Shakeel Ahmad ( Facilitator: Dr. H. K. Pradhan ( Executive Post Graduate Program (Ex-PGP) in Management XLRI (, Dubai ( Approved for submission: February 2004

Acknowledgements I am grateful to Dr. H.K. Pradhan, my guide, for his continuous encouragement that enabled this study of a subject that had remained within my heart, since early ages. His teachings of International Financial Management provided insights beyond theoretical concepts, and his friendly style inspired the quest for excellence. I am thankful to XLRI, an institution that provided me with the opportunity to pursue this post graduate study in management, for which this dissertation project was undertaken. I take this opportunity to express my sincerest gratitude to all the members of Islamic Banking and Finance Community (IBFnet) in the Yahoogroups mailing list. Islamic finance community has worked hard in providing a wealth of resources on the internet. They deserve appreciation and rewards from no less an entity than Allah SWT Himself. Special thanks go to Dr. Obaidullah, the IBFnet¶s founder. This dissertation work would not have been possible without the special help and encouragement from Dr. Shahid Ebrahim ± it is difficult to express my special thanks for him, in a few words. Finally, the time that I devoted on the Ex-PGP, and this project, was taken away from my family whose support acted not only as facilitator but also was a source of continuous inspiration.

Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04), XLRI, Dubai Campus

Exploratory Channel:
Sequence 1 2 3 4 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 Introduction Why Islamic Banking? Islamic Banking and Finance (IFB) Sector, now Why is Islamic Banking and Finance (IBF) creating ripples? Literature Review Islamic Banks Brief History Concepts behind Islamic Banking and Finance Distinguishing Features Role of Islamic Banks Prohibition of Interest Table-2: Comparison between Riba and Profit Table-3: Differences between Islamic & Conventional Banking Key Islamic Financial techniques/ Products Box-1: Islamic Financial Instruments Islamic Derivative Products Advantages of Islamic Finance Box-2: Landmark Islamic finance deal inked Perceived Disadvantages of IBFs Impediments to the growth of IBFs Recommendations to counter Impediments to growth of IBFs Latest Developments Box-3: How Islamic is Bank Negara¶s IIMM? Islamic Bonds (Sukuk) Funds Box-4: Conventional Investors find Islamic Bonds attractive Box-5: US$250 Government Islamic Leasing Securities Box- 6: Islamic Development Bank launches bond issue worth $400m Box-7: Latest Trends & Challenges Box-8: Bahrain: LMC to issue $1.2b bonds Rating Agencies Basel II Implications Important Institutions Conclusion References Appendix-A0: Estimation of TAI for UAE APPENDIX-A: Competitiveness of Banking Sector In Case of Opening Local Markets to GCC Banks APPENDIX-B: Islamic Financial Institutions in the World APPENDIX-C: Islamic Equity Funds in the World APPENDIX-D: The Dow Jones Islamic Market Indexes APENDIX-E1: Assets, Deposits and Loans of 53 Conventional local Banks in GCC APENDIX-E2: Assets, Deposits and Loans of 8 Islamic local Banks in GCC Title Pag e 3 4 6 6 7 10 11 13 13 14 14 15 16 17 19 21 21 23 24 24 36 38 40 41 41 42 43 45 46 48 49 49 51 54 59 59 61 68 72 73 74

Submitted by: Shakeel Ahmad

Page 2 of 74

Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04), XLRI, Dubai Campus

Introduction: To start with graphics may not be a novel idea, but if you are associated in
any way with promoting deposits or instruments of a conventional bank anywhere in the world, these graphics must already have left some alarm bells ringing in your mind. 32.83% CAGR in Deposits and 24.69% CAGR in total assets over a four-year period in a country which was written off the books of financial wizards and stock-market punters after the Asian Currency Crisis. In figure±1, the rapid rise can be seen not in one aspect but in all major aspects of banking and finance reinforcing the belief that the growth rate witnessed was an all encompassing one. The question that arises at this moment is whether this growth rate is

450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 1998 1999 2000 2001 ustomers 2002 Investments

18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0


Total ssets

ig-1: evenue ( M '000) (Le t Scale) and ssets/ Investments/ inancing/ eposits ( M '000) ( ight Scale) or Bank Islam Malaysia Berhad (BIMB), Malaysia¶s oldest Islamic bank (established on July 1st 1983) Source: BIMB Annual Report 2002

sustainable. An answer to that would be premature without looking at the reasons behind this phenomenon, and whether the same success story is repeated anywhere else in the world. We will try to answer some of the above questions, and also try to see if the growth in Islamic banking and finance sector could have been better. If yes, we will try to peep into the reasons behind less than expected growth. Much has been written by historians about the feudal lords who by virtue of charging high interest rates controlled those in desperate need to finance their survival. Financial clout led to political clout and ended up in enslaving the masses. Before the historians touched upon this exploitation of the masses, religious scriptures had already warned of usurious acts existing in the society. In the Old Testament (King James Version), Exodus, Chapter 22, verse 25: If you lend money to any of my people that is poor by thee, thou shalt not be to him as an usurer, neither shalt thou lay upon him usury. Leciticus, Chapter 25, verses 34-36: And if thy brother be waxen poor, and fallen in decay by thee; then thou shalt relieve him: yea though he be a stranger, or a sojourner, that he may live with thee. Take thou no usury of him, or increase: but fear thy God; that thy brother may live with thee.
Submitted by: Shakeel Ahmad Page 3 of 74





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6% 8.7% 14. If we compare the ratios that triggered the 1980s Debt crisis with the levels being experienced. % 12.3% 13.1% 6. Figures 2c and 2d provide a different picture altogether.6%   12% I P C) 14%    .3% 7.8% 20% 15% Amortization ountries) ) Int p ay ments o untries) Fig-2d: Interest Payments Fig-2c: Amortization payments Source: For Fig-1a: IMF World Economic Outlook 1999 & 2003. based upon µperfect competition¶. By creating a market for debt.8% 12.1% 9. because the interest rates or debt-service payments are within limits. 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 84% 84% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 126% 112% 101% 99% 97% 94% 92% 91% 91% 92% 48% 30% 31% 53% 55% 90% 89% 84% 49% 36% 42% 44% 45% 41% 40% 39% 38% 37% 37% 37% 38% 39% 41% 1980 Argentina 1982 Brazil 1985 Mexico Debt-to-GDP Ratio (Developing) Debt-to-GDP Ratio (HIPC) Fig-2a: Debt to GDP Ratios for Developing countries & HIPC Fig-2b: Debt to GDP Ratios of crisis-ridden countries during the Debt Crisis of 1980s 5. Figures 2a and 2b show how countries. Modern financial system learnt a lesson from these religious warnings and tried to adopt a system that limited the extent of usurious exploitation to a great extent.9% 10.4% 13.9% 6. What is definitely cause for stress is the false claim of the contemporary world order to have relieved the masses of this burden of debt. are getting trapped into slavery.7% 9.0% 8. % 16. There is no doubt that Debt to GDP ratio is a robust indicator of the Debt burden of countries. For Fig-1b: Sachs and Larrain (1993) Submitted by: Shakeel Ahmad Page 4 of 74 '$ & %$    #" !    16. instead of individuals.6% 12.6% 12. and could be enough cause for the unipolar world of the day. Thus the very mention of usury and the suggestion to avoid indulging in this act in Judaism and Christianity implies its existence in ancient times and the ills that it carried along for the society. Dubai Campus Why Islamic Banking? The New Testament also contains edicts on the same line. % 18.1% 2002 2001 2000 1999 1998 1997 1996 1995 0% 5% Amortization 10% 14. now.5% 12. From the traditional Jewish lending system of the Shylocks to the Indian feudal system.6% 2002 2001 2000 1999 1998 1997 1996 1995 15.7% 8. we can see that the situation is no better. it propounded an end to exploitative nature of usury and thus evolved the system of interest rates which was supposed to be determined by the market forces freely competing with each other. XLRI.6% 7.4% 8. the system prospered. % 17.8% 0% 2% 4% ev 6% 8% 10% Int p ay ments 9. % 16. Despite the warning against this practice. there is no need to strain our memories much. What we see today is an expansion of the ancient feudal system into a global arena with nations facing the same plight as did individuals earlier. % 13.9% 7. 14. Despite the claim that modern interest-based system is not exploitative or usurious.2% 7.Statistical Appendix.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).

If the paper being traded in stock exchanges were actually trading at their genuine value. may be illconceived.´ in V. bubbles that occasionally burst would not exist. Islamic banking and finance based on the Islamic economic system must be taken seriously. exchange rate. stock market or Debt) crisis. acting as a trap (particularly when they are floating rate. If the interest-free banking system could see the light of the day. Commerzbank. The urge to have a system that claims to provide a solution to such financial crises grows after every financial (monetary. Bank of America. It is not hard to understand that if the value of money carried its real worth. It is not easy to emphatically pronounce that the cause for this has been the interest-based system. Washington. BNP Paribas. ANZ Grindlays. Some of the Western banks already having dedicated Islamic subsidiaries are: Citibank. The diagnosis of the Debt Crisis of early 80s suggests that even low interest rates (Figure-3a). and is making its conventional competitors stand up and have a look. Interest-based system is one component of the economic system where the concept of money itself. as a worthless piece of paper carrying immense power. ABN Amro. The debt burden measured by Debt-to-GDP ratio (Fig-2b) is an indication of the inevitable crisis that was waiting to happen.C. Fig-3a and 3b: Interest rates and export prices in Latin America (1972-1986) Source: Andres Bianchi et al. no debt-crises would occur. Flushed with funds. The success of the Islamic system can be gauged by the rush among the conventional banks to open their own µIslamic windows¶ not just in countries dominated by Muslims but also in rest of the world. as all the financing would be PLS (Profit-and-Loss Sharing arrangement of Islamic financial system). due to the sharp oil price increase in 1973-74 leading to booming deposits by Oil-rich countries. Submitted by: Shakeel Ahmad Page 5 of 74 . Stantad Chartered. Goldstein.: International Monetary Fund and The World Bank. Similarly. 1981 -86. and M. Dubai Campus The transition of the world from a multipolar world order to a unipolar one has not been without pain and suffering. ³Adjustment in Latin America. 1987. Barclays. international commercial banks were eager to lend at lower interest rates enticing the third world to borrow more and more. This paper looks into the realities associated with this system which is growing at a m uch faster pace than its counterpart. American Express. as majority of debt was) could cause countries to come down to their knees. therefore.. XLRI. HSBC. ed. with no speculation. D. the argument that low interest rates cannot cause countries to lose their sovereignty also does not hold much ground. Deutche Bank. currency crises could be avoided. Growth Oriented Adjustment Programs.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Khan. Corbo.. but nobody should doubt that the cause has been the financial system as a whole. M.

For example. the Middle East alone had 12 top-tiered Islamic banks with total capital of about $1. UBS. the reason may be obvious (Figure-4). grew profits by forty-one percent in 2000 (MEED. a comparison of the assets of all Islamic banks to HSBC. In 1999. positioned as a regional Islamic bank for the Balkan area. 2000). 2002 2001 2000 1999 1998 1997 1996 -40% -20% 0% 20% 40% 60% 80% 100% 120% 140% Islamic Non-Islamic Fig-4: Proportion of Islamic Bonds in Malysia v/s Non-Islamic Bonds Source: Annual Reports of Bank Negara (Central Bank of Malaysia) and Authors¶ calculations Submitted by: Shakeel Ahmad Page 6 of 74 . Yet. Islamic Banking and Finance (IFB) Sector.8 billion and assets of approximately $18 billion. recently noted that the number of Islamic banks has grown from 34 institutions in 1983 to 250 today. Sudan and Iran adopting 100% Islamic Banking. Merrill Lynch and Kleinwort Benson. Pictet & Cie. The annual growth rate for Islamic financial institutions varies from 15 to 40 percent annually (Hamwi and Aylward. just one of the world's largest banks with assets of $569 billion in 1999 (Azzam. the prospects of more countries to follow suit rising. with wholesale and retail services in Bosnia (Carvalho. The chairman of Dubai Islamic Bank and Emirati Minister for Financial Affairs. Bank Al-Jazira. now : It is difficult to obtain exact figures on the size of the Islamic financial sector. 1999). Iqbal and Mirakhor (1999) report that Islamic banks grew from an asset base of $5 billion in 1985 to a level of over $100 billion in the late nineties. XLRI. Nevertheless. 2001). 2001). Dubai Campus Golman Schs. And the list is growing. Without doubt. the conventional counterparts cannot sit back and see their market share being eaten away. Mohammad Khalfan bin Kharbash. Al Rajhi Banking and Investment Corporation posted a net profit in 1997 of $347 million and return on capital of 25% (Hamwi and Aylward. Islamic banking is spreading and gaining acceptance in both Muslim and non Muslim countries. it is small in comparison to the conventional financial sector but it is experiencing strong growth. Many of the Islamic banks are gaining strength and achieving profits. Royal Bank of Canada. by far the smallest bank in the Saudi Islamic banking sector. Flemings. 1999). operating and managing assets of $200 billion (Phillips.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). 2001). Bosnia Bank International became operational in March 2001. demonstrates how small the Islamic sector remains on the world banking stage. Why is Islamic Banking and Finance (IBF) creating ripples ? Looking at the growth rates of IBF in comparison to the conventional banking. With countries like Pakistan.

we compared the figures for two banks in UAE under the same ownership .000 0 1.4%. Dubai Campus Malaysia being a pioneer in expansion of IFB products. 1. have joined the race for providing Islamic products. mostly.000 8. 00 9. Source: Annual Reports of respective banks Submitted by: Shakeel Ahmad 9 8 32 00 54 I 4 1.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). 00 ssets 0 1999 ational an of 2000 bu habi 2001 bu habi Is lamic an Fig.000 . It will be an impossible task for any conventional bank to match these figures during the period.: Comparison between Conventional and Islamic an s in U E ( ational an of bu habi v/s bu habi Islamic an ). Standard Chartered Bank Malaysia Bhd.5% 18. 00 8.000 7.6% Western banks and financial institutions. 2001). None of the Islamic banks yielded any negative growth rates during the period under study while thirteen conventional banks in terms of Loans.1% 31.000 9.21% 50.000 GG C 7. Deutsche Bank AG.1% 17. is no mean achievement.2% 69. Citicorp¶s Islamic banking unit in Bahrain established in 1996 is an example. HSBC. High-tech fever has not caused Islamic financial Web sites to crop up and grow along with Islamic Finance. The results are even more astounding. is planning to extend its Islamic banking services to become a total money management and financial provider within two to three years (The Star.2% 51. now. 00 bu habi Is lamic an ational an of bu habi bu habi Islamic an 2.000 10.4% 9. according to a report by Wall (2001).5% 28. Investments at 39. Morgan.3% Deposits 0.000 8. 00 7 0 0 0 0 7 34 54 63 54 .12% 2.3%. Citicorp and Bankers Trust. The data for all these banks are provided in Appendices-E1 and E2. our calculations for the CAGR for its leading bank BIMB (Bank Islamic Malaysia Berhard) between 1998 and 2002 yield the following results: Deposits grew at 32.000 0 1999 ational an of 2000 bu habi 2001 0 1999 2000 2001 . 00 CAGR (1999-01) NBAD ADIB NBD DIB Financing (Loans) 10. Table-1: Comparison of CAGR for 53 conventional and 8 Islamic banks in GCC Financing (Loans) Average CAGR (1999-2001) Local Conventional Banks Local Islamic Banks 7.000 . J.National Bank of Abu Dhabi. seven in terms of Assets and eight in terms of Deposits reported negative CAGR.P.000 1.45% 14.000 GE 65 2 0 0 0 0 ( ) 0 1 A @ A @ A @ 9 8 A @ 9 8 . XLRI. a Conventional Bank and Abu Dhabi Islamic Bank. From less than 10 Islamic mutual funds a decade ago to over 90. Independent financial institutions based on Shari'ah are also becoming common for the Western banks and financial institutions. as depicted in Figure-5.3% and Total assets at 28.000 2.000 oans 8. For the sake of diversity in outlook.6% 21. 00 9. an Islamic bank. 00 I eposits 1.000 C C C 2. like Chase Manhattan.000 .3% 19.3% 27. Commerzbank AG. but they currently exist in trade and other forms of shortterm finance. Goldman Sachs.2% Deposits Assets 7. May 17. 00 oans eposits 1. 00 10.1% Assets 1.1% ssets Table-1: Comparison between Conventional and Islamic Banks of UAE Page 7 of 74 P I FE D CB R Q R Q P I H GF 9 8 34 00 00 I 7.000 1.

000 ADIB Assets 10. 1989. the growth rate of Dubai Islamic Bank. and Sudin et al. Dubai Campus Literature Review: The information on Islamic Banking & Finance is available in many forms. the oldest Islamic bank of the modern world.. the risks of these vehicles are inherently higher than conventional ones as espoused by Ebrahim (1999).g. and the distribution of income and wealth (Iqbal and Mirakhor. which can be deemed as equity (Musharakah) and hybrid (modified Mudharabah and Ijara) facilities (Ahmad. 1987) and journal articles (e. and the Islamic Law (Shari'ah). 1994). 1987). e. 1983).800 1999 2000 2001 NBAD Loans 2. 1990. The Shari'ah specifies.950 1. Exceptionally larger growth for the Abu Dhabi Islamic Bank may be due to its short history ± the bank might be growing at this unprecedented rate because it has recently come to fulfill the unsatiated need of the people of Abu Dhabi (or UAE). 1987.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).850 1.000 0 6.000 3. Islamic banking advances the following set of beliefs: interest as a reward for saving does not have any basis as a moral foundation. property rights.000 ADIB Loans 2.000 Similar results can be seen when comparing Dubai Islamic Bank (Islamic) with National Bank of Dubai (conventional) ± two banks under Dubai Government (Figure-6). Because of Riba. But. The primary function of Islam is to guide human development on correct lines and in the right direction. Shook and Hassan. but treats this as an important part of a wider problem. that of total human development.000 0 1999 2000 2001 NBAD Deposits 2. 1994).000 8.000 ADIB Deposits 8.000 6.000 1.. Fig-6: Comparison between Conventional (National Bank of Dubai) and Islamic (Dubai Islamic Bank) Banks in UAE Source: Respective Annual Reports National Bank of Dubai The main thrust of Islamic financial contracts is on profit and loss sharing. 1990).g. opts to comply with two sets of law: the law of the Land (Jurisdiction). rules that relate to the allocation of resources. 1993).000 1. Erol and ElBdour.000 3. inter alia.000 2.000 0 1999 2000 2001 Dubai Islamic Bank NBAD Assets 3.900 1. Iqbal and Mirakor. production and consumption. Homoud. Another study of fifty-three conventional banks and eight pure Islamic IBFs in GCC.g.000 2. 4. XLRI. One definition of an Islamic Bank is a bank that.000 4. It deals with all aspects of economic development but always in the framework of total human development and never in a form divorced from this perspective" (Al-Harran.000 4. Shirazi. 1988. published research in the form of reports (Ahmad. by its own choice.000 1. 1984. 1994). books written by leading academics and practitioners (e..000 4. Khan. PhD dissertations (El-Bdour. This is why Islamic bankers have two types of legal counsel: traditional "lawyers" and "Shari'ah Councils" (Al-Bahar.000 2. The task has been achieved by creating a number of special financial products (Ali and Ali. abstinence from spending of present income does not Submitted by: Shakeel Ahmad Page 8 of 74 . 1985. 1996). "Islam is deeply concerned with the problem of economic development. covering almost the entire population of local banks in the region yielded results on similar lines.000 0 4. Erol et al. Islamic banks have had to develop financial products which are not in conflict with the Sharia'h.000 0 5. provides enough empirical evidence in favour of much larger growth rates for the IFBs. However.000 1. as listed in Table-1.

both Muslims and non-Muslims are generally unaware of the culture of Islamic banking. Conventional futures are very controversial with the Ulema . the development of it is largely unrealized (Khan. Ebrahim (2001) recommends to design. develop and implement Islamic facilities that enhance the competitive ability of Islamic banks and reduce their risk exposure. The potential of Islamic fixed income securities backed by an Ijara facility is discussed by Kahf (1997). and to benefit from money is to transform the money into investments.5 per cent of non-Muslims said they would withdraw their deposits. 1994. etc. Gharar and Maysir manifested in the conventional system can wreak havoc in an economy as advanced as the USA. as depicted by the massive failures of US savings and loans institutions of the 1980s. It should be noted that certain Ulema such as Justice Taqi Usamani have given their verdict allowing contracts with embedded options (Kahn. Rosly. 1999). 1999). for example. The results suggest that religious motivation did not appear to play a primary role in bank selection. while 66. while 39. 1998). Thomas (1995) is of the view that Riba. (1991). Kaynak et al. although not by design (Iqbal and Mirakhor. Laroche et al. (Ebrahim. The excessive use of credit facilities by Islamic banks globally has drawn the ire of scholars such as Ahmad (1989) and El-Naggar (1994). conditioned to accept risks and bringing the knowledge of other factors of production together (Presley. conducted in Jordan. However.religious scholars (Kamali. Gerrard & Cunningham¶s (1997) study establishes that. the opening of new branches was not an important factor in increasing the utilization of financial services provided by Islamic banks. Holstius and Kaynak (1995).. in Singapore. deliverability and precise determination.1 per cent of Muslims said they would keep their deposits within the Islamic banking movement. 2000) further recommends to design. Hence. 62. existence. Rayner (1991) lays down four elements of a contract on a property (mal): they are lawfulness. For example. 1999). 1999). develop and implement Islamic hedging and risk minimizing facilities such as Islamic futures (Bai Al-Salam/Istisna). XLRI. 1988). (Iqbal. with the degree of difference depending on the nature of the respective matter put to them.4 per cent of respondents would withdraw their deposits if an Islamic bank did not generate sufficient profit to make a distribution in any one year. Dubai Campus deserve a financial reward. Andrade and Kaplan.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).4 per cent would retain their deposits because the Islamic bank could distribute a higher dividend the following year. the "profits" and "interest-charge" implied are similar in outcome. and the working paper of Chan Submitted by: Shakeel Ahmad Page 9 of 74 . Ebrahim (1999) explains that profits on Murabahah facilities are generally higher than conventional loans because Islamic instruments are structured to share the risk of the asset or venture. Much has been written since the early 1960s on the theme of the bank selection process (see. (1986). Also the two separate groups have different attitudes towards the Islamic banking movement. (1976). Islamic swaps. the published articles of Anderson et al. Part of the study of Erol and El-Bdour (1989). 1995). Kaynak (1986). Islamic Derivatives: These comprise both Islamic Futures and Embedded Options in a contract. when asked what they would do if an Islamic bank did not make sufficient profits to make a distribution in any one year. aimed at establishing the attitude of local people towards Islamic banking. which has a minority of Muslims in its population. 30. Islamic banking aims to promote economic growth through risk-sharing instruments whose payoffs fluctuate with economic output and do not structurally impair the economy in the manner of excessive fixed-interest debt does in a poor economic environment such as a recession (Asquith et al. 1999.

Erol & El-Bdour (1989) and Erol et al. among other things. (Roman philosopher. none of whom had to be patronizing an Islamic bank at the time of the study. General Secretariat of the OIC¶s definition goes like this: ³An Islamic bank is a financial institution whose status. Islamic banks hardly look different from its conventional counterpart in terms of organisational set-up (Dar and Presley. The essential feature of Islamic banking is that it is interest-free. "friendliness of bank personnel". second. (1990) compared the bank selection process in relation to "conventional" and Islamic banks. The three most important criteria in the bank selection process for Muslims were: first." (Islamic Finance: A Euromoney Publication. In addition to establishing attitudes towards Islamic banking. among others. US Federal law allows penalty rates / insurance premiums Happy the man who far from schemes of business. . which do not guarantee a fixed certain return on investment deposits. in practice.µ Page 10 of 74 -The Koran: Surah 2. As regards the non-Muslims. This leads to a reluctance of deposit holders. That is because they say: "Trade is like usury but Allah hath permittedby: Shakeel Ahmad Submitted trade and forbidden usury. and third. in fact. like the early generations of mankind. sought to establish the relative importance of certain bank selection criteria using a sample of Muslims and non-Muslims. then compare. Although it is often claimed that there is more to Islamic banking. "Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon. This difference introduces an element of mutuality in Islamic banking. "the reputation and image of the bank".a Danish father advising his son. and third. 2000). Dubai Campus (1989)). who have no representation in the organisation. (1994). however. to use PLS accounts. Horace) Julius Caesar limited interest to 8 1/3 % Those who devour usury will not stand except as stands one whom the Evil one by his touch hath driven to madness. Sudin et al. Islamic banking has been defined in a number of ways. Islamic banks offer PLS accounts. the bank selection criteria of customers of conventional and Islamic banks in Jordan. such as contributions towards a more equitable distribution of income and wealth. Verse 275 . (1994) compared responses about the bank selection criteria of both Muslims and non-Muslims. UK usury laws on excessive interest abolished in 1854. with no yoke of usury on his neck. "friendliness of bank personnel". and increased equity participation in the economy (Chapra l982). XLRI. the basic practices and principles date back to the early part of the seventh century. "the provision of a fast and efficient service". ISLAMIC BANKS: An Islamic bank is an intermediary and trustee of other people¶s money like any conventional bank with the possible difference that the payoff to all its depositors is a share in profit and loss in one form or the other. ploughs and ploughs again his ancestral land with oxen of his own breeding. making its depositors as customers with some ownership rights inherent within it.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). it nevertheless derives its specific rationale from the fact that there is no place for the institution of interest in the Islamic order. rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations´ (Ali & Sarkar-1995) Unlike conventional banks. second.Shakespeare·s Hamlet . Sudin et al. 1997 Neither a borrower nor a lender be. "the speed of transaction". South Africa and US (except Virginia and Delaware) have usury laws. the three most important bank selection criteria were: first. "the provision of a fast and efficient service". Erol and his co-researchers (1989 and 1990) sought to establish. However. for loan oft loses both itself and friend and borrowing dulls the edge of husbandry. The bank faces a similar problem on the assets side when it comes to investing on PLS.

On loans of grain. Some products are more Islamic and than others. due to the scarcity of wood. In the case of houses. Usury and Riba are regarded as synonymous. Brief History: It is worth noting that there is nothing new or particularly Islamic or Christian about Usury or interest controls. The prohibition is on interest and not just on usurious interest. Hammurabi.usury or Riba used interchangeably . If the crop failed due to weather conditions. non-recourse project finance or ordinary equity investment. Just as interesting and useful for non-Islamic bankers are the lessons learned from the innovation and creativity applied in meeting Islamic criteria. It involves investing but not lending and therefore on a systemic basis is similar to the German. XLRI. by and large. also demonstrate a reluctance to give away a share in the profits of their enterprise. authored laws around 19th B.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). In its purest form. Beyond the question of interest or Riba lies an ethical issue. Unfair practices also existed. Islamic investments exclude tobacco. on the other hand. which were repayable in kind. Manu established a rate ceiling of 24% in India. a door could be used as collateral and was considered to be separate from a house. Dubai Campus It is simply an accepted fact that there are sufficient Muslim investors and borrowers in both Islamic and non-Islamic countries to warrant the attention of traditional banks who seek to serve such clients and capture a potentially profitable slice of a still relatively untapped market. C. through the laws of Solon. all interest on the loan would be cancelled for that year. if any. The search for acceptable investments is balanced by natural risk-aversion. The law remained for most of the next 12 centuries but as with any law "regulatory arbitrage" took place and was subsequently eliminated. trade-related and there is a perceived "genuine" need for the funds. Later. In 24th century B. Islamic borrowers. An analysis of the products suggests that Islamic banking has six key features: y y y y y y free of prohibited on the principle of no pain no gain. What a "pure" Islamic banking seems to be structurally very similar to venture capital finance. lifted all maximum limitations on the legal rate of interest a moneylender might charge. It is not therefore surprising that most of Islamic banking takes the form of one type of mark-up or other rather than profit-sharing. Under the current interpretation of the rules governing Islamic banking. it is equity related. C. there appears to be more emphasis on the prohibition and restructuring of interest than on the potentially exploitative aspect of financing. On loans of silver. there are retail and wholesale applications. Japanese and Spanish banking systems rather than the British or American systems. The temple at Delphi was the "City" or "Wall Street" of the Greek Empire lending money for Submitted by: Shakeel Ahmad Page 11 of 74 . Islamic investors. The basic principle is that interest . the maximum rate of interest was limited to 33 1/3% per annum. For example. gaming and other "undesirable" sectors. In practice. early Islamic investors were content to enter into zero-coupon bonds or discounted Treasury bills and receive the interest foregone in the form of capital gains. The 6th century Greeks. Just as in the process of converting interest into capital gains for tax purposes. established a cap on lending rates. creditors were forbidden from calling a loan made to a farmer prior to harvest. are motivated in their choice of investments by much the same criteria as their Western ethical counterparts. King of Babylon. The investor takes a share in the profits. invests ethically. alcohol. meant to avoid exploitation ± no usury. of the venture and is liable to lose his capital. the maximum legal rate was 20% although it appears that in some cases rates of 25 per cent per annum were charged.

quite a few Western countries have Usury laws that prohibit excessive interest rates. The controls are often on lending to persons. Back to the present day. family or household purposes at a rate not exceeding 10% per annum (compound annual percentage rate). THE New Testament also contains edicts on the same line. Chapter 25. Chronology of recent historical events in the industry: 1963: Egypt interest free savings banks. Virginia. or increase: but fear thy God. The allowable rate in California is 5% over the amount charged by the Federal Reserve Bank of San Francisco on advances to member banks on the 25th day of the month before the loan. (This section is drawn from Edwardes-2000. that thy brother may live with thee. And the federal rate limits are high. But these only apply to state banks and not to national banks. Chapter 22. that he may live with thee. Usury percentage limits vary by state. Leciticus. Thus we can see that Judaism and Christianity are no different in terms of prohibition of usury. The California Constitution allows parties to contract for interest on a loan primarily for personal. etc. Take thou no usury of him. not overtly Islamic . Usury results when a lender charges more than the legal amount of interest permitted in that geographical area.C. neither shalt thou lay upon him usury. Credit regulation was once again part of the legal code at the start of the Roman Empire. This applies whether or not he or she is acting as a real estate broker. South Africa and the US still have usury laws. Exodus. credit unions. The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. The UK¶s usury laws which prevented "excessive" interest were abolished in 1854. has no usury limit. California has recently imposed strict consumer lending limits. and at least one state. Submitted by: Shakeel Ahmad Page 12 of 74 . or a sojourner. In the Old Testament (King James Version). Julius Caesar¶s attempts to control interest rates could well have been the real reason for his assassination since many the Roman senators were the main moneylenders. In some states there is no restriction on the rates used for lending to incorporated entities. Today most of the states have had their ability to limit interest rates curtailed by over-riding US Federal law. in USA. pawn brokers. The legal limitation on interest was established at 8 1/3% per in the 5th century B. finance companies. verse 25: If you lend money to any of my people that is poor by thee. The usury laws do not apply to any real estate broker if the loan is secured by real estate. XLRI. still no overt reference to Islam. and fallen in decay by thee.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Higher than permissible rates have been regarded by US Federal banking authorities as penalty fees and insurance premiums. State laws place limitations on some of these loans. In September 1998 in North Dakota it was 10. (Refer to Edwardes-2000). then thou shalt relieve him: yea though he be a stranger. verses 34-36: And if thy brother be waxen poor. The limitations also do not apply to most lending institutions such as banks. (Refer to Edwardes-2000). thou shalt not be to him as an usurer. for more details). The reader is also referred to Armstrong-1987. 1971: Egypt Nasr Social bank.556%. Dubai Campus interest regularly. but at a higher percentage rate than the usury laws listed above. The usury rate usually is variable depending on market rates.invested in trade and industry on the basis of share in profits.

DMI Geneva. Dubai Campus 1973: Conference of Islamic finance ministers. first Islamic Commercial Bank in the world. (Refer to Edwardes-2000). there are normally no limits to finance charges except those set by the parties.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). The concept of riba extends beyond interest and usury. ANZ First ANZ International Murabah Ltd. Limited liability companies and limited liability partnerships can no longer assert usury as a defence in civil recovery actions. But there is a problem with usury laws as can be seen in South Africa. Islamic Finance House. another prominent Islamic scholar. Australia. 1970¶s: Faisal Islamic Bank of Sudan / Egypt. family or household purposes. Denmark. certain sectors or individuals deemed risky by the banks will simply not get the funding required.d. and functioned exclusively on an equity basis.« Baron-1952 In transactions for the purchase of goods or services which are not for personal. The maximum interest rate for car loans is almost 22%. riba can be considered as exploitation of one party who owns a product (that includes money and capital) and which another party wishes to acquire. (Refer to Edwardes-2000). It is not surprising to know that the first documented interest-free bank (Agibi Bank) was established circa 700 BC. The usury interest limit that applies to limited liability companies and limited partnerships has been raised from 30% per annum to 50% per annum to equate to the level that applies to corporations. Ebrahim (1998) explains that ³Riba is expounded by Ibn Qayyim & Al-Jawziyya (n. Indonesia. it is still better to consider riba as ³unfair exploitation´.).. riba-al-nasi'ah can be Submitted by: Shakeel Ahmad Page 13 of 74 .«. «««. Nigeria. gharar and maysir. Al Rajhi London. market manipulation or engaging a market participant to trade under duress (riba-al-fadl) and (ii) risk-free debt contracts (riba-al-nasi'ah). If there is a particularly risky investment and an interest rate limit. XLRI. Unless there is government imposed mandatory or tax driven lending to certain sectors or public opinion pressure. Malaysia. Luxembourg. and volumes have been written by scholars to explain the concept. in Babylonia. and under a free market there will be a shift to quality or to those that do not really need financing. discouraging price controls and forbidding financial contracts based on riba. Banks also treat interest charges for third party credit cards such as Visa. UAE. 1975: Dubai Islamic Bank. to imply (i) any form of unfair trade. South Africa. In simple terms. Time payment contracts such as retail installment contracts are not generally treated as loans and the usury laws normally do not apply to them. family and household goods or services at this time. There are no limits on finance charges for the purchase of personal. The Concepts behind Islamic Banking and Finance : Distinguishing Features: The economic doctrine of Islam is based on encouraging free markets. Philippines. Riba (Charging of Interest): Taking or paying of interest (riba) is prohibited by Shariah (Islamic law). IBU of United Bank of Kuwait.. 1975: Islamic Development Bank. fee based and PLS. (Refer to Edwardes-2000). Jeddah. Although interest comes very close to this concept. HSBC Amanah Fund. From a financial economist's perspective. MasterCard and American Express as not being subject to Usury law limitations. then banks will simply not lend. Bahrain Islamic Bank. revolving capital. The poorest will find themselves deprived of financing.

etc. arms & ammunitions. Yet some other Islamic banks provide interest free loans to small producers. alcohol. This eliminates a major role of the financial institution. Gharar (Uncertainty): The existence of uncertainty in a contract is prohibited because it requires the occurrence of an event which may not ultimately occur. Dubai Campus defined as a risk-free return from an investment vehicle or strategy. no gain is the basis. Any type of transaction where the (i) subject matter.5%) annually to cover their administrative costs. Implying social justice and general welfare: The basic principle is that everybody should be able to fulfill at least the basic needs. (ii) the price. The purpose of these loans is to help start them their independent economic life and thus to raise their incomes and standard of living. and therefore is prohibited. Conforming to Shariah: The Quran and Hadith clearly specify the guidelines for individual. Saeed-1995. Some restrict it to needy students and other economically weaker sections of the society. money is merely a means of exchange and should not be treated as a commodity. Hoarding: Hoarding money is considered improper in Islam. Some Islamic banks provide the privilege of interest free loans only to the holders of investment account with them. or both are not determined and fixed in advance amounts to ³uncertainty´. ³Full disclosure´ by both parties is the norm in contractual relationships. he suffers the losses. if it fails. investments involving products like pork. what do they do? They invest in viable projects. Tobacco. organizational. So. XLRI. pornography. They are also considered un-Islamic because for most of them. The loans are made from the pooled donations of the members and are generally granted to those who are facing emergency personal crisis. If the project succeeds. farmers and entrepreneurs who are not qualified to get finance from other sources. Cinema. and thus become the basic pillar for any Islamic system. with the banking and financial system being no exception. social. Islam encourages Trade and Enterprise. Role of Islamic Banks: The role of Islamic banks becomes difficult compared to their conventional counterparts because of the basic principle that money is not supposed to earn interest. This form of finance is very important part of Islamic financial system and all members are encouraged to become regular donors so that the fund may be strengthened for the benefit of all Muslim The guiding principle again is the social justice and general welfare. Prohibited Investments and Permissibility of Activities: Investments should only support Halal (permitted) activities. Thomas-1995). Conventional Financial Services and activities like gambling are prohibited. which can generate wealth for the benefits of the community as a whole with PLS as its core. Zaka¶h: A taxation system inherent in the Islamic system based on the principles of social justice and equity. 1. the banker shares in the profit. Swaps and forward contracts (that insure profit) are considered un-Islamic.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Qard-e-hasna (benevolent loan).´ (see also Chapra-1986. Profit and loss sharing (PLS): It is an alternative to interest-based transactions. Futures. rates are determined by interest differentials. with reliable borrowers. Derivative transactions like Options. Thus hedging and dealing in derivatives is not allowed. So. Some extend to all bank clients. Maisir or Speculation: Speculation is equivalent to gambling. governmental behaviour. Submitted by: Shakeel Ahmad Page 14 of 74 . or Qard Hassan: Qard-e-Hasna means an interest free loan and is the only type of loan permitted by the Shariah. Rahman-1969. Risk sharing: No risk. Banks usually charge a small fee (say.

without being exchanged for Submitted by: Shakeel Ahmad Page 15 of 74 . Similarly. Table-2: Comparison between Riba and Profit Riba 1. it can at best be very low or zero. it is Halal (allowed). By definition. but covers capital formation. in trading). In the past there has been dispute about whether Riba refers to interest or usury. It becomes actual capital only when it joins hands with other resources to undertake a productive activity. 3. like other commodities. capital markets. money is treated as "potential" capital. as its amount is not known until the activity is completed. From Islamic Shariah point of view. property rights. In short. From Islamic Shariah point of view. so that his principal may be saved or. but only when it acts as capital. and all types of financial intermediation. Riba con not be negative. supported by other principles of Islamic doctrine advocating risk sharing. when money begets money.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).52). its imposed positive and definite result is Riba 2. (c) He is advancing his money to share the profits of the borrower. Riba is prefixed. Even if a sharing ratio is agreed in advance. In other words. Muslim scholars term interest as Riba. and hence there is no uncertainty on the part of either the givers or the takers of loans. Riba is the predetermined return on the use of money. XLRI. By definition. the Islamic financial system is not limited to banking. 3. 5. 4. In other words. Dubai Campus Prohibition of Interest: Prohibiting the receipt and payment of interest is the nucleus of the system. If money is to be exchanged for money or it is borrowed.64). The most important characteristic of Riba is that it is the positive and definite result of money when changed. (b) He is lending money to the borrower. so that it is not used for trade in money itself. individuals' rights and duties. its uncertain result is profit. p. profit is the difference between the revenue from production and the cost of production. 5. not when it is "potential" capital. Riba technically refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity (Chapra 1985.the basic points of difference between money and commodity are highlighted to justify this. but there is now consensus among Muslim scholars that the term covers all forms of interest and not only ³excessive´ interest (Khan 1985.g. Its use is restricted to its basic purpose i. 2. The basic philosophy underlying transaction of money is that the one who is offering his money to another person has to decide whether: (a) He is lending money to him as a sympathetic act or. Making Money from Money is not permissible . zero or even negative. Riba is the premium paid by the borrower to the lender along with principal amount as a condition for the loan. the payment on both sides must be equal. Profit 1. to act as a medium of exchange and a measure of value. Under Shariah. p. Profit can be positive. it is Haram (prohibited). When money is ³charged´. Islam recognizes the time value of money. and the sanctity of contracts. profit is still uncertain.. it will be unjust not to provide some light on it. 4.e. When money is used in productive activity (e. Money (of the same denomination) is not held to be the subject matter of trade. Since prohibition on transactions based on interest payments is the most important factor and is at the heart of the Islamic financial system.

idle money Even idle money in bank deposits cannot earn any return. than in conventional systems. who of risks forces them to manage risks mostly enjoy a risk-free return. a comparison is justified between the two (Table-2). It has become one of the functions of Government Taxes perhaps serve Liquidation Assets Involvement of risk & Equity financing Return on Capital Prohibition of Gharar (uncertainty) Profit and Loss Sharing Zakat 1 It becomes actual capital only when it joins hands with other resources to undertake a productive activity. shareholders. but only when it acts as capital. Risk-sharing venture capital companies and and profit sharing go together. options are considered as having elements of Gharar. Depends on productivity. An Investment Account Holder will Depositors are paid before the have similar rights as shareholders. act as intermediaries between Depositors & investors have lenders & borrowers enjoying opportunity to earn higher returns almost a risk-free spread. with no religious or ethical considerations. Hadeeth. Table-3: Differences between Islamic & Conventional Banking: Characteristics Guiding principle Ethics of financing Islamic Banking System Guided by Quranic edicts. Derivatives trading e. conventional financial. Islamic ethics and Islamic laws. Equity financing is available to a Commercial banks do not usually project or venture that involves indulge in equity financing. XLRI. only potential capital1. Dubai Campus goods or services. The existence of uncertainty in a Trading and dealing in derivatives contract is prohibited because it are widely considered as the main requires the occurrence of an event source of liquidity in the which may not ultimately occur. Money is not earns returns. The basic characteristics of Riba are: y It must be related to loan. Most transactions are based on this There is no relationship between variable returns.g.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). only profit-and-loss sharing. Greater share the depositors or investors. bankruptcies. Conventional Banking System Guided by profit motive alone. more professionally. or without indulging in any productive activity. major part of the risks being transferred to the borrowers. the norm in contracts. not when it is "potential" capital. and Debt burden arising out of meant for productive use helps excessive use of credit leads to reduce the overall debt burden. Islam recognizes the time value of money. y A prefixed amount of money to be paid when due. to ensure better Conventional institutions mostly returns than conventional accounts. Conventional banks carry much less risk. commodity ³Full disclosure´ by both parties is and capital markets. Since Interest or Riba has emerged as the basic alternative for Profit. and waste of financial resources. Financing being asset-backed. y A time is fixed for the repayment. Page 16 of 74 Submitted by: Shakeel Ahmad . and y All these elements for repayment are taken as conditions for loan. it is called Riba. capital per se. dependent on bank performance and returns to lenders¶ performance. investment banks do.

An integral component Key Islamic Financial techniques : Islamic banking and financial institutions have developed a wide rage of techniques which allow them to uphold the religious and legal principles while enabling them. The conventional banks give greater emphasis on creditworthiness of the clients. borrowing from the money market is the main source of liquidity. For commercial banks. called the Mudarib) does not have any financial participation. it is comparatively difficult to borrow money from the money market. Usually the investment account holders are the provider of funds. to offer viable financial products. It can charge additional money (compound rate of interest) in case of defaulters. Underlying principle is µno-pain-nogain¶. The Islamic banks. The status of a conventional bank. in relation to its clients. but must not be considered as exhaustive: Mudaraba (Participation or trust financing): It involves two parties. the managing agent (beneficiary or the borrower. the Islamic banks pay greater attention to developing project appraisal and evaluation systems. In a Musharaka contract. Profits or losses will be split between the shareholders according to some agreed pre-formula depending on the investment ratio.mode and rate of charging are different. i. The borrower retains a fixed percentage of profits. No guarantee. or alternately it can provide funds to a customer who then acts as Mudarib. Since it shares profit and loss.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). The following list covers many of them. None the same purpose . Difference between Mudaraba and Musharaka Contracts: In a Mudaraba contract. XLRI. the agent is a financial partner along with the provider of fund (Rubb-ul-Maal of Mudaraba contract) sharing the gain or loss at the pre-designated Submitted by: Shakeel Ahmad Page 17 of 74 . For the Islamic banks. Here the partners or shareholders for a Project use their capital through a Joint Venture. at the same time. investors and trader. The status of Islamic bank in relation to its clients is that of partners. It involves financing through equity.. Since income from the advances is fixed. The search is actually still going on to find newer techniques. and for variations based upon the existing ones to offer more attractive and useful instruments for the investors. Dubai Campus Compounding or Interest on interest Money-Market Borrowing Developing expertise Viability v/s creditworthiness Relationship with Clients Capital Guarantee Deposit insurance the Islamic banks to collect and distribute Zakat. The Islamic Financial Institution may either put up all the funds itself and undertake responsibility for investing in them. the Islamic Financial Institution¶s reward is a fixed percentage in the balance of the revenue generated by the investments and the remainder goes to the investors. no one is entitled to any addition to the principal sum if he does not share in the risks involved. Limited Partnership to generate a profit. it gives little importance to developing expertise in project appraisal and evaluations. losses are wholly suffered by the Rub-ul-Maal. the managing trustee (Mudarib) and the beneficial owner (Rub-ul-Maal). on the other hand. is that of creditor and debtors. Although profits are shared on a pre-agreed basis. Musharaka (Equity Financing): It is quite similar to the Mudarabah contract. The Islamic banks have no provision to charge any extra money from the defaulters. give greater emphasis on the viability of the projects. Built into the system. though.e. and the Islamic Banks are the managing partner (mudarib).

the agent acts as a working partner who does not bear any losses and simply manages the fund (the project in which the fund is invested). and cannot include any charges for deferment. The most common such financial instrument is the 'mark-up' structure called Murabaha. If the capital markets are perfect and all agents in the economy have equal access to information. Both the quality and quantity of the sold products are definitely specified in the contract. Thus. the buyer pays the entire amount in cash. In a Murabaha transaction. Baisalam or Bai¶ Salaf (Purchase with deferred delivery): It is a short-term commodity finance contract in which the buyer (usually of agricultural or manufactured products) pays the seller full negotiated price of a product that is promised for delivery at a later date. It is deemed acceptable to charge higher prices for deferred payments. The 'cost-plus' nature of Murabaha sounds very much like the interest into capital gains manipulations of tax-avoiders. This is like as a Murabaha mode of investment with an exception that the sale under this cost-plus sale mode of investment is made on a credit basis rather than cash. XLRI. The instrument has been used increasingly in a range of asset classes including ships. From the perspective of modern finance. whereas in Musharaka. It sounds quite similar to a "repo" agreement commonly used in the West. Murabaha (Cost-plus financing): This technique is extensively used to facilitate trade financing activities of Islamic Financial Institutions. The Mudaraba and Musharaka transactions are often seen on the retail liability side of Islamic banks. a Murabaha facility is equivalent to an asset-backed risky loan.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). The lessee agrees to make payments into an Islamic investment account (with right to all profits) to be used in or towards financing the ultimate purchase of the asset. etc. The financier purchases the asset and leases it to the end-user for an agreed rental which may be fixed in advance or subject to occasional review by a mutually acceptable third party. Islamic banks are supposed to take a genuine commercial risk between the purchase of the asset from the seller and the sale of the asset to the person requiring the goods. Ijara (Operating Lease): It involves leasing of machinery. Ijara wa iqtina (Financial Lease): This is a leasing structure coupled with a right available to the lessee to purchase the asset at the end of the lease period (Bay¶ al Wafa). equipment. Such transactions are regarded as trades and not loans. aircrafts. buildings and other capital assets.g. e. It has similarities with the forward contracts of conventional financial systems except that in Islamic instruments the rate of return is tied to each transaction rather than to a time dimension. then competition between Islamic banks and conventional banks would result in Murabahah having the same expected return as that of conventional loans. Insuring of the asset remains a contentious issue. Baimuajjal (Deferred Payment Sales): The payments for this sale could be either in installments or a one-off deferred payment as per agreement between the parties at the time of the sale. Another difference lies in the fact that in Salam. the bank finances the purchase of an asset by buying it on behalf of its client. telecom equipment and power station turbines. an international firm of accountants. There is thus some form of guarantee with respect to the quality of the goods provided by the bank to the end user in the strict form of Murabaha. Dubai Campus ratio which is likely to be higher than what he is likely to get in a Mudaraba contract. Title to the goods financed may pass to the bank's client at the outset or on deferred payment. The bank stands in between the buyer and the supplier and is liable if anything goes wrong. in Mudaraba. all the parties are shareholders in the venture. at the time of contract. The asset side whether retail or wholesale is quite risky. The counter-party risk in Al Salam is one-sided as it lies with the buyer alone Submitted by: Shakeel Ahmad Page 18 of 74 . The bank then adds a "mark-up" in its sale price to its client who pays for it on a deferred basis.

XLRI. Savings accounts also are quite similar except for the absence of interest payments. Difference of opinion exists on whether the subject of Bai Salam transaction should be available in the market at the time of the contract or whether it is enough that the asset will be available at the date set in the contract for delivery. Losses are not. passed on to depositors and are absorbed through the banks' reserves. No return is paid to depositors. This involves the bank paying for the producer's goods at a discount before they have been delivered or even made. Since full Submitted by: Shakeel Ahmad Page 19 of 74 . The bank is the Mudarib on its liability side with respect to the depositors. Here the bank is the Rabbulmal with respect to the end users of the funds. depending on their own profitability. There are considerable variations on the Mudaraba principle. in practice. The profit-sharing ratio varies between institutions and could be a function of the bank's profitability or that of the portfolio of end borrowers. can be seen on the minimum time period between the date of contract and delivery of assets. There may or may not be a service charge incurred. PLS Special Notice Deposit Accounts. A common thread is the short-term liquid nature of the deposits. Under such a scenario the bank acts as a principal. savings. The bank may also act in an off-balance sheet capacity as a feeearning agent on behalf of the fund providers and/or fund seekers or as a traditional fund manager investing in a diversified portfolio of Musharaka contracts. The party on the purchase side of the contract may sell the asset back to the party on the sale side of the contract or to a third party for a profit. In practice there is only profit sharing and no loss sharing for retail investors. Alwadiah: It is equivalent of the current account of the conventional banks. Banks may sometimes pay the savers a return. The stipulation of full cash prepayment in Al Salam contracts is meant to facilitate working capital finance wherein the party on the buyer side is the IBF institution. Dubai Campus (the IBF) unlike the forward contracts in which it affects both parties.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). it is expected that this risk will be priced one way unless a security is provided by the seller. Most banks have no charges for such accounts. Even there almost all the deposits are under two years in maturity. and use the Mudaraba format. The bank uses the funds on the Mudaraba or Musharaka basis or any other Islamically approved basis with clients in search of funding. Term Deposits: They are considered as investment accounts. Hence. whilst in Egypt there is a quarterly distribution. The Islamic Bank of Bangladesh has been offering Profit and Loss sharing (PLS) Deposit Accounts. and provide facilities similar to any conventional bank. Retail Islamic Banking Products: At a retail level. Profits are declared and distributed monthly in Malaysia. In Bangladesh and Pakistan distributions tend to be half-yearly. Long-term mortgage-type finance hardly exists. and used for day to day cash management. Bank Islam Malaysia provides wholesale and retail investment accounts both on the PLS principle. The purchaser/ financier may also sell the assets by way of a parallel Bai Salam contract (a salam contract with a third party) to hedge the asset-risk or for profit. Islamic banks provide current. Difference of opinion also Box-1: Islamic Financial Instruments Islamic Bank as an intermediary for Mudaraba or Musharaka: Islamic bank depositors act as Rabbulmals and place funds with the bank. and investment accounts. The frequency of payment is another variable. and PLS Term Deposit accounts. The longest-term deposits are being raised in Malaysia. The lower risk means a lower profit share. Deposits are fixed term and cannot be cashed in before maturity. Alwadiah structures are also used for higher return savings account.

Dubai Campus prepayment is involved. full price for the asset must be paid at the outset. It is similar to a Murabaha contract. Khiyar al-shart: This is a sale contract concluded at the time of signing the agreement. A may choose to rescind the contract and instead sell the stock in the market. It is also similar to conventional work-in-progress financing of capital projects like construction. is a mark-up sale in which payments are delayed and made in equal installments. whereas in Istisna. payment structure and the date of delivery are fixed in advance. Arbun or Urboun (Pre-purchase of right to acquire asset): The purchaser makes a deposit (a down-payment. XLRI. payment in full or in installments may be made at any agreed upon time (even beyond delivery date). The similarity of the exercise features of this contract with the conventional Put Option invites some controversy. Because of its similarity to an option. the seller ( Al Sani¶). Submitted by: Shakeel Ahmad Page 20 of 74 . etc. and are getting ready to compete with their conventional counterparts. in the contract of BBA the bank sells the product (a house. payment by installments within a pre-agreed period. An important feature of Al salam contract is the underlying asset which must be standardizable. whose content consists of the cost price plus a profit margin The client may be allowed to settle . today. of determinate quality and easy to be quantified. or as a lump sum. which may be a fraction of the price) for the purchase of an asset at a later date on the understanding that. most popular being the Mudarabah contract modified to suit the technicalities. al-sani¶ may either provide the raw material or labour. A lot of work will be required to mould the instrument so as to remove any possibility of speculation ensuring total acceptability. Syndication: Islamic Financial Institutions are increasingly prepared to participate in large project financing. Party A has the right to either confirm or rescind the contract by a certain time in the future (let¶s term it as ³maturity´). undertakes to manufacture or have manufactured/ acquired the subject item (Al Masnoo¶) as per purchaser¶s specifications. Similarity with Bai Salam contract: Sale of a product not available at the time of the deal. The syndication works on the techniques discussed above. Similarity with Ijarah: In Istisna. equipment or machinery. but with payment on a deferred basis. Theoretically. Difference with Bai Salam contract: In Bai Salam. the price paid is lower than the future spot price of the goods in question unlike the futures or forward price which is always higher than the spot price.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). if the purchaser chooses not to proceed). party A enters into a contract with party B to sell a given quantity of equity stock on an agreed price. Al Bay Bithaman Ajil: BBA. If Pmaturity > Pcontract. In parallel Istisna. popular in Malaysia.) to the customer at a mark-up price. based upon an order from purchaser (Al Mustasni¶). and the proceeds to be utilised for the Customer¶s working capital. the Al-Sani¶ may enter into a second Istisna¶ contract (subcontract) with a third party to manufacture the subject item unless Al Mustasni¶ (ultimate purchaser) has stipulated in the contarct specifically for Al Sani¶ to manufacture himself. The BBA facility can also be utilised for refinancing of assets owned by the Customer. In this contract. it has met with varying levels of approval from the schools of Islamic jurisprudence. the seller will be permitted to retain the deposit. It is also used for trade finance such as pre-shipment export finance. Istisna and Parallel Istisna: It involves a deferred delivery sale contract similar to salam. but where one of the two parties to the contract has a right to cancel the sale within a stipulated time. The price. Cancellation is not contingent upon any uncertain future event. The labour part is the similarity with Ijarah. should the sale of the assets not proceed (say. For example.

These could be encashed by the seller at the bank at a discount.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). and trust services. to the loan amount or its maturity. It could be argued that Murabaha could involve interest if the parties seek to match the interest free but guaranteed return product with an interest-bearing equivalent. Gifts: Gifts to depositors are given entirely at the discretion of the Islamic banks on the basis of the minimum balance. It is argued that as derivatives "unquestionably" involve interest or interest-based products they are contaminated and should be prohibited. Islamic Derivative Products : Salam (Bai Al Salam). This seems very similar in structure to Baisalam. but this fee cannot be related. since this is taken for granted. They are used in cases where PLS modes cannot be implemented. It is simply a financial instrument that is derived from another financial instrument or a combination of such instruments. These gifts may be monetary or non-monetary are based on the banks¶ returns. The banks are permitted to offer bonuses and prizes on these deposits very similar to the UK¶s premium bonds. The requirements of derivatives and rules of Shariah at first sight are diametrically opposed and all derivatives are therefore Haram. It is generally assumed that the term "Islamic Derivatives" is a contradiction. Transaction charges are waived and interest is not paid on current accounts. The literature contains hardly any serious criticism of the interest-free character of the operation. Prizes and bonuses: Iran and Pakistan have both attempted to fully Islamise the entire banking. XLRI. Islamic banking derivatives should be perfectly acceptable so long as they do not involve interest. using Sharia-compatible building blocks (existing and extensively used instruments). fund placements. In Iran banks accept current and savings deposits without paying any return. Dr. Iran converted to Islamic banking in August l983 with a three-year transition period. Well. by any means. This mode usually applies to transactions such as consultations and professional services. But it is important to recall the generalised definition we use of a financial derivative. An International Monetary Fund (IMF) study by Iqbal Submitted by: Shakeel Ahmad Page 21 of 74 .g. There is a near-consensus that Islamic banks can function well without interest. derivatives only involve interest if one or both parties using the derivative seek to hedge the derivative.. Kenneth Baldwin has suggested some Profit Rate Swaps that replicate the risk management capability of conventional interest rate swaps. Dubai Campus Jo¶alah: A party undertakes to pay another party a specified amount of money as a fee for rendering a specified service in accordance with the terms of the contract stipulated between the two parties. Qard Al Hasnah (Beneficence Loans): Zero return loans that Islam edicts for Muslims to make to the needy. Non PLS Modes: Non-Profit-and-Loss Sharing Modes. in cases of small-scale borrowers or for consumption loans. e. This is apparently not regarded as gambling by the Iranian Islamic banking units. No fee accounts: There is a substantial Muslim population in South Africa and they are serviced by two small Islamic banks. Urboun (Arbun) and Khiyar alshart are the existing derivative products approved by some schools of Islamic jurisprudence. Certificates of sale: It has been suggested that consumers buying consumables on credit would issue 'certificates of sale' similar to letters of credit. Banks can only charge the borrowers a one-off service fee to cover the administrative expenses. although concerns have been expressed about the lack of adequate interest-free instruments. The main product being offered is the "no fee" current account which is also provided by the conventional banks by arrangement.

This is further expected to ensure greater prudence and responsibility. which does not help relieve the pressure much. Interest distribution is considered unjust and inequitable because it is not based on any productive use of capital. This may make credit rating agencies redundant. Generation of employment: Productive use of capital implies investments and creation of jobs. there will be no need for deposits to be insured. Siddiqui (1983)] Similarly. IBFs would promote economic growth [Chapra (1998). Reduction in run-on-deposits: Banks using profit and loss sharing (PLS) to mobilize resources are less likely to face a sudden run on their deposits. the Islamic financing institutions could play an important role in promoting socially desirable investment and corporate behavior. as is the conventional practice. Thus. it is worth mentioning that Islamic financing institutions are subject to Shariah (Islamic Law) regulations in addition to conforming to the conventional regulatory standards. both the fund providers and the financial intermediary contribute to promoting productive economic activities and greater financial responsibility. Productive use of capital: Banks are likely to know their fund users better in order to ensure that the funds are used for productive purposes. XLRI. Higher profits: Account holders under Islamic finance could expect higher profit from their investment as Islamic banks are required to share the entire net profit according to the agreed formula rather than just a portion of the profit. Reduction of debt burden: The IBF system of equity financing encourages debt to be swapped with equity which can help many developing countries get rid of the immense debt-burden. Saving in information costs: Being a partner of the entrepreneur (or a firm). Advantages of Islamic Finance :   Efficient allocation of funds: Since allocation of funds by banks will be dependent upon the soundness of projects under the PLS arrangements. More stable economic environment: The perspective of investments is long-term in comparison to short-term expectations of returns in conventional financial system ± this may result in a more stable economic environment less dependent on business cycles. The investment is not dependent upon the cost of capital (and positive NPVs) or time value of money. converting debt to equity promises a much more fruitful alternative. Dubai Campus and Mirakhor (l987) found Islamic banking to be a viable proposition that can result in efficient resource allocation. and lending more efficient. Promoting Ethical behaviour: Because of its strong emphasis on the ethical and moral dimensions of doing the business and selecting the activities/ commodities to be financed. In this way. Saving in deposit insurance costs: Risk-sharing concept built into the IBF system. In this context. the financial institution has easier and cheaper access to information on matters relating to the firm. Instead of rescheduling of existing loans or selling Brady bonds at heavy discounts. and it exploits the misfortune of the borrower (who has run out of money). since banks have no pressure of fixed regular payments on deposits. and creates additional wealth as well. the allocation is more efficient. Page 22 of 74           Submitted by: Shakeel Ahmad . Equitable distribution of wealth: The efficiency in allocation leads to this. the efficiency of allocating resources to profitable and more productive use is further boosted.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). hence number of investible projects is likely to be much higher resulting in larger capital formation.

Reduction in unproductive use of borrowings: By eliminating unnecessary and excessive borrowing (borrowing beyond productive use). Abu Dhabi power project signs $1. in Dubai recently. as lending is directly related to project appraisals and feasibility. The transaction involves the purchase of machines and engineering equipment by DIB and ABC and leased under Sharia principles to General Electric." Mr Smith said. debt instruments that may be created through selling goods and services on credit are not readily tradable. as over or under-supply of money with respect of supply of goods is not allowed (money directly linked to supply of goods in the economy). risk to lenders is reduced under PLS. Mr Smith added that the partnership transaction was made possible through cooperation between investment professionals at DIB and ABC Islamic Asset Management. Sumitomo. has signed a leasing transaction agreement with the AAA-rated General Electric of the USA. If General Electric is prepared to go the Islamic financing route. Automatic Shock-absorption: For banks involved in the equity-based system. XLRI. This makes the real values of assets and liabilities of banks equal at all times.8-billion loan facility was signed here yesterday for the expansion of Abu Dhabi's fourth independent power and water project in what was described as "the largest project financing ever" in the capital of the United Arab Emirates. Islamic banks and financial institutions are inherently prevented from carrying out such activities. More often than not. preventing banking crises.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). whose understanding of complex structures. HSBC. Islam being the fastest growing religion in the world further enhances the potential marketability of IBF instruments.A $1. Reduction of inflationary pressures: Under Islamic economics the inflationary pressures would be reduced to a great extent. "We intend to source more deals with investment grade companies from around the world. then it's hard to see how similar multinationals will not avail themselves of this excellent financing facility in the future. Dubai Islamic Bank (DIB). Mitsui Banking Corporation and National Bank of Abu Dhabi. DIB's Executive Vice-President for Investment Banking said. Khan (1986) argues that the shocks to asset positions are immediately absorbed by changes in the values of shares held by depositors in the bank.8b loan deal Khaleej Times: 3 July 2003 ABU DHABI . facilitated smooth cross-border dealings of significance in the development of investments in the Islamic financial industry. Submitted by: Shakeel Ahmad Page 23 of 74 Lead arrangers of the conventional loan include Gulf International Bank. "This is a landmark deal. in partnersh ip with ABC Islamic Asset Management of London. Guaranteed market of practicing Muslims. while Abu Dhabi Islamic Bank lead arranged a $250-million Islamic tranche. .In a landmark deal for Islamic finance. although liquidity will remain with secondary market trading allowed in stocks or investment certificates. such transactions are sources of instabilities. "We pay special attention to the elimination of risk by means of watertight structures that provide protection against residual risk during the term of the lease. and Tokyo Electric Power Company (Tepco). This will give the Islamic industry a tremendous boost. legal and other matters. ABC Islamic Asset Management's CEO." Mr Kooheji concluded the signing with Mr Duncan Smith. signed the facility with a consortium of local and international banks to finance the Umm Al Nar project. This greatly eliminates the possibility of sudden mass movement of funds from one country to another. Project developers International Power of Britain and Japan's Mitsui and Co. Nienhaus (1986) agrees with the argument. As a result destabilizing speculations would be significantly curtailed in financial markets. Dubai Campus  Less likelihood of flight of capital: Under Islamic finance. In contrast. particularly Sharia compliance.      Box-2: Landmark Islamic finance deal inked Khaleej Times: 03 July 2003 DUBAI ." Mr Aref Kooheji. Reduction in speculative transactions: Examination of daily records of trading in financial markets vividly shows that institutional participants carry out huge speculative transactions.

the possibility of exploitative contracts cannot be eliminated. Of course. as is the conventional practice.  Determination of mechanism for profit sharing in the short-term is difficult in a PLS system based on returns only from productive deployment of funds. agreements between counterparties. IBF proponents do not agree. accounting. as an opportunity for equitable sharing of wealth earned from productive activities could be enough stimulant for investors. (6) Political Impediments. its offering. and (7) Religious Impediments. as the account put forward by the borrower (entrepreneur) may not be convincing enough for the banks or other investor partners. In the absence of a standard mechanism for profit/ loss sharing (both for short-term as well as long-term).Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).        Impediments to the growth of IBF: The impediments are being discussed in this paper after grouping them in seven broad categories: (1) Social Impediments. A risk sharing proposition of IFBs and resulting absence of deposit insurance system leaves small investors in the risky avenues. Technological Impediments. Dubai Campus Perceived Disadvantages of IBFs :  With PLS. acquiring skills in all of them may be immensely costly. (5) Institutional Impediments. thus curtailing economic growth affecting employment (Pryor-1985). (4) Structural Impediments. XLRI. o Monitoring costs resulting from the need to prevent mishandling of the venture and fraudulent means (including creative accounting) adopted by borrowers/ partners are in addition to those involved in conventional financial system. sometimes. The role of an investment bank brings in added costs: o Search cost resulting from the need to decide on the most profitable ventures. Curtailing speculative activities in the secondary market would be extremely difficult resulting in the same risks and costs that the conventional financial systems carry. Eliminating interest may reduce the propensity to save (with banks) or invest (considering the risk associated with returns). (2) Economic Impediments. functioning of the IBF system. Dispute settlement mechanism adds to the cost further. o Managing costs incurred because of its obligation as a partner in the PLS deals. particularly when the Islamic financial institution carries fraudulent intentions. With an Islamic bank required to finance so many different kinds of businesses. generation of wealth and its distribution. to being an investing partner. etc need to be Sharia compliant which needs certification by the Sharia Boards resulting in additional cost burden over the IBF Operators. earning profits from the margin between lending and borrowing. the role of the bank undergoes a change from being an intermediary trader of money. Submitted by: Shakeel Ahmad Page 24 of 74 . The mark-up system of most of the non-PLS schemes resembles the interest-based system to the extent of becoming indistinguishable. and provides unscrupulous financiers opportunity to replicate the conventional system. Additional cost of supervision by the Sharia Board: Product development. Fixed return of the conventional system has no such costs. (3) Financial Impediments. Account holders under Islamic finance could expect higher profit from their investment as Islamic banks are required to share the entire net profit according to the agreed formula rather than just a portion of the profit.

1..94 0.47 0. (ii) knowledge.61 HDI Score HDI Rank 200 180 160 140 0. also in terms of IBF) the maximum effort has been made by Bahrain after Malaysia (Countries with 100% Islamic Financial system in place. Even in the field of IBF. These are: (i) longevity measured by life expectancy at birth.94 0. i.94 0.50 0. and sustainability of growth and the challenges Submitted by: Shakeel Ahmad Page 25 of 74 .30 0. However.90 0.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).50 0. Dubai Campus 1. The Human Developed Index (HDI) available with the Human Development Report brought out by United Nations Development Programme (UNDP) is a composite index that measures achievements of a country in three basic parameters of human development (HDR 2003). and (iii) standard of living. the Human Resources.70 0.60 0.29 120 100 80 60 40 20 0 Fig-7: Human Development Index Scores (left scale) and ranks (right scales) Source: Human Development Report2003 brought out by United Nations Development Programme (UNDP) Accumulation of human capital is an indicator of endogenous growth and is often used in empirical growth models.94 0.80 0. XLRI. having a look (Figure-7) at the HDI of member nations of Organization of Islamic Countries (OIC).40 0. is Brunei with a rank of 31.50 0.82 0. i. The initial successes may remain at superficial levels.74 0. It is worthwhile. Iran was placed at 106.73 0.94 0. Sudan at 138 and Pakistan had a rank of 144 in HDR of 2003).87 0. in comparison with some of the world leaders (promoters of Conventional banking & financial system).82 0. measured by a combination of the adult literacy rate and the combined primary. The development in the area is not likely to bear much fruit unless the promoter countries of IBF take giant steps towards developing their most important infrastructure element. both of them with so small a population that their impact on the development of as important a system as IBF is not expected to be large.46 0.70 0. secondary. the second highest being Bahrain at 37. The highest ranked country among the Islamic countries.20 0.65 0. it is the level of human development in the promoter nations that will ultimately steer the IBF into a competitive arena.46 0. measured by GDP per capita.88 0.94 0. in terms of developing a financial market (and related systems. this variable turns out with a positive coefficient (Barro.76 0.68 0.00 0. Social Impediments: Humans are undoubtedly the most important resource endowment for any country. in terms of HDI.43 0. and tertiary gross enrolment ratio.89 0.73 0.10 Norway Sweden Australia Belgium USA Canada UK Hong Singapore Brunei Bahrain Qatar Kuwait UAE Malaysia Saudi Oman Lebanon Jordan Tunisia Albania Turkey Palestine Iran Algeria Indonesia Egypt Morocco Sudan Banglade Pakistan Yemen Gambia Nigeria Djibouti Mauritani Senegal Guinea Niger 0.83 0.e.84 0.46 0.e. In most regressions.50 0.75 0.93 0. having some kind of IBF (as they are the promoters of IBF).74 0.00 0. 1991). Their development is the key to the competitiveness of any nation in any sphere.74 0.79 0.43 0. then.72 0.77 0.45 0.

all the countries in the OIC sample lag behind the world leaders. (b) Educational Impediments: Education is the backbone of any development. particularly in the wake of 11th September. and act as a major source of impediment. when the Islamic society ultimately lost its primacy to the Western world because of their consistent multi-dimensional development activities. and is one of the most important reasons behind the lost glory of the Islamic society. Saudi Arabia¶s figure is encouraging as it leads the sample in this respect (except Yemen. Education Index (left scale) and Public Expenditure on education (right scale) for selected countries Source: Human Development Report 2003 from United Nations Development Programme (UNDP) Submitted by: Shakeel Ahmad Page 26 of 74 Adult Literacy Education Index Public Expenditure 12% 10% 8% 6% 4% 2% 0% . Islamic Financial Institutions as part of this society have a strong barrier to scale. XLRI. is not easy. (a) Societal Impediments: The basic societal fabric builds the psyche of the masses. At the moment. it seems the members of the Islamic society also lost the motivation to win back. The absence of Islamic Banking and Finance from the horizon. figure-8 provides the status of education in the Islamic World represented here by countries of the Organization of Islamic Countries (OIC) Countries that have IBFs in comparison with some of the world leaders. However.5% during 1998-2000 (data refers to the year during this period for which it was available) which shows its recent commitment towards educating its citizen. In terms of Adult literacy and Education Index (a measure that provides a composite indicator of the level of education). is pointer enough towards lack of education and research. may detract non-Muslims even further away from anything Islamic. it poses a significant impediment to the growth of IBF. Coming out of this box. Dubai Campus posed to the conventional financial system may remain feeble otherwise. 120% 100% 80% 60% 40% 20% 0% Sweden Canada Australia Norway Belgium UK Singapore USA Kuwait Brunei UAE Bahrain Lebanon Malaysia Tunisia Oman Saudi Arabia Qatar Jordan Turkey Iran Algeria Egypt Morocco Bangladesh Pakistan Yemen Gambia Senegal Mauritania Nigeria Guinea Djibouti Niger Fig-8: Adult Literacy. and along with its parent society has a backlog of many generations to clear.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). This has had a lasting impact on the society in all spheres that are cited next. In terms of Public Expenditure on education reported as percentage of respective GDPs. whose ratio could be misleading as the GDP figure is too small) but also increased from 6. then.5% in 1990 to 9. But the scenario in all other countries even in this respect is no different from what is projected by the Adult literacy or the Education Index. for centuries. After initial leadership over a long period. Social alienation.

from fundamentalist organizations is keeping a check on declaring innovations that they could launch otherwise.5 368.6 0.8 4.5 9.0 100.9 147.0 400.0 2.7 54. based on combined enrollment.4 34.4 800.8 20. This tantamounts to a paradigm shift that is not easy to happen in a short period and it requires a lot of concerted effort on all fronts.0 600. The full list of 174 countries had 31% OIC members (54 numbers).5 166.3 114.8 186.6 4. The GDP of all the sample Islamic countries put together was less than 17% of the GDP of 694. among the OIC countries.6 69.5 12. whereas the lower half of the ranks.7 41.1 4. Dubai Campus The enrolment into educational institutions provides indication towards the future of education in a country. Only exponential growth in enrollments. 2.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). More than sixty-one percent (61%) OIC members fell in the lower half.7 16. Looking at the GDP of the IBF promoter countries (our sample of OIC having some type of IBF) vis-à-vis rest of the world provides some clue as to why it may be difficult to promote the IBF in the era of opening economy where they have to compete with the world players too. secondary and tertiary gross enrolment ratio.7 Canada Australia Belgium Sweden Saudi Arabia orway ong ong Turkey Indonesia Iran gypt alaysia Singapore AE Pakistan Algeria Bangladesh igeria orocco uwait Tunisia Oman Lebanon atar Sudan emen Jordan Bahrain Brunei Senegal Albania Palestine Guinea iger auritania D ibouti Gambia 229.8 16.0 19.0 200. in general. and for Brunei GDP data for 2000 from HDR 2002 has been used. Economic Impediments: Size of the economy is an important indicator of the kind of flow passing through the banking and financial channels that the IBF have to chase. The second quartile of ranks had twenty (20) OIC members while the third quartile had seventeen (17) and the last one had sixteen (16) of them.0 700. had 45% of them. psychological pressure on the Islamic institutions. can provide some hope of catching up with rest of the world.3 8.0 0. (c) Psychological Impediments: Psychological mindset needs to change for those who have been using the conventional banks and FIs as well as those for those who have been abstaining from them due to their anti-usurious beliefs.1 161. On the other hand. only Guyana with 91% enrolment (although its overall HDI rank is a poor 92) was part of the top quartile of Combined primary. we find that. Source: Human Development Report 2003 from United Nations Development Programme (UNDP) For UAE: Central Bank (UAE) Data. This presents a gloomy picture not only for the present but has repercussions for the foreseeable future.0 1. Considering that home banking and financial institutions have a clear advantage over foreign institutions.0 500.5 88.1 98.7 145. GDP should be a good indicator for development of these institutions. Submitted by: Shakeel Ahmad Page 27 of 74 a W S ` Y U W S X W V U T S b .9 4.0 3.0 85.0 300.7 46. From the data available in the Human Development Report 2003 (HDR 2003) for 175 countries.8 7.6 209. now. compared with thirty-three percent (33%) of non-OIC members.2 32. during the year 2000-01 compared with thirty (30) non-OIC members.0 Fig-9: ominal GDP (2001) of representative Islamic countries compared with some leaders excluding the top 7. XLRI.1 58.0 0.

debt issues become illiquid and costly. Since acquisition of technology is capital-intensive. bank finance is mostly suitable for Working Capital financing rather than Capital Expenditure funding that is required for Technology-intensive ventures. Some efforts in the direction of establishing technology parks and business incubators have started in some countries. The chart (Figure therefore -9) excludes USA. XLRI. by 170 nations included in the HDR 2003) so that the remaining figures could be comparable. e. Germany. At the same time. capital markets have proven to be the most successful and feasible means of financing. Financial Impediments: a. When we add Japanese GDP to the GDP of USA. Japan. technology. c. it acts as a deterrence to technology intensive ventures. A Silicon Valley type network of alliances is required which is largely absent in the OIC. There is no scope of long term debt financing and with bank financing catering to short term or medium term finance. high capital endeavors as well as any expansion of such projects. Lack of Money Market: It is another major impediment leaving the market not just illiquid and costlier. Universities. b. What influence an economy like USA or Japan can have on the prosperity of a financial system can be seen from this fact. Although the system has started in some countries like Submitted by: Shakeel Ahmad Page 28 of 74 . France. capital and know-how to leverage entrepreneurial talent. it is almost an impossible source for the start-ups. but also leaves the government devoid of financing its expenses through a cheaper and liquid medium. the sample Islamic countries do not reach even 12%. etc. VCF needs institutional support in terms of an active network of financiers.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). As a result. Lack of an active secondary market: Secondary markets are in the process of evolving and it will take time before they could really provide this market with the required liquidity. f. d. whereas bank borrowings seldom indulge in 100% financing or long-term financing. but the reality is surprisingly different. a strong need therefore is for the association of countries like the GCC or ASEAN to pool their resources. Dubai Campus USA. but they have a long way to go. upgrade or produce technology to sell as a product. Lack of Business incubators: Incubators connect talent. they become a benchmark for the health of the whole financial system. Lack of active debt market: The absence of secondary debt market in UAE is also a serious handicap for the investing community. Secondary markets do not just become meeting points between the investors and the corporates. China and Italy the top seven nations (constituting of 68. UK. An absence of active capital market hinders technology intensive. Supportive Institutions for Venture Capital Financing: The strongest form of Islamic financing being the PLS forms of Mudarabah and Musharakah. For individual small economies it may take a lot of time to achieve the critical mass. accelerate the development of new knowledge-based businesses and thus speed up the commercialization of new knowledge and technology. Lack of active capital market: Equity is an excellent source of capital and organizations are likely to exhaust this source before exploring other means when planning to acquire. the payback period for which is usually long. technology promoting institutions like Private and Government R&D laboratories. entrepreneurs. the world being represented. 3. Stock Exchanges and regulatory framework. Venture Capital financing (VCF) should have been the strongest in the countries that promote the IBFs.75% of World GDP. here.

120 6. 4.000 6.000.000 0 Fig-10a: Customer Deposits of BIMB (Source: Annual Reports) Fig-10b: Customer Finance of BIMB (Source: Annual Reports) y The mark-up system of most of the non-PLS schemes resembles the interest-based system. is an impediment to the growth of IBF system. Structural Impediments: y Financial Engineering: The structuring of any new system that can pose real competition to an existing well-established system requires not just a robust structure to start with but a structure that supports innovation and continual improvement. namely PLS (stronger Islamic system) and the mark-up type systems (weaker Islamic system). in the Islamic countries. y Maturity mismatch: It can be seen from the maturity structure for the Bank Islam Malaysia Berhard (BIMB) that the maturities on the deposit side (Figure-11a) are totally Submitted by: Shakeel Ahmad Page 29 of 74 .057.925 7.000 7. Dubai Campus UAE. Hence a lack of this system. if the stronger Islamic instruments based on PLS principles were dominant. There is a strong relationship between the financial institutions and the business incubators.000. and choose stronger Islamic products) whereas the banks are more risk averse and prefer to indulge in Mark-up type financing.000.981.000.000 4.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).000. as can be seen from Fig-10b.000.000 10. XLRI. The penetration would have been much faster had these doubts been cleared.036. As discussed above. Financial Engineering is an integral part of the financial service provider so that innovative products can be offered regularly to keep the depositors/ investors interest in the system alive.000 2.000.000 1. the IBF system could attract more investors to its fold. more so because of the need to differentiate itself from the conventional products.364 2001 Non-Mudharabah Fund 3.000 2.000. all products except those based on Mudaraba and Musharaka principles leave doubts in the minds of people who want Shariacompliant products. The current scenario can be judged from the proportion of funds based on the two types of systems. For a relative newcomer. Business incubators cannot grow without financial support and growth in the sector means a growth in demand for the financial sector.071 Financial Engineering acquires all the more importance. with variants far less in number and the scope limited by restrictions by Sharia.468 5. The Bahrain market¶s position is even more tilted towards the non-PLS schemes for deposits. 8.012 PLStype M ark-up type y 12.000.000 8.000 2.845 210.000.000 7.732 2002 Mudharabah Fund 3. It is obvious from Fig-10a that the depositors¶ preference is for PLS type deposits (ready to take larger risk.000 6. Currently.000 0 2001 2002 185. it will take time in shaping up to a stage where it could be of real use.000. Lack of Islamic credentials of the product: The products based on Sharia Committee of banks do not necessarily satisfy the psyche of the masses unless backed by religious edicts and logical reasoning.000 4.000.220.

The Finance by IBFs are mostly backed by tangible assets whose market value may not be constant over time. Dubai Campus different from the maturities of the financing side (Figure-11b). This creates problems in the cash-flow matching. This may be as a result of other impediments under discussion. 1% Due within 6 months 6 months to 1 year 82% More than 1 Year 10% 1% Due within 6 months 6 months to 1 year M ore than 1 Year 89% 17% Fig-11a: Maturity structure of Negotiable Islamic Debt Certificates and Mudharabah Fund for BIMB Source: Anuual Report 2002 37% 33% 41% 33% 14% 16% 16% 10% Maturing w ithin one year Three years to five years One year to three years Over five years Maturing w ithin one year Three years to five years One year to three years Over five years Fig-11b: Maturity structure of Customer Financing for Bank Islam Malaysia Berhard (BIMB) Source: Anuual Report 2002 y Unclear product proposition or processes: Competing with the conventional counterpart in marketing abilities is not easy for a relatively new entrant like IBF.. as do the conventional loans. the Salam or Bai Salaf contracts expose them to commodity risk in addition to the credit risk. Even the operational mode is more complex than the Conventional Debt financing.g. This volatility is in addition to the normal depreciation of assets. Even no-PLS modes have unique risks.g. The situation of other IBFs in the world is not much different in terms of maturity-mismatch. In fact. PLS modes of financing are not ted to collaterals. PLS modes have in-built risk component wherein the financier has to share the risk of failure (loss) along with the entrepreneur (the borrower). Additional risks: The PLS mode has its inherent risks similar to those of Venture Capital Financing or those faced by Equity financiers rather than the Debt financiers. feasibility and profitability studies of ventures being financed and their continuous monitoring and audit. e. Another example is that of the Displaced Commercial Risk which endangers the y Submitted by: Shakeel Ahmad Page 30 of 74 . Basel Committee¶s recommendation for Capital Adequacy does not incorporate this volatility.. Deposits with maturity of more than one year being less than 1% is a clear sign of lack of investors¶ confidence in the system. XLRI. calculation of the share in profit and loss. Similarly. too.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Further. Lack of skills that help in the matter is currently an impediment that can be removed only through learning which is path-dependent and will take time to set in. the Ijara contracts differ from conventional lease contracts in that the leased assets have to be carried on the Balance Sheet of the Bank which limits the transferability of substantial risks and rewards to the lessee. e.

Conventional financiers as well as the investors can use derivative instruments to hedge various types of risks to a great extent which is largely absent in IBF System. Dubai Campus competitiveness of IBFs in the long run. but to bridge the huge gap with respect to the competitors in the conventional sector. in the absence of which the growth may be lumpy in nature. For weaker institutions. dependence on the Submitted by: Shakeel Ahmad Page 31 of 74 . Bahrain and Jordan. even after twenty eight years of the modern Islamic Banking and Finance experience. Mutual cooperation in the networks helps pooling of resources and optimizing their exploitation to gain competitive advantage. Lack of liquidity itself poses a major risk. and smaller size of IBFs. Sudan and Iran) that have converted their banking system to 100% Islamic. It is the pressure on the IBFs to pay higher returns than that it is obliged to (as per agreed terms) in order to make its returns more lucrative than the market returns. In other countries. The need for Sharia Compliance makes the task even more difficult. All the IBF fund put together does not match the funds with Multinational banks like HSBC or Citibank. the AAOIFI¶s standards are mandatory only in Sudan. both for the borrower as well as for the lender. even after twelve years of existence. in general. Size carries the power in the market. Zaher and Hassan (2001) provide a comparative study on the salient features of Islamic Banking Supervisory Systems in 15 countries. (b) Lack of acceptance of existing Regulatory bodies: For example. 5. (d) Absence of Islamic Central banks except in three countries (Pakistan. compared to the Conventional ones. XLRI. What is seen today in the IBF world is some pockets of excellence in countries like Malaysia and Bahrain with a few institutions like Islamic Development Bank (IDB) playing some inspiring roles. y Size of the IBFs: Most of the IBFs are extremely small in size compared with the multinational banks operating in their markets. Saudi Monetary Agency just µrequests¶ Saudi banks to seek guidance from the AAOIFI standards. this involves paying the investors from its own share of profits which actually belonged to the IBFs¶ sharehlders. at present. For detailed insight into unique risks involved in Islamic Banking. a lot more is required a lot more quickly. and also because of difficulty in making the regulations compatible with the conventional regulations. Formation of such organizations is taking time mainly because of difficulty in developing consensus among Islamic nations. For example. does prove to be a source of impediment in that respect. Islamic Financial Institutions are weaker.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). y Financially weak institution offering the product: In a market with very high prospects for growth there is always a rush for every Tom. Dick and Harry to adopt a me-too strategy and entering without having a look at their own credentials. it becomes much more difficult to convince customers on the viability of their products and services. AAOIFI had come out with only 16 financial accounting standards in the ten years since its inception in 1991 [October issue of the quarterly ³Islamic Banking Hub´ of Bahrain reports µ43 standards and statements¶ having been issued]. Institutional Impediments: (a) Absence of a uniform regulatory framework: It is still evolving in some areas whereas in some other areas it is entirely absent. and this poses a major impediment to the growth of this system unless alternative comparable or better mechanisms are evolved. the reader may refer Chapra & Khan (2000) and Hassan (2000). and the rush to launch a new institution to grab the fast buck exposes the weakness further. (c) Absence of an Islamic Financial Network free from ribawee dealings: Networks play a major role in encouraging a system to grow and sustain the growth over longer terms. the oldest of such institutions.

75 70. Political Impediments: y Political pressure. (f) Limited availability of risk management and analysis tools to hedge against volatility poses an additional burden for IBFs and results in maintaining higher levels of liquidity.75 73.75 62.25 87.25 76. in general. particularly in the wake of 11th September not only affects the system physically but it has an impact 0 orway Singapore runei Sweden ong ong UAE U uwait ahrain man atar alaysia Saudi Arabia orocco USA Tunisia Jordan Egypt Albania emen ambia Iran Algeria Senegal uinea angladesh Indonesia Pakistan iger Turkey Lebanon Sudan igeria Iraq 20 40 60 80 91 89.25 83. as an integral part of Islamic system.5 57.25 73. as in Source: ICR website (www. Some examples: (i) the treatment of Ijara as Lease instead of mortgage.75 80. particularly in the non-Islamic nations.icrg. Dubai Campus conventional systems of the Central banks is a good explanation why the growth in this sector with immense potential is not happening at the desired pace.5 66 66 65.5 59. non-availability of qualified personnel who can analyse and manage portfolios is a major impediment.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).500 Submitted by: Shakeel Ahmad Page 32 of 74 s Figure-13: ICR Composite Risk rating for select countries.75 83. no amount in excess of AED 2.5 52. (iii) regulatory fees ± double payment due to the requirement to meet dual regulations.25 78.75 76.25 67 66.75 100 on the psyche. (e) Clash with the mainstream regulations. example. 6. (g) Lack of trained personnel: With the number of educational institutions and training centres catering to the need of this rapidly growing segment being limited.5 65 62.75 72. XLRI.75 80. having the same functionality ± amounting to double taxation effectively. on Islamic institutions from the Western World. For.5 86.5 r r f f c i h g d f d q q p c c i d e 41. From UAE.25 81.75 66. (ii) imposition of taxes despite the zakat.25 83.5 54.5 arch 2003 . almost every financial transaction (particularly relating to an Islamic Institution) is being monitored.25 56.5 54.

(j) Moody's Investor Services. UAE and Kuwait) out of the forty-four (44) OIC countries for which ICRG provides country risk ratings. Table-5: ICRG composite risk ratings for 44 OIC member countries (March 2003) Top quartile 2nd quartile 3rd quartile Bottom quartile Total OIC countries Numbers Percentage 6 14% 8 18% 15 34% 15 34% 44 100% The trend indicates that OIC member countries are considered as riskier than non-OIC countries for financial investments. An environment fraught with risks. Technological Impediments: The Islamic world has not kept pace with the developments in rest of the world. (1996) report country risk analysis being carried out by organizations like (a) Bank of America World Information Services. Indicator of new technology diffusion has been considered as ICT (Information and Communications Technology) by many agencies including UNDP. All of them point towards an overall lack of freedom in most of the OIC countries. The picture is not much different from what is seen with other Submitted by: Shakeel Ahmad Page 33 of 74 . and suggests that the Governments and Institutions in these countries need to do a lot. (e) Euromoney.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Freezing of accounts by the super-powers at short notices. and arbitrarily. fall far behind the promoters of conventional financial system. (f) Institutional Investor. (c) Control Risks Information Services (CRIS). Dubai Campus can be repatriated without leaving a copy of identity which then goes into the system under scrutiny. impedes it.A. Other indicators have developed by many other agencies and independent researchers point towards the same backwardness of the group. 7. XLRI. y Lack of economic. al. (g) Standard and Poor's Rating Group. Top half had just fourteen (14) countries (32%) whereas the bottom half had thirty (30) countries (68%) of them. Freedom indices like ³Index of Economic Freedom´ developed by Heritage Foundation of USA. military and political prowess of countries sponsoring the Islamic Financial system. A country¶s environment conducive to investments boosts the growth of financial systems. lagging behind in technology means backwardness in every sector of the economy. In the ICRG composite risk ratings for March 2003. The promoters of IBFs. only adds to the other weaknesses of the system. (i) Political Risk Services: CoplinO'Leary Rating System. Erb et. Technology being the backbone of banking and financial system and the main driver of market power today. They provide ratings that try to capture ratings based on qualitative and quantitative information into a single index. Many organizations try to capture countries¶ environment to reflect this aspect. (b) Business Environment Risk Intelligence (BERI) S. as this is what has revolutionized the integration of the world into a global village speeding up innovations by pooling talents together. ³Freedom in the World´ by Freedom House (emphasis on Political and civil rights) of USA and ³Economic Freedom of the World´ by Frazer Institute of Canada capture the economic environment of countries. (h) Political Risk Services: International Country Risk Guide (ICRG). Various measures of Technological strength like Technological Achievement Index developed by UNDP is a composite index providing enough indication of the level of Technology in a country. the least risky OIC country (Brunei) was ranked six (6). This is also reflected in the incoming Foreign Direct Investment (FDI) in these countries. on the contrary. Islamic countries.. The top twenty (20) least risky countries included only three OIC countries (Brunei. is only a symbolic threat to this institution. (d) Economist Intelligence Unit (EIU). Figure-13 represents a comparison between the Islamic world with a few of the world leaders.

Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04), XLRI, Dubai Campus

indicators. Except for United Arab Emirates (UAE), we hardly see any potential competitors to the countries promoting conventional systems of banking and finance. The best performer in Telephone Mainlines per thousand people from the Islamic world is placed at 31st position with a value of 259. Similarly, in terms of Internet Users per thousand people, the highest place for an Islamic Country goes to UAE at the 19th position (315 users), next best is Malaysia at the 26th place (273 users); in terms of Cellular penetration per thousand people, the highest ranked Islamic country is UAE at the 24th place with 616 users, but the next best falls at 32nd position with 460 users. From the chart in Figure-13, we can see that almost half
1000 900 800 700 600 500 400 300 200 100 0 800 700 600 500 400 300 200 100 0 Sweden Norway Canada USA U ong ong Australia elgium Singapore UAE Turkey atar ahrain runei uwait Malaysia Lebanon Iran Saudi Arabia Jordan Tunisia Egypt Oman Algeria Albania Morocco Indonesia ambia Senegal Pakistan emen D ibouti Sudan Mauritania Nigeria angladesh uinea Niger Internet users / 1,000 people Mobile Users/ 1,000 people) Telephone Users/ 1,000 people) Figure-13: ICT indicators per 1000 people - Cellular subscribers and Internet users (both left scale) and Telephone mainline Users (right scale) Source: Human Development Report 2003 from United Nations Development Programme (UNDP)

of the Islamic countries have no significant place. This, then, poses a significant impediment to the developments in the area of IBF in the modern world driven by ICT. Technology Achievement Index (TAI), developed by United Nations Development Programme (UNDP), focuses on achievements of a country as a whole in the technological arena. The Index has been found to be relevant for the least developed countries to the same extent as for the most highly developed countries. The index is based upon the four elements: Technology creation: number of patents per capita and royalty/ license receipts per capita, Diffusion of recent innovation: internet users as percentage of population, Diffusion of old innovation: electricity and telephone consumption per capita (logged), Human skills: Mean years of schooling and gross enrolment in tertiary science and mathematics education (Desai2001). Figure-14 compares OIC member countries for which the Index value is available (and UAE as per authors¶ own calculations presented in the Appendix A0 ) with others. Archibugi and Coco (2004) have developed a New Indicator of Technological Capabilities for Developed and Developing Countries (ArCo). This index is an improvement upon the TAI and UNIDO¶s Industrial Performance Scoreboard. This index takes into account more variables associated with technological change. Similar to TAI, three main components considered are: (a) the creation of technology, (b) the technological infrastructures and (c) the development of human skills. Eight sub-categories have also been included. ArCo also allows

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Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04), XLRI, Dubai Campus

for comparisons between countries over time. Figure-14 provides a comparison in this respect.
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8. Religious Impediments: For a detailed treatise on the effect of religion on economic or development activities, the reader is referred to Noland (2003) y Lack of consensus on issues: Developing a consensus on any religious matter has always been a difficult task. It becomes even more difficult when a matter as complex as the financial system comes up for discussion. Despite Quran being the most lucid religious book, creative minds tend to interpret the verses to their own benefit. Thus, just on the matter of interest there are many schools of thought, e.g., although the vast majority accepts that all forms of interest are un-Islamic and therefore prohibited, one group believes that only exploitative interest rates fall under the category of Riba, and prohibited (and what is the dividing line between the exploitative and the non-exploitative?), yet another group believes that despite the interest declared as un-Islamic, there is no need for a regulatory system to control dealings in interest and people should be free to follow whichever system suited them best, postponing God¶s judgment for the Last Day (Khan2000). y Absence of a central religious body with universal appeal or control only exacerbates the matter. Some even argue that religion must not be mixed with the daily lives of people. But Islam does not distinguish between the two. Although religious faith cannot be forced upon people, clear guidelines and regulatory mechanisms would help those who wish to become a part of Islamic way of life. y Divided House: Despite being the most promising religion capable of maintaining its structure through guaranteeing a non-modifiable holy book in the form of the Quran, the world of Islam is divided among sects some of which would like to oppose a proposal just for the sake of it. The flexibility in religious practices and the heterogeneity in the thoughtpatterns of groups could actually act as facilitator of innovation as can be witnessed in developments in Malaysia, Bahrain and UAE, but the same to diffuse to the rest of the
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Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04), XLRI, Dubai Campus

Islamic world needs a change in paradigm that will need institutional support in limiting other impediments. y Rise of fundamentalism: Despite the tenets of Islam being strongly based upon ³tolerance´, and ³peace´, the shift from a tolerant society to an intolerant one (whatever be the reasons) is diverting the attention of Muslim youth away from acquiring knowledge and making best use of it to prosper in all aspects of human life.

Recommendations to counter the impediments to the growth of IBFs: The
recommendations obviously emerge from the above discussion on impediments. For the Islamic Financial System to exploit its competitive advantages for maximum benefits, it has to remove the impediments in its way. It must control the impact of those factors that are not directly under its control. Educational: The foremost and urgent requirement is the advancement in the educational arena supported ably by research work in all areas that can enrich the level of education. It is important to understand that the people of the OIC region have different socio-cultural and religious orientations from those in the Western world. Therefore, simply adopting the Western system may not be so useful. In fact, there is a real threat of an increase in the level of confusion in the minds of the students if the available systems are not adjusted to suit their special needs. The Western educational system has advanced so well that it cannot be dumped with out jeopardizing the educational development of the young generation. Further, it is no use reinventing the wheel all over again. Therefore, a framework that can properly adapt the Western system of education to the local needs of the region in every resp (language, ect socio-cultural and religious requirements, educational level of parents, pace of learning, etc.) is preferable. Development of a workable and sustainable infrastructure requires a lot of time, effort, investment and will power. Coordination between countries with similar cultural background, in this respect, and pooling of their resources will help speed up the process of building the required infrastructure related to research & development of educational media as well as related to actual imparting of education to the needy. These efforts have to consider education at all levels. The system has to be attractive enough for the students to reduce their dropout ratio at all levels. Since dropout ratio is also tied up with the state of economy, efforts towards making the region¶s economy stronger are required. Thus, we can visualize the strong inter-relationship between various aspects that need attention, all at the same time, in order to provide a recipe for success. Figure-15 tries to capture this inter-relationship. Societal and Psychological: The social fabric needs to undergo deep introspection to trace the reasons behind the declining value systems followed by concerted efforts to build them back to their original levels where they were so attractive to the outside world that societies as a whole adopted them voluntarily. This requires a deep-rooted support from institutions and government agencies. At the psychological level, the confusion in the minds of the modern youth craving for modern ways of life and at the same time seeking solace in the roots have to be cleared. Islam is the only religion that clears the air of confusion through an authentic institution in the form of Quran by clearly recommending Muslims to pursue the worldly pleasures without compromising with the religious value system. Guidelines cannot be any clear, which means that there is something wrong with the educational, political, and sociocultural systems prevalent today. Thus, there is a need for thorough overhaul. Economy: Economy is the backbone without which no system can stand on its own, and if it does seem to do so for a while, it cannot sustain for long. Therefore, there is a need for accelerating the growth in all spheres of economic activity, at a much faster pace than others, in order to overtake them soon. This needs efforts to come out of isolation, develop common
Submitted by: Shakeel Ahmad Page 36 of 74

and continue with their goal of having one Submitted by: Shakeel Ahmad Page 37 of 74 . and make a combined effort towards capturing the global markets backed by competitive products manufactured indigenously. Financial: There is an urgent need for an active capital market. Institutional: A uniform regulatory framework is an ideal proposition. It needs a lot of effort towards the development of a research base supported by an innovative educational and training system. Islamic credentials of financial products must be established in order to gain acceptability and remove any confusion from the minds of those craving for ethical or Islamic products. Alternative options hardly exist. to graduate from their trading paradigm to an all-encompassing capability-building paradigm. the existing regulatory frameworks must attempt to limit the mismatch to the minimum. The countries will have Financial Infrastructure Political System Regional Networks & Alliances Technological Infrastructure Institutional Support Innovation & Diffusion Systems National Networks & Alliances Global Networks & Alliances Systems Research Establishments Industry Clusters Educational Infrastructure Factor Market conditions Product Market conditions Social & Cultural Values Regulatory framework Governmental Support Systems Communication Infrastructure Economic Environment Fig-15: A pictorial representation of the web of relationship that exists between various factors th at affect the growth of any system. Survival of a banking or financial system is contingent upon controlling the maturity mismatch in Islamic debt portfolio. Dynamic Financial Engineering is the need of the hour for a nascent financial sector with great potentials. but demands a lot of sacrifice from individual nations. etc. This needs additional efforts from Financial Engineers to develop Sharia-compliant hedging instruments. but if complete uniformity is difficult to achieve in the short run. This needs cooperation at all levels for pooling of resources. to bring dynamism into the Islamic Financial Sector. Dubai Campus markets among member countries.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Mechanisms need to be devised to contain additional risks inherent in the Islamic Financial systems. Clarity in product propositioning and processes is vital in this respect. including the Islamic Banking and Financial System. It also requires much better coordination between Sharia Boards and Financial Engineers across borders. XLRI. an active secondary market for Islamic debt instruments and Sharia-compliant equities. Supportive Institutions for Venture Capital Financing and business incubators. an active debt market. an Islamic money market.

provide strength to match (and later. and thus is unable to control the damage done to it by unscrupulous agents from within the community and beyond. Lot of examples exist to take inspirations from. It is not difficult for a religion whose fundamentals are built upon µpeace¶ and µpatience¶ to remove the tag of fundamentalism. and establishment of an Islamic Central bank with its branches in every country will enhance the pace of development in the Islamic financial arena. and provide ingredients for long-term competitiveness. Latest Developments: Bahrain Monetary Authority (BMA)¶s efforts in establishing Bahrain as a hub of Islamic Banking. supersede) the conventional counterparts. A head-on clash with the mainstream regulations must be avoided. This requires the coming together of not only the regulatory authorities but also the religious scholars on a common platform to sort out any differences that are natural to exist. the improved regulatory controls promised by IIFM. which are stronger than any other fundamentals. To start with. IIRA and IFSB are certainly important developments in the recent past. and the means to reach those goals (Quran and Hadeeth) are the same. Therefore. but a Central Sharia Board to deliberate on matters related only to Islamic Finance should not be so difficult after all. Technology parks and establishment of a NASDAQ type stock exchange may not seem to be direct enablers for this purpose. Finally. Although there is nothing wrong with the Islamic fundamentals. on its own. and must be encouraged at all costs. particularly when the ultimate goal is the same. a lot of misunderstanding exists in the minds of not just the non-Muslims but also in the minds of Muslims. the future support from the planned Bahrain Financial Harbour and the launch of Dubai International Financial Centre ± launched to coincide with Dubai 2003 (IMF/ World Bank Board of Governors Meet ± September 2003). Challenges of developing and sustaining the market for Islamic finance is no easy task. A central religious body may sound like a distant dream today. fundamentalism is the biggest enemy of anything Islamic. acceptance of existing Regulatory bodies is vital. Hence efforts are required not just towards use of latest technologies but also towards developing. Submitted by: Shakeel Ahmad Page 38 of 74 . Religious: The whole basis of this sector of financial system is based on religious edicts. but they would act as catalysts. and concerted efforts from many sides are required. so that the Islamic financial instruments can be marketed in countries where there is little possibility of establishing an Islamic regulatory system in the near future. The wings of institutions must spread to reach every nook and corner of the world which requires an Islamic Financial Network to be established. Islamic educational system is way behind other educational systems.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Dubai Campus such framework in the long run. This needs emphasis on research & development activities and establishment of an infrastructure (soft as well as hard) base. it is essential that consensus on issues related to Sharia is established. compatible technologies and continuously upgrading them to keep ahead of the conventional counterparts. Political: All the recommendations are dependent upon governmental and institutional support. Lack of education is to blame. XLRI. and encourage others to join the bandwagon. Since it is not an easy task for intellectuals to reach an absolute consensus on all issues. It is an excellent medium to build capabilities and core competencies. at least in the beginning. Pooling of resources together. a working mechanism needs to be established to limit misunderstandings to the minimum and exploit the differences to generate creativity and innovativeness. These differences can be positively utilized to boost creativity and innovativeness. which makes it extremely important to have a political system that is conducive to development of Islamic Financial system. Technological: There is no doubt in any mind that technology is an essential tool to gain competitive advantage in the modern world.

The deal between the two banks involves the Murabaha mark-up only. (iii) Islamic Interbank Money Market (IIMM): Islamic Interbank Money Market (IIMM) has been operative in Malaysia since October 1998. Networks and alliances will decide the future of IBFs in a world where the conventional financial system is quite well entrenched. Dubai Islamic Bank. This is one sector where it was difficult to imagine how the concept of interest-free credit could succeed. and therefore accepted as Islamic. Dubai Campus The success of Dubai 2003 and the concurrent International Islamic Finance Forum. The main concern of financial experts is how to improve liquidity in the Islamic financial markets with the Islamic concept of money as not Submitted by: Shakeel Ahmad Page 39 of 74 . a publication of the Bahrain Monetary Agency (BMA) provides the structure of Commodity Murababha contract in the Figure-16: Broker B (5) Buyer pays on deferred payment date (4) Conventional Bank sells as agent (2) Conventional Bank buys as agent Conventional Bank (Agent) (6) Conventional Bank pays client on deferred payment date (3) Conventional Bank pays the seller Broker A Islamic Investor (Principal) (1) Client pays Conventional Bank on Value Date Cash Flow Flow of Commodity Fig-16: The Structure of a Commodity Murabaha Contract (Source: BMA) The process of Commodity Murabaha involves a Conventioanal Bank as a commission agent whose payment to Broker A on the Value Date includes interest for the period between the buying of Commodity and the deferred paymnet date (Value Date). it gives us a picture of the level of convergence that is taking place. But. The commodity provides the asset backing for the short-term inter-bank deal between the Islamic Bank and the Conventional Bank. Shariah Funds Inc. But. iHilal Financial Services. Liquid money market is an important issue in the Islamic Financial system. the deal does promote payment of interest between the commodity broker and the conventional bank which raises questions about the validity of Islamic spirit in the contract. But. XLRI. have been an exceptionally large morale booster for the Islamic Financial Community. Oasis Global Management Company of Guernsey and South Africa and International Brunei Exchange. (ii) Islamic Credit Cards: Dubai Islamic Bank Visa card provides credit facilities and all the benefits of a normal credit card without any interest charges. The Forum marked coming together of the Institute for International Research (IIR). For a detailed discussion on these credit cards. . Dow Jones Indexes.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). So do other Islamic banks. the reader is referred to Darwish (2003). etc. the Saudi Economic & Development Company (SEDCO).a division of US-based Meyer Capital Partners. Some of the latest developments are briefly discussed hereunder: (i) Commodity Murabaha (Short-term Inter-bank deposit or placement): ³Islamic Banking & Finance in the Kingdom of Bahrain´. Bahraini banks have utilised this innovation extensively µto bridge the liquidity gap¶.

as of now. Box-3: How Islamic is the Bank Negara¶s IIMM? It is hard to conceive how this innovation by Bank Negara can fulfill the Sharia obligations. then how can we justify this as lawful as per Shariah? Some scholars have argued in favour of inflation rates as a reference rather than considering a ribawee reference rate. If money is to be exchanged for money or it is borrowed. the payment on both sides must be equal. but only when it acts as capital. This doubt would gain strength if there is a high level of correlation between the two rates (Rates of return on conventional Interbank deals and on Islamic Interbank deals). The doubt that immediately emerges in our minds is that the ³hibah´ could just be a cover-up for the interest rates.L. not when it is "potential capital´. Islam recognizes the time value of money. In the purely Islamic economy. as argued by Dr. Abdul Gafoor [in an Email on the IBF Netversity mailing list]. Al-Omar and Abdel-Haq (1996) state that some schools in Islam allow lenders to charge service fees to compensate them for the administration of the loan. ³Therefore a new index to measure the inflation due to currency depreciation is necessary´ [please refer to the book titled "Commercial Banking in the presence of Inflation". But then. With modern technology assisting such activities almost eliminating geographical barriers. to become real capital it must associate with other resources and undertake a productive activity. For the conventional banking system. or any other Interbank rate. as agreed Submitted by: Shakeel Ahmad Page 40 of 74 . Money has to be associated with goods or service to generate income. XLRI. this trade has been on the rise helping achieve great deal of liquidity in the money market. The Central banks can play an important role in this respect. Although regulations can force a bank to part with its excess money to help another bank in need of cash without charging any interest on it. by Dr. It can only be used as a medium of exchange and a measure of value. but as long as inflation exists because the Islamic Economy does not exist as of now. Bank Negara Malaysia allows Malaysian Islamic banks to participate in the interbank money market in order to prevent illiquidity. Under this concept. the inter-bank money market serves as an efficient means to transform excess money into income by short-term placements or overnight lending. But. But some scholars have reservation on even inflation being considered as a reference for distributing returns on deposits (probably due to inappropriateness of the measures of inflation). A recent mechanism introduced for accepting ³Islamic interbank deposits under the liquidity management operations based on the Islamic concept´ is termed as ³Wadiah Yad Dhamanah (Guaranteed custody). Making Money from Money is not permissible ± that is the basic difference between money and commodity. so that it is not used for trade in money itself. These charges are not proportional to the amount or the term of the loan or inflation. inflation could probably be a better reference than LIBOR. The data provided by the bank on its website presents rates of return on these Interbank transactions both for Conventional as well as Islamic banks.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).95. The data between October 1998 (inception of Islamic Interbank Money Market) and Novemebr 2003 yielded a very high correlation of 0. the measures available for inflation are not appropriate in the context of banking and finance because they are based on past data instead of being ³dynamic and concurrent´. It also participates in open market operations to stabilize the market. The Islamic banking system needs to tag some productive activity to every transaction which becomes an impossible task particularly for overnight trades. inflation has no place.M. Dubai Campus being able to generate any income on its own. Money (of the same denomination) is not held to be the subject matter of trade. A. Money is just "potential capital´. transaction time and costs. This means that Islamic banks have no motivation to deal in such trades making the money market highly illiquid. Does this mean that this innovation may simply be limited to changing the terminology from Interbank interest rate to ³hibah´? This may be one reason why interbank conventional rates like LIBOR have finally been accepted as lawful reference for providing return on ³Islamic Bonds´. An example of an institution which adheres to this practice is the Islamic Development Bank. Ghafoor]. Interest-based system through inter-bank deals not only helps tackle the asset-liability mismatch but also allows generation of income out of it. the Islamic banking institutions will offer to deposit their excess funds with the Central Bank over a period of time. like other commodities.

Ijarah sukuks. the Bank is not under obligation to promise any return to the depositors. nobody would object. in calculating profit or rent. the US$ 700 million Qatar issue is equally split between conventional and Islamic investors. at 52% and 48% respectively. The rental return on the Islamic leasing bonds (Ijara sukuk) is 60 basis points over the LIBOR for six months. or are we straying towards the path followed by our cousins. Fig-4. UAE. on the 3 rd September 2001. as for many of us it is difficult to see a real financial difference between the conventional and Islamic financing when the actual amount paid by a customer under an Islamic financing has a link to LIBOR. Finding it difficult to understand how this bond was any different from a conventional bond. Bhubneshawar]. with Government acting as the seller and buyer of goods (Aluminium. Structure of Sukooks in Bahrain: (a) Al Salam Sukook (Figure-17): These Government securities are equivalent to Treasury bills. More and more of European and Asian mutual funds. and the margin to the buyers (syndicate of Islamic Banks) is competitive with respect to returns from other conventional short-term money market instruments. but the growth rate of innovations is encouraging. another first by an Islamic Submitted by: Shakeel Ahmad Page 41 of 74 . led by Bahrain and Malaysia. comprising 70% conventional investors.7 billion in the year 2002. it will be too naïve a belief. M Shahid Ebrahim (four of his papers are cited in this dissertation). they do not have an alternative. It will take time.´ The total Box-4: Conventional Investors find Islamic Bonds attractive : Keeping up with the trend.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Obaidullah of XIM.25% rental return Islamic Leasing Certificates worth $100 million. But. pension managers. a sum amount of money may be paid as hibah (gift) to the depositors on the maturity date. international investors too are becoming increasingly comfortable with the pricing and structure of the rated. As a custodian to the deposits. XLRI. They tried to convince us that the bond does not lose its Islamic character just because it is pegged to the LIBOR. approximately 70% of both of these issues were placed in Middle East. financial institutions and central banks are holding sukuk paper as part of their diversification strategy. provides us with a glimpse of growing Islamic bonds market. «««« [As in October issue of the quarterly ³Islamic Banking Hub´ of LMC. Dubai Campus between both parties. of course. (b) BMA Ijara Certificates: BMA issued these 5 year 5. launched by Dr. I posed the question to Islamic Financial Scholars on ibfnet@yahoogroups. A case in point is the US$ 400 million IDB sukuk. The only fear is whether we are proceeding on the right path. (iv) Islamic Bonds (Sukuk) Funds: The Islamic Bond market is becoming vibrant with successful large issues at international levels by Malaysia. The news clip in Box-8 gives us an idea about the sincerity of the Bahraini Institutions in developing the primary as well as secondary Bond market. is acceptability of the fixed nature of return on these bonds by the Islamic scholars. But why LIBOR? Simply because. Numerous responses came to the author including one from Dr. [the most successful virtual discussion forum related to Islamic principles and the IBFs. Bahrain] volume of Islamic money market instruments traded in the IIMM reached RM32. based on the Central Bank¶s discretion. Recently. Bahrain and The biggest challenge for the bond market. so that compliance with Shari'a principles is indicated. Similarly. The counterparty and the market risks involved are the sovereign risks. and falling into a trap? A general belief among the Islamic financiers is that any benchmark can be used. and whether this could be called an Islamic Bond at all. These transactions have had a maturity of 3 to 7 years. in the case of Bahrain). They think that as long as the document does not explicitly indicate that the profit or rent is LIBOR but only the benchmark for calculations is LIBOR. showing growth of Malaysian Islamic Bond Market. there has been a flurry of Bond issues by Islamic Financial Institutions. However. with the remaining being equally distributed into Asia and Europe. Geographically.

how Islamic are these bonds? The debate on how far the fixed rentals/ guaranteed margins. (iv) Mudarib executes a contract for sale of the leased assets on maturity. The property right to the asset is represented by the Ijara certificate. sale (ii) in the market on Date-2 (future agreed date). for a price represented by the rental payments made by the lessee over the lease term. The leased assets in this Sale deed may be Box-5: US$250 Government Islamic Leasing Securities: [As in October 2003 issue of the quarterly ³Islamic Banking Hub´ of LMC. Mudarib executes the Ijara contract against collaterals & security from the lessee. the Sukuk Company sold these assets to investors who owned the assets after leasing them to the government for a specified rental price. and collects rentals. which is also listed on the Bahrain Stock Exchange. The Sukuk company purchased the assets from the government following which the assets were leased by the government by way of Ijarah Muntahia Bitamlik. or a fixed spread over LIBOR in the Islamic sukooks differ from the interest rates of the conventional bonds will continue. (ii) to sell at x ton Al a guranteed margin to the market Advanced payment in lieu of promise (i) on Date-1 Payment from proceeds of actual Al. via the assets purchase contract from the government. as Mudarib. purchased by the lessee or his agent. arranged by the Liquidity Management Centre (LMC) in Bahrain was oversubscribed by 40 percent. This is the Ijarah contract that ends up with the transfer of ownership of the leased assets to the lessee. (ii) The Mudarabah purchases specified tangible assets and Central Bank as Mudarib executes the deed. (iii) Purchased tangible assets are then leased out on the basis of Ijara-wa-iqtina to earn rental income. Bahrain] The recent US$ 250 million issue of Islamic leasing sukuks. Mudarabah is then liquidated and Sukook redeemed. The certificate holders having the property rights on the assets are the lessors and thus entitled to the rental proceeds.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). assets lease contract by the government. The second sukook (Issue size of $ 70 million) with a maturity of 3 years. Govt of Bahrain Syndicate of banks represented by BIB (i) Central bank. In issuing these Ijarah Sukuk. issues Participation Certificates (backed by Special Purpose Mudarabah) to the market and collect subscription money. Redemption of Salam Sukook Fig-17: A representative sketch for the Al Salam Sukook of Bahrain Govt. Steps in an Islamic Leasing (Ijara) Sukook deal: Commodity Market (Aluminium) Salam Sukook: a promise (i) to supply fixed amount of Aluminium (x ton) at a future date. The Ijarah Sukuks represented assets (Salmaniya Hospital Complex) owned by LMC Sukuk Company a special purpose vehicle created for the transaction. Dubai Campus Central bank. Property rights of the assets is transferred to the certificate holders with the possibility of further transferability of ownership and inherent benefits built-in. and the government promised to buyback the assets at its nominal value at the end of the lease period. So. The issue was the largest-ever offering of Bahrain Government¶s Islamic sukuks. annual lease rental return of 4.52% (paid semiannually) was issued on 27th February 2002. (v)The Participation Certificates can be traded in the secondary market during the validity of Mudarabah. or any third party at a fixed price on maturity of Ijara. XLRI. One simple test that can be applied to ascertain whether Submitted by: Shakeel Ahmad Page 42 of 74 .

As in the case of the futures. let us examine the fluctuation in the price of Aluminium during last five years. a fixed rate of return may be termed speculative and thus may not be allowed. how can the prices be guaranteed? If the future prices cannot be guaranteed.. The issue was increased from the original targeted size of $300 million due to strong demand. the asset or commodity acts like the hypothetical Eurodollar deposit used for the Eurodollar interest-rate futures traded on the Chicago Mercantile Exchange (CME) and the Singapore International Monetary Exchange (SIMEX). how can a return from a deal in such products/ projects/ commodities be guaranteed? Is it not speculation? This is one of the arguments that form the basis for prohibiting a guaranteed return to investors. Under Ijara concept. It provides us with some explanation why the Ijara based bonds are replacing the Salam based bonds. the prices can be predicted in the short run based upon the factors that govern the demand and supply. In such a scenario. sole bookrunner and lead manager on the transaction with Abu Dhabi Islamic Bank (Adib) and Kuwait Finance House (KFH) acting as co-lead managers. The whole cycle of activity does result in some productive economic activity unless it is purely speculative. Considering the fact that BMA¶s Al Salam Sukooks are based on Box. With Aluminium prices being so volatile. Asset or commodity backing can be considered as genuine if it satisfies the basic tenet of the Sharia.e. The question whether or not the asset or commodity backing is genuine may not be answered easily. the test for Islamic sukook deal is whether the economic activity is related to the asset or commodity that is used as backing for the deals. the transactions actually result in producing the asset or commodity at some level.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Aluminium as the underlying commodity. fixing a rent in advance may not be considered unIslamic whereas in Al Salam concept. in any system whether conventional or Islamic. HSBC and Nomura International acted as arrangers. the underlying asset may never actually change hands in the sukook deals. Submitted by: Shakeel Ahmad Page 43 of 74 .6: Islamic Development Bank launches bond issue worth $400m [Source: Gulf News dated 03-08-2003] The Islamic Development Bank (IDB) has announced the successful launch of its debut capital markets' $400 million Islamic Sukuk issue. Citigroup acted as ratings advisor. can the sovereign guarantee be sustainable? It is not difficult to conclude from the guaranteed rate offerings tagged to the recent bond issues that the necessity to provide the fixed returns as competitive as the returns from conventional securities of similar maturity may actually be guiding them instead of any forecasting methodologies. the transaction was priced to yield 3. In case speculative players dominate the market or in case where cartels exist. But.738 per cent. equivalent to a margin of 16 basis points (bp) over the five-year mid-swap rate. XLRI. at the tighter end of the indicated pricing range of 15-20 basis points. and guided by large international players. but what about the fixedness of returns guaranteed by these bonds? The price of an asset or commodity widely fluctuates in the market due to supply and demand factors in case perfect competition exists. which is the case in many product/ commodity markets (particularly in Aluminium) of the contemporary world. The discussion on the BMA¶s Al Salam Sukooks (described above) may yield interesting insights. i. Dubai Campus or not these returns are same as the interest rates is whether or not the asset or commodity backing is genuine. As the first international Islamic capital markets bond issue by a non-sovereign and only the second such international Islamic issue. A cursory look at the whole cycle leaves an impression that in the whole process. But jumping to conclusions so easily would be negating all the efforts put into these excellent innovations accepted by the Sharia Supervisory Boards.

Khan and Mirakhor (1987) argue on the same line and suggest ³all other modes of operations « are recommended only in cases where risk-return sharing (i.´ The size of the disposable funds owned by high networth Arabs is estimated to exceed $11 trillion. is it a possibility that Islamic Shariah principles are being kept aside or backdoors are being invented in the name of innovation? A more transparent system will provide better explanation apart from being helpful in clearing doubts from investor¶s minds. Dubai Campus $1. After 11th September 2001.700 $1.300 $1.380 $1. there has been a rush to tap this fund which used to be mostly invested in the US markets.300 $1. Qureshi-1984.420 $1.340 $1.e. in particular.200 $1. 2003 Source for Figure-18 & Figure-19: London Metal Exchange (LME).100 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Apr-98 Apr-99 Apr-00 Apr-01 Apr-02 Oct-98 Oct-99 Oct-00 Oct-01 Oct-02 Apr-03 Jul-03 24-Oct Oct-03 31-Oct Figure-18: Aluminium prices (monthly average) during January 1998 and October 2003 $1. Mudarabah and Musharakah as strongly Islamic (Siddiqui-1982.600 $1. Submitted by: Shakeel Ahmad Page 44 of 74 . XLRI.320 $1. Mudarabah and Musharakah) cannot be implemented.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).280 12-Sep 19-Sep 26-Sep 15-Aug 22-Aug 29-Aug 5-Sep 1-Aug 8-Aug 10-Oct 17-Oct 3-Oct Figure-19: Daily Aluminium prices between 01 st August and 31st October. Qureshi-1985.400 $1.800 $1.500 $1.360 $1.460 $1. In this mad rush. Mohsin-1982.440 $1. Cash Settlement and Reference Prices This may be the main reason why some scholars have termed only two modes of transactions.400 $1.. Chapra-1982).

Some more developments are described below. The recent cross-border mergers between major banks in the US and Europe not only show the direction in which the industry is moving. In Islamic finance. Second. The transaction is an alternative to the SBBA and the loan extended is based on the concept of Qardh. contracts. and to develop the financial and technical strengths to ensure success of these objectives. and payment mechanism. (vii) Sell and Buy Back Agreement (SBBA): The SBBA transaction is permissible. USD180bn worth of funds were available for investment in Islamic-approved holdings worldwide as of mid-2002. So much so that some question if there is any difference at all.´ says one Kuala Lumpur-based banker.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). accounting and compliance standards any investor would expect. ³You cannot operate without a differential between today¶s money and tomorrow¶s money. packaging them into securities. compensation can only be effected on the party who defaulted on his promise «« Bank Negara.2 introduced in the transaction. WI is a pre issuance transaction of debt securities that will be issued in the Islamic debt market to facilitate players in estimating the appropriate price to bid on the issuance date. Although recent bank mergers in the Gulf region are a step in the direction of countering this disparity. an amount anticipated to grow by 15% YoY.´ (More Than a Prayer. to meet customer expectations in a manner that is profitable to themselves. but also widens the gap between the capacities of the regional and international banks. NEWSWEEK INTERNATIONAL. Such is the overlap that more than half of Malaysia¶s Islamic loans go to non-Muslims. into units of equal value and issuing securities as per their value. which is a process of dividing ownership of tangible assets. the concept of securitization is in consonance with what is known as Taskeek in Arabic. the banks are expected to prefer this transaction due to its simplicity and its mutual-help feature «« Bank Negara. as long as it is an outright sale and purchase and enforced by two different contracts for each transaction. XLRI. (vi) When Issue (WI): Players in the Islamic money market of Malaysia are allowed to perform WI transactions prior to the issuance date of the Islamic securities. January. or By Lorien Holland and Peter Janssen. 2003) ISLAMIC BANKING: THE ROAD AHEAD The industry faces three main challenges: first. while being commercially viable must be aligned with the Submitted by: Shakeel Ahmad † ‡ †… Page 45 of 74 . Gulf Business -D c. (viii) Collateralised Borrowing: The National Shariah Advisory Council of Malaysia approved the proposal to introduce the collateral borrowing transaction in the Islamic money market based on the principle of Rahnu. in Malaysia. Although there is no profit element being Box-7: Latest Trends & Challenges Malaysia has become a leader in the world of Islamic banking by choosing the most practical interpretations of the term. (ix) Islamic Securitization: Islamic Securitization in a wider sense is defined as the process of pooling assets. The country¶s Islamic financial institutions²which make up about 8 percent of the banking sector²offer services that mirror and compete with conventional banks. Ayman Dunseath. In addition. and making them marketable to investors. It has invested heavily in developing a Sharia-friendly financial system²one that forbids charging interest. The Council viewed that the WI transaction is allowed based on the permissibility to promise for sale and purchase transactions «« Bank Negara. Some indications of things to come are provided by the news item in Box-8. conventional banks are increasingly competing in the Islamic sector. ³Islamic banking in Malaysia comes to exactly the same thing as conventional banking. it has to be acknowledged that regional banks will not become major players in the international markets until they themselves start to merge and/or pool their resources. Dubai Campus (v) Global Bond Market Growth: As reported by failaka. either by the introduction of 'Islamic windows' within their present structures or by the establishment of subsidiary or associate companies that operate entirely on Islamic principles. The underlying assets. Islamic institutions will need to respond to these competitive pressures and this will involve questions of substantial enhancement to the capital base of individual institutions or mergers and consolidations from within the sector. usufructs. but that has the regulatory.

"We are working aggressively to design and launch more and more sukuks or Islamic leasing bonds as part of LMC¶s strategy to create a secondary market for investors. "The LMC is the only institution which is to act as an agent for Special Purpose Vehicle (SPV). the LMC is poised to issue four leasing bonds of over $1. By securitising a pool of tangible medium and long-term assets acquired from a variety of sources. Aref Al Kooheiji." he said. Mudaraba and Istisna contracts with a minimum of 51% on the Ijarah assets." he said. The IIFM and the LMC are working independently under the umbrella of the BMA but at the same time these organisations complement each other. "It is not an overnight job to create a secondary market for Islamic financial institutions as it takes time. the guarantor. founding director of the LMC said: "The LMC will enable financial institutions to invest in quality assets of varying tenors. adding: "It will also establish lines of liquidity to support the issuance of securitised instruments (Sukuks). which is a combination of securitization of Ijarah. "Thus having the opportunity to act as both investors (providers of capital) and borrowers (providers of assets) and will channel their excess liquidity to the benefit of regional economies. to securitise assets." he said." "The LMC seeks to develop an active secondary market for short-term treasury products. told the Tribune that establishment of the LMC in Bahrain would help to mop up the market liquidity. "In addition. Dubai Campus requirements of Sharia. By and large. «. tradable. The Liquidity Management Centre (LMC) was established in Bahrain in July 2002. "These all are pillars of the Islamic financial market and we hope that the LMC initiative will trigger the investment opportunities. representing the Islamic Development Bank (IDB) on the board. it will significantly accelerate the development of the Islamic banking industry by addressing the industry¶s fundamental need to develop tradable products and secondary markets. The latter will provide impetus to the active trading of sukuks in over-the-counter deals or through the LMC as Islamic financial institutions gain access to competitively priced liquid instruments." he said. adding that the LMC was established in Bahrain with the objective of acting as a "market maker" for investors." he explained." he said. Box-8: Bahrain LMC to issue $1.. Submitted by: Shakeel Ahmad Page 46 of 74 .Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Mohammed Hisham Dafterdar. "The LMC business activities will help to facilitate the creation of an Islamic inter-bank money market that will allow Islamic financial institutions to effectively manage their assets and liabilities.2b bonds By Mehmood Rafique. asset-backed treasury instruments (Sukuks) where Islamic financial institutions can invest their surplus liquidity. In doing so. to establish. the arranger and more importantly the innovative structure of the deal. LMC will enable Islamic financial institutions to maintain a tenor mismatch between their assets and liabilities which is fundamental to the business of banking and imperative if the industry is to remain competitive with its conventional counterpart. Provide short and medium term liquid. XLRI. the LMC will provide access to a pool of quality assets. Mohammed S Al Omar said that the LMC would also explore marketing avenues across the Gulf and even beyond the Middle East region." he said.2 billion by December. The issue is unique in almost all its aspects ranging from the issuer. The LMC is a key element of a larger project to create an International Islamic Financial Market (IIFM). the LMC will create opportunities for buyers of quality assets that will allow Islamic financial institutions to finance long term projects that can be liquidated at their discretion. 20 May 2003 FOLLOWING an overwhelming response to the Liquidity Management Centre¶s debut $250 million five-year Islamic leasing bonds. Furthermore. Bahrain Tribune. He said that Islamic Financial Standards Board in Malaysia and establishment of Islamic Inst itutions Rating Agency were also important organs to support the existing market. the Sharia treatment of sukuk is similar to an equity security where shares are evidence of ownership in a going concern. facilitate the sourcing and securitisation of assets acquired from various sources. The sukuks issued to securitise this pool will offer enhanced Shrai¶a credibility. The issue size originally targeted at US$300 million was increased based on strong demand for the high quality instrument." "The LMC will also endeavour to create secondary markets for its products by establishing a consortium of liquidity providers. No individual bank or product currently offers this combination of quality instruments with diversified risk together with a ready market for trading. Islamic Development Bank¶s recent debut issue of US$400 million Islamic sukuks received overwhelming response from both conventional and Islamic investors around the world.

There is a strong Sharia opinion against the trading of these certificates if the underlying assets of the Musharaka are in liquid form (i. if any´. Likewise. which cannot be securitized independently to create a negotiable instrument to be traded in the secondary market. The Mudaraba bonds can be instrumental in the process of development financing because it is related to the profitability of the projects. XLRI. and an annual proportion of the realized profits in accordance with the predetermined profit sharing ratio. Musharaka bonds are relatively similar to Mudaraba bonds. The bondholders are solely dependent on the revenue generated by the project being financed and in the event of non-performance of the project. in the shape of cash or receivables or advances due from others).´ Mudaraba means an agreement between two parties where one partner gives money to another for investing in a commercial enterprise. bear the loss. The objects of a Mudaraba are restricted to only such businesses as are permitted under the Sharia. The certificate representing a monetary obligation from a third party or dayn arising out of a Murabaha transaction can be traded at face value and any difference in value will be tantamount to riba. which represents his proportionate ownership in the assets of the venture or project for which financing is being raised. Murabaha is a transaction. For instance. The certificate holders own the assets of Mudaraba operation and profit share as per agreement. Subsequent to the acquisition of substantial non-liquid assets. who is called "Mudarib" and the profits generated are shared in a predetermined ratio. subject to certain conditions. leasing and Murabaha. The realized funds are the share contribution of the subscribers in the Musharaka capital. The investment comes from the first partner who is called "Rab-ul-Maal" while the management and work is the exclusive responsibility of the other. The certificate holders own the assets of partnership and are entitled to profit. the Mudaraba bonds give its owner the right to receive capital at the time the bonds are liquidated. The only major difference is that the intermediary-party will be a partner of the group of subscribers represented by a body of Musharaka bondholders in a way similar to a joint stock company while the Mudaraba capital is only from one party.e. Revenue bonds are generally backed by revenue generated mainly for public sector projects funded by the bond issue.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). every subscriber can be given a participation certificate. Submitted by: Shakeel Ahmad Page 47 of 74 . if the security represents a mixed portfolio consisting of a number of transactions like Musharaka. then this portfolio may issue negotiable certificates. (a) Securitization of Mudaraba Bonds: AAOIFI¶s Sharia standard No-18 defines the arrangement of Mudaraba bonds as below: ³The issuer of the certificates is the Mudarib. Dubai Campus It should be noted that although some of these securitized financial instruments have been generally accepted as being in compliance with Islamic principles so that they can be traded in the secondary market. The concept of mudaraba is akin to revenue bond financing in the conventional system. if any. these Musharaka certificates can be treated as negotiable instruments and can be bought and sold in the secondary market. the subscribers are the capital owners and the realized funds are the Mudaraba capital. In securitizing a Musharaka arrangement. the negotiability of certain others still remain controversial due to their legal acceptability or compliance with Sharia. there is no recourse to the local government¶s general treasury fund. being the capital providers. The subscribers are the partners in the Musharka contract. (b) Securitization of Musharaka: AAOIFI¶s Sharia standard No 18 defines the arrangement of Musharaka bonds as follows: ³The issuer of the certificates is the inviter to a partnership in a specific project or activity. However. The certificate holders.

Ijarah is a contract. XLRI. in whole or in part. However. receive payment in advance for productive use without bearing the price risk. An investor can hedge his downside risk by selling stocks to be delivered later. Credit ratings for customers may not be different simply because the target customers are mostly the same for both. the Ijarah certificates can then be traded in the secondary market. Dubai Campus (c) Securitization of Ijarah: Ijarah sukuks have aspects in common with conventional assetbacked securities and are of particular interest to a broad range of investors representing both the conventional and Islamic financial communities. in conjunction with Saudi Arabian financial services group Permal. This will be important for inter-bank dealings. could be either fixed or a floater. hence the rating methodology has to be uniquely suited to the IFBs. project evaluation becomes an important and integral role for pure IBFs based mainly on the PLS principles. Fund managers Fostman-Leff of New York were responsible for managing the fund which were expected to start doing business by early October 2003 (as per their press release). the seller keeps the advance . SEDCO has been examining possible alternatives to prohibited derivates. with regard to the purchased part of the asset. he can sell the asset. it could be freely tradable at par.closest analogy to an option in IBF system. which come from leasing out the assets owned by the SPV. yes. Since Ijarah sukuks evidence the undivided pro-rata ownership of the underlying leased asset. Such flexibilities can allow Ijarah sukuks to be priced at par with their conventional counterparts. premium or discount. The issue was priced flat to the country¶s conventional credit curve and attracted no premium despite being a new deal structure. One such alternative is based on an innovative concept like "stipulated options" . liquid investment funds have facilitated Islamic secondary market.a buyer makes an advanced partial payment for deferred delivery of a product. where one sells a commodity to a buyer against full up-front payment for delivery at a future date. and if he decides not to buy this later. We have seen that the system in its purest form is entirely different from its conventional counterpart. the Saudi Economic and Development Company (SEDCO) launched the world's first-ever hedge fund compliant with Islamic Sharia'h law. transfer its ownership to a special purpose vehicle (SPV. then sell investors shares in the SPV. The returns on the shares.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). (x) Islamic hedge fund: At the outset of September 2003. Rating Agencies : Do we need separate rating agencies for the IBFs? Perhaps. Another such alternative likely to be used by them is the old concept of Al Salam. Typically. The lessor in Ijarah owns the leased assets. the expected returns are fixed and can be treated as predictable as the coupon on a conventional bond. An existing Sharia'h compliant offer from this group is a 5-year medium-term note with 100% principal protection provided by Societe Generale. A case in point is the issue of US$ 600 million 5-year floating rate trust Ijarah certificates by the Malaysian government in 2002. A third party can also guarantee rental payments and since the yield is predetermined. according to which a party purchases and leases out equipment required by the client for a rental fee. Thus. The securitisation of leasing transactions and the creation of tradable. Benchmark for lease rentals can be based on a conventional index such as US$ LIBOR which can be either fixed or floating. the underlying assets are tangible and secured. the issuer of the Ijarah certificates acquire assets. This may require specialized technical skills largely absent in the present lo of banks the t Submitted by: Shakeel Ahmad Page 48 of 74 . which is instrumental in alleviating the liquidity constraints of Islamic financial institutions. to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor. The duration of the rental and the fee are agreed in advance and ownership of the asset remains with the lessor. SEDCO claims that the fund is fully transparent to investors.

its monitoring during execution and participation in managing the project may be important to avoid false reporting by the other party.. One could argue that if Islamic mortgages based on Ijara are more efficient. On the other hand. and some like Bahrain which may claim to be over-regulated as they have started applying Basel II in terms of liquidity risk issues. or investment funds. but it attracts 100% capital risk weighting. Some implications that can be more easily visualized are as follows: . even after more than twenty eight years in operation is in defining what they are all about.Cost implications (mainly for estimation of new risk components like operational risks). but still the adequacy norms and risk management are areas that affect them as much as they affect the conventional banks. The Basel committee is unlikely to allow lesser risk weighting for lease across the board. AAOIFI. mutual funds. This is because of the cost implication to implement operational risk monitoring which may cost billions. known as Prudential Information and Regulations for Islamic Banks (PIRI) which takes into consideration standards developed by AOOFIFI and the Basel Committee's various guidelines. Products like mortgages already benefit from Murabaha structure in terms of capital risk weighting (50%) but Murabaha is not considered efficient in terms of early repayment. being developed in cooperation with the Islamic Development Bank and other central banks. IDB initiated a scheme to establish an Islamic Rating Agency recently called the ³International Islamic Rating Agency´(IIRA) to be incorporated as a profit-making independent company. The BMA has developed a framework. Modaraba and Musharika will continue to still attract 100% capital risk weighting. i. Majority of Islamic banks have no such liberty in investing a large amount for that purpose. IIBI Established in 1991 Submitted by: Shakeel Ahmad Page 49 of 74 . Ijara is the preferred mode at present for developing mortgage products. Although some of the regimes regulating Islamic financial institutions are already very stringent. they should attract less capital risk weighting. In an age where creative accounting is considered as creativity rather than sin. the confusion as to whether they are banks. Speculations are rife that banks will need to invest additional amounts (in millions) to comply with Basel II. IBFs will hold a total of 35% of the capital.CAR implications: There is much debate at present amongst western banks if Basel II will be implemented or not. as all banks will rush to reap benefits from Islamic leases. When the International Islamic Financial Market. today. There are views that in western countries it may likely improve the capital risk weighting for Islamic products. The main problem for the IBF. costs to the IBFs may escalate beyond expectations. will be operational the need to comply with the Basel II regulations would be felt even more. selected Islamic banks and Malaysian Rating Corporation (MARC) has been formed. A working group comprising of representatives from IDB. XLRI. and 50% will be held by rating agencies.e. Dubai Campus world over. asset managers. Important Institutions supporting the development of IBF : Institute of Islamic Banking and Insurance: Dar Al-Maal Al-Islami (DMI): HQ in Geneva Al-Baraka: HQ in Jeddah. the IDB 15%. Basel II Implications: The Basel Committee guidelines do not specifically focus on the Islamic Banking and Financial System. .Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). or determining a profit amount etc. Apart from the evaluation of projects. the benefits resulting from IBFs are likely to far exceed the costs.

ethics and Shari'a standards for Islamic financial institutions. the remaining list is tested by a financial-ratio "filter". Dubai Campus Publications: (a) International Directory of Islamic Banks and Institutions 2000. Due to its success over the past months. Sub-component Indices: FTSE Americas Islamic Index FTSE Europe Islamic Index Submitted by: Shakeel Ahmad Page 50 of 74 . any "tainted percentage" of any cash dividend received by a company which is not in accordance with Sharia law is computed. The FTSE Global Islamic Index Series addresses this demand by creating a standard for applicable Islamic equity investing. the purpose of which is to remove companies with an unacceptable debt ratio. AAOIFI was registered on 11 Ramadan 1411 corresponding to 27 March. Managed funds: over $200 billion Agreement of Association signed by Islamic financial institutions on 26 February.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Initially pioneered in January 1999 by The International Investor (TII) and calculated by FTSE. and should be donated to a proper charity. 1990 in Algiers. Finally. The International Islamic Rating Agency The Islamic Financial Services Board The International Islamic Financial Market. 1991 in the State of Bahrain. After removing companies with unacceptable core business activities. TII applies Sharia principles. Index Dow Jones Islamic Market U. Islamic investing is growing by 12-15% per annum. the series was the first truly global Islamic Index series. It was designed to track the performance of leading publicly traded companies whose activities are consistent with Islamic Sharia principles. Index Dow Jones Islamic Market Technology Index Some statistics related to the above indices are presented in Appendix-D FTSE Global Islamic Index Series: The FTSE Global Islamic Index Series (GIIS) are equity benchmark indices targeted at those who wish to invest according to Islamic investment guidelines. the Global Islamic Index Series will now be incorporated into the FTSE family of indices. following guidelines provided by its Fatwa and Sharia Supervisory Committee to rule out those companies whose business activities are incompatible with the Islamic law. Using the FTSE World Index as the universe. governance. auditing.S. XLRI. (b) International Directory of Islamic Insurance 2000 AAOIFI: The Accounting and Auditing Organization for Islamic Financial Institutions is an Islamic international autonomous non-profit making corporate body that prepares accounting. and The Liquidity Management Center The Dow Jones Islamic Market Indexes: Dow Jones Islamic Market World Index Dow Jones Islamic Market Titans 100 Index Dow Jones Islamic Market Asia/Pacific Index Dow Jones Islamic Market Europe Index Dow Jones Islamic Market Canada Index Dow Jones Islamic Market Japan Index Dow Jones Islamic Market U. as more and more international investment bodies stake an interest in this specialist service.K.

if any. prohibited business activities. packaging and processing or any other activity related to pork g) activities deemed offensive to the principles of Islam h) sectors / companies significantly affected by the above The companies that have incompatible lines of business are removed from the "universe" of stocks included in the FTSE World Index.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Muslims (and non-Muslims) can now obtain Islamic credit cards.2bn Equate petrochemical project. Conclusion: Dr. Bahrain's recent $255mn al-Hidd power financing is a case in point. the $55mn Islamic tranche arranged by the Saudi-based Islamic Development Bank and Kuwait Finance House was hailed as a landmark in regional power finance. XLRI. gharar and maysir but also be economically efficient. Ebrahim (1999) argues that the modes of financing selected should not only avoid riba. This convergence is evidence of how the Islamic financial sector is part of the globalizing trend and not rejectionist. Islamic Banks now participate in a wide financing domain stretching from simple Sharia-compliant retail products to highly complex structured finance and largescale project lending. of a dividend paid by a constituent company that has been determined to be attributable to activities that are not in accordance with Islamic Sharia principles and therefore should be donated to a proper charity or charities. Bank of Bahrain and Kuwait and Bank of Tokyo Mitsubishi. Companies that pass these screens are generally eligible for inclusion in the FTSE Global Islamic indices' investable universe. . Lead arranged by BNP Paribas. Islamic banks are now better positioned than ever to participate not only in large scale corporate financing but also more complex wholesale transactions such as syndications and securitization. stocks whose core activities are or are related to the following are excluded: a) banking or any other interest related activity b) alcohol c) tobacco d) gaming e) insurance f) pork production. Financial Screen: Debt ratio: (exclude companies) if Interest-Bearing Debt divided by Assets is equal to or greater than 1/3 or 33.Abdulkader Thomas Submitted by: Shakeel Ahmad Page 51 of 74 . can insure themselves and their property Islamically. Sharia Scholars: The screening criteria of the FTSE Global Islamic range of indices is supported by the credibility of TII's Fatwa and Sharia Supervisory Committee (Sharia Board).33%. Dividend Cleansing: "Tainted dividend" receipts relate to the portion. or revenues from. Companies classified in other industry groups may also be excluded if deemed to have a material ownership in. Dubai Campus FTSE Pacific Basin Islamic Index FTSE South Africa Islamic Index Sector Screens: By way of guidance. can invest on line in Islamic funds can track their investments Islamically and can even get a Sharia-compliant mortgage from a US firm. Islamic finance offers another set of well-understood tools within the understood frameworks of modern banking and finance . KFH had earlier helped set an inter-creditor agreement precedent when it secured in 1995 a $200mn Islamic tranche for Kuwait's $1. In search of this economic efficiency. HSBC Amanah. In essence.

Moreover. What is needed at this moment is an out-of-the-box thinking even if sounds like reinventing the wheel. About 50 percent of the respondents believed that Islamic banking products and services had a good potential to be accepted by customers. Haron et al (1994) who pioneered the research on bank patronage in Malaysia found that almost 100 percent of Muslims and 75% non-Muslims were aware of the existence of Islamic banks. however genuine and worthy. In another study wherein the respondents were individuals who had financial decision-making authority in the Malaysian corporate sectors. Similarly. they seem to have failed to do away with undesirable aspects of interest.failaka.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). This will require a bold initiative towards a total unwinding of the current system and a lot of unlearning before we could even conceive of a reasonable amount of success in clearing the clouds of ambiguity. Even if one concludes that the resource available with Islamic Financial System is peanuts compared to its conventional counterpart. and 80% of which were non-muslims. it looks like many techniques that the interest-free banks are practising are neither in full conformity with the spirit of Shari¶ah nor practicable in the case of large banks (or the entire banking system). and thus. seem to be swamped within the muddle of well-developed and widely accepted financial system of conventional banking and finance. it becomes very difficult to distinguish the Islamic instruments from the conventional ones. this study found no evidence of Muslims and non-Muslims differing in their bank¶s selection criteria. This is because these institutions have attempted to start from where the conventional banking system has left. The ultimate winner is the one who dares to At first glance. We feel that the basic infrastructure necessary for building an entirely new structure for the Islamic Financial System is not just available but is quite strong already. there is no need to despair. The solution lies not in changing the look or personality (face value) of the conventional instruments ± which is the primary reason for all the confusion ± but in evolving afresh. About 75 per cent indicated that Islamic banks in Malaysia however had not done enough marketing in promoting their products and services to corporate customers. they seem to have retained what an Islamic bank should eliminate. What is required at the moment is the ³strategy as stretch and leverage´ that Hamel and Prahlad (1993) advises. Gerrard and Cunningham (1997) found that just like their Malaysian counterparts. XLRI. Singaporean Muslims were more aware of the existence of Islamic banking than the non-Muslims. The innovations. For a commoner. While applying Haron et al¶s study. Dubai Campus 9% 23% 11% 57% Don't provide good return Lack reputation Can't find a Halal investment Others Fig-18: Survey Results ± Demand for Islamic Investments in America Source: www. Almost half of the individuals surveyed Submitted by: Shakeel Ahmad Page 52 of 74 . Ahmad & Sudin Haron found that more than 55 per cent perceived that both religion and economics were the patronage factors in this system.

Dubai Campus believed that the Islamic banking system had a good potential as an alternative to the conventional system. In order to give the conventional system any semblance of competition. And their appeal is expanding. They have already established a niche by roping in the Muslim community. particularly with the number of proponents of Ethical Banking and Finance on the rise in other communities. and convince everybody not just about the ethical aspects but also the economic benefits that it carries ± in fact it will have to prove that it is more profitable than its conventional counterpart. Submitted by: Shakeel Ahmad Page 53 of 74 .Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). it has to grow out of the niche. XLRI. The future is definitely bright for the Islamic banking and finance.

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AlMejren.001)/ 2 = 0. Recommendations of the Study By reviewing the weaknesses of the Kuwaiti banks compared to other GCC banks. Other banks in the GCC countries share the same view with the Kuwaiti banks.2 ± 0. XLRI. Dubai Campus APENDIX A0: Estimation of TAI for UAE Estimation of TAI for UAE to compare with TAI values of other countries in HDR (2001) is shown as below: (A) Calculation of the Technology Creation Index: Patent Index = (0.0.Increase the awareness as to the international financial developments and their local implications.198)/ 2 = 0.1)/ (27. .0 ± 0. 1.0) = 0.490 Technology Achievement Index (TAI ) = (0.987 + 0.9 .0)/ (80. The Islamic financial institutions are seen as a strong competitor for the banks in Kuwait.974 Electricity Index = 1.969) Diffusion of old innovations Index = (0.Increase the size of investment in information technology and communications up to the levels prevailing at non-Kuwaiti banks. Mudaraba and Murabaha services came at the forefront of Islamic banking services.974 + 1.0)/ (994 ± 0) ««««««.Increase the level of expenditure on training and human resources development.090 + 0.0005 (B) Calculation of Diffusion of Recent Innovations Index : Internet Host Index = (20.0005 + 0.000 + 0.8)/ (12.198 Diffusion of Recent Innovations Index =( 0. Issue no. now and in the future. 2.0.490) / 4 = 0.1) = 0. .441 APPENDIX-A: Competitiveness of Banking Sector In Case of Opening Local Markets to GCC Banks (Kuwait Foundation For Advancement of Sciences) Ghanem.Increase the level of experience for national manpower.288 (C) Calculation of Diffusion of old innovations Index: Telephony Index = [log {407 (Tel mainlines per 1000 people) + 347 (Cellular mobiles per 1000 people)} ± log(1)]/ [log(901)-log(1)] = 0. Submitted by: Shakeel Ahmad Page 59 of 74 .892 KWH per capita is above the goalpost (6. because its consumption of 9.980/ 2 = 0.288 + 0. (the official journal of the Union of Kuwaiti Banks. Al MASARAF.114 Human Skills Index = 0.4 .0) = 0. (1999 figure taken from USPO for number of Patents) = 0. 2002). and upgrade their readiness to meet the challenges of GCC banks or international banks.090 High and Medium Technology Export Index (ERF-2002) = (16. ElSakka.5 . 2.0 ± 0.Explore methods to increase the return on their assets up to the levels prevailing at nonKuwaiti banks.8) years: Expected Years of schooling from ERF (2002) = 0.Enhance their confidence in the ability to face foreign competition. .4 ± 0. we find that the Kuwaiti banks need to take the following actions: .0)/ (232.001 Royalty and Licence fee Index = 0 (assumed to be zero) Technology Creation Index = (0.000)/ 2 = 0. Paul. AlMahmeed.987 (D) Calculation of the Human Skills Index: Mean Years of Schooling Index = (10.0. . .866 Gross Tertiary Science Enrolment Index = (3.990 .8 ± 0.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).

.Strengthen their presence in the areas of advisory and investment services.Improve staff productivity. and ensure the good quality of the training provided to their staff . as such services represent an important source of income.Study the problem of staff absence and its reasons and treat it more seriously. with the exception of Omani banks. . because their share of these services is the least among GCC banks. . . Gulf or international.Improve FX and foreign operations risks management. Submitted by: Shakeel Ahmad Page 60 of 74 . Musharaka and Istisna. . There is also a need for expansion in futures and options. private funds management and investment advisory services. Mudaraba.Expand services delivery through the internet. particularly investment advisory services and investment portfolios management.national companies.Improve annual planning and control systems. .Expansion in insurance services to strengthen the role of these services as a source of income. . . .Study the opportunities of forming unions with other banks. whether local. and expand in the areas of issuing certificates of deposits and rendering brokerage services. .Allocate more financial resources to enhance staff flexibility and reinforce their ability to work as a team. likewise Qatari and Omani banks. .Develop an IT strategy.Establish and enhance the presence in GCC and Arab markets in general. .Reinforce relationships with the segments of the general public and multi. . likewise the banks in UAE. .Activate the role of foreign exchange services and certificates of deposits in revenues generation. because the results of the study indicated that the strength of Kuwaiti banks association with their customers in GCC markets is the weakest. options. so as to ensure staff satisfaction and consistency of those systems with the standards prevailing in the industry.Start to use the Smart Cards. whether local.Adopt more intensive plans for automating banking operations in line with other GCC banks.Exploit the opportunities offered by the GCC agreement on the liberalization of banking services.Consider the opportunities of merging with other banks. so as to more positively reflect on their performance. with the exception of Omani and UAE banks. . .Increase the attention given to the evaluation and review of training activities.Enhance the role of Musharaka and Istisna services as sources of income.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). as these services rank the first at Omani banks and the second at Saudi and UAE banks.Create more stability for staff in order to avoid the adverse implications of the high turnover. Dubai Campus . .Adopt plans for diversifying products and markets in line with other GCC banks. . . XLRI. capital markets. .Upgrade capital adequacy ratio to be in line with the levels prevailing at other GCC banks. such as money markets.Reinforce their Islamic banking services in the areas of Murabaha. and their association with their customers in Arab markets is also the weakest. . . .Periodic review of benefits and incentives. futures. . and enhance the readiness for expansion in new markets. investment portfolios management.Expand in advisory and investment services in the manner mentioned above. Gulf or international.

Deutsche Bank Rep office u. j. Nassau. Bahrain Islamic Bank Bsc. Albaraka Islamic Investment Bank d.C e. Albaraka Bangladesh Ltd (Dallah Al Baraka Group). for Securities and Investment Funds c. Algiers 3. Faysal Investment Bank of Bahrain n. XLRI. ABC Islamic Bank s. Al Amin Co. MCCA (Muslim Community Co-operative. Arab Albanian Islamic Bank. Dar al Mal al Islami Trust. First Islamic Investment Bank 6. Bahamas f.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Bahrain Monetary Agency y. Bangladesh a. Islamic Investment Company of the Gulf q. Australia a. Dhaka b. e. Bsc. Faisal Islamic Bank Submitted by: Shakeel Ahmad Page 61 of 74 . Banque Albaraka D'Algerie. Bank Melli Iran i. Islami Bank Bangladesh Ltd. Citi Islamic Investment Bank (Citicorp) k.php#albania) 1. 5. ABC Investment & Services Co EC b. Closed g. Massraf Faysal Islamic Bank & Trust. Bahamas Ltd. Dhaka c. Algeria a. Akida Islamic Bank International Ltd b. Turk Gulf Merchant Bank x. Islamic Investment Company of the Gulf Ltd. Dubai Campus APPENDIX-B: Islamic Financial Institutions in the World (Source: Islamic Institute of Banking and Insurance. Australia) b. Faysal Islamic Bank of Bahrain (Massraf Faisal Al Islami) o. Bahamas a. Chase Manhattan Bank N. Dallah Albarakah (Ireland) Ltd m. Bahrain Institute of Banking & Finance h. Khaleej Investment Company aa. Bahrain a. Investors Bank Shamil Bank z. Albania a.islamic banking. Nassau d. f. Arab Islamic Bank E. http://www. TAIB Bank of Bahrain w. MCCU (Muslim Community Credit Union) 4. Dallah Albaraka (Europe) Ltd l. Bahrain Islamic Investment Co. Gulf International Bank BSC p. Istishara Consulting Trust.A. Tirana 2. Islamic Trading Company r. ABN Amro Bank t. Bank Al Taqwa Ltd c.

Indonesia a. Bank Muamalat Indonesia. (Dallah Al Baraka Group) b. Djibouti a. Tehran b. Alwatany Bank of Egypt. Toronto 10. Canada a. Al-Falah Investment Ltd 19. BNP Paribas 15. British Virgin Islands a. Conakry b.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Algerian Saudi Leasing Holding Co. Cairo b. Ibn Majid Emerging Marketing Fund (International Investor Group) b. Bank Keshavarzi (Agricultural Bank). Guinea a. Germany a. Islamic Bank International for Investment and Development. XLRI. Deutsche Bank 17. Al Tawfeek Co. Iran b. Cairo g. Faisal Islamic Bank of Egypt. Egyptian Saudi Finance Bank (Dallah Al Baraka). Brunei a. Societe General c. Dubai Campus 7. Iran a. Gulf Company for Financial Investment e.A. Arab Gambian Islamic Bank 16. for Investment Funds Ltd. Cairo h. National Bank for Development. Banque Albaraka Djibouti 13. Egypt a. Islamic Bank of Brunei Berhad b. Islamic Co-operative Housing Corporation Ltd. Jakarta c. Massraf Faisal al Islami of Guinea. Dar Al-Maal Al-Islami Trust d. Cairo 14. Jakarta 20. Ibn Khaldoun International Equity Fund Ltd 8.. Egyptian Company for Business and Trade S.. Faisal Finance (Denmark) A/S 12. Cayman Islands a. Subsidiary of Albarka Group "DBG" 11. Karnatka b. France a. Al Barakah Islamic Investment Bank b. Cairo f. Al Ameen Islamic Financial & Investment Corp. Islamic Development Bank of Brunei Berhad c. Gambia a. Tabung Amanah Islam Brunei 9. (India) Ltd. Islamic Investment and Development Co.E c. Bank Muscat International (SOAG) c. PT Danareksa Fund Management. Tehran Submitted by: Shakeel Ahmad Page 62 of 74 . Bank Maskan Iran (Housing Bank). Banque Islamique de Guinee 18. Capital Guidance d. Denmark a. India a. Commerz Bank c. Bank Sepah. Cairo d.

Safat e. Kuala Lumpur f. Securities Commission m. The International Investment Group c. Kuala Lumpur c. XLRI. Kuala Lumpur k. Labuan Offshore Financial Services Authority (LOFSA) n. Takafol S. United Malayan Banking Corp. Arab Malaysian Merchant Bank Berhad. Tehran e. Berhad. Faisal Finance (Luxembourg) S. Bank Sepah. Kuala Lumpur h. Malaysia l. Jordan a. Arab-Malaysian Bank Berhad iv. Kuwait Finance House. Tehran g. Bank Utama (Malaysia) Berhad v. Bank Mellat. Kuwait Investment Co . Bank Sanat Va Maadan (Bank of Industry and Mines). Iran b. Dubai Campus c. Gulf Investment Corporation b. Islamic Finance House Universal Holding S. Labuan b. Bank Melli Iran. Kuala Lumpur j. Dallah Al Baraka (Malaysia) Holding Sdn Bhd g. Tehran 21. Tehran h. Tehran f. Bank of Beirut 26. Kuala Lumpur i. Iraqi Islamic bank for Investment and Development 22. Gulf International Bank.Dar Al-IsethmarSecurities House 25. Bank Islam Malaysia Berhad. Italy a. Amman 24. Malaysia a. International Trading Co. Commercial Banks: i. Luxembourg a. Multi-Purpose Bank Berhad. Luxembourg c. Iraq a. Tehran d. Al Barakah Bank c. Malayan Banking Berhad (Maybank). Malaysian banks with Islamic windows a. Islamic banking & Takaful Dept. Kuwait a. Lembaga Urusan Dan Tabung Haji (Fund).Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Bank Saderat Iran. Kuala Lumpur e. Bahrain b. Bank Kerjasama Rakyat Malaysia Berhad. Jordan Islamic Bank for Finance and Investment. Safat d. The International Investor. of Africa 23. Bank Bumiputra Malaysia Berhad. Alliance Bank Berhad iii. Affin Bank Berhad ii. Bank Negara Malaysia 28.A b. Citibank Berhad Submitted by: Shakeel Ahmad Page 63 of 74 . Lebanon a. Faisal Holding. Bank Muamalat Berhad. Bank Tejarat. Jordan Islamic Bank (Subsidiary of Dallah Al Barka Group) b. Adil Islamic Growth Fund (Innosabah Securities Sdn Bhd). Kuala Lumpur d. Bank Sepah.A d.A 27.

Niger a. Asia Commercial Finance Berhad iv.A b. EON Bank Berhad vii. Affin Discount Berhad iii. Nigeria a. Morocco a. RHB Bank Berhad xiii. BBMB Discount House Berhad v. OCBC Bank (Malaysia) Berhad xi. Discount Houses: i. Malaysian International Merchant Bank Berhad v. XLRI. Dubai Campus vi. Ahmed Zakari & Co 33. United Merchant Finance Berhad c. Faisal Finance Maroc S. Alliance Finance Berhad ii. Banque Alabaraka Mauritaninne Islamique (Dallah Al Baraka Group). Bank Saderat Iran. Hong Leong Finance Berhad vi. Amanah Short Deposits Berhad iv. Mauritania 30. Southern Bank Berhad xiv. The Netherlands c. KAF Discounts Berhad vi. Hong Leong Bank Berhad viii. Alliance Merchant Finance Berhad ii. Oman Arab Bank Submitted by: Shakeel Ahmad Page 64 of 74 . Affin Merchant Bank Berhad d. Mayban Finance Berhad viii. MBf Finance Berhad ix.V d. EON Finance Berhad v. Malaysia Discount Berhad vii. Mauritania a. Aseambankers Malaysia Berhad iv. Banque Islamique Du Niger. Bank Muscat International b. Public Finance Berhad x. Niamey 32. Public Bank Berhad xii. Habib Nigeria Bank Ltd b. Kewangan Bersatu Berhad vii.V 31. Mayban Discount Berhad 29. Faisal Finance (Netherlands ) B. Malayan Banking Berhad x. Merchant Banks: i. Arab-Malaysian Merchant Bank Berhad iii. Standard Chartered Bank Malaysia Berhad b. Muscat c. HSBC Bank (M) Berhad ix. Abrar Discounts Berhad ii.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Finance Companies: i. Faisal Finance (Netherlands Antilles) N. Oman a. Arab-Malaysian Finance Berhad iii.

Meezan Bank Limited 35. Banque Islamique Du Senegal 40. Islamic Investment Company of the Gulf Ltd. Palestine a.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Senegal a. Qatar a. Khartoum d. Durban (Dallah Al Baraka Group) 41. Cupola Asset Management SA. Geneva Submitted by: Shakeel Ahmad Page 65 of 74 . Khartoum i.C. Faysal Bank Ltd. Jeddah b. Khartoum. Amana Islamic Bank b. f. Islamic Co-operative Development Bank. Doha 37. Dar Al Maal Al Islami Trust. Karachi e. Al Baraka Al Sudani. Russia a. Sharjah b. Pakistan d. Al Tadamon Islamic Bank. Islamic Bank of Western Sudan. Qatar International Islamic Bank. Srilanka a. Geneva b. BADR Bank 38. Shamil Bank f.. Islamabad b. Dubai Campus 34. Arab Leasing International Finance (ALIF) Ltd d. Doha c. Switzerland a. Dammam e.. Cairo Amman Bank d. Faisal Finance (Switzerland) SA. National Commercial Bank Ltd. Sudanese Islamic Bank 43. Islamic Development Bank. Saudi Holland Bank j. Animal Resources Bank e. The Palestine Islamic Bank 36. Bank Al Jazira 39. Albaraka Investment and Development Co. (Dallah Al Baraka Group) b. Arab Islamic Bank b. Geneva c. Khartoum g. Al Rajhi Banking and Investment Corp. Jeddah. Khartoum h. Arab Islamic International Bank (AIIB) Plc c. Amana Takaful Limited 42.. Al Faysal Investment Bank Ltd. XLRI. Al Towfeek Investment Bank Ltd (Dallah Al Baraka Group). Riyad Bank h. Pakistan a. Faysal Islamic Bank of Bahrain E. South Africa a. Palestine International Bank e. Riyadh c. Saudi American Bank. Albaraka Bank Ltd. Qatar Islamic Bank SAQ. Al Shamal Islamic Bank c.. Jeddah g. El Gharb Islamic Bank (Islamic Bank for Western Sudan) f. Saudi Arabia a. National Investment Trust Ltd. Lahore c. Jeddah i. Sudan a. Faisal Islamic Bank of Sudan.

London h. (Goldman Sachs International Finance) Ltd. Al Rajhi Investment Corporation. London g. Dubai Campus d. Global Islamic Finance. Re-Insurance (Dallah Al Baraka Group) 45. Dubai i. Turkey e. United Arab Emirates a. Aron & Co. London m. Beit Ettamwil al Tunisi al Saudi. Arab Banking Corp 48. United Bank of Switzerland (UBS) f.T.. London f. National Bank of Dubai 47. Emin Sigorts A. London d.S c. J. Dallah Al Baraka (UK) Ltd.S.E.S 46. London d. London b. Riyadh Bank . London 49. Albaraka International Ltd. Al Safa Investment Fund e. Bank Muscat International (SOAG) c. National Bank of Sharjah h. Bank Sepah. Ireland Submitted by: Shakeel Ahmad Page 66 of 74 . Abu Dhabi. Pan Islamic Consultancy Services Istishara SA. Pictet & Cie 44. London c. London b. Dubai Islamic Bank. Ihlas Finance House f. Islamic Investment Company of the Gulf Ltd. Dubai d. Istanbul. Tunisia a. Asya Finans Kurumu A. d. Cedel International. Turkey a. Bahrain j. Islamic Investment Banking Unit (IIBU). Sharjah Subsidiary of Dar Al Maal Islami Trust g. Islamic Investment Company of the Gulf Ltd. London g. Kuwait-Turket Evkaf Finance House g. XLRI. IBJ International. Citibank International Plc. Bahrain e. ABC International Bank. Abu Dhabi Islamic Bank b. Faisal Finance Institution. Iran f. HSBC Amanah Finance j. Albaraka Investment Co. London c. f. Ltd. HSBC Investment Bank Plc i. The Halal Mutual Investment Company Plc k.. London e. HSBC. Geneva e. Barclays Capital i. Tunis (Dallah Al Baraka Group) b. Takafol (UK) Ltd. United Kingdom a. Arab Bank Plc.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Gulf International Bank Bsc. Dawnay Day Global Investment Ltd h. Gulf International Bank. B. United Bank of Kuwait. Albarakah Turkish Finance House Istanbul b. ANZ International Merchant Banking. United Kingdom banks with Islamic windows a. London (Subsidiary of Industrial Bank of Japan) l. ABCIB Islamic Asset Management. Faisal Islamic Bank of Kibris Ltd.

Jersey. Jersey) 50. Houston TX o. Indianapolis IN q. Faisal Islamic Bank d.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Dayton OH p. Inc. Fuloos Incorporated. Samad Group. Abrar Investments.. Iran i. San Francisco g. Bank Sepah. St Helier.. Chicago IL l.. State St. Ameen Housing Co-operative. Inc. Sana e.Massraf Faysal Al-Islami Ltd. Yemen Islamic Bank. Inc. MEF Money. Bellingham WA f.. United States of America a. Sana b.. Englewood NJ d. UK (+534) c. Inc. New Jersey j. Inc. Saba Islamic Bank. Clifton NJ n. Toledo OH m. (ICUM) t. Hudson Investors Fund. Sana Submitted by: Shakeel Ahmad Page 67 of 74 .. Islamic Credit Union of Minnesota. Dow Jones Islamic Index Fund of the Allied Asset Advisors Funds k. Failaka Investments. d. Amana Mutual Funds Trust. Dublin b. HSBC. Al-Madina Realty. XLRI. MSI Finance Corporation. Al-Baraka Bancorp Inc. Inc.. Yemen National Investment Co. Al-Manzil Islamic Financial Services e. BMI Finance & Investment Group. Islamic Bank of Yemen for Finance and Investment. MFAI (Jersey) Limited (formerly . Shared Equities Homes. American Finance House h. United Mortgage 51. Dubai Campus a. Stamford CT b. The Islamic Investment Company. Al Meezan Commodity Fund Plc. Sana c. USA s. Yemen a. USA r. Chicago c.

for Investment May-96 Funds Arab National Bank Securities House Bank Kanz Barclays Private Bank Commerical Bank of Qatar/BNP Citi Islamic Investment Bank Wafra Invest.000 $1. Apr-99 Mar-98 N/A Feb-00 Dec-99 Oct-97 Jul-99 Mar-00 Sep-96 May-00 Late 2001 Aug-98 12 Arab Investor Crescent Fund Schroder Investment Mgmt Int'l 13 14 15 16 17 Arzaq Investment Fund Bank Kanz Global Islamic Equity Barclays Global Equity Caravan Fund Citi Global Portfolios Global Alliance/Securities House Bank Kanz Wellington Management Co. LLP HSBC Amanah Finance HSBC Bank USA Miraj International Investment Ltd.000 $50.000 $10. Pictet & Cie Roll & Ross Asset Management Al Baraka Investment Bank Al Rajhi Banking & Investment National Commercial Bank (NCB) Securities House Wafra Investment Advisory Group The International Investor/Pictet & Cie Permal Asset Management Arab Bank Plc National Bank of Kuwait Bank Al-Jazira Dec-97 Jul-96 Jan-95 Apr-00 Aug-98 Feb-98 Dec-97 Oct-00 Jan-95 Sep-98 $25.000 $2.000.000 Fund Manager(s) Fund Promoter(s) Inception Date Min.000 $100. Advisory / AlTawfeeq First Investment Co Wellington Management Co.000 $100. LLP SSB Citi Asset Management Brown Brothers Harriman & Co.000 $100. Invest 3 Al-Ahli Global Trading Equity 4 5 6 7 8 9 Al-Bait Global Equity Al-Bukhari Global Equity Al-Dar World Equities Alfanar Investment Holdings Al-Firas Global Equity Al-Kawthar Fund 10 Al-Khair Global Equity Fund 11 Al-Safwa International Equity Al-Tawfeek Co.500 $10.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).000 $10. Alliance Capital Management LP Wellington Management Co. XLRI.000 $10.000 $5.000 $ Fund Name Global Equity Funds 1 2 Al Baraka Global Equity Al Rajhi Global Equity Mercury Asset Management UBS Asset Management Wellington Management Co.000 50 Shares $2. LLP Fremont Investment Advisors Inc.failaka.) SA N/A Royal Bank of Canada 18 Dow Jones Islamic Index Fund 19 Global Equity 2000 Sub-Fund 20 Hegira Global Equity 21 HSBC Amanah Global Equity 22 23 Islamic Global Equity * Miraj Global Equity Submitted by: Shakeel Ahmad Page 68 of 74 .000 $10. LLP HSBC Investment Funds (Lux.000 $5.000 $50.000 $5.000 $5. Dubai Campus APPENDIX-C: Islamic Equity Funds in the World List of Islamic Equity Funds (www.000 $10.000.000 $10. Wafra Investment Advisory Group Pictet & Cie Worms & Cie/SEDCO Arab Bank Plc Wellington/Al-Ahli Global Trading Eq. LLP Wellington Management Co.000 $10.

000 S$1.000 $500 C$500 European Equity Funds 43 Al-Ahli Europe Trading Equity 44 45 46 Al-Dar Europe Equities Alfanar Europe Al-Sukoor European Equity Gulf Int'l Bank (UK) Ltd. LLP Worms & Cie/SEDCO Orbitex Management Ltd.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).000 $1.000 $50.000 Submitted by: Shakeel Ahmad Page 69 of 74 .000 £1. Worms & Cie/SEDCO Worms & Cie/SEDCO Saturna Capital Saturna Capital Azzad Asset Management Azzad Asset Management Azzad Asset Management Allied Asset Advisors Funds Nova Bancorp Group National Commercial Bank (NCB) Permal Asset Management Permal Asset Management Saturna Capital Saturna Capital Azzad Asset Management Azzad Asset Management Azzad Asset Management Allied Asset Advisors Funds Nova Bancorp Group Dec-92 Jun-99 May-99 Feb-94 Jun-86 Dec-00 Feb-98 Sep-01 Jun-00 Jul-99 $2. & IT Fund Franklin Mgmt & Lord Abbott Al Rajhi Banking & Investment Wellington Management Co. AG & UBS Brinson Malayan Banking & Daiwa Securities Malayan Banking & Daiwa Securities TAIB Bank of Bahrain UBS Islamic Fund Mgmt Co $2. Singapore Unit Trust Ltd. XLRI.000 $100 $100 1.000 $100. Jun-99 Aug-98 Jun-99 Dec-99 200 Shares $2.000 Parosoli Capital & Finance Ltd.000 $5.000 $5.000 S$1. Pictet & Cie Worms & Cie/SEDCO Commerz Int'l Cap Mgmt/AlTawfeeq Co. Jun-01 Global Asset Management (GAM) Qatar Islamic Bank N/A Dec-99 Aug-01 Aug-01 Mar-00 May-00 SAMBA Capital Management SAMBA Capital Management Singapore Unit Trust Ltd.000 $5.000 47 Al-Thoraiya European Equity Small Cap & Technology Equity Funds 48 49 50 51 Al Rajhi Small Companies Al-Ahli Small-Cap Trading Equity Alfanar Essex Technology Orbitex Islamic Comm.000 30 TAIB Crescent Global Fund 31 UBS Islamic Fund Global Equities North American Equity Funds 32 33 34 35 36 37 38 39 41 42 Al-Ahli US Trading Equity Alfanar US Capital Growth Alfanar US Capital Value Amana Growth * Amana Income * Azzad DJIM Index Fund * Azzad Growth Fund LP Azzad Income Fund Dow Jones Islamic Index (US) Fund * SAMI Navigator INVESCO Capital Mgmt Inc. Dubai Campus 24 25 26 27 28 29 Musharaka Equity Fund Parsoli Global Equity QIB Global Equities SAMBA Global Equity SUT Ethical Growth Fund SUT Ethical Value Fund N/A Riyad Bank Jun-97 $10. Lomard Odier & Cie National Commercial Bank (NCB) The International Investor/Pictet & Cie Permal Asset Management Commerz Bank/Burgan Bank Bank Al-Jazira Nov-94 Feb-98 Jan-99 Mar-00 Sep-99 $2.000 1 Share $5. Wright Investors' Service UBS. National Commercial Bank (NCB) Permal Asset Management Orbitex Management Ltd.000 $5.00 $100.000 $50. Parosoli Capital & Finance Ltd.000 $100.

000 $10.000 RM 1. Parosoli Capital & Finance Ltd. XLRI.000 $2.000 $25.000 Al Rajhi Banking & Investment Al Rajhi Banking & Investment Nov-98 Al Rajhi Banking & Investment Al Rajhi Banking & Investment Dec-98 National Commercial Bank (NCB) National Commercial Bank (NCB) National Commercial Bank (NCB) The International Investor BHLB Pacific Trust Nov-99 Feb-00 Oct-99 Jul-97 Mar-01 Al-Ahli Global Equity Secured Wellington Management Co.000 $5. Parosoli Capital & Finance Ltd. Submitted by: Shakeel Ahmad Page 70 of 74 . Investment Management 68 Al Rajhi Middle East Equity 69 Al-Ahli Saudi Trading Equity 70 Al-Dar Eastern Europe Equities 71 Al-Taiyibat Fund (local share) 72 First Arabian Equity 2000 Al Rajhi Banking & Investment May-98 200 Shares National Commercial Bank (NCB) The International Investor/Pictet & Cie Bank Al-Jazira First Investment Company The International Investor Al-Mal Islamic Company Jun-98 Feb-98 Sep-98 N/A Nov-95 N/A Jan-99 1996 $100.000 $100. Dubai Campus TII Small Cap Equity (European) 52 Pictet & Cie The International Investor Dec-96 $100. Shares Al Rajhi Egypt Equity Al Rajhi Local Share Fund Arab National Bank EFG Hermes Arab National Bank Al Rajhi Banking & Investment May-93 SR 10.000 SR 5.000 $100.000 SR 10.000 $5. (Series B) LLP Al-Ahli International Equity Secured Al-Ahli US Equity Secured Alkhawarizmi Fund BHLB Pacific Dana Al Mizan (Balanced) Faysal Shield Fund Mutajarah Fund (Balanced) Deutche Bank Deutche Bank AXA Rosenberg BHLB Pacific Trust Banque National de Paris Swiss Alternative Investment Strategies Group (SAIS) Faysal Islamic Bank of Bahrain Nov-99 Towry Law International Oct-01 N/A Profit Sharing Fund (Aman-1) Al Rajhi Banking & Investment Al Rajhi Banking & Investment (secured) Emerging Market & Country Equity Funds 65 66 67 Al Arabi Saudi Co. Oasis Asset Management Ltd.000 73 Ibn Majid Emerging Markets 74 75 76 Khaled Ibn el-Waleed Fund Oasis Crescent Fund Parsoli Islamic Equity Oasis Asset Management Ltd.000 $25. Secured & Other Equity Funds 53 54 55 56 57 58 59 60 61 62 63 64 Al Hilal Fund Al Kawthar Global Equity Secured Al Rajhi Balanced Fund I Al Rajhi Balanced Fund II Mercury Asset Management National Commercial Bank (NCB) Abu Dhabi Islamic Bank (ADIB) National Bank of Kuwait Apr-00 Sep-99 $10.000 Balanced.000 Jun-97 Jul-92 200 Shares 1 Share Al Rajhi Banking & Investment Al Rajhi Banking & Investment Bakheet Financial Advisors Bakheet Financial Advisors Pictet & Cie Bank Al-Jazira Invesmtent Services N/A UBS Brinson PrimeCorp.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).000 $100.000 $25.000 $100.

XLRI.000 RM 1.000 S$1. for Investment Funds Mendaki Holding Pte. RHB Unit Trust Mgt Kuala Lumper Mutual Funds Mayban Life Assurance Bhd.000 S$500 80 Al-Mashariq Japanese Equity Julius Baer Asset Management 81 82 83 Al-Nukhba Asian Equity Mendaki Global Fund Mendaki Global Fund Nomura Investment Bank DBS Asset Mgmt DBS Asset Mgmt Malaysian Equity Funds 84 85 86 87 88 89 90 91 92 93 94 95 Abrar Investment Fund Amanah Saham Bank Islam Amanah Saham Darul Iman Amanah Saham Wanita BBMB Dana Putra BHLB Dana Al-Ihsan Dana Al-Aiman Kuala Lumpur Ittikal Fund Mayban Dana Yakin Pacific Dana Amana RHB Mudarabah Fund Tabung Amanah Bakti Abrar Unit Trust Managers BIMB Unit Trust Mgmt Bhd. Jun-00 Aug-01 Aug-01 RM 1.000 Asian Equity Funds 79 Al-Ahli Asia Pacific Trading Equity Gulf Int'l Bank (UK) Ltd.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04). Ltd May-00 Apr-00 Jul-98 Sep-97 May-91 $2.000 RM 1.000 99 Dahlia Syariah Income Fund Submitted by: Shakeel Ahmad Page 71 of 74 .000 $5.000 RM 1. PTB Amanah Saham Darul Iman Hijrah Unit Trust Management Bhd Abrar Unit Trust Managers Bank Islam Malaysia Bhd PTB Amanah Saham Darul Iman Hijrah Managers Bhd 1996 Jun-94 Oct-94 May-98 RM 100 500 Shares BBMB Unit Trust Management BBMB Unit Trust Management Jun-96 BHLB Pacific Trust Mara Unit Trust Kuala Lumpur Mutual Funds Mayban Mgt Berhad Pacific Mutual Fund Trust RHB Unit Trust Management Asia Unit Trust Berhad Arab-Malaysian Unit Trusts Bhd BHLB Pacific Trust Mara Unit Trust Kuala Lumpur Mutual Funds Mayban Mgt Berhad Pacific Mutual Fund Trust RHB Unit Trust Management Tabung Amanah Bakti Arab-Malaysian Unit Trusts Bhd May-98 May-68 May-97 Nov Apr-98 RM 500 RM 100 RM 1.000 $10. Dubai Campus Futuregrowth Unit Trust Management Riyad Bank Futuregrowth Unit Trust Management Riyad Bank 77 78 Pure Specialist Fund Riyad Equity Fund 2 (Saudi Shares) Jun-92 Nov-96 R 200 SR 10. National Commercial Bank (NCB) Bank Al-Jazira Al-Tawfeek Co. Ltd Mendaki Holding Pte.000 RM 1.000 May-96 500 Shares May-71 Jan-93 RM 500 500 Shares 96 Tabung Ittikal Arab-Malaysian Islamic Bonds (Sukuk) Funds 97 98 RHB Islamic Bond Kuala Lumper Islamic Bond Fund RHB Unit Trust Mgt Kuala Lumper Mutual Funds Mayban Life Assurance Bhd.

84 13.591.25 -9.3 4.70 P/ Cash Flow 11. Index Dow Jones Islamic Market U.806.06 1.42 22.504.0 574.2 4.3 4.69 0.62 9.S.0 1.27 -13.42 1.6 2.69 -4.31 -18.00 0.S.07 10.1 401.69 YTD -3. Index Dow Jones Islamic Market U.92 -19. Index Price Return (%) 1-Month 0.88 0.87 -28.78 -4.71 Annualized Price Return (%) 1-Year -24.S.7 0. Index Dow Jones Islamic Market U.83 -6.456.77 18.01 Fundamentals Index Name Dow Jones Islamic Market U.61 -7. Index Dow Jones Islamic Market U.209.70 4.26 -6.49 3.73 1.33 P/B 3.66 0.96 Dividend P/ Sales Yield (%) 1.6 4.64 5-Year -4.35 -25.71 -17.90 -2.00 0.5 0.5 Floatadjusted 6.06 1.S.4 0.K.5 Mean 4.36 14.95 12.86 -22.34 9.2 Smallest 0.00 0.S.71 10.36 1.4 8.89 16.08 1.00 Performance Index Name Dow Jones Islamic Market U.S.28 14.84 -1.57 -3.12 2.2 142.58 14.56 10.5 83.01 -6.59 -23.18 19.14 24.S.00 0.2 0.93 -25.7 723.18 -24.31 14.24 1.95 -39.69 20.603.S. Index Dow Jones Islamic Market U. Index Dow Jones Islamic Market U.0 4.9 223.76 22.35 -19.46 2.S.1 0.84 26. Index Dow Jones Islamic Market U.50 0.91 16.0 7.45 17.63 0.09 -27.28 7. Index Dow Jones Islamic Market U.61 0.45 -30.40 16.4 Median 0.88 21.1 30.004.69 1.4 Largest 234.S.5 30.04 2.29 22.25 -25.6 1.66 19.31 -1.98 2.80 -28.2 631.S.0 0.1 0.56 Submitted by: Shakeel Ahmad Page 72 of 74 .S.80 1.3 2.S.391.03 21.10 19.01 0.32 18. Index Dow Jones Islamic Market U.7 0. Dubai Campus APPENDIX-D: The Dow Jones Islamic Market Indexes Descriptive Statistics Index Name Dow Jones Islamic Market Index Dow Jones Islamic Market Titans 100 Index Dow Jones Islamic Market Europe Index Dow Jones Islamic Market Asia/ Pacific Index Dow Jones Islamic Market Technology Index Dow Jones Islamic Market Canada Index Dow Jones Islamic Market Japan Index Dow Jones Islamic Market U.8 1.52 1.3 1.08 3. Index Dow Jones Islamic Market U.34 -4.33 8.91 14.336.6 0.9 6.4 710.87 19.80 -22.S.32 -21.26 -39.0 0.18 -6.61 3-Year -23.2 1.47 2002 -22.8 27.06 0. Index P/E (including negative) Trailing 18.32 13.16 P/E (excluding negative) Projected 16.6 43.14 1.32 18.60 18.59 19.1 Component Weight (%) Largest 3.75 1.48 2. Index Dow Jones Islamic Market U.44 -22.49 -7.9 142.S.S.11 3.7 4.422 100 271 479 292 65 192 101 572 Market Capitalization Data (USD Billion) Full 7.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).71 -2.15 -8.24 15. Index Dow Jones Islamic Market U.13 16. Index Dow Jones Islamic Market U.S.S.0 0.5 111.11 -3.55 14. Index Dow Jones Islamic Market U.35 9.85 -0. Index Dow Jones Islamic Market U.92 0.96 21.2 234.97 18. Index Dow Jones Islamic Market U.43 17.77 0.56 Smallest 0.9 1.78 Projected Trailing 16.75 -9.09 1. XLRI.00 0.88 1.94 3.03 54. Index Component Number 1.10 0.1 234.2 980.9 0.79 32.634.18 -22.55 1.33 19.0 0.90 -36.01 5.55 5.1 7. Index Dow Jones Islamic Market U.S.

786.7 1068.37 772.23 9.61 708.482.426.70 7.95 2.43 1861.87 907.31 1.815.47 524.22 504.58 189.4 356.9 2849 324.98 3.753.18 1.85 460.893.3 627.3 1871.7 1599 480.403.039.69 408.942.734.99 1.07 6.628.579.668.1 279.20 1.13 334.4 1276.2 436.120.435.79 1.72 3.839.21 713.31 12.33 9.01 3062.05 5.15 465.66 568.46 1.12 423.76 346.178.114.721.57 6.83 348.62 Submitted by: Shakeel Ahmad Page 73 of 74 .97 5.65 Bank Dhofar Al-Omani AlFransi 876.48 5.325.25 554.71 5.094.47 1237.466.21 1.99 652.95 5538.697.52 327.462.31 404.75 355.61 6.83 Arab Banking Corporation 26.34 8.95 339.822.278.56 705.2 4050 AlAhli Bank of Kuwait 3.81 592.679.1 Bank of Bahrain & Kuwait 2.00 644.069.57 2.00 26.19 2.480.7 280.00 832.026.28 7.91 3213.927.28 1.84 2.86 424.96 4049.49 1.42 3.20 522.060.85 12.526.60 2.767.18 1.42 550.014.07 594.364.11 3.14 329.867.48 717.89 4.72 1.34 737.082.82 Al-Bank Al-Saudi Al-Fransi 10.83 427.25 659.55 548.53 966.13 5259.4 298.93 364.98 2.78 654.509.84 4.322.7 1946.36 346.17 478.24 6.85 1.26 1.391.62 5.88 470.03 594.622.196.85 655.945.45 3067.69 700.06 505.44 362.96 1.784.12 Bahraini Saudi Bank 595.22 2.049.79 1.22 3.11 424.59 534.25 2.05 1.342.335.42 667.49 3.9 Bahrain International Bank 887.430.246.2 3853.572.56 Bahrain Middle East Bank 512.65 673.5 3309.53 512.91 2.01 7.37 746.52 1.23 1.30 4453.696.145.442.859.758.89 5089.679.163.4 667.784.02 289.26 399.35 865.82 514.671.102.149.05 5.49 2.50 15.32 7.16 1.274.3 1957.514.29 1.210.56 14.47 2.840.4 1150.758.40 529.11 6.68 1.405.426.514.928.92 336.379.5 Arab Bank for Inv.3 3445.383.9 382.12 8.85 8.232.26 2.40 1.438.504.4 334.544.26 14.78 2855.03 315.181.30 10.7 4304.35 160.76 2.08 3.2 1902.461.82 489.45 4559.800.554.1 Al-Ahli Bank of Qatar 581.501.626.941.53 12.5 466.3 1344. & Foreign Trade 1.63 4.18 3.3 3923.09 1.078. Kuwait Assets Deposits Loans Bank/ Year 2001 2000 1999 2001 2000 1999 2001 2000 1999 Abu Dhabi Commercial Bank 7.74 450.00 20.519.00 21.3 1670.88 1.59 556.83 620.85 17.51 1.520.08 1.355.227.280.2 469.241.12 1.921.5 3715.50 11.280.358.89 11.338.73 Al-Ahli United Bank 4.740.53 434.00 24.605.8 1095.35 317.4 4038 242.471.66 1385.30 4.056.84 358.646.00 21.163.2 1869.49 508.901.681.102.04 1644.81 465.254.401.70 11.1 336.113.530.75 6.3 526.76 542.68 4479.81 1545.9 2592.002.36 16.86 482.329.788.7 1766.052.40 492.550.484.6 1625.46 3.146.16 1383.92 1.9 2377.96 553.566.60 2.43 4.661.119.03 685.153.38 355.01 5.97 4669.51 3.04 1.48 4.28 676.676.58 478.64 Bank Al-Jazira 1.77 358.96 4.949.9 2941.08 2.949.32 7.53 271.41 8.41 2.63 353.10 651.25 363.553.05 327.15 Bank Muscat 3.8 Bank of Kuwait & Middle East Bank of Sharjah Burgan Bank Commercial Bank International Commercial Bank of Dubai Commercial Bank of Kuwait Commercial Bank of Qatar Doha Bank Emirates Bank International First Gulf Bank Gulf Bank Gulf International Bank Industrial Bank of Kuwait Investment Bank Kuwait Real Estate Bank Mashreq Bank Middle East Bank National Bank of Abu Dhabi National Bank of Bahrain National Bank of Dubai National Bank of Fujairah National Bank of Kuwait National Bank of Oman National Bank of Ras AlKhaimah National Bank of Sharjah National Bank of Umm AlQaiwain Oman Arab Bank 3.41 732.5 400.15 323.413.62 2.07 13.41 1.40 2.13 4245.11 5.38 466.8 355.714.94 762.51 2259.4 1200.00 15.70 5.322.62 291. Deposits and Loans of 53 Conventional local Banks in GCC (US$ Millions) Source: Research Unit of the Institute of Banking Studies.03 1.86 267.6 3039.22 6.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).92 15.782.86 8.52 409.39 2. Dubai Campus Appendix-E1: Assets.13 659.5 332.71 9.88 333.215.05 8.50 5.3 412.63 6.434.60 1.87 5.74 2.01 591.51 556.53 13.586.46 3.154.11 2.133.40 3948.6 1316.88 1.79 937.28 469.777.90 8.889.43 4.20 5.524.90 3.562.130.064.26 1.01 332.092.10 705.81 365.02 1882.195.93 2.117.512.88 5.05 600.11 556.78 8.33 329.3 1209.91 346.772.00 14225 14039 12903 Arab National Bank 10.667.190.62 3.03 607.101.96 390.64 549.81 718.10 2.4 266.1 1514.6 386.09 581.158.609.42 2.91 3. XLRI.994.25 1278.818.10 720.22 1.35 513.86 3.40 10.01 1.664.7 1328.20 461.77 9.93 557.6 4703.05 3.151.33 5.414.90 467.76 1.1 1679.97 3.141.79 752.92 1.2 2856 749.41 10.360.34 371.77 1.4 357.80 680.13 1769.76 12.31 266.06 421.70 2.945.73 571.3 4580.64 10.94 1239.477.391.71 1192.67 328.

072.41 17.32 733.51 6.175.59 411.141.94 3.3 677.60 354.48 448.69 17.66 Qatar Islamic Bank Qatar International Islamic 741.91 99.23 1.944.08 412.546.19 64.71 17.67 4.612.15 712.38 507.47 11.30 417.82 1.34 1.90 10.28 2.85 414.05 2.48 910.21 20.91 10.543.24 654.720.73 44.68 11.47 931.46 358.6 5234.525.03 4.56 16.61 5.051.47 516.63 5.7 364.795.934.57 366.74 350.572.20 5.656.63 3.404.997.18 429.05 1456.36 23.61 1.6 8452.20 21.94 2.15 2.34 7.054.713.86 1.275.42 1.295.931.44 8.86 401.3 8984.661.03 2.763.74 2.64 6.21 4.55 14.1 5165.Dissertation: Islamic Banking and Finance in the Contemporary World Program: Ex-PGP (2001-04).5 341.68 17.573. Deposits and Loans of 8 Islamic local Banks in GCC (All figures are in US$ Millions) Source: Research Unit of the Institute of Banking Studies. XLRI.733.543.67 9.18 5.04 5.03 12.448.5 3067.937.077.05 58.35 9.44 3.05 14.817.6 2676.18 725.520.621.64 419.5 8418 4620.86 78.973.62 Kuwait Finance House 4.2 4277.27 5.70 1. 7.86 648.17 310.90 2.26 804.8 5657.30 860.521.038.728.243.455.004.29 439.90 1.91 Shamil Bank of Bahrain 1.700.494.22 93.664.4 2000.84 11.399.065.875.423.04 1.74 11.300.78 8.95 467.99 1187.65 10.05 2.634.921.45 435.73 20.34 974.20 940.595.86 6. Kuwait Assets Bank/ Year 2001 2000 1999 2001 Deposits 2000 1999 2001 Loans 2000 1999 Al-Rajhi Banking & 13.25 17.62 1332 3744.85 421.00 4.68 2.94 484. 5473.01 443.9 4338 2454.094.54 408.45 613.618.66 902.167.26 406.172.388.40 3.23 5.316.87 Bahrain Islamic Bank Submitted by: Shakeel Ahmad Page 74 of 74 . Dubai Campus Oman Housing Bank Oman International Bank Qatar National Bank Riyad Bank Saudi American Bank Saudi British Bank Saudi Hollandi Bank Saudi Investment Bank Union National Bank United Arab Bank United Gulf Bank 429.03 2.08 555.9 3982.7 2155.153.3 2009.092.02 1.40 4.24 6.748.632.815.73 Investment Corp.24 1.80 1.72 3.785.72 1.460.205.878.115.51 3.47 3.27 385.08 80.188.879.33 Bank 508.92 580.6 2029.542.26 5.26 6.444.212.8 1788 321.63 Dubai Islamic Bank 1.779.37 18.192.69 9.98 2.50 464.340.27 3.73 Appendix-E2: Assets.2 1885.29 505.34 1.416.622.20 4.15 444.661.682.188.324.05 Abu Dhabi Islamic Bank 1.26 14.39 9.67 576.096.70 3.43 408.939.

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