Structural Risks

in Sukuk designs
Dr. Tariqullah Khan, Professor of Islamic Finance

Sukuk as engineered and structured products

Architectural Elements of design
Ethical principles; Faith and social norms; Best practice standards; Operational guidelines and documentation

Architectural players
Architects setting the principles, norms and guidelines (Shariah & legal scholars); Engineers - (product developers & arrangers) Plumbers - (other professionals) Influencers independent scholars, Muftees, media Investors and users

structural risks are totally undesirable

Narrow but stable

Unstable but not narrow

Noise among players increases vulnerability

Preconditions for structural/architectural stability

Consensus among lead architectural players about key architectural elements

Non-existence of noise

Noisy architectural players and structural risk in the design of Sukuk

Promise to repurchase the Sukuk assets at the initial price is not permissible
Sukuk and their Contemporary Applications open source document 2007 by Muhammad Taqi Usmani, President of the AAOIFI Shariah Council

Promise to repurchase the Ijarah Sukuk assets at the initial price is permissible
AAOIFI Sukuk Resolution 2008

Noisy architectural players example 1

OIC Fiqh Academy

The issuer or the partner or the agent must not undertake any of the following: Purchase of sukuk or their assets in their nominal value or for a prefixed price so that it ensures the capital. ------------------The decisions issued by the Board come into effect from the time of its issuance and do not affect the previous contracts and from among them are the sukuk.
Resolution No. 188 (2012) of OIC Fiqh Academy on the subject of Sukuk

Noisy architectural players example 2

Prospective Holders should note that different Shariah advisers, and Saudi courts and judicial committees, may form different opinions on identical issues and therefore prospective Holders may wish to consult their own legal and Shariah advisers to receive an opinion if they so desire.

Noisy architectural players example 3

Structural basis of Financial Market Products

Ownership risk of the asset (price risk) Credit risk of the issuer & interest rate risk

Equity shares

Bonds

Independent Shariah scholars

Asset price risk

Interest rate risk

Credit risk

Equity Sukuk

Bond

Structural risk free Sukuk

Paid Shariah Advisors

Asset price risk

Interest rate risk

Credit risk

Equity

Bond Sukuk

Structural risk free Sukuk

Repurchase at initial price is not permissible

Repurchase at initial price is required

But noisy argument

But firm argument

Lack of consensus on architectural elements

Independent Shariah scholars

More noise No noise

Paid Shariah Advisors

Consensus on architectural elements

Sukuk Structural Risk bundled nature of credit, price and return risk
Consequence of disputes and noise between Shariah scholars
Credit risk Interest rate risk

Bond

Asset price risk

Sukuk

Equity

Can the market have this type of a product?

Independent Shariah Scholars No, because it has credit risk and the rate of return risk is actually interest rate risk Paid Shariah Scholars No, because rating and pricing is not possible

Structural risk in Islamic bank financing

Independent Team Murabahah financing is a genuine asset purchase

Paid Team Tawaruq is a comprehensive financing mechanism

Pitfall of Tawaruq
$100 Tawaruq $100 Tawaruq $100 Tawaruq $100 Tawaruq

$100 Tawaruq

Financing Scenario -3: But if we make non-genuine Murabahah like Tawaruq as the core business, this scenario prevails which is almost similar to Scenario 1, where financing gets out of the real economy.

BANK $100 5% interest

Murabahah for asset

Financing Scenario-2: If we make genuine Murabahah as the core business of banks, this scenario prevails, where financing cannot get out of the real economy. In this scenario, we can benefit from the advantages of the fractional reserve banking system but at the same time also avoiding the excessive and unhealthy credit creation by banks.

7% interest
10% interest
Financing Scenario-1: If we make lending as the core commercial activity of banks, financing gets out of the real economy and this scenario is the real possibility as lending will be primarily based on ratings and credit risk.

15% interest 20% interest $100 $100

$100

$100

$100

Structural risks exist because as if the key architectural players are only independent and paid Shariah scholars

Structural risks cause wealth losses as well as hamper growth and depth of the Islamic capital markets

Avoiding structural risk an imperative for Islamic capital market development

Avoiding structural risk for resilience and stability

Key architectural players are actually

Finance Ministers; Central Bank Governors; Islamic Bankers; Sukuk Issuers and dealers Investors Independent scholars

Looking ahead - Apex Islamic Finance Board is the need to avoid structural risks of industry

Do you know that Executive Education Program of QFIS offers:

Course on Sukuk and Islamic Capital Markets?

Thank you
tkhan@qfis.edu.qa