Topic 2: An Introduction To Islamic Finance & Banking

ESC Rennes School of Business
2009/2010 Dr Khalid ELBADRAOUI



Learning Objectives

This course is designed to:
 Help students consider in some detail the principles of Islamic Banking and the differences between Islamic and conventional banking.  Equip students with a practical and detailed understanding of Islamic products and their use in a business context.

 Iqbal Z. and Mirakhor A., “An Introduction to Islamic Finance: Theory and Practice”, Hardcover, 2006.  Ayub M., “Understanding Islamic Finance”, Hardcover, 2007.  Khan M. and Mirakhor A., “Theoretical Studies in Islamic Banking and Finance”, Islamic Publications International, 2005.


   Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI)  Islamic Financial Services Board (IFSB)  International Islamic Financial Market (IIFM)  Islamic International Rating Agency (IIRA)  Islamic Banks and Financial Institutions Information  Institute of Islamic Banking


Road Book
 What is Islamic Finance?  History & development of Islamic Finance  Islamic Contracts & use of funds  Islamic Bond (SUKUK)  Islamic Insurance (Takaful)  Asset Management/Fund Management  Subprime crisis and Islamic Finance  Challenges facing Islamic Finance  Conclusion


What is Islamic Finance and Banking?
•Islamic banking has the same purpose as conventional banking except that it claims to operate in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). •The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (interest). •Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharaba), safekeeping (Wadiah), joint venture (Musharaka), cost plus (Murabaha) and leasing (Ijarah). •The key Islamic contracts are described in more detail in the 3rd section.


Shariah terms

 Halal – that which is permitted or compliant  Haram – that which is not permitted  Riba – charging of interest or unjustified increase  Gharar – the taking of unreasonable risk; uncertainty  Maisir – reliance on chance or speculation, rather than effort

7 Islam Aqidah (Faith and Belief) Shariah (Practices and Activities) Akhlaq (Moralities and Ethics) .

8 Basis of Shariah Approval (At a Glance) Consideration of Primary Source Consideration of Secondary Source Consideration of Local Laws Acceptable To Market Quaran & Sunnah Holy Quran The sacred text of Islam Ijma Ijtehad Qiyas Law of Country Sunnah Practices and sayings of Prophet Muhammad Ijmaa Consensus of Ummah But Shariah principles shall not be compromise Qiyas Analytical comparison Ijtehad Reasoning applied by Scholars .

durable assets • Credit and debt products are not encouraged .Partnership .g. gambling.g. no derivatives. financial services.Purchase-resale .Islamic finance is the outcome of religion in banking Banking and finance needs Shariah sources Fiqh al-Muamalaat contracts – – – Musharaka Mudaraba Murabaha Ijara Istisna Salam . short-selling) • Asset-backed transactions with investments in real. limited option use. pornography.Forward sale – – – Islamic banking and finance solutions • Prohibition of:    Interest Speculation Gambling  • Prohibition of certain investments:  Sectors (e.: alcohol. no forward transactions.Lease . tobacco) Instruments (e.Manufacturing contract .Partnership 9 – – – – – Quran Sunnah Ijma‟ (jurist consensus) Qiyas (analogy) Ijtihad (reasoning) Shariah filter . pork. armaments.

10 Islamic Finance  Principles and Foundations laid down by Shariah (Islamic law)  Quran – Revealed word of God  Sunnah – Sayings and practices of the Prophet Mohammed  Moral guidance or set of principles practiced by muslims  Shariah Supervisory Board (SSB)  3-5 Islamic Scholars  Decide what is compliant or not  Interpret Islamic Jurisprudence (Fiqh) .

The Foundations of Islamic Finance 11  Avoid Interest (Riba)  Riba al Naseeyah or Riba al-Quran – excess resulting from a pre determined interest  Riba al-Fadl or Riba al Hadith – Excess compensation without consideration  Avoid Uncertainty/Deceit (Gharar)     Final result is uncertain Short Selling Fraud Options  Avoid Gambling (Maysir)  Involvement In speculative and gambling transactions  No Derivatives .

partnership (musyaraka). transparency justice and fairness in commercial dealings.  Promote honesty. and or debtor – creditor (qard hasan) relationship.  Charitable distributions:  Zakat (Mandatory) (2.  Obligation to share to a certain extent profits and losses and in the forms of buyer – seller (murabaha).5% Lunar or 2. lessor – leasee (ijarah).5775% Solar Calendar)  Sadakat (Voluntary) .12  Adult Entertainment  Alcohol  Banking  Gambling (Casinos)  Insurance  Pork  Weapons & Armaments  Transactions should be backed by Tangible assets.

. •Does not involve itself in trade and business directly Islamic BANKING . . Is based on profit or rent . production and valid services through valid contracts.Islamic vs. deposits side. Actively participates in trade. Is based on profit sharing on . Conventional CONVENTIONAL CONVENTIONAL BANKING 13 Money Bank Money + money (interest) ISLAMIC Client •Is based on interest. and on profit on assets side. Deals in assets. •Deals in money or papers •Is based on fixed return on both Sides of the balance sheet. Bank Goods & Services Client Money .

Islamic vs. Conventional 14 Conventional Bank  Bank acts as a financial Intermediary  Maturity Transformation – Takes in long term finance and lends short term  Main income consists of Interest Margin Islamic Bank  Return must take the form of a tangible asset  Bank acts a a fund/asset manager (Mudarib)  Depositors are seen as investors (Rab al Mal) .

due to participation of investors (debt holders) in risk sharing.  Better governance. so that it will add economic value.Expectations 15  More ethical business and economy.  Less speculation.  Shariah businesses deal only on real sector (goods and services).  Less uncertainty and less transaction costs. .

16 History and Development of Islamic Finance and banking .

Historical Background of IF&B 17 .

Limited to Commercial Banking 1980‟s-1990 • Expansion into Asian Markets • Introduction of Islamic Insurance (Takaful) + Project Financing • Oil shocks resulted in rapid growth • Birth of the Islamic bond (Sukuk) • Equities market • Leasing (Ijarah) 1990‟s 2000.Industry has developed a comprehensive product offering over its young history 1960‟s-1980 New Concept. Limited to Commercial Banking 18 • New Concept.Today • Internationalization of Islamic Finance • Creation of Islamic Funds / Asset Management • Structured Products .

Reach and richness Islamic finance industry is developing a global reach… 19 Mainstream relevance Niche presence Engaging with regulators Conceptual exploration Source: HSBC Amanah .

development and sophistication lead Source: HSBC Amanah.20 UK: New legislation for Islamic mortgages (2003) USA: Harvard workshop with six regulators (1995) Germany: Saxony issues E100m Sukuk (2004) China: Active member of Islamic Financial Services Board (2004) Japan: JBIC exploring Islamic financing opportunities (Dec. 2006) Saudi Arabia: 95%+ of new consumer lending is Islamic (2006) • Retail market rapidly converting to Islamic (2006) Bahrain: Leading Islamic financial centre. and housing regulatory bodies UAE: 30% of retail banking is Islamic (2005) • Several institutions have converted from conventional to Islamic Singapore: Active in developing Islamic finance Malaysia: Islamic product and industry. Press Reviews .

9% HSBC. Bahrain Islamic Bank $14.5% $81.3 B 13. Bank Islam Malayasia. Gulf Finance House.0 B 12.05% Islamic Bank of Britain.635 77.4 B 6.5m 8% $19.306 81.Islamic Banking Kuala Lumpur Dubai Manama Doha London 21 Singapore Population Muslims Fin Sector (Assets) Islamic % Major Players 1. Prudential $46.0 B 0.6m 14. DIB.8 B 18.1 Tr 4. Gulf Finance House.5% Acrapita Bank.2% Acrapita Bank. $16.3m 96% $340.9% $276. Islamic Bank of Asia.5 B $50. HSBC.0 B 718.5m 40% $387.2% $251. Malayan Bank .5 B 1. Emirates Islamic Bank. European Finance House $1. Bahrain Islamic Bank $10.1 B 928.5% Standard Chartered.8 B 6.3 B 7.5% Noor Islamic Bank.

6 Billion Muslims worldwide (24% of total world‟s population) •10-20% annual growth rate •Market of Shariah compliant assets approximately $800bn 22 •Islamic indexes on Dow Jones/FTSE//MSCI Assets held by muslim investors in $trillions 4 2 0 Muslim AUM 2008 Muslim AUM 2010 2.7 Number of Islamic Funds 1000 500 0 Islamic Islamic Funds 2008 Funds 2010 650 950 1.6 .Natures and Facts of the IF&B •1.

 Assets held by fully Shariah-compliant banks or Islamic banking windows of conventional banks rose by 28. compared to just 6.8% for that of conventional bank (The Banker‟s Top 500 Islamic Financial Institutions Survey). plus well over 250 mutual funds that comply with Islamic principles. 23 . including multinationals get into the business.  Grais & Pellegrini (2006) reported that the global Islamic financial services industry consisted of 284 institutions offering Islamic financial services (IIFS) operating in 38 countries. offering islamic financial products.Natures and Facts of the IF&B  Conventional banks.6% to $822bn from $639bn in 2008.  Solé (2007) identified that there were more than 300 Islamic financial institutions spread over 51 countries. both Muslim and non-Muslim.

 Australia/Europe/the United States (US$35. utilities. information technology. consumer discretionary.7bil). and nonGCC Middle East countries. education.3bil). financials. Middle East and North Africa (US$248. materials.1bil). etc.  The IF & B has involved in all of industries: energy.3bil).  IF & B also provides financing for large scale projects such as those in energy and infrastructure through sukuk (asset based) financing. health care. . staples. telecommunication.24 Natures and Facts of the IF&B  The major contributors to asset growth for Islamic funds:  Gulf Cooperation Council (GCC) countries (US$262.  Asia (US$67.

25 Global Islamic Banking Assets .

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including several national central banks. The board intially focussed on risk management and capital adequacy for islamic financial industry.  The most notable initiative is the establishment of Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) => to develop standards for accounting.Infrastructure. there are limitations in terms of the capacity of the jurists to deal with large scale economic transactions. However. International Monetary Fund and World Bank are members. auditing. in which twenty-two agencies. and that there is no court of final appeal that result in controversies (Monger and Rawashdeh 2008). Regulatory Framework and Governance for If & B 29  Islamic law and regulatory framework exist.  The Islamic Financial Services Board (IFSB) was created to set standards for the industry. including those deal with modern business. . and ethics to ensure Shariah compliance. governance.

studies. Dow Jones. indexes. etc.).Infrastructure. predictions and analysis for IF & B institutions are available and provided by conventional and international institutions (such as S&P. . Regulatory Framework and Governance for If & B 30  The IDB initiatives are also important to support the infrastructure for operation and development of Islamic financial industry.  Other supporting structures. such as ratings.

professionalism and transparency Standard-setting body of regulatory and supervisory agencies Complementing Basel II Capital Accord Key standards: risk management. transparency and harmonisation Development of global Islamic capital and money market Promoting active and regulated trading and capital flows Catalyzing trading infrastructure. governance and Shariah standards Enhancing clarity. auditing. product innovation and information flows Promoting industry in theory and practice 31 IIFM (2001) Bahrain GCIBFI (2001) Bahrain − −  Disseminating Shariah concepts & multilateral understanding between IFIs and public Improving IFI practices. credit. cooperation. capital adequacy & corporate governance Creation of active Islamic inter-bank market Creating secondary market for short-term Shariah-compliant treasury products Enabling IFI management of liquidity mismatch Reference point for IFI ratings Issuing sovereign.Self-regulatory organizations bring credibility through standardization of practices AAO-IFI (1991) Bahrain  − −  − −  Benchmark of Islamic accounting standards 56 accounting. Shariah quality and corporate governance ratings Providing effective tool for informed investment decision-making IFSB (2002) Malaysia − −  LMC (2002) Bahrain − −  − − IIRA (2005) Bahrain .

32 Islamic Banking Operating Structures  Islamic Windows  Branches  Subsidiaries  Fully fledged Islamic Banks .

33 Islamic Contracts & Use of Funds .


Sources & Uses of Client Funds
 Deposit Accounts
 Current account  Savings account  Investment account
 

Murabaha Musharaka

   

Ijara Salam Istisna Off Balance sheet Funds Sukuk (Islamic Bond) Reserves (general & statuary)

Type of Contracts

 Shareholders funds
 Share Capital  Reserves

 Other
 Off balance sheet (specific accounts)

  


Elements of a Contract
 Contracting parties  Mature  Sane  Subject Matter  Valuable according to Shariah law  Existence (material effect)  Must be owned  Ability to deliver  Specific  Conditions & offer and acceptance  Acceptance must match offer


Murabaha (Set Profit Sale)

Definition of Murabaha:  It is a sale contract, with a set increment on the original price, agreed upon by the two parties.  It is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit.

constructive or physical 37 Bank Client .Murabaha Financing Installment Credit Sale  Differed payment Sale/Installment Credit Sale + Profit Mark-Up  Closing & payment date must be clear  Bank can appoint client as agent (if bank is inexperienced)  Technical ownership of good remains with bank  Bank may request Collateral/Security/Guarantee  Buyer knows the original seller price  The banker in a Murabaha must have some form of actual ownership. registered or not.

Mechanics of Murabaha 38  A typical Murabaha transaction as practiced today takes place between 3 players:  The financier or the Islamic bank  The vendor or the original seller of the product  The user of the product requiring the bank to purchase and finance the product  The transaction is explained in detail in the following steps: .

Price Inquiry Client Price quote Trader/Vendor .39 Step 1  The bank‟s client seeking financing describes to the vendor the goods they intend to obtain. and ask the vendor to quote the price.

Price quote by Trader/Vendor Client Promise to buy at cost-plusprofit Islamic Bank .40 Step 2 The bank‟s client contacts the bank promising to buy the goods from the bank if the bank buys the same from the vendor and resells them to the client at price inclusive of the original cost + profit to be agreed mutually.

•The Murabaha contract is drawn between the client and the bank indicating the profit or mark-up to be charged. Cost-plus contract Payment Client Islamic Bank sale Item/Commodity Trader/Vendor sale Item/Commodity . installments).41 Step 3 •The bank purchases the product from the vendor by making payment. •The contract is finalized by agreeing on the mode of payment (lump sum.

Payments (Lump sum/Installments) Client Islamic Bank . •This payment includes the cost of the product + profit margin to the bank. the client makes the payment to the bank.42 Step 4 •At the time of payments.


Commodity Murabaha (Liquidity Management)



Futures and Conditions of Murabaha
 Murabaha must be based on a sale and should not be used for financing purposes.  In the case of default by the end used, the financier only has recourse to the items financed and no further mark-up or penalty may be applied to the outstanding liability.  The mark-up rate charged is influenced by: the type of product financed, the credit worthiness of the client, the length of time for which the financing takes place.  The financier is allowed to ask for security to protect itself against any non-payment in the future (often an other asset is taken as security).

Mudaraba (Partnership Contract) 46 Definition  This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise. . who is called “Mudarib” (Working Partner) and the profits generated are shared in a predetermined ratio.  The investment comes from the first partner who is called “Rab al Mal” (Investor) while the management and work is an exclusive responsibility of the other.

(even though a profit margin is structured into the deal)  Mudarib could hold reserves so as to smooth out income/make it more consistent. (unless bank broke rules) .  Risk of loss lies with the client.Mudaraba (Partnership Contract) 47  Client (Rab al Mal) „deposits‟ (Invests) his money.  Bank (Mudarib) offers its skill/effort/knowledge.  Banks profit: share of investment profit instead of spread.  Contracts between client & bank is a partnership contract.

000 Profit .48 Fund Manager/Asset Manager (BANK) (Mudarib) $10.

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51 Client A (Rab Al Mal) Client B (Rab Al Mal) Client C (Rab Al Mal) .

52 Client A (Rab Al Mal) Client B (Rab Al Mal) Client C (Rab Al Mal) .

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in which case he shall invest the money in that particular business only.Types of Mudaraba 54  Al-Mudaraba Al-muqayyadah (restricted Mudaraba): Where Rab al Mal specifies a particular business for the mudarib. . the mudarib shall be authorized to invest the money in any business he deems fit.  Al Mudaraba Al Mutlaqah (unrestricted Mudaraba): Where Rab al Mal leaves the door open for the mudarib to undertake whatever business he whishes.

and where they have similar rights and liabilities. to share the profits and losses. .55 Musharaka Contract (Sharing contract) Definition Musharaka or Shirka can be defined as a form of partnership where 2 or more people combine either their capital or labor.

000 Project .000. Bank Invests $20.000  Profit Share is Based on a 70%:30% 56 Client invests $80. Bank issues notes of participation.000 Bank invests $20.Musharaka Contract (Sharing contract)  Client Enters Agreement with bank to Invest in a Project.000 $100.  Client invests $80.

000 Bank receives $9.000 profit.000  Bank Receives 30% of profit $9.000 Client receives $21.  Client receives 70% of profit $21.000 $30.57  Musharaka Project makes $30.000 Profit .

000 Client receives $40.000 Project makes loss of $50. Project value=$50.000) = $10.000 Bank receives $10.000  Bank receives proportion of investment (20% of $50.000 loss.000) = $40.58  Musharaka Project $50.000 50. .000  Losses are borne according to their initial capital contribution  Client receives proportion of investment (80% of $50.000 remaining.

. In Mushararka all the partners can participate in the management of the business. while in Mudaraba the investments comes from Rab Al Mal only. and can work for it. only Rab Al Mal suffers the loss. which is carried out by the Mudarib only. This means that the Musharaka is a partnership in profit and capital. The investment in Musharaka comes form all the partners. While in the Mudaraba. In Musharaka all the partners share the loss. while Mudaraba is a partnership in profit not in capital. 3. while the Mudarib suffers the loss of his labor.59 Difference between Musharaka and Mudaraba 1. While in Mudaraba the Rab Al Mal has no right to participate in the management. 2.

because these are regarded as 'monetary values exchange' of which is covered under rules of Bai al Sarf (exchange of money for money).60 Bai Al Salam or Salam (Purchase with deferred delivery) •Bai Al Salam or as some call it 'Salam' means a contract in which an advance payment is made for goods to be delivered later on. silver or currencies. •The seller undertakes to supply some specific goods to the buyer at a 'future date' in exchange of an advance price fully paid at the time of contract. . •The objects of this sale are goods and cannot be gold.

61 Bai Al Salam or Salam (Purchase with deferred delivery) Purchase price (discounted) Purchase price (plus premium) SUPPLIER FINANCIER CUSTOMER Sale of asset (delivery deferred) Sale of asset (delivery deferred) .

• Price can be paid in installments.Istisna (Partnership in Manufacturing) 62 • Seller agrees to manufacture a particular product with pre determined specifications and commits to deliver it to the buyer at a pre determined price. or can even be deferred until the product is delivered .

Features of Istisna  Istitsna‟a is a pure sale contract and not a hire contract.  No fixed delivery date and no payment in full at outset required. cereals etc. It can be either be paid in installments or can be partially deferred until delivery.Major industrial.g. ships. Quality & Price are fixed at the time of signing the contract. 63  Commodity is non existing and is to be manufactured to bring it to existence.  Advance funding of: .Large equipment e.  Price need not be paid in advance. aircraft .  Does not include natural goods like fruits. construction and real estate development .  Quantity.

64 Mechanism of Istisna Purchase price Purchase price plus premium (deferred) DEVELOPER/CONTRACTOR/ MANUFACTURER FINANCIER CUSTOMER Sale of developed equipment/construction Sale of developed equipment/construction .

(object/lease date/rent)  Additional security is acceptable (guarantees. ship financing and project financing 65 . collateral)  Title remains with bank until full repayment  Used for aircraft financing.Ijara Contract (leasing)  Similar to the a conventional lease contracts  A bilateral contract allowing the transfer of the usufruct  Rental could be fixed for the life of repayment or adjusted periodically  Sub-leases are acceptable so long as lessor agrees  Bank (lessor) & client (lessee) agree to the terms of lease.

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69 Islamic Bond (SUKUK) .

It also allows for the diversification of risks by issuers and investors. thus avoiding the funding mismatches. . • Well developed bond markets ensures stable financial system as it minimize over-reliance on financing from the banking sector.70 Islamic Bond (SUKUK) • Bonds are important part of overall financial system. • The development of the bond market allows for access to funding with the appropriate maturities.

Firstly. they represent a portion of Debt payable by the issuer. Earning any kind of profit falls under the category of RIBA as defined in the Hadith. trading of Murabaha and Salam Sukuks is not permissible. However. Trade of such Sukuks is permissible. . Shariah prohibits trading of debts (Bai Dayn) as it involves Gharar.71 Islamic Bond (SUKUK) Dealing in Bonds is not permissible according to Shariah because of two aspects: 1. 1. because it will be equivalent to the sale/ purchase of holder‟s proportionate share in the assets. Second aspect pertain to the trading of Bonds.

it is not directly linked to the project  No Shariah Constraints  Sukuk prospectus includes all shariah related rules .  Sukuk are proof of ownership or beneficial ownership of the asset  Sukuk holders have a right to profits but also losses  Sukuk holders may dismiss sukuk manager/issuer  Maturity is based on underlying project/activity Conventional Bond  Bond holder does not incur damages/loses suffered by the company.  The security rights are not linked to the company‟s assets  Represents a share in the financing process.72 How is an Islamic Bond Different? Sukuk  Sukuk are always linked to underlying assets.

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Global (Listed) Sukuk Issuance 50000 45000 40000 35000 US $ Million 30000 25000 20000 15000 10000 5000 0 Rest of World Middle East 75 .

76 Islamic Sukuk-Types Sukuk Al Ijarah Sukuk Al Salam Sukuk Al Murabaha Sukuk Al Musharaka .

.77 ABC Ltd. (Corporate) ABC Ltd. wishes to purchase a new asset and plan to raise finance through issuance of Islamic Sukuk.

. ABC Ltd.78 Supplier Supplier of the Asset is identified and negotiations is finalized by ABC Ltd.

as a limited liability Company. SPV is created by ABC Ltd.) ABC Ltd.79 Supplier Issuer SPV (LLC 100% owned ABC Ltd. .

Proceeds Investors SPV issues certificates and receives proceeds which are used to purchase asset from the supplier .80 Supplier Payment made to Supplier Title is transferred to SPV Issuer SPV (LLC Sukuks 100% owned ABC Ltd.) ABC Ltd.

on Ijarah . SPV leases Plant to ABC Ltd.81 SPV holds Plant/ Asset as Trustee SPV holds Asset as Trustee and leases the plant to ABC Ltd. as per rules of Ijarah Issuer SPV Investor ABC Ltd.

(Lessee) Periodic Lease Rentals Issuer SPV Semi-annual coupon distribution amounts Investors ABC Ltd.82 ABC Ltd. (Lessee) pays periodic rentals to SPV for tenors & amounts matching the coupon & tenor of the Sukuks .

(Lessee) Pays the exercise price at dissolution Issuer SPV Redeems the Trust Certificates at dissolution Investors •ABC Ltd (Lessee) give the SPV an irrevocable purchase undertaking to purchase the Asset at maturity. •Asset is transferred back on maturity. Asset transferred to ABC Ltd. upon payment of the Exercise Price to the SPV / Sukuk Holders. •Exercise Price = Initial Purchase Price of Asset + service costs. .83 Exercises the purchase undertaking. ABC Ltd.

and not only a right to receive rent.84 Essential Condition “It’s essential that the Ijarah Sukuks are designed to represent real ownership of the leased assets.” .

85 • Government of Bahrain first issued Salam Sukuks as an alternate to short term government treasury bill.Sukuk Al Salam • so named because securities are based on the concept of Bai Salam. • Under the transaction Government took an advance payment from the investors for a future delivery of Aluminum ingots. • Upon delivery of Aluminum ingots to the investors at the time of completion of Salam contract. • The difference between Sale and Purchase price was the profit of the investors. . Government sold ingots to third parties as agent of the investors. A paper was issued as an acknowledgment of receipt which is known as Salam Sukuk.

86 Important Conditions • Salam Sukuk represent investors shares in the Advance Price paid to the seller. . • Since its a dayn. it cannot be traded in the secondary market.

• Every Sukuk would represent holder's proportionate ownership in the assets of the Musharaka. these Musharaka Sukuk can be treated as negotiable instruments in the secondary market. • Once the majority of the cash amount is converted into fixed assets. 87 • If a comapany required financing for any of its project through Musharaka it can issue Sukuks against which investors would provide funding as per the rules of Musharaka. • Musharaka Sukuks can be used for number of purposes including:  Construction of Projects and factories  Expansion Projects  Working Capital Finance .Sukuk Al Musharaka • Musharaka is a mode of financing against which Sukuks can be issued.

 . At least 20% of the value of Portfolio should be invested in non-liquid assets.  Loss is shared on pro rata basis.Important Conditions  Profit earned by the Musharaka is shared according to an agreed ratio between the Issuer and Investors at an agreed ratio.  To ensure tradability of the Sukuks following condition should be adhered to:  88 All the assets of the Musharaka should not be in liquid form.

Acknowledgment of their investment would be regarded as Murabaha Sukuk.89 Sukuk Al Murabaha  Sukuks can also be issued against a Murabaha transaction. .  The asset would be purchased from its supplier and would be immediately sold to the issuer against deferred price.  Profit earned from the transaction would be distributed among the investor proportionately. Under the transaction investors would provide funding to purchase some assets for the issuer.

it cannot be traded in the secondary market.  Since its dayn. .90 Important Conditions  Murabaha Sukuk represent investors shares in receivable from the purchaser.

91 Islamic Insurance (Takaful) .

being the contract of cooperative insurance. • The alternative Takaful contract which conforms to the principles of Islamic dealings is Halaal. KSA. which is founded on the basis of charitable donation and Shariah compliant dealings. meeting in its Second Session in Jeddah. (Dec 1985) issued a Resolution which in summary stated the following: 92 • The commercial Insurance contract… is prohibited (Haraam) according to the Shariah. .Islamic Insurance (Takaful)  Conventional Insurance means a way to provide security / and compensation of what is valuable in the event of its loss. damage or destruction based on the principle of risk taking and speculation.  Islamic Fiqh (science of Shariah) Academy.

 The company will be in deficit if claims are higher than premium.Why conventional insurance is prohibited? 93  Scholars view the insurance contract as an exchange contract – money is being exchanged for money over time.  Riba:  In the case of life insurance.  Gharar (uncertainty): in the case of general insurance. policyholders get back the premiums along with interest in the case of survival and the insured amount in the case of death before maturity of the policy.  Insurance funds are invested in financial instruments which contain the element of Riba. the policyholders have to pay the premiums against unknown risks:  Whether the insured will get the compensation promised?  How much the insured will get?  When will the compensation be paid?  Gambling: The insured loses the money paid for the premium when the insured event does not occur. .

.  It is a system of Islamic insurance based on the principle of TAAWUN (mutual assistance) and Tabarru (Voluntarily) where the risk is shared collectively by the group Voluntarily.  This is a pact among a group of members or participants who agree to jointly guarantee among themselves against loss or damage to any of them as defined in the pact.94 Definition for Takaful  Takaful is an Arabic word that means "guaranteeing each other".

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0 3.3 0 2004 2005 2006 2007 2008 2009(f) 2010(f) 2015(f) .7 2.4 1.5 3.96 Global Takaful premiums ($bn) 12 10 8 6 11.0 2.6 4.0 4 2 1.

.Basic Elements of Takaful  Mutuality and cooperation.  Constitution of separate “Participants‟ Takaful Fund”.  Joint Guarantee / Indemnity amongst participants – shared responsibility. Maisir and Riba.  Constitution of “Shariah Supervisory Board.  Wakalah/Modaraba basis of operations.  Payments made with the intention of Tabarru (contribution)  Eliminates the elements of Gharrar. 97  Takaful contract pertains to Tabarru’at as against mu’awadat in case of conventional insurance.”  Investments as per Shariah.

98 Main drivers of Takaful  Piety (individual purification)  Brotherhood (mutual assistance)  Charity (Tabarru or contribution)  Mutual Guarantee  Community well-being as opposed to profit maximization. .

Islamic contracts of Wakala or Mudarba with Tabar’ru (contributions) Investments Interest based Shariah compliant.Comparing Takaful to Conventional Insurance Issue Conventional Insurance Takaful 99 Organization Principle Basis Value Proposition Profit for shareholders Risk Transfer Profits maximization Mutual for participants Co-operative risk sharing Affordability and spiritual satisfaction Laws Ownership Management status Form of Contract Secular/Regulations Shareholders Company Management Contract of Sale Shariah plus regulations Participants Operator Cooperative. Riba-free Surplus Shareholders’ account Participants’ account .


50 Assets Under Management (US $Bn) 45 40 35 30 25 20 15 10 5 0 20 23 34 41 43 44 800 700 600 500 400 300 200 Number of Funds 101 29 100 0 2003 2004 2005 2006 2007 2008 of Islamic Funds AUM Number 1Q 2009 .

102 .

Type of Islamic Funds 103 .

104 Stock Selection Process .

105 Subprime Crisis and Islamic Finance .

Making of the Crisis 106 .

From the Mortgage Crisis to the Global Economic & Financial Crisis 107 .

108 Major Impacts .

0 -1.5 .Slowdown in Economic Growth Revisions by IMF for 2009 Growth Projections 109 3.1 -3.4 0.5 6.8 1.

Islamic Finance as a Solution 110 .

The Global Economic & Financial Crisis: The Real Causes 111 111 .

Implications for Islamic Banking 112 .

Islamic Finance as a Solution 113 113 .

Islamic Theory of Finance and the Global Financial Crisis Islamic Theory of Finance 114 .

Islamic Theory of Finance and the Global Financial Crisis Rules and Regulations 115 Forbid Stipulate 115 .

Islamic Theory of Finance and the Global Financial Crisis Islamic Theory of Finance 116 .

Islamic Theory of Finance and the Global Financial Crisis Principles of Islamic Finance against the Crisis 117 117 .

Islamic Theory of Finance and the Global Financial Crisis Principles of Islamic Finance against the Crisis 118 .

a practice of guaranteeing profit in some institutions is against islamic laws since it is similar to interest rate.Challenges Facing Islamic Banking 119  In governance. that may result in confusion in market. As an example.  Regulatory & tax issues  Shariah scholars & Shariah compliant products  Trained & Skilled Islamic Bankers  Understanding by its clients  Arabic Terminology . because they are part of management (paid by the banks). and there is moral hazard in Shariah based financing practices (Nasution and Wiliasih 2007).  Differences in practice and application of Shariah laws.  Studies (using Indonesian Islamic Index) indicate that speculation plays an influencial role in islamic market (Kurniawan 2008). independence of SSBs is being questioned.

during the economic crisis their growth is remained strong. so that the islamic laws and values are consistently and essentially actually applied. and they have shown resilience to global market dislocation. however.120 Conclusions  IF & B has been a choice of financial and banking services for Muslim and non-Muslim communities.  Islamic financial institutions are affected by the financial crisis. They are not risk immune. IF & B need to improve their infrastructure and governance.  The size of their businesses and the asset managed grow significantly.  To improve their role in global economy. .

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