Topic 2: An Introduction To Islamic Finance & Banking

ESC Rennes School of Business

2009/2010 Dr Khalid ELBADRAOUI

Learning Objectives

This course is designed to:

Help students consider in some detail the principles of Islamic Banking and the differences between Islamic and conventional banking. Equip students with a practical and detailed understanding of Islamic products and their use in a business context.

References
Books:
Iqbal Z. and Mirakhor A., An Introduction to Islamic Finance: Theory and Practice, Hardcover, 2006. Ayub M., Understanding Islamic Finance, Hardcover, 2007. Khan M. and Mirakhor A., Theoretical Studies in Islamic Banking and Finance, Islamic Publications International, 2005.

Websites:
[Link] [Link] [Link] Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) [Link] Islamic Financial Services Board (IFSB) [Link] International Islamic Financial Market (IIFM) [Link] Islamic International Rating Agency (IIRA) [Link] Islamic Banks and Financial Institutions Information [Link] Institute of Islamic Banking

Road Book
What is Islamic Finance? History & development of Islamic Finance Islamic Contracts & use of funds Islamic Bond (SUKUK) Islamic Insurance (Takaful) Asset Management/Fund Management Subprime crisis and Islamic Finance Challenges facing Islamic Finance Conclusion

What is Islamic Finance and Banking?

Islamic banking has the same purpose as conventional banking except that it claims to operate in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharaba), safekeeping (Wadiah), joint venture (Musharaka), cost plus (Murabaha) and leasing (Ijarah). The key Islamic contracts are described in more detail in the 3rd section.

Shariah terms

Halal that which is permitted or compliant Haram that which is not permitted Riba charging of interest or unjustified increase Gharar the taking of unreasonable risk; uncertainty Maisir reliance on chance or speculation, rather than effort

Islam

Aqidah
(Faith and Belief)

Shariah
(Practices and Activities)

Akhlaq
(Moralities and Ethics)

Basis of Shariah Approval (At a Glance)

Consideration of Primary Source Consideration of Secondary Source Consideration of Local Laws Acceptable To Market

Quaran & Sunnah

Holy Quran The
sacred text of Islam

Ijma Ijtehad Qiyas

Law of Country

Sunnah
Practices and sayings of Prophet Muhammad

Ijmaa
Consensus of Ummah

But Shariah principles shall not be compromise

Qiyas
Analytical comparison

Ijtehad
Reasoning applied by Scholars

Islamic finance is the outcome of religion in banking

Banking and finance needs
Shariah sources Fiqh al-Muamalaat contracts Musharaka Mudaraba Murabaha Ijara Istisna Salam - Partnership - Partnership

Quran Sunnah Ijma (jurist consensus) Qiyas (analogy) Ijtihad (reasoning)

Shariah filter

- Purchase-resale - Lease - Manufacturing contract - Forward sale

Islamic banking and finance solutions

Prohibition of: Interest Speculation Gambling Prohibition of certain investments: Sectors (e.g.: alcohol, armaments, financial services, gambling, pork, pornography, tobacco) Instruments (e.g. no forward transactions, limited option use, no derivatives, short-selling) Asset-backed transactions with investments in real, durable assets Credit and debt products are not encouraged

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Islamic Finance

Principles and Foundations laid down by Shariah (Islamic law) Quran Revealed word of God Sunnah Sayings and practices of the Prophet Mohammed Moral guidance or set of principles practiced by muslims Shariah Supervisory Board (SSB) 3-5 Islamic Scholars Decide what is compliant or not Interpret Islamic Jurisprudence (Fiqh)

The Foundations of Islamic Finance

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Avoid Interest (Riba)

Riba al Naseeyah or Riba al-Quran excess resulting from a pre determined interest Riba al-Fadl or Riba al Hadith Excess compensation without consideration
Avoid Uncertainty/Deceit (Gharar)

Final result is uncertain Short Selling Fraud Options

Avoid Gambling (Maysir)

Involvement In speculative and gambling transactions No Derivatives

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Adult Entertainment Alcohol Banking

Gambling (Casinos) Insurance Pork

Weapons & Armaments

Transactions should be backed by Tangible assets.

Obligation to share to a certain extent profits and losses and in the forms of buyer seller (murabaha), lessor leasee (ijarah), partnership (musyaraka), and or debtor creditor (qard hasan) relationship. Promote honesty, transparency justice and fairness in commercial dealings.

Charitable distributions: Zakat (Mandatory) (2.5% Lunar or 2.5775% Solar Calendar) Sadakat (Voluntary)

Islamic vs. Conventional

CONVENTIONAL
CONVENTIONAL BANKING

13

Money

Bank
Money + money (interest)
ISLAMIC

Client

Is based on interest. Deals in money or papers Is based on fixed return on both Sides of the balance sheet. Does not involve itself in trade and business directly

Islamic BANKING
. Is based on profit or rent . Deals in assets. . Is based on profit sharing on . deposits side, and on profit on assets side. . Actively participates in trade, production and valid services through valid contracts.

Bank

Goods & Services

Client

Money

Islamic vs. Conventional

14

Conventional Bank Bank acts as a financial Intermediary Maturity Transformation Takes in long term finance and lends short term Main income consists of Interest Margin

Islamic Bank Return must take the form of a tangible asset Bank acts a a fund/asset manager (Mudarib) Depositors are seen as investors (Rab al Mal)

Expectations

15

More ethical business and economy. Better governance, due to participation of investors (debt holders) in risk sharing.

Less uncertainty and less transaction costs.

Less speculation. Shariah businesses deal only on real sector (goods and services), so that it will add economic value.

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History and Development of Islamic Finance and banking

Historical Background of IF&B

17

Industry has developed a comprehensive product offering over its young history
1960s-1980 New Concept, Limited to Commercial Banking

18

New Concept, Limited to Commercial Banking

1980s-1990

Expansion into Asian Markets Introduction of Islamic Insurance (Takaful) + Project Financing Oil shocks resulted in rapid growth Birth of the Islamic bond (Sukuk) Equities market Leasing (Ijarah)

1990s

2000- Today

Internationalization of Islamic Finance Creation of Islamic Funds / Asset Management Structured Products

Reach and richness

Islamic finance industry is developing a global reach

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Mainstream relevance Niche presence Engaging with regulators Conceptual exploration

Source: HSBC Amanah

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UK: New legislation for Islamic mortgages (2003) USA: Harvard workshop with six regulators (1995)

Germany: Saxony issues E100m Sukuk (2004)

China: Active member of Islamic Financial Services Board (2004)

Japan: JBIC exploring Islamic financing opportunities (Dec. 2006)

Saudi Arabia: 95%+ of new consumer lending is Islamic (2006) Retail market rapidly converting to Islamic (2006)

Bahrain: Leading Islamic financial centre, and housing regulatory bodies

UAE: 30% of retail banking is Islamic (2005) Several institutions have converted from conventional to Islamic

Singapore: Active in developing Islamic finance Malaysia: Islamic product and industry, development and sophistication lead

Source: HSBC Amanah, Press Reviews

Islamic Banking
Kuala Lumpur Dubai Manama Doha London

21

Singapore

Population
Muslims Fin Sector (Assets) Islamic % Major Players

1.5m
40% $387.5 B

1.3m
96% $340.0 B

718,306
81.2% $251.1 B

928,635
77.5% $81.3 B

7.5m
8% $19.1 Tr

4.6m
14.9% $276.5 B

$50.0 B 12.9% HSBC, Bank Islam Malayasia, Prudential

$46.3 B 13.5% Noor Islamic Bank, DIB, Emirates Islamic Bank,

$16.4 B 6.5% Acrapita Bank, Gulf Finance House, Bahrain Islamic Bank

$14.8 B 18.2% Acrapita Bank, Gulf Finance House, Bahrain Islamic Bank

$10.0 B 0.05% Islamic Bank of Britain, HSBC, European Finance House

$1.8 B 6.5% Standard Chartered, Islamic Bank of Asia, Malayan Bank

Natures and Facts of the IF&B

1.6 Billion Muslims worldwide (24% of total worlds population)
10-20% annual growth rate Market of Shariah compliant assets approximately $800bn

22

Islamic indexes on Dow Jones/FTSE//MSCI

Assets held by muslim investors in $trillions

4 2 0 Muslim AUM 2008 Muslim AUM 2010 2.7

Number of Islamic Funds

1000 500 0 Islamic Islamic Funds 2008 Funds 2010 650 950

1.6

Natures and Facts of the IF&B

Conventional banks, including multinationals get into the business, offering islamic financial products.
Grais & Pellegrini (2006) reported that the global Islamic financial services industry consisted of 284 institutions offering Islamic financial services (IIFS) operating in 38 countries, both Muslim and non-Muslim. Sol (2007) identified that there were more than 300 Islamic financial institutions spread over 51 countries, plus well over 250 mutual funds that comply with Islamic principles. Assets held by fully Shariah-compliant banks or Islamic banking windows of conventional banks rose by 28.6% to $822bn from $639bn in 2008, compared to just 6.8% for that of conventional bank (The Bankers Top 500 Islamic Financial Institutions Survey).

23

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Natures and Facts of the IF&B

The major contributors to asset growth for Islamic funds: Gulf Cooperation Council (GCC) countries (US$262.7bil); Asia (US$67.1bil); Australia/Europe/the United States (US$35.3bil); and nonGCC Middle East countries, Middle East and North Africa (US$248.3bil). The IF & B has involved in all of industries: energy, consumer discretionary, staples, financials, materials, information technology, health care, telecommunication, utilities, education, etc. IF & B also provides financing for large scale projects such as those in energy and infrastructure through sukuk (asset based) financing.

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Global Islamic Banking Assets

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Infrastructure, Regulatory Framework and Governance for If & B

29

Islamic law and regulatory framework exist, including those deal with modern business. However, there are limitations in terms of the capacity of the jurists to deal with large scale economic transactions, and that there is no court of final appeal that result in controversies (Monger and Rawashdeh 2008). The most notable initiative is the establishment of Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) => to develop standards for accounting, auditing, governance, and ethics to ensure Shariah compliance. The Islamic Financial Services Board (IFSB) was created to set standards for the industry, in which twenty-two agencies, including several national central banks, International Monetary Fund and World Bank are members. The board intially focussed on risk management and capital adequacy for islamic financial industry.

Infrastructure, Regulatory Framework and Governance for If & B

30

The IDB initiatives are also important to support the infrastructure for operation and development of Islamic financial industry. Other supporting structures, such as ratings, indexes, studies, predictions and analysis for IF & B institutions are available and provided by conventional and international institutions (such as S&P, Dow Jones, etc.).

Self-regulatory organizations bring credibility through standardization of practices

AAO-IFI (1991) Bahrain Benchmark of Islamic accounting standards 56 accounting, auditing, governance and Shariah standards Enhancing clarity, transparency and harmonisation Development of global Islamic capital and money market Promoting active and regulated trading and capital flows Catalyzing trading infrastructure, product innovation and information flows Promoting industry in theory and practice

31

IIFM (2001) Bahrain GCIBFI (2001) Bahrain

Disseminating Shariah concepts & multilateral understanding between IFIs and public Improving IFI practices, cooperation, professionalism and transparency
Standard-setting body of regulatory and supervisory agencies Complementing Basel II Capital Accord Key standards: risk management, capital adequacy & corporate governance Creation of active Islamic inter-bank market Creating secondary market for short-term Shariah-compliant treasury products Enabling IFI management of liquidity mismatch Reference point for IFI ratings Issuing sovereign, credit, Shariah quality and corporate governance ratings Providing effective tool for informed investment decision-making

IFSB (2002) Malaysia

LMC (2002) Bahrain

IIRA (2005) Bahrain

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Islamic Banking Operating Structures

Islamic Windows

Branches

Subsidiaries

Fully fledged Islamic Banks

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Islamic Contracts & Use of Funds

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Sources & Uses of Client Funds

Sources
Deposit Accounts
Current account Savings account Investment account

Uses
Murabaha Musharaka

Mudaraba
Ijara Salam Istisna Off Balance sheet Funds Sukuk (Islamic Bond) Reserves (general & statuary)

Type of Contracts

Shareholders funds
Share Capital Reserves

Other
Off balance sheet (specific accounts)

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Elements of a Contract
Contracting parties Mature Sane Subject Matter Valuable according to Shariah law Existence (material effect) Must be owned Ability to deliver Specific Conditions & offer and acceptance Acceptance must match offer

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Murabaha (Set Profit Sale)

Definition of Murabaha: It is a sale contract, with a set increment on the original price, agreed upon by the two parties. It is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit.

Murabaha Financing Installment Credit Sale

Differed payment Sale/Installment Credit Sale + Profit Mark-Up Closing & payment date must be clear Bank can appoint client as agent (if bank is inexperienced) Technical ownership of good remains with bank Bank may request Collateral/Security/Guarantee Buyer knows the original seller price The banker in a Murabaha must have some form of actual ownership, registered or not, constructive or physical

37

Bank

Client

Mechanics of Murabaha

38

A typical Murabaha transaction as practiced today takes place between 3 players: The financier or the Islamic bank The vendor or the original seller of the product The user of the product requiring the bank to purchase and finance the product

The transaction is explained in detail in the following steps:

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Step 1

The banks client seeking financing describes to the vendor the goods they intend to obtain, and ask the vendor to quote the price.

Price Inquiry

Client
Price quote

Trader/Vendor

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Step 2

The banks client contacts the bank promising to buy the goods from the bank if the bank buys the same from the vendor and resells them to the client at price inclusive of the original cost + profit to be agreed mutually.

Price quote by Trader/Vendor

Client
Promise to buy at cost-plusprofit

Islamic Bank

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Step 3
The bank purchases the product from the vendor by making payment. The Murabaha contract is drawn between the client and the bank indicating the profit or mark-up to be charged. The contract is finalized by agreeing on the mode of payment (lump sum, installments).
Cost-plus contract

Payment

Client

Islamic Bank
sale Item/Commodity

Trader/Vendor
sale Item/Commodity

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Step 4 At the time of payments, the client makes the payment to the bank. This payment includes the cost of the product + profit margin to the bank.

Payments (Lump sum/Installments)

Client

Islamic Bank

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Commodity Murabaha (Liquidity Management)

44

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Futures and Conditions of Murabaha

Murabaha must be based on a sale and should not be used for financing purposes. In the case of default by the end used, the financier only has recourse to the items financed and no further mark-up or penalty may be applied to the outstanding liability. The mark-up rate charged is influenced by: the type of product financed, the credit worthiness of the client, the length of time for which the financing takes place. The financier is allowed to ask for security to protect itself against any non-payment in the future (often an other asset is taken as security).

Mudaraba (Partnership Contract)

46

Definition This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise.

The investment comes from the first partner who is called Rab al Mal (Investor) while the management and work is an exclusive responsibility of the other, who is called Mudarib (Working Partner) and the profits generated are shared in a predetermined ratio.

Mudaraba (Partnership Contract)

47

Client (Rab al Mal) deposits (Invests) his money. Bank (Mudarib) offers its skill/effort/knowledge. Contracts between client & bank is a partnership contract. Banks profit: share of investment profit instead of spread. (even though a profit margin is structured into the deal) Mudarib could hold reserves so as to smooth out income/make it more consistent. Risk of loss lies with the client. (unless bank broke rules)

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Fund Manager/Asset Manager (BANK) (Mudarib)

$10,000 Profit

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Client A (Rab Al Mal)

Client B (Rab Al Mal)

Client C (Rab Al Mal)

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Client A (Rab Al Mal)

Client B (Rab Al Mal)

Client C (Rab Al Mal)

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Types of Mudaraba

54

Al-Mudaraba Al-muqayyadah (restricted Mudaraba): Where Rab al Mal specifies a particular business for the mudarib, in which case he shall invest the money in that particular business only.

Al Mudaraba Al Mutlaqah (unrestricted Mudaraba): Where Rab al Mal leaves the door open for the mudarib to undertake whatever business he whishes, the mudarib shall be authorized to invest the money in any business he deems fit.

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Musharaka Contract (Sharing contract)

Definition Musharaka or Shirka can be defined as a form of partnership where 2 or more people combine either their capital or labor, to share the profits and losses, and where they have similar rights and liabilities.

Musharaka Contract (Sharing contract)

Client Enters Agreement with bank to Invest in a Project. Bank issues notes of participation. Client invests $80,000, Bank Invests $20,000 Profit Share is Based on a 70%:30%

56

Client invests $80,000

Bank invests $20,000

$100,000 Project

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Musharaka Project makes $30,000 profit. Client receives 70% of profit $21,000 Bank Receives 30% of profit $9,000

Client receives $21,000

Bank receives $9,000

$30,000 Profit

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Musharaka Project $50,000 loss, Project value=$50,000 Losses are borne according to their initial capital contribution Client receives proportion of investment (80% of $50,000) = $40,000 Bank receives proportion of investment (20% of $50,000) = $10,000

Client receives $40,000

Bank receives $10,000

Project makes loss of $50,000 50,000 remaining.

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Difference between Musharaka and Mudaraba

1. The investment in Musharaka comes form all the partners, while in Mudaraba the investments comes from Rab Al Mal only. This means that the Musharaka is a partnership in profit and capital, while Mudaraba is a partnership in profit not in capital. 2. In Mushararka all the partners can participate in the management of the business, and can work for it. While in Mudaraba the Rab Al Mal has no right to participate in the management, which is carried out by the Mudarib only. 3. In Musharaka all the partners share the loss. While in the Mudaraba, only Rab Al Mal suffers the loss, while the Mudarib suffers the loss of his labor.

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Bai Al Salam or Salam

(Purchase with deferred delivery)
Bai Al Salam or as some call it 'Salam' means a contract in which an advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a 'future date' in exchange of an advance price fully paid at the time of contract.

The objects of this sale are goods and cannot be gold, silver or currencies, because these are regarded as 'monetary values exchange' of which is covered under rules of Bai al Sarf (exchange of money for money).

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Bai Al Salam or Salam

(Purchase with deferred delivery)

Purchase price (discounted)

Purchase price (plus premium)

SUPPLIER

FINANCIER

CUSTOMER

Sale of asset (delivery deferred)

Sale of asset (delivery deferred)

Istisna
(Partnership in Manufacturing)

62

Seller agrees to manufacture a particular product with pre determined specifications and commits to deliver it to the buyer at a pre determined price. Price can be paid in installments, or can even be deferred until the product is delivered

Features of Istisna
Istitsnaa is a pure sale contract and not a hire contract.

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Commodity is non existing and is to be manufactured to bring it to existence. Does not include natural goods like fruits, cereals etc. Quantity, Quality & Price are fixed at the time of signing the contract. Price need not be paid in advance. It can be either be paid in installments or can be partially deferred until delivery. No fixed delivery date and no payment in full at outset required.

Advance funding of:

- Major industrial, construction and real estate development - Large equipment e.g. ships, aircraft

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Mechanism of Istisna

Purchase price

Purchase price plus premium (deferred)

DEVELOPER/CONTRACTOR/ MANUFACTURER

FINANCIER

CUSTOMER

Sale of developed equipment/construction

Sale of developed equipment/construction

Ijara Contract (leasing)

Similar to the a conventional lease contracts A bilateral contract allowing the transfer of the usufruct Rental could be fixed for the life of repayment or adjusted periodically Sub-leases are acceptable so long as lessor agrees Bank (lessor) & client (lessee) agree to the terms of lease. (object/lease date/rent) Additional security is acceptable (guarantees, collateral) Title remains with bank until full repayment Used for aircraft financing, ship financing and project financing

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Islamic Bond (SUKUK)

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Islamic Bond (SUKUK)

Bonds are important part of overall financial system. Well developed bond markets ensures stable financial system as it minimize over-reliance on financing from the banking sector.

The development of the bond market allows for access to funding with the appropriate maturities, thus avoiding the funding mismatches. It also allows for the diversification of risks by issuers and investors.

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Islamic Bond (SUKUK)

Dealing in Bonds is not permissible according to Shariah because of two aspects: 1. Firstly, they represent a portion of Debt payable by the issuer. Earning any kind of profit falls under the category of RIBA as defined in the Hadith. 1. Second aspect pertain to the trading of Bonds. Shariah prohibits trading of debts (Bai Dayn) as it involves Gharar. Trade of such Sukuks is permissible, because it will be equivalent to the sale/ purchase of holders proportionate share in the assets. However, trading of Murabaha and Salam Sukuks is not permissible.

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How is an Islamic Bond Different?

Sukuk Sukuk are always linked to underlying assets. Sukuk are proof of ownership or beneficial ownership of the asset Sukuk holders have a right to profits but also losses Sukuk holders may dismiss sukuk manager/issuer Maturity is based on underlying project/activity Conventional Bond Bond holder does not incur damages/loses suffered by the company. The security rights are not linked to the companys assets Represents a share in the financing process, it is not directly linked to the project No Shariah Constraints

Sukuk prospectus includes all shariah related rules

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Global (Listed) Sukuk Issuance

50000 45000 40000 35000 US $ Million 30000 25000 20000 15000 10000 5000 0 Rest of World Middle East

75

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Islamic Sukuk-Types

Sukuk Al Ijarah

Sukuk Al Salam

Sukuk Al Murabaha

Sukuk Al Musharaka

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ABC Ltd. (Corporate)

ABC Ltd. wishes to purchase a new asset and plan to raise finance through issuance of Islamic Sukuk.

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Supplier
Supplier of the Asset is identified and negotiations is finalized by ABC Ltd.

ABC Ltd.

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Supplier
Issuer SPV (LLC 100% owned ABC Ltd.) ABC Ltd.

SPV is created by ABC Ltd. as a limited liability Company.

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Supplier

Payment made to Supplier Title is transferred to SPV

Issuer SPV (LLC Sukuks

100%
owned ABC Ltd.) ABC Ltd. Proceeds

Investors

SPV issues certificates and receives proceeds which are used to purchase asset from the supplier

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SPV holds Plant/ Asset as Trustee SPV holds Asset as Trustee and leases the plant to ABC Ltd. as per rules of Ijarah Issuer SPV

Investor

ABC
Ltd.

SPV leases Plant to ABC Ltd. on Ijarah

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ABC Ltd. (Lessee) Periodic Lease Rentals

Issuer SPV Semi-annual coupon distribution amounts

Investors

ABC Ltd. (Lessee) pays periodic rentals to SPV for tenors & amounts matching the coupon & tenor of the Sukuks

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Exercises the purchase undertaking. Asset transferred to ABC Ltd.

ABC Ltd.
(Lessee) Pays the exercise price at dissolution

Issuer
SPV Redeems the Trust Certificates at dissolution

Investors

ABC Ltd (Lessee) give the SPV an irrevocable purchase undertaking to purchase the Asset at maturity. Exercise Price = Initial Purchase Price of Asset + service costs. Asset is transferred back on maturity, upon payment of the Exercise Price to the SPV / Sukuk Holders.

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Essential Condition

Its essential that the Ijarah Sukuks are designed to represent real ownership of the leased assets, and not only a right to receive rent.

Sukuk Al Salam
so named because securities are based on the concept of Bai Salam.

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Government of Bahrain first issued Salam Sukuks as an alternate to short term government treasury bill.
Under the transaction Government took an advance payment from the investors for a future delivery of Aluminum ingots. A paper was issued as an acknowledgment of receipt which is known as Salam Sukuk. Upon delivery of Aluminum ingots to the investors at the time of completion of Salam contract, Government sold ingots to third parties as agent of the investors. The difference between Sale and Purchase price was the profit of the investors.

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Important Conditions

Salam Sukuk represent investors shares in the Advance Price paid to the seller. Since its a dayn, it cannot be traded in the secondary market.

Sukuk Al Musharaka
Musharaka is a mode of financing against which Sukuks can be issued.

87

If a comapany required financing for any of its project through Musharaka it can issue Sukuks against which investors would provide funding as per the rules of Musharaka. Every Sukuk would represent holder's proportionate ownership in the assets of the Musharaka. Once the majority of the cash amount is converted into fixed assets, these Musharaka Sukuk can be treated as negotiable instruments in the secondary market. Musharaka Sukuks can be used for number of purposes including: Construction of Projects and factories Expansion Projects Working Capital Finance

Important Conditions
Profit earned by the Musharaka is shared according to an agreed ratio between the Issuer and Investors at an agreed ratio. Loss is shared on pro rata basis. To ensure tradability of the Sukuks following condition should be adhered to:

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All the assets of the Musharaka should not be in liquid form. At least 20% of the value of Portfolio should be invested in non-liquid assets.

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Sukuk Al Murabaha

Sukuks can also be issued against a Murabaha transaction. Under the transaction investors would provide funding to purchase some assets for the issuer. Acknowledgment of their investment would be regarded as Murabaha Sukuk.
The asset would be purchased from its supplier and would be immediately sold to the issuer against deferred price. Profit earned from the transaction would be distributed among the investor proportionately.

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Important Conditions

Murabaha Sukuk represent investors shares in receivable from the purchaser. Since its dayn, it cannot be traded in the secondary market.

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Islamic Insurance (Takaful)

Islamic Insurance (Takaful)

Conventional Insurance means a way to provide security / and compensation of what is valuable in the event of its loss, damage or destruction based on the principle of risk taking and speculation.
Islamic Fiqh (science of Shariah) Academy, meeting in its Second Session in Jeddah, KSA, (Dec 1985) issued a Resolution which in summary stated the following:

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The commercial Insurance contract is prohibited (Haraam) according to the Shariah.

The alternative Takaful contract which conforms to the principles of Islamic dealings is Halaal, being the contract of cooperative insurance, which is founded on the basis of charitable donation and Shariah compliant dealings.

Why conventional insurance is prohibited?

93

Scholars view the insurance contract as an exchange contract money is being exchanged for money over time. Riba: In the case of life insurance, policyholders get back the premiums along with interest in the case of survival and the insured amount in the case of death before maturity of the policy. Insurance funds are invested in financial instruments which contain the element of Riba. Gharar (uncertainty): in the case of general insurance, the policyholders have to pay the premiums against unknown risks: Whether the insured will get the compensation promised? How much the insured will get? When will the compensation be paid? Gambling: The insured loses the money paid for the premium when the insured event does not occur. The company will be in deficit if claims are higher than premium.

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Definition for Takaful

Takaful is an Arabic word that means "guaranteeing each other". It is a system of Islamic insurance based on the principle of TAAWUN (mutual assistance) and Tabarru (Voluntarily) where the risk is shared collectively by the group Voluntarily. This is a pact among a group of members or participants who agree to jointly guarantee among themselves against loss or damage to any of them as defined in the pact.

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Global Takaful premiums ($bn)

12

10

6
11.0

2
1.4

1.7

2.0

2.5

3.0

3.6

4.3

0 2004 2005 2006 2007 2008 2009(f) 2010(f) 2015(f)

Basic Elements of Takaful

Mutuality and cooperation.

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Takaful contract pertains to Tabarruat as against muawadat in case of conventional insurance. Payments made with the intention of Tabarru (contribution) Eliminates the elements of Gharrar, Maisir and Riba. Wakalah/Modaraba basis of operations. Joint Guarantee / Indemnity amongst participants shared responsibility. Constitution of separate Participants Takaful Fund. Constitution of Shariah Supervisory Board.

Investments as per Shariah.

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Main drivers of Takaful

Piety (individual purification) Brotherhood (mutual assistance) Charity (Tabarru or contribution) Mutual Guarantee

Community well-being as opposed to profit maximization.

Comparing Takaful to Conventional Insurance

Issue Conventional Insurance Takaful

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Organization Principle
Basis Value Proposition

Profit for shareholders

Risk Transfer Profits maximization

Mutual for participants

Co-operative risk sharing Affordability and spiritual satisfaction

Laws
Ownership Management status Form of Contract

Secular/Regulations
Shareholders Company Management Contract of Sale

Shariah plus regulations

Participants Operator Cooperative, Islamic contracts of Wakala or Mudarba with Tabarru (contributions)

Investments

Interest based

Shariah compliant, Riba-free

Surplus

Shareholders account

Participants account

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ASSET/FUND MANAGEMENT

50 Assets Under Management (US $Bn) 45 40 35 30 25 20 15 10 5 0 20 23 34 41 43 44

800 700 600 500 400 300 200 Number of Funds

101

29

100
0 2003 2004 2005 2006 2007 2008 of Islamic Funds AUM Number
1Q 2009

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Type of Islamic Funds

103

104

Stock Selection Process

105

Subprime Crisis and Islamic Finance

Making of the Crisis

106

From the Mortgage Crisis to the Global Economic & Financial Crisis

107

108

Major Impacts

Slowdown in Economic Growth

Revisions by IMF for 2009 Growth Projections

109

3.0

-1.4

0.5 6.1

-3.8 1.5

Islamic Finance as a Solution

110

The Global Economic & Financial Crisis: The Real Causes

111

111

Implications for Islamic Banking

112

Islamic Finance as a Solution

113

113

Islamic Theory of Finance and the Global Financial Crisis

Islamic Theory of Finance

114

Islamic Theory of Finance and the Global Financial Crisis

Rules and Regulations

115

Forbid

Stipulate

115

Islamic Theory of Finance and the Global Financial Crisis

Islamic Theory of Finance

116

Islamic Theory of Finance and the Global Financial Crisis

Principles of Islamic Finance against the Crisis

117

117

Islamic Theory of Finance and the Global Financial Crisis

Principles of Islamic Finance against the Crisis

118

Challenges Facing Islamic Banking

119

In governance, independence of SSBs is being questioned, because they are part of management (paid by the banks).

Differences in practice and application of Shariah laws, that may result in confusion in market. As an example, a practice of guaranteeing profit in some institutions is against islamic laws since it is similar to interest rate.
Studies (using Indonesian Islamic Index) indicate that speculation plays an influencial role in islamic market (Kurniawan 2008), and there is moral hazard in Shariah based financing practices (Nasution and Wiliasih 2007). Regulatory & tax issues Shariah scholars & Shariah compliant products Trained & Skilled Islamic Bankers

Understanding by its clients

Arabic Terminology

120

Conclusions
IF & B has been a choice of financial and banking services for Muslim and non-Muslim communities.

The size of their businesses and the asset managed grow significantly.
To improve their role in global economy, IF & B need to improve their infrastructure and governance, so that the islamic laws and values are consistently and essentially actually applied. Islamic financial institutions are affected by the financial crisis. They are not risk immune, however, during the economic crisis their growth is remained strong, and they have shown resilience to global market dislocation.