January – June 2015
Rabi Al Awwal - Shaban 1436



In the Spotlight: The Transformation of UK’s Al Rayan Bank
Food for Thought: Prophet Muhammad’s Conception of Property as a Bundle of Rights
Point of View: Islamic Finance: Confessions of a Conventional Banker
LSE Lecture Report: Risk Sharing and Co-operative Finance
Country Focus: Turkey Revisited
Legal Matters: Proposal for the Dubai World Islamic Finance Tribunal (DWIFAC) and Jurisprudence Office (DWIFACJO) as the Dispute Resolution Mechanism and Centre for the Islamic Finance Industry
IIBI Lectures
IIBI Awards

NEWHORIZON     January – June 2015 CONTENTS


The Transformation of UK’s Al Rayan Bank

As the UK’s Al Rayan Bank, we take the opportunity to examine the bank’s journey from a modest Birmingham-based start up called Islamic Bank of Britain to the heady environs of Knightsbridge.

Prophet Muhammad’s Conception of Property as a Bundle of Rights

Benedikt Koehler argues that waqfs are germane to Islam and that this has ramifications for policies on waqfs in contemporary Islamic societies.

Islamic Finance: Confessions of a Conventional Banker

Indian banker and author, Moin Qazi, suggests that it is time we moved out of the classical paradigm of the interpretation of the Qur’an, infuse fresh vigour and encourage multi-dimensional analysis.

Risk Sharing and Co-operative Finance: A Short Report

This report of an LSE lecture contributed by Professor Nazim Ali, examines the failure of orthodox debt finance and asks whether the Islamic finance industry is really addressing the issues o r simply dressing up interest in other forms.

Turkey Revisited

Turkey is one of the rising stars in Islamic finance. Islamic banks are growing twice as fast as conventional banks; new Islamic banks are opening and the country has issued its first sovereign sukuk. The rosy picture is, however, somewhat clouded by both economic and political problems, which could derail Turkey’s ambitions.

Proposal for the Dubai World Islamic Finance Arbitration Tribunal (DWIFAC) and Jurisprudence Office (DWIFACJO) as the Dispute Resolution Mechanism and Centre for the Islamic Finance Industry

Richard de Belder reviews Derivatives in Islamic Finance: Examining the Market Risk Management Framework by Dr Sherif Ayoub.

NEWHORIZON     Rabi Al Awwal - Shaban 1436 EDITORIAL

Executive Editor’s Note

There is a constant tension in the Islamic finance industry debate between the need to be true to the spirit of Shari’ah and the need to compete in the wider global finance market. Nowhere is this more clearly demonstrated than in the debate about riba. Several of the articles in this issue of NewHorizon touch on the subject of riba and its true meaning. Is riba only impermissible when it falls under the classification of usury where lenders are making excessive and abusive rates of interest or does it apply to all interest? Is the Islamic finance industry merely prevaricating by dressing interest up in other guises and if so, should it simply not be honest about what it is doing?

Some people, such as Moin Qazi, a Muslim and conventional banker in India , argue that public and development banks, where interest-bearing debts are shorn of the coercive aspects of usury and where defaults are treated sensitively, are delivering social benefits, a prime requirement of Maqasid al Shari’ah. On the other hand Farmida Bi, a practising lawyer based in London, argues that the prohibition on riba kept the Islamic finance industry shielded from the worst of the global financial crisis.

Iqbal Asaria in his May 2015 lecture to the IIBI said that he believed that part of the problem is that scholars do not look at Islamic financial issues in a holistic fashion. They look at individual elements of contracts and if each element is Shari’ah compliant then they give their blessing, even if the ultimate outcome is unwholesome. He went on to quote Sayyid Nawab Haider Naqvi, the author of Ethics and Economics, who believed that the removal of riba would do nothing for society; other things were more important and he was ridiculed for his views. Mr Asaria, however, suggested that it was a view that needed to be considered in relation to Islamic finance.

The tension will continue to exist in a market where Islamic banks and the like seek to provide the certainty of fixed income returns using LIBOR as a benchmark to determine the rate in any profit mark-up, profit sharing and lease rentals. While this debate will run and run it is more important that the industry should strive to implement the true spirit of the Shari’ah without seeking to maximise profits and promote a fairer, more decent and more wholesome way of providing financial services to all ranks of society worldwide.

Qayyum Signature

Mohammad Ali Qayyum
Director General

Deal not unjustly, and ye shall not be dealt with unjustly.

Surat Al Baqara, Holy Quran

Mohammad Ali Qayyum,
Director General, IIBI

Andrea Wharton

Farida Rahman

Mohammad Shafique
Iqbal Khan
M Iqbal Asaria
Mohammed Amin
Stella Cox
Richard T de Belder
Ajmal Bhatty
Mufti Abdul Qadir Barkatullah
Dr Imran Ashraf Usmani

Institute Of Islamic Banking and Insurance
7 Hampstead Gate
1A Frognal
London NW3 6AL
Tel: +44 (0) 207 433 0840
Fax: +44 (0) 207 433 0849
Email: iibi@islamic-banking.com

Tel: +44 (0) 207 433 0840
Fax: +44 (0) 207 433 0849
Email: iibi@islamic-banking.com

Design and Production by
CxO Research Ltd

©Institute of Islamic Banking and Insurance
ISSN 0955-095X

This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views expressed in the articles are those of the authors alone and should not be attributed to the organisations they are associated with or their management. Any errors and omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no responsibility to any person who acts, or refrains from acting, based upon any material published in the magazine. The Editorial Advisory Panel exists to provide general advice to the editors regarding matters that may be of interest to readers. All decisions regarding the published content of the magazine are the sole responsibility of the Editors, and the Editorial Advisory Panel accepts no responsibility for the content.
NEWHORIZON    January – June 2015 News

Expanding Islamic Finance in Africa

The Islamic Corporation for the Development of the Private Sector (ICD), the private sector arm of the Islamic Development Bank Group (IDB), has signed an agreement with the African

Export-Import Bank (Afreximbank) to cooperate in the development of private sector, Shari’ah-compliant investment opportunities in ICD member countries in Africa.

Under the terms of the agreement the two institutions will collaborate in joint operations, expand financial products and exchange information on the opportunities and approaches for private sector development in ICD countries.

Khaled Al Aboodi, CEO and General Manager of ICD, and Jean-Louis Ekra, President and Chairman of the Board of Directors of Afreximbank, signed the agreement on behalf of their respective institutions.

According to the agreement, ICD and Afreximbank will share information on projects and business opportunities in Africa and on participation in the arrangement of syndications or investment in funds. They will also cooperate in structuring sukuk/debt capital market transaction opportunities, co-invest in Islamic leasing companies and support local financial institutions in Africa through the raising of capital via lines of finances.

In addition, they will exchange information aimed at upgrading knowledge and expertise about Islamic finance, environmental assessment, project finance and advisory services. The agreement also covers exploration of opportunities for cooperation in financing projects in the construction, energy, manufacturing and leasing sectors in African countries.

Mr. Khaled Al Aboodi, the CEO of ICD commented, ‘Africa and the Islamic finance industry are key strategic directions for ICD and we hope, via this partnership, we will increase our presence in the continent.’

‘We are greatly encouraged at this opportunity to collaborate with ICD in growing the African private sector. ICD’s leadership and experience in promoting the establishment, expansion, and modernisation of private enterprises complements Afreximbank’s

longstanding commitment to using the private sector as the growth engine in achieving its mandate of promoting and financing intra- and extra- African trade,’ said Jean-Louis Ekra, President of Afreximbank.

IFSB Launch Islamic Finance Industry Indicators

The Islamic Financial Services Board (IFSB) has launched a set of indicators on the financial soundness and growth of the Islamic banking systems in 15 member countries. The IFSB claim the indicators, called Prudential and Structural Islamic Financial Indicators (PSIFIs), are the first set of internationally comparable measures of the soundness of Islamic banking systems. The PSIFIs capture information on the size, growth and structural features of Islamic banking systems and their macroprudential condition by looking at measures of their capital, earnings, liquidity and exposure to various types of risks. They also cover the indicators on capital adequacy and liquidity based on newly issued IFSB Standards to complement international regulatory reforms under the Basel III regime.

Many of the PSIFIs are parallel to the widely used IMF Financial Soundness Indicators (FSIs) on the strength or vulnerabilities of financial systems, but are customised to the specific characteristics of Islamic banking. As such, they will serve to highlight the role of Islamic banking within national economies and permit comparisons between the conventional and Islamic banking systems.

PSIFIs cover aggregated data of Islamic banking institutions at the country level, compiled by the regulatory and supervisory authorities (RSAs) of the participating countries. The data are separately provided on standalone Islamic banks and Islamic windows of conventional banks in jurisdictions where available.

The PSIFIs will be collected on a quarterly basis from the participating countries. These countries are: Afghanistan, Bahrain, Bangladesh, Brunei, Egypt, Indonesia, Jordan, Kuwait, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Sudan, and Turkey. The IFSB has received technical assistance from both the Islamic Development Bank and Asian Development Bank (ADB) over the years in setting up the PSIFI project.

NEWHORIZON    Rabi Al Awwal - Shaban 1436 News

Islamic Financial Services Board 2015 Stability Report

The Islamic Financial Services Board (IFSB) has recently published their 2015 Stability Report. It confirms that the all segments of the Islamic finance industry have continued to grow, although that growth is somewhat slower than in the past. In particular bank profitability has not returned to the levels seen before the 2008 world financial crisis. The IFSB confirm that liquidity continues to be a concern, as does compliance with Basel III requirements.

It notes that the sukuk market was resilient in 2014, with Malaysia dominating the sector, accounting for one-third of all issuance in 2014. It also notes the trend away from risk-sharing sukuk based on mudarabah and musharakah has continued, with less than 7% of 2014 issuance based on this type of contract. The slack was taken up by fixed-income and debt-creating contracts and this is very much at odds with the view that risk sharing should be a distinctive feature of Islamic finance.

The report identifies two major trends in global regulation. Firstly, there is an increased emphasis on consumer protection as a regulatory objective. This emphasis is coming from both governments and international institutions. Secondly there is a drive towards the provision of better financial soundness indicators. (See the later item in this section of the IFSB’s launch of finance industry indicators.)

The Middle East and North Africa (MENA) excluding the GCC remains the largest market in terms of banking assets, while Asia, largely due to the activities of Malaysia, is the largest sukuk market and the GCC records the highest level of taakful contributions, followed closely by MENA. Excluding Iran and Sudan, which operate fully Shari’ah-compliant banking systems, Islamic banking has achieved systemic importance in seven jurisdictions – Brunei, Kuwait, Malaysia, Qatar, Saudi Arabia, the UAE and Yemen. It also reports that Bahrain, Bangladesh, Jordan, Pakistan and Turkey were seeing rapid Islamic banking growth.

While banking growth has been good, the star is sukuk. This sector has overtaken banking as the fastest growing sector of the Islamic finance industry. This is in the main due to sovereign issues, particularly from jurisdictions that have entered the market for the first time, which have generated publicity and raised investor confidence, even though some of these issues such as the UK’s 2014 foray into the market, have been relatively modest. Corporate issues have been more volatile and have been particularly affected by the US’s signalled intention of tapering quantitative easing.

The Cinderella in growth terms is Islamic funds with 74% of the assets under management (AUM) being domiciled in just three jurisdictions – Saudi Arabia, Malaysia and Jersey. Institutional

investors and high-net-worth individuals are seen as two of the main targets for fund managers to pursue.

The Cinderella in growth terms is Islamic funds with 74% of the assets under management (AUM) being domiciled in just three jurisdictions – Saudi Arabia, Malaysia and Jersey. Institutional investors and high-net-worth individuals are seen as two of the main targets for fund managers to pursue.

A Strong Entrepreneurial Culture Exists within British Muslim Communities

Al Rayan Bank, formerly known as Islamic Bank of Britain (IBB), has revealed findings from the UK’s first ever survey into the British Muslim business market. The study, entitled ‘Understanding the UK Business Landscape’, provides a fascinating insight into the British Muslim business market, a previously under researched area of UK business. The results of the study, which were attained through a combination of public, modelled and research data, estimate that:

• The UK is home to 297,715 companies, where at least one third (33%) of directors are believed to be Muslim. Of these companies, 230,877 are considered ‘live and trading’.
• 6.8% of the companies in the UK are believed to have at least one third Muslim directors; with 5.8% having at least two thirds (67%) Muslim directors.
• 96.8% of companies where Muslims account for two thirds of directors have three or less directors in total. This compares with 93.0% of companies which are not Muslim influenced (i.e. where less than one third of directors are believed to be Muslim).

Commenting on the report’s findings, Tim Sinclair, Senior Head of Marketing & Retail Sales at Al Rayan Bank, said, ‘The findings from this research indicate that the UK is home to a thriving Muslim business community, particularly in the small business sector. Whilst Muslim adults account for 3.1% of the adult British population, Muslim-influenced businesses account for almost 7% of all UK businesses; this indicates that a strong entrepreneurial culture exists within British Muslim communities.’

He added, ‘This is the first time that research of this kind has been conducted into the British Muslim business market and it helps demonstrate the enormous opportunity which exists for Shari’ah compliant business banking products, such as business current and savings accounts, commercial property and development finance as well as Shari’ah-compliant auto-enrolment pension schemes. The information obtained from this study will help inform our plans for 2015, as we develop our product range for this extremely important market sector.’

NEWHORIZON    January – June 2015 News

Exploring Financial Inclusion

According to the World Bank 2.5 billion people around the world have no formal account with a financial institution. Digging below the headline figures, 75% of the world’s poor are unbanked; 59% of adults in developing economies have no bank account and 55% of people in developing economies only borrow from informal sources. All too often the finance industry is seen as self-serving, targeting those individuals and organisations that are likely to be most profitable for financial institutions and where the risks of default are low. This is true for both the conventional finance sector and for Islamic finance.

Recognising that this is a major issue and a significant opportunity, the Islamic Financial Services Board (IFSB) organised a seminar on ‘Enhancing Financial Inclusion through Islamic Finance’ in Jakarta, Indonesia. The one-day seminar aimed to explore the role of Islamic finance in supporting financial inclusion, the building unbanked population and key success factors and challenges in promoting financial inclusion for greater shared prosperity, financial stability and economic growth.

H.E. Agus D.W. Martowardojo, Governor, Bank Indonesia, in his keynote address highlighted the importance of providing greater financial access to the underserved segments of the population in order to offer equitable opportunities in the society and fostering sustained economic development. He commented, ’Islamic finance with a wider application of equity-based financing and micro-finance products can facilitate greater outreach to medium, small and micro enterprises to promote entrepreneurship and value-creating activities.’ Similarly, he suggested that other steps could be formulated such as integrating the commercial sector with the Islamic social sector to come up with financial services that are reachable by the micro entrepreneurs and low income society in general.

H.E. Dr. Muliaman D. Hadad, Chairman, Indonesia Financial Services Authority (OJK), in his keynote address, outlined the importance of financial inclusion and the role of policy makers in escalating this as a matter of national importance. He explained that the first step in achieving this objective is to study the voluntary or involuntary nature of financial exclusion. He added that a study is needed on whether consumers make choices based on proximity and convenience or based on religion. Quoting various studies, he noted that voluntary exclusion due to religious reasons is particularly high in certain Muslim countries. He expressed the view that ‘fundamentally, Islam approaches inclusivity with either the principles of risk sharing or the principles of redistribution.’ In order to better apply the risk sharing principle and deploy a more accurate risk pricing mechanism, he highlighted the need of proper alternative benchmarks. On the redistribution side, he asked for a comprehensive review of the way in which zakat and sadaqah operate in order to ensure a sustainable approach that requires an infrastructure to identify the needy and a more tailored solution, rather than the traditional bullet payment. He also proposed the establishment of dedicated qard al-hasan funds to address finance needs of specific target groups and as a means

to support social infrastructure financing. He noted that ‘without prioritisation and dedicated commitments from all stakeholders, we run the risk of perpetuating these imbalances on a global scale.’

Earlier, in his opening remarks, Mr. Jaseem Ahmed, Secretary-General of the IFSB explained various initiatives being undertaken at the global level to enhance financial inclusion. Citing some recent developments by the G-20 and various standards-setting bodies, he outlined the milieu in which financial inclusion increasingly comes into discussions on the evolution of the international financial system. He noted that religious-based voluntary exclusion is a common feature in many OIC countries, which makes ‘financial inclusion a key challenge in the Middle East and North Africa (MENA), South Asia and Sub-Saharan Africa (SSA).’ He updated the participants on various IFSB initiatives to provide guidance on financial inclusion, which include an ongoing joint project with the International Association of Insurance Supervisors (IAIS) on microtakaful; policy guidance in the IFSB publications and Islamic Financial Services Industry Stability Reports and participating in global dialogue with key partners and stakeholders. He mentioned that the IFSB’s new Strategic Performance Plan 2016-2018 will include work on financial inclusion as one of its objectives to be achieved through enhancing existing partnerships with various international bodies and providing guidance on the approach to balance the regulatory perimeter in Islamic finance with financial innovation.

During the seminars it became clear that one of the major issues facing various jurisdictions is the absence of clear policies and strategies toward financial inclusion. It was noted that a top-down strategy could be more effective whereby national financial inclusion programmes are synchronised with global and regional initiatives. Among other major challenges identified by the speakers were developing the regulatory environment, product development and education. It was further noted that, by providing low-income individuals with access to finance, social instability will be reduced.

The issues facing microfinance and microtakaful institutions were identified as law of critical mass in the industry, the absence of regulatory support, lack of financial education and product limitations. It was observed that efforts to promote financial inclusion have succeeded in those jurisdictions where policies have included a well-coordinated framework that ensured active participation by governments, policy makers, regulatory authorities, market players and the local community.

There was agreement that there is a need for alternative solutions to drive down the cost of offering products to the underserved segments of the population. It was also noted that concerted efforts are needed to tap alternative sources of funds for microfinance providers, in Muslim majority and minority jurisdictions, which can be facilitated by creating a flagship product. Such a product should focus on reducing time to market, enhancing cost efficiency and promoting standardisation, while following Shari’ah-compliant principles. It was also proposed that there should be standardisation of governance and operating principles for Islamic microfinance institutions.

NEWHORIZON    Rabi Al Awwal - Shaban 1436 News

Is Iran Preparing to Come in from the Cold?

Iran seems confident that the current talks to lift economic sanctions on the country in exchange for a guarantee that the development of nuclear weapons will be halted will be successful. A sign of this confidence is evidenced in Iran’s decision to increase its stake in the Jeddah-based International Islamic Trade Finance Corporation (ITFC), which has approved the increase. The move will make Iran the third largest stakeholder in the IIFC behind the Islamic Development Bank ($266 million) and Saudi Arabia ($120 million). Iran is to receive 8,500 new shares worth $85 million under the new arrangement. (At the end of 2013 Iran held shares worth just $1.92 million.) Iran will pay for the shares in three equal instalments, the first due by the end of the year.

Iran’s economy has already made progress under the leadership of President Rouhani, with a reduction in the rate of inflation and a stable exchange rate. The lifting of sanctions could, however, see stronger economic growth than would otherwise by the case. An increase in oil exports to pre-sanction levels, renewed foreign investment and the freeing of $80 billion worth of frozen assets are factors that would play a part in kick starting economic growth and the need for a good source of trade finance.

QIB Signs MoU with Korea’s Woori Bank

Qatar Islamic Bank (QIB) has signed a memorandum of understanding (MoU) with South Korea’s Woori Bank. The agreement was signed by Mr. Bassel Gamal, QIB’s Group CEO and Mr. Lee Dong-gun, Deputy CEO of Woori Bank.

The MoU calls for enhancing the cooperation between the two institutions in facilitating bilateral trade finance and corporate business. This partnership is aimed at servicing both Qatari and South Korean entities that are currently engaged in business activities in Qatar and/or South Korea and companies that are intending to set up such business arrangements in the future.

Trade exchange between Qatar and South Korea hit the $30 billion mark in 2014 compared to $26 billion in 2013, a 15% increase. Key Qatari exports to South Korea are oil and gas products accounting for 30% of the energy sector’s demand in Korea, a leading importer of Qatar-supplied LNG (liquid natural gas). Electronics and automobiles are Qatar’s main imports from Korea.

NEWHORIZON     January – June 2015 News

In Brief

Qatar National Bank and Qatar International Islamic Bank have signed an MoU (Memorandum of Understanding) with Chinese brokerage Southwest Securities to help the two Qatari banks to access China’s market for finance and investment. The quid pro quo is to help Southwest Securities access markets in Qatar and other parts of the Middle East. Few details of exactly how this joint venture will operate have been announced so far.

Kuveyt Turk opened the first fully-operational Islamic Bank in Germany at the beginning of July. The wholly-owned subsidiary of the Turkish lender is called KT Bank AG and is headquartered in Frankfurt with branches in Cologne and Berlin.

Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU) has announced that it has obtained an Islamic Financial Business endorsement to operate an Islamic Window from the Dubai Financial Services Agency. This approval has enabled its Dubai Branch to offer both conventional and Islamic financial services to customers. This is reflective of the recent change in the Japanese FSA’s supervisory guideline and the first ever case of a Japanese bank obtaining approval of an Islamic Finance Business from regulators outside Japan. The Dubai Branch will be the Bank’s central hub of Islamic finance services in the Europe, Middle East and Africa region.

TheCentral Bank of Oman has announced the formation of a new department to deal exclusively with all matters concerning Islamic banking operations in the country.

The Securities and Exchange Commission of Pakistan has approved the appointment of a Shari’ah Advisory Board, which will comprise three Shari’ah scholars and one technical member. The Board will provide guidance to the Commission and Shari’ah opinion on the laws, rules, regulations, agreements and documents submitted to it. The board will also advise on the products, instruments, Shari’ah auditing and reporting standards and business operations of the Islamic financial institutions, which include Islamic mutual funds, Islamic pension funds, takaful operators and other financial institutions, to ensure their compatibility with the Shari’ah. It is expected that the new Board

will be instrumental in harmonising the Shari’ah-related business, operations and structure of the instruments of the Islamic capital market, in keeping with the international norms and practices.

CIMB Group, RHB Capital and Malaysia Building Society (MBSB) have announced that they have received approval from Bank Negara Malaysia to commence discussions with the aim of merging the businesses of both RHB and CIMB as well as creating an enlarged Islamic Banking franchise with MBSB. Following this, the three parties have entered into a 90-day exclusivity agreement to negotiate and finalise pricing, structure, and other relevant terms and conditions for a proposed merger of the three entities and the creation of a mega Islamic bank. The exclusivity agreement comes with an automatic extension provision upon submission to Bank Negara Malaysia on the proposal.

Arab Banking Corporation (ABC) recently announced it has revamped its corporate identity and changed its brand name to Bank ABC. The Bank’s new identity launch coincides with the commemoration of its 35th Anniversary. The change to a single, unifying global brand name and corporate identity will took effect on 15 June 2015 across the Bank’s global network spanning 18 countries in the Middle East and North Africa (MENA), Europe, the Americas and Asia (with the exception of its subsidiary in Brazil, which will keep its own identity as Banco ABC Brasil). The Legal names of the Arab Banking Corporation and its subsidiaries will not change.

Kuwait Finance House - Bahrain has launched a Wealth Management Department offering new premium investment and asset management services.

Meezan Bank in Pakistan is to acquire the Pakistani operations of HBON (HSBC Bank Oman). Subject to all the appropriate approvals and agreements the acquisition is expected to be complete in the second half of 2015. HBON currently have one branch in Pakistan and assets of 4.1 billion Pakistani rupees.

Abu Dhabi Islamic Bank has applied to invest in Islamic banking in Morocco, according to a report in Le Matin, a Moroccan newspaper. The bank aims to start operations in 2016.

NEWHORIZON    Rabi Al Awwal - Shaban 1436SUKUK UPDATE


IFSB Put the Emphasis on Sukuk

In April the IFSB published its guidance (GN6) for Islamic financial institutions (IFIs) on liquidity management. The guidance is the result of a fairly lengthy consultation and discussion process, which had its roots in the 2008 financial crisis and the need to comply with Basel III, which has strengthened the regulatory regime in relation to liquidity management risk for financial institutions.

The guidance sets out the types of Shari’ah-compliant, high-quality liquid assets (HQLA) that meet the requirements of Basel III. Most obviously HQLA must be highly liquid. They also need to have a low correlation with risky assets, an active and sizeable market and low volatility, even in stress situations. Supervisory authorities need to consider various risks – operational, foreign exchange, legal, credit, market, liquidity and of course Shari’ah non-compliance.

Sukuk issued or guaranteed by sovereigns, multilateral development banks and the IILM (Islamic Liquidity Management Corporation) are considered to be the highest level of HQLA. Sukuk backed by commodities and other real assets are rated just below the top level of HQLA, but are still highly rated. The guidance acknowledges that there is currently a shortage of such instruments, which is exacerbated by the low level of trading in them.

Market Shows Signs of Weakness

In mid 2015 Standard & Poors revised their forecasts for sukuk issuance, halving their previous expectations to $50 60 billion. The reason for their revision is the fact that Bank Negara Malaysia (BNM), responsible for more than 42% of sukuk issuance in the first half of 2014, decided to stop issuing short-term sukuk in early 2015. One of BNM’s main objectives with their programme of sukuk issuance was to provide liquidity instruments for Malaysian banks, but their sukuk had proved so popular across a wide range of geographies and industry sectors that they were not fulfilling this objective as effectively as they wished. They have, therefore, switched to other instruments restricted to banks.

The fall in oil prices has also affected the sukuk market, so that even when the BNM effect is excluded, the market still fell more than 10% year on year. There are reports, however, of various sovereigns and multinational development banks preparing to issue sukuk during the second half of 2015. These include:

The International Finance Corporation, part of the World Bank, are, according to Reuters, preparing to issue sukuk in the GCC, providing underlying assets and market conditions permit. This would be their third sukuk. The first, worth $134 million was in Malaysia in 2004 and the second, worth $100 million, was listed in Dubai and Bahrain in 2009.

Turkey is planning to raise in excess of $1 billion through sukuk to be issued by the end of 2015.

In mid June the Islamic Development Bank (IDB) approved raising the current limit of the Bank’s medium-term sukuk issuance programme from $10 billion to $25 billion. Over the last 12 years the IDB has consistently been rated triple ‘A’ by leading credit rating agencies and therefore meets IFSB’s HQLA requirements.

In May Indonesia, currently one of the most active sovereigns, began marketing a 10-year sukuk aimed at raising around $500 million.

Oman is planning its first sovereign sukuk. Regulatory approval has been received and structuring and documentation is apparently at an advanced stage. The sukuk will aim to raise $520 million and will be sold through a private placement.

In April Malaysia raised $1.5 billion, $1 billion in a 10-year sukuk and $500 million in the first ever 30-year sukuk. The order book for the two sukuk reached $9 billion.

In July the Arab Petroleum Investments Corporation (APICORP) announced the establishment of a $3 billion sukuk programme rated Aa3 by Moody’s.

APICORP could issue its first sukuk later this year, subject to prevailing market conditions.

In July the Central Bank of Bahrain (CBB) successfully sold a long-term Islamic leasing, 10-year sukuk al-ijara, raising BD 200 million. The expected return on the issue, maturing on 09 July 2025, is 5.00%. The sukuk al-ijara are issued by the CBB on behalf of the Government of the Kingdom of Bahrain.

Other Sukuk News

At the end of June Qatar Islamic Bank raised $550 million in Basel III compliant Additional Tier 1 perpetual sukuk to enhance the Bank’s capital adequacy ratios and to support future business growth.

Khazanah Nasional Berhad raised $27.1 million from its first ethical sukuk. The proceeds of this seven-year sukuk will be used to fund schools. This is one of the first sukuk to be issued under the Securities Commission Malaysia’s Sustainable and Responsible Investment Sukuk framework.

At the end of May Pakistan’s K-Electric sold the country’s largest corporate sukuk. The seven-year sukuk raised $215.9 million. It will be listed on the Karachi stock exchange.

NEWHORIZON     January – June 2015 TAKAFUL NEWS

The UAE Insurance Authority Tightens Takaful Regulations

The UAE Insurance Authority has announced its intention to set up a Shari’ah committee for takaful operators to provide advice on legislation and issues in the sector. The Authority believes that the lack of such a committee has been a key factor in the loss-making situations of takaful operators in the recent past.

The Authority has also brought its solvency regulations into line with current European standards. Operators will have 1-3 years to comply with the new regulations depending on the sector. The new regulations will apply to both conventional and takaful providers. The result will be much stronger oversight of the insurance industry, as well as some limits on investment policies, for example real estate investments must be 30% or less of total investments.

Takaful Companies Hampered by Lack of Fixed Income Investments

The credit rating agency, A.M. Best in a report entitled ‘Sukuk Investment Opportunities Remain Limited for Middle East Takaful Operators’ notes that takaful operators continue to have very limited levels of fixed income investment, with the majority of funds invested in cash and short-term deposits, equity and real estate assets. The problem has been exacerbated by the surge in growth of takaful products on offer.

Salman Siddiqui, financial analyst commented, ‘The balance sheet compositions of takaful operators are in line with their conventional counterparts, which also have significant investment concentrations in equity and real estate assets. This is due to the underdeveloped fixed income markets in the region and potentially higher attractive returns being achievable through investing in shares and property investments.’

A.M. Best notes that this is further complicated by the simplicity of equity investments when compared with sukuk investments. Salman Siddiqui added: ‘In order to deploy capital into sukuks, asset managers at takaful companies need to spend time and resources understanding the structure and risk of each sukuk before investing. This would increase operating costs, which takaful companies can ill-afford given their smaller profiles and pressure on performance levels.’

Is Takaful Market Rationalisation on the Cards in the Middle East?

If you search the web for items on takaful market consolidation, you will discover a host of news items going back over at least five years suggesting that there are too many takaful providers in the market and that a spate of mergers and acquisitions is imminent. In particular there is a tendency to see a single event as an indicator that the process of market consolidation is under way.

Recently the Gulf Daily News reported the fact that the Bahrain Kuwait Insurance Company had raised its stake in Takaful International to 40.9%. In the same article they reported that Ibrahim Al Zaabi, Director General of the UAE Insurance Authority had said that several Islamic insurers were seeking guidance from the authority on the possibility of mergers and acquisitions.

While the takaful market is growing at a healthy rate (A.M Best are forecasting it will be worth $20 billion by 2017), the engines for growth are in Malaysia and Saudi Arabia. The Middle East is seeing slower growth and very high levels of competition, with a large number of relatively small takaful companies. For example, return on equity in the UAE is averaging 0.4% compared to 6% in Saudi Arabia and 14% in Malaysia.

Combine the market conditions with the fact that regulators in the region are introducing new measures such as higher capital requirements and consolidation would seem to be on the cards. It is possible to take the view that the recent moves by regulators are a fairly hefty nudge aimed at encouraging takaful operators in the direction of mergers and acquisitions.

IFSB Invite Comments on Microtakaful

In late June the Islamic Financial Services Board (IFSB) issued a draft of its joint paper prepared with the International Association of Insurance Supervisors (IAIS) ‘Issues in Regulation and Supervision of Microtakaful (Islamic Microinsurance)’ for public consultation.

The IFSB believes that regulators and supervisors in jurisdictions where takaful providers offer their services have relatively little experience or empirical data to support their role in creating a conducive environment for the microtakaful market that could work effectively for the lower income segments. The main objective of the joint paper is, therefore, to highlight and identify regulatory issues prevailing in the microtakaful sector and outline the role this sector can play in enhancing financial inclusion. In particular, the objectives include:

a. To identify the current practices and models used for offering microtakaful products, and the challenges and potential

b. To review the current regulatory framework for the microtakaful sector in various jurisdictions and suggest initiatives to strengthen the framework and thus enhance financial inclusion through the takaful sector; and
c. To provide guidance to the regulatory and supervisory authorities in putting in an enabling environment for the overall development and growth of the microtakaful sector

The joint paper highlights the distinguishing features of various models used for offering microtakaful products which, despite being similar to the models used for takaful products in many respects, pose various unique supervisory challenges. Backed by a survey from the regulatory authorities and microtakaful operators, the joint paper delineates the main features of microtakaful from various aspects including types of participants, product features and contributions as well as distribution channels.

It also examines critical issues that require the attention of regulatory and supervisory authorities pertaining to the microtakaful sector including separation of funds, solvency and capital adequacy framework, investment framework and Shari’ah compliance. Additionally, the joint paper illustrates the relevance of IAIS’ Insurance Core Principles in the practice of microtakaful. The joint paper is available to download from the IFSB’s web site.

London Displays its Horse Sense

XL Group recently announced that together with Cobalt Underwriting – the specialist Shari’ah compliant managing general agency – it has launched the first Shari’ah-compliant product to be available through Lloyd’s of London. The cover is an equine product which responds to named perils, mortality, theft, infertility and permanent disability, amongst other risks.

The need for Shari’ah-compliant Equine insurance coverage has never been greater; horses are frequently moved around the globe participating in a full calendar of events. Many of these horses are highly prized, crowd-drawing Arabian stallions coming from long and distinctive blood lines.

Richard Bishop, Chief Executive Officer, Cobalt Underwriting said, ‘We are delighted to be able to offer the first Lloyd’s Shari’ah-compliant product and provide our clients with access to secure Shari’ah-compliant insurance coverage in what is a very specialised and exciting market. It is also another clear sign of the London market’s ability to deliver innovative products that meet the changing needs of clients across the world in the way they want them to be both structured and delivered.’

Guy Morrison, Chief Underwriting Officer, Equine at XL Group said, ‘Today the movement of horses is supported by a highly specialised shipment and logistics industry. But travel, with varying climate and handling conditions, exposes these animals to a raft of risks.’

Mr. Morrison continued, ‘Until now, owners, especially those of Arabian horses, have not had the opportunity to insure their treasured animals in a Shari’ah-compliant manner. We hope this coverage will give owners the reassurance that their horses are well covered when participating and supporting the vibrant equine industry at events around the world.’

Lloyd’s Director of Global Markets, Vincent Vandendael said, ‘It’s very positive progress to see the Lloyd’s market providing its first Shari’ah-compliant insurance coverage. Takaful insurance products are an important offering to our customers and business partners in a growing number of markets around the world. It is great to see the market adapting to our customers’ needs and innovating with new products such as this. Lloyd’s unique structure means we are ideally equipped to provide Shari’ah-compliant insurance and reinsurance as we continue to expand globally.’

In Brief

Kenya’s Insurance Regulatory Authority (IRA) has issued new regulations for takaful operators in Kenya. Insurers will have to operate conventional and takaful businesses as completely separate entities, with separate reporting of assets, liabilities, revenues and expenses. They will also have to set up a Shari’ah supervisory council to monitor and advise on the takaful business.

The Islamic Insurance Association of London (IIAL) was launched in late April 2015. Its members include Lloyd’s, AIG, Aon, Cobalt Underwriting, Clyde & Co., Jardine Lloyd Thompson and Norton Rose Fulbright. The chairman of the new association, Mr Max Taylor, a former chairman of Lloyd’s, believes this an important development for London with its pre-eminent position in the insurance market and its commitment to becoming a global centre for Islamic finance.

Lloyd’s of London is apparently in talks with the Malaysian regulator to set up and office dedicated to takaful. It is believed that they would use such an office to target not only Malaysia, but also Saudi Arabia and the UAE. (Lloyd’s opened in an office in the Dubai International Finance Centre earlier this year.)

NEWHORIZON     Rabi Al Awwal - Shaban 1436 IN THE SPOTLIGHT

The Transformation of UK’s Al Rayan Bank

Step out of the side door of Harrods London, world’s most famous department store, give a nod to the double parked Ferraris on your right and you will find Al Rayan Bank’s. In the words of Al Rayan’s press release, ‘The exclusive branch .... will provide Gulf Cooperation Council (GCC) clients with exclusive private banking services.’ The branch is certainly in the right place to attract GCC clients of high net worth. Many of these individuals live in the area and use Harrods as their corner store.

The Road to Knightsbridge

So how did a modest start-up, then called the Islamic Bank of Britain (IBB), located in Birmingham, with the initial remit of providing retail banking for ordinary Muslims end up in one of the UK’s most exclusive and expensive shopping venues? IBB opened in 2004 and by late 2010 The Times was describing the experiment as a flop and in July 2012 in one of the Institute of Islamic Banking and Insurance’s regular evening lectures, Mohammed Amin, an Islamic finance specialist and former UK Head of Islamic Finance at PricewaterhouseCoopers LLP, described the bank as ‘running on a shoestring.’

The bank had made losses from its foundation in 2004 up to and including the 2013 financial year. This was despite capital injections from its then major shareholder Qatar International Islamic Bank and a cost cutting exercise begun in 2012. At this point the bank remained essentially a retail bank. Towards the end of 2013, however, Masraf Al Rayan, a Qatari bank established in 2006, appeared on the scene and made a successful bid to acquire IBB, boosting the bank’s share capital from just over £24 million to £100 million; renaming the bank Al Rayan Bank and expanding its remit to include commercial property and now, private banking. (Masraf Al Rayan in its home market of Qatar has traditionally focussed on the corporate sector, with retail banking forming a relatively minor element of its activities.)

The 2014 financial results were a landmark for the bank with the first profit reported since its foundation as IBB in 2004. The profit was modest at £1.2 million, but it was nevertheless a profit (the loss in 2013 had been £5.5 million). Operating income increased to £11.8 million from £4.4 million in 2013 (168%). A significant contributor to the improved performance was the bank’s Home Purchase Plans (HPPs), which tapped into the government’s Help to Buy scheme. (HPPs increased by 50% in 2014 to £311.6 million). Retail deposits also grew by 59%. Interestingly, Mr Choudhury said that the bank’s deposit rates have attracted non-Muslim customers, who now account for 80% of the term deposit business.

The Retail Business

We caught up with Sultan Choudhury, CEO of Al Rayan Bank before the opening of the Knightsbridge branch. He confirmed that the bank is evolving away from being a mainly retail bank, although he insisted that retail still remained an important element of the business. It is, however, a rather different retail business from the one IBB started in 2004. Mr Choudhury observed that trying to compete with the big high-street banks on a mass network basis was never going to work. It was, he said, too slow and expensive. Al Rayan has retained six retail branches – three in London and one each in Birmingham, Leicester and Manchester, but is betting its retail future on internet banking and agencies.

Mr Choudhury believes that Al Rayan’s cloud-based internet approach has allowed the bank to leapfrog other high-street banks with their massive investment in legacy computer systems. (Cloud computing allows businesses to connect to remote devices such as smart phones and tablets, anywhere, anytime and is both more scalable and cost effective than legacy systems.) Al Rayan Bank has also established three agency ‘branches’ – in south London (Tooting), Luton and Blackburn, with three more being considered in Glasgow, Leeds and Ilford, Essex. These agencies are not based passive, co-location agreements. The agency partners are incentivised to make customer introductions and there is also a profit-sharing arrangement in place. One agency, for example, is an estate agency and what could be more natural than to introduce potential property purchasers to a bank offering home purchase plans.

There is, however, no getting away from the fact that Islamic retail banking simply has not taken off in the UK. Mr Choudhury commented that there were probably two main reasons for the rather lukewarm response to IBB’s original offering. In the first place he said that many Muslims in the UK do not fully understand Shari’ah-compliant banking and the role it can play in their spiritual lives. (Al Rayan has been proactive in trying to educate the UK Muslim population with information/education events held in locations with a high Muslim population. For example, they held two such sessions in 2014 for Imaams/religious leaders in Blackburn and London.) At a more practical level, he said that it was difficult for a small Islamic bank with a limited range of products to compete with the full service offering of the major high-street banks.

Where Next?

While retail banking still dominated in 2014, Mr Choudhury said that he expected retail and commercial to be on an equal footing in asset terms by early 2016. It is doubtful whether Al Rayan would have been able to achieve such a goal without access to the resources of Masraf Al Rayan. Do not, however, believe that this is a one way street; Masraf Al Rayan have their own agenda, which was highlighted at the Knightsbridge opening ceremony by Group CEO, Adel Mustafawi. He said, ‘When Masraf Al Rayan was established nine years ago we set ourselves the ambitious goal of becoming a truly global bank. From the very beginning our strategy was to start from Qatar, then expand to the GCC and ultimately look beyond. When the time was right for us to develop outside of the GCC, the United Kingdom was the natural place for us to begin.’

It is interesting that Mr Mustafawi described the UK as ‘the natural place for us to begin.’ During the interview with Mr Choudhury we asked whether operating in a regulatory regime that was set up for conventional banks had in any way hampered the growth of Islamic banking in the UK. He expressed the view that the UK government had done more than any other western government to provide a level playing field for Islamic banks. The UK government has amended regulations in the past 10-15 years, so that, for example, anyone buying a property using an Islamic mortgage does not have to pay double stamp duty. (With an Islamic mortgage a finance provider will typically buy the property and then sell it to the real buyer at a premium, thus no interest is involved, but there are two property transactions, which, until the amendment, attracted two tranches of stamp duty.)

Perhaps more importantly, the Bank of England is currently working towards providing liquidity facilities to Islamic banks that have been prevented from accessing the traditional liquidity facilities, which involve interest-bearing instruments. Mr Choudhury believes that this will be a significant help to Islamic banks in the UK.

The result is that Masraf Al Rayan has been able to begin to fulfil its desire to develop outside the GCC by acquiring a ready-made organisation in a fairly Shari’ah friendly regulatory environment and Al Rayan Bank has found a white knight able to inject much needed capital that has enabled the organisation to diversify its activities.

Mr Choudhury told NewHorizon that currently the bank’s business is split 40%, retail, 40% commercial and 20% GCC. Mr Choudhury has said that retail banking will remain important; it gives the bank a solid and diverse income base. He did, however, admit, as we noted earlier, that the bank will be evolving away from a dominantly retail model.

We suspect, however, that in time Al Rayan’s profile will look very different. In the next 12 months, it is quite likely that commercial property will become the dominant element in the bank’s business mix. Within six months of Masraf Al Rayan’s acquisition of IBB they were touting the advantages of their new UK base for GCC customers wishing to acquire homes or investment properties in the UK, primarily prime central London sites. Their pitch is as follows: ‘Al Rayan Bank’s Home Purchase Plan Premier is tailored to meet the needs of the GCC national, with customers offered a bespoke product and service, including negotiable rental rates and discounted fees. Tax efficient structuring can also be provided through an approved third party. All relationship managers are Arabic-speaking.’

Now they have rounded out their offering to wealthy GCC customers with the private banking branch in Knightsbridge. (The GCC element already accounts for 20% of Al Rayan’s business.) The question is how quickly will this element grow. Even if retail offerings such as the Home Purchase Plans and ISAs (Individual Savings Accounts) continue to grow at the healthy rate seen in 2014, it is very likely that retail will be relegated to third position in Al Rayan’s mix within a couple of years. The experiment in Shari’ah-compliant retail banking in the UK will not have been abandoned, but its role will no longer be pivotal and the bank’s profile will look very different.


Prophet Muhammad’s Conception of Property as a Bundle of Rights

Benedikt Koehle

Property was first conceived of as a bundle of rights in early Islam. The legal instrument that crystallised this Islamic conception was the waqf, a legal entity delivering public welfare in accordance with the wishes of a benefactor. Trusts, which evolved in the thirteenth century, have a rationale analogous to that of waqfs and, in fact, may have replicated the legal template of waqfs. The finding that waqfs are germane to Islam has ramifications for policies on waqfs in contemporary Islamic societies.


Waqfs are Islamic institutions that provide welfare. Institutional economists and historians have been studying waqfs for three reasons, two of which are of interest to historians while the third relates to current policy issues. First, philanthropy in medieval Islam was of a scale and range unprecedented in Middle Eastern and European history; second, the legal structure of the waqf conceivably inspired common law trusts. These two historical facts bear on a third issue, one that is topical today, namely why civil society in Islamic countries seems stagnant and what remedy might act as an agent of change. Waqfs in many Islamic countries have been nationalised over the course of the twentieth century – a policy that, as this article shows, not only contravenes the original principles of the waqf but has thereby also enfeebled a traditional hub of civil society in Islam. Deliberations on how to promote civil society in Islam should rightly consider the contribution that waqfs made to civil society in Islam.

A conception of property as a bundle of rights crystallised in the waqf, I argue, from the precedents for the provision of welfare set by Muhammad. I reject the claim that waqfs from the outset represented an assimilation of pre-existing legal cultures in Islam’s enlarged empire and I aver that the conduit for transmitting the template of waqfs to England may have been the Knights Templar and Franciscan friars. My argument bears on policy issues in Islamic societies today, in two respects: restoring Muhammad’s original intent would reverse state control over waqfs and it would thereby widen the scope for pluralist welfare provision that was manifest in the early history of Islam.

Background to Waqfs and Welfare

A word on how a waqf is framed. A legal instrument constituting a waqf binds three parties: a donor, a manager, and beneficiaries. Accordingly, the donor passes assets to the waqf; a manager taking control of these assets must do so at arm’s length from the donor and the purpose to which these assets are put is defined in advance. Other determinations include particulars such as the manager’s salary, complaints procedures and what should happen in case the original purpose of the waqf falls away (the income never reverts to the donor and, as a general rule, is applied to poor relief). By way of example, a typical waqf in early Islam may have consisted of a distinct asset (say, an orchard), producing income (say, a harvest), applied to a defined purpose (say, feeding orphans).

Poor relief is a core Islamic obligation and the Koran specifies how it should be funded, namely through zakat, a levy on wealth. On the other hand, the Koran makes no mention of waqfs; at first blush, therefore, waqfs do not seem intrinsic to Islam. A consequential inference, that waqfs came into being only long after the death of Muhammad in 632, is further strengthened by certain facts, specifically that waqfs first appeared in legal literature in 818 (in a tract by Yayha ibn Adam; Hennigan 2004, p. 50) and the oldest inscription on a building documenting ownership by a waqf is dated to the tenth century (Cahen 1961, p. 40). The timing of the first waqfs – whether they are a Muhammadan or a post-Muhammadan innovation – is an issue of some consequence, because, if waqfs only came into being long after Muhammad’s lifetime, they are hardly essential to the ethos of Islam. This paper settles the issue of the moment in history when waqfs appeared: Muhammad introduced the conception of property as a bundle of rights when he disposed of conquered lands around Khaybar, an oasis north of Medin. Moreover, waqfs cannot be deemed to be derived from non-Islamic precursors, because antecedent models of welfare provision did not treat property as a bundle of rights. We first turn to how public welfare was delivered prior to the advent of Islam.

Precursors to Waqfs

Private philanthropy was already practised long before the advent of Islam. The world’s earliest record of a charitable endowment, wherein land was gifted to yield income for a temple, may be a Babylonian legal deed dated to ca. 1,300 BC (Laum 1914, pp. 207–9). The Babylonian template for charitable giving remained substantially unchanged throughout Roman and Byzantine history: assets, usually dedicated to maintaining religious institutions (or ancillary functions, such as administering cemeteries), were vested in a public authority, either the state or the church (Hennigan 2004, pp. 52–3). There was an exception, ancient Persia, where benefactors were free to appoint administrators unaffiliated to a church or state authority1. We will return to the implications of ring-fencing an endowment from control by state or church, because this legal provision has consequences of great moment; but for now note only that the Persian antecedent is the best fit with a waqf. We now turn to public charity as practised in Muhammad’s Medina.

The Overlap of Zakat and Waqfs

It is not obvious why the Koran could endorse zakat but not waqfs. However, as the economic historian Claude Cahen (1961, p. 45) has shown, conflating financial terms was not uncommon in early Islam. Cahen used in illustration the two Islamic taxes on non-believers, jizya and kharaj. Only one of these, jizya, is mentioned by the Koran, whereas kharaj was only introduced following Muslim occupation of regions outside Arabia, several years after Muhammad had died; hence, arguably, kharaj was superimposed on a Koranic guideline. But Cahen resolved this ostensible inconsistency: jizya is a levy on moveable assets (say, a herd), and kharaj is a levy on a fixed asset (say, a farm). Thus, the two taxes share an identical rationale – the taxation of non-believers – and differ only in the basis of the assessment.

There is an obvious analogy with zakat and waqfs: they share the same purpose – provision of welfare – and differ in that zakat is based on tax levied on moveable assets, whereas a waqf earns rents from property in its possession; zakat is managed within the public sector, waqfs are outside the public sector. What may seem an arcane minutia of fiscal procedure – which asset base is used to yield income – had important ramifications for the provision of public welfare. Zakat was levied on moveable wealth (say, a herd) that fluctuated from one year to the next; moveable assets in extremis could disappear altogether, and, consequently, so could tax yields. Waqfs, on the other hand, took possession of a fixed asset (say, a building) with a more predictable revenue flow. Zakat, therefore, was a less dependable tool for drafting a long-term budget, whereas a waqf, through control of assets, was thus equipped to commit to welfare provision over several budget periods.

We now track back in time to Medina in the days of Muhammad, to the origin of the first waqfs and how in practice they came to be differentiated from zakat.

We now track back in time to Medina in the days of Muhammad, to the origin of the first waqfs and how in practice they came to be differentiated from zakat.

Introduction of Waqfs by Muhammad.

In Medina, charitable endowments were a feature of civic life even before Muhammad arrived there. A certain Al Bar had died months before Muhammad settled in Medina and had settled a portion of his estate on charity. Muhammad not only raised no objection; on the contrary, he endorsed this bequest. Thus Al Bar was ‘the first to will away a third of his wealth and the Messenger of God allowed it’ (Ibn Sad 2013, p. 482). Muhammad acquired personal experience of handling endowments shortly after the Battle of Uhud (in 625) when Muqairiq, a Jewish warrior in Muhammad’s armed forces, who was fatally wounded in the Battle of Uhud, bequeathed to the Prophet seven properties with the proviso he put these to use for the expansion of Islam.

The Arab Islamic scholar

Ibn Sad describes how Muhammad managed this endowment. Muhammad once spotted his grandson Hassan eating fruit from a tree that had been given over to provide food for the poor (since no other landed endowments in Medina are ever mentioned, this orchard must have been part of Muqairiq’s bequest). Muhammad scooped the fruit from the boy’s mouth and scolded him, ‘Don’t you know you are not to eat sadaka?’ (Ibn Sad 2012, p. 122; Gil 1998, p. 128. The term sadaka is a synonym for zakat). Thus, Muqairiq’s bequest was of great moment in the evolution of waqfs: Muhammad was now in a position to fund zakat through charging rent on a capital asset and a mechanism for administering a waqf was in place. Two aspects of this hadith stand out: first, Muhammad was conversant with reserving an orchard to provide welfare and second, Muhammad applied the term sadaka to what was in fact a waqf. Muhammad saw no need for new nomenclature to distinguish between zakat and waqf.

Muqairiq’s bequest gave Muhammad a blueprint for administering a waqf and his next step was to scale up how this concept was applied. This occurred following the conquest of Khaybar in 628 (four years before Muhammad died). Previously, income from raids consisted exclusively of windfalls; now, Muhammad came into possession of extensive agricultural estates. The campaign against Khaybar marked a new phase in Muhammad’s bid for recognition as pan-Arabian leader; moreover, the finances of Muhammad’s polity were transformed when Khaybar and its environs were brought under his control. Tenants of farms in and near Khaybar were not evicted; instead, Muhammad permitted them to remain on their land but imposed on them an annual tribute, equivalent to 50 per cent of their harvests. Muhammad, as commander-in-chief entitled to one fifth of any booty, became the recipient of a very large recurring income stream; his annual income was higher than that of any other Arab of the time2.

Muhammad simultaneously awarded grants of lands to his Companions, but attached the condition that they apply the proceeds from the land to public welfare. The narrative of events by Ibn Sad shows that the term sadaka was still used interchangeably with waqf:

Umar got some land at Khaybar and went to the Prophet and he gave him command in it. He said, ‘I got land in Khaybar and I did not get any property dearer to me than it. What do you command me to do with it?’ He said: ‘If you wish, make it a waqf and give it as sadaqa.’ Umar gave it as sadaqa. … the first sadaqa given in Islam were the fruits of the sadaqa of Umar ibn al Khattab. (Ibn Sad 2013, p. 280)

A distinction was drawn between property rights over a capital asset and property rights over the yield from that asset. Fixed assets were owned by a waqf, but income flows were due to beneficiaries; the waqf was the legal entity constituted to administer this scheme. Muhammad thus complied with the Koranic injunction to provide charity, but he did so in a new way, namely by using capital assets and ring-fencing them from control by a secular or religious authority. Previously, assets reserved for the provision of welfare had always been in the hands of a secular or religious authority, but henceforth they were vested in an independent, distinct legal entity. Umar and other Companions had title to physical assets, but beneficiaries had claims over yields from assets: thus, at that very moment the conception of property as a bundle of rights had come into being. A transition in jurisprudence, which had proceeded in several stages, had now run its course. Muqairiq, who gifted a benefaction to the Prophet as head of the community, had complied with traditional philanthropic practice since he did not impose legal constraints on Muhammad; but after Khaybar, Muhammad broke new ground by granting to his Companions legal title over land while constraining how they could use income derived from it and making the distribution of benefits subject to legal oversight.

The novelty of Muhammad’s approach is thrown into relief by a recapitulation of traditional models of delivering welfare. Endowments in the era lasting from the Babylonian to the Byzantine empires were administered by state or church authorities and no institutional checks and balances afforded protection against these authorities absorbing and consolidating endowments. Administrators of waqfs, on the other hand, were independent of church or state. This key difference explains why prior to the advent of Islam the state or the church absorbed philanthropic institutions, whereas the legal structure of waqfs, where administrators were at arm’s length from church and state, safeguarded their independence. By creating a vehicle for a civic philanthropy that was legally autonomous, Muhammad and his Companions had in effect arrived at a conception of property as a bundle of rights; and the independent status of waqf administrators, I submit, explains why the philanthropic sector in Islam spawned creativity surpassing that of its predecessors. (Fixing the timing of the first waqfs has the collateral implication of settling the question of whether Islamic welfare provision imitated Persian models: this hypothesis is disproved because by the time Islam incorporated Persia the template for waqfs was already in place.)

1Furthermore, a distinction was drawn between the endowment’s principal and usufruct (Perikhanian 1983).

2Following the conquest of Khaybar, Muhammad drew annual rents of 1.5 million gold franks, according to an estimate by Leone Caetani (1907, p. 47)..

NEWHORIZON     Rabi Al Awwal - Shaban 1436 FOOD FOR THOUGHT

Reliability of Sources

Before we leave Arabia and turn our attention to England, and to how trusts there came into being, we should pause for a moment and deal with two questions that recur in the literature pertinent to the study of waqfs. The first concerns the reliability of hadiths that narrate the evolution of waqfs; the second what was the true motivation of benefactors of waqfs. Hadiths, some claim, are unreliable as historical evidence, because for generations they were passed on only orally and were therefore liable to distortions. This assertion, however, was refuted long ago by Aloys Sprenger (1856 a, b, c). As to the motivation of benefactors, there are doubts about what, if not charity, might explain why waqfs came into being. An intuitive putative motivation put forward is pecuniary considerations. One might question, however, the merit of this hypothesis. If acquisition of personal wealth had been uppermost in the mind of Muhammad and his Companions, nothing would have prevented them from owning the lands around Khaybar outright. A closer fit between intentions and outcomes is provided by the Koran, which teaches that the provision of charity is an essential aspect of Islam. ‘Islamic charity’, according to Yaacov Lev (2005, p. 144), ‘was a sacred charity, a form of worship, rather than a form of altruistic behaviour’. A vivid illustration of how fundamental to early Islam this virtue was is offered by another of Ibn Sad’s hadiths. Once, when one of Muhammad’s Companions descried an old man beset with dementia suffering from neglect by his family, he upbraided the family and compelled them to serve the old man the most delicious and costly dish they could afford; when they objected that ‘he does not know what he is eating’ and complained about the expense, they were cut short with a curt rebuke: ‘but Allah knows’ (Ibn Sad 2012, p. 227). In this hadith the motivation for endowing waqfs shines through; Islamic philanthropy can be comprehensively explained by the core values of Islam.

The Evolution of Trusts and Corporations in Christendom

In medieval England, the conception of property as a bundle of rights again emerged, in common law, in the form of trusts. A study of the statutes of one of Europe’s earliest instances of trusts – those of Merton College, Oxford, endowed in 1264 – has concluded: ‘Were the Merton documents written in Arabic, rather than Latin, the statutes could surely be accepted as a waqf instrument’ (Gaudiosi 1988, pp. 1254–5). Such parallels could be dismissed as spurious – how could lawyers in England have had knowledge of waqfs? I now turn to the question of how the jurisprudential expertise required to create waqfs could have been acquired in Europe.

Islamic law extended the privilege of endowing waqfs to non-Muslims, including Christians in Jerusalem. An early Islamic legal manual stated:

If a Christian makes his land or his house waqf and prescribes that their revenue be spent for repairs in Jerusalem or to buy oil for its lamps or any (other) of its needs (it is permitted) ... also, Jews have in this respect the same rights as the Christians. (Gil 1984, p. 157) 3

Christians must have made use of this right, since according to Ibn Sad (1997, p. 221), ‘Umar II said that the waqf of a dhimmi who leaves a place of worship as a waqf from his property for the Christians or Jews is allowed’. Christians were exposed to Islamic philanthropy also as beneficiaries. The Omayyad caliph Abd al Malik instructed his all-powerful minister Hajjaj ibn Yusuf to transfer funds to enable Nestorians (a Christian sect) to build a monastery; the Abbasid caliph Harun al Rashid made a donation for building a Nestorian monastery in Baghdad (Pahlitzsch 2009, pp. 146–7). A sixteenth-century legal deed that has come down to us documents a Muslim judge ascertaining the compliance of deeds of a waqf endowed by a Christian lady (Amin 1975). It follows that the mechanism of waqfs was known to Christians in the Middle East and benefactions crossed denominational lines.

Next, we follow the trail by which this institutional expertise might have migrated to England.

Jerusalem was a gateway between Christendom and Islam. Two organisations had a sizeable presence in both Jerusalem and England, the Knights Templar and Franciscan friars. The evolution of trusts in England owed much to them in particular. The benefactor of Merton College, Walter de Merton, had close ties to the Knights Templar; Franciscan friars, according to the legal historian Frederick Maitland (1894), were conspicuous as plaintiffs in cases leading to the endowment of trusts. Precedential actions for trusts were instigated by an official linked to the Knights Templar and by Franciscan friars rather than by other parties. Such facts constitute circumstantial evidence, which, however, falls short of irrefutable evidence; but even if circumstantial evidence is not tantamount to proof, it should be noted that no other plausible explanation for the emergence of trusts has ever been produced.

Before I move on to modern policy ramifications, a brief review of the argument of this article up to this point is in order. I argue that waqfs originated in provisions made by Muhammad and that, proceeding from these provisions, there emerged in early Islam an innovative legal conception of property, namely property as a bundle of rights. Placing the origins of waqfs in Muhammad’s lifetime by implication supports the assertion that early Islam was a catalyst for the self-sustaining evolution of formative institutions of civil society in sectors such as education and health. A corollary of the assertion that waqfs originated in Muhammad’s policy measures is that claims that civil society in Islam was stagnant from the outset are untenable. These findings have implications for present-day policies towards waqfs in Islamic societies.

Implications for Policy Today

Civil society in the West is dynamic, but in the Islamic East, quiescent. One of the reasons for this divergence is thought to lie in the different pathways of evolution of waqfs and trusts; waqfs remained the dominant model of welfare provision in medieval Islam while in contemporaneous Europe trusts evolved into corporations, which proved a far more malleable instrument for combining civic initiatives4. It is true that trusts were precursors of corporations, the jurisprudential frame for which, according to John Dewey (1926), appeared when in 1252 the Vatican issued the legal definition of a universitas as an entity with rights and duties distinct from those of its members5. The creation of the universitas marked a fork in the road from whence Europe progressed towards new forms of legal entities, whereas Islam did not. However, empirics demonstrate that waqfs also proliferated, flourished and expanded for many centuries, even until the modern era and their decline has been comparatively recent. Thus, we need to track back once more to Medina in the seventh century to discover the source of the vitality of waqfs.

Broadening the purposes of waqfs began almost at once and as time went on waqfs became an important feature of civic life in Islam. Muhammad encouraged reserving a third of bequests to charity (Ibn Hanbal 2012, vol. 2, hadith 1440). On a different occasion he instructed another Companion, Othman, to buy a well and give it over to free use (Ibn Hanbal 2012, vol. 1, hadiths 511, 545). Abu Bakr, the first caliph, created a waqf for the benefit of his descendants; Umar, the second caliph, passed his entitlement to one fifth of the booty following the conquest of Egypt to a waqf (Gil 1998, p. 128). Benefactors were inventive in their choice of dedicated purposes; mosques, schools, hospitals, homes for the aged were but a few of the proliferating beneficiaries of waqfs.

Nor were benefactions of waqfs the preserve of Islam’s male elite; donors came from every section of society (Hoexter 1998, p. 478). Women in particular were conspicuous in the history of waqfs from the first: Umar appointed as manager of the first waqf his daughter, Hafsa (Hennigan 2004, p. 162); and between 20 per cent and 50 per cent of all medieval waqfs are estimated to have been endowed by women (Hoexter 1998, p. 478). A prominent example in the sixteenth century was Roxelana, wife of the sultan Suleiman the Magnificent, who endowed a Jerusalem waqf funded by the revenues of 26 villages (Kuran 2001, p. 849). Nor did this tradition cease after the Middle Ages; waqfs in Islamic societies were a significant economic sector until relatively recently. In Egypt, by the time of the Ottoman conquest, virtually all the buildings in Cairo were waqfs (Behrens-Abouseif 1994, p. 145). In Istanbul in the eighteenth century, soup kitchens daily served some 30,000 meals; on the eve of the foundation of the Republic of Turkey in 1923, waqfs owned three-quarters of arable land in the country (Kuran 2001, pp. 849–50).


Waqfs originated in the era of Muhammad rather than at a later stage of Islamic history. Moreover, waqfs do not serve as an example of institutional stagnation in Islam, contrasting with European dynamism, for two reasons: first, Europeans were exposed to waqfs in Jerusalem, where they were authorised to introduce them and in Europe the first trusts replicated the very structure of waqfs; and second, waqfs outgrew their initial scale and even up to the recent past were a malleable instrument for welfare provision. It follows, therefore, that waqfs – by proliferation of purpose, range of social strata involved and assets under management – were in every respect suggestive of a civil society capable of exploiting potential institutional creativity.

Waqfs in the nineteenth and twentieth centuries came under state control; and today in many Islamic countries governmental departments are dedicated to central management of waqfs6. The dynamic inherent in waqfs at their origin, whereby a bundle of rights could be assigned to autonomous institutions, thus atrophied and waqfs suffered the fate of charitable foundations in pre-Islamic eras, namely to be dissolved by church or state authorities. What has been stifling a vibrant civil society in Islamic societies, I submit, has not been the presence of waqfs but, on the contrary, their disappearance. To privatise waqfs, by implication, would be a policy prescription strengthening the civil sector and reigniting the institutional dynamic once set in motion by Muhammad.


Amin, Muhammad (1975) ‘Un acte de foundation de waqf par une Chrétienne (Xe siècle h., XVIe s. chr.)’, Journal of the Economic and Social History of the Orient 18(1), 43–52.
Behrens-Abouseif, D. (1994) Egypt’s Adjustment to Ottoman Rule: Institutions, Waqf and Architecture in Cairo. Leiden: Brill.
Caetani, L. (1907) Annali d’Islam, vol. 2(i). Milan: Ulrico Hoepli.
Cahen, C. (1961) ‘Réflexions sur le Waqf ancien’, Studia Islamica 14, 37–56.
Dewey, J. (1926) ‘The Historic Background of Corporate Legal Personality’, Yale Law Journal 35(6), 655–73.
Gaudiosi, M. (1988) ‘The Influence of the Islamic Law of Waqf on the Development of the Trust in England: The Case of Merton College’, University of Pennsylvania Law Review 136(4), 1231–61.
Gil, M. (1984) ‘Dhimmi Donations and Foundations for Jerusalem (638–1099)’, Journal of the Economic and Social History of the Orient 27(4), 156–74.
Gil, M. (1998) ‘The Earliest Waqf Foundations’, Journal of Near Eastern Studies 57(2), 125–40.
Hennigan, P. (2004) The Birth of a Legal Institution: The Formation of the Waqf In Third-century A.H. Ḥanafī Legal Discourse. Leiden: Brill.
Hoexter, M. (1998) ‘Waqf Studies in the Twentieth Century: The State of the Art’, Journal of the Economic and Social History of the Orient 41(4), 474–95.
Ibn Hanbal, Ahmad (2012) Musnad (3 vols). Riyadh: Dar-us-Salam Publications.
Ibn Sad, Muhammad (1997) The Men of Madina, vol. 1. London: TaHa Publishers.
Ibn Sad, Muhammad ( 2012) Kitab At-Tabaqat Al-Kabir. Volume VI: The Scholars of Kufa. London: Ta-Ha Publishers.
Ibn Sad, Muhammad (2013) Kitab At-tabaqat Al-kabir. Volume III: The Companions of Badr. London: Ta-Ha Publishers.
Kuran, T. (2001) ‘The Provision of Public Goods under Islamic Law: Origins, Impact, and Limitations of the Waqf System’, Law & Society Review 35(4), 841–98.
Kuran, T. (2005) ‘The Absence of the Corporation in Islamic Law: Origins and Persistence’, American Journal of Comparative Law 53(4), 785–834.
Laum, B. (1914) Stiftungen in der griechischen und römischen Antike, vol. 2. Leipzig: Teubner.
Lev, Y. (2005) Charity, Endowments, and Charitable Institutions in Medieval Islam. Gainesville, FL: University Press of Florida.
Maitland, F. W. (1894) ‘The Origin of Uses’, Harvard Law Review 8(3), 127–37.
Pahlitzsch, J. (2009) ‘Christian Pious Foundations as an Element between Late Antiquity and Islam’, in M. Frenkel and Y. Lev (eds), Charity and Giving in Monotheistic Religions.
Berlin: de Gruyter.
Perikhanian, A. (1983) ‘Iranian Society and Law’, in E. Yarshater (ed.), The Cambridge History of Iran, vol. 3(2). Cambridge: Cambridge University Press.
Sprenger, A. (1856a) ‘Über das Traditionswesen bei den Arabern’, Zeitschrift der deutschen morgenländischen Gesellschaft 10, 1–17.
Sprenger, A. (1856b) ‘Notes on Alfred von Kremer’s Edition of Waqidy’s Campaigns’, Journal of the Asiatic Society of Bengal 25, 53–74, 199–220.
Sprenger, A. (1856c) ‘On the Origin and Progress of Writing Down Historical Facts Among the Musulmans’, Journal of the Asiatic Society of Bengal 25, 303–29, 375–81.

3This manual, Al-Khassaf, is dated to ca. 893.
4‘The waqf became Islam’s main organisational form for providing social services at a time when western Europe started to use the corporation to many of the same ends’ (Kuran 2005, p. 802).
5‘For example, the ‘fiction’ theory of the personality of corporate bodies, or universitates, was promulgated if not originated, by Pope Innocent IV (1243–1254)’ (Dewey 1926, p. 665).

Benedikt Koehler

Benedikt Koehler, now retired, spent his career involved in financial innovation in both the City of London and as a former economic adviser in to the UK government. In retirement he has turned his attention to the history of finance and has authored several books on both conventional and Islamic finance including Early Islam and the Birth of Capitalism published in 2014. He was educated at the Universities of Yale and Tübingen.

NEWHORIZON     January – June 2015 POINT OF VIEW

Islamic Finance: Confessions of a Conventional Banker

Moin Qazi

A Contentious Issue

One of the most contentious issues that has taxed the mind of Muslims is the concept of interest in modern day economies. The Islamic clerics (ulema) have exhibited an ambivalent stand on major issues concerning Islamic finance and on most occasions have preferred to diplomatically deflect questions relating to it. Islamic finance is one of the greyest areas of both scholarship and practice and has attracted a very small pool of talented researchers. This is largely on account of the misplaced notion that discussions on Islamic finance are fraught with serious consequences and implications and there are strong possibilities of one getting trapped in an act of heresy. The whole approach is clearly antithetical to the Qur’anic vision in which humankind is challenged to reflect, ponder and meditate: all qualities more connected with heurism and tentativeness and usually regarded as the basis of wisdom (‘He granteth wisdom to whom He pleaseth; and he to whom wisdom is granted receiveth indeed a benefit overflowing; but none will grasp the Message but men of understanding’ (Q: 2; 269). The Qur’anic assumption is that knowledge and reflection will invariably and inevitably lead to God: ‘Are the possessors of knowledge equal with those who possess no knowledge? It is the possessors of understanding that are mindful’ (Q39:9).

If we closely read verses 275-281 of Surah Baqarah, it leaves us in no doubt that riba (any addition or interest) is prohibited. Similarly predetermined interest to depositors is also equally not approved by Islam. In Islam, capital is not capital in the conventional sense; it is a potential capital, which has to be channelled through businesses to generate additional income. Money cannot grow by itself. It has to be used entrepreneurially so that both the health of the economy and individual wellbeing are enhanced. The Federal Court of Pakistan, the highest judicial forum of Pakistan, has unequivocally declared that interest in any form, irrespective of the logic we use, is reprehensible.

Riba and Secular Economies

Although the accepted position in Islamic countries is very clear, there are still several strands of conflict on the position in secular countries, particularly those which have seen a series of failures of Islamic financial institutions. In these countries there is still no unanimity among the Muslim clerics and bankers on the correct meaning of the term riba. Some prefer to translate it as interest. There are others who believe that accepting the term as the modern equivalent of riba, particularly on account of modern finance having been cleansed of the element of usury and its coercive character, would amount to a very superficial interpretation of a term that has multiple layers that colour it. Riba, according to this school, has a sinister connotation and is actually meant to construe the coercive informal finance practices followed and pursued by usurious and rapacious moneylenders.

In modern secular economic systems interest plays a very important role. In fact, in the Western world people cannot think of any economic system without interest. From a theoretical standpoint, interest has been a debatable subject among economic and political theorists. Abu Saud defines interest as ‘the excess of money paid by the borrower to the lender over and above the principal for the use of the lender’s liquid money over a certain period of time’. Economists have presented different interpretations of interest. Samuelson states that ‘Interest is the price of rental for the use of money’. Don Patinkin gives the following definition: ‘Interest is one of the forms of income from property, the other forms being dividends, rent and profit.’ However, J.M. Keynes did not define interest but mentioned the rate of interest as ‘The percentage of excess of a sum of units of money contracted for forward units of time over the spot or cash price of the sum thus contracted for forward delivery.’

However, Muslim, socialist and a number of capitalist economists have questioned these explanations on both theoretical and technical grounds. They often stress the point that money capital cannot be treated as capital goods on the same basis as productive factors. It is pertinent to remark here that the lending of money for interest was abhorred and, in most cases, prohibited by all the monotheistic religions. An eminent Western economist, Roy Harrod, regards the abolition of interest as the only way to avert a collapse of capitalism. Not only this, but he speaks with great admiration for an interest-less society in his work on Economic Dynamics. Harrod clearly recognises that, ‘It is not the profit itself, earned by services, by assiduity, by imagination or by courage, but the continued interest accruing from the accumulation that makes that profit taker eventually appear parasitical’ and he further states that an interest-less society, which will be a totally new kind of society, ‘would be the correct and final answer to all that is justly advanced by the critics of capitalism.’

Defining Riba

Islam is a complete code of life, which offers its own social, political and economic systems to guide human behaviour in all spheres of life. History has recorded that the economic system of Islam, for the first time in the world had established social and economic justice during the period of al-Khalifah al-Rashidah. In any ideal Muslim society, socio-economic justice is considered as one of the most significant characteristics for the social, political and economic as well as all realms of human interaction. Exploitation and any source of unjustified enrichment in Islam are prohibited. The Holy Qur’an has emphatically instructed Muslims not to acquire each other’s property wrongfully. Islam is not an ascetic religion. It takes a positive view of life as the natural outcome of the belief that human beings are the vicegerents of God.

In pre-Islamic Arabian society, interest or riba was considered similar to trade, but the Qur’an has enunciated that trade and interest are not the same. In trade, there are two parties involved – one is the purchaser and the other is the vendor. The vendor makes a particular product or commodity by exerting his labour, money and time or he purchases it from someone else. In both cases, the vendor along with his capital employs labour, time, intellect and experience and presents it before that buyer and by selling he makes some profit on top of it. In exchanging the product, sometimes he may incur a loss instead of making a profit. So he (the vendor) has to take the risk of losses in pursuit of trade.

On the other hand, in interest transactions there is no division of profit between the two parties on the basis of equality. A person lends his money to someone as a loan on the condition that the borrower has to pay a certain amount of money in addition to the principal within the given time period. Here, the lender or financier gets additional pre-fixed money with the principal. During this period it is not always possible for the debtor to make a profit. This is, in fact, an exchange of time and leisure. From the point of view of trade, the moment a commodity is exchanged for its price the transaction comes to an end. The purchaser does not give anything after that transaction to the vendor. In their transaction, whether of houses, land or other material, the original remains intact and is returned to the owner afterwards. It is only for the use of it that the hirer has to pay the rent to the owner, but in the case of interest, the debtor actually spends the amount borrowed from the creditor and has to return the same amount with an addition by way of interest. In its general, linguistic sense, the term riba denotes an ‘addition’ to or an ‘increase’ of a thing over and above its original size or amount; in the terminology of the Qur’an, it signifies any unlawful addition by way of interest, to a sum of money or goods lent by one person or body of persons to another. Considering the problem in terms of the economic conditions prevailing at or before their time, most early Muslim jurists identified this unlawful addition with profits obtained through any kind of interest-bearing loans irrespective of the rate of interest and the economic motivation involved. With all this - as is evidenced by the voluminous juridical literature on this subject - Islamic scholars have not yet

been able to reach an absolute agreement on the definition of riba: a definition, that is, which would cover all conceivable legal situations and positively respond to all the exigencies of a variable economic environment. In the words of Ibn Kathir (in his commentary on 2: 275), ‘the subject of riba is one of the most difficult subjects for many of scholars (ahl al-’ilm)’. It should be borne in mind that the passage condemning or prohibiting riba in legal terms (2: 275-281) was the last revelation received by the Prophet, who died a few days later; hence the Companions had no opportunity to ask him about the Shari’ah implications of the relevant injection - so much so that even ‘Umar ibn al-Khattab is reliably reported to have said: ‘The last [of Qur’an] that was revealed was the passage [lit., ‘the verse’] on riba; and, behold, the Apostle of God passed away without [lit., ‘before’] having explained its meaning to us’ (Ibn Hanbal, on the authority of Sa’id ibn al-Musayyab).

Some people say that no practice of commercial loans existed in Arabia at that time and people used to borrow money for their personal needs only. On the basis of this plea, they say that the interest which has been forbidden by Islam relates to the latter form. For this reason, they hold that interest is lawful when it is charged on a loan taken for industry and commerce. They contend that since the borrowers in the industrial and commercial sectors make huge profits from such loans, how does it become unlawful if they pay the lender a small fixed annual amount against it? In their opinion, it is a right of the lender, which should be paid to him on his wealth. But such arguments are totally wrong for two major reasons.

The Shari’ah establishes distinctly Islamic concepts of money and capital, focusing on the relationship between risk and profit and the social responsibilities of financial institutions and individuals. As is widely known, the payment or receipt of all forms of interest (or riba) is strictly forbidden by the Qur’an. This prohibition is intended to prevent exploitation from the use of money and to share profit and loss. Money is a means of exchange – not an asset that grows over time. Islam also forbids its followers from dealing in prohibited goods – alcohol, pork products, tobacco, pornography and weapons. The basic premise under Shari’ah law that no one should profit purely from money, leads to a shift in both parties’ perspective away from the short-term transaction and towards the longer-term relationship and its consequences.

In short, the structures that have evolved do away with classic debt – and the banks that provide such financing – in exchange for direct participation in risk and reward. For example, an ijara can be used to purchase real estate for the purpose of leasing it out to tenants and the rental income is distributed pro rata to subscribers. A sukuk is a fully negotiable certificate that can be bought and sold on the secondary market and allows the new owner to ‘step into the shoes’ of the original holder, taking all the rights, obligations and liabilities relating to the underlying assets that accompany the certificate.

Importantly, participants in an ijara and holders of a sukuk have no guaranteed return and are all economically aligned in the long-term success of the project. If the project fails, they cannot simply take their profits to date and sell off the loan collateral to recoup their investment. As a result, Islamic finance encourages the creation of social value alongside economic value.

Islamic Values

Because it has at its core the concept of both parties to a transaction explicitly sharing the risk, the argument has been made that Islamic finance is, in fact, more sustainable than its western counterpart. In addition, as questions still remain over whether the banks that were pushed to the brink during the recent financial crisis have actually changed their ways and become more responsible in their investment activities, the continued growth of Islamic finance demonstrates the growing acceptance in the market of radically different approaches.

Islam lays great emphasis on entrepreneurship and believes that investors should become stakeholders in businesses in order to generate income. It also emphasises, however, that the business venture must be carried out in the true Islamic ethos of honesty, piety and trust; otherwise the precious investment of the depositors would be doomed. Conventional commentators describe the industry as banking without interest, but the fundamental differentiator is the nature of money itself: in Islamic economic theory, money is merely a medium of exchange, not a commodity to be traded. It has no intrinsic value. Financial transactions must have an underlying attachment to the ‘real economy’. Real assets must be bought and sold as opposed to the trading of intangible pieces of paper, like the infamous derivatives that brought down Northern Rock and Lehman Brothers and (in theory at least) because money itself should have an asset backing, it cannot be created out of thin air.

But are the ideals of Islamic finance reflected in the industry? An industry dominated by conventional bankers addicted to cheap credit and exotic derivatives has focused on ‘reverse engineering’ of conventional financial products into their Shari’ah-compliant counterparts. An emphasis on the letter of the law over the spirit of the law has left the layman confused. With a global Muslim population of 1.6 billion, much of it under-penetrated by financial services, surely the time has come to emphasise broader ethical principles over adherence to arcane contractual mechanisms? Just as Christian financiers in the Middle Ages created elaborate contractual structures to circumvent the Church’s ban on usury, is Islamic finance not guilty of the very same today?

The Attraction of Islamic Banking

The reason that non-Muslims, as well as Muslims are attracted to Islamic banking is that, at its heart, it is an ethical system where depositors trust the bank to invest their savings in partnership, sharing any profits which are generated.

Unlike conventional banks, Islamic banks do not use financial instruments based on speculation, which can introduce a high element of risk to customers’ savings and assets. Instead, investments are backed by physical assets, such as property or metals. Following Shari’ah-compliant rules for investment, Islamic banks will never invest in industries which are not deemed positive for society, so those connected with gambling, pornography, alcohol, tobacco or arms.

NEWHORIZON     Rabi Al Awwal - Shaban 1436 POINT OF VIEW

Even after three decades as a banker and as one who is a humble student of Islam, I doubt whether I can defend interest-regulated banking. I can only seek solace in the Qur’anic verse 2:286:’Our Lord, do not impose blame upon us if we have forgotten or erred.’ I bow my head in humble gratitude to Almighty God seeking His acceptance and mercy and pray that He may grant me the sincerity of purpose in presenting a correct understanding of his controversial issue to the readers. As with every human effort, it cannot be claimed to be infallible. Following in the footsteps of the great 12th century Andalusian philosopher Ibn Rushd, I repeat after him: ‘God knows every single letter, and perhaps God will accept my excuse and forgive my stumbling in His bounty, generosity, munificence and excellence –there is no God but He!’

Conventional Banking in India

I have practiced conventional banking because I found Islamic banking in India a total disaster. God alone is our help! He alone is Witness of our commitment and Judge of our deed! I still believe that conventional banking in India is humane and just and not usurious and exploitative.

One unique feature of public sector banks in India is that they offer soft and subsidised loans to the poor, self employed and farmers. The annual rate of interest for the poor is 4.25% and for farmers it is 7%. Similarly in the case of defaulters, if a bank is convinced that the default is not wilful and deliberate and is on account of genuine circumstances the amount is written off and the loss is absorbed by the banks. Every year thousand of crores of rupees are being written off by banks. Where recoveries have to be enforced, it is done in a dignified manner, after following proper legal procedures. Similarly the operations of banks are monitored very stringently by the Reserve Bank of India and the interests of depositors, particularly the small depositors, are well protected. The assets of the defaulters are seized only in exceptional circumstances and only after all the efforts of the banks in recovering the loan amount fail and particularly when it involves hardcore defaulters. In short, banks in India are playing a developmental role in addition to providing banking services. Instead of demonising banks without any evidence, Shari’ah experts should build awareness of the status of public sector banks in India. The root cause of misconception is on account of the various interpretations of riba.

One serious complaint against the prevalent model of Islamic banking is that interest is being charged in the garb of a service fee. In fact loans from Islamic banks are much costlier than those from conventional financial institutions, particularly public sector banks. The defenders of the conventional banking, particularly the model followed by public and development banks, argue that their methods are shorn of the coercive practices generally related to the money lending and usury of private sharks and Shylocks, which drew the famous quote from Shakespeare:

Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
Hamlet Act 1, scene 3, 75–77

Islamic Banking in India

One issue that must engage us is that if Islamic banking is a viable alternative for us, how can we justify the collapse of so many Islamic financial institutions in India in recent times. The protagonists of Islamic banking must offer a satisfactory explanation. The real problem is that we are not prepared for a reasoned debate and the issue acquires emotional overtones whenever it comes up for discussion. Confusion continues to prevail with sharp divisions of opinion. As a result the ordinary Muslim is in a fix as to what is the right course of action for him.

Crores of rupees are lying unclaimed by depositors and are being appropriated by banks because of lack of clarity on the issues.

The situation in India is very different. We do not live in an Islamic state. The spate of failures of Islamic banks in India has caused untold suffering to small depositors. There is no alternative except to transact with conventional banks. Islamic banks require Shari’ah Councils manned by experts in both Shari’ah and banking. There is a severe dearth of such experts. The world’s major banks are facing problems because of absence of good experts.

In Conclusion

Modern-day banking has emerged out of the wisdom gleaned over the ages and is a direct weapon for eradicating usurious and unscrupulous moneylenders who have turned borrowers into slaves and stripped them of all their self respect. It would be grossly unfair to equate modern banking with money lending. In fact money lenders are treated as outcasts in the formal financial system. They have no presence in the universe of civilized finance. It would be foolish on our part if we try to include them in the debate: they are a totally alien species.

Development banking is very professionally operated and in developing economies interest rates are subsidised to enable individuals and institutions to set up their own businesses to earn a livelihood. Giant leaps in all spheres of life have been powered by financial institutions who have promoted healthcare, education, entrepreneurship, self employment and a host of services that have profoundly influenced human life.

It is time we moved out of the classical paradigm of the interpretation of the Qur’an, infuse fresh vigour and encourage multi-dimensional analysis. The safe approach of sticking to an obscurantist methodology would only keep muddling and obfuscating the issues.

The real challenge is from the classical school which disdains any discussion on this issue. This would certainly not help because ours is a very vibrant religion with a strong emphasis on reason and reflection. The discussion is all the more important on account of the complexities that confront contemporary society. It will help to crystallise the true perspective for all the stakeholders: the flag bearers of Shari’ah, proponents of Islamic finance, academics, jurists and the global banking community.

The industry balances on a turning point. The next few years will determine whether the history of Islamic finance blindly follows that of medieval European finance or whether its revolutionary ideals can bring something of benefit to the whole world.

Moin Qazi

Moin Qazi is a well known banker, author and journalist. He holds doctorates in Economics and English. He is the author of several books on Islamic topics including bestselling biographies of the Prophet Muhammad and Caliph Umar. He writes regularly for several international publications and was Visiting Fellow at the University of Manchester. He is also a recipient of the UNESCO World Politics Essay Gold Medal and Rotary International’s Vocational Excellence Award..


Risk Sharing and Cooperative Finance: A Short Report

What is Shar’iah screening? Why is it necessary?

The eighth annual public lecture on Islamic finance was jointly organised by the Harvard Law School (HLS) and the London School of Economics and Political Science (LSE) on Wednesday, 12th of February, 2014. The aim of the annual lecture series is to expand dialogue and understanding of contemporary issues in Islamic finance. The lecture was chaired by David Kershaw, Professor, Department of Law, LSE. The two speakers were Paul Mills, Senior Economist, International Monetary Fund, London Office and Farmida Bi, Head of Islamic Finance, Norton Rose Fulbright, LLP, London. 1

The first speaker, Paul Mills, who is an economist with a keen interest in values-based finance, focused on the dominance of debt and limited risk sharing in contemporary finance. He said that the global financial crisis that started in 2008 is the ‘calamitous failure’ of ‘orthodox debt finance.’ While this failure has led to some reflection, it has not led to any fundamental soul searching. The West has had a debt-based financial system for about 400 years, which has created substantial path dependence and network externalities in favour of debt.2

Mills argued that a debt contract is initially cheaper than a risk-sharing contract because of reasons such as lower transactions costs. The full costs of debt, however, are realised over time because debt contributes to financial instability. The costs of instability (or negative externalities) are paid by others, such as taxpayers and creditors in bankruptcy, as experienced in the bail-outs in the 2008 global financial crisis. In fact, the full cost of debt goes further because instability brought about by debt leads to policies that are prone to accelerating inflation, which also serve as a tax on savers. He said that debt is subsidised by the authorities who have bestowed upon it corporate tax breaks, individual tax breaks, favourable capital adequacy requirements for banks and implicit rescues for the ‘too big to fail.’

Mills was of the view that the failure of debt-based finance has not led to Islamic finance being seized upon as the alternative despite the emphasis on risk sharing in Islamic finance. He attributed this to the limited degree of profit-and-loss sharing that occurs in Islamic finance in practice and a lack of standardisation in the Islamic finance industry. He referred to the cynicism that exists among some Western observers that Islamic finance is simply dressing up interest in other guises. He said he was puzzled by the idea of ‘default’ in sukuk (or Islamic investment certificate) because for him sukuk were meant to be a pass-through structure (like a mutual fund), which does not involve a default. In reality, sukuk have been structured to behave like conventional bonds and this is why they are subject to credit risk. The controversy in 2007-08 regarding the Islamic authenticity of certain sukuk structures and whether they are Shari‘ah-compliant, highlighted the lack of standardisation in Islamic finance. Mills said that for Islamic finance to become an alternative to conventional debt-based finance and grow its appeal beyond Muslims, it should drop the Islamic label in favour of other labels, such as ‘risk-sharing’, ‘co-ownership’, ‘debt-freedom’ and ‘relational finance.’

Regarding how to make risk sharing more acceptable to policymakers, Mills suggested emphasising the full costs of debt finance. He said that economists and their macro-economic models tend not to take into account financial systems and non-linear behaviour of debt where there is suddenly a default after a period of stability. The subsidies in favour of debt should be removed if not reversed and there ought to be a credible threat that there will be no bail-outs. He said that the payment system should be separated from the banking system. Letting the banks run the payment system is similar to letting a hedge fund run a utility. Due to the very nature of its operations, a utility cannot be allowed to fail, and to save the utility, the hedge fund would have to be rescued. Mills argued in favour of mechanisms that facilitate debt-equity swaps and enable the passing of losses to creditors. Instead of debt-based home financing, there should be more lease-to-buy arrangements, which can then be securitised to enable participation by long-term investors, such as insurance companies and pension funds.

Commenting on the role of mutuals, Mills said that all major building societies that demutualised in the UK to become banks failed during the 2008 financial crisis, such as Abbey National, Northern Rock, Alliance & Leicester, Halifax and Bradford & Bingley. Member-owned mutuals have certain advantages over listed shareholder-owned entities, for instance, mutuals do not have to deal with the whims of the financial markets. Mutuals, however, are not without their challenges, such as seen in the scandal recently hitting the UK’s Co-op Bank. Some countries, such as Spain, are effectively excluding mutuals as they see mutuals as exacerbating the crisis by lending for non-commercial reasons and reducing bank profitability elsewhere. Mutuals have a role to play, but they are ‘not a silver bullet’, as, like commercial banks, they succumb to many of the same temptations as banks in a debt-based system.

Mills was candid in sharing his disappointment with the Church over debt-based financing. He believed that Biblical teachings are for freedom from debt and the ‘Church went the wrong way’ when it accepted interest-based debt financing. He pointed out that Biblical teachings relating to debt are more stringent than Qur‘anic teaching on debt. He argued debt freedom and risk sharing are ‘common ground’ between Christianity and Islam. Mills anticipates that ‘without a move to true risk sharing’, we face ‘several decades of debt burdens still to bear.’

Speaking next, Farmida Bi, a practicing lawyer with hands-on experience of structuring Islamic finance transactions, focused more on the Islamic finance industry and drew parallels between Islamic banks and mutuals. She said the Islamic finance industry is facing an ‘identity crisis.’ There is an ongoing anxiety about whether the industry is putting form over substance and whether or not it is staying true to its original principles. The questions being raised are that, if the Islamic finance industry does not charge interest but charges something that is like interest, is the industry needed and does it have a long term future.

Farmida pointed out that one of the earliest experiments in Islamic finance was inspired by European mutuals. Mutual finance in Germany can be traced to 1852 whereas the first

1Please note that the views expressed by the speakers in this event do not necessarily represent the views of their employers. 2In simple terms, path dependence can be described as the continued use of a product because it was used historically and transition costs are greater than the long- term benefits of a superior arrangement. Network externalities are the effects on a user of others using the same product. The prevalence of the Qwerty keyboard, despite there being more efficient key layouts, is an example of both path dependence and network externalities.

experiment in Islamic banking, -- Mit Ghamr Savings Bank in Egypt – came into being in 1963, after about 111 years, and its founder Ahmad El Najjar was influenced by German mutuals. Both Islamic and mutual banks have emerged largely unscathed from the global financial crisis, but Islamic banks are compared to conventional banks rather than mutuals.

She disagreed with Paul Mills who had suggested that the Islamic finance industry should drop the Islamic label. She said that many Muslims are underbanked and in some countries such as Indonesia these unbanked Muslims are more likely to deal with a bank that uses the Islamic label. The challenge, according to Farmida, is not that the Islamic finance industry is using the Islamic label but whether it is actually following Islamic principles. Farmida said that Islamic banks do not operate according to the ‘original dream’ of a two-tier investment agency (mudaraba), where individuals were supposed to invest in an Islamic bank on a risk-sharing basis; the bank was then supposed to invest in businesses on a risk-sharing basis. A challenge with risk-sharing financing is whether people actually want to put their principal at risk, moving away from a fixed contractual return. Where Islamic finance has offered profit-and-loss sharing arrangements, the take-up is not known to be high. It remains unclear if people hate debt-based finance as much as the media would have us believe and what alternative, if any, do people want.

Farmida was of the view that the appetite for risk by Islamic financial institutions as well as mutuals has been lower than that of conventional financial institutions. The Islamic prohibitions of riba (unearned gain, usury) and gharar (excessive uncertainty, trading in risk) have helped keep the Islamic finance industry away from the use of leverage and speculative instruments such as collateralised debt obligations and credit default swaps. This has helped save the Islamic finance industry from the worst of the global financial crisis, although it has suffered from its excessive exposure to the real estate bubble.

Talking about the ethics of Islamic finance, Farmida said European mutuals had similar objectives regarding socio-economic justice as early Islamic financial institutions. Pursuit of socio-economic justice throughout the chain means taking into account the interests of not just shareholders but stakeholders that include customers and employees. Islamic financial institutions need to decide if their purpose is to merely earn profits for shareholders or are they there to serve the community. She referred to discussions among Shari‘ah scholars on the need to take into account the impact on society and the environment in a religious ruling (fatwa) concerning Islamic finance. This holistic view, going behind shareholders and details of legal contracts, is needed to bring socio-economic justice, which is at the heart of the ideas underlying Islamic finance.

Farmida argued that a model for an Islamic financial institution is the UK retailer John Lewis. It is a partnership owned by its employees and it lives its values, such as every employee working in a busy period like Christmas, treating customers well or limiting the difference between the pay of senior management and shop-floor workers. She said a way forward for Islamic financial institutions is to become more like mutuals in their legal structure. They should go beyond the usual exclusionary screening of ‘sin’ businesses and consider the kind of projects they will be financing with respect to social and environmental impact. She emphasised the identity crisis facing Islamic finance and questioned what is going to be its unique selling proposition compared to conventional finance and conventional ethical finance offered by mutuals. Farmida believes that this unique selling proposition will be a key determinant of whether or not the two billion global Muslim populations by 2030 will chose to invest in Islamic finance or simply look for the best deal in the market regardless of who is offering it.

The presentations by Paul Mills and Farmida Bi were followed by an active question and answer session. Answering a question regarding moving away from a debt-based system towards greater risk sharing, Mills said that even though we have a culture of debt that is but servitude, the interests of politicians in winning elections and lobbying by special interest groups in favour of the status quo make progress difficult. He also suggested removing the tax advantages from debt and bringing it into line with the treatment of equity. Elaborating upon sukuk structures, Farmida Bi explained that most sukuk are asset based and therefore similar to fixed income instruments, their return does not depend on the performance of the underlying asset but is tied to an interest-rate benchmark, which remains controversial.

Professor Nazim Ali

This report was authored by Professor Nazim Ali, who is now Professor and Director, Centre for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Hamad Bin Khalifa University. He was the Director of the Islamic Finance Project (IFP) at Harvard Law School, Harvard University from 1995 until 2014. For the last thirty years, he has focused his research efforts exclusively on the field of Islamic finance. He has played a lead role in organising several conferences, workshops and symposia, including the Harvard University Forum on Islamic Finance and the annual workshop at the London School of Economics. He also led the effort that resulted in the publication of the world’s first academic software database covering the Islamic finance sector, the IFP DataBank http://www.ifpprogram.com/

NEWHORIZON     Rabi Al Awwal - Shaban 1436 COUNTRY FOCUS

Turkey Revisited


At the beginning of 2013, NewHorizon produced a Country Focus article on Islamic banking in Turkey. It reviewed the birth of the modern Turkish state under Mustafa Kemal Atatűrk with its secular, Western-facing character and strong state control over its economy. By the 1980s, however, the country had become disillusioned with the centrist approach and its failure to deliver strong economic performance. It was at this time that interest-free financial institutions were allowed to set up and the first Islamic banks (or participation banks as they are called in Turkey) began to emerge, although they operated in very restricted circumstances, being outside the regulatory framework of the central bank, with no central bank guarantee of customer deposits and prevented from investing in government securities.

In 2001, following a major economic crisis, which saw 20 banks fail, including one participation bank, the situation began to change. Participation banks were brought under the regulatory control of the central bank through compulsory membership of the Union of Private Finance Houses, which eventually evolved into the Participation Banks Association of Turkey (PBAT). In 2006 deposit guarantees and protection under the bankruptcy laws were extended to the participation banks.

In 2009 participation banking began to emerge from the shadows and the Islamic finance industry in Turkey began work to establish Turkey as a regional centre of Islamic finance.

A Turkish Action Plan

At the end of 2013 the Banking Regulation and Supervision Agency (BDDK) in cooperation with the PBAT published an action plan to bring participation banking into the mainstream. These actions were basically designed to establish a clear regulatory framework, which would set out the aims of interest-free finance, along with setting standards appropriate to the Turkish market; establishing advisory bodies and clear lines of communication between the industry and the religious authorities; promoting greater understanding of interest-free finance among Turks in general; encouraging educational institutions to develop courses in Islamic economics and finance and setting up a research centre for interest-free finance.

Global Islamic Finance Development Centre

One of the signal successes for Islamic finance in Turkey has been the opening of the World Bank’s Global Islamic Finance Development Centre, which also fulfils one of the BDDK’s objectives in the action plan issued at the end of 2013. The Centre is not only designed to foster the growth of interest-free finance in Turkey, but also to try to develop Istanbul as a major financial centre to rival London, Tokyo, New York and Frankfurt.

The Centre will become a centre of excellence facilitating the sharing of data and providing technical assistance and consultancy. At the opening of the Centre, Dr Jim Yong Kim, Head of the World Bank said, ‘This centre is a major symbol of our common aim to develop Islamic finance on a global basis. Turkey will provide a contribution to the neighbouring countries and even to the world with these developments. The Centre, which will provide global access, was shaped by the cooperation between the World Bank and the Turkish Government, the Turkish public and the private sector. The recent rapid growth and globalisation of Islamic finance have increased the total value of Islamic financial assets to US$1.5 trillion worldwide. While many countries, led by Bahrain, Saudi Arabia, Kuwait and Malaysia, already have a large-scale Islamic finance sector. Some other countries like Luxembourg and the UK have taken important steps to develop these financial instruments.’

Participation Bank Growth

So how well are Turkey’s participation banks doing? Participation banks are certainly growing faster than conventional banks in Turkey. Figures vary slightly depending on the source, but generally they all agree that deposit growth is somewhere around 25% year on year for participation banks, which is double the growth for conventional banks. (Turkey’s Participation Banks Association put the growth in 2013 at 27.9%.) It must, however, be remembered that currently participation banks only account for 5% of the total banking sector. This effectively means that growth per $100 in actual terms was $1.25 for participation banks and nearly $12 for conventional banks. The sector has a long way to go to achieve critical mass.

Increasing the Number of Participation Banks

The Turkish government, however, seems determined to boost interest-free finance to both strengthen ties with oil-rich Gulf economies and to diversify its investor base. (The importance of diversification was underscored when the US Federal Reserve announced that it was scaling back its economic stimulus programme and when the improvements in US economic conditions began to divert investor attention away from emerging markets.)

The government target is for Islamic banking assets to reach 15% of total banking assets by 2023. One way to help achieve that goal is to increase the number of participation banks active in the market, which has been stuck stubbornly at four for some years - Albaraka, Bank Asya, Kuyveyt Türk and Türkiye Finans. (Hopefully, new entrants would not just spread existing business a little more thinly.)

By mid 2013 the Turkish government was talking about state owned banks offering Islamic services, although this would have to be done through separate subsidiaries, as Turkish law does not permit window operations. They specifically mentioned Ziraat Bank, Halkbank and Vakifbank.

In late 2014 BSRA approved an application from state-owned Ziraat Bankasi to set up a participation bank with capital of $300 million and in May 2015 Ziraat opened its first Islamic branch in Istanbul. A government commentator said that the bank would have 20 branches and 400 employees by the end of 2015 growing to 170 branches and 2,200 employees in 2018. (Initially, Ziraat sought to get into the market through the acquisition of Bank Asya, which is the largest of the existing participation banks in terms of assets, but it is the only one with no dominant shareholders. No shareholder has a stake greater than 10% and nearly 54% of shares are publicly held. Negotiations, however, broke down and to understand why this might have happened readers should go to the section in this article on Bank Asya.)

At the end of 2014 a second of the state-owned banks, Halkbank applied to set up an Islamic banking affiliate. Halkbank expect to raise the capital for the new affiliate through a rights issue and are also aiming to open for business in 2015. Their aim is to have 150 branches operating throughout Turkey. (In December 2013 the CEO of Halkbank was one of those detained as part of a fairly wide-ranging enquiry into corruption at the highest levels of government and commerce.)

Vakifbank have also begun to take steps towards opening an Islamic subsidiary. The bank’s board granted approval at the end of 2014 for the raising of a $300 million loan guaranteed by the Islamic Development Bank to fund the new subsidiary. There were no further details about the size of the operation or potential opening date, but it seems likely that by the early months of 2016 Turkey will have almost double the number of participation banks it has currently.

Kuwait Finance House (KFH) has also announced their intention of setting up a bank in Turkey, aiming to be the largest Islamic banking operation in the country with 500 branches. This announcement followed KFH’s decision to review their operations in Malaysia, potentially looking to sell their operations there.

Established Participation Banks
Asya Bank

Asya , the largest of the Turkish participation banks, is seen as home grown and it was certainly set up in 1996 through the offices of a consortium of local businessmen, but only 14.5% of its shareholders are identified as domestic, with 85% being unspecified according to the BDDK, Turkey’s Banking Regulation and Supervision Agency. Asya went public in 2006, when it floated 23% of its shares. Currently 53.47% of their shares are publicly held. By the end of 2013 it had 280 domestic branches and one abroad.

Although its total assets have grown steadily year on year, with a 33% increase between 2012 and 2013 (from 21 billion Turkish Lira (TL) to TL 28 billion), profit has been steadily declining from TL 301 million in 2009 to TL 180 million in 2013 ( the decline was 5% between 2012 and 2013).

In 2014 the wheels fell off. In the nine months to the end of September 2014 the bank had notched up losses of TL 301 million; there was a significant outflow of deposits from the bank, mainly due to the flight of government-linked depositors and assets had fallen by around 25%. The bank closed 80 branches and shed 1,708 jobs. (At the beginning of 2015, Bank Asya also sold its 40% stake in Tamweel Africa Holdings to the Islamic Corporation for the Development of the Private Sector for $37.7 million.)

In June 2011 Banka Asya apparently employed Goldman Sachs to try and find a buyer for the bank. Talks with Qatar Islamic Bank (QIB) broke down in early August amid rumours that the state-owned Ziraat Bank was interested in acquiring Bank Asya. These rumours were denied by government officials a few days later, so effectively leaving Bank Asya high and dry. (There have been suggestions that the Turkish government deliberately sabotaged the potential deal with QIB.)

Bank Asya’s shares were suspended on the Turkish stock exchange for a month in the late summer and when trading resumed their shares fell 11.3% on the first day of trading. The problems seem to be related to a rather ugly battle between Bank Asya and the Turkish government. The bank was founded by supporters of the now US-based Islamic scholar, Fethullah Gülen, who has been implicated in a ‘plot’ to investigate former cabinet ministers and officials for corruption, including two of President Erdoğan’s sons. Reports in the Turkish media suggested that President Erdoğan and his government were deliberately trying to sink the bank, stating that it does not have a sound structure. In the past year he has variously described the bank as ‘bust’, ‘bankrupt’ and ‘failed’. Some legal experts in Turkey suggest that this constitutes a crime under Turkish law.

Such a situation is unlikely to have a positive effect on the confidence of international investors, which Turkey needs to woo if it is to kick start its stagnating economy. It is suggested that this stagnation is not so much due to global economic trends, but to Turkey’s failure to implement structural improvements. In particular it has been suggested the autonomy of the Central Bank of Turkey and the Banking Regulation and Supervision Agency (BDDK) has to some extent been compromised since 2007. This is really bad news for a country seeking inward investment.

In early January financiers connected with the Gülen Movement stumped up TL 92 million to increase the beleaguered Bank Asya’s capital. The Capital Markets Board, however, have not yet approved the capital increase and are reported to have made the following statement, ‘The Board will decide on Bank Asya’s capital increase. The financial conditions of companies that will participate in the capital increase will also be investigated. We will also examine whether the partners are financially capable of granting the amounts they have undertaken to deposit.’

In February 2015 Turkey’s banking watchdog, the BDDK, took management control of the bank and in May 2015 Turkish authorities took full control. Turkey’s Savings Deposit Insurance Fund (TMSF), which is responsible for dealing with troubled banks, is now responsible for the running of Bank Asya. Turkey’s Official Gazette subsequently announced that the bank would be sold in its entirety or in parts. Shareholders of the bank are expected to mount a legal challenge to the seizure.

This situation has all the characteristics of the gunfight at the OK Corral, where most of the protagonists were killed or severely wounded. Only Wyatt Earp walked away unharmed and it is anybody’s guess whether the Wyatt Earp role will be played by Fethullah Gülen or President Erdoğan. One thing is absolutely certain Bank Asya is now severely, if not mortally wounded.

Albaraka Turk Bank

Albaraka Turk bank, the oldest of the participation banks, was established in 1984 and opened for business in 1985. It is 66% foreign owned. The majority shareholder of Albaraka Turk is the Bahrain based Albaraka Group (54.06%) with minority shareholdings held by the Islamic Development Bank (7.84%) and the Alharthy Family (3.45%). Domestic Turkish shareholders

make up just less than 11% of the total. Just over 23% of the shares are publically traded on the Istanbul Stock Exchange following an Initial Public Offering (IPO) in 2007.

The bank had total assets of TL 17.2, a 40% increase over 2012. Profits rose to TL 241.41 million, an increase of around 25%. In the first nine months of 2014, it looked as though the bank was on track for another good year with profits up 21% on the same period in 2013. Assets were up 25%. The number of braches had increased to 187 by late 2014 from 166 at the end of 2013.

Although it is the oldest of the four participation banks it is also the smallest in terms of assets, loans and deposits. The bank has been raising money to fund expansion and diversify its funding sources through syndicated murabaha facilities. It has raised funds in this way in every year since 2010.

Another landmark development has been a partnership agreement with participation bank, Kuveyt Türk, to launch private pension schemes, through a new company, Katilim Emeklilik ve Hayat.

Turkiye Finans

Turkiye Finans came into being at the end of 2005 with the merger of two organisations – Family Finans and Andolu Finans. Early in 2008 60% of Turkiye Finans shares were acquired by the National Commercial Bank (NCB) of Saudi Arabia. (This holding by NCB has since grown to 66.27%.) Turkiye Finans serves an estimated 1 million customers through 259 branches. The bank is the most profitable of the participation banks.

The bank is very active in the sukuk market, but in 2014 they broke new ground by being the first Turkish bank to issue a Malaysian ringgit-denominated sukuk in the Malaysian capital market.

In late 2014 the bank announced its intention of setting up to establish operations in Bahrain. No details were available at the time of going to press as to when this might happen or what type of licence the bank are seeking.

At the end of June 2015 the bank’s CEO, Derya Gurerk, resigned unexpectedly and without explanation, although internet chatter suggests that there are allegations of corruption involving the purchase of a site for a new headquarters building. He had been in post since 2011. Osman Celik, an executive vice president of the bank will take over as CEO temporarily.

Kuyvet Türk

The major shareholders in Kuyvet Türk are Kuwait Finance House with 62% of the bank’s shares, the General Directorate Foundation of Turkey with 19%, The Public Institution for Social Security with 9% and the Islamic Development Bank with 9%. It had 269 branches at the end of 2013.

Assets rose 37% between 2012 and 2013 to TL 25.9 billion and profits were up 20% to TL 300 million. It also has the highest proportion of foreign deposits among the participation banks at 48%. It is, in some respects, the most conservative of the participation banks, being considered to be the most risk averse with a Capital Adequacy Ratio that is correspondingly high.

The bank was the first of the participation banks to issue sukuk, tapping the market in 2010 shortly after the framework to support sukuk issuance became law in 2010. They have continued to be active in the sukuk market and are currently planning to issue a ringgit-denominated sukuk in Malaysia.

Kuveyt Türk provides banking services to international customers through its wholesale banking branch in Bahrain, its subsidiary incorporated in the DIFC in Dubai, its financial services branch in Mannheim, Germany and most recently its first fully-fledged Islamic bank operation in Frankfurt, Germany designed to serve the 4 million Turks living and working in Germany.

Economic Background

As we observed in our 2013 article, Islamic banking does not exist in a vacuum; the economic, political and legal and regulatory environments in which it operates affect its growth. Since the millennium Turkey has experienced two significant economic crises. In 2001 the problems were largely domestic weak regulation, the accumulation of bad debts and a loan book that was heavily skewed to the public sector. In February 2001 the Turkish lira became a free floating currency and fell 40% in three days leading to rampant inflation and a liquidity crisis. More than 20 banks failed in this crisis, including one participation bank, Ihlas Finans. The actions taken in the wake of this crisis had a dramatic effect and World Bank data on Turkish Gross Domestic Product (GDP) shows GDP rising from $196 billion in the trough of the 2001 crisis to $647 billion in 2008.

The second crisis was a related to the 2008 global financial situation, which caused a blip in the growth with GDP falling back to $615 billion. Much of the recovery since 2009, however, has been reliant on foreign investment, which is notoriously fickle. In particular a probable US interest rate rise in 2015, as well as a reduction in the US Federal Reserve’s bond buying programme, are having an effect. This is likely to result in less investment flowing into emerging economies such as Turkey. Coupled with continuing economic weakness in Eurozone countries, Turkey’s biggest trading partners, sustaining growth in Turkey is looking progressively difficult. The World Bank is forecasting GDP growth of just over 3% for 2014 and only modest growth in the short to medium term.

The government has also failed to bring down the unemployment rate. In the third quarter of 2014 unemployment was running at 10.7%, the highest rate for four years and youth unemployment was 20%.

Turkey’s government point to their success in reducing the current account trade deficit, but, this is not due to booming exports, which are actually falling; it is due to even faster falling imports. The falling oil prices in later 2014 and early 2015 have been a positive factor for Turkey, which is heavily dependent on imported oil.

Political Background

The biggest threat to economic stability and growth may, however, be Turkey’s political situation. In parliamentary elections in June 2015 President Erdogan’s AKP failed to gain an overall majority following 12 years in power. Forming a coalition has proved impossible, with the nationalists, Kurds and the Republican People’s Party (CHP) refusing to enter coalition with AKP. In mid August attempts to form a coalition were formally abandoned. President Erdogan could ask the next largest party, the CHP, to try to form a government, but a snap election seems to be the most likely outcome of the stalemate. There is, however, no clear evidence that the election result would be very different. This has inevitably had a negative effect on the Turkish economy with the Turkish currency hitting record lows and there is no sign that the situation will improve in the foreseeable future.

At the micro level the situation at Bank Asya, where the Turkish government appear to have been involved in a deliberate attempt to bring the bank down, is just the tip of the iceberg. There is now an all-out war between the government and Gülen’s Hizmet movement, which can only damage Turkey’s economy including its financial sector and particularly the nascent Islamic finance industry. The state of affairs is now so bad that some commentators are even suggesting that Turkey is not that far from being a failed state. While all this internal turmoil is going on, Turkey is also dealing with the political instability in the Middle East, particularly the threat of IS on its doorstep.

The Future for Islamic Finance in Turkey

The present government has taken important steps to make Turkey a friendlier environment for Islamic finance and it is reasonable to assume that, providing there is no disruptive change in government, a big assumption in the present situation, they will continue along this path, particularly encouraged by the success of the country’s first sovereign sukuk. The threats to further progress are, however, both external and internal. Stable political and economic environments are essential for banks, conventional and Islamic, to flourish. Any hint of instability will affect both domestic and international confidence in the system. For example, in 2012/2013 it had been rumoured that a number of Gulf financial institutions were expressing strong interest in setting up operations in Turkey. Two years later nothing has materialised.

The problem for Turkey is that some of the factors affecting stability are beyond their direct control, for example, a return to solid economic growth in Europe, Turkey’s major trading partner and political unrest in the region. Two years ago we felt there was every reason to be optimistic about Turkey’s future as a major financial centre in the region. Since the beginning of 2013 a number of things have changed – the political stability of the whole region has worsened appreciably; the results of recent elections leading to a hung parliament and no effective government is a serious problem; the stand-off between the Turkish government Gülen’s Hizmet movement has not yet run its course and has the potential to destabilise Turkey; the economic weakness within the Eurozone, exacerbated by the Greek situation, shows little sign of improvement (we have yet to see whether the quantitative easing measures announced by the European Central Bank in January 2015 will make any difference) and with oil revenues dipping dramatically the investment appetite of Gulf states is likely to be depressed. We would, therefore have to be cautious about the future of Islamic finance, indeed the whole financial industry, in Turkey.

Turkey has been viewed as the bridge between Europe and Asia since antiquity. The Romans even called the region, Pontica Asiana, the Asian bridge. That is both Turkey’s strength and its weakness. Today, Turkey is facing west with its pursuit of EU membership and its membership of NATO and east as it attempts to strengthen its ties with Arab neighbours. If it can successfully balance these two aspects of its personality, in the long term Turkey could become a very important financial centre for the Middle East and the Gulf with local strength in both conventional and Islamic finance, but only if there is a resolution to Turkey’s internal and regional political and economic problems.

NEWHORIZON     January – June 2015 LEGAL MATTERS

Proposal for the Dubai World Islamic Finance Arbitration Tribunal (DWIFAC) and Jurisprudence Office (DWIFACJO) as the Dispute Resolution Mechanism and Centre for the Islamic Finance Industry

Camille Paldi, CEO, FAAIF Limited and Events DMCC Managing Director, ilovetheuae.com


As the Islamic finance industry is growing annually at a rate of 10% to 15% per year, it is imperative that a unique, independent legal framework is established in order to effectively adjudicate Islamic finance disputes. Currently, Islamic finance disputes are being adjudicated in inadequate civil and common law courts and arbitration centres where the contracts in dispute are being transformed from Islamic to conventional transactions. The aim of this paper is to explore the role of the Dubai World Islamic Finance Arbitration Centre (DWIFAC) and its jurisprudence office (DWIFACJO) as the dispute resolution centre of the Islamic finance industry, fitting in with the recent 2013 Sheikh Mohammad ‘Dubai as the Capital of the Islamic Economy’ initiative.

Islamic finance contracts should include an additional standardised dispute resolution contract issued by Dubai World Islamic Finance Arbitration Centre Jurisprudence Office (DWIFACJO) with a built-in dispute resolution procedure similar to the International Federation of Consulting Engineers (FIDIC) designating the Dubai World Islamic Finance Arbitration Centre (DWIFAC) as the arbitration centre. If the contractual dispute resolution procedure is exhausted, then the dispute may be referred to DWIFAC, which may utilise the Model Islamic Banking Law created by DWIFACJO as the substantive law of the arbitration, the procedural law of the seat of the arbitration and the DWIFAC arbitration rules, which includes Shari’ah and lex mercatoria. The arbitration centre may be staffed with the world’s top Shari’ah scholars and Islamic finance lawyers, judges and experts who can provide input about the Shari’ah aspects of the dispute through the use of an Islamic form of ex aqueo et bono, which allows disputes to be settled using commercial practice rather than purely legal devices.


DWIFAC along with the DWIFAC Jurisprudence Office shall be the central command station for Islamic finance dispute resolution in the UAE, GCC, and the world, providing a standardised contract with built- in dispute resolution, a uniform Islamic banking law, an arbitration centre, and a centralised Shari’ah authority in the form of the Supreme Shari’ah Council.

It is clear that state courts in common and civil law jurisdictions are inadequate to adjudicate Islamic finance disputes due to the lack of recognition of Shari’ah law, lack of independent Shari’ah advisory committees and/or the inability of court staff to apply effectively Islamic finance and Shari’ah concepts in dispute resolution. In addition, the currently existing arbitration centres are insufficient to handle Islamic finance matters due to lack of properly trained staff, inadequate procedure and rules, misapplication and non-application of Shari’ah and preference for national law, legal uncertainty and lack of popularity as a mode of dispute resolution. DWIFAC may offer the Islamic finance industry a globally recognised arbitration centre complete with the DWIFAC jurisprudence office, which may issue a uniform Islamic banking law and a standardised DWIFAC dispute resolution contract, creating harmony, legal certainty and investor confidence in and across the Islamic finance industry. The DWIFAC standardised dispute resolution contract contains a built-in dispute resolution mechanism, facilitating early dispute settlement and completion of contracts. This contract may be attached to all Islamic finance contracts industry-wide, making DWIFAC the central dispute resolution authority for the industry.

DWIFACJO Uniform Banking Law

As it stands now, the UAE does not have an Islamic Banking law, however, it has a law allowing Islamic Banks to exist, UAE Federal Law No. 6 of 1985 Regarding Islamic Banks, Financial Institutions and Investment Companies. There had previously been a proposed law for governing Islamic banks in 1985, but it had not been backed up by a decree and therefore, that is why the law is not in existence now. However, Federal Law No. 6 of 1985 was promulgated to legalise Islamic banking in the UAE. Article 5 provides that a Supreme Shari’ah Council should be established and approved through a cabinet decision, but it never materialised. The Supreme Shari’ah Council would oversee Islamic banks, financial institutions and investment companies and its opinion would be binding. However, Article 6 was implemented, which requires that each Islamic firm establish its own Shari’ah Supervisory Authority (SSA) consisting of three members, to be approved by the Shari’ah Supervisory Council (ISRA 2013:656) and inserted into the articles of association (ISRA 2013: 656). The SSA is obligated to apply Shari’ah to the company operations and contracts (Thani, Abdullah, Hasan 2004: 256).

DWIFACJO may take the opportunity to formulate and issue a Uniform Islamic Banking Law based upon the draft of the UAE 1985 Islamic Banking Law, UAE Federal Law No. 6 of 1985 Regarding Islamic Banks, Financial Institutions and Investment Companies, the Law Regulating Islamic Financial Business DIFC Law No. 13 of 2004 and AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) standards. The new law may then be utilised as the substantive law in DWIFAC arbitrations and submitted to the UAE government for approval and gazetting as this law would be necessary for the UAE in order to fulfil its mandate of becoming the capital of the Islamic economy. In addition, DWIFAC may establish a central Shari’ah Supervisory Authority or Supreme Shari’ah Council for the UAE, which may be utilised by all existing UAE dispute resolution bodies, including the Central Bank of the UAE, the Dubai Courts and the DIFC/DFSA, which lacks such a board. The Supreme Shari’ah Council may fulfil its original purpose of approving the Shari’ah boards of all Islamic financial institutions in the UAE, including in the DIFC.

The DWIFAC Standardised Dispute Resolution Contract

I propose that DWIFACJO issue a standardised dispute resolution contract, which may be attached to the main contract. The DWIFACJO standardised dispute resolution contract may contain a similar built-in dispute resolution mechanism as the FIDIC contract containing three stages including (1) the Dispute Resolution Board (DAB), (2) amicable settlement and (3) final referral to DWIFAC arbitration. Within thirty days of the occurrence of the subject-matter of a dispute, any party to the contract may submit a claim to the DAB, addressed to the chairman of the DAB and with a copy to all parties to the contract. However, if any of the parties to the contract considers that there are circumstances, which justify the late submission,

that party may submit the details to the DAB for a ruling. If the DAB considers that it, in all the circumstances, is fair and reasonable that the late submission be accepted, the DAB shall have the authority to override the relevant thirty day limit and if it so decides, it shall advise both parties accordingly.

The DAB shall have 60 days to issue a binding ruling, which must be implemented immediately. If either party is not satisfied with the DAB ruling, either party can give notice of dissatisfaction to the other before the 30 days after the day on which that party received the decision on or before the 30 days after the day on which the said period of 60 days expired. If there is no dissatisfaction within 30 days after the day on which that party received the decision, the DAB’s decision shall become final and binding upon both parties. The DAB’s decision may then only be overturned by settlement or arbitration.

The DAB shall consist of three people who must be suitably qualified in law, Islamic finance and Shari’ah. Each party shall nominate one member for the approval of the other party. The parties shall consult both these members and shall agree upon the third member, who shall be appointed to act as chairman. However, if a list of potential members is included in the contract, the members shall be selected from those on the list, other than anyone who is unable or unwilling to accept appointment to the DAB.

The agreement between the parties and either a sole member (adjudicator) or each of the three members shall incorporate by reference the General Conditions as written by DWIFACJO, with such amendments as agreed between them. The composition of the DAB shall be by nomination and then joint-selection. DAB members are to be remunerated jointly by the parties with each paying half of any fees. DAB members may only be replaced by mutual agreement. The appointment of any member may be terminated by mutual agreement of both parties, but not by any party acting alone. Unless otherwise agreed by both parties, the appointment of the DAB shall expire when the discharge of the matter shall have become effective. Where the parties fail or are otherwise unable to agree upon the appointment, nomination or replacement of any member of the DAB, then the appointing official so named in the contract shall make the appointment.

DWIFAC may establish an Ambassadors List similar to the FIDIC President’s List, from which arbitrators and DAB members may be selected, if not specified in the contract. Persons who have successfully completed a DWIFAC Adjudication Assessment Workshop and International Arbitrator’s Islamic Finance Contracts Course and applied for entry to the DWIFAC Ambassadors List of Approved Dispute Adjudicators are entered on the List for five years. Successful attendees at an Adjudication Assessment Workshop are required to be fluent in English and to be thoroughly familiar with Islamic finance, law and Shari’ah.

There may be situations where a party fails to comply with a DAB decision. In such cases, the other party may refer the failure to DWIFAC arbitration. Where notice of dissatisfaction has been given, both parties shall attempt to settle the dispute amicably before the commencement of arbitration. However, unless both parties agree otherwise, arbitration may be commenced on or after the fiftieth day after the day on which notice of dissatisfaction was given. The attempt to obtain an amicable settlement during this prescribed period of 50 days is a condition precedent to a referral to arbitration. There is no given timeframe to refer a dispute to arbitration, however it should be without undue delay. Once the arbitration procedure has been initiated, the arbitration shall commence according to the DWIFAC arbitration rules.

The arbitrator(s) shall have full power to open up, review and revise any decision of the DAB relevant to the dispute. Neither party shall be limited in the proceedings before the arbitrator(s) to the evidence or arguments previously put before the DAB to obtain its decision or to the reasons for dissatisfaction given in its notice of dissatisfaction. Any decision of the DAB shall be admissible in evidence in the arbitration. Arbitration may be commenced prior to or after completion of the contract. The obligations of the Parties and the DAB shall not be altered by reason of any arbitration being conducted during the progress of the contract.

The arbitration shall be conducted in the English language and any arbitral decision shall be final and binding. All of the DWIFAC decisions are to be published in English, French and Arabic and the arbitration itself to be conducted in English. In the event of a conflict of laws, the Shari’ah shall prevail. A valid arbitration decision should lead to a verdict that conforms to the rules of the Shari’ah (AAOIFI 2004:559). The Shari’ah and legal basis of the arbitration decision shall be mentioned in the decision (AAOIFI 2004:559).

In the context of DWIFAC, the Centre may make arrangements with the Dubai and DIFC courts for enforceability of DWIFAC arbitration awards. However, parties to the dispute must realise that the arbitration award issued by DWIFAC may be overturned or enforced in other jurisdictions (International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai300 F. Supp. 2d 112 (DDC. 2004)) or challenged in UAE courts based on Article 216 of the Civil Procedure Law. Shari’ah Supreme Council decisions shall act as a source of precedent and shall be binding, thus providing legal certainty to Islamic finance dispute adjudication. The Shari’ah Supreme Council established by DWIFAC shall act as the highest Shari’ah authority for DWIFAC arbitration, the UAE and the DIFC.

NEWHORIZON     Rabi Al Awwal - Shaban 1436 LEGAL MATTERS

The DWIFAC Standardised Dispute Resolution Contract

I propose that DWIFACJO issue a standardised dispute resolution contract, which may be attached to the main contract. The DWIFACJO standardised dispute resolution contract may contain a similar built-in dispute resolution mechanism as the FIDIC contract containing three stages including (1) the Dispute Resolution Board (DAB), (2) amicable settlement and (3) final referral to DWIFAC arbitration. Within thirty days of the occurrence of the subject-matter of a dispute, any party to the contract may submit a claim to the DAB, addressed to the chairman of the DAB and with a copy to all parties to the contract. However, if any of the parties to the contract considers that there are circumstances, which justify the late submission, that party may submit the details to the DAB for a ruling. If the DAB considers that it, in all the circumstances, is fair and reasonable that the late submission be accepted, the DAB shall have the authority to override the relevant thirty day limit and if it so decides, it shall advise both parties accordingly.

The DAB shall have 60 days to issue a binding ruling, which must be implemented immediately. If either party is not satisfied with the DAB ruling, either party can give notice of dissatisfaction to the other before the 30 days after the day on which that party received the decision on or before the 30 days after the day on which the said period of 60 days expired. If there is no dissatisfaction within 30 days after the day on which that party received the decision, the DAB’s decision shall become final and binding upon both parties. The DAB’s decision may then only be overturned by settlement or arbitration.

The DAB shall consist of three people who must be suitably qualified in law, Islamic finance and Shari’ah. Each party shall nominate one member for the approval of the other party. The parties shall consult both these members and shall agree upon the third member, who shall be appointed to act as chairman. However, if a list of potential members is included in the contract, the members shall be selected from those on the list, other than anyone who is unable or unwilling to accept appointment to the DAB.

The agreement between the parties and either a sole member (adjudicator) or each of the three members shall incorporate by reference the General Conditions as written by DWIFACJO, with such amendments as agreed between them. The composition of the DAB shall be by nomination and then joint-selection. DAB members are to be remunerated jointly by the parties with each paying half of any fees. DAB members may only be replaced by mutual agreement. The appointment of any member may be terminated by mutual agreement of both parties, but not by any party acting alone. Unless otherwise agreed by both parties, the appointment of the DAB shall expire when the discharge of the matter shall have become effective. Where the parties fail or are otherwise unable to agree upon the appointment, nomination or replacement of any member of the DAB, then the appointing official so named in the contract shall make the appointment.

DWIFAC may establish an Ambassadors List similar to the FIDIC President’s List, from which arbitrators and DAB members may be selected, if not specified in the contract. Persons who have successfully completed a DWIFAC Adjudication Assessment Workshop and International Arbitrator’s Islamic Finance Contracts Course and applied for entry to the DWIFAC Ambassadors List of Approved Dispute Adjudicators are entered on the List for five years. Successful attendees at an Adjudication Assessment Workshop are required to be fluent in English and to be thoroughly familiar with Islamic finance, law and Shari’ah.

There may be situations where a party fails to comply with a DAB decision. In such cases, the other party may refer the failure to DWIFAC arbitration. Where notice of dissatisfaction has been given, both parties shall attempt to settle the dispute amicably before the commencement of arbitration. However, unless both parties agree otherwise, arbitration may be commenced on or after the fiftieth day after the day on which notice of dissatisfaction was given. The attempt to obtain an amicable settlement during this prescribed period of 50 days is a condition precedent to a referral to arbitration. There is no given timeframe to refer a dispute to arbitration, however it should be without undue delay. Once the arbitration procedure has been initiated, the arbitration shall commence according to the DWIFAC arbitration rules.

The arbitrator(s) shall have full power to open up, review and revise any decision of the DAB relevant to the dispute. Neither party shall be limited in the proceedings before the arbitrator(s) to the evidence or arguments previously put before the DAB to obtain its decision or to the reasons for dissatisfaction given in its notice of dissatisfaction. Any decision of the DAB shall be admissible in evidence in the arbitration. Arbitration may be commenced prior to or after completion of the contract. The obligations of the Parties and the DAB shall not be altered by reason of any arbitration being conducted during the progress of the contract.

The arbitration shall be conducted in the English language and any arbitral decision shall be final and binding. All of the DWIFAC decisions are to be published in English, French and Arabic and the arbitration itself to be conducted in English. In the event of a conflict of laws, the Shari’ah shall prevail. A valid arbitration decision should lead to a verdict that conforms to the rules of the Shari’ah (AAOIFI 2004:559). The Shari’ah and legal basis of the arbitration decision shall be mentioned in the decision (AAOIFI 2004:559).

In the context of DWIFAC, the Centre may make arrangements with the Dubai and DIFC courts for enforceability of DWIFAC arbitration awards. However, parties to the dispute must realise that the arbitration award issued by DWIFAC may be overturned or enforced in other jurisdictions (International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai300 F. Supp. 2d 112 (DDC. 2004)) or challenged in UAE courts based on Article 216 of the Civil Procedure Law. Shari’ah Supreme Council decisions shall act as a source of precedent and shall be binding, thus providing legal certainty to Islamic finance dispute adjudication. The Shari’ah Supreme Council established by DWIFAC shall act as the highest Shari’ah authority for DWIFAC arbitration, the UAE and the DIFC.

DWIFAC Relationships Courts and Tribunals

A special component of the DWIFAC dispute resolution mechanism is the special relationship between DWIFAC, the Central Bank of the UAE, the Dubai Courts, the DIFC, DIFC-LCIA (Dubai International Financial Centre - London Court of International Arbitration) and DIAC (Dubai International Arbitration Centre). The Central Bank of the UAE (CBUAE) was formed in 1980 and is primarily responsible for overseeing banks in the UAE, except in the DIFC, where the regulatory authority is the Dubai Financial Services Authority or (DFSA). The DFSA is a Shari’ah Systems Regulator, requiring that any Islamic firm must have a Shari’ah Supervisory Board (SSB). The DFSA is unfortunately not itself a Shari’ah regulator and has not constituted its’ own Shari’ah Board to oversee the regimes in Islamic firms (DFSA: 2010). Under the Shari’ah Systems Regulator requirements, the firm must have systems and controls to implement the SSB’s rulings and must conduct annual Shari’ah reviews and audits and produce disclosures based on AAOIFI standards (DFSA: 2010). In general, most of the disclosures recommended by the IFSB are already mandated in the DFSA rules (DFSA: 2011) and the DFSA currently requires the use of AAOIFI standards for Islamic financial business (DFSA: 2011). In addition, the DFSA utilises the IFSB standards in determining its capital adequacy regulations and there are also special rules for Islamic funds and for sukuk (DFSA: 2010).

The DIFC has been actively promoting Islamic finance with the Law Regulating Islamic Financial Business DIFC Law No. 13 of 2004, the establishment of the Islamic Finance Advisory Council in 2005, the presence of the Islamic International Rating Agency (‘IIRA’) from 2006, and an MOU between the DFSA and the Securities Commission of Malaysia facilitating cross-border flows of Islamic Finance between the DIFC and Malaysia in 2006. There appears to be a substantial amount of Islamic finance business being conducted in the DIFC, under the regulation of the DFSA, however, the DIFC lacks an adequate Islamic finance dispute resolution mechanism and centralised Shari’ah authority.

DWIFAC, which shall be funded by Sheikh Mohammed bin Rashid Al Maktoum, may act as the independent central dispute resolution authority and Shari’ah regulator connecting all of the adjudication apparatus of Dubai, the UAE, and the DIFC into one consolidated framework for the adjudication of Islamic finance disputes with a centralised Shari’ah authority in the form of the Shari’ah Supreme Council. The decisions of the Shari’ah Supreme Council shall be binding and available to the public for review, thereby giving certainty to legal decisions and promoting confidence amongst investors. The DIFC, Dubai Courts, Central Bank of the UAE and the IICRCA may refer arbitration to DWIFAC and/or utilise the DWIFAC Ambassador’s List and facilities. In addition, DWIFAC may utilise the expert determination, mediation, and other services of the Dubai and DIFC Courts and the arbitrators of the IICRCA, DIFC-LCIA, DIAC and the Central Bank of the UAE governance unit. DWIFAC awards may be enforceable in the Dubai and DIFC Courts through a special protocol.


The DWIFAC arbitration centre along with the DWIFAC jurisprudence office provides the best solution to the dispute resolution conundrum of the Islamic finance industry, providing a globally recognised centre for dispute resolution. It is located in one of the world’s major financial centres, which adjudicates disputes using arbitration incorporating lex mercatoria and Shari’ah, the DWIFACJO uniform banking law, the DWIFAC arbitration rules and the procedural law of Dubai as well as using highly qualified Shari’ah and Islamic finance/law arbitrators. DWIFAC may also organise and utilise the existing dispute resolution framework in Dubai, the DIFC and the UAE, consolidating the centres into one hierarchical system, which includes the Shari’ah Supreme Council for the efficient adjudication and regulation of Islamic finance disputes.

Agha, O. (2009) ‘Islamic Finance Dispute Resolution’, Islamic Finance News, Leading Lawyers Report 28, pp. 29-31.
Al-Bali, A.H.M. (2006) Legislation on Islamic Banking: A Comparative Study, Conference Proceeding’, 6th Annual AAOIFI Conference of the Shari’ah Boards of Islamic Financial Institutions, Manama, Bahrain.
Aldohni, A.K. (2009) ‘The Challenge of Islamic Banking Disputes in the English Courts: The Applied Law’, Journal of International Banking and Financial Law, vol. 24, no. 6, pp. 350-356.
Aldohni AK (2011) The Legal and Regulatory Aspects of Islamic Banking, A Comparative Look at the United Kingdom and Malaysia, London and New York: Routledge Research in Finance and Banking Law.
Al-Shamsi, J. S. (2005) ‘Restricting Resorting to [Civil] Laws in Contract [Disputes] and Accepting the Arbitration of the Shari’ah Boards Instead, Conference Proceeding,’ The 5th Annual AAOIFI Shari’ah Supervisory Boards Conference for Islamic Financial Institutions, Manama, Bahrain.
Al-Tamimi, E. (2004) Practical Guide to Litigation and Arbitration in the United Arab Emirates, The Netherlands: Kluwer Law International.
Al-Zuhayli, W. (2007) Financial Transactions in Islamic Jurisprudence, Damascus: Dar al Fikr.
Azlin, A. (2013) Islamic Financing and the Relevant Laws of the UAE, Al-Tamimi and Company [Online], Available: http://www.tamimi.com/en/magazine/law-update/section-7/june-5/islamic-financing-and-the-relevant-laws-of-the-uae.html [13 August 2013].
Anthony, G. and Marrone, M.A. (2010) Recent Developments in Arbitration Law in the Middle East, [Online], Available: http://www.wwhgd.com/news-article-71.html [27 July 2013]
Archer, S. and Karim, R.A.A. (ed.) (2007) Islamic Finance: The Regulatory Challenge, Singapore: John Wiley & Sons (Asia) Party Limited.
Balz, K. (2008) ‘Shari’ah Risk? How Islamic Finance Has Transformed Islamic Contract Law’, Occasional Publications 9, Harvard Law School: Islamic Legal Studies Programme.
Balz, K. (2004) ‘A Murabahah Transaction in English Court’, Islamic Law and Society, vol. 11, pp. 117-134.
Bank Islam Malaysia Bhd v Azhar Osman & Other Cases [2010] 5 CLJ 54 [2010] 1 LNS 251.
Beximco Pharmaceuticals Ltd, Bangladesh Export Import Co. Ltd., Mr. Ahmad Solail Fasiuhur Rahman, Beximco (Holdings) Ltd. v. Shamil Bank of Bahrain E.C. [2004] EWCA Civ 19.
Blake, S., Browne, J. and Sime, S. (2013) The Jackson ADR Handbook, Oxford: Oxford University Press.
Civil Procedures Law, Federal Law No. 11 of 1992 as amended by Federal Law No. 30 of 2005.
Civil Transactions Law Federal Law No. 5 of 1985.
Colon, J.C. (2011) ‘Choice of Law and Islamic Finance’, Texas International Law Journal, vol. 46, pp. 411 – 435.
DIFC Courts. (2009) Protocol of Enforcement Between the Dubai Courts and DIFC Courts (2009), [Online], Available: http://difccourts.complinet.com/net_file_store/new_rulebooks/d/i/DIFCC_enf_protocol_summary.pdf [27 July 2013].
DIFC Courts. (2009) Summary of the 2009 Protocol of Enforcement between the Dubai Courts and DIFC Courts, [Online], Available: http://difccourts.complinet.com/net_file_store/new_rulebooks/d/i/DIFCC_enf_protocol_summary.pdf [27 July 2013].
De Silva, D. (2010) Dispute Resolution Mechanisms in FIDIC Conditions of Contract, [Online], Available: http://www.scribd.com/doc/45220781/Dispute-Resolution-Mechanisums-in-Fidic-Conditions-of-Contracts [14 April 2013].
DFSA. (2010) The DFSA’s Approach to Regulating Islamic Finance in the DIFC, [Online], Available: http://www.dfsa.ae/Documents/Islamic%20finance%20docs%20for%20upload/DFSA’s%20approach%20to%20regulating%20Islamic%20finance.pdf [13 August 2013].
DFSA. (2011) Consultation Paper No. 79, [Online], Available: http://dfsa.complinet.com/net_file_store/new_rulebooks/d/f/DFSA_CP79__Sharia_Gov.pdf [13 August 2013].
Eltom, O. (2009) The Emirates Law in Practice, Dubai: Future Book Shop.
FIDIC Red Book (1999) London: Thomas Telford Publishing.
Foster, N.H.D. (2006) ‘Encounters Between Legal Systems: Recent Cases Concerning Islamic Commercial Law in Secular Courts’, Amicus Curiae, vol. 68, pp. 2-9.
Hamid, T.A. and Trakic, M.A. (2012) ‘Enforceability of Islamic Financial Contracts in Secular Jurisdictions: Malaysian Law as the Law of Reference and Malaysian Courts as the Forum for Settlement of Disputes’, ISRA Research Paper, no. 33, pp. 1-34.
Hasan, Z. and Asutay, M. (2011) ‘An Analysis of the Courts ‘Decisions on Islamic Finance Disputes’, ISRA International Journal of Islamic Finance, vol. 3, no. 2, pp. 41-71.
Hoyle, M. (2009) ‘Specific Issues in Islamic Dispute Resolution’, Arbitration Magazine, vol. 75, pp. 219-222.
International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai 300 F. Supp. 2d 112 (DDC. 2004).
Investment Dar Co. KSCC v Blom Development Bank Sal [2009] EWHC 3545.
ISRA. (2012), Islamic Financial System, Principles, and Operations, Kuala Lumpur: International Shari’ah Research Academy (ISRA).
Jaris, J., Mohd, N.A. and Halili, K. (2011) ‘Alternative Dispute Resolution in Islamic Finance: Recent Development in Malaysia’, International Journal of Social Sciences and Humanity Studies, vol. 3, no. 1, pp. 185-195.
Jenkins, J. and Stebbings, S. (2006) International Construction Arbitration Law, The Netherlands: Kluwer Law International.
Khan, M.A. (1994) ‘The Federal Court Judgment on Riba and the Unresolved Issues’, Review of Islamic Economics, vol. 3, no. 3, pp. 19-27.
KLRCA Arbitration Rules, [Online], Available: http://www.klrca.org.my/scripts/view-anchor.asp?cat=29 [15 July 2013].
Krichene, N. (2013) Islamic Capital Markets: Theory and Practice, Singapore: John Wiley & Sons Singapore Pte. Ltd.
Lawrence, J. and Khan, H. (2012) ‘Dispute Resolution in Islamic Finance’, Global Islamic Finance Report, Leading Lawyer’s Report 28, 1-33.
Moghul, F. U. and Ahmed. A. A. (2003-2004) ‘Contractual Forms in Islamic Finance Law and Islamic Investment Company of the Gulf (Bahamas) Ltd. v Symphony Gems NV & Ors: A First Impression of Islamic Finance’, Fordham International Law Journal, vol. 27, pp. 150-194.
Muhammad, M. (2010) ‘The Implementation of Riba in Islamic Banking and Finance: An Analysis in Terms of Banking Operations and Maqasid Shari’ah’, ISRA International Journal of Islamic Finance, vol. 2, no. 1, pp. 157-160.
Nassif, K.J. (2009) ‘Note on Arbitration Under UAE Law’ DIAC Journal, vol. 3, no. 2, pp. 42.
Nurlaelawati, E. and Rahim, A. (2012) ‘The Training, Appointment, and Supervision of Islamic Judges in Indonesia’, Pacific Rim Law & Policy Journal at the University of Washington, vol. 21, no. 1, pp. 43-64.
Oseni, U.A. (2009) ‘Dispute Resolution in Islamic Banking and Finance: Current Trends and Future Perspectives’, Conference Proceeding at the International Conference on Islamic Financial Services: Emerging Opportunities for Law/Economic Reforms of the Developing Nations, 6-8 October 2009, University of Ilorin, Kwara State, Nigeria, organised by the Department of Islamic Law, University of Ilorin-Nigeria and Islamic Research and Training Institute (IRTI), IDB Group, Jeddah, Saudi Arabia.
Oseni, U.A. and Ahmad, A.U. F. (2011) ‘Dispute Resolution in Islamic Finance: A Case Analysis of Malaysia’, 8th International Conference on Islamic Economics and Finance 19-21 December 2011, Centre for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation.
Polkinghorne, M. (2008) Enforcement of Annulled Awards in France: The Sting in the Tail, International Construction Law Review, [Online] Available: http://www.whitecase.com/files/Publication/9519e3f5-1c7b-4531-8a62-a6ac59dc87de/Presentation/ublicationAttachment/153d6bd2-17f4-48a0-94b2-af4265abf8fc/article_Annulled_awards_v3.pdf [27 July 2013].
Redfern, A., Hunter, M., Blackaby, N. and Partasides, C. (2009) Law and Practice of International Commercial Arbitration, USA: Oxford University Press.
Salah, O. (2010) ‘Dubai Debt Crisis: A Legal Analysis of the Nakheel Sukuk’, Berkeley Journal of International Law, vol. 4, no. 22, pp. 19-32.
Tabari, N. M. (2010) ‘Islamic Finance and the Modern World: The Legal Principles Governing Islamic Finance in International Trade’, Company Lawyer, vol. 31, no. 8, pp. 23-28.
Thani, N.N., Mohamed Ridza Mohamed Abdullah and Hassan, M.H. (2007) Law and Practice of Islamic Banking and Finance, Malaysia: Sweet and Maxwell.
Toutounchian, I. (2009) Islamic Money and Banking: Integrating Money in Capital Theory, UK: Wiley Finance.
Van Greuning, H. and Iqbal, Z. (2008) Risk Analysis for Islamic Banks, Washington D.C: World Bank.
Yacoob, H. (2011) ‘A Critical Appraisal of Islamic Finance Cases and the Way Forward’, ISRA Research Paper, no. 19, pp. 1-28.
Yacoob, H., Muhammad, M. and Smolo, E. (2011) ‘International Convention for Islamic Finance: Towards Standardisation’, ISRA Research Paper, no. 29, pp. 1-58.

Hylmun Izhar

Camille Paldi is a UK Commonwealth and US trained lawyer certified in EU and Chinese legal systems from the European University Institute in Italy and the East China University of Law and Politics in Shanghai. Ms. Paldi founded the Franco-American Alliance for Islamic Finance and ilovetheuae.com (UAE Laws and Islamic Finance).


April 2015 Lecture - Accounting and Reporting Practices for Islamic Banks in UK and Overseas by Mohammed Amin

Mr Amin said that he would begin his lecture by looking at the objectives of accounting as set out by the IASB (International Accounting Standards Board) and AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) and their theoretical implications and then go on to talk about some recent developments that he felt would improve consistency in accounting standards. He said he would conclude with some recommendations of his own.

The Objectives of Accounting

The IASB set out, quite some time ago, their overall conceptual framework. The objectives are to provide financial information, measure performance and help people make economic decisions. These objectives are governed by the concepts of substance and economic reality. That is a very clear and focussed set of objectives.

AAOIFI on the other hand has separate types of objectives. Very much in line with the IASB, the key objective is to report an organisation’s financial position, but in a manner that will reveal what is halal and what is haram. The problem is that the twin objectives may conflict.

Theoretical Implications

Taking a hypothetical example, a customer owns a building, purchased for $20, many years ago. In January 2012 they sell the building to the bank for $100 and enter into a leaseback arrangement for $5 per annum for three years and then they are going to buy the building back for $110. That transaction can be arranged using conventional accounting practices. Alternatively it is possible to arrange the transaction using Shari’ah-compliant contracts.

The building belongs to the bank during the lease period; a proper sale has taken place, but under both conventional and Islamic accounting rules, the bank has no economic interest in the building. The agreement is that a certain sum will be paid to the bank at the contract’s maturity, regardless of whether the market value of the property has increased or decreased in the intervening three years.

Under IFRS (International Financial Reporting Standards) the building stays on the customer’s balance sheet, effectively behaving as though there has been no sale. The bank will simply report interest income of $5 in each of the three years of the lease, because, as far as the bank is concerned, this is just another loan. The building is simply the security for the loan. The customer keeps the building on its balance sheet and shows the loan liability to the bank.

Mr Amin said AAOIFI should show real transactions, but one thing they have not bothered doing is checking this example against their own published accounting standards. Mr Amin said he wanted to bring out the principles behind AAOIFI’s commitment to report real transactions showing whether something is Shari’ah compliant or not. This has been a genuine sale. If you are reporting what really happened, the customer has received $100 in cash for a building they bought for $20 and the tax authorities may well want to tax that gain. In the absence of special tax law, there is a taxable sale of this building. If you did this transaction in the UK, right now, I suspect the gain would be taxable. The chart below shows how IFRS and AAOIFI would report the transactions.

The theoretical conclusions are that:

• IFRS accounting shows the economic effect of transactions
• Many Islamic finance transactions are economically equivalent to interest-based transactions. IFRS accounts for them accordingly
• The main goal of AAOIFI accounting standards is to assess whether transactions are Shari’ah compliant
• Theoretical analysis suggests this should often result in different accounting from IFRS.

AAOIFI has conflicting standards – to assess Shari’ah compliance and at the same time to report economic effects. Mr Amin said

that he would expect these conflicting goals to lead to problematic accounting standards.

Who Uses Which Standards

The Americans are a law unto themselves. They have US GAAP, which at one time used to be the most important accounting standard in the world, but, because the rest of the world ganged up and decided to IFRS, America has realised it cannot rule the world in terms of accounting. As a result, there is an agreement between the US Financial Standards Accounting Board (FASB) and the International Accounting Standards Board (IASB) to converge. Most of that convergence will be done by the Americans, so eventually the Americans should be accounting under IFRS.

AAOIFI accounting standards are used and are compulsory for Islamic financial institutions in Bahrain, Jordan, Lebanon, Oman and Sudan. The rest of the world ignores AAOIFI accounting standards, including countries you would expect to use them such as Saudi Arabia and the UAE. Even Iran does not bother with AAOIFI accounting standards, even though all banking in Iran is Islamic by law.

Mr Amin commented that he has been saying for several years that AAOIFI is wasting its time. It is producing accounting standards for such a small part of the planet that it might as well not bother. Malaysia, the UK, the UAE, Saudi Arabia and so on all account under IFRS.

Achieving Greater Consistency

How do we get consistency? Firstly, the IASB is starting to take Islamic finance seriously. For a long time they ignored Islamic finance, but they have decided to be helpful, because there has been inconsistency in the way different Islamic banks account for identical transactions. This was as a result of there being no detailed application guidance in IFRS for Islamic banks; banks and their auditors were free at times to make up their own minds.

The IASB set up a consultative group on Shari’ah-compliant transactions. It commenced work in July 2013 and they set out four areas on which to focus:

1. the application of IFRS 9’s classification and measurement principles
2. the application of the IASB’s proposed lease standard to ijarah
3. whether restricted and unrestricted investment accounts are to be presented on or off balance sheet
4. profit equalisation reserves due to significant differences in practice

Mr Amin said that in his opinion the third area of focus is probably the most important. If one bank has something on its balance sheet and another bank does not, that is a pretty big difference.

AAOIFI’s initial reaction was that they did not want to know. From day one they were invited to join the IASB consultative group and without any clear explanation as to why, they said no. Some 18 months later, in December 2014, common sense prevailed and they decided to join and they are even going to host the next meeting of the group. Mr Amin said that he expected that IFRS rules and guidance on accounting for Islamic financial transactions should lead to much greater consistency across the world.

NEWHORIZON     Rabi Al Awwal - Shaban 1436 IIBI LECTURES

Specific Issues and Examples

The Asian-Oceanian Standard Setters Group (AOSSG) is based mostly in South-East Asia and includes countries such as Malaysia. The Group had been looking seriously at Islamic finance for some time. In March 2015 they published a study called ‘Financial Reporting by Islamic Financial Institutions: A study of financial statements of Islamic financial institutions’, which is really illuminating. The sample consisted of 132 Islamic financial institutions across 31 countries, with no more than 10 respondents per country. All of the respondents were drawn from the ‘Top Islamic Financial Institutions’ list published by The Banker in November 2013. The respondent organisations had to have accounts in English. The full report is freely available on the following website: http://www.aossg.org/docs/Publications/AOSSG_Islamic_Finance_WG-Paper_Post_6th_Meeting-2_Mar15.pdf.

According to the survey the reporting framework for the sample institutions was as follows:

• 46% IFRS or IFRS as adopted by the jurisdiction • 34% local GAAP – 14% without differential requirements for Islamic transactions and 20% with differential requirements for Islamic transactions
• 18% AAOIFI
• 2% unspecified

What actually happened when accounting for leases? There were 87 instances of lessors in ijarah with arrangements to transfer ownership of which:

• 14% recognised IAS 17 finance lease receivable
• 45% recognised IAS 39/IFRS 9 financial asset at amortised cost
• 37% recognised AAOIFI FAS No 8 leased asset subject to depreciation.

The other big area is customer investment accounts. Industry practice says that there are two different kinds of such accounts. There are unrestricted ones where a customer hands over money to the bank; the bank does with it whatever it wants and shares some of the profits with the customer. There are also restricted ones, where the customer, usually a large customer, stipulates what the bank can do with it, which is much closer to asset management. The issue is how do you classify these accounts? Are they a liability of the bank; are they part of the bank’s equity like a minority interest, where it is equity as far as outside creditors are concerned, but it is not really true equity, because the return is being paid out to the investor or do you ignore them completely and have it off balance sheet? While having a bank liability off balance sheet sounds really perverse, you have it in the model of asset management. If you look at the accounts of an asset management company, you will find that the one thing it does not have on its balance sheet is vast quantities of investments, because these are held in trust for the people who put the money into the funds. In fact the investments are often held by third-party custodians. It is a case of what is an acceptable model in the case of Islamic banks operating customer investment accounts.

What actually happens in practice? A lot of banks do not even distinguish between unrestricted and restricted accounts; they do not distinguish between deposits that are genuine liabilities and investment accounts. That demonstrates how sloppy an enormous amount of Islamic banking is. Mr Amin expressed the view that it was sad that many of these banks probably have ‘big four’ accounting firms signing off their accounts.

Since there is not that kind of disclosure what the study did was to use the language that banks actually use; they will usually describe this as some kind of mudarabah transaction, so that is what the study used. They found that 79 of the respondent banks had them. Of these 79, 50 recorded them as financial liabilities; 13 as an intermediary element between liability and equity; 12 as an intermediary element off balance sheet; three as a financial liability and off balance sheet and one off balance sheet. This was incredibly inconsistent accounting.

Looking first at ijarah, how did the 87 banks using this instrument account for the financing?

• 61% used the effective interest method
• 9% used proportional allocation
• 14% used a ‘time-apportioned’ basis
• 16% used some other method such as straight line, cash or accruals.

Again there is a terrible lack of consistency. It is to be hoped that as the IFRS consultative group start to produce really detailed applications, this kind of inconsistency will become a thing of the past at least in the countries that adopt IFRS standards. It will take longer in countries that have some other standard.

The situation was very similar with the 111 banks that had murabaha transactions.
64 used the effective interest method
11 used proportional allocation
12 used a ‘time-apportioned’ basis
24 used other methods including straight line, cash and accruals.

Mr Amin commented that using a straight-line method was like something out of the 1800s.

Asim Khan

Mohammed Amin graduated in mathematics from Clare College, Cambridge and obtained a Post Graduate Certificate in Education from Leeds University. He then trained as a chartered accountant and in 1978 qualified as a chartered tax advisor. In 1995 he also became an associate member of the Association of Corporate Treasurers.

For 33 years he practiced as a tax advisor, most recently spending 19 years as a tax partner in Price Waterhouse, now PricewaterhouseCoopers LLP. He was the first Muslim to be admitted to the Price Waterhouse partnership in the UK, specialising in international tax and the taxation of derivatives and foreign exchange and for four years he led the firm’s UK finance and treasury tax network.

Before his retirement at the end of 2009, he was PwC’s head of Islamic finance in the UK and a member of PwC’s four person Global Islamic Finance Leadership Team. He has presented on Islamic finance around the world as well as advising the UK Government. In retirement, as well as Islamic finance consulting and writing, he now spends most of his time ‘giving back’ to the community by writing, speaking, informal mentoring and active involvement in a number of organisations. He has a longstanding relationship with IIBI, being a regular speaker at IIBI events and a frequent contributor to New Horizon, of which he is a member of the Editorial Advisory Board.

Asim currently works with Khalijislamic and specialises in developing and monitoring Islamic financial products and has structured various Islamic finance transactions (including sukuk and Shari’ah-compliant structured notes); developed various Shari’ah-compliant investment funds (including sukuk funds, hedge funds, long-short equity funds, etc.); established monitoring processes for on-going Shari’ah compliance for various Islamic products (including that of Islamic indices, Shari’ah-compliant investment banking products, private equity and infrastructure funds); converted various conventional products into Shari’ah-compliant products and advised on purification strategies for non-Shari’ah-compliant income.


Firstly, how should you think about the accounting issues themselves? Before you can come up with detailed recommendations about how to account, you need a conceptual framework. Mr Amin said that his view, which is very controversial, is that Islamic banks are banks. A bank is an organisation that receives money from one set of customers; provides finance to another set of customers and makes money from that process either by charging for specific services or engaging in credit or maturity transformation. When you put money into a bank you are usually highly confident of getting that money out of the bank on the day when the bank has promised to give it to you. With credit risk the bank is giving that money to people you would not normally want to supply it to yourself such as small businesses, third parties that you do not know, and customers borrowing money for mortgages. The bank sits in the middle and takes that credit risk. With maturity transformation the bank takes your money and promises to give it back to you in seven days’ time, meanwhile they will lend it to somebody for five years. As long as the bank is good at juggling that, there is nothing wrong with it.

The purpose of accounting for the way that banks operate is to measure economic reality. That leads to my first recommendation, which is that all Islamic bank accounts should be prepared under IFRS, because IFRS is designed with one goal in mind and one goal only, which is to measure economic reality as best you can. You can argue about individual standards, but the goal is to measure economic reality and that is the best way of doing it.

There is, however, a second leg to this conceptual framework, because I have not forgotten that Islamic banks are Islamic banks and that really matters. It matters to their shareholders. There are people who will own shares in Islamic banks, who will never own shares in a conventional bank, because they believe it would be against the laws of God to do so. There are also staff who work in Islamic banks and who do not want to work in a conventional bank. People depositing money and the people being financed are also dealing with an Islamic bank, because it is an Islamic bank. The bank, therefore, must provide additional disclosures beyond IFRS to demonstrate Shari’ah compliance, but the way to demonstrate Shari’ah compliance is not by messing up the primary financial statements. Additional information in the notes to the accounts to demonstrate Shari’ah compliance is highly desirable.


May 2015 Lecture - From Halal to Halal and Tayyib
by M Iqbal Asaria


Mr Iqbal Asaria began by observing that there is an increasingly significant role for Islamic finance in Malaysia and in many GCC countries. Malaysia has set a target for Islamic finance to be 25% of its economy in the next three years and it is working systematically to achieve that.

Most of the products that we see, however, are reverse engineered from conventional products and this has both benefits and pitfalls; Islamic finance institutions may have to fit things into structures with which they do not agree. For example, one of the main issues that practitioners face is how to structure things without interest-bearing debt and working around that involves quite challenging problems. Not least it can result in Islamic financial products being more expensive.

A structure that is based on murabaha, which is cost plus financing and known as tawarruq, has come to dominate retail banking structures. Mr Asaria said that in his view this is one of the least satisfactory Islamic finance products intellectually speaking. In any new products coming to the market such as credit cards and consumption loans there is a tendency to mimic conventional products and not to look for newer, more innovative solutions. There is an increase in the issuance of sukuk, which is trying to replace interest-bearing bonds, but in doing that the balance between equity and debt has been skewed towards debt, particularly because of rating agencies, which understand debt-based structures better; they do not understand equity structures in terms of rating. There is, therefore, a tension between having equity structures and not having them. Part of the benefit of the Basel III capital requirements is that some Islamic banks have been forced to issue what are called perpetual tier one bonds, which are much more loss absorbing than before. These have come about, however, through necessity, to meet Basel III requirements rather than positive design moves on the party of Islamic banks.

One key question is – are we going to a great deal of effort for something that has no real benefits; is there any real social impact. In addition Shari’ah has a certain number of basic objectives. For example, Muslim economists have always contended that the basic purpose of economics in Islam is to deliver a certain degree of equity and justice. Are these financial products advancing that objective or not? If not, where is Islamic finance going wrong? This is the challenge we are posed today.


There is the term halal, which is well known. In general it signifies permissibility’ in principle it is permissible. Sometimes, however, in the Qur’an itself Allah decides to use the terms halal and tayyib together – permissible and wholesome. The question is why. If halal is enough, why does he add another qualifying objective. There is something in wholesomeness that needs to be examined. Is something that is halal always wholesome? If not, what do we need to do to make it wholesome?

About 10 years ago a debate started about the terms Shari’ah compliant and Shari’ah based. For example, in the 1960s, Professor Aziz, who was a professor of economics in the University of Malaysia and also the father of the present governor of the central bank of Malaysia, wrote a paper and presented it to the prime minister, that said the basic desire of every Malay, in the main rural, agricultural workers, was to go for hajj. They would save for their whole lives to fulfil this desire. He said that if Malaysia was to form an institution so that they could save money, which would be invested back into improving agricultural production, then they would be able to go for hajj eight years earlier. When they looked at it later, it was actually 12 years earlier. They formed a pilgrims’ fund, which had 4.3 million customers. When Bank Islam was formed in Malaysia in the 1980s, the pilgrims’ fund too the majority stake and so the bank opened with 4.3 million customers. We will call that Shari’ah based. There was a need with which people could identify and then grow with it.

Following the financial crisis, there began to be talk of morality in economics; it cannot be a completely amoral activity. There are consequences, particularly in terms of inequality, that need to be factored in. There is also the issue of ethics with socially-responsible and environmentally sensitive funds. Increasing numbers of people want to know how their money is being used rather than just sitting back and accepting a return.

The Moral Context

Most people will probably know Adam Smith as the author of The Wealth of Nations, in which he talks about the invisible hand of the market, but not many people know that his first book was called The Theory of Moral Sentiments. It includes the following:

‘When the general rules, which determine the merit and demerit of actions come thus to be regarded as the laws of an All-powerful Being, who watches over our conduct and who in the life to come will reward the observance and punish the breach of them; they necessarily acquire a new sacredness from this consideration. That our regard to the will of the Deity ought to be the supreme rule of our conduct can be doubted by nobody who believes his existence. How vain, how absurd would it be for man, either to oppose or neglect the commands that were laid upon him by Infinite Wisdom, and Infinite Power. The idea that however we may escape the observation of man or be placed above the reach of human punishment, yet we are always acting under the eye and exposed to the punishment of God, the greatest avenger of injustice, is a motive capable of restraining the most headstrong passions.’

This is the moral context when he is talking about the operations of the market. If you strip away the moral context, you get what we have today. Similarly Islamic finance, if it is stripped of its moral context, we get what we have today. We need to rebuild the moral context.

If you talk to Muslims about Islamic finance, they say, ‘Just remove riba and everything will be fine.’ It is just like people who say, ‘Just leave the market alone and everything will be fine.’ Mr Asaria said that he does not think that is true.

We define Shari’ah compliance as the removal of riba and do not think about anything else. Other parameters are ignored or de-emphasised and so you have a disconnect between form and substance. In form you have removed riba, but in substance nothing is changing.

Iqbal Iqbal

M Iqbal Asaria, a qualified economist and accountant, is an associate of Afkar Consulting Ltd. He is also head of European operations for Yasaar Ltd and non-executive director at Amiri Capital Services. He has worked as an investment analyst in the City of London for several years. More recently he has been involved in consultancy on financial product structuring and niche marketing services to faith and ethnic communities in the UK and was a member of the Governor of the Bank of England’s working party set up to facilitate the introduction of Shari’ah-compliant financial products in the UK market. He teaches graduate level courses in Islamic finance, banking and insurance at a variety of UK universities and business schools. He was awarded a CBE in 2005 for services to international development.

Atomistic versus Holistic Views

The problem is that the view of Shari’ah scholars and jurists is atomistic; it is not holistic. Take a product such as tawarruq, you want a loan of $100 from the bank and you want to pay it back in a year. A normal loan where you pay interest would be haram, so it needs to be structured to be Shari’ah compliant.

You go to the bank and the banks says it will buy a commodity from Supplier A at $100; the bank sells it to you at $110 payable in year one as a murabaha contract; you will sell the commodity to Buyer B and get $100. At the end of the year you will pay $110 to the bank. Neither you nor the bank care what the commodity was or whether it was actually purchased or not, but it is a fully Shari’ah-compliant transaction, so the scholars will say it is fine.

In form it is fully compliant, but in substance you can see that it is problematic. For many retail Islamic banks, this is 80% of their balance sheet.

There is another problem here. The loan you get can be spent on anything; there are no conditions attached to the loan in terms of the purpose, so once again the connection between the real economy and the monetary economy is lost. Originally it was designed to link productive purposes and finance. The way it is used now is like normal consumer debt, so the main underlying objective, the maqasid, is gone.

There is no holistic perspective. The scholars are not looking at what the end result of the transaction is. They are looking at each part of the transaction; each part is compliant so the whole transaction is compliant. We cannot go on like this; we need to find a process to stop making things halal that are not wholesome. Can things become haram because they are not wholesome? It is a difficult issue.

Halal Debt

If you do stock screening, one of the criteria is the gearing ratio, the percentage of debt, should be under one third. This is a rule laid down by Shari’ah scholars. What happens if it is Islamic debt? It does not count as debt, but the risk of bankruptcy is the same, whether the debt is interest bearing or Islamic. Wherever there is a fixed payment the possibility of bankruptcy is there when profits decline, so the bankruptcy risk is not mitigated by it being halal. This is a problem.

Islamic Finance in Context

The question is can Islamic finance flourish when there are other socio-economic factors making it difficult to achieve the objectives that should characterise a Muslim society. Sayyid Nawab Haider Naqvi, who was the president of the Pakistan Institute of Development Economics, wrote a book called Ethics and Economics. At the time he wrote the book there was a demand that riba should be removed from Pakistan. It was his view that this would do nothing for Pakistan; it would make no difference to people’s lives, so what was the point. He said the priority was not riba. There were other things such as literacy levels that needed to change more urgently to make a difference. He was ridiculed for his views, but Mr Asaria said that he thought this was a view that needed to be considered in relation to Islamic finance.

Alternative Approaches

The Shari’ah supervisory process is very atomistic and Shari’ah scholars tend to take the view that it is not their job to look at things in their holistic context. Their vision is limited to Shari’ah compliance. We need to find ways to encourage them to take a broader view.

We need to look at whether things that are halal are also tayyib, because being closer to that ideal will bring us closer to being ethical, socially-responsible communities. In the 1980s and 1990s there was a big debate with and among the multilateral institutions about how to measure the effect of their poverty-reduction activities. Eventually that discussion led to the publication of the Millennium Development Goals. Now, staff at the World Bank, for example, have to state on every project how it will impact on any of the MDGs. The challenge for Islamic finance is to find as similar measure to embed some of our desired objectives, because the Shari’ah scholars cannot do it. If, however, we do not do it, Mr Asaria expressed the view that young people will not take up Islamic finance; they might study it, because it might help them to get a job, but they will not take up the products. When researchers ask people whether they will take up Islamic products, they say they will, but the fact is that they do not. Mrs Asaria said that he felt strongly that part of the solution was to combine halal and tayyib.

NEWHORIZON     Rabi Al Awwal - Shaban 1436 IIBI LECTURES

June 2015 Lecture - External Shari’ah Compliance Audit and Islamic Funds’ Challenges and Practicalities
by Dr Najib Aswad

Dr Najib Al Aswad said that islamic Funds receive far less attention than Islamic banks, probably because they form a much smaller part of the Islamic finance industry, but at the end of the day they make a reasonable impact. Unfortunately there are astonishing practices in the market, where you see financial institutions claiming to be Islamic without even having the minimum requirement of being Shari’ah compliant, without having the requisite knowledge and sometimes you see organisations operating with a fatwa signed in 1995 and applying it in the current market. This is why it is critical to have an understanding about Shari’ah-compliance requirements and the context of Islamic funds, especially now because of the recent growth in their numbers and the size of the funds they control. (Currently Islamic funds stand at $80 billion and are projected to reach $180 billion within five years.)

Shari’ah Compliance and Governance

Shari’ah for Muslims is the legal framework that regulates all aspects of their lives and that includes the relationship between them and their God and also the relationship between them and other human beings. In the context of Islamic financial institutions the situation will be a bit more complex. Mr Al Aswad said that he intended to look at the practical issues and try to avoid the theological background about what Shari’ah is and what are the sources and go straight to how it is being implemented by Islamic financial institutions and funds in reality.

Islamic funds are financial institutions that have to be regulated and they also have to be Shari’ah compliant. They are subject to two governance models – the corporate governance model and the Shari’ah governance model. This is what makes them different; Shari’ah compliance in the context of Islamic finance is a moral and spiritual duty. In some jurisdictions such as Oman and Bahrain the regulators have made a specific set of regulations with which they need to comply, if they are claiming to be Shari’ah compliant.

Is conformity with the rules of Shari’ah something that is complementary or is it an obligation? It is an obligation from a spiritual point of view, sometimes from a regulatory point of view and from a transparency point of view. When an organisations claims a product is Shari’ah compliant, clients have a right to know and the organisations has the obligation of proving that its products and services are Shari’ah compliant.

When there is a failure to adhere to Shari’ah principles, there is the danger of having non-Shari’ah-compliance risk. This is a risk that is unique to Islamic finance institutions. It can be very significant and can lead to both financial and reputational losses. There have been situations where Islamic finance institutions have had to close down and in the modern world of social media the risk is enhanced. It is, therefore, very important for Islamic financial institutions to take the issue very seriously.

Key Areas of Shari’ah Non-Compliance

Shari’ah-non-compliance risk is a risk that can affect the financials of a company. Shari’ah governance according to AAOIFI requires a set of components in addition to the normal to the normal organisational structure.

When a company offers products and services that claim to be Shari’ah compliant then you have non-compliance risk straight away. For example, a company can have a murabaha product that is offered to clients, but if there is a single mistake in the implementation, the Shari’ah supervisory board of that institution can decide to purify all the profit, i.e. the profit must be donated to charity. This is why procedures manuals in all Islamic financial institutions have to be reviewed from a Shari’ah-compliance perspective. Shari’ah controls should be added in to make sure the implementation and documentation both comply with Shari’ah requirements.

Even in accounting treatment there is a risk of Shari’ah non-compliance. For example, a delay in a client payment for a murabaha transaction, from a Shari’ah perspective and according to AAOIFI, a bank cannot profit from the delay; it is, however, allowed to make late payment charges if there are no valid reasons for the delay. These late payment charges, however, should be donated to charity. If a late payment charge is accounted as ‘fees receivable’, that is Shari’ah non-compliant; it should be going into a charity account approved by the Shari’ah supervisory board.

Purification and zakah are very specific topics peculiar to Islamic financial institutions. Purification is the amount any Shari’ah board would ask to be donated to charity so it is non-permissible income and should not go into the income statement. Zakah is the obligation for Muslims to donate a certain amount of money on a periodic basis. Some financial institutions offer an advisory service on this to their clients.

Shari’ah Governance Framework

The Shari’ah supervisory board is at the head of the Shari’ah governance framework in any Islamic financial institution. It will consist of a minimum of three Islamic scholars specialising in Fiqh Al-Muamalat, the section of Shari’ah law focussing on dealings between humans and especially financial transactions. Their main duty is overseeing transactions and giving the overarching levels of guidance and supervision.

The second level is Shari’ah review department. This is an internal department that will act as the right hand of the Shari’ah supervisory board. Their role is to provide the day-to-day Shari’ah compliance support, disseminating information and the fatwas that have been approved by the Shari’ah supervisory board.

The third element is the external Shari’ah auditor, whose role is very similar to an external financial auditor providing a second layer of assurance. Their mandate is providing periodic Shari’ah compliance audits to ensure the Shari’ah review department are doing what they are required to do and the organisation is complying with the guidance of the Shari’ah supervisory board.

The Shari’ah supervisory board and the external Shari’ah auditor are independent bodies, although they are employed by the Islamic financial institution.

External Shari’ah Compliance Audit

This is the process of reviewing the controls, procedures and investment transactions to ensure three objectives are met. Firstly, there is the overall Shari’ah compliance test on the investments of the fund. Second, there is the strength of the internal control system so that, if there is a Shari’ah-non-compliance issue, internal controls can determine why it has occurred and how it can be resolved. Third, have the management performed their role in a manner that will ensure the requirements of Shari’ah are met.

The process is very simple and is very similar to any financial audit. There are four phases. Firstly, there is a planning phase to agree on the scope of the Shari’ah audit, the timeline, agree the parameters that need to be checked and identify any potentially weak areas in relation to Shari’ah non-compliance. The second stage is execution. The third stage is reporting, discussing the findings of the audit with the management, getting their feedback and finally documenting everything so that it can be presented to the Shari’ah supervisory board for their approval. Once the report has been approved, the final stage is a follow up to ensure that any agreed remedial actions have been implemented.

The Planning Stage

Islamic funds will have two objectives – the Shari’ah-compliance status of the investments and the strength of the internal controls. Once these two objectives have been agreed with the management, it will be necessary to identify and detail inherent Shari’ah-non-compliance risks in all functions. For example, say we have a public fund investing in stocks, the first area that will need to be examined is the mechanism they have in place for purchasing equities or stocks, which is an area of potential non-compliance. Once the mechanism has been identified the auditor needs to examine the residual risk. So, although there may be an approved list of stocks, the risk is that a manager purchases outside that list.

The Execution Stage

There will be two types of audit folders – current and permanent. The permanent folder contains a complete history, including all the Shari’ah supervisory board meeting minutes with records of all resolutions passed. The current folder contains the documents pertaining to the current audit year including the procedures, which should be updated each year.

With public funds the auditors are probably looking at equities that are passively managed. The Shari’ah requirements for such funds are twofold according to AAOIFI. Firstly the fund needs to exclude all Shari’ah-non-compliant stocks such as companies that produce alcohol and casino operators. Second, is filtering out companies that are Shari’ah compliant, but where there are some non-compliant aspects to their work, such as their exposure to interest-bearing debt. Once these two types of equity are excluded, the fund has the universe from which they can select their investments.

To determine whether the investments meet Shari’ah requirements, the auditor will have to look at a list of purchases, but will also have to look at a list of holdings, because a stock could have been Shari’ah compliant when it was purchased, but has since become non-compliant due to change in its operations. If the auditor finds a non-compliant stock in the purchase list then this is an active breach. If the non-compliant stock is in the holdings list, then is a passive breach. In the latter case, a fund manager may be given a grace period of three months, but if the situation does not change and the stock remains non-compliant then it has to be sold. The active management element needs closer monitoring, because a manager is making investment decisions based on his own calculations, if he is buying outside an approved list and therefore the residual risk is greater.

Private equity funds will be investing in private companies through private arrangements; they are not listed equities and that is another challenge. Private equity funds will normally have two types of transactions – capital calls and share distributions. Typically they will have a lot of investments, effectively spreading their risk, because these small companies represent a higher risk. Some of these companies will take off; others will go bankrupt.

Shari’ah auditors have to look at both types of transaction. In capital calls, the fund invests money and for each capital call there should be Shari’ah approval, i.e. each company should be examined and approved by the Shari’ah review department.

With share distributions, it works the other way around. Shares are coming to the fund manager, but these transactions also need Shari’ah approval.

Sukuk funds are more straightforward. They have been approved by Shari’ah supervisory boards, however some Shari’ah scholars will want to approve every investment and the auditor will have to ascertain whether approval has been granted for each purchase. Other scholars will take a different approach, e.g. giving a list of approved issuers. Much will depend on the structure of the fund and the jurisdiction in which it is located.

Property funds have in two main types – development and rental services. With development funds all the agreements will have to be examined to ensure they are Shari’ah compliant. Similarly with rental services, all agreements have to be examined for Shari’ah compliance and any interest-based clauses have to be removed. In addition the final use of these properties has to be Shari’ah compliant. This is not an issue for residential properties; however, in commercial property it may be if the final use involves, for example, the sale of alcohol.

Tests for purification also have to be checked by the Shari’ah auditor. This involves ensuring that there is a detailed methodology approved by the Shari’ah scholars; there is a procedures manual for implementing the methodology and a template to report this to investors. In the context of public equity, for example, some scholars would recommend using a dividends methodology. This involves looking at every dividend payment and deciding the proportion of the income that needs to be purified. Other Shari’ah scholars would recommend a capital gains methodology together with a dividends methodology, so that, if a stock grows in value, they will need to ensure the stock was Shari’ah compliant throughout the period of the gain. If it was not, the gain would need to be purified. AAOIFI recommend yet a third methodology, which is earnings based, which looks at the total earnings, regardless of whether the company has declared a dividend or made a loss. If there is an earnings line that is not Shari’ah compliant, then it needs to be purified. Typically Islamic funds just notify the investors of the amount of purification as a percentage of their shares, so that purification becomes their own responsibility.


Reporting and Follow-up

All the findings are documented in the Shari’ah compliance audit report. The first stage is the issue rating. Suppose there is an investment that is not Shari’ah compliant; this is an issue that has a significant impact. This is why issues should be divided into two elements – priority and level of significance. Priority dictates how quickly any remedial action should take place; who is responsible for taking that action and what is the risk to which the company is exposed. Once all this has been documented, a rating given and a follow-up plan agreed, then there will be an audit rating. A satisfactory rating means that from the auditor’s point of view this company is operating in a Shari’ah-compliant way. Sometimes the rating is room for improvement and sometimes that rating can be unsatisfactory. The report has to be submitted to the Shari’ah supervisory board and they will have to give their annual fatwa and a list of remedial actions.

The Importance of the External Shari’ah Audit

The foregoing has demonstrated how an external audit works and just how involved the auditors are all the transactions. This reflects the difference between just having a fatwa at the end of the year for this structure and having all this active involvement in the business, ensuring that all the transactions are in compliance with Shari’ah requirements.

Firstly, the importance is acting as a pre-audit risk mitigation tool. When we have this layer of assurance, it will ensure the company is complying with Shari’ah. Having an internal Shari’ah review is sometimes important, but having independent monitoring is very important. The independent verification that all parties in the company are striving to achieve Shari’ah compliance will spread confidence to all stakeholders including investors, the Shari’ah supervisory board and regulators.

Key Challenges for Fund Managers

Firstly, there is lack of awareness and knowledge. Many fund managers think that, because they have started equity funds previously, starting an Islamic fund is not going to be a big issue. Unfortunately that is not the reality.

The Shari’ah-compliance function adds an additional layer of cost to the overall business, which results in lower returns for investors. In addition, sometimes mistakes in the Shari’ah-compliance function might cause the business to incur losses. The fund manager, therefore, needs to structure the Shari’ah-compliance in a cost effective manner, while ensuring Shari’ah compliance.

Any Shari’ah-compliant fund, especially when exposed to public equity, will have a smaller investment universe and therefore fewer diversification opportunities. In investment terms that means they have higher volatility and their exposure to fewer asset classes will make them less competitive and attractive when compared with conventional funds.

An additional headache for the find manager is that he can buy stock that is Shari’ah compliant and after a period of time it becomes non-compliant. Sometimes that will result in having to sell in unfavourable market conditions and potentially make losses.

Sometimes a fund can be holding equity to which warrants and rights are given. Warrants and rights have some Shari’ah-non-compliance issues and so the fund has to sell them in the market, again causing profitability issues.

Conventional fund managers can use interest-based risk hedging tools – options, swaps and futures, for example. This will minimise their exposure to different currencies and market risks. Islamic funds do not have access to all these risk-hedging tools. Although there are some Shari’ah-compliant, risk-hedging tools, they are not widely accepted at the moment and they do not cover all the areas that convention risk-hedging tools do.

Unintentional, non-Shari’ah-compliant income and purification is another key challenge, where the fund manager will have to inform the investors that certain income has to be purified. Again this will reduce the level of return for investors.

Shari’ah-Non-Compliance Violations

Why do violations happen? There is, of course, lack of knowledge. There are also the technical restrictions of the

Najib Al Aswad

Najib Al Aswad is a seasoned and multilingual professional with extensive expertise across various sectors of the Islamic finance industry. Currently as the Senior Manager at IFAAS he is leading many international projects across the Gulf and Europe. He has rich experience in Shari’ah compliance where he has been designing Shari’ah Governance Frameworks, evaluating and assessing Shari’ah non-compliance risks, and conducting Shari’ah audits for many Islamic financial institutions worldwide including a number of Islamic funds with aggregate assets under management of $5 billion.

Najib is an AAOIFI Certified Shari’ah Adviser & Auditor (CSAA - Bahrain), an AAOIFI Certified Islamic Professional Accountant (CIPA - Bahrain), and an Accredited IFQ Trainer by the Chartered Institute for Securities & Investment (CISI - UK). He also holds Distinction in MSc Islamic finance from Durham University and a first class PGDip in Finance & Banking.

investment model. Some investment managers will structure their investment model based on the asset universe that is permissible at a given point. After a few months, however, the Shari’ah-compliant status of these stocks may change. This is a very important violation that needs to be addressed.

There are also rebalancing issues. Some fund managers, particularly passive fund managers, will do rebalancing on a quarterly basis, but if a stock becomes non-compliant within a few days of purchase, the fund will have held a non-compliant stock for almost three months.

Other factors include human error, lack of close supervision in periodic audits and exploiting the guidelines.

Mitigating the risk of Shari’ah non-compliance can be achieved in various ways including building training capacity for all fund managers; making audits a compulsory exercise; developing ad hoc Shari’ah-compliance models to ensure that funds do not face technical restrictions or rebalancing issues and making Shari’ah guidelines and procedures clearer with sanctions when guidelines are ignored.

The Form and Substance Debate

If you go to any Islamic finance conference, there will always be a discussion about form and substance. These debates will identify products that are Shari’ah compliant in form, but they are not achieving the real objectives of Shari’ah. What are the implications for Islamic funds? When auditors look at equities or sukuk, they cannot do much about the structures themselves, because they are just doing the audit. So how can they ensure that the objectives of Shari’ah are being achieved? First they must make sure their external Shari’ah audit is in line with the objectives of the company. The audit should be based on principles and not rules. The audit should also be designed specifically for an individual fund, in line with their needs and not an off-the-shelf solution. The main focus should be added value and not a loss-minimisation tool.

Final Thoughts

• Many of the Islamic funds are located in Islamic countries and the external Shari’ah auditor should have an understanding of the political and cultural sensitivities of those jurisdictions.
• The external Shari’ah-compliance audit should be seen as an evolving tool.
• It should be looked at as an investment, not as a cost to the company.
• It should be integrated within the overall Shari’ah-compliance structure of the company.

If all of these elements are taken into account, then the external Shari’ah-compliance audit should ensure that the substance and the form of doing this exercise have been satisfied.

NEWHORIZON    Rabi Al Awwal - Shaban 1436IIBI NEWS

IIBI Awards in Islamic Banking and Insurance

To-date hundreds of students have secured Islamic finance qualifications from IIBI and many are employed in the Islamic financial sector. Presently students from more than 80 countries are enrolled in IIBI courses by distance learning. Each course builds students’ knowledge of Islamic banking and takaful concepts as well as their practical applications. The Post Graduate Diploma, IIBI’s flagship course, also supports students seeking to pursue higher studies. In the period January to June 2015, the following students successfully completed their studies:

Post Graduate Diploma in Islamic Banking and Insurance (PGD) Awards

► Abba Babandi Gumel, Chief Accountant, Nigerian Railway Corporation, Nigeria

► Abdul Mobeen Akram, UK

► Abdullahi Ismail Ibrahim, Assistant Branch Manager, Chase Bank Kenya Ltd, Kenya

► Ahamed Hibbathur Rahuman Ahamed Ashkar, Junior Executive Assistant, Amana Bank Ltd, Sri Lanka

► Ahmad Usman Kollere, Senior Manager, National Insurance Commission, Nigeria

► Ahmed Shabani Ndope, Director Sterling Capital Ltd, Kenya

►Julien Carasse, Principal Consultant, Syncordis, Luxembourg

► Khadija Ali Mbarak, Cash Officer, Gulf African Bank, Kenya

► Mark Wafula Wanjala, Legal Counsel, Bloom Zeit Ltd, Kenya

► Misdhaaque Ahmed Manarudeen, Finance Officer, Sri Lanka

► Mohamed Ayoub Niyaz, Trainee Banking Associate, Amana Bank Ltd, Sri Lanka

► Mohammad Amir Ashraff, India

► Mohammed Abdallah Mohammed, Delivery Channel, The People’s Bank of Zanzibar, Tanzania

► Mounia Belkadi, Auditor Trainee, ONAPAR, Morocco

► Muhammad Doma, Underwriting Department Head, Niger Insurance Plc, Nigeria

► Saad Allah Benkhabba, Head of Working Capital – MENA Region, WSP/Parsons Brinckerhoff, UAE

► Ahmed Shabani Ndope, Director, Sterling Capital Ltd, Kenya

Diploma in Islamic Banking (DIB) Awards

► Ahmed Taha Abdel Ghani, Associate – Business Development Department, Rige Capital Holdings, Egypt

► Julien Carasse, Principal Consultant, Syncordis, Luxembourg

► Caroline Alexandra Hagg, Trainee Solicitor, Herbert Smith Freehills, UK

► Helena Da Conceicao Enosse, Banco De Mocambique, Mozambique

► Zainab Idris, Denmark

► Igor Beretta, Executive Director, Bank Julius Baer & Co, Switzerland

► Jasri Jamal, Associate Professor, The National University of Malaysia, Malaysia

► Emilia Da Conceicao Fanuel Nabunda Matsinhe, Lawyer Examiner, Banco De Mocambique, Mozambique

► Mohamed Yacoob Kassim, UK

► Moses Ssentamn, Operations Manager, Forex Bureau, Uganada

► Robert Nalbach, Executive Director, Bank Julius Baer & Co, Switzerland

► Wajhe Fatima, UK

Isa Nsereko

Isa Nsereko, Islamic Banking Professional, Uganda I now have a much more clear understanding of Islamic Banking and Finance. The course addressed how the principles and concepts of Islamic Banking are applied within Islamic Financial Institutions (IFIs) and the key challenges faced by the IFIs in the implementation of Islamic Banking and Finance. I have also found the principles and ideology of Takaful very unique from conventional insurance. I now appreciate the need for Islamic Banking and Finance as a value proposition that is geared towards attaining public good and well-being of society at large.

 Ahmer AmmarUsmani

Caroline Alexandra Hagg, Trainee Solicitor, Herbert Smith Freehills, UK I found the course very stimulating. It really opened my eyes to a whole new area of finance. It has been excellent preparation for the work I hope to do in the future as a lawyer,and will hopefully allow me to be seconded to a country or company working under Islamic financial principles

NEWHORIZON    January – June 2015 IIBI NEWS

Diary of Events

September 2015

1-2: Global Ethical Finance Forum, Edinburgh, Scotland

Officially hosted by the Scottish Government, this forum has been organised by Middle East Global Advisors in conjunction with the Islamic Finance Council UK. It covers Islamic finance as well as other forms of ethical finance and responsible investing. Speakers include Dr Zeti Aziz of Bank Negara Malaysia, Professor Dr Laldin of ISRA, Richard de Belder of Dentons and Sultan Choudhury of Al Rayan Bank. Sessions will include a look at the ways in which different elements of the ethical finance sector can co-operate and learn from each other, as well as ways in which suluk and green bonds can become part of the mainstream.
Contact: Christina Rebello
Tel: +603 2162 7800 ext 43
Email: Christina@meglobaladvisors.com www.geff2105.com

8-9: Inaugural Symposium on Islamic Economics and Finance, Istanbul, Turkey

This conference has been jointly organised by Global Islamic Finance Development Center (GIFDC), Islamic Development Bank (IDB), Islamic Research and Training Institute (IRTI), Guidance Financial Group and Borsa Istanbul. Its aim is to promote the exchange of cutting-edge ideas and foster objective discussion on Islamic economics and finance among academicians, policy makers, private sector and development practitioners. Its theme is Islamic Finance: A Catalyst for Shared Prosperity. The speakers are drawn mainly from the world of academia and international institutions such as the World Bank and the International Monetary Fund.
Contact: Canan Ozcan
Email: Email: cozcan@worldbank.org www.worldbank.org

17-18: The Inaugural Africa Islamic Finance Forum, Abidjan, Ivory Coast

Sponsored jointly by the Islamic Corporation for the Development of the Private Sector, part of the Islamic Development Bank and the government of the Ivory Coast will include sessions on takaful in Africa, Developing the Ivory Coast as an Islamic investment destination, trends in Islamic asset management and asset allocation strategies and attracting cross-border investments.
Contact: Emerson Dinesh
Tel: +603 2162 7800 ext 43
Email:emerson.dinesh@REDmoneygroup.com www.redmoneyevents.com

October 2015

19: IFN Forum Kuwait, Kuwait City

While Kuwaiti investors seeking Shari’ah-compliant investments have been very active in overseas markets, the domestic market has had limited opportunities. In an attempt to allow for more

domestic activity Kuwait’s regulators have begun to revise laws. It is against this background that the conference takes place. Topics in this half-day conference will include the outlook for Islamic finance in Kuwait; treasury and liquidity management in GCC financial institutions and Kuwait’s potential as an investment destination.

Contact: Emerson Dinesh
Tel: +603 2162 7800 ext 43
Email:emerson.dinesh@REDmoneygroup.com www.redmoneyevents.com

21-23: International Congress on Islamic Economics and Finance, Sakarya, Turkey

This congress aims to provide a platform for researchers, academicians as well as industrial and business professionals from all over the world to present their research papers in the area of Islamic economics and finance. It is expected that ICISEF-2015 will serve as a discussion forum and platform that strengthens the link between academia and industry. The organisers, the University of Sakarya are currently at the stage of inviting papers and the final programme will not be finalised until mid September. All contact and programme information is via the icisef website.

November 2015

17-18: 7th World Islamic Retail Banking Conference, Dubai

The theme for this conference is ‘Creating Smarter Banking’. It will explore all aspects of innovative, technically advanced and competitive retail banking strategies to provide a customer-smart Islamic banking experience. At the time of writing there is no further information about the agenda.
Contact: Mohor Mukherjee
Tel: +971 4609 1570
Email:info@icg-events.com www.fleminggulf.com

1-3: 22nd World Islamic Banking Conference, Manama, Bahrain

There are as yet no programme details available about this conference, organised by Middle East Global Advisors (formerly Mega Events). If you want to register for a brochure as soon as this become available or make an early bird booking, contact details can be found below. The conference will be held at the Gulf Hotel Convention Centre.
Contact: Sahar
Tel: +971 4 441 4946
sahar@meglobaladvisors.com sahar@meglobaladvisors.com

NEWHORIZON    Rabi Al Awwal - Shaban 1436 BOOK REVIEW

Derivatives in Islamic Finance: Examining the Market Risk Management Framework

By: Dr Sherif Ayoub. Publisher: Edinburgh University Press (2014)
ISBN: 9780748695706
Reviewed by: Richard de Belder, Partner with Dentons and Global Head of Islamic Finance

As the author notes in the preface, this book is a product of his curiosity about the controversy surrounding derivatives in Islamic finance and the ‘divergent, and seemingly obstinate, views of some of the notable members of the Islamic finance community’ when it comes to considering the use of derivatives.

The book analyses economic principles, the Shari’ah, commercial risk issues and policy factors which, in the author’s view, have not been adequately considered and debated in the area of derivatives. He maintains that many of the current positions of the Shari’ah scholars (both individually and through organisations such as AAOIFI and the OIC) have been too legally orientated and have not recognised that the view of the Shari’ah on economic matters will inherently be an economic one (and not a legal one that focuses on contractual technicalities). He argues that this is holding back the development of derivates for market-based risks in Islamic finance, which means that, unfairly, these risks have to be retained by real sector economic agents even though they are not part of their core commercial activities. His view is that the management of market risks that do not relate to a person’s core business activities (and which can be distinguished from gambling) is defensible on a proper Shari’ah analysis of economic principles.

After a short introductory chapter, the second chapter explores the methodology in Mua’amalat (truth formation). Dr Ayoub describes the different Shari’ah processes that are used to investigate issues and to seek the truth such as maslaha (public interest), qiyas (analogical reasoning) and igma’a (consensus).

In the third chapter entitled ‘Market risks and their management’ he discusses in detail the types of market risks faced by real sector entities (and Islamic finance organisations supporting their operations), the modern risk management framework and the rationale behind the concept of hedging. He analyses the theory and practice of conventional derivatives in the next chapter and, in particular, the economics of derivative instruments including how the pricing of derivative instruments is formulated. There is also an interesting exploration of the technicalities involved in using derivatives as hedging tools through considering various types of derivative instruments. In the following chapter the author looks at derivatives in Islamic finance. Here he considers resolutions that have been passed by various Islamic standard-setting bodies, theoretical and contractual Shari’ah issues and contemporary derivatives in Islamic finance.

The sixth chapter deals with the permissibility of the underlying variables and the recognition of the derivative contract. Here he undertakes a review of various pronouncements by bodies such as AAOIFI and the OIC in relation to the use of interest rate and currency benchmarks as well as prohibitions on trading in indices and trading in currencies. He also analyses the nature of money in Islam and considers the IAS treatment of derivatives. The author makes the interesting observation in the conclusion to this chapter that ‘it is not evident that .... God limited the economic practices of Muslims to either trade (with an underlying corporeal asset) or riba with nothing permitted in-between.’

The next chapter is entitled ‘Maysir, hedging and derivatives’. It contains an in-depth consideration of gambling, both in the context of Western and Islamic jurisprudence. He also considers the ‘recent trend in the Islamic finance literature to define the ‘act’ of maysir by linking it to any zero-sum arrangement in an absolute monetary sense.’ The discussion considers where speculation fits into the spectrum with investment at one end and gambling at the other. Dr Ayoub also considers the role of financial intermediaries as speculators and examines the issue of whether it is permissible for them to charge fees for these activities. Throughout Dr Ayoub maintains that the Islamic finance discourse has been too focused on the legal sphere when interpreting the scriptures and instead more credence should be given to economic theories that can explain human behaviour and the way they utilise resources. He believes there needs to be a better understanding of riba, maysir and gharar when analysing the modern day need for real sector economic agents to access derivatives in order to manage market risks not associated with their core trading activities (in contrast to pure gambling activities).

Dr. Ayoub must be congratulated for undertaking this extremely thoughtful, carefully argued and detailed explanation of the various issues that affect the analysis of derivatives in the Islamic finance space (and indeed often, by extension, other areas of Islamic finance).

While not everyone may agree with all of Dr Ayoub’s arguments, his work deserves to be seen as an extremely important contribution to the debate not only about derivatives but also how to move Islamic finance away from its over-emphasis on form over substance.

Richard de Belder

Richard de Belder is a partner at SNR Denton and returned to the UK in 2007 after being the Managing Partner in the firm’s Abu Dhabi office. He has been involved with the Middle East since 1979 and has spent 20 years living and working in the UAE and Oman. Richard heads up the firm’s Islamic finance practice. Richard has many years’ experience in dealing with Shari’ah scholars and has been actively involved in the structuring and documentation of many leading Shari’ah compliant transactions.

NEWHORIZON    July – December 2014GLOSSARY

An Islamic version of option, a deposit for the delivery of a specified quantity of a commodity on a predetermined date.

bai al-ina
This refers to the selling of an asset by the bank to the customer on a deferred payments basis, then buying back the asset at a lower price, and paying the customer in cash terms.

commodity murabaha
A murabaha contract using certain specified commodities, through a metal exchange.

A ruling made by a competent Shari’ah scholar on a particular issue, where fiqh (Islamic jurisprudence) is unclear. It is an opinion, and is not legally binding.

Lit: uncertainty, hazard, chance or risk. Technically, sale of a thing which is not present at hand; or the sale of a thing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does not know whether it will come to be or not.

A record of the sayings, deeds or tacit approval of the Prophet Muhammad (PBUH) halal Activities which are permissible according to Shari’ah.

Activities which are prohibited according to Shari’ah.

A leasing contract under which a bank purchases and
leases out a building or equipment or any other facility required by its client for a rental fee. The duration of the lease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

ijara sukuk
A sukuk having ijara as an underlying structure.

ijara wa iqtina
The same as ijara except the business owner is committed to buying the building or equipment or facility at the end of the lease period. Fees previously paid constitute part of the purchase price. It is commonly used for home and commercial equipment financing.

A contract of acquisition of goods by specification or order, where the price is fixed in advance, but the goods are manufactured and delivered at a later date. Normally, the price is paid progressively in accordance with the progress of the job.

Gambling – a prohibited activity, as it is a zero-sum game just transferring the wealth not creating new wealth.
A form of business contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual agreement at the start. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour.

In a mudarabah contract, the person or party who acts as entrepreneur.

A contract of sale between the bank and its client for the sale of goods at a price plus an agreed profit margin for the bank. The contract involves the purchase of goods by the bank which then sells them to the client at an agreed mark-up. Repayment is usually in instalments.

An agreement under which the Islamic bank provides funds which are mingled with the funds of the business enterprise and others. All providers of capital are entitled to participate in the management but not necessarily required to do so. The profit is distributed among the partners in predetermined ratios, while the loss is borne by each partner in proportion to his contribution

musharakah, diminishing
An agreement which allows equity participation and provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers the ownership of the asset to the participants.

qard hasan
An interest-free loan given for either welfare purposes or for fulfilling short-term funding requirements. The borrower is only obligated to pay back the principal amount of the loan.

In a mudarabah contract the person who invests the capital. retakaful Reinsurance based on Islamic principles. It is a mechanism used by direct insurance companies to protect their retained business by achieving geographic spread and obtaining protection, above certain threshold values, from larger, specialist reinsurance companies and pools.

Lit: increase or addition. Technically it denotes any increase or addition to capital obtained by the lender as a condition of the loan. Any risk-free or ‘guaranteed’ rate of return on a loan or investment is riba. Riba, in all forms, is prohibited in Islam. Usually, riba and interest are used interchangeably.

Salam means a contract in which advance payment is made for goods to be delivered later on. Shari’ah Refers to the laws contained in or derived from the Quran and the Sunnah (practice and traditions of the Prophet Muhammad (PBUH)

Shari’ah board
An authority appointed by an Islamic financial institution, which supervises and ensures the Shari’ah compliance of new product development as well as existing operations.

A contract between two or more persons who launch a business or financial enterprise to make profit. sukuk
Similar characteristics to that of a conventional bond with the key difference being that they are asset backed; a sukuk represents proportionate beneficial ownership in the underlying asset. The asset will be leased to the client to yield the return on the sukuk.

A principle of mutual assistance. tabarru A donation covenant in which the participants agree to mutually help each other by contributing financially.

A form of Islamic insurance based on the Quranic principle of mutual assistance (ta’awuni). It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members.

A sale of a commodity to the customer by a bank on deferred payment at cost plus profit. The customer then a third party on a spot basis and gets instant cash.

The diaspora or ‘Community of the Believers’ (ummat al-mu’minin), the world-wide community of Muslims.

A promise to buy or sell certain goods in a certain quantity at a certain time in future at a certain price. It is not a legally binding agreement.

A contract of agency in which one person appoints
someone else to perform a certain task on his behalf, usually against a certain fee.

An appropriation or tying-up of a property in perpetuity so that no propriety rights can be exercised over the usufruct. The waqf property can neither be sold nor inherited nor donated to anyone.

An obligation on Muslims to pay a prescribed percentage of their wealth to specified categories in their society, when their wealth exceeds a certain limit. Zakat purifies wealth. The objective is to take away a part of the wealth of the well-to-do and to distribute it among the poor and the needy.