Islamic Banking

Lloyds TSB has opened its 17th Islamic banking centre at Bethnal Green that has been designed to provide financial services to the areas Muslim community.

The branch will offer customers financial products that comply with Islamic law, which forbids the payment or receipt of interest.

Paul Sherrin, head of Lloyds TSB Islamic financial services, said: "Bethnal Green is home to one of London’s strongest Muslim communities and by bringing Islamic banking to the area we hope to give our customers a real alternative to traditional banking."

The current account comes with no credit interest and there is no overdraft facility. However, a debit card is provided and there is no fee or minimum balance requirement.

There is also a home finance product, with which the bank buys the customers home outright – paying up to 90 per cent. The "owner" then pays rent on the property as well as regular repayments until the home is effectively re-purchased.

All Lloyds TSB Islamic financial services funds are held by the bank in accordance with Islamic laws.

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The Qatar International Islamic Bank (QIIB) is keen to tap the vast expatriate population in the country, non-Muslims in particular. QIIB strategists hope to reach out to the expatriate communities by spreading general awareness about Islamic banking.

Islamic banking is not for Muslims alone. This is the first and foremost thing that needs to be made clear, says Abdul Basit Al Sheibi, general manager of QIIB. The basic difference between conventional and Islamic banking is that the latter’s focus is on making a society savings-oriented rather than encouraging people to spend.

“In that sense, you can say that Islamic banks basically follow the concept of investment banking as they do not preach and encourage spending,” stresses Abdul Basit. And, that is precisely the reason why Islamic banks do not lend. That they do not deal in interest-based banking, is common knowledge.

QIIB, says the general manager, is the only bank in the country that shares profits with customers four times in a year, on a quarterly basis. Other banks disburse returns twice a year. Return by way of profits is 4.25 per cent annual on term deposits of a year. The percentage is four for six-month deposits and 3.5 and 3.25 per cent, respectively, for three and one month deposits.

Savings bank deposits carry a return (profits) of three per cent a year. Anyone can open term and savings deposit accounts with QIIB, says the GM. As conventional banks have been permitted to set up Islamic banking windows and some have been allowed to open full-fledged Islamic banking branches in the country, the competition has become fierce.

“It is a good sign, though, for the opening of so many Islamic banking windows and branches point to the fact that there is growing demand for its products and services,” says Abdul Basit. Additionally, the competition has prompted us to learn and enhance our own products and services, he adds.

Qatar was the only country in 1991 to have two Islamic banks, he said. Islamic banking is growing at a rate of 15 per cent worldwide annually. The figure is much lower for traditional banks.

There are an estimated 235 Islamic banks in some 40 countries, including outside the Muslim world. Their total assets were worth $250bn until recently. However, with the opening of Islamic banking windows and full fledged branches by some conventional banks around the world, the assets have risen to $350bn presently, said Abdul Basit.

Bahrain continues to be the country with the maximum number of Islamic banks.

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Small-and-Medium Enterprises (SMEs), usually considered to be the backbone of an economy, are set to receive a major boost especially in the Islamic banking and finance sector. Countries such as Saudi Arabia and Malaysia are encouraging greater allocation of financing for SMEs by the banking sector in an effort to stimulate the private sector and to boost rural and inner city poverty alleviation policies.

In Malaysia, for instance, according to Bank Negara, the central bank, financing for SMEs by the Islamic banking sector continued to increase from RM3.5 billion in 2002 to RM6.2 billion in 2003 to RM8 billion in 2004. The year-on-year increase in 2004 was almost 30 percent. More encouragingly, the market share of Islamic banking financing out of total financing for SMEs in Malaysia almost doubled from 7.5 percent in 2003 to 13.9 percent in 2004.

However, the Islamic SME financing in Malaysia in 2004 is merely RM8 billion out of a total financing by the Islamic financial sector of RM57.882 billion, which suggests that there is a huge challenge and business opportunity for Islamic banking in Malaysia in respect of financing SMEs.

This trend is reflected elsewhere in member countries of the Islamic development Bank (IDB), as the role and contribution of the SMEs to GDP and economic activity assumes greater importance.

Saudi Arabia is also encouraging the financing of SMEs. The country’s largest bank, National Commercial Bank (NCB), which is owned 69.3 percent by the Saudi Public Investment Fund (SPIF), earlier this year launched a Shariah-compliant financing scheme aimed at small businesses and self-employed professionals.

The "Al-Ahli Program for Free Tradesmen" offers Shariah-compliant loans of up to SR1 million repayable over three years to small businesses and professionals such as consultant doctors, engineers, and accountants who own and manage their own activities.

This financing program, according to Al-Sharif Khalid Al-Ghalib, head of NCB’s customer management group at the time, was the first of its kind on the Saudi market, and offers financing without collateral to all qualifying business people whether they are NCB customers or not.

"The small business sector makes up 80 percent of the Saudi market", stressed Ibrahim Al-Buloushi, head of NCB’s small business group, "and the bank’s aim is to expand the national economic structure; provide additional support to increase sources of income; and activate the economy to create more jobs and investment opportunities."

Some Islamic bankers have criticized the sector’s over-concentration on corporate, institutional and high networth clients, and its slowness in targeting SMEs.

"The reasons why SME financing should be a natural niche for Islamic banking," stresses Dr. Adalet Djabiev, CEO of Badr-Forte Bank in Moscow, which is Russian sole Islamic bank, "is that it deals directly with the real economy; creates employment; involves the productive use of resources especially capital and finance; and contributes directly toward the alleviation of poverty."

The IDB offers lines of financing for onward financing of SMEs in member countries along with extension, in principle, of full delegation of authority to selected National Development Financial Institutions (NDFIs), which are also encouraged to use the IDB’s technical assistance facilities.

At the 29th annual meeting of the IDB board of governors in Tehran in September 2004, SME financing was high on the agenda with particular emphasis on the need for using modern banking products to help alleviate poverty by generating wealth in rural areas.

The biggest policy boost for SME financing has come from Malaysia in the last two years. Bank Negara in October 2004 embarked on a project to enhance the capabilities of its development financial institutions (DFIs) such as Bank Pembangunan; Bank Industri; EXIM Bank; MECIB; and Bank Pertanian Malaysia.

The Bank Negara SME policy thrust is part of Prime Minister Abdullah Badawi’s so-called "agro-revolution", whose priorities include reducing poverty significantly, especially among the hardcore poor; rooting out corruption; and reforming education.

Indeed of the 22 banking measures introduced by Bank Negara in 2003, some eight dealt with measures to improve access to financing and those promoting active consumerism.

Malaysian Second Finance Minister Tan Sri Nor Mohammed Yakcop last year rightly called on Islamic finance to impact more on the ordinary citizens and not just bring value to shareholders, and bonuses to senior executives.

For instance, in the context even of an Islamic Capital Market (ICM), he is suggesting greater use of equity-based and hybrid financial instruments, and more non-collateral-based Islamic financial products to promote entrepreneurial development.

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Banking could get sensitive to religious beliefs soon. A special committee of the Reserve Bank of India (RBI), appointed on the directions of the Government of India, is studying ‘‘instruments of Islamic banking.’’

Islam prohibits interest, the fundamental instrument of modern banking. Offering financial products and services that conform to Islamic principles can lead to the unlocking of large financial capital that believers are unable to invest. In Kerala alone, thousands of crores earned in interest is kept in suspended accounts as believers do not claim it. ‘‘This money could be above Rs 40,000 crore,’’ says sociologist Imtiaz Ahmad, formerly of JNU.

Formed in July, the committee headed by Anand Sinha, Chief General Manager in charge (Banking Operations and Development), RBI, has not fixed a deadline yet. ‘‘The present committee is only studying the possibilities of instruments of Islamic banking. I cannot say if it will lead to changes in banking regulations,’’ an official said.

However, trends worldwide show the change. Banks such as HSBC, Standard Chartered etc have Islamic banking divisions started in recent years, and Indian banking regulators are perhaps catching up.

Instruments of Islamic banking are broadly based on the concept of sharing risk and profits rather than assured rates of interests.

• For instance, murabaha is a mechanism of financing trading. Here, the contract will have cost and profit components, profit will be shared by the trader and the financier.

• Mudaraba involves a sleeping partner who invests and the labour partner who does the work—the first gets his principal and share of profit; if the business fails his capital and the latter’s labour sinks.

• In musharaba, it is equivalent to a joint venture where banks get on board with equity and management partnership.

• In muqarada, or Islamic bonds, investors share the profits of the cumulative investments. And the bank collects a service charge, where profit sharing is not involved.

Jamaat-e Islami Hind, campaigning for Islamic banks for long, is excited about the RBI move. ‘‘There are many Muslims who are unwilling to deal with the existing banking system. And some are earning a lot of wealth too. If they have an opportunity to invest, on a profit-sharing basis, it is going to have a major impact on the economy,’’ says Siddique Hassan, secretary.

Abdur Raqeeb, Tamil Nadu state president of the Jamaat-e Islami, says interest-based banking can create havoc, as it happened in the case of farmers in AP. ‘‘Islamic banking is based more on sharing of responsibilities and is more compassionate,’’ he says, adding it could make credit available for the weaker sections.

But there is a lot of heated debate among ulemas on what is permissible and what’s not and some scholars say it is all a farce. ‘‘It is all very good to talk about but I am not convinced of its viability,’’ says Prof Imtiaz Ahmad.

However, it may not be the moral or religious arguments, but the economic ones that got the concept moving across the globe and now in India—assets controlled by Muslims is estimated to be $1.5 trillion and growing at 15 per cent a year. Banks began to eye this—Islamic bonds collected $30 billion in 2004, $20 billion already this year. Malaysia, headquarters of Islamic Financial Services Board (IFSB), has emerged the hub of Islamic banking. As many as 265 Islamic banks across 40 countries have assets of $262 billion.

Services offered by Islamic banks are a hit among non-Muslims too. More than 50 per cent business of HSBC’s Islamic banking division started last year in Malaysia is with non-Muslims!

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There will be no separate banking regulatory framework for Islamic financing in Singapore.

Instead, the Monetary Authority of Singapore said it would promote Islamic financing using the existing regulatory framework.

In what is seen as a step forward, the central bank announced on Thursday that all banks would now be allowed to offer an important form of Islamic finance known as Murabaha.

According to the central bank, not having a separate regulatory framework could make it less burdensome for Islamic banks to set up shop here.

Heng Swee Keat, Managing Director, MAS, said: "As many of the supervisory processes and prudential measures are common to both conventional and Islamic banking activities, MAS’ assessment is that there is no need to create a separate islamic banking supervisory framework in Singapore. Hence, MAS is open to admitting Islamic banks based on prudential criteria for admission."

From Thursday, all banks will be allowed to offer Murabaha which is commonly used as short-term financing and in trade finance.

It is a contract under which a client wishing to buy some items requests the Islamic bank to purchase them and sell them to him at cost plus a declared profit.

Mr Heng said: "Previously, MAS regulations impose broad restrictions on banks against conducting non-financial activities. Starting from Thursday, MAS will exempt Murabaha financing, which requires the banks to purchase goods on behalf of its customers, and to sell the goods to the customer at a mark-up, from this restriction."

The move is seen as significant.

Ahmad Khalis A Ghani, Chief Executive Officer, IFIS Business Advisory, said: "With the allowing of Murabaha processes, it will allow banks to develop many syariah-compliant products, whether in the retail side, trade financing and other services as well. There are also many bankers in Singapore who are able to create interesting financial products. With this talent, if we assimilate with expertise in Islamic banking, it will position as an interesting, reliable financial hub, with Islamic expertise in its suite."

The MAS sees explosive growth ahead for Islamic financing.

Mr Heng said: "Globally, we see all areas of islamic capital markets growing rapidly. Global asset size for Islamic finance is estimated at between 200 and 400 billion US dollars - and growing at 15 percent per annum. Global issuance of sukuk is expected to top US$10 billion this year, compared with just US$2 billion in 2003."

Rising oil prices are helping the push towards Islamic finance in the region as cash-rich businesses in the Middle East look for opportunities to raise their exposure in Asia.

Mr Heng said: "Asia is estimated to need over a trillion dollars in infrastructure financing in the coming years to build power plants, gas pipelines, toll roads, airports and telecommunication systems."

The MAS said all these projects were well-suited for Islamic financing.

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With the increasing demand for Islamic banking in the country, there is a need for trained bank staff with the right qualifications to undertake Islamic banking based on Shariah principles and methodologies, said Dr Ishrat Husain, governor, State Bank of Pakistan (SBP), here on Monday.

The governor, while inaugurating the First Islamic Banking Certificate Course at the National Institute of Banking & Finance (NIBAF), Karachi Campus, said the State Bank was implementing in letter and spirit the decision of the Supreme Court regarding the Riba-free banking in the country.

He said that they would provide a level playing field for the conventional and Islamic banking in the country. Islamic banking would run parallel to the conventional banking and it is upto the people of Pakistan to choose which type of banking they would adopt, he said and added: “We need to encourage growth of genuine Islamic banking in the country.”

Dr Ishrat Husain said the State Bank had taken a number of steps for the promotion of Islamic banking in Pakistan, which included the issuance of licences to Islamic banks, Islamic banking branches and setting up of subsidiaries by commercial banks for Islamic banking

He said the State Bank had issued the Essentials and Model Agreements of Islamic Modes of Financing as recommended by the Commission for Transformation of Financial System and approved by the Shariah Board of the SBP in order to ensure observance of Shariah principles by the institutions conducting Islamic banking in Pakistan.

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 Abu Dhabi Commercial Bank (ADCB) is weighing its options to venture into Takaful (Islamic insurance), Islamic banking and launching a number of investment funds, said its CEO Eirvin Knox.

"We are considering to acquire an insurance or Takaful company or to launch a new one", Eirvin Knox Chief Executive Officer, Abu Dhabi Commerce Bank told Khaleej Times, after the extra ordinary general meeting of shareholder on Monday in the capital.

Eirvin Knox said Abu Dhabi Commercial Bank has an ambitious plan to enter Islamic banking. "It could be in the shape of a dedicated division in the existing set up of the bank to launch products based on Islamic principles or by even launching a full-fledged subsidiary, though nothing has been decided as yet on the proposed paid up capital and other details", he told this reporter.

He said that the bank wants to expand its partnership with Australian Macquarie Bank to branch out into specialised products offering like infrastructure funds, sector specific or country dedicated mutual funds, after the success of Al Nokhita Fund, which has raised Dh2.5 billion, till now.

Recently, the bank launched its share brokerage company. Now this company would start its research activities.

Earlier, the shareholders of Abu Dhabi Commercial Bank gave their consent to a proposal of board of directors to raise the paid up capital to Dh3.9 billion from at present level of Dh1.95 billion, a 33 per cent interm bonus, a right issue of Dh2 billion besides spiltting the Dh10 share into Dh1. The shareholders also approved offering 25 per cent ownership of the bank to non-UAE nationals.

The Extra ordinary general meeting (EOGM) was told that the board of directors (BoD) had increased the per centage of an interim bonus from 30 per cent to 33 per cent for rounding off purposes making it Dh500 million which will be appropriated from current year’s earnings and be applied to the paid in capital of the bank.

It was told that government has waived the premium on the right issue to be offered to shareholders on September 28. For the alternate sourcing of capital, the EOGM was informed that it could be raised in the form of a subordinated debt and the BoD would be empowered to set its terms.

Eirvin Knox told shareholders that authorised capital is being further increased by Dh2 billion. Abu Dhabi Commercial Bank had a resounding first half of year 2005, when financial figures grew manifold.

The strategic initiatives for 2005 include joint ventures for banking and treasury derivatives, infrastructure fund of ICAD. Other developments are dedicated wealth management centres, ICAD banking unit; first mutual fund —Al Nokhita —which has raised Dh2.5 billion till now; new customers acquisition channels; full service share brokering capabilities etc.

On the products launched, Knox said that cash management; specialised advisory and structuring for energy; Excellency brand launch for wealth management; seven new branches (two in Abu Dhabi, one each in Dubai and Sharjah) along with kiosk location and significant penetration of ATM locations with upgrades. On the future plans, he mentioned the reorganisation of the financial institution division; upgrade of the commercial banking division; retail mortgage and auto loan products; new customer acquisition channels, corporate and retail internet banking.

Speaking on the factors that led to the impressive growth the ADCB has made during the first six month and during the last year, Knox described them as the continued aggressive acquisition of new customers, product innovation and active participation in market opportunities and continued focus on risk management.

The ADCB CEO, in his brief summary on the financial achievements during the first six months of the year, said that the balance sheet size has grown by 22 per cent; profitable growth in balance sheet with higher return on average assets is 68 per cent; customer deposits are improved by nine per cent; non performing loans have declined by 15 per cent; provision coverage ratio is 55.6 per cent.

He said that half yearly profits surpassed, all profits ever booked during any financial year when it reached Dh844 million; return on equity has shot up by 92 per cent against 87 per cent in the comparable period; EPS of Dh5.63 is up by 177 per cent over Dh2.03 during same period last year; net interest income went up by 51 per cent to Dh536 million; net interest margin improved to 2.72 per cent against 2.69 per cent; there has been a turnaround on fee income which multiplied by an impressive 96 per cent; ADCB earned Dh500 million under the head of net fee and commissions, climbing up by 102 per cent.

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Islamic banking is on track towards attaining the target of representing 20 percent of the financial market by 2010, said Minister in the Prime Minister’s Department, Datuk Mustapa Mohamed.

"The target is achievable. At present, it is already 11 percent and 20 percent is achievable," he told reporters after officiating Islamic Banking and Takaful Week 2005 (IBTW 2005) here Thursday.

According to Mustapa, Islamic banking in the country is growing at a rapid pace, faster than the domestic conventional banking and Islamic banking overseas.

For the past five years, the Malaysian Islamic banking industry grew at annual rate of 19 percent compared to between 10 and 15 percent annually elsewhere in the world.

IBTW 2005 was organised by the Association of Islamic Banking Institutions Malaysia and Bank Negara Malaysia.

In his speech, Mustapa welcomed the move by Bank Negara to encourage Islamic banking operations to be conducted by subsidiaries of conventional banks.

He said with this strategy, more attention could be given to the development of Islamic financial products and services in advancing the industry.

Mustapa said Malaysia now has six Islamic banks, 16 conventional banks and four development finance institutions with window for Islamic banking and four takaful companies.

There are also 70 Islamic unit trusts and various supporting institutions and mechanism like Cagamas, Credit Guarantee Corporation and Islamic indexes, he added.

Islamic banking assets have increased to over RM100 billion by end of July this year from only RM1.4 billion in 1990, Mustapa said.

He said the assets of the takaful industry rose to over RM5 billion by end of July this year from RM300,000 10 years ago.

Mustapa called on Bank Negara and institutions of higher learning to hold more courses on Islamic banking in order to raise the level of skill and expertise.

On plans to set up an education centre for international Islamic finance, he said: "I understand that an initiative is being undertaken to realise such a centre."

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Islamic banking bonus

By: Jackie Cameron

How does a western bank make money off devout Muslim individuals when it can’t charge interest, which is forbidden in Islamic law? It charges profit margins and rewards clients with dividends generated from a share in the business.

First National Bank (FNB) recently launched Shari’ah-compliant banking and so far it is proving to be a lucrative niche, said Ebi Patel, chief executive officer of the bank’s IslamicFinance division.

In the last three months, more than 400 bank accounts have been opened with about R20-m in funds, he said.

The Shari’ ah-compliant banking initiative follows the introduction of WesBank Islamic Finance, which has made it possible for devout Muslims to buy assets like cars with the help of a major bank – without contravening religious principles.

Shari’ ah law does not allow for interest.

In the last year, WesBank IslamicFinance has financed about R175-m worth of assets, with about 5% for non-Muslim clients, said Patel.

Next on the cards is a special property deal as an alternative to the traditional home loan for clients who wish to comply with the tenets of Islam but require some financial assistance when acquiring assets, he revealed.

Patel said the way the bank is able to structure asset financing as well as transactional banking is not a case of changing terminology, as some have suggested.

Customers who opt for Shari’ ah-compliant bank accounts effectively become partners in a joint venture between FNB and WesBank Islamic Finance.

Bank customers provide funding used by WesBank to purchase the vehicles on behalf of Islamic customers – who are then charged a mark-up on their vehicles instead of interest.

Assets are repaid on a fixed basis.

The mark-up is “market-related”, said Patel, pointing out that the profit is in line with what a bank might expect to generate through a normal transaction.
Deals are fixed and there is no provision for arrear interest payments as these are not permissible in terms of Islamic law.

This should make it risky for the bank. However, as clients are doing these deals for religious reasons they shy away from breaking the conditions, noted Patel.

He said that in terms of Islamic law you should never oppress your debtor so those who are opting for these products out of religious conscience should never default on their debt.

When it comes to generating a return on money held in the Shari’ ah compliant bank accounts, the profits of WesBank IslamicFinance are shared in the form of dividends in the following breakdown: 40% for Wesbank; 30% for FNB; and 30% for clients.

FNB estimates that there are about 1,2-m Muslims in South Africa, of which about 250 000 to 300 000 are economically active – many of these sole traders and business people.

“This latest initiative is the first ever Shari’ ah compliant transactional account with a debit card in South Africa,” said Patel, According to him, closest competitors in this space do not offer transactional accounts.

As is expected of Shari’ah-compliant financial products, a Shari’ah compliance officer will have oversight of the way money is managed and shared out.

Shari’ ah compliant financial services products are gaining popularity, with unit trust funds attracting millions into pooled investments that ensure the underlying assets are not invested in companies that derive their proceeds in ways that are not in line with Islamic law.

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Islamic banking and finance are increasingly becoming an attractive form of financial intermediation among Muslim and a growing number of non-Muslim countries, Governor of Bank Negara (Malaysia), Tan Sri Dr. Zeti Akhtar Aziz, said.

The international community now looks at Islamic finance as "interesting," and several countries such as Britain and Singapore, have revised their legislation to accommodate Islamic finance. Islamic banking is also picking up in the United States and Europe - some mainstream banks are opening up divisions within their institutions to develop and provide these products and services to their clients, she told Malaysian journalists.

"We believe that the global development of Islamic finance has gathered momentum," said Dr. Zeti, who lead a Malaysian delegation to the annual World Bank/International Monetary Fund meetings in September 2005.

Islamic banking and finance started with Muslims looking for financial services which met Islamic principles. "Now it has moved further than that - non-Muslims look at it as an attractive form of financial intermediation, " she said.

Islamic banking currently accounts for about 11 percent of Malaysia’s financial system. Dr. Zeti said, the Islamic Financial Services Board (IFSB), which sets prudential standards for Islamic finance, ensures the soundness of the system and brings about harmonisation of standards across the international community. "What I find is that this (Islamic finance) has really gained significant momentum," she said.

EuroMoney magazine Sunday awarded her the World’s Best Central Bank Governor of the year for overseeing successful reform of the exchange rate, the capital markets and the banking industry. "With her encouragement, the country has also become a hub for Islamic finance," the prestigious magazine said.

Malaysia provides 40 different products under Islamic finance. One budding industry is Takaful, or Syariah-compliant insurance. In May-05, Bank Negara announced several measures to strengthen the infrastructure of the Takaful industry, which included guidelines for the licensing of new Takaful operators and brokers.

Another growing area is the local Islamic bond market. In 2005, local companies had sold RM15.76 billion of bonds by the end of July, of which 84 percent was Islamic debt. This compares with RM9.1 billion of Islamic corporate debt in 2004, according to Bank Negara. The biggest source of bond issuance stems from the water, power, oil and gas industries. Euromoney said foreign entities were also offering Islamic bond products denominated in local currency. The World Bank, for example, sold RM760 million of Islamic bonds in April while its private sector arm, the International Finance Corportaion, raised RM500 million through an Islamic structure in December.

"The ability of multilateral and multinational corporations to raise ringgit-denominated debts has expanded the volume of Islamic instruments in the market," Dr. Zeti said.

Risk management is one area that needs more attention, she said. The lack of effective hedging instruments has not proved to be an issue yet, but the Governor is aware of the pitfalls that might show up should market conditions turn suddenly. In June, Bank Negara hosted a seminar on "Derivatives in Islamic Finance" to make market participants aware of the need to manage risks more prudently.

"Another challenge is to define what exactly is an Islamic product. One of the big problems is the lack of a clear definition of Syariah law in the Islamic world. "At its most basic, Syariah law prohibits payment and receipt of interest, but for complex financial transactions, disagreements have emerged over the definition of interest," the magazine noted.

In April, the central bank introduced the Syariah governance framework to help develop a better understanding of the approaches taken by different jurisdictions in their Syariah interpretations. Bank Negara has also invested RM200 million to support Syariah scholars in their research and capacity-building work.

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