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GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 176JULY–SEPTEMBER 2010RAJAB–RAMADAN 1431

FOCUS: TAYYAB INVESTMENT

RISK SHARING AND ISLAMICFINANCE

TAKAFUL FOCUS: NORTH AMERICA

FINANCIAL DECISIONS:INSIGHT FROM ISLAMIC TEXTS

ANALYSIS: ISLAMIC RATE OF RETURN

IIBI SUKUK WORKSHOP REVIEW

PUBLISHED SINCE 1991

Decisions based on solid foundations

Shari’ah compliance services from IBS INTELLIGENCE

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www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Rajab–Ramadan 1431

Features

Regulars

10 Takaful in North America

Ajmal Bhatty, CEO takaful at Tokio Marine MiddleEast, Dubai, discusses the opportunities of the Islamicinsurance industry in Canada and the US, the challenges it faces and what can be done to overcome them.

14 Islamic rate of returnJoseph DiVanna, MD of Maris Strategies, discusses the key issues of the development of alternative bench-marks to LIBOR that can be used with confidence bythe Islamic finance industry.

18 Risk sharing and Islamic financeIslamic finance, based on risk sharing, has had a longand distinguished history. It has been shown to be inherently stable and socially equitable, argue AbbasMirakhor, first chair in Islamic finance at the Interna-tional Centre for Education in Islamic Finance, andNoureddine Krichene, economist at the IMF.

CONTENTS

10

32 IIBI LECTURESMarch, May and June lectures reviewed; July lecture preview.

37 APPOINTMENTS

40 RATINGS AND INDICESIslamic financial institutions and instruments from Capital Intelligence (CI).

41 DIRECTORYComprehensive listing of Islamic finance industry players.

42 GLOSSARYIslamic finance terminology explained.

28 IIBI NEWSTAIB meets IIBI director general; Stenden University students visit;IIBI awards post graduate diplomas.

30 IIBI WORKSHOPSukuk, their practical applications and challenges.

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

16 DIARYUpcoming Islamic finance events endorsed by the IIBI.

14

TAIB visits IIBI IIBI sukuk workshop

22 Psychology of financial decision-makingParvez Ahmed, PhD, US Fulbright scholar and associate professor of finance atthe University of North Florida, examines Islamic texts for insights about whatimpacts our financial decision-making.

26 Tayyab investment: beyond Islamic investingTrevor Norman, director at Volaw Trust, presents an overview of ethical investment within an Islamic context.

38 Book review‘The New Economics: A Bigger Picture’ by David Boyle and Andrew Simms.

www.newhorizon-islamicbanking.com

NEWHORIZON July–September 2010

Executive Editor’s Note

EDITORIAL

EXECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORTanya Andreasyan

IIBI EDITORMohammad Shafique

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 Intelligence8 Stade StreetHythe, Kent, CT21 6BEUnited KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: www.ibsintelligence.com

IBS Intelligence is a trading name of IBS Publishing Ltd

CONTACTAdvertisingMohammad ShafiqueInstitute of Islamic Banking and Insurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: [email protected]

SUBSCRIPTIONMohammad ShafiqueInstitute of Islamic Banking and Insurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: [email protected]

©Institute of Islamic Banking and InsuranceISSN 0955-095X

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

Surat Al Baqara, Holy Quran


What drives our financial decision-making? It would be foolish to believe that we are guided by logic alone. Psychological and be-havioural factors, such as greed, are as much part of economic decision-making as cold rationality. In this issue of NewHorizon,Parvez Ahmed, a US scholar, ponders the idea that all human beingsare not always rational finds support in normative Islam. He exam-ines the Islamic texts, including the Holy Quran, to gain a clearerunderstanding of the fundamental nature of human existence andargues that this insight can be the key towards deconstructing whyhuman beings are often influenced by irrational thinking and cogni-tive dissonance when making money-related decisions.

Whilst the above subject is more philosophical than practical, theissue of creating alternative benchmarks to the London InterbankOffered Rate (LIBOR) is quite the opposite. Shari’ah scholars havebeen divided on the use of LIBOR in Islamic banking, as it gives the appearance of an interest-like quality to Shari’ah-compliant financial instruments. The development of an alternative to it has been extensively debated for the last few years, but is yet to produce far-reaching results. Shari’ah scholars have generally ap-proved the use of LIBOR as a benchmark since it is the interest it-self, rather than the benchmark rate, that is the forbidden part.

And as the development of Islamic finance continues, so does theIIBI’s input in promoting the industry worldwide, expanding its skill base and providing education opportunities to Islamic financenovices and specialists alike. The Institute’s Post Graduate Diploma(PGD) in Islamic Banking and Insurance continues to be highly regarded worldwide. Its holders can now obtain an MA degree in Islamic banking, finance and management within six months, offered by UK-based Markfield Institute of Higher Education(MIHE). It will admit the holders of PGD for the MA in IslamicBanking and holders have to complete only a research methodologymodule and a dissertation. The degree is validated and awarded bythe University of Gloucestershire.

EDITORIAL

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

NEWHORIZON July–September 2010EDITORIAL

4 IIBI

Mohammad Ali QayyumDirector General IIBI



Banque Zitouna, the first Islamicbank in Tunisia, has opened forbusiness. It was initiated and cre-ated by seven shareholders, in-cluding a well-known localbusinessman, Mohamed SakherEl Materi, chairman of PrincesseHolding Group. Princesse Hold-ing Group is the largest stake-holder in the bank.

Banque Zitouna offers around30 Islamic savings and loansproducts to retail and corporatecustomers. It has capital of $23million, which is expected to riseto $65 million by 2011. Thebank’s initial branch network ofnine offices is planned to in-crease to 20 next year.

‘Our idea of founding an Islamic

bank in Tunisia had several ob-jectives, including to consolidateand enrich the banking and fi-nancial system of our countryby offering new innovative solu-tions that complement the prod-

ucts and services already offeredby traditional banks,’ stated ElMateri.

Tunisia’s finance minister, Mo-hamed Ridha Chalghoum, who

Tunisia’s first Islamic bank opens doors

was present at the opening cer-emony of Banque Zitouna, saidthat the launch of the country’sfirst Islamic bank is part ofstrengthening financing mecha-nisms of the national economyand increasing the volumes ofsavings. Taoufik Baccar, gover-nor of the Central Bank ofTunisia, also attended the cere-mony. In his view, Banque Zi-touna will enrich the country’sbanking landscape, which cur-rently consists of aroundtwenty institutions. He alsonoted that the launch of thebank is in line with the five-year presidential programme,which includes establishingTunisia as ‘a hub for bankingservices and a regional finan-cial centre’.

NEWS

A new pan-Gulf Arab Shari’ahsupervisory board may be inplace by 2013, according to aShari’ah scholar, HusseinHamad Hassan. A regionalShari’ah council to oversee thestandardisation and harmoni-sation of Islamic finance indus-try, and to facilitate the spreadof services to a growing num-ber of clients, is ‘not a far-fetched reality’, according toHassan. He is head of theShari’ah committee of DubaiIslamic Bank and chairman ofthe Shari’ah CoordinationCouncil of Islamic FinancialInstitutions in the UAE. Has-san is also a member of the

board of the Accounting andAuditing Organisation for Is-lamic Financial Institutions(AAOIFI).

Hassan raised the issue of thecurrent difficulties faced byclients who may want to buyan Islamic financial product ina different country. Having asingle regional Shari’ah boardis seen as a way of easing this.The issue is also a topical one:Malaysia’s central bank, BankNegara Malaysia, is known tobe preparing a system to helpcross-border transactions be-tween Islamic financial institu-tions.

International Shari’ahcommittee mooted

In response to growing demandand a recovering economy, Pak-istan is looking to double thesize of its Islamic banking sec-tor over the next three years.Salim Ullah, director of Islamicbanking at the State Bank ofPakistan, wrote recently thatthe industry would grow to thesize of twelve per cent of itsconventional counterpart, fromsix per cent currently, in thenext two to three years. Thisprocess will be driven by ‘in-creasing awareness and inter-est’ in finance which complieswith the tenets of Islam, Ullahbelieves. Part of this increasinginterest is a response to the

flaws of the conventional sys-tem made clear by the recentglobal financial crisis, he stated.

Pakistan currently has six fully-fledged Islamic banks. Of these,Meezan Bank, which has over200 branches across the coun-try, is the largest. Others includeDawood Islamic Bank and Al-baraka Islamic Bank. On top ofthese six, another 13 lendersprovide both conventional andIslamic financial services, andthe State Bank of Pakistan hasrecently given authorisation toanother two. Pakistan is hometo about 170 million Muslims,second only to Indonesia.

High hopes for Islamicbanking in Pakistan

Medina of Sousse, Tunisia

6 IIBI www.newhorizon-islamicbanking.com

NEWHORIZON July–September 2010NEWS

The Central Bank of the UAE isplanning to offer the country’sfirst Shari’ah-compliant instru-ment by the end of 2010. Thecentral bank is working on in-troducing an Islamic certificateof deposit, as part of its effortsto develop a money market.‘There is a need for Shari’ah-compliant certificates of depositto be issued by the centralbank,’ stated Saif Hadef AlShamsi, senior executive direc-tor, the treasury department at the Central Bank. However,he added that the final producthas not been approved yet.

The Shari’ah Coordination

Committee of Islamic Finan-cial Institutions has reviewedthe bank’s proposal and hasgiven it preliminary approval,according to Hussein HamadHassan, chairman of the com-mittee. However, some ‘minorchanges’ are required.

He also noted that the CentralBank ‘cannot issue licences forIslamic banks and then askthem to accept products andservices that are not Shari’ah-compliant’.

There are forecasts of thebank raising up to $2.7 billionwithin a year of offering the

UAE Central Bank prepares first Islamic certificate of deposit

product. At present, it holdsover $16 billion from financialinstitutions in the countrythrough its conventional cer-tificates of deposit. The devel-opment follows the call of theAccounting and Auditing Or-ganisation for Islamic Finan-cial Institutions to widen thepool of money market securi-ties to help companies and in-vestors manage risk moreeffectively.

Malaysia, which has theworld’s largest market for Is-lamic debt, launched a newelectronic trading platform in2009 that enables its partici-

pants to buy and sell com-modities, such as palm oil,used as assets to back Islamicloans.

The UAE is now preparingnew legislation on establishinga federal debt market by theend of 2010, according to theCentral Bank’s governor, Sul-tan bin Nasser al-Suwaidi. Itwill allow the Central Bank toissue treasury bills, bonds andIslamic notes. Malaysia andBahrain already offer such se-curities as a monetary tool tomanage liquidity and to de-velop benchmarks for short-term bond yields.

Gulf African Bank, an Islamicbank in Kenya, has posted apre-tax profit of $310,000 forQ1 2010, which puts it oncourse for its first full-yearprofit, according to the bank’sCEO, Najmul Hassan.

Hassan spoke to the Reutersnews agency, describing thebank’s Shari’ah-compliant ac-tivity as a ‘successful model’and saying that the positivefigures indicate that the localmarket ‘has really acceptedGulf African Bank’.

There are plans to increase itsbranch network to 14 loca-tions by opening two morebranches shortly.

Hassan also indicated that the bank is in discussions withthe government regarding issu-ing sukuk. However, it is not yet known whether the govern-ment will issue a standalonesukuk or whether it will be atranche from its regular bonds.

In 2009, the bank partneredwith Kenya’s other Islamic bank, First Community Bank, to invest in a $12 million gov-ernment sukuk. The inauguralsukuk was a tranche in thecountry’s first infrastructurebond worth around $230 million.

Islam is the religion of around10 million people in Kenya.

Islamic bank in Kenya is a ‘successful model’

Pakistan’s first Islamicmicrofinance bank planned

Pak-Qatar Family Takaful isplanning to set up Pakistan’sfirst Shari’ah-compliant mi-crofinance bank. PervaizAhmed, director and foundingCEO of Pak-Qatar FamilyTakaful, said that the bankwill focus on the SME sector.

The microfinance bank willintroduce Islamic insurance(takaful), including familytakaful products, and short-term Shari’ah-compliant loansfor lower income groups, ac-cording to Ahmed.

The company will heavily in-vest to expand Pak-QatarFamily Takaful’s reach in the

course of 2010, as well as toacquire new technology andprovide innovative facilities to customers. In 2009, Pak-Qatar Family Takaful’s busi-ness stood at $10.6 millionand this year it aims to growthreefold, said Ahmed.

However, Ahmed acknowl-edged that takaful still faces alot of challenges in Pakistan.‘Lack of general awarenessand education amongst themasses about the use andbenefit of insurance, let alonetakaful, is the biggest impedi-ment in the growth of the in-surance industry in Pakistan,’he stated.


NEWHORIZON Rajab–Ramadan 1431 NEWS

Islamic banking sees progress in India

Islamic non-banking financecompanies (NBFCs) are beingconsidered by India’s ministryof finance. This comes as a result of the reluctance of the country’s central bank, the Reserve Bank of India(RBI), to allow banks to offerIslamic finance products andservices.

The initiative is currently in theearly stages of discussion, saida finance ministry official. ‘Theidea is to start with NBFCs sothat they can gain experience.Also, this way issues regardingfinancing and the model of Islamic banking can be ad-dressed,’ the source explained.Together with the RBI, theministry will work on theguidelines and exemptions forIslamic NBFCs. At present, thegovernment allows four typesof NBFCs: asset financing, in-vestment, lending and infra-structure financing.

There are some NBFCs inIndia that are already working

with Shari’ah-compliant offer-ings, but the existing regula-tory framework makes themnon-viable. For example, Is-lamic NBFCs work on thelease-transaction and hire-pur-chase model, which results indouble taxation of profits.

Earlier, the RBI concluded thatIslamic banking did not fitinto India’s banking legisla-tion. There is some room forrule relaxation, indicated theofficial, but it was added that the ministry cannot deviatefrom the basic principles ofbanking. Areas such as assetclassification, accounting stan-dards, capital adequacy andprovisioning for bad assetswill be looked into.

Overall, India’s banking andfinance specialists agree thatinterest-free banking will be apositive development for thecountry’s market. The commit-tee on financial sector reform,chaired by a renowned Indianeconomist, Raghuram Rajan,

has recommended the intro-duction of this type of banking.Also, the Indian Centre for Is-lamic Finance (ICIF) has madepresentations to the RBI andIndia’s finance minister, PranabMukherjee, on Islamic bank-ing. In this presentation, theICIF has stated that ‘if financeis available without the burdencaused by pre-determined in-terest rates, it will be a wel-come development for all themarginalised sectors, and espe-cially SMEs. Interest-free Is-lamic banking can fill this gap.’

The ICIF has also supported the idea of Shari’ah-compliantNBFCs and suggested that theyshould be allowed to floatsukuk (Islamic bonds) to raisecapital.

The government of the Keralaregion has been in talks forsome time with an Islamic in-vestment entity about settingup an Islamic NBFC, sup-ported by the Kerala State In-dustrial Development

Corporation (KSIDC). In 2009,the KSIDC proposed to set upthe first state-supported Islamicbank in the region, with aneleven per cent stake held by the KSIDC. The entity was to be registered as an IslamicNBFC to start with, and con-verted into a fully-fledged Shari’ah-compliant bank later.

However, the venture has experienced set-backs when petitions challenging the cre-ation of this NBFC were filedby Subramaniam Swamy, headof the Janata Party, and R VBabu, secretary of Hindu AikyaVedi. Babu argued that theKSIDC, which has a mandate to promote industrial activitiesin Kerala, should not partici-pate, financially or otherwise, in a financial venture.

The issue has not been resolvedto date. Recently, the high courtof Kerala adjourned the petitionuntil early September. This wasdone after the RBI’s request formore time.

New Delhi,India

New Delhi,India


NEWHORIZON July–September 2010NEWS

DBS Bank, one of the largestbanks in South East Asia andthe largest lender in the region,is rowing back on its ambitionsfor the Islamic banking industryfollowing heavy losses in itsShari’ah-compliant subsidiary,Islamic Bank of Asia (IBA). The move is being seen as asign that efforts to increase Is-lamic banking in Singapore arestruggling.

IBA, which is the only whollyowned, fully licensed Islamicbank in the city state, suffered aloss of $77 million last year, on$725 million of assets in 2009.

In response, IBA has transferredten of its 65 staff back to DBS(which owns just over 50 percent of IBA), while other staffare being redeployed within theIslamic bank. Staff to leave havenot been replaced, including theformer CEO, Vince Cook, wholeft IBA in December 2009.

There has been speculation thatIBA would be shut entirely butDBS has stated that it remainscommitted to growing Islamicbanking in Singapore. IBA’s tra-vails are perhaps mirrored bythose of Kuwait Finance HouseSingapore, which was set up to

manage the Islamic funds ofKuwait Finance House. It has

Slow progress for Islamic banking in Singapore

yet to do so, however, and hasalso seen its workforce cut.

Four major UAE companieshave teamed up to establish a new Islamic insurance firm.

The participants in the ven-ture are the National Bank ofAbu Dhabi, Aldar Properties

(a real estate firm), AbuDhabi National InsuranceCompany (Adnic) andTaqa (energy company).All four are either fully orpartially owned by thegovernment of Abu Dhabi.

The new takaful entity is currently under forma-tion, so no details arebeing disclosed. The UAEmarket is prime for Islamicinsurance providers, ex-perts believe. Al HilalBank, Abu Dhabi IslamicBank, Noor Islamic Bankand Dubai Islamic Bankhave already set up theirtakaful operations.

New takaful venture to belaunched in Abu Dhabi

Islamic insurance (takaful) ispoised to grow significantly inthe next four years, according toErnst & Young Islamic financialservices division. The team’s di-rector, Ashar Nazim, forecastedthe takaful business trebling insize over the next four years andreaching $25 billion.

He presented these findings dur-ing the recent launch of Ernst &Young’s third annual WorldTakaful report, which tookplace in London. Nazim notedthat the industry should play amore active role in facilitating‘consistent regulatory, legal, ac-counting, capital markets andtax regimes’.

The way forward for the indus-try, in his view, is to focus on

‘generating sustainable rev-enues from the core underwrit-ing business’. The discussionalso tackled the issues of cleardifferentiation between conven-tional and Islamic insurance, as well as the way for takafuloperators to increase scale ofactivity and at the same timedecrease dependence on a fewinvestment instruments.

Sameer Abdi, head of Ernst &Young Middle East financialservices group, described the Islamic insurance industry as a ‘case study in resilience’. According to Abdi, globaltakaful contributions grew 29per cent in 2008 and reached$5.3 billion, and are expectedto exceed $8.9 billion by theend of 2010.

High growth expectations for takaful

Singapore



Islamic insurance (takaful) has been grow-ing at an incredible pace in the Middle Eastand parts of Asia, Africa and Europe. How-ever, it has yet to find its place within theinsurance industry in North America, aplace for takaful that may be seen as aniche for its appeal to customers who find it aligned with their values and beliefs. Buttakaful need not be confined to a niche be-cause of its appeal to all of us who under-stand the benefits of socially responsibleinstitutions (SRIs), the socially responsibleways to invest for the good of society andenvironment that affects all of us.

Takaful has distinct differences from con-ventional insurance, although the two alsoshare many common aspects. Takaful pro-vides financial protection against unfore-seen risks just like conventional insurance.It is bound by and based on similar scien-tific rules and actuarial approaches to mor-tality rates, morbidity rates, loss ratios,claims experience and discounted cashflows for calculating price of risk and evalu-ation of liabilities. Islamic insurance is simi-lar to conventional mutual insurance as itspolicyholders conceptually own the co-op-erative takaful pool. However, takaful alsohas shareholders to support developmentand expansion plans unlike conventionalmutuals.

Insurance is risk mitigation through the ap-plication of law of large numbers. Takafulis the same except that its basic meaning is

Takaful in North America: a global view for local perspectiveWhat are the challenges for Islamic insurance in Canada and the US? How promising is theNorth American market? The Usury Free Association of North America (UFANA) recently held adedicated conference in Toronto, gathering international specialists to address these and othertopical questions. Ajmal Bhatty, CEO takaful at Tokio Marine Middle East, Dubai, presented hisview.

mutual protection through large numbersmade up of those who care to help eachother, and the pooling of their money goesbeyond this, to help the community and theenvironment.

If we ask anyone what is meant by insur-ance the answer is buying protection froman insurance company. When we ask thesame question about takaful, the answerought to be mutually protecting each other.There is a sense of mutuality – a conceptmore related to mutual companies, exceptthat mutual companies may have ethical investments as a matter of choice not obli-gation. Ethical investments are not a mustfor them.

The compliance system of takaful is meantto make it non-exploitative with little or no margin for misinterpretation. Moniesgenerated from its funds and reserves are invested to generate trade, wealth and employment, and not to create merely more money in reference to interest baseddealings.

Takaful expresses the essence of insurancein a way that focuses on shared responsibil-ity or solidarity amongst those who takepart for the common good. The risk istransferred from one to many but still therisk remains with them, shared jointly andnot transferred to a third party. In conven-tional insurance, the risk is transferred frommany to one party – the insurer.

TAKAFUL FOCUS

Ajmal Bhatty,Tokio Marine Middle East


NEWHORIZON Rajab–Ramadan 1431 TAKAFUL FOCUS

Development of takaful around the world

Takaful started in 1979 and has perseveredas an industry in reaching its current stateespecially within the last five to six years,with consistent and rapid growth throughseveral companies. Some estimates indicateover 150 takaful companies and windowsworldwide.

The past growth of some 30 per cent perannum in Malaysia and 20 per cent perannum in some parts of the Middle Eastconsistently achieved over the last severalyears is actually considered to be on thelower side when compared to the takafuldynamics of several markets with potentialfor much higher growth. Much of this hold-ing back in the current markets of takaful inthe Middle East, Asia and Africa is to dowith the mindset of those players (insurers,brokers and reinsurers) who are well-en-trenched in these markets in conventionalinsurance and see takaful as a nicheonly. Takaful, for what it stands forin its essence of ethics, should rightlybe the mainstream form of insurancein countries where takaful is a cus-tomer-driven phenomenon.

It is this customer-driven push thatled lots of local and regional takafulcompanies to be established. Manybig international players for manyyears continued to argue that insur-ance offers the same as takaful, butthe fact of the matter is that some of the big international players havenow their own takaful companiesand windows. Amongst such compa-nies are Tokio Marine, AIG, Pruden-tial, HSBC Insurance, Zurich, AXA,Munich Re and Swiss Re. Tokio Marine, operating in Saudi Arabiasince 1967, was the first ever interna-tional player to have introduced taka-ful as a product in that market in2001. By January 2008, it was offer-ing takaful products in Saudi Arabia,Malaysia and Indonesia. The Groupalso has a family retakaful company(Shari’ah-compliant life reinsurance)in Singapore.

The estimated global takaful premiums were$3.4 billion in 2007 excluding Iran, and this number more than doubles to $7.5 bil-lion with Iran included. It is estimated thatabout 40 per cent of global takaful businessrelates to family takaful.

The markets where Islamic insurance hashigh potential for growth are concentratedin the middle part of an S-curve. This is il-lustrated in the graph below:

The S-curve plots countries according to theGDP per capita and life insurance premium.The shaded portion shows as an examplethe large gaps that exist in several countries.If the market dynamics are right in terms ofeconomic and political fundamentals, socialdevelopment, income levels and insuranceawareness, there is no reason why takafulshould not be the key to success in greaterpenetration of insurance in future, albeitthrough takaful.

Source: Sigma Swiss Re, graph by Tokio Marine Middle East

If we ask anyone what is meant by insurance the answer is buying protectionfrom an insurance company.When we ask the samequestion about takaful, theanswer ought to be mutuallyprotecting each other.

S-Curve potential

gaping gap or opportunity?


NEWHORIZON July–September 2010TAKAFUL FOCUS

In 2008, Saudi Arabia had $6 per capitaspend on life insurance and yet other coun-tries with lower GDP per capita such asMalaysia had much higher spend of $226.The figure for Canada was $1,443 (withthe GDP per capita of $39,100) in 2008. It is not surprising that the compound an-nual growth of insurance in countrieswithin the middle part of the S-curve isvery high. The two graphs on the left illus-trate this in putting the growth of insur-ance over 2000 to 2008 within the contextof GDP per capita.

The world average growth was nine percent in general insurance. Most countrieswith takaful potential have shown higherthan average growth. Canada shows bettergrowth (twelve per cent per annum) thanthe world average and many of the matureinsurance markets, such as the UK, the USand Japan.

Whilst insurance awareness is low in manymarkets due to cultural reasons, takafulhas all the room to grow. In life insurance,referring to the graph below, the countrieson the middle part of the S-curve have all shown impressive consistent yearlygrowth: Malaysia 15 per cent, Egypt 17per cent, Indonesia 24 per cent, the UAE32 per cent and Saudi Arabia 37 per cent.Canada registered growth of nine per cent,higher than the US (four per cent). Theworld average growth was six per cent an-nually from 2000 to 2008.

The projected figures for the global size of takaful are estimated to be $7.7 billionby 2012 and up to $14 billion by 2015, as new companies open up and become es-tablished in the GCC, especially in Saudi Arabia and the Levant region, in additionto the growing markets of South East Asia and Asia Pacific, led by Pakistan,Malaysia and Indonesia. Europe holds agreat deal of promise for the growth oftakaful and a number of initiatives arebeing considered there. The total capitalcommitted within the takaful industry in2007 was around $3.5 billion. Takaful as-sets are estimated to grow to around $30billion to $40 billion by 2015, approxi-



Non Life CAGR 2000/08

Life CAGR 2000/08

business into takaful.

Finding interim solutions until solid perma-nent solutions can be found is the way togo, provided we have the will to persevereto deliver this system which is fair to all thestakeholders – the customers, shareholders,employees and the society at large. Theseare some key challenges facing promotersof takaful in North America:

❏ Pricing products competitively, thisbeing a function of returns on Shari’ah-compliant assets available (or not quiteavailable) locally.

❏ Promoting the takaful system correctlyand ensuring customer expectations aremet fully. This includes the co-operativeand community spirit and how funds con-tribute to the larger benefit of the commu-nity and environment.

❏ Creating and maintaining Shari’ahcredibility.

There is a large Muslim population inCanada and the US. Also, there are manypeople who find the concept of channellingfunds back into the community very ap-pealing. Takaful is evolving rapidly inother parts of the world, and it can do soin North America. Companies taking alead in securing an early market share with professional management and ratedsecurity should reap the long-term rewardsfrom this business. Anyone wishing to develop takaful for North America wouldbenefit from studying and learning fromboth successful and adverse experiences inother markets, to see how others have triedto overcome the challenges.


NEWHORIZON Rajab–Ramadan 1431 TAKAFUL FOCUS

mately 40 per cent of this backing familytakaful business.

In 2002, there were around 41 companiesoffering Islamic insurance (either as taka-ful companies or Islamic windows of con-ventional ones) in some 23 countriesaround the world. The institutions offer-ing this business as Islamic windows wereestimated to be just around five per cent of the total. The number of takaful entitieshas grown more than four times to about179 in six years (by September 2008) in32 countries. Windows represent 20 percent of this number (36), showing a grow-ing trend of conventional companies wish-ing to enter this industry ranging fromdefensive moves to protect their existingmarket share to genuinely increasing mar-ket share.

Takaful system and products must strikethe right chord with customers on severallevels, achieving the following:

❏ The products and services are fullyaligned with values and beliefs.

❏ The products are competitive, al-though there are challenges here if a suitable Shari’ah-compliant mix of invest-ments is not available.

❏ Funds are channelled into assets andbusinesses that are good for society andthe environment.

❏ The products are transparent, built on mutual trust and co-operative spirit.This is also the community spirit at themicrofinance level that is built on jointand caring risk management in a financialproposition.

❏ The system is fair to all parties, withmutual surplus sharing. Customer expec-tations are for a claim to be met if it is dueor where there is no claim a share in thesurplus, if indeed the fund is in surplus.

Given these appealing qualities of thetakaful proposition, the experience oftakaful operators in Malaysia has been

very favourable. People buying takafulthere have represented a fair balance be-tween Muslims and non-Muslims.

The practitioners of takaful in other partsof the world have gone through similarkinds of challenges that exist today inNorth America. In the 1990s, many sen-ior insurance executives in the MiddleEast rejected takaful at first but over thecourse of some ten to 15 years there hasbeen a paradigm shift in these markets. Alot of these executives have ended upheading takaful companies and busi-nesses, providing reasonable returns toboth the customers and shareholders.

So why hasn’t takaful taken firm roots inNorth America yet? Is it that it is not yetproperly understood by the insurance in-dustry in the region? Or that the regula-tory and investment constraints appear tobe too big a hurdle, leading to challengesin pricing and returns on capital? Andwhat can be done to get takaful going inCanada and the US?

One option is to look closely at the In-donesian approach where the insuranceregulator allowed takaful windows to be set up in conventional companies. Thisresulted in the mushrooming of takafulwindows (some 30 windows by 2008) inresponse to good demand. Having ob-served the successful growth of takafulportfolios within the windows, the regula-tor has asked the companies to allocate acertain level of capital to the takaful busi-nesses of these windows. The regulator’snext step might be asking these compa-nies to segregate the windows into sepa-rate subsidiaries or convert all of the

RegionsTakaful companies & windows

Sept 2008

Middle East 69

Africa 27

Asia Pacific 56

The Rest 27

Total 179



Islamic finance is poised for a significantsurge as world markets reorganise andShari’ah-compliant banks reassess their po-sition in local markets. As a global market,Islamic banking has grown at an impressive27 per cent per annum over the past fiveyears, and is estimated to reach $1 trillionin 2010. Growth in the Islamic finance in-dustry will occur along three distinct fronts:organic growth, new market growth andproduct growth. Organic growth will con-tinue as Shari’ah-compliant banks persist in engaging their clients with additionalservices (aiming to increase deposits). Newmarket growth will consistently rise asmore banks are engaging previously un-banked populations in Africa, the MiddleEast and Southern Asia where the ratio ofpeople banked is very low. It is however thethird area of product growth which holdsthe most long-term benefits for Islamic fi-nance.

Shari’ah-compliant institutions are emerg-ing from 2009 with a renewed sense of confidence as the impact of the financial crisis is passing from a panicked search forguilty parties to a refocused approach torisk management. Islamic banks have beensomewhat insulated from the global finan-cial crisis because of their lack of access towhat is now labelled as ‘toxic assets’. WhatIslamic banks have noticed during the crisisis a steady increase in assets as investors/de-positors take conservative postures and amarked reduction in the generation of feeand investment income. Unlike their con-ventional counterparts, during 2008-09Shari’ah-compliant institutions continued adeliberate plan of innovation, mainly in re-

Islamic rate of return: the new IRR

The issue is discussed by Joseph DiVanna, MD of Maris Strategies, a Cambridge-basedstrategy think tank for financial services specialising in economic, demographic and consumerintelligence in emerging markets.

tail banking distribution, experimentingwith technology. Now these banks are turn-ing their attentions toward a longer-termgrowth agenda which includes product in-novation that is more distinctly a represen-tation of Islamic values and beliefs.

However, the rate at which this potential for growth is achieved is predicated on theestablishment of additional national and international financial infrastructure. Onekey area of discussion is in the use ofLIBOR (London Interbank Offered Rate) as an industry benchmark for sukuk andother instruments. Today, the performanceof Shari’ah-compliant products such assukuk are measured (or linked) to LIBOR as a benchmark, not by design, simply as a matter of convenience in the early stage of market development. To compete withconventional banks, which many of theirclients have been using for decades, Shar-i’ah-compliant institutions have adoptedthe use of LIBOR so customers have a read-ily recognised mechanism to assess the rela-tive rate of return on their productofferings.

Shari’ah scholars have been divided on the use of LIBOR as it gives the appearance of an interest-like quality to Shari’ah-com-pliant financial instruments. Conversely,some Islamic scholars have argued that sim-ply using an interest rate as a benchmarkfor determining the relative rate of returnfor a Shari’ah-compliant instrument doesnot render the instrument non-compliant.

‘In the final analysis, a benchmark is nomore than a number, and therefore non-

ANALYSIS

The key point of debate is the appearance of a Shari’ah-compliant financial instrumentto generate a fixed rate return.


NEWHORIZON Rajab–Ramadan 1431 ANALYSIS

objectionable from a Shari’ah perspective. If it is used to determine the rate of repay-ment on a loan, then it is the interest-bear-ing loan that will be haram. LIBOR, as amere benchmark, has nothing to do withthe actual transaction or, more specifically,with the creation of revenues or returns,’says Shaykh Yusuf Talal DeLorenzo, chiefShari’ah officer and board member ofShariah Capital, a US-based Shari’ah advi-sory firm.

The key point of debate is the appearance of a Shari’ah-compliant financial instru-ment to generate a fixed rate return.Under Shari’ah principles, money cannotgenerate money, which in modern times is represented by interest. Numerous Shari’ah scholars have argued that instru-ments such as murabaha (debt) cannot besecuritised, since sukuk-backed pools ofmurabaha are simply the sale of docu-ments representing money, which can beinterpreted as merely trading of monies.On the other hand, Malaysian scholarshave argued that if the underlying receiv-able is associated with a true trade trans-action or to a commercial transfer of anon-monetary interest, such a receivablecan be traded freely for the purposes ofShari’ah.

Theoretically, a hybrid (debt/equity) sukukcould be structured to emulate a quasi-fixed return found in conventional bondswhereby the LIBOR benchmark wouldgive investors an understanding of the instrument’s return relative to a conven-tional counterpart. Thus if structuredproperly the hybrid sukuk can generate aprofit-based return that is comparable to aconventional LIBOR-based product. Whatthis boils down to is the fundamental needfor the industry to mature to a new levelthrough a process of product/market inno-vation that increases the depth of marketofferings. Market infrastructure such as aShari’ah-compliant money market instru-ment, the establishment of a secondarymarket and secondary market pricing arebut a few of challenges in the years tocome, which will reach higher levels ofdiscussion in 2010.

Islamic rate of return (IRR)

Fundamentally, the industry, or more specif-ically central banks, must address the cre-ation of a benchmark that represents thecost of capital in Shari’ah-compliant terms.Without a clear Islamic rate of return (IRR)LIBOR will continue to be used. The use of LIBOR and the development of an alter-native has been discussed and debated dur-ing the past five years resulting in fewalternatives. The central issue is the cost of capital and the establishment of an Is-lamic rate of return for procurement andplacement of funds. Some scholars advocatethe development of a mechanism similar to a rent index used when working with ijara instruments. Hence the industry willcontinue to use LIBOR as the only recog-nised benchmark. That said, the Islamic International Financial Market (IIFM), aBahrain-based non-profit international in-frastructure development institution, identi-fies several alternative theories:

❏ Abbas Mirakhor approach: proposesthat the cost of capital be measured withoutresort to a fixed and predetermined interestrate using equity financing as the source offinancial capital (Tobin ‘q’ theory).

❏ Sheikh Taqi Usamni approach: a bench-mark can be achieved by creating a commonpool which invests in asset-backed instru-ments (e.g. musharakah, ijara) where unitscan be sold and purchased on the basis oftheir net asset value determined on a peri-odic or daily basis.

❏ Bank Negara Malaysia (Malaysia’s cen-tral bank) approach: proposed in ‘Frame-work of the Rate of Return’ sometimesreferred to as mudarabah interbank invest-ments (MII) – a standard methodology tocalculate the distribution of profits and thederivation of the rates of return to deposi-tors. A calculation table prescribes the in-come and expense items that need to bereported. It also sets out the standard calcu-lation in deriving the net distributable in-come and a distribution table sets out thedistribution of the net distributable incomeposted from the calculation table among de-

Joseph DiVanna,Maris Strategies


NEWHORIZON July–September 2010ANALYSIS

mand, savings and general investment de-posits according to their structures, maturi-ties and the pre-agreed profit sharing ratiosbetween the bank and the depositors.

Another alternative, which was introducedin 2004 by the State Bank of Pakistan (SBP)and the Pakistan Banks’ Association (PBA), is the KIBOR (Karachi Interbank OfferedRate) a benchmark for corporate lending inlocal currency defined as ‘the Average rate,Ask Side, for the relevant tenor, as publishedon Reuters page KIBOR or as published bythe Financial Markets Association of Pak-istan in case the Reuters page is unavailable.The banks and the borrowers are free to decide the relevant tenor of KIBOR and the spread over KIBOR at their discretion.KIBOR will be set for the lending facility onthe date of drawdown or on the mark-upreset date. The offer letters from the banksto their clients should clearly indicate theKIBOR’s tenor and the agreed spread, fre-quency of revision’. The six-month KIBOR is most widely used as a benchmark.

How will an Islamic interbank rate work?

One theoretical construct is the use of a mudarabah concept whereby Shari’ah-compliant institutions with excess reserves(surplus banks) can invest in the interbankmoney market which in turn providesfunding to banks looking for funds (deficitbanks). Surplus banks act as investorswhile the central bank acts as an entrepre-neur. The parties agree on a profit sharingratio between the surplus banks (70 percent) and the central bank (30 per cent).The surplus bank receives 70 per centprofit while the central bank will receive 30 per cent. The profit rate is based on the benchmark calculation of the profit as: profit equals (principal x profit rate xtime x profit sharing ratio) divided by365. Although theoretically, profit ratesare acting under a similar means as an interest rate there is a built-in risk associ-ated with the performance of the underly-ing assets associated with all thetransactions initiated by the banks.

Clearly, these types of mechanisms are intheir infancy and will require a great dealof discussion between Shari’ah scholars,central bankers, monetary policy makersand bankers.

Conclusion

The Islamic finance market will continueto grow and strengthen during 2010. The rate at which the growth will occur is dependent on two things: the develop-ment of supporting market infrastructuresuch as a replacement for LIBOR and the confidence in the bankers themselves to conduct business in challenging eco-nomic times. The development of alterna-tive benchmarks demonstrates the risingindependence of Islamic finance as a viable alternative to conventional financ-ing. As new economic data slowly reveals the emergence of renewed growth, Is-lamic finance is poised to enter 2010 as the first year of a new generation ofdevelopment.

Diary of events endorsed by the IIBIJuly

13–15: 4th International Takaful Summit,LondonSummit to gather practitioners and re-searchers from around the world to explorethe current state of the Islamic insurance industry.Contact: Abbas KhakuTel: +44 (0) 20 8861 2012Email: [email protected] www.takafulsummit.com

30 –1 August: Structuring Innovative Islamic Financial Products, Cambridge, UKFourth annual three-day residential work-shop to cover a wide range of highly topicalissues of structuring innovative Shari’ah-compliant financial products. Contact: Mohammad ShafiqueTel: +44 (0) 20 7245 0404Email: [email protected]

November

22–24: 17th Annual World Islamic Banking Conference (WIBC), BahrainConference to discuss the key issues, developments and challenges of Shari’ah-compliant banking and finance worldwide.Contact: Naomi NjorogeTel: +971 4 343 1200Email: [email protected]

Cambridge

Throughout 2010, IIBI is organising a number of training workshops to build the skill baseand share ideas among practitioners within the Islamic finance industry. The objective ofthe Institute’s training is to fill the human resource gap and to enhance the professionalskills of personnel who are either interested in building their careers or already involved in the Islamic finance sector. Training programmes are delivered by experienced profes-

sionals; the number of participants is kept small to ensure the interactive environment andprovide 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



ever collateral may be involved, without los-ing the property rights claim to the moneylent. This is a violation of Islamic propertyrights principles. The most important ofthese principles are that:

❏ The Creator has ultimate property rightson all things.

❏ He (swt) has created resources for allmankind and no one can be denied access to these resources.

❏ Work is the only means by which indi-viduals gain the right of possession of property when they combine their physi-cal/mental abilities with natural resources to produce a product.

❏ Since resources belong to all mankind, a right is created in the products producedby the more able for the less able; in effectthe less able are silent partners in the products, income and wealth produced by the more able whose share has to be redeemed.

❏ All instantaneous property rights claims,such as theft, bribery, interest and gambling,are prohibited.

❏ A person can transfer a property rightsclaim to another via exchange, inheritanceor the redemption of the rights of the lessable. Interest rate-based debt contracts cre-ate an instantaneous property rights claimfor the creditor against the debtor regardlessof the outcome of the objective for whichthe two sides entered the contract. The cred-itor obtains this property rights claim with-out commensurate work.

Equity-based Islamic finance and risk sharing

The foundational principle of Islamic fi-nance is the prohibition of interest (riba)and interest-based contracts. This prohibi-tion has been stated in many verses inQuran and was explicated in many sayingsof the Prophet PBUH.

In Quran, Chapter Two, verse 275, Allahsays: ‘those who devour riba (interest) willstand except as stands one who the evil oneby his touch has driven to madness. That isbecause they say exchange is like riba; butAllah has permitted exchange and forbiddenriba.’ In Chapter Two, verse 276, ‘Allah willdestroy riba; but will increase charity’. Inverses 278-279, Chapter Two, ‘Oh you whobelieve fear Allah and give up what remainsof riba; if you do it not, take notice of warfrom Allah and His Apostle’.

As can be observed from the last part of the quoted verses, there is no rule violationin the Quran that has been treated as seri-ously as the charging of interest which isconsidered a paramount act of injustice. Aneconomic understanding of the essence ofthe above verses – that interest-based debtcontracts have to be replaced by contracts of exchange – would require analysis of par-ticularities of the two contracts. Interestrate-based debt contracts have two majorcharacteristics. Firstly, they are instrumentsof risk shifting, risk shedding and risk trans-fer. The second characteristic of interest-based debt contracts is that upon enteringinto this contract, the creditor attains aproperty rights claim on the debtor, equiva-lent to the principal plus interest and what-

Risk sharing and Islamic finance Abbas Mirakhor, first chair in Islamic finance at the International Centre for Education in IslamicFinance, Malaysia, and Noureddine Krichene, economist at the International Monetary Fund(IMF), with a PhD from University of California, Los Angeles, examine the issue.

Ordaining exchange to replace interest rate-based debt contracts has significant economicimplications. First, before parties can enterinto a contract of exchange they must haveproperty rights over the subject of exchange.Second, the parties need a place to undertakethe exchange: a market. Third, the marketneeds rules for its efficient operations.Fourth, the rules of market need enforce-ment. Exchange facilitates specialisation andallows the parties to share production, trans-portation, marketing, sales and price risks.Therefore exchange is above all a means ofrisk sharing. From an economic standpoint,by prohibiting interest rate-based contractsand ordaining exchange contracts, the Quranencourages risk sharing and prohibits risktransfer, risk shedding and risk shifting. In a typical risk sharing arrangement such as equity finance, the parties share the risk aswell as the reward of a contract. In an inter-est rate-based debt contract the risk is trans-ferred from the financier to the borrower,with the financier retaining not only theproperty rights claim to the principle and in-terest but also that of any collateral that hasenhanced the financing arrangement. In a risksharing arrangement such as equity participa-tion, the asset is invested in remunerativetrade and production activities, the return tothe asset is not known at the instant the assetis invested and is therefore a random vari-able, making equities risky assets. In equityinvestment, owners of money and physicalassets, and entrepreneurs, share the risk; theirincome is random and depends on the per-formance of the equity investment.

Not all debt contracts are forbidden in Islam.However, they have to be free of interest. Be-cause they are not remunerative, debt con-

ACADEMIC ARTICLE


NEWHORIZON Rajab–Ramadan 1431 ACADEMIC ARTICLE

tracts cannot play a significant economicrole in financing trade and investment inIslamic finance. How about borrowing bythe needy and the poor for survival? BeforeIslam, and also in medieval Europe, thepoor used to borrow by pledging theirproperty as a collateral. As default was acommon event, the poor risked the loss ofall their properties with the consequencethat often they were forced into slavery. Asa direct consequence of the principles ofproperty rights, in Islam, the poor, the or-phans and the needy have a prescribed andmandatory share in the earnings of assets,which provide a safety net. Thus, the richare mandated to share the risk of the life ofthe poor. Prohibition of interest and theobligation of zakat and other prescribedduties levied on the well-to-do are statedoften jointly and not separately in both theQuran and the Sunnah. When the econom-ically more able shirk their duty of redeem-ing the rights of the less able, the poor willhave to borrow or fall in abject poverty.Existence of wide-spread poverty in a soci-ety is prima facie evidence of shirking ofthe duty of sharing.

Islamic finance is inherently stable, conventional finance is inherently unstable

Islamic finance, by emphasising equity investment and risk sharing, has character-istics that render it inherently stable. Conventional finance, being debt- and in-terest-based, has proven to be unstable.Hyman Philip Minsky, a prominent Ameri-can economist, dubbed conventional fi-nance instability ‘endogenous instability’because conventional finance experiences athree-phased cycle: relative calm, specula-tion and fictitious expansion, and then cri-sis and bankruptcy. The bankruptcy aspectof conventional finance is not limited tothe private sector as the recent Greek debtcrisis illustrates; governments too can facebankruptcy. Recent historical analysis hasdemonstrated that all financial, bankingand currency crises have been ultimatelydebt crises. The widespread bankruptciesof many developing countries in the recentpast shows that often governments thatborrowed what were considered as reason-

able debt levels compared to their GDPfound themselves in an unsustainable debtspiral due to increased debt service obliga-tions. Many found themselves with debt levels many times larger than the originalborrowed.

In the aftermath of the financial crisis thatbroke out in August 2007, the InternationalMonetary Fund (IMF) and regulators in in-dustrial countries have called for capital surcharges on banks and for strengthenedregulation and supervision to make conven-tional banking less crisis-prone. In contrastto the regulatory reforms proposed by theG20 group in its November 2008 summitand in following summits, the Chicago Re-form Plan (1935) advocated a financial sys-tem based on 100 per cent reserve banking,equity-based banking, and elimination of interest rate-based contracts. In line withmany classic economists, the authors of theChicago Reform Plan (1935) considered thatmodern banking created fictitious credit, expanded in a multiplicative way throughmoney creation, and contracted in a multi-plicative way through money destruction,causing grave gyrations in asset prices andlarge fluctuations in real economic activity.In the Chicago Reform Plan (1935), depositsat investment banks would be considered as equity shares and would finance long-term investment. Maurice Allais, a Nobellaureate in economics, strongly advocatedthe Chicago Reform Plan (1935) and calledfor a reform of the stock market in order toenhance its role in financial intermediationand reduce its speculative aspects.

Islamic finance and the evolutionary processof equity financing

In an Islamic finance system in which thereare no risk-free assets, where all financial as-sets are contingent claims, and in whichthere are no interest rate-based debt con-tracts, it has been shown that the rate of re-turn to financial assets was determined bythe return to the real sector. Output is di-vided between labour and capital. Oncelabour is paid, the profit is then divided be-tween entrepreneurs and equity owners.Since profits are ex post, returns on equities

In line with many classiceconomists, the authors of theChicago Reform Plan (1935)considered that modernbanking created fictitiouscredit, expanded in a multi-plicative way through moneycreation, and contracted in amultiplicative way throughmoney destruction, causinggrave gyrations in asset pricesand large fluctuations in realeconomic activity.

Abbas Mirakhor,International Centre for Education in Islamic Finance


NEWHORIZON July–September 2010ACADEMIC ARTICLE

cannot be known ex ante. It is demon-strated that in such a system there is a one-to-one mapping between finance and realeconomy and that an equity-based finance is stable as assets and liabilities adjust toshocks, therefore the system is immune tobanking crisis and disruption in the pay-ments mechanism.

Equity financing has been an essential modeof financing of trade and industry through-out the centuries. It continues to be em-ployed as a mode of financing in manydeveloping countries where it has evolvedwith the advent of enterprise creation andeconomic growth.

Historically, enterprises were establishedwith share ownership and were recorded asshare owned or anonymous enterprises.Shares were not necessarily offered to thepublic via stock markets and were primarilyprivate contributions of founders of thecompany. In many countries, share-ownedcompanies continue to be formed withoutnecessarily resorting to stock market publicofferings. Nonetheless, with the spread ofequity-financed firms, stock markets, as aform of organised exchanges, became an in-tegral part of financial intermediation andin channelling savings to long-term invest-ment. Stock markets, considered as the first-best instruments of risk sharing, offerliquidity for listed shares in that the ownersof listed shares may sell them when theyneed liquidity. Moreover, liquidity and at-tractiveness of stocks have been enhancedby the proliferation of derivatives, such asoptions and futures, that allow portfolio insurance that provides protection againstbear markets. For instance, a protective put provides protection against stock down-turns. While stock markets have been vul-nerable to speculative bubbles and stockmarket crashes have been ruinous to saversand to pension funds, the main reason hasoften been informational problems, self-dealings such as insider trading, unregulatedshort sales that promote unnecessary specu-lation, lack of protection of minority shareholder rights, weak regulation and supervision, and even weaker enforcementof contracts.

The development of Islamic finance and itsequity financing aspects could be signifi-cantly rewarding for countries that seek an alternative to the conventional system.Many developing countries have tried to develop conventional banking to enhancetheir financial infrastructure; however, alarge number of these countries have experi-enced repeated severe banking and currencycrises and have failed so far to create a deep and stable financial system. Economicgrowth and employment in these countriescontinue to be severely constrained. Devel-oping long-term equity-based banking andefficient stock markets could be a promisingalternative for financing growth and em-ployment creation in all countries.

Islamic finance: balance between short-termless risky liquid assets and long-term, higherrisk, and less liquid assets – the vibrant stockmarket approach

For Islamic finance to achieve its expectedpotential, it has to emphasise long-term in-vestment and economic growth and not con-fine itself to short-term, highly liquid, andsafe commodity trade and cost-plus sale fi-nancing contracts. Long-term investmentsare more risky than short-term investments.In fact, the more distant in time the payoffsof an investment are, the riskier these pay-offs become. Risk increases with time. How-ever, long-term investments have higherexpected payoff. Nonetheless, a stumblingblock to long-term finance is liquidity, infor-mational problems, lack of level playingfield between equity and debt financing,weak regulation and enforcement as well as non-protection of minority shareholderrights. The liquidity problem has been ad-dressed by developing secondary marketswhere securities can be sold. The liquidity of equity shares is enhanced through twochannels. Firstly, over-the-counter (OTC)trade where deposits in investment accountsheld at an Islamic bank are transferred to anew owner who redeems the previous ownerfor the amount being deposited in long-termequity accounts. The second channel is or-ganised stock market exchanges where listedshares can be traded at low cost in liquidmarkets.

Noureddine Krichene,International Monetary Fund


NEWHORIZON Rajab–Ramadan 1431 ACADEMIC ARTICLE

Risk sharing and equity finance was empha-sised in a recent paper, presented at the Inaugural Securities Commission Malaysia(SC) and Oxford Centre for Islamic Studies(OCIS) Roundtable, entitled ‘Developing aScientific Methodology on Shari’ah Gover-nance for Positioning Islamic Finance Glob-ally’. The paper notes that the first bestinstrument of risk sharing is a vibrant stockmarket, which is the most sophisticated mar-ket-based risk sharing mechanism. Develop-ing an efficient stock market can effectivelycomplement and supplement the existingand future array of other Islamic finance in-struments. It would provide the means forbusiness and industry to raise capital. Suchan active market would reduce the domi-nance of banks and debt financing whererisks become concentrated and create systemfragility. In the current evolution of Islamicfinance, what needs emphasis is long-terminvestment contracts that allow the growthof employment and income and expansionof the economy. Moreover, through holdingdiversified stock portfolios, investors caneliminate idiosyncratic risks specific to indi-vidual investor as well as to firms. Diversifi-cation can allow reduction in the overallportfolio risk. The paper calls for strength-ening the regulatory framework, levellingthe playing field between debt and equity, reducing the costs of equity market opera-tions through provisions of laws and regula-tions that promote market based barriers tospeculative abuse of stock markets, protec-tion of minority shareholders, regulation of reputational intermediaries – such as ac-countants, lawyers, and Shari’ah scholars –that certify companies and financial instru-ments, and strong enforcement of contracts.

Conclusion

Islamic finance, based on risk sharing, hashad a long and distinguished history, partic-ularly in the Middle Ages when it was thedominant form of financing investment andtrade in the then global economy. Eventoday, venture capital financiers use tech-niques very similar to Islamic risk sharingcontracts such as mudarabah. Conventionalbanking, which began with the goldsmiths’idea of fractional reserve banking, received

strong support from heavily subsidised lastresort lender central banks and rules andregulations heavily biased in favour of in-terest rate-based debt contracts and againstrisk sharing contracts. These developmentshave helped the perpetuation of a systemthat a number of well-known scholars,such as Keynes, deemed detrimental togrowth, development and to equitable in-come and wealth distribution. In more recent times, reforms proposed in theChicago Reform Plan (1935) and in agrowing literature thereafter have arguedthat the stability of a financial system canonly be assured by 100 per cent reservebanking to support the payment system ofthe country – which obviates the need forcostly central bank guarantees, on the onehand, and promotes equity-based invest-ment banking, on the other. Islamic fi-nance, based on risk sharing in investmentactivities and 100 per cent reserve bankingto ensure the safety of the payment system,has been shown to be inherently stable andsocially equitable. In such a system there isa one-to-one mapping between the growthof the financial sector and real sector activi-ties. This means that credit cannot expandor contract, as it does in the conventionalsystem, independently of the real sector. Tofoster further the development of Islamic finance, there is a need to emphasise risk-sharing aspect of the system; remove biasesagainst equity finance; reduce transactioncosts of stock market participation; create a market-based incentive structure to min-imise speculative behaviour; and developlong-term financing instruments as well aslow cost efficient secondary markets fortrading equity shares. These secondarymarkets would enable a better distributionof risk and achieve reduced risk with ex-pected payoffs in line with the overall stockmarket portfolio. Absent true risk sharing,Islamic finance may provide a false impres-sion of being all about developing debt-like, short-term, low risk and highly liquidfinancing without manifesting the most important dimension of Islamic finance: its ability to facilitate high growth of em-ployment and income with relatively lowrisk to individual investors and market participants.

The first best instrument of risk sharing is a vibrant stockmarket, which is the mostsophisticated market-based risksharing mechanism. Developingan efficient stock market caneffectively complement andsupplement the existing andfuture array of other Islamicfinance instruments.



(nafsi)’. Another verse in the Quran uses theword nafs to allude to human soul stating:‘It was We (God) who Created human be-ings, and We know what dark suggestionshis soul (nafsuhu) makes to him’ (50:16).The soul and the person make up the self.This self in the Quranic hermeneutics hasthree stages or states of development:

1. Nafs al-ammarah bi al-su’ (the self urging evil)

This is the stage of human developmentwhere the soul is motivated by base desiresand may suggest of wrong actions. Allahsays: ‘Surely the human self urges evil’(12:53). When in this primitive stage of itsdevelopment, the soul can overpower thenatural cognitive human processes and in-duce biases, such as the heuristic biases de-scribed in behavioural finance literature.

The Quran asserts that in this stage thehuman being may not always benefit fromall their God-given cognitive faculties. The‘animal instinct’ of the nafs al-ammarah willsometimes overpower the cognitive senses.‘They have hearts wherewith they do notunderstand; have eyes wherewith they donot see; have ears wherewith they do nothear. These are like cattle – no, but they areworse! These are the neglectful’ (7-179).

A well-known Islamic scholar, Al-Ghazali,interprets that at this stage the nafs can di-rect its owners to nifaq (hypocrisy, prideand arrogance) and hawa (base desire) lead-ing to greediness, negligence and restless-ness. This is the classic fear and greed state,

An economic and financial meltdown aspervasive as the one we just witnessed nat-urally evokes renewed interest in examin-ing the very fundamentals of the currenteconomic system. A dogmatic belief in theinvisible hand of the free market had dis-couraged financial regulation. Regulators,bankers and some academics were unwill-ing to budge from the assumption that investors are ‘rational’, all the while disre-garding a nascent body of scholarly re-search in finance and economics, whichsuggests that investor behaviour is not al-ways driven by logic alone. Psychologicalor behavioural factors, such as fear andgreed, are as much part of economic deci-sion making as cold rationality.

The idea that human beings, even the smartones, are not always rational finds supportin normative Islam. Understanding the fun-damental nature of human existence can be the key towards deconstructing whyhuman beings are often influenced by cog-nitive dissonance (perceiving somethingthat in reality does not exist) and not ra-tional logic, even when making decisionsabout money matters.

The Quran uses words like nafs and ruh togive different shades to the utterly complexhuman nature. Nafs linguistically can betranslated as ‘soul’ or ‘self’. The term ‘nafs’has different uses in the Holy Quran. Inmost instances, nafs is related to the humanself. In verse 54 of chapter twelve, the Kingof Egypt summons Prophet Yusuf (AS) bysaying: ‘Bring him unto me; I will take himespecially to serve about my own person

Psychology of financial decision-making:insights from Islamic textsBy Parvez Ahmed, PhD, US Fulbright scholar and associate professor of finance at theUniversity of North Florida.

which in the financial markets leads tospectacular booms and busts. The recentsub-prime mortgage crisis was caused bygreedy bankers pushing risky loans togreedy customers who were applying know-ing full well that the debt they were assum-ing was beyond their means to repay. So aslong as the house prices were going up, thedefaults of these extremely risky loans didnot overwhelm the banking system. Duringperiods of rising house prices, the banksfound it easy to dispose of the foreclosedhomes at higher prices, thus recoveringtheir bad loans. But when house pricesstalled, the risky bets turned sour and con-tributed mightily to the current economiccrisis. The banks in their own myopic viewof profitability preyed upon the greed offolks who should have known better.

2. Nafs al-lawwama (the blaming self)

As human beings begin to discern betweenright and wrong, the human soul may startthe process of self-examination. At thisstage, the soul may blame its owner for hisor her own shortcomings. In this self-reflec-tive state the soul becomes self-observantand self-critical. In Sura al-Qiyamah Allahsays: ‘And I do call to witness the nafs thatblames’ (75:2). At this stage of its develop-ment, the soul is called nafs al-lawwamaand far from being perfect the soul at thisstage exhibits bi-polarity – rememberingand forgetting, submitting and withdraw-ing, loving and hating, rejoicing and be-coming sad, accepting and rejecting,obeying and rebelling. This nafs is thehuman conscience.

FOOD FOR THOUGHT


NEWHORIZON Rajab–Ramadan 1431 FOOD FOR THOUGHT

If this stage is provided proper nurturing itcan spur human beings towards growth andperfection. Thus, under the right set of im-pulses (conditions), the human soul can beself-reflecting and self-correcting. The role of good regulation in the market is to createthe conditions that allow human beings a mo-ment of self-reflection even under the mosttempting of situations.

Well-known behavioural economist, RichardThaler, and law professor, Cass Sunstein, intheir book, ‘Nudge’, suggest that improvingthe choice architecture in mortgages by mak-ing mortgage forms easy to understand canhelp borrowers avoid the lure of sub-primemortgages. At least one economist has sug-gested banning certain type of mortgages thatare extremely misleading such as those withfeatures like negative amortisation or balloonpayments. Others favour an approach thatforces borrowers to wait for a period aftersigning their papers, allowing them the op-tion to withdraw if they become over-whelmed with the well-known psychologicalphenomenon known as ‘buyer’s remorse’.Even Islamic mortgages can improve theirchoice architecture by disclosing upfront theimplicit interest (sometimes euphemistically labeled as rate of return or profit) in a mort-gage contract. Timely, accurate and easy tounderstand disclosures of complicated finan-cial contracts will allow borrowers andbankers to avoid the greed trap.

3. Nafs al-mutma’inna (the self at peace)

When a person advances to this stage he orshe achieves harmony with their immediatesurroundings and accepts their current stateof being as God’s will. At this stage, the per-sonality shows signs of mildness, tolerance,forgiveness, and understanding. This stage ofnafs ultimately leads to resolution of one’sinner conflicts and attainment of harmonywith God. This is the soul to whom it is saidat the time of death: ‘O soul at peace, returnto your Lord, well pleased and well-pleasing.Enter with My servants, enter into My Gar-den’ (89:27-30).

This stage can be viewed as the state of ra-tionality as the Quran asserts that its message

is truly directed towards people of intellect.The foundation of intellect is rationality.Numerous times (at least 13) in the Quran,God asks a rhetorical question, ‘a fa-lataqilun?’, or ‘will you then not understandor use reason?’. For example, chapter 21,verse 67 Allah points out that worshippingone God is not just a matter of faith butalso of reason. It is not just a matter of theheart but also of the mind. While chapter23, verse 80 points out that the cosmicorder of life and death, the alteration of dayand night are not accidents but part of HisDivine Order and to understand this orderrequires exertion of intellectual energy. In itsrational state, the soul confronts and ac-cepts the reality of human existence, whichin the Quranic view is to be God-centric, es-chewing base human desires. However, thisstate of rationality does not come by osmo-sis. It is the result of striving (jihad al-akbar,considered as a major struggle and far moredifficult than fighting on a battlefield). Theone who succeeds in this struggle can riseabove and beyond the level of angels.

A Cherokee Indian legend tells of a man explaining to his son about a battle thatgoes on inside people. He said: ‘My son, thebattle is between two wolves inside us. Theevil wolf is anger, envy, jealousy, sorrow, regret, greed, arrogance, self-pity, guilt, re-sentment, inferiority, lies, false pride, superi-ority, and ego. The good wolf is joy, peace,love, hope, serenity, humility, kindness,benevolence, empathy, generosity, truth,

compassion and faith.’ The son thoughtabout it for a minute and then asked his father: ‘Which wolf wins?’ The old manreplied: ‘The one you feed.’

The best vaccinations against being the vic-tim of unscrupulous brokers and bankers is to avoid the greed trap by training thehuman soul to feel satisfied with what wehave and not long for what we do not own.The famous line in the movie ‘Wall Street’,that ‘greed is good’, has proven to be an exaggeration of truth. Being ambitious isgood, but ambition need not imply in-dulging in unmitigated hedonism. Ambitioncan also take the form of worshipping Godby helping His creation and being a goodsteward of the planet, thus embracing theideas inherent in all great philosophies (reli-gious or otherwise) that happiness resultsfrom the pursuit of what Adam Smith de-scribed as the ‘internal good’.

Beethoven wrote his ninth symphony whilehe was deaf and yet he frequently mis-placed his house keys. This has led RichardThaler and Cass Sunstein (who was BarackObama’s colleague at University of ChicagoLaw School and is one of his informal advi-sors) to ask, how can human beings be sobrilliant and yet so dumb at the same time?The answer lies in the understanding of thestages of development of the human soul.The three stages identified above are notstatic states. They are dynamic, indicatingthat human beings can vacillate between

Islamic mortgages can improve their choice architecture bydisclosing upfront the implicit interest (sometimes euphemisticallylabeled as rate of return or profit) in a mortgage contract. Timely,accurate and easy to understand disclosures of complicatedfinancial contracts will allow borrowers and bankers to avoid thegreed trap.


NEWHORIZON July–September 2010FOOD FOR THOUGHT

nafs al-ammarah and nafs al-mutma’inna.If left without nurturing and spiritual de-velopment the base desires or ‘animal spir-its’ can overwhelm the cognitive faculties.Thus, the assumption so deeply held bythe Chicago school of economic thought,that markets by the power of the ‘invisiblehand’ (supply and demand) will resolvemost of society’s economic problems, isunsupported in Islamic hermeneutics. Key-nesians, on the other hand, take the viewthat markets often fail and such failure canbe repetitive rather than self-correcting.The Keynesians favour frequent interven-tions in the market to correct its excesses.

The Behaviouralists (Thaler being one ofits foremost proponents), on the otherhand, have struck a balance between thedogmatic polarity of the Chicago school’slaissez-faire and the Keynesian school’sheavy-handed governmental interventions.The Behaviouralists support the notionthat markets can sometimes experiencedeep shocks (bubbles and busts). Theseshocks are more likely when people areforced to make complicated choices. TheBehaviouralists do not support draconianregulations but view that people will haveto be given gentle nudges (Thaler and Sun-stein call it ‘libertarian paternalism’) tomotivate rational choices. Thaler and Sun-stein assert that ‘libertarian paternalism isa relatively weak, soft and non-intrusivetype of paternalism because choices arenot blocked, fenced off or significantlyburdened. A nudge, as we will use theterm, is any aspect of the choice architec-ture that alters people’s behaviour in a predictable way without forbidding anyoptions or significantly changing their economic incentives. To count as a merenudge, the intervention must be easy andcheap to avoid. Nudges are not mandates.’This view supports the idea in Islamichermeneutics that without appropriatestimulus the nafs will not travel from itsal-ammarah stage to the al-mutma’innastate.

At the nafs al-ammarah bi al-su stage, thehuman soul is characterised by the weak-ness of laziness and the propensity to take

shortcuts. Behaviouralists have uncoveredseveral human traits that are consistentwith this view of the human soul. ‘Anchor-ing’ is one such mental shortcut. Whenasked a question, most people will providean answer that they can guess with theleast amount of effort rather than expendenergy thinking about the correct answer.Another shortcut is called the ‘availabilityheuristic’, which involves assessing risks onthe basis of what is most familiar to a per-son rather than on objective assessment ofmathematical probabilities. Most peopleoverestimate the chance of being killed in aterrorist attack when the chances of dyingin a car crash are greater. Another short-cut, known as ‘representativeness’, involvesseeing patterns where none exist. We at-tribute our skill to events of chance, suchas picking a winning stock.

These notions of the Behaviouralists areconsistent with the Quranic view of thehuman soul. If left to their own devices,human beings are likely to make sub-opti-mal economic choices. Banks marketedsub-prime mortgages knowing full welltheir inherent risks and the moral hazardsof the contracts. People accepted thesebank loans in amounts far greater thanthey could afford. Both parties willinglyentered into a contract that was not goodfor either side. However, a paternalisticnudge in the form of greater regulationand/or greater transparency would haveled both sides to make a more rationalchoice.

In the Islamic view, the ultimate paternal-ism comes from God (as their Creator Heknows what is best for human beings).Thus, the refrain in the Quran, ‘And so, [OProphet,] exhort them; your task is only toexhort’ (88:21). Having received this formof paternalism, Islam leaves the choice toindividuals. The Quran clearly proclaims:‘There is no compulsion in faith’ (2:256).Most people of faith readily accept suchforms of paternalism. Thus it is not coinci-dental that leading scholars dating back toAdam Smith and Max Weber have arguedthat religion can play a fundamental role inshaping economic choices.

Muslim philosophers like al-Farabi andIbn-Rushd assert that even though thehuman soul is made of different parts, allthe parts are working towards the final endof happiness. In pursuing happiness peoplewill be faced with choices, some of themeconomic in nature. Most economic choicesare complicated. Understanding the choicebetween different mortgage terms offeredby banks (Islamic or otherwise) is not aseasy as making a choice between wearing ablue shirt or yellow shirt. The more compli-cated the choice, the more likely are peopleto be afflicted with heuristic biases (takingshortcuts), egged on by their nafs al-am-marah. Some sort of libertarian paternalismis necessary to move the soul to its morepeaceful state of nafs al-mutma’inna.

Islam does not prohibit the pursuit of finance’s fundamental goal – wealth max-imisation. However, it conditions this en-deavour, as it does all human endeavours,on upholding such basics as keeping prom-ises, fulfilling contracts, avoiding usury,shunning excessive speculation etc. Islam’sintense commitment to justice and kinshipdemands that society take care of the basicneeds of all people, regardless of colour, re-ligion, ethnicity or social status. While en-couraging such help, Islam also obligesindividuals to work hard to earn a living,stressing that the hand that gives is superiorto the hand that receives.

Prophet Muhammad (SA) described Islamas the ‘middle way’ and advised Muslims to be moderate in whatever they do. Butsuch moderation cannot be achieved if left to individual choices alone. Society,through government intervention and/orthrough socio-religious institutions, mustnudge people towards moderation and ra-tional choices. A balance in human endeav-ours is necessary to ensure social well-beingand the continued development of humanpotential. Islam does not neglect the issueof rights but places a greater emphasis onduties. The wisdom behind this is that if allpeople fulfill their duties (relating to justiceand trusteeship, for example) then self-in-terest will not run amock, ensuring thateverybody’s rights are safeguarded.



The investment fund world continues to experience the repercussions of the globalcredit crisis and the high profile Madoff and Stanford scandals. Many articles werewritten claiming that Islamic Finance Insti-tutions had been immune to the affects ofthese events because they did not invest insuch products. However, many of these in-stitutions had invested heavily in real estate,the value of which has decreased because ofthe lack of available credit, and many suf-fered from the affects of defaults by varioussukuk issuers, so claims that Islamic financehas been immune to these events are greatlyoverstating the facts.

These factors, among others, have resultedin an increased focus by regulators on alter-native asset classes, not least in the form of the European Union’s draft Directive on Alternative Investment Fund Managers.Similarly, investors themselves remain ap-prehensive and raising new capital continuesto be challenging for the managers and pro-moters of funds.

With continued misgivings over investmentin traditional funds, as well as a heightenedgeneral awareness of and global concern for the environment, climate change and the sustainability of the world’s natural re-sources, an increasing number of investors

Tayyab investment: beyond Shari’ah-compliant investingTrevor Norman, director at Jersey-based Volaw Trust, discusses ethical investment within an Islamic context.

are looking to ‘ethical’ or ‘socially respon-sible’ companies and funds for diversifica-tion, or as a preferred class of investment.

Ethical investment is an asset class that hasbeen in existence for many years, but untilrecently has been considered quite special-ist and has maintained a relatively lowpublic profile. Islamic finance, or Shari’ah-compliant investment, is often seen as aform of ethical investment, but, as will bediscussed below, Shari’ah compliance isonly a step towards Islamic ethical invest-ment, or tayyab (wholesome) investment as it is sometimes known.

Shari’ah compliance

A common misconception within tradi-tional financial circles is that Shari’ah lawonly allows Muslims to invest in companiesundertaking certain activities. The actualposition is really the opposite to this in thatMuslims are allowed to invest in the sharesof any company, unless the company is un-dertaking haram (disallowed or harmful)activities, or is financed in a haram manner– generally meaning involving interest-bearing debt.

However, there is much more to Islamic finance than simply investing in the sharesof halal (allowable) companies. The under-lying principles of Islamic finance involvemore than the prohibition of riba (interest)and haram activities. Consideration needsto be given to such matters as sharing ofprofits and losses in financial enterprise,avoidance of speculation and uncertaintysuch that transactions are based on identifi-

OVERVIEW

A common misconception within traditional financial circles is that Shari’ah law only allows Muslims to invest in companies

undertaking certain activities.


NEWHORIZON Rajab–Ramadan 1431 OVERVIEW

able assets and transparent contractualterms, so that all parties are aware of theirrespective rights and obligations.

From these principles, various bodies havedeveloped filtering mechanisms that havebeen approved by their Shari’ah supervi-sory boards, and a number of Islamic shareindexes have developed. The most com-monly prohibited companies are those in-volved in commercial activities involvingthe production or sale of alcohol or porkproducts, gambling, conventional financialservices or pornography.

But these are all negative investment crite-ria, and whilst ethical investment is derivedfrom an investor’s values and beliefs, the criteria for selection should be forward-looking, where investors derive a certain‘feel good’ factor over their investment ra-tionale and the returns derived from thoseinvestments.

Tayyab – ethical investment

By investing in certain socially responsiblecompanies and ethical funds, investors aretaking comfort in the knowledge that theirmoney, as well as being invested for theirown benefit, is actually contributing to-wards the development of less prosperousareas and communities of the world. Anexample of this is an investment opportu-nity being promoted by a UK-based invest-ment advisor, whereby investors maypurchase shares in a company undertakinga forestry project in a developing country,in conjunction with local smallholders; andsubject to the financial manner in whichthis investment was structured, such an in-vestment would most likely be acceptableto a Shari’ah-compliant screening.

As well as sustainable forestry, ethical assetclasses include alternative and renewableenergy sources, such as development ofwind and solar power, and extend also tothe trading of carbon credits, where gov-ernments and companies purchase ‘certifiedemission reductions’ to assist them in meet-ing their targets for the reduction of green-house gas emissions, as agreed in Kyoto

by the United Nations Framework Con-vention on Climate Change. Several funds have been established to trade carbon cred-its, and whilst the underlying objective of these would appear to be compatiblewith Shari’ah law, the financial structure of the credits themselves is unlikely to beShari’ah-compliant. However, there aremany other ‘green’ investment opportuni-ties including bio-fuels, eco-friendly hous-ing, farming and food production, clothingand technology which could be included inan investor’s tayyab portfolio.

In line with the increase in the number of companies and funds there is a corre-sponding increase in the number of indicestracking these asset classes. Some verywell-known institutions operate these, forexample the Nasdaq Cleantech Index andthe Dow Jones Sustainability Index andthere are numerous lesser-known indicessuch as the International Securities Ex-change Global Wind Energy Index. Thisindex is comprised of over fifty companies.Dow Jones and FTSE both offer a numberof Islamic equity indexes based on regionaland industry criteria, but there appears tobe a gap in the market for an Islamic sus-tainability index.

Future of Islamic finance

The ‘Guide to Islamic Finance’, preparedby the Dubai International Finance Centre(DIFC), includes a statement that ‘the fu-ture of Islamic finance depends on ensur-ing compliance with the underlyingprinciples and purposes of Shari’ah, notjust the letter of Shari’ah but the spirittoo’.

This goes to the heart of tayyab invest-ment, where investors are more concernedwith the socially responsible aspect of theirinvestments than the absolute return de-rived from the investments. Such investingis not without risk. Indeed, many ethicalinvestments are more risky because theyare often under-funded or under-resourced,but ultimately, the rewards to the investorcan be far greater that those measured insimple financial terms.

Trevor Norman,Volaw Trust



TAIB meets IIBI director general

IIBI NEWS

Ms Halija Jaya, acting deputymanaging director at PerbadananTabung Amanah Islam Brunei(TAIB), called on Mohammad A.Qayyum, director general of theIIBI. She was accompanied byHajah Suzana Haji Mirasan, as-sistant general manager, humanresources, and Hjh Zazarina bteHj Zainuddin, senior executiveofficer, retail and commercialbanking. Qayyum briefed thevisitors on the activities of theIIBI and areas of mutual interestwere also discussed. MohammadShafique, programme develop-

ment co-ordinator and IqbalAsaria, an associate of the IIBI, were also present at themeeting.

The IIBI and TAIB agreed to explore working together inorder to build the knowledgeand skill base of the staff ofTAIB. TAIB was established in1991 and its launch marked anew beginning for BruneiDarussalam as the first finan-cial institution that conductedall its activities in accordancewith Shari’ah principles.

Netherlands university students visit IIBI

A group of 23 students fromStenden University in theNetherlands visited the IIBI.The students, led by Prof DrIneke Nevels-Wigchering andProf Derek Struik, are complet-ing a Bachelor’s degree in fi-nancial service management atthe university. This visit waspart of their study tour to theUK to widen their understand-ing of Islamic banking and fi-nance, which has received a lotmore attention due to the re-cent problems in the conven-tional financial sector.

The group was received byMohammad Shafique, theIIBI’s programme developmentco-ordinator. He delivered apresentation on the conceptand principles of modern Is-lamic finance, its evolutionsince the early 1970s, key con-tracts used in Islamic financialtransactions and recent devel-

opments in the sector. The lec-ture also highlighted the moraland ethical principles of Islamicbanking as well as the linkageof real and financial sector inIslamic financial transactions.There was a lively Q&A ses-sion after the presentation. Stu-dents raised various questionssuch as whether the Islamic fi-nance industry has benefitedfrom the loss of confidence inconventional banking due tothe recent financial crisis.

One student described the lec-ture as ‘short but clear’ and‘very informative and enlight-ening’. It gave the students newinsights into the moral and eth-ical principles of Islamic bank-ing, and also taught themabout the recent developmentof the industry, said the stu-dent. ‘If you ask us whether weknow more about Islamicbanking, our answer is defi-

nitely “yes”. The IIBI openedour eyes to it. We recommendanyone interested in Islamic fi-nance to attend a lecture at theIIBI, because, let’s be honest, Is-lamic banking is on the move.’

Another student gave the fol-lowing feedback: ‘We all appre-ciated the lecture given by the

IIBI’s expert. It was a high qual-ity, interesting and understand-able presentation, especially dueto the fact that the lecturer hasan Islamic finance backgroundand is working with the indus-try. We learned a different per-spective of Islamic banking. Wealso received professional an-swers to our questions.’

IIBI and TAIB members

IIBI’s Mohammad Shafique (far left)and students of Stenden University



The IIBI’s Post Graduate Dip-loma (PGD) course in Islamicbanking and insurance, offeredsince 1994, is highly regardedworldwide.

The PGD holders may attain an MA degree in Islamic bank-ing, finance and managementwithin six months, offered byUK-based Markfield Institute of Higher Education (MIHE). It will admit the holders ofPGD for the MA in IslamicBanking programme and theyhave to complete only a re-search methodology moduleand a dissertation. The degreeis validated and awarded by theUniversity of Gloucestershire.

UK-based Durham Universityhas accorded this course recog-nition as an entry qualificationfor its postgraduate degrees in Islamic finance, including the MA and MSc in Islamic fi-nance and the Research MA.Applicants will also have to ful-fil the specific entry qualifica-tions for each specialist degreeprogramme.

To date, students from nearly 80 countries have enrolled in the PGD course. In the period of April 2010 to June 2010, thefollowing students successfullycompleted their studies:

❏ Fabio Vanorio, Italy;

❏ Umar Rafi, principal consultant, Oracle Financial Services, UAE;

❏ Abass Ibrahim Mohamed,Kenya;

❏ Fathima Shaznaa, Sri Lanka;

❏ Rahanash N, officer, recon-ciliation unit, Dubai IslamicBank, UAE;

❏ Suleiman Onimisi Abdullahi,team member, clearing and set-tlement, United Bank for Africa,Nigeria;

❏ Abrar Ishaq, assistant

manager, trade finance, UnitedBank Limited, Pakistan;

❏ Mohammad Waseem, asso-ciate, Noor Islamic Bank, UAE;

❏ Mohamed Charaf Sekkat,data quality team leader,Traderforce, France;

❏ Mohammad Noman Hossain Chowdhury, faculty

IIBI awards post graduate diplomas

IIBI NEWS

The Post Graduate Diploma course wascomplete, enriching and inspiring. It al-lows one to fully dive into the concepts of Islamic finance and grasp its roots, perspectives and applications in the realworld. I also enjoyed how resourceful the tutor was, and he enriched my knowl-edge by constantly bringing new insightsas the course went on.

Mohamed Charaf Sekkat, Traderforce, France

This course has helped me to better understand Islamic banking. In the begin-ning, I used to think that Islamic bankingis about not accepting interest on deposit,but now I’ve come to realise that it’s notjust about interest. It’s about banking thatis for human welfare.

Mohammad Waseem, Noor Islamic Bank, UAE

Overall, the course was very helpful. Thecontents of the notes were particularly ex-cellent as well as the manner in which themodules were structured.

Umar Rafi, Oracle Financial Services,UAE

Mohammad NomanHossain Chowdhury

Fathima Shaznaa

member, BIMS, Bangladesh;

❏ Khalfan Abdalla Salim, Islamic banking compliancemanager, KCB Bank Limited,Tanzania;

❏ Adil Mustafa AneequeKhan, India;

❏ Aminu Ibrahim, branchmanager, Intercontinental Bank Plc, Nigeria;

❏ Abdel Nasser Ahmed AbdRabou, credit analyst, ArabTrade Financing Program, UAE;

❏ Muhammad Sohail, MeezanBank Limited, Pakistan;

❏ Nadeem Mohammed Abdul,India;

❏ Nancy Abdel-Aal, assistantdirector, Berlitz Language Centre, Egypt.



underlying assets financed by sukuk pro-ceeds and it has profound implications onthe nature of sukuk instruments whencompared with interest-based bonds.AAOIFI has listed 14 authorised types ofsukuk so far, and it does not differentiatebetween project finance sukuk, asset fi-nance sukuk and other types of sukuk asits classification is based on the underly-ing contracts in the sukuk transactions.

Therefore, sukuk may be considered as fi-nancial securities of equal denominationsrepresented by a portfolio of eligible as-sets and/or services. Sukuk represent Is-lamic investment instruments registered inthe name of their holders and are basedon the principles of a certain underlyingShari’ah-compliant contract that may be a sale (murabaha, salam or istisna), leas-ing (ijara) or partnership (mudarabah ormusharakah), whereby investors mix theirfunds with other investors to make profit.Sukuk are considered similar to asset-backed securities.

Then Ismail explained key features ofsukuk instruments, such as that sukuk investments are used only for Shari’ah-compliant business activities, sukuk hold-

After the sharp slowdown in sukuk activityin 2008, the market started to pick up in H22009. Total sukuk issuance reached $22.3billion in 2009 compared with $14.9 billionin 2008 and $34.3 billion in 2007. This mo-mentum is gathering pace in 2010 as finan-cial market conditions are beginning toimprove. Also, Islamic financial institutions,standard setting bodies and other stakehold-ers are working on overcoming the intrinsicchallenges related to the sukuk market, suchas standardisation of legal documents andclarity in Shari’ah rulings.

Sakk (singular of sukuk) is an Arabic wordmeaning ‘a document representing a con-tract or conveyance of rights, obligationsand/or monies’. Mohammed Ismail, finan-cial controller of Sony Europe, started thefirst session by discussing the Accountingand Auditing Organisation for Islamic Fi-nancial Institutions (AAOIFI) definition ofsukuk. According to this standard-settingbody, sukuk are certificates of equal valuerepresenting undivided shares in the owner-ship of tangible assets, usufructs and serv-ices or (in the ownership of) the assets ofparticular projects or special investment ac-tivity. The key word in the AAOIFI defini-tion is ‘ownership’ of investors in the

Sukuk, their practical applications and challengesIIBI organised its third annual one-day workshop, hosted by the National Skills Academy forFinancial Services, London. The aim of this workshop was to clarify the sukuk concepts, the key underlying Shari’ah-compliant contracts used in sukuk transactions, Shari’ah compliance-related issues in sukuk structuring, issues of benchmarking of returns for sukuk investors with reference to international interest rate benchmarks, and the sukuk taxation issues facingthe UK market. It also looked at the recent developments in the sukuk market and futurechallenges. The workshop was led by key experts from the industry and attended by bankers,accountants, lawyers, regulators and members of academia.

ers own assets/projects financed by thesukuk proceeds, they have the right to prof-its and bear the loss, the sukuk maturity corresponds to an underlying project andsukuk may be equity or debt instruments de-pending on the underlying contract. Thesefeatures are not present in conventionalbonds which represent a loan relationshipbetween the issuer and bond holders. Sukukmay be used as a means of raising financefor businesses, for project finance and liq-uidity and risk management purposes.

Ismail observed that the key sukuk playerstoday are CIMB, HSBC Amanah, Kuwait Finance House, Liquidity Management Centre (Bahrain) and Citigroup. The mainparties involved in the sukuk issuanceprocess are the originator, issuer (specialpurpose vehicle, SPV), the lead arranger,legal councils (both for issuers andarrangers), investors, service providers,trustees, auditors, regulators and Shari’ahadvisors/scholars. He also touched upon the rating criteria of sukuk, which have beenbroadly based upon the creditworthiness ofthe originator in most of the sukuk transac-tions. There is still a lack of diversity in thesukuk instruments’ ratings, which meets therisk appetite of certain investors only.

IIBI WORKSHOP


NEWHORIZON Rajab–Ramadan 1431 IIBI WORKSHOP

After a major downturn in 2008 due to thedrying up of liquidity in international mar-kets and weakening investor confidence,coupled with AAOIFI’s statement on thepermissibility of certain sukuk structures,activity improved in 2009 and Q1 2010.There has been a number of sukuk defaultsin the last eighteen months. However, on thepositive side, a notable development was theissuance of $500 million General ElectricIjara Sukuk in November 2009, which mayencourage other Western corporates to use sukuk for their funding requirements.This, in turn, will impact on the depth andbreadth of the sukuk market and facilitategrowth of the Islamic finance industry.Malaysia is still the market leader while theUAE and Saudi Arabia are in second andthird place respectively, in the global sukuk issuance league table. As financial marketsrecover from recent problems and in-vestor confidence improves, these arelikely to further stimulate the sukukmarket growth.

In the next session, Richard T de Belder,partner and head of Islamic finance atDenton Wilde Sapte, an internationallaw firm, elaborated on the sukukstructuring issues with the help of casestudies. He pointed out that the major-ity of sukuk issued so far have beenasset-based, where the returns to thesukuk holders are assured from theoriginator in the form of a purchase un-dertaking to cover the periodic shortfall inreturns as well as repayment of capital. Onthe contrary, in asset-backed sukuk whichare few in number, investors’ returns arelinked with the performance of the underly-ing asset/projects. De Belder then examinedthe most popular sukuk structure of ijaraand also mudarabah and looked at the spe-cific issues involved in the structuring ofDCA Ijara, Aldar Convertible Mudarabah,Tamweel and Sun Finance (Sorouh) Sukuk.There was an interesting discussion aboutthe various classes in Sun Finance (Sorouh)Sukuk, representing various risks and re-turns to each class of sukuk holders, andhow these were handled to ensure thatsukuk is compliant with Shari’ah principles.He also discussed the position of most

sukuk issued so far in the light of the state-ment made by AAOIFI in February 2008.

The following session focused on the concept of ownership in Shari’ah in the context of sukuk and key issues raised inAAOIFI’s February 2008 statement, such as purchase undertaking and profit distribu-tion mechanisms. Ownership may bemilkiyyah naqisah (incomplete ownership)or milkiyyah kamilah (complete ownership).Incomplete ownership refers to the owner-ship of property alone whereas the usufructis owned by some one else; it can come inmany forms such as a simple loan (withoutcompensation) and lease. Ownership (in-complete or full) of underlying asset is re-quired for all types of Islamic transactionsincluding sukuk. However, legal documentsin asset-based sukuk indicate that the sukuk

holders do not have interest in the underly-ing asset. Thus, the asset in such sukuktransactions is viewed as just facilitating aShari’ah compliance requirement. The re-turn to the investors in such sukuk transac-tions also has little or nothing to do withthe performance of the underlying asset.Since such sukuk holders do not have inter-est in the underlying asset, they cannot dis-pose the asset to third parties. They rely ona purchase undertaking from the originatorwhich promises payment of principal plusunpaid profit. Such restriction in the right ofasset disposal poses serious doubt whetherasset based sukuk structures truly complywith the principle of Shari’ah. Also, accord-ing to Shari’ah principles, sukuk assets soldto sukuk holders must not appear on the

balance sheet of the originator (seller). Simi-larly, certain rules should be followed fortradability of sukuk instruments which nor-mally relate to their underlying Shari’ah-compliant contracts.

In the ensuing session, Ahmad Chaudry, dynamic strategies structurer with the equi-ties division at Royal Bank of ScotlandGlobal Banking & Markets, explored vari-ous strategies which may be used for offer-ing a return to investors based on actualperformance of the sukuk assets instead oflinking the returns to international interestrate benchmarks, such as the London Inter-bank Offered Rate (LIBOR). These strate-gies involve analysis of the risk-returnprofile of sukuk investors as well as cashflow from the inception of sukuk to invest-ment life and maturity. He also touched

upon the allocation mechanism ofsukuk proceeds in various asset classesin a manner that these meet the objec-tives of the sukuk investors.

In the final session, Mohammed Amin,Islamic finance consultant and memberof NewHorizon editorial advisorypanel, discussed the taxation issues ofsukuk from a UK market perspective.After analysing the popular structuresof ijara and mudarabah sukuk, he ex-plained the practical issues which aUK-based issuer would have faced inthe absence of any changes in the tax

law in terms of corporate tax, withholdingtax, value added tax (VAT), capital gains tax and stamp duty land tax (SDLT) for is-suance of such instruments. Amin also dis-cussed the treatment of income and capitalgains in the hands of UK-based investors.Then, he elaborated on the changes made inthe UK tax law in the past five years espe-cially in Finance Acts 2007 and 2009 to ac-commodate issuance and trading of sukuk.He concluded the session by stating thateven though the rules are complex and de-scriptive, UK tax law now makes it feasiblefor UK companies to issue sukuk using UKland without adverse tax costs.

At the close, Amin presented certificates tothe workshop attendees.

IIBI sukuk workshop

www.newhorizon-islamicbanking.com32 IIBI


The recent credit crisis led to a loss ofconfidence of investors in the conventionalprofit-centred model which, in turn, contributedto an increased interest in socially responsibleinvesting (SRI). Haliza Abd Rahim discussedthe concept of SRI and compared it withpopular Islamic investment guidelines alongwith a brief overview of recent developments in the Islamic finance sector.

Abd Rahim is currently head of projectmanagement at BMB Islamic UK Ltd. She has extensive experience of structuringShari’ah-compliant financial products rangingfrom retail to corporate and investment bankingproducts. She holds an LLB (Hons) from theUniversity of Nottingham and is dually qualifiedas a solicitor of England and Wales and anadvocate and solicitor of Malaysia.

The lecture was chaired by Richard T deBelder, head of Islamic finance at Denton Wilde Sapte, an international law firm.

March: Adherence tosocially responsibleinvesting within Islamicfinance products

Promoting Islamic financewhere the reasons for providing capitalare based not only on returns in terms ofdollars and cents but also on the impactsuch an investment would have on thesurrounding environment and society.Typically, SRI investing requires an in-vestor or, in most cases, a fund managerto avoid investing in companies which areinvolved in sectors or practices that aredeemed unethical and irresponsible. How-ever, in some cases, investors take an evenmore active role whereby they use theirinfluence to promote the adoption of bet-ter environmental, social and governancepractices in investee companies.

Abd Rahim mentioned that an investorseeking to avoid investing in companiesthat are involved in sectors or practicesdeemed unethical and irresponsible wouldapply what is commonly termed as nega-tive screens, which screens out companiesinvolved in industries such as tobaccoproduction, alcohol production, gam-bling, pornography or violent materials,manufacturing and sale of weapons, un-necessary exploitation of animals, nuclearpower generation or those that have poorenvironmental practices. It would alsoscreen out companies whose operationsimpinge upon or involve human rightsabuses and who have a record of poor re-

IIBI LECTURES

lations with employees, customers or sup-pliers. As for investors that wish to applya ‘best in class’ approach, they would ac-tively seek out companies involved in in-dustries which supply the basic necessitiesof life, offer product choices for ethicaland sustainable lifestyles, improve qualityof life through the responsible use of new technologies, have good environ-mental management, promote and pro-tect human rights, actively addressclimate change, have good employmentpractices, have positive impact on localcommunities, implement good relationswith customers and suppliers, implementeffective anti-corruption controls andhave transparent internal and externalcommunications.

Afterwards, she explained the concept of Islamic investing which is based on theguidance from the Holy Quran and theteachings of the Prophet Muhammad(PBUH). She highlighted that in practice,Islamic concepts of socially responsible investing commonly include the establish-ment of Islamic investment guidelines(which take the exclusive approach and utilise negative screens), the giving of zakat or charitable donations, waqfand purification of haram income bycharitable giving. She noted that in termsof the collection and distribution of zakatand charitable donations, this is seen as a form of income redistribution for thepromotion of social equality. As for thenegative screening employed by Islamicinvestors, various criteria are utilisedwhich include avoiding ‘sin stocks’, suchas companies which are engaged in theproduction and sale of alcohol, tobacco,pork production, the provision of con-ventional banking, financial, or any otherinterest-related activity, companies in thegaming and arms manufacturing indus-tries and companies which are involvedin the provision of haram entertainment,such as casinos and pornography. Shementioned that Islamic investment guide-

The most serious recession since World WarII has led many investors to question thewidely accepted capitalist model and its failure has led them to question the funda-mentals of such a system. This recession has also caused a loss of confidence in a system which is based on, and rewards onlyfinancial profits, leading many to turn theirattention to a more socially responsible ap-proach to investing such as that of SRI andIslamic finance.

Abd Rahim started the lecture by statingthat SRI is an attempt to inject a more so-cially conscious element into investing,

Haliza Abd Rahim,BMB IslamicUK Ltd

should not pose a problem to practitionersin either industry as the screens would be anadded layer on top of the current Shari’ahscreens. Other concepts of SRI, such as envi-ronment, social and governance (ESG) crite-ria may also be scrutinised for similar fusionwith principles of Islamic investing. Again,popular Western concepts of responsible en-gagement or active ownership could be in-fused with that of Islamic investing to createa robust investment approach. It appearsthere are stark geographical and regionaldifferences in the application of both invest-ment principles.

In Asia, SRI is mainly prevalent in Japanand South Korea, whilst Islamic investing is popular in countries like Malaysia and Indonesia. In the Western hemisphere, SRIprinciples are popular mainly in Europe. Islamic investing has a presence in the UK.Based on this simple scrutiny, a question

IIBI 33www.newhorizon-islamicbanking.com


lines not only require the screening out ofsuch companies but also prohibit the in-volvement in usury or interest which hasled to development of financial ratios andalso the avoidance of excessive uncer-tainty (gharar) in transactions.

Then, she went on to discuss various simi-larities between the concept of SRI aspopularly practised in the West and prin-ciples of Islamic investment. Firstly, SRIstems from Protestant and Catholic reli-gious convictions. One of the first knownproponents of SRI is John Wesley, theleader of the Quakers in the 19th century,whilst Islamic investing is based on Shar-i’ah law. Essentially, both approaches arebased on the fundamental concept ofmankind being a ‘steward’ over theEarth’s resources and other creations.Furthermore, both investment approachesexhibit a social purpose and exclude unethical businesses by avoiding invest-ment in sin stocks.

Abd Rahim highlighted that due to thesesimilarities, other guidelines set out in SRI but not currently expressly present in Islamic investment guidelines, such asavoiding companies which are engaged inthe unnecessary exploitation of animals,could be fused with principles of Islamicinvesting in order to create a more inclu-sive system of screening. In her view, this

IIBI LECTURES

may arise as to how one may cross overfrom one investor base to another.

Then, she discussed the attempts to de-velop fused financial products such as aShari’ah-compliant water-focused invest-ment strategy fund, jointly developed bySustainable Asset Management (SAM) andGatehouse Bank. Also, BMB Islamic is cur-rently working with a Western SRI-focusedmanager to develop an investment strategywhich is both socially responsible andcompliant with Shari’ah. Both funds seekto fuse the best of both SRI and ethicalscreening and Islamic investment guide-lines in order to create products whichcomplement both approaches and maycater to a more diverse investor base.

Abd Rahim concluded the lecture by stat-ing that currently the success of both SRIand Islamic finance do not correlate butthe concepts do not contradict each other,and are in fact compatible and comple-mentary. It is a wise approach for both industries to encourage more ethical andsocially responsible practices with a focuson fusing and jointly developing these two approaches in order to widen theirnatural investor base and more impor-tantly ensure the creation of socially re-sponsible and ethical products which aremore comprehensive than those currentlyseen in practice.

The lecture discussed the developments in the takaful sector over the past year,especially from the UK market perspective,and looked at what can be learnt from the set-back of Salaam Halal Insurance as effortsare made to re-establish takaful players inEurope. Faisal Khan, director of banking andinsurance at 3i Infotech (Western Europe),explored potentially successful businessmodels and discussed how technology may beused to make takaful a viable offering in theWest.

May: Making takaful fit forpurpose

Khan has 34 years of experience in the ITindustry. He spent 17 years at the UK’s divisionof IBM, where he held senior managementpositions in systems integration within thebanking and insurance sectors. He also heldsenior positions in several software companiesand sits on the Oracle Corporation partneradvisory board. He is a graduate of CambridgeUniversity and holds an MA from LondonUniversity.

Salaam Halal Insurance, the only takaful operator in the UK, received authorisationfrom the Financial Services Authority (FSA,the UK’s financial regulator) in 2008 to offer

Richard T de Belder,Denton Wilde Sapte

Islamic insurance products in the UK. Theseproducts, having an ethical or co-operativenature, have the potential to appeal to bothMuslim and non-Muslim communities.After less than 18 months in business,Salaam’s status is now a solvent run-off,which means that while the company maycontinue to offer existing policyholders fullsupport, it cannot provide any further poli-cies to new or existing customers.

Khan started the lecture by stating thatmany analysts have suggested the potentialfor takaful is significantly higher in Europeand the US than in those areas of the worldwhere it has already been very successful.This is because, while the concentration of


NEWHORIZON July–September 2010IIBI LECTURES

Muslims in Europe and the US is muchlower, the propensity to take insurance ismuch higher due to legal requirements tohave insurance and a much higher disposableincome. In addition the analysts forecast thatthere is an ever-growing need for ethical in-surance products in the developed economieswhich could be significantly larger than eventhe Muslim market for takaful. All of thissuggests that takaful insurance should havebroken through into the mainstream of in-surance in developed economies, yet theenigma is that it has not done so with anyreal success. He emphasised that the reasonsfor this failure must be explored.

Khan mentioned that the experience of takaful in the Middle East and South EastAsia, where the market itself is rich with po-tential customers, shows that issues existaround scarcity of skills, high levels of com-petition and the consequent difficulties inmaking underwriting profits. Despite this,most insurers in these regions also report alack of investment capability to tap intopent-up demand. Projecting these experi-ences into the developed economies to estab-lish how takaful business might be moresuccessful is, perhaps, a futile exercise sinceit is the uniqueness of the market itself thatrequires serious analysis before any attemptshould be made to formulate a ‘go to mar-ket’ strategy.

Afterwards, he pointed out that every entre-preneur will stress the importance of know-ing the target market deeply, and havinginexpensive access to it is the secret of suc-cess, especially when the market is crowdedwith alternatives and there is no compulsion

for the buyer to take a particular product. Itis estimated that there are about two mil-lion Muslims in the UK, 350,000 Muslimhouseholds and 1456 mosques; around20,000 Muslims from the UK perform Hajjeach year, 7500 restaurants are owned byMuslims, one in 20 businesses in London isAsian-owned, and 20 per cent of lamb andmutton consumption is halal. He high-lighted that analysing these statistics amongmany others and in analysing the lifestylesthat they represent to formulate a targetmarket for takaful is crucial. Lifestyleanalysis will also facilitate a clear under-standing of what insurance products will beattractive to the target markets and at whatprice.

Then Khan went on to discuss the lifestyles,citing the extended family culture, which is still at the core of the Muslim way of life, as an example. This has major implica-tions for considering risk when it comes tohousehold insurance. He pointed out thathaving grandparents at home throughoutthe day may reduce the risk of theft com-pared to many households that are often

empty. There should be a clear analysis of how the UK’s 1456 mosques are used.This will provide a broad spectrum againstwhich risk may be analysed and this will fa-cilitate the development of products that arespecific to the needs of the mosques, whichthe traditional insurers might not be able toprovide. Similarly, the risks associated withtravelling to perform Hajj are more likely tobe understood by fellow Muslims than tra-ditional insurers.

Based on the need for market analysis, heexplained that one conclusion is the Muslimcommunity itself is in the best position totake takaful insurance forward in developedeconomies. This is almost an evident truthfrom the ethos of takaful which is all aboutself-help and mutual risk sharing. A secondconclusion is that the market is not uniformgeographically but exists in concentratedpockets. Using technologies that can reachthe target markets will be crucial and theseare abundantly available at realistic costtoday. A third conclusion is that for thetakaful market in developed economies, avariable cost model must be adopted wher-ever possible and the investment in fixedoverhead must be kept to a minimum toallow for higher marketing cost. With theopportunity to outsource most functions ofan insurance company this should be rela-tively easy to do nowadays.

Khan made closing remarks that takingcareful consideration of these conclusionsshould hopefully result in more sustainabletakaful providers emerging in developedeconomies to address a pent-up demand that is surely present as the analysts andcommentators insist.

The launch of the first of a kind ISDA/IIFMTahawwut (Hedging) Master Agreement(TMA) in March 2010 is a great development

June: Shari’ah-compliantderivatives – ISDA/IIFMTahawwut MasterAgreement

for the Islamic finance industry as thisagreement provides a globally standardisedstructure for privately negotiated Islamic hedgingproducts and will facilitate the risk managementfunction of Islamic financial institutions.

Priya Uberoi, director of Islamic derivatives andstructured products at Clifford Chance LLP, aninternational law firm, discussed the salientfeatures of this agreement, highlighting its

Faisal Khan, 3i Infotech

May lecture

protect their capital. She pointed outthat the liquidity from oil revenues aswell as the likely growth in sovereignwealth funds (SWFs) will push furtherthe development of Islamic finance asa part of this wealth is likely to bechannelled in the Islamic finance in-dustry. As Islamic financial institutionsgrow, the potential scale of structuralmismatches between their asset and li-ability positions will grow, and in theabsence of a mechanism to managethat mismatch, the institutions willhave to restrain their growth.

Uberoi emphasised that hedging tools pro-vide one means of managing the mismatchand the recent global financial crisis hasunderscored the importance of sound riskmanagement, primarily related to hedgingtransactions. For some time considerablediscussion as to whether derivatives are ac-ceptable from the Shari’ah perspective hasbeen going on, and some growth in Islamicderivatives has been noted, particularly inMalaysia, through the early 2000s, but thiswas slow and bespoke. However, a notable

development in the early stages of Islamicderivatives market was the agreement in2006 between two Malaysian banks, BankIslam and Bank Muamalat Malaysia, to execute a proforma derivative masteragreement for documentation of Islamicderivative transactions in that region.Looking at the practical problems faced byIslamic financial intuitions, many Shari’ahscholars now accept the use of hedging as atool of prudence and risk management as


NEWHORIZON Rajab–Ramadan 1431 IIBI LECTURES

The launch of the TMA in March 2010 bythe International Swaps and DerivativesAssociation (ISDA) and the InternationalIslamic Financial Market (IIFM) was theculmination of a number of years’ effortand consultation with industry players,Shari’ah scholars and other stakeholders of the Islamic finance industry. The devel-opment is a breakthrough in the risk man-agement function of Islamic financialinstitutions (IFIs), as the TMA providesthe structure under which institutions cantransact Islamic hedging operations suchas profit-rate and currency swaps, whichare estimated to represent most of today’sIslamic hedging activity.

At present, the Islamic finance industry’s assets are estimated to be over $1 trillionand expected to grow at 15-20 per centper annum over the next five years. Uberoistarted the lecture by highlighting notabletrends in recent years such as the emer-gence of some very large corporates inMuslim majority countries, even excludingthe oil and gas sector, which are exposed torisks like foreign exchange (FX), profit/in-terest rates and commodity prices. There’sa new body of Islamic institutional in-vestors, both endowments (e.g. the KingFaisal Foundation Fund; Al-Azhar Univer-sity Waqf) and pension funds (e.g. Em-ployee Provident Fund, Malaysia; AbuDhabi Retirement, Pensions and BenefitFund) which will be looking for ways to

the use of derivatives for speculation is notacceptable.

Uberoi explained that the lack of standardi-sation means a proliferation of bespoke doc-umentation which increases the cost ofevaluating and negotiating documentation,which often delays their execution and con-strains the growth of the market. On theother end, standardisation contributes to ef-ficiency, liquidity and certainty and providesa benchmark in the market. Therefore, theTMA will help to reduce price divergencebetween Islamic derivatives and their con-

ventional counterparts. The agree-ment is a new market document and,in preparing it, where practical, it wasensured that it is consistent with othermarket standard documentation (es-pecially the form and structure of the 2002 ISDA Master Agreement).The architecture of the TMA is verymuch on the lines of the ISDA MasterAgreement and it can be used for multiproduct agreements such asmurabaha, musawama and wa’adbased products as well as potentiallysalam and arboun. This agreement isavailable for use by all market partici-

pants and in all geographical regions.

Uberoi then elaborated on the guidelines re-garding transactions that may be enteredinto under the TMA. These transactionsshould only be for the purpose of hedgingactual risks of the relevant party; theyshould not be for the purposes of specula-tion; they must be real transactions involv-ing the actual transfer of ownership of realassets, actual risk and real settlement; the

June lecturecomparison with the 2002 ISDA MasterAgreement.

Uberoi has advised on a number of complexstructured finance transactions, mainly inemerging markets. She has advised a numberof major banks on over-the-counter (OTC)Shari’ah-compliant derivative transactions, andhas worked extensively in helping to developthe TMA.

The lecture was chaired by Warren Edwardes,CEO of Delphi Risk Management and amember of the IIBI’s banking advisory panel.

June lecture


NEWHORIZON July–September 2010IIBI LECTURES

asset itself must be halal and interest mustnot be chargeable under the transaction.The TMA requires representations likethe ISDA master agreement plus an addi-tional representation as to the satisfactionof parties regarding Shari’ah compliance.

Then she discussed the classification oftransactions in the TMA which arebroadly of two types: one are transactionswhich are executed at the start of theagreement and the other are designatedfuture transactions (DFTs) which will beexecuted in future. However, both trans-actions and DFTs fall within the scope ofall parameters of the ISDA Master Agree-ment. In case of dispute between the par-ties, the decision will be made based

The review of taxation treatment and reg-ulation of Islamic financial products hasbeen receiving constant attention to en-sure that these products have parity withconventional products, with regard totheir economics substance.

The UK has had new legislation for Islamic finance in every finance bill en-acted since 2005, with the exception ofthe Finance Act 2010. Mohammed Amin,a renowned Islamic finance specialist andchair of the Business and EconomicsCommittee of the Muslim Council ofBritain, will review some of the practicalproblems which currently remain in thetax treatment of Islamic finance. In partic-ular, he will cover the tax rules for sukukintroduced in 2009, the tax and regula-tory changes introduced by statutory in-strument since Finance Act 2009, andlook forward to proposed changes to Is-lamic property refinancing.

To register, please visit:www.islamic-banking.com

July lecture preview: Regulation and taxation of Islamic finance – recent and forthcoming developments

The lecture will take place on12th July 2010 at 6.15pm at:

British Bankers’ AssociationPinners Hall105–108 Old Broad StreetLondonEC2N 1EX

The mission of the IIBI is to be a centre of excellence for professional education,training, research and related activities, to build a wider knowledge base anddeeper understanding of the world of

finance promoting the Islamic principles of equity, socio-economic justice

and inclusiveness. The Institute holdsregular lectures on topical issues, delivered

by industry experts. For information onupcoming lectures and other events,

please visit the IIBI’s website:www.islamic-banking.com

either on English or New York governinglaw as stipulated at the start of the agree-ment. There are no interest provisions incase of dispute for unpaid amounts; nocompensation for late deliveries and thereis a clause of waiver of right to interestarising as a result of any arbitral or judicialaward or by operation of law. There arealso early termination provisions.

Afterwards, she explained the working ofthe conventional interest rate swap andhow an Islamic profit rate swap differsfrom it, using the concept of transactionand DFTs as incorporated in the TMA.

Uberoi concluded the lecture by statingthat the potential demand for Shari’ah-compliant risk management products isvery substantial and use of the TMA willoffer standardisation which will facilitatecost-effective entry into transactions aswell as assist emergence of new entrantsinto the market. The TMA will be rolledout in all key markets of Islamic financesuch as Kuala Lumpur, Dubai, Bahrain andLondon, and will be used to document awide variety of Islamic derivatives con-tracts. Currently, active market partici-pants can readily integrate the TMA intotheir existing documentation platform andthere is a potential for increased integra-tion of Shari’ah-compliant financial prod-ucts into securities platforms.

Priya Uberoi,Clifford Chance LLP

Mohammed Amin



Bahrain-basedBMI Bank, whichprovides conven-tional and Islamicfinancial services,has appointedJamal Ali Al-Hazeem (left) asBahrain CEO. Hebrings years of ex-perience to the

bank, having worked as managing directorof Arthur Andersen, CEO of the EconomicDevelopment Board and CEO of First In-vestment Bank, all in Bahrain. He alsoworked with The International Investor inKuwait. Al-Hazeem currently sits on theboards of Nass Corporation, Al-MasalehReal Estate Co (Kuwait), Taameer Real Estate Investment Company (Kuwait) andBank of Bahrain and Kuwait.

In his new role at BMI Bank, Al-Hazeemwill be reporting to Andrew Bainbridge,who has been appointed Group CEO. Bain-bridge will oversee the bank’s internationaloperations and expansion strategy.

Saudi British Bank (SABB), which offers Islamic banking services in Saudi Arabia,has appointed David Dew as its managingdirector. Prior to jointing SABB, Dew wasdeputy CEO of HSBC Amanah and chief of administration, global banking and mar-kets, MENA for HSBC. Before that, he heldsenior management positions at HSBC inNorth America, Europe and Asia Pacific.Dew has also worked for SABB in the past,as deputy managing director and chief oper-ating officer, 2001-04. He is a member ofthe bank’s board.

Omar Subhi has become chief financial officer of National Bonds Corporation, aDubai-based private joint-stock company

that provides a Shari’ah-compliant savingsscheme. This is a newly created post, whichcombines investment, finance and treasuryoperations supervision. The merger comesas part of a company-wide restructuringprocess. It has also resulted in the departureof Jacques Bernard, who was chief invest-ment officer at the company.

Subhi has over 13 years’ experience in theindustry, including managerial roles atKPMG, Al Rostamani Group and TECOM.Most recently, he was executive director, fi-nance and treasury at National Bonds Cor-poration. Subhi’s appointment is in line withthe company’s ambitious strategy for 2010,which includes international bondholder ex-pansion and a targeted 30 per cent growthof the Shari’ah-compliant savings scheme.

Al-Harith Sinclair(left) has joinedPinsent Masons,an internationallaw firm, as headof the company’snew Islamic bank-ing and financepractice. Sinclairmoves from DLAPiper, where he

was a member of the Islamic finance team in the Gulf. Most recently, Sinclair headedDLA Piper’s Islamic finance practice inDubai, before relocating to the UK in No-vember last year as a partner in the firm’sLondon office.

At Pinsent Masons, Sinclair will be workingclosely with the firm’s international projectsand infrastructure lawyers to develop op-portunities in the Gulf and EMEA. He willfocus on Shari’ah-compliant finance for newLondon and Gulf-based clients; Islamic fi-nancial services, including Islamic treasuryproducts, for financial institutions in the

Middle East and the UK; and wider UK and Gulf financial regulatory work, includ-ing insurance.

Bahrain-based Global Banking Corporation(GBCORP) has announced a range of newappointments and promotions. Ahmed AlMahmood is named as Shari’ah reviewer onthe bank’s Shari’ah supervisory board andLaeeq Ahmad Hussain becomes head of in-ternal audit. Fatima Al Banna has been pro-moted from assistant manager in the bank’sHR division to HR and administration man-ager at GBCORP’s affiliate group, GlobalReal Estate Development Co.

Prior to joining GBCORP, Al Mahmoodwas Shari’ah auditor at Abu Dhabi IslamicBank and Al Baraka Islamic Bank. Hussainhas joined the bank with 14 years of experi-ence in the industry, having worked forErnst & Young in Bahrain, Al Baraka Is-lamic Bank and PricewaterhouseCoopers(PWC). Al Banna worked at the Arab Insur-ance Group, prior to joining GBCORP as arecruitment specialist.

Sharjah Islamic Bank (SIB) has namedRahma Mohammed Al Shamsi (below) ashead of its corporate banking division. Al Shamsi will be responsible for the bank’sproducts and services for corporate clientsin compliance with Shari’ah. Al Shamsijoined SIB in 2004and since then heldsenior managementroles at the bank’sstrategic planningdivision and alsoinvestment andbanking relationsdivision. Most re-cently he wasdeputy head ofcredit group at SIB.

On the move

APPOINTMENTS


NEWHORIZON July–September 2010BOOK REVIEW

This book suggests that there is a ‘NewEconomics’ approach, or to be more accu-rate, a bundle of approaches, that valuesreal, rather then illusory, wealth, and putspeople and planet first. This presents a se-rious challenge to conventional economics,in particular about what constitutes realwealth and the role of banks in creating ordestroying it. It brings together ideas thatlead to joined-up solutions which don’tsacrifice the environment in pursuit of un-limited growth, and demonstrate how toincrease the real quality of life for allmankind, not just the privileged few. TheNew Economics shows how we can, andmust, look at the world in a very differentway centred on people, not profit – if weare to create a sustainable future for us all.

At the heart of the problem is money, itsdesigns, what it does and how it is used,and the fundamental and ruinous discon-nection between the idea of money andwealth. Conventional economics measures

money, and assumes that it is real and valu-able in itself; worse, that everything can bereduced to it, and so misunderstands theway the world is. That critique is both an-cient, as old as money itself, and newly ur-gent, because it goes some way to explainingwhy the economic system is working sobadly for most of us. But there is anotherkind of money as well: the kind that drivesout everything else because it is so profitableand so corrosive. Speculating and gamblingwith money are such activities that replaceproductive business and economic activity.

The New Economics reaches back to the origins of economics in moral philosophy,putting it back in what it regards as itsproper place – embedded in ethics, in biol-ogy, psychology and sciences of the Earth.There is no gulf in the New Economics be-tween economics and morality. The authorsargue that there is no excuse, for example,for the cult of the chief executive officer, towhom ordinary morality does not apply.The New Economics embraces higher truthsthan those of the narrowly economic worldbefore us. Unfortunately for us, the authorspoint out, the current batch of world leadersare criticised for supporting a brand of eco-nomics that misunderstands real life, en-courages vulnerability, remains blind tovalues, encourages consumption for its ownsake and encourages and relies on debt andindenture. Taken together, these criticismsreveal not just an economic system that ispartially blind, but one that has no moralcompass. The book is in eleven chapters.

The New Economics: A Bigger Pictureby David Boyle and Andrew Simms. Publisher: Earthscan (August 2009) ISBN: 978-1844076758

IIBI regularly researches the market for books and publications on various aspects of Shari’ah-compliant banking and insurance that may help the IIBI community to advance their knowledge of Islamic finance. In the series of book reviews, the Institute’s specialists bring you concise and up-to-date

analysis of specialist literature. If you have any questions regarding the reviewed books or would like to suggest a book, please email [email protected]

The first two look at the economic problemand provide a brief history of the New Eco-nomics, and the last chapter ponderswhether New Economics can become main-stream. The book is well-written and inspir-ing for those wishing to really understandwhat went wrong with the global economy,and what we could be doing to make itright. For Islamic bankers and Shari’ah ad-visers ‘The New Economics’ offers a boldand sustainable vision based on justice, notexploitation, that is the higher objectives ofIslamic economics. The authors want tobreak the still orthodox view that economicgrowth and happiness are the same thing bydelving into public policy, economic insightsand alternative models.

About the authors

David Boyle, a British author and journalist,is a fellow of New Economics FoundationUK (NEF) and the author of a series ofbooks about history, social change and thefuture, including new ideas in economics,money, business and culture. All of hisbooks are devoted to one broad theme: theimportance of human-scale institutions overcentralised ones, human imagination overdull rationalism, and the human spirit overtechnocratic reduction. In search of an alter-native to cash, he launched the Time Bank-ing movement in the UK. Andrew Simms ispolicy director of NEF and a board memberof Greenpeace UK. He is also the author ofTescopoly, and Do Good Lives Have to Costthe Earth?



Islamic financial institutions and instruments

RATING & INDICES

Below is a monthly list of the latest long and short-term credit ratings for Islamic banks,corporates and sukuk monitored by Capital Intelligence (CI), an international credit ratingagency. Detailed information on rating processes and definitions can be found on the CI’swebsite www.ciratings.com

BANK RATING

FOREIGN CURRENCY FINANCIALSTRENGTH

SUPPORTOUTLOOK

DATEISLAMIC BANKS LONG TERM SHORT TERM FC FSR

AlBaraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Stable 1/7/2009

Al Rajhi Banking & Investment Corp. (Saudi Arabia) A+ A1 A+ 2 Stable Stable 1/8/2009

Bank Aljazira (Saudi Arabia) BBB+ A2 BBB+ 2 Stable Negative 1/8/2009

Bank Islam Malaysia BBB- A3 BB+ 2 Stable Stable 1/2/2010

Capivest BSC (Bahrain) BB+ A3 BB+ 4 Stable Stable 1/11/2009

Faysal Bank (Pakistan) B- C BB 4 Negative Negative 1/4/2009

Gulf Finance House (Bahrain) BB B BB 4 Negative Negative 1/2/2010

Jordan Islamic Bank BB B BBB- 3 Stable Stable 1/11/2009

Kuwait Finance House A+ A1 A- 2 Stable Stable 1/10/2009

Qatar International Islamic Bank BBB+ A2 BBB+ 2 Stable Stable 1/3/2010

Qatar Islamic Bank A A2 A 2 Stable Stable 1/3/2010

Shamil Bank of Bahrain (Bahrain) BBB- A3 BBB- 3 Stable Stable 1/9/2009

Sharjah Islamic Bank (UAE) A- A2 BBB+ 2 Stable Stable 1/7/2009

Tadhamon International Islamic Bank (Yemen) B B BB- 4 Stable Stable 1/2/2010

The National Commercial Bank (Saudi Arabia) AA- A1+ AA- 1 Stable Stable 1/6/2010

All ratings are reviewed on a regular basis

FINANCIAL INSTRUMENTS – SUKUK SUKUK RATING

FOREIGN CURRENCYLONG TERM

OUTLOOK FOREIGNCURRENCY

DATEMATURITY

DATECOUPON

KCMCC Sukuk Company BSC (Bahrain) BBB- Negative 1/10/2009 16/11/2011variable rate 6M LIBOR

+ 2.50% p.a.

Mangaf Sukuk Company BSC (Bahrain) BBB- Negative 1/2/2010 31/7/2012 6M LIBOR + 225 bp

NIG Sukuk Ltd (Cayman Islands) BBB+ Negative 1/3/2009 15/8/2012 3M LIBOR + 105 bp

Tijara & Real Estate Investment Sukuk BSC (Bahrain) BBB- Stable 1/10/2009 7/6/2012 V 3M LIBOR + 1.50%

ISLAMIC CORPORATES CORPORATE RATING

FOREIGN CURRENCYLONG TERM

FOREIGN CURRENCYSHORT TERM

OUTLOOK FOREIGN CURRENCY

DATE

Al Tawfeek Company for Investment Funds Ltd (Bahrain) BBB A2 Stable 1/2/2008

First Investment Co. (Kuwait) BBB A3 Stable 1/2/2008

Osoul Investment Co. (Kuwait) BB- B Negative 1/12/2008

Qatar Finance House (Qatar) BB- B Negative 1/7/2009

IIBI 41

DIRECTORYNEWHORIZON Rajab–Ramadan 1431

Directory

Volaw specialises in the formation of trusts, foundations, companies, limited partnershipsand other fiduciary vehicles, and in providing offshore management and administrationservices to such structures established for corporate, institutional and private clients.Volaw is regulated by the Jersey Financial Services Commission.

With over 25 years experience of working with leading Islamic finance institutions, Volaw has built a reputation for creating and managing innovative structures for Shari’ah-compliant and conventional funds and structured finance transactions, including Sukuk.

Trevor Norman, Director Tel: +44 (0) 153 4500 400 Fax: +44 (0) 153 4500 450 Email: [email protected] Templar House, Don Road, St Helier, Jersey, JE1 2TR

Volaw Trust & Corporate Services Limitedwww.volaw.com

ERI is a large international company, specialised in the conception, design and distributionof the banking software: OLYMPIC Banking System. Market leader in Luxembourg,Monaco and Switzerland, with 280 banking clients in over 45 countries and more than530 highly qualified staff, ERI is recognised as a key player internationally by providing aproven robust, real-time integrated solution, which clearly meets the needs of the market.This is proven by the solution being the system of choice of numerous significant interna-tional financial groups for their banking networks. ERI also offers a full range of develop-ment, implementation, support and maintenance services.

Nicholas HackingTel: +44 (0) 207 987 4859 Fax: +44 (0) 207 5385 547 Email: [email protected] Exchange Tower, Building 1 suite 6.01, Harbour Exchange Square, London, UK, E14 9GE

ERI Banking Software Ltdwww.eri.ch I www.olympic.ch

EIIB was incorporated in January 2005 and received authorisation by the FSA in March2006. In April 2006, EIIB opened for business, and in May 2006 completed its IPO andwas admitted to London’s AIM market. In November 2006, EIIB opened a representativeoffice in Bahrain. EIIB’s mission is to achieve excellence in the provision of Shari’ah-compliant investment banking products and services. Headquartered in London, EIIB'srange of products and services include the following Shari’ah compliant investment banking activities:

Louise Protain, PA to the Chief Executive OfficeTel: + 44 (0) 207 8479 924 Email: [email protected] Finsbury Pavement, London, UK, EC2A 1N

EIIBwww.eiib.co.uk

Path Solutions is a worldwide provider of Islamic and Investment software solutions forthe global finance industry and in specific the Islamic finance industry. It is the 1st andonly banking software firm to be recognised and certified by the Accounting and AuditingOrganisation for Islamic Financial Institutions. Path offers a wide range of Islamic,AAOIFI-certified and IAS-compliant integrated software covering Core Banking, Invest-ment and Private Equity, Treasury, Funds Management, etc. Path Solutions is headquar-tered in Kuwait, with offices in Beirut, Manama, Karachi, London, Kuala Lumpur andRiyadh.

Agnes Carrasco, Administration Manager Tel: +965 2482 4600 Email: [email protected] Kuwait Red Crescent bldg, 3rd floor, Al Jahra Street Shuwaikh. P.O.Box 592 Safat 13006

Path Solutionswww.path-solutions.com

ICS is dedicated to software development and integration for the banking industry since1978, one of the leading companies in the field of banking automation technologies and services. Its Integrated Banking Solution, BANKS® is a complete, integrated andmodular system that includes full delivery channels support, built on an open platform ina web-based browser environment and available on many environments. Handle IslamicBanking, Retail, Wholesale, Corporate, Investment and Commercial Activities with Business Process Management and Prebuilt Business Intelligence layers, CRM, RiskManagement and Basel II.

Wail Malkawi, VP Business Development Tel: +44 (0) 208 6815 421 Fax: +44 (0) 208 6881 673 Email: [email protected] Courtyard, 14a Sydenham Road, Croydon, Surrey, UK, CR0 2EE

International Computer Systems (ICS)www.banks-solutions.com

To advertise here, please contact:Institute of Islamic Banking & Insurance

7 Hampstead Gate1A Frognal

London NW3 6ALUnited Kingdom

Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769

Email: [email protected]

❏ Islamic Treasury and Capital Markets❏ Asset Management, including Private

Banking

❏ Structured Trade Finance ❏ Private Equity and Corporate Advisory❏ Shari’ah Advisory.


NEWHORIZON July–September 2010GLOSSARY

arbounA non-refundable down payment for attaining the rightto buy goods at a certain time and certain price in future;if the right is exercised, it becomes part of the purchaseprice.

baiSale.

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.

fiqh muamalatIslamic commercial jurisprudence, jurisprudence offinancial transactions or the rules of transacting in aShari’ah-compliant manner.

ghararLit: uncertainty, hazard, chance or risk. Technically, saleof 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.

halalActivities which are permissible according to Shari’ah.

haramActivities which are prohibited according to Shari’ah.

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.

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.

maysirGambling – a prohibited activity, as it is a zero-sumgame just transferring the wealth not creating newwealth.

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 ofthe capital, in which case the entrepreneur gets nothingfor his labour.

mudaribIn a mudarabah contract, the person or party who actsas the entrepreneur.

murabahaA contract of sale between the bank and its clientfor the sale of goods at a price plus an agreed profitmargin for the bank. The contract involves the purchaseof goods by the bank which then sells them to the clientat an agreed mark-up. Repayment is usually ininstalments.

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 borneby each partner in proportion to his contribution.

qimarLit: gambling. Technically, an agreement in whichpossession of a property is contingent upon theoccurrence of an uncertain event. By implication itapplies to those agreements in which there is a definiteloss for one party and definite gain for the other withoutspecifying which party will gain and which party willlose.

rab-al-maalIn a mudarabah contract, the person who invests thecapital.

retakafulReinsurance based on Islamic principles. It is amechanism used by direct insurance companies toprotect their retained business by achieving geographicspread and obtaining protection, above certain threshold values, from larger, specialist reinsurancecompanies and pools.

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

sadaqahCharitable giving.

salamA contract in which advance payment is made for goodsdelivered later on.

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

Shari’ah boardAn authority appointed by an Islamic financialinstitution, which supervises and ensures the Shari’ahcompliance of new product development as well asexisting operations.

SunnahIt refers to the sayings and actions attributed to ProphetMuhammad (PBUH).

sukukSimilar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownershipin the underlying asset. For example, in ijara sukuk theasset will be leased to the client to yield the return forthe sukuk holders.

tahawwutHedging.

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

tayyabWholesome, pure, clean.

taqaabudreciprocal taking possession of commodity and its monetary equivalent by buyer and seller respectively.

ujraThe financial charge for using services (wage, salary,allowance, commission. fee).

wa’adA promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price.Generally, it is not a legally binding agreement.

wadiahCustody. Lit: safekeeping. In Islamic banking, wadiahrefers to deposited property.

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) isallowed to generate an income for himself in excessof the minimum agreed upon returns as agreed withrab-al-maal (investor of the capital).

waqfAn appropriation or tying-up of a property inperpetuity so that no propriety rights can be exercisedover the usufruct. The waqf property can neither besold nor inherited nor donated to anyone.

zakatA religious obligation on Muslims to pay a prescribedpercentage of their wealth to specified categories in their society, when their wealth exceeds a certain limit. Zakat purifies wealth. The objective is to takeaway a part of the wealth of the well-to-do and todistribute it among the poor and the needy.

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