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GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 170JANUARY–MARCH 2009

MUHARRUM–RABI AL AWWAL 1430

THE GLOBAL FINANCIAL CRISIS: CAN ISLAMIC FINANCE HELP?

COUNTRY FOCUS:BANGLADESH

ISLAMIC & ETHICAL FINANCE: ON THE SAME PATH?

POINT OF VIEW: ISLAMIC MORTGAGES

IT FOCUS: EUROPE ARAB BANK

ACADEMIC ARTICLE:A SHARI’AH SCHOLAR’SROLE IN ISLAMIC FINANCE

PUBLISHED SINCE 1991

www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Muharrum–Rabi Al Awwal 1430

Features

Regulars

24 Islamic finance progress in BangladeshBeing one of the largest Muslim countries in the world, Bangladesh clearly has thepotential and the market for Shari’ah-compliant finance. Abdul Awwal Sarker, whois directly involved in the central bank’s efforts to strengthen the country’s Islamicbanking sector, talks about accomplishments and challenges of the industry.

10 Islamic and ethical finance:on the same path?

Don Brownlow, NewHorizon’s contributingeditor, talks to the industry experts about the differences and similarities of Shari’ah-compliant, ethical and socially responsiblemodes of finance.

36 Islamic mortgages: Shari’ah-based or Shari’ah-compliant?

A controversial interview with Sheikh Haitham Al Haddad, a London-based Islamic scholar and Muslim community leader.

18 In the spotlight: South AfricaWhat is the current state of Islamic finance industry in South Africa, home to about onemillion Muslims?

CONTENTS

24

42 APPOINTMENTSSummary of appointments within the Islamic finance industry.

44 DIARYUpcoming Islamic finance events worldwide endorsed by the IIBI.

45 RATINGS & INDICES

46 GLOSSARY

32 IIBI LECTURESOctober and November lectures reviewed.

34 IIBI NEWSNew book published in conjunction with the IIBI. IIBI launches a new website and prepares online courses. More students complete the IIBI’s Post Graduate Diploma course.

05 NEWSA round-up of the important stories from the last quarter around the globe.

20 ACADEMIC ARTICLEThe global financial crisis: can Islamic finance help?

30 ACADEMIC ARTICLEPlacing faith in Islamic finance: the role of a Shari’ah scholar in the industry.

40

40 IT focus: Europe Arab BankAntoine Sreih, CEO of Europe Arab Bank, a UK-based subsidiary of Arab BankGroup, tells NewHorizon about the bank’s major IT project.

43 Book Review‘Developments in Islamic Banking: The Case of Pakistan’ by M. Mansoor Khanand M. Ishaq Bhatti.

16 Balance sheet analysis:Islamic vs. conventional

Comparing the balance sheet structures of conventional and Shari’ah-compliant banks.

4 IIBI www.newhorizon-islamicbanking.com

NEWHORIZON January–March 2009

Executive Editor’s NoteAs this issue of NewHorizon comes out in the New Year, I would like to wish the very best in 2009 to all our readers, members andsupporters as well as their families.

The global financial crisis is largely attributed to the financial liberal-isation that took place in the last two decades and the impact of thefinancial collapse on the real economy will be significant in 2009.The financial euphoria fuelled distorted perceptions of risk, leadingto excess leveraging. This leveraging added to the scant regulation of the non-traditional banking sector and already existing over-indebtedness of households and businesses, all of which combinedhas created a huge economic burden for future generations.

The crisis does not signal the failure of capitalism. Financial marketshave shown that they are incapable of regulating themselves and tend towards imbalance, especially after long periods of growth andstability which encourage excesses. Islam is indeed compatible withfree enterprise based on shared responsibility. Islam is not opposed tothe creation of wealth but is opposed to the hoarding of wealth andall forms of extravagance. The 14th century Muslim scholar, Ibn Khaldun, long before Adam Smith, made a case for a free economy.

Of course, it would be wrong to say that the ongoing crisis has completely bypassed the Islamic financial sector. Islamic banks aresometimes criticised for appearing to mimic conventional bankingstructures, based on the securitisation of assets, devising new prod-ucts that allowed commercial banks to create and multiply money.The implications are felt worldwide, from Europe, where the UKgovernment has postponed the long-planned sukuk issuance, to theMiddle East, where the two of Dubai’s largest Islamic mortgage companies had to be merged under a government-owned entity.

Even so, major challenges remain in terms of establishing sharedleadership with an aim of devising better rules for financial globalisa-tion. The Islamic finance industry can play a greater role in increas-ing awareness of its practices to help restore and maintain financial stability worldwide.

Mohammad Ali QayyumDirector General IIBI

EDITORIAL

EXECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORTanya Andreasyan

IIBI EDITORMohammad Shafique

CONTRIBUTING EDITORSDon BrownlowJames Ling

NEWS EDITORLawrence Freeborn

IIBI EDITORIAL ADVISORY PANELMohammed AminRichard T de BelderAjmal BhattyStella CoxDr Humayon Dar Iqbal KhanDr Imran Ashraf Usmani

DESIGN CONSULTANTEmily Brown

PUBLISHED BY IBS Publishing Ltd8 Stade StreetHythe, Kent, CT21 6BEUnited KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: www.ibspublishing.com

CONTACTAdvertisingIBS Publishing LtdPaul MinisterAdvertising ManagerTel: +44 (0) 1303 263 527Fax: +44 (0) 1303 262 646Email: [email protected]

SUBSCRIPTION IBS Publishing Limited8 Stade Street, Hythe, Kent, CT21 6BE, United KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: newhorizon-islamicbanking.com

©Institute of Islamic Banking and InsuranceISSN 0955-095X

Cover photo: © david Bronson glover, iStockphoto.com

Deal not unjustly,and ye shall not be dealt with unjustly.

Surat Al Baqara, Holy Quran

This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views expressed inthe articles are those of the authors alone and should not be attributed to the organisations they are associated with or their management. Any errorsand omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no responsibility to any person who acts, orrefrains from acting, based upon any material published in the magazine. The Editorial Advisory Panel exists to provide general advice to the editorsregarding matters that may be of interest to readers. All decisions regarding the published content of the magazine are the sole responsibility of theEditors, and the Editorial Advisory Panel accepts no responsibility for the content.

www.newhorizon-islamicbanking.com

NEWHORIZON Muharrum–Rabi Al Awwal 1430 NEWS

Risk Specialists Companies, asubsidiary of AIG CommercialInsurance, announced that it is introducing a takaful home-owners policy, the first instal-ment in Lexington TakafulSolutions, which will be anumber of Islamic product offerings for the US.

The product has been releasedin conjunction with AIG Taka-ful Enaya, a Bahrain-basedoutfit. Its Shari’ah supervisoryboard includes well-knownnames such as Sheikh NizamYaquby, who also sits on the

supervisory board of UK-based takaful operator, Principle Insurance.

The takaful offering for homeowners will be the firstIslamic insurance product to be marketed in the US. Abdallah Kubursi, global head of AIG Takaful Enaya,described the undertaking as‘truly a global effort’ and emphasised the commitmentof the participants to offerconsumers wider choice ‘based not only on need butalso social preference’.

First takaful productlaunched in US

Al Salam Investment in Dubai,which has identified Islamic finance as a big driver for the regional financial sector, haslaunched a major initiative andsigned an agreement to partnerwith Germany-based HSHNordbank, specialising in ship-ping and renewable energy fi-nance. The agreement initiallycovers the GCC but the inten-tion is to expand throughoutMENA in future. The partnersare expected to set up a jointventure in 2009, operating on Islamic principles. No detailshave been provided, though aventure is likely to be registeredin the Dubai International Financial Centre. Al Salam Investment’s CEO, PegmanHaghshenas, said: ‘Islamic finance can become the catalystthat restores the deal flow, per-

vious levels of transactions andultimately the confidence in the financial system needed toreverse the move away fromgrowth.’ Haghshenas went onto explain that the Middle Eastwill be a region of change andopportunity, and the partnershipis a way of ensuring Al Salam Investment is well placed to capitalise on it.

For HSH Nordbank, this collab-oration ‘opens the door to op-portunities that cannot be foundelsewhere at this time’, accord-ing to director Michael Bresges.German interest in Shari’ah-compliant finance follows onfrom the issue of sovereign Is-lamic debt by Saxony-Anhalt(one of the sixteen federal statesthat make up Germany) a fewyears ago.

German bank ties up with Al Salam Investment

The Museum of Islamic Art, theflagship project of the QatarMuseums Authority, has re-cently opened in Doha. QatarFinancial Center (QFC) Author-ity signed a partnership agree-ment to be its strategic financialpartner for three years from2009. The agreement will allowthe QFC and its staff to visitand benefit from the brand new,45,000 square metre venue,which is the largest museumdedicated to Islamic art in theworld.

The opening of the museum,which covers 1400 years of Islamic creativity, has beenbilled as one of the most signifi-cant cultural events in the his-tory of Qatar, and the staff ofQFC will benefit from its state-of-the-art hospitality and educa-tional facilities. Also included inthe agreement will be hostingcorporate and social events on

museum premises, private toursof the galleries, involvementwith educational workshops,and linkage between the QFCand the museum in publica-tions, websites and other mate-rials, and through sponsorshipof future exhibitions.

An opening ceremony for themuseum was held in November,under the patronage of HH TheEmir Sheikh Hamad bin KhalifaAl Thani. The project sets afounding stone in the culturalblueprint to transform Qatarinto a global capital of culture.The museum, designed byPritzker Prize (an architecturalaward) laureate Ieoh Ming Pei,is inspired by the 13th centuryablutions fountain at the 9thcentury Mosque of Ahmad ibnTulun in Cairo. The museum’sartworks, dating from the 7thto the 19th century, are drawnfrom three continents.

Qatar Financial Centresupports the largest

museum of Islamic art

IIBI 5

© Vatikaki Dreamstime.com

Museum of Islamic Art, Doha



iMAL, the Islamic core bankingsystem from Path Solutions, avendor based in Kuwait, has become the first core bankingplatform to be certified by theAccounting and Auditing Or-ganisation for Islamic FinancialInstitutions (AAOIFI), the inter-national standard setting body.The certificate was presented toPath at the AAOIFI & WorldBank Annual Conference on Islamic Banking and Finance, a yearly event organised byAAOIFI and held in Bahrain(where its headquarters arebased).

According to Dr MohamadNedal Alchaar, AAOIFI’s secre-tary general, the certificationcovers ‘the iMAL modules, business processes, contracts, Islamic accounting principles,implications and behaviour’.

Naji Moukadam, president ofPath Solutions, says: ‘Thepreparation and review startedin April 2008 and took sevenand a half months, duringwhich different teams, each intheir area of expertise, validated

iMAL as well as the businessprocesses and contracts to becompliant with AAOIFI’s re-quirements.’ The work involvedproduct strategy, developmentand business development de-partments, as well as corporatecommunications. The first meet-ing with AAOIFI’s secretarygeneral took place in May 2008‘to discuss the certification pro-cedures’. Dr Alchaar states thatthe system ‘has been thoroughlyreviewed and has proven it trulydeserves to be certified’.

Moukadam is convinced thatsuch recognition will give Path‘an additional edge over com-petitors’. He adds: ‘It translatesinto fast-tracking processes andguaranteed compliance withShari’ah as well as access to certified contracts, thus savingeffort, cost and time for our customers.’

Path has always maintained thatone of the key strengths of itsflagship offering, iMAL (‘i’stands for Islamic and ‘mal’means money in Arabic), is itspurely Islamic roots as opposed

to the Islamic systems of othervendors, which were convertedfrom conventional ones. InMoukadam’s view, this factorplayed a significant role in ob-taining the AAOIFI’s approvaland secured Path’s ‘pole positionin the battle for survival' in thecurrent tough economic climate.

Global financial unrest has notstopped the vendor from gain-ing a host of new deals in 2008,across the Middle East and fur-ther afield in Africa and SouthEast Asia. The most recent winsare at Al Jazeera Islamic co, asubsidiary of Qatar IslamicBank in Qatar, Khalijia Invest,an investment firm in Saudi Ara-

Path Solutions’ IT system gains approval of AAOIFI

bia, and Elaf Bank, a Shari’ah-compliant wholesale bank inBahrain.

Yousif Janahi, head of informa-tion technology at Elaf Bank,says that ‘based on the life cycleand the IT needs at our bank, we found that the iMAL productis the most Shari’ah-compliantproduct, and is mostly compre-hensive and user-friendly’. ElafBank had undertaken a detailedstudy of the products on offerfrom four international vendors,Temenos, Misys, InternationalTurnkey Systems and Path, before selecting the iMAL product, and should be live with it by March 2009.

NEWS

Dourria Mehyo, Path, receives AAOIFI certification

Consolidation in the GulfAmlak and Tamweel, two of Dubai’s largest Islamicmortgage lenders, will bemerged under a government-owned entity to form an Islamic real estate bank in a response to the global financial crisis.

The firms had faced difficul-ties obtaining credit against a

backdrop of falling prices in the property market. The combined value of the two firms will be AED2.5 billion($600 million), and the new entity, the largest real estate finance institution in the coun-try, will be known as UAE Real Estate Bank. Pressure hadgrown on the government inDubai to respond to the crisis.

This followed shortly afterAmlak, whose shares havedropped by 80 per cent in 2008,stopped writing new loans, although Tamweel, whoseshares had lost an even higherpercentage, had continued tooperate. Trading of shares inboth firms was suspended for a day in November, as mergerdetails were released.

A similar agreement in AbuDhabi then saw state regulatorsapprove the merger of the new Real Estate Bank and Emirates Industrial Bank, which offers some Shar’iah-compliant services. The com-bined entity, dubbed EmiratesDevelopment Bank, will become the largest financialservices company in the UAE.

6 IIBI


NEWHORIZON Muharrum–Rabi Al Awwal 1430 NEWS

OCBC’s Islamic strategytakes shape

OCBC Al-Amin Bank Berhad,the Islamic subsidiary of Over-sea-Chinese Banking Corpora-tion (OCBC), has commencedoperations in Malaysia with theopening of its first branch. Ac-cording to the CEO of OCBCAl-Amin, Tuan Syed AbdullAziz Syed Kechik, the entity will initially focus on themurabaha, mudarabah and ijaramodels. OCBC Al-Amin plansto open a further four branchesthrough 2009. OCBC BankMalaysia has operated Islamicwindows in its conventionalbranches for 13 years, but theintroduction of a fully-fledgedShari’ah-compliant subsidiaryrepresents the second majorphase of the bank’s developmentin Islamic finance. Islamic products will continue to be offered in OCBC’s conventionalbranches.

OCBC Bank Malaysia’s chair-man, Tan Sri Dato NasruddinBahari, stated at the unveilingceremony in November that thebank’s Islamic services have

been used by an even distribu-tion of Muslims and non-Muslims, reflecting the broadappeal of Shari’ah principles.

OCBC’s Islamic banking cus-tomer deposits have recentlygrown at seven per cent annu-ally, and Kuala Lumpur’s statusas a global financial hub hascontinued to strengthen, with Islamic banking accounting forabout 17 per cent of Malaysia’sbanking assets according toBank Negara Malaysia.

OCBC

Islamic banking spreads in Hong Kong

Malaysia-based CIMB Islamichas launched its first Shari’ah-compliant product in HongKong. It has signed the firsttransaction with Hong LeongBank for its commoditymurabaha deposit. The de-posit will utilise crude, palmoil, metal and other tradeablecommodities as underlying assets.

The Hong Kong branches ofCIMB and Hong Leong are thefirst institutions based in HongKong to offer Islamic banking,and the Hong Kong MonetaryAuthority successfully gaveclearance for the launch of theinterbank money product.

The launch of this productmarks the opening not only of

an Islamic window in HongKong but also mainland China,as the group has acquired a 20per cent stake in the Bank ofYing Kou in Liaoning province earlier this year.

CIMB hopes to expand fromShari’ah-compliant wholesalebanking to asset management,and will consider the viability of

consumer banking. The lattermight be difficult due to the thin geographical spread of Muslims in the country, thebank has indicated. CIMB obtained Bank NegaraMalaysia’s (central bank andregulator) approval to under-take Shari’ah-compliant bank-ing operations overseas inDecember 2007.

Standardisation for IslamicOTC derivatives

The International Swaps andDerivatives Association (ISDA)intends to make a template contract available in early 2009for Islamic over-the-counter(OTC) derivatives. This move isexpected to enhance growth op-portunities for Islamic finance,and to provide a useful tool forrisk management. The availabil-ity of the template contractshould make time-to-market forIslamic OTC derivatives faster,by standardising legal terms andallowing parties to focus on thecommercial side of the deal.

OTC derivatives are privatelynegotiated deals between in-vestors and counterparties. Ac-cording to the latest report fromthe Bank for International Set-tlements (BIS), the notionalamounts outstanding of OTCderivatives continued to expandin the first half of 2008, with alltypes of OTC contracts reaching$683.7 trillion by the end ofJune that year. Meanwhile, thegross market values (whichmeasure the cost of replacing all

existing contracts), stood at$20.4 trillion for the same pe-riod (29 per cent increase). Thecurrent financial crisis is partlyblamed on the global derivativestrade.

The exact volume of Shari’ah-compliant OTC derivativestrade is not known. However, it comprises only a small part of the industry, due to the nature of Islamic OTC trading.Shari’ah requires the underlyingassets to be tangible, such ascommodities, which excludesmost mainstream derivatives instruments.

The ISDA is working to stan-dardise regulation across theGCC, which would start to address a major hurdle of Islamic OTC derivatives, namelythat there is no uniform set of guidelines. There are one or two other moves in this direction, with Bank NegaraMalaysia, that country’s centralbank, also encouraging greaterstandardisation.


NEWHORIZON January–March 2009NEWS

The pre-budget report deliv-ered by UK chancellor AlistairDarling in November ruledout the issuance of Islamicbonds (sukuk) by the govern-ment any time soon. The gov-ernment confirmed it wouldlegislate to help develop Is-lamic corporate debt. Thiscame as a surprise, as ob-servers had expected chancel-lor Darling to approve theUK’s first Islamic debt instru-

ment – the government had pre-viously mentioned the possibilityof issuing sukuk at the same oc-casion in 2007. Saxony-Anhalt, astate in Germany which launcheda e100 million ($126 million) Islamic debt programme in 2004,remains the only example of asovereign sukuk issuance inWestern Europe.

Meanwhile, Christine Lagarde,minister of finance of France,

Islamic finance has setback in UK, shows progress in France

welcomed Islamic finance to the country at the 2nd Frenchforum of Islamic finance held inParis in November, echoing ear-lier positive sentiments. At leastthree Islamic banks are reportedto be requesting accreditation tooperate in France. These are Al Baraka Islamic Bank fromBahrain, Qatar Islamic Bank,which already has offices inLondon, and Kuwait FinanceHouse. There is a huge potential

market of over five millionMuslims in France, and a sur-vey conducted by the FrenchInstitute of Public Opinion(IFOP) in 2007 indicated thatat least 500,000 would be in-terested in Shari’ah-compliantfinance. Also reflecting France’spotential is the opening of anew website, Finance IslamiqueFrance, the purpose of which isto boost the profile of Islamicfinance and provoke debate.

IDB deepens support forstruggling member countries

Islamic Development Bank(IDB), based in Jeddah, has announced plans designed tohelp Muslim countries throughthe global financial storm. Thebank will issue bonds to collectfunds from international mar-kets to support member coun-tries of the bank. This will help cushion against the predicted decline in foreign investment due to difficult credit conditions.

IDB has played an importantrole in propping up Pakistan’sfinances, with a $200 millionloan in November. It also recently signed two agreementswith Egypt to provide $169 million for projects for electric-

ity and bird flu vaccine, ofwhich $159 million will helppay for Abu Qir power station.This is out of a total of $2.8 billion in loans to Egypt so far,covering over 226 operations altogether.

Core principles shield Islamicbanking from economic stormShari’ah-compliant financial institutions in the GCC haveweathered the economic turmoilwell, according to Moody’s Investors Service. The ratingsagency suggests this is not only a result of strong growthand a characteristically conser-vative approach, but also thanks to following core Islamicprinciples.

Global Islamic banking assetsgrew about 27 per cent in 2007,and similar growth is expectedto be shown for 2008. While2009 is expected to be a toughyear for Islamic finance, just asit is for conventional banking,Anouar Hassoune, Moody’s vicepresident and author of the report, suggests that Islamicbanks will still benefit from anumber of factors.

These factors include that credit portfolios are normallydomestic, they are strong retail banking platforms with

customers displaying a high degree of loyalty to Shari’ah-compliant banks, and they havea good capital base and ampleliquidity. Moody’s therefore predicts that the Gulf will con-tinue to grow in 2009, thoughslowing, before assuming its upward march in a year and ahalf or so.

It also suggests that the financialcrisis has improved the reputa-tion of Islamic finance, as a con-servative, traditional approachto finance becomes more valuedonce again.

Finally, Moody’s explains thatthe prohibition in Shari’ah ofspeculation and riba (interest)has also helped Islamic financialinstitutions avoid the worst ofthe credit crisis. The Shari’ah-compliant banking market is not immune from problemsaround it, but seems to have the ability to withstand thestorm.

IDB

To stay up to date with all the news in the Islamic financial sector, visit the ‘Breaking News’ section of the NewHorizon

website at www.newhorizon-islamicbanking.com

Two innovative firms...

One colourful combination



in alcohol and gambling. Since that time,the industry has flourished with banks, suchas the Netherlands-based Triodos Groupand the UK-based Co-operative Bank, taking prominent positions in the conven-tional banking world supported by hun-dreds of mutual investment funds, eachspecialising in some aspect of ethical or socially responsible investment.

So how interchangeable are these technicalterms – ethical investing, socially responsi-ble investing and Islamic investing? Ethicalinvesting, as we have seen, uses negativescreening to weed out companies that en-gage in undesirable lines of business. TheEthical Partnership goes on to classify so-cially responsible investment in the conven-tional world as not only adhering to agreednegative criteria, but actively seeking outfirms which make a positive contribution to society. This is very much along the linesof classical Islamic economic theory whichholds that the Earth’s resources are to beused for the benefit of the community as a whole. Another fundamental tenet of Is-lamic economic theory is that it is the dutyof mankind to care for the world’s resourcesand to hold them in stewardship, or trust,for future generations. It is interesting then,that the UK’s first purely ethical trust, whichwas launched in 1984 by Friends Provident,was called The Stewardship Fund. Concep-tually, the two forms of banking would ap-pear to be operating on parallel paths.

‘We think Islamic finance is better [thanconventional interest-based finance] becauseit’s fair, it’s just and it’s equitable,’ says

‘Is Islamic banking a sub-set of ethical in-vesting, or vice versa?’ asked Baron JunaidBhatti, CEO, Ballencreiff House, at TheRise of Islamic Finance and Ethical Invest-ments conference that was held recently inLondon. Responding to his own question,Bhatti thought that Islamic finance is a not a small sub-set, but a huge sub-set, of ethi-cal finance. Islamic finance is very clear regarding ‘green’ issues and sustainablesources. Both forms of banking have muchin common.

The Ethical Partnership, a UK non-profit organisation, classifies ethical investment asusing negative criteria to avoid investing incompanies that are involved in specific areas(see Box 1). This screening is largely subjec-tive, often depending on individual con-sciousness, but a general consensus of thosescreenings shows an unerring similarity tothe screens used by the Islamic world whenselecting suitable investments – with riba(interest) probably being the major differ-ence between the two sets. The same typesof prohibition of firms are excluded by ethical screening in the conventional bank-ing world as are screened by the Islamicworld – such as those that are involved ingambling, alcohol, arms manufacture, tobacco, pornography and the like.

It is notable that the roots of socially responsible investing in the conventionalworld also seem to have stemmed from a religious connection – they have been tracedback to the 1920s when the MethodistChurch wished to invest in the UK stockmarket while avoiding companies involved

Islamic and ethical finance: on the same path?Can the rising level of interest in ethical and socially responsible investment, which is takingplace in the conventional banking world, be used to widely promote the inherently ethical natureof Islamic banking? Don Brownlow, NewHorizon’s contributing editor, investigates.

ANALYSIS

We need to look not just atwhat we can’t invest in – weneed to look at what we shouldinvest in.

Naveen Raza,Cru Investment Management


NEWHORIZON Muharrum–Rabi Al Awwal 1430 ANALYSIS

Naveen Raza, head of Islamic finance atCru Investment Management. These arealso the objectives of the ethical and sociallyresponsible investment movement in theconventional world. Raza is looking to promote the synergies between the twobanking models, saying: ‘I think the futureof Islamic finance lies in the overlap be-tween Islamic and ethical investing. If wewant our industry to grow then we need to start tapping into an audience which goes beyond the borders of the Islamicworld.’

Mufti Mohammed Zubair Butt, chairman of the Al Qalam Shari’ah Scholars Panel, the first ever UK-based panel of Shari’ahscholars, agrees, saying: ‘Islamic finance issocially responsible finance. It is designed to come to the market and promote thepublic interest.’ He thinks there are somethings in common between the understand-ing of ethical finance and Islamic finance,for example, both forms avoid investment in gambling, prostitution and alcohol. ‘But the main difference, of course, is the Islamicprohibition on interest-based transactionsand interest-based finance. As far as conven-tional ethical schemes are concerned thisdoesn’t even register.’ The effect of interest-based lending, Butt thinks, ‘is that conven-tional banks gear their project financingdecisions on the creditworthiness of the borrower, as opposed to Islamic bankingwhere the viability of the project is the main concern because the bank itself is apartner’. The outcome is that the Islamicsystem must exclude investing in interest-based products or companies that deal with them such as banks and finance companies.

Other differences may be more readily understood by conventional banking’s ethical investment community. These differences include the avoidance of short-selling and the more conservative use of derivatives, which would typically be used only as hedging tools if they are used at all. Many in the West may well now sympa-thise with this position, particularly in lightof the current turmoil in the conventional financial markets and the abuses that havereportedly taken place.

Mohammad Khan, director of takaful atPricewaterhouseCoopers, speaking at theconference mentioned above, pointed outthat in Malaysia it is estimated that about40 per cent of Islamic banking is done bythe non-Muslim, ethnic Chinese community.He thought that this showed that Islamicbanking has the potential, and appeal, to beused outside of the Muslim community. Hesuggested that when addressing the Muslimcommunity the differentiation of Islamic

banking to conventional banking should be stressed – showing the faith-oriented differences between Islamic modes and theconventional and indeed stressing those differences. But to the non-Muslim market,non-differentiation should be stressed because to that market, banking is just a commodity item.

Possibly there is a third alternative, that ofstressing what the Islamic model has in

Box 1

What is ethical investment and socially responsible investment?

Ethical investment has been defined as putting your money where your morals are, orinvesting according to your beliefs.

Ethical investments tend to use negative criteria to avoid investing in companies involved in areas such as:

✖ Environmentally damaging practices; ✖ Trading with oppressive regimes and countries with poor human rights records;✖ Pornography and offensive advertising; ✖ Gambling; ✖ Tobacco and alcohol production; ✖ Unnecessary exploitation of animals; ✖ Unsafe products and services; ✖ Genetic engineering, abortion and embryonic research; ✖ Armaments.

Socially responsible investments, as well as adhering to agreed negative criteria, ac-tively seek out firms which make a positive contribution to society, for example:

✔ Products and services which are of long term benefit to the community; ✔ Conservation of energy and natural resources; ✔ Environmental improvements and pollution control; ✔ Good relations with customers and suppliers; ✔ High employee welfare standards; ✔ Organic farming and foods; ✔ Strong community involvement; ✔ A good equal opportunities record; ✔ Respect for the sanctity and dignity of human life; ✔ Openness about their activities.

The list is not exhaustive. Each fund tends to differ in negative and positive criteriaand also in investment risk. It is, therefore, very important to select the right funds tomatch your views.

Source: The Ethical Partnership Ltd


NEWHORIZON January–March 2009ANALYSIS

What ethical screening means:

Shari’ah-based Islamic index screening

Shari’ah indexes are mechanisms that track the performance of selected, leading Shari’ah-compliant companies. The indexes may beglobal or limited to a particular geographic region. Two of the major providers of Islamic indexes are Dow Jones and the FTSE.

Boards, made up of leading Shari’ah scholars, advise suppliers on the make-up of the indexes and advise on Shari’ah principles. TheDow Jones uses its own in-house appointed Shari’ah scholars; the FTSE uses the services of Yassar Research Inc.

Excluded from the Islamic indexes are companies that are involved in activities that are not in keeping with the fundamentals of theIslamic faith (haram activities). Companies that are involved in the following activities are automatically excluded:❏ Alcohol manufacture, distribution, or related activities;❏ Conventional banking services or other interest-based service companies;❏ Entertainment and gaming services (casinos/gambling, cinema, hotels, music, pornography, etc);❏ Life insurance;❏ Pork-related products.

Although not specifically prohibited by the Shari’ah, companies engaging in the following activities are considered to be against theinterests of the community, so are generally excluded:❏ Arms manufacture or sales;❏ Tobacco-related production and products.

To be considered Shari’ah-compliant, companies must also adhere to strict financial ratio screening (see below) as determined by theindex’s Shari’ah advisory board.

Other ethical based screening

Many ‘ethical’ and ‘socially responsible’ investments will screen out most, if not all, of the above categories. Additionally, otherscreens, such as human rights violations or use of child labour, may be included in the ethical screenings of conventional financial investments depending on the consciousness of the particular screen.

These activities are not strictly considered as ‘haram’, so are not automatically excluded from the Shari’ah screenings.

Financial ratio screening

Islamic scholars recognise that business activities must be carried out with non-Islamic organisations so they tolerate a limitedamount of otherwise ‘haram’ activities to take place within those conventional companies. Those activities must be within acceptablelimits. This type of screening has protected the Islamic community from investment losses in the past. A commonly quoted example is when Enron, prior to its collapse, exceeded the Shari’ah guidelines of acceptable levels of debt and was taken out of the Islamic indexes at the insistence of the Shari’ah scholars, and so protected Islamic investors from its dramatic fall in the markets.

Some of the common financial screens include:❏ Debt to total assets should not equal or exceed 33 per cent;❏ Illiquid to total assets should be at least 51 per cent (this figure can vary according to region);❏ Total investment in non-compliant activities should not equal or exceed 33 per cent;❏ Income from non-compliant investment should not equal or exceed five per cent of gross revenue;❏ What is referred to as ‘net liquid assets’, calculated as [(tangible fixed assets + inventory) – liabilities], per share should be at less

than the market price of the share.

Source: Mufti Mohammed Zubair Butt

of a box-ticking exercise – how can we getthis product past our scholars?’ says Raza.‘If we think Islamic finance is a better waythen we need to show why it’s a better wayand for that I think we need to go back tothe roots of Islamic finance; we need tothink of what were the original principles ofShari’ah and ask why are we doing what weare doing.’ Raza believes this type of ques-tioning will provoke answers such as – totry and reduce the gap between the rich andthe poor, to try and give help to people whoare not blessed with having as much wealthas others, and to enable them to earn a liv-ing and do well for themselves. If you get tothese sorts of answers, then you may think‘how can I actually create a product that istrue to the principles that I am rooted in’.To hold these basic humanitarian beliefs you need not be Muslim – they are valuesthat the majority of people throughout theworld will uphold.

A common criticism of Islamic finance isthat, although it is recognised that the in-dustry is a new one, it has spent too muchtime mimicking conventional finance. ‘Wedo need an [Islamic] home finance product,we do need car finance, we do need a sav-ings account and a current account and wedo need liquidity management. We neededto mimic the conventional world to get to apoint where we can be competitive,’ con-cedes Raza. But she goes on to say, ‘I hopethat people will start to think outside of thebox and not just think about the conven-tional industry and how we can copy ormimic that. We need to look not just atwhat we can’t invest in – we need to look at what we should invest in. So positivescreening comes into play.’

This level of ‘positive’ investment places obligations on the investor which are abovesimply placing money into non-haram companies. ‘As Islamic investors, we need to be responsible – not just say we have notinvested in anything that we are not al-lowed, so that’s fine. We need to do a littlebit more, we need to take responsibility. Ifthey have practices that are not ethical or Islamic then we need to put on pressure atannual meetings. This is important,’ believesRaza.



common with the socially responsible in-vestment community of the conventionalworld and pointing out that the industry isalready pre-screened, so that it inherentlymeets the needs of the ethically consciousconventional market. There may already be some traction in this message – ImranPasha, head of branch network at the Islamic Bank of Britain has noted that, inthe UK, his bank has experienced a five to ten per cent increase in inquiries fromnon-Muslims who were interested in theethical aspects of Islamic finance.

Raza is hoping that the potential for cross-selling between the Islamic and the ethicalworlds can be used in a real way. A newfund, the Africa Transformational Agri-Fund, is to be launched by Cru InvestmentManagement in March 2009 to provide di-rect investment and infrastructure to farm-ers in the sub-Sahara region. The fund had awarm reception from the Islamic communityin the UK and Middle East when it was an-nounced. ‘People loved the idea, they lovedthe fact it was purely Islamic – not just thestructure of the product but actually the un-derlying ethos of it. What we are doing onthe ground is Islamic – as opposed to justthe structural requirements that make itShari’ah-compliant. We are saying that it isShari’ah-based, it is rooted in the principlesof Shari’ah,’ explains Raza.

A key point, though, is that the fund, al-though being totally Islamic in practice andintention, is also being actively promoted to the socially responsible investment com-munity in the conventional world as well as to Islamic investors. ‘In Europe, ethicalinvesting is a very big thing and we need toalign ourselves more closely to ethical andsocially responsible investors,’ says Raza.Potentially, this fund and similar fundscould give ethical investors vehicles for di-rect investment into the region rather thansimply making donations to charity relieforganisations.

The hope is that these primary investmentideas will appeal to both the ethical in-vestors in the conventional world and the ethical investors in the Islamic world. ‘Islamic finance has become more and more

Islamic finance is sociallyresponsible finance. It isdesigned to come to themarket and promote thepublic interest.

Mufti Mohammed Zubair Butt,Al Qalam Shari’ah Scholars Panel

be an issue that will need to be addressed inthe future.

The Islamic finance industry has often been criticised for mimicking the conven-tional banking industry but in attempting to follow ethical and socially responsible investment paths, perhaps those in the conventional banking world are, possiblyunknowingly, mimicking Islamic finance.


NEWHORIZON January–March 2009ANALYSIS

This is exactly the view held by anothernewly established fund that is targeting its investment into companies with high levels of corporate transparency. Addition-ally, this new fund has been designed to bemarketed to both the Islamic and the ethical communities. The ASEAN (Association ofSoutheast Asian Nations) Corporate Gover-nance fund, offered by Malaysia-basedCorston-Smith Asset Management, will invest in ASEAN companies that not onlyhave a good business model but also havehighly rated corporate governance princi-ples. The fund has two versions – a conven-tional version that was launched in June2008 and an Islamic version, which isscheduled to be launched shortly.

The fund is a result of a strategic collaboration between Corston-Smith Asset Management and Hermes EOS, themanagement arm of the UK’s BT pensionscheme, which advises institutional investorson corporate governance issues and whichhas £50 billion ($74 billion) of assets understewardship.

‘The purpose of the fund is to raise the level of transparency in the industry,’ saysShireen Muhiudeen, managing director,Corston-Smith Asset Management. ‘In-vestors are willing to pay a premium for a high level of corporate transparency, particularly in the current subprime crisis, in which even the sellers of some paper havenot known what it is that they are selling’.In addition to the Hermes screening, poten-tial investments are subject to an additional49 question checklist by the fund. The questions relate to details of the company’scorporate governance. The target is to getaround 20 to 30 stocks in the fund. At themoment, in the conventional version of thefund, there are about eight companies cur-rently approved but that will rise to 13 once those in the pipeline are given thegreen light. The Shari’ah version has a ‘uni-verse’ of 212 stocks, but this will reduce toaround ten per cent or so once screening hastaken place.

To provide a benchmark, Dow Jones hascreated a new index, the Dow Jones IslamicMarket ASEAN Index to represent perform-

ance of the Shari’ah companies in six of theten member states of the ASEAN nations.As of end of November 2008, the index consisted of 284 companies.

Muhiudeen raises a point which is topicalamong Islamic fund managers and will be-come more so if cross-selling occurs be-tween the ethical and the Islamic worlds.That is the topic of co-mingling of invest-ments from different individuals. At theheart of this issue is the different level ofShari’ah compliance required by differentinvestors. The ASEAN Corporate Gover-nance Fund itself is open about the scholarsit uses and other compliance issues. Each investor is then able to determine for themselves whether the fund’s Shari’ah compliance is within their own tolerancelevel. Some investors will not wish to co-mingle their investment with others whomay be seen as being less strict than them-selves. This will give the need to segregatefunds of certain investors.

Although the ASEAN fund will have separate conventional and Islamic versions,if Islamic funds are to be cross-sold outside of the Muslim world then co-mingling may

Investors are willing to pay a premium for a high level of corporatetransparency, particularly in the current subprime crisis, in whicheven the sellers of some paper have not known what it is that theyare selling.

Shireen Muhiudeen,Corston-Smith Asset Management

Shireen Muhiudeen,Corston-Smith Asset

Management



balance sheet items with specific risk aspectsso that the interaction between varioustypes of risk is understood to ensure thatthey are not evaluated in isolation. The relative share of various balance sheet components – assets and liabilities – is agood indication of the levels and types ofrisk to which a bank is exposed.

Table 1 below shows stylised balance sheetof a conventional commercial bank. On theliability side, it accepts demand and savingdeposits, issues term certificates such as certificate of deposits (CD), and has capital.

On the asset side, there is much more diversity and options in the form of marketable securities, trading accounts,lending to corporations and to consumers.

From the risk point of view, two observa-tions can be made. First, the deposits createinstantaneous pre-determined liabilities irrespective of the outcome of the usage ofthe funds on the asset side, thus creating an

The goal of financial risk management is to maximise the value of a financial insti-tution as determined by its level of prof-itability and risk. Since risk is inherent in banking and unavoidable, the task of therisk manager is to manage the differenttypes of risk at acceptable levels to achieveoptimal profitability. Doing so requires thecontinual identification, quantification, and monitoring of risk exposures, which in turn demands sound policies, adequate organisation, efficient processes, skilled analysts and elaborate computerised infor-mation systems. In addition, risk manage-ment requires the capacity to anticipatechanges and to act in such a way that abank’s business can be structured and restructured to profit from the changes or at least to minimise losses. Regulatory authorities should not prescribe how business is conducted; instead, they shouldmaintain prudent oversight of a bank byevaluating the risk composition of its assetsand by insisting that an adequate amount of capital and reserves is available to safe-guard solvency.

Although the approaches to risk manage-ment are diverse, a good starting point is to undertake a top-down approach startingwith the balance sheet. One cannot underes-timate the importance of understanding thestructure and composition of the balancesheet of a financial institution.

It is critical to assess the ways in which abank’s risk managers and analysts cananalyse the structure of balance sheets andincome statements, as well as individual

Balance sheet analysis: Islamic vs. conventional

Hennie van Greuning (left) and Zamir Iqbal (right), senior advisor and lead investment officerrespectively at The World Bank Treasury in the US, and the authors of ‘Risk Analysis for IslamicBanks’, compare the balance sheet structures of Islamic banks and their conventional counterparts.

asset-liability mismatch. Second, medium- tolong-term assets are financed by the stream ofshort-term liabilities, exposing the bank to amaturity mismatch risk and discouraging thebank from investing in long-term non-liquidprojects. An increase in the level of non-retaildeposits or funding could expose a conven-tional bank to greater volatility in satisfyingits funding requirements, requiring increas-ingly sophisticated liquidity risk management.Certain funding instruments also expose abank to market risk.

For Islamic financial institutions, the nature of financial intermediation, including thefunction of banking, is different from that of conventional financial institutions. This is the key to understanding the difference in the nature of risks in conventional and Islamic banking. For Islamic banks, the mudarabah contract is the cornerstone of financial intermediation and thus of banking.The basic concept is that both the mobilisa-tion and (in theory) the use of funds are basedon some form of profit sharing among the

ANALYSIS

Assets Liabilities

Loans and advances to customers Customers’ deposits

Cash and cash balances with other banks Due to banks and other financial institutions

Investments in associates, subsidiaries and joint ventures Other liabilities

Financial assets held for trading Sundry creditors

Cash and cash balances with the central bank Equity and reserves

Table 1 Stylised balance sheet of a conventional bank – based on functionality



depositors, the bank, and the entrepreneurs(users of funds). The financial intermedia-tion is merely a ‘pass-through’ arrangementsimilar to funds management, with the difference that there are multiple portfolioson the asset side.

Table 2 below presents a stylised balancesheet of an Islamic bank, displaying different activities and financial instru-ments. It serves as a good starting point for understanding the dynamics of the risksinherent in Islamic banks. This balancesheet classifies the functionality and purposeof different instruments – a common practice among Islamic banks.

The structure of a typical balance sheet hasdemand deposits and investment accountsfrom customers on the liability side and Islamic financing and investing accounts(the equivalent of conventional banks’ loans to customers) on the asset side. Thispattern reflects the nature of banks as inter-mediaries, with ratios of capital to liabilitiesat such a low level that their leverage wouldbe unacceptable to any business outside thefinancial services industry. The analystshould be able to assess the risk profile ofthe bank simply by analysing the relativeshare of various asset items and changes intheir proportionate share over time.

While the types of liabilities present in an Islamic bank’s balance sheet are nearly universal, their exact composition variesgreatly depending on a particular bank’sbusiness and market orientation, as well asthe prices and supply characteristics of dif-ferent types of liabilities at any given pointin time. The funding structure of a bank di-

rectly affects its cost of operation and there-fore determines a bank’s potential profit and level of risk. The structure of a bank’sliabilities also reflects its specific asset-liability and risk management policies.

When compared with conventional banks,balance sheet risk profile of Islamic banks is different. First, the foremost feature of anIslamic bank is the ‘pass-through’ nature ofthe balance sheet. This feature removes thetypical asset-liability mismatch exposure ofa conventional bank, as the Islamic bank’sdepositors’ return is linked to the return onthe assets of the bank. However, this fea-ture also introduces some operational issues,

such as estimation and accrual of ex-post returns and the treatment of intra-periodwithdrawal of deposits.

Second, the nature of assets of two institu-tions is different. Whereas a conventionalbank tends to stay with fixed income verylow credit risk debt securities, an Islamicbank’s assets are concentrated on the asset-based investments which has credit risk butare also backed by a real asset. As a result,the lending capacity of the Islamic bankingsector (at least for commercial banks) isbound by the availability of real assets inthe economy. Thus, there is no leveragedcredit creation.

Third, the assets of Islamic banks contain financing assets where tangible goods andcommodities are purchased and sold to thecustomers. This practice creates distinct exposures. For example, in case of conven-tional banking, the asset is financed by aloan from the bank to the customer whereas

Application of funding Sources of funding

Cash balances Demand deposits (amanah)

Financing assets (murabaha, salam, ijara, istisna) Investment accounts (mudarabah)

Investment assets (mudarabah, musharakah)Special investment accounts (mudarabah, musharakah)

Fee-based services (ju’ala, kafala, and so forth) Reserves

Non-banking assets (property) Equity capital

Table 2 Stylised balance sheet of an Islamic bank – based on functionality

in case of an Islamic bank, the asset and thefinancing are coupled together. The bank isnot limited to the exposure as a financierbut can develop additional exposures result-ing from dealing with physical assets. An-other feature which distinguishes the risksof an Islamic bank from a conventionalbank is the general lack of liquid securitieson the asset side. This feature is not a designissue but is a temporal phenomenon until awell-functioning securities market for Shar-i’ah-compliant instruments is developed.

Finally, due to prohibition of interest, Islamic banks cannot issue debt to financethe assets which consequently discouragescreation of leverage. Due to the lack ofleverage, Islamic banks can be consideredless risky during a time of financial crisis.The current financial crisis was precipitatedby excessive leverage and complexity in the financial system, which had developedmultiple layers of intermediaries. Hence, the financing – or the claims on assets – becameremote from the underlying assets. For Islamic banks, the financial intermediary isclosely associated with the asset and is ableto perform better monitoring of the asset as well as the obligor. These features can enhance the stability of the banking system.

In short, a holistic approach to understand-ing the risk of Islamic financial institutionsshould start with a rigorous analysis of therisk profile of different financial contractson each side of the balance sheet. Standardanalysis techniques such as trend analysis,impact analysis, bucketing, duration andmaturity mismatch, and value-at-risk analy-sis can be applied to each financial contractor instrument type but then the resultsshould be aggregated at the balance sheetlevel to understand a global picture at theinstitution level.

Typical risk analysis often focuses on finan-cial risks, and especially on the asset side.However, given the nature of Islamic banks,a good analysis should not ignore non-financial risks on the liability side such aswithdrawal risk and lack of geographical diversification. And of course, competitionfrom conventional banking should not beignored either.



South Africa’s minority Muslim populationconsists of an estimated 1.5 per cent of a total figure of 48 million. Shari’ah-compliant vehicle finance remains the product with the most traction, which maybe attributed to the infrastructure of thecountry. The Islamic banking system at thispoint is inadequate to provide full bankingservices in the fashion of conventional banksto the Muslim community. Areas of foreignexchange and personal finance still remainin the domain of conventional banks.

However, Islamic finance contains inherentfeatures that offer protection against thepresent state of global finance, and theSouth African Reserve Bank (SARB) thatregulates banking practices in South Africahas curbed international financial integra-tion so that the country is not suffering the complete effects of the global financial turmoil.

SARB provides the framework of regula-tions to all financial sectors operating in the country. The emerging Shari’ah-compliant financial institutions are com-pelled to operate under the same regulatoryframework as conventional institutions, and SARB is the only body authorised toissue licences.

Islamic financial institutions must, there-fore, obtain a licence from SARB and under the stipulated regulations contained in the Banks Act of 1990, but since the Banks Act provides no legislation on Shari’ah compliance of banking operations,individual Islamic financial institutions appoint their own Shari’ah boards to ensureit. The Shari’ah boards are an independentcomponent of the governance structure ofthese institutions and advise on matters relating to Islamic jurisprudence.

In the spotlight: South AfricaRabiah Talib Badroen, majoring in Islamic studies and international politics at the University ofSouth Africa, outlines the state of the country’s Islamic finance industry.

The independence of the banks in this areais demonstrated by the make-up of theboards. For example, First National Bank’s(FNB) Islamic window has a Shari’ah boardconsisting of an all South African member-ship, whereas the Oasis Group, a fund manager, relies on a board made up of inter-national members. Each institution appointswhichever members it considers most quali-fied to fill the position. At the investmentcompany Stanlib, among the members ofthe Shari’ah board is Mohammed HashimKamali, an international author on the subject of Islamic jurisprudence. A factorthat is noticeable in this emergent market is the lack of collaboration amongst all the institutions operating in Islamic finance. At present there is also no vision of a unifiedShari’ah board – a Shari’ah board’s expert-ise is confined to Islamic jurisprudence anda unifying body is unforeseen at this stage.

These institutions are also members of theAccounting and Auditing Organisation forIslamic Financial Institutions (AAOIFI) andthe Islamic Financial Services Board (IFSB).Both memberships are viewed as compli-mentary and the institutions respect theguidelines and directives offered by thesestandard-setting bodies.

Albaraka Bank is the longest established Islamic bank in the country. The bank isowned by South African investors, UK-based DCD London & Mutual Plc andSaudi Arabia-based Dallah Al BarakaGroup. The bank is renowned for striving to operate strictly within the confines ofShari’ah-compliant principles. Its headquar-ters are in Durban, and it has six regionalbranches spread throughout the country.The bank offers the more common Islamicfinancial services such as murabaha,musharakah, ijara and ijara wa iqtina. Ijara

OVERVIEW©

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financing is currently being pioneered by Albaraka; the inception of this scheme wasin August 2008. Clients have the option ofchoosing between murabaha and ijara.

The bank is also involved in takaful. TheTakaful Waqf Fund, which offers Shari’ah-compliant asset protection in collaborationwith Takafol South Africa (subsidiary of aGerman reinsurance company, Hannover Re Group), channels all excess funds to Shari’ah-compliant projects. This fund hasbecome instrumental in South Africa’s muchneeded social development. It is interest(riba) free and this condition is governed bythe bank’s supervisory council, AlbarakaBoard of Shari’ah Advisors.

Albaraka also offers a very popular productknown as the Hajj Investment Scheme. Thisis a scheme for individuals and organisationswho wish to take part in the pilgrimage. Aminimum fixed amount is deposited everymonth and a share of profits is earnedmonthly.

Islamic windows have been incorporatedinto two leading South African conventionalbanks, the afore-mentioned FNB and AbsaBank. FNB’s CEO, Ebi Patel, started re-searching Islamic windows in 2000. He rejected all previous approaches and struc-tured a package suitable for the indigenousmarket. In 2004, FNB launched the first Islamic window in the domestic market, concentrating only on vehicle and asset finance. Due to FNB’s widespread geo-graphic accessibility in comparison to Al-baraka’s six branches, it was able to exceedAlbaraka within a period of 18 months, according to Patel. However, Albaraka’s objective is to remain a niche firm.

FNB offers cheque accounts, debit cards and property finance as well as the productwith which its launch is associated, vehiclefinance. Meanwhile, Absa offers similarproducts, and both exclude musharakah financing.

Patel has revealed potential products in thepipeline to give FNB a larger share of themarket. The bank is planning on adding de-velopment bonds (based on istisna) and an

IIBI 19

investment account, designed to attractoversees investors, to its product portfolio.This will be the first istisna product avail-able to the South African Islamic financemarket.

Investment institutions offering Islamic equity on the South African stock exchangemarket occupy a larger share than the bank-ing sector. Albaraka offers an investment account, and Fraters and Stanlib are theother investment companies offering sharedinvestment. However, the investment institu-tion that holds the greatest recognition is,undoubtedly, the Oasis Group. Establishedeleven years ago in Cape Town, it hasgrown regionally and internationally – atpresent it occupies offices throughout SouthAfrica, in Dublin’s financial district and inDubai. As an international player it hasclaimed the Failaka Islamic Fund awardconsecutively and the Kuala Lumpur IslamicFund award for Outstanding Islamic FundManager. The institution has an aggressivecontinuous advertising campaign. In themonth of Ramadan this year, at the heightof the US-led financial crisis, the CEO ofOasis, Adam Ismael Ebrahim, addressedlocal investors’ concerns by reiterating theinsulation Islamic investment can provide by not engaging in derivative instruments,speculation and hedge funds. Oasis’ Islamicequity fund is definitely suffering in thepresent bearish climate, but the impact isless severe than in conventional and interna-tional investments. Islamic fund managersare requesting patience in a market with lesssystematic risks.

Plans are in the pipeline to grow Shari’ah-compliant finance in South Africa, but thesuccess and the sustainability of Islamicproducts ultimately depend on the con-sumer. The emergence of better educatedyoung population, with a deeper under-standing of Islamic finance and, thereforemore open to it, is undoubtedly a positivesign. At present, apart from a handful ofworld renowned Islamic finance players, theoverall Islamic banking and finance sectorof South Africa is not prominent on the in-ternational scene. However, there is a poten-tial which, once fully realised, will benefitthe country socially and financially.



big banks that the central bank will defi-nitely come to their rescue and not allowthem to fail.

The false sense of immunity from losses that all these factors together provide, hasintroduced a fault line in the financial sys-tem. Banks have not, therefore, undertakena careful evaluation of the loan applications.This has led to an unhealthy expansion inthe overall volume of credit, to excessiveleverage, and to an unsustainable rise inasset prices, living beyond means, and spec-ulative investment. Unwinding later on givesrise to a steep decline in asset prices, and tofinancial frangibility and debt crises, partic-ularly if there is over-indulgence in shortsales. Jean Claude Trichet, president of theEuropean Central Bank, has rightly pointedout that ‘a bubble is more likely to developwhen investors can leverage their positionsby investing borrowed funds’.

The subprime mortgage crisis

The subprime mortgage crisis, in the grip of which the US finds itself at present, is a classical example of excessive andimprudent lending. Securitisation or the‘originate-to-distribute’ model of financinghas played a crucial role in this. Thecreation of collateralised debt obligations(CDOs) by mixing prime and subprime debt made it possible for mortgageoriginators to pass the entire risk of defaultof even subprime debt to the ultimatepurchasers who would have normally beenreluctant to bear such a risk. Mortgageoriginators had, therefore, less incentive toundertake careful underwriting.

The whole world is now in the grip of a financial crisis which is far more seriousthan any experienced since the Great Depression. It has taken more than $3 trillion of bailout and liquidity injections by a number of industrial countries to abate somewhat the intensity of the crisis.Nevertheless, there are fears that this crisis may have exposed the world economyto a long period of economic slowdown.There is, hence, a call for a new architecturethat would help minimise the frequency andseverity of such crises in the future.

Primary cause of the crisis

It is not possible to design a new architec-ture without first determining the primarycause of the crisis. The generally recognisedmost important cause of almost all criseshas been excessive and imprudent lendingby banks over a long period. This is clearlyacknowledged by the Bank for InternationalSettlements (BIS), which states as much inits annual report (released on 30th June2008).

This raises the question of what makes itpossible for banks to resort to such an un-healthy practice which not only destabilisesthe financial system but is also not in theirown long-run interest. There are three factors that make this possible. One of theseis inadequate market discipline in the finan-cial system resulting from the absence ofprofit-and-loss sharing (PLS). The second isthe mind-boggling expansion in the size ofderivatives, particularly credit default swaps(CDSs), and the third is the ‘too big to fail’concept, which tends to give an assurance to

The global financial crisis: can Islamic finance help?

Dr Umer Chapra, senior research advisor at Islamic Research and Training Institute of the Islamic Development Bank (IDB), explores this issue in the first of the IIBI lecture series, dedicated to Ibn Khaldun*.

Consequently, loan volume gained greaterpriority over loan quality and the amount of lending to subprime borrowers and spec-ulators increased steeply. According to Ben Bernanke, chairman of the board ofgovernors of the US Federal Reserve System,‘far too much of the lending in recent yearswas neither responsible nor prudent… Inaddition, abusive, unfair, or deceptive lending practices led some borrowers intomortgages that they would not have chosenknowingly.’ The check that market disci-pline could have exercised on the serving of self-interest did not come into play. Eventhe supervisors failed to perform their taskeffectively by not taking serious notice ofthe unfair practices at an early stage andnipping them in the bud.

The result is that a number of banks haveeither failed or have had to be bailed out or nationalised by the governments in theUS, the UK, Europe and a number of otherplaces. This has created uncertainty in themarket and prolonged the credit crunch,which made it hard for even healthy banksto find financing. There is a lurking fearthat this might be only the tip of the icebergand a lot more may follow if the crisiscauses a prolonged recession and leads todefaults on the part of credit card institu-tions, corporations and derivatives dealers.

When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive resort toderivatives like CDSs to seek protectionagainst default. The buyer of the swap(creditor) pays a premium to the seller (a hedge fund) for the compensation he

ACADEMIC ARTICLE


NEWHORIZON Muharrum–Rabi Al Awwal 1430 ACADEMIC ARTICLE

will receive in case the debtor defaults. Ifthis protection had been confined to the ac-tual creditor, there may not have been anyproblem. What happened, however, wasthat hedge funds sold the swaps not to justthe actual lending bank but also to a largenumber of others who were willing to beton the default of the debtor. These swapholders, in turn, resold the swaps to others.The whole process continued several times.

While a genuine insurance contract indem-nifies only the actually insured party, in the case of CDSs there were several swapholders who had to be compensated. Thisaccentuated the risk and made it difficult forthe hedge funds and banks to honour theircommitments. The notional amount of alloutstanding derivatives (including CDSs of$54.6 trillion) is currently estimated by theBIS to be over $600 trillion, more than tentimes the size of the world economy. Nowonder George Soros described derivativesas ‘hydrogen bombs’, and Warren Buffettcalled them ‘financial weapons of mass destruction’.

The Islamic financial system

One of the most important objectives ofIslam is to realise greater justice in humansociety. According to the Quran, a societywhere there is no justice will ultimately head towards decline and destruction(Quran, 57:25). Justice requires a set ofrules or moral values, which everyone accepts and faithfully complies with. The financial system may be able to promotejustice if, in addition to being strong andstable, it satisfies at least two conditionsbased on moral values. One of these is thatthe financier should also share in the risk soas not to shift the entire burden of losses tothe entrepreneur, and the other is that an eq-uitable share of financial resources mo-bilised by financial institutions shouldbecome available to the poor to help elimi-nate poverty, expand employment and self-employment opportunities and, thus, helpreduce inequalities of income and wealth.

To fulfill the first condition of justice, Islam requires both the financier and the entrepreneur to equitably share the profit

as well as the loss. For this purpose, one ofthe basic principles of Islamic finance is ‘norisk, no gain’. This should help introducegreater discipline into the financial systemby motivating financial institutions to assessthe risks more carefully and to effectivelymonitor the use of funds by the borrowers.The double assessment of risks by both thefinancier and the entrepreneur should helpinject greater discipline into the system, andgo a long way in reducing excessive lending.

Islamic finance should, in its ideal form,help raise substantially the share of equityand PLS in businesses. Greater reliance on equity financing has supporters even in mainstream economics. Professor Kenneth Rogoff of Harvard Universitystates that in an ideal world equity lendingand direct investment would play a muchbigger role.

Greater reliance on equity does not neces-sarily mean that debt financing is ruled out.This is because all the financial needs of individuals, firms, or governments cannotbe made amenable to equity and PLS. Debtis, therefore, indispensable, but should notbe promoted for nonessential and wastefulconsumption and unproductive speculation. For this purpose, the Islamic financial sys-tem does not allow the creation of debtthrough direct lending and borrowing. Itrather requires the creation of debt throughthe sale or lease of real assets by means ofits sales- and lease-based modes of financing(murabaha, ijara, salam, istisna and sukuk).The purpose is to enable an individual orfirm to buy now the urgently needed realgoods and services in conformity withhis/her ability to make the payment later. Ithas, however, laid down a number of condi-tions, some of which are:

❏ The asset which is being sold or leased must be real, and not imaginary or notional.

❏ The seller or lessor must own and possess the goods being sold or leased.

❏ The transaction must be a genuine trade transaction with full intention of giving and taking delivery.

❏ The debt cannot be sold and thus the risk associated with it must be borne by the lender himself.

The first condition will help eliminate a largenumber of derivatives transactions which in-volve nothing more than gambling by thirdparties who aspire to claim compensation forlosses which have been actually suffered onlyby the principal party and not by them.

The second condition will help ensure thatthe seller (or lessor) also shares a part of therisk to be able to get a share in the return.Once the seller (financier) acquires owner-ship and possession of the goods for sale orlease, he/she bears the risk. This conditionalso puts a constraint on short sales, therebyremoving the possibility of a steep decline in asset prices during a downtown. The Shari’ah has, however, made an exception to this rule in the case of salam and istisnawhere the goods are not already available in the market and need to be produced ormanufactured before delivery. Financing ex-tended through the Islamic modes can thusexpand only in step with the rise of the realeconomy and thereby help curb excessivecredit expansion.

The third and the fourth conditions will not only motivate the creditor to be morecautious in evaluating the credit risk but alsoprevent an unnecessary explosion in the vol-ume and value of transactions. This will pre-vent the debt from rising far above the size ofthe real economy and also release a substan-tial volume of financial resources for the realsector, thereby helping expand employmentand self-employment opportunities and theproduction of need-fulfilling goods and serv-ices. The discipline that Islam wishes to in-troduce in the financial system may not,however, materialise unless governments re-duce their borrowing from the central bankto a level that is in harmony with the goal ofprice and financial stability.

One may raise an objection here that allthese conditions will perhaps end up shrink-ing the size of the economy by reducing thenumber and volume of transactions. This isnot likely to happen because a number of thespeculative and derivatives transactions are


NEWHORIZON January–March 2009ACADEMIC ARTICLE

generally known to be zero-sum games and have rarely contributed positively tototal real output. Hence a decline in them is also not likely to hurt the real economy. While a restriction on such transactions will cut the commissions earned by the speculators during an artificially generatedboom, it will help them avert losses andbankruptcy that become unavoidable duringthe decline and lead to a financial crisis.

The injection of a greater discipline into the financial system may tend to deprive the subprime borrowers from access tocredit. Therefore, justice demands that somesuitable innovation be introduced in the system to ensure that even small borrowersare also able to get adequate credit. Suchborrowers are generally considered to besubprime and their inability to get creditwill deprive them from realising their dream of owning their own homes and establishing their own microenterprises.

There is no doubt that a number of coun-tries have established special institutions togrant credit to the poor and lower middleclass entrepreneurs. Even though these havebeen extremely useful, there are two majorproblems that need to be resolved. One ofthese is the high cost of finance, rangingfrom 30 to 84 per cent in the interest-ori-ented microfinance system. This causes seri-ous hardship to the borrowers in servicingtheir debt. No wonder the minister of fi-nance for Bangladesh described microcreditinterest rates in that country as extortionatein an address he delivered at a microcreditsummit in Dhaka in 2004. It is, therefore,important that microcredit is provided tothe very poor on a humane, interest-freebasis (qard hasan). This may be possible ifthe microfinance system is integrated withzakat and waqf institutions. For those whocan afford to bear the cost of microfinance,it would be better to popularise the Islamicmodes of PLS and sales- and lease-basedmodes of finance, not only to avoid interestbut also to prevent the misuse of credit forpersonal consumption.

Another problem faced by microfinance is that the resources at the disposal of mi-crofinance institutions are inadequate. This

problem may be difficult to solve unless the microfinance sector is scaled up by integrating it with the commercial banks.Commercial banks do not generally lend tosmall borrowers because of the higher riskand expense involved in such financing. It is, therefore, important to reduce their risk and expense. This may be done partly by a subsidy from zakat and waqf funds forthose borrowers who are eligible for zakat.

Thus we can see that the Islamic financial system is capable of minimising the severityand frequency of financial crises by gettingrid of the major weaknesses of the conven-tional system. It introduces greater disci-pline into the financial system by requiringthe financier to share in the risk. It linkscredit expansion to the growth of the realeconomy by allowing credit primarily forthe purchase of real goods and serviceswhich the seller owns and possesses, and thebuyer wishes to take delivery. It also re-quires the creditor to bear the risk of defaultby prohibiting the sale of debt, thereby en-suring that he evaluates the risk more care-fully. In addition, Islamic finance can alsoreduce the problem of subprime borrowersby providing credit to them at affordableterms. This will save the billions that arespent after the crisis to bail out the richbankers. These do not, however, help thepoor because their home may have alreadybecome subject to foreclosure and auctionedat a give-away price.

The problem is that the Islamic finance isstill in its infancy and shares a very smallproportion of international finance. In addi-tion, it does not genuinely reflect the ethosof Islamic teachings. The use of equity andPLS is still very small while that of debt-cre-ating modes is preponderant. Moreover,even in the case of debt-creating modes, allthe conditions laid down by the Shari’ah arenot being faithfully observed by the use oflegal stratagems (hiyal). This is partly due to a lack of proper understanding of the ultimate objectives of Islamic finance, thenon-availability of trained personnel, andthe absence of a number of shared or sup-port institutions that are needed to minimisethe risks associated with anonymity, moralhazard, principal/agent conflict of interest,

and late settlement of financial obligations.The system is, thus, not fully prepared at pres-ent to play a significant role in ensuring thehealth and stability of the international finan-cial system. It is, however, expected that thesystem will gradually gain momentum withthe passage of time and complement the ef-forts now being made internationally for promoting the health and stability of theglobal financial system.

Concluding remarks

Since the current architecture of the conven-tional financial system has existed for a longtime, it may perhaps be too much to expectthe international community to undertake a radical structural reform of the kind that the Islamic financial system envisages. How-ever, the adoption of some of the elements of the Islamic system, which are also a part of the western heritage, is indispensable forensuring the health and stability of the global financial system. These are:

❏ The proportion of equity in total financing needs to be increased and that of debt reduced.

❏ Credit needs to be confined primarily to transactions that are related to the real sector so as to ensure that credit expansion moves more or less in step with the growth of the real economy and does not promote destabilising speculation and gambling.

❏ Leverage needs to be controlled to ensure that credit does not exceed beyond the ability of the borrower to repay.

❏ If the debt instruments, and in particular CDOs, are to be sold, then there should be full transparency about their quality so that the purchaser knows exactly what he is getting into. It would also be desirable to have the right of recourse for the ultimate purchaser of the CDOs so as to ensure that the lender has incentive to underwrite the debt carefully.

❏ While there may be no harm in the use of CDSs to provide protection to


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the lender against default, it needs to be ensured that the swaps do not become instruments for wagering. Their protective role should be confined to the original lender only and should not cover the other purchasers of swaps who wish to wager on the debtor’s default. For this purpose the derivatives market needs to be properly regulated to remove the element of gambling in it.

❏ All financial institutions, and not

*A distinguished 14th century polymath and the forerunner of classical economicsand social sciences, Ibn Khaldun broke newground in many fields and anticipated thelater findings of Western social scientists.Some hundreds of years ago, he presented acomprehensive theory arguing that the de-velopment and decline of societies does notdepend on any single factor, but rather thecombination of factors, including moral,social, economic, political and historical.

just the commercial banks, need to be properly regulated and supervised so that they remain healthy and do not become a source of systemic risk.

❏ Some arrangement needs to be made to make credit available to subprime borrowers at affordable terms to enable them to buy a home and to establish their own microenterprises. This will help save the financial system from crises resulting from widespread defaults by such borrowers.



The aspiration of Bangladesh to run a banking system based on Islamic principlesmoved closer to becoming a reality in 1978, after the Organisation of the IslamicConference (OIC) meeting of its membercountries’ foreign ministers. OIC recom-mended its members (including Bangladesh)to develop Islamic banking systems of theirown. Five years after that declaration, in1983, the country’s first Shari’ah-compliantbank, Islami Bank Bangladesh, was estab-lished. More banks have followed, includ-ing Al-Arafah Islami Bank (opened in 1995) and Shahjalal Islamic Bank Ltd(2001).

Observing the success of their Islamic counterparts, a number of conventional financial institutions have been keen tolaunch Islamic banking products and services alongside the conventional ones.The main area of focus for such entities is safeguarding the Islamic nature of their operations, ensuring the separation of theircapital from the main pool, and segregatingaccounts accordingly, as well as recruitmentof the qualified staff. To ensure compliancewith Shari’ah, these conventional banks,just like the Islamic ones, need strong Shari’ah supervisory boards, which assist in preparing the model agreements, approvethe structure of all new operations and lay down the basic guidelines for Islamic financing. A good example of a financial institution which successfully offers bothmodes of financing, is Prime Bank Ltd, one of the country’s top ten banks. Thebank has been maintaining the two businesslines in parallel since 1995.

Islamic finance progress in BangladeshWhat are the achievements of Islamic banking in Bangladesh, one of the largest Muslimcountries in the world? With over 130 million Muslims, the demand for this type of financing isclearly there, but has it been adequately met by supply? Abdul Awwal Sarker, deputy generalmanager of the internal and Islamic economics division at Bangladesh Bank (central bank andregulator), reflects on the accomplishments and challenges of the industry.

COUNTRY FOCUS


NEWHORIZON Muharrum–Rabi Al Awwal 1430 COUNTRY FOCUS

Meanwhile, another bank, The PremierBank Ltd, has opened two separate, dedi-cated branches (in addition to its 25 conven-tional ones) that operate in accordance withShari’ah principles. Some banks, like EximBank (Export Import Bank of BangladeshLtd), took a step further and fully convertedto Islamic banking.

Today, out of 48 banks in Bangladesh sixare fully-fledged Islamic banks (with anoverall network of around 350 outletsacross the country) and ten traditionalbanks have Islamic windows (comprising 21 branches). The industry employs over14,000 people, which constitutes over athird of the private banking sector and over a tenth of the country’s entire bankingindustry.

It is worth noting that the major part of the operational financial resources of Is-lamic banks in Bangladesh is derived fromdeposits, mobilised primarily on the princi-ples of al-wadia and mudarabah. Utilisationof funds within the Islamic framework hasopened multifarious ways for making loansconforming to Shari’ah principles. SinceShari’ah-compliant banks cannot use interest-based lending, they have deviseddifferent types of interest free financing modes. The lending instruments applied in Bangladesh include profit-and-loss sharing (PLS) based on mudarabah andmusharakah; mark-up principle ofmurabaha; lease principle of ijara; advancepurchase principles of salam and istisna;and output sharing principles of muzara’aand musaqat.

Although the Islamic banking market inBangladesh started with a very limited resource base, it has shown strong growththroughout the past two decades to date. Itsongoing development signals a high level ofacceptance by the public in general.

In 2008, coupled with the country’s eco-nomic growth, the market share of Islamicfinancial institutions continued its increasein terms of assets, financing and deposits.By September 2008, total deposits at the Islamic windows and standalone Islamicbanks in Bangladesh reached $5.4 billion,

Star Mosque,Dhaka

equating to 24 per cent of the deposits ofall private banks and eleven percent of thedeposits of the total banking system. Totalinvestment of Islamic financial institutionsin the same period stood at $5.5 billion,equivalent of 27 per cent of all privatebanks and 19 per cent of the whole bankingsystem of the country.

The statutory liquidity requirement (SLR)for the Islamic banks is fixed at ten per centsince inception of Islami Bank Bangladeshback in 1983. This has remained unchangedto date, while SLR for the traditional com-mercial banks has been changed severaltimes and is presently fixed at 18 per cent.

Islamic banks have been facing an excessliquidity problem, which equalled $94.1million in September 2008 (around six percent of the assets of private banks and just over three per cent of all banks inBangladesh). This issue originated mainlydue to the lack of response from the goodborrowers for credit demand and the lack of adequate interest-free financial instruments.

Today, the investment activity ofBangladeshi Islamic banks is by and largeconcentrated in the mark-up and rental-based modes of financing – murabaha, bai mu’ajjal and ijara – which comprisenearly 75 per cent of total investments.Meanwhile, the combined investment basedon PLS instruments like mudarabah andmusharakah barely surpass the one per centmark (almost unanimously, the banks viewthe PLS-based products as bearers of highrisk).

There is also a notable tendency towardslarge projects and clients, although in reality it is micro, small, and medium enterprises (MSMEs) that should get prior-ity when making investment decisions. Themarket’s inclination towards short-term investments poses a pertinent problem. Islamic banks depend so heavily on baimu’ajjal and murabaha in competing with their interest-based counterparts and chasing assured return, that true Islamic financial mechanisms, rooted in PLS, fall by the wayside.

Though there is still no complete Islamicbanking act for controlling, guiding and supervising Shari’ah-compliant financial institutions in Bangladesh, some Islamicbanking provisions have been incorporatedin the amended Banking Companies Act of 1991 (Act No 14 of 1991). BangladeshBank is yet to set up a separate departmentto regulate the operations of the Islamicbanking market. Therefore, for the time-being, the inspection and supervision of thismarket is conducted by the central bank asper the general guidelines for conventionalbanks. In observing the Shari’ah compliancestatus of Islamic banks, Bangladesh Bankexamines only the reports of the respectivebanks’ Shari’ah councils. A more definedrole of Bangladesh Bank in regulating thecountry’s Islamic finance sector is currentlyat the preparatory stage.

The inspectors and supervisors ofBangladesh Bank have been undergoingmassive training, both at home and abroad,to be equally familiar with the technicalitiesof the different operational methodologiesof the Islamic banking system. The regula-tor’s training academy and Bangladesh Institute of Bank Management (BIBM) have also been arranging various trainingcourses on the subject.

The central bank has also issued a letter to the Islamic banking sector, urging theparticipants to address a number of perti-nent issues facing the industry, through discussion and cooperation. In response to Bangladesh Bank’s call, Islamic BanksConsultative Forum (IBCF) was formed by the industry players. It facilitated inpreparing the ground for creation of a central Shari’ah board and also assisted the government in issuing the afore-men-tioned mudarabah sukuk. Of late, anotherconsultative body has been set up, calledFocus Group on Islamic Banking. The group operates within Bangladesh Bank and focuses on developing the necessary guidelines for setting up Islamic financial institutions in Bangladesh.

Another recent development is Bangladesh’smembership of the Islamic Financial Ser-vices Board (IFSB), an international stan-

There is a genuine concern among Islamicscholars in Bangladesh that if interest islargely substituted by a device like ‘mark-up’ it would represent a change just in name rather than in substance, and the new banking system would be no differentfrom the conventional one as far as equity is concerned. Also, prohibition of interest inIslam is meant to stimulate the productivesegments of the economy, which can be fullyachieved only if the interest-based financialsystem is completely uprooted and replacedby a fundamentally different structure,based on PLS.

As for the financial resource mobilisationthrough issuance of Islamic bonds (sukuk),it is still at a nascent stage. Islami BankBangladesh is the only bank to have issuedsukuk (called Mudarabah Perpetual Bond),no other players have issued either bonds or any other financial instruments, such asdebentures or mutual funds in the primaryor secondary markets. They continue tofully depend on the deposited funds. How-ever, in 2004, the government introducedsukuk, dubbed Bangladesh Government Islamic Investment Bond, which used mu-

darabah as an underlying structure. The objective was to mitigate the long-felt needfor a Shari’ah-based monetary instrument,which can be used as an approved securityfor the purpose of maintaining the SLR, aswell as providing an outlet for investment or procurement of funds by Islamic banks.This bond is also open for investment by private individuals and corporations.

In general, Bangladesh’s government and financial regulators have been receptive to Shari’ah-compliant banking and finance activities. In 1990, a small Islamic econom-ics unit was established at the research department of Bangladesh Bank, to conductanalytical research on Islamic economics,banking and finance. In due course, the unitwas expanded and upgraded, and today it is known as the internal and Islamic eco-nomics division.

A series of national and international con-ferences and workshops have been arrangedand held in the country’s capital, Dhaka, in joint collaboration with the Islamic Development Bank (IDB) to understand and explore the dynamics of the industry.


NEWHORIZON January–March 2009COUNTRY FOCUS

Ahsan Manzil palace, old Dhaka


NEWHORIZON Muharrum–Rabi Al Awwal 1430 COUNTRY FOCUS

Although the Islamic bankingmarket in Bangladesh started with a very limited resourcebase, it has shown stronggrowth throughout the past twodecades to date. Its ongoingdevelopment signals a highlevel of acceptance by thepublic in general.

dard-setting organisation based in Malaysia.In light of this, the existing supervisory procedures of Bangladesh Bank may be redesigned to evolve in line with the best international Islamic finance practices.

Without doubt, regulatory and supervisorystandards that specifically address theunique peculiarities of Islamic banking operations are needed to promote the resilience and competitiveness of the indus-try in Bangladesh. In this regard, the workof the IFSB would act as a catalyst to the development of a stronger and robust regulatory framework for the country’sShari’ah-compliant finance sector. In addi-tion to this, Competency Group on IslamicBanking has been set up at the Departmentof Banking Inspection (DBI) to develop so-called ‘Shari’ah Compliance Checklists’ –a tool to assist Islamic banking supervisorsin their work.

Although a number of issues have been duly addressed, there are still plenty of hurdles to overcome before the Shari’ah-compliant financial industry can realise itsfull potential in Bangladesh. There are still

no organised Islamic wholesale and second-ary financial markets, as well as no Islamicinter-bank money market. To become liquidand efficient, Bangladesh’s Islamic bankingsector must develop standardised andwidely tradable financial instruments. How-ever, there is evident lack of cooperationand coordination between the market participants.

Within the banks themselves, there is insufficient corporate governance and notenough transparency in financial reportingand accounting. These deficiencies are a result of the absence of a dedicated legal framework. It should be noted thatBangladesh Bank has already started work-ing on the Islamic Banking Act, with the financial support of the Central BankStrengthening Project (CBSP), a division es-tablished under the auspices of BangladeshBank to devise and implement reforms inthe country’s financial sector.

Although there is a dedicated department at the central bank that focuses on Islamicfinance – the afore-mentioned internal andIslamic economic division – the regulator

Mosque in Barisal,Bangladesh

Rural Development Scheme participants hassurpassed 500,000.

In a similar accord, Bangladesh’s entire Islamic banking market, not just a few players, should provide access to bankingproducts and services for the unbankedmembers of the society, especially whilst the country’s conventional banking systemeffectively excludes this segment of popula-tion from participating in economic activi-ties, due to a collateral-based approach tofinancing.

A reasonable portion of Shari’ah-compliantinvestment funds should be allocated to social priority sectors, such as agriculture(crop cultivation, poultry and fishery),MSME and export-led industries, for example, textile and garment manufactur-ing. Pilot schemes in both rural and urbanareas should be started to test innovativeideas with PLS modes of financing as amajor component. This endeavour will serve as a ready reference that Islamic banks are transforming themselves as PLSfinancial institutions. Only through such ahands-on approach will they be able to dealwith the practical issues that might come up in the process and gain necessary experience.

A well-established Islamic finance sector will be of indisputable advantage toBangladesh’s economy. The country still has a long way to go to reach the level ofmaturity of the industry in Malaysia and the Middle East. However, whatever devel-opments are yet to be undertaken and what-ever obstacles still need to be overcome, the true objectives of Shari’ah – maqasid al-Shari’ah – should be given priority at alltimes. And that implies that economic and financial activity must, before everythingelse, lead to human well-being.

moted concurrently. Islamic banks shouldclearly demonstrate by their actions thattheir practices are not guided merely byprofitability. As Shari’ah ethics strongly supports poverty alleviation, the banksshould act as ‘banks for enriching the poor’or ‘rural/urban banks for the poor’.

At present, there is, in all probability, onlyone bank in Bangladesh fully dedicated tothis cause – Grameen Bank (Grameen trans-lates as ‘rural’ or ‘village’ from the Banglalanguage). It offers loans to the poorest segments of rural Bangladesh without any security or collateral, albeit on interest basis (riba al-nasiah). To date, Grameen has helped over 7.6 million borrowers (anoverwhelming majority of whom, 97 per-cent, are women) through its 2535 branchesin 83,343 villages of Bangladesh (about 99per cent of rural coverage). The efforts ofthe bank and its founder, Dr MuhammadYunus, to create economic and social devel-opment from below were recognised by theNobel Committee and resulted in the NobelPeace Prize 2006 award for Grameen andDr Yunus. Yet, the bank’s microfinance activity utilises interest-based instruments,which contradicts with the key principle of Shari’ah.

Islamic microfinance, provided as qardhasan (interest-free loan) or based on mu-darabah, has the potential of reaching thepoorest of the poor. Islami Bank Bangladeshhas introduced a scheme, dubbed Rural De-velopment Scheme, specifically to addressthe investment needs of the country’s agri-cultural and rural sectors. This undertakinghas proved to be hugely successful and, hav-ing started as a pilot at a handful of thebank’s outlets, has now been rolled out to129 branches (the entire network consists of 186 branches), covering over 10,000 villages across Bangladesh. The number of


NEWHORIZON January–March 2009COUNTRY FOCUS

would benefit from another Islamic-relateddepartment that deals with specific bankingissues. It could conduct field surveys, collectdata from financial institutions and producereports based on the obtained information.

A Central Shari’ah Supervisory Council(CSSC) is needed to guide and monitor the operations of the Islamic banks inBangladesh, in a similar fashion as it is done in Iran, Malaysia and Pakistan. TheCSSC could also serve as an example forShari’ah advisory boards in individualbanks, which by and large suffer from inappropriate organisation and a weak follow-up of the Shari’ah compliance status.

The dearth of qualified personnel commit-ted to Islamic finance also needs to be tack-led. The industry would benefit greatly ifthe budget for research and development(R&D) is enhanced, allocating top impor-tance to education and creation of the efficient manpower for the industry.

However, one of the first and foremostthings that require immediate attention is the promotion of the image of Islamicbanks as PLS banks. This strategy has to be devised very carefully so that the banks’Islamic nature and their solvency are pro-

Although a number of issues have been duly addressed, there arestill plenty of hurdles to overcome before the Shari’ah-compliantfinancial industry can realise its full potential in Bangladesh.

Mosque in Sylhet,Bangladesh



engage consultants who should be recog-nised Islamic scholars in their own right andable to provide Shari’ah guidance to theirclients.

Products based on well established Shari’ahprinciples, such as murabaha, wakala andijara, usually require minimal involvementof a Shari’ah scholar due to their relativelystandard forms. However, products andservices provided by financial institutionshave evolved over the years (whether forgood or worse!) in a much more sophisti-cated and complex manner. The new inno-vative products available, such as differenttypes of debt/equity sukuk, the more controversial wa’ad-based instruments andstructures based on intertwined Shari’ahstructures, require much greater involve-ment of the scholar. Some of these so-called ‘innovative’ structures and productscontinue to be scrutinised for their actualShari’ah compliance and whether they succeed in achieving the objectives of Shari’ah.

The sophisticated and innovative nature ofrecent products and the complexity of therelated documents require scholars to be engaged on a full-time basis to oversee their execution and implementation as wellas to monitor the day to day activities of financial institutions dealing with suchproducts. Scholars providing these servicesshould be members of a SSB and certain executive powers should be vested in themto enable them to execute some simple andrepeat transactions without having the need to convene a full SSB meeting.

There is no doubt that the Islamic financeindustry is rapidly growing at a pace that is running ahead of the emergence of newShari’ah scholars with expertise in Islamicfinance. In the midst of the turmoil in theworld’s financial sector, financial institu-tions are exploring alternatives to conven-tional finance and in particular are turningtowards Islamic finance, which continues to attract interest from around the world atan unprecedented rate. Such growth of theindustry requires the services of competentShari’ah scholars in order to adequatelyguide financial institutions in pursuing legitimate Shari’ah-compliant products andservices.

It has been seen in the past decade or so thatonly a handful of scholars with the relevantexpertise are available to financial institu-tions to approve their products and services.Although the numbers of competent schol-ars have increased in the last two or threeyears, there is still inadequate involvementof scholars in Islamic finance transactions,products and services offered by financialinstitutions to their customers.

Shari’ah scholars should and do play a significant role within financial institutionsactive in the Islamic finance sector, as with-out them such financial institutions are unable to operate their business activities inaccordance with the principles of Shari’ah.Financial institutions wishing to engage inproviding Shari’ah-compliant products andservices must engage either a minimum of three individual Shari’ah scholars andform a Shari’ah supervisory board (SSB) or

Placing faith in Islamic financeMufti Muhammad Nurullah Shikder, a full-time Shari’ah scholar at Gatehouse Bank and anexecutive member of the bank’s Shari’ah supervisory board, looks at the changing role ofShari’ah scholars within the Islamic finance industry and explores ways in which some of thepressures placed on today’s scholars may be alleviated to ensure better Shari’ah service tofinancial institutions.

This process will facilitate and achieve anumber of benefits for financial institutions,including the smooth operation of the banknot only from a transactional aspect butalso from day to day procedural and execu-tion points of view. It will also help financialinstitutions to monitor all aspects relating tomarketing materials, internal and externalcommunications and so on.

The advantages of having a full-time scholarworking within a financial institution whois also a member of the SSB are numerous.For example, my experience to date at Gatehouse in this role shows how it allowsthe scholar to focus on internal product development and training, as well as facilitating Shari’ah audit and compliance.Some of these advantages are discussedbelow.

Firstly, the financial institutions themselveswill have regular and easy access to thescholar which will allow them to obtainguidance on the hour, every hour, withouthaving to wait for a response from the SSBor having to convene a SSB meeting. It isworth pointing out here that, regardless ofhow simple an issue may be, a banker is un-able to make a final decision on a Shari’ahissue without referring the matter to ascholar.

The problem of accessibility to the Shari’ahscholars is immense and needs to be ad-dressed sooner rather than later. Criticswould argue that certain Shari’ah scholarssit on too many Shari’ah boards, take ontoo much responsibility, and are not able to

ACADEMIC ARTICLE



give much time to financial institutions asthey are so thinly spread. Currently, how-ever, there are only a handful of reputableand able scholars who are familiar withmodern economics and finance and they areworking extremely hard to cope with thedemand of the growing Islamic finance in-dustry. The lack of scholars creates a severehindrance to the development of businessactivities of financial institutions. On thewhole this puts constraints on financial institutions and Shari’ah scholars alike.

On the one hand, scholars are being putunder unrealistic time pressures to respondto Shari’ah queries and unjustifiably beingheld responsible for delaying transactions.However, we should not forget that scholarsalso have family, social, religious and manyother commitments like everyone else and itis not always reasonable to expect immedi-ate attention and replies at all times fromthe scholars in respect of particular Shari’ahissues. On the other, there will be times thatfinancial institutions need advice promptlyin order to make business decisions, andcannot wait for days or weeks. By workingfull-time for one particular institution, ascholar is able to build on his in-house roleand expertise which will not only alleviatethese pressures in-house, but also in other institutions by offering advisory services tothird parties.

Secondly, by appointing a full-time Shari’ahscholar, financial institutions will be able to design their own programmes for trainingjunior graduates of Shari’ah to enable themto satisfy the demands of their businesses.On a wider scale, unless further graduatetraining programmes are put in place, there will be a constant shortage of supplyin meeting the increasing demands of financial institutions for Shari’ah scholars.

An urgent assessment is required of the extent to which financial institutions havecontributed towards bringing on board newShari’ah scholars. What support is beingprovided to new graduates of Shari’ah to getthem more involved in the Islamic financeindustry? Are they supporting any traineeprogrammes for new Shari’ah graduates togain experience? If we were to look back

over the last 30 years or so, the truth is thatsome of the established Islamic financial institutions haven’t done enough to createopportunities for newly graduated Shari’ahscholars.

Unless we adopt similar approaches to thoseof legal, accountancy and other professionalbodies in developing our Shari’ah scholarbase, there is a real danger that the industrywill be filled by unqualified people who arenot in a position to opine on Shari’ah mat-ters. This will result in financial institutionscarrying out transactions without correctlyobserving Shari’ah principles.

Thirdly, the appointment of a full-timescholar will greatly assist in the educationand training of employees in the applicationof Shari’ah principles in all areas of theworking environment. This is relevant tolegal and compliance matters, and willgreatly assist in all areas of the auditprocess, both internally and externally. Inaddition, Islamic financial institutions needto follow instructions from the Shari’ahscholar in their day to day activities such as the manner in which they conduct theirbusiness. For example, adherence to Shari’ah principles of truth, transparency,

honesty and fairness should be observed,whilst guests and clients should be entertainedin a manner that complies with the principlesof Shari’ah.

It is also important to ensure that Shari’ahprinciples are followed by an institution whenit is dealing with its own employees. Some-times they are not adhered to inadvertentlydue to the lack of knowledge or because thepersonnel that deal with the particular issuesmay not necessarily be aware what Shari’ahprinciples are at stake. It may not havecrossed their minds that a particular issuemay involve certain Shari’ah laws. The pres-ence of a scholar on a full time basis wouldalleviate this potential problem.

Adequate training of Islamic awareness ingeneral and more specific training is para-mount in order to facilitate the understandingof Islamic culture and the principles of Islamicfinance. This is to ensure that Muslim andnon-Muslim employees are equipped with the required knowledge and understanding of Islamic principles. The above ongoingtraining can only be achieved if a scholar isengaged to identify all the needs of the busi-ness as a whole and also to cater for the needs of individuals within the financial institutions as and when required.

Certain critics argue that some Islamic financial institutions offer Shari’ah-compliant products for commercial benefitonly and there is no desire to follow the true spirit of Shari’ah principles. However, it should be remembered that earning a profitin a Shari’ah-compliant manner is encouragedeven from a Shari’ah perspective, althoughShari’ah will never allow Islamic financial institutions to make gains in its name whentheir activities may not conform to the principles of Shari’ah. Financial institutionsseeking to provide Shari’ah-compliant prod-ucts and services may overcome potential criticism by taking pre-emptive steps to en-gage a Shari’ah scholar on a full time basis tooversee their day to day activities. This willboost the confidence of everyone associatedwith such financial institutions, whether employees or customers, and enhance thequality of the Shari’ah-compliant activities of such financial institutions.

Mufti Muhammad Nurullah Shikder,Gatehouse Bank

www.newhorizon-islamicbanking.com32 IIBI


Bashir Timol, director of 1st Ethical Ltd, a UK-based firm of Islamic investment and taxadvisers, delivered the lecture on 16th October2008. Timol has played a central part over the last seven years in developing a range ofShari’ah-compliant investments, tax planningproducts and Islamic wills for the domesticMuslim community. He has also liaised withHer Majesty’s Revenue & Customs (HMRC),HM Treasury and the Financial ServicesAuthority (FSA) over the development ofShari’ah-compliant regulation and legislation in the UK and has considerable experience of advanced tax mitigation strategies for UK-based owner-managed companies andprofessionals.

The lecture was chaired by Mukhtar Karim,solicitor at Trowers & Hamlins, an internationallaw firm.

October: Surviving thecredit crunch – Shari’ah-compliant retail investmentopportunities

Promoting Islamic finance

IIBI LECTURES

The love affair with bricks and mortar hasbeen especially pronounced within the UKMuslim community who have historicallyembraced property as a low-risk ‘Shari'ah-compliant’ alternative to conventional in-vestments. The credit crunch and resultingproperty market price fall have dramaticallyunderlined the need for investors to hold adiverse range of assets. Timol first discussedthe key principles for Shari’ah complianceof investment transactions; all Islamic in-vestment transactions must conform to certain guidelines to meet Shari’ah compli-ance. Like ethical or socially responsible investing, undesirable companies and indus-tries are screened out on the basis of bothqualitative criteria (nature of business) andquantitative criteria (level of receivables,debt and interest), and the investment sup-

ports only those products and businessespermissible from the Shari’ah viewpoint.Shari’ah-compliant investment transactionsdo not involve riba (interest). Instead, in-come is generated by investing the capital in the real economic activities and earningprofit is legitimised by engaging in an eco-nomic activity and thereby contributing to the development of resources and the society.

He mentioned that such transactions shouldnot involve gharar (excessive uncertainty) or

any kind of ambiguity in terms of the rightsand responsibilities of the parties in thetransaction. While uncertainty cannot beavoided altogether in any business transac-tion, Shari’ah scholars have derived a gen-eral principle that any contract must not bedoubtful and uncertain as far as rights andobligations of the parties are concerned.Also, funds should not be channelled to eco-nomic activities involving maysir (gambling).

Timol then listed the key businesses ex-cluded from Shari’ah-compliant investmentsbased on the above criteria. These includegambling outlets, the tobacco industry, the pornography industry, conventional interest-based banks and insurance compa-nies, alcohol manufacturers and distributors,etc. Apart from business screening, financialscreening criteria are also applied. Organisa-tions whose principal activity is not theabove, but derive more than five per cent of income from above activities or highly

leveraged (having interest-bearing debt inexcess of 33 per cent) are also excludedfrom Shari’ah-compliant investment transactions.

Timol outlined the key guidelines from theFSA, the UK regulator for the financial sector, for investment advice; these includecomprehensive understanding of clients’ riskprofile – risk is inextricably linked to rewardbut can also result in a loss. This criterionsits alongside all other Shari’ah require-ments when structuring a balanced clientportfolio. The issue of penalties and client’srequirement to access funds is also consid-ered in the decision-making process.

He then classified the available Shari’ah-compliant investment opportunities in theUK into three categories: low risk, mediumrisk and high risk. Low risk investments include Islamic bank accounts. These are offered by the Islamic Bank of Britain (IBB),HSBC Amanah and Lloyds TSB; other lowrisk investments are Shari’ah-compliantproperty funds, though these have provedriskier in the recent financial turmoil. Ethi-cal/Islamic unit trusts (such as offered byFriends Provident), agricultural land andleasing contracts were classified as mediumrisk, while Shari’ah-compliant UK equities,musharakah projects, musharakah and commodity funds were classified as high risk investments.

He concluded the presentation by statingthat Islam allows a wide investment remit as long as interest and unethical businessesare avoided; a portfolio must be diversified; accessibility of investments must also beavailable to investors.

After the presentation, participants raisedvarious questions about the musharakahfunds on offer in UK, the performance ofShari’ah-compliant equity funds as com-pared to conventional ones, key providers of Islamic investment products in the UKand the criteria for setting the financialscreening ratios for Shari’ah compliance.

October lecture

IIBI 33www.newhorizon-islamicbanking.com


The lecture, held on 10th November 2008,was the first in the IIBI’s Ibn Khaldun lectureseries. Ibn Khaldun (1332–1406) presentedessential economics concepts, such as theimportance of trading and value of labour inwealth generation and growth. He paved theway for development of classical economics.

The lecture was delivered by Dr Umer Chapra,senior research advisor at the Islamic Researchand Training Institute (IRTI) of the IslamicDevelopment Bank (IDB). He was working atSaudi Arabian Monetary Agency (SAMA) assenior economic adviser prior to his current roleat IRTI. He has made seminal contributions toIslamic economics and finance over more thanthree decades in the form of 15 books andmonographs and more than 100 papers andhas received numerous awards for hiscontribution, including the prestigious KingFaysal International Award in Islamic studies.He has also taught in the US at the Universitiesof Wisconsin (Platteville) and Kentucky.

The lecture was chaired by Warren Edwardes,CEO of Delphi Risk Management and a boardmember of the IIBI.

November: The prevailinginternational financial crisis– can Islamic finance help?

IIBI LECTURES

After a brief introduction on the financialcrisis, Dr Chapra mentioned that in order tominimise the frequency and severity of suchcrisis in future, it is important to analyse theprimary causes of the crisis which appearedto be the result of excessive and imprudentlending practices. All this took place prima-rily due to inadequate market discipline andinsufficient regulation and supervision.There was lack of transparency in manyproducts on offer. Collateralised debt obliga-tions (CDOs) were offered to investorswhich bundled prime with subprime debt,paralysing the whole financial system.Credit default swaps (CDSs) were offered tomany players who were not a party in anyinvestment in the first place and there was

no, or only a remote, link between the un-derlying asset and such instruments offeredin the secondary market.

Dr Chapra then analysed the role that Is-lamic finance would play to minimise suchcrisis in future. As there is greater emphasison equity and profit-and-loss sharing (PLS)in Islamic finance, this will make banksmore cautious and act responsibly in lend-ing operations. Debt in Islamic finance isnot created through direct lending and borrowing but rather through the sale andpurchase of real goods and services; theasset being sold or leased must be real andnot notional or imaginary; the seller mustown and possess the assets being sold or

leased and the transaction must be a gen-uine trade transaction with the full intentionof giving and taking delivery of the underly-ing goods or services. The risk of default associated with debt must be borne by thelender. This will motivate the lender to exer-cise greater care and self-restraint in lendingas the institution/person which is exposed tothe risk of suffering a loss is the best one toalso provide the market discipline.

Dr Chapra emphasised that Islamic finance is still in its infancy and the share of equity-based structures with PLS, such as mudarabah and musharakah, is small ascompared to debt-based structures. Despitesome lean practices, Islamic financial insti-tutions have performed well – or at least theimpact of the financial crisis is minimal onthem due to the safeguards provided by theadoption of Islamic economic principles.The way forward would be the applicationof these principles in both form as well as

The mission of the IIBI is to be a centre of excellence for

professional education, training,research and related activities, tobuild a wider knowledge base anddeeper understanding of the worldof finance promoting the Islamic

principles of equity, socio-economicjustice and inclusiveness. The

Institute holds regular lectures ontopical issues, delivered by the

industry experts. For information onupcoming lectures and other

events, please visit the IIBI’s website:

www.islamic-banking.com

substance, and it will have an enormous impact on prudent lending practices in future.

There was a lively question and answer session after Dr Chapra’s presentation; keyissues raised were about Islamic financial institutions mimicking conventional struc-tures, why Islamic finance especially in theUS is not being taken up much more or promoted positively, and the limitation of Islamic finance products in serving the needsof peoples of all faiths or no faith.

The full article based on Dr Chapra’s presentation can be found on page 20 of this issue.

November lecture

November lecture


NEWHORIZON January–March 2009IIBI NEWS

IIBI launches a brand new website

New book outlines the investment opportunities in Islamic finance

A new book, ‘Islamic Finance: A Guide forInternational Business and Investment’, has been produced in association with theInstitute of Islamic Banking and Insurance(IIBI), London. The book aims to supportprofessionals engaged in the ever-buoyantarea of Islamic finance. While the globaleconomy remains uncertain, Islamic financeis steadily growing at an annual rate of tento 15 per cent, and is estimated to be worth$800 billion. Although Islamic financialproducts do not pay interest, they can oftenbe as advantageous, or more so, than theirconventional counterparts.

This new book provides accessible adviceand up-to-date guidance for foreign in-vestors, helping them understand the principles and current practice of Shari’ah-compliant banking and finance. With con-tributions from leading industry experts,including Denton Wilde Sapte LLP, the

Islamic Bank of Britain (IBB), the IIBI and the Bank of London and the Middle Eastplc, this new book is an essential resourcefor organisations engaged in business devel-opment, asset management, banking and finance in an Islamic context. This bookoutlines the background to Islamic finance,examines Islamic financial products such asloans, mortgages, trade finance, investmentbanking and takaful (Islamic insurance) and explores important regulatory issues. To view the contents, please visit:www.globalmarketbriefings.com/?id=2979

A 25 per cent discount will be provided toIIBI’s members and students. Please quotethe reference IIBI08 with membership orstudent number to receive the discount.

Book orders may be placed by [email protected] or by calling +44 (0) 20 3031 2900.

The IIBI will be introducing a brand newwebsite in early 2009. Since inception in1991 the Institute has been serving the Islamic financial services industry and promoting awareness of Islamic bankingand insurance globally. This is reflected inour website.

The IIBI has been providing continuousprofessional development through its Post Graduate Diploma (PGD) course bydistance learning, training workshops andan executive development programme. Asone of the oldest, if not the oldest, institutesof its kind, the IIBI stays abreast of globaltrends in Islamic banking and insurance reporting on major developments and addressing important issues in itsNewHorizon magazine. The IIBI is thusable to provide the Islamic financial sectorrelevant, meaningful and up-to-date educa-

tion and training services to embrace anever changing business world.

The website will feature many new sectionsand sub-sections containing plenty of usefulinformation, articles, reviews and audio andvideo presentations that visitors can view.

Of particular value will be the IIBI Forumwhich will enable members, students andalso invitees to debate relevant issues, sharetheir own vision and experiences as well ascooperate in looking at practical solutionson current and new issues in the evolving Islamic financial services industry. In addi-tion, the Test Your Knowledge section willallow visitors to the IIBI’s new website totake a test on Islamic banking and insur-ance, and the Knowledge section will growinto an essential research and reference toolfor students and practitioners of Islamic

finance, tracing the development of Islamiceconomics and jurisprudence over thedecades.

The IIBI will be deploying a Learning Man-agement System (LMS), using the industry-standard Moodle 1.9 framework. It willhelp the IIBI to create online courses withopportunities for rich interaction, wherestudents will be ale to interact in a virtuallearning environment. The IIBI will use thissystem to deliver, track and manage its PGDcourse and other courses that it will offer inthe near future. The system will provide acomplete one-stop solution for all IIBI's distance learning needs like registration ofstudents, online collaboration, assessments,and management of continuous professionaleducation. The IIBI's LMS will be availableto our existing and new students in early2009.


NEWHORIZON Muharrum–Rabi Al Awwal 1430 IIBI NEWS

IIBI awards post graduate diplomas

IIBI’s Post Graduate Diploma (PGD) coursein Islamic banking and insurance, offeredsince 1994, is highly regarded worldwide.UK-based Durham University has accordedrecognition to this course as an entry quali-fication to the University’s Research MA aswell as its modules on Islamic economicsand Shari’ah-compliant finance.

To date, students from 77 countries have enrolled in the PGD course. In the period of September to November 2008, the following students successfully completedtheir studies:

❏ Anthony James Lindsay, Australia

❏ Asif Ali, India

❏ Aziz Idris, P&L controller, BNP Paribas,Japan

❏ Christopher F Richardson, attorney, Vinson & Elkins LLP, Hong Kong

❏ Gerard Jerome Vincent D’Souza, IT project manager, Saudi Hollandi Bank, Saudi Arabia

❏ Ghulam Rasul Chughtai, assistant vice president, United Bank Limited, Pakistan

❏ Ehtesham Uddin Khan, ICICI Bank Ltd, India

❏ Farrukh Nadeem, UK

❏ Imraan Solomons, Krew Investment SA (Pty) Ltd, South Africa

❏ Jaffar Hussain, advances in charge/inspecting officer, Allied Bank Limited, Pakistan

❏ Lok Chak Yin Basmah, office manager, Islamic Union of Hong Kong, Hong Kong

❏ Masagoes Abdul Karim Bin Masagoes Din, legal director and consultant, Barakah Capital Planners Pte Ltd, Singapore

❏ Mohammed Hasan Khan, manager, product development, Sabb Takaful, Saudi Arabia

❏ Mubashir Akram, assistant vice president, The Bank of Punjab, Pakistan

❏ Mujtaba Habib, Pakistan

❏ Mujtaba Muhammad Farouk, desk officer, payments, Central Bank of Nigeria, Nigeria

❏ Mujeebur Rahman A, India

❏ Musa Ibrahim Musa Bahit, chief dealer, Baobab Capital Limited, Kenya

❏ Philip Crawford, HSBC Bank Middle East Limited, Oman

❏ Sa’adatu Aminu Ibrahim, Nigeria

❏ Sultan Hamed Albortmany, Germany.

Regardless of one’s exposure to Islamic or conventional finance,the IIBI’s Post Graduate Diploma course in Islamic banking and insurance provides students with an essential understanding of the core elements of this growing area. My tutors were very helpful in providing additional material to clarify my understanding of difficult concepts. The programme also provided me with some insights behind the wisdom of the Shari’ah. A highly recommended course of study.

Lok Chak Yin Basmah, Islamic Union of Hong Kong

Anthony JamesLindsay

Musa IbrahimMusa Bahit

Mujeebur Rahman A

MohammedHasan Khan



Islamic mortgages: Shari’ah-based or Shari’ah-compliant?

POINT OF VIEW

Sheikh Haitham Al Haddad is a director of the Muslim Research and Development Foundation(MRDF). The MRDF, was awarded charity status in 2007, and is a co-operative research basedventure, run by scholars, imams and other professionals. It has the aim of articulating Islam in amodern context, as well as addressing the unique situation faced by Muslims in the West. He isalso involved with the Islamic Shari’ah Council, a body which deals chiefly with the issue ofShari’ah-compliant marriage and divorce in the UK. The council also provides advice andguidance to British Muslims on financial, business and other matters. He is currently working ona PhD in Islamic jurisprudence at the School of Oriental and African Studies (SOAS), a majorpart of which is about mortgages. He also sits as an advisory scholar for Ansar Finance, anIslamic initiative in Manchester, which was founded in 1994. Here, he explains to NewHorizonhis views on the problems with Islamic finance in the UK.

Al Haddad believes that, while Muslims living in non-Islamic countries deserve ‘special consideration’ within the Ummah(worldwide community of Muslims), ‘thereare some aspects of their daily lives thatcannot be changed because they live in theWest’. Finance is not the only aspect whichAl Haddad believes this applies to, anotherexample being marriage. However, the ‘interest based system is one of the mostdangerous systems in the world’, so ‘thegravity of the problem’ for Western Mus-lims is huge. Al Haddad quotes the lateAmerican president Thomas Jefferson, that‘if the people wanted to be enslaved, theyshould allow the banks to create money’,and he goes on to say that the creation ofmoney and the creation of interest-basedsystems are of course linked.

The bulk of Al Haddad’s work concerns Islamic mortgages in the UK. However hestates that his criticism is ‘equally applicableto other product classes’ in the space. Thereason that he focuses on mortgages in par-ticular is that they represent most of the

Islamic finance industry in the UK. Only recently has the first independent takaful (Islamic insurance) operator, Salaam Halal Insurance, been launched in the country(NewHorizon, October–December 2008issue). ‘More or less the main products hereare the Islamic mortgages.’

‘We Muslims should hold firmly onto thevalue that the interest-based system is prohibited.’ However, Al Haddad is also aprominent critic of supposedly Shari’ah-com-pliant finance in the UK and elsewhere. Hismain criticism is the way in which riba is in-terpreted in a literal, semantic way by equat-ing it to the word ‘interest’. What this allows is for a system to be devised in which the flow of money and the share of risk between agents is completely equivalent in a suppos-edly halal transaction to a conventional trans-action based on interest. ‘My problem withShari’ah-compliant finance is that the wholeprocess is more or less the same’ as conven-tional banking, he explains. The effect of thisis that the prohibition of riba makes no no-ticeable difference to finance.

Sheikh Haitham Al Haddad


NEWHORIZON Muharrum–Rabi Al Awwal 1430 POINT OF VIEW

‘In all the schemes for Islamic mortgages, the bank buys the property and sells it toyou. This will be now, or later, according tomurabaha, and may be just with part of theproperty. The bank buys the property andsells it to you. The big problem is that thebank buys it in order to sell it to you’. Thusthe bank buys the property with the intentionof selling the property. Moreover, ‘when thebank buys it, the bank knows that you areobliged to buy it’. This means, to Al Haddad,that since the bank is guaranteed to sell theproperty, the concept of the bank’s owner-ship of the property during the mortgage isphoney.

‘The bank is paying X money to buy theproperty, and by contract is obliging you topay the bank X amount plus Y. So in a nut-shell, the bank pays money, and gets moremoney for it, which is the interest-based system’. This is achieved by combining con-tracts which, on their own, are halal, butlooked at as a whole, clearly include theequivalent of interest. A bank might buy a property and sell it in instalments to ahomebuyer at a profit, and this will only bepossible if the homebuyer promises to buythe property from the bank, as soon as thebank has purchased it. From the banks perspective, in this murabaha model, thebank avoids a situation where it owns theproperty for any length of time. This can be added to the fact that the rate and amount of repayment from the homebuyer to the bank is likely to be strongly linked tointerest rates.

For Al Haddad, the key for considering thisas riba is the fact that the transaction will be carried out in this way is explicitly stipu-lated in a contract. This is because of his sec-ond major criticism of Islamic finance in theUK, that it allows banks to minimise theirown exposure to risk. ‘If the agreement isdone on a handshake, it means if the home-buyer ends up breaking the agreement, thebank has no obligation against him, and can-not sue him. This is the principle of loss-shar-ing. The bank should not secure itself againstany risk of loss. It is as simple as that.’

Instead, Al Haddad promotes the model ofAnsar Finance Group, where, as mentioned,

he sits on the advisory board. Ansar’s statedmission is ‘to provide and promote aware-ness of halal financial borrowings and in-vestments among the Muslim community of the UK’. A membership-based organisa-tion (membership is open to anyone), it provides interest-free finance based on theqard hasan model. Qard hasan is usually associated with charitable giving, either forwelfare purposes or for fulfilling short termfunding requirements. The borrower is ex-pected only to pay back the original sum. AlHaddad describes Ansar as a ‘communityproject’, and transactions are done on ahandshake. A moral, rather than a binding,agreement, must be based on the goodwilland trust engendered amongst the members.‘The bank buys the property, an agreementwith the client is made, and if the clientcan’t continue paying, then the risk on theproperty is with the bank.’

However, the example of Ansar is of ques-tionable value to Haddad’s argument. Hav-ing started in 1994, the model has yet tocatch on, or to grow significantly (its web-site claims 800 members). Haddad doesprovide a reason for this which is that it isdifficult to build sufficient funds for mort-gage lending from scratch. Secondly, hesays, ‘I am often disappointed by the lack ofsupport for Ansar from the community andalso businesses’. Yet he is sure that Ansar’smodel is commercially viable, and believesthat larger Islamic banks in Britain have notcopied Ansar’s example, or developed a sim-ilar framework, because ‘they want to elimi-nate any possible risk’. The larger banks’Shari’ah boards adopt a lenient approach,for example, by arguing that it is unfair fora bank to suffer a loss since it is respondingto a client’s expressed need for a home.

Meanwhile, the mainstream of Islamic fi-nance would most likely make the criticismthat, while qard hasan is suitable for micro-finance, it is not so suitable for attractinghuge funds with high volumes of invest-ments. To do so, there would need to be aprofit motive. And neither the Holy Qurannor Prophet Muhammad prohibit entrepre-neurship and possible subsequent wealth(provided that both are confined to permis-sible activities, sharing in the risk and re-

We Muslims should hold firmlyonto the value that the interest-based system is prohibited.


NEWHORIZON January–March 2009POINT OF VIEW

ward without involving usury and interest).The Quran clearly states, ‘God hath permit-ted trade and prohibited riba’ (2:275).

Al Haddad’s criticisms of Islamic banks’approach to risk are compounded by thedifficulties he sees in regulating the industryin the non-Islamic West. He is particularlycritical of the auditing processes. Scholarsat most Islamic banks in Britain, who as Al Haddad has already made clear take a lenient approach, ‘are not auditing theimplementation of whatever opinion theygive’. ‘What they should say is “here iswhat we suggest is halal. Then let us see examples of your transactions. Are you im-plementing what we are saying?” but theydon’t do so.’ Al Haddad states that there iscurrently no legal requirement for scholarsto do so. However, ‘in order to ensure anorganisation has received a certificate thatits products are of a certain standard ofquality, we need to audit it regularly’.

But who can perform such a task in theUK? The Financial Services Authority (FSA)would be ideally placed, thinks Al Haddad,except that it represents a secular govern-ment. ‘We can discuss whether the UK gov-ernment should play a role, in ensuring thatthe audits are real, and making sure that

the interpretation is accepted by the vast majority of Muslims.’ However, Al Haddad does not see this as realistic. ‘Itdoesn’t fit. For example, if I don’t believe in halal meat, how can I monitor it? Maybetechnically it can be done but it would notbring confidence’ to Muslims.

The alternative, as Al Haddad has suggestedto his peers, is to form an independent body of scholars in the UK to perform thefunctions that the FSA ideally would. Thereare some examples of this throughout theworld. The AAOIFI (the Accounting andAuditing Organisation for Islamic FinancialInstitutions) is one. And there are only a few institutions which work on a similarmodel to Ansar Finance Group. In themeantime, Al Haddad believes, ‘we needMuslim governments to play a role. Then itwould be easier for non-Muslim govern-ments such as in the UK to get help fromMuslim governments, and to establish theirown Shari’ah board’.

As Al Haddad accepts, however, his viewsare in a minority. This means that any neworganisation would most likely back up thestats quo view of the majority of scholars.So, he acknowledges, ‘the system would re-main the same. At the end of the day, that is

IIBI’s point of view

While Al Haddad’s position raises a num-ber of valid issues, these are not practicalto implement to the letter without takingaccount of the environment in whichmodern business is conducted. His mainissue with Shari’ah-compliant finance isthat it is more or less the same as conven-tional banking, however, he appears to ignore that the basic Islamic financestructures adopted today were used pri-marily in trade in the early Islamic pe-riod. A study of the pattern of someprohibitions in Islam will show gradual-ism or a step by step approach, whichmade their implementation ‘in letter aswell as in spirit’ possible. For example,

riba (interest) and alcohol were not prohib-ited in one go. A new form or procedure ofstructures cannot be rejected merely becauseit has no precedent in the past. In fact, ac-cording to renowned international scholar,Justice (Ret’d) Taqi Usmani, every new formcan be acceptable to the Shari’ah so long as it does not violate any basic principle laid down by the Holy Quran, the Sunnahor the consensus of the Muslim jurists.

Al Haddad’s main criticism is that, accord-ing to murabaha, the bank buys the prop-erty with the intention of selling it and takesa binding agreement from the intendedowner, therefore according to him the own-

ership of the property by the bank duringan Islamic mortgage is ‘phoney’.

Murabaha, though not an ideal mode in Shari’ah-compliant finance, wasadopted initially for home purchases inUK in late 1990s, as pure musharakahand other pure models were not wellsuited for mortgage transactions. Thispaved the way for further developmentsuch as the diminishing musharakahmodel between an Islamic bank and a buyer for home purchase incorpo-rating features of risk-sharing. Under diminishing musharakah the bank facesrisk associated with property ownership

their view. We have a different view’. In themeantime, therefore, Al Haddad works tospread his message, though the internet, andthrough his involvement in Ansar Finance.‘On a frequent basis I receive emails frompeople who have read my arguments andare convinced.’

The big question for Al Haddad, though, is whether there is a realistic, alternativeway of persuading people to provide theirmoney for the use of others, whether this isdone conventionally, for interest, or throughthe West’s established Islamic banks, forprofit. It is very difficult to believe that theAnsar model provides an alternative tomainstream Islamic finance for the massmarket, since it does not involve profit. Buta large part of Islam’s problem with interestis that it favours the person who has moneyto start with. Al Haddad’s problem withShari’ah-compliant finance in the West isthat it does also. ‘I should not have anyprivilege because I have loaned money tosomeone else,’ he says. But is there anotherway? ‘Yes, qard hasan is viable.’ But it depends on goodwill and trust. Is it going to happen? ‘Yes, because Ansar Financestarted on a goodwill basis. It started withpeople lending and not expecting anything.With education, people can change.’


POINT OF VIEWNEWHORIZON Muharrum–Rabi Al Awwal 1430

that does not exist in the interest-basedmortgage provided by conventionalbanks.

Murabaha, in its original Islamic conno-tation, is simply a particular type of saleand not a mode of financing. The onlyfeature distinguishing it from other kindsof sale is that the seller in murabaha expressly tells buyer the cost incurredand the profit (mark-up) on the cost.

On murabaha as a mode of financing,Justice (Ret’d) Usmani states: ‘The idealmode of financing according to Shari’ahis mudarabah or musharakah… however,in the perspective of the current eco-nomic set up, there are certain practicaldifficulties in using mudarabah andmusharakah instruments in some areasof financing. Therefore, the contempo-rary Shari’ah experts have allowed, sub-ject to certain conditions, the use of themurabaha on deferred payment basis as a mode of financing. But there are two essential points which must be fullyunderstood in this respect: 1) it shouldnever be overlooked that, originally,murabaha is not a mode of financing.Therefore, this instrument should beused as a transitory step… and its useshould be restricted only to those caseswhere mudarabah or musharakah arenot practicable; 2) the murabaha trans-action does not come into existence bymerely replacing the word of “interest”by the words of “profit” or “mark-up”.Actually, murabaha as a mode of financehas been allowed by the Shari’ah schol-ars with some conditions… it is the ob-servance of these conditions which candraw a clear line of distinction betweenan interest-bearing loan and a transac-tion of murabaha.’

Al Haddad proposes the Ansar Financeqard hasan model as a way forward forproviding interest-free finance supportedby members’ contributions. From a com-mercial perspective, qard hasan typicallymay be used to provide small unsecuredloans to the needy, but appears impracti-

cal when it involves large numbers andlarge amounts.

The Ansar Finance model for house pur-chases through members’ donations maywork well on a small level and in a localcommunity, but whether it can be rolledout to and successfully implemented for allmembers of a large community living invarious places is questionable. If a personbecomes a member, and after purchasing ahouse under the Ansar Finance model be-comes unemployed and defaults on pay-ments, the property may not be sold due tosocial reasons. If there are a large numberof defaults it would place an enormous fi-nancial burden on the membership.

The community-based model is very simi-lar to the credit unions in the West, whichare financial institutions controlled by theirmembers (account holders), and operatedfor the purpose of promoting thrift, pro-viding credit at reasonable rates, and providing other financial services to itsmembers. However, credit unions have typically remained smaller than banks.

Islamic banks as financial intermediariesprovide capital for purchase of houses,their function is not dealing in properties.However, it is to be commended that con-

What do you think? Do you agree with Sheikh Al Haddad that Ansar’smodel is the only acceptable model for Islamic finance, or with the IIBI’s

view that Islamic banks in the UK are correct to have grown as they have? Please email us at:

[email protected]

[email protected]

ventional regulators, moving with times,are helping to create a level playing fieldfor the Islamic finance industry. The UKregulatory body, the Financial ServicesAuthority (FSA), has clearly stated that itneither favours nor discriminates in regu-lating Islamic banks. Due to the differentnature of contracts, there are practicalproblems for Islamic banks. That is rea-son for using instruments which are Shari’ah-compliant such as murabaha,ijara and diminishing musharakah, butnot Shari’ah-based (mudarabah andmusharakah).

The proposal to set up a central Shari’ahsupervisory board in UK has been mootedon a number of occasions. However, asthe UK Islamic financial services industryis still very small in comparison to someother countries, it would be more practi-cal and cost effective for the Islamic financial institutions in UK to adopt thestandards of the existing internationalstandard setting bodies like AAOIFI (Accounting and Auditing Organisationfor Islamic Financial Institutions), IFSB(Islamic Financial Services Board), LMC(Liquidity Management Centre), IIFM (International Islamic Financial Market)and IIRA (International Islamic RatingAgency).

age. Another firm, Sungard (Arab BankSwitzerland is a client), was also very brieflylooked at. Sreih characterises this process as‘for background information, rather thanselection’. This ‘assumptive’ process wasable to work since Path responded positivelyto the requirements drawn up based on thedifferences between EAB and IIAB. If not,Sreih suggests, ‘we would have gone backand had a proper, structured look at it. Butwe were pretty sure that iMAL was going tobe the one because it was being used moreor less for the same purpose elsewhere in thegroup.’

The implementation itself was divided into anumber of key stages. Following hardwareand software installation, requirementsgathering, system configuration, interfacedevelopment, application training and useracceptance testing were all marked out asdistinctive stages by the bank. More than 50staff members of the bank were involved atsome stage, and an implementation teamfrom the vendor’s support centre in Beirutwas also present throughout. This, saysSreih, ‘gave us the benefit of very good ac-cess to their key technicians’. Path’s teamcarried out user training and system set-up.The system would need to be interfaced intothe general ledger and regulatory reportingsystems as well as the Swift network.

The integration with Equation, the core so-lution of EAB’s conventional business, wasdeliberately limited so as to maximise segre-gation of the two lines. ‘We have to makesure of meeting the Shari’ah board’s needs,and formally segregate the business.’ Thereare only one or two crossovers; the need to



Europe Arab Bank plc (EAB) is a wholly-owned subsidiary of Arab Bank Group.Headquartered in London, EAB incorpo-rates all of the banking business of the ArabBank Group in the UK, France, Germany,Spain, Italy and Austria. With a capital baseof E700 million (approximately $1 billion),EAB focuses on corporate and private bank-ing as well as treasury services across the region. EAB’s sister companies include ArabBank Australia and Islamic InternationalArab Bank (IIAB), based in Jordan.

About five per cent of EAB’s business is currently in Islamic finance (in terms of deal numbers – in value terms it is probablyhigher). The bank plans to increase this proportion, from what its CEO, AntoineSreih, describes as a ‘contributory part’ to a ‘major part’ of the business. In 2007, thebank announced its intention to open an Islamic window, consolidating and expand-ing its range of Islamic products alongsideits conventional banking activities. Havingdecided its IT infrastructure should reflectthis aspiration, EAB signed a contract withPath Solutions, a Kuwait-based vendor, inDecember 2007 to implement iMAL, thevendor’s Islamic core banking system. Im-plementation began in March 2008 and finished in July, and EAB’s Islamic activitieswill henceforth be almost completely segre-gated from its conventional activities, whichrun on a separate core system, Equation,built by the UK-based firm, Misys. The Islamic window was launched around October 2008.

EAB had two key criteria for the system. Itneeded, says Sreih, ‘a system that could act

IT focus: Europe Arab BankWith the news that Path Solutions’ iMAL core banking platform has gained the recognition of the AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions),NewHorizon’s news editor, Lawrence Freeborn, looks at how one bank sought to takeadvantage of the system.

as a complete processing system for our Islamic business yet be integrated with ourconventional business systems to allow themto continue to show the overall view of thebank’s books, risks, positions and so forth’.The chosen solution would be required to process Islamic corporate banking andtreasury business as well as basic current accounts.

EAB did not, however, engage in a conven-tional selection process. Rather, iMAL waschosen ‘on an assumptive basis’. The expla-nation for this is that the afore-mentionedIIAB, a completely Shari’ah-compliant out-fit, was already a user of iMAL, and EAB requirements were similar. Sreih elaborates on this approach: ‘Our sister company wentthrough the full Invitation to Tender andRequest for Information approach. Theylooked at all possible systems they couldfind. When we decided we needed an Islamic system, we initially looked to see what we’d got across the group. This iswhere we came across iMAL. We then compiled a list of the requirements we werelooking for, and checked it back againstwhat they were already using the system for in Amman.’ Where there were gaps inrequirements between the siblings, EABwent directly to Path Solutions to ask if thevendor could cover them.

Early on, EAB did cast a ‘cursory’ glance atdifferent systems; as an Equation user, thebank obtained brochures to see what Misyscould offer, though Misys’ Islamic modulewas felt to be unsuitable on the groundsthat it is ‘fairly retail-based’ and not verycomprehensive in terms of product cover-

CASE STUDY


NEWHORIZON Muharrum–Rabi Al Awwal 1430 CASE STUDY

feed both lines into an overall book iscatered for by the existence of a separatesub-ledger book, which feeds into a consolidated book. ‘Apart from that, it’s just managing some of the risk aspects.’

The entire project was aggressivelytimetabled due to the business plan, withthe Islamic window launch in mind. Thesystem successfully went live on time, andthe project was actually completed underbudget.

‘Ring-fencing’ enough resources for theproject was a particular challenge for thebank, specifically in terms of manpower.The cause of this difficulty was simply thesize of the bank. This translated into a lack of specialist knowledge about Islamicfinance, so that ‘we relied heavily on thehalf dozen or so people who really under-stood Islamic finance. An awful lot of test-ing and configuration had to be done bythem because they were the only ones thatactually understood it.’ However, since thestaff had ‘day jobs’ throughout, it became ‘a bit of a part-time project’ while businessas usual took priority. ‘Obviously fromhindsight it would have been better if we’d managed to carve out more time, becausethese people were put under a huge amountof pressure doing effectively two full-timejobs for three months,’ says Sreih. ‘Therewere several late nights.’

EAB did initially retain some headhunters to trawl the market. But the bank found ‘almost nobody’ suitable to help. The combination of theoretical and practicalknowledge of Islamic finance as well as therequisite IT skills was not on offer: ‘If youtry to do this purely from the IT side you’dfail totally, because you need to have thebusiness understanding to design the prod-ucts that go into it. We probably could havedone with a couple of people, but theredoesn’t seem to be much in the way of amarket for them.’ Sreih believes that theavailability of such people, while lagging,will increase in relation to the growth in Islamic banking. ‘Those workers are goingto be gold dust.’ Sreih mentions that he hasseen no sign of Path itself being stretched,but points out that, as Path continues to

We have to make sure ofmeeting the Shari’ah board’sneeds, and formally segregatethe business.

Antoine Sreih,Europe Arab Bank

grow quickly, the expertise of its staff maybe diluted; ‘I haven’t heard of that happen-ing yet, but I assume it will at some point’.

iMAL has been working smoothly since theproject finished. It finished on time, andsince much of the interface developmentwas done by EAB staff, it finished underbudget. It was, however, ‘very intense fromthe moment we started’. As well as the levelof support from Path, Sreih puts successdown to the determination of the staff, espe-cially since few had much experience ofShari’ah products and rules, and most werealso working on other projects concurrently.

Sreih does not believe the bespoke, compli-cated Islamic products EAB will offer would be possible with another universalbanking system. ‘From the way the system is structured, it’s not just the word “inter-est” changed to “profit”. There is a bit oftruth in that; the data model does lend itselfto Islamic finance. Other universal systemshave put all sorts of bodies in place to tryand mimic that, but they’ll never work aswell as a system that has actually been designed for it.’ iMAL will render many previous paper-based processes obsolete.‘Using systems designed for conventionalbanking, there had to be a lot of interven-tion, intercepting something before it went out. It’s dangerous, as you might get it wrong, sending a statement out to an Islamic client with interest all over it. Now,we shouldn’t have to worry about that sortof thing.’

For the future, EAB will continue to workwith Path to develop the functionality of the system. Since the launch, EAB has foundthat more and more customers prefer to use Islamic finance, a product of increasinginterest in the sector across Europe. EAB already has more than £200 million ($294million) in its asset book, including a com-modity murabaha portfolio for around 60clients through contracts on the LondonMetals Exchange (LME). Islamic financehas become an increasingly important partof its plan to survive the global financial crisis, and the implementation of a core system designed specifically for this has undoubtedly helped this strategy.



Elaf Bank, a Bahrain-based Islamic invest-ment bank, has hired Helmi Haruna Rashidto be general manager for treasury and capital markets. As well as heading the treas-ury operations, Rashid will manage and leadthe treasury and capital markets team to de-velop new Islamic investment and hedgingtools. Since 2005 he was senior vice presidentand head of treasury and capital markets atBank Muamalat. Prior to this, he worked atStandard Chartered Bank Malaysia Bhd,CIMB Bank and the country’s central bank.

Azrulnizam Abdul Aziz has been appointedby Standard Chartered Bank Malaysia Bhd as CEO and executive director of StandardChartered Saadiq Bhd, its Islamic bankingsubsidiary. Aziz was previously head of

the Islamic banking division of StandardChartered. Before that, he was vice presi-dent of mortgage sales and Islamic home financing at another international bank fornine years. His key role will be to developShari’ah-compliant products.

Tharawat Investment House, a new Islamic investment company in Bahrain, has appointed Nader Al Khalili as chief investment officer. Al Khalili has a decade of experience and has held several executivepositions at firms such as Bapco, BDOJawad Habib and International InvestmentBank. He is currently undergoing profes-sional certification from the AAOIFI to become a certified Shari’ah advisor and auditor. Tharawat also recently hired Khalid Alkhayat as director of corporatecommunications.

Citi has appointed Mudassir Amray as head of Islamic banking in Asia-Pacific, toreplace Rafe Haneef. Amray moves fromCiti Pakistan to the firm’s Singapore andKuala Lumpur offices, to develop consumerand corporate Islamic banking products.

Bahrain-based Gulf International Bank(GIB) has recently made four appointments.Dr Yahya Al-Yahya has been named CEO,to replace GIB’s founder, Dr Khaled Al-Fayez, who has retired after 35 years. Dr Al-Yahya was executive director for SaudiArabia at The World Bank in Washington,and has also served as director general at the Institute of Banking at the Saudi Arabian Monetary Agency.

Fadel AlMeer has been appointed as coun-try head for the bank’s operations in SaudiArabia, and manager of the Riyadh branchof the bank. AlMeer joins GIB from Na-tional Commercial Bank, where he workedfor 14 years, most recently as chief corpo-rate banker in the institutional banking

group. Prior to that, AlMeer worked atBank Saudi Fransi.

Antoine L Dijkstra has become managingdirector – chief investment and treasury office at the headquarters of GIB in Bahrain.Dijkstra was previously senior managing director at Bear Stearns in London, and wasalso a board member at NIB Capital. With a breadth of experience in internationalbanking, Dijkstra has also worked at ZurichFinancial Services Group and AIG FinancialProducts.

GIB has also named Richard David Scott asmanaging director – head of risk manage-ment. Scott was previously regional head for country risk management for Europe,Middle East and Africa for Citigroup. Priorto this, he was risk manager at Smith Bar-ney, a private equity finance business, forAsia-Pacific and Europe. In the past, Scottalso worked at Citibank in London andRussia and Saudi American Bank.

Tuan Haji Ismail bin Ibrahim has been appointed CEO of Public Islamic Bank Bhd,a newly set up, wholly owned subsidiary of Public Bank in Malaysia. Public Bankpreviously offered Shari’ah-compliant services through an Islamic window –Ibrahim was its general manager prior to his appointment as head of the Islamicbanking subsidiary.

Musa Abdul Malek has been named thenew CEO of HSBC Amanah Malaysia Bhd,a wholly owned subsidiary of HSBC BankMalaysia Bhd. He will be responsible for all aspects of the Islamic subsidiary’s busi-ness in the country, including retail andcommercial banking, wealth management,capital market and the promotion of inter-national currency business unit business.Malek was earlier deputy CEO, but hasbeen acting CEO since the departure ofYakub Bobat.

On the move

APPOINTMENTS

UK-basedGatehouse Bankhas made two recent appoint-ments. ZaidMaleh (right)has been ap-pointed directorin the capitalmarkets origination team. He joinedGatehouse in September 2008 from Raif-feisen ZentralBank Österreich AG (RZB),having been responsible for the origina-tion and structuring of syndicated loansand capital markets products. He alsoworked to develop RZB’s Islamic desk.

Mufti Muhammad Nurullah Shikderhas been chosen as head of Shari’ah advisory and Shari’ah compliance. Previ-ously, Shikder spent three and a halfyears with Dubai Islamic Bank in theShari’ah Coordination Department. Healso sits on the Shari’ah boards of LloydsTSB, Alburaq of Arab Banking Corpora-tion and Scottish Widows Investment Partnership (SWIP).


NEWHORIZON Muharrum–Rabi Al Awwal 1430 BOOK REVIEW

Mohammad Mansoor Khan is a lecturer at the University of South Australia and M. Ishaq Bhatti is an associate professor inthe department of economics and finance atLa Trobe University, Melbourne, Australia.The book discusses various key paradigms,theories and developments in Islamic bank-ing and analyses recent developments inPakistan during the period 1980–2007. The book contains nine chapters with thefirst being a general introduction. The sec-ond chapter discusses Islamic economics.The authors criticise conventional econom-ics (which is clearly justified as can be seenby the ongoing credit crisis) but the reviewerfelt that some of these criticisms could havebeen more detailed. There is also an inter-esting discussion about modern theories ofequity and justice.

The third chapter focuses on Islamic bank-ing and contains an informative descriptionof its recent history and developments. Thecountry-by-country breakdown is in partic-ular interesting in showing how the Islamicfinance industry has expanded. The descrip-tion of the different types of transactions ishelped by the use of tables. In reality thesestructures are currently created in such away that the risk/reward paradigms areshifted so that they often end up the same asconventional financings and, while the au-thors do allude to this, a more detailedanalysis of these circumvention structuresmay have been of interest to the reader. The fourth chapter deals with when Pak-istan was first considering Islamic banking.

There is an informative summary and cri-tique of the initial report issued by theCouncil of Islamic Ideology and its consid-eration of various policy instruments. Thesection where the authors discuss how theweightage system used with Shari’ah-com-pliant deposits evolved and their criticismof how it is used in practice was of particu-lar interest. The authors also analyse thefact that in order to convert the system it isnot enough to merely prohibit interest butone also needs to change a society’s ap-proach to matters such as the distributionof wealth, ethics, moral hazard and taxa-tion, without which full implementation ofIslamic banking will fail.

The fifth chapter reviews the period1981–1990 and what law changes wereconsidered as being necessary. The authorsalso consider the different Shari’ah-compli-ant products that were offered and the ex-tent to which in practice they failed toconform to Shari’ah principles. The au-thors’ view is that during this time therewas a failure to succeed due to gross devia-tions from the original conversion plan, alack of proper training for bankers, publicconcerns and doubts and the failure tomake major structural changes to products.

The sixth chapter reviews the backgroundto, and the impact of, the well-known 1991Federal Shariat Court decision on riba.The seventh chapter focuses on the effortsto revive Islamic finance in the period1992–1998 by discussing two reports pro-

duced in this period. The authors critique themanner in which the production of these re-ports was approached and also discuss someof the conflicts within Pakistani society andthose factions that wanted to rein in or cur-tail the implementation of Islamic banking.

The eighth chapter considers the impact ofthe 1999 and 2002 decisions of the SupremeCourt that ruled on the initial 1991 FederalShariat Court decision which had decidedagainst riba. The rulings are discussed in de-tail and in particular the 2002 decision thatset aside the 1999 judgment which upheldthe 1991 decision.

Chapter nine goes into more detail as to the reaction of the different stakeholders in Pakistani society to these court decisions andtheir willingness or otherwise to support orhinder the growth of Islamic banking. Whilethese court decisions are particular to Pak-istan, they and the reactions of the variousparts of Pakistani society to them, offer aninteresting perspective as to what issues othercountries might face in similar circumstances.

The final chapter ends with the conclusionthat the prospects for Islamic banking in Pakistan are highly unpredictable and bleak.The book provides interesting insights intothe significant problems facing a country thatwants to move towards a society based on Islamic economics including Islamic bankingand is worthy of study by those involved inpolicy making, whether in financial, regula-tory or political bodies or authorities.

‘Developments in Islamic Banking: The Case of Pakistan’ by M. Mansoor Khan and M. Ishaq BhattiRichard T de Belder, partner at Denton Wilde Sapte LLP and head of the firm’s Islamic financepractice, reviews the book, published in 2008 by Palgrave Macmillan (ISBN-10: 1-4039-9877-9).The book is 264 pages long including tables, bibliography and index.



February

Diary of events endorsed by the IIBI

8–9: 5th Annual Middle East InsuranceForum (MEIF 2009), BahrainForum to focus on the crucial issues of un-locking new growth opportunities in the Islamic and conventional insurance marketof the Middle East, including assessing keyregional (as well as global) industry trends,pinpointing real growth potential in the es-sential market segments, and looking at theopportunities in the emerging captives andtakaful markets.Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]

24–25: 6th Annual Middle East Trade & Export Finance Conference, DubaiConference to discuss the latest develop-ments and applications of trade finance solutions in the region, including the waysof incorporating Shari’ah-compliant struc-tures. The event will feature case studies ofthe latest supply chain financing applica-tions and focus sessions on overcoming thecurrent market instability.

CALENDAR

April

Contact: Katherine BurchellTel: +44 (0) 20 8673 9666Email: [email protected]

24–25: 8th Annual Islamic Finance Summit, LondonSummit to address the most pressing issueswithin Shari’ah-compliant finance world-wide, including Islamic loan and bond is-suance, sukuk market, wealth management,equity financing and structured products. Contact: Adam KingTel: +44 (0) 20 7779 8673Email: [email protected]

1–2: The Asia Pacific Islamic FinancialMarket Conference, Kuala LumpurConference organised jointly by theMalaysian Investment Banking Association(MIBA) and Islamic Banking and FinanceInstitute Malaysia (IBFIM) to focus on ex-panding Islamic capital market in the globalfinancial environment. Will concentrate on developing Shari’ah governance, riskmanagement and branding Islamic CapitalMarket (ICM) amidst the financial marketuncertainty. Contact: Khairul SabudinTel: +603 2031 1010 ext 532Email: [email protected]

May

20–21: The 2nd International Islamic Venture Capital & Private Equity Conference, Kuala LumpurConference to focus on Shari’ah-compliantalternative investments and strategic fundsand the vital role the industry should play insocial and economic development of Islamiccountries. Contact: Khairul SabudinTel: +603 2031 1010 ext 532Email: [email protected]

Throughout 2009, IIBI will organise a number of training workshops to build theskill base and share ideas among practitioners within the Islamic finance industry.

The objective of the Institute’s training is to fill the human resource gap and to enhance the professional skills of personnel who are either interested in building

their careers or already involved in the Islamic finance sector. Training programmes are delivered by experienced professionals; the number of

participants is kept small to ensure the interactive environment and provide a practical learning experience for the participants with the help of suitable case studies. For more information about upcoming programmes,

please visit: www.islamic-banking.com

Bahrain Kuala Lumpur

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NEWHORIZON Muharrum–Rabi Al Awwal 1430 RATINGS & INDICES

Islamic financial institutions and instrumentsBelow is a monthly list of the latest long and short-term credit ratings for each Islamic financial institution and financialinstruments monitored by Capital Intelligence (CI), an international credit rating agency. Detailed information on ratingprocesses and definitions can be found on the CI’s website www.ciratings.com

11th December 2008

CURRENT RATING

FOREIGN CURRENCYFINANCIALSTRENGTH

SUPPORTOUTLOOK

FC FSRSINCE

LONG TERM SHORT TERMISLAMIC BANKS

Abu Dhabi Islamic Bank A A2 A 2 Stable Stable Jun 2007

Al Baraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Stable Oct 2008

Al Rajhi Banking & Investment Corp. A+ A1 A+ 2 Stable Stable Jan 2008

Bahrain Islamic Bank BBB A3 BBB 3 Stable Stable Sep 2007

Bank Islam Malaysia BBB- A3 BB+ 2 Stable Stable Jan 2008

Faysal Bank (Pakistan) B- C BB 3 Negative Stable Oct 2008

Gulf Finance House BBB+ A2 BBB+ 4 Stable Stable Oct 2008

Jordan Islamic Bank for Finance & Investment BB B BBB- 3 Stable Stable Nov 2007

Kuwait Finance House A+ A1 A+ 2 Stable Stable Jul 2008

Qatar International Islamic Bank BBB+ A2 BBB+ 3 Stable Stable Jul 2008

Qatar Islamic Bank A A2 A 3 Stable Stable Aug 2008

Sharjah Islamic Bank A- A2 BBB+ 2 Stable Stable Jul 2008

Shamil Bank of Bahrain BBB A3 BBB 3 Stable Stable Sep 2007

The National Commercial Bank AA- A1+ AA- 1 Stable Stable Sep 2008

Tadhamon International Islamic Bank B- B BB- 3 Stable Stable Oct 2007

CORPORATE RATING

OUTLOOK SINCELONG TERM SHORT TERM

FINANCIAL INSTITUTIONS

Al Tawfeek Company for Investment Funds Limited BBB A2 Stable Feb 2008

A'Ayan Leasing & Investment Co BBB A3 Stable Oct 2008

First Investment Co BBB A3 Stable Feb 2008

Grand Real Estate Projects Co BB B Stable Nov 2006

Investment Dar Company BBB+ A3 Stable Oct 2007

International Investment Group BB B Positive Dec 2006

CAPIVEST BB+ A3 Stable Jan 2007

SUKUK RATING

OUTLOOK SINCELONG TERM SHORT TERM

FINANCIAL INSTRUMENTS

Commercial Real Estate Sukuk Company A- Stable Oct 2008

KCMCC Sukuk Company BBB Stable Jul 2008

KSA MBS International Sukuk Co. Ltd A- Stable Oct 2007

Kuwait Resorts Sukuk Co. BSC BBB Stable May 2006

NIG Sukuk Ltd. A Stable Aug 2007

Tijara & Real Estate Investment Sukuk Company BSC BBB+ Stable Jul 2006

All ratings are reviewedon a regular basis


NEWHORIZON January–March 2009GLOSSARY

amanahLit: trustworthiness, reliability, loyalty, honesty.Technically, it describes a business deal where one partykeeps another’s funds or property in trust.

al-wadia Safe custody; it is an arrangement that allows a person to keep the wealth belonging to oneself with an Islamicbank for safekeeping purposes.

bai mu’ajjalLit: a credit sale. Technically, a financing techniqueadopted by Islamic banks. It is a contract in which theseller allows the buyer to pay the price of a commodityat a future date in a lump sum or in instalments. Theprice fixed for the commodity in such a transaction isgenerally higher than the spot price.

fatwaA ruling made by a competent Shari’ah scholar on aparticular issue, where fiqh (Islamic jurisprudence) isunclear. It is an opinion, and is not legally binding.

ghararLit: uncertainty, hazard, chance or risk. Technically, sale of a thing which is not present at hand; or the sale of athing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does notknow whether it will come to be or not.

HajjAn annual pilgrimage to Mecca and other holy places.The fifth pillar of Islam, Muslims have the duty toperform Hajj at least once in their lifetime, provided they have the means to do so.

halalActivities which are permissible according to Shari’ah.

haramActivities which are prohibited according to Shari’ah.

hila (pl. hiyal)Legal devices or tools used to avoid direct violation ofShari’ah and achieve a certain objective through lawfulmeans.

ijaraA leasing contract under which a bank purchases andleases out a building or equipment or any other facilityrequired by its client for a rental fee. The duration of the lease and rental fees are agreed in advance.Ownership of the equipment remains in the hands of the bank.

ijara wa iqtinaThe same as ijara except the business owner iscommitted to buying the building or equipment orfacility at the end of the lease period. Fees previouslypaid constitute part of the purchase price. It is commonlyused for home and commercial equipment financing.

istisnaA contract of acquisition of goods by specification or order, where the price is fixed in advance, but thegoods are manufactured and delivered at a later date.Normally, the price is paid progressively, in accordancewith the progress of the job.

ju’alaA unilateral contract for performing a specified task for acertain wage. Technically, a contract between a client anda bank for certain services for a specified price.

kafalaLit: responsibility or suretyship. In kafala, a third party becomes surety for the payment of debt. It is acovenant/pledge given to a creditor that the debtor willpay the debt or any other liability.

maysirGambling – a prohibited activity, as it is a zero-sum gamejust transferring the wealth not creating new wealth.

mudarabahA form of business contract in which one party bringscapital and the other personal effort. The proportionateshare in profit is determined by mutual agreement at thestart. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour.

murabahaA contract of sale between the bank and its client for the sale of goods at a price plus an agreed profit marginfor the bank. The contract involves the purchase of goodsby the bank which then sells them to the client at an agreed mark-up. Repayment is usually ininstalments.

musaqatA contract in which the owner of the orchard shares itsproduce with another person in return for his services inirrigating the orchards.

musharakahAn agreement under which the Islamic bank providesfunds which are mingled with the funds of the businessenterprise and others. All providers of capital are entitledto participate in the management but not necessarilyrequired to do so. The profit is distributed among thepartners in predetermined ratios, while the loss is borne by each partner in proportion to his contribution.

musharakah, diminishingAn agreement which allows equity participation andsharing of profit on a pro rata basis, but also provides amethod through which the bank keeps on reducing itsequity in the project and ultimately transfers theownership of the asset to the participants.

muzara’aA contract in which one person agrees to till the land ofthe other person in return for a part of the produce of theland.

qard hasanAn interest-free loan given for either welfare purposes orfulfilling short-term funding requirements. The borroweris only obligated to pay back its principal amount.

ribaLit: increase or addition. Technically it denotes anyincrease or addition to capital obtained by the lender as a condition of the loan. Any risk-free or ‘guaranteed’rate of return on a loan or investment is riba. Riba, in all forms, is prohibited in Islam. Usually, riba and interestare used interchangeably.

riba al-nasiahIncrement on the principal of a loan payable by theborrower. It refers to the practice of lending money forany length of time on the understanding that at the endof the agreed period the borrower would return theoriginal amount plus an increment in consideration ofthe lender having granted him/her time to pay.

salamSalam means a contract in which advance payment ismade for goods to be delivered later on.

Shari’ahRefers to laws contained in or derived from the Quranand the Sunnah (practice and traditions of the ProphetMuhammad).

sukukSimilar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownership in the underlying asset. The asset will be leased to theclient to yield the return on the sukuk.

takafulA form of Islamic insurance based on the Quranicprinciple of mutual assistance (ta’awuni). It providesmutual protection of assets and property and offers joint risk sharing in the event of a loss by one of itsmembers.

tawaruqA sale of a commodity to the customer by a bank ondeferred payment at cost plus profit. The customer thensells the commodities to a third party on a spot basis andgets instant cash.

UmmahThe diaspora or ‘Community of the Believers’ (ummat al-mu’minin), the worldwide community ofMuslims.

wa’adA promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price. It isnot a legally binding agreement.

wakalaA contract or agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee. The agent (wakil) is allowed to generate an income for himself in excess of the minimum agreed upon returns as agreed with rab-al-maal (investor of the capital).

waqfAn appropriation or tying-up of a property in perpetuityso that no propriety rights can be exercised over theusufruct. The waqf property can neither be sold norinherited nor donated to anyone.

zakatAn obligation on Muslims to pay a prescribed percentage of their wealth to specified categories in their society, when their wealth exceeds a certain limit.Zakat purifies wealth. The objective is to take away apart of the wealth of the well-to-do and to distribute itamong the poor and the needy.

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