered a number of situations in which people’s savings were lost in the recent past, the Russian population is being cautious and somewhat sceptical of the current developments. There is still an estimated $1.5 billion in so-called ‘mattress’ money held by the public. Nevertheless, the

12 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: RUSSIA

banks hope to introduce the financial as so are some countries in the Caucasus transactions; and the philosophy of Islamic services to as many of the 145 million such as Azerbaijan. law. Russian citizens as possible. One of Russia’s specialists in Islamic finance, So what is his opinion on the situation with An estimated 15–20 million of them who has contributed to its promotion across Islamic financial institutions in Russia? are Muslims. And while the country’s the territory of the former USSR, is Renat population is largely diminishing, Russia’s Bekkin, international law lecturer at one of ‘There is still a lot of scepticism over the idea Muslim population is on the increase. It has the most prestigious universities in Russia, of Islamic banks among Russia’s Muslims,’ grown by around 40 per cent since 1989, the Moscow State Institute of International says Bekkin. ‘Actually, a number of Muslims due to high birth rates in the Muslim Relations (MGIMO-University). The around the world do not support Islamic community and continued immigration university functions under the auspices banking and consider it to be unacceptable, from the Caucasus and Central Asia. Some of the Ministry of Foreign Affairs of the the same as Islamic whisky. Some people in analysts project Muslims to become one-fifth Russian Federation. Russia also support this theory, even if they of the country’s overall population by 2020. don’t know much about Islamic finance to Bekkin studied at MGIMO and graduated begin with.’ Today, Russia has about 8,000 mosques from it with a Master of Law degree in compared to 300 mosques 15 years ago. Statistics predict that by the end of 2015, the number of mosques in the country Although the Arab world considers Russia a potentially will exceed 25,000. emerging market with regard to Islamic finance, there is still One would expect that, with such a growth a lot of apprehension when it comes to investing capital in it. in the Islamic population in the region, there ‘There are many hitches and complications.’ would be increasing demand for Islamic financial services. However, this is not quite the case. As mentioned earlier, the confidence of Russia’s population in the 2000. A few years later, he received a Bekkin explains: ‘Generally, the attitude of country’s banking system is still low. And PhD in Law, having written a dissertation Muslims in Russia towards Islamic finance it’s not only the confidence problem; it is the ‘Insurance in Islamic Law: Theory and can be divided into four main categories. general knowledge about banking. Russia’s Practice’. Today, he is a professor at the The first one is that it is not vital to use President, Vladimir Putin, once mentioned UNESCO (United Nations Educational, Islamic banking services. These people that ‘the majority of Russian citizens are Scientific and Cultural Organization) consider that observing other rites, for still avoiding banks, just don’t understand department in MGIMO. example, praying and fasting, is sufficient. how they work and consider them to be The second category consists of those who too complicated and requiring professional Bekkin is originally from St Petersburg but do not practise any rites at all or are not knowledge’. According to Putin, only moved to Moscow to attend the university even aware of them. This category often one quarter of Russian citizens have and continues to live there today. He speaks includes ethnic Muslims. And there is a third bank accounts and less than ten per cent three foreign languages – English, Arabic small category of people who think that of the population uses plastic cards. and Chinese. Literature is one of Bekkin’s practising all principles of Islam, including in passions, so much so that he writes himself the financial sphere, is essential.’ He goes on: And if conventional banking, which has and has also established an open literary ‘So, these Muslims have to somehow find a existed for a long time, is still a mystery for prize called ‘Islamic Breakthrough’. way of minimising the risks of using non- a large number of people in Russia, what Islamic banking products. The solution can one say about the Islamic financial Bekkin’s interest in Islamic finance of banking abroad is, unfortunately, not institutions, which have emerged only has developed gradually. Originally, affordable for the majority of them.’ recently? The situation is much the international law was his subject of same in other countries comprising the specialisation but then, in the course of ‘There is also a fourth category of Commonwealth of Independent States (CIS), research, he came across the legal issues intellectuals who are very enthusiastic about the successor to the USSR. Depending on the of Islamic insurance (takaful) which later Islamic finance. These Muslims, generally geographical location and ethnic population, became the topic of his thesis. Eventually, ethnic, may not be as strict in following some of these countries are more advanced Bekkin’s area of interest broadened to other other Islamic rites but are very interested in their knowledge of Islam and Islamic aspects of Islamic law and finance including: in Islamic finance and the concept of ethical banking than others. The countries situated retakaful; Islamic law in non-Muslim banking.’ The latter category includes in Central Asia – for example Kyrgyzstan countries; Islamic economics; Islamic Muslims who have tried to establish Islamic and Tajikistan – are predominantly Muslim, law of banking, securities and business financial institutions in Russia since the early www.islamic-banking.com IIBI 13 Kul Sharif Mosque, Kazan, COUNTRY FOCUS: RUSSIA Republic of Tatarstan, Russia

The secret of success is 1990s. Regrettably, none of these to introduce the economic undertakings seems to have resulted in anything long-lasting. aspects of Islam before any penalising sanctions. Back in 1992, an Islamic Cultural Centre in It is necessary to begin with Moscow and the All-Russia Tatar Cultural and Educational Centre, together with a economics rather than with number of Russia’s large machinery and scaring. This is a much more metallurgical plants, announced the effective way to familiarise and establishment of the United Islamic Commercial Bank Inc. It was going to attract people to Shari’ah law. be located in the Kemerovo Region, an industrial district in the north-east of Russia. The reasons behind this collaboration were more practical than religious; the bank was set up to develop the industry in the region and to attract foreign investors primarily from Muslim states. ‘The regional government knew next to nothing about Islamic finance at the time, they just wanted to create a financial structure to attract capital from the Arab world,’ says Bekkin. However, this project was never completed.

Another unrealised project, which directly involved Bekkin, was the launch in 2005 of an Islamic insurance company in the republic of Tatarstan (a federal subject of Russia) called ‘Itil’. It was supposed to be a joint venture between local entrepreneurs and foreign investors from the Arab world. ‘There were no obstacles from the legislative or political point of view,’ says Bekkin. He was appointed director of the company. ‘We drew up a business plan and presented it to the foreign investors. The problem turned out to be quite worldly – apathy from both sides to actually press on with the project. Renat Bekkin, MGIMO-University So, it didn’t end with anything.’

Indeed, although the Arab world considers Russia a potentially emerging market with regard to Islamic finance, there is still a lot of apprehension when it comes to investing capital in it. ‘There are many hitches and complications,’ admits Bekkin. ‘One of the potential investors [from UAE] in the takaful company, Itil, once said that Sudan interested him more than Russia from the point of view of the Islamic financial services market.’

And it’s not just the Middle East countries that are contemplating introducing Islamic banking in Russia. Not long ago, Bekkin

14 IIBI COUNTRY FOCUS

held some talks ‘on a consulting level’ with the Swiss bank Fortis, which was pondering a move into the Russian banking market with its Islamic offering. The idea was to develop tailored financial products and services using the Islamic model, yet without calling them Islamic. However, the bank’s initial analysis was not satisfactory and so far Fortis has not taken any further steps.

Bekkin thinks that chances of success in this field would be higher if large international conglomerates like HSBC or Citibank opened their Islamic subsidiaries in Russia, as opposed to purely Arab banks doing the same thing. ‘It is more likely to have a positive reaction,’ he says. However, to date, neither western nor Middle Eastern investors have carried out such a project from start to finish.

The only undertaking that actually moved further than ‘half a step’ (although today it is also history) was Badr-Forte Bank. This bank was set up in Moscow back in 1991, and operated according to Shari’ah law from 1997. Officially it was not called Islamic, but its charter stated that the bank had the right ‘to act according to Russian and international laws by applying Islamic economic technologies which do not contradict the banking laws of Russia’. Badr-Forte was also a member of the General Council of Islamic Banks under the IDB (Islamic Development Bank).

The bank managed to adapt successfully to the Russian legislation and economy whilst following the Islamic principles of banking although, according to Bekkin, ‘due to the specifics of Russian laws Badr-Forte had to compromise more in some respects than its foreign counterparts’. The piece of legislation that became a stumbling-block for Badr-Forte and Russia’s Central Bank was the deposit insurance scheme, which the Central Bank made mandatory. Badr- Forte tried to explain that the essence of an obligatory deposit insurance scheme contravened the very principles of Islamic banking, but the Central Bank stood firm. In the end, Badr-Forte’s licence was revoked on the grounds of money-laundering activity plus the gross violation of order and period when reporting suspicious transactions.

IIBI 15 COUNTRY FOCUS: RUSSIA NEWHORIZON January–March 2007

but it doesn’t seem likely that Russia’s only Kremlin of Kazan, Republic of Tatarstan, Russia Islamic financial institution is going to be revived any time soon. Dzhabiev is not in a rush to open another Islamic bank in the country. As the proverb goes, ‘Once bitten twice shy’.

Of course, Bekkin regrets that the idea of an Islamic bank in Russia still remains only theoretical, but he thinks that Badr-Forte had more than Russia’s legislation and the current state of the Russian banking market to blame. The lack of the bank’s activity in the social and educational spheres resulted in the absence of a wide-spread support for the bank among Russia’s Muslims.

‘One of the primary functions of any Islamic financial institution is a social one,’ states Bekkin. ‘Unfortunately, Badr-Forte did not really fulfill that.’ He goes on to give an example: ‘Dzhabiev and his right hand, Samira Karahanova, were the only Muslims working in the bank, and Dzhabiev was The bank had focused on foreign keen on recruiting qualified Muslim trade operations, such as cross-border staff to work in Badr-Forte. Since such transfers, guarantees and letters of credit. personnel were hard to come by, there was Unfortunately, its retail Islamic offering a suggestion to train the potential staff, was limited to deposits, money transfers provide them with the necessary literature and mortgages, with the latter being and let them get a feel for Islamic banking launched shortly before the bank’s closure. in practice. Dzhabiev’s position on this issue Furthermore, the bank had no branches was far from supportive, as he suggested and was not widely known to the general that those willing should research and learn Muslim public even in Moscow (the city Islamic banking themselves, without the which hosted the bank’s headquarters), let bank’s help. And this kind of attitude alone regionally. Badr-Forte, however, tried spread to other things too.’ to compensate for its absence of outlets by actively promoting both internet and However, in spite of Badr-Forte’s fate, mobile phone banking. the idea of establishing an Islamic financial institution in Russia continues to hover in Bekkin is very familiar with the bank and its the air. So, if another Islamic bank were to founder and chairman, Adalet Dzhabiev, as open in the country, what would be the best Bekkin worked on probation in the bank for geographical location for it? Bekkin thinks a while during his university years. ‘Actually, that ‘Moscow is the city with the most everyone who was studying Islamic finance potential of developing an Islamic finance at the time or was writing about it bore service industry, as it has a large Muslim some relation to Badr-Forte,’ he says. community, and quite a lot of well-off ‘Everything concerning Islamic banking Muslims, both ethnic and newly converted’. in Russia and everybody involved in it Russia’s capital is among the most expensive were revolving around this bank.’ cities in the world, and the standard of living there (regardless of people’s faith) is However, in December 2006, the Central traditionally high compared to other parts of Bank of Russia revoked Badr-Forte’s the country. Plus, Moscow has embraced the banking licence. There have been a few financial services industry with considerably unsuccessful attempts to recover the licence, more enthusiasm than the regions.

16 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: RUSSIA

Another part of Russia that is also a financial products’. Even a basic thing, such potential Islamic banking and insurance as zakat (Islamic concept of tithing and Mosque in Norilsk, Siberia, Russia hub is the republic of Tatarstan, situated alms), is a very unclear subject for a lot of in the central part of Russia. Tatarstan lies Muslims in the country. ‘Knowledge of zakat between the Volga River and the Kama is a touchstone by which you can judge the River (a tributary of the Volga) and extends people’s attitude to Islamic finance,’ says to the Ural Mountains. It is a predominantly Bekkin. ‘Here it is very often thought to Muslim republic, with a population of be unnecessary, or many people think that nearly four million people. ‘It has a claim giving alms to the paupers by the mosque on being the leading Muslim community is zakat.’ centre of Russia,’ says Bekkin, ‘so there is a potential interest in the Islamic financial Also, creating favourable conditions for structures there; however, it is more the development of Islamic financial services political than economic’. is essential. ‘The secret of success is to introduce the economic aspects of Islam Then, there is also the republic of before any penalising sanctions. It is Dagestan, situated on the Caspian Sea coast necessary to begin with economics rather in the southern part of Russia, the North than with scaring. This is a much more Caucasus. Over 90 per cent of this republic’s effective way to familiarise and attract population (2.3 million) is Muslim, with people to Shari’ah law,’ states Bekkin. Islamic faith dating back centuries there. ‘This region is exactly the case where people At the moment, Bekkin is involved in the Moscow for a long time. Although the follow Shari’ah principles in various aspects project of creating an Islamic mutual fund, primary goal of establishing this company of life except the financial one. There is a Gold Dinar, which is expected to commence is to offer the public Shari'ah-compliant lack of understanding and support of this operations later this year. ‘The management services, it is also seen as a ‘promising matter both from the local government and company has already been registered, and business’. ‘The investors are very the local population,’ says Bekkin. Even so, now we are in the process of developing the experienced in this field – some of them have there has been sporadic talk of establishing products,’ says Bekkin. Gold Dinar will be been dealing in securities for over a decade,’ an Islamic financial institution there, but situated in Moscow, with the ambition of says Bekkin. ‘So they clearly see the potential this has turned out to be unsubstantiated. moving into Russia’s regions in due course. in the Islamic mutual fund and know that At present, Bekkin’s role in the project is there is a demand for its products and Such empty promises are not an purely consultative; however he is services in Russia.’ unusual thing for Russia. Once in a while, considering further involvement in this announcements of establishing an Islamic mutual fund. ‘I am always interested in The concept of mutual funds is relatively new to the Russian market and this niche has recently been developing rapidly, with Moscow is the city with the most potential for developing plenty of coverage in the mass media and a an Islamic finance service industry, as it has a large Muslim mushroom growth of conventional mutual funds as an alternative way of depositing community and quite a lot of well-off Muslims, both ethnic money. Muslims in Russia turn to mutual and newly converted. funds for financial services, as these organisations are regarded as more ethical and less contradictory of Shari’ah law than bank or a takaful company appear in the learning something new,’ he says. ‘Maybe banks. Therefore, setting up a proper mass media. Bekkin thinks that most of the I’ll work in the company.’ It all depends Shari’ah-compliant mutual fund in the time ‘it is merely a trick to attract attention whether the company’s investors stick to the country is indeed ‘a hopeful activity’. And and to occupy a niche in this market in project and go all the way. So far ‘everything the successful completion of this project advance’. seems to be serious’, but having encountered will surely be a step in the right direction so many canards before, Bekkin is cautious towards further development of Russia’s Nevertheless, the development of Islamic in his prognosis. Islamic financial services market. banking in Russia is by no means a lost cause. More widespread education about The ‘initiative group’ organising Gold Islamic economics and finance is needed, as Dinar consists of seven people. Most of the ‘the lack of knowledge in this area is one of participants are originally from Dagestan, the main causes of low demand for Islamic but they have been living and working in www.islamic-banking.com IIBI 17 IIBI NEWS NEWHORIZON January–March 2007

Meeting with Japanese delegation

Warren Edwardes, a member the latter two both from the and what remains to be done in problems, for instance, in of the IIBI’s informal Board of Japan Centre for International this area. damaging the stability of Governors, received a Japanese Finance, acknowledged that issuance or trading of sukuk. delegation visiting London for a London is seen as one of the key The talks were not limited to the research project ‘The Emergence centres of growth in the Islamic domestic issues of the industry, Other global problems, such as of Islamic Finance in the UK’. finance sector today. They but embraced other topical a possible increase in the costs Professor Koji Muto, professor discussed London’s prospects subjects of Islamic finance on a of Islamic products and services of Middle Eastern economic of becoming the centre of global worldwide scale. The Japanese due to the conflict between studies and Islamic finance, Islamic finance transactions, delegation raised the very strengthening competitiveness College of Asia Pacific such as sukuk, and the pros interesting question of the and Shari’ah compliance, as Management; Katsura and cons of this scenario. The differences in Shari’ah well as the negative effect that Daikuhara, principal economist delegation also assessed the UK interpretation between the Gulf the petrodollar shrinkage might (Middle Eastern economic government’s efforts to promote countries and Malaysia, and have on Islamic finance, were development); and H. Hosoda, Islamic finance in the country whether such uncertainty causes also discussed.

IIBI director general joins Muslim Power 100

Mohammad Ali Qayyum, who established the IIBI as a Mohammad Ali Qayyum, director general of IIBI, has IIBI non-profit organisation, was been included in the Muslim a pioneer and highly respected Power 100 list, an initiative figure; he realised early on that set up by Carter Andersen, the success of the Islamic media and business consulting banking movement would organisation. In the words depend heavily on education, of Khalid Darr, chairman of training and research. Carter Andersen, the Muslim Power 100 names ‘Muslim Since taking on the position men and women who of director general, Qayyum contribute positively and has been working closely with often powerfully within members of the IIBI’s informal all sectors of British life’. The country’s Islamic finance In 2003, Qayyum became Board of Governors on services sector has grown director general of the London- developing the short-term The purpose of the nomination considerably over the past few based Institute of Islamic as well as long-term business is to set out how the Islamic years and continues to increase Banking and Insurance (IIBI), plans to take the IIBI to a ‘traditional core values of steadily. Qayyum believes bringing in-depth knowledge higher level. Together with empathy, objectivity, integrity that unbiased education and and practical experience gained his team and the Institute’s and impartiality drive the training from independent from nearly three decades in ‘friends’, Qayyum is continuing contribution to the social and organisations like the IIBI the banking industry. the late Ali’s legacy of cultural welfare of Britain’. supported by professionals, promoting Shari’ah-compliant Today, the Muslim population the industry, regulators and Until the sad demise in March finance and of establishing the in the UK is estimated at 2.1 government is the key to 2005 of the IIBI’s founder IIBI as a global centre of million with a contribution successful promotion and and chairman, Muazzam excellence in Islamic banking to the annual GDP (gross implementation of Islamic Ali, Qayyum assisted him in and insurance education, domestic product) of £51 finance both within the reviewing the Institute’s short- training and research based billion. UK and outside it. term strategy. The late Ali, in the City of London.

18 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 IIBI NEWS/LECTURES

Korea Promoting Islamic finance Economic January: of wealth by prohibiting riba (interest), Daily maysir (gambling) and gharar (speculation). What should be our Some permissible Islamic financing modes vision and objectives were preferred and encouraged by the interviews IIBI Islamic Shari’ah over others – the contract in Islamic finance? of equities, for example. Due to the growing interest in Islamic banking in South Korea This was the theme addressed by Dr Dr Imran said that Islamic banking and in order to introduce it to Muhammad Imran Ashraf Usmani for the transactions should be based primarily on South Korean national readers, IIBI monthly lecture on 30th January 2007. musharakah /mudarabah (profit and loss Yong-Seok Ju, a journalist at the sharing models), so that capital would flow Korea Economic Daily (Han Dr Imran is one of the leading Shari’ah advisors from the rich to the poor, while the ratio of Kyung), one of the largest in the Islamic finance world and currently serves equity based transactions should increase finance and business daily on the Shari’ah boards of many international over non-participatory based transactions to national newspapers in financial institutions. He is also a member of achieve the real benefits of Islamic banking. South Korea, along with his the IIBI’s Shari’ah Advisory Group. Where profit and loss sharing contracts interpreter, Ms Hee Choo, were not feasible, however, exchange visited IIBI and interviewed The lecture was chaired by Iqbal Khan, former contracts such as murabaha, ijara and salam, Mohammed A. Qayyum, the founding CEO, HSBC Amanah, and member diminishing musharakah and istisna should Institute’s director general. of the IIBI Board of Governors. be used. These are asset-backed transactions that would reduce the level of economic inflation. In the course of the discussion, Forty years ago, when the modern Islamic Ju raised various questions on banking movement began to establish itself Islamic financial institutions should evaluate the history of Islamic finance, in the global financial system, pioneers of the the extent to which they fulfil the basic its present position in the movement saw it as a cure for the economic requirements of the community. If they were mainstream financial system, and social ills of society. According to to increase their product range they would the role of Middle Eastern them, these ills stemmed from unbridled boost the confidence of the community and economies in its development, capitalism. Islamic banking is now regarded broaden the customer net. This would be and the future prospects of as the defining characteristic of the Islamic key to the growth of the Islamic finance the industry. He also enquired economic system and, while many Islamic industry. ‘Products should be Shari’ah about the Institute’s objectives, banks are now operating around the world, compliant not only in form, but also in activities and areas of support debate continues as to what constitutes substance, in order to realise the true in promoting Islamic finance. success in relation to its potential to benefits of the Islamic financial system,’ Qayyum informed him that IIBI maximise social welfare. Meanwhile, he concluded. has been endorsing this sphere the belief still lingers that profit and loss of finance for over a decade, sharing banking is superior to interest- providing training and education based banking. January lecture in the form of post-graduate diploma courses, monthly Dr Imran pointed out that Islam is lectures in London, publication a complete religion and provides a of reference books, and issuing comprehensive code of life, with guidance in NewHorizon, an official every sphere including socioeconomic fields. magazine of IIBI. Qayyum If this guidance were followed by society, the also stated that the Institute welfare and well-being of mankind would has further plans to expand benefit. He referred to specific instances: its activity and upgrade its ‘Allah (SWT) permitted trade and prohibited services, while continuing to riba’; and Prophet Muhammad (SAW) offer assistance to all those encouraged shirkah (partnership) in willing to learn more about various maxims and sayings. Islamic Islamic banking and insurance. finance facilitates the equitable distribution www.islamic-banking.com IIBI 19 IIBI LECTURES NEWHORIZON January–March 2007

companies, pornographic concerns, banks February: and insurance firms dealing in interest, and March: How to create a Shari’ah- manufacturers and distributors of alcohol Risk management in must be filtered out. Add to this list compliant, balanced organisations whose principal activity may Islamic finance investment portfolio not centre on the above but which derive more than ten per cent of their income For the IIBI March lecture, Professor Rodney from one or more of these activities; highly Wilson, director of Postgraduate Studies at Sufyan Gulam Ismail, CEO and founder of leveraged companies (with gearing in excess Durham University’s School of Government 1st Ethical group, considered how to create of 33 per cent); and companies involved in and International Affairs, addressed some a Shari’ah-compliant, balanced investment activities prejudicial in any other way to of the key issues faced by Islamic financial portfolio at the IIBI February lecture. the interests of the Shari’ah. institutions in managing credit, operational, liquidity, Shari’ah, legal and regulatory risk. Ismail started his career with Deloitte & Touche, a firm of chartered accountants, which also Sufyan Gulam Ismail, 1st Ethical group The lecture was jointly chaired by Richard offers advisory, financial, management and Thomas, the former managing director of Asset taxation services. In 2001, Ismail identified Management at Arab Banking Corporation, a gap in the marketplace for a specialist firm London, and Professor Mahmood Faruqui, to provide bespoke tax solutions to owner- honorary vice-chairman, IIBI. managed businesses. He filled that gap by starting up 1st Ethical in the same year. With an increasing number of organisations operating across borders, facilitated by The lecture was chaired by Sultan Choudhury, advances in information technology, director of sales, Islamic Bank of Britain. executives are focusing increasingly on the management of the risk incurred by Social responsibility is gaining increasing the various business operations. popularity in the corporate world. It is perceived as a means of self-regulation to As financial institutions are key players demystify stakeholders’ concerns about in each country’s economic stability and the operations of a business and a way growth, governments all over the world of highlighting the contribution to the are developing regulations and monitoring community and environment in which the mechanisms. enterprise is operating. Shari’ah-compliant products, with their underlying principles Such mechanisms are necessary in order of equity and social justice, embody the to maintain and enhance public trust in same values. their financial institutions, in this era of globalisation, where millions of funds As the Islamic finance industry grows, Ismail looked at the current retail products can be transferred at the click of a mouse. Islamic financial institutions must in the UK marketplace and segregated them disseminate information about the range according to their risk profile. He also While the modern Islamic banking of products available, along with their discussed the tax efficiency of these movement is still in its infancy, it must different risk profiles, and must commit investments. He cited low risk products, devote more resources, train more personnel to responsible business conduct, investment including the Islamic bank accounts and build a comprehensive strategy to in people and in the community. presently offered by HSBC Amanah, manage risk and develop confidence in its LloydsTSB and Islamic Bank of Britain; and operations and long-term sustainability. The basic principles of Shari’ah, as Shari’ah-compliant property investments. applicable to investments, include the Medium risk products are the ethical The distinctive nature of Shari’ah- prohibition of interest and the avoidance unit trusts, which minimise the risk of compliant financial liabilities and assets of unethical concerns and contractual investment by diversifying the portfolio, has implications for risk management. deficiencies, such as uncertainty and ‘risk such as Friends Provident, musharakah and reward’ consideration. There are other funds and property share funds. High risk Professor Wilson focused on credit risk key factors, however, which must also be products include Middle East Islamic bank initially – an area of great concern for all considered when screening for Shari’ah- equity funds, Shari’ah-compliant UK financial institutions, but more important compliant investments. The shares of equities and direct investment in the in Islamic banking as Shari’ah ruling gambling outlets and businesses, tobacco Dow Jones Islamic index. emphasises the need to take a lenient

20 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 IIBI LECTURES

March lecture loan without interest, where the borrower pays back the capital only).

This approach could enhance the reputation of Islamic banks, so improving client loyalty while helping to attract new clients, as the bank is partnering with the client to overcome a difficult financial situation.

Mudarabah and musharakah financing modes are used infrequently because these expose Islamic banks to maximum liability and it is also very costly to establish effective monitoring mechanisms – a prerequisite here. Therefore most Islamic banks tend towards non-participatory modes, where the risk is much lower compared to the mudarabah and approach when borrowers are in genuine changes in their circumstances, should musharakah. financial difficulty. be given more time and, if possible, their capital payments should be treated on the A more detailed article on credit risk from Investment mudarabah deposits cannot basis of quard hasanah (the extension of a Professor Wilson can be found on page 36. be guaranteed, a fact which conflicts potentially with deposit protection insurance requirements. In murabaha April lecture preview: financing operations, and with ijara Successful strategies for attracting Muslim operating leases, Islamic banks take on ownership risks which conventional customers by Islamic banks banks try to avoid. This is the topic of the IIBI’s April Since Islamic banking is based on traditional lecture, which will be presented by Sultan principles of profit sharing, there are also Choudhury, director of sales, Islamic potential asymmetric information problems Bank of Britain. Choudhury has plenty that increase risk. Internal management of knowledge and experience to share, as processes and client screening criteria the customer base of this, the UK’s first should be strong to minimise these risks. standalone Islamic bank, has trebled in the past two years reaching 51,000. Having an experienced management team and well-trained staff may curtail the The lecture will address the issues of operational risk for the banks. Liquidity risk understanding the increasing importance can be managed by using murabaha inter- of the emerging Islamic financial services bank deposits, to utilise the surplus funds industry; benefiting from the new of one bank by another. demographic and economic realities; learning how to identify and target Professor Wilson also discussed ways to potential customers with the right deal with unscrupulous defaulters. These products and customised services; Branch of Islamic Bank of Britain included blacklisting a client, taking him/ training the workforce to ensure that her to court and the confiscation of his/her they genuinely believe in the products The lecture will take place on passport. These penalties may vary from and services they are selling to the 30th April 2007 at 5.30pm at: country to country, depending on the profile Muslim customers and that they British Bankers’ Association of the client and the national, legal and are able to empathise with them. Pinners Hall regulatory structures in place. 105–108 Old Broad Street To register, please visit: London At the same time, those who had genuinely www.islamic-banking.com EC2N 1EX fallen into financial difficulty, as a result of www.islamic-banking.com IIBI 21 CONFERENCE REVIEW NEWHORIZON January–March 2007

The murabaha can be used to configure a profit rate swap which is a structure The London Islamic equivalent to an interest rate swap in the conventional market. The murabaha profit swap is often used in conjunction with a tawaruq. Also, Deutsche Bank has published Financial Services Summit a white paper on how it structured an innovative product using wa’ad (promise) features that allows Shari’ah-compliant Investors, lawyers, accountants and bankers gathered at the investments to reference a wide range Barbican Centre in London on 29th March 2007 to discuss of asset classes, including indices. developments in Islamic banking products and services. There are over 260 Islamic scholars around The summit was endorsed by the IIBI. the world involved with banking in some way, although there are only around 20 who are recognised globally. Of these, a dozen or A key thrust of the conference was institution because the instruments so regularly deal with Western banks. The discussing London’s role in the Islamic it uses have different risk profiles from objective of having an Islamic scholar to banking industry. Some of the City’s conventional ones. Basel II requires banks review a structure is to obtain a fatwa heavyweight figures – including Ed Balls to allocate capital according to the perceived regarding the Shari’ah compliance of the MP, economic secretary to the Treasury; Sir risk of each asset class. The IFSB (Islamic product. One respected scholar shared Michael Oliver, a former Lord Mayor of the Financial Services Board) is attempting to his viewpoint on the concept of Shari’ah City of London; Michael Ainley, the head of create capital adequacy guidance standards compliance with the conference. He pointed the UK’s FSA (Financial Services Authority – for Islamic financial institutions, which will out that Shari’ah consists of two parts: the the UK’s financial market regulator); and provide a standard platform to help these practical; and the theoretical representing wholesale banks and investment firms unit, institutions make allocations against belief based on faith. When a product is all made enthusiastic addresses on the way specific Basel II risk categories. accepted as being Shari’ah compliant it the UK government has changed regulations means that it is in-line with the practical to accommodate Islamic banking. There New structures of Islamic products are aspects and therefore doesn’t offend Islam. were several references to the way in which being developed and some were presented This is not the same as a product being the UK has adopted a ‘principles-based’ to the conference. The world of derivatives Shari’ah based – one that incorporates a approach rather than ‘just ticked boxes’ is now being made available to investors in full partnership between the bank and the in a ‘rules-based’ approach. a form that is acceptable to Islamic scholars. customer for their mutual benefit, including Traditionally, scholars saw these instruments genuine assistance as well as sharing of the To create a ‘level playing field’ between as speculative and a form of gambling. They profits and risks. In this scholar’s opinion, the conventional banking market and are now increasingly being accepted as a Islamic banking has grown from almost the rapidly developing Islamic market, hedging tool. The lack of standardisation in nothing 30 years ago to a significant the government has passed legislation Shari’ah products and differences between business today. Currently, he feels, it is trying specifically aimed at accommodating Islamic countries makes developing Shari’ah- to copy the conventional banking products instruments and has adopted changes to its compliant derivative products a more that have been developed over hundreds of tax environment. In the March 2007 Budget, expensive process. The ISDA/IIFM years. He questions whether the aim should the Chancellor announced changes to (International Swaps and Derivatives be to become Shari’ah based, rather than accommodate ‘alternative finance investment Association/International Islamic Financial simply Shari’ah compliant. bonds’ specifically intended for the sukuk. Market) are jointly discussing the principles Currently, there are around 25–30 regulated of a Shari’ah-compliant ‘master agreement’. Although the sukuk is regarded by some firms in the UK that are authorised to offer The developed draft is being reviewed by a as a ‘new’ product, one speaker pointed Islamic products, with more applications working group in conjunction with Islamic out that it is, in fact, one of Islam’s oldest from banks in the pipeline. A UK base scholars. The agreement will make derivative instruments. There are references dating enables firms to open in any EU country. products much easier to structure. back to the Islamic Caliphates about the ‘sakk’ (whose plural is ‘sukuk’). The word Some speakers felt that other worldwide The conference was told that the most means ‘note or certificate’ and relates to regulations and accords are proving more common Shari’ah derivative structures ancient traders acquiring additional capital problematic for Islamic banks to adopt. are the murabaha followed by the arboun through mudarabah when setting off on The Basel II Accord, for example, is more (resembling a conventional call option) and trading missions to India and other places. difficult to apply to an Islamic financial then the salam (resembling a forward sale). Modern structures are more complex.

22 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 RATINGS AND INDEXES

Islamic Banks, Financial Institutions & Financial Instruments

Below is a monthly list of the latest long- and short-term credit ratings for each Islamic financial institution and financial instruments monitored by Capital Intelligence (CI), an international credit rating agency. Detailed information on rating processes and definitions can be found on the CI’s website www.ciratings.com

CURRENT RATING 1st April 2007 FOREIGN CURRENCY FINANCIAL SUPPORT OUTLOOK SINCE LONG TERM SHORT TERM STRENGTH ISLAMIC BANKS Abu Dhabi Islamic Bank A- A2 A- 2 Positive Feb 2006 Al Amin Bank BB+ B BB+ 2 Positive Oct 2006 Al-Baraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Aug 2006 Al Rajhi Banking & Investment Corp. A+ A1 A 2 Stable Jul 2006 Arab Islamic Bank NA NA B+ 3 Stable Oct 2005 Bahrain Islamic Bank BBB A3 BBB 3 Stable Nov 2006 Bank Islam Malaysia BBB- A3 BB+ 2 Stable Oct 2006 Faysal Bank (Pakistan) B+ B BB 2 Stable Aug 2006 Gulf Finance House BBB A2 BBB 3 Positive Nov 2006 Jordan Islamic Bank for Finance & Investment BB B BBB- 3 Stable Oct 2006 Kuwait Finance House A A1 A 2 Stable Oct 2006 Qatar International Islamic Bank BBB A2 BBB 3 Stable Nov 2006 Qatar Islamic Bank BBB+ A2 BBB+ 3 Stable Oct 2006 Sharjah Islamic Bank BBB A3 BBB 3 Positive Jan 2006 Shamil Bank of Bahrain BBB A3 BBB 2 Stable Nov 2006 The National Commercial Bank A+ A1 A+ 1 Stable Jul 2006 Tadhamon International Islamic Bank B- B BB- 2 Stable Nov 2006

CORPORATE RATING OUTLOOK SINCE LONG TERM SHORT TERM FINANCIAL INSTITUTIONS Al Tawfeek Company for Investment Funds Limited BBB A2 Stable Oct 2006 A'Ayan Leasing & Investment Co BBB- A3 Stable Feb 2006 Grand Real Estate Projects Co BB B Stable Nov 2006 Investment Dar Company BBB A3 Stable Jul 2006 Khaleej Finance & Investment Company BB+ A3 Stable Jan 2007

BOND RATING OUTLOOK SINCE LONG TERM SHORT TERM FINANCIAL INSTRUMENTS Commercial Real Estate Sukuk Company A- A2 Stable Oct 2006 KCMCC Sukuk Company BBB A3 Stable Jul 2006 www.islamic-banking.com IIBI 23 Bahrain Fort: The old and the new NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: BAHRAIN

Bahrain: Middle Eastern promise

As the world’s Islamic finance industry continues to grow and mature, striving for more transparency and a wider range of products and services, so does the banking market of Bahrain. Innovation, modernisation and regulation are the three cornerstones of the country’s main regulator, the Central Bank of Bahrain.

Although the practice of Islamic finance in Pakistan has adopted a Shari’ah-compliant Central Bank is very potent the Muslim world dates back to the Middle banking system alongside its conventional Ages, it’s only the last few decades that have counterpart. The entire banking system in imposing and supervising seen the globalisation of Islamic banking. of Sudan has made its practices Shari’ah- banking activities. That is Islamic financial institutions are now compliant. A number of conventional banks why Shamil Bank chose to rightfully recognised as fully-functional in the Muslim world have converted to counterparts of conventional ones. Today, Islamic banking, with Sharjah Islamic Bank be headquartered here. the market size of this industry is estimated being one example. In 2005, the former Abdulnasser Ali Bukamal, at $250–300 billion spread over around Sharjah National Bank announced its ‘new Shamil Bank 75 countries. vision and commitment’, becoming the first and only bank in Sharjah offering Islamic The Kingdom of Bahrain is traditionally banking products and services to the public. considered to be the hub of Islamic banking and, according to the Central Bank of Adopting such practices has not been Bahrain (formerly the Bahrain Monetary confined to the Muslim countries and Agency or BMA), ‘is proud to play host to has spread to the Western world. In mid- the largest concentration of Islamic financial 2004, the first UK-based entirely Shari’ah- institutions in the Middle East region’. compliant bank, Islamic Bank of Britain, Indeed, a country with an area of only 665 was established, followed by the European square kilometres (253 square miles) has Islamic Investment Bank in 2005. A similar become one of the leading Islamic financial project is now in the pipeline in France. centres in the region having licensed 33 Large conventional banking conglomerates, financial institutions of this type, including including Lloyds TSB, have capitalised 26 banks and seven investment business on this niche by establishing Islamic firms and financing companies. departments. And global financial institutions such as Citigroup and The history of Islamic banking in the HSBC have created fully-fledged Islamic country dates back to 1978, when the first subsidiaries operating in various parts of the Islamic bank, Bahrain Islamic Bank, was world, including the Kingdom of Bahrain. licensed. The industry’s growth in the years ‘They have recognised the importance of following the bank’s establishment was slow. Islamic banking,’ says Abdulrahman Abdulla One of the triggers which prompted a rapid Al-Sayed, director of Islamic Financial development of Islamic finance was the Gulf Institutions, Central Bank. ‘And although war, which broke out in the early 1990s. the number of Islamic banks has increased It stimulated the Islamic finance market significantly, there is still a very good by pushing up oil prices and boosting potential for them to grow further in revenues, thus increasing the demand for the region and worldwide.’ Islamic tailored investments. Since then, the world in general and Bahrain in particular However, Bahrain is not focusing solely has witnessed a mushroom growth and on Islamic banking. It also encourages the rapid development of Islamic financial presence of conventional banks by pursuing institutions. a dual banking system. ‘There is no reason www.islamic-banking.com IIBI 25 COUNTRY FOCUS: BAHRAIN NEWHORIZON January–March 2007

why both types of banks cannot co-exist for the Central Bank’s approval,’ says successfully in the Kingdom of Bahrain’ Abdulnasser Ali Bukamal, senior manager, states Al-Sayed. ‘We offer them equal banking operations, and money laundering opportunities and provide equal treatment.’ reporting officer (MLRO), at Bahrain-based According to him, there has been an increase Shamil Bank. in conventional banks in the country, but this increase ‘hasn’t been as significant as Shamil Bank of Bahrain is one of the that of their Islamic counterparts’. oldest Islamic banks in the country. It launched Shari’ah-compliant operations There is a lot of interaction going on back in 1982, when it was established as an between Islamic and conventional banks in offshore banking unit, only a few years after Bahrain. A large number of specialists from Bahrain Islamic Bank was licensed. In 1994, the latter move to work at Islamic financial it obtained a commercial banking licence institutions. ‘There is no Shari’ah law that and became a fully-fledged Islamic financial says that Islamic banks should only recruit institution. Today, Shamil Bank has a Muslims,’ states Al-Sayed. The staff is hired shareholding equity of $353.4 million (as according to the universal rule of judging of 31st December 2006), seven branches potential employees by their knowledge and and 14 ATMs in the country, and the holders abilities, not by their faith. Conventional of the bank’s cards can use ATM facilities in bankers can ‘provide skills and experience’, any of the GCC (Gulf Cooperation Council) given the fact that conventional banking is countries. It also maintains a presence much older than Islamic banking. ‘Islamic overseas (including China and Saudi banking, not Islamic transactions,’ Arabia) through its associated and We have a number of prominent emphasises Al-Sayed. ‘Islamic transactions affiliated companies. have existed for over a thousand years, Shari’ah scholars. But we need but they were done on an individual basis The bank provides financial and investment a new generation of specialists between individuals. So, the concept is services for both corporate and retail who, in addition to knowledge there to take and develop into products.’ customers. Facing the competition from its In the course of this development (in counterparts, it has expanded the range of of the Shari’ah law, also have addition to traditional Islamic products) standard products offered by the majority of a background in banking, the conventional banking specialists use the Islamic financial institutions. In addition especially practical banking. some conventional products as a basis and to such services as murabaha, mudarabah then ‘modify them in order to make them (profit loss sharing), musharakah (joint Abdulrahman Abdulla Al-Sayed, Shari’ah-compliant’. Al-Sayed goes on to venture), ijara and istisna (contractual Central Bank of Bahrain give an example: ‘Let’s take a credit card. agreement for manufacturing goods and Ten years ago, everybody would say there commodities), Shamil Bank has introduced was no way it could be Shari’ah-compliant, al-ruban (credit card), commodity murabaha as it involves ‘selling’ cash and there is a (personal loan, cash money) and tawaruq prohibition of direct cash financing in (personal loan). To date, it is the only bank Islamic banking. But Islamic banks are in Bahrain offering al-ruban services, with very innovative and today, there is a range around 2000 takers so far. As for tawaruq, of Shari’ah-compliant credit cards, based on it is ‘a newly developed product’ not just murabaha [the bank buys and sells the items for the bank, but for the Bahrain’s Islamic required by the customer], ijara [leasing] financial market as a whole. ‘Now we can and so on.’ fully compete with conventional banks,’ states Bukamal. Needless to say, the Bahraini Islamic banking system is ‘booming’. In 2006, its total assets Shamil Bank’s database consists of both reached $20 billion compared to just over Muslim and non-Muslim customers, and $10 billion two years ago. In 2006 alone, Islamic banking is proving to be more and three new Islamic banks were granted more popular among people of non-Islamic banking licences (Al Salam Bank and United faith. But what is the secret of its success? International Bank (UIB) are amongst the Bukamal gives his outlook: ‘When some newcomers), with another two a year earlier. people approach a certain bank, it is not ‘There are more banks in the queue waiting done only from a religious point of view.

26 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: BAHRAIN

The costs are also considered, and the expanding rapidly. The Bahraini banking Having worked at the Shamil Bank for customer will go where the costs are lower.’ market has witnessed the emergence of the 21 years, Bukamal himself has plenty of In times of intense competition in the aforementioned Shari’ah-compliant credit knowledge and experience to share. He is country’s banking market today, it is logical cards and a recent introduction (although, a private instructor at the BIBF in addition for a bank to offer favourable conditions. as with many other Islamic products, its to his main job at Shamil Bank, lecturing roots go back centuries), the tawaruq or in Islamic international trade finance, Al-Sayed expounds his opinion: ‘Some personal loan service referred to earlier documentation structure for financing people deal with Islamic banks simply by Bukamal. facilities and teaching the advanced Islamic because they are Muslim and they wish Banking Diploma Programme at evening to transact in accordance with their However, this policy is not the only classes. faith. Others are looking for investment factor attracting financial institutions opportunities. And that’s where non- to the Kingdom of Bahrain. Al-Sayed However, there is still room for Muslims come in. Islamic banks are thinks there are several reasons for such improvement in Islamic finance education innovative and they introduce products recognition. ‘First of all, it is human and training, thinks Al-Sayed. Shortage of that offer an attractive return to customers. resources,’ he says. ‘Bahrain has individuals Shari’ah scholars remains a challenge for the So, innovation together with the yield who are very experienced in banking in country. ‘We have a number of prominent that the banks are offering has contributed general and have extensive knowledge Shari’ah scholars,’ he says. ‘But we need positively towards attracting non-Muslims.’ of it. And I am comparing Bahrain not a new generation of specialists who, in to the GCC only, but to the whole region.’ addition to knowledge of the Shari’ah Encouraging innovations is one of the law, also have a background in banking, keystones of the Central Bank’s policy. Due to the country’s long tradition in especially practical banking.’ The Central Every Islamic bank based in the country finance, the Central Bank offers its expertise Bank encourages such ‘skilled talent has its own Shari’ah board – a mandatory to specialists both within the country and development’ in every way possible. authority which consists of a minimum of outside it. The Bahrain Institute of Banking three people. It is up to the board to advise and Finance (BIBF) was set up under the A strong regulatory framework is another the bank on various aspects of Islamic auspices of the Central Bank back in 1981 cornerstone of the Central Bank’s policy. finance and to decide which products and to provide training and education in various ‘Central Bank is very potent in imposing services are Shari’ah-compliant. The Central aspects of finance, such as conventional and supervising banking activities,’ says Bank, in its turn, also has a supervisory and Islamic banking, IT, accounting and Bukamal. ‘That is why Shamil Bank chose Shari’ah board, but this has a different role. regulation. Central Bank has advised a to be headquartered here. Bahrain is a It deals with the issue of sukuk (government number of countries on regulation matters, good base for a bank’s head office, and its bonds). The Central Bank does not centralise including the USA, UK, Sudan and Malaysia. branches can be located in any of the GCC the decision-making processes concerning Such international acknowledgement makes countries or outside.’ Shari’ah compliance issues of individual Al-Sayed very proud of Central Bank’s banks, and it does not interfere in these achievements. ‘They approached us processes. because they knew that Bahrain’s banking regulation was in compliance Such practice is different in some other with the best international practices.’ Islamic financial centres, such as Malaysia, where the Central Bank (Bank Negara And on the ground the banks are Malaysia) – or to be more precise its contributing to this educational process Shari’ah board, has to approve any too. Shamil Bank, for example, is known innovations in Islamic finance before they as ‘a training bank’ both in Bahrain and are introduced to the market. In addition, outside it. As one of the oldest and most Shari’ah boards of all of the banks in the well-established Islamic financial institutions country are ‘to some extent subject to review in the country, it offers its expertise to by the Central Bank’. ‘This does not seem banking specialists and graduates. ‘Providing practical for Bahrain,’ says Al-Sayed. In his sufficient training has always been our view, Bahrain’s approach ‘does not hinder policy,’ states Bukamal. With such a rapid innovation or delay the process of growth of Islamic banks, there has to be transactions’. enough trained personnel to work in them. ‘Handling of Islamic transactions and Creating a favourable environment for the documentation is not easy, and far from innovations has proved to be worthwhile. the straightforward practices at the Abdulnasser Ali Bukamal, The product range of Islamic finance is conventional banks,’ says Bukamal. Shamil Bank www.islamic-banking.com IIBI 27 COUNTRY FOCUS: BAHRAIN NEWHORIZON January–March 2007

‘Our regulations are of the highest standards bank, he/she is generally guaranteed a So, whilst the conventional banks operating of the best international practices,’ assures return. But in an Islamic bank when a in Bahrain must fully comply with Basel II, Al-Sayed. ‘But at the same time they are mudarib (manager) and a customer, who their Islamic counterparts must comply with flexible.’ He explains: ‘We are in constant is a fund provider, draw up a mudarabah ‘the combination of IFSB standards and ongoing consultation with the industry. contract, there is no guarantee on return. Basel II’. ‘This is not a deviation from Basel requirements,’ emphasises Al-Sayed, ‘but rather an enhancement and addition to them to reflect the nature of the unique Central Bank does not introduce any local or international characteristics of Islamic transactions regulations without consulting the financial services industry first. and the bank–customer relationship.’ Abdulrahman Abdulla Al-Sayed, Central Bank of Bahrain Bahrain was the first country to introduce the regulatory framework specifically for Islamic banks in 2001. But even prior to Central Bank does not introduce any local or If the investment is successful, a bank this, according to Al-Sayed, it was ‘the first international regulations without consulting and a customer share the return; if not, a country in the world to request the Bahrain- the financial services industry first.’ customer bears losses. An Islamic bank is based Islamic banks to comply with AAOIFI not liable for the losses, except in the case [Accounting and Auditing Organisation This proved to be very topical when of misconduct or negligence.’ This aspect for Islamic Financial Institutions]’. This introducing Basel II requirements (the changes an asset–liability mix which, in organisation was founded in 1990 in international agreement on the amount its turn, impacts the capital adequacy Algiers, with its main purpose being ‘to of capital needed by a bank; a refined requirements. Therefore, ‘the capital issue accounting and auditing standards’ version of Basel I). At the moment, Bahrain adequacy is treated differently in and governance norms within the Islamic is in full compliance with Basel I, with the Islamic banking’. finance sector. Al-Sayed thinks that implementation work of Basel II in progress. compliance with AAOIFI ‘gives the local It is expected to come into effect in January market more disclosure, makes the financial 2008. ‘Both conventional and Islamic banks Central Bank, statements more transparent and reflects the have been involved in the process for the last Bahrain actual transaction’. Bahrain’s example was 12 months,’ says Al-Sayed. Recently, the followed by Sudan, Jordan and Qatar, who Central Bank has sent out the consultation also adopted the standards for their papers on the introduction of Basel II to all banking markets. the banks in the country, and is now ‘waiting for their comments’. And with the Central As a matter of fact, Bahrain has been the Bank leading the way, the banks on the pioneer in a number of Islamic-related ground are striving to meet all the necessary activities. The country’s government was Basel II requirements. Shamil Bank, for at the forefront in issuing sukuk through example, is seeking help in this matter from the Central Bank. It was the first to release its auditor, PricewaterhouseCoopers, who, Islamic securities, and to date it has issued according to Bukamal, ‘is working closely over $1 billion worth of ijara sukuk (Islamic with the risk managers on this issue’. leasing bonds). This initiative has proved to be successful and has resulted in other GCC Both conventional and Islamic banks are In order to cater for these differences, countries turning to Bahrain to manage their subject to the same supervisory regulations, the Prudential Information and Regulatory sukuk programmes. including those of the Basel requirements. Framework (PIRI) was devised. The Islamic However, Islamic banking has ‘unique Financial Services Board (IFSB) – of which The Kingdom of Bahrain hosts a number characteristics’ that make it somewhat Bahrain is a member – has issued standards of supporting organisations for Islamic problematical to be compliant with exactly in a number of areas, including capital financial institutions. In 2001, the General the same regulations when it comes to adequacy, corporate governance and asset Council for Islamic Banks and Financial Basel. Islamic transactions are dissimilar management. And there are two more Institutions (GCIBFI) was founded in the to conventional ones. ‘And it’s not just the standards to come which will cover country. One of its major purposes is to transactions,’ states Al-Sayed, ‘it’s the whole Pillar II and Pillar III requirements (market gather accurate information and data relationship between the customer and the difference and supervisory review). ‘IFSB on the Islamic finance industry. bank that is different.’ He gives an example used the fundamental principles of Basel II, based on a mudarabah contract: ‘When a and modified them to be suitable for the A year later, the Liquidity Management customer brings money to a conventional Islamic banking market’, says Al Sayed. Centre (LMC) was established. This seeks

28 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: BAHRAIN

Manama, Bahrain

to develop an active secondary market various countries, including Bahrain, Iran, for short-term Shari’ah-compliant treasury Pakistan, Sudan, Egypt, Jordan and products and to create additional investment Malaysia, put forward the idea of creating opportunities for financial institutions and a supervisory board for supporting and investors. This centre, ‘the first of its kind’, adapting the international standards for in the words of Central Bank, commenced Islamic financial products and different its operations in 2003. aspects of Islamic finance.

Also, in 2002, the International Islamic One of the most recent supporting Financial Market (IIFM) launched its organisations to be based in the Kingdom of operations. This non-profit organisation was Bahrain is the International Islamic Rating a result of an agreement between the Central Agency (IIRA). This is an independent group Banks of Bahrain, Indonesia and Sudan, the that, according to the country’s Central Islamic Development Bank, the Labuan Bank, ‘will help to increase transparency Offshore Financial Services Authority and accordingly provide more confidence (representing Malaysia) and the Ministry to investors, regulators and to the public of Finance of Brunei Darussalam. The main at large’. aim of IIFM is to ensure further growth and development of the Islamic financial market All in all, recent years have seen a lot of in compliance with Shari’ah law. changes on the Bahraini financial market front. 2006 was proclaimed a ‘milestone As mentioned above, Bahrain is a member year’ by the country’s Central Bank. That of IFSB. The initiative to establish this year, it took over ‘the role of a central bank organisation was originally proposed in and a single regulator for the country’s 2000, at the Regulation of Islamic Banking financial industry’ from the BMA. This conference held in Bahrain. Governors of means that the Central Bank’s policies the Central Banks and senior officials from cover Bahrain’s banking, insurance and www.islamic-banking.com IIBI 29 COUNTRY FOCUS: BAHRAIN NEWHORIZON January–March 2007

investment business and also the capital the Central Bank is tightening its grip on Shamil Bank of Bahrain, Manama, Bahrain markets. Since its activity instigation, AML by imposing stricter regulations on Central Bank has carried out a number of banking activities, especially international reforms in these sectors. It has introduced payment transactions. Middle East and ‘a new, modernised licensing framework for North Africa (MENA) countries, including financial institutions’ which became effective Bahrain, adopted FATF (Financial Action in October 2006. There are five licensee Task Force on Money Laundering) categories that comprise the new framework: recommendations concerning AML and conventional banking, Islamic banking, KYC (Know Your Customer) so that they insurance, investment business and could continue dealing and competing in specialised licensees. The sub-categories have the global market. Furthermore, a MENA- also undergone changes, and there are now FATF centre was created in 2005 with two sub-categories instead of three: ‘retail headquarters in Bahrain. The centre claims bank’ (instead of ‘full commercial bank’) a 90 per cent decline in illegal money and ‘wholesale bank’ (instead of ‘offshore laundering activity in the region since banking unit’ and ‘investment banking it came into existence. licence’). According to Al-Sayed, one of the main reasons for this is ‘lifting the Being true to its policy, the Central restrictions on dealing with residents Bank confers on the subject of AML with and non-residents’. representatives from the banks operating in the country. Bukamal and other MLROs The country’s payment system, ‘the lifeline from all Bahrain-based banks attend regular of the national economy’, as it has been meetings held by the executive director of described by the Central Bank, is also being the compliance unit at the Central Bank. ‘We modernised. The implementation of the discuss relevant issues and consider various Real Time Gross Settlement (RTGS) system suggestions on how to improve things and which ‘facilitates inter-bank payments and avoid any concealing of dirty money in the settlements in real-time online mode’ is a country’s banking system,’ says Bukamal. vital component of this project. According to the Central Bank, in addition to its main As Bahrain’s banking system continues purpose, RTGS will also ‘take care of retail to surge ahead, with year-on-year growth fund transfers on behalf of banks’ of an average of 18 per cent for the past customers’. In the course of the project, two years, so does the country’s capital, the system will be seamlessly integrated Manama. Cranes are dominating the with the Securities Settlement Systems (SSS). horizon wherever you look, erecting more The latter will assist in the ‘real-time online ultra-modern buildings for banks, hotels and settlement of all government securities’. Both business centres. Manama is without doubt RTGS and SSS are expected to go live in the one of the leading financial centres in the first half of 2007. To ensure that all banks in Middle East and it seems it has ambitious the country are ready for these innovations, plans to go even further and become number the Central Bank is providing education and one. A grand project of building Bahrain training for the users, with the second phase Financial Harbour on 380,000 square of this task currently underway. Dr Abdul metres of reclaimed land aims to create a Rahman Saif, executive director, banking complete financial city, a self-contained operations, at the Central Bank, is reported community, in the centre of Manama. as saying: ‘We are very pleased with the progress made by the banks. We welcome With the continuing transformation and the support from the industry in development of the geographical and implementing such a project of financial landscapes of the Kingdom national importance.’ of Bahrain, the strategy of encouraging innovations while sustaining a strong Anti-money laundering legislation is also regulatory framework, and its extensive high on the Central Bank’s agenda. ‘The tradition in finance, the country is bound anti-money laundering laws are getting to retain the title of one of the foremost tougher and tougher,’ says Bukamal. Indeed, financial centres in the region.

30 IIBI www.islamic-banking.com

INTERVIEW: BANK AL JAZIRA NEWHORIZON January–March 2007

First line of protection

Bank Al Jazira’s Takaful Ta’awuni programme is the first and only Shari’ah-compliant protection savings plan located in Saudi Arabia. Tom Alford spoke to divisional head, Dawood Taylor.

such benefits is becoming increasingly But as a player in the Middle East, a region evident. Commercially, world takaful accounting for around 36 per cent of the contributions are estimated to be on the rise global takaful market, BAJ’s unique life- in no uncertain terms. Dubai-based Salama, based offering is still something of a the largest Islamic insurance operator for national treasure. takaful and re-takaful (Shari’ah-compliant reinsurance) in the world, expects The bank and its insurance offering operate substantial growth during the next five years totally on a Shari’ah-compliant basis – there in the global market. It currently values this is no conventional aspect whatsoever. As a market at $1.7 billion and fully anticipates fully Islamic insurance offering, it engages in this figure to grow to between $7.5 billion Takaful Ta’awuni, a system based on mutual and $10 billion, with sustainable growth co-operation for financial assistance and looking likely to hit an average 20 per protection. Naturally it is informed by the cent per year over the next five to ten years, Quranic principles of Ta’awuni, or mutual particularly in the major markets which fall assistance. Takaful Ta’awuni is therefore Dawood Taylor, in Malaysia, Indonesia, the GCC and other BAJ’s response to what the Holy Quran Bank Al JazIra Arab countries. asks Muslims to do on a co-operative basis to achieve the interests of the ummah (the ‘We are the market,’ says the head of diaspora of Islam), avoiding forbidden Bank Al Jazira’s (BAJ) Takaful Ta’awuni practices. Although the BAJ approach does programme. It’s not an idle boast, but a The needs are very much the not yet cross international boundaries, it is fact; it is the only organisation offering same, whether you’re a Muslim locally inclusive, encouraging membership Shari’ah-compliant protection savings plans or non-Muslim. of its schemes from all elements of the for the people of Saudi Arabia. But new community in Saudi Arabia, whether laws coming on stream from the country’s local or expatriate, individuals or banking and insurance regulator, the Saudi families, businesses or groups. Arabia Monetary Authority (SAMA), may see competition hotting up in this already The upsurge of customer interest in a BAJ’s Takaful Ta’awuni began life in lively global market. Bank Al Jazira is hitherto sparsely populated takaful provider 1999. Although SAMA rules on entry to the prepared. market has created a rush of interest from market have recently become more unified, the big international insurance players such at that point any insurance provider offering Since the Islamic Insurance Company of as Allianz, AIG, Prudential and Axa. And a long-term investment element had to be Sudan was established in Sudan in 1979 based on a Shari’ah dispensation, there managed by a bank. According to Taylor, as the first formalised takaful provider, the is now a corresponding uptake of interest a period of ‘significant research and concept of Islamic insurance has expanded in providing re-takaful for life policies, development’, and the co-creation (with a to fill an evermore appreciative market. something which BAJ is in the process of Malaysian vendor) of a bespoke IT system To date, around 85 providers, covering 26 switching to. ‘We’ve gone from not enough to match, allowed the first products to be countries from the Bahamas to Yemen, offer suppliers, to too many,’ Taylor jokes. brought to market by the bank in 2001. takaful products. In doing so, they provide an ethical financial service free from the Already, major international players have The provision of this product-set follows concepts of riba, maisir and gharar. emerged in the general takaful reinsurance the Islamic wakala model, in which the field, with Tunis-based Best Re emerging as customer effectively appoints the insurance The desire for Muslims, and indeed an the world’s largest re-takaful company; the provider as a representative to undertake increasing number of non-Muslims, to Salam-owned business operates in more transactions on his or her behalf – it is engage with financial products affording than 60 countries. similar to granting power of attorney.

32 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 INTERVIEW: BANK AL JAZIRA

In understanding that there is little room Saudi Arabia or need to go beyond the product-set of the conventional market, BAJ currently offers an education plan, a retirement plan, group protection for employees (covering death and disability), savings and investment plans, protection plans, a capital plan, a group retirement plan, a loan repayment credit plan, and a waqf plan (waqf is similar to an endowment or trust as defined in common law). And through the concept of tabarru (which means to give away) customers are able to donate sums as they wish.

Despite not breaking any serious boundaries within the panoply of general insurance offerings, BAJ effectively stole a march on the competition by virtue of being the only bank offering an investment-based Islamic insurance product in Saudi. Since inception, BAJ has moved forward quickly in terms of customer numbers. It now claims to protect around 16,000 individual and 25,000 group customers, the latter drawn from around 40 corporate clients. Even so, Taylor admits There is a good reason for adopting this As an Islamic financial advisory company that, with a Saudi population of around model, notes Taylor. It revolves around ‘a selling individuals and corporates products 26 million, ‘we’re only just scratching the clear separation or segregation’ between the for protection, savings and investment, BAJ’s surface’. It’s the same for everyone though. client and the service provider so all business current range of Takaful Ta’awuni products Indeed, Saudi penetration for life insurance expenses are handled by the operator. This, looks remarkably similar to those of by Swiss Re, the world’s largest life and he says, ‘overcomes the [very topical] issue conventional insurance providers. And why health reinsurer, stands at just one tenth of the operator participating in surplus’, a shouldn’t it, asks Taylor? ‘The needs are very of one per cent. problem inherent in mudarabah, the former much the same, whether you’re a Muslim model of choice for takaful providers or non-Muslim.’ The conventional market, But Taylor notes that BAJ’s efforts have (mudarabah is a kind of profit and loss having enjoyed a 300-year or so head start been ‘very successful’ on a small business sharing venture between the insurance on takaful, has obviously used the time to model. In 2006 it scooped the Euromoney company and the investor). ‘It’s a much great advantage. It knows what people Life Takaful Award for its efforts. The bank more transparent contract,’ he observes. want and need. As a result, Taylor says the hopes to expand this success in a number products on offer in the takaful industry do of ways. It currently operates through five Much to its credit, BAJ was ‘at the forefront’ not ‘vary significantly’ from the products in offices, distributed evenly across the major of the development of the wakala approach the conventional industry. Indeed, apart Saudi cities. Another eight will be opened to takaful. And it has proven most popular. from being Shari’ah-compliant, he asks this year, with staff already being recruited. In double-quick time, it has spread far ‘what would you come up with as being It also hopes to ‘significantly extend’ its and wide. ‘Just about every other takaful unique?’ It’s a fair point. agency network. Some 400 staff work operator that has come into business from these outlets, around 320 of throughout the world has followed our However, there are a few culturally-informed whom are sales people. lead,’ Taylor remarks. Of course, the products amongst the usual health, motor bank does not stake a claim to being the and pension-style general takaful offerings, Overall, Taylor predicts that volumes originator of wakala –it is an ancient Islamic and BAJ knows its market well; one of its of life assurance and savings will increase contract system – but it has clearly played biggest sellers is a marriage plan to help substantially over the next three to five years a vital role in changing the shape of the offset the vast expense of a typical Saudi in the local market, as will the numbers of market, something of which it is justly wedding. But even here, Taylor is aware market players. This, in part, will be driven proud. that, ‘at the end of the day, it is still a by the new licensing laws which have savings plan’. already seen three new Saudi takaful www.islamic-banking.com IIBI 33 INTERVIEW: BANK AL JAZIRA NEWHORIZON January–March 2007

operations licensed in as many months. pursuing a sophisticated in-depth insurance The two current methods of moving beyond However, these recent changes in the legal lifecycle route. As a result, Taylor states that a provider’s natural reach, whether within environment have not changed any of BAJ’s the products often tend to be ‘bought not or beyond the borders, are either through development plans in terms of how it wants sold’, the distinction being a real mark of bancassurance, which delivers the benefit of to progress its business. Taylor is adamant sales success. Product complexity may a big bank network and corresponding client that the bank would be aiming for much the demand a greater degree of underwriting base, or through an agency distribution same rate of development regardless of for life cover but Taylor is convinced model. ‘Because we are a small bank, we’ve whether the revised insurance business ‘we are doing it the best way’. adopted the latter to increase the size of our distribution capability,’ says Taylor, mindful And whilst the Takaful Ta’awuni not to dismiss the former method as a programme is open to the two million possibility. Takaful is still in its infancy so strong Muslim and non-Muslim expatriate it’s difficult to say when cross- community in Saudi, Taylor is realistic However the market moves forward over in acknowledging that these people may be the next few years, BAJ’s Takaful Ta’awuni border selling will happen. keen in theory, but they may harbour ‘some division will always be the first of its kind hesitation’ in buying a product that does not in that country. ‘We believe our success has yet legally cross international borders. He shown our competitors that you can sell a is, however, totally convinced that takaful Shari’ah-compliant life insurance savings structure had been implemented or not – will be subject to cross-border selling at product in Saudi Arabia where people have although as part of the new requirements, some point in the not too distant future. failed with conventional products,’ states BAJ’s Takaful Ta’awuni business is now on Of course, each operation will have to Taylor. target to spin off from its banking parent. work within the regulatory framework of Come that day, it will transform into a each country, the only bar perhaps being an Indeed, most types of insurance are about fully-fledged IPO, creating a separately individual country’s acceptance of takaful trust, and trust only comes with time. As the capitalised, but still totally Islamic-focused, in the first place. ‘It took a long time for established player in the region, on that basis legal entity. With its new-found agility, it Europe to have its cross-border arrangement alone, BAJ may well prove to be the first line should then be in a position to meet head- set up [for conventional insurance],’ notes of financial protection for many. But given on the anticipated growth in the number Taylor. ‘Takaful is still in its infancy so it’s that it is clearly open to taking on new of market players. difficult to say when cross-border selling challenges, this is unlikely to be the only will happen.’ reason for its progression. The natural rise of interest in Shari’ah- compliant financial products is not yet One potential barrier to expansion for at its peak though. To overcome this, BAJ BAJ and the new Saudi providers is size. is engaged in a programme of customer education. ‘We still see this as a major issue,’ says Taylor, acknowledging that the insurance market has to all intents and Al Jazira scoops Middle East award purposes been non-existent in Saudi until now. ‘Both the idea of protecting your family against any financial disaster in the event In the first week in April 2007, BAJ’s awards were held during 2007 Insurex of death or disability, and savings beyond Takaful Ta’awuni Division won the 2007 Conference on 2nd April 2007, at the GOSI [the General Organisation of Social Middle East Insurance Award for Life Grand Hyatt Hotel, Dubai. Insurance], are relatively new within an Insurer of the Year. This is the only Islamic insurance wrapper,’ he notes. independent award in the region that This award follows BAJ’s collection of recognises excellence in all sectors of the Euromoney 2006 award for Best Life But BAJ’s takaful offering tends to centre on the insurance industry, as voted on Takaful Operator worldwide, and the more complex ‘financial advisory products’. by peers from within the industry. Islamic Finance Weekly 2004 award As such, having put sophisticated business for Best Takaful Operator. intelligence tools and targeted advertising Life insurance companies, both ‘on the back seat’ for the duration of the conventional and takaful, were eligible Mishari Ibrahim Mishari, chief executive licensing transition (‘we don’t want to for consideration in this category which officer and general manager of the bank, confuse the public’), it can only really covered the Gulf region, Yemen, Lebanon, comments: ‘We see this development, educate as it sells. Through direct customer Egypt, Syria, Jordan and Iran. Hosted by inshallah, as only a beginning of better contact in an advisory role it is building the Dubai-based Policy Magazine, the things to come’. long-term relationships and actually

34 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428

www.islamic-banking.com IIBI 35 ACADEMIC ARTICLE NEWHORIZON January–March 2007

Credit risk management in Islamic finance

Professor Rodney Wilson is director of Postgraduate Studies at Durham University’s School of Government and International Affairs. He is a consultant to the Islamic Financial Services Board and also serves on the IIBI’s academic committee.

Based on Professor Wilson’s presentation at virtually all banking operations, and Islamic the case of ijara – all of which should be the IIBI’s monthly lecture, London, March 2007. banking is no different in this respect. honoured under the contract. Operational risk is also excluded although it can impact on credit risk as it involves Although parties to financial contracts are Introduction inadequate management controls over liable to fulfil the terms and conditions they The central issue addressed here is the employees and flawed internal reporting have signed for, exemptions can be made implications of Shari’ah compliance for systems. Shari’ah risk has less impact on where the late settlement of obligations is credit risk management. This concerns not credit risk, as it arises from potential due to genuine financial difficulties. The only Islamic banks, Shari’ah-compliant inadequacies in Shari’ah governance. It teaching of the Holy Quran is clear on investment companies and takaful operators, is best dealt with separately, as it links to this, and should be respected: but also conventional banks offering Islamic legal risk, dispute settlement procedures financial products. It also involves regulators and commercial arbitration, worthy topics ‘If the debtor is in difficulty, grant him time since, if risks are not adequately identified for further research. till it is easy for him to repay. If ye remit by and managed, resultant defaults could way of charity, that is best for you if ye jeopardise institutional stability and lead Types of credit risk and settlement of only knew.’ Sura 2:280 to systemic failures in financial markets. financial obligations Effective risk management is a core banking The two major types of credit risk are, The first part of this injunction can be challenge, and any failure by Islamic banks firstly, the inability to make regular payments interpreted in the parlance of modern finance could threaten not only their reputation, to service debt and, secondly, the failure to as justifying re-scheduling but keeping the but also potentially that of the entire repay the principal advanced. The latter may same financing method and terms with no Shari’ah-compliant financial services sector. be repaid through regular instalments, at the penalty to the borrower. The difficulty is of The distinctive nature of Shari’ah-compliant end of the contract period, or subsequent course to define what constitutes a ‘genuine financial liabilities and assets has implications to a service payments default that involves financial difficulty’. Where this is recognised, for risk management. Investment mudarabah a breach of contract, necessitating the perhaps because of health problems, or deposits cannot be guaranteed, which financing being recalled. The obligations unforeseen family circumstances, granting potentially conflicts with deposit protection regarding repayment of principal will not be more time to honour financial obligations insurance requirements. In murabaha materially different in a Shari’ah-compliant may be appropriate. financing operations and with ijara operating contract, as it will usually be through leases, Islamic banks take on ownership risks deferred instalments in the case of murabaha, One way forward might be to provide the which conventional banks seek to avoid. istisna or diminishing musharakah, and client with a qard hasan loan, the only loan More fundamentally, as Quranic teaching a lump sum final repayment in the case of permissible under Shari’ah, as no interest stresses leniency towards debtors, what an ijara wa iqtina hire purchase contract. is involved, although there can be an are the implications for credit risk? arrangement fee and a recurrent charge to What is distinctive in Shari’ah-compliant cover the administrative costs. The aim of The discussion here is confined to credit contracts is that there should be no reference this loan would be to enable the client to risk, notably payments defaults. There are to riba or interest, but there will be reference meet their existing contractual obligations. of course other types of risk not covered here to mark-up payments in the case of This would benefit the bank because no – such as liquidity risk – which arise when mudarabah, salam or istisna; sharing provision would then need to be made for there is a mismatch between the maturity of profit in the case of mudarabah and non-performing debt. Qard hasan is of of assets and liabilities. The latter arises with musharakah; and rental obligations in course unprofitable for Islamic banks, which

36 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 ACADEMIC ARTICLE

like conventional banks are not charities, microfinance, and if all those involved imprisonment or confiscation of passport, the as they have to provide dividends for their in Islamic finance feel they are part of a latter being an especially effective deterrent shareholders and returns to their depositors. community with shared religious values in the Gulf. Payments safeguards can also be However, although such interest-free lending this should help ensure compliance with provided through the sequestration of assets, only constitutes a small proportion of Islamic contractual obligations. as murabaha and ijara involve financing real financing, it can serve to reduce losses and assets which can be seized if default occurs. the write-down in asset values once For Islamic financing based on traditional This is very much a last resort, as an asset provisions are made for impairments. principles of profit sharing, such as seized may not be worth much to the mudarabah and musharakah, there are also financier where it is a particular piece The second sentence of Sura 2:280 in the potential asymmetric information problems of equipment or commercial facility that Holy Quran concerns debt remission, which that increase risk. The difficulty with profit- was tailored to the client’s need and may in modern financial parlance means debt sharing arrangements is that there is always therefore be unattractive to other purchasers. forgiveness. This is obviously more costly the possibility of the management of the For second-hand equipment the resale value for an Islamic bank than rescheduling, as company receiving the mudarabah and will inevitably be limited. there is no longer the possibility of getting musharakah financing overstating or being the principal returned or any further service lax with control over costs, including its Shari’ah restrictions apply to the type of payments on the bad debt. Assets will have wage costs, which will result in a lower profit assets which can be used as collateral, as to be written down and provisions made for being reported and shared with the financial they should have usufruct and be halal. their impairment so that overall asset quality institution. Rigorous auditing can alleviate Conventional financial assets such as bonds can be maintained, otherwise the bank’s own the financial reporting problem, but not or other securities that pay interest cannot be rating will be downgraded and the financial necessarily solve the conflict of interest over used as collateral, as an Islamic bank cannot regulator will be concerned. Remission is cost controls. With mudarabah the problem hold such assets, and conventional accounts therefore costly, but if the root cause of the is compounded by only the financier, the receivable are also problematic since the failure of the client to meet their obligations rab-al-mal, bearing any losses, the argument current value of these is usually discounted reflects inadequate credit screening, or indeed being that the mudarib or entrepreneur has by the interest rate and firms that rely heavily negligence, by the bank, then it should share lost his or her time and should not be further on income from supplier credits function like some of the responsibility for what has gone penalised. Not surprisingly, this is a real riba-based banks. wrong rather than passing on all the blame deterrent to mudarabah and musharakah to the client. financing. In the case of personal Shari’ah-compliant financing of a vehicle or home purchase, the Furthermore, where clients get into With murabaha, salam, istisna and ijara amount provided is usually based on salary, additional unanticipated difficulties involving financing, there can be no additional with a requirement being that the income of chronic health problems or terminal illness, financial charges levied in the event of late the client is paid directly into an account then remission may be justified on grounds of or non-payment since, if an Islamic bank with the Islamic bank making the advance. humanity. Remission in these circumstances benefited from such charges, this would In the event of a default, the bank can will bring goodwill from other clients and represent an addition to the principal impose limits on personal access to stakeholders in the Islamic bank, with owed and therefore would amount to riba. salary until its claims are met. depositors prepared to accept a lower return However, the Shari’ah boards of most Islamic and investors a lesser dividend in such cases banks have approved a financial penalty Conclusion as long as the reasons are properly explained. being levied in the case of defaults, provided Under Shari’ah, those facing real problems that the proceeds are given to a designated in meeting financial obligations should be Default issues and payments safeguards charity; a just solution especially in the case treated with leniency, but that does not imply Leniency towards debtors can be abused of unscrupulous defaulters where, arguably, that Islamic banks should be regarded as a and it is often difficult to distinguish between immoral behaviour can be potentially ‘soft touch’. Indeed, arguably, they need to those who cannot meet their obligations cleansed through charity. An Islamic bank be more rigorous in their credit appraisal through no fault of their own and is also justified in levying additional charges systems than conventional institutions, and unscrupulous defaulters who will not pay. to cover the costs associated with defaults. practices such as credit scoring to determine There are potential moral hazard problems eligibility for financing are entirely legitimate in Islamic finance, and those who would There are, of course, a range of non-financial under Shari’ah. Islamic banks are also quite take advantage of any perceived leniency by penalties that can be applied in the case of a justified in pursuing cases against Islamic banks. Shari’ah-compliant contracts payments default, notably the blacklisting of unscrupulous debtors through the assume a degree of trust between the parties, defaulters so that they will not have recourse conventional courts and under English law who should be governed by a higher moral to financing from any other bank, including Shari’ah-compliant financial contracts will authority. Peer pressure can make borrowers conventional banks. In addition, it is possible be enforced as long as all the parties have acknowledge their responsibilities, as with to seek redress through the courts involving signed to indicate their consent. www.islamic-banking.com IIBI 37 ANALYSIS: SUKUK NEWHORIZON January–March 2007

can be structured to achieve a risk/yield profile comparable to an inter-bank deposit. The role of the sukuk in However, murabaha products have a significant disadvantage in that many are not particularly liquid and are therefore more difficult to trade; others, because managing liquidity issues of Shari’ah stipulation, can not be traded at all.

Managing liquidity is essential if banks are to maximise their Historical estimates indicate that up to 80 earnings and control their risks. Conventional banks have the per cent of Islamic banking assets are held in murabaha and other similar products. inter-bank market to help manage short- and medium-term The net effect is that Islamic banks can liquidity, but what options are available to Islamic banks? Don suffer from asset concentration and from large holdings of short-term, but illiquid, Brownlow talks to Stella Cox, managing director at DDGI Ltd. investments. As a result, Islamic banks need to maintain much higher levels of cash to meet their liquidity requirements than their Liquidity management is the art of matching conventional banking counterparts. This an organisation’s incoming and outgoing reduces their profitability. Of more concern cash-flows so that it can usefully invest any is the future compliance of Islamic banks to excess funds. Such investment needs to be the Basel II accord, which requires a bank made in a way that provides a return while to provide capital according to the risk still allowing the organisation quickly and weighting of its assets. easily to convert the investment back to cash. Conventional banks use the inter-bank Most market participants believe that market to buy and sell interest-bearing the sukuk is the long-term way forward to instruments amongst themselves to meet enable Islamic banks to manage liquidity liquidity requirements. through a range of maturity profiles while still remaining Shari’ah compliant. This This inter-bank market is termed a versatile instrument first appeared in secondary market because the instruments Malaysia around 2000. Despite some initial Stella Cox, that are traded are not bought directly from scepticism in the Middle East, many of the DDGI Ltd the issuers, as they are in primary markets, structures supporting sukuk issues have now but are traded among participating banks. been accepted in this region. Although some In this way Bank A, which has excess observers estimate that the total sukuk liquidity, may buy a ‘Treasury 8%, maturity market is now worth around $54 billion, 2009 Gilt’ from Bank B, which wishes to international users only account for around raise cash to meet outgoings. The Treasury $25 billion. In both Malaysia and the Gilt was originally issued by the UK Middle East, sovereign nations, banks and Government and bought by an investor commercial businesses have brought to bank in what is known as the primary market sukuk issues. At sovereign level, market. That note is then traded – the Government of Bahrain has led the starting with the investor bank – and way with its regular, consistent issues moves backwards and forwards between of sukuk into the market. others as part of the secondary market. However, there needs to be a secondary Islamic banks wishing to remain Shari’ah market before the sukuk can become compliant cannot utilise these interest- an instrument suitable for liquidity bearing inter-bank products. So Islamic management. Such a secondary sukuk banks have developed alternative Shari’ah- market will allow banks to buy and then compliant instruments and products. The readily sell sukuk for cash, depending on most popular have been those based around their liquidity needs. Once this market murabaha, where the financial contracts are exists, Islamic banks will have a true supported by physical assets. The contracts liquidity management tool that they can

38 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 ANALYSIS: SUKUK

use to manage their short- and medium- (including individuals) three per cent. The of the necessary infrastructure in place term investments and to adjust their risk presence of investors from areas other than as a result of hosting parallel Islamic and levels. the Middle East, as well as fund managers, conventional banking markets. Specifically, suggests that those investments were made in the capital markets space, Dubai and Traditionally (if this word can be used to for strategic reasons and not simply to London are keen to promote their depth of describe such a new instrument), investors ‘buy-and-hold’. That in turn suggests market expertise, regulators, ready-made bought part of a sukuk issue with the that the investments will be sold once their pool of investors and market support intention of holding that investment to investment objectives are met. These sales professionals. maturity. There are a number of reasons will add to the size of the secondary market. for this phenomenon, several of which are It will take time to build up a deep linked to the small size and number of Other factors will need to be present before secondary sukuk market. More sukuk sukuk issues. For example, there have been a secondary market can be considered to issues, made more frequently, would help so few benchmark issues, that a significant be efficient. These will include regulation, that growth. Until now, many of the sukuk investor could take part in each new one the presence of standard sized instruments, issues have been ‘one-off’ events, introduced without having to liquidate any existing standard settlement procedures, and to raise money for a specific purpose. sukuk holding. Also, should that investor market-makers who are prepared to step Regular and frequent issues with different sell an existing holding, there are few viable in and provide liquidity to the market itself. maturity dates – along the lines of Gilt alternative issues with which to replace it. Over the last 25 years or so, the Islamic issues in the UK or T-Bills in the US – would With sovereign issues offering a premium banking community has built infrastructures add depth to the market. That depth would return, there is little incentive to sell prior to when they have been needed and this is facilitate banks buying and selling sukuk- maturity. Without investors selling prior to another such case in point. based instruments ‘on demand’. Once that maturity, there can be no secondary market. is in place then Islamic banks will be able Some Islamic banking centres, including to use the sukuk to invest excess cash and There are early signs that selling prior Malaysia and Bahrain, already have much manage liquidity to suit their needs. to maturity may be about to become more commonplace. In the last few months, several sizeable sukuk issues have attracted international attention. Abu Dhabi Islamic How the Dubai Islamic Bank’s Bank’s (ADIB) issue in November 2006 of $800 million sukuk bonds was rated A2 by March 2007 sukuk issue works Moody’s and A by Fitch. That issue was originally planned as a $400–$500 million issue but was increased due to demand. In March of this year, Dubai Islamic Bank In March of 2007, Dubai Islamic Bank The day-to-day management of the assets (DIB) came to market with its first US (DIB) issued a $750 million sukuk. DIB will be performed by DIB, as managing dollar denominated sukuk worth $750 was founded in 1975 in Dubai and claims agent. It will collect all rental and profit million. That issue gained an A1 rating to be the world’s first fully Islamic bank. payments from the lease and musharakah from Moody’s. Both of these issues were For this sukuk issue, it was assisted by contracts. It will pay DIB Sukuk Company listed on the Dubai International Financial Barclays Capital, Citigroup and Standard an amount sufficient to fund the required Exchange and the London Stock Exchange. Chartered Bank. The issue gained an A1 periodic distribution amount to the sukuk- rating from Moody’s. holders on each distribution date. Any No doubt fuelled by their international excess payments from the co-ownership listings and investment grade ratings, The structure of the issue was based on assets will be paid to DIB as an incentive these issues attracted investment, not two entities, DIB and a special-purpose fee, while any shortfalls will be covered only from Islamic investors but from company that was set up specifically for by DIB to ensure that the required conventional investors around the world. the issue, called DIB Sukuk Company Ltd. periodic distribution amount is paid. In the ADIB issue, for example, the Middle That company was the entity that actually East accounted for 50 per cent, Europe issued the sukuk certificates to investors DIB has also agreed to purchase the accounted for 37 per cent, Asia accounted (the sukuk-holders). The funds raised are DIB Sukuk Company’s interest in the for twelve per cent, and the US one per used to buy assets consisting of lease and co-ownership assets at a pre-agreed price cent. There were also different types musharakah assets (equity participations, on maturity. This will be the source of organisations that invested, with profit and loss sharing) from DIB, with of principal repayment. banks accounting for 58 per cent of the the two companies becoming co-owners transaction, fund managers 31 per cent, in the co-ownership assets. corporates eight per cent and other investors www.islamic-banking.com IIBI 39 POINT OF VIEW NEWHORIZON January–March 2007

Innovations in Islamic finance

The explosive growth in the Islamic banking sector over the last few years may soon be replicated in the insurance sector. NewHorizon talks to Dr Humayon Dar, CEO of Dar Al Istithmar, a subsidiary of Deutsche Bank group that provides Shari’ah consultancy services to the institutions offering Islamic finance.

The huge demand for Shari’ah-compliant cards. In Malaysia, for example, Islamic financial services has created innovative credit cards can be supported by the bai al- service offerings from the Islamic banks. ina or buyback sale. In this the bank and the Nowadays, credit cards, car loans and client buy and sell a piece of land between mortgages are all available to private them with the difference in the buying and individuals while investment products, many selling prices being used to provide the credit based around the sukuk and investment limit on the credit card. funds of different types, are available to wealthy individuals and corporate bodies. This is the model used by Bank Islam Malaysia Berhard, the largest Islamic bank The housing market, in particular, has seen in that country. In the Middle East the more tremendous growth according to Dr Dar. popular contract is the tawaruq which is Until recently, banks did not offer mortgages similar to the bai al-ina but there are three to individuals but the liberalisation of the parties involved in the buying and selling of financial market has meant that these the underlying asset: the bank, the client and products are now available and Islamic a third party often found through the mortgages are becoming very popular. general marketplace. Housing markets across the world have expanded but the demand for Islamic home In the UAE, credit cards are often provided finance has been even further fuelled by the as a fee-paying service with no underlying growth in the emerging Muslim economies, transaction. Banks provide different classes particularly those of the Gulf Cooperation of card – gold, platinum, etc. – based on the Council (GCC) countries. client’s income with different fee brackets based on the type of card. Dr Dar thinks the positive image that the availability of Islamic financial services sends The explosive growth in demand, and the to the rest of the financial world is enhanced fledging nature of the Islamic financial by Islamic scholars working closely with market means that, as yet, not all business Western bankers in London, New York and areas are fully serviced. An example of elsewhere. There is evidence that wealthy a relatively difficult area is the Treasury Muslims tend to invest in Shari’ah-compliant Operations function within a bank or large financial products when investing locally, corporation. According to Dr Dar these although they may be prepared to invest money market operations are an ‘Achilles’ in conventional banking products when heel’ of Islamic banking and are a rather investing overseas. more complex area in which to achieve compliance. There is nothing religious Some of the devices used to support Islamic about Islamic banking – products differ from country to country. In In conventional banking circles a bank with it is a structure that is used response to the rise in demand for credit excess liquidity will lend to another bank cards, Islamic banks in different countries through inter-bank loans. To achieve the to differentiate between have created different models to replicate same function while still being Shari’ah- halal and haram products the economic effects of conventional credit compliant, most Islamic banks will use a

40 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 POINT OF VIEW

commodity murabaha. In this both ethical banking though, explains Dr Dar. banks instruct a commodity broker – bank There is not much similarity between Islamic A will instruct the broker to buy, say, $100 finance and ethical investments or socially million of commodity and sell it to bank B responsible investing. Ethical banking has on a deferred payment basis. Bank B retains more of a Western influence. As an example, the funds obtained from instructing the the Dow Jones screening for Shari’ah- broker to sell the commodity for cash on compliant companies includes companies the open market. Repayment occurs at that are doing prohibited business, such as a predetermined frequency agreed by making or distributing alcohol, or casinos. both banks. The sukuk is becoming more But there are others which are strange from prominent in this market, particularly those an Islamic point of view such as tobacco or issued in Malaysia and Bahrain, and this the defence industry. ‘There is no consensus area may present future innovations. in Islam about tobacco,’ says Dr Dar ‘but Islamic funds will not invest in tobacco Dr Dar feels that the real growth area is because it is considered unethical – an occurring in Islamic insurance or takaful inference that has come from Western which until recently has been a relatively influence’. untapped market. Some analysts think that this sector may prove to be bigger than Dr Dar feels that the next big event in Islamic banking. Islamic banking may be what some people refer to as ‘real’ Islamic banking. The Dr Humayon Dar, Part of the demand for these products existing attempts to conduct business in a Dar Al Istithmar is in response to directives from financial Shari’ah-compliant way could be called institutions. If an individual obtains ‘halal’ banking rather than Islamic banking. financing from a bank for a car or There is nothing inherently Islamic about the a home, the bank makes it compulsory to operations of Islamic banks. They are simply obtain insurance. Some of the large Western doing business in compliance with Islamic banks are aggressively entering this market. law. Islamic banking to some people implies For example, HSBC Bank Malaysia Bhd has a social responsibility. ‘Islamic banking so announced that in the next two years it aims far has not shown an explicit responsibility to at least double the amount of insurance towards the community in which it serves products used by its existing customers. so possibly this will be the next step – the Currently, around 30 per cent of its emergence of banks that are genuinely customers use insurance products. socially responsible,’ says Dr Dar. ‘Co-

Islamic banking so far has not shown an explicit responsibility towards the community in which it serves so possibly this will be the next step – the emergence of banks that are genuinely socially responsible.

operatives and mutuality have gone out of The reinsurance market, where insurance fashion in the UK but it is something that is companies spread the risk among specialist needed in some countries.’ Dr Dar goes on underwriters, may also present a growth to say that ‘there is nothing religious about area. Although there are four or five small Islamic banking – it is a structure that is Islamic reinsurance companies, it is still used to differentiate between halal and largely dominated by conventional haram products’. insurance organisations.

The emphasis in Islamic banking up until After such an explosive growth period in now has been on the Shari’ah compliance Islamic banking, it may be time to pause for aspects and whether the underlying contract reflection while the insurance sector takes complies with the law. This is not necessarily up the financial expansion. www.islamic-banking.com IIBI 41 ANALYSIS NEWHORIZON January–March 2007

Healthy Islamic banking sector reaches new heights in Pakistan

important area to help people comply with Islamic banking assets, deposits, and State Bank of Pakistan their faith. The provision of Islamic banking financing and investment over the same last has in turn led to an increase in the branch quarter period for the previous three years network for Islamic banks. There are shows that all areas of Islamic finance are currently five exclusively Islamic banks in increasing at an ever improved rate. In the Pakistan with a sixth due to start operations last year, total assets have increased by later this year; between them they have 99 $758 million (Rs46 billion), deposits have branches. Add to this 13 other banks which increased by $544 million (Rs30 billion), offer Islamic banking services and their 58 and financing and investment by $395 branches, and a healthy backdrop for the million (Rs24 billion). These are all good industry with good access to the general improvements for one year, but when population can be seen. comparing them back as far as 2003, the amount of money as assets and deposits is The Islamic banking industry is healthy and The last quarter of 2006 was a very good around ten times higher, and the financing continues to grow in Pakistan. This is the one for the Islamic banking industry. Figures and investment money is now seven times finding that comes out of a report published from the SBP show that the total assets the size it was in December 2003. by the State Bank of Pakistan (SBP). Set portfolio within the sector expanded by up as Pakistan’s central bank following 24 per cent to just under $2 billion The most favoured form of Islamic independence in 1948, the SBP is the (Rs118.183 billion). The cash held by financing in Pakistan is murabaha. This organisation responsible for running Islamic banks also increased by a quarter mirrors a global trend where murabaha the country’s economy. In its most recent to around $250 million (Rs15.266 billion). leads the field with the majority of Islamic Islamic banking bulletin, SBP has published These figures show that the growth in the banks. In Pakistan it accounts for almost the figures for the last quarter of 2006, Islamic sector is not matched by Shari’ah- 40 per cent of the total financing done by and announced continuing growth for compliant money market instruments, and Islamic banking institutions. The second the Islamic banking sector. hence there are excess liquid funds that can most widely used form of financing is ijara. not be properly utilised. With this accounting for 30 per cent, these Around 90 per cent of the Pakistani two financing models represent nearly population is Muslim, and the provision of The increase for the last quarter of 2006 three-quarters of the financing from Shari’ah-compliant banking products is an is part of a growing trend. Comparing the Islamic banks in Pakistan.

Islamic Banking 2003–2006 Mode of Financing Dec 2006 120 Istisna Salam 1% 100 Diminishing 1% 80 Musharakah 16% Others 11% 60 Mudarabah

Rs in Bn. 40 0% Musharakah 20 1% 0 Dec 06 Dec 05 Dec 04 Dec 03

Years Ijara Murabaha 30% 40% Total Assets Deposits Financial & Invest.

Graphs adapted from SBP Islamic Banking Bulletin, February 2007

42 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 APPOINTMENTS

On the move

developments in the UK in all spheres Islamic finance specialist, Oliver Agha of international Islamic financial services. (left), has been appointed a partner of Thomas has over 28 years of experience law firm DLA Piper based in its Dubai from companies such as Saudi International office. Prior to this appointment, Agha Bank and the United Bank of Kuwait. Prior was head of projects at Clifford to his appointment at GSH UK, Thomas Chance’s Saudi Arabian law firm affiliate was the head of Islamic financial services, Al-Jadaan. In his time there, he worked and CEO of Islamic asset management and on some of the most complex Islamic alburaq at the Arab Banking Corporation finance projects in the Kingdom of in London. In addition to his new position, Saudi Arabia, such as the Rabigh project Thomas is also a member of the UKTI financing of a petrochemical refinery, Financial Services Sector Advisory Board; and restructuring the first conventional in this capacity he chairs the Sub- loan transaction into an ijara Islamic Committee on Islamic Financial Services, finance transaction. and advises on Corporate Governance oversight for the Institute of Islamic Banking and Insurance (IIBI), London. Bank Islam Malaysia Berhad has appointed boards of many of Dubai Holding’s entities, three new directors and one alternative such as Empower, Dubai International director, who are all representatives of the Capital and Noor Islamic Bank. Prior Tejoori, the Shari’ah-compliant investment Dubai Group. The three new directors are to joining Dubai Properties, he was the company, has made two new senior Salaam Said Al-Shaksy, managing director executive director of Dubai Islamic Bank, appointments. Yaqub Yousuf has been of Dubai Group, Fadel Al-Ali, COO and and also has ten years’ experience within appointed as non-executive director to the CFO of Dubai Holding LLC and Hashim Citibank. board. Yousuf has been an advisor to the Al-Dabal, executive chairman, Dubai company since its inception in 2005 and Properties. Marwan Al-Khatib, director Alternative director, Al-Khatib, is the now acts as chairman of the executive at Dubai Islamic Investment Group, is an director of Islamic banking at Dubai committee to oversee the company’s alternative director to Hashim Al-Dabal. Islamic Investment Group. He has over operations. 15 years of finance experience working for Al-Shaksy has over 20 years’ experience Al-Futtaim Group, Mashreq Bank, Dubai The second appointment is Ilke Toklu in finance and investments. He is the vice Chamber of Commerce and Deloitte as general manager. Most recently she chairman of board – Muscat Securities Touche Tohmatsu. was director of business development at Market, vice chairman of board – Shell International Holdings group. Toklu joins Marketing, and a board member of the the board with experience on a global level College of Banking and Financial Studies, Bank Negara Malaysia Governor, Tan Sri in management consultancy, business Oman. Prior to joining the Dubai Group, Dr Zeti Akhtar Aziz, has been appointed development and board direction in North he was deputy chief executive for Bank as the fourth chairperson of the Islamic America, Asia Pacific and the Middle East Dhofar, and head of business planning Financial Services Board Council. The at companies such as Citibank, Dubai and analysis for Citibank Global role is on a one-year rotation amongst Holding and Prudential Securities. Consumer Business in the UAE. full members, and Dr Zeti will be in the role for the 2007 calendar year. The Al-Ali joined Dubai Holding in 2004 as deputy chairperson for the year will be Faiz Azmi, a partner at Pricewaterhouse CFO, and was promoted to COO in 2005. Dr Shamshad Akhtar, who is the governor Coopers (PWC) Malaysia, has been Prior to this, he worked for 16 years at of the State Bank of Pakistan. appointed as the inaugural Islamic finance Citigroup in various roles, such as head leader of PWC worldwide. Azmi will be of UAE distribution for Citibank. responsible for leading PWC’s Islamic Richard Thomas has been appointed as finance initiatives worldwide. In addition, Al-Dabal is the executive chairman of managing director of GSH UK. The new he serves as a member of the Malaysian Dubai Properties and a board member UK subsidiary of GSH has been set up in Accounting Standards Board’s committee of Dubai Holding. He has served on the order to take advantage of the rapid on Islamic Accounting Standards. www.islamic-banking.com IIBI 43 ACADEMIC ARTICLE NEWHORIZON January–March 2007

The time value of money in Islamic banking

The use of the Karachi Interbank Offered Rate (KIBOR) as a benchmark by Islamic banks in calculating the selling price of their commodities in murabaha sale transactions is not only justified, but also necessary, to remain competitive given the current banking industry dynamics in which Islamic banks have a pretty low share. However, it is not permissible under Shari’ah to price loans using KIBOR, as many conventional banks do. Najmul Hassan, general manager for coprorate and business development, Meezan Bank, explains the underlying differences in approach.

Unlike conventional banking based on Bearing in mind the definition given in has no intrinsic value but is rather a measure interest-bearing loans, funds invested in Hadith, as mentioned above, we can discuss of value or a medium of exchange. It cannot an Islamic bank are used essentially for the time value of money and the workings of fulfil human needs by itself, but needs to be trade. The Quran clearly mentions riba in a present day Islamic banks. For this, we have converted into a commodity. On the other number of places (Surah Ar-Rum, Al-Imran, to look at the differences between the ways hand, a commodity can fulfil human needs An-Nisa, and Al-Baqra), with a very strong in which modern capitalist theory (the basis directly. Furthermore, commodities can view against such people who indulge in it. of interest-based banking) views ‘money’ differ in quality while money has no The authentic definition from Hadith (with and ‘commodity’ and the principles differential quality, in the sense that a new the chain of transmission being Hazrat Ali) defined by Islam. note of Rs1000 is exactly equal in value and leaves no room for ambiguity: ‘every loan quality to an old note of Rs1000. Similarly, that draws a gain is riba’. According to capitalist theory, there is no commodities are transacted or sold by difference between money and commodity pinpointing the item in question or at Many people question whether in so far as commercial transactions are least by giving certain specifications. Islamic finance differs meaningfully from concerned. Accordingly, both are treated at Money, however, cannot be pinpointed in conventional finance. Outwardly in form, par and can be sold at whatever price parties a transaction of exchange. Even if it could many structures do bear a similarity in agree upon. With this theory, selling Rs100 be, it would be of no use to do this since a number of respects. The present day operating environment is a conventional one, from market structuring and dynamics, According to capitalist theory, there is no difference between to rate benchmarks and circulation of money and commodity in so far as commercial transactions are money, then on to regulatory controls. However, the way these two financial concerned. Islamic principles differ from this concept because systems function with respect to core money and commodity have different characteristics. defining parameters is very different. Many things look the same but are, in essence, fundamentally different. for Rs110 or renting Rs100 for a monthly the different denominations of money rental of Rs10 is the same as selling a bag making up an equal amount have the We begin with basic principles. The one is of rice costing Rs100 for Rs110 or renting same ultimate value. interest-based money lending while the other a fixed asset costing Rs100 for a monthly operates like a trading house. Where does rental of Rs10. With these differences in mind, to exchange this difference originate? Two core principles Rs1000 for Rs1100 in a spot transaction lie at the centre – elimination of riba and Islamic principles differ from this concept would make no sense since the money in gharar. Any Islamic transaction needs to because money and commodity have itself has no intrinsic utility or specified assess these two things first and foremost. different characteristics. For instance, money quality. So, the excess amount on either

44 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 ACADEMIC ARTICLE

of the other conditions of a valid sale are Mosque in Karachi, Pakistan fulfilled. It is often the case that a trader, whether a large multinational trading corporation or a roadside store, will arrive at a decision on profit or margin rates, having taken into account a number of factors. A major variable of which is the competitive environment in which the trader is operating his business.

If a rice trader or a cloth merchant uses KIBOR as the basis for adding profit margins to the cost of his commodities to arrive at the price, this would not amount to interest or riba and it would not make the transaction impermissible. The principle is similar for Islamic banks using the KIBOR to arrive at the selling price of their commodities.

In contrast, conventional banks price their side is without consideration and hence not It is true that the seller may take account of loans based on KIBOR, which does result in allowed under Shari’ah. The same would the time factor in increasing the price of his riba since it is an exchange between money hold true if we were to exchange these commodity in a credit sale, but the increased and money and not a sale transaction in Rs1000 for Rs1100, to be delivered after price is being fixed for the commodity and which commodities are exchanged with a period of one month, since the excess of not exclusively for the time element. money. Rs100 would be without consideration of either utility or quality but would only be Time is not the exclusive consideration It is being questioned in some circles related to time. in fixing the price; therefore once the price whether Islamic banks could price their is fixed it relates to the commodity and commodities by applying some other The same is not true when commodities not to the time. For the same reason, if the benchmark rate. The rationale behind are involved. Since a commodity is known purchaser fails to pay at the agreed time, the using KIBOR is the banking environment to possess an intrinsic value and quality, the price would remain the same and under no is dominated by conventional banks, owner of such a commodity is allowed to circumstances would the seller be allowed which discourages the development sell it at whatever price is mutually agreed to charge more than is actually owed. of an Islamic benchmark rate. with the buyer, provided that, in selling, he does not commit a fraud but is subjected Keeping in mind the above discussion, the In the light of this situation, Islamic to the forces of supply and demand. This use of KIBOR as a benchmark by Islamic banks are compelled to use an interest- would hold true even if the price that is banks in calculating the selling price of their based benchmark to price their products. mutually agreed upon is higher than the commodities in murabaha sale transactions This not only ensures stable returns in prevailing market price. is not only justified, but also necessary, to line with the industry but also assures remain competitive given the current competitively priced products for the In conclusion, any excess amount charged situation in which Islamic banks have a customers. against deferred payment is riba only when pretty low share in the banking industry. money is exchanged for money, since the As more and more Islamic banks begin to excess is charged only against time. The We must understand that the use of KIBOR operate, an inter-bank market between proof lies in the fact that, if the debtor as a benchmark to determine the profit is for Islamic banks will be created and a new fails to repay at the stipulated time, he is indicative purposes only and this does not benchmark for the Islamic banking charged extra money. In contrast, where a make the transaction impermissible if all industry will then be able to be developed. commodity is being exchanged for money, the seller may take into consideration various factors (like the supply and demand Any excess amount charged against deferred payment is riba only situation, quality, utility, special features and so on) as well as the time of deferred when money is exchanged for money, since the excess is charged payment. only against time. www.islamic-banking.com IIBI 45

Institute of Islamic Banking & Insurance (IIBI) 12–14 Barkat House Tel: +44 (0) 207 245 0404 116–118 Finchley Road Fax: +44 (0) 207 245 9769 London NW3 5HT Email: [email protected] United Kingdom Web: www.islamic-banking.com CALENDAR NEWHORIZON January–March 2007

Diary of Events

April May Ottawa

15–19: Corporate Governance Forum, 7–10: Risk Management in Islamic Dubai Banking, Kuala Lumpur Conference to move corporate governance Four-day training course for risk thinking and practice forward in the management within Islamic banking. Middle East. Tel: +60 321 438 100 Tel: +97 143 352 437 www.islamicfinancetraining.com/rmib.php Email: [email protected] www.iirme.com/cg 8–9: 4th Annual Middle East Insurance Forum, Bahrain 24–25: Annual Islamic Wealth The region’s largest platform for the Management Event, Geneva international and regional insurance Conference focusing on wealth management industry to assess the new growth for the Muslim investor. opportunities in the market. Tel: +44 (0) 20 7868 1717 Contact: Welma Williams Email: gassner@islamicfinance.de Tel: +97 143 431 200 www.islamicwealthmanagement.com Email: [email protected]

25: Sukuk: Exploring the Phenomena, 13–15: Islamic Treasury Simulation, Dubai Dubai Course to help understand key Conference focusing on the sukuk mode characteristics in Islamic banking, and 17–18: 3rd International Islamic Banking, of Shari’ah-compliant financing. how to develop and implement treasury Finance & Insurance (Takaful) Conference, Tel: +44 (0) 20 7286 6523 strategies. Ottawa Email: Tel: +60 321 438 100 Conference to educate and introduce Shari’ah [email protected] www.islamicfinancetraining.com/Islamic concepts and rules about Islamic banking. www.middleeastbusinessforum.com/sukuk TreasurySimulation.php Email: [email protected] www.ansargroup.com/conference 15–16: Islamic Finance & Capital Market Dubai Conference, Kuala Lumpur 22–24: 1st Islamic Banking, Conference to provide insight into the Finance and Insurance modus operandi and related issues of Awareness Conference and Islamic finance and Islamic capital Exhibition Pakistan, Lahore market instruments. Conference to educate and introduce Tel: +60 321 636 990 various groups to Shari’ah concepts, Email: [email protected] rules about Islamic banking, financing www.globalpro.com.my and insurance and highlighting successful applications worldwide. 15–16: 4th Islamic Financial Services Tel: +92 042 504 8213 Board Summit, Dubai Email: [email protected] Summit looking at the need for a cross- sector approach to the supervision of 22–24: Islamic Finance World North Islamic financial services. America 2007, Toronto Contact: Ms Farrah Aris Conference focused on the key business Tel: +60 326 984 248 drivers of the Islamic finance business in Email: [email protected] North America. www.ifsbdubai2007.com Tel: +1 212 379 6322 Email: [email protected] www.terrapinn.com/2007/ifwna

48 IIBI www.islamic-banking.com NEWHORIZON Muharram–Rabi Al Awwal 1428 CALENDAR

27–28: Middle East Islamic Capital Market, 20–21: The Sukuk Summit 2007, London Dubai Summit to provide a platform for issuers August Forum to equip delegates with the strategic and end users to engage with investors, information to deal with the complexities arrangers, listing and rating agencies, 10–12: Structuring Innovative of Islamic finance. and community organisations. Islamic Financial Products Contact: Bernadine Michael Tel: +44 (0) 20 8209 1751 Workshop, Cambridge Tel: +60 327 236 604 Email: [email protected] A three-day residential workshop to focus Email: [email protected] www.sukuksummit.com on new developments in Islamic structured www.marcusevans.com/events/cfeventinfo products, funds, capital market structures .asp?eventid=12131 25–26: Successful Strategies and retail, corporate and investment in Planning, Negotiating & banking products. 27–29: 2nd Annual Bank Marketing and Managing Mergers & Acquisitions, Contact: Mohammad Shafique Management Forum, Jordan Kuala Lumpur Tel: +44 (0) 207 245 0404 Forum from the Arab Academy for Banking Conference to address the key steps Email: [email protected] and Financial Sciences to deliver big-picture of pre-M&A stages, from planning and strategies and practical solutions to address negotiating, to structuring, financing and 20–23: Structuring Islamic Financial marketing challenges in the banking due diligence; and post-M&A issues Products, Johannesburg industry. including HR, change management Course designed to give an all round Contact: Amal Mishlawi and communications strategies. understanding of the most important and Tel: +96 265 502 900 Tel: +60 320 703 299 widely offered Islamic financial products. Email: [email protected] Email: [email protected] Tel: +60 321 438 100 www.aabfs.org/bmmf2.asp www.abf-sia.com/project/9436MC_EM.pdf www.islamicfinancetraining.com/sifp2007.php

25–27: 2nd Islamic Finance Summit 2007, Kuala Lumpur June Summit to explore Islamic investment November opportunities and meet product operators. Contact: Alison McInerney Singapore 26–29: B-Tech Libya: 1st International Tel: +65 6514 3173 Banking, Financial Sector & Investment Email: [email protected] Exhibition 2007, Tripoli Exhibition offering the full range of products and services offered by banking sectors, financial and investment institutions July and insurance companies. www.atex.com.ly/b-techlibya/index.html 4: Islamic Finance Conference, London A one-day introduction to Islamic finance. Tel: +44 (0) 1354 695 599 Zurich Email: [email protected] www.marchpublishing.co.uk/ifc.html

9–12: Structuring Islamic Financial Products, Zurich Course designed to give an all round 18–19: International Islamic understanding of the most important and Banking & Finance Forum 2007, widely offered Islamic financial products. Singapore Tel: +60 321 438 100 Conference to address the trends, www.islamicfinancetraining.com/sifp2007.php opportunities and challenges facing Islamic banking. Contact: Bernadine Michael Tel: +60 327 236 604 Email: [email protected] www.marcusevans.com/events/cfeventinfo Events endorsed by the IIBI .asp?eventid=11883 www.islamic-banking.com IIBI 49 GLOSSARY NEWHORIZON January–March 2007

arboun mudarabah Shari’ah An Islamic version of option, a deposit for the delivery of A form of business contract in which one party brings Refers to the laws contained in or derived from the a specified quantity of a commodity on a predetermined capital and the other personal effort. The proportionate Quran and the Sunnah (practice and traditions of the date. share in profit is determined by mutual agreement at the Prophet Muhammad (PBUH). start. But the loss, if any, is borne only by the owner of bai al-ina the capital, in which case the entrepreneur gets nothing Shari’ah board This refers to the selling of an asset by the bank to the for his labour. An authority appointed by an Islamic financial customer on a deferred payments basis, then buying back institution, which supervises and ensures the Shari’ah the asset at a lower price, and paying the customer in mudarib compliance of new product development as well as cash terms. In a mudarabah contract, the person or party who acts existing operations. as entrepreneur. commodity murabaha shirkah A murabaha contract using certain specified murabaha A contract between two or more persons who launch commodities, through a metal exchange. A contract of sale between the bank and its client for the a business or financial enterprise to make profit. sale of goods at a price plus an agreed profit margin for fatwa the bank. The contract involves the purchase of goods by sukuk A ruling made by a competent Shari’ah scholar on a the bank which then sells them to the client at an agreed Similar characteristics to that of a conventional bond particular issue, where fiqh (Islamic jurisprudence) is mark-up. Repayment is usually in instalments. with the key difference being that they are asset backed; unclear. It is an opinion, and is not legally binding. a sukuk represents proportionate beneficial ownership in musharakah the underlying asset. The asset will be leased to the client gharar An agreement under which the Islamic bank provides to yield the return on the sukuk. Lit: uncertainty, hazard, chance or risk. Technically, sale funds which are mingled with the funds of the business of a thing which is not present at hand; or the sale of a enterprise and others. All providers of capital are entitled ta’awuni thing whose consequence or outcome is not known; or to participate in the management but not necessarily A principle of mutual assistance. a sale involving risk or hazard in which one does not required to do so. The profit is distributed among the know whether it will come to be or not. partners in predetermined ratios, while the loss is borne tabarru by each partner in proportion to his contribution. A donation covenant in which the participants agree Hadith to mutually help each other by contributing financially. A record of the sayings, deeds or tacit approval of the musharakah, diminishing Prophet Muhammad (PBUH). An agreement which allows equity participation and takaful sharing of profit on a pro rata basis, but also provides A form of Islamic insurance based on the Quranic halal a method through which the bank keeps on reducing principle of mutual assistance (ta’awuni). It provides Activities which are permissible according to Shari’ah. its equity in the project and ultimately transfers the mutual protection of assets and property and offers joint ownership of the asset to the participants. risk sharing in the event of a loss by one of its members. haram Activities which are prohibited according to Shari’ah. qard hasan tawaruq An interest-free loan given for either welfare purposes A sale of a commodity to the customer by a bank on ijara or for fulfilling short-term funding requirements. The deferred payment at cost plus profit. The customer then A leasing contract under which a bank purchases and borrower is only obligated to pay back the principal sells the commodities to a third party on a spot basis leases out a building or equipment or any other facility amount of the loan. and gets instant cash. required by its client for a rental fee. The duration of the lease and rental fees are agreed in advance. Ownership rab-al-maal ummah of the equipment remains in the hands of the bank. In a mudarabah contract the person who invests the The diaspora or ‘Community of the Believers’ (ummat capital. al-mu’minin), the world-wide community of Muslims. ijara sukuk A sukuk having ijara as an underlying structure. retakaful wa’ad Reinsurance based on Islamic principles. It is a A promise to buy or sell certain goods in a certain ijara wa iqtina mechanism used by direct insurance companies to quantity at a certain time in future at a certain price. The same as ijara except the business owner is protect their retained business by achieving geographic It is not a legally binding agreement. committed to buying the building or equipment or spread and obtaining protection, above certain threshold facility at the end of the lease period. Fees previously values, from larger, specialist reinsurance companies and wakala paid constitute part of the purchase price. It is commonly pools. A contract of agency in which one person appoints used for home and commercial equipment financing. someone else to perform a certain task on his behalf, riba usually against a certain fee. istisna Lit: increase or addition. Technically it denotes any A contract of acquisition of goods by specification or increase or addition to capital obtained by the lender waqf order, where the price is fixed in advance, but the goods as a condition of the loan. Any risk-free or ‘guaranteed’ An appropriation or tying-up of a property in perpetuity are manufactured and delivered at a later date. rate of return on a loan or investment is riba. Riba, in all so that no propriety rights can be exercised over the Normally, the price is paid progressively in accordance forms, is prohibited in Islam. Usually, riba and interest usufruct. The waqf property can neither be sold nor with the progress of the job. are used interchangeably. inherited nor donated to anyone. maysir salam zakat Gambling – a prohibited activity, as it is a zero-sum Salam means a contract in which advance payment is An obligation on Muslims to pay a prescribed percentage game just transferring the wealth not creating new made for goods to be delivered later on. of their wealth to specified categories in their society, wealth. when their wealth exceeds a certain limit. Zakat purifies wealth. The objective is to take away a part of the wealth of the well-to-do and to distribute it among the poor and the needy.

50 IIBI www.islamic-banking.com INFRASOFT AD NEWHORIZON January–March 2007

52 IIBI www.islamic-banking.com