Ekrem PAKDEMIRLI

Istanbul, Point Hotel, 18/5/2012

All the divine books prohibits usury (riba).That is “Earning Moneyfrom lending Money” is prohibited. Obedient Jews created Gemach, theMuslims created Qharzı-Hassan for transfer of funds from savers to needyones. In the last century, financial industry, needing funds and newresources, has forced scholars of Islam, to create new financial institutionsand financial tools in line with their faith and if possible parallel with theWestern World’s practices. Participation Banks has been established in themid of twentieth century with banking activities in line with the Shariah. Inthis country such banks- Shariah-complaint- have been established by1985. These banks carry saving transactions such as mudarabah (profitsharing for deposits, and called participation accounts) and wakalah. Forfinancial resource lending, modarabah, musharakah murabaha, ijara,sukuk, e.t.c (These must be interest free borrowings and deposits). Anobedient Muslim, do not ask fixed rate income (interest) for his bankdeposits, as well as do not want to pay interest for his borrowings.

People with different faiths are living in, rich, medium and low income countries. The rich countries are more in trading sector. And their wealth is mostly from natural resources as crude oil and natural gas. They have excess funds to be lended.

The medium income countries are of developing countries and they lack capital. They have entrepreneurs, but with limited capital to invest. All the developing countries are starving for funds. The poor countries are lacking both entrepreneur and capital.

The Classical Banks are the institutions to finance projects coupled with interest, which has to be paid periodically. With defined interest rate no matter the profitability of the project, interest is to be paid. Muslim entrepreneurs operating in the same environment because of usury ,haveshort comings in reaching funds.

ISLAMIC BANKING

In Islam, the earnings should involve profit and loss probability. The conventional “interest” is a fixed income and no matter the borrower or lender are making a profit or loss, that interest has to be paid. To overcome this bottleneck, Muslim scholars introduced profit/loss sharing idea to replace the “interest”. With this concept, profit sharing banks have been established. The finance industry, liked such Islamic banks and give some thoughts to adaptation of other classical financial instruments to Shariah. Fifty years back, participation Banks which may be called Islamic banks, have been established with trading philosophy.

A man or company needing funds for investing in fixed assets or funding the inputs of his production line , would find the supplier, who invoices the goods to the borrower. The borrower will pay back the sum of initially agreed debt in instalments to the participation bank. This form is called Murabahah (it is known as cost plus) which is the most widely used tool for lending funds in Islamic banking .

Other types of finance are Mudarabah (venture capital, profit sharing) , Musharakah(joint venture) and Ijara(leasing) .Today in Turkey we have four participation banks operating in Islamic finance industry. The total Turkey based Islamic banks assets is about five percent of all the banking assets. This percentage is small when compared with the classical banking activities.

The main drive in Islamic banks is not different than conventional banking. Both receives deposits and lend money and expect a return.

Islamic banking, keeps an eye on Shariah in accepting deposits and lending funds.

The most widely used transactions are profit sharing, venture capital (Mudarabah), safe keeping (wadia), joint venture (Musharaka) cost plus (Murabaha ) and Leasing (İjara).

Today, the standarts have not been yet completely settled with respect to Islamic finance context, except Musharakah, Mudaraba and Morabaha. The intricit drive of the human-beings, is that the risk taken forsavings is proportional to the profit expectation. This is contradiction toteachings of islam

Not all of the derivatives of classical Banking can be employed in Islamic Banking because of usury (riba) . There must be scholar work for Islamic banking to enrich the product and services inline with Shariah.

The problem with these profit sharing banks is the Limited amount financial products and services to be offered to the customers-entrepreneurs. The Limited amount of products and services in the Islamic finance industry is impeding higher growth of Islamic funds accumulation. We have to create new tools to excavate the huge Islamic funds available in Middle East as well as in Far East. The most recent financial tool in Islamic financial industry is Sukuk.

SUKUK- ISLAMIC BONDSukuk is an Arabic word and it is used synonymy for BOND. A bond

with variable income, bearing risk i.e. profit and loss probability . In other words,. a bond which is not bearing riba. It should be in line with shariah.Many Muslim scholars think that Sukuk is in line with Islamic faith. Still there are some discussions going on. In general terms, Sukuk , transfers an asset`s future cash flow in to the present cash flow. Today we in thiscountry think Sukuk is compatible with Islamic rules and regulations in other words it is Shariah complaint.

The word of bond has two synonyms in Turkish. The first one is “bono” with maturity period less than one year. This instrument is used by the treasury. The second is Tahvil, with maturity more than a year, preferably more than five years. This vehicle is used by public and private sectors. Sukuk is a bond inconformity with Shariah. This means in essence the earnings from sukuk is bearing a risk.. For the past two decades Sukukis introduced to Islamic financial industry.

Sukuk is not only a financial instrument in Islamic countries, but it became a world wide used instrument.

Today Sukuk can be issued as,

Project Related As morabaha(Cost plus like) As Musharaka (Joint venture like) As Mudaraba (Venture capital like) As Ijara (Leasing like)

Assets Related, and asBalance Sheet Related

There are other types of Sukuk, such as Salam (forward/future transactions like), Istisna(a version of salam), and Hybrid Sukuk. Hybrid Sukuk is a pool of Istisna, Murabaha, and Ijara Sukuks.

according to International Islamic Financial Market data base, since 2001, 338 bn $ worth of various types of sukuk have been issued of which 63,16% belongs toMalaysia, while Turkish issuing remained in 450 mi.$. The maturity varied from one tofifty years. The bulk of it has less than 10 years of maturity. 81% of the total outstanding sukuk is murabaha, ıjara, and musharaka type.

In this country, last year, taxation regulation published, eliminating excessive tax burden on Sukuk. So financial infrastructure is ready, awaiting entrepreneurs. Last year Kuveyt-Turk Participation Bank successfully issued to oversees an Ijara Sukuk worth of 350 million $. We made a start, it remains moving fast.

It is needless to emphasis the added value created by bond in the western economies. So Sukuk being resembling to bond , also should play an important role in the finance industry.

Sukuk, can be attractive investment tool fort the obedient Muslim investor. And also an additional product to be in the financial market.

Sukuk is one of the new financial means which is backed with reel fixed assets. It is a Bond with no interest, but with profit and losspossibility. A pool with different level of incomes of predetermined fixed assets (not interest bearing bonds or accounts with the banks) is created and sold to the customers. In the past in 1985, we created profit sharing bonds(shares) of the Bosphorus Bridge. We sold a chunk of the income of the bridge. With the funds of the first bridge we constructed the second bridge. The profit to be distributed depended on the numbers of the vehicles passed from the bridge. That was perhaps a form of Sukuk of today.

In many Industrial companies there are fixed assets with variable income. These fixed assets can be gathered in a pool at certain value and Sukuk can be issued ( backed by a certain portion of this pool¸ i.e profit, revenues). A major part of the profit accumulated in the pool can be distributed to Sukuk holders. This will create additional funds for the industry.

Sukuk being a new instrument , will bring a new momentum to Islamic banking.

Islamic banking funds (more than one trillion$) is about %1, 5 of the total available funds in the world. A small portion, but cannot be disregarded.

In Islamic Banking, Iran is leading by volume. One question to be answered is why Islamic finance has not yet reached critical volume. Today in Turkey we have 30 billion $ assets in Islamic Banking which counts roughly 3%.of all the Islamic funds globally available. The Islamic banking is available for the past six decades. In Turkey it started three decades before.

During 2012, 120 billion worth Sukuk have been sold around the world. The news are such that, The Turkish Treasury is planning to sell new Sukuk within 3 months. My humble opinion is that, the most tradable of Sukuk will be Ijara type. It will be easy to form the pool, and due its simplicity, it will be accepted by the obedient Muslims. This Sukuk will be traded in Istanbul Stock Exchange.

CAN SUKUK DRIVE ECONOMIC GROWTH INDEVELOPING COUNTRIES

In developing countries, usually it is very difficult to arrange collateral for bank barrowings. A company, may use their assets to create Sukuk and thus get funds for its expansion or new investment. In short, Sukuk may shorten the red tape in getting funds and bring ease reaching to credits.

Sukuk being a new tool in the financial industry, will bring additional depth to open market activities. In other words, the volume of the financial transactions will grow.

To make a quantitive analysis for the effect of financial resources on the growth of Gross Domestic Product (GDP), the total deposits in the industry since 2000 are tried to be related to GDP of Turkey.The data is given in the following table. It is found that an inverted parabolic curve can be assigned to indicate the trend. The correlation coefficient is 0,984.This is shown by the first curve. Furthermore it is derived from this parabolic behaviour that marginal propensity to growth(for the year 2011) is approximately 0,9 percent ( one percent increase in the accumulation of financial resources, created 0,9 percent increase in the GDP ).

Today in Turkey ,the total of exploitable financial resources(as total deposits) is 397 bn$. So if we can create new resource of 5 bn$, it will create 4,5bn$ additional GDP. This will mean 0,6% increase in GDP. A third degree curve fits better(shown by the second curve), with correlation factor of 99,4%, but does not represent fully the last years.

Table: Total Bank Deposits / GDP Figures At Current Prices

YEAR 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

TOTALDEPOSİTBillionTL

68,4 116,6 142,4 160,8 197,4 253,6 311,5 356,7 453,1 507,1 614,5 695,5GDPBillionTL

166,6 240,2 350,6 454,3 559 649 758,3 871,8 960,5 927,7 1122,6 1351,5

Grafic 1: second degree curve fitting

y = -0.0013x2 + 2.7393x + 8.3595R² = 0.9702

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Grafic 2: Third degree curve fitting

y = 8E-06x3 - 0.0109x2 + 5.7755x - 237.14R² = 0.9881

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The new financial tool of SUKUK, if properly marketed may create

6 - 10 bn $ additional financial source from idle, none operative capital already existing as gold or silver. Thus, reflection of this amount of new resource to GDP will be 6 - 9 bn $. This will mean 0,8-1,2 percent increase in Gross Domestic Product of this country.

I am sure that there is a similar positive correlation between magnitudes of financial resources and GDP in all the other developing countries. Thus inevitably Sukuk will affect positively to economic growth. So to ask the question of “can Sukuk drive economic growth in developing countries” may have short answer as YES...