THE PROSPECT OF ISLAMIC FINANCE IN THE PHILIPPINES

MEHOL K. SADAINCommissioner

NCMF

February 9, 2015

Definition of Terms

• Finance is the science or study ofmanagement of funds; the system thatincludes the circulation of money, the grantingof credit, the making of investments, and theprovision of banking facilities.

• Economics is the analysis and description ofthe production, distribution and consumptionof goods and services.

[Webster’s Ninth Collegiate Dictionary]

What is Islamic Finance?

“Islamic finance is based on the principle that theprovider of capital and the user of capital should equallyshare the risks of business ventures. It encouragessanctity of contracts, sharing of risks, prohibition ofinterest and speculative trading, and gambling. Islamictheories of finance encourage earnings throughparticipation in business activities, and discourage theavenues of unearned income.”

[Salahuddin Ahmed. Islamic Banking, Finance and Insurance, 2006]

ISLAMICINVESTMENT

ISLAMICBANKING

ISLAMIC INSURANCE

THE ISLAMIC FINANCE TRIUMVIRATE

Distinguishing Feature of Islamic Finance

• The most obvious, says Mahmoud El-Gamal, is the“central importance of Islamicity certification (alsocalled Shari’ah compliance) of the various contracts.[from Islamic Finance: Law, Economics and Practice, 2006]

• Islamic Finance is a value-based financial system andbrings to fore the importance of Islamic businessethics.

“Give full measure when you measure and weigh with a

balance that is straight: that is the most fitting and mostadvantageous in the final determination.” [17:35]

From “Working with Islamic Finance”by Marc L. Ross

• Islamic finance refers to the means by which corporations in the Muslim world, including banks and other lending institutions, raise capital in accordance with Shari’a… A unique form of socially responsible investment, Islam makes no division between the spiritual and the secular…

• Although mandated since the beginning of Islam, Islamic banking and finance have been formalized gradually in the late 60s coincident with and in response to the tremendous oil wealth which fueled renewed interest in and demand for Shari’a compliant products and practice.

Modes of Islamic Finance

• MUDARABAH (Profit Sharing or Trust Financing)

• MUSHARAKAH (Partnership Financing)

• MURABAHA (Mark-Up Financing/Credit Sale)

• IJARA (Leasing)

• ISTISNAA’ (Manufacturing Contract)

• ISLAMIC SECURITIZATION (Sukuk/Shari’ah Compliant Securites/Bonds)

• QARD HASAN (Benevolent Loan)

Mudarabah or Profit Sharing/Trust Financing

• 100 percent capital from one party and 100 percentmanagement/labor from the other party

• Mudarib manages without interference by capitalist,except in the monitoring aspect

• Financial loss borne by capitalist/investor

• Does not provide guaranteed amount as return

• Prophet Muhammad (SAW) was a mudarib for thecapital provided by Khadijah who later became hiswife.

Musharakah or Partnership Financing

• A joint enterprise or partnership with profit-loss sharing implications that is used in Islamic finance instead of interest-bearing loans. [investopedia.com]

• Partnership to carry out specific project, usually for a limited period

• All parties contribute to financing and profits and losses are shared according to equity [S.

Ahmed]

Murabaha or Credit Sale

• A popular financing product in the nature of a contract of sale, where an intermediary (usually the bank or creditor) buys a property, and then the intermediary and prospective buyer agree upon a sale price (with an agreed profit for the intermediary), and payment is made through installments or by lump sum payment.

• In short, the bank purchases goods on behalf of clients and later sells them at a marked up price

• Murabaha is not an interest-bearing loan, but an acceptable form of credit sale where the financier retains ownership of property until the loan is paid in full.

Ijara or Lease

• Ijara means to give something on rent. The client selects the asset to be financed by the financial institution, and the financial institution purchases the asset and leases it to the client for a fixed period.

• Applies to costly assets or things, which the borrower cannot afford. The bank buys the asset and leases it to the borrower for monthly payments totalling cost of purchase plus profit.

Istisna or Manufacturing Contract

• A pre-production financing tool where a manufacturer is ordered to produce a specific commodity

• Price and specifications are fixed

• Payment is usually deferred

• In Istisna the subject matter is always something that needs to be manufactured, in salam, it is anything that can be specified

• In Istisna, the manufacturer obtains the material and does the work to produce the item, in Ijarah, the customer provides the material and the manufacturer employs labor and skill only.

• Istisna is for manufactured good and labor to manufacture it, while ju’ala is for labor only or for a specific work.

Islamic Securitization

• Done by converting illiquid assets into marketable securities, and is an ideal financing tool for emerging markets (Sukuk)

• Securitization has to be Shari’ah compliant

• Shari’ah compliance for stocks/bonds is based on: Business activity must not be prohibited in Islam [Prohibited income screen]

If prohibited activity is but a part of the business, its total revenue from suchprohibited business must not exceed 5% [sum of interest earned and revenuedivided by total income]

Financial ratio-based screen: Total cash, deposits and receivables divided byimmediately preceding 12-month average total market capitalization cannotexceed 70% [avoidance of gharar], and total cash, deposits and interest-bearingsecurities divided by the immediately preceding 12 month average total marketcapitalization cannot exceed 33% [avoidance of riba].

Dividend Purification – investor gives in charity the portion of income deemedimpure.

Qard Hasan

• Means “Good Loan” and is based on the Qur’anic verse which says: “If you lend to ALLAH a good loan, He will multiply it for you.” [64:17]

• An interest-free loan for financing welfare projects or fulfilling short-term requirements. Borrower only pays the principal amount, but he may pay an additional amount, as a token of appreciation, if he may so desire.

Islamic Banking

• A banking system that is based on the principles ofIslamic law and guided by Islamic economics. Twobasic principles behind Islamic banking are thesharing of profit and loss, and the prohibition ofpayment of interest.

• All undertakings of the Islamic bank follow Islamicmorals or Islamic business ethics, making it a form ofethical investing. [investopedia.com]

Islamic Banking in the Philippines

• In the Philippines we have the Al Amanah Islamic Investment Bank of the Philippines created under R.A. 6848 which repealed P.D. 264 as amended by P.D. 542 (Creating the Philippine Amanah Bank)

• The AAIIB is mandated to accept investment account placements and invest the same in Islamically permissible transactions on participation basis [Sec. 6 (7.c). R.A. 6848]

• It can also undertake various investments in all transactions allowed by Islamic Shari’a is such a way that shall not permit the haram (forbidden) nor forbid the halal (permissible). [Sec. 6 (7.l)]

• It can likewise carry out financing and joint investment operations by way of mudarabah partnership, musharaka joint venture … murabaha purchasing for others on a cost-plus financing arrangement, and to invest funds directly in various projects whose owners desire to invest jointly with other resources of the bank, on a joint mudarabah.

Islamic Insurance

• Islamic insurance or Takaful according to thewebsite Investopedia is “a type of Islamicinsurance where members contribute moneyinto a pooling system in order to guaranteeeach other againt loss or damage.

• Takaful is an alternative to commercialinsurance, and goes against riba (interest), al-maisir (gambling) and al-gharar (uncertainty)

The Shari’ah Advisory Council

• There is a need for a National Shari’ah Advisory Council to, among others, formulate fatwa on questions and issues in Islamic finance.

• The Shari’a Advisory Council is also mentioned in R.A. 6848 [Sec. 4] as composed of five (5) members selected from among Islamic scholars and jurists of comparative law “to offer advice and undertake reviews pertaining to the application of the principles and rulings of the Islamic Shari’a to the Islamic Bank’s transactions, but it shall not directly involve itself in the operations of the bank”.

Strides in Philippine Shari’ah Compliant Bonds

• There are now more than sixty (60) Shari’ah compliant bonds being traded in the Philippine Stocks Exchange.

• The evaluation is being done by IdealRatings which offers services in Shari’ah screening, purification, fund and index management, and identify and manage Shari’ah compliant equities, funds and sukuk.

The Need for Market Regulations

• The need for local laws on Islamic Banking or Islamic Finance in general

• “You are the best of peoples, evolved from mankind, enjoining what is right and forbidding what is wrong and believing in ALLAH.” [3:110]

• Hisbah (Morality, Ethics and Accountability in Enjoining Right and Forbidding Wrong)

Rabbi zidhnee ‘ilma

As-salaamu alaikum