July to September 2013
Ramadan - Dhual Qa’dah 1434


Great Mosque at Djenne, Mali



NEWHORIZON     July to September 2013 CONTENTS


Perceptions Surrounding the Contemporary Practice of Islamic Finance

S Nazim Ali examines common perceptions about the Islamic finance industry and looks at the ways that the industry can influence how both Muslims and non Muslims see it.

India Revisited

A brief update on India’s progress towards the establishment of interest-free banking.

Food for Thought: The Tense Dichotomy Between Shari’ah Compliance and the Economic Goals of an Islamic Bank

Camille Paldi explores the trade-off between Shari’ah compliance and economic goals in the development of Islamic financial products and the various ways in which this tension can be resolved.

Point of View: Re-analyzing the Inherent Complexities in the Principal/Agent Relationship of Two-Tier Mudarabah

Mohammad Saif Sarwar and Mohammad Abdullah Nadwi analyse the advantages and disadvantages of mudarabah as a key instrument in Islamic banking.

Maqasid Driven Islamic Banking Some Suggested Baby Steps

Shahul Hameed bin Mohamed Ibrahim exhorts the captains of the Islamic finance industry to do some soul searching, along with the depositors and Shari’ah scholars, in order for the Maqasid Shari’ah in Islamic finance to be achieved in the future.

Salam: A Good Alternative to Controversial Tawarruq

Jassim Mahadik suggests the use of salam as an alternative to the controversial tawarruq.

Retrospective: Money Management and General Trading under Islamic Banking Procedures

The modern Islamic finance industry is barely 40 years old and sometimes it is good to remind ourselves just how far the industry has come in that short period. This edited paper from a 1984 conference on Islamic banking provides an interesting insight into the road the industry has travelled so far.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434EDITORIAL

Executive Editor’s Note

Are Islamic financial products just conventional products with a thin Islamic veneer? This is a question that will not lie down and go away, but does it actually matter? Provided the products being offered by Islamic banks and takaful operators are less morally hazardous and less exploitative than the offerings of conventional financial institutions, is not the Islamic finance industry a force for the good? The answer is yes and yes – yes they are a force for the good and yes it matters that they do not fully reflect the substance of the Shari’ah, but just satisfy the legal form.

To some extent Islamic finance’s mimicking of the conventional industry is understandable. First and foremost, the people who set up Islamic banks had for the most part received their training in the conventional industry. Conventional financial products were what they knew and indeed what their customers were familiar with and hence would feel comfortable with. It could be said that the policy of being different but not too radically different worked well; it is forecast that the value of the Islamic finance industry will reach $2 trillion sometime in 2013 or 2014, although it has yet to reach the masses.

The question is where does Islamic finance go now? The debate is between those who want to see the Islamic finance industry move closer to the just socio-economic ideals that motivated the founders of the industry and those who see the future in terms of adapting conventional products. Shahul Hameed bin Mohamed Ibrahim argues strongly in this issue for more charitable giving by Islamic financial institutions, but this may be a hard sell given that shareholders, many of whom, having a conventional mindset, may expect management to maximise profit.

What may be possible is to encourage financial institutions to devote greater attention to and to invest more in the types of operation that are designed to help the disadvantaged in society and poor work their way out of poverty, for example, providing venture capital financing to SMEs. Such financing has created established names like Apple, Microsoft and Google. Investing in developing Muslim countries may produce somewhat lower returns in the short term, but perhaps the idea can be sold to shareholders on the grounds that while the long-term potential is enormous it is also the essence of the message of Islam to care for the disadvantaged and needy in society.

It may be difficult to challenge the status quo in established financial markets, but in the developing world Islamic finance there must be a serious willingness and sacrifice on the part of shareholders and the management of Islamic financial institutions to look beyond just maximising profits. They would also need to demonstrate much more about the practical benefits of adopting the social and legal commercial practices emphasised in Islamic teachings and emphasised also in all faiths.

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

Tel: +44 (0) 207 433 0840
Fax: +44 (0) 207 433 0849

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    July to September 2013News

The General Council for Islamic Banks and Financial Institutions to Spread its Wings

The General Council for Islamic Banks and Financial Institutions (CIBAFI), a non-profit organisation headquartered in Manama, Bahrain, plans to expand its sphere of influence beyond the GCC. It has traditionally focused on neighbouring countries. Omar Hafiz, CIBAFI’s secretary-general, said he was keen to enlarge its geographic scope while engaging national regulators more actively. In particular he indicated the organisation was trying to set up a representative office in Tunisia, operating as a gateway to Africa, and also in Azerbaijan to reach central Asian countries.

Founded in 1999 by the Jeddahbased Islamic Development Bank, CIBAFI has 114 member institutions, including Egypt’s Faisal Islamic Bank, Kuwait Finance House and Bahrainbased Al Baraka Banking Group. Saudi-Arabia’s National Commercial Bank joined in 2012. Saudi-born Hafiz, 62, said that for its long-term health, the industry should focus as much on improving the regulatory environment as increasing its size.

‘It is not just a matter of licensing Islamic banks, but preparing a platform for success for Islamic banking,’ he said. ‘We want to ensure competition between the conventional and Islamic banking industries is in its best shape, not inferior or second class, but on the same level.

Addressing a major weakness in Islamic finance, a lack of well-trained professionals, CIBAFI plans to expand its training and certification programmes, which are currently distributed through a network of over 30 agents. They hope to expand this network to 50 agents by the end of 2014. The body also plans to hold forums in new markets for Islamic finance, including events in Morocco and Libya later in 2013.

One of CIBAFI’s key messages is that Islamic windows - units of conventional banks which offer Islamic financial products and services - need to operate under clear rules to improve the perceptions of consumers. ‘In some cases, conventional banks which offer Islamic windows or Islamic transactions are trying to pull the financial products towards their conventional ways of operation,’ Hafiz said. He argued that this hindered consumers from distinguishing between conventional and Islamic products and that full technical and legal separation needed to be demonstrated. He believes that this could improve the industry’s appeal and eventually reduce the reliance on the Islamic window model in favour of full-fledged operations

Bahrain Islamic Bank Put on Notice

Bahrain Islamic Bank (BIsB) is one of four Bahraini banks placed in review for the downgrading of their deposit, issuer and senior debt ratings by Moody’s Investors Service. In addition BIsB has been placed on review for the downgrading of its standalone bank financial strength rating.

This follows the potential weakening in the sovereign’s capacity to provide support to the banks, as signalled by Moody’s decision to place the Baa1 Bahraini government bond rating on review for possible downgrade.

The sovereign review was prompted by the fiscal implications of Bahrain’s high and rising break-even oil price; the outlook for lower trend economic growth in the country over the medium term and the impact of a low-growth, high government expenditure and weaker oil price scenario on Bahrain’s long-term debt sustainability. Moody’s decision to place the standalone bank financial strength rating of BIsB on review reflects the extensive recapitalisation needs of the bank coupled with a potential weakening in the support capacity of its key Bahraini sovereign-related shareholders, which could affect the timing, amount and nature of the recapitalisation.

UAE Takaful Market Overcrowded

A recent statement from Standard & Poors (S&P) suggests that overcrowding in the UAE takaful market means companies are not performing effectively for either fund members or shareholders. Premiums grew by 15% in 2012, but fund deficits grew 40% in the same period and in the first quarter of 2013 the situation deteriorated further with deficits running at 70%. This compares unfavourably with conventional insurance companies which showed a growth of 5% in shareholder funds, despite lower premium growth.

A major factor in the underperformance is the increasing levels of wakala fees, which rose from 33% of net contributions at the end of 2011 to 54% at the end of 2012, with a further increase to 66% in the first quarter of 2013. (Loss ratios are fairly comparable with the conventional sector.)

S&P highlight the fact that takaful companies are struggling to compete with the conventional insurance companies, which enjoy economies of scale, better distribution mechanisms and longer service track records. In addition these companies have in the main mopped up the available business in the region – there is no significant uninsured Islamic market

NEWHORIZON     Ramadan - Dhual Qa’dah 1434 News

Shari’ah-Compliant Underwriting Business Launched

Cobalt Underwriting a Shari’ahcompliant insurance/reinsurance business based in the City of London was launched in May 2013. The new company, backed by Capita and the Bank of London and Middle East, has entered into an agreement with global broking group Aon which will work exclusively with Cobalt across the initial process development phase of the business, which is expected to last until September.

Nigel Denison

Cobalt began operations with underwriting capacity from XL Group to underwrite property risks out of London. The initial focus will be on property cover, with a maximum capacity of up to $300 million. The products will be offered on a worldwide basis with the exception of the U.S. and Canada. Shortly after launch Cobalt entered negotiation with QBE Europe to extend underwriting capacity to $425 million for property and $160 million for construction. They are also in negotiation with a third panel member and if these negotiations are successfully completed they will add marine cargo and on and offshore energy to their portfolio.

Richard Bishop, Chief Executive Officer, Cobalt Underwriting said, ‘We believe what Cobalt is able to deliver will change the industry’s ability to provide access to Shari’ah-compliant insurance and reinsurance capacity for organisations that require it. We are currently in the process of working closely with Aon Group and XL Group during this initial phase and we will be in a position to provide further details on our future plans at the end of that process.’

Terry Masters, leader of Aon Benfield ReSolutions, said, ‘The London market is recognised as a global leader in terms of its ability to provide insurance and reinsurance coverage for a full range of risks. As part of this expertise, it is of growing importance to being able to offer Shari’ah-compliant commercial insurance capacity.’

Nigel Denison, Director, Bank of London and The Middle East PLC said of the launch, ‘We see significant demand for Islamic insurance from our clients and also believe that a strong Shari’ahcompliant market will support the development of Islamic Asset Management’.

Turkish Unrest Triggers Nervous Response from UAE Central Bank

In July the UAE central bank asked local commercial banks to provide details of their exposure in Turkey. This follows a fall in the value of the Turkish lira, which is widely believed to have been caused by civil unrest in the country and rumours that the US plans to cut its financial stimulus package to Turkey. Turkey has been a recent investment target for UAE banks looking to dilute their heavy reliance on hydrocarbons. Despite their growing exposure in Turkey UAE banks are not thought to be at any great risk as they are well capitalised by international standards.

Standardised Wakala Documentation and Guidelines Launched by IIFM

Bahrain based standardsetting body International Islamic Financial Market (IIFM) has announced new guidelines and standard documentation for wakala agreements designed to extend the range of liquidity tools available to banks, which are currently heavily reliant on commodity murabaha. Mr Khalid Hamad Abdul-Rahman Hamad, Executive Director-Banking Supervision, Central Bank of Bahrain and Chairman of the IIFM said, ‘This much-awaited documentation standard is another milestone in the standardisation and harmonisation of the Islamic finance industry across the globe.

He went on to state his belief that development will encourage the use of unrestricted wakala in the Islamic inter-bank market and will persuade all jurisdictions to implement this IIFM standard as well as address any accounting or regulatory requirements in their respective jurisdictions.

Mr Ijlal Ahmed Alvi, Chief Executive Officer, IIFM explained, ‘This standard documentation has been developed in accordance with IIFM comprehensive procedures in developing global standards, i.e. consultation with the IIFM Shari’ah Advisory Panel from the early stages, market consultative meetings, forming a global working group and the appointment of external legal counsel, Norton Rose LLP.’

The key main features of this Agreement is that the Investor, the muwakkil, will appoint the wakil as its Agent to invest its funds in a Shari’ah-compliant manner in exchange for a fee, the wakala pool can be managed on a segregated asset pool or comingled asset pool basis at the wakil’s discretion. The treatment of early termination caused by either party defaulting is also clearly defined in this documentation, for example, the wakil is obliged to notify the muwakkil if the anticipated profit cannot be achieved etc.

‘The Operational Guidance Memorandum for the wakala agreement is one of the unique features of IIFM efforts to enhance the development of Islamic finance industry. The industry will find this Memorandum very useful as it explains how the standard is to be used and in addition to that it provides very comprehensive recommendations,’ said Mr. Alvi.

NEWHORIZON    July to September 2013News

Developing Shari’ah-Compliant Credit Unions

The World Council of Credit Unions has published the Islamic Finance Manual: Operating Policies and Procedures for Credit Unions, the first known guide to establishing Shari’ah-compliant credit unions in the developing world. The manual is based on the World Council’s experience establishing Islamic investment and finance cooperatives in Afghanistan (2004–2012).

The comprehensive guide details operating policies and procedures based on international standards for financial cooperatives and adapted to comply with Islamic Law. The 305-page document addresses membership, shares and savings mobilisation, Shari’ah-compliant financing and collection, provisions and allowances for bad debts, asset and liability management, capitalisation and capital adequacy, accounting, cash operations, internal controls, human resources, procurement and information technology and security. Each chapter includes a comprehensive review of procedural requirements and who should be involved, including template forms and contracts.

The manual is based on the World Council’s experience in Afghanistan, where for nine years it has worked to develop sustainable financial cooperatives as well as a national apex trade association. The World Council consulted Islamic scholars and local religious leaders to modify its traditional credit union development methodology and establish the country’s first fully Shari’ah-compliant financial institutions. By the summer of 2013 there were more than 30 financial cooperatives in 14 provinces across the country offering Shari’ah-compliant share savings and loan products.

Malaysia Updates Financial Services Legislation

In June 2013 new financial legislation came into effect in Malaysia with the Financial Services Act 2013 (FSA) and Islamic Financial Services Act 2013 (IFSA). In addition to bringing the legislation up to date and giving Bank Negara Malaysia the means to maintain their oversight of the financial market in Malaysia there is an increased focus on pre-emptive measures to protect the interests of depositors and policyholders, when financial institutions begin to give cause for concern.

Effectively the FSA and IFSA amalgamate and replace several separate laws designed to govern the financial sector into a single legislative framework - the Banking and Financial Institutions Act 1989 (BAFIA), Islamic Banking Act 1983, Insurance Act 1996 (IA), Takaful Act 1984, Payment Systems Act 2003 and Exchange Control Act 1953. One of the key features of the new legislation is a clear focus on Shari’ah compliance and governance in the Islamic financial sector, changing the rules from guidelines to statutory duties, where breaches can attract fines and imprisonment. One particularly interesting change is that the new legislation makes Shari’ah advisers legally liable for the financial products they approve.

Promoting Microfinance in Pakistan

Meezan Bank, Pakistan’s first and largest Islamic bank and Akhuwat, a leading Pakistani non-profit organisation that provides interest-free microfinance facility to micro-businesses, recently signed a Memorandum of Understanding (MoU) for facilitating the implementation of a musharakah-based financing model.

Under this MoU, Meezan Bank will support Akhuwat through providing Shari’ah advisory services as well as professional support in areas such as training, technical assistance, feasibility analysis, market research and development of business models and policies. Meezan Bank will also monitor the musharakah’s performance and conduct its Shari’ah audit at regular intervals.

Mr. Ahmed Ali Siddiqui, Head of Product Development and Shari’ah Compliance at Meezan Bank and Dr. Muhammad Amjad Saqib, Executive Director of Akhuwat signed the MoU. The ceremony was also attended by Mr. Irfan Ali Bostan, Director of Pakistan Currency Exchange Co. Ltd. as Akhuwat’s representative and Mr. Ijaz Farooq, Group Head Branch Banking, Commercial & SME Business at Meezan Bank.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434News

Pakistan to Establish Central Shari’ah Board

Following the Malaysian example, the Securities and Exchange Commission of Pakistan (SECP) have decided to set up a central Shari’ah board. The SECP said that they were doing this ‘considering the need for Islamic financial institutions (IFIs) and Islamic capital markets (ICMs) to innovate and operate within the purview of Shari’ah principles and to ensure that the aforesaid organisations’ business dealings are in line with Islamic principles.’

The nine member board will be drawn from among prominent scholars, but will also include a jurist, an accountant and representatives of the Commission. These board members will also be qualified individuals with an in-depth knowledge and experience of Islamic accounting, finance, economics and Shari’ah law.

Among the functions of the Board will be the validation of the products of IFIs, ensuring they are compatible with Shari’ah principles; recommending guidelines on investment criteria for Islamic capital institutions; advising and reporting on audit standards; undertaking educational activities and introducing and implementing new models and products based on international research.

This move is part of Pakistan’s desire to grow the share of Islamic finance in Pakistan to 15% of the total by 2017. The SECP believe that having a central authority will increase investor confidence in Islamic finance and address some of the issues that have tended to worry investors such as potential conflicts of interest where scholars serve on multiple Shari’ah boards and apparently contradictory rulings.

DIB Settle Tamweel’s Outstanding Debts Early

Dubai Islamic Bank (DIB) today announced that it has settled all the bilateral liabilities of property finance house, Tamweel, amounting to approximately AED 4 billion, two years ahead of scheduled maturity. The bank cited robust capitalisation and ample liquidity as the reason for early repayment. These outstanding obligations of Tamweel comprised of the liabilities, which were part of a five-year moratorium agreed with creditors in late 2010, were due to mature in October 2015. Having brought the company back to a growth oriented, profitable franchise, DIB announced a tender offer to acquire outstanding shares of Tamweel in March 2013. (They had owned 58% of Tamweel’s shares since November 2010.) Following the closure of the tender offer by the bank, DIB now owns close to 90% of the entity and has already initiated the process to delist the company from Dubai Financial Market.

BLME to List on NASDAQ Dubai

Bank of London and the Middle East (BLME), which claims to be Europe’s largest Islamic bank, has announced its intention to list on NASDAQ Dubai under the name ‘BLME Holdings’. BLME will be listing 195,733,691 shares on NASDAQ Dubai with no new capital being raised and no new shares being issued. The listing price is expected to be $2.571 for each consolidated share, implying a market capitalisation of approximately US$503 million.

BLME sees significant potential for expansion in the GCC and the UK across its three key business areas corporate banking, treasury and wealth management.Commenting on the proposed listing, Humphrey Percy, BLME’s Chief Executive Officer, said,’ We are delighted to announce our intention to list on NASDAQ Dubai, as the Middle East’s international exchange with excellent links to regional and global investors. With HH Sheikh Mohammed bin Rashid Al Maktoum’s commitment to establishing Dubai as the economic capital of Islamic finance and BLME’s position as a market leading Shari’ah-compliant bank, NASDAQ Dubai is the exchange of choice for BLME. With the opening of our representative office in Dubai, we are now well positioned at the heart of the Islamic finance industry across the UK and GCC and look forward to growing along with the sector.’

NEWHORIZON    July to September 2013News

Update on Egypt

In the wake of the army’s overthrow of the Morsi government, new ministerial appointments have focussed on strengthening financial expertise at the top. The interim prime minister, Hazem el-Beblawi, appointed to run the country until elections can be held, has a financial background, having worked with Egypt’s Export Development Bank for 12 years, as well as various other economic agencies in the Middle East. His finance minister, Ahmed Gamal was a long-time researcher with the World Bank. MENA newspaper reports are suggesting that Islamic finance is unlikely to be at the top of the agenda for the interim government, which is faced with a deteriorating economic situation, as well as continued outbreaks of violence on the streets.

In addition, in the short term an IMF loan seems to be out of the picture not least because the IMF have said they will not resume negotiations on a loan until the interim government receives international recognition. The pressure on Egypt, however, has been eased somewhat as funds (reportedly around $12 billion) from various Gulf regimes have flowed in to plug the financial gap left by the economic turmoil and the withdrawal of support by Western countries.

Bahrain’s BMI and Al Salam Banks to Merge

The saturated local market and the need to form larger, stronger financial institutions able to compete locally and regionally are given as the main reasons for the decision of BMI and Al Salam to merge. It is proposed that the merger will be accomplished via a share swap – 11 Al Salam shares for each BMI share. The merged bank would be the fourth largest commercial bank in Bahrain. The merger is subject to approval by Al Salam Bank shareholders and the regulatory authorities in Bahrain.

Slowdown in GCC Takaful Markets

A.M. Best’s report, ‘GCC Insurance Markets Brace for Competitive and Profitability Pressures’, suggests that relatively modest economic growth in the region will have a knock-on effect on insurance markets. They note that while gross insurance premiums increased by 25% in 2008, the comparable figure in 2012 was just 10.4%. The report also suggests that one of the most significant challenges for the takaful sector is the ability to grow profitability and differentiate itself in an increasingly competitive operating environment. Most takaful and retakaful operators are new entrants to the market. Rather than distinguishing themselves through targeting new untapped segments of the market, these operators tend to compete directly with their conventional counterparts, some of whom benefit from a strong reputation and economies of scale.

Despite these problems A. M. Best say that they expect takaful to grow at a faster rate than conventional counterparts in the short to medium term. (Without seeing the full detail of their report it is quite difficult to interpret this comment. If the established conventional market is worth, say, $100 and it grows at 10%, then it will be worth $110. On the other hand if the embryonic takaful market is worth, say, $10 and it grows at 50%, it is still only worth $15. It will take a long time to catch up.)

On the positive front, the report notes regulation of the takaful market is developing. Some regulators have introduced or are considering the introduction of specific rules that cater to the takaful market and its unique characteristics.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434News

In Brief

In May 2013 the Islamic Development Bank (IDB) increased its authorised capital to $150 billion. The last time the IDB increased its capital was in 2006. In early July, the IDB announced funding of $789.4 million for projects in 11 member countries as well as support for education projects among Muslim communities in three non member countries.

Malaysia’s BIMB Holdings is on track to acquire full control of Bank Islam, Malaysia’s oldest Islamic bank. Currently BIMB has 51% of Bank Islam and is already in negotiation with the Dubai Financial Group to acquire their 30.5% stake. It has now received approval from Malaysia’s central bank to open negotiations with Lembaga Tabung Haji to acquire their 18.5%.

Standard Chartered Bank is to open an Islamic bank in Kenya using its Saadiq Islamic banking brand. (Kenya already has two Islamic banks – Gulf African Bank and First Community Bank and an Islamic window operated by Barclays.) Standard Chartered say that this is a springboard that they will use to open operations in other countries in Africa.

Tamweel, the UAE-based, Shari’ah compliant mortgage lender has begun the process of delisting from the Dubai stock exchange, clearing the way for its acquisition by the Dubai Islamic Bank (DIB). DIB already own more than 58% of Tamweel’s shares.

The Oman Development Bank is believed to be considering opening an Islamic banking window operation. The government-owned bank have apparently rejected the idea of converting to fully Islamic bank status, but are, nevertheless, keen to grab a share of the apparently burgeoning market for Islamic banking products in Oman.

Tunisian leasing company, El Wifack, have applied to the central bank to become the country’s third Islamic bank, joining Tunisia’s Zitouna Bank and the Tunisian arm of Bahrain’s Al Baraka banking group.

Standard Chartered Bank has appointed Christos Papadopoulos to head its Islamic Banking arm. Mr Papadopoulos was formerly CEO of Standard Chartered’s Middle East, North Africa and Pakistan operation. He will be based in Dubai.

Takaful Insurance of Africa (TIA) has launched a microtakaful product aimed at small farmers in Wajir County in northeast Kenya. The product will compensate farmers for the death of livestock due to drought conditions. The product was developed in conjunction with the International Livestock Research Institute and Mercy Corps. If this limited launch is successful, it will be rolled out to other areas of northern Kenya.

NEWHORIZON    July to September 2013SUKUK UPDATE


Earlier this year, on the back of strong 2012 statistics for sukuk issuance, commentators were tending to be very bullish about the prospects for 2013. By midsummer, however, Bloomberg were reporting a slowdown in sukuk sales, particularly in the GCC where sukuk issuance to mid July was nearly 30% down on the same period in 2012. The market was doing better in Malaysia with a growth of 14% year-on-year, but this was perhaps lower than had been expected. Bloomberg have suggested the slowdown may be due in part to rumours that the US Federal Reserve is scaling back its bond-buying programme.

Milestone for Oman

Regulatory Approval has been granted in Oman for a corporate sukuk worth $130 million. The Tilal Development Company intends to use the funds to pay off existing debt and to further expand the Muscat Grand Mall. The five-year sukuk is based on an ijara structure and will pay a 5% profit rate. It is hoped that the issue will take place before the end of July. It is also understood that there are two further corporate sukuk in the pipeline. Such investment products could significantly help the fledgling Islamic finance industry in Oman.


Nigeria’s Osun State to Issue Sukuk

Nigeria’s Osun State has issued the country’s first sukuk, which was 20% oversubscribed. (It is in fact the first sukuk to be issued in sub-Saharan Africa.) The seven-year, $62 million ijara sukuk is part of a broader debt raising programme by Osun State. Sukuk holders will receive half-yearly payments. The funds are to be usedto finance the construction of educational facilities. Local credit rating agency Agusto & Co has assigned an A rating to the note which will be listed on the Nigerian Stock Exchange.

Bank of Thailand to Issue Sukuk

The government-owned Bank of Thailand plans to issue the country’s first ever sukuk worth 5 billion baht. This is likely to be a five-year instrument and will be handled by Malaysia’s CIMB Bank, targeting domestic and institutional investors in Hong Kong and Malaysia.

Tunisian Parliament Paves the Way for Sukuk Issuance

In July the Tunisian parliament passed a law that will enable the country to issue sukuk. Tunisia is in a difficult economic position with a budget deficit which is expected to be $3.2 billion this year and over the summer foreign currency reserves fell below 94 days of import cover, the level that the central bank considers adequate. It is unlikely that any sukuk issuance will happen before the end of 2013 or the beginning of 2014 and that timing assumes there is no further political instability.

Turkey to Amend Sukuk Legislation

The Turkish Capital Markets Board is currently working on legislation that will expand the types of sukuk that may be issued in Turkey. Current legislation is limited to ijara sukuk, but it is hoped that new legislation will open the door to other types of sukuk – istisna, musharakah, mudarabah, murabaha and wakala. It is generally thought that this legislation will be ready by late summer 2013. According to a Bloomberg report in May, HSBC are bullish about the prospects for sukuk in Turkey, forecasting that sales could reach $3 billion by the end of the year.

IILM Issue Sukuk

The long-delayed initial sukuk from IILM finally made it to the market in August 2013. The three-month, $490 million sukuk backed by sovereign assets was rated A1 by Standard and Poors.

The sukuk, priced at 30 basis points over the London Interbank Offered Rate (LIBOR), was auctioned off to seven institutions from around the world: Kuwait Finance House, Europe’s KBL Private Bankers, Malayan Banking Bhd (Maybank), National Bank of Abu Dhabi, Qatar National Bank, Standard Chartered Bank and AlBaraka Turk, which is the Turkish unit of Bahrain’s AlBaraka Banking Group. It will be the responsibility of these primary dealers to create an active secondary market by selling the sukuk on to other institutions.

The issuance came after nearly 12 months of internal turbulence at the IILM with the replacement of the chief executive in October 2012, the withdrawal of Saudi Arabia in April 2013 and a fairly radical reshuffle of the Shari’ah board as recently as July 2013, when four out of six original scholars left the organisation (four scholars are now listed on IILM’s web site).

Pakistan Makes AAOIFI Standards on Sukuk Mandatory

Pakistan’s central bank has indicated that issuers of sukuk will have to comply with AAOIFI standards or face penalties. It is believed that the central bank’s tightening of rules surrounding various aspects of Islamic finance is an attempt to attract higher levels of inward investment, particularly from GCC countries. Although Islamic finance has been growing at a healthy, double-digit growth rate in Pakistan, it has failed to meet the bullish targets set out by the central bank in 2007.

Rumours of Sukuk from Societe Generale

Reuters have reported that Societe Generale is planning to issue a ringit-denominated sukuk worth $305 million in the Malaysian market towards the end of 2013. It would be only the second Western bank to do this and the first to do so in the Malaysian market. (The Middle Eastern division of HSBC issued a $500 million sukuk in 2011.) The very clear rules laid down by Malaysia’s regulatory authority should help Societe Generale to avoid the controversy that scuppered Goldman Sachs attempt to issue a sukuk through the Irish stock exchange in 2011.

Malaysia Claims Dominance of the Global Sukuk Market

Deputy Prime Minister of Malaysia, Tan Sri Muhyiddin Yassin, speaking at the Kuala Lumpur Islamic Finance Forum claimed that Malaysia dominates the global sukuk market. With issuances worth $148 billion (US) by the middle of 2013, he said that this accounted for 60.4% of the global market. He attributed Malaysia’s success in the sukuk market and in Islamic finance in general to three key factors – expertise, Shari’ah governance and the legal and regulatory framework.

Indonesian Sovereign Sukuk Three Times Oversubscribed

The Indonesian government’s $1.5 billion sukuk was three times oversubscribed. The 5.5 year issue has a yield of 6.125%. According to an anonymous source, Bloomberg report that 15% of the issue went to local investors, 25% to other Asian countries, 24% to the US, 16% to Europe and 20% to Islamic and Middle Eastern funds. The ratings agencies have not been very generous in the ratings they have given mainly to due to their nervousness about Indonesia’s growing current account deficit.

NEWHORIZON    Ramadan - Dhual Qa’dah 1434ANALYSIS

Perceptions Surrounding the Contemporary Practice of Islamic Finance

S Nazim Ali, Director, Islamic Finance Project, Harvard Law School,
Harvard University, Cambridge, Massachusetts, USA


Islamic finance refers to the industry that structures financial transactions and institutions so that they are compliant with traditional Shari’ah law. Islamic finance has gone through several stages of development beginning with the establishment of the first modern Islamic bank in Dubai in 1975. During the past two decades, the industry has gained unprecedented levels of public attention because of its tremendous growth in size and position as an alternative to conventional banking practices. With the discovery of oil and the subsequent growth of wealth in the Gulf, Islamic banking has spread throughout the Middle East and Asia, garnering the most support in Iran, Saudi Arabia and Malaysia. Today there are over 600 Islamic financial service institutions worldwide with size estimations ranging from $500 billion to almost a trillion dollars.

Its growth, however, has also led to competing claims on the direction Islamic finance should take in the local economy. For instance, in the face of rising income inequality, many claim that Islamic finance needs to play a larger role in alleviating the social ills of economic development. It is believed that the industry may have veered off-track and many accuse the sector of not being substantively different from conventional finance products or of failing to realise its original economic and social ideals.

Islamic Finance and the Perceptions of Non-Muslims

The Islamic finance industry faces a number of external challenges to its reputation and outward perceptions both from consumers and practitioners within the industry and the general public. Especially after the attacks of September 11, 2001, the words ‘Islam’ and ‘Shari’ah’ have taken on negative connotations within the media and the Western consciousness. Similarly, after the global economic crisis of 2008, the term ‘finance’ has come to be viewed more critically, both in the West and the rest of the world. The combination of the two leads to an even higher level of concern, especially as the outside media has often tended to equate Islamic finance or Shari’ah compliant economics to money laundering and terrorism financing. For non Muslims especially, Islamic finance and economics can appear as a black box of unfamiliar terms, non-transparent processes and an unclear purpose and expected outcome. Even the majority of Muslims are not knowledgeable about many of the basic tenets of Islamic economics; the average consumer might often confuse terms or concepts or not even be motivated to open an account or engage in an Islamic investment in the first place.

Post 9/11 there was a dramatic surge in the percentage of American non-Muslims who viewed Islam and related entities in a negative light. Among these entities was Islamic finance and banking, considered by some to be the source funding terrorist organisations around the world. These claims were fuelled by people in positions of power such as the former National Security Adviser, Sandy Berger, shortly after 9/11, who said that it would be difficult to track down Osama bin Laden’s money because it was in ‘underground banking, Islamic banking facilities’. These statements, however, have been offset by other equally prominent figures such as former President George W. Bush who in his remarks at the Islamic Centre of Washington shortly following the September 11th attacks stated, ‘The face of terror is not the true faith of Islam…Islam is peace.”

Unfortunately, this statement was not enough to convince everyone as evidenced by the prevalence of sites and organisations like the Centre for Security Policy, which heads the project Shari’ah Finance Watch. The purpose of this project is to educate governments, policymakers and the general public about what the founders deem as the ‘dangers of Shari’ah’. They claim that Shari’ah compliant financial institutions are ‘terror financing mechanisms’ that impose significant national security, financial and legal risks on Western financial institutions.

This author characterises Islamic finance as a ‘black box’ for non-Muslims, especially after the 2008 financial crisis. Negative perceptions about Islam lingering from 9/11 combined with new suspicions about finance have raised even more concerns. People are uncertain about investing their money in general, let alone in an industry they do not fully understand.

More recently, trends have suggested that the European Union may emerge as the latest centre for Islamic finance, possibly due to the mass immigration of Muslims from the Middle East, Asia and North Africa. Britain’s Islamic finance sector has nearly $19 billion in Islamic banking assets, exceeding the holdings of several Islamic states including Turkey, Egypt and Pakistan. Perhaps more important is the establishment of Islamic financial education programmes in 55 British colleges and educational institutions. France, with the largest population of Muslims of any European country, has also begun to make progress by passing a series of instructions for facilitating the introduction of Islamic financial products. This legislation was heavily backed by the former French Finance Minister, Christine Lagarde, (now the Managing Director, International Monetary Fund) who characterised it as an ‘exciting new beginning for Islamic finance in the Republic.’

Islamic finance has also received support from a number of religious institutions, including Christian organisations, after the 2008 global market crash, which led to criticism of the conventional banking system. The Vatican’s official newspaper L’Osservatore Romano published an article stating that the free-market model has ‘grown too much and badly in the past two decades.’ It concluded, ‘The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.’ This trend was continued in February 2008 when, at a lecture on civil and religious law at the Royal Courts of Justice, the then Archbishop of Canterbury Rowan Williams stated that ‘giving Islamic law official status in the United Kingdom would help achieve social cohesion because some Muslims do not relate to the British legal system.’

Observable Global Trends: Perceptions about Islamic Finance

The Islamic finance industry initially began as a means for Muslims to participate in the modern financial world while still adhering to Shari’ah law and, while it has attracted non-Muslims, its main focus is still its Muslims clients. Islamic banking is appealing to pious Muslims who, for many reasons, but particularly the conventional banks’ practice of charging interest, are unable to engage in traditional banking. Studies show that many Muslims are in fact willing to pay ‘faith premiums’ for financial services and products that are Shari’ah compliant.

Post 9/11 Perceptions

Ali and Abdur-Rahman have conducted a study to investigate perceptions of the Islamic finance industry and impacts on the industry following 9/11 by studying representations in mainstream media and by surveying Islamic finance industry and Islamic finance media professionals globally for their perceptions and experiences post-9/11. Study of media articles related to Islamic finance post-9/11 reveals that relatively few articles linked Islamic finance with terrorism, and few (12%) maintained a negative tone. Islamic finance professionals reported that 9/11 brought closer scrutiny of the industry, which increased apprehension, but also led to growth and awareness. The majority of Islamic finance media professionals, however, perceived a negative impact and 70% of them are critical of how the industry handled media attention post 9/11. The study finds that despite some negative media coverage of Islamic finance following 9/11, development of the industry was not significantly impacted and the outlook for future development is overwhelmingly positive.

U.S. Consumer Perception

Shari’ah compliant home financing (mortgages) holds the key to the success of an expanded role for the Islamic finance industry as a whole in the U.S., because it represents, almost literally, a foot in the consumer’s door. Unfortunately although some Islamic home finance providers have been quite successful and, in fact, have become competitive with conventional mortgage companies, customers remain sceptical and unconvinced.

Shopping for Scholars

One of the areas receiving the strongest criticism from both inside and outside the industry is the role of the Shari’ah scholars themselves. The main concern of many is the concentration of a few key scholars on a number of Shari’ah advisory boards. A 2010 study conducted by Funds at Work found that three scholars make up 20.9% of total board positions in international organisations while 10 scholars make up over 40% of all positions. It was noted that one scholar held 78 board positions at the same time, leading bank managers to question scholars’ commitments to their responsibilities. Stemming from this is the view that Shari’ah boards have now turned into a ‘brand game’. The so-called ‘market for scholars’ has become saturated and there is little opportunity for new scholars to enter the industry. Instead, current scholars take on apprentices who later express views on key issues that are nearly identical to their predecessors’ views. Lastly, many are concerned with the inherent conflict of interest that stems from having the same Shari’ah scholars on the boards of multiple banks and financial institutions as well as in an advisory capacity to various governments. Some suggest that this might lead to favouritism as well as a failure to properly evaluate documents, products and transactions.

Muddassir Siddiqui, a Shari’ah scholar now based in Dubai and a member of the Shari’ah board of AAOIFI, believes that part of the problem is that the number of banks and financial institutions around the world offering Shari’ah compliant products is growing rapidly and that the industry cannot provide enough scholars to meet the demand. He said, ‘There is a big shortage of scholars. Also, some scholars have developed a very deep understanding of how certain aspects of finance works. Wouldn’t you want those scholars who have gone through similar challenges?’

Scholars point out however, that no member of any Shari’ah board has been accused or publicly challenged in relation to a conflict of interest situation. They also argue that product providers know what they are getting into. ‘If a financial institution knowingly engages the services of a Shari’ah scholar who they know is sitting on the board of a competing financial institution, then really, it is up to them. Do they trust him to keep their secrets? If they don’t see it as a problem, then I don’t see any conflict there,’ says Muddassir Siddiqui. (Siddiqui incidentally does not sit on multiple boards himself, preferring to avoid any potential conflicts.)

Usman Hayat, director of Islamic finance and ESG investing at CFA Institute, says it comes down to transparency. ‘You can’t always avoid a conflict of interest to ensure independence of judgment. Where you have to manage it, you manage it through strengthening transparency and accountability. The same should apply here to enhance the credibility of the Islamic finance industry.’

Consumer Perceptions

A prominent criticism of the industry is that while it is expanding and making profit, the people whom it was originally designed to help have not benefitted. When looking at the distribution of Islamic finance institutions, the majority of them are concentrated in the oil-rich Gulf States. Shareholders and not the general public benefit from the banking system, where constant pressure to produce profits leads managers to invest imprudently. Even more troubling is that many of these institutions that offer Islamic banking services are either owned by non-Muslims or are located in the West and part of conglomerate groups. In a panel discussion held at Harvard in 2009. Mahmoud El-Gamal presented the findings of his book, Islamic Finance: Law, Economics, and Practice (Cambridge University Press, 2006). He argued that Islamic finance, though based on noble objectives in principle, is reduced to legal arbitrage in practice. The approach historically taken towards Islamic finance, which he terms ‘the Arab-Pakistani model,’ is concerned with morally regulating the operations of individual businessmen rather than promoting economic growth at the macro level and distributing resources in accordance with Islamic principles of social justice. This has led to the equally troubling concern that products offered by Islamic institutions are simply ‘conventional products with an Islamic label.’

Several studies were conducted regarding the perception of the Islamic finance industry. Muslim Amin and Zaidi Isa examined the perceptions of Islamic banking in Malaysia and found that, while the majority of customers were satisfied with the quality of the industry, there was a need for improved customer service and more financial counselling to satisfy customers.

Mohammed Hossain and Shirley Leo’s paper on the perception of the service quality within the Islamic banking industry in Qatar found that customers rated Islamic banks highest in terms of the infrastructure of the bank, the convenience of banking and their return on investment. The paper recommended that banks deliver a higher level of customer service in order to increase their market presence and profitability.

A study conducted by Muhammad Hanif and Abdullah Muhammad Iqbal, found that while the majority of respondents in Pakistan understood the theoretical basis of Shari’ah compliant economics, many were sceptical about how Islamic finance operated in Pakistan. Several respondents stated that an interest free economy was not possible and that Islamic banks should exist alongside conventional banks.

Proponents of Islamic finance suggested that the industry should launch an awareness campaign to counteract some of the misconceptions about Shari’ah compliant financing. Another suggestion was for the government and other regulatory bodies in Pakistan to play a larger role in mandating the inclusion of Islamic banking within the financial services industry. Others suggested that banks and other financial institutions engage more in the practice of profit and loss sharing (PLS) as a viable Islamic financial product that has to date been underutilised in Pakistan. Finally, some also suggested that other players outside of academia and the industry ought to be involved in the transition to an Islamic economy, including businesspeople, regulators, members of civil society, clerics and well known intellectuals.

Asyraf Wajdi Dusuki and Nurdianawati Irwani Abdullah’s study of Islamic bank customers in Malaysia conducted in 2010 seconds these recommendations. The study found that Islamic banks and financial institutions could no longer depend solely on those customers who purchase Islamic financial services motivated by religious or pious considerations. Rather, the industry must strengthen its marketing initiatives to broaden consumer awareness of the Islamic banking sector as well as increase the quality level of its customer service to expand its market share.

A survey of Malaysian consumers conducted by Mark Loo found that while the majority of Muslims were attracted to Islamic banking for religious reasons, the majority of non-Muslims were mainly attracted towards it for the products and services it offered. In Malaysia in particular, 75% of Muslims saw a strong prospect for Islamic banking in Malaysia, while only 20% of non-Muslims agreed. According to the authors, portraying Islamic finance as a religious obligation to Muslims and as a way to save money from non-Muslims gives the industry as a whole a bad reputation. Secondly, the authors recommended that practitioners and providers improve their communication with potential customers by introducing the Islamic financial services they sell in their local language rather than in Arabic. It was recommended that the industry as a whole engage in a concerted effort to improve their human resources divisions and talent recruitment process.

Yussof, Ibrahim Moh Yussof and Mustafa Daud studied the perceptions of the future of Islamic finance in Nigeria among young people. They observed that the perceptions of Nigerian youth studying outside of the country have a strong impact on the development of the Islamic finance industry in their home country. Based on the results of their statistical study, they offered three recommendations to further the development of a Shari’ah compliant economy in Nigeria. The first of these was the need to educate the Nigerian people more on the benefits of Islamic banking for the country’s economy as a whole. Secondly, it recommended that the Central Bank of Nigeria (CBN) especially engage in such efforts, as it is optimally placed to encourage research and formulate policy. Lastly, the report encouraged Islamic finance institutions in Nigeria, and the CBN in particular, to focus on improving the quality of training and talent selection within the industry as a whole and provide more opportunities for professional development.

Outside of the negative perceptions, if Islamic finance is to be a legitimate competitor to conventional banking, it must appeal to clients outside the Arab world. A 2005 study by Jorg Bley and Kermit Kuehn found that the use of Arabic terms in Islamic finance served as an obstacle to many in understanding the mechanics of Islamic financial products and services. The study suggested allowing suppliers of Islamic financial services to rename Islamic products as they see fit, after the regulatory bodies have clearly and comprehensively defined the instruments in question. The study recommended that Islamic financial institutions improve their marketing campaigns in order to better appeal to consumers. If the industry does not do this, the study argues that it will no longer be able to compete with conventional finance in growing its market share.

Job Market Perception

A widespread misperception created by a few professionals is that thousands of professionals are needed to run the industry. As a result of that there are hundreds of universities both in the East and the West offering both undergraduate and postgraduate degrees and diplomas as well as certifications in Islamic finance. This view has been contradicted, however, by a recent report from Paul McNamara. He highlighted that highly qualified professionals pouring out of these institutions to be placed in the market are not having any luck in finding the job they envisage. In his analysis of the website,, there were only eight jobs listed in the Islamic finance section as compared to a segment on the same website for hedge funds where there were 400 jobs listed. When the industry is claiming to be a trillion dollar industry with 15 20% growth a year, where are the jobs and who is being employed to undertake the work? If these professionals are not being employed, it begs the question whether these institutions are hiring professionals with conventional qualifications? If that is the case, what employment prospects are there for graduates with Islamic finance degrees?

Countering Common Misperceptions

According to Rushdi Siddiqui, former Global Head of Islamic Finance & OIC Countries at Thomson Reuters, many still associate Islamic finance with the funding of terrorism and totally misunderstand the industry as a whole. He placed some of the blame on the industry itself, explaining that Shari’ah compliant financiers have done a poor job of explaining their products and services and how they differ from the tools of conventional finance. According to Siddiqui, there is a great need to educate the ‘man on the street’ about the workings of Islamic finance in order to dispel the notion that Islamic finance is no more than ‘terrorism finance.’ Siddiqui identified what he saw as the three main challenges facing the industry as transparency, the search for information and industry connectivity. He specifically pointed to the inability to use the search engine Google to find useful and meaningful information on Islamic finance as a pressing challenge. He also explained that Islamic banks have a presence throughout the Muslim and non Muslim world but that they are not connected in the way that conventional banks are, communicating electronically and engaging in financial transactions together.

Redefining and Reappraising the Islamic Finance Industry

Over the last 25 years, as the industry has grown to be a global force, a process of self-criticism has begun. There are competing views about the direction the Islamic finance industry should take both locally and globally. For instance, in the face of rising income inequality, many observers claim that Islamic finance needs to play a larger role in alleviating the social ills of economic development. Others claim that this responsibility falls beyond the imperatives of Islamic finance, which they see as simply a Shari’ah compliant version of conventional finance.

In the past 10 years Harvard forums discussions have focused on the challenges faced by Islamic finance practitioners in structuring Shari’ah compliant financial products. It was recognised, however, that the meteoric rise of Islamic finance in recent years has caused a gap to emerge between two professional groups required for its success the Shari’ah scholars and the Islamic economists. With this in mind Harvard and the London School of Economics (LSE) created a new platform in 2006 to bring together these two groups, the scholars and the economists. Both professions have seen significant developments in their respective fields and it was felt that there was a need for further understanding and cooperation between the two. At an annual meeting participants share their thoughts and opinions and discuss some of the most pressing issues facing the Islamic finance sector today. The aim is for the participants to engage in open dialogue and develop further insight in the field, rather than prescribe a particular course of action or conclusion.

Looking Ahead

There are institutional and strategic changes that the Islamic finance industry can adopt to address the negative perceptions it faces. In order to improve the current perception, greater dialogue is needed among all those involved in the industry, including Islamic economists, Shari’ah scholars, practitioners, regulators and legal professionals. Public lectures are needed to educate the media and general public, including both Muslims and non-Muslims. The role of academia is critical in engaging Islamic finance stakeholders in a healthy discourse on the subject of Islamic finance. Academic institutions such as Harvard University can engage in efforts to bring together all the actors to develop a better understanding and resolve the issues facing the industry. In particular, initiatives should focus on improving transparency and organisation at a national and international level, so that Islamic financial institutions can better communicate with each other and become more involved with one another. Islamic finance industry leaders should make themselves available to discuss the issues openly and provide clear directions for the industry, removing any misunderstandings being created by Islamophobia or other issues. Issues of ethics and governance as well as social relevance must be addressed to bring about greater community participation. As evidenced by the views of Islamic finance practitioners and media professionals, increasing coverage in the global media, and the sustained growth of the industry worldwide, the outlook for future development of the industry is overwhelmingly positive.


This article has identified some of the most pressing issues confronting Islamic finance today and particularly the perceptions of the industry among both Muslims and non Muslims. Studies have shown that the primary motivating factors for most Muslim customers in deciding between a conventional and an Islamic bank have been a combination of religious and economic reasons. On the other hand, non Muslim customers tend to value the speed and efficiency of service, the reputation and the image of the institution, confidentiality and convenience when choosing a bank or a financial institution. The Islamic finance industry has fallen short in meeting many of these expectations, for both Muslims and non Muslims because of ineffective marketing efforts on the part of Islamic banks and financial institutions.

A few remedies have been suggested by past studies to address these negative perceptions. These include awareness campaigns to counteract some of the misconceptions about Shari’ah compliant financing; a need for regulators to develop a tailored structure for Islamic financial institutions; better marketing campaigns and products to attract new customers, both Muslim and non-Muslim; allowing providers to rename Islamic products as they see fit in order to better appeal to customers and a focus on improving the quality of training and talent selection within in the industry as a whole and providing greater opportunities for professional development.

Looking beyond the industry itself, academics and professionals should look to other fields, including faith based financing and social corporate responsibility as a model for future development. Economists should be appointed to Shari’ah boards, as many Shari’ah scholars lack an understanding of the macroeconomic forces impacting the industry. Additionally, more specialists from other industries, as well as more non-Muslims, should be involved in the academic and professional sides of the industry as their perspectives can be crucial in moving forward.

Yusuf DeLorenzo

S. Nazim Ali has been the Director of the Islamic Finance Project (IFP) at Harvard Law School, Harvard University since 1995. 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 (

   NEWHORIZON    July to September 2013COUNTRY FOCUS

India Revisited

Andrea Wharton,

Two years ago NewHorizon (NewHorizon, Issue No. 179) carried an article about India and the prospects for Islamic banking there by Fayaz Ahmad Lone, a research scholar at India’s Aligarh Muslim University. It highlighted the fact that India has the third largest Muslim population in the world with 156 million Muslims living in India today, 13 14% of the population, although that percentage is much higher in some regions such as in Kerala and the disputed state of Jammu and Kashmir. One of the main problems is that India was set up as a secular state after the British granted the country its independence in 1947.

It would require an amendment to the Banking Regulation Act 1949 for fully-fledged Islamic banks to be allowed to operate in the country. An interim step would be non-banking finance companies and in 2010 the State of Kerala began to move tentatively in that direction.

Kerala’s Journey

In 2010 it looked as though the first Islamic bank in the country was about to be set up in Kerala with the active involvement of the Kerala government through the Department of Industries for Kerala. According to government officials, the proposed bank would be registered as a non-banking finance company, before being transformed into a fully-fledged Shari’ah-compliant bank. The concept reportedly had widespread support among the Muslim community of the state. It was thought that the biggest challenge facing the Kerala-based bank would be the formation of a Shari’ah supervisory board due to the shortage of suitably qualified scholars.

The project was stopped in its tracks, however, when Dr Subramaniam Swamy, president of India’s Janata party and a former government minister, succeeded in putting the project on hold, issuing a writ in the High Court arguing that the involvement of government agencies in setting up an Islamic bank runs contrary to the secular principles enshrined in the Indian constitution. In February 2011 The Kerala High Court dismissed the writ, observing that they had no objection to KSIDC carrying on a business that was in accordance with Shari’ah law in addition to complying with the laws of the country. They also stated that, although the institution was based on religious principles, its motive was not to propagate religion and the state’s participation in it was based on purely commercial reasoning. After that everything went quiet. The Kerala project still needed to have the Reserve Bank of India (RIB) on side.

Permission Granted

The permission from the RIB for the Kerala Industrial Development Corporation to launch a non-banking finance company (NBFC) operating in a Shari’ah-compliant manner finally came in August 2013. Interestingly this permission came just two weeks before the retirement of the existing governor of the RIB, Duvuuri Subbarao. In November 2012, he had said, ‘Islamic banking is not possible in the country as there are some legal problems.’ The RBI insists it has not permitted Islamic banking; it says the permission is not for commercial banking, merely for an NBFC.

Curiously, as late as 2012, the RBI tried to close down another non-interest NFBC in Kerala, Alternative Investments and credits Ltd, a company that had been operating for almost 10 years. It will be interesting to see what happens in the ongoing legal wrangle over this case; it would certainly be odd if the RBI pursue this action and even more odd if they succeed.

Light at the End of the Tunnel

Do the RBI’s actions indicate that there is light at the end of the tunnel; that there is a softening in India’s attitude to Islamic banking? Regrettably the answer is probably no. Commentators in the region believe that conservative attitudes within the central bank itself coupled with strong opposition from India’s Bharatiya Janata Party, the main opposition in India, will militate against any approval for fully-fledged Islamic banking. Without that the consensus view is that it will be difficult for Islamic banking to gain any real traction in the Indian market.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434FOOD FOR THOUGHT

The Tense Dichotomy Between Shari’ah Compliance and the Economic Goals of an Islamic Bank

Camille Paldi, Founder and CEO, FAAIF Ltd


The Islamic finance industry is growing strongly, at a rate of 10-15% per year. Instead of producing a boom and bust phenomenon, if practitioners take the time to establish a proper regulatory framework for Islamic finance, the industry may be able to continue as a viable and sustainable financial platform into the future. In order to produce a genuine and stable Islamic banking industry, in addition to establishing a regulatory framework, it is imperative to change direction from producing Shari’ah-compliant to Shari’ah-based products. In order to facilitate the development of Shari’ah-based products, banks may utilise a number of measures including, but not limited to, risk mitigation techniques such as derivatives, risk mitigation techniques derived from the Shari’ah and improved asset-liability management. At the same time regulators need to take measures to ensure Islamic banks remain liquid, solvent and competitive through, inter alia, adjusting capital adequacy regulations and ratio calculations.

This article will explore the trade-off between Shari’ah compliance and economic goals in the development of Islamic financial products and the various ways in which this tension can be resolved. It will examine the dilemma surrounding derivative usage and the importance of risk management, asset-liability management, capital adequacy requirements and liquidity to the economic goals of a bank. Islamic banks must compete in a conventional system, which limits the scope for true Shari’ah banking at this time as Islamic banks must mitigate risks and preserve their liquidity function to remain profitable. Furthermore, banks are restricted by capital adequacy regulations and constrained by the reality of existing in an interest-based system. The tense dichotomy between Shari’ah compliance and remaining solvent produces a proliferation of Shari’ah-compliant products, which mimic conventional banking products as well as pressures banks to use conventional products.

The Push for Derivatives Usage and the Tense Dichotomy

Currently, Islamic finance imitates and directly uses conventional finance for product development. One way to illustrate this point is the push for the use of derivatives in the Islamic financial industry. The gut instinct of many financial experts and even surprisingly Islamic scholars such as Kamali and Obiyathulla would be to propose that Islamic banking utilise conventional products such as derivatives to mitigate risks, however, using derivatives violates the Shari’ah and can equally be used for speculation as well as hedging. In fact, even Warren Buffet takes a stronger stance against derivatives than many leading Islamic academics and refers to derivatives as ‘financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal’ (Al-Suwailem 2006: 36). In addition, Alan Greenspan recognises that derivatives are highly leveraged by construction and that this leverage makes the financial system highly vulnerable. Greenspan says, ‘Leveraging always carries with it the remote possibility of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked’ (Al-Suwailem 2006: 50). This tendency for Islamic scholars to lean towards conventional products and solutions for Islamic finance is perhaps leading Islamic banking professionals in the wrong direction. It is best to delve deep into the Shari’ah for product innovation and solutions rather than to depend on the conventional counterpart.

This tension between Shari’ah compliance and the mimicry or use of conventional products in Islamic finance is well illustrated by Kamali’s argument for the use of derivatives, which can be easily picked-up and utilised by bankers to advocate the use of derivatives and other conventional products in Islamic banking. Kamali argues that instruments such as clearing houses reduce the uncertainty element of futures contracts and that the regulation of trading activity combined with standardised contracts and the margin deposit and marked-to-market procedure somehow allows futures the ability to evade the necessity of Shari’ah compliance. In particular, futures contracts do not comply with the Shari’ah rules on the prohibition on the sale of something that one does not own or possess and the prohibition on taking possession prior to re-sale (qabd), sale of debt-for-debt (bai a’l-kali bi’l-kali) and sale of unbundled risks.

Kamali (2000:39) claims that, ‘Hedgers provide actual goods and services to the economy and futures and options enable them to provide these goods and services more efficiently.’ Kamali (2000:39) also asserts that ‘Hedging allows the risk of price changes to be shifted or shared; hence the costs of production, marketing and processing are reduced and this is ultimately beneficial to the public.’ It is questionable that hedgers provide real goods and services to the economy using options and futures as this involves the sale of unbundled risks, which separates the transaction from the real economy. Although Kamali argues that the option premium transforms the unbundled risk into a bundled risk as he says the premium price constitutes property (mal), Al-Suwailem states that derivatives involve separating risk from economy activity, thereby opening the door for pure speculation and potentially leading to the destabilisation of the entire global financial system (Al-Suwailem 2006:40). Furthermore, the cost of doing business may actually go up as the business’s core activity may shift to speculation for profit, exposing real capital to major risks totally unrelated to their normal business (Al-Suwailem 2006:53). Although Kamali addresses pertinent issues in Shari’ah law, he does not give adequate weight to the importance of the rules found in Shari’ah and he fails to acknowledge the adverse effects of hedging and speculation and the long term costs to society.

Obiyathulla (2004: 73) takes a similar stance to Kamali and argues that disallowing derivatives use in Islamic finance has adverse implications for the industry including value loss and inability to compete. Obiyathulla (2004:73) says that in a system where conventional banks hedge and Islamic banks do not that wealth is transferred from the unhedged to the hedged. Obiyathulla (2004:73) gives the example that, ‘In a zero sum world, if we imagine two firms trading with each other, if one side is able to fully hedge while the other is unable to, losses incurred by one will constitute the gains to the other.’ Obiyathulla, however, fails to understand that derivatives are in fact instruments of loss and not gain as 70% of derivatives trading ends up in loss (Al-Suwailem 2006:53) and therefore may be more detrimental to wealth creation than using other risk mitigation techniques. Obiyathulla (2004:73) further asserts that unhedged equity risk ‘stunts capital market growth, denies businesses easy access to capital in order to grow and allocates resources into non-tradable assets, which are amenable to asset bubbles.’ Obiyathulla, however, fails to address the fact that derivatives are not ‘real’ transactions since no transfer of ownership takes place and therefore result in the selling of unbundled risk, which leads to the distortion of asset prices, leading to negative impacts on real investment opportunities (Al-Suwailem 2006:53). As mentioned previously, speculative activity may expose the real capital of the business to major risks totally unrelated to the normal business and increase the costs of the business as a result (Al-Suwailem 2006:53). The truth is that derivatives will, therefore, render businesses less competitive in the long-run.

Furthermore, Obiyathulla does not acknowledge or admit in his analysis that the sale of something one does not own, unbundled risk, and debt-for-debt as well as transferring ownership without taking possession are expressly prohibited by the Shari’ah.

While it is possible to appreciate Obiyathulla’s passion for derivatives, he does not consider that risk mitigation solutions may be found within the Shari’ah itself. According to Al-Suwailem, derivatives provide value through management and distribution of risk (2006:53). Al-Suwailem (2006:53) says, however, that they are also perfect tools for gambling and consequently would distort incentives in a manner that defeat their legitimate purpose. Kamali (2009:39) admits that ‘In addition to transferring risk, hedging can also be used to make a profit, which is why it is difficult to draw a clear distinction between the hedger and the speculator, for hedging is also a form of speculation.’ There is, therefore, no real distinction between hedging and speculation as hedging is a gamble. Al-Suwailem (2006:40) explains that derivatives unbundle risk from real economic activity and make it trade separately, thereby transforming risk into a commodity. Al-Suwailem (2006:40) says that commoditising risk is likely to make risk multiply and proliferate, making the economy more risky and less stable. Derivatives allow for unbundling and repackaging risks in any manner players find suitable for their preferences (Al-Suwailem 2006:40). He goes on to explain that this feature means that these instruments end up with risk-reward structures that differ greatly from those of the underlying real assets and that as a consequence, ‘artificial risk structures create artificial arbitrage opportunities that can be exploited through pure speculation with no connection to real economic activities.’ Derivatives result in the creation of a pure speculative market totally separated from the real economy. This is a destabilising factor to the world financial system and constitutes a threat to humanity. Gambling in the form of derivatives also leads to social disintegration and moral decay.

For these and possibly other reasons, the general principle in Islam is that risk cannot be severed and separated from real transactions. Al-Suwailem (2006:40) refers to prohibitions found in the Shari’ah and explains that this form of speculative risk transfer leads to a zero-sum game and thus to a form of eating wealth for nothing (akl al- mal bi’l-batil). ‘Devour not each other’s property unlawfully unless it be through trading by your mutual consent’ (Qu’ran 4:29). Derivatives use is clearly prohibited in the Qu’ran and in the Shari’ah. It is dangerous for academics and scholars to suggest products on the basis of denying Qu’ranic prohibitions such as akl al- mal bi’l-batil based on commercial justifications such as the need to compete in a conventional world. The banking community should abide by the dictates of the Shari’ah in product development.

Banks can actually use Shari’ah-compliant risk mitigation and asset-liability management techniques as well as improve its capital adequacy, diversify product development and usage and improve liquidity in order to relieve tension between Shari’ah compliance and economic goals and promote Shari’ah exploration and production. As we can see, the failure to completely understand the conventional product combined with denial of and improper understanding of the Shari’ah and the desire for quick-fix solutions has led the Islamic financial industry to mimic or use conventional products without a full understanding of their effect on the development and sustainability of the Islamic financial industry and on society.

Shari’ah-Based Financial Engineering

The very art of financial engineering can be described as a process through which risk is partitioned into the smallest possible, unique components and then financial assets are designed that can best match the profile of the micro and specific risk takers (Iqbal and Khan 2005:9). Derivatives are not the only devices available to hedge risk. Islamic financial engineers can develop products using other existing products, hybrid combinations of existing products and also by looking directly into the Shari’ah for new ideas for new products. The reality of the current situation, however, is succinctly summed up by Vogel and Hayes (2006:236) ‘Because depositors are loath to face losses, banks must also avoid risks, again pushing them toward short-term transactions and murabahah and causing them to seek Islamic equivalents for the risk management devices (options, futures, swaps, and other hedges) used routinely by conventional banks.’ It is within this dichotomy, which the current tension in the Islamic finance industry exists. Banks must remain profitable, therefore, face pressure to use the least Shari’ah-compliant and conventional products to preserve liquidity, hedge risks and comply with capital adequacy regulations.

Capital Adequacy

In most countries, banks hold a minimum amount of capital, based on the risk embedded in their asset holding (Archer and Karim 2007:73). To be considered adequately capitalised, international banks in the G10 countries are required to hold a minimum total capital (Tier 1 and Tier 2) equal to 8% of risk-adjusted assets (Van Greuning and Iqbal 2008:223). Accordingly, banks with relatively risky assets hold a higher amount of capital than banks with less risky assets (Archer and Karim 2007:73). A bank would prefer to use modes of finance with lower capital charges in order to sustain solvency and lower its capital adequacy requirement. In order to improve its capital adequacy ratio, a bank can either increase its capital or reduce the risky assets it holds or both (Archer and Karim 2007:81). This induces Islamic banks to utilise the least risky, shortest term and more liquid modes of finance leading to undiversified portfolios, which further hampers risk management. As a result, banks are exposed to specific sectors, raising the level of banking risk (Van Greuning and Iqbal 2008:149). For institutions whose liquid assets are a small proportion of their liabilities, banks have traditionally needed to show a good margin of reserves in order to retain the confidence of their depositors and the public (Archer and Karim 2007:215).

Risk management affects the level of capital a bank needs in relation to assets and deposits and the extent to which its structure affects its value (Archer and Karim 2007:72). A bank’s capital structure relates to the ratio of capital to deposits and the ratio of debt to equity capital. Its performance, in terms of return on equity capital, is influenced by its ability to calibrate the level of capital required (Greuning and Iqbal 2008: 220). Banks opt, therefore, for short-term, liquid, low-risk modes of finance in order to improve capital structure and lower their capital adequacy ratio. In addition to risk and capital structure, management, providing for strong internal and external controls may create a more stable risk mitigation system.

Overall regulation of the Islamic banking industry requires improvement as it is not clear which standard Islamic banks should follow. Basel II is required, IFSB is optional and AAOIFI is only mandatory in certain countries.


Overall regulation of the Islamic banking industry requires improvement as it is not clear which standard Islamic banks should follow. Basel II is required, IFSB is optional and AAOIFI is only mandatory in certain countries. Banks may be confused as to which regulations must be followed and to what extent, creating havoc for the Islamic financial industry and indirectly constraining innovation. For example, the IFSB issued a capital adequacy standard based on the Basel II Standardised Approach with a similar approach to risk weights. The minimum capital adequacy requirements for both credit and market risks are set out for each of the Shari’ah-compliant financing and investment instruments. The IFSB Standard calls for supervisory discretion in determining a share (alpha) of risk-weighted assets funded by risk-sharing investment deposits that can be deducted from the total risk-weighted assets for the purpose of assessing capital adequacy. This share represents the extent of total risk assumed by the investment account holders, with the remainder absorbed by the shareholders on account of displaced commercial risk (Archer and Karim 2007:83).

It is not clear to what extent IFSB should be followed and what to do in the case of an overlap between IFSB and Basel. In addition, AAOIFI promulgated the Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks, which takes into account the differences between deposit accounts in conventional banking and investment accounts in Islamic banking (Van Greuning and Iqbal 2008:59). AAOIFI standards, however, are optional except for those countries, which have declared them mandatory. Standardising capital adequacy regulations for Islamic banks and clarifying which guidelines and standards are optional versus binding and what to do in the case of overlap between Islamic and conventional standards would strengthen the regulatory regime for Islamic banking.

The Importance of a Secondary Market for Islamic Finance

This tension, which exists between Shari’ah compliance and the need to compete in a conventional system, can also be relieved through the creation of a secondary market for Islamic finance. According to Vogel and Hayes, one means of obtaining liquidity is through the securitisation of both short-term and long-term Islamic financial contracts and through the establishment of a Shari’ah approved liquid secondary market for these securitised instruments (Vogel and Hayes 2006: 238). The increased liquidity provided by such a market would relieve pressure on banks in fulfilling their liquidity function and lessen the pressure for risk mitigation while at the same time lowering the levels of required capital. Issuing sukuk reduces risk as it moves assets off-balance sheet and diversifies and lowers the cost of funding (Archer and Karim 2007:25).


The tense dichotomy between developing Shari’ah compliant and Shari’ah-based products and competing in the conventional market can be resolved by strengthening the regulatory regime, creating a secondary market for Islamic finance and producing Shari’ah-based and Shari’ah-compliant risk mitigation techniques, paying attention to the capital adequacy ratio, capital structure and asset-liability management of the bank and strengthening internal and external controls in order to minimise capital requirements. In addition, banks should begin to diversify products for the purpose of risk mitigation. Furthermore, it is imperative that academics and scholars abandon the practice of justifying non-Shari’ah compliance for reasons of commercial competitiveness and instead devote their intellect to deciphering the many tools and products, which may be found in the Shari’ah itself.


1. Ahmed, Habib (2011), Product Development in Islamic Banks, Edinburgh University Press, Edinburgh.

2. Ahmed, Habib and Tariqullah Khan (2007), ‘Risk Management in Islamic Banking,’ in M. Kabir Hasan and Mervyn K. Lewis (eds), Handbook of Islamic Banking (UK: Edward Elgar), 144 – 160.

3. Al-Suwailem, Sami Ibrahim (2006), Hedging in Islamic Finance, Occasional Paper No. 10, Islamic Research and Training Institute, Islamic Development Bank Group, Jeddah, [].

4. Archer, Simon and Rifaat Ahmed Abdel Karim (Editors) (2007), Islamic Finance The Regulatory Challenge, John Wiley & Sons (Asia) Party Limited, Singapore.

5. Arif, Mohamed and Munawar Iqbal and Shamsher Mohamed (2012), The Islamic Debt Market for Sukuk Securities, The Theory and Practice of Profit Sharing Investment, Edward Elgar, UK.

6. IFSB (2005), Guiding Principles of Risk Management for Institutions (Other than Insurance Institutions) Offering only Islamic Financial Services, Islamic Financial Services Board, Kuala Lumpur, [http:/].

7. IFSB (2005), Capital Adequacy Standard for Institutions (Other Than Insurance Institutions) Offering Only Islamic Financial Services, Islamic Financial Services Board, Kuala Lumpur, [].

8. Iqbal, Munawar and Tariqullah Khan (2005), Financial Engineering and Islamic Contracts, IRTI and the International Association of Islamic Economics, Jeddah.

9. Ismath Bacha, Obiyathulla (2004), ‘Value Preservation Through Risk Management: A Shari’ah Compliant Proposal for Equity Risk Management,’ The European Journal of Management and Public Policy, vol. 3, No. 1 (65 – 83).

10. Kamali, Mohammad Hashim (2000), Islamic Commercial Law: An Analysis of Futures and Options, Islamic Texts Society, Cambridge.

11. Khan, Tariqullah and Habib Ahmed (2001), Risk Management: An Analysis of Issues in Islamic Financial Industry, IRTI, Jeddah.

12. Van Greuning, Hennie and Zamir Iqbal (2008), Risk Analysis for Islamic Banks, World Bank, Washington D.C.

Camille Paldi has a Masters Degree in Islamic Finance from Durham University in the UK. In addition to being a qualified Islamic finance specialist, Camille is also a lawyer in four countries and nine jurisdictions around the world and has received legal training in common, civil and Shari’ah law in six countries. She is a US citizen, but has lived half of her life outside the US in various countries around the world. Ms. Paldi founded FAAIF Limited (Franco-American Alliance for Islamic Finance) and (UAE Laws and Islamic Finance).

NEWHORIZON     Ramadan - Dhual Qa’dah 1434POINT OF VIEW

Re-analyzing the Inherent Complexities in the Principal/Agent Relationship of Two-Tier Mudarabah

Mohammad Saif Sarwar and Mohammad Abdullah Nadwi, Markfield Institute

In the context of Islamic banking and finance, theoretically, mudarabah has long been touted as one of the ideal instruments of the Shari’ah-compliant banking system its advocates and proponents. The structure of mudarabah is based on a limited-liability, joint-venture-undertaking in which the provider of capital and the entrepreneur agree on common terms of business. Historically, the mechanism of similar financial arrangements has been in practice since Babylonian times and indeed this type of business arrangement is referenced in the Talmud. Some researchers have suggested that this financing instrument was first proposed by Hashim bin Abd e Manaf; the great-grandfather of the Prophet (peace be upon him). According to this theory, the suggestion came in the wake of ‘ritual suicides’ by Makkans, called itifad’, who took their own lives when they had suffered great business losses or disasters. The mechanism of mudarabah was employed by the Prophet (peace be upon him) himself in the pre-prophetic era and then received his approval after the advent of Islam. Later this instrument assumed a remarkable role in Islamic financing arrangements, which enabled Islamic societies to mobilise resources to finance productive activities without resorting to riba.

After the revival of the Islamic financial system and the inception of Islamic banking in the 1970s, it was believed that Islamic banking would, ideally, take the form of a two-tier mudarabah model, which is based on the classical notion of al-mudarib yudarib. Experience, however, shows that, due to some intrinsic problems in the principal/agent relationship of mudarabah, it could not stand up to the complexities and demands of modern financial systems. Consequently, in practice, the instrument could not become the preferable mode of financing, and currently constitutes less than one fifth of cumulative financing arrangements made by Islamic financial institutions around the world.

The principal/agent relationship is at the forefront of the most frequently cited problems of mudarabah. This article seeks to analyse the principal/agent relationship and its impact on the profitability of two-tier mudarabah.

The Structure of Two-Tier Mudarabah

Two-tier mudarabah is a financial instrument in which funds are mobilised from depositors on a PLS (profit and loss sharing) basis. These funds are then channelled to an entrepreneur to invest in a productive venture based on the same PLS basis. In the banking sector, a bank, which is a highly-regulated joint-stock company, obtains funds from the public on the basis of mudarabah and supplies it, using the same arrangement, to the entrepreneur. The gross income of the bank comprises a share in the actual profit of the venture in accordance with an agreed upon profit-sharing ratio. The income after deducting the expenses is distributed pro rata among shareholders and depositors, whereas if there is a loss it is borne solely by the capital provider.

It has been repeatedly argued that the structure of mudarabah is prone to problems due to its idiosyncratic uncertainty, extreme linearity and the vast discretionary power vested in the entrepreneur. The economic interest of the Islamic bank (the first-tier agent) vis a vis the depositors (the principal in the first-tier) or the interest of entrepreneur (the second-tier agent) vis a vis the Islamic bank (the principal in the second-tier) may conflict despite the contractual relationship between the two that requires the former to act in the best interest of the latter. Arguably, however, due to information asymmetry, the principals may not be able to detect any misconduct on the part of their agents.

Principal/Agent Relationships in Two-Tier Mudarabah

It is manifest from the foregoing discussion that there are two principal-agent relationships in two-tier mudarabah. The first relationship is between the depositors and the Islamic bank, whereas the second is between Islamic bank and entrepreneur. On the liability side of their balance sheet, Islamic banks raise funds from the depositors on the basis of mudarabah, which is first of the two tiers. The level of principal/agency problems asymmetric information, adverse selection and moral hazard are lower here than in the second tier for the following reasons:

a. Banking is a highly regulated sector and the reputational risk faced by banks is relatively high. These two elements impel the bank to act in the best interest of its principals.

b. Although, the recent credit-crunch has revealed that bank executives frequently make decisions designed to boost their own earnings and fringe benefits at the expense of their principals’ interests, it is not considered moral hazard by their principals (depositors), as it is the industry norm and explicitly known behaviour.

c. Another factor minimising the agency problem is the explicit deposit guarantee (up to certain amount) and implicit bail-out guarantee given by governments to the banks.

d. Another consolation for the depositor is that, when the bank, instead of doing business itself, loans money to an entrepreneur on a mudarabah basis without the explicit permission of the depositor, the capital of the depositor becomes guaranteed, as it is considered to be a kind of misconduct on the part of the bank (mudarib in the first tier). This notion of capital being guaranteed in the second-tier of mudarabah has been expounded by classical Shari’ah scholars under the discussion of the well-known legal maxim ‘al mudarib yudarib’; hence, in case of similar misconduct by the bank, it will have to guarantee the capital. Islamic jurists have drawn an analogy between the underlying misconduct in a mudarabah contract and ‘bai ul fuduli’ in which the sold article, due to the misconduct of the ‘fuduli’ (one who enters into a transaction without the consent of the real owner of an object), becomes guaranteed for its owner from any kind of loss. So, in such a case, the owner of the capital would enjoy the profit without sharing the risk of any loss.

Along with these advantages in the first tier of mudarabah from the principal/agency point of view, there are few disadvantages. The real agency problem in the first tier, which is generally overlooked, is the mechanism and use of PER (Profit Equalisation Reserve) and IRR (Investment Risk Reserve) in Islamic banks. Islamic banks, in order to avoid displaced commercial risk, appropriate a certain percentage from the total gross income of the bank and the depositor, to be used in the event that the bank faces losses, in order to stabilise the cash flow and to give a fixed return to the depositors. In the first place, giving a pre-specified fixed return on a mudarabah account may be tantamount to riba. Secondly, in this mechanism, it is not clear whose money is used to equalise whose loss, which leads to gharar. At the time of closing a mudarabah account, if the depositor seeks to claim any sums diverted into a bank’s PER fund, generally he/she is not allowed to do so, which is tantamount to confiscation by the Islamic bank.

The treatment and utilisation of IRR is more problematic. In addition to the aforementioned problems, if the actual return is higher than expected, it is displayed on the depositor’s account. He/she, however, can never withdraw more than the expected return, and can only enjoy the fixed amount throughout the life of his/her account.

Virtually every company had some degree of impermissible interest income or expense, primarily as a result of direct or indirect deposits, investments or indebtedness.

One potential solution to this problem of gharar and confiscation in the first tier of mudarabah is the set up of an independent pool, where an SPV (special purpose vehicle) is created for the treatment of PER and IRR similar to that used in takaful. The contract, which would be signed by the bank and all the mudarabah account holders, would state clearly that if the actual return is higher than the expected return, the account holders of their own free-will would agree to donate the excess amount to this pool in the form of tabarru’. In turn, the PER or/and IRR pool as an SPV would be responsible for taking care of any kind of deficiency in the funds in case the actual return is lower than expected rate of return. Through this mechanism the problem of the appropriation of the depositors’ money would be resolved. In addition it would consolidate mudarabah projects by providing a considerable amount of financial backing. The funds in the pool could also be invested to generate further profit, strengthening the pool and enabling the bank, which would act as a wakil or mudarib for the investments of the pool, to claim its share from the profit generated by the investment of the pool funds.

Principal/Agent Relationships in the Second Tier

The principal/agent relationship in the second tier of mudarabah is severely problematic. The separation of management and ownership, coupled with the principal’s lack of control over the functions of the business receiving the finance, gives rise to asymmetric information, which in turn leads to adverse selection and moral hazard, as the managers in control may act in their own interest rather than in the interest of the principal (rabb ul mal).

On the asset side of their balance-sheets, Islamic banks invest the funds raised by the first tier with an entrepreneur on the same mudarabah basis. If it is restricted mudarabah, the Islamic bank can stipulate some conditions upfront, however, if it is unrestricted then the entrepreneur has complete control over the investment of the funds, using it in the way he/she thinks is best for the business. This feature of mudarabah gives rise to a plethora of problems, but there are three that are very significant and indeed are considered by some academics and practitioners to be an inseparable part of mudarabah. They are:

a. Idiosyncratic uncertainty the source of this uncertainty is the fact that the bank’s return is supposed to depend completely on the reported future cash flows resulting from operating profitability, which in turn depends entirely on the corporate investment decisions taken by the agent. The fact of the matter is the agent enjoys a considerable measure of freedom and cannot be fully monitored. The uncertainty is worsened by the fact that the bank (the principal) has no right to control the assets employed in the mudarabah project due to Shari’ah restrictions on taking collateral from a partner in a PLS arrangement. Although, lately, an AAOIFI standard has granted permission to take collateral as a guarantee in mudarabah, this is subject to very specific terms and conditions. Due to the foregoing factors, the level of uncertainty is severe and the Islamic bank faces very high risks, which leads to a high incidence of adverse selection and moral hazard problems facilitated by the ability of entrepreneur to hide information about his abilities and background as well as the efforts employed in the project.

b. Extreme linearity between the return and the performance of the project undertaken is another problematic feature of the principal/agency relationship. The expected return is primarily dependent upon the efforts invested in the project by the entrepreneur and his/her skills as well as the level to which the entrepreneur rewards himself/herself.

c. Discretionary power and excessive control by the entrepreneur over the mudarabah project is another problematic feature of principal/agency relationships in the mudarabah structure. The agent (the entrepreneur) makes decisions concerning investments and the distribution of immediate cash flows, providing him/her with full discretion over assets without bearing the risk of financial losses. This could be an incentive for the entrepreneur to work in his or her own interest instead of that of the principal.

Some solutions have been suggested to resolve these problems – some are based on practical experience, while others are theoretical.

Incentive Compatible Profit Sharing Contracts

In order to minimise any misconduct by agents, some scholars such as Dr. Habib Ahmad, have proposed incentive compatible profit sharing contracts. The proposal seeks to use the assets of the entrepreneur as collateral that can be used to punish him in cases of proven false reporting. According to the proposed structure, the Islamic bank reserves the right to audit the accounts of the project. The auditing expenditures are a part of the monitoring costs and are used to reward/penalise the honesty/dishonesty of the entrepreneur.

In the case of true reporting by the entrepreneur, verified by the audit, the bank will bear the whole cost of auditing. In the case of false reporting, however, where the actual profit found in the audit is greater than reported profit due to the moral hazard, the entrepreneur will pay back the whole invested amount along with the whole auditing cost, plus a fine. Dr. Ahmad asserts that the threat of such a penalty should be costly and credible enough to dissuade the firm from being dishonest.

After ensuring compliance with the aforementioned factors ex-ante, Islamic banks should invest in low-capital, short-term, profit-sharing ventures, which already have job orders, avoiding liquidity risk. Job orders mean that an Islamic bank knows the value of the project in advance and is able to determine the profit sharing ratio by calculating the risk involved, along with distributing the risk between the entrepreneur (performance risk) and job-order issuer (credit risk). The issue of credit risk is further minimised because the Islamic bank can check the credit record of the job-order issuer through mechanisms provided by the central bank. This structure of financing can be substantially beneficial for the asset side of two-tier mudarabah.

To minimise agency problems and to engage in more PLS activities, Islamic banks can make good use of venture capitalism on the asset side of two-tier mudarabah. By its structure and essence, venture capitalism is a modern form or a ‘Western version’ of mudarabah, according to Dr. Humayun Dar and John Presley, who assert that ‘Venture capital financing as practiced in the USA, UK and other European countries is a modern example of mudarabah. This Western version of mudarabah is in essence commensurate with Islamic teachings and provides a balance between managers and financiers in terms of control of business decisions.’

One of the most salient features of venture capitalism is staged-financing. It is suggested that Islamic banks should adopt staged financing, as do the venture capitalists, to avoid the principal-agency problem in its second tier of mudarabah. In some businesses especially high-tech industries, it has been found that new start-up companies are relatively more risky due to the uncertainty surrounding returns, the lack of substantial tangible assets and the lack of a track record in operations. Islamic banks can take the initiative to invest in these kinds of young and high-risk firms on the basis of staged financing.

The mechanism and salient feature of staged financing is staggering the commitment of capital and preserving the option to abandon the project. Instead of disbursing all the required capital upfront, Islamic banks can invest in stages to keep the project under control. It will allow the banks to monitor the progress and productivity of the firm before they allocate the next instalment of project capital. It will substantially reduce losses from inefficient continuation of finances and would create an exit option for the Islamic banks, if deemed necessary. By monitoring and implicitly threatening termination, Islamic bank can also exercise better control over potential moral hazard.

In the context of venture capitalism, Wang and Zhou have clearly shown that staged financing is an effective mechanism to reduce agency costs and to control risks. Its flexibility has enabled many highly promising projects to prosper and become highly profitable, which may otherwise have been abandoned under upfront financing. According to Hellmann’s theory, the staged financing avoids risk and triggers the entrepreneur’s short-term behaviour. To give an impulse to this short-term behaviour, the investor (the Islamic bank) should be allocated a larger share, which provides the incentive to monitor the entrepreneur. In brief, staged financing with good-looking, high-potential ventures on the asset side of two-tier mudarabah can achieve the best results for Islamic banks.

In order to optimise the efficiency of the product, there are suggestions for incorporating the theory of stewardship in the mudarabah contract. The idea of stewardship is based on a theory which is diametrically opposed to the principal-agency theory. Principal-agency theory, having its roots in economics, starts from the assumption of self-interest, whereas stewardship theory, tracing its roots back to psychology and sociology, rejects self-interest. This theory, which was developed by Donaldson and Davis, is a new perspective for understanding the existing relationships between the ownership and management of the company. It is an attempt to achieve a reconciliation between the relationship based on agency, where the Board of Directors (BOD) are responsible for governance, and the relationship based on management theory, where the management itself is responsible for the same. Stewardship theory argues that the BOD and management are a single collective stewardship team at the top of the corporation. The BOD’s role is not to control or direct the corporation, but to support and assist the CEO and management in accomplishing their tasks. Management, as steward, maximises the performance of the organisation, working under the premise that both the steward and the principal benefit from a strong organisation.

This structure of governance has recently been implemented and is in practice only in the UK under the patronage of the FRC (Financial Reporting Council) to promote and safeguard the interests of institutional investors. It is acting upon the recommendations of Sir David Walker following his review of corporate governance in the financial sector, working on the concept of ‘comply or explain’.

Islamic banks can use this concept of stewardship as a solution for the principal-agency problem on the asset side of two-tier mudarabah by constituting a stewardship team, which would include having representatives of the bank on the board of directors, as well as management representatives from the entrepreneur’s firm. By doing so it can have better control of the firm’s activities and the interests of the Islamic bank will be safeguarded by the notion of ‘comply or explain’.


Two-tier mudarabah is inherently prone to agency problems due to its idiosyncratic uncertainty, extreme linearity and discretionary power resting in the agent. Due to this principal-agency relationship, some specific problems arise, which compel the Islamic banks to resort to the mechanism of IRR and PER on the liability side and understatement of profit due to moral hazard on the asset side. To resolve these problems there have been different solutions suggested by different scholars such as using penalty/reward mechanisms, investing under incentive-compatible profit-sharing contracts, the application of incentive-compatible constraints by investing in projects with job orders or purchase orders, etc.

There are some other options to reduce agency problems such as staged-financing and stewardship, which can be used to mitigate the asymmetric information and moral hazard to attain optimum productivity from two-tier mudarabah. Incorporating the notion of tabarru (unilateral donation) by depositors in IRR and PER pools may resolve the problem of gharar arising out of the complex and ambiguous structure on which these two terms are based.

Mohammad Abdullah Nadwi

Mohammad Abdullah Nadwi is a partner of Mohammad Abdullah Nadwi is a Shari’ah scholar and a doctoral candidate (Islamic Economics) at the Markfield Institute (University of Gloucestershire, UK). He has worked with Islamic Relief, Birmingham, as a research assistant in its Islamic microfinance and waqf department. He completed his first degree at the Islamic University Nadwatul Ulama Lucknow, India, followed by an MA in the UK.

Mohammad Saif Sarwar

Mohammad Saif Sarwar is a Research Fellow at Quranic Arabic Foundation (QAF) based in Birmingham. He is a trained Shari'ah Scholar and has expertise in Fiqh al-Muamlat. Sarwar, completed his MA in Islamic Banking and Finance at University of Gloucestershire, UK, following a BA in Shari’ah studies in India and an MA in Islamic Sciences in Syria.

NEWHORIZON    July to September 2013STATE OF PLAY

Maqasid Driven Islamic Banking Some Suggested Baby Steps

Shahul Hameed bin Mohamed Ibrahim, Associate Professor, International Centre for Education in Islamic Finance


Although the Islamic finance and banking is going to hit the US$2 trillion mark sometime this year, there are many Muslims (academics, potential and current depositors and customers) who are sceptical about Islamic banking. Potential and current customers compare the mark ups charged by Islamic banks and whenever Islamic banking mark ups are higher than their interest-charging counterparts, they assume Islamic banking is not Islamic. On the other hand, academics and intellectuals complain about the lack of social services provided by Islamic banks, although this is one of the four functions of Islamic banks according to AAOIFI.

Controversial Financial Instruments

Islamic banking has grown mainly through controversial sukuk issues and by replicating conventional products using the fixed income contracts of murabaha and ijarah. Sukuk issues have changed little since Sheikh Taqi Usmani’s warning on sukuk some years ago and from a fundamental Shari’ah point of view the situation has deteriorated. Sukuk conditions such as fixed redemption prices, minimum return guarantees, refunds of excess profits to issuers, ‘beneficial’ as opposed to real ownership arising from asset-based sukuk, do not bode well for the achievement of a just Islamic financial system.

The Malaysian Security Commission’s Shari’ah Advisory Council and Shari’ah Advisors have in particular approved sukuk, which in my view (with due respect to them) , create misleading sukuk classifications. While the Malaysian Security Commission proudly proclaims the majority of their sukuk are mudharaba/musharaka sukuk, this may not hold water on close inspection. Term sheets reveal that these sukuk are actually replications of conventional bonds with fixed percentage returns not co-related directly to any project or economic activity. While returns above a certain amount are given back to the issuer as an ‘incentive’ share, topping up low returns by the issuer, through repayable loans, which may never get paid, is certainly objectionable. In substance, therefore, the return on mudharaba/musharkaa sukuk are not linked to the cash flows of the underlying project but they are actually ‘guaranteed’ at a fixed rate. The musharaka in musharaka sukuk have been defined, not by the contract of the underlying activity as it should be, but in terms of the relationship between the sukuk holders and the SPV (Special Purpose Vehicle), i.e. the sukuk holders are in a musharaka among themselves and the SPV, hence, the real spirit of risk sharing is lost. Second, after almost 30 years of Islamic banking in Malaysia most Islamic banks use bai bithaman ajil (BBA). BBA as practised in Malaysia is a genetically modified version of murabaha with ‘cancerous DNA materials’ including bai al inah and the sale of non-existent subject matter in the case of home financing. Some Islamic banks use BBA and ijarah for up to 98% of their financing portfolio. Credit must be given to Bank Negara Malaysia (BNM) for introducing guidelines under the new Islamic Financial Services Act of 2013, wherein it has required the banking industry to move towards real risk sharing mudarabah deposits within the next few years.

What about social services?

The Malaysian Islamic banks from the very beginning have denied that they are charitable organisations and according to the CEO of the First Islamic Bank of Malaysia ‘social services should be left to charities; it is not the business of Islamic banks.’

True, Malaysia is probably the largest Islamic finance hub in the world in terms of the range of products and infrastructure, although the GCC countries are higher in terms of assets. The just socio-economic ideals, spirit, intentions and objectives of the pioneer thinkers and advocates of the Islamic economic system have, however, been long forgotten by the Malaysian Islamic finance industry, as they are still in the capitalist ethos of maximising profits. Their oft-repeated answers to any concern raised regarding the socio-economic objectives, is ‘why should we worry; the Shari’ah board has declared our products halal’ is in my view, a betrayal of the socio-economic justice objectives of the Islamic financial systems as they were pioneered by the early Islamic economists.

The Shari’ah Board Problem

Until, recently, when the Malaysian Central Bank introduced a Shari’ah Governance Framework, the Shari’ah boards’ reports have been another problem, in that the Malaysian Islamic Bank’s two-line Shari’ah reports that they used to come out with have left much to be desired. They just stated that two of the Shari’ah board members ‘confirm’ that, in their opinion, the bank had conducted its operation in a Shari’ah compliant manner. The scope of the review work undertaken and the evidence on which their opinions were based and exactly what they were reporting on was all a mystery! To give credit to the industry, these reports have vastly improved. Some individual Islamic banks have been improving their Shari’ah reports even before the Shari’ah governance framework came along. They are, however, still formulaic reports devoid of any spirit or passion. It does not even have the cold, calculated, scientific objectivity of, for instance, the Shari’ah advisors’ report from the Meezan Bank of Pakistan, which sounds more like a SOX (Sarbanes-Oxley) 404 report.

Is there an alternative?

Idealists are tempted to give up and go home. Sceptical Muslims are still not convinced of the Islamic nature of the Islamic banks in many parts of the world. As a noted Islamic finance academic commented, ‘What is the alternative? Do you want to go back to conventional banking?’ Of course, the answer is NO. Islamic banking has been successful in channelling Muslims’ deposits away from haram uses, i.e. financing haram industries; it is tethered to the real economy to a certain extent and, of course, there is no compounding of late payment charges on Islamic financing or on Islamic credit card overdue charges. In the current uncertain global financial recession, Islamic banks are also more secure (at least when there is no fraud), as they do not as yet deal with speculative derivatives and securitised debt securities (although this too might be changing).

What about issues such as risk-sharing contracts, micro-finance, financial inclusion of SMEs, financing environmentally friendly industries and qard hasan? The oft repeated answer of the industry is that the depositors are not willing to lose their money.

The objective of Maqasid Shari’ah in finance is not to lose one’s money or give all of it away for charitable purposes and start to beg themselves, but to share risk. Again the central banks have to nudge the industry. In the case of Pakistan the State Bank of Pakistan has introduced a mudharaba risk pools framework, where depositors with different risk appetites can deposit in different risk pools whose funds will then be directed to more risk-sharing contracts. The pro-active Malaysian central bank (BNM) has issued tough new guidelines on the risk sharing nature of mudharaba contracts. Let us hope this takes off. This is not a baby step, but a giant leap for the risk-sharing ideals of Islamic finance.

Baby Steps

Other baby steps, however, can be taken to bring about a culture of social responsibility and compassion in the following ways:

1) Introducing deposit products with charity features. Affin Islamic Bank of Malaysia has recently introduced a mudharaba deposit product where part of the depositors’ profit share can be distributed to a named charity. For example, a depositor can elect to share the profits 40% (depositor), 20% (charity) and 40% (bank) instead of the usual 60:40 ratio in favour of the bank, effectively donating 1/3 of their profits. Let us hope shareholders join the party by contributing a small percentage of their share as well. Of course this requires a resolution to be passed by shareholders at an Annual General Meeting.

2) Another source of funds for charity or qard hasan can be from current account or savings account depositors who are not entitled to any return but are given ‘hibah’ (a gift) by the bank. These depositors can be asked to give away their hibah or a portion of it, to a qard hasan fund or charity.

3) It is high time for either the regulator to instruct Islamic banks or for Islamic banks themselves to make changes to their aims and objectives so that they set aside a small percentage of their profits for a qard hasan fund from which they can disburse loans to the poor and needy. Many Middle Eastern banks especially those in Jordan have been doing this for a long time, although the amount is small.

4) Some banks have takaful combined savings deposits accounts which will mature to a certain amount and then be given away as a waqf endowment. In this way, middle income and even lower income people can put aside a small amount of their savings to enable them to become waqf creators. In the event that they die during the term of the savings policy, the takaful operator will top up their savings to the amount the depositor initially intended to give to a chosen waqf fund.

5) There is a company in Malaysia which intended eventually to turn itself into a waqf. If Islamic banks can be persuaded to follow this example, by using a percentage of their profits every year to buy their own shares and donate them to a waqf, then the resulting waqf’s share of profits can be used for qard hasan, microfinance or SME financing with lower profit rates. This waqf can also be supplemented by hibah and profit contributions from depositors.

6) Shari’ah scholars should, through critical and professional Shari’ah audit reports and product approval processes, nudge the industry towards the socio-economic financing ideals of the Shari’ah.

7) Islamic finance academics can develop Maqasid Shari’ah-based performance measurement tools which can enable stakeholders to assess the industry performance compared to the Maqasid instead of just financial achievement.

Let us hope and pray the captains of the Islamic finance industry do some soul searching along with their shareholders, depositors and Shari’ah scholars, in order for the Maqasid Shari’ah in Islamic finance to be achieved in the future, albeit a bit late. Let us make some real efforts to contribute to an alternative just financial system which the world so badly needs.

The views expressed in this paper are entirely those of the author and do not in any way represent the views of the INCEIF, Bank Negara Malaysia or the Malaysian Securities Commission.

Dr Shahul Hameed Mohamed Ibrahim

Dr Shahul Hameed Mohamed Ibrahim is a Chartered Accountant (Malaysia). He is also a Fellow of the Association of Chartered Certified Accountants (UK) (FCCA) and a Chartered Islamic Finance Professional (CIFP). He is a graduate of Tunku Abdul Rahman College. He also holds an MA (Accounting and Finance) from Lancaster University and a PhD from the University of Dundee as well as a Post Graduate Diploma in Islamic Revealed Knowledge from IIUM. He has been teaching for more than 25 years in higher education in both Malaysia and overseas, with another 5 years in practice and industry as an accountant. He is currently an Associate Professor at INCEIF.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434Product Focus

Salam: A Good Alternative to Controversial Tawarruq

Jassim Mahadik, Project Manager, Al Maali Islamic Finance Training and Consultancy, Dubai

Working capital finance is one of the essential solutions offered by financial institutions worldwide; Islamic financial institutions (IFIs) being part of the financial world are no exception. Working capital finance solutions provided by IFIs are mostly based on the concept of tawarruq, which is also known as commodity murabaha. Many top Shari’ah scholars have ruled that tawarruq is impermissible. In 2009 the International Islamic Fiqh Academy of the Organisation of Islamic Conference also declared organised tawarruq as practiced by contemporary IFIs as impermissible. This declaration not only stirred a big debate over the legality of tawarruq from the perspective of Islamic jurisprudence, but also strengthened the position of the critics of tawarruq.

The main objective of Islamic financial institutions (IFI) is to conduct their business activities in conformity with the tenets of Islamic jurisprudence. Noncompliance with the juristic precepts can expose IFIs to Shari’ah non-compliance risk, which has the potential to further convert into serious reputational risk for IFIs. There are many issues surrounding the practice of tawarruq by IFIs. For example, one of the big criticisms of tawarruq is that there is no economic activity taking place in a tawarruq transaction and so tawarruq is just a subterfuge and a legal stratagem to bypass riba (interest). Similarly, most of the IFIs executing tawarruq use international metal exchanges to buy and sell commodities for the tawarruq transaction. Many scholars and academicians have voiced their concerns over the quality and even the existence of the underlying commodities. Apart from the malpractice in the industry, many scholars such as Ibn Taymiyah and Ibn Qayyim al-jawziyah disallow tawarruq even in its pure form. Even if Tawarruq is restructured in another way and the industry abstains from the malpractices mentioned above, tawarruq will remain controversial as its basic concept itself is debatable.

There are also some other Islamic financing products in the market which provide access to cash. For example, bai inah and sale and lease-back mechanisms are also used by IFIs, albeit very few, to structure working capital finance products, but all these Islamic working capital finance products are highly controversial and debatable from the Shari’ah compliance perspective. It is, therefore, imperative that the industry develops an alternative working capital finance product, which will be in conformity with all schools of thoughts as well as will being economically viable.

Bai-al-salam can be a good alternative to tawarruq. It can be deployed to structure financing products wherein the client gets access to cash. Salam is a forward sale contract wherein the seller undertakes to deliver certain goods on a future date in return for the full price paid in advance. In a salam contract, the payment date, quantity, quality delivery date and all the specifications of the commodity necessarily need to be clear to both the buyer and the seller at the time of signing the contract.

Salam is considered to be permissible by all major jurists. The precedent to consolidate this point can be found in the hadith which says that when the Prophet (Peace be upon him) came to Madinah, people used to do bay-al-salam in dates for the duration of one or two years. The Prophet said, therefore, that those who do bay-al-salam, should do it for a specified quality, quantity and period (IbnMajah/2280). Similarly, Ibn-Al-Abbas (May Allah be pleased with him) is of the opinion that the verse no 282 of Surahal- Baqarah of the Holy Qur’an permits sale with deferred payment as well as with deferred delivery of a commodity, that is, salam (IbnKaseer).

Some Islamic contracts utilised by IFIs, for example murabaha, are basically sale contracts and the main purpose of these contracts is not finance, but general sale. In the case of salam, however, it is very evident and a well-established fact that the contract of salam was used historically by farmers to finance/fund their farming activities, so apart from the fact that salam is not controversial, the element of finance is inherently embedded in the contract of salam. The main purpose of using salam during the times of the Prophet (peace be upon him) was to obtain finance, thus there is no doubt that salam can be used for financing purposes.

Some Islamic contracts utilised by IFIs, for example murabaha, are basically sale contracts and the main purpose of these contracts is not finance, but general sale. In the case of salam, however, it is very evident and a well-established fact that the contract of salam was used historically by farmers to finance/fund their farming activities, so apart from the fact that salam is not controversial, the element of finance is inherently embedded in the contract of salam. The main purpose of using salam during the times of the Prophet (peace be upon him) was to obtain finance, thus there is no doubt that salam can be used for financing purposes.

Working Model of the Product and Process Flows

1. Client applies for working capital finance.
2. The IFI assesses the profile, credit risk, etc. of the client. If the client qualifies for getting the finance, a salam agreement is signed between the client and the IFI wherein the client is the seller of the salam commodity and the IFI is the buyer. The price, payment date, quantity, quality, delivery date and all the specifications of the commodity to be delivered by the client are specified in this agreement. With regards to the delivery of the commodity, the client is given two options:
The client is free to deliver the commodity himself to the IFI; or The client is given the option of choosing a commodity supplier authorised by the IFI. The IFI will cooperate with this commodity supplier to supply the commodities on behalf of the client. In case the client chooses this option, the commodity supplier will give a quotation for the price of the commodity to be delivered on future dates. On acceptance by the client, the IFI will be authorised by the client to transfer the salam commodity at the price quoted from the client’s account into the account of the commodity supplier on the specified dates.

a. If the client chooses the commodity supplier authorised by the IFI, the client will ask for a quotation from the commodity supplier for the price of the commodity on future specified dates. These dates will coincide with the dates on which the client has to deliver the commodity to the IFI.
b. The commodity supplier will provide the quotation to the client and will undertake to provide/ deliver the specified quantity of the commodity at the said price on the said dates.
3. The IFI pays the purchase price of the salam commodity. This price is equivalent to the finance amount needed by the client. The IFI signs a parallel salam contract with a third party under which the IFI sells the commodity to be received from or on behalf of the client to this third party by adding a profit margin. The third party pays the full price to the IFI. The two salam contracts (with the client and the thirdparty) should be independent and segregated contracts and should not be dependent on each other.
4. The client either delivers the commodity himself or the authorised commodity supplier delivers the commodity to the IFI or to the party specified by the IFI. In consideration for the commodity, the commodity price is transferred from the client’s bank account to the commodity supplier’s account on the specified date.
5. The third-party receives the commodity.

Utility for the Industry

One of the biggest disadvantages that IFIs have compared with their conventional counterparts is that IFIs cannot securitize their receivables. This is one of the big liquidity management challenges for IFIs, but this problem can be solved through the execution of a parallel salam contract. This means that the commodity to be delivered by the client to the IFI on a future date will be sold by the IFI in advance through the execution of a salam contract with a third party (as described in the process). This can be done immediately after the client has been provided with the finance, so the IFI can get the whole financed amount plus profit without having to wait for the client’s payments in instalments. An interesting element worth mentioning here is that in the securitisation of receivables (in conventional finance), the receivables are discounted. In a salam transaction, however, the IFI will get back the money at a compounded rate, i.e. the IFI will also earn profit.

Another benefit for the industry is that, as mentioned earlier, salam is considered permissible by all the major schools of thoughts of Islamic jurisprudence. This reduces the Shari’ah non-compliance risk to the maximum.

Other Potential Risks

Under a salam contract, the IFI is exposed to market risks related to the salam commodity. There is a possibility that the IFI may not find a buyer for the salam commodity or may not get the expected price or the client may find it difficult to get the commodity from the market on the delivery date. All these risks can be managed by executing a parallel salam contract with a third party as mentioned in the process.

Secondly, the IFI can do salam in commodities which are easily available and are traded very frequently and in high volumes in the open market. For instance, in the GCC market, commodities like petrol and dates can be a good choice for salam transactions.

Use of International Metal Exchanges

One of the controversies that has plagued Islamic finance is the use of international metal exchanges like the London Metal Exchange in tawarruq transactions. There are doubts over the quality and even the existence of the metals bought and sold. Many scholars and professionals have voiced their concerns that the buying and selling of the commodities through these exchanges may be a mere exchange of receipts and that the commodities may not actually exist. IFIs must learn from these past mistakes and avoid this controversy, by using commodities available in the local market for the salam transactions and ensuring there is real trading taking place. This will help linking the financial economy to the real economy, thus fulfilling one of the objectives of Islamic economics.

Jassim Mahadik

Jassim Mahadik is currently a Project Manager with Al Maali Islamic Finance Training and Consultancy in Dubai. He is involved with handling projects related to product development and Shari'ah compliance in Islamic banking and finance. He holds an MA in Islamic Banking, Finance & Management from the University of Gloucestershire.


Money Management and General Trading under Islamic Banking Procedures

Dr Ibrahim Kamel, Chairman, Kamel Brothers (Islamic Consultants), Geneva

This is an edited version of the presentation given at a conference on ‘Islamic Banking Its Impact on World Financial and Commercial Practices’, held in London on Tuesday, 18 September 1985. The modern Islamic finance industry is barely 40 years old and sometimes it is good to remind ourselves just how far the industry has come in that short period.


Mr Chairman, ladies and gentlemen, I wish to start by thanking the Middle East Association and Monadnock International Management Development for organising this conference in Islamic banking and trying to examine its impact on world financial and commercial procedures. As a Muslim myself, I have since 1970 started in my own company intensive studies, trying to understand my own religion, not because the religion itself was not understandable, but because I went to school where my teacher was educated here, in the UK, and I was probably at that time, more capable of describing English history than I was of describing the history of my own country. I probably would have continued to remain in that situation having graduated and gone on to France, where once again I was taught Western education. In our education system, Islam took a very, very backward position.

It is I think, because this educational gap was created and continued to exist in my mind, that in 1970 we, Kamel Brothers, started in our own office in Geneva and in our offices in Cairo and the Middle East, began to try and understand a lot of things. The starting point in my case was His Highness the Actual Crown Prince of Kuwait. I had been asked over to Kuwait to look into financing a $35m complex in Al Ahmadi and the proposal I received was that I would be given an Irrevocable Unconditional Bank Guarantee issued by the National Bank of Kuwait to supply the finance and I would be left to manage the venture until I had recouped the capital and whatever profits I should be entitled to and after that I would redeem the property it to its owners.

Highly excited I went back to Geneva; we prepared the architectural and engineering drawings and the cash flow with the obvious interest charges and presented this to His Highness who told me, ‘No, no, no, I don’t want to be involved’ and I finally understood that he did not want to be involved in ‘interest’ – ‘riba’. That effectively to me was a shock, because I had been taught at school that the French National Assembly had decided in the 15th century against the ‘Papal Decree’ which we have on file damning any Christian who was to deal with ‘usury’. The French National Assembly decided that 7% was interest, and 7.5% was usury! A few years ago when interest rates went up to 20% there were a lot of very embarrassed constitutional experts trying to explain how they were going to get around this point because most of the constitutions of the Western world refer to a prohibited usurious rate, which is set at around 15-16%, so the distinction between interest and usury is purely linguistic. The concept of ‘interest’ is money on money if I give you $100 and ask you to guarantee that you return the $100, plus $10, that is called ‘riba’ in Arabic it means what has grown in excess, not resulting from the direct involvement of the parties in the risk/reward factors that exist in any economic venture. True, a lot of banks today have ‘beautiful’ pieces of paper signed by central banks guaranteeing to return capital and interest I am certain there must be a lot of bankers here with such paper from banks like the Central Bank of Brazil, the Central Bank of Mexico, and the Central Bank of Argentina. IMF meetings taking place right now are looking at what to do about the horrendous Third World debt, so the fact that somebody pays back or doesn’t pay back, whether we call it interest or whether we call it usury, still remains a point that we don’t know how to handle, but the underlying factor is that we have artificially created money with money, I will explain that as we go further into this presentation.

Kamel Brothers

In the autumn of 1978 Kamel Brothers, came out with the Islamic Investment Company and this company (IIC), which turned to the public offering participations in Islamic trust funds which we call ‘modaraba’, wherein the company is ‘manager’ and would manage the funds of the public and distribute the profits among the beneficial owners and the managing trustee the manager.

For two years IIC remained in the red and we were losing a lot of money, and our indications showed that IIC was going to lose something like $15m before we started to climb back in 1984/85 to the positive side of the financial graph. We were thus amazed, as by the end of 1980 we had passed the $l billion in deposits and we had became profitable in two years.

There was mass response by our own people to IIC. Why? Because they were never taught like I was that interest is not-prohibited; that interest is fine and it is usury that is prohibited. In Arabic for them interest is riba and riba is haram prohibited, period. True, there are ‘hiyal’ (tricks), ways of getting around riba but I also recall that in Christian history, there also are hiyal. As a matter of interest what happened in both the cases of Christianity and Islam is very similar. The decree issued by the Pope in the 15th century damning usury, uses terminology that would be identical to the contemporary statement made by the former Grand Mufti of Egypt, when he approved IIC operations and disapproved of the whole contemporary financial concept based on riba (interest usury).

By 1981 it became evident that we needed a much bigger corporate vehicle to expand, as the Islamic Investment Company had now successfully tested out a whole series of different ‘modarabas’ (trust-funds). Some were designed to serve the purpose of creating the basis for massive mobilisation of funds from the man in the street; others were designed to set the basis for what has become the Islamic banking system and one modaraba was designed to set up what is now called the Islamic takaful or ‘solidarity’ system, which is the Islamic alternative to insurance.

Islam in the World

The brilliant presentation before me by my colleague, Mr Malise Ruthven of BBC External Services, has raised a number of points. [He referred to Islam as an unusual religion in terms of the categories with which we are familiar because it has a very strong social dimension. He also referred to the particular contribution of the preaching of Prophet Muhammed, which was to fuse the multiplicity of tribal systems in 7th century Arabia within a single unitary ‘umma’ or community. He understood that the commitment was to social equality and social cohesion and in line with the whole tradition of Islam, which is to maintain a balance between the requirements of trade and economic growth and those of social responsibility. While riba in its original sense means the additional increase in a thing over its size and amount, he also pointed out that scholars are not entirely agreed on what is meant by riba, although there is an emerging consensus that riba, means interest. He mentioned that the Islamic system really began to disintegrate at the time when European political and economic power asserted itself with the establishment of the first European banks in the Muslim world in the 19th century, although we are now seeing a new impulse in the Muslim world towards re-establishing interest-free banking. He also referred to the two partnership contracts of musharakah and mudarabah and the legal system of Islam, the Shari’ah, a development which comes from four principal sources the Quran itself, the reports of the sayings and examples of Prophet Muhammed, ‘qiyas’, which are arguments by analogy and ‘ijma’ – consensus.

I would quickly comment that the Quran was revealed 1400 years ago. The Quran establishes principles and we (Muslims) are supposed to use those principles to guide us through every generation, every age, to understand and find out the way as to the best application possible. It is from this philosophy that the Quran stems, if one reads the Quran one will find in it a very strong commitment to social equality and social cohesion. When I put the Quran on the computer, I was amazed to discover that every chapter in the Quran that starts in Arabic with ‘In the name of God the Beneficent, the Merciful’ is composed of 19 letters. Each word of that phrase is repeated a multiple of 19 times. Throughout the Quran the number of suras (chapters), the ayat (verses) are all multiples of this mathematical code, 19. This makes one stop a little bit – I am an engineer, a mathematician and I asked myself how could the Quran, revealed to an illiterate shepherd, 1400 years ago, contain all these meanings, that today provide a source of inspiration for over a billion Muslims.

Money Management and General Trading Procedures in Islam

Islamic financial institutions are only five years old. The existing Western institutions are over 500 years old so give us a chance, maybe 500 years from today somebody will be much more capable of giving a better detailed presentation than I can I am simply trying to describe what the problem is.

We all speak of money. The first question is that I think we speak of two different things. Economists agree that money fulfils a number of tasks. It is a medium of exchange, a unit of deferred payment, a unit of account and a store of wealth, however, money in Islam has to perform five basic functions.

1. Money has to measure wealth correctly and not in any artificial form. The Quran is full of verses that say measure correctly, weigh correctly, you shall be just, etc. so does the Old Testament by the way and the New Testament. Are we measuring wealth correctly today? Is the salary that you and I were paid this month equal to the salary that we received last month? Or last year? Can we buy the same amount of goods and services?
2. The Quranic prohibition is ‘not to devalue people’s wealth’. Did the house you buy this year or last year lose in value? True you may be given more pounds, but in real terms can you buy the same thing, for the same amount? For example, an Egyptian pound issued in 1960, a gold pound, was worth one paper pound plus some small change. This gold pound today (1984) in Egypt is worth 150 of the printed pounds. Is money performing its function? No.
3. To measure correctly wealth, to determine ‘zakat’. Zakat is the only tax on capital and income which a ruler is authorised to impose on a Muslim resident in the state. He has other taxes which he can apply to non-Muslims or to goods coming in from outside the state. If we all think of the canons of taxation, again Adam Smith’s canons of taxation, can we today in our present fiscal world feel happy with the rather happy-go-lucky fiscal systems that we are all suffering. Different governments apply different fiscal measures and everybody is spending a lot of time trying to find ways of evading them, and the result is that fiscal measures are not really performing their social function.
4. Money should permit exchange in mutually accepted commerce does it do that today? Can I today freely trade my goods or services against money that would be paid to me in two months or in three months with some degree of confidence that I will not get paid less in purchasing power than what I am supposed to receive?

5. Money is not to be utilised with interest or usury, both called riba, introducing an artificial element on money for money, i.e. not representing services, real assets or real goods, because finally at the end of the day money is simply a measuring unit.

From this we are today speaking about two different things. In Islam when we say money we mean this type of money that I have just described - a money that does measure wealth correctly; that does not devalue people’s wealth; that measures correctly for fiscal purposes; that permits exchange in mutually accepted commerce and that cannot, repeat cannot, be utilised for riba.

This severe contradiction is the purpose for which we have set up the third company. This company’s founding principles and declaration contain the following ‘The founding members, state that the Islamic banking system is an integral part of belief and submission to Allah (Islam means submission to Allah, it means literally to submit to God) and that the inherited contemporary economic system raises repeated and fundamental contradictions with Islamic Shari’ah.’

Islamic Economic Principles

The Islamic economic principle says, first: ‘Wealth is attributed by Allah alone to his designates among human individuals or communities and Muslims individually, collectively and through their governments are Allah’s surrogates and are accountable before Allah for the Islamically legitimate growth, distribution and consumption of such wealth’.

The contemporary economic systems that we are living under in our countries where wealth is measured in the value of an artificial currency, pieces of printed paper; regulated markets subjected to massive government spending through budget deficits and ever-increasing national and international interest-bearing riba borrowings, is prohibited destruction of wealth amongst Muslims, for which we shall be accountable before Allah. Here is the first contradiction, wealth in the Western system is something you produce by turning the handle of a printing machine, you call it a monetary unit or you call it a currency, a treasury bill or a bond bearing interest; for us that is prohibited; we cannot do so.

The second principle says ’Muslims whilst striving to improve their share and partake-of their legitimate share of such wealth must accept what Allah has bestowed on them with gratitude and contentment and while fulfilling the duties imposed by Allah with respect to the wealth entrusted to their care, they are instructed to protect their wealth with the same dedication with which they would protect their lives, for both are sacred gifts of Allah’.

The rule in Islam is that a stimulus for capital formation and for social contentment can only be through the development of the community, which can only occur from the fact that everybody feels secure in both their wealth and self. The Muslim public’s inability to understand the prohibited aspects of the manipulations of government budgets, borrowings, interest rates, etc. has engendered envy and discontent.

The third principle is again a contradiction. The Islamic economic principle says that ‘wealth is measured in value’. Only through free mutually accepted market prices and only, is very important. Islamic principles centre around protecting the market from any intervention, falsifying the market valuation mechanism, market price manipulation through arbitrary fiscal subsidies and regulated prices. These are all destructive to wealth and are rejected by Islam. In the contemporary economic system wealth is measured in units of value taken to be the price, interest (prohibited riba) of the commodity, government paper money, without gold or silver backing. This has destroyed the function of money. Such money is no longer a valid medium of exchange nor a standard of deferred payment, nor a unit of account, nor is it a store of liquid wealth and I think everybody will agree, people who had £10,000 ten years ago were probably wealthier than people who have £100,000 today.

The fourth Islamic economic principle, says; gold dinars and silver dirhams and paper money truly representing them, constitute the only Islamic monetary units that can be used by both the government and the public to measure the free market value of assets, goods and services. The same monetary units are also used to define wealth and zakat. Contemporary systems allow governments a discretionary and exclusive right to .issue paper money without a counter value of gold and silver. The value of this money is ‘theoretically’ maintained through a government’s monetary policy by increasing or reducing the money mass available in the financial markets. Such a policy is implemented through the imposed purchase or sale of treasury bills or bonds bearing interest (riba) by the banks, using public deposits or the imposed ‘legal reserves’ that banks have to keep with the central bank, or by imposed variations to the interest rates applied by the banks. This money cannot measure the free market value of assets, goods and services and cannot correctly and legitimately measure zakat.

We are all seeing an example with the American dollar. By keeping the interest rate high Mr Volker is pumping world capital into the United States, keeping the dollar at some estimated 30% above its value; we are all paying for it in every nation in the world, especially the poor ones, and that is something very important. How many people open their newspapers in the morning and don’t understand what is happening when the prime rate is hiked by one point or one half point? They don’t; the government is simply borrowing from your deposits and mine in the bank, asking us to reimburse the same borrowing by increased fiscal measures!! It is a crazy system. Allah, the Almighty, put down the principles and ordained, prohibiting usury, interest or riba; we the Muslims are trying to understand them and see how they would apply to today’s world.

The fifth Islamic principle limits taxation to zakat - that is the only fiscal burden that can be imposed on a Muslim citizen. Zakat is calculated as 2.5% of capital, capital reassessed annually at current market prices, plus income, minus expenses including living expenses and minus any debts if there are. In the contemporary fiscal situation, everybody knows that we pay direct/indirect, progressive/regressive, etc a whole range of taxation. I live in Switzerland and I frankly haven’t the faintest idea of how things are calculated; I just pay what they tell me to pay and hope that all is well!

These are the basic contradictions I am using simply to illustrate the point that there is nothing parallel between when we Muslims say money and what today is called money. This is a total and highly complex problem - I don’t know if we will get around to a solution one day.

Islamic Money Management Mechanics for Utilisation of Funds

First, Islamic financial institutions use ’musharakah’, which is the profit and loss sharing or participation system. The principle is very simple. We can share in the equity of a given venture; we can share in the ‘debt financing’ which we call ‘funding’ of the project and in this case we take our risks with the project owner – we lose or make money with the project owner. We have developed various alternatives, which are being worked into, I think, a much more refined system with ‘standard contracts’ that are easier to understand and very quick to grasp in our part of the world, and I must say, funnily enough, in certain less developed countries I visited in Africa where people turned around to me and said, ’Yes, we know the musharakah, we have been using it in the village’, so it is a very straightforward system. We have tried to introduce concepts of controls, cash flow studies that are done very quickly to try and assess the correct levels of participation, profit sharing, etc.

The second format is the ‘murabaha’ which is cost plus and is a form of simple trading. We can buy something a client wants for $100 and sell it to the same client with an agreed profit mark up and that, because it is not money for money, is a clear cut transaction where there is a capital asset or goods that are there as the basis of the transaction. That is permitted in Islam.

‘Mudarabah’ is the third system and it has a managing trustee who will perform the functions of managing the money and get a share of the profit, if any.

Fourth, we have ‘ijara’, which is ’rental’. It is straightforward; there is something effectively being rented for an income. Fifth, there is ijarawa-iktina, which is ‘rental and purchase’, where effectively we intervene to buy from one person, a building to rent to another person. It is important that this involves two different parties. If we were to do it for the same person it would come under the heading of the prohibited hiyal (tricks) as a way of disguising the payment of interest.

On the money markets we perform ‘cash and carry’ operations in both commodities and currencies and one of the questions that has been raised numerous times is that the difference between the spot price of the Swiss franc today and the forward price of the Swiss franc is nothing but interest. I beg to disagree. The difference between the two prices is the result of a lot of conditions political, social and economic. We have also taken positions for ‘arbitrage’ or ‘straddles’, between different currencies or different commodities and open positions where we can buy a commodity and hold it to be sold it at a future date, obviously taking the risk of loss or profit.

We have tried to bring in some of our modern money management techniques and I am rather hesitant because obviously we are only, as I said, five years old and learning the hard way how to do it, but essentially we have tried to break up the risks into different levels of risks starting from what we have called minimum risk all the way to what we call high risk, and we try and put these operations under these various headings. Funds in the Islamic financial institutions are mobilised through practically the same mechanisms that I have just described, again the modaraba/musharakah format which allow funds to come into the system.

General Management Principles

The general management principle that we apply can be very quickly summarised as follows: ‘respect for Islamic principles’, obviously and we are still searching, we still make mistakes, we still refer to our religious board for clarification. There is a lot of debate but I want to say please don’t take that as a fault of Islam, it is our fault that we have not been thoroughly educated in Islam and our Muslim scholars have not been thoroughly educated in economics, so we are trying to bridge the gap. It is taking time but I must say one measure of comparison will give you an idea. I understand that it takes many years for a western bank here to be able to raise 10 times their capital in deposits.

The second principle we try and interpose in our management of the portfolio we hold is to look for a valid ‘risk reward’ for the portfolio and, obviously again, we are going through a trial and error process to find out how that functions, making the best use we can of computers, to help track the different trends and find out how we can get this corrected. We are trying to increase our information, the market situation which allows us to pick and select the good investments from the bad one. We also trying to refine the corporate policies that we are implementing as we learn of this new technique, which is managing today’s money, which is not Islamic money, within an Islamic system.

Islamic Shari’ah provides that Muslims can when a calamity has become general move out of it in phases. We cannot stop the contemporary economic system overnight; that would be ridiculous, so we have to do it in phases and we are doing so.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434IIBI LECTURES

IIBI Monthly Lecture Series – July to September 2013

April: Islamic Finance and Financial Inclusion: A Critical Imperative

Mohammed Iqbal Asaria’s lecture posed three questions – what is the status of Islamic finance today; what are the new areas into which Islamic finance can expand and is the industry equipped to take on the challenge? He said that he would examine these questions through the lens of financial inclusion.

In the last 10 years or so institutions such as the World Bank have done a lot of work on financial inclusion, which estimates suggest can, in itself, deliver between 1% and 2% in GDP (Gross Domestic Product) growth for an economy per annum. This is a significant amount of additional growth for developing economies that may be growing by 4-5% per annum.

A Snapshot of Islamic Finance

Currently it is Malaysia and the GCC countries that are driving Islamic finance with something like 10-20% of their banking systems being Islamic. A lot of the products being offered by Islamic financial institutions, however, are reverse engineered conventional financial products. This has meant that two particular types of instrument – tawarruq and murabaha, both controversial in Islamic commercial law, dominate about 80% of the Islamic banking market. The key feature of these two products is that they are the closest to conventional banking products.

Islamic banking today is addressing a comfortable, affluent urban market. Looking outside Malaysia and the GCC to where new growth opportunities exist, countries in Africa for example, these are not countries with large urban populations; they have rural populations relying on agriculture. The current Islamic banks will be unable to deliver anything in these markets.

Target Markets

The target markets are those with large Muslim populations and foremost among these are the following:

India 200 million
Indonesia 200 million
Pakistan 160 million
Bangladesh 160 million
Nigeria 90 million
Egypt 74 million
Ethiopia 53 millio
Sudan 22 million
Tanzania 22 million

The global adult population is approximately 4.7 billion. The best estimates are that 2.5 billion of those people are unbanked – more than half of the world’s adult population. If you exclude the developed countries from the equation, then the unbanked percentage increases to around 80%.

Many people assume that this huge unbanked population is too poor to be banked and that banks are not interested in them, but, for example, of the 365 million adults with bank accounts in India slightly less than 6% earn more than $5 a day. Clearly the’ too poor to be banked’ argument does not hold. Similarly, a large proportion of the unbanked population lives in rural areas and the assumption is that they have no physical access to banking facilities, but this is simply not true. For example, in Bangladesh, Islamic and non-Islamic microfinance serving a largely rural population (75% of the population lives in rural areas) has increased the country’s growth rate by 2%. (Incidentally 31% of the population in Bangladesh is now banked.) Islamic financial institutions need to work out how to talk to people earning less than $5 a day, if they want to make inroads into these markets.

Across Africa 60% of the population is rural with key occupations being agriculture and animal husbandry.

Arab states as a whole have a banked population of 33%, although the figures are much higher in largely urban, affluent states such as Saudi Arabia (62%). In Egypt 41% of the population is banked with 43% of the total population living in urban areas. In Iraq only 17% of the population is banked although 67% live in urban areas. In states such as Yemen the banked population is smaller again, 14%.

In South Asia 42% of the population is banked with Malaysia having 60% of the population banked (67% of the population is urban) and Indonesia has 40% of the population banked (48% of the population is urban). India is unusual in that 48% of the population is banked although only 29% of the people live in urban areas, evidence that the rural population can be reached. Interestingly the proportion of Muslims in India with bank accounts is about half the national average. In Pakistan the banked population is just 12%.

In sub-Saharan Africa 20% of the population is banked, although once again there are wide variations from country to country. For example in Kenya only 10% of the population is banked and in Nigeria the figure is 15%. (In high-income OECD countries 92% of the population is banked.)

Promoting Financial Inclusion

Some countries, notably India, Iran and Egypt, are developing some interesting ways of promoting financial inclusion. For example, the IMF has been talking to Iran and telling them they must reduce subsidies. What Iran did was give to give each individual an annual payment equivalent to the subsidy on a per capita basis, about $40, in place of the subsidies, but, to get that payment, individuals needed to have a bank account. That creates financial inclusion.

India is trying something similar in a number of states and Egypt is also believed to be looking at similar options. Egypt currently is spending some 70% of its total budget on subsidies and Nigeria is in a similar situation. This is not a sustainable position.

Whatever method is used to promote financial inclusion Mr Asaria said that he believed financial inclusion in some of these under-banked markets would increase in the next 5 10 years and the opportunities for banks would increase correspondingly.

Market Challenges

Typically these under-banked markets have significant infrastructure needs, which require immediate investments, but have long payback periods relying as often as not on uncertain government revenue. There requirements are sometimes met by international bodies such as the World Bank, but there is a role for private banks. Another challenge is developing banking systems that can deliver services cost effectively to account holders with small amounts of money, often located in remote rural areas.

Financing Needs and Innovation
Contract Types

Islamic financial institutions need to go back to basics and look at the type of contracts that might meet the needs of the non-banked populations of developing countries. Essentially the types of contract available were originally intended to support the types of transactions that rural populations need. Salam, for example, was tailor made for agricultural finance; it was intended to pay farmers for the value of their crops in advance of the delivery of the harvest. Today it is being used for other things such as stock trades.

Microfinance and Microtakaful

Microfinance is an important service for developing countries, but the risks of default are quite high. Borrowers may be unable to repay loans through no fault of their own – illness, drought, livestock diseases, etc. In addition to banking services and microfinance in particular, there is also a need to provide microtakaful to mitigate risk and to increase the willingness to lend. Microfinance and microtakaful need to go together.

Delivery Mechanisms

To increase the percentage of a population with a bank account in developing countries with their large rural populations, often earning very little, banks need to be innovative about the types of services they offer and the way they deliver these services. One development that will help banks to deliver their services is the growth of internet coverage. For example, today the whole of Africa has internet coverage. The efficiency of the coverage may be patchy at the moment, but it is there and broadband developments mean that it will become more efficient in the foreseeable future.

Another technology which has the potential to help banks is mobile communications. Today 80% of Africans have access to mobile phones. M-Pesa in Kenya uses the Safaricom mobile phone network to deliver banking services – transferring money, making payments, etc. The system makes a small charge for each transaction. Internet and mobile technology have the potential to reduce the cost of delivering banking services across most of the developing world.

The African Example

Across Africa 60% of the population is rural with key occupations being agriculture and animal husbandry. Key exports are commodities, oil and minerals and the average GDP per capita is less than $1,000 per annum. The banked population is a maximum of between 20% and 30%, skewed towards the urban population (40% banked compared to 10% of the rural population) with around one bank per 100,000 people. There are few capital markets – essentially Johannesburg, Nairobi, Lagos and Cairo, with littler depth.

A number of African countries have started to show an interest in Islamic finance – Egypt, Tunisia Morocco, Kenya, Tanzania, Gambia, Algeria, Sudan, Senegal, Nigeria, Uganda and South Africa. They are changing laws, doing regulatory studies and trying to issue sukuk. The opportunities are there; can Islamic finance take them?

The Competition

Who else is active in these places? The first big player, especially in infrastructure, is the World Bank Group. This includes the International Development Association (IDA), which concentrates on countries with a per capita GDP of less than $500. It is impossible to compete here – loans are for 50 years with a 10 year grace period and no interest. It is, however, only for projects such schools, hospitals and basic infrastructure.

Another element of the World Bank Group is the International Bank for Reconstruction and Development (IBRD), which gives long-term loans on infrastructure projects, but they do no operate in the private sector. What they do, however, does tend to create business opportunities for private financial institutions.

The third part of the World Bank, which does sometimes compete with private financial institutions, is the International Finance Corporation (IFC); it lends on commercial terms. It does, however, tend to form syndicates with banks rather than taking on the whole cost of a project itself.

There are also multilateral development banks such as the African Development Bank and the Islamic Development Bank, as well as bilateral aid funds and predatory land seekers. Any financial institution interested in opportunities in developing countries need to be aware of who else is operating in any given area and where appropriate steer clear for them.

What Can Islamic Finance Deliver?

Currently Islamic finance is delivering products and services to the urban middle classes. There is little agricultural lending, microfinance or microtakaful and little use of innovative technology. Unless Islamic finance changes its focus, it will be unable to move on; Islamic finance will be looking at a 20% share of the 20% banked population, which is 4%. It is not a big enough market and even there competition will be around price – not service levels or product differentiation. This cannot work.

M Iqbal Asaria

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.

NEWHORIZON     July to September 2013IIBI LECTURES

IIBI Monthly Lecture Series – July to September 2013

May: Islamic Asset and Fund Management Practice and Growth Potential

Global financial assets are estimated to have reached US$ 225 trillion (about 3.2 times the size of the global economy, which is at about US$ 70 trillion) of which about US$ 25.6 trillion is due to the mutual funds industry alone (about 11% of the total financial assets.) The estimate of Islamic financial assets, however, stands at about US$ 1.5 trillion. This is about twice the size of the economies of OIC (Organisation of Islamic Co-operation) member countries (about US$ 0.77 trillion). The assets managed by Islamic financial institutions are only worth about US$ 77 billion.

Given that the management of funds in the Islamic finance industry is closer to real economic activity and that it is somewhat lagging behind its conventional counterpart in comparison, the lecture focused on providing the audience with an opportunity to understand the current practices of the Islamic asset and fund management industry as well as critically appraising the growth potential and the means through which further growth may be achieved.

After providing a bird’s eye view of the global financial industry in general and the fund and asset management industry in particular (both conventional and Islamic), the lecture focused on providing a critical appraisal of both types of financial industry and the role and importance of the fund/asset management component within them. It was noted that while the conventional financial industry had noticeably over leveraged itself compared to the real economic value of the global assets, the Islamic financial industry was also on a similar trend, albeit at a lower level. It was observed that while the race to increase the size of financial assets in the Islamic financial industry was obvious, in the conventional sector the growth rate is lower than in its Islamic counterpart.

A question was raised as to whether the higher growth rate of the Islamic industry was an indicator of good health in the industry and an indication of a prosperous and sustainable future. It was also noted that despite being ahead in rate of growth, the profitability of the Islamic financial industry was lower than in its conventional counterpart. This led to another question – is it the rate of asset growth or the associated profitability that is important.

The lecture concluded that while it has become almost impossible (given the fiat nature of current economic landscape of the world) to avoid having some variance between the real and financial economies, but there was still a way to create some kind of built-in discipline within the practice of the financial industry for such a disparity not to cause unmanageable levels of vulnerability. The funds and asset management industry by its very nature focuses on engaging directly with real economic activities (funds focused on trading in financial instruments, however, should be kept at a minimum level). It was also noted that the Islamic asset and funds management industry needed to achieve a higher growth rate. This was also considered to be more in line with the spirit of Islamic financial industry, which had a natural legal framework to support such a growth.

M Iqbal Asaria

Dr Aziz received his formal academic training in the field of Islamic economics, banking and finance from the International Islamic University (IIU) in Pakistan and a doctorate from Loughborough University in UK. He has had extensive consultancy and senior managerial industry experience having worked for Deutsche Bank and BMB Islamic UK Ltd. He is currently CEO of the British Virgin Islands based Islamic GDP.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434IIBI LECTURES

IIBI Monthly Lecture Series – July to September 2013

June: Shari’ah Governance to Enhance Corporate Governance

Mufti Barkatulla opened the lecture by stressing the importance of corporate governance and the attention that is being paid to it, particularly since the 2008 financial crisis. To set the scene he gave a brief definition of the Shari’ah describing it as a set of principles and guidelines derived from primary and secondary sources rather than a codified system of law governing personal, social, business and financial affairs. It can be considered to be an additional regulatory layer in the financial world.

Shari’ah Boards

Shari’ah governance in an organisation is the responsibility of a small group of people called the Shari’ah Board. They are for the most part external advisors, although there also needs to be an internal Shari’ah officer or committee, depending on the size of the organisation. The appointees and their terms of reference are set at the most senior levels of the organisation and sometimes there is even a clause in the articles of association referring to Shari’ah compliance and the way it will be organised. There will be a manual or set of guidelines that indicate how the internal and external Shari’ah officers interact.

Shari’ah governance is a key risk element for Islamic financial institutions – it is the backbone of the business plan; gives the business legitimacy and provides shareholders, customers, etc. with confidence in the way the business is being conducted. There tends to be a lot of discussion about just how independent Shari’ah boards are, but they are not the employees of the bank or other financial institution; they appointed in the same way as other non-executive directors. They report to the board of directors and the shareholders.

If the size of the business can justify it, it is recommended that there should be three members of the Shari’ah board. In practice, new businesses may work with just one advisor, adding new advisors as and when the business grows large enough to justify this. A single advisor is a risky proposition, but in a start-up business there may be no alternative.

In the case of start –up businesses, Shari’ah governance is enforced either through the articles of association or a resolution of the board of directors. In the case of an existing business, which is opening an Islamic window operation, the relationship is governed by letters of engagement with the Shari’ah advisors and through certificates issued to say products are Shari’ah compliant.

Who Can Be a Shari’ah Scholar?

There are very few internationally-known Shari’ah scholars; most are local or regional scholars. All scholars, however, should have some educational qualifications and, ideally, a good reputation, although, obviously, that takes time to build. It will also be necessary to find scholars who have a background in the appropriate branch of Islamic law to reflect the values of shareholders and customers. For example, if there is an institution that is only operating in the Middle East, the preference would be for a scholar with a Middle Eastern background.

The requirements of the central banks in relation to Shari’ah scholars vary from region to region. As a basic requirement, however, they would ask for a bachelor’s degree in Islamic studies plus a specialisation in Islamic jurisprudence and some knowledge of finance. In general, however, financial institutions are looking for scholars of experience, whether that is in industry or a more traditional background, for example, as a Mufti. This, of course, makes it difficult for young, newly graduated scholars to find positions on Shari’ah boards, although many are finding positions as internal Shari’ah officers within financial institutions.

It goes without saying that Shari’ah scholars are subject to all the same regulatory checks as anyone else in senior positions in the field of banking and finance – criminal records checks, solvency, financial integrity, etc. Boards of directors will also take up formal and informal references on any individual before they are appointed to a Shari’ah board.

The strictness of the criteria for appointing scholars to Shari’ah boards varies across region. Malaysia and Pakistan tend to have very strict criteria. For example, they stipulate that a Shari’ah scholar can only sit on one board in a single industry. In the Middle East, on the other hand, where there is a shortage of scholars, they cannot afford to impose such restrictions without damaging the industry. In Western markets such as the UK and the US the central banks impose no restrictions on the composition of Shari’ah boards.

What Do Shari’ah Scholars Do?

First and foremost their role is to give an opinion, a Shari’ah ruling, on issues at both the business planning stage and during live operations, but they are also responsible for training, supervision, monitoring and the promotion of the Shari’ah culture within an institution. They may meet quarterly, half yearly or annually to give their rulings and they also make an input to the annual report, the Shari’ah audit. Scholars may form opinions by working individually or in groups using AAOIFI standards to help to form those opinions, which are binding on the institution.

The four functions can be summarised as issuing fatwas, certificates and rulings; monitoring and training; auditing and certifying.

Occasionally scholars may get involved in dispute resolution, whether these disputes relate to the products or the behaviour of the management. Most of the time management will respect the decisions of the Shari’ah board in such disputes. (The Shari’ah board will not get involved in regulatory or legal issues, but only in disputes relating to Shari’ah compliance.)

The Importance of Shari’ah Governance

Any failure in the Shari’ah approval and monitoring process is a source of risk, both financial and reputational. The Islamic Financial Services Board has highlighted some issues that occur in some jurisdictions and some financial institutions, which can be considered to be a source of risk. These include the competence of Shari’ah advisors; management attitudes to compliance; the independence of Shari’ah scholars, both internal and external and scarce resources, i.e. not enough suitably qualified scholars, which is probably the biggest problem currently and one which needs to be addressed by the industry rather than any particular institution or country.

Mufti Barkatullah believed that third party organisations providing Shari’ah compliance services have and continue to play a useful role in the industry. By taking on much of the detailed analysis and leg work, they free scholars to spend more time on the complex issues of jurisprudence. KMPG, for example, are now applying all their experience of conventional auditing to Shari’ah audit, which is a welcome development.

Next Steps

There are three developments that will lead to improvements in Shari’ah governance. The first is standardisation, which is largely undertaken by AAOIFI. The second is improving governance and here Bank Negara in Malaysia are an excellent example of how this should be done. The final step is to have a Shari’ah rating system for financial institutions. This later step is something for the future. Mufti Barkatulla concluded by saying that everybody has a part to play in improving Shari’ah governance, not just the scholars.


Chairman Warren Edwards commented that there had been a lot of talk about products, but very little about purpose – the whole issue of giving an Islamic identity to what are effectively conventional banking products. He asked Mufti Barkatulla how much importance should be attached to purpose rather than just product.

Mufti Barkatulla replied by saying that the problem with intentions is measuring them. They are internal motives and any objective measure of them is difficult. The Shari’ah can only deal with declared intentions.

A member of the audience raised the issue of whether Shari’ah board rulings had to be unanimous. Mufti Barkatulla referred to the AAOIFI standard, which says that Shari’ah boards should comprise three scholars. The ideal is that rulings should be unanimous, but if there is a difference of opinion the fact there are three scholars will mean there will be a clear majority. He added that if a scholar continually found himself at odds with the other members of the Shari’ah board, the most likely result would be for him to resign.

Mufti Barkatulla

Mufti Barkatulla is a leading UK based Shari’ah scholar with a strong background in economics and finance. He is a member of the Shari’ah Supervisory Boards of several Islamic financial institutions including the Islamic Bank of Britain and the Arab Banking Corporation London.

NEWHORIZON     July to September 2013IIBI NEWS

IIBI Awards Islamic Finance Qualifications

IIBI awards a choice of qualifications by distance learning courses. Students who have gained Islamic finance qualifications awarded by IIBI are employed in many parts of the world, some have proceeded to obtain a Master research degree in Islamic finance.

The British Accreditation Council (BAC) for Independent Further and Higher Education has awarded accreditation as an online, distance and blended learning (ODBL) provider to the Institute of Islamic Banking and Insurance (IIBI). This is the first accreditation that the BAC has awarded to an organisation dedicated solely to Islamic finance education and it is an important milestone in the continuing growth and success of the IIBI.

Candidates having a graduate degree may take up the IIBI Post Graduate Diploma in Islamic Banking and Insurance (PGD), however those who wish to build a good foundation of Islamic banking concepts and operations, may opt to take the DIB course and later on progress to the PGD. DIB holders wishing to take up the PGD course will get an exemption from some of the Post Graduate Diploma modules.

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

To date students from more than 80 countries have enrolled in the PGD course. In the period July to September 2013, the following students successfully completed their studies:

► Adamu Shuaibu Abdullahi, Aschdo Consult, Nigeria

► Ahmad Abubakar Sharrif, Head of Business Dept., Gliss, Ghana

► Amana Ismaily Abdallah, Managing Director, Coastal Insurance Agency, Tanzania

► Amina Hassan, Contact Centre Agent, Gulf African Bank, Kenya

► Anaem Mansoor, Jnr Account Executive, Adel Abuljadayel Flight Catering, Saudi Arabia

► Hassan Kinyua Omari, Lecturer – Islamic Studies, University of Nairobi, Kenya

► Junaid Khan, Teacher, The Best Tutor London (UK), UK

► Mudhakkir Abdulhamid, Legal Assistant, Equity Bank Ltd, Kenya

► Mwinza Mukuni, Zambia

► Umma Yusuf Aboki-Ali, Group Head/Manager, Guaranty Trust Bank Plc, Nigeria

► Jamal Nasoor, Branch Manager, KCB Ltd, Kenya

Diploma in Islamic Banking (DIB) Awards

Students from 23 countries have enrolled on this course so far. The following students completed their studies in the period July to September 2013:

► Abdul Mobeen Akram, UK

► Amin Gros, Germany

Amin Gros

Amin Gros The course has been of great personal value to me. Through this course, I am no longer as naive as before the course. I know now that it is not just black and white, but many different aspects need to be considered - in Islam, as in Islamic banking.

 Hassan Kinyua Omari

Hassan Kinyua Omari The course is very beneficial. I have really learned about the Shari’ah financial concepts. The most interesting part for me was the insurance module and the conversion of conventional banking to Shari’ah banking. The course has enabled me to sit on various Shari’ah boards and contribute as an expert whereas without it I would not be able to do so.

 Anaem Mansoor

Anaem Mansoor I have gained a thorough knowledge and understanding of Islamic Banking. This course has made me capable of differentiating properly between Islamic and conventional banking and to explain the difference confidently to anyone with proper facts and reasoning. I have become more attentive regarding my personal banking transactions and now read the complete details for each new banking product to ensure it is riba free and Shari’ah compliant. It also made me and my family members change our saving accounts to current accounts after realising the importance of riba and its effects.

NEWHORIZON     Ramadan - Dhual Qa’dah 1434IIBI NEWS

Diary of Events

October 2013

29 31: 9th World Islamic Economic Forum, London
This will be the first time this event has been held in Europe. It will take place at London’s Excel Centre and the organisers have indicated that the format will be adapted to increase the level of delegate participation. Islamic finance is just one strand in this event which also covers topics such as infrastructure development, technology and education. Programme details are not yet available.
Tel: +603 2163 5500

November 2013

6-7: 2nd Annual Islamic Banking Summit Africa, Djibouti This conference will review the Islamic financial landscape in Africa, the prospects for growth and government and regulatory support for Islamic finance. The keynote address will be given by H. E. Khaled Mohammed Al-Aboodi, the CEO of the Islamic Corporation for the Development of the Private Sector, a division of the Saudi-based Islamic Development Bank.
Contact: Yasmeen Shah
Tel: +971 4 343 1200

10-13: Sukuk Congress Mena, Dubai The main conference takes place on 11 and 12 November, sandwiched between pre and post conference workshops on 10 and 13 November. Topics to be discussed at this conference include harmonising sukuk structures, the need for short-term sukuk to boost the range of liquidity instruments available to Islamic financial institutions, the legal and taxation implications of cross-border sukuk and the need for a secondary market.
Contact: Negin Bagherian
Tel: +971 4 374 8284

25: IFN Africa Forum 2013, Cairo, Egypt This very full one-day event will look at the growth prospects for Islamic finance in Africa in general, with particular focus on Egypt, South Africa and Kenya. There will also be an interview-style session with Ijlal Alvi, CEO, International Islamic Financial Market and Dr Khaled Al Fakih, Secretary General and CEO of AAOIFI on standard setting for the Islamic finance industry.
Contact: Cindy Wong
Tel: +603 2162 7800 ext. 46

26-27: 5th World Islamic Retail Banking Conference, Dubai Taking place at the Shangri La Hotel – Dubai, this conference and exhibition includes the Annual Open Fatwa Session, microfinance workshops and a CEO roundtable, which includes CEOs from Noor Islamic Bank, the Islamic Bank of Britain, the AlBaraka Banking Group, Standard Chartered, Jordan Islamic Bank, Meezan Bank, Dubai Islamic Bank and Mashreq Al Islami.
Contact: Mohor Mukherjee
Tel: +971 4609 1570


December 2013

3-5: World Islamic Banking Conference, Bahrain The 20th anniversary conference is titled ‘Industry Transformation to Improve Global Competitiveness’. It will focus on building critical mass in the Islamic finance industry looking at issues such as cross-border transactions and regulatory matters. It will also see the launch of the 2013/14 WIBC Competitiveness Report. The event is expected to attract in excess of 1,300 delegates from more than 50 countries.
Contact: Sophie McLean
Tel: +971 4 343 1200


February 2014

17-18: Second GTG/ICMIF/IFTI Takaful Network Seminar, Khartoum, Sudan The first Takaful Network Seminar was held towards the end of 2011 in Sri Lanka. This second event is being sponsored by the Association of Sudanese Insurance and Reinsurance Companies. As yet there are few details available about the 2014 event, but for anyone interested in takaful it is a date for the diary.
Contact: Livia Gonzalez
Tel: +44 161 952 5093



25-26: The 8th International Takaful Summit 2014, Abu Dhabi This year’s event will be held at Abu Dhabi’s St. Regis Saadiyat Island. The event will investigate the obstacles faced by the industry and seek to provide constructive solutions to nurture the continued development of the global industry. It will also host the 2014 International Takaful Awards.
Contact: Randa Buaras/Mohaned Abdullah
Tel: +44 161 952 5093/+9971 55848 9844


NEWHORIZON     July to September 2013GLOSSARY

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.