GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 178JANUARY–MARCH 2011

MUHARRAM-RABI AL AWWAL 1432

IDOES ISLAMIC FINANCENEED TO PUT ITS HOUSE IN ORDER?

POINT OF VIEW:STRATEGY CHANGE ANDTHE ECONOMIC CRISIS

ACADEMIC ARTICLE:WHITHER ISLAMICFINANCE?

COUNTRY FOCUS:ISLAMIC FINANCEFLOURISHES IN KENYA

MARKET FOCUS:SHIPPING MEETS ISLAMICFINANCE IN LUXEMBOURG

CONFERENCE REPORT:THE POLEMICS OFGOVERNING LAW INISLAMIC FINANCE

PUBLISHED SINCE 1991NEWHORIZON

NEWHORIZON Muharram-Rabi Al Awwal 1432

CONTENTS

of Funds@Work’s survey of Shari’ah scholars and their boardmemberships.

39 TECHNOLOGY NEWSNews from Path Solutions andJordan-based SSSProcess.

32 AWARDSListing of IIBI awards of postgraduate diplomas.

33 IIBI LECTURESReports of the September 2010lecture on Islamic derivatives and structured products and theOctober 2010 lecture in which Murat Ünal presented the findings

05 NEWSA round-up of the important storiesfrom the last quarter around theglobe including the launch of theInternational Islamic LiquidityManagement Corporation and anupdate on the sukuk market.

30 EVENTSRead all about the events coming upduring the first four months of 2011.

8 Does Islamic FinanceNeed to Put its House inOrder?

Andrea Wharton looks at the issuessurrounding Shari’ah boards and askswhether the multiple positions held byscholars raise conflicts of interest andwhether the present system adversely affectsthe prospects of younger scholars. She alsoasks whether an absence of global standardsis likely to restrict the growth of the Islamicfinance industry.

11 Strategy Change andthe Economic Crisis: TheBusiness Models of IslamicInvestment Banks

Dr Ken Baldwin, formerly Chief OperatingOfficer for Capinnova Investment Bank,Bahrain examines the changes to products,structures and investment mechanisms that may well be necessary to enable GCC financial institutions to remain viable in the post-financial-crisisenvironment.

15 WhitherIslamicFinance?

Dr AzeemuddinSubhani of AjmanUniversity presents adetailed definition ofthe terms riba andbay’, arguing that is the doctrines of ex-nihilo creation and ex-sui-creation, whichprohibit riba and that it is ex-alio-creationthat makes bay’ permissible.

19 Islamic FinanceFlourishes in Kenya

Andrea Wharton examines the progress ofIslamic finance in Kenya, set against thatcountry’s ambitions to become the Islamicfinance hub in East Africa.

24 Shipping Meets IslamicFinance in Luxembourg

Landlocked Luxembourg has a flourishingmaritime registry and with tax laws

sympathetic to Islamic finance, CédricRaths, a member of the LuxembourgMaritime Cluster believes that Luxembourgis set to have a major impact as a providerof shipping finance, possibly eclipsingformer leaders in that sector such asHamburg.

26 The Polemics ofGoverning Law in IslamicFinance

Mohammad Shafique reports from the 2ndAnnual Thematic Workshop organised bythe IIBI and ISRA in collaboration withThomson Reuters. With opening addressesfrom the Lord Mayor of London and theDeputy Governor of Bank Negara, theconference examined the issues surroundingdispute resolution in the Islamic financeindustry, particularly in those cases wherecross-border transactions are involved.

NEWHORIZON January–March 2011

At the heart of the crisis in Western economies and the near collapseof the global financial system is the simple truth that too much moneywas loaned to states, companies and individuals. The situation wascompounded by speculation in financial dealings, the development ofthe ‘originate and sell’ model and trade in very complex derivativeinstruments. The problem would have been minimised, if not avoidedaltogether, if those mainly involved in the financial crisis had not beendriven by an unbridled desire for profits and, in an interconnectedworld, had been more considerate of others. By prohibiting riba,speculation and investments in highly-geared enterprises the Islamicfinance principles offer an alternative paradigm, which emphasises amoral code and reduces the risk of overheating. In this climate Islamicfinance should prosper and yet, even taking its youth intoconsideration, it punches below its weight.

There is much work to be done to put this right. In his article onStrategy Change in this issue of NewHorizon, Dr Ken Baldwinexamines the challenges faced by Islamic (and other) institutions,encouraging investment in equity rather than debt. Sharing risk is atthe heart of the Islamic model, but managing that risk to thesatisfaction of investors and regulators is no simple matter.

Our feature article on Shari’ah scholars analyses the problem offinding enough scholars for the growing population of IFI’s and thenfinding sufficient consistency in their rulings to allow the developmentof international standards without which Islamic finance cannotachieve global status. Importantly, there should be clear parameters ofengagement and a professional code of conduct for Shari’ah scholarsthat also embodies the moral objectives of fairness and socialdevelopment which underlie the Shari’ah.

It is heartening to see in our article on Kenya, how Islamic financeinitiatives have helped nomadic cattlemen to prosper. Examples suchas this, often a combination of Islamic and micro finance, may notinvolve large sums of money, but their effects are fundamental.

On matters fundamental, we have a fresh and very different view onriba and bay’ (sale) definitions by Dr Subhani, ‘Whither IslamicFinance?’ In his article he explains an important test for a transactionto be permissible – is it truly co-generative or does it involve self-generation, usury.

And finally, on behalf of the Institute and the NewHorizon editorialteam, I would like to wish the very best in 1432H/2011 to all ourreaders, members and supporters.

EDITORIAL

Mohammad Ali Qayyum,Director General, IIBI

Andrea WhartonSue Dobson

Mohammad Shafique

Humphrey Tizard

Mohammed AminRichard T de BelderAjmal BhattyStella CoxDr Humayon Dar Iqbal KhanDr Imran Ashraf Usmani

Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: newhorizon@cambcorp.co.ukWebsite: www.cambcorp.co.uk

Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: newhorizon@cambcorp.co.ukWebsite: www.cambcorp.co.uk

Mohammad ShafiqueInstitute of Islamic Banking andInsurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: iibi@islamic-banking.com

©Institute of Islamic Banking andInsuranceISSN 0955-095X

Surat Al Baqara, Holy Quran

NEWHORIZON Muharram-Rabi Al Awwal 1432

Bank of London and the MiddleEast plc (BLME), London’sleading wholesaleShari’ah-compliant bank, hascreated an Islamic capitalmarkets desk in response tomarket demand for high qualityIslamic assets and sukuk byestablished issuers.

The Islamic capital marketsdesk, which will be headed upby Dr Massoud Janekeh, willprovide UK and internationalcorporates with robust andcommercially attractiveproducts that offer a genuine alternative toconventional financinginstruments.

Humphrey Percy, CEO ofBLME, said: ‘The developmentof Islamic capital markets is

critical to the growth of globalIslamic banking. London’scapital markets offer more depthand diversity that can help toovercome sector issues such asliquidity and risk management.’

‘As the largest wholesale Islamicbank in Europe, BLME is wellpos i tioned to facilitate the issu -ance and distribution of sukuk, aswell as a growing range ofinnova tive Islamic investmentproducts that can help to meetinvestor demand for a greaterchoice of alternative and relatively secure investmentproducts.’

Prior to becoming head ofIslamic capital markets atBLME, Dr Massoud Janekehwas head of Trade and Business Finance at the bank. In

his new role, DrJanekeh will beresponsible formanaging thecapital marketsdesk, as well asbalance sheetmanagement forBLME. RodneyBallard, previouslya director of TradeFinance at BLME, has been promoted to head of TradeFinance. He will be joined byAlfonso Rodriguez,who has movedfrom Barclay’sTrade Financedepartment tobecome manager ofTrade Finance.

BLME Create Capital Markets Desk

NEWS

Dr Massoud Janekeh

Bahraini retail and commercialbanking institution, BMI Bankand Tamkeen (a semi-autonomous, governmentalorganisation funded by theLabour Market RegulatoryAuthority in Bahrain) haveannounced the launch of aShari’ah-compliant financingscheme for enterprises withinthe local private sector tobolster the segment within thecountry. Created in partnershipwith Tamkeen, the scheme willoffer a suite of Shari’ah-compliant financial productsunder the umbrella of the

Islamic Financial Servicesdivision within the bank.

Announcing the launch of thescheme, Chief Executive Officerof BMI Bank, Jamal Al-Hazeem,said, ‘Enterprises within theprivate sector are a crucial andincreasingly importantcomponent in our country’sdevelopment and through thelaunch of this Shari’ah-compliant financing schemecreated in partnership withTamkeen, we will now be ableto deliver on our commitmenttowards providing a truly

Bahrain Bank Supports Local Private Sector

innovative financial solutionthat has been createdspecifically for this segment.These facilities will offerenterprises quick andconvenient access to finance tomeet their expansion plansresulting in enhancedproductivity. The finance isoffered to them at a subsidisedprofit rate of 4% per annum onreducing balance with an optionof a longer repayment term ofup to 10 years.’

As part of the agreement,Tamkeen will guarantee 50% of

the total financing amount aswell as subsidise 50% of theprofit payments due fromcustomers. Through thisfinancing scheme, enterpriseswithin the private sector willbe eligible to receive financing ranging fromBD 10,000 to BD 500,000.This scheme offers a range of trade finance products suchas letters of credit andguarantee, murabahafinancing covering workingcapital, auto and equipmentfinancing as well as ijarafinancing.

NEWHORIZON January–March 2011

Gulf Finance House Still on Life Support

It plans to use the money itraises to develop Shari’ah-compliant institutions in Syria,Turkey, Tunisia and India; toestablish a Gulf Energy Fundthat will see it partner oil andgas companies in developmentprojects; to set up a holdingcompany, Transal, to acquire ininvestments in transport andlogistics organisations and tocreate a retakaful company thatwill be able to operate asyndicate in the London market.It has not altogether given up onreal estate projects, but these atleast are now focused in thefinance arena with the

development of offshorefinancial centres in Tunisia and Malta in the projectpipeline.

Providing they can raise the newcapital they require GFH expectto see some revenue growth in2011 with significant growththereafter. They also expecttheir tier 1 ratio to be above18%. Overall, however, it might still be premature tosay the patient can be moved off the critical list. Much depends on the success oftheir immediate capital raisingplans.

A number of financialinstitutions in the Middle East,particularly those relying heavilyon property developmentprojects, are still trying torecover from the effects of theglobal financial crisis. One ofthe most severely affectedinstitutions was Gulf FinanceHouse (GFH), which has beenundergoing some radicalrestructuring over the last 12months. A glance at the thirdquarter 2010 results shows that CEO, Ted Pretty,brought in from MacquarieCapital in late 2009, has alreadyslashed staffing costs by about66%; sold off some of thecompany’s assets to realise muchneeded capital and restructureddebt, giving the company moretime to meet its debt obligations.

Despite the restructuring todate, the notes to third quarterresults state that GFH’s ‘currentcontractual obligations exceedits liquid assets.’ KPMG, whoreviewed the third quarterresults, comment that ‘theGroup’s liquidity position andregulatory capital adequacy maycast significant doubt about theappropriateness of the goingconcern assumption used in thepreparation of the interimfinancial statement.’

GFH reported a net loss of justover $115 million for the thirdquarter, almost four times up onthe same period in 2009 andincome down more than sixtimes at $533,000, withabsolutely no income frominvestment banking servicesduring the period. This posessomething of a conundrum forGFH who need to raise money

to fund growth as well as servicethe debts on their books. One ofthe proposals to increaseliquidity and provide GFH withthe ability to move forward isan asset swap that will increasetheir stake in the KhaleejiCommercial Bank in exchangefor their holdings in the LostParadise of Dilmun Waterpark,which will be transferred toGFH’s executive chairman inreturn for an increasedshareholding in GFH. It alsoplans to raise money throughinitial public offerings (IPOs) or by listing some of itsinvestment portfolio.

NEWS

Bahrain Waterfront and Financial Harbour

NEWHORIZON Muharram-Rabi Al Awwal 1432

In the last issue of thispublication there were severalarticles that touched on theproblems experienced by Islamicbanks in the matter of liquidityinstruments. Many of theinstruments approved byregulatory bodies in the in theWest are not open to Islamicbanks, because they are notShari’ah-compliant. Theestablishment of theInternational Islamic LiquidityManagement Corporation(IILM) is an attempt to resolvethis problem. The primary

objective of the IILM is to issueShari`ah-compliant financialinstruments in order to facilitatemore efficient and effectiveliquidity management solutionsfor institutions offering Islamicfinancial services (IIFS), as wellas to facilitate greaterinvestment flows of Shari`ah-compliant instruments acrossborders.

This initiative, facilitated by theIslamic Financial Services Board(IFSB) is in line with the IFSBmandates to enhance and

coordinate initiatives to developinstruments and procedures forefficient operations and riskmanagement and to encouragecooperation amongst membercountries in developing theIslamic financial servicesindustry. IFSB claims theestablishment of the IILM is a major breakthrough in the development of the Islamic financial industry as it will provide liquid short-term Shari`ah-compliantinstruments that wouldpromote further the

Liquidity Management Solutions for Islamic Banks

competitiveness and resilience ofIIFSs globally.

The articles of agreement weresigned at the end of October inKuala Lumpur, Malaysia by 11central banks, including oneEuropean organisation,Luxemburg’s central bank andtwo multilateral banks. Speakingin London in mid November,Raja Teh Maimunah, GlobalHead Islamic Markets at BursaMalaysia, said the first outputsfrom the IILM could be expectedin March 2011.

NEWS

issuances have included $500million for the IslamicDevelopment Bank and $750million for Qatar Islamic Bank inOctober 2010 and $100 millionfor Kuveyt Turk in August 2010.

At the same conference AlbertoBrugnoni, President of ASSAIF,a not-for-profit organisationthat aims to bridge the gapbetween Islamic and ethicalfinance, served notice thatcontinental Europe is set tochallenge London’s position. Inevidence he cited the expectedissue of a $1 billion sukuk inthe fourth quarter of 2010, partof the financing package for theJubail refinery on the Gulf. Thelead arrangers for this issuanceon behalf of Saudi Aramco andTotal are Credit Agricole,Deutsche Bank and the Saudi-based Samba Financial Group.

Early in 2008 AAOIFI issuednew recommendations, inparticular guidelines relating tothe ownership of the underlyingassets in a sukuk transactionand the guarantee of theprincipal investment to theholders of the sukuk. Thecomments of one scholar to theeffect that 80% of sukukstructures were not Shari’ahcompliant sent shock wavesthrough the industry. Later inthe year, the global financialcrisis and particularly Dubai’sdebt crisis compounded theproblems for the sukuk marketand issuances dried to a trickle.After two years with the marketat a virtual standstill, however,the fourth quarter of 2010 hasseen some revival.

In September and October 2010Gulf issuers sold approximately

$6 billion in debt, including a$1.25 billion sovereign issue fromDubai; in October Abu DhabiBank said that a $750 millionsukuk was nearly five timesoversubscribed with strongdemand from the Middle East,Europe and Asia and Saudi firmsexpected to issue 2–3 sukuks perquarter in 2011 according tobanking sources in the country.

At the Islamic Finance News(IFN) Roadshow in London inNovember, Gillian Walmsley ofthe London Stock Exchange (LSE)highlighted London’s highlightedthe significance of the Londonmarket for sukuk. To date theLSE has issued 30 sukuks raisingjust less than $19 billion.London’s closest Europeancompetitor is Luxem bourg with16 sukuk issues raising$7.3 billion. Recent London

Sukuk – Is the Market Reviving?

Despite the signs of life nowbeing exhibited by the sukukmarket, however, fundamentalissues remain if globalinvestors are to be temptedback into the market. RajaThe Maimunah, Global HeadIslamic Markets, BursaMalaysia, speaking at the IFNRoadshow suggested thatclarity on pricing, globalstandards and short-termissuances are needed to boostconfidence. Farmida Bi, apartner at Norton Rose LLPsuggested that one approachto achieving clarity on pricingwas through a programme ofgovernment benchmark issues.Her final remarks neatlysummarised the issues – thereis a need for pricetransparency, bettergovernance and mechanismsto mitigate counterparty risk.

NEWHORIZON January–March 2011

In an interview with Bloomberg in May2010, Hussein Hamid Hassan, chairman ofthe Shari’ah Coordination Committee of theIslamic Financial Institutions in the UnitedArab Emirates and an eminent Egyptianscholar suggested that the industry needsstability to grow, citing how banks in theUAE struggle to do business with each otherdue to variations in Shari’ah interpretationof deal structuring from board to board. Ifthis is a problem within one relatively smallgeographic region, where there aresignificant cultural and religious similarities, it is not hard to see that theproblems increase exponentially on a globalbasis.

One of the primary issues is that there is nosingle model for the way Shari’ahsupervision is organised. In somejurisdictions, such as Malaysia, Pakistan andSudan, there is a central Shari’ah advisorycouncil at a national level with variousShari’ah boards at the institutional level; inothers there are Shari’ah advisory boards atthe institutional level only and a third modelis the outsourcing of Shari’ah advisoryservices, primarily due to a shortfall in thesupply of suitably qualified Shari’ahscholars.

The Role of Shari’ah Scholars

According to AAOIFI, ‘Shari’ah advisors arespecialised jurists particularly in fiqhmuamalat (jurisprudence of transactions)and Islamic finance entrusted with the duty

Does Islamic Finance Need to Put its House in Order?

The October lecture ‘The Small World of Islamic Finance’, in which Murat Unalrevealed the findings of the Funds@Work study on Shari’ah governance (see IIBILectures in this issue), highlighted the claustrophobic nature of the world of Shari’ahscholarship as it related to the Islamic finance. It, therefore, seemed appropriate totake a look at this small world and ask whether the way it is currently organised isserving the best interests of Islamic finance and whether there is any likelihood ofchange taking place in the short to medium term.

FOOD FOR THOUGHT

of directing, reviewing and supervising theactivities related to Islamic finance in orderto ensure that they are in compliance withShari’ah rules and principles. The views ofthe Shari’ah advisor shall be binding in thespecific area of supervision.’ Islamic financedoes not, however, exist in a vacuum. It ispart of a global financial industry and istherefore in competition with conventionalfinancial institutions. Perhaps, therefore,AAOFI’s definition needs to include a clauseabout understanding modern financialpractices beyond the confines of Islamicfinance. Dr Mohamad Laldin, executivedirector of ISRA (International Shari’ahResearch Academy for Islamic Finance)lecturing to the IIBI in February 2010 saidof Shari’ah scholars, ‘They are required tobe more proactive and need to be assistedby new, well-trained scholars and otherstakeholders of the industry.’

Shari’ah Scholars – Supply and Demand

The problem is that there is already ashortage of suitably-qualified Shari’ahscholars. There are just 221 scholarsavailable worldwide to fill 1,054 boardpositions and IFIs have a tendency to wantto recruit the better-known scholars to theirShari’ah board. As a result scholars tend tohave multiple board appointments and thatraises the issues of conflicts of interest and alack of responsiveness. For example, if ascholar sits on multiple boards, as verymany do, in the two most extreme cases onmore than 80 boards, how can impartiality

be guaranteed or, at a very practical level,how can you expect a timely response, whenthe workload is so onerous. Delays ingetting new products and services to themarket too often means financialinstitutions, both Islamic and conventional,lose the opportunity to reap the financialand reputational benefits of being marketleaders and are left to pick up the crumbsthat are left by those who are more fleet offoot.

One response has been to outsource theproblems to consultancy firms specialisingin devising products and services and thengetting them approved by a group of threeor four scholars retained by the consultancy.Critics see this as a rubber-stamping exercisethat cannot be described as proper Shari’ahsupervision. Samir Alamad, Shari’ahCompliance Officer and ProductDevelopment Manager at the Islamic Bankof Britain added, ‘External Shari’ahadvisory companies will be less effectivethan internal Shari’ah advisors, who knowthe precise issues their institutions face andwill therefore be more capable of addressingthese issues.’

If you look at a cross section of articles inthe press about Shari’ah scholars, you willcome to the conclusion that the problem isthat there is a shortage of appropriatelyqualified scholars available to take up thepositions on Shari’ah boards, but is thisreally the case. An alternative view is thatthere is no real shortage and the problem

NEWHORIZON Muharram-Rabi Al Awwal 1432 FOOD FOR THOUGHT

lies with the IFIs, who want to have thewell-known names on their boards. Thislimits the pool of available scholars anddenies many, particularly the youngerscholars, who may well have a broaderunderstanding of modern financialpractices, the opportunity to serve onboards, gain experience and become thetop-name scholars of the future.

Dr Azeemuddin Subhani, a noted Shari’ahacademic from the UAE’s Ajman Universitybelieves that the shortage is a reality andlikely to continue. He said, ‘The entry doorsto this small, self-entrenched group areeither not open or at least the entryrequirements are not well defined. Whilequalifications for becoming a Shari’ahadvisor have been laid down, for exampleby the State Bank of Pakistan and AAOIFIhas a certification programme for Shari’ahadvisors and auditors, there is no indicationavailable as to how an advisor, is, if ever,elevated to the position of scholar. UnlessAAOIFI starts regulating the profession andlays down achievable and uniform entrystandards, the situation is not going toimprove.’

Changing the Rules

Some countries have already takenunilateral action to limit the number ofboards on which a scholar may serve. Forexample Bank Negara Malaysia restrictedscholars to one board and as a result nowhas a pool of more than 100 scholars ontheir list. Interestingly, Malaysia has alsotaken a lead in the acceptance of femalescholars; there are reported to be 10 femaleadvisers working in Malaysia today. Themore conservative Middle East has yet tosee any evidence of this phenomenon.

One of the best hopes for a morewidespread reform of Shari’ah boards,however, lies with Bahrain-based AAOIFI(Accounting and Auditing Organisation forIslamic Financial Institutions). While theorganisation’s rulings are not mandatoryoutside Bahrain, their guidelines do tend tobe followed by a very broad spectrum ofcountries such Lebanon, France, Indonesia,Jordan, Kuwait, Malaysia, Pakistan, Qatar,

Saudi Arabia, South Africa, Sudan, Syriaand the United Arab Emirates.

AAOIFI, the oldest and possibly mostauthoritative standard-setting body, iscurrently discussing guidelines, which willlimit the number of boards on which anyindividual scholar may serve. They are alsoaddressing issues such as whether scholarsmay have shareholdings in the institutionson whose boards they serve; compensationfor scholars and whether scholars may haveroles with Shari’ah advisory firms that havelinks to institutions that they serve. AAOIFIplan to have a draft guideline ready fordiscussion by the end of the first quarter2011 with the intention of having guidelinesin place by the end of 2011. SheikhMuddassir Siddiqui, a prominent Islamic

Muddassir Siddiqui, Partnerand Head of Islamic Finance,SNR Denton and Member ofAAOIFI’s Shari’ah Standards

Committee

scholar, partner at law firm, SNR Dentonand member of AAOIFI’s Shari’ahStandards Committee comments, ‘What we need is a carefully drafted code of ethics, which must address potentialconflicts of interest and provide realsolutions.’

A potential problem is that a largeproportion of AAOIFI’s Shari’ah board arealso serving members of the Shari’ah boardsof IFIs. Samir Alamad commenting on thissaid, ‘As respected scholars, I believe theywill live up to this challenge and facilitatethese changes and then the IFIs will follow.’

The IFSB (Islamic Financial Services Board)based in Kuala Lumpur, Malaysia hasalready set some guidelines for Shari’ah

NEWHORIZON January–March 2011FOOD FOR THOUGHT

boards, which could be viewed as a movetowards encouraging IFIs to appoint a morediverse group of scholars to their Shari’ahboards. Their standards require Shari’ahboards ‘to have at least three members,possibly trained in different schools ofjurisprudence, have a mix of members withdifferent lengths of experience and, whereappropriate, comprise of differentnationalities. In addition to their Shari`ahexpertise, members of the Shari`ah boardshould possess some exposure in the areasof commerce or finance.’

The question is whether the carrot or thestick is the most effective way of effectingchange. Somehow IFIs need to beencouraged to appoint young scholars andgive them the opportunity to gain theexperience they need, but at the same timethey need to feel comfortable that this willnot expose them to increased risk. Perhapsone avenue worth exploring would be ascheme, in which young scholars areapprenticed to senior colleagues, whose rolewould be one of teaching and supervision.That of course presumes that the seniorscholars have time to undertake this role,which brings us back to the issue of limitingthe number of boards on which they mayserve. Essentially, the Islamic financeindustry needs both the carrot and the stickto achieve real, effective change, but withgood will and common sense a moresensible arrangement vis a vis Shari’ahadvisors seems eminently achievable in theforeseeable future.

Global Standards

That takes us back to the comments byHussein Hamid Hassan with which westarted this article, agreeing globallyacceptable standards that will allow IFIs totrade easily and openly across borders. Thatis a much more complex issue. Islam, justlike many other belief systems, does nothave a single, unified face to present to theworld, but it is the only one that requires afinancial institution to have a religiousadvisory board sitting alongside itsexecutive to scrutinise and approve theproducts and services being offered. Theviews held by these advisory boards are not

consistent globally and as Hussein HamidHassan highlighted, they are not evenconsistent within a relatively smallgeographic area.

It is entirely likely that some agreement canand will be reached to bring some order tothe composition of Shari’ah boards, therebyincreasing their effectiveness and addressingthe issues of transparency and conflicts ofinterest. Achieving agreed standards,however, allowing products and services tobe traded freely on a global basis, is anentirely different matter. When discussingthe issue many commentators tend tohighlight the more liberal approach ofMalaysia with the more orthodox approachof GCC countries, but as Hussein HamidHassan has pointed out there are problemseven within the GCC region.

It is difficult to see just how the views ofscholars and legislators from differentIslamic traditions can be reconciled. Withoutsuch reconciliation, however, the world ofIslamic finance will continue to struggle toreach its full growth potential. It has beensuggested that a complete reorganisation ofindividual regulatory systems, monetarypolicies and religious interpretations into asingle set of standards would be prohibitivein terms of cost, if indeed all theparticipating countries and regions could bepersuaded to agree to such a compromise.The cost of not working towards a morelevel playing field, however, is to hand global

financial dominance to the conventionalfinance industry with all its weaknesses andmoral shortcomings so amply demonstratedin the recent financial crisis.

Sheikh Muddassir Siddiqui takes asomewhat more restrained approach to theissue. He comments, ‘The USA has onefederal law and 50 variations applicable inthe different states. This has not hinderedthe economic growth of the country.Diversity can, in fact, be a tool of strength.What we need is a rational approach to theprinciples of Shari’ah so that the rulesbecome more predictable and consistent. Weshould learn to live with dissent rather thansilencing it by force.’

No matter whether you favour the softly,softly approach to change or somethingmore prescriptive, there is no doubt that theIslamic finance industry has a uniquewindow of opportunity to demonstrate thatthere is an alternative and effective way oforganising the financial services industry.The question is whether the individualjurisdictions and the financial institutionsinvolved have the will or the wherewithal tograsp that opportunity. If they do not, thelosers will not just be the IFIs, but the widerworld in general. The IFIs will go on beingcomfortably successful in their nichemarkets, but they will miss the chance tochallenge the conventional finance industryand to offer a real and effective alternativeto it.

(For a more in depth look at the role of Shari’ah scholars,readers may wish refer to an article on the subject authored bythe IIBI’s Mohammad Shaifique in the April–June 2010 issue ofNewHorizon.)

NEWHORIZON Muharram-Rabi Al Awwal 1432 POINT OF VIEW

Background

After what will have been the longest periodof sustained economic contraction since thegreat depression, Islamic banks, which havenot suffered to the same extent or in thesame manner as their conventionalcounterparts, should be seen as a safer andmore socially responsible alternative. Itwould be naïve to suggest that the businessconstraints of Islamic banks are a panaceafor the problems of conventional banking.The widely adopted Shari’ah prohibition ofconventional derivative financialinstruments, however, should at leastprovide a stark and direct reminder toIslamic banking circles of the importance ofproceeding cautiously when structuring toreplicate rather than to innovate alternativesto the economic profile of conventionalproducts.

Economic crises by their very nature evokesignificant change. Previously untestedscenarios are played-out in real life. Thesukuk industry up until this crisis was inessence untested. Post-facto, the first sukukdefaults have revealed that sukuk structureswere largely asset based, rather than assetbacked; liquidity mismatches havedemonstrated the folly of the pursuit bysome Islamic banks of substantially fundingmid to long-term illiquid assets with short-term interbank deposits and the evaporationof confidence in the credit markets left thesebanks distressed. The prevalence of a ‘toobig to fail’ mentality widely applied to twoof the largest GCC-based conglomeratesworsened the position of regional players

even further. Furthermore, the herding ofinvestors to take on outsized real estateexposures, with off-plan ownership indevelopment projects repeatedly changinghands in quick succession, paved the way for a bubble that has stressedinstitutional as well as small investors alike. The IPO market, important as an exitroute for private equity investors, dried upon the back of depressed equity marketsgenerally and consequent low valuationmultiples, leaving many Islamic banks andtheir investors unable to realise muchneeded liquidity. Most recently Dubai has for the first time revealed the difficultyit faces in servicing its mountainous debtpile.

So the mood changed, and with it, Islamicbanks moved to a defensive stance,managing their existing portfolio assets andpreferring not to transact new business.Balance sheet preservation became de-rigueur and revenue generation took a backseat to cost cutting. The question now ishow should Islamic banks proceed from thispoint to ensure they are positioned toprosper in the new economic landscape andwould a strategic redirection need to beradical?

Why has the existing business model failedto work in the current environment?

The business models run by Islamicinvestment banks in the GCC have reliedextensively on their ability to sell investmentopportunities at a premium. This had formany years enabled such institutions to

Strategy Change and the EconomicCrisis: The Business Models of IslamicInvestment BanksBy: Dr. Ken Baldwin, Formerly Chief Operating Officer, Capinnova Investment Bank,Bahrain

Dr. Ken Baldwin waspreviously Chief OperatingOfficer of CapinnovaInvestment Bank, Kingdomof Bahrain, prior to whichhe worked in seniortreasury and riskmanagement roles for 17years at top-tier investmentfirms including UBS, CreditSuisse and Investcorp. Heholds a first class honoursdegree in Physics fromOxford University, a PhD inGame Theory and is aChartered Accountant.

NEWHORIZON January–March 2011POINT OF VIEW

front load transaction-related revenue, withan expectation of additional returns fromdistributions made during a holding periodlasting until exit, at which time capital gaincould also be realised. This model hasalmost entirely failed in the current marketenvironment. Following highly-correlatedimpairment in the value of investmentsacross multiple asset classes includingequities and real estate, high net-worthindividuals and financial institutions losttheir appetites for more risky investments,preferring instead to retain uninvestedcapital in cash or near-cash instruments.With the dissipation of investor interest inmany of the product lines financialinstitutions had structured themselves todeliver, the very lifeblood of these businessmodels dried up.

A Key Challenge

One of the main challenges facing Islamic financial institutions is tounderstand whether this problem is shortterm or long term. If it is short term, achange in business model will not berequired. The so-called ‘dry powder’ orlarge cash balances, which many institutions have gathered, will eventually bedeployed, and in the interim, expensemanagement and investment transactiondeferral may continue with deal teams stillworking to identify good opportunities towarehouse for future investment. If,however, there is a long-term reduction inrisk appetite for these products, financialinstitutions will need to restructure theirbusiness models in order to remain viable.

Product-Level Changes

During the boom period experienced in theGulf on the back of high oil prices between2003 and 2007, private equity investorsexpressed their willingness to wait severalyears for exits in order to realise returnsover and above repayment of their initialcapital. This patience was on average wellrewarded, however, sentiment towardsprivate equity has since changed withincreasing investor risk aversion due tolosses concentrated in real estateinvestments in the region.

From an investor perspective, there areseveral ways to reduce the amount ofincremental risk assumed by continuing toinvest in this asset class. Investing in a largernumber of smaller opportunities in pursuitof diversification is perhaps the mostobvious approach. Additionally, and againfrom a portfolio perspective, opportunitiesmay be evaluated in terms of incrementalrisk given an investor’s existing exposuresacross all asset classes as well as sectors,industries, and geographies. If, however,such measures do not reduce incrementalrisk to acceptable levels and it is notpossible to find opportunities with shorterexpected holding periods, then temporalrisk tolerance requirements for theseinvestments will remain prohibitive.

To mitigate investor concern over long waittimes to realise returns, opportunities thatreturn cash to investors throughdistributions made before exit should befavoured. By distributing rather thanreinvesting a portion of the net incomecreated by businesses, a significant portionof the return that would otherwise berolled-up and paid to investors as capitalgain at exit is realised earlier.

Finally, investors should look toopportunities in which the deal sponsor hasan expertise. Leveraged buy-out plays(LBO’s) were a huge casualty of the crisiswith the collapse of the credit markets. Acommon perception among industryprofessionals is that such plays will notreturn and private equity investors will berequired to take on meaningful involvementat an operational level in order to createvalue. Sound in-house knowledge andexperience of the businesses that privateequity houses acquire and place with theirinvestors will reduce investor concernregarding the validity of post-acquisitionbusiness strategies and the mitigation ofexecution risk related to them.

Investment Mechanism Changes

Many investment banks and private equityhouses in the GCC region pursue a directmodel, which basically means that theysource opportunities and then seekparticipation from their investors on a deal-

by-deal basis. This creates a significantstrain on liquidity as well as the sufficiencyof the investment firm’s equity capital toabsorb unexpected losses in the value of theinvestment until it can be sold to investorsand also constrains the firm’s ability todeploy capital to other opportunities.

The key alternative route to direct investingis to structure off-balance-sheet fundvehicles. The investment firm acts as a fundmanager and investors providecommitments, which are funded as andwhen the fund manager identifiesopportunities. In this way, the investmentfirm effectively pre-sells the private equityopportunities acquired by the fund, withoutthe placement risks encountered with thedirect route. As long as investors fund theircommitments when called upon to do soand there are no timing differences betweenfunding by investors and private equity dealclosures, the investment firm suffers none ofthe issues of liquidity and capital constraintsattributable to the direct model.

The investment firm, however, still facessignificant risks. The target size of the fundmust be determined taking intoconsideration how successful its placementis likely to be; raising large amounts ofcapital in the current environment is fraughtwith difficulties and investment firms, whichare too ambitious, may suffer fromreputational problems if they are laterunable to procure sufficient investorcommitments. Additionally, income in theform of subscription fees is typically farlower than the sell-down premiumsinvestment firms have been able to generatefrom the direct route, whilst infrastructurerequirements to set up and operate a fundare far greater. Finally, investors may nolonger be willing to commit capital to futureinvestments the fund will make on theirbehalf without first knowing precise detailsabout those opportunities.

One approach, at least as an interimmeasure, until investor appetite for privateequity returns to more normal levels, reliesin a sense on going back to the basics ofbanking. During the boom period, manyinvestment firms were content to assumeinvestor interest in their products without

NEWHORIZON Muharram-Rabi Al Awwal 1432 POINT OF VIEW

mind-set required to run these businesses issignificantly different from that required torun a commercial banking operation.

Commercial banks benefit from havingstable deposit bases, which provide animportant source of non-volatile liabilitieswithin the overall capital structure. This is asignificant advantage for many reasons.Unlike investment banks, commercial banksneed not rely on the credit markets to raisefunds. Islamic investment banks, which arewholesale entities, rely on a mix of volatile,inter-bank money-market deposits and termfunding such as term murabahas and sukukissuances. During this crisis, both of theseimportant sources of funding were notaccessible. There has, therefore, been anincrease in merger interest, with severalannouncements to combine investment andcommercial banking entities made in theKingdom of Bahrain alone. Whilst from aneconomic perspective this makes perfectsense, realistically we may not hear of manymore such announcements.

In Europe, central banks have a far widerrange of powers, including being able toforce the merger of entities that it licensesand regulates. In the GCC, however, this isnot the case and resistance by seniorbankers, who would be personally adverselyaffected, renders merger infeasible. Oneexception to this is where the commercialbanking party to the business combinationmay have all but failed and a compellingvalue proposition, for example, derives from access to an established branchnetwork.

Role of the Regulator

In light of the crisis much attention has beendrawn to the role of the regulator inminimising systemic risk. In the GCC, thecrisis did not see central banks providingrelief packages as they did in the U.S. and inEurope - central banks in the GCC do notact as a lender-of-last-resort. The mandateof GCC central banks, however, could bewidened in future to provide a discountwindow to facilitate inter-bank money-market financing arrangements given thereliance of Islamic investment banks on thismode of financing. GCC regulators have

first thoroughly gauging that interest. Thiswas fine when investors were makingmoney. Given the current environment,however, a suitable approach to mitigateplacement risk must be to start withcomprehensive profiling of a bank’s investorbases. There is no placement risk ifinvestment firms act upon the specificinstructions of their investors to sourceopportunities that fit their requirementsmore precisely. The investment firm couldthen precede any acquisition of privateequity with funding from investors. One ofthe main drawbacks of this approach is thatit would potentially create a large numberof small sub groups. As a result, deal sizesand therefore returns for the investmentfirm would typically be lower.

Structural Changes

While private equity has been most affectedby the current crisis, it is worth looking atissues arising at the enterprise level. Beforethe crisis, some business models werestructured with lines of business that werehistorically uncorrelated or with lowcorrelation, where at least one provided arecurring income stream to cover operatingexpenses. Investment firms having lostacross all lines of asset-based businessesduring the current crisis of course no longerbelieve it is possible to achievedifferentiated performance during periodsof severe stress. Building assets thatgenerate cash has, however, naturallyretained its appeal and therefore manyinvestment banks in the GCC have beenactive in corporate financing transactions,typically within the remit of theircommercial banking counterparts.

What is also so appealing about corporatefinancing is that a bilateral arrangement forthe extension of finance does not depend oninvestor risk appetite since there is noplacement of a transaction as such. Whatremains to be seen is whether this signalsthe beginning of a more permanent change.The idea of a mixed business model, inwhich the lines of business include bothinvestment as well as credit, is not new. Inthe past, bankers have argued the case forspinning-off their investment bankingactivities into a separate entity since the

The views of the author are his aloneand do not necessarily represent thoseof organisation by which he is employed.

NEWHORIZON January–March 2011POINT OF VIEW

acted, however, by seeking assurances fromlicensed entities that they remain liquid andthat their capital adequacy is sufficient. Insome instances they have applied pressurefor banks to take necessary remedialmeasures to shore up their finances.Regulators have also sought greateroversight of licensees with respect to off-balance-sheet structures and related SPV’s(Special Purpose Vehicles) incorporated forproduct offerings, as well as introducing

new limits to reduce exposure whereconcentrations arise. None of theseregulatory measures necessarily limits thestrategies that Islamic investment banks areat liberty to pursue and, if anything, closeroversight by regulators of their licenseesshould encourage banks themselves tochallenge their existing business models inorder to assess whether or not anexpectation of future profitability isreasonable.

Final Remarks

While this discussion has presented strategicalternatives for Islamic investment banks,attitudes to change vary widely byinstitution and the process of self-assessment will sometimes uncover painfultruths and call into question the willingnessof boards to make bold decisions that havelong-lasting implications.

NEWHORIZON Muharram-Rabi Al Awwal 1432 ACADEMIC ARTICLE

Background

The global financial crisis has raised thenear universal awareness of the ethical flawsof the conventional financial system. This inturn has the potential to make ‘Islamicfinance’ appeal beyond the Muslim world toother monotheists in particular and ethicistsin general, but that urgently requires anenunciation of the fundamentals of Islamicfinance in universally comprehensible termsin order to protect the expanding Islamicfinancial architecture from becomingunwieldy and its foundations shaky. Thishas to be in the form of clearly articulatedgeneral operative principles as opposed topatchy and curt legal injunctions fromIslamic fiqh councils and the Shari’ahsupervisory boards of Islamic financialinstitutions as at present. There is a need fora cohesive theory of Islamic financial law,stemming from a philosophical insight intothe rationale of its prohibitory andpermissible norms.

Defining the Terminology

The foundational norms of Islamic finance –the prohibited gharar, maysir and riba(unilateral growth) and the permitted bay‘(bilateral exchange) – are still engulfed inlinguistic and juridical controversy, resultingin a multiplicity of fatawas, which are oftendiametrically opposed to each other.

The controversy concerning gharar and, itsextreme form, maysir concerns the extent ofthe prohibited risk taking. If all risk-takingis prohibited, then how can it be thefoundation of the Islamic financial structureand, even if risk taking is the foundation,why are speculative transactions forbidden?Furthermore, if only excessive risk taking is

held to be prohibited, where is the dividing line between ‘excessive’ and ‘non-excessive’ and its scriptural authority?The foundational pillar encapsulated in the permission of bay’ is, in fact, not the question of risk, but rather thegenerating process of the transaction of bay’. The correct focus for thefoundational pillar is not the effectof the transaction (risk/return), but theprocess of generation of any effect of thetransaction.

While juxtaposing bay‘ and riba as halaland haram, respectively, the Quranic verse(2:275) imposes the punishment of Satanicinsanity and eternal Hellfire on theindulgers of riba, expressly for their likeningof bay’ with riba.

This verse raises the crucial question ofwhat sets riba apart from bay‘, in terms oftheir intrinsic distinguishing characteristic.If the effects of riba and bay’ appear similarto some, how does the generation of ribadiffer from the generation of bay’ and, howdoes that attract Satanic insanity?

If riba and bay’ only have a conventionalcommercial connotation, then the Quran issimply prohibiting usury/interest andpermitting sale instead. Surely, if this werethe case, a simple inability to distinguishtwo seemingly commercial terms can easilybe a case of ignorance, lack of commercialknowledge and cannot be so serious as to beequated with such grave punishment. Surely,indulgence in one seemingly commercialactivity cannot be such a grave sin as toimperil such grave punishment. What, then,is the veiled layer of meaning beyond theapparent commercial meaning that attractssuch punishment?

This makes the definition of, and theterminological contrast between, riba andbay‘ a matter of not only theoretical butalso of practical concern, because itpotentially guides not only everydayfinancial decision-making, but also regulatesthe highly creative financial engineeringresponsible for new Islamic businessapplications.

Extant scholarship translates bay’ in itsrestricted technical meaning as sale and,surprisingly, extends the meaning byinterpreting bay’ as trade, while in theQuranic Arabic an entirely different word,tijara, translates as trade. Quran 2:275specifically permits bay’ and not tijara assuch. The scholarship further attributes thedesirability of risk taking as the rationalefor the permission of bay’ (mistranslated astrade), as against what it calls risk-free,riba-based lending. The scholarship furtherextrapolates the notion of risk taking tomean profit/loss-sharing and posits it as thefoundational principle of Islamic finance.

Problems with the DefinitionThere are several problems with thisformulation. Firstly, profit/loss-sharingcannot be held to be the fundamental, all-inclusive principle of Islamic finance. Surely,profit/loss-sharing is the distinguishingfeature of the permitted participatorycontracts of musharaka and mudaraba, butwhere is the element of profit/loss-sharing inthe permitted trading contract of murabahaand in the permitted leasing contract ofijara? What then is the common legitimisingbasis of the participatory, trading andleasing contracts?

Second, riba-based lending is not risk free;among others, it has default risk. Moreover,

Whither Islamic Finance?‘… bay‘ riba …’ – Quran2:275

By Dr. Azeemuddin Subhani, Ajman University, UAE

NEWHORIZON January–March 2011

counter-parties in the deal. This interactionof opposites is a process of co-generation,commensurate with the creation ofeverything in pairs, as repeatedlyemphasised in the Quran. The definingcharacteristic of bay’, then, is not risktaking, as generally held, but co-generationand interaction leading to co-generation isthe only common factor that legitimises theparticipatory trading and leasing contractsin Islamic law – the interaction of moneyand labour in the permitted participatorycontracts of musharaka and mudaraba; theinteraction of money and commodity in thepermitted trading contract of murabaha andthe interaction of money and usufruct in thepermitted leasing contract of ijara. Bycontrast, this feature of interaction and co-generation is absent in the prohibitedcontract of lending at interest and in theprohibited contract of selling (exchanging)homogenous items for profit. These twocontracts are characterised by thediametrically opposite feature of intra-action and self-generation.

The participatory contracts (musharaka andmudaraba), however, are co-generating onlyin their pristine application, which did notrecognise the modern notion of theartificial, juridical personality of thecorporation. The later half-hearted Islamicacceptance of this notion, however, ignoresthe fact that the recognition of the bank andthe customer as separate legal personalitiesconverts the financial returns from thesecontracts from co-generating to self-generating returns between the bank and thedepositor and between the bank and theclient. The legal concept of the corporateperson, not known to pristine Islamic law,requires re-examination to ensure thepristine integrity of the Islamic financialarchitecture.

The Definition of Riba

In extant scholarship riba is interpreted withits technical meaning of usury/interest andits prohibition is mainly attributed to thenotion of human exploitation, which,however, is not commensurate with its dire,other-worldly Quranic punishments.Another serious scholarly misconception isto look at the prohibition of riba as the

the fixity, certainty and pre-determinabilityof interest (riba) cannot be a rationale for itsprohibition, because these very threefeatures of fixity, certainty and pre-determinability are also the main attributesof the permitted contract of ijara.

Third, while trade (buying and then selling)does involve risk-taking, sale (just selling),which is the technical meaning of bay’, isfree of all internal risk. Islamic law ensuresthat the sale transaction is also devoid ofany external risks, such as market orsettlement risk. Finally, the Islamicprohibition of gharar is designed to makethe transaction free from any risk.

This leads to a contradiction, because thefoundational permission of bay’,mistranslated as trade, is held to encourage,in fact require, risk taking, while the equallyfundamental prohibition of gharar isdesigned to eliminate that very risk-taking.The scholarly explanation that a basic levelof risk taking is permitted and that theprohibited gharar refers not to all but toexcessive risk taking only is at best a facesaving attempt to lend cover to theirmisinterpretation of bay’ as trade. Thereliance on the hadith-derived Shari’ahmaxim of al-kharaj bi’l-daman (return/gainmust be justified by guarantee/risk) as thelegitimising basis of risk taking andprofit/loss sharing as the fundamental pillarof Islamic financial law is problematic atbest. The stronger linguistic connotation ofal-kharaj is extraction/tax rather than profitand of al-daman issecurity/guarantee/liability rather than loss.This maxim has not yet been satisfactorilyexplained and flies in the face of theprohibition of gharar.

The Correct Translation of Bay’

Quran 2:275 juxtaposes, not tijara and riba,but bay’ and riba. What, then, is the correcttranslation of bay’? Linguistically, bay’refers to all exchanges, not just commercialbut also political and social, among others.In the absence of an Islamic theory ofcontract, the bay’ contract is the prototypeof all contracts in Islamic law. The commonelement in all bay’ contracts is theinteraction of two different and opposing

ACADEMIC ARTICLE

Thus, the derived operativeprinciple for Islamic financialarchitecture is to regard thepermission of bay’ as thepermission, even requirement,of co-generation in atransaction.

NEWHORIZON Muharram-Rabi Al Awwal 1432 ACADEMIC ARTICLE

prohibition of the effect of a businesstransaction and not as the prohibition of theprocess of the transaction, i.e., as theprohibition of the method of generation ofthe effect. In a business transaction, Islamiclaw permits profit-making, i.e., moneyultimately resulting in more money (theeffect); what it regulates is the underlyingprocess/method of generation of that effect;it prohibits self-generation of the effect (ribamethod) and permits co-generation of theeffect (bay’ method). It does not matterwhat names are assigned to the effect (usury,interest, profit); what matters is the methodof generation of that effect. If the effect isself-generating, the transaction becomesribawi (riba method) and, hence, prohibited.If the effect is co-generating, the transactionbecomes bay’awi (bay’ method) and, hence,permitted.

A linguistic/contextual analysis shows thatall riba-derived verbs, as used in the Quran,denote self-generation and bay’ denotes co-generation. Self-generation occurs in anexchange of homogeneity where onetransacting agent is acting on itself, e.g.,money on money directly and co-generationoccurs in an exchange of heterogeneitywhere one transacting agent is acting on adifferent agent, e.g., money on goods andgoods on money.

The gold for gold hadith, contrary to thepopular scholarly perception, is notrequiring a homogenous exchange; in fact itis prohibiting it by making it meaningless.An instant exchange of commodities, whichare identical, is obviously a pointlesstransaction. Upon deeper reflection, thishadith is not ordering this equal andinstantaneous exchange of homogeneity,rather it is prohibiting it, although not by adirect negative command (amr nahi) of ‘donot do this’, but by the rhetorical, indirectand positive command of making theexchange meaningless and purposeless. Thehadith opening ‘gold for gold’, does notmean ‘[Sell] gold for gold, like for like, inequal weights, from hand to hand’; therhetorical construction actually means ‘[Theonly way you can exchange] gold for gold[is] like for like, in equal weights, from handto hand [which is meaningless and hence

better avoided]. He who gives in excess oracquires an excess [or delays] has chargedriba. This is a clear prohibition ofhomogenous exchanges in which any excessby default becomes self-generating andhence the prohibited ribawi. The furtherstipulation in this hadith, ‘If thecommodities differ, exchange them as youwish [but hand to hand]’ is a clearendorsement of heterogeneous exchanges inwhich any excess by default becomes co-generating and hence the permitted bay’awi.

The universally guiding principle of riba,therefore, is not the external presence ofinterest/usury per se, but the internalpresence of self-generation. Usury (in itsoriginal meaning of any usage charge) andinterest (as the modern equivalent of theoriginal usury) are prime examples of selfgeneration. Self generation as the definingcharacteristic of riba is not only Quranicallyand linguistically supported, but is also fullycommensurate with the Quranicpunishment for it, as self generation/selfsubsistence is a sole divine attribute and anyhuman indulgence in it is a transgression inthe divine domain.

The Definition of Nasi’a

Yet another scholarly misconceptionsurrounds the question of the permissibilityof delay (nasi’a) in the settlement of anycounter value in an exchange transaction.Two authentic Prophetic hadiths prohibitany delay in the settlement of an exchangetransaction. The ‘gold for gold … hadith’clearly stipulates instantaneous hand-to-hand (yad bi-yad) settlement, both forhomogenous and heterogeneous exchanges.The other hadith is pointedly to the effectthat ‘indeed there is riba in nasi’a (delay).’Accordingly, pristine Islamic law requiresthe instantaneous settlement of both countervalues in the transaction in the samecontracting session (majlis), so much so thateven a slight delay, e.g., to get the moneyfrom the other room, invalidates thetransaction and the sale contract.

The obvious practical implication of thisunequivocal requirement is that credit sale(delay in price settlement), salam (forward)sale (delay in commodity settlement) and

Thus, the derived operativeprinciple for Islamic financialarchitecture is to regard theprohibition of riba as theprohibition of any instance ofself-generation in atransaction.

NEWHORIZON January–March 2011ACADEMIC ARTICLE

futures sale (delay in both price andcommodity settlement) stand strictlyprohibited as per pristine Islamic law. It isonly as per the doctrine of extreme necessitythat credit sale and salam sale havehistorically been permitted solely as anexception. The futures sale has no parallelin Islamic legal history and requires anevaluation to determine whether or not itqualifies under the doctrine of extremenecessity as an exception.

Yet, modern juristic scholarship posits theexception as the pristine rule, by stipulatingthat ‘one if not both of the counter values ina transaction must be present at contracttime.’ The pristine rule requires the presenceof both; the exception allows the delay ofone. This cannot change the pristine ruleand obviously every delay cannot qualify forthe exceptional treatment. This conclusioncould have far-reaching implications forIslamic financial architecture, if not foractual reconstruction, at least for a coherentunderstanding of the integrity of theunderlying law.

The question of why delay in settlement isprohibited and how riba arises from delayhas not satisfactorily been answered by thescholarship. This author associatestransactional delay with a semblance of ex-nihilo creation (creation from nothing),another sole divine attribute. This ex-nihilocreation argument draws heavily on theIslamic legal notion of ‘unity of thetransacting session’ (ittihad al-majlis).

In a cash sale, the receipt of commodity andcash in the same session can be construed asthe creation of each one from the other. In acredit sale, however, delay in settlementprevents this creation and leads to twoinstances (sessions) of semblance of ex-nihilo creation – the receipt of thecommodity in exchange for nothing in thefirst session and the receipt of the money inexchange for nothing in the second session.The delayed transaction, by producing thesetwo instances of the semblance of ex-nihilocreation, invites another Prophetic hadith –‘there is no riba [of such severity], except innasi’a (delay).’ The Quran does permitdelayed settlement loans (Q. 2:282), becausea loan is only a temporary, reversible

transfer of possession and hence no ex-nihilo creation occurs.

In Summary

To sum up, the operative principles ofIslamic finance require that the internalprocess of the transaction, which is thefocus of Islamic law and not the effect of thetransaction, must incorporate cogenerationand eliminate self generation, delay (exceptunder dire necessity) and risk-taking.

These operative principles of Islamic financeare consistent with the theoretical model ofcreation, which conceptually consists of (i)creation from nothing (ex-nihilo creation);(ii) creation from the object itself (ex-suicreation, to coin a new term) and (iii)creation from other object (ex-alio creation,to coin yet another new term). Ex-nihilocreation is expressly and exclusively a divinecapability and hence any human action even

resembling ex-nihilo creation (e.g. delay intransaction settlement, as explained above)stands prohibited. Similarly, ex-sui creationis expressly and exclusively a divinecapability and hence any human action evenresembling ex-sui creation (e.g. interest onmoney) stands prohibited. These twoprohibitions constitute the essence of theprohibition of riba. Ex-alio creation alone isa human capability and hence any humanaction that incorporates ex-alio creation(e.g. murabaha in the commercial domain)stands permitted. This permission is theessence of the permission of bay’. Finally,with the Islamic legal focus on generation(the prohibited self generation and ex-nihilo generation and the permitted co-generation), speculation (risk-taking)automatically stands prohibited, yielding a cohesive theory of Islamic financial law, at once monotheist, moral and ethical.

Dr. Azeemuddin Subhani is a Shari’ah Scholar, practitioner and professor of Islamicfinance, holding an MBA in conventional accounting (IBA Karachi) and another MBA anddoctoral course work in conventional finance (University of Southern California), and an MAand PhD in Islamic law and Islamic finance (Institute of Islamic Studies, McGill University).His PhD dissertation on the Divine law of riba and bay’ is regarded as a seminal work inIslamic law, as it posits a pioneering interpretation of this Divine injunction.

NEWHORIZON Muharram-Rabi Al Awwal 1432 COUNTRY FOCUS

There has been a Muslim presence in Kenyasince the 8th century when Arab tradersworking the east coast of Africa broughttheir faith to the country. For centuries theMuslim community was mainly located inthe coastal regions, but events inneighbouring countries during the latterpart of the 20th century boosted thatpopulation. The arrival of many UgandanAsians in the country in the 1970s wasresponsible for a relatively small increase inthe Muslim population, but it was the civil

war in Somalia that was responsible for adoubling in that population.

The 2009 Kenyan census reported that therewere 4.3 million Muslim in Kenya, 11% ofthe population. This figure is, however,disputed by Muslim leaders in the countrywho claim the figure is much higher;perhaps even 30% of the total population.Whatever the real figure is, conventionalfinancial institutions and Islamic banks have seen an opportunity, helping to

finance businesses catering to the Islamicmarket, such as restaurants, hotels, foodstores and halal slaughter houses, as well asdeveloping Shari’ah-compliantwealth-management and investmentproducts targeted at some of the wealthySomali immigrants.

Barclays were the first to test the water in2005 and there are now eight financialinstitutions offering Shari’ah-compliantproducts in Kenya. Among them are two

Islamic Finance Flourishes in Kenya

Kenya has ambitions to become the Islamic finance hub for East Africa, but what isthat informs that ambition; what progress have they made so far and what are thefactors that will help and hinder them.

FCB Garissa Branch Staff

NEWHORIZON January–March 2011ACADEMIC ARTICLE

Islamic banks licensed by the Central Bankof Kenya (CBK) in 2007, First CommunityBank and the Gulf African Bank, whichopened for business in 2008. Unlike theIslamic windows of conventional banks,these two organisations offer retail bankingservices through a currently limited, butgrowing network of branches. By mid 2010they controlled 0.8% and 1% of bankingassets in Kenya according to the CentralBank of Kenya.

First Community Bank

FCB is owned by East African businessmenand is headed by Nathif Adam, who startedhis 25-year banking career in Kenya,although much of his banking experiencewas gained in Saudi Arabia, Qatar andSharjah. By the end of 2010 FCB will have 17 branches across Kenya, with aheavier concentration in the south of thecountry; they have opened an IslamicFinance Training Centre; in 2010 theyreceived approval to set up FCB Capital, an investment banking subsidiary andthey have already reached the target of1 billion Kenyan shillings in capital set as a 2011 target by the central bank, well ahead of many of Kenya’s other banks. FCB believes it is on course todeclare its first shareholder dividend in2011.

In early October 2010 FCB announced thelaunch of the FCB Takaful InsuranceAgency, which is set to work in partnershipwith insurance companies, to offer Shari’ah-compliant insurance products. They alsoannounced a joint venture with the KenyaMeat Commission to help provide financeto the nomadic cattlemen of the arid andsemi-arid regions of Kenya, whose lifestylehas excluded the from accessing financeuntil now – a positive demonstration of thesocial responsibility that is an underlyingtenet of Islamic banking.

On a similar theme FCB were selected asone of four banks in the country to workwith the Youth Enterprise DevelopmentFund, which is a development initiativeformed by the government in 2007 toaddress the economic empowerment ofyouth through enterprise development and

strategic partnerships. The key mandate ofthe fund is to support youth-oriented micro, small and medium enterprises withstart-up and growth capital. FCB’sparticipation in the fund aims largely atensuring that the financing supportavailable from the fund reaches Muslimyouth in the country in a Shari’ah-compliantmanner. ‘We are a bank conscious of thedevelopment of our youth and wediscovered that since the formation of thefund, not many Muslim youth benefited,because of its interest-based nature.However, through our ‘Youth Advantage’programme, Muslim youth in the countrycan now benefit from the fund’ said FCB’sCEO, Mr. Nathif Adam.

Gulf African Bank

Gulf African Bank is principally backed byMiddle Eastern investors and its CEO,Najmul Hassan was formerly GeneralManager at Al Meezan in Karachi, Pakistan.In contrast to FCB’s Kenya-centric board ofdirectors, it has directors from Pakistan,Oman, UK and Zambia to complement itstriumvirate of Kenyans including thechairman and deputy chairman. Its trackrecord is in many respects is very similar toFCB. By the end of 2010 they expect tohave 16 branches in Kenya, but their plansto venture into other East African countriesare more concrete than those of FCB. In2011 they plan to open branches in Ugandaand Tanzania and to follow FCB into thetakaful business in 2011. Principal investor,GulfCap Investments is expected to raise$1 billion Kenyan shillings in capital tounderwrite the move into takaful.

Gulf African Bank recorded profits in thesecond and third quarters of 2010. Thethird quarter profit was 42.7 millionKenyan shillings compared to a loss of208.8 million Kenyan shillings for the sameperiod in 2009. They expect the fourthquarter to be even stronger.

Investment Products

Currently one of the gaps in the Kenyanmarket is in Shari’ah-compliant investmentproducts. FCB Capital obviously intend toaddress that gap, but they are not alone.

ApexAfrica Capital, the third largestmember of the Nairobi Stock Exchange isalso working to develop Shari’ah-compliantinvestment products, including unit trusts,which are particularly popular in Kenya.The Kenyan Capital Markets Authority is inthe process of setting up a regulatoryframework to govern this nascent market.

Kenya’s Ambitions

Professor Njuguna Ndung’u, Governor ofthe Central Bank of Kenya in a paperdelivered at a conference in Nairobi in May2010, asserted that Kenya had the potentialto become the regional Islamic finance hub.He also commented that the Central Bankof Kenya had had to make adjustments tosome of its regulations to accommodateIslamic banking. For example, the law inKenya required banks to pay interest onsavings accounts as long as the minimumbalance is maintained. Changes to theBanking Act now offer Islamic banks theleeway to give some alternative form ofreturn on Shari’ah compliant products.

CBK have also announced their intention tolaunch Shari’ah-compliant treasury bills inthe money market. Analysts believe that agovernment sukuk could be an importantfactor in establishing Kenya as the Islamicfinance hub in the region. It would also be awelcome move for the two Islamic banks inthe country, which need new investmentShari’ah investment opportunities tounderpin their growth. The CBK are veryaware of this requirement and did in fact setaside a portion of a governmentinfrastructure bond in 2009 for Islamicinvestment. Both Gulf Africa Bank and FCB did in fact advantage of thisopportunity.

The Kenyan Context

So, Kenya is doing what it can to fosterIslamic finance and establish itself as thepremier Islamic financial hub in East Africa.This admirable ambition has, however, to beset in a broader context. Investors likestability and transparency and while Kenyahas a much better record than some othercountries in the region, there are still someworrying issues.

NEWHORIZON Muharram-Rabi Al Awwal 1432 ACADEMIC ARTICLE

Kenya is a country with strong triballoyalties, which generally come to the forein election years, leading to seriousoutbreaks of civil unrest, the latest in 2007.A new constitution ratified in August 2010is set to try to resolve the problems, but thefight is still far from over. Many aspects ofthe implementation of the constitution arebeing challenged and towards the end of2010 it was a race against time to meet the 90-day deadline set in the newconstitution.

According to Transparency International, a German-based global organisationdedicated to fighting corruption, lists Kenya as being 154 out of 178 countries in its Corruption Perceptions Index. There have been several attempts to address the problem since the mid 1990s,when the International Monetary Fundinsisted on the setting up on an anti-corruption agency as the price of aid. Thelatest iteration, the Kenya Anti-CorruptionCommission, under the directorship of

Downtown Nairobi

Patrick Lumumba is showing signs ofactivity and determination, but historysuggests any optimism should be counterbalanced by a heavy dose ofcaution.

It would be a great shame if the very realprogress of Islamic banking in Kenya wasset back by issues, which are essentiallybeyond its control. It would also be a greatshame for a significant minority of Muslimcitizens in Kenya.

NEWHORIZON January–March 2011

Stormy Times

Shipping companies are facing difficulties inobtaining bank financing, because the creditcrisis has drastically reduced the appetite ofconventional banks for this type of business.Several ship owners have been forced tocancel or postpone their orders for newvessels and therefore to delay the upgrade oftheir fleets.

The world’s economy relies on the shippingindustry to transport the world’s trade.Shipping remains the most economical andeffective means to carry much of the world’sgoods; it is crucial for the global economy,so the demand for shipping services willalways be strong and consequently thedemand for financing to facilitate theconstruction and purchase of vessels.

Historically, ship finance was undertaken bybanks based in the German port ofHamburg, but these banks have been hit sohard by the crisis that a few of them cameclose to bankruptcy. With the massive dropin tonnage prices in mind, the creditcommittees of most banks have drasticallyreconsidered their lending strategies in thisarea. Vessels, however, are by natureShari’ah compliant investments, so this is anexcellent opportunity for Islamic banks tostep into the financing gap left by theconventional banks and to become a viablealternative.

Luxembourg’s Involvement in Shipping

In 1990 Luxembourg introduced theMaritime Act, which created the maritimepublic registry and the Commission forMaritime Affairs (Commissariat auxAffaires Maritimes, CAM – theLuxembourg supervising authority). CAMwas the first Luxembourg administration toreceive ISO 9001 certification and since2004 it has been responsible to the Ministryof Economy and Foreign Trade. Currently

more than 240 commercial vessels with atotal tonnage of 1.9 million are registered inthe landlocked duchy, perhaps encouragedby the favourable environment in terms ofboth tax and labour laws. In particular,Luxembourg has double tax treaties withcountries such as Malaysia, Qatar, theUnited Arab Emirates and Indonesia, which allow profits to be repatriated toshareholders under favourable conditions.

Luxembourg’s Involvement in IslamicFinance

Despite being a non-Muslim country,Luxembourg has well-established experiencein Islamic finance. The first steps were takenwell before the maritime register initiative.In 1978, Luxembourg was the first westerncountry to host an Islamic financialinstitution; in 1983, the first Shari’ah-compliant insurance company in Europewas established in Luxembourg; in 2002Luxembourg was the first European stockexchange to list a sukuk and in 2009 theLuxembourg Central Bank was the firstnon-Muslim organisation to become amember of the Islamic Financial ServicesBoard (IFSB).

On January 2010 the Luxembourg taxauthorities released a circular clarifying thetax treatment applicable to instruments ofIslamic finance. These were murabaha,musharaka, mudaraba, ijara, ijara-wa-iqtina, istisna and sukuk. The Luxembourgtax authorities defined the four instrumentsmainly used to finance shipping activities asfollows:

❏ Murabaha: a sale based transactionwhereby an investor acquires an asset (e.g. avessel) for further resale to a client at a cost-plus profit. This is a financing arrangementwhere the cost-plus profit margin of theinvestor is determined in advance and mayapply to all types of assets.

MARKET FOCUS

❏ Ijara: a leasing agreement by which theparty contributing the capital (generally abank) acquires an asset (e.g. a vessel) for itsclient and places it as his disposal in returnfor a rental payment for a fixed period. Thebank owns the asset and transfers theusufruct to its client.

❏ Ijara-wa-Iqtina: a similar mechanism,where the client has the opportunity to buythe asset at the end of the contract.

❏ Istisna: a method of financing theproduction of a good (e.g. building of avessel) that allows advance payment for afuture delivery or deferred payment for afuture delivery.

On June, 2010, the Luxembourg VATadministration released a circular clarifyingthe treatment of murabaha purchases andijara leases for Luxembourg VAT andregistration duty purposes. The circularconfirmed that SPVs (Special PurposeVehicles) incorporated in Luxembourg andcreated under murabaha or ijara agreementsshould qualify as taxpayers for VATpurposes.

A Malaysian View of Shipping Finance

Professor N Khalid of MIMA (MaritimeInstitute of Malaysia) commenting on theuse of Shari’ah financing for shipping said,‘In the last two decades or so, Shari’ahfinancing has grown in prominence infacilitating the growth in the shippingsector. Over the years, several high profileship financing deals have been transactedusing Shari’ah principles.

The increasing popularity of Shari’ahfinancing in ship financing stands testimonyto its viability as a worthy, if not moreattractive, alternative to its conventionalcounterpart. The framework of Islamicbanking, financing, insurance, tax and otherfinance-related areas have been strengthened

Shipping Meets Islamic Finance in Luxembourg

By: Cédric Raths, Director, Pandomus, Member of the Luxembourg Maritime Cluster

25 IIBI

to such an extent that Shari’ah financinghas emerged as a lucrative industry in itsown right with its own high financing,accounting and ethical standards, which arehighly regarded even by conventionalfinancing practitioners.

Shari’ah financing has already developed adecent track record for itself as analternative means of raising financing inshipping. While much of the financingraised in shipping is still interest-based,there is huge potential for Shari’ahfinancing, with all its attractions andstrengths, to grab a bigger slice of the shipfinancing pie.

As more Shari’ah financing deals aresuccessfully transacted in shipping, therewill be growing confidence among shipowners and operators in the viability of‘going Islamic’. Islamic bankers andfinancial dealmakers have proved to beskilful and adaptable in developingattractive financial structures andengineering innovative solutions to meet thefunding needs of their clients in the shippingmarkets.

Shari’ah financing, which features highlytransparent, no-surprises, pre-agreedfinancing structures and costs and knownrisks offers the opposite end of itsconventional counterpart. The emergence ofinnovative and attractive financingstructures based on Shari’ah principles inshipping in recent years augurs well for itscontinued contribution to the growth ofglobal shipping and hence global trade andthe world economy. When applied andstructured judiciously and creatively,Shari’ah financing can no doubt standshoulder to shoulder, if not taller, thanconventional financing in raising adequateand competitive financing in shipping.’

Ijara Structures for Shipping

How does Islamic shipping finance work?The ship owner selects the vessel, which willmeet his needs. The Islamic bank sets up anaccredited maritime company inLuxembourg, which buys a vessel, thenleases it to its customer, the ship owner. Theaccredited maritime company (lessor)

applies for a bareboat, chartered-outregistration of the vessel in Luxembourgand the customer (lessee) applies for abareboat, chartered-in registration in thecountry of his choice. The lessor is the soleowner of the vessel (he retains the legal titleon the vessel) until the end of the lease, thecustomer makes a series of lease paymentsuntil the end of the term of the ijaraagreement and the customer can eventuallyexercise an option to buy the vessel, wherethe agreement is an ijara-wa-iqtina.

Under certain conditions, the lessor benefitsfrom the favourable Luxembourg taxframework reserved to the accreditedmaritime companies and profits can berepatriated via an Islamic bank at

competitive conditions. In practice, anaccredited maritime company is set up foreach vessel acquired.

The structure could be developed further byoverlaying a Luxembourg fund vehicle tohold all the accredited maritime companies.The Islamic bank would then be able todistribute fund units to its clients andbenefit from Luxembourg’s well-knownreputation and expertise in the fundsindustry.

Luxembourg is rather unexpectedly, giventhat it is a landlocked state, a verysignificant maritime registry and one of thelargest non-Muslim Islamic finance hubs inthe world.

NEWHORIZON Muharram-Rabi Al Awwal 1432 IIBI LECTURES

NEWHORIZON January–March 2011

The Rationale for theWorkshop

Compliance with Shari’ahprinciples is the raison d’Ítre ofIslamic financial contracts. AllIslamic finance transactionshave a governing law clause. AsShari’ah is non-national systemof laws, however and is subjectto various interpretations, inorder to create certainty aboutthe rights and obligations of thecontracting parties, English lawis normally chosen as thegoverning law in Islamic financecross-border transactions. Therehave recently been a number ofcommercial litigation casesheard in the English courtsinvolving Islamic financecommercial contracts, wherethe issue of the governing law insuch contracts came underscrutiny. From the arguments ofdefaulting parties in thesetransactions, it becameapparent that there is scope forabuse via the tactic of opinionshopping among scholars andunfortunately a great deal ofpotential for Shari’ah invalidityarguments to be used bydefaulting borrowers in order toevade their responsibilitiesunder commercial agreements.

The 2nd annual thematicworkshop was organised againstthis background and set out to

look at recent disputes, as wellas to analyse the implications ofthe recent court decisions. Italso discussed the evolvingShari’ah compliance structuresand alternative disputeresolution mechanisms, as wellas whether there is a need for aninternational convention togovern cross-border Islamicfinance transactions.

The Keynote Addresses

The programme started withone of two keynote speechesfrom Alderman Michael Bear,the Lord Mayor of the City ofLondon. He is head of the Cityof London Corporation and aglobal ambassador for the UK-based financial servicesindustry. Financial inclusion ofthe Muslim population in theUK as well as the positioning of London as a leadinginternational financial centreare the two key objectives ofUK government policy forsupporting Islamic finance. TheLord Mayor mentioned thevarious regulatory changes inthe tax law for Islamic financialtransactions in order to level theplaying field with theconventional financial servicessector.

He commented that the UK isthe only centre of Islamic

IIBI NEWS

finance in the West with fivefully Islamic banks and manyIslamic window operationswithin conventional bankstructures. He also suggestedthat the UK is at the forefrontof developing the humanresources with many institutesincluding IIBI and universitiesoffering Islamic financeeducation and training courses.

Afterwards, Dato’ MuhammadIbrahim, Deputy Governor,Bank Negara Malaysiadelivered the second keynoteaddress in which he shared theexperience of Malaysia’s Islamicfinance market and talkedabout the support by the centralbank and the government ofMalaysia aimed at promotingthe Islamic finance industry.Since the passing of the firstIslamic banking act in 1983,Malaysia has been supportingthe development of the marketand is now a global leader withIslamic financial transactionsaccounting for approximately20% of the total financialsystem.

Market Analysis

The first workshop session,‘Malaysia and London –Leading Beyond Islamic FinanceHubs’, was moderated byRushdi Siddiqui, global head of

The Polemics of Governing Law in Islamic Finance: Recent Developments and the Way Forward

The 2nd annual thematic workshop organised by the Institute of Islamic Banking andInsurance (IIBI) and the International Shari’ah Research Academy for Islamic Finance(ISRA) in collaboration with Thomson Reuters on 29th November, 2010 was a hugesuccess with more than 200 delegates managing to attend despite adverse weatherand a tube strike on the day. The workshop held in London was sponsored byWestlaw Business.

Islamic finance at ThomsonReuters. The panel discussed thevarious developments in Islamicfinance treasury operations, aswell as funds management in theUK and Malaysia. At present,there are around 600 Shari’ah-compliant funds domiciled in 31countries managing $35 billionof assets. After Saudi Arabia,Malaysia is the largest marketfor Shari’ah-compliant fundswith 34% of the market share interms of number of funds and26% in terms of the assetsunder management (AUMs).The panel also discussedwhether levelling the playingfield between Islamic financialinstitutions and theirconventional counterparts inMuslim-minority countries isenough to facilitate furthergrowth of the industry orwhether there is a need foractive government support interms of a budget for educationand awareness and removingsome of the misunderstandings.

The panel also deliberated theissue of the creation of aShari’ah-compliant benchmark,critical for establishing the costof funds in a framework that isShari’ah compliant. At present,the London Interbank OfferedRate (LIBOR) is usually used asa benchmark in Islamic financecross-border transactions. It was

NEWHORIZON January–March 2011

suggested that de-linking fromLIBOR would create greaterconfidence among customersand other stakeholders withinthe Islamic finance industry,which would assist in its furthergrowth and development.

A Critical Review of RecentDisputes

The second session, ‘A CriticalReview of the Recent Disputesin the Islamic Finance Industry’was moderated by Richard deBelder, partner and head ofIslamic finance at SNR Denton– an international law firm. Thepanel pointed out that the keycharacteristics of an effectivelegal and regulatory frameworkfor the Islamic finance industryare an enabling environmentthat accommodates andfacilitates the development ofthe industry; a clear andefficient system that preservesthe enforceability of Islamicfinancial contracts and acredible and reliable forum forsettlement of legal disputesarising from Islamic financetransactions.

The panel acknowledged thatthere are several challengesfaced by the Islamic financeindustry including lack ofstandardised documentation,different school of thoughts andtherefore differentinterpretations of variousShari’ah compliance-relatedmatters and a lack of legalexpertise in both Islamic andconventional finance. In respectof the legal challenges, there arevarious initiatives underway todevelop the people resources invarious jurisdictions active in

Islamic finance sector such asMalaysia, with measures beingtaken to ensure that playerswithin the industry includingjudges and lawyers are trainedin Islamic finance. Internationalstandard setting bodies such asAccounting and AuditingOrganisation for IslamicFinancial Institutions (AAOIFI)and Islamic Financial ServicesBoard (IFSB) are working onstandardisation issues andalready have made someprogress.

In recent years a number ofIslamic finance cases have beenbrought to court for settlementin different jurisdictionsincluding and beyond Muslim-majority countries. The panelexamined the recent Islamicfinance transactions disputessuch as the one betweenInvestment Dar and Blom Bankand also looked at the key legalissues in such disputes,particularly transactionstructuring and documentation.

Cross-Border Transactions

The third session,‘Contemporary Shari’ahDiscourse in Cross-BorderTransactions’ was moderated byDr Asyraf Wajdi Dusuki, headof research affairs at ISRA. Thepanel looked at some of thepractical issues in striking abalance between Shari’ahcompliance and national legaland regulatory requirements.For example, Shari’ah scholarssometimes allow certaintransactions, questionableunder Shari’ah law, on the basisof necessity and public good,

IIBI NEWS

but it was pointed out thatthese should not become thenorm. The panel also pointedout, using sovereign sukuks asan example, that sukuk holdersmay not have access to theunderlying asset in the case ofsukuk default for reasons ofnational security among others.The panel also discussed theway Shari’ah complianceframeworks have evolved invarious jurisdictions over time.

Dispute Resolution

The final session, ‘AlternativeDispute Resolution Mechanismsin Islamic Finance: Do We Needto Have an InternationalConvention to Govern Cross-Border Islamic FinanceTransactions?’ was moderatedby Dr Mohamad Akram Laldin.Alternative Dispute Resolution(ADR) may be defined as arange of procedures that serveas alternatives to litigationthrough the courts for theresolution of disputes, generallyinvolving the intersession andassistance of a neutral andimpartial third party. The wordalternative has generally beenunderstood to refer to thealternatives to litigation. Thereare, however, various forms ofADR mechanisms, whichinclude arbitration andmediation. Arbitration (tahkim)is the private, judicialdetermination of a dispute, byan independent third party.Mediation (sulh) is a process inwhich an impartial third partyknown as a mediator assistsparties involved in a dispute toresolve their differences in an

amicable manner. Arbitration(“tahkim”) and mediation(“sulh”) are recognised underthe Shari’ah. The advantages ofboth arbitration and mediationare that the parties have a fullsay over the final result. Theycan participate in the process;decide on the outcome and worktogether, not against each other;can maintain, restore or rebuildtheir relationship and enjoysubstantial savings in terms ofmoney and time. ADRapproaches are more efficient,private and more flexible forboth parties as compared tolitigation.

The panel highlighted that theaim of Shari’ah-compliantarbitration is to have disputesresolved in accordance withShari’ah principles. Theoutcome, however, still needs tobe enforceable in the secularcourts and therefore thearbitration process should becarried out in a way that willnot result in the secular courtsrefusing to enforce anyagreement reached. Arbitratorsor other persons involved inarbitration procedures also needto have some familiarity withfinancial, commercial and legal issues and not just theShari’ah.

The panel looked at the variousalternative dispute resolutionmechanisms that are beingpracticed in the market; howthese have evolved over timeand the enforceability issues.They also deliberated the use ofthese dispute resolutionarrangements as they applyIslamic finance transactions.

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January

24: 3rd Annual One-Day Workshop:Islamic Project Financing, LondonDemand for Shari’ah-compliant financing forprojects is increasingly an important area ofactivity in the world of finance. Theworkshop presented by industry experts willacquaint the participants with Shari’ah-compliant project financing structures; issueswhich may arise in structuring Islamicproject financing transactions with the helpof case studies; the role of syndication inIslamic project financing transactions and theprocess of Shari’ah compliance certification.Contact: Mohammad ShafiqueTel: +44(0)20 7245 0404Email: m.shafique@islamic-banking.comwww.islamic-banking.com

February

7-8: 7th Annual Middle East InsuranceForum (MEIF) 2011: Realising PotentialandCharting the Next Phase of Developmentfor the Regional Insurance Industry,BahrainHeld in Strategic Partnership with theCentral Bank of Bahrain, MEIF 2011 willbe held at the Ritz Carlton Hotel, Kingdomof Bahrain. It will set the stage for criticaldiscussions that will chart a new phase ofdevelopment for the regional insurance andre-insurance industry, exploring strategiesfor unleashing the significant potential forgrowth evident in the comparatively lowdensity and penetration figures in theMiddle East insurance markets.Contact: Andrew ChopraTel: +9714 343 1200Email: andrew.chopra@megaevents.netwww.megaevents.net

21-23: 10th Annual Islamic FinanceSummit, LondonThe conference will be held at London’sLandmark Hotel, where Shari’ah scholarsreflect on the latest fatwas; economists and

regulators review the current economicclimate and the changing regulatoryenvironment with particular reference to theimplications for Islamic finance and thecommercial drivers and obstacles to futuredevelopment.Contact: Natasha WoodTel: +44 (0) 20 7779 8547Email: mwood@euromoneyplc.comwww.euromoneyplc.com

March

28-29: World Islamic FinanceConference, LondonSponsored by Bursa Malaysia Berhard andsupported by the Islamic Finance CouncilUK and the Australia Arab Chamber ofCommerce and Industry, this two-dayconference will focus on regulatory changesin the UK and continental Europe, Shari’ahcompliance and European law, theexpansion of Islamic retail banking,liquidity management and sukuk. Contact: Welma WilliamsTel: +9714 609 1565Email: welma.williams@fleminggulf.comwww.fleminggulf.com

April

11-13: 6th Annual Middle East RetailBanking Forum, DubaiEntitled ‘Redefining Growth Opportunitiesin Retail Banking’, this conference willaddress current issues and the way forwardin the still growing retail banking business inthe Middle East. Speakers will address issuessuch as identifying the best retail bankingmodels for the region, the importance ofchannel management and best practice in theregion and internationally. Contact: Sakib BazazTel: +91 9902 774 751Email: sakib.bazaz@fleminggulf.comwww.fleminggulf.com

12: 4th Annual One-Day Workshop:Sukuk, Their Applications andChallenges, London

The workshop presented by industry expertswill acquaint the participants with the mostpopular Shari’ah-compliant contracts usedin Sukuk structuring; issues arising instructuring Sukuk transactions with help ofcase studies; how Sukuk may be used forproject financing; the process of Shari’ahcompliance certification; key points ofAAOIFI’s standards on sukuk and taxationissues for UK-based sukuk issuers andinvestors.Contact: Mohammad ShafiqueTel: +44(0)20 7245 0404Email: m.shafique@islamic-banking.comwww.islamic-banking.com

12-13: 1st Annual Middle EasternBanking Conference, DubaiThis launch event will take place at DusitThani Dubai. It is designed to provide ahigh-profile platform to specifically focus onthe opportunities and challenges that areforging the Islamic banking, finance andinvestment landscape in the region.Contact: sophie@megaevents.netTel: +9714 343 1200www.megaevents.net

18-19: MEFTECThis major technology exhibition andconference will take place at Bahrain’sInternational Exhibition and ConventionCentre, just five minutes from Manama’sfinancial district. In 2010 the eventattracted more than 700 visitors from 27countries and 150 exhibitors and withimproving financial conditions the hope isthat 2011 will be even bigger and better.Contact: Syed Faisal AbbasTel: +973 17215665Email: faisal@mediageneration.co.ukwww.mediageneration.co.uk

Diary of Events endorsed by the IIBI

NEWHORIZON January–March 2011

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presents the

❑ Aisha S Ashafa, FinBankNigeria Plc, Nigeria

❑ Mutaz T Agha, Shari’ahAudit Administrator, AbuDhabi Islamic Bank, UAE

❑ Munazza Bokhari, UK

❑ Salat Mohamed Salat,Branch Manager, National Bankof Kenya Ltd, Kenya

❑ Packeer Lebbe MohamedRoshen, Lecturer, Asia PacificCampus, Sri Lanka

IIBI Awards Post Graduate Diplomas

❑ Mohamed FarookMohamed Usama Farook,Amana Takaful, Sri Lanka

❑ Amjad Nasir Kayani,Administrative Officer, SkbzapSchool, UAE

NEWHORIZON January–March 2011

Rejimon Mattathil, General Manager,Patrick York Ireland Insurance &Reinsurance Brokers, Bahrain

The manner in which all steps of thecourse went through is reallycommendable. The compactness oflessons, the quality of content and thefeedback of the tutor were simply superb.

❑ Erik van Os, TransactionManager, TMF Management,Luxembourg

❑ Dr Aqsa Aziz, CoventryUniversity, UK

Shazia Riaz, Pakistan

Overall the course was very interestingand provided wonderful in-depthknowledge of each topic. I highlyrecommend this course.

Ghalib Riaz, The Saudi Investment Bank,Saudi Arabia

I loved this course. It scared me a little atthe beginning, but I got used to it andenjoyed it immensely. Thank you for thiswonderful opportunity.

Shakeel Anwar, Canada

Excellent introduction to the subject,highlighting key points and providingreal-world examples. The content waswell laid out and logically presented.

Alaa Guidara, Doctoral Student, LavalUniversity, Canada

This course is well written in a manneryou enjoy reading and the distancelearning gives a lot of flexibility. Irecommend the course for bothprofessionals and academics who want toexpand their knowledge of Islamicbanking and insurance.

Mohammed Zeeshan Akram,Accountant, Islamic Development Bank,Saudi Arabia

This course gave me an in depthunderstanding of Islamic bankingproducts, especially takaful, which isreally helpful in my Islamic bankingworking environment.

To date students from nearly 80 countries have enrolled in the PGD course. In the period October to December 2010, the followingstudents successfully completed their studies:

Despite major developments in thestructuring of Islamic financial products,including derivatives, there aremurmurings of disquiet in theblogosphere and Linkedin Islamic financechat rooms over which structures are trulycompliant and which are not. WarrenEdwardes looks at the continuing debateon the true niyya behind a structuredtransaction: is this a genuine trade orrepackaged riba?

Background

Despite a 20-year involvement in Islamicbanking, Warren Edwards was only recently introduced to the concept of niyya,when, as a non-Muslim, he attended anintensive ‘Understanding Islam’ course.Subsequent discussions with Muslimsrevealed that niyya is everything and isfundamental, but he had never previouslyencountered this term in connection withIslamic finance.

Its significance to the derivatives market isthat products may be structured as a seriesof trades, which are permitted according tothe Holy Qur’an and so are individuallyhalal, while the niyya of the package as awhole is to replicate riba, which is haram orforbidden. The challenge for the Islamicinvestor is to establish what the true niyya is.

The Need for Islamic Derivatives

Islamic banks face a mismatch betweentheir assets and liabilities. Their investmentsare usually in long-term fixed assets, butmost of their deposit liabilities are short-term and variable, leading to a massiveliquidity problem.

Promoting Islamic FinanceThe market for Islamic derivatives is still atan embryonic stage and although the recentintroduction of the ISDA/IIFM tahawwutmaster agreement now provides a standardstructure under which institutions may carryout Islamic transactions for privatelynegotiated Islamic hedging products, there ishowever, still an element of gharar oruncertainty in the actual transaction as wellas in the hidden terms.

The Issues

The tahawwut usually consists of a fixed leg, represented by a single-termmurabaha (cost price + fixed-profit portion)and a floating leg reverse murabahatransaction (commodity market price +

floating rate profit portion, normally overLIBOR).

The question posed by Mr Edwardes iswhether or not, under the tahawwut masteragreement, the two commodity transactionsare connected or disconnected. If they areconnected and there is a circulartransaction, does this make a difference? Ifthey are not connected, is there a daylightcommodity risk and a bid/offer spread? Inany event, what do the Islamic parties to thetransaction understand about tradingcommodities, i.e. the elements of thepackage?

If each of the elements of the transaction ispermitted or halal, does this mean that the

NEWHORIZON Muharram-Rabi Al Awwal 1432

NEWHORIZON January–March 2011

whole package is acceptable? If acommodity is required as a basis, why notuse a one litre carton of milk? All murabahatransactions could be carried out by sellinga single, one-litre carton for $1 everynanosecond. This would generate $1 billionper second or $3.6 trillion per hour.

Anything is possible using murabaha andwhen the transaction depends on astructured Special Purpose Vehicle (SPV),because whatever is inside would beinvisible to the investor and could be relatedto gambling, alcohol stocks, money marketfunds, interest bearing bonds or otheractivities which are haram. There is a needfor transparency to enable potentialinvestors to fully assess the structuredproducts which they are considering.

What is niyya?

Mr Edwardes’ first exposure to atransaction that enabled his client, a SwissIslamic Bank, to perform a hedgedinvestment in such a way that no riba wasincurred, was regarded as a trade and sopermissible at the time. Now, suchtransactions in currencies are no longerdeemed to be halal, but trading incommodities is permitted, with a multiple-part or circular package of independenttransactions being the principal vehicle.

Niyya is the intention which underlies alltransactions and is the responsibility of theinvestor. It is therefore important to havefull transparency and disclosure about all ofthe transactions making up the product, sothat investors and financial advisers canevaluate the true intention behind it.

Back to Basics

The Holy Qur’an states:

[3:130] ‘O you who have believed, do notconsume usury, doubled and multiplied …’

[2:275] ‘Allah hath permitted trade andforbidden interest.’

Murabaha is deemed to be trading, butwhat is the niyya behind the package oftransactions?

Warren Edwardes, a member of IIBI Islamic Banking Advisory group, is CEO of DelphiRisk Management Ltd., the London-based financial instrument innovation and riskmanagement consulting, expert-witness and training firm.Prior to founding Delphi he was on the board of Charterhouse Bank as director, financialengineering. He has also worked for the Equitable Life Assurance Society, the UKGovernment Actuary’s Department and the treasuries of British Gas, Barclays Bank andMidland Bank as a strategist, dealer, asset/liability risk manager and product developer.Edwardes’ best-selling book ‘Key financial instruments: understanding and innovating inthe world of derivatives” (FT Prentice Hall) includes an appendix on Islamic Banking as acase study on financial innovation.

NEWHORIZON Muharram-Rabi Al Awwal 1432

Mr Edwardes cited Hadith 1 in al-Nawawi’s Forty Hadith, which states that‘actions are according to intent’ or ‘actionsare what they are by virtue of intent’.Niyyah is intention: an inner act of theheart whereby one performs an outer act asthe fulfillment of a particular duty, ratherthan merely a series of motions withoutreligious value.

He gave the hypothetical example of acompany importing Mercedes cars to theGulf and needing to manage currency riskas part of this process. Could an ancillarytransaction to manage the currency risk bejustified as part of this? The person doingthe transaction has to make his own mindup as to the true intention behind thetransaction, contested Mr Edwardes.Fundamentally, was it part of a permittedtrade or a way of acquiring prohibited riba?

Before entering an Islamic financialtransaction, each person involved must ask

himself what the niyya is. If the transactionsinvolve trading in wheat and coffee, do theinvestors really understand these markets orare they entering into a synthetic ribatransaction that does not depend on theperformance of these markets?

There are many shades of grey. A Muslimmay enter into a halal transaction with anon-Muslim outside a bank, with the latterthen going into the bank to invest in aninterest-bearing deposit, from the proceedsof which he repays the Muslim, in the formof capital plus mark-up after three months.What is the Muslim’s niyya? On the widerfinancial stage, it can be difficult forMuslims to know if the funds from Islamictransactions have been commingled withthe proceeds of conventional banking.

Conclusion

Your intention may be to trade withoutreceiving or paying riba, but in the case of

structured products, can you be sure of theniyya behind the package of transactions? If you are entering into a series of tradesrelating to commodities without anyknowledge of these markets and how theymay be moving, is your true niyya to carryout a synthetic riba transaction?

At the end of the day, it is for the Musliminvestor to decide whether or not the niyyaon which the return on investment is basedis halal or haram and the niyya comes fromthe heart.

Mr Edwardes concluded with a reference tothe origins of the concept of niyya, whichaccording to Hadith 1, related to thereasons for undertaking a journey. Toparaphrase, if the trip was undertaken as apilgrimage, then the niyya was acceptable;if, on the other hand, it was beingundertaken to emigrate and so for economicgain, then it was not acceptable.

Promoting Islamic Finance

Background

Traditionally corporate governance is basedaround a series of checks and balances andreflected in a distinction between theexecutive and supervisory boards ofcorporations, but in Islamic finance at banklevel governance is centred on the Shari’ahboard. It has the ultimate say as to whetheror not a new banking product is acceptableand at national and international level,there are standard-setting and governmentbacked bodies, as well as a growing number

of Shari’ah consulting firms. Murat �naldrew attention to the fact that these entitiesall tend to be populated from the same poolof Shari’ah scholars. The inherent risk isthat the same group of people could beresponsible for making and advising on aswell as monitoring policy.

An Analysis of Shari’ah Scholars

Prior to 2008, there was very little dataavailable about Shari’ah scholars and theirboard memberships, to the potentialdetriment of transparency and goodgovernance. Funds@Work AG, therefore,embarked on a screening of more than2,000 entities across the world, identifying

almost 400 Islamic financial institutions(FIs) and conventional players with Islamicwindows and tracked their Shari’ah boardmembers systematically through legal andpublic documents, as well as engaging withthe scholars and institutions themselves.The company then analysed the backgroundand the connections that existed betweenthese scholars.

In a survey of 1,141 board positions, thetop 20 Islamic scholars held 621 boardmemberships between them, with the toptwo each holding 85 positions, acrossdifferent countries. This number is well inexcess of the guidelines set by the OECD(Organisation for Economic Cooperation

NEWHORIZON January–March 2011

and Development) for normal corporatedirectorships and begs the question as towhether it is possible for someone tocontribute meaningfully over so manypositions. It could also be seen as aninhibitor to innovation.

Furthermore, the analysis demonstrated thatscholars could sit on the boards of IFIs andat the same time on the boards of standard-setting bodies, resulting in virtually noseparation between the governed and thegoverning. For example, Abdul Satar AbdulKarim Abu Ghuddah held 85 positions inIslamic FIs at 31 July 2010, with a furthertwelve positions in standard-setting bodies,unions, foundations, governmental entitiesand Shari’ah consulting firms.

On average there are 3.33 scholars perboard, but this varies by country. Therecommended minimum threshold bystandard setters AAOIFI and the IslamicFinancial Services Board (IFSB) is threeboard members, but there is sizeablevariation. Bahrain for example recommendsthree people, whereas Bank NegaraMalaysia prefers five.

In the Gulf Cooperation Council States(GCC), a small core of scholars dominatethe boards resulting in a rather closed shop:For example, in Kuwait, there are 49 activescholars, with 41.78% of the positions inIslamic FIs held by the top five scholars and63% of the 246 available positions held bythe top ten scholars; in the UAE, 36Shari’ah scholars are active, with the topfive holding 48.47% and the top ten 73.01% of all 163 available positions; SaudiArabia has some 44 scholars, with the topfive holding 56.58 % and the top tenrepresenting 69.74 % of all 152 positionsavailable; in Bahrain, there are 40 scholars,with the top five holding 48.92 % and thetop ten representing 64.75 % of all 139available positions and among the 26scholars in Qatar, the top five hold 46.67%and the top ten represent 74.67 % of all 75positions available.

The 260 scholars outside the top 20 groupshare 271 boards with the 20 mostprominent scholars, interacting with themand so developing particular insights.

Mr Ünal suggested that these additionalskills could potentially be leveraged goingforward, complementing the work of theexisting top scholars and benefitting thefurther development of the industry.

In the 25 countries outside the GCC, some 177 Shari’ah Scholars are currentlyactive. The distribution of Boardmembership positions shows the top fiveScholars holding 27.87 % and the top tenScholars 40.44 % of all 366 availablepositions.

Interconnection between AAOIFI Scholars

Since board membership is not exclusive, itis likely that in many instances this core ofsenior Shari’ah scholars will sit on the sameboards. This may be the result of socialnetworking or a desire to includecomplementary skills, such as having anEnglish speaker to sit alongside a non-English speaker or it could simply be adesire to increase the visibility of the FI byhaving big names to sit on its board.

This policy, however, has implications forsuccession planning. If the IFIs are onlyemploying the most senior Shari’ahscholars, there is no opportunity forapprentices to come through and so developthe next generation of experts. In short, it isnot the most effective way to use humancapital, as the collective wisdom ofprominent scholars is concentrated andcannot adequately be passed on to futuregenerations.

The 12 most active AAOIFI scholarsbetween them hold 439 (38.47 %) of the1,141 available board positions in IslamicFIs today. If the affiliations of these 12AAOIFI scholars are plotted, based on thepositions they hold outside Islamic FIs (thatis with standard-setting bodies, associations,government entities and consulting firms),the numbers are highly significant. AAOIFIscholars will on average share 72.17 % ofall other boards. Taking out consultingfirms, this average actually goes up to81.9%. In the case of Abdul Karim AbuGhuddah and Sulaiman Al Manee’a,72.77% of their boards potentially overlap.

Mr Ünal suggested that a better system ofchecks and balances would result byemploying different scholars in thegoverning institutions to those who wereprimarily leading the FIs. Top scholarswould be in an ideal position to govern theindustry going forward with more and morenew scholars joining the existing FIs. If topscholars’ positions were exclusive ratherthan overlapping, they could make theircollective experience and wisdom availableto a much broader number of Shari’ahboards and thus get more exposure to otherscholars who are less visible and who couldprofit greatly from their know-how. In thisway mentorship programmes andapprenticeships could be enabled.

Scholars and Training

Having established the closeinterconnectivity at country level and thatresulting from membership of the sameboards for both Islamic FIs and non-FIorganisations, Mr Ünal went on to considerhow Shari’ah scholars should be trained.The IFSB, for example, requests a Shari’ahdegree from a recognised university.

The research revealed further connectionsbetween Islamic scholars resulting from theuniversity attended. The 12 AAOIFIScholars were widely distributed throughthe educational networks, but acted as alink between a variety of universitynetworks. For example, the three mainGCC universities (Al-Azhar University, theUniversity of Kuwait and Ibn Saud IslamicUniversity) are linked together by seniorscholars.

This linking of universities could provideaccess to greater social capital and resourcesand thus, potentially, greater success too.Here it is important to state that the top20–100 scholars are almost identicallytrained and do not lack in relevanteducation - they even graduated withsimilar degrees.

The research also showed that 21 out of thetop 30 scholars had received a universityeducation outside of the GCC – in the UK, aCommonwealth country or the US. Was thisa factor for success then? It is seemingly a

NEWHORIZON Muharram-Rabi Al Awwal 1432

good predictor for board membershippenetration internationally and with such abackground, these people might also find iteasier to link different perspectives andassist in regional integration by bridgingacross countries and languages.

Analysing the educational pattern andmajors of Shari’ah scholars is vital. Thereare less prominent scholars with similar oreven identical tertiary educationalbackgrounds as the prominent scholars,who could move into more visible roles.Outside of Shari’ah, finance skills are heldby less than 10% of scholars. Should FIs

compensate for this by adding incomplementary skills to their boards asrecommended by Bank Negara? The morerecently educated scholars held finance andeconomics degrees. Could they also betrained in Shari’ah wisdom so that theyacquired the full range of specialist skillsrequired to advise the boards?

Moving Forward

A key concern for the Islamic financeindustry must be to put succession plans inplace for the existing scholars, many ofwhom are elderly. Greater transparency

should also be built in to the board scholarsystem and stricter governance appliedacross the industry as a whole. This wouldgreatly increase trust in the system. Mr Ünalcited the example of Malaysia, wheregovernance is changing. If a scholar sits onthe Shari’ah board of one insurancecompany, he is not allowed to sit on theboard of another insurance company.

Issues still remain, however and Mr Ünalreferred to a policy paper on which he isworking as part of his research. The paperlooks at corporate governance based ondifferent standard setters’ recommendations

Mr Murat Ünal is an executive board member of Funds@Work AG, a research based strategy consultancy focussing on the investmentindustry. Mr Ünal is also a doctoral candidate and senior researcher at IE Business School in Madrid.

NEWHORIZON January–March 2011

and introduces, among other ideas, thehypothesis that social networks such asthose described above, can undermine goodgovernance.

He concluded with a reminder thatcorporate governance issues can also arisefrom the linking of bonuses for the scholarsto the FI’s performance or turnover. The

policy paper aims to provide a muchbroader framework, considering state of theart corporate governance research and therole of social networks.

NEWHORIZON Muharram-Rabi Al Awwal 1432

At the end of September theInternational Development Bank(IDB) of Iraq signed up foriMAL, which will integratevarious aspects of the IraqiInternational DevelopmentBank’s divisions including corebanking, internet banking,branch automation, tradefinance, Islamic treasury, Islamicprofit calculation, datawarehouse and managementinformation systems, deliverychannels and central bankreporting.

Path Solutions’ Chairman andCEO, Mohammed Kateeb, saidthat the InternationalDevelopment Bank of Iraq winreaffirms Path Solutions’ greaterregional focus. ‘Signing up withIDB of Iraq is an importantlandmark for Path Solutionssince it establishes a dominantplace for iMAL core bankingsolution in the country. Over thepast year, we have been in rapidclient acquisition mode in Iraq,which we see as one of our keymarkets’, he said. ‘We willcontinue to focus strongly onthe Iraqi market, where we havealready made our mark withtwo other clients, by providingbest-of-breed AAOIFI-certifiedsoftware solutions and services’,Kateeb added.

General Manager of theInternational Development Bankof Iraq Hussein Alhakim said,‘Our plans are totally focused inmeeting current and evolvingclient needs towards sustainable

business growth. Thisagreement is in line with thestrategy of InternationalDevelopment Bank of Iraq tofurther strengthen its leadershipposition in the Islamic bankingspace not only in Iraq but thewhole region’.

In October they announcedShamil Bank of Yemen andBahrain has gone live with theiMAL Islamic core bankingsuite. ‘We want to positionourselves as a leading providerof innovative products andcustomer-friendly Islamicbanking services in Yemen’, saidSaeed Bazara, General Managerof SBYB. ‘Deployment ofeffective technology is a keyelement in enabling SBYB todeliver first-class bankingservices to its privilegedclientele. We have been workingclosely with Path Solutions’project team to ensure a smoothtransition from our bank’ssystems to iMAL , which webelieve will address thechallenges of real-timeavailability, scalability,improved time to market andenhanced modern bankingservices to our customers.’

SBYB went live on Saturday the2 October, after turning off itsold systems. The decision wastaken after two successful weeksof parallel run.

In December Path announcedthat Maldives Islamic Bank Pvt.Ltd. (MIB), the first Islamic

bank to be set up in Maldives,has selected Path Solutions’iMAL for its core bankingsolution including IslamicInvest, Trade Finance, SWIFTand reporting modules.

MIB is a collaboration betweenthe Islamic Corporation for theDevelopment of the PrivateSector, the private sector arm ofthe Islamic Development Bankwith a 70% interest and theGovernment of Maldives whichholds the remaining 30%. Itreceived a banking licence toconduct Islamic bankingbusiness from the MaldivesMonetary Authority in August2010. MIB Chairman Khaled Al

Path Solutions Successes in Iraq,Yemen and the Maldives

Aboodi said the bank hopes tocapture up to 25% of its localmarket share within three yearsor so by offering Islamic financeproducts targeting small andmedium enterprises (SMEs) andfisheries.

Harith Harun, ManagingDirector of MIB commented,‘MIB is focused on offeringinnovative Islamic bankingproducts and solutions ofinternational standards thatmeet the needs of corporate andretail clients, stimulating thedemand for such services in thecountry. To meet itsdevelopment requirements, MIBrequired a highly scalable, pure

Water Bungalows in the Maldives

NEWHORIZON January–March 2011

Islamic banking software systemwhich could support fasterproduct innovation and deliver adifferentiated customerexperience.’ With a 100%Muslim population of some

330,000 in Maldives, Harunexpects strong demand forShari’ah-compliant products todrive the bank’s future growth.

As part of the evaluation

process, MIB considered severalsolutions from other majorproviders before selecting iMALfrom Path Solutions. Theextensive selection processfocused on acquiring new

SSSProcess Implement ProjectManagement at the Islamic DevelopmentBankJordan-based SSSProcess haverecently completed the firstphase of a Microsoft-basedproject management system forthe Islamic Development Bank(IDB). The system is builtaround Microsoft’s Enterprise

Project Management softwaredesigned to help organisationsgain visibility and controlacross all work, enhancingdecision-making, improvingalignment with businessstrategy, maximising resource

utilisation, and enhancingproject execution to optimiseROI (Return on Investment).

SSSProcess were selected to assistIDB, because of their experienceof the EPM (Enterprise Project

Path Solutions in Education InitiativePath Solutions, a leadingprovider of Islamic bankingsoftware solutions hasannounced that it has signed aMemorandum of Understandingwith the International IslamicUniversity of Malaysia to enableIslamic banking technologysimulation for educational andtraining purposes.

Founded in 2004, the Instituteof Islamic Banking and Financeat the International IslamicUniversity of Malaysia is at theforefront of the Islamic bankingindustry and ranks amongst themost reputable educationalinstitutions in the region. It isone of the prominent

universities internationallydevoted to providing educationand research in Islamic bankingand finance.

‘This strategic collaborationwith Path Solutions willsignificantly benefit the Instituteof Islamic Banking and Financewith an Islamic banking systemthat will allow scholars to workon real simulations and put into practice the knowledgeacquired from courses in Islamic banking and finance’,said Prof. Dato’ Dr. Mohd Azmi Omar, the UniversityDean. ‘I am confident thatthrough our combined efforts,we can make an important step

forward towards our commongoals in taking Islamic bankingto a new standard ofexcellence’.

Under this agreement, theinstitute will provide PathSolutions’ community of userswith specialised trainings inIslamic finance and otherShari’ah advisory services topave the way for commonapproaches to capture growthand increase competitiveness.

‘This groundbreakingcollaborative partnershipbetween Path Solutions and theInstitute of Islamic Banking andFinance at the International

generation technology tosupport the bank’s imperativeson Shari’ah compliance,customer centricity and time-to-market for business relatedchanges.

Management) and PMO (ProjectManagement Office) softwaresuites. The contract has involvedhands-on training andfamiliarisation sessions for allstakeholders at the bank tointroduce the new technologies.

Islamic University of Malaysiareaffirms our commitment todeveloping and promotingIslamic finance in South EastAsia and particularly inMalaysia by combining ourefforts to share knowledge,innovations and best practicesfor the benefit of the Islamicbanking community’, saidMohammed Kateeb, Chairman & CEO of PathSolutions. ‘It is a privilege toteam up with the InternationalIslamic University of Malaysia,who not only shares our vision, but also is in a leadingposition to help us deliver ourgrowth potential’, Kateebconcluded.

WORLD EXCHANGESGLOBAL INDUSTRY OUTLOOK AND INVESTMENT ANALYSIS

MARCH 2010

.

NEWHORIZON January–March 2011GLOSSARY

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

This 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.

A murabaha contract using certain specifiedcommodities, through a metal exchange.

A 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.

Lit: 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.

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

Activities which are permissible according to Shari’ah.

Activities which are prohibited according to Shari’ah.

A 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.

A sukuk having ijara as an underlying structure.

The 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.

A 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.

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

A 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.

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

A 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.

An 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.

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.

In a mudarabah contract the person who invests thecapital.

Reinsurance 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.

Lit: 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.

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

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

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

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

Similar 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.

A principle of mutual assistance.

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

A 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.

A 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.

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

A 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.

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

An 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.

An 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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