Global+Islamic+Finance+Interview+With+Marcel+Papp Jan2011

January 2011

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2010A Year of Innovation

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2010 Islamic Finance

Ethical

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12 Global Islamic Finance January 2011

Islamic Finance

Abstract: The Islamic finance and banking industry has steadily progressed into a major financial branch which utilises the highly ethical Shariah compliant principles which many investors prefer to use in comparison to conventional banking. The year of 2010 has seen an array of innovation in the Islamic finance sector with latest de-velopments affecting the financial industry on a global scale. Global Islamic Finance Magazine will take you through the highs and lows of the major industry events and developments which have spurred success in Islamic Finance and banking

Keywords: Islamic Finance, Islamic Banking, Sukuk, Takaful, Regulation, Standardi-sation, Risk Management, Innovation, Technology, Islamic Finance 2010, Islamic Fi-nance 2011.

Author: Farhad Reyazat, PhD in Risk Management, Editor in Chief of Global Islamic Finance Magazine, United Kingdom Tasnim Nazeer, Global Islamic Finance Magazine Editorial Team, United Kingdom

20102010A Year of Innovation - Islamic

Finance and Banking ReportA Year of Innovation - Islamic

Finance and Banking Report

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2011 January Global Islamic Finance 13

Islamic Finance Making MilestonesThe Islamic finance and banking industry has steadily progressed into a major finan-cial branch which utilises the highly ethical Shariah compliant principles which many investors prefer to use in comparison to conventional banking. The year of 2010 has seen an array of innovation in the Islamic finance sector with latest developments affecting the financial industry on a global scale. Many challenges that the Islamic fi-nancial sector has experienced during the years have been addressed by key players.

The Islamic financial industry has made many milestones throughout the year and has reached a global audience. The Sha-riah compliant areas of transition between an unheard method of financing to a global one cover the sectors of Sukuk, Takaful, Risk Management, Standardisation and regula-tion amongst many others that this report will comprehensively aim to address.

Islamic finance has not only attracted pre-dominant Muslim populated countries but also European and Western countries which want to tap into a slice of the pie. As the sector is estimated to be worth over $2 trillion dollars by 2012 it is inevitable that many countries across the world want to establish branches and fully fledged Sha-riah compliant banks to cater for the demand from customers and in-vestors alike.

Malaysia and the Mid-dle East have remained at the top of the list of Islamic financial hubs with a real dedication to providing innovative and fresh developments in the sector which has further reinforced the growth of the in-dustry in 2010 and created a benchmark for profits in 2011. Global Islamic Finance Magazine will take you through the highs and lows of the major industry events and developments which have spurred success in Islamic Finance and banking.

Regulating the Islamic Financial Industry- A Necessary ChallengeOne of the main challenges of the Islamic financial industry across the years has been the need for proper regulation and standard-isation of the industry. The need for stand-ardisation has been addressed more so in 2010 due to the rapid growth of the industry. Many key players who want to overcome the problem in order to promote growth of the in-dustry in consecutive years have addressed the issue in various conferences and Islamic financial events. Islamic finance needs to

be better regulated to enhance its ability in identifying risks and restoring its reputa-tion after a series of turbulences within the GCC industries, Global accountancy network Deloitte & Touché revealed in a survey con-ducted in September 2010.

The diagram number 1. shows the system of regulation for Islamic financial institutions. A sizeable number of Shariah compliant finan-cial institutions do not follow globally accept-ed standards; the Bahrain based Deloitte Islamic Finance Knowledge Centre reported after surveying more than 40 Islamic in-stitutions and officials in the Middle East. Deloitte’s report revealed that “The survey findings emphasize the importance of intro-ducing new or revised regulatory measures, chief among them being Islamic accounting standards and risk management.”

A multilateral framework of rules controlling Islamic finance in the region was needed if the industry was serious about entering new markets, said Hatim al-Tahir, the director of Deloitte’s Islamic finance knowledge centre in Bahrain.“Failure cases have triggered in-

terest in more transparency and disclosure,” he said, adding that “Increased corporate governance is needed within the manage-ment of Islamic finance products.”The Islam-ic finance industry has assets of about $1 trillion and this amount is expected to grow even more as it is on the roll to attract more funds from the world’s Muslim population. But ripples of defaults and other financial problems involving Gulf companies shook investor confidence and led to questioning the ‘regulations’ ruling the industry.

In order for the Islamic financial industry to further diversify it is imperative that the standardisation of what is deemed Shariah compliant by scholars and what is not should be made into a legislative paper which will act as a benchmark for Shariah compliant investments. The industry also needs to cre-ate guidelines to prevent the type of uncer-tainty investors had over the structuring of Islamic finance products and the underlying assets that are used to create them, said

Mohd Daud Bakar, an Islamic scholar. “We need to have in place by regulators what we mean by asset-based and asset-backed (se-curities),” Bakar said. “We need more trans-parency and regulation. That’s the missing link in this part of the world.”(Reuters). In May last year Kuwaiti shareholding com-pany Investment Dar missed a payment on a $100 million Islamic bond. Standard & Poor’s Ratings Services has downgraded six GCC banks based on weak operating BMI, Bank of Muscat, Kuwait Finance House, Bur-gan Bank, Bank Muscat and BMI bank.

“Although Islamic finance is expected to con-tinue its growth path, the development of the industry’s infrastructure and regulatory framework is of high concern to most ex-ecutives who took part in this survey,” Tahir said. Only half of the firms participating in the survey said they had risk management systems in place to manage Islamic finan-cial product requirements, and the survey showed that some institutions failed to de-velop risk management systems to address Islamic financial products. Also 64 percent of participants agreed that Islamic finance

needs to implement risk management systems. Disclosure procedures to identify important areas in which Islamic finance can develop a compre-hensive risk manage-ment system was also recommended.

Despite the working of regulators in the GCC to examine ways to improve the assessment of risks in Shariah-compliant fi-nancial products, there

is still an absence of a standard legal frame-work organizing this sector.

This hampers efforts to push the industry to grow internationally, said Rasheed al-Maraj, the governor of Bahrain’s central bank. Is-lamic finance is expected to grow globally with the Islamic financial services board in Malaysia estimating a quadruple of the in-dustry’s assets to $ 2.8 trillion by 2015, a huge increase from its 2005 figure of $700 billion. Malaysia is considered to be the Is-lamic finance frontier, but both the UAE and Bahrain are vying to be regionally important centers for the industry. UAE’s and Bahrain’s assets of Islamic banks last year stood at $65.8 billion and $26 billion, accounting for 16 percent and 11 percent of the total bank-ing systems respectively in each of the Gulf countries (Al Arabiya). Bank Negara’s Gover-nor Dr Zeti Akhtar Aziz said in a speech at the Asset A Triple Islamic Finance Awards 2010 that, “More recently, conscious efforts to initiate platforms for greater engagement

Islamic banks are regulated by a fudiciary law

Approaches adopted by countries to regulate

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Islamic banks are governed by law that

regulated Islamic banks

Islamic banks are Regulated by an

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Diagram 1

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among practitioners, scholars and regula-tors have brought about greater conver-gence and standardisation of Shariah inter-pretations and thus enhancing the potential for product harmonisation which has in turn supported greater cross border transactions in Islamic finance” (BIS International). Islam-ic financial conferences of 2010 around the globe have brought together scholars, regu-lators and practitioners such as the Asset A Triple Islamic Finance Awards 2010 which creates an arena for exchange of ideas.

The ideas and opinions expressed at Islamic financial banking events can further help to bring about proper regulation and stand-ardisation within the industry which is set to further enhance into a growing sector by 2012.

Promoting the Transparency of Islamic Fi-nance in 2010In previous years the Islamic Finance indus-try had to meet the challenges of transpar-ency in the sector in order to cater for the rapid growth. Investors and business profes-sionals lacked the access to statistical data and creation of effective marketing due to the sudden rise of the Islamic financial sec-tor. However following the economic crisis the Shariah compliant methods of banking and finance were the perfect alternative to conventional banking and drew attention to the ethical and highly successful ways of managing your wealth in adherence to the Islamic jurisprudence.

In 2010 some key players felt that the indus-try has progressed in exhibiting transparen-cy in the banking sector. Transparency is the basis of greater ingen-uousness and shared information that can facilitate work-ing partnerships be-tween Islamic banks and its stakeholders, as well as deepen understanding of its performances, com-petitiveness, and risk management, even promote investment. Transparency is cru-cial for Islamic banks. Islamic banks oper-ate on the concept of interest-free bank-ing, with Musarakah (partnership) and Mudarabah (profit-sharing) being some of its basic products. Mudarabah financ-ing involves projects managed by a client, in which the bank

shares the risks with the client. The bank acts as a partner and is entitled to monitor, supervise and have access to books and records. As a consequence, the manage-ment of Islamic banks is often confronted with an ethical impasse when faced with a conflict of interest between shareholders and Mudarabah partners. In Musyarakah contracts however, losses are borne propor-tional to the capital invested. Here Islamic banks provide funds that are combined with funds of the enterprise. Profits are distrib-uted in pre-determined ratios among part-ners.

In light of the above situation, financial dis-closures become of utmost importance from the view point of both the banks and the in-vestors. Financial disclosures by means of financial statements have been the source of information for actual performance of financial institutions. Like conventional financial institutions, Islamic Financial In-stitutions (IFIs) also deals with money by means of deposit collections, safeguarding it, lending it to borrowers and investing in profitable and feasible projects based on Shariah principles. Given this importance, IFIs are more obliged to be transparent by making sufficient disclosures to their invest-ment account holders, not only with regards to their own financial condition, as is the case with conventional banks, but also in re-spect of the management of trust money of depositors who are investing in accordance with Mudarabah agreements. The degree of transparency also determines the bank’s funding cost to its risk-taking behaviour. Transparency which arises from greater dis-closure by banks reinforces the efforts of su-

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Marcel Omar Papp, Head of Swiss Re Retakaful, based in Kuala Lumpur, Malaysia

What are your views on Takaful progression in 2010?

It is good to see that Takaful has made in-roads into new markets such as Russia this year. Also, some interesting projects were launched in 2010 to bring Takaful to Europe, North America and other Emerging Markets. Also in the established markets in the Middle East and South East Asia, several new Takaful companies were established (e.g. 4 new Family Takaful licences were issued in Malaysia). This is a positive sign that more and more regional and global (re)insurers are taking an interest in Takaful, and becoming active in Islamic insurance. Also, some new Takaful regulations issued recently in key markets (e.g. Malaysia; UAE; Indonesia) will strengthen the industry further. All the above should help to keep the Takaful industry growing by 10-20% in 2010. At the same time, there are worrying signs as competition between Takaful operators, and also with conventional insurers, has further intensified this year with a negative effect on the bottom line.

What do you personally feel are the future chal-lenges for Takful Industry?

Despite impressive growth rates, Takaful is still very small compared to conventional insur-ance. Even in the main markets with a big Muslim population, awareness is still low and has to be raised. Takaful will also have to come up with a clearer value proposition to differenti-ate itself from conventional insurance, and to make it more attractive to non-Muslims. Cur-rently several different (Re)takaful models are used and different practices applied in various countries, and even within the same market. All of them have some inherent disadvantages (e.g. agent-principal problem in Wakala model) which need to be addressed. There is also a shortage of well-qualified people with the necessary knowledge in Shari’a and Islamic Fi-nance, which needs to be tackled. Finally, and specific to Retakaful is the issue that a lot of business from Takaful operators are still going to conventional reinsurers instead, even though sufficient Retakaful capacity is available for most risks. This needs to be addressed in order for Retakaful operators to develop further.


pervisors by encouraging market discipline. It also provides substantial benefits to the banks by giving them more efficient access to the capital markets as well as a broader range of counterparties. Greater transpar-ency will further benefit the financial system as a whole, by reducing the doubts that might give rise to bank insolvencies. On the whole, better transparency provides an es-sential foundation to a more stable and ef-ficient financial system (Halal Journal).

Many fully fledged Islamic Banks such as Emirates Islamic Bank which has branch-es in the Middle East work hard to ensure transparency in investor transactions and investments. Many Islamic financial institu-tions are working hard to ensure that trans-parency goes hand in hand with proper regu-lation and aspire to ensure that the industry is successful in the years to come.

Takaful – Insurance that ensures a perfect investmentAs the Islamic financial industry is thriving and becoming an emerging sector in global finance, the opportunities for individuals wanting to tap into the Takaful Insurance are expanding and more so in 2010. The very first Takaful company was established in 1979 which was the Islamic Insurance Company of Sudan. Today in 2010 there are 28 registered Takaful companies world-wide writing takaful directly and 10 more as Islamic windows or marketing agencies placing insurance risk with conventional and takaful companies and the number is continuing to grow. In fact the number of takaful companies is higher as all insurance companies in Sudan are deemed to operate in accordance to the Shariah principles. In addition, new takaful companies have been established recently in Sri Lanka and Tuni-sia. At least four more Takaful companies are under formation in the Middle East in countries such as Kuwait, UAE and Egypt.

Several other Takaful companies are being contemplated in various countries such as Pakistan, Australia and Lebanon. The coun-tries of South Africa, Nigeria, and some of the former states of the Soviet Union are also contemplating tapping into the Taka-ful market. The graph number 1. shows the expected growth rate of the takaful industry and as you can see in 2010 the takaful in-dustry is worth $3.67 billion and is expected to grow to up to $7.39 billion by 2015 with steady progression.

The Takaful market is still in a formative stage in 2010 however it is reported that market projections estimate growth rates between 15% and 20% over the next 10 years and is set to reach US$7.4 billion in premium by 2015. With challenges around customer service and productivity, technol-

ogy can enable this growing industry through its formative stage. The Takaful insurance and reinsurance sector is likely to continue to grow in 2010, according to a report by Standard & Poor’s Corp.

S&P said the market for takaful insurance and reinsurance, which complies with Is-lamic Sharia law, is supported by high levels of growth and an increase in profitability. In a report, “Takaful Insurance Has Long-Term Viability and Benefits from Expected Growth, but Stiff Competition Exists,” S&P said par-ticularly strong growth is likely in Malaysia and the Gulf Cooperation Council states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

But the Takaful market is becoming highly competitive and is suffering from the impact of global investment markets on returns, factors that “place an ongoing strain on sustainable development,” Neil Gosrani, a credit analyst at S&P in London and one of the report’s authors, said in the report. One area of concern is the lack of risk-based regulatory supervision of the Takaful sector, particularly in the GCC region. This means the sector lacks “the growing sophistication of risk management and capital demand increasingly found in Europe and North America,” according to the report (Business Insurance). The Takaful sector is an area that is rapidly growing with increasing de-mands from investors in particularly in Ma-laysia and the Middle East. Samer Kanan, Managing Director of Methaq Takaful Insur-ance, told an invited gathering of insurance broker partners in Dubai and Abu Dhabi that the Islamic insurance industry continued to grow around the world, as he highlighted the significant role being played by Takaful Insur-ance in supporting economic growth in UAE and the role Methaq Takaful in particular was playing as a national Islamic company.

“Takaful Insurance has achieved phenom-enal success despite the recent financial swings and global economic crisis, and we therefore see massive opportunities for the growth and development of Islamic Takaful in the Region. Our drive to succeed and to further enhance our position as one of the market leaders stems from this belief, and further driven by our technology, our com-mitment towards society , ably supported by a well constituted board of directors,” said Kanan.

“We, at Methaq, lay great emphasis on hir-ing the best local talents, as well as the best brains from the GCC and other Arab countries, as we pursue our goals and ob-jectives. In addition, we seek to leverage the experience of international experts who can add value to the Islamic Insurance in-dustry by providing a global perspective and

Davud Vicary Abdullah, Global Islamic Finance Leader, Deloitte Corporate Advisory Services Sdn Bhd, Malaysia

What are your views on Islamic finance progression in 2010?

Good progress has been made overall in the IF Industry. In particular in the following three areas:

Globalisation of standards (Account-• ing, legal, tax, Sharia’a process

Positive changes in perception - the • performance of IF during the crisis and post crisis has drawn attention and developed understanding of the ethi-cal valoues of IF

The development of cross border • liquidity through the foundation of the IILM Corporation

What do you personally feel are the future challenges for the Islamic finance and how do you think they can be overcome? Still much work to be done in the areas of changing negative perception regarding Islam and Islamic Finance. This can be done through deepening and widening the education process. It also requires sup-porters of IF to stand up for what is right in a non-confrontational way and explain the values of IF when they hear incorrect com-ments or interpretations.

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guide us into a strong leadership position,” Kanan added (Al Bawaba). The Takaful sec-tor is even attracting attention from Western countries such as the USA. The US-based insurer, American International Group has offered Takaful, an Islamic homeowners in-surance in the US, with a six months plan to expand into auto and other insurance products reported MEDILL Reports Chi-cago. Currently, Takaful in the US is issued through AIG’s underwriting subsidiary, Risk Specialist Companies, along with Lexington Insurance. New York-based Islamic financial services firm, Zayan Finance is the exclusive broker for the product, which is presently of-fering Takaful in 13 states.

Substantially, that number is expected to increase. Through AIG Takaful Enaya, AIG first began offering Takaful health, auto, and property and casualty products in Bahrain in 2006. The concept of Takaful insurance was first introduced in Malaysia and was spread to other Muslim countries such as Saudi Arabia, Indonesia and Pakistan. Mat-thew Power, president of Risk Specialist Companies, in a news release, said: “We are pleased to offer socially responsible solu-tions to this segment of the domestic mar-ket.” Nasser Nubani, spokesman for Zayan Finance, said that Takaful pools are jointly owned by the policyholders and are “a sepa-rate entity from the insurance company.” The policyholders would pay into the pool with the intention of helping the community in case of accidents, fully expecting that the money may not be returned. In case of a surplus, the money is distributed back to the policyholders. Takaful is a way to avoid gambling or speculation. Karen Hunt-Ahmed, assistant professor of finance at DePaul University, said: “Conven-tional insurance is based on speculation in the sense that you’re speculating how long a person may live or whether or not your home will be damaged. She informed that Takaful insurance would be a way of managing risk without the troubling aspects of specula-tion.” Takaful companies are not supposed to invest their policyholder contributions in banks and other companies that earn prof-its through interest. They can be invested in real estate, stocks of companies that don’t deal with interest and other non-interest in-vestments (Insurance Business Review).

The Sukuk Market Spurring the Industry AheadSukuk which is Islamic bonds is one of the most successful Islamic financial commodi-ties to date has been spearheading the in-dustry ahead into the lucrative and highly ethical sector that it is in 2010. The Sukuk market in 2010 has seen many unprece-dented deals and many firsts in the Sukuk industry as the market has really progressed

Islamic Finance

There are also issues being discussed relat-ing to different structures, such as tawar-ruq, the role of Sharia boards, the future of Islamic derivatives, etc. While these are all very important and pertinent challenges to be addressed, the industry should not be entrapped by these discussions and lose focus from further growth. This is especially valid for Islamic banking expansion into new markets and wider coverage of retail customers’ needs.

Notwithstanding important challenges mentioned above, arguably the key to future development of the industry is the availability of a human capital. The chal-lenge is not only availability of the requisite skill sets but also ability to lead and chart the way forward. As Islamic finance is under increasing pressure to provide equivalents of conventional finance the role of leader-ship will play even more prominent role.

Which sectors of the Islamic Finance do you personally feel will be successful in the upcoming years?

The sukuk market has clearly recovered after initial impact of global financial crisis on corporate credits and ensuing liquidity crunch. The market is expected to see fur-ther proliferation of issuers, corporate and sovereign, and structures with recovering macro conditions and the need to finance further expansions. A further penetration of Islamic finance across sectors is expected, such as infrastructure finance and insur-ance.

GCC infrastructure development needs alone are significant and many of these will be financed using Islamic finance struc-tures. There is strong alignment between the nature of underlying infrastructure development and objectives of Islamic finance, including its strong asset basis and risk/return profiles.

Takaful market, on the other hand, is in expansion with growth and deepening of health industry, retirement planning and, in general, evolution of long term savings culture. In addition, all the indications are that asset management/private equity has the strongest growth potential. It is the sec-tor that is severely underrepresented within Islamic finance universe while at the same time closely adheres to substance and form of Islamic finance principles. While the growth of the sector will largely depend on risk appetites and willingness of investors to look beyond their own comfort zones, its growth will also signal a new phase in Islamic finance. And the consumers, to im-part skills and innovation and to ensure the authenticity of Islamic finance practice.

Harun Kapetanovic, Economic Adviser, Department of Economic Development Government of Dubai, UAE What are your views on Islamic finance pro-gression in 2010?

Year 2010 was the year of consolidation, restructurings and baselining. Along with the preceding year, this was also a test year of Islamic finance resilience and maturity. By all measures the industry has passed the test. Islamic finance, after being impaired by general economic challenges, has estab-lished new foothold. The sector is emerging stronger as a result of portfolio rebalancing, more prudent credit policies and more robust governance structures.

It is important to highlight that the industry did not see any significant deterioration in confidence levels in retail and corporate market. While this is certainly a credit to a local regulators, due praise is to institutional development of Islamic financial institu-tions as well. As such, we have witnessed resurgence of sukuk market and increasing project finance activities. Nevertheless, strong correlation between Islamic and main-stream market is certainly exhibited. While no outright exposures to troubled derivative markets have been recorded, initial crisis and subsequent slow recovery has exposed some industry weaknesses.

One of the key challenges Islamic finance faces is proper understanding of its essence and certainly 2010 was a year of reflection and debates on the future path of Islamic finance.

What do you personally feel are the future challenges for the Islamic finance and how do you think they can be overcome?

There are a lot of debates about Islamic finance being asset backed or asset based finance, standardization issue is frequently discussed and, in general, ability of Islamic finance to answer the needs of a modern and global economies.

Mughees Shaukat, PhD researcher and assistant in INCEIF & ISRA, Malaysia

What are your views on Islamic finance pro-gression in 2010?

Present day Islamic finance has grown far from its domestic roots to emerge as one of the fastest growing financial markets in the international field, no wonder the growth of Islamic finance stayed strong in 2010, just when many of the world’s financial systems found themselves deleveraging amid the capital market dislocation and its spread to economies around the globe.

Assets of the top 500 Islamic banks expand-ed over 20% to total close to $992 billion in 2010, compared with $639 bil-lion in 2009, according to publicly available information. One contin-ues to believe a bright outlook is likely worldwide for Islamic finance in 2011, on the back of steady growth and geographic diversifica-tion. In our view, Islamic finance is poised to make further inroads in developed Western markets while Southeast Asian countries will likely fuel the Islamic finance advance in Asia during the com-ing year.

The philosophy and principles of Islamic banking are becoming increasingly attractive to a large proportion of consumers, and if anything, Islamic finance is more strongly positioned for growth in a worldwide spectrum. it is pro-jected that the Islamic financial system will soon manage approxi-mately 4% of the world economy. Below are some statistics.

What do you personally feel are the future challenges for the Is-lamic finance and how do you think they can be overcome?

Despite indications determining continued growth, Islamic banking achievement and de-velopment need to be careful not to celebrate it too soon. Their very success may be the source of future challenges:

i) Although, there are different mode of Islamic banking but the commonly practiced mode is Murabaha financing i.e., financing via sale on deferred payment basis. The process involved is the process that is materially not different from credit supply in interest based banking. Change in labels and terms are unlikely to be a lasting defense.

So, the line of distinction between Islamic financing and interest-based financing must be above reproach in order to avoid identity crisis for Islamic banking. Offering more float-ing rates products and providing comprehen-sive Islamic offerings without any leakages to conventional. Inclination towards equity-par-ticipation as distinguishing factor from con-ventional moving away from debt-financing instruments. Develop sophisticated financial engineering products such as Islamic struc-tured products, Islamic derivatives and hedg-ing (pointing to refined Risk Management techniques), and Islamic ETFs

ii) The industry faces competition from a number of angles, that is Islamic banks should be ready to brace not only intra-industry com-petition but also inter-industry competition from interest-based banks. Hence Depositors

and savers confidence is also an important challenge for Islamic banking. If the deposi-tors came to know that the bank has violated its Shariah mandate, the depositors will lose confidence and the finding will trigger deposit withdrawal and probably collapse of the bank. Therefore, caution is warranted against any thing that creates doubts about the Shariah credentials of Islamic banks’ transactions.

Standardization in any respect of banking is necessary, and it is bound to happen as the world is a global village. Islamic finance has long been criticized for its lack of standardi-zation especially the disunity in the interpre-tation of shariah law which is not unlikely for the rapidly-expanding new industry. Harmoni-zation and mutual recognition of Shariah dif-ferences could have the answers.

iii) The lack of human capital leaves a lot to ponder. The trained or experienced bankers supplying has lagged behind the expansion of Islamic banking. Attention to the issue is the need of the hour. Humanizing Islamic finan-cial services could be the way to go. Building pool of talents and experts in Islamic finance includes providing ease for education, aware-ness and employment of expatriates.

iv) Liquidity management in Islamic banking now demands instant attention. The lack of other direct or indirect funding sources such as a developed secondary market and the money market provokes further challenges.

The recent decision in the latest GIFF conference in Malaysia to develop the Islamic Liquidity man-agement Hub is the right way to go about.

Finally, from the above discussion it can be concluded that although a lot of challenges coming ahead still, if this sector can maintain a high-ethical, well-regulated and beneficial Islamic financial archi-tecture then it would not be im-possible to face the future chal-lenges of Islamic banking and finance sector.

Indeed, working in this field with more transparency, with effective corporate governance and with better interaction with relevant international, regional and na-tional institutions, along with a strong political will, will definitely help all who wish to contribute to the welfare of their community as well as to the welfare of the world as a whole.


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this year and looks to further expand in the years to come. In 2010 Dubai based firm Millennium Private Equity issued the first European Sukuk in the UK. Millennium, part-owned by Dubai Islamic Bank PJSC, the United Arab Emirates’ largest.

Shariah-compliant bank, bought $10 million of four-year convertible notes in July that were sold by International Innovative Tech-nologies Ltd., a clean energy company in Gateshead. “We are looking at transactions in Europe and other areas,” Vally Khamisani, a director at Millennium said in an interview in Dubai. “They can tap into capital which is focused on Shariah principles. The struc-tures can fly well here.” Persian Gulf inves-tors are exploring opportunities outside the region, taking advantage of tightened lend-ing in Europe to diversify. Middle East and North Africa private equity funds have about $10 billion available to invest after raising a record $5.4 billion in 2008, Gulf Venture Capital Association said in a July 20 state-ment. European companies may turn to the Middle East, which has more than 400,000 millionaires, Cap Gemini SA and Bank of America Corp.’s Merrill Lynch unit said in a world wealth report in June. Their combined wealth grew 5.1 percent in 2009 to $1.5 tril-lion, the report said.

Many companies decided to sell their bonds in 2010 such as the International Innova-tive which sold Sukuk due in 2014 that pay an annual return of 10 percent in a private placement, said George Ord, the managing director of the maker of industrial milling machines in northeast England. The bonds will be converted to an equity stake in the coming weeks, he said in an interview from Gateshead yesterday, declining to disclose the size.

“We wouldn’t hesitate to go back into the market,” Executive Chairman Thomas Wilkinson said yesterday. “Our funding streams at the moment are fine, so we have no immediate need to go back into the mar-ket. If we want to do further expansion, that may change.” Dato’ Yusli added, “There is a growing interest for foreign issuers to list Shariah financial instruments on the Ma-laysian market. Without a doubt, this Sukuk listing by IDB will augur well for our goal to further position Malaysia as a premier Is-lamic investment and Sukuk listing hub in tandem with the Malaysia International Is-lamic Financial Centre (MIFC)’s initiatives to push our Islamic capital market’s standing on the global map.”

2010 is the year that global Sukuk issuance has reached over the $30 billion mark ac-cording to Kuwait Finance House (KFH) re-ports. Total global Islamic bond issuance reached $20.2 billion last year, up from

$14.1 billion in 2008, and reached a record $31 billion in 2007. The Sukuk issued glo-bally jumped by 116.3 million to $16.5 bil-lion during the first half of 2010, compared to $7.6 billion raised during the same period last year. In the Middle East and North Afri-ca region Sukuk issuance increased by 235 per cent in the second quarter, compared to the same period in 2009.

Issuance of Islamic debt from the Gulf has declined 24 per cent to $2.5 billion so far this year, involving sales by three compa-nies, according to data compiled by Bloomb-erg. The UAE may sell Islamic securities as legislators consider establishing a local debt market, central bank governor Sultan bin Nasser Al Suwaidi said in March. KFH report said long-term prospects for the Sukuk mar-ket are expected to remain strong given the increasing popularity of Shariah-compliant products, governments’ support for Islamic finance, huge investment and financing re-quirement in the GCC and Asia regions, and issuers’ desire to tap investors from the Mid-dle East and Muslim Asia.

With a healthy array of Sukuk in the pipeline, the market is attracting interest from an in-creasing number of issuers in Muslim and non-Muslim countries alike. On a quarterly basis, the first quarter Sukuk issuance was up by 114 per cent year-on-year to $4.7 bil-lion, while the second quarter issuance in-creased by 112 per cent to $11.8 billion, underpinned by an emerging markets-led global economic recovery and huge govern-ment stimulus packages and infrastructure spending. The research report expects Sukuk market to maintain its vitality dur-ing 2010, and foreseeable future under the push of positive factors monitored by the report.

The most important factors are stimulus pro-grammes, huge government expenditures and government initiatives that will enforce and develop Sukuk as well as the increasing popularity of Shariah-compliant products, the report said. According to the report, the value of the Sukuk market has increased to reach about $100billion in 2009, point-ing out that the total value of issues for this market has seen a marked increase during the first half of 2010. Hence, sovereign and similar funds played a prominent role in the rehabilitation of the Sukuk market after hit-ting 79.7 per cent of the funding period, as Malaysia is still controlling the largest share of global Sukuk market.

At the level of the GCC, the report highlight-ed government allocation of these countries to spend large amounts on development projects during 2010 and the coming years, which enforce the demand for Islamic Su-kuk. The Sukuk market has grown to reach

Zulkifli HasanSenior LecturerFaculty of Shari’ah and LawIslamic Science University of Malaysia

What are your views on Islamic finance progression in 2010?

What do you personally feel are the future challenges for the Islamic finance and how do you think they can be overcome?

Despite the steady and consistent global growth, Islamic finance in 2010 had faced significant challenges that may shape its fu-ture prospects and direction. The inherent effect of Nakheel Sukuk default in 2009, several legal conundrums such as in the case of the Investment Dar, the unresolved issue of Shari’ah non-compliance risk as in the declaration of impermissibility of Tawar-ruq by the Islamic Fiqh Academy last year are considered as a real test for Islamic finance. I believe that Islamic finance is now going beyond its infancy stage and moving towards maturity and sophistication.

At this transformation stage, it is expected that Islamic finance will face enormous challenges in various areas and aspects. In order to ensure Islamic finance will continue to progress and sustain, I am of the view that it really needs a strong market penetration, active government backing, appropriate regulatory frameworks, sound corporate governance and integrated coop-eration from all stakeholders.

On the face of it, I strongly emphasize on the importance of knowledge-based culture and research and development in Islamic finance. I consider these elements as the prerequisites for the success of future Islamic finance as they play an important role to eradicate illiteracy, to educate the players and the consumers, to impart skills and innovation and to ensure the authentic-ity of Islamic finance practice.

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Islamic Finance

approximately $100 billion and contributed to 12 per cent of the total global Islamic fi-nance assets in 2009 (GIF). Malaysia con-tinued to dominate the global Sukuk market, contributed to 60.5 per cent of total value of Sukuk issued in the first half. Saudi Arabia and Indonesia each trailed at 14.1 per cent.

As such, by currency type, ringgit-denomi-nated Sukuk deals topped at 53.4 per cent, followed by US dollars deals of 10.3 per cent and Qatar riyal issues of 8.3 per cent. 2010 saw the Sukuk market in the Gulf shifting its success on to Asia where unprecedented Sukuk sales are totalling to over $5.7 bil-lion this year. The value of Sukuk Islamic bonds raised in the Gulf so far this year has fallen by 25 per cent to US$2.5 billion(Dh9.18bn)compared with the same period last year. Khalid Howladar, an Islamic finance expert at Moody’s Investors Service, said while appetite for Gulf Sukuk had been driven by global demand, the Asian economies where Sukuk are popu-lar – Malaysia and In-donesia – have great domestic interest.Mr Howlader further added that, “In the Asian countries like Indonesia and Malaysia, demand is more domestically driven. The people there want it, the governments want it, the regulators want it and the whole system works in concert to make it happen. Here I think it’s more capital market driven.” Saudi Arabia has the potential to har-ness a domestic surge in demand, he said, given its population of about 25 million and strong culture of invest-ing. Analysts have long thought that appetite for Gulf Sukuk might pick up as Dubai World neared a deal on its $23.5bn debt restructuring.

But there is little evidence of that coming closer to reality, even as the government-owned conglomerate sews up a final pact with scores of banks and trade creditors. “It’s of strate-gic importance that some of the countries here in the Gulf look towards developing these markets,” Mohammed Da-wood, the director of debt capi-tal markets at HSBC in Dubai, said last week. “Especially to compete with Malaysia, the de-velopment of the local market will be crucial.” The Sukuk in-

dustry is set to further expand and progress in the years to come with the Islamic finance industry totalling in at $2 trillion dollars.

Islamic Risk Management- Worth the RisksRisk management for Islamic banking fi-nancial products and services is one of the greatest challenges that many westernized, as well as Islamic Banks, are facing today. As a result of this market growth in Islamic financial products there is a high demand to understand how to assess and manage the

risks arising from applying these products and services.

Credit, operational, market and liquidity risks together with the risk of non compliance with the Shariah law are becoming very im-portant issues for financial institutions. Risk Management in Islamic finance has to ad-here to the principles of the Shariah. There are three main Risk management products which have been doing increasingly well during 2010 as many Islamic fully fledged banks and conventional Islamic subsidiaries have been launching them.

These include those that are formally being standardized, such as the ISDA/IIFM

Ta’Hawwut (Hedging) Master Agree-ment; second, risk management

methods directly based on the well-recognized Islamic fi-

nancing modes and rules; and third, the possibility

to use formally Shariah-compliant mechanisms to replicate convention-al risk management products and risk profiles. The diagram 2. shows the meth-ods used in Islamic finance when dealing with risk management. One of the challenges of Islamic banking in-

stitutions is the push to embrace risk man-

agement as Moody’s had stated in a report. Moody’s

report explains how, in the years before the crisis, a handful

of key SCIBs diversified the sector by moving away from pure banking in-

termediation and into more sophisticated investment/merchant banking lines of business, like private equity, asset management, brokerage, infrastructure and structured real-estate finance, as well as advisory, corporate and project finance - thereby laying the groundwork for an SCIB sector.

These developments and inno-vations meant that - just before the crisis - Islamic finance was poised to enter a new era that would bring Islamic finance closer to the profit-and-loss sharing, asset-backed and real-economy financing ide-als, which traditional Islamic universal banks had not previ-ously been able to handle fully. Specifically, Moody’s report says that Islamic finance was

Islamic Banking Terms

Normal Banking Terms

Description

Al-Wadiah Custodianship Savings and Deposits

Al-Mudhuarabah Profit Sharing Bank provides capital to entrepre-neur to run business. profit is shared according to predetermined ratios.loss is 100% borne by Bank.

Al-Musyarakah Joint Venture Similar to Al-Mudharabah, however the losses is borned by both parties according to basis of their equity partiapation.

Al-Murabahah Cost Plus Profit Refers to sales of a good at a price, which includes profit margin as agreed by both parties

Al-Bai` Bithamin Ajil

Deferred Sale Payment In Malaysia, commonly used for Housing Loan

Al-Ijarah Thumma Al Bai`

Hire & Purchase Purchasing cars

Sukuk Bonds Borrowing and Lending

Hibah GIft

Riba Interest

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Islamic Finance

on the cusp of moving beyond its sole fo-cus on raising cheap Murabaha or Wakala deposits (so as to recycle them into safe, stable and expensive retail and corporate loans) - and to adopt a greater emphasis on risk-taking instead. However, the onset of the financial liquidity crisis prevented the dawning of this new era, and almost led to the collapse of the SCIB model (GIF). Given the strong growth in Islamic finance, balance sheet size and lack of loss data are not ex-pected to remain issues for many banks in the long run. Moreover, ensuring the use of robust internal counterparty ratings systems should have a positive impact on the risk management process and the level of capi-tal required at Islamic banks. The structure of Mudaraba and Musharaka transactions are capital intensive, and are therefore more expensive from the bank’s perspective.

Consequently, Islamic banks should take the cost of capital into consideration when they are advising clients and when they are developing new transaction types in the future. In fact, one of the questions that must be addressed as part of the advisory function of an Islamic bank is whether the client’s interest can be served equally well with structures separate from the Mudaraba and Musharaka.

Although it could be argued that the chanc-es of default will decrease in any Mudaraba and Musharaka transaction. Data sharing in the financial sector is a sensitive point, and such a project will need to be managed by a trustworthy third party. Following the selec-tion of this third party and the creation of a comprehensive loss database for Islamic finance, Islamic banks will have the ability to start designing advanced risk measure-ment models that would otherwise remain out of reach. The Risk Management sector is clearly one that uses highly ethical Shariah compliant ways of wealth management and will continue to diversify in the years to come (BLME).

Islamic Finance and Banking Paving the way forward for 2011The Islamic financial industry has made many milestones and developments with the introduction of innovative products to cater for the demand of investors and cus-tomers. The highly ethical financial sector is attracting a global audience and due to the unprecedented success of developments in the sector in 2010 the outlook looks promis-ing for 2011.

It can be expected that in 2011 the Islamic financial industry will work hard on imple-menting standardisation and regulatory bodies to ensure that the industry is further diversified and promote further growth. The Islamic financial world is thriving and set to

reach over $1.5 trillion US dollars in 2011 and this rapid growth seeks to have proper standards in place in order to cater for the demand of forthcoming Islamic financial services and institutions. Resolving the im-portant issues of implementation of key staff and new methods in the supervision of Capital adequacy and data collection will fur-ther benefit the industry. A unified standard Shariah banking principles legislation would significantly enhance the sector’s methods of regulation and make things easier for people in regulatory positions.

Further to this, challenges can be overcome if central banks and institutions enhance their multilateral cooperation, and create the appropriate environment and condi-tions. The new conditions would create a level playing field and provide the infrastruc-ture needed for the industry’s market-driven development.

A stable and well-functioning Islamic finan-cial system can potentially make way for the regional financial integration on a global scale. If a stable regulatory system is imple-mented it can also aid in benefiting with eco-nomic and social development. Using mod-ern technology can further promote growth in the sector. Correct utilisation of mobile or internet banking can create safe transac-tions which customers can take control of to manage their accounts and transactions ef-ficiently. It also allows investors to tap into the Islamic banking market and broaden its appeal by keeping up to date with the latest technology services that conventional banks use.

2011 is a year of promise and the industry has room to work on their achievements and spearhead the industry forward by address-ing the challenges and working towards per-fecting the industry. The Shariah compliant principles of Islamic finance and banking are appreciated by both Non Muslims and Mus-lims alike to want to utilise Islamic Banking and financing methods in order to manage their wealth effectively.

2011 may bring about a global introduction of many more fully fledged Islamic financial institutions and banking outlets as more global networks form to create partnerships with leading conventional banks around the world. One such as example is in the UK the Islamic Bank of Britain is a leading fully fledged Islamic bank and second to it is HSBC Amanah which has opened up global subsidiaries around the world.

With many investors eager to make Shariah compliant investments and utilise the highly ethical opportunities that Islamic finance brings to the fold it is inevitable that the in-dustry is set to soar in 2011.

Hallam, IFSL Research Islamic Finance • 2010, (2010) International Financial Serv-ices London

Al Arabiya, ‘Islamic Finance Needs • Better Regulation’ (2010) Retrieved from: http://www.alarabiya.net/articles/2010/09/25/120295.html

S. Pasha, ‘Islamic Finance Needs Regula-• tion: Experts (2010) Retrieved from: http://www.reuters.com/ar ticle/idUSTRE61 -H3AT20100218

Dr. Z Aziz, ‘The global Islamic financial mar-• ket today – challenges and way forward (2010) Retrieved from: http://www.bis.org/review/r100716b.pdf

N. Alam & Prof. B.Shanmugam (2007) Pro-• moting Transparency in Islamic Banks’ The Halal Journal Retrieved From: http://www.halaljournal.com/article/1897/promoting-transparency-in-islamic-banks

Celent ‘Takaful Source 1’ (2006) Re-• trieved from http://reports.celent.com/PressReleases/20061129/Takaful.htm- (source 1)

S. Veysey, ‘ Takaful Insurance Sec-• tor To Grow In 2010’ (2010) Retrieved from Business Insurance.com http://www.bus iness insurance.com/apps/p b c s . d l l / a r t i c l e ? A I D = / 2 010 0714 /NEWS/100719975

Al Bawaba, ‘Takaful Insurance Forecasts Ro-• bust Growth 2010’, Retrieved from:

http://www1.albawaba.com/en/business/• methaq-takaful-insurance-forecasts-robust-2010-growth

IBR, ‘American International Group Plans • Takaful Expansion In US’ (2010) Retrieved from

http://www.insurance-business-review.• com/news/american_international_group_plans_takaful_expansion_in_us_090828

M. Mahlknecht, Islamic Risks, Trends and • Types, Islamic Bankers Report (2009) Re-trieved from: http://www.islamicbanker.com/islamic-risk-management.html

Global Islamic Finance Magazine (2010) • Retrieved from http://www.globalislam-icfinancemagazine.com/?com=news_list&nid=1075

BLME, (2007) Islamic Risk Management • and the Challenges of Basel II Retrieved from: http://www.blme.com/pdfs/news/GARP_risk_review_july07.pdf

References and Further Reading:

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