Islamic Finance: Concepts,

Products, Issues
30 Oct, 2009

Usman Hayat, CFA, FRM

Director Islamic Finance & ESG Investing
 Agenda

 Islamic finance @ CFA Institute

 Big picture & common misconceptions

 Concepts & applications

 Issues

 Q&A
Page 2
 Islamic Finance @ CFA Institute

•Growing field, GBOK, Approach: Integrate in

CBOK? life long learning
•Publications •Events
•Academic & (SRP)
professional
qualifications available
•Multimedia
www.cfawebcasts.org

•Globally, 10%
members “interested”,
regional variations
(2009 survey)

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 Old Ideas, Young Industry

2009 AD = 1430 Hijri; but industry barely 40

50s & 60s: initial theoretical work, some

experimentation

70s: DIB, IDB, petrodollars

80s: OIC’s IFA, initiatives in Malaysia,

Bahrain, Pakistan, Sudan

90s: AAOIFI, Dow Jones & FTSE indexes,

growth in number & type of funds

00s: IFSB, IIRA, more innovation, credit cards

to hedge funds, more petrodollars

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 Industry Statistics

•Size estimates go up to US $1 trillion (small)

•2007 asset mix, as per IFSL 2009 Report:

Commercial banks (74%) Investment banks (12%)
Sukuk (11%) Funds (2%), Takaful (1%)

•Major countries, as per The Banker: Iran, Saudi

Arabia, Malaysia, Kuwait, UAE, Bahrain, Qatar, UK

•Estimated 300 IFI, 50+ countries

•Industry reports available on the net for free

•Growth story, favorable outlook

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 Common Misconceptions

 Practice exclusive to Muslims, modes

exclusive to Islam

 No time value of money in pricing

 Dominant form of finance in Muslim

countries

 No gap between Islamic finance

theory & practice

 All Muslims highly sensitive to Shari’a

compliance in finance
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 Islamic finance

• Finance that complies with

Shari’a

• Primary Sources
Qura’n (the Holy Book)
Sunnah (or tradition of Prophet
Mohammad)

“The obligation of the Shari’a is to

provide the wellbeing of all
humankind, which lies in
safeguarding their faith, their
human self (nafs), their intellect
(’aql), their progeny (nasl) and
their wealth (mal)”
Al-Ghazali
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 Religion & Economics

•Economics takes human behaviour as given

•Religion seeks to influence human behaviour

– Accountability to God should be a

permanent concern

– Earning an honest living an act of worship

– Moral economy of Islam (a theoretical ideal)

neither communism, nor capitalism

•Depends on belief in God (which is up to the

individual)
 Islamic finance Concepts

•Islamic commercial jurisprudence:

human dealings, default ruling is permissibility

Test of impermissibility:
_Purpose involves prohibited activities
(socially responsible, ethical)
_Structure involves Riba or Gharar or both

•On riba & gharar: “…the talented jurist Ibn

Taymiyya …famously stated that two
prohibitions can explain all distinctions
between contracts that are deemed valid or
invalid: those of riba and gharar.” Page 8, “Islamic
Finance: Law Economics, and Practice” (2006) by Mahmoud A. El - Gamal
 Riba & Gharar (simplified)

Riba
• No perfect translation; excess, usury
• Lending money on interest
• Absolute prohibition; money not commodity
• Why? unnatural? unfair? evidence?

Excessive Gharar
• No perfect translation; risk, uncertainty
• Trading of risk unbundled from an asset
• Applies to commutative contacts
• Why? disputes? externalities? evidence?

Implication: asset & enterprise, risk-sharing

 Application

Riba Gharar

Capital _Equity funds: business, Derivatives (or at

Market debt & income screening least their trading)
_Sukuk: ownership of largely avoided
assets
_Debt trading constrained

Banking _Trade, lease, share Sales/leases of assets

_No money after purchases
borrowing/lending

Insurance Avoid interest bearing Mutuality (risk-

/ Takaful investments sharing, solidarity
group)

Note: Sin industries to be avoided in all cases

 Opportunities

• Inclusive, simple, tied to real economy

• Small size means growth potential;

petrodollars to invested

• Responsible investments also growing

• More countries promoting Islamic

finance

• Industry reports & surveys still

suggesting double digit growth
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 Challenges

• Covering gap of centuries in decades

• Global economy - lending money, trading risk

• Legal, regulatory, tax issues

• Lack of global Shari’a standards

• Industry requires multidisciplinary expertise

• And the form versus substance debate…

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 Form vs Substance

• Concern on similarity in substance (banking

& fixed income)

• Profit/rent on trade/lease or price of credit?

• Innovation or replication? risk-reward

sharing? economic justice?

• Conflict of interest in Shari’a governance?

• Shari’a adjustments:
• AAOIFI statement 2008
• OIC’s IFA resolution on tawarruq 2009 Page 14
 Financial Crisis & Islamic Finance

• We did better (Proponents)

• You got hit by real estate (Critics)

• Much noise, but not a sound debate:

What were the reasons toxic products were avoided
by IFI?
Real estate investments business or Shari’a issue?
Can a small segment in the same market be
unaffected in a market wide turmoil?

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 Summary

• Old ideas, young industry, long term future

• Belief in God implies moral economic behaviour

• Avoid sin industries, don’t lend money on interest,

don’t trade risk

• Asset & enterprise required; equity preferred

• Business & career opportunities, lots to happen!

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Q&A

Page 17
 Learning Resources

• Books

• Webcasts/podcasts

• Websites & social media

• Training

• Professional qualifications

• Academic qualifications
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