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ISLAMIC FINANCE A Catalyst for Shared Prosperity?
GLOBAL REPORT ON ISLAMIC FINANCE
ISLAMIC FINANCE A Catalyst for Shared Prosperity? Copyright © 2016 by Islamic Development Bank Group Some rights reserved 1 2 3 4 20 19 18 17 This work is a product of the staff of The World Bank and Islamic Development Bank Group (IDBG) with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank and IDBG, their Boards of Executive Directors, or the governments they represent. The World Bank and IDBG do not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank and IDBG concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of The World Bank and IDBG, all of which are specifically reserved.
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Contents ...... v
Foreword ...... xi
Acknowledgments ...... xiii
Glossary ...... xv
Abbreviations ...... xxvii
Overview ...... 1 1 Islamic Finance and Shared Prosperity ...... 17 2 The State of Development and Shared Prosperity in OIC Countries ...... 41 3 The Islamic Banking Sector ...... 57 4 Islamic Capital Markets ...... 75
5 TakƗful (Islamic Insurance), RetakƗful, and MicrotakƗful ...... 103 6 Nonbank Financial Institutions ...... 119 7 Alternative Asset Classes ...... 139 8 Islamic Social Finance ...... 153 9 Public Policy Measures to Enhance Shared Prosperity ...... 181
Chapter Attributions ...... 201
Index ...... 203
GLOBAL REPORT ON ISLAMIC FINANCE v vi CONTENTS GLOBAL REPORT ON ISLAMIC FINANCE
BOXES 1.1 The World Bank Group Approach to Enhancing Shared Prosperity...... 22 1.2 The Islamic Development Bank Group Strategy for Development ...... 23 1.3 Key Institutions in an Ideal Islamic Economy ...... 27 1.4 Why Is Debt Finance So Prevalent? ...... 30 1.5 Key Instruments of Redistribution in Islamic Finance ...... 33 1.6 How Development of the Financial Sector Could Promote Shared Prosperity ....35
3.1 Abu Halima Mud. Ɨrabah Greenhouse Project in Sudan ...... 58 3.2 Channels of Financial Inclusion from an Islamic Finance Perspective ...... 59 3.3 Islamic Banking: Is It Good for Growth? ...... 68 4.1 Issuances in IDB’s Medium-Term Note Program ...... 94 5.1 Similarities and Differences between Conventional Mutuals/Cooperatives and TakƗful ...... 104 5.2 Country Case: Regulation and Challenges in Nigeria ...... 114 6.1 Case 1. Green Suknjk and the Rising Trend in Responsible Investment ...... 125 6.2 Case 2. Liwwa: A Shari‘ah-Compliant Peer-to-Peer Lending Platform ...... 127 6.3 Case 3. NBFI Shari‘ah-Compliant Home Financing in Canada ...... 130 6.4 Case 4. ASR Leasing in Tajikistan ...... 131 8.1 Case 1. Revolving Credit out of Pooled Sadaqa¯ t and Zaka¯t Proceeds: Akhuwat, Pakistan ...... 156 8.2 Case 2. Community-Driven Development: Dompet Dhuafa Republika, Indonesia...157 8.3 Case 3. A Zaka¯t Fund: Al-Aman Microfinance Fund, Sudan...... 159 8.4 Case 4. Corporate Waqf: Johor Corporation’s Waqaf Al-Noor, Malaysia ...... 160 8.5 Case 5. Using Waqf to Fund Microfinance: The Fa’el Khair Program, Bangladesh ...... 161 8.6 The Role of Islamic Finance in Empowering Women: The Islami Bank Bangladesh Limited Microfinance Program...... 177 9.1 Indonesia’s Initiative to Take Islamic Finance to the Next Level of Development . . . 189 9.2 Diversified Institutions and Efforts toward Financial Inclusion: Highlights of Some Policy Initiatives of the State Bank of Pakistan ...... 191 9.3 Integrating Islamic Finance into Global Finance: IMF–World Bank Joint G-20 Note ...... 195 9.4 Regulatory Developments at the International Level: Supporting Shared Prosperity ...... 196 GLOBAL REPORT ON ISLAMIC FINANCE CONTENTS vii
FIGURES 1.1 GDP Growth Reduces Poverty ...... 19
1.2 Percentage of Income Held by the Top and Bottom 10 Percent in Select Countries . . . 21
1.3 Islamic Framework to Achieve Sustainable Development and Shared Prosperity . . . 24
B1.4.1 Global Outstanding Debt ...... 30
B1.4.2 Stock Markets versus Debt Securities ...... 31
1.4 The Contrasting Effects on Growth of Different Forms of Financial Expansion . . . 32
2.1 Progress in Meeting Millennium Development Goals 1–5 ...... 42
2.2 Poverty Headcount Ratios, Income-Level Classification...... 43
2.3 Poverty Headcount Ratios, Regional Classification...... 44
2.4 Income Distribution by Decile ...... 45
2.5 Per Capita Income (Consumption) of the Bottom 40 Percent and the Total Population ...... 46
2.6 Change in the Gap between Per Capita Consumption (Income) of the Bottom 40 Percent and the Overall Population between 2007 and 2014 ...... 46
2.7 Rule of Law Index, Income-Level Classification...... 48
2.8 Government Effectiveness Index, Income-Level Classification...... 49
2.9 Correlation between Consumption and Real GDP, Income-Level Classification ....50
2.10 Relative Value of Market Capitalization of Listed Companies, Ratio of OIC to Non-OIC Countries ...... 51
2.11 Sources People Use to Obtain Funds, Ratio of OIC to Non-OIC Countries, Regional and Income-Level Classification...... 51
2.12 Social Inclusion, Ratio of OIC to Non-OIC Countries ...... 52
2.13 Domestic Credit to the Private Sector ...... 53
2.14 Gross Portfolio Debt Assets to GDP ...... 54
2.15 Gross Portfolio Equity Assets to GDP ...... 54
B3.2.1 Channels of Financial Inclusion ...... 60
3.1 Average Percentage Increase in Various Elements of Islamic Banking, 2010–13 .. . 63
3.2 Financing by Sector, Islamic Banks, 2012 ...... 65
3.3 Regional Shares of Number of Banks, Deposits, and Assets ...... 67
3.4 Islamic Modes of Finance by Islamic Banks, 2012 ...... 69
4.1 The Values-Driven Structure of the Islamic Capital Market ...... 76 viii CONTENTS GLOBAL REPORT ON ISLAMIC FINANCE
4.2 Market Capitalization versus Capital Formation in OIC and Non-OIC Member Countries by Income Group ...... 78
4.3 Relative Performance of Conventional versus Shari‘ah-Compliant Stocks, Global Indexes ...... 80
4.4 Relative Performance of Conventional versus Shari‘ah-Compliant Stocks, Regional Indexes ...... 81
4.5 Breakdown by Sector of Major Conventional and Shari‘ah-Compliant Indexes . . 82
4.6 Suknjk Issuance, 2001–14 ...... 84
4.7 Cumulative Issuance of Suknjk, 2001–14 ...... 86
4.8 Characteristics of the Suknjk Market ...... 88
4.9 Maturity Structure of Suknjk Instruments ...... 89
4.10 Suknjk by Structure, 2001–14 ...... 90
4.11 Suknjk Issuance by Sector, 2001–14 ...... 91
5.1 Total Amounts of Global Gross Taka¯ful Contributions by Region, 2009–2014f . . . 107
6.1 Global Islamic Asset Management Industry, 2008–14 ...... 122
6.2 Assets under Management by Fund Type, 2008–14...... 123
6.3 Global Islamic Funds Outstanding by Geographic Area, End-2014 ...... 124
6.4 Global Islamic Asset Management Funds by Asset Class, End-2014 ...... 124
B6.2.1 Liwwa’s Operating Framework...... 128
9.1 Distinctive Features of the Mid-Term Review ...... 187
TABLES O.1 Recommendations and Policy Interventions by Sector...... 6
1.1 Percentage of Population Living below $1.25 a Day, 1981–2011 ...... 19
1.2 Functions of the Financial Sector and Factors Affecting Shared Prosperity ...... 35
2.1 Factors to Measure Core Development Components ...... 47
3.1 Islamic Financial Institutions and Financial Inclusion by Country ...... 61
3.2 Islamic Banking Assets by Region, 2013 ...... 64
3.3 Financial Soundness Indicators, All Islamic Banks ...... 66
3.4 Demand Deposits and Investments of Islamic Banks, 2012 ...... 70 GLOBAL REPORT ON ISLAMIC FINANCE CONTENTS ix
4.1 Measures of Selected Shari‘ah-Compliant Indexes and Benchmark Indexes for Various Holding Periods ...... 83
4.2 Status of Suknjk as of December 31, 2014 ...... 83
4.3 Status of Suknjk by Region, 2001–14 ...... 85
4.4 Suknjk by Their Underlying Contracts ...... 92
5.1 Taka¯ful Models ...... 107
5.2 General Characteristics of MicrotakƗful ...... 111
5.3 Best Practice Charter for TakƗful Operations Worldwide ...... 115
6.1 Classification of Nonbank Islamic Finance Institutions...... 120
6.2 Size of Capital Markets and Mutual Fund Assets in Selected World Regions, 2012...... 121
6.3 Funds Launched and Asset Type, 2009–13 ...... 123
6.4 Gaps in Enterprise Financing ...... 126
6.5 Financing Penetration for SME Financing and Preference for Shari‘ah-Compliant Products ...... 127
6.6 Demand for Housing Units by Region, 2010–20 ...... 129
6.7 Housing Finance in Pakistan, End-2014 ...... 129
6.8 Deposit Raising by Mud. Ɨrabah Companies, End-2104 ...... 131 7.1 Alkhabeer Financial Highlights ...... 141
7.2 Funding of Phase III Electricity Project in Rural Mozambique ...... 149
8.1 Gap in Resources Needed to Alleviate Poverty ...... 163
8.2 Estimates of the Potential of ZakƗt ...... 164
9.1 Potential of Various Channels of Islamic Finance to Meet the SDGs and Enhance Shared Prosperity ...... 182
9.2 Twenty Key Initiatives under the Mid-Term Review ...... 187
9.3 Progress in Developing Islamic Finance in Indonesia, Malaysia, and Pakistan . . . 193
9.4 Recommendations and Policy Interventions by Sector...... 197
Foreword
nder a joint initiative of the Islamic The Global Report provides a comprehen- UDevelopment Bank Group and the sive overview of the existing status of various World Bank Group, the inaugural Islamic finance sectors and identifies major chal- Global Report on Islamic Finance has been lenges hindering the growth of Islamic finance. prepared with a focus on the widening disparity It also identifies policy interventions and tools of global wealth and how Islamic finance can for policy makers to leverage the principles of help in enhancing shared prosperity. This Islamic finance in an effort to eradicate extreme Report is timely, as world leaders have adopted poverty and work toward a more equitable dis- the 2030 Agenda for Sustainable Development, tribution of wealth. The main message of the which includes a set of Sustainable Development Report is that Islamic finance, built on a founda- Goals (SDGs) to end poverty, fight inequality tion of social and economic justice, can contrib- and injustice, and tackle climate change by ute to shared prosperity through the principles 2030. The Islamic Development Bank Group, of inclusive participation and risk sharing. in its 2016–25 Strategic Plan, gives priority to The experts from both institutions who inclusive and sustainable socioeconomic devel- helped create this Report come with vast expe- opment among member-countries within its rience and technical knowledge and provide role in advancing Islamic finance globally. dual perspectives on finance, enabling readers Besides imposing social and environmental to connect with the Islamic perspective of costs, severe inequality adversely affects eco- finance. The joint initiative highlights that nomic growth and wealth creation. The ques- there is a lot that we can learn from one tion that needs to be addressed is how to another. We hope that this Report will be the minimize the disparity in wealth and enhance beginning of a fruitful and productive collabo- shared prosperity. Given its potential role in ration among international and multilateral economic development, Islamic finance can institutions to serve our global community. contribute toward achieving these objectives. Accordingly, the joint initiative of the Islamic Dr. Ahmed Mohamed Ali Development Bank Group and the World President, Islamic Development Bank Group Bank Group provides detailed research under September 2016 the general theme “Islamic Finance: A Catalyst for Shared Prosperity.”
GLOBAL REPORT ON ISLAMIC FINANCE xi
Acknowledgments
his Report was prepared as a joint initia- wisdom, experience, and expertise. As advisers, Ttive of the World Bank Group (WBG) they provided extensive feedback and com- and Islamic Development Bank Group ments throughout the conceptualization and (IDBG). The team was led by Azmi Omar, review stages of the Report. Their comments Director General of the Islamic Research and helped the team enhance the content of earlier Training Institute (IRTI), IDBG, and Zamir versions of the Report. Iqbal, Lead Financial Sector Specialist, Finance The team would also like to thank the peer and Markets (F&M) Global Practice, World reviewers, Alwaleed Fareed Alatabani, Lead Bank. Special thanks are owed to Dawood Financial Sector Specialist, Finance and Ashraf, Senior Researcher–Islamic Finance, Markets Global Practice, East Asia and Pacific IRTI, for his commitment and contributions, Region, World Bank; Muhammad Umar and for taking the lead at IRTI in preparation Chapra, Advisor to the Director General of this Report. We are also thankful to of IRTI, IDB; Ahmed Mohamed Tawfick Abayomi Alawode, Head of Islamic Finance, Rostom, Senior Financial Sector Specialist, Finance and Markets Global Practice, World Finance and Markets Global Practice, Bank; Ahmed Fayed al-Gebali, Director, South Asia Region, World Bank; and Sami Islamic Development Bank (IDB); and Abdul Al-Suwailem, Head of Financial Product Aziz Al-Hinai, former Vice President of Development Centre, IDB, for their valuable Finance, IDB, for their support on this project. comments and feedback, which enriched the The team would like to thank and acknowl- Report. edge the contributions of the Advisory The teams at IRTI and World Bank Global Committee, comprising Dr. Ishrat Husain, Islamic Finance Development Center are rec- Chairman, Center of Excellence for Islamic ognized for their commitment and efforts in Finance, Institute of Business Administration; writing, updating, editing, and assembling this Prof. Dr. Abbas Mirakhor, the International Report. They were led by Dawood Ashraf Centre for Education in Islamic Finance (IDBG) and Nihat Gumus (World Bank (INCEIF); and Dr. Ghiath Shabsigh, Assistant Group). We thank all the team members from Director, Monetary and Capital Markets both institutions for their valuable expertise Department, International Monetary Fund and contributions, including Ayse Nur Aydin, (IMF), who guided the team with their Financial Analyst; Mehmet Murat Cobanoglu,
GLOBAL REPORT ON ISLAMIC FINANCE xiii xiv ACKNOWLEDGMENTS GLOBAL REPORT ON ISLAMIC FINANCE
Financial Sector Specialist; Nihat Gumus, and Prof. Rodney Wilson, INCEIF, who served Financial Sector Specialist; Rasim Mutlu, as consultants to the team for select chapters. Research Assistant; Canan Ozkan, Financial The team would also like to thank Prof. Sector Specialist; and Mustafa Tasdemir, Obiyathulla Ismath Bacha, INCEIF; Sohail Financial Sector Specialist, all from the World Jaffer, FWU-Group; Prof. Tariqullah Khan, Bank; and Tamsir Cham, Economist; Hylmun Qatar Foundation; Dr. Shehab Marzban, Izhar, Economist; Anis Ben Khedher, Shekra; Prof. Abbas Mirakhor, INCEIF; and Information Technology Specialist, Prof. Philip Molyneux, Bangor University, for Mohammed Obaidullah, Senior Economist; their valuable comments and feedback as Ousmane Seck, Senior Economist; Nasim Shah external peer reviewers for select chapters. Shirazi, Lead Economist; Salman Ali Syed, Finally, we acknowledge the support of Senior Economist; and Muhamed Zulkhibri, Liudmila Uvarova, Knowledge Management Senior Economist, all from IDB. Officer, Finance and Markets Global Practice, In addition, the team benefited greatly from World Bank; the World Bank publishing team; discussions, valuable input, and constructive the IRTI publishing team; and Nancy comments provided by Prof. Habib Ahmed, Morrison, Editor, the Morrison Group, for her Durham University; Prof. Azam Shah, INCEIF; invaluable efforts in editing this Report. Glossary
Introduction Notes A lot of Islamic technical terms of Arabic ori- • Usually most of the terms used in this gin have, over the last few decades, entered the glossary are preceded by the article al-, dictionary of economics, banking, and finance meaning the. The articles are not used in view of the rise and spread of Islamic eco- in this glossary, except when it is neces- nomics, banking, and finance worldwide. It is sary to keep them, such as al-ghunm not possible to collect them all and add them bi al-ghurm or al-kharƗj bi al-DamƗn. all to this glossary, however, the most impor- Therefore, words like al-‘adl, for exam- tant and most used ones are provided here. ple, are written just ‘adl without the A large number of the teachers, practitio- al- article. ners, researchers, and students interested in • Some Arabic words bearing the same learning, practicing, or researching the sub- meanings are pronounced differently. jects of Islamic economics, banking, and These are separated by a slash / as in the finance need to know the meanings of these case of ‘arbnjn/‘urbnjn, mean- technical terms and their proper usage. ing down payment. Therefore, this glossary has been prepared to • Both the singular and plural forms of facilitate their tasks. It provides broad, gen- some Arabic words are put in the same eral, and precise explanations of the technical entry instead of in two entries. The plu- terms used in the literature of Islamic econom- ral forms are put between parentheses ics, banking, and finance. Because the terms after the singular form, as in the case were collected and compiled from various of ϡ˶ϟΎϋ˴ (˯Ύϣ˴ Ϡ˴ ϋ˵ ) ‘alim (‘ulamƗ’) meaning sources, it is difficult to recall or point out scholar(s). which term comes from which source. Our • The terms used in this glossary are thanks and gratitude go to all of those from arranged alphabetically according to whom we benefited in compiling this the second column on the left, titled glossary. “Transliterated as.”
GLOBAL REPORT ON ISLAMIC FINANCE xv xvi GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ϝΩ˸ ϋ˴ ‘adl Justice, equity, fairness ϑΎϔ˴ ϋ˴ ‘afa¯f Abstinence, satisfaction with the little one has ϭϔ˸ ϋ˴ ‘afw Surplus, which is over one’s basic needs ΩϭϬ˵ ϋ Ω˵ Ϭ˸ ϋ˴ ‘ahd (‘uhuˉd) Covenant(s), treaty(ies) ˯Ύϣ˴ Ϡ˴ ϋ ϡ˵ ˶ϟΎϋ˴ ‘alim (‘ulama¯’) Scholar(s) ˯ϼ˴ ϣ˴ ϋ ϝϳ˵ ϣ˶ ϋ˴ ‘amƯl (‘umala¯’) Customer(s) ϝΎϣ͉ ϋ ϝ˵ ϣΎ˶ ϋ˴ ‘a¯mil (‘umma¯l) Worker(s), manager(s), entrepreneur(s) ΕέΎ˴ Ϙ˴ ϋ έΎ˴ Ϙ˴ ϋ˴ ‘aqa¯r (‘aqa¯ra¯t) Immovable property(ies), building(s) Ωϭ˵Ϙϋ Ω˵ Ϙ˸ ϋ˴ ‘aqd (‘uquˉd) Contract(s), agreement(s), bond(s) ΩΎ˶ Ϙ˴ ϋ ΓΩϳ˴ ˶Ϙϋ˴ ‘aqƯdah (‘aqa¯’id) Belief(s), creed(s), doctrine(s) ΔϠ˴ ˶ϗΎϋ˴ ‘a¯qilah Mutual solidarity between the members of a community to help those in need ϝϭ˵Ϙϋ ϝ˴ Ϙ˸ ϋ˴ ‘a¯ql (‘uquˉl) Intellect(s), mind(s) ϥϭΑ˵ έ˸ ϋ˵ /ϥϭΑ˵ έ˸ ϋ˴ ‘arbun/‘urbuˉn Down payment Δϳ˴ έΎ˶ ϋ˴ ‘a¯riyah Loan of small items Ώϭϳ˵ ϋ Ώ˵ ϳ˸ ϋ˴ ‘ayb (‘uyuˉb) Defect(s), fault(s) ϥϳ˸ ϋ˴ ‘ayn Tangible (physical) asset Δϧ˴ ϳ͋ ϋ˴ ‘ayyinah Sample ˯έ˴ Ο˴ ˵ έϳΟ˶ ˴ ajƯr (ujara’) Employee(s), worker(s) έϭΟ έ˵ Ο˸ ˴ ajr (ujuˉr) Salary(ies), wage(s), commission(s), compensation(s) ϝΛ˸ ϣ˶ ϟέ˸ Ο˸ ˴ ajr al-mithl Prevalent similar wage Γέ˴ Χ˶ a¯khirah Hereafter ϕϼ˴ Χ˸ akhla¯q Ethics, morals
ϡέ˸ ϐ˵ ϟΎ˸ Αϡ˶ ϧ˸ ϐϟ˵ al-ghunm bi al-ghurm Earning profit is legitimized by risk taking. Earning is subject to taking risk. ϝϭ˸ Σ˴ ϟ˸ al-hawlʋ A year ϥΎϣ˴ οϟΎ͉ ΑΝ˶ έ˴ Χϟ˴ al-khara¯j bi al-dama¯n Revenue is subject to liability ΔϓίΎ˴ Ο˴ ϣ˵ ϟ˸ al-muja¯zafah Speculation ϥΎϣ˴ ˴ ama¯n Security ΕΎϧΎ˴ ϣ˴ ˴ ΔϧΎ˴ ϣ˴ ˴ ama¯nah Trust, honesty, trustworthiness ˯Ύϧ˴ ϣ˴ ˵ ϥϳϣ˶ ˴ amƯn (umana’) Trustee(s), trustworthy, honest έϣ˸ ˴ amr Order ϲο˶ έ˴ ˴ νέ˸ ˴ ardʋ (ara¯dʋi) Land(s) ϝϭλ˵ ˵ ϝλ˸ ˴ aslʋ (usuʋˉl) Origin(s) ϑΎϧλ˸ ˴ asnaf Eligible beneficiaries ΙΎΛ˴ ˴ atha¯th Furniture ΕΎϳ Δϳ˴ a¯yah (a¯ya¯t) Qur’anic verse(s) Δϛ˴ έ˴ Α˴ barakah Blessing ϝρΎ˶ Α˴ ba¯tilʋ Null, void, invalid ΔΣ˴ Α˴ έ˴ ϣϟ˵ ϊ˵ ϳ˸ Α˴ bay‘ al- mura¯bahahʋ Mark-up sale GLOBAL REPORT ON ISLAMIC FINANCE GLOSSARY xvii
Arabic original word Transliterated as English meanings ωϭ˸ ϳ˵ Α ϊ˵ ϳ˸ Α˴ bay‘ (buyuˉ ޏ) Sale(s) ϥϭΑ˵ έ˸ όϟ˵ ϊ˵ ϳ˸ Α˴ bay‘ al-‘urbuˉn Sale with down payment ϥϳ˸ Ωϟϊ͉ ϳ˸ Α˴ bay‘ al-dayn Sale of debt Ί˶ϟΎϛϟΎΑΊ˸ ˶ϟΎϛϟ˴ ϊ˵ ϳ˸ Α˴ bay‘ al-ka¯lƯ’ bi-al-ka¯lƯ’ A sale in which both the delivery of the object of sale and the payment of its price are delayed. It is similar to a modern forward sale contract. ϡϠ˴ γϟ͉ ϊ˵ ϳ˸ Α˴ bay‘ al-salam Sale in which payment is made in advance by the buyer and the delivery of goods is deferred by the seller ˯Ύϓ˴ ϭϟ˴ ϊ˵ ϳ˸ Α˴ bay‘ al-wafa’ Buy-back sale, sale and repurchase ρϳγ˶ Ϙ˸ ΗϟΎΑϊ˴ ϳ˸ Α˴ bay‘ bi al-taqsƯt Sale with installment payments ϝΟ͉ ΅˴ ϣϟϥ˵ ϣ˴ ΛϟΎ͉ Α˶ ϊ˵ ϳ˸ Α˴ bay‘ bi al-thaman al-a¯jil Credit sale or sale at deferred payment ϝΟ͉ ΅˴ ϣ˵ ϊ˵ ϳ˸ Α˴ bay‘ mu’ajjal Credit sale or sale at deferred payment Δϧϳ˴ όϟ˶ ϊ˵ ϳ˸ Α˴ bay‘-al-‘inah Buying an object for cash then selling it to the same party for a higher price whose payment is deferred so that the purchase and sale of the object serve as a ruse for lending on interest ϝΎϣϟ˴ Ε˵ ϳ˸ Α˴ bayt al-ma¯l Treasury ωΩ˴ Α Δ˶ ϋ˴ Ω˸ Α˶ bid‘ah Innovation in Islamic rituals Γϭ˴ ϋ˸ Ω˴ da‘wah Claim, invitation ϝϳ˶ϟΩ˴ dalƯl Proof, evidence, reason ϥΎϣ˴ ο˴ dʋama¯n Guarantee έέ˴ ο˴ dʋarar Harm Γέ˴ ϭ˸ έ˵ ο˴ dʋaruˉrah Necessity ΕΎϳ͉ έ˶ ϭ˸ έ˵ ο˴ dʋaruˉrƯya¯t Basic needs ϥϭϳ˵ Ω ϥ˵ ϳ˸ Ω˴ dayn (duyuˉn) Debt(s) ϡϣ˴ Ϋ Δ˶ ϣ͉ Ϋ˶ dhimmah (dhimam) Liability(ies), responsibility(ies) ϥϳΩ˶ dƯn Religion έΎϧϳ˴ Ω˶ dƯna¯r Dinar (currency) ϡϫ˴ έ˸ Ω˶ dirham Dirham (currency) Δϳ͉ Ω˶ diyyah Blood money (compensation) ˯Ύϋ˴ Ω˵ du‘a¯ Supplication Ύϳ˴ ϧ˸ Ω˵ dunya Life in this world ν˶ ϭ˴ ϓ ν˴ Ύ˶ ϓ˴ fa¯’id (fawa’id) Surplus(es), excess(es) ϝο˸ ϓ˴ fadl Excess, additional, surplus ௌϝο˸ ϓ˴ fadl-al-Allah The bounties bestowed by Almighty Allah Ρ˴ϼ˴ ϓ˴ fala¯hʋ Prosperity, success ˯ΎϬ˴ Ϙ˴ ˵ϓ Ϫϳ˶Ϙϓ˴ faqƯh (fuqaha’) Jurist(s) ˯έ˴ Ϙ˴ ˵ϓ έϳ˶Ϙϓ˴ faqir (fuqara’) Poor person(s) ν˶ έ˴ ϓ ν˴ έ˸ ϓ˴ fardʋ (fara¯’idʋ) Duty(ies) ϥϳ˸ ϋν˴ έ˸ ϓ˴ fardʋ ‘ayn Compulsory duty on everyone ΔϳΎ˴ ϔ˴ ϛν˶ έ˸ ϓ˴ fardʋ kifa¯yah Compulsory duty on everyone if nobody did it xviii GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ΩγΎ˶ ϓ˴ fa¯sid Void, invalid Φγ˸ ϓ˴ faskh Terminate ̵Ի ϭΎ˴ Η˴ ϓ ˴ ̵Ի ϭ˴ Η˸ ϓ˴ fatwa (fata¯wá) Religious verdict(s) made by a faqih-competent shari‘ah scholar ϪϘ˸ ˶ϓ fiqh Islamic jurisprudence Εϼ˴ ϣΎ˴ ό˴ ϣϟ˵ Ϫ˵ Ϙ˸ ˶ϓ fiqh al-mu‘a¯mala¯t Jurisprudence of transactions ϲϬ˶ Ϙ˸ ˶ϓ fiqhƯ Juristic Γέ˴ ρ˸ ˶ϓ fitrah Law of nature ϥΑ˸ Ϗ˵ /ϥΑ˸ Ϗ˴ ghabn/ghubn Misappropriation or defrauding others with respect to specifications of the goods and their prices ϡΎ˶ ϧ˴ Ϗ Δ˴ ϣϳ˴ ϧ˶ Ϗ˴ ghanƯmah (ghana’im) Spoils of war, booty(ies) έέ˴ Ϗ˴ gharar Excessive risk and uncertainty, ambiguity εΣΎ˶ ϓέ˴ έ˴ Ϗ˴ gharar fa¯hishʋ Excessive risk έϳγ˶ ϳέ˴ έ˴ Ϗ˴ gharar yasƯr Minor risk ϥϳϣ˶ έΎ˶ Ϗ±ϡ˴ έΎ˶ Ϗ˴ gha¯rim (gha¯rimƯn) Indebted, bankrupt Ώλ˸ Ϗ˴ ghasbʋ Taking by force, possess unlawfully ΏλΎ˶ Ϗ˴ gha¯sibʋ Violator ε˷ Ϗ˶ ghishsh Deception, fraud Ιϳ˸ ΩΎ˶ Σ˴ ˴ ΙϳΩ˶ Σ˴ haʋ¯dƯth (ahaʋ¯dƯth) Sayings of the Prophet Mohammed Ύϳ˴ Ω˴ ϫ Δ˴ ϳ͉ Ω˶ ϫ˴ hadiyyah (hada¯ya) Gift(s), donation(s) ΕΎΟΎ˴ Σ Δ˴ ΟΎ˴ Σ˴ haʋ¯jah (haʋ¯ja¯t) Need(s) ΕΎϳ˴ ΟΎ˶ Σ˴ hajiya¯t Basic needs ΞΣ˴ hajjʋ Pilgrimage ϝϼ˴ Σ˴ halaʋ ¯l Permissible, lawful, allowed ϕϭ˵ϘΣ ˵ ϕ˷ Σ˴ haqqʋ (huquʋ ˉq) Right(s) ϡέ˴ Σ˴ haraʋ ¯m Not permissible, unlawful, not allowed Δϟ˴ ϭ˴ Σ˴ hawaʋ ¯lah Bill of exchange, promissory note, cheque, draft ΕΎΑ˴ ϫ Δ˶ Α˴ ϫ˶ hibah (hibat) Donation(s), gift(s) υϔ˸ Σ˶ hifzʋ ʋ Learning by heart Γέ˴ Ο˸ ϫ˶ Hijrah Migration Δϣ˴ ϛ˸ Σ˶ hikmahʋ Wisdom, rationale ϝϳ˴ Σ Δ˶ Ϡϳ˴ Σ˶ hƯʋ lah (hiyal)ʋ Trick(s), ploy(s), ruse(s) ̶Ի ϣ˴ Σ˶ himáʋ ΔΑ˴ γ˸ Σ˶ hisbahʋ Ombudsman, regulation ϡΎϛ˴ Σ˸ ˴ ϡϛ˸ Σ˵ hukmʋ (ahkaʋ ¯m) Ruling, decision ΕΩΎ˴ Α˴ ϋ Γ˶ ΩΎ˴ Α˴ ϋ˶ ‘iba¯dah (‘iba¯da¯t) Ritual(s), act(s) of worship ϝϠ˴ ϋ Δ˶ Ϡ͉ ϋ˶ ‘illah (‘ilal) Defect(s), justification(s), reason(s), rationale(s) ϡϭ˵Ϡϋ ϡ˵ Ϡ˸ ϋ˶ ‘ilm (‘uluˉm) Knowledge(s) Δϧϳ˴ ϋ˶ ‘Ưnah Debt buying and selling νϭ˴ ϋ˶ ‘iwadʋ Compensation GLOBAL REPORT ON ISLAMIC FINANCE GLOSSARY xix
Arabic original word Transliterated as English meanings ΓέΎ˴ ϋ˴ ˶· i‘a¯rah Lending έΎγ˴ ϋ˸ ˶· i‘sa¯r Insolvency ϝΩ˴ Η˶ ϋ˸ ˶ i‘tida¯l Moderation ΩΎϣ˴ Η˶ ϋ˸ ˶ i‘tima¯d Approval ΔΣΎ˴ Α˴ ˶· iba¯hahʋ Permission ϝΩ˴ Α˸ ˶· ibda¯l Change ϝΑ˶ ˶· ibil Camels ϥΑ˸ ˶ ibn Son ϝϳ˸ Α˶ γϟ͉ ϥ˵ Α˸ ˶ ibn al-sabƯl Traveler έΎΧ˴ Ω͋ ˶ iddikha¯r Saving ϥΫ˸ ˶· idhn Permission αϼ˴ ϓ˸ ˶· ifla¯s Bankruptcy ΔΛΎ˴ Ϗ˴ ˶· igha¯thah Relief ϥΎγ˴ Σ˸ ˶· ihsaʋ ¯n Benevolence, compassion, kindness έΎϛ˴ Η˶ Σ˸ ˶ ihtikaʋ ¯r Hoarding ˯Ύϳ˴ Σ˸ ˶· ihyaʋ ¯’ Reform, revival, restoration ΏΎΟϳ˴ ˶· ija¯b Offer (in contract) ΓέΎ˴ Ο˴ ˶· ija¯rah Leasing, rent ϙϳ˶Ϡϣ˸ ΗϟΎ͉ ΑΔϳ˶ Ϭ˶ Η˴ ϧ˸ ϣΓ˵ έΎ˴ Ο˴ ˶· ija¯rah muntahia-bi-tamlƯk Hire purchase ˯Ύϧ˴ Η˶ ϗϭΓ˸ έΎ˴ Ο˴ ˶· ija¯rah wa-iqtina’ Hire purchase ωΎϣ˴ Ο˸ ˶· ijma¯‘ Consensus ΩΎϬ˴ Η˶ Ο˸ ˶ ijtiha¯d Effort, exertion, diligence, legal reasoning ιϼ˴ Χ˸ ˶· ikhla¯sʋ Sincerity έΎϳ˴ Η˶ Χ˸ ikhtiya¯r Choice ϩέ˴ ϛ˸ ˶· ikra¯h Compulsion ΏΎγ˴ Η˶ ϛ˸ ˶ iktisa¯b Earning ˯Ύϐ˴ ϟ˸ ˶· ilgha¯’ Cancellation ϕΎΣ˴ ϟ˸ ˶· ilhaʋ¯q Annexation ϡί˴ Η˶ ϟ˸ ˶ iltiza¯m Commitment ϡΎϣ˴ ˶· ima¯m Leader, guide, ruler ϥΎϣϳ˴ ˶· ima¯n Faith, conviction, belief ΔΑΎ˴ ϧ˴ ˶· ina¯bah Repentance ΫΎϔ˴ ϧ˸ ˶· infa¯dh Enforcement, execution ϕΎϔ˴ ϧ˸ ˶· infa¯q Expenditure, spending ϝΎλ˴ ˶ϔϧ˸ ˶ infisaʋ¯l Separation ϥΎγ˴ ϧ˸ ˶· insa¯n Human being ωΎϔ˴ Η˶ ϧ˸ ˶ intifa¯‘ Utilization ϝΎϘ˴ Η˶ ϧ˸ ˶ intiqa¯l Movement, transmission ΔϟΎ˴ ϗ˴ ˶· iqa¯lah Dismissal, firing, sacking xx GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ΔϣΎ˴ ϗ˴ ˶· iqa¯mah Residence, establishment έέ˴ ϗ·˸ iqra¯r Declaration, assertion, testimony ωΎρ˴ ϗ˸ ˶· iqta¯‘ʋ Deduction ˯ΎϧΗ˶ ϗ˸ ˶ iqtina¯’ Acquisition ΩΎλ˴ Η˶ ϗ˸ ˶ iqtisaʋ¯d Economics ϕΎϓ˴ έ˸ ˶· irfa¯q Attachment, concession Ιέ˸ ˶· irth Inheritance ϙέ˴ Η˶ η˸ ishtira¯k Contribution, participation, premium Ρϼ˴ λ˸ ˶· islaʋ ¯hʋ Improvement, reform ϡϼ˴ γ˸ ˶· isla¯m Submission, peace ϑέ˴ γ˸ ˶· isra¯f Wasteful expenditure, extravagance ϝΎϣ˴ ό˸ Η˶ γ˸ ˶ isti‘ma¯l Use έΎϣ˴ ό˸ Η˶ γ˸ isti‘ma¯r Colonization έΎΟ˴ Η˶ γ˸ isti’jar Hiring, renting ϝΩ˴ Α˸ Η˶ γ˸ ˶ istibda¯l Exchange ϝϼ˴ ϐ˸ Η˶ γ˸ istighlal Exploitation ϙϼ˴ Ϭ˸ Η˶ γ˸ ˶ istihla¯k Consumption ϕΎϘ˴ Σ˸ Η˶ γ˸ ˶ istihqaʋ ¯q Maturity ϥΎγ˴ Σ˸ Η˶ γ˸ ˶ istihsaʋ ¯n Juristic preference, approbation έέ˴ Ο˸ Η˶ γ˸ ˶ istijra¯r Recurring or repeat sale ϑϼ˴ Χ˸ Η˶ γ˸ ˶ istikhla¯f Succession ϡϼ˴ Η˶ γ˸ ˶ istila¯m Receipt έέ˴ ϣ˸ Η˶ γ˸ ˶ istimra¯r Continuity ρΎΑ˴ ϧ˸ Η˶ γ˸ ˶ istinba¯tʋ Elicitation Ρϼ˴ λ˸ Η˶ γ˸ istisla¯h Improvement, refurbishment, renovation ωΎϧ˴ λ˸ Η˶ γ˸ ˶ istisnaʋ ¯‘ Manufacturing contract whereby a manufacturer agrees to produce (build) and deliver a well-described good (or premise) at a given price on a given date in the future
έΎϣ˴ Λ˸ Η˶ γ˸ ˶ istithma¯r Investment ˯Ύϧ˴ Λ˸ Η˶ γ˸ ˶ istithna¯’ Exception
ΕΎΑ˴ Λ˸ ˶· ithba¯t Proof, evidence ϡΛ˸ ˶· ithm Sin ϑϼ˴ Η˸ ˶· itla¯f Damage, spoliation έΎΟΗ͋ ˶ ittija¯r Doing business, trafficking ΔϟΎ˴ Ϭ˴ Ο˴ jaha¯lah Lack of knowledge, ignorance ΓΫ˴ ΑΎϬ˶ Ο Ϋ˴ Α˴ Ϭ˸ Ο˴ jahbad, (jaha¯bidah) Financial expert(s) Δϳ͉ ˶ϠϫΎ˶ Ο˴ ja¯hilƯyah In the Days of Ignorance ϝϬ˸ Ο˴ jahl Ignorance, unfamiliarity ΩΎϬ˴ Ο˶ jiha¯d Striving, doing one’s utmost GLOBAL REPORT ON ISLAMIC FINANCE GLOSSARY xxi
Arabic original word Transliterated as English meanings Δϳ˴ ί˸ Ο˶ jizyah Poll tax paid by members of other religious groups in a Muslim state for protection of life and property. Muslims on the other hand pay zaka¯t as part of their religious obligation to help the poor. ΔϟΎ˴ ό˴ Ο˵ ju‘a¯lah Commission, fee, wage ΔϟΎ˴ ϔ˴ ϛ˴ kafa¯lah Guarantee ϝϳ˸ ˶ϔϛ˴ kaf Ưl Guarantor ˯Ύϔ˴ Ϡ˴ Χ Δ˵ ϔ˴ ϳ˸ ˶ϠΧ˴ khalƯfah (khulafa’) Leader(s), successor(s), ruler(s) έϭϣ˵ Χ έ˵ ϣ˸ Χ˴ khamr (khumur) Intoxicant(s) Νέ˴ Χ˴ khara¯j A levy on land use, revenue έΎγ˴ Χ Γ˴ έΎ˴ γ˴ Χ˴ Khasa¯rah (khasa¯’ir) Loss(es) έρΎ˶ Χ˴ ϣ έ˴ ρ˴ Χ˴ Khatar (ma kha¯tir) Danger, risk έϳ˸ Χ˴ khayr Good, beneficial Δϓ˴ ϼ˴ Χ˶ khila¯fah Leadership, succession ΔϧΎ˴ ϳ˴ Χ˶ khiya¯nah Betrayal έΎϳ˴ Χ˶ khiya¯r Choice, option ρέ˸ ηϟέΎ͉ ϳ˴ Χ˶ khiya¯r al-shart Optional condition ϑλ˸ ϭϟέΎ˴ ϳ˴ Χ˶ khiya¯r al-wasf Optional specifications ϊϠ˸ Χ˵ khul‘ Divorce, separation αϣ˸ Χ˵ khums One-fifth ϥέ˴ γ˸ Χ˵ khusra¯n Loss, failure ϡί˶ ϻ˴ la¯zim Necessary, compulsory Δρ˴ Ϙ˴ ˵ϟ luqatahʋ Found property ϡϭΩ˵ ό˸ ϣ˴ ma‘duˉm Nonexistent ϡϭ˵Ϡό˸ ϣ˴ ma‘luˉm Known, defined Ώϫ˶ Ϋ˴ ϣ Ώ˴ ϫ˴ Ϋ˸ ϣ˴ madhhab (madha¯hib) School(s) of Islamic jurisprudence, regime(s), system(s) ΩγΎ˶ ϔ˴ ϣ Γ˴ Ω˴ γ˴ ϔ˸ ϣ˴ mafsadah (mafa¯sid) Spoiler(s) ϝϭ˸ Ϭ˵ Ο˸ ϣ˴ majhuˉl Not known, anonymous ϩϭ˸ έ˵ ϛ˸ ϣ˴ makruˉh Reprehensible, discouraged ϝϭ˴ ϣ˸ ˴ ϝΎϣ˴ ma¯l (amwa¯l) Capital, money, property, wealth ϊ˶ϓΎϧ˴ ϣ Δ˴ ό˴ ϔ˴ ϧ˸ ϣ˴ manfa‘ah (mana¯fi‘) Benefit(s), utility(ies), usufruct(s) Δόϳ˴ έ˶ ηϟ͉ Ω˵ λΎ˶ Ϙ˴ ϣ Ω˴ λ˴ Ϙ˸ ϣ˴ maqsad (maqa¯sidʋ al-sharƯ‘ah) Objectives of Islamic Law ΔϠ˴ γ˴ έ˸ ϣ ˵ ˶ϟΎλ˴ ϣ Δ˴ Σ˴ Ϡ˴ λ˸ ϣ˴ maslahʋ ahʋ (masaʋ¯lih)ʋ mursalah General benefits, public interest(s) ϑϭ˵ϗϭ˸ ϣ˴ mawquˉf Suspended έγ˶ ϳ˸ ϣ˴ maysir Gambling Δϳϛ˶ Ϡ˸ ϣ˶ milkiyyah Ownership Ιέϳ˴ ϣ˶ mira¯th Inheritance ϥϳϛΎ˶ γ˴ ϣ ϥϳ˴ ϛ˶ γ˸ ϣ˶ miskƯn (masakƯn) Poor, poor people ϕΎΛϳ˴ ϣ˶ mƯtha¯q Charter xxii GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ϝΛ˸ ϣ˶ Α˶ ϼ˱ Λ˸ ϣ˶ mithlan-bi-mithl Like for like ϲ˶ϠΛ˸ ϣ˶ mithlƯ Similar ϕϠ͉ ό˴ ϣ˵ mu‘allaq Suspended Εϼ˴ ϣΎ˴ ό˴ ϣ Δ˵ Ϡ˴ ϣΎ˴ ό˴ ϣ˵ mu‘a¯malah (mu‘a¯mala¯t) Transactions ΕΎο˴ ϭΎ˴ ό˴ ϣ Δ˵ ο˴ ϭΎ˴ ό˴ ϣ˵ mu‘a¯wadʋa¯t Exchange, compensation ΡΎΑ˴ ϣ˵ muba¯hʋ Permissible ΔΑ˴ έΎ˴ ο˴ ϣ˵ mudʋa¯rabah A partnership whereby one party (the capital owner) provides capital to an entrepreneur to undertake a business activity. Profits are shared between them as agreed, but any financial loss is borne only by the capital owner, as his loss is his unrewarded efforts put into the business activity. ΏέΎ˶ ο˴ ϣ˵ mudʋa¯rib The partner in mud.a¯rabah contract providing work, entrepreneurship, and management α˶Ϡϔ˸ ϣ˵ muflis Bankrupt ϲΗ˶ ϔ˸ ϣ˵ mufti Jurist who provides legal shari‘ah opinions Δγ˴ έΎ˴ ϐ˴ ϣ˵ mugha¯rassah Sharecropping between two parties whereby one provides land, equipment, and shoots of trees and the other agrees to plant the trees and take care of them in return for a share in the harvest or the profit Ώγ˶ Η˴ Σ˸ ϣ˵ muhtasibʋ Ombudsman ΩϬ˶ Η˴ Ο˸ ϣ˵ mujtahid Legal expert or a jurist who exerts great effort in deriving a legal opinion ΕΎό˴ ϣ˴ Η˴ Ο˸ ϣ ϊ˵ ϣ˴ Η˴ Ο˸ ϣ˵ mujtama‘ (mujtama‘a¯t) Community, society Γέ˴ ρΎ˴ Χ˴ ϣ˵ mukha¯tarahʋ Taking risk Δγ˴ ϣ˴ ϼ˴ ϣ˵ Mula¯masah Touching Δο˴ έΎ˴ Ϙ˴ ϣ˵ muqa¯radʋah Same meaning as mud.a¯rabah Δο˴ ϳΎ˴ Ϙ˴ ϣ˵ muqa¯yadah Barter ΔΣ˴ Α˴ έ˴ ϣ˵ mura¯bahahʋ Mark-up sale, sale at a margin ΓΎϗΎ˴ γ˴ ϣ˵ musa¯qa¯h A sharecropping contract whereby the owner of a garden/ orchard shares the produce with a worker in return for his services in irrigating the garden/orchard Δϣ˴ ϭΎ˴ γ˴ ϣ˵ musa¯wamah Bargaining on price, haggling Δϛ˴ έΎ˴ η˴ ϣ˵ musha¯rakah Partnership whereby all the partners contribute capital for a business venture. The partners share profits on pre-agreed ratios while losses are shared according to each partner’s capital contribution. Δλ˴ ϗΎ˴ ϧ˴ Η˴ ϣΔ˵ ϛ˴ έΎ˴ η˴ ϣ˵ musha¯rakah mutana¯qisahʋ Diminishing partnership ϙέ˶ Η˴ η˸ ϣ˵ mushtarik Participant ΏΣ˴ Η˴ γ˸ ϣ˵ mustahab Meritorious ϕ˷ Σ˶ Η˴ γ˸ ϣ˵ mustahiq Eligible for recipient of zaka¯t ϲϟ͋ ϭ˴ Η˴ ϣ˵ mutawallƯ Manager, director ϕϠ˴ ρ˸ ϣ˵ mutlaq Absolute GLOBAL REPORT ON ISLAMIC FINANCE GLOSSARY xxiii
Arabic original word Transliterated as English meanings ϲϛ͋ ί˴ ϣ˵ muzakki Zaka¯t payer Δϋ˴ έ˴ ί˴ ϣ˵ muza¯ra‘ah A sharecropping contract whereby one party agrees to provide land, seeds, and equipment and the other agrees to do the work needed in return for a part of the produce of the land ΓΩ˴ ϳ˴ ί˴ ϣ˵ muza¯yadah Auction sale, bidding ΕΎϘ˴ ϔ˴ ϧΔ˴ Ϙ˴ ϔ˴ ϧ˴ nafaqah (nafaqa¯t) Expense(s) εΟ˴ ϧ˴ najash Prohibited practice of deceiving and inciting a potential buyer of goods during the course of pre-sale negotiations or bidding to secure a greater value for the goods ι˷ ϧ˴ nassʋ ʋ Text, scripture ΏΎλ˴ ϧ˶ nisa¯b Threshold, exemption limit for the payment of zakat Δϳ͉ ϧ˶ nƯyyah Intention νΑ˸ ϗ˴ qabdʋ Receipt ϝϭΑ˵ ˵ϗ/ϝϭΑ˵ ϗ˴ qabuˉl/qubuˉl Acceptance ϲοΎ˶ ϗ˴ qa¯dʋi Judge νϭέ˵ ˵ϗ νέ˸ ϗ˴ qardʋ (quruˉdʋ) Loan(s) ϥγ˴ Σν˴ έ˸ ϗ˴ qardʋ hasanʋ Interest-free loan ϡϳ˴ ˶ϗ Δϣϳ˴ ˶ϗ qƯmah (qiyam) Value(s) έΎϣ˴ ˶ϗ qima¯r Gambling νέ˴ ˶ϗ qira¯dʋ Another name for mud.a¯rabah ιΎλ˴ ˶ϗ qisaʋ¯sʋ Punishment αΎϳ˴ ˶ϗ qiya¯s Analogical reasoning ϥέ˸ ˵ϗ Qur’a¯n The sacred book of Islam νϭέ˵ ˵ϗ quruˉdʋ Loans ϝΎϣϟ˴ αέ˴ ra’s al-ma¯l Capital(s) ϝϭ˴ ϣ˸ ˴Ϸαϭ΅˵ έ˵ ru’uˉs al-amwa¯l ϝΎϣϟ˴ ΏΎ˵ Α˴ έ˸ ˴ ϝΎϣϟ˴ Ώ͊ έ˴ rabb al-ma¯l arba¯b al-ma¯l Capital owner(s) ϥϫ˸ έ˴ rahn Collateral, pledge, guarantee ϥΎο˴ ϣ˴ έ˴ ramada¯n Month of fasting for muslims ΎΑ˴ έ˶ riba¯ Usury, interest ωϭϳ˵ ΑϟΎ˵ Α˴ έ˶ riba¯ al-buyuˉ‘ Usury of trade; another name for riba al-fadl ϥϭϳ˵ ΩϟΎ͊ Α˴ έ˶ riba¯ al-duyuˉn Interest/usury of debt; another name for riba al-nasi’ah ϝο˸ ϔϟΎ˴ Α˴ έ˶ riba¯ al-fadʋl Difference in exchanging two similar commodities ΄γ˴ ϧϟ˴ /Δϳ˴ γ˶ ϧϟΎ˴ Α˴ έ˶ riba¯ al-nasƯ’ah/al-nasa’ Interest-based lending for the delay in repayment νϭέ˵ ˵ϘϟΎΑ˴ έ˶ riba¯ al-quruˉdʋ Interest on loans ΡΎΑ˴ έ˸ ˴ Α˸ έ˶ ribh ʋ (arba¯h)ʋ Profit(s) ίΎϛ˴ έ˶ rika¯z Treasure Γϭ˴ η˸ έ˶ rishwah Bribe ϕί˸ έ˶ rizq Sustenance xxiv GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ϥΎΑ˴ ϛ˸ έ˵ rukba¯n Business traveler ϥϛ˸ έ˵ rukn Pillar Δό˴ ϗ˸ έ˵ ruq‘ah Promissory note Ωη˸ έ˵ rushd Maturity ΔϳέΎ˶ ΟΔ˴ ϗ˴ Ω˴ λ˴ sadaqahʋ ja¯riyah Perpetual charity ΕΎϗ˴ Ω˴ λ Δ˴ ϗ˴ Ω˴ λ˴ sadaqaʋ ¯t Charity(ies) Δόϳ˴ έ˶ Ϋϟ˴ Ω͊ γ˴ sadd al-dharƯ‘ah Prohibition of a deed that, if permitted, may lead to another prohibited deed ΔΑΎ˴ Σ˴ λϲ˴ ΑΎ˶ Σ˴ λ˴ sahʋ aʋ¯bƯ (sahʋ aʋ¯bah) Companion(s) ϳΣ˶ λ˴ sahʋ Ưʋ hʋ Valid; opposite of ba¯tilʋ and fa¯sid ϡϬ˵ γϡ˸ Ϭ˴ γ˴ sahm (ashum) Share(s) ϙϭϛ˵ λ ˵ ϙ˷ λ˴ sakkʋ (sukuʋ ˉk) Asset-based or asset-backed financial certificate(s) ϑϠ˴ γ˴ salaf Loan; another name for salam Γϼ˴ λ˴ salaʋ ¯h Prayers offered by muslims
ϡϠ˴ γ˴ salam Forward sale where the price of a specific good is paid in advance for its delivery at a specified time in the future ΕΩ˴ ϧ˴ γ Ω˴ ϧ˴ γ˴ sanad (sanada¯t) Bond(s) ϑέ˸ λ˴ sarfʋ Currency exchange ϡϭ˸ λ˴ sawmʋ Fasting ΓΩΎ˴ Ϭ˴ η˴ shaha¯dah Testimony, certification ϥΣ˸ η˴ shahnʋ Shipping Δϛ˴ έ˴ η˴ shara¯kah Partnership
Δόϳ˴ έ˶ η˴ shari‘ah Islamic law ΕΎϛ˴ έ˶ η Δ˴ ϛ˴ έ˶ η˴ sharikah (sharika¯t) Company(ies), enterprise(s), partnership(s) Ωϭ˵ϘϋΔ˵ ϛ˴ έ˶ η˴ sharikat ‘uquˉd Contractual partnership ϥΩ˴ ΑΔ˸ ϛ˴ έ˶ η˴ sharikat abda¯n A partnership company based on the skills of professionals working together and sharing the proceeds ϝϭϣ˸ ˴Δϛ˴ έ˶ η˴ sharikat amwa¯l Financial partnership ϥΎϧ˴ ϋΔ˶ ϛ˴ έ˶ η˴ sharikat ޏina¯n Limited liability partnership ϙϠ˸ ϣΔ˶ ϛ˴ έ˶ η˴ sharikat milk Joint property partnership Δο˴ ϭΎ˴ ϔ˴ ϣΔ˵ ϛ˴ έ˶ η˴ sharikat mufawadah Unlimited liability partnership ϊΎ˶ ϧ˴ λΔ˴ ϛ˴ έ˶ η˴ sharikat sana¯i‘ A partnership company based on the skills of professionals working together and sharing the proceed. Same as sharikat abda¯n.
ϩϭΟ˵ ϭΔ˵ ϛ˴ έ˶ η˴ sharikat wujuˉh A partnership company based on the credibility and creditworthiness of the partners ρέ˸ η˴ shart ʋ Condition Δό˴ ϔ˸ η˵ shuf‘ah Right of preemption ̵Ի έ˴ ϭ˸ η˵ shuˉrá Consultation GLOBAL REPORT ON ISLAMIC FINANCE GLOSSARY xxv
Arabic original word Transliterated as English meanings έΎγ˴ ϣ˸ γ˶ simsa¯r Middleman, broker ΔΟ˴ Η˴ ϔ˸ γ˵ suftajah Bill of exchange ϙϭ˸ ϛ˵ λ˵ sukuˉk Equity-based certificates of investment Δϧ͉ γ˵ sunnah Tradition of the prophet mohammed Γέ˴ ϭ˸ γ˵ suˉrah Qur’anic chapter ϝϣΎ˵ ό˴ Η˴ ta‘a¯mul Dealing ϥϭΎ˵ ό˴ Η˴ ta‘a¯wun Cooperation ϲϧ˶ ϭΎ˵ ό˴ Η˴ ta‘awuni A principle of mutual assistance ΕΎϋ˴ έ͊ Α˴ Η ω˴ έ͊ Α˴ Η˴ tabarru‘ (tabarru‘a¯t) Donation(s), gift(s), charity(ies) έϳ˸ Ϋ˶ Α˸ Η˴ tabdhƯr Wastage ϝϭ˵ Ω˴ Η˴ tada¯wul Circulation νϳϭ˶ ϔ˸ Η˴ tafwƯd Authorization ρϭ͊ Σ˴ Η˴ tahawwutʋ ʋ Hedging ΕΎϧϳ˴ γ˶ Σ˸ Η˴ tahsina¯t Luxuries ϝ˵ϓΎϛ˴ Η˴ taka¯ful Solidarity, mutual support ϲϧ˶ ϭΎ˵ ό˴ Ηϝ˴ ˵ϓΎϛ˴ Η˴ taka¯ful ta‘awuni Cooperative risk sharing and mutual insurance ϥϳ˸ ϣ΄˶ Η˴ ta’mƯn Insurance ϙϳ˶Ϡϣ˸ Η˴ tamleek Transfer of ownership Ωϳ˶ϠϘ˸ Η˴ taqlƯd Imitation ̵Ի ϭ˴ Ϙ˸ Η˴ taqwá God consciousness ϝϛ͊ ϭ˴ Η˴ tawakkul Trust in God ϕέ͊ ϭ˴ Η˴ tawarruq The process of buying a commodity at a deferred price, in order to sell it in cash at a lower price. Usually, the sale is to a third party, with the aim to obtain cash. This is the classical form tawarruq, which is permissible. Organised tawarruq, where the bank plays both the roles of seller and buyer, is not permissible according to the majority of contemporary fuqaha’ (jurists, scholars) ΩϳΣ˶ ϭ˸ Η˴ tawhid Oneness of Allah ΕΎοϳ˴ ϭ˶ ό˸ Η νϳ˴ ϭ˶ ό˸ Η˴ ta‘wƯdʋ (ta’widʋat) Compensation(s) ϥϣ˴ Λ˴ thaman Price Ώϭ˴ Λ˴ thawa¯b Reward ΓέΎ˴ Ο˴ Η˶ tija¯rah Business, commerce, trade Γέ˴ Ο˸ ˵ ujrah Allowance, commission, fee, salary, wage Γϭ͉ Χ˵ ˵ ukhuwah Brotherhood Δϣ͉ ˵ ummah Muslim community Γέ˴ ϣ˸ ϋ˵ ‘umrah Mini-pilgrimage to Makkah that is not compulsory but highly recommended. It can be performed at any time of the year. Δϳ͉ ˶ϗϭ˵ uˉqƯyyah Ounce xxvi GLOSSARY GLOBAL REPORT ON ISLAMIC FINANCE
Arabic original word Transliterated as English meanings ϑέ˸ ϋ˵ ‘urf Custom, common practice έϭη˵ ϋ έ˵ η˸ ϋ˵ ‘ushr (‘ushuˉr) Ten percent of zaka¯t on nonirrigated agricultural produce payable by the Muslim at the time of the harvest ϝϭλ˵ ˵ usuʋˉl Origins ϪϘ˸ ˶ϔϟϝϭ˸ λ˵ ˵ usuʋˉl al-fiqh Islamic legal bases Ωϭϋ˵ ϭ Ω˵ ϋ˴ ϭ˴ wa‘d (wu‘uˉd) Promise(s), undertaking(s) ϊ˶ Ω˴ ϭ Δ˴ όϳ˴ Ω˶ ϭ˴ wadƯ‘ah (wada¯’i‘) Deposit(s) ΏΟ˶ ϭ˴ wajib Obligatory, compulsory, mandatory ΕϻΎ˴ ϛ˴ ϭ Δ˴ ϟΎ˴ ϛ˴ ϭ˴ waka¯lah (waka¯lat) Agency; a contract whereby one party appoints another party to perform a certain task on its behalf, usually for payment of a fee or a commission ˯ϼ˴ ϛ˴ ϭ ϝϳ˵ ϛ˶ ϭ˴ wakil (wukala¯’) Representative(s), agent(s) ϲ˶ϟϭ˴ wali Guardian ϑΎϗ˴ ϭ˸ ˴ ϑϗ˸ ϭ˴ waqf (awqa¯f) Endowment(s), foundation(s), trust(s) Δϳ͉ λ˶ ϭ˴ wasƯʋ yah Will. bequest ϥΎ˶ Α˴ ί ϥϭ˴ Α˵ ί˴ zabuˉn (zaba’in) Customer(s) ΓΎϛ˴ ί˴ zaka¯h, zaka¯t Obligatory contribution or poor due payable by all Muslims having wealth above nisab (threshold or exemption limit) έρ˸ ˶ϔϟ˵ΓΎϛί˴ zaka¯t al-fitrʋ Poll tax payable on every muslim at the end of Ramadan (the month of fasting) ϝΎϣϟ˴ ˵ΓΎϛ˴ ί˴ zaka¯t al-ma¯l An annual levy on the wealth of a Muslim (above a certain level). The rate paid differs according to the type of property owned. ίΎϛ˴ έϟ˶ ˵ΓΎϛ˴ ί˴ zaka¯t al-rika¯z Levy on treasure trove ΓέΎ˴ Ο˴ ΗϟΓΎ˶ ϛ˴ ί˴ zaka¯t al-tija¯rah Levy on business ϡϠ˸ υ˵ zulmʋ Injustice, oppression, exploitation Abbreviations
10-PoA Ten-Year Program of Action IDB Islamic Development Bank 10YF Ten-Year Framework and IDBG Islamic Development Bank Strategies document for the Group development of the Islamic IEI Islamic equity index financial sector IFIs Islamic financial institutions 10-YS 10-Year Strategy (Islamic IFSB Islamic Financial Services Development Bank Group) Board AAOIFI Accounting and Auditing IFSIs Islamic financial services Organization for Islamic institutions Financial Institutions IICRA International Islamic Center for AUM Assets under management Reconciliation and Arbitration BMI Broader Market Index IIFM International Islamic Financial BNM Bank Negara Malaysia (central Markets bank, Malaysia) IIRA International Islamic Rating CAGR Compound annual growth rate Agency CAR Capital adequacy ratio IMF International Monetary Fund CDD Community-driven development IPOs Initial public offerings CIBAFI General Council for Islamic IRTI Islamic Research and Training Banks and Financial Institutions Institute (Islamic Development CSR Corporate social responsibility Bank) EC European Commission ISRA International Shari‘ah Research ETFs Exchange traded funds Academy FTSE Financial Times Stock IT Information technology Exchange KPIs Key Performance Indicators G-20 Group of Twenty MDGs Millennium Development Goals GCC Gulf Cooperation Council MENA Middle East and North Africa GDP Gross domestic product MFI Microfinance institution GEI Government Effectiveness Index MSCI Morgan Stanley Capital GIFR Global Islamic Finance Report International HQLA High Quality Liquid Assets MSE Micro and small enterprises
GLOBAL REPORT ON ISLAMIC FINANCE xxvii xxviii ABBREVIATIONS GLOBAL REPORT ON ISLAMIC FINANCE
MSMEs Micro, small, and medium PCA Prompt Corrective Action enterprises PLS Profit and loss sharing MTR Mid-Term Review of the Ten- PPP Purchasing power parity Year Framework and Strategies PRs Pakistan rupees document RBC Risk-based capital approach NBFIs Nonbank financial institutions REITs Real estate investment trusts NGOs Nongovernmental organizations SAMA Saudi Arabian Monetary NPLs Nonperforming Loans Authority OECD Organisation for Economic SDGs Sustainable Development Co-operation and Development Goals OIC Organisation of Islamic SMEs Small and medium enterprises Cooperation SRI Socially responsible OJK Otoritas Jasa Keuangan investment (Financial Services Authority, UCTs Unconditional cash transfers Indonesia) UN United Nations
All dollar-denominated currency is in U.S. dollars, unless otherwise noted. ContentsOverview
here is broad consensus that the objec- • In the United States, the wealthiest 1 per- Ttive of economic development is not cent has captured 95 percent of growth only to boost economic growth but since 2009, while the bottom 90 percent has also to share prosperity with all segments become poorer (Working for the Few 2014). of society through equitable distribution of income and wealth. The trickle-down There is growing realization that despite approach asserts that higher productivity good intentions, development policies have and industrial advancement lead to higher led to an undesirable imbalance in income gross domestic product (GDP) growth, which and wealth distribution. Given the significant will improve the well-being of all segments evidence of growing inequality, its adverse of the society, including the poorest and effects on economic growth, and its social most marginalized in a country. However, costs, among other wide-ranging negative recent experience has shown that the imme- impacts, there is an ongoing debate as to how diate impact of such a growth-led policy can to minimize extreme inequality and enhance be an undesirable concentration of wealth in shared prosperity. Much has been said about the hands of a few, while the growth benefits the damages of high inequality of income trickle down to the extremely poor only over and wealth to society. It erodes trust, creates a relatively long period of time. Inequality barriers to social mobility for current and increased considerably in the aftermath of future generations, increases social resent- the financial crisis of 2007–08. The serious- ment, undermines effective governance, cre- ness of the problem is highlighted by a few ates a “winner-takes-all” society, and breaks striking facts: down social solidarity. While income and wealth inequality undermines economic per- • Almost half of the world’s wealth is now formance, shared prosperity and economic owned by just 1 percent of the population performance support each other; there is no (Working for the Few 2014). trade-off. • The richest 10 percent of the world’s popula- In this regard, several global agencies, tion holds 86 percent of the world’s wealth, including the United Nations, place an empha- and the top 1 percent alone accounts for 46 sis on inclusive and sustainable development percent of global assets (Credit Suisse 2013). rather than mere economic development.
GLOBAL REPORT ON ISLAMIC FINANCE 1 2 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
The World Bank Group has revised its mis- sharing and entrepreneurship; and financial sion for the first time in 30 years and has and social inclusion for all, thereby promoting included promotion of shared prosperity, one development, growth, and shared prosperity. of the two goals, in addition to reducing the The risk-sharing and asset-based financing number of people living in extreme poverty.1 nature of Islamic finance and its potential Similarly, the new 10-Year Strategy of the contribution to growth and inclusive prosper- Islamic Development Bank Group (IDBG) ity have considerable merit, particularly in (2016–25) also aims at promoting inclusive light of the mounting evidence of the negative and sustainable socioeconomic development effects of debt and leverage on the economy. among member-countries by providing a For example, two recent seminal works by leadership role in promoting Islamic finance Mian and Sufi (2014) and Turner (2015) doc- globally. ument the strong relationship of household Although the development community’s leverage to financial crisis and instability, and concern about growing inequality and the their adverse effects on economic growth. imbalance in distribution of wealth has led to a Islamic finance, through its core principles, realization that equitable sharing of prosperity advocates for the just, fair, and equitable dis- is essential, there is a difference of opinion as tribution of income and wealth during the to the approaches to achieve this goal. Islamic production cycle and provides mechanisms economics and finance provide an alternative for redistribution to address any imbalances perspective and solution to the development that may occur. Islamic finance’s approach to challenges mentioned. Given the potential redistribution is based on a balanced blend of role of Islamic finance in economic devel- income-based redistribution through redis- opment, the World Bank Group and IDBG tributive instruments and asset-based redis- decided to focus on the topic of “Islamic tribution through the notion of risk sharing Finance and Shared Prosperity” as the general (dispersion of ownership). The income-based theme for the inaugural edition of the Global redistribution approach offers only a partial Report on Islamic Finance (GRIF). This solution because it takes the current income Report has three main objectives: distribution as given and aims at fairer dis- tribution of future GDP. By contrast, asset- • To develop understanding of the theo- based redistribution is basically a risk-sharing retical foundation of Islamic finance and approach; it empowers equity participation shared prosperity by the lower-income groups in the society. • To review recent development and trends Rewards are shared, but so is risk. Making in various sectors of Islamic finance, such the poor direct holders of real assets in the as banking, capital markets, and social real sector of the economy reduces their aver- finance sion to risk. It also creates positive incentives • To identify policy interventions and tools for behavioral factors that enhance produc- for policy makers to leverage Islamic tivity (such as trust, truthfulness, and hard finance to eradicate extreme poverty and work) through the design of contracts that ensure equitable distribution of wealth. reduce or eliminate the difference between principals and agents and are conducive to The Report develops a theoretical frame- the advancement of the interests of all parties work to analyze the progress of Islamic eco- to a contract (Mirakhor 2015). nomics and finance based on four fundamen- Islamic finance is very relevant to the Sus- tal pillars: an institutional framework and tainable Development Goals (SDGs)—the public policy oriented to the objectives of sus- global development agenda for 2015–30— tainable development and shared prosperity which require unprecedented mobilization of in line with the broader objectives of Islam; resources to support their implementation. prudent governance and accountable leader- Because of the transformative and sustain- ship; promotion of an economy based on risk able nature of the new development agenda, GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 3
all possible resources must be mobilized if the decades, accumulating nearly US$1.9 trillion world is to succeed in meeting its targets. Given in assets and spreading across 50 Muslim and the principles of Islamic finance that support non-Muslim countries around the world. socially inclusive and development-promoting Financial intermediation through risk- activities, the Islamic financial sector has the sharing contracts, as well as financial inclu- potential to contribute to the achievement of sion by Islamic banks, could contribute to the SDGs. Particularly in member-countries shared prosperity—provided that Islamic of the Organisation of Islamic Cooperation banks pursue risk-sharing intermedia- (OIC)—where policy makers are challenged tion and increase the allocation of credit to with high levels of inequality and highly the micro, small, and medium enterprise indebted households, firms, and sovereigns— (MSME) sector. Islamic banking is not typi- a solution provided by Islamic finance could cal conventional banking; rather, it is a mode lead to sustainable development and enhanced of financial intermediation offering bank- shared prosperity. Mobilization of Islamic ing and asset management services. Current financial institutions, capital markets, and practices are restraining its full potential the social sector in promoting strong growth, because of attempts to replicate conventional enhanced financial inclusion and intermedia- banking. tion; reducing risks and vulnerability of the To live up to the ideals of Islamic finance, poor; and more broadly contributing to finan- Islamic banks face many challenges, rang- cial stability and development will be pivotal ing from the gap between the prevalence of in achieving the SDGs in countries with a seri- debt-based instruments and the aspirations of ous commitment to Islamic finance. financing predominantly through equity and Despite encouraging developments and a risk sharing, to the need for increased social rich theoretical foundation, there are a num- capital, and to the challenges of creating an ber of aspects where policy interventions enabling regulatory framework. To contrib- or improvements in policy effectiveness are ute to shared prosperity, the Islamic bank- needed to develop Islamic finance to boost ing sector should focus on six key areas of shared prosperity. These include enhanc- improvement and adopt best practices. These ing the harmonization, implementation, and include the following: enforcement of regulations; creating institu- tions that provide credit and other informa- 1. Creating an enabling regulatory environ- tion, which in turn support the provision of ment by supporting consistent regulations, equity-based finance, particularly to small ensuring consistent implementation of the and medium enterprises (SMEs) and microen- Basel III and Islamic Financial Services terprises; development of capital markets and Board (IFSB) frameworks, ensuring that suknjk (Islamic bond) products to help finance systemic risks in dual banking systems large infrastructure projects; and regulatory (conventional and Islamic) are addressed, recognition of products from other jurisdic- and implementing cross-border supervision tions to expand the markets through cross- 2. Introducing innovative risk-sharing prod- border transactions. ucts and services, rather than replicating To overcome challenges and to realize the conventional risk-transfer products full potential of Islamic finance, a serious and 3. Harmonizing shari‘ah governance through concerted effort by stakeholders is required. efforts to unify cross-country shari‘ah rul- A summary of findings of the Report follows. ings about Islamic finance, which would help accelerate the growth of the industry Going Beyond Banking 4. Enhancing the scale of and access to Islamic finance to include low-income earners The Islamic banking sector is the dominant 5. Improving liquidity and ensuring stability component of the Islamic finance industry. 6. Bolstering human capital and literacy in It has grown exponentially in the past two Islamic finance. 4 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
Developing Vibrant Capital Markets currently underdeveloped and underutilized in Islamic finance and therefore should be Capital markets through equity- and asset- given priority by policy makers. based finance could play a critical role in A good place to start is with Islamic reducing poverty by providing opportunities insurance. In addition to providing protec- for the poor to build assets. Islamic capital tion against risk and uncertainty, takƗful markets are relatively young, but they are the could play a critical role in enhancing finan- second largest segment of the Islamic finance cial inclusion, reducing poverty, achiev- sector after banking. The suknjk market has ing inclusive economic growth, and boost- grown considerably over the last decade. ing shared prosperity. TakƗful can provide Suknjk offer great potential for promoting important benefits to households and firms. shared prosperity because of their suitability Greater access to financial services for for financing infrastructure, raising funds both households and firms may help reduce for new businesses, encouraging entrepre- income inequality and accelerate economic neurship, and supporting economic develop- growth. Protection against unexpected ment. Unlike other asset classes, suknjk offer shocks to income and enhanced productiv- a hybrid profile between pure equity and ity through better health for the poor and debt, and are thus attractive to a wide range vulnerable segments of society through of investors and finance seekers, again with a microtakƗful could become effective tools positive potential for shared prosperity. for combating poverty. With the growth of Development of vibrant capital markets is Islamic microfinance, especially in member- the essential ingredient for Islamic finance. countries of the OIC, there is a need to There is the need for incentives to encourage develop the microtakƗful industry to pro- risk sharing, particularly through the devel- vide protection against uncertain events and opment of markets for equity trading. This loss of income. is hindered by the perverse tax treatment To attain a robust Islamic NBFI sec- that classifies interest as a tax- deductible tor that will promote inclusive economic expense. In order to create a level playing development and shared prosperity, certain field for debt and equity, there is a need to requirements must be met, including support- eliminate the tax shelter on interest pay- ive institutions and public policy, responsible ments. Tax neutrality for suknjk issuers and governance and leadership, promotion of risk investors could further boost the market. sharing and entrepreneurship, and a sound The use of suknjk by governments and gov- regulatory and supervisory framework. Seri- ernmental agencies to mobilize financing is ous supply- and demand-side and legal chal- essential to develop a long-term yield curve lenges must be overcome. Increasing the num- and to develop a corporate suknjk market, ber and diversity of Islamic NBFIs, together as well as to promote transparency and effi- with increasing the range of products offered ciency of asset pricing. to various segments, are two major chal- Promoting the Nonbank Financial lenges on the supply side. On the demand Institutions Sector side, low levels of financial literacy about the products and services offered by Islamic International financial systems are realizing NBFIs; cultural, social, and physical barri- the growing importance of nonbank finan- ers; insufficient consumer protection prac- cial institutions (NBFIs)—such as housing tices; and reputation- and credibility-related finance, leasing, and asset management— challenges are the biggest obstacles hinder- and especially their potential contribution ing further improvement of Islamic NBFIs. to economic development. The risk-sharing A balanced and enabling regulatory and and asset-backed nature of Islamic finance taxation framework that also fosters cross- products is more suitable for providing finan- border investments in the Islamic NBFI sec- cial services through NBFIs. This sector is tor is also needed. GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 5
Alleviating Poverty and Sharing play the role of a catalyst. Despite recent Prosperity through Islamic Social encouraging developments and the growth of Finance Islamic finance, there are a number of areas in which policy interventions or improve- Islamic social finance advocating a sharing ments in policy effectiveness are needed to economy and promoting redistribution could further develop Islamic finance and boost play a significant role in helping achieve shared prosperity. Lower-income countries the twin development objectives of end- are lagging behind higher-income countries ing extreme poverty globally by 2030 and in terms of developing Islamic finance to promoting shared prosperity by raising the enhance shared prosperity. The significance incomes of the bottom 40 percent of the pop- of timely and effective policy cannot be ulation. The institutions and instruments of overemphasized. Islamic social finance are rooted in redistri- This Report identifies areas in different bution and philanthropy. Such interventions, sectors that could guide policy makers in involving qarG ̙ hasan̙ , zaka¯ t, and sadaq̙ Ɨt,2 formulating policy interventions to meet the can potentially address the basic needs of the objective of leveraging Islamic finance to alle- extremely poor and the destitute and create viate poverty and enhance shared prosperity. a social safety net. The instrument of awqƗf These include enhancing implementation and (Islamic endowments or trusts) is ideal for enforcement of regulations; creating institu- the creation and preservation of assets that tions that provide credit and information that can ensure a flow of resources to support in turn support the provision of equity-based the provision of education, health care, and finance, particularly to SMEs and microenter- other social goods. These Islamic institu- prises; developing capital markets and suknjk tions can play a critical role in the realization products to help finance large infrastructure of the global vision of generating sufficient projects; harmonizing regulations; and using income-earning opportunities; investing in regulation to recognize products from other people’s development prospects by improv- jurisdictions to expand the markets through ing the coverage and quality of education, cross-border transactions. health, and sanitation; and protecting the The process of identifying policy interven- poor and vulnerable against sudden risks tions and areas to focus on has been going on of unemployment, hunger, illness, drought, for more than a decade. Notably, the IDBG and other calamities. These measures would and IFSB jointly prepared a Ten-Year Frame- greatly boost shared prosperity, improving work and Strategies document and Mid-Term the welfare of the least well-off. Review (MTR). These and other initiatives The role of Islamic social finance has great emphasize incorporating the use of Islamic significance in countries with high levels of finance in national development plans, as exclusion and deprivation. This Report esti- well as building master plans to develop the mates that for most countries in South and Islamic finance sector domestically. Recently, Southeast Asia and Sub-Saharan Africa, the the Group of Twenty (G-20) has made similar resource needs to alleviate deprivation could recommendations to better integrate Islamic be met adequately if the potential of institu- finance with global financial systems. This tions of zakƗt and waqf were realized, even if Report identifies additional areas for policy only in part. recommendations. Table O.1 summarizes recommendations Public Policy Interventions and policy measures for each sector with In an environment of constrained sources of respect to each pillar of the development development financing, timely public policy framework for Islamic finance discussed in this interventions are the need of the hour. Islamic Report. Without the right enabling environ- finance, with its rich theoretical promise to ment, Islamic finance may not be able to attain fight poverty and enhance prosperity, could the potential expected from it. However, with 6
TABLE O.1 Recommendations and Policy Interventions by Sector Institutional framework Governance and Risk sharing and entrepreneurship Financial and social inclusion and public policy leadership Banking • Create an enabling regulatory • Harmonize shari‘ah • Introduce innovative risk-sharing • Enhance the scale and environment by supporting consistent governance through efforts to unify products and services, rather than access to Islamic finance regulations and ensuring consistent cross-country shari‘ah rulings about replicate conventional risk-transfer to include low-income implementation of the Basel III and Islamic finance. products. earners. Islamic Financial Services Board • Bolster human capital. (IFSB) framework. • Increase Islamic finance • Ensure that systemic risks in dual literacy. banking systems (conventional and Islamic) are addressed. • Implement cross-border supervision. • Improve liquidity. • Ensure stability. Capital markets • Create a level playing field for debt • Incorporate higher ethical standards • Encourage investment in equities, • Introduce retail suku¯k for and equity instruments by through transparent governance which is the purest form of risk sharing smaller investors 0 Eliminating the tax shelter mechanisms and a robust regulatory that not only distributes wealth more • Relax the condition for on interest expense, framework. equitably but also creates more jobs listing of companies in 0 Allowing tax-free transfer of assets • Improve shari’ah governance: and enhances shared prosperity. order to provide a larger in asset-backed suku¯k—or at least 0 Align shari’ah screening standards • Improve the scalability and liquidity universe of equities for treating the transfer fee as a tax- for equities across jurisdictions. of suku¯k by providing an enabling investment. deductible expense. 0 Publish shari’ah screening environment for trading suku¯k in standards, and list compliant secondary markets. equities for the convenience of • Provide incentives for issuing long- investors on a periodic basis. term suku¯k based on more equity-like • Provide disclosures relevant to shari’ah structures such as muda¯rabah̙ and compliance, especially events that may musha¯rakah. trigger noncompliance in the regular reporting of firms. • Strengthen resolution frameworks and investor protection mechanisms. table continues next page
TABLE O.1 Recommendations and Policy Interventions by Sector (continued) Institutional framework Governance and and public policy leadership Risk sharing and entrepreneurship Financial and social inclusion Taka¯ ful • Adopt a holistic approach while • Establish clear and transparent • Introduce taka¯ful and microtaka¯ful as a • Allow participants to use formulating the policy guidelines corporate governance and regulatory mode for pooling risk and assets. microtaka¯ful for savings for the industry that takes into framework for formal as well as • The long-term shari‘ah-compliant and investment. consideration both the industry and informal taka¯ful operations. investment from the savings and • Allow microtaka¯ful for consumers in a shari’ah-compliant • Regulate the taka¯ful industry based on investments in taka¯ful funds can family, health, crops, manner. its risk characteristics. A risk-based be a critical source for economic livestock, and property • Design policies that balance the approach may be desirable; however, development. based on the cooperative protections for participants’ rights this should take into consideration • Encourage investment in capital (waka¯lah-partner) model. with the need for effective pricing, the difference between conventional market instruments. greater solvency, operators’ financial insurance and taka¯ful. sustainability, good business conduct, • Set requirements for solvency purposes and relevant disclosures. on the investment activities of taka¯ful • To avoid confusion among Muslims, a in order to address the risks faced by board consisting of shari‘ah scholars the operators. at the national level may provide guidance as to how to implement taka¯ful. • Expand investment through the Islamic capital market to provide flexibility in the implementation of the risk-based capital regime. table continues next page
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TABLE O.1 Recommendations and Policy Interventions by Sector (continued) Institutional framework Governance and and public policy leadership Risk sharing and entrepreneurship Financial and social inclusion Nonbank • Develop policies that require strong • Develop legal infrastructure to support • Enhance diversification by directing • Increase the number and financial investor protection and stringent contract enforcement—a prerequisite more financing to small and medium diversity of Islamic NBFIs. institutions disclosure requirements as far as the for the development of the financial enterprises relative to larger firms. • Encourage Islamic NBFIs (NBFIs) investment is concerned. sector, as it not only reduces • Develop skills and alternative to provide Islamic financial • Ensure that the products and transaction costs but also enhances approaches to mitigate risks (moral services in countries where activities of NBFIs comply with investor confidence. hazard) through proper monitoring and establishing Islamic banks shari‘ah. • Clearly define regulatory requirements evaluation. is not possible because such as licensing, disclosure, and of legal and regulatory corporate governance. restrictions.
Islamic social • Recognize the diversity in zaka¯t • Create a network of supporting • Mitigate and absorb high risks • Recognize self-exclusion finance management practices across the infrastructure institutions, including with financing to the poor through as a key problem resulting globe and create an adequately research, training, and advocacy for mechanisms rooted in philanthropy and from religious, cultural, and flexible and enabling regulatory the sound and orderly function of benevolence. ethical beliefs of the poor. environment. Islamic social finance institutions. • Make innovative use of zaka¯t and • Enhance social and human • Introduce/reform the waqf regulatory • Develop a sound governance system waqf to create risk management tools capital through community framework in order to establish waqf that recognizes the significance of (credit enhancement/guarantees and empowerment initiatives as an institution in the voluntary trust and credibility as key drivers microtaka¯ful). funded through the sector. underlying Islamic social finance. sustainable Islamic social • Recognize Islamic social finance • Harmonize the financial reporting of funding instrument. as sustainable means of absorbing Islamic social finance institutions to operational costs and providing enhance transparency. “affordable” financing to the poor. GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 9
adequate policy interventions and an enabling The third pillar is the distribution chan- financial infrastructure, Islamic finance could nel; it works at both the individual and orga- become a catalyst for alleviating poverty and nizational level. One of the central features promoting inclusive prosperity. is the advocacy of risk sharing and promo- tion of entrepreneurship. This is one of the Brief Overview of Chapters most important aspects of Islamic finance, which differentiates it from the conventional Chapter 1 lays the theoretical framework of approach of overreliance on debt-dominated the role of Islamic economics and finance in instruments that shift or transfer risk. Shar- promoting development, growth, and shared ing the risks of economic and financial trans- prosperity. This framework is based on four actions also ensures the stability of the finan- fundamental pillars: an institutional frame- cial system. In addition, risk sharing with work and public policy oriented to the objec- equitable sharing mechanisms encourages tives of sustainable development and shared entrepreneurship and innovation because prosperity in line with the broader objectives counterparties receive their fair share in the of Islam; prudent governance and account- investment. This in turn will increase the allo- able leadership; promotion of an economy cation of resources to the real sector, rather based on risk sharing and entrepreneurship; than channeling excessive financial flows to and financial and social inclusion for all. the financial sector, leading to overfinancial- The first pillar is crucial because having a ization of economy. sound institutional framework and appropri- An important component of risk shar- ate public policies are the foundation upon ing in Islamic economics is risk sharing which the other pillars must rest and can func- through Islamic instruments of redistribu- tion optimally. Institutions play a critical role tion. Without this channel, certain segments in this framework, as they implement the rules of the society could easily be left out of the prescribed by the tenets of Islam. The institu- system, which would marginalize them and tions also adhere to the core objectives of Islam decrease the full productive potential and (commonly known as maqƗsid al-sharƯ‘ah, or social harmony of society. This redistribution Objectives of Shari‘ah) that lay the foundation of income and wealth is not charity; rather, to formulate the policies promoting economic it is an endowment that would enable them and social justice, preservation of human to conduct their lives honorably and have an rights, dignity, health, and the intergenera- equal opportunity to contribute productively tional wealth of the society. to society. The second pillar focuses on developing The fourth pillar aims to ensure that the a governance mechanism and accompanying fruits of higher growth are distributed to compliance system based on the objectives every segment of the society inclusively, either and institutions prescribed by the first pil- through participation in the economic growth lar. The ethically based governance, leader- or through Islam’s instruments of redistribu- ship, and compliance system helps increase tion. Since member-countries of the OIC the transparency and accountability in the have predominantly Muslim populations— public, private, and social sector institutions for whom certain methods of conventional of the overall economic system, and hence finance could contradict their faith and thus strengthens trust in the system. Trustworthy exclude them from the financial system— and capable leadership can ensure protec- using a new framework of economic devel- tion of rights of the vulnerable or those who opment and finance could help increase could be vulnerable (as in future generations). financial and social inclusion, which could Increased trust and better governance in facilitate equal opportunity. turn strengthen the institutional framework, Chapter 2 presents a snapshot of the cur- which enables better implementation of better rent state of the extreme poverty and income public policies. disparity globally and compares it with the 10 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
OIC countries. A brief analysis of the histori- countries. The capital market could be a bet- cal trend also is provided in several metrics ter proxy for entrepreneurship. However, with respect to select benchmarks against the stock markets are not established in most framework of economic development devel- lower-middle- and lower-income countries. oped in chapter 1. Finding and discussing the The development of capital markets with root causes of the disparities between OIC wider access to the public under a strong and non-OIC countries is beyond the scope legal and governance framework is desirable of this Report and is left for future research. to promote shared prosperity in countries Extreme poverty has been reduced con- where poverty is still prevalent. In social siderably around the world in the past two and financial inclusion, OIC countries tend decades—although at a slower pace within to borrow less from formal financial insti- the group of OIC countries than globally. tutions, which may indicate self- exclusion OIC countries are very diverse in terms of because of religious reasons. Developing the income group, geography, and culture and Islamic finance sector may enhance financial are tied only by religion. The rate of poverty inclusion. alleviation among the extreme lower-middle- In summary, chapter 2 presents the state income and lower-income countries is higher of affairs with respect to trends in poverty for OIC member-countries than for the non- alleviation and income distribution, which OIC group. Among the regional differences, can be used by policy makers to formulate in Sub-Saharan Africa, OIC countries have policy interventions and to identify areas to exhibited higher poverty reduction than the strengthen, keeping in mind the objective of non-OIC countries in the same region. How- leveraging Islamic finance for alleviating pov- ever, OIC countries have lagged non-OIC erty and enhancing shared prosperity. countries in poverty reduction in East Asia Chapter 3 focuses on the Islamic bank- and South Asia. In income disparity, there ing sector, which is the dominant component is no significant difference between OIC and of the Islamic finance industry, accounting non-OIC countries. In both groups of coun- for more than three-quarters of the indus- tries, the top decile receive the major share of try’s assets. Islamic banking is based on key the income. Islamic principles of prohibiting exploita- To assess the state of shared prosperity, tion, emphasizing ethical standards, promot- various indexes are used as a proxy for each ing moral and social values, and rewarding pillar of shared prosperity, as discussed in enterprise (linking risk and reward). The chapter 1. In the institutional framework and aspiration of Islamic banking is the creation, public policy, the Rule of Law Index score equitable distribution, and circulation of is negative for all groups of countries except wealth in order to promote economic and for the high-income group, clearly highlight- social justice and to satisfy customers’ needs ing the need to strengthen the legal system in for shari‘ah-compliant investments and order to break out of the poverty cycle. The financing opportunities. This wealth creation Government Effectiveness Index indicates a and its fair distribution ensure shared pros- similar trend for governance and leadership; perity. Islamic banking contributes to shared on average, countries from the lower-income prosperity through its effect on economic and lower-middle-income groups trail behind growth, as a provider of capital for economic the high-income group, highlighting the activities, and through the risk-sharing char- importance of governance and leadership in acteristics of its products. enhancing shared prosperity. The key features of risk-sharing contracts, As an admittedly imperfect proxy for and financial inclusion through increased risk sharing, this Report uses the inverse of banking options, contribute to shared pros- the correlation between consumption and perity. Islamic banking can have a posi- income. OIC countries on average have a bet- tive effect on financial intermediation by ter risk-sharing environment than non-OIC the poor, which ultimately should boost the GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 11
mobilization of savings and prosperity. In corporate and sovereign entities. The suknjk addition, Islamic banks have a social respon- market recovered quickly after the global sibility that transcends the maximization of financial crisis and peaked in 2012. Issuance profits. declined somewhat in 2014 and 2015, but it Chapter 4 addresses how capital markets is still considerably higher than its precrisis can contribute to enhancing shared pros- level. Suknjk offer great potential for promot- perity by facilitating long-term financing ing shared prosperity due to their suitability through tradable instruments that enable for financing infrastructure, raising funds for easy market entry and exit. In a pure equity- business, and supporting economic develop- based and risk-sharing framework, Islamic ment. Unlike other asset classes, they offer a capital markets can serve the real sector of hybrid profile between pure equity and debt, economy more effectively in an equitable and and are thus attractive to a wide range of sustainable manner than conventional capital investors and finance seekers, again with a markets. The main requirements to facilitate positive potential for shared prosperity. the development of Islamic capital markets An MTR of the Islamic financial services are similar to those for conventional capital industry jointly prepared by the Islamic markets: notably, protecting property rights, Research and Training Institute (IRTI) of the controlling market manipulation and fraudu- Islamic Development Bank and the IFSB high- lent practices, maintaining fair pricing, and lights some of the major challenges hindering supporting the rule of law. However, there the development of Islamic capital markets. are additional requirements for the sound First is the need for incentives to encourage development of Islamic capital markets— risk sharing, in particular, through the devel- particularly the promotion of risk sharing opment of markets for equity trading. This is and asset-based finance in light of the prohi- hampered by the perverse tax treatment that bition of debt-based finance. classifies interest as a tax-deductible expense. At present, there is no organized stock In order to create a level playing field for debt exchange that is operating in full compliance and equity, there is a need to eliminate the tax with shari‘ah principles. Any investor in the shelter on interest payments. Second, because Islamic equity market invests in the shares of asset-backed suknjk could be more costly to shari‘ah-compliant companies or in a publicly structure than conventional securities, there offered portfolio consisting of these equities is a case for allowing these expenses to be offered through unit trusts, mutual funds, or tax-deductible. In addition, provision should exchange traded funds (ETFs). There are sev- be made for tax exemption on the asset trans- eral prevailing standards for screening equi- ferred in sale-based structures because such ties, including screens offered by major index transfers are a precondition for shari‘ah com- provider companies such as the Financial pliance. The authorities may wish to extend Times Stock Exchange (FTSE), Standard and the favorable treatment of suknjk further by Poor’s (S&P), Dow Jones, and Morgan Stan- exempting investors from income and capital ley Capital International (MSCI). The empiri- gains tax. This could apply where suknjk are cal evidence provided in the Report suggests used to fund specific development projects, that Islamic equity indexes based on the rather than for unspecified government or S&P’s shari‘ah screening standard perform at corporate expenditures. least as well on average as their conventional The MTR highlights the lack of a uniform counterparts—despite lower diversification approach to Islamic capital market regulation due to the exclusion of financial products and governance. It is important for Islamic and stocks backing activities prohibited by capital markets to be seen as incorporating shari‘ah. higher ethical standards through transpar- The suknjk (Islamic bond) market has ent governance mechanisms and robust regu- grown considerably over the last decade. latory frameworks. It would also be helpful Suknjk are now used for financing by for market confidence and perceptions of 12 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
financial product integrity if shari‘ah gov- investment opportunities are lacking in many ernance standards were harmonized. This jurisdictions; thus the operators do not have would facilitate cross-border activities in both adequate venues for long-term and stable primary and secondary markets, and the investments offering desirable risk and return acceptance of contracts across regions and profiles. As a result,tak Ɨful operators lack across schools of thought and markets. The access to adequate portfolio and risk manage- MTR urges the adoption of the shari‘ah stan- ment instruments to adequately match and dards proposed by the Accounting and Audit- hedge their liabilities. Development of Islamic ing Organization for Islamic Financial Insti- capital markets, particularly suknjk, is essen- tutions (AAOIFI) and the IFSB, with shari‘ah tial for further development of the takƗful boards taking full responsibility for the capi- industry. tal market products they approve. Chapter 6 discusses the growing impor- The chapter also cites liquidity constraints tance of NBFIs and highlights the important as an impediment: notably the lack of depth links of the products and services offered in the secondary market in suknjk, reflecting by NBFIs to shared prosperity. The chapter limited issuance and the preference of inves- covers Islamic asset management, housing tors to hold suknjk to maturity rather than finance, and some specialized NBFIs, such trade. Greater pricing transparency and faster as mudƗ̙ rabah (risk-sharing partnerships) settlement procedures are recommended to and ijƗrah (leasing) financing companies. The encourage suknjk trading. Revaluation of the chapter argues that NBFIs in an economy add underlying assets may also be justified for the to the development of a diverse financial sec- resolution of disputes and investor protection. tor that expands the menu of products to bet- A high level of financial literacy is needed by ter serve dynamic needs of the society. those investing and trading in Islamic finan- A diverse financial sector also increases the cial markets, especially with respect to legal stability of the financial system. NBFIs can and shari‘ah safeguards and the nature of the serve as backup institutions that may help risks shared rather than transferred. stabilize the financial sector when negative Chapter 5 focuses on takƗful, the Islamic shocks adversely affect the dominant finan- counterpart of conventional insurance. The cial institutions, notably banks. Moreover, a scheme is similar to a mutual insurance con- well-developed NBFI sector can provide ser- cept, but it complies with Islamic Law and is vices to those segments of the society that are based on concepts of mutual solidarity and not adequately served by the formal banking risk sharing. A group of participants agree sector. In this way, NBFIs have great potential to support one another jointly for the losses to promote shared prosperity more effectively. arising from specified risks. The scheme is Despite the low levels of development in managed on the participants’ behalf by a most of the countries with a high Muslim pop- takƗful operator. The takƗful industry has ulation, Islamic NBFIs have gained momen- two unique characteristics: mutual risk shar- tum since the global financial crisis, espe- ing and shari‘ah compliance. In order to make cially on the asset-management side. Assets it feasible, viable, and accessible to all seg- under management of Islamic funds exceeded ments of the society, there should be a glob- US$60 billion as of 2014, with an average ally acceptable takƗful business model. annual growth of 13.5 percent between 2008 TakƗful, as an infant industry, faces many and 2014. A case can be made to exploit challenges. Sound public policy is needed to the synergies between socially responsible balance protection for participants’ rights investments and suknjk as an alternative tool with the requisite for effective pricing, greater for mobilizing financing that could attract solvency, operators’ financial sustainability, Islamic and socially responsible investors to good business conduct, and relevant dis- make a visible contribution to sustainable closures. One of the major challenges for development. Advocating for the potential of takƗful operators is that shari‘ah-compliant Islamic NBFIs for SMEs, chapter 6 presents a GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 13
case study of novel shari‘ah-compliant crowd- mudƗ̙ rabah and mushƗrakah for alternative funding to demonstrate how Islamic finance investments. can be deployed to enhance SMEs’ access to At the same time, it must be recognized finance. The chapter also includes some high- that those involved in alternative invest- lights and cases on Islamic house financing, ments are typically sophisticated investors mudƗ̙ rabah, and ijƗrah companies that when who do not need protection in the same way properly implemented have the potential as retail investors. Many analysts urge so- to improve financial inclusion in most OIC called “light touch” regulation for alternative developing markets. investments, as this reduces transaction costs, Chapter 7 provides an overview of alter- which ultimately get passed on to the inves- native asset classes in Islamic finance and tors. The European Union and the United explores how this sector could enhance shared Kingdom have relatively liberal directives on prosperity. As alternative investments are a alternative investments. Nevertheless, in the diverse asset class, there are no all-embracing case of Islamic investment, the shari‘ah over- regulations or guidelines that can be applied. sight should not be “light touch”: otherwise Usually alternative investments are under the this might undermine the credibility of the remit of securities or capital market regula- investments for the pious. There would be tors, rather than being the responsibility of reputational risks to the financial institutions central banks. Among OIC countries, the offering such investments and potential repu- Malaysian Securities Commission and the tational damage to the scholars involved in Capital Markets Authority of Saudi Arabia approving the investments. have played leading roles in identifying the Shari‘ah scholars working on Islamic issues that arise with alternative investments. finance need to address the issue of the per- The Kuala Lumpur-based IFSB has not yet missibility of alternative asset classes more issued any standards specifically on alterna- comprehensively. At the international level, tive investments, as it focuses more on Islamic this includes the OIC Islamic Fiqh Academy banking, capital markets, and takƗful, (IFA), which has issued fatƗwá (religious opin- although it has published Guiding Principles ions) on many Islamic financing contracts, but for Islamic Collective Investment Schemes. not specifically on alternative investments. There is clearly a case for more comprehen- The shari‘ah scholars advising securities sive guidance on alternative investments by regulators also have a role to play, although the IFSB, as its membership includes regula- at present only the Securities Commission in tory authorities from the OIC states. Kuala Lumpur has a formal shari‘ah board. It Regulators should at least try to ensure has produced a joint report on Islamic capital that their policies do not inhibit risk sharing markets in collaboration with another Kuala and asset-based financing. These are core Lumpur–based institution, the International principles of Islamic finance that are partic- Shari‘ah Research Academy (ISRA). A similar ularly applicable to investment in alternative joint initiative in the field of Islamic alterna- assets. There is a case for encouraging the tive asset classes would be welcomed by the establishment of nonbank Islamic financial worldwide Islamic finance community. institutions that can serve investors seeking Chapter 8 advocates that Islamic social alternative assets. The IFSB and national finance could play a significant role in help- regulators should take the initiative in pro- ing achieve the twin development objectives viding an enabling environment, specifically of ending extreme poverty globally by 2030 by drafting guidelines that could be applied and promoting shared prosperity by raising to shari‘ah-compliant alternative invest- the incomes of the bottom 40 percent of the ment. They need to consider the incentive population. The institutions and instruments structures for new entrants and the gover- of Islamic social finance are rooted in redis- nance framework that can best promote tribution and philanthropy. Such interven- the use of risk-sharing partnerships such as tion, involving zakƗt and sadaq̙ Ɨt (charity), 14 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
can potentially address the basic needs of the cross-sectoral, well-coordinated, and timely extremely poor and the destitute and create a reforms in financial sector regulations, in social safety net. The chapter reports several legal provisions for new types of institutions, creative experiments using zakƗt and waqf, in contract enforcement, and in tax treat- including creating an interest-free credit pool ment. Such changes lie beyond the capaci- funded with zakƗt and sadaq̙ Ɨt, supporting ties of individual financial institutions; hence community-driven development using zakƗt the role of government and financial sector and sadaq̙ Ɨt funds, creating a guarantee fund regulators and stakeholders is particularly with zakƗt; providing affordable health care important. through corporate waqf, and engineering a Efforts are under way at the national and waqf to provide relief and rehabilitation. supranational levels to develop and enhance Policies are needed to support the efficient the impact of Islamic finance. At the interna- mobilization of Islamic social finance, effi- tional level, various financial infrastructure cient use and management of such resources, institutions are developing standards for and their integration with microfinance to accounting, auditing, governance, shari‘ah make it more inclusive and affordable. At compliance, regulation, and supervision the macro and meso levels, these include for the Islamic financial sector. Multilateral policies to create enabling legal, regulatory, cooperation at the international level helped and fiscal frameworks and to provide a sup- create a Ten-Year Framework and Strategies portive infrastructure. At a micro level, these document for the development of the Islamic include policies to enhance the account- financial sector, which underwent a MTR in ability and transparency of the institutions, 2013. The MTR emphasizes enablement, improve their governance structures, and performance, and reach as three pillars of diversify their product offerings, while trans- strategic importance, and proposed 20 ini- forming the poor into financially literate and tiatives within these three pillars that can more responsible clients. be pursued by individual countries and their Chapter 9 provides a road map for sup- respective regulatory authorities. It is hoped portive public policy, a sound enabling envi- that this undertaking will help coordinate ronment, and conducive financial infrastruc- policies and consolidate efforts to develop ture to support the development of Islamic Islamic finance across countries. Some coun- finance and its effectiveness in delivering the tries have used these recommendations as socioeconomic benefits expected from it. As guides to come up with their own national Islamic finance caters to the needs of real eco- plans to foster the development of Islamic nomic activities and provides financing by finance. taking on the risk of the business or the eco- The issue of development of the Islamic nomic activities it finances, policies to develop financial sector to increase shared prosperity that Islamic financial sector cannot be pur- was also a part of the agenda of the G-20 in sued in isolation from broader public policy 2015. The World Bank and the International concerning economic development, business Monetary Fund (IMF) offered suggestions at promotion, and social advancement. the national and international level to bet- Islamic finance at present is working ter integrate Islamic finance with the global within a system that is heavily biased in favor financial system. At the national level, recom- of debt-based financing. The financial infra- mendations included adapting regulatory and structure, peripheral support institutions, supervisory frameworks to take into account and legal environment are more conducive the industry’s specific features such as risk to debt than other modes of financing. Thus, sharing where deemed appropriate; exploring creating an enabling environment to support means for enhancing the liquidity manage- the proper growth and socially beneficial ment of Islamic banks; adapting tax systems development of the risk-sharing aspect of to avoid placing Islamic finance instruments Islamic finance is important. This entails at a disadvantage; and providing the right GLOBAL REPORT ON ISLAMIC FINANCE OVERVIEW 15
incentives to ease access to asset-based and Islamic finance has been a priority area equity-like financing, particularly for SMEs. in Malaysia for three decades. In 2013, it At the global level, the G-20 calls for system- enacted a comprehensive Financial Services atically incorporating the industry’s features Act to consolidate Islamic financial sector in global standards and guidance and devel- regulations, improve shari‘ah governance, oping accounting and statistics standards, properly differentiate Islamic deposit taking especially for suknjk; granting membership to from investment activities, and provide rel- Islamic finance standard-setters in the con- evant regulations for both. These efforts fos- sultative groups of global standard- setters, ter proper risk sharing between the financial with the view to strengthen the emerging institutions and their clients. cooperation between these institutions; and Pakistan has a strategic plan in place to stepping up the engagement of international develop Islamic finance. It also developed a financial institutions and multilateral devel- National Financial Inclusion Strategy that opment banks in Islamic finance through encompasses many of the areas needed to analytical work, policy advice, and capacity develop Islamic finance. It is one of the few development. countries that has a well-developed regu- Chapter 9 also provides an overview of latory framework for microfinance and a recent policy initiatives undertaken as case microfinance credit information bureau. studies by Indonesia, Malaysia, and Pakistan Pakistan has a system of zakƗt collection to highlight recent developments in, and the and distribution at both the private and enactment and implementation of, policies to public levels. promote shared prosperity. Islamic financial sector development and financial inclusion are Notes integrated within the national development or financial development plans of these three 1. Specifically, the goals are to end extreme countries. Strengthening shari‘ah governance, poverty globally by 2030 and to promote shared prosperity by raising the incomes of improving the alignment of the national-level the bottom 40 percent of the population. banking regulations with the principles issued See “Ending Poverty and Sharing Prosper- by international Islamic financial infrastruc- ity,” http://www.worldbank.org/content/dam ture institutions, and establishing diversified /Worldbank/gmr /gmr2014/GMR_2014_Full financial institutions have become explicit _Report.pdf. parts of their agenda. Similarly, financial 2. Qard̙ h̙asan is a voluntary loan, without any inclusion, its promotion by integrating zakƗt expectation by the creditor of any return on and awqƗf, and fostering the financing of the principal. ZakƗt are obligatory contri- a wider set of economic sectors are gaining butions to the poor and marginalized, pay- policy importance. able by all Muslims having wealth above In an effort to align Islamic financial sec- a certain threshold. S̙adaqƗt are recom- tor development with its long-term economic mended contributions to the less privileged or less able. development plan, Indonesia has issued a road map for Islamic banking development, a road map for Islamic capital market develop- References ment, and a road map for sustainable finance. Credit Suisse. 2013. Global Wealth Report 2013. These are targets for improving the resilience Zurich: Credit Suisse. and competitiveness of the Islamic financial Mian, Atif, and Amir Sufi. 2014. House of Debt, sector, promoting economic growth and well- How They (and You) Caused the Great Recession, being, and supporting the national commit- and How We Can Prevent It from Happening ment to environmental protection. Indonesia Again. Chicago, IL: University of Chicago Press. is also working toward integrating the collec- Mirakhor, Abbas. 2015. “Risk Sharing and tion and distribution of zaka¯ t into its finan- Shared Prosperity.” Paper presented at the cial system. inaugural World Bank–Islamic Development 16 OVERVIEW GLOBAL REPORT ON ISLAMIC FINANCE
Bank Guidance Financial Symposium on Working for the Few. 2014. “Political Capture and Islamic Finance and Shared Prosperity, Istan- Economic Inequality.” Oxfam Briefing Paper 178, bul, September 8–9. Oxfam GB for Oxfam International, Oxford, Turner, Adair. 2015. Between Debt and the Devil: U.K. https://www.oxfam.org/sites/www.oxfam Money, Credit, and Fixing Global Finance. .org/files/bp-working-for-few-political-capture Princeton, NJ: Princeton University Press. -economic-inequality-200114-summ-en.pdf. 1 Islamic Finance and Shared Prosperity
here is broad consensus that the objec- Rising inequality and ways to cope with Ttive of economic development is not this growing problem top the agenda of mul- only to boost economic growth but tilateral development institutions and the pol- also to share prosperity with all segments of icy makers in both developed and developing society through the equitable distribution of countries. International organizations such as income and wealth. In recent decades, policy Organisation for Economic Co-operation and makers—including multilateral develop- Development (OECD) and the International ment organizations such as the World Bank Monetary Fund (IMF) and multilateral devel- opment institutions including the World Bank Group—have often applied a “trickle-down” Group have repeatedly warned about the dire approach to reduce levels of absolute poverty. consequences of the increasing gap between This approach asserts that higher productiv- the incomes of the very rich and the very poor. ity and industrial advancement lead to higher Professor Thomas Piketty’s influential 2013 gross domestic product (GDP) growth in a book, Capital in the Twenty-First Century, country. However, the immediate impact of highlighted the inequality in 20 countries dur- such a growth-led policy could be an undesir- ing the past three centuries. The drastic deterio- able concentration of wealth in the hands of a ration in the distribution of wealth and income few, while the growth benefits trickle down to between the very rich and the very poor in the the extremely poor only over a relatively long world is highlighted by a few striking facts: period of time. This approach has resulted • Almost half the world’s wealth is now in only partial success at the cost of social owned by just 1 percent of the population disequilibrium. (Working for the Few 2014).
GLOBAL REPORT ON ISLAMIC FINANCE 17 18 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
• The richest 10 percent of the population main reasons behind the 2007–08 hold 86 percent of the world’s wealth, global financial crisis. Rajan’s thesis is and the top 1 percent alone account for that the declining share of low-income 46 percent of global assets (Credit Suisse households was compensated by ever- 2013). expanding credit facilities, which in • In the United States, the wealthiest 1 turn increased fragilities in the eco- percent has captured 95 percent of growth nomic system through high leverage since 2009, following the financial crisis, ratios, creating systemic risk. while the bottom 90 percent became • A 2013 study of Asia (Egawa 2013) finds poorer (Working for the Few 2014). that the middle-income trap problem can be alleviated by creating a more equal Income distribution is worsening around distribution of income. the world, leading to widening inequality.1 Recent research on inequality and growth has The economists’ perception that there provided strong evidence that inequality has is always a trade-off between growth and damaging effects not only on economic devel- inequality and their notion that redistribu- opment and growth but also on social mobil- tive policies are necessarily not conducive to ity and the social contract,2 as follows: growth are both gradually changing (Ostry, Berg, and Tsangarides 2014). In the context • An extensive literature review in a 2012 of finance, the recent literature also empha- report by the European Commission (EC) sizes how inequality intensifies leverage, pro- finds that high inequality has adverse duces financial cycles, and precipitates a crisis effects on household well-being, criminal- (Rajan 2012). A host of political- economic ity, health, social capital, education, politi- factors also comes into play through the cal participation, and female labor market power of the richer few (Stiglitz 2012). Against participation. the backdrop of growing inequality and more • The same report (EC 2012) notes that refined understanding of its harmful effects, according to human capital accumulation this chapter focuses on an alternative perspec- theory, in imperfect financial markets, an tive that could assist countries in reaching the agent’s ability to invest is determined by goals of reducing poverty and promoting his or her own wealth. Hence a highly shared prosperity. We should emphasize that unequal income distribution would block the perspective presented in this chapter is not agents with insufficient funds from con- intended to substitute for but to augment the tributing to economic growth. World Bank Group perspective. • Considering all the negative externalities of income distribution, a 2014 report for the OECD (Cingano 2014) concludes that Reducing Extreme Poverty unequal distribution of income slows eco- In 2000, United Nations member-countries nomic growth. Enhancing the income of unanimously agreed on achieving eight devel- the lowest 10 percent of the population is opment goals, commonly known as especially needed to increase economic Millennium Development Goals (MDGs), by growth.3 2015.5 Several international and multilateral • A 2010 study for the IMF (Kumhof and development organizations, including the Rancière 2010) shows that the precrisis World Bank, IMF, and Islamic Development periods of 1920–29 and 1983–2008 were Bank (IDB), have pledged to help achieve both characterized by a large increase in these eight development goals. Progress has the income share of the rich and a large been made in several MDG goals, such as increase in leverage.4 reducing extreme poverty, narrowing dispari- • The influential book Fault Lines (Rajan ties of primary school participation between 2012) argues that rising income inequal- girls and boys, and decreasing tuberculosis ity in the United States was one of the and malaria (UN 2014). GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 19
Under a new initiative that followed the maintain the growth rates they have achieved MDGs, the Sustainable Development Goals since the late 1990s (figure 1.1). (SDGs), a new goal to reduce the number of The recent decrease in global poverty was people living on less than $1.25 a day to 3 per- mainly the result of rapid growth in China. cent globally by 2030 follows the success of As China’s growth rate starts to slow down, the MDG. Set in 2000 to be achieved by 2015, reducing poverty will be more complex the goal of reducing the percentage of people (Narayan and others 2013). Even if develop- living on less than $1.25 a day by half was ing countries achieve the high growth rates of reached ahead of its target in 2010. By 2011, the past decade, the benefits of high growth the share of the worldwide population living may not be evenly distributed to different on less than $1.25 a day had decreased from income groups in the society. In addition to 43 percent in 1990 to 17 percent (table 1.1). maintaining high growth rates, low-income The share has declined in every region. countries urgently need to implement institu- Reaching the target of reducing the tional and governance reforms that enhance extreme poverty level to 3 percent by 2030 is the accountability of the State, raise the qual- not impossible, but it is certainly very ambi- ity of service delivery, and improve the over- tious. It requires developing countries to all economic and social environment.
TABLE 1.1 Percentage of Population Living below $1.25 a Day, 1981–2011 Region 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 East Asia and Pacific 77.95 65.63 54.27 57.01 51.66 38.27 35.89 27.34 16.56 13.72 7.93 Europe and Central Asia 2.92 2.31 1.88 1.54 2.87 4.28 3.83 2.13 1.26 0.49 0.49 Latin America and the Caribbean 11.66 13.38 12.47 12.63 11.14 10.57 10.95 10.22 7.35 5.37 4.63 Middle East and North Africa 8.85 6.62 7.24 5.77 5.33 4.78 4.79 3.83 2.99 2.05 1.69 South Asia 61.35 57.73 56.85 54.09 52.07 48.55 44.96 44.10 39.28 34.05 24.50 Sub-Saharan Africa 52.81 56.29 55.81 56.78 60.84 59.75 59.40 57.18 52.86 49.65 46.85 World total 52.71 47.53 42.98 43.44 41.56 35.87 34.24 30.62 24.77 21.85 16.99 Source: http://iresearch.worldbank.org/PovcalNet/index.htm?4. Note: Data are in 2005 U.S. dollars in purchasing power parity terms.
FIGURE 1.1 GDP Growth Reduces Poverty
10
Romania
Zambia Burkina Faso Indonesia Senegal Bolivia Brazil Bangladesh Ghana Tunisia India Uganda in poverty head count
Annual percentage change El Salvador Vietnam –10 –4 0 8 GDP growth
Source: AFD and others 2005. Note: The downward sloping line (the decrease in poverty relative to the increase in growth) represents the best fit of the data of countries in the sample. 20 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
Complementing Poverty Reduction with incentive structure that improves productiv- Shared Prosperity ity by better aligning the interests of prin- There are various approaches designed to ciples and agents in such a way that avoids moral hazard and other informational prob- deal with inequality. Those approaches fall 6 into two main categories: those dealing with lems. The intention is not only to include income-based distribution and those dealing the excluded in the financial system, but with asset-based distribution. also to empower them to become asset and Income-based distribution approaches wealth builders, thus effectively addressing take the current income distribution as the dual problems of poverty and inequality given and aim at fairer distribution of future simultaneously. GDP. Within this approach, there are “soft” Given the strong evidence of the negative and “hard” redistribution proposals. The impact of inequality on economic growth, World Bank Group’s proposal is considered the social and economic costs associated with a soft solution, as it requires no immedi- inequality, and the risks high inequality poses ate redistribution. It does recommend that to any economic system, it is difficult to argue member-countries consider a new social that inequality in a society can be ignored. contract, labor and gender empowerment, Inequality in a society not only damages the and institutional reforms, and that they growth prospects of a country but also cre- redirect public expenditures. ates social unrest and has negative effects on Almost all income-based redistribution mobility between different income groups. proposals require a new social contract. No country has managed to escape from the Nobel Prize winner and former World Bank middle-income trap while maintaining high Chief Economist Joseph Stiglitz (2014) levels of inequality. Hence, shared prosper- argues that without a new social contract, ity could be instrumental both in decreasing the problem of inequality will remain intrac- extreme poverty and in increasing average table. He proposes rewriting the rules of the growth rates of countries (Ostry, Berg, and game (40 different rules) in economic and Tsangarides 2014). financial areas. This approach presents a The shared prosperity indicator (figure 1.2) serious challenge in terms of political accept- focuses directly on the income of the less well- ability and viability because existing rules, off, rather than focusing only on growth rates of Stiglitz argues, are put in place for the ben- GDP per capita. Shared prosperity is not a sim- efit of the “haves” who control the legislative ple redistributive policy where wealth is taken and enforcement power of the State. His pro- from the rich and given to the poor. Instead, posals, like those of Thomas Piketty—high- shared prosperity aims not only to increase income taxes, property taxes, and inheritance the economic resources of the countries, but taxes—are considered “hard” redistribution also to maximize the share of those continu- precisely because they entail such difficult ously increasing resources going to the bottom political, economic, and social challenges. 40 percent of the income distribution. Hence The second approach is asset-based redis- shared prosperity mainly relies on enforcing a tribution. The approach is explained best in social contract where all agents in society have Samuel Bowles’s 2012 book, The New Eco- a fair opportunity to realize their full potential, nomics of Inequality and Redistribution. contribute to economic growth, and receive This approach does not require an explicit their fair share of income and wealth. new social contract, does not propose The adoption of the SDGs by the devel- explicit changes in the rules of the game, opment community, including the IDB, and does not pose a political challenge. signifies the shared belief that achieving the It relies principally on the methods of con- SDGs will lead to sustainable development tracting, financing, and ownership through and shared prosperity. However, one of the the market. Its major objective is changing key constraints in achieving the SDGs will financial and labor contracts to create an be funding the huge investments necessary to GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 21
FIGURE 1.2 Percentage of Income Held by the Top and Bottom 10 Percent in Select Countries
60
50
40
30 Percentage 20
10
0
Chile Brazil Turkey Mexico Nigeria Pakistan Colombia Malaysia Vietnam Indonesia South Africa Egypt, Arab Rep. Income share held by highest 10% Income share held by lowest 10%
Source: World Bank, World Development Indicators, 2014. achieve the goals. At current levels of invest- asset-based approach to redistribution.8 The ment, the developing countries will face an asset-based approach is basically a risk- annual gap of $2.5 trillion to achieve the sharing approach. It converges with Islamic SDGs, the United Nations Conference on finance’s contractual framework in terms of Trade and Development (UNCTAD 2014) empowering equity participation by the estimates. Given the scale of funding require- lower-income groups in a society. Making the ments, promotion of sustainable develop- poor direct holders of real assets in the real ment will need “significant mobilization sector of the economy reduces their high risk of resources from a variety of sources and aversion. It also creates positive incentives for the effective use of financing,” the United behavior to enhance productivity (such as Nations concludes.7 It will also require the trust, truthfulness, and hard work) through engagement of different stakeholders, includ- the design of contracts that reduce or elimi- ing government, businesses, civil society, and nate the difference between principals and the financial sector. agents and are conducive to achievement of Boxes 1.1 and 1.2 briefly present the devel- interests of all parties to a contract. opment strategies from two multilaterals— The foundations of human and economic the World Bank and the IDB. Both strategies development in Islam are well defined. The have common goals but different approaches. Islamic system of economics can be regarded The key difference in the two approaches is as a rule-based system with well-defined the use of Islamic finance by IDB, but the end principles, rules, and institutions. Compli- goals are the same—reducing poverty and ance with this rule-based system leads to enhancing shared prosperity. material and nonmaterial progress of soci- ety as a whole. The conventional perspective on economic development during the 1950s The Islamic Perspective on Development equated economic development with eco- and Shared Prosperity nomic progress without taking into consider- The Islamic perspective on income distribu- ation the well-being of individuals. This par- tion shares many similarities with the adigm evolved and has shifted considerably 22 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
BOX 1.1 The World Bank Group Approach to Enhancing Shared Prosperity
For the first time in 30 years, the development their human capital for the future and assist in the community, led by the World Bank Group, has revised recovery of the economy. In addition to increasing its objectives to give priority to inequality. The new financial access, increasing the financial literacy of mission of the World Bank Group, introduced in low-income groups is important. 2013, has two pillars: reducing the number of people living in extreme poverty and promoting shared prosperity. The World Bank Group defines promoting Fiscal sustainability shared prosperity as boosting the incomes of the Fiscal sustainability became an important focus after bottom 40 percent of the population in every country. public debt-to-GDP ratios rose rapidly in the after- By focusing on the advancement of the poor and math of the global financial crisis. The high level of vulnerable segment of the society, the World Bank public indebtedness not only limits the functionality Group aims to achieve a more equitable distribution of welfare states but also makes using Keynesian types of growth revenues. of growth policies less plausible. Throughout history, The World Bank Group’s approach in promoting the prevailing financial system has created a growth shared prosperity relies on five sets of policies. path that many experts describe as a boom-bust cycle. During the boom period, high growth rates have been Raising growth potential accompanied by high levels of leverage. When the level of leverage reaches a certain inflection point, the Increasing economic growth is the most efficient system collapses and a rebound follows. Smoothing method of reducing poverty levels and promoting out this cycle through fiscal sustainability is an impor- shared prosperity of the poorest 40 percent of the tant task for the economy and society, as recognized population. Dani Rodrik (2008) has stated that “his- by the World Bank Group strategy. torically nothing has worked better than economic growth in enabling societies to improve the life chances of their members, including those at the very bottom.” Environmental sustainability These groups are mostly excluded from the economic In addition to fiscal responsibility, creating environ- developments benefiting the other segments of their mentally friendly economic growth strengthens the society. Without access to proper health care, educa- sustainability of economic growth. The World Bank tion, credit, and land use, they are trapped in a spiral of Group has committed to develop new metrics to extreme poverty. To tackle these problems, policy mak- measure the true positive effects of economic growth ers should carefully analyze the needs of those people that takes into account not only the economic growth and consider specific microeconomic policies reflecting but also the negative effects of pollution and deple- the realities of each different geographic location. tion of natural resources.
Financial and social inclusion Institutional and governance reforms To improve the prospects and well-being of the mar- In order to create a well-functioning social contract ginalized extreme poor, the World Bank Group is also where all income groups—not just the very few privi- focusing on enhancing social and financial inclusion leged ones—are included in the prospects of economic of the society, in addition to increasing growth rates. growth, trust in government and institutions should These two priorities are connected. Increasing finan- be established and strengthened. Measures to increase cial and social inclusion would also help boost overall accountability of institutions will reduce corruption economic growth by promoting countercyclical eco- and make institutions more efficient in fulfilling their nomic policy and by helping poor people maintain responsibilities. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 23
BOX 1.2 The Islamic Development Bank Group Strategy for Development
In 2015, the Islamic Development Bank Group (IDBG) Infrastructure development and private sector adopted its 10-Year Strategy (10-YS) to be support are critical areas because of their role in implemented during the period 2016–2025. The new fostering growth and because they offer the potential 10-YS is based on the IDBG Vision, and is in line with to build on capabilities already in place. Social the 10-Year Program of Action (10-PoA) of the development (including agriculture and rural Organisation of Islamic Cooperation (OIC) and the development, education, and health) as a priority Sustainable Development Goals (SDGs) adopted by area would provide solutions to problems of the the United Nations General Assembly in September neediest and underserved populations, build on 2015. The new 10-YS aims to promote inclusive and widespread experience, and fulfill the IDBG’s sustainable socioeconomic development and enhance inclusive mandate. Islamic finance and cooperation cooperation between IDB member-countries. It enables are unique areas of activities and core mandates for the IDB Group to serve the varying development needs IDBG. In each of the pillars, capacity development of its 56 member-countries. It also aspires for the IDB will play a very important role. Group to take a leadership role in promoting Islamic In order to translate the strategic pillars into finance globally. action, given the existing constraints, the strategy The 10-YS is founded on a framework that revolves includes a set of guiding principles to improve oper- around three strategic objectives, five priority areas, ational effectiveness and organizational efficiency. and seven guiding principles for effective and efficient These guiding principles will help IDBG continue implementation. These strategic objectives translate growing, with greater emphasis on mobilization of the vision in the member-countries into IDBG goals external resources and implementation through for the next 10 years. The five strategic pillars have gradual decentralization; be more selective, to max- been chosen to reflect three main considerations: the imize the impact in development given the available uniqueness, by mandate, of IDBG; the strengths and resources; build capabilities in strategic areas in a capabilities accumulated over decades of experience; cost-efficient manner; and better integrate and and the relative position and potential of IDBG in the coordinate activities across the Group to maximize context of the evolving development landscape. synergies.
during the past 50 years. Today, development social development of society. From this per- economists acknowledge the importance of spective, Islamic economics and finance offer individuals as well as the state of institutions. an alternative and viable framework that The Islamic perspective on economic devel- can play an important role in achieving sus- opment encompasses this revised view. It has tainable development and boosting shared three dimensions: the development of the prosperity. This framework is based on four material world, self-development, and devel- fundamental pillars, depicted in figure 1.3: opment of the society as a whole (Iqbal and Mirakhor 2013). 1. An institutional framework and public The central economic tenet of Islam is policy in line with the objectives of Islam to develop a prosperous and egalitarian 2. Prudent governance and accountable economic and social system wherein all mem- leadership bers of society can maximize their intellec- 3. Promotion of the economy based on risk tual capacity; preserve and promote their sharing and entrepreneurship (distribution) faith, health, and wealth among generations; 4. Financial and social inclusion for all and actively contribute to the economic and (redistribution). 24 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 1.3 Islamic Framework to Achieve Sustainable Development and Shared Prosperity
- - • Maqasid. al-shari ‘ah—justice, freedom of religion and protection of life, intellect, • Capable and trustworthy posterity, and wealth systems (justice) • Economic and social justice • Leadership with strong • Spirit of solidarity, mutuality, accountability and cooperation Institutional Governance and • Stakeholder-oriented • Environmental and framework and leadership governance intergenerational sustainability public policy
Prerequisites • Trust/social capital • Respect, dignity, and opportunity for all • Avoidance of information asymmetries (gharar)
Financial and Risk sharing and social inclusion entrepreneurship • Prohibition of interest • Redistributive instruments (redistribution) (distribution) - • Asset-backed and equity (zakat, qard. hasan,. waqf, - financing sadaqat,. and so on)
Channels • Exchange and trade • Entrepreneurship
Sustainable social and economic development
Inclusive growth Shared prosperity Human well-being
Note: For definitions of the terms of Islamic finance, see the glossary.
The first two pillars are prerequisites, The first pillar is crucial because having a while the last two are the channels to achieve sound institutional framework and appropri- sustainable development with equitable dis- ate public policies are the foundation upon tribution of both opportunities and wealth, which the other pillars must rest and can which are the main objectives of the concept function optimally. Institutions play a criti- of economic development in Islam. The pro- cal role in this framework, as they implement posed framework, which is constructed by the rules prescribed by the tenets of Islam. interpreting central tenets of Islamic prin- The institutions also must adhere to the ciples, could be used in creating a universal core objectives of Islam (commonly known strategy and policy that align with the prin- as maqƗsid̙ al-sharƯ‘ah, or Objectives of ciples of Islamic finance to achieve the goal Islamic Law)9 that lay the foundation to for- of sustainable development and to increase mulate the policies promoting economic and the welfare of all members of the society. social justice, preservation of human rights, GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 25
dignity, health, and the intergenerational transactions also ensures the stability of the wealth of the society. financial system (Askari and others 2010). The second pillar focuses on developing a In addition, risk sharing with equitable shar- governance mechanism and accompanying ing mechanisms encourages entrepreneurship compliance system based on the objectives and innovation, since counterparties receive and institutions briefly outlined in the first their fair share in the investment. This in step. The ethically based governance, leader- turn will increase the allocation of resources ship, and compliance system helps increase the to the real sector, rather than channeling transparency and accountability in the public, excessive financial flows to the financial sec- private, and social sector institutions of the tor (overfinancialization).11 overall economic system and hence strength- The fourth pillar aims to ensure that the ens trust in the system. Trustworthy and capa- fruits of the higher growth are distributed ble leadership can ensure protection of rights to every segment of the society inclusively, of the vulnerable or those who could be vul- either through participation in the economic nerable (as in future generations). Increased growth or through Islam’s instruments of trust and better governance in turn strengthen redistribution. the institutional framework that enables bet- ter implementation of better public policies. Pillar I. Institutional Framework The desired institutional and governance structure must be able to do the following: Establishing efficient institutions and an insti- tutional framework in line with the principles 1. Design policies to foster inclusive growth of Islam—that emphasize universal values and development by promoting entre- such as protecting life, preserving property preneurship, risk-sharing financial trans- rights and sanctity of contracts, building a actions, and equity participation, and more just society, protecting the rights of by discouraging financial leverage and future generations, fostering mutuality and speculation. solidarity, and being sensitive to environmen- 2. Encourage all members of society to con- tal issues—is essential in creating an enabling tribute to the creation of economic, social, environment for the Islamic economic and human, and moral capital. financial systems to flourish. 3. Enhance the equitable distribution of The institutional framework of the ideal wealth by promoting sharing of both risk economy consists of a collection of institu- and rewards. tions: rules of conduct and their associated 4. Alleviate poverty by redistributing wealth, means of enforcement to deal with the alloca- with special focus on the poorest. tion of resources, production, and exchange 5. Achieve economic and social justice by the of goods and services and the distribution correct use of material growth and develop- and redistribution of the resulting income and ment that enhances the overall well-being wealth. The objective of these institutions is to of the society. achieve social justice. Each economic system has an “institutional matrix” that “defines The third pillar is the distribution chan- the opportunity set … that makes the highest nel; it works at both the individual and orga- payoffs in an economy’s income distribution nizational level. One of the main features or … that provides the highest payoffs to pro- is the advocacy of risk sharing and promo- ductive activity” (North 2005, 61). Douglass tion of entrepreneurship. This is one of the North, in his 2005 book Understanding the most important aspects of Islamic finance, Process of Economic Change, contends that which differentiates it from the conventional in all economic systems, institutions (rules of approach of overreliance on debt-dominated behavior) are designed by humans to impose risk-shifting or risk-transfer mechanisms.10 constraints on human interaction. These Sharing the risks of economic and financial institutions “structure human interaction 26 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
by providing an incentive structure to guide can reduce information asymmetries. The human behavior. But an incentive structure Islamic institutional framework has well- requires a theory of the way the mind per- defined rules and guidance on everyday life ceives the world and its functioning so that and economic transactions. Rules govern- institutions can provide those incentives” ing transactions—such as trustworthiness, (North 2005, 66). At this point, paradigms truthfulness, faithfulness to the terms and become relevant because paradigms in eco- conditions of contracts, transparency, and nomics include conceptions of humankind noninterference with the workings of the and society and their interrelationships. markets and the price mechanism so long as An important function of the institutional market participants are complying with the framework is reducing uncertainty caused by rules—provide a reasonably strong economy lack of information, which can hinder decision where information flows without hindrance. making. Rules specify what kind of conduct Participants can engage in transactions con- is most appropriate in achieving just results, fidently, with minimal concern for uncer- especially when individuals face alternative tainty regarding the actions and reactions of choices and must take action. Rules impose other participants. Because of the high level restrictions on what society’s members can do, of trust, transaction costs can be minimal. without upsetting the social order upon which Due to the level of depth and clarity in these all members depend in choosing their own rules, if agents in an economy comply with actions and forming their expectations of how them, the problem of information asymmetry others will respond and act. Compliance with would be minimized, which in turn would the rules makes people more certain in form- encourage Islamic financial instruments to ing those expectations, prevents conflict, rec- function. onciles differences, coordinates actions, facili- tates cooperation, promotes social integration The Role of Public Policy and social solidarity, and strengthens the In all economic systems, the State plays a social order. In an ideal society, the degree of role in the economy. Only the extent of the effectiveness in enforcing rules is determined State’s involvement differs, depending on the by the degree to which the objective of achiev- common values and belief system shared by ing social justice becomes integral to members the individuals that make up the particular of the society. society and the political structure that is in power during a particular period. The Key Institutions of Islamic Finance Islamic economy is to ensure that everyone The Islamic economic paradigm is a Creator- has equal access to resources and means of centered conceptualization of reality (box 1.3). livelihood, that markets are supervised so Its view of the institutional framework is that justice is attained, that transfers take based on the following: place from the more able to the less able, and that distributive justice is ensured • Clear and secure property rights for the next generation (Al-Hasani and • Contract enforcement Mirakhor 2003). • Trust among people and between government The role of the government is only that of and people, and among people and other a trustee to society, and it is to act according institutions. Such abiding trust can reduce to the rules prescribed in the Qur’Ɨn and sun- risk, uncertainty, and ambiguity; strengthen nah.12 The role of the government is broadly social solidarity; bring private and public divided into two functions: a policy function interests into closer harmony; and ensure that ensures that private interest does not coordination so risk can be shared better. diverge too far from public interest, and a One of the main advantages of having a function to design and implement an incen- well-established institutional framework is tive structure to encourage rule compliance, that it improves the flow of information and coordination, and cooperation. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 27
BOX 1.3 Key Institutions in an Ideal Islamic Economy
The institutional structure of the ideal Islamic economy trustworthy an obligatory personality trait. In the rests on rules governing property, production, shari‘ah, the concepts of justice, faithfulness, reward, exchange, trust, markets, and distribution and and punishment are linked with the fulfillment of redistribution, among others. obligations incurred under the stipulations of the con- tract. Being trustworthy and remaining faithful to promises and contracts are absolute requirements, Property rights regardless of the costs involved or whether the other All property ultimately belongs to the Creator, who has party is a friend or a foe. made all created resources available for humans, to empower them to perform what their Creator expects Markets of them. Individuals are free to acquire and accumulate property as long as it does not violate the rights and the The market’s institutional structure is built around interests of the society and individuals. Islam prohibits five pillars: property rights, the free flow of informa- the concentration of wealth and imposes limits on con- tion, trust, contracts, and the right not to be harmed sumption through its rules prohibiting overspending by others and the obligation not to harm anyone. (isrƗf), waste (itlƗf), and ostentatious and opulent Together, they serve to reduce uncertainty and trans- spending (itrƗf). action costs and enable cooperation and collective action to proceed unhindered. Contracts Islam places great significance on the sanctity of and Distribution and redistribution commitment to contracts. Islam’s strong emphasis on The most important economic institution of the the strictly binding nature of contracts covers private Islamic economic paradigm to achieve social justice and public contracts, as well as international treaties. is its set of rules regarding distribution and redistri- Moreover, every public office in Islam is regarded as a bution. Distribution takes place after production and contract, that is, an agreement that defines the rights sale, when all factors of production are given what is and obligations of the parties. Every contract entered due to them commensurate with their contribution into by the believer must include a forthright inten- to production, exchange, and sale of goods and ser- tion to remain loyal to performing the obligations vices. Redistribution occurs after the distribution specified by the terms of the contract. phase, when the charges due to the less able are lev- ied. These expenditures are essentially repatriation Trust and redemption of the rights of others in one’s income and wealth. Trust is considered the most important element of social capital in Islam, which considers being Source: Iqbal and Mirakhor 2011.
Islam uses the market as a mechanism to into a private greed for gains, especially when solve part of the coordination problem within the gains are nonproductive. the economy. The State enters the market as The symbiotic relationship of human- the supervisor/regulator of economic activity. kind, the Creator, and the environment can It is the combination of State supervision/reg- offer an alternative in achieving sustained ulation and free enterprise that will be used and civilized development that could aug- to maximize social welfare. The State must ment the proposed framework proposed by actively complement market forces to ensure the World Bank Group. Macroeconomic that individual initiative does not degenerate policies are taking cognizance of social and 28 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
environmental elements as integral parts of to any risk as a result of a firm’s activities. the decision process (Mirakhor and Askari Whereas the conventional financial system is 2010). Hence there is a clear link between struggling to find convincing arguments to public policy based on Islamic principles and justify stakeholders’ participation in gover- the emphasis on inclusive and environmen- nance, a stakeholder model is built into tally friendly and fiscally sustainable develop- Islam’s principles of property rights, commit- ment policies. ment to explicit and implicit contractual Islamic finance clearly states that the sole agreements, and implementation of an effec- owner of all the property, including natural tive incentive system. resources, is the Creator. Hence any abuse of The design of the governance system in natural resources, their wasteful or inefficient Islam can be best understood in light of use, or disregard or negligence in creating principles governing the rights of the indi- externalities such as pollution is forbidden vidual, society, and the State; the laws (Majah 1952). The Islamic perspective places governing property ownership; and the a strong emphasis on intergenerational sus- framework of contracts. Islam’s recognition tainability in both environmental and fiscal and protection of rights is not limited to issues. human beings but encompasses all forms of In addition, Islamic public policies are life as well as the environment. Each element required to pay a great deal of attention of Allah (swt)’s creation has been endowed to inclusiveness and efficiency. MaqƗsid̙ with certain rights, and each is obligated to al-sharƯ‘ah principles direct the State to respect and honor the rights of others (Iqbal implement socially optimal and effective pub- and Mirakhor 2004). lic policies that encourage cooperation rather The principles of property rights and than competition and support basic freedoms contracts in Islam offer theoretical founda- under which a market-oriented and socially tions to acknowledge the rights of all inclusive economic system can flourish. Public stakeholders, Iqbal and Mirakhor (2004) policy to support financial integration with argue. Islam’s principles of property rights, the real economy and to mobilize savings in contracts, and a just social order define the developing countries could help promote risk business environment where economic mitigation and risk sharing, thus building agents are morally conscious of protecting resilience in the face of shocks. property rights and contractual obligations to one another, whether acting as public ser- Pillar II. Responsible Governance and vants, managers, employees, suppliers, or Leadership customers, or in any other capacity. All par- ticipants in economic activities—whether Governance can be regarded as the set of individuals, firms, corporations, nonprofit rules and norms that deals with the process organizations, or public institutions—are and structures with which entities are man- subject to the same degree of commitment. aged, and that define the distribution of The notion of the sanctity of contractual responsibilities between the management obligations is not limited to explicit con- and related parties that are to gain or lose tracts, which are well defined, stipulated, from the actions of the entity. The main and documented, but is equally applicable objective of governance is to maximize the to implicit contracts, which are incomplete gains of the related parties and stakeholders by nature. Property rights of all contractual within the social, legal, and market environ- parties—whether individuals, local commu- ment. The governance model in the Islamic nities, intangible legal entities, or the economic system is a stakeholder-oriented society—are preserved and protected. model where the governance structure and A financial sector with weak governance process at the system and firm level protect and lack of transparency is bound to lead to the rights of stakeholders that are exposed debt financing, market frictions, inefficiencies, GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 29
and financial exclusion. Strong corporate gov- unsecured debt from the financial system. ernance values would increase the account- Instead, preference is given to asset-backed ability and transparency of the financial and equity or participatory finance, as well as system. financing of trading and exchange activities. In Islam, the expected behavior of a Encouraging financial instruments that firm is not any different from the expected promote risk sharing and asset-backed behavior of any other member of the society. financing could help deleverage financial Although the entity itself does not have a systems (box 1.4) and make them more conscience, the behavior of its managers stable and resilient to economic shocks. The becomes the behavior of the firm, and their development of equity-based capital mar- actions are subject to the same high stan- kets could play an important role in mobi- dards of moral and ethical commitment lizing resources without creating leverage in as expected from any member of society. the economy. A financial system based on A firm’s economic and moral behavior is asset-backed financing would encourage shaped by its managers acting on behalf of real transactions and growth in the real sec- the owners, and it is their fiduciary duty to tor. A financial system based on risk-sharing manage the firm for the benefit of all the principles would smooth out the boom-bust stakeholders and not for the owners alone. cycles in the economy, thus creating a more Consequently, it will be incumbent upon just and equitable society, because in such managers and owners to ensure that the a system the distribution of profit and loss behavior of the firm conforms to the prin- would be determined according to the risks ciples and the rules of Islamic law. each agent bears. Notions of responsibility and account- Because counterparties would receive ability play an important role in shaping their fair share of proceeds in investments the behavior of the leaders in the public and according to the risk they bear, the entrepre- private sector. Business leaders are expected neurial spirit in a society would be invigo- to act prudently as opposed to recklessly rated. Agents would be willing to take judi- and to act with the best ethical behavior. cious risk in developing innovative ideas and For example, taking excessive risks is a actually bringing these ideas to life if they form of acting without prudence and prob- were rewarded according to the risk they ably in one’s own self-interest rather than would bear. A growing body of evidence the larger interest of the shareholders and demonstrates the significance of developing stakeholders. Similarly, attempts to circum- entrepreneurship in the economy through vent regulatory constraints,13 find loopholes micro, small, or medium enterprises, which in the law, and misrepresent matters, and could serve as the engine for growth. Entre- acts of willful negligence that were common preneurship encourages socially optimum practice among top business leaders during risk sharing and promotes innovation. the global financial crisis would not be the An economic system based fully on the traits of a leader compliant with the rules principle of risk sharing mitigates the nega- of Islam. tive effects of recessions on certain investors while enabling the returns during high-growth Pillar III. Risk-Sharing Finance episodes to be distributed in a more equitable manner. Hence the risk-sharing principle The core principle of Islamic finance (Askari not only can help create smoother business and others 2010) is risk sharing among the cycles but also can enhance a more sound and investors and the users of funds that stipulates equitable pattern of income distribution in a that both share the outcome of the business society. or asset being financed —whether positive or Islamic finance, through its core princi- negative.14 Unconditional prohibition of ples, advocates for just and fair distribution interest in any form by Islamic Law eliminates of income and wealth during the production 30 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
BOX 1.4 Why Is Debt Finance So Prevalent?
In 2013, outstanding global debt reached $199 trillion By contrast, the dividend payments and retained (Dobbs and others 2015)—almost triple the capitalization profits that flow to shareholders are taxable of the equity market, at $64 trillion (Deutsche Bank (Economist 2015). It could be argued that debt Research 2014) (figures B1.4.1 and B1.4.2). finance is being subsidized by sovereigns, and this One of the major reasons why debt finance is so subsidy makes it more favorable than equity finance. prevalent is because the interest payments are tax Another reason is information asymmetry. deductible. Tax breaks for debt occur in two principal Investors have insufficient information regarding forms. Interest payments on mortgages are tax the state of investment projects. Townsend (1979) deductible for personal income tax purposes in many argues that debt contracts are optimal when only countries. Meanwhile, firms can deduct interest the entrepreneur can observe the state of the world payments to debtholders from their taxable earnings. and his or her project; investors must pay a fixed
FIGURE B1.4.1 Global Outstanding Debt
Compound annual growth rate (%) Global stock of debt outstanding by typea $ trillion, constant 2013 exchange rates 2000–07 2007–14a 199 200 7.3 5.3
Household 8.5 2.8 +57 trillion
150 142
Corporate 5.7 5.9
100 87
Government 5.8 9.3
50
Financial 9.4 2.9
0 4Q00 4Q07 2Q14a Total debt as % of GDP 246 269 286
Source: Dobbs and others 2015. Note: Numbers may not sum due to rounding. a. 2Q14 data for advanced economies and China; 4Q13 data for other developing economies.
box continues next page GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 31
BOX 1.4 Why Is Debt Finance So Prevalent? (continued)
cost (in terms of time, money, and/or effort) to change drastically, favoring instruments based on verify the prospects of the project. However, if the risk sharing. probability of monitoring the environment in Another reason why debt financing is much more which the future stream of investment are to be prevalent is because investors might prefer the relative realized is somehow endogenized through some safety of bonds to equities. Moreover, the entrepreneur sort of screening process, then a debt contract is retains the entire marginal return through a debt no longer efficient even after the debt contract has contract; the entrepreneur does not have to share the matured. Furthermore, considering the systemic future stream of profits with other investors. This risks posed by the debt-fueled growth that this creates incentives for debt financing rather than equity strategy poses, the optimality of contracts would financing (Jensen and Meckling 1976).
FIGURE B1.4.2 Stock Markets versus Debt Securities $ trillion
250 242 224 213 207 197 200 196
173 172
151 150
108 100 72
51 50
0 1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 2013 est. Stock market capitalization Public debt securities outstanding Financial institution bonds outstanding Nonfinancial corporate bonds outstanding Securitized loans outstanding Nonsecuritized loans outstanding
Source: Roxburgh, Lund, and Piotrowski 2011. 32 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
cycle and provides mechanisms for redistri- to households due to excessive risk taking; bution to address any imbalances that may achieving and sustaining economic and occur. Islamic finance’s approach to redis- political stability; and promoting financial tribution is based on a balanced blend of sector development. In terms of the insti- income-based redistribution through redis- tutional framework, clear and secure prop- tributive instruments and asset-based redis- erty rights, contract enforcement, and trust tribution through the notion of risk sharing. among people and between government and Whereas the income-based redistribution people and other institutions can reduce approach offers only a partial solution—as risk, uncertainty, and ambiguity; strengthen it takes the current income distribution as social solidarity; bring private and public given and aims at fairer distribution of future interests into closer harmony; and ensure GDP—the asset-based redistribution is basi- coordination to encourage risk sharing cally a risk-sharing approach and converges (North 2005; Mirakhor 2009; Mirakhor to Islamic finance’s contractual framework in and Askari 2010). terms of empowering equity participation by A system based on risk sharing has the the lower-income groups in the society. Ana- potential of not only creating a smoother lytically, by making the poor direct holders business cycle and a more equitable distri- of real assets in the real sector of the econ- bution of wealth but also speeding up the omy, the approach reduces their empirically deleveraging of the financial system while observed high aversion to risk. It also creates encouraging the entrepreneurial spirit. positive incentives for promoting behavioral Figure 1.4 illustrates how equity finance is factors that enhance productivity (such as more conducive to economic growth than trust, truthfulness, and hard work) through other forms of financing. the design of contracts that reduce or elimi- nate the difference between principles and Pillar IV. Financial and Social Inclusion agents and are conducive to achievement of the interests of all parties to a contract. The main problems in enhancing financial Researchers suggest that good public inclusion are linked to risks arising from infor- policy and strengthened institutional frame- mation asymmetries and the high transaction works in developing countries can go a costs of processing, monitoring, and enforcing long way toward reducing aggregate risk in small loans. Information asymmetries can an economy. Policy improvements include result from adverse selection (the inability of strengthening governance to reduce damage the lender to distinguish between high- and
FIGURE 1.4 The Contrasting Effects on Growth of Different Forms of Financial Expansion
Increase in private credit or stock market capitalization by 10% of GDP 0.4 0.2 0 –0.2 –0.4 –0.6 –0.8 real GDP per capita growth Percentage point change in –1 All private Bank lending Bonds Household Business Stock market credit credit credit captialization
Source: OECD 2015, http://www.oecd.org/eco/How-to-restore-a-healthy-financial-sector-that-supports-long-lasting-inclusive-growth.pdf. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 33
low-risk borrowers) or from moral hazard • Inheritance rules specified in theQur’ Ɨn, (the tendency for some borrowers to divert through which the wealth of a person at resources to projects that reduce their likeli- the time of death is distributed among hood of being able to repay the loan, and the current and future generations of inheritors inability of the lender to detect and prevent (Mirakhor and Iqbal 2012). such behavior). Instruments of redistribution are used to From an Islamic perspective, property is redeem the rights of the less able through not a means of exclusion but of inclusion, in the income and wealth of the more able. which to redeem the rights of those less able Rules of redistribution ensure that those through the income and wealth of the more unable to benefit by participating directly in able. Islam emphasizes financial inclusion production and consumption in the market, more explicitly than conventional finance; through a combination of their labor and inclusion is embedded in core economic and their right of access to resources provided social institutions of Islam. Two distinct fea- by the Supreme Creator for all humans, can tures of Islamic finance—the notions of risk redeem their rights through various redis- sharing and redistribution of wealth—differ- tributive mechanisms (see box 1.5). Once entiate its path of development significantly these rights have been redeemed out of the from the conventional financial model. income and wealth of the more economi- The following are the main drivers of cally able, the latter’s property rights on the financial inclusion: remaining income and wealth are held invi- • Contracts of exchange and risk-sharing olable. Contrary to common belief, these instruments in the financial sector are not instruments of charity, altruism, • Redistributive risk-sharing instruments that or beneficence, but instruments of redemp- the economically more able segment of soci- tion of rights and repayment of obligations ety uses to share the risks faced by the less (Iqbal and Mirakhor 2013). able segment of the population (Askari, The Qur’Ɨn considers the more able as Iqbal, and Mirakhor 2015; Iqbal and trustee-agents in using these resources on Mirakhor 2011) behalf of the less able. In this view, property
BOX 1.5 Key Instruments of Redistribution in Islamic Finance
Sadaqah̙ (recommended contributions) Qard. h. asan (benevolent loan free of any charge) Sadaqah̙ is intended to redeem the rights of the less privileged in society. Sadaq̙ Ɨt is the plural of the term Qard. h. asan, a loan mentioned in the Qur’Ɨn as “beau- Vadaqah̙ , a derivative of the root meaning truthfulness tiful” (hasan), is a voluntary loan, without any expec- and sincerity. tation by the creditor of any return on the principal.
Zaka¯t (mandatory levy) Waqf (endowment) A waqf is a trust established when the contributor ZakƗt is one of the key pillars of Islam and is ordained endows the stream of income accruing to a property to mobilize funds for the welfare of the poor. Its for a charitable purpose in perpetuity. collection was enforced by governments in early Islamic history. Source: Iqbal and Mirakhor 2013. 34 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
is not a means of exclusion but inclusion, population but also brings idle wealth into in which the rights of those less able are circulation and productive use. Islam also redeemed through the income and wealth puts in place an overall system of fairness, of the more able. The result would be a bal- unambiguity in transactions, risk sharing, anced economy without extremes of wealth and equitable dealings. This is important to and poverty. The operational mechanism avoid nullifying any redistributive effect and for redeeming the right of the less able in the to ensure proper incentives for members of income and wealth of the more able are the society to work, take risks, and share in the network of mandatory and voluntary pay- outcomes. Together these elements of dis- ments such as zakƗt (a 2.5 percent levy on tribution and redistribution of income and asset-based wealth), khums (a 20 percent wealth ensure circulation of wealth and avoid levy on income), and payments referred to its concentration among the rich. as sadaq̙ Ɨt (recommended contributions). Finally, individuals who for some reason were The Role of the Financial Sector in Achieving left marginalized in the system without hav- Shared Prosperity ing the necessary resources to meet their basic The financical sector can promote shared pros- needs are provided with the necessary social perity by facilitating economic growth, safety net through redistributive instruments. decreasing income inequality, and reducing For centuries, Islamic redistributive vulnerability. On a macroeconomic level, aca- instruments such as zakƗt, qard. h. asan, waqf, demic research has shown that not all types of and sadaq̙ Ɨt have played a vital role of ensur- growth contribute to the reduction in poverty ing social protection and alleviating poverty rates in the same manner. Even though overfi- in a dignified manner that has led to wider nancialization poses dangers to economic social and financial inclusion. These instru- stability, in order to achieve sustainable ments need to be revived and institutional- growth, it is essential to have a well-functioning ized to gain optimal benefits.15 Through financial system that can channel the funds to these redistributive instruments, the rich the most productive resources. Growth fueled share the risk by helping the poor, which cre- by the financial sector generates less employ- ates a more equitable society where everyone ment for the lower-income segment of the soci- would have equal opportunity and contrib- ety than growth driven by labor-intensive ute to economic development of the society. sectors. For example, growth favoring the agri- Although periodic income redistribution cultural sector helps improve the conditions of can reduce inequality in the dimension of the very poor. Hence, channeling the resources income, the change may not persist over the of the financial sector into the development of longer run. For example, incomes through the real sector is crucial to realizing the redistribution could be subject to misuse World Bank Group goals. Several studies have by the recipient or allocated to consump- shown that financial sector development can tion, which could bring the system back to make positive contributions to economic the same state of inequality. Compared with development (Levine 1997). income redistribution, asset redistribution is Development of the financial sector can potentially more durable because it affects make a significant contribution to achieving the potential future stream of earnings, not shared prosperity in several areas. Table 1.2 one-time income. For these reasons, Islam not presents the relationships of the functions only puts in place a method of redistribution that the financial sector typically performs of wealth—for example, at the time of distrib- and the factors that can contribute to enhanc- uting an inheritance—but also a method of ing shared prosperity. periodically redistributing income and wealth Box 1.6 describes how the development in the form of zakƗt, waqf, and more frequent of the financial sector could contribute to sadaq̙ Ɨt and other contributions. This not shared prosperity under each pillar of Islamic only directly helps the poorer segment of the finance’s framework of development. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 35
TABLE 1.2 Functions of the Financial Sector and Factors Affecting Shared Prosperity Mobilizing savings/ managing assets Allocating capital/financing Managing risks Facilitating growth Mobilize financial resources for Allocate capital for production. Avoid economic crisis and promote investments. innovation. Decreasing income Manage assets for poorest 40 Provide financing to the poor and micro Protect the poor against downturns and inequality percent of the population. and small enterprises. negative shocks. Reducing Allow savings for emergencies. Reduce risk by monitoring and provide Provide insurance and protection against vulnerability financing for short-term needs and risks and uncertain events. emergencies. Source: Ahmed 2015.
BOX 1.6 How Development of the Financial Sector Could Promote Shared Prosperity
Institutions and Public Policy to debt financing, market frictions, inefficiencies, and financial exclusion. Institutional framework: Establish efficient, well-run institutions in line with the principles of maqƗsid̙ Enhanced accountability: Greater accountability al-sharƯ‘ah that emphasize universal values such as would induce policy makers and agents within an protecting life, preserving property rights and the economy to act according to the predefined set of rules sanctity of contracts, building a more just society, that would enhance property rights, contracts, and protecting the rights of future generations, fostering trust in the entire economic system. This, in turn, mutuality and solidarity, and being sensitive to envi- would lead to more efficient resource allocation and a ronmental issues. more vibrant economy. An increase in trust would reduce the cost of screening and monitoring and Fiscal prudence and environmentally sustainable devel- encourage investments in the real economy. opment: Develop risk-sharing instruments to finance fiscal deficits. Ensure that prudent fiscal policies are in Strong leadership to implement policies: Strong politi- place to protect the rights and wealth of future genera- cal will and leadership is of utmost importance to tions. Pay special attention to the negative externalities implement the theoretical goals of responsible higher economic growth might create, such as pollu- governance. tion and depletion of resources. Not taking these effects into account would shift the burden from the current generation to future generations. Promotion of Risk Sharing and Socially optimal and inclusive public policy: Use Entrepreneurship maqƗsid̙ al-sharƯ‘ah principles to implement socially Deleveraging the financial system and promoting risk optimal and effective public policies that encourage sharing: Financial instruments promoting risk sharing cooperation rather than competition, and basic free- and asset-based financing can help deleverage financial doms under which a market-oriented and socially systems to make them more stable and robust, thus inclusive economic system could flourish. promoting sustainable growth. Similarly, the develop- ment of equity-based capital markets can play an Responsible Governance and Leadership important role in mobilizing resources without creat- ing leverage in the economy. A financial system based Enhanced governance: A financial sector with weak on asset-based financing would encourage transac- governance and lack of transparency is bound to lead tions and growth in the real sector. A financial system
box continues next page 36 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
BOX 1.6 How Development of the Financial Sector Could Promote Shared Prosperity (continued)
based on risk-sharing principles would smooth out the zakƗt, qard. h. asan, waqf, and sadaq̙ Ɨt have played a boom-bust cycles in the economy. This would create a vital role of social protection and alleviation of poverty more just and equitable society, because in such a sys- in a dignified manner that have led to wider social and tem, the distribution of profit and loss would be deter- financial inclusion. These instruments need to be mined according to the risks agents bear. revived and institutionalized to yield optimal benefits. Reducing information asymmetries (gharar): Because Creating innovative social finance: Both social inclu- agents are rewarded according to the risk they bear, sion and financial inclusion are critical tools in boost- counterparties have incentives to act in a responsible ing shared prosperity. However, the conventional manner without taking unnecessary risk. This mutual- means of financial inclusion through microfinance ity increases the trust in counterparties, which decreases and SME financing face serious challenges, including gharar and results in a more efficient allocation of the high cost of borrowing and lack of affordable resources. Because Islamic principles strictly prohibit funding. This problem is even more serious for coun- the existence of vagueness in contracts, this also tries with massive poverty, including the majority of reduces information asymmetries. OIC countries. There is a need to develop financial Promoting entrepreneurship: Promoting entrepreneur- mechanisms that make affordable financing available ship through micro, small, and medium enterprises to the poor. Market-based solutions, public-private can serve as an engine for growth. Entrepreneurship partnerships, and social finance instruments can help. encourages socially optimal risk sharing and promotes Creating unconventional means of social protection: innovation. However, every owner of a micro, small, Conventional finance’s answer to increasing social or medium enterprise is not an entrepreneur. A key inclusion mainly relies on the activities of the welfare consideration is how to develop such skills and state. However, the spike in government indebtedness encourage calculated risk taking to promote develop- after the financial crisis, especially in developed coun- ment, and how to make opportunities available to tries, has limited the availability of sovereign financial share in the prosperity. resources and thus the role welfare states might play in terms of reducing income inequality. Countries that Financial and Social Inclusion have high levels of poverty also often have very weak institutions, which makes it difficult to support a wel- Revitalizing and institutionalizing redistributive instru- fare state. Hence a different framework is needed to ments: For centuries, redistributive instruments such as reach the poor and marginalized.
Conclusion lead to sustainable development and This chapter presents a perspective based on enhanced shared prosperity. Islamic economics and finance that offers an The main core principles of Islamic alternative approach to achieving two key finance are its asset-based and risk-sharing development objectives: reducing extreme principles. The asset-backed nature of poverty to 3 percent globally by 2030, and Islamic finance prevents an economy from promoting shared prosperity. Given the sever- becoming overfinancialized and leveraged. ity of these problems in member-countries of Risk sharing not only offers the foundation the OIC, where policy makers are challenged for a more stable financial system but also with high levels of inequality and highly more equitable growth because the proceeds indebted households, firms, and sovereigns, a of returns to growth are shared by agents in solution provided by Islamic finance could line with the risk they bear. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 37
For those core principles to be realized, 4. Kumhof and Rancière (2010) present a certain preconditions must be met. The dynamic general equilibrium model that pro- starting point is establishing a sound insti- duces these stylized facts. tutional framework that has well-defined 5. The eight main MDGs seek to (1) eradicate rules and reduces information asymmetries extreme poverty and hunger; (2) achieve univer- sal primary education; (3) promote gender in economic transactions. The institutional equality; (4) reduce child mortality; (5) improve framework should be strengthened by gov- maternal health; (6) combat HIV/AIDS, malaria, ernance structures that take into account and other diseases; (7) ensure environmental all the stakeholders, as well as the broader sustainability; and (8) develop a global partner- society. Finally, adherence to redistributive ship for development. principles could enhance financial inclusion 6. Moral hazard is a situation in which one and would enable the proceeds of growth to party gets involved in a risky event knowing be redistributed to the marginalized groups that it is protected against the risk, and the who for some reason did not have the neces- other party will incur the cost. sary resources to participate in the growth 7. United Nations Economic and Social Council. strategies. “Millennium Development Goals and Post- 2015 Development Agenda,” page 3. http:// www.un.org/en/ecosoc/about/mdg.shtml. 8. For an in-depth discussion of development Notes issues in Islam, see Chapra (2007); Mirakhor 1. Various theories have been proposed to explain and Askari (2010); and Askari, Iqbal, and the deterioration in income and wealth distri- Krichene (2010). bution. One strand of academic literature con- 9. For purposes of this book, and as an oversim- siders the globalization of finance and trade to plification, theshari‘ah is Islamic Law derived be the main culprit of rising inequality around from two divinely revealed sources: the the world (Krugman and Venables 1995). Qur’Ɨn and the Tradition of the Prophet Another strand focuses on recent technological Mohammed. There are other means of ascer- advances, and identifies a “skill bias” that tends taining the shari‘ah from nonrevealed sources, to benefit skilled workers more in comparison such as ijma (the contemporary consensus of to unskilled workers (Acemoglu 2002). scholars of the shari‘ah) and qiyƗs (reason- 2. Earlier views on inequality thought that it ing); however, there are many others. might help spur growth. For example, Lazear 10. Islamic finance comprises four areas of activ- and Rosen (1981) argue that high inequality ity that are conducted in accordance with might strengthen the incentives for workers to shari‘ah principles: banking, financing, invest- work harder and take on risk and pursue ing, and takƗful (shari‘ah-compliant coopera- innovative ideas. Okun (1975) argues that tive insurance). there is a negative relationship between poli- 11. Financialization is a term sometimes used to cies addressed to reducing inequality and pro- describe the form of financial capitalism that ductivity and coined the term “equity-efficiency developed between 1980 and 2010, in which trade-off.” Kaldor (1955) argues that since financial leverage tended to override capital rich people have a higher saving rate than (equity), and financial markets tended to dom- poor people, higher inequality results in higher inate over the traditional real sector economy. savings and capital accumulation, which spur 12. The Qur’Ɨn is the holy book of Islam. The sun- economic growth. nah are established practices that Muslims 3. From a different perspective, and drawing on are required to follow, embodied in h. ƗdƯth, or extensive empirical data and theory, Kuznets verified reports of the utterances, actions, and (1955) argues that at the early stages of eco- tacit approvals of the Prophet Mohammed. nomic development, equality declines, but as 13. The financial sector and its lobbyists are often the development process proceeds, there will accused of resisting any substantial regulation be a turning point as equality begins to that attempts to restrict the sector’s risky improve. He postulates that the relationship behavior. If one believes the accusation of between economic development and inequal- Nobel laureate Joseph Stiglitz that the finan- ity is in the form of an equality U-curve or an cial sector in the United States prefers to inequality inverse U-curve. return to the golden (unregulated) days before 38 ISLAMIC FINANCE AND SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
the crisis (Stiglitz 2014), the world is in for Askari, Zamir Iqbal, Noureddine Krichene, another financial and humanitarian catastro- and Abbas Mirakhor, 75–81. Singapore: John phe (Graafland and van de Ven 2011). Wiley & Sons (Asia). 14. Arrow (1971, 121–33, 143, 239–66) demon- Askari, Hossein, Zamir Iqbal, Noureddine strated that in a competitive market economy, Krichene, and Abbas Mirakhor, eds. 2010. in which markets are complete and Arrow The Stability of Islamic Finance: Creating a securities whose payoffs are State-contingent Resilient Financial Environment for a Secure are available, it would be Pareto optimal for Future. Singapore: John Wiley & Sons (Asia). the economy if its members were to share risk Askari, Hossein, and Abbas Mirakhor. 2014. according to each participant’s ability to bear “Risk Sharing, Public Policy and the Contribu- risk (Askari and Mirakhor 2014). tion of Islamic Finance.” PSL Quarterly Review 15. For example, a World Bank study estimates 67 (271): 345–79. the resource shortfall to close the poverty gap in countries using zakƗt collection and finds Askari, Hossein, Zamir Iqbal, and Abbas Mira- that 20 out of 39 OIC countries could lift the khor. 2015. Introduction to Islamic Econom- poorest, living on less than $1.25 per day, ics: Theory and Application. Singapore: John above the poverty line simply with adequate Wiley & Sons (Asia). zakƗt collection (Mohieldin and others 2011). Bowles, Samuel. 2012. The New Economics of See also chapter 8. Inequality and Redistribution. Cambridge, U.K.: Cambridge University Press. Chapra, Muhammad Umer. 2007. Islam and Eco- References nomic Development: A Strategy for Develop- Acemoglu, Daron. 2002. “Technical Change, ment with Justice and Stability. New Delhi: Inequality, and the Labor Market.” Journal of Adam Publishers. Economic Literature 40 (1): 7–72. Cingano, F. 2014. “Trends in Income Inequality AFD (Agence Française de Développement), Bun- and Its Impact on Economic Growth.” OECD desministerium für Wirtschaftliche Zusam- Social, Employment and Migration Working menarbeit und Entwicklung, U.K. Department Paper 163, Organisation for Economic Co- for International Development (DFID), and the operation and Development, Paris. World Bank. 2005. Pro-Poor Growth in the Credit Suisse. 2013. Global Wealth Report 2013. 1990s: Lessons and Insights from 14 Coun- Zurich: Credit Suisse. tries. Washington, DC: World Bank, on behalf Deutsche Bank Research. 2014. Mapping of the Operationalizing Pro-Poor Growth the World’s Financial Markets. https://etf. Research Program. deutscheawm.com/ITA/ITA/Download / Rese Ahmed, Habib. 2015. “The Role of Islamic arch-Global/47e36b78-d254-4b16-a82f-d5c Finance in Achieving Sustainable Development 5f1b1e09a/Mapping-the-World-s-Financial- Goals and Shared Prosperity.” Paper presented Markets.pdf. at the inaugural World Bank-Islamic Develop- Dobbs, Richard, Susan Lund, Jonathan Woetzel, ment Bank-Guidance Financial Symposium on and Mina Mutafchieva. 2015. Debt and (Not Islamic Finance and Shared Prosperity, Istan- Much) Deleveraging. London; Washington, DC; bul, September 8–9. Shanghai, China; Brussels: McKinsey Global Al-Hasani, Baqir, and Abbas Mirakhor. 2003. Iqtisad: Institute. The Islamic Approach to Economic Problems. EC (European Commission). 2012. Literature New York: Global Scholarly Publications. Review on Income Inequality and the Effects Arrow, K. J. 1971. Essays in the Theory of Risk- on Social Outcomes. Brussels: European Com- Bearing. Chicago, IL: Markham Publishing mission Publications Office. Company. Economist. 2015. “A Senseless Subsidy; Ending Askari, Hossein, Zamir Iqbal, and Noureddine the Debt Addiction.” May 16. Krichene. 2010. “The Inherent Stability of Egawa, Akio. 2013. “Will Income Inequality Cause Islamic Finance.” In The Stability of Islamic a Middle-income Trap in Asia?” Bruegel Work- Finance: Creating a Resilient Financial Envi- ing Paper 2013/06, Brussels European and ronment for a Secure Future, edited by Hossein Global Economic Laboratory, Brussels. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC FINANCE AND SHARED PROSPERITY 39
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———. 2014. “Reforming Taxation to Promote UNCTAD (United Nations Conference on Trade Growth and Equity.” Roosevelt Institute White and Development). 2014. The Trade and Devel- Paper, Roosevelt Institute, New York. opment Report 2014: Global Governance and Townsend, R. 1979. “Optimal Contracts and Com- Policy Space for Development. New York: United petitive Markets with Costly State Verification.” Nations. Journal of Economic Theory 22: 265–93. Working for the Few. 2014. “Political Capture and UN (United Nations). 2014. The Millennium Economic Inequality.” Briefing Paper 178, Oxfam Development Goals Report 2014. http://www GB for Oxfam International, Oxford, U.K. https:// .un.org/millenniumgoals/2014%20MDG%20 www .oxfam .org /sites/www.oxfam.org/files Report/MDG%202014%20English%20 /file_ attachments /bp-working-for -few-political web.pdf. -capture -economic- inequality-200114-en_3.pdf. 2 The State of Development and Shared Prosperity in OIC Countries
his chapter provides a brief overview of The Millennium Development Goals Teconomic development in the 57 coun- At the turn of the new millennium, all member- tries belonging to the Organisation states of the United Nations and more than 20 of Islamic Cooperation (OIC) in relation to international organizations identified eight the goals of the World Bank Group, Islamic development goals, known as the Millennium Development Bank, and other multilateral 1 Development Goals (MDGs), and pledged to development institutions. The aim is to pro- achieve them by 2015. The eight goals aimed vide an overview of the state of development to achieve the following: and shared prosperity in those countries and to identify the gaps in meeting the goals set 1. Eradicate extreme poverty and by the global development community. Such hunger an analysis is vital for formulating effective 2. Achieve universal primary education policy responses in OIC countries, some of 3. Promote gender equality which are facing serious development and 4. Reduce child mortality income distribution issues. 5. Improve maternal health
GLOBAL REPORT ON ISLAMIC FINANCE 41 42 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
6. Combat HIV/AIDS, malaria, and other ratio of people living in extreme poverty (on diseases less than $1.25 a day) has declined consider- 7. Ensure environmental sustainability ably among OIC countries and worldwide. 8. Develop a global partnership for However, there is a great variation between development. the distributions of the ratio of people liv- ing on less than $1.25 a day. The trend lines Good progress has been made, and some of clearly indicate that the reduction of the pov- the development goals have been met ahead of erty among the OIC member-countries was the target deadline. Figure 2.1 presents prog- much faster than their non-OIC counterparts ress in the first five MDGs as of 2014. The red in almost all income groups, as highlighted dotted line represents the MDG target for every with solid lines in figure 2.2. metric. For the sake of brevity, the comparison Figure 2.3 presents the regional distri- is reported at the level of the world compared bution of poverty ratios by both measures. with the OIC countries as a group.2 Except As expected, the region that is worst off in for goal 1, of reducing the extreme poverty by terms of people living in extreme poverty is 50 percent, no other MDGs were attained by Sub-Saharan Africa. In contrast, East Asian either the world or the OIC countries. In terms nations succeeded in reducing the extreme of comparative performance, the OIC countries poverty ratios significantly between 1990 as a group, on average, did not deviate signifi- and 2014, thanks to their high growth rates. cantly from the world as a group. The world has witnessed a reduction by half in the share of people living under The State of Shared Prosperity extreme poverty; however, this success has Despite progress made toward reducing not been distributed evenly across different extreme poverty ahead of the target deadline, income groups or regions. Figure 2.2 shows the gap between the rich and poor has wid- the state of poverty according to two different ened, especially after the global financial crisis. benchmarks: the poverty headcount ratios at The proceeds of the economic growth seemed $1.25 a day and at $2 a day, grouped by dif- to be concentrated in the very top layer of ferent income levels.3 Overall, the headcount economies, creating social unrest.
FIGURE 2.1 Progress in Meeting Millennium Development Goals 1–5
Goal 5: Reduce maternal mortality ratio by 75 percent between World 49.58 1990 and 2015 (as of 2014, divide the value of 2014 by the value OIC 49.99 of 1990)
Goal 4: Reduce child mortality by two-thirds between 1990 and World 45.96 2015 (as of 2014, divide the value of 2014 by the value of 1990) OIC 47.63
Goal 3: Eliminate the gender disparity in secondary enrollment World 3.40 (as of 2014, subtract the value of 2014 from 100 to find the gap) OIC 9.32
Goal 2: Achieve universal primary education World 9.90 (as of 2014, subtract the value of 2014 from 100 to find the gap) OIC 15.71
Goal 1: Halve extreme poverty between 1990 and 2015 World 41.37 (as of 2014, divide the value of 2014 by the value of 1990) OIC 58.04
08010 20 30 40 50 60 70 Percentage of 1990 levels
Source: http://mdgs.un.org/unsd/mdg/Data.aspx. Note: The red dotted line indicates the MDG targets for each subcategory. OIC = Organisation of Islamic Cooperation. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 43
FIGURE 2.2 Poverty Headcount Ratios, Income-Level Classification Percentage of population
a. $1.25 a day (PPP) Upper-middle-income Lower-middle-income Low-income 50 75 40 45 70 30 65 35 60 20 25 55 10 50 Non-OIC and world Non-OIC and world 0 Non-OIC and world 15 45 1990 1995 2000 2005 2010 2014 1990 1995 2000 2005 2010 2014 1990 1995 2000 2005 2010 2014
b. $2 a day (PPP) Upper-middle-income Lower-middle-income Low-income 90 60 80 50 85 40 70 80 30 60 20 75 10 50 Non-OIC and world Non-OIC and world
0 Non-OIC and world 40 70 1990 1995 2000 2005 2010 2014 1990 1995 2000 2005 2010 2014 1990 1995 2000 2005 2010 2014 Non-OIC World OIC Linear (Non-OIC) Linear (OIC)
In the upper-middle-income group, OIC In the lower-middle-income group, the In the low-income group, OIC countries countries are better off compared to pace of poverty reduction in the OIC group reduce extreme poverty more effectively non-OIC countries for both poverty metrics. is steeper than the non-OIC group. than the non-OIC countries, especially However, the pace of reduction of extreme Furthermore the rate of poverty eradication between 1990 and 2014 on both metrics. poverty has stalled, especially after 2005. is steeper for the $2 a day metric.
Source: Compiled using data from World Bank World Development Indicators (WDI) database. Note: OIC = Organisation of Islamic Cooperation; PPP = purchasing power parity.
Figure 2.4 makes it clear that the share of by only 6 percent. For the lower-income group, the income going to the top 10 percent is sig- the gap is narrowing in OIC countries; how- nificantly higher than the income of the rest ever, in non-OIC, the per capita income for of the deciles throughout the world. This is the bottom 40 percent increased at almost the the case for both OIC countries and non-OIC same rate as the total population from 2007 countries. to 2014. The growth rate in per capita income Figure 2.5 presents survey data on con- for the non-OIC group is much higher than sumption or income (depending on the type of that of the OIC group. While in the upper- survey) of the bottom 40 percent and the total middle-income group, the growth rate of per population. Unfortunately, the lack of contin- capita income for the total population and the uous survey data hampers analysis. However, bottom 40 percent within the group for OIC based on the available data, the figure depicts countries and non-OIC countries is not very the state of OIC and non-OIC countries with different, the growth rate for non-OIC coun- respect to regional and income classifications. tries is higher than that of the OIC group. The Panel a of figure 2.5 compares the non- slower growth rates for the OIC group clearly OIC and OIC member-countries. The OIC indicate the need for a policy response to boost countries in the lower-middle-income group the distribution of economic growth overall, as increased the income for the bottom 40 per- well as for the bottom 40 percent. cent of their populations by 10 percent, while Figure 2.6 analyzes whether the gap the income of the total population increased between per capita consumption (income) 44
FIGURE 2.3 Poverty Headcount Ratios, Regional Classification Percentage of population
a. $1.25 a day (PPP) 15 11.46 100 60 10 50.53 47.25 4.79 50 5 50 26.82 23.31 1.81 0.30 14.48 6.79 40 0 0 30 OIC Non-OIC OIC Non-OIC OIC Non-OIC OIC Non-OIC OIC Non-OIC Europe and Latin America and East Asia and South Asia Sub-Saharan Africa Central Asia the Caribbean Pacific
b. $2 a day (PPP) 30 100 58.68 85 18.02 80 62.60 80 75.47 20 60 75 9.86 39.04 70.47 10 7.42 40 19.91 70 0.94 20 65 0 0 60 OIC Non-OIC OIC Non-OIC OIC Non-OIC OIC Non-OIC OIC Non-OIC Europe and Latin America and East Asia and South Asia Sub-Saharan Africa Central Asia the Caribbean Pacific
1990 1995 2000 2005 2010 2014 Poverty declined for OIC and non-OIC countries in both Poverty declined considerably in East Asia and Pacific Between 1990 and 2000, the ratio of people living in regions according to both metrics. However, the poverty and South Asia for both OIC and non-OIC countries. extreme poverty increased in Sub-Saharan Africa but ratios in OIC countries remained flat or even increased in However, the pace of decline seems to have slowed started declining in the 2000s. The net reduction in the same period. down in OIC countries for the $2 a day metric. poverty among OIC countries since 2000 was better compared with non-OIC countries. Overall, OIC countries marginally lagged non-OIC countries.
Source: Compiled using data from World Bank World Development Indicators (WDI) database. Note: OIC = Organisation of Islamic Cooperation; PPP = purchasing power parity. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 45
FIGURE 2.4 Income Distribution by Decile
a. Selected OIC countries Albania Yemen, Rep. 60 Algeria Uganda Azerbaijan Turkmenistan 50 Bangladesh Turkey Benin 40 Tunisia Burkina Faso Togo 30 Cameroon Tajikistan Chad 20 Syrian Arab Republic Comoros Suriname 10 Côte d’Ivoire Sierra Leone Djibouti Senegal 0 Egypt, Arab Rep. Pakistan Gabon Nigeria Gambia, The Niger Guinea-Bissau Mozambique Guinea Morocco Guyana Mauritania Iran, Islamic Rep. Mali Iraq Maldives Jordan Malaysia Kazakhstan Kyrgyz Republic
b. Selected non-OIC countries Zambia AngolaAustralia Vietnam Belarus 60 Uruguay Belize United Kingdom Bolivia 50 Trinidad and Tobago Botswana Thailand 40 Bulgaria Switzerland Cabo Verde Swaziland 30 Canada St. Lucia Chile Spain 20 Congo, Dem. Rep. Slovenia Seychelles 10 Costa Rica São Tomé and Príncipe Czech Republic 0 Dominican Republic Russian Federation Poland El Salvador Peru Ethiopia Papua New Guinea Finland Norway Georgia Netherlands Ghana Namibia Guatemala Moldova Honduras Mauritius Iceland Madagascar Israel Luxembourg Liberia Latvia Kenya Jamaica
1st decile 2nd decile 3rd decile 4th decile 5th decile 6th decile 7th decile 8th decile 9th decile 10th decile
Source: Compiled using data from World Bank World Development Indicators (WDI) database. 46 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 2.5 Per Capita Income (Consumption) of the Bottom 40 Percent and the Total Population 2005 PPP $ per day
a. Income level classification
4 10 8.439 2.950 7.193 3 1.953 1.811 1.794 2 5 1 0 0 Lower-middle- Lower-middle- Low-income Low-income Upper-middle-income OIC Upper-middle-income non-OIC income OIC income non-OIC OIC non-OIC
2007 (bottom 40%) 2007 total population 2014 (bottom 40%) 2014 total population
For the lower-middle-income group, the OIC countries follow the same The upper-middle-income OIC countries fared better than the trend as non-OIC countries. They have similar measures for the low- non-OIC countries on both measures in 2007 and 2014. The two income group. segments of the population had similar growth rates.
b. Regional classification 15 13.290 4 3.599 9.494 10.000 3 10 2.087 2.287 1.584 4.796 2 5 1 0 0 OIC Europe and Non-OIC OIC Middle Non-OIC Middle OIC Non-OIC OIC Non-OIC Central Asia Europe and East and East and Sub-Saharan Sub-Saharan South Asia South Asia Central Asia North Africa North Africa Africa Africa
2007 (bottom 40%) 2007 total population 2007 (bottom 40%) 2014 total population
The share of the bottom 40 percent as well as total population increased Whereas the distribution for the total population increased in both for both OIC and non-OIC countries in Europe and Central Asia, as well as OIC and non-OIC countries, the growth in distribution of the bottom for Middle East and North African countries. 40 percent in OIC countries took place at a slower pace.
Source: Calculations using data from World Bank World Development Indicators (WDI) database. Note: OIC = Organisation of Islamic Cooperation; PPP = purchasing power parity.
FIGURE 2.6 Change in the Gap between Per Capita Consumption (Income) of the Bottom 40 Percent and the Overall Population between 2007 and 2014
1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0 Upper-middle- Lower-middle- Low-income Aggregate Europe and Middle East and Sub-Saharan South Asia income income Central Asia North Africa Africa OIC Non-OIC
Source: Calculations using data from World Bank World Development Indicators (WDI) database. Note: OIC = Organisation of Islamic Cooperation. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 47
of the bottom 40 percent and overall popu- perspective on economic development was lation increased or decreased between 2007 presented as based on four pillars: and 2014. To be more specific, the gap between the bottom 40 percent and the 1. An institutional framework and public overall population (Δ) was calculated as the policy in line with the objectives of Islam difference between the gaps in 2007 and 2. Prudent governance and accountable 2014 to observe whether that gap between leadership the bottom 40 percent and overall popula- 3. Promotion of the economy and entrepre- tion in terms of income per capita has been neurship based on risk sharing increasing or decreasing. A positive value for 4. Financial and social inclusion for all. Δ implies that the relative position of the bot- tom 40 percent has worsened. Overall, the This section takes this general framework gap was positive in all countries, but more as the starting point and examines the state so in non-OIC countries. This indicates that of each pillar to enhance our understanding the bottom 40 percent were worse off in all to suggest an adequate policy response. Since regions, but the disparity in OIC countries each component is a composite of various was lower compared to other countries in variables, some of which are not directly the region. In other words, the relative gap observable, proxies are used to analyze the between the bottom 40 percent and overall state of each component. Given the complexi- population diverged less in OIC countries ties of the framework and the broad nature than that in non-OIC countries. It is difficult of the components, developing a comprehen- to attribute this trend to any specific factor; sive analytical tool would require extensive it could be a result of various factors that effort and resources. This section includes a require further research. very broad analysis to get a sense of the state of affairs without delving too deeply into subcomponents. Several studies have been The State of the Pillars of the Economic undertaken to determine the observation Development Framework of Islamic and implementation of Islamic principles in Finance Islamic countries.4 Chapter 1 presented a theoretical framework Table 2.1 presents these proxies, which of how inclusive growth and shared prosper- are used to quantify the relative status of ity could be achieved through principles of OIC countries with respect to other coun- Islamic economics and finance. The Islamic tries according to several classifications.
TABLE 2.1 Factors to Measure Core Development Components Dimension Proxy Institutional framework and public policy Rule of Law Index Governance and leadership Government Effectiveness Index Risk sharing and entrepreneurship Correlation between real GDP and consumption Relative value of market capitalization of listed companies Financial and social inclusion Alternative sources of funding (percentage of population, age 15+) CPIA (Country Policy and Institutional Assessment) policies for social inclusion/equity cluster average Financial sector depth and interaction with shared Domestic-credit-to-private-sector ratio (percentage of GDP) prosperity and poverty reduction Gross-portfolio-debt-assets-to-GDP ratio (percent) Gross-portfolio-equity-assets-to-GDP ratio (percent) 48 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
Additional measures are included to under- the world and the OIC group, with the low- stand the dynamics of the financial sector income group at the bottom. Since, as men- with respect to poverty and shared prosperity. tioned, economic growth is the main force that reduces poverty, strengthening the legal Institutional Framework and system should be a priority in supporting Public Policy development in OIC countries. In particular, the largest discrepancy between OIC and non- A well-established institutional framework is OIC countries is in the lower-middle-income one of the major requirements for Islamic group, which constitutes roughly 54 percent finance to flourish and to achieve fairness in a of the overall OIC population. Hence, policy society. In a panel of around 100 countries makers from these countries should especially from 1960 to 1990, Barro (1996) finds that focus on strengthening the legal system. among other factors, better maintenance of the rule of law enables countries to grow Governance and Leadership faster. He argues that a country where rule of law principles are strongly adhered to would Sound public policy is essential to providing grow faster because the environment for services in an efficient manner and addressing investment would be sound. the needs of the public. Strong leadership is The core foundation of a sound institu- needed to implement the necessary reforms. tional framework is the strength of the legal Conversely, the lack of a well-functioning structure. To assess the quality of the institu- and effective government could result in an tional framework in OIC countries, the World environment that is chaotic and unfriendly Bank’s Rule of Law Index is used as a proxy. toward market practices and economic The Rule of Law Index, shown in figure 2.7, growth. For example, Middle East and North captures the essential elements that should African countries with better measures of be present in a well-functioning judicial sys- political stability, government effectiveness, tem. The values of this index range between and corruption control metrics grow by as −2.5 (weak) and 2.5 (strong). On aggregate, much as 2.5 percentage points a year faster in the value of the index was below zero in both terms of GDP than those that score lower in
FIGURE 2.7 Rule of Law Index, Income-Level Classification
1.5
1.0
0.5
0
–0.5
–1.0
–1.5 OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OICNon-OIC World OIC World High-income Upper-middle- Lower-middle- Low-income Aggregate income income 1996 1998 2000 2005 2010 2013
Source: http://info.worldbank.org/governance/wgi/index.aspx#home. Note: The Rule of Law Index captures perceptions of the extent to which agents have confidence in and abide by the rules of society, particularly the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. The estimate gives the country’s score on the aggregate indicator, in units of a standard normal distribution, ranging from approximately −2.5 to 2.5. OIC = Organisation of Islamic Cooperation. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 49
these indicators, according to Han, Khan, and financing, is risk sharing. Quantifying the Zhuang (2014). extent of risk sharing in an economy is very Good governance also ensures that the difficult because risk sharing is an abstract rights of shareholders and all stakeholders term that encompasses many channels, will be protected. This will promote invest- including the welfare state, financial global- ment because investors will feel secure in ization, and revenues from the export of nat- making investments. Good governance will ural resources. Despite these difficulties, a also strengthen the soundness and effective- proxy for risk sharing—the inverse of the ness of institutions. Rodrik, Subramanian, correlation between domestic aggregate con- and Trebbi (2004) analyze the relative contri- sumption and GDP—can be used. If there is butions of institutions, geography, and trade perfect risk sharing in a given economy, then in determining income levels around the the evolution of consumption should not be world and conclude that the quality of insti- determined solely by movements of income; tutions “trumps” everything else.5 other factors would smooth the negative and To capture the state of the quality of positive effects on the consumption (Kalemli- governance, the World Bank’s Government Ozcan, Sørensen, and Yosha 2003). Effectiveness Indicators (GEI) are used as a As figure 2.9 shows, the correlation proxy. Figure 2.8 shows that on average, the between consumption and income is very countries from the lower- and lower-middle- high, but on an aggregate level, OIC coun- income group have low GEI scores, trailing tries seem to be faring better in terms of risk non-OIC countries from the same group in sharing than the world as a whole (that is, terms of the effectiveness of government. the correlation of OIC countries is lower). However, it is important to keep this result Risk Sharing and Entrepreneurship in regional context. The slightly lower corre- lation between income and consumption in A core concept of Islamic finance, which OIC countries might not necessarily indicate clearly distinguishes it from conventional better risk sharing, but might reflect the high
FIGURE 2.8 Government Effectiveness Index, Income-Level Classification
1.3
0.8
0.3
–0.2
–0.7
–1.2 OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC World
High-incomeUpper-middle-incomeLower-middle-income Low-income Aggregate
1996 2005 2013
Source: http://info.worldbank.org/governance/wgi/index.aspx#home. Note: The government effectiveness index captures perceptions of the quality of public services, the quality of the civil service, and the degree of its indepen- dence from political pressures; the quality of policy formulation and implementation; and the credibility of the government’s commitment to such policies. Estimate gives the country’s score on the aggregate indicator, in units of a standard normal distribution, ranging from approximately −2.5 to 2.5. OIC = Organisation of Islamic Cooperation. 50 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 2.9 Correlation between Consumption and Real GDP, Income-Level Classification
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC World High-income Upper-middle-income Lower-middle-income Low-income Aggregate
Source: http://www.rug.nl/research/ggdc/data/pwt/pwt-8.1. Note: Consumption includes both private and government consumption. The Penn World Table (PWT), upon which this figure is based, is a set of national accounts data developed and maintained by scholars at the University of California, Davis, and the Groningen Growth Development Centre of the University of Groningen, the Netherlands, to measure real GDP across countries and over time. Successive updates have added countries (currently 167), years (1950–2011), and data on capital, productivity, employment, and population. OIC = Organisation of Islamic Cooperation.
level of oil revenues that have accumulated in such as Islamic finance cannot be envisioned. sovereign wealth funds, which could offset the Hence in order for OIC countries to grow negative effect of recessions on consumption, faster in a development model based on risk hence weakening the correlation between sharing, stock markets must play an essential income and consumption. role; to materialize, OIC countries need to In all income levels, OIC countries per- reform legal and governance structures and form better than non-OIC countries. A value strengthen their institutions. of 1 indicates that OIC and non-OIC coun- tries are on a par. In all income groups and Financial and Social Inclusion regions, the relative ratio is less than 1. The relative spikes in 1995 could partially be While Islamic principles stress the importance explained by the booms and busts in com- of hard work and free market enterprise where modity markets, which might be important everyone is expected to contribute according for OIC countries. to his or her ability, they also emphasize that Stock market development is positively individuals who are left behind should be pro- and robustly associated with long-term eco- tected and provided with the basic needs that nomic growth, Levine and Zervos (1996) would enable them to live their life in a find, using cross-country growth regressions. humane way. Figure 2.10 presents the relative value of mar- To analyze the extent of financial inclu- ket capitalization to GDP between OIC and sion in the world and in OIC countries, non-OIC countries. Since Islamic finance two metrics were used. Figure 2.11 depicts is based on risk sharing and has an asset- the various sources people use in obtaining backed nature, one would expect to see a funds. A value of 1 indicates that OIC and higher ratio of this metric among OIC coun- non-OIC countries are on a par. A value tries compared to the others. However, due greater than 1 indicates that OIC countries to the less developed capital markets for equi- use a particular type of funding more exten- ties and asset-based securities, the OIC coun- sively than non-OIC countries. In almost tries’ relative performance is not impressive. all income groups and regions, the relative Without developed capital markets, the full ratio is less than 1. The use of formal finan- potential of a risk-sharing financial system cial institutions is limited in OIC countries GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 51
FIGURE 2.10 Relative Value of Market Capitalization of Listed Companies, Ratio of OIC to Non-OIC Countries Percentage of GDP
3.0
2.5
2.0
1.5
1.0
0.5
0
World income income Africa South Asia High-income Low-income Europe and Upper-middle- Lower-middle- Sub-Saharan Central Asia Middle NorthEast and Africa Latin Americathe Caribbean and East Asia and Pacific
1990 1995 2000 2005 2010 2014
Source: Calculated using data from http://data.worldbank.org/indicator/CM.MKT.LCAP.GD.ZS. Note: A value of 1 indicates that OIC and non-OIC countries are on a par. Market capitalization (also known as market value) is the share price times the number of shares outstanding. Listed domestic companies are the domestically incorporated companies listed on the country’s stock exchanges at the end of the year. Listed companies do not include investment compa- nies, mutual funds, or other collective investment vehicles. OIC = Organisation of Islamic Cooperation.
FIGURE 2.11 Sources People Use to Obtain Funds, Ratio of OIC to Non-OIC Countries, Regional and Income-Level Classification Percentage of population age 15+
8 7 6 5 4 3 2 1 0 High-income Upper-middle- Lower-middle- Low-income Europe and Middle East Sub-Saharan East Asia South Asia World income income Central Asia and North Africa Africa and Pacific
Borrowed from a financial institution Borrowed from a private informal lender Borrowed from a store by buying on credit Borrowed from an employer Borrowed from family or friends
Source: Calculated using data from http://datatopics.worldbank.org/financialinclusion/ (Findex) 2011. Note: A value of 1 indicates that OIC and non-OIC countries are on a par. OIC = Organisation of Islamic Cooperation. compared to non-OIC countries. Other the population is condensed rather than dis- sources—such as private informal lenders, persed, where citizens have higher income per buying on credit, or borrowing from family capita, and/or where the banking system is or friends—are more common. more competitive may find it easier to provide Several factors could affect the level of financial services to their citizens. In addi- access of citizens in a country to finan- tion, some individuals may stay away from cial services. For example, countries where financial services due to religious principles. 52 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
Demirgüç-Kunt, Klapper, and Randall (2014) Financial Sector Depth and Interaction find that Muslims are less likely to have an with Shared Prosperity and Poverty account at official financial institutions. This Reduction could be one factor that explains the patterns for OIC countries depicted in figure 2.11. The positive relationship between financial sec- Figure 2.12 is intended to capture the tor development and economic development degree of social inclusion in the world and in has been well established; various studies have OIC countries. In terms of social inclusion, shown the contribution of a developed finan- 6 OIC countries lag behind the world on an cial sector to overall economic growth. In this aggregate basis. respect, it is important to understand the The figure depicts the World Bank’s social degree of financial sector development in any inclusion metric as a ratio of OIC to non- country. It is particularly important for a risk- OIC countries. OIC countries in the upper- sharing financial system such as Islamic middle-income and Europe and Central Asia finance, which requires a well-developed finan- regions have greater social inclusion than cial sector with reduced information their counterparts in the same classification. asymmetry. Variations in the social inclusion metric The next three figures examine the finan- across countries could have various sociologi- cial depth of countries with respect to certain cal, economic, political, and other dimensions. metrics. Figure 2.13 examines domestic credit Minorities and different ethnic and religious to the private sector as a ratio of GDP and groups could be marginalized, depending on compares the OIC and non-OIC countries the historical and cultural situation of a coun- belonging to the same income-level groups. try. Income level could be another factor that The OIC group in all income-level groups could make it difficult for certain individuals lags the non-OIC group, implying that the to participate in the society productively, uti- financial sector in select OIC countries is in lize education and health care, and earn a liv- the early stages of development and, with ing. Hence, when trying to pinpoint the root further development, could contribute to eco- causes of the social exclusion in their coun- nomic growth. In addition, businesses do not tries, policy makers in OIC countries should usually borrow from financial institutions; take a broad perspective and design policies to this could be due to lack of access to financial effectively deal with these causes. services or to voluntary religious constraints
FIGURE 2.12 Social Inclusion, Ratio of OIC to Non-OIC Countries
World South Asia Sub-Saharan Africa Latin America and Caribbean Europe and Central Asia Low-income Lower-middle-income Upper-middle-income 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4
Source: Calculated using data from http://data.worldbank.org/indicator/IQ.CPA.SOCI.XQ/countries. Note: A value of 1 indicates that OIC and non-OIC countries are on a par. The figure presents the Country Policy and Institutional Assessment policies for social inclusion/equity cluster average. The policies for social inclusion and equity cluster include gender equality, equity of public resource use, building human resources, social protection and labor, and policies and institutions for environmental sustainability. Scores range from a low of 1 to a high of 6. OIC = Organisation of Islamic Cooperation. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 53
FIGURE 2.13 Domestic Credit to the Private Sector Percentage of GDP
160 140 120 100 80 60 40 20 0 OIC OIC World OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC World High-income Upper-middle-income Lower-middle-income Low-income Aggregate
1985–90 1990–95 1995–2000 2000–05 2005–10 2010–13
Source: Calculated using data from http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS. Note: Domestic credit to the private sector refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable that establish a claim for repayment. OIC = Organisation of Islamic Cooperation. on borrowing from conventional modes In the aggregate, OIC countries have of financing. This practice underscores the reduced the amount of debt assets in their importance and potential of the provision of portfolios, while that ratio has been increas- Islamic finance in the OIC member-countries. ing in the world. Similarly, in the aggregate, Using the World Bank’s Business Enter- OIC countries have reduced the amount of prise surveys, Bhattacharya and Wolde equity assets in their portfolios in recent (2012) quantify the impact of the various years, while the same ratio has been increas- constraints faced by local businesses in the ing in the world. This could indicate a shift Middle East and North Africa (MENA) toward alternative asset classes, but further Region and conclude that the main difficul- analysis and research is required to under- ties are access to finance, labor skill mis- stand these trends. matches and shortages, and constraints on electric power. Hence easing the financial Policy Response access to firms and individuals in the MENA Region would promote growth and speed up While there is strong theoretical support for their convergence to better-off nations. Islamic economics and finance to lead to sus- Figures 2.14 and 2.15 analyze the forms tainable growth and enhance shared prosper- of financing (equity versus debt financing) ity, the enabling environment is lacking to relative to GDP, and contrast OIC countries reap the benefits. Public policy measures are to non-OIC countries belonging to the same needed to develop and strengthen institutions income level groups. The objective is to deter- in key areas of governance, the legal system, mine how conducive a country is to developing and government effectiveness. In addition, risk-sharing finance as advocated by Islamic strengthening the financial sector in ways finance. Given the prohibition of interest-based that are conducive to risk-sharing finance debt by Islamic finance, the equities market based on the core principles of Islam should and asset-based securities market become the be the main objective of policy makers wish- preferred capital markets. Figure 2.14 shows ing to exploit the full potential of Islamic the gross-portfolio-debt-assets-to-GDP ratio, finance. Until these reforms are undertaken, it while figure 2.15 depicts the gross-portfolio- would be unrealistic to expect Islamic finance equity -assets-to-GDP ratio and contrasts OIC to fulfill the promise of developing a more countries to non-OIC countries belonging to stable, sustainable, and inclusive economic the same income level groups. system. 54 THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 2.14 Gross Portfolio Debt Assets to GDP Percentage of GDP
10 9 8 7 6 5 4 3 2 1 0 OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC World Upper-middle-income Lower-middle-income Low-income Aggregate 2000 2005 2010 2013
Source: Compiled using data from the World Bank Global Financial Development Database. Note: Ratio of gross portfolio debt assets to GDP. OIC = Organisation of Islamic Cooperation.
FIGURE 2.15 Gross Portfolio Equity Assets to GDP Percentage of GDP
8 7 6 5 4 3 2 1 0 OIC Non-OIC World OIC Non-OIC World OIC Non-OIC World OIC World Upper-middle-income Lower-middle-income Low-income Aggregate 2000 2005 2010 2013
Source: Compiled using data from the World Bank Global Financial Development Database. Note: Ratio of gross portfolio equity assets to GDP. Equity assets include shares, stocks, participation, and similar documents (such as American depository receipts) that usually denote ownership of equity. OIC = Organisation of Islamic Cooperation.
The analysis in this chapter assesses the Notes state of affairs with respect to trends in pov- 1. The Organisation of Islamic Cooperation erty alleviation and income distribution, (OIC) (formerly the Organisation of the Islamic which can be used by the policy makers to Conference) has a membership of 57 countries formulate policy interventions and to iden- spread over four continents, covering around tify areas to strengthen, keeping in mind the 1.7 billion people. It is the collective voice of objective of leveraging Islamic finance for the Muslim world, dedicated to ensuring and alleviating poverty and enhancing shared safeguarding the interests of the Muslim world prosperity. Chapter 9, the final chapter, pro- in the spirit of promoting international peace vides a road map for such policy measures. and harmony among various people of the world. http://www.oicun.org/. GLOBAL REPORT ON ISLAMIC FINANCE THE STATE OF DEVELOPMENT AND SHARED PROSPERITY IN OIC COUNTRIES 55
2. We are thankful to Ishrat Husain for urging References caution in making interpretations based on Askari, H., and S. Rehman. 2010. “An Economic aggregate data for a group as heterogeneous Islamicity Index.” Global Economy Journal 10 as the OIC. Furthermore, data on various (September): 1–37. variables used in this chapter are not con- sistent, as highlighted by Bello and Suleman ———. 2013. “A Survey of the Economic Devel- (2011). Hence, the interpretation should be opment of OIC Countries.” In Economic used cautiously. Development and Islamic Finance, edited by 3. For each five-year period, the latest available Zamir Iqbal and Abbas Mirakhor. Washington, data for every country were used. High-income DC: World Bank. OIC countries were excluded from the analysis Barro, Robert J. 1996. “Determinants of Economic because no data were available. The income Growth: A Cross-country Empirical Study.” and regional classifications are adopted from NBER Working Paper 5698, National Bureau World Bank Group classifications. Aggregate of Economic Research, Cambridge, MA. values were computed with a weighted aver- Bello, Abdullateef, and Areef Suleman. 2011. “The age, using the overall population of a given Challenge of Achieving the Millennium Develop- country. Data are in purchasing power parity ment Goals in IDB Member Countries in the Post- (PPP) terms. Crisis World.” IDB Occasional Paper 16, Islamic 4. For example, see Askari and Rehman (2010), Development Bank, Jeddah, Saudi Arabia. who construct an Islamicity index of various Bhattacharya, Rina, and Hirut Wolde. 2012. “Busi- countries. See also Askari and Rehman (2013). ness Environment Constraints on Growth in 5. Adam Smith, in The Wealth of Nations the MENA Region.” Middle East Development (1776), long ago recognized the significance Journal 4 (1): 1250004-1–125994-18. of the first two pillars as the prerequisites for the development model described in Demirgüç-Kunt, Asli, Leora Klapper, and Douglas chapter 1: “Commerce and manufactures Randall. 2014. “Islamic Finance and Finan- can seldom flourish long in any state which cial Inclusion: Measuring Use of and Demand does not enjoy a regular administration for Formal Financial Services among Muslim of justice, in which the people do not feel Adults.” Review of Middle East Economics and themselves secure in the possession of their Finance 10 (2): 177–218. property, in which the faith of contracts Feenstra, Robert C., Robert Inklaar, and Marcel is not supported by law, and in which the P. Timmer. 2015. “The Next Generation of the authority of the state is not supposed to be Penn World Table.” American Economic Review regularly employed in enforcing the payment 105 (10): 3150–82. http://www.ggdc.net/pwt. of debts from all those who are able to pay. Han, Xuehui, Haider Ali Khan, and Juzhong Zhuang. Commerce and manufactures, in short, can 2014. “Do Governance Indicators Explain seldom flourish in any state in which there Development Performance? A Cross-Country is not a certain degree of confidence in the Analysis.” Economics Working Paper 417, Asian justice of government” (cited in Rodrik, Sub- Development Bank, Manila. ramanian, and Trebbi 2004). Kalemli-Ozcan, Sebnem, Bent E. Sørensen, and Oved 6. In a seminal paper, Levine (1997) finds evi- Yosha. 2003. “Risk Sharing and Industrial Spe- dence suggesting a positive, first-order rela- cialization: Regional and International Evidence.” tionship between financial development and American Economic Review 93 (3): 903–18. economic growth. Enhancing financial ser- Levine, Ross. 1997. “Financial Development and vices could make it easier for firms to obtain Economic Growth: Views and Agenda.” Journal funds to make additional investments and of Economic Literature 35 (June): 688–726. for individuals to smooth their consumption and weather the negative income shocks to Levine, Ross, and Sara Zervos. 1996. “Stock Mar- their income stream. Furthermore, a well- ket Development and Long-Run Growth.” The functioning financial system not only chan- World Bank Economic Review 10 (26): 323–39. nels funds to the most efficient sectors, but Rodrik, Dani, Arvind Subramanian, and Francesco also enables risk and assets to be priced; such Trebbi. 2004. “Institutions Rule: The Primacy of prices are essential for reducing uncertainty Institutions over Geography and Integration in about future investments. All these factors Economic Development.” Journal of Economic contribute to economic growth. Growth 9 (2): 131–65.
3 The Islamic Banking Sector
he Islamic banking sector, which is the This wealth creation and its fair distribution Tdominant component of the Islamic ensure shared prosperity. Islamic banking finance industry, has grown dramati- contributes to shared prosperity through its cally since the first known experiment impact on economic growth, as a provider of started in the Egyptian village of Mit capital for economic activities, and through Ghamr in 1963. Today, more than 300 the characteristics of its products. Islamic Islamic finance institutions, with assets economics is normative in nature, with the close to $1.9 trillion (IFSB 2016), are spread objective of complying with shari‘ah across 50 economies around the world in (maqƗsid̙ al-sharƯ‘ah). The Islamic economy both Muslim and non-Muslim countries. is built upon a set of objectives, or maqƗsid,̙ This chapter discusses the theoretical chan- that are the underlying principles that pro- nels through which Islamic banking contrib- mote the well-being of all humanity.1 The utes to shared prosperity, presents an overview existence of Islamic finance and banking is of Islamic banking, examines the key chal- supported by these key Islamic principles, lenges facing Islamic banks, and offers policy which can be summarized as showing a pref- recommendations. erence for risk sharing over risk transfer through debt, prohibiting social and eco- nomic exploitation, emphasizing ethical Islamic Banking and Shared Prosperity standards, promoting moral and social val- The aspiration of Islamic banks is the cre- ues, and rewarding enterprise (linking risk ation, equitable distribution, and circulation and reward) that would boost shared pros- of wealth in order to promote social justice perity, as discussed in chapter 1. and to satisfy customers’ needs for shari‘ah- The Abu Halima projects in Sudan are a compliant investment opportunities. good illustration of the potential for Islamic
GLOBAL REPORT ON ISLAMIC FINANCE 57 58 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
banking to take advantage of business oppor- all economic actors. Islam banking adheres to tunities and enhance living conditions in low- certain conditions for financing real economic income settings (see box 3.1). Justice demands activities that help prevent the excessive expan- that resources be employed in a manner that sion of debt (Chapra 2011) and for moving benefits the whole of society and is accompa- the economy from a debt-based, risk-shifting nied by an underlying productive economic economy to a risk-sharing economy (Askari activity that generates real wealth. and others 2012). Islamic banking, in its essence, should help mobilize resources from a large spectrum of How Risk Sharing through Islamic the population, substantially increase the Banking Promotes Shared Prosperity share of equity financing in business, and Islamic banking is built on the principle of risk advance risk sharing in entrepreneurial activi- sharing in the financial system. Islamic financ- ties. A close examination of Islamic modes of ing instruments ensure that the sharing of the finance reveals that they keep finance tied to rewards from economic activity is not skewed real economic activity. Islamic modes of profit by individuals’ initial endowment of financial and loss–sharing share this characteristic, resources. Furthermore, the prohibition of whether through partnership (mushƗrakah), interest and usury is intended to create more agency (mud̙Ɨrabah), trade-based contracts favorable conditions for shared prosperity by such as deferred payment mark-up sales removing guaranteed returns and safeguarding (murƗbah̙ah), the sale of goods to be manu- the fair transfer of property and value among factured (istisn̙ Ɨ‘), or forward sales (salam).
BOX 3.1 Abu Halima Mud.arabah¯ Greenhouse Project in Sudan
This small project, located in Abu-Halima, a rural com- The project has the following characteristics: munity in north Khartoum, is an example of how • Beneficiaries: 125 families headed by college of Islamic banking products have the potential to contrib- agriculture graduates, forming one cooperative. ute to shared prosperity. This initiative by the Islamic • Business type: Greenhouses for production of Development Bank, the Bank of Khartoum (Sudan), 1,400 tons of vegetables annually. and the Central Bank of Sudan aims to empower low- • Mode of financing: MuG̙Ɨrabah (capital manage- income households by financing 125 graduates of col- ment). Profits are shared on a ratio of 40 percent leges of agriculture who work with their families to set for the project managers and 60 percent for the up and operate greenhouses through the profit-sharing bank. Losses are absorbed by the bank. However, contract of muGƗ̙ rabah (see details to follow). The proj- each family receives a living allowance throughout ect supports shared prosperity through two modalities. the production process, whether there is a loss First, by targeting low-income households, it or not. ensures an efficient way of reducing poverty and • Finance amount: $4 million for the cooperative, income inequality. One of the qualifying criteria is which works out to $30,000 for each family. that the young graduate’s income must not exceed • Partners: One technical consultant and two private twice the Sudanese minimum wage. supermarkets for commercialization. Second, by adopting profit sharing, the project helps low-income households build equity, acquire Today, these units are among the most important productive capacities, and develop human capital. providers of vegetables near Khartoum. The adopted mode of financing is restricted muG̙Ɨrabah, a joint venture in which the financier Source: Bank of Khartoum, Sudan. attaches some conditions to the use of funds. GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 59
This concept of financing helps promote How Islamic Banking Promotes Shared growth of the financial sector in tandem with Prosperity through Financial Stability that of the real sector. Risk sharing ensures that banks thor- The pass-through nature of Islamic banking oughly evaluate business proposals because eliminates the asset-liability mismatch inher- it creates an incentive for financial institu- ent in classical conventional banking, thereby tions to internalize costs related to bank- promoting a stable financial system. In case of ruptcy. In addition, risk sharing is a financial crisis, portfolios are balanced auto- implemented through equity-based financ- matically, and there is less need for any ing. This type of financing helps foster coop- bailouts by the governments (Askari and oth- eration, interdependence, and above all ers 2010). The built-in stabilizing feature of universal brotherhood by involving everyone Islamic banking could protect poor segments in both production and investment. of the society from the financing of bailouts Advocates of shifting the reliance from debt- through additional taxes and higher costs. based to equity-based financing are growing In this respect, shared prosperity can be pro- in mainstream economics. Greater reliance tected because the bottom 40 percent of the on equity also opens the door to greater population will be less burdened. demands by investors for shareholder values. The International Monetary Fund, in a How Islamic Banking Promotes Shared World Economic Outlook on the causes and Prosperity through Financial Inclusion indicators of financial crises, acknowledges the advantage of equity financing in sustain- The concepts of financial and social inclusive- ing financial stability, noting that foreign ness and income equality are central to direct investment, in contrast to inflows that Islamic economic teaching. Islamic finance create debt, is often regarded as providing a can be effectively used to address the issue of safer and more stable way to finance devel- financial inclusion (see box 3.2) because it opment (IMF 1998). can provide a viable alternative to conven- Although Islamic banking may not be the tional debt-based financing by promoting ultimate answer to improving socioeconomic risk-sharing contracts. It can also utilize spe- justice and shared prosperity, the ethical cific wealth redistribution instruments to aid aspects ingrained in the principles of Islamic access to finance for the poorest in society. banking can lead to increased transparency These instruments distribute income from the and social accountability, which in turn can wealthy and privileged to those defined as help societies achieve economic growth and poor and needy, through voluntary or invol- prosperity.2 untary levies (Mirakhor and Iqbal 2012).
BOX 3.2 Channels of Financial Inclusion from an Islamic Finance Perspective
Islamic financial services can address the issue of The users of formal Islamic financial services can financial inclusion with two approaches: by be categorized into user and nonuser groups. promoting risk-sharing contracts, which provide a Nonusers may not be able to access the financial viable alternative to conventional debt-based system (involuntary exclusion) or may opt out of the financing; and by using specific wealth redistribution financial system (voluntary exclusion) (figure B3.2.1). instruments (Mirakhor and Iqbal 2012). The financially excluded do not have access to the
box continues next page 60 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
BOX 3.2 Channels of Financial Inclusion from an Islamic Finance Perspective (continued)
financial system because they do not have enough and/or the informational and contractual framework income or present too high a lending risk; certain might prevent financial institutions from reaching segments of the population are subject to social, out to certain segments because outreach is too religious, ethnic, gender, or other discrimination; costly to be commercially viable.
FIGURE B3.2.1 Channels of Financial Inclusion
Financial inclusion
Users of formal Islamic Nonusers of formal financial services Islamic financial services
Voluntary Involuntary • No need/intention, cultural/ • Discrimination; price/contract religious reasons features; information gaps; insufficient income; high risk • Widening Islamic Islamic financial financial services • By promoting risk-sharing services offerings contracts, which provide a viable alternative to conven- tional debt-based financing • By specific instruments of redistributing wealth (volun- tary and involuntary levies) among the society
Source: Adapted from World Bank 2008.
This redistribution not only ensures social more than 40 million financially excluded justice, but also mobilizes resources, making individuals into the formal financial system. finance available to the poor and improving At present, however, the number of banks the productive capacity of the community. that offer shari‘ah-compliant financial ser- Table 3.1 shows the state of Islamic bank- vices per 10 million adults is low except in a ing and financial inclusion in selected few countries such as Bahrain, Kuwait, Muslim-majority countries. The degree of Malaysia, and Qatar (Zulkhibri 2016). religiosity3 is on average about 85 percent in Geographical reach is also limited for banks these countries, highlighting the important offering shari‘ah-compliant financial ser- role of religion in daily life and society. vices (as measured by such banks per About 9 percent of the population of these 10,000 square kilometers). Efforts to countries is financially excluded due to reli- increase financial inclusion in countries gious reasons (World Bank 2014). Hence with Muslim populations thus require sus- Islamic finance can play a role in bringing tainable mechanisms to be able to offer GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 61
TABLE 3.1 Islamic Financial Institutions and Financial Inclusion by Country
Religiosity and financial inclusion Islamic financial institutions (IFIs)
Adults with no Adults with no Account at a Islamic Number account due account due to Number Religiositya formal financial Number assets per of IFIs per Economy to religious religious reasonsb of IFIs per (%) institution of IFIs adultc 10 million reasonsb (thousands, 10,000 km2 (%, age 15+) ($) adults (%, age 15+) age 15+) Afghanistan 97 9.0 33.6 5,830 2 — 1.1 0.03 Albania 39 28.3 8.3 150 1 — 4.0 0.36 Algeria 95 33.3 7.6 1,330 2 — 0.8 0.01 Azerbaijan 50 14.9 5.8 355 1 — 1.4 0.12 Bahrain 94 64.5 0 0 32 29,194 301.6 421.05 Bangladesh 99 39.6 4.5 2,840 12 14 1.2 0.92 Benin — 10.5 1.7 77 0 0 0 0 Burkina Faso — 13.4 1.2 98 1 — 1.1 0.04 Cameroon 96 14.8 1.1 114 2 — 1.7 0.04 Chad 95 9.0 10.0 573 0 0 0 0 Comoros 97 21.7 5.8 20 0 0 0 0 Djibouti 98 12.3 22.8 117 0 0 0 0 Egypt, Arab Rep. 97 9.7 2.9 1,480 11 146 1.9 0.11 Gabon — 18.9 1.5 12 0 0 0 0 Guinea — 3.7 5.0 279 0 0 0 0 Indonesia 99 19.6 1.5 2,110 23 30 1.3 0.13 Iraq 84 10.6 25.6 4,310 14 98 7.4 0.32 Jordan — 25.5 11.3 329 6 1,583 15.4 0.68 Kazakhstan 43 42.1 1.7 126 0 0 0 0 Kuwait 91 86.8 2.6 7 18 28,102 87.2 10.10 Kyrgyz Republic 72 3.8 7.3 272 0 0 0 0 Lebanon 87 37.0 7.6 155 4 — 12.4 3.91 Malaysia 96 66.2 0.1 8 34 4,949 16.8 1.03 Mali 95 8.2 2.8 218 0 0 0 0 Mauritania 98 17.5 17.7 312 1 76 4.7 0.01 Morocco 97 39.1 26.8 3,810 0 0 0 0 Mozambique — 39.9 2.3 189 0 0 0 0 Niger 99 1.5 23.6 1,910 0 0 0 0 Nigeria 96 29.7 3.9 2,520 0 0 0 0 Oman — 73.6 14.2 78 3 — 14.4 0.10 Pakistan 92 10.3 7.2 7,400 29 40 2.5 0.38 table continues next page 62 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 3.1 Islamic Financial Institutions and Financial Inclusion by Country (continued)
Religiosity and financial inclusion Islamic financial institutions (IFIs)
Adults with no Adults with no Account at a Islamic Number account due account due to Number Religiositya formal financial Number assets per of IFIs per Economy to religious religious reasonsb of IFIs per (%) institution of IFIs adultc 10 million reasonsb (thousands, 10,000 km2 (%, age 15+) ($) adults (%, age 15+) age 15+) Qatar 95 65.9 11.6 64 14 13,851 86.5 12.08 Saudi Arabia 93 46.4 24.1 2,540 18 1,685 9.2 0.08 Senegal 96 5.8 6.0 411 0 0 0 0 Sierra Leone — 15.3 9.9 287 0 0 0 0
Sources: Bankscope; Global Findex; World Bank, World Development Indicators (database); World Bank 2014. Note: — = not available. a. Percentage of adults in a given country who responded affirmatively to the question, “Is religion an important part of your daily life?” in a 2010 Gallup poll. b. Number of adults and percentage of adults that point to a religious reason for not having an account at a formal financial institution. c. Islamic assets per adult ($)/Size of Islamic assets in the banking sector of an economy per its adult population.
shari‘ah-compliant financial services to all and households experiencing extreme poverty residents, especially the Muslim poor and (via zakƗt, sadaq̙ Ɨt, waqf, and collective risk near poor, estimated at around 700 million sharing); poverty (via qard ̙ hasan,̙ zakƗt, waqf, people who are living on less than $2 a day. microfinance, and microtakƗful); and low A substantial number of Muslims have income (via market-based solutions and sup- voluntarily shunned formal banking activi- port to micro, small, and medium enterprises) ties because of their religious beliefs (see chapter 8, on social finance). The unique- (Zulkhibri 2016). At the same time, as the ness of the risk-sharing principle should be Islamic financial sector has deepened, many promoted more in rural areas in Muslim- previously excluded individuals have started majority countries. The availability of profit to undertake Islamic banking transactions. and loss–sharing instruments helps individuals This suggests that Islamic banking can have mitigate their market risks because it contrib- a positive impact on financial intermediation utes to portfolio diversification. by the poor, which ultimately should boost A World Bank (2014) study shows that the mobilization of savings and prosperity. the greater the number of Islamic banks per The opportunities for Islamic banking to 100,000 adults, the lower the proportion of offer financial products and services to the firms identifying access to finance as a major poor, especially in Muslim-dominated popu- constraint. This finding suggests that increas- lations, are expected to grow. Islamic bank- ing the number of shari‘ah-compliant finan- ing may also be more likely to finance cial institutions can make a positive difference projects that can be beneficial for low- in the operations of small firms (0–20 income people, given the religious nature of employees) in countries with Muslim popula- its business and the ethical objectives tions by reducing barriers to accessing formal enshrined in Islamic financing principles. financial services. Despite the apparent difficulties in applying principles in practice, Islamic banking may Recent Developments in Islamic increasingly play an important and positive Banking and Current Status role in improving financial inclusion. Structured approaches can be applied to Recently, the Islamic Financial Services Board enhance financial inclusion for individuals (IFSB 2015) estimated the size of the industry GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 63
in terms of assets at $1.87 trillion and the First, increased oil prices prior to 2015, partic- size of the banking sector at $1.4762 trillion ularly in GCC states, have bolstered liquidity as of mid-2014.4 in these economies, increasing demand for financial services. However, the substantially Size and Structure lower oil prices in 2014 and 2015 and pro- jected for 2016 has raised issues related to sus- Islamic banking has been growing not only in tainability. Second and more positively, Islamic Muslim countries, but also in the non-Muslim banks were not as adversely affected by the world. The global spread of Islamic banks has 2008–09 global financial crisis as were conven- transformed the financial systems of a grow- tional banks. Finally, Islamic banking has ing number of Muslim countries. According gained momentum as a credible competitor to to Bureau van Dijk Bankscope data, there conventional banking. Its products and ser- were 161 deposit-taking Islamic banks glob- vices continue to evolve, as has the legal and ally as of the end of 2014, a 28 percent regulatory frameworks under which it increase from 2010. Net income, total assets, operates. and total equity have also grown (figure 3.1). Together, the GCC countries and the Islamic Globally, the Islamic Republic of Iran Republic of Iran constitute the dominant play- accounts for one-third of the assets of Islamic ers with the majority of the assets in the bank- banks (table 3.2). Together with Sudan, these ing industry. As a consequence, the Middle are the only two countries with a financial East dominates the growth of Islamic banking system based solely on Islamic finance. The globally. The South and Southeast Asia Region rapid increase in Islamic banking and the ranks as second globally for Islamic banking, importance of the sector for the economies of with 15 percent of the market share. The various other countries, particularly the region includes Malaysia, the second largest member-countries of the Gulf Cooperation economy in terms of total shari‘ah-compliant Council (GCC), Indonesia, Malaysia, and financial assets, and Indonesia, the country Pakistan, make it important to increase the with the world’s largest Muslim population. understanding of recent developments, cur- Pakistan and Bangladesh are two other emerg- rent trends, and industry drivers. ing countries in the region, with combined Recent increases in Islamic banking activity assets of almost 2 percent of the global market. have been driven by a number of factors. Overall, there is a large potential for Islamic
FIGURE 3.1 Average Percentage Increase in Various Elements of Islamic Banking, 2010–13
50
40
30
20
10
0 Number of banks Total assets Equity Net income
Source: Figures calculated from data extracted from Bankscope 2015. 64 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 3.2 Islamic Banking Assets by Region, 2013
Region/country Total assets ($billion) Middle East, including the Islamic Republic of Iran Iran, Islamic Rep. 482.40 Saudi Arabia 121.70 United Arab Emirates 100.30 Kuwait 78.70 Qatar 59.00 Bahrain 46.20
South and Southeast Asia Malaysia 156.70 Bangladesh 17.00 Indonesia 13.00 Pakistan 6.20
Africa Sudan 6.50 Egypt, Arab Rep. 5.00 Tunisia 0.76 Gambia, The 0.02
Other Turkey 44.80 United Kingdom 3.30
Source: Figures calculated from data extracted from Bankscope 2015.
banking to continue growing, taking into population. Countries such as Nigeria and account income growth rates in these coun- Senegal in West Africa are good candidates for tries, in addition to the large and growing pop- an expansion of Islamic banking in the near ulation of Muslims. Turkey and the United future. Other candidates include Afghanistan, Kingdom complete the current picture, Algeria, Azerbaijan, Cameroon, Libya, Mali, accounting for 4 percent and a symbolic frac- Kazakhstan, Morocco, Mozambique, and tion of 1 percent of bank assets, respectively. Uzbekistan. In addition, there are a larger number of Although data availability is an issue in countries that have less developed Islamic most of the 57 member-countries of the banking sectors but that host substantial Organisation of Islamic Cooperation (OIC), Muslim populations. Thus there are two clear there is some evidence that Islamic banks are potential areas for expansion: the entry of new contributing to shared prosperity through the Islamic banks, as well as the expansion of modes of financing they are offering, as well as existing banks, in countries where Islamic the sectors they are supporting (see chapter 2 banking already exists; and the introduction of of this Report). new Islamic banks, and expansion of existing Figure 3.2 shows the distribution by sector institutions, where Islamic banking is underde- of financing provided by Islamic banks, veloped despite a substantial Muslim reported as a percentage of the total, and GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 65
FIGURE 3.2 Financing by Sector, Islamic Banks, 2012 in 2014 the CARs for Islamic banks in the United Kingdom, Turkey, the GCC, and the Islamic Republic of Iran were all satisfac- tory, averaging 33, 32, 26, and 19 percent, 17% respectively, well above the minimum 27% 8 percent requirement for total capital under 3% Basel III. In terms of profitability, return on assets of 15% 0% Islamic banks is positive, with banks operating in Africa, the GCC, the Islamic Republic of 12% Iran, the Middle East, and Asia scoring better than their counterparts elsewhere, with a 16% 8% return on assets above 0.5 percent. One possi- ble reason is that some of the banks in these regions are state-owned banks and for the 2% most part finance state-owned enterprises and Consumer durables Agriculture Manufacturing government projects at concessionary rates. Trading Transportation Real estate and In terms of credit risk, nonperforming construction loans (NPLs) have declined across the regions, Banks and financial Service Others although they have remained relatively high institutions in the GCC, the Islamic Republic of Iran, and
Source: Ibisonline.net /IRTI. Africa, averaging double digits from 2010 to 2013. The GCC and the Islamic Republic of Iran made significant progress in reducing the aggregated by country. More than one-quarter ratio of NPLs to total loans from double dig- of financing facilitates the acquisition of con- its in 2010–13 to single digit in 2014. Islamic sumer durables, while financing for real estate banks in Indonesia, Malaysia, Pakistan, and and construction, manufacturing, and trading Sudan have relatively lower levels of credit accounts for 16 percent, 12 percent, and risk, averaging 6 percent in the period under 8 percent, respectively. All these sectors are review. In 2014, the level of NPLs for the drivers of economic development, a necessary United Kingdom, Turkey, the GCC, and the condition for shared prosperity. Islamic Republic of Iran averaged 9 percent, 8 percent, 7 percent, and 6 percent, Performance of Islamic Banks: respectively. Indicators of Financial Soundness The high level of NPLs in the Middle East and Asia highlights the relatively high level of The Islamic banking system as a whole is well credit risk in the region and calls for greater capitalized and liquid, although the degree of regulatory oversight. Regulatory frameworks liquidity varies by region and according to the for banking supervision need to be scaled up. market share of Islamic banks. The capital ade- Banks with double-digit NPLs need more quacy ratio (CAR) for Islamic banks is gener- intensive credit risk supervision from their ally well above the regulatory requirement (see central banks to mitigate such risks. In partic- table 3.3). Major portion of the risk weighted ular, central banks in these countries need to capital ratio consists of Tier 1 capital. pay greater attention to Islamic banks and In 2014, Islamic banks in the United also monitor the banks’ largest clients more Kingdom, Turkey, Africa, the GCC, and the closely. In addition, both central credit regis- Islamic Republic of Iran had the strongest tries and credit reference bureaus could be capital positions, followed by countries established to check borrowers’ credit where Islamic banks were relatively impor- histories. There is also the need in these juris- tant in terms of market share. For instance, dictions to establish Asset Management 66 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 3.3 Financial Soundness Indicators, All Islamic Banks
2010 2011 2012 2013 2014 GCC, including the Islamic Republic of Iran Capital adequacy ratio (CAR) 27.7 36.7 29.5 30.8 26.3 Tier 1 ratio 27.0 33.0 29.6 30.0 25.4 Nonperforming loans to total loans 10.1 12.3 10.1 9.2 6.0 Return on assets 2.5 0.5 0.3 1.5 0.5 Return on equity 2.0 4.9 5.2 6.4 5.8 Liquid assets/Deposits and short-term funding 50.7 85.6 60.1 63.6 45.1 Liquid assets/Total deposits and borrowing 47.6 50.2 47.5 46.6 51.4
Middle East and Asia (excluding GCC/Iran, Islamic Rep.) Capital adequacy ratio 45.6 27.4 24.9 19.0 19.1 Tier 1 ratio 25.0 24.1 20.4 15.3 14.4 Nonperforming loans to total loans 6.6 7.9 7.0 9.2 9.2 Return on assets 0.3 1.1 0.9 1.3 0.7 Return on equity 6.5 7.5 4.3 2.4 7.4 Liquid assets/Deposits and short-term funding 110.5 85.4 52.2 44.2 35.1 Liquid assets/Total deposits and borrowing 23.6 26.2 19.5 17.9 18.9
Africa Capital adequacy ratio (CAR) 35.2 102.8 26.7 30.2 32.2 Tier 1 ratio 22.9 163.1 22.2 25.3 27.9 Nonperforming loans to total loans 6.5 11.5 10.8 10.8 7.8 Return on assets 3.7 2.4 2.7 1.6 2.7 Return on equity 17.1 9.6 10.3 12.3 18.4 Liquid assets/Deposits and short-term funding 83.8 97.6 74.9 81.7 48.8 Liquid assets/Total deposits and borrowing 93.3 112.0 77.1 115.7 29.7
United Kingdom and Turkey Capital adequacy ratio 36.2 30.4 30.1 28.4 32.8 Tier 1 ratio 14.3 13.0 12.9 11.6 12.5 Nonperforming loans to total loans 3.5 3.0 2.9 3.1 7.2 Return on asset 8.1 6.3 4.9 1.1 0.1 Return on equity 21.1 18.5 16.3 11.2 0.9 Liquid assets/Deposits and short-term funding 161.1 216.2 86.0 176.9 22.5 Liquid assets/Total deposits and borrowing 158.2 265.7 101.6 176.2 21.1
Source: Figures calculated using data extracted from Bankscope 2014/2015. Note: GCC = Gulf Cooperation Council.
Recovery Corporations in order to recover in Africa. The reason for this pattern is that some of the bad loans. the lion’s share of Islamic banks in Africa are Islamic banks in the GCC and the Islamic located in Sudan—one of the two countries, Republic of Iran are more liquid than their with the Islamic Republic of Iran, where the counterparts elsewhere, followed by banks whole banking system is shari‘ah compliant, GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 67
and Islamic banks are not in competition Sub-Saharan Africa, despite having less than with conventional banks. Compliant Islamic 1 percent of total assets. In the MENA Region, banks in the Middle East, Asia, the United which has the bulk of Islamic bank assets, Kingdom, and Turkey appear to have only more than half the assets belong to Iranian moderate liquidity positions. banks ($451 billion), and the largest seven banks account for 80 percent of the Iranian Regional Perspectives market. These banks individually have assets valued at more than $20 billion. Assets and deposits in the global Islamic banking industry are highly concentrated, yet the majority of Islamic banks are small. Challenges Facing the Islamic Banking Eleven percent of the 161 banks identified as Sector Islamic banks with Bankscope data have Over half a century since the establishment of assets above $20 billion; 11 percent have modern Islamic banking, the evidence from assets between $10 billion and $20 billion; Muslim-majority countries remains mixed 12 percent have assets between $5 billion and concerning the sector’s contribution to socio- $10 billion; 27 percent have assets between economic development. A few studies have $1 billion and $5 billion; and 40 percent have found that Islamic banking has yet to make a less than $1 billion in assets. significant contribution to financial inclusion The bulk of the world’s assets (77 percent) and economic development (Abedifar and in Islamic banking are in the Middle East and others 2015), while others find a positive link North Africa (MENA) Region, followed by (Imam and Kpodar 2015). Some studies have Asia (18 percent), Europe (3.73 percent), and found that gains from Islamic banking have Sub-Saharan Africa (less than 1 percent) (see been limited to only a small segment of the figure 3.3). The pattern for the number of general population. Islamic banks is similar, with 50 percent of The main reason is that the benefits of Islamic banks located in the MENA Region, Islamic banking can be achieved only if it is 30 percent in Asia, and 15 percent in practiced in its true spirit and form. Its misuse,
FIGURE 3.3 Regional Shares of Number of Banks, Deposits, and Assets Percentage share
Middle East and North Africa
Asia
Sub-Saharan Africa
Rest of the world
0 20 4060 80 100 Total deposits Total assets Number of banks
Source: Figures calculated using data extracted from Bankscope 2014. 68 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
like the misuse of any system, can preclude the would be its ability to induce growth and attainment of its benefits. Another reason has reduce poverty through its chief characteristic, to do with how the business and industry of risk sharing (Askari and others 2012). Islamic Islamic banking evolved and how it has been banks have social responsibilities that tran- preoccupied with high–net worth individuals, scend the goal of profit maximization. In reach- making it difficult to develop a healthy socio- ing these goals, many challenges exist that need economic environment that would be close to to be addressed by all stakeholders. the ideal of Islam. Shari‘ah-compliant practices may have created additional burdens, ineffi- Divergence between Theory and ciencies, and operational constraints, under- Practice of Islamic Banking mining the original shari‘ah objectives of fairness, inclusiveness, equity, and economic Closing the gap between theory and practice justice (Sufian, Noor, and Zulkhibri 2008). is the most important issue facing Islamic There is empirical evidence that Islamic finance banks. To date, Islamic banks have tended to contributes positively to growth, and the litera- position themselves close to conventional ture argues that there is a large potential for banks through product innovations, such as shari‘ah financial products to play a role in this tawarruq, commodity murƗbah̙ah, Islamic growth (see box 3.3). This suggests that the lit- repos, and asset-based securities, which some mus test of the usefulness of Islamic banking argue are detached from the real economy
BOX 3.3 Islamic Banking: Is It Good for Growth?
Islamic banking, with unique attributes that differen- development (ratio of loans, assets, or deposits in tiate it from its conventional counterpart, seems bet- Islamic banks to GDP); FD is the measure of overall ter adapted to characteristics prevailing in poorer financial development (ratio of private sector credit countries of the Middle East and North Africa, Sub- by commercial banks to GDP); X is the set of control Saharan Africa, and parts of South Asia and Southeast variables described above; u is the country-specific Asia. The distinct attributes of Islamic banking that effect; e is the error term; and v is the time-specific encourage sharing risk, prohibiting interest, enhanc- effect. ing financial stability, and promoting investment in The results show that, holding constant the level of morally acceptable projects are advantages that could financial development and other growth determinants, make it better adapted to the local environment, not countries where Islamic banking is developing—and only in Islamic countries, but also in low- and middle- hence its impact on growth is measurable—experience income non-Muslim countries. Under certain circum- faster economic growth than others. This suggests stances it could be better at stimulating growth than that despite its relatively small size compared to the conventional banking. economy or the overall size of the financial system, A study by Imam and Kpodar (2015) investigates Islamic banking is positively associated with economic whether the development of Islamic banking has had growth. The results are robust across different a positive impact on growth, using a sample of low- measures of Islamic banking development, and middle-income countries with data from 1990 to econometric estimators (pooling, fixed effects, and 2010. The study uses the following regression: system generalized method of moments), and the sample composition and time periods. a b d j e u Git = + IslBankit + FDit + Xit + uit + it + t, Thus, the empirical evidence examined in Imam (3.3.1) and Kpodar (2015) suggests that as the industry matures and the obstacles it faces are addressed over where G is the growth rate of real GDP per capita; time, Islamic banking represents a growth opportunity IslBank is the indicator of Islamic banking for countries. GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 69
and move too far away from the theoretical FIGURE 3.4 Islamic Modes of Finance by Islamic underpinnings of Islamic economics. There is Banks, 2012 a need to develop policies that could narrow the gap between the aspirations of Islamic 2.36% 0.26% 0.73% 1.53% banking to be based essentially on risk-sharing 4.17% instruments such as mud̙Ɨrabah and 1.67% mushƗrakah, and the reality of Islamic banks relying heavily on debt-based instruments 10.82% such as murƗbahah̙ .5 Nowhere is such a gap between aspiration and reality more apparent than on the asset side of the balance sheets of Islamic banks. Islamic banking is still largely based on mark- up or profit margin techniques—a pattern 78.47% identified over a decade ago (Iqbal and Molyneux 2005). This shift from equity-based financing or profit and loss–sharing contracts - Qard.. hasan Murabahah- and Leasing and hire to debt-based financing poses the risk of negat- deferred sales purchase - - - ing their advantages in terms of financial sta- Mudarabah. Musharakah Istisna‘. bility, and the systemic benefits in terms of Salam Other promoting sustainable development. Figure 3.4 clearly illustrates this challenge: more than Source: Islamic Banks and Financial Institutions Information, Ibisonline.net/IRTI. 75 percent of the financing offered by Islamic banks globally is in the form of murƗbah̙ah Scale, Access, and Outreach of Islamic and deferred sales contracts. Leasing and hire Banking purchase contracts come second, with about 11 percent. The shares of profit-sharing instru- Underdevelopment of risk-sharing instru- ments (mushƗrakah and mudƗ̙ rabah) remain at ments discourages investors from investing in a lowly 4.17 percent and 1.67 percent, respec- sectors that are perceived as high risk, such as tively. To put it another way, it appears that less micro, small, and medium enterprises than 6 percent of global Islamic financing is on (MSMEs). The MSME market is largely a profit-sharing basis. The benevolent qard̙ untapped in emerging markets and has huge hasan̙ contract stands at 1.53 percent. Overall, potential (World Bank-IDB-IRTI 2015). With the “star” Islamic banking products represent the proper enabling environment, investors less than 8 percent of the total of Islamic with a matching risk appetite are likely to be financing globally. attracted to providing capital for these sec- Governments and the relevant authorities tors. Increasing the access of poor and low- should look to remove barriers in order to income groups to wider Islamic financial boost the attractiveness of risk-sharing con- services and products could be a way forward tracts in Islamic banking. The issues of clearly to achieving the goal of ending poverty, par- defining property rights and improving tax ticularly in Muslim countries. rate treatment will be a starting point to pro- To create real impact, Islamic finance needs vide a level playing field. Internalizing the to reach a critical mass by exploring untapped social dimension and social justice aspects into markets or by consolidating existing platforms Islamic banks’ own operational functions also to build an entity with the required expertise may help close the gap between theory and and capital that can influence multiple areas of practice. Extending financial inclusion via the market. A large-scale Islamic financial insti- profit and loss–sharing Islamic modes of tution, with a large amount of capital, is finance will extend this economic dynamic to a needed to generate change. The fragmentation larger section of society. in domestic markets has led to the erosion of 70 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
banks’ profit margins and difficulties for banks receives advantageous tax treatment, while that want to scale up their business operations. some Islamic finance products face double However, a large-scale Islamic financial institu- taxation. Treatment of such products tion would be able to scale up through its requires uniform regulation, as well as a sup- presence in key financial markets. This, in turn, portive legal framework. Similarly, existing would make vital funding sources available to legal and supervisory frameworks that are a wider range of consumers, generating new based on the conventional banking model product profiles to penetrate new markets, may also create difficulties in the longer term influencing global markets, and increasing for the efficient running of Islamic banks. investor awareness. An accounting procedure based solely on conventional banking practice is inadequate Soundness, Stability, and Efficiency of because of the different nature and treatment Islamic Banking of financial instruments. Islamic banks pose several regulatory, market behavioral, and legal challenges. One challenge Liquidity and Basel III Compliance is designing and implementing an effective Issues of liquidity and compliance with the financial regulation and supervisory frame- Basel III capital requirements also present work for Islamic banking that takes into challenges. Banks in general, and Islamic account the unique features of the Islamic banks in particular, are inherently subject to banking business, without increasing the regu- liquidity risk, relying mostly on relatively latory burden and restricting its growth poten- short-term demand deposits to finance illiq- tial. The soundness of Islamic banking is uid investments. For example, in 2012, important for the overall stability of the 77 percent of Islamic bank liabilities con- domestic and global financial system. One way sisted of demand deposits, while 76 percent to ensure stability is to reduce asset-liability of their assets were in the form of invest- risks and to adopt policies that minimize ments (see table 3.4). Issues of maturity mis- moral hazard and adverse selection, excessive match are therefore unavoidable. It is critical debt creation, and leverage. for Islamic financial institutions to innovate An appropriate and robust legal, regulatory, and revolutionize shari‘ah-compliant prod- and tax framework is a basic requirement for ucts to enhance and manage liquidity. establishing sound Islamic financial institutions By relying on equity-based finance, Islamic and markets. It is also important to ensure a banks incur a higher charge of regulatory capi- more integrated Islamic financial services tal, since by definition Islamic banks are industry globally so it can withstand shocks and adverse market developments. Putting in place these building blocks and applying mutu- ally acceptable rules and standards will TABLE 3.4 Demand Deposits and Investments of Islamic Banks, 2012 strengthen the resilience of the Islamic financial system. Innovation and knowledge sharing Total deposits over Total investments between various market players at the global Region total liabilities, over total assets, level can facilitate the standardization and glo- percent percent balization of Islamic financial products. Europe 30.47 69.85 Accelerating the development of these critical building blocks of the Islamic financial system Middle East 83.15 76.23 is vitally needed to respond to the changing Asia 73.67 75.41 economic and financial landscape. Africa 87.04 73.38 Leveling the playing field with respect to Global 76.95 75.60 the tax treatment of financial instruments is urgently needed. Conventional debt often Source: Ibisonline.net /IRTI. GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 71
required to hold more equity than conven- shari‘ah supervisory board (SSB), a well- tional banks. This places Islamic financial insti- resourced internal shari‘ah review process, tutions at a disadvantage under Basel III’s new and periodic external shari‘ah reviews capital requirements. A further complication (Kammer and others 2015). However, a cen- concerns the calculation of risk-weighted tralized shari‘ah board, in addition to bank- assets, given variation across jurisdictions in level shari‘ah boards, can be advantageous in the treatment of profit-sharing investment ensuring consistent shari‘ah compliance accounts (PSIAs). It is important to ensure approaches. Malaysia is a leader in terms of proper regulatory treatment of the PSIAs of shari‘ah regulatory and governance frame- Islamic banks. It is also essential to identify work for its Islamic financial services indus- instruments eligible for treatment as additional try. An increasing number of countries Tier 1 and Tier 2 capital, bearing in mind (including Bahrain, Indonesia, Morocco, revised IFSB standards on capital adequacy Nigeria, Oman, Pakistan, and Sudan) are (IFSB 15).6 moving in the same direction in putting in place their own shari‘ah regulatory and gov- Shari‘ah Governance Credibility in ernance framework. For Islamic finance to Islamic Banking move to the mainstream and extend into a broader range of jurisdictions, it must resolve Improvement in the shari‘ah governance inefficiencies associated with the shari‘ah framework is needed to enhance shari‘ah compliance process. compliance, credibility, and integrity. A strong shari‘ah governance framework helps increase Adequately Trained and Skilled Human consumer confidence and provides greater Capital flexibility for Islamic financial institutions to be innovative within the boundaries of The institutional, technical, and human shari‘ah. The shari‘ah board contributes to resource requirements of Islamic banks are public awareness about the philosophical unique. The Islamic banking industry requires basis and concepts of Islamic banking and human capital with a combination of compe- finance.Shari‘ah governance adds value to the tencies in accounting, finance, and shari‘ah. existing corporate governance framework in Without appropriate training and skilled Islamic financial institutions. Furthermore, human resources, even if demand for Islamic shari‘ah compliance is not just restrictive with banking services increases, the supply of such respect to investment in companies with unac- services cannot be met unless the industry has ceptable business; it also promotes investment suitably qualified staff at all levels of manage- in businesses that contribute to the ethical ment. Even so, if skilled human capital is not values of Islam and purification of dubious of the highest standard, the credibility, com- profits by distributing them to charity for the petitiveness, and stability of the Islamic bank- welfare of the community as a whole. ing industry will be at stake. Hence a critical On the other hand, standardized fatƗwá and unique challenge of Islamic banking insti- (religious opinions) and centralized shari‘ah tutions is to address the shortfall of trained boards help unify operations between and skilled human capital for the industry to Islamic banks and also increase public adequately meet its operational requirements awareness and confidence. Differences in and shari‘ah governance standards. shari‘ah interpretations can lead to a lack of Many banks still have limited capabilities harmonization both within and across bor- and expertise to consistently originate and ders, which can affect trust in the industry. structure large Islamic finance deals, which The IFSB and Accounting and Auditing often include pioneering arrangements and fea- Organization for Islamic Financial tures. The need for highly skilled staff will Institutions (AAOIFI) recommend establish- increase with the development of innovative ing, at the bank level, an independent Islamic financial products and services. 72 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
Shari‘ah experts need to have an adequate 2. Harmonize shari‘ah standards. Efforts must knowledge of banking and finance, while be made to develop global shari‘ah refer- Islamic bankers, finance specialists, and regula- ence bodies that can assist in harmonizing tors need an adequate knowledge of the appli- cross-country fatƗwá relating to Islamic cable shari‘ah rules and principles. Specialized finance and help in accelerating the growth training and educational institutions to pro- of the industry. Facilitating regional harmo- vide Islamic financial knowledge to the popu- nization may be the first step toward greater lace are also needed, along with collaboration harmonization of the Islamic banking sys- and exchange of knowledge across jurisdic- tem. It would be desirable to have clear and tions, and supplementary research into and consistent rulings by scholars on shari‘ah development of key specialized and human issues so that no ambiguity remains. resource areas. To meet this human capital 3. Create an enabling regulatory environ- requirement, large financial institutions can act ment. Given the evolving global financial as knowledge centers to attract foreign talent landscape, critical regulatory challenges from the existing international financial hubs, include ensuring a level playing field for as well as retain local talent. both conventional and Islamic banks through consistent regulations, ensuring consistent implementation of the Basel III Policy Recommendations framework, ensuring that systematic risks The rapid development of Islamic banking is in dual banking systems are addressed, and adding considerable variety and choice for implementing cross-border supervision. both Muslims and non-Muslims who wish to 4. Enhance the scale of and access to Islamic engage in financial activities. However, the finance. For Islamic banking to live up absence of a truly global Islamic financial sys- to the promise of delivering equitable tem based on shari‘ah principles, as well as growth, it is vital that the scale, access, the varying ways in which Islamic banking and outreach of Islamic banking be business is conducted in different jurisdic- increased to include low-income earners. tions, has led to somewhat haphazard growth There is a need to enhance risk manage- and development of Islamic banking and ment practices; reduce costs; make best finance. In terms of policy response, the use of available technology; and use a Islamic banking sector should focus on six range of channels, such as branchless key priorities to improve and adopt best prac- banks, e-money, and mobile banking, to tices for the sector to contribute to shared deliver financial services. prosperity. The joint IMF-World Bank Group 5. Improve liquidity and ensure stability. The of Twenty note on integrating Islamic finance problem of liquidity management needs with global financial systems could serve as a to be addressed by developing new instru- good road map as discussed in chapter 9. ments through research and innovation. Developing a credible liquidity manage- 1. Shift toward shari‘ah-based banking and ment framework will help accelerate the practices. Currently, Islamic banking growth of the industry. Sustainable growth based on shari‘ah compliance is primarily and stability in Islamic banks require the serving established corporate entities and development of a comprehensive risk man- relatively high–net worth individuals. The agement framework geared to their spe- operating model of Islamic financial insti- cific situation and requirements. tutions needs to be revisited to promote 6. Bolster human capital and Islamic finance shari‘ah-based banking models. This will literacy. The human capital of the indus- ensure that a greater portion of finance is try could be strengthened by creating available for micro, small, and medium credible Islamic finance knowledge plat- enterprises through the use of risk-sharing forms through regular training, seminars, instruments. and workshops, as well as by developing GLOBAL REPORT ON ISLAMIC FINANCE THE ISLAMIC BANKING SECTOR 73
frontier knowledge in Islamic finance References for the industry, with the support of the Abedifar, P., S. Ebrahim, P. Molyneux, and industry and academia. Trust and confi- A. Tarazi. 2015. “Islamic Banking and Finance: dence in using Islamic financial services Recent Empirical Literature and Directions for needs to be increased. Public awareness Future Research.” Journal of Economic Surveys can be increased by promoting Islamic 29 (4): 637–70. financial literacy, including knowledge of Askari, H., Z. Iqbal, N. Krichene, and A. Mirakhor. which financial products are best suited 2010. The Stability of Islamic Finance: for particular purposes. Creating a Resilient Financial Environment for a Secure Future. Singapore: John Wiley and Sons (Asia). Notes ———. 2012. Risk Sharing in Finance: The Islamic Finance Alternative. Singapore: John Wiley and 1. For more on this, see the maqƗsid̙ al-sharƯ‘ah Sons (Asia). as developed by al-Ghazel and al-Shatibi, in Zarqa (1980). Askari, H., and N. Krichene. 2014. “Islamic 2. Askari and Krichene (2014) provide a review Finance: An Alternative Financial System for of the arguments in support of risk sharing Stability, Equity, and Growth.” PSL Quarterly being the essence of Islamic banking and the Review 67 (268): 9–54. major reason for its stability. Hassan and Bankscope. 2014/2015. Database. https://bankscope Dridi (2010) also argue that risk-sharing .bvdinfo.com/version-2016114/home.serv characteristics of Islamic banking should ?product=scope2006. increase stability, thereby stimulating growth. Chapra, M. U. 2011. “The Global Financial Crisis: 3. Religiosity was measured as the percentage of Can Islamic Finance Help?” In Islamic Econom- adults in a given country who responded affirma- ics and Finance: A European Perspective, edited tively to the question, “Is religion an important by J. Langton, C. Trullols, and A. Turkistani. part of your daily life?” in a 2010 Gallup poll. London: Palgrave Macmillan. 4. There are many reports on the state of Islamic banking, but they adopt different approaches, Dar, H., and J. Presley. 2000. “Lack of Profit Loss leading to a wide range of estimates of the size Sharing in Islamic Banking: Management and of the industry. Data on Islamic banks often Control Imbalances.” International Journal of cover commercial as well as investment banks, Islamic Financial Services 2 (2): 3–18. and sometimes they even include multilateral Hassan, M., and J. Dridi. 2010. “The Effects of institutions such as the Islamic Development Global Crises on Islamic and Conventional Bank. Such differences in the choice of institu- Banks: A Comparative Study.” IMF Working tions to include explain the wide range of Paper WP/10/201, International Monetary estimates of the size of the Islamic banking Fund, Washington, DC. industry. IFSB (Islamic Financial Services Board). 2015. 5. Dar and Presley (2000) suggest several explana- Islamic Financial Services Industry Stability tions for the tendency of Islamic banks to prefer Report 2015. Kuala Lumpur: IFSB. to use modes of financing other than profit and ———. 2016. Islamic Financial Services Industry loss–sharing (overwhelmingly murƗbahah̙ ). Stability Report 2016. Kuala Lumpur: Islamic 6. IFSB-15 provides guidelines for the compo- Financial Services Board. nents of regulatory capital (Tier 1 and Tier 2). IFSB-15 also defines common equity as the Imam, P., and K. Kpodar. 2015. “Is Islamic Banking Tier 1 core capital and preferred stock as the Good for Growth?” Working Paper WP/15/81, additional Tier 1 capital. Currently, the IFSB International Monetary Fund, Washington, standard is the only international guideline to DC; also presented at the inaugural World integrate Islamic contracting principles into Bank-IDB-Guidance Financial Symposium on the global financial system. A unified adoption Islamic Finance, Istanbul, September 8–9. of this standard would ensure that institutions IMF (International Monetary Fund). 1998. World offering Islamic financial products and ser- Economic Outlook: Financial Crises: Causes vices assign sufficient capital to cover the risk and Indicators. Washington, DC: International of the institution’s Islamic operations. Monetary Fund. 74 THE ISLAMIC BANKING SECTOR GLOBAL REPORT ON ISLAMIC FINANCE
Iqbal, M., and P. Molyneux. 2005. Thirty Years World Bank. 2008. Finance for All? Policies and of Islamic Banking: History, Performance and Pitfalls in Expanding Access. World Bank Policy Prospects. New York: Palgrave Macmillan. Research Report. Washington, DC: World Bank. Kammer, A., M. Norat, M. Pinon, A. Prasad, ———. 2014. Global Financial Development C. M. Towe, and others. 2015. “Islamic Report 2014: Financial Inclusion. Washington, Finance: Opportunities, Challenges, and DC: World Bank. Policy Options.” IMF Staff Discussion Note World Bank-IDB-IRTI (World Bank, Islamic SDN/15/05, International Monetary Fund, Development Bank, Islamic Research and Washington, DC. Training Institute). 2015. Leveraging Islamic Mirakhor, Abbas, and Zamir Iqbal. 2012. “Finan- Finance for Small and Medium Enterprises cial Inclusion: Islamic Finance Perspective.” (SMEs). Washington, DC: World Bank. Journal of Islamic Business and Management Zarqa, A. 1980. “Islamic Economics: An Approach 2 (1): 35–64. to Human Welfare.” In Studies in Islamic Eco- Sufian, F., M. A. Noor, and M. Zulkhibri. 2008. nomics, edited by K. Ahmad. Leicester, U.K.: “The Efficiency of Islamic Banks: Empirical The Islamic Foundation. Evidence from the MENA and Asian Coun- Zulkhibri, M. 2016. “Financial Inclusion, Finan- tries Islamic Banking Sectors.” Middle East cial Inclusion Policy and Islamic Finance.” IRTI Business and Economic Review 20 (1): Working Paper 1437-01, Islamic Research and 1–19. Training Institute, Jeddah, Saudi Arabia. 4 Islamic Capital Markets
he purpose of capital markets is to facil- contribution to achieving economic develop- Titate long-term investment. The prin- ment and enhancing shared prosperity using ciples of Islamic finance promote risk the principles of risk sharing and equity par- sharing in lieu of risk transfer in conventional ticipation. There is ample research supporting markets. The risk-sharing and equity partici- the contribution of the financial sector to eco- pation principles of Islamic finance promote nomic development and its impact on income the long-term value of investments in real distribution. Levine (1997, 2005) clearly dem- assets rather than the maximization of short- onstrates that financial development produces term profits. The ethical dimension of Islamic faster average growth. Pagano (1993); King finance ensures the long-term sustainability and Levine (1993); Bekaert and Harvey of society. The main components of Islamic (1997); and Beck, Demirgüç-Kunt, and Levine capital markets are equity markets and suk k nj (2007) emphasize the importance of capital (asset-backed securitized Islamic products). markets development on the path of eco- This chapter evaluates the current state of the nomic growth. Similarly, Agarwal and equity and suknjk markets and analyzes their Mohtadi (2004) find that stock market devel- role in fostering economic development with opment is positively associated with economic shared prosperity. growth. Pradhan and others (2014) investi- gate the linkages between stock market devel- The Role of Capital Markets in opment, bank development, and economic Enhancing Shared Prosperity growth and find that stock market develop- A well-functioning capital market not only ment is an important ingredient of growth. improves the capital allocation in the econ- It is well documented that when risk is omy but also enhances productive growth. spread among a large number of participants Islamic capital markets can make a significant through an efficient capital market, closer
GLOBAL REPORT ON ISLAMIC FINANCE 75 76 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
coordination between the financial and real risk taking in the expectation of better returns. sector is promoted, as well as better sharing of The alignment of risk taking with the expected the benefits of economic growth and greater returns of investment enhances risk-sharing stability for the financial system. By contrast, opportunities, improves the dissemination of risk transfers through debt instruments, along information, lowers the cost of mobilizing with higher leverage, weaken the link between funds, facilitates investments in the most pro- the financial and real sector, thus posing a ductive technologies, and enhances the efficient threat to financial stability. The growth of pure allocation of capital (Levine and Zervos 1998; financial assets can outpace the growth of the Agarwal and Mohtadi 2004). Furthermore, real sector, a phenomenon known as decou- liquidity in capital markets encourages firms to pling (Menkoff and Tolksdorf 2001) or finan- invest in long-term and more productive proj- cialization (Epstein 2006; Palley 2007), ects. This higher productivity raises the return whereby economic growth is no longer on the investment and encourages more saving anchored with growth of the real sector. and investment in physical capital, which lead Excessive financialization of assets may result to faster economic growth. in bubbles (Parenteau 2005). All too often, What makes the Islamic capital market dif- financial sector crises have required large gov- ferent from the conventional capital market is ernment interventions and massive bailouts. the ethical dimension, which focuses on the Thus while private financiers enjoy the gains of long-term sustainability of society, and its prin- robust pure financial innovations, which ulti- ciples of risk sharing (dispersion of ownership) mately lead to decoupling, the society at large and avoidance of excessive leverage and specu- suffers the pain of saving the real sector from lation. Figure 4.1 depicts the mechanism of an the vagaries of financial sector crises. Islamic stock market based on respect for core Efficient risk sharing requires that economic values. Economic and social justice, the spirit risks are allocated among participants in accor- of solidarity, and intergenerational respect dance with their respective degree of risk toler- supersede the market structure. Organizations ance (Mirakhor 2010).1 Efficient capital that are socially and ethically responsible can markets allow risky investments to be matched raise funds in this market on the basis of shar- with those investors who have the appetite for ing both risk and reward. In the absence of
FIGURE 4.1 The Values-Driven Structure of the Islamic Capital Market
Beliefs and core values
Economic and Spirit of Intergeneration social justice solidarity respect
Corporations
Savers, Funds Funds Infrastructure Capital market investors projects Return Return
Governments • Promote socially and ethically responsible organizations • Promote entrepreneurship—risk sharing • Prohibit interest • Avoid information asymmetry (gharar) GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 77
interest and speculation, the possible return is support economic growth. It does all this in a based purely on the underlying economic activ- way that does not increase risk—unlike debt- ity. The Islamic principles of finance thus help based speculative capital. in the allocation of more resources to the real sector of the economy, create more job oppor- tunities, and ultimately distribute wealth more Current Status of Islamic Capital equitably. Markets Equity-based investment is well established Despite the extraordinary growth of the in the world of Islamic finance. Investment in Islamic banking industry, there is a great need instruments such as common stocks and suknjk for vibrant and efficient capital markets in the is permissible in those companies that are not area of Islamic finance. The Islamic capital engaged in businesses such as gambling or pro- market is underdeveloped—which is not sur- duction or trade in prohibited items like alco- prising, because Islamic finance is a relatively hol or pork (harƗm), and those that are new industry. engaged in socially irresponsible activities (usu- There is no organized stock exchange dedi- ally referred to as sin stocks). Although invest- cated to trading in equities that are compliant ment in stocks is permitted, many of the with the Islamic investment principles. practices associated with stock trading are not. Organized markets for conventional stocks Speculation through derivative positions and exist in a number of member-countries of the short selling are some of the practices not Organisation of Islamic Cooperation (OIC), allowed under shari‘ah principles (Naughton and some are quite mature, as in Indonesia, and Naughton 2000). The main distinction Malaysia, Pakistan, and Saudi Arabia. between the conventional and Islamic capital However, growth in market capitalization market is the lower leverage and the absence of does not necessarily contribute to economic speculative behavior promoted by short selling development or the more equitable distribu- and derivative trading. tion of wealth (Ali 2005, 2013). Figure 4.2 Suknjk are one of the two pillars of Islamic shows the relationship between capital forma- capital markets. Instead of conventional bonds tion (gross domestic investment) and market that are based on a debt contract, suknjk are capitalization. based on risk-sharing contracts backed by real As the figure shows, market capitalization underlying assets, such as asset-backed securi- does not translate into capital formation in any tization. The aim for suknjk is to develop inno- income group, including the high-income vative assets and distribute income from countries. However, there is a stark difference entrepreneurial activities funded by the suknjk between the low-income and higher-income (Jobst 2007). groups of countries. For low-income countries, In summary, equity-based financing and no relationship between market capitalization asset-backed securitization have a positive and capital formation seems to exist, which impact on economic growth. The absence of suggests either the nonexistence or lower depth leverage in a risk-sharing framework will of the stock market. Other factors may also be lower riskiness and risk premiums on financial at play. Investors may voluntarily exclude assets such as stocks and suknjk. This will sup- themselves because of their conservative nature port shared prosperity. The risk-sharing frame- (their risk aversion to the speculative nature of work links the financial sector to the real markets). Or they may stay out of the market sector. Thus the risk premium on financial because of their faith, especially in countries assets directly reflects the riskiness of the real where a majority of the population is Muslim. sector. The stock market will have low correla- This factor is evident in the figures depicting tion with the rest of the world, which makes it the OIC member-countries. The only exception a good alternative for foreign investors looking is the OIC high-income group—and even here, to diversify their portfolio. It facilitates capital capital formation remains well below the mar- inflows, which lower the cost of capital and ket capitalization ratio. Interestingly, peaks in 78 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.2 Market Capitalization versus Capital Formation in OIC and Non-OIC Member Countries by Income Group Ratios
a. Non-OIC member-countries
Low-income Lower-middle-income Upper-middle-income High-income 1.5 1.5 1.5 1.5
1.0 1.0 1.0 1.0
0.5 0.5 0.5 0.5
0 0 0 0
b. OIC member-countries
Low-income Lower-middle-income Upper-middle-income High-income
1.5 1.5 1.5 1.5
1.0 1.0 1.0 1.0
0.5 0.5 0.5 0.5
0 0 0 0 1990 1995 2000 2005 2010 1990 1995 2000 2005 2010 1990 1995 2000 2005 2010 1990 1995 2000 2005 2010
Market capitalization to GDP Capital formation to GDP
Source: World Bank, World Development Indicators (database). Note: OIC = Organisation of Islamic Cooperation.
the market capitalization ratio for the non- between speculation and investment in stock OIC member-country groups coincide with the markets and suggests that although speculators formation of bubbles in those markets, espe- in the market provide liquidity and depth to cially before the onset of the global financial the market, by trading stocks or futures with- crisis in 2008. out actually possessing those assets at any In summary, stock markets in their current point in time, they ultimately increase specula- form contribute relatively less to economic tion in those markets. development than their potential and expecta- tions because of the speculative nature of these Risk-Return Analysis of Main Shari‘ah markets. The rise in speculation in recent years Indexes has been the result of easy access to leverage in a very low interest-rate environment, and has Whether to invest in equity stocks through led to the formation of asset bubbles. If the stock markets is a matter of heated debate capital markets are to play any role in eco- among Muslim scholars. On the one hand, nomic development, there is a need for a com- some believe that investment in the stock mar- prehensive policy initiative covering both ket encourages speculation among market regulatory and governance mechanisms to participants, which is not a permissible activ- curb the speculative behavior in those markets. ity, since the outcome of speculation is similar Al-Masri (2007) highlights the difference to that of gambling (Taj El-Din 2009). On the GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 79
other hand, most scholars consider investment OIC member-states, as measured by the S&P through stock markets to be permissible, Frontier Broader Market Index (BMI). based on the view that shareholders are simi- Figure 4.4 provides a similar analysis on lar to the partners in a partnership firm the regional level for the S&P indexes. The (Naughton and Naughton 2000). However, shari‘ah-compliant indexes usually outper- these scholars endorse only long-term invest- form the conventional indexes for developed ment, in which an investor seeks dividend markets in the United States, Europe, and income or long-term gains by investing in Asia. However, for the Pan Arab Region shares of those companies with sound man- with a majority Muslim population, the agement, a good business model, positive shari‘ah-compliant index lags behind the future growth potentials, and shari‘ah- conventional index. This can be attributed compliant business activities. to the fact that in developed markets, Any investor in the Islamic equity market shari‘ah screening filters out financial sector invests in the shares of shari‘ah-compliant companies, resulting in a lean portfolio with companies2 or in a publicly offered portfolio lower financial risk. Since most of the listed consisting of these equities offered through Islamic banks are in the Pan Arab Region, unit trusts, mutual funds, or exchange the performance of the shari‘ah-compliant traded funds (ETFs). Measuring the perfor- index is not very different from that of the mance of fund managers is one of the major conventional index. challenges for investors in Islamic capital mar- Figure 4.5 provides the sectoral breakdown kets. To meet this need, all the major index of conventional indexes versus shari‘ah- providers—the Financial Times Stock compliant S&P indexes. One of the important Exchange (FTSE), Standard & Poor’s (S&P), differences between the indexes is the absence Dow Jones, and Morgan Stanley Capital of the financial sector from the IEIs. The infor- International (MSCI)—now build and provide mation technology (IT) sector dominates the Islamic equity index (IEI) data based on inde- IEIs globally and in the developed markets of pendent shari‘ah screening criteria at the the United States and Japan. The proportion of global, regional, and country level. Each of financial sector firms is similar in the Islamic these index providers follows slightly different index and the conventional index for the Pan screening criteria for including equities in IEIs, Arab Region, suggesting the presence of a based on the interpretation of the shari‘ah strong Islamic banking sector. The sectoral board.3 breakdown further confirms the assertion that To avoid unnecessary confusion, this Report the diversification of the IEIs and the conven- uses shari‘ah screening standards for perfor- tional indexes are similar, even though a major mance comparison only as proposed by S&P.4 portion of equities have been screened from Since the scope of this Report is global, this the Islamic index. chapter provides a detailed analysis of the Table 4.1 reports the return on risk of S&P global and regional index performance. conventional and shari‘ah indexes. In terms of Figure 4.3 compares the performance of S&P excess return, it is evident that shari‘ah- shari‘ah-compliant indexes with that of the compliant indexes outperform their bench- conventional indexes. Panel a compares the mark, with the exception of the indexes for performance of the S&P Global 1200 with the OIC countries and the United States. For that of the shari‘ah-compliant version of the other indicators, higher correlation, lower same index, titled S&P Global 1200 Shariah. tracking error, and positive information ratios The performance of the shari‘ah-compliant clearly indicate that investors in Islamic equi- index was superior over the entire period. ties do not have to sacrifice return to reap the However, a similar comparison of the S&P/ benefits of adhering to their faith. Although OIC COMCEC 50 Shariah index,5 as shown not reported here, a comparison of perfor- in panel b, reveals that the performance of the mance based on the MSCI standard was made shari‘ah-compliant index was quite similar to following a book value of equity approach. the index for the 50 biggest listed companies in No significant difference was found between 80 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.3 Relative Performance of Conventional versus Shari‘ah-Compliant Stocks, Global Indexes
a. S&P Global 1200 versus S&P Global 1200 Shariah
180
160
140
120
100
80 Index level
60
40
20
0 11/3/2008 7/30/2009 4/27/2010 1/20/2011 10/17/2011 11/17/2012 4/8/2013 1/2/2014 9/29/2014
S&P Global 1200 S&P Global 1200 Shariah b. S&P Frontier BMI versus S&P Frontier BMI Shariah and S&P/OIC COMCEC 50
180 160 140 120 100 80 Index level 60 40 20 0 7/6/2009 11/18/2010 4/1/2012 8/14/2013 12/27/2014 5/10/2016
S&P Frontier BMI S&P Frontier BMI Shariah S&P/OIC COMCEC 50 Shariah
Source: S&P Dow Jones Indexes, http://eu.spindices.com/. Note: BMI = Broader Market Index; COMCEC = Committee for Economic and Commerical Cooperation of the OIC; OIC = Organisation of Islamic Cooperation; S&P = Standard & Poor’s.
shari‘ah-compliant S&P indexes and the con- shari‘ah scholars need to closely work and ventional S&P indexes on the global scale or align these standards to provide a single in the developed markets of the United States benchmark to measure performance, to avoid and Europe. The similar performance pattern confusing the investing public. A good exam- suggests that different shari‘ah screening stan- ple is the revision of shari‘ah screening stan- dards only add confusion for investors. This dards released by the Malaysia Securities further suggests that policy makers and Commission in November 2013. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 81
FIGURE 4.4 Relative Performance of Conventional versus Shari‘ah-Compliant Stocks, Regional Indexes
a. United States b. Europe 300 300
250 250
200 200
150 150 Index level Index level 100 100
50 50
0 0
11/3/2008 11/3/2009 11/3/2010 11/3/2011 11/3/2012 11/3/2013 11/3/2014 11/3/2008 11/3/2009 11/3/2010 11/3/2011 11/3/2012 11/3/2013 11/3/2014
S&P 500 S&P 500 Shariah S&P Europe 350 S&P Europe 350 Shariah c. Pan Asia d. Pan Arab 300 300
250 250
200 200
150 150 Index level Index level 100 100
50 50
0 0
11/3/2008 11/3/2009 11/3/2010 11/3/2011 11/3/2012 11/3/2013 11/3/2014 11/3/2008 11/3/2009 11/3/2010 11/3/2011 11/3/2012 11/3/2013 11/3/2014 S&P Pan Asia S&P Pan Asia Shariah S&P Pan Arab S&P Pan Arab Shariah
Source: S&P Dow Jones Indexes (http://eu.spindices.com/). Note: S&P = Standard & Poor’s.
In summary, the investors in a passive The Status and Contribution of the shari‘ah-compliant portfolio do not lose in Asset-Based Securities (Sukuk ¯ ) Market terms of diversification or returns, whether on to Economic Development with Shared a nominal or risk-adjusted basis. The perfor- Prosperity mance of shari‘ah-compliant portfolios is at Global Trends in Suk¯uk least as good as the performance of more diversified portfolios with higher financial and Suknjk products have been used to raise funds lower operating leverage. Since the Islamic for businesses, support economic develop- portfolio represents shares of those companies ment, provide government financing, and in the real sector, it thus helps create more jobs manage liquidity in financial institutions. and distribute wealth more equitably. Because they are different from stocks and 82 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.5 Breakdown by Sector of Major Conventional and Shari‘ah-Compliant Indexes
a. Sectoral distribution S&P Global b. Sectoral distribution S&P Frontier 1200 versus S&P Global 1200 Shariah BMI versus S&P Frontier BMI Shariah IT Telecommunication services 30.0% 60.0% Utilities Health care Utilities Materials 20.0% 40.0% Financials 10.0% Industrials Consumer 20.0% Financials discretionary 0.0% 0.0% Telecommunication Consumer services discretionary Health care Energy
Materials Energy Consumer staples Industrials Consumer staples IT S&P Global 1200 Shariah S&P Global 1200 S&P Frontier BMI Shariah S&P Frontier BMI
c. Sectoral distribution S&P 500 versus d. Sectoral distribution S&P Europe S&P 500 Shariah (United States) 350 versus S&P Europe 350 Shariah IT Health care 40.0% Telecommunication Health care 40.0% services 30.0% Utilities 30.0% Industrials 20.0% 20.0% Utilities Industrials 10.0% Financials 10.0% Consumer staples 0.0% 0.0% Consumer Financials Energy Telecommunication services discretionary Consumer Materials discretionary IT Materials Consumer staples Energy S&P 500 Shariah S&P 500 S&P Europe 350 Shariah S&P Europe 350
e. Sectoral distribution S&P Pan Asia f. Sectoral distribution S&P Pan Arab Composite BMI versus S&P Pan Asia Shariah versus S&P Pan Arab Composite Shariah IT Financials 60.0% Telecommunication 60.0% Consumer staples services IT Materials 40.0% 40.0% Utilities 20.0% Industrials Energy 20.0% Telecommunication 0.0% 0.0% services Health care Energy Health care Consumer staples
Financials Materials Utilities Industrials Consumer Consumer discretionary discretionary S&P Pan Asia Shariah S&P Pan Asia BMI S&P Pan Arab Composite Shariah S&P Pan Arab Composite
Source: S&P Dow Jones Index Website, various fact sheets as of May 31, 2015. Note: BMI = Broader Market Index; IT = information technology; S&P = Standard & Poor’s.
can be adjusted to various contractual forms The total suknjk outstanding was $310.95 bil- and structures, they suit the needs of both the lion as of year-end 2014. Table 4.2 presents investors and seekers of funds. Suknjk have summary statistics; figure 4.6 provides a been growing globally since the debut of the breakdown of suknjk issuance by currency first global suknjk in 2001. In 2014 alone, from 2001 to 2014. The U.S. dollar-denomi- suknjk issues totaled $133.26 billion from 22 nated suknjk have been growing, but suknjk domicile countries. Of the 826 issues, 54 were denominated in Malaysian ringgit (RM) are international and 772 were domestic. growing even faster and dominate the market. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 83
TABLE 4.1 Measures of Selected Shari‘ah-Compliant Indexes and Benchmark Indexes for Various Holding Periods
Indexes Variables 5 years 4 years 3 years 2 years 1 year S&P Global 1200 Excess return (%) 0.44 0.58 0.30 0.52 0.61 Tracking error (%) 2.23 2.18 1.87 1.83 1.64 Information ratio 0.20 0.27 0.16 0.28 0.37 Correlation 0.99 0.99 0.99 0.99 0.99 S&P 500 Excess return (%) 0.65 0.36 0.94 0.37 0.47 Tracking error (%) 2.07 1.91 1.68 1.64 1.63 Information ratio 0.31 0.19 0.56 0.23 0.29 Correlation 0.99 0.99 0.99 0.99 0.99 S&P Europe 350 Excess return (%) 1.15 1.99 0.28 1.00 2.33 Tracking error (%) 4.99 4.74 3.91 3.60 3.23 Information ratio 0.23 0.42 0.07 0.28 0.72 Correlation 0.96 0.96 0.96 0.97 0.98 S&P/OIC COMCEC Excess return (%) 1.63 0.99 4.49 4.51 2.97 50 Shariah Tracking error (%) 8.22 8.43 8.63 9.68 9.14 Information ratio 0.20 0.12 0.52 0.47 0.32 Correlation 0.70 0.69 0.63 0.61 0.70 S&P Pan Asia Excess return (%) 4.17 3.91 2.14 2.39 2.24 Tracking error (%) 8.15 8.76 8.68 9.14 7.06 Information ratio 0.51 0.45 0.25 0.26 0.32 Correlation 0.88 0.85 0.77 0.73 0.83 S&P Pan Arab Excess return (%) 0.62 0.97 0.01 1.05 0.76 Tracking error (%) 2.90 3.00 3.13 3.37 4.02 Information ratio 0.21 0.32 0.00 0.31 0.19 Correlation 0.98 0.98 0.98 0.99 0.99
Source: S&P Dow Jones Indexes, http://eu.spindices.com/. Notes: Excess return reflects the excess return of the shari’ah index over the conventional index. Tracking error is the standard deviation of the excess return. Information ratio is the ratio of excess return to the tracking error. Correlation measures the correlation between the shari’ah-compliant index and its conventional benchmark index.
TABLE 4.2 Status of Suku¯k as of December 31, 2014 In the first half of 2015, 302 suknjk were issued, amounting to $36.845 billion.6 Status Amount ($ billion) After dipping slightly in 2008 in the Announced 71.16 aftermath of the global financial crisis, Defaulted 1.71 suknjk issuance has risen and has surpassed Redeemed early 13.83 the precrisis amounts. Suknjk issuance Outstanding 310.95 peaked in 2012 at $218.3 billion. In 2013 and 2014, issuance declined (see figure 4.6). Redeemed 451.57 However, the market is gaining strength and Restructured 103.97 getting established; during the same period, Total 953.11 some very large-size suknjk were issued. The
Source: Islamic Research and Training Institute (IRTI) calculations based on total issuance per year for the last four years IFIS (Islamic Finance Information Service) data. has been well above $100 billion—a level 84 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.6 Suku¯k Issuance, 2001–14
a. Total sukuk- issuance 180 160 140 120 100 80 $ billions 60 40 20 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Issuance ($) Issuance (RM) Issuance (other currency)
b. Sukuk- issuance by currency 140 120 100 80 60
$ billions 40 20 0 –20 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Issuance ($) Issuance (RM) Issuance (other currency) Linear (Issuance, $) Linear (Issuance, RM)
Source: IRTI calculations based on IFIS data. Note: RM = Malaysian ringgit.
that was not anticipated after the global suknjk issuance market. The cumulative financial crisis. amount and percentage of suknjk issued from 2001 to 2014 was $639.9 billion (75 percent) Regional Analysis in Asia, compared to $108 billion (13 per- cent) in MENA, $91 billion (11 percent) in A regional analysis using four major regions— the Europe/NA Region, and about $10.75 bil- Asia, the Middle East and North Africa lion (1 percent) in Africa (see figure 4.7, pan- (MENA), Africa,7 and Europe and North els a and b). The pattern of suknjk amounts America (Europe/NA)—shows that the bulk outstanding is similar across the regions (see of the market is dominated by Asia, followed panel c). by the MENA Region (table 4.3). Within In 2014 and 2015, several new jurisdictions Asia, Malaysia has been dominating the progressed toward issuing suknjk, particularly GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 85
TABLE 4.3 Status of Suku¯k by Region, 2001–14 a. Amount ($ billion) Status Asia MENA Europe/NA Africa Others Announced 34.56 22.68 7.37 6.05 0.50 Defaulted 0.70 0.65 0.37 — — Redeemed early 6.08 4.29 3.46 — — Outstanding 207.89 42.60 57.31 3.14 — Redeemed 390.65 37.76 21.57 1.59 — Restructured 0.02 0.10 0.92 — — Total (regional) 639.90 108.09 91.00 10.78 0.50 b. Number of issuances Status Asia MENA Europe/NA Africa Others Total Announced 39 25 16 7 1 88 Defaulted 46 120049 Redeemed early 135 4500144 Outstanding 2,030 70 108 62 0 2,270 Redeemed 5,396 264 54 378 0 6,092 Restructured 111003 Total 7,647 365 186 447 1 8,646
Source: IRTI calculations based on IFIS data. Note: Europe/NA = Europe and North America; MENA = Middle East and North Africa; — = not available. in Africa. Some huge suknjk at the sovereign Several Islamic financial institutions and quasi-sovereign levels were launched in (IFIs) have issued perpetual suknjk to cre- MENA and Asia. These include the following: ate a risk-absorbing capital buffer and to use as high-quality liquid assets to meet • Saudi Aviation suknjk of $7.7 billion to the capital requirement of the Basel III purchase 50 Airbus aircraft. accord. While this does not promote • Saudi Aramco SADARA Basic Service shared prosperity directly, it does so indi- Company suknjk to fund construction rectly by strengthening IFIs, helping them of a chemicals and plastics complex manage their risks, and supporting a con- (Saudi Arabian riyal-denominated, total- tinuity of their own business operations ing $2 billion). that ultimately support the operations of • Malaysia Trust Certificates (suknjk) of the businesses they invest in. $1 billion with a 10-year maturity and Despite these developments, more inno- $500 million with a 30-year maturity. vation on the fiqh and shari‘ah regulatory These were long-term suknjk, and all of side is needed to expand the horizon of them were oversubscribed. suknjk and provide refinements to the struc- • The Islamic Development Bank (IDB) has turing and operational practices. Nonetheless, announced expansion of its Medium- every new suknjk structure and issuance must Term Suknjk Program from $10 billion to undergo evaluation and be endorsed for $25 billion, and plans to issue at least one shari‘ah compliance. Thus some degree of suknjk publicly each year with a minimum innovation and changes in practices are tak- size of $1 billion. ing place. 86 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.7 Cumulative Issuance of Suku¯k, 2001–14
a. By jurisdiction b. By percent 700
Africa 600 MENA 1% 13% 500 Europe and NA 11% 400
$ billion 300
200 Asia 100 75%
0 Asia MENA Europe Africa and NA c. Outstanding amount at end-2014 Asia 250
200
150
Europe and NA 100 MENA $ billion
50 Africa
0
–50 0 12345
Source: IRTI calculations based on IFIS data. Note: MENA = Middle East and North Africa; NA = North America.
A Framework for and Analysis of corporate suknjk issuance can reflect the the Contribution of Suk¯uk to Shared extent of public versus private benefits gen- Prosperity erated in the economy. However, assuming that the private sector is more efficient than Knowing whether suknjk are actually contrib- the public sector, the breakdown of sover- uting to the socioeconomic development and eign versus corporate issuances can represent shared prosperity, and if so, by how much, are different levels of effectiveness in their eco- difficult tasks. However, some informed nomic impact. In this regard, both the size assessment of suknjk’s contribution can be and the number of issuances can be ana- made at the macro level by analyzing vari- lyzed. The average size of the suknjk and the ous dimensions and compositions of suknjk. long-term versus short-term maturity can That is the focus of this section. also shed light on the possible economic The proportion of sovereign suknjk in the impact over time. The intended use of the total issuance compared to the proportion of funds and the nature of projects and GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 87
economic subsectors they will support also had been higher than the average size of cor- matter for their impact on the economic porate suknjk (panel c). Overall, corporate development of a country or a region. Since suknjk issuance remained higher from 2001 to various economic sectors differ in terms of 2014; however, sovereign issues dominated factor intensity, the choice of sector can also the market in terms of size during the same have varying implications for job creation time period (panel d). and employment generation. Suknjk that sup- Since the motivations of the government as port the development of infrastructure proj- an economic agent are more social as com- ects can have long-term and economy-wide pared to the motivations and decision-making impact, compared to general-purpose suknjk. criteria of other economic agents such as pri- Similarly, the accessibility of diversified kinds vate sector businesses, sovereign suknjk are of investors, including the general public, to expected to generate wider socioeconomic suknjk purchases has implications for gener- impacts through the provision of public goods ating savings and channeling them for pro- and services, as well as infrastructure develop- ductive use. The retail-denominated suknjk ment. Sovereign issuance also has positive units can diffuse the benefits ofsuk njk more implications for the development of the suknjk quickly, compared to the large unit value market by providing confidence and assur- suknjk targeting only institutional investors. ances of the continuity of the market develop- Moreover, diversifying the investor base by ment policies. However, if the suknjk also attracting the retail investors can help in mechanism is used by governments simply to creating an active secondary market in finance their current expenditures, then sover- suknjk. The more diverse the investor base, eign issuance can contribute to financial the more likely their investment holding repression and crowding out of private horizon will be asynchronous and hence the investment. more likely the suknjk will change hands dur- ing the maturity period, creating a liquid Maturity Structure market. All these comparisons and judg- The maturity structure of the suknjk instruments ments mentioned are only heuristic because is presented in figure 4.9. Short-term suknjk many other factors at the implementation with tenure of one year or less are the dominant stage, as well as the finer details of thesuk njk kind, both in the number and in the total structure, matter for the attainment of eco- amount per year (panel a). These are mostly nomic impact and the sharing of prosperity. based on commodity murƗbahah̙ or ޏƯnah sale Nonetheless, the various ratios and propor- or tawarruq transactions,8 and commonly are tions-based criteria can help gauge the direc- used either for liquidity management by finan- tion of the development of the suknjk cial institutions or for provision of short-term market. finance. The trend to issue very short-term suknjk of three months or less is increasing. Sovereign versus Corporate Issuance Long-term suknjk with a maturity of 10 or more Sovereign issuers dominate the market in years have been declining and are relatively terms of the amounts, number, and average rare. Medium-term suknjk with maturities size of suknjk. In 2013, 2014, and the first half between 3 to 5 years and 5 to 7 years occupy a of 2015, the total amount of sovereign issu- middle ground but are increasing (panel b). ance was much higher than the total corpo- rate issuance (see figure 4.8, panel a). The Suk¯uk by Type of Contractual Structure number of sovereign issues was lower than corporate issues in 2013, but the situation MurƗbahah̙ -based suknjk account for 38 per- reversed with a higher proportion of sover- cent of the cumulative amount of suknjk eign issues in 2014. The trend continued in issued from 2001 to 2014, followed by ijƗrah the first half of 2015 (panel b). Despite this, at 15 percent and Bai Bi-Thaman Ajil at the average size per issue of sovereign suknjk 12 percent (figure 4.10). A disadvantage of 88 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.8 Characteristics of the Suku¯k Market
a. Amount ($ billion) b. Number of issues
90 500 80 450 70 400 350 60 300 50 250 40 200 30 150 20 100 10 50 0 0 2013 2014 2015H1 2013 2014 2015 H1
c. Average size ($ million) d. Sukuk- by type of issuer, cumulative 2001–14 250 8,000
7,000 Corporate
200 6,000
5,000 150 4,000 Sovereign 3,000 100 Number of issues 2,000 Government 1,000 related 50 Supranational 0
0 –1,000 2013 2014 2015H1 012345 Corporate Sovereign
Source: IRTI based on data from Zawya data and IFIS. Note: 2015H1 = first half of 2015.
murƗbah̙ah suknjk is that they are not trad- changing since 2001. In recent years, the able in the secondary market;9 this reduces most commonly used structure has been their potential to change and diversify owner- ijs r̙ ah (43 percent). This has been followed ship through secondary trades and lowers the by wakƗlah (34 percent), which are becom- potential for shared prosperity. Moreover, a ing more prominent (see table 4.4). large proportion of these murƗbah̙ah suknjk MurƗbahah̙ constituted a smaller proportion are issued only to manage liquidity. Hence, (13 percent) in 2013–14. Factors for these they do not directly contribute to economic changes include shari‘ah rulings and revi- development; they contribute only indirectly, sions in the standards issued by the by strengthening IFIs. Accounting and Auditing Organization for The composition of the types of contrac- Islamic Financial Institutions (AAOIFI). tual structure used in suknjk has kept However, the main drivers of change have GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 89
FIGURE 4.9 Maturity Structure of Suku¯k Instruments
a. Duration (tenor) 45 40 35 30 25 20 $ billion 15 10 5 0 2011 2012 2013 2014 Less than 3 months 3 months–1 year 1–3 years 3–5 years 5–7 years 7–10 years 10–15 years 15–25 years 25+ years
b. Trends in each maturity bucket 45 40 35 30 25 20 $ billion 15 10 5 0 Less than 3 months– 1–3 years 3–5 years 5–7 years 7–10 years 10–15 15–25 25+ years 3 months 1 year years years 2011 2012 2013 2014
Source: IRTI based on IFIS data.
been issuers’ quest to issue suknjk without the followed by real estate (7 percent), energy requirement of qualifying assets, and inves- (5 percent), transport (5 percent), industrial tors’ demand for secured returns. manufacturing (4 percent), utilities (3 per- cent), telecommunication (2 percent), water Suku¯k Issuance by Sector and power (2 percent), and services (2 per- cent) (panel b). Issues for agriculture, food, Sovereign suknjk had a larger share of the health care, education, and other sectors market (58 percent) than private suknjk have been very small. This was the case from (42 percent) from 2001 to 2014 (figure 4.11, 2001 to 2014. In recent years, the share of panel a). For private suknjk, the largest share sovereign issuance and the share of issuance of the total cumulative suknjk issuance has for the financial sector have increased, while been for the financial sector (12 percent), issuance for other private nonfinancial 90 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 4.10 Suku¯k by Structure, 2001–14
a. Amount ($ billion) 350 300 250 200 150 100 50 0 - . - - - Ijarah - - . Salam Hybrid Istisna‘ Wakalah . Tawarruq Investment Murabahah Musharakah Unspecified Bay‘-al-’inah Mudarabah
Bai Bi-Thaman Ajil b. Percentage share of each structure, 2001–14
Tawarruq Salam - Istisna‘. Investment - Mudarabah. Bay‘-al-‘inah Wakalah- Hybrid Unspecified Musharakah- Bai Bi-Thaman Ajil Ijarah - Mudarabah. 0 5 10 15 20 25 30 35 40 Percentage c. From pure debt to pure equity sukuk- (left to right) 40 35 30 25 20 15 Percentage 10 5 0 - . - - - . Salam Ijarah - - Istisna‘ Hybrid . Tawarruq Wakalah UnspecifiedBay‘-al-’inah Murabahah Investment Mudarabah Musharakah
Bai Bi-Thaman Ajil
sectors has declined. In 2013–14, the share Economic Development and Shared of sovereign issuance and financial sector Prosperity through Suku¯k Markets issuance reached 61.4 percent and 21.5 per- Potential for Infrastructure Financing cent, respectively, while the issuance for the private nonfinancial sector declined to Physical infrastructure plays an important 17 percent.10 role in the socioeconomic development of GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 91
FIGURE 4.11 Suku¯k Issuance by Sector, 2001–14
a. Sovereign or private issuance (percentage)
42
58
Sovereign Private
b. Percentage of cumulative issuance for private sukuk- 14 12 10 8 6 Percentage 4 2 0
Food Other Energy Utilities Retail TransportIndustrial Services Education Real estate Agriculture Health careInformation Water/power technology Financial services manufacturing Metals and mining Telecommunications
Source: IRTI, based on IFIS data. countries and regions in many ways, both quite large and long term. A common prob- during its construction phase and for a long lem encountered is the mismatch in maturities period after its construction. It helps long- between the underlying assets and funding. term development by lowering the costs of Some projects can generate revenues, while economic activity and by facilitating connec- others may be in the nature of a public good. tions and networks. Its benefits reach a wide In such cases, some kind of public-private range of the population, thus contributing to partnership may be needed. Yet another issue shared prosperity. Often the investments is scalability: Some projects may offer suffi- required for such infrastructure projects are cient incentives for the private sector to 92 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 4.4 Suku¯k by Their Underlying Contracts
Underlying contract 2013–14 2009–12 structure ($ million) Percent ($ million) Percent Ijar¯ah 17,295 43 19,085 48.000 Wak¯alah 13,628 34 10,670 27.000 Murabah ¯ . ah 5,047 13 1,942 5.000 Hybrid 1,964 5 5,408 14.000 Mud.arabah¯ 1,599 4 1 0.002 Mush¯arakah 391 1 2,605 6.000
Source: IIFM 2014.
step in, but the size of the individual projects financial sector side, it requires domestic bank- may be small and thus have little or no econ- ing and nonbanking financial institutions, omy-wide impact. Scaling up and coordina- along with capital markets. tion would be required to have a wider Given these complexities, less developed development impact. An example could be countries tend to rely more on external debt renewable energy projects, such as those pro- and foreign aid for infrastructure projects. moting wind power. Each windmill is a small This adds to their debt burden, particularly investment, but thousands of windmill gener- when projects get delayed or remain incom- ators are required to create an economy-wide plete or are even abandoned because of the impact. institutional development difficulties men- Harmonization and connectedness of one tioned. Even for better performing developing infrastructure project with another are also countries, only 2.5 to 3 percent of infrastruc- important. For example, the usefulness and ture investment comes from international impact of some infrastructure projects in donors (World Bank 2013). Private sector one country can depend on the development financing from big private international banks of coordinated infrastructure projects in is also drying up, as these banks are also facing neighboring countries. The impact of a deleveraging and will not be funding large cross-country highway built in country A infrastructure projects. will be enhanced if a highway is also con- In this environment, suknjk have the oppor- structed in country B and linked to it. The tunity to play a role in increasing shared pros- impact of the infrastructure will be amplified perity (see Ali 2014). Given that the size of the both nationally and regionally. This implies Islamic capital market is small, a strategic use the need for regional initiatives for large of sovereign and quasi-sovereign suknjk can be infrastructure projects and coordinated issu- to finance crucial enabling infrastructure proj- ance of suknjk. ects that can facilitate further inflows of pri- In short, infrastructure investment requires vate funding for infrastructure. Project-specific more than a financial instrument. On the suknjk, instead of general-purpose suknjk, financial instruments side, it requires scalability would be ideal to overcome some of the prob- and liquidity so that all types of investors are lems encountered in infrastructure financing. able to participate. On the institutional side, it Suknjk can facilitate risk sharing between the requires supportive laws, adequate enforce- investors, the project company, the govern- ment, and good governance to create an envi- ment, and the operators. These risk-sharing ronment where just and fair treatment of all arrangements can vary in different parts of a parties is ensured. On the political side, it large project. Financing infrastructure would requires coordination and public will. On the also require longer-term suknjk. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 93
Potential for Social Inclusion and traditionally relied on capital contributions Poverty Alleviation through Awq¯af from its members to fund its operations. As the demands for development assistance have The nonprofit, voluntary sector is a privately been rising faster than the Bank’s equity capi- initiated sector that provides social goods and tal, the IDB has been resorting to the capital works in parallel to the government public market. Its debut issue in 2003 of a stand- sector. AwqƗf (singular, waqf), a kind of trust alone, five-year, $400 millionsuk njk was done institution (see glossary), can be used to sup- as an experiment with the market and to con- port the voluntary sector. AwqƗf can be used vey the IDB’s intentions of using market not only to provide immediate necessities to resources in the coming years. the poor, but also to create or strengthen busi- In 2005, IDB established its $1 billion ness support institutions that can lower the Medium-Term Note (MTN) Program, which cost of doing business for the poor. AwqƗf can allowed issuance of suknjk in multiple curren- also be used to support and build infrastruc- cies as and when needed (box 4.1). The pro- ture institutions that can improve corporate gram was initially listed on the Luxembourg governance and reduce the cost of doing busi- Stock Exchange, but was later shifted to the ness. For example, information bureaus, mar- London Stock Exchange and Bursa Malaysia. ket regulatory bodies, the provision of The MTN program was updated and expanded accountancy services, and other such shared several times in tandem with the bank’s grow- services for a group or for the entire society ing operational funding needs. It was increased can be funded through waqf. to $10 billion in 2013. By 2014, it was listed in Many of the properties of awqƗf are ame- multiple markets, including Nasdaq Dubai, to nable to securitization through the issuance of further enhance IDB’s suknjk profile and suknjk on the usufruct of those properties. The improve its liquidity for investors. In June proceeds can be used to expand operations 2015, IDB increased the ceiling of its suknjk and build new social projects. These suknjk, program from $10 billion to $25 billion, in like government suknjk, have multiple benefits. keeping with its aim to expand its financ- They help expand the provision of social goods ing across member-countries. The expanded and services. The issuance and performance of program will take advantage of IDB’s AAA rat- these suknjk require appropriate monitoring, ing. It seeks to issue one suknjk publicly every reporting, and payment mechanisms. Thus, as year, with a minimum size of $1 billion, while a by-product these suknjk foster institutional- keeping pace with growing investor requests ization of reporting and monitoring practices for private placements. that can also become useful for the entities in The proceeds from the suknjk are mainly the for-profit sector. By fostering shared institu- used to complement IDB’s equity resources for tions, awqƗf can help reduce the cost of doing its development funding. The funding needs business. Equally important, the public provi- are expected to grow 10 percent a year in the sion of social goods through the voluntary sec- years to come. So far, using proceeds from the tor, such as awqƗf, builds mutual trust in suknjk, the bank has been able to expand its society, which is a requirement for exponential development assistance in energy, infrastruc- growth and economic development. ture, agriculture, health, and other sectors to its member-countries. This has been achieved at a Suk¯uk for Socioeconomic Development: much lower cost than what the beneficiary Experiences and Lessons countries would have paid if they had raised the funds themselves from the international Case 1. The Islamic Development Bank’s Use of markets. Suku¯k for Development Financing11 IDB suknjk can be considered hybrid bal- The IDB promotes economic development in ance sheet asset suknjk because these suknjk are its 56 member-countries, as well as in Muslim issued against a specified pool composed of communities in non-member-countries. It has ijƗrah (leasing) and non-ijƗrah (non-leasing) 94 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
BOX 4.1 Issuances in IDB’s Medium-Term Note Program
Under the Medium-Term Note (MTN) Program, issued three tranches of Malaysian ringgit (RM) IDB had issued 17 series of suknjk as of April 2014. suknjk in 2008, 2009, and 2013, with a cumulative In 2015, IDB announced that it intends to issue up total of RM 700 million, under a different MTN to $25 billion in suknjk cumulatively over the next program of 1.000 RM billion, with maturity dates several years under the MTN program, with at least of August 2013, March 2014, and August 2018, $1 billion issued each year. In addition, IDB also respectively.
Series Currency Amount (million) Type of issuance Issue date Maturity date 1 USD 500 Public issuance 2005 June 2010 2 SRls 200 Private placement 2009 September 2012 3 USD 850 Public issuance 2009 September 2014 4 SRls 1,875 Private placement 2010 September 2020 5 SRls 1,875 Private placement 2010 September 2020 6 USD 500 Public issuance 2011 October 2015 7 £ 60 Private placement 2011 February 2016 8 USD 750 Public issuance 2011 May 2016 9 £ 100 Private placement 2012 January 2017 10 USD 800 Public issuance 2012 June 2017 11 £ 100 Private placement 2012 August 2015 12 USD 300 Private placement 2012 October 2015 13 USD 500 Private placement 2012 October 2017 14 USD 700 Private placement 2013 March 2018 15 USD 1,000 Public issuance 2013 June 2018 16 USD 1,500 Public issuance 2014 March 2019 17 USD 100 Private placement 2014 April 2017
Source: Omar and others 2014. Note: SR1s = Saudi riyals.
assets segregated from the balance sheet of the secondary market, making them liquid. IDB. The asset pool contains a significant pro- Each issuance of suknjk represents a different portion of ijƗrah compared to receivables (or pool. Suknjk cannot be issued against the same nontangible assets) so that the composite pool assets until those assets come back into the itself can be considered as a tangible asset class ownership of IDB. for all practical purposes and in the legal clas- Using this type of suknjk structure for sification. Hence the laws pertaining to tangi- development funding poses challenges. In ble asset class are applicable to it, and the order to be continually able to issue suknjk suknjk issued against this pool become eligible backed by assets, the IDB must be able to to receive a return and also eligible for sale in increase the creation of tangible assets or GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 95
tradable contracts in the IDB balance sheet liquid assets. It is yet another way in which more quickly before it can issue further IDB suknjk are contributing to economic prog- suknjk. Moreover, most of the assets held by ress through the development of the Islamic IDB on its balance sheet are development financial sector globally. projects or development financing contracts that are not rated; because they are develop- Case 2. Vaccination and Immunization Suku̙ ¯k12 ment oriented, they do not generate commer- The suknjk issued by the International cial rates of return. How to induce investors Financial Facility for Immunization (IFFIm) to accept low-return suknjk in the market is a provide another example of suknjk used for challenge. social and developmental purposes. The pro- Therefore, IDB suknjk are asset based ceeds will be used to fund vaccination devel- rather than asset backed. This essentially opment and immunization programs by the means that the ultimate recourse in case of Global Alliance for Vaccination and default on the suknjk would be to IDB as the Immunization (Gavi).13 The $700 million obligor and originator of the suknjk through suknjk were issued in 2014 and mature in a special purpose vehicle (SPV), rather than December 2017. They are based on commod- the suknjk assets themselves. This does not ity murƗbahah̙ structure.14 Because the suknjk meet AAOIFI suknjk standards or conform to are murƗbahah̙ based, they are not tradable in the views of the majority of shariޏah schol- the secondary market. Although there is noth- ars, who hold that suknjk should represent ing innovative in the structure of the suknjk, undivided ownership in the specified assets the fact that they are dedicated to an impor- (or pool of assets) that are sold to the SPV tant social and health purpose is laudable and and held in trust with it. This would justify demonstrates the usefulness of a shari‘ah- the periodic payments (rents) to the suknjk compliant structure in attracting the funding. holders as the de facto owners of the under- It is noteworthy that 85 percent of the bids for lying assets. In case of default, they would the suknjk came from new investors, mainly have recourse to those assets in some form. from the Middle East (68 percent) and Asia However, this defect exists, and the reasons (21 percent). Seventy-four percent of the for this anomaly in IDB suknjk are economic suknjk were taken by Islamic banks, while cen- and legalistic in nature. Thus, to give com- tral banks and other official institutions took fort or rather to enhance the credit profile of 26 percent.15 its suknjk, IDB has to link the performance of Before it issued the immunization suknjk, the suknjk to the bank’s credit strength, IFFIm pioneered the issuance of (conven- which is AAA rated, based on the strength of tional) vaccination bonds to overcome the its capital and the commitment by its problem of slow delivery of money (dona- member- countries to provide support. In this tions) pledged by sovereigns. Such pledges way, IDB has been able to mobilize resources pass through various channels of approvals at a cost much lower than that of the benefi- until they are delivered, or sometimes they ciary countries if they had raised the funds are promised to be delivered several years in themselves from the international markets. the future. IFFIm was created in 2006 to In addition to its high credit rating, the securitize the donation pledges made by cer- Basel Committee on Banking Supervision has tain developed countries for the development designated IDB as a “zero-risk weighted” mul- of vaccines and immunization programs. tilateral development bank since 2004. The IFFIm essentially securitizes and sells these European Commission has accorded the same pledged cash receivables at a discount to the treatment to IDB since 2007. All these factors investors to get cash-in-hand to finance its have made it possible for the Islamic financial immunization projects. Selling of future cash services industry to use IDB suknjk in various for the present at a discount would not be ways, including as an acceptable asset class to permissible in Islam. However, by purchasing satisfy Basel III requirements of high-quality a commodity on the basis of a deferred 96 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
payment and selling it on a spot price, the Recommended Policies to Enhance cash-in-hand is generated without explicitly Shared Prosperity through Islamic resorting to a sale of pledges.16 In this pro- Capital Markets cess, the AA credit rating of the IFFIm, along The main requirements of the Islamic capital with the shari‘ah-compliant structure of the market framework are not any different suknjk, also helped. However, greater compli- from the requirements of the conventional ance with shari‘ah structuring would have capital market. These include protecting been possible without the use of the com- property rights, minimizing corruption and modity murƗbahah̙ structure, as follows. fraudulent practices, and supporting the rule The donations from sovereigns are essen- of law. However, there are some differences tially a purchase order for vaccines from the in the requirements for the sound develop- donor countries for distribution to less-devel- ment of Islamic capital markets. These differ- oped countries. The IFFIm needs to purchase ences stem from the needs to attain shari‘ah the available vaccines from Gavi (the vaccine compliance and the overarching objectives of alliance) on spot payment to sell to the pur- Islamic teachings. These include the prohibi- chase orderer at a higher deferred price. IFFIm tion of interest, and the execution of transac- could have issued mud̙Ɨrabah certificates to tions in ways that neither circumvent nor investors for this particular deal and shared covertly help in circumventing any shari‘ah with them the murƗbahah̙ mark-up profit. In prohibition. The needs arising from meeting this way, the risk of vaccine purchase and sale the moral and overarching Islamic objectives would have been shared by the investors along include facilitating the circulation of wealth with the IFFIm. The deal would have directly instead of its concentration, sharing of risks linked financing with the actual business and and rewards more widely instead of shifting the actual intended commodity (the vaccine), risk, and serving the real economy instead of rather than creating a secondary layer of trans- commandeering it. action on a second commodity that was not The growth of the Islamic capital market intended for final use by any of the transacting has been hindered by several challenges. parties. The mud̙Ɨrabah certificates so issued A mid-term review (MTR) of the Islamic finan- would have been tradable in the secondary cial services industry, jointly prepared by the market, which would have been good for their Islamic Research and Training Institute (IRTI) liquidity and an added attraction for the and the Islamic Financial Services Board investors. (IFSB), highlights some of the major challenges There is another important lesson to be and the policy response needed by the Islamic learned in the structuring of this suknjk. finance industry. Some policy recommenda- Although the second mudƗrabah-based struc- tions emerging from the above discussion ture was possible, the issuers chose the first follow, including those from the review, specifi- structure because it was easier to administer. cally addressing the Islamic capital markets in Thus the transaction shifted from the market enhancing shared prosperity, along with some for the vaccine to the market for the other context.17 commodity (such as metals), which was not intended by any party but used for the com- modity murƗbahah̙ only. A policy recommen- Create More Incentives for Risk Sharing dation for the development of the Islamic financial sector, and specifically for the devel- One of the biggest challenges that may hinder opment of Islamic capital market products, is the promotion of equity markets in general that the government and the regulators should and Islamic capital markets in particular is the take steps to make it easy to do the transaction preferential tax treatment of interest expenses on the intended commodity and make the use paid by corporations. This provides an incen- of ribƗ (interest) and its alternate stratagems tive to corporations to issue more debt than more difficult and costly. equity. In order to level the playing field for GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 97
debt and equity, the tax shelter on interest suknjk markets. So is addressing legal and fiscal payments needs to be eliminated. Abolishing impediments to suknjk issuance by corporates. the tax shelter on interest payments would help reduce reliance on debt markets and Standardize and Harmonize the Approach increase investment in the equity markets. to Islamic Capital Market Regulation Another challenge that Islamic capital mar- kets face is discrimination in the use of finan- The need for better corporate governance cial innovations such as asset-backed mechanisms and regulatory frameworks can- securitization. Securitization facilitates risk not be overemphasized for Islamic capital sharing and thus enhances shared prosperity. markets. Since Islamic capital market prod- In the case of conventional finance, there is no ucts are based on higher ethical standards requirement for the assets (title) to be trans- than the conventional market because of the ferred. Moreover, the lack of transfer of the requirement to be shari‘ah compliant, a well- asset does not create a tax liability for the designed regulatory framework is the basic investor. However, in the case of Islamic securi- requirement. However, there is a lack of con- tization (suknjk), transfer of assets is a shari‘ah sensus among regulators in terms of devising requirement. It incurs additional expenses at uniform rules across jurisdictions. the origination and termination of the transac- tion. There is a need to develop regulations that allow the transfer of ownership without Improve Shari‘ah Governance any additional cost for the issuance of suknjk. Islamic finance is not a local phenomenon any- Suknjk are also failing to meet their goal of more. The Islamic financial services industry sharing prosperity when they are structured to exists in some form in at least 50 countries. refinance an existing loan as opposed to creat- The need to harmonize shari‘ah rulings and ing a new economic activity, are general pur- standardize practices or products in the Islamic pose rather than project specific, or are used to finance industry is obvious. To stimulate cross- finance government budget deficits rather than border activities in both primary and second- development financing. The refinancingsuk njk ary markets, the acceptance of contracts across do not directly contribute to the projects, but regions and across schools of thought and only provide continuity to the existing suknjk. If markets will also be helpful. Conformity or the original suknjk were not funding economic similarity among the shari‘ah supervisory development projects, extending such suknjk boards of IFIs is urgently required to extend would be detrimental to sharing prosperity. Use the possibilities of the concept and application of such suknjk can simply increase public expen- in the industry. A global approach is required ditures and adversely affect sustainability. for dealing with governance issues, especially Short-termism dominates the suknjk markets issues related to shari‘ah governance. globally as well as regionally, as can be seen Developing and adopting universal standards from the higher proportion of short-term such as those proposed by AAOIFI and IFSB, suknjk issuance to total issuance and a trend among others, is highly recommended. toward very short maturities. An entire spec- In the absence of a stock market for the trum of maturities would be needed to benefit Islamic equities, it may be difficult for investors from the development and orientation of suknjk to identify the investible universe of shari‘ah- markets. Many of the short-term suknjk are compliant capital market products, especially based on murƗbahah̙ or other such arrange- equities. Policy makers may consider a two- ments that are not suitable for developing a sec- step approach: disclosure by the firm and attes- ondary market for suknjk. Hence the risk tation by the regulator. sharing that is possible through trade is cur- tailed by reliance on nontradable suknjk. • Disclosures: Firms are required to report Developing short- and longer-term sovereign their shari‘ah compliance status based on and corporate suknjk is critical for developing a minimum compliance criterion, with the 98 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
encouragement to provide better disclo- of suknjk instruments in the secondary market sures, especially all those events that may would require a valuation of the underlying result in possible noncompliance in the assets pool or business venture. Policies are future. required to promote correct valuation of the • Attestation: A shari‘ah board at the apex underlying asset pool, enhance standardiza- level validates/attests that the disclosures tion of products and the design of structures by the reporting firm are to their satisfac- that can be traded with wide acceptance as tion in terms of meeting the shari‘ah compliant with shari‘ah, and ensure transpar- requirements, and publishes the list of ency and discourage ambiguities. In addition, such firms and products on a regular basis. targeting a diverse set of investors to buy suknjk can also improve liquidity of the sec- There is no limit to the financial innovation ondary markets. A diversity of investor types in Islamic finance, provided that it complies would mean that different investors would with shari‘ah. However, several recent finan- have different investment horizons and their cial innovations have attempted to replicate a liquidity needs would not be correlated. Thus conventional product, especially leveraged or sale and purchase in the secondary market derivative products. This has led to criticism of would remain active. Islamic finance practices in general. A clear- ance requirement from an apex shari‘ah com- mittee to attest to the shari‘ah compliance of Strengthen Resolution Frameworks all financial products offered in any jurisdic- and Investor Protection tion is recommended. Weak or nonexistent default resolution and insolvency regimes to handle suknjk defaults Improve Market Liquidity by Addressing pose a challenge. Legal uncertainty about the the Constraints resolution framework is mitigated in sover- eign suknjk, which are often issued under There is evidence that the secondary market international law (IMF 2014). However, there in suknjk is very thin, due to the limited supply is a need for further clarification of the resolu- of suknjk, as well as the strategy of the suknjk tion framework regarding corporate and buyers to hold their suknjk to maturity. Suknjk quasi-sovereign suknjk. Most corporate suknjk certificates are traded only about 40 percent are issued under domestic law in jurisdictions of the time (Safari 2013), which works out to with underdeveloped legal and regulatory trading once every 12 trading days. A market infrastructures. Default cases have illustrated infrastructure that facilitates trading, price that legal uncertainty is high when the perfor- transparency, and efficient clearing and settle- mance of the underlying asset falls below ment of transactions is required. According to expectations and the suknjk effectively an IMF report (2014), limited secondary mar- defaults. Given the lack of a clear legal frame- ket activity results in lack of adequate pricing work for restructuring, suknjk holders must and severely hinders effective marking to seek resolution in case-by-case negotiations. market. Main factors that hinder the second- In addition, the necessary infrastructure to ary market trading of suknjk instruments are quickly identify current suknjk holders—which lack of supply, incorrect valuations, and the would help speed negotiation—is not in place shari‘ah limitation on tradability. Investors in many jurisdictions. The problem is com- tend to hold their suknjk to maturity. Some pounded when the SPV that is normally cre- suknjk types are eligible for secondary market ated to issue the suknjk and hold the assets in trading, such as equity-based suknjk (as in trust does not have any executive power to mushƗrakah and mud̙Ɨrabah) or those based negotiate with any party or do any transaction on the value of an underlying asset (as in except with the permission of the originator suknjk ijƗra). Others are not, such as debt- (IIFM 2014). To alleviate these problems, based suknjk (murƗbahah̙ suknjk). The pricing building robust bankruptcy and insolvency GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 99
frameworks and scenarios of how suknjk deferred price (trade-generated debt). The instruments might unwind in the event of trade-generated debt is tradable in the sec- default could be helpful. In the same vein, it ondary markets in Malaysia. would be helpful to have a mechanism for 10. Percentages for 2013–14 are based on the IFSB defined executive powers of the SPV in case of (2015) Islamic Financial Services Industry Stability Report. default by the obligor. 11. This case is based on Ali (2014). 12. This case is based on Ali (2014). Notes 13. Gavi is an international organization created in 2000 to improve access to new and under- 1. This process is explored in the Arrow and used vaccines for children living in the world’s Debreu (1954) model of competitive poorest countries. See http://www.gavi.org/. equilibrium. 14. In a commodity murƗbahah̙ structure, the party 2. Shari‘ah-compliant companies include compa- seeking finance buys a commodity today from nies whose major source of revenue comes the party providing finance for a marked-up from permissible (halƗl) activities. Companies price to be paid on a future date. It then sells that are excluded are predominantly engaged that commodity in the spot market (or to the in any of the following nonpermissible (harƗm) same seller) at a discount to get upfront cash. activities: trading of alcohol or pork, pornog- The price payable in the future with a markup raphy, gambling, or from profit associated becomes a debt obligation for the buyer. with the charging of interest on loans. 15. http://www.iffim.org/Library/News/Press 3. The general criteria for including any security -releases/2014/International-Finance -Facility in an Islamic index depends on two levels of -for-Immunisation-issues-first-Sukuk, -raising screening: business and financial. Business -US$-500-million/ and http://www.reuters .com screening excludes shares of all companies /article/2014/12/07/iffim-sukuk -id USL6 engaged in activities strictly prohibited (harƗm) N0TI04J20141207. in Islam. Financial screening further screens 16. “Under the sukuk Al-Murabaha structure, those companies that passes the business IFFImSC issued $500 million in sukuk certifi- screen but have a portion of revenue from cates to investors in November 2014. The pro- harƗm activities, such as borrowing or lending ceeds of these sukuk certificates were used by money with interest (ribƗ) and/or have a major IFFImSC to purchase eligible commodities, proportion of assets in liquid form. These which were then sold to IFFIm at a pre-specified screens are based on arbitrary financial ratios deferred price. This deferred price included the and are quite controversial within the Muslim $500 million principal cost component and a community (Ashraf 2014; Obaidullah 2005). profit component. Simultaneous to its purchase For a detailed discussion of the different of the commodities, IFFIm on-sold the com- screening criteria and their impact on portfolio modities to a third party commodity purchaser, performance, see Ashraf (2014). through a commodity agent, generating $500 4. There is no specific reason for the choice of million in proceeds for use in funding vaccine S&P shari’ah screening. programmes and refinancing IFFIm’s existing 5. COMCEC is the Standing Committee for debt” (Gavi 2014, 17). Economic and Commercial Cooperation of 17. The list of general recommendations is well the Organisation of Islamic Cooperation. documented in IRTI and IFSB (2014). 6. IRTI calculations based on data from Zawya. 7. For the purpose of this chapter, Africa refers to Sub-Saharan Africa, excluding North Africa. References 8. See glossary for definitions ofmur Ɨbahah,̙ ޏƯnah sale, tawarruq, and other Arabic terms. Agarwal, Sumit, and Hamid Mohtadi. 2004. 9. The murƗbahah̙ sales contract creates a cash “Financial Markets and the Financing Choice receivable as the asset of the seller. This type of Firms: Evidence from Developing Coun- of asset cannot be traded at a premium or dis- tries.” Global Finance Journal 15 (1): 57–70. count. However, this shari‘ah restriction is Ali, Salman Syed. 2005. Islamic Capital Mar- not operational in Malaysia, which differenti- ket Products: Development and Challenges. ates between a loan (pure debt) and debt Jeddah, Saudi Arabia: Islamic Research and resulting from the sale of a commodity at a Training Institute, Islamic Development Bank. 100 ISLAMIC CAPITAL MARKETS GLOBAL REPORT ON ISLAMIC FINANCE
———. 2013. “Islamic Capital Markets: Objec- Islamic Financial Services Industry Development: tives and the Way Forward.” In Islamic Capi- Ten-Year Framework and Strategies—A Mid- tal Markets—Competitiveness and Resilience, Term Review. Jeddah, Saudi Arabia: Islamic edited by Salman Syed Ali. Jeddah, Saudi Arabia: Research and Training Institute. Islamic Research and Training Institute, Islamic Jobst, A. A. 2007. “The Economics of Islamic Development Bank. Finance and Securitization.” IMF Working Ali, Salman Syed, ed. 2014. Islamic Finance and Eco- Paper, International Monetary Fund, Washing- nomic Development: Lessons from the Past and ton, DC. Prospects for the Future. Jeddah, Saudi Arabia: King, R., and R. Levine. 1993. “Finance and Islamic Research and Training Institute, Islamic Growth: Schumpeter Might Be Right.” Quar- Development Bank. terly Journal of Economics 108: 717–38. Al-Masri, Rafic Yunus. 2007. “Speculation Levine, R. 1997. “Financial Development and between Proponents and Opponents.” Jour- Economic Growth: Views and Agenda.” Jour- nal of King Abdul-Aziz University: Islamic nal of Economic Literature 35: 688–726. Economics 20 (1): 43–52. ———. 2005. “Finance and Growth: Theory Arrow, K. J., and G. Debreu. 1954. “Existence of and Evidence.” In Handbook of Economic an Equilibrium for a Competitive Economy.” Growth, edited by P. Aghion and S. Durlauf, Econometrica 22: 265–90. Vol. 1A, 867–934. New York, Amsterdam: Ashraf, D., 2014. “Does Shari‘ah Screening Cause Elsevier B.V. Abnormal Returns? Empirical Evidence from Levine, R., and S. Zervos. 1998. “Stock Market, Islamic Equity Indices.” Journal of Business Banks and Economic Growth.” American Eco- Ethics. doi:10.1007/s10551-014-2422-2. nomic Review 88: 537–58. Beck, T., A. Demirgüç-Kunt, and R. Levine. 2007. Menkoff, Lucas, and Norbert Tolksdorf. 2001. “Finance, Inequality and the Poor.” Journal of Financial Market Drift: Decoupling of the Economic Growth 12 (1): 27–49. Financial Sector from the Real Economy? Bekaert, G., and C. R. Harvey. 1997. “Capital Heidelberg-Berlin: Springer-Verlag. Markets: An Engine for Economic Growth.” Unpublished paper, National Bureau of Eco- Mirakhor, Abbas. 2010. “Whither Islamic Finance?” nomic Research, Cambridge, MA. Paper presented at the Inaugural Malaysia Securities Commission and Oxford Center for Epstein, Gerald A. 2006. Financialization and the Islamic Studies Conference, Oxfordshire, U.K. World Economy. New York: Edward Elgar. March 15. Gavi Alliance (Global Alliance for Vaccination Naughton, Shahnaz, and Tony Naughton. 2000. and Immunization). 2014. The Vaccine Alliance “Religion, Ethics and Stock Trading: The Case 2014 Annual Financial Report. Washington, of an Islamic Equities Market.” Journal of DC: Gavi Alliance. Business Ethics 23 (2): 145–59. IFSB (Islamic Financial Services Board). 2015. Obaidullah, M. 2005. Islamic Financial Services. Islamic Financial Services Industry Stability Jeddah, Saudi Arabia: Scientific Publishing Report 2015. Kuala Lumpur: IFSB. Center, King AbdulAziz University. IIFM (International Islamic Financial Markets). Omar, Mustafa, Salman Syed Ali, Mohamed 2014. IIFM Sukuk Report: A Comprehensive Obaidullah, and Turkhan Abdulmanp. 2014. Study of the Global Sukuk Market. 4th ed. “Funding for Development Finance.” In Manama, Bahrain: International Islamic Finan- Islamic Finance and Economic Development: cial Markets. Lessons from the Past and Prospects for the IMF (International Monetary Fund). 2014. Suknjk Future, edited by Salman Syed Ali. Jeddah, Market Surveillance—Market Trends and Saudi Arabia: Islamic Research and Training Financial Stability Implications. Washington, Institute, Islamic Development Bank. DC: International Monetary Fund. Pagano, M. 1993. “Financial Markets and Growth: IRTI and IFSB (Islamic Research and Training Insti- An Overview.” European Economic Review 37: tute and Islamic Financial Services Board). 2014. 613–22. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC CAPITAL MARKETS 101
Palley, T. J. 2007. “Financialization: What It Is Safari, Meysam. 2013. “Contractual Structures and and Why It Matters.” Working Paper 252, Payoff Patterns of Suknjk Securities.” International The Levy Economics Institute, Annandale- Journal of Banking and Finance 10 (2): 1–24. on-Hudson, NY. Taj El-Din, Seif El-Din. 2009. “The Stock-Exchange Parenteau, R. W. 2005. “The Late 1990s U.S. Bubble: from an Islamic Perspective.” In Issues in the Financialization in the Extreme.” In Financializa- International Financial Crisis from an Islamic tion and the World Economy, edited by G. Epstein. Perspective, 99–122. Jeddah, Saudi Arabia: Cheltenham, UK: Edward Elgar. Islamic Economic Research Center King Abdu- Pradhan, R. P., M. B. Arvin, J. H. Hall, and laziz University. S. Bahmani. 2014. “Causal Nexus between World Bank. 2013. “Long-Term Financing of Infra- Economic Growth, Banking Sector Develop- structure: A Look at Nonfinancial Constraints.” ment, Stock Market Development, and Other Issues Note No. 6 for Consideration by G-20, Macroeconomic Variables: The Case of ASEAN coordinated by the Infrastructure Policy Unit, Countries.” Review of Financial Economics 23: Sustainable Development Network, World Bank, 155–73. Washington, DC.
5 Taka¯ful (Islamic Insurance), Retaka¯ful, and Microtaka¯ful
akƗful, or mutual assistance, is the wholly to the insurance company. The under- TIslamic counterpart of conventional lying contract between the insurance insurance. The word takƗful is derived companies and the policyholders is an from an Arabic word kafƗlah, which means exchange contract, where the insurance to guarantee. A group of participants agree to company promises to indemnify any losses in support one another jointly for the losses aris- consideration of premiums, and the insur- ing from specified risks. They contribute to ance company’s only hope of making a profit a fund, and are compensated or reimbursed would be for the risk covered not to occur, from that fund in the event of certain risks. and for the premiums collected to exceed the The scheme is managed on the participants’ payouts for claims. However, in takƗful, the behalf by a takƗful operator. It is similar to risk is usually borne by the individual partici- a mutual insurance concept, but it complies pant but is shared and transferred to the with shari‘ah and is based on concepts of group of participants. mutual solidarity and risk sharing. Although takƗful and conventional insur- The Potential Role of Takaful in ance share the same function of handling ˉ Promoting Shared Prosperity pure risks, they differ in a number of ways (box 5.1). From the perspective of insurance Besides being shari‘ah compliant, takƗful policyholders, risk management entails trans- promotes shared prosperity by helping indi- ferring a risk held solely by the policyholder viduals and businesses reduce their exposure
GLOBAL REPORT ON ISLAMIC FINANCE 103 104 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
BOX 5.1 Similarities and Differences between Conventional Mutuals/Cooperatives and Taka¯ful
The majority of modern insurance companies in the agent (wakil). The operator administers the schemes developed countries (classified as stock insurance and manages the risks and investment aspects of the companies) are owned by investors who have takƗful funds for a fee or share of the investment purchased the company’s shares. Any profits profits. The operator does not cover the risk the par- generated by this form of insurance company are ticipants face because the participants have already distributed to the investors in the form of dividend agreed to mutually help one another. TakƗful opera- payments. Profits are typically generated if claim tors are required by regulation to lend funds to sup- experiences are lower than those expected in the port any deficiency in the takƗful risk funds to pricing assumption. Policyholders are customers who protect the interests of the participants, but are have purchased a policy from the company for restricted to using only a temporary interest-free protection in the event of unforeseen events. loan (qarG ̙ Kasan̙ ). The operators have the right of Policyholders usually do not benefit directly when recovery once the fund is solvent. claims are low because the insurance company takes TakƗful based on a cooperative model may the underwriting surpluses as profits. resemble a mutual insurance setup; however, By contrast, a mutual insurance company is mutual insurance does not have any restriction as owned entirely by its policyholders. Any profits may to the type of activities and investments that it be distributed back to policyholders. They have a can enter into. By contrast, takƗful contributions stronger influence on the company management from participants must be invested in a halƗl practices; they may elect or terminate the company’s (permissible) or shari‘ah-compliant type of invest- management at annual meetings. The major ments, which are free from ribƗ. If the invest- disadvantage of mutual insurance companies is the ments generate a surplus, all the participants will difficulty in raising capital needed to remain solvent share the benefits. TakƗful operators are also or fund expansion. The independence of management required to have a shari‘ah advisory board to can also be limited, as policyholders are the owners. monitor the processes and activities of the opera- In both kinds of companies, the contract of insur- tions, including their product offerings and invest- ance is still a bilateral contract of exchange (mu‘ƗwaGƗ̙ t) ments, so that they are shari‘ah compliant. In involving a seller and buyer. This differs from the certain jurisdictions, such as in Malaysia, takƗful takƗful contract, which is a unilateral contract companies must undertake a shari‘ah audit in (tabarru‘Ɨt). By contributing a sum of money to a com- addition to the customary accounting audit, in mon takƗful risk fund in the form of a donation each accounting period. (tabarru’), an individual will become one of the partici- Although the results for both insurance and pants and agree to mutually help other participants, takƗful are the same—to provide compensation should they suffer from a mishap. TakƗful participants against possible losses—the central difference lies in are not owners of any company, though they have a the way that each achieves this objective. The notion collective interest in the takƗful risk fund. “the ends will justify the means” does not hold The relationship of the takƗful operator to the when it comes to shari‘ah, where both the ends and participants is that of a manager (muGƗ̙ rib) or the means must be compliant.
to risks, increase their savings, and promote aid may arise from a number of situations, long-term capital investment. such as being members of a community or Because takƗful is based on the concept a cooperative, residents of the same of mutualization (resource pooling and risk neighborhood, or members of a social or sharing), the understanding and acceptance Islamic movement. Such common ties can of the takƗful mechanism is enhanced when increase social trust, which underpins traditions of mutual aid exist within the microtakƗful—supporting the growth in target population. This spirit of mutual Islamic microfinance. GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 105
Generally, saving in takƗful, as opposed to return on investment and diversification. in a commercial bank, is regarded as a better Furthermore, infrastructure investments can means to accumulate an estate and distribute provide a predictable cash flow that can often such wealth to heirs. There may also be other keep pace with inflation. While takƗful and advantages, as risk management practices are microtakƗful funds are still small in size, the a natural discipline of a takƗful operator, rapid growth of the industry in such countries which reduces the possibility of failure. is encouraging. Furthermore, takƗful operators’ businesses MicrotakƗful has a great role to play to focus on investments, while the bank focuses promote financial inclusion. Besides being on financing. As a low-yield environment is shari‘ah compliant, takƗful promotes social likely to continue, takƗful investors will tend and economic values by helping individuals to earn higher yields than account holders in and businesses reduce their exposure to a typical conventional or Islamic bank. There risks. Though microtakƗful is still limited in is evidence that microtakƗful has encouraged comparison to microinsurance, it has great savings, and thus alleviated poverty, in the potential in the light of the growing demand Arab Republic of Egypt, as microfinance insti- for shari‘ah-compliant microfinance. Financial tutions and microleasing companies are not institutions are now promoting the use of allowed to accept deposits. Thus while being insurance or takƗful as a guarantee for credit. socially responsible, microtakƗful helps This is very important in developing coun- support poor microfinance consumers by tries, where the poor have low liquidity in boosting their savings. general and low capacity to pledge other types Funds from pensions and insurance com- of guarantees that might be acceptable to for- panies have deepened and widened financial mal banking standards. systems in the developed world. In the United MicrotakƗful is a socially responsible tool States, institutional investors have contributed that aims to reduce poverty, help the vulner- not only to the deepening of equity markets able, and assist the underserved population but also to the development of the corporate through financial inclusion and practices bond market, which in 2012 ranked largest in such as pooling risks and assets within the world, at 140 percent of GDP. The greater villages or communities. MicrotakƗful cover- involvement of insurance companies and pen- ing family and health benefits and crop, live- sion funds has also helped reduce the volatility stock, and property damages can be of the equity and bond market. Institutional implemented through a community-based investors bring stable pools of capital with an model, a cooperative-based model, a wakƗlah interest in long-term positions instead of spec- partner model, or even a provider-driven ulative trades. TakƗful operators can similarly model. People who participate in a micro- contribute to the growth of the suknjk market level health insurance scheme will be able to (see chapter 4). reduce their out-of-pocket expenditures and Likewise, savings or investments made in increase their use of health care services takƗful funds can provide a critical source of (Panda and others 2015). funding for a variety of economic activities for MicrotakƗful also has several comparative the community and even for the country. There advantages as a means to extend traditional is an immense need for infrastructure invest- social security schemes. MicrotakƗful has the ments worldwide, especially in developing capacity to reach groups excluded from statu- countries. As traditional sources of public tory social insurance, especially where the and private financing face greater constraints, workers are in the rural and informal economy. institutional investors are increasingly being The transaction costs necessary to reach these considered as sources of financing for infra- populations can be reduced, since microtakƗful structure project development and maintenance schemes can be operated by local governmen- in developing countries. Together, these institu- tal or social organizations or nongovernment tional investors would benefit from the better organizations that are usually in the vicinity of 106 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
their target population; their staffs include 22 percent in 2007–11 to a still healthy growth social workers who are used to working with rate of 14 percent in 2012–14 (Ernst & Young and are closer to targeted groups. MicrotakƗful 2014). The takƗful market in ASEAN coun- benefits packages can be designed in close tries (Brunei Darussalam, Indonesia, Malaysia, partnership with the target population to Singapore, and Thailand), driven by strong ensure a higher participation rate. economic dynamics and young demographics, An area of concern for microtakƗful is that continues to grow at 22 percent. The countries the poor are more likely to prefer informal of the Gulf Cooperation Council (GCC), takƗful schemes rather than formal ones, as including Saudi Arabia, have registered a they are easier to join and more affordable. In growth rate of about 12 percent. addition, while enrollment can be increased Saudi Arabia accounts for nearly half through options like subsidies and coupons, (48 percent) of the share of global gross complete inclusion will not be possible for all, takƗful contributions (excluding the Islamic given the cost. Republic of Iran, which has a unique domes- Awareness programs linked with microin- tic industry).1 Malaysia and Indonesia surance schemes have also increased financial account for nearly one-third (30 percent), literacy, which in turn can increase participa- followed by other GCC countries (15 per- tion in the financial system and adoption of cent), and Africa, South Asia, and the Levant financial products and services. This pattern is (the remaining 7 percent). supported by studies in Burkina Faso (Cofie and others 2013), Cameroon (Noubiap and Taka¯ful Practices in Selected Countries others 2013), and India (Panda, Chakraborty, and Dror 2015). A study of a farmers’ literacy The two takƗful models most widely adopted training program in Gujarat, India (Gaurav, are wakƗlah (agency) and muGƗ̙ rabah (profit Cole, and Tobacman 2011), showed that sharing) (see table 5.1). In each case, the training through a financial module increased operator is responsible for developing the the take-up rate of microinsurance from products, underwriting the risk, collecting 8 percent to 16 percent. the contributions, investing the contributions, and dealing with claims. There has also been a significant growth in the use of a mixed The Current State of the Takaful Industry ˉ or hybrid model, which combines aspects of The market for takƗful is potentially huge. wakƗlah and muG̙Ɨrabah. Another model, The world’s 1.5 billion Muslims represent a known as the waqf model, has also evolved as potential customer base that no insurer can an enhancement to the governance structure afford to ignore. Moreover, the majority of the of takƗful, though it is not widely practiced. world’s Muslim population is young (under 25 years of age). The underinsured status of The Waka¯lah Model most Muslims is also a significant enticement to potential takƗful operators. In the wakƗlah model, mutual risk sharing The takƗful market has been growing occurs among participants who contribute to strongly. It is currently concentrated in a takƗful fund. These contributions include Malaysia and the Middle East (primarily the payment of fees and charges due to the Saudi Arabia). The growth rate of the takƗful operator, together with a donation to the market in those areas is well ahead of the takƗful fund. The operator acts as the agent conventional insurance market. (or wakil) of the participants, and is therefore Global gross takƗful contributions entitled to a fee for the services provided. The amounted to an estimated $14 billion in 2014, fee is deducted up front when participants up from $12.3 billion in 2013 (figure 5.1). make contributions, and the balance is chan- Year-on-year growth has moderated from a neled into the takƗful fund. In the strictest high compound annual growth rate of sense, the takƗful operator should not share GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 107
FIGURE 5.1 Total Amounts of Global Gross Takaˉful Contributions by Region, 2009–2014f
16
14
12
10
8 $ billion
6
4
2
0 2009 2010 2011 2012 2013e 2014f Saudi Arabia ASEAN GCC Africa South Asia Levant
Source: Ernst & Young 2014. Note: ASEAN = Association of Southeast Asian Nations; GCC = Gulf Cooperation Council; GCC countries include Bahrain, Kuwait, Qatar, and the United Arab Emirates, excluding Saudi Arabia; 2013e = estimate; 2014f = forecast.
TABLE 5.1 Taka¯ful Models
Properties Mud· a¯rabah Pure Waka¯lah Mixed Waka¯lah-Waqf Creation of fund Participants’ Participants’ Participants’ Donations to create contributions contributions contributions initial waqf Fees None Up-front fees as agreed Up-front fees as agreed Up-front fees as agreed Underwriting As per agreed ratio Nonea Nonea Nonea surplus Underwriting Qard ̙ h asanҕ from Qard ̙ h asanҕ from Qard ̙ h asanҕ from Waqf to solicit funds losses taka¯ful operator taka¯ful operator taka¯ful operator Investment None None Profit-sharing ratio as Profit-sharing ratio as profits agreed agreed Investment Borne by participants Borne by participants Borne by participants Borne by participants losses Operational Borne by taka¯ful operator Borne by taka¯ful Borne by taka¯ful Borne by taka¯ful expenses (with some exceptions) operator operator operator Liquidation Proceeds accrue only to Proceeds accrue only to Proceeds accrue only to Proceeds accrue only to participants participants participants participants Jurisdiction Some GCC members, United Kingdom Bahrain, Malaysia, Pakistan, South Africa Malaysia, Saudi Arabia Sudan Note: AAOIFI = Accounting and Auditing Organization for Islamic Financial Institutions; GCC = Gulf Cooperation Council. a. Following the strict AAOIFI interpretation. 108 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
directly in either the investment or underwrit- The mixed model combines elements of ing risks borne by the takƗful fund or in any the wakƗlah and muG̙Ɨrabah models. It is surplus/deficit of the fund. Under the generic structured so that the takƗful operator retains wakƗlah model, the operator faces the chal- two funds: one for the shareholders and the lenge of ensuring that the operational and other for participants. The underwriting management expenses are less than the fees activities are conducted according to the collected; only then can the operator make a wakƗlah model; the shareholders manage profit. Depending on the terms of the contract, the funds as an agent on behalf of the partici- the operator’s remuneration may include a pants. In exchange, each participant is performance fee, charged against any surplus, charged a wakƗlah fee, which is normally a as an incentive to effectively manage the percentage of their contribution. As an incen- takƗful fund. tive for effective management, the operator is This model is gaining popularity across also entitled to earn a fee if there is a surplus the world due to its transparency and the in the participants’ fund. With regard to fixed nature of charges, irrespective of the investment activities, the operator invests the amount of takƗful contribution received, as surplus contributions in different shari‘ah- it provides an incentive for the company to compliant instruments based on the act in the best interests of participants and muda̙ ¯rabah contract. The operator acts as the enhance their returns. Moreover, there are investment manager or mud̙Ɨrib on behalf of fewer issues associated with this model that the participants. The ratio of profit is fixed might create disagreements among shari‘ah and agreed between the parties at the time the scholars of different schools of thoughts contract begins. The Accounting and Auditing (Akhter 2010). Organization for Islamic Financial Institutions (AAOIFI) recommends that the mixed model be adopted (Yusof 2001). The Muda¯rabah̙ Model
In the mud̙Ɨrabah model, the operator is The Waqf Model usually entitled to a fixed pre-agreed per- centage of any underwriting surplus and/or After several objections were raised regarding investment profits of the takƗful fund. the shari‘ah issue that a “profit-sharing” TakƗful participants are similar to investors contract should not be applied (as donations who provide capital and contributions in a cannot simultaneously be capital), the issue of business venture. Under this arrangement, sharing any surplus in the mud̙Ɨrabah model, the operator is allowed to share in the and the legal status of the takƗful fund, the underwriting results from operations, as waqf (Islamic trust) model emerged. The well as the favorable performance returns model is a modified form of the wakƗlah on invested premiums. However, the opera- model, where a waqf fund is created by the tor’s earning is not guaranteed, as there may initial donations of shareholders. Participants’ be no investment return or underwriting contributions then go directly to the waqf surplus at year’s end. fund. A waqf has no owner; however, the operator has the right to devise and adminis- The Mixed Model ter the fund’s rules and regulations. The general idea is that the takƗful fund should be The mixed model is widely practiced by perpetual communal property devoted to takƗful companies around the globe and is public and community use. Waqf-like trusts currently the dominant model in the Middle are legal institutions in their own right and East. The Central Bank of Bahrain has also can be governed by the trustees under a civil taken the initiative to make it compulsory for legal structure. Waqf can be expanded beyond takƗful and retakƗful companies to adopt this the scope of religious activities to cover educa- mixed model in their business. tion, public utilities, social work, and other GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 109
areas of social services. The takƗful operator is commercial risks, partly due to a lack of scale usually paid its fees from the waqf fund as the and retakƗful. Whatever the situation may administrator. be, the wealth from oil-driven growth is The contributions or donations in the waqf encouraging society and businesses to seek fund are invested in shari‘ah-compliant instru- protection using shari‘ah-compliant products ments. The takƗful operator and participants and hence will raise the demand for takƗful, share the profits from investments according to and thus for retakƗful. pre-agreed ratios. The waqf fund will pay The existing retakƗful operators are claims, retakƗful expenses, and underwriting located mainly in GCC states and Malaysia, costs as usual; the net surplus will be vested to where the takƗful businesses are concen- the participants. Participants who have no trated. Bahrain and Dubai each have two prior claims can be paid the surplus according registered retakƗful operators, Malaysia has to their proportion of contribution. The waqf four, and Singapore has one. Several model has been adopted by takƗful operators renowned companies are also operating from in South Africa. a low tax haven in Malaysia, Labuan Business International Financial Center, mainly as Retaka¯ful branches of their worldwide entities serving the regional markets in Asia. RetakƗful2 allows operators to share risks One of the main problems worldwide is that they cannot or do not wish to absorb the lack of retakƗful companies that are cap- themselves. The main purpose of retakƗful is italized to the levels required by insurers, similar to that of reinsurance: to spread risk and more particularly the lack of A-rated and add capacity, so that larger or more risks retakƗful companies. This has resulted in can be included. By spreading risk within the takƗful companies having to reinsure on a industry, takƗful operators can function conventional basis, contrary to the preferred more efficiently. RetakƗful plays a vital role option of seeking cover consistent with in the general takƗful sector, especially for Islamic principles. About 80 percent of ceded large and specialized risks, as compared to premiums are placed with traditional rein- family takƗful. surers.3 This practice is allowed under the This arrangement seems very much like concept of G̙arnjrah, or extreme necessity. reinsurance, but the fundamental difference is Shari‘ah scholars have granted dispensation that conventional underwriting is about to takƗful companies to reinsure on a con- transferring risk, but retakƗful is about shar- ventional basis so long as there are no ing the risk. The operator also becomes a risk retakƗful alternatives available, but they may manager instead of a risk taker. This is a do so for a limited period only. At the same mirror of the relationship between a takƗful time, industry traditionalists are increasingly operator as agent and the takƗful participants challenging whether the necessity (G̙arnjrah) as owners of the takƗful fund (hence the concept is still applicable in today’s market name, retakƗful). The risk remains with the and are encouraging alternatives. participants. By extension to retakƗful, this One alternative that some takƗful opera- implies that the risk remains with the ceding tors may embark on is the practice of takƗful operator (Frenz and Soualhi 2010). cotakƗful. In this arrangement, a common Currently, there are a limited number takƗful certificate is issued, and the risk will of retakƗful operators in the industry. be shared based on certain agreed percentages Commercial market takƗful operations have between several takƗful operators. Often, one not yet grown to scale in many jurisdictions, operator will take the lead. The leading except for the GCC countries and Malaysia. takƗful operator will be responsible for On the other hand, takƗful operators have administering various aspects of the coverage, claimed that their expansion has been limited: such as collecting contributions, making particularly their inability to take on large claims, and preparing the documents. In this 110 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
situation, the lead operator may levy a charge perceive many uncertainties. Usually, compa- (leader fee). nies have segregated the takƗful funds from In another practice, a number of large other insurance funds, but these companies conventional reinsurance companies from tend to market takƗful merely as just another Muslim countries take on the risks and retro- insurance product. Generally, the public lacks cede a large proportion of risk with interna- awareness of takƗful and what is shari‘ah tional reinsurance companies that operate on compliant and what is not. a conventional basis. The cession from takƗful Conflict among brands is also an issue companies ranges from some 10 percent in when a company is providing both conven- Southeast Asia, where takƗful companies have tional insurance and takƗful. Another cause relatively smaller commercial risks (so far), to of concern for a window operation is the the Middle East, where up to 80 percent of high likelihood of its Muslim takƗful inter- risk is reinsured on a conventional basis. mediaries marketing takƗful and selling Even though a typical reinsurance trans- insurance at the same time. action is generally based on the principles of When shari‘ah compliance is left totally to contract (‘aqd), the nature of this transac- the producer (in this case, the insurance tion is quite different from other forms of company), there is a danger as to whether the commercial contracts in conventional rein- operator will eventually achieve its status as an surance. It must also comply with shari‘ah Islamic organization. The concept of principles. Reinsurance contracts must “permissible in times of necessity” (Gar̙ njrah) essentially be financial transactions that may be invoked only sparingly, such as fulfill- bind both the reinsurance company and the ing the reinsurance needs of the takƗful opera- insurance company on the general principles tor in the absence of sophisticated retakƗful of contract. arrangements for large and specialized risks. All the same, there have been several Achieving consistency and standardization in moves for Islamic reinsurance to displace use shari‘ah review may take several years; of conventional reinsurance. One of the however, it is a strategy that should be under- world’s largest reinsurer/retakƗful operators taken with full enthusiasm. Similarly, shari‘ah is in talks with Malaysian market players compliance risk should be minimized by and the Malaysian TakƗful Association to set installing a mandatory shari‘ah board. up a market retakƗful pool. This initiative is A definite timeline should be formulated and supported by Bank Negara Malaysia. Given followed to separate the takƗful business so that stricter regulation is likely, especially in that it can be a stand-alone entity. In Indonesia, GCC countries, takƗful operators’ demand all windows were given three years to for retakƗful arrangements should increase. dismantle before the OJK (Otoritas Jasa Lloyd’s of London is also building its capac- Keuangan, Indonesia’s equivalent of the ity in the takƗful sector. It has opened an Financial Services Authority) was inaugurated. office in Dubai and is in talks with regulators to access the Malaysian market. Microtaka¯ful
Taka¯ful/Retaka¯fulWindows MicrotakƗful can be defined as takƗful accessed by the low-income market. As such, Where the market and its regulation are still microtakƗful is not just a scaled-down version in their infancy, as in Indonesia and many of regular takƗful; the product and processes countries in Africa, window operations within need to be completely reengineered to meet an insurance company are prevalent. A win- the characteristics and preferences of the low- dow is attractive from the standpoint of share- income market, such as farmers, blue collar holders, since setting up a separate takƗful workers, and small traders. This means that entity requires additional capital. While share- microtakƗful must have unique product holders see the potential of takƗful, they also features in line with the income and other GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 111
realities of the target market. It also requires • Community-based model: Local communi- innovative and cost-effective approaches to ties form groups that capitalize and manage reach masses of people who may not be a risk pool for their members. formally employed or have a bank account. • Provider model: Providers, such as hospi- The first microtakƗful scheme was estab- tals, clinics, or dairy cooperatives, create lished in 1997 in Lebanon by the Lebanon prepaid or risk pooling coverage for people Agricultural Mutual Fund. It provides health who use their facilities or services. insurance coverage and meets costs not • Social protection models: National govern- covered by the Government Social Security ments underwrite cover for certain risks Fund, which usually covers 85 percent of through social insurance programs, such as hospital fees. The fund covers more than for health care, crops, and livestock, as well 5,000 families (23,000 beneficiaries). Each as covariant risks.4 family pays a premium of $10 per month. General characteristics of microtakƗful are Those who cannot afford the premiums are presented in table 5.2. sponsored by local villagers or other policy- holders (Brugnoni 2013). As with conventional microinsurance, Challenges for the Taka¯ful Industry microtakƗful is delivered with the help of With regard to regulations, the same regula- agents and financial institutions. However, tory regime cannot be applied to both to reach the poor, additional innovative dis- microtakƗful and conventional insurance, tribution channels are organized, including even for operator-provided schemes. For the following: example, any risk-based requirements will • Full-service model: Regulated takƗful drive up capital costs. The capital require- operators downsize their insurance ser- ments for microtakƗful operators should also vices and charge a premium the poor can be much reduced, and regulations must afford. Islamic microfinance institutions encourage schemes through cooperatives with can assume the role of insurers by offering additional tax incentives. basic credit life insurance to protect their loan portfolios. Corporate Governance and Regulatory • Partnership model: TakƗful operators with Framework products pair with Islamic microfinance institutions and others to provide microin- Although the application of takƗful products surance in low-income markets. has grown considerably in recent years, only
TABLE 5.2 General Characteristics of Microtaka¯ful Consideration Microtaka¯ful Extension of social insurance Yes Benefits and coverage Basic assistance, funeral benefits, income during hospital stays, small term life cover benefits Risks General, catastrophic Customer segmentation Informal economy, affinity groups, cooperatives Affordability Salary deductions, benevolent sponsorships, affordable contributions by low-income participants Underwriting Group basis, link with microfinance Distribution Home service agents, micro Islamic financial institutions , cooperatives, affinity groups, Masjid (place of worship) 112 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
a few countries have distinct takƗful regula- hybrid nature of its setup. A risk-based tions, and some countries favor the use of approach to regulating takƗful is desirable, one takƗful model over another. Regulators but well-thought-out, rules-based regula- need to understand the implications of regu- tion may suffice initially. An important lations and accounting standards for how early decision for the regulators is whether assets are valued and how surplus and prof- to allow takƗful windows. Shari‘ah is flex- its are computed and distributed. In takƗful, ible on this matter only if regulations pre- just like insurance, premiums are due up clude the setup of stand-alone takƗful front before service is rendered. This means companies. that premiums must be invested in suitable Having a holistic approach that keeps in shari‘ah-compliant assets. For contingent mind the viewpoint of both the industry and benefits where claims can happen at any consumers is a critical factor to nurture time, investing solely in volatile assets like industry best practices and market develop- equities is not advisable. ment. Policies need to balance protections for Malaysia has one of the most advanced participants’ rights with the need for effective sets of takƗful regulations. The growth of pricing, greater solvency, operators’ financial takƗful is only one part of the general sustainability, good business conduct, and rel- growth of Islamic finance in the country. evant disclosures. On the consumer side, Malaysia has a vibrant Islamic banking and there is demand for greater transparency of capital market, with by far the largest suknjk takƗful operators and better financial educa- market anywhere in the world (see chapter tion to unlock various opportunities for 4). It also has a large (but not large enough) industry’s growth. To avoid confusion among base of human capital trained in Islamic Muslims, there should be a consensus among finance, including takƗful. Thus, using shari‘ah scholars in the country as to how Malaysia as a standard as to how takƗful takƗful is implemented. Although in Malaysia should be regulated may not be appropriate the majority of Muslims are happy for the for a country only now venturing into government to decide what shari‘ah compli- takƗful. ance means, this may not be possible in other In contrast to Malaysia, Bahrain’s conven- jurisdictions. An early consensus among local tional and takƗful industry remains rules scholars on how takƗful is structured is based. Regulations are set out in rulebooks important. that provide guidance as to how insurance Looking at substance over form is impor- and takƗful liabilities should be valued tant, as ultimately, if risks are similar, the (Central Bank of Bahrain 2011). There is capital solvency requirements should be the built-in flexibility, though, as other methodol- same, no matter how the risk fund is ogies can be acceptable, if justified. As in branded. Regulators should look for arbi- Malaysia, takƗful windows are not allowed. trage opportunities between takƗful and the However, the regulation says that only the insurance industry. For example, a similar wakƗlah (agency) contract can be used in product could require lower solvency capital takƗful, with a subsidiary mudƗrabah contract if it were sold as a takƗful product than if it for assets being invested. were sold as a conventional product. Such There is no explicit guidance as to how arbitrage may harm the takƗful industry takƗful products should be priced. Thus opera- over the long term if such lower solvency tors are free to set their fee under the wakƗlah capital is not justified. contract. This arrangement has been exploited by some takƗful companies, with little consid- Lack of Investment Opportunities eration for whether the premium net of wakƗlah fees is sufficient to pay claims. The investment environment remains chal- Regulating takƗful is different from reg- lenging for takƗful operators. Not only are ulating insurance. This stems from the shari‘ah-compliant investments lacking in GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 113
many jurisdictions, but takƗful operators The global takƗful industry is small in do not have many options for long-term and comparison with the conventional insurance stable investments. In addition, as many of the industry. Thus the market needs to gain players in the industry are relatively young, worldwide brand recognition and exceed the takƗful industry has generated higher performance. TakƗful can build up public expense ratios in comparison to insurers oper- confidence. Once it has, the public can be ating in the same market, reducing operators’ expected to voluntarily opt for the various profitability. Stricter solvency and capital takƗful options in their individual and col- requirements also make it harder for smaller lective interests. Financing for small and players to achieve profitability. Youngtak Ɨful medium enterprises (SMEs) and microfi- players will need to either quickly build scale nancing are high on the agenda of the Group or consider mergers to meet the regulatory of Twenty (G-20). This will have a positive demands. Hence governments wanting higher influence on takƗful, especially for Muslim growth in takƗful should also look into devel- start-ups and SMEs. MicrotakƗful can be a opment of an Islamic capital market and mechanism to mitigate financial risk for the provide flexibility in the implementation of poor by safeguarding and ensuring the pro- the risk-based capital regime. ductive use of their savings and credit facili- ties, and can also be effective in reducing their vulnerability to the impact of disease, Policy Response theft, disability, and other perils. TakƗful, like Islamic finance, has two sides: Regulators need to be cohesive in their financial efficiency andshari‘ah compliance. approach to regulation of the industry; There is a need to develop a globally accepted regulations should not hamper the growth business model based on risk sharing that and stability of the takƗful market. Industry promotes shared prosperity. Governments practitioners and regulators must attempt have always played a pivotal role in creating to discover an approach to implement a conducive legal and regulatory framework. the conceptual requirements of takƗful as They must recognize that takƗful is markedly defined by shari‘ah scholars in a way that is different than insurance. Unlike insurance, commercially viable for shareholders and takƗful is a unilateral agreement that is based considerate of participants’ interests. In the on the principles of mutual cooperation marketplace, the attraction of takƗful busi- (ta’awun) of the participants and donation ness should be not just for the fact that it is (tabarru’). based on shari‘ah law, but because it is bet- Bahrain, Malaysia, and Pakistan have com- ter, rational, and equitable. This aspect prehensive takƗful regulations in place that should be attractive to everyone, irrespec- take into account the unique requirements of tive of any religious foundation upon which the industry. The Saudi Arabian Monetary the system stands initially. Authority (SAMA) now requires all takƗful The dual takƗful/insurance regulatory businesses to be aligned with the cooperative system, as in Malaysia, may be a good alter- insurance model rather than wakƗlah and qard native to adopt and can stand as a world- concepts. Several regulatory changes have been wide benchmark for takƗful services in terms introduced recently in many countries; while of customer satisfaction, quality of services, they are positive in nature, there is concern and transparency of its operations. However, about the increased inconsistencies across regulators need to watch for any operators jurisdictions, such as differences in accounting taking advantage of the situation and work- standards. Inconsistencies in takƗful regula- ing to converge its operations along the lines tions make it difficult for multinationaltak Ɨful of conventional insurance. TakƗful operators operators to function across regions and also have tended to choose this as their preferred lead to confusion for customers (Ernst & form and have modeled a takƗful operation Young 2012). around them or have feigned a shari‘ah wrap 114 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
over these contracts, just to be compliant. Developing a best practice charter as a New operators, especially, have taken a busi- benchmark for takƗful operations world- nesslike perspective on takƗful. Although wide is valuable but has proved to be chal- this is correct, there is a risk that the spirit of lenging, mainly because of diverse legal takƗful may be lost or severely diluted in the frameworks, the varying kind of markets process. Box 5.2 highlights the approach and their level of maturity, and the Nigeria has taken to regulation and the differences in interpretations on matters challenges the country faces in implementing related to shari‘ah. Table 5.3 is an attempt takƗful. to provide elements of such a charter.
BOX 5.2 Country Case: Regulation and Challenges in Nigeria
With a population of 177.2 million people, Nigeria penetration rate of insurance in Nigeria. As has about one-sixth of the population of Africa and is Muslims are a big majority, intensifying insurance the eighth most populous country in the world. Fifty penetration in the Muslim population can contrib- percent of the population is Muslim (U.S. CIA 2015). ute to the nation’s gross domestic product (GDP). Nigeria currently has no social security system, and The main challenge for both insurance and the only 1 percent of the total adult population is insured, takƗful industry is poverty. MicrotakƗful can play a according to the Nigerian Insurance Regulator role in overcoming this challenge; as discussed, (NAICOM). The reasons for the low rate of penetra- microtakƗful is not social welfare or social assistance tion include low income levels and limited awareness but a complementary market solution. For the low- of insurance products and their benefits, as well as a income market to access microtakƗful, it needs to be lack of transparency regarding the operating practices affordable and appropriate to the target market’s of some companies. needs and be convenient. To increase the penetration of insurance among Another major challenge is customers’ awareness the Muslim population, NAICOM has issued land- of takƗful. For a long time, many Nigerian Muslims mark guidelines to support the takƗful operations in believed that insurance is contrary to Islamic prin- Nigeria.a The guidelines provide the framework for ciples, particularly with regard to life insurance takƗful operations. The approved models to operate (Fadun 2014). TakƗful intermediaries such as the takƗful include muGƗ̙ rabah (profit sharing), wakƗlah takƗful agents must be properly trained and com- (agency), and hybrid wakƗlah-muGƗ̙ rabah (agency– mitted, as they are usually the operators’ first point profit sharing). of contact and primary source of information about The guidelines recommend that each takƗful oper- takƗful. ation have in place an Advisory Council of Experts Another important pillar for successful takƗful (ACE) to ensure that the operations are in line with operation is the presence of sustainable investment best practice. The ACE is responsible and accountable portfolios that comply with shari‘ah requirements. for all shari‘ah decisions, opinions, and views pro- The lack of Islamic financial instruments poses enor- vided by them. As having their own shari‘ah advisers mous challenges to takƗful operators in Nigeria and experts can be challenging in the initial stages, because takƗful funds cannot be invested in conven- operators can refer shari‘ah matters to a TakƗful tional bonds and interest-based financial assets. It is Advisory Council, which resides with NAICOM. also essential that the regulatory regime does not NAICOM had two main objectives in introduc- treat takƗful less favorably than conventional insur- ing the guidelines. The first was to make WDNƗIXOa ance in Nigeria. This is necessary to promote prudent better platform for financial inclusion, especially takƗful practices. for Muslims, but also for Christians and others a. Information collected by the authors and Operational Guidelines 2013, Taka¯ful with ethical inclinations and beliefs. The second Insurance Operators Guidelines, http://naicom.gov.ng /payload?id=964fc42e was to make WDNƗIXOa better means to intensify the -4025-43f3-8b34-97e82b2c50f7. GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 115
TABLE 5.3 Best Practice Charter for Taka¯ful Operations Worldwide Taka¯ful core principles Description Best practice Regulations Clear and transparent regulation and A separate taka¯ful law is recommended, but supplementary regulation is supervisory procedures that are appropriate needed, at minimum. for taka¯ful are needed. Microtaka¯ful should be regulated differently from taka¯ful. Licensing A legal entity that intends to engage in taka¯ful A full-fledged operation with some minimum initial capital for a single requirements activities must be licensed before it can license is preferred. operate. The taka¯ful legislation must set out A “window” operation may be permissible under special conditions, provided the procedure and form of establishment it is only a temporary arrangement. under which companies will be allowed to conduct taka¯ful activities within a jurisdiction. Taka¯ful model Taka¯ful operators should establish an The waka¯lah model is preferred, with sharing of investment returns. operational model that outlines the key waka¯lah fees should be limited to 40 percent of tabarru’. The profit- policies, procedures, and management sharing ratio to the company should be restricted to 30 percent. responsibilities in carrying out the taka¯ful Surplus-sharing to the operator is not allowed. operations. The operational model should be based on fair and equitable agreements and Where the law permits, taka¯ful funds should be ring-fenced as a waqf. approved by the shari‘ah committee. Shari‘ah Regulations must ensure that the taka¯ful entity A proper shari‘ah governance framework should be followed. compliance demonstrates the essential features of A shari‘ah board should be established and consist of no fewer than three fit and taka¯ful and that they are consistent with and proper members. corporate shari‘ah principles. governance Members should serve on no more than three committees. Operators must also establish and implement a corporate governance framework that The board and shari‘ah committee will be liable for non-shari‘ah provides for sound and prudent compliance. management and oversight of the business and adequately recognizes and protects the A shari‘ah audit should be conducted annually. interests of participants. A report by the chairman of the shari‘ah committee should be included in its annual report. Various committees of the board, such as risk management, audit, and investment, must be established. Risk As part of its overall corporate governance Because taka¯ful operators derived their income mainly from fees and management framework, the operator must have effective performance incentives, they must establish effective policies and and internal systems of risk management and internal procedures to manage operating costs. Guidelines on controlling control controls, including effective functions for operational cost can be introduced. risk management, compliance, actuarial All operators must acquire their own actuarial expertise. matters, and internal audit. Conduct of Requirements should be established for the To strengthen public trust and consumer confidence in the taka¯ful sector, business conduct of the business of taka¯ful to ensure staff must be properly and adequately trained, particularly with that customers are treated fairly, both respect to operational and shari‘ah aspects of the business. before a contract is entered into and through A minimum levy (for example, 5 percent of total salaries) should be imposed to the point at which all obligations under a if staff training is deficient. contract have been satisfied. These requirements are expected to enhance market discipline in the area of marketing and business development. table continues next page 116 TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 5.3 Best Practice Charter for Taka¯ful Operations Worldwide (continued) Taka¯ful core principles Description Best practice Customers must be treated fairly. • Products should be developed and marketed with due regard for customers. • Customers should be provided with clear information before, during, and after the point of sale. Any advice given should be high quality. • The privacy of information obtained from customers should be protected. • The reasonable expectations of customers should be met. Capital Capital adequacy requirements (CAR) should A risk-based capital (RBC) framework should be established. The adequacy be established for solvency purposes so that supervisory CAR should be set at appropriate levels to recognize the and solvency operators can absorb significant unforeseen different level of maturity of the market. losses. Investments Requirements should be set for solvency The concept of “admitted assets” should no longer apply. Risk charges purposes on the investment activities of applicable for different asset classes under the RBC framework will taka¯ful in order to address the risks faced ensure the right investment discipline. by the operators. Shari‘ah-compliant assets that are back by real assets should have lower risk charges. Consumer The interest of the participants must be given • The law must require the separation of the taka¯ful funds from the protection priority by the operator, especially if there is shareholder’s fund and explicitly stipulate that taka¯ful funds do not a conflict of interest. belong to the operators. • Taka¯ful contracts and certificates must be written in a language that is easily understood by the participants and other stakeholders. • The law must stipulate that taka¯ful intermediaries have ostensible authority and will bind the operator. • A cooling-off period must be provided to the participants. Public Operators should disclose relevant, In addition to their annual reports, taka¯ful operators should publish a disclosure comprehensive, and adequate information special report on the fund’s investment performance. on a timely basis to enable participants, To further promote transparency, taka¯ful operators should publish on their stakeholders, and the public to better website details of their operational model, together with the underlying understand the underlying taka¯ful shari‘ah principles, and details of products, fees, and charges. operations and to give participants and the public a clear view of their business activities, performance, and financial position.
Notes part of the contribution it receives with the retaka¯ful operator. 1. For more on the Iranian market, see the World 3. Estimated by Vasilis Katsipis, Dubai-based Islamic Banking Competitiveness Report general manager for market development at 2014–15 (Ernst & Young 2015). insurance rating agency A.M. Best, quoted in 2. Retaka¯ful is a transaction whereby one “Islamic Reinsurance Moves to Displace Use company (typically, the retaka¯ful opera- of Conventional Finance,” http://uk.reuters tor) agrees to indemnify another taka¯ful .com/article/2015/04/26/islam-reinsurance company (the ceding company, or cedant) -idUKL5N0XJ11Z20150426. against all or part of the loss. For this ser- 4. Microinsurance Network website, http://www vice, the ceding company transfers or shares .microinsurancenetwork.org. GLOBAL REPORT ON ISLAMIC FINANCE TAKA¯ FUL (ISLAMIC INSURANCE), RETAKA¯ FUL, AND MICROTAKA¯ FUL 117
References Frenz, Tobias, and Younes Soualhi. 2010. Takaful and ReTakaful: Advanced Principles and Prac- Akhter, Waheed. 2010. “Takaful Models and tices. 2nd ed. Kuala Lumpur: IBFIM. Global Practices.” Journal of Islamic Banking and Finance 27 (1): 30–44. Gaurav, Sarthak, Shawn Cole, and Jeremy Tobac- man. 2011. “Marketing Complex Financial Brugnoni, A. 2013. “MicroTakaful.” In Takaful Products in Emerging Markets: Evidence from and Mutual Insurance: Alternative Approaches Rainfall Insurance in India.” Journal of Market- to Managing Risks, edited by Serap O. Gonulal. ing Research 48 SPL (November): S150–62. Directions in Development Series. Washington, Noubiap, Jean Jacques, Walburga Yvonne Joko, Joel DC: World Bank. Marie Obama, Jean Joel Bigna, and Valery Nzima Central Bank of Bahrain. Rulebook. Volume 3— Nzima. 2013. “Community-based Health Insur- Insurance. 2011. Central Bank of Bahrain. ance Knowledge, Concern, Preferences, and Cofie, Patience, Manuela De Allegri, Bocar Kouy- Financial Planning for Health Care among até, and Rainer Sauerborn. 2013. “Effects of Informal Sector Workers in a Health District of Information, Education, and Communication Douala, Cameroon.” Pan African Medical Jour- Campaign on a Community-Based Health nal 16: 17. doi:10.11604/ pamj.2013.16.17.2279. Insurance Scheme in Burkina Faso.” Global Panda, Pradeep, Arpita Chakraborty, and David Health Action (6): 20791. M. Dror. 2015. “Building Awareness to Health Insurance among the Target Population of Ernst & Young. 2012. The World Takaful Report. Community-based Health Insurance Schemes London: Ernst & Young. in Rural India.” Tropical Medicine & Interna- ———. 2014. Global Takaful Insights 2014: Mar- tional Health 20 (8): 1093–107 ket Updates. London: Ernst & Young. Panda, Pradeep, Arpita Chakraborty, Wameq Raza, ———. 2015. World Islamic Banking Competi- and Arjun Bedi. 2015. “Renewing Membership tiveness Report 2014–15. http://www.ey .com in Three Community-based Health Insurance /Publication/vwLUAssets /EY-world-islamic Schemes in Rural India.” International Insti- -banking-competitiveness-report-2014-15/$FILE tute of Social Studies Working Paper Series 608: /EY-world-islamic-banking-competitiveness 1–28. http://hdl.handle.net/1765/77965. -report-2014-15.pdf. U.S. CIA (United States Central Intelligence Agency). Fadun, Olajide Solomon. 2014. “Takaful (Islamic 2015. CIA World Fact Book. Washington, DC: Insurance) Practices: Challenges and Prospects U.S. Central Intelligence Agency. in Nigeria.” Journal of Insurance Law & Prac- Yusof, Mohd Fadzli. 2001. “An Overview of the tice 4 (2): 12. Takaful Industry.” New Horizon 107: 9–11.
6 Nonbank Financial Institutions
hereas banks are the dominant form The Islamic financial system should be able to Wof financial intermediaries in most fulfill these general economic goals and include economies, nonbank financial insti- institutions that aim to meet these objectives. tutions (NBFIs) complement the activities Accordingly, Islamic financial institutions of banks by providing various services that should give prominence to risk-sharing modes banks typically do not provide. NBFIs pro- of financing that promote growth and cater to vide diversity in the financial sector and per- the social needs of all segments of the society. form various functions essential for growth While Islamic banks modeled as commercial and development of the economy (Carmichael banks do not reflect these features completely and Pomerleano 2002). A diversified financial (see chapter 3), NBFIs may be able to provide sector that includes banks and NBFIs provide services that fulfill the broader goals of Islam a basis for a sound and stable financial system and promote shared prosperity more effec- (Bakker and Gross 2004). NBFIs can also act tively. Similar to banking and capital markets, for a robust Islamic NBFI sector that enhances as backup institutions that may help stabilize shared prosperity, the requirements include the financial sector when negative shocks supportive institutions and public policy, adversely affect the dominant financial insti- responsible governance and leadership, and a tutions, notably banks. robust regulatory framework that promotes A comprehensive Islamic financial system risk sharing and entrepreneurship. reflects the broader goals of Islam, which aim not only to achieve economic goals but also to address social needs. The eradication of pov- Recent Developments and Current Status erty, socioeconomic justice, and the equitable Broadly speaking, NBFIs cover all financial distribution of income are core features of institutions other than commercial banks. an Islamic economic system (Chapra 1985). However, for the purpose of this Report,
GLOBAL REPORT ON ISLAMIC FINANCE 119 120 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
NBFIs include all those institutions that are typically to the underbanked (those not not subject to the supervision of the central served by formal financial institutions). bank but can act like banking institutions: • Through hajj̙ funds, Muslims from different that is, accepting funds and investing those income groups can save to finance travel and funds, whether in the capital market or accommodations for pilgrimages at various through direct placement. Specifically, this stages of their lives. chapter focuses on Islamic asset management, The composition of the NBFI sector differs housing finance, and some specialized NBFIs from country to country, depending on the such as mudƗҕ rabah1 and ijƗrah (Islamic leas- legal environment and the organizations that ing) financing companies. exist. With the exception of a few countries, The NBFIs operating in the field of Islamic the nonbank financial sector is relatively finance can be classified according to the nature underdeveloped in most emerging economies of the service they provide to their clients and in general and in member-countries of the the segment of their clients. From this perspec- Islamic Development Bank (IDB) in particular. tive, Islamic NBFIs provide four basic financial For example, whereas the banking systems in services for their clients from five different the Middle East and North Africa (MENA) are segments (table 6.1): generally large relative to other regions, the • Islamic asset management, venture capi- NBFIs are mostly undeveloped (Rocha, Arvai, tal, and private equity companies provide and Farazi 2011). The average development investment-related services for their insti- index for the nonbank financial sector in the tutional and corporate clients. MENA Region (3.3) is much lower than the • Corporate foundations provide philan- index for the banking sector (5.5) (Creane and thropic services such as awqaf (Islamic others 2006). Indonesia, however, has a vibrant foundations, endowments, and trusts). nonbank financial sector, with a wide array of • Asset financing andmud Ɨrabah compa- financial institutions providing a diversity of nies provide financing and investment ser- financial products. In a survey of 3,360 house- vices either to their private customers or holds in Indonesia, 51 percent of the respon- to customers from various segments of the dents disclosed that they saved in a nonbank mass market. financial institution, compared to 41 percent • Microfinance and microsavings institu- who had bank accounts. Moreover, 52 percent tions provide small amounts of funding, took loans from informal sources, compared
TABLE 6.1 Classification of Nonbank Islamic Finance Institutions
Type of client Financing Investment Pilgrimage Philanthropy Institutional Investment banks and funds Asset management (fund managers, venture capital, private equity) Corporate Corporate foundations Affluent Financing companies Brokerage, fund managers, Hajj̙ funds Mass market Financing companies, leasing mud. a¯ rabah companies companies, credit unions, and cooperatives Underbanked Microfinance pawn shops, Microsavings microfinance institutions Source: Adapted from IDB, IRTI, and IFSB 2014. GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 121 to 25 percent who had formal loans (Cole, Asset Management Sampson, and Zia 2011). Not only is the NBFI sector small in most The overall size of the mutual funds industry is IDB member countries, but the bulk of the relatively small in most IDB member-countries. NBFIs are still conventional. For example, As table 6.2 shows, the stock market in the in Pakistan, the total asset size of the NBFI MENA Region is relatively large, amounting sector was 747.07 billion Pakistan rupees to 23.37 percent of GDP; however, there are (PRs) ($7.34 billion) in April 2015, and only no comparative data available on mutual 21 percent of the total assets were shari‘ah fund assets for the region (Rocha, Arvai, and compliant (SECP 2015). However, the sector Farazi 2011). has been moving toward greater shari‘ah com- Islamic mutual funds grew rapidly in the pliance over time. In Pakistan, the Islamic 1990s, following the ruling by the Islamic Fiqh NBFI sectors grew about 224 percent from Academy (IFA) on the legitimacy of investment June 2010 to April 2015, while the conven- in stocks. The recent growth trends in numbers tional sector grew 74 percent; as a result, the and assets under management (AUM) of global share of shari‘ah-compliant NBFI assets grew Islamic funds and mutual funds are shown in from 12.3 percent to 21 percent of all NBFI figure 6.1. The Islamic asset management assets (SECP 2015). industry has gained remarkable momentum The discussion that follows describes the since the global financial crisis. The total status and development of different types of amount of AUM has more than doubled from NBFIs in IDB members. Unfortunately, the $28.35 billion in 2008 to $60.65 billion as of data and information on NBFIs in general and 2014, with a cumulative average growth rate Islamic NBFIs in particular are scattered and around 13.5 percent. Despite the dramatic are not available in an organized manner. growth, the sector still has a market share that Given these constraints, the discussion that is below 1 percent of the total global asset follows summarizes recent developments management industry and around 3 percent of in Islamic asset management, SME finance, all Islamic financial assets worldwide. housing finance, and other NBFIs such as Nevertheless, during the same period, the num- mudƗ̙ rabah and ijƗrah companies. ber of funds has increased from 756 to 1,181,
TABLE 6.2 Size of Capital Markets and Mutual Fund Assets in Selected World Regions, 2012
Regions Mutual fund assets to GDP (%) Stock market capitalization to GDP (%) Income group World 10.91 30.76 High-income 18.75 53.01 Middle-income 2.01 20.14 Low-income .. 19.37 Developing countries only Sub-Saharan Africa 19.01 22.19 East Asia and Pacific 4.04 44.07 Europe and Central Asia 1.37 11.66 Latin America and the Caribbean 3.35 24.58 Middle East and North Africa .. 23.37 South Asia 3.76 20.09 Source: World Bank Global Financial Development Database. Note: .. = negligible. 122 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 6.1 Global Islamic Asset Management Industry, 2008–14
1,400 70
1,181 1,200 960 1,063 60
935 1,000 909 50 819 756 800 40
60.65 30 600 56.85 57.59 Number of funds 47.02 47.09 400 39.48 20
28.35 Assets under management ($ billion) 200 10
0 0 2008 2009 2010 2011 2012 2013 2014 Assets under management Number of funds
Source: Thomson Reuters 2015.
corresponding to a cumulative average growth to $53.17 between 2008 and 2014 (figure 6.2), rate of around 8 percent per year. while the number increased from 568 to 953. The traditional assets classes include With a cumulative average annual growth of shari‘ah-compliant stocks, suknjk, and money around 13 percent in terms of AUM and 9 per- market instruments. Alternative Islamic invest- cent in terms of number of funds, the mutual ment assets comprise real estate/infrastructure, fund segment is the flagship of the global commodities, private equity funds, and some Islamic asset management industry. newly established hedge funds. Table 6.3 A promising segment of the Islamic asset shows the asset type of the Islamic funds that management sector is exchange traded funds were launched over the five years from 2009 to (ETFs). From 2008 to 2014, the segment expe- 2013. The bulk of the funds (41.8 percent) rienced a remarkable rate of growth of around were equity based, followed by suknjk (24.1 20 percent on a cumulative average basis. Total percent). Mixed funds were 14.3 percent of the AUM by Islamic ETFs grew from $2.17 billion new funds during the period, followed by in 2008 to $10.75 billion in 2012. After a sharp money market funds (12.8 percent) and real decline in 2013 to $5.77 billion, the Islamic estate funds (4.6 percent). ETF sector recovered in 2014, with AUM rising The global Islamic asset management indus- by around 10 percent to $6.33 billion, which try is dominated by mutual funds. As of 2014, accounted for more than 10 percent of total mutual funds accounted for almost 88 percent assets managed by the Islamic funds industry. of all assets managed by the global Islamic The share of pension, insurance, and equity asset management industry and 80 percent of funds is around 2 percent of the total AUM the total number of Islamic funds. The AUM of (figure 6.2). The share of these three categories Islamic mutual funds rose from $25.71 billion of funds did not change significantly from GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 123
TABLE 6.3 Funds Launched and Asset Type, 2009–13
Total number of Bonds Money Real Year Equity Mixed Other funds launched (suku¯k) market estate 2013 (through September) 82 24 30 19 8 1 — 2012 5492396 34 2011 6293241061 2010 77 19 34 12 7 4 1 2009 53 18 18 3 11 1 2 Total 328 79 137 47 42 15 8 Percentage 100.00 24.09 41.77 14.33 12.80 4.57 2.44 Source: Thomson Reuters 2014. Note: — = not available.
FIGURE 6.2 Assets under Management by Fund Type, 2008–14
70
60
50
40
44.98 53.17 50.81 30 37.80 37.31 33.52 20 AUM by fund type ($ billion) 25.71 10 8.28 8.77 0 2008 2009 2010 2011 2012 2013 2014 Insurance funds Pension funds ETFs Equity funds Mutual funds
Source: Thomson Reuters 2015. Note: AUM = assets under management; ETF = exchange traded funds.
2008 to 2013, reflecting the general trends make up 17 percent of the total, while 7 per- within the industry. This indicates that there is cent target North America, and 4 percent are scope for diversification and expansion of directed toward other Asian countries, nota- these types of funds in the future. bly Japan and China. Figure 6.3 shows the distribution of out- As of end-2014, funds invested in equities standing Islamic funds by geographic area. dominated the Islamic asset management sec- Islamic funds are concentrated in the Gulf tor, with around 40 percent of the total AUM Cooperation Council (GCC) Region (see figure 6.4). Money market funds were also (37 percent), followed by Southeast Asia popular, accounting for 36 percent of the total. (31 percent). Globally focused Islamic funds While there was a move away from commodity 124 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
FIGURE 6.3 Global Islamic Funds Outstanding by Islamic funds, and real estate funds accounted Geographic Area, End-2014 for around 3 percent. Percentage of assets under management Whereas most of the Organisation of Islamic Cooperation (OIC) member-countries 1% 2% have public pension schemes for government employees, the number of private pension schemes is very small. Nevertheless, several shari‘ah-compliant pension schemes are being 31% established by Islamic financial institutions, 37% which will enhance provision in the private sector. For example, in Pakistan, Meezan Bank 4% has established a voluntary pension scheme 7% called the Meezan Tahafuzz Pension Fund, and 17% MCB-Arif Habib Savings, an asset manage- 1% ment firm, launched the Pakistan Islamic Sub-Saharan Africa Southeast Asia Pension Fund. In some countries, such as Other Asia North America Turkey, the government has initiated regula- MENA Global tory reforms that promote expansion of GCC Europe pension schemes under public-private partner- ships. Under the new regime that became effec- Source: Thomson Reuters 2015. Note: GCC = Gulf Cooperation Council; MENA = Middle East and North Africa. tive in January 2013 in Turkey, the government matches 25 percent of the contributions of participants (KPMG Turkey 2013). The reform FIGURE 6.4 Global Islamic Asset Management has boosted the fund management industry in Funds by Asset Class, End-2014 general and the private pension market in par- Percentage of assets under management ticular in the country (Sezer 2013). The majority of the asset management 3% products are targeted toward people who are well-off. For example, in the MENA Region, 6% while public pension funds target government 10% employees, private pension funds are targeted toward a small number of privileged profes- 36% sionals (Rocha, Arvai, and Farzi 2011). As a result, people with lower income levels are unable to benefit. 40% Achieving the goal of shared prosperity will 5% require coming up with products that serve the needs of the poor and low-income groups. One Sukuk- Commodities way for asset management products to be more Equity Sukuk- mixed assets accessible to lower-income groups is to make Money market Real estate them more affordable by, for example, lowering the minimum subscription rates. The Meezan Source: Thomson Reuters 2015. Islamic Fund is an example of a fund that has a low minimum subscription—only PRs 5,000 (approximately $50)—to open an account, funds from 2009 to 2014 because of commod- with subsequent investments of PRs 1,000 ity price volatility, these funds still accounted (approximately $10), which are very affordable for 10 percent of the total at the end of 2014. amounts for small investors. Similarly, the Suknjk funds constituted 6 percent of the total Amana Mutual Funds in the United States has assets, mixed assets funds made up 5 percent of a minimum subscription of only $250.2 GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 125
BOX 6.1 Case 1. Green Suku¯k and the Rising Trend in Responsible Investment
The area of socially responsible investment (SRI) has use the proceeds on educational projects. The first great potential for the Islamic asset management tranche of the suknjk worth RM 100 million was industry to increase its contribution to shared pros- issued in 2015. The issue received a AAA rating by a perity. The notions underlying the SRI concept have local rating agency. The Ihsan suknjk has several a lot in common with the broad goals of Islamic unique features, including a reduction in the princi- finance. The strong emphasis on adhering to the val- ple amount invested whenever the projects to be ues related to social and environmental development financed meet specified performance indicators. inherent in Islamic theology and jurisprudence has Given this feature, the main driver for the demand important implications for the investment behavior for the suknjk is expected to be the annual distribu- of investors in Islamic finance. Therefore, relating tions investors may collect and the buy-back guaran- the Islamic finance products such assuk njk to the tee provided by Khazanah for a nominal concept of SRI and building a product structure that consideration. In addition to local investors, the complies with the fundamentals of the SRI concept suknjk is expected to attract a wide range of corpo- will not only increase the number of products in rate investors with social responsibility agendas. which both Muslim and non-Muslim investors may Along with Malaysia’s efforts in terms of SRI invest but also increase the contribution of Islamic suknjk, the Gulf countries are working to develop asset management to shared prosperity. green suknjk that will finance renewable and clean One recent example of relating Islamic finance to energy projects. The Dubai Supreme Council of SRI can be found in Malaysia. The Securities Energy has announced a partnership with the World Commission of Malaysia launched a new framework Bank to develop a green energy strategy, which also for SRI suknjk in August 2014 to facilitate the financ- includes suknjk financing tool. The United Arab ing of sustainable and responsible investment initia- Emirates Securities and Commodities Authority has tives (Securities Commission Malaysia 2014). As an recently developed reforms to incorporate green extension of existing suknjk regulations, the new suknjk into its suknjk regulation framework. The framework has refined the conditions for the issuance Saudi Arabian government also has ambitious inten- of SRI suknjk, defining the utilization of the proceeds; tions in the area of green energy. Given the fact that eligible SRI projects in areas such as education, the Gulf Cooperation Council (GCC) Region is one health, and renewable energy that will contribute to of the fastest growing regions in the world, with a the quality of life within society; disclosure require- population expected to exceed 53 million by 2020, ments; and the appointment of independent auditors the need for sustainable and responsible investments to provide detailed financial reporting. in energy, water, transport, and urban development Following this new legislation, Malaysia’s sover- is also predicted to grow. This need increases the eign wealth fund, Khazanah Nasional, issued potential for the development of SRI suknjk invest- Malaysia’s first social impactsuk njk under the Suknjk ments within the region. Ihsan Programme (Reuters 2015). The aim is to raise 1 billion Malaysian ringgit (RM) ($282 million) and Sources: Islamic Finance News 2015a, 2015b.
Although still at the idea stage, a recent describes a promising new market for sustain- opportunity in the Islamic finance realm that able and responsible investment suknjk. can contribute to the well-being of a society is the socially responsible investment (SRI) SME Finance suknjk, which provides the investors opportuni- ties to invest in assets and projects that are tar- Small and medium enterprises (SMEs) con- geted to produce environmentally sustainable tribute significantly to employment in devel- and socially responsible outcomes. Box 6.1 oping countries. SMEs employing 5–250 126 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
workers contribute two-thirds (66.4 percent) table 6.5. In a survey of 160 conventional of the average total permanent full-time banks from nine countries, the International employment in 99 countries, Ayyagari, Finance Corporation (IFC) found that although Demirgüç-Kunt, and Maksimovic (2011) esti- 47 percent had adequate SME product offer- mate. While they find that SMEs contribute ings, the overall SME portfolio penetration rate greatly to employment and GDP, they do not was only 37 percent (IFC 2014b). The corre- find a robust relationship between the SME sponding figures were much lower for Islamic sector and productivity growth. banks: 16 percent had SME product offerings, Despite this remarkable contribution of but the portfolio penetration rate was only SMEs to GDP, in a survey of micro and small 11 percent (IFC 2014a). enterprises from 13 countries, the World Bank In the same study of nine countries, IFC (2014, 107) found that limited access to (2014b) estimates that about one-third finance was the key obstacle to operations (32.2 percent) of the SMEs would prefer identified most frequently (by 36 percent of the shari‘ah-compliant financing. That suggests a firms). SMEs worldwide face huge financing potential gap of $8.63 billion to $13.29 billion gaps. Table 6.4 shows the number of formal for Islamic SME financing in these countries. and informal SMEs that are unserved and While there is a large demand for Islamic underserved and the estimated amounts of the finance from SMEs (as table 6.5 indicates), financing gap in different regions. Islamic banks have been unable or unwilling to Although the financing gap for the SME sec- meet this demand. tor is huge in developing countries, traditional An alternative to provide financing to SMEs banks do not have incentives or appetite to pro- would be NBFIs. A survey of 36 providers of vide financing to these enterprises because they Islamic microfinance to SMEs revealed that are considered risky and costly (World Bank only 15 percent of the institutions were banks 2008). Specifically, banks are not willing to (Sanabel 2012). Nearly half of the providers finance SMEs due to the various obstacles they (49 percent) were nongovernmental organiza- face, including not only high risk but also lim- tions (NGOs), followed by NBFIs (24 percent). ited specialization, high operating costs, and While 6 percent of the providers were microfi- poorly developed legal systems (IFC 2014b). nance banks, government organizations and This reluctance is also reflected in the financ- cooperatives constituted 3 percent each. ing practices of Islamic banks, as displayed in The substantial demand for SME financing
TABLE 6.4 Gaps in Enterprise Financing
Unserved or Unserved or Total number Total formal Formal SME underserved underserved Region of SMEs SMEs credit gap SMEs formal SMEs (million) (million) ($ billion) (million) (million) East Asia and Pacific 188 92 12 8 $150–$180 Europe and Central Asia 20 10 3 2 $150–$190 Latin America and the 52 27 3 2 $210–$250 Caribbean Middle East and North Africa 21 10 2 1 $260–$320 South Asia 78 36 2 1 $10–$20 Sub-Saharan Africa 40 22 4 3 $70–$90 Source: Stein, Pinar Ardic, and Hommes 2013. Note: SMEs = small and medium enterprises. GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 127
TABLE 6.5 Financing Penetration for SME and the low penetration by banks indicate that Financing and Preference for Shari‘ah-Compliant there is a role that NBFIs can play to fill the Products gap. The gap can be filled by various types of NBFIs, such as private equity funds, rural SME Preference for cooperatives, and leasing companies. An exam- penetration shari‘ah-compliant Countries ple of an innovative NBFI using crowdfunding (percent of products (percent lending) of SMEs) is given in box 6.2. Egypt, Arab Rep. 8.0 20 Iraq 5.0 35 Housing Finance Jordan 12.5 25 The use of Islamic finance has significant impli- Lebanon 16.1 4 cations with respect to enhancing shared pros- Morocco 24.0 54 perity and risk sharing in housing finance. Indeed, the deployment of Islamic finance tools Pakistan 7.3 25 for home financing has the potential to prevent Saudi Arabia 2.0 90 some of the problems that led to the recent Tunisia 15.0 18 global financial crisis. One of the main reasons Yemen, Rep. 20.3 37 underlying the global financial crisis was the Source: IFC 2014b. housing market bubble in the United States, Note: SMEs = small and medium enterprises. which was fueled by excessive household debt
BOX 6.2 Case 2. Liwwa: A Shari‘ah-Compliant Peer-to-Peer Lending Platform
Liwwa is an electronic platform that aims to tackle becomes the whole owner of the assets acquired the chronic unemployment and underdevelop- through raised funds. Working along the lines of ment problems of the Middle East. Developed in an ijƗrah-like lease-to-own basis, the transactions 2012 by two Palestinian entrepreneurs at Harvard taking place through the platform are recognized University, it was launched in September 2013. as shari‘ah compliant. Since investors know what Specifically, the new company’s mission is to deliver they are going to get in returns and at which date, job and income growth in the markets it serves. the model offered is more like a bond than an Liwwa is operating in Amman, Jordan, for borrow- equity investment. The platform takes services fees ers and across the MENA Region for those who from the monthly repayments made by the bor- seek to lend to SMEs. The platform provides inves- rowers to cover administrative expenses and the tors a return on a regular basis through a shari‘ah- funding of a reserve to underwrite the payments to compliant mechanism with no equity or interest in the investors. the equation (figure B6.2.1). The services are available to the small businesses The platform focuses particularly on the in Jordan, and to investors from countries such as finance of small businesses in compliance with Algeria, the Arab Republic of Egypt, Jordan, shari‘ah. Using the crowdfunding model offered by Lebanon, Saudi Arabia, Sudan, Tunisia, the United Liwwa, SMEs that need working capital and phys- Arab Emirates, and the United Kingdom. As of ical capital can raise funds from crowds of inves- March 2015, the target loan of the company was tors, who pool their assets through the Internet 10,000–15,000 Jordanian dinars (around $14,100– platform in return for the principal amount raised $21,100). Up to that time, Liwwa had provided 34 and part of the profit in the form of monthly pay- loans, some of which were still at the funding stage, ments. After the full payment, the borrower for a total of $260,000.
box continues next page 128 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
BOX 6.2 Case 2. Liwwa: A Shari‘ah-Compliant Peer-to-Peer Lending Platform (continued)
FIGURE B6.2.1 Liwwa’s Operating Framework
1. Investors and SMEs 5 subscribe to the website. 2. Liwwa buys needed capital goods from suppliers. 3. Liwwa pays the cost from 1 1 the proceeds collected from investors. Investors Liwwa SMEs 4. The capital is delivered to the 6 4 SME. 5. The SME repays the capital 3 with regular monthly payments and a final lump 7 sum payment. Supplier 6. Payments are delivered to investors after fees are 2 deducted. 7. The ownership is delivered after final payment.
Source: https://www.liwwa.com/. Note: SMEs = small and medium enterprises.
Although these amounts are rather small, the com- Liwwa, which is based on a lease-to-own structure, has pany has grown by 400 percent since March 2015, attracted not only investors with an Islamic orientation, when the initial $500,000 of seed capital was paid in. but also a diversified set of investors from various parts Moreover, the model presents a good example of how of the world. This is promising in light of the momen- Islamic finance tools can be used by people who have tum in the peer-to-peer finance sector worldwide. excess funds to share prosperity with SMEs so that added value is created. The crowdfunding model of Source: https://www.liwwa.com/.
(Mian and Sufi 2014; Turner 2015). Turner wealth and reduces consumption and aggregate (2015) contends that the financial sector has demand—which can further aggravate the tendencies to create excessive debt and pro- recession—it leaves the debt owed to the bank poses introducing regulations that restrict the intact. They suggest that one way of solving this growth of credit to the household sector. Mian problem is to use risk-sharing contracts that not and Sufi (2014) assert that debt-based contracts only protect households but also can prevent used to purchase houses leave the household housing bubbles from emerging. In this regard, sector vulnerable when the bubble eventually properly implementing Islamic finance bursts. For example, equity of a household put- solutions, such as a diminishing mushƗrakah ting a 10 percent down payment on a mortgage (partnership) structure,3 in-home financing can can become negative with a drop in the house serve as a stabilizing factor for both the finan- price of more than 10 percent in a housing mar- cial and housing sectors and protect households ket downturn. While this decreases household during recessions. GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 129
Housing finance in most IDB member- which has a mortgage-to-GDP ratio of 0.46 countries is at a nascent stage. Considerable percent. The total size of gross outstanding housing financing is needed to meet housing housing financing in the country on December finance requirements. While the bulk of housing 31, 2014, was PRs 53.7 billion ($5.35 million), finance is provided by banks, governments in advanced to 74,147 clients.4 Thirty-six percent some countries have established specialized of the financing was supplied by private banks, home financing institutions. Some 8.2 million 24 percent by the House Building Finance units are needed each year in the urban areas of Corporation Limited (HBFCL), 28 percent by IDB member countries, according to estimates Islamic banks, and 11 percent by public sector based on the growth rates of population and banks (SBP 2015). urbanization (Shirazi, Zulkhibri, and Ali 2012). Outreach to the poorer sections of the popu- Providing for these units is estimated to cost lation can be gauged by examining the average $15.6 billion a year. The distribution of the hous- size of financing. Private financial institutions ing units and the corresponding financing costs averaged PRs 5 million or more, compared to for different regions are shown in table 6.6. PRs 3 million for public financial institutions, As an illustration, table 6.7 presents the fea- with HBFCL extending the smallest amount, tures of the housing finance market in Pakistan, PRs 2.5 million. Microfinance banks provided PRs 216.07 million to 2,154 borrowers as of TABLE 6.6 Demand for Housing Units by Region, December 2014, according to SBP (2015). With 2010–20 an average of PRs 0.1003 million outstanding per borrower, the number of people served Amount of No. of appears to be very small compared to the poor financing/ Regions (number of countries) units/year and low-income population in the country. year (million) The case of Pakistan shows that most of the ($billion) housing finance comes from banks and special- Middle East and North 3.2 6.0 ized financial institutions that serve the rela- Africa (19) tively well-off. Some housing financing to the Asia (8) 2.7 5.2 bottom 40 percent of the population is pro- Sub-Saharan Africa (22) 1.9 3.7 vided by specialized banks such as HBFCL and Countries in transition (7) 0.4 0.7 by microfinance banks. Other NBFIs have a role to play in providing house financing to the Total (56) 8.2 15.5 unserved. An example of an NBFI that provides Source: Shirazi, Zulkhibri, and Ali 2012. home financing is given in box 6.3.
TABLE 6.7 Housing Finance in Pakistan, End-2014
Outstanding Gross outstanding Average financing Financial institutions disbursed Number of borrowers (PRs billion) size (PRs million) (percent of total) Public banks 6.0 11 4,991 3.0 Private banks 19.2 36 10,613 5.8 Foreign banks 0.3 1 129 5.0 Islamic banks 15.3 28 3,277 5.1 DFIs 0.1 0 53 — HBFCL 12.7 24 55,084 2.5 Total 53.7 100 74,147 3.8 Source: State Bank of Pakistan (SBP) 2015. Note: — = not available; DFIs=development financial institutions; HBFCL = House Building Finance Corporation Limited; PRs = Pakistan rupees. 130 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
BOX 6.3 Case 3. NBFI Shari‘ah-Compliant Home Financing in Canada
Ansar & Islamic Cooperative Housing Corporation including any deposits they gave to the vendor when Ltd. (ACHC) was established in Toronto in 1981 to they signed the contract to buy the house. The con- provide shari‘ah-compliant home financing for cept of diminishing musharƗkah (partnership) is Canadian Muslims using the diminishing musharƗkah used to finance the housing. The diminishing part- model. ACHC has two kinds of shares. Common nership model was chosen because of its practical shares are shares in the equity of the cooperative. features and flexibility. There is no fixed term in the Preferred shares are attached to the individual mem- contract. A rental value for the house is determined, bers’ own houses. The price of both common and pre- and the members pay a proportionate rent to the ferred shares is fixed at Can$100 each. Initially, every cooperative every month. The members are free to member is an investor or common shareholder pro- buy any number of preferred shares at any time. viding equity to the cooperative. Everyone who When they do, their proportionate rent is adjusted wishes to participate in the cooperative must become for the following month. When members complete a member by paying a one-time membership fee of 100 percent purchase of the required preferred Can$75 and must invest a minimum of Can$600 by shares, they surrender those shares to the coopera- buying six common shares. Those members who wish tive and the legal title of their house is transferred to to buy a house through the cooperative must buy and them after sharing any gain or loss in the value accumulate a certain minimum number of common of the house. The members are entitled to share shares, depending on the cost of the house. This mini- 90 percent of any gain or loss, and the cooperative mum investment must remain in the cooperative for shares 10 percent. At this point, the partnership in at least six months before the member can qualify to that house between the member and the cooperative apply for housing finance. is terminated. The membership in the cooperative, Once a member becomes eligible to buy a house, however, continues and members are expected to he/she submits an application to the cooperative. If continue to invest their savings in the cooperative approved, the member is authorized to locate a so that the other members can be helped the same suitable house anywhere in Canada, negotiate the way. The cooperative pays dividends annually to price, and obtain a closing date from the coopera- all common shareholders from the rental income tive for the full payment and possession of the house. according to the ratio of their quarterly ownership At the time of the purchase of the house, members of the shares. surrender their common shares and are issued pre- ferred shares to reflect their total contribution, Sources: Nasim 2003; http://www.ansarhousing.com/.
Other NBFIs (Mud. a¯ rabah and Ija¯rah company in 1980, the number increased to Companies) 56 in the mid-1990s and then declined to 24 A unique example of Islamic NBFIs are the as of December 2014 (NMAP 2013; SECP 2014). The value of total assets held by the mudҕƗrabah companies. MudҕƗrabah compa- mudƗҕ rabah companies was PRs 30.19 billion nies operate on the principle of “profit shar- 5 ing and loss bearing,” wherein entrepreneurs ($296.8 million) as of December 2014. d share the profit with the financier but losses While the bulk of the funds of mu ҕƗrabah companies are in the form of equity, some of are fully borne by financiers. MudҕƗrabah companies started their operations in them also raise funds by issuing mushƗrakah Pakistan after the enactment of the Certificates of Investment and Terms Finance Certificates (NMAP 2013).6 The total amount MudҕƗrabah Companies and MudҕƗrabah Floatation and Control Ordinance in 1980. of funds raised from different categories of clients is shown in table 6.8. More than After the launch of the first mudҕƗrabah GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 131
two-thirds of the funds raised by mudƗҕ rabah economic growth. However, they account for companies come from individuals, followed only a very small part of the financial sector, by corporations and trusts. representing only 0.12 percent of Pakistan’s The scope of operations of mudҕƗrabah GDP as of December 2014. companies is wide ranging. In addition to pro- Another important type of NBFIs are viding financing using a variety of methods, ijƗrah companies. IjƗrah is similar to the con- mudҕƗrabah companies are also involved in cept of leasing in conventional finance. One trading, manufacturing, investment in equities, of the important features of leasing is the portfolio management, financing of private financing of assets without any collateral. equity/venture capital, housing finance, and Leasing companies are better able to assess providing investment finance services (NMAP credit risk due to their ability to understand 2013). Given the range of activities that the cash flows associated with the assets. Thus mudƗҕ rabah companies can engage in, they can leasing can be a better financing mode for potentially make a positive contribution to SMEs that do not have a sound credit history (Rocha, Arvai, and Farazi 2011). The leasing sector in most of the IDB member-countries, TABLE 6.8 Deposit Raising by Mud. a¯ rabah Companies, End-2104 however, is small. Box 6.4 illustrates an exam- ple in Tajikistan. Amount Percentage Categories (million PRs) of total Individuals 4,226.84 67.4 Islamic NBFIs and Shared Prosperity: Key Challenges and Policy Corporates 970.27 15.5 Recommendations Trusts 840.34 13.4 Sectoral Challenges: Supply-Side Issues Financial institutions 229.45 3.7 Total 6,266.90 100 The achievement of shared prosperity Source: SECP 2014. requires expansion of the NBFI sector to Note: PRs = Pakistan rupees. facilitate the provision of financial services to
BOX 6.4 Case 4. ASR Leasing in Tajikistan
The leasing industry in Tajikistan is relatively small. leasing contract include paying a 20 percent minimum Before the establishment of ASR Leasing as the first security deposit/advance payment and insuring the ijƗrah company in 2013, the country had seven other leased asset for the duration of the tenure. The lease conventional leasing companies. ASR Leasing was contract can be structured in either the local currency established by Ansar Leasing of Azerbaijan along with or U.S. dollars. Repayments must be made using the two local partners with initial paid-in capital of only prevailing exchange rate announced by the National $200,000. The paid-in capital was later increased to Bank of Tajikistan. The expected rate of return on leas- $4 million with additional shareholders’ funds that ing is in the range of 20–23 percent, depending on the include Islamic Corporation for the Development of length of the tenure. Given that 90 percent of the coun- the Private Sector (ICD) of the Islamic Development try’s population is Muslim and that SMEs account for Bank Group. more than 80 percent of the trading sector, the demand ASR Leasing typically leases fixed assets to small for Islamic leasing is expected to increase in the future. and medium enterprises (SMEs) and corporations up to a maximum of $200,000 per contract, for a tenure Source: Presentation by the managing director of ASR Leasing, http://idbgbf .org that can range from 1 to 4 years. The conditions of the /assets/2013/7/9/pdf/23edbe7c-6b56-49a6-9e80-237804c5b058.pdf. 132 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
more segments of the population. Specific The financial sector requires specific knowl- challenges in expanding the NBFI sector are edge and skill sets that analysts, bankers, discussed next. accountants, and lawyers often lack in devel- oping countries. The growth of the financial Increasing the Number and Diversity of sector in general and the NBFI sector in par- Islamic NBFIs ticular can be constrained by the availability of The key constraint on the supply side is the adequate and relevant human capital limited number of NBFIs in most Muslim (Carmichael and Pomerleano 2002, 199). The countries. The development of the range of risks arising in providing financial services to Islamic NBFIs can take place in two ways. the bottom 40 percent of the population are The first approach is to create new institu- considerable and need to be dealt with pru- tions that do not have counterparts in the dently. For example, information asymmetry is conventional financial world. Examples of more acute in the case of financing SMEs rela- these are Tabung Haji in Malaysia and the tive to larger firms and would require different mudƗҕ rabah companies developed in Pakistan. types of skills and approaches for mitigation. These institutions have unique institutional features serving different purposes in the Sector-Specific Supply-Side Issues economy. The second approach is to adopt The limited number of service providers is and adapt conventional financial institutions constraining the asset management industry to encourage them to provide Islamic finance (Rocha, Arvai, and Farazi 2011). Many coun- services. Adaptations involve eliminating tries lack the critical mass of fund managers undesirable elements (like ribƗ and gharar) to serve different segments of the population. from transactions. In this process, the func- Furthermore, there is a lack of suitable instru- tions performed by the Islamic NBFIs will be ments and products. Thus there is a need to similar to their conventional counterparts, expand the products geared toward lower- but the operations would be within the income groups. bounds prescribed by shari‘ah. In response to SME financing has relatively high risks, as is demand, some conventional NBFIs are offer- evident from the proportion of nonperforming ing Islamic financial alternatives to their cli- loans (IFC 2014a, 33). NBFIs may have lim- ents. Examples include the ORIX Leasing ited specialization in SME financing. Their Company in Pakistan and the Peoples Leasing capabilities to serve the SME sector must be and Finance Company in Sri Lanka.7 improved to deal with the specific risks Another key role of Islamic NBFIs is to pro- involved in SME financing (IFC 2014b). vide Islamic financial services in countries Enhancing the skills to manage the risks aris- where establishing Islamic banks is not possible ing in SME financing is thus important. In due to legal and regulatory restrictions. As laws coming up with a strategy, a distinction should related to NBFIs are less stringent than those be made between the different market seg- governing Islamic banks, Islamic NBFIs can ments: well-served, unserved, and underserved provide Islamic financial services under existing enterprises. While the former are being funded laws and regulations. For example, finance adequately, the latter two segments are not. companies in the United States and coopera- In this regard, a classification of SMEs accord- tives in Canada are offering Islamic housing ing to sectors would be useful. products to Muslims residing in these countries. The bulk of SME financing is short term An indigenous institution providing funds to and is used to finance working capital. There small-scale enterprises and businesses is the appears to be a gap in the provision of long- pawning institution in Malaysia (Ahmed 2011). term financing for SMEs. Furthermore, the By combining contracts of wadƯ‘ah (deposit) product offerings for SMEs are very limited. and rahn (pledge or mortgage), the pawning There is a need to come up with new product services provide short-term cash advances, offerings that meet the needs of SMEs (IFC including working capital for businesses. 2014a). Currently, debt-based products GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 133
dominate the assets side of the balance sheet. to have local NBFIs that can provide financial Other modes of financing such as istidҕnƗ‘, services to the poor. Another option is to use mudƗҕ rabah, and mushƗrakah also need to be modern information and communications used. However, the risks associated with these technology to deliver basic financial services products need to be mitigated. at a very low cost. Since most leasing companies use financial leases in most of the developing markets, there Consumer Protection is a need to expand the number of leasing One of the key determinants of the growth companies that also use operating leases to of the financial sector is the protection of the fulfill theshari‘ah requirements. An enabling rights of the investors. Expanding the inves- environment that can provide support to these tor base requires not only products and kinds of companies is needed. instruments that are appropriate, but also systems to ensure the protection of clients Demand-Side and Investor Issues and investors. Because the NBFI sector is less stringently regulated, cases might emerge Consumer demand determines the financial where institutions have been mismanaged services that are provided. In the case of and have resulted in the loss of investors’ NBFIs, individuals and entities use the sector assets. After the financial crisis of 2008, to obtain capital and also supply the funds as some NBFIs, including a few that were investors. The expansion of Islamic NBFIs Islamic, became insolvent or declared bank- will largely be driven by demand for their ser- ruptcy.8 These failures highlighted the need vices, which in turn depend on several factors, for sound disclosure of relevant information discussed next. related to the terms and conditions of the contracts, with the relation to returns and Low Levels of Financial Literacy risks. This needs detailed disclosure. In coun- Research shows a positive relationship tries that have weak investor rights, funds between financial literacy and financial inclu- with longer-term investment horizons will sion (Atkinson and Messy 2013). A survey of not be forthcoming. Thus leasing companies 301 microfinance institutions revealed limited that depend on long-term funding will face financial literacy to be the main obstacle in funding constraints that will hamper their providing financing (Gardeva and Rhyne growth (Nasr 2004, 9). 2011). This is particularly true for Islamic financial products, which are not only new Reputation and Credibility for many people, but also may be more com- Provision of funds to financial institutions by plex. There is a need to come up with schemes investors also depends on their perceptions of to educate people and raise awareness of risks and rights. As a significant percentage of Islamic financial products. customers use Islamic financial institutions for religious reasons, there is a need to ensure that Cultural, Social, and Physical Barriers the products and activities of NBFIs comply Many Muslims will not engage with the con- with shari‘ah. Furthermore, perceptions about ventional interest-based financial institutions and trust in the integrity and efficient manage- due to religious convictions. Furthermore, the ment of the operations are important determi- lack of language and technological skills may nants of the growth of the Islamic financial prevent people from using modern technol- industry. There have been a few cases of mis- ogy such as the Internet to access financial management and fraud that have hurt the services. A large percentage of the population reputation and credibility of the industry. For living in rural areas in developing countries example, UM Financial, an Islamic NBFI in face physical barriers because of poor physi- Canada, filed for bankruptcy in December cal infrastructure (Atkinson and Messy 2013). 2011 because of mismanagement (Pasha and One way to overcome the physical barrier is French 2011). 134 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
Legal and Regulatory Challenges The specific issues related to the establish- ment and operations of Islamic NBFIs, such as An enabling environment to promote Islamic licensing, minimum capital requirements, and finance in general entails the presence of a disclosure requirements, can be covered under favorable political, economic, and regulatory regulations for the supervision of specific environment (IFC 2014b). The legal and reg- NBFIs. The nature of regulatory measures ulatory framework not only determines the applied to different NBFIs will depend on the specific NBFIs that can be established in a extent to which they are exposed to and gener- country, but also the activities they can ate anticompetitive behavior, market miscon- engage in. There is a need to have not only duct, asymmetric information, and systemic laws that support Islamic NBFIs, but also a instability (Carmichael and Pomerleano 2002, legal infrastructure to support contract 33). The regulatory measures to deal with these enforcement. A sound contract enforcement problems can be broadly categorized as com- regime is essential for the development of the petition regulation, market conduct regulation, financial sector because it not only reduces prudential regulation, and systemic stability the transaction costs (Nasr 2004) but also regulation. instills trust among investors and financial Because mutual funds are less exposed to institutions. systemic risks, investor protection regulations A balanced regulatory framework can and standards, such as licensing, disclosure, play an important role in the healthy growth and good governance, would be required of the NBFI sector. The key objectives of (Carmichael and Pomerleano 2002, 111). The regulations are to deal with anticompetitive regulation of pension funds, however, would behavior, market misconduct, asymmetric depend on their type and the risks involved. information, and systemic instability For example, whereas a defined contribution (Carmichael and Pomerleano 2002, 33). scheme managed by competitive private sector The nature of an NBFI in terms of its asso- entities would have the same regulatory ciation with these areas of concern and the requirements as mutual funds, the regulation risks involved will determine the regulatory of a defined benefits scheme would require parameters that would govern the specific more regulatory oversight, which may include institution. periodic actuarial reviews. A sound legal and regulatory framework Sector-Specific Legal and Regulatory Issues for leasing companies is necessary for the In addition to general laws that support growth of the leasing industry in general and economic and financial activities, such as for Islamic leasing companies in particular. For property rights and contractual enforcement, leasing companies, the World Bank (2008) the legal framework is a key determinant of asserts that the leasing law should clarify the the strength and soundness of the NBFI sector lessor’s effective ownership and repossession (Carmichael and Pomerleano 2002). Given rights and acknowledge the lessee’s responsibil- the diversity of NBFIs, there is a need to come ity as the custodian of the asset. For leasing to up with laws that can deal with the specific succeed, it requires a sound legal framework issues arising from the different areas and the that defines the rights and obligations of the ways in which NBFIs operate. While the lessor and lessee in general, and in case of existing laws on NBFIs can be extended with bankruptcy in particular. The law needs to rec- minor adjustments for Islamic NBFIs, such as ognize that some features of Islamic leasing are Islamic leasing companies and mutual funds, different from financial leases. Most countries there may be a need to enact new laws to lack registries for leased assets, which limits accommodate unique Islamic NBFIs, such as leasing financing. the MudƗrabah Companies and MudƗrabah One of the key financial infrastructure Floatation and Control Ordinance in institutions that reduces asymmetric infor- Pakistan. mation are credit bureaus (Nasr 2004). GLOBAL REPORT ON ISLAMIC FINANCE NONBANK FINANCIAL INSTITUTIONS 135
Financing to SMEs could be expanded by References different NBFIs if credit registries exist that Ahmed, Habib. 2011. Product Development in enable financiers to reduce adverse selection Islamic Banking. Edinburgh: Edinburgh problems. University Press. Housing sector financing for construction Atkinson, A., and F. Messy. 2013. “Promoting or acquisition would also require a facilitating Financial Inclusion through Financial Education: legal environment. The lack of efficient laws OECD/INFE Evidence, Policies and Practice.” related to land registration, land division, Organisation for Economic Co-operation and mortgage laws, laws related to collateral, and Development (OECD) Working Papers on precise legal titles can be challenging (Shirazi, Finance, Insurance and Private Pensions, No. 34, Zulkhibri, and Ali 2012). OECD Publishing, Paris. http://dx.doi.org/10.1787 /5k3xz6m88smp-en. Ayyagari, Meghana, Asli Demirgüç-Kunt, and Notes Vojislav Maksimovic. 2011. “Small vs. Young Firms across the World: Contribution to 1. MudҕƗrabah is a partnership whereby one Employment, Job Creation, and Growth.” party (the capital owner) provides capital to Policy Research Working Paper 5631, World an entrepreneur to undertake a business Bank, Washington, DC. activity. Profits are shared between them as agreed, but any financial loss is borne only by Bakker, M. R., and A. Gross. 2004. “Development the capital owner because the loss is the capi- of Non-bank Financial Institutions and tal owner’s unrewarded effort put into the Capital Markets in European Union Accession business activity. Countries.” Working Paper 28404, World Bank, 2. See http://www.almeezangroup.com/Mutual Washington, DC. Funds/OpenEndFunds/MeezanIslamicFund Carmichael, Jeffrey, and Michael Pomerleano. / tabid/75/Default.aspx for the Meezan Islamic 2002. The Development and Regulation of Fund, and http://www.saturna.com/pdf /amana Non-bank Financial Institutions. Washington, /Amana-application.pdf for the Amana Mutual DC: World Bank. Funds. Chapra, M. Umer. 1985. Towards a Just Monetary 3. Under a diminishing mushƗrakah structure, System. Leicester, U.K.: The Islamic Foundation. an investor’s equity share diminishes, while a homeowner’s share increases over time. Cole, Shawn, Thomas Sampson, and Bilal Zia. 4. The U.S. dollar figure was calculated at 2011. “Prices or Knowledge? What Drives the exchange rate of $1.00 to PRs 00.30 as of Demand for Financial Services in Emerging December 31, 2014. Markets.” Harvard Business School Working 5. Calculated with an exchange rate of $1 = Paper 09–117. http://www.ifmrlead.org/cmf/wp PRs 101.7 (on June 24, 2015) - content/uploads/2011/08/09-117.pdf. 6. MushƗrakah is a partnership whereby all the Creane, Susan, Rishi Goyal, A. Mushfiq Mobarak, partners contribute capital for a business ven- and Randa Sab. 2006. “Measuring Financial ture. The partners share profits on a pre- Development in the Middle East and North agreed ratio, while losses are shared according Africa: A New Database.” IMF Staff Papers 53 to each partner’s capital contribution. (3): 479–511. 7. See http://www.orixpakistan.com/islamic Gardeva, A., and E. Rhyne. 2011. Opportunities -financing.aspx for ORIX Leasing Company, and Obstacles to Financial Inclusion. Survey and http://www.plc.lk/inpages/products_and Report. Center for Financial Inclusion at _services/islamic_finance.php for the Peoples ACCION International. http://centerforfinan Leasing and Finance Company. cialinclusionblog.files.wordpress.com/2011 8. The failures in the GCC, in particular, caused /07/opportunities-and-obstaclesto-financial reputational damage to the industry. The -inclusion_110708_final.pdf. institutions affected included Aayan Leasing and Investment Company (2011), Investment IDB, IRTI, and IFSB (Islamic Development Bank, Dar (2010), Noor Financial Investment Islamic Research and Training Institute, and Company (2011), and Arcapita Bank (2012) Islamic Financial Services Board). 2014. (Raghu, Pattherwala, and Tulysan 2013). Islamic Financial Services Industry Development 136 NONBANK FINANCIAL INSTITUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
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and Informal Micro, Small, and Medium World Bank. 2008. “Leasing in Developing Enterprises. Washington, DC: International Countries: IFC Experience and Lessons Learned.” Finance Corporation. Access Finance, Issue 23, World Bank Group, Thomson Reuters. 2014. Global Islamic Asset Washington, DC. Management Outlook 2014. Thomson Reuters. ———. 2014. Global Financial Development ———. 2015. Global Islamic Asset Management Report 2014. Washington, DC: World Bank. Outlook 2015. Thomson Reuters. ———. n.d. Global Financial Development Turner, Adair. 2015. Between Debt and the Devil: Database. http://databank.worldbank.org/ data Money, Credit, and Fixing Global Finance. / reports .aspx?source =global-financial Princeton, NJ: Princeton University Press. -development.
7 Alternative Asset Classes
slamic financial institutions have endeav- real estate investment trusts (REITs), the h. alƗl Iored to provide as wide a range of facili- food industry, trade financing instruments, ties for their clients as their conventional and infrastructure investments through proj- counterparts. This includes not only banking ect finance (Terhaar, Staub, and Singer 2003). services and mainstream capital market All of these serve very different purposes and products, but also alternative investments. share few common characteristics apart from Asset diversification is desirable not just for usually being less liquid than mainstream investors seeking shari‘ah-compliant assets; investments. Most are relatively new from an it also opens up wider possibilities for those Islamic finance perspective, as the industry seeking financing. The pricing of alterna- has been focused mainly on banking and cap- tive assets is often uncorrelated with equity ital market instruments for most of the half prices and those of fixed income instruments, century since its development. It is only in the including suknjk (Islamic certificates of invest- last decade, and especially since the global ment). Hence such assets provide investors a financial crisis of 2007–08, that interest in degree of hedging from the inevitable busi- Islamic alternative investments has increased, ness cycles. partly reflecting disillusionment with returns on shari‘ah-compliant equities and suknjk Overview of Alternative Asset Classes securities. There is a very wide variety of Islamic alter- When considering the merits of alternative native assets, which in essence comprise all asset classes from an Islamic perspective, the financial investments apart from listed equity principles of risk sharing and participatory and fixed income securities (Schneeweis, finance should be taken into account. How Kazemi, and Martin 2003). The major cate- much do the alternative asset classes adhere gories include private equity, hedge funds, to these principles, which justify the returns
GLOBAL REPORT ON ISLAMIC FINANCE 139 140 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
earned by investors? Islamic finance is not be sold at any time (Siegel 2008). Once funds about earning windfall gains, but rather are locked in, there is little that investors can implies an active involvement in what is do if there are market downturns as the eco- being funded, usually by sharing in risk nomic outlook deteriorates. Because alterna- rather than playing a managerial role in a tive assets are so diverse, however, their price project (Archer and Karim 2006). movements are not necessarily correlated The wide variety of alternative asset with those of listed equity or bonds. Some, classes means that shari‘ah concerns vary such as hedge funds, can be regarded as coun- according to the particular asset being con- tercyclical. Real estate valuations are subject sidered as an investment vehicle; it is difficult to different business cycles than those for to generalize across alternative assets as a equity markets. In short, alternative assets whole. Some of the assets, such as private may be more risky, but they also serve to equity holdings, are inherently more shari‘ah diversify risk. compliant than others, such as hedge funds. Alternative investments are usually less The detail matters from a shari‘ah perspec- transparent than those in stock markets, as tive, and it is important to understand the private equity purchase and sales prices are workings of the financial arrangements and subject to negotiation, and in the case of real how returns are generated for the investors. estate, valuations may differ widely. Hedge Shari‘ah-compliant capital is often deployed funds are often opaque, with limited informa- alongside conventional finance in alternative tion provided on their investments or the con- asset categories. Although such combinations tracts used to generate profits (Agarwal and may be quite legitimate, it is necessary to Naik 2004). This lack of transparency adds understand the nature of the interactions. to risk, with most investors in alternative Islamic alternative asset classes are man- asset classes largely relying on their previous aged by a wide range of financial institu- performance for information about them, tions, including Islamic and conventional rather than the fundamentals regarding the banks, Islamic funds, takƗful providers, pen- underlying assets and the disaggregated sion funds, and other institutional investors. sources of income and capital gains. As a consequence, there are no aggregate data enabling comparisons to be made of the Islamic Private Equity size of different asset categories, such as pri- vate equity or hedge funds. It is likely that Shari‘ah-compliant private equity investment real estate dominates, given the preference is subject to the same screens as investment in of many Muslim investors for tangible listed companies, which exclude companies assets. This is especially the case with high- that are heavily leveraged or are engaged in net-worth individuals in many Muslim h. arƗm activities, such as production or distri- countries, including family offices in the bution of alcohol and pork (Chatti and Gulf Cooperation Council (GCC) states, Yous 2010). Companies that derive a signifi- which tend to value investment in commer- cant proportion of their income from ribƗ’ cial and residential real estate more than (interest) are also excluded, including conven- investment in financial instruments. tional banks and many other financial institu- Investors in alternative assets, especially tions. In practice, as the dominant financial those seeking superior returns, typically have institutions are large listed companies, private a greater appetite for risk than those invest- equity plays no role in their financing. Rather, ing in bonds and traded equities. One motiva- it is usually small to medium enterprises tion for investment in alternative investments (SMEs) that seek private equity, especially in is to seek higher returns, especially for inves- fields such as pharmaceuticals, alternative tors in private equity and hedge funds. Often energy, or information technology, which are investments in alternative assets are less inherently shari‘ah compliant. Injections liquid than bonds and listed equities that can of private equity into such companies can GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 141
reduce their debt burdens, resulting in their private equity finance to fund expansion. In being more suitable for Islamic investment. the case of pious owners, Islamic private Venture capital represents a subset of equity seems the obvious choice, especially as private equity finance, as it is sought by their businesses are already shari‘ah recently established companies that are insuf- compliant (Wilson 2006). The institutions ficiently mature to be listed on the market providing Islamic private equity finance are but that can use private equity not only to mostly investment companies rather than fund development directly but also to gain Islamic banks, which are much more con- additional debt finance. In the case of strained as regulated deposit takers. shari‘ah-compliant venture capital, this can include trade and project financing from Case Study: Alkhabeer Islamic banks, often under murƗbah. ah (trade Typical of these companies is Alkhabeer finance) and istiVn̙ Ɨ‘ (project finance) Capital, an investment company based in contracts. MushƗrakah (joint ventures) and Jeddah, which is playing a major role in the mud̙Ɨrabah partnership finance can also be provision of private equity finance in Saudi used for private equity. MushƗrakah is more Arabia.1 The company was established in suitable for proactive investors who wish to 2004 as an investment advisory business be more involved in the management of the focused on the development of shari‘ah- venture that is seeking capital (Choudhury compliant products, but has since increased its 2001). Shari‘ah-compliant private equity and own proprietary capital base, as well as man- venture capital finance should not be seen as aging investments on behalf of its clients. It an alternative to debt finance, but rather as a employs a staff of 80 professionals, including facilitator of such financing, while keeping investment analysts. As table 7.1 shows, its the use of leverage within limits that are assets under management have grown rapidly. acceptable from an Islamic perspective. As it has gained more experience with the Islamic private equity finance has emerged businesses financed, the return on assets has only since the 1990s, with most of the activ- increased impressively. ity confined to Malaysia and the GCC states Two initiatives sponsored by Alkhabeer in (Karake-Shalhoub 2008). While much of the 2014 illustrate its business priorities. The first financing in Malaysia has been in domestic aims to assist the SME sector in playing an enterprises, in the GCC the financing has increasing role in the economy of Saudi largely been directed toward European and Arabia. SMEs, while considered to be the U.S. companies. This is starting to change, engine of growth and stability in developed however, as opportunities for private equity economies, often suffer from a lack of access increase, especially in Saudi Arabia and the to capital in emerging markets. As a result, United Arab Emirates. Family businesses Alkhabeer decided to support this subsector are becoming more interested in raising by providing SMEs with growth capital.
TABLE 7.1 Alkhabeer Financial Highlights
2010 2011 2012 2013 2014 Assets under management (SRls million) 535.84 1,442.87 1,641.87 2,498.18 3,335.07 Total revenue (SRls million) 54.81 64.63 107.35 125.70 158.18 Operating expenses (SRls million) 43.81 45.49 76.31 83.19 100.88 Net income (SRls million) 11.00 19.15 31.04 43.32 57.30 Return on assets (percent) 2.74 3.23 3.89 5.25 6.32 Source: Alkhabeer Annual Report 2014. Note: SRls = Saudi Arabian riyals. 142 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
Second, Alkhabeer decided to invest The second initiative, the Alkhabeer SME further in the small but expanding venture Fund I, is a private placement closed-end capital sector in Saudi Arabia. Whereas the fund launched in December 2014 to manage Kingdom is the largest economy in the the acquisition of the majority stake in the region, it has lagged regional centers such as Ajaji Medical Group, based in Riyadh. Dubai in providing the ecosystem required Established in 1995, the group owns and for venture capital companies to succeed. operates four polyclinics and five pharmacies Despite significant amounts of resources in Riyadh, providing health care services pri- invested in this sector, the landscape is still marily to resident expatriates in the Kingdom. mostly void of serious participants. No This new fund heralds the implementation of authorized person2 has yet moved into this Alkhabeer’s private equity SME strategy, arena. Alkhabeer has therefore launched a which targets shari‘ah-compliant small and venture capital initiative to plug the gap in medium enterprises in Saudi Arabia and the the marketplace. United Arab Emirates. Alkhabeer Private Equity is closely involved with the senior management of its portfolio companies to realize both opera- Hedge Funds tional and financial value for all parties, The term hedge implies an investment including co-investors. It invests in potential strategy that seeks to minimize risk, often by targets through opportunity-specific funds. transferring it to another party. Islamic Target companies are primarily selected with finance involves risk sharing, rather than risk on the basis of the following investment transfers. As sharing is what justifies the strategies: returns to investors, hedging activity would appear at first glance to be off limits to inves- • Acquisition of majority stakes in noncore tors seeking shari‘ah compliance. In reality, operating companies owned by family however, hedge funds represent a very hetero- groups geneous class of assets, and the distinction • Acquisition of significant minority stakes between risk sharing and risk transfers often in blue chip companies with prospects for becomes somewhat blurred. Hedge funds are initial public offerings (IPOs) relatively safe investments most of the time, • Involvement in partnerships with interna- but when they fail, the results for the inves- tional companies tors can be catastrophic, wiping out all their • Investments in small and medium enterprises. capital. Some investors are willing to be In 2014, Alkhabeer launched two exposed to hedge funds with such a risk pro- shari‘ah-compliant closed-end private place- file, either because they expect vastly superior ment health care funds. The first, Alkhabeer returns when markets are rising or positive Health Care Private Equity Fund I (AHPEF I returns in falling markets. closed fund), acquired a majority stake in Managers of hedge funds usually have a Eed Group, a Saudi-based health care com- less restrictive mandate than those managing pany based in Jeddah. Established in 2001, equity or bond portfolios, as they can invest Eed Group is one of the leading vertically in derivative instruments such as futures and integrated health care groups in Saudi option contracts to hedge their positions Arabia. The group initially operated as an (Ackermann, McEnally, and Ravenscraft independent health care provider focusing 1999). Instead of diversifying by holding a on cosmetic surgery and outpatient specialty wide range of investments in equities and primary care services, but in 2013 it bonds to reduce risk, they often concentrate expanded into additional services such as on acquiring major holdings in a few com- a pharmacy business, medical equipment panies, while limiting the risks through supply, and third-party management and derivatives trading. The aim is not to attain operations. market returns as with tracker funds or GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 143
exchange traded funds, but to obtain high More fundamentally, simply making absolute returns. money by trading financial instruments that While direct investing in equities is seen as have little connection with real business is socially useful, as it contributes to business not viewed as productive, as it amounts to a expansion and job creation, the link between zero-sum game similar to gambling, which derivatives and the real economy is much is designated as maysir, a practice also less clear. Derivatives trading can either condemned in Islamic teaching. Maysir is destabilize or stabilize financial markets. derived from yusr, in Arabic, meaning Although it may be justified in commodity “ease.” Gambling both fails to qualify as markets, where hedging can be helpful for work and provides an opportunity to gain companies and their clients,3 its merits in a pecuniary advantage at the expense of equity or bond markets are more question- others. On the same basis, an investment able. In particular, short selling, which is entered into for purely speculative reasons widely used by hedge funds, can be viewed as would be deemed unacceptable (Mohamad exploitative of counterparties, whose losses and Tabatabaei 2008). accrue to the hedge fund as gains in what Existing Islamic hedge funds claim to use amounts to a zero-sum game. contracts that were accepted in traditional One type of short selling to profit from fiqh (Islamic jurisprudence), notably arboun, falling markets is where an investor lends which is a type of option contract, and stock to a hedge fund manager under a salam, a contract under which a financier repurchase contract. The hedge fund man- pays in full, up front, for a commodity to be ager then proceeds to sell the stock at the delivered at a future date. Arboun involves prevailing spot price, while simultaneously paying a deposit for a commodity for purchasing a future contract to buy back the delivery at a future date, rather than paying stock at a lower price, given some market in full. There is a revocation option akin to participants’ anticipation of price falls. The a call option in the conventional sense. hedge fund manager gains from the price However, the contract is about a sale of a difference, while ensuring that the transac- good for which the deposit is part of the tion can be closed with the return of the price, while the option is about the right to stock to the original investor (Agarwal and purchase, and the price for this right is lost if Naik 2004). the contract is allowed to lapse without From a shari‘ah perspective, short selling being exercised. In classical fiqh, arboun is activity is highly dubious, as it is regarded as controversial, but it is accepted by the speculative and involves gharar (contractual Hanbali School of Islamic jurisprudence uncertainty or legal ambiguity), which is (Dali and Ahmad 2005). explicitly condemned in Islamic teaching (Dusuki 2008). Moreover, disposing of stock Case Study: Shari‘ah Capital that is not owned by the seller is viewed as potentially deceptive. Although there is a New York–based Shari‘ah Capital has a long- future contract to buy back the stock, the short Islamic commodities hedge fund that trades are always in danger of unwinding has been operating since 2007.4 Sheikh Yusuf before the stock is returned to the original Talal DeLorenzo, the firm’s chief shari‘ah supplier. There is also concern that the pricing adviser, is well known and respected in the of the contracts is potentially unfair, espe- Islamic finance industry. The chief executive cially if the hedge fund manager is in a officer is Eric Meyer, who has long been monopoly position and the transactions are involved in hedge funds and Islamic finance. not conducted in an open market. The lack of Although the fund mainly generates income transparency with hedge fund transactions is from commodity trading, transportation and often criticized by financial commentators, no manufacturing have been identified as sectors matter their religious beliefs (if any). that can accommodate Islamic hedge funds. 144 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
Just over $250 million is invested in Shari‘ah oversight within a pre-established Cayman Capital’s fund, with institutional investors trust framework. The Al Safi Trust was from Saudi Arabia, the GCC, and Malaysia named Best Islamic Alternative Product at among the participants. Shari‘ah Capital’s the Hedge Funds World Middle East hedge fund trades in commodities such as oil, Conference in 2009. as well as in energy, mining, and natural In 2008, Shari‘ah Capital formed a joint resource stocks. venture, Dubai Shari‘ah Asset Management Investors in the fund buy securities (DSAM), with Dubai Commodity Asset instead of borrowing them, using arboun Management (DCAM), a wholly owned contracts to short the market to comply with division of DMCCA. DCAM, an investment the shari‘ah rule that one must own an asset company licensed by the United Arab to sell it. Using arboun, the fund manager Emirates central bank, develops and distrib- pays a deposit, which forms part of the pur- utes shari‘ah-compliant, commodity-linked chase price, to buy assets at a later date. investment products in the United Arab In the unlikely event that the sale does not Emirates. The first four hedge funds were proceed, the seller keeps the deposit and gets funded by DMCCA in 2008 and registered back the assets. on the Al Safi Trust platform. Two funds are Shari‘ah Capital’s Commodity Fund marketed under the DSAM Kauthar brand gained 41 percent in its first year, compared name as the DSAM Kauthar Gold Fund and with the Lipper Global Hedge/Long/Short the DSAM Kauthar Global Resources & equity index, which had a one-year return Mining Fund. that same year of 31 percent. Since then, The DSAM Kauthar funds have received returns have been more modest, reflecting numerous performance awards: the poor performance of hedge funds gener- • Barclay Hedge, an independent hedge fund ally, rather than shari‘ah constraints on trad- research organization with a database ing activity. As the U.S. economy rebounded of over 5,800 hedge funds, consistently after the global financial crisis, mutual funds ranked the DSAM Kauthar Gold Fund, often outperformed hedge funds. However, Ltd. in its Top Ten Metals and Mining the low level of investment in Shari‘ah hedge funds, based on its monthly perfor- Capital also reflected the uncertainty over mance results throughout 2009, 2010, and the legitimacy of arboun by many shari‘ah 2011. In both 2010 and 2011, the DSAM scholars. Islamic institutional investors tend Kauthar Gold Fund received the MENA to be conservative and concerned about their Fund Manager Award for outstanding reputations and client perceptions. Given this performance and innovation. context, it is not surprising that there was a • The DSAM Kauthar Energy Fund was reluctance to invest in structures as contro- ranked among the Barclay Hedge Top versial as Islamic hedge funds. Nevertheless, Ten Energy Funds for its performance in major shareholders include the Dubai Multi February 2011. Commodities Centre Authority (DMCCA), an agency of the Dubai government, which has a 5 percent stake in the fund. Real Estate Investments In 2007, Shari‘ah Capital jointly Exposure to real estate markets is correctly announced with Barclays Capital the devel- viewed as a real alternative to equities and opment of the Al Safi Trust, a comprehensive bonds, but it should be seen as a very long- shari‘ah-compliant platform for alternative term investment with a payback over decades investments. Designed as a “one-stop” plat- rather than months or even years (Faishal and form primarily for single strategy hedge Eng 2008). Such investments are well suited funds, Al Safi provides shari‘ah screening to the time horizon of pension funds, insur- and arboun sale solutions, along with prime ance companies, and other institutional inves- brokerage, administration, and trustee tors seeking rental yields, as well as long-term GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 145
capital gains, or at least inflation proofing. In conventional insurance offices; betting shops the case of Muslim-majority countries, most and casinos; manufacture or sale of non-h. alƗl pensions are paid by the state rather than pri- beverages and foodstuffs, such as alcohol or vate providers, and are often financed from pork products; tobacconists; and entertain- current revenues rather than long-term fund- ment venues of a morally dubious nature. ing. Family takƗful, the shari‘ah-compliant Where real estate with existing tenants is alternative to life insurance, remains in its acquired by the Islamic REIT manager, it infancy (see chapter 5). Hence institutional is recognized that some of the activities of investors are much less important than in the tenants may be h. arƗm. Such activities do developed markets. The main potential insti- not preclude the acquisition of the property, tutional sources for Islamic real estate invest- provided they do not account for more than ment are the semiautonomous sovereign 20 percent of the rental income. However, wealth funds, none of which is managed on a as tenancies are renewed, only shari‘ah- shari‘ah-compliant basis (Jen 2009). compliant activities are permissible, with The means of obtaining exposure to real tenancies such as betting shops or alcohol estate markets are also diverse, with direct retailers obliged to close or move elsewhere. investment in commercial and residential The properties should be insured with a property and indirect exposure through takƗful operator; existing conventional investment in construction and real estate building insurance contracts should not be development companies. REITs are an renewed when they expire. Cash holdings of increasingly popular asset class, including Islamic REITs should be deposited in an Islamic REITs, which have been pioneered Islamic bank. in Malaysia (Newell and Osmadi 2009). Malaysia has 14 REITs, of which 3 are Case Study: Al Salam REIT shari‘ah compliant. Each specializes in a different asset subclass. For example, Al Malaysia’s Johor Corporation, a state invest- Hadharah specializes in oil palm planta- ment firm, launched the Al-Salam REIT in tions. Another, specializing in office build- June 2015. It has subsequently been listed ings and industrial properties, was formed on the Kuala Lumpur stock exchange.6 Its by the conversion of a conventional REIT. mandate is to focus on shari‘ah-compliant Real estate investments are inherently illiq- diversified assets, including, but not limited uid, but the attraction of REITs is that the to, commercial retail, office, and industrial funds can be redeemed at any time, as they assets. It raised RM 900 million ($253.24 are listed in a market. Therefore, they repre- million), which is funding real estate proj- sent financial vehicles rather than invest- ects in Johor, the port city and development ments in buildings. The disadvantage is that zone on the Malay Peninsula across the the prices are more correlated with other straits from Singapore. The REIT already market instruments, especially equities, than owns 31 assets, including a chain of direct investments in commercial and resi- Kentucky Fried Chicken and Pizza Hut res- dential property, because when stock taurants, as well as industrial assets. The markets are performing well, investors have REIT manager, Damansara Sdn. Berhad more spare cash to invest in REITs. (DRMSB), a Malaysian-based company, was In Malaysia, guidelines for Islamic REITs founded in 2005 and has considerable expe- were issued by the Shari‘ah Advisory Council rience, including management of the of the Securities Commission in November Al-‘Aqar Healthcare REIT, which was listed 2005.5 To ensure shari‘ah compliance, there on the Main Board of Bursa Malaysia on are restrictions on the purposes for which August 10, 2006. By 2014, the Al-‘Aqar investment properties can be used. The rentals Healthcare REIT had total assets under cannot be derived from h. arƗm activities. management amounting to RM 1.5 billion Prohibited tenancies include ribƗ-based banks; ($339 million). 146 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
Demand for Malaysian Islamic REITs has foodstuff industry. This industry has grown withstood a sluggish property market, as worldwide as the global Muslim population their steady rental income is popular with has increased and become more prosperous. pension funds amid a shortage of shari‘ah- Although h. alƗl foodstuff is traditionally asso- compliant assets. Returns for 2016 are pro- ciated with meat production, it extends to jected to be 6.3 percent, an attractive rental other sectors, including pharmaceuticals, and yield. Islamic lenders in Malaysia are facing a niche areas such as alcohol-free mouthwash. shortage of investing options, with worldwide In the past, most h. alƗl foodstuff production suknjk issuance down 28 percent in 2015. The was undertaken by small family businesses, Southeast Asian nation’s $1.5 billion global which did not seek external funding. This is Islamic bond sale in August 2015 drew more changing as major multinational corpora- than $9 billion of bids and was priced below tions get involved and as h. alƗl products are the initial target, reflecting demand for increasingly marketed and sold by supermar- shari‘ah-compliant instruments. ket groups, including those based in North There are only 3 listed Islamic REITs in America, Europe, and Japan. This brings new Asia, compared with 128 non-Islamic investment opportunities, although there is vehicles, according to data compiled by debate over whether mixed businesses are Bloomberg. Al-Salam REIT is targeted at legitimate destinations for shari‘ah-compliant investors or fund managers with long-term investment, or such investment should be investment objectives who seek regular channeled solely to enterprises that are stable income distribution and long-term exclusively h. alƗl. capital appreciation. Malaysia’s two shari‘ah Until recently, h. alƗl production was very REITs outperformed suknjk in 2014. The fragmented; there were no industry associa- Al-’Aqar Healthcare REIT, majority owned tions and no attempt to use the term h. alƗl as by Johor Corp., returned 11.7 sen a unit to a trademark or brand. The United Kingdom– shareholders, equivalent to a dividend yield based Muslim Food Board, which was of 8.4 percent based on its year-end closing established in 1992, was a pioneer in h. alƗl price. Axis REIT paid out a quarterly aver- certification.8 Approved producers can use age dividend of 4.94 sen a unit last year, or their registered logo for advertising pur- an annual yield of 5.5 percent. The third poses. The organization provides ongoing Islamic REIT in Asia, Singapore’s Sabana monitoring after certification to reassure Shari‘ah-compliant Industrial REIT, was less Muslim consumers, as well as training for successful. It declined 10 percent in 2015, those employed in the industry. Similar orga- while the city-state’s benchmark stock index nizations providing certification are found in rose 2.2 percent. Australia and North America, but their The falling prices are unlikely to dent the absence in most Muslim-majority countries popularity of Islamic REITs due to the amount largely reflects the inadequate legal environ- of funds that need to be invested in a shari‘ah- ment for trademark protection. Such protec- compliant manner. Malaysian Islamic banking tion is as important for investors as for assets climbed 12 percent to RM 625.2 billion consumers. ($141.4 billion) in 2014, central bank data Malaysia has had more initiatives in h. alƗl show. That represents almost half of the $300 activities than most Muslim-majority billion of outstanding suknjk worldwide, countries. In 2014, the SME Bank announced according to figures from the Malaysia it was allocating another RM 200 million International Islamic Financial Centre.7 ($45.4 million) under its H. alƗl Industry Fund, which is available for SMEs to add value or improve their halƗl products.9 The initiative Hala¯l . Investment in ̙ Foodstuff was made in collaboration with strategic An obvious destination for shari‘ah- partners, including the Islamic Development compliant alternative investment is the h. alƗl Bank (IDB), the Malaysia External Trade GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 147
Development Corporation, and the H. alƗl business in the Middle East. The value of the Industry Development Corporation, as well h. alƗl food sector is almost V700 billion annu- as the Young Entrepreneur Fund (YEF), ally. The nonfood sector is even bigger and which helps youths ages 18–30 years venture includes chemicals, health care, cosmetics, into entrepreneurship. The SME Bank is personal care, and pharmaceuticals. The open for investment from GCC countries, Expo also stressed the shari‘ah-compliant and the involvement of the Jeddah-based services available in the h. alƗl cluster, which IDB gives assurance to these investors. Most include banking and finance, logistics, ware- of the SMEs are involved in the distribution housing, and distribution. and sale of h. alƗl produce rather than pro- duction, apart from fields such as poultry production, where there is a local industry. Investment in Traded Commodities Much of the cattle and mutton originates in Despite the dramatic fall in commodity Australia and New Zealand, where h. alƗl prices in 2014 and 2015 with the slowing in producers welcome investment from China’s economic growth, commodities are consuming nations. still regarded as a potentially worthwhile alternative investment asset (Tang and Xiong 2012). From an Islamic finance perspective, Case Study: Hala̙ ¯l Cluster in Dubai Industrial City commodities are regarded as tangible assets rather than simply as financial instruments. To cater to the growing demand for h. alƗl The buying, holding, and selling of produce, the United Arab Emirates govern- commodities are viewed as useful service ment has established a h. alƗl cluster on a site activities that justify the earning of profits. comprising 6.7 million square feet in Dubai Historically, many of the great capitals of Industrial City.10 The cluster is designated for the Islamic world thrived as trading centers, firms dealing in h. alƗl food, cosmetics, and with the buying and selling of metals and personal care items. An emerging industry of agricultural commodities handled by special- h. alƗl certification has been created to attempt ist brokers on behalf of wealthy investors to verify any issues that may arise when con- (Kathirithamby-Wells 1986). sidering the true definition of “h. alƗl” prod- As modern Islamic banking emerged in ucts. The methods for discovering h. arƗm the 1970s, murƗbahah transactions took off, impurities in products are rapidly improving. with the Islamic financial institution purchas- These days, the types of animals that the raw ing commodities on behalf of clients who materials are derived from can be identified agree to repay the institution with a deferred using polymerase chain reaction (PCR), lump sum or through installments (Dusuki which greatly improves the potential for h. alƗl 2007). The Islamic bank charges a markup integrity, allowing the development of h. alƗl for this service, which clients are willing to supply chains and product tracking. pay, as they have insufficient funds to buy the The h. alƗl cluster has been promoted at the commodity until they arrange their financial annual H. alƗl Expo held in Dubai, now a well- affairs or receive payments from business established business-to-business event.11 The partners. Islamic banks can also arrange seventh Expo was held in Dubai in September commodity financing through salam and 2015, with the promoters stressing the huge arboun contracts. With salam, the bank pays potential that the global $2.3 trillion h. alƗl in advance the full amount for a commodity market has to offer. The Expo has proved to to be delivered at a future date. The bank be a high-impact business platform to can- will not be speculating on the future price, as vass the lucrative business opportunities that it will usually have a client or clients lined up the global h. alƗl market presents and cater to who have already agreed to purchase the the needs of the h. alƗl producers, traders, and commodity from the bank at a slightly higher business leaders looking to expand their price, to cover the bank’s financing costs. 148 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
These clients prefer to purchase from the Project Finance bank for a known fixed price, rather than Alternative financing can contribute to proj- purchasing through a commodity market at ect finance. Although such financing used to a future unknown spot price. be largely undertaken by governments, there Similar considerations arise with arboun, have been many initiatives to encourage pri- but under these contracts the Islamic financial vate sector involvement since the 1980s institutions pay only a deposit for a commod- (Brealey, Cooper, and Habib 1996). Most of ity that is to be delivered at a future date for a these initiatives have been aimed at diversi- fixed price, rather than paying the full amount fying the sources for long-term project in advance. As discussed, an arboun agreement finance rather than changing the methods, as resembles an option contract, but it is usually the financing largely involved syndicating exercised, rather than left simply to expire as debt rather than alternative financing such with derivatives contracts, which are used for as private equity (Kleimeier and Megginson gambles on spot and futures prices. 2000). Islamic financial institutions can also participate in syndicated funding with the Case Study: Jadwa Saudi Riyal money raised by issuing suknjk, rather than Mura¯bahah Fund bonds paying interest. The IDB, for example, has regular suknjk issuances to fund its proj- Riyadh-based Jadwa was incorporated on ect financing, and given its Aaa rating by August 21, 2006, with paid-in capital of Moody’s, the cost of its capital is very low SRl 500 million ($133 million), when the (Moody’s Investors Services 2014). Capital Markets Authority (CMA) of Saudi IstiVn̙ Ɨ‘ is regarded as a particularly useful Arabia granted the company all five licenses method for providing project finance, as it is to operate as a full service shari‘ah-compliant widely favored by Islamic scholars as suit- investment bank in the Kingdom under able for paying for manufacturing supplies license number 37-6034. Jadwa offers wide- (Zarqa 1997). Most Islamic finance is used ranging investment services that support both to pay for assets that already exist, but with individual and institutional clients. Jadwa is a projects, it often takes several years for facil- comprehensive financial services firm with a ities to be constructed. For investors, istiVn̙ Ɨ‘ proven track record in asset management, provides a steady long-term income stream financial advisory, and mergers and acquisi- 12 once the project is completed, but they may tions, as well as researched brokerage. have to wait two years or longer until the Designed for low-risk investment in local first income is received. Such assets are currency, the Jadwa Saudi Riyal MurƗbahah attractive for managers of pension funds and Fund mirrors certificates of deposits in terms takƗful providers, especially for family of investment strategy and easy liquidity, but takƗful, the shari‘ah-compliant alternative to in compliance with shari‘ah guidelines. Jadwa conventional life insurance. There is an ele- places the trades with banks in a shari‘ah- ment of risk sharing in istiVn̙ Ɨ‘ contracts, as compliant manner in short-term murƗbahah the completion of projects is often delayed; contracts, usually for 30 or 90 days. The fund hence it is important to spell out clearly the aims to attract retail investors with a mini- protection for investors, while allowing some mum initial subscription of SRl 50,000 flexibility for contingencies. ($13,332) and a minimum additional sub- scription or redemption of SR1 25,000. The Case Study: The Islamic Development fund is valued on a daily basis and charges a Bank’s Funding for Electricity in Rural management fee of 0.5 percent annually. Mozambique The fund was first established on June 30, 2007, and has a track record of yielding The Cahora Bassa dam generates most of modest returns while maintaining the value Mozambique’s electricity, but the northern of investors’ capital.13 province of Cabo Delgardo had no GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 149
TABLE 7.2 Funding of Phase III Electricity Project in Rural Mozambique
Finance Percentage of Agency Purpose ($ million) total funding IDB 9.49 32 248 km subtransmission lines Arab Bank for Economic Development 9.00 31 95 km transmission line in Africa (BADEA) European Union 5.99 20 194 km subtransmission line Government of Mozambique 4.85 17 Joint financing with each donor Source: IDB Success Story Series, No. 22, June 2015. Note: km = kilometers.
distribution network. The construction of the the less affluent arguably weak—if they network was a long-term project scheduled as exist at all. Private equity finance is more three phases from 1999 to 2013. The IDB has positive from a developmental perspective, been involved since the start. The third phase, but it tends to be concentrated in higher- implemented from 2009 to 2013, is an espe- income countries, as opportunities in low- cially successful example of syndicated funding income economies are less easy to identify involving the IDB and other international and support. The World Bank vision of agencies, as table 7.2 shows. shared prosperity is commendable, but the The benefits from the Cabo Delgado challenge of building the physical infra- electrification were not only to house- structure and developing human resources holds but also to businesses and the wider to achieve this goal is enormous (Badré economy. The former diesel generators were 2015). There is a question of causation: unreliable and expensive to maintain. With What comes first? Does the accumulation reliable electricity supplies, businesses of alternative assets facilitate economic can stay open longer and use modern equip- development, or vice versa? ment, including air conditioners, computers, When alternative investment is under- photocopiers, refrigerators, and freezers. taken using shari‘ah-compliant contracts, Employment opportunities have been this helps ensure that there are outcomes enhanced, as businesses have flourished and that contribute to shared prosperity. From the local inhabitants have been more willing an Islamic perspective, economic develop- to stay in the region than move. Many regard ment should be socially inclusive, which all being able to recharge mobile phones cheaply too often is not the case in practice. Islamic and easily as a significant benefit. alternative investment contracts should be transparent. It is the responsibility of the religious scholars vetting the contracts to Alternative Assets and Economic ensure there is no element of gharar, defined Development in classical Islamic jurisprudence as con- Although project finance directly contrib- tractual uncertainty or ambiguity that utes to economic development, the link favors one party at the expense of the other with other alternative investments is less (El-Gamal 2001). The prohibition of gharar robust. For example, the link between is more important today than ever, espe- hedge fund investments involving financial cially given the complexity of the contracts speculation and wider development is for alternative investments. There is consid- doubtful. Such investments often benefit erable potential for fund managers to the rich and contribute to income inequali- exploit investors who are locked in ties, with so-called trickle-down effects to (Al-Suwailem 1999). 150 ALTERNATIVE ASSET CLASSES GLOBAL REPORT ON ISLAMIC FINANCE
Regulatory Implications and Policy which has issued fatƗwá on many Islamic Responses for Alternative Investments financing contracts, but not specifically on 16 As alternative investments are a diverse asset alternative investments. The shari‘ah schol- class, there are no all-embracing regulations ars advising securities regulators also have a or guidelines that can be simply applied. role to play—although at present only the Usually alternative investments are under the Securities Commission in Kuala Lumpur has a remit of securities or capital market regula- formal shari‘ah board. It has produced a joint tors where such institutions exist, rather than report on Islamic capital markets in collabora- being the responsibility of central banks. tion with another institution based in Kuala Lumpur, the International Shari‘ah Research Within the Islamic world, the Malaysian 17 Securities Commission and the CMA of Saudi Academy (ISRA). A similar joint initiative in Arabia have played leading roles in identify- the field of Islamic alternative asset classes ing the issues that arise with alternative would be welcomed by the Islamic finance investments. The Kuala Lumpur–based community around the world. Islamic Financial Services Board (IFSB) has not yet issued any standards specifically on Notes alternative investments, as it focuses more on Islamic banking and takƗful, although it has 1. http://www.alkhabeer.com/. published Guiding Principles for Islamic 2. Authorized person is a registered fund, regu- Collective Investment Schemes.14 There is lated by the Capital Markets Authority of clearly a case for more comprehensive guid- Saudi Arabia. 3. Many airlines, for example, hedge their fuel ance on alternative investments by the IFSB, purchases so that they can control their costs. as it is the institution that includes regulatory 4. http://www.shariahcap.com/. authorities from the Organisation for Islamic 5. http://www.sc.com.my/guidelines-for-islamic Cooperation (OIC) States as its members. -real-estate-investment-trusts/. At the same time, it must be recognized 6. http://www.jcorp.com.my/reit-sector-107 that those involved in alternative invest- .aspx; http://www.bloomberg.com/profiles ments are normally sophisticated investors / companies/SALAM:MK-al-salam-real who do not need protection in the same way -estate-investment-trust. as retail investors. Many analysts urge so- 7. http://www.mifc.com/. called “light touch” regulation for alterna- 8. http://www.tmfb.net/about. tive investments, as this reduces transaction 9. http://www.freemalaysiatoday.com/category / business/2013/03/22/halal-industry-fund-for costs, which ultimately get passed on to -smes -to-improve-halal-products/. the investors. The European Union and 10. http://www.gulfood.com/Content/Dubai-gears the United Kingdom have relatively liberal -up-for-67million-sqft-Halal-Cluster. 15 directives on alternative investments. 11. http://www.worldhalalexpos.com/. Nevertheless, in the case of Islamic invest- 12. http://www.jadwa.com/en/article/about-jadwa ment, the shari‘ah oversight should not be /who-we-are.html. light touch; otherwise this might undermine 13. http://www.jadwa.com/en/fund/asset the credibility of the investments for the -management-products-and-services/mutual pious. There would be reputational risks to -funds /jadwa-saudi-riyal-murabaha-fund-1 the financial institutions offering such invest- .html. ments, and potential reputational damage to 14. http://www.ifsb.org/standard/ifsb6.pdf. 15. http://ec.europa.eu/finance/investment the scholars involved in approving the / alternative_investments/index_en.htm investments. #maincontentSec2; http://www.fca.org.uk Shari‘ah scholars working on Islamic /firms/markets/international-markets/aifmd. finance need to address the issue of the permis- 16. http://www.fiqhacademy.org.sa/. sibility of alternative asset classes more com- 17. http://www.sc.com.my/highlight/isra-and-sc prehensively. At the international level, this -launch-joint-publication-on-islamic-capital includes the OIC Islamic Fiqh Academy (IFA), -markets-principles-and-practices-2/. GLOBAL REPORT ON ISLAMIC FINANCE ALTERNATIVE ASSET CLASSES 151
References of Real Estate Portfolio Management 14 (4): 401–14. Ackermann, Carl, Richard McEnally, and David Ravenscraft. 1999. “The Performance of Hedge Jen, Stephen L. 2009. “How Big Could Sovereign Funds: Risk, Return, and Incentives.” Journal Wealth Funds Be by 2015?” Revue d’Economie of Finance 54 (3): 833–74. Financière (English edition) 9 (1): 195–98. Agarwal, Vikas, and Narayan Y. Naik. 2004. “Risks Karake-Shalhoub, Zeinab. 2008. “Private Equity, and Portfolio Decisions Involving Hedge Funds.” Islamic Finance, and Sovereign Wealth Funds in Review of Financial Studies 17 (1): 63–98. the MENA Region.” Thunderbird International Business Review 50 (6): 359–68. Al-Suwailem, Sami. 1999. “Towards an Objective Measure of Gharar in Exchange.” Journal of Kathirithamby-Wells, Jeyamalar. 1986. “The Islamic Islamic Economic Studies 7: 61–102. City: Melaka to Jogjakarta, c. 1500–1800.” Modern Asian Studies 20 (02): 333–51. Archer, Simon, and Rifaat Ahmed Abdel Karim. 2006. “On Capital Structure, Risk Sharing and Kleimeier, Stefanie, and William L. Megginson. Capital Adequacy in Islamic Banks.” International 2000. “Are Project Finance Loans Different Journal of Theoretical and Applied Finance from Other Syndicated Credits?” Journal of 9 (03): 269–80. Applied Corporate Finance 13 (1): 75–87. Badré, Bertrand. 2015. Long-Term Finance for Infra- Mohamad, Saadiah, and Ali Tabatabaei. 2008. structure Essential to Ending Poverty. Washington, “Islamic Hedging: Gambling or Risk Manage- DC: World Bank. https://www . linkedin.com ment?” Paper presented at the 21st Australasian / pulse / long-term-finance-infrastructure-essential Finance and Banking Conference. Islamic Law -ending -poverty-badr %C3%A9. and Law of the Muslim World Paper No. 08-47, Sydney, December 16–18. Brealey, Richard A., Ian A. Cooper, and Michel A. Habib. 1996. “Using Project Finance to Fund Moody’s Investors Services. 2014. “Credit Analysis: Infrastructure Investments.” Journal of Applied Islamic Development Bank.” October 12. http:// Corporate Finance 9 (3): 25–39. www.isdb.org/irj/go/km/docs/documents /IDBDevelopments/Attachments/Capital%20 Chatti, Mohamed Ali, and Ouidad Yous. 2010. Market/RatingReportsMoodys14.pdf. “Islamic Private Equity.” Munich Personal RePEc Archive Paper 28705. http://mpra.ub.uni Newell, Graeme, and Atasya Osmadi. 2009. “The -muenchen.de/28705/. Development and Preliminary Performance Analysis of Islamic REITs in Malaysia.” Journal Choudhury, Masudul Alam. 2001. “Islamic Venture of Property Research 26 (4): 329–47. Capital–A Critical Examination.” Journal of Economic Studies 28 (1): 14–33. Schneeweis, Thomas, C. F. A. Hossein Kazemi, and George Martin. 2003. “Alternative Investments.” Dali, Nuradli Ridzwan Shah Mohd, and Sanep Journal of Alternative Investments 5 (4): 8–30. Ahmad. 2005. “A Review of Forward, Futures, and Options from the Shari‘ah Perspective: From Siegel, Laurence B. 2008. “Alternatives and Complexity to Simplicity.” Paper presented at the Liquidity: Will Spending and Capital Calls Eat Conference on Ekonomi and Kewangan Islam Your ‘Modern’ Portfolio?” The Journal of Bangi, Malaysia, August 29–30. Portfolio Management 35 (1): 103–14. Dusuki, Asyraf Wajdi. 2007. “Commodity MurƗbah.ah Tang, Ke, and Wei Xiong. 2012. “Index Investment Programme (CMP): An Innovative Approach to and the Financialization of Commodities.” Liquidity Management.” Journal of Islamic Financial Analysts Journal 68 (5): 54–74. Economics, Banking and Finance 3 (1): 1–23. Terhaar, Kevin, Renato Staub, and Brian D. Singer. ———. 2008. “Fiqh Issues in Short Selling as 2003. “Appropriate Policy Allocation for Alter- Implemented in the Islamic Capital Market in native Investments.” The Journal of Portfolio Malaysia.” Islamic Economics 21 (2): 63–78. Management 29 (3): 101–10. El-Gamal, Mahmoud A. 2001. “An Economic Wilson, Rodney. 2006. “Islam and Business.” Explication of the Prohibition of Gharar Thunderbird International Business Review in Classical Islamic Jurisprudence.” Islamic 48 (1): 109–23. Economic Studies 8 (2): 29–58. Zarqa, Muhammad Anas. 1997. “Istisna’a Financing Faishal, Muhammad, and Seow Eng. 2008. “Shari‘ah of Infrastructure Projects.” Islamic Economic Compliance in Real Estate Investment.” Journal Studies 4 (2): 69–70.
8 Islamic Social Finance
overty and financial exclusion go hand Philanthropy and benevolence occupy a Pin hand. Any attempt to enhance shared central position in the Islamic scheme of pov- prosperity and curb poverty must there- erty alleviation and redistributive justice. fore address the issue of financial exclusion. Islamic social finance comprises instruments The task may be more daunting in Muslim and institutional structures that are rooted in societies, where the poor may be excluding philanthropy. Their integration with for-profit themselves from the financial system because risk-sharing instruments may provide some of their faith and beliefs. As a 2007 survey key success factors while addressing some for the Consultative Group to Assist the Poor critical challenges. The broad instrument of (CGAP) concluded, “Islamic microfinance Islamic philanthropy is sadaq̙ Ɨt. When made has the potential to combine the Islamic social compulsory on well-to-do Muslims, Vadaq̙ Ɨt is called zak t. When adaq t results in flows principle of caring for the less fortunate with Ɨ V̙ Ɨ of benefits that are expected to be stable and microfinance’s power to provide financial permanent (such as through endowment of a access to the poor. Unlocking this potential physical property), it is called Vadaq̙ Ɨt jƗriyah could be the key to providing financial access or waqf. Contemporary Islamic economists to millions of Muslim poor who currently emphasize that a philanthropy-based inter- reject microfinance products that do not com- vention inherent in the institutions of zakƗt ply with Islamic law” (Nimrah, Tarazi, and and Vadaq̙ Ɨt could potentially take care of the Reille 2008, 1). Islamic social finance that basic needs of the extremely poor and the des- includes the provision of microfinance along titute and create a social safety net (Chapra with safety nets and social goods could be a 2008). A recent study that estimates the powerful tool to fight financial exclusion and potential zakƗt collection in member- poverty and enhance shared prosperity. countries of the Organisation of Islamic
GLOBAL REPORT ON ISLAMIC FINANCE 153 154 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
Cooperation (OIC) finds supporting evidence shari‘ah, to flow to the poor and the needy. By that 20 out of 39 OIC countries could actu- definition, it is a tool of redistribution of ally lift the extreme poor (those living on less wealth, transferring wealth from the rich to than $1.25 per day) above the poverty line the poor. Every Muslim individual who pos- simply through the collection and distribution sesses wealth beyond a prescribed minimum of zakƗt from domestic sources and remit- threshold is liable to contribute from his or tances (Moheildin and others 2012). her wealth. ZakƗt is levied on savings that The other institution of philanthropy— account for part of the wealth of an waqf, or Islamic endowment—is ideal for the individual. It is also levied on forms of wealth creation and preservation of assets that can that are characterized as stocks, such as gold, ensure flows of resources to provide education, silver, trade inventory, and livestock. ZakƗt is health care, and other social goods. Waqf may not levied on income that is used for con- also direct resources toward improving skills sumption, and items of wealth that are for and developing human resources through tech- personal and family use, such as a house or a nical assistance and capacity building. The car. It is also not levied on wealth that is cate- social safety net, technical assistance, and gorized as the means of production, or capital capacity building may then be linked to finan- goods. Thus the levy of zakƗt results in the cial assistance by helping to develop microen- transfer of wealth from the rich without terprises. Thus these Islamic financial adversely affecting their consumption or pro- institutions, by improving access to and the ductive investments.1 quality of education, health, and other social Islam stipulates conditions on the use of goods, can play a critical role in achieving the zakƗt funds and requires that funds must global goals of generating sufficient income- clearly flow only to specified categories of ben- earning opportunities and investing in people’s eficiaries.2 ZakƗt is primarily targeted to the development. These Islamic institutions can underprivileged and the excluded sections in also serve to protect the poor and vulnerable the society, such as the poorest of the poor, the against sudden risks of unemployment, hunger, needy, the destitute, and those in bondage or illness, drought, and other calamities. These overburdened with debt. These include indi- measures would greatly boost shared prosper- viduals with no means of livelihood or inade- ity, improving the welfare of the least well-off. quate income to meet basic necessities, such as The Islamic approach to poverty alleviation orphans, the sick, the disabled, and the home- is more inclusive than the conventional inter- less. ZakƗt is thus rightly seen as a safety net to ventions based on microcredit. It provides for take care of the basic necessities of life of those the basic conditions of sustainable and success- who cannot afford them. ful microfinance, blending wealth creation with ZakƗt funds must be clearly distinguished empathy for the poorest of the poor. It favors from funds in a treasury of an Islamic country models based on equity and cooperation, in that are pooled through taxes and State reve- contrast to mechanisms that tend to perpetuate nues. ZakƗt cannot be used to finance infra- debt (Obaidullah and Khan 2007). The discus- structure projects, public utilities, and services sion that follows briefly describes zakƗt and beneficial to all Muslims—the poor and the waqf as the key instruments of Islamic social rich—or to meet the administrative expendi- finance that help reduce extreme poverty and tures of the State. ZakƗt funds may, however, boost shared prosperity. It presents brief case be used to defray the operational costs of man- studies to highlight alternative models of inter- aging a zakƗt organization, in the form of vention that utilize Islamic social finance. wages and salaries of zakƗt personnel. This provision aims to maintain the integrity and independence of collection and disbursement The Redistributive Role of Zak¯at of zakƗt funds (Obaidullah 2012). ZakƗt is a compulsory annual levy on the The primary objective of zakƗt is to provide wealth of the rich that is directed by the a safety net for all Muslims by providing for GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 155
basic needs. Basic needs by definition are recur- otherwise—remains unaffordable to the ring in nature. Some Islamic scholars thus poorest of the poor. The cost of microcredit argue that zakƗt proceeds should be used for remains high because of the high operational economic empowerment and not simply to costs involved. Even where the Islamic micro- meet immediate consumption needs—which finance provider seeks to recover only the could encourage dependence and make the actual cost of financing from the borrower poor permanently dependent on zakƗt. In their without any profit element, in conformity zeal to bring about economic empowerment, with shari‘ah, the very poor are likely to find proponents often tend to undertake large it unaffordable. The extreme vulnerability of investments in education, health care, and this segment of society makes them reluctant other social welfare projects (which benefit the to opt for such loans. As a solution, a model poor, the not-so-poor, and even the well-to-do) combining zakƗt and Vadaq̙ Ɨt funds may be or engage in financing of microenterprises. used to cover part of the operational costs in Although worthy, such expenditures may a sustainable manner and make the credit result in a drying up of funds to meet the affordable to the poor. immediate consumption needs of the poorest The model envisages provision of revolv- of the poor. ing credit through qarG̙ K̙asan loans out of Economic empowerment and meeting basic pooled Vadaq̙ Ɨt and zakƗt proceeds. It is a consumption needs should not be mutually departure from the traditional approach of exclusive. In any program of economic empow- making grants out of zakƗt funds to the poor. erment through zakƗt, satisfying the immediate Creating a credit pool ensures that the fund is basic needs of the poorest of the poor must automatically replenished every time loans always be accorded top priority. In a subse- are repaid. The outcome is a sustainable quent phase, zakƗt funds can finance education shari‘ah-compliant financial service provider and training so the poor can gain the skills and for the poor. human capital to be more self-sufficient.Zak Ɨt An excellent example of this model is the funds may also be provided as start-up capital Akhuwat scheme, based in Pakistan (box 8.1). for the poor for their business activities, The key elements of the Akhuwat strategy are accepted either in the form of outright grants as follows. The first is to bring down the oper- or loans (qarG ̙ Kasan̙ ) or micro-equity without ational cost of providing microcredit to the expectation of returns, depending upon the poor by drawing on volunteers and other degree of their vulnerability. This would enable means (such as use of places of worship for the poor to generate a sustainable means of credit delivery). The second is to mobilize char- livelihood and transform them from zakƗt itable funds on a sustained basis to absorb the recipients into zakƗt payers. Such ambitious operational costs, which are now much lower. poverty alleviation and economic empower- As a result, the costs of loans have not just ment projects, through efficient collection and been brought down—they have been brought distribution of zakƗt, can be undertaken by the down to zero. State or a not-for-profit organization funded The model is not without its critics, who with zakƗt. At the same time, the use of zakƗt feel that the poor should be provided grants funds for the provision of microfinance raises and not loans. The provision of microcredit several important issues. may violate the very essence of zakƗt: of pull- ing an individual out of indebtedness. Proponents defend the Akhuwat model on the Low-Cost Microcredit with Sadaq¯ҕ at and Zak¯at grounds that the amount of zakƗt funds mobi- lized in contemporary Muslim societies may A critical issue for conventional micro- be grossly inadequate if given as grants. As credit and its Islamic equivalent relates to loans from a revolving pool, a given amount the pricing of the finance. In general, of zakƗt can serve a much larger number of microcredit—whether shari‘ah compliant or beneficiaries. 156 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
BOX 8.1 Case 1. Revolving Credit out of Pooled Sadaqa¯ t and Zaka¯t Proceeds: Akhuwat, Pakistan
From modest beginnings in 2001 (with an initial charitable contributions from its donors. To cut transaction of PRs 10,000 funded through a single costs, Akhuwat delivers credit and manages the pro- donation), Akhuwat has steadily expanded and cess at places of worship, and draws on volunteers, now has 350 branches in 250 cities and towns in including for its top staff. The CEO and the top Pakistan. With a beneficiary-to-staff ratio of 475 to 1, management and about one-third of Akhuwat staff Akhuwat serves 953,933 beneficiaries with a total work voluntarily without any remuneration. staff of 2,007 as of June 30, 2015. It had about PRs Akhuwat also seeks to minimize its personnel costs 4.8 billion in outstanding loans as of June 30, 2015, by recruiting staff from the same communities as with total disbursements of about PRs 16.3 billion to their borrowers, and not hiring highly qualified pro- date, and an impressive recovery rate of 99.9 percent fessionals. The organization has made minimal in the same period. investments in office assets. It owns no vehicles. Its Drawing on a credit pool established through staff sits on the floor, as do its clients. It has found a philanthropic donations, Akhuwat makes small way to do business with the poor that keeps costs to loans (qarG ̙ Kasan̙ ) to the poor. The credit pool is in bare minimum. As a result, its operating costs as a the nature of a revolving fund that is continuously percentage of loan amount disbursed have consis- depleted with the disbursal of loans, and replen- tently been in the range of 8–12 percent of amount ished and enhanced as they are repaid and new disbursed, and they fell to 5 percent in 2015. donations are received. Akhuwat uses a simple loan Akhuwat seeks to mitigate credit risk using an product that is free from any element of profit. innovative combination of credit delivery at places Loans are made to start or expand businesses or to of worship and personal guarantees. Using places meet social needs that are ultimately aimed at of worship for loan disbursement significantly increasing the income of poor and improving the reduces the probability that borrowers will break quality of their lives. The loan size is small and is their commitment to repay their loans on time. In based on the borrower’s need and repayment per- addition, borrowers need to bring two other guar- formance. The loan amount may be increased in antors to cosign their loans. The guarantors may subsequent cycles, but only up to a predetermined not be from the borrower’s household, and may maximum. Akhuwat actively discourages the per- not have high net worth, but should have high petuation of debt, unlike conventional microcredit. moral character, displaying piety and trustworthi- More than 90 percent of Akhuwat borrowers have ness and willingness to assist the borrower in times incomes of less than $70 a month, thus belonging of adversity. This mechanism effectively replaces to the poorest of the poor. Akhuwat also provides a the group guarantee. Extending the loan to the small percentage of loans to the moderately poor entire family, rather than the individual, also who are economically active as microentrepre- ensures that the entire family is the guarantor and neurs. Akhuwat provides family loans targeting the beneficiary. entire households instead of individuals. The transformation of borrowers into donors Initially, Akhuwat worked on cost recovery basis, has become an important component of with 5 percent of the loan amount termed as the Akhuwat’s strategy for the future. Past borrowers administrative fee, without charging any markup or have increasingly sought to donate to Akhuwat. fee to microenterprises. The sustained growth in Such donations now are a significant pool and charitable contributions and special donations from cover over one-third of Akhuwat’s total operating borrowers has enabled Akhuwat to absorb all costs costs. and make all loans entirely costless. Akhuwat has also consistently worked to minimize its operational Source: Personal interviews and information collected from the organization by the costs so that these could be easily absorbed by authors. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 157
Community-Driven Development with in support of community-identified activities Sadaq¯ҕ at and Zak¯at over the course of a CDD program—yet the full development of the community will require An alternative approach to poverty alleviation much more than these few grants. To sustain that is of more recent origin than the main- local initiatives, an ongoing grant funding stream microfinance models is the community- mechanism is needed. A zakƗt-funded CDD driven development (CDD) approach. CDD is program can meet this need, since zakƗt, by a grant-based intervention. It approaches the definition, involves recurring annual flows. poor as partners in the development process, However, any arrangement that pools zakƗt rather than as mere recipients, and builds on funds to be used for a common good or collec- their institutions and resources. Its key tive benefit must resolve ownership issues. elements include the following: A key principle of shari‘ah relating to disburse- • Focus on communities and/or community ment of zakƗt is tamleek, which translates as groups the “transfer of ownership” of zakƗt. The norm • Inclusive and participatory decision-making requires the poor and the needy (eligible bene- processes ficiaries) to be made owners of zakƗt or zakƗt- • Direct transfer of resources to the funded assets. As such, zakƗt-funded collective community enterprises are allowed only when these are • Community involvement in implementing fully owned only by the poor. Shari‘ah scholars subprojects rule out the possibility of financing broad • Community involvement in monitoring development projects with zakƗt funds that and oversight. may benefit both the well-to-do and the poor. While this restriction on development projects While CDD has been quite effective as an in the nature of social goods, such as schools intervention, its fundamental weakness has and hospitals, appears to be severe, a novel been the absence of a sustained grant-funding experiment by the Indonesian nongovernmen- mechanism. Even in the most effective of CDD tal organization (NGO) Dompet Duafa programs, participating poor communities Republika seems to be providing a solution may expect to receive from one to three grants that is both sustainable and practical (box 8.2).
BOX 8.2 Case 2. Community-Driven Development: Dompet Dhuafa Republika, Indonesia
Dompet Dhuafa Republika (DDR) is a philanthropic the long-term need of the poor is economic and institution that helps the poor using donated assets, social self-reliance, DDR seeks to enhance the utili- including zakƗt, Vadaq̙ Ɨt, and waqf, from individuals, zation of zakƗt for community empowerment groups, companies, or institutions. The funds dedi- programs. cated to economic empowerment programs average These programs focus on promoting self-reliant around 10 percent of total zakƗt resources available. communities, enhancing health, and encouraging The low dedication is attributable to apparent organic farming and livestock development. Like shari‘ah objections by some scholars, who emphasize Akhuwat in Pakistan (box 8.1), DDR extends the utilization of zakƗt for consumption alone in the interest- free loan financing to groups from a pool short term. In the face of a growing realization that created out of zakƗt funds. The distinguishing fea- an emphasis on meeting short-term needs may lead ture of this model is the phased building of self- to a dependency syndrome among the poor, and that reliant communities and the creation of a community
box continues next page 158 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
BOX 8.2 Case 2. Community-Driven Development: Dompet Dhuafa Republika, Indonesia (continued)
organization that will continue to provide financing The program provides the following services to its to the members. beneficiaries: To ensure full shari‘ah compliance as well as the • Developing human resources through training efficiency and effectiveness of the intervention, the programs, workshops, and meetings among model follows clearly defined criteria to identify its members. target region and beneficiaries. A rural region tar- • Developing institutions with proper documen- geted for the program should have comparative tation of standard operating procedures, so advantages in specific commodities or produce; natu- each organization or group can be commonly ral resources that can be accessed by the poor; and monitored. available human resources in both quality and quan- • Providing capital to local businesses through tity. It also should not be experiencing or exposed to group-based credit and self-help savings. conflicts or have a high potential for conflict. • Providing business development services to The program has the following key components: improve production methods. • Awareness building. It helps the community iden- • Developing markets by sharing information about tify its problems and its potential under the business opportunities, and building networks and assumption that the community itself has the synergies. ability to solve its problems. The program has a clear termination and exit • Organization. It generates self-help groups as the strategy. It withdraws from the region and the pro- way to give voice and authority to those groups gram comes to an end as soon as the community cad- and helps form a local organization through com- res are ready to take part in maintaining the program’s munity initiative. financial and institutional sustainability. It ensures • Building of local support. It prepares a local cadre that a community-based organization is a legal entity that will develop local self-help and will take over with adequate capacity to sustain cooperation among the “hand-holding” role once the program ends. all stakeholders. From a shari‘ah perspective, this • Technical support. It provides technical training ensures that the tamleek condition of zakƗt is com- based on locally available and appropriate plied with, since the poor beneficiaries ultimately technology. become the owners of the local organization in a col- • Partnership. The local community figures out lective sense, with the transfer of assets from the pro- what can be implemented and what support will gram to the local organization. Thus the fact that they be needed from the program. The community are borrowers in the first instance does not appear to establishes cooperation based on specific roles for violate the tamleek requirement. each stakeholder, based on mutual trust and transparency. Source: Personal interviews and information collected from the organization by the authors.
Guarantee Fund with Zak¯at for-profit Islamic financial institutions can undertake the direct financing. The guaran- As some scholars point out, there is a large tee can encourage institutions that have gap between the potential and actual real- been reluctant to finance microenterprises ization of zakƗt—for many reasons. Thus because of the high perceived default risk to there is a need to leverage the use of such extend financing, backed by the guarantee. funds. A zakƗt fund can be used to provide Given that the observed default rate in a guarantee for microfinance, while other GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 159
BOX 8.3 Case 3. A Zaka¯t Fund: Al-Aman Microfinance Fund, Sudan
The microfinance program (IRADA) of the Bank of organized manner, a security portfolio of Khartoum (BoK) was established in 2009 with the SD 200 million was created. Diwan ZakƗt contrib- support and assistance from the Jeddah-based Islamic uted 25 percent, and the banks contributed the rest. Development Bank. IRADA was given the mandate to The portfolio covers all productive sectors (commer- implement the SD 200 million Al-Aman Fund for cial, agricultural, and vocational) across Sudan. It Microfinance. The fund was formed in a strategic provides insurance to the program against genuine partnership between the apex body of zakƗt manage- defaults by clients at the second level. At the first ment in Sudan, Diwan ZakƗt, and 32 Sudanese com- level, the default is covered by individual personal mercial banks. guarantor(s) brought in by the client.
In perhaps the first documented example of utili- Source: Personal interviews and information collected from the organization by the zation of zakƗt for al-ghƗrimƯn (the indebted) in an authors.
many microfinance operations is Yet the potential of waqf remains largely 3–5 percent, the fund may back 20–30 times untapped. Thus there is an urgent need to as many microentrepreneurs. The 3–5 revise the existing inefficient laws to create percent of microentrepreneurs facing default an enabling legal and regulatory frame- will be able to avoid insolvency with the work. The welcome developments in knowl- help of zakƗt funds. A guarantee fund could edge pertaining to waqf (including cover all those who are indebted, both poor reinterpretations of fiqh rules based on con- and not-so-poor. A pioneer of this model of temporary conditions) can yield very posi- intervention is the Al-Aman Microfinance tive results in developing the waqf sector if Fund in Sudan (box 8.3). national laws change to convert the possi- bilities into realities. Contemporary devel- opments in the Islamic financial sector have Sustainable Provision of Social Goods also opened up many possibilities in terms through Waqf of new structures for financing the develop- Waqf is an important institution in the Islamic ment of waqf assets. economy. It is a perpetual endowment. Certain physical assets are held or set aside by Role of Waqf in Establishing Fair and the donor and preserved so that benefits flow Affordable Prices continuously to a specified group of beneficia- ries or a community.3 By providing a flow of The integration of waqf with the market has benefits on a sustained basis, waqf can thus yielded positive results in terms of providing serve as a mechanism to create and support microfinance, education, and health care at robust charitable institutions. It has a legal affordable prices to the poor and excluded. A identity separate from its manager and there- case in point is provision of health care by the fore is most suitable for creation of a sustain- Waqaf al-Noor, an innovative corporate waqf able entity, governed by the fundamental that was structured by the Johor Corporation principles of perpetuity, inalienability, and of Malaysia (box 8.4). irrevocability. By creating community assets, Waqf may also directly contribute to the it has the potential to address the education, success of Islamic microfinance experiments health care, and other social needs in Muslim to improve the economic lot of the poor. societies. Islamic economists have often sought to make 160 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
BOX 8.4 Case 4. Corporate Waqf: Johor Corporation’s Waqaf Al-Noor, Malaysia
Johor Corporation (JCorp) was established as a State allocated for reinvestment, as well as to fund Islamic investment corporation in 1968 in the state of Johor, CSR programs that are not restricted to Muslims as Malaysia. It is one of the country’s largest conglomer- beneficiaries. For instance, in 2009, WANCorp ates, with core business sectors encompassing palm received RM 4.9 million as dividends; of this, it allo- oils, foods and quick service restaurants, specialist cated 70 percent for reinvestment. It spent another health care services, hospitality, property, and logistic 25 percent of the dividends on various Islamic CSR services. initiatives, including the nationwide chain of charity As part of its corporate social responsibility Waqaf An-Nur clinics and hospitals to serve the (CSR) initiatives, JCorp has created nonprofit enti- health care needs of the poor of all ethnic groups. ties under its umbrella, called Amal Business Johor Islamic Religious Council is the beneficiary of Organizations (ABOs). They function as a medium the remaining 5 percent. for JCorp to contribute to the development of the A flagship initiative of WANCorp is to provide society through various aspects of charity, well- health care and dialysis services to the less fortunate being, and recreation, as well as entrepreneurship. In segments of the society through a full-fledged hospi- 2011, 27 ABOs were operating in four areas: social tal, Waqaf An-Nur Hospital, and 16 Waqaf An-Nur and public welfare development, entrepreneurship Clinics that it owns and manages. The clinics provide development, sports and recreation development, health services not only in Johor, but also in nearby and staff welfare. states, including Negeri Sembilan, Selangor, Perak, The innovative element of these initiatives is the and Sarawak, in cooperation with the respective establishment of a corporate waqf in the form of State Islamic Councils. The number of beneficiaries Waqaf An-Nur Corporation Berhad (WANCorp), a from these services has steadily increased from 0.56 limited liability company set up to guarantee proper million in 2009 to 0.77 million in 2011. About 6 per- management of Johor Corporation and Waqaf cent of the treatments are provided to non-Muslim An-Nur and the stocks and assets in the endowment. patients. Patients of Waqaf An-Nur clinics pay only WANCorp has entered into a memorandum of agree- RM 5 for treatment by a qualified doctor, plus the ment with the Johor Islamic Council, recognizing its cost of medicine prescribed. role in making a success of JCorp’s corporate waqf. Another program with high impact is the provi- WANCorp has consequently been endowed with sion of treatment for kidney ailments through dialy- powers of trusteeship and with the duty and obliga- sis centers that operate alongside these clinics. These tion to manage JCorp’s corporate waqf. centers offer subsidized dialysis treatments. For JCorp’s corporate waqf took off in 2006 when many patients, the cost is reduced to almost zero JCorp transferred RM 200 million (on a net asset with further financial support from other charities value basis) in public listed shares to WANCorp. (such as the Bayt al-mƗl Funds of state religious WANCorp’s main income is derived from the annual councils) that are part of the support network. dividend payout by the public listed companies (PLCs), part of whose equity is now endowed and Source: Personal interviews and information collected from the organization by the transferred to its ownership. These payouts are authors.
microfinance more affordable by suggesting as affordable for the poorest of the poor. an integration of zakƗt and/or waqf with Nowhere is this phenomenon better docu- microfinance. A cash waqf with returns dedi- mented than in Bangladesh, which is often cated to fully or partly absorb the cost of referred to as the “university of microfi- financial and nonfinancial services may be nance.” Fa’el Khair Waqf offers a real-life able to ensure that loans are offered at zero example of this exciting solution to poverty or low cost, making them interest-free as well and destitution (box 8.5). GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 161
BOX 8.5 Case 5. Using Waqf to Fund Microfinance: The Fa’el Khair Program, Bangladesh
The Fa’el Khair Program of the Islamic Development into the Fa’el Khair Waqf account. The Committee Bank was motivated by the urgent need to help the of MutawallƯs will then decide whether to renew victims of the Sidr cyclone, which devastated the agreements with the partner NGOs. southwestern coast of Bangladesh in November 2007, The NGOs together recruited and trained some resulting in loss of life and considerable damage in 30 774 staff and are operating through 80 field offices of the 64 districts of the country. Since cyclones are a in the areas most impacted by the cyclone. As of recurring phenomenon in the country, long-term January 2014, qard ̙ amounting to Tk 8 billion rehabilitation solutions were needed, as well as an (roughly $105 million) has been disbursed to immediate emergency response. The program has two 192,821 beneficiaries. This implies that the original main components: funding (amounting to $20 million) has been lever- aged more than five times. Theqar d ̙ repayment rate • The Fa’el Khair project, initially funded at $110 was as high as 99.75 percent. In addition, 196,710 million, supports the construction of several hun- beneficiaries were trained through 6,338 training dred schools that also serve as cyclone shelters in courses on agriculture, cattle rearing, and fishing the coastal belt of Bangladesh. and fish farming. • The Fa’el Khair microfinance program, initially In 2012, the NGOs were instructed to start funded at $20 million, provides urgent relief and implementing their exit plan by returning one-third support steps to restore the livelihoods of affected of the program funds to the Fa’el Khair Waqf. It was farmers, fishermen, and small businesses. It was then up to the Committee of MutawallƯs to decide registered as the Fa’el Khair Waqf under the provi- how to use the funds that were returned. They have sions of Waqf Ordinance 1962. been placed in Islamic investments that have gener- The second component initially aimed at provid- ated returns in the range of 10 percent a year. These ing urgent relief to the victims of the Sidr cyclone in proceeds are being used to cover the administrative the form of agricultural inputs and support for small costs of the Fa’el Khair Program. businesses. To implement the program, the Islamic The Fa’el Khair project provides an excellent Development Bank signed three-year (extendable) example of how a benevolent cash donation can be agreements with several nongovernmental organiza- used to engineer a waqf. It is also a rare example of tions (NGOs). The microfinance intervention pro- how the high administrative costs of a poverty alle- vides interest-free (qard)̙ microloans as well as viation program (with finance as well as skill training to the cyclone victims in order to help them enhancement inputs) may be absorbed by returns recover their losses and regain their livelihoods. generated by a waqf dedicated to poverty alleviation. When the agreement period of three years is over, Source: Personal interviews and information collected from the organization by the NGOs are to return the funds by depositing them authors.
Hybrid Models of Islamic Microfinance ZakƗt and waqf funds should be an integral part of any poverty alleviation initiative. First, Both zakƗt and waqf funds may be used to they provide for the immediate basic consump- support microfinance. While the zakƗt funds can be used immediately and on a one-to-one tion needs of the poorest of the poor, such as basis,4 the establishment of a portfolio with food, clothing, and shelter. As discussed, such waqf funds requires a larger initial amount of safety nets can be funded only through charity. resources because only the returns from Second, they support ways to impart or investing such resources may be used for strengthen appropriate skills so that the poor microfinance. are able to generate income on a sustained 162 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
basis without being dependent on charity. The monetary assets may be in the form ZakƗt and charity funds can also fund initia- of a cash waqf or simply as ordinary tives to impart these technical and entrepre- Vadaq̙ Ɨt. neurial skills. 3. The program carefully identifies the poor- So that the same individuals may move est of the poor and the destitute who are through several stages, from poverty to self- economically inactive and directs a part sufficiency, it is important to link safety nets of the zakƗt funds as a safety net to meet- with microfinance programs. While for-profit ing their basic needs. A revolving qard ̙ microfinance institutions (MFIs) are reluctant fund is created to provide emergency to invest in start-up equity, zakƗt and waqf credit. could fill the gap by providing micro-equity to 4. Skills training is provided to the econom- enterprises set up by the poor. ically inactive, using the revenue from Often, individuals borrow funds from community-held physical assets under MFIs to meet emergency needs relating to waqf. health, education, and social obligations 5. Beneficiaries graduate with improved such as weddings and funerals. Further, the skills and managerial acumen. The recur- gains people may achieve through a growing ring costs of the training programs are business could easily be set back by a catas- borne by the zakƗt fund. trophe such as a tsunami or even smaller 6. Beneficiaries are formed into groups with risks at a household or personal level. What mutual guarantees under the concept of is needed is a way to finance productive kafƗlah.5 activities as well as to meet contingencies 7. Financing is provided using a combina- and emergencies. While a revolving qard̙ tion of for-profit debt-based modes, such al-h̙asan fund based on zakƗt may not be an as bay‘ mu’ajjal, ijƗrah, salam, istiVn̙ Ɨ‘, ideal solution for developing microenter- and istijrƗr, or equity-based modes, such prises, it may be ideal to provide emergency as mud̙Ɨrabah, mushƗrakah, or dimin- credit. Since individuals burdened with debt ishing mushƗrakah (see the glossary for constitute eligible recipients of zakƗt, it may definitions). also be used to create guarantee funds that 8. Group members pay back their debt leverage its use for provision of finance to or meet the expectations of equity pro- greater numbers of people who suddenly viders and, in turn, are provided with must take on debt. Finally, zakƗt along with greater amounts of financing. Vadaq̙ Ɨt and waqf may be used to establish 9. Guarantee against default by the group microtakƗful projects for the poor and the is provided by the zakƗt fund, and actual vulnerable (see chapter 6). defaulting accounts are paid off with Given these considerations, a hybrid model zakƗt funds; this is the distinct feature of of Islamic microfinance is presented that can this model. lead to economic empowerment in a compre- 10. Group members are encouraged to hensive manner. ZakƗt plays an important role save under appropriate microsavings in the model and is integrated with Vadaq̙ Ɨt, schemes. waqf, and various nonprofit and for-profit 11. Group members are encouraged to form modes of Islamic finance. The model encom- a takƗful fund to provide microinsur- passes 11 activities: ance against unforeseen risks and uncer- tainties resulting from loss of livelihood 1. A zakƗt fund is created with contribu- or illness (see chapter 5). tions from the zakƗt payer (muzakkƯ). 2. A program is established to facilitate A few recent experiments in Islamic microfi- waqf of physical as well as monetary nance in Sudan use hybrid models of interven- assets. The physical assets are used to tion with components that are rooted in support education and skills training. benevolence, which may easily be replaced GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 163
with zakƗt or waqf. A good example is the Abu extreme poor and $2.00 a day for the rela- Halima MuG̙Ɨrabah Greenhouse Project in tively poor, which represents the mean of pov- Sudan, discussed in chapter 3 (box 3.1). erty lines found in the poorest 10–20 The various case studies clearly demonstrate countries ranked by per capita consumption.7 that the institutions of zakƗt and waqf can be This reflects the depth of poverty, as well as used to provide finances to the deprived and its incidence. The poverty gap index does not underprivileged, provide for their education explicitly provide the total income (consump- and health care, and create livelihood opportu- tion) shortfall. For this purpose, the estimated nities by enhancing skills and extending finan- poverty gap indexes based on international cial services. These have been made possible poverty lines of $1.25 a day and $2.00 a day, despite the many challenges and constraints, respectively, have been converted into per- notably the absence of an enabling environ- centages of gross domestic product (GDP) ment and supportive infrastructure. The sec- for selected countries. Table 8.1 shows the tions that follow highlight some good practices resource gap for sampled countries. The at the macro, meso, and micro levels in several resource gap is highest in Bangladesh, countries across the globe. If replicated, these Tanzania, India, and Pakistan and lowest in will go a long way toward strengthening the Malaysia and South Africa. institutions of zakƗt and waqf, enabling them to address the key problems they are meant to Estimating the Potential Resources from tackle, such as poverty, exclusion, and denial of Zak¯at opportunities, in a sustainable manner. The estimates for the zakƗt potential of Meeting the Resources Gap for Poverty the countries under study are based on three Alleviation different opinions of jurists regarding zakƗt and the method of calculating zakƗt liability, While poverty and deprivation is a global denoted as Z1, Z2, and Z3. Z1 is estimated phenomenon, the plight of Muslim societies is in accordance with the majority traditional particularly bad. The role of Islamic view—according to which zakƗt is levied philanthropy-driven funds, or what are called Islamic social funds, assumes great signifi- cance in countries with high levels of exclu- TABLE 8.1 Gap in Resources Needed to Alleviate Poverty sion and deprivation. This section seeks to Resource gap at $1.25 a Resource gap at $2.00 a estimate to what extent Islamic social funds Country may meet the resource requirements to allevi- day (percentage of GDP) day (percentage of GDP) ate deprivation for a sample of countries in Bangladesh 7.570 33.360 South and Southeast Asia and Sub-Saharan India, total population 2.390 12.590 Africa.6 It proceeds first by estimating the India, Muslim 0.344 1.813 resource gap and then discusses the potential population Islamic social funds that could be tapped to Indonesia 0.350 2.740 meet the resource gap. Malaysia None 0.020 Pakistan 1.620 13.350 Estimating the Resource Gap Kenya 0.320 0.960 The resource gap has been estimated by using Nigeria 1.470 3.500 the poverty gap index, which is defined as the South Africa 0.001 0.010 mean shortfall below the poverty line, expressed as a percentage of the poverty line. Sudan 0.490 2.200 The World Bank has used the recently Tanzania 3.020 8.170 updated poverty lines of $1.25 a day in 2005 Sources: Global Islamic Finance Development Center calculations, based on Obaidullah and others 2014; purchasing power parity (PPP) terms for the Obaidullah and Shirazi 2015. 164 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
on agriculture, livestock, stock-in-trade, gold, of GDP). The potential is low for South Africa, silver, and money. Z2 is based on the view as well, reflecting its small Muslim population. of some contemporary Muslim scholars Juxtaposing tables 8.1 and 8.2 provides a that zakƗt is payable on net returns of manu- comprehensive picture of whether and to what facturing concerns, rentals of building, and extent the resource shortfall required for pov- net savings out of salaries. Z3 is based on erty alleviation may be met by potential zakƗt views of the Maliki School, in which the zakƗt collection. The resource shortfall in Bangladesh base includes buildings and other fixed assets, is much higher than its potential zakƗt collec- except those assigned for personal and tion. However, in some other countries, family use. resources needed for poverty alleviation can ZakƗt is collected from the rich Muslims easily be provided by the potential zakƗt col- only, and non-Muslim citizens are exempt lection. Indian Muslims can generate enough from the payment of zakƗt. Thus the GDP of resources (0.630 percent of GDP) to provide each country under study has been adjusted by for the resource shortfall (0.344 percent of taking into account per capita income and the GDP) for lifting their extreme poor out of pov- proportion of Muslim population in each erty. Countries like Nigeria, South Africa, and country. The average score of Zs 1–3 has been Sudan can easily generate resources for pov- applied as a proxy to estimate potential zakƗt erty alleviation. In some countries with Muslim collection for the countries. minorities, the gap between resource required Table 8.2 shows that zakƗt potential under and potential zakƗt collection is minimal. In Z1 varies from about 1.00 percent of GDP to Kenya, for instance, the resource gap for 1.74 percent of GDP in the five predominantly extreme poverty is 0.32 percent of GDP, Muslim countries. Under Z2, potential zakƗt whereas corresponding potential zakƗt collec- ranges from 2.00 percent of GDP to 3.71 tion is 0.30 percent of GDP, using the Z3 mea- percent of GDP, while under Z3 it ranges from sure. However, Tanzania would be unable to 2.25 to 4.18 percent of GDP. Potential zakƗt is bridge the resource gap with potential zakƗt much lower for the Muslim minorities in India collection. (0.26 percent) and Singapore (0.65 percent Based on the evidence from sampled coun- tries, it appears that the potential resources from zakƗt collection alone can meet the short- TABLE 8.2 Estimates of the Potential of Zak¯at fall in resources required for poverty allevia- Percentage of GDP tion in most countries in the sample. Country Z1 Z2 Z3 Bangladesh 1.63 3.48 3.92 Estimation of Potential Resources from India 0.26 0.55 0.63 Waqf Indonesia 1.59 3.39 3.82 The process of estimating potential resources Malaysia 1.11 2.36 2.66 from waqf is more challenging due to the Pakistan 1.74 3.71 4.18 absence of data in most countries. However, Kenya 0.13 0.27 0.30 based on limited data available for two coun- tries, India and Indonesia,8 the potential Nigeria 0.86 1.84 2.08 resources that may flow from the waqf assets South Africa 0.03 0.06 0.07 can be estimated. Sudan 1.44 3.08 3.47 Estimates of the economic potential of waqf Tanzania 0.54 1.15 1.30 assets in India indicate that there are about 490,000 registered waqf assets in India, with a Sources: Global Islamic Finance Development Center calculations, based on Obaidullah and others 2014; Obaidullah and Shirazi 2015. total area of about 600,000 acres and with a Note: Z1 is estimated in accordance with the majority traditional view. Z2 is book value of about Rs 60 billion. Many of the based on the view of some contemporary Muslim scholars that zak¯at is pay- able on net returns of manufacturing concerns, rentals of buildings, and net waqf properties are located in city centers, and savings out of salaries. Z3 is based on views of the Maliki School. See text. the current market value is many times more GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 165
than the book value. The authors of the Islamic countries choose to levy 2.93 percent of the Social Finance Report 2014 argue, “as the GDP as social tax, then as many as 66 coun- book values of the properties are about half a tries could entirely cover the resource gap century old, the current value can safely be measured at the $1.25-a-day level, and the estimated to be several times more and the rest of the countries would be able to bridge market value of the properties can be put at the poverty gap partially. Rs 1,200 billion (about $24 billion). If these properties are put to efficient and marketable Toward the Optimal Mobilization of use they can generate at least a minimum return Zak¯at and Waqf Resources of 10 percent, which is about Rs 120 billion (about $2.4 billion) per annum. Wherever the The previous sections clearly demonstrate waqf lands have been put to efficient use, they how zakƗt can potentially meet the resource have generated an average return of about 20 gap for poverty alleviation in all the countries per cent” (Obaidullah and others 2014, 75). At under study. However, the potential remains Rs 120 billion, the annual return is about unrealized, as actual zakƗt mobilized falls far 0.3 percent of India’s GDP as of 2005. The short of its potential in most countries. For resource shortfall of the Muslim poor is instance, in Indonesia, the actual zakƗt col- 0.344 percent, as indicated in table 8.1. By lected according to the latest figures available combining zakƗt and waqf, a surplus could be is just 0.03 percent of GDP against a potential generated, which would be enough to lift the of 1.59 percent, while the estimated resource poor Muslims in India out of grinding poverty. shortfall is 0.41 percent of GDP. In Pakistan, ZakƗt and waqf could also wipe out actual zakƗt collected is just 0.06 percent of extreme poverty in Indonesia. According to GDP, against a potential of 1.74 percent, data obtained from the Ministry of Religious while the estimated resource shortfall is Affairs, the market value of registered waqf 0.71 percent of GDP. In Sudan, the situation land is about Rp 590 trillion ($60 billion). At a is better; the actual zakƗt collected is 0.33 similar minimum rate of return of 10 percent, percent of GDP against a potential of 1.44 these assets may generate an annual cash flow percent and an estimated resource shortfall of of $6 billion, which is 0.849 percent of 0.49 percent. In Malaysia, the actual zakƗt Indonesia’s GDP. This compares favorably collected is 0.24 percent of GDP, against the against a resource shortfall of 0.350 percent potential of 1.11 percent with an estimated needed to lift Indonesia’s poor above the resource shortfall of 0.01 percent of GDP. $1.25-a-day poverty level. Similarly, while potential returns from exist- ing waqf could meet the resource gap to eradi- cate extreme poverty, the actual returns are Estimation of Potential Resources from a dismal. Studies show widespread usurpation of Social Tax (Equivalent to Zak¯at) waqf assets by both State and non-State actors, A recent study extended the analysis of zakƗt as well as leasing of waqf assets at rates that 10 and waqf to a scenario where a social tax are grossly below market. equivalent to zakƗt potential is levied and col- lected.9 This study found the expected impact Trends in Mobilizing Zak¯at and Waqf of social tax collection to be at least Resources 2.93 percent of GDP (equivalent to the Mobilization of zakƗt has generally been median for zakƗt collection under three dif- increasing in the countries under study, as ferent definitions of zakƗt: Z1, Z2, and Z3). shown according to the latest data available: This includes transfers to reduce the poverty gap and headcount ratio and improve the • Brunei Darussalam increased mobilization income distribution of the lowest 40 percent by 55 percent over 10 years ($13.8 million of population for a sample of 104 low-income in 2010). and middle-income countries. It finds that if • Indonesia increased mobilization by over 166 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
32 times over 10 years ($231.6 million Evidence and Policy Recommendations in 2012). to Better Mobilize Zak¯at Resources • Malaysia increased mobilization by 7 times over the past 12 years and by 37 times over 1. Contrary to commonly held perceptions 22 years ($628.6 million in 2013). regarding the lack of dependability in • Nigeria collected total zakƗt of $3 million the flow of donations,zak Ɨt is depend- in 2013, but it has fluctuated greatly. able and sustainable, and could be a • Pakistan increased mobilization by 40 growing source of funds for institutions percent11 over 3 years ($105 million in that acquire the necessary professional- 2011). ism in fundraising and seek continued • Singapore increased mobilization by 20.2 improvement in their social credibility percent over 3 years ($20.4 million in through actions to promote integrity, 2012). transparency, and good governance. • Sudan increased mobilization by 4.8 times This is the evidence in Southeast Asian over the past 9 years ($220 million countries. The evidence is more mixed in 2013). in the agrarian economies of Sub- Saharan Africa, where there is greater In Indonesia and Pakistan, where private volatility in zakƗt collections because institutional zakƗt collection is permitted, sev- of the changing fortunes in the farming eral nongovernment actors perform exceed- sector. ingly well. In Indonesia, private institutional 2. There is a clear upward trend in the collectors together mobilize about 38 percent mobilization of zakƗt in South Asia of total national collection (Islamic Social and Southeast Asia. ZakƗt mobilization Finance Report 2014). Interestingly, just three has grown steadily in Indonesia and institutions account for 17 percent, or one- Malaysia, under two distinct zakƗt man- sixth, of the total national collection. Similarly, agement systems. While zakƗt collection in Pakistan, just one NGO—the Edhi is mandatory in Malaysia, it is voluntary Foundation—collects about 16 percent of all in Indonesia. The pattern of growth is zakƗt mobilized, according to unofficial more varied in other countries in those estimates. regions, such as Bangladesh, India, and With respect to mobilization of waqf Pakistan, as well as in Sub-Saharan resources, data indicate a near-freeze in the cre- Africa. While zakƗt is mandatory in ation of new social waqf, though religious Sudan and four states in Nigeria, it is vol- waqf continue to be created. Places of worship untary in other states of Nigeria, as well (masjids) and seminaries (madrasas) have as in the other countries under study. In increased in numbers, especially where new Sudan, zakƗt has been steadily increas- Muslim communities have emerged. There has ing at an annual average growth rate of been some rejuvenation of social waqf in the 19 percent. In absolute terms, zakƗt col- form of cash waqf in Indonesia, Malaysia, and lected in Sudan is impressive. At around Singapore. Some development of waqf assets $200 million per year, it ranks lower than and their prudent investment to generate Saudi Arabia, Malaysia, and Indonesia. returns has also occurred in these countries, as However, in terms of per capita zakƗt well as in Sudan, which is also known for its collected, it fares better than Indonesia. successful family waqf. Annual zakƗt collection in all Nigerian What factors have contributed most to suc- states together is much smaller—around cess in mobilization of zakƗt and waqf ? What $3 million—particularly considering the factors constitute major obstacles and chal- much larger size of the Muslim commu- lenges? What should be the strategic response nity. This is perhaps explainable because of policy makers? Some policy recommenda- these bodies are relatively new, and tions follow. the per capita income of the Nigerian GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 167
people has fallen greatly since the coun- In this sense, zakƗt payment may func- try became independent. tion as a perfect substitute for the direct 3. Malaysia and Sudan provide support- taxes to the State and may be allowed as ing evidence for compulsory zakƗt. The deductions to taxes payable. However, Nigerian states that have both com- there must be absolute clarity on the pulsory and voluntary zakƗt provide issue, as well as coordination between modest supporting evidence in favor of zakƗt and tax authorities. The absence of compulsory zakƗt, with relatively bet- clarity seems to have adversely affected ter performance in states like Jigawa zakƗt collection in Sudan in the initial and Zamfara. However, the policy in stages of operation of the Diwan, but it these states may not have paid off well was sorted out later with a tax incentive in view of lack of enforcement mecha- that was made available only on zakƗt nisms, unlike in Sudan. The voluntary paid on salaries. In the Nigerian states, nature of zakƗt may not itself have on the other hand, the incentive was contributed to the poor performance withdrawn because of difficulties in of other states. A more important fac- coordination among agencies, creating tor may be the absence of a vibrant further confusion. Where private agen- network of organizations at different cies are permitted to collect zakƗt, there levels. In Indonesia, Pakistan, and South seems to be merit in allowing zakƗt pay- Africa, the performance of voluntary ment as a deduction to taxable income zakƗt organizations has been excellent. only, on a par with various kinds of char- Irrespective of whether zakƗt is com- ity flows. Treating zakƗt payment on a pulsory or voluntary, a policy of decen- par with taxes to the State when the pay- tralization seems to work. The presence ment is made to private collecting bodies of a network of healthy institutions at might seriously erode State revenues. multiple levels—in the public, not-for- 6. There does not seem to be a strong case profit, and private domains—seems to for having standardized and globally lead to increased public awareness and acceptable definitions of assets liable to greater participation in the process of zakƗt and methods of estimating zakƗt poverty alleviation through zakƗt. liability. Since Islamic societies are typi- 4. The issue of incentivizing zakƗt payment cally characterized by a multitude of is crucial. Where zakƗt payment is made madhabs and schools of thought, the compulsory and noncompliance leads to zakƗt laws must retain enough flexibil- penalties and punishment, weak enforce- ity to accommodate alternative views. ment can lead to low zakƗt collection, as The diversity in legal opinions should in the case of some Nigerian states. With be respected. However, in societies like reasonably strong enforcement mecha- Sudan, where there is great homogene- nisms, as in Sudan, incentives in the form ity in shari‘ah legal positions, and where of benefits for compliance (such as tax zakƗt is compulsory, the clarity provided incentives for levies of zakƗt on salaries), by law in the definitions and methods as well as costs for noncompliance (such seems to have imparted greater stabil- as making zakƗt payment a precondition ity and added to enforceability. Where to other commercial transactions), work zakƗt is voluntary, it is more practical to well. At the same time, where zakƗt pay- ensure that zakƗt estimation is an out- ment is voluntary, its mobilization has come of a consultative process between not been any less impressive. the muzakki (zakƗt payer) and the insti- 5. Where zakƗt collection and distribution tutions that collect zakƗt. is entrusted entirely to the State, zakƗt 7. The success or failure of an institu- may be seen as a component to the aggre- tion as zakƗt collector and distributor gate resources available to the State. depends not so much on whether it is 168 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
in government or private hands, but on Due to the vast expanse of agricultural the credibility and trust it enjoys among areas and given the hugeness of the mon- the muzakki population—which in turn itoring task, the zakƗt collection efforts depends on the integrity, transparency, may be timed to allow for the seasonal- and good governance reflected in its ity of crops. ZakƗt mobilization should practices and as perceived by the stake- actively involve local committees as a holders. For example, the national zakƗt way to build social capital and enhance body in Indonesia is highly regarded, community solidarity. Local participa- while the national body in Pakistan tion should be sought in the collection of seems to suffer from a severe deficit in zakƗt on agricultural products of small- trust. holdings, inventory merchandise, and 8. The coexistence of public and private leased property in the locality. players as zakƗt collectors raises certain issues. Competition among a multitude Policy Recommendations to Better of zakƗt institutions brings efficiency Mobilize Waqf Resources and gives more choice to the muzakki. However, competition also presupposes 1. The legal framework must not put a level playing field for the players. undue restriction on creation of new Where the public agency also assumes waqf. A case in point is the restriction the role of the regulator of the zakƗt sec- on the creation of new waqf in Zanzibar. tor, it should restrict itself only to regula- Legal requirements that make the pro- tion, leaving zakƗt collection to private cess more difficult, such as the approval agencies. Alternatively, the entire process of the head of State, are both unneces- of zakƗt management could be under- sary and undesirable. A simple process taken by the public agency, through its of registration with the regulatory body own decentralized network. Such a sce- is both desirable and adequate. The nario does not preclude the involvement legal framework should actually encour- of private players as agents of the pub- age creation of new waqf by minimiz- lic body, as is the case with Malaysian ing financial and nonfinancial costs of states. creating and managing waqf. Sudan, 9. Using a large network of private institu- for instance encourages the creation of tional collectors to mobilize zakƗt is far waqf; by law, the major objectives of the more efficient than having a large num- Diwan are to conduct scientific studies ber of unconnected private individual and research on waqf, carry out training collectors. How to remunerate the pri- and capacity building and institutional vate collector, however, is a tricky issue development in the field of waqf, and under shari‘ah and calls for putting in encourage citizens to establish waqf. The place adequate and transparent mecha- case of Zamfara state in Nigeria is quite nisms to ensure that a minimal percent- interesting: government agencies and age of zakƗt collected is used in this contractors are encouraged to endow a manner. Use of private entities should certain percentage of their total revenues not be pushed too far. For example, pri- as waqf, thereby ensuring the continu- vate agencies should not be allowed to ous enhancement of waqf. offer zakƗt investment services, as this 2. Waqf, in general, have fallen behind might involve a misalignment of objec- common trusts and other forms that tives of such private agencies with those are organizing charitable and non- of other stakeholders. profit activities in response to evolving 10. In the context of in-kind zakƗt involv- social needs. Creation and management ing crops and livestock, some specific of waqf is a relatively more complex policy recommendations may be made. and demanding process and involves GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 169
additional financial and nonfinancial within the annual cycle. Related consider- costs. Incentivizing waqf in a manner ations include prioritizing among the similar to secular trusts and other forms categories of beneficiaries and among regions. of nonprofit organizations, such as Prudent zakƗt management requires com- through tax rebates on contributions pletely and effectively transferring resources to for the donor/endower, would make the beneficiaries and meeting their pressing needs system both efficient and fair. as soon as possible. 3. The legal framework should make it Prudent waqf management, on the other possible for all segments of the society hand, requires preservation and development to establish waqf. Currently, some laws of the waqf assets, investment and generation restrict making a waqf only to Muslim of returns, and ensuring that the returns/bene- individuals. Laws should permit both fits flow to the beneficiaries as intended by the non-Muslims and institutions to estab- waqif. lish waqf as long as the purpose of waqf is religious or charitable. Trends in Use of Zak¯at and Waqf 4. The legal framework should not restrict the definition of the endowed asset to Distribution of zakƗt has kept pace with its immovable tangible assets, such as real mobilization and is growing in almost all estate, but should also explicitly recog- sampled countries that have a zakƗt manage- nize movable, financial, and intangible ment system in place. The trends in zakƗt dis- assets, such as cash, equities, bonds and tribution in the sampled countries reveal that financial securities, transportation vehi- the poor receive the following: cles, rights on land and buildings, leasing • More than 90 percent of zakƗt distributed rights, and intellectual property rights. in Bangladesh, Indonesia, India, and 5. Most observers and scholars of waqf Pakistan believe that the institution of family waqf • More than 80 percent of zakƗt distributed must be revived. Sudan and Mauritius in Brunei Darussalam provide some excellent examples of fam- • About two-thirds of zakƗt distributed in ily waqf. The law in Mauritius explicitly Sudan provides for family waqf. Interesting fea- • About 35–40 percent of zakƗt distributed tures include the possibility of restricting in Malaysia and Singapore. the benefits to one or two generations; the need for concurrence of a wife before As a percentage of total zakƗt distributed, a husband may make a waqf; a list of the following are distributions to fi-sabilillah relatives who may benefit from waqf and (those in the path of Allah): the order of priority among them; the • Less than 5 percent in Indonesia and Sudan definition of a child and a descendant; • About 40 percent in Singapore and how waqf benefits should be appor- Malaysia. tioned between children and descen- dants and other possible beneficiaries Within the poor category, education, health, across generations and between males and social safety nets receive priority; around and females; and the conditions under 10 percent is allocated for economic empower- which the benefits will lapse. ment programs in Indonesia. As much zakƗt is collected as is distributed in Malaysia and Singapore, over time. In Toward Better Management of Zak¯at Brunei Darussalam, the relative proportion and Waqf Resources varies widely, from 50 percent to 500 percent, ZakƗt management essentially involves its safe indicating symptoms of zakƗt “holding” or deposit and its timely distribution among the accumulation of surplus. asnaf, or the eligible categories of beneficiaries 170 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
The proportion of administrative costs to Where there is a genuine possibility zakƗt collected varies from zero to 10 percent that the poor may not use the donated for most countries. The exception is India, cash in an optimal way, can the institu- where anecdotal evidence suggests that the tion distributing zakƗt insist on condi- percentage could be more than 30 percent. tionality for the possible use of zakƗt, In countries with in-kind zakƗt such as crops such as zakƗt payment in the form of and livestock, such as Nigeria and Sudan, scholarships to poor students to cover the costs are higher due to costs of storage tuition fees? Given the recent evidence and transportation. Sudan considers in the development literature in favor 20 percent as the cap for the proportion of of unconditional cash transfers (UCTs) administrative costs. over alternative methods of financial Some policy recommendations are dis- assistance to beneficiaries (Haushofery cussed next, in the light of findings pertaining and Shapiro 2013), the case in favor of to the countries under study. interpreting tamleek as UCTs appears to be a sound one. However, it is perhaps Policy Recommendations to Improve a good idea to treat the issue more as the Use of Zak¯at related to efficiency than as a matter of shari‘ah compliance. 1. Considering various legal opinions relat- 4. Traditionally, scholars have frowned ing to the distribution of zakƗt among upon the prospect of giving zakƗt as eligible beneficiaries, there is a case loans, since zakƗt is supposed to make in favor of a scheme of prioritization the mustahiq the owner of donated among different types of beneficiaries, funds and not a borrower of funds. The with highest priority being given to the objections seem to lose weight in light of needs of the extreme poor. the leveraging possibility that loans offer. 2. Basic consumption needs are, by defini- Arguably, a professionally managed tion, more urgent than needs that may zakƗt-financed microfinance program be deferred to a future date. In this could potentially serve a much larger sense, zakƗt is traditionally viewed as population of the poor as compared to a solution to the consumption needs of the prospect of grant-making to a small the poor. However, there is also merit number of beneficiaries. Further, a sce- in using zakƗt to enhance the wealth- nario where the poor are also made the creating capacity of the poor so that sole owner of the revolving fund is on far they are able to get out of the vicious stronger grounds. The first scenario (an circle of poverty and find lasting solu- independent zakƗt-funded microfinance tions to their needs. Complete neglect institution) appears to involve efficiency- of the empowerment dimension is likely related gains while raising concerns to perpetuate the dependency syndrome about shari‘ah compliance. The second among the poor. scenario (the microfinance institution 3. The term tamleek implies a process of being owned by the poor) is clearly supe- imparting ownership. In the context of rior, as it simultaneously takes care of zakƗt, tamleek is seen as a requirement the tamleek requirement. that essentially entails making the mus- 5. ZakƗt payment is an act of worship tahiq the owner of the donated funds. (ibada) for the zakƗt payer or muzakki. This clearly rules out the possibility of It is a matter of grave concern for the giving zakƗt as a loan to be repaid later. muzakki to ensure that zakƗt is not only The question of ownership, however, paid, but also distributed in compliance opens up two further issues. Should the with the norms of the shari‘ah. A zakƗt poor beneficiary have absolute right to institution essentially acts as an agent decide how he or she will use the funds? of the zakƗt payer or muzakki. As the GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 171
principal, the zakƗt payer or muzakki technology in zakƗt management may would like its agent to ensure that the make a payer-to-beneficiary (muzakki- zakƗt funds flow to eligible beneficiaries to-mustahiq, or M2M) flow a reality as according to shari‘ah. Therefore, fulfill- well as a good practice to replicate. ment of the conditions relating to collec- 9. There is a case in favor of using zakƗt to tion and distribution of zakƗt is the most cover genuine credit defaults by the poor, fundamental requirement for a zakƗt since such borrowers qualify as eligible institution to earn the trust of the zakƗt beneficiaries in the teachings of shari‘ah. payers and enhance its credibility. There is, however, need for caution while 6. Separation of zakƗt funds from other designing an institutional mechanism forms of donations is a primary con- for this purpose. It is not easy for any cern for a zakƗt institution acting as an microfinance institution operating with agent of the zakƗt payer or muzakki for inadequate and imperfect information to distribution of zakƗt. Since the condi- differentiate between genuine and willful tions relating to eligibility apply only to defaulters. The simultaneous functioning zakƗt and not to other forms of donor of a microcredit initiative and a zakƗt- funds, it becomes extremely important based initiative to cover credit defaults to ensure separation between zakƗt and by poor borrowers under the same orga- other types of funds. To ensure this is the nizational umbrella may involve serious case, zakƗt institutions must put in place conflicts of culture and moral hazard appropriate standard operating proce- issues. The Sudanese experiment of using dures and accounting and governance zakƗt only as a third-level institutional practices. guarantee to microfinance providers 7. The shari‘ah identifieszak Ɨt officials (after postdated checks and personal as one of the eight eligible categories guarantors) is a step in the right direc- of beneficiaries. Therefore, part of the tion for a zakƗt-based credit default zakƗt mobilized by the institution may mechanism to evolve. be used to cover the administrative and 10. There is a need to revisit the fiqh of operational costs of the zakƗt institution. Muslim minorities, as it relates to zakƗt. While some would like to place a legal The interpretations of “eligible” ben- cap of one-eighth on the percentage of eficiaries asnaf)( , the definition of assets zakƗt that may be used for this purpose, liable to zakƗt, and the legal and institu- others would like to treat the matter as tional infrastructure for zakƗt are largely one of good governance. As good prac- influenced by whether Muslims are a tice, a zakƗt institution that typically majority or minority in the population. collects other forms of donations should 11. ZakƗt management in Sub-Saharan cover its administrative and operational Africa in general seems to have suf- costs from such “free” funds as much as fered a great deal due to absence of possible. mid-level organizations, such as net- 8. Within the overall eligibility framework works, training and education provid- stipulated by shari‘ah, a zakƗt payer or ers, consultancy and standard-setting muzakki may have a unique preference bodies, and advocacy organizations. or priority scheme in favor of specific As a result, public awareness about regions, beneficiaries, or projects. In the zakƗt obligations is extremely low in interest of good governance, a zakƗt insti- many parts of this region. Data are very tution should ensure compliance with scarce. Capacity building is extremely such “revealed preferences.” While there important, but neglected. Arguably, a may be practical hurdles that impede large percent of zakƗt should go to this. such compliance for some zakƗt institu- A major change in the mind-sets of all tions, an increasing use of information stakeholders is needed. There is a lot to 172 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
be done in the matter of improving the 2. While preservation is important, the law administration, governance, and disclo- must clearly recognize the importance sures. Transparency and accountability of sustaining and enhancing the benefits are preconditions for credibility and that result from the waqf—this being successful fund-raising. the ultimate purpose of the act of waqf. 12. In the context of in-kind zakƗt such as This is possible only when the impor- crops and livestock, some specific policy tance of development of waqf is clearly recommendations may be made. ZakƗt recognized. An undue emphasis on pres- should be distributed in the neighbor- ervation (such as constraints on leasing) hood in order to enhance community would lead to neglect of developmental solidarity. A large proportion of cattle possibilities with private participation. collected as zakƗt should be distrib- Similarly, an undue emphasis on develop- uted at the collection area itself to save ment, to the extent that it results in loss on costs of transportation and storage. of full or partial ownership of assets to The workers engaged in the collection of private developers, would dilute and viti- zakƗt for cattle may be given a special in- ate the concept of waqf. The regulatory kind incentive to devise livelihood proj- framework must seek to strike a balance ects for rural poor owners of livestock. between concerns about preservation ZakƗt bodies should set up their own and development. A good example is the storage facilities and warehouses to save Sudanese law that seeks to strike a bal- the crops and livestock. ance between preservation and develop- 13. Because management of in-kind zakƗt ment aspects of investment by requiring entails huge collection costs, a more flex- the Diwan to undertake the maintenance ible approach is called for in relation to and improvement of endowed funds and the cap on operational costs, which is the evaluation, construction, and recon- traditionally one-eighth of zakƗt funds struction of endowed assets. Further, the collected. Further, once zakƗt are col- issue of sale and replacement (istabdal) lected, the transportation and storage of of endowed assets is explicitly dealt with in-kind zakƗt involves substantial costs. by the law. The Diwan is empowered to This justifies the strategy of on-the-spot sell an endowed asset to replace it with distribution. better ones “only to the extent deemed absolutely necessary.” Policy Recommendations to Improve the 3. Waqf is an institution originally and Management of Waqf always meant to be in the voluntary sec- tor, with management of waqf entrusted 1. Preservation of waqf is the most impor- to private parties. However, the State tant concern in waqf management. The has often sought to play a role in the legal framework must clearly articulate ownership and management of waqf the permanent nature of waqf arising assets, at times governed by motives to from the principle of “Once a waqf, expropriate, and at other times, by the always a waqf.” In case old laws fail to need to curb the corrupt practices of pri- ensure protection, they must be replaced vate trustee-managers. There is no clear with new provisions that enable recov- answer to the question of whether own- ery of lost waqf assets. A good example ership and management of waqf assets is the Sudanese law that empowers the should be in private hands or with the Diwan to recover all the endowed money State. There seems to be some positive that is possessed by other individuals, evidence that the State can play the role institutions, companies, or governmental of an efficient manager of waqf assets. authorities or to receive just and equita- Contrary to general belief, State control ble compensation from them.12 may not necessarily hamper creativity GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 173
and innovation in waqf development. tendency to corrupt, and the possibility Positive examples include corporate of such action can significantly increase waqf as well as cash waqf in Malaysia, the nonfinancial cost of creating new and large-scale development of existing waqf. Endowers are likely to seek alter- waqf assets in the public-private mode in native forms of organizing their chari- Malaysia, Singapore, and Sudan. table activities if there is a possibility of 4. Where waqf management is in private undue State interference in the manage- hands, the State agency as regulator ment of the endowed assets or outright should clearly stipulate elaborate and usurpation of the endowed assets by clear eligibility criteria for a mutawallƯ the State. or nazir, or trustee-manager, not only 6. The law must explicitly prohibit the waqf covering aspects of integrity and trust- asset from being used as a mortgage, worthiness but also professional com- confiscated, given away, sold, inherited, petence. If the individual or institution exchanged, or being alienated into any so nominated meets the criteria, the form of right. The waqf asset, however, regulator must respect the expressed may be exchanged as an exception to the intention of the waqif or endower. Laws above general rule, when this is deemed must clearly articulate the responsibil- to be in the public interest. Such exchange ity of waqf management to emphasize requires prior permission from the regu- not only preservation and protection lator, with additional conditions that of waqf assets, but also their develop- the exchange is necessary or beneficial ment. The responsibility should also to the waqf; consistent with the objects include transparent and honest report- of the waqf; made against another asset ing of financial assets and transactions. of equal or higher value; and made with Laws must clearly stipulate the method due respect to the inalienability of reli- of determining remuneration of manag- gious waqf. Laws are quite explicit in ers, sufficiently incentivizing sound and preventing the waqif, or mutawallƯ from professional management of waqf assets. selling, exchanging, or using the waqf The laws in Indonesia and Mauritius assets as collateral for mortgages. They provide good examples related to these can, however, permit leasing for vary- matters. The law stipulates that the ing periods. Caps on leases range from remuneration to which a mutawallƯ is 1 year in Zanzibar to 3 years in Mauritius entitled shall not exceed one-tenth of the to 99 years in Singapore. In India, caps income of the waqf. were 3 years, subsequently increased to 5. There is every reason for the State to 30 years. However, the rules could be less take punitive action against mutawallƯs explicit in preventing similar actions by who are negligent or lack integrity and State agencies. Laws often permit sale and transparency. The measures must act as replacement (istibdal) by State agencies to effective deterrents against further acts the extent considered necessary and even of carelessness, neglect, and misappro- in some cases sale of the property where priation. At the same time, the State the intentions of the endower cannot be should not be allowed to wield abso- reasonably carried out. lute power to engage in irrational or 7. Waqf development must be a mandatory whimsical action against the mutawallƯ. obligation of the waqf management. Instances of unfair and unlawful action Innovative financing methods may be by the State are numerous, as are cases employed that bring in new waqf capi- of corrupt mutawallƯs. There is need for tal to develop existing waqf. Innovative effective checks and balances in the law methods may also be employed that against wrongful acts by both the State facilitate private-public partnerships and private mutawallƯs. Power has a that involve the transfer of rights to 174 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
lease, as distinct from ownership rights may or may not be reluctant to incur to private financing entities for a finite, debt and start a microenterprise because yet sufficiently long period to provide a of risk and uncertainty about cash flows. fair return on investment capital. Legal Profit-maximizing and risk-minimizing constraints motivated by preservation behavior on the part of the microfinance concerns, such as on long-term leas- institution would lead to exclusion of ing of waqf assets, should be removed. such clients. Usually, such clients do not The Singaporean and Sudanese cases of possess the entrepreneurial and techni- partnership between the State waqf body cal skills needed to create wealth. Such and private Islamic financial institutions an economically inactive individual are worth replicating in other countries. would find it difficult to obtain financ- 8. Financial penalties, especially when these ing from for-profit MFIs. Indeed, more are expressed in absolute amounts, than financial services, these individuals tend to lose their effectiveness as deter- must be provided their basic needs, such rents over time. These should either be as food, shelter, or guaranteed employ- subjected to continuous revision or be ment. Such safety nets may be funded linked to the extent of misappropriation. through charity. Such individuals also 9. It is compulsory to invest waqf assets, need training to develop skills before whether they are real estate or movable they can make good use of microfinance. assets like cash. Investment can gener- Thus, safety nets may be linked with ate returns, which may then be applied microfinance programs, so that the same to the purpose for which the waqf has individuals may move through several been created. The assets purchased using stages: from extreme poverty to a stage the waqf investment returns do not form where they are able to meet their con- part of the waqf, and therefore may be sumption needs, then to a stage where resold, unlike the original assets that they acquire the necessary technical and have been given as waqf. Further, the entrepreneurial skills to set up microen- conditions given by the endower or terprises, and then to a stage where they waqif with regard to the investment of are able to obtain required funds from the waqf or conditions that the returns MFIs and get the microenterprises up from investment are to be spent on spe- and running. Fighting poverty in this cific areas are also binding. It would be way requires an integrated finance-plus rational to try to minimize risks through approach, or the provision of financial diversification or avoidance of high-risk services along with business develop- investment activities. Risk minimization, ment services that are linked to social however, may not be sought if the pur- safety nets. This is possible only by pose of the waqf itself is to engage in bringing philanthropy and cooperation specific risky ventures. into the model of microfinance. With the institutionalization of philanthropy and Policy Recommendations to Integrate its integration with for-profit microfi- Zaka¯t and Waqf with Microfinance nance, Islamic MFIs would perhaps be better placed to address the needs of the 1. There are sound economic reasons why extreme poor. conventional microfinance and espe- 2. There are also sound economic rea- cially microcredit may not be appro- sons why high-cost microfinance may priate for the chronically poor and the push beneficiaries into a spiral of debt. destitute. Loans to the destitute may Microfinance entails high administra- make the poor poorer if they lack oppor- tive charges, monitoring costs, and of tunities to earn the cash flow necessary course, high portfolio risk. Thus it is to repay the loans. A destitute person invariably costlier than the traditional GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 175
sources of finance. At the same time, programs to meet basic consumption both the microfinance institution and needs, and improve health and educa- its clients may find this an attractive tion; economic empowerment programs option if they believe that the expected involving skill enhancement and busi- return on the microenterprise is higher ness development services; programs than the cost of debt. Such expectations to provide emergency grants or credit; may indeed materialize for the successful programs to provide microtakƗful; and projects during “good times.” However, programs to provide guarantees against the same may not be true for all projects credit default. The administrative costs at all times. Debt-related liability can related to zakƗt management may compound and accentuate the financial partially be recovered from the zakƗt problems of a project experiencing bad collected, thus paving the way for a self- times and hasten its failure. The pace, sustained zakƗt management institu- frequency, and intensity of such failure tional infrastructure. is directly related to the levels of cost There is total flexibility with respect of debt. In contrast to debt, profit- and to beneficiaries of voluntaryV adaq̙ Ɨt. In risk-sharing mechanisms provide a clear the case of Vadaq̙ Ɨt jƗriyah or waqf, per- alignment between the profitability of petuity of endowed assets is an essen- the project and cost of capital. The lat- tial condition that ensures that benefits ter rises and falls in line with the real- from the assets flow to the beneficiaries ized profits of the venture. Islamic MFIs, on a sustainable basis. Waqf similar to as compared to conventional MFIs, are zakƗt may form the basis of various pov- more inclined to use profit- and risk- erty alleviation initiatives, as discussed. sharing modes. Even when they use While the major requirement in the case financing methods that create debt such of zakƗt is that benefits flow to the poor, as murƗbaKah̙ , the amount of debt once in the case of waqf, benefits must flow to created cannot be increased through beneficiaries as intended by the donor. restructuring if the client fails to repay However, if the intention of the donor the debt on time. Further, given the is not explicit, the proceeds may be used Islamic emphasis on avoidance of debt, for general- purpose community welfare an Islamic MFI should refrain from seek- projects, including poverty alleviation ini- ing to entrap a client in ever-rising levels tiatives. Waqf therefore provides a defini- of debt. tive mechanism with added elements of 3. Charity and philanthropy occupy a cen- sustainability and flexibility. The issue of tral position in the Islamic scheme of high-cost microfinance can be addressed poverty alleviation. The shari‘ah clearly by creating waqfs whose benefits can be identifies eight categories of beneficia- dedicated to absorbing specific cost ele- ries who may benefit from zakƗt. Out of ments so as to make microfinance afford- these, the potential beneficiaries relevant able to the extreme poor. from the standpoint of poverty alle- In an Islamic system, far greater prior- viation programs are the poor (fuqara), ity is given to the needs of the chroni- the destitute (masakeen), the indebted cally poor than those of the poor or the (ghƗrimƯn), and the zakƗt administrators moderately poor or the not-so-poor. (amileen). Scholars generally agree that Therefore, an Islamic microfinance insti- zakƗt may be disbursed in the form of a tution, unlike its conventional counter- grant or may be used to form a revolv- part, is expected to aggressively integrate ing credit pool from which microloans the various forms of Islamic philan- may be provided. ZakƗt could thus form thropy with for-profit microfinance to the basis of designing a range of pro- address the multiple issues related to grams for the poor, including safety net poverty alleviation programs. 176 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
4. MurƗbaKah̙ remains overwhelmingly and therefore the need for financial popular among Islamic MFIs for two literacy: main reasons. First, murƗbaKah̙ is simple. a. Returns on micro-murƗbaKah̙ and The straightforward calculation of the micro-ijƗrah financing are deemed installments for repayment is easier for shari‘ah compliant, while interest the beneficiary to comprehend. In con- rates are not. However, both can be, trast, the payments under a partnership- and often are, high to the point of based mode are uncertain, and therefore exploitation. are less favored. Second, murƗbaKah̙ is b. In case of participatory modes of finance familiar. For conventional MFIs ven- such as muGƗ̙ rabah, mushƗrakah, and turing into Islamic microfinance and mudharaa, the sharing ratio could using murƗbaKah̙ , the transition is less be unfairly biased against the poor demanding. Among all Islamic products, beneficiary because of their low bar- murƗbaKah̙ comes closest to interest- gaining power. Similarly, in case of fee- bearing microloans. based financing throughwak Ɨlah and For Islamic modes of finance involving Kaw̙ Ɨlah, the agent-microfinance insti- multiple contracts such as murƗbaKah̙ , tution may charge an exorbitant fee for shari‘ah compliance often requires care- the same reasons. ful sequencing of contracts to ensure that c. The permissibility of salam (sale of profits are associated with risk bearing. nonexistent produce) is linked to However, in the context of microfinance the economic benefits it confers on involving a large number of repetitive poor farmers who need financing contracts for small amounts, adherence before they can cultivate their crops to desired sequencing becomes practi- or produce their agricultural goods. cally impossible. Creative fiqhi solutions However, salam can involve exploita- such as istijrƗr may have significant tion when the advance price paid to advantages over murƗbaKah,̙ as istijrƗr is the poor farmer is artificially pegged tailor-made for repetitive transactions. at low levels due to his or her weak Partnership-based modes place demands bargaining power. on beneficiaries by the need for proper bookkeeping and the reporting of the An Islamic economy promotes free financial results of the business. Financial pricing and allows intervention by the illiteracy acts as a constraint. Further, regulator only when natural forces of the beneficiaries may be justifiably reluc- demand and supply are manipulated tant to share information relating to all to result in an artificial price. By impli- aspects of their business with the MFI. cation, price ceilings or administered Output-sharing modes or revenue- sharing prices are frowned upon in a market modes13 may work better in such situa- where there is free and fair play of com- tions due to the “revealed” nature of the petitive forces in the determination of benefits to be shared between the parties prices. However, in the case of financing and the difficulties and uncertainties asso- methods where the regulator is in a posi- ciated with cost calculation. tion to determine a fair estimate of the 5. For-profit shari‘ah-compliant methods costs for the MFI, it may seek to regulate of financing offer no built-in protection the profit margin so that prices charged against exploitation and abuse through by MFIs ensure full cost recovery and a overpricing. Enhancing the financial lit- fair amount of returns in the interest of eracy of poor clients is perhaps the only sustainability. effective bulwark against such exploi- At times, identifying an appropriate tation. The following examples clearly organizational structure may offer a highlight the possibility of exploitation, bulwark against possible exploitation. GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 177
For example, in the case of salam, a MFIs, which are financial intermediaries farmer’s cooperative may replace the as well as players in the real economy at vendor and thus prevent exploitation of the same time. Fiscal constraints in the individual farmers by the latter. form of taxes on real transactions must 6. There is no consensus on how to estimate be removed. the actual cost of operations chargeable 8. Islam gives utmost importance to the to the beneficiary under not-for-profit family as the core social institution that modes, such as qard and kafƗlah. There plays a major role in shaping the future is a need to develop accounting stan- of humankind. It also sees a balanced dards to estimate the actual cost of role for men and women in ensuring operations and clear guidelines on what the economic and social well-being of should ideally be passed on to the ben- the family. Islam promotes the concept eficiary. Vigilance by shari‘ah scholars to of “family empowerment” by exhorting prevent disguised ribƗ may also ensure men and women to play their respec- that actual administrative costs recov- tive roles in seeking economic and social erable from the beneficiary in qard or well-being of all members of the family. kafƗlah are not overstated. Indeed, the “women only” approach to 7. A conventional MFI seeking to trans- conventional microenterprise devel- form into an Islamic MFI is confronted opment and poverty alleviation is less with a range of issues at various levels. favored than family empowerment. An enabling environment and a regula- Nevertheless, there are successful exam- tory and policy framework are needed ples of women’s empowerment through that permit the MFI to engage in trade, affordable Islamic microfinance (see leasing, and investment in real proj- box 8.6). Further, there is the possibil- ects. This is usually not permitted for a ity that in underdeveloped countries, conventional MFI, which is viewed as women may be exploited instead of being a financial intermediary. The law must empowered, wherein they are made to recognize the special status of Islamic take the loan-related liability while the
BOX 8.6 The Role of Islamic Finance in Empowering Women: The Islami Bank Bangladesh Limited Microfinance Program
Women in developing countries face barriers in access areas, where a majority of them can engage in activi- to trade, industry, educational services, health care, ties such as management of crops, livestock, fisher- and politics, leading to a lower well-being of their ies, and energy. However, because these institutions families and less progress for their countries. provide interest-based credit, many of the poor are Furthermore, because gender inequality remains an excluded from the benefits of these loans due to reli- issue, women encounter many problems in the econ- gious reasons. omy, such as narrower occupational choices and With the aim of alleviating rural poverty by pro- lower earnings compared to men. viding shari‘ah-based microfinance, Islami Bank In Bangladesh, microcredit programs aiming to Bangladesh Limited (IBBL) launched a Rural reduce poverty have been developed and have gener- Development Scheme (RDS) in 1995. It focuses on the ated employment for women who live in marginal agricultural and rural sector, and seeks to generate
box continues next page 178 ISLAMIC SOCIAL FINANCE GLOBAL REPORT ON ISLAMIC FINANCE
BOX 8.6 The Role of Islamic Finance in Empowering Women: The Islami Bank Bangladesh Limited Microfinance Program (continued)
employment and raise the income of the poor. health and hygiene of women’s families has improved The scheme has 650,000 participants, of whom through investments in pure drinking water and sani- 90 percent are women. Women who participate in the tation funded by the microfinance loans. Recipients’ RDS program can supplement their household’s children have also increased their years of schooling. income, help increase household expenditures, diver- IBBL’s RDS illustrates the role that Islamic finance sify income sources, and provide insurance in the face can play in empowering women and providing of risk in the form of their extra earnings and saving. opportunity to share growth and prosperity. With As a result of the RDS, women’s income and the aspiration of promoting distributive justice to assets have increased, which has played an important maximize social welfare and reduce poverty, Islamic role in enhancing women’s economic independence financial institutions can play an active role in includ- and self-confidence. Furthermore, the program has ing women in economic activities, thus strengthening helped break the cycle of poverty women live in and both their families and their countries. has allowed them to have more control over their lives and economic decisions. Most importantly, the Source: Rahman 2015.
male member in the family manages in economic empowerment initiatives, to pocket the cash. Therefore, there is preferring the direct channels of distribu- merit in the argument that Islamic MFIs tion for consumption purposes instead. should aim to empower families and not Therefore, better accounting standards women alone. and regulatory norms are needed. Further, 9. The institutionalization of charity as well the law relating to charities must clearly as voluntarism is a creative strategy that address governance issues related to the has the effect of drastically cutting down commingling of funds. operational costs. Under this arrange- ment, microfinance can be provided at low or zero costs, making it affordable Notes to the poorest of the poor. 1. Islamic Law provides elaborate rules relating 10. Combining Islamic charity, especially to estimation of the zakƗt base (the amount zakƗt collection and application, with for- of wealth on which zakƗt is levied) and the profit financing involves serious transpar- rates of levy that vary with forms of wealth. ency and governance issues concerning the With most forms of financial assets, the rate commingling of funds. A major condition is 2.5 percent. in raising zakƗt funds requires such funds 2. The eight eligible categories of beneficiaries of zak t, according to shari‘ah, include fuqara to be directly channeled into the hands of Ɨ (the poorest of the poor); masakeen (the the eligible beneficiaries or the poor; they needy and the destitute); ameleen-a-alaiha cannot simply be credited to the organiza- (zakƗt personnel); muallafat-ul-quloob tion capital. In the absence of relevant and (people whose hearts are inclined toward adequate accounting standards and regu- Islam); fir-riqaab (those in bondage); ghƗrimƯn latory norms, shari‘ah scholars have gen- (the indebted); ibn al-sabƯl (travellers); and erally discouraged the use of zakƗt funds fi- sabilillah (those in the path of Allah). GLOBAL REPORT ON ISLAMIC FINANCE ISLAMIC SOCIAL FINANCE 179
3. The nature of the expected benefit or purpose Government of India. 2006. Social, Economic and of the waqf is clearly stated in the waqf deed or Educational Status of the Muslim Community articles of association created for that purpose of India: A Report (Sachar Committee Report). by the donor. The donor also specifies New Delhi: Government of India. the trustee-manager(s), who ensure that the Haushofery, J., and J. Shapiro. 2013. “Household intended benefits materialize and flow to the Response to Income Changes: Evidence from an community. The trustee-manager is variously Unconditional Cash Transfer Program in Kenya.” described as mutawallƯ or nazir. The waqf deed https://www.princeton.edu/~joha /publications provides for the method of compensation of / Haushofer_Shapiro_UCT_2013.pdf, accessed the trustee-manager, usually a part of the earn- on January 19, 2016. ings or benefits from the assets underwaqf . Moheildin, M., Z. Iqbal, A. Rostom, and X. Fu. 4. That is, a dollar (or its equivalent, in local 2012. “The Role of Islamic Finance in Enhancing currency) in the fund can support a dollar (or Financial Inclusion in OIC Member Countries.” its equivalent) in microfinance lending. Islamic Economic Studies 20 (2): 55–120. 5. KafƗlah and other fiqhi terms used for vari- Nimrah, Karim, Michael Tarazi, and Xavier ous modes of Islamic finance are explained in Reille. 2008. Islamic Microfinance: An the glossary. Emerging Market Niche. Washington, DC: 6. The data are drawn from Obaidullah and oth- Consultative Group to Assist the Poor (CGAP). ers (2014) and Obaidullah and Shirazi (2015). 7. For more precise estimates, national poverty Obaidullah, M. 2012. ZakƗt Management for lines and microdata of each country are required, Poverty Alleviation. Jeddah, Saudi Arabia: which are not available. Therefore, international Islamic Research and Training Institute, Islamic poverty lines and the corresponding poverty gap Development Bank. indexes are used for estimation. Obaidullah, M., and T. Khan. 2007. Islamic 8. See chapter 2 of Obaidullah and others (2014). Microfinance Development: Challenges and 9. This section is based on Shirazi and Zarka Initiatives. Jeddah, Saudi Arabia: Islamic Research (2015). and Training Institute, Islamic Development Bank. 10. See, for example, chapter 11 of Government Obaidullah, M., and N. S. Shirazi. 2015. of India (2006). Islamic Social Finance Report 2015. Jeddah, 11. Based on figures available forzak Ɨt collected by Saudi Arabia: Islamic Research and Training the government of Pakistan; excludes zakƗt col- Institute, Islamic Development Bank. lected by private institutions and individuals. Obaidullah, Mohammed, Nasim Shah Shirazi, 12. The law excludes endowments from applica- Dadang Muljawan, and Hylmun Izhar. 2014. tion of any superseding law, and the law also Islamic Social Finance Report 2014. Jeddah, applies the provisions of the Evacuation of Saudi Arabia: Islamic Research and Training Public Buildings Act concerning expropria- Institute, Islamic Development Bank. tion to endowments. Rahman, Md. Mizanur. 2015. “Women’s Par- 13. Unlike profit and loss–sharing modes known ticipation in Islamic Microfinance in Bangladesh in mainstream Islamic finance, output or rev- and Their Role in Sharing Prosperity: An enue sharing is simpler. A landowner and a Empirical Study.” Paper presented at the inau- landless farmer can come together and jointly gural World Bank-IDB-Guidance Financial undertake farming; the postharvest output is Symposium on Islamic Finance, Istanbul, shared between them as per an agreed ratio. September 8–9. Shirazi, Nasim Shah, and Muhammad Anas References Zarka. 2015. “Social Tax and Transfers for Reducing Income Inequality and Poverty: Chapra, M. U. 2008. The Islamic Vision of A Case for Low- and Middle-Income Development. Jeddah, Saudi Arabia: Islamic Countries.” Paper presented at the Financial Research and Training Institute, Islamic Management Association Annual Meeting, Development Bank. Atlanta, Georgia, October 14–17.
9 Public Policy Measures to Enhance Shared Prosperity
f the world is to succeed in meeting its could support efforts to achieve the SDGs and Itargets for the transformative and sustain- thus shared prosperity through five tracks: able new development agenda, all possible financial stability; financial inclusion; reducing resources must be mobilized. Building on the vulnerability; social and environmental activi- basic principles of Islamic finance that sup- ties; and infrastructure finance, according to port socially inclusive activities that promote Ahmed and others (2015). Table 9.1 summa- development, the Islamic financial sector has rizes the interventions and potential contribu- great potential to help achieve the Sustainable tions of Islamic financial institutions, capital Development Goals (SDGs). Financing for markets, and social finance. development focuses on four pillars: domestic Mobilization of Islamic financial institu- resource mobilization, better and smarter aid, tions, capital markets, and the social sector in domestic private finance, and external private promoting strong growth, enhanced financial finance. Islamic finance has the potential to inclusion, and intermediation; reducing risks play a major role in supporting all four of and the vulnerability of the poor; and more these pillars (Ahmed and others 2015). broadly contributing to financial stability and Given the magnitude of the task of promot- development will be pivotal in achieving ing shared prosperity and achieving the SDGs, SDGs in countries with a serious commitment the important role that Islamic finance can to Islamic finance. However, an effective role play in supporting implementation of the for Islamic finance would require the supply goals and ensuring more robust and inclusive of an innovative mix of products, adequate growth cannot be missed. Islamic finance governance of Islamic finance intermediaries,
GLOBAL REPORT ON ISLAMIC FINANCE 181 182 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 9.1 Potential of Various Channels of Islamic Finance to Meet the SDGs and Enhance Shared Prosperity
Financial institutions Capital markets Social sector Financial stability • Organizational diversity • Expansion of equity-based (venture capital, private capital markets equity firms, mud. a¯ rabah • Listing opportunities for companies) medium and smaller firms • Equity-based financing • Public and private risk- • New equity-based financial sharing suku¯k firms Financial inclusion • Special units to provide • Social suku¯k to raise funds • Integration with microfinance microfinance in Islamic • Retail suku¯k • Waqf/zaka¯t-based MFIs banks • Subsidize MFIs • Organizational diversity (cooperatives, nonprofits) • Use of ICT to expand provision of services Reducing • Savings opportunities for the • Using zaka¯t and waqf as vulnerability poor safety nets • Expansion of micro-taka¯ful • Use waqf/zaka¯t to pay contributions for taka¯ful Social and • Incorporation of macro- • Positive screening (along with • Expand zaka¯t and waqf base environmental maqa¯s.id perspective in negative screening) • Increase the efficiency and factors operations • Social suku¯k effectiveness of zaka¯t and • Financing development of • Suku¯k to develop waqf waqf social sector Infrastructure • Syndicated finance • Private/public sector suku¯k development for infrastructures • Retail suku¯k Source: Ahmed and others 2015. Note: ICT = information and communications technology; MFIs = microfinance institutions. For definitions of Arabic terms, see glossary.
and a supportive legal and regulatory frame- will to overcome the obstacles, are much higher work. In addition, based on the experience for Islamic finance. The policies needed to spur with the Millennium Development Goals economic activity are also important to the (MDGs) that preceded the SDGs, and given growth of the Islamic financial sector. Similarly, the requirements of Islamic finance instru- the obstacles that constrain the business envi- ments for better ex ante and ex post under- ronment and create legal uncertainties not only standing and scrutiny of transactions, the hamper economic growth but also are detri- need for high-quality data cannot be mental to Islamic finance. overemphasized. It is imperative to note that the existing The Islamic financial sector cannot reach its legal and regulatory environment is not full potential in terms of the expected socioeco- attuned to the requirements of Islamic finance. nomic benefits without supportive public pol- There is a need for reforms not only in finan- icy, conducive financial regulations, and strong cial sector regulations to comply with the institutions. While this assertion is true for any Islamic financial principles but also in the financial system, the significance of the proper legal system to provide necessary protection public policy initiatives and legal and business for new types of institutions, help in contract environment, and the need for strong political enforcement, and provide favorable tax GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 183
treatment. Implementing these changes is not tasked with designing regulatory and supervi- within the power of individual Islamic finan- sory standards for Islamic banks; it has also cial institutions or in the hands of the users of started issuing standards or guidance notes for finance, who are the source of the demand for other nonbanking institutions, as well. The Islamic finance. Here the role of regulatory International Islamic Financial Markets (IIFM) bodies, development agencies, taxation promotes development of Islamic capital mar- authorities, legislatures, and governments kets. The IIFM has focused on developing stan- becomes crucial to move Islamic finance for- dardized documents for various Islamic capital ward. Coordination among various stake- market products, including suku¯k. The holders and strong political will are needed to International Islamic Rating Agency (IIRA) bring about the change. provides credit rating services, taking into con- The recommendations contained in the sideration the shari‘ah compliance of the previous chapters underscore the point that financial institutions and their products and interlinked and coordinated policy responses services. The International Islamic Center for across various dimensions will be required. Reconciliation and Arbitration (IICRA) han- Some key recommendations for the develop- dles resolution of financial and commercial dis- ment of an Islamic financial sector aligned putes among the Islamic financial institutions, with shared prosperity include strengthening their customers, or other third parties through the enabling regulatory environment, enhanc- arbitration and reconciliation. It thus addresses ing the scale of and access to Islamic finance, the uncertainty and ambiguity faced by Islamic improving liquidity management and ensur- financial institutions regarding shari‘ah com- ing stability of the financial sector, bolstering pliance of the decisions issued by conventional human capital, increasing Islamic finance lit- law courts. eracy, promoting risk sharing, promoting These infrastructure organizations not project-specific suknjk,1 broadening the inves- only help avoid multiplicity of efforts and tor base by introducing retail suku¯k, develop- costs, but also significantly contribute to bet- ing capital markets, and enhancing the small ter regulation, convergence/harmonization of and medium enterprise (SME) sector. These rules, and improved shari‘ah compliance— and other recommendations require coordi- the factors that enhance shared prosperity nation among various stakeholders and orga- through financial sector stability and its com- nizations nationally as well as internationally. pliance with shari‘ah. At present, the Islamic financial infrastruc- At the country level, central banks, security ture at the international level consists of vari- market commissions, and the respective regu- ous support institutions that are responsible latory bodies contribute to the regulation and for setting standards concerning regulatory, development of the Islamic financial sector. shari‘ah (Islamic Law), and accounting The contributions of taxation authorities, aspects, as well as institutions that are facili- legal and judicial institutions, and other sup- tating market development, credit rating, and port organizations are also important. arbitration of commercial and financing dis- The discussion that follows surveys recent putes. These support institutions offer services initiatives to develop the Islamic financial sec- to all Islamic financial institutions and to the tor and related regulatory policies and evalu- country-level regulators. ates them in terms of their alignment toward Each of these Islamic financial infrastruc- meeting the goal of promoting shared pros- ture institutions has a different and well- perity. This evaluation is done in relation to defined scope for its work. The Accounting and the Ten-Year Framework and Strategies docu- Auditing Organization for Islamic Financial ment (10YF) for the development of the Institutions (AAOIFI) sets accounting, audit- Islamic financial sector. Many other regula- ing, and the related shari‘ah standards for tory measures and financial sector policies Islamic financial services institutions (IFSIs). that affect shared prosperity only indirectly The Islamic Financial Services Board (IFSB) is are not discussed. 184 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
The Status of the Ten-Year Framework the Seminar on Challenges Facing the Islamic and Mid-Term Review Financial Industry, held on April 1, 2004, in The Ten-Year Framework document was Bali, Indonesia. The seminar, which was jointly produced by the Islamic Research and jointly organized by IRTI and IFSB, was held Training Institute (IRTI), the Islamic in conjunction with the meeting of the IFSB Development Bank (IDB), and the IFSB in Council hosted by Bank Indonesia. To follow 2007 in consultation with a large number of up on the issues discussed in the seminar, IRTI IFSIs and central banks. The document was and IFSB undertook a joint initiative to created to have a strategic framework to sys- address the challenges in a systematic manner tematically study, discuss, and propose policy and began preparing the Ten-Year Framework measures to promote the orderly development and Strategies document. of the Islamic financial services industry. It As a first step, a number of leading special- aimed to provide a general blueprint for new ists and practitioners were asked to prepare and existing Islamic finance jurisdictions in technical papers on various themes. These designing and developing their national plans were presented in a technical workshop and major initiatives as part of their financial jointly organized by IRTI and IFSB, held from sector development policies. May 31 to June 1, 2005, in Dubai, and hosted The 13 framework recommendations pro- by the Dubai Financial Services Authority. posed have stood the test of time. Nonetheless, IRTI and IFSB jointly held a policy dialogue in order to reflect the current status of the on the same theme on June 22, 2005, in Islamic finance industry more accurately, Putrajaya, Malaysia, which was facilitated by three recommendations have been added. The Bank Negara Malaysia. A drafting committee updated set of recommendations is based on was formed as a result, which held three three pillars: meetings and finalized a draft document. The draft document was distributed by IFSB to 1. Enablement: Fostering conditions for the solicit feedback from its members and other industry to thrive interested parties. It was also discussed at the 2. Performance: Enhancing the effectiveness Islamic Bankers’ Forum on May 28, 2006, in of institutions active in the industry Kuwait, which was jointly organized by IRTI, 3. Reach: Expanding the set of potential IFSB, and the General Council for Islamic beneficiaries of the industry. Banks and Financial Institutions (CIBAFI). At its final meeting on August 17, 2006, in Kuala The Mid-Term Review (MTR) was Lumpur, Malaysia, the drafting committee launched in 2014 in conjunction with the reviewed all the comments, received feed- 11th IFSB Summit, hosted by the Bank of back, and reached a consensus on the revised Mauritius. It discussed proposed measures to document. address the gaps or challenges in meeting the objectives of the Ten-Year Framework, as Why Was a Mid-Term Review well as the roles of the public and private sec- Conducted? tors and other stakeholders of the IFSIs in carrying out the 16 recommendations, taking In 2013, IRTI and IFSB initiated a Mid-Term into account the state of development of the Review of the Ten-Year Framework, as more IFSIs in the respective jurisdictions (IRTI, than half the period has passed since its IDB, and IFSB 2014). publication in 2007. The MTR was aimed at assessing the impact of macroeconomic events, How Did the Ten-Year Framework monitoring progress in implementing the rec- Document Come About? ommendations, and proposing additions or modifications to the recommendations to The idea of preparing such a strategic frame- guide the industry. The effort was considered work document was first considered during crucial due to the increasingly challenging GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 185
economic and financial environments, as well initiatives are under way, reflecting cus- as the significant developments taking place in tomer confidence in the sector, whose con- the international financial landscape, particu- cept has been proved in many markets. larly after the 2008 global financial crisis. 2. Macroeconomic events and external fac- Even more important was to ensure that the tors have brought both challenges and Ten-Year Framework document remained rel- opportunities to the sector, which has evant as a platform for various Islamic finance been affected by the global financial cri- jurisdictions to assist them in orchestrating the sis directly and indirectly, via the eco- future direction of the industry. The Mid-Term nomic impact, the approach to financial Review was guided by the following regulation, the strength of partners and objectives: counter parties, and the value of assets and investments. As the global economy • To assess the impact of developments in has stumbled, some member-countries the global financial system following the of the IDB have acted as important cen- global financial crisis on various segments ters of growth. Political developments of the Islamic finance industry in recent years have also made several • To examine the progress and current sta- countries more open to Islamic financial tus of the priorities and initiatives sug- services. Technological innovations such gested in the Ten-Year Framework and as branchless financial services are now Strategies available, which can allow the industry to • To identify gaps in implementing the pri- broaden its reach. orities and initiatives 3. The development of the industry has var- • To assess the need for a reorientation of ied by sector. Islamic banking remains such priorities and initiatives. the most developed subsector of the The Mid-Term Review thus sought to industry. Estimates of its total asset size assess progress made by the industry in imple- and growth rate vary significantly (from menting the 2007 recommendations of the nearly $1 trillion to well above that level). Ten-Year Framework and to amend it in light To cite a notable example, Islamic micro- of developments since its publication. finance has made the transition from In conducting the Mid-Term Review, IRTI a concept with isolated case studies to and IFSB were supported by a number of a fledgling sector in multiple markets. prominent research institutions and have Moreover, the breadth and sophistication engaged with leading regulators, market play- of shari‘ah-compliant instruments (shares ers, academicians, and shari‘ah scholars. and suku¯k) in capital markets have Intensive discussions took place in roundta- improved. However the performance of bles held in Qatar, Malaysia, and Turkey, certain instruments in terms of market where IRTI and IFSB had an opportunity to value has been mixed due to overall capi- obtain further insights from key stakeholders tal market challenges. Challenges related and the entire Review Committee. to the shari‘ah compliance remain.
What Were the MTR’s Key Findings? What Are the Distinct Features Following in-depth research and engagement of the MTR? with key stakeholders in the industry, the MTR Three additional recommendations were document generated three main findings: made (in addition to the 13 recommendations in the original document): 1. The industry has shown growth and resil- ience. Market share and profitability are • Recommendation no. 14. Develop an under- growing, the number of institutions has standing of the linkages and dependencies expanded, and numerous industry-level between different components of Islamic 186 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
financial services to enable more informed framework is dynamic. The three main pillars strategic planning to be undertaken. (enablement, performance, and reach) sup- • Recommendation no. 15. Foster and port the 16 core recommendations, imple- embrace innovative business models, mentation plans, and key initiatives, but all including new technologies and delivery those elements strengthen one another and channels, in offering Islamic financial strengthen the entire system. services. • Recommendation no. 16. Strengthen Why Does the MTR Matter? contributions to the global dialogue on financial services, offering principles and The recommendations of the MTR must be perspectives to enhance the global implemented in a diverse group of nations that financial system. vary in terms of region, culture, stages of eco- nomic development, and types of law (Islamic The three-pillar framework was intro- Law, common law, and civil law). Thus the duced. While the original document catego- MTR recognizes that diverse views are partic- rized the recommendations into two groups ularly salient with respect to whether (institutional and infrastructural), the new • Countries should have specific laws for categorization (enablement, performance, and Islamic financial services or fit Islamic reach) places greater emphasis on the outcome structures into a single set of financial ser- desired from the framework. The first pillar vices laws. (enablement) centers on fostering conditions • Countries should adopt national-level for the industry to thrive. The second pillar i boards or retain i gover- (performance) supports efforts to enhance the shar ‘ah shar ‘ah nance solely at the institutional level. effectiveness of institutions active in the indus- • Central banks should allow conventional try. The third pillar (reach) seeks to substan- institutions to offer Islamic financial tially increase the commitment to expand the services. set of potential beneficiaries in the industry. • Adopting international standards specific Key performance indicators (KPIs) were to Islamic finance is essential or not. developed to help address weaknesses and • Product standardization should be a policy monitor progress in a more focused manner. As objective or not. noted, the progress made on the original rec- ommendations has been mixed. While many Against this diverse backdrop, an underly- countries have adopted international standards ing theme is that a supportive public policy specific to Islamic financial services, those have stance is essential to enable the industry to not gone far enough and more work is needed. reach its full potential. Different countries Metrics for tracking progress, which ini- have been successful under various models; tially were not specified, are now considered each choice has benefits and drawbacks. In all crucial for assessing progress. Thus the MTR models, a strong and supportive public policy proposes a set of KPIs, and countries are stance can help contribute to greater confi- urged to set national targets to meet them. dence, which energizes the private sector. A stronger implementation plan was estab- The MTR therefore does not seek to pre- lished for a range of stakeholders. The role of scribe specific approaches to the choices central banks and governments will be espe- above. It does, however, urge various jurisdic- cially important in driving implementation. tions to deliberate carefully on these matters Twenty Key Initiatives were identified and form well-considered strategies. The and prioritized, based on their potential MTR also encourages Islamic financial ser- impact and the feasibility of implementation vices to offer benefits to the wider economy (see table 9.2). and the public at large, and advocates Distinctive features of the MTR are illus- thoughtful strategies on how best to bring trated in figure 9.1. As the figure shows, the about these benefits. GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 187
TABLE 9.2 Twenty Key Initiatives under the Mid-Term Review
Pillar Initiative Enablement Integrate Islamic finance in national development plans. Introduce national Islamic financial services master plans. Enhance regulatory implementation and enforcement. Harmonize, where possible, regulation and regulatory frameworks across borders. Adopt and strengthen national shari‘ah governance frameworks. Where mandates overlap, align the positions of industry bodies. Link Islamic financial markets across borders. Form a “Technical Assistance and Linkage Network.” Form regional working groups. Foster information-providing institutions that support the provision of Islamic finance. Incorporate Islamic finance data in statistical and official reporting. Performance Institute centralized R&D for Islamic financial products in addition to the decentralized R&D. Establish diversified financial institutions. Demonstrate the industry’s distinctive value proposition. Fund public infrastructure projects to build Islamic capital markets. Reach Revitalize zaka¯t and awqa¯f for greater financial inclusion and make them an integrated part of the Islamic financial system. Ensure that regulations allow for the use of new technology to provide affordable services. Engage with newly opened markets. Foster the financing of a wider set of economic sectors. Brand Islamic financial services for wider markets. Source: IRTI, IDB, and IFSB 2014. Note: R&D = research and development.
FIGURE 9.1 Distinctive Features of the Mid-Term Review
16 core recommendations Reach Enablement Performance
Implementation plans and key initiatives 188 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
As a result, the framework recognizes the Over the course of the Mid-Term Review need to uplift the underprivileged in society so process, over 70 initiatives were suggested they can also benefit from the economic to help implement the recommendations. growth. The framework also recognizes that These initiatives included ideas from sector the “financialization” of economies has con- specialists, input from expert reviewers, and siderably worsened the linkage between the guidance from various review committees. real sector and the financial sector and has An analysis of how Indonesia, Malaysia, failed to ensure that the least privileged bene- and Pakistan have adopted these initiatives fit from economic growth.2 follows. The third pillar of the MTR addresses such issues. It shares this focus with the World Integrate Islamic Finance in National Bank Group, which has recently revised its Development Plans and Introduce mission to make “shared prosperity” the sec- National Islamic Financial Services ond of its twin goals (see chapter 1). The MTR Master Plans and the World Bank Group are committed to this goal; however, the mechanisms of attain- This initiative is of the utmost importance ing a society based on shared prosperity under since it is the basis for the institutional each approach might differ. building and policy formulation to bring As discussed in chapter 1, achieving shared about shared prosperity. Some recent devel- prosperity from the perspective of Islamic opments in selected jurisdictions have been economics and finance is based on four fun- promising. The fact that a strategic plan or a damental pillars: an institutional framework road map on a national level is in place in and public policy in line with the objectives of jurisdictions such as Indonesia, Malaysia, Islam; prudent governance and accountable and Pakistan shows that the governments in leadership; promotion of an economy based those countries are no longer taking Islamic on risk sharing and entrepreneurship; and finance lightly. financial and social inclusion for all. The Indonesian government committed to taking the initiative to the next level by establishing the National Committee in Enacting and Implementing Policies Islamic Finance, chaired directly by the presi- to Promote Shared Prosperity: A dent of Indonesia, Joko Widodo (box 9.1). Three-Nation Case Study Indonesia recently introduced a revised ver- This section examines whether policy sion of its 2002 road map. In addition, the objectives in selected jurisdictions are in line Financial Services Authority (OJK), has come with the notion of shared prosperity by seeing up with a road map for Islamic capital mar- how they have adopted the MTR’s Key ket development and a road map for sustain- Initiatives. The analysis compares the strate- able finance in Indonesia for 2015–19 gic plan or road map established in selected (Indonesia OJK 2015a, 2015b, 2015c). jurisdictions, and related efforts, with the Key Although the road map for sustainable Initiatives. Indonesia, Malaysia, and Pakistan finance does not address Islamic finance were selected because these countries have directly, the objectives of promoting eco- comprehensive road maps or strategic plans. nomic sectors such as agriculture, manufac- The objective of the comparison is to figure turing, infrastructure, SMEs, and energy, out whether the MTR and the selected strate- which contribute to sustainable development gic plans and road maps are moving in the and have a high multiplier effect for the same or similar directions. In addition to con- Indonesian economy, are aligned with the tent analysis, feedback was also gathered from norms of Islamic finance. A key step forward regulators in Indonesia (Financial Services would be if the country could promote Authority, Otoritas Jasa Keuangan) and Islamic modes of financing to mobilize funds Malaysia (Bank Negara Malaysia). and investment for these sectors. GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 189
BOX 9.1 Indonesia’s Initiative to Take Islamic Finance to the Next Level of Development
Indonesia has become one of the main engines for resulting from a harmonious relationship between growth in the world of Islamic finance. However, com- economic, social, institutional- governance, and envi- pared to the country’s huge potential and its large ronmental interests. Muslim population, the development of Islamic The road map for sustainable finance sets forth a finance in Indonesia remains modest. Penetration of detailed work plan on the sustainable finance pro- Islamic finance has been surprisingly low: only 3.7 per- gram for the banking, capital market, and nonbank cent of the total banking sector, according to the latest sectors of the financial services industry as governed data in the World Islamic Banking Competitiveness by OJK. The road map is also aligned with the Report 2016 (Ernst & Young 2015). Master Plan for Indonesia’s Financial Services It has become evident that the traditional Sector, which will serve as a reference for other bottom-up approach in Indonesia can no longer be stakeholders in the sustainable finance program. relied upon. Thus the Financial Services Authority The goals of the sustainable finance program in (Otoritas Jasa Keuangan, OJK) felt the need to pro- Indonesia include the following: vide further clarity on how the Islamic finance 1. Improving the resilience and competitiveness of the industry should move forward. Hence it undertook financial services industry so it can grow and a revision of the first blueprint for the development develop in a sustainable manner. Resilience, in this of Islamic banking development, first published in respect, is associated with improved risk manage- 2002. A revision is vital to align future steps with ment, while competitiveness is associated with the the long-term development plan for the Indonesian ability to innovate and produce environmentally economy and to anticipate the commencement of friendly products and services. the South East Asia Economic Society in early 2. Providing financing resources required by the pub- 2016. In early 2015, OJK published the road map lic by using the pro-growth, pro-job, pro-poor, and for the development of Islamic banking develop- pro-environment approach. ment (OJK 2015a), followed by the road map for 3. Contributing to the national commitment to the development of the Islamic capital market (OJK address the challenge of global warming by sup- 2015b) and a road map for sustainable finance porting businesses’ efforts to mitigate and adapt to (OJK 2015c) in Indonesia. climate change, in a move toward a competitive Sustainable finance from OJK’s viewpoint is low-carbon economy. defined as comprehensive support from the financial services industry to achieve sustainable development Sources: Indonesia OJK 2015a, 2015b, 2015c.
The Malaysian government amended its • Most significantly, it required financial Islamic Financial Services Act in 2013 (Bank institutions to properly differentiate between Negara Malaysia 2013). The following are Islamic deposits (which are principal- among the major changes: guaranteed shari‘ah contracts) and investment accounts (which are principal-nonguaranteed • It consolidated various pieces of legisla- shari‘ah contracts) in their business processes tion, acts, and regulations issued at differ- and clearly communicate the differences to ent points in time for various financial stakeholders. This implies putting into place subsectors. The consolidated act helps appropriate processes to utilize such funds, remove ambiguities across subsectors. calculate their profits, maintain transparency, • It provided legal recognition and standing and communicate this information. for shari‘ah governance and the shari‘ah governance framework. Such governance Pakistan’s central bank has set out its stra- had been in practice previously but had tegic plan for 2014–18 regarding the Islamic not had legal cover. banking industry (SBP 2014). This is an effort 190 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
to reach an industry-wide consensus on the development of Islamic finance. The shari‘ah future direction of the industry in the coun- governance framework is advanced in try. The four key elements of this strategy are all three countries, particularly Malaysia. well aligned with the recommendations of All three countries have introduced a compre- the MTR: hensive two-tiered shari‘ah governance framework whereby shari‘ah boards are in 1. Enabling of the policy environment. place not only at the national level but also at Enabling the legal, regulatory, supervisory, the institutional level. In all three countries, and liquidity management frameworks, no shari‘ah scholar may serve in more than the taxation regime, and the financial two Islamic financial institutions. This limita- accounting and reporting framework tion is in place to ensure the credibility and 2. Shari‘ah governance and compliance. accountability of not only the products and Standardization and harmonization of the institutions, but more importantly the shari‘ah practices, as well as creation of industry as a whole. distinct Islamic banking products and services Where Mandates Overlap, Align the 3. Awareness and capacity building. Increasing Position of Industry Bodies coordination and collaboration among internal and external stakeholders to A strong commitment to create synergies enhance awareness of Islamic finance and among regulators across sectors is needed. build stakeholders’ capacity The banking sector has been the dominant 4. Market development. Initiatives for prod- sector in the Islamic financial services indus- uct diversification and financial inclusion, try. Harmonization of regulations is needed to with the collaboration of stakeholders. enable other sectors to flourish as well. The governments of Indonesia and Pakistan have Harmonize, Where Possible, Regulation clearly stated that effective coordination and and Regulatory Frameworks across collaboration among key stakeholders are Borders vital for sustaining the momentum for growth of Islamic finance. Harmonization of regulations is necessary to The principles set out by standard-setting increase cross-border market activity and to bodies in the Islamic financial services indus- encourage more collaboration between mar- try, such as the IFSB and AAOIFI, also need to ket players. In the context of Islamic finance, be synchronized with one another. All three the importance of harmonization of shari‘ah countries have made a strong commitment to through fiqh interpretations cannot be under- continuously align their regulations with the stated. Shari‘ah scholars in Indonesia and principles of these bodies. Malaysia regularly conduct symposiums on these matters. Although both countries fol- low the same school of thought, in practice Establish Diversified Financial there are differences that cannot be over- Institutions looked. A similar effort to resolve differences Achieving an economy based on shared pros- in understanding may be considered in the perity cannot be attained by depending solely Indian subcontinent. on the banking sector, given its risk tolerance, costs, and business model. It is thus very Adopt and Strengthen the National important to support the development of other segments of the sector to achieve bal- Shari‘ah Governance Framework anced growth of a stable and inclusive indus- Prudent governance and accountable leader- try that covers the full spectrum of financial ship are required to bring about shared pros- services. Indonesia and Pakistan are excellent perity and are needed to support the examples; their respective road maps GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 191
BOX 9.2 Diversified Institutions and Efforts toward Financial Inclusion: Highlights of Some Policy Initiatives of the State Bank of Pakistan
• The State Bank of Pakistan (SBP) has developed • Branchless banking has become a promising way a National Financial Inclusion Strategy (NFIS) to deliver financial services at low cost. Pakistan that encompasses many of the areas needed has built up the retail capacity of financial institu- to develop the Islamic financial sector (SBP tions through an agent network that reduces ser- 2015a). The Strategy covers Islamic finance, vice delivery costs. The use of such services is along with other areas such as branchless growing quickly. For example, during the last banking, SME finance, infrastructure finance, quarter of 2014, around 72 million transactions microfinance, rural and agricultural finance, worth PRs 372 billion ($3.55 billion) were pro- housing finance, digital payment systems, con- cessed, with an average size of PRs 5,181 (about sumer protection and financial literacy, insur- $50).a A Secured Transaction Law will facilitate ance, and pensions. establishment of a registry office in the country to • Pakistan has a well-recognized legal and regulatory use movable assets as collateral. framework for microfinance. In 2015, ten microfi- • SBP has issued a separate regulatory framework nance banks (MFBs) were operating in Pakistan. for housing finance.b All are privately owned and have a diversity of • SBP is encouraging the development of agricultural ownership and approaches. financing based on warehouse receipts and salam • Three leading microfinance institutions (MFIs) concepts. It has issued a consultative paper on the have been transformed into MFBs. They are now “Framework of Warehouse Receipt Financing in among the top five MFBs in the country. Pakistan” (SBP 2015b). • Pakistan is one of the few countries in the world that has a national microfinance credit information Source: Compiled from various sources available at the SBP website, http://www .sbp.org.pk/. bureau. a. Speech by Riaz Riazudding, deputy governor, State Bank of Pakistan, July 6, • A microfinance credit guarantee facility provides 2015. http://www.sbp.org.pk/DG-Speeches/DGSpeech-06-Jul-2015.pdf. MFBs and MFIs with the access to commercial b. Speech by Ashraf Mahmood Wathra, governor, State Bank of Pakistan, May 28, 2015, delivered at the International Conference on Affordable Housing Finance. funding sources such as banks and the domestic http://www.sbp.org.pk/about/speech/Governors/Mr.Ashraf.Mahmood.Wathra capital market. /2015/Affordable-Housing-28-May-15.pdf.
explicitly state the need for diversification at Inclusion Strategy recently embraced by the level of both products and institutions. Pakistan (SBP 2015a) (box 9.2). More importantly, the road maps also address the need to move away from prod- Revitalize Zaka¯t and Awqa¯f for Greater ucts that create debt and toward greater use Financial Inclusion and Make Them of products based on risk sharing. an Integrated Part of Islamic Financial Diversified financial services increase finan- System cial inclusion. Further improvement is possible through policies that target the adoption of The potential of zakƗt and awqƗf in alleviat- new technologies to lower the cost of delivery ing poverty and improving financial inclusion of finance, incorporate regulatory changes to is high. However, use of this potential increase the use of the new delivery channels, requires not only initiatives from the contrib- and enhance financial literacy to increase its utors but also a concrete support from the acceptance by the population. This route has authority at the national level, as it involves been followed in the National Financial working with zakƗt organizations, financial 192 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
institutions, and the zaka¯ t beneficiaries. In their own investment; they are the direct oppo- Indonesia, for instance, zaka¯ t is a tax- site of institutional investors, who buy on behalf deductible instrument; such a policy is of their clients and have the capacity to hold expected to encourage more people to pay the until maturity. annual zaka¯ t obligation. This practice has a Pakistan clearly makes financial inclusion legal standing based on the Indonesian a goal in its road map of Islamic banking National Act on Zaka¯ t Management (Act No. development and Islamic capital market 38/1999).3 Following registration at the development for the 2014–18 period. Zaka¯ t National Authority (BAZNAS), the Pakistan also places greater importance on muzakki (zaka¯ t payer) will receive a zaka¯ t ID channeling financing to the agriculture sector card along with a zaka¯ t ID number (NPWZ).4 and to SMEs. Once the payer completes the zaka¯ t payment at the bank or via an automated teller machine Incorporate Islamic Finance Data in (ATM), as a proof of zaka¯ t payment, the Statistical and Official Reporting payer will automatically receive a notification from BAZNAS stating that the zaka¯ t pay- Some jurisdictions have started to compile ment has been received. The proof is then fac- Islamic finance data as an official reporting tored in when paying the tax. The initiative requirement for their regulatory purposes. indicates the government’s commitment to About 16 jurisdictions are now collecting and make this sector part of the Islamic financial reporting aggregated prudential indicators system. Indonesia and Pakistan are perhaps data proposed by the IFSB. Indonesia, the strongest proponents of incorporating Malaysia, and Pakistan are among the coun- financial inclusion as a policy objective. tries that are collecting and compiling such data and regularly contributing to the IFSB Foster the Financing of a Wider Set of database on prudential indicators for Islamic Economic Sectors banking. Data for 2013 and all quarters of 2014 are available now on the IFSB website.6 Islamic finance is often known for serving the “haves” rather than the “have nots,” which may Develop the Required Pool of be contrary to the fundamental principles of Specialized, Competent, and ideal Islamic finance and the rationale for insti- High-Caliber Human Capital tutionalizing Islamic finance. Current evidence may reinforce such a contention. However, The development of a pool of competent, some recent efforts may be widening the eco- skilled, and high-caliber human capital is also nomic base for Islamic finance somewhat. For important for developing Islamic finance and instance, the introduction of retail suku¯k5 in using it to enhance shared prosperity. Pakistan Indonesia is an indication that Islamic finance has been developing education and research can also be designed to cater to segments of infrastructure to promote Islamic finance in society with lower net worth. It will facilitate partnership with leading higher education greater retail participation in the suku¯k market institutions. It aims to develop the industry’s by making suku¯k available in smaller denomi- human capital base in the form of Islamic nations that can be bought directly by retail finance professionals, specialists including investors. This not only meets the retail inves- shari‘ah scholars, economists, and researchers tors’ demand for access to a wider range of to meet the growing demands for compliant investment products, but increases the diversity products and services in Pakistan. Through a of the investor base to the issuers and makes the nationwide competition, three universities market more liquid. Access for retail investors have been selected to establish Centers of to suku¯k was previously available only through Excellence in Islamic Finance in three prov- suku¯k unit trust funds (mutual funds) and inces. The impact of these centers will be felt exchange traded funds. Retail investors buy for in a few years. GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 193
Malaysia has established the International still below potential. The reason why is related Shari‘ah Research Academy (ISRA) as part of to the fact that every system develops its own the International Centre for Education in culture, and the culture it develops help per- Islamic Finance (INCEIF) at the national petuate the system. The financial institutions, level, as well as several other smaller institu- supporting rules, and methods that were cre- tions affiliated with educational institutions ated for Islamic finance were not radical or professional bodies, to meet the human departures from the existing debt-based insti- capital needs of this growing sector. Along tutions. However, with the introduction of the similar lines, Indonesia has also created cen- Financial Services Act in 2013, it is expected ters of learning and training at the national that the public will be able to distinguish and regional levels. between an Islamic and conventional financial Islamic finance has been a priority area in institution in terms of product offering, and it Malaysia for more than three decades. is hoped that this will lead to higher penetra- Because of strong policy commitment, legal, tion of Islamic finance in Malaysia. institutional, and regulatory frameworks and Table 9.3 depicts the key initiatives set out infrastructure have evolved and are in place. by MTR’s three pillars against the progress of However, despite such support and commit- Islamic finance development in Indonesia, ment, Islamic finance’s share of the market is Malaysia, and Pakistan.
TABLE 9.3 Progress in Developing Islamic Finance in Indonesia, Malaysia, and Pakistan
MTR’s three Country analysis Twenty key initiatives Remarks pillars Indonesia Malaysia Pakistan Enablement Integrate Islamic finance in national Well established in all three countries. development plans. Introduce national Islamic financial Well formulated in all three countries. services master plans. Enhance implementation and May require further development. enforcement of regulations. Harmonize, where possible, regulation Harmonization does not take place across and regulatory frameworks across jurisdictions. Furthermore, although borders. Indonesia and Malaysia share the same fiqh school of thought, in practice there are variations of financial products offered in the market. Adopt and strengthen national Malaysia may be most advanced. shari‘ah governance frameworks. Where mandates overlap, align the Adaptation and adoption are promising. positions of industry bodies. Link Islamic financial markets across Needs a boost. borders. Form a Technical Assistance and Further synergy needed. Linkage Network. Form regional working groups.
table continues next page 194 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 9.3 Progress in Developing Islamic Finance in Indonesia, Malaysia, and Pakistan (continued)
MTR’s three Country analysis Twenty key initiatives Remarks pillars Indonesia Malaysia Pakistan Foster institutions that support the provision of information about Islamic finance. Incorporate Islamic finance data in Efforts established by central banks in each statistical and official reporting. country. Performance Institute centralized R&D for Islamic This is a vital initiative that remains largely financial products in addition to the unmet. decentralized R&D. Establish diversified financial institutions. Demonstrate the industry’s distinctive Indonesia stands out, as it has introduced value proposition. the concept of sustainable finance that also fosters a harmonious relationship with economic, social, and environmental interests.a Fund public infrastructure projects to build Islamic capital markets. Reach Revitalize zaka¯t and awqa¯f for greater financial inclusion and make them an integrated part of the Islamic financial system. Ensure that regulations allow for the The act and regulations are rather silent on use of new technology to provide this matter. Pakistan has issued a affordable services. National Financial Inclusion Strategy and made some progress in exploiting new technology in delivering financial services to a wider population at lower cost. Engage with newly opened markets. Foster the financing of a wider set of economic sectors. Brand Islamic financial services for wider markets. Source: Compiled from the Mid-Term Review of the Ten-Year Framework and Strategies. a. Road map for Sustainable Finance in Indonesia 2015–2019, 16. Work is fully implemented. Work is under way. Work has started. Work needs to be initiated or developed.
Challenges and Policy Recommendations economic growth. One recent positive develop- Recognition is growing among policy makers ment is the attention that the G-20, under the in the financial sector that with its emphasis on presidency of Turkey, has given to Islamic risk sharing and asset-based financing, Islamic finance. The final communique of the G-20 finance has the potential to foster investment meeting in 2015 made explicit reference to and infrastructure, and thus to support the alternative financing, such as asset-based Group of Twenty (G-20) strategy to raise global finance, which needs to be developed through GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 195
capital markets.7 Such encouraging develop- In addition to these efforts, creating sup- ments offer significant opportunities to the portive infrastructure in the form of busi- stakeholders of Islamic finance to take core ness information bureaus that can collect principles of Islamic finance to the next level and share information about business wor- and to have Islamic finance compete at a global thiness (as opposed to creditworthiness) of level through its value proposition of risk- firms seeking finance will greatly help sharing, asset-based, and ethical finance. Islamic banks as well as other nonbank A joint G-20 draft note prepared by the institutions scale up financing to SMEs and World Bank and International Monetary microenterprises. Fund (2015), in consultation with the IDB Finally, in its developmental stage, the and other stakeholders, highlights the need Islamic financial services industry needs for integrating Islamic finance in the global strong public policy support from the govern- financial system (see box 9.3). The note calls ments and stakeholders to realize the full for the full adoption of IFSB and AAOIFI potential of Islamic finance in achieving sus- standards to manage the risks arising from tainable development and becoming a beacon exposure to equity, complexity of products, of shared prosperity. and uncertainties over resolution of Long-term sustainability of Islamic insolvency. finance can be achieved if Islamic financial
BOX 9.3 Integrating Islamic Finance into Global Finance: IMF–World Bank Joint G-20 Note
For countries that wish to further develop Islamic At the global level, actions could include the following: finance, national policies should aim to build • Increasing the G-20 membership in the Islamic an enabling environment and level the playing finance standard setters field with conventional finance. Actions could • Leveraging these institutions to further coopera- include the following: tion and experience sharing among the G-20 • Further opening up to Islamic financial ser- members, and advance standardization, notably vices, including by considering granting of suknjk licenses to new Islamic financial institutions, and • Granting membership to Islamic finance standard adapting regulatory and supervisory frameworks setters in the consultative groups of global stan- to take into account the industry’s specificfeatures dard setters with the view to strengthen the emerg- (national regulators) where deemed appropriate ing cooperation between these institutions • Exploring means for enhancing liquidity manage- • Systematically incorporating the industry’s features ment of Islamic banks (central banks) in global standards and guidance, and developing • Adapting tax systems to avoid Islamic finance accounting and statistics standards for suknjk instruments being at a disadvantage (ministries of • Stepping up the engagement of international finan- finance) cial institutions and multilateral development • Tapping into suknjk markets to finance investment banks (MDBs) in Islamic finance through analyti- through asset-pooling schemes that could allow for cal work, policy advice, and capacity development regular issuance of tradable instruments while • Expanding MDBs’ operations to include Islamic strengthening public investment frameworks (minis- finance instruments. tries of finance) • Providing the right incentives to ease access to Sources: http://www.g20.org.tr/wp-content/uploads/2015/09/IMF-WBG-Note asset-based and equity-like financing, particu- -on-Integrating-Islamic-Finance-into-Global-Finance.docx. Also see: http://g20 .org.tr/resources/current-presidency/?stream%5B%5D&wpv_column_sort larly for SMEs (ministries of finance and _ id=post_date&wpv _column_sort_dir=desc&wpv_post_id=4472&wpv_view regulators). _count=4475 -CPID4472&wpv_paged=1. 196 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
services have a positive impact on the lives Many of the problems in the current direc- of a broader spectrum of people. Islamic tion the Islamic finance industry is taking and finance holds the promise of sharing risk, its deficiencies in achieving the goals of risk sharing prosperity, promoting social and sharing and shared prosperity can be traced economic justice and ethical finance, to the tendency to avoid addressing these sys- strengthening linkages with real economic temic challenges. When faced with bottle- activity, increasing the stability of financial necks, which the individual financial systems, and supporting the pursuit of institutions cannot correct by themselves, the mutual gains with social responsibility. To players in the industry tend to seek out sub- realize these benefits, policy makers need to optimal short-term solutions. These devices address the challenges and issues that are or strategies provide them a way out of the constraining the proper development of difficulty, but they do not necessarily generate Islamic finance. The policy stance must be long-term solutions or foster institutional clear, firm, and openly made in coordina- development. This short-term, self-interested tion with various stakeholders. approach also dilutes the spirit and objectives Development of sustainable legal and of Islamic finance. Hence intervention by the economic institutions—as envisioned by the authorities and coordination of efforts by all principles of Islamic economics and articu- stakeholders to create an enabling environ- lated in chapter 1—should be the first prior- ment for Islamic financial sector is very ity. Development of institutions cannot be important. done overnight; it takes time and requires As discussed in this Report, Islamic finance strong commitment and efforts by policy emphasizes financing economic transactions makers. A long-term view and vision is through trade finance, leasing, partnership, required to achieve the full potential of such and securitization through asset-backed institutions. Issues can be prioritized as part suku¯k. Hence it can directly contribute to eco- of the strategy by the national and supra- nomic growth and shared prosperity. This national authorities, instead of avoiding them approach entails commercial and economic because they are difficult. Some recent devel- risk taking and managing of those risks. opments are highlighted in box 9.4. However, the financial sector supervisory
BOX 9.4 Regulatory Developments at the International Level: Supporting Shared Prosperity
In the regulatory arena, a recent development is the industry, International Islamic Financial Markets issuance of core principles of the regulation of (IIFM), has come up with two initiatives. The first is Islamic finance by the Islamic Financial Services standardization of documents for various hedging and Board (Standard No. IFSB-17) (IFSB 2015). One of capital market products. The second is its work the stated objectives of IFSB-17 is to link the finan- toward creating bankruptcy resolution regimes for cial sector with the real economic sector (see para. 8 suku¯k. This second initiative is conducive to promo- of IFSB-17). Such a linkage is one of the key features tion of shared prosperity by streamlining shari‘ah of Islamic finance to promote the sharing of compliance and quick resolution in case of default and economic and enterprise risks among investors and bankruptcy. financiers. Source: Standard No. IFSB 17 is available at http://www.ifsb.org/standard/. In the area of Islamic capital markets, the advo- Note: More information about IIFM activities can be found at http://www.iifm.net/. cacy organization for the Islamic financial services GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 197
frameworks that exist in many countries regulations, liquidity management, taxation, focus only on financial risk management and bankruptcy resolution, and infrastructure to thus hinder the growth of Islamic finance. For support asset-backed financing. Sector-specific Islamic finance to flourish, key reforms are policy recommendations are presented in needed in the areas of financial sector table 9.4.
TABLE 9.4 Recommendations and Policy Interventions by Sector
Institutional framework Risk sharing and Financial and social Governance and leadership and public policy entrepreneurships inclusion Banking • Create an enabling regulatory • Harmonize shari‘ah • Introduce innovative • Enhance the scale of environment by supporting governance through efforts risk-sharing products and and access to consistent regulations and to unify cross-country services, rather than Islamic finance to ensuring consistent shari‘ah rulings about replicating conventional include low-income implementation of the Basel Islamic finance. risk-transfer products. earners. III and Islamic Financial • Bolster human Services Board (IFSB) capital. framework. • Increase Islamic • Ensure that systemic risks in finance literacy. dual banking systems (conventional and Islamic) are addressed. • Implement cross-border supervision. • Improve liquidity. • Ensure stability. Capital markets • Create a level playing field for • Incorporate higher ethical • Encourage investment in • Introduce retail debt and equity instruments standards through a equities, which is the suku¯k for smaller by transparent governance purest form of risk investors. 0 Eliminating the tax mechanism and robust sharing that not only • Relax the condition shelter on interest regulatory framework. distributes wealth more for listing of expense. • Improve shari‘ah equitably but also creates companies in order to 0 Allowing tax-free transfer governance: more jobs and enhances provide a larger of assets in asset-backed 0 Align shari‘ah screening shared prosperity. universe of equities suku¯k or at least treat standards for equities • Improve the scalability for investment. the transfer fee as a tax- across jurisdictions and liquidity of suku¯k by deductible expense. 0 Publish shari‘ah providing an enabling screening standards, environment for trading and list compliant suku¯k in secondary equities for the markets. convenience of investors • Provide incentives for on a periodic basis. issuing long-term suku¯k • Provide disclosures relevant based on more equity-like to shari‘ah compliance, structures such as especially events that may mud. a¯ rabah and trigger noncompliance in musha¯rakah. the regular reporting of firms. • Strengthen resolution frameworks and investor protection mechanisms. table continues next page 198 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
TABLE 9.4 Recommendations and Policy Interventions by Sector (continued)
Institutional framework Risk sharing and Financial and social Governance and leadership and public policy entrepreneurships inclusion Taka¯ful • Adopt a holistic approach • Establish clear and • Introduce taka¯ful and • Allow participants to while formulating the policy transparent corporate microtaka¯ful as a mode use microtaka¯ful for guidelines for the industry governance and a regulatory for pooling risk and savings and that takes into consideration framework for the formal as assets. investment. both the industry and well as informal taka¯ful • Recognize that the • Allow microtaka¯ful consumer in a shari‘ah- operations. long-term shari‘ah- for family, health, compliant manner. • Regulate the taka¯ful compliant investment crop, livestock and • Design policies that balance industry based on its risk from the savings and property based on the protections for characteristics. A investments in taka¯ful cooperative participants’ rights with the risk-based approach may be funds can be a critical (waka¯lah-partner) need for effective pricing, desirable; however, this source for economic model. greater solvency, operators’ should take into development. financial sustainability, good consideration the difference • Encourage investment in business conduct, and between conventional capital market relevant disclosures. insurance and taka¯ful. instruments. • To avoid confusion among • Set requirements for Muslims, set up a board solvency purposes on the consisting of shari‘ah investment activities of scholars at the national level taka¯ful in order to address to provide guidance as to how the risks faced by the to implement taka¯ful. operators. • Expand investment through the Islamic capital market to provide flexibility in the implementation of the risk-based capital regime. Nonbank • Develop policies that require • Develop legal infrastructure • Enhance diversification by • Increase the number financial strong investor protection and to support contract directing more financing and diversity of institutions stringent disclosure enforcement. This is a to small and medium Islamic NBFIs. (NBFIs) requirements as far as the prerequisite for the enterprises relative to • Encourage Islamic investment is concerned. development of the financial larger firms. NBFIs to provide • Ensure that the products and sector, as it not only reduces • Develop skills and Islamic financial activities of NBFIs comply transaction costs but also alternative approaches to services in countries with shari‘ah. enhances investor mitigate risks (moral where establishing confidence. hazard) through proper Islamic banks is not • Clearly define regulatory monitoring and possible due to legal requirements such as evaluation. and regulatory licensing, disclosure, and restrictions. corporate governance. table continues next page GLOBAL REPORT ON ISLAMIC FINANCE PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY 199
TABLE 9.4 Recommendations and Policy Interventions by Sector (continued)
Institutional framework Risk sharing and Financial and social Governance and leadership and public policy entrepreneurships inclusion Islamic social • Recognize the diversity in • Create a network of • Mitigate and absorb high • Recognize self- finance zaka¯t management practices supporting infrastructure risks with financing to the exclusion as a key around the world and create institutions, including poor through mechanisms problem due to an adequately flexible and research, training, and rooted in philanthropy and religious, cultural, enabling regulatory advocacy for the sound and benevolence. and ethical beliefs of environment. orderly function of Islamic • Make innovative use of the poor. • Introduce/reform the waqf social finance institutions. zaka¯t and waqf to create • Enhance social and regulatory framework in order • Develop a sound governance risk management tools human capital to establish waqf as an system that recognizes the (credit enhancement/ through community institution in the voluntary significance of trust and guarantees and empowerment sector. credibility as key drivers microtaka¯ful). initiatives funded • Recognize Islamic social underlying Islamic social through the finance as a sustainable finance. sustainable Islamic means of absorbing • Harmonize the financial social funding operational cost and provide reporting of the Islamic instrument. “affordable” financing to social finance institution to the poor. enhance transparency.
Notes References 1. Project-specificsuku ¯ k are the suku¯ k that are Ahmed, Habib, Mahmoud Mohieldin, Jos Verbeek, issued for financing a specific project (or a and Farida Wael Aboulmagd. 2015. “On the well-defined set of projects), and they gener- Sustainable Development Goals and the Role ate returns for suku¯ k holders from the same of Islamic Finance.” Policy Research Working project(s). For a general definition of suku¯ k, Paper 7266, World Bank, Washington, DC. see the glossary. Bank Negara Malaysia. 2013. “Islamic Financial 2. See Palley (2007), who notes that the princi- Services Act 2013.” http://www.bnm .gov.my pal impacts of financialization are to elevate / documents/act/en_ifsa.pdf. the significance of the financial sector relative Ernst & Young. 2015. World Islamic Banking to the real sector, transfer income from the Competitiveness Report 2016. http://www real sector to the financial sector, and increase .ey.com/Publication/vwLUAssets /ey-world income inequality and contribute to wage -islamic-banking -competitiveness-report stagnation. -2016/$FILE/ey-world-islamic -banking 3. http://kemenag.go.id/file/dokumen/UU3899 -competitiveness-report-2016.pdf. .pdf. 4. NPWZ stands for Nomor Pokok Wajib IFSB (Islamic Financial Services Board). Zaka¯t, or zaka¯t ID number. 2015. IFSB 17 Core Principles for Islamic 5. Retail suku¯ k in Indonesia are available to Finance Regulation (Banking Segment). individual investors, as opposed to only insti- http://www .ifsb.org/standard/IFSB17-%20 tutional investors. The minimum investment Core%20Principles%20for%20Islamic%20 requirement is Rp 5 million (about $350). Finance%20Regulation%20(Banking%20 6. For the Prudential and Structural Islamic Segment) -April%202015_final.pdf. Financial Indicators (PSIFIs) data, see http:// IRTI, IDB, and IFSB (Islamic Research and ifsb.org/psifi_01.php. Training Institute, Islamic Development Bank, 7. http://www.g20.org/English/Documents and Islamic Financial Services Board). 2014. /PastPresidency/201512/t20151201_1661 Islamic Financial Services Industry Develop- .html. ment: Ten-Year Framework and Strategies. 200 PUBLIC POLICY MEASURES TO ENHANCE SHARED PROSPERITY GLOBAL REPORT ON ISLAMIC FINANCE
A Mid-Term Review. http://www.ifsb.org SBP (State Bank of Pakistan). Various years. “Vari- / docs/2014 -05-12A%20MID-TERM%20 ous Speeches of the Governor and Deputy Gov- REVIEW%20FINAL.pdf. ernors.” http://www.sbp.org.pk. OJK (Indonesia’s Financial Services Authority). ———. 2014. Strategic Plan Islamic Banking 2015a. “Roadmap for the Development of Industry of Pakistan 2014–2018. http://www Islamic Banking.” http://www .ojk.go.id/id .sbp.org.pk/departments/pdf/StrategicPlanPDF / kanal /syariah/berita-dan -kegiatan /publikasi /Strategy%20Paper-Final.pdf. / Documents/roadmap -pbs_2015 -2019.pdf. ———. 2015a. National Financial Inclusion ———. 2015b. “Roadmap for Islamic Capital Strategy. http://www.sbp.org.pk/AC&MFD Market Development.” http://www.ojk.go.id / Events/National-Financial-Inclusion-Strategy / Files/box/roadmap-pms_2015-2019.pdf. - Pakistan.pdf. ———. 2015c. “Roadmap for Sustainable Finance ———. 2015b. “Framework of Warehouse Receipt in Indonesia 2015–2019.” http://www.ojk Financing in Pakistan.” A Consultative Paper. .go .id/id/berita-dan-kegiatan/publikasi/Pages http://www.sbp.org.pk/acd/Guidelines/2014 / Roadmap-Keuangan-Berkelanjutan-Sarana / Draft-Frmwork-Warehouse-Receipt-Financing -Berinovasi-LJK.aspx. .pdf. Palley, Thomas I. 2007. “Financialization: What It World Bank and IMF (International Monetary Is and Why It Matters.” Working Paper 153, Fund). 2015. “Integrating Islamic Finance into Political Economy Research Institute, Univer- Global Finance.” Draft Note for the G-20. http:// sity of Massachusetts, Amherst. http://www www.g20.org.tr/wp-content / uploads/2015/09 .peri.umass.edu/fileadmin/pdf/working_papers /IMF-WBG-Note-on-Integrating-Islamic / working_papers_151-200/WP153.pdf. -Finance-into-Global-Finance.docx. Chapter Attributions
Team Leads Team Coordinators Mohamed Azmi Omar, Director General, Dawood Ashraf, Senior Researcher–Islamic Islamic Research and Training Institute, Finance, IDBG Islamic Development Bank Group (IDBG) Nihat Gumus, Financial Sector Specialist, Zamir Iqbal, Lead Financial Sector Specialist, World Bank Finance and Markets (F&M) Global Practice, World Bank
GLOBAL REPORT ON ISLAMIC FINANCE 201 202 CHAPTER ATTRIBUTIONS GLOBAL REPORT ON ISLAMIC FINANCE
Authors by chapter
Chapter number Chapter title Author(s) Overview Dawood Ashraf (IDBG) World Bank staff 1 Islamic Finance and Shared Prosperity World Bank staff 2 The State of Development and Shared Prosperity in World Bank staff OIC Countries 3 The Islamic Banking Sector Ousmane Seck (IDBG) Muhamed Zulkhibri (IDBG) Tamsir Cham (IDBG) Anis Ben Khedher (IDBG) World Bank staff 4 Islamic Capital Markets Syed Salman Ali (IDBG) Dawood Ashraf (IDBG) Anis Ben Khedher (IDBG) World Bank staff 5 Taka¯ ful (Islamic Insurance), Retaka¯ ful, and Microtaka¯ ful Ezamshah Ismail (INCEIF) World Bank staff 6 Nonbank Financial Institutions Habib Ahmed (Durham University) World Bank staff 7 Alternative Asset Classes Rodney Wilson (INCEIF) Dawood Ashraf (IDBG) 8 Islamic Social Finance Mohammed Obaidullah (IDBG) Nasim Shah Shirazi (IDBG) 9 Public Policy Measures to Enhance Shared Prosperity Salman Syed Ali (IDBG) Hylmun Izhar (IDBG) World Bank staff Note: IDBG = Islamic Development Bank Group; INCEIF = International Centre for Education in Islamic Finance. Index
Boxes, figures, notes, and tables are indicated by “b,” “f,” “n,” and “t” respectively.
A Africa. See Middle East and North African countries; Sub-Saharan Africa; specific AAOIFI. See Accounting and Auditing countries Organization for Islamic Financial Agarwal, Sumit, 75 Institutions Ajaji Medical Group, 142 Aayan Leasing and Investment Company, Akhuwat case study, 155, 156b 135n8 Al-Aman Fund for Microfinance Abu Halima projects (Sudan), 57–58, 58b, 163 case study, 159, 159b access to finance Al-’Aqar Healthcare REIT, 146 constraints on, 51–53, 62, 126 Al Hadharah, 145 Islamic banking sector, 62, 69–70, 72 Alkhabeer Capital, 141–42, 141t Islamic social finance, 153 Alkhabeer Health Care Private Equity Fund I micro, small, and medium enterprise (MSME) (AHPEF I closed fund), 142 sector, 69 Alkhabeer Private Equity, 142 microfinance.See microfinance Alkhabeer SME Fund I, 142 mutual funds, 124 Al-Masri, Rafic Yunus, 78 NBFI sector, 4, 133 Al-Salam REIT case study, 145–46 public policy’s role in facilitating, 26 alternative asset classes, 139–51 recommendations to improve, 3, 72, 183 Alkhabeer Capital case study, 141–42, 141t SMEs’ access. See small and medium-sized desirability of asset diversification, 139 enterprises economic development and, 149 technology to facilitate, 133 তalƗl foodstuffs investment, 146–47 accountability. See transparency and তalƗl cluster in Dubai Industrial City case accountability study, 147 Accounting and Auditing Organization for Islamic hedge funds, 140, 142–44 Financial Institutions (AAOIFI), 12, 71, Shari‘ah Capital case study, 143–44 88, 97, 108, 183 Islamic private equity investment, 140–42 accounting norms, 178, 183
GLOBAL REPORT ON ISLAMIC FINANCE 203 204 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
overview of, 139–40 Bank of Khartoum (Sudan), 58b, 159b project finance, 148–49 bankruptcy resolution regimes, 196b IDB’s funding for electricity in Mozambique Bankscope on size and structure of (case study), 148–49, 149t Islamic banks, 63, 67 real estate investments, 144–46 Barclay Hedge, 144 Al-Salam REIT case study, 145–46 Barro, Robert J., 48 regulatory implications and policy Basel III compliance, 3, 65, 70–71 recommendations, 150 suknjk issuance and, 85 risk diversification and, 140 Beck, T., 75 shari‘ah-compliant assets, 140, 149 Bekaert, G., 75 traded commodities investment, 147–48 Bello, Abdullateef, 55n2 Jadwa Saudi Riyal MurƗbahah Fund case bond market. See suknjk study, 148 Bowles, Samuel, 20 Amal Business Organizations (ABOs), 160b Brunei Darussalam Amana Mutual Funds, 124 mobilization of zakƗt collected in, 165 Ansar Leasing of Azerbaijan case study, 131b zakƗt distribution to poor in, 169 arboun (option contracts), 143 Burkina Faso, microinsurance in, 106 Arcapita Bank, 135n8 business information bureaus, 195 Arrow, K. J., 38n14, 99n1 ASEAN countries, takƗful industry in, 106, 107f Asia. See also specific countries and regions C housing finance in, 129t Cameroon, microinsurance in, 106 Islamic banking assets in, 67, 67f Canada, finance companies offering Islamic middle-income trap in, 18 housing products in, 130b, 132 shari‘ah compliant banks in, 67 Capital in the Twenty-First Century (Piketty), 17 suknjk market analysis in, 84–85, 85t capital markets. See Islamic capital markets Askari, H., 55n4, 73n2 Central Bank of Bahrain, 108 ASR Leasing case study, 131b Central Bank of Sudan, 58b asset-backed securitization. See suknjk China, economic growth and poverty asset-based redistribution, 32 alleviation in, 19 compared to income-based COMCEC, 79, 99n5 redistribution, 2, 21, 32 community-driven development (CDD) with as productivity enhancement, 21 Islamic social finance, 157 risk-sharing approach of, 2, 21, 24f Dompet Dhuafa Republika (DDR) case study, asset-based securities. See suknjk 157, 157–58b Asset Management Recovery Corporations, need Consultative Group to Assist the to establish, 65–66 Poor (CGAP), 153 awqƗf. See waqf consumer protection, 133 Axis REIT, 146 contracts, 2, 21, 27b, 28, 35b corporate social responsibility (CSR) initiatives, 160b B corruption, 48, 173 Bahrain credit retakƗful operators in, 109 compared to other forms of finance, 32f shari‘ah-compliant financial services in, 60, 71 comparison of OIC with non-OIC countries takƗful industry in, 112, 113 and, 50–51, 51f bailouts, 59, 76 dangers of increasing amounts of, 18 Bangladesh nonperforming loans (NPLs), 65 Islamic banking sector in, 63 crowdfunding, 127, 127–28b microfinance programs in, 160, 161b resource gap in, 163, 163t D zakƗt distribution to poor in, 169 banking sector. See Islamic banking sector Dar, H., 73n5 Bank Negara Malaysia, 184 Debreu, G., 99n1 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 205
debt finance, 30–31b Eed Group (Saudi-based health care compared to equity finance, 53 company), 142 Islam banking sector and, 58 entrepreneurship, promotion of, 25, 36b decoupling, 76 environmental sustainability, 22b, 35b Demirgüç-Kunt, Asli, 52, 75 equity-based financing, 29, 30–31b, 32, 32f. derivatives trading, 77, 143 See also suknjk developing countries. See also shared compared to debt finance, 53 prosperity; wealth gap in Islamic finance, 77 good public policy, effectiveness of, 32 Islamic private equity growth rates, need to maintain, 19 investment, 140–42 infrastructure investment in, 92, 105 microfinance institutions (MFIs), start-up innovative social finance and, 36b equity from, 162 SDGs and, 21 shift to debt-based finance as danger, 69 SMEs in, 126 venture capital, 141 women in, 177b equity-efficiency trade-off, 37n2 dignity, 9, 24, 25 European Commission (EC), on effects of disclosure requirements inequality, 18 Islamic capital markets, 97–98 Europe and European Union takƗful operators, 116t EU directives on alternative discrimination, 60b investments, 13, 150 distributive justice, 26 suknjk market analysis in, 84–85, 85t Diwan (Sudan), 159b, 167, 172 Dompet Dhuafa Republika (DDR) case study, 157, 157–58b F Dow Jones, 79 Fa’el Khair Program case study, 160, 161b Dridi, J., 73n2 fairness, as Islamic principle, 2, 34 DSAM (Dubai Shari‘ah Asset Management), 144 family empowerment, 177–78 DSAM Kauthar Energy Fund, 144 family waqf, 169 DSAM Kauthar Global Resources & Mining Fault Lines (Rajan), 18 Fund, 144 financial inclusion, 22b, 24f, 32–34, 36b, 37. DSAM Kauthar Gold Fund, 144 See also redistribution Dubai Islamic banking sector and, 3, 59–60b, 59–62, retakƗful operators in, 109 67, 69, 182t Supreme Council of Energy, 125b policy recommendations, 181, 182t, 192 Dubai Commodity Asset Management state of development and, 47t, 50–52, 51f (DCAM), 144 suknjk and, 182t Dubai Financial Services Authority, 184 financialization defined, 37n11 E effects of, 76, 188, 199n2 overfinancialization, 25 East Asia, poverty alleviation in, 10, 19f financial literacy economic empowerment of the poor, 155 Islamic banking sector recommendations economic growth. See also shared prosperity and, 3, 72–73 financial development linked to, 55n6 Islamic finance in Malaysia and, 112 Islamic banking sector and, 67, 68b microinsurance schemes and, 106 Islamic perspective on, 23 NBFI sector and, 133 poverty alleviation linked to, 48 policy recommendations, 183 stock markets’ contribution to, 50, 75 as protection against exploitation, 176 World Bank Group on, 22b financial sector development, 34, 35–36b, 35t. Edhi Foundation (Pakistan), 166 See also Islamic banking sector education and training. See also financial literacy; depth and interaction with shared prosperity, human capital 47t, 52–53, 53–54f financed byzak Ɨt, 155, 161–62 official financial institutions in OIC policy recommendations, 192–93 countries, 52 206 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
financial stability ণalƗl Industry Development Corporation, 147 improvements in, 3 Han, Xuehui, 49 Islamic banking sector and, 59, 70, 181, 182t Hanbali School of Islamic jurisprudence, 143 indicators of, 65–67, 66t hard redistribution of wealth, 20 policy recommendations, 72 harmonization initiatives, 3, 92, 97–98, 112, Islamic capital markets and, 181, 182t 167, 183, 190 policy recommendations, 181, 182t, 183 Harvey, C. R., 75 Financial Times Stock Exchange (FTSE), 79 Hassan, M., 73n2 fiqh (Islamic jurisprudence), 143 health care and dialysis services, provision to fiscal sustainability, 22b the needy, 160b hedge funds, 140, 142–44 G Shari‘ah Capital case study, 143–44 House Building Finance Corporation Limited G-20 (Group of Twenty) (HBFCL), 129 on integrating Islamic finance with global housing finance, 127–29, 129t systems, 5, 72 mushƗrakah structure, 135n3 IMF–World Bank Joint G-20 regulation of, 135 Note, 14, 194–95, 195b risk-sharing contracts, use of, 128 on SMEs financing, 113 shari‘ah -compliant financing in Canada, 130b strategy to raise global economic growth, 194 human capital gambling, as forbidden practice, 77, 78, 99n2, 143 policy recommendations, 3, 72–73, 192–93 Gavi (Global Alliance for Vaccination and shortage of skilled human resources Immunization), 95, 99n13 in Islamic banking sector, 71–72 gender discrimination, 60b in NBFI sector, 132 General Council for Islamic Banks and Financial human rights, 24 Institutions (CIBAFI), 184 Husain, Ishrat, 55n2 global debt levels, 30–31b global financial crisis (2008–09), 63, 127–28, 133 globalization of finance and trade, 37n1, 70 I governance and leadership as pillar of Islamic finance, 24f, 25, 28–29, 35b, 37 IBBL (Islami Bank Bangladesh Limited), Rural state of development and, 47t, 48–49 Development Scheme, 177–78b governance reforms, 22b IDB. See Islamic Development Bank Government Effectiveness Indicators (GEI, World IEI (Islamic equity index), 79 Bank), 49, 49f IFA (Islamic Fiqh Academy), 13, 121, 150 greenhouse project in Sudan (Abu Halima), IFC (International Finance Corporation), on SME 57–58, 58b, 163 financial product offerings, 126 green suknjk, 125b IFFIm (International Financial Facility for guarantee fund with zakƗt, 158–59 Immunization), 95–96 Al-Aman Fund for Microfinance case study, 159b IFSB. See Islamic Financial Services Board Guiding Principles for Islamic Collective IICRA (International Islamic Center for Investment Schemes (IFSB), 13, 150 Reconciliation and Arbitration), 183 Gulf Cooperation Council (GCC) countries IIFM (International Islamic Financial Markets), Islamic banking sector in, 63, 65, 66 183, 196b Islamic funds in, 123, 124f IIRA (International Islamic Rating Agency), 183 Islamic private equity finance in, 141 ijƗrah (leasing) financing companies, 12–13, retakƗful operators in, 109 131, 131b sustainable development as priority in, 125b Imam, P., 68b takƗful industry in, 106, 107f IMF. See International Monetary Fund inclusiveness. See financial inclusion; social inclusion H income-based redistribution তalƗl foodstuffs investment, 146–47 compared to asset-based redistribution, 2, 32 তalƗl cluster in Dubai Industrial City case study, new social contract and, 20 147 theories to explain deterioration in, 37n1 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 207
India how development of financial sector can leasing with waqf assets in, 173 promote shared prosperity, 35b microinsurance in, 106 policy recommendations and poverty alleviation in, 165 reforms, 3, 22b, 182 resource gap in, 163, 163t state of development and, 47t, 48 zakƗt in insurance. See takƗful base and potential, 164, 164t interest distribution to poor, 169 interest-free microloans (case study of Fa’el Indonesia Khair program), 161b classification of, 120, 120t prohibition on, 29, 53, 58 diversification in financial sector in, 190–91 tax deductibility of, 30b financial reporting’s inclusion of Islamic International Finance Corporation (IFC), on SME finance data, 192 financial product offerings, 126 Financial Services Authority (OJK), 188, 189b International Financial Facility for Immunization human capital, development of, 193 (IFFIm), 95–96 integration of Islamic finance in national International Islamic Center for Reconciliation development plans, 188, 189b and Arbitration (IICRA), 183 Islamic banking sector in, 63, 65 International Islamic Financial Markets (IIFM), MTR’s Key Initiatives, implementation 183, 196b of, 188–93 International Islamic Rating Agency (IIRA), 183 progress on, 193–94f International Monetary Fund (IMF), 17 National Committee in Islamic Finance, 188 on increase in wealth gap, 18 nonbank financial institutions (NBFIs) in, 120 on integrating Islamic finance into global overlapping financial institutions in, 190 financial system (IMF–World Bank Joint poverty alleviation in, 165 G-20 Note), 14, 195, 195b retail suknjk, introduction of, 199n5 MDGs and, 18–19 shari‘ah-compliant financial services in, 71 World Economic Outlook, 59 shari‘ah scholars, limitations on financial International Shari‘ah Research Academy (ISRA), positions of, 190 13, 150, 193 stock markets in, 77 Investment Dar, 135n8 sustainable finance program in, 188, 189b Iqbal, Zamir, 28 takƗful industry in, 106, 110 Iran, Islamic Republic of waqf in financial system based solely on Islamic asset development, 166 finance, 63, 66 legal requirements, 173 Islamic banking sector in, 65, 66 zakƗt in IRTI (Islamic Research and Training Institute), 11, distribution to poor, 169 96, 184. See also Mid-Term Review mobilization of, 165–66 Islami Bank Bangladesh Limited (IBBL), Rural National Act on ZakƗt Management, 192 Development Scheme, 177–78b tax deductibility of, 192 Islamic Bankers’ Forum (Kuwait 2006), 184 trust of government in handling of, 168 Islamic banking sector, 3, 10–11, 57–74 inequality. See also wealth gap access to finance, recommendations to among OIC countries, 36 improve, 69, 72 increasing, 17–18, 37nn1–2, 43, 45f Asset Management Recovery Corporations, negative impact of, 20 need to establish, 65–66 information asymmetry, 30b, 36b, 37, 134–35 Basel III compliance, 65, 70–71 infrastructure financing, 87, 90–92 capital adequacy ratio (CAR) for, 65 infrastructure policy recommendations, 182t, 183 challenges facing, 67–68 inheritance rules, 33, 34 distinguished from conventional banking, 3 innovation divergence between theory and practice Islamic banking sector, need for, 70 of, 3, 68–69, 69f social finance and, 36b economic growth and, 67, 68b institutional framework of Islamic finance, 24, estimates of size of, 73n4 24f, 25–28 financial inclusion and, 59–60b, 59–62, 67, 182t 208 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
by country, 60, 61–62t risk-return analysis of shari‘ah moving from theory to practice, 69 indexes, 78–81, 99n3 financial stability and, 59, 70, 182t risk sharing, 76 financing by sector (2012), 64, 65f need for more incentives for, 96–97 large-scale Islamic financial institution, need screening of companies involved in for, 69–70 prohibited activities, 77, 99n3 liquidity and, 65, 70–71, 70t shared prosperity and, 75–77, 181 policy recommendations, 72 shari‘ah compliance, 77 micro, small, and medium enterprise (MSME) need to harmonize rulings, 97–98 sector, potential represented by, 69 short selling, not allowed under shari‘ah, 77 mobilization of, 3 socioeconomic development and, 93–96 nonperforming loans (NPLs), 65 speculation, not permitted activity, 77, 78–79 opportunities to serve the poor, 62 suknjk market, 4, 77, 81–92. See also suknjk performance of, 65–67, 66t underdevelopment of, 77, 92 policy recommendations for, 6t, 72–73, 197t Islamic Development Bank (IDB) potential for expanding, 64 Abu Halima project in Sudan and, 58b profit-sharing investment accounts (PSIAs), 71 development strategy of, 21, 23b recent developments and current status of, 62–67 Fa’el Khair Program case study, 160, 161b regional perspectives, 67, 67f housing finance in member countries, 129 regulatory supervision, need to IDBG Vision, 23b increase, 3, 65–66, 70, 72 MDGs and, 18–19 risk sharing and, 3, 58–59, 68, 73n2 Medium-Term Note (MTN) Program, 85, scale, access, and outreach of, 69–70 93–95, 94b shared prosperity and, 57–58, 181 microfinance and, 159b shari‘ah compliance in, 57, 60, 62, 71 nonbank financial sector in member policy recommendations, 3, 72 countries of, 120–21 size and structure of, 63–65, 63f, 64t reports on state of Islamic banking skilled human capital, effect of and, 73n4 shortage of, 71–72 rural electricity in Mozambique (case study), policy recommendations, 72–73 148–49, 149t soundness, stability, and efficiency of, 70 suknjk, use of, 93–95, 148 indicators of, 65–67, 66t 10-Year Strategy (10-YS), 2, 23b, 183, 184 policy recommendations, 72 Islamic equity index (IEI), 79 Islamic capital markets, 4, 11, 50, 75–101. Islamic finance See also stock markets asset-based, 2 attestation requirements, 98 challenges and policy recommendations, 194–97 comparing performance of S&P shari‘ah- contracts and, 27b, 28, 35b compliant indexes with conventional debt finance and, 30–31b indexes, 79–80, 80–83f distribution and redistribution and, 27b current status of, 77–78 economic tenets of Islam and, 21, 23, 26 market capitalization vs. capital financial institutions.See Islamic banking formation in OIC and non-OIC sector countries, 77–78, 78f G-20 focus on, 14, 194–95. See also G-20 derivatives trading, not allowed under (Group of Twenty) shari‘ah, 77, 143 key institutions of, 26, 27b, 37n10 disclosure requirements, 97–98 key redistribution instruments, 33b IDB’s use of, 93–94 markets and, 27, 27b investor protection, strengthening of, 98–99 modes of, 58 Islamic stock market based on core values, overview, 17–21 76–77, 76f pillars of, 9, 23–34, 24f liquidity, 76, 98 financial and social inclusion, 25, 32–34, policy recommendations, 3, 6t, 96–99, 197t 36b, 47t, 50–52 regulatory supervision and harmonization of, institutional framework, 24, 25–28, 35b, 92, 97 47t, 48 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 209
responsible governance and leadership, 25, women’s empowerment and, 177–78b 28–29, 35b, 37, 47t, 48–49 zakƗt. See also zakƗt risk-sharing finance, 2, 25, 29–32, 35–36b, community-driven development with, 157, 49–50 157–58b state of development and, 47–48, 47t distributive role of, 154–55 profit-sharing basis found to be minimal in, 69 estimating potential resources from, 163–64 property rights and, 27b, 28, 35b guarantee fund with, 158–59, 159b public policy’s role in, 26–28 integration with microfinance, policy recom- redistribution of wealth and, 2 mendations for, 174–77, 182t shared prosperity and, 181 low-cost microcredit with, 155–56 short-term solutions, negative effects of, 196 mobilizing resources from, 165–68 social finance.See Islamic social finance policy recommendations to improve use of, socially responsible investment 170–72, 191–92 (SRI) and, 125b poverty alleviation through, 154, 161 trust and, 27b revolving credit from pooled proceeds of, Islamic financial institutions.See Islamic 156b banking sector trends in use of, 169–70 Islamic Financial Services Board (IFSB), 11, 96, Islamic Social Finance Report 2014, 165 97, 183. See also Mid-Term Review Islamic trusts. See waqf framework, 3, 71, 73n6, 184, 195 ISRA (International Shari‘ah Research Academy), Guiding Principles for Islamic Collective 13, 150, 193 Investment Schemes, 13, 150 Standard No. IFSB-17, 196b Islamic Fiqh Academy (IFA), 13, 121, 150 J Islamic Research and Training Institute (IRTI), 11, Jadwa Saudi Riyal MurƗbahah Fund 96, 184. See also Mid-Term Review case study, 148 Islamic social finance, 5, 153–79 Johor Corporation (Malaysia), 145, 159, 160b Akhuwat case study, 155, 156b Fa’el Khair Program case study, 160, 161b financial inclusion and, 182t K hybrid models of, 161–63 Kaldor, N., 37n2 output or revenue sharing, 176, 179n13 Katsipis, Vasilis, 116n3 policy recommendations, 8t, 165–69, 199t Khan, Haider Ali, 49 poverty alleviation through, 5, 154, 161, Khazanah Nasional (Malaysia sovereign wealth 163, 175, 181 fund), 125b s.adaqƗt khums (levy on income), 34 community-driven development with, 157 King, R., 75 low-cost microcredit with, 155 Klapper, Leora, 52 revolving credit from pooled proceeds of, Kpodar, K., 68b 156b Krichene, N., 73n2 social tax, estimating potential resources Kumhof, M., 37n4 from, 165 Kuwait, shari‘ah-compliant financial waqf. See also waqf services in, 60 estimating potential resources from, 164–65 Kuznets, Stanley, 37n3 Fa’el Khair Program case study, 160, 161b fair and affordable prices, role in establishing, 159–60 L integration with microfinance, policy recom- Labuan Business International Financial mendations for, 174–77, 182t Center, 109 mobilizing resources from, 166, 168–69 large-scale Islamic financial institution, need for, policy recommendations to improve use of, 69–70 172–74, 191–92 Lazear, Edward P., 37n2 sustainable provision of social goods leasing companies through, 159 Ansar Leasing of Azerbaijan case study, 131b 210 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
ijƗrah companies and, 131, 131b waqf asset development in, 166, 173 need for expansion of, 133 zakƗt in regulation of, 134 distribution to poor, 169 Lebanon mobilization of, 165, 166 Agricultural Mutual Fund, 111 Malaysia External Trade Development microtakƗful in, 111 Corporation, 146–47 Levine, Ross, 50, 55n6, 75 Malaysia Trust Certificates, 85 liquidity Maliki School views on zakƗt base, 164 capital markets, 76, 98 maqƗs͓d al-sharƯ‘ah (Objectives of Islamic Law), improvements, 3 24–25, 28, 57, 73n1 of Islamic banking sector, 65, 70–71, 70t, 72 markets, 27, 27b, 38n14 policy recommendations, 72, 98, 183 Mauritius, waqf in literacy. See financial literacy family waqf, 169 Liwwa (lending platform), 127–28b leasing with waqf assets, 173 loans to the poor, 170, 174. See also access to legal requirements, 173 finance; microfinance maysir (forbidden practice), 143 low-income earners, access to Islamic finance, 3 MCB-Arif Habib Savings, 124 MDGs. See Millennium Development Goals Meezan Tahafuzz Pension Fund, 124 M MENA. See Middle East and North African macroeconomics, 27–28, 34 (MENA) countries Malaysia MFIs. See microfinance institutions financial literacy in Islamic finance in, 112 Mian, Atif, 2, 128 financial reporting’s inclusion of Islamic finance micro, small, and medium enterprise (MSME) data, 192 sector, 3, 69, 174 human capital, development of, 193 microfinance, 36b, 62, 126, 133. See also integration of Islamic finance in national microtakƗful development plans, 189 administrative costs associated with, 174–75 International Centre for Education in Islamic hybrid models of, 161–63 Finance (INCEIF), 193 Islamic social finance and microcredit, 155 International Shari‘ah Research Academy in Pakistan, 191b (ISRA), 13, 150, 193 waqd used to fund, 160, 161b Islamic banking sector in, 63, 65, 112, 189 women’s empowerment and, 177, 177–78b Islamic Financial Services Act, 189 zakƗt and, 170 Islamic private equity finance in, 141 fund used as guarantee for, 158, 171 MTR’s Key Initiatives, implementation of, microfinance institutions (MFIs) 188–93 conversion from traditional to Islamic MFI, progress on, 193–94f 177 murƗbaতah sales contracts in, 99n9 family empowerment and, 177–78 overlapping financial institutions in, 190 fees charged by, 176 pawning institutions in, 132 focus on poverty alleviation programs, 175 REITs in, 144–46 start-up equity from, 162, 174–75 resource gap in, 163, 163t microinsurance, 105–6 retakƗful operators in, 109 microtakƗful, 4, 105–6, 110–11, 111t, 175, 182t Securities Commission’s shari‘ah screening defined, 110 standards, 13, 80, 145, 150 in Nigeria, 114b shari‘ah-compliant financial services in, 60, 63, Middle East. See also Middle East and North 71, 189, 190 African (MENA) countries; specific shari‘ah scholars, limitations on holding countries finance-related positions, 190 Islamic banking in, 64t socially responsible investment (SRI) in, 125b mixed model of takƗful companies, popularity stock markets in, 77 in, 108 Tabung Haji in, 132 shari‘ah compliant banks in, 67 takƗful industry in, 106, 112, 113 takƗful industry in, 106, 110 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 211
Middle East and North African (MENA) N countries. See also specific countries NAICOM (Nigerian Insurance Regulator), 114b housing finance in, 129t National Bank of Tajikistan, 131b Islamic banking dominated by Middle East, 63, NBFIs. See nonbank financial institutions 67, 67f The New Economics of Inequality and Islamic banking in, 68b Redistribution (Bowles), 20 nonbank financial institutions new social contract, 20 (NBFIs) in, 120 Nigeria poverty alleviation in, 19f creation of new waqf in, 168 responsible governance and leadership in, 48 in-kind zakƗt in, 170 suknjk market analysis in, 84–85, 85t Islamic banking sector, potential for expanding middle-income trap, 18, 20 in, 64 Mid-Term Review (MTR), 11–12, 14, 96, mobilization of zakƗt collected in, 166, 167 184–88, 187t poverty alleviation in, 164 key findings of, 185 shari‘ah-compliant financial services in, 71 progress of Islamic finance, 193, 193–94t takƗful industry in, 114b reasons for, 184–85 Nigerian Insurance Regulator (NAICOM), 114b recommendations added to original nonbank financial institutions (NBFIs), 4, 12, framework, 185–86, 187t 119–37 Millennium Development Goals (MDGs), 18–19, asset management, 120, 121–25, 121t, 122f 37n5, 41–42, 42f, 182 by asset class, 123–24, 124f Mirakhor, Abbas, 28 asset types, 122, 123f, 123t Mohtadi, Hamid, 75 by geographic distribution, 123, 124f money market funds, 123. See also nonbank bankruptcy or insolvency of, 133, 135n8 financial institutions consumer protection, 133 moral hazard, 20, 37n6 corporate classification, 120, 120t Morgan Stanley Capital International (MSCI), 79 cultural, social, and physical barriers for, 133 Morocco current status of, 119–21 Islamic banking sector, potential for expanding data shortage on, 121, 134–35 in, 64 demand-side issues, 133 shari‘ah-compliant financial services in, 71 financial literacy as issue for, 133 Mozambique h̩jj funds, 120 Cahora Bassa dam in, 148–49 housing finance, 127–29, 129t IDB’s funding for electricity in (case study), diminishing mushƗrakah structure, 135n3 148–49, 149t shari‘ah -compliant financing in Islamic banking sector, potential for expanding Canada, 130b in, 64 increasing number and diversity of, 132 mudƗrabah, 12–13, 58, 68, 69, 73, 87–88, 95–98, . Islamic mutual funds, 121, 121t, 134 99n9, 147, 176 leasing companies. See leasing companies commodity structure, 95, 99n14 legal and regulatory challenges, 4, 134–35 NBFIs, 130–31, 131t, 132, 133 microfinance and microsavings institutions, 120 regulation in Pakistan, 134 microtakƗful. See microtakƗful takƗful model, 106, 107t, 108 mudƗrabah and ijƗrah companies, 120, 130– vaccination and immunization programs, . 31, 131b, 132, 135n1 95–96 policy recommendations, 8t, 134–35, 198t murƗbahah transactions, 147, 175 reputation and credibility of, 133 Islamic MFIs favoring, 176 responsible investment trend, 125b Jadwa Saudi Riyal MurƗbahah Fund case shared prosperity and, 131–33 study, 148 shari‘ah compliance, 121, 126, 127t, 132, 133 microfinance and, 176 SME finance, 125–27 mushƗrakah (partnership), 130b, 133, 135n3, shari‘ah -compliant products, 126, 127t 135n6, 141 supply-side issues, 131–33 Muslim Food Board (UK), 146 takƗful. See takƗful mutual funds. See nonbank financial institutions underdevelopment of, 120 212 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
nongovernmental organizations (NGOs), resource gap in, 163, 163t contracting with IDB for interest-free Secured Transaction Law, 191b microloans, 161b shari‘ah-compliant financial services in, 71, 190 Noor Financial Investment Company, 135n8 shari‘ah scholars, limitations on financial North, Douglass, 25–26 positions of, 190 stock markets in, 77 takƗful industry in, 113 O zakƗt in Okun, Arthur M., 37n2 distribution to poor, 169 Oman, shari‘ah-compliant financial services in, 71 mobilization of, 165, 166 Organisation for Economic Co-operation and trust of government in handling of, 168 Development (OECD) on effects of Pakistan Islamic Pension Fund, 124 inequality, 17, 18 Palley, Thomas I., 199n2 Organisation of Islamic Cooperation (OIC), 3 participatory finance, 29 closing the poverty gap in OIC pawning institutions, 132 countries, 38n15 pension funds. See nonbank financial institutions comparing OIC and non-OIC member- Peoples Leasing and Finance Company, 132 countries for income (consumption), philanthropy. See s.adaqƗt; zakƗt 9–10, 43, 46f, 48–52, 48–52f Piketty, Thomas, 17, 20 data shortage from most members of, 64 policy recommendations, 5, 6–8t, 14, 181–200 membership and organization of, 54n1 alternative asset classes, 150 public vs. private pensions in member coordination of policy responses, 183 countries, 124 diversification in financial sector, 190–91 10-Year Program of Action (10-PoA), 23b financial inclusion, 181, 182t, 192 ORIX Leasing Company, 132 financial stability, 181, 182t, 183 harmonization of regulatory frameworks, 190 P integration of Islamic finance in national development plans, 188–90 Pagano, M., 75 Islamic banking sector, 6t, 72–73, 182t Pakistan Islamic capital markets, 6t, 96–99, 182t Akhuwat case study, 155, 156b Islamic finance, 26–28 Centers of Excellence in Islamic Finance, 192 Islamic social finance, t8 , 165–69, 182t, 199t diversification in financial sector in, 190–91 Mid-Term Review (MTR), 11–12, 14, financial inclusion in, 192 184–88, 187t financial reporting’s inclusion of Islamic finance three-nation case study of MTR’s Key data, 192 Initiatives, 188–93. See also Indonesia; housing finance in, 129, 129t Malaysia; Pakistan human capital, development of, 192 nonbank financial institutions (NBFIs), t8 , integration of Islamic finance in national 134–35, 198t development plans, 189–90 for shared prosperity, 6–8t, 53–54, 181–200 Islamic banking sector in, 63, 65, 189–90 takƗful, 7t, 113–14, 198t microfinance in, 191b best practice charter, 114, 115–16t MTR’s Key Initiatives, implementation of, Ten-Year Framework, 5, 183, 184 188–93 waqf, 172–74 progress on, 193–94f integration with microfinance, policy mud.Ɨrabah companies in, 132 recommendations for, 174–77, 182t MudƗrabah Flotation and Control zakƗt, 170–72 Ordinance, 134 integration with microfinance, policy National Financial Inclusion recommendations for, 174–77, 182t Strategy, 191, 191b poverty alleviation nonbank financial institutions comparing OIC and non-OIC member- (NBFIs) in, 121, 132 countries for income (consumption), overlapping financial institutions in, 190 9–10, 43, 46f, 48 pension funds in, 124 economic empowerment of the poor, 155 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 213
enhancing wealth-creating capacity of Islamic instruments of, 2, 33–34, 33b, 37. the poor, 154, 170 See also specific types GDP growth rate and, 19, 19f risk sharing and, 2, 9, 24f, 33 Islamic social finance’s role in, 5, 154, 161, shared prosperity and, 20 163, 170, 175 social justice and, 60 leadership and governance to encourage, 25 social safety net of, 34 Millennium Development Goals (MDGs) and, regulatory environment, 3 18, 42, 42–43f alternative asset classes, 150 percentage of population living below poverty Islamic banking sector, 3, 65–66, 70, 72 line, 19, 19t, 42, 43f, 163, 163t Islamic capital markets, 92, 97 regional distribution of poverty ratios, 42, 44f Islamic Financial Services Board (Standard No. shared prosperity and, 20–21. See also shared IFSB-17), 196b prosperity NBFI sector, 4, 134–35 Sustainable Development Goals policy recommendations, 182t, 183 (SDGs) and, 19 takƗful (mutual assistance) industry, 111–12 UN goals for, 18–19 best practice charter, 115t Pradhan, R. P., 75 in Nigeria, 114b Presley, J., 73n5 policy recommendations, 113 profit-sharing investment accounts (PSIAs), 71 waqf as means for sustainable provision of project finance, 148–49 social goods and, 159 IDB’s funding for electricity in Mozambique Rehman, S., 55n4 (case study), 148–49, 149t reinsurance. See retakƗful property rights, 27b, 28, 35b, 69 REITs, 144–46 PSIAs (profit-sharing investment accounts), 71 Al-Salam REIT case study, 145–46 public policy interventions. See policy religiosity, measurement of, 60, 73n3 recommendations religious discrimination, 60b resilience to economic shocks, 29 resource gap, estimation of, 163, 163t Q retakƗful, 109–10, 116n2 qard. h̩san (benevolent loan free of charge), 5, revolving credit from pooled s.adaqƗt and zakƗt, 33b, 34, 36b, 62, 69, 155, 177 156b Qatar, shari‘ah-compliant financial services risk sharing in, 60 asset-based redistribution and, 2, 24f Qur’Ɨn benefits of, 25 defined, 37n12 capital markets and, 76 on inheritance, 33 need for more incentives for, 96–97 on redistribution of wealth, 33–34 risk-return analysis of shari‘ah indexes for, source of Islamic law, 37n9 78–81 core principle of Islamic finance, 24f, 25, R 29–32, 35–36b, 49–50 correlation between consumption and income Rajan, R., 18 in OIC countries and, 49–50, 50f Rancière, R., 37n4 as driver of financial inclusion, 33 Randall, Douglas, 52 housing finance, 128 real estate investments, 144–46 insurance for. See takƗful Al-Salam REIT case study, 145–46 Islamic banking sector and, 3, 58–59, 68, 73n2 redistribution. See also asset-based policy recommendations, 3, 183 redistribution; income-based state of development and, 49–50 redistribution through Islamic instruments of redistribution, 9 as core principle of Islamic finance, 2, 27b value of market capitalization to GDP in OIC distinguished from charity, 9 and non-OIC countries, 50, 51f economists’ perception of, 18 Rodrik, Dani, 22b, 49 financial and social inclusion and, 36b Rosen, Sherwin, 37n2 hard vs. soft approaches, 20 rule of law, 48 214 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
Rule of Law Index (World Bank), 48, 48f takƗful operations, 112 rural electricity in Mozambique, IDB investment zakƗt requiring flexibility, 167 in (case study), 148–49, 149t Islamic banking sector compliant with, 57, 60, 62, 67, 68 policy recommendations, 72 S Islamic capital markets compliant with, 99n2 Sabana Shari‘ah-compliant Industrial REIT, 146 Islamic equity index (IEI) screening criteria s.adaqƗt (recommended contributions), 5, 13–14, based on, 79 33b, 34, 36b, 62 key financial principles, 37n10 beneficiaries of, 175 maqƗs͓d al-sharƯ‘ah (Objectives of Islamic community-driven development with, 157 Law), 24–25, 28, 57, 73n1 low-cost microcredit with, 155 microtakƗful compliance, 105–6 revolving credit from pooled proceeds of, 156b NBFI sector compliant with, 121, 126, 127t, S&P. See Standard & Poor’s 132, 133 Saudi Arabia “permissible in times of necessity” concept, 110 Capital Markets Authority, 13 retakƗful companies, operations allowed Eed Group (health care company), 142 by, 109 Islamic private equity finance in, 141 short selling not allowed, 77, 143 shari‘ah-compliant small and medium suknjk compliance requirements, 12, 85, 196b enterprises in, 142 takƗful operations, 109–10, 112–13, 115t stock markets in, 77 venture capital compliance, 141 suknjk market analysis in, 85 Shari‘ah Capital case study, 143–44 takƗful industry in, 106, 107f, 113 short selling, 77, 143 Saudi Arabian Monetary Authority (SAMA), 113 short-term solutions, negative effects of, 196 Saudi Aramco SADARA Basic Service Singapore Company, 85 REITs in, 146 SDGs. See Sustainable Development Goals retakƗful operators in, 109 Securities Commission of Malaysia, 125b takƗful industry in, 106 Seminar on Challenges Facing the Islamic waqf in Financial Industry (Bali 2004), 184 asset development, 166 shared prosperity leasing with waqf assets, 173 capital markets and, 75–77 public-private partnerships, 174 policy recommendations, 96–99 zakƗt in financial sector’s depth and interaction base and potential, 164, 164t with, 47t, 52–53, 53–54f distribution to poor, 169 financial sector’s role in creating, 34, 35t, mobilization of, 166 35–36b skill bias, 37n1 indicator by top and bottom skills training. See education and training; countries, 20, 21f, 43, 45f human capital Islamic banking sector and, 57–58 small and medium-sized enterprises (SMEs), 36b, Islamic perspective on, 10, 21–36, 24f 113. See also micro, small, and medium Islamic social finance’s role in creating, 5 enterprise (MSME) sector policy recommendations for, 2–3, 53–54, financing of, 3, 13, 15, 125–27 181–200. See also policy recommendations credit registries, need for, 135 poverty alleviation and, 20–21 Liwwa example of shared prosperity, state of development and, 42–47 127–28b suknjk market’s contribution to, 86–87 shari‘ah-compliant financing, preference for, takƗful and, 103–6, 115t 126, 127t World Bank Group perspective on, 22b, 188 short-term nature of, 132 shari‘ah underserving needs of, 126, 126t defined, 37n9 number of employees and contribution derivatives trading not allowed, 77, 143 to GDP, 125–26 harmonizing over countries, 3, 183 private equity investment sought by, 140–41 capital markets, 97–98 Smith, Adam, 55n5 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 215
social finance, 36b. See also Islamic social finance in MENA region, 121, 121t social inclusion, 22b, 24f, 32–34, 36b Subramanian, Arvind, 49 financial sector development and, 35b Sub-Saharan Africa Islamic policies and, 28 housing finance in, 129t leadership and governance to encourage, 25 Islamic banking sector in, 64t, 65, 67, 67f, 68b state of development and, 47t, 52, 52f Islamic social finance in, 5 social justice, 9, 10, 24, 25, 26, 27b poverty alleviation in, 10, 19f Islamic banking sector and, 57, 69 Islamic social funds needed for, 163 Islamic capital markets and, 76 suknjk market analysis in, 84–85, 85t redistribution and, 60 zakƗt mobilization in, 166, 171–72 socially responsible investment (SRI), 125b Sudan social protection Abu Halima projects, 57–58, 58b, 163 microtakƗful and, 111 Islamic microfinance models in, 162–63 unconventional means of, 36b poverty alleviation in, 164 social safety nets shari‘ah-compliant financial services linked to microfinance institutions in, 63, 66, 71 (MFIs), 162, 174 soundness of Islamic banking sector in, 65 redistribution of wealth and, 34 waqf in zakƗt’s role, 154, 169, 182t assets developed, 166 soft redistribution of wealth, 20 creation of new waqf, 168 South Africa family waqf, 169 poverty alleviation in, 164 laws governing, 172 resource gap in, 163, 163t public-private partnerships, 174 zakƗt base and potential in, 164, 164t zakƗt in South Asia distribution to poor, 169 Islamic banking in, 63, 64t, 68b as guarantee against debt default, 171 poverty alleviation in, 10, 19f in-kind zakƗt, 170 Islamic social funds needed for, 163 mobilization of zakƗt collected, 165, 166 takƗful companies in, 106 Sufi, Amir, 2, 128 zakƗt mobilization in, 166 suknjk (asset-based securities) market, 4, 11, 12, Southeast Asia 77, 81–92 Islamic banking in, 63, 64t, 68b Al-Murabaha structure, 99n16 Islamic funds in, 123, 124f bankruptcy resolution regimes for, 196b Islamic social finance in, 5 constraints on, 98 needed for poverty alleviation, 163 contribution to shared prosperity, 86–87 takƗful companies in, 110 economic development and, 90–92 zakƗt mobilization in, 166 financial inclusion and, 182t South East Asia Economic Society, 189b global trends in, 81–84, 83t, 84f speculation, not permitted activity, 77, 78–79 IDB issuances, 148 SRI (socially responsible investment), 125b infrastructure financing and, 87, 90–92 Sri Lanka, NBFIs in, 132 lessons of socioeconomic development stability improvements. See financial stability and, 93–96 Standard & Poor’s (S&P), 79 maturity structure, 87, 89f, 98 comparing performance of S&P shari‘ ah- policy recommendations, 3, 183 compliant indexes with conventional project-specificsuk njk, 199n1 indexes, 79–80, 80–83f regional analysis of, 84–85, 85t, 86f Stiglitz, Joseph, 20, 37–38n13 retail suknjk, introduction of, 182t, stock markets 183, 192, 199n5 compared to other forms of finance, 32f by sector issuing, 89–90, 91f debt securities vs., 31b shari‘ah compliance requirements, 12, 85, 98 development correlated with long-term social inclusion and, 93 economic growth, 50, 75 socially responsible investment (SRI) Islamic stock market based on core and, 125b values, 76–77, 76f sovereign vs. corporate issuance, 87, 88f 216 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
special purpose vehicle (SPV) offering recourse, suknjk market and, 105 95, 98–99 wakƗlah model of, 106–8, 107t, 112 takƗful investors and, 105 waqf model of, 107t, 108–9 by type of contractual structure, 87–89, window operations, 110, 112 90f, 92t Tanzania for vaccination and immunization, 95–96 poverty alleviation in, 164 Suknjk Ihsan Programme (Malaysia), 125b resource gap in, 163, 163t Suleman, Areef, 55n2 taxes sustainable development, 1–2, 21 improving rate treatment, 69 environmental sustainability, 22b, 35b social tax, estimating potential resources fiscal sustainability, 22b from, 165 in Indonesia, 188, 189b suknjk issuers and investors, tax neutrality for, 4 pillars of Islamic finance and, 24, 24f, 76, zakƗt payment substituting for direct taxes to 195–96 the State, 167, 192 priority in GCC countries, 125b Thailand, takƗful industry in, 106 waqf as means for sustainable provision of Townsend, R., 30b social goods, 159 traded commodities investment, 147–48 Sustainable Development Goals (SDGs) Jadwa Saudi Riyal MurƗbahah Fund case development community’s adoption of, 20–21 study, 148 IDBG’s 10-Year Strategy in line with, 23b trademark protection, 146 Islamic finance and, 2–3, 181 transparency and accountability, 25, 26, 28–29 poverty alleviation and, 19 Islamic banking sector and, 59, 190 Islamic capital markets and, 98 promoting shared prosperity, 35b T takƗful operations and, 112 wakƗlah model of takƗful and, 108 Tabung Haji (Malaysia), 132 waqf management and, 173 Tajikistan, leasing case study in, 131b zakƗt management and, 171–72 takƗful (mutual assistance) industry, 4, 12, 37n10, Trebbi, Francesco, 49 103–17 trickle-down approach, 1 benefits over bank saving account, 105 trust case study in Nigeria, 114b inequality’s effect on, 1 challenges for, 111–13 information sharing and, 36 compared to conventional insurance, 104b, 113 institutional framework creating, 32 corporate governance and regulatory Islamic finance based on, 26 framework, 111–12 microtakƗful and, 104 case study in Nigeria, 114b NBFIs and, 133, 134 current state of, 106, 107f, 145 productivity enhanced by, 2, 21 defined, 103, 104b promoting shared prosperity, 35b, 55n5 disclosure requirements, 116t responsible leadership and, 9, 25 investment opportunities, lack of, 112–13 as social capital element in Islam, 27b microtakƗful, 4, 105–6, 110–11, 111t waqf and, 93 mixed model of, 107t, 108 zakƗt, trust in government handling of, 168 mudƗrabah model of, 106, 107t, 108 . trusts. See suknjk; waqf “permissible in times of necessity” Turkey concept and, 110 Islamic banking sector in, 64, 65 policy recommendations, 7t, 113–14, 198t pension funds in, 124 best practice charter, 114, 115–16t shari‘ah compliant banks in, 67 practices in selected countries, 106 Turner, Adair, 2, 128 REITs and, 145 retakƗful, 109–10, 116n2 risk management, 115t U shared prosperity and, 103–6 shari‘ah compliance, 109–10, 112–13, 115t UM Financial (Islamic NBFI), 133 soundness and capital adequacy, 116t unconditional cash transfers (UCTs), 170 GLOBAL REPORT ON ISLAMIC FINANCE INDEX 217
Understanding the Process of Economic Change microfinance funded through, 161b (North), 25–26 mobilizing resources from, 166, 168–69 United Arab Emirates policy recommendations to improve use of, Islamic private equity finance in, 141 172–74, 191–92 Securities and Commodities Authority, 125b poverty alleviation through, 161 shari‘ah-compliant small and medium preservation of, 172 enterprises in, 142 private-public partnerships involving, 173–74 United Kingdom restrictions on use of assets of, 173 directives on alternative investments, 13, 150 social inclusion and, 93 Islamic banking sector in, 64, 65 statement of purpose in deed or articles of shari‘ah compliant banks in, 67 association, 179n3 United Nations. See also Millennium sustainable provision of social goods Development Goals through, 159, 175 poverty alleviation goals of, 18–19 takƗful model, 107t, 108–9 on sustainable development, 21 transparency and accountability United Nations Conference on Trade and in management of, 173 Development (UNCTAD), 21 trustee-manager’s role, 173 United States voluntary nature of, 172 finance companies offering Islamic housing Waqaf Al-Noor case study, 159, 160b products in, 132 Waqaf An-Nur Corporation Berhad housing market bubble and global financial (WANCorp), 160b crisis in, 127–28 wealth gap mutual funds in, 124 effect on society, 1 pension funds and insurance company funds, growing inequality, 1, 43, 45f investment of, 105 literature on, 18 risky behavior of financial sector in, 37–38n13 statistics on, 1, 17–18 wealth gap in, 18 The Wealth of Nations (Smith), 55n5 Widodo, Joko, 188 V women’s empowerment and microfinance, 177, 177–78b vaccination and immunization suknjk, 95–96 World Bank venture capital, 141 on closing the poverty gap in vulnerability, policies to reduce, 3, 22b, 181, 182t. OIC countries, 38n15 See also Islamic social finance development strategy of, 21, 22b on entrepreneurs’ access to formal W financial services in OIC countries, 62 Government Effectiveness Indicators wakƗlah model of takƗful, 106–8, 107t, 112 (GEI), 49, 49f waqf (endowment), 14, 33b, 34, 36b on integrating Islamic finance into global beneficiaries of, 175 financial system (IMF–World Bank corporate waqf, 173 Joint G-20 Note), 14, 195, 195b case study of, 160b Islamic finance and, 27 creation of new waqf, 168 MDGs and, 18–19 estimating potential resources from, 164–65 mission revision, 2. See also Sustainable Fa’el Khair Program case study, 160, 161b Development Goals fair and affordable prices, role in establishing, Rule of Law Index, 48, 48f 159–60 shared prosperity as goal of, 22b, 188 family waqf, 169 social inclusion metric, 52, 52f financial inclusion and, 62 soft solution of income redistribution incentivizing, 168–69 proposed by, 20 integration with microfinance, policy warning about wealth gap’s consequences, 17 recommendations for, 174–77, 182t investment of assets, compulsory, 174 Y leasing vs. mortgaging, 173 legal reforms needed, 168–69, 173 Young Entrepreneur Fund (YEF), 147 218 INDEX GLOBAL REPORT ON ISLAMIC FINANCE
Z Maliki School views on zakƗt base, 164 mobilizing resources from, 165–68 zakƗt (mandatory levy), 5, 13–14, 33b, 34, payment substituting for direct taxes to 36b, 38n15 the State, 167 administrative costs associated with, 170, policy recommendations to improve use 171, 175 of, 170–72, 191–92 base and potential in individual Muslim poverty alleviation through, 154, 161 countries, 164, 164t enhancing wealth-creating capacity of capacity building for management of, 171–72 the poor, 170 community-driven development with, 157, poor receiving majority of distribution 157–58b of, 169 default of debt, payment to cover for priority of, 170 the poor, 171 social safety net role, 154, 169, 182t dependability of, 166 preferences of zakƗt payers to be honored, 171 distributive role of, 154–55 public vs. private collectors of, 168 eligible categories of beneficiaries revolving credit from pooled proceeds of, 156b of, 171, 178n2 role of zakƗt institution, 170–71 estimating potential resources from, 163–64 separate holding of funds from other forms of financial inclusion and, 62 donations, 171 guarantee fund with, 158–59, 159b tamleek (transfer of ownership) of, 157, 170 incentivizing, 167 trends in use of, 169–70 in-kind zakƗt, 168, 170, 172 types of disbursements, 175 integration with microfinance, policy voluntary vs. mandatory, 167 recommendations for, 174–77, 182t Zanzibar Islamic Law on how to estimate zakƗt base, leasing with waqf assets in, 173 178n1 legal restrictions on creation of loans and microfinance funded from, 170 new waqf in, 168 local participation to build community Zervos, Sara, 50 solidarity and, 168 Zhuang, Juzhong, 49 low-cost microcredit with, 155–56
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