Islamic Banking - NewHorizon 181 NewHorizon 27/09/2011 …data.islamic-banking.com/NH/PDF/181.pdfEmail: [email protected] CONTACT Advertising Institute Of Islamic Banking and

GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 181OCTOBER–DECEMBER 2011

DHU AL QADDAH 1432 – MUHARRAM 1433

FOOD FOR THOUGHT:WHAT DOES THE FUTUREHOLD FOR ISLAMICASSET MANAGEMENT?

COUNTRY FOCUS:ISLAMIC FINANCE INWEST AFRICA GETS AMIXED RESPONSE

ACADEMIC ARTICLE:REVISITING THEFUNDAMENTALS OFTAKAFUL

ANALYSIS:SHARI’AH GOVERNANCEFOR ISLAMIC FINANCIALINSTITUTIONS

REGULATORY ISSUES:DOES BASEL III REALLYAPPLY TO ISLAMICBANKING?

PUBLISHED SINCE 1991NEWHORIZON

NewHorizon 181_NewHorizon 27/09/2011 11:38 Page 1

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SMART ORDER ROUT

ING -

STILL A LONG WAY

TO GO

Huw Jones, Reuters Cor

respondent

Scratch beneath th

e SMO surface inEurope

and you quickly realise

all is notquite wha

t

it seems.

“You havea feeling that SMO

is everywhere,

but in reality there

are a lot of places t

hat

have notengaged

with it,” said Bradley

Duke, managing director o

f Knight Direct,

Knight’s institution

al direct access and

algorithmic trading

offering.

“Brokersneed to be see

n to be offering

SMO with the result that

some offerings are

poor or underdeve

loped and more likea

‘box-ticking exercise’,

” Duke said.

Good SMO systems are not che

ap and so

many brokers are r

enting an SMO service

from one of thebig banks like

Goldman, a

useful moneyspinne

r for them.

Also, partof the pro

blem is regulatory.

Under MiFID, a broker only

has to inform its

customerwhich tra

ding venues itwill use

and this can be just one

, the localexchange

.

Comparethis with t

he UnitedStates wh

ere

smart order routing

has led to ferocious

competition becau

se there is a legal d

uty to

pass on an order to

another venue if it

offers a better price

, thus forcing brokers to

have access to all trading

venues.

A tape thatconsolida

tes shareprices fro

m

every trading venue in

the United States

also reinforcesthe impac

t of SMO, but

Europe currently ha

s no consolidated tape.

And there aretoo many inc

entives for big

banks tomatch tra

des in-house and

bypass external tra

ding venues. Both these

issues arebeing scrutinise

d by regulators

as part ofa MiFID review in 2010. T

his may

lead to changesthat will a

llow SMO to play

a greaterrole.

But, in the meantim

e, Chi-X,BATS Europe

and others continue to

build up volume.

Brokers will find it harder t

o stick witha

best execution poli

cy that excludes th

ese

new trading venues, especially

as

exchanges no longer ac

count forthe

overwhelming majority o

f trading in some

blue chips. Greate

r competition amon

g

vendors of SMO systems i

s also cutting

link-up costs forbrokers.

Some retail corner

s of the market will

be

harder toconvert to

SMO. In theUnited

States, powerful ret

ail brokers like

Smart order routing

, it was promised,

would

link investors to a string of new trading

venues, drive down

tariffs, narrow spreads

and increase volume. Th

is surely would be

the perfect mechan

ism to make Europe’s

MiFID deregulation of sha

re tradingwork on

the ground. If a ma

jor boursewere to break

down, other share t

rading platformscould

pick up the baton.

Late last year, howe

ver, a trading suspe

nsion

at the London Stoc

k Exchange reveal

ed

that thereis some w

ay to go before smart

order routing (SMO) in com

bination with

MiFID makes this possibl

e.

SMO has helped Chi-X to become o

ne of

Europe’sbiggest s

hare trading platforms

.

Its growthis testimo

ny to the power of a

technology which h

as already helped

changedthe face o

f US trading.

Two things hindered the Londo

n market

carrying on whenthe LSE was susp

ended

for threehours. When the s

ystem went

down theexchange

was put into auction

phase, amove wh

ich SMO experts say

confusedthe marke

t.

“It is inappropriate

that whenthey have

a

system failure they go into

pre-auction status

rather than tell the

market they have a

systems outage,” sa

id RichardBalarkas,

chief

executiveof Chi-X parent Ins

tinet in Europe.

“Traders expect a lo

t of activity in such

auctions,therefore

it is quitelegitimate

for

smart order routers

to react to an auction

flag by avoiding trading on multila

teral

trading facilities and placing orders int

o the

auction on the prim

ary,” Balarkas said.

Even if the LSE had not put its

elf into pre-

auction, some have

asked, how much trad

ing

would have taken place?

It’s a bigquestion.

Chi-X was ableto switch off

its link tothe

LSE and offercustomer

s tradingon the oth

er

venues itis hooked

up to but, as Balarkas

says, it take two to

tango andthere wer

e too

few players inthe marke

t to generate enoug

h

liquidity for effective

trading to take place.

“One would have hop

ed that in thepast

year, smart order ro

uting technology and its

adoptionwould have mov

ed forward, but

the market reaction

to the LSE outage was

depressingly simila

r to the year before,”

Balarkassaid.

January2010

ISSN 1748-5339

AmeriTrade and Schwab hook up small

investorsto the best p

rices, whereas in

Europe many of the

ir counterparts are

local

and just plugged into the nation

al exchange

via affiliated banks.

This andother issu

es need to be tackled if

there is tobe strong

er competition in s

hare

trading across borders and

if volumes are

to be grownin line wit

h the United States.

Bradley Duke of Kn

ight Direct states it

plainly: “In Europe,

the biggest barrier

to

trading volumes picking up is high cle

aring

and settlement costs.”

NEWS

EURO TLXSIM JOINT

VENTUREGETS EC

APPROVAL

The European Com

mission has cleared

under theEU Merger Reg

ulation the

proposedjoint vent

ure between the

Italian financial insti

tutions Unicredit

S.p.A. and Banca IM

I S.p.A. The

planned transaction would transform

the existing joint vent

ure TLX S.p.A.

into a new full function joint v

enture

Euro TLX Societa Intermediaz

ione

Mobiliare S.p.A (Euro TLX SIM). After

examiningthe opera

tion, the

Commission concl

uded that the

transaction would not signif

icantly

impede effective c

ompetition in the

EuropeanEconomic

Area (EEA) or any

substantial part of

it.

UniCreditis an inter

national financial

institutionoffering a wide ra

nge of

banking and financial services in

several European c

ountries.Banca IM

I

is an investment co

mpany belonging to

the banking group Intesa Sa

n Paolo.

TLX is currently jointly c

ontrolledby

UniCreditand Banca IM

I and manages

two electronicplatforms

for trading in

financial instrumen

ts, principally for th

e

account of its paren

t companies.

Upon completion of

the planned

transaction, TLX will chang

e its name

to Euro TLX SIM and start operating a

single electronic pl

atform for trading in

financial instrumen

ts namedEuro TLX,

offering services to third parties on

a

commercial basis.

0

nlocal

hange

kled if

n share

es are

States.

s itrier to

clearing

OINTEC

has cleared

lation the

tween the

s Unicredit

.A. The

d transform

TLX S.p.A.

oint venture

mediazione

LX SIM). After

n, the

d that the

significantly

petition inthe

Area (EEA)A)A or an

national financia

wide range of

al services in

ountries.Banca

ompany belongi

Intesa San Pao

intly controlled b

nca IMI and man

atforms for tradin

ents, principally f

arent companies

n of the planned

X will change its

M and start opera

ic platformfor tra

ments named Eu

ces to third parties ona

asis.

WORLD EXCHANGESGLOBAL INDUSTRY OUTLOOK AND INVESTMENT ANALYSIS

MARCH 2010

“The transformation of exchanges from quasi-public mutual

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global economic phenomenon. This volume is the first to attempt

a comprehensive analysis of the exchange industry as a business,

and it does so with impressive scope and depth. It is destined

to be a standard reference for all of us working in and writing on

the industry.”

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Senior Fellow and Director for

International Economics,

Council on Foreign Relations

WO

RLD

EXCH

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GES

GLO

BAL IN

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STRY O

UTLO

OK

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INVESTM

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EXcovers0310.qxd:Ex_Cover0310 30/3/10 11:57 P

age 1

www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433

Features

Regulars

CONTENTS

5 NEWSA round-up of the important storiesfrom the last quarter around theglobe.

33 IIBI NEWS ANDEVENTS ENDORSED BYTHE IIBI

35 AWARDSListing of IIBI post graduatediplomas and diplomas in Islamicbanking.

36 IIBI LECTURESReports of the June 2011 lectureon restructurings in Islamic finance and the July lecture onliquidity management at Islamicbanks.

41 BOOK REVIEW

10 What Does the FutureHold for Islamic AssetManagement?

Asset management is something of a poorrelation in the Islamic finance sector. Thisarticle examines the reasons why it islagging behind other sectors of the Islamicfinance industry and the potential for futuregrowth.

14 Does Basel III ReallyApply to Islamic Banking?

Rohit Verma argues that Islamic banks needto comply with Basel III or the IFSB’sinterpretation of Basel III in order to remaincompliant and profitable.

15 Islamic Finance inWest Africa Gets a MixedResponse

West Africa straddles a fault line across thecontinent dividing the largely Muslim north

from the mainly Christian south. As aresult the arrival of Islamic banks in theregion is getting a mixed reception. Thisarticle reviews progress so far and thedifficulties that may lie ahead, particularlyin Nigeria.

20 A Critical Look at theIdeal Mode of IslamicFinancing

Salman Ahmed Shaikh argues thatinstruments such as mudabarah andmusharakah are largely unusable and arethus failing the Islamic finance industry.

24 Revisiting theFundamental Structure ofTakaful

ISRA’s Dr. Asyraf Wajdi Dusuki suggeststhat the fundamental structure of takafulneeds to be re-examined to accommodatethe various practices of takaful operationand to address the needs of the customerbase.

27 Shari’ah Governancefor Islamic FinancialInstitutions

Professor Rodney Wilson examines thevariations in the way Shari’ah governance isorganised and highlights the problems thatcan arise from the diverse systems in use.

Mosque of Touba, Senegal


www.newhorizon-islamicbanking.com

NEWHORIZON October–December 2011

Executive Editor’s NoteThe last decade has seen Islamic financial institutions achieveremarkable growth, weathering the financial storms since 2008 andmany have fared better than their conventional counterparts,according to a comparative study published by the InternationalMonetary Fund in late 2010. The Shari’ah tenets of profit and risksharing and the prohibition on trading in the sorts of toxic assets andderivatives that brought the conventional system almost to its knees,have served Islamic financial institutions well. However, thecomparative study findings were based on a number of assumptionsthat should not be oversimplified and Islamic financial institutionsshould not be complacent. Embraced properly, Islamic financeprinciples have the potential to support real economic activity andenhance responsible financial practices that promote financial stabilityand real economic growth – this is the very essence of Islamic finance.

This issue covers the importance of takaful and related issues inprevailing takaful practices. There is also an in-depth analysis aboutthe potential and development of Islamic finance in West Africa.There is still much work to be done by industry players to educatepotential customers as well as members of the wider public (bothMuslims and Non-Muslims) around the globe. There is a need todemonstrate that Islamic finance offers an alternative approach tobanking, finance and investment; it is all about providing anequitable and soundly functioning financial system with no ulterioragenda. In Nigeria, for example, where the first Islamic bankingorganisations have recently received approval in principle, there isstrong opposition from some sections of the community, who seethis as ‘Islamisation’ by the back door.

As Islamic finance continues its development and seeks to competewith global players, it will be increasingly tested by risks andpractices in the challenging environment presented by theconventional financial system. It is perhaps time to call uponIslamic finance industry players to pause and give serious thoughtto re-examining practices and innovations adopted in pursuit ofshort-term profits; they should also examine their disclosure andShari’ah governance processes that should provide a high level oftransparency about the ethical foundations in Islamic financepractices. Otherwise, simply extolling the benefits of adopting theunderlying principles of Islamic finance will begin to sound hollow.

EDITORIAL

This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The viewsexpressed in the articles are those of the authors alone and should not be attributed to the organisations they are associated with or theirmanagement. Any errors and omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept noresponsibility to any person who acts, or refrains from acting, based upon any material published in the magazine. The Editorial Advisory Panelexists to provide general advice to the editors regarding matters that may be of interest to readers. All decisions regarding the published contentof the magazine are the sole responsibility of the Editors, and the Editorial Advisory Panel accepts no responsibility for the content.

4 IIBI

ExECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORSAndrea WhartonSue Dobson

IIBI EDITORMohammad Shafique

PUBLISHERHumphrey Tizard

IIBI EDITORIAL ADVISORY PANELMohammed AminRichard T de BelderAjmal BhattyStella CoxIqbal KhanDr Imran Ashraf Usmani

PUBLISHED BY Institute Of Islamic Banking andInsurance7 Hampstead Gate1A FrognalLondon NW3 6ALTel: +44 (0) 207 2450 404Fax: +44 (0) 207 2459 769Email: [email protected]

CONTACTAdvertisingInstitute Of Islamic Banking andInsurance7 Hampstead Gate1A FrognalLondon NW3 6ALTel: +44 (0) 207 2450 404Fax: +44 (0) 207 2459 769Email: [email protected]

SUBSCRIPTIONMohammad ShafiqueInstitute of Islamic Banking andInsurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: [email protected]

©Institute of Islamic Banking andInsuranceISSN 0955-095X

Deal not unjustly,and ye shall not be dealt with unjustly.

Surat Al Baqara, Holy Quran

Mohammad Ali QayyumDirector General IIBI




International Law firm PinsentMasons has jointly launchedFinaXiom-Shareef’s newShari’ah-compliant regulatorycapital product, which isdesigned to provide Basel IIITier I Standby RegulatoryCapital for Islamic banks.

Finaxiom’s Standby RegulatoryCapital product breaks themarket trend of simply

translating conventional financialproducts into Islamic productsand instead is a new and originalIslamic product that is equallyattractive to conventional banks.The product was developed overmore than a year of closecollaboration betweenFinaXiom-Shareef andMuhammad Abdullah Al-HarithSinclair supported by corporatepartner Jay Birch, funds partners

Ian Warner and Dan Greenaway,tax partner Eloise Walker, as wellas Islamic finance seniorassociate Amir Ali Ahmad inPinsent Masons’ Dubai office.

In the new Basle III-gearedfinancial regulatoryenvironment FinaXiomShareef’s Standby RegulatoryCapital product levels theplaying field for Islamic banks

Basel III Tier 1 Standby Regulatory Capital for Islamic Banks

by providing them with standbycapital on similar terms to thoseavailable to conventional banks.It aims to offer investors inShari’ah-compliant assets anattractive rate of return whilesimultaneously offeringtreasurers of Islamic financialinstitutions a cost effective wayof managing their capitalrequirements.

Bank of London and TheMiddle East plc (BLME) hasannounced its participation ina five year transaction worthUSD $130m with BoubyanPetrochemical CompanyK.S.C. (BPC), the Kuwaitishareholding company. Thefinancing facility providesBoubyan Petrochemical withworking capital to financetheir expansion and businessdevelopment plans in Kuwait.The lead arranger wasBoubyan Bank with otherparticipating banks includingAhli United Bank and KuwaitInternational Bank.

Massoud Janekeh, Head ofIslamic Capital Markets atBLME stated:

‘This is the largest Islamicfinancing transactionundertaken by theBoubyan PetrochemicalCompany to date. This

landmark dealdemonstrates theconfidence a blue chipKuwaiti corporation suchas this has in BLME’sability to providecompetitive, flexible, andeasy to accessShari’ah-compliantproducts.’

Mr. Adel Al Majed, DeputyChairman of the Board ofDirectors and ManagingDirector of Boubyan Bank, said:

‘Signing this agreementtoday proves that Kuwait’sbanks have the ability tofinance large scale projectsduring these difficultfinancial times globally.The lack of liquidity andfinance requires hard workand cooperation in order tocontinue to financecompany expansionprojects. This, along with

NEWS

Boubyan Petrochemical Company Raises Expansion Finance

the Government’s plans forimproving theinfrastructure of thecountry, will undoubtedlyadd value to the Kuwaitieconomy.’

Dabbous Mubarak Al-Dabbous, the Vice-Chairman of BoubyanPetrochemical,commented:

‘Despite the currenteconomic climate,BoubyanPetrochemical was ableto gain the trust andsupport of internationalbanks to obtain thefinance needed formoving ahead andrealising expansiongoals. This reflects thecompany’sperformance,shareholders’ profitsand the Kuwaiti

economy as a whole.’ Headded, ‘The company plansto increase the ratio ofShari’ah-compliant finance.’

Massoud Janek


customers a competitiveselection of Shari’ah-compliantinvestment products. Thesynergy resulting from our newalliance with NCB Capital willensure that our customers canaccess a range of investmentproducts to meet their diverseneeds.’

Hamed Fayez, Head of AssetManagement at NCB Capital,

said, ‘We look forward to along-term and rewardingrelationship with TakafulEmarat. More and more clientsare demanding access toworld-class, Shari’ah-compliantinvestment products asimportant components of theirportfolios. We are delighted tobe working with TakafulEmarat to help meet thesegrowing needs.’

UAE-headquarteredTakafulEmarat, a Shari’ah-compliantlife and health insurancecompany, has announced theirpartnership with NCB Capital,Saudi Arabia’s largestinvestment bank and the GCC’sleading wealth manager, tomake world-class,Shari’ah-compliant fundsaccessible to its customers. Aspart of the alliance, Takaful

Emarat will offer its customers arange of 21 Shari’ah-compliantfunds managed by NCB Capital.

Speaking on the announcement,Mr. Ghassan Marrouche,General Manager, TakafulEmarat, said, ‘Our partnershipwith NCB Capital, the largestinvestment bank in the Kingdomof Saudi Arabia, signifies ourdedication to bringing our

6 IIBI www.newhorizon-islamicbanking.com


Qatar Science andTechnologyPark (QSTP).’

Andrew Elphick, CEO of IOTANanoSolutions, commented,‘ContraSol™ is highlyinnovative and offers manypossibilities within thepharmaceutical, agrochemicaland related industries. We lookforward to working with QIB(UK) and Unilever to furtherdrive the company’s growth andaccelerate development withinthese key strategic sectors.’

ContraSol™ addresses the ‘poorsolubility of active ingredientsthat can pose formulationconstraints, impair theperformance of productingredients and restrict the wideuse of commercial materials’.The new product allows thetransformation of poorlysoluble organic active

ingredients into dry solidformats (for example:powders, tablets or granules)that rapidly formnanodispersions on contactwith liquids. Thesenanodispersions then aid thedelivery of and lead toperformance enhancement ofpoorly soluble activeingredients.

This seems to be yet anotherexample of Qatar’sdetermination to build abusiness base that is notreliant on petrochemicals.Although it is estimated thatQatar have sufficient oilreserves to continue at theirpresent output levels for morethan 20 years, the country’sgovernment is apparentlytaking a long-term view, usingits oil wealth to secure itsfuture.

QIB (UK), a subsidiary of Qatar Islamic has joinedforces with Unilever VenturesLimited, the Europeanventure capital arm ofUnilever, the world’s secondlargest FMCG (Fast MovingConsumer Goods) company,in putting together a financinground to support thecommercialisation of a newtechnology that has beendeveloped by IOTANanoSolutions (INS). INS is a high-tech science technology company based inLiverpool in North WestEngland, which has developed‘ContraSol™’, described as a‘proprietary nanodispersionformation technology’. Theinvestment by QIB (UK) andUnilever will help INS bringits new product successfullyto market.

Philanthropy with an Agenda

NEWS

Akbar Ahsan, Head ofCorporate Finance at QIB (UK),commenting on the jointventure, said, ‘We are delightedto join Unilever in supportingIOTA NanoSolutions in theirdevelopment andcommercialisation ofContraSol™. Our involvementis driven by our investmentthesis of backing highly-regarded management teamsand partnering with leadingnames. IOTA’s leading scientificteam and Unilever’s pivotal rolein the company’s developmentand success makes this a uniqueopportunity for us. In time wewill work with IOTA to expandits research activities in Qatarthrough establishing a presencethere and participating in theknowledge-based economy,which is being developed by theQatar Foundation and the

Takaful Emerat Partners with NCB Capital




The Durham Centre for IslamicEconomics and Finance is tolaunch a new doctoral trainingcentre in the autumn. The centreis a collaboration between theUniversity’s Durham BusinessSchool and the School ofGovernment and InternationalAffairs. Durham has been acentre for research in Islamicfinance for over 25 years, with a significant history of PhD study. The new centre willbuild on this success and theinternational popularity of theDurham Islamic FinanceSummer School.

Professor Rob Dixon, dean ofDurham Business School, said:‘Due to such exciting anddynamic developments in theIslamic financial and bankingsector, it is important thatfinanciers and bankers who areworking in the field, or who

In the last few months severalIslamic banks have announcedtheir intentions to expand ininto new markets. In somecases this means expansioninto new countries and inothers it means extendingbanking services within theirown countries. In the firstcategory is Bahrain-based Al

Baraka, who have said theyintend to open a bank in Francein 2012. The proposed bankwill have a capital of€100 million, although thesuccess of this venture wouldseem to depend on somechanges to French law. Also inthe first category is Turkey’sBank Asya, who are said to be

considering an acquisitionsomewhere in the Balkans. Thisproject will be undertaken inconjunction with the IslamicDevelopment Bank.

In the second category and inline with their strategy to expand access to bankingthroughout Pakistan, the central

bank there has ordered Islamic banks in the country to open 20% of new branchesin rural areas. This is part of their strategy to increase the Islamic banking share ofthe total banking industry from just over 7% to 12% by2015.

Durham University Launch New Doctoral Training Centre

wish to enter the Islamicfinancial market, are aware ofthe principles, operations,techniques and mechanisms ofIslamic finance and financialproducts as well as the dynamicsof Islamic financial and capitalmarkets.’

Dr Mehmet Asutay, the directorof the summer school and asenior member of the newcentre, said: ‘The centre willprovide exclusive facilities forresearch students who havechosen to specialise in Islamicfinance, which will enhanceDurham University’slong-standing efforts tocontribute to the developmentof academic and intellectualdiscourse and the practice ofIslamic finance. It will alsosupport the internationalreputation and recognition ofDurham University.’

NEWS

Islamic Banks Flex Their Wings

Durham Cathedral and the River Wear




Following the granting of alicence from the Central Bankin Sri Lanka, AmanaCommercial Bank hasannounced that it will open 14branches across the country toprovide a range of servicesincluding trade finance andtreasury services. The firstbranch was opened at the endof July in Colombo.

Saudi Arabia’s Al-Rajhi Bankis planning to expand itsoperations in Jordan. Thebank, which opened twobranches in Amman in 2009,believes there is great potentialfor the expansion of Islamicbanking in Jordan, whichcurrently represents just15–18% of the country’sbanking market.

The Dubai-based HawkamahInstitute for CorporateGovernance has partnered withthe Islamic Finance Council UK(IFC) to trial a unique trainingprogramme which providestailored conventional marketstraining for Shari’ah scholars. Itclaims to be the only globallysynchronised programme of itskind.

The programme has beendeveloped by the IFC, aUK-based, not-for-profitorganisation, assisted by theChartered Institute for Securities& Investment Institute (CISI). Itis exclusively tailored forShari’ah scholars and thoseinvolved with the Shari’ahassurance process and has beenrun successfully in London,Bahrain and Kuala Lumpur.

Dr Nasser Saidi, ExecutiveDirector Hawkamah and ChiefEconomist of the DubaiInternational Finance Centre(DIFC) Authority commented,‘Hawkamah has been active instrengthening corporategovernance in Shari’ah-compliantinstitutions and building capacityat the level of the board ofdirectors. We hope that suchcapacity-building programmeswill encourage Shari’ah scholarsto drive innovation in the Islamicfinance industry by developingIslamic finance instruments forfinancing the infrastructure andpublic developmental projects,which will ultimately lead to thedevelopment of the IslamicCapital markets.’

IFC Chairman, Tariq Masood,commented, ‘We welcome thedecision by Hawkamah to

Training Programme for Shari’ah Scholars Launched

NEWS

Dubai Islamic Bank (DIB) hasopened a Rolls Roycebanking service for what itdescribes as ‘discerningclients who expect nothingbut the best’. They claim thenew elegantly designedbranch on Al Maktoum Roadin Dubai offers greaterconvenience and a range ofexclusive services for AlIslami private bankingcustomers, who will haveaccess to the personalisedservices of highly-experiencedrelationship managers. Dr. Adnan Chilwan, DeputyCEO – Chief of Consumerand Wholesale Banking, DIBcommented, ‘Customers whovisit the new concept branchwill be able to fulfil theirbanking requirements incomplete comfort and luxury.

In Brief

introduce this uniqueprogramme. To be a meaningfulglobal industry it is importantfor key global jurisdictions inIslamic finance to co-ordinateand work together to raisestandards for all.’

The inaugural Dubai sessionheld in June 2011 was the firstsuch session in the UAE region.It focussed on debt capitalmarkets and was hosted at theDIFC offices of internationallaw firm, Simmons & Simmons.

Muneer Khan, Partner and Headof Islamic Finance at Simmons &Simmons commented, ‘This is amuch needed internationalinitiative to help Shari’ahScholars to develop the practicallegal and commercial contextthey need to be able to applytheir Shari’ah knowledge.’

The importance of continuousprofessional developmentprogrammes have beenrecognised by AAOIFI, IFSB andthe recently updated Shari’ahGovernance standards issued byBank Negara as a vitalcomponent in empoweringShari’ah scholars by both raisingstandards and enhancingcapacity.

Dr Daud Bakar, a seniorShari’ah scholar comments, ‘Toprovide meaningful fatwas it isimperative for Islamic financescholars to have a sound graspof conventional finance tocompliment their Shari’ahknowledge. This course aims toachieve exactly that in astructured and systematicmanner and thus presents a keytool in developing Shari’ahscholars. I commend the Islamic

Finance Council’s vision anddetermination in delivering thisnow truly global course.’

The next sessions of theprogramme will take place in

Kuala Lumpur, Malaysia on the5th and 6th October 2011, witha further session planned forLondon by the end of the year,although the date has yet to beconfirmed.

Conservative peer, Lord Sheikh, in discussionwith delegates to the London event


www.newhorizon-islamicbanking.com 9 IIBI

NEWS

mutual funds, which faces ascarcity of short-term tradableinstruments. The sukuk was50% oversubscribed byinvestors, mainly Islamicmutual funds.

Saudi Aramco and France’sTotal have announced they havegained regulatory approval for asukuk to finance the SaudiArabian Jubail oil refinery.Deutsche Securities SaudiArabia, Samba Capital andSaudi Fransi Capital have beenappointed joint lead managersand book runners. The sukuk,believed to have a value ofapproximately $1 billion, willopen on 10 September and willrun for 16 days. It is only open toSaudi nationals or thoseregistered in the country. Thesukuk will be the first Shari’ah-compliant project sukukinstrument in the Kingdom ofSaudi.

The London-based EuropeanIslamic Investment Bank isrefocusing its activities oninvestment opportunities in theMiddle East and Asia and aspart of this change in strategyis relocating some of its staff toBahrain. This is very much aresponse to the fact that, in thewake of the financial crisis, themajor growth markets are inthe Middle East and Asia. Inpart it is also due to the factthat the UK governmentappears to have pulled backfrom the idea of launching asovereign sukuk in the UK.Currently conventional bondsenjoy certain tax advantages inthe UK, which do not apply to

sukuk. Had the UKgovernment gone ahead, itwould probably have meantchanges that would havelevelled the playing field forsukuk. As this has nothappened the attractions of theUK market have, at least forthe present, diminished.

The Securities CommissionMalaysia recently issuedrevised guidelines for sukukdesigned to streamline theapproval process and time-to-market for the issuance ofsukuk. Among other thingsthese provide greater clarity onthe application of Shari’ahrulings and principles inrelation to sukuk transactions,while the Trust DeedGuidelines improve disclosurestandards and protection forsukuk holders.

AAOIFI has appointed Ernst &Young to collate recom-mendations for the currentreview of financial accountingstandards for takaful andretakaful companies. One ofthe main issues to beinvestigated is the sharing ofunderwriting surpluses amongsttakaful operators. At present,takaful operators acting asmanaging agents for the takafulpool are not permitted to sharein any surplus arising from therisk fund. This position has,however, been questionedrecently on the grounds thattakaful operators sharing inunderwriting surpluses wouldhave an added incentive toensure the profitability of itsrisk pool.

As part of DIB’s growthstrategy, we plan to launchmany more Private Bankingbranches across the UAE overthe next few years.’

Following on from theFebruary ban on conventionalbanks operating Islamicwindows, the Qatar FinancialCentre Regulatory Authorityhas authorised the Abu DhabiIslamic Bank to conductbusiness in and from the QatarFinancial Centre. Abu DhabiIslamic Bank’s authorisationpermits it to carry on regulatedactivities in relation to deposittaking, providing andarranging financing facilitiesand managing investments.

The International Bank ofQatar (IBQ) have sold theirAl-Yusr Islamic retail bankingoperations to Barwa Bank,bringing IBQ into line with theinstructions issued by theQatar Central Bank in Januaryfor all commercial banks in thecountry to cease their Islamicoperations by the end of 2011.The sale includes the transferof all the Al-Yusr retail loanand deposit accountportfolios, the two Al-Yusrbranches located at Al Saddand Al Rayyan includingATMs and all employees. Theprivate and corporate bankingportfolios are not included.

In August the Bahrain IslamicBank BSC (BisB) confirmedthat is in merger talks with theAl-Salam Bank-Bahrain(ASBB). The merger wouldcreate the largest Islamic bank


in Bahrain in terms of totalassets. The combined entitywould have total assets ofBD1.7 billion and shareholders’equity of BD337 million. Thecombined entity would be thethird largest domestic bank interms of total assets and thesecond largest in terms of equity.It will have significantunderwriting capacity, synergycoming from the two banks’enhanced service deliverycapabilities and be a strongerregional player in the Islamicbanking industry. The twoBoards of Directors of BisB andASBB stated that consolidationis the way forward for localbanks in general and Islamicbanks in particular in theaftermath of the financial crisisand economic downturn and theincreasingly competitive bankingenvironment in the region. The merger has received theapproval of the central bank.

Meezan Bank claims to haveachieved a first in Pakistan’sIslamic banking industry bybecoming the advisor and leadarranger for the first ever short-term sukuk for Kot Addu PowerCompany Limited (KAPCO),Pakistan’s largest independentpower producer. The six-monthsukuk structured on amusharaka basis, an Islamicalternative to commercial paper,was issued by KAPCO to meetits working capitalrequirements.

Meezan Bank believes thissix-month sukuk marks theopening of another muchneeded avenue for Islamic

In Brief




Market Background

Islamic asset/funds management is currentlythe poor relation in the Islamic financeindustry. It seems to have been somewhatoverlooked in the work to formulate a set ofrules and principles to guide Islamicbanking carried out early in the 21stcentury. According to Professor RodneyWilson of Durham University Islamic assetmanagement has largely servedhigh-net-worth individuals rather thaninstitutional investors. Private pensionschemes are crowded out by governmentprovision in most of the Islamic World andthe funds controlled by takaful providersare very limited. He does, however, notethat in the last 10-15 years there has seen arise in the demand for Shari’ah-compliantasset management services from bothinstitutional and private investors,particularly in the GCC.

The response to that demand has comemainly from the conventional bankingindustry, organisations such as HSBC andDeutsche Bank, who have adapted existingproducts and appointed Shari’ah boards toassure Muslim investors that the productsdo conform to Shari’ah principles.Commenting on this situation inNewHorizon in 2009 Swiss-based specialistin Islamic wealth and asset management,John Sandwick, expressed the view thatthese products fall short of true Islamic assetmanagement. He said:

‘When a client walks into a bank and asksfor Shari’ah-compliant asset management,there is either one of two responses. Thefirst is an honest ‘no, we don’t offer thatservice here.’ Truthfully, no institutionanywhere outside of Malaysia can offerIslamic asset management today.

‘The second response is dishonest. Some ofthe most prestigious banks in the world

claim they have Islamic assetmanagement, but in reality, theyuse derivative-based structuredproducts (with fatwa) combinedin such a fashion as to achievethe objectives of MPT (ModernPortfolio Theory).’ He went onto describe these derivative-basedstructures as ‘by and large toxicwaste’ and ‘not a substitute forMPT allocations.’

Modern Portfolio Theory

Modern Portfolio Theory wasoriginally formulated by HarryMarkowitz in the early 1950s.The fundamentals of the conceptare that investments should notbe selected individually on theirown merits but as part of aportfolio where price changes inone asset are considered inrelation to changes in price in allthe other assets in the portfolio.In other words a portfolio should

What Does the Future Hold for Islamic Asset Management?

FOOD FOR THOUGHT

Some of the most prestigiousbanks in the world claim theyhave Islamic assetmanagement, but in reality,they use derivative-basedstructured products (withfatwa) combined in such afashion as to achieve theobjectives of MPT (ModernPortfolio Theory)

John Sandwick



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 FOOD FOR THOUGHT

contain a mix of different types ofinvestment – cash, equities, bonds andproperty, so that a drop in any one type ofinvestment is balanced by the performanceof the other types of investment. (In thecurrent market conditions where both thebond and equities market are in free fall andreal estate has still not recovered from the2008 financial crisis, perhaps the best thatMPT can hope to do is minimise losses.) In2009 John Sandwick concluded that therewas effectively no real Islamic asset orwealth management market. The question iswhether the situation has radically alteredsince he came to that conclusion.

The answer is apparently not. In an articlein the Global Islamic Finance magazine inJune 2011, he reiterated his view that bankscontinue to offer ‘random product sales’ toMuslim customers rather than asset orwealth management services.

Modern Portfolio Theory and IslamicFinance

There is, however, no reason why Islamicasset management and wealth managementshould not operate on exactly the same linesas those same services in the conventionalsystem. Service providers need to have agood understanding of the client and whatthat client wants to achieve from his or herinvestment and develop a strategy whichwill achieve those aims. In simplistic terms,is the client prepared to accept a higher levelof risk to achieve a high rate of return or ishe or she looking for something safer thatwill produce steady returns over a long termperiod? Having established a strategy, theservice provider will select a mix of funds ordiscrete investments to reflect thoseobjectives and it is only at this stage thatIslamic funds will differ from conventionalfunds, because the choice of investmentswill be limited to those that are Shari’ahcompliant.

Shari’ah-Compliant Investments

Does this limitation on the choice ofinvestments present a real problem and isthis why the Islamic asset and wealthmanagement has failed to reach the level ofdevelopment achieved by its conventional

counterpart? The answer is both yes and no.Commodities are clearly not a problem. It isalso perfectly possible to find equities thatare acceptable to Islamic investors.

The bond component of funds relies onsukuk. Although the sukuk market is onceagain growing, there is still a shortage ofnew issuances, particularly of sovereignsukuk. Political turmoil in parts of the Arabregion, the ‘Arab Spring’ has done nothingto help the situation. When governments arefighting for survival, sukuk issuance isprobably not at the top priority of their listof things to do. In a report in Arab News inMay 2011, Noripah Khamso, CEO, CIMBPrincipal Islamic Asset Management,Malaysia, whose investors are institutional,including sovereign wealth funds andgovernment agencies, commented thatmarket appetite for AAA-rated sovereignsukuk papers is healthy, but her companycannot find enough sukuk in which toinvest. The result is she is being forced toturn down new orders from institutionalclients. The response to recent sovereignissuances reinforces her comments. Forexample, in July Malaysia’s five-year and10-year Wakala Global Sukuk worth US$2billion in total was oversubscribed by 4.5times and in August Bahrain’s latest issue oftheir monthly, short-term sukuk was nearlyfour times oversubscribed. This shortage ofsukuk creates a further problem,particularly for institutional investors, and that is the absence of a vibrantsecondary market in sukuk. If a fund sellssukuk that it holds, finding a suitablereplacement for the portfolio may very wellprove challenging.

As for real estate, there is plenty that is notlinked to unacceptable activities such asdrinking and gambling. (The growth ofIslamic Real Estate Investments Trusts(REITs) discussed in the July to September2011 issue of NewHorizon is a usefuladdition to the range of Shari’ah-compliantinvestment vehicles.) The performance ofreal estate in the last few years has,however, not been reassuring. Anunemotional description of the real estatesector would be that it has been difficult;those of a more choleric nature would

perhaps describe it as a horror story. If youwant to raise an investment manager’s bloodpressure, just whisper the words ‘USsub-prime market’ or ‘Dubai’. Nor can weassume that the turmoil is largely in the past and that the real estate market isreturning to something approachingnormality.

The latest rumblings concern China’soverheated property market. Although theChinese government is taking steps to try toavoid the sort of debacle that has occurredin other countries, the general consensusseems to be that it cannot avoid some sortof a spill. The question is just how big thatwill be.

In theory, however, it should be quitepossible to build a balanced,Shari’ah-compliant portfolio. Sukuk is theonly issue that is particular to Islamic funds.Although the choice of equities is morelimited than for conventional funds, there isreasonable choice and the problems inherentin real estate affect the conventional assetmanagement sector just as much as theIslamic sector.

The problem, as John Sandwick points out,is that ‘fund-of-funds allocationspredominate in the asset managementuniverse’. In other words organisations suchas pension funds do not create portfolios byselecting individual equities or bonds; theygo to specialists who have created vehiclesto meet the requirements of particularinvestment strategies, but the number ofthese that are Shari’ah compliant is tiny,representing less than 1% of the total fundsunder management.

Above all, however, the Islamic investmentmanagement industry is still a work inprogress and that is recognised by thosecompanies already operating in the field. InJuly 2011, Peter Chiang, Head ofInternational Equities at HwangDBS IMsaid, ‘There is an enormous untappedmarket locally and abroad. In order tocapture these opportunities we need toattract and develop talent; have an in-depthunderstanding of our target audience andensure we are able to innovate andcustomise our offerings to meet their need.



NEWHORIZON October–December 2011FOOD FOR THOUGHT

Understandably, no one fund orinterpretation fits all. Industry players needto recognise that to be on an even playingfield, we have to up our game and bring tothe table more attractive and competitiveofferings. At the same time, we also have todeal with the challenges of a developingindustry in which the regulatory frameworkand collaboration at the country level is stillin a relatively preliminary stage.’

The Islamic Investment Fund Market

In early 2010 Ernst & Young produced the‘Islamic Funds and Investment Report’,which claimed that at the end of 2009 justover half of Islamic funds had less than$50 million and almost 70% had less than$75 million under management. In total theIslamic sector of the industry accounted for$52.3 billion, compared to $22 trillion forthe conventional mutual funds industry.Even more depressing was the fact that,while 29 funds were launched in 2009, 27other funds were liquidated. The problem isthat many funds are relatively new, foundedin the last few years; many are small andilliquid and trading across borders is oftendifficult.

On the plus side the report noted that therehas been substantial investment inenhancing risk infrastructure, adoptingflexible business models and a segmentedapproach to accessing new customers aswell as dramatic changes in fee and coststructures (a 25% drop in fees since 2006)including more transparency and incentivebased remuneration. Add to that the alreadyconsiderable and growing wealth of theGCC and logic suggests that theopportunities for Islamic investment fundsare there.

A Rich Man’s Game?

For the mega rich building an investmentportfolio that meets their requirements interms of delivering the results they want andbeing Shari’ah compliant is not too much ofa problem. They can afford to retaininvestment advisors and they have the fundsto invest directly in sukuk, where minimumlevels of investment are generally beyondthe resources of many potential investors.

Even among this group, however, the skiesare not completely unclouded. Thephenomenon generally referred to as the‘Arab Spring’ has perhaps changed thepriorities of the super rich in the region.Protecting their wealth for futuregenerations has probably nudged Shari’ah-compliant investment down the listof their priorities.

Asset Management Funds

In the world of conventional finance, assetmanagement funds have two main types ofclients – small investors, who do not havethe funds or the knowledge to build theirown portfolios and institutions, such aspensions and insurance companies and it isthe latter that underpin most of the businessin the asset management universe. ProfessorRodney Wilson suggests that thegovernment pension provision in mostIslamic countries crowds out privatepension schemes and that, for the moment,the funds controlled by takaful operatorsare very limited.

The recent Ernst & Young report on theworldwide takaful industry estimated that itwas currently worth about 1% of the totalinsurance industry worldwide. Even givenbullish predictions of growth, the takafulindustry will remain small for theforeseeable feature and thus will not havethe investment power of the conventionalinsurance industry. The nascent Islamicprivate pensions business is similarly placed.Growth from within the Islamic financialcommunity is likely, therefore, to be slow,but what about investment from outside. Ina comment, while he was still global head ofIslamic finance at Deloitte, Daud VicaryAbdullah, now president and chief executiveofficer of the International Centre forEducation in Islamic Finance, noted anincrease in the level of interest inShari’ah-compliant investments frompension funds around the world. If suchinterest were to gather momentum andperhaps spread to other institutionalinvestors, the growth of the Islamic assetmanagement industry could receive aconsiderable boost and that would perhapsencourage some of the big conventional

In July 2011, Peter Chiang,Head of International Equitiesat HwangDBS IM said, ‘Thereis an enormous untappedmarket locally and abroad. Inorder to capture theseopportunities we need toattract and develop talent;have an in-depthunderstanding of our targetaudience and ensure we areable to innovate andcustomise our offerings tomeet their need.Understandably, no one fundor interpretation fits all.Industry players need torecognise that to be on aneven playing field, we have toup our game and bring to thetable more attractive andcompetitive offerings. At thesame time, we also have todeal with the challenges of adeveloping industry in whichthe regulatory framework andcollaboration at the countrylevel is still in a relativelypreliminary stage.



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 FOOD FOR THOUGHT

fund management companies to launchShari’ah-compliant funds.

In Conclusion

Back in the 1960s a Harvard professor,Theodore Levitt, developed a concept hecalled the ‘product lifecycle’. While Islamicasset management is a sector of the Islamicfinance industry rather than a discreteproduct, Levitt’s product introduction stagealmost exactly describes the state of theIslamic assent management market untilrelatively recently – costs are high; salesvolumes are low; there is little competition;demand has to be created and no one makesmoney. There are some indicators to suggest that the sector may now have tentativelyentered what he called the growth stage –costs begin to reduce, i.e. fees and coststructures are reducing and publicawareness and competition begin toincrease. We are still waiting, however, forsignificant increases in sales volumes andprofitability.

The simple fact is that Islamic finance is notinsulated from the turbulence in financialmarkets around the world or the politicalturmoil that has been dubbed the ‘ArabSpring’. Equity markets are volatile; realestate is still far from stable and, while thesukuk market has been showing some signsof recovery from the dark days of 2008, its

growth has almost certainly been inhibited.In the short term, therefore, growthprospects for the Islamic asset managementindustry are at best very modest; this is notan environment that will encourage newplayers to come into the market or investorsto move away from investments theyconsider safe. In the long term, however,there is no reason to believe the market willnot achieve significant growth.

Usman Hayat, Director of Islamic Finance& ESG at the CFA Institute, also makes thepoint that genuine investment funds may fitmore comfortably with Islamic economicthought. He commented, ‘Unlikecommercial banking products, investmentmanagement products, most notablylong-only equity funds, can be a better fitwith the risk-reward sharing expected fromIslamic finance. However, the 2011 reportby TheCityUK, suggest that it is Islamiccommercial banks that account for as muchas 72% of industry assets compared to only5% for funds. Islamic investment accountsoffered by these commercial banks can beseen as a challenging way of carrying outinvestment management within thecommercial banking framework. Thus,Islamic investment management may beseen as a better fit with Islamic economicthought but data suggests it has an evenlonger way to go than Islamic banking.’

Usman Hayat The simple fact is that Islamicfinance is not insulated fromthe turbulence in financialmarkets around the world orthe political turmoil that hasbeen dubbed the ‘Arab Spring’.Equity markets are volatile;real estate is still far fromstable and, while the sukukmarket has been showingsome signs of recovery fromthe dark days of 2008, itsgrowth has almost certainlybeen inhibited.



NEWHORIZON October–December 2011REGULATORY ISSUES

Background

Basel III is striving to re-set the rules for theglobal financial industry, following thedownturn of the financial markets in 2008,which resulted in governments having tobail out multi-national corporations tostabilise the economy. A significant numberof financial institutions had crossed theboundaries of risk-taking; banks that hadtypically held up to 20% of their total assetsas core capital were holding less than 3%and liquid assets accounted for less than10% of this. Following intervention bygovernments, financial regulatory boardsgathered to put in place a new set ofregulations to better govern the financialmarkets and to prevent another downturn.

As a result, Basel III was born, focusing onregulating solvency and liquidity to ensurebanks have sufficient capital to returndeposits in the event of a crisis and are ableto survive a protracted liquidity freeze, whilstbeing less dependent on the vagaries ofshort-term credit markets. With the BIS(Bank for International Settlements) releasingnew regulations for capital framework andliquidity management, banks can startassessing and adapting their systems to ensurethey are compliant, however, does Basel IIIreally apply to the Islamic banks?

Basel III and Islamic Banking

The Islamic Financial Services Board (IFSB)did publish a standard for capital adequacyfollowing the Basel II directive and it can beexpected to do the same for the Basel IIIdirective as well. Like Basel II, Basel IIImakes no distinction between Islamic andnon-Islamic banking financial institutions,however, the nature of Shari’ahtransactions, whereby the payment oracceptance of interest for loans of money isprohibited, as well as investing in businessesthat provide goods or services considered

contrary to its principles, means that Islamicbanking institutions are in a differentsituation to others. So should regulatorsgrant exemptions that are within theirjurisdiction, therefore encouraging Islamicbanks to follow the IFSB standards insteador should these banks be treated on a parwith other financial institutions?

Islamic banking institutions, both smaller insize and fewer in number, tend to be someof the best capitalised banks in the worldand historically comply with regulations setout by the IFSB. The IFSB has strictercapital requirements than those proposed inBasel III, with tier 1 and total capitalrequirements currently standing at 8% and12% respectively. The minimum commonequity requirements for Basel III are set at4.5% and total capital requirements havebeen set at 8% with a 2.5% buffer. Withthis being the case, it makes sense forIslamic banks to continue to follow IFSBregulations as it provides the Islamicbanking industry with a stronger capitalbuffer than that provided by Basel III.

Additional Risks for Islamic Banks

Islamic banks are, however, still exposed tosimilar credit, market, operational andreputational risks as traditional banks are.Additionally, Shari’ah-compliant banks faceunique challenges in managing liquidity –firstly, surplus liquidity cannot betransferred to non-Shari’ah compliant banksand secondly, access to liquidity duringstress situations is limited due to constraintson borrowing. Given this situation, Islamicfinancial institutions need to adopt andincorporate some of the liquidityrequirements from Basel III into their ownrisk management standards and practices,especially given the restricted range ofproducts that these institutions deal in andtheir ability to hedge these transactions. Forexample, Islamic banks should still

implement innovative risk management andcompliancy systems and optimise thesesolutions by revamping their risk andcompliance departments so that they havedaily interaction and communication withall divisions across the organisation and arefully aware of real risks to the business. Inaddition, Islamic banks need to runstringent stress testing and scenario analysisto avert potential liquidity problems andavoid any issues snowballing out of control.

To comply with IFSB capital requirementsand manage liquidity risks, be it in line withBasel III or the IFSB’s own standard that maypotentially be published, Islamic banks willstill need to address their IT infrastructures toensure the systems have the necessarycapabilities in place. IT systems will requirefunctionality that can produce consistent andaccurate data based on multiple models andcalculations, which correlate across divisions.Plus, the IT infrastructure will have to berobust enough to deal with data integrity,usability and compliancy. From a capitalperspective, Islamic banks will need to beable to aggregate data from the asset side and it will be critical for the banks to have anIT infrastructure that has real-timecapabilities in order to measure liquidity risksat all times.

Conclusion

With regards to risk, and liquidity risk inparticular, Islamic banks are as exposed astraditional banks. Those with stable fundingsources and prudent business practices willbenefit from being able to access liquidityand capital for business growth, but theymust ensure they have the processes in placeto remain compliant and profitable. As aresult, they should therefore fully complywith Basel III or the IFSB’s interpretation ofBasel III and the regulations that are putinto place as a consequence.

Does Basel III Really Apply to Islamic Banking?

By: Rohit Verma, Product Management Director, Oracle Financial Services



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 COUNTRY FOCUS

Islam in West Africa

Islam arrived in sub-Saharan West Africa asearly as the 8th century travelling with Arabtraders from North Africa. The Muslimmerchants, however, brought more thantrade goods to exchange for gold; theyfacilitated trade by introducing conceptssuch as contract law and creditarrangements. Perhaps even more criticallythey became valued for the literacy theybrought, particularly written script, whichAfrican rulers rapidly discovered could helpthem to administer their kingdoms. Initially,however, the merchants were kept at arms’length. In ancient Ghana, a kingdom thatwas very different from the modern state of

Ghana, encompassing the Niger Delta andMali, as well as parts of Senegal andMauritania, merchants were not allowed tostay in the cities overnight.

It was not until the Middle Ages that Islamreally began to flourish with the conversionof some of West Africa’s most powerfulrulers. The Islam that they practised,however, would not be recognised by thepurists; it combined Islamic beliefs andaspects of traditional African religions. Itwas the 19th century that saw significantchanges take place. Initially movementsgenerated from within the Muslimcommunity sought to transform the practice of Islam into something that would

be recognised by the rest of the Muslimworld.

At the same the region was coming underthe influence of European powers. In WestAfrica this was primarily the French and theBritish. While the European imperialismeffectively brought an end to Islamic rule inparts of the region, the colonial powersclearly saw the advantages of recruitinglocal rulers to help them administer theirnew colonies and there was therefore acertain tolerance of Islam. This tolerancedid, however, have its limits. The British, forexample, discouraged people from NorthernNigeria going to North Africa to furthertheir Islamic studies. They did not want new

Islamic Finance in West Africa Gets a Mixed Reception



NEWHORIZON October–December 2011COUNTRY FOCUS

and possibly radical influences disturbingthe status quo.

Today, those countries to the north of theWest African region such as Gambia,Guinea, Mauritania, Mali and Niger arepredominantly Muslim. To the south of theregion, in countries such as modern Ghana,Muslims are very much in the minority.Countries in the middle, most notablyNigeria, are split with their northern regionsbeing largely Muslim and the south largelyChristian, which leads to some tensionsspilling over into the broader society, withbanking being no exception. Most recentlythe 20 Anglican bishops of Sapele in the farsouth of the country issued a statement atthe end of their first synod urging thegovernment to ‘review the conditions for theapproval of non-interest banking and makeall possible amendment that would ensurethe interest of every religious group inNigeria.’

Banking in West Africa

The fact is that an estimated 80% offamilies in West Africa have no bankaccount. It could be argued that inpredominantly Muslim countries this maybe related to the unavailability ofShari’ah-compliant financial services, but infact it is equally, if not more likely, to berelated to low wages, unemployment andthe lack of physical access to banks. There issome expectation that technology, i.e.mobile phones/mobile banking may help toresolve the issue of lack of access, but theeconomic development that would pullpopulations out of poverty is a much morecomplex issue and perhaps not unrelated tothe interest in Islamic banking beingexpressed by a number of countries in WestAfrica.

The West African Economy and theOpportunities for Islamic Banking

Speaking about West Africa at theInternational Islamic Finance Forum, whichtook place in Senegal in June 2011, MrKhaled Al-Aboodi, CEO and GeneralManager of ICD (Islamic Corporation forthe Development of the Private Sector), anorganisation affiliated to the Islamic

Development Bank said, ‘Now let mespecifically touch upon the potential of theWest Africa, the sub-region of the continentwith the greatest diversity in terms of itslinguistic, geographical, and naturalresources. Having a combined GDP of over$500 billion based on purchasing powerparity valuation, the Western Africa regionprovides great opportunities for Islamicbanking. The dynamism of the region is alsoevident in the real GDP growth rate andrecent FDI (Foreign Direct Investment)figures. The cumulative GDP of the regionincreased 6.7% in 2010, a figure muchhigher than the overall growth rate of 4.9%in Africa. The vibrant Western Africaneconomies have also been successful inattracting about 20% of inward FDI toAfrica over the last five years despite theslow-down in global economic growth.With these impressive achievements, experts believe that Western Africa will be surpassing both global and African average growth in the next 3–5years.’

In fact the ICD is taking a very proactiverole in promoting Islamic finance across itsmember countries including a substantialnumber of West African states. In the lasttwo years, in co-operation with Turkey’sBank Asya, it has acquired a majority stakein three Islamic banks – one each in Guinea,Senegal and Niger and acquired a licence toestablish an Islamic bank in Mauritania.Future expansion possibilities areunderstood to include Benin and Mali. Tomanage its embryonic network ICD have setup a holding company, Tamweel Africabased in Dakar, Senegal.

And Then There is Nigeria

All of the countries where the ICD arecurrently active are predominantly Muslimand there seem to have been few problemsin establishing Islamic financial institutions.Indeed there seem to have been fewproblems in establishing Islamic finance insome African countries with quite smallMuslim minorities, most notably Kenya inthe east. The prospect of Islamic banking inNigeria on the other hand seems to becreating something of a storm.

The Islamic Corporation for theDevelopment of the Private Sector (ICD)is a subsidiary organisation of the SaudiArabia based Islamic Development Bank.It was established in 1999 and has 45country members from four continents –Asia, Africa, Europe and Latin America.Its objectives are to support theeconomic development of its membercountries by financing private sectordevelopment in accordance with theprinciples of Shari’ah and to advisegovernments and private organisations toencourage the establishment, expansionand modernisation of private enterprises.

Between 1999 and 2010, the ICD’s netcumulative approvals stood at 201projects worth $1.8 billion in 33countries. The bulk of the financingtargeted the industrial sector (33%),followed by the financial sector (29%),real estate (13 %), the oil and gas sector(6%) and the transport sector (6%).




The fact is that Nigeria is almost 50/50Muslim and non Muslim in terms of itspopulation. Just as with pre-partition Indiaand Sudan, Nigeria’s Muslim population isgeographically concentrated, so that thenorth of the country is predominantlyMuslim and the south is predominantlyChristian. Tension between the twocommunities has been a part of thelandscape of Nigerian politics ever sinceindependence in 1960 and problems havebeen exacerbated recently by the election ofsoutherner, Goodluck Jonathan, aspresident, following the death after a longillness of Umaru Yar’Adua, a northerner, inMay 2010. (Under an informal arrangementdating back to when military rule came toend in 1999 it was agreed that thepresidency would alternate between amember of the community from the Muslim

north and one from the Christian south.)Northerners have argued that their ‘turn’ inthe presidency had not come to an end andconsequently religion-based sensitivities arecurrently running high.

In addition to the political and socialtensions, 2009 saw Nigeria trying tostabilise its banking industry after a debtcrisis in 2009 almost led to its collapse. Thechief executives of eight lenders were firedby the central bank, which then pumped620 billion naira (approximately $4 billionUS) into the troubled banks, creating astate-owned company to buy bad debts.

This is the backdrop against which theenergetic new governor of Nigeria’s centralbank, Sanusi Lamido Sanusi, released finalguidelines in June 2011 for non-interest

National Mosque, Ajuba, Nigeria



NEWHORIZON October–December 2011COUNTRY FOCUS

banks that would allow the establishment ofIslamic banking in Nigeria. (Draft guidelineshad been issued in March 2009). Indeed thefirst approvals in principle under theseguidelines have now been issued and Islamicbanking operations are expected to start inNigeria by the end of 2011 – onefully-fledged Islamic bank and one windowoperation.

The Nigerian Journey

The basic regulation that would permit theestablishment of Islamic banking in Nigeriais not in fact that new. The Banking andOther Financial Institutions Act (BOFIA)came into law in 1991 and this is seen as thelegal basis for the establishment of Islamicbanking in Nigeria. One of the restrictionsimposed was as that no bank should use the

words Islamic, Christian, northern orsouthern in their titles, so as not toexacerbate religious and political tensions.Since that date there have been one or twoattempts to set up an Islamic bank, whichhad come to nothing for various reasons.

In June 2011 the Central Bank of Nigeria(CBN) issued revised guidelines fornon-interest banking. They were at some

The Contribution of the Nigerian IslamicFinance Working Group

Writing from Nigeria, Basheer Oshodi,who is a PhD candidate in IslamicIntegral Development, Associate Fellowof the IIBI and a member of the NigerianIslamic Finance Working Group EFInA(Enhancing Financial Innovation &Access) described the work of EFInA,which is an independent, professional,

consist of relevant financial regulatorsand a few Islamic finance operators.Their primary obligation is to provide afriendly environment for Islamic bankingand finance practice in the country.NIFWG has actively contributed to theCBN framework for non-interestbanking; the Securities & ExchangeCommission (SEC) guidelines for Islamicfund management and the NigeriaDeposit Insurance Corporation (NDIC)draft framework for the Non-Interest(Islamic) Deposit Insurance Scheme(NIDIS). It is also working to lay thegroundwork for sukuk issuance,including sovereign sukuk and a reviewof tax policies in order to achieve a levelplaying field for Islamic bankingproducts; as well as several other policiesthat would allow Islamic banking and finance to be sustainable in thecountry.

EFInA has also embarked on acomprehensive capacity developmentprogramme for members of the NIFWGto encourage the exchange of knowledgeand build the necessary foundation forIslamic finance in Nigeria. BasheerOshodi emphasises the importance of thelatter given that the CBN Shari’ahgovernance regulation for AdvisoryCommittees of Experts (Shari’ahadvisors) requires that no individualadvisor can belong to more than onefinancial institution in the same category.This means there is a pressing need formore scholars trained in Islamiccommercial jurisprudence as it relates tobanking and finance.

non-profit organisation funded by DFID(the UK’s Department for InternationalDevelopment), the Bill & Melinda GatesFoundation and the Ford Foundation.EFInA was set up in 2007 with the aim ofmaking the country’s financial system workbetter, especially for the poor. EFInA led theinitiative to constitute the Nigerian IslamicFinance Working Group (NIFWG) andenjoys technical partnership from the UKIslamic Finance Council (UKIFC). NIFWG

Mr Basheer Oshodi




pains to make it clear that non-interestbanking was not just about Islamic banking,but also other forms of non-interestbanking; additionally banks were strictlyprohibited from discriminating againstindividuals or institutions on religious orany other grounds. They also removed anyreference to a Shari’ah Council and replacedthis with the term Advisory Council ofExperts, whose responsibility will be ‘toadvise the CBN on the appropriateness ofrelevant financial products to be offered bythe institutions.’

In May 2011 Jaiz Bank was granted apreliminary licence to set up an Islamicbank and in June Stanbic IBTC Bank, adivision of South Africa’s Standard Bank,was granted a similar approval to set up aShari’ah-compliant banking window. Jaizand Stanbic have six months to make use ofthese preliminary licenses, but if they fail todo this, then they will have to reapply.Apparently other banks have expressed aninterest in acquiring a licence to establishIslamic banking operations in Nigeria,although at the time of writing there was nodefinite news of any specific applications orapprovals.

Why Now?

Why is there an apparently sudden surge ofinterest in establishing Islamic banking in

West Africa? Ostensibly it is aboutproviding Shari’ah-compliant banking forthe Muslim populations of West Africanstates. Certainly that is an important andlaudable objective, but there is something ofa chicken and egg situation in play here.People living at a subsistence level have verylittle need for bank accounts. If people areto be raised out of poverty, there is a needfor investment to develop West Africaneconomies.

West African countries, notably Nigeria and Senegal, have seen the enormoussuccess of Malaysia in the sukuk marketand can readily understand the benefits acomparable development would bring toWest Africa. Both Nigeria and Senegal are already talking about issuing sovereign sukuk in the foreseeable future. The IDB is already working withSenegal to issue a $200 million sukuksometime in 2011. Nigeria is also talkingabout a sovereign sukuk sometime beforethe end of 2012, but there are no furtherdetails, just a statement of intent by Lamido Sanusi at a June conference inSenegal.

Before Nigeria can realise its ambitions it needs to have the right financialinfrastructure in place and in July 2011 thecountry set up a Non-Interest BankingRegulation Project that will address issues

such as establishing the right regulation and taxation framework. This is all part of Nigeria’s attempt to bridge its huge infrastructure deficit of 32 trillion naira (approximately $2 trillion). Thecentral bank’s objective is to cut publicfunding of development projects and largely replace it with private investment and its eyes are firmly on theoil-rich investors of the Middle East and the GCC. Certainly the types of investments in West Africa should beattractive to Muslim investors, for example, gold mining, oil refining, powergeneration, transport and logging; these areall industries compatible with Shari’ahrequirements.

Nigeria, however, has to address more than creating the right environment forIslamic banking and investment to takeplace; it has to convince the whole country that this is not Islamisation by the back door and therefore in directcontravention of that country’s secularconstitution. It has to convince all sectors of the community, Muslim, Christian and those of other religions or no religion at all that Islamic finance canbring enormous benefits to everyone. Readsome of the less than temperate outpouringsin local African media and you will realisethat this is going to be no quick or easytask.



NEWHORIZON October–December 2011POINT OF VIEW

Impediments to the Use of Mudarabah

One of the major impediments to the use ofmudarabah on the asset side of a bank, i.e.for financing, is that the rabb-al-maal bearsall the financial losses. If, therefore, anIslamic bank enters into a mudarabahcontract as a rabb-al-maal, the Islamic bankwould bear all the losses. The mudaribbears no loss, but he is in sole charge ofrunning the affairs of the business. Therabb-al-maal is not allowed to interfere inthe affairs of the business.

When a loss occurs, the mudarib, like anyemployee of the business, has responsibilityfor the loss, but when a profit occurs, heshares in the profit as if he were solelyresponsible for those profits. This juristicviewpoint did not create much problemduring the early Islamic era, when themudarib was often a poor person with fewresources; limited incentive and ability toengage in corrupt activities and no capacityto participate in loss sharing, if the loss wascaused by anything other than negligence onhis part.

Loss Sharing

The principle that loss sharing should bebased upon and limited to the amount ofcapital invested is not a conditionmentioned in the Qur’an or Hadith. Fuqaha recommended it, but it does notmean that it cannot be modified, especiallyif doing so is necessary to make thepreferable Islamic modes of financing moreapplicable. When we set the terms andconditions for employment contracts or forthe appointment of Shari’ah advisors, forexample, any condition not in violation ofIslamic principles is allowed and is used.

Similarly, limiting loss sharing up to theamount of capital invested is not the onlyway loss sharing could take place.

Furthermore, in musharakah, lossparticipation by all partners across theboard is justifiable, because all partners arealso allowed to work, but, due to thecondition in mudarabah that the workingpartner is the sole authority when it comesto decision making in the business,stipulating that the rabb-al-maal iscompletely responsible for all losses isunjustified in the first place.

It is considered that in the case of loss, themudarib loses the compensation for hisefforts, but, the mudarib was never anemployee; he was a joint partner, moreprecisely, a working partner. Taking theposition that he lost the compensation forhis work is inviting opportunity cost, whichIslamic economics apparently does notacknowledge.

In mudarabah, the prevalent concept of loss sharing makes it different from ageneral partnership, where all partners have unlimited liability and even fromlimited partnership, where some or all have limited liability. In mudarabah, therabb-al maal not only has unlimited liability,but no authority to participate in thebusiness.

The Impact on Small Savers

In an Islamic economy with mudarabah onthe asset and liability side, the mudarib(usually blue chip companies) with noliability for sharing losses can obtainfinancing from banks, who would be rabb-al-maal on the asset side of mudarabah; onthe liability side, the bank will be mudarib

A Critical Look at the Ideal Mode ofIslamic Financing

By Salman Ahmed Shaikh, Research Analyst and Financial Consultant, BMC Pakistan

The principle that loss sharingshould be based upon andlimited to the amount of capitalinvested is not a conditionmentioned in the Qur’an orHadith. Fuqaha recommendedit, but it does not mean that itcannot be modified, especiallyif doing so is necessary tomake the preferable Islamicmodes of financing moreapplicable.



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 POINT OF VIEW

and small savers and investors will be rabb-al-maal, so any loss incurred by bluechip companies is ultimately paid by smallsavers and investors who have all theliability for losses without having a say inthe affairs of the business! Restrictedmudarabah and a clause of wilful negligenceare insufficient to protect them from lossesincurred through fluctuations in thebusiness cycle. This example shows thatwith the current structure, mudarabah usedalone in an economy is insufficient to bringabout any egalitarian change, let aloneprove to be fairer than an interest-basedsystem.

Let us analyse trust deficit anddocumentation problems, which are cited asreasons why mudarabah is not being usedwidely. Relax these assumptions and nowconsider there is no trust deficit anddocumentation problem in the economy. If a loss occurs due to business cyclefluctuations, no part of the loss is borne bythe business that had all the authority to run the business; nor is the loss is borne bythe bank, because the bank is mudarib onthe liability side. All losses are borne by thesmall savers and investors.

Mudarabah is Currently Ineffective

Will people want to be rabb-al-maal inmudarabah with a bank or the shareholdersin a blue chip company, which can take allthe money, invest it, earn from it and if aloss occurs, pass it on to the small savers!Mudarabah (with the current structure),even when assumptions of trust deficit anddocumentation problems are relaxed andeven when there is no competingconventional banking system, is ineffectiveto say the least.

If we look at mudarabah as it is currentlyunderstood, the mudarib is basically anemployee who would get ujrat-e-misl(normal salary) and his compensationwould feature some share in profit as well.He is not liable to bear any loss. (Somescholars say the mudarib should not get asalary where a loss occurs – Ed.) The rabb-al-maal is basically the entrepreneur (whohas the ultimate responsibility for anylosses). How can this be described as a

participatory mode; it should not be cited asa participatory mode with its currentstructure. Secondly, it is also different froma principal/agent relationship in corporateorganizations in that the principal hires theagent only because of his owninability/incapacity, but the rules do notprevent him from influencing an agent’sdecisions. Important decisions taken by theagent(s) have to be vetted in an AGM.Mudarabah rules do not even allow thatmuch participation, so, in my humbleopinion, we first need to justify howmudarabah can be considered a ‘just’ modeof financing, let alone a participatory oneand a most preferable one.

Equity Financing

With important covenants in place, equityfinancing can be and is used widely. It isinteresting to study the size of the debt andequity markets in developing countries. Forinstance, in Pakistan, the corporate bondmarket barely exists, whereas equityfinancing is more prevalent and widely used.Equity financing will forever deny theclaims of bankers in general and Islamicbankers in particular, who hide behind trustdeficit and documentation problems. Whythen do people invest in equity without anyguarantee over par value, let alone dividendand when the cash inflow situation is farfrom transparent? This is an importantquestion, which needs an answer, especiallygiven that some financiers promote Islamicfinance and the way it is currently practicedfor commercial reasons.

Conclusion

With the current orthodox understandingand practice of Islamic finance, the oftencited preferable modes such as mudarabahand musharakah are inadequate even in asimple economy. The end result is that theyare not used and will not be used for thereasons discussed above.

The prevalent Islamic products linked withLIBOR are and will be used for the mostpart with the result that Islamic finance mayremain incapable of providing theegalitarian benefits it once promised.Ironically, Islamic values like justice,

Salman Ahmed Shaikh in addition to hisrole at BMC Pakistan is a visiting facultymember at several institutions of highereducation and a prolific author with twobooks and a number of research papersto his credit. He has also worked with anumber of financial organisations, mostrecently for Pakistan’s Meezan Bank.

equality, truth, trust, kindness, honesty andresponsibility are often discussed inliterature and seminars on Islamiceconomics; whereas, in reality, the lack ofthese values in practice in most Muslimcountries is the major reason why preferable participatory modes remainunusable!



NEWHORIZON October–December 2011ACADEMIC ARTICLE

Islamic and Conventional Insurance – AComparison

It has been widely accepted today thatIslamic insurance or takaful, unlike itsconventional counterpart, is based on thefundamental principles of mutualcooperation (ta’awun) and donation(tabarru`). Under the Islamic laws oftransactions (fiqh muamalah), the existenceof gharar (ambiguity) and maysir (gambling),which normally nullify an exchange contract(muawadah), are tolerated in a contract ofdonation (tabarru`). This corresponds to theIslamic legal maxim ‘uncertainties aretolerable in a gratuitous contract’.

This is mainly due to the fact that partieswho enter into a tabarru` contract do notaim to make profit out of the contributedsum and hence the potential dispute thatnormally arises in a profit-makingtransaction is deemed to be negligible in agratuitous-based transaction. Furthermore,the issue of uncertainty is irrelevant sincethe contributor voluntarily gives away hisproperty or right to the recipient withoutany consideration.

In contrast, conventional insurance, whichis based on the principle of muawadah(exchange) and aims at making profit out ofthe insurance operations, is prohibited fromthe Shari’ah viewpoint since it containsgharar (ambiguity). This is particularly truesince a person who pays the premium(insurance price) for the insurance policyhas actually paid for ‘peace of mind’, whichwill indemnify him should any mishap occurin the future. Being free from uncertaintiesis never possible in the insurance industry,because uncertainties are peculiar andintegral to both premium/contribution andclaim/compensation.

On the other hand, the Islamic alternative toconventional insurance, also known as

takaful, reflects a reciprocal relationshipand agreement of mutual help betweenparticipating members, who undertake tomutually guarantee and indemnify eachother in a particular defined event. The actof guaranteeing each other implies mutualhelp and mutual indemnity on the basis ofbrotherhood and is deeply rooted in thetabarru` principle, which tolerates thepresence of gharar.

What is Tabarru’?

Tabarru’ is derived from the word tabarra’a,which carries the meaning of contribution,gift, donation or charity. Tabarru’technically is a unilateral declaration ofintent, which is a contract with a particularnature in Islamic commercial law. Thepurpose of this type of contract is to give afavour to the recipient without any specificconsideration in return. Unlike the exchangecontract, this type of contract is valid andenforceable in Islamic commercial law evenfor no consideration.

The basis for tabarru’ is stated in theQur’an:

قرشملا لبق مكهوجو اولوت نأ ربلا سيلمويلاو هللاب نمآ نم ربلا نكـلو برغملاو

ىتآو نييبنلاو باتكلاو ةكئآلملاو رخآلاىماتيلاو ىبرقلا يوذ هبح ىلع لاملا

يفو نيلئآسلاو ليبسلا نباو نيكاسملاونوفوملاو ةاكزلا ىتآو ةالصلا ماقأو باقرلا

ءاسأبلا يف نيرباصلاو اودهاع اذإ مهدهعباوقدص نيذلا كئـلوأ سأبلا نيحو ءارضلاو

نوقتملا مه كئـلوأو

‘It is not righteousness that ye turn yourfaces to the East and the West; butrighteous is he who believeth in Allah andthe Last Day and the angels and theScripture and the prophets; and givethwealth, for love of Him, to kinsfolk andto orphans and the needy and thewayfarer and to those who ask, and to set

Revisiting the Fundamental Structure of Takaful

By: Dr. Asyraf Wajdi Dusuki, International Academy for Islamic Finance (ISRA)

Under the Islamic laws oftransactions (fiqh muamalah),the existence of gharar(ambiguity) and maysir(gambling), which normallynullify an exchange contract(muawadah), are tolerated in acontract of donation (tabarru`).



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433ACADEMIC ARTICLE

slaves free; and observe proper worshipand pays the poor-due; and those whokeep their treaty when they make one,and the patient in tribulation andadversity and time of stress. Such are theywho are sincere. Such are the God-fearing.’ (2: 177)

It is also supported by many hadiths; forinstance, in a hadith Asma’ narrated thatthe Prophet (p.b.u.h) said:

الو كيلع هللا يصحيف يصحت الو يقفنأكيلع هللا يعويف يعوت

‘Give (in charity) and do not givereluctantly lest Allah should give you in alimited amount; and do not withholdyour money lest Allah should withhold itfrom you.’ (Sahih Bukhari)

Essentially, tabarru’ is a contribution ordonation, which entails no return but rathera reward from Allah alone. There are twoimportant pillars of tabarru’, namely theabsence of counter-value and the intentionto perform tabarru’. In the absence of anyof the two, it is no longer consideredtabarru’. For instance, if a donorcontributes with an expectation of acounter-value from the donation given, thenthe whole transaction will be perceived asan exchange (muawadah) rather than atabarru` contract.

Tabarru in the Takaful Context

This basic structure of takaful premised onthe tabarru` principle gives rise to one of thefundamental Shari’ah concerns, which isregarding the absolute ownership transfer.When a participant pays a premium to thetakaful operator, he has effectively donatedhis contribution as tabarru`, hence,relinquishing his ownership over the objectdonated as prescribed by the rules oftabarru`. Ibn Qudamah in his famous bookAl-Mughni asserts that hibah (which is aform of tabarru` contract) requires the giftgiver to enable the beneficiary to own theobject of hibah. It is further reiterated byIbn Nujaym in Al-Bahr al-Raìq Sharh Kanzal-Daqaìq that the most importantimplication of hibah will be the transfer ofthe subject matter to the beneficiary/donee,

which entitles him to hold the title ofownership over the object of hibah (thubutal-milk li`l mawhib lahu).

Nevertheless, it is observed that a takafulcontract cannot be considered a puretabarru’ contract, but rather a qualified orconditional tabarru’ contract for thefollowing reasons:

Firstly, the contribution made by aparticipant in takaful is withconsideration to a right to claim forcompensation in the event of loss ordamage of subject matter. Thus, thetabarru’ is not merely for charity, butconditional upon certain consideration,namely the right to claim takaful benefitsin the event of loss. Without such a right,he will neither participate nor perform the tabarru’. This is deemed to be aviolation of the fundamental objective oftabarru’.

Secondly, takaful participants arenormally obliged to pay differentamounts of contributions depending ondifferent degrees of risk exposure. Thisinevitably implies that their participationin the fund is conditional upon a certainamount of contribution to deserve acertain amount of compensation. Shouldthe participant disagree with the amount,he will not be allowed to participate orbenefit from the takaful protectionscheme. Again this would be perceived ascontradictory to the nature of tabarru`since the real intention of the contractingparties is not donation, but rather tomake them eligible for certain benefitsunder takaful.

Thirdly, there are some controversialpractices in takaful operations, whichcontravene the pure tabarru’ concept, for example, surrendering of benefit,survival benefit or even sharing ofunderwriting surpluses amongparticipants of takaful, although theyhave surrendered all their rights over theirmoneys donated to the fund. It shouldnot, therefore, return to the participantsupon maturity of the policy or liquidationof the fund.

In takaful, the participantscommit themselves to performtabarru’ to other participantswho sustain losses. Thisprinciple is important as themajority of scholars are of theopinion that tabarru’ is notcomplete unless the subjectmatter is transferred to thedonee, although a commitmentto donate has been given.



NEWHORIZON October–December 2011ACADEMIC ARTICLE

An Alternative to Pure Tabarru’

As an alternative to the pure tabarru`concept the Accounting and AuditingOrganisation for Islamic FinancialInstitutions (AAOIFI) has suggested theprinciple of Iltizam bil tabarru’ or acommitment to donate, in order tounderscore the relationship between theparticipant and the fund. According to this concept, a contributor may donate asum of money for mutual assistancepurposes on condition that the balance, ifany, should be returned to him. This willallow him to retain his ownership right over the initial contribution he made, with a provision allowing him to waive hisright of ownership over the portion used to indemnify other participants.

This principle was expounded by Malikijurists, whereby if a person commits himselfto do a good deed without subjecting it toother conditions, he is obliged to fulfil it aslong as he did not die or become bankrupt(See Al Hattab, Tahrir Al Kalam fi Masa’ilAl Iltizam, Beirut: Dar Al Gharb Al Islami,1984 at p 71). In takaful, the participantscommit themselves to perform tabarru’ toother participants who sustain losses. Thisprinciple is important as the majority ofscholars are of the opinion that tabarru’ isnot complete unless the subject matter istransferred to the donee, although acommitment to donate has been given. Thisis observed in the question of hibah,whereby possession (qabd) of the subjectmatter is a condition for a binding hibah;this is the opinion of many jurists not onlyMaliki jurists.

However, the Maliki jurists are of theopinion that a commitment to donate orgive is sufficient to create a bindingdonation, based on the saying of Saidina Aliand Ibn Mas’ud that:

مل وأ تضبق ةمولعم تناك اذإ ةزئاج ةبهلاضبقت

‘A gift, if specifically defined, is binding,whether received or not’ and to preventthe materialization of the saying of theProphet:

هئيق يف عجري بلكلاك هتبه يف دوعي يذلا

‘a person who withdraws his gift ordonation is like a dog that withholds itsvomit.’ (Sahih Bukhari).

This principle is important in the case oftakaful whereby upon participating in atakaful contract, the participants are said tohave given a full commitment to paycontributions to the takaful fund; the fundis also committed to compensate themagainst any losses experienced by themwithin the period of the policy. If aparticipant delays payment of hiscontributions, the company can claim thecontributions from him and it may beconsidered as his debt to the fund until heofficially withdraws from the policy. Thefact that he has not delivered his donationdoes not make him not liable to pay it, as hehas committed himself to pay it and it isalready a binding contract. So, iltizam biltabarru’ here is deemed to be binding andenforceable as iltizam or a pledge alone cancreate a binding tabarru’ contract. Assertingthat takaful is a binding contract isimportant as it is the basis for thecomputation of the periodical contributionsand the amount of compensation payable tothe participant.

On the other hand, the relationship betweenthe fund and the recipient of thecompensation is said to be iltizam bil ta’widor a commitment to compensate, which is aform of iltizam bil tabarru’. It is said to be aform of conditional commitment wherebythe performance of the commitment issubject to the certain need, namely a claimby a takaful participant due to some losssustained. In takaful, therefore, thecontributions of the participant may beutilised fully or partially, thus allowing himto claim any underwriting surplus. This isbased on the opinion of Sheikh Abdul SattarAbu Ghuddah in Buhuth fil Mu’amalat walAsalib Al Masrifiyyah Al Islamiyyah, vol. 6,Jeddah, Majmu’ah Dallah Al Baraka, 2005at p. 300.

Notwithstanding the above, the questionremains whether the counter-value in suchtakaful practice is tantamount to an

exchange contract? This is so according toAl Hattab in his book Tahrir Al Kalam fiMasa’il Al Iltizam; if a commitment is givensubject to a condition that when a donorcontributes something, he is expecting acounter-value then it falls under thecategory of hibah al thawab, a gift given tothe beneficiary on condition that a reward isgiven to the donor in exchange. Forexample, I give this pen as a gift oncondition that you give your book in return.In the takaful context, the gift is thecontribution and the thawab is theindemnification by the risk fund. It isopined that the ruling of hibah bi al-thawabwill take the ruling of an exchange contract.In the final analysis, the fundamentalstructure of takaful needs to be re-examinedto accommodate the various practices oftakaful operation and to address the variousclientele’s needs.

Associate Professor Dr Asyraf WajdiDusuki is currently Head of ResearchAffairs, International Shariàh ResearchAcademy for Islamic Finance (ISRA). Healso serves as a Chairman of theShari’ah Committee for AIA AFG Takafuland AIA Takaful International.



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 ANALYSIS

If Islamic financial institutions are to becredible to their clients, they need to have aformalised system to ensure that all theiractivities are Shari’ah compliant. Exactlywhat constitutes an effective Shari’ahgovernance system is a matter of debatehowever and it is apparent from examiningthe experiences of different countries andinstitutions that a variety of systems are inplace. This pluralistic approach hasadvantages, as the legal environments inwhich Islamic financial institutions operatediffer, not only in terms of the status ofShari’ah but also depending on whether thecountries use common or civil law.Furthermore client expectations of whatconstitutes acceptable and effective Shari’ah governance differ, and as will beevident from this study, most systemscurrently employed are market rather than state driven. Indeed in the realm ofIslamic finance, Shari’ah governance haslargely been privatised rather thannationalised.

The Legal Framework

Although Islamic financial institutionsoperate around the world in bothpredominately Muslim and non-Muslimcountries, there are few states that haveincluded provision for Shari’ah governancein their banking, insurance or capitalmarket laws.

Saudi Arabia

Saudi Arabia, despite its central position inthe Islamic world, has no specific legislationon Islamic finance, although adherence toShari’ah is enshrined in the legal system.Under chapter 1 of its Basic Law it is statedthat that the Qur’an and the Sunnahrepresent the constitution of the Kingdomand the role of Shari’ah governance isstressed under article 45 which provides forthe establishment of a board of religiousadvisers drawn from the ulama (the body ofeducated Muslim scholars). The charterwhich established the Saudi ArabianMonetary Agency (SAMA), which serves asthe central bank, states under article 2 thatSAMA will not pay or receive interest, butrather pay fees for its services. The BankingControl Law is silent on the question ofinterest and contains no reference toShari’ah, and several articles in the law,notably article 16, specifically refer to loanson which interest will presumably becharged. In practice like most central banksSAMA uses repurchase agreements (repos)for its money market operations, whichgiven the fixed exchange rate with the USdollar tend to follow Federal Reserve rates.The repo rates directly influence banklending rates, which can be viewed as riba.

However the banking laws and regulationsin Saudi Arabia make no explicit mention of

interest. In the Consumer Credit regulationsof January 2006 reference is made to bothconventional borrowing and Islamic profitrates under section 2.2.2 and theterminology used rather than interest is theannual percentage rate of charge (APR),which must be disclosed to clients. Section2.3 states that for Islamic productsdocumentation covering the underlyingpurchase and sale of goods should complywith the requirements of the banks Shari’ahCommittee, the first ever mention ofShari’ah compliance in the SAMAregulations. SAMA, although it has beencriticised in the past for ignoring Islamicbanking, has become more actively involvedin recent years, and indeed its DeputyGovernor, Dr Abdulrahman Al Hamidy,served as chairman of the Shari’ahGovernance Working Group of the IslamicFinancial Services Board. (IFSB)

Iran

Across the Gulf in Iran the entire financialsystem has been Islamic since the enactmentof the Law on Interest Free Banking in1983. Article 1 provides for theestablishment of a monetary and creditsystem based on rightness and justice asdelineated by Islamic jurisprudence andArticle 3 provides for the acceptance ofcurrent deposits based on qard hasan,whereby the clients provide the bank with

Shari’ah Governance for Islamic Financial Institutions

By: Professor Rodney Wilson, Durham University, UK

Earlier this year we reported on Shari’ah governance, particularly the shortage ofsuitably qualified scholars and the potential conflicts of interest arising from scholarsserving on multiple Shari’ah boards. This paper given by Professor Rodney Wilson inSeptember 2009 provides a more detailed background, which goes some way toexplaining how and why Shari’ah governance varies from region to region andcountry to country. It concludes that although much work remains to be done interms of Shari’ah governance, it is market forces that will remain the main driver ofthe growth of Islamic finance across the globe.



NEWHORIZON October–December 2011ANALYSIS

an interest free loan and term investmentdeposits based on mudaraba, where theclient shares in the bank’s profits.Mudaraba can also be used for financing asspecified in Article 9, and reference is alsomade to operational leasing and otherfunding methods commonly accepted aspermissible under Shari’ah. Iran’s lawhowever does not cover Shari’ahgovernance, as there is no provision for on-going surveillance through the appointmentof a Shari’ah Board to ensure that financialtransactions comply with the law. Ratherthis is the responsibility of the Central Bank,but the Bank itself does not have a Shari’ahBoard. Banks themselves are still regulatedunder the earlier Monetary and BankingLaw of 1972, which was enacted wellbefore the Islamic Republic was founded.The seven state owned and six private banksoperating in Iran make no reference toIslamic values or Shari’ah-based orcompliant financial products in their reportsor publications, although there is noreference to interest, but rather to profitrates.

Gulf Co-operation Council

The first Islamic banking law in the GulfCo-operation Council (GCC) was enactedby the UAE in 1985. Under Article 5provision was made for the establishment ofa Higher Shari’ah Authority including fiqhscholars and legal and banking personnel toensure that Islamic banks, financialinstitutions and investment companies wereconducting their business in accordancewith Shari’ah law. The proposal of havingcommercial lawyers, financial experts aswell as fiqh scholars was subsequentlyadopted in Sudan, but nowhere else. In theUAE Article 5 provided that the HigherShari’ah Authority should be establishedand approved through a cabinet decision,but this never happened, although there hasbeen some debate since 2008 about whethersuch a body should be established.

In practice it was Article 6 of the UAEIslamic banking law that was implemented.This states that each Islamic bank, financialinstitution and investment company shouldestablish its own Shari’ah Supervisory

Authority to ensure that its transactions andpractices conform to Islamic law. Provisionfor this should be made in the articles andmemorandum of association of each Islamicbank and the Authority should consist of atleast three members. This devolved systemof Shari’ah governance was favoured in theUAE, not least because at the time the lawwas passed the Dubai Islamic Bank was thesole institution of its type and it preferred toregulate itself as far as Shari’ah compliancewas concerned rather than being governedfrom Abu Dhabi.

Very comprehensive legal provision forIslamic banking was introduced in Kuwaitwhen the banking law was revised in 2003so that the Kuwait Finance House could bebrought within the regulatory authority ofthe Central Bank and the market for Islamicfinancial services could be opened for newentrants. Section 10 was added withconventional banks permitted under Article86 to apply for licenses to establishsubsidiaries offering Islamic bankingfacilities. Under Article 93 each Islamicbank is required to appoint a Shari’ahBoard with at least three members, withappointments subject to ratification by eachbank’s general assembly. Shari’ah Boards arerequired to submit an annual report to thegeneral assembly confirming that the banks’operations comply with Shari’ah principlesand this report should be included in theannual financial statements. In the event ofdisputes between Shari’ah Board members,the board of directors may refer the matterto the Fatwa Board of the Ministry ofAwqaf and Islamic Affairs, which will serveas the final authority.

Indonesia

As knowledge of what is required forIslamic financial institutions to functioneffectively has increased legislation hasbecome much more detailed. TheIndonesian legislative provision of 2008 is agood example of this, as, although Islamicbanks account for less than two percent ofdeposits, there is a political commitment toShari’ah finance playing an increasing rolein what is the world’s most populousMuslim country. This is driven by two

factors, the first being to ensure that thepious participate in the financial systemrather than being excluded and the secondby the desire to benefit from Indonesia’sgood relations with other Muslim countriesthrough the Organization of the IslamicConference (OIC) and in particularcapitalise on its relations with the GCC.

Under Article 32 of the Indonesian Shari’ahBanking Act a Shari’ah Board must beestablished by each Islamic bank and allconventional banks offering Islamicfinancial services. The Shari’ah Boardmembers are nominated by the IndonesianUlama Council, a state body which is incharge of all Islamic matters in the country.The nominees have to be approved by thegeneral meeting of shareholders of theinstitution that they serve. Under Clause 3of Article 32 the remit of the Shari’a Boardis to give advice and recommendations tothe Board of Directors of the Islamic bankor conventional bank offering Islamicfinancial services. Clause 4 of Article 32states that Bank Indonesia will regulateShari’ah governance, which provides greaterongoing flexibility and the ability torespond more rapidly to issues as they arisethan might be the case with the UlamaCouncil.

Regulatory requirements

Malaysia

In most jurisdictions Shari’ah governancehas been dealt with at the regulatory level.Malaysia for example passed an IslamicBanking Law in 1983 which specified thatbanks registered under the act should notundertake operations which were notapproved by the religion of Islam. Howeverno mechanism for Shari’ah governance wasspecified in the law and it was only inDecember 2004 that Bank Negara, theCentral Bank of Malaysia, produceddetailed guidelines on Shari’ah governance.These guidelines provide for how membersof Shari’ah Boards should be appointed, theduties and responsibilities of the Boards andtheir relationship with the Islamic financialinstitutions they serve. The system ofShari’ah compliance is more centralised inMalaysia than in the GCC, as only the




Shari’ah Boards of Bank Negara and theSecurities Commission have the power toissue fatwa, the role of the Shari’ah Boardsof Islamic financial institutions being toserve as audit units to ensure that thesefatwa are implemented with respect to thecontracts offered. In contrast in the GCCnone of the central banks, SAMA or theSaudi Arabia Capital Markets Authorityhave their own Shari’ah Boards.

The Bank Negara Guidelines apply toIslamic banks, takaful operators andconventional banks offering Shari’ahcompliant products. They recommend thatShari’ah Boards should have at least threemembers, all of whom should have thenecessary knowledge, expertise andexperience in either Islamic jurisprudence orIslamic commercial law, fiqh muamalat.Those appointed who fail to attend morethan 75 percent of board meetings will bedisqualified, as will any member whobecomes bankrupt or is found guilty of anyserious criminal offence. Members of theShari’ah Boards of Bank Negara and theSecurities Commission cannot serve on theboards of Islamic commercial institutionsand vice versa. For reasons ofconfidentiality Shari’ah Board members canonly serve on one board. All Shari’ah Boarddecisions will be recorded in a Shari’ahcompliance manual which should beretained for future reference. Decisionsshould be backed with evidence fromrelevant Shari’ah jurisprudential literature.Shari’ah opinions should not only beprovided to the Islamic financial institutionbut also its external auditors and legalcounsel if requested. For its part the Islamicfinancial institution should make availablewhatever documents are required toconduct its work and provide adequateresources to facilitate the smooth running ofthe Shari’ah Board. Once the Shari’ahBoard’s recommendations are made theIslamic financial institution has a duty tocarry them out.

An appendix to the Bank Negara Guidelinesprovides an application form for those whowish to serve on Shari’ah Boards.Applicants have to provide details of theiracademic and professional qualifications as

well as information on working experience.As those appointed are often academics inMalaysian universities, applicants are alsoasked to provide details of any scholarlypublications such as books or journalarticles as well as working papers and otherresearch in progress. If they are alreadyserving as Shari’ah advisors this must bedeclared. This standardised system meansthat Bank Negara has a database on allShari’ah Board members serving in thecountry. While the process of appointmentdoes not represent a formal system ofaccreditation, it does provide a centrallycontrolled vetting procedure for all thoseserving on the Shari’ah Boards of Islamicfinancial institutions in Malaysia. Inpractice it can be regarded as a system ofpeer review, as it is the members of theShari’ah Board of Bank Negara who decidewho should be approved, which obviouslyenhances the power and status of that body.

Sudan and Pakistan

Sudan and Pakistan also have Shari’ahBoards affiliated with their central bankswith the power to issue fatwa and providedefinitive rulings on questions referred tothem by the Shari’ah Boards or advisorsserving Islamic financial institutions. In thecase of Sudan the High Shari’ah SupervisoryBoard comprises not only fiqh scholars, butalso specialists in finance. This has the meritof ensuring the fiqh scholars are aware ofthe financial consequences of their actionsand are better informed about the oftencomplex structures they are asked toapprove. On the other hand it could beargued that having members of the HighShari’ah Supervisory Board with limitedknowledge of fiqh serving dilutes theinfluence of Islamic jurisprudence.

The State Bank of Pakistan issued verydetailed Instructions and Guidelines forShari’ah compliance in Islamic bankinginstitutions in 2008. Part A of theInstructions provides for the appointment ofShari’ah advisors. Under Clauses (i) and (ii)Shari’ah advisors should be appointed bythe Board of Directors in the case of adomestic bank, or by the management in thecase of foreign Islamic banks having

This standardised systemmeans that Bank Negara has adatabase on all Shari’ah Boardmembers serving in thecountry. While the process ofappointment does notrepresent a formal system ofaccreditation, it does provide acentrally controlled vettingprocedure for all those servingon the Shari’ah Boards ofIslamic financial institutions inMalaysia.




branches in Pakistan. Under Clause (iii) theShari’ah advisors should meet ‘fit andproper’ criteria and under Clause (iv) theyshould be appointed for a renewable term ofthree years. If Shari’ah advisors are removedor resign before the end of their period ofappointment, under Clause (vii) the StateBank of Pakistan should be informed withinfourteen days and the reasons given for thetermination of the appointment. This clauseshould help safeguard the independence ofShari’ah advisors. Under Clause (ix) thefatawa and rulings of Shari’ah advisors arebinding on the institution that appointsthem.

Part B of the State Bank of PakistanInstructions outlines the duties andresponsibilities of Shari’ah advisors. TheInstructions stipulate that it is the duty ofthe Shari’ah advisor to ensure that allproducts and services offered by Islamicfinancial institutions are Shari’ah compliant.In the case of newly approved products theShari’ah advisor shall arrange a trainingprogramme for the staff involved. Thisshould help ensure bank staff are betterinformed when advising clients and dealingwith their queries. Shari’ah advisors shouldhave access to all the necessary records anddocuments needed in their work and theywill be responsible for ensuriung that anyincome derived from a source, which is notcompliant with Shari’ah, is paid into acharity account and thereby purified.Shari’ah advisors can also be called on togive advice to the legal team of an Islamicfinancial institution.

Part C of the State Bank of Pakistan’sInstructions stipulates that Shari’ah advisorsshould prepare a report for inclusion in theannual financial statements of the Islamicfinancial institution. The report shouldindicate whether all the institutionsoperations were Shari’ah compliant andwhether the funds allocated to the profitand loss sharing mudaraba investmentaccounts are fair and whether the profitsharing ratios are appropriate. This is auseful stipulation, as it provides a measureof protection to investment mudarabaaccount holders, as there is a potentialconflict between their interests and those of

the shareholders in an Islamic financialinstitution. The Board of Directors looksafter the shareholders’ interests, so it is alsoappropriate that the investment mudarabaaccount holders should have someone tochampion their rights.

Part D of the State Bank of PakistanInstructions deals with conflict resolution inShari’ah rulings where Shari’ah advisorsdisagree. This is dealt with in a similarmanner to the Malaysian practice, asdisputes should be referred to the StateBank of Pakistan’s Shari’ah Board. They arethe final authority and their decisions arebinding. This type of system encouragesShari’ah Boards to reach consensus, asobviously there will be a reluctance to refercases to a higher authority unless allavenues of reaching agreement areexhausted.

Gulf Co-operation Council

In the GCC the regulators do not have theirown Shari’ah Boards and therefore the issue ofdispute resolution becomes more problematic.In the case of Kuwait where there isdisagreement this should be referred to theBoard of Directors of the Islamic financialinstitution. They can then refer the matter to theShari’ah Board of the Ministry of Awqaf andIslamic Affairs, as already indicated, for anindependent, but binding opinion. The concernwith this procedure is that the expertise of theShari’ah Board of the Ministry concern Awaqfand not necessarily Islamic banking,Shari’ah-compliant fund management ortakaful. The position is similar in Qatar, wherethere is also no Central Bank Shari’ah Board,but disputes can be referred to the SupremeShari’ah Council of the Ministry of Awaqaf. InQatar there is also provision for the CentralBank to appoint independent Shari’ah scholarsto resolve the issue, although this has neverbeen used.

Both Qatar and Dubai have financial centres,which function under their own laws andregulations rather than under national laws. Thepurpose of these centres is to attract a widerange of financial institutions to provideinvestment banking and asset managementservices, rather than retail financial business for

local nationals and residents, which areregulated by the central banks. The DubaiInternational Financial Centre has no specialprovision for Islamic finance, but at itsinception the Qatar Financial Centre RegulatoryAuthority decided to draft a detailed rulebookon Islamic finance. The rules governing theappointment and operation of Shari’ahSupervisory Boards are set out in Section 6.This states that the Shari’ah Supervisory Boardshould comprise at least three members and thatthose appointed should be suitably qualifiedand experienced. Appointments should beapproved by the governing body of the Islamicfinancial institution, normally the Board ofDirectors, and Shari’ah Board membersthemselves cannot serve as directors orexecutive officers. This is to ensure theirindependence. Islamic financial institutionslicensed by the Qatar Financial Centre mustdocument their policies with regard to theappointment of Shari’ah Board members andprovide details of their remuneration and termsof engagement. They should also supplyinformation on the competency of thoseappointed and maintain records on those whoserve for a minimum of six years.

The Qatar Financial Centre recognises theShari’ah standards of the Bahrain-basedAccounting and Auditing Organisation forIslamic Financial Institutions (AAOIFI). Theseinclude the requirement for each Shari’ahSupervisory Board to provide an annual report,which will normally be included with thefinancial statements, a copy of which should bemade available to the regulator. Islamicfinancial institutions regulated by the QatarFinancial Centre are also required to undertakean internal Shari’ah review in compliance withAAOIFI standards on governance. This aims toensure that the contracts and other documentsmade available to clients conforms to the fatwa,rulings and guidelines provided by eachinstitutions’ Shari’ah Board.

Bahrain unlike Qatar has a unified system ofregulation, with the Central Bank responsiblefor all regulation, including that of Islamicfinancial institutions. Bahrain serves as aregional centre for Islamic finance and has 24Islamic banks and 11 takaful operators, whosetotal Shari’ah-compliant assets exceed US $10.3 billion. As the headquarters for AAOIFI




are in Bahrain, not surprisingly its governancestandards are mandatory, including those onShari’ah governance. The Central BankRulebook simply refers to the AAOIFIgoverning standards, notably those requiringeach Islamic financial institution to appoint aShari’ah Board of at least three members andhave an internal Shari’ah audit unit.

The Islamic Financial Services Board (IFSB)Guiding Principles on Shari’ah Governance

The IFSB is the institution which providesguidance on the key regulatory issuespertaining to Islamic financial institutions.Its procedures correspond to internationalnorms, as it members are consulted on eachset of guidelines it produces and there isextensive public consultation. Work on theGuiding Principles on Shari’ah Governancecommenced in 2007 and the final draft ofthe Guidelines became available inDecember2009.

The IFSB is not in a position to impose onits members any one system of Shari’ahgovernance, but its aim is to identify the keyissues, and drawing on best practice, suggestpossible ways in which the major concernscan be managed. Its overriding assumptionis that there is no single model that shouldbe adopted, a ‘one size fits all’ approach,but rather different solutions which dependon the circumstances in each jurisdictionsand informed perceptions of what isappropriate. Standardisation in any casetends to stifle innovation, and in a rapidlydeveloping and changing area such asIslamic finance, it would arguable becounter-productive to settle on a singlesystem.

It is important to note that the IFSB wasconcerned with the process of Shari’ahgovernance, with ensuring the systems aresound and not with the actual rulings ofShari’ah Boards, which are matters ofjudgment for those serving on the Boards. Inother words it is not the substance of thefatawa that is being dealt with, but ratherthat the conditions under which the Shari’ahBoards work. The aim is to ensure thatsound systems are in place to facilitateeffective decision taking by Shari’ah Boards,

which is of vital importance for thereputation of Islamic financial institutions.It is also recognised that some systems maybe acceptable in certain jurisdictions but notin others. It may, for example, be politicallypossible for regulators to have their ownShari’ah Boards in predominately Muslimcountries, but in countries where otherreligions have larger numbers of adherentsthis will not usually be the case. Howevereven in jurisdictions such as the UnitedKingdom, the Financial Services Authority(FSA), as the regulator, recognises the valueof sound procedures to ensure productsmarketed as Islamic are Shari’ah compliant,as otherwise the interests of Muslim clientswould not be protected.

The four key attributes identified by theIFSB for sound and effective Shari’ahgovernance are competence, independence,confidentiality and consistency. Competenceimplies diligence and capability andobviously relates to whether thoseappointed to Shari’ah Boards are suitablyqualified and have relevant experience,while recognising at the same time that forsome it will be their first appointment tosuch a position. This implies that thereshould be continuing training opportunitiesfor those serving on Shari’ah Boards andperhaps a system of mentoring wherebymore experienced members can pass ontheir knowledge to newer, and usuallyyounger, members. In other words provisionshould be made for the professionaldevelopment of those appointed to Shari’ahBoards, not least because while many maybe knowledgeable concerning fiqh, theirunderstanding of the complexities ofmodern finance and contemporary legalcontracts may be more limited, but this hasto be enhanced if they are to provideinformed advice. The IFSB propose thatthere should be a formal process to assessboth the overall effectiveness of the Shari’ahBoards and the contribution of theirindividual members. I n so far asinformation is available on other Boards thecollective effectiveness can be assessed inrelation to peer performance. Forindividuals effectiveness can be measured interms of attendance at meetings, diligence,commitment to attend training programmes

As the earlier discussion hasshown there are widevariations in Shari’ahgovernance standards acrossjurisdictions, largely reflectinglegal and regulatorydifferences, as well as theextent to which Islamicfinancial institutions havedeveloped in particularcountries.




and willingness to accept responsibility forduties assigned. In other words bothquantitative and qualitative measures can beused for performance evaluation.

Independence is the second attributestressed in the IFSB guidelines. Shari’ahBoard members are of course paid by theinstitutions on which they serve and thisinevitably leads to criticism that they cannotbe completely impartial and independent.Of course financial auditors are in the sameposition and have been subject to the samecriticism. An alternative would be to havethe Shari’ah Boards paid by government,but this is not feasible in Muslim minoritycountries and there would in any case beconcern about possible politicalinterference. No country has adopted thisapproach. The IFSB Guidelines stress thatapart from remuneration for work on theShari’ah Board, no member or his or herrelatives should receive any payment fromthe Islamic financial institution they serveeither as an employee or as a shareholder.Where there is a conflict of interest themember should declare it writing to theIslamic financial institution. Financialauditors are usually appointed for a fixedterm and then the position must rotate.There is a case for Shari’ah Board membersserving non-renewable terms rather thanserving in perpetuity, although this is notincluded in the IFSB Guidelines. Thecontrary argument is that where Shari’aBoard members have extensive experienceand their integrity is beyond doubt, it isdesirable to retain their services.

Confidentiality is a third attribute, as thoseserving on Shari’ah Boards will have accessto a wide range of information anddocuments that could be of commercialvalue to rival institutions. This is aparticular issue when Shari’ah Boardmembers serve several Islamic financialinstitutions. This is why multiple Boardmembership is not permitted in Malaysia. Itis recognised however that given theshortage of Shari’ah scholars in the GCC, itwould not be feasible to adopt such arestriction there. If confidentiality iscompromised however an Islamic financialinstitution should have procedures in place

to take appropriate disciplinary action toprotect its interests.

Consistency is the fourth attribute stressedas desirable in the IFSB Guidelines. Thisapplies to consistency over time by aShari’ah Board of a particular Islamicfinancial institution, as well as consistencyacross different Islamic financialinstitutions, both within a country andinternationally. Of course Shari’ah Boardsshould be free to change their opinions ifthey become aware of new issues that haveimplications for previous judgments. Thedebate over the legitimacy of bai bithamanajil (BBA) in Malaysia is an example of this,as is the controversy over tawarruq as acontract without substance and mudarabaand musharaka sukuk, where fixed re-purchase undertakings make these into puredebt instruments. Consistency betweenIslamic financial institutions within a singlejurisdiction is more likely where there arenational Shari’ah Boards, and elsewhere thepractice of scholars serving on multipleboards might actually promote consistency,even though this can be criticised on othergrounds.

International Shari’ah Governance

As Islamic finance has spread globally theneed for international standards has becomeapparent not least because Islamic banksand takaful operators based in the GCC arerapidly expanding in other jurisdictions,which raises the issue of which Shari’ahrulings should apply. As already indicatedBBA has been declared legitimate inMalaysia, but is clearly unacceptable in theGCC, where murabaha is viewed aspreferable because of its greatertransparency regarding the purchase priceand the mark-up. Al Rajhi Malaysia, thesubsidiary of Al Rajhi Bank of SaudiArabia, has four members on its Shari’ahBoard in Kuala Lumpur, one from theRiyadh Board, and the others fromMalaysia, but it is notable that the productrange corresponds to those offered in SaudiArabia, with BBA excluded.

There are two major bodies which provideinternational Shari’ah governance, the

AAOIFI Shari’ah Board and the OIC FiqhAcademy. The former comprises 14 scholarsrepresenting the AAOIFI members, witheach serving a four-year term. They haveissued Shari’ah standards for most of themajor Islamic contracts, which has aidedconvergence. The OIC Fiqh Academy wasinaugurated in 1988 before AAOIFI wasfounded, and considers a wider range ofissues, most recently tawarruq as alreadyindicated. There is no coordination betweenthese institutions however and, if theinternational Shari’ah governanceinfrastructure is to improve, there is a needto determine how the remit of eachinstitution should relate, or perhaps even fora new unified institution to be founded withthe support of OIC member states andleading industry players. Clearly much hasbeen achieved. Shari’ah financial governancehas gained increased respect and recognitionand the IFSB Guidelines should provehelpful in increasing the credibility ofShari’ah assurance processes. Numerousissues remain to be resolved however, sothere is clearly much work to do, althoughultimately market forces will continue to bewhat drives the Islamic finance industryforward.

Rodney Wilson is Professor in the School ofGovernment and International Affairs atDurham University. He was formerly a visitingprofessor at the Qatar Faculty of IslamicStudies, the universities of Kuwait and Paris Xand the International University of Japan. Heis also a prolific author on Islamic economicsand finance.


As part of its continuing commitmenttowards practice-based training, IIBI held its5th annual three-day residential workshopon ‘Structuring Innovative Islamic FinancialProducts’ amid the prestigious surroundingsof Clare College, University of Cambridgefrom 22nd to 24th July, 2011. Theworkshop had international participationthat included Islamic and conventionalbankers, lawyers, accountants andregulators, who travelled from as far afieldas South Africa, Iran, Jordan and Oman.The workshop was sponsored by PathSolutions, a leading provider of Islamic andinvestment software solutions worldwide.

Mr Keith Phillips, Executive Director at theUK Islamic Finance Secretariat (UKIFS),gave the opening address, which highlightedthe UK’s position as a leading Islamicfinance centre and home to five fully-fledgedIslamic banks as well as many conventionalbanks which have Islamic windows. Islamicfinance is a growing industry withincreasing global demand for humanresources. UK is (and has been) at theforefront of providing qualifications for theIslamic finance industry. The UKIFS has setup an Education, Training & Qualifications(ETQ) Working Group which is engagingacademia, business schools, professionalinstitutions and trade associations, andpartnering with leading institutes such asthe Institute of Islamic Banking andInsurance.

The workshop provided an in-depthpractical analysis of the key innovativeIslamic financial products in the marketwith special focus on corporate and capitalmarket instruments. It looked at the mainstructures of murabaha, ijarah, salam,istisna’a, mudarabah and musharakah andimportant requirements for their practicalapplications. It also analysed the majorinnovative products and product featurescurrently being used in the industry, as well

as exploring both the nature of theinnovations as well as the underlyingrationale and philosophy for suchinnovations within the Shari’ah parameters.The use of case studies and an interactiveformat enriched the discussion and helpedthe participants to grasp the subject mattermore comprehensively. At least as importantwere the offline discussions during breaktimes, when participants were able toexchange information and views about thepractice of Islamic finance in their owngeographies.

The workshop was led by Dr Salman Khan,Head of Shari’ah Office (Dubai) at a leadingGCC-based Islamic bank. He was joined byRichard de Belder, partner at SNR Denton -an international law firm;Mohammed Amin, Islamic financeconsultant andMuhammad Ali Jinnah Ahmad, Co-ordinator of Takaful Research Unit at theInternational Shari’ah Research Academyfor Islamic Finance (ISRA) Malaysia.

In the closing address, Mr MohammedQayyum, Director General of the Institute ofIslamic Banking and Insurance emphasisedthat genuine product innovation is crucial forthe reputation and development of theIslamic finance industry. This workshopprovides a unique platform for advancingtechnicalknowledge anddeveloping theskill base for theindustry. At theclose,‘Certificate ofAttendance’were awardedto theparticipants.

As an antidoteto all the hard

work during the sessions, participants wereable to see something of Cambridge with awalking tour of the colleges and punting onthe River Cam providing wonderful viewsof the famous Backs.

Among the comments made by theparticipants were the following:

‘Excellent workshop. I enjoyed thecontent and spirit of the workshop’

Mr Jonathan Lawrence, Partner, K & L Gates, UK

‘Great overall setting. IIBI did not spareanything on the course and the facilities.’

Mr Ahmad Quandour, lawyer, Jordan

‘An excellent workshop giving a detailedinsight into the issues with currentShari’ah-compliant products.’

Ms Bilkis Ismail, Barrister (Senior Associate), SJ Berwin (MENA),

Dubai, UAE

‘The workshop was very informative. Theinteractive methodology used iscommendable.’

Mr Tajelkhatim Daoud Khari, Sharjah Islamic Bank, UAE

‘The workshop was excellent.’ Ms Naseeha Mahomed, Assurance

Senior – Banking and Capital Markets,Ernst & Young, South Africa

IIBI Holds 5th Annual Workshop at Clare College, University of Cambridge, UK

Delegates to the 2011Cambridge Workshop

NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 IIBI NEWS




NEWHORIZON October–December 2011IIBI NEWS

October

10–11: International Summit on IslamicCorporate Finance, Abu Dhabi

This first Islamic Corporate Finance Summitwas apparently originally suggested by seniorcorporate bankers, who had participated inlarge-scale conferences, but wanted to engagethe corporate end users of Islamic finance ina more intimate and focused environment.Similarly, the financial decision-makerswithin large corporations expressed aninterest in exploring Islamic finance as anincreasingly important component of theiroverall financing mix. The organisers claimthat this concept has now been developedinto an innovative form of summit, which isspecifically tailored to expand businessopportunities and meet the funding needs oflarge businesses.

Contact: Sophie ShahTel: +9714 343 1200Email: [email protected]

18–20: 3rd World Islamic Retail BankingConference, Dubai

The theme of WIRBC this year is: ‘EvolvingEconomy: Spotlight on Islamic Retail

Banking’. Conference topics will include‘Islamic Retail Banking: What is the nextstep?’, the ‘Annual Open Fatwa Session’ and‘Fuelling Regional Competition.’

Contact: Lucia KasanickaTel: +9181 0580 5411 800Email: [email protected]

24–27: Islamic Investment and FinanceForum 2011, Turkey

The focus of this conference is emerging andfrontier markets. Sessions include in depthdiscussions of Turkey, whether it is set tobecome an international financial hub and ifso, what does this mean for Istanbul as anIslamic financial hub and the potential fordeveloping Islamic finance in Africa and theimpact of regulation, as well as a series ofspecial interest sessions on sukuk, real estatefunds, asset management and private equityamong others.

Contact: Vanessa HeywoodTel: +971 4 335 2437Email: [email protected]

25–26: 3rd Annual Moscow InternationalForum – Islamic Finance andInvestments

Leadingeconomists andfinanciers willdiscuss thecurrent situationand the specificsof Islamic financein the world andRussia inparticular.Dialogue withregulators,included in theagenda for thefirst time, willgive anopportunity tolearn about the

regulators’ vision and possible approachesto the regulation of Islamic finance inRussia. Business representatives, lawyers,experts and consultants will discuss thefuture development of the industry and newopportunities for attracting Islamicinvestment into the Russian economy.

All enquiries via the website of BankConference Moscow atwww.bankconference.ru/en

27–28: Mediterranean Islamic FinanceConference 2011 – New Openings, Malta

Malta has ambitions to become the centrefor Islamic finance in the Mediterranean.This conference, sponsored by Ernst &Young, will focus on the practical issues andopportunities the island faces.

All enquiries via the website of the MaltaInstitute of Management atwww.maltamanagement.com

November

21–23: The World Islamic BankingConference, Bahrain

This event promises an attendance of morethan 1,200 industry leaders from over 50countries, plus the launch of the latestCompetitiveness Report produced inconjunction with McKinsey & Company.The theme for the 2011 conference is‘Competing for Global Growth’, addressingnew expansion opportunities for theindustry – boosting cross-bordertransactions, accessing new markets andcreating new products. The conference willtake a fresh look at some of the issues thatcontinue to exercise the minds of thoseinvolved in Islamic finance, such as howIslamic banks can scale up their operationsand the evolving role of Shari’ah advisors.

Contact: Andrew ChopraTel: +9714 343 1200Email: [email protected]

Diary of Events endorsed by the IIBI

Gulf Hotel Convention Centre, Bahrain


Post Graduate Diploma in Islamic Banking and Insurance (PGD)Awards

To date students from nearly 80 countries have enrolled in the PGDcourse. In the period July to September 2011, the following studentssuccessfully completed their studies:

❑ Hamidu Sa’ad, CEO, Frontier Investments, Nigeria

❑ Yasin Ebrahim, UK

❑ Michelle Cunningham, Trainee Solicitor, Arthur Cox Solicitors,Ireland

❑ Imran Bhatia, UK

❑ Fezel Khan Boodhoo, Director, Isfahaan Ltd, Mauritius

Diploma in Islamic Banking (DIB) Awards

In order to offer wider choice to potential applicants, IIBI launchedits Diploma in Islamic Banking (DIB) by distance learning inJanuary, 2010. The course builds candidates’ knowledge of Islamicbanking concepts as well as their practical applications. It supportscandidates seeking a career in Islamic banking and also in theircareer progression in the Islamic finance industry.

Candidates having a graduate degree may take up the IIBI PostGraduate Diploma course in Islamic Banking and Insurance (PGD),however those who wish to build a good foundation of Islamicbanking concepts and operations, may opt to take the DIB courseand later on progress to the PGD. DIB holders wishing to take upthe PGD course will get exemption from some of the Post GraduateDiploma modules.

At present, DIB is priced at only £335.00 inclusive of registrationfee, one year membership, course study material and tutor support.

Students from 23 countries have enrolled on this course so far. Thefollowing students completed their studies in 2011

❑ Amanullah Shahid, UK

❑ Chowdhury Shahed Akbar, UK

❑ Feizal Sheik Fareed, Supervisor, State Bank of Mauritius,Mauritius

❑ Jazeera Yousuf, Processor, Abu Dhabi Islamic Bank, UAE

❑ Kassim Ahmed Abeid, Tanzani

❑ Mark Fribbens, Assistant Manager, Trading Desk, DDGI Ltd,UK

❑ Md. Shahbaz Alam, Relationship Officer (Personal Banking),State Bank of India, India

❑ Philip Schroevers, Business Analyst, Logica, Netherlands

❑ Saad Chishti, UK

❑ Saad Sheikh, UK

❑ Shabbir Ahmed, UK

❑ Steve Allen, Executive Manager – Treasurer, National Bank ofKuwait, Kuwait

Aminu Hamza, Managing Director, Cherish MicrofinanceBank Ltd Batsari, Nigeria

The course modules are detailed,comprehensive and well written insimple English for easy comprehensionby students. The course is actuallycapable of transforming every studentfrom ‘novice to professional’ in the fieldof Islamic banking and finance uponcompletion.

Alifar Badurudeen, Accountant, CornishHotel Apartments, UAE

It’s a great course and I will highlyrecommend it to anyone who intendspursuing a career in the Islamic bankingand financial services industry.

Hamid Rustamov, Savings Consultant,GTZ, Tajikistan

DIB course provided by the IIBI isdesigned with high quality and providesappropriate and useful information tounderstand and get invaluableknowledge in foundations of the Islamicbanking and insurance.

IIBI Awards – Diplomas in Islamic Banking and Insurance


NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 IIBI NEWS



NEWHORIZON October–December 2011IIBI LECTURES

June: RestructuringsInvolving IslamicFinancing

Although the Islamic finance industry wasshielded to some extent from the troublesthat conventional banks faced with theonslaught of the financial crisis in late2007, nonetheless, there have been anumber of Islamic defaults in the last twoyears; some of them generated a greatdeal of attention. With the help of casestudies the lecture discussed theimportant issues, which need to beconsidered and dealt with whenundertaking the restructuring of Islamicfinancial transactions including those co-financed with conventional facilities.

Mr Ahmed started the lecture byhighlighting the legal uncertainty of securityenforcement and the shortcomings of thelaw and procedures relating to insolvency inthe GCC region making it necessary forborrowers facing financial difficulties andtheir financiers to enter into consensualrestructuring arrangements whereverpossible. The method of restructuring willdepend on the nature and type of Islamicfinancing and whether the borrower has asingle source of finance or whether financecomes from different sources (includingconventional debt). He pointed out thatbanks are likely to be more flexible aboutagreeing changes in the terms andconditions of financing arrangements thansukuk holders whose decision making willbe more formal and time consuming.

Though compliance with Shari’ah principlesis the primary requirement for Islamicfinancial products and services, Shari’ah is anon-national system of laws and is subjectto various interpretations. In order to createcertainty about the rights and obligations ofthe contracting parties, Islamic financial

documents for syndicated facilities (andmajor bilateral facilities) are, in most cases,governed by English law. He went on todiscuss the enforceability of Islamicfinancings governed by English law in caseof default. He also briefly explained theAccounting and Auditing Organisation forIslamic Financial Institutions (AAOIFI)standard on default in payment by a debtor;the issue of on-shore security and theacceptability of such security from aShari’ah prospective with the examples ofsecurity for tangible assets, claims onreceivables and intellectual property rights.He also examined the distinction betweenthe on-shore and free zone regulatoryregimes in the UAE. With the examples ofthe legal regime in the UAE, he indicatedthat Shari’ah pronouncements may not bebinding on the courts. There is a need forclarity about the treatment by the courts ofcontracts governed by Shari’ah and English

law; assuming English courts grantjudgement, then mechanisms for and thelikelihood of enforcement of the judgementby the local courts are uncertain. There isalso a need to look at whether an arbitralaward is easier to enforce (compared with acourt judgement) and whether the assets ofpublicly-owned entities in the GCC can beseized for the purposes of enforcement.

Mr. Ahmed then examined the local securityenforcement and insolvency regimes and thecircumstances in which security can beenforced and the effect of the insolvencyprocedures on the rights of securedcreditors. He stated that restructuringstandalone Islamic facilities is easier inrelative terms due to the commonality ofinterest amongst the participant banks,particularly if the issues related to theShari’ah compliance are dealt with by thesame Shari’ah board(s) who approved the

Promoting Islamic Finance

Mr Shibeer Ahmed is a partner in the Finance Practice of the law firm, White & Case LLP.He has expertise in both Islamic and conventional banking, restructuring and projectfinance. He has also been involved in a number of Shari’ah-compliant power,petrochemical and infrastructure project financings in the GCC region.


original financing and there is no (new)security sharing and inter-creditor issues.

He then looked at the restructuring issues inrelation to multiple Islamic finance facilities,which may involve use of ijarah, murabahaand commodity murabaha and practicalproblems regarding ownership and titleregistration as well as the engagement of theShari’ah board in restructuring. In the caseof Islamic and conventional co-financingfacilities, there is a need to look at whetherthere is an existing inter-creditor agreementregulating the relationship between theIslamic and conventional facility banks andthe need for a security sharing arrangement(particularly in relation to the borrower’sassets used for the purposes of any ijarah

facility). Restructuring of such deals iscomplex and may take more time due to therelative negotiating strengths of the Islamicand conventional facility banks; thenegotiation process between theconventional banks, the borrower and theIslamic banks and their Shari’ah boards islikely to be a complex and time consumingprocess.

Mr. Ahmed also examined the combinationof secured and unsecured Islamic financingfacilities and the possible issues in relationto the secured facilities if all security is notregistered and related enforcement issues.He indicated that there is a need tonegotiate and agree to inter-creditorarrangement to regulate all of the post-

restructuring facilities; the termination ofexisting facilities should be by mutualconsent to avoid calling defaults that wouldtrigger cross-default provisions in theexisting finance documents. There is a needfor the post-restructuring facilities to beacceptable to Islamic banks, which cannotparticipate in commodity murabahafinancings.

Finally, Mr. Ahmed looked at the practical issues relating to sukuk defaultsand restructurings with the help of casestudies. There is need to hold certificateholders’ meetings to satisfy minimum voting thresholds for taking decisions aswell as dealing with inter-creditornegotiations.

in 2007, when customers were queuingaround branches of Northern Rock plcdemanding the repayment of their deposits.

is taking the risk that the customers maywant to have their deposits repaid when it cannot obtain new deposits; thatconstitutes a ‘run on the bank’ like the one

July: LiquidityManagement at IslamicBanks

For most banks one of the major sources of revenue is maturity transformation toprofit from the shape of the yield curve. The graph below shows the sterlingcommercial bank yield curve on 7 July 2011 from the Bank of England website. It demonstrates that short-term moneycould be borrowed or lent at approximately1%. Conversely a 10-year loan would earn5%.

It is profitable for banks to take short-termdeposits while making long-term loans (e.g.for 10-year periods, although in practicemost bank loans would be shorter, say 3–5years) thereby earning a 4% spread betweenthe short-term rate and the 10-year rate. Asthe short-term bank deposits becomerepayable, they are rolled over by takingnew deposits.

This strategy of ‘borrowing short andlending long’ has been followed by banks for centuries. The bank, however,


NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 IIBI LECTURES



NEWHORIZON October–December 2011IIBI LECTURES

Banks manage this liquidity risk in threemain ways:

1. Banks hold cash and short-maturityinvestments, which can be quickly soldfor cash to repay depositors makingwithdrawals. Banks, however, want toavoid holding too much liquidity as itsreturns are low as illustrated by thegraph.

2. The bank’s assets such as loans tocustomers are usually structured to beresalable. Accordingly if the bank isfinding it difficult to raise deposits, it can‘slim its balance sheet’ by selling itscustomer loans, typically to other banks,but also to other purchasers such ashedge funds.

3. The country’s central bank (in the UKthe Bank of England) provides lender oflast resort facilities.

Mr Amin reminded the audience that Islamicbanks are banks, but ones that conduct theiraffairs in accordance with the rules laiddown by their Shari’ah supervisory boards

and by other Shari’ah regulators. Islamicbanks face the same liquidity managementchallenges as conventional banks with someadditional issues:

❑ Often there may be no lender of lastresort in practice. For example, the UKlender of last resort, the Bank of England,does not offer Shari’ah-compliant facilities.

❑ Many of the assets of Islamic banks arenot resalable in practice. For example, forShari’ah reasons the bank’s rights undermurabaha contracts can only be sold at facevalue, but nobody will buy them except at adiscounted price.

❑ There is a shortage of highly-rated, liquid,short-term assets to hold for liquiditymanagement purposes.

Mr Amin went on to discuss how thesechallenges are managed in practice byIslamic banks. A particularly illuminatingpart of the presentation was his analysisfrom a liquidity management perspective ofthe balance sheets of two UK Islamic banksusing their published accounts.

Mohammed Amin is an Islamic financeconsultant and before retirement wasPricewaterhouseCoopers’ UK Head ofIslamic Finance.

The 3rd Annual ISRA/IIBI Thematic Workshop – 12 December 2011

Form and Substance in Islamic Finance – Challenges, Problems and the Way Forward

Despite the phenomenal growth of the Islamic finance industry in the last four decades, there are genuine concerns about its uniquenessand the direction it has taken. Many of the transaction structures were approved by Shari’ah boards to kick start the industry, butbecame a ‘norm’ over time. There are arguments that there has been too much focus on the ‘form’ instead of the ‘substance’ in theIslamic finance transactions. The 3rd Annual ISRA/IIBI Thematic Workshop in collaboration with SNR Denton will critically analysethe ‘form’ versus the ‘substance’’ issues in Islamic financial transactions that need to be resolved to bring much needed credibility andmainstream acceptance of the Islamic finance industry.

This is an invitation only programme. For more details please contact, Mr Mohammad Shafique on +44 (0) 207 245 0404 or email [email protected].


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NEWHORIZON October–December 2011TECHNOLOGY NEWS

Iraq-based InternationalDevelopment Bank (IDB) hasgone live with Path Solution’siMAL Islamic banking system atits main branch in Baghdad.IDB Iraq, a startup bank with apaid up capital of250,000,000,000 IRQ Dinar($213,948,140 US), aims to useiMAL to introduce new Islamicproducts to the market whilemeeting local bankingrequirements, including centralbank reporting. IDB expect tobe among the 10 leading Iraqibanks and plan to open fivebranches in Baghdad and afurther five in the provincesduring 2011.

Nazar Al Monshi, IT Managerof IDB Iraq commented: ‘We arevery happy with the level ofprofessionalism Path Solutionshas shown during theimplementation. Armed with a

Sharjah Islamic Bank (SIB) haslaunched banking access to theirbanking services throughFacebook and Twitter. With thismove SIB aims to get closer toits customers and change theperception of Islamic banks asbeing out-of-touch with moderncommunication needs andmethods.

Speaking of the decision to takethis important step, SIB CEO,H.E Mohammed Abdulla, said,‘At SIB we are committed togiving our customers the highestlevels of convenience and serviceat all times and embracingcreative solutions in order to doso. The decision to embracesocial mediaplatforms such asTwitter andFacebookstemmed fromour desire tomove Islamicbanking into the21st century andto be more intouch with our

solid implementationmethodology and supported bya team of skilled andenthusiastic businessconsultants, Path Solutions wastasked with implementing amodern Shari’ah-compliantbanking system capable ofmatching local bankingrequirements to enable us tomeet our possible expansionplans for any banking productor service in the future’.

Modules included in the firstphase of implementationincluded CIF Opening, AccountOpening, Cash Transactions(deposits and withdrawals),Credit Limits (retail andcorporate limits) and IslamicOperations (murabaha,musharaka, ijara). The nextphase will include internetbanking, investment bankingand branch automation.

customer base, particularly ouryounger customers.’

‘Over the past few years, the Webexperience has become an integralpart of people’s lives, with moreand more aspects of their dailylives going online and beingintegrated into social mediaplatforms. SIB realises theimportance of these platforms inthe lives of our customers, and weare responding to this by offeringthem the chance to incorporatetheir banking into their onlinelives. This will not only allow usto get closer to the community weserve, but will also add anotherchannel of communication,’Abdullah added.

IDB Iraq Implement PathSolutions Systems

Sharjah Islamic BankEmbraces Social Media

Afghan United Bank Go Live with Oracle Flexcube

Afghan United Bank is the firstbank in the country to obtainpermission for Islamic bankingfrom Da Afghanistan Bank (theCentral Bank of Afghanistan).Its ultimate aim is become afully-fledged Islamic bank, butcurrently the laws andregulatory framework in the

country do not allow this, so forthe time being they areoperating an Islamic windowoperation with branches inKabul and Kandahar.

They signed the contract to buy Flexcube in 2009, butproblems associated with the

infrastructure in Afghanistanmeant that the implementationtook roughly twice as long as originally planned. Thesystem is supported fromOracle’s Dubai office, whichprovides training, back up and disaster recovery facilities.

The Flexcube system supportsboth the conventional financialoperation and the Islamicwindow operation. UsingFlexcube the Afghan UnitedBank has already launchedinternet banking and expects toimplement ATMs and mobilebanking shortly.

Al Noor Mosque, Sharjah



NEWHORIZON Dhu Al Qaddah 1432 – Muharram 1433 BOOK REVIEW

In the introductory chapter Dr Ahmedconsiders the key goals of Islamic banking –alleviating poverty, contributing to socialwelfare and promoting sustainable projects,as well as the the contention that the Shari’ahrequirements are being diluted, leading to thedisillusionment of many proponents of theindustry. He sets the context by taking a brieflook at the evolution of the modern Islamicfinance industry and some of itscontemporary practices, highlighting theimportance of innovation and productdevelopment in the financial sector.

The second chapter on ‘Islamic Law andFinance: Concepts and Principles’ toucheson the sources and methodology applied forderiving the tenets of the Shari’ah, such asthose relating to property rights and thefundamental conditions of a valid contractfrom the Islamic perspective. It also looks attraditional Islamic nominate contracts,discusses the significance of the concepts ofriba and gharar, as well as the development

of innovative financial products. ‘IslamicBanking: Institutional Environment,Organisational Design and Product Features’is the title of the third chapter, which looks atthe institutional environment in which theIslamic banking industry operates. Thefourth chapter, ‘Innovation and ProductDevelopment: Strategy, Structure andProcess’ looks at the importance of productdevelopment in general and discussesproduct development processes.

The fifth chapter on ‘Product DevelopmentPractices in Islamic Banks’ presents findingsfrom a survey on product development inIslamic banks. These findings are based on asurvey questionnaire completed by a sampleof 20 Islamic banks, supplemented byinterviews with senior officials responsiblefor product development. The paradoxfacing Islamic banking is highlighted by oneMalaysian bank, where 70% of thecustomers are reportedly non-Muslims,while it is proving difficult to attract alarger Muslim customer base, because theyask many questions about the authenticityof Islamic products.

Chapter six ‘Islamic Financial Products:Categories and Controversies’ discusses somecritical issues related to various types ofproducts offered by Islamic financialinstitutions. It provides definitions forShari’ah-based, Shari’ah-complaint andpseudo-Islamic products. Shari’ah-compliantproducts satisfy the form and substance ofIslamic law, but fail to pay attention to thesocial goals. Specifically, Dr Ahmed pointsout that a Shari’ah-compliant product willnot adequately meet the financial needs of thepoor and small/micro enterprises. A Shari’ah-based product, however, will not only satisfythe form and substance of Islamic law, it will

also satisfy the financial needs of all sectionsof the population including the poor andsmall/micro entrepreneurs. A pseudo-Islamicproduct conforms to legal form only; it doesnot fulfil the substance of Shari’ah principlesor serve social needs.

The penultimate chapter, ‘Shari’ah-BasedIslamic Finance: The Way Forward’, buildsthe case for a move towards Shari’ah-basedproducts. Such a move to Shari’ah-basedproducts, however, could only happen ifvarious basic issues were addressed – thecreation of an enabling institutionalframework, organisational diversity thatincludes venture capital and equity funds,cooperatives and microfinance, thestrengthening of Shari’ah governancemechanisms, approaches to innovation andresearch and product development, as wellas the provision of incentives for choosingShari’ah-based products.

The concluding chapter reiterates theconcerns that are being raised around theuse of pseudo-Islamic banking products andthose replicating conventional products.According to Dr Ahmed a key factor thatwill determine the future development of theIslamic finance industry is its ability to comeup with new products that will satisfy theneeds of various segments of society on onehand and the Shari’ah requirements on theother. He also states that the types ofproducts offered by Islamic financialinstitutions will shape the customer andcommunity perceptions of the industry inthe long run. The strength of the Shari’ahgovernance framework and the quality ofShari’ah supervision, both at organisationaland national level, will play a critical role indetermining the nature of products andprotecting the credibility of the industry.

Product Development in Islamic Banksby Professor Habib Ahmed. Publisher: Edinburgh University Press Limited (2011)ISBN 978-0-7486-3952-6 (Paperback) and 978-0-7486-3951-9 (Hardback) The book is part of the Edinburgh Guides to Islamic Finance series edited byProfessor Rodney Wilson of the Durham University.



NEWHORIZON October–December 2011GLOSSARY

arbounAn Islamic version of option, a deposit for the delivery ofa specified quantity of a commodity on a predetermineddate.

bai al-inaThis refers to the selling of an asset by the bank to thecustomer on a deferred payments basis, then buying backthe asset at a lower price, and paying the customer incash terms.

commodity murabahaA murabaha contract using certain specifiedcommodities, through a metal exchange.

fatwaA ruling made by a competent Shari’ah scholar on aparticular issue, where fiqh (Islamic jurisprudence) isunclear. It is an opinion, and is not legally binding.

ghararLit: uncertainty, hazard, chance or risk. Technically, saleof a thing which is not present at hand; or the sale of athing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does notknow whether it will come to be or not.

Hadith A record of the sayings, deeds or tacit approval of theProphet Muhammad (PBUH).

halalActivities which are permissible according to Shari’ah.

haramActivities which are prohibited according to Shari’ah.

ijaraA leasing contract under which a bank purchases andleases out a building or equipment or any other facilityrequired by its client for a rental fee. The duration of thelease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

ijara sukukA sukuk having ijara as an underlying structure.

ijara wa iqtinaThe same as ijara except the business owner iscommitted to buying the building or equipment orfacility at the end of the lease period. Fees previouslypaid constitute part of the purchase price. It is commonly used for home and commercial equipmentfinancing.

istisnaA contract of acquisition of goods by specification ororder, where the price is fixed in advance, but the goodsare manufactured and delivered at a later date.Normally, the price is paid progressively in accordancewith the progress of the job.

maysir Gambling – a prohibited activity, as it is a zero-sumgame just transferring the wealth not creating newwealth.

mudarabahA form of business contract in which one party bringscapital and the other personal effort. The proportionateshare in profit is determined by mutual agreement at thestart. But the loss, if any, is borne only by the owner ofthe capital, in which case the entrepreneur gets nothingfor his labour.

mudarib In a mudarabah contract, the person or party who actsas entrepreneur.

murabahaA contract of sale between the bank and its client for thesale of goods at a price plus an agreed profit margin forthe bank. The contract involves the purchase of goods bythe bank which then sells them to the client at an agreedmark-up. Repayment is usually in instalments.

musharakahAn agreement under which the Islamic bank providesfunds which are mingled with the funds of the businessenterprise and others. All providers of capital are entitledto participate in the management but not necessarilyrequired to do so. The profit is distributed among thepartners in predetermined ratios, while the loss is borneby each partner in proportion to his contribution.

musharakah, diminishingAn agreement which allows equity participation andsharing of profit on a pro rata basis, but also provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers theownership of the asset to the participants.

qard hasan An interest-free loan given for either welfare purposes or for fulfilling short-term funding requirements. Theborrower is only obligated to pay back the principalamount of the loan.

rab-al-maalIn a mudarabah contract the person who invests thecapital.

retakafulReinsurance based on Islamic principles. It is amechanism used by direct insurance companies toprotect their retained business by achieving geographicspread and obtaining protection, above certain thresholdvalues, from larger, specialist reinsurance companies andpools.

ribaLit: increase or addition. Technically it denotes anyincrease or addition to capital obtained by the lender as a condition of the loan. Any risk-free or ‘guaranteed’rate of return on a loan or investment is riba. Riba, in allforms, is prohibited in Islam. Usually, riba and interestare used interchangeably.

salamSalam means a contract in which advance payment ismade for goods to be delivered later on.

Shari’ahRefers to the laws contained in or derived from theQuran and the Sunnah (practice and traditions of theProphet Muhammad (PBUH).

Shari’ah boardAn authority appointed by an Islamic financialinstitution, which supervises and ensures the Shari’ahcompliance of new product development as well asexisting operations.

shirkah A contract between two or more persons who launch a business or financial enterprise to make profit.

sukukSimilar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownership inthe underlying asset. The asset will be leased to the clientto yield the return on the sukuk.

ta’awuni A principle of mutual assistance.

tabarruA donation covenant in which the participants agree to mutually help each other by contributingfinancially.

takafulA form of Islamic insurance based on the Quranicprinciple of mutual assistance (ta’awuni). It providesmutual protection of assets and property and offers joint risk sharing in the event of a loss by one of itsmembers.

tawaruqA sale of a commodity to the customer by a bank ondeferred payment at cost plus profit. The customer thensells the commodities to a third party on a spot basis and gets instant cash.

ummah The diaspora or ‘Community of the Believers’ (ummatal-mu’minin), the world-wide community of Muslims.

wa’adA promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price. It is not a legally binding agreement.

wakalaA contract of agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee.

waqfAn appropriation or tying-up of a property in perpetuityso that no propriety rights can be exercised over theusufruct. The waqf property can neither be sold norinherited nor donated to anyone.

zakatAn obligation on Muslims to pay a prescribed percentageof their wealth to specified categories in their society,when their wealth exceeds a certain limit. Zakat purifieswealth. The objective is to take away a part of thewealth of the well-to-do and to distribute it among the poor and the needy.


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