issue no. 173 - october–december 2009 / shawwal–dhu al hijjah 1430

GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 173OCTOBER–DECEMBER 2009

SHAWWAL–DHU AL HIJJAH 1430

WAQF: ALLEVIATING POVERTY

FINANCIAL CRISIS: LESSONS FOR ISLAMIC FINANCE

IT FOCUS: ARAB BANK

ANALYSIS: MUSHARAKAH MUTANAQISAH

IIBI CAMBRIDGE WORKSHOP REVIEW

PUBLISHED SINCE 1991

46 Shari’ah and legal issues of musharakah mutanaqisah

Adam Ng Boon Ka, PhD candidate at the International Centre for Education in Islamic Finance, Malaysia, takes a close look at this type of financing.

www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Shawwal–Dhu Al Hijjah 1430

Features

Regulars

12 Recent crisis: lessons for Islamic finance

Leading financial hubs are increasingly looking towardIslamic finance as a new type of banking that will promote lasting stability. NewHorizon examines thevaluable lessons the Islamic finance industry shouldlearn from the recent financial turmoil.

18 Horses for courses

There is no doubt thattechnology is vital for any financial institutionnowadays, whether conventional or Islamic.NewHorizon talks to Andrew Cobb, chief proj-ects officer at Arab Bank, about the bank’s first-handexperience in implementing Islamic banking softwareacross its international locations.

40 Would Islamic finance have prevented the global financial crisis?

Mohammed Amin, UK head of Islamic finance at PricewaterhouseCoopers LLP,addresses the question on everyone’s lips.

24 Waqf and zakat: alleviating poverty How can Shari’ah-compliant finance mechanisms assist in the burning issue of alleviating poverty? In thefirst of a two-part analysis, NewHorizon focuses onwaqf.

CONTENTS

London conference, ‘Managing Shari’ah Risk through Shari’ah Governance’.

38 DIARYUpcoming Islamic finance events endorsed by the IIBI.

45 RATINGS & INDICESCredit ratings of Islamic financial institutions and instruments by Capital Intelligence (CI).

50 GLOSSARY

IIBI and ISRA sign MoU. IIBI and SII join forces to promote the UK as Islamic finance hub.More students complete the IIBI’s Post Graduate Diploma course.

30 IIBI LECTURESJuly and August lectures reviewed.

34 IIBI EVENTS REVIEWReviews of the Cambridge workshop,‘Structuring Innovative Islamic Financial Products’, and the

04 EXECUTIVE EDITOR’S NOTE

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

16 APPOINTMENTSA summary of appointments within the Islamic finance industry.

20 IIBI NEWSIIBI, GK Partners and the British Library hold the UK’s first Access to Islamic Finance (A2IF) conference.

24

46

18

www.newhorizon-islamicbanking.com

NEWHORIZON October–December 2009

Executive Editor’s Note

On behalf of the staff at the IIBI and NewHorizon I would like towish all our readers Eid Mubarak.

The month of Ramadan has special significance for Muslims theworld over. ‘The month of Ramadan is the month in which was sent down the Quran, as a guide to mankind, also clear (Signs) for guidance and judgement (between right and wrong).’ (TheQuran 2:185). It is a time for deep devotion and reflection on thewisdom and guidance that comes with faith. It brings the spirit ofgiving and sharing to the fore. US President Barack Obama in hisRamadan message this year reminded us that fasting is shared bymany faiths as a way to bring people closer to God and to thoseamong us who cannot take their next meal for granted, and for all of us to remember that the world we want to build and thechanges we want to make must begin in our own hearts and in our own communities.

NewHorizon ponders how Islamic finance mechanisms can be applied to a long-term strategy of poverty alleviation. To begin with, we focus on waqf, followed by an in-depth analysis of zakat in the next issue of the magazine. Would Islamic finance have prevented the crisis? What lessons should be learned from recentevents? Eminent Islamic finance specialists attempt to answer thesepertinent questions.

Together with GK partners (advisers to socially responsible business)and the British Library, the IIBI held the UK’s first Access to IslamicFinance (A2IF) conference. The Institute’s third annual residentialworkshop on structuring innovative Islamic financial products, heldin August in Cambridge, was also a success. Furthermore, the IIBIhas signed a memorandum of understanding with the InternationalShari’ah Research Academy for Islamic Finance (ISRA), and anagreement with the Securities and Investment Institute (SII), a Lon-don-based professional body for those working in the financial andinvestment industry, to promote the UK as an Islamic finance hub.

As always, I hope that you will find this issue of the magazine interesting, informative and thought-provoking.

Mohammad Ali QayyumDirector General IIBI

EDITORIAL

EXECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORTanya Andreasyan

IIBI EDITORMohammad Shafique

CONTRIBUTING EDITORJames Ling

NEWS EDITORLawrence Freeborn

IIBI EDITORIAL ADVISORY PANELMohammed AminRichard T de BelderAjmal BhattyStella CoxDr Humayon Dar Iqbal KhanDr Imran Ashraf Usmani

DESIGN CONSULTANTEmily Brown

PUBLISHED BY IBS Publishing Ltd8 Stade StreetHythe, Kent, CT21 6BEUnited KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: www.ibspublishing.com

CONTACTAdvertisingIBS Publishing LtdPaul MinisterAdvertising ManagerTel: +44 (0) 1303 263 527Fax: +44 (0) 1303 262 646Email: [email protected]

SUBSCRIPTION IBS Publishing Limited8 Stade Street, Hythe, Kent, CT21 6BE, United KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: newhorizon-islamicbanking.com

©Institute of Islamic Banking and InsuranceISSN 0955-095X

Cover photo: © Amanda Rihde,iStockphoto.com

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

Surat Al Baqara, Holy Quran

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

4 IIBI



The Accounting and AuditingOrganisation for Islamic Finan-cial Institutions (AAOIFI) hasannounced its intention to mon-itor Islamic financial products inthe absence of a sector watch-dog. AAOIFI stated it plans to‘screen products and services of-fered by the industry for Shar-i’ah compliance’. According toMohamad Nedal Alchaar, secre-tary general of the organisation,the move would help to ‘ho-mogenise the market’.

‘Although AAOIFI is not takingon a permanent role of industrywatchdog, there exists a currenthuge gap in the market relating

to credible Shari’ah compliancescreening of products and serv-ices,’ stated Alchaar.

Currently, the Islamic financialindustry must rely on differentstandard-setting bodies, such asAAOIFI in Bahrain and the In-ternational Financial ServicesBoard (IFSB) in Malaysia, whichrecently issued new governanceand capital adequacy guidelines(NewHorizon, April–June2009). The guidance of individ-ual, qualified Shari’ah scholarsalso plays an important role, asdo national governments incountries which practice Islamicfinance.

An example of the difficultiesfacing the industry came withcomments from Shaikh Muham-mad Taqi Usmani, head of theShari’ah committee of AAOIFI,pronounced in February 2008that many sukuk issues up tothat point were not Shari’ah-compliant. This resulted in asharp drop in new issues ofsukuk, despite having doubledevery year since 2004(NewHorizon, October–December 2008).

As well as preparing accounting,governance, ethics and Shari’ahstandards for Islamic bankingand financial institutions,

AAOIFI to perform temporary watchdog role

AAOIFI already provides prod-uct and auditing standardswhich are mandatory in sevencountries across the Islamicworld (Dubai, Bahrain, Jordan,Lebanon, Qatar, Syria andSudan). Alchaar stated thatAAOIFI wants to screen prod-ucts of all institutions, not justthose which are members ofAAOIFI, and not just those inthe seven countries listed. ‘It willbe market-wide, regardless ofthe geographic distribution ofproducts,’ he said.

AAOFI plans to submit a pro-posal to this effect to its boardof trustees by the end of 2009.

Thailand’s Ministry of Inte-rior has told governmentagencies and state-owned or-ganisations to provide techni-cal, management and financialsupport to encourage Islamicmicrofinance in the country.The proposal by the Ministryhas received cabinet support.It will result in knowledge oftransactions, accountancy andwelfare arrangements accord-ing to Shari’ah being passedon to staff in the sector by theagencies and organisations in-volved. Social welfare andother benefits, in terms of ed-ucation, social services andthe environment, will also beprovided for members of Is-lamic microcredit plans.

According to the Ministry ofInterior, the Southern BorderProvinces Administrative Cen-

tre had appointed aworking group to studywhat form and model ofIslamic microcreditwould be most appropri-ate. The population ofthis region is predomi-nantly Muslim, and theMinistry’s objective isthat communities in thearea have access to finan-cial institutions whichoperate in accordancewith their own lifestyleand religious beliefs.

The working group’sstudy demonstrated thatmost villagers were keento see the establishmentof Shari’ah-compliant micro-finance in their communities,although they still lacked un-derstanding of financialmechanisms used in the in-

Thailand’s government supports Islamic microfinance

NEWS

dustry. Once the workinggroup submitted its study, inMay 2009, the administrativecentre then made its proposalon Shari’ah-compliant microfi-

nance to the government. Muslims are the second largestreligious group in Thailand,numbering approximately twomillion.

Pattani Mosque,Thailand

© Jean-Yves Benedeyt, iStockphoto.com

6 IIBI www.newhorizon-islamicbanking.com


Malaysia’s central bank andregulator, Bank NegaraMalaysia (BNM), has issued itsmurabaha parameter, the firstin a series of Shari’ah parame-ters to Islamic financial institu-tions in the country. These areissued as guidance and refer-ence to promote greater har-monisation in the developmentof the Islamic finance industryin the Malaysia.

This initiative aims to definethe essential features of Shar-i’ah-compliant financial prod-ucts and services based onexisting contracts that havebeen endorsed by Shari’ahboards and used by Islamic in-

time as it would unlock thehuge potential of the domestic market. He believed that theagreement could improve theinnovation level of depositproducts.

‘The adoption of the CMMAfor corporate deposits is ex-pected to result in cost and resource savings for both Is-lamic banks and corpora-tions,’ said Zukri at thelaunch. Takaful Malaysia,ACR Retakaful, Astro, Mae-sat and the Employees Provi-dent Fund have all signed amemorandum of understand-ing (MoU) to participate inthe CMMA.

Bank Negara Malaysia issues first Shari’ah parameter

stitutions. The parameters willact as standard documents forunderstanding the principlesand basis for adopting Shari’ahcontracts.

The murabaha parameter out-lines the main Shari’ah require-ments in the contracts andprovides examples, methods andmodels for practical applicationof this mode of financing. It willalso contribute to further har-monisation in the interpretationand application of Shari’ahviews and opinions among Shar-i’ah committee members.

To ensure the robustness of theparameter, BNM has conducted

extensive research and compiledvarious fatwas in addition to theviews of several local and inter-national Shari’ah boards.

Further parameters are currentlybeing developed, including ijara,mudarabah, musharakah, is-tisna and al-wadia.

Meanwhile, the Association ofIslamic Banking InstitutionsMalaysia (AIBIM) has launcheda Corporate Murabaha MasterAgreement (CMMA), with theintention of boosting the work-ings of the Islamic money mar-ket in the country. AIBIM’spresident, Datuk Zukri Samat,said the launch came at a good

NEWS

First fully Islamic bank to open in India

The first Indian bank to dealonly in Islamic financial prod-ucts is to open in Kochi, in thesouth western Indian state ofKerala, early next year. The Ker-ala State Industrial DevelopmentCorporation has initiated thecompany with an authorisedcapital of over $100 million.The company is expected to in-vest mainly in infrastructureprojects and pay dividends todepositors, and the state govern-ment is looking into which prod-ucts to finance with the bank.

P. Mohammed Ali of Oman’sGalfar Group, C.K. Menon ofDoha-based Behzad Group,M.A. Yusuf Ali who heads theLuLu supermarket chain in theGulf, and Azad Moopen ofMoopen’s Group are said to be

the company’s major promot-ers. The state government saidthat the outfit will first oper-ate as a non-banking financecompany before becoming afully Shari’ah-compliant bank.

There are approximately 150million Muslims in India,making the Indian Muslimpopulation the third largest inthe world (after Indonesia andPakistan). Senior politiciansand officials in India, such asAmar Singh, general secretaryof India’s Socialist party, havein recent times spoken infavour of Islamic finance inthe country. The push in Kerala is supported by the regional government headedby state finance minister DrThomas Isaac, who believes

that Islamicfinance op-tions will helpexpatriateswho return toIndia havinglost their jobsas a result ofthe global recession.

It will appar-ently also setup a separatesocial fundfor financing interest-free loansfor Gulf returnees (Indianswho had previously worked inthe GCC) to start small-scaleventures. Isaac was recentlyquoted as saying that hewanted GCC members to con-tribute to the fund. The gov-

ernment had formed a promot-ers group, including business-man Mohammed Ali, who wasquoted as explaining that ‘Is-lamic banking doesn’t work oninterest. It invests deposits inbusiness and returns a share ofits profit to depositors.’

New Dehli,India


NEWHORIZON October–December 2009NEWS

A number of Islamic financialinstitutions around the worldare celebrating the holy monthof Ramadan by stepping uptheir charitable operations. Cor-porate social responsibility(CSR) is an important year-round consideration, but thistime represents a valuable op-portunity to double charitabledeeds and strengthen relationswith the community.

In Malaysia, Maybank has setup a fund, Tabung Maybank Se-jahtera, to assist the creation ofsustainable living environmentsfor vulnerable communities inthe country regardless of race,religion or creed. Members ofthe public are able to donate tothis fund via all of the bank’sdelivery channels.

For the second successive yearSaudi Arabian bank, SABB, issponsoring orphans to performUmrah during Ramadan. Thebank is covering the expenses of300 boys and girls to performthe pilgrimage through its par-ticipation in the Umrah Pro-gramme organised by Riyadh

Orphan Care Charitable Soci-ety, Ensan.

Shamil Bank, an Islamic com-mercial bank in Bahrain, ishelping two children in theKingdom regain their ability tohear with the purchase of twosophisticated cochlear implanthearing aids. The bank has pre-sented the hearing aids to theBahraini Society forCochlear Implanta-tion and Hearing Im-pairment (right). Theywill then be passed on to the CochlearImplantation team of the country’s Min-istry of Health for implantation to twochildren on the waiting list.

The Indian Islamic Associationand Qatar International IslamicBank have partnered to trans-late three Arabic religiousbooks into Malayalam to helpcreate awareness of Islam in theIndian community in Qatar.The books are: ‘The CompletePrayer’ by Sheikh Abdullah Jar-

Ramadan inspires CSR in Islamic banks

allah al-Jarallah; ‘This Is What Life Has Taught Me’ byMustafa al-Sibaai and ‘Compre-hensiveness of Islam’ by SheikhYousef al-Qaradawi. The bookshave been printed in India andare being distributed amongMalayalam speakers in Qatarfor free. A number have alsobeen sent to educational estab-lishments and public libraries in

the Indian state of Kerala.Meanwhile in Malaysia, Taka-ful Ikhlas, a provider of Shar-i’ah-compliant insurance, hasbrought joy to a score of poorchildren in the Petaling Jaya dis-trict of Selangor, by treatingthem to a day of Hari Raya(Eid) shopping followed by adinner to break their fast. The

day out was organised by Taka-ful Ikhlas in conjunction withthe Petaling Jaya branch of theSelangor Tithe Board.

The children, aged between fiveand 17, were accompanied to a shopping complex in BukitTinggi, Klang, where the takafulfirm paid for the purchase of all their clothes and shoes, be-fore picking up the tab for aniftar dinner. Takaful Ikhlas alsomade a donation to nine furtherchildren, who were unable to attend.

‘The children got to know ourstaff, who could be like fosterbrothers and sisters to them,’said chief operating officer and executive vice president of Takaful Ikhlas, Wan MohdFadzlullah.

While Takaful Ikhlas has em-braced the social side of Islamicfinance for Ramadan, it doeshave a track record of makingcharitable donations. In July2009, it donated a dialysis ma-chine to the Mersing DistrictHospital in Johor.

Pakistan-based MeezanBank has signed a memoran-dum of understanding(MoU) with internationalnon-governmental organisa-tion (NGO), Islamic Relief.

Under the terms of theMoU, Meezan will assist Is-lamic Relief to further en-

hance its Shari’ah-compliantmicrofinance operations in thecountry by capacity building,training and product develop-ment support.

Islamic Relief has been offer-ing Shari’ah-compliant micro-credit facilities around theworld for a number of years,

Meezan Bank partners with Islamic Relief

and in Pakistan since 2001. Itgives out loans through a non-interest bearing mudarabah financing strategy. Once se-lected for loan eligibility, bene-ficiaries are provided thedesired working capital oncredit. Repayments are made in instalments over the periodof one year.

Islamic Relief has several on-going projects in Pakistan,such as a small enterprise development programme inpartnership with HSBC thatoffers halal lending to femaleentrepreneurs. To date, thisproject has helped 388women in the Rawalpindidistrict in Punjab.


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 NEWS

The Turkish operation ofKuwait Finance House (KFH),known as Baytak, has received alicence from the Federal Finan-cial Supervisory Authority ofGermany to establish a Shar-i’ah-compliant financial servicesbranch in the country. Thebranch will be headquartered inMannheim, in the south westernGerman state of Baden-Würt-temberg. Mohammed Al-Omar,chairman of Baytak, stated thatthis is a significant step in thegeographical expansion strategyof the bank. He added that it islikely to open more branches inGermany, and also apply for li-cences to operate in other Euro-pean countries.

Turks are the second largest eth-

nic group in Germany, whileMuslims in the country accountfor 3.7 per cent of the popula-tion. Saxony-Anhalt, anotherfederal state of Germany, hasthe distinction of issuing theonly sovereign sukuk in westernEurope (NewHorizon, January– March 2009), showing thatthere is an interest in Islamicbanking that KFH will be ableto target.

KFH has over 100 branches in Turkey, as well as offices inother countries including re-cently established representationin Kazakhstan. Other parts ofKFH have also continued togrow, for example in Kuwait,where another five branches are due to open.

Gulf Finance House (GFH),the Middle Eastern Islamic investment bank, plans tofound a joint Islamic financialservices platform in the Mid-dle East with MacquarieGroup Limited, the Australia-listed global bank. The plat-form will focus on providingShari’ah-compliant financialservices on the wholesale side for the Middle East andNorth Africa. The two partiessigned a memorandum of un-derstanding at a ceremony inBahrain.

The partnership, whichawaits approval, will see ajoint presence based in the re-

gion and an investment byMacquarie in GFH of around$100 million in the form of aconvertible murabaha, as partof GFH’s current capital man-agement initiatives. An execu-tive of GFH stated that the pairplan to have the platform upand running by the beginningof 2010. The agreement willenable GFH to structure Mac-quarie’s existing products to beShari’ah-compliant, while al-lowing GFH access to Mac-quarie’s global advisory servicesand trading links, and helpingit expand geographically.

Meanwhile, the agreement sig-nals Macquarie’s interest in the

GFH and Macquarie enter into wholesale Islamic finance JV

Middle Eastern region, as wellas in Shari’ah-compliant finance.

John Wright, group COO ofGFH, suggested that part of therationale for the joint venturewas to help the bank diversifyaway from its core business ofinfrastructure and real estate fi-nancing, which currently standsat around 65 per cent of its busi-ness. Wright indicated that GFHaims to reduce this down toabout 20 per cent. It also re-cently signalled its intention toraise up to $300 million of freshcapital, which is to help it ex-pand the activities and geogra-phies it covers, as well asstrengthen its balance sheet.

Meanwhile, the involvementof Macquarie reflects a wider interest from Australiain Islamic finance – The Muslim Community Co-op-erative (Australia) recently received a financial services license from the Australian Securities and InvestmentsCommission (ASIC)(NewHorizon, April–July2009), and has sincelaunched the first AustralianShari’ah-compliant invest-ment fund. It is believed to be the first ASIC registeredretail managed investmentmortgage fund directed primarily to Islamic invest-ments.

Kuwait Finance House eyes up Germany

T’azur, a takaful firm head-quartered in Bahrain, haslaunched what it claims to bethe world’s first Shari’ah-compliant charitable insur-ance product, called the‘Sadaqah’ plan.

The plan helps donors saveregular contributions whichT’azur invests over a setnumber of years in Shari’ah-compliant funds. Accumu-lated capital is then passedon to the donor’s charity ofchoice. T’azur will continueto make payments on behalfof the donor if unforeseenevents (such as an illness)force the donor to stop pay-ing them. These donationswill be made through taka-ful, thereby ensuring that thecharity chosen by the donor

receives the intended amountno matter what happens.

Dr Abdulaziz Bin Naif AlOrayer, chairman of theboard of T’azur, said: ‘Thisplan embodies the essence oftakaful, namely mutual helpand assistance for the com-mon good, and demonstratesour commitment to charitiesand all communities inBahrain.’

Nikolaus Frei, T’azur’s chiefexecutive officer, added: ‘TheSadaqah plan is to our knowl-edge the world’s first insuredcharitable savings plan.’ Thisinnovation, in his view, is an affirmation of Bahrain’s position as a leading financialservices hub in the MiddleEast.

New charity takaful scheme


NEWS NEWHORIZON October–December 2009

Despite, or perhaps because of,the strong headwinds in theconventional international fi-nancial markets, the world’slargest fully-fledged Islamicbanks have continued to growstrongly, according to statisticsfrom Asian Banker Research,the consultancy division of TheAsian Banker. The hundredlargest Islamic banks’ assetsgrew to $580 billion in 2008,up from $350 billion the previ-ous year (a 66 per cent rise).

Compared to the previous year,the identities of the largestbanks remained fairly constant,with Bank Melli of Iran at thetop of the list and Al-RajhiBank, headquartered in SaudiArabia, in second place. Indeed,seven out of the top ten institu-tions are Iranian, and the twelveIranian banks in the list account

for 40 per cent of the top 100banks’ assets. Four other coun-tries, Malaysia, the UAE, SaudiArabia and Kuwait, accountedfor most of the rest of the wealthof the top 100 banks, in roughlyequal proportion to each other.

Some have questioned whetherthe Iranian institutions should beincluded, since their treatment ofriba (interest) appears to be dif-ferent from other Islamic financemarkets. Likewise, the reportshows that, while Iranian banksare often very large by assets,they are not necessarily the mostprofitable. Al-Rajhi Bank had thehighest net income at $1.74 bil-lion, with the next highest, Ku-wait Finance House, just under$1 billion. In terms of asset size,the study suggested that BankMelli may lose its top spot, sinceit did not grow in 2008.

Largest Islamic banks’ assetscontinue to grow

As the Islamic finance industrycontinues to modernise the tech-nology which underpins it, anumber of banks have recentlytaken the decision to upgradetheir core banking systems.

Among these are two Sudanesebanks, United Capital Bank(UCB) and Bank of Khartoum(BOK). Both have chosen to im-plement the iMAL core bankingsystem of Kuwait-based PathSolutions, which was recentlycertified by the Accounting andAuditing Organisation for Is-lamic Financial Institutions

(AAOIFI) as Shari’ah-compliant(NewHorizon, January–March2009).

BOK is a universal financial in-stitution, while UCB focuses oncorporate banking. UCB lookedat four international core bank-ing system offerings beforechoosing iMAL, which thebank’s IT manager, AbdelrazagMustafa Abdelrazag, describesas a ‘pure Islamic system’. Headds that ‘Path Solutions hasgood knowledge of Islamicbanking itself, which is reflectedin the solution’. The project at

Islamic banks make core system decisions

UCB includes about ten modulesof the product, and will lastuntil March 2010. Among thebenefits UCB will see will be aneasing of the process of openingnew branches. ‘The system is de-signed in a way that when weopen a new branch we can dothat with minimum effort.’

Among other banks who haverecently been active in upgrad-ing their IT, Abu Dhabi IslamicBank in Egypt has gone livewith a new Shari’ah-compliantbanking system from Interna-tional Turnkey Systems (ITS),

while First East Export Bank inMalaysia, a subsidiary of Iran-based Bank Mellat, also tookiMAL from Path Solutions.

Path Solutions itself has recentlyclaimed to be nearing the com-pletion of a rewrite of its corebanking system in Java, with allmodules to be completed andcommercially available by theend of 2009. Around 35 of thecompany’s staff have been work-ing on the project, and existingusers of iMAL will be able toupgrade over a period of threeyears or so.

The secretary general of thezakat fund of the UAE, Ab-dullah Bin Aqeeda AlMuhairi, has rowed back onsuggestions made last year(NewHorizon, July – Septem-ber 2008) that the collectionand distribution of zakatshould be made mandatoryfor all UAE citizens whoseincome surpassed a certainthreshold. According to theseplans, local Islamic financialinstitutions and companieswould have had to pay 2.5per cent of their net operat-ing capital to the fund fromthe beginning of 2009, witheight Islamic banks includedamong those that would haveto make payments.

Al Muhairi had wanted toamend the fund’s bylaws to

make it mandatory to submitaudited accounts and pay therequired share, the purposebeing to streamline the processof distribution. However, thegovernment of the UAE lastyear rejected the fund’s pro-posal for new legislation,which would have mandatedthat individuals earning over athreshold make an annual pay-ment. Al Muhairi has now ad-mitted that the payment ofzakat will remain discretional‘for the time being’, for bothcompanies and individuals.

‘What we have to do now israise awareness of how volun-tary payment can benefit us asa society,’ Al Muhairi said. TheUAE’s zakat fund has grownfrom its inception in 2004 tobe worth over $12 million.

Alms to remain voluntary in UAE



crisis. New regulations often engenderedregulatory arbitrage where these regulationswere evaded by financial innovations. Leg-islative gaps were also a factor in sustainingweak or outdated regulatory framework.Additionally, ideologically driven deregula-tion exacerbated efforts at forging an effec-tive regulatory framework that couldpromote stability. The frequency and magni-tude of banking crises with significant ad-verse consequences for income andemployment both over time and acrosscountries has led many thinkers to concludethat the conventional financial system con-tains seeds of inherent instability. The the-ory of inherent instability of theconventional interest-based, debt-dominatedfinancial system has been expounded uponat least since the late eighteenth and earlynineteenth centuries. One of the most eru-dite advocates of the inherent instability hy-pothesis was an American economist,Hyman Minsky (1996) who, beginning inthe second half of the last century, notedthat the stability of such a system, if andwhen achieved, could not be sustained. Thiswas because conventional finance was des-tined to evolve from stability created by eq-uity-dominated financial transactions byfirms, which he called hedge finance, to in-stability created by interest-debt-dominatedfinancing, which he called speculative andPonzi finance. Such instability would hardlybe a surprise when we recall Verse 2, 276 inthe Quran which unequivocally declaresthat riba-based debt transactions havewithin them the seeds of their own destruc-tion. Instability would be unavoidable when

Inherent instability of the conventional financial system

The conventional financial system, based oninterest and debt contracts, has been shakenby frequent crises with varying intensityover the centuries in almost every countrywhere it has operated. Both advanced andpoor countries have suffered major bankingcrises; some devastating. Each crisis re-quired a government guarantee of depositsand bank bailouts, without which the conta-gious effect would have led to total failureof the banking system with severe conse-quences for the real economy. The role ofthe central bank as a lender of last resortwas stressed by a prominent British econo-mist and journalist, Walter Bagehot (1873). Deposit insurance was introduced in 1935in response to massive losses of depositsthat occurred in each crisis. Each bankingcrisis has had dramatic effect on economicgrowth and employment and caused an eco-nomic recession or depression.

Financial crises have occurred in spite of theexistence of regulatory and supervisoryframeworks, including Basel I and II regula-tions. Each crisis called for more regulationand supervision. Such was the case for PeelAct in 1844 in the United Kingdom, the es-tablishment of the US Federal Reserve Sys-tem (Fed) in 1913, and the RooseveltAdministration banking regulations in1935. At times, new regulations becamesources of new instability. For instance, theFed was a key contributing factor in theGreat Depression and in the recent financial

Recent crisis: lessons for Islamic financeAbbas Mirakhor, former executive director at the International Monetary Fund (IMF), andNoureddine Krichene, economist at the IMF and former advisor at the Islamic DevelopmentBank in Jeddah, examine the valuable lessons that the recent financial turmoil can teach theIslamic finance industry.

ANALYSIS

To promote Islamic banking,there is a priority to develop theregulatory and supervisoryframework and demonstratethe strength and resilience ofIslamic banks.


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 ANALYSIS

those who resort to riba-based transactionscall forth a declaration of a direct war fromAllah (s.w.t) and His Messenger PBUH(Quran, Verse 2, 279).

During the Great Depression, a number ofscholars, especially those economists associ-ated with the Department of Economics ofthe University of Chicago, offered a pro-posal to the Government of the USA for thereform of the financial system. The crux ofthe Chicago Reform Plan corresponds to alarge degree to the core of the financial sys-tem that emerges from Islamic teachings.The Reform proposed a two-tier bankingsystem: (i) 100 per cent reserve banking thatwould preclude money creation and destruc-tion by the banking system, which wouldconsequently fully protect deposits and thenation's payments system; and (ii) a regu-lated investment banking system withoutgovernment protection such as a depositguarantee system of insurance. The Islamicfinance version converts the second tier intoan equity-based system in which interest-based debt transactions are prohibited. The-oretical analyses of such a system havedemonstrated its inherent stability. This con-clusion stems from the fact that no maturitymismatching is possible since there is a 100per cent money reserve system in place andbecause any asset-side price inflation or de-flation is mapped one-to-one onto the liabil-ity side of the balance sheet of the financialinstitution.

Causes of conventional finance instability

Economic literature has analysed at greatlength the causes of financial instability. Asearly as the beginning of the nineteenth cen-tury, English economist, banker and philan-thropist Henry Thornton (1802) observedcostless paper money creation by the centralbank and banks and explained a bankingcrisis essentially as the result of two factors:(i) deviation of the market interest rate froma non-observed natural interest rate whichmeasures the rate of profit or marginal pro-ductivity of capital in the economy; and (ii)consequent multiple expansion and contrac-tion of the deposit base of the banks intocredit. If the market interest rate is belowthe natural rate, demand for credit expands.

Banks have no difficulty issuing loans inmultiples of their deposits and capital, in-cluding fictitious credit that has no depositbackup in the form of promissory notes.Asset and commodity prices rise. Monetisa-tion of government deficits causes abundantliquidity, depresses money interest rates, and leads to credit expansion. When the in-verted credit pyramid becomes too over-leveraged, i.e. unsustainable, in relation toreal economy, or to the tax base, govern-ments, entrepreneurs, and consumers facedifficulties in servicing their debt. A rapidcontraction of credit ensues, asset and com-modity prices fall steeply, and a massivebank failure occurs.

Thornton’s two interest rates theory waselaborated by many writers. Among thesewas the re-examination of the quantity the-ory of money (1898) by Johan Gustaf KnutWicksell, a renowned Swedish economist.He argued that deviations of the moneymarket interest rates from the natural inter-est rates set forth changes in money velocity,as well as in the quantity of money, leadingin turn to changes in the price level as wellas in real economic activity. Observing theGreat Depression unfold, American econo-mist Irving Fisher (1933) ruled out all possi-ble causes except over-indebtedness arisingfrom cheap money followed by debt defla-tion as the single cause of financial crises.He firmly concluded that financial crises canbe explained only by excessive expansion ofcredit and grave financial and economic dis-orders that follow such expansion, includingmoney and credit contraction, falling prices,bankruptcies, and massive unemployment.

The recent financial crisis which broke outin August 2007 could be explained by thesame factors repeatedly mentioned in the lit-erature, namely interest and over-indebted-ness. Financialisation has drasticallyweakened the link between the financial andreal sectors, allowing for the inverted creditpyramid to reach a leverage ratio in relationto real GDP that might have exceeded amultiple of 50. Mirakhor (2002) noted thealarming growth of the inverted credit pyra-mid in relation to real GDP and determinedthat financialisation had nearly severed therelationship between finance and produc-

tion. He stated that for each dollar worth ofproduction there are thousands of dollars ofdebt claims, and predicted the imminent col-lapse of such a credit pyramid.

The chart indicates that the crisis was pre-ceded by a long period of record low inter-est rates and largely negative real interestrates forced by the US Fed and over-abun-dant liquidity that fuelled excessive specula-tion in asset and commodity markets. TheUS war financing and excessive externalcurrent account deficits that ranged betweenfive and seven per cent during 2002/07 haveallowed dollar deposits of foreign centralbanks at US banks to increase considerablyand fuel more liquidity and lending in theUS markets. Over-abundant liquidity couldnot be absorbed by prime markets. Finan-cialisation, which encompasses securitisa-tion of assets and credit derivatives, pushedfloods of liquidity into sub-prime marketsand fuelled housing and commodity bub-bles. The ratio of credit has risen to an un-precedented level in relation to GDP, whichled to difficulties in servicing such credit.Households were not able to pay the specu-lative prices and speculative gains as well asthe high salaries of debt merchants. Thesebecome a burden on households. Foreclo-sures have transferred all the burden tobanks that suffered large losses and had tobe bailed out with trillions of dollars bygovernments.

Major reserve banks have become a danger-ous destabilising force and a powerful taxa-tion and wealth redistribution agency. Muchfinancial wealth, in the form of stocks, hasbeen wiped out. No financial system nomatter how perfectly regulated could sur-vive cheap money policy in the form of ex-cessively low interest rates and abundantliquidity. Although the credit to GDP ratiohas been at its highest level ever, centralbanks have been reckless in pushing moresub prime debt by injecting trillions of dol-lars in liquidity at near-zero interest ratesthat has been amassed in excess reserves andhas only fuelled speculation in commodityand exchange markets. By depressing inter-est rates and printing unlimited money, cen-tral banks are only paving the ground for aneven more powerful financial crisis, creating


NEWHORIZON October–December 2009ANALYSIS

considerable distortions, and imposing pro-hibitive taxation on workers and fixed in-come pensioners.

Islamic finance is inherently stable

Logically, there can be little doubt that a fi-nancial system that derives its operatingprinciples from the Quran and the Sunnahwill be inherently stable. In such a system,banks do not contract interest bearing loansand do not create and destroy money. Theydo not finance speculation, nor do they en-gage in debt trading. Although lending isnot prohibited in Islam, it has to be free ofany element that can be considered as inter-est. Interest-based lending cannot be part ofIslamic economic activity. Such lending andborrowing redistribute wealth when thereare wide price fluctuations and thereforecannot be part of Islamic finance that isbased on justice. Lending can increase thewealth of borrowers in undeserved ways atthe expense of workers and low-incomeclasses. Besides causing inflation when it ex-ceeds savings, it can fuel speculation. More-over, borrowers always shift the risk tolenders. They repay interest and principalonly when their projects are profitable.When projects instead make losses, borrow-ers default, resulting in the deterioration ofbank portfolios.

Mirakhor (1988) defined an Islamic finan-cial system as one in which there are norisk-free assets and where all financialarrangements are based on risk and profitand loss sharing. Hence all financial assetsare contingent claims and there are no debtinstruments with fixed or floating interestrates. Modelling the financial system asnon-speculative equity shares, he showedthat the rate of return to financial assets isprimarily determined by the return in thereal sector, and therefore in a growingeconomy, Islamic banks will always experi-ence net positive returns. Mirakhor notedthe absence of an inverted credit pyramidand showed that there is a one-to-onemapping between the real and financialsector. Because the interest rate is absent,there is no discrepancy between interestand profit rates, and hence the economyalways operates at full employment equi-librium. More specifically, underemploy-ment equilibrium (devised by Britisheconomist John Maynard Keynes), basedon pivotal role of interest rate, liquiditytrap and deficient demand, is inapplicableto Islamic finance.

Conceptually, an Islamic banking systemcan have two basic types of banking activi-ties: first, a safekeeping and payments ac-tivity as in the pre-Islam and early Islam

periods and also as in goldsmith houses,and the second are investment activities.The first type of activity is similar to the100 per cent reserve system, with depositsremaining highly liquid and checking services fully available. This system has to be a fee-based system to cover the costof safekeeping, transfers and paymentsservices.

The second activity, investment activity, iswhere deposits are considered as longer-term savings and banks engage directly inrisk taking in trade, leasing, and produc-tive investment in agriculture, industry,and services. The most important charac-teristic of this activity is that it is immuneto un-backed expansion of credit. An Is-lamic bank is assumed to match depositmaturities with investment maturities.Short-term deposits may finance short-term trade operations, with the bank pur-chasing merchandise or raw materials andselling to other companies; liquidity is re-plenished as proceeds from sales opera-tions are generated. For longer-terminvestment, longer-term deposits are used.Liquidity is replenished as amortizationfunds become available. It can also be re-plenished through stock market transac-tions by selling and buying shares.

In all these cases, an Islamic bank is a di-rect owner of the investment. In such asystem, a financial institution participatesdirectly in the evaluation, managementand monitoring of the investment process.Returns to invested funds arise ex-postfrom the profits or losses of the operation,and are distributed to depositors as if theywere shareholders of equity capital. Sinceloan default is absent, depositors face asmall risk of loss of their assets. In con-ventional finance, loan default is perva-sive, and the rate of default increases morethan proportionally relative to the rate ofcredit expansion. Furthermore, the higherthe share of consumer loans the higher therisk of default. Credit default can becomea systemic risk and degenerate into abanking crisis. Without government guar-antee, depositors face a significant risk oflosing their deposits. Such risk does notexist in Islamic finance.

Key Interest Rates2000M1 – 2009M5



Lessons for Islamic finance

The recent financial crisis has brought Is-lamic finance to the centre stage. Leadingfinancial places are looking toward Is-lamic finance as a new type of bankingthat will promote lasting stability anddurable growth of production, trade, andemployment. To promote Islamic bank-ing, there is a priority to develop the regu-latory and supervisory framework anddemonstrate the strength and resilience ofIslamic banks. The establishment of a uni-versal regulatory framework and diffu-sion of knowledge about Islamic bankingwould help attract investors and business-men to this field.

The regulatory and supervisory frame-work of conventional finance cannot re-move the two fundamental causes ofbanking instability namely: interest anddebt. Islamic finance is theoretically in-herently stable as these two fundamentalcauses do not exist in Islamic finance.However, practitioners admit that Islamicfinance as it is practiced at this stage can-not be distinguished from conventional fi-nance. Financialisation is proceeding atthe same rate as in conventional finance.There is evidence that failed Islamic bankswere simply conducting conventionalbanking and were plagued by the samecauses that made conventional banksfragile and prone to failure.

Regulators have to agree on a definitionof Islamic finance. Our view is that such asystem has to be a two component sys-tem: a 100 per cent reserve componentand an equity investment component. Thetwo functions should be mandated to sep-arate institutions; a legislative-regulatoryfirewall must keep the two separate. Theinvestment component can undertake fi-nancial transactions stemming from con-tractual modes of financing such asmudarabah, murabaha, ijara and istisna.More broadly, it has to be an equity-based component. Where and whenneeded, non-interest debt financing canfacilitate transactions that are notamenable to equity participation. Regula-tors have to set guidelines for ensuring the

soundness and viability of the investmentcomponent through up to date risk analysisand compliance with Shari’ah principles.

The promulgation of a theoretical regula-tory framework that represents a consensus-driven definition of Islamic finance wouldenable people to determine deviations ofpracticing institutions from pure Islamic fi-nance and the degree of their compliancewith Shari’ah principles. Currently, Islamicfinancial institutions operate in differentregulatory jurisdictions and under differentschools of jurisprudence that have varyingunderstandings of Islamic banking. The ex-istence of a universal regulatory frameworkwould allow the measurement of cross-country differences.

Only banks licensed by central banks shouldbe allowed to practice Islamic banking. Thiswould prevent swindles and schemes thatrob consumers under the cover of Islamicbanking. Many types of financial transac-tions and instruments should be excludedfrom Islamic finance, particularly interestrate-based bonds, and securities often dis-guised as collateralised instruments thatmake them more expensive than those is-sued under the conventional system. Addi-tionally, excluded from Islamic transactionsare finance based on securitisation of ficti-tious assets, speculative finance, hedgefunds, and consumer finance that is notbacked by real assets. In all of this type offinance, either the acquired assets are finan-cial papers, or loans that have no real back-ing, and do not contribute to generating realactivity, income, and employment. In partic-ular, conventional consumer loans, besides

being expensive for consumers, have a high default risk, and do not generate newwealth. Financial innovations such as se-curitisation, originate and distribute mod-els, and many instruments that lead tospeculation or to fictitious assets, cannotexist in an Islamic system. Attempts bybanks to issue their own money and liabil-ities, beyond full asset-liability matching,would be strictly prohibited. Supervisionshould be tightly conducted to ensure fullcompliance with Islamic banking princi-ples. Violations should carry prohibitivepenalties.

The resilience of many Islamic banks tothe Asian as well as the recent financialcrises has shown the inherent stability ofthese institutions. Such resilience would befurther enhanced through issuing universalregulatory and supervisory guidelines forIslamic finance and putting in place an ef-fective reference framework that measurescompliance with true Islamic banking andaims at eliminating serious credit and in-terest rate risks that may compromise depositors’ savings and undermine thesafety of Islamic banks. Such an edifice ofunified and universal regulatory-supervi-sory framework is becoming increasinglyurgent lest the failure of a few more osten-sibly Islamic financial institutions and in-struments lead to reputational damagethat would be more destructive to Islamicfinance than in the case of the conven-tional system. Whereas in the conventionalsystem, the failure of a few institutionscannot threaten the entire system, damageto the reputation of Islamic finance is apronounced systemic risk.

Many types of financial transactions and instruments shouldbe excluded from Islamic finance, particularly interest rate-based bonds, and securities often disguised as collateralisedinstruments that make them more expensive than thoseissued under the conventional system.



On the move

APPOINTMENTS

HSBC Middle East has appointed DavidHunt as head of insurance for the region.Hunt will oversee all HSBC insurancebusiness in the Middle East, includingEgypt and Saudi Arabia. He will also beresponsible for the provision of insuranceproducts and services for all of the bank’spersonal and commercial customers in-cluding the development of its Shari’ah-compliant takaful business. Hunt movesfrom SABB Takaful Company in SaudiArabia, which is an associate company ofSABB and HSBC.

Ithmaar Bank, the Bahraini outfit whosesubsidiaries include the Shari’ah-compli-ant universal bank, Shamil Bank, inBahrain, has appointed Mohamed Hus-sain as chief executive officer. Hussain hasbeen co-CEO since April 2008, and takesover from Michael P Lee. Prior to his ap-pointment at Ithmaar last year, Hussainwas an executive and board member atthe bank.

Dow Jones Indexes, which produces theDow Jones Islamic Market World Index,has announced the appointment of TariqAl-Rifai as its new director of Islamic in-dexes. He will be charged with workingwith clients to develop new business op-portunities, developing new Shari’ah-com-pliant indexes and working with moneymanagers and investors. Al-Rifai will alsobe the contact point between Dow Jones’board of Islamic scholars and its mainte-nance, research and development teams.

Al-Rifai is a veteran of 13 years in Islamicfinance. He founded Failaka Advisors in1996 to develop and promote Shari’ah-compliant financial instruments. He hassince served as vice president of Islamicbanking at HSBC, and was a partner inThe International Investor, a Kuwaitishareholding company. Since 2004, he hasbeen vice president of UIB Capital.

Ali bin Za’al Al Mansouri has replaced DrAbdul Latif Al Shamsi as chairman of UAE-based Methaq Takaful Insurance Company,after the latter resigned at the end of July.Samer Mohammed Kanan has also beenelected as managing director. Kanan willmanage the company’s administrative staffand represent Methaq legally and financially.

Abu Dhabi IslamicBank (ADIB) has re-cently made a spate ofnew appointments.Malik Sarwar has beennamed global wealthmanagement executiveto target high networth and affluentclients with Shari’ah-compliant products.Dhafer Faroq Lugman has been named headof strategy, product management and inter-national retail banking. Lugman will be responsible for planning and directing allbusiness development strategies, includingthe tapping of new geographies. Mrs NawalAl Bayari (above) has been appointed vicepresident and business head for ladies bank-ing, in a role to ensure the development of new products and services for female customers.

Sarwar has worked in the US, Asia and theMiddle East in a career which spans numer-ous posts, including at Permal Group, Citi-group and Merrill Lynch. He worked at thelatter for 17 years, in sales and businessroles, primarily in global wealth manage-ment. Before moving to ADIB, he was headof US business for Permal, an independentfund of hedge funds.

Lugman has 19 years of experience, mostlywith HSBC and Dubai Islamic Bank (DIB) inthe Saudi and UAE markets. He finished hiscareer at HSBC as country manager for retailin the UAE. He previously spent twelve yearsin Saudi Arabia in the corporate and retailbanking divisions. While at DIB, he was

head of corporate development and a boardmember of two of its subsidiaries.

Mrs Al Bayari boasts considerable experi-ence at international banks including Bar-clays, Standard Chartered Bank, AmericanExpress and DIB. She joins ADIB from Bar-clays, where she spent two years overseeingbusiness coordination in over 15 countriesacross MENA, Africa, Asia and Eastern Eu-rope. While at DIB, she was relationshipmanager and acting head of private bankingfor ladies. Her spell at Standard CharteredBank was as business support manager foroffshore accounts in the international bank-ing wealth management division.

Kuwait’s Securities House is to bring to-gether its two UK-listed subsidiaries, Gate-house Bank (a fully fledged Islamic bank)and GSH UK (a Shari’ah-compliant finan-cial services firm), into one organisationunder the Gatehouse Bank brand, resultingin a number of senior management changes.Fahed Faisal Boodai has been appointedchairman of Gatehhouse Bank, and RichardThomas will become CEO, stepping downfrom his former roles as non-executivechairman of Gatehouse Bank and managingdirector of GSH. He is to replace DavidTesta, who is leaving the group. Thomashas worked in merchant and investmentbanking for 29 years, the last 25 of whichhave been in Islamic banking. He hasworked for Saudi International Bank,United Bank of Kuwait and Arab BankingCorporation, helping each set up Islamicbanking operations.

Rohail Ali Khan has become deputy CEOof Pak-Qatar General Takaful, a Pakistan-based Islamic insurance company. Khan hasover 15 years of senior management experi-ence in the Islamic finance sector, with pre-vious senior roles at Adamjee Insurance,Pak-Kuwait Takaful Company Ltd andTakaful Pakistan Ltd.



‘Currently we have alternative models todeliver Islamic banking services in differentparts of the group. We offer servicesthrough the IIAB and Arab Sudanese Bankas full Islamic subsidiaries, with Islamicwindows and branches offered by ArabBank Plc in Qatar and the UAE. The reason behind the different approaches is a combi-nation of market preference and the prevail-ing central bank regulations in thesecountries,’ explains Cobb.

Another critical factor has been the technol-ogy that supports the delivery of the Islamicbanking services. Arab Bank has set upIIAB using a core system from Path Solu-tions, iMAL. Two of its other Islamic unitshave recently launched, and have shownthat different operations require differenttypes of software.

The first project was with the Islamic win-dows and branches in Qatar and the UAE.It is one thing to start a fully Islamic opera-

Established in 1930, Arab Bank was thefirst private sector financial institution inthe Arab world. It has achieved a number of milestones throughout its nearly 80-year history, such as becoming the firstArab financial institution in Switzerland in 1962. It is the largest company listed on the Amman Stock Exchange and thebiggest bank in Jordan in terms of assets,equity and banking market share.

As part of the larger Arab Bank Group, ithas a presence of over 500 branches in 30countries across five continents, and morethan $48 billion in assets. It has been runsince its inception by the Shoman family.Current chairman and CEO, AbdelHamid Shoman, marks the third genera-tion to take charge of the bank that hisgrandfather established.

Across the group it offers products viafour divisions, which are personal bank-ing, corporate and investment banking,private banking and treasury. These areaimed at individuals, corporations, gov-ernment agencies, and other internationalfinancial institutions.

It made the decision to enter the Islamic financial services market 13 years ago with the launch of its International IslamicArab Bank (IIAB) subsidiary. According to Andrew Cobb, chief projects officer at Arab Bank, ‘we wanted to extend the existing services within our establishedbusinesses in the Gulf to provide a wider range of products in response to the needs of our customers and the growing demand for Shari’ah-compliantbanking’.

Horses for coursesGood technology is the cornerstone of any Islamic institution, but different approaches toShari’ah-compliant banking require different systems. One bank with first-hand experience of this is Arab Bank. It has recently completed two implementation projects of separate systemsto cover its operations. James Ling, NewHorizon contributing editor, reports.

tion with a purpose-built Shari’ah-compliantsystem. It is a very different challenge to takean existing conventional institution and addin Islamic products. And, at the end of 2007,this was exactly what the bank wanted todo. ‘We were looking to extend our corpo-rate and treasury Islamic banking productsand services in Qatar and the UAE through a branch/window model,’ says Cobb. Itstarted by defining its business case, beforemoving on to the operating model designand platform selection in the first quarter of 2008.

The technology to power its Islamic offer-ings was an important factor for considera-tion at the bank. It had been using aconventional system for a number of years,but this would not be able to support the additional products. ‘Key processes that underpin the Islamic products and serviceshave special characteristics and functionalrequirements related to Shari’ah rules, in-cluding profit calculation and distributionthat are fundamentally different from inter-est calculation.’ The bank decided thatwhere it did not impact Shari’ah rules andregulations it would leverage its existingback office functions and processes. But itwould need new technology for the rest.

The selection process began with a review of the available Islamic banking systems.The policy at the bank is to ‘consider allknown solutions from existing and potentialsuppliers’, explains Cobb. As a result, ‘weshortlisted a number of solutions and con-ducted an in-depth review with each one be-fore finalising the decision’. It was a rapidselection process which lasted approximatelyeight weeks.

IT FOCUS

Arab Bank


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 IT FOCUS

Among the vendors considered was a UK-based software house, Misys. The companyhad an advantage as it provided Arab Bankwith the existing core system it was lookingto expand, Equation. On top of its conven-tional core, the vendor can also boast ahigh number of users for the Islamic versionof its software, particularly in the MiddleEast. Indeed, Equation was tailored for Is-lamic banking in the region. The vendoralso had experience of installing the systemfor Islamic windows, with twelve banks inthe Middle East, South and South East Asiausing it for this purpose on top of their con-ventional operations.

There were a number of factors that led tothe selection of Misys. ‘Arab Bank has along relationship with Misys,’ says Cobb.‘It was very important that we can extendthe current platform functionality using theresources and expertise that we have devel-oped internally.’ The contract with Misyswas signed in April 2008, and the imple-mentation began the following month.

The implementation was two months long,with the first Islamic branch in Qatar goinglive at the end of July. The project contin-ued in Qatar until August 2008. The imple-mentation then moved to the UAE where itran from October to December of that year.

The bank used a team of internal resourcesfrom various banking functions as well asexternal consultants and key staff fromMisys. Cobb puts the rapid implementationdown to good planning, business commit-ment and effective decision making. ‘Thisenabled us to commit to deliver the solutionto our customers within a relatively shorttimeframe.’

The most recent project was at Arab Su-danese Bank. This involved setting up a fullIslamic bank, so presented a different chal-lenge from a technology point of view.

Again, it did a full but rapid selection, opt-ing for iMAL from Path after a six-week re-view of the available products. ‘Thissolution was already implemented at IIABand enabled us to leverage the resourcesand expertise that we have to support this

critical re-launch into Sudan,’ explainsCobb.

The bank signed the contract with Path forArab Sudanese Bank in October 2008 andthe implementation started in November. Itinitiated the programme with a team of in-ternal resources and various external con-sultants. ‘The team collaborated in definingand planning the best approach and imple-mentation phases which enabled us to de-liver Islamic banking to our customerswithin the expectations of senior manage-ment and the Arab Bank CEO,’ says Cobb.‘The project teams worked with high disci-pline to meet the delivery schedule dead-lines and were able to deliver the requiredsolution on time, within budget, and thebank achieved full customer launch in June2009.’

Arab Bank has seen many benefits from expanding its Islamic operations. ‘Primarily,this allows us to provide a wider choice toexisting and new customers. We can achievethis through building on our well estab-lished business and operations and the existing network of branches and sub-sidiaries around the world to this new lineof business.’

The bank is now able to offer a variety ofservices through its new units. ‘We offer full

Islamic banking products and services forretail, corporate and treasury, such asmurabaha, ijara, trade finance, commoditymurabaha and sukuk in addition to Islamicdeposits and services to all our customersegments,’ says Cobb. He believes the newoperations have enabled the bank to offer awider choice for its customers, and addsthat it will ‘continue to deliver the productsbased on our customer needs and develop-ments of the market’.

The experiences of Arab Bank highlight theimportance that different types of technol-ogy play in Islamic banking. When settingup a full Islamic subsidiary there can beconsiderable advantages from taking a com-plete Shari’ah-compliant system. However,if Islamic windows are being added to exist-ing operations, it is always worth consider-ing Shari’ah-compliant modules that can beadded to the conventional core.

Arab Bank had the advantage of previousexperience and knowledge of the systems itchose, and this enabled the rapid selectionand implementation times. However, not allprojects run this smoothly, and the most im-portant factor for banks embarking on thisprocess is making sure they select the systemthat best meets their needs. Arab Bank didthis for both projects and is now reaping thebenefits.

Key processes that underpin the Islamic products and serviceshave special characteristics and functional requirements relatedto Shari’ah rules, including profit calculation and distribution thatare fundamentally different from interest calculation.

Andrew Cobb, Arab Bank



Improving Islamic finance in-vestment in socially responsiblebusinesses in the UK was thefocus of the UK’s first Access toIslamic Finance (A2IF) confer-ence, held at the British LibraryConference Centre. It washosted by GK Partners, a con-sultancy firm to socially respon-sible business, in partnershipwith The British Library and theIIBI. The conference followedon from the series of Islamic fi-nance workshops run at the li-brary. Gabrielle Rose of theBritish Library’s Business andIntellectual Property Centre in-troduced the conference.

For the first time in the UK, theA2IF event brought finance pol-icymakers and practitionersfrom the ethical, social enter-prise, community developmentand SME sectors, together withIslamic finance experts, to dis-cuss the areas of common inter-est. As professionals working onenterprise development, A2IFenabled them to understand therelevance of Islamic finance totheir work and highlighted howthey can make new businesspartnerships.

Gibril Faal, director of GK Part-ners and convenor of A2IF,stated that ‘the A2IF pro-gramme is a comprehensive andinclusive approach, based onnew forms of synergistic cross-sectoral partnerships. The prac-tical business benefits andethical virtues of Islamic financeare relevant and consistent withthe values and financing needsof commercial and social enter-prises from a wide range of sec-

Access to Islamic Finance (A2IF): meeting new social economy partners

tors. I want to see more busi-nesses from the social and realeconomy having greater access to Islamic finance funds andservices.’

He spoke passionately abouthow Islamic finance should em-brace new partners in a mannerthat improves the financial andsocio-economic benefits that ac-crue to the whole society andcountry. This theme was rein-

forced by various speakers. An-thony Clarke, chairman of theBritish Business Angels Associa-tion stated that ‘Business Angelinvestment is a form of equity finance which is in line with theIslamic principles of profit-and-loss sharing’. Therefore, he be-lieves that the two types ofmodels fit well together.

Bernie Morgan, CEO of Com-munity Development FinanceAssociation, and Penny Shep-herd, CEO of UK Sustainable Investment and Finance, gavebackground information abouttheir sectors. This demonstratedthe commonality of goals and of-fered a framework for partner-ship and collaboration betweenIslamic, sustainable and commu-nity development investment. Richard T de Belder, partner at

law firm Denton Wilde Sapte,explored the legal and regula-tory challenges relating to theexpansion of Islamic finance in-vestment in UK businesses, andthe issues raised were discussedby other speakers and delegates.Stephen Alambritis of the Feder-ation of Small Businesses urgedIslamic finance institutions (IFIs)to engage with smaller busi-nesses and provided statisticaldata to challenge the myth that

SMEs are riskierbusinesses to investin. MohammedAmin, tax partner at Pricewaterhouse-Coopers, demon-strated how IFIs canuse current tax reliefschemes as incen-tives to increase andexpand their invest-

ments in the commercial and social economy. Some ofthese schemes are already widelyused to enhance equity-based in-vestments in SMEs and socialenterprises.

Ian Shaw, who is responsible forreviewing the government’s En-terprise Finance Guaranteescheme (a loan guaranteescheme introduced to cushionthe impact of the current eco-nomic recession) represented theDepartment of Business, Innova-tion and Skills (BIS). He talkedabout the importance of Busi-ness Link (the government’sbusiness support agency) havinggreater awareness of Islamic fi-nance options. As the only Is-lamic retail bank in the UK,Islamic Bank of Britain (IBB)was among the institutions that

IIBI NEWS

participated in the ‘A2IF mar-ketplace’ – meeting delegates in-terested in their services. FezalBoodhoo of IBB explained thatabout 20 per cent of depositsheld by the bank are in businessaccounts and about 35 per centof the value of IBB mortgages re-late to the bank’s CommercialProperty Finance scheme.

For the benefit of delegates whowere new to Islamic finance,master classes were held. MuftiMuhammad Nurullah Shikderof Gatehouse Bank and MuftiMohammed Zubair Butt of theInstitute of Islamic Jurispru-dence presented on the ‘Princi-ples of Islamic Finance’; DavideBarzilai, partner at law firmNorton Rose, presented on‘Legal Structures of Islamic Fi-nance Products’. For those fa-miliar with Islamic finance butnot with a business background,Faal conducted a master class,‘Shari’ah-Compliant BusinessPlans’. GreenEquity, a firm of Is-lamic and ethical investment ad-visers, presented case studies onthe ‘dos and don’ts’ of raisingequity and debt finance fromIFIs.

As part of the A2IF programme,GK Partners, in association withthe IIBI, had started a researchproject assessing the nature andsize of Islamic finance invest-ment in the UK. Prior to theconference, both BIS and HMTreasury expressed interest inthe results of the findings of theresearch. In light of the potentialpolicy implications of the re-search project, delegates were in-vited to make suggestions and


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 IIBI NEWS

recommendations on how Is-lamic finance investment in theUK can be improved. These rec-ommendations were collated tobe reflected in the final reportpublished later this year. At theend of the conference, delegatesexpressed their satisfaction withthe content, quality and diversityof the programme and speakers,with one commenting about theexcellent quality of all the speak-ers who were engaging, conciseand kept the attention of the au-dience.

There was overwhelming realisa-tion and palpable excitement

amongst the profes-sional delegates aboutthe potential for part-nership between Is-lamic finance andother vibrant socio-economic developmentsectors. The first A2IFconference has estab-lished a definitiveframework and plat-

form through which to pursueambitious and feasible goals of‘mainstreaming’ Islamic financein the UK, and improving in-vestment in the corporate, pub-lic, charitable, social enterpriseand SME sectors. GK Partnershas developed an A2IF actionplan to cultivate and deepen re-lationships with new strategicand business partners. Further-more, after the publication ofthe A2IF research report, a se-ries of thematic A2IF events areplanned for 2009/10, focussingon improving Islamic financeinvestments in other sectors ofthe UK economy.

IIBI and SII join forces to promote the UK as Islamic finance hub

The IIBI has inked an agreementwith the Securities and InvestmentInstitute (SII) to promote the UKas the hub of Islamic finance.

The SII is a professional body for practitioners in the securitiesand investment industry globally,which sets professional standardsand measures them through examinations. It also monitorsand develops the competence ofindividual specialists and organi-sations through a code of conduct,and provides continuous profes-sional development (CPD) oppor-tunities for its members, throughseminars, conferences and web-based services.

The institutes will share their ex-pertise and advocate each other’sservices to advance the profes-sional development in the Islamicfinance industry. Aspart of the agreement,the IIBI will encour-age its members tostudy for the SII’s Is-lamic Finance Qualifi-cation (IFQ) as anentry level exam inthe field. In its turn,the SII will promotethe IIBI’s Diplomaand Post GraduateDiploma (PGD) in Islamic Bank-ing and Insurance as qualifica-tions for further progression for

students following achievementof the IFQ. There is also poten-tial for the two organisations todevelop a long-term strategy to

include market research relatingto specialist Islamic financemodules, such as sukuk.

‘We are delighted to work withthe IIBI to promote our com-mon goals for the developmentof Islamic finance skills in theUK,’ said Ruth Martin, manag-ing director of the SII.

Mohammad A. Qayyum, IIBIdirector general, stated that theInstitute is looking forward toworking closely with the SII instrengthening the UK’s positionas the leading centre for Islamicfinance qualifications. ‘Theagreement with the SII will un-doubtedly afford greater scopeof advancement of competentpersons in the Islamic financialservices industry,’ he added.

IIBI and ISRA sign MoU

IIBI and the InternationalShari’ah Research Academyfor Islamic Finance (ISRA)signed a memorandum of un-derstanding (MoU) at a one-day Islamic finance conferencein London, titled ‘ManagingShari’ah Risk through Shari’ahGovernance’.

ISRA was established byMalaysia’s central bank, BankNegara Malaysia (BNM), as arepository of knowledge forShari’ah fatwas and part ofthe International Centre forEducation in Islamic Finance(INCEIF). It also promotes applied research and under-takes studies on contemporaryissues in the Islamic finance industry.

The organisations will workon areas of mutual interest in

Islamic finance to further theknowledge in Shari’ah rulingsas well as other aspects, partic-ularly with regard to transla-tion and fatwa collection.

‘ISRA is playing a very proac-tive role to promote applied re-search in the area of Shari’ahand Islamic finance, and thestrength of our relationshipwill benefit the industry aswhole,’ stated Mohammad A.Qayyum, IIBI director general.

Dr Mohammad Akram, ISRAexecutive director, added: ‘Weare pleased to sign this agree-ment and look forward toworking with the IIBI – theonly organisation of its kind in Europe, in furthering the research as well as other activi-ties intended for promotion ofIslamic finance.’

Mohammad A. Qayyum and Ruth Martin


NEWHORIZON October–December 2009IIBI NEWS

The IIBI’s Post GraduateDiploma (PGD) course in Islamic banking and insurance,offered since 1994, is highly regarded worldwide. UK-basedDurham University has ac-corded this course recognitionas an entry qualification for its postgraduate degrees in Is-lamic finance, including the MAand MSc in Islamic finance andthe Research MA. Applicantswill also have to fulfil the spe-cific entry qualifications foreach specialist degree pro-gramme.

To date, students from nearly 80countries have enrolled in thePGD course. In the period ofJuly 2009 to September 2009,the following students success-fully completed their studies:

o Adamu Ibrahim, executive director, IntegratedMicrofinance Bank, Nigeria

o Afsaneh Leissner, trainee solicitor, Gide Loyrette NouelLLP, UK

o Muath Mubarak, assistantmanager, corporate strategy,First Global Group, Sri Lanka

o Alaaddin Karakus, US

o Amjad Zaki Mohamed Radi,head of structured finance products, Qatar National BankIslamic Branch, Qatar

o Enoch Lawrence, senior vicepresident, CBRE, Capital Mar-kets, USA

o Farhan Ahmed, senior finan-cial analyst, Hewlett-Packard,India

IIBI awards post graduate diplomas

o Fawaz Abdul Basith, financial analyst, EKSAB Investments, Saudi Arabia

o Garry Monksfield, director,authorisation, QFCRA, Qatar

o Hussain Buhary, senior manager, Saif Capital (Pvt) Ltd,Sri Lanka

o Hussain Alloub Mohammed,underwriter, export credit insur-ance, The Islamic Corporationfor the Insurance of Investmentand Export Credit (ICIEC),Saudi Arabia

o Inuwa Garba Affa, lecturer,Bahrain Institute of Banking and Finance (BIBF), Bahrain

o Irshad A A Byraub, opera-tions officer, Barclays Bank Plc,Mauritius

o Irum Saba, assistant director,Islamic banking department,State Bank of Pakistan, Pakistan

o Mohamed Farhad Chundoo,compliance officer, South EastAsian Bank Ltd, Mauritius

o Mohammad Amin Tejani,vice president, Habib Metropoli-tan Bank Ltd, Pakistan

o Muhammad Adam, risk analyst, Khushhali BankLtd, Pakistan

o Muhammad Saarim Ghazi,student, International IslamicUniversity, Islamabad, Pakistan

o Muhammad Hisham Alif,junior executive, operations,First Global Group, Sri Lanka

o Muhammad Nadeem, branchmanager, Bank AlFalah, Pakistan

o Muhammad Nasir Aliyu,transaction processing assistant,Bank PHB Plc, Nigeria

o Muhammad Zahid Bhatti,Atlas Asset Management Ltd,Pakistan

o Mukthar MohamedMubarak, assistant manager,Amana Investments Ltd, Sri Lanka

o Mulindwa Mubarak, banking officer, Bank of Africa(U) Ltd, Uganda

o Murtadh Al-Sharae, content manager, ThomsonReuters, UAE

o Nariman A Barakjie, business structuring manager, Access Company WLL, Qatar

o Sani Danbatta, operations manager, Afribanking Plc, Nigeria

o Md Touhidul Alam Khan, executive vice president andhead of syndications andstructured finance, Prime BankLtd, Bangladesh

o Vanessa Wood, associate director, Qatar Financial Centre Regulatory Authority,Qatar.

The course has brilliantly taught me the fundamentals of Islamic banking and in-surance. The lessons are written in such a way that the more you read the moreeager you are to know of what’s coming next. Not only do we understand howIslamic banking functions but we also learn about its history and its value propo-sition, which is very important to get a bigger picture of Islamic finance and itsobjectives. The course was great to follow. The IIBI team is very professional andI would certainly recommend this course to anyone who wishes to learn about Islamic banking. If it’s Islamic banking, then it’s definitely the IIBI!

Irshad A A Byraub, Barclays Bank Plc, Mauritius

Enoch Lawrence Afsaneh Leissner Mohammad Amin Tejani



was practically no demand for Islamic finan-cial services domestically. Time is needed tocreate this kind of demand. In a number ofRussia’s regions (Moscow, Tatarstan, Dages-tan, Chechnya, etc.) there is constantlygrowing interest in Islamic financial servicesfrom potential Muslim clients.

o Europe has almost 30 years of experiencein Islamic finance. Over this time there wereboth successes and noticeable failures. InRussia, Islamic financial services were pro-vided by Badr-Forte since the late 1990s. Inother words, an Islamic bank with a limitednumber of products consistent with Shari’ahworked in Russia for just over six years. Thistime span is too short to seriously discuss theprospects of Islamic banking.

Some experts note that one substantial ob-stacle to the development of Islamic financein Russia is lack of demand from the Russianpopulation for such services. This is trueonly in part. Many Muslims realise that conventional financial institutions build their operations on the basis of charging interest. However, they don’t know how theycan avoid participating in interest-bearingtransactions. To resolve this problem it isnecessary that as many people as possiblehave access to information on Islamic finan-cial services.

However, even when Islamic financial bodiesstart fully functioning in Russia, they willnot be able to satisfy the demand of all thosein need of this kind of service. As the experi-ence of other countries demonstrates, few Is-lamic banks in a post-industrial society wantto work in rural areas providing microfi-nancing. Moreover, one should not forget

Islamic finance in Russia: overview

At the dawn of Islamic finance, when therewere no Islamic banks, some of the scholarswere writing that it would be enough to cre-ate an effective mechanism of collecting anddistributing zakat and to restore waqfs inorder to set up a fair economic system in theMuslim world. However, even today only ahandful of countries have set up workingzakat systems and effective waqfs. Even inthe countries with developed Islamic bank-ing, investment and insurance systems zakatand waqf do not play a key role in eco-nomic development.

Russia, which according to various sourcesis home to between nine and 25 millionMuslims, is a country with a conventionalbanking system, where Islamic financial in-stitutions do not enjoy any special status.Moreover, in December 2006, the centralbank revoked Badr-Forte Bank’s licence, theonly Islamic bank in the country. And sincethen Russia has not been deemed the bestplace for developing Islamic economics, atleast in comparison with Europe.

At the same time one should not be exces-sively pessimistic about the prospects of Islamic financing in Russia due to the fol-lowing reasons:

o The establishment of Islamic banks andIslamic banking windows in Europe at theend of the 1990s and the early 2000s was aresponse to a firm interest European Mus-lims showed in such services. Badr-Fortewas thus unique not because it was the onlyIslamic financial institution in Russia butrather because it was established when there

Waqf and zakat: alleviating poverty

In the first of a two-part analysis, Dr Renat Bekkin, researcher at Moscow State Institute ofInternational Relations, Ministry of Foreign Affairs of Russia, ponders the issue of povertyalleviation by the means of waqf, in the case of Russia.

that any bank, be it Islamic or conventional,is not a charity organisation – its main goalis maximising profit.

In recent years a number of banks in Russiahave been lending to SMEs. However, thisco-operation is hardly mutually beneficial.For example, even before the US mortgagecrisis influenced Russia’s economy, a num-ber of banks raised interest rates on previ-ously granted loans, basing their decisionson the clauses in the loan agreements thatcovered possible changes in the macroeco-nomic situation. As a result, many SMEswere unable to service their debts and wentbankrupt. It is obvious that in this situationbanks need help from other classical Islamicfinancial institutions that for centuries havebeen proving their effectiveness in resolvingthe problems of economic development, in-cluding a major issue of alleviating poverty.Waqf and zakat are among these institu-tions. Nevertheless, it is fair to note that bythe mid-twentieth century waqf and zakatdid not play a key role in economic develop-ment in most of the Muslim countries.

Russia can be viewed as one of the countrieswith historically developed waqf usage,which was seemingly lost in the Soviet era.This study attempts to determine whetherthis is true and, if so, whether there are ob-jective preconditions for setting up waqfand zakat systems anew in Russia.

Waqf in Russia

Waqf is property alienated for charity.When certain property is made waqf (or, ac-cording to some Muslim theologians, whenthe intention is announced), it no longer be-

ANALYSIS

www.newhorizon-islamicbanking.com


standing the waqf institution in the Volgaarea: the heirs of a rich industrialist, Uti-amyshev refused to fulfill his will underwhich part of his money was intended forwaqf, arguing that there was no specificprocedure for executing the will.

Prominent Tatar enlightener of the 19th century, Shigabuddin Mardjani, resolutely rejected this interpretation of waqf ex-ploited by rich merchants to control the economic life of the community (mahallya).It was mainly thanks to his efforts that thequestion regarding the direct purpose ofwaqf, which corresponded to the Shari’ah,was raised and a system of collective self-administration in individual Muslimparishes established. The number of embez-zlements in the charity sphere decreasedalong with, first, the power of the patrons in the Yunusov brothers’ mahallya and thenof other Tatar merchants who had beendominating their communities. Thus, ap-proximately since the mid-nineteenth cen-tury in the Volga region waqf started beingused for its main social purpose, that of aninstitute for protecting economic interests ofMuslim communities and their individualrepresentatives.

In the late 19th century, the mechanism for transforming property into waqf waslegally registered. Under the newly estab-lished legal procedure, a waqf institutor applied in writing to the assembly of parish-ioners representing the community. He wasduty bound to describe in detail the prop-erty to be turned into waqf, state its value,and enumerate the owners and the condi-tions for managing and disposing of thisproperty. The community empowered themosque leaders to apply to the governorwith a request to seek permission from theMinistry of the Interior Affairs. The latter’spermission was sent to the Orenburg Ma-homeddan Spiritual Assembly which, inturn, approved the permission and informedthe parishioners of the ministry’s decision.After a dedicatory inscription was made on the property transferred to waqf, a no-tary procedure completed the process. Thecommunity was responsible for annual re-porting about waqf management and book-keeping.

longs to the waqf institutor (waqif), but noris it transferred as property to those who re-ceive the waqf and manage it in the interestsof the receivers (designated by the waqif) ofwaqf-created profits. Using waqf propertyfor purposes other than those designated bythe waqif is prohibited.

The renaissance of waqfs in the Muslimworld happened in the eleventh century.History testifies to the existence of a broadrange of waqf, contributing to the develop-ment of medicine, education, and enabledthe provision of food essentials to the needy.For centuries, waqf was the only regularsource of funding for higher education inMuslim countries.

A few years ago, Kazan hosted ‘Waqf and Its Prospects in Modern Russia’ – an all-Russian seminar of the heads of Muslim religious boards. According to the imamswho spoke at the event, today, waqf is theonly chance for Russia’s Muslim religiousorganisations to preserve their financial in-dependence. Judging by what was said atthe seminar and by the information pre-sented at previous similar seminars, theMuslim spiritual leaders do not alwaysclearly understand the purpose of waqf.

Sometimes waqf is confused with other Is-lamic institutions: gyshar (‘ushr is the morecorrect name, that is, tithe, or a tenth partof the yield), zakat, as well as the revenuesproduced by some religious rituals: khatem-lar (gatherings that pray for the dead),janaza (burial rites), etc.

Quite often waqf is treated as a fund for fi-nancing of the operational expenditure ofmosques and Muslim clergymen. It is hardto start a constructive dialogue if those whowant to develop the waqf system have vagueideas about it.

Significantly, similar problems also existedin Russia before the revolution: one of thefirst officially registered waqfs bequeathedin 1830 to the First Main Mosque of Kazanby merchant Gabdulla Yunusov did notspecify the rules of its management and con-trol over the revenue it produced. This wasby far not the only example of misunder-

Russian Muslims, instead ofrestoring waqfs that arequestionable from the point of view of Shari’ah, have achance to set up new waqfs,capable of coping with thechallenges of the 21st century,one of which is the demand ofIslamic SMEs for financing.

Dr Renat Bekkin,Moscow State Institute of International Relations

IIBI 25

darabah mechanism, but instead is providedas a loan with an interest rate, where the interest is transferred to the beneficiary.

The modern world provides plenty of otherways to use cash waqf in compliance withShari’ah rules. One example is transferringshares that have been approved by Islamicscholars into waqf. The shareholder mightdecide that all of the dividends on shares orpart of them will be used for charity pur-poses. An institute of waqf may also play



It should be said that in pre-revolutionaryRussia, so-called cash waqf was very popu-lar: the institutor allotted a certain sum, the interest on which was used by themosques, Muslim clergy, students (shakirds)of religious schools etc. for which the waqfwas intended. In this way, while one of theprovisions of Islamic law was strictly ob-served practically everywhere, another,much more important provision, the ban onusury repeatedly formulated in the Quran,was violated.

In the Volga region a large number of Mus-lim parishes were financed by the interestfrom bank deposits. After the October revolution in 1917, waqfs were abolished invarious regions of Russia, although thishappened over time. Waqf institutions ex-isted for longest in the North-Eastern Cau-casus. Only ten years after the revolution, in1927, a decree nationalising the waqf prop-erty was issued by the local authorities ofthe Dagestan Autonomous Socialist SovietRepublic.

The waqf issue is repeatedly discussed inpresent-day Tatarstan at the highest level. In the mid-1990s, at one of the first meet-ings, members of the Muslim clergy and therepublic’s president, Mintimer Shaimiev,discussed the possibility of setting up awaqf system badly needed for the construc-tion and maintenance of mosques andmadrasahs, and for public activities. Thepresident set up a special commission tostudy the issue in depth. Specialists weresent to Turkey to gain experience. A fewyears later, a united congress of the repub-lic’s Muslims created the post of chairmanof the waqfs, in the rank of first deputymufti, and a waqf department under themufti. The very concept of waqf was firstintroduced into Russia’s legislation by theLaw of Tatarstan on the Freedom of Con-science and Religious Associations.

The provision on the waqf property and itsinalienability, contained in this law, was justa declaration of intentions rather than alegal norm that was spelling out existingpractices. However, even this provision overtime has raised questions on its compliancewith federal legislation, and the law was

subsequently amended. Nevertheless, theprovision on waqf property, although non-existent in practice, was retained.

The deputies of the State Council ofTatarstan have insisted that all efforts toprovide a legal framework for non-existentwaqfs are useless unless necessary changesare made in federal laws. In June 2008,they came up with an initiative to includethe notion of ‘waqf property’ into Russianlegislation. Earlier that year, the chairmanof the Muslim Religious Board of the Re-public of Tatarstan, Gusman Iskhakov, pro-posed the same measures. There has beenno reaction from the federal authorities sofar.

The issue of spelling out the notion of waqfin federal legislation is also important interms of restoring Muslim ownership of the waqf property, nationalised after the1917 revolution. For example, in the Au-tonomous Republic of Crimea (Ukraine),when local Tatars argue for restoring theirownership of the lands confiscated in Soviettimes, they refer among other things to theexistence of waqf property in the tsaristtimes in Russia. As was mentioned before,work is done by Tatarstan historians andlaw scholars on finding previously existingwaqfs in the Volga region. However, even ifthe notion of waqf is introduced in federallegislation, it will not guarantee the Mus-lims that their waqf property, confiscatedafter the revolution, would be returned,since the major part of documentation onsetting up waqfs has not been preserved.

And in terms of setting up new waqfs, then,even without the notion of ‘waqf property’spelled out in the Russian federal legisla-tion, those willing to do so can use manyother legal mechanisms at their disposal.For example, in order to set up the afore-mentioned cash waqf there is no need tocreate any institutional structure.

Cash waqfs exist in two forms. In the firstcase, cash turned into waqf is given to thebeneficiary as a loan with no interest rate.This form raises no objections on the side of Islamic law scholars. In the other formmoney is invested not based on the mu-

Kremlin of Kazan,Tatarstan



an important role in dealing with Islamicbonds (sukuk).

In terms of Russian legislation, it is inad-visable to include cash waqf in the trustlaw structure. In accordance with the Civil Code of Russia, money cannot be an independent object for a trust, exceptfor the cases specified by law (art. 1013,point 2, Civil Code of Russian Federation).An alternative solution is in acquiringshares and other equities, allowed by the

Shari’ah, in the name of the beneficiary.

As for the real estate as the base for waqfproperty, in 2004 the State Duma (Russia’slegislative body) passed amendments to theLand Code, which transferred, free ofcharge, land under the buildings and otherfacilities used for religious and charity pur-poses to the religious organisations thatowned them. Those religious organisationsthat do not own the buildings in which theyfunction will receive the land under them

© Andrew Veretennikov, Dreamstime.com

gratis for the entire period they continueusing the buildings. These amendmentswere intended to favour the Russian Ortho-dox Church, but other faiths benefited fromthem as well.

Therefore, from a legal point of view, thereare no problems with instituting waqfs inRussia or, to be correct, institutions close to waqfs. Neither were there such problemsin the previous legislation, which was morevague about waqf property. However, thisstudy refers to the institutions close to waqf,or so-called quasiwaqfs. Waqfs in their clas-sical interpretation in the Muslim law can-not be set up in modern Russia – except forthe cash waqf mentioned by a Hanafi jurist,Zufar ibn Hudhayl. When the status of allparties to a waqf is not clear, it is hard toguarantee that waqf will be used for thepurposes it was initially set up for and thatthe rights and obligations of the parties willbe within the Shari’ah.

Those who propose using a trust agreement(chapter 53 of the Civil Code) in order toset up a waqf forget that a trust agreementin contrast to a waqf is limited in time andcannot be concluded for a period over fiveyears (art. 1016, point 2 of the Civil Code).Moreover, current legislation does not en-visage any mechanism of managing the trustif it is managed by a citizen who is not abusinessman or by a non-commercial organ-isation (art. 1015, point 1 of the CivilCode).

Naturally, this situation requires appropri-ate amendments to the legislation. Certainlyit would be naive to talk about introducingprovisions of Islamic law on waqf propertyinto Russian legislation. And the problem isnot even in the political complications. Amore serious obstacle lies in the loss of Is-lamic legal culture in Russia.

After analysing the recent experience of reviving waqf property in the Republic ofDagestan (federal subject of Russia), wherea few waqfs appeared here and there in the early 1990s, Russian researcher V. Bobrovnikov concluded that even this re-public, which is arguably the most Islamicamong Russia’s republics, lacks the prereq-

associated with religious waqfs, not thephilanthropic ones.

One of the leading contemporary waqf specialists, Monzer Kahf, divides waqfsinto the following categories: philan-thropic, religious (mosques, graves of thereligious leaders, gravestones etc.) and pri-vate. At the same time, a waqf in any ofthe three groups can be direct or second-ary. In the first case, waqfs directly per-form their charitable, religious or socialrole: e.g. a well transferred into waqf is a free source of water for everybody. Inthe case of the secondary waqf, materialobjects or revenue from them are initiallyinvested in various spheres and only after-wards are the revenues from these invest-ments donated for charity purposes. Anexample of secondary waqf is cash waqf.

In modern Russia, direct waqfs are practi-cally ignored while they are in fact an example of non-targeted help to the im-poverished. For example, a waqf in theform of a public library, given the highprices of books, may practically be theonly source for the poor to raise their so-cial status by increasing their knowledge.

As is known, revenues from waqfs as wellas from zakat and sadaqah can be trans-ferred gratis to those who are not capableof providing for themselves (children, dis-abled etc.), as well as to those who are intemporary need of resources, including re-sources for implementing specific projects.

And as for the waqfs that have their pri-mary goal as receiving revenues, there isno need to reinvent the wheel. The experi-ence of Western states, where waqf andquasiwaqf enterprises effectively function,can be borrowed. The managing organisa-tion, specialising in managing waqf prop-erty, plays the role of a collectivemutawalli.

Although the main goal of the RussianUmmah lies in developing charity waqfs,the philanthropic enterprises that want toprovide various services and not generaterevenue should not be left unnoticed. It ishard to deny the importance for Muslim



uisites for further development of the waqfsystem as it was known before the revolu-tion. The most important reason is that theinstitution of waqf lost its former social andcultural meaning. Today, Muslim schoolsand higher educational establishments inDagestan are mainly functioning on per-sonal donations (sadaqah) and incomes de-rived from leasing out property and traderather than on waqf-created incomes. Thesame is true of the Volga region where thewaqf culture was lost even earlier than inDagestan.

In view of the above, waqf today and to-morrow is a different phenomenon that haslittle in common with the classical waqf ofthe Islamic law. It seems that in the contextof the lost Islamic legal culture in Russia asa whole (and Dagestan in particular), mostwaqf-related issues will be regulated byRussian legislation and adats, while Islamiclaw will no longer affect this institution inthe old way.

Does all of the above mean that waqf incontemporary Russia has no prospects? Notat all. The author of this article believes thatRussia losing its waqf culture, which existedbefore the revolution, is positive rather thannegative. Contemporary Tatar historiansoften recall the experience of using waqfs in the Volga region in mid-19th century.However, the fact that a substantial part of these waqfs functioned in violation of afundamental Islamic law on the prohibitionof usury is omitted. A large part of waqfs inthe Volga region were the results of usuriousoperations. That means that Russian Mus-lims, instead of restoring waqfs that are questionable from the point of view of Shari’ah, have a chance to set up newwaqfs, capable of coping with the challengesof the 21st century, one of which is the de-mand of Islamic SMEs for financing. Theprocess of creating new characteristics forthe waqf institute is inevitable. In contrastto zakat, waqf is open to a wider interpreta-tion within specific provisions of the Quranand Sunnah on charity.

Since the problem of waqfs is mostly raisedby Muslim clerics and people associatedwith them, waqf in modern Russia is usually

people of a waqf in the form of a public li-brary, where besides access to books thevisitors can enjoy free access to the inter-net, including access to scientific and otherarticles on various aspects of Muslim faith.

The institute of waqf can prove to be effec-tive in the sphere of helping Muslim mi-grants in Russia to adapt. It is commonknowledge that there are large numbers of migrants from Central Asia working inthe country: according to some sources between 500,000 and one million citizensof Tajikistan temporarily live and work inRussia. Most do not speak proper Russian,do not know basic information about thecountry, its laws etc. It is the migrantsfrom former Soviet republics who are mostactively involved in developing SMEs. In-creasing their knowledge will undoubtedlyfacilitate an increase in the effectiveness oftheir businesses.

To help Muslims from other countriesadapt to the Russian environment it is nec-essary to set up a non-governmental cen-tre, where migrants can study the Russianlanguage, Russian legislation, and evenmaster a new profession. It is even possibleto pay stipends to needy Muslim studentsfrom the funds of this quasiwaqf. The cen-tre can be set up either by one legal entityor by a number of individuals.

The real support to SMEs belonging to Muslims in Russia is provided by their fellow believers. This way, given the highrent prices for commercial real estate,some owners or renters of the buildingsprovide them gratis. Specifically, there areknown cases when publishers, specialisingin Islamic literature, were given offices tosell books and other printed matters forfree. Moreover, these premises can be used for an extended period of time. Statis-tics on this kind of activity are hard to find since businessmen try not to make itpublic.

In other words, help for SMEs does nothave to take the form of cash, but can alsobe a substantial decrease in their expenses.In this respect, information and consul-tancy services financed through a waqf

o Help for SMEs does not necessarily have to be expressed in cash, but can also be given in the form of decreasing the ex-penses of these entities. In this respect, free premises for business providing free information or consultancy services, fi-nanced through waqf or quasiwaqf, can be priceless.



or quasiwaqf can also be priceless. As for the financing of Muslim religiousboards and mosques, at present the most effective sources of their financing in Russiaare sadaqah and partly zakat, not waqf.

Main conclusions

o Banks are not reliable partners for SMEsin Russia. As a result of the global financialcrisis, many of them increased the interestrates on loans, making businessmen unableto service their debt.

o Although the notion of waqf is absent inthe federal legislation, Russia has a real op-portunity to create institutions close to waqf(quasiwaqf).

o The fact that the waqf culture was lost in modern Russia is positive, since alarge part of waqfs in pre-revolution timesin the Volga region were functioning with violations of the Islamic law against usury.

o Raising the issue of returning the pre-revolution waqfs to the Muslims is point-less, since most of legal papers on setting up those waqfs have been lost.

o When there is no clear definition of the status of all sides to the waqf agreementin the federal legislation, it is hard to guarantee that waqf will serve the pur-poses it is created for and that the rights and responsibilities of the parties will not violate the Shari’ah.

o Trust institutions, stipulated in the Russian legislation, do not suit waqf princi-ples for a number of reasons. Many func-tions of a charity waqf can be performed bya charity fund, combining targeted help tothe impoverished and the needy with educa-tional and art sponsoring activities.

o Nowadays in Russia waqf is mostly perceived as religious waqf for Muslim religious boards and mosques, whereas the most effective waqf that does not require any amendments to the current legislation is the charity cash waqf that can be used for wide-ranging support ofSMEs.

The second part of our perspectives of poverty alleviation series will focus on zakat, and will appear in the next edition of NewHorizon.

Mosque, St Petersburg, Russia

© Nikolaev, Dreamstime.com

www.newhorizon-islamicbanking.com30 IIBI


At the July lecture, Mohammed Amin

(right), UK head of Islamic finance at

PricewaterhouseCoopers LLP, raised the

question of whether Islamic finance would

have prevented the financial crisis of 2008.

The lecture was chaired by Iqbal Khan, CEO

of Fajr Capital plc and former founding CEO

of HSBC Amanah.

July: Would Islamic financehave prevented the globalfinancial crisis?

Promoting Islamic finance

Amin began with a chart of EurodollarLIBOR (the rate prime banks pay to bor-row from each other) from January 1999to January 2009 compared with the yieldon US Treasury securities (see the diagrambelow). They are regarded as risk free, so

LIBOR is alwaysabove the Treasuryyield. The red lineshows the difference,called the TEDspread. This was al-most always belowone per cent, and formuch of the decadewas below 0.5 percent.

Amin pointed outthat the first spike toalmost 2.5 per centcoincided with the run on Northern Rock inthe UK. The TED spread then stayed highand volatile, peaking in September 2008when Lehman Brothers collapsed in the US.

He showed IMF projections of global banklosses for the period 2007/10 totalling $2.8trillion, and reminded the audience of the

IIBI LECTURES

massive falls in share prices ofglobal banks such as Citigroupand the Royal Bank of Scotland.He explained the danger of adownward spiral: losses reducingbanks’ capital, making them lesswilling to lend, leading to cus-tomer bankruptcies resulting inmore bank losses. This dangerforced governments around theworld to support their bankingsectors.

In Amin’s view, the key cause of the crisis was securitisation,

which led to US banks reducing the caregiven to credit assessment of sub-prime borrowers. These sub-prime mortgages were then packaged along with much largeramounts of regular mortgages into securitiessuch as collateralised debt obligations. When borrowers began defaulting, there was a very large fall in the market value ofthe securities causing the huge bank lossescalculated by the IMF.

He then compared Islamic finance with con-ventional finance and explained that some of the contracts used in the former, such asmudarabah, share risk in very different waysfrom the latter. This should make Islamicbanks more resilient to losses than conven-tional banks, since losses on assets areshared by the holders of profit-sharing in-vestment accounts.

Most fundamentally, Amin pointed out the requirements in Islam for fair dealing,and that in his view ‘caveat emptor’ (let the buyer beware) had no place in Islamic finance. Accordingly, Islamic financiersshould not provide finance to customerswhen borrowing was clearly against the customer’s best interests. Such ethical behav-iour would have prevented the growth of the sub-prime mortgage market, which wasthe root cause of the global financial crisis.

A more detailed article on this subject canbe found on p40.

PricewaterhouseCoopers LLP

The US Treasuries/Eurodollar Libor (TED) spread

Allawi then went on to discuss the phenom-enon of globalisation and liberal capitalism.Liberal capitalism is predicated on the indi-vidual, driven by self-interest (or greed) andconstrained only by law. The entire scaffold-ing of the modern capitalist era presumesthe individual as the irreducible actor. Theideas of duty, charity, solidarity, and self-sufficiency do not sit well with the premisethat it is only through cultivating and chan-nelling a ‘natural’ selfishness that economicactivity can be optimised or maximised. Theassumption is made that man by nature isacquisitive and predatory, and that the func-tion of a well-ordered economy is to chan-nel these energies and drives into a sociallyproductive direction. This, of course, doesnot square well with the idea that humanscan perfect (or at least aspire to perfect)their qualities, and that a moral imperativeshould underlie human action. Islam doesnot deny the follies and greed of man butthese must always be tempered by a con-stant questioning of the purposes of humanaction. Wealth-creation is a by-product ofmoral action and not the purpose of man’swork.

He mentioned that the latest onslaught onthe world-view of Islam, the spread of theethic of globalisation and the liberal econ-omy, has created another battleground forthe loyalties of Muslims. The last twentyyears have seen a powerful push to univer-salise the ‘benefits’ of globalisation and theliberal capitalist order. According to Allawi,the push is championed not only by themajor western economic powers but also bythe international financial institutions thatfrequently act as their proxies on the worldstage. They have had a significant impact onthe world of Muslims, and not only in nega-tive ways. Privatisation, deregulation and licensing of monopolies all played their part in the shift of economic power from a poorly managed and frequently corruptstate sector to a better managed but preda-tory form of liberal capitalism. He statedthat this process further distanced the Mus-lim world from the possibility of regenerat-ing the basis of an Islamic economic systemand order. In Allawi’s mind, Islamic bankingwas the single most important step in thelast thirty to forty years in trying to realise

the institutional basis of a new Islamic eco-nomic order. But for a variety of reasons ithas been shunted along a different track, atrack where the rules of transactions may beobeyed in their narrow sense but their pur-pose and meaning is lost. He reflected theopinion shared by some academics, scholarsand practitioners that in the demand forbeing competitive, flexible and pragmatic,certain parts are chosen that eliminate an alternative route.

Allawi considered how far Muslims havegone down the road in disconnecting withthe seeds of change and rejuvenation tobring back the moral economy. He pointedout that in reality, the order can only be re-born if certain fundamental reforms – in

fact fundamental paradigm shifts – are un-dertaken. The main features of an Islamiceconomy have been eroding for several cen-turies, so that most are merely religious ves-tiges of a long-forgotten past. The role ofzakat, for example, in the public finance ofIslamic states, or the structuring and formu-lation of economic and financial transac-tions in which the use of interest is simplyunimaginable, had been long superseded byeconomic models that draw their outlinesfrom the conventional world of businessand banking. The weakening in the averageMuslim’s commitment to the idea of zakatas fundamental to his or her identity as aMuslim is mirrored by the loss of charitablegiving that lies at the heart of Islamic redis-tributive justice. It has become almost com-monplace to bemoan the unwillingness ofthe wealthy in the Muslim lands to sharetheir wealth through charitable acts and theendowment of foundations. The Muslim

IIBI 31www.newhorizon-islamicbanking.com


Despite the enormous growth of the Islamic

finance industry in the last three and half

decades, still the most popular structures

used by Islamic financial institutions (IFIs)

are murabaha (cost plus mark-up) and ijara

(leasing), which in economic terms are similar

to conventional secured loans and leasing

from the customers’ point of view. These

structures constitute around 80 per cent of

all global Shari’ah-compliant finance

transactions.

Ali Allawi, visiting fellow, Carr Centre, Kennedy

School of Government, Harvard University

and senior associate member, St. Antony's

College, Oxford, delved into the wider

paradigm and economic parameters which

must be in place to achieve the social benefits

of economic transactions as emphasised in

Islam. He also looked at whether existing

Islamic finance practices are leading to the

right direction. The lecture was chaired by M

Iqbal Asaria from Afkar Consulting Ltd.

August: Beyond the forms –economic transactions andthe ideals of Islam

IIBI LECTURES

The lecture began by looking at the histori-cal developments in Muslim civilisationsand the loss of vitality that Allawi consid-ered one of the most important props, both economic and material, in any civilisa-tion, and how it has impacted on the eco-nomic activities. Allawi referred to theremarkable achievements of the early Mus-lim traders and merchants who promotedlong distance trade and commercial partner-ship over vast areas of land. These commer-cial relationships and economic transactionswere overlaid by a very sophisticated systemand detailed regulations and rulings. Justifi-cation of all kinds of transactions and theirlegal and moral basis were rooted in theQuranic and Prophetic tradition. Accordingto him, there was always a form and anideal that to a very large extent determinedthe boundaries and limits of economictransactions.

August lecture


NEWHORIZON October–December 2009IIBI LECTURES/EVENTS REVIEW

world’s wealthy are notorious for their pri-vate indulgences and excesses, and theirlack of any public spiritedness. There are no major research foundations, universities,hospitals or educational trusts that arefunded by large charitable donations. Thescale and scope of the philanthropic workof the modern west – especially the US – is inconceivable amongst the Muslim rich,even though their individual fortunes alsorun into the billions of dollars. But service-based charitable work is an essential ele-ment of the Islamic economy, weaving, as it were, religious obligations with astrong sense of social justice and moral responsibility.

He mentioned that it will be of course impossible to reconstruct the basis of an Islamic economy without tackling the‘problem of interest’. The rise of the Islamicbanking movement was primarily driven bythe continuing public suspicions of interest-bearing accounts and the work of commer-cial banks. It is thus doubly incongruous,even disturbing, that after waiting for a

long time to produce financial practices andinstitutions that reflect the teachings ofIslam, the Islamic banking movement, whichwas this very outcome, was in turn sub-verted to the purposes of finance capital.

In Allawi’s view, ‘Islamising’ economic andfinancial transactions in conventional insti-tutional forms, such as banks and insurancecompanies, will not lead to the revitalisationof the Islamic economy nor significantly af-fect the well-being of Muslims around theworld. What is needed is a re-imagination ofthe nature and purpose of economic transac-tions in Islam. From this process will evolvethe policies, institutions and enterprises thatcould form the basis of an entirely new eco-

nomic framework that reflect the ideals ofIslam. These ideals may provide some solu-tions for the future stability of the global financial system and return to old truthsand values.

He concluded that a revitalisation of an Islamic economy does not simply mean thereinvention of ancient institutions and prac-tices in a modern context. It will have to bebased on a fundamental rethinking of thepurposes and goals of individual and socialeconomic acts; and how these could be bestexpressed outwardly in the form of new in-stitutions, practices and habits of conductthat reflect the ethical foundations that un-derlie all economic life.

The mission of the IIBI is to be a centre of excellence for professional education, training,research and related activities, to build a wider knowledge base and deeper understandingof the world of finance promoting the Islamic principles of equity, socio-economic justice

and inclusiveness. The Institute holds regular lectures on topical issues, delivered by industry experts. For information on upcoming lectures and other events,

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

Managing Shari’ah Risk through Shari’ah Governance

The IIBI, in collaboration with the International Shari’ah Research Academy for Islamic Finance(ISRA) and Thomson Reuters, conducted a one-day conference in London. The event,sponsored by Westlaw Business, focused on managing Shari’ah risk through Shari’ahgovernance.

fines Shari’ah governance as the structuresand processes adopted by IFIs to ensurecompliance with Shari’ah. Alternatively,Shari’ah governance focuses on the rolesand functions of the Shari’ah boards in IFIsto ensure the implementation of the Shari’ahrules in product development and supervi-sion of IFIs’ operations to fulfil the Shari’ahobjectives.

Currently, different IFIs adopt differentmodels of Shari’ah governance. Malaysia,on the one hand, has a two-tier Shari’ahgovernance system: one at the institutional

level and one at the National Shari’ah Advi-sory Council, which has the final say. This isalso referred to as the centralised Shari’ahgovernance system. On the other hand,most other jurisdictions practice a decen-tralised Shari’ah governance model withShari’ah governance being carried out at theinstitutional level.

The aim of the workshop was, firstly, to deliberate on Shari’ah risk (particularly infund management and structured products)and, secondly, to elaborate on Shari’ah gov-ernance models practised in the market and

Shari’ah compliance is the raison d’être ofIslamic financial institutions (IFIs), whilenon-compliance is a significant and substan-tial risk for IFIs. If a product is found to benon-compliant, it must be retracted fromthe market and any profit earned on it mustbe channelled to charity. Although Shari’ahcompliance risk is difficult to quantify ex-ante, IFIs must explore ways to manage thisimportant risk as it might significantly dam-age their reputation and creditability.

The Islamic Financial Services Board (IFSB),a Malaysia-based standard-setting body, de-


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 IIBI EVENTS REVIEW

examine how effective these models are inmanaging this risk.

After the welcome address by Dr MohamadAkram Laldin, executive director at ISRA,Ahmad Hizzad, the director of Islamic bank-ing and takaful department at Bank NegaraMalaysia (BNM, the central bank), deliveredthe first keynote address, in which he sharedthe experience of the Malaysian market andBNM’s efforts to create an effectiveShari’ah governance framework. How-ever, he pointed out that the soundnessof a Shari’ah governance structure liesin the efficiency of the organisation asa whole.

Professor Rifaat Ahmad Abdel Karim,secretary general of the IFSB, was thesecond keynote speaker. He discussedthe broader issues of Shari’ah gover-nance and the important role playedby the IFSB in this regard.

The conference had five sessions fol-lowed by a panel discussion at the end.The first session, ‘Shari’ah risk inproduct development, processes andoperations: Islamic equity indices andtheir use in Islamic fund management’,was presented by Rushdi Siddiqui,global head of Islamic finance atThomson Reuters. He discussed theShari’ah-related risks in Islamic indexconstruction, including applying thescreening criteria for business as wellas financial ratios, the role of Shari’ahboards and the purification and zakatcalculations.

In the second session Mohamed Vi-rani, vice president, Islamic structuringof Société Générale, discussed theShari’ah risk in product development,processes and operations in the context of Islamic structured products which are instru-ments created for specified needs and to pro-vide an alternative to direct investment. Helooked at structural, legal and documenta-tion risks, as well as scholars’ non-consensusand reputational risks in developing struc-tured products. He also elaborated on theconstraints resulting from providing Shar-i’ah-compliant solutions, such as hedging is-

sues, and extra collateral funding costs,greater operational requirements and gov-erning law of the product documents. ISRA’s Laldin presented the third session,‘Shari’ah governance from scholars’ per-spective’. He explained that Shari’ah gover-nance requires an adequate framework withdefined roles and responsibilities of Shari’ahadvisors. He pointed out that at the momentthere are different approaches in Shari’ah

decision-making, ranging from having afull-time in-house Shari’ah advisor to a pro-fessional body of Shari’ah advisors. Hehighlighted that a comprehensive Shari’ahgovernance framework is vital for the devel-opment and growth of the Islamic financeindustry; continuous enhancement of thecurrent framework as well as advisory serv-ices is necessary and it requires the supportand co-operation of all Islamic finance in-dustry stakeholders. Nowadays, Shari’ah

advisors need to be more dynamic and gainas much exposure and experience as theycan, as well as ensure enhancement of theirknowledge and skills to effectively supervisethe activities of IFIs.

In the fourth session, Madzlan MohamadHussain, senior project manager of theIFSB, focused on the regulatory approachto a Shari’ah governance system. He pro-

vided an insight into the exposuredraft of IFSB-10 – Guiding Principleson Shari’ah Governance Systems forIFIs. The four key attributes identifiedby the IFSB for sound and effectiveShari’ah governance are competence,independence, confidentiality andconsistency.

In the fifth and final session, Dr Humayon Dar, CEO of BMB Islamic,discussed the challenges of imple-menting Shari’ah governance. He explained various approaches to regu-lating Shari’ah advisory services: oneis laissez faire in which there is nogovernment intervention in the provi-sion of Shari’ah advisory services; a second one is central regulationwhere government regulates the Shar-i’ah advisory firms on a central level;another one is a hybrid model whereIFIs must ensure Shari’ah complianceon their own and report their effortsto the central regulatory authority. Hecommented that Shari’ah governanceis a national issue and not an interna-tional one; the regulators must playan active role in ensuring Shari’ahcompliance, and the Shari’ah gover-nance regime must be developed onthe national level.

This was followed by a panel discussion, titled ‘The road ahead for Shari’ah gover-nance, regulation and Islamic capital markets’, and a lively Q&A session. Theconference was attended by 120 partici-pants and included representatives of finan-cial regulators from Germany, France, Italy and the UK, as well as Shari’ah schol-ars, legal practitioners, accountants, aca-demics and post graduate students inIslamic finance.



Structuring Innovative Islamic Financial Products

Mohammad Shafique, IIBI editor of NewHorizon and programme development co-ordinator,presents a summary of the third annual three-day residential workshop organised by the Instituteand held at Clare College, University of Cambridge, UK.

There is increasingly recognition that theremust be an ethical and moral face to finan-cial transactions. These voices are heardfrom all corners, from financial industry reg-ulators to veteran bankers to religious lead-ers. There is much said and written aboutthe recent financial crisis in the media,nonetheless, the lack of a moral compass ingovernance structures of conventional finan-cial institutions is among the main causes of the financial quandary we are in today. Islamic finance is all about embedding moralvalues in financial dealings. With its value-oriented system, Islamic finance stands apartfrom conventional financing, providing a viable alternative.

Against this backdrop, the IIBI held a three-day residential workshop in Cambridge, the historic University town in the UK, onstructuring innovative Islamic financialproducts. The event was supported by PathSolutions, a core banking system providerfor the Islamic finance industry. The work-shop was aimed at increasing the partici-pants understanding of the products andservices offered within the model of conven-tional finance, and was attended by partici-pants who came from Argentina, France,Lebanon, Saudi Arabia, Trinidad and To-bago, Tanzania, the US and the UK. Withthe help of practical examples, the work-shop also provided an opportunity to learnhow to structure innovative Islamic financialproducts and reconcile Islamic and conven-tional legal and compliance requirements.

The workshop was run by Dr HumayonDar, chief executive of BMB. He was as-sisted by: Richard T de Belder, partner atDenton Wilde Sapte, an international lawfirm; Ms Haliza Abd Rahim, head of projectmanagement at BMB Islamic; Jasani Abdul-

IIBI EVENTS REVIEW

lah, chief executive officer of Hong LeongIslamic Bank, Malaysia; Dr Asyraf WajdiDato’ Dusuki, head of research affairs at theInternational Shari’ah Research Academyfor Islamic Finance (ISRA), Malaysia; andMuhammad Ismail, financial controller atSony Europe.

After the introduction, Dr Dar discussedsome of the essential elements of structuringShari’ah-compliant products. These includedeep knowledge of Shari’ah, insight into de-velopments in the financial markets andclear understanding of the customers’ needs.

In the next session, Jasani Abdullah ex-plained the idea of product innovation andcompliance in Islamic finance and sharedthe experience of the Malaysian market, andhow basic structures of ijara, murabaha,mudarabah and istisna have been innova-tively used in various products. Innovationis referred to as introducing something newor an act of starting something for the firsttime. In the Islamic finance context, ques-tions arise from the adaptation of financialproducts from a conventional structure as towhether those converted products can beconsidered as innovative efforts or other-wise. He stated that one may say that thestructuring of a conventional product tocomply with Shari’ah standards is some-thing new and if such a structure is a first ofits kind, thus it can be accepted as innova-tion. Conversely, some may view that aproduct can only be considered innovativewhen it is derived from an Islamic conceptwithout similar conventional structure be-fore it. However, every innovative productmust comply with Shari’ah principles andthe national legal framework, should meetcustomers’ needs and must be commerciallyviable.

Abdullah mentioned that the innovative use of murabaha includes, but is not limitedto, syndicated murabaha financing andsukuk murabaha. It is also used for bridgefinancing, treasury and liquidity manage-ment and offering a fixed return to deposi-tors. He also discussed the hybrid structureswhich are a combination of murabaha, leaseand other contracts with the example of theAir Asia Bank Guarantee Sukuk. He re-ferred to the PLSA Sukuk and MPG SukukMudarabah as examples of innovative ap-plications of mudarabah and musharakahstructures. He pointed out that risk manage-ment is the key to success in offering inno-vative products, whether it is credit risk,Shari’ah compliance or operational risk, andin case of Islamic finance, due to the smallsize of the industry, reputational risk is veryhigh. Then he discussed the credit crunchand its impact on Islamic product develop-ment. As Islamic finance industry players donot as yet have access to diverse asset classesfor their asset and liquidity management ascompared to their conventional counter-parts, innovation of products is thereforevery important for creating more Shari’ah-compliant instruments and products and toavoid the concentration of assets in onearea.

In the following session, Ms Rahim went onto discuss the key issues in the documenta-tion required for Islamic financial products.She mentioned that broadly there are twotypes of Islamic financial products, retailand investment, and documentation ofproducts should reflect the legal structure aswell as their operational mechanism and theresulting tax and regulatory requirements.With the help of practical examples such asa profit rate swap and a euro medium termnote (EMTN) structure, she elaborated vari-



sold to investors. In Islamic finance, thisprocess is achieved through ‘taskeek’ – theprocess of issuing sukuk which are certifi-cates that represent ownership of the assetpool. In this way, the owner of income-producing assets, for example, commer-cial properties that produce rental income,can package and sell them to a specialpurpose vehicle (SPV), which in turn re-sells these assets to investors. Periodi-cally, income from the asset is distributedto the sukuk holders and at the end of theterm, the asset is re-sold to get back theinitial investment of investors.

Ismail stated that the size and coverage of the issues to date means that there ishuge potential for growth of the sukukmarket. Although most of the sukuk is-sues have been done by governments orgovernment-backed entities, there is morepotential for multi-national companies toenter the market and diversify theirsources of funding. The increase in sizeand depth of the sukuk market will alsobenefit the Islamic finance industry byproviding a secondary market for liquiditymanagement.

ous practical issues which needed to betaken care of in the documentation applica-ble for Islamic financial products.

Then, Ismail provided an overview ofsukuk and its applications. He pointed outthat though sukuk share some financialcharacteristics with conventional bonds,these may be debt or equity instrumentsbased on the underlying contract. Sukukholders have proportional ownership of as-sets of the underlying project, but this is notthe case in conventional bonds where bondholders own cash flow only. The proceedsof sukuk issuance are invested in Shari’ah-compliant businesses and the maturity ofsukuk corresponds to an underlying proj-ect; returns for sukuk holders are linked toactual profit earned from the underlyingproject (which includes the risk of loss),while in conventional bonds the returns arelinked to interest rates. These features ofsukuk make them closer to conventionalbank securitisation than to conventionalbonds. He explained that securitisation is afinancial process which involves poolingand repackaging of cash flow producing fi-nancial assets into securities that are then

In the ensuing session, de Belder presentedsome case studies of recent sukuk dealswhich included Tamweel, Sun Finance(Sorouh), Aldar, Purple Island and TabreedSukuk. The $210 million Tamweel Sukukis considered to be a ‘true’ sukuk, involv-ing securitisation of the properties andleases, but which involved special opera-tional issues relating to the dual SPV struc-ture and issues of relating to UAE law. Hediscussed the legal and Shari’ah compli-ance issues which existed in the Sun Fi-nance (Sorouh) Sukuk – an Abu Dhabibased issue, in which property sale formedthe basis of the mudarabah assets. He alsocommented on an AAOIFI statementwhich looked at purchase undertaking inmudarabah or musharakah sukuk. He dis-cussed sukuk which are issued with war-rants attached, where these sukuk areissued at a discount and the sukuk holdershave the option to exchange sukuk withcompany shares. He also highlighted thedifference between asset-based and asset-backed sukuk. If the returns to sukuk holders are dependent purely on the per-formance of the underlying project, thenthis is termed as asset-backed, and if theobligor gives an undertaking to cover theshortfall in the profit to match the requiredreturn to sukuk holders, then it is asset-based. The majority of sukuk issued so farare asset-based.

In the next session, Dr Dusuki elaboratedon the Shari’ah considerations in sukukstructuring and also discussed the recentcontroversies in sukuk after an AAOIFIstatement in 2008 (NewHorizon, Octo-ber–December 2008). He stated that theAAOIFI guidelines on sukuk primarily focused on two points; tradability and redemption at maturity. Trading of sukukthat represent common ownership of tangi-ble assets, usufructs or services is allowed.This is not considered bai al-dayn (tradingof debt) because the sukuk are backed byownership of a real, tangible asset and donot represent pure indebtedness in theform of monetary receivables. Then helooked at the use of hybrid structures, suchas ijara and istisna, in some sukuk dealswhere the debt element becomes an over-whelming part of the sukuk transaction in

IIBI EVENTS REVIEW

Cambridge workshop


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 IIBI EVENTS REVIEW

the beginning and its implications on thetrading of sukuk. He commented that theAAOIFI statement on sukuk, which wasmisreported by some in the mainstreammedia, emphasised that the tradable sukukmust represent ownership of the underly-ing project/asset and must not represent receivable or debt except incidental to thephysical asset. In equity-based sukuk, noliquidity facility should be provided by the manager of the sukuk, whether themanager acts as mudarib (investment manager), sharik (partner), or wakil(agent) for investment. However, buildinga reserve is allowed. In such sukuk, a pur-chase undertaking should not be at par,but it should represent market or fairvalue. The AAOIFI statement allowed apurchase undertaking in the case of ijarasukuk, and widened the scope of Shari’ahscholars from the mere approval of sukukstructures to ongoing supervision, and en-couraging the sukuk issuers to use equitybased structures.

In the following session, taxation of sukukfrom the UK perspective was discussed.The UK Government has progressively incorporated changes in the UK Tax Lawsince 2003 with particular changes relatingto sukuk in the 2007 Finance Act. Thesechanges will bring taxation of sukuk, subject to compliance with certain condi-tions, in line with conventional interest-bearing debt, and will also address thecapital gains and capital allowances issuesin such transactions.

Then, Dr Dar explained the innovations in Islamic depository/savings schemes withan example of sukuk al-wataniyya, whichis a savings product offered by the Na-tional Bonds Corporation (NCB) in theUAE and structured on mudarabah basis.Sukuk holders are investors (arbab-al-maal) while NCB acts as mudarib. NCBinvests proceeds from the sale of sukuk inShari’ah-compliant assets and the returnfrom such investments is shared in agreedratio between the investors and NCB.However, NCB distributes the share of itsprofits among the sukuk holders, which isdone normally by prize draws, on a regu-lar basis. He then looked at the parallels

between premiums bonds in the UK andsukuk al-wataniyya and also highlightedcommercial and Shari’ah related issues insuch structures. Afterwards, he discussedShari’ah-compliant options contracts. Anoption is a contract that gives its holder aright to buy or sell an asset at a future dateor in a certain period for a specified price.However, it is not ‘maal’ (a valuable assetaccording to Shari’ah principles). There-fore, it is not permissible to buy and sellan option for a price. He explained a calloption contract that gives the holder theright to buy a certain quantity of an un-derlying security from the writer of the op-tion, at a specific price (the strike price) ator up to specified date (the expirationdate). Then, he discussed whether it in-volves gharar (excessive uncertainty), gam-bling or riba (interest) and looked at theuse of arboun as a call option. He went onto discuss a put option which gives theholder a right to sell a certain quantity ofan underlying security to the writer of theoption, at a specific price (the strike price)

at or up to a specified date (the expirationdate) and elaborated on a few structuresusing wa’ad (promise) which may replicatethe economic effects of conventional putoptions. He stated that unbundled optionscannot be traded. However, options bun-dled with other assets can be traded.

Dr Dar then provided an overview of finan-cial swap contracts. There are various typesof swap contracts such as currency swaps,commodity swaps and interest rate swaps.He mentioned that as long as a Shari’ah-compliant asset is being traded against another Shari’ah-compliant asset in a Shar-i’ah-compliant way, swapping is permissible.Then he explained a Shari’ah-compliantswap contract which was developed usingwa’ad and another one using commoditymurabaha.

In the next session, Dr Dar explained Shar-i’ah-compliant hedge funds (SCHFs) and re-lated issues. Hedge funds provide ‘top-endof the market’ investment opportunities andare typically invested in by wealthy individ-uals/institutions. Rules and regulations gov-erning (other) mutual funds do not apply tohedge funds, enabling them to pursue ag-gressive investment goals. Investors in hedgefunds pay a management fee and hedge fund managers also collect a percentage ofthe profits (usually 20 per cent). Hedge fund managers pursue various strategies to achieve their investment goals including but not limited to long/short selling andleveraging. However, statistics indicate thatlong/short funds represent the largest universe of current hedge funds (in the region of 30 per cent). He pointed out thatleveraging does not pose a Shari’ah concernas long as it is obtained through a Shari’ah-compliant debt mechanism. As such, it ismore of a financial/economic decision.

Nevertheless, conventional techniques ofselling short are not allowed by Shari’ah.Shorting (or selling short) means borrowingstock and selling it with the expectation thatits price will fall and then buying the samestock from the market at lower price. Thisprocess gives rise to a range of problems Is-lamically. The principal attempts to repro-duce pay-offs of conventional shorting forSCHFs are based on using salam and ar-boun contracts. However, both of the abovecontracts are not accepted by the majorityof Shari’ah scholars and this implies re-stricted marketability. Another key issue inSCHFs is liquidity management. While con-ventional hedge funds have a wide array ofinstruments for liquidity management, this

Cambridge, UK


NEWHORIZON October–December 2009IIBI EVENTS REVIEW/CALENDAR

is not the case for SCHFs and therefore, itis a key area of concern for SCHFs. DrDar shared with the participants informa-tion contributed by Sheikh Yusuf TalalDeLorenzo, chief Shari’ah officer at Shar-i’ah Capital, on the workings, perform-ance and transparency of the DSAM AlKauthar Funds.

In the final session, there was group dis-cussion on innovation and product devel-opment. As the Islamic finance industry isstill relatively small, in order to meet thecustomers’ needs and maintain the paceof development, it has to widen the prod-uct range. Though some products mayhave similar economic effects as theirconventional counterparts, Islamic fi-nance practitioners should focus their at-

tention and exert their energies on devel-oping new products which are Shari’ah-compliant in ‘substance’ as well as in‘form’. Such products will bring much re-quired credibility to Islamic finance andpave the way for its growth in the main-stream financial industry.

Iqbal Khan, CEO of Fajr Capital and former founding CEO of HSBC Amanah,and Dr Mohamad Akram Laldin, execu-tive director at ISRA, shared their viewswith the participants. They highlightedthe industry challenges, especially thedearth of well trained practitioners whomust not only have competence to de-velop products, but also believe in the Is-lamic finance industry and be fullycommitted to it.

The workshop ended with the award of a ‘Certificate of Attendance’ by Dr Laldinand a Cambridge University souvenir byKhan to all participants.

October

Diary of events endorsed by the IIBI

12–14: World Islamic Retail Banking 2009,

Dubai

Conference to seek what lessons can belearnt from the economic ‘meltdown’, andhow resilient Islamic banks have been dur-ing the current crisis, as well as to focus onIslamic banking and finance as an alterna-tive model to the conventional industry.Contact: Anthony PermalTel: +971 4 609 1581Email: [email protected]

November

3: 4th World Islamic Infrastructure Finance

Conference (WIIFC), Doha

Conference to strengthen the role Islamicproject finance can play in meeting massiveinfrastructure investment needs – which isseen as key to revitalising growth.Contact: Naomi NjorogeTel: +971 4 343 1200Email: [email protected]

December

6–8: 16th World Islamic Banking

Conference, Bahrain

Conference to discuss the key issues, devel-opments and challenges of Islamic bankingand finance worldwide. The event boastsstrategic partnerships with central banksand regulators.Contact: Naomi NjorogeTel: +971 4 343 1200Email: [email protected]

February 2010

7–8: 6th Middle East Insurance Forum,

Bahrain

Forum to engage the key issues shaping thefuture of the regional Islamic and conven-tional insurance, including innovation anddevelopment, as well as achieving interna-tional best practice and standards. Contact: Naomi NjorogeTel: +971 4 343 1200Email: [email protected]

Dubai

Bahrain

The fourth IIBI three-day residentialworkshop at Cambridge University

will be held on 30th July to 1st August,2010. For further details, please contactthe IIBI. Contact details can be found on p4 or in the ‘Contact us’ section

on the website.

What caused the crisis?

A number of different factors came togetherin what has been called ‘a perfect storm’.

a) US sub-prime mortgages

This is a mortgage loan to a borrower withflaws in his or her credit rating, such as aprevious bankruptcy. Normally such bor-rowers need additional collateral for loansand face higher interest rates.

However, several years of strongly risinghouse prices caused lenders to relax theirlending criteria. Loan-to-value ratios roseand low starter-interest rates were intro-duced (typically for the first two years ofthe mortgage) to be recouped by higher interest rates for the remaining 28 years of the typical 30 year US mortgage. Inmany cases the borrowers knew that they could not afford the monthly pay-ments after the initial two-year low interest period expired; they were relying on risinghouse prices to enable a profit on sale or refinancing.

However, US house prices started to fall.Faced with negative equity many US house-holders simply walked away from theirproperties. Unlike the UK, in many USstates residential mortgages are non-re-course, with no personal liability for theborrower. The mortgage default rates onthese sub-prime mortgages were muchhigher than predicted by the lenders’ creditmodels. These models were based upon the historical behaviour of prime borrow-ers, not sub-prime borrowers who behaveddifferently.



to nearly 2.5 per cent, remained volatileand in late 2008 soared to over 4.5 percent. What was happening?

Newspapers report that in mid-2007 UKbank, Northern Rock, became unable to fund its operations in the interbankmoney market. Liquidity had disappeared,evidenced by the almost instantaneous rise in the TED spread to levels unprece-dented in recent memory. The historicalphrase ‘credit crunch’ reappeared; an environment where even creditworthy borrowers are simply unable to accessfunds. In the UK, the US and elsewhere,central banks had to supply a hugeamount of liquidity to the interbankmoney market, but with limited impact as can be seen from the TED spread chart.In September 2008, Lehman Brothers collapsed in the largest bankruptcy, by size of assets ever.

Diagram 2 shows the International Mone-tary Fund's projections for the period2007/10 of bank writedowns on assets byregion. The US write-down of 8.8 per centof total assets is enough to wipe out al-most all the capital of the US banking sys-tem. It is therefore no surprise to see themassive falls in bank share prices illus-trated in Diagram 3.

Governments have been forced to supporttheir banking sectors with capital injec-tions. Otherwise their economies faced a perpetual downward spiral: losses reducing banks’ capital, making them less willing to lend, leading to customerbankruptcies resulting in more banklosses.

Based on Amin’s presentation at the IIBI’smonthly lecture, London, July 2009.

2008 saw the most severe crisis in theglobal financial system since the Great De-pression of the 1930s. At conferences onIslamic finance one question occurs re-peatedly: ‘Would it have happened withIslamic finance?’

To address this question systematically,one needs to consider the following:

o What exactly is the global financial crisis?

o What caused it?o How does Islamic finance differ from

conventional finance?o Would the differences between Islamic

finance and conventional finance have averted the crisis?

These are complex issues and this shortarticle can only provide signposts for fur-ther study.

What is the global financial crisis?

Diagram 1 shows the difference betweenEurodollar LIBOR (the London InterbankOffered Rate at which prime banks lendto each other) and the yield on US Trea-sury securities. As the US government can print dollars and has never defaulted,its dollar-denominated liabilities are regarded as risk-free, so LIBOR alwaysexceeds the Treasuries’ yield. The spreadbetween them (called the TED spread) has typically been under one per cent, andfor most of the last decade was under 0.5per cent. However it spiked in mid-2007

Would Islamic finance have preventedthe global financial crisis?Mohammed Amin, UK head of Islamic finance at PricewaterhouseCoopers LLP, addresses aquestion often asked by Islamic finance practitioners.

ACADEMIC ARTICLE


NEWHORIZON Shawwal–Dhu Al Hijjah 1430 ACADEMIC ARTICLE

b) Securitisation

Over the years, the US mortgage market hadmoved away from a ‘lend and collect’ model(the bank lends on a mortgage and collect itback over 30 years) to an ‘originate to sell’model (the bank makes a mortgage loan inorder to sell it on.) Originating loans andselling them on means that banks makeprofits from lending as much as possible,provided that the loans can be sold on; oncethe loan has been sold the bank is relativelyindifferent to its collectibility.

c) Complex securitisation structures

As well as securitising original loans, invest-ment bankers developed more complexstructures such as CDO2 (collateralised debt obligations squared) illustrated on Diagram 4.

Here CDO securities created by Bank 1 and Bank 2 selling their customer loans are purchased by Special Purpose Entity (SPE) 3which pays for them by issuing CDO securi-ties to investors. As these are CDOs basedon other CDOs, they are called CDO2.

The challenge with such complex structuresis that it becomes almost impossible to accu-rately project likely defaults on the originalcustomer loans to the likely defaults on thesecurities issued by SPE 3. In many cases,complex CDO structures involved somesub-prime mortgages being blended withprime mortgages to boost the yield of theoverall package of assets. Accordingly, oncedefaults started happening in the relativelysmall sub-prime market, that led to a col-lapse in the market value of a much largeramount of CDOs.

d) Credit derivatives

Under a credit default swap contract (CDS)as shown in Diagram 5, the seller is paid aregular amount each year by the buyer ofthe CDS. If a credit event occurs in relationto the underlying asset which is referencedby the CDS, the seller pays the buyer for thefall in value of the reference asset. However,the buyer does not need to own the refer-ence asset; in that case the CDS buyer is

Writedownson assets

$US billion

% of total assets

US banks 1049 8.8

UK banks 316 5.0

Europeanbanks ex UK

1109 4.6

Asian banks 337 3.5

Total 2810 5.4

Diagram 2IMF Global Financial Stability

Report April 2009 estimated bankwritedowns 2007–2010


Diagram 3Falls in bank share prices


1 or 2Jan

2007

Lowestprice

Date

Citigroup $56.28 $0.97 2/3/2009

Bank ofAmerica

$54.18 $2.53 16/2/2009

Royal Bank of Scotland

582.51p 10.3p 20/1/2009

Lloyds TSB

577.35p 42p 6/3/2009


Diagram 1The US Treasuries/Eurodollar Libor (TED) spread


NEWHORIZON October–December 2009ACADEMIC ARTICLE

simply speculating that the reference assetwill fall into default.

Until a credit event occurs, the seller of theCDS receives cash each year. Accordingly, toassess its profits, it needs to assess an actu-arial liability for the likelihood of payingout under the CDS. If it underestimates theCDS payout risk, it will erroneously reportprofits each year. Some very large CDS sellers did report large profits, only to findthat as credit market conditions changedthey faced losses on their CDS contractslarge enough to bankrupt them. Accord-ingly, the US government had to inject capi-tal into the largest US insurance company,American International Group, to save itfrom bankruptcy.

The existence of CDS contracts also changesthe incentives that apply in the capital mar-kets. A CDS purchaser may be in a positionto directly influence the solvency of the un-derlying borrower of the reference asset. Forexample, the CDS may be over bonds issuedby a bank. If the CDS buyer can force theborrowing bank into distress (which canlead to counterparties becoming reluctant todeal with it) the buyer will make profitsfrom the resulting default due to its owner-ship of the CDS contracts.

e) General over-leveraging

The economies of the UK and US had notsuffered a serious recession for many years.In these benign business conditions, compa-nies had gradually increased their gearing,as interest on debt is tax deductible whereasdividends on share capital are not tax de-ductible. The high gearing was particularlystriking in companies owned by private eq-uity firms, which were typically very highlyleveraged. If economic conditions worsened,such firms would risk insolvency.

All of the above factors came together in thecrisis.

How does Islamic finance differ?

As illustrated in Diagram 6, Islamic financeis a strict subset of conventional finance.Everything done in Islamic finance can be

Diagram 4CDO squared


Diagram 5Insurance companies selling credit default swaps (CDS)


Diagram 6Introduction to Islamic finance



NEWHORIZON Shawwal–Dhu Al Hijjah 1430 ACADEMIC ARTICLE

done using conventional contracts; theconventional contracting parties need notcare whether their contracts are Shari’ah-compliant. Conversely, there are manycontracts used in conventional financewhich cannot be used in Islamic finance.Most practitioners consider that Islamicfinance prohibits:

o contracts with excessive levels of complexity or uncertainty (gharar);

o trading of debts at amounts different from face value;

o short selling;o most derivatives including CDS.

Some of the contracts used in Islamic finance have similar economic characteris-tics to conventional contracts. For exam-ple, the customer in a murabaha contractor an ijara contract makes predeterminedcash payments, which can be identical inamount and timing to those a conven-tional customer might pay under an inter-est-bearing loan or under a conventionalleasing contract.

However, other contracts used in Islamic finance have economic characteristicswhich differ from the contracts commonlyused in conventional finance. For exam-ple, in a mudarabah contract, losses areborn exclusively by the rab-al-maal (thecapital provider) and not by the mudarib(the entrepreneur or business manager.)Diagram 7 shows a sukuk structure wherethe originator, XYZ Trading Company,does not make any payment to the sukukinvestors (directly or indirectly) if thebusiness being conducted with the fundsraised fails to generate sufficient profits.This is quite different from a conventionalbond.

There are three main reasons why Islamic finance would have been less likely to re-sult in the global financial crisis.

a) Prohibited contracts

Certain contracts are simply prohibited inIslamic finance. The prohibition of ghararand of selling things not owned precludescomplex contracts such as CDO2 and

Diagram 7Mudarabah sukuk – risk-sharing economics


Diagram 8Conventional bank balance sheet

Diagram 9Islamic bank balance sheet



NEWHORIZON October–December 2009ACADEMIC ARTICLE

CDS. Accordingly, many of the contractsthat have led to the greatest difficultieswould never have been used.

b) Different risk sharing

The Islamic financial system distributesrisk differently from conventional fi-nance. While the same aggregate businesslosses may arise, their different distribu-tion makes the system less likely to ‘seizeup’ or result in corporate bankruptcies.

For example, with a conventional bank,as in Diagram 8, liabilities are repayablein full so losses fall exclusively on thebanks equity. Accordingly, even a rela-tively small asset default rate can seri-ously impair the banks equity and itsability to lend. Conversely, the Islamic

bank in Diagram 9 shares losses with the holders of profit-sharing investmentaccounts. As the equity of the bankingsystem does not bear all of the losses, its ability to continue to lend is less im-paired than in the conventional financescenario.

Similarly, the issuer of a sukuk based on a mudarabah contract, as in Diagram 7, is less exposed to corporate bankruptcy if the business faces a temporary declinethan is the issuer of a conventional bond.

c) Requirement for ethical conduct

There are some prescribed situations, suchas UK financial services companies deal-ing with retail customers, where the insti-tution is required to treat customers fairly.

Absent at such special cases, the underly-ing model of conventional finance is‘caveat emptor’ (let the buyer beware).However Islam imposes on its adherents a requirement for ethical conduct at alltimes. Accordingly an Islamic bank should not ‘lend’ money to customers if such ‘borrowing’ is not in their best interests.This would for example apply to the provision of Shari’ah-compliant housing finance to sub-prime borrowers who couldnot afford the cost once any low-cost in-troductory period had elapsed.

This overarching requirement for ethicalconduct may be the most powerful reasonwhy an Islamic financial system is lesslikely to repeat the global financial crisis,as it protects against some of the behav-iours that led to the crisis.


RATINGS & INDICES

Islamic financial institutions and instrumentsBelow is a monthly list of the latest long and short-term credit ratings for each Islamic financial institution and financial instruments monitored by CapitalIntelligence (CI), an international credit rating agency. Detailed information on rating processes and definitions can be found on the CI’s websitewww.ciratings.com

All rates are reviewed on a regular basis


14 September 2009

CURRENT RATING

FOREIGN CURRENCY

FINANCIALSTRENGTH

SUPPORT

OUTLOOK SINCE

LONGTERM

SHORTTERM

FC FSRISLAMIC BANKS

Abu Dhabi Islamic Bank A A2 A 2 Stable Jun-2007

Al Baraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Stable Aug-2009

Al Rajhi Banking & Investment Corp A+ A1 A+ 2 Stable Stable Aug-2009

Bahrain Islamic Bank BBB A3 BBB 3 Stable Sep-2007

Bank Islam Malaysia BBB- A3 BB+ 2 Stable Stable Dec-2008

Gulf Finance House BBB+ A2 BBB+ 4 Stable Stable Oct-2008

Jordan Islamic Bank for Finance & Investment BB B BBB- 3 Stable Stable Dec-2008

Kuwait Finance House A+ A1 A+ 2 Stable Stable Jul-2008

Qatar International Islamic Bank BBB+ A2 BBB+ 2 Stable Stable Jun-2009

Qatar Islamic Bank A A2 A 2 Stable Jun-2009

Sharjah Islamic Bank A- A2 BBB+ 2 Stable Stable Jul-2009

Shamil Bank of Bahrain BBB A3 BBB 3 Stable Stable Dec-2008

The National Commercial Bank AA- A1+ AA- 1 Stable Stable Jul-2009

Tadhamon International Islamic Bank B B BB- 3 Stable Stable Dec-2008

FINANCIAL INSTITUTIONSCORPORATE RATING

OUTLOOK SINCE

LONG TERM SHORT TERM

Al Tawfeek Company for Investment Funds Ltd (Bahrain) BBB A2 Stable Feb-2008

CAPIVEST BSC (Bahrain) BB+ A3 Stable Dec-2008

Osoul Investment Co (Kuwait) BB- B Negative Dec-2008

Qatar Finance House (Qatar) BB- B Negative Jul-2009

FINANCIAL INSTRUMENTS SUKUK RATING OUTLOOK SINCE

LONG TERM SHORT TERM

Commercial Real Estate Sukuk Company A- Stable Oct-2008

KCMCC Sukuk Company (Kuwait) BBB Stable Jul-2008

NIG Sukuk Ltd BBB+ Negative Mar-2009



ferred to him. The ijara structure may beembedded in the MM structure to facilitatea continuous repayment term based on anagreed schedule and the purchase of thebank’s shareholding. For completed proper-ties, a normal lease will be used, whereasfor under-construction properties, a for-ward lease shall take place. The diagrambelow depicts the processes of MM.

Deemed as a better alternative to baybithaman ajil (BBA – sale of goods on a de-ferred payment basis) a study on the issuesof musharakah mutanaqisah (MM) is timelyfor a more equity-oriented and Islamic uni-versal banking philosophy. Some may viewdiversification of product space to fulfil theexpectation of Shari’ah compliance as driv-ing factors behind the offering of MM.However, one seldom comes across roseswithout thorns. And, the worrisome thornin the side of Islamic finance is the limiteduse of MM, notwithstanding its appeal as aShari’ah-based innovation.

Drawing lessons from the BBA conundrumas a result of the Malaysian High Court’sprohibitive judgment in July 2008 (whichhas been reversed by the Appellate Court in2009) and rejection by the Middle East,there is a need to mitigate Shari’ah and legalrisks for future Islamic financial products.The Shari’ah and legal issues may be deci-phered by examining the legal documenta-tions of various banks, such as KuwaitFinance House (KFH), Maybank Islamic,RHB Islamic and Citibank, offering MM inMalaysia. At the outset, these documenta-tions may not be fully reflective of the trueevent, although credit should be given tosome well-drafted clauses in tandem withthe Shari’ah (e.g. ‘no payment of interest’)and overall compliance with Shari’ah re-quirements.

MM is a diminishing partnership, wherebyone of the partners promises to purchase theequity share of the other partner until theownership of the equity is completely trans-

Shari’ah and legal issues ofmusharakah mutanaqisah

Adam Ng Boon Ka, law graduate from the University of Oxford and PhD candidate at theInternational Centre for Education in Islamic Finance, Malaysia, takes a close look at this type of financing.

MM can be financially engineered to havean amalgam of economic effects. It can be either financing or partnership equityparticipation, or both. In the books of mostbanks, MM is treated as financing where itis classified under musharakah financingand not truly recognised as investment.Hence, banks take the function of a purefinancier without any underlying economic

ANALYSIS



interest as an equity holder (partner). From a fiqh viewpoint, emphasis should begiven to the essence and objective (maqasid)of the transaction, not the words or theform (Ibn Qayyim Al-Jawziyya, famous Islamic jurist and scholar of the 14th cen-tury). Based on the principle of consistencyfor financial engineering devised by a mod-ern Islamic finance specialist, Dr Sami Al-Suwailem, the form and substance ofIslamic products must be consistent witheach other. Nevertheless, the form of part-nership here does not serve the substance of financing.

As an unequal playing field will be created,effect is given to the form over substance forpublic interest (maslahah) by taking into ac-count extenuating circumstances (rukhsah).Here, an economic benefit shapes the legallandscape, and not vice versa. The financiermay still take the role of equity partner inaddition to financier depending on the vari-ety of economic purpose and types of fi-nancing products.

Two agreements in one

Given the Shari’ah prohibition of the com-bination of two agreements in one transac-tion that are made conditional upon eachother, it is still permissible for the contract-ing parties to combine the two contracts ofmusharakah and ijara into one document as long as both were concluded separatelyand do not overlap.

In regard to the issue of refinancing in MM,it is akin to having a new partner in a newpartnership in the same venture/asset, albeitwith different value. The previous MM fi-nancing must be terminated for the newMM refinancing to take place; otherwise,there will be two contracts in one contract.Thus, there will be a discharge of charge bythe originating bank, as part of the legal re-quirements in Malaysia.

Based on a sample MM refinancing agree-ment which involved a partial refinancing,the charge is on the entire property despitethe partial refinancing not indicating themarket price of the entire property. Right-fully, the charge should be on a slice of

property being partially refinanced, andnot the entire portion.

Ownership

As a partner in the ownership of the prop-erty, the financier shares the responsibilityand risks arising from the said property. Inan ijara relationship, the owner (lessor)has to bear the cost of basic and structuralmaintenance while the occupying party (customer/lessee) shall bear the routineand operational maintenance of the prop-erty. Nonetheless, since the customer’s ultimate objective of engaging in the trans-actions is to own an asset, and not merelyto rent it for a certain period of time, ithas been arguably accepted that the cus-tomer should bear all the costs, particu-larly when the customer is acknowledgedas the sole legal owner in the document oftitle (except in the case of KFH wheretrust deed is used). The validity of MMmay also be disputed in respect of the leas-ing of property by the partnership to oneof its partners.

Perusal of a sample MM co-ownershipagreement (a clause on payment of taxesand outgoings) indicates that ‘the cus-tomer shall pay 100 per cent of theamount of all taxes due in relation to orassociated with the property, notwith-standing the customer being the partialowner of the property until the end of theco-ownership’.

This unequal bargain position is furtheraggravated by clauses relating to expensesin the form of stamp duty, whereby ‘thecustomer shall pay all stamp, documen-tary and other similar duties and taxes towhich the agreement or any related docu-ments may be subject and shall fully in-demnify the bank…’. These provisions areinserted in view of ‘the customer havingthe exclusive right to occupy, possess, useand enjoy the property’. While this com-plies with the letter of partnership, it isdoubtful whether it serves its spirit.

While the general principle expounds thattakaful of an asset is the responsibility ofthe owner, eminent Islamic scholar,

Muhammad Taqi Usmani, stresses that itshould be at the expense of the hirer. Someexperts in Malaysia say that risks and liabili-ties that are not detrimental, which includeinsurance and maintenance, can be trans-ferred to the hirer, according to academi-cians, Dr Tag El-Din and Dr N. IrwaniAbdullah. The Shari’ah Legal Opinions ofKFH affirmed that it is lawful to make thehirer responsible for a known amount of in-surance as it may then become part of thelease payment (according to Shari’ah advisorand Islamic scholar, Yusuf Talal DeLorenzo).

In most legal documentations, the customerwill have to solely maintain the ‘takaful cov-erage of not less than the outstanding buy-out amount or for such amount as may beacceptable to the bank’. Worse still, the cus-tomer has to continuously assign all rightsto the takaful proceeds to the bank. The customer is also encouraged to take up aShari’ah-compliant mortgage reducing-term takaful. The indemnity clause in agree-ments may be tantamount to some form ofguarantee or assurance by one partner foranother.

Wa’ad (unilateral promise)

An additional instrument of wa’ad is usuallyentrenched in two forms. First, the customerundertakes to pay the monthly paymentuntil the end of MM. Second, the customerirrevocably undertakes to purchase thebank’s share in the event of default. Byvirtue of the wa’ad, the customer shall beobliged to acquire the bank’s ownershipshare in the property at the buyout amountwhen there are changes in circumstances re-sulting in illegality, even if it is not caused bythe customer.

In contemporary juristic opinions, wa’ad becomes legally binding if it is made condi-tional upon the fulfilment of an obligationand the promisee has already incurred ex-pense on the basis of such a promise (Reso-lution no. 40-41 of Islamic Fiqh Academy).In the Malaysian context, the judicial prece-dents applying the Contracts Act 1950 haveduly recognised promise and promissoryestoppels as legally enforceable in the courtof law.



Compensation and event of default

In terms of compensation (ta’widh) for latepayment, while some view penalties for late payment of rentals as not permissible (as stipulated by Ravil Hairetdinov, Moham-mad Taqi Usmani and Meezan Bank), con-temporary scholars have given concessionprovided that the amount recovered must bechannelled to charity and not accounted foras income. The AAOIFI Shari’ah Rules forijara and ijara wa iqtina, issued in 2000,provided that the lessee shall undertake todonate a certain amount or percentage ofrental due in the case where there is no goodreason for late payment. There are slight di-vergences in the legal documentations, whilea legal documentation explicitly requiressuch compensation to be donated to any reg-istered charitable organisation or utilised forany charitable purpose; the other documen-tation is silent in this regard.

According to Johan Lee, a legal practitioner,even in the case of non-indebtedness, thebank may exercise its rights as trustee to selloff the property and the proceeds/loss shouldbe shared between the partners according tostated ratios. As a Shari’ah requirement, theredemption sum or formula has to be certainand fixed in advance. Hence, any referenceto the market price at the point of redemp-tion may trigger issues of riba. The time-frame to call on this option can be fixed orflexible. As redemption and failure to re-deem are always the two common scenarios,the partners will be stuck with the businessin the event that the redeeming party fail todo so. This explains why agreements areslanted in favour of banks over the redeem-ing party.

Ideally, the loss will be shared by the bankand customer according to the last owner-ship ratio if there is shortfall in the recoveryof payment. Nevertheless, the extent of thissharing is doubted in reality. In most cases,‘the customer shall pay to the bank the dif-ference between the amount due to the bankand the amount so realised… Until paymentof such differential amount, the customershall pay late payment compensation chargeson the differential sum until the date of ac-tual payment made.’

In the provisions on events of default, thecustomer shall be obligated to acquire thebank’s ownership share in the property at the buyout amount for matters such as ‘de-veloper’s winding up’ and ‘property aban-doned’, which are not the fault of thecustomer. This resembles a conventional loanwhereby the customer will continue to makepayments if the property is destroyed untilthe insurance proceeds are received. Thissmells apologetic against the Islamic risk-re-ward principle.

One of the prominent legal issues faced byIslamic banks is on the sale of the propertyfollowing an event of default by the cus-tomer. In the case of KFH, the security is byway of registering the property under KFH’s

name as trustee. In the absence of precedentsand legal provisions governing this arrange-ment, customers may challenge the bank’srights in court when the bank wishes to exer-cise its rights under the trust deed. Even thenotion of trust here is a limited concept as afull blown version will impinge on the Na-tional Land Code (NLC).

The NLC does not provide for banks to bethe co-partner with customers. Thus, theasset is charged to banks despite the bankstheoretically being partners who have owner-ship shares in the asset. The raison d’être forthis may be due to the unequal arms doctrinein terms of contractual rights and obligationswhere the bank would naturally have morefinancial muscle and undue influence. Strictly, no security (via legal charge) can bearranged in MM transactions since it cannothave a guarantee attached to the financing

(contribution of) principal according to theShari’ah. It is understood that the CentralBank of Malaysia’s (Bank Negara Malaysia,BNM) Law Review Committee has re-viewed this issue. However, amendment ofrelevant legislations has yet to see the lightof day.

Conclusion

The structuring of MM documentations deserves circumspection to ascertain the validity of MM contracts in light of Shari’ahand legal requirements. It is not the permis-sibility of MM contracts per se, but their indiscreet use, faulty structuring and ‘win-dow dressing’ which are igniting the percep-tion that MM is no different from BBA, or, worse still, conventional home-financing.A holistic application of the Shari’ah, bothex-ante and ex-post, shall warrant Islamicbanks to ensure the use of property is Shari’ah-compliant particularly in view ofthe inherent reputational risk in Islamictransactions and governance. As MM is theoretically deemed to be fairer than BBA,MM must truly reflect its maqasid al Shar-i’ah (objectives of Shari’ah). Apart from reviewing statutes to accommodate Shar-i’ah-based principles, it is understood thatthe International Shari’ah Research Acad-emy for Islamic Finance (ISRA) is reviewingthe trustee corporation framework fortrustee corporations to be the registeredowner of the joint property as a resolutionfor ownership issues.

Given that the foregoing issues are not ex-haustive, it is paramount to parameterisethe validity and viability of MM. In the con-text of Shari’ah harmonisation and productinnovation, BNM is developing ‘Shari’ahparameters’ to provide a standard guidanceon applying and operating the contracts inIslamic finance. This may minimise the pos-sibility of Shari’ah arbitrage and may pro-mote more consistent application of Islamicfinancial contracts, both locally and abroad.ISRA is also working on standardised con-tracts for Islamic home financing. As MMhas not been tested in courts, it would beprudent to have such standards as an under-lying philosophy for more standardised legaldocuments in the industry.

Adam Ng Boon Ka


DIRECTORYNEWHORIZON Shawwal–Dhu Al Hijjah 1430

Directory

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

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

Trevor Norman, Director

Tel: +44 (0) 153 4500 400 Fax: +44 (0) 153 4500 450 Email: [email protected]

Templar House, Don Road, St Helier, Jersey, JE1 2TR

Volaw Trust & Corporate Services Limitedwww.volaw.com

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

Nicholas Hacking


Exchange Tower, Building 1 suite 6.01, Harbour Exchange Square, London, UK, E14 9GE

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

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

Louise Protain, PA to the Chief Executive Office

Tel: + 44 (0) 207 8479 924 Email: [email protected]

131 Finsbury Pavement, London, UK, EC2A 1N

EIIBwww.eiib.co.uk

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

Agnes Carrasco, Administration Manager

Tel: +965 2482 4600 Email: [email protected]

Kuwait Red Crescent bldg, 3rd floor, Al Jahra Street Shuwaikh. P.O.Box 592 Safat 13006

Path Solutionswww.path-solutions.com

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

Wail Malkawi, VP Business Development


The Courtyard, 14a Sydenham Road, Croydon, Surrey, UK, CR0 2EE

International Computer Systems (ICS)www.banks-solutions.com To advertise here, please contact:

Paul MinisterIBS Publishing Ltd

8 Stade StreetHythe, Kent UK

CT21 6BETel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646

Email: [email protected]

o Islamic Treasury and Capital Marketso Asset Management, including Private

Banking

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


NEWHORIZON October–December 2009GLOSSARY

al-wadia

Lit: safekeeping. In Islamic banking, it refers to thedeposited property, the acceptance of sums of money forsafekeeping in a Shari’ah-compliant framework, underwhich it will be repaid.

arboun

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

bai

Sale.

bai al-dayn

Sale of debt. An overwhelming majority of scholars agreethat debt cannot be sold for money, except at its facevalue, but can be sold for goods and services.

bai bithaman ajil

Sale of goods on a deferred payment basis – credit sale;another term used for such sales is bai muajjal.Equipment or goods requested by the client are boughtby the bank which subsequently sells the goods to theclient at an agreed price which includes the bank’s mark-up (profit).

fatwa

A ruling made by a competent Shari’ah scholar on aparticular issue, where fiqh (Islamic jurisprudence) isunclear. It is an opinion, and is not legally binding.

fiqh

Islamic jurisprudence. The science of the Shari’ah. It isan important source of Islamic economics.

gharar

Lit: uncertainty, hazard, chance or risk. Technically, saleof a thing which is not present at hand; or the sale of athing whose consequence or outcome is not known; or asale involving risk or hazard in which one does not knowwhether it will come to be or not.

halal

Activities which are permissible according to Shari’ah.

haram

Activities which are prohibited according to Shari’ah.

ijara

A leasing contract under which a bank purchases andleases out a building or equipment or any other facilityrequired by its client for a rental fee. The duration of thelease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

ijara wa iqtina

The same as ijara except the business owner iscommitted to buying the building or equipment orfacility at the end of the lease period. Fees previouslypaid constitute part of the purchase price. It is commonlyused for home and commercial equipment financing.

istisna

A contract of acquisition of goods by specification ororder, where the price is fixed in advance, but the goodsare manufactured and delivered at a later date.Normally, the price is paid progressively in accordancewith the progress of the job.

maal

Wealth, money, property; any valuable thing which canbe possessed.

maysir

Gambling – a prohibited activity, as it is a zero-sum gamejust transferring the wealth not creating new wealth.

mudarabah

A form of business contract in which one party bringscapital and the other personal effort. The proportionateshare in profit is determined by mutual agreement at thestart. But the loss, if any, is borne only by the owner ofthe capital, in which case the entrepreneur gets nothingfor his labour.

mudarib

In a mudarabah contract, the person or party who acts as the entrepreneur.

murabaha

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

musharakah

An agreement under which the Islamic bank providesfunds which are mingled with the funds of the businessenterprise and others. All providers of capital are entitledto participate in the management but not necessarilyrequired to do so. The profit is distributed among thepartners in predetermined ratios, while the loss is borneby each partner in proportion to his contribution.

musharakah, diminishing

An agreement which allows equity participation andsharing of profit on a pro rata basis, but also provides a method through which the bank keeps on reducing itsequity in the project and ultimately transfers theownership of the asset to the participants.

mutawalli

Caretaker. In the case of waqf, an official appointed tocare for the waqf property.

qimar

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

rab-al-maal

In a mudarabah contract, the person who invests thecapital.

riba

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

sadaqah

Charitable giving.

salam

A contract in which advance payment is made forgoods delivered later on.

Shari’ah

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

Shari’ah board

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

Sunnah

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

sukuk

Similar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownershipin the underlying asset. The asset will be leased to theclient to yield the return on the sukuk.

takaful

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

taskeek

The process of issuing sukuk.

ta’widh

Compensation.

wa’ad

A promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price. It is not a legally binding agreement.

wakala

A contract or agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee. The agent (wakil) isallowed to generate an income for himself in excess of the minimum agreed upon returns as agreed withrab-al-maal (investor of the capital).

waqf

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

zakat

A religious obligation on Muslims to pay a prescribedpercentage of their wealth to specified categories intheir society, when their wealth exceeds a certain limit.Zakat purifies wealth. The objective is to take away apart of the wealth of the well-to-do and to distribute itamong the poor and the needy.

issue no. 173 - october–december 2009 / shawwal–dhu al hijjah 1430

Documents