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Islamic Banking & Finance

Concept, Present State & Prospects

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Islamic Banking & Finance Concept, Present State & Prospects Click to edit Master subtitle style Muhammad

Muhammad Saarim Ghazi

Head Shari’a Advisory & Structuring Head University of London International Programmes Al-Hidayah Centre for Islamic Finance

Lecture Roadmap

Lecture Roadmap p The concept behind development of Islamic finance – Why Islamic finance evolved? p

p The concept behind development of Islamic finance – Why Islamic finance evolved?

p Historical development of Islamic finance & its current position – How Islamic finance evolved ?

p Strength of the industry in global financial crisis 2008 – Is Islamic finance a viable alternative ?

p Questions & Answers Session

The Idea Generation

The Idea Generation Western commercial banks date from about three - four centuries ago…. When the

Western commercial banks date from about three - four centuries ago….

When the Muslim world came into contact with the west, Muslims had two choices: to accept the interest based banking or to establish their own interest free-banking

The idea of establishing an interest free bank goes back to 1940s

Prophet (peace be upon him)

Prophet (peace be upon him) p The Messenger of Allah cursed the one who accepted riba,

p The Messenger

of Allah

cursed the one

who accepted riba, the one who

paid

it,

the

one who

recorded

it,

and

the two

witnesses

to

it.”

He said:

“They

are

all

alike.”

(Sahih Muslim)

p ‘Aun

ibn Hanifa reported from

his father

that the Prophet (peace be upon him) had

condemned both the receiver of interest and its payer.

(Sahih Bukhari)

Evolution & Development

Evolution & Development p First Experiments; Saving Association 1. Mit Ghamr Saving Association – Egypt (1963)

p

First Experiments; Saving Association

1.

Mit Ghamr Saving Association – Egypt (1963)

2. Tabung Haji – Malaysia (1963)

p

The Emergence of Islamic Banks

  • 1. Nasser Social Bank - Cairo (1971)

  • 2. Islamic Development Bank – Jeddah (1975)

  • 3. Dubai Islamic Bank – Dubai (1975)

  • 4. Faisal Islamic Bank - Egypt & Sudan (1977)

  • 5. Kuwait Finance House - Kuwait (1977)

p

International Holding Companies

  • 1. Dar-al-Maal-al-Islami (DMI) Trust -1981

  • 2. Al Baraka Group – 1981

Evolution & Development

Regulatory & Supervisory Organisations

Evolution & Development Regulatory & Supervisory Organisations p Accounting & Auditing Organizations for Islamic Financial Institutions

p

Accounting & Auditing Organizations for Islamic Financial Institutions (AAOIFI) - Bahrain (1990)

p

Islamic Finance Services Board (IFSB) – Malaysia

(2002)

p

International Islamic Financial Market (IIFM ) – Bahrain (2002)

p

Liquidity Management Center (LMC) - Bahrain

(2002)

p

International Islamic Rating Agency (IIRA) – Bahrain

(2005)

Evolution & Development

Islamic Indices

Evolution & Development Islamic Indices p Dow Jones Islamic Market Index (DJIM) - New York USA

p Dow Jones Islamic Market Index (DJIM) - New York USA

p Kuala Lumpur Shari’ah Index (KLSI) - Kuala Lumpur Malaysia

p Jakarta Islamic Index (JII) – Jakarta, Indonesia p Global GCC Islamic Index – Kuwait p HBSC/ DIFX Index p FTSE Islamic Global Index

Evolution & Development Financial Highlights
Evolution & Development
Financial Highlights

Total Islamic Financial Institutions

 

Over 3000

Continents

6

Countries

80

Total Assets

 

USD 1.13 trillion

Expectation in 2015

USD 2.8 trillion

Annual Growth

15-20%

Pakistan

 

Full Fledged Islamic Banks

5

13

Conventional Banks with Islamic branches

Takaful Companies

5

Global Islamic Financial Services Industry

Global Islamic Financial Services Industry p Potential Size of the Industry USD 4.4 trillion p Actual

p

Potential Size of the Industry

USD 4.4 trillion

p

Actual Size

USD 1.13 trillion

p

The Size Gap

USD 3.27 trillion

p

Global Growth Rate (2010)

10%

p

Catch up Parameter

9 Years (with 25% growth)

Deposit Mobilization by Islamic Banks – Liability Side

Current Account

Qard-e-Hasan

Saving & Term Deposit

Mudarabah

Demand/ Interest Free Deposit

Islamic Framework

 

Loa

Depositors

n

 
Loa Depositors n Princip al Conventional Framework Loa Depositors n
 

Princip

al

Conventional Framework

Loa

Depositors

n

 
Loa Depositors n Princip al Conventional Framework Loa Depositors n

Princip

al

  • Bank

  • Bank

Deposits Carrying a Return

Islamic Framework

Depositors

 
*Principal is not guaranteed Depositors

*Principal is not guaranteed

Depositors

 
*Principal is not guaranteed Depositors

Funds for Investments

  • Bank

Principal* + Share in Profits

Conventional Framework

Interest based Loan

Principal + Interest

  • Bank

Islamic Modes of Financing

  • 1. Musharakah (Partnership Mode)

  • 2. Modarabah (Partnership Mode)

  • 3. Diminishing Musharakah (Partnership Mode)

  • 1. Murabaha (Credit Sale)

  • 2. Musawamah (Credit Sale)

  • 3. Salam (Future Sale)

  • 4. Istis’na (Future Sale)

  • 5. Istijrar (Repeat Sale)

Riba

Riba Any amount, big or small, over the principal, in a contract of loan or debt

Any amount, big or small, over the principal, in a contract of loan or debt is “Riba” prohibited by the Holy Qur’an, regardless of whether the loan is taken for the purpose of consumption or for some production activity.

Misconception about the Nature of Money

Money should be treated as a commodity. So, just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value: therefore he can lend his money and can claim interest thereupon”.

Difference between Money and Commodity

p Money has no intrinsic utility. It can not be utilized in direct fulfillment of human needs

it

can only

be used for acquiring some

goods or services.

p The

commodities

can

be

of different

qualities while money has no quality except that it is a measure of value or a medium of exchange.

p In

commodities, the transactions of sale

and purchase are effected on an identified

particular commodity Money

on contrary

Misconception

Riba is restricted to consumption loans and does not include Productive/ Commercial loans. The Holy Qur'an had prohibited claiming any increase over and above the principal in the case of consumption loans only, where the borrowers used to be poor person's borrowing money to meet their day to day needs of food and clothes etc. While in case of productive & commercial loans there is no Zulm because in most cases the debtors are wealthy or at least economically well-off and the loans taken by them are generally used for generating profits. Therefore, any increase charged from them by the creditors cannot he term as Zulm (injustice) which was the basic cause of the prohibition of 'riba'.

Answer

p Firstly, The validity of a financial or commercial transaction does never depend on the financial position of the parties. It rather depends on the intrinsic nature of the transaction itself.

p Secondly, 'poverty' is

a relative term which has

different degrees. Once it is accepted that interest cannot be charged from the poor, while it is quite lawful to be charged from the rich, who will have the authority to determine the exact degree of poverty required for exempting a person from the charge of interest?

p Thirdly, Qur’an has prohibited riba in general terms, which include all the forms of riba.

p Fourthly, Zulm is the hikmat and not the illat (basic cause) of prohibition.

Misconception

p The prohibition of riba is applicable only to those interest transactions where the rate of interest is exorbitant or excessive.

p

This argument is sought to be supported by the verse of Surah Al-i-'Imran:

افًاعَ ضْ أَ ابَرّ لا اولُكُ أْتَ لَ

اونُمَ آ نَ يذِ لّا اهَ يّأَ ايَ

نَ وحُ لِفْ تُ مْ كُ لّعَ لَ لَّ ا اوقُتّاوَ ۖةً فَعَ اضَ مُ

p No verse can be interpreted in isolation from the other relevant material available in other parts of the Holy Qur'an.

نَ ينِمِ ؤْ مُ مْ تُنْكُ نْ إِ ابَرّ لا نَ مِ يَ قِبَ امَ اورُ ذَوَ

لَّ ا اوقُتّا اونُمَ آ نَ يذِلّا اهَ يّأَ ايَ

"O those who believe fear Allah and give up whatever remains of riba, if you are believers." [AlBaqarah 2:278]

p

The point is further clarified in express terms by the following sentence:

مْ كُ لِاوَ مْ أَ سُ وءُ رُ مْ ُكلَفَ مْ تُبْتُ نْ إِوَ

p

Unlike the text of a statute book, the Holy Qur'an contains some words or expressions used either for emphasis or for explaining the evil results of a particular act.

لً يلِقَ انًمَ ثَ يتِايَآبِ اورُ تَشْ تَ لَ وَ "Do not sell my verses for a little price." [Al-Baqarah 2:41]

Performance of Top 10 Islamic Banks Vs Top 10 Conventional Banks Financial Crisis 2008

Performance of Top 10 Islamic Banks Vs Top 10 Conventional Banks

Financial Crisis 2008

Top 10 Conventional

VS
VS

Top 10 Islamic

p

Citigroup

 

p

Al Rajhi Bank

p

Bank of America

p

Kuwait Finance House

p

ICB of China

p

Dubai Islamic Bank

p

HSBC

p

Bank Al Bilad

p

JP Morgan Chase

p

Qatar Islamic Bank

p

Bank of China

p

Investment Dar

p

China Construction Bank

p

Abu Dhabi Islamic Bank

p

UBS

p

Kuwait International Bank

p

Royal Bank of Scotland

p

Gulf Finance House

p

Mitsubishi UFJ Fin.

p

Qatar Int’l Bank

Top 10 conventional banks

Top 10 Islamic banks

Combined Market Capitalisation 42.8% 8.5% Aggregate Net Profits USD116 billion in 2006 to Net loss of
Combined Market Capitalisation
42.8%
8.5%
Aggregate Net Profits
USD116 billion in 2006
to
Net loss of USD42 billion-
USD4.2 billion to USD4.6
billion
(9 % Profit)
2008
Growth in Assets
36%
55%
Growth in Equity
24%
36%

%

Conventional Vs Islamic

12 10 8 6 4 2 0
12
10
8
6
4
2
0

Financial Assistance

Financial Assistance Five of the top 10 conventional banks received government financial assistance of USD163 billion

Five of the top 10 conventional banks received government financial assistance of USD163 billion in aggregate i.e. 26% of the affected banks’ combined equity.

Vs.

As at end 2009, none of the Islamic banks needed any government rescue scheme.

The Great Destruction

The Great Destruction Sept 15, 2008 Lehman Brothers; 4th Largest Investment Bank becomes Bankrupt Merrill Lynch;

Sept 15, 2008

Lehman Brothers; 4th Largest Investment Bank becomes Bankrupt Merrill Lynch; 3rd Largest Investment Bank sold to Bank of America

Sept 17, 2008

AIG; US Treasury seized control of the Company

Sept 22, 2008

Goldman Sachs & Morgan Stanley; Last two major investment banks converted into traditional banks holding companies

Sept 25, 2008

Washington Mutual; Forced sale to JP Morgan Chases by Regulators

November 1, 2009

CIT Group filed for bankruptcy protection

Finance

Why Islamic

?

More Resilient

Remained

General Principles of Contracts & Transactions in Islamic Law

Guiding Principles of Islamic Commercial Law

Principle Prohibition of Gharar (Uncertainty, Deceit & Hazard)

Principle Prohibition of Gharar (Uncertainty, Deceit & Hazard) Gharar takes place where the consequences (of a

Gharar takes place where the consequences (of a transaction) are concealed.

(Imam Sarkhsi; Al Mabsut, Vol 13 p 194)

Uncertainty and Excessive Risk

كدنع سيل ام عبت ل

Financial innovation with unnecessary complications

Islamic commercial law requires absolute certainty about the

resulted in new risks that are less

understood, assessed &

terms and conditions of contractual obligations.

controlled.

Principle Prohibition of Speculative Behaviour

Principle Prohibition of Speculative Behaviour p Every form of money acquisition of which depends upon luck

p

Every form of money acquisition of which depends upon luck or chance (zero-sum-game)

p

You gain what you have not earned - Gambling

According to the International

Swaps and Derivatives

Examples

Association (ISDA), the total notional value of CDSs in mid

Mobilizing resources on the basis of lottery & draws.

2008 is approximately $55 trillion,

doubling its size from mid 2006.

Futures & Options contracts that are settled through

price differences only.

AIG alone is reported to have sold over $440 billion of CDSs protection on a notional basis.

Volume of global international trade in 2008 = USD32 trillion Average of USD88 billion on a

Volume of global international trade in 2008 = USD32 trillion

Average of USD88 billion on a daily basis

Daily turnover in global foreign exchange markets was USD3.98 trillion i.e. 45 times more than the vol. of international trade.

Only 2% of trade in currencies is based on the genuine cross-border trade, while 98% of currencies transactions account for nothing but speculation in money prices.

Total derivatives was USD741.1 trillion in 2008 (Year end)

Total GDP of the entire world

Principle Prohibition of Khilabah & Ghishsh (Fraud & Deception)

Principle Prohibition of Khilabah & Ghishsh (Fraud & Deception) Khilabah: “concealing the defects of and in

Khilabah: “concealing the defects of and in merchandise”

Tatfeef: Giving short weight and measure

Najash/ Tanajush: False bidding to raise prices

Hiding defects of commodity in Sale.

Ghabn-e-Kaseer / Ghabn-e-Fahish

False Swearing

Low level of transparency & disclosure damaged market confidence & contributed to market panic

Talaqqi al-Rukban: purchasing merchandise before they reach the market place.

Conclusion

Conclusion This was not the first time when Islamic financial institutions were tested with a systematic

This was not the first time when Islamic financial institutions were tested with a systematic crisis.

Resilience in the Past

The experience of KFH in surviving the Kuwait Souq al-Manakh crisis in 1982. The performance of Bank Islam in navigating through the Asian financial crisis

1997-98.

The resilience of Turkish participation banks in coming out of the economic crisis in 2000-01.

“Today we have reached a tipping point, which leaves us only one choice: change or face continued decline and misery.”

Chairman World Economic Forum

p T h a n k Y o u Muhammad Saarim Ghazi saarim.iiu@gmail.com 0300 – 515

p Thank You

Muhammad Saarim Ghazi

saarim.iiu@gmail.com

0300 – 515 9750

Courtesy for Statistics

IM