SUDAN: FORGOTTEN FINANCE ZAKAT: FINANCE OR FAITH? …data.islamic-banking.com/NH/PDF/171.pdf · global perspective on islamic banking & insurance issue no. 171 april–june 2009 rabi

GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 171APRIL–JUNE 2009

RABI AL THANI–JUMADA AL THANI 1430

SUDAN: FORGOTTEN CENTRE OF ISLAMIC FINANCE

ZAKAT: FINANCE OR FAITH?

CASE STUDY: DUBAI BANK

FOOD FOR THOUGHT: INTEREST RATE RISK

ANALYSIS: ISLAMIC BANKING IN THE US

NEWS: VATICAN BACKS ISLAMIC FINANCE

PUBLISHED SINCE 1991

www.newhorizon-islamicbanking.com IIBI 3

NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430

Features

Regulars

10 Dubai Bank: taking the Shari’ah route

NewHorizon examines the bank’s conversion from a conventional financial institution to a fully-fledged Islamic one, and talks to the project leaders about thechallenges of taking the Shari’ah route.

14 The Islamic doctrine of zakat: finance or faith?

Dr Azeemuddin Subhani, who offered an original inter-pretation of riba on the pages of NewHorizon in 2008,returns to reassess the importance of zakat, the Islamicprinciple of charitable giving.

20 Interest rate risk: a threat to the Islamic bankingsystem?

In this new section, ‘Food forThought’, two experts from the IIBI voice different viewpointson the issue that may prove to bea real challenge to the industry.

22 Sudan: forgotten centre of Islamic finance

Renat Bekkin, PhD in Law, from the Institute for African Studies at the RussianAcademy of Sciences, travels to Sudan to see the application of Shari’ah princi-ples to the country’s banking sector in practice.

CONTENTS

40 ACADEMIC ARTICLEResilience and stability of Islamic finance.

44 RATINGS & INDICESDow Jones Islamic Market World Index.

45 DIARYUpcoming Islamic finance events endorsed by the IIBI.

46 GLOSSARY

31 IIBI NEWSIIBI accredits G-TEC for Islamic finance courses in India. IIBI welcomes representatives of AAOIFI, World Bank Treasury and ISRA. IIBI and GK partners to hold a series of Islamic finance workshops throughout 2009.More students complete the IIBI’s Post Graduate Diploma course.

34 IIBI WORKSHOPReview of the Islamic Project Financing workshop organised by the IIBI.

05 NEWSA round-up of the important stories from the last quarter around the globe.

19 APPOINTMENTS Summary of appointments within the Shari’ah-compliant finance industry.

28 IIBI LECTURESJanuary, February and March lectures reviewed.

36 Islamic banks in the United States: breaking through the barriers

Analysis of the current state of play in the US and what its Islamic finance market has to offer.

43 Book review‘Islamic Capital Markets: Products, Regulation & Development’;‘Risk Analysis for Islamic Banks’;‘Financial Risk Management for Islamic Banking and Finance’.

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NEWHORIZON April–June 2009

Executive Editor’s Note

Mohammad Ali QayyumDirector General IIBI

EDITORIAL

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

Surat Al Baqara, Holy Quran

This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views expressed in thearticles are those of the authors alone and should not be attributed to the organisations they are associated with or their management. Any errors andomissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no responsibility to any person who acts, or refrainsfrom acting, based upon any material published in the magazine. The Editorial Advisory Panel exists to provide general advice to the editors regardingmatters that may be of interest to readers. All decisions regarding the published content of the magazine are the sole responsibility of the Editors, and theEditorial Advisory Panel accepts no responsibility for the content.

4 IIBI

With turmoil continuing to sweep across the global financial mar-kets, the pressure is more than ever on Islamic finance to demon-strate its credentials as a viable, safe alternative to the conventionalfinancial industry. Its underpinning principles of prohibiting specu-lation and interest whilst endorsing asset-based transactions arelooked upon more and more favourably by practitioners across the globe. Even the Vatican has recently supported Islamic financeprinciples as a solution for the current worldwide economic crisis.But could it be that, with interest rates in the conventional bankingworld approaching zero, the conventional sector will ape Islamicbanking with profit sharing replacing interest? This issue is raised in the magazine’s new section, ‘Food for Thought’.

Islamic finance has many parallels with ethical and socially respon-sible finance, with zakat paid by Muslims being one of the coreprinciples of the fair redistribution of wealth in the society. ManyMuslim economists and jurists see the entire financial levy structureof an Islamic country built around zakat. The question is – doeszakat represent finance or faith? Dr Azeemuddin Subhani, who of-fered an original interpretation of riba on the pages of NewHorizonlast year, ponders the subject of zakat and its relevance to moderntimes.

This issue of NewHorizon also features an in-depth analysis ofSudan, which claims to be the only country in the world with awholly Islamic financial sector. Its neighbour, Ethiopia, is also mov-ing towards Shari’ah-compliant finance, and further afield, the gov-ernments of two states in Central Asia, Kyrgyzstan and Kazakhstan,have amended their regulatory frameworks to accommodate Islamicfinancial institutions. Halfway across the world, US officials havealso stated the country’s readiness to embrace the industry.

Closer to home, the Institute is working hard to promote the indus-try. It will hold a series of dedicated workshops and other events inLondon throughout 2009. Also, on 16th April, the IIBI will conducta one-day workshop on sukuk; and on 7th August, it will begin athree-day residential workshop in the historic University of Cam-bridge, UK, to examine structuring innovative Islamic financialproducts.

EXECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORTanya Andreasyan

IIBI EDITORMohammad Shafique

CONTRIBUTING EDITORDon Brownlow

NEWS EDITORLawrence Freeborn

IIBI EDITORIAL ADVISORY PANELMohammed AminRichard T de BelderAjmal BhattyStella CoxDr Humayon Dar Iqbal KhanDr Imran Ashraf Usmani

DESIGN CONSULTANTEmily Brown

PUBLISHED BY IBS Publishing Ltd8 Stade StreetHythe, Kent, CT21 6BEUnited KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: www.ibspublishing.com

CONTACTAdvertisingIBS Publishing LtdPaul MinisterAdvertising ManagerTel: +44 (0) 1303 263 527Fax: +44 (0) 1303 262 646Email: [email protected]

SUBSCRIPTION IBS Publishing Limited8 Stade Street, Hythe, Kent, CT21 6BE, United KingdomTel: +44 (0) 1303 262 636Fax: +44 (0) 1303 262 646Email: [email protected]: newhorizon-islamicbanking.com

©Institute of Islamic Banking and InsuranceISSN 0955-095X

Cover photo: © Claudia Dewald,iStockphoto.com



L’Osservatore Romano, a dailynewspaper in the Vatican re-garded as the mouthpiece of the Pope, has endorsed the values of Shari’ah-compliant finance as a solution to theproblems in the world of con-ventional, interest-based finance.The paper suggested that theethical foundations of Islamic finance should be adopted byconventional banks as a way of restoring the trust of their depositors and shareholders. Italso stated the belief of the Vati-can that the Islamic financialsystem could help the global financial system overcome thecrisis.

‘The ethical principles on whichIslamic finance is based maybring banks closer to theirclients and to the true spiritwhich should mark every finan-

cial service,’ said L’OsservatoreRomano. The article alsoquoted a fixed income special-ist from Abaxbank Spa, theItalian investment bank of Credem Group, as saying:‘Western banks could use tools such as the Islamicbonds, known as sukuk, as collateral’. Sukuk, the Shar-i’ah-compliant alternative toconventional bonds, could finance the ‘car industry or the next Olympic Games inLondon’. The Vatican has previously been critical of thedestructive excesses of the interest-based conventional financial system during the ongoing crisis. The Pope, Benedict XVI, alluded late last year to the illusory natureof fiat money, and the Vatican has also recently been criticalof the free market system.

Vatican backs Islamic finance

NEWS

The country’s parliament hasapproved legislation enabling allcommercial banks in Kyrgyzstanto operate according to Shari’ahprinciples. Until now, only onebank there, EcoBank, has hadan Islamic window (NewHori-zon, April–June 2007). It wasinitiated as a pilot project in thecountry’s banking sector andwas issued an authorisation bythe financial authorities to applyIslamic principles of finance(within the confines of the pilotproject).

Now the regulators are hopefulthat with the adoption of thenew laws more financial institu-tions will move into Islamic fi-nance. According to the MaratAlapaev, chairman of the Na-tional Bank of Kyrgyzstan (the

country’s central bank and regulator), the introduction ofIslamic banking in Kyrgyzstanalongside its conventional coun-terpart will enhance the range of products and services, facili-tate competition in the bankingsector and develop the country’sfinancial system as a whole. Na-tional Bank of Kyrgyzstan willbe responsible for issuing licences to Shari’ah-compliantfinancial institutions, as well assupervising and regulating theiractivity.

A similar move has been re-cently made by Kyrgyzstan’sneighbour, Kazakhstan, with thepresident approving a range ofamendments and additions tothe existing legislation to ac-commodate Islamic finance.

Boost for Islamic banks in Kyrgyzstan

The positive signals towardsIslamic finance which em-anated from the governmentof France in 2008 (NewHori-zon, January–March 2009)have been translated into action in the form of specificchanges to the tax code. Thepurpose of the changes is toensure that Islamic modes offinancing do not attract extratax penalties in relation toconventional transactions.There would otherwise be achance that an underlyingasset changing hands – a necessary part of an Islamictransaction – would attractlevies such as stamp duty. Be-

cause there is no requirementfor an asset to change hands in a conventional transaction,such a tax would not enter consideration.

The change of the tax code has already encouraged somefirms to move into France, in-cluding Islamic Finance Advi-sory and Assurance Services(IFAAS), which decided to relo-cate in expectation of thechange. IFAAS is a UK-basedShari’ah-compliance advisoryfirm. Invest in France Agency(IFA), a group which encour-ages foreign direct investmentinto France, welcomed the

France and Hong Kong encourage Islamic finance

move, reflecting the attractive-ness of Islamic finance to mar-kets in the West. There arebetween six and seven millionMuslims in France, which is the largest concentration inWestern Europe. A survey car-ried out in 2007 by the FrenchInstitute of Public Opinion(IFOP) suggested that half amillion Muslims in the countrywould be interested in Islamicfinance.

Senior officials in Hong Konghave echoed the moves taken by the French government. Thesecretary for the financial serv-ices and the treasury bureau of

the Hong Kong government,Professor KC Chan, con-firmed in a speech at theAsian Sukuk Summit, recentlyheld in the country, that thegovernment is finalising newtax laws. These would makesure that sukuk are treated inthe same way as conventionalbonds, relating to stamp duty,profits tax and property tax.Confirming Hong Kong’s in-terest in Islamic finance, SamKwok, treasurer at the HongKong Monetary Authority(HKMA), also suggested thatHong Kong plans to issue a sovereign sukuk when themarket conditions are right.

6 IIBI www.newhorizon-islamicbanking.com

NEWHORIZON April–June 2009NEWS

Two new insurance companies,Legal and General Gulf andLegal and General Gulf Takaful,have been licensed by the Cen-tral Bank of Bahrain. The twoventures have a total paid upcapital of $26.5 million andwere set up by a UK-based fi-

nancial services provider, Legal& General Group Plc, and alocal bank, Ahli United BankBSC. The companies are to offer conventional and Islamicinsurance products and servicesin Bahrain as well as other Mid-dle East countries. Ahli UnitedBank’s existing branch networkwill be used to market the offerings.

‘The Middle East insurance sector continues to attract a lotof interest from internationalfirms,’ said Ahmad Abdul AzizAl Bassam, director of licensingand policy at the Central Bank

New takaful ventures hit the GCC market

of Bahrain. He noted that suchfactors as the country’s strongsupervisory framework, well-developed infrastructure, strate-gic location and the availabilityof qualified human resources,have been attracting business toBahrain.

Meanwhile, a local Islamic insurance provider, SolidarityFamily Takaful, has teamed upwith Nexus, financial advisoryfirm, to market a takaful offer-ing in Bahrain. The productportfolio will include educationand retirement protection plans, various saving and investment

features, and life insurance. ‘Weare seeing an increased demandfor customised takaful productsin Bahrain,’ says Gopi Rao, general manager of SolidarityFamily.

Nexus will add the Islamic in-surance line to its existing per-sonal and corporate financialproducts. Nigel Watson, generalmanager of Nexus Bahrain, be-lieves the new offering will be-come one of its most popularlines in the course of a year,with the help of Solidarity Fam-ily’s ‘strong localised service andmarketing support’.

New charitable initiative of the OIC

The International Zakat Organisation (IZO), a newcharitable body of the Organ-isation of the Islamic Confer-ence (OIC), has announcedits selection of BMB Group,the Cayman Islands basedglobal alternative asset man-agement firm, to lead a newcharitable initiative, theGlobal Zakat and CharityFund. BMB Islamic (BMBGroup’s subsidiary) is headedby Dr Humayon Dar, a lead-ing figure in Islamic financeand close associate of the Institute of Islamic Bankingand Insurance (IIBI).

The fund is expected to be $3 billion in size, and its pur-pose will be to fund charita-ble causes across the world,helping the needy and allevi-ating poverty. Zakat, one ofthe five pillars of Islam, is a

religious obligation on Muslimsto pay a prescribed percentageof their wealth to specified categories in their society, whentheir wealth exceeds a certainlimit. The objective is to takeaway a part of the wealth of the well-to-do and to distributeit among the poor and theneedy.

The Hon. Dato’ Seri Dr AhmadZahid Hamidi, minister in theMalaysian Prime Minister’s department and chairman of the board of directors of IZO,commented in his address at the signing ceremony that everyMuslim ‘has the responsibilityto solve the collective crises ofpoverty, corruption and in-equality’.

As well as administering thefund, BMB will help encourageother OIC members onboard

the project and its worthygoals.

Four general areas have beentargeted for attention by thefund. These are: generation of income by private Shari’ah-compliant SME financing; assisting the establishment ofthe social infrastructure of deprived communities, includ-ing the building of hospitals,schools and housing; develop-ing agriculture to ensure stablesupplies of food; and disasterrelief and emergency funding.The fund will enjoin other in-stitutions, such as govern-ments, to assist in its work.

The fund will be co-managed by BMB Group and the IZO itself, and will be run on a professional asset managementbasis. ‘It is a long-awaited initiative,’ said Dr Dar, CEO

of BMB Islamic. ‘Inevitably,there has been a huge empha-sis on Shari’ah compliance inIslamic banking and finance,but the announcement of aGlobal Zakat and CharityFund is the beginning of a newIslamic financial trend whichfavours social responsibilityand community development.’

Mohammad Hassan Esa, man-aging director and CEO of theIZO, who played an impor-tant role in its establishment,explained the importance ofthe new fund: ‘Zakat is a tool that can single-handedlyeradicate poverty not onlyfrom the Muslim world butfrom the entire world. Theonly condition is that we col-lect and manage the funds effi-ciently. The Global Zakat andCharity Fund is a step towardsachieving that efficiency.’

Central Bankof Bahrain


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 NEWS

The Muslim Community Co-op-erative (Australia) (MCCA) hasrecently received an Australianfinancial services licence fromthe Australian Securities and In-vestments Commission (ASIC).The licence will help the MCCAto attract partners and investorsfrom abroad as well as fromwithin the country, and shouldhelp the MCCA grow. It is alsonecessary for the MCCA to setup its Managed InvestmentScheme, the ‘MCCA Islamic Fi-nance Investment Fund’, bywhich the MCCA plans tolaunch its Shari’ah-complianthome finance products.

‘This is fantastic news as wehave been working on this proj-ect for just over two years,’ saidChaaban Omran, the managingdirector of the MCCA. ‘Thiswill represent a significant mile-

stone in the history of theMCCA in that rather than bestate-based, we can be federallyregulated by ASIC.’ A new en-tity, MCCA Ltd, will be a publiclisted company. It will also bethe first licensed Islamic finan-cial institution in Australia.

The MCCA has until now beena mutually-owned co-operative.The plan for the next three yearsis to wind down the co-opera-tive outfit and sell its assets tothe new fund. And the intendedlaunch date will either be 1stMay or 1st July 2009. ‘A lot ofwork has been done recently toraise the awareness of the poten-tial of the Australian market,and the role the MCCA can andwill play in developing the op-portunities for providing full re-tail Islamic banking operationsin Australia,’ Omran said.

Australian Islamic co-operative awarded

banking licence

Ethiopia latest in rushtowards Islamic banking

The authorities in Ethiopiahave approved the establish-ment of an Islamic bank.When set up, this will be the first in the country. TheAccounting and Auditing Organisation for Islamic Fi-nancial Institutions (AAOIFI)will conduct talks with theEthiopian government, and asource stresses that it maytake some time for the bankto become operational.

Ethiopia is the latest of anumber of countries to em-brace Islamic banking, otherrecent examples being Malta,Tanzania, Italy, Sweden and neighbouring Kenya(NewHorizon, January–March 2009). Ethiopia, situ-ated in the Horn of Africa, is home to about 80 millionpeople, and is thought to contain more than 25 millionMuslims.

New Islamic investmentproduct for Kazakhstan

Darahim Sukuk Basket has be-come the first Shari’ah-compli-ant product to be introduced toKazakhstan’s financial marketon a broad basis. The basket,with a value of $40 million, was introduced by Encore FundManagement Co Ltd, subsidiaryof a Swiss management com-pany, Encore Management SA,set up specifically to manage Islamic strategy portfolios. Thecompany confirms that DarahimSukuk Basket has already re-ceived commitments from in-vestors for $23.5 million.

The product is a three-year noteto be issued by BNP Paribas andis set to accumulate a portfolioof high grade rated sukuk issuedin the GCC region, with the em-phasis on Saudi Arabia.

According to John A. Sandwickfrom Encore Fund Management,the firm is ‘the first-ever invest-ment company to offer highquality Shari’ah-compliantstructured investments to Kazakhstani pension funds, cor-porate treasuries, commercial

banks and national governmentagencies’.

Dhafer S. Alqahtani, CIO of En-core Fund Management, statedthat this venture indicates thestart of the remaking of the SilkRoad, ‘by creating an importanttwo-way flow of capital’. Kaza-khstan and the Gulf region havemany similar aspects, he added,such as abundant oil, gas andmineral resources, as well as up-and-coming markets ‘with a rich history and deep roots inIslam’.

Alqahtani is also setting up aninvestment company in Bahrain,Darahim Capital BSC (whollyowned by Encore Fund Manage-ment), which is currently await-ing regulatory approval of thecountry’s central bank. Once licensed, it will become theworld’s first dedicated Islamicmutual funds company. Alqah-tani noted that naming thesukuk basket ‘Darahim’ isstrategic and in line with theplans to establish Darahim Capital.

Astana, Kazakhstan



IFSB issues new governance and capital adequacy guidelines

NEWS

The International Financial Ser-vices Board (IFSB), the standard-setting body based in Malaysia,has recently adopted two newstandards for Shari’ah-compli-ant finance. The two standardsare, Guiding Principles on Gov-ernance for Islamic CollectiveInvestment Schemes (IFSB-6),and Capital Adequacy Require-ments for Sukuk Securitisationsand Real Estate Investment(IFSB-7). They update and com-plement existing recommenda-tions issued by IFSB in the pastin their own particular areas.Specifically, they build on thestandards of Guiding Principleson Corporate Governance forInstitutions offering only Islamic

Financial Services (IFSB-3), andCapital Adequacy Standard for Institutions offering only Islamic Financial Services (IFSB-2). These standards were formulated in 2006 and 2005respectively.

IFSB-6 is designed to reinforceexisting international best prac-tices in the area of collective investment schemes, but also to address the specifics of the Islamic variants of this model of finance. It is split into fourparts, which relate to generalgovernance and the incorpora-tion of best practices, trans-parency and disclosure issues,Shari’ah compliance, and the

additional protection requiredby investors in Islamic collectiveinvestment schemes. IFSB-7looks to cover those areas ofcapital adequacy which are notalready covered by IFSB-2. ThisStandard applies to both issuingand originating Islamic financialinstitutions (including originat-ing institutions that invest in Sukuk which they themselvesoriginate). For real estate finance, IFSB-7 focuses princi-pally on the capital require-ments for a Shari’ah-compliantinstitution which invests its ownfunds in real estate investmentactivities. IFSB-7 also places importance on the necessity forthose authorities which super-

vise Islamic banks to set appro-priate threshold limits.

IFSB, which is a global organisa-tion, is comprised of regulatoryand supervisory agencies, whichall have a vested interest in en-suring the soundness and stabil-ity of the Islamic financialservices industry. It covers awide range of sectors, frombanking and insurance to capitalmarkets. Its membership hasnow reached the total of 178,including the InternationalMonetary Fund (IMF), theWorld Bank, the Bank for Inter-national Settlements (BIS), Is-lamic Development Bank andAsian Development Bank.

Islamic hedge fund poised for launch

Amiri Capital, a Shari’ah-compliant global asset man-agement firm, and Newedge,an international brokeragecompany, have teamed up tolaunch the first Islamic fundof funds for the Middle Eastmarket. The fund, calledAmiri Equity AlternativeStrategies (AEAS), will be registered in the Cayman Islands, according to theReuters news agency, and will include long and shorthedge funds.

The original partnership forthis venture consisted ofAmiri Capital and LehmanBrothers, but the project hadto be put on hold due to thelatter’s collapse. Now theventure is back on track andaccording to Richard Ellis,

Amiri’s co-founder, it won’t be long before AEAS com-mences its operations. ‘We are working with our seed in-vestors to agree a time to in-vest in the market,’ he toldReuters. He added that the investors have already pledgedassets to the fund, but invest-ments will be made once themarket starts picking up.

The fund will operate in compliance with Shari’ahprinciples, which means it will not undertake short-selling, as practised in the conventional markets. AEASwill apply a stock screeningprocess to exclude companiesthat are involved in haram(prohibited) activities, such as gambling and alcohol, as well as companies that

have debt to equity ratio, account receivables or interest payment exceedingcertain limits. Certain typesof derivatives will also be excluded.

Hedge funds are a controver-sial subject, igniting a largeamount of debate amongShari’ah scholars, with someconsidering hedge fund struc-tures Shari’ah-compliant andacceptable, and others la-belling them speculative andviolating Shari’ah principles.NewHorizon has received alot of feedback supportingeach side of the argumentafter publishing an academicarticle, ‘Islamic hedge funds:work in progress’, last year(NewHorizon, July–Septem-ber 2008).

AAOIFI tocertify more

vendors

Following Path Solutions’ iMALcore banking system receivingcertification for Islamic compli-ance by the Accounting and Au-diting Organisation of IslamicFinancial Institutions (AAOIFI)(NewHorizon, January–March2009), a source from theAAOIFI states that at least acouple of other vendors are intalks with the body.

It is likely that more bankingsystem suppliers will receive cer-tification soon. The AAOIFI hasdeclined to name any of them,though the process with PathSolutions lasted seven and a halfmonths, and covered both mod-ules and contracts.



portfolio at Dubai Bank. ‘It is a totally newIslamic module, named internally as IslamicFinance System (IFS), which handles ourShari’ah portfolio and allows for the Islami-sation of our financial products,’ Najimcontinues.

The detailed functionality demanded fromIFS was arrived at with the help of thebank’s Shari’ah experts. ‘Through them wegot the Islamic knowledge of the productsthat we wanted to have in IFS,’ explainsNajim (see Box 1 for an explanation ofthese products). All of the Islamic function-ality was to be built into the new system.One advantage of this approach, in thebank’s view, is that the module can be inde-pendent of its core banking system but stillshare features such as customer informationfile (CIF) and general ledger.

‘IFS does all of the processing of the Islamicproducts, all of the payment schedules, allof the Islamic business functionality andtransaction processing,’ explains Najim. Atthe end of the processing, only the generalledger accounting entries and informationrelating to the CIF are sent to the core bank-ing system.

One of the most important differences between conventional and Islamic financesystems is the ‘profit’ calculations on cus-tomer accounts. So a key feature for thetransformation process was the methods tobe used to allocate profit amounts (see Box2 for details). At Dubai Bank, the profit calculations for financing products are donewithin IFS, while the profit calculations forretail deposit accounts are done within the

The bank was incorporated in 2002 as aconventional financial institution, but inmid-2006, the board of Dubai Bank decidedto join the growing movement towards pro-viding fully Shari’ah-compliant bankingservices and products. With the aim oflaunching Islamic operations on 1st January2007, the bank had only six months to com-plete the conversion.

As can be imagined, ‘the conversion itselfwas the only initiative that the entire bankwas focused on,’ says Faizal Eledath, chiefinformation officer of Dubai Bank, who wasbrought in to oversee the systems aspects ofthe initiative. Although a three-year planwould soon be created, at the very begin-ning there was a freeze on any other IT ini-tiative, so the bank’s focus was directedentirely on becoming Shari’ah-compliant.‘We already had Islamic experts in the bankwhich helped us from the business definitionand Shari’ah compliance standpoint,’ saysEledath. As is required in all Islamic banks,Dubai Bank formed a Shari’ah supervisoryboard (SSB) which was charged with advis-ing and ensuring Shari’ah compliance. ‘TheSSB also guided us with transformation,’points out Eledath.

From a systems standpoint, the bank wasusing a conventional banking package as itscore banking system. A decision was neededquickly as to what would be the future di-rection. The bank evaluated all options andmade the decision to build its own Islamicbanking solution. ‘We built a custom appli-cation to meet our Islamic banking needs,’points out Ashraf Najim, project leader andthe person responsible for the application

Dubai Bank: taking the Shari’ah route

When the board of UAE-based Dubai Bank decided to convert from a conventional to a totallyShari’ah-compliant business model, the technology division had only six months to achieve thisconversion. Don Brownlow, NewHorizon’s contributing editor, talks to two of the leaders of thatconversion, which was the first step in a three-year IT strategy that culminates this year.

core banking system in a Shari’ah-compliantway.

The biggest challenge for the bank was thetime that it had available. To mitigate therisk, ‘we had a very good governanceprocess around the initiative, which meantwe had people from the business includingoperations, the Shari’ah team, as well as thebusiness units themselves’, claims Eledath.The implementation team was reporting tothe bank’s executives and making decisionson a week-to-week basis. Because of thetimeline constraint, the go-live had to be abig-bang, ‘as we did not have time for aphased approach’. So, to diminish that riskthere were five test conversions (dress re-hearsals) during the IFS application develop-ment. The bank went live, as scheduled, on1st January 2007.

‘One of the hardest parts of the project wasthe migration of all the customers’ personalfinancings to the Islamic way of banking,’recalls Najim. The approach that the banktook was to get each customer’s permissionto move their account to the Islamic way. Itdid that by sending a letter to each customersaying that it is going to be Islamic andpointing out how all personal financing willoperate. If the customer did not agree, thenthey were invited to come to the bank andclose their accounts prior to the conversiondate. ‘Only a very few customers came backand said that they didn’t wish to continue,’says Eledath, ‘most of them remained withus’.

For the actual conversion of the loan ac-counts, the bank took the outstanding prin-

CASE STUDY


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 CASE STUDY

cipal balance of each account on 1st Janu-ary and, based on the remaining term, cre-ated a new Shari’ah-compliant financingbased on a commodity purchase transac-tion. ‘At the time of the conversion, we ap-plied the same profit rate to the new loans,’says Eledath. That was necessary from apractical standpoint of converting and rec-onciling the transfer, but also from the cus-tomer’s standpoint, otherwise they may havebeen impacted adversely from changes totheir personal finances. However, as Najim points out, under the Islamic method of financing, from that point on there were no changes in the total amount of profit due from a customer on a financing for the whole of its term, even if that customerwanted to change the payment schedule, in-crease the term or was late with a payment,the bank could not recalculate any moreprofit or perform delinquency processing.‘The amount of profit that was calculated at conversion couldn’t vary over time,’ henotes.

One other point relating to the Islamic con-version was that the bank was not permittedby its SSB to take into earnings any interestthat had been accrued, but not yet paid bythe customer, before 1st January. The bankwas obliged to move that accrued interestinto a charity account, otherwise the bankwould have benefited from earning interest.The bank’s savings account holders, how-ever, had already received the benefit of theinterest that had accrued on their accountsbecause that interest was paid out at theyear end, 31st December, prior to the timeof the conversion.

The bank was determined that all of its op-erations would be Shari’ah-compliant, so al-though much of the attention during theconversion was on the retail banking arm,the bank also realised that its treasury oper-ations also needed reviewing. Prior to theconversion, the treasury operated in a con-ventional manner, dealing in the interna-tional money markets and conducting awide range of interbank transactions. TheSSB would not allow many of these opera-tions and the main treasury product was tobe the ‘murabaha deposit’, an Islamicallyacceptable transaction that has similar char-

acteristics to a conventional money marketdeposit. The treasury modified its process-ing systems to accept the murabaha. This in-volved not only changing the input screensbut changing the accounting entries becausein a murabaha transaction the total cus-tomer profit amount is amortised daily overthe life of the deal, which is the opposite tothe conventional deposit where interest isaccrued daily over the life of the deal (seeBox 2). Now all transactions performed bythe treasury department of Dubai Bank areShari’ah-compliant. The treasury still doessome foreign exchange deals under Shari’ahgovernance.

Since the time of the conversion the bankhas moved on. ‘When we started our IFS so-lution, it only covered retail products. Nowwe have also extended it to corporate ones,’explains Najim. This has meant addingother Islamic products to the IFS repertoire(see Box 1) but has expanded the bank’smarket through service offerings of cashmanagement, treasury, trade finance, work-ing capital, asset and project finance to SMEand large corporates.

In the meanwhile, during the later parts ofthe conversion process, the bank began tolayout its IT strategy with a planning hori-zon of 2007 through to 2009. ‘The bank deciding to become Islamic was a businessstrategy that had evolved, so we had toalign the IT strategy with that,’ says Ele-dath. Once the gap ‘between where we wereand where we wanted to be’ was under-stood, the required key initiatives were de-fined and laid out into a three-year plan.The bank’s achievements during the last twoyears of the initiative have been impressive.It launched Shari’ah-compliant credit cardsand brokerage operations, and implementedan Islamic trade finance application. It alsoadded new delivery channels such as tele-banking, mobile and SMS banking, as wellas internet banking,

Dubai Bank has also updated its technicalinfrastructure which has enabled it to rap-idly launch a new series of delivery chan-nels. For example, it claims to have been thefirst in the country to launch mobile bank-ing (PDA banking) because it had the infra-structure that allowed it to do that before itscompetitors. The new service simply reusedthose services that had been developed forthe launch of the internet banking facility.

So, what has been the reaction from thebank’s customers? ‘I would like to think thecustomers are enjoying the services,’ says

Eledath. ‘As we speak, there are initiativesunderway to find out how our customersare reacting to our new banking services,but if you look at the transaction volumesof internet banking as an example, they arevery high.’

Eledath is modest about what has beenachieved, saying, ‘the critical thing is that itall boils down to having the right team, theright people and the right mandate’.

The bank deciding to become Islamic was a business strategy thathad evolved, so we had to align the IT strategy with that.

Faizal Eledath, Dubai Bank


NEWHORIZON April–June 2009CASE STUDY

Some Shari’ah-compliant products and how Dubai Bank uses them

The Islamic products that were initially needed for IFS at Dubai Bank were oriented towards retail customers. The bank usesmurabaha for auto financing, tawaruq for personal finance and ijara for mortgages. All of the transaction processing is done within IFS, including specialist processing, such as the commodity transactions necessary for tawaruq (as described below). The bank’s treasury department uses commodity murabaha for treasury operations. Later, with the launch of corporate banking, capabilities for sukuk and musharakah products were added to IFS.

Murabaha: This is the most commonly used instrument in the Shari’ah-compliant banking world. It has various forms, but the mostbasic is the ‘cost-plus’ form of financing. In the retail arm of Dubai Bank, this instrument is used for personal finance of specificitems such as auto finance operating under the product name of ‘Markaba Auto Finance’.

In this form of transaction, the bank agrees to buy a specific item (in this case a car) and then sell it to the client for the cost priceplus an agreed mark-up amount (profit). An essential part of the murabaha agreement is that the cost price and the mark-up are fullydisclosed. The client can repay the bank in instalments over time (deferred payment). Once the mark-up amount has been agreed,that amount cannot change, even if the repayment time is extended.

The same instrument is also used for house purchase at Dubai Bank. In this case, the bank buys the property on behalf of the clientand then sells it to the client on a deferred payment basis at an agreed marked-up price. The client repays the bank in instalments. AtDubai Bank this product is one of the options of its ‘Mulki Property Finance’.

Tawaruq: This is a variation of murabaha which is also known as commodity murabaha. In this case, the retail arm of Dubai Bankuses the instrument to provide personal financing to the client.

In its standard form, the process involves the sale and purchase of some easily tradable commodity (not gold or silver which have aspecial meaning in the Shari’ah). The bank is appointed as agent for the client and performs the commodity trades on their behalf.The process starts with the bank buying some commodity at market price (usually from a broker) and immediately selling it to theclient on a deferred payment basis at an agreed marked-up amount to the original market cost. The client then sells the commodity,at a market price, to a third party for cash (this may be the original broker that sold the commodity to the bank in the first step ofthe transaction). The client then has a cash amount and an obligation to repay a higher amount to the bank. The marked-up amountrepresents the bank’s profit.

In some regions, a piece of land is bought and sold instead of a commodity.

At Dubai Bank, tawaruq forms the basis of its ‘Sanad Personal Finance’ product.

Ijara: This is a Shari’ah-compliant form of leasing. It is used in the retail arm of Dubai Bank as one of the options of financing home purchase through its ‘Mulki Property Finance’. The bank buys the property on behalf of the client who then leases the property back and makes regular agreed payment amounts. The lease payments contain the agreed lease amounts plus an element of capitalrepayment such that at the end of the lease period all of the bank’s original purchase price has been repaid and the ownership of theproperty is transferred to the leaseholder.

Musharakah: This is regarded by many as an Islamic banking product that follows the true spirit of the Shari’ah principles. It is aform of profit-and-loss sharing (PLS) financing arrangement in that the bank makes its money by sharing the profits and the risks of the business. In the standard form of this arrangement the bank, along with other investor(s), provides capital to the business in a partnership arrangement. The bank shares the profits of the business in a predefined ratio with the other investor(s). In the event of a loss, the bank shares that loss along with the other investor(s) in proportion to their original investments. Quite often, the bankwill wish to reduce its investment over time, so the profit distribution from the business may include an element of repayment to thebank. This arrangement is known as a diminishing musharakah.

Box 1


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 CASE STUDY

Musharakah is used at Dubai Bank to support its corporate banking activities.

Sukuk: Sukuk (plural of sakk) are often referred to as Islamic bonds. These do have similar financial characteristics to conventionalinterest-based bonds and are often used to finance large projects. A financial institution forms a special company (the sukuk com-pany) to obtain funds from investors. In exchange for the funds, investors are given certificates (sukuk) that entitle them to share in regular profit amounts. The funds are used to finance a special project or fund some profit-making venture. Profits from that venture are collected by the sukuk company and distributed among the sukuk holders. From a financial institution’s standpoint itmay be involved in the operation of the sukuk company or, more regularly, one of its clients may be a sukuk holder in which case the institution simply ensures that the regular profit payments are collected and the ‘face amount’ (often the amount of funds originally invested) is paid at the sukuk’s maturity date. This final repayment amount has caused some discussion in Islamic scholarlycircles.

Treasury murabaha: This is essentially the tawaruq described above. The instrument can be used either by the bank to provide fundsto other institutions (often other financial institutions through interbank treasury operations), or, when the flows are reversed, forthe bank to receive funds from a depositor in the form of a fixed-term deposit. The treasury murabaha or tawaruq is characterised asoften being for large amounts for fixed periods of time (often a year).

When the transaction is used by the bank to provide funds to another person or institution so that it receives back, at some futuredate, its original deposit amount plus a known marked up profit amount, it uses commodity trading as described under the tawaruqentry opposite.

When used as a deposit to the bank, the depositor buys some commodity to the equivalent value that they wish to deposit with the bank. The client then immediately sells that commodity to the bank on a deferred payment basis with the bank agreeing to paythe client, at a future date, the original sales price of the commodity plus an agreed marked-up amount that will represent profit tothe client.

Profit calculations and how they work

In Islamic banking, any form of interest is prohibited but customers can benefit from profits made by the bank. As a simplistic example, the bank may use depositors’ funds to finance the building of an apartment block and then benefit from rental income whichis distributed among the bank’s depositors. This would be how a mudarabah or musharakah account could work. Alternatively, it mayuse funds to provide a lease of capital equipment to a company and receive back lease payments that include profit.

In practice, the process is more complex. At Dubai Bank, as is most often the case at Islamic banks, an interim or ‘provisional’ rate isused to give some indication of the amount of bank outgoings to be given to savings/investment account customers in benefits. Thisrate is revised prior to actual payout and the calculation repeated using the ‘final’ or actual rate.

For a murabaha treasury deposit, the bank agrees upfront with the customer the amount of return that they will earn and will be dueat the deposit’s maturity. This amount is amortised over the length of the deposit. This is the opposite of the calculation that is done in conventional interest bearing accounts where the amount of interest is accrued at a given rate during the term of the deposit.

For a murabaha financing, such as Dubai Bank’s Markaba Auto Finance, the amount of profit (or mark-up) is agreed with the customer at the time of the transaction. Under AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) standards, the bank records the total amount of profit as ‘unearned income from murabaha’ at the time the customer signs the agreement and amortises this amount into earnings over the term of the agreement.

Box 2



to clear Quranic evidence, zakat (as well assalat) was prescribed in the earlier revealedScriptures as well, through Prophets Abra-ham, Isaac and Jacob, Prophet Ismail, theChildren of Israel, and finally, ProphetJesus.

While warranting further research in thecase of Judaism and Christianity, the prac-tice of zakat in Islam has evolved and hascome to be established as a well defined financial institution – from the concept ofgeneral charity and poverty alleviation to afiscal levy – with specific definitions andevasion penalties.

The Islamic normative perspective of zakatis reflected in several Quranic stipulationswhich juxtapose zakat with salat, in at least20 verses, describe zakat as purification,juxtapose charity (of property) with zakatand salat, contrast zakat with riba, associatedenial of zakat with shirk (and consequentaffliction), juxtapose sadaqah (charitablegiving), zakat and salat, declare Divine ex-action of sadaqah, reserve sadaqah for theeligible eight categories of recipients, andcontrast sadaqah with riba.

The historical perspective

The early Quranic injunction stipulated the

The above quoted command in The Quran– to establish salat (prayer) and give zakat(alms) – sets the tone for the central positionof the concept of zakat in the belief systemof Islam. The practice of zakat, being one of the five pillars of Islam, is an element offaith, although the historically evolved technical usage of the term colours it as a financial levy.

The resolution of this apparent lack of congruence between the scriptural and thetechnical usage lies in an examination of the term from a normative, historical andconceptual perspective.

The normative perspective

The zakat obligation, based on the Quranic, Prophetic/Companion Sunnaic and Ijmaic evidence, is enjoined by the repeated Quranic command to establishsalat and give zakat, and is ranked as thethird element of faith (thalit al-iman) by the Quran. The Sunnah of the Prophettreats zakat among the five pillars of faith.Ijma justifies it because the entire Muslim community has agreed upon zakat beingfard (compulsory).

The belief in zakat as an obligation of faithpredates Islam to antiquity as, according

The Islamic doctrine of zakat: finance or faith?Dr Azeemuddin Subhani, who completed a PhD in Islamic Law and Finance at McGill in 2007,offered an original interpretation of riba on the pages of NewHorizon in 2008. He returns here to reassess the importance of zakat, the Islamic principle of charitable giving.

concept of obligatory help for the poor, theorphans and the deprived, as a rightful shar-ing between the rich and the poor, with thebasic motive and enforcing power being thefear of God and the concept of individualresponsibility before God in the Hereafter.The terms in vogue to describe this obliga-tory spending included infaq fi sabil Allah,sadaqah and zakat. However, the historicalevolutionary process of these terms is com-plicated by the fact that the term infaq fi sabil Allah, spending in the way of Allah, which most closely describes thisobligatory spending, got discarded and theterm sadaqah, with its intrinsic meaning oftruthfulness, acquired the status of generalusage. The term zakat, with its intrinsicmeaning of purification, acquired the statusof technical/legal usage for this obligatoryspending.

The textual support for the term sadaqahcomes from the Quran and the PropheticHadith, both of which describe this obliga-tory spending as sadaqah and not as zakat.But the Prophetic Hadith also equatessadaqah with ‘impurities of the people’(awsaq al-nas) unfit for consumption by theProphet and his family. Finally, in the olderCompanions/Successor jurists’ period zakatas the technical term and its treatment as astate financial levy enforceable with punitivemeans were finalised and confirmed, exceptfor a fundamental controversy as to whetherthe zakat obligation was discharged by payment to the state publicly, or by directpayment to the beneficiary privately? Theanswer, with terminological and conceptualimplications, is clearly dependent upon the

POINT OF VIEW

Aqimu ‘I-salatwa atu ‘I-zakat.Holy Quran


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 POINT OF VIEW

perception of zakat – either as a governmen-tal financial levy or as a faith obligation.

The conceptual perspective

The central conceptual question that thisanalysis will attempt to deal with – and perhaps answer – is ‘Why is zakat a funda-mental pillar of religion if it is only a statefinancial levy and thus apparently not afaith issue?’ – or conversely – ‘Why is zakata financial levy when it is a faith issue?’ and then, ‘What is the faith issue at stake?’The conceptual model(s) to answer thesequestions rely on certain crucial relation-ships – Quranic and Sunnaic, above, andlexical and juridical, below:

Lexical relationship

The lexical meanings associated with zakatand sadaqah are the foundation of the con-ceptual lexical model (see p16).

The verb zaka means:

Verb form I: to be pure, just, righteous,good, fit, suitable; to thrive, grow, increase;Verb form II: to increase, augment, makegrow; purify, chasten; to justify, vindicate,vouch for, bear witness to integrity, honesty,uprightness; to attest to the truth, validity,credibility; to commend, praise; to recommend;Verb form III: (not applicable to this verb); Verb form IV: to cause to grow;Verb form V: to be purified, be chastened.

It is significant, as above, that the verb zaka does not include almsgiving and, asbelow, the noun zakat does not includegrowth/increase.

The noun zakat means:

Meanings common to the verb and thenoun: purity; justness, integrity, honesty;justification, vindication; Meaning of the verb but not of the noun: to grow, increase, augment;Meaning of the noun but not of the verb:almsgiving, alms, charity; legally prescribedalms tax, obligatory donation of food be-fore Eid al-fitr prayer.

The verb sadaqah means:

Verb form I: to be true, correct, right; fit exactly, apply, keep promise; advise sincerely;Verb form II: to deem credible; to believe;to consent, approve, sanction, certify, confirm, substantiate, attest, ratify; Verb form III: to befriend, consent, agree,approve, grant, sanction, certify, confirm,substantiate; Verb form IV: to fix a bridal dower (for awoman);Verb form V: to give alms, donate.

The noun sadaqah means:

The noun conforms to verbal Form Vonly, meaning charitable gift; almsgiving,charity, voluntary alms; legally prescribedalms tax; obligatory donation of food before Eid al-fitr prayer.

The noun sadaaq means: a bridal dower.

The noun sidq means: truth; sincerity; veracity, correctness; efficiency.

The noun sadaaqa means: friendship.

Juridical relationship

The technical Hanafite juridical definitionof the obligatory alms is:

The giving (tamlik: transfer of ownership of a property), as an act of piety, of alegally stated portion of one’s property to a poor Muslim who is not of theHashim family or their clients (mawla), in such a way as to preclude for the giverany sort of benefit. This absence of ‘reci-procity’, above, is the foundation of the conceptual philosophical model (seep17).

Proposed conceptual models

Based on the above relationships, the author of this article has developed threemodels – lexical, monetary and philosoph-ical – in an effort to reconcile and synthesise the various, often conflicting,relationships outlined above.

Dr Azeemuddin Subhani


NEWHORIZON April–June 2009POINT OF VIEW

Monetary model(based on a translation of Quranic/Sunnaic injunctions in financial terms)

Postulate 1A simple but necessarily very lengthy mathematical model, constructed by this writer, shows that the run out period to reduce a bal-ance of 100 to near zero at 2.5 per cent per annum on declining balance is a staggering 540-plus years. The balance is reduced to 50per cent in about 28 years, to 25 per cent in about 55 years, to eight per cent in 100 years, and one per cent in 180 years.

Postulate 2In a riba-based loan transaction, the interest rate, say 2.5 per cent, remains the same at 2.5 per cent for both the lender and the bor-rower because it is expressed as a function of the loan amount and not of the net worth of either party.

Postulate 3In zakat, however, the 2.5 per cent rate is expressed as a percentage of the giver’s net worth (over nisab – the minimum threshold),which, when expressed as a percentage of the recipient’s net worth (under nisab), equates to more than 2.5 per cent:

The Postulates 2 and 3 provide a financial explanationof the Quranic verse (30:39) that riba does not in-crease, but zakat increases manifold.

Giver Recipient

2.5% of 100 N.W = 2.50

(N.W = net-worth = zakatable assets minus debts held for minimum one year)

= 50% of 5 N.W (assumed nisab)= 100% of 2.50 N.W (below nisab)= 200% of 1.25 N.W (below nisab etc.)

Lexical model(based on lexical, legal and faith relationships)


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 POINT OF VIEW

Conclusion

The lexical model demonstrates that zakat –the third pillar of faith of Islam – is a concept much broader and deeper than amere financial levy which has come to be its popularly understood technical meaning.The Quranic zakat obligation, enjoined repeatedly with the salat obligation on allhumanity, represents a whole process of legitimatisation, truthfulness, and purifica-tion. In the area of legitimatisation of trans-fer of resources, it regulates the process ofgrowth – actual or potential productivity.

Through the fiscal levy (2.5 per cent zakat),it legitimatises and regulates materialgrowth. Through the social levy (bridal

dower and inheritance), it legitimatises andregulates procreational growth. Through the religious levy (sadaqah al-fitr and thehistorical sadaqah al-najwa), it legitimatisesand regulates bodily and spiritual growth,respectively. This process of resource trans-fer and the financial levy thereon is part ofthe concept of zakat, because it is a processof regulation of growth, which has deepertheological and metaphysical implications.In the area of purification, zakat covers the whole state of purity and chastity represented by ablution, sexual discipline,fasting and state of ihram in pilgrimage.

The monetary model demonstrates thegrowth characteristics of riba and zakat. Itillustrates that riba is a process of static

growth, while zakat is a more than a lifetime process of purification (for thegiver) and of unlimited growth (for the recipient).

Furthermore, this principle of unlimitedgrowth, through self-sacrificing zakat asagainst self-seeking riba applies to all re-sources – whether physical or non-physical,i.e. monetary, physical, intellectual, political,social, cultural or human. For example,what a teacher shares with his student maybe a fraction of the teacher’s knowledgereservoir but it could represent a 100 percent increase in the student’s knowledge.The transfer from higher resource base to a lower resource base always triggers thisunlimited growth.

In the case of riba, the growth of the loan is intra-active because the growth measure-ment agent is ‘single’, i.e. the common loanamount, and the interest received by thelender is growth thereon – thus a growth ofsimilarity. This intra-active growth of simi-larity is prohibited (haram), as being self-generating and hence an incursion in theDivine domain.

In the case of zakat, the growth is inter-active because the growth measurementagent is ‘dual’, i.e. the different net worth of the giver and the net worth of the recipi-ent. For the giver, zakat is a reduction ofsimilarity – the zakat on each property wasoriginally payable for that property alone.For the recipient, the zakat received and hisnet worth do not necessarily represent thesame property. Thus this growth is an inter-active growth – a growth of dissimilarity.This inter-active growth of dissimilarity isnot only permitted (halal) – through bai permission, but also enjoined (fard) –through zakat injunction. A metaphysicalexplanation for the prohibition of intra-active growth and the permission of inter-active growth has been posited elsewhere by this writer. The main thesis is that intra-active growth is strictly prohibited tomankind because, being self-generating andself-subsisting, it is a sole divine attribute, and inter-active growth is prescribed formankind because, being co-generating, it is the only mode of existence (duality) in

Action‘Give’

Reciprocity‘Take’

Interaction result Implication

1 Excess: 1.1/1 1x1.1/1 =1.1Growth (self-generating)(prohibited by Quran/Hadith)

= Riba

1 Equal: 1/1 1x1/1 =1Subsistence made meaningless =prohibited by Gold for Gold Hadith

= Baqa

1

1

Less: .9/1

Nil: 0/1

1x.9/1 =.9 }}

1x0 = 0 }

Annihilation (Zakat)(enjoined by Quran/Hadith)

= Fana

Philosophical model

This model is structured around the mathematical concept of ‘reciprocity’ – a functionof ‘inverse correspondence’ – which finds a religious use in the juridical definition ofzakat, above, which reads in part ‘the giving (tamlik) in such a way as to preclude forthe giver any sort of benefit’. Reciprocity finds religious expression also in the prohibi-tion of riba and the permission of bai.

Exchange of similarity

Action ‘Give’

Reciprocity ‘Take’

Interaction result Implication

1 Excess: 1.1/1 1x1.1/1 =1.1

Increase (co-generating)(permitted by:❏ Quran 2:275❏ Gold for Gold Hadith)

= Bai

Exchange of dissimilarity

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NEWHORIZON April–June 2009POINT OF VIEW

full consonance with the mode of humancreation, i.e. inter-action in pairs.

While the full treatment of these metaphysi-cal questions is beyond the scope of thispaper, the profound nature of zakat, beyonda mere financial levy, is clearly established inthe process.

The philosophical model, based on themathematical concept of reciprocity, demonstrates that growth from exchange of similarity (riba) is prohibited. Even thepermitted growth from exchange of dissimi-larity (from bai and from other legal re-source transfers – dowry, inheritance, gift,waqf) is then subjected to a process of de-crease through enjoinment of absence ofreciprocity on a fractional basis, i.e. throughthe imposition of 2.5+ per cent zakat on actually or potentially productive proper-ties. This entire process emanating from reciprocity is thus a process of regulation of growth. In a universe of finite resources,

infinite growth is not sustainable. Circularityand not linearity is the law of our existence.

In sum total, zakat (self-annihilation) is antithesis of riba (self-generation) and bothextend beyond the monetary/fiscal manifes-tations. The relevant Quranic verses are notfocused merely on the external manifesta-tions of positive and negative growth. Theyin fact provide a mode of behaviour formankind, which is:

❏ Meaninglessness (= prohibition) of self-subsistence (baqa);

❏ Prohibition of self-generating growth (riba) and permission of co-generating growth (bai);

❏ Enjoinment of self-annihilation (fana – zakat), on fractional basis.

In this prescribed scale of actions, if frac-tional self-annihilation (zakat) is practised,as required, the self-subsistence and self-generating growth modes are further auto-

matically precluded. The practice ofzakat, signifying self-annihilationthrough giving and perhaps also throughwaging jihad leading to martyrdom,being the only positive command in thisscale, is included in the fundamentals offaith of Islam. The other two commands,prohibition of baqa and riba, by virtueof being negative commands are not appropriate for inclusion in a listing of fundamentals, but are nevertheless inherently covered by the list.

In fact it appears that the five fundamen-tals of Islam can be captured by twofoundations – salat and zakat. Salat regulates relations with God, while zakat regulates relations with man himself.

The relevant question, then, is not what is embodied in the title of this paper –whether zakat represents finance or faith– but why is it misrepresented?



Rushdi Siddiqui has been appointed byThomson Reuters, the information servicebusiness, as head of its Islamic finance busi-ness. His primary occupation will be towork with professionals from the Islamicbanking industry including fund managers,treasury, financial hubs, regulators, stock ex-changes, central banks, takaful entities, halalindustry, intra-OIC (57 Muslim countries),trade and investment. Siddiqui joins fromDow Jones, where he spent ten years. His career there culminated in the post of globaldirector for the Islamic market indices.

Salama-Islamic Arab Insurance, a takafulfirm listed on the Dubai Financial Market,has reorganised part of its top level manage-ment. Rafiq Halani has become generalmanager for general and health takaful. AndNoel D’Mello has been named general man-ager for family takaful. Salama claims to bethe largest takaful and re-takaful firm in theworld, and saw overall revenue growth of 42 per cent in 2008. The shake-up reflects efforts to focus more on attracting new

On the move

APPOINTMENTS

customers in today’s volatile climate, and toimprove the existing management structure.

Al Khaliji Commercial Bank, a Qatar-basedbank which offers both conventional and Islamic financial products, has named HisExcellency Sheikh Hamad Bin Faisal Al-Thani as chairman of Al Khaliji, succeedingto Tariq Al Malki. Al-Thani held a numberof prominent positions before joining thebank, including the post of minister of economy and commerce of Qatar and vicechairman at Qatar National Bank.

Elaf Bank, an Islamic wholesale investmentbank, has hired Nasser Haram as generalmanager for support services. Haram willperform oversight of areas including finan-cial control, risk control, operations, ad-ministration, human resources, informationtechnology and public relations. Harambrings over 27 years of experience in Is-lamic and conventional finance, havingworked as senior vice president of the SaudiEconomic and Development Company,where he controlled over $1.5 billion ofpublic and private equity. Before this,Haram was chief financial officer of IsamKabbani & Company in Saudi Arabia andfinancial controller of Solidere Inc inLebanon.

The global law firm, DLA Piper, has an-nounced that Shezhaad Sacranie has joinedits Abu Dhabi office as project finance andIslamic finance partner. Shezhaad movesfrom Allen & Overy, an international lawfirm. The appointment reflects DLA Piper’saspirations for the region, the outfit havingalso recently opened an office in Oman.

Malaysia Building Society Berhad has an-nounced that En. Ahmad Zaini has replacedEn. Ahmad Farid Omar as chief executiveofficer. Zaini has 24 years of experience

in the banking and corporate sector, andmoves from AmIslamic Bank, where he wasalso chief executive officer for three years.Other previous roles include senior generalmanager of corporate banking at Ambank,and senior general manager and director ofcorporate finance at Perwaja Steel. He alsospent four years at Bumiputra MerchantBankers and Intradagang Merchant Bankers.

In the Maldives, the state minister for Islamic affairs, Mohamed Shaheem AliSaeed, has been appointed by the IslamicDevelopment Bank (IDB) to the post of al-ternate governor of the country. He willfocus on facilitating the introduction ofShari’ah-compliant banking to the island.The Islamic Corporation for the Develop-ment of the Private Sector (ICD) signed amemorandum of understanding (MOU)with the Republic of the Maldives with theaim of looking into the feasibility of settingup such a bank in 2007 (NewHorizon,April–June 2007). Saeed has suggested that,since the country is 100 per cent Muslim,the banking system should reflect this fact.

Gatehouse Bank,the Islamic whole-sale bank based inLondon, has ap-pointed PhilipChurchill (right) toits origination teamas head of real es-tate. Before joiningGatehouse, Churchill gained experiencein Islamic finance and real estate throughposts at HDG Mansur, where he washead of investment management, andHSBC Amanah Global Properties In-come Fund, where he was fund manager.Churchill also previously spent nineyears at Citigroup, where he was en-gaged in the launch of two Shari’ah-compliant real estate funds in Europe.

AREIT Manage-ment Limited,the manager ofArabian Real Es-tate InvestmentTrust (AREIT),has added ChrisPurdon (left) toits management,as chief invest-

ment officer. As CIO, Purdon will beoverseeing investments across the Mid-dle East, including a Shari’ah-compliantreal estate fund in Saudi Arabia. Purdonmoves to AREIT from Landmark RealEstate Investment Management, wherehe was CEO, and the manager of tworeal estate funds for the Middle East. Healso co-managed a pan-Asian real estateinvestment fund at Jardine Fleming.


NEWHORIZON April–June 2009FOOD FOR THOUGHT

Interest rate risk: a threat to the Islamic banking system?

At first glance this topic may be dismissed as contradictory. How can interest rate risk impact a banking system that is independent of interest? In this new section of NewHorizon, dubbed ‘Food for Thought’, two experts from the IIBI voice different viewpoints on

the issue that may present a real challenge to the industry.

Don Brownlow, NewHorizon’s contributing editor:

‘Islamic banking can’t go against the traffic’ –note many practitioners. From a commercialpoint of view, the effective returns on Islamic accounts, both deposit and financing, need to be of the same scale as the conventional ones.

In reality, the disparity in real returns may potentially represent athreat to the Islamic banking industry, at least in the short-term. As base rates in the conventional banking world have begun to approach zero, the interbank rates, although slow to respond, havenow also begun to fall. Although the majority of Islamic banking is conducted through murabaha and ijara, the rates of return onmudarabah and musharakah are not immediately similarly im-pacted. The real returns on those products are reflected in the profits made by those enterprises that are financed in the Islamic profit-and-loss sharing (PLS) concept.

So, the dilemma Islamic banks that have financed through mu-darabah or musharakah may face is that their returns may be significantly above the rates achieved by conventional banking.They may now face the commercial risk of being overwhelmed byan influx of funds for which there is no short-term liquid market;or alternatively, they may face the ethical dilemma of reducing thereal return on their PLS investments to bring them in line with thelow interest rates of the conventional world. Sukuk issuers, thathave benchmarked their returns from ijara or mudarabah invest-ment pools against LIBOR or other interbank investment rates,may have to deal with this problem soon, as their steady investmentreturns will be much higher than international rate benchmarks.

When the balance sheets of conventional banks have been decimated by derivatives and other questionable trading strategies,could the real, asset-backed investments of PLS be of genuine inter-est to conventional bankers anxious to gain some sort of return in a world where their interest-rate based investments are almostworthless? Is it conceivable that it is the conventional banks thatlead the way into Islamic banking?

Mohammad Shafique, IIBI programme development co-ordinator:

Islamic Bank of Britain’s indicative rate of returnon its direct savings account has now gone downto 0.40 per cent from four per cent in Augustlast year. At present, over 75 per cent of Islamicfinancial transactions are based on murabahaand ijara, and others may be wakala, salam or istisna, with a maximum of five per cent for PLS-based structures.

The Islamic finance industry, as it stands today, relies on debt-basedstructures instead of equity-based ones. Thus, it cannot offer a visible difference to depositors as well as borrowers. The industry’ssize is still very small, compared to conventional finance, andhence, it is not in a position to influence the market. Therefore,there is no choice except to ‘follow the traffic’.

Conventional banks’ lending rates will stay positive even if the baserate goes down to zero and the same will apply to Islamic banks;the impact will be felt by depositors (savers), irrespective whetherthey are banking with Islamic or conventional institutions.

If Islamic banks use equity-based structures, like mudarabah andmusharakah, on asset and liability sides ‘in substance’, their opera-tions will be riskier. While this may provide some comfort in thepresent economic scenario, in the long term the real rate of returnto depositors at Islamic banks will be low, due to compliance withregulatory and taxation rules. Capital adequacy requirements forequity-based products are higher than debt-based ones. Also, taxa-tion treatment of debt makes it more attractive than equity.

In a nutshell, due to the above-mentioned issues, Islamic bankingproducts are not very different from conventional ones. Is it nottime to re-think and change the strategy for moving to equity-based structures at least in the markets that are more supportive of Islamic finance, such as Malaysia and Bahrain? Surely, oncethere is a success story in one market, it will become easier to emulate it in other places.

What do you think? The Institute is calling for the readers’ input and feedback on this subject, which will be discussed in more depth in the following issues of NewHorizon.

Please email us at: [email protected] or [email protected]



during the rule of president Jaafar Nimeiry,in the early 1990s Sudan’s current presi-dent, Omar al-Bashir, initiated another series of efforts to make Sudan’s financialindustry Shari’ah-compliant. These eco-nomic reforms were less sporadic and moreconsistent, yet they were not introduced as rapidly as those during Nimeiry’s rule.From the early 1990s, the monistic modelof the finance sector introduced by al-Bashir’s government has left no alternativeto Shari’ah-compliant financing tools.

In 1992, the state established the HighShari’ah Supervisory Board, a supervisorycouncil to oversee the progress of the re-forms and their compliance with Shari’ah.The body was comprised of scholars, juristsand economists. Prior to this, some of thefunctions of the council had been carriedout by the department of technical controlat the central bank, Bank of Sudan. How-ever, it never dealt with the issues of Shari’ah.

In 1998, a new clause was added to thecountry’s legislation, stating that the statedirects the growth of the national economyguided by planning on the basis of work,production and free market to prevent mo-nopoly, usury, fraud, and to ensure nationalself-sufficiency, abundance, blessings andthe aims of justice among states and regions(Article 8).

The status of the High Shari’ah SupervisoryBoard is subject to the terms of the law regulating the banking activity (ordained in2003). The council consists of eleven peo-

In late 1970s/early 1980s, three countries –Iran, Pakistan and Sudan – embarked on theprocess of converting their financial systemsto Islamic ones. This implied that startingfrom a predetermined date, all banks and financial institutions in these countries wereto use only Shari’ah-compliant methods of financing in their work. In addition, Pak-istan and Sudan introduced a new obligatorystate tax – zakat (an religious obligation onMuslims to pay a prescribed percentage oftheir wealth to specified categories in theirsociety, when their wealth exceeds a certainlimit). However, the takaful (Islamic insur-ance) sector was left virtually untouched bythe reforms in all three countries.

By the start of the new millennium it becameapparent that Sudan was the only countrythat managed to successfully complete theproject of Islamising its entire financial sec-tor. In Iran, despite the official prohibitionof interest (riba), interest-based transactionsare quite common within the banking sectorand the black market. For example, mu-darabah (profit-and-loss sharing) comprisesan ample portion of financing instruments inIran, but in a form that does not really com-ply with Shari’ah – the profit of the bank isspecified in advance and does not depend onthe outcome of a project. Meanwhile, inPakistan, after several attempts to eradicateinterest-based banking, it was decided toadopt a dual model, thus giving equalground to conventional and Islamic financialinstitutions.

In Sudan, following a failed attempt to Is-lamise the financial sector in the mid-1980s

Sudan: forgotten centre of Islamic finance

When discussing Islamic economics, specialists usually cite Malaysia, Bahrain, the UAE, Iranand, of late, the UK, as evident examples. But such a country as Sudan is either not brought upat all or mentioned in passing. Meanwhile, Sudan is the only country in the world that has awholly Islamic financial sector, argues Renat Bekkin, PhD in Law, senior researcher at theInstitute for African Studies at the Russian Academy of Sciences.

ple, the majority of whom are Shari’ahscholars, although it also has economistsand bankers (including the central bank’sgovernor) amongst its members. All mem-bers are Sudanese citizens and are appointedby the president of the country upon recom-mendation of the Bank of Sudan’s governorand the minister of finance. There is no timerestriction on the mandate, so theoreticallyit can be a life-long post. The members areallowed to combine their membership at thecouncil with the membership of the Shari’ahboards of commercial banks.

The decisions of the council are based onthe majority of votes if agreement cannot bereached otherwise, but practice shows thatin most cases consensus is achieved withoutvoting.

The High Shari’ah Supervisory Board alsoacts as an appeal authority for disputes be-tween various Islamic banks, Islamic banksand the Bank of Sudan, and an Islamic bankand its customers. Therefore, the council’sfunctions are not limited to the direct super-vision over the country’s banking sector.

A bank can also turn to the High Shari’ahSupervisory Board as the ultimate authorityif it doesn’t agree with a decision of its inter-nal Shari’ah board. The distinguishing traitof Shari’ah boards of some Sudanese banks(e.g. at Tadamon Islamic Bank of Sudan) isthat they act as in-house law departmentsand deal with various legal issues on a dailybasis, carrying out the supervisory role atthe same time. In the majority of Islamicbanks across the world a Shari’ah board is

COUNTRY FOCUS


just a supervisory body, similar to the boardof directors.

Fatwas (rulings) of the High Shari’ah Super-visory Board are not based on views of oneparticular school of law (for example, theMaliki school, which is dominant in Sudan).

In the period of 1999–2002 the country underwent financial reforms that introducedBasel requirements to the banking sectorand aligned them with Shari’ah principles.Sudan learnt from the mistakes of similarreforms in other countries, including Pakistan, where the central bank simply executed orders of the ideological organisa-tions, such as the Council of Islamic Ideol-ogy. The High Shari’ah Supervisory Boarddoes not interfere in the issues outside itscompetence.

Today, all banks in Sudan use only the con-tracts that are halal (permitted by Shari’ah).Bank of Sudan does not differentiate be-tween Islamic banks and those financial in-stitutions that have conventional roots. Thelatter must use only the Islamic financialmechanisms approved by the central bank.

There are currently 30 banks in Sudan. Aconsiderable portion of their business is fo-cused on the foreign trade sector. The agri-cultural and livestock sectors are serviced byspecialised banks, such as Farmers’ Com-mercial Bank, Agricultural Bank of Sudan

and Animal Resources Bank. The latter hasthe Ministry of Finance among its share-holders. The bank’s share capital is $35 million and since its establishment in 1993,it has accrued a regional network of 18branches. Its main activity is financing theexport of cattle to Saudi Arabia, based onthe murabaha mechanism (the exporter purchases the cattle) and the musharakahmechanism (the actual process of export –mainly services for the cattle drive from thebreeding regions in the West Kurdufanprovince to Port Sudan on the Red Seashore). Livestock financing comprises up to80 per cent of the bank’s operations. Otherbanking services for this sector are offeredthrough the subsidiaries and affiliated com-panies of Animal Resources Bank, namelyLivestock Routes Company (provision ofwater for the cattle) and Animal ResourcesServices Company (import of the veterinarymedicines). The finance models used aremurabaha, musharakah and mudarabah. Atpresent, the bank is financing a large-scaleproject of building of a slaughter-house inOmdurman, worth around $9 million.

Animal Resources Bank also offers standardservices such as deposits (current, savingsand investment accounts), money transfersand correspondent operations to the publicand enterprises.

In the recent years, Sudan has experiencedgrowth of Islamic microfinance. Islamic mi-

Despite some deviation fromthe course along the way,Sudan became the only countrythat introduced reforms in theset direction more or lessconsecutively.

Sunset over Khartoum,Sudan


NEWHORIZON April–June 2009COUNTRY FOCUS

crofinance organisations face the sameproblems as the Sudanese banks: for exam-ple, an overwhelming majority of projects(up to 95 per cent) are financed usingmurabaha and only a tiny portion of ven-tures is based on musharakah.

Sudan-based financial institutions at presentconcentrate on the local market and theirexpansion abroad is unlikely. Moreover, thedomestic growth of Islamic banking is beingtapered. Thus, in 2007, following the civilwar, all banks operating in Southern Sudanwere told either to convert to the conven-tional way of conducting business or tocease their operations there. 15 banks thathad branches in the south chose the latteroption. By late February 2009, Faisal Is-lamic Bank, Omdurman National Bank andthe Agricultural Bank of Sudan announcedthe closure of their branches in the region,resulting in the capital outflow of over $45million. Conventional banks are taking theplace of their Islamic counterparts, witharound ten institutions now operating inSouthern Sudan, including Kenya Commer-cial Bank, Nile Commercial Bank and IvoryBank. The Bank of Southern Sudan regu-lates the activities of the financial sector inthe region.

The issue of banning takaful companies inthe south of the country was not as pressingas the prohibition of the Islamic banking ac-

tivity, mainly due to the lack of takaful op-erators in that region. The majority of the population there is not covered by Is-lamic insurance. However, it is clear that theban on Shari’ah-compliant finance in South-ern Sudan will affect any takaful operators

there, if for no other reason than without Is-lamic banks, the activity of Islamic insur-ance companies will be virtually impossible.

Everywhere else in Sudan, the insurance sec-tor must comply with Shari’ah, and it isstipulated in state legislation. The world’sfirst takaful company was set up in Sudan.

It is not a coincidence that the country be-came the birthplace of Islamic insurance.The afore-mentioned three states thatstarted Islamising their financial sectors inthe 1970s, sooner or later had to turn theirattention to takaful. In 1977, Faisal IslamicBank of Sudan initiated the idea of estab-lishing an Islamic co-operative insurancecompany. A group of experts, which in-cluded the representatives of the bank’sShari’ah supervisory board, drafted a mem-

orandum and internal rules and regulationsof the proposed company. In January 1979,the new venture, Islamic Insurance Com-pany of Sudan, obtained public companystatus.

The main reason for the emergence of Islamic insurance in Sudan was the banks’need to insure their operations according to Islamic principles. The issue was particu-larly acute in the sphere of marine insur-ance. Life insurance appeared later, but didnot manage to gain popularity (alongsideother savings-oriented products), due to thecountry’s rate of inflation of 50 per cent atthe time.

Traditionally, in the conventional commer-cial insurance company the shareholders arethe company’s owners. Therefore, all pro-ceeds and profits belong to them. In the caseof Islamic Insurance Company of Sudan, theshareholders retained the right to receiveprofits earned by the company. At the sametime, the surplus was to be distributed onlyamong the policy-holders in proportion to

their contributions. The policy-holders alsoobtained the right to a portion of the profitgained as a result of the surplus investment.Furthermore, the insured party could alsoparticipate in the decision-making processof the company. The general meeting of thepolicy-holders takes place once a year, todiscuss financial results and to elect a repre-sentative to a directors board (practically all boards of directors of takaful companieshave a number of representatives of the policy-holders community, usually up to fivepeople). The general meeting of the policy-holders can also provide recommendationsto the shareholders of the company.

Islamic Insurance Company of Sudan wasgiven a range of incentives, including tax ex-emption on all of its assets and profits. Also,the firm’s assets could not be confiscated or

The main reason for the emergence of Islamic insurance in Sudan was the banks’ need to insure their operations accordingto Islamic principles.

Khartoum


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 COUNTRY FOCUS

nationalised. The regulatory framework forconventional insurance companies did notapply to the Islamic Insurance Company of Sudan. At the time, Sudanese lawmakerssaw Islamic insurance as an alternative toconventional, and therefore takaful compa-nies were not to be regulated by the conven-tional legislation, still present at that time in Sudan.

It took a while for the legislation dealingspecifically with the takaful sector to be devised and implemented. The first refer-ence to Islamic insurance in the country’sregulatory documents appeared in the civilcode of 1983. By 1985, Sudan had fourtakaful operators.

In 1992, the state passed a decree on thecontrol and supervision of the insurance sector, which stated that all insurance opera-tors in Sudan must comply with Shari’ahprinciples. In 2001, more detailed legislationwas adopted, and in 2003 the governmentexpanded it further and passed the Law ofInsurance and Takaful. Thus, Sudan is theonly country today that has a completely Islamised insurance sector de jure.

Despite some deviation from the coursealong the way, Sudan became the only country that introduced reforms in the setdirection more or less consecutively. The development strategy encompassed thetransformation of the banking and insur-ance markets, as well as government bonds(the first Islamic bond was issued in 1999).However, none of the legislation coversSouthern Sudan, where, as mentionedabove, Shari’ah-compliant finance isbanned.

Of course, creating an Islamic economy in Sudan would be much more difficult if it hadn’t received foreign assistance. The International Monetary Fund (IMF) playeda significant role in supporting Sudan’s en-deavours. Amongst other things, the IMFspecialists helped to devise governmentbonds, based on the mechanism ofmusharakah.

In 1994, Khartoum Stock Exchange (KSE)was set up. Today, the exchange trades

shares of 54 Sudanese companies, nine in-vestment funds and twelve issues of govern-ment sukuk (Islamic bonds). KSE requiresfull information disclosure, which ensures ahigh level of transparency. The stock ex-change has its own Shari’ah board, whichscreens and approves the products prior totheir trading. Such a conservative approachprevents speculation. It is also worth notingthat the banks in Sudan do not lend moneyfor any speculative operations and financeonly certain projects. Shari’ah prohibitsshort-selling, as one cannot sell what onedoes not own.

In 2003, KSE launched the KhartoumIndex, developed with the assistance of theIMF. In five years it grew from 1000 to2500 points. Today, KSE is one of the topfive African exchanges – it ranks fifth, withthe volume of trading around $5 billion (not including sukuk trading). Due to theprohibition of speculation, the price of thelisted stock usually equals its nominal bookvalue. For that reason, the problems of theworld stock markets hardly affected KSE.

The listing rules of the exchange are stipu-lated in the Law of Khartoum Stock Ex-change of 1994. The trading process is stillmanual, but a move towards automation isscheduled for the first half of 2009.

Like in many other countries, sukuk havebeen one of the most popular financial instruments in recent years in Sudan. Sukuktrading accounts for a major segment ofKSE’s activity, with the choice of musha-rakah, ijara and government investment certificates.

Government musharakah certificates(GMCs) are also known as shahama bonds,and their existence in Sudan dates back to1999. These are short-term securities.Through shahama bonds the state borrowsmoney in the domestic market instead ofprinting more banknotes. After one year,holders of GMCs can either cash or extendthem. These bonds are backed by the stocksand shares portfolio of various companiesowned by the Ministry of Finance andtherefore are asset-backed. The profitabilityof GMCs can reach 33 per cent per annum

and depends on the financial results of thecompanies involved. Hence, the profit of aGMC is variable rather than fixed. The gov-ernment issues these bonds on a quarterlybasis and their placement is done veryquickly – in just six days. The major prob-lem is that the revenue from these securitiesis mainly used by the Sudanese governmentto cover the costs of civil service, defenceand so on, rather than for development purposes.

Government investment certificates (GICs)are medium-term securities, based on vari-ous contracts financed by the Ministry of Finance of Sudan via the istisna, murabahaand ijara tools. Issuance of these sukuk issimilar to the conventional securitisation,where the Ministry of Finance acts as theoriginator. GICs are based on a limited mudarabah, which means that the raisedmoney is invested solely in the projects stipulated in the original contract.

Ijara certificates of the Bank of Sudan(CICs) are backed by the buildings ownedby the central bank. According to the law,Sudanese banks must invest up to 30 percent of deposits in CICs. These bonds useijara as the method of financing. At the endof each term, an independent surveyor eval-uates the buildings.

Al-Mahdi’s tomb,Omdurman


NEWHORIZON April–June 2009COUNTRY FOCUS

All of the afore-mentioned sukuk can be in-vested in only by banks, and only banks arepermitted to resell them.

In October 2003, the Ministry of Financeset up a special committee to deal withsukuk, with the main task to research theways of effective use of the attracted funds.The advantage of issuing government sukukis that they are based on actual, tangible as-sets. Such instruments help to contain theinflation level (additional banknotes are notprinted, and therefore, the money supply isnot increased). In five years, Sudan’s Min-istry of Finance raised around $3.5 billionvia sukuk (about $600 million annually).

Although sukuk is still issued as a hard copyin Sudan, a depository has recently been setup and there are plans to automate theclearing process in the near future.

The reforms have also addressed the coun-try’s fiscal policy. However, the governmenthas not achieved the same results as in thebanking sector. In 1984, it passed a law onzakat and taxation. Unlike the precedinglegislation of 1980, where zakat was a vol-

untary act, the new regulation made itobligatory for all Muslim citizens of Sudanresiding in the country and outside it.

A decree in 1984 made void 19 laws thatregulated various taxes and levies, includingthe excise duty on alcohol, which made a substantial regular contribution to thebudget. Instead, the government introducedthree new taxes: stamp duty, social solidar-ity tax for local non-Muslims and foreignersresiding in Sudan, and development tax.The latter does not quite fit in the strategyof creating an Islamic financial system, as Shari’ah, whilst not having anythingagainst capital investment, strongly opposeshoarding.

Unfortunately, these reforms were ill-timed– in 1984 Sudan experienced one of theworst droughts in history. It transpired veryquickly that the results of the undertaken re-forms did not meet the expectations of thegovernment. By the end of the first fiscalyear since the introduction of zakat, thebudget received a considerably lower sumthan the anticipated $51.7 million. A fewweeks after the budget announcement, thegovernment was forced to introduce a valueadded tax (VAT) and social fairness tax.

The new government that came to power a year later, restored the previous tax policy,but zakat retained the status of a state fi-nancial levy. Today, the zakat system existsindependently from the rest of the fiscal system in Sudan. Zakat is paid prior to pay-ing taxes and from a fiscal point of view it is calculated as costs, i.e. the taxed sum isreduced by the amount of zakat payment.

Sudan tried to avoid the serious mistakesthat were made during tax reforms in Pak-istan and attempted to couple the zakat col-lection with the ease of the tax burdenrather than its increase. But the financial

levies left after the reform of 1984 were notsufficient for replenishing the budget andfulfilling a vital task of bridging the gap between the rich and the poor through fairredistribution of the resources within the society.

Many Muslim economists and jurists seezakat as the main tax in the fiscal system of a Muslim country. The rest of the taxes,both direct and indirect, should be just additional payments, delivering on targetsnot dealt with by zakat funds. The entire financial levy structure of a Muslim countryshould be built around zakat. Meanwhile, inSudan it turned out to be the exact opposite– zakat is de-facto taken outside the tax sys-

tem, thus depriving it of the opportunity tofunction as the core. Furthermore, the zakatcollection and distribution scheme is farfrom transparent, making it easy to abusethe system. At present, the government isworking on a new model of zakat alloca-tion, according to which the funds will beissued directly to the needy.

As for another important Islamic charity institution, waqf, it has not yet found any application in the Islamic economic infra-structure of Sudan. The majority of waqf endowments are circulated in the religion-related sector. Waqf is well established in theform of shops that sell gold items and otherarticles on the territory of the mosques.

Overall, Sudan’s Islamic economic system has proved to be effective. It has been devel-oping continuously since the establishment of the country’s first Shari’ah-compliant bank in 1977. However, whilst acknowledg-ing Sudan’s progress in creating an Islamic financial sector, many specialists point outthat the undertaken reforms brought thecountry political, rather than economic dividends. Its Islamic financial institutions in reality do not fulfil the role they should in a poor agricultural country. The over-whelming majority of Islamic banks tend toinvest in short-term commercial projectsusing murabaha, rather than in the indus-trial or agricultural sectors. 90 per cent ofinvestments of Sudanese banks are made inthe export and import operations, whilst theagricultural sector gets no more than four per cent.

Without doubt, the consistent approach of Muslim scholars and practitioners inSudan has helped the market to avoid a number of problems related to applying some questionable mechanisms, like reversemurabaha or tawaruq (a sale of a commod-ity to the customer by a bank on deferred payment at cost-plus profit). On the otherhand, Sudanese banks drastically lack cre-ativity, which would enable them to expandthe product range. In addition, the defi-ciency of competition from conventionalcounterparts adversely affects the process of introducing innovations to the market-place.

Creating an Islamic economy in Sudan would be much moredifficult if it hadn’t been for foreign assistance. The InternationalMonetary Fund (IMF) played a significant role in supportingSudan’s endeavours.

www.newhorizon-islamicbanking.com28 IIBI


Ahmad Chaudry explained the current status ofthe Islamic structured products industry andsuggested that the way forward for theseinstruments would be in offering unique,bespoke solutions matching investors’requirements with consideration not only toShari’ah-compliant contracts, but alsounderlying assets, strategy and wrappers.

Chaudry is a dynamic strategies structurer with the equities division at RBS GlobalBanking & Markets. His primary responsibilityinvolves the development of conventional andShari’ah-compliant trading algorithms for retail,private and institutional clients. An aerospaceengineer by academic background, Ahmad hasalso worked at HSBC Global Markets andHSBC Amanah.

The lecture was chaired by Iqbal Asaria fromAfkar Consulting Ltd.

January: The way forwardfor Islamic structuredproducts

Promoting Islamic finance

Structured finance has no particular defini-tion. Generally, it involves the combinationof various legal structures to achieve a certain solution or products matching in-vestors’ requirements. Normally, the startingpoint is to analyse the commercial objectivesof the investors. Once those are known andclearly set out, then it becomes a question of looking at the possible Shari’ah-compli-ant financing techniques and undertakingany necessary due diligence, which may extend to matters such as legal research, tax analysis and a review of underlying assets that are to be employed in Islamic financing or investments structures.

After describing the structured products,Chaudry mentioned that for centuries, Mus-lims all over the world have conducted com-

modity-based trades, financed ambitiousprojects and managed their physical/cashwealth in methods consistent with Islamiclaw. As a result, they have gained a highlysophisticated understanding of transactions,based on a prescribed set of Shariah-compli-ant contracts.

Islamic financial institutions employ a boardof Shari’ah scholars with the primary aim ofreconciling the Shari’ah requirements andthe law of the land in the business transac-tions. He pointed out that enormous devel-opment has been made in innovation ofvarious Shari’ah-compliant contracts used in Islamic structured products in the last25–30 years, for which credit goes to Shar-i’ah scholars, lawyers and practitioners.However, to achieve the true potential of Islamic structured products, there is a needto focus on the underlying assets and strat-egy for investment which received little orno consideration so far. In 1999, the DowJones Islamic Index was launched whichemploys various sectorial and financial cri-teria for the screening of stocks for Shari’ah-compliant investments. While it was a goodstart to facilitate Shari’ah-compliant invest-ment transactions, for Islamic product struc-turers it really did not meet the objectives oftheir clients, especially those who wanted toinvest in particular sectors or wanted totake a specific (either bullish or bearish)view on the stock. The problem is that afterbusiness and financial screening, the avail-able universe of stocks becomes very limitedand difficult to invest in due to liquidity(and sometimes foreign ownership issues)and it does not meet the requirements forbig investments. On top of this, hedging theinvestment becomes a real problem due tolack of active secondary market and widebid-offer spreads on such stocks.

Chaudry then proposed that the true poten-tial of Islamic structured products can onlybe realised if there is a shift from Shari’ah-compliant to Shari’ah-based structuringwhich is possible by employing ‘dynamicstructuring strategies’. He pointed out that

IIBI LECTURES

such strategies meet very well the investors’investment objectives and are gaining morepopularity. These strategies change the allo-cation (and weighting) of investment in vari-ous stocks over time. Then, he went on toexplain the concept of dynamic weightingand risk allocation in such structured prod-ucts with the help of an example of threestocks. If an Islamic investor has $1millionfor investment and based on his require-ments there are three Shari’ah-compliantstocks available to invest in, the weightingof investment in each stock will be moni-tored and adjusted continuously, either on a weekly or monthly basis, after looking atthe pattern (upside as well as down side) inthe respective stock movements. If in theportfolio of three stocks, A, B and C, aweighting of 50 per cent was assigned tostock A, and 25 per cent to stock B and Crespectively, and the value of stock C appre-ciates in a week’s time, then weighting ofstock C and A will be adjusted after oneweek to match the investor’s requirements.He emphasised that it is the shift in selectionof underlying assets, strategy of investmentsand wrapper used for such products thatwill bring credibility to Islamic structuredproducts and make them different from con-ventional ones.

After the presentation, participations raisedvarious questions about the costs of employ-ing dynamic strategies, why bid-offerspreads are so wide in Shari’ah-compliantstocks and the risk management techniqueswhich may be used in dynamic structuringstrategies.

January lecture


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 IIBI LECTURES

Following the credit crunch, investors arenow looking for alternatives to conventionalbanking methods which led to the financialcrisis in the first place. Many have arguedthat global economies are ‘broken’ and new more ethical practices must be sought.Islamic bankers have taken this opportunityto highlight the benefits of Islamic financewhich has been shielded to some extent fromthe troubles that conventional banks havefaced.

Ms Raza started off by examining the Islamicequity markets, using the Dow Jones IslamicIndexes for October 2008 and comparingthem to their conventional counterparts. Thetable above shows that there was not a vastamount of difference between the two:She then went on to look at other asset

classes in the Islamic world, such as theproperty and sukuk markets, which have suffered in the credit crunch in similarways to their conventional counterparts.From this, Ms Raza concluded that al-though the Islamic sector has been shieldedto some extent from the problems of theglobal economy, there is no doubt that Is-lamic investors have still suffered heavily.

She then went to ask: the global economy is in meltdown... what’s next? The answerlies in more ethical banking practises. MsRaza went on to make a comparison be-tween Islamic finance and ethical invest-ing. She discussed the overlaps – such asscreening out companies whose activitiesare seen as harmful to society – and thedifferences, such as the ban in Islamic finance on short-selling and investing inconventional finance/banks. Furthermore,Ms Raza discussed what each type of investment practice can learn from theother.

She then discussed the use of the term‘Shari’ah-based’ investing; which has beenused quite frequently within the industry in the last few years. Such investing willonly be possible when Islamic banks stopreverse engineering conventional productsand when product innovation comes fromwithin the Islamic industry. Although theterm is quite well known to Islamic bank-ing practitioners, there are not many prac-tical examples of Shari’ah-based productsavailable. Therefore, a case study was used to illustrate the product Ms Raza isworking on, dubbed Africa Transforma-tional Agri Fund. She claims it is one of the closest products to the true ethos of Islamic finance available in the markettoday.

Ms Raza then talked about AIFM and itsorigins. The concept was the brainchild of Cru and Africa Invest chairman, JonMaguire, who was moved to do somethingabout the plight of orphan children in someof the world’s poorest countries. She wenton to discuss the company’s investment philosophy which believes in investing inhuman endeavour and human capital ratherthan capital markets.

AIFM currently has one fund which investsinto commercial agriculture in sub-SaharanAfrica, working on large commercial farmsand with smallholder farmers. It is now dueto launch a second fund in May 2009, toreplicate the model in another seven sub-Sa-haran countries. The fund has multiple aimsincluding increased food security, povertyand hunger alleviation, achieving the UN’sMillennium Development Goals as well asoffering attractive returns to investors.

Ms Raza used this case study to demon-strate how a Shari’ah-based product canachieve multiple bottom lines for the in-vestor but also contribute positively to society. The fund aims to return 15–25 percent per annum, showing that investmentreturns need not be compromised in orderto achieve social returns. AIFM has strict

Naveen Raza, head of Islamic finance at AfricaInvest Fund Management (AIFM), explored theappeal of Islamic finance to ethical investorsand used a case study to illustrate an exampleof an Islamic investment with ethical andsocially responsible appeal.

Ms Raza specialised in Islamic finance bybecoming the very first graduate on the HSBCAmanah Graduate Programme. At HSBC, sheworked in various departments including wealthmanagement, global onshore banking andHSBC Amanah private banking. She iscurrently head of Islamic finance for AIFM, partof Cru Investment Management, a UK-basedfirm. In her latest role, Ms Raza is working onthe first Shari’ah-compliant African agriculturefund, which aims to help alleviate poverty insub-Saharan Africa while also offering attractivereturns to investors.

The lecture was chaired by Mohammed Amin,partner, PricewaterhouseCoopers LLP and amember of the IIBI editorial advisory panel forNewHorizon.

February: The appeal ofIslamic finance to investorsseeking ethical alternatives

Region Islamic Conventional

Global (DJIM Titans vs. Global Titans)

-24.05% -25.51%

Asia Pacific (DJIM Asia Pac Titans vs. DJ Asian Titans)

-28.34% -28.23%

Europe(DJIM Europe Titans vs. DJ STOXX 50)

-27.33% -30.78%

US(DJIM US Titans vs. DJ Industrial Average)

-22.07% -24.65%

February lecture

www.newhorizon-islamicbanking.com30 IIBI


policies in place to ensure that the African farmers are being treated fairly. According toMs Raza, the motivation behind launchingthe fund was to assist the rural poor of sub-Saharan Africa to help themselves out ofpoverty as well as become contributors toglobal food security.

She concluded her presentation by statingthat there are always risks associated in starting new venture, especially when invest-ing in developing countries. However, Islamicinvesting is about sharing risk – not shyingaway from it. ‘Intelligent risk mitigationstrategies are needed in order to effect suchinvestments,’ she stated. ‘This requiresthought, innovation and to some extent aleap of faith – but that is what Islamic fi-nance is all about.’

After the lecture, participants raised ques-tions about the competition in this area of investment especially when countries likeChina and the UAE were making investmentin some African countries to ensure theirfood security; how AIFM will use returns if in excess of 20 per cent and how invest-ment risks are mitigated arising from less developed legal and regulatory institutionalframework and, in some cases, political instability.

IIBI LECTURES

and has worked with the leading Islamicfinance advisory team at Dar Al Istithmarbefore moving on to BMB Islamic, aninternational Shari’ah consultancy firm. Shehas extensive experience of working on Islamicretail and investment banking structures(including structured products) andaccompanying legal documentation and hasworked extensively with European and MiddleEast fund managers.

Haliza Abd Rahim, head of projectmanagement at BMB Islamic, discussed the highly controversial issue of ‘Shari’ah-compliant derivative instruments with emphasison future contracts’ and why their trading wasproblematic in Shari’ah, and explored thepossibility of developing Shari’ah-compliantfutures.

Ms Abd Rahim holds an LLB degree from theUniversity of Nottingham and is a dual-qualifiedsolicitor (Malaysia and the UK). She started hercareer at one of the first law firms in Malaysiato focus on and specialise in Islamic banking

March: Is there any futurefor Shari’ah-compliantderivatives?

Derivatives are financial instruments thatderive their value from underlying assets.There are many derivatives products avail-able in the conventional financial markets;most common are futures, swaps, forwardsand options. Negative connotations of ex-cessive risk taking or gambling are attachedto derivatives, especially after the hugelosses incurred by AIG, brought on by itsextensive use of credit default swaps, butthese products were originally developed toprovide low-cost protection, or hedging,against unwanted market trends.

Ms Abd Rahim pointed out that Shari’ah-compliant funds are seeing strong demandand leading to an increased number of Islamic fund managers. Islamic fund managers are restricted from carrying out conventional derivatives trading as it con-travenes Shari’ah. She argued that in theprevalent market conditions, there is a case for allowing Islamic fund managers,sovereigns and Islamic financial institutions access to Shari’ah-compliant hedging techniques. A challenge for the Islamic finance industry is to further probe Shari’ah-compliant derivatives for risk-mitigating strategies.

Although Shari’ah-compliant versions ofthese instruments do exist in some cases, the liquidity associated with these markets is considerably reduced compared with theconventional alternative. Traditionally,scholars saw these instruments as specula-tive and a form of gambling. They are nowincreasingly being accepted as a hedgingtool. She mentioned that the most commonShari’ah-compliant derivative structures arethe wa’ad followed by the arboun (resem-

bling a conventional call option) and thenthe salam (resembling a forward sale).

She then discussed the elements of conven-tional derivatives that contravene the principles of Shari’ah. A basic principle of Shari’ah is that there must not be anygharar, or excessive uncertainty, in relationto any trade. After examining the conven-tional future trading sequence, she ques-tioned whether current futures tradingcarries excessive risk or uncertainty anymore than other forms of financial trade.Another fundamental Shari’ah rule is thattrade should happen at spot with bothcounter-values being exchanged at spot. Ifthe seller does not own the asset at the timeof effecting the trade and subject to certainexceptions, this breaches the fundamentalShari’ah rule that one must not sell whatone does not own. Another issue related tothe lack of possession is where there is a resale. In practice, futures trading works on the principle of margin accounts, effec-tively allowing traders access to interest-based leverage which would breach Shari’ahprinciples.

At the close of her presentation, Ms AbdRahim raised points about the regulation of Islamic futures trading; could Shari’ah-compliant futures trading be tailor-made to be less uncertain than its conventionalcounterpart? To remove access to leverageand involvement of riba (interest) she con-sidered whether it would be possible for afutures trade to require a 100 per cent de-posit, and whether this would address theissue of speculation.

The mission of the IIBI is to be a centre of excellence for professional education,training, research and related activities, to build a wider knowledge base anddeeper understanding of the world of

finance promoting the Islamic principles of equity, socio-economic justice and

inclusiveness. The Institute holds regularlectures on topical issues, delivered by

industry experts. For information onupcoming lectures and other events,

please visit the IIBI’s website:www.islamic-banking.com



Mohammad Ali Qayyum, director generalof the Institute of Islamic Banking and In-surance (IIBI), has recently visited India atthe invitation of Mehroof Manalody, man-aging director of G-TEC Computer Educa-tion, for the launch of Islamic financecourses at the company’s headquarters inCalicut, India.

The courses have been developed by the IIBIand the Association of Business Executives(ABE) and offered by the Association ofBusiness Practitioners (ABP). G-TEC is thetraining division of the Glosoft Technologies(P) Limited based in India. It is one of thelargest computer education networks with238 training centres in both local and inter-national markets, including Saudi Arabia,Kuwait, Dubai and Iran.

The launch ceremony was attended by na-tional and international delegates includingorganisations such as the ABE, British Com-puter Society, International Association ofBook-keepers and De Montfort Universityfrom the UK. V. P. Abdul Kareem, chairmanof G-TEC, hosted the event which was at-tended by over 300 representatives from G-TEC centres. The launch of Islamic financecourses in India will give G-TEC students anopportunity to build their knowledge andskills for a career in the growing field of Is-lamic finance worldwide. The courses in-clude the Concepts and Principles of IslamicEconomics and Islamic Finance.

On successful completion of both pro-grammes, candidates will be eligible for ex-emption from the first two modules of theIIBI’s Post Graduate Diploma (PGD) courseon their enrolment, subject to fulfilling otherentry criteria. Upon completion of the PGD,students can enter the Masters Programmeat the University of Durham, a highlyranked UK-based university.

G-TEC is now accredited by the Institute todeliver the Islamic finance courses and along-term association with G-TEC is an op-portunity for the IIBI to raise the awareness

IIBI director general visits India

IIBI NEWS

of the industry for the large Muslim popula-tion in India, as well as specifically thosewho wish to study in the UK or consider acareer abroad. One of the key challengesfacing Islamic finance today is the availabil-ity of qualified human capital. G-TEC’s of-fering will certainly help in bringing a poolof talented people to the Islamic finance in-dustry through its well-established networksand state of the art IT facilities. It will en-able potential students to achieve an inter-

national qualification in Islamic finance andfacilitate their career building in this sector.

Andy Eames, ABP’s representative, re-quested Qayyum to present the plaque from the ABP to Manalody confirming theaccreditation given to G-TEC. This was fol-lowed up by an award ceremony. Qayyumwas requested to present nine laptops andtwelve camcorders to students whose nameswere drawn from a list of entries.

World Bank Treasury senior advisor visits IIBI

Hennie van Greuning, senior advisor inthe World Bank Treasury, visited the IIBIin early March 2009. He was received byMohammad Ali Qayyum, director gen-eral of the Institute, along with Moham-mad Shafique, programme developmentco-ordinator. Qayyum briefed him on theIIBI’s efforts to expand its courses in Is-lamic banking and also introduce newcourses on takaful. Van Greuning is asso-ciated with Islamic finance efforts at theWorld Bank and has co-authored a num-ber of publications.

He expressed his interest in assisting theIIBI with the development of courses in Islamic banking, in particular the lessonsdealing with Islamic accounting, risk andgovernance. Van Greuning is a CFA char-terholder and a chartered accountant. Heworked in an international accountingfirm and a central bank before moving onto the World Bank. Together with his col-league, Zamir Iqbal, van Greuning has recently co-authored ‘Risk Analysis for Islamic Banks’, which was well-receivedby the industry’s practitioners.

Launch of Islamic finance courses at G-TEC


NEWHORIZON April–June 2009IIBI NEWS

GK Partners, advisers to socially responsi-ble business, and the IIBI are to organiseone-day workshops on ‘Access to IslamicFinance’ at The British Library. The lasttwo workshops, held in December 2008and February 2009, were very successful.

The next workshop will be held on 27thApril 2009, followed by one every twomonths until end of 2009. The pro-gramme explores Shari’ah-compliant fi-nancing options available to small andmedium size enterprises (SMEs) in the UK.This sector of the economy is badly af-fected by the current financial crisis, due to the decrease or non-availability of busi-ness credit from conventional banks.

Islamic finance workshops to be held at the British Library

The workshops start with an introductionto Islamic financial principles compared and contrasted with conventional finance.The main prohibitions in Islamic financesuch as riba (interest), gharar (excessive risk or uncertainty) and maysir (gambling)along with other prohibited activities arediscussed.

The workshops draw attention to the strongparallels between ethical or socially respon-sible investments and Islamic investments.In both cases, business, financial and socialscreening criteria are used to exclude com-panies which contravene the underlying eth-ical and Shari’ah principles. The main typesof equity investments, such as musharakah

and mudarabah, and debt-based financialstructures such as murabaha, ijara, salamand istisna are introduced. To reinforceunderstanding of Islamic contractual struc-tures and the state of the sector in the UK,participants are given role-play exercisesfor them to analyse and explain the struc-tural nature of the different types of Is-lamic commercial and personal financeproducts available in the UK.

The final session of the workshop broadlyoutlines the key principles for preparingbusiness plans suitable for raising financefrom Islamic financial institutions. Eachworkshop has a maximum of 20 partici-pants.

Dr Asyraf Wajdi Dato’ Dusuki, head of re-search affairs at International Shari'ah Re-search Academy for Islamic Finance (ISRA),has recently called on the IIBI and met withMohammad Shafique, IIBI programme de-velopment co-ordinator.

ISRA head of research visits IIBI

Dr Dusuki was accompanied by Dr Humayon Dar, CEO of BMB Islamic.Shafique shared with Dr Dusuki the Insti-tute’s history and current activities.

In turn, Dr Dusuki explained the reasons for establishing ISRA which was set up last year with the support of Bank NegaraMalaysia (the central bank of Malaysia) and aims to be the premier Shari’ah re-search centre in Islamic finance promotingapplied research. It will also act as a repository of knowledge for Shari’ah views or fatwas, and undertake studies on contemporary issues in the Islamic finance industry.

The discussions covered the avenues of co-operation between ISRA and IIBI and the possibility of working together in un-dertaking research related programmes in Shari’ah-compliant finance in the future.

AAOIFI directorcalls on IIBI

Khairul Nizam, director at the Accountingand Auditing Organisation for Islamic Financial Institutions (AAOIFI), has recentlyvisited the IIBI and Mohammad Shafique,the Institute’s programme development co-ordinator.

They discussed areas of mutual interest.Nizam briefed Shafique about the AAOIFI’scontinuing efforts in developing accountingand Shari’ah standards. Shafique updated Nizam on the Institute’s efforts to expandits activities, in particular introducing newcourses and increasing the number of train-ing workshops from previous years.

The IIBI and AAOIFI have a memorandumof understanding (MOU) in place to supporteach other and the Institute conductsAAOIFI’s Certified Islamic Professional Accountant examination for the UK and European candidates.

Dr Humayon Dar (left), Mohammad Shafique (centre), Dr Asyraf Wajdi Dato’ Dusuki (right)


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 IIBI NEWS

IIBI awards post graduate diplomas

IIBI’s Post Graduate Diploma (PGD) coursein Islamic banking and insurance, offeredsince 1994, is highly regarded worldwide.UK-based Durham University has accordedthis course recognition as an entry qualifica-tion for the University’s Research MA aswell as its modules on Islamic economicsand Shari’ah-compliant finance.

To date, students from 77 countries have enrolled in the PGD course. In the period of December 2008 to March 2009, the following students successfully completedtheir studies:

❏ Abid Mahmood, teacher, S. K. B. Zayd Arab Pakistan School, UAE

❏ Amine Imghi, director, project office, BNP Paribas, US

❏ Bilal Rasul, registrar (mudarabah), Securities & Exchange Commission, Pakistan

❏ Don Brownlow, banking systems consultant, UK

❏ Imran Mahmood, senior financial analyst, GMAC LLC, US

❏ Mansoor Ahmed Qazi, Pakistan

❏ Mohamed-Umer Esmail, UK

❏ Mohd Nazir Bin Abu Hassan, UK

❏ Meera Mohideen Sahib Quvylidh, head of operations, Amana Investments Limited, Sri Lanka

❏ Muhammad Ismail, financial controller, Sony Marketing Europe, UK

❏ Muhammad Owais, senior accountant, International Turnkey Systems (ITS), UAE

❏ Rahul Sharan, India

❏ Rehab Lootah, senior vice president, Mawarid Finance, UAE

❏ S. M. Fazly Marikar, Sri Lanka

❏ Salah Aldin Alkhair Abdulmageed, senior legal advisor, Arab National Bank, Saudi Arabia

❏ Syed Farhan Shah, UK

❏ Usman Tariq Khan, centralised operations controller, United Bank Limited, Pakistan

❏ Zoeb Adamali, senior consultant, business process transformation, Oracle Financial Services Consulting, India.

I have done research on Islamic banking for my MBA dissertation before starting this course, but Ifound the material of this course very detailed andcomprehensive, particularly Module VI on takaful. As there has been very little literature available ontakaful products compared to other Islamic financialproducts, I was pleased that the module material isvery comprehensive and understandable.

After studying this course, I’ve become very informed about Islamic banking and itsproducts. The IIBI’s administration has been very helpful and supportive on all queriesand issues. I have already recommended this course to my university fellows. I wishthe Institute the best of luck.

Syed Farhan Shah, UK

Bilal Rasul Imran Mahmood Abid Mahmood Rehab Lootah

Muhammad Ismail Usman Tariq Khan Don Brownlow Zoeb Adamali


NEWHORIZON April–June 2009IIBI WORKSHOP

Islamic project financing On the 29th January 2009, around 30 delegates gathered at the British Bankers’ Associationoffices in the heart of the City of London to attend a one-day workshop organised by the IIBI.

The number of attendees indicates the growing importance that Islamic financingis taking in the world of project finance.Delegates travelled in from as far a field asthe UAE, Poland and the Maldives. Practic-ing lawyers made up around 30 per cent of the attendees, with bankers making up 35 per cent, so it was always going to bean intensive hands-on workshop.

The speakers were also all active partici-pants in the field of project finance and their experience showed in the depth of the presentations. These were not academic aspirations as to what may be offered andwhat could happen in the future, but, in-stead, showed the real-life practical contri-butions that were being made to majorinfrastructure projects through the use of Islamic finance. The topics discussed at theworkshop ranged from introductory con-cepts as to what constitutes Islamic projectfinance, what instruments and structures are used and why, through to specific casestudies of how several real-life projects had been put together, the problems en-countered and overcome, as well as discus-sions on how these arrangements can besyndicated.

Naturally, the istisna and ijara contracts received much attention but murabaha,musharakah and mudarabah, along withsukuk structures, were also discussed in detail with the practical implications of real-life decisions being demonstrated.

Mufti Muhammad Nurullah Shikder, headof Shari’ah advisory and compliance atUK-based Gatehouse Bank, discussed thewider issues of what constituted Islamicproject finance but pointed out other usefulpractical aspects. Richard T de Belder, awell-known friend of the IIBI, and a part-

ner at Denton Wilde Sapte, shared histhoughts on various Shari’ah-compliant fi-nancing structures. Those thoughts werebased on his experience of setting up someof the structures used in significant deals,such as the convertible mudaraba sukuk forAldar Properties (a real estate developer inAbu Dhabi) to build tower blocks.

Other sukuk issues were examined byFarmida Bi, partner at Norton Rose, wholooked at the types of sukuk that are usedfor project finance and showed the struc-tures behind some of the recent deals. Thetechniques and detailed structures for the$134 million Bahrain Financial Harboursukuk were examined, and some of the keyissues and hurdles encountered in the deal

were discussed. This included an assessmentof the concept and compliance of advancerentals, a topic that had also been discussedby de Belder. The details of the firstmusharakah sukuk, the 2005 Dubai MetalsCorporation that used the musharakah tobuild two towers, were also discussed, aswas the $1.1 billion Sorouh Real Estatesukuk in Abu Dhabi that closed in Augustof 2008. The size of some of these projectsand the need to share the risks has broughtabout the need for syndication.

Allen Merhej, a colleague of Ms Bi at Nor-ton Rose, talked about the similarities anddifferences of mudarabah and wakala whenenabling syndication, and the issues in-volved in mixing conventional debt with Islamic financing. Complexities of choosingthe governing law when entering into inter-national agreements and syndications andthe problems associated with that choicewere discussed, culminating in a review ofthe Shamil versus Beximco court of appealrulings.

Many of the day’s concepts were pulled together when Merhej looked at the detailof the Queen Alia International Airportproject, a 25 year concession for the reha-bilitation, expansion and operation of theairport in Amman, Jordan. This was a public-private partnership that used dualtranche conventional and Islamic financingin Jordan’s biggest project finance deal andprivate sector investment. The Islamic portion was based on an istisna manufac-turing agreement and an ijara mawsufa fi al-dhimah (Islamic forward lease) thatraised $100 million.

The next IIBI workshop will be held on16th April 2009 and will look at sukuk,their applications and challenges.

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with Islamic-centric banks or banks thatseek to offer Islamic products and serviceswould be seen as a means to enhance com-munity development activities in such un-banked segments.

Finally, from a macro-economic perspective,the United States, like other western coun-tries, has every interest in attracting Gulf-based capital that has built up over the lastfive years due to the bullish oil market. Ac-commodating Islamic finance may be oneway to entice this capital to come back tothe country after some left post-9/11.

One significant misunderstanding that is de-terring some Gulf-based Islamic institutions



Gordon Brown (UK’s prime minister) orKitty Ussher (formerly a Treasury ministerand now parliamentary under secretary atthe Department of Work and Pensions) inrecent years – where London has been de-clared to be ‘the next global hub for Islamicbanking’. The important thing to note, however, is that just because US officialsdon’t offer the same type of direct declara-tions, it does not mean that they are not in-terested in accommodating the growth ofthe industry. The reality is that US regula-tors have significant constitutional, policyand economic reasons to accommodate thegrowth of Islamic banking in the country.From a constitutional perspective, US regu-lators are (and will continue to be) involved,in part, because it is their duty as public servants under the US Constitution to makesure they accommodate the free exercise ofreligion, even as it relates to banking prac-tices. There is a limit to this accommoda-tion, however, in that the constitution alsoprohibits the promotion of a particular religion over another by a public official oragency. This limit may explain why we don’tsee the same type of direct encouragementfrom US officials like the ones witnessed inthe UK.

From a policy perspective, US regulatorsmay have an interest in accommodating thegrowth of Islamic banking as a means ofproviding banking services to the unbankedpopulation. For example, many Muslims inthe country currently do not bank at a con-ventional bank because doing so violatesShari’ah restrictions on the receipt and pay-ment of interest. US regulatory involvement

The question of whether US regulators willbe accommodating towards the growth ofIslamic banking is now moot. Today, theUnited States is home to at least nineteenproviders of Islamic banking products andservices, including retail banks, investmentbanks, mortgage companies, investment advisors and community-based financeproviders (see the chart on pp38–39). Withthe estimated number of Muslims living inthe country ranging from three to eight mil-lion (based on various private surveys) itnow appears that real market demand andviability for offering Islamic banking prod-ucts and services in the US either exists or isbeing developed and penetrated by theseearly-to-market providers.

Given these positive factors and the push by Gulf-based Islamic institutions to estab-lish a strong presence in the United King-dom, their absence from the US is puzzling.One explanation is that Gulf-based Islamicinstitutions are most likely suffering from a mirage of barriers and a set of misunder-standings when it comes to entering the USmarket.

One significant mirage relates to a misper-ception that US regulators are not interestedin the growth of Islamic banking. Unfortu-nately, many believe that they are resistanttowards the growth of the industry in theUS, just because the country’s officials arenot as vocal or direct about expressing theirinterest as their counterparts are in the UK.Many Gulf bankers have noted that theywould like to hear the same type of ‘cheer-leading’ speeches like the ones made by

Islamic banks in the United States:breaking through the barriers Abdi Shayesteh, senior associate with the King & Spalding law firm in New York and a memberof the Middle East and Islamic finance practice group, takes a look at what the US Islamicfinance market has to offer.

ANALYSIS

Abdi Shayesteh,King & Spalding

While initially the analyst reports weremixed concerning how Islamic financial institutions will weather the current finan-cial crisis, it is now clear that they, while not immune from the crisis, are being lessimpacted than conventional institutions.This is because Islamic financial institutions,by their nature, have not invested in toxicassets or derivative structured instrumentsthat many conventional institutions investedin. While some Islamic banks in the MiddleEast have recently taken a hit due to theirover-investment in the Gulf real estate mar-ket, on the whole, many were not as im-pacted because they either took a morediversified approach or they have enoughcash to absorb the temporary losses. Let’snot forget that many Gulf-based Islamic financial institutions also benefited from afive-year windfall due to the bullish run inthe oil markets.

On the demand side of the equation, thepicture looks quite encouraging, as econom-ically distressed western countries have not been shy at all recently about using theunique healthy position of Gulf-based Is-lamic institutions to their advantage. For example, in November last year, the USTreasury department hosted a seminar inWashington DC, called ‘Islamic Finance101’. A large number of Islamic scholarsand banking professionals from around theworld were invited to this event to engage in discussions focused on the provisioningof Islamic finance products in the US. Just a few weeks prior to this seminar, the USTreasury department deputy secretary,Robert Kimmit, travelled to the Middle Eastand publicly expressed the US’s positive and accommodating attitude towards thedevelopment and growth of the industry inthe country.

Given this continued spirit of accommoda-tion in the current US economic environ-ment, Gulf-based Islamic financialinstitutions, if they are as healthy as theysay, are perhaps at the most optimal posi-tion they have ever been concerning theprospects for growing their industry in theUS. It is encouraging to see that more in-vestors are waking up and taking advantageof this opportunity today.


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 ANALYSIS

from entering the US market relates to thecomplexity of the US regulatory regime. Sofar, the investors launching Islamic financeoperations in the UK predominantly had todeal with one regulator, the Financial Ser-vices Authority (FSA), which is the coun-try’s primary regulator of banks, insurancecompanies, securities dealers and other fi-nancial institutions. Unfortunately, manyGulf bankers mistakenly think that theyonly need to deal with one regulator whenit comes to managing their entire charteringprocess in the United States as well. But thisis not the case. Depending on the types ofproducts and services a prospective bankwould offer, an applicant would likely haveto deal with a variety of US regulators, in-cluding the Federal Reserve, the Office ofthe Comptroller of the Currency, the Fed-eral Deposit Insurance Corporation, statebanking authorities, the Internal RevenueService and the Securities Exchange Com-mission. This misunderstanding has oftenled to confusion and frustration as well as alot of wasted time and resources for manyprospective applicants, sometimes leading to unnecessary suspicion and a mistakenperception that the US authorities are beingdeliberately unaccommodating and not in-terested in facilitating any Islamic banking-related applications. In the light of this, itwould be prudent for the applicants to firstengage with the right advisors that havedeep experience in understanding bothShari’ah law and US laws and bank regula-tions. Equally important, applicants shoulddevelop a thorough business plan early onin the process that identifies the range ofproducts and services they want to offer, asthis will ultimately dictate the relevant au-thorities to work with.

Another area of misunderstanding relates tothe actual time and investment involved inlaunching a Shari’ah-compliant financial in-stitution in the United States. A conven-tional bank application there may typicallytake up to a year and a half to be approveddue to the various regulatory approvals thatmay be needed. Launching a bank that hasShari’ah components may take up to twoyears or more depending on the types ofproducts and services the institution plansto offer. Many Middle East investors have

a difficult time understanding this and areoften discouraged when they learn about thepotential lengthy timeframes. Of course, noapplication is the same and there are noexact timescales to go by, but many areoften surprised that any application couldtake longer than six months. If it took theIslamic Bank of Britain in the UK almosttwo years to get all of the right approvals inplace, why should it take less time in theUS?

Fortunately, we are finally beginning to see more potential investors from the Gulfregion getting a deeper understanding of the situation and gaining the necessaryknowledge to overcome the mirage of barri-ers and take advantage of the upcoming op-portunistic US market. Over the last fewmonths, US legal and consulting firms havewitnessed a surge in interest from Gulf-based institutions and individual investorswanting to venture into the United States tomake Shari’ah-compliant investments or tooffer Shari’ah-compliant banking productsand services — both at a retail and whole-sale level. There is an increasing realisationthat the perceptions about the US regulatoryenvironment regarding Islamic banking weresimply incorrect. This, of course, is attribut-able to the fact that the country’s Islamic finance market is now more populated withplayers and offerings than it used to be.More and more investors are also recognis-ing the opportunities that will exist for themin the American market by mid to end of2009. Many are seeing this downturn as an opportunity to utilise the down time tobuild the appropriate infrastructure, obtainthe necessary (and time consuming) regula-tory approvals, and establish the importantrelationships with the right advisors, serviceproviders and managers, so that all the rightpieces are in place by the time the US econ-omy picks up.

Given the positive financial position thatmany Islamic financial institutions (includ-ing Gulf-based ones) are reporting to havein this current global financial crisis (ascompared to their conventional counter-parts around the world), the timing couldnot be more perfect for them to take the in-dustry to the next level in the United States.


NEWHORIZON April–June 2009ANALYSIS

FINANCIALINSTITUTION

GEOGRAPHIC PRESENCECOMPANY STRUCTURE/

FUNDING SOURCEPRODUCTS OFFERED

STRUCTURESUSED

BANKS

University Bank

• Headquarters: Detroit, Michigan• Shari’ah-compliant products offered in: California,

Connecticut, Idaho, Illinois, Maryland, Michigan, New Jersey, New York, Ohio, Pennsylvania, Virginia

• State chartered bank• Financing products are offered

through its wholly owned subsidiary, University Islamic Financial

• Residential real estate financing• Deposit product• Money market product• Mutual funds

• Murabaha and ijara • Profit sharing

deposits• Mutual funds

offeredby HSBC Amanah

Devon Bank

• Headquarters: Chicago, Illinois• Shari’ah-compliant products offered in: Alaska,

Alabama, Arizona, Arkansas, California, Colorado,Connecticut, Florida, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, North Carolina, North Dakota, New Hampshire, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington DC,Wisconsin, Wyoming

• State chartered bank• Financing products are offered

through its wholly owned subsidiary

• Residential real estate financing• Commercial real estate financing• Real estate construction financing • Lines of credit• Cash management• Business & trade financing• Institutional deposit products• Investment products• Trust and advisory services

• Murabaha and ijara• Musharakah• Profit sharing

deposits• Mutual funds

offered by third party providers (Amana, Azzad, Iman, see below)

Broadway Bankof Chicago

• Headquarters: Chicago, Illinois• Shari’ah-compliant products offered in Illinois only

Community bank• Residential real estate financing• Commercial real estate financing

Ijara

RomAsia Bank Headquarters: Monmouth Junction, New Jersey State chartered bank To be determined To be determined

Lincoln StateBank


State chartered bank Residential real estate financing Ijara

Mutual Bank• Headquarters: Chicago, Illinois• Shari’ah-compliant products offered in Illinois only

State chartered bankCommercial real estate financing Murabaha

Cole TaylorBank


State chartered bank Commercial real estate financing Murabaha and ijara

MORTGAGE COMPANIES

Zayan Finance• Headquarters: Chicago, Illinois• Shari’ah-compliant products offered nationwide

• Non-bank mortgage company• Funding provided by foreign

investorsCommercial real estate financing

Diminishingmusharakah and ijara

GuidanceResidential

• Headquarters: West Falls Church, Virginia• Shari’ah-compliant products offered in: California,

Connecticut, Washington DC, Florida, Georgia, Illinois, Indiana, Massachusetts, Maryland, Michigan, Minnesota, Missouri, North Carolina, New Jersey, New York, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Washington

• Non-bank mortgage company• Funding provided by Freddie

Mac and/or foreign investorsResidential real estate financing

Diminishingmusharakah

Lariba –AmericanFinanceHouse/Bank ofWhittier

• Headquarters: Pasadena, California• Shari’ah-compliant products offered nationwide

• Non-bank mortgage company• Brokers/offers its financing

products in some states through its affiliate, Bank of Whittier

• Funding provided by Freddie Mac, Fannie Mae and/or Bank of Whittier

• Residential real estate financing• Commercial real estate financing• Home construction• Business & trade finance• Current account/deposit product

Ijara plus diminishingmusharakah,musharakah andmurabaha

Samad Group• Headquarters: Ypsilasti, Michigan• Shari’ah-compliant products offered in Michigan

onlyNon-bank mortgage company Residential real estate financing Ijara


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 ANALYSIS

FINANCIALINSTITUTION

GEOGRAPHIC PRESENCECOMPANY STRUCTURE/

FUNDING SOURCEPRODUCTS OFFERED

STRUCTURESUSED

COMMUNITY-BASED FINANCING PROGRAMMES/ORGANISATIONS

City of Minneapolis– AlternativeFinancingProgramme

Headquarters: Minneapolis, Minnesota

• Government sponsored programme for small business owners

• Co-financing arrangements with other community providers (i.e. African Development Center, or other banks)

• Real estate construction financing

• MicrofinancingMurabaha

Minnesota HousingFinance Agency,State of Minnesota

Headquarters: Minneapolis, Minnesota

• Government sponsored programme for low income participants

• Funding provided by State of Minnesota

• Low-income residential real estate financing; wholesale provider to Devon Bank’s residential real estate financing products

Murabaha

AfricanDevelopmentCenter

Headquarters: Minneapolis, MinnesotaNon-profit community developmentcorporation

• Microfinancing• Residential real estate financing• Residential mortgage broker for

Devon-Minnesota Housing Finance Agency Project

Murabaha

NeighborhoodDevelopmentCenter – Riba FreeProgramme

Headquarters: Minneapolis/St. Paul,Minnesota

Non-profit community developmentcorporation

MicrofinancingMurabaha andmusharakah

World Relief Headquarters: Nashville, Tennessee

• Non-profit community development corporation

• Funding provided by Office of RefugeeResettlement in the US Department of Health and Human Services

Microfinancing Murabaha

Ameen HousingCo-operative

Headquarters: Palo Alto, California • Funding provided by co-op and investors

Co-op residential financingprogramme

Co-operativefinancing structurewith incomedistributed asdividends

INVESTMENT ADVISORS/MUTUAL FUND COMPANIES

Saturna Capital Headquarters: Bellingham, Washington Investment advisor, asset managerPublic investment funds (Amana Mutual Funds)

Azzad AssetManagement

Headquarters: Falls Church, Virginia Investment advisor, asset managerPublic investment funds (Azzad Mutual Funds)

North AmericanIslamic Trust/AlliedAsset Advisors

Headquarters: Burr Ridge, Illinois Investment advisor, asset managerPublic investment funds (The Iman Fund)

INVESTMENT BANKS

Arcapita Headquarters: Atlanta, Georgia Subsidiary of Arcapita Bank (Bahrain)• Private equity• Real estate focused investments• Venture capital

Innovest Capital Headquarters: Cleveland, OhioSubsidiary of Gulf Investment House(Kuwait)

Real estate focused investments

TransOcean Group Headquarters: Boston, MassachusettsSubsidiary of Gulf Investment House(Kuwait)

Private equity

UIB Capital –Chicago

Headquarters: Chicago, IllinoisSubsidiary of Unicorn Investment Bank(Bahrain)

Private equity

Overland CapitalGroup

Headquarters: Boston, MassachusettsInvestors include Gulf-based financialinstitutions and investors

• Real estate focused investments• Equipment leasing• Asset management



tainable public debt? In view of the incredi-bly high liquidity injection by major centralbanks, is money supply growth out of con-trol? What will be the crisis’ impact ongrowth and employment? What will be itsfiscal and inflationary cost? While preciseanswers are not possible, the present crisishas already slowed down economic growthin industrial countries, triggered food riotsand energy protests in many vulnerablecountries, increased unemployment and im-posed extraordinary fiscal costs. Notwith-standing its devastating consequences, the crisis has made the quest for financialstability a pressing and fundamental issue in economics and finance. Such was thepurpose of the G20 Summits in November2008 and April 2009.

Financial instability has been a recurringphenomenon in contemporary economichistory, affecting countries with varying intensity. The most enduring crisis was theGreat Depression of 1929–33. Eminenteconomists who lived through the GreatDepression fought very hard to establish abanking system capable of achieving andpreserving financial stability. Their propos-als became known as the Chicago ReformPlan, as they were elaborated by somemembers of the economic faculty of theUniversity of Chicago. Although unawareof Islamic finance, their proposals were anatural restatement of some basic pillars of Islamic finance. The Chicago Plan basi-cally divided the banking system into twocomponents: a depository component with100 per cent reserve requirement and an in-vestment component with no money con-

In contrast to conventional finance whichhas periodically experienced crises, Islamicfinance is considered as a stable financialsystem capable of promoting sustainedgrowth of income and employment. Pro-hibiting interest, speculation, and debt trad-ing, Islamic finance establishes one-to-onemapping of financial and real sectors of theeconomy. That is, it is based on real tradeand production activities. The financial sec-tor cannot expand beyond the real economy,and is immune to unbacked credit expan-sion and speculation that are characteristicsof conventional finance and that have desta-bilised even the most sophisticated and com-plex financial systems.

Conventional finance is inherently unstable

The financial crisis that broke out in August2007 is considered to be the worst in thepost-war period. Representing the collapseof trillions of dollars of fictitious credit de-rivatives and the meltdown of uncontrolledcredit growth, the scope of the crisis couldreach unmanageable size. The crisis hasshown that advanced financial systems arevery vulnerable. Massive bankruptcies wereavoided only at the cost of gigantic govern-ment bailouts. Capital markets are frozen.Consequent de-leveraging led in turn to anunexpected crash in stock markets, wipingout trillions of dollars in share values and inretirement investment accounts.

Economic uncertainty has never been ashigh. Has the crisis been correctly tackled orhas it only been made worse? Could af-fected industrial countries grow with unsus-

Resilience and stability of Islamic financeAbbas Mirakhor, former executive director at the International Monetary Fund (IMF), andNoureddine Krichene, economist at the IMF and former advisor at the Islamic DevelopmentBank in Jeddah, examine the issue.

tracts and no interest payments, where deposits were considered as equity sharesand were remunerated with dividends, andwhere assets’ and liabilities’ maturities werefully matched. Independently of this plan,Muslim economists reached the conclusionthat if Islamic finance were to achieve sta-bility, the banking system had to be organ-ised along a similar ‘two-tier’ structure.

In view of its devastating effects, consider-able effort has been devoted to explainingthe causes of financial instability and toprescribe remedies that would reduce riskof deep contraction in output, large-scaleunemployment, bankruptcies, dramatic fallin real incomes and social hardship. Theclassical economists attributed financial instability to money and credit expansion.They considered excessive credit expansionand contraction to be caused by deviationof the money interest rate from a non-ob-servable natural interest rate which equili-brates real savings and investment in theeconomy. The natural rate of interest wasdefined in many ways; mainly, it was seenas a rate of profit, productivity of capital in roundabout production, or marginal efficiency of capital.

Irving Fisher, a prominent American econo-mist of the Great Depression era, stronglyargued that two dominant factors were responsible for each boom and depression:over-indebtedness in relation to equity,gold, or income which starts a boom, and deflation consisting of a fall in assetprices or a fall in the price level which startsa depression. He noted that over-investment

ACADEMIC ARTICLE


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 ACADEMIC ARTICLE

and over-speculation were often important,but they would have far less serious results if they were not conducted withborrowed money. That is, over-indebted-ness may reinforce over-investment andover-speculation.

Another American economist, HymanMinsky, considered that conventional finance dominated by interest-based debtcontracts is inherently unstable. This asser-tion is based on a construct known as Financial Instability Hypothesis (FIH),which posits that stability is inherently unsustainable. A fundamental characteris-tic of a conventional financial system, according to Minsky, is that it swings be-tween robustness and fragility and theseswings are an integral part of the processthat generates business cycles. In the early1990s, Minsky addressed financial innova-tion, which he considered to be evolving at a fast pace and to be driven by fiercecompetition among financial institutionsfor profits. In his view, the proliferation ofinnovations in deregulated capital marketswould lead to a huge inverted credit pyra-mid based on a thin real basis, i.e. over-leverage. Any small fall in expected cashflows would send this pyramid crumbling.

Central banks’ cheap money policy is a key factor in a major financial crisis. No-tably, the present crisis was caused bymajor central banks deliberately setting interest rates at record lows irrespective of risk. As a consequence, total credit ex-panded at an unsafe high rate of twelve per cent per year in the United States dur-ing 2001–08. This phenomenal creditgrowth was at the cost of creditworthinessand erosion of underwriting standards.George Soros wrote, ‘when money is free,the rational lender will keep on lendinguntil there is no one else to lend to’.Rapidly expanding money and credit com-bined with an ideologically-based fierce de-regulation movement which began inthe early 1980s in industrial economiesand continued throughout the next twodecades. It put at high risk the financialstability of these countries and, as the re-sult of rapid financial globalisation, therest of the world as well.

Islamic finance is inherently stable

The sources of financial instability in theconventional system, i.e. interest, unbackedcredit, abundance of liquidity and highlyleveraged financial transactions, as well asopportunities for speculation are by andlarge absent in an Islamic financial systembasically because of absence of interest-based debt contracts and the 100 per centreserve requirement that protects the na-tions' payment system, thus ensuring the inherent stability of this system.

In the Quran and Sunnah, Islamic financehas always been conceived as existingwithin an institutional framework com-posed of rules of behaviour such as sanctityof contracts, strict rules of conduct for allmarket participants, including rules regard-ing distribution and redistribution of in-come, and wealth resulting from productionand sale of goods and services which guar-antee equitable and just distribution in thesociety as well as rules regarding gover-nance, transparency, cooperation and socialsolidarity. In such a system, finance will beguided toward employment creating invest-ment and wealth creation.

In Islamic finance there are no risk-free as-sets and all financial arrangements arebased on risk and profit-and-loss sharing(PLS). Hence, all financial assets are contin-gent claims and there are no debt instru-ments with fixed or floating interest rates.Investment accounts could be conceived asnon-speculative equity shares. The rate ofreturn on financial assets is primarily deter-mined by the return to the real sector, andtherefore in a growing economy, Islamicbanks will always experience net positivereturns.

Financial intermediation in Islam is differ-ent from that in a conventional system.Banks do not contract interest bearing loansand do not create and destroy money. Theyparticipate directly in production and tradeoperations on a PLS basis. Banks do not actas simple lenders; they have to be directlyinvolved in trade and investment opera-tions, and assume direct ownership of realassets.

There is no credit creation out of thin air in Islamic finance. Under conventional frac-tional reserve banking, deposits at one bankcan be instantaneously loaned out or usedto purchase a financial asset and become reserves and a basis for a new loan at a second bank. The credit multiplier is deter-mined by the reserve requirement and couldbe high. In case of securitisation and over-leverage, the credit multiplier is theoreticallyinfinite, leading to violent asset and productprice fluctuations. Such a phenomenon doesnot exist in Islamic banking because of the100 per cent reserve requirement. Depositsintended by their owner for investment pur-poses find their way directly as investmentin trade and production activities to createnew jobs as well as lead to additional flowsof goods and services. New money flowsarise from the proceeds of sales of goodsand services. Money expansion is deter-mined by the savings ratio in the economyand the money multiplier is very small, en-suring price stability. Investment is equal tosavings, and aggregate supply of goods andservices is always equal to aggregate de-mand. The liabilities of the financial institu-tions are covered by tangible real assets thatare owned directly by the institution. Theyare not covered by financial assets. Risks forIslamic financial institutions are mitigatedas they relate essentially to returns from in-vestment operations and not to the capitalof these institutions.

Architecturally, an Islamic banking system is composed of two tiers: amanah or safe-keeping plus payments, transactions serv-ices, and transfer activities. In this tier,banks are required to keep 100 per cent reserves against deposits which remainhighly liquid.

The second tier is composed of investmentactivities whereby deposits are longer-termsavings and placed for the sole purpose ofinvestment in trade, leasing, and productiveactivities in agriculture, industry, and serv-ices. The most important characteristic ofthis activity is that it is immune to unbackedexpansion of credit. Returns to investedfunds arise ex-post from the profits or lossesof the operation, and are distributed to de-positors as shareholders of equity capital.


NEWHORIZON April–June 2009ACADEMIC ARTICLE

The expansion of finance is fully determinedby real growth in the economy and not byunstable speculative finance or money cre-ation by financial institutions. Accordingly,an Islamic system would not be expected toexperience deep boom and busts cycles.Moderate and brief booms and recessionmay be generated by good crops, productiv-ity, technical change, or by adverse shocks.They cannot be generated by the financialsystem itself. Equilibrium in an Islamiceconomy thus structured will be stable andthe rate of return to the financial sector willbe fully aligned with the profit rate in thereal sector of the economy.

Risks in Islamic finance consist of creditrisk, market risk, displaced commercial risk,operational risk, and governance risk. Whilethe individual financial institutions engagedin investment activities face these risks, inand of themselves these are not systemic anddo not impact the overall stability of the fi-nancial system, as this system is immune tospeculative mania, liquidity expansion, andinstability of returns. The latter is due to thefact that there is no value or maturity mis-matching between assets and liabilities ofthe institutions. If asset prices decline, sowill the liabilities, unlike what happens in asystem dominated by interest-based debtcontracts.

Many types of financial transactions and instruments are excluded from Islamic finance, particularly interest rate-basedbonds, securities, finance based on securiti-sation of fictitious assets, speculative fi-nance, hedge funds, and consumer financethat is not backed by real assets. In all ofthis type of finance, either the acquired as-sets are financial papers, or loans that arenot backed by real assets and do not con-tribute to generate real activity and income.

In Islamic finance, the central bank has thesole monopoly for creating money. An inter-est rate cannot be used as a policy instru-ment. The central bank does not refinancebanks as in conventional banking. The cen-tral bank has to apply a quantitative ceilingon money aggregates. Such policy when andwhere implemented has been effective inmaintaining financial stability and preclud-

ing speculative booms and inflation. Moneyinjection occurs through the central bankbuying foreign exchange, gold, or non-interest bearing government debt, possiblyindexed to gold, a commodities basket, or a portfolio of real assets created by the government.

Conclusion

History is replete with episodes of instabilityof the conventional financial system. Promi-nent economists have argued that such asystem is inherently unstable and prone tosevere financial crisis. They have consideredthe interest rate to be a cause of large fluctu-ations in asset and commodity prices, asource of financial instability and cumula-tive inflation, and detrimental to long-termeconomic growth. They have called for a separation of deposit and investmentbanking.

Islamic finance prohibits interest and specu-lation and engages directly in trade and investment operations. Unbacked expansionof credit is preempted, and banks cannotinitiate and accentuate a speculative process.Credit is based on real savings. Hoardingfor the sake of earning interest does not take place. Savings can only earn a return if directly invested in employment creatingactivities. Not only does hoarding earn no

monetary reward, there is also a direct dis-incentive for doing so since whatever ishoarded is subject to zakat which will con-tinuously erode its base. In such a system,no excess purchasing power can be createdby a stroke of the pen. Money flows arisefrom sales of goods and services and transitthrough the banking system for paymentsor investment purposes. Islamic banks donot compete to issue loans to borrowers forliability management purposes arising frommismatched maturities between assets andliabilities; they compete only for real invest-ment opportunities; their resources are rein-vested in real activities. Given the stabilityof its financial system and resilience tomonetary shocks, an Islamic economic sys-tem would experience sustained economicgrowth and avoid detrimental impacts onsocial justice since inflation cannot be usedto tax creditors and wage earners in favourof debtors and speculators. Although re-forms of the conventional system along thelines comparable to Islamic finance systemwere strongly advocated by some leadingeconomists in the 1930s in the aftermath ofthe Great Depression, these reforms werenot fully implemented. The intensity of re-cent financial instability has renewed callsfor such reforms which many consider asthe only path in the quest for stability. Thechart below contrasts distinctive features ofconventional and Islamic finance.

Contrast of two financial systems

Conventional finance

❏ Interest and interest-based transactions.❏ Deposits and loans.❏ Banks create and destroy money.❏ Asset-liability mismatch, illiquid.❏ Money multiplier depends on reserve ratio,

very high; infinite with securitisation.❏ Speculation, a casino, debt trading. ❏ Interest rate not related to real economy,

high price distortion.❏ Social inequity: inflation tax, redistributive

issues, food riots.❏ Highly cyclical: booms and busts,

uncertainties, unpredictable growth.❏ Massive bankruptcies, contagion, bailouts.❏ Interest rate policy, highly destabilising.

Islamic finance

❏ No interest and interest-based transactions. ❏ Equity shares and ownership of real assets in

investment projects.❏ Banks do not create or destroy money.❏ No asset-liability mismatch, liquid.❏ Money multiplier depends on the savings ratio,

very low.❏ No speculation, no debt trading.❏ Profit rate determined by real economy,

no price distortion. ❏ Social equity: no inflation tax, no redistribution.❏ Stable economic growth, predictable.❏ No systemic bankruptcies, no bailouts.❏ No interest policy, money aggregates are

used, highly stable.


NEWHORIZON Rabi Al Thani–Jumada Al Thani 1430 BOOK REVIEW

Risk Analysis for Islamic BanksAuthors: Hennie van Greuning and Zamir IqbalPublisher: The World Bank (2008)ISBN-13: 978-0-8213-7141-1

Islamic finance today is a global phenomenon reaching beyond traditional markets. The book has fifteen chap-ters and aims to fill a knowledge gap for risk management in Islamic finance and discuss the issues that have notbeen adequately addressed by others in this field. The authors deal extensively with a wide range of issues in onepublication, which assists in understanding the complexities of Islamic banks. It considers the theory and prac-tice of Islamic financial intermediation and matters of corporate governance that can affect the welfare of morethan 20 per cent of the current world population. The chapter on risk management provides a comprehensive ex-planation of the framework for risk analysis, the balance sheet and income statement structures as well as look-ing at the operational risk that include credit risk, liquidly and market risk and risks specific to Islamic banking,in particular reputational risk. A chapter is devoted to governance and regulation dealing with issues in Shari’ah governance, trans-parency and data quality, capital adequacy and Basel II. The last chapter deals with future challenges covering areas for improvementand some recommendations. The book is recommended reading for all practitioners as well as regulators in the Islamic financial sector.Hennie van Greuning is a senior advisor in the World Bank Treasury. Zamir Iqbal is also serving at the World Bank in Washington andhas published several articles in reputed Islamic finance magazines and presented papers at international forums. The book has 309pages including appendices, references and index.

Islamic Capital Markets: Products, Regulation & DevelopmentEdited by Syed Salman AliPublisher: Islamic Research and Training Institute (IRTI) of Islamic Development Bank (2008)ISBN: 978-9960-32-179-0

The global financial markets are in a crisis and could take a lesson from the products and strategies of an evolv-ing Islamic capital market. The Islamic financial system’s ability to remain largely unscathed by the difficulties affecting the conventional international financial system may see greater interest in Islamic finance playing amore prominent role in the global financial sector. This publication is a collection of articles covering develop-ments in the important and growing segments of Islamic finance and has 21 chapters divided into three parts.The book combines the developments in Islamic capital markets and analyses the opportunities and challengesposed, in particular relating to product development and strategies, regulatory framework and policies, as well as comparative development in various countries. This publication edited by Salman Syed Ali (who is also work-ing at IRTI) has 451 pages including tables and glossary, and is an important contribution to the debate on issues of policy and a good read for all those interested in Shari’ah-compliant finance.

Financial Risk Management for Islamic Banking and Finance Authors: Ioannis Akkizidis and Sunil Kumar KhandelwalPublisher: Palgrave Macmillan (2008)ISBN-13: 978-0-230-55381-1

Risk management in banking and finance is one of the greatest challenges that the world faces today, and thisapplies equally to the market growth in Islamic financial products. Islamic banks face similar but not entirelyidentical risks to the conventional banks. This book analyses in detail the risk management issues for Islamicbanks in seven chapters. Both authors appear to have done extensive research to write this book, which presentsa common framework of how to efficiently manage the risks faced and minimise the overall degree of financialrisks pertinent to the Islamic financial services industry. This book would be a good addition to the library of those working in the Islamic financial sector. Ioannis Akkizidis works as a risk management consultant atFRSGlobal, and Sunil Kumar Khandelwal was head of risk management, Middle East, for IRIS integrated riskmanagement AG (now part of FRSGlobal). The book has 220 pages including bibliography and index.


NEWHORIZON April–June 2009RATINGS & INDICES

Dow Jones Islamic Market World IndexBelow is a chart of the performance of Dow Jones Islamic Market World Index, provided by Dow Jones Indexes,the first index provider to launch Shari’ah-compliant indices in 1999. Over the course of 2008, the Dow JonesIslamic Market World Index was down -38,87%, compared to its standard counterpart, the Dow Jones WorldIndex which was down -42,85% over the same time period. Also listed is the performance of the respectiveindustry indices for both indices in 2008. More information can be found on www.djindexes.com

Industry IndexDow Jones Islamic Market World Index

Dow Jones World Index

Basic Materials -51,90% -52,90%Consumer Goods -38,13% -36,28%Consumer Services -28,62% -35,25%Financials -36,01% -54,18%Health Care -21,44% -23,03%Industrials -44,77% -45,18%Oil & Gas -39,79% -41,29%Technology -43,96% -45,26%Telecommunications -34,71% -36,25%Utilities -42,04% -31,87%

Dow Jones Islamic Market World Index

Dow Jones World Index

1 Exxon Mobil Corp. 4,09% Exxon Mobil Corp. 2,01%

2 Procter & Gamble Co. 1,84% Procter & Gamble Co. 0,91%

3 AT&T Inc. 1,70% AT&T Inc. 0,84%

4 Johnson & Johnson 1,68% Johnson & Johnson 0,83%5 Microsoft Corp. 1,55% General Electric Co. 0,80%

Dow Jones Islamic Market World Index vs. Dow Jones World Index

Source: Dow Jones IndexesAll data is as of December 31st 2008

Industry performance in 2008: Top 5 components and their weights, as of December 31st 2008:


CALENDAR

April

Diary of events endorsed by the IIBIMay

14–15: 4th Annual World Takaful Conference (WTC 2009), DubaiConference to chart the future direction of the market, showcase innovations andaddress the key enablers to boost growth in the international takaful market.Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]

16: Sukuk, Their Applications and Challenges, LondonOne-day workshop to focus on this increasingly important asset class, its developments, structures, applications and challenges. Contact: Mohammad ShafiqueTel: +44 (0) 20 7245 0404Email: [email protected]

20–21: 2nd International Islamic VentureCapital & Private Equity Conference, Kuala LumpurConference to discuss Islamic alternative investments and strategic funds, as well asthe role of Shari’ah-compliant finance in social and economic development of Islamiccountries.Contact: Khairul SabudinTel: +603 2031 1010 ext 532Email: [email protected]

25–26: 5th Annual World Islamic Funds &Capital Markets Conference (WIFCMC2009), BahrainSupported by the Central Bank of Bahrain,conference to review which markets andasset classes offer the most upside in a challenging global landscape.Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]


August

7–9: Structuring Innovative Islamic Financial Products, Cambridge, UKThree-day residential workshop to focus ondifferent types of innovative structures, theirunderlying techniques and legal issues, aswell as new developments in this field. Contact: Mohammad ShafiqueTel: +44 (0) 20 7245 0404Email: [email protected]

November

3: 4th World Islamic Infrastructure FinanceConference (WIIFC 2009), DohaConference to explore the latest develop-ments and opportunities for the next gener-ation of Islamic finance structures on aglobal scale.Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]

December

6–8: 16th World Islamic Banking Conference (WIBC 2009), Bahrain Conference to discuss the key issues, devel-opments and challenges of Islamic financeworldwide, with special focus on Italy,China, Japan, Singapore, France and the UK.Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]

Throughout 2009, IIBI will organise a number of training workshops to build the skill base and share ideas among practitionerswithin the Islamic finance industry. The objective of the Institute’s training is to fill the human resource gap and to enhance the

professional skills of personnel who are either interested in building their careers or already involved in the Islamic finance sector.Training programmes are delivered by experienced professionals; the number of participants is kept small to ensure the interactive

environment and provide a practical learning experience for the participants with the help of suitable case studies. For more information about upcoming programmes, please visit: www.islamic-banking.com

Dubai

February 2010

8–9: 6th Annual Middle East InsuranceForum (MEIF 2010), BahrainForum to focus on unlocking new growthopportunities in the Islamic and conven-tional markets of the Middle East, and assess key regional industry trends. Contact: Naomi Njoroge Tel: +971 4 343 1200 Email: [email protected]


NEWHORIZON April–June 2009GLOSSARY

arbounA non-refundable down payment for attaining the rightto buy goods at a certain time and certain price in future;if the right is exercised, it becomes part of the purchaseprice.

baiSale.

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

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

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

HajjAn annual pilgrimage to Mecca and other holy places.The fifth pillar of Islam, Muslims have the duty toperform Hajj at least once in their lifetime.

halalActivities which are permissible according to Shari’ah.

Hanafi School of law Islamic school of law founded by Imam Abu Hanifa.Followers of this school are known as Hanafis.

haramActivities which are prohibited according to Shari’ah.

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

ijara mawsufa fi al-dhimahShari’ah-compliant forward lease.

IjmaConsensus of Shari’ah scholars on certain matters.

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

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

murabahaA contract of sale between the bank and its client for thesale of goods at a price plus an agreed profit margin forthe bank. The contract involves the purchase of goodsby the bank which then sells them to the client at anagreed mark-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 areentitled to participate in the management but notnecessarily required to do so. The profit is distributedamong the partners in predetermined ratios, while theloss is borne by each partner in proportion to hiscontribution.

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

nisabExemption limit for the payment of zakat. It is differentfor different types of wealth.

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

sadaqahCharitable giving.

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

salatThe five daily prayers, practised by Muslims insupplication to Allah s.w.t.

Shari’ahRefers to laws contained in or derived from the Quranand the Sunnah (practice and traditions of the ProphetMuhammad).

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

SunnahIt refers to the sayings and actions attributed to ProphetMuhammad (PBUH).

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

tamlikTransfer of ownership of a property.

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

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

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

wakalaA contract or agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee. The agent (wakil) isallowed to generate an income for himself in excess ofthe minimum agreed upon returns as agreed with rab-al-maal (investor of the capital).

waqfAn appropriation or tying-up of a property inperpetuity so that no propriety rights can be exercisedover the usufruct. The waqf property can neither besold nor inherited nor donated to anyone.

zakatA religious obligation on Muslims to pay a prescribedpercentage of their wealth to specified categories intheir society, when their wealth exceeds a certain limit.Zakat purifies wealth. The objective is to take away apart of the wealth of the well-to-do and to distribute itamong the poor and the needy.

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Documents

SUDAN: FORGOTTEN FINANCE ZAKAT: FINANCE OR FAITH? …data.islamic-banking.com/NH/PDF/171.pdf · global perspective on islamic banking & insurance issue no. 171 april–june 2009 rabi