Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

An Introduction to Islamic Banking and Finance The history, role and future of Islamic Banking Warren Edwardes, ceo, Delphi Risk Management Ltd Presentation to The Financial Services and Banking Department of the Dubai Men's College at The Institute of Islamic Banking & Insurance London, 19th April 2004 Full article on: http://dc3.co.uk/islamicbanking.htm Islamic banking news: http:// dc3.co.uk/ibnews

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Quotes
Happy the man who far from schemes of business, like the early generations of mankind, ploughs and ploughs again his ancestral land with oxen of his own breeding, with no yoke of usury on his neck. Roman philosopher, Horace Julius Caesar limited interest to 8 1/3 %

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Quotes
Neither a borrower nor a lender be; For loan oft loses both itself and friend and borrowing dulls the edge of husbandry. Shakespeares hamlet, a Danish father advising his son UK usury laws on excessive interest abolished in 1854 South Africa and US (except Virginia and Delaware) have usury laws

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Quotes
Those who devour usury will not stand except as stands one whom the evil one by his touch hath driven to madness. That is because they say: "trade is like usury but Allah hath permitted trade and forbidden usury. The Koran: Surah 2, verse 275

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Latin Jargon used by lawyers

In haec verba
Verbatim nunc pro tunc

Retroactive
Caveat emptor Let the buyer beware

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Greek Jargon used by derivatives dealers

Delta

Sensitivity of an option price to changes in the price of the underlying equity

Theta

Sensitivity of an option price to changes in time

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Arabic Jargon used by Islamic bankers

Alwadiah
Safe keeping Baimuajjal Deferred-payment sale Baisalam Pre-paid purchase

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Jargon Arabic - used by Islamic bankers

Ijara
Leasing Muqarada Mudaraba Mudaraba Profit-sharing

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Jargon Arabic - used by Islamic bankers

Murabaha or Shirka
Cost-plus or mark-up Musharaka

Equity participation
Qard Hasan Benevolent loan (interest free)

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Overview
Hallal vs. Haram
Not just about Hallal mutton curry but also about a way of life

This is including finance

Interest, usury, riba used interchangeably Essentially three dimensions of Islamic products
1. Riba free - Profits and loss sharing PLS
2. Riba free - Mark up 3. Ethical dimension
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Overview Profit & Loss Sharing

Profit & Loss Sharing
basically, no pain no gain Venture capital, non-recourse project finance, equity investment vs lending US / UK banking vs German, Japanese, Spanish banking

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Overview - Markup
Mark up - predetermined profit. Predominates 87% Pakistan, 63% Iran Investors risk aversion Borrowers protection of equity interests Tax similarities - interest versus capital gains tax Interpretations change Treasury bills, foreign exchange, zero coupons, circular transactions. Various jurisdictions / opinions Gulf, Malaysia, London

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Overview - Ethics
Ethical dimension - undesirable investments sectors Tobacco Alcohol Armaments Gambling Charitable aspects Interest donated to charity Can the borrower afford to repay? Faith does not mean soft option.
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Brief History
1963 Egypt interest free savings banks
Not overtly Islamic - invested in trade and industry Share of profits 1971 Egypt Nasr social bank Still no overt reference to Islam 1975 Islamic development bank Jeddah. Conference of Islamic finance ministers1973 Fee based and PLS Revolving capital
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Brief History
1970s Dubai Islamic bank, Faisal Islamic bank of Sudan / Egypt, Bahrain Islamic bank Malaysia, Philippines, Nigeria, Indonesia Islamic finance house, Luxembourg, DMI Geneva, Al Rajhi London Denmark, Australia, south Africa HSBC Amanah fund, ANZ first ANZ International Murabaha ltd., IBU of United Bank of Kuwait.
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Riba is more than Usury

US, South Africa, UK Excessive interest Early repayment penalty Active vs passive lending Pawn broking / money lending vs modern banking. No distinction between fair and unfair interest Trade is allowed Repayment only if borrower is able to?
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Warren Edwardes

Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Why?
Pork etc.

Property rental - Hallal

Real benefit, wear and tear Capital rental - Haram

Gold for gold, barley for barley; Inflation indexed?

Equity/debt hybrid profit sharing? Undated preference shares? Section 233 loans?

Unearned income taxed at 97% in the UK

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments PLS

Mudaraba / Modaraba
PLS no pain no gain Rabbulmal - capital provider / investor Mudarib - entrepreneur / borrower Profits split between Rabbulmal and Mudarib as agreed Losses only to financier. Looks like non-recourse project finance

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments PLS

Shirka
Generalised Mudaraba More than 2 parties Non contractual - Al Milk, Contractual Ul Uqud Looks like syndicated non-recourse project finance

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments PLS

Musharaka / Mosharaka Equity investing Limited partnership Profits distributed according to pre-agreed formula Fair share of profits? 95% to investor? Looks like normal equity investments or fund management Sounds like shares Loss sharing? Limited liability to investment.
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments PLS

Al- Wadiah Retail savings account Cheque books bill payments, credit cards etc. Dividend paid subject to profits through the year Only profits no loss of capital Short term accounts Looks like with profits bonds Other retail Prizes, gifting of interest to charity, no transaction fees

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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments Mark-up

Murabaha / Morabaha Mudaraba / Musharaka on bank liability side Murabaha / Morabaha on asset side. Locked-in return Bank buys asset on behalf of client / borrower and then sells it for deferred payment

Title transfers at outset or on payment at maturity

Interest into capital gains? Use of Libor Sounds like Repo a sale and repurchase agreement
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments mark-up

Baimuajjal Property financing on a deferred basis Payment in instalments or lump sum with mark-up Predetermined profit. Ijara Leasing type transaction Title stays with lessor Option to buy goods on maturity of contract Ijara wa iqtina is renting then purchase
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Islamic Financial Instruments Mark-up

Baisalam
Manufacturers financing of production Bank buys and pays for goods at a discount before manufacture Commodity futures contract? A derivative? Similar to Bankers Acceptance BAs Al Bay Bithaman Ajil BBAs popular in Malaysia Financing sales by deferred instalments Trade not debt
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Institute of Islamic Banking & Insurance London, 19 April 2004

Introduction to Islamic Banking & Finance

Key Features of Islamic Banking

Interest free
Trade related and perceived need for funds Pure form of Islamic Banking? - equity related Avoids exploitation - no usury Ethical investments Alcohol, tobacco, gambling, armaments, pornography etc

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Introduction to Islamic Banking & Finance

European Retail Islamic Banking

mainly high net worth
7 million Muslims in Europe 1.2 Mio UK, 3 Mio France, 2.9 Mio Germany so why minimal penetration? Poor image, Mystery, Risk aversion, tax issues.

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Introduction to Islamic Banking & Finance

Conclusion
Growth market for strongly capitalised banks
Islamic investors are risk averse Aware of rating agencies Top banking brand names such as HSBC, ANZ, UBK have an advantage - I believe

But local banks need to try harder with relationship and innovation
Speech not about economics or social science Idea is to encourage growth and achieve reasonable profit for capital invested
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