Islamic Banking, Finance and...

Islamic Banking, Finance and InvestmentDr. Salah Almajthoob

Oman, 14 March 2018

Session 1: Key Concepts of Islamic BankingDr. Salah Almajthoob

Part 1. General Introduction to Islamic Banking

March 2018ISLAMIC BANKING 3

Introduction


This presentation is about the basics of Islamic Banking

Goal is to understand what is Islamic Banking

A practical approach

Islamic Finance Market


Quick history

The first Islamic bank is Dubai Islamic Bank, 1975

Followed by Kuwait Finance House, 1977

Al Baraka Bank, 1978

Bahrain Islamic Bank, 1981

Today the size of Islamic Finance is $2.4 trillion (Thomson Reuters)

Growth rate of 14% during the last 15 years

The Sukuk outstanding value $366 billion (IIFM)

Major centers are the GCC, Malaysia and UK

Growth of Islamic Finance


Global Islamic Finance Report 2017Islamic Finance Development Report 2017

Islamic Banking in Oman

The Royal Decree No. 69/2012 amended the banking law to include Islamic banking at licensed banks through either specialized banks or independent entities at the existing commercial banks.

Islamic Banking has 11% market share

Overall assets OR 3.3 million

Two Islamic Banks

1. Bank Nizwa, 2012

2. Alizz Islamic Bank, 2012

Six Islamic Banking Windows

1. Maisarah (Bank Dhofar)

2. Meethaq (Bank Muscat)

3. Muzn (National Bank of Oman)

4. Al Yusr (operated by Oman Arab Bank)

5. Sohar Islamic (Bank Sohar)

6. Al Hilal Islamic Banking (Ahli Bank)


Conventional Banks

BankDeposits Loans

Other Banks(Treasury)

Source Funds Utilize Funds

Manage LiquidityInvestment

March 2018 8ISLAMIC BANKING

Basics of conventional banks

Features of Conventional Banks

Buy and sell money

Money is the commodity

Buy low, sell high and keep the spread

A mediator between those who have excess funds and those who need funding

Risk free interest

Continuous accumulation of interest

Complex treasury transactions

Fee based services


BankDeposits Loans


Conventional Banking and Islamic Principles


The basic principle of charging interest on a loan is not allowed in Islamic Sharia

In fact many of the business activities performed by conventional banks are not allowed in Islamic Sharia

Conventional banking is not aligned with Islamic principles

Riba (Usury) is Forbidden

منا البيع مثل الراب وأ حل هللا البيع وحرم الراب﴾ سورة البقرة : قال تعاىل 275﴿ذكل بأ هنم قالوا ا

”That is because they say trading is only like usury, and Allah has allowed trading and forbidden usury“ [2:275]

Conventional banking is based on usury

Usury is forbidden in Islam in the strongest language


Islamic Sharia Issues

Forbidden Transactions

Riba (usury) is forbidden

Gharar (ambiguity) is forbidden

Trading debt is forbidden

Must share the risk

Forbidden activities

Alcohol

Tobacco

Riba based financing

Pork

Entertainment

Arms


Banks are still needed


We still need financing and other banking services

Therefore, we need banks that adhere to the principles of Islamic Sharia

These banks provide the same services provided by conventional banks but in a Sharia compliant way

We call them Islamic Banks or Islamic Sharia Compliant Banks

How to build an Islamic Bank?


The solution is to trade, i.e., buy and sell at a deferred price with a mark-up.

Most usury transactions are converted to a sale at a deferred price.

Financing in general is performed through buy and sell at a deferred price transactions

Invest the money of depositors as partners and have them share the risk

Look in the books of Fiqh for trading and financing transactions and use them

Islamic Banking Transactions

Islamic Bank

Deposits Loans

Other Banks (Treasury)

QardMudarabaReverse MurabahaWakala

MurabahaIjaraMusharakaSalamIstisnaTawarruq

Commodity MurabahaWakalaSukuk


Step 1. Replace usury based transactions with Sharia compliant transactions

Islamic Banking Products

Islamic Bank

Deposits Loans


• Current Account (Qard)

• Saving Account (Mudaraba)

• Term Deposit (Mudaraba)

• VIP Deposit (Reverse Murabaha)

• Wakala Deposit (Wakala)

• Car Financing (Murabaha)

• Real Estate Financing (Murabaha)

• Real Estate Financing (Ijara)

• Cash Financing (Tawarruq)

• Placement and Borrowing (Commodity Murabaha)

• Placement and Borrowing (Wakala)

• Investment (Sukuk)


Step 2. Build Islamic banking products based on Islamic transactions

Features of Islamic Banks

Buy and sell goods not money

Profit is generated through the buying and selling process

Still a mediator between those who have excess funds and those who need funding

Not just a bank; a merchant and a trader

Goods are the commodity

More risk sharing

Fee based services


Islamic

BankDeposits Loans

Other Banks

(Treasury)

Islamic Banking Window

A conventional bank that wants to offer Islamic finance solutions to its customers establishes an Islamic arm

The Islamic arm types differ depending of the level of integration and independence

Integrated Islamic Window

Autonomous Islamic Window

A separate Islamic subsidiary

Integration/independence factors include

Comingling of funds or not

Separate operation/treasury or not

Separate branches or not


Islamic Banking Window


Bank(parent)

Deposits Loans


Islamic Window

Deposits LoansIslamic Transactions Only

Conventional Transactions

Capital and revenue

Deposits must be invested using Sharia complaint instruments

Islamic Financial Transactions

Islamic law has a section called Fiqh al-Muamalatthat regulates financial and business transactions

Islamic law has many financial contracts that were used for buying and selling before the advent of banks

Now we use these contracts for financing

Islamic Finance in essence is in general buying and selling

Common Islamic Law financial contracts

Murabaha

Mudaraba

Musharaka

Ijara

Istisnaa

Salam

Wakala

Tawarruq


AAOIFI Sharia Standards

What are the Sharia Standards?

Sharia standards tells us what is allowed and what is forbidden

40 different standards and more are on the way

Written in a legal style

Formulated by a committee of renowned scholars from many Muslim countries

Endorsed by many banks

Enforced by several central banks

Highly recommended

Popular Sharia Standards

Murabaha

Ijara

Wakala

Istisnaa

Salam

Tawaruq

Stocks and Bonds

Sukuk

Takaful


AAOIFI Accounting Standards

What are the Accounting Standards?

Several types

Accounting

Auditing

Governance

Ethics

More than 35 standards

Prepared by professional accountants and Muslim scholars

Covers needs of Islamic banks

How to record, how to value and how to recognize profit (loss)

Popular Accounting Standards

Presentation and Disclosure

Murabaha

Ijara

Istisnaa

Salam

Auditors report

Sharia Review

Code of Ethics


Retail vs. Investment Islamic Banks

Retail Banks

Islamic alternative to conventional banking

Deposits and financing

Focus on retail and corporate customers

Profit through the spread & fee based services

Sustainable business model

Investment Banks

Some are investment arms of retail banks for offering investment products.

While others are private equity firms but call them selves investment banks for marketing purposes

Some are true investment banks offering investment banking services; M&A, raising equity and raising debt.

Private Equity firms acquire assets, put them into funds then placing those funds

Focus on institutional investors, family offices and high net worth individuals

Profit through markup & asset management fees

Many questions about the sustainability of the business model


Sharia Supervisory Board

Every Islamic Bank has a Sharia Supervisory Board

The task of this board is to oversee Sharia compliance

Formed by knowledgeable Muslim scholars

Internal Sharia Department role is similar to Internal Audit but its scope is Sharia Complaince

Governance standards determine the roles and responsibilities

Managing the bank is still the responsibility of Management (Board and executive management)

Sharia compliance is also the responsibility of Management NOT the Sharia Board


Part 2. Financing Products


Introduction

The Financing Methods are the Sharia compliant contracts used to finance a customer

Common methods

Murabaha

Ijara

Diminishing Musharaka

Salam

Istisnaa

Tawarruq

The Sharia complaint financing methods have a similar cash flow that is similar to the conventional methods.

The contracts though are dramatically different. The effect is usually seen in the case of a default


Murabaha Financing


Introduction to Murabaha Financing

The most common way of financing in Islamic Banks

Most car loans, short term and medium term real estate financing are Murabaha financing

Easy to implement

The concept is based on a traditional Islamic financial transaction from Fiqh al-Muamalat

Two sales contracts; the first is spot and the second is deferred

Has other variations


Basic Murabaha

A purchaser buys certain goods from a seller

The seller declares to the purchaser the cost and the profit; 'honest declaration of cost and profit‘

The Seller already owns the goods when he is approached by the purchaser and during the time of price negotiation and contracting

Not of much use in practice

Seller Purchaser

Goods

Price = Cost + Profit


Murabaha Definition

Definition: The sale of goods at cost plus a declared profit (markup).

Murabaha is defined as a particular kind of sale, compliant with Sharia, where the seller mentions the cost he has incurred on the goods to be sold and sells it to the purchaser by adding some profit or mark-up.


Murabaha for the Purchase Orderer

In practice Murabaha needs three parties: Seller, Purchaser and a Financial Institution.

The purchaser requests that the Financial Institution buys the goods from the Seller then sell it to the Purchaser

Seller Purchaser

Goods


(on credit)

Financial

Institution

Goods

Price = Cost

(Cash based)


Murabaha for the Purchase Orderer: The Process

Three Step Process

Step 1: The purchaser requests that the Financial Institution buys the goods from the Seller then sell it to the Purchaser.

Step 2: the Financial Institution buys the goods from the Seller and pays him in cash.

Step 3: the Purchaser buys the good from the Financial Institution for the cost price plus profit. The sale is on usually credit basis.

Seller Purchaser

Goods


(on credit)

Financial

Institution

Goods

Price = Cost

(Cash based)

2 3

1


Murabaha for the Purchase Orderer: Legal Documents and Roles

Step 1

A Request by the purchaser to the Financial Institution to buy certain goods

A Promise to buy the goods once bought by the Financial Institution.

An Undertaking (Wa’ad) by the purchaser in favor of the Financial Institution

Binding or non-binding; with obligation to buy or without

Step 2

The first sales contract (spot exchange)

The Financial Institution is the buyer and the Seller is the seller

Step 3

A second sales contract (deferred payment)

This is the Murabaha contract

The Financial Institution is the seller and the Purchaser is the buyer


Murabaha as a Financing Tool

A purchaser needs financing to buy certain goods

The Financial Institution buys the goods for cash and sells it to the purchaser on a deferred payment (a deferred lump sum or in a series of installments)

Usually used for short & medium term financing

A fixed profit rate is agreed upon on day one

Payment plan calculated using the amortization table

The purchaser owns the goods once the second sale contract is signed


Murabaha as a Financing Tool

Similar to fixed rate unsecured loan in conventional banking.

The bank is taking the credit risk of the cusomer.

Very popular for auto financing, short term real estate financing and trade finance.

Some unwarranted criticism regarding having a large percentage of booked assets as Murabaha

This is a strategy and a product mix issue NOT a Sharia issue

Murabaha has both a Sharai and an Accounting AAOIFI standards


Amortization Table for Murabaha

Payment Number

Payment DateBeginning Balance

Payment Principal Profit Ending

1 1/4/2016 10,000.000 1,365.098 1,165.098 200.000 8,834.902

2 1/7/2016 8,834.902 1,365.098 1,188.400 176.698 7,646.502

3 1/10/2016 7,646.502 1,365.098 1,212.168 152.930 6,434.334

4 1/1/2017 6,434.334 1,365.098 1,236.411 128.687 5,197.923

5 1/4/2017 5,197.923 1,365.098 1,261.140 103.958 3,936.783

6 1/7/2017 3,936.783 1,365.098 1,286.362 78.736 2,650.421

7 1/10/2017 2,650.421 1,365.098 1,312.090 53.008 1,338.331

8 1/1/2018 1,338.331 1,365.098 1,338.331 26.767 (0.000)

Principal: SAR 10,000, Rate: 8%, Period: 2 years, Quarterly payments

Total Profit: 920, Quarterly Installment: 1,365


Murabaha Conditions

Cost must be known to purchaser (customer)

The first contract must be valid (completed)

No usury in the contracts

Financial institution must disclose any fault/damage that occurred after the (first) purchase and all what is related to being a fault

Financial Institution must disclose the terms of payment in the first contract

No increase in the price if there is a default or delay

Fines can be applied but should cover cost and the rest should be paid to charity


Murabaha or Musawama


In Murabaha a discount in price after sale still belongs to the end customer

This is a Sharia Issue

Musawama is a similar contract were the bank doesn’t reveal the original price and you keep any future discounts to the institution

Musawama if you trade; used by banks who trade by them selves.

Murabaha when you don’t

Ijara Financing


Introduction to Ijara

Ijara is the act of leasing as asset

Ijara is considered a sale contract; The seller is the lessor and the buyer is the lessee.

The sold item is the benefit of an asset; the usufruct.

The price is the rent payment

Ijara is used as a financing tool in a lease-to-own manner


Ijara as a Financing Tool


A purchaser needs financing to buy a certain durable item.

The Financial Institution buys the asset for cash and lease it to the purchaser over a specific period

Through lease-to-own method the ownership of the asset is transferred to the lessee at the lease end

Usually used for medium & long term financing

The rate can be fixed or floating through having a different rate for every period

Very popular for long term real estate financing, and equipment financing

Ijara Process

Three Step Process

Step 1: The Purchaser requests that the Financial Institution buys the durable goods (fixed asset) item from the Seller

Step 2: the Financial Institution buys the goods from the Seller and pays him in cash

Step 3: the Financial institution (lessor) leases the item to the Purchaser (lessee). At the end of the lease the ownership is transferred to the lessee.

Seller Lessee

Durable goods

Price = Cost

(Cash Based)

Lessor

Durable Goods

Rent

2 3

1

42ISLAMIC BANKING March 2018

Definition and Elements of Ijara

Definition of Ijara

“Ownership of the right to the benefit (usufruct) of using an asset for a specific period in return for consideration”

Elements of Ijara

Wording

Offer

Acceptance

Contracting Parties

Lessor

Lessee

Subject of the contract

Rent

Benefit (usufruct)


Subject Matter

Benefit

Types of Benefit

Benefit (usufruct) or Service (labor)

Condition of Benefit

Doesn’t consume the asset

Permissible benefit

Lessee is capable of utilizing the benefit

Clearly specified with no room for disputes

Specifying the Benefit

A specific particular asset: Ijara becomes nullified if the asset is impaired.

A generic described asset: If the benefit of the asset is impaired during the lease, the lessor will provide a replacement.

Rent

Rent must be clearly specified and known to both parties

Rent amount is flexible (conditional)

Entitlement of rent is tied to availability of the benefit not by the contract itself

Rent is an indivisible amount. Just rent without a profit and a principal

Rent can be paid in advance, deferred, paid in installments


Contracting Parties Obligation

Lessor’s Obligations

Making the leased asset available

Guarantee the asset

Maintenance of the asset

Major maintenance needed to make the benefit available to the lessee must be performed by the lessor

Operating and periodical maintenance can be performed by the lessee

Lessee’s Obligations

Proper and professional usage of asset (fiduciary capacity)

Payment of rent

Not liable in the case of impairment due to Force Majeure

Liable if damage is due to misconduct or negligenece


Maintenance of the Leased Asset


The lessor is responsible for the defects throughout the Ijara period unless such defects are due to the lessee’s misconduct or negligence.

It is not permissible to have the lessee pay for the maintenance (unknown extra to the rent)

The lessor should maintain the asset and carry out all repairs

However, the lessee can be asked to carry out the maintenance if

Operating maintenance

Periodic maintenance

Known amount maintenance (add to rent)

Maintenance that is a must in order to provide the usufruct (benefit) must be paid by the lessor

Types of Ijara Muntahia Bittamleek(Lease to Own)


IMB through Gift

IMB through sale at end for a token consideration

IMB through sale at end for an specified amount

Sale and Lease back

Ijara Issues


Calculation of Ijara can use the same amortization table used for Murabaha (Standard amortization table)

The asset is on your balance sheet and you will need to depreciate the asset

More complex to implement than Murabaha

In some counties the sales tax (Stamp Duty Land Tax) is paid twice; at the beginning of the Ijar and at the end

The bank takes the asset risk

Ijara has a Sharia and an Accounting AAOIFI standards

Diminishing Musharaka Financing


What is Musharaka

ISLAMIC BANKING 50

A form of partnership between the Islamic bank and its clients whereby each party contributes to the capital of partnership in equal or varying degrees to establish a new project or share in an existing one and whereby each of the parties becomes an owner of the capital on a permanent or declining basis and shall have his due share of profits.

However losses are shared in proportion to the contributed capital.

March 2018

Constant & Diminishing Musharaka


Constant Musharaka

A Musharaka in which the partners’ shares in the capital remain constant throughout the period as specified in the contract

Diminishing Musharaka

A Musharaka in which the Islamic Bank agrees to gradually transfer to the other partner the banks share in the Musharaka. The Bank’s share declines and the other partner’s share increases until the latter becomes the some proprietor of the venture

Financing Through Musharaka


A financing technique based on partnership

Usually diminishing Musharaka

Used for long term financing when we cannot use Ijara

The bank sells its shares gradually at a profit.

Diminishing Musharaka Example

House Price (USD) 200,000 Rate (Annual) 8%

Down Payment 50,000 Tenor (years) 4

Financing Amount 150,000 Payment Frequency monthly

Initial Customer Share 25.00% Payment per month 3,661.94

Initial Bank Share 75.00%


Example (cont.): Diminishing Musharaka Table


Month Beginning BalanceMonthly Payment

Principal ProfitEnding Balance

Share bought

Total Partner Share

1 150,000.00 3,661.94 2,661.94 1,000.00 147,338.06 1.33% 26.33%

2 147,338.06 3,661.94 2,679.68 982.25 144,658.38 1.34% 27.67%

3 144,658.38 3,661.94 2,697.55 964.39 141,960.83 1.35% 29.02%

4 141,960.83 3,661.94 2,715.53 946.41 139,245.30 1.36% 30.38%

5 139,245.30 3,661.94 2,733.64 928.30 136,511.66 1.37% 31.74%

6 136,511.66 3,661.94 2,751.86 910.08 133,759.80 1.38% 33.12%

7 133,759.80 3,661.94 2,770.21 891.73 130,989.59 1.39% 34.51%

8 130,989.59 3,661.94 2,788.67 873.26 128,200.92 1.39% 35.90%

9 128,200.92 3,661.94 2,807.27 854.67 125,393.65 1.40% 37.30%

10 125,393.65 3,661.94 2,825.98 835.96 122,567.67 1.41% 38.72%

11 122,567.67 3,661.94 2,844.82 817.12 119,722.85 1.42% 40.14%

12 119,722.85 3,661.94 2,863.79 798.15 116,859.06 1.43% 41.57%

Diminishing Musharaka Table for the first 12 months

Deminishing Musharaka Issues


Complex to implement

Should not be used at the first two years of operations due to its complexity

Used only when we cannot use Ijara, e.g., the benefit (usufruct) is not available

TawarruqTAWARRUQ AND OTHER FORMS OF CASH FINANCING


Cash Financing


Cash financing is possible in Islamic finance through a complex three step process

Tawarruq is the most common type of cash financing

A family of similar transactions

Tawarruq

Reverse Murabaha

Treasury Borrowing (Money Market Transaction)

Treasury Financing (Money Market Transaction)

All these transactions are identical in nature. The only difference is the roles

Tawarruq


A method where the financial institution, either directly or indirectly, will buy an asset and immediately sell it to a customer on a deferred payment basis.

The customer then sells the same asset to a third party for immediate delivery and payment,

the end result being that the customer receives a cash amount and has a deferred payment obligation for the marked-up price to the financial institution.

The asset is typically a freely tradable commodity such as platinum or copper.

Gold and silver are treated by Sharia as currency and cannot be used.

Tawarruq: The Process

Three Step Process

Step 1: The Bank buys the goods from the Seller at cost and pays him in cash

Step 2: The Customer buys the goods from the Bank at cost plus profit and pays in installments (deferred payment).

Step 3: The Purchaser buys the good from the Customer at cost and pays him in cash

The customer has the cash ($10,000) and he needs to pay the debt ($12,000) to the bank in installments.


Price = Cost

(Cash Basis)


(On Credit)

2 31

Price = Cost

(Cash Basis)

Bank CustomerSupplier Purchaser

Goods Goods Goods

Tawarruq

Tawarruq is a financing transaction in which the bank finances the customer with cash through a three step process.

The customer pays back to the Bank in monthly installments

Used for consumer finance

Tawarruq Cash Flow


M1 M2 M3 M4 M60

Monthly Installments

Reverse Murabaha: The Process

Three Step Process

Step 1: The Customer buys the goods from the Seller at cost and pays him in cash

Step 2: The Bank buys the goods from the Customer at cost plus profit and pays him at the maturity of the deposit tenor.

Step 3: The Purchaser buys the good from the Bank at cost and pays him in cash.

The Bank has the cash ($1,000,000) and he needs to pay the principal plus profit ($1,020,000) to the Customer at maturity.

Price = Cost

(Cash Basis)


(On Credit)

2 31


Price = Cost

(Cash Basis)

Custome

rBankSupplier

Purchase

r

Goods

Goods

Goods

Reverse Murabaha

Reverse Murabaha is a deposit transaction in which the customer puts a deposit with the bank and gets the principal plus Profit at the maturity date of the deposit

Same process as Tawarruq but the roles are reversed

The Bank pays back to the Customer in a single bullet payment that includes principal and profit

Used for large deposits by high net worth individuals usually $1 Million and above


Maturity

Date

Principal

Profit

Reverse Murabaha Cash Flow

Treasury Borrowings & Placements

Three Step Process

Step 1: Bank 1 buys the goods from the Seller at cost and pays him in cash

Step 2: Bank 2 buys the goods from Bank 1 at cost plus profit and pays him at the maturity of the deposit tenor.

Step 3: The Purchaser buys the good from Bank 2 at cost and pays him in cash.

Bank 2 has the cash ($10,000,000) and he needs to pay the principal plus profit ($10,200,000) to Bank 1 at maturity.

Price = Cost

(Cash Basis)


(On Credit)

2 31


Price = Cost

(Cash Basis)

Bank 1

Placemen

t

Bank 2

BorrowingSupplier Purchaser

Goods

Goods

Goods

Treasury Money Market Transactions

Treasury Money market transactions are Placements and Borrowings

In Placements the bank puts the cash with another bank and gets the profit at maturity

In borrowings the Bank borrows the cash from another bank and pays the other bank principal plus profit at the maturity date

Borrowings and Placements are the same thing; only the roles are reversed

Used for large amounts by two different banks through their respective treasury departments

This is the Islamic way of doing money market transactions


Maturity

Date

Principal

Profit

Borrowings & Placements Cash Flow

Cash Financing Differences

The Difference is Roles

All the cash financing transactions are identical but the difference is in the Roles of two parties

One party is giving the cash and the other party is getting the cash

Cannot do it directly because it will be Riba

Many scholars would prefer if the transaction using local goods not international, e.g., London, based goods

Different names

All these names are different forms of Tawarruq or Cash Financing

Tawarruq

Reverse Murabaha

International Murabaha

Commodity Murabaha

Money Market Transaction

Treasury Placement

Treasury Borrowing


Part 3 Deposits


Overview

ISLAMIC BANKING 67

This section is about the basics of Islamic Banking

Mudaraba

Wakala

Deposits in an Islamic Bank

Mudaraba based deposits

Profit Distribution

Wakala based deposits

March 2018

Deposits in an Islamic Bank

Deposits at an Islamic Bank are mainly the following types

Mudaraba

Wakala

Reverse Murabaha

Most deposit accounts are Mudaraba based

Mudaraba is usually invested in financing activities and in Sukuk

Mudaraba has no capital guarantee

Mudaraba requires a sophisticated profit distribution mechanism

Wakala was introduced in the last few years

Wakala is usually invested in the treasury

Profit distribution for Wakala is straight forward

Wakala amounts are usually large while Mudaraba are small to medium

Reverse Murabaha are the largest in terms of amount

All are low risk low return instruments


What is Mudaraba


Mudaraba is a partnership in profit between capital and work

The first party will provide the funds

The second party will provide the work

Profit will be shared between the two parties

An old investment and financing technique

Applications in financial institutions

Deposits: These are called “equity of investment accountholders” in retail banks; they are saving accounts & time deposits.

Used to be called “Unrestricted investment accounts (URIA)”

Investment Accounts in investment banks (private equity firms). These are Restricted Investment Accounts.

Mudaraba Deposits

The bank is the Mudarib

The customer is Rab-ul-Mal

The Mudaraba pool is the pool of money deposited in Mudaraba deposit accounts

Called equity of investment accountholders

Invested in low risk retail and corporate financing and Sukuk

Accounts

Saving Accounts

Time deposits

Calculation and distribution of profit is complex

No capital guarantee


Mudaraba; Restricted & Unrestricted

Restricted

Used for high risk investment accounts by investment banks (private equity firms)

The investment agreement imposes restrictions on where, how and what to invest in.

Usually invested in private equity, venture capital and real state projects

Cannot be commingled with banks other funds

Off balance sheet

Unrestricted

Used by retail banks for low risk saving accounts and time deposits

The banks invests the fund in a way the bank deems appropriate without restrictions to where and how (still must be low risk)

Usually invested in retail financing, corporate financing and Sukuk

Usually commingled with bank other funds

On balance sheet at the Equity of Investment accountholders (URIA) item


Parties


A Mudaraba contract has two parties

Rab-ul-Mal

Mudarib

Rub-ul-Mal is the provider of funds

Mudarib is the funds manager

Both must be eligible to act as principle and as agent

Contract

There are three elements in every Islamic finance

The names under every element are different depending on the type of the contract

Wording

Offer

Acceptance

Contracting Parties

Rab ul Mal

Mudarib

Subject of the Contract

Funds

Work

Profit


Capital (Funds)


Capital is the amount of money given by Rab ul Mal to the Mudarib for the purpose of investing in the Mudaraba activity.

Capital should be known; amount and type

Capital should be in cash but also it could be assets

Capital cannot be debt (financial assets)

If the Mudarib contributes capital (in addition of Rab ul Mal) then he is a Mudarib and another Rab ul Mal.

Work


Work is the exclusive right of the Mudarib.

No fee is paid for the Mudarib for his work. Can charge a fee for other services.

Rab ul Mal should not restrict the Mudarib in way that prevents him from achieving the goals of Mudaraba.

Mudaraba could be restricted or unrestricted.

Restricted in terms of the business activity, business location, business sector, timing, etc.

Profit


Profit is the amount earned in excess of the capital

No profit is distributed before the capital is returned to Rab ul Mal

For a continuous Mudaraba done in phases/stages periodic valuations with profit distributions are fine. Future losses can affect capital, realized undistributed profit and even already distributed profit.

The end objective of Mudaraba is Profit

Profit should be distributed to both parties

The distribution ratio

must be known to both parties

Must be a percentage

The percentage can be renegotiated at later stages

Losses


Losses are only borne by Rab ul Mal

Mudarib does not bear any loss unless the loss was due to his misconduct or negligence

A loss is considered a decrease in the Mudaraba capital

Periodic losses in the course of continuous Mudaraba shall be set off against realized undistributed profit, capital and previously distributed profits,

i.e., Mudarib should get no profit if Rab ul Mal does not get his capital back.

Claw back call of profit

Guarantee in Mudaraba


Guarantee refers to the responsibility of the Mudarib to return the capital to Rab ul Mal regardless of the outcome of the business activity and under all circumstances

Guarantee is NOT allowed in Mudaraba except in the case of misconduct and negligence

Rab ul Mal can ask for a guarantee that he can utilize if there is a misconduct and negligence. This is called Betrayal Guarantee.

Profit Distribution in Retail Banks


The distribution of profit in retail banks means the distribution of the returns of the Mudaraba based deposits to the deposit accounts

Mudaraba based deposits are saving accounts and time deposit accounts

Current accounts (checking accounts) are not part of URIA

Sources & Uses of Mudaraba Deposits

Sources of Mudaraba Deposits

A bank needs deposits to have more cash.

Depositors are Rab ul Mal

To attract deposits a bank will provide the depositors with returns (profit). This is the Mudaraba profit to Rab ul Mal

Types of deposits

Saving accounts

Time deposits; 1, 3, 6 & 12 months

Uses of Mudaraba Deposits

The bank will take is cash and the cash of the depositors and use it in banking activities at higher rate of return

Bank is Mudarib

The profit of the financing is the return of Mudaraba. To be distributed between the depositors and the bank

Uses of Deposits

Retail financing; home and car financing

Corporate financing

Sukuk


Other factors in the Profit Distribution


Reserve

We don’t always distribute the whole profit. We have a reserve account that takes a percentage of the profit during the periods where profit is high

When profit is low the reserve account can be enhanced using the reserve

Expenses

The bank can charge part of the banking activities related to the Mudaraba activities

Must be other than the direct work of the Mudaraba

Provisions

A provision will make the profits less


Mudaraba Pool of Funds (in Retail Banks)

MudarabaPool

Saving

Time Deposit1 month

Car Financing

Home Financing

Corporate Financing

Sukuk

Time Deposit3 month

Time Deposit12 month

Deposits(Liabilities)

Financing(Assets)

Reserve

Bank

Bank is both a Mudarib & Rab-ul-Mal (Partner)

Expenses

Profit Distribution Diagram

ADIB Bank—Customer Profit Rate For Jan 2018

Tier 5 K - 10 K 10 K - 25 K > 25

AED & USD 0.36% 0.37% 0.38%

EUR 0.36% 0.37% 0.38%

GBP 0.36% 0.37% 0.38%

Tier 10 K-250 K 250 K-1 M 1 M-5 M 5 M-10 M > 10 M

1 Month 0.56% 0.56% 0.56% 0.56% 0.59%

3 Month 0.58% 0.58% 0.58% 0.58% 0.61%

6 Month 0.60% 0.60% 0.60% 0.60% 0.69%

9 Month 0.63% 0.63% 0.63% 0.63% 0.73%

12 Month 0.68% 0.68% 0.68% 0.68% 0.78%


•Above are the actual profit distribution rates for January 2018. Future month

profit distribution rates, if any, may vary.

Please note that profit distribution to the Savings account's are on quarterly

basis.

Saving Accounts Time Deposits Accounts

Above are the actual profit distribution rates for January 2018. Future month profit distribution rates, if any, may vary and will be made in accordance with the ADIB’s Banking Services Agreement.

Mudaraba Deposit Example


Mudaraba Type

Amount (Monthly minimum Balance)

weight (Percentage

Invested)Amount Invested Profit

Mudarib Share

Bank (Mudarib) Profit

Customer (Rab ul Mal)

Profit

Rate of return

Saving Account 40,000,000 30% 12,000,000 89,000 25% 22,250 66,750 2.0%

TCD 1 month 20,000,000 60% 12,000,000 89,000 25% 22,250 66,750 4.0%

TCD 3 month 25,000,000 70% 17,500,000 129,792 25% 32,448 97,344 4.7%

TCD 6 month 30,000,000 80% 24,000,000 178,000 25% 44,500 133,500 5.3%

TCD 12 month 10,000,000 90% 9,000,000 66,750 25% 16,688 50,063 6.0%

Assume that the rate of return is 8.9%This slide shows how to calculate the rate of return for each Mudaraba Deposit Account type.

Example: (cont.) Calculation of the Investment rate of return


Investment TypeAllocation

Rate of Weighted Rate

Return

Credit Cards 10% 15% 1.500%

Car Financing 25% 8% 2.000%

home Financing Ijara 45% 9% 4.050%

home Financing 10% 8.50% 0.850%

Sukuk 10% 5% 0.500%

Total (Rate of return) 8.900%

Wakala Deposits


Wakala

Wakala is an agency contract

Wakala is used as a tool for investment

A restricted Wakala for investment purposes

Provider of funds is called al-Muwakil

Agent is called al-Wakeel

Wakala fees

Fixed fee

Percentage of funds

Performance fee

Beyond a hurdle rate fee


Wakala Deposits

Sometimes its called Wakala Treasury Deposit Account

The account is operated under the Islamic Finance principle of Wakala which is an “agency agreement” where the bank would act as the agent to achieve an agreed expected rate of profit for an agreed number of days.

The bank is the agent of the customer, i.e., the bank is the Wakeel

The bank fees are any extra profit beyond the expected return rate

Invested in the treasury activities

Profit is paid at the maturity of the deposit

Minimum amount is usually medium to high


Mudaraba vs. Wakala

Wakala is more flexible than Mudaraba

Profit Distribution for Mudaraba requires a sophisticated software application. Profit distribution in Wakala is easier to implement.

The difference between the two is that with a Mudaraba all the profit is divided between the parties, whilst with a Wakala the investor receives only the agreed ratio against investment. Anything made above that ratio is kept by the financial institution and not given to the investor.

Reverse Murabaha is given to VIP customers and requires a large deposit ($1 million and above)


Session 2: Financial Statements of an Islamic Bank

Overview

ISLAMIC BANKING 91

What are Financial Statements

Who uses them and why

Balance Sheet

Income Statement

Cash Flow Statement

March 2018

Financial Statements

What are Financial Statements

Financial statements are formal records of the financial activities of a business

Status of Business

Performance of Business

Cash

Ownership

Basic Financial Statements

Balance Sheet

Income Statement

Cash Flow Statement

Statement of Changes in Equity


Users of Financial Statements

Owners and managers require financial statements to make important business decisions that affect its continued operations.

These statements are also used as part of management's annual report to the stockholders.

Prospective investors to assess the viability of investing in a business.

Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital. or extend debt securities.

Government entities (tax authorities)

Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.

Media and the general public


Company

Financial

Statements

Financial Statements of Islamic Banks

Islamic banks have their own financial statements that resemble typical financial statements

Financial institutions

Assets are financial assets

Liabilities are deposits. In Islamic banking this is a special type of liabilities.


AAOIFI Accounting Standards

Usually, each product has its own Accounting standards: Murabaha, Ijara, etc.

For the financial statements we use two items from the AAOIFI Accounting Standards

Conceptual Framework for Financial Reporting by Islamic Financial Institutions

General rules

Standard 1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions

Rules related to the presentation of financial statements


Typical Balance Sheet (Financial Position)

ISLAMIC BANKING 96

Basic Equation of Accounting

Assets = Liability + Owner’s Equity

Balanced equation, always

A Balance Sheet is made on a certain date in time

A Balance Sheet is a snapshot in time

What the company has at date xxx

What the company owes at date xxx

What the company is worth at date xxx

March 2018

Typical Balance Sheet (Financial Position) Format

Assets

Cash X

Accounts Receivable X

Inventory X

Supplies X

Prepaid Expenses X

Total Current Assets A

Fixed Assets (at Cost) X

Depreciation (X)

Net Fixed Assets B

Total Assets A + B

Liability & Owner’s Equity

Accounts Payable X

Accrued Expenses X

Unearned Revenue X

Total Current liabilities C

Long term debt D

Total Liabilities E = C+D

Capital F

Retained Earnings G

Owner’s Equity H = G+F

Total Liability & Owner’s Equity E+H


Typical Assets

Assets could be cash, stocks, buildings, rights to collect cash, ..

Assets have value that must be quantified

Some assets are tangible while some assets are intangible like Patents.

The assets are usually ordered in their order of liquidity.

Assets

Current Assets

Long Term Investment

Intangible Assets

Fixed Assets


Typical Assets

Current Assets: Assets expected to be converted to cash or used up within 12 months

Cash

Cash Equivalent (short term securities)

Accounts Receivable

Inventories

Prepaid expenses (supplies & insurance)

Long term investments

Investments in Stocks and Bonds (Sukuk)

Real estate investments

Intangible Assets

Patents

Copyrights

Trademarks

Fixed Assets

Land & Buildings

Machinery & Equipment

Less: Depreciation


Typical Liabilities

Liabilities are economic obligations of the enterprise, such as money that the corporation owes to lenders, suppliers, employees, etc.

Most companies do not depend solely on the equity for financing

In fact owner’s equity is less than debt in most companies

Liabilities

Current Liabilities

Long Term Liabilities


Typical Liabilities

Current Liability

Obligations that the company is to pay within the coming year.

Accounts Payable

Bills to other companies for items bought on credit

Current portion of the long term debt

The amount of a long term debt that must be paid within the coming 12 months

Accrued expenses

Expenses incurred but not yet paid like rent and salaries

Long term liability

Obligations that a company expects to pay after one year.

Bonds (Sukuk)

Mortgage payments


Owner’s Equity

Owner’s Equity

Capital

The amount of capital collected from share holders

Retained Earnings

Retained Earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends.

Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or accumulated deficit.

Retained earnings and losses are cumulative from year to year with losses offsetting earnings.

Owner’s Equity

Capital

Retained Earnings


Statement of Financial Position (Balance Sheet) of an Islamic Bank

The Statement of Financial Position for an Islamic bank is described by AAOIFI Financial Accounting Standard 1 (FAS 1).

Assets must reflect the financing products the bank has offered.

Debt based financing

Partnership based financing

Ijara based financing

Investments

Liabilities must reflect the deposits of the clients

Current account

Partnership based investment accounts

Agency based investment accounts


Statement of Financial Position (Balance Sheet) of an Islamic BankAssets

a) Cash and cash equivalent

b) Receivables (Murabaha, Salam and Istisnaareceivables)

c) Investment securities

d) Mudaraba financing

e) Musharaka financing

f) Investments in other entities

g) Inventories

h) Investment in real estate

i) Assets acquired for leasing (Ijara assets)

j) Other investments

k) Fixed assets

l) Other assets


Statement of Financial Position (Balance Sheet) of an Islamic BankLiabilities

a) Liabilities

b) Equity of Investment Accountholders

c) Owners Equity


Islamic Bank Balance Sheet


Assets = Liability + Equity of Investment Accountholders + Owner’s Equity

+ +++ + =

Equity of investment accountholders

Owner’sEquity

Investments

Financing

LiabilitiesCash

Other Assets

Assets on the Balance Sheet

Financing

Those are the Islamic finance tools to provide financing to clients

Murabaha, Ijara, Musharaka, Salam, Istisnaa, etc.

Usually the largest element on the asset side for a balance sheet

The main source of income for an Islamic retail bank.

Investments

Those are usually Sukuk, Stocks and subsidiaries

Sukuk are the most important part. They are used for liquidity management and can be very profitable sometimes.

Stocks are usually for low companies

Subsidiaries can be other companies usually financial, insurance and real estate companies that the banks owns partially or fully.

Sometimes you might have some real estate investments on the balance sheet. This is dependent of the Bank Strategy.


Equity of Investment Accountholders

The equity of investment account holders is an item that is between the liabilities and owner’s equity on the balance sheet.

Its an unrestricted investment account

Only for Islamic banks

The largest item on the balance sheet


Income Statement


An Income Statement measures the profit or loss over an accounting period

The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

An Income Statement represents the performance of a company over a period of time.

This contrasts with the balance sheet, which represents a single moment in time.

Income Statement form depends on the type of business

Typical Income Statement Format

This is the format for an Income Statement for a merchandising company

Service companies and financial institutions will have slightly different formats

The top line is the total sales

The bottom line is the net income

Income StatementFrom 1st of Jan . till 31st of Dec.

Sales Revenue X

Cost of Goods Sold (X)

Gross Profit A

Sales & Marketing X

General & Administration X

Operating Expenses B

Income from Operations C = A – B

Other Revenues D

Other Expenses E

Net Income C+D – E


Income Statement for Islamic Bank

Islamic Banks will have three main sources of income

Financing

Investment

Services

Notice that the bank needs to pay the depositors their profit.

Income Statement (From 1st of Jan . till 31st of Dec.)

Income from Financing X

Income from Investment X

Income from Banking Services X

Profit on Equity of Inv. Accountholders (X)

Total Income A

Staff Cost (X)

Sales & Marketing (X)

General & Administration (X)

Operating Expenses B

Income from Operations C = A – B

Other Revenue D

Other Expenses E

Net Income C + D – E


Cash Flow Statement

Cash is very important for the continuity of a business

Companies can be profitable but have no cash

Cash flow statement reports cash receipts, cash payment and net changes in cash

Operating activities: Net income cash

Investing activities: Acquiring fixed assets and giving loans

Financing activities: Getting loans and paying dividends

Cash Flow Statement

Operating Activities

Investing Activities

Financing Activities


Cash Flow Statement

Operating Activities

Income statement items

Adjust for noncash expenses e.g. depreciation

Investing Activities

Inflow: sale of fixed asset

Inflow: collection of debt

Financing Activates

Inflow: sale of common stocks

Inflow: Issuance of long term debt (sukuk)

Outflow: Dividends

Cash Flow StatementFrom 1st of Jan . till 31st of Dec.

Cash flow from operating activities

========= X

========= X

Net cash flow from operating activity A

Cash flow from investing activities

========= X

========= X

Net cash flow from investing activities B

Cash flow from financing activities

========= X

========= X

Cash flow from financing activities C

Net Increase in cash D = A+B+C

Cash at beginning of period E

Cash at end of period E+D


Examples of Financial Statements

Albaraka Bank Bahrain

Kuwait Finance House -- Bahrain


Session 3. Islamic Investments

Stocks


Investing in Stocks

Stocks

We can invest in the stocks of all sharia complainant companies.

As for the none Sharia compliant companies we follow the screening criteria from AAOIFI or the Islamic Dow Jones

AAOIFI criteria (Sharia Standard 21)

Islamic Dow Jones criteria

For these approved stocks we must purify our profit regularly by giving it to charity

Ideal Ratings automates the screening process


Islamic Dow Jones Criteria

Sector Based Screening of Stocks

Based on the Shariah Supervisory Board established parameters, the businesses listed below are inconsistent with Shariah law.

Income from the following impure sources cannot exceed 5% of revenue.

Alcohol

Tobacco

Pork-related products

Conventional financial services (banking, insurance, etc.)

Weapons and defense

Entertainment (hotels, casinos/gambling, cinema, pornography, music, etc.)


Islamic Dow Jones Criteria

Accounting Based Screening of Stocks

After removing companies with unacceptable primary business activities, the remaining stocks are evaluated according to several financial ratio filters.

The filters are based on criteria set up by the Shariah Supervisory Board to remove companies with unacceptable levels of debt or impure interest income.

All of the following must be less than 33%:

Total debt divided by trailing 24-month average market capitalization

The sum of a company’s cash and interest-bearing securities divided by trailing 24-month average market capitalization

Accounts receivables divided by trailing 24-month average market capitalization


Equity Screening Solution from Ideal Ratings

Ideal Ratings is US and Egypt based company that provides Islamic investment solutions

IR developed a research methodology to accurately analyze companies’ business activities and revenue breakdown, by mixing the manual research approach and the automated classification techniques

Covers more than 40,000 equities in over 160 countries.

IR research team analyzes companies to identify more than 32 unique categories of Shariah non-compliant activities that cover most of the global Shariah guidelines.

AAOIFI based but also includes other optional filters like sustainability


Equity Screening Solution from Ideal Ratings

Fund managers utilize this screening platform that enables them to identify their investable universe based on their own customized ethical, Shariah and investment guidelines.

IR developed a Shariah/Islamic purification engine to ensure that fund managers are able to accurately purify their funds and portfolios more frequently (weekly, monthly, quarterly etc…) and

The exact purification value can be calculated, which would have an outstanding impact on the funds returns.

Subscription based service and a free app for individuals

See Fedex and Boing reports


Islamic Equity Funds

Equity funds are funds of approved Stocks

There are many of these funds around the world; actively managed funds and index funds

Case study: Jadwa GCC Index Fund (Saudi Arabia).


Islamic Indexes

S&P Shariah

The S&P Shariah indices provide investors with a comprehensive set of Shariah-compliant investment solutions.

Representative of each market, with high correlations to their underlying indices, each index offers a comparable investable portfolio while adopting explicit, transparent selection criteria as defined by Islamic law.


Dow Jones Islamic Market

The Dow Jones Islamic Market™ Index series includes thousands of broad-market, blue-chip, fixed-income and strategy and thematic indices that have passed rules-based screens for Shariah compliance.

Launched in 1999, DJIM World was the world’s first global Shariah-compliant benchmark.compliance concerns Muslim investors would otherwise face in constructing Islamic investment portfolios.

Sukuk


Basics of Sukuk

125

Sukuk is the Islamic version of bonds

Sukuk is a way for Islamic organizations to issue an instrument similar to a tradable Western bonds, while still being Sharia compliant. Sukuk in general may be understood as a Sharia compliant ‘Bonds’.

Sukuk gives the same cash flow behavior of bonds

Sukuk are financial securities that represent a proportional or undivided interest in an asset, or pool of assets, and the claim embodied in Sukuk is not simply claim to a cash flow but an ownership claim.

March 2018ISLAMIC BANKING

Sukuk Design


We have designed Sukuk as a structured product using ideas from Bonds, Securitization and Islamic Sharia

Sukuk

Structure

(Securitization)

Cash Flow

(Bonds)

Transactions & Rules

(Sharia)

Sukuk Cash Flow

Sukuk cash flow is identical to bond’s cash flow

Sukuk Proceeds: Initial payment by investor to the Sukuk issuer

Profit: Periodical payments paid back to the investors usually every 6 months.

Principal Payback: Final payment at maturity, e.g., after 5 years. Final payment is called dissolution payment.


y1 y2 y3 y4 y5

Sukuk Proceeds paid by Sukuk Holders (Investors)

Periodical Payments to Sukuk Holders

Dissolution Payment paid to Sukuk Holders

Basic Sukuk Structure

Seller

Investors(Sukuk Holders)

Purchaser

Issuer

Servicer

Dissolution Payment

Periodical Payments

Sukuk Proceeds

128March 2018ISLAMIC BANKING

Structure Cash Flow Relationship

Seller

Investors(Sukuk Holders)

Purchaser

Issuer

Servicer

Dissolution

Payment

Periodical

Payments

Sukuk

Proceeds

y1 y2 y3 y4 y5

Buy

Sell

Utilize

1

2

3

129

March 2018ISLAMIC BANKING

Sukuk Features

Sharia Compliance

Debt with interest is not allowed in Sharia

Sukuk is a structured product that is Sharia Complaint and have similar features to Bonds

AAOIFI Sharia Standard for Sukuk

Many types of Sukuk based on the contract type

Contract Type is one of the types used in Fiqh Al Muamalat

Cash Flow

Similar to Bonds

Structuring Sukuk

A structured product with several entities

Tradability

Some Sukuk types are tradable while others are not

Secondary Market

Listing

Sukuk can be listed today in several securities exchanges

Rating

Islamic Capital Market

Risk Management


Sukuk Buyers and Sellers

Buyers

Treasury departments in Islamic banks

Pension funds

Insurance and Takaful companies

Asset management firms

Wealth management

High demand in general

Investment allocation and liquidity management thinking

Sellers

Governments

Semi-Government

Corporates

Banks (Tier 2 Capital)

Supply depends on market conditions

Project finance thinking


Sukuk ExampleDubai Islamic Bank 2023

Type: Ijara

Issue Size: $1 billion

Profit rate 3.625%

Currency: USD

Maturity: 06 February 2023

Country of Issue:

United Arab Emirates

Tenor: 5 years

Issue Date: 06 February 2018

Exchanges: Irish Stock Exchange , Nasdaq Dubai/DFM ,

Arrangers:Bank ABC, Dubai Islamic Bank, First Abu Dhabi Bank, HSBC, J. P. Morgan, KFH Capital, Sharjah Islamic Bank and Standard Chartered Bank


Real Estate Investment


Real Estate Funds

Real estate funds are very popular way for investment in the GCC region

The fund would consist of a single real estate asset or a portfolio of real estate assets

Sharia Compliance: A real estate investment/fund must be Sharia complaint from the start. This means that certain properties cannot be part of the fund. This prohibited list includes the following:

Hotels that sell or serve alcohol.

Bars and liqueur stores.

Banks and most financial institutions.

Night clubs and adult entertainment facilities.

Gambling facilities

Please note that supermarkets are allowed in general even if they sell alcohol.


Property Types

Property Types: Most clients prefer a portfolio of properties not just a single big property. Type of assets attractive to local clients

Logistics and warehousing

Retail shops

Student housing

Nursing homes

Office building with single tenant.

Multifamily apartments.


Real Estate Funds

Underlying Asset Class:

Income Generating existing Assets: This asset class is the most requested class.

Real Estate Development Projects.

A Mix of Existing and Development: This is used sometimes to get a recurring income and increase the return at the same time.


Leveraging the Fund

Leveraging the real estate fund through debt is very typical in most real estate funds to increase the return.

The borrowing can be from the local market to get a low cost of funding.

In most cases there will not be Sharia compliant borrowing. In this case the fund can still use a specific legal structure to segregate the non-compliant debt from the asset income. Legal firms working in this area have already developed structures that does that.

Typically, the leverage rate LTV can be from 50% to 75%.


Tax Efficient Structure

Funds related to assets within the GCC usually don’t need a tax efficient structure.

For assets residing in the US and Europe we must use a tax efficient structure to decrease the tax

The fund must be designed from inception to be marketed to GCC investors.

Due to tax regulations in the US/Europe the fund must be structured using a tax efficient structure that reduces the amount of tax paid by the fund. By doing so the return to the GCC investors will be higher.


Examples

Jadwa AlBasateen Real Estate Investment Fund

Markaz Real Estate Fund


Real Estate Investment Fund (REIT)

A Real Estate Investment Trust (REIT) is a company that owns, and in most cases operates, income-producing real estate assets.

REITs are listed and traded on major exchanges just like stocks.

REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, and hotels.

REITs generally must pay out an amount equal to at least 90% percent of their income in the form of dividends to shareholders.

A REIT is an income generating asset.


Islamic REIT

The structuring of Islamic REITs will be the same like the conventional REITs except for the Shariah Guidelines and principles that must be followed

Contracts and principles used.

Managing the REITs:

Utilization of the real estate must be Shariàh compliant, including tenancies & sub-tenancies

Financing of the acquisition / development of the real estate should be Shariàh Compliant

Investment of cash / liquidity must be made in Shariàh compliant instruments

Insurance scheme for protecting the real estate should also be Shariàh compliant


REIT Structure


Islamic REITs are Becoming Popular

Islamic Real Estate Investment Trusts (IREITs) are increasingly becoming popular as an investment vehicle that is much more flexible and diversifying than direct exposure to real estate with similar yields.

The world’s first Islamic REIT created upon such principles was the Malaysia-based Al Aqar KPJ REIT, launched in June 2006. It invested in domestic hospitals.

This was followed by several REITs in Malaysia

While the first REIT in the GCC was actually launched in Kuwait in 2007 as Al Mahrab Tower REIT, it remained a closed and non-listed.

Several GCC REITs were launched but they were closed and non-listed

In 2017 REITs became more popular in the GCC. Several GCC REITs were launched or listed in 2017 and 2018.


GCC Islamic REITs

Emirates REIT: launched in Dubai in 2011 as the UAE’s first REIT and listed on Nasdaq Dubai in April 2014. The world’s largest Islamic REIT. The trust reported total assets of $773 million (Dh2.83 billion) and a market capitalization of $333 million.

Emirates NBD, Dubai’s largest bank, listed its own Islamic REIT called ENBD REIT on Nasdaq Dubai on March 23 2017, raising about $100 million. Today it has $460 million of AUM.

Riyadh REIT was launched in 9 June 2015, and listed in 13 November 2016. Its managed by Riyad Capital (Saudi Arabia).

Jadwa REIT Alharamain Fund (Saudi Arabia).

Al Jazira Mawten REIT (Saudi Arabia)

Wasatah REIT (Saudi Arabia)

Eskan Bank REIT (Bahrain)


Private Equity Funds and Venture Capital


Private Equity Funds

Private equity funds are funds that usually acquire privately owned businesses

They grow the portfolio companies for several years then they sell them at a premium

Islamic private equity funds can only acquire companies that are Sharia complaint

The debt structure has to be Sharia complaint too.

These funds are usually high risk high return funds and offered to sophisticated investors only

The fund is usually managed using a Mudaraba agreement where the fund manager is the Mudarib and the investors are Rab al-Mal.

Usually involves complicated tax efficient structures


A Basic Private Equity Structure


Private Equity in the GCC

The GCC based private equity firms flourished in the 90s and 2000’s.

Started as a platform to invest GCC funds in the US and then GCC investments took place in the 2000’s.

Most of them did not recover after the financial crisis of 2008/2009.

Gradually some of them are having a come back.

The business model was based on huge markup fees.

This model is obsolete.

It did not align the interest of the investor with the interest of the financial firm

More realistic and transparent fees are offered today.


Venture Capital

Venture capital investments are becoming very popular recently in the GCC

Local startups

Islamic versions of the standard contracts have been developed.

Very risky asset class.

VC / Entrepreneurship eco system is developing very fast in the region.

Most startups are Sharia compliant in nature.

Most of the investment is equity investment.

Different types of shares is the main challenge to VC deal from a Sharia point of view


VC Sharia Issues

Equity finance

Convertible debt

Preferred shares

Warrants

Liquidation and sales preference

Transfer restrictions (lockups)


Venture Capital Funds in the GCC Region

Middle East Venture Partners (MEVP)MEVP is a Middle East-focused venture capital firm with offices in Beirut, Dubai and Silicon Valley.

STC VenturesSTC Ventures is a venture capital fund funded by Saudi Telecom Company (STC) and managed by IRIS Capital. Focuses on investments in IT, telecommunications, and digital media.

Wamda CapitalWamda Capital is a Dubai based venture capital firm with FadiGhandour, founder of Aramex at the heart of its operation.

Aramco’s WaedWa’ed, Aramco’s entrepreneurship arm was established in 2011 to promote entrepreneurship in Saudi Arabia.

BECO CapitalBECO Capital is a technology-focused venture capital. Founded in 2014 with its headquarter in Dubai.

500 Falcons500 Falcons is a new $30 million venture capital fund established in Qatar through a partnership between Qatar Foundation Research & Development (QF R&D) and “500 Startups” from the USA.

ISLAMIC BANKING 151March 2018

Wealth Management


Wealth Management in Islamic Banking

Most Islamic banks today offer wealth management services to its clients

This allows the clients to invest in several financial products that are Sharia complaint

Stocks

Sukuk

Funds (equity and fixed income funds)

ETF

REIT

Liquid low and medium risk products

The bank can manage the portfolio or the client can manage the portfolio himself



ADIB Wealth ManagementFour Investment Options

AggressiveBalanced

Ultra Conservative Conservative

Wahed Invest Robo-Advisory

Wahed Invest is a wealth management company based in the US

A Fintech company

Wahed Invest uses a Robo-Advisory to select the right portfolio for the client depending on the risk profile of the client

Technology based

Minimum investment is $100.

Sharia complaint


Wahed Invest Portfolio Offerings


Thank you

Salah Almajthoob

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Islamic Banking, Finance and...

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