16th WBD Executive Session IBF

Islamic Finance as an Alternative Banking Business Model Executive Session – 16th World Business Dialogue

Kevin Gilhawley

130314_WBD_IBF_v01.pptx 16th World Business Dialogue

Why should you care about Islamic Finance?

1

1 2 3 Market Size and Growth Rate

Business Opportunities Need for Change in the Financial System

16th World Business Dialogue 130314_WBD_IBF_v01.pptx

Market Overview

Islamic Finance Fundamentals

Comparison to Conventional Finance

Case Studies

Islamic Finance as an Alternative System

Discussion

2

130314_WBD_IBF_v01.pptx 16th World Business Dialogue 3

Islamic Finance has received positive comments from influential individuals in the last decade

„The rapidly growing Islamic Finance sector contributes

significantly to a broadening of our funding-structure“

Dr. Josef Ackermann, Former CEO Deutsche Bank

„We need to make Britain the global centre for Islamic

finance to participate in the industry’s promising future“

Gordon Brown, Former Prime Minister of the United

Kingdom

“The ethical principles on which Islamic finance is based

may bring banks closer to their clients and to the true

spirit which should mark every financial service”

Benedict XVI

1 Market Overview


More than one quarter of the world population are Muslims

Share of Muslims in % of Population

<5 5-14 15-49 50-89 90-100

1 Market Overview

Source: Booz & Company Analysis

Global Estimated Muslim Populations – Selective Markets (2010)


Malaysia

Bank Islam Malaysia Berhad

Bank Muamalat

Asian Finance Bank (January 2007)

KFH Malaysia (February 2006)

Al Rajhi Bank Malaysia (October 2006)

The penetration of Islamic banking is growing on the back of a number of new institutions in traditional markets

Saudi Arabia

Al Rajhi Bank

Bank Al Jazira

Bank Al Bilad (2006)

Bank Al Inma (October 2008)

Bahrain

Bahrain Islamic Bank

Shamil Bank

Khaleeji Commercial Bank

Al Baraka Islamic Bank

Al Salam Bank (April 2006)

Al Masref Bank (March 2006)

Note (*) Conversions of conventional banks to Islamic banks

Source: Central Banks, The Banker, Islamic Business and Finance Network, Islamic Development Bank

UAE

Dubai Islamic Bank

Abu Dhabi Islamic Bank

National Bank of Sharjah

Emirates Islamic Bank

Sharjah Islamic Bank*

Dubai Bank*

Noor Islamic Bank (January 2008)

Al Hilal Bank (June 2008)

Ajman Bank (June 2008)

Syria

Syria International Islamic Bank (September 2007)

Cham Bank (October 2006)

Albaraka Bank Syria (January 2008)

Kuwait

Kuwait Finance House

Kuwait International Bank*

Boubyan Bank (January 2006)

Warba Bank (March 2010)

Qatar

Qatar Islamic Bank

Qatar International Islamic Bank

Masraf Al Rayan (October 2006)

Barwa Bank (June 2007)

Indonesia

Bank Syariah Mandiri

PT Bank Muamalat Indonesia

UUS BNI Syariah

PT Bank Syariah Mega Indonesia

PT BRI Syariah (2008)

PT Bukopin Syariah (2008)

1 Market Overview

Selected Islamic Banks (excluding Banks with Islamic windows)


We‘ve experienced some Islamic banking activity in Europe, but everybody is still waiting for the major breakthrough

Germany

First institutional transactions

Limited retail offering

United Kingdom

5 Islamic Banks – only one with focus on retail banking (Islamic Bank of Britain)

High Street Banks setting up Islamic Windows

Austria

Islamic Banking-Concepts in development

Switzerland

Numerous Islamic Wealth Management-Offerings On- and Offshore

Luxembourg

Popular location for Islamic investment funds due to regulatory adjustments

France

Expected market entry of several Islamic Banks Turkey

Currently four purely Islamic Banks (Participation Banks), mostly founded by Arab banks

Islamic Banking in Europe

1 Market Overview


Especially Swiss Banks recognized the potential of Islamic Finance and strengthend their position in the GCC-countries

GCC (Saudi-Arabia, United Arab Emirates Kuwait, Qatar, Bahrain, Oman)

Indonesia, Malaysia, Singapur

Lebanon

1 Market Overview


Swiss banks in Muslim countries (Onshore)


1.00

0.87

0.75

0.55

0.400.370.330.310.280.260.230.160.14

2010E 2008E 2006 2004 2002 2000 1998

105.3101.198.690.8

77.565.563.2

56.047.4

41.541.840.840.1

2010E 2008E 2006 2004 2002 2000 1998

* Estimated based on publicly available data and forecast; years for which no data was available have been extrapolated based on the average growth rate for the period Source: Council for Islamic Banks, Press Releases, Standard & Poor’s, Economist Intelligence Unit; Booz & Company analysis

Worldwide banking assets USD trillion

Worldwide Islamic banking assets* USD trillion

Islamic Banks’ Market Share 2008 vs. 2003

4.0%

9.0%

14.0%

16.0%

34.5%

38.0%

0.7%

4.0%

9.0%

9.0%

21.0%

16.0%

Indonesia

Bahrain

Malaysia

UAE

KSA

Kuwait

2003

2009

CAGR 9.5%

CAGR 5.1%

CAGR 16.4%

CAGR 22.1%

Islamic Finance grows at a higher pace than conventional finance and continually gains more market share

1 Market Overview


Market Overview



Case Studies


Discussion

9


Introducing Islamic Banking and Finance

EXAMPLE

4 Case Studies

http://www.youtube.com/v/M7kiLLlwbuQ


Islamic Finance describes financial services which are conducted according to Islamic Law

Prohibition of Usury Prohibition of Speculation Prohibition of Gambling Shari’ah Board

2 Islamic Finance Fundamentals

ي “The trade of the petty usurer is hated with most reason: it makes a profit from currency itself, instead of making it from the process which currency was meant to serve.”

Shari’ah-Restrictions for Financial Services

Aristotle


In Islam activities can be classified as haram (prohibited) or halal (lawful)

12


Haram Halal

Permissibility of Things in Islam


Islamic principles embrace risk sharing and have a strong focus on productive activities

Overarching principles founded in Shari’ah objectives aiming at the protection of individuals’ personal and religious rights, upholding of high ethical standards and higher equality of wealth distribution

Transaction requirements

ي Underlying activities based in real economy

ي Actual trade or business activities (not pro-forma)

ي No speculative transactions

ي No interest-based deals

ي No business involving illegal or unethical activities not complying with Shari’ah

Risk sharing requirements

ي Earning of legitimate profits requires sharing of risks as well (e.g. in Mudaraba or Musharaka structures)

ي Not only form, but substance of contract have to be honoured at all times

Source: Islamic Finance and Global Financial Stability Report (April 2010), Booz & Company analysis

ي Shari’ah law do not allow the detachment of the financial sector from productive activities, thus Islamic assets can be expected to grow in line with real economy and usage of excessive leverage is avoided

ي Speculation is forbidden and excessive risk taking is discouraged by the risk sharing nature of many contracts

ي Upholding of Shari’ah principles reduces risk of financial unrest and promotes stability


Key Principles of Islamic Finance


Fee Based Services Equity

Participatory profit and risk sharing contract structures play a key role for the generation of funds in Islamic banks

Assets Liabilities

Asset-backed Transactions

Current / Demand Deposits

Profit Sharing Transactions

Inventory

Unrestricted Investment Accounts

Restricted Investment Accounts

Profit Equalization Reserves

Similar to conventional loans, however, legal positions of both parties based on different contract forms

Murabaha (cost plus) Ijara (leasing) Istisna’ (manufacture) Salam (forward delivery)

Investor - Entrepreneur relationship between bank and client

Mudaraba (profit sharing, loss bearing)

Musharaka (profit and loss sharing) Building of reserves for

losses on profit and loss sharing accounts as prudential measure

Similar to fixed deposits, but returns to depositors are set as a fixed ratio of returns earned on the asset side, while losses are borne by the client alone

Mudarabah (profit sharing, loss bearing)

Mudarabah (profit sharing, loss bearing)

Wadiah (Safe custody) / Ward (loan)

Real estate Automobiles


ILLUSTRATIVE


Financing Structure of Islamic Banks


Market Overview



Case Studies


Discussion

15


There are significant differences between Islamic Finance and conventional Finance

3 Comparison to Conventional Finance

ي No explicit values associated

ي Strong emphasis on debt financing

ي Sophisticated product offering

ي Making money from money is possible

ي Risk is shifted/transferred to the client

ي Normative banking system

ي Strong emphasis on equity financing

ي Basic banking service offering

ي Transactions must be tied to real assets

ي Risk is shared between bank and client

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Conventional Banking Islamic Banking


The global financial crisis has its roots in a dangerous mixture of developments in the conventional banking system

Origins of Financial Crisis

Misaligned Incentive Structures

Uncontrolled Financial

Innovations

Erosion of Prudency


ي Looser underwriting and risk management standards allowed in exchange for short-term gains

ي Uncritical and passive regulators interfering too late too little to prevent crisis

ي Short-term profits as sole rewarded goal

ي No consideration for other stakeholders’ objectives build into compensation schemes

ي No regard for system stability encouraged

ي Increasingly complex financial engineering techniques employed

ي Risks separated from actual underlyings

ي Encouraged excessive lending and risk taking

ي Development was not accompanied by similar advances in governance processes and risk management



Islamic banks have proven more resilient during the financial crisis than conventional banks..

24%36%

-136%

-43%

36%55%

9%

-9%

Change in market

capitalization

Change in net profits

Change in assets

Change in equity

Islamic

Conventional

18.2x16.6x

6.6x5.8x

2008 2006

Key Financial Indicators Performance of Top10 Conventional vs. Top10 Islamic Banks during Crisis

Leverage Ratio

Top10 Conventional vs. Top10 Islamic Banks

Explanations for Superior Performance

Shari’ah principles as outlined above require, among other things, prudency due to risk sharing, prohibit speculation and limit risks through close links to real economy

Particularly, conventional derivative instruments, a main facilitator for the emergence of the crisis, are banned entirely

Significantly lower leverage ratios reflect this lower risk appetite and more conservative business practices of Islamic banks




..Islamic equity markets have also survived the financial crisis better than conventional indexes

Shari’ah Restrictions

Capital investment and financing restrictions

ي General prohibition of interest (riba), gambling (maisir) and uncertainty (gharar)

ي Restrictions for capital investments in and financing of certain industries, e.g.:

ي Alcohol fabrication and distribution

ي Casinos and hotels (if alcohol is served)

ي Banks and insurance companies

ي Tobacco industry, etc.

Compliance with key financial ratios

ي Investments in businesses that have bonded capital or cash + interest bearing bonded capital of more than 33% of the market value of the equity are prohibited

ي Accounts payable are not allowed to cross 49% of the market value of the equity

ي Revenues from prohibited industries have to be less than 5%

Performance-Comparison Total Market vs. Shari‘ah-Compliant Index

Source: S&P, Dow Jones, Bloomberg, Booz & Company Analysis

Shari‘ah compliant investments significantly outperformed

conventional ones due to Shari‘ah restrictions

Beginning of Financial Crisis Performance

(indexed)



Market Overview



Case Studies


Discussion

20


A typical example for an Islamic financial product is a car financing according to the so-called Murabahah concept

Islamic Bank

Purchaser

Transfer of Ownership Purchasing price

Purchasing price plus profit margin

1 2

Vendor

EXAMPLE

4 Case Studies

Source: Gassner/Wackerbeck, Islamic Finance 2007

Murabahah-Structure


Islamic Mortgage Financing via co-ownership has been copied by conventional financial instituitions

EXAMPLE

4 Case Studies

http://www.youtube.com/v/SmROuXO4lD0


Many companies in the GCC countries finance themselves increasingly Shari‘ah-compliant Islamic bonds

Transaction Details Rationale

ي 265 Mio. USD for financing two new Boeing 777-300 ER airplanes

ي Shari’ah-compliant Leasing over 12 years

Financing Objects

ي The Emirates-Management decided to use Islamic Finance as a strategic source of financing to help finance the company‘s growth plan

ي In total Emirates have already taken over 1.3bn USD in Shari‘ah-compliant loans

ي In 2005 Emirates took a 550 Mio. USD loan for the construction of their new headquarters

ي Financing via Islamic bond (Sukuk) based on a Musharakah-Structure

EXAMPLE

Nice to know: The German Federal Land Sachsen-Anhalt was 2005 the first western issuer of an Islamic bond (Sukuk)

4 Case Studies

Islamic Finance-Strategie Emirates Airlines


Market Overview



Case Studies


Discussion

24


The Islamic Finance Industry still has many obstacles to overcome

25

5 Islamic Finance as an Alternative System

ي Lack of Standardization

ي Lack of Human Capital

ي Lack of Money Market Instruments

ي Lack of Awareness and Trust

ي Lack of Economies of Scale

ي Lack of Shari‘ah Scholars

Growth Constraints in Islamic Finance


The availability of Shari’ah scholars is one of the most significant bottlenecks in Islamic Finance

Informal Standardization of Shari’ah Standards

Rank Scholar Board

Memberships

1 Shaikh Nizam Mohammed Saleh Yaquby 77

2 Shaikh Dr. Abdul Satar Abdul Karim Abu Ghuddah 72

3 Dr. Mohammed Eid Elgari 64

4 Sheikh AbdullahSulaiman Al Manee’a 37

4 Dr. Abdulaziz Khalifa Al Qassar 37

Board Memberships of Top 5 Scholars GCC Network Analysis of Top 15 Scholars’ Board Memberships

ي Top 5 out of 176 scholars in the GCC are members in almost a third (30.1%) of entire universe of ~956 GCC Board positions

ي Top 6 scholars in Kuwait (out of 45) make 48.3% of all (226) Board positions - local Boards dominated by local scholars

Source: Funds@work, Booz & Company analysis



I believe a number of factors are likely to fuel the growth of Islamic banking going forward


Financial Inclusion

Demand/ Wealth Islamic

Movements LOHA

Innovation Demografic

Change

Key Drivers for Growth in Islamic Finance


A great example for innovative business models in Islamic Finance is the Kuwait Finance House (1/2)


Car Sale in the Kuwait Finance House


A great example for innovative business models in Islamic Finance is the Kuwait Finance House (2/2)

Positioning of Car Sale Islamic Banking and Takaful-Services

Advisory Offices Murabahah-Boxes and Sales Offices

Insurance Counter Cash Register



Market Overview



Case Studies


Discussion

30


Do you think Religion and Finance should be strictly separated?

31

+


Which is the right approach: Trying to prevent financial crises with regulatory measures or by promoting ethical behavior?

32

vs.


What do you think about Dr. Tomáš Sedláček’s argument? Is Islamic Finance a possible solution?

33

„Our problem is not lack of growth but too much of it “

Dr. Tomáš Sedláček, Chief Macroeconomic Strategist


Could Islamic Banking be the next generation of Socially Responsible Investments?

34


What role does sustainable economic growth in the MENA region play for the future of Islamic Finance?

35


Islamic Banking – Backward Banking or Next Generation Business Strategy?

36

or


Wrap-Up

37


List of other student conferences

ي South American Business Forum (SABF) The SABF is an event that takes place annually in Buenos Aires for 3 days in the month of August. Each year the forum invites 100 outstanding university students from around the globe together with 40 leaders in business, politics and academics.

ي Harvard Project for Asian & International Relations (HPAIR) Harvard’s largest annual student connection in Asia: The Harvard Project for Asian and International Relations creates a forum of exchange and facilitates discussion of the most important economic, political, and social issues relevant to the Asia-Pacific region. Applications are closed for 2012.

ي Kairos Global Summit 2013 The Kairos Global Summit in partnership with the United Nations and New York Stock Exchange, brings together 350 innovative and entrepreneurial students from around the world to meet 150 of today’s influential leaders.

ي St. Gallen Symposium The St. Gallen Symposium aims to foster the intergenerational and intercultural dialogue between the Leaders of Today and the Leaders of Tomorrow. The 43rd symposium will take place from 2nd–3rd May 2013 at the University of St. Gallen.

ي International Development Conference at Harvard 2013 A yearly student-organized conference dedicated to fostering a constructive dialogue between leading academics, practitioners, policy makers and students, concerned with creating a better world. Applications will open at the end of the year.

ي United Nations International Student Conference Amsterdam 2012 (UNISCA) UNISCA is a Model United Nations (MUN) organised by the University of Amsterdam. It is a program which consists of a two week long summer course, in which a simulation of an United Nations Conference takes place.

ي 24th International Youth Leadership Conference The one week-long youth forum on world politics, international relations and justice will take place in Prague. It gives you an opportunity to test your leadership skills, debate current issues, deliver speeches, draft resolutions, make executive decisions, and experience the complexities of international relations.

ي International Youth Forum Seliger 2012 1,000 young leaders meet in Russia to build an international youth community based on the principles of peaceful coexistence, the promotion of personal and democratic liberties and recognition cultural diversity. Applications are closed for 2012.

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Kevin Gilhawley about.me/kevingilhawley Private: [email protected] Aiducation: [email protected] zig: [email protected]

About : Kevin Gilhawley is currently interning at the strategy consulting firm Booz & Co. He holds a Bachelor‘s degree in banking and finance from the University of Zurich. After having worked in the wealth management division of UBS for a few years, he held different part-time positions in the financial industry. Kevin is also active as a volunteer in sales development in the for-impact organization Aiducation. In addition, he co-founded the time-sharing platform ZIG in 2012. Kevin’s research focus is on responsibility in finance and Islamic Finance. He gained first practical experience in Islamic Banking while working with clients from the GCC countries at UBS. Going forward he is going to intern at Credit Suisse’s IBD and complete his Master‘s degree in Finance at the London School of Economics thereafter.

Contact Information

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16th WBD Executive Session IBF