Islamic Banking

The global market for sukuk (Sharia-compliant bonds) has grown tremendously in recent years. Total outstanding sukuk rose from $8 billion in 2003 to around $100 billion in 2008. Sukuk provides companies and governments with access to financing and liquidity and offer a much needed Sharia-compliant instrument to investors. While the growth of the fixed income market in the Kingdom has been dwarfed by that of the equity market, we think that conditions are in place for strong growth in sukuk issuance and trading.

An important step was the launch by Tadawul of an automated order-driven secondary market for sukuk in mid-June. Previously, sukuk transactions were in an over-the-counter market, meaning that they were executed through bank treasuries and settled by Tadawul. Liquidity was very low, as most sukuk issues were held until maturity. The introduction of the new platform is intended to encourage investors to more actively trade sukuk. With the new system, investors can buy and sell sukuk through their brokers.

With the new trading platform in place, we think the following factors will stimulate supply from issuers and demand from investors in Saudi Arabia:

* Predictability and portfolio diversification: The collapse in the stock market last year has encouraged investor interest in more predictable assets such as sukuk. Given the very limited investment channels open to investors in the Kingdom, sukuk could also play in important role in portfolio diversification.
* Problems raising finance from traditional sources: Companies needing to raise finance have generally used a combination of bank loans and IPOs. With banks reluctant to lend and low valuations making IPOs unattractive, sukuk issuance should emerge as an important source of funding.
* Balance sheet mismatches: Little long-term bank lending is available, meaning that companies borrowing to finance long-term projects face an asset-liability mismatch on their balance sheets. Long-term sukuk would ease this problem.
* Healthy sukuk pipeline: Following two successful sukuk issues earlier this year, other local companies have announced their intention to issue sukuk, in addition to some GCC governments.

Notwithstanding the bright future for sukuk, there are still formidable challenges may impede growth. Liquidity is very low; there were only 50 transactions in the first two months of trading on the sukuk market. In addition, the local market lacks breadth and depth (there are only five listed sukuk) and there are no indications that the government will begin actively issuing sukuk (government support is generally a key factor in the development of debt markets). Furthermore, the lack of skilled human resources, Sharia-compliance standardization and innovative product development remain serious issues.

Background

The use of sukuk has become increasingly popular in recent years both for governments and companies. In part this has stemmed from the dramatic growth in Islamic banking that has been the result of the large inflows of liquidity (primarily oil revenues) into the Islamic world and a greater appetite among businesses and individuals to conduct their finances in a Sharia-complaint way. As the take up of Islamic financial services grew, demand from issuers for a product that performs a similar function to a bond leapt. Demand from investors has also surged as growing wealth within the Islamic world has made regional credit risk more attractive and greater understanding of the instrument and clarity of documentation, supported by credit ratings from international agencies, has enhanced investor comfort with sukuk.

Malaysia accounts for around 47 percent of global sukuk issuance by market value, followed by the GCC, which is the source of a further 46 percent. Sukuk issuance is not limited to Islamic countries and there have been issues from institutions in Singapore, Sri Lanka, Canada, Thailand, the UK and US. Recently, the second largest bank in Russia, VTB, indicated that it is considering a sukuk. The growing interest in sukuk worldwide reflects the spread of Islamic banking and the desire of foreign issuers to tap the liquidity within the GCC. As it is the structure of the instrument that has to be Sharia-compliant, rather than the issuer or the purchaser, the supply and demand for sukuk is set to grow in nontraditional markets.

Sukuk are generally built around one of six main contracts: Ijara, Mudaraba, Musharaka, Murabaha, Istisina and Istithmar. Ijara accounts for around 32 percent of global sukuk issuance followed by Musharaka and Mudaraba. The Saudi sukuk market is dominated by the Istithmar. The variation in the dominance of structures is explained by the lack of Sharia-compliance standardization. It is the responsibility of Sharia boards to determine what structures are Sharia-compliant and given that there are no universally agreed standards, boards across countries exercise considerable discretion in arriving at their opinions. Some countries adopt a conservative interpretation of Sharia, while others are more flexible, leading to an inconsistency about what is considered Sharia complaint. For instance, most Ijara structures that have been issued in other countries do not meet Sharia-compliance requirements in Saudi Arabia. This lack of Sharia standardization poses a great challenge to growth of sukuk.

Source

This week saw the meeting of the World Islamic Economic Forum (WIEF), the equivalent of the Muslim world’s Davos, held this year in Jakarta. In attendance were heads of states and senior government figures from across the Muslim world, including Indonesia, Malaysia, Morocco, UAE and Qatar, with delegates from 38 countries.

The purpose of the WIEF is to increase trade and business activity among Muslim countries and beyond. I had the privilege of chairing one of the sessions. Fazil Irwan, director at the WIEF Foundation explained to me that WIEF’s central pillar is to develop itself as a networking conduit between the Muslim and non-Muslim world, as they believe business collaboration can generate greater prosperity and mutual understanding. Established in 2004, WIEF gives particular focus on investing in women and the young; understandable given the high levels of unemployment among these two categories in Muslim countries.

The Muslim world’s economic performance is generally dire. Despite making up one-fifth of the world’s population, it produces a measly 7% of its output. Much of the discussion at the WIEF revolved around the global economic meltdown and its impact on Muslim countries that are now facing economic contraction, job losses and greater poverty due to the reckless model of unfettered market liberalism. With the interconnectivity that comes with globalisation, no state is immune. The systemic failure of the current banking model has generated much more official interest in Islamic finance. Shariah-compliant finance is based on financing secured against underlying tangible assets and involves risk-sharing between the parties in the pursuit of genuine commercial activities, rather than profiteering from paper instruments whose trail often led back to highly leveraged low-quality debt (better known now as toxic debt). There was a widespread view among those attending (including non-Muslims) that Islamic finance could provide one possible way out of the current malaise and become an important foundation in a new, more stable world economic order.

One official pointed out that it is not the labeling of products as “Islamic” that is the solution, as it is perfectly possible for a shariah-compliant bank to create sophisticated financial products that end up mirroring the conventional system. What is needed is ethical standards for the financial system based on transparent risk assessments and controlled debt levels. Whether such a model of greater fairness and integrity should be necessarily labelled with the exclusive term “Islamic” is a separate debate. Gordon Brown yesterday, in his speech to Congress, spoke in similar terms when he said that “markets should be free but never values-free, that the risks people take should never be separated from the responsibilities they meet”.

The conference showed the efforts the Muslim world is making to help pull the world out of recession. Indonesia itself is home to the world’s largest Muslim population, the third largest democracy and the fourth largest population, at 230 million. It is also a member of the G20. Its stable democracy and impressive economic growth over the last decade has marked Indonesia out as a front-line state in the west’s greater desire for a more respectful engagement with the Muslim world after the Bush years.

Indonesia is seen as a possible template of how to deal with Muslim democracies and markets, new and old. In her recent visit to Jakarta in February, Hillary Clinton asked colleagues whether Indonesia held lessons for Pakistan, a state with the sixth largest population but far less stable. Given the different role Islam plays in Pakistani and Javanese culture and public life it is not immediately clear what those lessons might be. Indonesia is also strategically important given its commanding presence over the narrow Strait of Malacca, through which supertankers transport Middle Eastern oil to the Pacific Rim. There is great excitement here that President Obama may choose Jakarta to deliver his promised address to the Muslim world from a Muslim capital, the home of his childhood school.

The way out of the current economic crisis will require innovative thinking and a meeting of minds. The WIEF provides one such forum.

By: Asim Siddiqui - guardian.co.uk

With global finance on its knees, this summer’s business graduates face an even trickier jobs market than most. But there is one area of banking still experiencing boom time – Islamic finance – and universities have been quick to grasp its possibilities.

This September will see new courses and postgraduate qualifications in Islamic finance springing up throughout the UK and elsewhere in Europe, reflecting the fact that it has become one of the fastest-growing sectors of the global banking industry, expanding by between 15% and 20% a year. Assets held by institutions adhering to Islamic finance principles now amount to nearly 1 trillion dollars.

In the UK, interest in the sector also reflects the government’s commitment to promoting Britain as an Islamic finance centre. The UK already leads Europe in the number of Islamic finance training courses it offers, from entry to postgraduate level, and in 2006 saw the launch of the Islamic Finance Qualification, a joint initiative between a Lebanese business school and the Securities and Investment Institute.

London gateway

Last December, the Treasury published a paper setting out the government’s aim for London to be “Europe’s gateway to international Islamic finance”. This acknowledged that the industry was still young and therefore not yet experiencing skills shortages, but predicted that it soon would be. It stated: “The pool of potential applicants in the UK will have to keep up with the rapid growth of the market.”

Universities have responded enthusiastically. Newcastle University is offering an MSc in finance and law with Islamic finance from next academic year. Henley Business School at the University of Reading has been offering an MSc in investment banking and Islamic finance since last year, with students spending the second part of the year in Kuala Lumpur. The University of Bangor in Wales has also been running its Islamic finance MA and MSc for a year and is considering introducing a new MBA in the subject, while the first students to take an Islamic finance option as part of an executive MBA offered in Dubai by Cass Business School will graduate this summer. Durham, which has been offering postgraduate research degrees in Islamic finance for some time, is now introducing a taught MA and MSc (the MSc is more quantitative), to respond to demand. Elsewhere in Europe, Reims Management School is offering a new specialist course in Islamic banking and finance for students on its masters in management programme, taught in English.

Student demand is driving the subject as much as any urging from governments. According to Rodney Wilson, founder and director of the Islamic finance programme at Durham, it is coming mainly from south-east Asia, particularly Malaysia, and the Middle East, although there is plenty of interest from the UK as well.

Joanna Gray, professor of financial regulation at Newcastle Law School, says she is keen that their new degree course is not just seen as something for Muslims. “It’s for anyone interested in a fast-developing industry that in the UK has been quite busy in the past few years to accommodate forms of investment in finance that are sharia-compliant.”

Sharia principles

Islamic finance really dates from the mid-1970s, with attempts to make products available through conventional banking, such as loans and mortgages, compatible with sharia principles. Sharia law prohibits any transaction that involves paying interest or investing in certain economic sectors such as gambling or pornography. It demands that both the investor and recipient of the investment must share any risk, and transactions have to be underpinned by tangible assets.

In the years immediately after 9/11, anything involving money and Muslims was viewed with suspicion by many in the west because of fears about terrorism, and Islamic finance is still taking off faster in the UK and France than in the US. But in the current global financial climate the principles it is based on have struck a chord.

“There is an extent to which, to a westerner, Islamic finance products look very similar to ethical finance products,” says Stefan Szymanski, professor of economics at Cass. “There is a demand for morally upright investment vehicles, and Islamic finance is the Islamic version of that.”

Philip Molyneux, head of the business school at Bangor, suggests that even if western banks do not want to introduce specific Islamic finance products – and an increasing number do – they still want to know how it is that many Islamic institutions escaped the worst effects of the credit crunch.

He has been surprised that demand for the MA and MSc has come not just from recent graduates and bankers wanting to improve their career prospects, but also from sharia scholars, who play a key role in Islamic finance. Any new financial product must be passed by them as sharia-compliant, so many financial institutions must now have scholars standing by ready to give their verdict. These scholars often disagree, and can even change their minds, but this offers plenty of scope for the kind of intellectual arguments that universities relish, not to mention graduate jobs.

On the whole, most of the new Islamic finance courses steer well clear of religious issues in favour of legal and financial questions because these are what most interest students. Khalid El Sheik applied for Bangor’s Islamic finance MA because, having taken a first degree in computer science in Sudan before switching to a career in marketing, he felt his CV needed a business boost. He saw it as a chance to mark himself out from other students and to have a headstart in an area that was likely to offer plenty of future employment opportunities. “I had read about Islamic banking and how it was going to increase in future, and how most of the banking sector is now looking to it,” he says. His fellow students at the university, including one from China, had the same idea, he says.

Szymanski agrees that it is the idea of the moment in many universities, and while Cass is still waiting to see how the market develops before introducing any similar courses, it is certainly considering the possibility.

“You just have to measure how many billions of dollars Islamic finance already handles in a year,” he says. “If that grows over the years, it will become a universal part of every business school.”

By: Harriet Swain - Guardian.co.uk

Economic Challenges of Muslims in America - Lecture by Dr. Jamal Badawi

Buying a Car or Home Without Riba (Interest)

LAHORE: Islamic banks have withstood the recent turmoil in the global banking industry triggered by the subprime mortgage crisis because their rules do not allow dealings in products like derivatives, options or papers that caused the meltdown.

While financial institutions in the developed world lined up for huge state assistance, the few Islamic banking institutions in these countries like the European Islamic Bank in the United Kingdom emerged unscathed from the crisis.

“The recent financial crisis exposed the flaws in the western banking system and proved that Islamic banks are safe which do not offer any risky product in line with the injunctions of Islam,” said Al-baraka Islamic Bank Country Head Shafqat Ahmad. He said the French president had appreciated the modes of financing offered by Islamic banks and expressed willingness to allow the setting up of these banks in France.

Shafqat said Shariah experts ensured that Islamic banks operated strictly according to the Islamic financial laws. “These banks do give profit to their depositors but it is based on the true principle of profit and loss. This is the reason that profits on savings in Islamic banks are not pre-determined.” However, “Islamic banks generally distribute more profit to their depositors than conventional banks.”

An Islamic Shariah expert said majority of the credit provided by Islamic banks was under the Morahaba mode (sale-purchase agreement). Explaining, he said “an Islamic bank purchases an item, for instance cotton, on behalf of the client (in fact the client selects the quality and quantity of cotton and the bank makes the payment) and the client agrees to the date when the amount will be returned. The Islamic bank charges certain profit on the purchased cotton that the client has to pay along with the principal amount.”

When reminded that conventional banks almost did the same and instead of profit they called it mark-up, the Shariah expert said “the difference is that even if the client fails to make payment on time the bank does not charge any additional amount while conventional banks levy punitive interest and net payable amount increases with time.”

Shafqat said normally Islamic banks did not penalise the debtor if the payment was not unduly delayed. However, he pointed out that in view of the prevailing culture in Pakistan some people took undue advantage of that and deliberately delayed the payment.

He said banks were then forced to impose a penalty on unduly late payments. However, the penalty was not added to the income of the bank and was set aside by Shariah experts to be given as charity.

Islamic banking in Pakistan registered the most robust growth last fiscal year at a time when the global financial crisis hit the peak. The number of Islamic bank branches doubled during the period to 524. There are six dedicated Islamic banks in the country while 13 conventional banks have opened Islamic banking windows which operate on the same laws that govern dedicated Islamic banks.

The share of Islamic banking in Pakistan has increased from two per cent in 2001 to 4.9 per cent in 2009. Total deposits in Islamic banks have increased from Rs8 billion in 2001 to Rs206 billion in 2009.

LAHORE: Islamic banks have withstood the recent turmoil in the global banking industry triggered by the subprime mortgage crisis because their rules do not allow dealings in products like derivatives, options or papers that caused the meltdown.

While financial institutions in the developed world lined up for huge state assistance, the few Islamic banking institutions in these countries like the European Islamic Bank in the United Kingdom emerged unscathed from the crisis.

“The recent financial crisis exposed the flaws in the western banking system and proved that Islamic banks are safe which do not offer any risky product in line with the injunctions of Islam,” said Al-baraka Islamic Bank Country Head Shafqat Ahmad. He said the French president had appreciated the modes of financing offered by Islamic banks and expressed willingness to allow the setting up of these banks in France.

Shafqat said Shariah experts ensured that Islamic banks operated strictly according to the Islamic financial laws. “These banks do give profit to their depositors but it is based on the true principle of profit and loss. This is the reason that profits on savings in Islamic banks are not pre-determined.” However, “Islamic banks generally distribute more profit to their depositors than conventional banks.”

An Islamic Shariah expert said majority of the credit provided by Islamic banks was under the Morahaba mode (sale-purchase agreement). Explaining, he said “an Islamic bank purchases an item, for instance cotton, on behalf of the client (in fact the client selects the quality and quantity of cotton and the bank makes the payment) and the client agrees to the date when the amount will be returned. The Islamic bank charges certain profit on the purchased cotton that the client has to pay along with the principal amount.”

When reminded that conventional banks almost did the same and instead of profit they called it mark-up, the Shariah expert said “the difference is that even if the client fails to make payment on time the bank does not charge any additional amount while conventional banks levy punitive interest and net payable amount increases with time.”

Shafqat said normally Islamic banks did not penalise the debtor if the payment was not unduly delayed. However, he pointed out that in view of the prevailing culture in Pakistan some people took undue advantage of that and deliberately delayed the payment.

He said banks were then forced to impose a penalty on unduly late payments. However, the penalty was not added to the income of the bank and was set aside by Shariah experts to be given as charity.

Islamic banking in Pakistan registered the most robust growth last fiscal year at a time when the global financial crisis hit the peak. The number of Islamic bank branches doubled during the period to 524. There are six dedicated Islamic banks in the country while 13 conventional banks have opened Islamic banking windows which operate on the same laws that govern dedicated Islamic banks.

The share of Islamic banking in Pakistan has increased from two per cent in 2001 to 4.9 per cent in 2009. Total deposits in Islamic banks have increased from Rs8 billion in 2001 to Rs206 billion in 2009.

LAHORE: Islamic banks have withstood the recent turmoil in the global banking industry triggered by the subprime mortgage crisis because their rules do not allow dealings in products like derivatives, options or papers that caused the meltdown.

While financial institutions in the developed world lined up for huge state assistance, the few Islamic banking institutions in these countries like the European Islamic Bank in the United Kingdom emerged unscathed from the crisis.

“The recent financial crisis exposed the flaws in the western banking system and proved that Islamic banks are safe which do not offer any risky product in line with the injunctions of Islam,” said Al-baraka Islamic Bank Country Head Shafqat Ahmad. He said the French president had appreciated the modes of financing offered by Islamic banks and expressed willingness to allow the setting up of these banks in France.

Shafqat said Shariah experts ensured that Islamic banks operated strictly according to the Islamic financial laws. “These banks do give profit to their depositors but it is based on the true principle of profit and loss. This is the reason that profits on savings in Islamic banks are not pre-determined.” However, “Islamic banks generally distribute more profit to their depositors than conventional banks.”

An Islamic Shariah expert said majority of the credit provided by Islamic banks was under the Morahaba mode (sale-purchase agreement). Explaining, he said “an Islamic bank purchases an item, for instance cotton, on behalf of the client (in fact the client selects the quality and quantity of cotton and the bank makes the payment) and the client agrees to the date when the amount will be returned. The Islamic bank charges certain profit on the purchased cotton that the client has to pay along with the principal amount.”

When reminded that conventional banks almost did the same and instead of profit they called it mark-up, the Shariah expert said “the difference is that even if the client fails to make payment on time the bank does not charge any additional amount while conventional banks levy punitive interest and net payable amount increases with time.”

Shafqat said normally Islamic banks did not penalise the debtor if the payment was not unduly delayed. However, he pointed out that in view of the prevailing culture in Pakistan some people took undue advantage of that and deliberately delayed the payment.

He said banks were then forced to impose a penalty on unduly late payments. However, the penalty was not added to the income of the bank and was set aside by Shariah experts to be given as charity.

Islamic banking in Pakistan registered the most robust growth last fiscal year at a time when the global financial crisis hit the peak. The number of Islamic bank branches doubled during the period to 524. There are six dedicated Islamic banks in the country while 13 conventional banks have opened Islamic banking windows which operate on the same laws that govern dedicated Islamic banks.

The share of Islamic banking in Pakistan has increased from two per cent in 2001 to 4.9 per cent in 2009. Total deposits in Islamic banks have increased from Rs8 billion in 2001 to Rs206 billion in 2009.

By Mansoor Ahmad

CAIR-LA Executive Director Hussam Ayloush discusses Islamic financing on FOX Business Network. His interview was intended to offer a balancing perspective to a guest on the program earlier this week who sought to demonize Islam and Muslims by demonizing Islamic law, or shariah.

Thanks: CAIR Fox

There has been focus upon Islamic banking by different forms of media, including television, over the past two years. The programs that are broadcast by television channels range between talks shows and programs that issue religious edicts.

However, to the viewers who watch these shows, whether they are experts in the field or ordinary members of the public, it is clear that there are many flaws on various levels even though some of them are exclusive to the field of Islamic banking.

Perhaps the cause behind these shortcomings is related to the lack of experience and knowledge amongst those who work on such programs, especially the presenters. The weaknesses are reflected in the choice of subject matter as it is apparent that topics are often repeated and insignificant to the majority of people who are interested in this field.

Furthermore, guests who are invited to appear on these shows are not members of the Islamic banking sector in most cases. The points that they make are often superficial, issues are not discussed in depth and problems are not raised in a professional manner. What makes matters worse is that the presenter fails to understand the points raised by the guest speaker and this causes embarrassment to the guest at times when the presenter tries to divert from the topic or asks for clarification on a point that he has failed to understand.

This deficiency in the quality of television programs that deal with Islamic banking has turned viewers away from these shows leading to their cancellation and a reduction in this genre.

The truth is that the audience and those who work within the Islamic banking field yearn for such programs that specialize in Islamic banking as long as they are produced in a professional manner that satisfies viewers and their need for knowledge and that issues are raised with clarity for the concerned individuals and decision makers away from falsehood or flattery and in an objective manner far from false accusations and preconceptions. This can only be achieved by experienced individuals with knowledge of Islamic banking.

If people want these shows about Islamic banking to be successful then these channels must seek to bring together the professional competencies of this field to work as presenters, or at least advisers, to suggest the topics that should be tackled and recommend suitable guests. In addition, these channels should be diligent towards familiarizing hosts – if they do not belong to the field of Islamic banking – to a suitable level by enrolling them on training courses related to Islamic banking that would teach them the basics of this system.

A significant field such as that of Islamic banking, and the speed of its growth that reaches an average of 20% per year and 35% in some countries, is a huge market for advertising. It is worth television channels gaining a foothold in this market where financial, Islamic and traditional institutions that provide Islamic services are competing to gain access to target consumers by all available means with the aim of selling their services, establishing trademarks and strengthening the confidence that their customers have in them.

Perhaps an indication of the lucrative gains to be made by these channels from such programs is the success of Islamic banking articles that are published in newspapers in attracting advertisers and the fact that Islamic and traditional financial institutions that provide Islamic services compete for this.

Specialized publishing institutions have become aware of this fact as they have become more active in this field by establishing magazines that specialize in Islamic banking in both the Arabic and English languages.

Will we soon be watching professional programs about Islamic banking on pioneering channels? I hope so for the benefit of the viewer.

By Lahem al Nasser

Interest and Islamic Banking - Contemporary Issues - Bilal Philips

By: Jean-Pierre Fenech

Switzerland’s UBS has become the latest of just a handful of Western banks to open up to Islamic banking, aiming to capture a $180 billion market that seems to be underserved and certainly expanding1. In June 2003, HSBC in Malaysia completed the world’s first Islamic Global Bond Issue valued at $600 million2. In September 2003, Citibank in Bahrain was the sole lead manager to underwrite another $250 million International Islamic compliant funds, bringing the total to $1 billion over three years 3. This list of new ventures keeps going on, an indication that Islamic banking is on an aggressive expansion phase.

But what is really Islamic banking and how does it differ from conventional banking?

The Islamic holy book, the Qu’ran regulates the way Muslims are to carry out their day- to- day banking transactions. In fact it includes a prohibition against charging interest. That is the charging or receiving of interest on bank accounts being either deposit accounts or loan accounts is forbidden. This paper will investigate the different ways Muslims carry out their banking transactions. Readers need to be aware that Islamic scholars are continuously studying new ways to develop banking products that are in line with Islamic thinking.

Muslims like everybody throughout the world would like to save money, keep up with inflation, invest in ways that will offer a steady return and meet other financial needs. In addition Muslims would like the companies they own to expand, build new plants and finance their working capital needs. These contradictory demands of religious belief and economic necessity have provided the impetus to the origin and growth of Islamic Banking. More so when the petro-dollars started pouring during the 1970’s and local companies/governments planned major capital spending projects. A school of economic thought began developing new ways of meeting the saving, investing and financial needs of Muslims in a religiously acceptable way. In 1975 the Islamic Development Bank was formed to promote Islamic financial markets that was acceptable to Islam. Banks (both private and also government owned) were also being established all over the Middle-East, offering banking services. Some followed a strict Muslim regime, others offered conventional banking services and others offered both.

Permissible Financial instruments, allowing Muslims to acquire finance for capital expenditure purposes:

Islamic banks offer current and savings accounts. Although the deposit is guaranteed (a fundamental concept in Islam is that capital entrusted to the bank by a depositor must be returned to him/her in full) the depositor does not receive interest. To induce clients to open accounts, some banks may allocate part of the year’s profit to the accounts at the end of the financial year. This may usually be equivalent to the savings rate a conventional bank pays on its current/savings accounts. This profit allocation is not seen as interest but regarded more of a profit sharing exercise.

Other banking services such as money transfers, bill collections and trade in foreign currencies at the spot rate (forwards are not allowed as discussed below) are provided on a commission or charges basis. These services are granted as long as the bank’s own money is not involved.

Mortgage facility, a cost-plus asset exercise:
Since Islamic Banks are not allowed to charge interest on loans they approve, another way to finance the real estate needs of Muslims is to go for the cost-plus asset method. This is a system where a customer will approach an Islamic Bank and ask the Bank to purchase the house on the customer’s behalf at a particular price with x% profit margin for the bank. This ‘round-about-way’ of financing is completely permissible and in line with Islamic philosophy. So once the debt covenant between the customer and the bank has been agreed upon, a repayment program will be established. This way of financing property is not subject to interest rate risk, since the bank’s profit will already have been established at the outset of the agreement. The bank will continue to own the property until the customer makes his final payment and that is when ownership is transferred. The cost-plus method is proving to be quite popular in countries where interest rates are quite volatile. In fact it has been reported that there are non-Muslim customers that have taken up this option to finance their homes or other investments.

Financial Instruments used to hedge any form of risk:

In any transaction between two or more parties, the object of sale must be well defined and specific. Forwards, futures, options and other derivative instruments are not allowed since the underlying asset may not exist at the time of when the trade is to be executed. All such cases involve the sale of an item, which may or may not exist. This way of thinking goes back a very long time when contracts where drawn on the purchase of the unborn animal in its mother’s womb, the sale of the milk in the udder without measurement and the purchase of the catch of a diver. These examples are analogues with today’s derivative trading, where the underlying asset might not even be purchased by one of the contracting parties such as for example the sale of a commodity option by a bank on a recognised exchange. The commodity, like for example wheat or coffee, will not have been purchased as yet but the bank is still prepared to sell an option contract. So Islamic Jurists strongly recommend that the object of sale and price is well defined and all ambiguities are eliminated.

Likewise in a contract, where premia are paid regularly, the insured receives compensation for any insured losses in the event of a loss. This uncertainty does not constitute a sale and therefore is also not allowed.

Trade Finance, overdraft facilities and lines of credit:

Islamic Banks are allowed to finance a purchase on behalf of their customers so long as the consideration is agreed upon at the outset of the agreement. The payment to the seller may be deferred and paid in instalments. The deferment ensures that the seller’s profit is collected over a period of time. If the buyer misses out on a payment, the seller cannot claim interest for further deferment of the payment of such debts as a function of time. This will constitute the worst form of ‘Riba’ which is condemned in the Qur’an. The opposite rule in which the amount of the debt is reduced due to prepayment is also prohibited. The rule ‘prepay and reduce’ breaches another fundamental rule that the debt must be settled ‘at face value’ only, nothing more and nothing less. Therefore credit sale facilities may be used as a form of finance – as long as interest-bearing loans are avoided.

Leasing:
Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct (the right to use the object) for a specified period of time. The sale of usufruct is permissible in Islam. The leasing agency must own the leased object for the duration of the lease, sub-leasing requires the permission of the lessor and late payment penalties must be handed very carefully to avoid the forbidden interest.

Leases will have an additional promise by the lessor that he will agree to sell the leased object at the end of the lease at a pre-determined residual value. This promise is binding on the lessor only, and the lessee has the option of purchasing the item at the end of the lease, or returning it to the owner-lessor.

Partnerships and Joint Ventures:
Various forms of partnership can be direct financing methods. Here the financing house and the customer share the ownership of real estate. In contrast to the leasing model, where ownership of the financed item remains with the lessor for the entire period, ownership in a diminishing partnership is explicitly shared between the customer and the Islamic financial institution. The periodic payments of the customer in this model contain two parts:

• A rental payment for the part of the property owned by the Islamic financial institution; and
• A buy-out of part of that ownership.

Over time, the portion of the asset which is owned by the customer increases, until he owns the entire asset and needs to pay no more rent. At that time the contract is terminated. This method may look like a conventional mortgage schedule, where a large portion is ‘rent’ (corresponding to ‘interest payment’ in conventional mortgage) and a small part is ‘buy out’ (corresponding to the ‘principal payment’ in a conventional mortgage). Although there are many similarities, the main difference remains that the mortgage company does not hold a lien on the property.

Permissible Investment vehicles and instruments available to Muslims:

Shares in companies may be bought and sold only if the potential Muslim owner sees fit. In fact there are ‘filters’ in place to assist the Muslim investor.

The first set of filters exclude all companies whose primary business involves forbidden products. These products consist of items like alcohol (supermarkets and hotels that sell alcohol are also forbidden), pork, tobacco, financial services like banks and companies (since they charge and receive interest), weapon production and entertainment centres that include gambling/casinos, pornography etc.

The second set of filters is based on financial ratios. Islamic investors exclude companies:

• with a debt to total asset ratio of 33% or more;
• companies with ‘impure plus non-operating interest income’ to revenue ratio of 5% or more is also excluded; and
• companies with accounts receivable to total assets ratio of 45% or more are also excluded.

Equities:

Therefore removing the above mentioned ‘impurities’ one wonders what Muslims can invest in. Al-Ahli Europe Trading Equity is one of the best performing funds on the Islamic markets. It is based in Saudi Arabia and has $92.2 million worth of assets under its control. It has a minimum investment of $2,000. The following are the top 10 holding equities within this fund:

The world markets were affected by the events of September 11, but managed to recover most of the losses in the following months. The Technology market was the worst performing sector and most Islamic funds had a considerable exposure in such a sector. Subsequently the defensive strategies of such investors were to reduce the exposure to the hi-tech sector and invest more in the petrochemical industry, pharmaceutical, healthcare and food industry.

Equity investment is a multi billion- dollar business. The latest figures supplied by Failaka International Inc4 (the official equity body in the Middle-East) states there are $3.3 billion worth of assets held under Investors control invested according to Islamic principles. This area suffered a set-back with the September 11th event and also with the uncertainty in the financial markets. The losses are being recovered and more money is being channelled in this sector, because of the wish Muslims have to invest according to the Qu’ran teachings. (For an industry report look up the Failaka Islamic Fund Review at www.failaka.com)

‘Fixed Income’ funds:

Many retirees and others need to invest in income generating vehicles with minimal risk. The vast majority of conventional fixed income investments include the forbidden interest. Retirees and those nearing retirement are limited in their choice but investments in real estate, eg an apartment building or warehouse can generate income in the form of rent. Rent will go up with inflation, as will the value of the real estate, thus providing a reasonable inflation hedge and helping the investor keep the real value of his or her wealth, while generating an income on which to live. Not all individuals may afford to purchase real estate so investors may team-up and own collectively one building or a collection of buildings in different areas. This simple diversification method can allow investors to maximise their income with a group of well hedged assets.

Permissible Alternatives:

When thinking about reducing risks, one often thinks of taking out a policy. The majority of the Islamic jurists have concluded that conventional contracts are invalid mainly due to the fact that companies invest in interest-bearing bonds that obviously include interest. The Islamic response to conventional is Cooperative5. This is a system where subscribers contribute to a pool of funds and whenever one of the members makes a legitimate claim they draw money out of the pool. In the meantime, the funds in the pool are invested in an Islamic manner, without exposing the policy holders to any extra significant risk. The profit is subsequently distributed among the policy holders.

Population Statistics:

Islam is the fastest growing religion and the second largest religion in the world. According to the CIA World’s Facts Book (which can be found at: http://www.odci.gov/cia/publications/factbook) the Muslim population is expanding at a high rate. These results were reproduced on an Islamic website and may be downloaded from http://www.islamicweb.com/begin/population.htm. According to these sources among every four humans in the world, one of them is Muslim. Muslims have increased by over 235 percent in the last fifty years, up to nearly 1.6 billion. By comparison:

• Christians have increased by 47 %
• Hinduism, 117 %, and
• Buddhism by 63 %.

Islam is also the second largest religious group in France, Great Britain and USA These statistics strongly indicate that the Muslim population will eventually have a say in the day to day running in the countries where they have a significant number of people. Malta does not seem to be immune to this new wave of Muslim population.

Effects on the Maltese banking System/Society:

Banks in Malta are not offering any Islamic banking instruments as yet. The above- mentioned web-sites are stating that in Malta from a population of 375,576 there are 52,581 that declared that they follow the Muslim religion. ie 14% of the Maltese population is Muslim. If this statistic is correct, then one may put forward many questions, like for example, What will the Muslim population in Malta be in 10 years time? This is a question that people involved in marketing will definitely analyse. If there is a niche market that is underserved then it is up to these people to develop products that can service these needs. In the introduction of this paper there is mention of International banks that are already active in this area. Even HSBC which is a main player in the Maltese Banking sector is heavily involved in Islamic Banking in the Middle East. They already have the expertise, all they need to do (when the need arises) is to apply it in the local context.

Islamic Banking is certainly not a fad. The market size in dollar value terms is increasing and is definitely not letting down. Many traditional Muslims have decided to follow banking practises that are in line with Islamic philosophy. There is evidence that interest from non-Muslims is also starting to grow, the reason being that in Islamic banking there is no talk about collateral since the viability and profitability of the project is given more importance. There is also the issue of no interest rate volatility – since interest is prohibited.

The future of Islamic Banking depends to a large extent on product development6. Bank officials together with Islamic jurists need to work together to continuously provide their customers with financial instruments. This is certainly not an easy task but certainly it will not discourage policy makers to pull the plug on this industry. On the contrary there is a great deal of optimism and Islamic Banking will continue to be the main driving force in the Middle East and in North Africa for many years to come.

References:
1 Iley k, and Megalli M, (2003), Western banks eye billion dollar Islamic market, Banker Middle East, Vol 2, No 2
2Home J, (2003), Malaysia’s Islamic global first. – www.financeasia.com.
3 Akbar S, (2003), Billion Dollar Sukuk, Islamic Banking Hub Bahrain, Vol 1, No 3. Failaka International Inc., Company profile.www.failaka.com.
4 Failaka International Inc, Failaka Islamic Fund Review Year End 2002/3, pg 2.
5 Mills P.S. and Presley J.R., (1999), Islamic Finance: Theory and Practice, PALGRAVE.
6 Gainor Thomas, (2000), Product Development, Fourth Harvard University Forum on Islamic Finance.

Professor M.A. Mannan, founder chairman of Social Investment Bank (SIB) in Bangladesh, yesterday urged Muslim countries and organizations to promote "cash waqf" (endowment in cash) as a new product to collect funds required for their educational, social and charitable projects.

"The main attraction of this product is that it enables every Muslim to participate in it by contributing any amount he or she can afford," Mannan told Arab News while attending the 7th International Conference on Islamic Economics at the King Abdul Aziz University.

Mannan, former chief economist at the Islamic Development Bank in Jeddah, said contributions to cash waqf could be collected through banks. "We have introduced cash waqf at SIB and have received encouraging response from the public," he said. Bank Muamalat and other Islamic banks in Indonesia have also adopted the system. "We don’t use cash waqf funds directly to finance projects. The fund will be invested in viable ventures and the returns from projects will be used to finance projects. This will help organizations to maintain funds for their projects without resorting to contributions," he explained.

Mannan said SIB had made 300 percent growth during the past 10 years. "I hope SIB would pave the way for the establishment of a world social bank in order to finance social infrastructure projects for the Ummah."

The conference was officially opened on Tuesday by acting Higher Education Minister Dr. Matlab Al-Nafeesa. He said the economic problems facing the humanity today were the results of its distancing itself from Islamic teachings and values. He hoped that the conference would open a new chapter in Islamic economics research. The minister honored eminent economists who had contributed to the development of Islamic Economics Research Center at the university.

Dr. Osama Tayyeb, president of KAU, stressed the conference’s significance in exchanging expertise and making use of research works.

Speaking to Arab News, Dr. Najatullah Siddiqui, winner of King Faisal International Prize for Islamic Studies, called for more efforts to promote Islamic endowment and Zakah systems and fight poverty in Muslim countries. Siddiqui emphasized the need for narrowing the gap between the rich and poor and reminded the wealthy of their duty toward the less fortunate. He presented a paper on "Obstacles to Research in Islamic Economics."

Dr. Mehmet Asutay, lecturer in political economy at School of Government and International Affairs, Durham University, was one of the nearly 1,000 delegates attending the conference. His school, which offers training in Islamic finance, has a pavilion at the conference along with other major players in the industry including Harvard Law School and the Islamic Development Bank.

"There is a lot of demand for our Ph.D and master degree programs in Islamic finance," Asutay told Arab News. He also disclosed the university’s plan to open a center for Islamic finance studies. "We provide short-term courses for employees of Islamic banks and other financial institutions. Last year we provided training to more than 40 people from different countries including Australia, Germany, Italy and Switzerland. Half of them were non-Muslims." Asutay said Islamic economics was making "impressive" progress over the past years. However, he emphasized the importance of developing authentic Islamic finance products to meet the needs of different societies.

"Islamic banking has to move from commercial banking to social and retail banking. It should also get involved in social issues such as environment protection." He called for concrete efforts to establish transparency.

Professor Mohamed Aslam Haneef of International Islamic University in Malaysia was one of the speakers yesterday. He called for the establishment of an international fund for research in Islamic economics. "Students of Islamic universities should become agents of change, not changed agents," Haneef said. "We should also chart a clear agenda for the future," he told the delegates who came from all over the world including the US, UK, Egypt, Pakistan, India, Indonesia, Malaysia, Australia and New Zealand.

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