Professional Documents
Culture Documents
13 DECEMBER 2010
CONTENTS
FINANCE AND ISLAM
Definition
Essence of Islamic Finance
Inherent Features of the IFSI and its Stability and Resilience
Milestones of Shariah Contract Application
CONTENTS (continued)
SELECTED IFSI SEGMENT: ISLAMIC BANKING
MOVING FORWARD
Challenges
Emerging Mega-Trends in Islamic Finance
The Islamic Finance and Global Stability Report
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DEFINITION
Islamic finance, in contrast to conventional finance, involves the provision of
financial products and services by institutions offering Islamic financial services
(IIFS) for Shariah approved underlying transactions and economic activities,
based on contracts that comply with Shariah laws. Shariah, the basis for finance
that meets the religious requirements of Muslims in line with their aqidah, is the
factor that distinguishes Islamic finance from conventional finance. Provision of
these Shariah compliant financial products and services must add value to the
real economy.
These IIFS may comprise:
full-fledged Islamic financial institutions or market intermediaries
Islamic subsidiaries or branches of conventional financial groups
From its original meaning of the way to the source of life, Shariah is now used
to refer to a legal system with rules & principles and code of behaviour. To
ensure compliance with Shariah rules & principles, IIFS rely on an external or inhouse Shariah committee or board comprising Shariah scholars.
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Different
contractual
relationships
Equity-based
Risk and reward sharing
which helps ensure greater
market discipline
Shariah
values
consistent
with
universal
values
Although the Islamic financial services industry (IFSI) is not totally insulated from
an economic slowdown given its strong linkages to real economic activities, it has
proven to be more resilient in times of crisis, mostly thanks to its intrinsic
stabilizers (or checks and balances) and in-built shock absorbent mechanisms
which act as inherent hedge against distress and crisis.
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All Shariah values and elements embedded in Islamic finance, which are
consistent with universal values, are similar to those that found in ethical finance
and socially responsible investing (SRI).
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1983-1990
1991-2000
Sarf Forex
Mudharabah Interbank
Investment
Musharakah Financing
Bay Inah Credit Card
2001-2005
2009
onwards
2006-2008
Commodity Murabahah
Profit Rate Swap
Commodity Murabahah
Forward Rate Agreement
Ijarah Rental Swaps-i
BBA Floating Rate
Murabahah Floating Rate
Istisna Floating Rate
Ijarah Floating Rate
Mudharabah Capital
Protected Structured
Investment
Bay Inah Floating Rate
NID
Mudharabah Savings
Multiplier Deposit
Tawarruq Commodity
Undertaking
Tawarruq Business
Financing
Tawarruq Personal
Financing
Tawarruq Credit Card
Murabahah with Novation
Agreement
Istisna convertible to
Ijarah
Bay and Ijarah (Sale and
Lease Back)
Musharakah Mutanaqisah
Istisna with Parallel
Istisna
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Definition
Shariah non-compliance
risk
Risk arises from the failure to comply with the Shariah rules and
principles
Displaced commercial risk The risk that the Bank may confront commercial pressure to pay
returns that exceed the rate that has been earned on its assets
financed by investment account holders. The Bank foregoes part
or its entire share of profit in order to retain its fund providers and
dissuade them from withdrawing their funds.
Equity investment risk
The risk arising from entering into a partnership for the purpose of
undertaking or participating in a particular financing or general
business activity as described in the contract, and in which the
provider of finance shares in the business risk. This risk is relevant
under Mudharabah and Musharakah contracts.
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11.70%
0.70%
82.10%
Islamic banking
Takaful
Sukuk
Islamic funds
Consensus forecasts expect the asset size of global IFSI to hit US$2 trillion in the
next 3 to 5 years while forecasts for 2012 vary between US$1.2 trillion and
US$1.6 trillion.
There are still tremendous opportunities in the IFSI going by the Standard &
Poors estimates that the overall potential market is valued at US$4 trillion.
In asset terms, Islamic banking (82.1%) is the largest IFSI segment, followed by
Sukuk (11.7%), Islamic funds (5.5%) and Takaful (0.7%) as at end-2009.
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Measure or
success or
profitability
Saturation
High
Take off
Maturity
Medium
Early start
Low
1960
1970
2000
20xx
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Islamic Banking
Islamic
financings
Islamic deposits
Islamic
investment
accounts
Takaful/Re
-Takaful
Takaful /ReTakaful
products
Takaful linked
investments
Islamic Interbank
Money Market
Islamic Asset/Fund
Management
Derivatives
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Equity
Islamic Capital
Markets
Debt
Islamic Securities
Islamic Medium
Term Notes
Islamic
Commercial
Papers
Exchangeable
Sukuk
Malaysia:
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Financial relationship in Islamic banking is participatory in nature with riskreward profile is guided by socio-economic principles:
Risk sharing through partnership in ventures building expertise and understanding
of ventures being financed, importance of viability of ventures instead of solely
creditworthiness of customers and know-your-customer culture
Balancing act between pursuit of profit and fair and equitable distribution of
wealth/income
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36.0%
8.0%
10.0%
10.0%
Iran
Saudi Arabia
Malaysia
UAE
Kuwait
16.0%
Bahrain
Qatar
UK
Turkey
Others
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EVOLUTION OF SUKUK
1990
Introduction & market
familiarisation
Development of
markets, players &
products
Very limited growth
Confined to some
countries only e.g.
Malaysia
Limited structures (debt
bonds):
* Bai Bithaman Ajil
* Murabahah
* Qard Hasan
2000
2004
Acclelerated growth in
market size & players
Broader & deeper
market
Better market
understanding
Innovative & new
product structures
(non-debt)
* Mudharabah,
Musharakah
* Islamic ABS
* Istisna-Ijarah
* Convertible Sukuk
* Exchangeable Sukuk
Better growth in
market size players
Additional product
features/structures:
* Istisna
* Salam
* Ijarah
* Intifa
Intoduction of Sukuk in
the global market
* Malaysia Global
Sukuk (2002)
* Qatar Global Sukuk
(2003)
Stronger growth of the
Sukuk market globally
Maturing &
globalisation
More breadth & depth
More accelerated
growth
Moving towards globally
accepted & highly
competitive structures
Activating the
secondary market for
Sukuk
More & more product
innovation
Unlocking new asset
classes
Development of Sukuk
yield curve & pricing
benchmark
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Flexibility
Greater transparency
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MOVING FORWARD
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CHALLENGES
Lack of coordination and policy synchronisation between authorities within and
across jurisdictions e.g. between the Government (Ministry of Finance), the
central bank/monetary authority and the securities regulator of a country;
overlapping activities among the existing major international infrastructure
institutions such as the IDB, IFSB, AAOIFI, IIFM, etc
Achieving greater harmonisation and convergence across jurisdictions in terms of
products & services, practices and systems could be a daunting task given
diversity in Shariah interpretations and opinions arising from the existence of
different mazhab or schools of thought in the Muslim world. To bridge this gap:
The need for a global authority for Shariah matters or at least a universally accepted
Shariah governance framework?
Implementation of mechanisms to ensure greater acceptance of Islamic financial
products and services across jurisdictions
wider cross-country representation on the Shariah committees or Shariah supervisory
boards (SSBs) of Islamic financial institutions e.g. the presence of more Shariah scholars
from the Middle East in the SSB of Malaysian financial institutions
further financial sector liberalisation measures that allow entry of more Islamic financial
institutions from other jurisdictions e.g. opening of the Malaysian financial sector that
allows entry of more Islamic banks from the Middle East
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CHALLENGES (continued)
Given the specialist nature of Islamic finance, the IFSI requires well-trained and
high calibre workforce with specific skills sets to cater to specificity of Islamic
finance. The global IFSI suffers from a shortage of Islamic finance talents at
almost all levels especially the middle and senior management. The IFSI in
particular Islamic financial institutions face the difficulty of building a talent pool
with the right combination of knowledge in Islamic law and modern finance while
addressing the issue of poaching by competitors within the country and other
aspiring Islamic financial hubs given their lucrative remuneration packages. The
IFSI needs to find the most effective ways of how to attract, retain and develop
Islamic finance experts.
Shortage of Shariah scholars with adequate financial acumen or expertise required to
apply Shariah law to financial products & services
Shortage of financial experts with adequate Shariah knowledge to accelerate product
innovation
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CHALLENGES (continued)
Market related issues that could hamper growth of the IFSI
Inexistence or limited existence of a secondary market in many jurisdictions although growing, the secondary market for Islamic securities/financial instruments in
particular Sukuk remains generally sparse, illiquid and inactive due to the tendency to
hold them until maturity.
Virtual absence of a domestic Islamic money market as well as practical and tradable
Shariah compliant short-term money instruments for both monetary operations (as a
transmission channel for the implementation of central banks monetary policy) and
liquidity management of Islamic financial institutions in many jurisdictions.
Controversy surrounding most derivatives contracts among Shariah scholars in some
jurisdictions in particular in the Middle East although nobody can deny how crucial
Shariah compliant derivatives instruments for liquidity management and hedging
purposes. Hence, the establishment of a joint working group in 2006 between the
International Swaps and Derivatives Association (ISDA) and IIFM towards creating a
standardised master agreement for Shariah compliant derivatives transactions with
the hope of reaching a common ground eventually.
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CHALLENGES (continued)
Absence of conducive legal and regulatory environment as well as supportive tax
framework in many countries with keen interest in Islamic finance.
No enabling legislation that allows and facilitates activities of Islamic financial
institutions. In early Nov 2010, the Kerala High Court ruled the legal impossibility for
banks in India or their branches abroad to undertake Islamic banking activities.
Absence of tax neutrality regime to facilitate Islamic financial transactions in some
jurisdictions.
CHALLENGES (continued)
Although the number of Muslims is estimated to total around 1.57 billion or
equivalent to about 22.9% of the worlds population at present, the size of the
IFSI is only a fraction of the global financial system as most Islamic financial
institutions have small capital structure. The presence of more highly capitalised
Islamic financial institutions will contribute positively to the soundness and
stability of the financial system as a whole. In a highly competitive environment,
being big may translate into:
Larger economies of scale, better cost-efficiency, greater capacity (deeper pockets) to
finance larger and riskier projects
Greater capability to innovate due to more extensive financial muscles
Increased potential for regional or even global expansion
Increased ability to withstand systemic occurrences such as a bank run
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More in-depth studies and research work to prove that equilibrium is possible in
an interest-free open economy i.e. in an economy where there are no interestbearing assets, only equity shares exist while all financial arrangements are
based on risk and reward sharing. In this model, since all financial assets are
contingent claims that represent ownership claims to real capital i.e. no debt
instruments with fixed and/or predetermined rates of return, return to financial
assets must be determined by return of the real economy.
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Wassalam
Thank You
The information contained in this presentation may be meaningful only with the oral presentation and is of the
personal view of the presenter and does not necessarily represent an official opinion of Bank Islam Malaysia
Berhad.
For further information, please contact:
Azrul Azwar Ahmad Tajudin
Chief Economist
Strategic Planning, Managing Directors Office
Bank Islam Malaysia Berhad
Email: azrulazwar@bankislam.com.my
Direct Line: +603-20888075
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