islamic finance: an overview

Islamic Finance : An overview

Mahmoud Sami Nabi Senior Researcher Economist

Islamic Finance Workshop Dakar – Senegal

11-13th, November 2013

Member of

OUTLINE

1. Introduction: Why “finance” is important ? 2. Islamic Finance 2.1. Origin and principles 2.2. Segments and trends 2.3. Islamic Finance Multilateral Institutions 2.4. Modes of Islamic Finance 2.5. Specific Risk to Islamic Finance 2.6. Islamic Finance and inclusive development 3. Islamic Banks

3.1. Origin and Current state 3.2. Business Model of Islamic Banks 3.3. Islamic Banks in practice 3.4. Resilience to the global crisis 3.5. High potential of growth 3.6. Main challenges

4. Successful Islamic Finance Experiences and prospects in Africa 5. Way forward for African countries

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1. Introduction:

Why “finance” is important ?

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1. Introduction > Why “finance” is important ?

• “Financial system influences who can start a business and who cannot, who can pay for education and who cannot, who can attempt to realize one's economic aspirations and who cannot. Thus, finance can shape the gap between the rich and the poor and the degree to which that gap persists across generations.” (Source: Demirgüç-Kunt and Levine, 2009)

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Production of ex-ante

information about the

investment opportunities

Monitoring of investments -

Corporate governance

Easing the exchange of goods and

services

Mobilization and pooling of savings

Trading, diversification- Management

of risk

Quality of institutions,

Government policies,

Geographic conditions,

Income level,

Cultural characteristics

Source: Levine (2005)

Functions of the Financial System

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• The recent global financial Crisis has generated new initiatives to

rethink economics and to restore the ethics to finance.

• Freeman (2010): “…Restoring finance to its role as a productive force in the economy will require new institutions and modes of compensation, as part of a general overhaul of the relation between finance and the real economy”. Source: "It’s financialization!", International Labour Review, Vol. 149, No. 2.

• The tight connection of the financial sphere to the real economic sphere is one of the main features characterizing Islamic Finance.

2. Islamic Finance

2.1. Origin and principles

2.2. Segments and trends

2.3. Islamic Finance Multilateral Institutions

2.4. Modes of Islamic Finance

2.5. Specific Risk to Islamic Finance

2.6. Islamic Finance and inclusive development

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2. Islamic Finance > 2.1. Origin and Principles

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• Purposes of the Islamic law (Shari’ah) according to Ghazali are preserving and enriching :

Faith Life Intellect

Posterity Wealth

Socially-agreed moral filter ensuring cooperation and well-being of all

It is not an end in itself – it is a mean for realizing human well-being

Source: Chapra (1992, p.7)

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• “.. The goals of socio-economic justice and equitable distribution of

income and wealth are an integral part of the moral philosophy of Islam and are based on its unflinching commitment to human brotherhood.” Source: Chapra, U. (1983, p2) “Monetary Policy in an Islamic Economy”

• “.. Pursuit of self-interest demands that one should be conscious of

the interest of others and should avoid hurting them. The requirement invokes mutual respect and calls for cooperation - not conflict - for promoting the interest of each other.” Source: Hasan, Z. (2011, p16) “Scarcity, self-interest, and maximization from Islamic angle”

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Many verses of the Holy Quran and Hadiths:

• { And those who, when they spend, are neither prodigal nor grudging;

and there is ever a firm station between the two} {Ceux qui, pour leurs dépenses, ne sont ni prodigues, ni mesquins, car la juste mesure se trouve entre les deux} (Al-Tawbah,103) ---------------------------------------------------------------------------------------------------------

• {Allah hath blighted usury and made almsgiving fruitful} {Dieu anéantit les profits de l'usure et fait fructifier les aumônes} (Al-Baqara,103)

{ باللا يمحق الصدقاتوي ربيالر } http://www.altafsir.com

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• “…the Islamic system creates a balanced relationship between the individual and society. Self-interest and private gains of the individual are not denied, but they are regulated for betterment of the collectivity.” Source: Greuning and Iqbal (2008, p.31) "Risk Analysis for Islamic

Banks"

• “Islam proposes a model of social responsibility more extensive than the models suggested by the classical economic theories”

Source: Forget E. (2009) “Le développement durable dans la finance éthique et la finance islamique“, Cahier de la finance islamique, n° 1 juin, 2009.

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• Muslim narrated on the authority of Abu Saiid Al-Khudriy; Prophet Mohammed (pbuh) said:

“Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts; and any increase is Riba.”

• Muslim narrated on the authority of Abu Saiid Al-Khudriy

{Bilal visited the Messenger of Allah (pbuh) with some high quality dates, and the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah (pbuh) said: “this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other.”}

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• “Riba” literally means “excess” and reflects any unjustifiable

increase of capital whether in loans or sales. More precisely, any positive, fixed, predetermined rate tied to the maturity and the amount of principal (Greuning and Iqbal, 2008)

Riba al-fadl : where money is exchanged for money hand-to-

hand, but in different quantities.

Riba al-nası’ah: where money is exchanged for money with deferment.

• In conventional finance: time value of money is reflected in interest

payments. • In Islamic finance: Money has no intrinsic utility. It is a potential

capital which materialize only if it joins other resources (effort and labor) to undertake a productive activity

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• The remuneration of capital should be the counterpart of risk inherent to trade and investment activities based on:

Profit and Loss Sharing when capital finance investment activities.

Difference in the price of buying and the price of selling when financing trade activities.

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• {…they said: Trade is just like usury; whereas Allah permitteth trading and forbiddeth usury...}

{…ils disaient : " La vente est semblable à l'usure ". Mais Dieu a permis la vente et Il a interdit l'usure...} (Al-Baqara,103)

• All financial transactions must be backed by real assets.

• Debt (originated from a trade transaction) cannot be traded, rescheduled or discounted for interest. However, debt can be swapped for goods and services.

2. Islamic Finance > 2.2. Segments and trends

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• The Islamic financial services industry (IFSI) has grown in size and geographic coverage. More than 600 Islamic Financial Institutions operating in more than 75 jurisdictions.

Islamic Finance Assets Growth

Source: KFH Research (2012)


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Banking Assets

81%

Sukuk Outstanding

13%

Islamic Funds Assets

5%

Takaful Assets

1%

Islamic banks and Islamic banking

windows: central pillar with 40.3% og

CAGR over 2004-2011 and total assets

estimated to USD 1.1 tln.

Sukuk : issuances growing at CAGR

of 42.3% over 2004-2011 passing

from USD 7.2 bln to USD 85.1 bln.

Global aggregate sukuk 1996-2012

USD 396.4 bln.

Cooperative Insurance (Takaful): small

segment but its total gross contributions

have grown by a CAGR of 23.1% over

2004-2011 with an estimate of USD 15.2

bln in 2012.

Islamic funds (680) : assets under the

management of passed from USD

29.2 bln in 2004 to USD 64 bln in Oct.

2012 .

Breakdown of Islamic

Assets by type (2011e)

Sources: KFH, 2012 ; Thomson Reuters, Zawya, 2012.


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• Islamic Microfinance: emerging market niche and promising segment for financial inclusion:

~ 255 providers around the world 164 providers in East Asia and Pacific and 72 providers in MENA. Poor clients using Sharia-compliant products estimated at 1.28

million Source: CGAP (2013)

• CGAP (2008): “ Islamic microfinance represents the confluence of the two rapidly growing industries: Microfinance and Islamic finance. It has the potential to not only respond to unmet demand but also to combine the Islamic social principle of caring for the less fortunate with microfinance’s power to provide financial access to the poor. Unlocking this potential could be the key to providing financial access to millions of Muslim poor who currently reject microfinance products that do not comply with Islamic law.”

2. Islamic Finance > 2.2. Segments and trends > Islamic Microfinance

Types of IMFIs

Source: CGAP (2013) “Trends in Sharia-Compliant Financial Inclusion”

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Global Islamic Finance Industry: Stage of Development



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Breakdown of Islamic Assets by Region (2011e)



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Islamic Financial Institutions in Africa

Source: Faye et al. / Review of Development Finance (2013)


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Islamic Financial Institutions in Africa

Source: Faye et al. / Review of Development Finance (2013)

Regional distribution of Islamic project finance transactions

(number and value) (2005–2012)

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Sukuk / Global sukuk issuance 1996-2011

Source: Standard & Poor’s (2011)


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Sukuk / Absolute sukuk issuance by country 1996-2011

Source: Standard & Poor’s (2011) “Analysis of Sharia-compliant cooperative and Takaful insurers in

the middle east focuses primarily on financial strength”


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Sukuk

Source: Reuters


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The 10-year framework and strategies

http://www.ifsb.org/docs/10_yr_framework.pdf

• A document published by IDB and IFSB in 2007 to mainly provide a platform for countries in formulating their national and regional master plans to promote Islamic financial services industry.

Mid-Term Review of 10Y Framework & Strategies:

• Identify the progress, gaps and also to examine the need to have a reorientation of priorities and initiatives in light of the 10Y document

2. Islamic Finance > 2.3. Islamic International Financial Institutions

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• Islamic Development Bank (IDB): is a multilateral financial

institution established in October 1975 to foster economic development and social progress in its member countries (56 which are member of the Organization of Islamic Cooperation OIC) and in Muslim communities in nonmember countries.

• IDB has channeled more than $20 billion to the infrastructure sector, since its inception in 1975. At the end of 2011, the Bank’s infrastructure portfolio comprised 219 active projects.

• IDB financing modes: equity, lease financing (ijarah), installment sale financing (murabahah), istisnah (construction and manufacturing) contracts, …

• IDB played a leading role in establishing several institutions supporting the Islamic financial services industry which includes

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2. Islamic Finance > 2.3. Islamic International Financial Institutions AAOIFI

Adopting international standards to suit Islamic financial institutions.

IFSB serve as an international standard-setting to ensure the soundness and stability of the Islamic financial services industry.

IIFM

Develop Sharia compliant instruments allowing Islamic financial institutions to overcome liquidity management problems.

LMC

represents the Islamic Finance Industry globally and support its expansion and cooperation between its institutions

CIBAFI

Accounting and Auditing Organization for the Islamic Financial Institutions: created in 1993.

Islamic Financial Services Board : started operations in 2003.

standard setting organization focusing on Islamic financial products, documentation and related processes at the global level.

International Islamic Financial Market : established in 2012.

General Council for Islamic Banks and Financial Institutions: established in 1999.

Liquidity Management Centre: established in 2002.

IIRA

facilitate development of the regional and national financial markets by providing an assessment of the risk profile of entities and instruments.

Islamic International Rating Agency : started operations in 2005.

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Leasing

•Lease (Ijarah)

•Lease-purchase (Ijara wa iqtina)

Sale

• Cost-plus sale (Murabahah)

• Deferred-payment sale (bay‘ bi-thaman ’ajil)

Forewards

•Salam: paiment at t=0 and delivery at t = T

•Istisna (Manufacture) paiement at t=0,1,2.. and delivry at t = T.

•Profit sharing & loss bearing (Mudharabah)

•Profit and loss sharing (Musharakah)

•Loan without charge (Qard Al-Hasn )

•Donation (Hiba)

• Endowment (waqf)

Exchange-based

Trading contracts

Equity-based– Partnership contracts

Social well-being Gratuitous contracts

Mutual insurance where each participant contributes to fund which is used to support the group. Premiums are invested in Islamic financial products. Surpluses are shared.

Cooperative–Insurance Takaful contracts

Islamic Investment Certificates - Sukuks

Certificates of ownership of underlying assets, issued with the aim of using the mobilized funds for establishing a new project, developing an existing project, or financing a business activity.

2. Islamic Finance > 2.4. Modes of Islamic Finance

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Profit sharing & loss bearing - Mudharabah

Entrepreneur

Financier

Invest in

Business Outcome

X%

Y%

Profit

Loss

Labor

Capital

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Profit & loss sharing - Musharakah

Financier

Entrepreneur

Capital

Investment

Profit

Loss

Y% X%

Labor

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Example: Musharakah agreement to finance a residential development project

Source: Kamarul Ariffin Mohd Jamil (2013), "Musharakah Project Financing" 3rd ISRA – IRTI – Durham University Strategic Roundtable Discussion“Risk Sharing in Theory and Practice: Fiqhi Evidence vis-a-vis Current Reality”

An Islamic Bank (“AFFIN ISLAMIC”) and Company A, a subsidiary of a Public Listed Company (PLC) entered into a Musharakah joint venture agreement.

They created a joint venture company (“SPV”) as the Special Purpose Vehicle to undertake a residential development project in Pulau Pinang.

The Musharakah Agreement outlines the objective of the partnership as well as the terms and regulation of the relationship, namely responsibilities of both Musharakah partners.

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Example: Musharakah agreement to finance a residential development project

Source: Kamarul Ariffin Mohd Jamil (2013), "Musharakah Project Financing" 3rd ISRA – IRTI – Durham University Strategic Roundtable Discussion“Risk Sharing in Theory and Practice: Fiqhi Evidence vis-a-vis Current Reality”

• The authorized and paid-up capital of SPV stands at RM5,000,000 and RM1,000,000 respectively which was subscribed equally by both AFFIN ISLAMIC and Company A.

• Additional requirements was made through Shareholder’s Advances.

• The Capital Contribution Ratio (CCR), Profit Ratio (PR) and Loss Ratio (LR) was pre-agreed as follows:

Musharakah Partner Capital Contribution Ratio Profit Ratio Loss Ratio

AFFIN ISLAMIC 50% 50% 50%

Company A 50% 50% 50%

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Example of Sukuk Al-Ijarah

SPV for

Sukuk Al Ijarah Originator

1. Negotiations for

lease of assets to be

procured

Sukuk Sukuk Sukuk

2. Issuance of

Sukuk to raise

fund for

procurement of

asset

QUALIFIED

INVESTORS

3. Subscriptions $

3. $

Equipment

Suppliers

1.(a) Order for

assets by SPV.

Istisna’

Contract

Assets

4. Delivery of completed assets. Progress

payments against progress deliveries

Assets

5. Ijarah of assets to Originator; now assuming

role as Obligor 6. Ijarah

Rental

Payment

s $

Sukuk al Ijarah Rental s

Admin. Account 7. Distribution of Profits and final settlement to

Investors

Asset Backed

Securitisation

8. Upon termination of Ijarah, asset sold to Originator

Source: "Sukuk Al IJarah: Whether Asset Backed or Asset Based?" ,Wan Abdul Rahim Kamil, Islamic Capital Market Securities Commission Malaysia

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2. Islamic Finance > 2.5. Specific Risk to Islamic Finance

• In addition to the types of risks (Credit risk, Market risk, Liquidity risk, Operational risk, …) faced by conventional financial institutions, Islamic Financial Institutions are exposed to a specific risk: Sharia Non-Compliance Risk.

• Sharia Non-Compliance Risk: is the potential loss to the institution arising from lawsuits by partner(s) due to Sharia non-compliance.

Importance of Sharia advisors and Sharia boards.

• The Shariah framework in Islamic finance refers to the overall scope that governs the process of product development and approval. It comprises the Sharia sources, Maqasid al Shariah, legal maxims, AAOIFI and IFSB guidelines (Source: Lahsasna and Hassan (2010) "The Shariah

Process in Product Development and Approval", in Islamic Capital Markets)

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Example: Sharia compliance of sukuk • In November 2007 the President of the Shariah Council of AAOIFI

estimated that 85% of all Sukuk in issuance were not Shariah-compliant due to the existence of guaranteed returns and/or repurchase obligations from the issuer.

• “In late 2007 and early 2008, sukuk issuance slowed after Sheikh Muhammad Taqi Usmani, chairman of the board of scholars at AAOIFI, suggested that about 85 percent of sukuk might not comply with Islamic law.” (Source: Davies and Sleiman (2012) " Insight: "Rock star" scholars a risk for Islamic finance", http://www.reuters.com/)

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Example: Sharia compliance of sukuk

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Example: Non-compliant application of Tawarruq • (Individual) Tawarruq: to purchase a commodity from one party on credit then

sell it immediately to another for cash.

• Non-complinant (Institutional) Tawarruq : 1) IB purchases some commodity from the market, like metal form London

Metal Exchange (LME). 2) IB sells it to the customer on Murabaha basis for deferred payment. 3) IB , acts as the customer’s agent, and sells the metal on LME for

immediate cash. IBs gains Murabaha profit and agency fees, The customer obtains immediate cash and remains committed to repay the

outstanding debt that he has incurred when acquiring the commodity from the bank on Murabaha basis

Source: Abdulazeem ABOZAID (2010), «Contemporary Islamic Financing Modes between Contract Technicalities and Shari[ah Objectives», Islamic Economic Studies, Vol.17, No. 2. Janvier 2010 and Etudes en Economie Islamique, Vol., No.1. December 2011.

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1. Introduction > 2.6- Islamic Finance and Inclusive development

• Economic Inclusiveness: “the degree to which economic

opportunities are shaped by individual skill, ideas, and initiative rather than by familial wealth, political influence, and social connections” (R. Levine, 2011)

• Financial development: “factors, policies, and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services” (WEF, Financial Development Report,2012)

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2. Islamic Finance > 2.6- Islamic Finance and Inclusive development

Risk sharing-Equity based

contracts

Solidarity (obligatory

alms, endowments

solidarity)

Connection to the real economy

Moral Filter

– Social Responsibility- Sustainability Financial

inclusion of poor and

Social cohesion

Innovation, entrepreneurship

and SMEs financing

Health, Education, Transport, Housing

Transport, Housing

Food security, Renewable

energy, Green economy,

Insulation from excessive

leverage and speculative

financial activities

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• “20 out of 39 OIC countries can actually alleviate the poorest living with income under $1.25 per day of the poverty line simply with domestic and remittances Zaqah (obligatory alms) collection”

Source: Mohieldin, M., Z. Iqbal, A, Rostom, and X. Fu (2011) "The Role of Islamic Finance in Enhancing Financial Inclusion in Organization of Islamic Cooperation (OIC) Countries", Policy Research Working Paper 5920, World Bank, Washington DC.

Role of Zaqat in reducing poverty

• {Establish worship, pay the poor-due, and bow your heads with those who bow (in worship).} {Acquittez-vous de la prière, faites l'aumône ; inclinez-vous avec ceux qui s'inclinent. (Al-Baqara,43)


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(1) (2) (3) (4) (1) (2) (3) (4)

Country Zakah

(% of

GDP)

resource

shortfall

under

$1.25 per

annum as

% of GDP

Does

Zakah

cover

(3)?

Country Zakah (%

of GDP)

resource

shortfall

under

$1.25 per

annum as

% of GDP

Does

Zakah

cover (3)?

Albania 1.44 0.01 y Bangladesh 1.62 5.58 n

Algeria 1.77 0.14 y Benin 0.44 5.78 n

Azerbaijan 1.82 0.01 y Burkina Faso 1.06 9.83 n

Cameroon 0.32 0.26 y Comoros 1.77 8.89 n

Djibouti 1.75 1.49 y Cote d'Ivoire 0.66 2.05 n

Egypt 1.9 0.04 y Gambia 1.72 5.42 n

Gabon 0.17 0.03 y Guinea 1.52 6.71 n

Indonesia 0.89 0.39 y Guinea-Bissau 0.76 8.21 n

Iran 1.79 0.02 y Guyana 0.13 0.88 n

Iraq 1.78 0.09 y Mali 1.67 8.2 n

Jordan 1.77 0.01 y Mozambique 0.41 13.62 n

Kazakhstan 1.02 0 y Niger 1.77 8.31 n

Kyrgyz Republic 1.55 0.02 y Nigeria 0.91 8.26 n

Malaysia 1.09 0 y Senegal 1.74 3.05 n

Maldives 1.77 0.02 y Sierra Leone 1.28 16.1 n

Morocco 1.81 0.06 y Suriname 0.29 0.61 n

Pakistan 1.55 0.91 y Tajikistan 1.51 1.7 n

Syrian Arab 1.39 0.02 y Togo 0.22 6.42 n

Turkey 1.86 0.04 y Uganda 0.22 3.1 n

Yemen 1.78 0.87 y

Role of Zaqat in reducing poverty


3. Islamic Banking

3.1. Origin and Current state

3.2. Business Model of Islamic Banks

3.3. Islamic Banks in practice

3.4. Resilience to the global crisis

3.5. High potential of growth

3.6. Main challenges

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3. Islamic Banking > 3.1. Origin and current state

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Source: A. Chachi (2005) "Origin and Development of Commercial and Islamic Banking Operations" J.KAU: Islamic Economics Vol. 18, No. 2.

• In 1950s in a rural area in Pakistan: a small experimental Interest-Free Bank founded by a small number of landowners to finance poorer landowners for agricultural improvements. Failure due to shortage of funds and problems of specialized staff.

• In 1963, in Mit-Ghamr in Egypt: Mit-Ghamr Islamic Savings Bank (MGISB), started following the business model of German savings banks adapted to Sharia rules. Within three and a half years, MFISB counted 251,000 depositors and the deposits grew at unprecedented higher rates than expected.

• MGISB financed a variety of purposes : house building and repairs, purchase of simple machinery for handicraft industries, purchase of farm animals, basic improvement to the irrigation.

• Stopped in 1967: the success of the bank began in the development of the local area, created conflicts with the local social authorities who saw it as interfering in their own area of authority...

• IDB in 1975 • Dubai Islamic Bank in Dubai (UAE) in 1975 the first major Islamic commercial

bank.

3. Islamic Banking > 3.1. Origin and current state

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Source: E&Y - World Islamic Banking Competitive Report 2011-2012

Islamic Banking Asset Growth (US$bn)

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• Chapra (2008) : In order for the financial system to promote justice, it should satisfies at least two conditions, in addition to being strong and stable :

1. Financier must share in the risk so as not to shift the entire

burden of losses on the entrepreneur.

2. An equitable shares of bank lending should become available to the poor to help eliminate poverty, expand employment and self-employment opportunities and, thus, help reduce inequalities of income and wealth.

Source: "Innovation and Authenticity in Islamic Finance", paper presented in the "Eighth Harvard University Forum on Islamic Finance: Innovation and Authenticity", April 19-20, 2008.

3. Islamic Banking > 3.2. Business Model of Islamic Banks

Islamic banks’ balance sheet

Assets Capital & Liabilities

Equity Investment deposits

• Neither the principle nor the return are guaranteed • Depositors share the bank’s net profit according the PLS ratio stipulated in the contract • Can be withdrawn only on maturity

• Yield no return and repayable on demand at par value

Demand deposits

PLS modes of financing

Trade modes of financing



• Separation of the investment funds from the demand deposits + 100% reserve on the demand deposits removes the risk of bank

runs à la Diamond and Dybvig (Khan, 1987) •PLS principle: neither the principal nor the return of the investment

deposits are guaranteed, any loss occurred on the asset side is totally absorbed on the liability side IBs maintain their net worths under difficult economic situations. (Khan, 1987; Ahmed, 2002; Syed, 2007; Cihak and Hesse, 2008).

• Prohibition of Riba and derivatives, the linkage with the real economy

principle prevent the financial crises (Ahmed, 2002)

STRENGTHS

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• The empirical studies revealed that the current practices of IBs deviate from their theoretical model.

• Zainol and Kassim (2010) and Cevik and Charap (2011): CB deposit rates Granger cause returns on PLS accounts in Malaysia and Turkey.

• Chong and Liu (2009): in Malaysia showing the retail Islamic deposit rates mimic the behavior of conventional interest rates.

3. Islamic Banking > 3.3. Islamic Banks in practice

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Source: Bourkhis and Nabi (2013)


•Beck, Demirgüç-Kunt and Merrouche (2013) "Islamic vs. conventional banking: Business model, efficiency and stability", Journal of Banking and Finance carried an empirical investigation on a broad cross-country sample and reached the following:

few significant differences in business orientation.

IBs less cost-effective, have higher intermediation ratio, higher asset quality and better capitalized.

large cross-country variation in the differences between conventional and Islamic banks as well as across Islamic banks of different sizes.

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Islamic banks assets’ breakdown by type

© 2012 INCEIF

• Cihak and Hesse (2010) “Islamic banks and financial stability: An empirical analysis,” Journal of Financial Services Research, analyses the stability of IBs relatively to CBs in a cross-country analysis during the period 1993-2004 and show that:

(i) small Islamic banks tend to be financially stronger than small conventional banks

(ii) large conventional banks tend to be financially stronger than large Islamic banks;

(iii) small Islamic banks tend to be financially stronger than large Islamic banks.


© 2012 INCEIF


• Empirical finding: superior efficiency of Islamic banks suggesting that Islamic banking could be beneficial for Africa.

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Source: Islamic Banking and Finance Information System (IBFIS) - IRTI


Islamic Modes of Finance for 63 Banks: 2012 (Billion US Dollar)

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One of the explanations of the low use by Islamic banks of the “Profit and Loss Sharing” modes of finance relatively to “mark-up” modes is the difficulty to deal with the agency problems (moral hazard and adverse selection) (Siddiqui, 2006).

According to Ul Haque and Mirakhor (1987, p161) “bankers ascribe the problem of moral hazard or asymmetric information to be an important explanation for individual preference for short-term liquidity.”



• Deviations of the current practices from the theoretical model

IBs distribute profits to the investment depositors even when they accrue loss, so the profits are paid out of equity (Displaced Commercial Risk) (El- Hawary, 2007; Greuning and Iqbal, 2008).

Example: Ihlas Finance House, the Turkish Islamic financial institution was closed during the financial crisis of 2000-2001 due to liquidity problems and financial distress that originated from its strategic error to allow withdrawals from Investment Accounts. “On the contrary other SFHs (Islamic financial institutions) which survived the crisis did not en-cash the investment deposits and advised their clients to hold them to maturity.” (source: Syed A.S. (2007) Financial Distress and Bank Failure: Lessons from Closure from Ihlas Finans in Turkey. Islamic Economic Studies, 14 (1-2), 1-52. )

In some cases IBs may not fully respect Sharia principles in their activities. Such behaviour makes them vulnerable to risks normally born by the peers. (Chong and Liu, 2009).

IBs may lose their comparative advantages against the CBs.

• Dominance of less risky, low return assets deprives IBs of the benefits of the portfolio diversification, as PLS contracts are more profitable (El- Hawary, 2007; Greuning and Iqbal, 2008)

WEAKNESSES

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• “…Although IBs have illustrated a degree of resilience and stability, they have been impacted by the crisis because of their higher exposure to real estate and their limited reliance on risk sharing or equity based transactions…” Source: Shamshad Akhtar (2009), Speech during the “Symposium on Islamic Finance in Roma: Developments in MENA region”, Bank Italia, Rome, Italy, November, 11th, 2009)


3. Islamic Banking > 3.4. Resilience to the global crisis

© 2012 INCEIF

• Hasan and Dridi (2010) “The effects of the global crisis on Islamic and conventional banks: A comparative study, “ IMF WP 10/201 analyse the effects of the crisis on profitability, credit growth, asset growth and external ratings of 120 Islamic and conventional banks in 8 countries.

IBs’ showed stronger resilience in the early stages of the crisis. However, as the crisis moved to the real economy in 2009, IBs’ profitability has steeply declined relatively to the CBs.

IBs contributed to financial and economic stability during the crisis, given that their credit and asset growth was at least twice as high as that of CBs.


© 2012 INCEIF

• Bourkhis and Nabi (2013) "Islamic and conventional banks' soundness during the 2007–2008 financial crisis," Review of Financial Economics. analyse the effects of the crisis on a set of financial soundness indicators (FSIs) related to banks‘ earnings and profitability, capitalization, asset quality, efficiency, liquidity and financial stability using a matched sample of 34 IBs and 34 CBs from the 16 countries covered on the period 1998–2009.

IBs outperformed CBs in regards to the return on average assets (ROAA)

during and after the financial crisis. ..partially due to differences in the provisioning strategies during the crisis : CBs increased their Loan Loss Provision (LLPs) during 2007–2008 in response to the increase of their Non Profit Loans (NPLs). However, IBs increased their LLPs only in 2009 although their NPLs increased in 2007–2008 similarly to their conventional peers.

Considering the impact of the financial crisis on the banking soundness (measured by the Z-score and capital to asset ratio) we find no significant difference between IBs and CBs. However, there is some evidence that IBs were in average more sound (in regards of the Z-score).


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63



2006-2

008

•Beck, Demirgüç-Kunt and Merrouche (2013) "Islamic vs. conventional banking: Business model, efficiency and stability", Journal of Banking and Finance

Less likely to disintermediate during crises.

Better stock performance of listed Islamic banks during the recent crisis due to their higher capitalization and better asset quality.

3. Islamic Banking > 3.5. High potential of growth - Case of Indonesia

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Banking Asset Penetration (% of Nominal GDP) and

Islamic Banking Market Share of Total Assets (%) in 2010

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3. Islamic Banking > 3.5. High potential of growth - Case of Tunisia

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3. Islamic Banking > 3.5. High potential of growth - Case of Tunisia

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3. Islamic Banking > 3.5. High potential of growth - Case of Turkey

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3. Islamic Banking > 3.5. High potential of growth - Case of Morocco

Source: IFAAS Survey 2012

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WSBI/ESBG (World Savings Banks

Institute/European Savings Banks Group)

3. Islamic Banking > 3.5. High potential of growth - Europe

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Misconception against Islamic Banking

• Islamic Banking is only for Muslims, is not profitable because no interest is charged, is only offered in the Middle East, etc.

Increase financial inclusiveness (retail and corporate levels)

Moving towards equity-based financing

• New set of technical and risk management capabilities i.e. industry experts, know-how.

• Institutional development (Supervisory and prudential regulatory framework, Accounting and auditing standards, credit bureau, judicial procedure, etc.)

• Balance sheet size and economies of scale.

Innovating in products and services to meet the customer needs and expectations in presence of fierce Competition.

3. Islamic Banking > 3.6. Main challenges

4. Successful Islamic Finance Experiences

and prospects in Africa

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Malaysian experience

4. Successful Islamic Finance Experiences and prospects in Africa

• Over the last decade, Malaysia has implemented important reforms in the Islamic finance industry to favor its development

• Dr. Mohamad Akram Laldin: The Malaysian Islamic financial sector is seen as one of the most progressive and attractive in the world given the numerous incentives planned and further liberation in the coming years.”

Source: Mohamad Akram Laldin (2013) "Proposed Suitable Islamic Financial Instruments for Central Asia Countries", Presentation during the Annual Meeting of IDB, May 2013 - Dushanbe - Tajikistan

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• Sovereign Sukuk for infrastructure development


Country Sector Structure Size

Australia - SGI-Mitabu

(pipeline) Solar energy

Ijara (first 20 years) then

Musharaka A$ 550

Saudi - GACA Airport Murabaha SAR 15 billion

Malaysia - Syarikat Prasarana

Negara Bhd

Transportation &

Railways Possibly Istisnaa RM 1 billion

Sukuk / Example of recent project finance Sukuk issued and announced

Source: Zawya


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The Microfinance Development Program (MDP) of IDB

The MDP aims to increase outreach of microfinance to reduce poverty through the development of Islamic Microfinance industry:

o Financial and Technical interventions designed to address the wide ranging microfinance needs in member countries.

o Leverages resources and partners with established Microfinance organizations – such as Grameen, BRAC, AGFUND and agencies such

as DFID (UK), and GIZ.

Example of initiatives of the MDP:

o Rice growing, harvesting and local marketing: Indonesia, Pakistan

o Cotton and Livestock (Cows and goats): Pakistan

o Herbal tea growing, exotic vegetables and fruits growing in greenhouses harvesting, packaging and marketing, local marketing and export: Sudan

o Olive orchards to oil mill: Palestine

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50.5% 50.0% 68.8%

40% 60%

100.0%

IDB role in fostering and Developing Islamic Banks in Africa

• ICD in partnership with Bank Asya has created Tamweel Africa a holding company that invests in and manages a portfolio of four Islamic banks: Senegal, Niger, Mauritania and Guinea.

USD 33m

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• IDB is a shareholder of Jaiz Bank Plc. the first Non-Interest Bank in Nigeria which begun full operations as the first Non-Interest Bank in Nigeria on the 6th of January, 2012 with 3 branches located in Abuja FCT, Kaduna and Kano.

--------------------------------------------------------------------------------------------------------- • Gulf African Bank (GAB) one of only two fully fledged Islamic banks

in Kenya. registered 154% after-tax profit growth to Sh242 million for the year ended December 31 compared to Sh95 million registered in similar period in 2011. ROE increased from 7.2% in 2011 to 15.5% in 2012 while ROA rose to 1.8% compared to 0.7% in 2011. (Source: "Islamic banks break even and post growth in profit," nation.co.ke).

• GAB obtained US$5million equity investment from IFC to favor the growth of its SME and Corporate lending business. Further US$3 million trade line will be made available by IFC to the Bank… (Source: IFC website).

5. Way forward for African countries

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• Establishing a ten-years national strategy for the development of the Islamic Financial Services Industry (Tax regime and regulatory framework, capacity building, awareness, international cooperation,…)

• Establishing a short/medium term strategy focusing on the development of voluntary sector (Zaqat/ Awqaf/ Islamic Microfinance)

• Further Enhancement of the Business Environment to stimulate FDI in the Islamic financial services

• Develop infrastructure (Transport, energy, telecoms, health and sanitation) and use sukuk as one of the financing instruments

5. Way forward for the African countries

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Example: Developing the enabling environment for Mobile-banking (which will serve also the expansion of Islamic financial services)


…This Brief discusses the increasing importance of mobile money services, associated regulation of the sector and the actions needed to create an enabling environment for these services to continue growing in Africa as mechanisms for social inclusion and poverty reduction.

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Example: Developing the enabling environment for Mobile-banking (which will serve also the expansion of Islamic Microfinance financial services)


Thank you

[email protected]

[email protected]

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©2013 Islamic Research and Training Institute - www.irti.org

All rights reserved.

This work is a product of his author (staff of IDB Group). The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of IRTI-IDB.

IRTI and IDB do not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of IRTI-IDB concerning the legal status of any territory or the endorsement or acceptance of such boundaries.

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Islamic Development Bank Group www.isdb.org

Snapshot

IDB Scorecard

Total Assets : US$ 13.79 bn

Authorised Capital : US$ 150 bn

Paid-up Capital : US$ 6.10 bn

Rated : Aaa/AAA/AAA

Member Countries : 56

Africa – 22 Middle-East & North-Africa – 19

South & South-East Asia – 8 Central Asia –7

Total Employees : 1,014

• Head Quarter: Jeddah, Kingdom of Saudi Arabia

• Regional Offices: Kazakhstan, Malaysia, Morocco and Senegal

• Field Representatives in several Member Countries

• AAA Rating by Moody’s, Fitch, and S&P. Zero-Risk Rating by the European Commission

“To promote comprehensive human development, with a focus on the priority areas of alleviating poverty, improving health, promoting education, improving governance and prospering the people.”

• Human Development

• Agricultural Development & Food Security

• Infrastructure Development

Mission Statement

Priority Areas

• Private Sector Development

• Intra-Trade among Member Countries

• R&D in Islamic Banking & Finance

86

Islamic Research and Training Institute www.irti.org

• Islamic Research and Training Institute (IRTI) was established in 1981.

• The purpose of the organization is to develop and advance the Islamic

Financial Industry through Research, Training, Advisory and Information

• The name IRTI is now synonym with Islamic Finance, Islamic Economics and Islamic Banking.

Functions

Undertake research for enabling the economic, financial and banking activities in Member countries to conform to Islamic Shariah

Provide advice, consultancy and technical assistance in Islamic Banking and Finance to IDB Group Members, to the Bank’s Member Countries and to third parties

Develop curricula and course material to disseminate research and policy findings in different fields, and organize seminars, workshops and training programmes for IDB member ‎countries

Develop, update and maintain information systems and databases in Islamic Banking and Finance, and disseminate them through all modern media

islamic finance: an overview

Economy & Finance

mohamad akram laldin

abu saiid al

fiqhi evidence vis

country zak ah

islamic banking gt

islamic economic studies

islamic finance gt

residential development project