Islamic Banking & Finance

Concept, Present State & Prospects

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Muhammad Saarim Ghazi
Head Sharia Advisory & Structuring Head University of London International Programmes Al-Hidayah Centre for Islamic Finance

Lecture Roadmap
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The concept behind development of Islamic finance Why Islamic finance evolved? Historical development of Islamic finance & its current position How Islamic finance evolved ? Strength of the industry in global financial crisis 2008 Is Islamic finance a viable alternative ? Questions & Answers Session

The Idea Generation

Western commercial banks date from about three - four centuries ago. When the Muslim world came into contact with the west, Muslims had two choices: to accept the interest based banking or to establish their own interest free-banking The idea of establishing an interest free bank goes back to 1940s

Prophet (peace be upon him)

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The Messenger of Allah cursed the one who accepted riba, the one who paid it, the one who recorded it, and the two witnesses to it. He said: They are all alike.
(Sahih Muslim)

Aun ibn Hanifa reported from his father that the Prophet (peace be upon him) had condemned both the receiver of interest and its payer.

Evolution & Development

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First Experiments; Saving Association 1. Mit Ghamr Saving Association Egypt (1963) 2. Tabung Haji Malaysia (1963) The Emergence of Islamic Banks 1. Nasser Social Bank - Cairo (1971) 2. Islamic Development Bank Jeddah (1975) 3. Dubai Islamic Bank Dubai (1975) 4. Faisal Islamic Bank - Egypt & Sudan (1977) 5. Kuwait Finance House - Kuwait (1977) International Holding Companies 1. Dar-al-Maal-al-Islami (DMI) Trust -1981 2. Al Baraka Group 1981

Evolution & Development Regulatory & Supervisory Organisations

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Accounting & Auditing Organizations for Islamic Financial Institutions (AAOIFI) - Bahrain (1990) Islamic Finance Services Board (IFSB) Malaysia (2002) International Islamic Financial Market (IIFM ) Bahrain (2002) Liquidity Management Center (LMC) - Bahrain (2002) International Islamic Rating Agency (IIRA) Bahrain (2005)

Evolution & Development Islamic Indices

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Dow Jones Islamic Market Index (DJIM) - New York USA Kuala Lumpur Shariah Index (KLSI) - Kuala Lumpur Malaysia Jakarta Islamic Index (JII) Jakarta, Indonesia Global GCC Islamic Index Kuwait HBSC/ DIFX Index FTSE Islamic Global Index

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Evolution & Development

Financial Highlights

Total Islamic Financial Institutions Continents Countries Total Assets Expectation in 2015 Annual Growth 80 6

Over 3000

USD 1.13 trillion USD 2.8 trillion 15-20%

Pakistan

Full Fledged Islamic Banks Conventional Banks with Islamic branches Takaful Companies

5 13 5

Global Islamic Financial Services Industry

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Potential Size of the Industry Actual Size The Size Gap Global Growth Rate (2010) Catch up Parameter

USD 4.4 trillion USD 1.13 trillion

USD 3.27 trillion 10%

9 Years (with 25% growth)

Deposit Mobilization by Islamic Banks Liability Side

Current Account Qard-e-Hasan Saving & Term Deposit Mudarabah

Demand/ Interest Free Deposit

Islamic Framework Loa n Princip al

Depositors

Bank

Conventional Framework Loa n Princip al

Depositors

Bank

Deposits Carrying a Return

Islamic Framework Depositors Funds for Investments Principal* + Share in Profits
*Principal is not guaranteed

Bank

Conventional Framework Interest based Loan Principal + Interest

Depositors

Bank

Islamic Modes of Financing

1. Musharakah

(Partnership Mode) 2. Modarabah (Partnership Mode) 3. Diminishing Musharakah (Partnership Mode)

1. Murabaha

(Credit Sale) 2. Musawamah (Credit Sale) 3. Salam (Future Sale) 4. Istisna (Future Sale) 5. Istijrar (Repeat Sale)
1. Ijarah

(Leasing)

Riba
Any amount, big or small, over the principal, in a contract of loan or debt is Riba prohibited by the Holy Quran, regardless of whether the loan is taken for the purpose of consumption or for some production activity.

Misconception about the Nature of Money

Money should be treated as a commodity. So, just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value: therefore he can lend his money and can claim interest thereupon.

Difference between Money and Commodity

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Money has no intrinsic utility. It can not be utilized in direct fulfillment of human needs it can only be used for acquiring some goods or services. The commodities can be of different qualities while money has no quality except that it is a measure of value or a medium of exchange. In commodities, the transactions of sale and purchase are effected on an identified

Misconception
Riba is restricted to consumption loans and does not include Productive/ Commercial loans. The Holy Qur'an had prohibited claiming any increase over and above the principal in the case of consumption loans only, where the borrowers used to be poor person's borrowing money to meet their day to day needs of food and clothes etc. While in case of productive & commercial loans there is no Zulm because in most cases the debtors are wealthy or at least economically well-off and the loans taken by them are generally used for generating profits. Therefore, any increase charged from them by the creditors cannot he term as Zulm (injustice) which was the basic cause of the prohibition of 'riba'.

Answer
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Firstly, The validity of a financial or commercial transaction does never depend on the financial position of the parties. It rather depends on the intrinsic nature of the transaction itself. Secondly, 'poverty' is a relative term which has different degrees. Once it is accepted that interest cannot be charged from the poor, while it is quite lawful to be charged from the rich, who will have the authority to determine the exact degree of poverty required for exempting a person from the charge of interest?

Thirdly, Quran has prohibited riba in general terms, which include all the forms of riba. Fourthly, Zulm is the hikmat and not the illat (basic cause) of prohibition.

Misconception
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The prohibition of riba is applicable only to those interest transactions where the rate of interest is exorbitant or excessive. This argument is sought to be supported by the verse of Surah Al-i-'Imran:

No verse can be interpreted in isolation from the other relevant material available in other parts of the Holy Qur'an.

"O those who believe fear Allah and give up whatever remains of riba, if you are believers." [AlBaqarah 2:278]
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The point is further clarified in express terms by the following sentence: Unlike the text of a statute book, the Holy Qur'an contains some words or expressions used either for emphasis or for explaining the evil results of a particular act. "Do not sell my verses for a little price." [Al-Baqarah 2:41]

Performance of Top 10 Islamic Banks Vs Top 10 Conventional Banks

Financial Crisis 2008

Top 10 Conventional VS
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Top 10 Islamic

Citigroup Bank of America ICB of China HSBC JP Morgan Chase Bank of China China Construction Bank UBS Royal Bank of Scotland Mitsubishi UFJ Fin.

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Al Rajhi Bank Kuwait Finance House Dubai Islamic Bank Bank Al Bilad Qatar Islamic Bank Investment Dar Abu Dhabi Islamic Bank Kuwait International Bank Gulf Finance House Qatar Intl Bank

Top 10 conventional banks

42.8%

Top 10 Islamic banks

8.5%

Combined Market Capitalisation

Aggregate Net Profits

USD116 billion in 2006 USD4.2 billion to USD4.6 to billion Net loss of USD42 billion(9 % Profit) 2008

Growth in Assets

36% 24%

55%
Growth in Equity

36%

12

Conventional Vs Islamic

10

Financial Assistance
Five of the top 10 conventional banks received government financial assistance of USD163 billion in aggregate i.e. 26% of the affected banks combined equity. Vs. As at end 2009, none of the Islamic banks needed any government rescue scheme.

The Great Destruction

Sept 15, 2008 Lehman Brothers; 4th Largest Investment Bank becomes Bankrupt Merrill Lynch; 3rd Largest Investment Bank sold to Bank of America Sept 17, 2008 AIG; US Treasury seized control of the Company Sept 22, 2008 Goldman Sachs & Morgan Stanley; Last two major investment banks converted into traditional banks holding companies Sept 25, 2008 Washington Mutual; Forced sale to JP Morgan Chases by Regulators November 1, 2009 CIT Group filed for bankruptcy protection

hy Islamic Finance W More Resilient ? Remained

General Principles of Contracts & Transactions in Islamic Law

Guiding Principles of Islamic Commercial Law

Principle Prohibition of Gharar (Uncertainty, Deceit & Hazard)

Gharar takes place where the consequences (of a transaction) are concealed.
(Imam Sarkhsi; Al Mabsut, Vol 13 p 194)

Uncertainty and Excessive Risk

Financial innovation with

unnecessary complications Islamic commercial law requires resulted in new risks that are less absolute certainty about the understood, assessed & terms and conditions of contractual obligations. controlled.

Principle Prohibition of Speculative Behaviour

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Every form of money acquisition of which depends upon luck or chance (zero-sum-game) You gain what you have not earned - Gambling According to the International
Swaps and Derivatives Association (ISDA), the total Examples notional value of CDSs in mid 2008 is lottery & draws. Mobilizing resources on the basis of approximately $55 trillion, doubling its size from mid 2006.

Futures & Options contracts that are settled through price differences only. AIG alone is reported to have sold
over $440 billion of CDSs protection on a notional basis.

Volume of global international trade in 2008 = USD32 trillion Average of USD88 billion on a daily basis Daily turnover in global foreign exchange markets was USD3.98 trillion i.e. 45 times more than the vol. of international trade. Only 2% of trade in currencies is based on the genuine cross-border trade, while 98% of currencies transactions account for nothing but speculation in money prices. Total derivatives was USD741.1 trillion in 2008 (Year end) Total GDP of the entire world

Principle Prohibition of Khilabah & Ghishsh (Fraud & Deception)

Khilabah: concealing the defects of and in merchandise Tatfeef: Giving short weight and measure Najash/ Tanajush: False bidding to raise prices Hiding defects of commodity in Sale. Ghabn-e-Kaseer / Ghabn-e-Fahish False Swearing
Low level of transparency & disclosure damaged market confidence & contributed to market panic

Talaqqi al-Rukban: purchasing merchandise before they reach the market place.

Conclusion
This was not the first time when Islamic financial institutions were tested with a systematic crisis. Resilience in the Past
The experience of KFH in surviving the Kuwait Souq al-Manakh crisis in 1982. The performance of Bank Islam in navigating through the Asian financial crisis 1997-98. The resilience of Turkish participation banks in coming out of the economic crisis in 2000-01.

Today we have reached a tipping point, which leaves us only one choice: change or face continued decline and misery. Chairman World Economic Forum

pThank

You

Muhammad Saarim Ghazi saarim.iiu@gmail.com 0300 515 9750

Courtesy for Statistics

IM