ISSUE NO. 170 JANUARY–MARCH 2009 MUHARRUM–RABI AL AWWAL 1430
PUBLISHED SINCE 1991 GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE
THE GLOBAL FINANCIAL CRISIS: CAN ISLAMIC FINANCE HELP?
COUNTRY FOCUS: BANGLADESH
ISLAMIC & ETHICAL FINANCE: ON THE SAME PATH?
POINT OF VIEW: ISLAMIC MORTGAGES
IT FOCUS: EUROPE ARAB BANK
ACADEMIC ARTICLE: A SHARI’AH SCHOLAR’S ROLE IN ISLAMIC FINANCE
NEWHORIZON Muharrum–Rabi Al Awwal 1430 CONTENTS
Features 24
10 Islamic and ethical finance: on the same path? Don Brownlow, NewHorizon’s contributing editor, talks to the industry experts about the differences and similarities of Shari’ah- compliant, ethical and socially responsible modes of finance. 16 Balance sheet analysis: Islamic vs. conventional 24 Islamic finance progress in Bangladesh Comparing the balance sheet structures of Being one of the largest Muslim countries in the world, Bangladesh clearly has the conventional and Shari’ah-compliant banks. potential and the market for Shari’ah-compliant finance. Abdul Awwal Sarker, who is directly involved in the central bank’s efforts to strengthen the country’s Islamic 18 In the spotlight: South Africa banking sector, talks about accomplishments and challenges of the industry. What is the current state of Islamic finance industry in South Africa, home to about one 36 Islamic mortgages: Shari’ah-based or million Muslims? Shari’ah-compliant? A controversial interview with Sheikh Haitham Al Haddad, a London-based 40 Islamic scholar and Muslim community leader. 40 IT focus: Europe Arab Bank Antoine Sreih, CEO of Europe Arab Bank, a UK-based subsidiary of Arab Bank Group, tells NewHorizon about the bank’s major IT project. 43 Book Review ‘Developments in Islamic Banking: The Case of Pakistan’ by M. Mansoor Khan and M. Ishaq Bhatti. Regulars
05 NEWS 32 IIBI LECTURES 42 APPOINTMENTS A round-up of the important stories October and November lectures Summary of appointments within the from the last quarter around the globe. reviewed. Islamic finance industry.
20 ACADEMIC ARTICLE 34 IIBI NEWS 44 DIARY The global financial crisis: can Islamic New book published in conjunction Upcoming Islamic finance events finance help? with the IIBI. worldwide endorsed by the IIBI. IIBI launches a new website and 30 ACADEMIC ARTICLE prepares online courses. 45 RATINGS & INDICES Placing faith in Islamic finance: the role More students complete the IIBI’s of a Shari’ah scholar in the industry. Post Graduate Diploma course. 46 GLOSSARY
www.newhorizon-islamicbanking.com IIBI 3 EDITORIAL NEWHORIZON January–March 2009
Deal not unjustly, and ye shall not be Executive Editor’s Note dealt with unjustly.
Surat Al Baqara, Holy Quran As this issue of NewHorizon comes out in the New Year, I would like to wish the very best in 2009 to all our readers, members and EXECUTIVE EDITOR supporters as well as their families. Mohammad Ali Qayyum, Director General, IIBI The global financial crisis is largely attributed to the financial liberal- EDITOR isation that took place in the last two decades and the impact of the Tanya Andreasyan financial collapse on the real economy will be significant in 2009. IIBI EDITOR The financial euphoria fuelled distorted perceptions of risk, leading Mohammad Shafique to excess leveraging. This leveraging added to the scant regulation CONTRIBUTING EDITORS of the non-traditional banking sector and already existing over- Don Brownlow indebtedness of households and businesses, all of which combined James Ling has created a huge economic burden for future generations. NEWS EDITOR Lawrence Freeborn The crisis does not signal the failure of capitalism. Financial markets IIBI EDITORIAL ADVISORY PANEL have shown that they are incapable of regulating themselves and Mohammed Amin tend towards imbalance, especially after long periods of growth and Richard T de Belder Ajmal Bhatty stability which encourage excesses. Islam is indeed compatible with Stella Cox free enterprise based on shared responsibility. Islam is not opposed to Dr Humayon Dar the creation of wealth but is opposed to the hoarding of wealth and Iqbal Khan Dr Imran Ashraf Usmani all forms of extravagance. The 14th century Muslim scholar, Ibn Khaldun, long before Adam Smith, made a case for a free economy. DESIGN CONSULTANT Emily Brown Of course, it would be wrong to say that the ongoing crisis has PUBLISHED BY IBS Publishing Ltd completely bypassed the Islamic financial sector. Islamic banks are 8 Stade Street sometimes criticised for appearing to mimic conventional banking Hythe, Kent, CT21 6BE structures, based on the securitisation of assets, devising new prod- United Kingdom Tel: +44 (0) 1303 262 636 ucts that allowed commercial banks to create and multiply money. Fax: +44 (0) 1303 262 646 The implications are felt worldwide, from Europe, where the UK Email: [email protected] Web: www.ibspublishing.com government has postponed the long-planned sukuk issuance, to the Middle East, where the two of Dubai’s largest Islamic mortgage CONTACT Advertising companies had to be merged under a government-owned entity. IBS Publishing Ltd Paul Minister Even so, major challenges remain in terms of establishing shared Advertising Manager Tel: +44 (0) 1303 263 527 leadership with an aim of devising better rules for financial globalisa- Fax: +44 (0) 1303 262 646 tion. The Islamic finance industry can play a greater role in increas- Email: [email protected] ing awareness of its practices to help restore and maintain financial SUBSCRIPTION stability worldwide. IBS Publishing Limited 8 Stade Street, Hythe, Kent, CT21 6BE, United Kingdom Tel: +44 (0) 1303 262 636 Fax: +44 (0) 1303 262 646 Email: [email protected] Web: newhorizon-islamicbanking.com Mohammad Ali Qayyum Director General IIBI ©Institute of Islamic Banking and Insurance ISSN 0955-095X This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views expressed in Cover photo: the articles are those of the authors alone and should not be attributed to the organisations they are associated with or their management. Any errors © david Bronson glover, iStockphoto.com and omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no responsibility to any person who acts, or refrains from acting, based upon any material published in the magazine. The Editorial Advisory Panel exists to provide general advice to the editors regarding matters that may be of interest to readers. All decisions regarding the published content of the magazine are the sole responsibility of the Editors, and the Editorial Advisory Panel accepts no responsibility for the content.
4 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 NEWS
Qatar Financial Centre First takaful product supports the largest launched in US
museum of Islamic art Risk Specialists Companies, a supervisory board of UK- subsidiary of AIG Commercial based takaful operator, The Museum of Islamic Art, the museum premises, private tours Insurance, announced that it Principle Insurance. flagship project of the Qatar of the galleries, involvement is introducing a takaful home- Museums Authority, has re- with educational workshops, owners policy, the first instal- The takaful offering for cently opened in Doha. Qatar and linkage between the QFC ment in Lexington Takaful homeowners will be the first Financial Center (QFC) Author- and the museum in publica- Solutions, which will be a Islamic insurance product ity signed a partnership agree- tions, websites and other mate- number of Islamic product to be marketed in the US. ment to be its strategic financial rials, and through sponsorship offerings for the US. Abdallah Kubursi, global partner for three years from of future exhibitions. head of AIG Takaful Enaya, 2009. The agreement will allow The product has been released described the undertaking as the QFC and its staff to visit An opening ceremony for the in conjunction with AIG Taka- ‘truly a global effort’ and and benefit from the brand new, museum was held in November, ful Enaya, a Bahrain-based emphasised the commitment 45,000 square metre venue, under the patronage of HH The outfit. Its Shari’ah supervisory of the participants to offer which is the largest museum Emir Sheikh Hamad bin Khalifa board includes well-known consumers wider choice dedicated to Islamic art in the Al Thani. The project sets a names such as Sheikh Nizam ‘based not only on need but world. founding stone in the cultural Yaquby, who also sits on the also social preference’. blueprint to transform Qatar The opening of the museum, into a global capital of culture. which covers 1400 years of The museum, designed by Islamic creativity, has been Pritzker Prize (an architectural German bank ties up with billed as one of the most signifi- award) laureate Ieoh Ming Pei, cant cultural events in the his- is inspired by the 13th century Al Salam Investment tory of Qatar, and the staff of ablutions fountain at the 9th QFC will benefit from its state- century Mosque of Ahmad ibn Al Salam Investment in Dubai, vious levels of transactions and of-the-art hospitality and educa- Tulun in Cairo. The museum’s which has identified Islamic ultimately the confidence in tional facilities. Also included in artworks, dating from the 7th finance as a big driver for the the financial system needed to the agreement will be hosting to the 19th century, are drawn regional financial sector, has reverse the move away from corporate and social events on from three continents. launched a major initiative and growth.’ Haghshenas went on signed an agreement to partner to explain that the Middle East with Germany-based HSH will be a region of change and Museum of Islamic Art, Doha Nordbank, specialising in ship- opportunity, and the partnership ping and renewable energy fi- is a way of ensuring Al Salam nance. The agreement initially Investment is well placed to covers the GCC but the inten- capitalise on it. tion is to expand throughout MENA in future. The partners For HSH Nordbank, this collab- are expected to set up a joint oration ‘opens the door to op- venture in 2009, operating on portunities that cannot be found Islamic principles. No details elsewhere at this time’, accord- have been provided, though a ing to director Michael Bresges. venture is likely to be registered German interest in Shari’ah- in the Dubai International compliant finance follows on Financial Centre. Al Salam from the issue of sovereign Is- Investment’s CEO, Pegman lamic debt by Saxony-Anhalt Haghshenas, said: ‘Islamic (one of the sixteen federal states
© Vatikaki Dreamstime.com finance can become the catalyst that make up Germany) a few that restores the deal flow, per- years ago. www.newhorizon-islamicbanking.com IIBI 5 NEWS NEWHORIZON January–March 2009
Path Solutions’ IT system gains approval of AAOIFI iMAL, the Islamic core banking iMAL as well as the business system from Path Solutions, a processes and contracts to be vendor based in Kuwait, has compliant with AAOIFI’s re- become the first core banking quirements.’ The work involved platform to be certified by the product strategy, development Accounting and Auditing Or- and business development de- ganisation for Islamic Financial partments, as well as corporate Institutions (AAOIFI), the inter- communications. The first meet- national standard setting body. ing with AAOIFI’s secretary The certificate was presented to general took place in May 2008 Path at the AAOIFI & World ‘to discuss the certification pro- Dourria Mehyo, Path, Bank Annual Conference on cedures’. Dr Alchaar states that receives AAOIFI certification Islamic Banking and Finance, the system ‘has been thoroughly a yearly event organised by reviewed and has proven it truly to the Islamic systems of other bia, and Elaf Bank, a Shari’ah- AAOIFI and held in Bahrain deserves to be certified’. vendors, which were converted compliant wholesale bank in (where its headquarters are from conventional ones. In Bahrain. based). Moukadam is convinced that Moukadam’s view, this factor such recognition will give Path played a significant role in ob- Yousif Janahi, head of informa- According to Dr Mohamad ‘an additional edge over com- taining the AAOIFI’s approval tion technology at Elaf Bank, Nedal Alchaar, AAOIFI’s secre- petitors’. He adds: ‘It translates and secured Path’s ‘pole position says that ‘based on the life cycle tary general, the certification into fast-tracking processes and in the battle for survival' in the and the IT needs at our bank, covers ‘the iMAL modules, guaranteed compliance with current tough economic climate. we found that the iMAL product business processes, contracts, Shari’ah as well as access to is the most Shari’ah-compliant Islamic accounting principles, certified contracts, thus saving Global financial unrest has not product, and is mostly compre- implications and behaviour’. effort, cost and time for our stopped the vendor from gain- hensive and user-friendly’. Elaf customers.’ ing a host of new deals in 2008, Bank had undertaken a detailed Naji Moukadam, president of across the Middle East and fur- study of the products on offer Path Solutions, says: ‘The Path has always maintained that ther afield in Africa and South from four international vendors, preparation and review started one of the key strengths of its East Asia. The most recent wins Temenos, Misys, International in April 2008 and took seven flagship offering, iMAL (‘i’ are at Al Jazeera Islamic co, a Turnkey Systems and Path, and a half months, during stands for Islamic and ‘mal’ subsidiary of Qatar Islamic before selecting the iMAL which different teams, each in means money in Arabic), is its Bank in Qatar, Khalijia Invest, product, and should be live their area of expertise, validated purely Islamic roots as opposed an investment firm in Saudi Ara- with it by March 2009. Consolidation in the Gulf
Amlak and Tamweel, two backdrop of falling prices in This followed shortly after A similar agreement in Abu of Dubai’s largest Islamic the property market. The Amlak, whose shares have Dhabi then saw state regulators mortgage lenders, will be combined value of the two dropped by 80 per cent in 2008, approve the merger of the merged under a government- firms will be AED2.5 billion stopped writing new loans, new Real Estate Bank and owned entity to form an ($600 million), and the new although Tamweel, whose Emirates Industrial Bank, Islamic real estate bank in entity, the largest real estate shares had lost an even higher which offers some Shar’iah- a response to the global finance institution in the coun- percentage, had continued to compliant services. The com- financial crisis. try, will be known as UAE operate. Trading of shares in bined entity, dubbed Emirates Real Estate Bank. Pressure had both firms was suspended for Development Bank, will The firms had faced difficul- grown on the government in a day in November, as merger become the largest financial ties obtaining credit against a Dubai to respond to the crisis. details were released. services company in the UAE.
6 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 NEWS
Islamic banking spreads in Hong Kong
Malaysia-based CIMB Islamic The Hong Kong branches of an Islamic window in Hong consumer banking. The latter has launched its first Shari’ah- CIMB and Hong Leong are the Kong but also mainland China, might be difficult due to the compliant product in Hong first institutions based in Hong as the group has acquired a 20 thin geographical spread of Kong. It has signed the first Kong to offer Islamic banking, per cent stake in the Bank of Muslims in the country, the transaction with Hong Leong and the Hong Kong Monetary Ying Kou in Liaoning province bank has indicated. CIMB Bank for its commodity Authority successfully gave earlier this year. obtained Bank Negara murabaha deposit. The de- clearance for the launch of the Malaysia’s (central bank and posit will utilise crude, palm interbank money product. CIMB hopes to expand from regulator) approval to under- oil, metal and other tradeable Shari’ah-compliant wholesale take Shari’ah-compliant bank- commodities as underlying The launch of this product banking to asset management, ing operations overseas in assets. marks the opening not only of and will consider the viability of December 2007.
Standardisation for Islamic OCBC’s Islamic strategy OTC derivatives takes shape
The International Swaps and existing contracts), stood at OCBC Al-Amin Bank Berhad, OCBC Derivatives Association (ISDA) $20.4 trillion for the same pe- the Islamic subsidiary of Over- intends to make a template riod (29 per cent increase). The sea-Chinese Banking Corpora- contract available in early 2009 current financial crisis is partly tion (OCBC), has commenced for Islamic over-the-counter blamed on the global derivatives operations in Malaysia with the (OTC) derivatives. This move is trade. opening of its first branch. Ac- expected to enhance growth op- cording to the CEO of OCBC portunities for Islamic finance, The exact volume of Shari’ah- Al-Amin, Tuan Syed Abdull and to provide a useful tool for compliant OTC derivatives Aziz Syed Kechik, the entity risk management. The availabil- trade is not known. However, will initially focus on the ity of the template contract it comprises only a small part murabaha, mudarabah and ijara should make time-to-market for of the industry, due to the models. OCBC Al-Amin plans Islamic OTC derivatives faster, nature of Islamic OTC trading. to open a further four branches by standardising legal terms and Shari’ah requires the underlying through 2009. OCBC Bank allowing parties to focus on the assets to be tangible, such as Malaysia has operated Islamic commercial side of the deal. commodities, which excludes windows in its conventional most mainstream derivatives branches for 13 years, but the been used by an even distribu- OTC derivatives are privately instruments. introduction of a fully-fledged tion of Muslims and non- negotiated deals between in- Shari’ah-compliant subsidiary Muslims, reflecting the broad vestors and counterparties. Ac- The ISDA is working to stan- represents the second major appeal of Shari’ah principles. cording to the latest report from dardise regulation across the phase of the bank’s development the Bank for International Set- GCC, which would start to in Islamic finance. Islamic OCBC’s Islamic banking cus- tlements (BIS), the notional address a major hurdle of products will continue to be tomer deposits have recently amounts outstanding of OTC Islamic OTC derivatives, namely offered in OCBC’s conventional grown at seven per cent annu- derivatives continued to expand that there is no uniform set branches. ally, and Kuala Lumpur’s status in the first half of 2008, with all of guidelines. There are one as a global financial hub has types of OTC contracts reaching or two other moves in this OCBC Bank Malaysia’s chair- continued to strengthen, with $683.7 trillion by the end of direction, with Bank Negara man, Tan Sri Dato Nasruddin Islamic banking accounting for June that year. Meanwhile, the Malaysia, that country’s central Bahari, stated at the unveiling about 17 per cent of Malaysia’s gross market values (which bank, also encouraging greater ceremony in November that the banking assets according to measure the cost of replacing all standardisation. bank’s Islamic services have Bank Negara Malaysia. www.newhorizon-islamicbanking.com IIBI 7 NEWS NEWHORIZON January–March 2009
Islamic finance has setback in UK, shows progress in France
The pre-budget report deliv- ment – the government had pre- welcomed Islamic finance to market of over five million ered by UK chancellor Alistair viously mentioned the possibility the country at the 2nd French Muslims in France, and a sur- Darling in November ruled of issuing sukuk at the same oc- forum of Islamic finance held in vey conducted by the French out the issuance of Islamic casion in 2007. Saxony-Anhalt, a Paris in November, echoing ear- Institute of Public Opinion bonds (sukuk) by the govern- state in Germany which launched lier positive sentiments. At least (IFOP) in 2007 indicated that ment any time soon. The gov- a e100 million ($126 million) three Islamic banks are reported at least 500,000 would be in- ernment confirmed it would Islamic debt programme in 2004, to be requesting accreditation to terested in Shari’ah-compliant legislate to help develop Is- remains the only example of a operate in France. These are finance. Also reflecting France’s lamic corporate debt. This sovereign sukuk issuance in Al Baraka Islamic Bank from potential is the opening of a came as a surprise, as ob- Western Europe. Bahrain, Qatar Islamic Bank, new website, Finance Islamique servers had expected chancel- which already has offices in France, the purpose of which is lor Darling to approve the Meanwhile, Christine Lagarde, London, and Kuwait Finance to boost the profile of Islamic UK’s first Islamic debt instru- minister of finance of France, House. There is a huge potential finance and provoke debate.
Core principles shield Islamic IDB deepens support for banking from economic storm struggling member countries
Shari’ah-compliant financial customers displaying a high Islamic Development Bank ity and bird flu vaccine, of institutions in the GCC have degree of loyalty to Shari’ah- (IDB), based in Jeddah, has which $159 million will help weathered the economic turmoil compliant banks, and they have announced plans designed to pay for Abu Qir power station. well, according to Moody’s a good capital base and ample help Muslim countries through This is out of a total of $2.8 Investors Service. The ratings liquidity. Moody’s therefore the global financial storm. The billion in loans to Egypt so far, agency suggests this is not predicts that the Gulf will con- bank will issue bonds to collect covering over 226 operations only a result of strong growth tinue to grow in 2009, though funds from international mar- altogether. and a characteristically conser- slowing, before assuming its kets to support member coun- vative approach, but also upward march in a year and a tries of the bank. This will IDB thanks to following core Islamic half or so. help cushion against the principles. predicted decline in foreign It also suggests that the financial investment due to difficult Global Islamic banking assets crisis has improved the reputa- credit conditions. grew about 27 per cent in 2007, tion of Islamic finance, as a con- and similar growth is expected servative, traditional approach IDB has played an important to be shown for 2008. While to finance becomes more valued role in propping up Pakistan’s 2009 is expected to be a tough once again. finances, with a $200 million year for Islamic finance, just as loan in November. It also it is for conventional banking, Finally, Moody’s explains that recently signed two agreements Anouar Hassoune, Moody’s vice the prohibition in Shari’ah of with Egypt to provide $169 president and author of the speculation and riba (interest) million for projects for electric- report, suggests that Islamic has also helped Islamic financial banks will still benefit from a institutions avoid the worst of number of factors. the credit crisis. The Shari’ah- compliant banking market is To stay up to date with all the news in the Islamic financial These factors include that not immune from problems sector, visit the ‘Breaking News’ section of the NewHorizon credit portfolios are normally around it, but seems to have website at www.newhorizon-islamicbanking.com domestic, they are strong the ability to withstand the retail banking platforms with storm.
8 IIBI www.newhorizon-islamicbanking.com Two innovative firms...
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Since that time, vesting, or vice versa?’ asked Baron Junaid the industry has flourished with banks, such Bhatti, CEO, Ballencreiff House, at The as the Netherlands-based Triodos Group Rise of Islamic Finance and Ethical Invest- and the UK-based Co-operative Bank, ments conference that was held recently in taking prominent positions in the conven- London. Responding to his own question, tional banking world supported by hun- Bhatti thought that Islamic finance is a not dreds of mutual investment funds, each a small sub-set, but a huge sub-set, of ethi- specialising in some aspect of ethical or cal finance. Islamic finance is very clear socially responsible investment. regarding ‘green’ issues and sustainable sources. Both forms of banking have much So how interchangeable are these technical in common. terms – ethical investing, socially responsi- ble investing and Islamic investing? Ethical The Ethical Partnership, a UK non-profit investing, as we have seen, uses negative organisation, classifies ethical investment as screening to weed out companies that en- using negative criteria to avoid investing in gage in undesirable lines of business. The companies that are involved in specific areas Ethical Partnership goes on to classify so- (see Box 1). This screening is largely subjec- cially responsible investment in the conven- tive, often depending on individual con- tional world as not only adhering to agreed sciousness, but a general consensus of those negative criteria, but actively seeking out We need to look not just at screenings shows an unerring similarity to firms which make a positive contribution what we can’t invest in – we the screens used by the Islamic world when to society. This is very much along the lines need to look at what we should selecting suitable investments – with riba of classical Islamic economic theory which invest in. (interest) probably being the major differ- holds that the Earth’s resources are to be ence between the two sets. The same types used for the benefit of the community as of prohibition of firms are excluded by a whole. Another fundamental tenet of Is- Naveen Raza, ethical screening in the conventional bank- lamic economic theory is that it is the duty Cru Investment Management ing world as are screened by the Islamic of mankind to care for the world’s resources world – such as those that are involved in and to hold them in stewardship, or trust, gambling, alcohol, arms manufacture, for future generations. It is interesting then, tobacco, pornography and the like. that the UK’s first purely ethical trust, which was launched in 1984 by Friends Provident, It is notable that the roots of socially was called The Stewardship Fund. Concep- responsible investing in the conventional tually, the two forms of banking would ap- world also seem to have stemmed from a pear to be operating on parallel paths. religious connection – they have been traced back to the 1920s when the Methodist ‘We think Islamic finance is better [than Church wished to invest in the UK stock conventional interest-based finance] because market while avoiding companies involved it’s fair, it’s just and it’s equitable,’ says 10 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ANALYSIS Naveen Raza, head of Islamic finance at Cru Investment Management. These are Box 1 also the objectives of the ethical and socially responsible investment movement in the What is ethical investment and socially responsible investment? conventional world. Raza is looking to promote the synergies between the two banking models, saying: ‘I think the future Ethical investment has been defined as putting your money where your morals are, or of Islamic finance lies in the overlap be- investing according to your beliefs. tween Islamic and ethical investing. If we want our industry to grow then we need Ethical investments tend to use negative criteria to avoid investing in companies to start tapping into an audience which involved in areas such as: goes beyond the borders of the Islamic world.’ ✖ Environmentally damaging practices; ✖ Trading with oppressive regimes and countries with poor human rights records; Mufti Mohammed Zubair Butt, chairman ✖ Pornography and offensive advertising; of the Al Qalam Shari’ah Scholars Panel, ✖ Gambling; the first ever UK-based panel of Shari’ah ✖ Tobacco and alcohol production; scholars, agrees, saying: ‘Islamic finance is ✖ Unnecessary exploitation of animals; socially responsible finance. It is designed ✖ Unsafe products and services; to come to the market and promote the ✖ Genetic engineering, abortion and embryonic research; public interest.’ He thinks there are some ✖ Armaments. things in common between the understand- ing of ethical finance and Islamic finance, Socially responsible investments, as well as adhering to agreed negative criteria, ac- for example, both forms avoid investment tively seek out firms which make a positive contribution to society, for example: in gambling, prostitution and alcohol. ‘But the main difference, of course, is the Islamic ✔ Products and services which are of long term benefit to the community; prohibition on interest-based transactions ✔ Conservation of energy and natural resources; and interest-based finance. As far as conven- ✔ Environmental improvements and pollution control; tional ethical schemes are concerned this ✔ Good relations with customers and suppliers; doesn’t even register.’ The effect of interest- ✔ High employee welfare standards; based lending, Butt thinks, ‘is that conven- ✔ Organic farming and foods; tional banks gear their project financing ✔ Strong community involvement; decisions on the creditworthiness of the ✔ A good equal opportunities record; borrower, as opposed to Islamic banking ✔ Respect for the sanctity and dignity of human life; where the viability of the project is the ✔ Openness about their activities. main concern because the bank itself is a partner’. The outcome is that the Islamic The list is not exhaustive. Each fund tends to differ in negative and positive criteria system must exclude investing in interest- and also in investment risk. It is, therefore, very important to select the right funds to based products or companies that deal match your views. with them such as banks and finance companies. Source: The Ethical Partnership Ltd Other differences may be more readily understood by conventional banking’s Mohammad Khan, director of takaful at banking to conventional banking should ethical investment community. These PricewaterhouseCoopers, speaking at the be stressed – showing the faith-oriented differences include the avoidance of short- conference mentioned above, pointed out differences between Islamic modes and the selling and the more conservative use of that in Malaysia it is estimated that about conventional and indeed stressing those derivatives, which would typically be used 40 per cent of Islamic banking is done by differences. But to the non-Muslim market, only as hedging tools if they are used at the non-Muslim, ethnic Chinese community. non-differentiation should be stressed all. Many in the West may well now sympa- He thought that this showed that Islamic because to that market, banking is just a thise with this position, particularly in light banking has the potential, and appeal, to be commodity item. of the current turmoil in the conventional used outside of the Muslim community. He financial markets and the abuses that have suggested that when addressing the Muslim Possibly there is a third alternative, that of reportedly taken place. community the differentiation of Islamic stressing what the Islamic model has in www.newhorizon-islamicbanking.com IIBI 11 ANALYSIS NEWHORIZON January–March 2009 What ethical screening means: Shari’ah-based Islamic index screening Shari’ah indexes are mechanisms that track the performance of selected, leading Shari’ah-compliant companies. The indexes may be global or limited to a particular geographic region. Two of the major providers of Islamic indexes are Dow Jones and the FTSE. Boards, made up of leading Shari’ah scholars, advise suppliers on the make-up of the indexes and advise on Shari’ah principles. The Dow Jones uses its own in-house appointed Shari’ah scholars; the FTSE uses the services of Yassar Research Inc. Excluded from the Islamic indexes are companies that are involved in activities that are not in keeping with the fundamentals of the Islamic faith (haram activities). Companies that are involved in the following activities are automatically excluded: ❏ Alcohol manufacture, distribution, or related activities; ❏ Conventional banking services or other interest-based service companies; ❏ Entertainment and gaming services (casinos/gambling, cinema, hotels, music, pornography, etc); ❏ Life insurance; ❏ Pork-related products. Although not specifically prohibited by the Shari’ah, companies engaging in the following activities are considered to be against the interests of the community, so are generally excluded: ❏ Arms manufacture or sales; ❏ Tobacco-related production and products. To be considered Shari’ah-compliant, companies must also adhere to strict financial ratio screening (see below) as determined by the index’s Shari’ah advisory board. Other ethical based screening Many ‘ethical’ and ‘socially responsible’ investments will screen out most, if not all, of the above categories. Additionally, other screens, such as human rights violations or use of child labour, may be included in the ethical screenings of conventional financial investments depending on the consciousness of the particular screen. These activities are not strictly considered as ‘haram’, so are not automatically excluded from the Shari’ah screenings. Financial ratio screening Islamic scholars recognise that business activities must be carried out with non-Islamic organisations so they tolerate a limited amount of otherwise ‘haram’ activities to take place within those conventional companies. Those activities must be within acceptable limits. This type of screening has protected the Islamic community from investment losses in the past. A commonly quoted example is when Enron, prior to its collapse, exceeded the Shari’ah guidelines of acceptable levels of debt and was taken out of the Islamic indexes at the insistence of the Shari’ah scholars, and so protected Islamic investors from its dramatic fall in the markets. Some of the common financial screens include: ❏ Debt to total assets should not equal or exceed 33 per cent; ❏ Illiquid to total assets should be at least 51 per cent (this figure can vary according to region); ❏ Total investment in non-compliant activities should not equal or exceed 33 per cent; ❏ Income from non-compliant investment should not equal or exceed five per cent of gross revenue; ❏ What is referred to as ‘net liquid assets’, calculated as [(tangible fixed assets + inventory) – liabilities], per share should be at less than the market price of the share. Source: Mufti Mohammed Zubair Butt 12 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ANALYSIS common with the socially responsible in- of a box-ticking exercise – how can we get vestment community of the conventional this product past our scholars?’ says Raza. world and pointing out that the industry is ‘If we think Islamic finance is a better way already pre-screened, so that it inherently then we need to show why it’s a better way meets the needs of the ethically conscious and for that I think we need to go back to conventional market. There may already the roots of Islamic finance; we need to be some traction in this message – Imran think of what were the original principles of Pasha, head of branch network at the Shari’ah and ask why are we doing what we Islamic Bank of Britain has noted that, in are doing.’ Raza believes this type of ques- the UK, his bank has experienced a five tioning will provoke answers such as – to to ten per cent increase in inquiries from try and reduce the gap between the rich and non-Muslims who were interested in the the poor, to try and give help to people who ethical aspects of Islamic finance. are not blessed with having as much wealth as others, and to enable them to earn a liv- Raza is hoping that the potential for cross- ing and do well for themselves. If you get to selling between the Islamic and the ethical these sorts of answers, then you may think worlds can be used in a real way. A new ‘how can I actually create a product that is fund, the Africa Transformational Agri- true to the principles that I am rooted in’. Fund, is to be launched by Cru Investment To hold these basic humanitarian beliefs Islamic finance is socially Management in March 2009 to provide di- you need not be Muslim – they are values responsible finance. It is rect investment and infrastructure to farm- that the majority of people throughout the designed to come to the ers in the sub-Sahara region. The fund had a world will uphold. warm reception from the Islamic community market and promote the in the UK and Middle East when it was an- A common criticism of Islamic finance is public interest. nounced. ‘People loved the idea, they loved that, although it is recognised that the in- the fact it was purely Islamic – not just the dustry is a new one, it has spent too much Mufti Mohammed Zubair Butt, structure of the product but actually the un- time mimicking conventional finance. ‘We Al Qalam Shari’ah Scholars Panel derlying ethos of it. What we are doing on do need an [Islamic] home finance product, the ground is Islamic – as opposed to just we do need car finance, we do need a sav- the structural requirements that make it ings account and a current account and we Shari’ah-compliant. We are saying that it is do need liquidity management. We needed Shari’ah-based, it is rooted in the principles to mimic the conventional world to get to a of Shari’ah,’ explains Raza. point where we can be competitive,’ con- cedes Raza. But she goes on to say, ‘I hope A key point, though, is that the fund, al- that people will start to think outside of the though being totally Islamic in practice and box and not just think about the conven- intention, is also being actively promoted tional industry and how we can copy or to the socially responsible investment com- mimic that. We need to look not just at munity in the conventional world as well what we can’t invest in – we need to look as to Islamic investors. ‘In Europe, ethical at what we should invest in. So positive investing is a very big thing and we need to screening comes into play.’ align ourselves more closely to ethical and socially responsible investors,’ says Raza. This level of ‘positive’ investment places Potentially, this fund and similar funds obligations on the investor which are above could give ethical investors vehicles for di- simply placing money into non-haram rect investment into the region rather than companies. ‘As Islamic investors, we need simply making donations to charity relief to be responsible – not just say we have not organisations. invested in anything that we are not al- lowed, so that’s fine. We need to do a little The hope is that these primary investment bit more, we need to take responsibility. If ideas will appeal to both the ethical in- they have practices that are not ethical or vestors in the conventional world and Islamic then we need to put on pressure at the ethical investors in the Islamic world. annual meetings. This is important,’ believes ‘Islamic finance has become more and more Raza. www.newhorizon-islamicbanking.com IIBI 13 ANALYSIS NEWHORIZON January–March 2009 This is exactly the view held by another ance of the Shari’ah companies in six of the newly established fund that is targeting ten member states of the ASEAN nations. its investment into companies with high As of end of November 2008, the index levels of corporate transparency. Addition- consisted of 284 companies. ally, this new fund has been designed to be marketed to both the Islamic and the ethical Muhiudeen raises a point which is topical communities. The ASEAN (Association of among Islamic fund managers and will be- Southeast Asian Nations) Corporate Gover- come more so if cross-selling occurs be- nance fund, offered by Malaysia-based tween the ethical and the Islamic worlds. Corston-Smith Asset Management, will That is the topic of co-mingling of invest- invest in ASEAN companies that not only ments from different individuals. At the have a good business model but also have heart of this issue is the different level of highly rated corporate governance princi- Shari’ah compliance required by different ples. The fund has two versions – a conven- investors. The ASEAN Corporate Gover- tional version that was launched in June nance Fund itself is open about the scholars 2008 and an Islamic version, which is it uses and other compliance issues. Each Shireen Muhiudeen, scheduled to be launched shortly. investor is then able to determine for Corston-Smith Asset Management themselves whether the fund’s Shari’ah The fund is a result of a strategic compliance is within their own tolerance collaboration between Corston-Smith level. Some investors will not wish to co- be an issue that will need to be addressed in Asset Management and Hermes EOS, the mingle their investment with others who the future. management arm of the UK’s BT pension may be seen as being less strict than them- scheme, which advises institutional investors selves. This will give the need to segregate The Islamic finance industry has often on corporate governance issues and which funds of certain investors. been criticised for mimicking the conven- has £50 billion ($74 billion) of assets under tional banking industry but in attempting stewardship. Although the ASEAN fund will have to follow ethical and socially responsible separate conventional and Islamic versions, investment paths, perhaps those in the ‘The purpose of the fund is to raise the if Islamic funds are to be cross-sold outside conventional banking world are, possibly level of transparency in the industry,’ says of the Muslim world then co-mingling may unknowingly, mimicking Islamic finance. Shireen Muhiudeen, managing director, Corston-Smith Asset Management. ‘In- Investors are willing to pay a premium for a high level of corporate vestors are willing to pay a premium for transparency, particularly in the current subprime crisis, in which a high level of corporate transparency, particularly in the current subprime crisis, even the sellers of some paper have not known what it is that they in which even the sellers of some paper have are selling. not known what it is that they are selling’. In addition to the Hermes screening, poten- Shireen Muhiudeen, tial investments are subject to an additional Corston-Smith Asset Management 49 question checklist by the fund. The questions relate to details of the company’s corporate governance. The target is to get around 20 to 30 stocks in the fund. At the moment, in the conventional version of the fund, there are about eight companies cur- rently approved but that will rise to 13 once those in the pipeline are given the green light. The Shari’ah version has a ‘uni- verse’ of 212 stocks, but this will reduce to around ten per cent or so once screening has taken place. To provide a benchmark, Dow Jones has created a new index, the Dow Jones Islamic Market ASEAN Index to represent perform- 14 IIBI www.newhorizon-islamicbanking.com ANALYSIS NEWHORIZON January–March 2009 Balance sheet analysis: Islamic vs. conventional Hennie van Greuning (left) and Zamir Iqbal (right), senior advisor and lead investment officer respectively at The World Bank Treasury in the US, and the authors of ‘Risk Analysis for Islamic Banks’, compare the balance sheet structures of Islamic banks and their conventional counterparts. The goal of financial risk management balance sheet items with specific risk aspects asset-liability mismatch. Second, medium- to is to maximise the value of a financial insti- so that the interaction between various long-term assets are financed by the stream of tution as determined by its level of prof- types of risk is understood to ensure that short-term liabilities, exposing the bank to a itability and risk. Since risk is inherent in they are not evaluated in isolation. The maturity mismatch risk and discouraging the banking and unavoidable, the task of the relative share of various balance sheet bank from investing in long-term non-liquid risk manager is to manage the different components – assets and liabilities – is a projects. An increase in the level of non-retail types of risk at acceptable levels to achieve good indication of the levels and types of deposits or funding could expose a conven- optimal profitability. Doing so requires the risk to which a bank is exposed. tional bank to greater volatility in satisfying continual identification, quantification, its funding requirements, requiring increas- and monitoring of risk exposures, which Table 1 below shows stylised balance sheet ingly sophisticated liquidity risk management. in turn demands sound policies, adequate of a conventional commercial bank. On the Certain funding instruments also expose a organisation, efficient processes, skilled liability side, it accepts demand and saving bank to market risk. analysts and elaborate computerised infor- deposits, issues term certificates such as mation systems. In addition, risk manage- certificate of deposits (CD), and has capital. For Islamic financial institutions, the nature ment requires the capacity to anticipate of financial intermediation, including the changes and to act in such a way that a On the asset side, there is much more function of banking, is different from that bank’s business can be structured and diversity and options in the form of of conventional financial institutions. This restructured to profit from the changes marketable securities, trading accounts, is the key to understanding the difference or at least to minimise losses. Regulatory lending to corporations and to consumers. in the nature of risks in conventional and authorities should not prescribe how Islamic banking. For Islamic banks, the business is conducted; instead, they should From the risk point of view, two observa- mudarabah contract is the cornerstone of maintain prudent oversight of a bank by tions can be made. First, the deposits create financial intermediation and thus of banking. evaluating the risk composition of its assets instantaneous pre-determined liabilities The basic concept is that both the mobilisa- and by insisting that an adequate amount irrespective of the outcome of the usage of tion and (in theory) the use of funds are based of capital and reserves is available to safe- the funds on the asset side, thus creating an on some form of profit sharing among the guard solvency. Table 1 Stylised balance sheet of a conventional bank – based on functionality Although the approaches to risk manage- ment are diverse, a good starting point is Assets Liabilities to undertake a top-down approach starting with the balance sheet. One cannot underes- Loans and advances to customers Customers’ deposits timate the importance of understanding the structure and composition of the balance Cash and cash balances with other banks Due to banks and other financial institutions sheet of a financial institution. Investments in associates, subsidiaries and joint ventures Other liabilities It is critical to assess the ways in which a Financial assets held for trading Sundry creditors bank’s risk managers and analysts can analyse the structure of balance sheets and Cash and cash balances with the central bank Equity and reserves income statements, as well as individual 16 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ANALYSIS depositors, the bank, and the entrepreneurs rectly affects its cost of operation and there- in case of an Islamic bank, the asset and the (users of funds). The financial intermedia- fore determines a bank’s potential profit financing are coupled together. The bank is tion is merely a ‘pass-through’ arrangement and level of risk. The structure of a bank’s not limited to the exposure as a financier similar to funds management, with the liabilities also reflects its specific asset- but can develop additional exposures result- difference that there are multiple portfolios liability and risk management policies. ing from dealing with physical assets. An- on the asset side. other feature which distinguishes the risks When compared with conventional banks, of an Islamic bank from a conventional Table 2 below presents a stylised balance balance sheet risk profile of Islamic banks bank is the general lack of liquid securities sheet of an Islamic bank, displaying is different. First, the foremost feature of an on the asset side. This feature is not a design different activities and financial instru- Islamic bank is the ‘pass-through’ nature of issue but is a temporal phenomenon until a ments. It serves as a good starting point the balance sheet. This feature removes the well-functioning securities market for Shar- for understanding the dynamics of the risks typical asset-liability mismatch exposure of i’ah-compliant instruments is developed. inherent in Islamic banks. This balance a conventional bank, as the Islamic bank’s sheet classifies the functionality and purpose depositors’ return is linked to the return on Finally, due to prohibition of interest, of different instruments – a common the assets of the bank. However, this fea- Islamic banks cannot issue debt to finance practice among Islamic banks. ture also introduces some operational issues, the assets which consequently discourages creation of leverage. Due to the lack of Table 2 Stylised balance sheet of an Islamic bank – based on functionality leverage, Islamic banks can be considered less risky during a time of financial crisis. Application of funding Sources of funding The current financial crisis was precipitated by excessive leverage and complexity in Cash balances Demand deposits (amanah) the financial system, which had developed Financing assets (murabaha, salam, ijara, istisna) Investment accounts (mudarabah) multiple layers of intermediaries. Hence, the financing – or the claims on assets – became Special investment accounts Investment assets (mudarabah, musharakah) remote from the underlying assets. For (mudarabah, musharakah) Islamic banks, the financial intermediary is Fee-based services (ju’ala, kafala, and so forth) Reserves closely associated with the asset and is able to perform better monitoring of the asset Non-banking assets (property) Equity capital as well as the obligor. These features can enhance the stability of the banking system. The structure of a typical balance sheet has such as estimation and accrual of ex-post demand deposits and investment accounts returns and the treatment of intra-period In short, a holistic approach to understand- from customers on the liability side and withdrawal of deposits. ing the risk of Islamic financial institutions Islamic financing and investing accounts should start with a rigorous analysis of the (the equivalent of conventional banks’ Second, the nature of assets of two institu- risk profile of different financial contracts loans to customers) on the asset side. This tions is different. Whereas a conventional on each side of the balance sheet. Standard pattern reflects the nature of banks as inter- bank tends to stay with fixed income very analysis techniques such as trend analysis, mediaries, with ratios of capital to liabilities low credit risk debt securities, an Islamic impact analysis, bucketing, duration and at such a low level that their leverage would bank’s assets are concentrated on the asset- maturity mismatch, and value-at-risk analy- be unacceptable to any business outside the based investments which has credit risk but sis can be applied to each financial contract financial services industry. The analyst are also backed by a real asset. As a result, or instrument type but then the results should be able to assess the risk profile of the lending capacity of the Islamic banking should be aggregated at the balance sheet the bank simply by analysing the relative sector (at least for commercial banks) is level to understand a global picture at the share of various asset items and changes in bound by the availability of real assets in institution level. their proportionate share over time. the economy. Thus, there is no leveraged credit creation. Typical risk analysis often focuses on finan- While the types of liabilities present in an cial risks, and especially on the asset side. Islamic bank’s balance sheet are nearly Third, the assets of Islamic banks contain However, given the nature of Islamic banks, universal, their exact composition varies financing assets where tangible goods and a good analysis should not ignore non- greatly depending on a particular bank’s commodities are purchased and sold to the financial risks on the liability side such as business and market orientation, as well as customers. This practice creates distinct withdrawal risk and lack of geographical the prices and supply characteristics of dif- exposures. For example, in case of conven- diversification. And of course, competition ferent types of liabilities at any given point tional banking, the asset is financed by a from conventional banking should not be in time. The funding structure of a bank di- loan from the bank to the customer whereas ignored either. www.newhorizon-islamicbanking.com IIBI 17 OVERVIEW NEWHORIZON January–March 2009 In the spotlight: South Africa Rabiah Talib Badroen, majoring in Islamic studies and international politics at the University of South Africa, outlines the state of the country’s Islamic finance industry. South Africa’s minority Muslim population The independence of the banks in this area Muslim quarter, consists of an estimated 1.5 per cent of is demonstrated by the make-up of the Cape Town, South Africa a total figure of 48 million. Shari’ah- boards. For example, First National Bank’s compliant vehicle finance remains the (FNB) Islamic window has a Shari’ah board product with the most traction, which may consisting of an all South African member- be attributed to the infrastructure of the ship, whereas the Oasis Group, a fund country. The Islamic banking system at this manager, relies on a board made up of inter- point is inadequate to provide full banking national members. Each institution appoints services in the fashion of conventional banks whichever members it considers most quali- to the Muslim community. Areas of foreign fied to fill the position. At the investment exchange and personal finance still remain company Stanlib, among the members of in the domain of conventional banks. the Shari’ah board is Mohammed Hashim Kamali, an international author on the However, Islamic finance contains inherent subject of Islamic jurisprudence. A factor features that offer protection against the that is noticeable in this emergent market present state of global finance, and the is the lack of collaboration amongst all the South African Reserve Bank (SARB) that institutions operating in Islamic finance. At regulates banking practices in South Africa present there is also no vision of a unified has curbed international financial integra- Shari’ah board – a Shari’ah board’s expert- tion so that the country is not suffering the ise is confined to Islamic jurisprudence and complete effects of the global financial a unifying body is unforeseen at this stage. turmoil. These institutions are also members of the © Steven Allan iStockphoto.com SARB provides the framework of regula- Accounting and Auditing Organisation for tions to all financial sectors operating Islamic Financial Institutions (AAOIFI) and in the country. The emerging Shari’ah- the Islamic Financial Services Board (IFSB). compliant financial institutions are com- Both memberships are viewed as compli- pelled to operate under the same regulatory mentary and the institutions respect the framework as conventional institutions, guidelines and directives offered by these and SARB is the only body authorised to standard-setting bodies. issue licences. Albaraka Bank is the longest established Islamic financial institutions must, there- Islamic bank in the country. The bank is fore, obtain a licence from SARB and owned by South African investors, UK- under the stipulated regulations contained based DCD London & Mutual Plc and in the Banks Act of 1990, but since the Saudi Arabia-based Dallah Al Baraka Banks Act provides no legislation on Group. The bank is renowned for striving Shari’ah compliance of banking operations, to operate strictly within the confines of individual Islamic financial institutions Shari’ah-compliant principles. Its headquar- appoint their own Shari’ah boards to ensure ters are in Durban, and it has six regional it. The Shari’ah boards are an independent branches spread throughout the country. component of the governance structure of The bank offers the more common Islamic these institutions and advise on matters financial services such as murabaha, relating to Islamic jurisprudence. musharakah, ijara and ijara wa iqtina. Ijara 18 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 financing is currently being pioneered by investment account, designed to attract Albaraka; the inception of this scheme was oversees investors, to its product portfolio. in August 2008. Clients have the option of This will be the first istisna product avail- choosing between murabaha and ijara. able to the South African Islamic finance market. The bank is also involved in takaful. The Takaful Waqf Fund, which offers Shari’ah- Investment institutions offering Islamic compliant asset protection in collaboration equity on the South African stock exchange with Takafol South Africa (subsidiary of a market occupy a larger share than the bank- German reinsurance company, Hannover ing sector. Albaraka offers an investment Re Group), channels all excess funds to account, and Fraters and Stanlib are the Shari’ah-compliant projects. This fund has other investment companies offering shared become instrumental in South Africa’s much investment. However, the investment institu- needed social development. It is interest tion that holds the greatest recognition is, (riba) free and this condition is governed by undoubtedly, the Oasis Group. Established the bank’s supervisory council, Albaraka eleven years ago in Cape Town, it has Board of Shari’ah Advisors. grown regionally and internationally – at present it occupies offices throughout South Albaraka also offers a very popular product Africa, in Dublin’s financial district and in known as the Hajj Investment Scheme. This Dubai. As an international player it has is a scheme for individuals and organisations claimed the Failaka Islamic Fund award who wish to take part in the pilgrimage. A consecutively and the Kuala Lumpur Islamic minimum fixed amount is deposited every Fund award for Outstanding Islamic Fund month and a share of profits is earned Manager. The institution has an aggressive monthly. continuous advertising campaign. In the month of Ramadan this year, at the height Islamic windows have been incorporated of the US-led financial crisis, the CEO of into two leading South African conventional Oasis, Adam Ismael Ebrahim, addressed banks, the afore-mentioned FNB and Absa local investors’ concerns by reiterating the Bank. FNB’s CEO, Ebi Patel, started re- insulation Islamic investment can provide searching Islamic windows in 2000. He by not engaging in derivative instruments, rejected all previous approaches and struc- speculation and hedge funds. Oasis’ Islamic tured a package suitable for the indigenous equity fund is definitely suffering in the market. In 2004, FNB launched the first present bearish climate, but the impact is Islamic window in the domestic market, less severe than in conventional and interna- concentrating only on vehicle and asset tional investments. Islamic fund managers finance. Due to FNB’s widespread geo- are requesting patience in a market with less graphic accessibility in comparison to Al- systematic risks. baraka’s six branches, it was able to exceed Albaraka within a period of 18 months, Plans are in the pipeline to grow Shari’ah- according to Patel. However, Albaraka’s compliant finance in South Africa, but the objective is to remain a niche firm. success and the sustainability of Islamic products ultimately depend on the con- FNB offers cheque accounts, debit cards sumer. The emergence of better educated and property finance as well as the product young population, with a deeper under- with which its launch is associated, vehicle standing of Islamic finance and, therefore finance. Meanwhile, Absa offers similar more open to it, is undoubtedly a positive products, and both exclude musharakah sign. At present, apart from a handful of financing. world renowned Islamic finance players, the overall Islamic banking and finance sector Patel has revealed potential products in the of South Africa is not prominent on the in- pipeline to give FNB a larger share of the ternational scene. However, there is a poten- market. The bank is planning on adding de- tial which, once fully realised, will benefit velopment bonds (based on istisna) and an the country socially and financially. www.newhorizon-islamicbanking.com IIBI 19 ACADEMIC ARTICLE NEWHORIZON January–March 2009 The global financial crisis: can Islamic finance help? Dr Umer Chapra, senior research advisor at Islamic Research and Training Institute of the Islamic Development Bank (IDB), explores this issue in the first of the IIBI lecture series, dedicated to Ibn Khaldun*. The whole world is now in the grip of a big banks that the central bank will defi- Consequently, loan volume gained greater financial crisis which is far more serious nitely come to their rescue and not allow priority over loan quality and the amount than any experienced since the Great them to fail. of lending to subprime borrowers and spec- Depression. It has taken more than $3 ulators increased steeply. According to trillion of bailout and liquidity injections The false sense of immunity from losses Ben Bernanke, chairman of the board of by a number of industrial countries to that all these factors together provide, has governors of the US Federal Reserve System, abate somewhat the intensity of the crisis. introduced a fault line in the financial sys- ‘far too much of the lending in recent years Nevertheless, there are fears that this tem. Banks have not, therefore, undertaken was neither responsible nor prudent… In crisis may have exposed the world economy a careful evaluation of the loan applications. addition, abusive, unfair, or deceptive to a long period of economic slowdown. This has led to an unhealthy expansion in lending practices led some borrowers into There is, hence, a call for a new architecture the overall volume of credit, to excessive mortgages that they would not have chosen that would help minimise the frequency and leverage, and to an unsustainable rise in knowingly.’ The check that market disci- severity of such crises in the future. asset prices, living beyond means, and spec- pline could have exercised on the serving ulative investment. Unwinding later on gives of self-interest did not come into play. Even Primary cause of the crisis rise to a steep decline in asset prices, and to the supervisors failed to perform their task financial frangibility and debt crises, partic- effectively by not taking serious notice of It is not possible to design a new architec- ularly if there is over-indulgence in short the unfair practices at an early stage and ture without first determining the primary sales. Jean Claude Trichet, president of the nipping them in the bud. cause of the crisis. The generally recognised European Central Bank, has rightly pointed most important cause of almost all crises out that ‘a bubble is more likely to develop The result is that a number of banks have has been excessive and imprudent lending when investors can leverage their positions either failed or have had to be bailed out by banks over a long period. This is clearly by investing borrowed funds’. or nationalised by the governments in the acknowledged by the Bank for International US, the UK, Europe and a number of other Settlements (BIS), which states as much in The subprime mortgage crisis places. This has created uncertainty in the its annual report (released on 30th June market and prolonged the credit crunch, 2008). The subprime mortgage crisis, in the grip which made it hard for even healthy banks of which the US finds itself at present, is to find financing. There is a lurking fear This raises the question of what makes it a classical example of excessive and that this might be only the tip of the iceberg possible for banks to resort to such an un- imprudent lending. Securitisation or the and a lot more may follow if the crisis healthy practice which not only destabilises ‘originate-to-distribute’ model of financing causes a prolonged recession and leads to the financial system but is also not in their has played a crucial role in this. The defaults on the part of credit card institu- own long-run interest. There are three creation of collateralised debt obligations tions, corporations and derivatives dealers. factors that make this possible. One of these (CDOs) by mixing prime and subprime is inadequate market discipline in the finan- debt made it possible for mortgage When there is excessive and imprudent cial system resulting from the absence of originators to pass the entire risk of default lending and lenders are not confident of profit-and-loss sharing (PLS). The second is of even subprime debt to the ultimate repayment, there is an excessive resort to the mind-boggling expansion in the size of purchasers who would have normally been derivatives like CDSs to seek protection derivatives, particularly credit default swaps reluctant to bear such a risk. Mortgage against default. The buyer of the swap (CDSs), and the third is the ‘too big to fail’ originators had, therefore, less incentive to (creditor) pays a premium to the seller concept, which tends to give an assurance to undertake careful underwriting. (a hedge fund) for the compensation he 20 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ACADEMIC ARTICLE will receive in case the debtor defaults. If as well as the loss. For this purpose, one of ❏ The debt cannot be sold and thus the this protection had been confined to the ac- the basic principles of Islamic finance is ‘no risk associated with it must be borne by tual creditor, there may not have been any risk, no gain’. This should help introduce the lender himself. problem. What happened, however, was greater discipline into the financial system that hedge funds sold the swaps not to just by motivating financial institutions to assess The first condition will help eliminate a large the actual lending bank but also to a large the risks more carefully and to effectively number of derivatives transactions which in- number of others who were willing to bet monitor the use of funds by the borrowers. volve nothing more than gambling by third on the default of the debtor. These swap The double assessment of risks by both the parties who aspire to claim compensation for holders, in turn, resold the swaps to others. financier and the entrepreneur should help losses which have been actually suffered only The whole process continued several times. inject greater discipline into the system, and by the principal party and not by them. go a long way in reducing excessive lending. While a genuine insurance contract indem- The second condition will help ensure that nifies only the actually insured party, in Islamic finance should, in its ideal form, the seller (or lessor) also shares a part of the the case of CDSs there were several swap help raise substantially the share of equity risk to be able to get a share in the return. holders who had to be compensated. This and PLS in businesses. Greater reliance Once the seller (financier) acquires owner- accentuated the risk and made it difficult for on equity financing has supporters even ship and possession of the goods for sale or the hedge funds and banks to honour their in mainstream economics. Professor lease, he/she bears the risk. This condition commitments. The notional amount of all Kenneth Rogoff of Harvard University also puts a constraint on short sales, thereby outstanding derivatives (including CDSs of states that in an ideal world equity lending removing the possibility of a steep decline $54.6 trillion) is currently estimated by the and direct investment would play a much in asset prices during a downtown. The BIS to be over $600 trillion, more than ten bigger role. Shari’ah has, however, made an exception times the size of the world economy. No to this rule in the case of salam and istisna wonder George Soros described derivatives Greater reliance on equity does not neces- where the goods are not already available as ‘hydrogen bombs’, and Warren Buffett sarily mean that debt financing is ruled out. in the market and need to be produced or called them ‘financial weapons of mass This is because all the financial needs of manufactured before delivery. Financing ex- destruction’. individuals, firms, or governments cannot tended through the Islamic modes can thus be made amenable to equity and PLS. Debt expand only in step with the rise of the real The Islamic financial system is, therefore, indispensable, but should not economy and thereby help curb excessive be promoted for nonessential and wasteful credit expansion. One of the most important objectives of consumption and unproductive speculation. Islam is to realise greater justice in human For this purpose, the Islamic financial sys- The third and the fourth conditions will society. According to the Quran, a society tem does not allow the creation of debt not only motivate the creditor to be more where there is no justice will ultimately through direct lending and borrowing. It cautious in evaluating the credit risk but also head towards decline and destruction rather requires the creation of debt through prevent an unnecessary explosion in the vol- (Quran, 57:25). Justice requires a set of the sale or lease of real assets by means of ume and value of transactions. This will pre- rules or moral values, which everyone its sales- and lease-based modes of financing vent the debt from rising far above the size of accepts and faithfully complies with. The (murabaha, ijara, salam, istisna and sukuk). the real economy and also release a substan- financial system may be able to promote The purpose is to enable an individual or tial volume of financial resources for the real justice if, in addition to being strong and firm to buy now the urgently needed real sector, thereby helping expand employment stable, it satisfies at least two conditions goods and services in conformity with and self-employment opportunities and the based on moral values. One of these is that his/her ability to make the payment later. It production of need-fulfilling goods and serv- the financier should also share in the risk so has, however, laid down a number of condi- ices. The discipline that Islam wishes to in- as not to shift the entire burden of losses to tions, some of which are: troduce in the financial system may not, the entrepreneur, and the other is that an eq- however, materialise unless governments re- uitable share of financial resources mo- ❏ The asset which is being sold or leased duce their borrowing from the central bank bilised by financial institutions should must be real, and not imaginary or to a level that is in harmony with the goal of become available to the poor to help elimi- notional. price and financial stability. nate poverty, expand employment and self- employment opportunities and, thus, help ❏ The seller or lessor must own and One may raise an objection here that all reduce inequalities of income and wealth. possess the goods being sold or leased. these conditions will perhaps end up shrink- ing the size of the economy by reducing the To fulfill the first condition of justice, ❏ The transaction must be a genuine trade number and volume of transactions. This is Islam requires both the financier and the transaction with full intention of giving not likely to happen because a number of the entrepreneur to equitably share the profit and taking delivery. speculative and derivatives transactions are www.newhorizon-islamicbanking.com IIBI 21 ACADEMIC ARTICLE NEWHORIZON January–March 2009 generally known to be zero-sum games problem may be difficult to solve unless and late settlement of financial obligations. and have rarely contributed positively to the microfinance sector is scaled up by The system is, thus, not fully prepared at pres- total real output. Hence a decline in them integrating it with the commercial banks. ent to play a significant role in ensuring the is also not likely to hurt the real economy. Commercial banks do not generally lend to health and stability of the international finan- While a restriction on such transactions small borrowers because of the higher risk cial system. It is, however, expected that the will cut the commissions earned by the and expense involved in such financing. It system will gradually gain momentum with speculators during an artificially generated is, therefore, important to reduce their risk the passage of time and complement the ef- boom, it will help them avert losses and and expense. This may be done partly by forts now being made internationally for bankruptcy that become unavoidable during a subsidy from zakat and waqf funds for promoting the health and stability of the the decline and lead to a financial crisis. those borrowers who are eligible for zakat. global financial system. The injection of a greater discipline into Thus we can see that the Islamic financial Concluding remarks the financial system may tend to deprive system is capable of minimising the severity the subprime borrowers from access to and frequency of financial crises by getting Since the current architecture of the conven- credit. Therefore, justice demands that some rid of the major weaknesses of the conven- tional financial system has existed for a long suitable innovation be introduced in the tional system. It introduces greater disci- time, it may perhaps be too much to expect system to ensure that even small borrowers pline into the financial system by requiring the international community to undertake are also able to get adequate credit. Such the financier to share in the risk. It links a radical structural reform of the kind that borrowers are generally considered to be credit expansion to the growth of the real the Islamic financial system envisages. How- subprime and their inability to get credit economy by allowing credit primarily for ever, the adoption of some of the elements will deprive them from realising their the purchase of real goods and services of the Islamic system, which are also a part dream of owning their own homes and which the seller owns and possesses, and the of the western heritage, is indispensable for establishing their own microenterprises. buyer wishes to take delivery. It also re- ensuring the health and stability of the global quires the creditor to bear the risk of default financial system. These are: There is no doubt that a number of coun- by prohibiting the sale of debt, thereby en- tries have established special institutions to suring that he evaluates the risk more care- ❏ The proportion of equity in total grant credit to the poor and lower middle fully. In addition, Islamic finance can also financing needs to be increased and that class entrepreneurs. Even though these have reduce the problem of subprime borrowers of debt reduced. been extremely useful, there are two major by providing credit to them at affordable problems that need to be resolved. One of terms. This will save the billions that are ❏ Credit needs to be confined primarily these is the high cost of finance, ranging spent after the crisis to bail out the rich to transactions that are related to the from 30 to 84 per cent in the interest-ori- bankers. These do not, however, help the real sector so as to ensure that credit ented microfinance system. This causes seri- poor because their home may have already expansion moves more or less in step ous hardship to the borrowers in servicing become subject to foreclosure and auctioned with the growth of the real economy their debt. No wonder the minister of fi- at a give-away price. and does not promote destabilising nance for Bangladesh described microcredit speculation and gambling. interest rates in that country as extortionate The problem is that the Islamic finance is in an address he delivered at a microcredit still in its infancy and shares a very small ❏ Leverage needs to be controlled to summit in Dhaka in 2004. It is, therefore, proportion of international finance. In addi- ensure that credit does not exceed important that microcredit is provided to tion, it does not genuinely reflect the ethos beyond the ability of the borrower to the very poor on a humane, interest-free of Islamic teachings. The use of equity and repay. basis (qard hasan). This may be possible if PLS is still very small while that of debt-cre- the microfinance system is integrated with ating modes is preponderant. Moreover, ❏ If the debt instruments, and in particular zakat and waqf institutions. For those who even in the case of debt-creating modes, all CDOs, are to be sold, then there should can afford to bear the cost of microfinance, the conditions laid down by the Shari’ah are be full transparency about their quality it would be better to popularise the Islamic not being faithfully observed by the use of so that the purchaser knows exactly modes of PLS and sales- and lease-based legal stratagems (hiyal). This is partly due what he is getting into. It would also modes of finance, not only to avoid interest to a lack of proper understanding of the be desirable to have the right of recourse but also to prevent the misuse of credit for ultimate objectives of Islamic finance, the for the ultimate purchaser of the CDOs personal consumption. non-availability of trained personnel, and so as to ensure that the lender has the absence of a number of shared or sup- incentive to underwrite the debt carefully. Another problem faced by microfinance port institutions that are needed to minimise is that the resources at the disposal of mi- the risks associated with anonymity, moral ❏ While there may be no harm in the crofinance institutions are inadequate. This hazard, principal/agent conflict of interest, use of CDSs to provide protection to 22 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ACADEMIC ARTICLE the lender against default, it needs to just the commercial banks, need to be ensured that the swaps do not be be properly regulated and supervised *A distinguished 14th century polymath come instruments for wagering. Their so that they remain healthy and do not and the forerunner of classical economics protective role should be confined to become a source of systemic risk. and social sciences, Ibn Khaldun broke new the original lender only and should ground in many fields and anticipated the not cover the other purchasers of ❏ Some arrangement needs to be made later findings of Western social scientists. swaps who wish to wager on the to make credit available to subprime Some hundreds of years ago, he presented a debtor’s default. For this purpose borrowers at affordable terms to comprehensive theory arguing that the de- the derivatives market needs to be enable them to buy a home and to velopment and decline of societies does not properly regulated to remove the establish their own microenterprises. depend on any single factor, but rather the element of gambling in it. This will help save the financial system combination of factors, including moral, from crises resulting from widespread social, economic, political and historical. ❏ All financial institutions, and not defaults by such borrowers. The Who, What, Where Guide to Printed £595 Ebook £495 Islamic Banking Printed & Ebook £750 Systems Edition 3 – 2008 A comprehensive guide to the Islamic core systems market with fully updated vendor profiles and unbiased editorial comment. Inside the Islamic Guide: J Introduction J View from the Suppliers J Suppliers & Systems List J Supplier Analysis J Technology Overview J Country Analysis J Islamic Authorities J Summary Analysis J Shari’ah Boards J Case Studies of banks which have already implemented Islamic banking systems For more information including suppliers profiled visit our website: www.ibspublishing.com COUNTRY FOCUS NEWHORIZON January–March 2009 Islamic finance progress in Bangladesh What are the achievements of Islamic banking in Bangladesh, one of the largest Muslim countries in the world? With over 130 million Muslims, the demand for this type of financing is clearly there, but has it been adequately met by supply? Abdul Awwal Sarker, deputy general manager of the internal and Islamic economics division at Bangladesh Bank (central bank and regulator), reflects on the accomplishments and challenges of the industry. The aspiration of Bangladesh to run a banking system based on Islamic principles moved closer to becoming a reality in 1978, after the Organisation of the Islamic Conference (OIC) meeting of its member countries’ foreign ministers. OIC recom- mended its members (including Bangladesh) to develop Islamic banking systems of their own. Five years after that declaration, in 1983, the country’s first Shari’ah-compliant bank, Islami Bank Bangladesh, was estab- lished. More banks have followed, includ- ing Al-Arafah Islami Bank (opened in 1995) and Shahjalal Islamic Bank Ltd (2001). Observing the success of their Islamic counterparts, a number of conventional financial institutions have been keen to launch Islamic banking products and services alongside the conventional ones. The main area of focus for such entities is safeguarding the Islamic nature of their operations, ensuring the separation of their capital from the main pool, and segregating accounts accordingly, as well as recruitment of the qualified staff. To ensure compliance with Shari’ah, these conventional banks, just like the Islamic ones, need strong Shari’ah supervisory boards, which assist in preparing the model agreements, approve the structure of all new operations and lay down the basic guidelines for Islamic financing. A good example of a financial institution which successfully offers both modes of financing, is Prime Bank Ltd, one of the country’s top ten banks. The bank has been maintaining the two business lines in parallel since 1995. 24 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 COUNTRY FOCUS Meanwhile, another bank, The Premier equating to 24 per cent of the deposits of Bank Ltd, has opened two separate, dedi- all private banks and eleven percent of the cated branches (in addition to its 25 conven- deposits of the total banking system. Total tional ones) that operate in accordance with investment of Islamic financial institutions Shari’ah principles. Some banks, like Exim in the same period stood at $5.5 billion, Bank (Export Import Bank of Bangladesh equivalent of 27 per cent of all private Ltd), took a step further and fully converted banks and 19 per cent of the whole banking to Islamic banking. system of the country. Today, out of 48 banks in Bangladesh six The statutory liquidity requirement (SLR) are fully-fledged Islamic banks (with an for the Islamic banks is fixed at ten per cent overall network of around 350 outlets since inception of Islami Bank Bangladesh across the country) and ten traditional back in 1983. This has remained unchanged banks have Islamic windows (comprising to date, while SLR for the traditional com- 21 branches). The industry employs over mercial banks has been changed several 14,000 people, which constitutes over a times and is presently fixed at 18 per cent. Star Mosque, third of the private banking sector and Dhaka over a tenth of the country’s entire banking Islamic banks have been facing an excess industry. liquidity problem, which equalled $94.1 million in September 2008 (around six per It is worth noting that the major part of cent of the assets of private banks and the operational financial resources of Is- just over three per cent of all banks in lamic banks in Bangladesh is derived from Bangladesh). This issue originated mainly deposits, mobilised primarily on the princi- due to the lack of response from the good ples of al-wadia and mudarabah. Utilisation borrowers for credit demand and the of funds within the Islamic framework has lack of adequate interest-free financial opened multifarious ways for making loans instruments. conforming to Shari’ah principles. Since Shari’ah-compliant banks cannot use Today, the investment activity of interest-based lending, they have devised Bangladeshi Islamic banks is by and large different types of interest free financing concentrated in the mark-up and rental- modes. The lending instruments applied based modes of financing – murabaha, in Bangladesh include profit-and-loss bai mu’ajjal and ijara – which comprise sharing (PLS) based on mudarabah and nearly 75 per cent of total investments. musharakah; mark-up principle of Meanwhile, the combined investment based murabaha; lease principle of ijara; advance on PLS instruments like mudarabah and purchase principles of salam and istisna; musharakah barely surpass the one per cent and output sharing principles of muzara’a mark (almost unanimously, the banks view and musaqat. the PLS-based products as bearers of high risk). Although the Islamic banking market in Bangladesh started with a very limited There is also a notable tendency towards resource base, it has shown strong growth large projects and clients, although throughout the past two decades to date. Its in reality it is micro, small, and medium ongoing development signals a high level of enterprises (MSMEs) that should get prior- acceptance by the public in general. ity when making investment decisions. The market’s inclination towards short-term In 2008, coupled with the country’s eco- investments poses a pertinent problem. nomic growth, the market share of Islamic Islamic banks depend so heavily on bai financial institutions continued its increase mu’ajjal and murabaha in competing in terms of assets, financing and deposits. with their interest-based counterparts and By September 2008, total deposits at the chasing assured return, that true Islamic Islamic windows and standalone Islamic financial mechanisms, rooted in PLS, fall banks in Bangladesh reached $5.4 billion, by the wayside. www.newhorizon-islamicbanking.com IIBI 25 COUNTRY FOCUS NEWHORIZON January–March 2009 There is a genuine concern among Islamic darabah as an underlying structure. The Though there is still no complete Islamic scholars in Bangladesh that if interest is objective was to mitigate the long-felt need banking act for controlling, guiding and largely substituted by a device like ‘mark- for a Shari’ah-based monetary instrument, supervising Shari’ah-compliant financial up’ it would represent a change just in which can be used as an approved security institutions in Bangladesh, some Islamic name rather than in substance, and the for the purpose of maintaining the SLR, as banking provisions have been incorporated new banking system would be no different well as providing an outlet for investment in the amended Banking Companies Act from the conventional one as far as equity or procurement of funds by Islamic banks. of 1991 (Act No 14 of 1991). Bangladesh is concerned. Also, prohibition of interest in This bond is also open for investment Bank is yet to set up a separate department Islam is meant to stimulate the productive by private individuals and corporations. to regulate the operations of the Islamic segments of the economy, which can be fully banking market. Therefore, for the time- achieved only if the interest-based financial In general, Bangladesh’s government and being, the inspection and supervision of this system is completely uprooted and replaced financial regulators have been receptive market is conducted by the central bank as by a fundamentally different structure, to Shari’ah-compliant banking and finance per the general guidelines for conventional based on PLS. activities. In 1990, a small Islamic econom- banks. In observing the Shari’ah compliance ics unit was established at the research status of Islamic banks, Bangladesh Bank As for the financial resource mobilisation department of Bangladesh Bank, to conduct examines only the reports of the respective through issuance of Islamic bonds (sukuk), analytical research on Islamic economics, banks’ Shari’ah councils. A more defined it is still at a nascent stage. Islami Bank banking and finance. In due course, the unit role of Bangladesh Bank in regulating the Bangladesh is the only bank to have issued was expanded and upgraded, and today it country’s Islamic finance sector is currently sukuk (called Mudarabah Perpetual Bond), is known as the internal and Islamic eco- at the preparatory stage. no other players have issued either bonds nomics division. or any other financial instruments, such as The inspectors and supervisors of debentures or mutual funds in the primary A series of national and international con- Bangladesh Bank have been undergoing or secondary markets. They continue to ferences and workshops have been arranged massive training, both at home and abroad, fully depend on the deposited funds. How- and held in the country’s capital, Dhaka, to be equally familiar with the technicalities ever, in 2004, the government introduced in joint collaboration with the Islamic of the different operational methodologies sukuk, dubbed Bangladesh Government Development Bank (IDB) to understand of the Islamic banking system. The regula- Islamic Investment Bond, which used mu- and explore the dynamics of the industry. tor’s training academy and Bangladesh Institute of Bank Management (BIBM) have also been arranging various training Ahsan Manzil palace, old Dhaka courses on the subject. The central bank has also issued a letter to the Islamic banking sector, urging the participants to address a number of perti- nent issues facing the industry, through discussion and cooperation. In response to Bangladesh Bank’s call, Islamic Banks Consultative Forum (IBCF) was formed by the industry players. It facilitated in preparing the ground for creation of a central Shari’ah board and also assisted the government in issuing the afore-men- tioned mudarabah sukuk. Of late, another consultative body has been set up, called Focus Group on Islamic Banking. The group operates within Bangladesh Bank and focuses on developing the necessary guidelines for setting up Islamic financial institutions in Bangladesh. Another recent development is Bangladesh’s membership of the Islamic Financial Ser- vices Board (IFSB), an international stan- 26 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 COUNTRY FOCUS Although the Islamic banking market in Bangladesh started with a very limited resource base, it has shown strong growth throughout the past two decades to date. Its ongoing development signals a high level of acceptance by the public in general. Mosque in Barisal, Bangladesh dard-setting organisation based in Malaysia. no organised Islamic wholesale and second- In light of this, the existing supervisory ary financial markets, as well as no Islamic procedures of Bangladesh Bank may be inter-bank money market. To become liquid redesigned to evolve in line with the best and efficient, Bangladesh’s Islamic banking international Islamic finance practices. sector must develop standardised and widely tradable financial instruments. How- Without doubt, regulatory and supervisory ever, there is evident lack of cooperation standards that specifically address the and coordination between the market unique peculiarities of Islamic banking participants. operations are needed to promote the resilience and competitiveness of the indus- Within the banks themselves, there is try in Bangladesh. In this regard, the work insufficient corporate governance and not of the IFSB would act as a catalyst to the enough transparency in financial reporting development of a stronger and robust and accounting. These deficiencies are regulatory framework for the country’s a result of the absence of a dedicated Shari’ah-compliant finance sector. In addi- legal framework. It should be noted that tion to this, Competency Group on Islamic Bangladesh Bank has already started work- Banking has been set up at the Department ing on the Islamic Banking Act, with the of Banking Inspection (DBI) to develop financial support of the Central Bank so-called ‘Shari’ah Compliance Checklists’ – Strengthening Project (CBSP), a division es- a tool to assist Islamic banking supervisors tablished under the auspices of Bangladesh in their work. Bank to devise and implement reforms in the country’s financial sector. Although a number of issues have been duly addressed, there are still plenty of Although there is a dedicated department hurdles to overcome before the Shari’ah- at the central bank that focuses on Islamic compliant financial industry can realise its finance – the afore-mentioned internal and full potential in Bangladesh. There are still Islamic economic division – the regulator www.newhorizon-islamicbanking.com IIBI 27 COUNTRY FOCUS NEWHORIZON January–March 2009 moted concurrently. Islamic banks should Rural Development Scheme participants has Mosque in Sylhet, clearly demonstrate by their actions that surpassed 500,000. Bangladesh their practices are not guided merely by profitability. As Shari’ah ethics strongly In a similar accord, Bangladesh’s entire supports poverty alleviation, the banks Islamic banking market, not just a few should act as ‘banks for enriching the poor’ players, should provide access to banking or ‘rural/urban banks for the poor’. products and services for the unbanked members of the society, especially whilst At present, there is, in all probability, only the country’s conventional banking system one bank in Bangladesh fully dedicated to effectively excludes this segment of popula- this cause – Grameen Bank (Grameen trans- tion from participating in economic activi- lates as ‘rural’ or ‘village’ from the Bangla ties, due to a collateral-based approach to language). It offers loans to the poorest financing. segments of rural Bangladesh without any security or collateral, albeit on interest A reasonable portion of Shari’ah-compliant basis (riba al-nasiah). To date, Grameen investment funds should be allocated to has helped over 7.6 million borrowers (an social priority sectors, such as agriculture overwhelming majority of whom, 97 per- (crop cultivation, poultry and fishery), cent, are women) through its 2535 branches MSME and export-led industries, for in 83,343 villages of Bangladesh (about 99 example, textile and garment manufactur- per cent of rural coverage). The efforts of ing. Pilot schemes in both rural and urban the bank and its founder, Dr Muhammad areas should be started to test innovative would benefit from another Islamic-related Yunus, to create economic and social devel- ideas with PLS modes of financing as a department that deals with specific banking opment from below were recognised by the major component. This endeavour will issues. It could conduct field surveys, collect Nobel Committee and resulted in the Nobel serve as a ready reference that Islamic data from financial institutions and produce Peace Prize 2006 award for Grameen and banks are transforming themselves as PLS reports based on the obtained information. Dr Yunus. Yet, the bank’s microfinance financial institutions. Only through such a activity utilises interest-based instruments, hands-on approach will they be able to deal A Central Shari’ah Supervisory Council which contradicts with the key principle with the practical issues that might come (CSSC) is needed to guide and monitor of Shari’ah. up in the process and gain necessary the operations of the Islamic banks in experience. Bangladesh, in a similar fashion as it is Islamic microfinance, provided as qard done in Iran, Malaysia and Pakistan. The hasan (interest-free loan) or based on mu- A well-established Islamic finance sector CSSC could also serve as an example for darabah, has the potential of reaching the will be of indisputable advantage to Shari’ah advisory boards in individual poorest of the poor. Islami Bank Bangladesh Bangladesh’s economy. The country still banks, which by and large suffer from has introduced a scheme, dubbed Rural De- has a long way to go to reach the level of inappropriate organisation and a weak velopment Scheme, specifically to address maturity of the industry in Malaysia and follow-up of the Shari’ah compliance the investment needs of the country’s agri- the Middle East. However, whatever devel- status. cultural and rural sectors. This undertaking opments are yet to be undertaken and what- has proved to be hugely successful and, hav- ever obstacles still need to be overcome, The dearth of qualified personnel commit- ing started as a pilot at a handful of the the true objectives of Shari’ah – maqasid ted to Islamic finance also needs to be tack- bank’s outlets, has now been rolled out to al-Shari’ah – should be given priority at all led. The industry would benefit greatly if 129 branches (the entire network consists times. And that implies that economic and the budget for research and development of 186 branches), covering over 10,000 financial activity must, before everything (R&D) is enhanced, allocating top impor- villages across Bangladesh. The number of else, lead to human well-being. tance to education and creation of the efficient manpower for the industry. Although a number of issues have been duly addressed, there are However, one of the first and foremost still plenty of hurdles to overcome before the Shari’ah-compliant things that require immediate attention financial industry can realise its full potential in Bangladesh. is the promotion of the image of Islamic banks as PLS banks. This strategy has to be devised very carefully so that the banks’ Islamic nature and their solvency are pro- 28 IIBI www.newhorizon-islamicbanking.com ACADEMIC ARTICLE NEWHORIZON January–March 2009 Placing faith in Islamic finance Mufti Muhammad Nurullah Shikder, a full-time Shari’ah scholar at Gatehouse Bank and an executive member of the bank’s Shari’ah supervisory board, looks at the changing role of Shari’ah scholars within the Islamic finance industry and explores ways in which some of the pressures placed on today’s scholars may be alleviated to ensure better Shari’ah service to financial institutions. There is no doubt that the Islamic finance engage consultants who should be recog- This process will facilitate and achieve a industry is rapidly growing at a pace that nised Islamic scholars in their own right and number of benefits for financial institutions, is running ahead of the emergence of new able to provide Shari’ah guidance to their including the smooth operation of the bank Shari’ah scholars with expertise in Islamic clients. not only from a transactional aspect but finance. In the midst of the turmoil in the also from day to day procedural and execu- world’s financial sector, financial institu- Products based on well established Shari’ah tion points of view. It will also help financial tions are exploring alternatives to conven- principles, such as murabaha, wakala and institutions to monitor all aspects relating to tional finance and in particular are turning ijara, usually require minimal involvement marketing materials, internal and external towards Islamic finance, which continues of a Shari’ah scholar due to their relatively communications and so on. to attract interest from around the world at standard forms. However, products and an unprecedented rate. Such growth of the services provided by financial institutions The advantages of having a full-time scholar industry requires the services of competent have evolved over the years (whether for working within a financial institution who Shari’ah scholars in order to adequately good or worse!) in a much more sophisti- is also a member of the SSB are numerous. guide financial institutions in pursuing cated and complex manner. The new inno- For example, my experience to date at legitimate Shari’ah-compliant products and vative products available, such as different Gatehouse in this role shows how it allows services. types of debt/equity sukuk, the more the scholar to focus on internal product controversial wa’ad-based instruments and development and training, as well as It has been seen in the past decade or so that structures based on intertwined Shari’ah facilitating Shari’ah audit and compliance. only a handful of scholars with the relevant structures, require much greater involve- Some of these advantages are discussed expertise are available to financial institu- ment of the scholar. Some of these so- below. tions to approve their products and services. called ‘innovative’ structures and products Although the numbers of competent schol- continue to be scrutinised for their actual Firstly, the financial institutions themselves ars have increased in the last two or three Shari’ah compliance and whether they will have regular and easy access to the years, there is still inadequate involvement succeed in achieving the objectives of scholar which will allow them to obtain of scholars in Islamic finance transactions, Shari’ah. guidance on the hour, every hour, without products and services offered by financial having to wait for a response from the SSB institutions to their customers. The sophisticated and innovative nature of or having to convene a SSB meeting. It is recent products and the complexity of the worth pointing out here that, regardless of Shari’ah scholars should and do play a related documents require scholars to be how simple an issue may be, a banker is un- significant role within financial institutions engaged on a full-time basis to oversee able to make a final decision on a Shari’ah active in the Islamic finance sector, as with- their execution and implementation as well issue without referring the matter to a out them such financial institutions are as to monitor the day to day activities of scholar. unable to operate their business activities in financial institutions dealing with such accordance with the principles of Shari’ah. products. Scholars providing these services The problem of accessibility to the Shari’ah Financial institutions wishing to engage in should be members of a SSB and certain scholars is immense and needs to be ad- providing Shari’ah-compliant products and executive powers should be vested in them dressed sooner rather than later. Critics services must engage either a minimum to enable them to execute some simple and would argue that certain Shari’ah scholars of three individual Shari’ah scholars and repeat transactions without having the sit on too many Shari’ah boards, take on form a Shari’ah supervisory board (SSB) or need to convene a full SSB meeting. too much responsibility, and are not able to 30 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 ACADEMIC ARTICLE give much time to financial institutions as honesty and fairness should be observed, they are so thinly spread. Currently, how- whilst guests and clients should be entertained ever, there are only a handful of reputable in a manner that complies with the principles and able scholars who are familiar with of Shari’ah. modern economics and finance and they are working extremely hard to cope with the It is also important to ensure that Shari’ah demand of the growing Islamic finance in- principles are followed by an institution when dustry. The lack of scholars creates a severe it is dealing with its own employees. Some- hindrance to the development of business times they are not adhered to inadvertently activities of financial institutions. On the due to the lack of knowledge or because the whole this puts constraints on financial personnel that deal with the particular issues institutions and Shari’ah scholars alike. may not necessarily be aware what Shari’ah principles are at stake. It may not have On the one hand, scholars are being put crossed their minds that a particular issue under unrealistic time pressures to respond may involve certain Shari’ah laws. The pres- to Shari’ah queries and unjustifiably being ence of a scholar on a full time basis would held responsible for delaying transactions. alleviate this potential problem. However, we should not forget that scholars also have family, social, religious and many Adequate training of Islamic awareness in other commitments like everyone else and it general and more specific training is para- is not always reasonable to expect immedi- Mufti Muhammad Nurullah Shikder, mount in order to facilitate the understanding ate attention and replies at all times from Gatehouse Bank of Islamic culture and the principles of Islamic the scholars in respect of particular Shari’ah finance. This is to ensure that Muslim and issues. On the other, there will be times that non-Muslim employees are equipped with financial institutions need advice promptly over the last 30 years or so, the truth is that the required knowledge and understanding in order to make business decisions, and some of the established Islamic financial of Islamic principles. The above ongoing cannot wait for days or weeks. By working institutions haven’t done enough to create training can only be achieved if a scholar is full-time for one particular institution, a opportunities for newly graduated Shari’ah engaged to identify all the needs of the busi- scholar is able to build on his in-house role scholars. ness as a whole and also to cater for the and expertise which will not only alleviate needs of individuals within the financial these pressures in-house, but also in other Unless we adopt similar approaches to those institutions as and when required. institutions by offering advisory services to of legal, accountancy and other professional third parties. bodies in developing our Shari’ah scholar Certain critics argue that some Islamic base, there is a real danger that the industry financial institutions offer Shari’ah- Secondly, by appointing a full-time Shari’ah will be filled by unqualified people who are compliant products for commercial benefit scholar, financial institutions will be able not in a position to opine on Shari’ah mat- only and there is no desire to follow the to design their own programmes for training ters. This will result in financial institutions true spirit of Shari’ah principles. However, junior graduates of Shari’ah to enable them carrying out transactions without correctly it should be remembered that earning a profit to satisfy the demands of their businesses. observing Shari’ah principles. in a Shari’ah-compliant manner is encouraged On a wider scale, unless further graduate even from a Shari’ah perspective, although training programmes are put in place, Thirdly, the appointment of a full-time Shari’ah will never allow Islamic financial there will be a constant shortage of supply scholar will greatly assist in the education institutions to make gains in its name when in meeting the increasing demands of and training of employees in the application their activities may not conform to the financial institutions for Shari’ah scholars. of Shari’ah principles in all areas of the principles of Shari’ah. Financial institutions working environment. This is relevant to seeking to provide Shari’ah-compliant prod- An urgent assessment is required of the legal and compliance matters, and will ucts and services may overcome potential extent to which financial institutions have greatly assist in all areas of the audit criticism by taking pre-emptive steps to en- contributed towards bringing on board new process, both internally and externally. In gage a Shari’ah scholar on a full time basis to Shari’ah scholars. What support is being addition, Islamic financial institutions need oversee their day to day activities. This will provided to new graduates of Shari’ah to get to follow instructions from the Shari’ah boost the confidence of everyone associated them more involved in the Islamic finance scholar in their day to day activities such with such financial institutions, whether industry? Are they supporting any trainee as the manner in which they conduct their employees or customers, and enhance the programmes for new Shari’ah graduates to business. For example, adherence to quality of the Shari’ah-compliant activities gain experience? If we were to look back Shari’ah principles of truth, transparency, of such financial institutions. www.newhorizon-islamicbanking.com IIBI 31 IIBI LECTURES NEWHORIZON January–March 2009 Promoting Islamic finance October: Surviving the ports only those products and businesses leveraged (having interest-bearing debt in permissible from the Shari’ah viewpoint. excess of 33 per cent) are also excluded credit crunch – Shari’ah- Shari’ah-compliant investment transactions from Shari’ah-compliant investment compliant retail investment do not involve riba (interest). Instead, in- transactions. come is generated by investing the capital opportunities in the real economic activities and earning Timol outlined the key guidelines from the profit is legitimised by engaging in an eco- FSA, the UK regulator for the financial Bashir Timol, director of 1st Ethical Ltd, a nomic activity and thereby contributing sector, for investment advice; these include to the development of resources and the comprehensive understanding of clients’ risk UK-based firm of Islamic investment and tax society. profile – risk is inextricably linked to reward advisers, delivered the lecture on 16th October but can also result in a loss. This criterion 2008. Timol has played a central part over He mentioned that such transactions should sits alongside all other Shari’ah require- the last seven years in developing a range of not involve gharar (excessive uncertainty) or ments when structuring a balanced client Shari’ah-compliant investments, tax planning portfolio. The issue of penalties and client’s products and Islamic wills for the domestic October lecture requirement to access funds is also consid- Muslim community. He has also liaised with ered in the decision-making process. Her Majesty’s Revenue & Customs (HMRC), HM Treasury and the Financial Services He then classified the available Shari’ah- Authority (FSA) over the development of compliant investment opportunities in the Shari’ah-compliant regulation and legislation UK into three categories: low risk, medium risk and high risk. Low risk investments in the UK and has considerable experience include Islamic bank accounts. These are of advanced tax mitigation strategies for offered by the Islamic Bank of Britain (IBB), UK-based owner-managed companies and HSBC Amanah and Lloyds TSB; other low professionals. risk investments are Shari’ah-compliant property funds, though these have proved The lecture was chaired by Mukhtar Karim, riskier in the recent financial turmoil. Ethi- solicitor at Trowers & Hamlins, an international any kind of ambiguity in terms of the rights cal/Islamic unit trusts (such as offered by law firm. and responsibilities of the parties in the Friends Provident), agricultural land and transaction. While uncertainty cannot be leasing contracts were classified as medium avoided altogether in any business transac- risk, while Shari’ah-compliant UK equities, The love affair with bricks and mortar has tion, Shari’ah scholars have derived a gen- musharakah projects, musharakah and been especially pronounced within the UK eral principle that any contract must not be commodity funds were classified as high Muslim community who have historically doubtful and uncertain as far as rights and risk investments. embraced property as a low-risk ‘Shari'ah- obligations of the parties are concerned. compliant’ alternative to conventional in- Also, funds should not be channelled to eco- He concluded the presentation by stating vestments. The credit crunch and resulting nomic activities involving maysir (gambling). that Islam allows a wide investment remit property market price fall have dramatically as long as interest and unethical businesses underlined the need for investors to hold a Timol then listed the key businesses ex- are avoided; a portfolio must be diversified; diverse range of assets. Timol first discussed cluded from Shari’ah-compliant investments accessibility of investments must also be the key principles for Shari’ah compliance based on the above criteria. These include available to investors. of investment transactions; all Islamic in- gambling outlets, the tobacco industry, vestment transactions must conform to the pornography industry, conventional After the presentation, participants raised certain guidelines to meet Shari’ah compli- interest-based banks and insurance compa- various questions about the musharakah ance. Like ethical or socially responsible nies, alcohol manufacturers and distributors, funds on offer in UK, the performance of investing, undesirable companies and indus- etc. Apart from business screening, financial Shari’ah-compliant equity funds as com- tries are screened out on the basis of both screening criteria are also applied. Organisa- pared to conventional ones, key providers qualitative criteria (nature of business) and tions whose principal activity is not the of Islamic investment products in the UK quantitative criteria (level of receivables, above, but derive more than five per cent and the criteria for setting the financial debt and interest), and the investment sup- of income from above activities or highly screening ratios for Shari’ah compliance. 32 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 IIBI LECTURES November: The prevailing no, or only a remote, link between the un- derlying asset and such instruments offered November lecture international financial crisis in the secondary market. – can Islamic finance help? Dr Chapra then analysed the role that Is- lamic finance would play to minimise such The lecture, held on 10th November 2008, crisis in future. As there is greater emphasis was the first in the IIBI’s Ibn Khaldun lecture on equity and profit-and-loss sharing (PLS) series. Ibn Khaldun (1332–1406) presented in Islamic finance, this will make banks essential economics concepts, such as the more cautious and act responsibly in lend- importance of trading and value of labour in ing operations. Debt in Islamic finance is not created through direct lending and wealth generation and growth. He paved the borrowing but rather through the sale and way for development of classical economics. purchase of real goods and services; the substance, and it will have an enormous asset being sold or leased must be real and impact on prudent lending practices in The lecture was delivered by Dr Umer Chapra, not notional or imaginary; the seller must future. senior research advisor at the Islamic Research own and possess the assets being sold or and Training Institute (IRTI) of the Islamic There was a lively question and answer Development Bank (IDB). He was working at November lecture session after Dr Chapra’s presentation; key Saudi Arabian Monetary Agency (SAMA) as issues raised were about Islamic financial senior economic adviser prior to his current role institutions mimicking conventional struc- at IRTI. He has made seminal contributions to tures, why Islamic finance especially in the Islamic economics and finance over more than US is not being taken up much more or promoted positively, and the limitation of three decades in the form of 15 books and Islamic finance products in serving the needs monographs and more than 100 papers and of peoples of all faiths or no faith. has received numerous awards for his contribution, including the prestigious King The full article based on Dr Chapra’s Faysal International Award in Islamic studies. presentation can be found on page 20 He has also taught in the US at the Universities of this issue. of Wisconsin (Platteville) and Kentucky. leased and the transaction must be a gen- The lecture was chaired by Warren Edwardes, uine trade transaction with the full intention CEO of Delphi Risk Management and a board of giving and taking delivery of the underly- The mission of the IIBI is to member of the IIBI. ing goods or services. The risk of default be a centre of excellence for associated with debt must be borne by the professional education, training, lender. This will motivate the lender to exer- After a brief introduction on the financial cise greater care and self-restraint in lending research and related activities, to crisis, Dr Chapra mentioned that in order to as the institution/person which is exposed to build a wider knowledge base and minimise the frequency and severity of such the risk of suffering a loss is the best one to deeper understanding of the world crisis in future, it is important to analyse the also provide the market discipline. of finance promoting the Islamic primary causes of the crisis which appeared principles of equity, socio-economic to be the result of excessive and imprudent Dr Chapra emphasised that Islamic justice and inclusiveness. The lending practices. All this took place prima- finance is still in its infancy and the share rily due to inadequate market discipline and of equity-based structures with PLS, such Institute holds regular lectures on insufficient regulation and supervision. as mudarabah and musharakah, is small as topical issues, delivered by the There was lack of transparency in many compared to debt-based structures. Despite industry experts. For information on products on offer. Collateralised debt obliga- some lean practices, Islamic financial insti- upcoming lectures and other tions (CDOs) were offered to investors tutions have performed well – or at least the events, please visit the which bundled prime with subprime debt, impact of the financial crisis is minimal on paralysing the whole financial system. them due to the safeguards provided by the IIBI’s website: Credit default swaps (CDSs) were offered to adoption of Islamic economic principles. www.islamic-banking.com many players who were not a party in any The way forward would be the application investment in the first place and there was of these principles in both form as well as www.newhorizon-islamicbanking.com IIBI 33 IIBI NEWS NEWHORIZON January–March 2009 New book outlines the investment opportunities in Islamic finance A new book, ‘Islamic Finance: A Guide for Islamic Bank of Britain (IBB), the IIBI and International Business and Investment’, the Bank of London and the Middle East has been produced in association with the plc, this new book is an essential resource Institute of Islamic Banking and Insurance for organisations engaged in business devel- (IIBI), London. The book aims to support opment, asset management, banking and professionals engaged in the ever-buoyant finance in an Islamic context. This book area of Islamic finance. While the global outlines the background to Islamic finance, economy remains uncertain, Islamic finance examines Islamic financial products such as is steadily growing at an annual rate of ten loans, mortgages, trade finance, investment to 15 per cent, and is estimated to be worth banking and takaful (Islamic insurance) $800 billion. Although Islamic financial and explores important regulatory issues. products do not pay interest, they can often To view the contents, please visit: be as advantageous, or more so, than their www.globalmarketbriefings.com/?id=2979 conventional counterparts. A 25 per cent discount will be provided to This new book provides accessible advice IIBI’s members and students. Please quote and up-to-date guidance for foreign in- the reference IIBI08 with membership or vestors, helping them understand the student number to receive the discount. principles and current practice of Shari’ah- compliant banking and finance. With con- Book orders may be placed by emailing tributions from leading industry experts, [email protected] or by calling including Denton Wilde Sapte LLP, the +44 (0) 20 3031 2900. IIBI launches a brand new website The IIBI will be introducing a brand new tion and training services to embrace an finance, tracing the development of Islamic website in early 2009. Since inception in ever changing business world. economics and jurisprudence over the 1991 the Institute has been serving the decades. Islamic financial services industry and The website will feature many new sections promoting awareness of Islamic banking and sub-sections containing plenty of useful The IIBI will be deploying a Learning Man- and insurance globally. This is reflected in information, articles, reviews and audio and agement System (LMS), using the industry- our website. video presentations that visitors can view. standard Moodle 1.9 framework. It will help the IIBI to create online courses with The IIBI has been providing continuous Of particular value will be the IIBI Forum opportunities for rich interaction, where professional development through its which will enable members, students and students will be ale to interact in a virtual Post Graduate Diploma (PGD) course by also invitees to debate relevant issues, share learning environment. The IIBI will use this distance learning, training workshops and their own vision and experiences as well as system to deliver, track and manage its PGD an executive development programme. As cooperate in looking at practical solutions course and other courses that it will offer in one of the oldest, if not the oldest, institutes on current and new issues in the evolving the near future. The system will provide a of its kind, the IIBI stays abreast of global Islamic financial services industry. In addi- complete one-stop solution for all IIBI's trends in Islamic banking and insurance tion, the Test Your Knowledge section will distance learning needs like registration of reporting on major developments and allow visitors to the IIBI’s new website to students, online collaboration, assessments, addressing important issues in its take a test on Islamic banking and insur- and management of continuous professional NewHorizon magazine. The IIBI is thus ance, and the Knowledge section will grow education. The IIBI's LMS will be available able to provide the Islamic financial sector into an essential research and reference tool to our existing and new students in early relevant, meaningful and up-to-date educa- for students and practitioners of Islamic 2009. 34 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 IIBI NEWS IIBI awards post graduate diplomas IIBI’s Post Graduate Diploma (PGD) course in Islamic banking and insurance, offered Regardless of one’s exposure to Islamic or conventional finance, since 1994, is highly regarded worldwide. the IIBI’s Post Graduate Diploma course in Islamic banking and UK-based Durham University has accorded insurance provides students with an essential understanding recognition to this course as an entry quali- of the core elements of this growing area. My tutors were fication to the University’s Research MA as very helpful in providing additional material to clarify my well as its modules on Islamic economics understanding of difficult concepts. The programme also and Shari’ah-compliant finance. provided me with some insights behind the wisdom of the Shari’ah. A highly recommended course of study. To date, students from 77 countries have enrolled in the PGD course. In the period Lok Chak Yin Basmah, Islamic Union of Hong Kong of September to November 2008, the following students successfully completed their studies: ❏ Masagoes Abdul Karim Bin Masagoes ❏ Mujtaba Muhammad Farouk, desk Din, legal director and consultant, officer, payments, Central Bank of ❏ Anthony James Lindsay, Australia Barakah Capital Planners Pte Ltd, Nigeria, Nigeria Singapore ❏ Asif Ali, India ❏ Mujeebur Rahman A, India ❏ Mohammed Hasan Khan, manager, ❏ Aziz Idris, P&L controller, BNP Paribas, product development, Sabb Takaful, ❏ Musa Ibrahim Musa Bahit, chief dealer, Japan Saudi Arabia Baobab Capital Limited, Kenya ❏ Christopher F Richardson, attorney, ❏ Mubashir Akram, assistant vice ❏ Philip Crawford, HSBC Bank Middle Vinson & Elkins LLP, Hong Kong president, The Bank of Punjab, East Limited, Oman Pakistan ❏ Gerard Jerome Vincent D’Souza, IT ❏ Sa’adatu Aminu Ibrahim, Nigeria project manager, Saudi Hollandi Bank, ❏ Mujtaba Habib, Saudi Arabia Pakistan ❏ Sultan Hamed Albortmany, Germany. ❏ Ghulam Rasul Chughtai, assistant vice president, United Bank Limited, Pakistan ❏ Ehtesham Uddin Khan, ICICI Bank Ltd, India ❏ Farrukh Nadeem, UK Anthony James Mujeebur Lindsay Rahman A ❏ Imraan Solomons, Krew Investment SA (Pty) Ltd, South Africa ❏ Jaffar Hussain, advances in charge/ inspecting officer, Allied Bank Limited, Pakistan ❏ Lok Chak Yin Basmah, office manager, Islamic Union of Hong Kong, Musa Ibrahim Mohammed Hong Kong Musa Bahit Hasan Khan www.newhorizon-islamicbanking.com IIBI 35 POINT OF VIEW NEWHORIZON January–March 2009 Islamic mortgages: Shari’ah-based or Shari’ah-compliant? Sheikh Haitham Al Haddad is a director of the Muslim Research and Development Foundation (MRDF). The MRDF, was awarded charity status in 2007, and is a co-operative research based venture, run by scholars, imams and other professionals. It has the aim of articulating Islam in a modern context, as well as addressing the unique situation faced by Muslims in the West. He is also involved with the Islamic Shari’ah Council, a body which deals chiefly with the issue of Shari’ah-compliant marriage and divorce in the UK. The council also provides advice and guidance to British Muslims on financial, business and other matters. He is currently working on a PhD in Islamic jurisprudence at the School of Oriental and African Studies (SOAS), a major part of which is about mortgages. He also sits as an advisory scholar for Ansar Finance, an Islamic initiative in Manchester, which was founded in 1994. Here, he explains to NewHorizon his views on the problems with Islamic finance in the UK. Al Haddad believes that, while Muslims Islamic finance industry in the UK. Only living in non-Islamic countries deserve recently has the first independent takaful ‘special consideration’ within the Ummah (Islamic insurance) operator, Salaam Halal (worldwide community of Muslims), ‘there Insurance, been launched in the country are some aspects of their daily lives that (NewHorizon, October–December 2008 cannot be changed because they live in the issue). ‘More or less the main products here West’. Finance is not the only aspect which are the Islamic mortgages.’ Al Haddad believes this applies to, another example being marriage. However, the ‘We Muslims should hold firmly onto the ‘interest based system is one of the most value that the interest-based system is dangerous systems in the world’, so ‘the prohibited.’ However, Al Haddad is also a gravity of the problem’ for Western Mus- prominent critic of supposedly Shari’ah-com- lims is huge. Al Haddad quotes the late pliant finance in the UK and elsewhere. His American president Thomas Jefferson, that main criticism is the way in which riba is in- ‘if the people wanted to be enslaved, they terpreted in a literal, semantic way by equat- should allow the banks to create money’, ing it to the word ‘interest’. What this allows and he goes on to say that the creation of is for a system to be devised in which the money and the creation of interest-based flow of money and the share of risk between systems are of course linked. agents is completely equivalent in a suppos- edly halal transaction to a conventional trans- The bulk of Al Haddad’s work concerns action based on interest. ‘My problem with Sheikh Haitham Al Haddad Islamic mortgages in the UK. However he Shari’ah-compliant finance is that the whole states that his criticism is ‘equally applicable process is more or less the same’ as conven- to other product classes’ in the space. The tional banking, he explains. The effect of this reason that he focuses on mortgages in par- is that the prohibition of riba makes no no- ticular is that they represent most of the ticeable difference to finance. 36 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 POINT OF VIEW ‘In all the schemes for Islamic mortgages, he sits on the advisory board. Ansar’s stated the bank buys the property and sells it to mission is ‘to provide and promote aware- you. This will be now, or later, according to ness of halal financial borrowings and in- murabaha, and may be just with part of the vestments among the Muslim community property. The bank buys the property and of the UK’. A membership-based organisa- sells it to you. The big problem is that the tion (membership is open to anyone), it bank buys it in order to sell it to you’. Thus provides interest-free finance based on the the bank buys the property with the intention qard hasan model. Qard hasan is usually of selling the property. Moreover, ‘when the associated with charitable giving, either for bank buys it, the bank knows that you are welfare purposes or for fulfilling short term obliged to buy it’. This means, to Al Haddad, funding requirements. The borrower is ex- that since the bank is guaranteed to sell the pected only to pay back the original sum. Al property, the concept of the bank’s owner- Haddad describes Ansar as a ‘community ship of the property during the mortgage is project’, and transactions are done on a phoney. handshake. A moral, rather than a binding, agreement, must be based on the goodwill ‘The bank is paying X money to buy the and trust engendered amongst the members. property, and by contract is obliging you to ‘The bank buys the property, an agreement pay the bank X amount plus Y. So in a nut- with the client is made, and if the client shell, the bank pays money, and gets more can’t continue paying, then the risk on the money for it, which is the interest-based property is with the bank.’ system’. This is achieved by combining con- tracts which, on their own, are halal, but However, the example of Ansar is of ques- looked at as a whole, clearly include the tionable value to Haddad’s argument. Hav- equivalent of interest. A bank might buy ing started in 1994, the model has yet to a property and sell it in instalments to a catch on, or to grow significantly (its web- homebuyer at a profit, and this will only be site claims 800 members). Haddad does possible if the homebuyer promises to buy provide a reason for this which is that it is the property from the bank, as soon as the difficult to build sufficient funds for mort- bank has purchased it. From the banks gage lending from scratch. Secondly, he perspective, in this murabaha model, the says, ‘I am often disappointed by the lack of bank avoids a situation where it owns the support for Ansar from the community and property for any length of time. This can also businesses’. Yet he is sure that Ansar’s be added to the fact that the rate and model is commercially viable, and believes amount of repayment from the homebuyer that larger Islamic banks in Britain have not to the bank is likely to be strongly linked to copied Ansar’s example, or developed a sim- interest rates. ilar framework, because ‘they want to elimi- nate any possible risk’. The larger banks’ For Al Haddad, the key for considering this Shari’ah boards adopt a lenient approach, as riba is the fact that the transaction will for example, by arguing that it is unfair for be carried out in this way is explicitly stipu- a bank to suffer a loss since it is responding lated in a contract. This is because of his sec- to a client’s expressed need for a home. ond major criticism of Islamic finance in the UK, that it allows banks to minimise their Meanwhile, the mainstream of Islamic fi- own exposure to risk. ‘If the agreement is nance would most likely make the criticism done on a handshake, it means if the home- that, while qard hasan is suitable for micro- buyer ends up breaking the agreement, the finance, it is not so suitable for attracting bank has no obligation against him, and can- huge funds with high volumes of invest- not sue him. This is the principle of loss-shar- ments. To do so, there would need to be a ing. The bank should not secure itself against profit motive. And neither the Holy Quran any risk of loss. It is as simple as that.’ nor Prophet Muhammad prohibit entrepre- We Muslims should hold firmly neurship and possible subsequent wealth onto the value that the interest- Instead, Al Haddad promotes the model of (provided that both are confined to permis- Ansar Finance Group, where, as mentioned, sible activities, sharing in the risk and re- based system is prohibited. www.newhorizon-islamicbanking.com IIBI 37 POINT OF VIEW NEWHORIZON January–March 2009 ward without involving usury and interest). the interpretation is accepted by the their view. We have a different view’. In the The Quran clearly states, ‘God hath permit- vast majority of Muslims.’ However, meantime, therefore, Al Haddad works to ted trade and prohibited riba’ (2:275). Al Haddad does not see this as realistic. ‘It spread his message, though the internet, and doesn’t fit. For example, if I don’t believe through his involvement in Ansar Finance. Al Haddad’s criticisms of Islamic banks’ in halal meat, how can I monitor it? Maybe ‘On a frequent basis I receive emails from approach to risk are compounded by the technically it can be done but it would not people who have read my arguments and difficulties he sees in regulating the industry bring confidence’ to Muslims. are convinced.’ in the non-Islamic West. He is particularly critical of the auditing processes. Scholars The alternative, as Al Haddad has suggested The big question for Al Haddad, though, at most Islamic banks in Britain, who as to his peers, is to form an independent is whether there is a realistic, alternative Al Haddad has already made clear take body of scholars in the UK to perform the way of persuading people to provide their a lenient approach, ‘are not auditing the functions that the FSA ideally would. There money for the use of others, whether this is implementation of whatever opinion they are some examples of this throughout the done conventionally, for interest, or through give’. ‘What they should say is “here is world. The AAOIFI (the Accounting and the West’s established Islamic banks, for what we suggest is halal. Then let us see Auditing Organisation for Islamic Financial profit. It is very difficult to believe that the examples of your transactions. Are you im- Institutions) is one. And there are only a Ansar model provides an alternative to plementing what we are saying?” but they few institutions which work on a similar mainstream Islamic finance for the mass don’t do so.’ Al Haddad states that there is model to Ansar Finance Group. In the market, since it does not involve profit. But currently no legal requirement for scholars meantime, Al Haddad believes, ‘we need a large part of Islam’s problem with interest to do so. However, ‘in order to ensure an Muslim governments to play a role. Then it is that it favours the person who has money organisation has received a certificate that would be easier for non-Muslim govern- to start with. Al Haddad’s problem with its products are of a certain standard of ments such as in the UK to get help from Shari’ah-compliant finance in the West is quality, we need to audit it regularly’. Muslim governments, and to establish their that it does also. ‘I should not have any own Shari’ah board’. privilege because I have loaned money to But who can perform such a task in the someone else,’ he says. But is there another UK? The Financial Services Authority (FSA) As Al Haddad accepts, however, his views way? ‘Yes, qard hasan is viable.’ But it would be ideally placed, thinks Al Haddad, are in a minority. This means that any new depends on goodwill and trust. Is it going except that it represents a secular govern- organisation would most likely back up the to happen? ‘Yes, because Ansar Finance ment. ‘We can discuss whether the UK gov- stats quo view of the majority of scholars. started on a goodwill basis. It started with ernment should play a role, in ensuring that So, he acknowledges, ‘the system would re- people lending and not expecting anything. the audits are real, and making sure that main the same. At the end of the day, that is With education, people can change.’ IIBI’s point of view While Al Haddad’s position raises a num- riba (interest) and alcohol were not prohib- ership of the property by the bank during ber of valid issues, these are not practical ited in one go. A new form or procedure of an Islamic mortgage is ‘phoney’. to implement to the letter without taking structures cannot be rejected merely because account of the environment in which it has no precedent in the past. In fact, ac- Murabaha, though not an ideal mode modern business is conducted. His main cording to renowned international scholar, in Shari’ah-compliant finance, was issue with Shari’ah-compliant finance is Justice (Ret’d) Taqi Usmani, every new form adopted initially for home purchases in that it is more or less the same as conven- can be acceptable to the Shari’ah so long UK in late 1990s, as pure musharakah tional banking, however, he appears to as it does not violate any basic principle and other pure models were not well ignore that the basic Islamic finance laid down by the Holy Quran, the Sunnah suited for mortgage transactions. This structures adopted today were used pri- or the consensus of the Muslim jurists. paved the way for further development marily in trade in the early Islamic pe- such as the diminishing musharakah riod. A study of the pattern of some Al Haddad’s main criticism is that, accord- model between an Islamic bank prohibitions in Islam will show gradual- ing to murabaha, the bank buys the prop- and a buyer for home purchase incorpo- ism or a step by step approach, which erty with the intention of selling it and takes rating features of risk-sharing. Under made their implementation ‘in letter as a binding agreement from the intended diminishing musharakah the bank faces well as in spirit’ possible. For example, owner, therefore according to him the own- risk associated with property ownership 38 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 POINT OF VIEW that does not exist in the interest-based cal when it involves large numbers and ventional regulators, moving with times, mortgage provided by conventional large amounts. are helping to create a level playing field banks. for the Islamic finance industry. The UK The Ansar Finance model for house pur- regulatory body, the Financial Services Murabaha, in its original Islamic conno- chases through members’ donations may Authority (FSA), has clearly stated that it tation, is simply a particular type of sale work well on a small level and in a local neither favours nor discriminates in regu- and not a mode of financing. The only community, but whether it can be rolled lating Islamic banks. Due to the different feature distinguishing it from other kinds out to and successfully implemented for all nature of contracts, there are practical of sale is that the seller in murabaha members of a large community living in problems for Islamic banks. That is rea- expressly tells buyer the cost incurred various places is questionable. If a person son for using instruments which are and the profit (mark-up) on the cost. becomes a member, and after purchasing a Shari’ah-compliant such as murabaha, house under the Ansar Finance model be- ijara and diminishing musharakah, but On murabaha as a mode of financing, comes unemployed and defaults on pay- not Shari’ah-based (mudarabah and Justice (Ret’d) Usmani states: ‘The ideal ments, the property may not be sold due to musharakah). mode of financing according to Shari’ah social reasons. If there are a large number is mudarabah or musharakah… however, of defaults it would place an enormous fi- The proposal to set up a central Shari’ah in the perspective of the current eco- nancial burden on the membership. supervisory board in UK has been mooted nomic set up, there are certain practical on a number of occasions. However, as difficulties in using mudarabah and The community-based model is very simi- the UK Islamic financial services industry musharakah instruments in some areas lar to the credit unions in the West, which is still very small in comparison to some of financing. Therefore, the contempo- are financial institutions controlled by their other countries, it would be more practi- rary Shari’ah experts have allowed, sub- members (account holders), and operated cal and cost effective for the Islamic ject to certain conditions, the use of the for the purpose of promoting thrift, pro- financial institutions in UK to adopt the murabaha on deferred payment basis viding credit at reasonable rates, and standards of the existing international as a mode of financing. But there are providing other financial services to its standard setting bodies like AAOIFI two essential points which must be fully members. However, credit unions have (Accounting and Auditing Organisation understood in this respect: 1) it should typically remained smaller than banks. for Islamic Financial Institutions), IFSB never be overlooked that, originally, (Islamic Financial Services Board), LMC murabaha is not a mode of financing. Islamic banks as financial intermediaries (Liquidity Management Centre), IIFM Therefore, this instrument should be provide capital for purchase of houses, (International Islamic Financial Market) used as a transitory step… and its use their function is not dealing in properties. and IIRA (International Islamic Rating should be restricted only to those cases However, it is to be commended that con- Agency). where mudarabah or musharakah are not practicable; 2) the murabaha trans- action does not come into existence by What do you think? Do you agree with Sheikh Al Haddad that Ansar’s merely replacing the word of “interest” model is the only acceptable model for Islamic finance, or with the IIBI’s by the words of “profit” or “mark-up”. view that Islamic banks in the UK are correct to have grown as they have? Actually, murabaha as a mode of finance has been allowed by the Shari’ah schol- Please email us at: ars with some conditions… it is the ob- servance of these conditions which can [email protected] draw a clear line of distinction between or an interest-bearing loan and a transac- [email protected] tion of murabaha.’ Al Haddad proposes the Ansar Finance qard hasan model as a way forward for providing interest-free finance supported by members’ contributions. From a com- mercial perspective, qard hasan typically may be used to provide small unsecured loans to the needy, but appears impracti- www.newhorizon-islamicbanking.com IIBI 39 CASE STUDY NEWHORIZON January–March 2009 IT focus: Europe Arab Bank With the news that Path Solutions’ iMAL core banking platform has gained the recognition of the AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions), NewHorizon’s news editor, Lawrence Freeborn, looks at how one bank sought to take advantage of the system. Europe Arab Bank plc (EAB) is a wholly- as a complete processing system for our age. Another firm, Sungard (Arab Bank owned subsidiary of Arab Bank Group. Islamic business yet be integrated with our Switzerland is a client), was also very briefly Headquartered in London, EAB incorpo- conventional business systems to allow them looked at. Sreih characterises this process as rates all of the banking business of the Arab to continue to show the overall view of the ‘for background information, rather than Bank Group in the UK, France, Germany, bank’s books, risks, positions and so forth’. selection’. This ‘assumptive’ process was Spain, Italy and Austria. With a capital base The chosen solution would be required able to work since Path responded positively of E700 million (approximately $1 billion), to process Islamic corporate banking and to the requirements drawn up based on the EAB focuses on corporate and private bank- treasury business as well as basic current differences between EAB and IIAB. If not, ing as well as treasury services across the accounts. Sreih suggests, ‘we would have gone back region. EAB’s sister companies include Arab and had a proper, structured look at it. But Bank Australia and Islamic International EAB did not, however, engage in a conven- we were pretty sure that iMAL was going to Arab Bank (IIAB), based in Jordan. tional selection process. Rather, iMAL was be the one because it was being used more chosen ‘on an assumptive basis’. The expla- or less for the same purpose elsewhere in the About five per cent of EAB’s business is nation for this is that the afore-mentioned group.’ currently in Islamic finance (in terms of IIAB, a completely Shari’ah-compliant out- deal numbers – in value terms it is probably fit, was already a user of iMAL, and EAB The implementation itself was divided into a higher). The bank plans to increase this requirements were similar. Sreih elaborates number of key stages. Following hardware proportion, from what its CEO, Antoine on this approach: ‘Our sister company went and software installation, requirements Sreih, describes as a ‘contributory part’ to through the full Invitation to Tender and gathering, system configuration, interface a ‘major part’ of the business. In 2007, the Request for Information approach. They development, application training and user bank announced its intention to open an looked at all possible systems they could acceptance testing were all marked out as Islamic window, consolidating and expand- find. When we decided we needed an distinctive stages by the bank. More than 50 ing its range of Islamic products alongside Islamic system, we initially looked to see staff members of the bank were involved at its conventional banking activities. Having what we’d got across the group. This is some stage, and an implementation team decided its IT infrastructure should reflect where we came across iMAL. We then from the vendor’s support centre in Beirut this aspiration, EAB signed a contract with compiled a list of the requirements we were was also present throughout. This, says Path Solutions, a Kuwait-based vendor, in looking for, and checked it back against Sreih, ‘gave us the benefit of very good ac- December 2007 to implement iMAL, the what they were already using the system cess to their key technicians’. Path’s team vendor’s Islamic core banking system. Im- for in Amman.’ Where there were gaps in carried out user training and system set-up. plementation began in March 2008 and requirements between the siblings, EAB The system would need to be interfaced into finished in July, and EAB’s Islamic activities went directly to Path Solutions to ask if the the general ledger and regulatory reporting will henceforth be almost completely segre- vendor could cover them. systems as well as the Swift network. gated from its conventional activities, which run on a separate core system, Equation, Early on, EAB did cast a ‘cursory’ glance at The integration with Equation, the core so- built by the UK-based firm, Misys. The different systems; as an Equation user, the lution of EAB’s conventional business, was Islamic window was launched around bank obtained brochures to see what Misys deliberately limited so as to maximise segre- October 2008. could offer, though Misys’ Islamic module gation of the two lines. ‘We have to make was felt to be unsuitable on the grounds sure of meeting the Shari’ah board’s needs, EAB had two key criteria for the system. It that it is ‘fairly retail-based’ and not very and formally segregate the business.’ There needed, says Sreih, ‘a system that could act comprehensive in terms of product cover- are only one or two crossovers; the need to 40 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 CASE STUDY feed both lines into an overall book is grow quickly, the expertise of its staff may catered for by the existence of a separate be diluted; ‘I haven’t heard of that happen- sub-ledger book, which feeds into a ing yet, but I assume it will at some point’. consolidated book. ‘Apart from that, it’s just managing some of the risk aspects.’ iMAL has been working smoothly since the project finished. It finished on time, and The entire project was aggressively since much of the interface development timetabled due to the business plan, with was done by EAB staff, it finished under the Islamic window launch in mind. The budget. It was, however, ‘very intense from system successfully went live on time, and the moment we started’. As well as the level the project was actually completed under of support from Path, Sreih puts success budget. down to the determination of the staff, espe- cially since few had much experience of ‘Ring-fencing’ enough resources for the Shari’ah products and rules, and most were project was a particular challenge for the also working on other projects concurrently. bank, specifically in terms of manpower. The cause of this difficulty was simply the Sreih does not believe the bespoke, compli- size of the bank. This translated into a cated Islamic products EAB will offer lack of specialist knowledge about Islamic would be possible with another universal finance, so that ‘we relied heavily on the banking system. ‘From the way the system half dozen or so people who really under- is structured, it’s not just the word “inter- stood Islamic finance. An awful lot of test- est” changed to “profit”. There is a bit of ing and configuration had to be done by truth in that; the data model does lend itself them because they were the only ones that to Islamic finance. Other universal systems actually understood it.’ However, since the We have to make sure of have put all sorts of bodies in place to try staff had ‘day jobs’ throughout, it became meeting the Shari’ah board’s and mimic that, but they’ll never work as ‘a bit of a part-time project’ while business well as a system that has actually been as usual took priority. ‘Obviously from needs, and formally segregate designed for it.’ iMAL will render many hindsight it would have been better if we’d the business. previous paper-based processes obsolete. managed to carve out more time, because ‘Using systems designed for conventional these people were put under a huge amount banking, there had to be a lot of interven- Antoine Sreih, of pressure doing effectively two full-time tion, intercepting something before it Europe Arab Bank jobs for three months,’ says Sreih. ‘There went out. It’s dangerous, as you might get were several late nights.’ it wrong, sending a statement out to an Islamic client with interest all over it. Now, EAB did initially retain some headhunters we shouldn’t have to worry about that sort to trawl the market. But the bank found of thing.’ ‘almost nobody’ suitable to help. The combination of theoretical and practical For the future, EAB will continue to work knowledge of Islamic finance as well as the with Path to develop the functionality of requisite IT skills was not on offer: ‘If you the system. Since the launch, EAB has found try to do this purely from the IT side you’d that more and more customers prefer to fail totally, because you need to have the use Islamic finance, a product of increasing business understanding to design the prod- interest in the sector across Europe. EAB ucts that go into it. We probably could have already has more than £200 million ($294 done with a couple of people, but there million) in its asset book, including a com- doesn’t seem to be much in the way of a modity murabaha portfolio for around 60 market for them.’ Sreih believes that the clients through contracts on the London availability of such people, while lagging, Metals Exchange (LME). Islamic finance will increase in relation to the growth in has become an increasingly important part Islamic banking. ‘Those workers are going of its plan to survive the global financial to be gold dust.’ Sreih mentions that he has crisis, and the implementation of a core seen no sign of Path itself being stretched, system designed specifically for this has but points out that, as Path continues to undoubtedly helped this strategy. www.newhorizon-islamicbanking.com IIBI 41 APPOINTMENTS NEWHORIZON January–March 2009 On the move the Islamic banking division of Standard group. Prior to that, AlMeer worked at UK-based Chartered. Before that, he was vice presi- Bank Saudi Fransi. Gatehouse Bank dent of mortgage sales and Islamic home has made two financing at another international bank for Antoine L Dijkstra has become managing recent appoint- nine years. His key role will be to develop director – chief investment and treasury ments. Zaid Shari’ah-compliant products. office at the headquarters of GIB in Bahrain. Maleh (right) Dijkstra was previously senior managing has been ap- director at Bear Stearns in London, and was pointed director Tharawat Investment House, a new also a board member at NIB Capital. With in the capital Islamic investment company in Bahrain, a breadth of experience in international markets origination team. He joined has appointed Nader Al Khalili as chief banking, Dijkstra has also worked at Zurich Gatehouse in September 2008 from Raif- investment officer. Al Khalili has a decade Financial Services Group and AIG Financial feisen ZentralBank Österreich AG (RZB), of experience and has held several executive Products. having been responsible for the origina- positions at firms such as Bapco, BDO tion and structuring of syndicated loans Jawad Habib and International Investment GIB has also named Richard David Scott as and capital markets products. He also Bank. He is currently undergoing profes- managing director – head of risk manage- worked to develop RZB’s Islamic desk. sional certification from the AAOIFI to ment. Scott was previously regional head become a certified Shari’ah advisor and for country risk management for Europe, Mufti Muhammad Nurullah Shikder auditor. Tharawat also recently hired Middle East and Africa for Citigroup. Prior has been chosen as head of Shari’ah Khalid Alkhayat as director of corporate to this, he was risk manager at Smith Bar- advisory and Shari’ah compliance. Previ- communications. ney, a private equity finance business, for ously, Shikder spent three and a half Asia-Pacific and Europe. In the past, Scott years with Dubai Islamic Bank in the also worked at Citibank in London and Shari’ah Coordination Department. He Citi has appointed Mudassir Amray as Russia and Saudi American Bank. also sits on the Shari’ah boards of Lloyds head of Islamic banking in Asia-Pacific, to TSB, Alburaq of Arab Banking Corpora- replace Rafe Haneef. Amray moves from tion and Scottish Widows Investment Citi Pakistan to the firm’s Singapore and Tuan Haji Ismail bin Ibrahim has been Partnership (SWIP). Kuala Lumpur offices, to develop consumer appointed CEO of Public Islamic Bank Bhd, and corporate Islamic banking products. a newly set up, wholly owned subsidiary of Public Bank in Malaysia. Public Bank Elaf Bank, a Bahrain-based Islamic invest- previously offered Shari’ah-compliant ment bank, has hired Helmi Haruna Rashid Bahrain-based Gulf International Bank services through an Islamic window – to be general manager for treasury and (GIB) has recently made four appointments. Ibrahim was its general manager prior to capital markets. As well as heading the treas- Dr Yahya Al-Yahya has been named CEO, his appointment as head of the Islamic ury operations, Rashid will manage and lead to replace GIB’s founder, Dr Khaled Al- banking subsidiary. the treasury and capital markets team to de- Fayez, who has retired after 35 years. Dr velop new Islamic investment and hedging Al-Yahya was executive director for Saudi tools. Since 2005 he was senior vice president Arabia at The World Bank in Washington, Musa Abdul Malek has been named the and head of treasury and capital markets at and has also served as director general new CEO of HSBC Amanah Malaysia Bhd, Bank Muamalat. Prior to this, he worked at at the Institute of Banking at the Saudi a wholly owned subsidiary of HSBC Bank Standard Chartered Bank Malaysia Bhd, Arabian Monetary Agency. Malaysia Bhd. He will be responsible for CIMB Bank and the country’s central bank. all aspects of the Islamic subsidiary’s busi- Fadel AlMeer has been appointed as coun- ness in the country, including retail and try head for the bank’s operations in Saudi commercial banking, wealth management, Azrulnizam Abdul Aziz has been appointed Arabia, and manager of the Riyadh branch capital market and the promotion of inter- by Standard Chartered Bank Malaysia Bhd of the bank. AlMeer joins GIB from Na- national currency business unit business. as CEO and executive director of Standard tional Commercial Bank, where he worked Malek was earlier deputy CEO, but has Chartered Saadiq Bhd, its Islamic banking for 14 years, most recently as chief corpo- been acting CEO since the departure of subsidiary. Aziz was previously head of rate banker in the institutional banking Yakub Bobat. 42 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 BOOK REVIEW ‘Developments in Islamic Banking: The Case of Pakistan’ by M. Mansoor Khan and M. Ishaq Bhatti Richard T de Belder, partner at Denton Wilde Sapte LLP and head of the firm’s Islamic finance practice, reviews the book, published in 2008 by Palgrave Macmillan (ISBN-10: 1-4039-9877-9). The book is 264 pages long including tables, bibliography and index. Mohammad Mansoor Khan is a lecturer There is an informative summary and cri- duced in this period. The authors critique the at the University of South Australia and tique of the initial report issued by the manner in which the production of these re- M. Ishaq Bhatti is an associate professor in Council of Islamic Ideology and its consid- ports was approached and also discuss some the department of economics and finance at eration of various policy instruments. The of the conflicts within Pakistani society and La Trobe University, Melbourne, Australia. section where the authors discuss how the those factions that wanted to rein in or cur- The book discusses various key paradigms, weightage system used with Shari’ah-com- tail the implementation of Islamic banking. theories and developments in Islamic bank- pliant deposits evolved and their criticism ing and analyses recent developments in of how it is used in practice was of particu- The eighth chapter considers the impact of Pakistan during the period 1980–2007. lar interest. The authors also analyse the the 1999 and 2002 decisions of the Supreme The book contains nine chapters with the fact that in order to convert the system it is Court that ruled on the initial 1991 Federal first being a general introduction. The sec- not enough to merely prohibit interest but Shariat Court decision which had decided ond chapter discusses Islamic economics. one also needs to change a society’s ap- against riba. The rulings are discussed in de- The authors criticise conventional econom- proach to matters such as the distribution tail and in particular the 2002 decision that ics (which is clearly justified as can be seen of wealth, ethics, moral hazard and taxa- set aside the 1999 judgment which upheld by the ongoing credit crisis) but the reviewer tion, without which full implementation of the 1991 decision. felt that some of these criticisms could have Islamic banking will fail. been more detailed. There is also an inter- Chapter nine goes into more detail as to esting discussion about modern theories of The fifth chapter reviews the period the reaction of the different stakeholders in equity and justice. 1981–1990 and what law changes were Pakistani society to these court decisions and considered as being necessary. The authors their willingness or otherwise to support or The third chapter focuses on Islamic bank- also consider the different Shari’ah-compli- hinder the growth of Islamic banking. While ing and contains an informative description ant products that were offered and the ex- these court decisions are particular to Pak- of its recent history and developments. The tent to which in practice they failed to istan, they and the reactions of the various country-by-country breakdown is in partic- conform to Shari’ah principles. The au- parts of Pakistani society to them, offer an ular interesting in showing how the Islamic thors’ view is that during this time there interesting perspective as to what issues other finance industry has expanded. The descrip- was a failure to succeed due to gross devia- countries might face in similar circumstances. tion of the different types of transactions is tions from the original conversion plan, a helped by the use of tables. In reality these lack of proper training for bankers, public The final chapter ends with the conclusion structures are currently created in such a concerns and doubts and the failure to that the prospects for Islamic banking in way that the risk/reward paradigms are make major structural changes to products. Pakistan are highly unpredictable and bleak. shifted so that they often end up the same as The book provides interesting insights into conventional financings and, while the au- The sixth chapter reviews the background the significant problems facing a country that thors do allude to this, a more detailed to, and the impact of, the well-known 1991 wants to move towards a society based on analysis of these circumvention structures Federal Shariat Court decision on riba. Islamic economics including Islamic banking may have been of interest to the reader. The seventh chapter focuses on the efforts and is worthy of study by those involved in The fourth chapter deals with when Pak- to revive Islamic finance in the period policy making, whether in financial, regula- istan was first considering Islamic banking. 1992–1998 by discussing two reports pro- tory or political bodies or authorities. www.newhorizon-islamicbanking.com IIBI 43 CALENDAR NEWHORIZON January–March 2009 Diary of events endorsed by the IIBI February Contact: Katherine Burchell May Tel: +44 (0) 20 8673 9666 Email: [email protected] Bahrain www.exportagroup.com Kuala Lumpur 24–25: 8th Annual Islamic Finance Summit, London Summit to address the most pressing issues within Shari’ah-compliant finance world- wide, including Islamic loan and bond is- suance, sukuk market, wealth management, equity financing and structured products. Contact: Adam King Tel: +44 (0) 20 7779 8673 Email: [email protected] www.islamicfinancesummit.com April 1–2: The Asia Pacific Islamic Financial Market Conference, Kuala Lumpur Conference organised jointly by the © Klaas Lingbeek-van Kranen iStockphoto.com Malaysian Investment Banking Association 8–9: 5th Annual Middle East Insurance (MIBA) and Islamic Banking and Finance 20–21: The 2nd International Islamic Forum (MEIF 2009), Bahrain Institute Malaysia (IBFIM) to focus on ex- Venture Capital & Private Equity Forum to focus on the crucial issues of un- panding Islamic capital market in the global Conference, Kuala Lumpur locking new growth opportunities in the financial environment. Will concentrate Conference to focus on Shari’ah-compliant Islamic and conventional insurance market on developing Shari’ah governance, risk alternative investments and strategic funds of the Middle East, including assessing key management and branding Islamic Capital and the vital role the industry should play in regional (as well as global) industry trends, Market (ICM) amidst the financial market social and economic development of Islamic pinpointing real growth potential in the es- uncertainty. countries. sential market segments, and looking at the Contact: Khairul Sabudin Contact: Khairul Sabudin opportunities in the emerging captives and Tel: +603 2031 1010 ext 532 Tel: +603 2031 1010 ext 532 takaful markets. Email: [email protected] Email: [email protected] Contact: Naomi Njoroge www.apifmc.com www.islamicvc.com Tel: +971 4 343 1200 Email: [email protected] www.megaevents.net Throughout 2009, IIBI will organise a number of training workshops to build the skill base and share ideas among practitioners within the Islamic finance industry. 24–25: 6th Annual Middle East Trade & The objective of the Institute’s training is to fill the human resource gap and to Export Finance Conference, Dubai enhance the professional skills of personnel who are either interested in building Conference to discuss the latest develop- their careers or already involved in the Islamic finance sector. Training ments and applications of trade finance programmes are delivered by experienced professionals; the number of solutions in the region, including the ways participants is kept small to ensure the interactive environment and of incorporating Shari’ah-compliant struc- provide a practical learning experience for the participants with the help of tures. The event will feature case studies of suitable case studies. For more information about upcoming programmes, the latest supply chain financing applica- please visit: www.islamic-banking.com tions and focus sessions on overcoming the current market instability. 44 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Muharrum–Rabi Al Awwal 1430 RATINGS & INDICES Islamic financial institutions and instruments Below is a monthly list of the latest long and short-term credit ratings for each Islamic financial institution and financial instruments monitored by Capital Intelligence (CI), an international credit rating agency. Detailed information on rating processes and definitions can be found on the CI’s website www.ciratings.com CURRENT RATING 11th December 2008 FOREIGN CURRENCY OUTLOOK FINANCIAL SUPPORT SINCE LONG TERM SHORT TERM STRENGTH ISLAMIC BANKS FC FSR Abu Dhabi Islamic Bank A A2 A 2 Stable Stable Jun 2007 Al Baraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Stable Oct 2008 Al Rajhi Banking & Investment Corp. A+ A1 A+ 2 Stable Stable Jan 2008 Bahrain Islamic Bank BBB A3 BBB 3 Stable Stable Sep 2007 Bank Islam Malaysia BBB- A3 BB+ 2 Stable Stable Jan 2008 Faysal Bank (Pakistan) B- C BB 3 Negative Stable Oct 2008 Gulf Finance House BBB+ A2 BBB+ 4 Stable Stable Oct 2008 Jordan Islamic Bank for Finance & Investment BB B BBB- 3 Stable Stable Nov 2007 Kuwait Finance House A+ A1 A+ 2 Stable Stable Jul 2008 Qatar International Islamic Bank BBB+ A2 BBB+ 3 Stable Stable Jul 2008 Qatar Islamic Bank A A2 A 3 Stable Stable Aug 2008 Sharjah Islamic Bank A- A2 BBB+ 2 Stable Stable Jul 2008 Shamil Bank of Bahrain BBB A3 BBB 3 Stable Stable Sep 2007 The National Commercial Bank AA- A1+ AA- 1 Stable Stable Sep 2008 Tadhamon International Islamic Bank B- B BB- 3 Stable Stable Oct 2007 CORPORATE RATING OUTLOOK SINCE All ratings are reviewed LONG TERM SHORT TERM FINANCIAL INSTITUTIONS on a regular basis Al Tawfeek Company for Investment Funds Limited BBB A2 Stable Feb 2008 A'Ayan Leasing & Investment Co BBB A3 Stable Oct 2008 First Investment Co BBB A3 Stable Feb 2008 Grand Real Estate Projects Co BB B Stable Nov 2006 Investment Dar Company BBB+ A3 Stable Oct 2007 International Investment Group BB B Positive Dec 2006 CAPIVEST BB+ A3 Stable Jan 2007 SUKUK RATING OUTLOOK SINCE LONG TERM SHORT TERM FINANCIAL INSTRUMENTS Commercial Real Estate Sukuk Company A- Stable Oct 2008 KCMCC Sukuk Company BBB Stable Jul 2008 KSA MBS International Sukuk Co. Ltd A- Stable Oct 2007 Kuwait Resorts Sukuk Co. BSC BBB Stable May 2006 NIG Sukuk Ltd. A Stable Aug 2007 Tijara & Real Estate Investment Sukuk Company BSC BBB+ Stable Jul 2006 www.newhorizon-islamicbanking.com IIBI 45 GLOSSARY NEWHORIZON January–March 2009 amanah ju’ala riba al-nasiah Lit: trustworthiness, reliability, loyalty, honesty. A unilateral contract for performing a specified task for a Increment on the principal of a loan payable by the Technically, it describes a business deal where one party certain wage. Technically, a contract between a client and borrower. It refers to the practice of lending money for keeps another’s funds or property in trust. a bank for certain services for a specified price. any length of time on the understanding that at the end of the agreed period the borrower would return the al-wadia kafala original amount plus an increment in consideration of Safe custody; it is an arrangement that allows a person Lit: responsibility or suretyship. In kafala, a third the lender having granted him/her time to pay. to keep the wealth belonging to oneself with an Islamic party becomes surety for the payment of debt. It is a bank for safekeeping purposes. covenant/pledge given to a creditor that the debtor will salam pay the debt or any other liability. Salam means a contract in which advance payment is bai mu’ajjal made for goods to be delivered later on. Lit: a credit sale. Technically, a financing technique maysir adopted by Islamic banks. It is a contract in which the Gambling – a prohibited activity, as it is a zero-sum game Shari’ah seller allows the buyer to pay the price of a commodity just transferring the wealth not creating new wealth. Refers to laws contained in or derived from the Quran at a future date in a lump sum or in instalments. The and the Sunnah (practice and traditions of the Prophet price fixed for the commodity in such a transaction is mudarabah Muhammad). generally higher than the spot price. A form of business contract in which one party brings capital and the other personal effort. The proportionate sukuk fatwa share in profit is determined by mutual agreement at the Similar characteristics to that of a conventional bond A ruling made by a competent Shari’ah scholar on a start. But the loss, if any, is borne only by the owner of with the key difference being that they are asset backed; particular issue, where fiqh (Islamic jurisprudence) is the capital, in which case the entrepreneur gets nothing f a sukuk represents proportionate beneficial ownership unclear. It is an opinion, and is not legally binding. or his labour. in the underlying asset. The asset will be leased to the client to yield the return on the sukuk. gharar murabaha Lit: uncertainty, hazard, chance or risk. Technically, sale A contract of sale between the bank and its client for takaful of a thing which is not present at hand; or the sale of a the sale of goods at a price plus an agreed profit margin A form of Islamic insurance based on the Quranic thing whose consequence or outcome is not known; or for the bank. The contract involves the purchase of goods principle of mutual assistance (ta’awuni). It provides a sale involving risk or hazard in which one does not by the bank which then sells them to the client mutual protection of assets and property and offers know whether it will come to be or not. at an agreed mark-up. Repayment is usually in joint risk sharing in the event of a loss by one of its instalments. members. Hajj An annual pilgrimage to Mecca and other holy places. musaqat tawaruq The fifth pillar of Islam, Muslims have the duty to A contract in which the owner of the orchard shares its A sale of a commodity to the customer by a bank on perform Hajj at least once in their lifetime, provided produce with another person in return for his services in deferred payment at cost plus profit. The customer then they have the means to do so. irrigating the orchards. sells the commodities to a third party on a spot basis and gets instant cash. halal musharakah Activities which are permissible according to Shari’ah. An agreement under which the Islamic bank provides Ummah funds which are mingled with the funds of the business The diaspora or ‘Community of the Believers’ haram enterprise and others. All providers of capital are entitled (ummat al-mu’minin), the worldwide community of Activities which are prohibited according to Shari’ah. to participate in the management but not necessarily Muslims. required to do so. The profit is distributed among the hila (pl. hiyal) partners in predetermined ratios, while the loss is borne wa’ad Legal devices or tools used to avoid direct violation of by each partner in proportion to his contribution. A promise to buy or sell certain goods in a certain Shari’ah and achieve a certain objective through lawful quantity at a certain time in future at a certain price. It is means. musharakah, diminishing not a legally binding agreement. An agreement which allows equity participation and ijara sharing of profit on a pro rata basis, but also provides a wakala A leasing contract under which a bank purchases and method through which the bank keeps on reducing its A contract or agency in which one person appoints leases out a building or equipment or any other facility equity in the project and ultimately transfers the someone else to perform a certain task on his behalf, required by its client for a rental fee. The duration ownership of the asset to the participants. usually against a certain fee. The agent (wakil) is of the lease and rental fees are agreed in advance. allowed to generate an income for himself in excess Ownership of the equipment remains in the hands of muzara’a of the minimum agreed upon returns as agreed with the bank. A contract in which one person agrees to till the land of rab-al-maal (investor of the capital). the other person in return for a part of the produce of the ijara wa iqtina land. waqf The same as ijara except the business owner is An appropriation or tying-up of a property in perpetuity committed to buying the building or equipment or qard hasan so that no propriety rights can be exercised over the facility at the end of the lease period. Fees previously An interest-free loan given for either welfare purposes or usufruct. The waqf property can neither be sold nor paid constitute part of the purchase price. It is commonly fulfilling short-term funding requirements. The borrower inherited nor donated to anyone. used for home and commercial equipment financing. is only obligated to pay back its principal amount. zakat istisna riba An obligation on Muslims to pay a prescribed A contract of acquisition of goods by specification Lit: increase or addition. Technically it denotes any percentage of their wealth to specified categories in or order, where the price is fixed in advance, but the increase or addition to capital obtained by the lender their society, when their wealth exceeds a certain limit. goods are manufactured and delivered at a later date. as a condition of the loan. Any risk-free or ‘guaranteed’ Zakat purifies wealth. The objective is to take away a Normally, the price is paid progressively, in accordance rate of return on a loan or investment is riba. Riba, in part of the wealth of the well-to-do and to distribute it with the progress of the job. all forms, is prohibited in Islam. Usually, riba and interest among the poor and the needy. are used interchangeably. 46 IIBI www.newhorizon-islamicbanking.com