Islamic Finance: An overview

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  • Islamic Finance Workshop Dakar Senegal 11-13th, November 2013 Islamic Finance : An overview Mahmoud Sami Nabi Senior Researcher Economist Member of
  • OUTLINE 1. Introduction: Why finance is important ? 2. Islamic Finance 2.1. Origin and principles 2.2. Segments and trends 2.3. Islamic Finance Multilateral Institutions 2.4. Modes of Islamic Finance 2.5. Specific Risk to Islamic Finance 2.6. Islamic Finance and inclusive development 3. Islamic Banks 3.1. Origin and Current state 3.2. Business Model of Islamic Banks 3.3. Islamic Banks in practice 3.4. Resilience to the global crisis 3.5. High potential of growth 3.6. Main challenges 4. Successful Islamic Finance Experiences and prospects in Africa 5. Way forward for African countries 2
  • Islamic Finance Workshop Dakar Senegal 11-13th, November 2013 1. Introduction: Why finance is important ? 3
  • 1. Introduction > Why finance is important ? Financial system influences who can start a business and who cannot, who can pay for education and who cannot, who can attempt to realize one's economic aspirations and who cannot. Thus, finance can shape the gap between the rich and the poor and the degree to which that gap persists across generations. (Source: Demirg-Kunt and Levine, 2009) 4
  • 1. Introduction > Why finance is important ? Monitoring of investments Corporate governance Easing the exchange of goods and services Mobilization and pooling of savings Quality of institutions, Government policies, Geographic conditions, Income level, Cultural characteristics Production of ex-ante information about the investment opportunities Trading, diversificationManagement of risk Functions of the Financial System Source: Levine (2005) 5
  • 1. Introduction > Why finance is important ? The recent global financial Crisis has generated new initiatives to rethink economics and to restore the ethics to finance. Freeman (2010): Restoring finance to its role as a productive force in the economy will require new institutions and modes of compensation, as part of a general overhaul of the relation between finance and the real economy. Source: "Its financialization!", International Labour Review, Vol. 149, No. 2. The tight connection of the financial sphere to the real economic sphere is one of the main features characterizing Islamic Finance. 6
  • Islamic Finance Workshop Dakar Senegal 11-13th, November 2013 2. Islamic Finance 2.1. Origin and principles 2.2. Segments and trends 2.3. Islamic Finance Multilateral Institutions 2.4. Modes of Islamic Finance 2.5. Specific Risk to Islamic Finance 2.6. Islamic Finance and inclusive development 7
  • 2. Islamic Finance > 2.1. Origin and Principles Purposes of the Islamic law (Shariah) according to Ghazali are preserving and enriching : Faith Life Posterity Socially-agreed moral filter ensuring cooperation and wellbeing of all Intellect Wealth It is not an end in itself it is a mean for realizing human wellbeing Source: Chapra (1992, p.7) 8
  • 2. Islamic Finance > 2.1. Origin and Principles .. The goals of socio-economic justice and equitable distribution of income and wealth are an integral part of the moral philosophy of Islam and are based on its unflinching commitment to human brotherhood. Source: Chapra, U. (1983, p2) Monetary Policy in an Islamic Economy .. Pursuit of self-interest demands that one should be conscious of the interest of others and should avoid hurting them. The requirement invokes mutual respect and calls for cooperation - not conflict - for promoting the interest of each other. Source: Hasan, Z. (2011, p16) Scarcity, self-interest, and maximization from Islamic angle 9
  • 2. Islamic Finance > 2.1. Origin and Principles Many verses of the Holy Quran and Hadiths: { And those who, when they spend, are neither prodigal nor grudging; and there is ever a firm station between the two} {Ceux qui, pour leurs dpenses, ne sont ni prodigues, ni mesquins, car la juste mesure se trouve entre les deux} (Al-Tawbah,103) --------------------------------------------------------------------------------------------------------- {Allah hath blighted usury and made almsgiving fruitful} {Dieu anantit les profits de l'usure et fait fructifier les aumnes} (Al-Baqara,103) { } http://www.altafsir.com 10
  • 2. Islamic Finance > 2.1. Origin and Principles the Islamic system creates a balanced relationship between the individual and society. Self-interest and private gains of the individual are not denied, but they are regulated for betterment of the collectivity. Source: Greuning and Iqbal (2008, p.31) "Risk Analysis for Islamic Banks" Islam proposes a model of social responsibility more extensive than the models suggested by the classical economic theories Source: Forget E. (2009) Le dveloppement durable dans la finance thique et la finance islamique, Cahier de la finance islamique, n 1 juin, 2009. 11
  • 2. Islamic Finance > 2.1. Origin and Principles 12
  • 2. Islamic Finance > 2.1. Origin and Principles Muslim narrated on the authority of Abu Saiid Al-Khudriy; Prophet Mohammed (pbuh) said: Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts; and any increase is Riba. Muslim narrated on the authority of Abu Saiid Al-Khudriy {Bilal visited the Messenger of Allah (pbuh) with some high quality dates, and the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah (pbuh) said: this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other.} 13
  • 2. Islamic Finance > 2.1. Origin and Principles Riba literally means excess and reflects any unjustifiable increase of capital whether in loans or sales. More precisely, any positive, fixed, predetermined rate tied to the maturity and the amount of principal (Greuning and Iqbal, 2008) Riba al-fadl : where money is exchanged for money hand-tohand, but in different quantities. Riba al-nasah: where money is exchanged for money with deferment. In conventional finance: time value of money is reflected in interest payments. In Islamic finance: Money has no intrinsic utility. It is a potential capital which materialize only if it joins other resources (effort and labor) to undertake a productive activity 14
  • 2. Islamic Finance > 2.1. Origin and Principles The remuneration of capital should be the counterpart of risk inherent to trade and investment activities based on: Profit and Loss Sharing when capital finance investment activities. Difference in the price of buying and the price of selling when financing trade activities. 15
  • 2. Islamic Finance > 2.1. Origin and Principles {they said: Trade is just like usury; whereas Allah permitteth trading and forbiddeth usury...} {ils disaient : " La vente est semblable l'usure ". Mais Dieu a permis la vente et Il a interdit l'usure...} (Al-Baqara,103) All financial transactions must be backed by real assets. Debt (originated from a trade transaction) cannot be traded, rescheduled or discounted for interest. However, debt can be swapped for goods and services. 16
  • 2. Islamic Finance > 2.2. Segments and trends The Islamic financial services industry (IFSI) has grown in size and geographic coverage. More than 600 Islamic Financial Institutions operating in more than 75 jurisdictions. Islamic Finance Assets Growth Source: KFH Research (2012) 17
  • 2. Islamic Finance > 2.2. Segments and trends Islamic funds (680) : assets under the management of passed from USD 29.2 bln in 2004 to USD 64 bln in Oct. 2012 . Islamic Funds Assets 5% Cooperative Insurance (Takaful): small segment but its total gross contributions Takaful have grown by a CAGR of 23.1% over Assets 2004-2011 with an estimate of USD 15.2 bln in 2012. 1% Sukuk Outstanding 13% Sukuk : issuances growing at CAGR of 42.3% over 2004-2011 passing from USD 7.2 bln to USD 85.1 bln. Global aggregate sukuk 1996-2012 USD 396.4 bln. Breakdown of Islamic Assets by type (2011e) Banking Assets 81% Islamic banks and Islamic banking windows: central pillar with 40.3% og CAGR over 2004-2011 and total assets estimated to USD 1.1 tln. Sources: KFH, 2012 ; Thomson Reuters, Zawya, 2012. 18
  • 2. Islamic Finance > 2.2. Segments and trends Islamic Microfinance: emerging market niche and promising segment for financial inclusion: ~ 255 providers around the world 164 providers in East Asia and Pacific and 72 providers in MENA. Poor clients using Sharia-compliant products estimated at 1.28 million Source: CGAP