islamic finance todady oct dec 2008
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2 Islamic Finance Today October - December 2008
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3October - December 2008 Islamic Finance Today
The Financial Meltdown06 Ancient Values11
Scope of Islamic Banking16 Private Equity21
Non-Muslims in IFIs23 Ijarah Leasing25
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4 Islamic Finance Today October - December 2008
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5October - December 2008 Islamic Finance Today
Asiff Hussein - Editor - Islamic Finance Today
Today, at a time whenwe are witnessing theglobal nancial system
being shaken to its very core,it is heartening to learn thatIslamic Finance has gainedadded respectability evenin previously skepticalquarters. The built-infeatures of Islamic Financethat ban highly speculativeinvestments such as seenin modern-day hedgefunds and such practices as
short selling has meant that it has taken the punch that hasknocked out the powerhouse economies of the west verylightly and suered only a little over a 2 percent dent over
this period. For instance, the DJIM Financials Index lost only2.74% when the crisis was at its peak while almost all othernancial indexes globally lost more than a fth of its valuedue to the banking meltdown at Wall Street.
Grard Al-Fil in his Commentary on the Dow Jones IslamicMarket Indexes in September When the night is at itsdarkest observes that in the wake of the takeovers it isbecoming clear that the future of the nancial world will takeon a completely new shape. Observing that at the beginningof the 1970s former U.S. President Richard hailed the statecontrolled economic policy of famous economist JohnMeynard Keynes and declared We are all Keynesians now,
he asks whether after banning short-selling, the next USPresident will announce that we are all Muslims now? . Headds that though this might be far-fetched, the future seemsto be bright for a new way of ethical investments; somethingsimilar to Islamic Finance. The message of Islamic Financeis: yes, you can earn money, even if you deny short-sellingand exclude options, swaps and hedge funds from yourportfolio. This is certainly food for thought for the worldscapital markets.
This brings us to another important topic, namely, the idealeconomic system envisaged in Islam. It is evident that Islamicnancial theory is based on the principle of economic
The case for Islamic Financestronger than ever
development of the masses as a whole as against the benetsof such development accruing to a very privileged few. Theimposition of Zakat or the Alms Tax and the prohibitionagainst Riba or interest- based transactions and monopolisticpractices are all meant to achieve just this - The circulationrather than the accumulation of wealth so that all membersof society could benet.
Ideally, Islam does not know of a nancial system thatessentially bets on what is going to happen in the realeconomy as the conventional capital market does. Rather itseconomic system is based on the real economy. As Islamicscholars point out, the prohibition of Riba along with theimposition of Zakat means that one can invest only byplacing ones wealth in the real economy since there is noother avenue to invest such monies. Such monies couldeither be invested directly in the real economy or through
an intermediary in the form of an Islamic bank or nancialinstitution. As saved wealth is subject to Zakat it will be moreprudent to invest it, since although wealth invested is alsosubject to Zakat, it nevertheless brings in prot to the investorand also makes him or her a direct player in the economic lifeof the nation of which he or she is an integral part.
There is another important dimension to it. Taxation inIslam is wealth- based rather then income-based since it isthe wealth saved and invested that is liable to taxation, notthe income one earns or derives from investments. As suchthere cannot be income taxes such as we come across inconventional economies. What this means is that individuals
will have much more disposable income which can be spentor invested in the real economy. This in turn should create amultiplier eect as money will circulate freely leading to avibrant and dynamic economic system where all concernedare beneciaries. This is indeed a far cry from the conventionalsystem where a few benet at the expense of many. It istherefore high time the concept of Islamic economy andnot just Islamic Finance is promoted amongst the rest of theworld. Islam, after all, is meant for all mankind.
Islamic Finance Today is a magazine exclusively
dedicated to Islamic Banking & Finance
published by Pioneer Publications (Pvt) Ltd.
It contains a variety o interesting eatures on
various aspects o Islamic banking and fnance
as well as other inormation o relevance to
the Islamic fnance industry. No part o this
publication may be reproduced in any orm
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publisher. Views expressed in this magazine are
not necessarily those o the publisher.
No 04, Collingwood Place,Colombo 06, Sri Lanka.
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EditorAsi Hussein
Editorial BoardDr. M.A.M. Shukri
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Khalid [email protected]
Research PartnerResearch Intelligence Unit
ThePulseofEthical Business
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6 Islamic Finance Today October - December 2008
and its implications forIslamic bankingBy Roshan Madawela - Research Intelligence Unit
REPORT
The mentality of reckless greed and the resulting spread of toxicnancial externalities into the real economy can be viewed asbeing diametrically at the opposite end of Islamic nance, intheory at least. This year has witnessed the most serious break-down in the US nancial system in some 70 years. However it isnot only the US that has been aected. It has spread out acrossthe globe touching Islamic nance as well.
S
hould we be surprised? Many commentators have been forecasting
something of this nature for a number of years based on the underlying
concerns regarding the US economy. The Research Intelligence Unitfor example has been following the series of events that have led up to this
years collapse and gave out warnings of such a shock for a number of years.
Whilst no one could predict the precise moment of events as they unfolded,
many were sounding the alarm that the rails were loose but the train kept
on moving at full speed until its inevitable derailment.
As economist James Galbraith says, a well-functioning nancial system has
rules and its when the rules are relaxed that shady practices and get rich
quick schemes ourish. This is what happened in the [sub-prime] mortgage
system in 2005 and 2006, triggering o a bigger collapse. This collapse
has spread out to the entire globalized economy. The implications of the
nancial crunch and the subsequent bail-out on the US economy and itscurrency, the global commodity markets, on other major economies in
Europe, India, China and the wider world are yet to be fully realized.
There are of course developing nations like Sri Lanka, for instance, which issaid to be somewhat insulated from the US led meltdown due to the lower
The fnancial meltdown
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7October - December 2008 Islamic Finance Today
levels of nancial integration with the global system.However, many people with foreign income are aected
and this would have an impact on the demand for luxurygoods like local condominiums and vehicles. For theaverage citizen, the impact of lower demand for the islandsexports will have a signicant impact on their economicwell-being. The garment industry was perhaps the rst tofeel the pinch from declining US demand. Moreover theuncertainty regarding the availability of nance as well asthe negative sentiments prevailing in most of Sri Lankasexport markets has hit many exports. The negative impacton the Colombo tea auctions has been acute to the extentthat the government had to intervene with a home-spunbail-out package.
Conspiratorial context
So how long will the global recession last? From a historicalperspective, the series of events that have taken place oflate are in keeping with the recent pattern that has beencharacterized by a shift in economic power from the Westto the East, particularly in the direction of India and China.The markets in Europe have had severe slumps at varioustimes during the past few decades and recession hasalways followed. The early nineties was a case in point forthe UK whilst the US had a recession in 2001. Meanwhile,strong growth has characterized Asian economies duringthe same period with increasing trade volumes being a
driving factor of the growth. The dierence with the latestshock to the market is the sheer magnitude of the collapsethat has touched all corners of the world economy.
However, if we go back even further, to the 19th century, wecould nd some comfort in the knowledge that nancialmarkets have always uctuated, slumped and recovered.Conspiracy theorists have always asserted that shadowyand powerfully gures that lurk behind the scenes havealways made a killing on depreciated stocks each andevery time there was a recession or depression. The greyarea between public and private nance is said to oer
ample scope for taking advantage of such times for thoseon the sunny side of asymmetrical market information.
A case in point, when Napoleon escaped from Elba in1815, the London gold market hiked overnight by over 25percent as the UK treasury gave orders to dispatch goldto the Duke of Wellington who was preparing to stopNapoleon with military force. Only following the decisivebattle of Waterloo did gold prices ease. So those in theknow made plenty of bucks in the meantime.
Returning to this generation, Gary Allen wrote in 1979;Whatever the future holds, you can bet it will be unstable
with wide swings in the value of the dollar and preciousmetals. As long as Volckers sponsors know in advancewhat his policies will be, they will make big money. This
accurate prediction was followed by 20 percent interestand 25 percent ination.
In another example, Business week, Feb. 20, 1984, stated,The worst market for traders is a stable one.... Investmentbanks now have a greater than ever vested interest inmarket instability. They can rack up enormous protsby guessing right about rapid, wide swings in prots,prices and interest rates. It is obvious that they can rackup enormous prots if they know in advance what themonetary decisions will be.
Eustace Mullins in his book The World Order A Studyin the Hegemony of Parasitism (1985) says: Anyone whoseriously believes that no one knows in advance what
Federal Reserve decisions will be is too naive to be allowedout on their own; anybody who believes that there isno one who can tell the Federal Reserve Board what itspolicies are to be is even more out of touch with reality.
According to some sources, including Bloomberg, thebailout itself is likely to result in a skewed distributionof rescue funds. As the man in charge of the rescuepackage is a Wall Street veteran, the Wall Street bailouthas the danger of being biased in favour of the specialinterests that have a greater inuence on those holdingthe purse strings. Goldman Sachs and Morgan Stanley areamongst some of the names that are said to be in the list
of institutions that will benet disproportionately fromthe $700 tax-payer allocation. With some ten percent ofthe $700 billion going directly to those responsible for themess in the form of due payments and incentives to topexecutives, the guilty dont seem to have done too badlythis time around either.
Shariah consequences
Some observers have claimed that Islamic nance whichhas been on a spectacular growth path over the pastseven years might actually benet from the collapse in
condence in the conventional nancial system. Thenancial consultant agency BDO Stoy Haywood for instancehas claimed that increasing numbers of investors will nowturn to the Shariah compliant nancial sector as they havefar less exposure to the toxic debt that characterizes theUS nance institutions. There is information from theUK to suggest that this is already taking place, not justamongst the Muslim communities but also amongst non-Muslims who are vexed at whats going on.
Statistics tell their own story. The Dow Jones Islamic Market(DJIM) index only lost 2.74 percent in September whilstalmost all other indices around the world shed around 20
percent. The Sukuk (Islamic bond) index of City group wasthe best performer, loosing only 0.27 per cent and was theonly index anywhere to remain positive for the year to date
REPORTFinancial meltdown....
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8 Islamic Finance Today October - December 2008
(October). However, the overall level of sukuk issues forthe year thus far remains well down as compared to 2007.The Secretary-General of the Accounting and AuditingOrganization for Islamic Financial Institutions (AAOIFI) tolda conference in Dubai recently that only $14 billion worthof sukuk had been issued so far this year, compared with$40-50 billion last year.
Many jobs are also at stake as the current crisis is likely toshift the labour market supply curve to the right. With lots ofmoving and shaking going on in the conventional sector aseveryone from the janitors to senior banking professionalsfeels the threat of retrenchment, Islamic banking coulduse this opportunity to do some head-hunting that cancompensate for the gap in current demand for qualiedShariah compliant nance professionals. Failure on thepart of vocational and academic institutions to keep pacewith the demand for professionally qualied people in theShariah compliant industry has resulted in a shortfall inprofessionals amidst growing demand.
Other opportunities may also arise with more high-net-worth individuals switching to the safer bet Shariahcompliant option. The operation of Wealth Managementarms of conventional banks as well as independentnancial agencies have witnessed strong growth in recentyears especially in South Asia where there has been anincreasing demand for wealth management servicesamongst a growing middle and upper class.
However, anyone expecting a sea-saw eect on the Islamic
nance sector would be out of touch with reality. The
nancial crunch has resulted in falling commodity prices,
especially oil along with a marked drop in real estateprices which has started to hit the Shariah compliant
sector. The direct impact comes from the fact that the
Shariah compliant sector relies on these real assets in
order to support Shariah compliant nance deals. So
to some extent, the current situation has demonstrated
that Islamic nance is operating in a distinctly un-Islamic
economic system whereby Shariah compliant windows
get directly aected when the house catches re.
Opportunities
So to some extent the current situation oers an optimalopportunity for Islamic economists and academics toput forward an alternative system. Adnan Khan notes anumber of key points that we can build on to stress thefundamental dierence between the two systems ofnance and economics. Some of these dierences arefundamental and too far reaching to deal with in theshort term even though the glaring weaknesses in theconventional system have surfaced for all to see. Takefor instance the paper currency system that is backed upby absolutely nothing tangible since 1972. Any systemclaiming to be Islamic has to be based on silver, gold or asimilar commodity of value.
Likewise Islamic economics cannot promote a so-calleddual-economy separating the nancial and real segments.Everything would be real. Much of the dealings that takeplace in the nancial economy are anyway prohibitedunder Islam. Banks would be active in performing manyof their functions as collectors of deposits in order toreinvest funds in to the real economy.
Similarly, under an Islamic system taxation would bebased on wealth and not income. Ownership rights toowould be distinguished into state, public and private.
Many resources would fall into the category of publicproperty whereby their benet would have to be open forenjoyment by all citizens. This is derived from the hadith
REPORTFinancial meltdown....
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9October - December 2008 Islamic Finance Today
of the Prophet: Muslims are partners in three things: inwater, pastures and re. The implications of this hadith
is that water resources, forests, rewood, pastures forlivestock, electricity and oil elds and reneries belongto the community. Thus, the privatization of water forexample would not be permitted.
Outlook
The Shariah compliant sectors ability to draw in bothMuslims and non-Muslims will depend on how well thisalternative system is marketed as a more stable and ethicallong-term option. The industry will also have to withstandopposition from anti-Shariah nance groups, mostlybased in the US who spread myths about its dangers to
Western civilization.
Essentially, the message that the Islamic banking sectorengages in lower risk prole investments should be intune with current times. It also abstains from a numberof unethical practices including short-selling whichdescribes selling a stock which you do not own in orderto benet from its falling price. Even the US banned thispractice for a limited time in the aftermath of the Lehmancollapse but then reversed the ruling.
The world economic outlook report of the IMF has claimedthat the world economy is entering a major downturn
in the face of the most dangerous shock in the maturenancial markets since the 1930s. Whilst the globaleconomy grew by 3.9 per cent in 2007, the forecast for2008 has been revised down to 3.9 per cent and just threepercent for 2009. This would make 2009 the worst yearsince 2002 according to the IMF.
Since the report was released, the Central Banks of anumber of powerhouse economies made a unison rate
cut. These included the US and the UK which slashedtheir rates by 0.5 per cent whilst China, Canada, Sweden
and Switzerland also cut their rates. The IMF supportedthe move that was aimed at mitigating the impact of thecredit squeeze on the real economy.
Oering some hope for the battered economies, the IMFreport did claim that there is no risk of a Great Depression.However, subsequent information suggested otherwise aseconomies in Europe including the powerhouse Germanywhich claimed they were now ocially in recession. AG20 meeting was hosted by G.W Bush in November wherefurther attempts at facing the challenge in concert weremade. This represents a style u-turn on the part of themost unilateral US leader as his last days in oce seem to
have witnessed a shift towards multilateralism.
The coming year 2009 is likely to pose sti challenges tothe Islamic nance industry despite a steady and consistentincrease in the demand forecast. Lower credit availabilityin 2009, slack demand from the developed world thatwill reduce commodity prices, and uncertainty regardingcurrency are all likely to pose serious challenges. In thenal analysis, there will be few winners.
Politically, the evolving scenario is likely to oer greaterinuence and sway to the larger developing nations on
the world stage. This might also open more doors forShariah compliant nance to be discussed and debatedon the world stage. One can only hope for change thatwill lead to the emergence of a more ethical economicsystem for all concerned.
Sources : Al Jazeera, BBC, Bloomberg, China Peoples Daily,Conway, Edmond, IMF, www.informaitonclearinghouse.com, Kettell, Brian, Pakin, Brian, Research IntelligenceUnit, Trends Research, Eustace Mullins.
REPORTFinancial meltdown....
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10 Islamic Finance Today October - December 2008
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11October - December 2008 Islamic Finance Today
Alberto Brugnoni, President, Associazioneper lo Sviluppo di Strumeuti Alternativi e diInnovazione Finanziaria (ASSAIFI)
ANCIENT VALUES CREEPINGBACK INTO THE EUROPEANECONOMY
Islamic nance on the rise in Europe
Demand for nance based on Islamic religiousprinciples has been skyrocketing across the globefor years originally driven by demand from HNWIs
and institutions in the Middle East - typically a reallocationof oil-derived wealth into Islamic products. This ishardly surprisingconsidering thatapproximately oneperson in four inthe world is Muslim.
This has also meantthat both the needfor halal investmentopportunities hasgrown as well as thedesire to nance themin accordance withShariah principles.Most of this activityhas focused oninfrastructure and realestate projects andhas been supportedby the possibility ofemulating more andmore conventionalproducts in a way thatcomplies with Shariahthrough the use ofmodern techniquesto structure relativelycomplicated nancial transactions. In a nutshell: thegrowing sophistication of nancial products means thatHNWIs and institutional demands are now satisfactorilymet
The new aspect of this activity is the emergence of thedemand of religious-based nance in non Muslim countries
and, in particular, in secularized Europe. But this shouldhardly come as a surprise as the interaction betweeneconomy and religious and ethical issues is an old story inEurope, a continent home to some of the ercest religiouswars that humanity has ever known. The Old Continents
economic history is a vivid example that the intertwiningof economic and nancial activity and religious beliefsand traditions are never carved in stone but are constantlyevolving to provide insight and answers to contemporary
questions. This has been true not only for the churchsCanon law but also for Islamic Shariah today. As we knowone of the meanings of the word Shariah is path to the
OVERVIEW
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12 Islamic Finance Today October - December 2008
OVERVIEWEuropean economy....
to nancing since the 1920s when the Eastern Bank -the predecessor of Standard Chartered - and Nationale
Handelsbank - the predecessor of ABN-Amro - wereallowed to bank in Bahrain and Jeddah respectively oncondition of avoiding all interest based transactionsReasons
What are the reasons for the awakening of this demand?They are manifold:
- Firstly is the fact that Islam is Europes fastest growingreligion with many countries recording a rapid rise intheir Muslim populations coupled with the steadygrowth of the Muslim auent middle class in Europe.
We know for a fact that Muslims in the developedworld and Europe account for 50% of savings frommiddle-class Muslims worldwide. This, I suspect, willbe the drive of the next stage in the growth of Islamicnance as the European Muslim customers preferencefor halal management of their nancial aairs becomesmore and more self asserting.
water source and this etymology alone proves thatShariah is not a nished, petried work but is a constantly
adapting framework of rules searching for responsiblesolutions for issues aecting Muslims daily livesThe pent-up demand for banking and nance productsthat ultimately need to be assessed by an Islamic scholaris today on the rise and nally coming to light in Europe.These are nance products based on a number of guidingprinciples that have guided commerce in the Islamic worldfor well over fourteen centuries, such as the prohibitionon usury; the prohibition of investments in gambling,pornography, tobacco, pig products and alcohol; therequirement that investments be focused on real traderather than speculation and an endless securitization
process.
It is of interest to note that these principles are themselvessteadily making inroads into the mainstream conventionalbanking scene and have been widely discussed duringthe last US-originated nancial turmoil. This conventionalbanking scene has been exposed to a rib-free approach
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OVERVIEWEuropean economy....
- Secondly, a growing interest in halal nance productshas also been observed among non-Muslims. The
conventional European banks and institutionsinvestments in Sukuk has been mirrored by privateinvestors who also wish to factor ethical and/or religiousaspects into their investment decisions. By choosingShariah-compliant products they can be sure thatthey are not investing in unethical areas. And devoutChristians and Jews can be sure that the interest ban,which can also be valid for them, has been observed.In sum: the Islamic bankers and nanciers initiativesand innovative approaches have attracted investorsstill on the look out for ethical or Sharia-compliantinvestments
- Thirdly, the spate of licensing and permits that hasallowed the start of consumer banking operationsaccording to Shariah - particularly mortgages, insuranceand loans - has been facilitated by governments policyshifts that have called for greater attention to theneeds of Muslim communities in Europe. Authoritieshave started accommodating demands that, although
made repeatedly over the years, had regularlybeen brushed aside: the fear of alienating asizeable percentage of European society andsecurity risk consideration have played a rolein this change of ocial attitudes
- Fourthly, government policy makersand the conventional banks have begun toview Islamic banking and nance as a lucrativebusiness opportunity and not just a sop tothe ethnic minorities. Also: there is also anincreasing number of professional investorswho want to include Islamic nance productsin their portfolios for reasons of diversication.This is true despite the reservation thatmany Shariah-compliant nance productscannot yet fully compete with conventionalproducts as far as the price-performanceratio is concerned due to their intrinsicallycomplicated structure
It is therefore safe to draw a rst conclusion:Islamic nancial products are moving,albeit very slowly, from niche products tothe mainstream in continental Europe. Thenumber of events, seminars, newspapersarticles and university dissertations beartestimony of Islamic nance coming of age inthe Old Continent!
Hurdles
Lets now proceed further in our analysis.But before moving to the challenges that the
new environment just depicted poses for the legislator,the regulator, the banking industry and for institutions
wishing to provide Islamic nancial services in Europe,lets see the two major hurdles
The rst one, a sort of philosophical or perhapspsychological barrier, revolves around the fact thatthe European banking system is, for the rst time in itsmodern history (I would say since at least the XVII centurybut, on many accounts, well before) confronted withthe emergence of models of credit brokerage based onprinciples that are religious in nature.
This is sending shock waves throughout the system!Bankers are discovering that knowledge of fourteen
hundred-year-old religious principles is as much an assetas the ability to write clever algorithms. This, in turn, hasa practical consequence that poses the second majorhurdle: the nancial products and concepts behindIslamic nance are basically unfamiliar to the regulatorsand the business community and the lack of precedentsraises very practical issues in accounting, scal andregulatory matters. Although Islamic nancial productshave equivalents in conventional banks, the theorybehind them raises complex accounting issues on how totreat them. Just to name a few: whether products shouldappear on the balance sheet; whether a product shouldbe classied as a nancing product or a leasing product;
whether an investment should be classied as an equityinvestment or a loan. All these issues are hampering thedevelopment of Islamic nance in Europe.
ChallengesChallenges to the legislator
- the creation of a uniform level playing eld or, in otherwords, the existence of a comparable legal and, inparticular, tax law framework for conventional and halalnance products. One of the biggest issues is the taxtreatment of Islamic customer deposits and whether
the expenses paid out on these deposits should be taxdeductible.
The double stamp duty, or registration tax, is an issueshared in all continental Europe but swiftly resolved inthe UK a few years ago. With regard to indirect taxation,that must conform with EU legislation, progress on theextra VAT (Value Added Tax) for murabahah transactionsis still to be made. Another example is the issue ofwhether customer deposits under the mudarabahmodel should be on or o the balance sheet - which,in other words, is the issue of the dierence in the levelof risk that the depositor assumes in the Islamic versus
the conventional system; this has clear implicationsfor the deposits protection scheme. All these existingobstacles must be analysed and removed or mitigated
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14 Islamic Finance Today October - December 2008
Challenges to the regulator
- the banking supervisors must begin to gure out howto assess Islamic nance products, their risks and theamount of capital these institutions need to hold.
The solution nd by the FSA with regard to the IslamicBank of Britain is only half satisfactory. As the turmoilon the markets for structured nance products hasshown dramatically over the last few weeks a decisivefactor for adequate risk assessment is that bankingsupervisors and, in particular, institutions be able tofully comprehend the structure of the products onoer. For this reason some European central bankshave successfully pressed for the inclusion of provisions
governing halal nance products in the CapitalRequirements Directive, which transposes the Basel IIframework into European law
- the necessity to have a Shariah Supervisory Board asa sole authoritative body to advise the Central Bankon Islamic banking and Takaful matters is still to beaddressed. This body should exert a priori control onthe Shariah advisory boards of Islamic institutions anda posteriori control to coordinate their activities. It shallbe referred to by a court or an arbitrator in disputesinvolving Shariah issues in Islamic banking and nance
Challenges to the banking industry.Some of these challenges relate to the market as a wholeand some to the banking industrys own capabilities
The market challenges can be summarized as follows
- a shortage in the number of nancial service providersoering solely halal nance products or oering theseproducts via Islamic windows. There is also a lack ofqualied specialists for the Islamic nance marketsegment
- the supply of Shariah-compliant nance products is stilllargely geographically constrained as the bulk of Islam-compliant nancial transactions take place in London.Consequently, it is dicult if not impossible for thelarge number of Muslims who live in continental Europeto access these services. There have been initiatives toestablish halal nance products in other EU countriesbut so far these eorts have had rather limited success
- the range of Shariah-compliant nance products iscurrently not sucient to meet the substantial risein demand. The bulk of Islam-compliant nancialproducts that are available outside traditional Islamicstates and the UK are primarily aimed at wealthy private
and institutional investors. Hardly any service is aimedat the middle-class Muslim population of continentalEurope who have almost no possibilities for nancing
homes or for investing their assets in a Shariahcompliant way while at the same time productively. It
can be said that a gap is wide open between the supplyof and demand for Islamic nance products and thatthis sector will only take o if savings take o, and ifIslamic products are available for it
- but even for products aimed at institutional investorsthere is a shortage of liquidity. For example, banks havestill to resort for the management of their liquidity tomurabahah transactions as there is no tradable salamsukuk available
- banks located in continental Europe face the challengeof using attractive Islam-compliant services in the retailbanking area as well as target group-oriented marketing
to tap the dormant capital of the Muslim population.The issue of advertising and proper communicationremains unaddressed as, for example, the key fact thatIslamic nance is neutral and accessible to all whateverconviction one might have
- cost for faith: Islamic retail products available in themarket have traditionally been expensive
- lack of education. Consumers lack knowledge aboutproducts that comply with Shariah. The UK is a notableexception and something is also happening now inFrance and Italy
The internal challenges can, on the other hand, besummarized as follows
- rigid yet unclear religious rules: while institutions haveno latitude in implementing the strictures of theirreligious advisors, the advice itself is not necessarilyconsistent between advisors. Shariah compliance itselfremains a thorny issue as we have recently seen with theSukuk saga. While the formation of the AAOIFI shouldhelp drive standardization, individual interpretationwill always play a role
- Islamic nancial institutions will also face additionalregulatory challenges, not only around Basel II, whichI must say is probably dead, but also the capitalrequirements mandated by the Islamic FinancialServices Board in Malaysia
- the Islamic products are inherently complex, raisingconcerns about risk management
- the growth in Islamic nance is driving sta salarieshigher
A look forwardReduction of legal or scal irritants
- legislators are called upon to follow the way of HongKong, Singapore, Malaysia and Japan and to lay the
OVERVIEWEuropean economy....
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15October - December 2008 Islamic Finance Today
foundations for a level playing eld for Islamic nance ineach European country. This will require minor changes
in the law and in the administrative rules on the modelof what has been done by the UK government in thepast few years. This will contribute to the governmentseort to combat the social exclusion of Muslimsand should, of course, be backed up by courses andqualications in Islamic nance
- European banking supervisors have to rise to thechallenge of adequately assessing the risks associatedwith Islam-compliant nance products
- the banking industry is faced with the task of providingan adequate range of Shariah-compliant nanceproducts to meet growing demand and to developnew customer bases
Convincing the European public of the soundness ofIslamic investments as an ethical, modern viable nancealternative
- The current mayhem gives Islamic nance a keenopportunity to lead the way and move from focusingon expedited transactions and on a few narrowprohibitions and contractual concerns to a morecomprehensive stakeholder approach. The Islamicfaith creates an entire social order of which customerrelations and the health of future generations are a
vital part. Islamic nance is expected to follow suit byestablishing a model by which conventional bankingcould be re-imbued with ethical norms. Let me giveyou two examples:
- while private property is defended, individual rightsare subject to the rights of others in the community tobenet from environmental resources such as water,forests, air and sunlight. These are held in commonby all members of society. If you degrade a resource,you are accountable for its use and liable for its repair.Islams environmental and social concerns are echoedin the Equator Principles and the UN Principles for
Responsible Investment, yet no Islamic nancialinstitution has signed up to these instruments, leavingsecular European institutions to lead the way. Adaptingthe Equator Principles for Islamic purposes mightrepresent a way forward that does not stretch thealready overburdened Shariah board system and couldbe a major marketing success
- special care is taken in Islam to prioritise the interestsof the weak and vulnerable. There is even a processin Islam akin to the assessment of impacts onstakeholders and the resolution of conicts betweenthem so as to maximise the overall public interest,
known as maslahah mursalah. But this is pretty muchthe paradigm of Socially Responsible Investing (SRI)!For with its injunctions against investing in nancial
products linked with alcohol or tobacco, and, moregenerally, with its use of criteria and rules at odds with
standard western practices, Islamic nance bears astriking resemblance to SRI. What is more, the growthin Islamic nance in the west may in turn serve to breakdown more barriers for SRI advocates pushing for thegreater use of non-nancial investment criteria bywestern investors.
This will also be of mutual benet as special attentionwould be paid as to the compatibility with Islamic socialconcerns of private sector involvement in infrastructuredevelopment, an issue often disregarded by Islamicnance.
ConclusionSo, where do we go from here?
While in the short term the GCCs and HNWIs are likely tocontinue to represent the largest share of Islamic nancein the EU and particular in London, the longer termprospects will be shaped by developments within Europeand by further EU enlargements I leave aside the problemof the negative perception by the European public opinionof Shariah as an imposition and not as a choice
- the rst issue is whether full retail Islamic bankingservices will be provided for continental EuropesMuslim population. Although the EU functions as
a single market, banking and nancial regulation isdevolved to member states. While the debate is stillopen on the compatibility of Islamic activities with eachmember states domestic banking regulatory systemand on whether it is necessary to identify other normsthat actually permit the legal regulation of the Islamicmodel, the use of the so called EU passporting - wherean institution authorized in a EU country (in our casethe UK) may oer products throughout the EU withoutthe need to have separate authorization - oers a viableway for such an institution to start operations in any EUcountry.
The second EU directive on banking (646/1989) with itstwo fundamental principles of mutual recognition andprudential vigilance also facilitate, at least in principle,the opening of such a bank
- the second issue is the EU enlargement to encompasscountries and regions with long established Muslimpopulations in the Balkans and, of course, Turkey withits 70 plus million inhabitants is a critical country.Turkey, an aspiring EU member and an active memberof the Organization of the Islamic Conference butalso of NATO and other EU bodies, has been involvedin Islamic banking since the 1980s, has more Islamic
bank branches, or special nance houses, than anyother European country. Turkey can serve as a bridgebetween the EU and the wider Muslim world!
OVERVIEWEuropean economy....
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16 Islamic Finance Today October - December 2008
Scope of Islamic Bankingfor the Indian Economy
FOCUS
The fall of manynancial sector giants
and insulation of
Islamic Banking during
the present crisis in the
nancial sector is drawing
the attention of many
Economists towards Islamic
Banking. Relevent here
are the recommendations
by the Raguram Rajan
Committee for Financial
Sector Reforms in India:
Another area that falls
broadly in the ambit of
nancial infrastructure for
inclusion is the provision
of interest-free banking.
Certain faiths prohibit the
use of nancial instruments
that pay interest. The non-
availability of interest-free
banking products (where
the return to the investoris tied to the bearing of
risk, in accordance with the
principles of that faith) results
in some Indians, including
those in the economically
disadvantaged strata of
society, not being able to
access banking products
and services due to reasons
of faith. This non-availability
also denies India access
to substantial sources ofsavings from other countries
in the region.
Syed Zahid Ahmad
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17October - December 2008 Islamic Finance Today
FOCUSIndian economy....
While interest-free banking is provided in a limited
manner through NBFCs and cooperatives, the Committee
recommends that measures be taken to permit thedelivery of interest-free nance on a larger scale, including
through the banking system. This is in consonance with
the objectives of inclusion and growth through innovation.
The Committee believes that it would be possible, through
appropriate measures, to create a framework for such
products without any adverse systemic risk impact.
It would be interesting to see how the Indian Government
reacts to these recommendations because the committee
has proposed to set a working group for nancial sector
reforms. We feel that there is a need to understand the
economics of Islamic banking for the Indian economy.
Prospects for Islamic Banking in India:A few companies are already dealing big in Shariah
Investment funds. Many nancial sector players are
eyeing the trillion dollar worth Islamic investment funds.
Parsoli and Eastwind have launched their Islamic Indices;
and Reliance Money and Religare have launched Shariah
compliant PMS, and Indian Stock market is observing fair
business in Shariah Compliant Stocks.
If China is going for Islamic banking to attract Islamic
Investment Funds, why should India hesitate developing
Islamic banking with 150 millions Muslim who may help to
pool around one trillion dollars Islamic investment funds
from Gulf countries and that too on equity basis which
may keep Indias national current account and scal decit
under control?
No visualization document for Islamicbanking in India:So far Islamic banking has been considered as a religious
matter for Indian Muslims and thus it was subjected to
nancial segregation, for fear of the threat of parallel
banking system along with a hidden fear of SCBs loosing
Muslim depositors. There has never been any publiccommittee analyzing the impact of Islamic banking in
India because Muslims of India were never so evocative
about features of Islamic banking in India.
Though the concept of Islamic banking is driven by the
ethics of Islam, it has more economic rationality compared
to its religious rigour which needs some genuine study by
professionals having basic knowledge of Islamic banking
with expertise on the Indian economy because Islamic
banking carries more advantageous features to boost real
sector economy compared to nancial sector.
Islamic banking and bankruptcy :Islamic banking also restrains the chances of bankruptcy
because it adheres to a strict credit rating system by
disallowing indebted economic agents to avail more debt
nance. The strict regulations for credit rating under Islamicbanking could save our nancial and economic enterprises
from bankruptcy. The Islamic banking mechanism would
certainly strengthen the credit rating system to provide
security of funds for depositors and investors. Moreover
since equity nance by Islamic banking allows the banks
to recover the assets by right of ownerships, it would
be fairer on the part of nancial institutions to recover
assets in case of bankruptcy or crisis by any individual or
enterprise.
Islamic Banking for Inclusive Growth:
Islamic banking is more desirable for achieving Inclusivegrowth in India. It is interesting to evaluate the probable
impact of Islamic banking in dierent segments of the
Indian economy. Islamic Banking has the potential to tame
the liquidity and ination problems along with allowing
inclusive growth. Structural changes in the Indian
economy during the post-reform period are no barometer
for equitable growth.
For real inclusive growth, we have to ensure an increase
in income and employment status of workers in all
segments. Empirical evidence reveals that though India
has registered a better growth rate in recent years,
the number of poor living below the poverty line has
increased. Indias household consumption which has
declined in recent years is driven by household income;
while corporate savings reects income of the corporate
sector which has increased over the years during the
last decade and half. The fruits of growth seem to have
favoured more the corporate sector than vast sections of
population below the poverty line.
Similarly the share of the nancial sector in the GDP has
increased in recent years. It is well known that the SCBs
extend debt nance. The interest component ipso facto
becomes part of GDP. Interest rate sensitivity to ination iswell known. However, equity nance if extended with far
lower costs of credit has potential to restrict ination and
there is enough evidence from West Asia in this regards.
Simultaneously the dividend shared by depositors on
equity nance helps equitable distribution of income
generated by the nancial sector. Once the basic dierence
between the debt and equity credit is understood, it will
be easy to appreciate its potential contribution to better
economic growth.
Low collateral strength of farmers and poor workersassociated with unorganized sector manufacturing units
and retail service outlets does not encourage SCBs to
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18 Islamic Finance Today October - December 2008
extend more debt nance. With schemes of loan waiver,
the debt markets are shrinking in the agricultural sector.
Even the SHGs and JLG schemes of Micro Finance havefailed to add livelihood stocks for the poor and vulnerable.
Inequitable distribution of resources has led naturally to
serious imbalances both across sectors and regions and
need systemic corrections that are possible with the new
instrumentality of Islamic Banking.
It is time that the policy makers realise these options as
imperative at this moment of economic history when
youth unrest is being exploited by terrorism. A big price
has been paid by the economy and it cannot aord this
any longer.
Insights into Islamic banking reveal its potential to
build infrastructure for our agriculture sector where the
economies of scale are hostile to adding new infrastructure
to the farm worker households. Islamic banking could also
help our unorganized sector due to its non-insistence on
collateral as a precondition for lending even small sums
of money.
This would also alter the
desperate labour-capital
ratios in rural India, in
particular, in States like
Uttar Pradesh, Bihar, West
Bengal and the seven sisters
of the North East. Financial
empowerment of the
vulnerable sections of the
population is a possibility
with Islamic Banking.
Islamic banking may also
induce our political leaders
to substitute grants and
subsidies with equity
nance schemes throughspecialized nancial
institutions because equity
nance allows access to
credit without adding
debts to borrowers. Equity
Finance helps achieve self-
reliance. The stabilization
funds for poor farmers /
artisans may be utilized to
experiment such nance.
Islamic banking unlike what
many think has less to dowith religion than with
economics.
Islamic Banking and Financial Inclusion:Though we do not have any survey to compare community
wise nancial exclusion in India, the study of data availablethrough the Sachar Committee report reects Muslims
are a most disadvantaged community in the nancial
sector. Muslims have over 80% nancial exclusion due
to interest based deposit and credit schemes available
with nancial institutions and SCBs. Due to restrictions on
Islamic banking India, the nancial sector could not attract
even the rich Muslims to partake in the growth of India.
Even lower worker participation in institutional growth is
seen from the Muslims employed in the nancial sector, if
one were to go by the statistics put out in this regard: RBI
and SCBs, have just 0.78% and 2.2% share of Muslims in
employment with RBI and SCBs.
Similarly the participation of Muslims in specialized
nancial institutions and corporations like SIDBI, NABARD
and NMDFC is also desperate. it is hard to believe but true,
that even Institutions like National Minority Development
and Finance Corporation (NMDFC) have no Muslim
managers.
FOCUSIndian economy....
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19October - December 2008 Islamic Finance Today
The Sachar Committee Report reects that Indian Muslims
have a share of 7.4% in saving deposits while they just get
4.7% in credit (in terms of PSAs). If we consider this as astandard proportion in national aggregate deposits at
and credits by SCBs according to the annual report of the
RBI for the year 2007-08, Indian Muslims annually loose
around Rs. 63,700 crores because Muslims would have a
credit deposit ratio of 47% against the national average
of 74%. It shows that Indian Muslims annually lose around
27% of their deposits (by not availing of credit).
After Islamic banking this decit may be removed to
curb nancial loss to Indian Muslims. With 31% Muslims
living below the poverty line, this big decit of credit is
apparently a serious economic disadvantage. Muslimsavail just 4% and mere 0.48% credits from special nancial
institutions like NABARD and SIDBI respectively because
there too the community has to indulge in interest which
is strictly prohibited in Islam.
Of course, although it is well understood that the credit
worthiness does not get related to either caste or creed
but on the related assets
and repayment capabilities
the underlying assets could
generate, quicker and easy
access to nance has the
innate potential for asset
creation and related product
markets at least in the
domestic environs as proved
in the SHG group eorts in the
southern States.
The schemes launched by
RBI, NABARD, SIDBI and the
Ministry of Finance for nancial
inclusion focus on providing
access to credit and other
nancial products. The factis that interest-based banking
system has a potential for
exclusion of a great majority
of Indian Muslims. On the
other hand, introduction of
Islamic banking will allow the
Muslims to work with other
community members in the
banking sector. This would
denitely help India build its
economy.
The introduction of Islamic
banking in India apart from
pleasing 150 million Indian Muslims, the second largest
community of India will also help the government gain
diplomatic advantage to make nancial dealings withMuslim dominated nations and especially to attract trillion
dollars of equity nance from the gulf countries.
With the fall of giants in the world nancial sector like
Lehman Brothers in the aftermath of the US sub-prime
mortgage crisis, we need to be alert to the alternate sources
from where FDIs could ow into the Indian economy and
Islamic nations are the potential alternatives.
Our opening the doors for Islamic Banking at this
juncture would also accelerate the fund inows and
slight decoupling of the US Dollar to inviting the Euro.Since Islamic Banking encourages equity nance even
the small players could enter the Equity Markets and the
SME bourses likely to come into being shortly would have
better access through Islamic Banking channels as the
SMEs mostly have inadequate collaterals to oer for their
expansion needs in their growth stage.
Islamic banking and nationalized banks:It must be made clear, however, that Islamic banking is
not a childrens game. It requires even better professional
expertise compared to conventional banking because it
deals more with commercial projects than mere monetary
credit and debit transactions. Indian Muslims may feel
privileged in terms of Islamic ethics required for Islamic
banking but they certainly lack professional eciency to
manage modern commercial banking on Islamic ethics.
The organic link between Islamic and nationalized banking
emerges from the innate professional competencies
developed by Institutions like the SBI, Bank of Baroda,
Bank of India and Corporation Bank that has recently
opened its representative oce in Dubai with a view
to raise itself to the status of a commercial bank. Underan Islamic banking mechanism the thrust would be on
equity deposits and credits while interest charged would
be replaced with prot margins on commercial credits
and interest expended over deposits would be replaced
by dividend on equity nance with deposits mobilized as
equity deposits by banks.
It is expected that with the introduction of Islamic banking
in India, the rst choice of depositors and investors would
be nationalized banks as despite conict of interest,
Indian Muslims have a condence in nationalized banks.
To ensure the safety of deposits, the majority of Muslimsdepositors would prefer to join Islamic banking managed
by nationalized banks.
FOCUSIndian economy....
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20 Islamic Finance Today October - December 2008
However it is expected that Foreign Investors looking to
invest in India through Islamic banking, would prefer to
have services of foreign banks. As far as Indian Muslimsare concerned, they will have to make an eort to nd
their place in managing Islamic banking in India because
they lack the required nancial depth; infrastructure and
more importantly they have poor credibility among the
depositors and investors due to some past failures of
nancial institutions.
Interest-free banking could also incorporate Muslims
into the formal nancial sector. Through this nancial
inclusion of Indian Muslims to formal sector Islamic Banks,
it is expected that Indian nationalized banks may see
additional savings and credit which may help banks togain higher rate of prots compared to their SLR. After the
successful operation of Islamic banks by the nationalized
banks, private banks could also enter into the business of
Islamic banking.
Stock Market CapitalizationSince Islamic banking focuses on equity deposits and
nance, it is expected that the Stock market will be the
most preferred avenue for investments by future Islamic
banks of India because currently it is our stock market
which is attracting new investments under Shariah Finance
schemes. Technological innovations would facilitate
easier ow of equity-based deposits of Islamic Banks into
the rising Indian Stock Markets. It is common sense that
when equity based nancing takes place through Islamic
banking route, the number of D -mat accounts may surge
in millions.
Corporate Sector and Islamic BanksEven the Corporate sector would be a gainer. All the
companies listed in stock markets will get additional
potential investors to genuinely subscribe their shares
instead of speculator trading. Even the Bond Markets
could stabilize. Long term resources for infrastructure
sectors like irrigation, power, oil and communicationprojects could be expedited through the Islamic Banking
route. New modes of public private partnerships for the
execution of infrastructure projects could also emerge.
Since Islamic banks may also have managerial control
over commercial nancing, the government could utilise
Islamic banking units as a source for mobilizing tax
revenues as well.
With equity nance, the Government may also be able
to convert grants, subsidies and stabilization funds into
equity for Islamic Banks to lend equity nance to prioritysector agents instead of highly subsidized lending which
costs a lot to the exchequer.
Islamic banking to counter Terrorism:The experience of Islamic banks of Malaysia and Britain may
be interesting; as in Malaysia, the Chinese businessmenare the biggest customers of Islamic banking; in Britain
also, Islamic banks are not for Muslims alone. Stringent
anti-money laundering measures are in place in these
countries and have seen far less terrorist intrusions during
the last decade. Shariah principles require transparency
in monetary routes. Every extended credit under Islamic
Banking will need supportive documentation with
managerial control of the fund to monitor the use of
credits, which may not be available with debt nance
under interest-based banking. All we have to do is to place
a fairer and stricter audit system to monitor the fund ows.
The universal nature of banking through Islamic Banks
prevents surreptitious routes for investments and mutual
funds. The petro-dollars and SDRs have the potential for
greater ows and these could also contribute to more
dynamic commodity markets. With greater nancial
muscle, Muslim youth could look to a greater contribution
to domestic GDP through better education and higher
productivity.
Present Crisis in Financial Sector and IslamicBanking:
Interestingly, Islamic banks are unaected by the subprime mortgage crisis; rather many non-Muslims are
turning up to Islamic banking as the customers spooked
by turmoil in the interest based banking system are feeling
Islamic banks are a safer haven because they are immune
against such crisis due to inherent business ethics within
Islamic banking.
There are mainly two important reasons for insulation of
Islamic banks under this current credit crisis as compared
to the interest based banks and nancial institutions.
The rst is security from the liquidity problem due to
inter banks lending in the money markets, merger andresales of debted companies. The second reason is rating
of complete investment risks instead of mere credit risks.
Islamic banking ethics thus help to tame the crisis in
nancial sectors.
In conclusion, Islamic Banking should be seen as a
powerful economic instrument capable of creating multi-
sectoral impacts and contribute to greater stabilization,
helping the real economy signicantly, and reducing
unemployment. Most importantly, it can act as a powerful
antidote to poverty sans huge subsidies and grants that
are making a big dent in the countrys scal framework.It would also open the doors for nancial inclusion to all
concerned.
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21October - December 2008 Islamic Finance Today
Private Equity in MENA A Growing Asset Class
Faisal Hasan - Head of Research Global Investment House - Kuwait
Private equity in the MENA region has witnessedsubstantial growth in 2007 on the fund raisingfront, as well as fund sizes, although a bit sedate
in 2008 on the fund raising front. According to EMPEA
data, the fundraising for private equity investment in theregion has grown manifold over the past ve years andhas increased from a meager US$680mn raised in 2003to over US$5bn in 2007. Average fund sizes also havegrown from US$215mn in 2005 to US$265mn in 2007.There is no doubt that the recent surge in oil prices haveprovided the GCC countries with ample liquidity enablingthem to rehabilitate and diversify their economies whichhave long been dependent on the oil sector. To thatend, the GCC governments have embarked on a totalmake-over of their economies. Massive infrastructureprojects throughout the GCC, enhancement of nancialsectors, privatization eorts, and opening the markets
to international competition, are only a few of the eortsundertaken by the GCC governments to capitalize on theirgrowing cash balances.
The GCC countries have also realized the importanceof involving the private sector in this restructuring, soprivatization has played a pivotal part in the process. Theprivate equity market is an important source of funds for
startup and young rms, rms in nancial distress andthose seeking buyout nancing.
These recent trends in the GCC, had a positive spill-over eects on the MENA regions. MENA countries haveadopted openness to their economic and nancialsectors, which gave cash rich private equity managersthe incentive to seek investment opportunities within theregion. To that end, private equity funds that invest in theMENA region have increased tremendously in numbersand sizes, whereby over US$13bn in private equity capitalare currently under management in the region. What isnoteworthy is until recently, many local and international
private equity operators had looked at the MENA regiononly to raise cash. However, due to the rapid economicgrowth and fundamental strength of the MENA countries,
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22 Islamic Finance Today October - December 2008
many of them are looking for investment opportunities aswell. And while the real estate and construction sectors
attracted a large share of these investments for the timebeing, opportunities in private-sector transportation,nancial services, travel and tourism, energy, and othersectors are ourishing as never before.
The results of the 2007 GVCA survey on the impact ofprivate equity investments on private companies inthe GCC region highlighted the nancial as well as nonnancial contributions that a private equity infuses in thepartner company.
The survey results indicated average annual growth in salesin the years following the investment of 92%; in capital
expenditure of 86%; in exports of 95%; and in researchand development (R&D) expenditure of 32%. Exactly thesehigh-growth companies nanced by private equity andventure capital are central to GCC governments eortsto grow their non-oil economies. Besides the funding fromprivate equity houses, the private equity executives alsobring expertise and experience from other companies intheir portfolios to these companies, including strategyand nance, and industry-specic knowledge. Manyof these private equity investors are also instrumentalin introducing international best practice and soundcorporate governance.
Recent downturns in the Western nancial markets havesent ripples through most markets across the world,including the MENA region, despite having their strongfundamentals. The nancial markets of the MENA regionare largely self-contained and insulated from the maindrivers of the Western nancial markets. The regional stockmarkets always recovered sharply after a temporary pricefall, triggered by a setback in the developed markets.
We rmly believe that this temporary price fall in theMENA regional nancial stocks will certainly rebound overa short period of time. The main reason for the expected
rapid recovery is the strong fundamentals of the regionalcompanies.
The subprime crisis has had no fundamental impact onthe macroeconomic performance of the MENA region.The lack of contagion is attributable to weaker integrationof MENAs nancial sector with those of the US andEurope; and improvements in MENAs fundamentalsover the last decadeincluding better scal andmonetary management; more open regimes with moreexible exchange rates, and better debt and nancialmanagement that has reduced exposure to internationalcapital markets.
However, the current nancial turmoil and resultantslowing of economic growth worldwide have impacted
the private equity fund raising as well, which has sloweddown in MENA during 2008. Private equity players in the
MENA region as well are likely to feel the pinch of creditsqueeze and may nd it dicult to raise funds with thesame ease as they had in the recent past.
These are challenging times and for those raising funds,track history will become more important than ever, as willa dened plan for how the fund manager will adapt theirfocus to suit the current nancial climate. However, bigand established players like Global Investment House ofKuwait, Abraaj Capital of Dubai and Investcorp of Bahrainwith a solid track record history have been and would beable to raise funds as and when the need would arise andwould also be able to deliver the high returns they have in
the past. Global Investment House have had an enviablerecord Gross IRR return of 61.1% on the four funds it ismanaging between the period 2003 till 1H-2008 and a NetIRR return of 55.0% for the same period.
Number of deals happening is low with institutionalinvestors getting highly cautious when presented withnew investment opportunities. Consequently, the numberof investments made till 1H-2008 is far fewer with only 13reported as per zawya private equity monitor, down from33 during the same period in 2007. Not only the numberof transactions has come down signicantly in 1H-2008but so has the size with the largest deal closed being IntajCapitals purchase of a majority stake at an announced$188m transaction size. However, deals will continue to bedone with much lower levels of debt, and more equity.
The silver lining of the current stock market correction is
that sellers price expectations will now start to come into
line with reality, opening the door for more deals which
had been a major impediment for deals not happening as
per the GVCA survey 2007. The drop in stock market value
also means that company valuations are less inated than
they were one year ago and there is more value to be
found. Company owners too would be more realistic about
valuations and consequently would be more receptive toprivate equity alternatives. There also seems to be less
resistance from local businesses to private equity, now
that they can see cases where the cash injection has made
a positive dierence.
The most protable fund vintages to invest in have often
been those where the in-going investments have been
made in challenging times. 2008 may well be one of these.
The most successful investors in private equity have been
those with a consistent long-term strategy, investing
over a long period. Fundamentally nothing has changed:
private equity will continue to grow, and will continue todeliver net returns well in excess of those available in the
public markets.
ANALYSISPrivate equity....
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23October - December 2008 Islamic Finance Today
OPINION
The permissibility ofnon-Muslims workingfor an Islamic Financial
institutionBy Mohammed Robbani -INSIF The Institute of Islamic Finance London
Afrequently asked question nowadays is whether itis permissible for non-Muslims to work for an IFI?Yes, it certainly is. It is allowed for non-Muslims to
be employed by Muslims for almost anything except fora few roles (e.g. Imam of a mosque). The Prophet himselfonce hired a man from Banu Ad-Deel who was a non-Muslim. Also, it is narrated that a Jewish valet who usedto serve the Prophet was once taken ill, so the Prophetvisited him (Sahih Bukhari). This indicates that not only
is it permitted to hire a non-Muslim, but that we shouldrespect them in the same manner as we would respect afellow Muslim of equal stature.
There are however those who question the appointmentof non-Muslims to positions where they would be able toexert authority over Muslims.
Those who say so depend upon a saying of Umar Ibn al-Khattab who is reported to have said No one of them(non-Muslims) should hold a position in which he can havepower over a Muslim. Umars command was apparentlybased on the Quranic injunction 3:28 Let not the believers
take those who deny the truth for their allies/guardians inpreference to the believers - since he who does this, cutshimself o from God in everything - unless it is to protect
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24 Islamic Finance Today October - December 2008
yourselves against them in this way. But God warns you tobeware of Him: for with God is all journeys end.
The term allies/guardians does not mean that a Muslimshould not have non-Muslim friends, employers oremployees or that non-Muslims must not be given jobswith managerial authority over Muslims. What it simplymeans in essence is that it is not allowed for a Muslim toput a non-Muslim in a position (in any capacity) wherethe non-Muslim will have subjugative powers over otherMuslims and in particular, where the non-Muslim cansubvert the laws and spirit of Islam if he/she wishes todo so without having to answer to a higher Muslimauthority.
The fact however is that all Islamic banking and nancialinstitutions today have Shariah Supervisory Boards whichare regarded as the highest authority in any given IFI withregard to ensuring compliance with the Shariah and noboard member or ocial including the managementhas the power to override the authority of the SSB in thisregard. Thus even if non-Muslims are placed in positionsof authority over certain levels of Muslims they would ndit rather dicult to subvert the law or spirit of Islam.
However, having said this it must be borne in mind thatthe Shariah Supervisory Boards are not responsible for
the day-to-day running of the institution, which lies withthe management team, which may not have any Shariahscholars within it. Furthermore, the SSBs certify onlywhat is presented to them in documentary form and donot have control over the subsequent execution of thatproduct or even how it is ultimately distributed (and underwhat non-documented terms).
Thus, they may certify that a particular type of product isShariah compliant on paper, but if the management teamrunning the institutions do not have the same sense ofcompliance as the SSB, then the product may actuallybecome non-compliant out in the eld.
We have seen a major case of this occurrence recently whenMufti Taqi Usmani declared that certain types of Sukuksthat were originally certied as Shariah compliant by theSSBs, actually become partly non-compliant becauseof the way the transactions were executed. This meansthat although just like conventional nancials systems(which have central banks, etc) there are regulatorysystems in place within the Islamic nancial system (whichhave Shariah Supervisory Boards, etc) to prevent non-compliance; these regulatory systems cannot preventmajor non-compliance if the senior members of an IFIs
management team do not feel strongly enough to remainwithin the bounds of compliance no matter what (i.e. ifthey put prot above principle).
It is desirable therefore (or as some may hold mandatory),that Muslims be appointed to positions of responsibility in
IFIs in preference to non-Muslims subject to the provisionthat they are as equally or better qualied.
Thus if all things are equal, then Muslims should be favouredover non-Muslims if there are no adverse consequences indoing so. So if a Muslim and a non-Muslim have the samequalications, experience and ability the Muslim shouldbe selected due to the ties of brotherhood that bindthe Muslim community (Ummah). Besides, a Muslim willhave the religious inner drive to follow the spirit of Islamwhich may be absent in a non-Muslim, though here tooone cannot select a Muslim based on his name alone, butrather after a sound evaluation of his character.
This brings us to another question: Are non-Muslims ableto discharge the objectives of an IFI in its full spirit?It is obvious that a non-Muslim with sincere intentions canindeed discharge the Islamic objectives of an Islamic Bankin its full spirit if the bank is managed that way from thetop-down. Consider a non-Muslim bank ocer in chargeof Islamic micro-nance.
This person does not have to be a Muslim to fully complywith a function of Islamic law in letter as well as in spiritif, for example, he/she lends someone money and doesnot seek any interest or any benets-in-kind in returnwhatsoever (i.e. gives a qard hasan) and writes-o the loan
if the borrower cannot repay.
This non-Muslim person is therefore, not only fulllingthe Islamic law relating to riba but also the spirit relatingto sadaqah. However, this can only be achieved by thisnon-Muslim person if the organisation he/she works foroperates within this Islamically ethical manner. It is at anyrate preferable that sincere Muslims work alongside themto ensure that the team keeps to the law.Having said this, it must be stressed that there can be nonegative discrimination towards non-Muslims by Muslims.This is totally against Islamic principles for God has stated
in the Quran (5:8) O You who have attained to faith! Beever steadfast in your devotion to God, bearing witnessto the truth in all equity; and never let hatred of any-onelead you into the sin of deviating from justice. Be just: thisis closest to being God-conscious. And remain consciousof God: verily, God is aware of all that you do.All people regardless of nationality, religion or race areequal as human beings Muslims are superior in faithonly. The Muslim creed demands that all people (inc. non-Muslims) are respected and treated kindly, fairly and justly.Any kind of discrimination, racism, etc. is a form of hatred and thus forbidden (as per the above verse). Besides,
taking non-Muslims to work in Islamic institutions couldopen up their hearts to Islam which would be a greataccomplishment for the faith.
OPINIONThe Permissibility....
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INSIGHT
IJARASuresh R. I. Perera LLB, Attorney at Law, ACMADirector Tax & Regulatory KPMG Sri Lanka
The nature of IjaraThe literal meaning of Ijarah is to give something on rent. As per
Islamic jurisprudence the term connotes two distinct situations.
1) The services of human beings for wages - the
Mustajir(employer) employing the services of an Ajir
(employee) on wages or Ujrah in lieu of hired services. An
Ajir for this purpose could be anyone rendering services
including labourers, doctors and lawyers.
2) Usufructs of assets & properties for rent transferring the
usufruct of an asset by Mujir (lessor) to Mustajir (lessee)
in lieu of Ujrah (rent) payable by the latter. The form ofIjara referred to herein and the category that is relevant for
investment purposes connotes this form.
Ijara has proven to command a high demand among the Islamic
nancial instruments and perhaps is on the way to be the most
popular instrument. This is the appropriate Islamic nancial
instrument for inter - mediate or long term nancing of assets.
Shariah Rules permits the levy of rental in lieu of granting the right to
use real assets. As the nancier undertakes the risk of the ownership
he is entitled to receive a return by way of rental under the Shariah
Rules. Normally the rent is so xed, that the nancial institution gets
back its original investment plus a prot on it. Finance leases or IjaraMuntahia Bittamleek (IMB) embodies an option to purchase the
asset at the end of the period.
Comparison with the conventional leaseFinancial Accounting Standard (FAS) 8 formulated by Accounting
& Auditing Organization for Islamic Financial Institutions (AAOIFI)
provides for accounting treatment for Ijara and IMB. This AAOIFI
recommended Standard for Ijara and the Standard formulated
by International Accounting Standard 17 (IAS 17) for conventional
leasing dier in many aspects.
A lease as per International Accounting Standard is an agreementwhereby the lessor conveys to the lessee in return for a payment or
series of payments, the right to use an asset for an agreed period of
time. According to IAS 17 a lease is classied as
a nance lease if it transfers substantially the
risks and rewards incidental to ownership. A
lease is classied as an operating lease if it doesnot transfer substantially all risks and rewards
incidental to ownership.
Ijara is dened as ownership of the right
to the benet of using an asset in return for
consideration. However AAOIFI denition
embodies the additional condition that the
benet should be Shariah complaint. Thus
Ijara & a conventional lease dier in this aspect
regarding the requirement to comply with
Shariah Rules. Shariah does not permit Ijara
for use of an asset for payment of interest andinvolving merchandise considered as haram
nor for unlawful transactions.
A more compassionateform of Leasing
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AAOIFI FAS 8 also embodies a classication of the
instrument into two categories. If the contract refers to a
promise to the eect that the legal title would ultimatelypass on to the Mustajir (lessee) at the expiry, it is referred
to as Ijara Muntahia Bittamleek. In I MB which is loosely
considered as equivalent to the conventional nance
lease, at the expiry of the term the passing of the legal title
to Mustajir (lessee) could occur either :
(a) on transfer on payment of balance rentals,
(b) as a gift,
(c) on payment of a token or for an amount specied
in the contract or
(d) on the gradual transfer of the title.
As per AAOIFI Juristic Rules on fulllment of the promise,
for the transfer to be eective, a contract distinct from the
Ijara contract should be executed. The Mustajir has an
option, which he may or may not exercise. Thus IMB would
have the characteristics or the substance of a conventional
lease only if the Mustajir exercises the option. In the
absence of such exercise IMB for all intents and purposes
is an operating lease. Hence in legal form and in concept
IMB and a conventional nance lease are not identical.
Perhaps the key distinction between the Ijara Muntahia
Bittamleek and the conventional nance lease is that inthe Islamic version the lessor undertakes full ownership
risks of the corpus of the leased asset. Whilst in Islamic
version the risk remains with the lessor (Mujir), the
passing of the risk to the lessee is a prerequisite for a lease
to be classied as a nance lease under International
Accounting Standards. It could be seen in Ijara the risk
follows the legal title unless the damage is caused by the
negligence or the misconduct of Mustajir. As IAS looks at
substance over form for accounting purposes, on passing
of the risks and rewards of the asset to the lessee, the asset
is recorded in the books of the lessee coupled with the
right to claim depreciation. Major repairs, maintenanceand insurance remains to the account of Mujir (lessor) in
a Ijara, whereas these costs are passed on to the lessee in
a conventional lease.
Compassion underlying Ijara
Perhaps the compassion of Ijara is manifested over its
counter part when it concerns the asset being out of order
for a period due to major defects. During the period the
asset is out of order, Ijara rentals would be in suspension
so that Mustajir (lessee), who cannot benet from the
use of the asset is provided relief. Shariah also prohibitsthe levy of penalty in an Ijara arrangement for delayed
payments, unlike in a conventional lease.
The issue of delayed payments may be addressed in an
Ijara contract by various means such as inclusion of a
donation clause, by acceleration of installments or by thecancellation of the contract. The compassionate attitude
towards charging Ujrah (rent) from the Mustajir (lessee)
is manifested at the commencement of the charge itself.
In a conventional lease the payment obligation may
commence from the date of execution from contract for
funding. But in the Islamic version the obligation for the
payment commences only upon the delivery of the asset
to Mustajir or upon enabling the use thereof by him.
Accounting under AAOIFIThe nature of Ijara rental or Ujrah is that it represents
consideration for the right to use an asset. Ujrah does notconsist of a capital component and an interest element.
Hence the application of accounting methodology
adopted for conventional lease rentals under International
Accounting Standards of recording lease rentals
receivable and interest in suspense in the books of the
lessor would pose an issue in accounting for Ujrah. FAS
8 formulated by AAOIFI stipulates that both assets rented
on the basis of Ijara & IMB to be recorded in the books
of the Mujir (lessor). The two categories of assets should
be shown in the Statement of Financial position under the
heading investments in Ijara assets and Ijara Munthia
Bitamleek Assets respectively on initial recognition atcost and at book value thereafter.
The right for the depreciation claim follows the recording
of the asset in the books of the lessor and unlike in a
conventional nance lease under IAS, the depreciation
entitlement for both forms are vested on the Lessor.
Whilst depreciation of Ijara assets shall be on the basis
of the depreciation policy of the lessor, in calculating the
depreciation of Ijara Bitamleek Assets residual value shall
be taken as zero, if the lessees acquisition of ownership at
the end of the period is through gift. On the other hand if
the transfer to the lessee is at a token or amount specied
in contract, the said amount should be subtracted in
determining the depreciable cost.
Installments of both forms, i.e Ijara & IBM should be
presented in the income statement of the lessor as Ijara
Revenue on accrual basis allocated proportionately
according to the term of the lease recognized in the
period in which they are due. Where the lessee acquires
title through gradual sale the revenue decreases
progressively.
The Ijara installment paid is presented in the lessees
income statement as Ijara expense allocated over thelease period recognized when due under both forms of
Islamic leases.
INSIGHTIjarah leasing....
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INSIGHTIjarah leasing....
Tax issues involving IjaraThe cost of Ijara in comparison to a loan may be high due
to the associated transactional taxes on additional stepsinvolved. The legal / notary fees and stamp duty involved
on the dual transfer of title (in Ijara Munthia Bittamleek)
and the property transfer tax may increase the cost of the
entire structure in many jurisdictions.
The exposure of the Ijara rentals to VAT as opposed to the
VAT exemption enjoyed by interest is another factor that
may have an impact on the pricing. Though interest paid
on a loan from a bank does not attract any withholding
tax under most of the tax systems found in the world, Ijara
rental would be exposed to withholding tax.
In certain countries like Sri Lanka, though the local Tax
Statute does not explicitly provide for the claiming of
capital allowances by the lessor under operating as well
as nance leases, under the presumption that the leased
assets are deemed to be used in the lessors business of
leasing, the lessor enjoys the right for claiming capital
allowances. In these countries the same status quo ought
to prevail for Ijara and IMB regarding capital allowances.In a scenario involving a cross border Ijara, Mujir (lessor)
should also be cautious on the possibility of creation of a
permanent establishment in Mustajirs jurisdiction.
Structuring using IjaraThe apparently simple and straightforward Ijara contract
could be adopted to achieve many ends. An Ijara could be
the retail structure of a Sukuk Al Ijara, that permits the
originator to raise funds as well as Sukuk holders to trade in
the Sukuk certicates to enable the liquidity management.
Ijara is also a means for unlocking and realizing the capitalvalue of an asset to fulll the working capital needs of
an organization. An organization that already owns an
asset may sell it to the nancier for immediate funds and
continue to use it under an Ijara agreement on payment
of periodical rentals.
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By: Seema Mohamm