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NEWHORIZON Muharram–Rabi Al Awwal 1428

GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 163JANUARY–MARCH 2007

MUHARRAM–RABI AL AWWAL 1428

BAHRAIN: MIDDLE EASTERN PROMISE

INNOVATIONS IN ISLAMIC FINANCE

ISLAMIC BANKING AND TAKAFUL IN RUSSIA

SUKUK: MANAGING LIQUIDITY ISSUES

TAKAFUL AT BANK AL JAZIRA

CREDIT RISK MANAGEMENTIN ISLAMIC FINANCE

PUBLISHED SINCE 1991

2 IIBI www.islamic-banking.com

NEWHORIZON January–March 2007

38 The role of the sukuk in managing liquidity issuesAn interview with Stella Cox, managing director of the UK-based DDGI Ltd,one of the leading Islamic asset investment companies.



Features

Regulars

12 Islamic banking and takaful in Russia: What the future holds

Today’s challenges and the future prospects of theindustry in the world’s largest country with over 15 million Muslim population.

22 The London Islamic Financial Services Summit

Discussing London’s role in the Islamic banking industry.

40 Innovations in Islamic financeDr Humayon Dar, CEO of Dar Al Istithmar, gives his view on what is the nextbig thing in Shari’ah-compliant finance.

25 Bahrain: Middle Eastern promiseA country focus on Bahrain’s financial services marketand its main regulator, the Central Bank.

32 First line of protectionBank Al Jazira introduces takaful ta’awuni, the first andonly Islamic protection savings plan in Saudi Arabia.

CONTENTS

12

32

43 APPOINTMENTS

44 ACADEMIC ARTICLEThe time value of money in Islamic banking.

48 DIARY

50 GLOSSARY

23 RATINGS AND INDEXES

36 ACADEMIC ARTICLECredit risk management in Islamic finance.

42 ANALYSISHealthy Islamic banking sector reachesnew heights in Pakistan.

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

18 IIBI NEWS

19 IIBI LECTURESJanuary, February and March lectures reviewed; April lecture preview.



Editor’s Note

EXECUTIVE EDITORMohammad Ali Qayyum,Director General, IIBI

EDITORTanya Andreasyan

CONTRIBUTING EDITORSTom AlfordDon BrownlowJames Ling

IIBI EDITORMohammad Shafique

IIBI EDITORIAL PANELMohammad AminStella CoxDr Humayon Dar Iqbal KhanRichard ThomasDr Imran Ashraf Usmani

DESIGN CONSULTANTBecky Ellison

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SUBSCRIPTION Institute of IslamicBanking & Insurance (IIBI)12–14 Barkat House116–118 Finchley RoadLondon NW3 5HTUnited KingdomTel: +44 (0) 207 245 0404Fax: +44 (0) 207 245 9769Email: [email protected]: www.islamic-banking.com

©Institute of Islamic Banking and InsuranceISSN 0955-095X

Views expressed in this magazine are notnecessarily those of the Publisher

NewHorizon is possibly the oldest magazine published inEnglish on Islamic banking and insurance. It has been inpublication for over 15 years, and is the official journalof the Institute of Islamic Banking and Insurance (IIBI),an independent not-for-profit organisation. Founded in London back in 1991, it is now one of the world'sleading independent education, training and researchorganisations dedicated solely to the promotion andimplementation of Islamic finance in the UK andglobally.

NewHorizon publishes in-depth articles on variousaspects of Islamic banking and insurance and alsoreports on events and developments from around the world. The magazine enjoys a wide readership in around 105 countries.

Over the years the look and contents of NewHorizon have evolved to reflect the times. IIBI is now working with IBS Publishing, a UK-based company, to producethe magazine, with the first issue of this quarterly journalcovering the period from January to March 2007.

NewHorizon embraces challenges facing the Islamic financial sector right across the globe, from the developments in the well-established Islamic banking markets in the Middle East, through thegrowing markets of Pakistan, UAE and the UK, to theattempts to introduce this industry in Russia. Africandevelopments continue at pace with Kenya becoming one of the latest countries to provide its citizens withIslamic financial services.

The range of such services continues to expand. Shari’ah-compliant credit cards and personal loans are amongstthe newcomers. Sukuk (government bonds) are becomingmore prominent in the Islamic banking market. Thisissue of NewHorizon also tackles the subject of takaful(Islamic insurance) with further in-depth analysis of this matter to come in our future publications.

Whether you are already an Islamic finance specialist,about to enter the world of Islamic banking andinsurance or just interested in this subject, we hope youfind the magazine interesting, cognitive and educational.

Mohammad Ali QayyumDirector General IIBI

Some previousNewHorizon issues

EDITORIAL



Islamic bank, Masraf Al Rayan,and real-estate developer, Qatari Diar, have signed aMemorandum of Understandingworth $2.25 billion for thedevelopment of the LusailCorniche Project in Qatar.Under the terms of theagreement, Masraf Al Rayanwill take the primary role inarranging and managing themobilisation of funds to financethe project. However, the bankis not only limited to a financialrole within the project, it willalso be working with QatariDiar to develop the projectthrough an investment fund.

The agreement was signed by Dr Hussain Al-Abdulla,chairman and managing directorof Masraf Al Rayan, and NasserAl-Ansari, CEO of Qatari Diar

(above). Both men were happywith the agreement and saw it asa step forward for their relativeinstitutions. Al-Abdulladescribed the agreement as onethat will ‘strengthen our positionin the local market and help usto achieve our goals of being a truly progressive force in the banking world’. Al-Ansarisaw the deal as ‘part of ourstrategy in developing projects in partnership with and support

of local financial institutions’.

Masraf Al Rayan is the onlyfully-fledged Islamic commercialand investment bank in Qatar,and has an entirely Shari’ah-compliant portfolio of products.This deal will come as nosurprise; the bank has beenheavily involved with thefinancing of new real estatedevelopments in Qatar since itsinception in October last year.

Bank and real-estate developer sign Memorandum of Understanding

The Lusail Corniche Project ispart of the waterfront district of the Lusail development.Consisting of two small islands,the Corniche district will havearound two and a halfkilometres of waterfrontpromenade made up of retailand restaurant outlets. QatariDiar, a real-estate companywholly owned by the QatarInvestment Authority, is thecompany behind the Lusaildevelopment. The waterfrontdistrict looks to be a populararea for the developers; recentlyall 46 plots within the districtwere sold to investors withinhours of going on sale.Development of the CornicheProject is planned to start by the end of this year, with acompletion date set for the end of 2009.

The government of Abu Dhabiis setting up an Islamic bankwith $1.1 billion in authorisedcapital. The new bank, calledAl Hilal Bank, will operateunder the provisions of IslamicShari’ah while rendering allmodern services required forthe business sector, as well asinvestment in the industrial,agricultural and real estatesectors.

The bank will be aimed at theprivate sector. The Founders’Committee says, ‘the bank has

been designed to cater toproject-related requirementsand provide credit facilities for the private sector, whichwill be the backbone of theeconomic development of the country’.

The bank will deal withcorporate and retail banking,consultancy services, fundsmanagement and will investcustomer funds in Shari’ah-compliant financialinstruments.

Government of Abu Dhabisets up Al Hilal Bank

Maybank has been ranked as thelargest Islamic banking serviceprovider in the Asia Pacificregion by The Asian BankerIslamic Bank 40 survey. Theannual study identifies the 40key players in the Asia Pacificbanking sector, and ranks themaccording to the size of theirShari’ah-compliant products.

The inaugural study has revealed that Maybank, which is not a standalone Islamic bank,currently holds over $6.4 billionin assets through its Islamicbanking window. The largest

standalone Islamic bank wasBank Islam Malaysia; this hadabout half as many Shari’ah-compliant assets as Maybankand was ranked number two in the region.

The study also revealed thatMalaysia was leading the wayfor Islamic financial servicesindustry in the region. It showed the country to have 17 institutions which hold 73 per cent of the top 40’s total assets.

Maybank tops TheAsian Banker survey

NEWS



UK to become global centrefor Islamic finance

Three banks in dual tranche deal

Plans to establish the UK as aleading global centre for Islamicfinance have been announced by economic secretary, Ed Balls(below). In his speech to theEuromoney Annual IslamicFinance summit, Ballsannounced plans for newlegislation to facilitate theissuance and trading of sukuk,and guidance on diminishingmusharakah and takaful.

The market for Islamic finance products in the UK hasshown strong growth since thegovernment started shaping thetax and regulatory framework,and it hopes that these newmeasures will help to makeBritain the financial partner of choice for Muslim countriesall over the world. Balls said, ‘As Islamic finance grows inimportance, we want to seemore of this business coming to the UK.’

In his speech, Balls announcedthat the Treasury will set out in the Budget what the taxframework for sukuk will looklike, and that detailed legislationwill follow in the Finance Bill.He also indicated that guidanceon how diminishing musharakahproducts will be treated for

Global House to establishIslamic bank in Syria

The Bahrain-based investmentbanking group Global House isto launch a new Islamic bank inSyria. The new bank will be setup with an initial capital of$500 million; so far half of thisfigure has been put up by thebanking group. Dr Ahmed BinHussein Al-Dawsary, chairmanof Global House, says the group‘will be a partner in the newbank’ with the initialcontribution that it makesdependent on other keyshareholders.

The group has been studying theSyrian market for well over a

year, since the country becamemore open to internationalinvestors. It concluded that it would be feasible for GlobalHouse to invest in more thanone Syrian city. Al-Dawsarysays, ‘The creation of an Islamicbank in Syria had for a longtime been on the cards for thegroup, as the country itself is yetto benefit from Islamic finance’.

The group plans thatpreliminary operations for the bank will begin in the nextfew months, depending oncompletion of the requiredpaperwork.

Emirates Global Islamic Banklaunched in Pakistan

A new six-branched Islamicbank has been set up inPakistan. Emirates GlobalIslamic Bank Ltd (EGIBL) is adedicated commercial Islamicbank and, according to presidentand CEO Syed Tariq Husain, it plans to become ‘a leadingIslamic commercial bank inPakistan’.

The bank aims to capturemarket share by offeringShari’ah-compliant competitivebanking products. EGIBL willoffer Shari’ah-compliant savingsand current accounts, as well asterm deposit schemes, and trade,ijara, murabaha, and consumerfinancing.

The bank, which is sponsored byleading investors from the UAE

and Saudi Arabia, has openedwith five branches in Karachiand one in Lahore. However, itis looking to extend its branchnetwork to gain access to morepeople. EGIBL chairman, SheikhTariq Bin Faisal Al-Qassimi says,‘The Pakistani market offerstremendous potential and thefinance sector has been doingexceptionally well. We areconfident we can build upon thework already being done here todevelop the sector even further.’

The bank has big plans for thefuture. It plans to establish anasset management company andlaunch Shari’ah-compliant fundsthis year. It is also looking to belisted on the stock exchangethrough an IPO (Initial PublicOffering) in 2008.

Asya Katilim Bankasi of Turkeyhas mandated three banks toarrange a $50 million murabahafinancing facility. The mandatedbanks are ABC Islamic Bank,Standard Chartered Bank andUnicredit Markets & Investment

Banking. It has been structuredas a one- and two-year dualtranche facility, with theproceeds being used to financethe Turkish bank’s Shari’ah-compliant trade financeactivities.

capital gains and capitalallowances will be published, to provide certainty ofinterpretation. In his speech,Balls also announced the plansto publish guidance on howtakaful products will be taxedwithin current rules; it is hopedthat this guidance will clarify theuncertainty in the market overtreatment of these products.

The government hopes thatthese new measures will ensurethat the tax and regulatorysystem will encourage thedevelopment of Shari’ah-compliant products, and will cement Britain’s role as a global centre for Islamicfinance and trade.

NEWS



RHB takeover rumbles on

NEWS

March has been an interestingmonth in the ongoing takeoverof Malaysia’s fourth largestlender Rashid Hussain Behad(RHB). It was originallythought that the KuwaitFinance House (KFH) wouldbe successful with its bid forthe debt-ridden institution, andthat it would go on to form theworld’s largest Islamic bank.

This plan was shattered when Malaysia’s state pensionfund company, the EmployeesProvident Fund (EPF), outbidKFH to buy the UtamaBanking Group’s (UBG) 32 per cent stake in RHB, takingits overall stake in the bankinggroup to about 64 per cent.The deal was initiallywelcomed by KFH – in a statement to Bernama(Malaysian National NewsAgency) it said it was confidentthe consortium it led would

have a role to play in the new development to create the world’s largest Islamicbank. EPF seemed to confirmthis; the pension fund plans to cut its stake in the bank to around 35–40 per cent andis looking for two or threestrategic partners in order toachieve this. In an interviewwith Bernama, EPF’s CEODatuk Azlan Zainol said that it would consider KHF as astrategic partner in RHB due to its extensive expertise inIslamic banking. Speakingabout KHF as a potentialpartner, Zainol said ‘it willaugur well in helping Malaysiabecome an Islamic financehub’.

There seems to have been noprogress on a deal between thetwo companies since this point.Speaking at the Invest Malaysia2007 conference, managing

director of KFH (Malaysia)Bhd, K. Salman Younis toldreporters that the bank wouldbe ‘interested’ in taking a 49per cent stake in RHB IslamicBhd, but as yet had not beenoffered the opportunity.

EPF is looking to cut costs atRHB in order to clear some ofthe banks debts. It has decidedto sell the bank’s non-coreassets, such as Vision City, andeven hinted that the RHB headoffice could be sold off. The ITsystems at the bank will belooked at. Zainol told Bernamathat improvements here would‘bring down the cost of doingbusiness and increase marketshare’. The branch network isalso under consideration; thebank currently has around 200branches in Malaysia, whichwill be restructured to betterposition the firm in thebanking business.

Securing future of Islamic finance market

CIMB goesglobal

CIMB Islamic Bank plans to take its Shari’ah-compliantfinance products into the globalmarket. Executive directorBadlisyah Abdul Ghani (above)explains, ‘We have variousfinancing products available for local and foreign players in the halal industry’.

Speaking at the World HalalForum in Kuala Lumpur, Ghani told reporters that theglobal halal and Islamic financeindustry is estimated to be worth $1.5 trillion, which meansthere is enormous potential forpartnerships. ‘Players shouldconsider using Islamic financingas an option to raise funds as the cost is lower compared withconventional banking,’ he said.

Ghani also announced thebank’s plans to expand itsMalaysian operations. The bank plans to open 320branches across Malaysia by June this year, says Ghani.‘These branches will contributetoward making our productsand services more accessible to the market.’

A landmark agreement has been reached between theInternational Capital MarketAssociation (ICMA) and theInternational Islamic FinancialMarket (IIFM) to sign aMemorandum of Understandingthat it is hoped will help securethe long-term future of theIslamic finance market.

The agreement, signed on 30thJanuary at the Annual IslamicFinance Summit in London, is a significant step in thedevelopment of a key section of the global Islamic financialservices industry. It will allow

agreement will ‘enable the IIFMand ICMA to address criticalmarket issues, through sharedexpertise and throughconsultation with industry’.

The Memorandum ofUnderstanding will establish a joint working group betweenthe ICMA and the IIFM. Thisgroup will develop standardisedcontracts, language andpractices for secondary markettransactions and will alsodevelop standardised practicesfor the trading of sukuk andother Islamic financialinstruments.

focused work on the sukukmarket, now worth over $40billion, which is increasinglyattracting non-Islamic financialinstitutions and firms. KhalidHamad, vice chairman of theIIFM (below), said that the

electronics or air tickets to everycustomer.

The next wave of the newproduct range was released inmid-March. The bank launchedits markaba auto finance andsouk goods finance products.These products have beendesigned to aid the purchase ofcars and goods within the UAE.With both new products, thebank will purchase the goodsrequested by the customer and then sell them on to thecustomer at an agreed profit.

The product launches have beena success for the bank. Head ofdistribution, Mohammad Al-Nahdi, said the products hadreceived ‘a tremendous response’and had ‘increased the inflow of traffic at our branches’. Thebank has also increased itsbranch footprint, opening fivenew branches across the UAE on 1st April. It has also openedthree new branches in Dubai, as well as one in Ras Al Kaimahand one in Al Ain, in an attemptto enhance its customer reach.



Dubai Bank launches newShari’ah-compliantfinance products

Dubai Bank has launched a newIslamic finance product range.The bank started its Shari’ah-compliant operations in January,and a series of announcementsin March has seen four newproducts become available in the UAE. The first new offeringswere launched in the first weekof March. The most interestingof these new lines were a mulkiproperty financing productdesigned to facilitate thepurchase of properties in theUAE, and a sanad personalfinance product. The mulkiproduct has a financing structurebased on those of murabaha orijara, and is available to UAEnationals and expatriates living in the UAE.

The sanad was designed to helpcustomers meet their personalfinance needs or transfer theirexisting liabilities from otherbanks. In an attempt to boostthe uptake of the offering, thebank promised a gift voucherworth between $136 (AED500)and $1089 (AED4000), which could be redeemed for

A consortium of investors is setto open Kenya’s first Shari’ah-compliant bank, Gulf AfricaBank. The setting up of the bank is good news for Kenya’sMuslim community. Around 26 per cent of the Kenyanpopulation are followers of

Islam, but until now they havenot had a dedicated Islamicfinancial service.

The consortium is made up of a collection of investors fromaround the financial industry.They include BankMuscat

International, the Dubaigovernment investment agencyIsithmar and The World BankGroup International FinanceCorporation. The bank will startwith $25 million in capital andaims to become a domestic bankwith a regional presence.

First Islamic bank to open in Kenya

Credit Suisse expands itsIslamic banking product rangeCredit Suisse is set to expandits Shari’ah-compliant range of banking products. The bankentered the market in Marchthis year with a Shari’ah-compliant fund, and hasquickly decided to expand its offering. There was nospecified amountthat the Swiss bankplanned to raisewith the initial fund,but it did announcethat up to 20 per cent of theamount raised will be invested in emerging economies.

The bank is expecting to see a continued demand forinvestments that conform toIslamic principles in the globalmarket. ‘I have not witnessed a banking activity that hasshown such sustained growthfor two decades,’ global headof Credit Suisse Islamicinvestments, Fares Murad(above), told Gulf News.

There is currently an increasingdemand from Arab investors inthe Gulf for opportunities that

do not involve profiting frominvestments in interest-basedassets, or in businessesinvolved with alcohol,gambling, weapons,entertainment or non-halalmeat. Murad believes that thiswill mean that, in terms of

assets, the Islamicbanking sector couldovertake theconventional banks.‘The possibility isthere. Islamic banks in the region are veryactive and innovativeand they are eager togrow,’ explained

Murad.

The Islamic banking sector in the Gulf is believed to holdaround half of the assets of theentire Islamic financial sector.This works out to about $200billion and is still growing.Murad does not believe thatthe reasons for this are entirelyto do with oil. ‘There are manysocio-political factors that aredriving this growth. To saythat Islamic finance is growingbecause of petro-dollars issimplistic.’

NEWS

Nairobi, Kenya



Two deals for the EuropeanIslamic Investment Bank

Islamic banks growing rapidlyIslamic banks are growing atmore than twice the rate ofconventional banks accordingto Ahmed Darweesh BinDagher Al Marar, managingdirector of Abu Dhabi IslamicBank (ADIB). Globally thegrowth rate of Islamic banks is23 per cent, more than doublethe ten per cent growth rate ofconventional banks. Islamicdeposits in Gulf investmentaccounts have more thandoubled in the last five years,and Al Marar believes thatIslamic banks will attract half

of the world’s Islamic funds inas little as a decade.

The research that led to theseresults has been carried out byADIB for the Oxford BusinessGroup (OBG), a UK-basedpublishing, research andconsultancy conglomerate.OBG is preparing its new guide to doing business in AbuDhabi and this research will gointo a chapter dedicated to theIslamic financial services industry.The guide will be available in thesecond quarter of this year.

Amlak Finance and Real EstateInvestment, a company offeringIslamic home finance products,has been launched in Egypt. It is the first to offer Islamic homefinance products to the localmarket.

‘With growth of over 1.5 percent annually, and a currentshortfall of approximately145,000 houses per year, the real-estate industry has beenhighlighted by the currentgovernment as an area fordevelopment in 2007,’ saysShahil Akram Juma, CEO ofAmlak Finance and Real EstateInvestment in Egypt. Added to this, the government hasintroduced the mortgage financelaw, enabling individuals acrossthe country to own a homewithin a well regulated systemheaded up by the MortgageFinance Authority (MFA).Chairman of the MFA, OsamaSaleh, says ‘As we work toprovide physical housing for allsectors of society, it is right thatpeople should have the ability tochoose a financing solution thatis in line with their beliefs’.

When this backdrop is combinedwith Egypt’s largely Muslimpopulation, it is no wonder thatthe parent company AmlakFinance has decided the time is right to enter the Egyptianmarket. Initially, customers will be able to purchase anycompleted property, with long-term tenures of up to 20 years.

The Islamic Chamber ofCommerce and Industry (ICCI)has announced that, through itssubsidiary the Foras InvestmentCompany, it will help to set up 200 companies in the nextfive years in the 57 membercountries of the Organisation of the Islamic Conference (OIC).The announcement is part of aten-year development plan and,according to Foras CEO HatimJamil Mukhtar, it has been setup ‘to accelerate the process ofeconomic development acrossthe Muslim Ummah’. Mukhtarmade this announcement to aselect gathering of businessmenin Lahore.

Foras currently has a paid upcapital of $100 million and it ishoped that this will soon double.The company will set up fivesub-holding entities in Pakistan,Malaysia, Turkey, Egypt andSenegal, which it is hoped willhelp speed up the process ofcompany formation across theMuslim world. According toMukhtar, the companies will be set up ‘for the promotion of diverse fields ranging frombio-technology to IT andinfrastructure’.

Foras has already begun itswork with the preparation of investment road maps for ten Muslim countries, such asPakistan. It is hoped that thesesteps will lead to the formationof an economic consortium ofthe Islamic world.

Islamic home finance

products in Egypt

ICCI to set up 200companies in ten years

The European IslamicInvestment Bank (EIIB), the firstShari’ah-compliant Islamicinvestment bank to beauthorised and regulated by theFinancial Services Authority inthe UK, has announced thecompletion of two deals.

The first is a structured tradefinance facility with tradefinance group CCHInternational (CCH). Under thedeal, EIIB has signed anagreement with CCH and itssubsidiaries for a sterling-denominated revolving financingfacility. The proceeds of thefacility will be used according tothe principles of Shari’ah tofinance UK-based supplier ofsteel products, Alphasteel. Thisdeal is the sixth structured tradefinance transaction to be signedby EIIB and the first in the UKfor CCH. Managing director ofCCH, Eren Nil (right), said that

the deal was ‘a key addition toour funding base which hastraditionally been provided byMiddle Eastern institutions’.

In the second deal, EIIB hassigned a committed standbyfacility with the Islamic Bank ofBritain (IBB). The facility isstructured as an undrawnrevolving commodity murabahaand is designed to assist IBB inmanaging its liquidity profile.

NEWS



Lloyds TSB (below) haslaunched the first high-streetIslamic business accounts in theUK. The Shari’ah-compliantaccounts have been split intotwo categories. If the turnover of a business is under £2 million($3.9 million) it will be eligiblefor the Islamic Business account.If a business has a turnovergreater than this it will beeligible for the Islamic Corporateaccount. Both accounts complywith Shari’ah law and, as such,offer no credit interest and nooverdraft facility, but still offer

all the other services available to traditional business andcorporate account holders.

The launch of these newaccounts establishes Lloyds TSBas the largest provider of Islamicbanking across the UK. TruettTate, group executive directorfor wholesale and internationalbanking, says: ‘We’reconsolidating our position as the UK’s leading provider ofIslamic financial services andmaking it possible for Britain’sMuslim businesses and aspiringentrepreneurs to bank accordingto their principles’.

This is the latest addition to the bank’s Islamic finance range.The range was developed after a survey last year revealed thatthree quarters of the UK’sMuslim population wereinterested in Islamic finance. The new business accounts areavailable across the bank’s 2000strong branch network, and thebank is hoping that it will meanthat Muslims will not have tocompromise their principleswhen it comes to their business finance.

Saudi Arabia’s NationalCommercial Bank (NCB) haslaunched a new investment fund for individuals to invest in international corporations.The Al-Ahli Ma’moun Fund

for International Stock Trade Dwill allow investors to invest ininternational corporations thatare leaders in their field. Thetwo-year fund will also protectthe investor’s capital by investing

in an international stock folderthat is compliant with Islamicprinciples. Sami Abdo, head ofNCB’s Investment ServicesDivision, said, ‘The new fundwill provide alternative

investment channels compliantwith Islamic principles andinvest in large internationalcorporations that enjoy strongand stable growth averages’.

New Islamic investment fundlaunched in Saudi Arabia

Sharjah Electricity and Water Authority (SEWA) hassuccessfully closed its $350million sukuk al ijara facility. It received strong interest fromregional banks in the generalsyndication, and was over-subscribed. SEWA, themonopoly supplier of electricity,water and gas to the Emirate of

Sharjah, is the first entity ownedby the government of Sharjah toapproach the syndication marketfor a long-term Islamic financingfacility. The financing wasprovided by a total of twelvebanks including ABC IslamicBank, Gulf International Bank,Kuwait Finance House andSharjah Islamic Bank.

Islamic banks supportSharjah Electricity and

Water Authority

Islamic business banking on the UK high street

NEWS

Malaysia International IslamicFinancial Centre initiativesstrengthened with MOU

A Memorandum ofUnderstanding (MOU) hasbeen signed between BankNegara Malaysia, QatarFinancial Centre RegulatoryAuthority and Dubai FinancialServices Authority. The dealhas been signed as part of theMalaysia International IslamicFinancial Centre initiatives.

The initiatives aim to establishcollaborative relationshipswith strategic partners towardsthe development of Islamicfinance, and are based aroundthree themes. The first is co-

operation on capacity building and human capitaldevelopment in Islamic finance.The second is a mutual co-operation on the developmentof international Islamicfinance, and the third includesShari’ah harmonisation andstrategic promotion initiatives.

It is hoped that this MOU,signed between East and WestAsia, will mutually strengthenthe inter-linkages amongst theIslamic financial centres, andreinforce trade and investmentflows between the regions.


NEWHORIZON January–March 2007COUNTRY FOCUS: RUSSIA

In recent years, the Russian banking markethas been developing at a rapid pace. As thecountry’s economy is stabilising and taking a definitive shape, so is its financial servicesindustry.

In typically dramatic Russian style, recentevents within the Russian banking sectorhave attracted attention on a worldwidescale, not always in a positive way. Themurder of the Central Bank’s vice chairman,Andrei Kozlov; the revoking of bankinglicences; the control of many domestic banks by foreign investors; and theupcoming changes connected with theRussian Federation joining the World TradeOrganisation (WTO) are contributing to theshape of the Russian banking sector today.

Currently, there are around 1200 banksoperating in Russia, with Sberbank (SavingsBank of the Russian Federation) having thelargest share and the widest spread over alleleven time zones of the country. The rest are a pretty mixed bunch, but there are some strong and growing players. Regionalexpansion is high on the banks’ agenda andretail banking services are of the utmostimportance in capturing the largest market share.

However, having suffered a number ofsituations in which people’s savings were lostin the recent past, the Russian population isbeing cautious and somewhat sceptical ofthe current developments. There is still anestimated $1.5 billion in so-called ‘mattress’money held by the public. Nevertheless, the

Islamic banking and takaful in Russia:What the future holdsWith over 15 million Muslims living in Russia today, the domestic introduction of Islamic financialservices has been discussed and attempted by both businessmen and scholars. But is thecountry ready for it? Renat Bekkin, Moscow State Institute of International Relations lecturer,talks to Tanya Andreasyan about the challenges facing Islamic banking and insurance in Russia.

Mosque in St Petersburg, Russia


NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: RUSSIA

banks hope to introduce the financialservices to as many of the 145 millionRussian citizens as possible.

An estimated 15–20 million of them are Muslims. And while the country’spopulation is largely diminishing, Russia’sMuslim population is on the increase. It hasgrown by around 40 per cent since 1989,due to high birth rates in the Muslimcommunity and continued immigration from the Caucasus and Central Asia. Someanalysts project Muslims to become one-fifthof the country’s overall population by 2020.

Today, Russia has about 8,000 mosquescompared to 300 mosques 15 years ago.Statistics predict that by the end of 2015, the number of mosques in the country will exceed 25,000.

One would expect that, with such a growthin the Islamic population in the region, therewould be increasing demand for Islamicfinancial services. However, this is not quite the case. As mentioned earlier, theconfidence of Russia’s population in thecountry’s banking system is still low. And it’s not only the confidence problem; it is thegeneral knowledge about banking. Russia’sPresident, Vladimir Putin, once mentionedthat ‘the majority of Russian citizens are still avoiding banks, just don’t understandhow they work and consider them to be too complicated and requiring professionalknowledge’. According to Putin, only one quarter of Russian citizens have bank accounts and less than ten per cent of the population uses plastic cards.

And if conventional banking, which hasexisted for a long time, is still a mystery for a large number of people in Russia, whatcan one say about the Islamic financialinstitutions, which have emerged onlyrecently? The situation is much the same in other countries comprising theCommonwealth of Independent States (CIS),the successor to the USSR. Depending on thegeographical location and ethnic population,some of these countries are more advancedin their knowledge of Islam and Islamicbanking than others. The countries situatedin Central Asia – for example Kyrgyzstanand Tajikistan – are predominantly Muslim,

as so are some countries in the Caucasussuch as Azerbaijan.

One of Russia’s specialists in Islamic finance,who has contributed to its promotion acrossthe territory of the former USSR, is RenatBekkin, international law lecturer at one ofthe most prestigious universities in Russia,the Moscow State Institute of InternationalRelations (MGIMO-University). Theuniversity functions under the auspices of the Ministry of Foreign Affairs of theRussian Federation.

Bekkin studied at MGIMO and graduatedfrom it with a Master of Law degree in

2000. A few years later, he received a PhD in Law, having written a dissertation‘Insurance in Islamic Law: Theory andPractice’. Today, he is a professor at theUNESCO (United Nations Educational,Scientific and Cultural Organization)department in MGIMO.

Bekkin is originally from St Petersburg butmoved to Moscow to attend the universityand continues to live there today. He speaksthree foreign languages – English, Arabicand Chinese. Literature is one of Bekkin’spassions, so much so that he writes himselfand has also established an open literaryprize called ‘Islamic Breakthrough’.

Bekkin’s interest in Islamic finance has developed gradually. Originally,international law was his subject ofspecialisation but then, in the course ofresearch, he came across the legal issues of Islamic insurance (takaful) which laterbecame the topic of his thesis. Eventually,Bekkin’s area of interest broadened to otheraspects of Islamic law and finance including:retakaful; Islamic law in non-Muslimcountries; Islamic economics; Islamic law of banking, securities and business

transactions; and the philosophy of Islamiclaw.

So what is his opinion on the situation withIslamic financial institutions in Russia?

‘There is still a lot of scepticism over the ideaof Islamic banks among Russia’s Muslims,’says Bekkin. ‘Actually, a number of Muslimsaround the world do not support Islamicbanking and consider it to be unacceptable,the same as Islamic whisky. Some people inRussia also support this theory, even if theydon’t know much about Islamic finance tobegin with.’

Bekkin explains: ‘Generally, the attitude ofMuslims in Russia towards Islamic financecan be divided into four main categories.The first one is that it is not vital to useIslamic banking services. These peopleconsider that observing other rites, forexample, praying and fasting, is sufficient.The second category consists of those whodo not practise any rites at all or are noteven aware of them. This category oftenincludes ethnic Muslims. And there is a thirdsmall category of people who think thatpractising all principles of Islam, including inthe financial sphere, is essential.’ He goes on:‘So, these Muslims have to somehow find away of minimising the risks of using non-Islamic banking products. The solution of banking abroad is, unfortunately, notaffordable for the majority of them.’

‘There is also a fourth category ofintellectuals who are very enthusiastic aboutIslamic finance. These Muslims, generallyethnic, may not be as strict in followingother Islamic rites but are very interested in Islamic finance and the concept of ethicalbanking.’ The latter category includesMuslims who have tried to establish Islamicfinancial institutions in Russia since the early

Although the Arab world considers Russia a potentially emerging market with regard to Islamic finance, there is still a lot of apprehension when it comes to investing capital in it.‘There are many hitches and complications.’

14 IIBI

1990s. Regrettably, none of theseundertakings seems to have resulted in anything long-lasting.

Back in 1992, an Islamic Cultural Centre inMoscow and the All-Russia Tatar Culturaland Educational Centre, together with anumber of Russia’s large machinery andmetallurgical plants, announced theestablishment of the United IslamicCommercial Bank Inc. It was going to be located in the Kemerovo Region, anindustrial district in the north-east of Russia.The reasons behind this collaboration weremore practical than religious; the bank wasset up to develop the industry in the regionand to attract foreign investors primarilyfrom Muslim states. ‘The regionalgovernment knew next to nothing aboutIslamic finance at the time, they just wantedto create a financial structure to attractcapital from the Arab world,’ says Bekkin.However, this project was never completed.

Another unrealised project, which directlyinvolved Bekkin, was the launch in 2005 of an Islamic insurance company in therepublic of Tatarstan (a federal subject ofRussia) called ‘Itil’. It was supposed to be a joint venture between local entrepreneursand foreign investors from the Arab world.‘There were no obstacles from the legislativeor political point of view,’ says Bekkin. He was appointed director of the company.‘We drew up a business plan and presented itto the foreign investors. The problem turnedout to be quite worldly – apathy from bothsides to actually press on with the project.So, it didn’t end with anything.’

Indeed, although the Arab world considersRussia a potentially emerging market withregard to Islamic finance, there is still a lot of apprehension when it comes to investingcapital in it. ‘There are many hitches andcomplications,’ admits Bekkin. ‘One of the potential investors [from UAE] in thetakaful company, Itil, once said that Sudaninterested him more than Russia from thepoint of view of the Islamic financial services market.’

And it’s not just the Middle East countriesthat are contemplating introducing Islamicbanking in Russia. Not long ago, Bekkin

The secret of success is to introduce the economicaspects of Islam before any penalising sanctions. It is necessary to begin witheconomics rather than withscaring. This is a much moreeffective way to familiarise andattract people to Shari’ah law.

COUNTRY FOCUS: RUSSIA

Renat Bekkin, MGIMO-University

Kul Sharif Mosque, Kazan, Republic of Tatarstan, Russia

IIBI 15

held some talks ‘on a consulting level’ withthe Swiss bank Fortis, which was ponderinga move into the Russian banking marketwith its Islamic offering. The idea was todevelop tailored financial products andservices using the Islamic model, yet withoutcalling them Islamic. However, the bank’sinitial analysis was not satisfactory and sofar Fortis has not taken any further steps.

Bekkin thinks that chances of success in thisfield would be higher if large internationalconglomerates like HSBC or Citibankopened their Islamic subsidiaries in Russia,as opposed to purely Arab banks doing thesame thing. ‘It is more likely to have apositive reaction,’ he says. However, to date, neither western nor Middle Easterninvestors have carried out such a projectfrom start to finish.

The only undertaking that actually movedfurther than ‘half a step’ (although today itis also history) was Badr-Forte Bank. Thisbank was set up in Moscow back in 1991,and operated according to Shari’ah law from 1997. Officially it was not calledIslamic, but its charter stated that the bankhad the right ‘to act according to Russianand international laws by applying Islamiceconomic technologies which do notcontradict the banking laws of Russia’. Badr-Forte was also a member of theGeneral Council of Islamic Banks under the IDB (Islamic Development Bank).

The bank managed to adapt successfully tothe Russian legislation and economy whilstfollowing the Islamic principles of bankingalthough, according to Bekkin, ‘due to thespecifics of Russian laws Badr-Forte had tocompromise more in some respects than its foreign counterparts’. The piece oflegislation that became a stumbling-blockfor Badr-Forte and Russia’s Central Bankwas the deposit insurance scheme, which the Central Bank made mandatory. Badr-Forte tried to explain that the essence of an obligatory deposit insurance schemecontravened the very principles of Islamicbanking, but the Central Bank stood firm. In the end, Badr-Forte’s licence was revokedon the grounds of money-laundering activityplus the gross violation of order and periodwhen reporting suspicious transactions.

COUNTRY FOCUS



but it doesn’t seem likely that Russia’s onlyIslamic financial institution is going to berevived any time soon. Dzhabiev is not in a rush to open another Islamic bank in thecountry. As the proverb goes, ‘Once bittentwice shy’.

Of course, Bekkin regrets that the idea of an Islamic bank in Russia still remains onlytheoretical, but he thinks that Badr-Fortehad more than Russia’s legislation and thecurrent state of the Russian banking marketto blame. The lack of the bank’s activity inthe social and educational spheres resulted in the absence of a wide-spread support forthe bank among Russia’s Muslims.

‘One of the primary functions of any Islamicfinancial institution is a social one,’ statesBekkin. ‘Unfortunately, Badr-Forte did notreally fulfill that.’ He goes on to give anexample: ‘Dzhabiev and his right hand,Samira Karahanova, were the only Muslimsworking in the bank, and Dzhabiev waskeen on recruiting qualified Muslim staff to work in Badr-Forte. Since suchpersonnel were hard to come by, there was a suggestion to train the potential staff,provide them with the necessary literatureand let them get a feel for Islamic banking in practice. Dzhabiev’s position on this issuewas far from supportive, as he suggestedthat those willing should research and learnIslamic banking themselves, without thebank’s help. And this kind of attitude spread to other things too.’

However, in spite of Badr-Forte’s fate, the idea of establishing an Islamic financialinstitution in Russia continues to hover inthe air. So, if another Islamic bank were toopen in the country, what would be the bestgeographical location for it? Bekkin thinksthat ‘Moscow is the city with the mostpotential of developing an Islamic financeservice industry, as it has a large Muslimcommunity, and quite a lot of well-offMuslims, both ethnic and newly converted’.Russia’s capital is among the most expensivecities in the world, and the standard of living there (regardless of people’s faith) istraditionally high compared to other parts ofthe country. Plus, Moscow has embraced thefinancial services industry with considerablymore enthusiasm than the regions.


Kremlin of Kazan, Republic of Tatarstan, Russia

The bank had focused on foreign trade operations, such as cross-bordertransfers, guarantees and letters of credit.Unfortunately, its retail Islamic offering was limited to deposits, money transfers and mortgages, with the latter beinglaunched shortly before the bank’s closure.Furthermore, the bank had no branches and was not widely known to the generalMuslim public even in Moscow (the citywhich hosted the bank’s headquarters), letalone regionally. Badr-Forte, however, triedto compensate for its absence of outlets byactively promoting both internet and mobile phone banking.

Bekkin is very familiar with the bank and itsfounder and chairman, Adalet Dzhabiev, asBekkin worked on probation in the bank fora while during his university years. ‘Actually,everyone who was studying Islamic financeat the time or was writing about it boresome relation to Badr-Forte,’ he says.‘Everything concerning Islamic banking in Russia and everybody involved in it were revolving around this bank.’

However, in December 2006, the CentralBank of Russia revoked Badr-Forte’sbanking licence. There have been a fewunsuccessful attempts to recover the licence,



Another part of Russia that is also apotential Islamic banking and insurance hub is the republic of Tatarstan, situated in the central part of Russia. Tatarstan liesbetween the Volga River and the KamaRiver (a tributary of the Volga) and extendsto the Ural Mountains. It is a predominantlyMuslim republic, with a population ofnearly four million people. ‘It has a claim on being the leading Muslim communitycentre of Russia,’ says Bekkin, ‘so there is a potential interest in the Islamic financialstructures there; however, it is more political than economic’.

Then, there is also the republic of Dagestan, situated on the Caspian Sea coastin the southern part of Russia, the NorthCaucasus. Over 90 per cent of this republic’spopulation (2.3 million) is Muslim, withIslamic faith dating back centuries there.‘This region is exactly the case where peoplefollow Shari’ah principles in various aspectsof life except the financial one. There is alack of understanding and support of thismatter both from the local government andthe local population,’ says Bekkin. Even so,there has been sporadic talk of establishingan Islamic financial institution there, but this has turned out to be unsubstantiated.

Such empty promises are not an unusual thing for Russia. Once in a while,announcements of establishing an Islamic

bank or a takaful company appear in themass media. Bekkin thinks that most of thetime ‘it is merely a trick to attract attentionand to occupy a niche in this market inadvance’.

Nevertheless, the development of Islamicbanking in Russia is by no means a lostcause. More widespread education aboutIslamic economics and finance is needed, as‘the lack of knowledge in this area is one ofthe main causes of low demand for Islamic

financial products’. Even a basic thing, suchas zakat (Islamic concept of tithing andalms), is a very unclear subject for a lot ofMuslims in the country. ‘Knowledge of zakatis a touchstone by which you can judge thepeople’s attitude to Islamic finance,’ saysBekkin. ‘Here it is very often thought to be unnecessary, or many people think thatgiving alms to the paupers by the mosque is zakat.’

Also, creating favourable conditions for the development of Islamic financial servicesis essential. ‘The secret of success is tointroduce the economic aspects of Islambefore any penalising sanctions. It isnecessary to begin with economics ratherthan with scaring. This is a much moreeffective way to familiarise and attractpeople to Shari’ah law,’ states Bekkin.

At the moment, Bekkin is involved in theproject of creating an Islamic mutual fund,Gold Dinar, which is expected to commenceoperations later this year. ‘The managementcompany has already been registered, andnow we are in the process of developing theproducts,’ says Bekkin. Gold Dinar will besituated in Moscow, with the ambition ofmoving into Russia’s regions in due course.At present, Bekkin’s role in the project ispurely consultative; however he isconsidering further involvement in thismutual fund. ‘I am always interested in

learning something new,’ he says. ‘Maybe I’ll work in the company.’ It all dependswhether the company’s investors stick to theproject and go all the way. So far ‘everythingseems to be serious’, but having encounteredso many canards before, Bekkin is cautiousin his prognosis.

The ‘initiative group’ organising Gold Dinar consists of seven people. Most of theparticipants are originally from Dagestan,but they have been living and working in


Mosque in Norilsk, Siberia, Russia

Moscow is the city with the most potential for developing an Islamic finance service industry, as it has a large Muslimcommunity and quite a lot of well-off Muslims, both ethnic and newly converted.

Moscow for a long time. Although theprimary goal of establishing this company is to offer the public Shari'ah-compliantservices, it is also seen as a ‘promisingbusiness’. ‘The investors are veryexperienced in this field – some of them havebeen dealing in securities for over a decade,’says Bekkin. ‘So they clearly see the potentialin the Islamic mutual fund and know thatthere is a demand for its products andservices in Russia.’

The concept of mutual funds is relativelynew to the Russian market and this nichehas recently been developing rapidly, withplenty of coverage in the mass media and amushroom growth of conventional mutualfunds as an alternative way of depositingmoney. Muslims in Russia turn to mutualfunds for financial services, as theseorganisations are regarded as more ethicaland less contradictory of Shari’ah law thanbanks. Therefore, setting up a properShari’ah-compliant mutual fund in thecountry is indeed ‘a hopeful activity’. Andthe successful completion of this project will surely be a step in the right directiontowards further development of Russia’sIslamic financial services market.



IIBI director general joins Muslim Power 100

Mohammad Ali Qayyum,director general of IIBI, hasbeen included in the MuslimPower 100 list, an initiative set up by Carter Andersen,media and business consultingorganisation. In the words of Khalid Darr, chairman ofCarter Andersen, the MuslimPower 100 names ‘Muslim men and women whocontribute positively and often powerfully within all sectors of British life’.

The purpose of the nominationis to set out how the Islamic‘traditional core values ofempathy, objectivity, integrityand impartiality drive thecontribution to the social andcultural welfare of Britain’.Today, the Muslim populationin the UK is estimated at 2.1million with a contribution to the annual GDP (grossdomestic product) of £51billion.

In 2003, Qayyum becamedirector general of the London-based Institute of IslamicBanking and Insurance (IIBI),bringing in-depth knowledgeand practical experience gainedfrom nearly three decades inthe banking industry.

Until the sad demise in March2005 of the IIBI’s founder and chairman, Muazzam Ali, Qayyum assisted him inreviewing the Institute’s short-term strategy. The late Ali,

who established the IIBI as anon-profit organisation, was a pioneer and highly respectedfigure; he realised early on thatthe success of the Islamicbanking movement woulddepend heavily on education,training and research.

Since taking on the position of director general, Qayyumhas been working closely withmembers of the IIBI’s informalBoard of Governors ondeveloping the short-term as well as long-term businessplans to take the IIBI to ahigher level. Together with his team and the Institute’s‘friends’, Qayyum is continuingthe late Ali’s legacy ofpromoting Shari’ah-compliantfinance and of establishing theIIBI as a global centre ofexcellence in Islamic bankingand insurance education,training and research based in the City of London.

Meeting with Japanese delegation

Warren Edwardes, a member of the IIBI’s informal Board ofGovernors, received a Japanesedelegation visiting London for aresearch project ‘The Emergenceof Islamic Finance in the UK’.Professor Koji Muto, professorof Middle Eastern economicstudies and Islamic finance,College of Asia PacificManagement; KatsuraDaikuhara, principal economist(Middle Eastern economicdevelopment); and H. Hosoda,

the latter two both from theJapan Centre for InternationalFinance, acknowledged thatLondon is seen as one of the keycentres of growth in the Islamicfinance sector today. Theydiscussed London’s prospects of becoming the centre of globalIslamic finance transactions,such as sukuk, and the pros and cons of this scenario. Thedelegation also assessed the UKgovernment’s efforts to promoteIslamic finance in the country

and what remains to be done inthis area.

The talks were not limited to thedomestic issues of the industry,but embraced other topicalsubjects of Islamic finance on aworldwide scale. The Japanesedelegation raised the veryinteresting question of thedifferences in Shari’ahinterpretation between the Gulfcountries and Malaysia, andwhether such uncertainty causes

problems, for instance, indamaging the stability ofissuance or trading of sukuk.

Other global problems, such asa possible increase in the costsof Islamic products and servicesdue to the conflict betweenstrengthening competitivenessand Shari’ah compliance, aswell as the negative effect thatthe petrodollar shrinkage mighthave on Islamic finance, werealso discussed.

IIBI NEWS

The country’s Islamic financeservices sector has grownconsiderably over the past fewyears and continues to increasesteadily. Qayyum believes that unbiased education andtraining from independentorganisations like the IIBIsupported by professionals, the industry, regulators andgovernment is the key tosuccessful promotion andimplementation of Islamicfinance both within the UK and outside it.

Mohammad Ali Qayyum,IIBI



KoreaEconomic

Dailyinterviews IIBI

Due to the growing interest inIslamic banking in South Koreaand in order to introduce it toSouth Korean national readers,Yong-Seok Ju, a journalist at theKorea Economic Daily (HanKyung), one of the largestfinance and business dailynational newspapers in South Korea, along with hisinterpreter, Ms Hee Choo,visited IIBI and interviewedMohammed A. Qayyum, theInstitute’s director general.

In the course of the discussion,Ju raised various questions onthe history of Islamic finance, its present position in themainstream financial system, the role of Middle Easterneconomies in its development,and the future prospects of the industry. He also enquiredabout the Institute’s objectives,activities and areas of support in promoting Islamic finance.Qayyum informed him that IIBIhas been endorsing this sphereof finance for over a decade,providing training and educationin the form of post-graduatediploma courses, monthlylectures in London, publicationof reference books, and issuingNewHorizon, an officialmagazine of IIBI. Qayyum also stated that the Institute has further plans to expand its activity and upgrade itsservices, while continuing tooffer assistance to all thosewilling to learn more aboutIslamic banking and insurance.

This was the theme addressed by DrMuhammad Imran Ashraf Usmani for the IIBI monthly lecture on 30th January 2007.

Dr Imran is one of the leading Shari’ah advisorsin the Islamic finance world and currently serveson the Shari’ah boards of many internationalfinancial institutions. He is also a member ofthe IIBI’s Shari’ah Advisory Group.

The lecture was chaired by Iqbal Khan, formerfounding CEO, HSBC Amanah, and member of the IIBI Board of Governors.

January: What should be our vision and objectives in Islamic finance?

Promoting Islamic finance

Forty years ago, when the modern Islamicbanking movement began to establish itselfin the global financial system, pioneers of themovement saw it as a cure for the economicand social ills of society. According to them, these ills stemmed from unbridledcapitalism. Islamic banking is now regardedas the defining characteristic of the Islamiceconomic system and, while many Islamicbanks are now operating around the world,debate continues as to what constitutessuccess in relation to its potential tomaximise social welfare. Meanwhile, the belief still lingers that profit and losssharing banking is superior to interest-based banking.

Dr Imran pointed out that Islam is a complete religion and provides acomprehensive code of life, with guidance inevery sphere including socioeconomic fields.If this guidance were followed by society, thewelfare and well-being of mankind wouldbenefit. He referred to specific instances:‘Allah (SWT) permitted trade and prohibitedriba’; and Prophet Muhammad (SAW)encouraged shirkah (partnership) in various maxims and sayings. Islamic finance facilitates the equitable distribution

of wealth by prohibiting riba (interest),maysir (gambling) and gharar (speculation).Some permissible Islamic financing modeswere preferred and encouraged by theIslamic Shari’ah over others – the contract of equities, for example.

Dr Imran said that Islamic bankingtransactions should be based primarily onmusharakah /mudarabah (profit and losssharing models), so that capital would flowfrom the rich to the poor, while the ratio ofequity based transactions should increaseover non-participatory based transactions toachieve the real benefits of Islamic banking.Where profit and loss sharing contracts were not feasible, however, exchangecontracts such as murabaha, ijara and salam,diminishing musharakah and istisna shouldbe used. These are asset-backed transactionsthat would reduce the level of economicinflation.

Islamic financial institutions should evaluatethe extent to which they fulfil the basicrequirements of the community. If they wereto increase their product range they wouldboost the confidence of the community andbroaden the customer net. This would bekey to the growth of the Islamic financeindustry. ‘Products should be Shari’ahcompliant not only in form, but also insubstance, in order to realise the truebenefits of the Islamic financial system,’ he concluded.

IIBI NEWS/LECTURES

January lecture



Sufyan Gulam Ismail, CEO and founder of 1st Ethical group, considered how to create a Shari’ah-compliant, balanced investmentportfolio at the IIBI February lecture.

Ismail started his career with Deloitte & Touche,a firm of chartered accountants, which alsooffers advisory, financial, management andtaxation services. In 2001, Ismail identified a gap in the marketplace for a specialist firm to provide bespoke tax solutions to owner-managed businesses. He filled that gap bystarting up 1st Ethical in the same year.

The lecture was chaired by Sultan Choudhury,director of sales, Islamic Bank of Britain.

February: How to create a Shari’ah-compliant, balancedinvestment portfolio

Social responsibility is gaining increasingpopularity in the corporate world. It isperceived as a means of self-regulation todemystify stakeholders’ concerns about the operations of a business and a way of highlighting the contribution to thecommunity and environment in which theenterprise is operating. Shari’ah-compliantproducts, with their underlying principles of equity and social justice, embody thesame values.

As the Islamic finance industry grows,Islamic financial institutions mustdisseminate information about the range of products available, along with theirdifferent risk profiles, and must commit to responsible business conduct, investmentin people and in the community.

The basic principles of Shari’ah, asapplicable to investments, include theprohibition of interest and the avoidance of unethical concerns and contractualdeficiencies, such as uncertainty and ‘riskand reward’ consideration. There are otherkey factors, however, which must also beconsidered when screening for Shari’ah-compliant investments. The shares ofgambling outlets and businesses, tobacco

Ismail looked at the current retail productsin the UK marketplace and segregated themaccording to their risk profile. He alsodiscussed the tax efficiency of theseinvestments. He cited low risk products,including the Islamic bank accountspresently offered by HSBC Amanah,LloydsTSB and Islamic Bank of Britain; andShari’ah-compliant property investments.Medium risk products are the ethical unit trusts, which minimise the risk ofinvestment by diversifying the portfolio,such as Friends Provident, musharakahfunds and property share funds. High riskproducts include Middle East Islamic bankequity funds, Shari’ah-compliant UKequities and direct investment in the Dow Jones Islamic index.

For the IIBI March lecture, Professor RodneyWilson, director of Postgraduate Studies atDurham University’s School of Government and International Affairs, addressed some of the key issues faced by Islamic financialinstitutions in managing credit, operational,liquidity, Shari’ah, legal and regulatory risk.

The lecture was jointly chaired by RichardThomas, the former managing director of AssetManagement at Arab Banking Corporation,London, and Professor Mahmood Faruqui,honorary vice-chairman, IIBI.

March: Risk management inIslamic finance

With an increasing number of organisationsoperating across borders, facilitated byadvances in information technology,executives are focusing increasingly on the management of the risk incurred by the various business operations.

As financial institutions are key players in each country’s economic stability andgrowth, governments all over the world are developing regulations and monitoringmechanisms.

Such mechanisms are necessary in order to maintain and enhance public trust intheir financial institutions, in this era ofglobalisation, where millions of funds can be transferred at the click of a mouse.

While the modern Islamic bankingmovement is still in its infancy, it mustdevote more resources, train more personneland build a comprehensive strategy tomanage risk and develop confidence in itsoperations and long-term sustainability.

The distinctive nature of Shari’ah-compliant financial liabilities and assets has implications for risk management.

Professor Wilson focused on credit riskinitially – an area of great concern for allfinancial institutions, but more important in Islamic banking as Shari’ah rulingemphasises the need to take a lenient

IIBI LECTURES

Sufyan Gulam Ismail,1st Ethical group

companies, pornographic concerns, banksand insurance firms dealing in interest, andmanufacturers and distributors of alcoholmust be filtered out. Add to this listorganisations whose principal activity maynot centre on the above but which derivemore than ten per cent of their income from one or more of these activities; highlyleveraged companies (with gearing in excessof 33 per cent); and companies involved inactivities prejudicial in any other way to the interests of the Shari’ah.

loan without interest, where the borrowerpays back the capital only).

This approach could enhance the reputationof Islamic banks, so improving client loyaltywhile helping to attract new clients, as the bank is partnering with the client toovercome a difficult financial situation.

Mudarabah and musharakah financingmodes are used infrequently because theseexpose Islamic banks to maximum liabilityand it is also very costly to establisheffective monitoring mechanisms – aprerequisite here. Therefore most Islamicbanks tend towards non-participatorymodes, where the risk is much lowercompared to the mudarabah andmusharakah.

A more detailed article on credit risk fromProfessor Wilson can be found on page 36.

changes in their circumstances, should be given more time and, if possible, theircapital payments should be treated on thebasis of quard hasanah (the extension of a



This is the topic of the IIBI’s April lecture, which will be presented by SultanChoudhury, director of sales, Islamic Bank of Britain. Choudhury has plenty of knowledge and experience to share, asthe customer base of this, the UK’s firststandalone Islamic bank, has trebled in the past two years reaching 51,000.

The lecture will address the issues ofunderstanding the increasing importanceof the emerging Islamic financial servicesindustry; benefiting from the newdemographic and economic realities;learning how to identify and targetpotential customers with the rightproducts and customised services; training the workforce to ensure that they genuinely believe in the products and services they are selling to the Muslim customers and that they are able to empathise with them.

To register, please visit:www.islamic-banking.com

April lecture preview:Successful strategies for attracting Muslim customers by Islamic banks

approach when borrowers are in genuinefinancial difficulty.

Investment mudarabah deposits cannot be guaranteed, a fact which conflictspotentially with deposit protectioninsurance requirements. In murabahafinancing operations, and with ijaraoperating leases, Islamic banks take on ownership risks which conventionalbanks try to avoid.

Since Islamic banking is based on traditionalprinciples of profit sharing, there are alsopotential asymmetric information problemsthat increase risk. Internal managementprocesses and client screening criteriashould be strong to minimise these risks.

Having an experienced management team and well-trained staff may curtail theoperational risk for the banks. Liquidity riskcan be managed by using murabaha inter-bank deposits, to utilise the surplus funds of one bank by another.

Professor Wilson also discussed ways todeal with unscrupulous defaulters. Theseincluded blacklisting a client, taking him/her to court and the confiscation of his/herpassport. These penalties may vary fromcountry to country, depending on the profileof the client and the national, legal andregulatory structures in place.

At the same time, those who had genuinelyfallen into financial difficulty, as a result of

IIBI LECTURES

March lecture

The lecture will take place on30th April 2007 at 5.30pm at:British Bankers’ AssociationPinners Hall105–108 Old Broad StreetLondonEC2N 1EX

Branch of Islamic Bank of Britain



A key thrust of the conference wasdiscussing London’s role in the Islamicbanking industry. Some of the City’sheavyweight figures – including Ed Balls MP, economic secretary to the Treasury; SirMichael Oliver, a former Lord Mayor of theCity of London; Michael Ainley, the head ofthe UK’s FSA (Financial Services Authority –the UK’s financial market regulator); andwholesale banks and investment firms unit,all made enthusiastic addresses on the waythe UK government has changed regulationsto accommodate Islamic banking. Therewere several references to the way in whichthe UK has adopted a ‘principles-based’approach rather than ‘just ticked boxes’ in a ‘rules-based’ approach.

To create a ‘level playing field’ between the conventional banking market and the rapidly developing Islamic market, the government has passed legislationspecifically aimed at accommodating Islamicinstruments and has adopted changes to itstax environment. In the March 2007 Budget,the Chancellor announced changes toaccommodate ‘alternative finance investmentbonds’ specifically intended for the sukuk.Currently, there are around 25–30 regulatedfirms in the UK that are authorised to offerIslamic products, with more applicationsfrom banks in the pipeline. A UK baseenables firms to open in any EU country.

Some speakers felt that other worldwideregulations and accords are proving moreproblematic for Islamic banks to adopt. The Basel II Accord, for example, is moredifficult to apply to an Islamic financial

institution because the instruments it uses have different risk profiles fromconventional ones. Basel II requires banks to allocate capital according to the perceivedrisk of each asset class. The IFSB (IslamicFinancial Services Board) is attempting tocreate capital adequacy guidance standardsfor Islamic financial institutions, which willprovide a standard platform to help theseinstitutions make allocations against specific Basel II risk categories.

New structures of Islamic products are being developed and some were presented to the conference. The world of derivatives is now being made available to investors in a form that is acceptable to Islamic scholars.Traditionally, scholars saw these instrumentsas speculative and a form of gambling. Theyare now increasingly being accepted as ahedging tool. The lack of standardisation inShari’ah products and differences betweencountries makes developing Shari’ah-compliant derivative products a moreexpensive process. The ISDA/IIFM(International Swaps and DerivativesAssociation/International Islamic FinancialMarket) are jointly discussing the principlesof a Shari’ah-compliant ‘master agreement’.The developed draft is being reviewed by aworking group in conjunction with Islamicscholars. The agreement will make derivativeproducts much easier to structure.

The conference was told that the mostcommon Shari’ah derivative structures are the murabaha followed by the arboun(resembling a conventional call option) andthen the salam (resembling a forward sale).

The murabaha can be used to configure a profit rate swap which is a structureequivalent to an interest rate swap in theconventional market. The murabaha profitswap is often used in conjunction with atawaruq. Also, Deutsche Bank has publisheda white paper on how it structured aninnovative product using wa’ad (promise)features that allows Shari’ah-compliantinvestments to reference a wide range of asset classes, including indices.

There are over 260 Islamic scholars aroundthe world involved with banking in someway, although there are only around 20 whoare recognised globally. Of these, a dozen orso regularly deal with Western banks. Theobjective of having an Islamic scholar toreview a structure is to obtain a fatwaregarding the Shari’ah compliance of theproduct. One respected scholar shared his viewpoint on the concept of Shari’ahcompliance with the conference. He pointedout that Shari’ah consists of two parts: thepractical; and the theoretical representingbelief based on faith. When a product isaccepted as being Shari’ah compliant itmeans that it is in-line with the practicalaspects and therefore doesn’t offend Islam.This is not the same as a product beingShari’ah based – one that incorporates a full partnership between the bank and thecustomer for their mutual benefit, includinggenuine assistance as well as sharing of theprofits and risks. In this scholar’s opinion,Islamic banking has grown from almostnothing 30 years ago to a significantbusiness today. Currently, he feels, it is tryingto copy the conventional banking productsthat have been developed over hundreds ofyears. He questions whether the aim shouldbe to become Shari’ah based, rather thansimply Shari’ah compliant.

Although the sukuk is regarded by some as a ‘new’ product, one speaker pointed out that it is, in fact, one of Islam’s oldestinstruments. There are references datingback to the Islamic Caliphates about the‘sakk’ (whose plural is ‘sukuk’). The wordmeans ‘note or certificate’ and relates toancient traders acquiring additional capitalthrough mudarabah when setting off ontrading missions to India and other places.Modern structures are more complex.

The London IslamicFinancial Services SummitInvestors, lawyers, accountants and bankers gathered at theBarbican Centre in London on 29th March 2007 to discussdevelopments in Islamic banking products and services. The summit was endorsed by the IIBI.

CONFERENCE REVIEW

IIBI 23www.islamic-banking.com

RATINGS AND INDEXES

Islamic Banks, Financial Institutions & Financial Instruments

Below is a monthly list of the latest long- and short-term credit ratings for each Islamic financial institution and financialinstruments monitored by Capital Intelligence (CI), an international credit rating agency. Detailed information on ratingprocesses and definitions can be found on the CI’s website www.ciratings.com

1st April 2007

CURRENT RATING

FOREIGN CURRENCYFINANCIALSTRENGTH

SUPPORT OUTLOOK SINCELONG TERM SHORT TERM

ISLAMIC BANKS

Abu Dhabi Islamic Bank A- A2 A- 2 Positive Feb 2006

Al Amin Bank BB+ B BB+ 2 Positive Oct 2006

Al-Baraka Islamic Bank (Bahrain) BB+ A3 BB 2 Stable Aug 2006

Al Rajhi Banking & Investment Corp. A+ A1 A 2 Stable Jul 2006

Arab Islamic Bank NA NA B+ 3 Stable Oct 2005

Bahrain Islamic Bank BBB A3 BBB 3 Stable Nov 2006

Bank Islam Malaysia BBB- A3 BB+ 2 Stable Oct 2006

Faysal Bank (Pakistan) B+ B BB 2 Stable Aug 2006

Gulf Finance House BBB A2 BBB 3 Positive Nov 2006

Jordan Islamic Bank for Finance & Investment BB B BBB- 3 Stable Oct 2006

Kuwait Finance House A A1 A 2 Stable Oct 2006

Qatar International Islamic Bank BBB A2 BBB 3 Stable Nov 2006

Qatar Islamic Bank BBB+ A2 BBB+ 3 Stable Oct 2006

Sharjah Islamic Bank BBB A3 BBB 3 Positive Jan 2006

Shamil Bank of Bahrain BBB A3 BBB 2 Stable Nov 2006

The National Commercial Bank A+ A1 A+ 1 Stable Jul 2006

Tadhamon International Islamic Bank B- B BB- 2 Stable Nov 2006

CORPORATE RATING

OUTLOOK SINCELONG TERM SHORT TERM

FINANCIAL INSTITUTIONS

Al Tawfeek Company for Investment Funds Limited BBB A2 Stable Oct 2006

A'Ayan Leasing & Investment Co BBB- A3 Stable Feb 2006

Grand Real Estate Projects Co BB B Stable Nov 2006

Investment Dar Company BBB A3 Stable Jul 2006

Khaleej Finance & Investment Company BB+ A3 Stable Jan 2007

BOND RATING

OUTLOOK SINCELONG TERM SHORT TERM

FINANCIAL INSTRUMENTS

Commercial Real Estate Sukuk Company A- A2 Stable Oct 2006

KCMCC Sukuk Company BBB A3 Stable Jul 2006


Bahrain Fort: The old and the new


NEWHORIZON Muharram–Rabi Al Awwal 1428 COUNTRY FOCUS: BAHRAIN

Although the practice of Islamic finance inthe Muslim world dates back to the MiddleAges, it’s only the last few decades that haveseen the globalisation of Islamic banking.Islamic financial institutions are nowrightfully recognised as fully-functionalcounterparts of conventional ones. Today,the market size of this industry is estimated at $250–300 billion spread over around 75 countries.

The Kingdom of Bahrain is traditionallyconsidered to be the hub of Islamic bankingand, according to the Central Bank ofBahrain (formerly the Bahrain MonetaryAgency or BMA), ‘is proud to play host tothe largest concentration of Islamic financialinstitutions in the Middle East region’.Indeed, a country with an area of only 665square kilometres (253 square miles) hasbecome one of the leading Islamic financialcentres in the region having licensed 33financial institutions of this type, including26 banks and seven investment business firms and financing companies.

The history of Islamic banking in thecountry dates back to 1978, when the firstIslamic bank, Bahrain Islamic Bank, waslicensed. The industry’s growth in the yearsfollowing the bank’s establishment was slow.One of the triggers which prompted a rapiddevelopment of Islamic finance was the Gulfwar, which broke out in the early 1990s. It stimulated the Islamic finance market by pushing up oil prices and boostingrevenues, thus increasing the demand forIslamic tailored investments. Since then, theworld in general and Bahrain in particularhas witnessed a mushroom growth and rapid development of Islamic financialinstitutions.

Pakistan has adopted a Shari’ah-compliantbanking system alongside its conventionalcounterpart. The entire banking system of Sudan has made its practices Shari’ah-compliant. A number of conventional banksin the Muslim world have converted toIslamic banking, with Sharjah Islamic Bankbeing one example. In 2005, the formerSharjah National Bank announced its ‘newvision and commitment’, becoming the firstand only bank in Sharjah offering Islamicbanking products and services to the public.

Adopting such practices has not beenconfined to the Muslim countries and has spread to the Western world. In mid-2004, the first UK-based entirely Shari’ah-compliant bank, Islamic Bank of Britain,was established, followed by the EuropeanIslamic Investment Bank in 2005. A similarproject is now in the pipeline in France.Large conventional banking conglomerates,including Lloyds TSB, have capitalised on this niche by establishing Islamicdepartments. And global financialinstitutions such as Citigroup and HSBC have created fully-fledged Islamicsubsidiaries operating in various parts of theworld, including the Kingdom of Bahrain.‘They have recognised the importance ofIslamic banking,’ says Abdulrahman AbdullaAl-Sayed, director of Islamic FinancialInstitutions, Central Bank. ‘And althoughthe number of Islamic banks has increasedsignificantly, there is still a very goodpotential for them to grow further in the region and worldwide.’

However, Bahrain is not focusing solely on Islamic banking. It also encourages thepresence of conventional banks by pursuinga dual banking system. ‘There is no reason

Bahrain: Middle Eastern promiseAs the world’s Islamic finance industry continues to grow and mature, striving for moretransparency and a wider range of products and services, so does the banking market ofBahrain. Innovation, modernisation and regulation are the three cornerstones of the country’smain regulator, the Central Bank of Bahrain.

Central Bank is very potent in imposing and supervisingbanking activities. That is why Shamil Bank chose to be headquartered here.Abdulnasser Ali Bukamal, Shamil Bank



why both types of banks cannot co-existsuccessfully in the Kingdom of Bahrain’states Al-Sayed. ‘We offer them equalopportunities and provide equal treatment.’According to him, there has been an increasein conventional banks in the country, butthis increase ‘hasn’t been as significant asthat of their Islamic counterparts’.

There is a lot of interaction going onbetween Islamic and conventional banks inBahrain. A large number of specialists fromthe latter move to work at Islamic financialinstitutions. ‘There is no Shari’ah law thatsays that Islamic banks should only recruitMuslims,’ states Al-Sayed. The staff is hiredaccording to the universal rule of judgingpotential employees by their knowledge andabilities, not by their faith. Conventionalbankers can ‘provide skills and experience’,given the fact that conventional banking ismuch older than Islamic banking. ‘Islamicbanking, not Islamic transactions,’emphasises Al-Sayed. ‘Islamic transactionshave existed for over a thousand years, but they were done on an individual basisbetween individuals. So, the concept is there to take and develop into products.’In the course of this development (inaddition to traditional Islamic products) the conventional banking specialists use some conventional products as a basis and then ‘modify them in order to make themShari’ah-compliant’. Al-Sayed goes on togive an example: ‘Let’s take a credit card.Ten years ago, everybody would say therewas no way it could be Shari’ah-compliant,as it involves ‘selling’ cash and there is aprohibition of direct cash financing inIslamic banking. But Islamic banks are very innovative and today, there is a range of Shari’ah-compliant credit cards, based onmurabaha [the bank buys and sells the itemsrequired by the customer], ijara [leasing] and so on.’

Needless to say, the Bahraini Islamic bankingsystem is ‘booming’. In 2006, its total assetsreached $20 billion compared to just over$10 billion two years ago. In 2006 alone,three new Islamic banks were grantedbanking licences (Al Salam Bank and UnitedInternational Bank (UIB) are amongst thenewcomers), with another two a year earlier.‘There are more banks in the queue waiting

for the Central Bank’s approval,’ saysAbdulnasser Ali Bukamal, senior manager,banking operations, and money launderingreporting officer (MLRO), at Bahrain-basedShamil Bank.

Shamil Bank of Bahrain is one of the oldest Islamic banks in the country. Itlaunched Shari’ah-compliant operationsback in 1982, when it was established as anoffshore banking unit, only a few years afterBahrain Islamic Bank was licensed. In 1994,it obtained a commercial banking licence and became a fully-fledged Islamic financialinstitution. Today, Shamil Bank has ashareholding equity of $353.4 million (as of 31st December 2006), seven branches and 14 ATMs in the country, and the holdersof the bank’s cards can use ATM facilities inany of the GCC (Gulf Cooperation Council)countries. It also maintains a presenceoverseas (including China and Saudi Arabia) through its associated and affiliated companies.

The bank provides financial and investmentservices for both corporate and retailcustomers. Facing the competition from itscounterparts, it has expanded the range ofstandard products offered by the majority ofthe Islamic financial institutions. In additionto such services as murabaha, mudarabah(profit loss sharing), musharakah (jointventure), ijara and istisna (contractualagreement for manufacturing goods andcommodities), Shamil Bank has introducedal-ruban (credit card), commodity murabaha(personal loan, cash money) and tawaruq(personal loan). To date, it is the only bankin Bahrain offering al-ruban services, witharound 2000 takers so far. As for tawaruq, it is ‘a newly developed product’ not just for the bank, but for the Bahrain’s Islamicfinancial market as a whole. ‘Now we canfully compete with conventional banks,’states Bukamal.

Shamil Bank’s database consists of bothMuslim and non-Muslim customers, andIslamic banking is proving to be more andmore popular among people of non-Islamicfaith. But what is the secret of its success?Bukamal gives his outlook: ‘When somepeople approach a certain bank, it is notdone only from a religious point of view.

We have a number of prominentShari’ah scholars. But we needa new generation of specialistswho, in addition to knowledgeof the Shari’ah law, also have a background in banking,especially practical banking.Abdulrahman Abdulla Al-Sayed,Central Bank of Bahrain

COUNTRY FOCUS: BAHRAIN



The costs are also considered, and thecustomer will go where the costs are lower.’In times of intense competition in thecountry’s banking market today, it is logicalfor a bank to offer favourable conditions.

Al-Sayed expounds his opinion: ‘Somepeople deal with Islamic banks simplybecause they are Muslim and they wish to transact in accordance with their faith. Others are looking for investmentopportunities. And that’s where non-Muslims come in. Islamic banks areinnovative and they introduce products that offer an attractive return to customers.So, innovation together with the yield that the banks are offering has contributedpositively towards attracting non-Muslims.’

Encouraging innovations is one of thekeystones of the Central Bank’s policy. Every Islamic bank based in the country has its own Shari’ah board – a mandatoryauthority which consists of a minimum ofthree people. It is up to the board to advisethe bank on various aspects of Islamicfinance and to decide which products andservices are Shari’ah-compliant. The CentralBank, in its turn, also has a supervisoryShari’ah board, but this has a different role.It deals with the issue of sukuk (governmentbonds). The Central Bank does not centralisethe decision-making processes concerningShari’ah compliance issues of individualbanks, and it does not interfere in theseprocesses.

Such practice is different in some otherIslamic financial centres, such as Malaysia,where the Central Bank (Bank NegaraMalaysia) – or to be more precise itsShari’ah board, has to approve anyinnovations in Islamic finance before theyare introduced to the market. In addition,Shari’ah boards of all of the banks in thecountry are ‘to some extent subject to reviewby the Central Bank’. ‘This does not seempractical for Bahrain,’ says Al-Sayed. In hisview, Bahrain’s approach ‘does not hinderinnovation or delay the process oftransactions’.

Creating a favourable environment for theinnovations has proved to be worthwhile.The product range of Islamic finance is

expanding rapidly. The Bahraini bankingmarket has witnessed the emergence of theaforementioned Shari’ah-compliant creditcards and a recent introduction (although, as with many other Islamic products, itsroots go back centuries), the tawaruq orpersonal loan service referred to earlier by Bukamal.

However, this policy is not the only factor attracting financial institutions to the Kingdom of Bahrain. Al-Sayed thinks there are several reasons for suchrecognition. ‘First of all, it is humanresources,’ he says. ‘Bahrain has individualswho are very experienced in banking ingeneral and have extensive knowledge of it. And I am comparing Bahrain not to the GCC only, but to the whole region.’

Due to the country’s long tradition infinance, the Central Bank offers its expertiseto specialists both within the country andoutside it. The Bahrain Institute of Bankingand Finance (BIBF) was set up under theauspices of the Central Bank back in 1981 to provide training and education in variousaspects of finance, such as conventional and Islamic banking, IT, accounting andregulation. Central Bank has advised anumber of countries on regulation matters,including the USA, UK, Sudan and Malaysia.Such international acknowledgement makesAl-Sayed very proud of Central Bank’sachievements. ‘They approached us because they knew that Bahrain’s banking regulation was in compliance with the best international practices.’

And on the ground the banks arecontributing to this educational process too. Shamil Bank, for example, is known as ‘a training bank’ both in Bahrain andoutside it. As one of the oldest and mostwell-established Islamic financial institutions in the country, it offers its expertise tobanking specialists and graduates. ‘Providingsufficient training has always been ourpolicy,’ states Bukamal. With such a rapidgrowth of Islamic banks, there has to beenough trained personnel to work in them.‘Handling of Islamic transactions anddocumentation is not easy, and far from the straightforward practices at theconventional banks,’ says Bukamal.


Abdulnasser Ali Bukamal,Shamil Bank

Having worked at the Shamil Bank for 21 years, Bukamal himself has plenty ofknowledge and experience to share. He is a private instructor at the BIBF in additionto his main job at Shamil Bank, lecturing in Islamic international trade finance,documentation structure for financingfacilities and teaching the advanced IslamicBanking Diploma Programme at eveningclasses.

However, there is still room forimprovement in Islamic finance educationand training, thinks Al-Sayed. Shortage ofShari’ah scholars remains a challenge for thecountry. ‘We have a number of prominentShari’ah scholars,’ he says. ‘But we need a new generation of specialists who, inaddition to knowledge of the Shari’ah law, also have a background in banking,especially practical banking.’ The CentralBank encourages such ‘skilled talentdevelopment’ in every way possible.

A strong regulatory framework is anothercornerstone of the Central Bank’s policy.‘Central Bank is very potent in imposing and supervising banking activities,’ saysBukamal. ‘That is why Shamil Bank chose to be headquartered here. Bahrain is a good base for a bank’s head office, and itsbranches can be located in any of the GCCcountries or outside.’



‘Our regulations are of the highest standardsof the best international practices,’ assuresAl-Sayed. ‘But at the same time they areflexible.’ He explains: ‘We are in constantongoing consultation with the industry.

Central Bank does not introduce any local orinternational regulations without consultingthe financial services industry first.’

This proved to be very topical whenintroducing Basel II requirements (theinternational agreement on the amount of capital needed by a bank; a refinedversion of Basel I). At the moment, Bahrainis in full compliance with Basel I, with theimplementation work of Basel II in progress.It is expected to come into effect in January2008. ‘Both conventional and Islamic bankshave been involved in the process for the last12 months,’ says Al-Sayed. Recently, theCentral Bank has sent out the consultationpapers on the introduction of Basel II to allthe banks in the country, and is now ‘waitingfor their comments’. And with the CentralBank leading the way, the banks on theground are striving to meet all the necessaryBasel II requirements. Shamil Bank, forexample, is seeking help in this matter fromits auditor, PricewaterhouseCoopers, who,according to Bukamal, ‘is working closelywith the risk managers on this issue’.

Both conventional and Islamic banks aresubject to the same supervisory regulations,including those of the Basel requirements.However, Islamic banking has ‘uniquecharacteristics’ that make it somewhatproblematical to be compliant with exactlythe same regulations when it comes to Basel. Islamic transactions are dissimilar to conventional ones. ‘And it’s not just thetransactions,’ states Al-Sayed, ‘it’s the wholerelationship between the customer and thebank that is different.’ He gives an examplebased on a mudarabah contract: ‘When acustomer brings money to a conventional

bank, he/she is generally guaranteed areturn. But in an Islamic bank when amudarib (manager) and a customer, who is a fund provider, draw up a mudarabahcontract, there is no guarantee on return.

If the investment is successful, a bank and a customer share the return; if not, acustomer bears losses. An Islamic bank isnot liable for the losses, except in the case of misconduct or negligence.’ This aspectchanges an asset–liability mix which, in its turn, impacts the capital adequacyrequirements. Therefore, ‘the capitaladequacy is treated differently in Islamic banking’.

In order to cater for these differences, the Prudential Information and RegulatoryFramework (PIRI) was devised. The IslamicFinancial Services Board (IFSB) – of whichBahrain is a member – has issued standardsin a number of areas, including capitaladequacy, corporate governance and assetmanagement. And there are two morestandards to come which will cover Pillar II and Pillar III requirements (marketdifference and supervisory review). ‘IFSBused the fundamental principles of Basel II,and modified them to be suitable for theIslamic banking market’, says Al Sayed.

So, whilst the conventional banks operatingin Bahrain must fully comply with Basel II,their Islamic counterparts must comply with‘the combination of IFSB standards andBasel II’. ‘This is not a deviation from Baselrequirements,’ emphasises Al-Sayed, ‘butrather an enhancement and addition to them to reflect the nature of the uniquecharacteristics of Islamic transactions and the bank–customer relationship.’

Bahrain was the first country to introducethe regulatory framework specifically forIslamic banks in 2001. But even prior tothis, according to Al-Sayed, it was ‘the firstcountry in the world to request the Bahrain-based Islamic banks to comply with AAOIFI[Accounting and Auditing Organisation for Islamic Financial Institutions]’. Thisorganisation was founded in 1990 in Algiers, with its main purpose being ‘to issue accounting and auditing standards’ and governance norms within the Islamicfinance sector. Al-Sayed thinks thatcompliance with AAOIFI ‘gives the localmarket more disclosure, makes the financialstatements more transparent and reflects theactual transaction’. Bahrain’s example wasfollowed by Sudan, Jordan and Qatar, whoalso adopted the standards for their banking markets.

As a matter of fact, Bahrain has been thepioneer in a number of Islamic-relatedactivities. The country’s government was at the forefront in issuing sukuk through the Central Bank. It was the first to releaseIslamic securities, and to date it has issuedover $1 billion worth of ijara sukuk (Islamicleasing bonds). This initiative has proved tobe successful and has resulted in other GCCcountries turning to Bahrain to manage theirsukuk programmes.

The Kingdom of Bahrain hosts a number of supporting organisations for Islamicfinancial institutions. In 2001, the GeneralCouncil for Islamic Banks and FinancialInstitutions (GCIBFI) was founded in thecountry. One of its major purposes is togather accurate information and data on the Islamic finance industry.

A year later, the Liquidity ManagementCentre (LMC) was established. This seeks

Central Bank does not introduce any local or internationalregulations without consulting the financial services industry first.Abdulrahman Abdulla Al-Sayed, Central Bank of Bahrain


Central Bank,Bahrain



to develop an active secondary market for short-term Shari’ah-compliant treasuryproducts and to create additional investmentopportunities for financial institutions andinvestors. This centre, ‘the first of its kind’,in the words of Central Bank, commencedits operations in 2003.

Also, in 2002, the International IslamicFinancial Market (IIFM) launched itsoperations. This non-profit organisation wasa result of an agreement between the CentralBanks of Bahrain, Indonesia and Sudan, theIslamic Development Bank, the LabuanOffshore Financial Services Authority(representing Malaysia) and the Ministry of Finance of Brunei Darussalam. The mainaim of IIFM is to ensure further growth anddevelopment of the Islamic financial marketin compliance with Shari’ah law.

As mentioned above, Bahrain is a member of IFSB. The initiative to establish thisorganisation was originally proposed in2000, at the Regulation of Islamic Bankingconference held in Bahrain. Governors of the Central Banks and senior officials from

various countries, including Bahrain, Iran,Pakistan, Sudan, Egypt, Jordan andMalaysia, put forward the idea of creating a supervisory board for supporting andadapting the international standards forIslamic financial products and differentaspects of Islamic finance.

One of the most recent supportingorganisations to be based in the Kingdom ofBahrain is the International Islamic RatingAgency (IIRA). This is an independent groupthat, according to the country’s CentralBank, ‘will help to increase transparency and accordingly provide more confidence to investors, regulators and to the public at large’.

All in all, recent years have seen a lot ofchanges on the Bahraini financial marketfront. 2006 was proclaimed a ‘milestoneyear’ by the country’s Central Bank. Thatyear, it took over ‘the role of a central bankand a single regulator for the country’sfinancial industry’ from the BMA. Thismeans that the Central Bank’s policies cover Bahrain’s banking, insurance and


Manama, Bahrain



investment business and also the capitalmarkets. Since its activity instigation,Central Bank has carried out a number ofreforms in these sectors. It has introduced ‘a new, modernised licensing framework forfinancial institutions’ which became effectivein October 2006. There are five licenseecategories that comprise the new framework:conventional banking, Islamic banking,insurance, investment business andspecialised licensees. The sub-categories havealso undergone changes, and there are nowtwo sub-categories instead of three: ‘retailbank’ (instead of ‘full commercial bank’)and ‘wholesale bank’ (instead of ‘offshorebanking unit’ and ‘investment bankinglicence’). According to Al-Sayed, one of the main reasons for this is ‘lifting therestrictions on dealing with residents and non-residents’.

The country’s payment system, ‘the lifelineof the national economy’, as it has beendescribed by the Central Bank, is also beingmodernised. The implementation of the Real Time Gross Settlement (RTGS) systemwhich ‘facilitates inter-bank payments andsettlements in real-time online mode’ is avital component of this project. According to the Central Bank, in addition to its mainpurpose, RTGS will also ‘take care of retailfund transfers on behalf of banks’customers’. In the course of the project, the system will be seamlessly integrated with the Securities Settlement Systems (SSS).The latter will assist in the ‘real-time onlinesettlement of all government securities’. BothRTGS and SSS are expected to go live in thefirst half of 2007. To ensure that all banks inthe country are ready for these innovations,the Central Bank is providing education andtraining for the users, with the second phaseof this task currently underway. Dr AbdulRahman Saif, executive director, bankingoperations, at the Central Bank, is reportedas saying: ‘We are very pleased with theprogress made by the banks. We welcomethe support from the industry inimplementing such a project of national importance.’

Anti-money laundering legislation is alsohigh on the Central Bank’s agenda. ‘Theanti-money laundering laws are gettingtougher and tougher,’ says Bukamal. Indeed,

the Central Bank is tightening its grip onAML by imposing stricter regulations onbanking activities, especially internationalpayment transactions. Middle East andNorth Africa (MENA) countries, includingBahrain, adopted FATF (Financial ActionTask Force on Money Laundering)recommendations concerning AML andKYC (Know Your Customer) so that theycould continue dealing and competing in the global market. Furthermore, a MENA-FATF centre was created in 2005 withheadquarters in Bahrain. The centre claims a 90 per cent decline in illegal moneylaundering activity in the region since it came into existence.

Being true to its policy, the Central Bank confers on the subject of AML withrepresentatives from the banks operating in the country. Bukamal and other MLROsfrom all Bahrain-based banks attend regularmeetings held by the executive director ofthe compliance unit at the Central Bank. ‘Wediscuss relevant issues and consider varioussuggestions on how to improve things andavoid any concealing of dirty money in thecountry’s banking system,’ says Bukamal.

As Bahrain’s banking system continues to surge ahead, with year-on-year growth of an average of 18 per cent for the past two years, so does the country’s capital,Manama. Cranes are dominating thehorizon wherever you look, erecting moreultra-modern buildings for banks, hotels andbusiness centres. Manama is without doubtone of the leading financial centres in theMiddle East and it seems it has ambitiousplans to go even further and become numberone. A grand project of building BahrainFinancial Harbour on 380,000 squaremetres of reclaimed land aims to create acomplete financial city, a self-containedcommunity, in the centre of Manama.

With the continuing transformation anddevelopment of the geographical andfinancial landscapes of the Kingdom of Bahrain, the strategy of encouraginginnovations while sustaining a strongregulatory framework, and its extensivetradition in finance, the country is bound to retain the title of one of the foremostfinancial centres in the region.


Shamil Bank of Bahrain,Manama, Bahrain



Bank Al Jazira’s Takaful Ta’awuni programme is the first and only Shari’ah-compliant protectionsavings plan located in Saudi Arabia. Tom Alford spoke to divisional head, Dawood Taylor.

‘We are the market,’ says the head of Bank Al Jazira’s (BAJ) Takaful Ta’awuniprogramme. It’s not an idle boast, but a fact; it is the only organisation offeringShari’ah-compliant protection savings plansfor the people of Saudi Arabia. But new laws coming on stream from the country’sbanking and insurance regulator, the SaudiArabia Monetary Authority (SAMA), maysee competition hotting up in this alreadylively global market. Bank Al Jazira isprepared.

Since the Islamic Insurance Company ofSudan was established in Sudan in 1979 as the first formalised takaful provider, theconcept of Islamic insurance has expandedto fill an evermore appreciative market. To date, around 85 providers, covering 26countries from the Bahamas to Yemen, offertakaful products. In doing so, they providean ethical financial service free from theconcepts of riba, maisir and gharar.

The desire for Muslims, and indeed anincreasing number of non-Muslims, toengage with financial products affording

such benefits is becoming increasinglyevident. Commercially, world takafulcontributions are estimated to be on the risein no uncertain terms. Dubai-based Salama,the largest Islamic insurance operator fortakaful and re-takaful (Shari’ah-compliantreinsurance) in the world, expectssubstantial growth during the next five yearsin the global market. It currently values thismarket at $1.7 billion and fully anticipatesthis figure to grow to between $7.5 billionand $10 billion, with sustainable growthlooking likely to hit an average 20 per cent per year over the next five to ten years,particularly in the major markets which fallin Malaysia, Indonesia, the GCC and otherArab countries.

The upsurge of customer interest in ahitherto sparsely populated takaful providermarket has created a rush of interest fromthe big international insurance players suchas Allianz, AIG, Prudential and Axa. Andbased on a Shari’ah dispensation, there is now a corresponding uptake of interest in providing re-takaful for life policies,something which BAJ is in the process ofswitching to. ‘We’ve gone from not enoughsuppliers, to too many,’ Taylor jokes.

Already, major international players haveemerged in the general takaful reinsurancefield, with Tunis-based Best Re emerging asthe world’s largest re-takaful company; theSalam-owned business operates in more than 60 countries.

But as a player in the Middle East, a regionaccounting for around 36 per cent of theglobal takaful market, BAJ’s unique life-based offering is still something of a national treasure.

The bank and its insurance offering operatetotally on a Shari’ah-compliant basis – thereis no conventional aspect whatsoever. As afully Islamic insurance offering, it engages inTakaful Ta’awuni, a system based on mutualco-operation for financial assistance andprotection. Naturally it is informed by theQuranic principles of Ta’awuni, or mutualassistance. Takaful Ta’awuni is thereforeBAJ’s response to what the Holy Quran asks Muslims to do on a co-operative basisto achieve the interests of the ummah (thediaspora of Islam), avoiding forbiddenpractices. Although the BAJ approach doesnot yet cross international boundaries, it islocally inclusive, encouraging membership of its schemes from all elements of thecommunity in Saudi Arabia, whether local or expatriate, individuals or families, businesses or groups.

BAJ’s Takaful Ta’awuni began life in 1999. Although SAMA rules on entry to themarket have recently become more unified,at that point any insurance provider offeringa long-term investment element had to bemanaged by a bank. According to Taylor, a period of ‘significant research anddevelopment’, and the co-creation (with aMalaysian vendor) of a bespoke IT system to match, allowed the first products to bebrought to market by the bank in 2001.

The provision of this product-set follows the Islamic wakala model, in which thecustomer effectively appoints the insuranceprovider as a representative to undertaketransactions on his or her behalf – it issimilar to granting power of attorney.

First line of protection

The needs are very much thesame, whether you’re a Muslimor non-Muslim.

INTERVIEW: BANK AL JAZIRA

Dawood Taylor,Bank Al JazIra



In understanding that there is little room or need to go beyond the product-set of theconventional market, BAJ currently offers an education plan, a retirement plan, groupprotection for employees (covering deathand disability), savings and investmentplans, protection plans, a capital plan, agroup retirement plan, a loan repaymentcredit plan, and a waqf plan (waqf is similarto an endowment or trust as defined incommon law). And through the concept of tabarru (which means to give away)customers are able to donate sums as they wish.

Despite not breaking any serious boundarieswithin the panoply of general insuranceofferings, BAJ effectively stole a march onthe competition by virtue of being the onlybank offering an investment-based Islamicinsurance product in Saudi. Since inception,BAJ has moved forward quickly in terms ofcustomer numbers. It now claims to protectaround 16,000 individual and 25,000 groupcustomers, the latter drawn from around 40corporate clients. Even so, Taylor admitsthat, with a Saudi population of around 26 million, ‘we’re only just scratching thesurface’. It’s the same for everyone though.Indeed, Saudi penetration for life insuranceby Swiss Re, the world’s largest life andhealth reinsurer, stands at just one tenth of one per cent.

But Taylor notes that BAJ’s efforts have been ‘very successful’ on a small businessmodel. In 2006 it scooped the EuromoneyLife Takaful Award for its efforts. The bankhopes to expand this success in a number of ways. It currently operates through fiveoffices, distributed evenly across the majorSaudi cities. Another eight will be openedthis year, with staff already being recruited.It also hopes to ‘significantly extend’ itsagency network. Some 400 staff work from these outlets, around 320 of whom are sales people.

Overall, Taylor predicts that volumes of life assurance and savings will increasesubstantially over the next three to five yearsin the local market, as will the numbers ofmarket players. This, in part, will be drivenby the new licensing laws which havealready seen three new Saudi takaful


Saudi Arabia

As an Islamic financial advisory companyselling individuals and corporates productsfor protection, savings and investment, BAJ’scurrent range of Takaful Ta’awuni productslooks remarkably similar to those ofconventional insurance providers. And whyshouldn’t it, asks Taylor? ‘The needs are verymuch the same, whether you’re a Muslim or non-Muslim.’ The conventional market,having enjoyed a 300-year or so head starton takaful, has obviously used the time togreat advantage. It knows what people want and need. As a result, Taylor says theproducts on offer in the takaful industry donot ‘vary significantly’ from the products inthe conventional industry. Indeed, apartfrom being Shari’ah-compliant, he asks‘what would you come up with as beingunique?’ It’s a fair point.

However, there are a few culturally-informedproducts amongst the usual health, motorand pension-style general takaful offerings,and BAJ knows its market well; one of itsbiggest sellers is a marriage plan to helpoffset the vast expense of a typical Saudiwedding. But even here, Taylor is awarethat, ‘at the end of the day, it is still a savings plan’.

There is a good reason for adopting thismodel, notes Taylor. It revolves around ‘aclear separation or segregation’ between theclient and the service provider so all businessexpenses are handled by the operator. This,he says, ‘overcomes the [very topical] issueof the operator participating in surplus’, aproblem inherent in mudarabah, the formermodel of choice for takaful providers(mudarabah is a kind of profit and losssharing venture between the insurancecompany and the investor). ‘It’s a muchmore transparent contract,’ he observes.

Much to its credit, BAJ was ‘at the forefront’of the development of the wakala approachto takaful. And it has proven most popular.In double-quick time, it has spread far and wide. ‘Just about every other takafuloperator that has come into businessthroughout the world has followed ourlead,’ Taylor remarks. Of course, the bank does not stake a claim to being theoriginator of wakala –it is an ancient Islamiccontract system – but it has clearly played a vital role in changing the shape of themarket, something of which it is justlyproud.

The two current methods of moving beyond a provider’s natural reach, whether within or beyond the borders, are either throughbancassurance, which delivers the benefit ofa big bank network and corresponding clientbase, or through an agency distributionmodel. ‘Because we are a small bank, we’veadopted the latter to increase the size of ourdistribution capability,’ says Taylor, mindfulnot to dismiss the former method as apossibility.

However the market moves forward over the next few years, BAJ’s Takaful Ta’awunidivision will always be the first of its kind in that country. ‘We believe our success hasshown our competitors that you can sell aShari’ah-compliant life insurance savingsproduct in Saudi Arabia where people havefailed with conventional products,’ statesTaylor.

Indeed, most types of insurance are abouttrust, and trust only comes with time. As theestablished player in the region, on that basisalone, BAJ may well prove to be the first lineof financial protection for many. But giventhat it is clearly open to taking on newchallenges, this is unlikely to be the onlyreason for its progression.



operations licensed in as many months.However, these recent changes in the legalenvironment have not changed any of BAJ’sdevelopment plans in terms of how it wantsto progress its business. Taylor is adamantthat the bank would be aiming for much thesame rate of development regardless ofwhether the revised insurance business

structure had been implemented or not –although as part of the new requirements,BAJ’s Takaful Ta’awuni business is now ontarget to spin off from its banking parent.Come that day, it will transform into a fully-fledged IPO, creating a separatelycapitalised, but still totally Islamic-focused,legal entity. With its new-found agility, itshould then be in a position to meet head-on the anticipated growth in the number of market players.

The natural rise of interest in Shari’ah-compliant financial products is not yet at its peak though. To overcome this, BAJ is engaged in a programme of customereducation. ‘We still see this as a major issue,’ says Taylor, acknowledging that the insurance market has to all intents andpurposes been non-existent in Saudi untilnow. ‘Both the idea of protecting your familyagainst any financial disaster in the event of death or disability, and savings beyondGOSI [the General Organisation of SocialInsurance], are relatively new within anIslamic insurance wrapper,’ he notes.

But BAJ’s takaful offering tends to centre onmore complex ‘financial advisory products’.As such, having put sophisticated businessintelligence tools and targeted advertising‘on the back seat’ for the duration of thelicensing transition (‘we don’t want toconfuse the public’), it can only reallyeducate as it sells. Through direct customercontact in an advisory role it is buildinglong-term relationships and actually

pursuing a sophisticated in-depth insurancelifecycle route. As a result, Taylor states thatthe products often tend to be ‘bought notsold’, the distinction being a real mark ofsales success. Product complexity maydemand a greater degree of underwriting for life cover but Taylor is convinced ‘we are doing it the best way’.

And whilst the Takaful Ta’awuniprogramme is open to the two million strong Muslim and non-Muslim expatriatecommunity in Saudi, Taylor is realistic in acknowledging that these people may bekeen in theory, but they may harbour ‘somehesitation’ in buying a product that does notyet legally cross international borders. He is, however, totally convinced that takafulwill be subject to cross-border selling atsome point in the not too distant future.Of course, each operation will have to work within the regulatory framework ofeach country, the only bar perhaps being anindividual country’s acceptance of takaful in the first place. ‘It took a long time forEurope to have its cross-border arrangementset up [for conventional insurance],’ notesTaylor. ‘Takaful is still in its infancy so it’sdifficult to say when cross-border selling will happen.’

One potential barrier to expansion for BAJ and the new Saudi providers is size.

Takaful is still in its infancy soit’s difficult to say when cross-border selling will happen.


Al Jazira scoops Middle East award

In the first week in April 2007, BAJ’sTakaful Ta’awuni Division won the 2007Middle East Insurance Award for LifeInsurer of the Year. This is the onlyindependent award in the region thatrecognises excellence in all sectors of the insurance industry, as voted on by peers from within the industry.

Life insurance companies, bothconventional and takaful, were eligible for consideration in this category whichcovered the Gulf region, Yemen, Lebanon,Egypt, Syria, Jordan and Iran. Hosted bythe Dubai-based Policy Magazine, the

awards were held during 2007 InsurexConference on 2nd April 2007, at theGrand Hyatt Hotel, Dubai.

This award follows BAJ’s collection of the Euromoney 2006 award for Best LifeTakaful Operator worldwide, and theIslamic Finance Weekly 2004 award for Best Takaful Operator.

Mishari Ibrahim Mishari, chief executiveofficer and general manager of the bank,comments: ‘We see this development,inshallah, as only a beginning of betterthings to come’.



virtually all banking operations, and Islamicbanking is no different in this respect.Operational risk is also excluded although it can impact on credit risk as it involvesinadequate management controls overemployees and flawed internal reportingsystems. Shari’ah risk has less impact oncredit risk, as it arises from potentialinadequacies in Shari’ah governance. It is best dealt with separately, as it links tolegal risk, dispute settlement procedures and commercial arbitration, worthy topicsfor further research.

Types of credit risk and settlement offinancial obligationsThe two major types of credit risk are, firstly, the inability to make regular paymentsto service debt and, secondly, the failure torepay the principal advanced. The latter maybe repaid through regular instalments, at theend of the contract period, or subsequent to a service payments default that involves a breach of contract, necessitating thefinancing being recalled. The obligationsregarding repayment of principal will not bematerially different in a Shari’ah-compliantcontract, as it will usually be throughdeferred instalments in the case of murabaha,istisna or diminishing musharakah, and a lump sum final repayment in the case of an ijara wa iqtina hire purchase contract.

What is distinctive in Shari’ah-compliantcontracts is that there should be no referenceto riba or interest, but there will be referenceto mark-up payments in the case ofmudarabah, salam or istisna; sharing of profit in the case of mudarabah andmusharakah; and rental obligations in

IntroductionThe central issue addressed here is theimplications of Shari’ah compliance forcredit risk management. This concerns notonly Islamic banks, Shari’ah-compliantinvestment companies and takaful operators,but also conventional banks offering Islamicfinancial products. It also involves regulatorssince, if risks are not adequately identifiedand managed, resultant defaults couldjeopardise institutional stability and lead to systemic failures in financial markets.Effective risk management is a core bankingchallenge, and any failure by Islamic bankscould threaten not only their reputation, but also potentially that of the entireShari’ah-compliant financial services sector.The distinctive nature of Shari’ah-compliantfinancial liabilities and assets has implicationsfor risk management. Investment mudarabahdeposits cannot be guaranteed, whichpotentially conflicts with deposit protectioninsurance requirements. In murabahafinancing operations and with ijara operatingleases, Islamic banks take on ownership riskswhich conventional banks seek to avoid.More fundamentally, as Quranic teachingstresses leniency towards debtors, what are the implications for credit risk?

The discussion here is confined to credit risk, notably payments defaults. There are of course other types of risk not covered here– such as liquidity risk – which arise whenthere is a mismatch between the maturity of assets and liabilities. The latter arises with

Credit risk managementin Islamic finance

Professor Rodney Wilson is director of Postgraduate Studies at Durham University’s School ofGovernment and International Affairs. He is a consultant to the Islamic Financial Services Boardand also serves on the IIBI’s academic committee.

Based on Professor Wilson’s presentation at the IIBI’s monthly lecture, London, March 2007.

the case of ijara – all of which should behonoured under the contract.

Although parties to financial contracts areliable to fulfil the terms and conditions theyhave signed for, exemptions can be madewhere the late settlement of obligations is due to genuine financial difficulties. Theteaching of the Holy Quran is clear on this, and should be respected:

‘If the debtor is in difficulty, grant him timetill it is easy for him to repay. If ye remit byway of charity, that is best for you if ye only knew.’ Sura 2:280

The first part of this injunction can beinterpreted in the parlance of modern financeas justifying re-scheduling but keeping thesame financing method and terms with nopenalty to the borrower. The difficulty is ofcourse to define what constitutes a ‘genuinefinancial difficulty’. Where this is recognised,perhaps because of health problems, orunforeseen family circumstances, grantingmore time to honour financial obligationsmay be appropriate.

One way forward might be to provide theclient with a qard hasan loan, the only loanpermissible under Shari’ah, as no interest is involved, although there can be anarrangement fee and a recurrent charge tocover the administrative costs. The aim ofthis loan would be to enable the client tomeet their existing contractual obligations.This would benefit the bank because noprovision would then need to be made fornon-performing debt. Qard hasan is ofcourse unprofitable for Islamic banks, which

ACADEMIC ARTICLE



like conventional banks are not charities, as they have to provide dividends for theirshareholders and returns to their depositors.However, although such interest-free lendingonly constitutes a small proportion of Islamicfinancing, it can serve to reduce losses andthe write-down in asset values onceprovisions are made for impairments.

The second sentence of Sura 2:280 in theHoly Quran concerns debt remission, whichin modern financial parlance means debtforgiveness. This is obviously more costly for an Islamic bank than rescheduling, asthere is no longer the possibility of gettingthe principal returned or any further servicepayments on the bad debt. Assets will haveto be written down and provisions made fortheir impairment so that overall asset qualitycan be maintained, otherwise the bank’s ownrating will be downgraded and the financialregulator will be concerned. Remission istherefore costly, but if the root cause of thefailure of the client to meet their obligationsreflects inadequate credit screening, or indeednegligence, by the bank, then it should sharesome of the responsibility for what has gonewrong rather than passing on all the blameto the client.

Furthermore, where clients get intoadditional unanticipated difficulties involvingchronic health problems or terminal illness,then remission may be justified on grounds ofhumanity. Remission in these circumstanceswill bring goodwill from other clients andstakeholders in the Islamic bank, withdepositors prepared to accept a lower returnand investors a lesser dividend in such casesas long as the reasons are properly explained.

Default issues and payments safeguardsLeniency towards debtors can be abused and it is often difficult to distinguish betweenthose who cannot meet their obligationsthrough no fault of their own andunscrupulous defaulters who will not pay.There are potential moral hazard problems in Islamic finance, and those who would take advantage of any perceived leniency byIslamic banks. Shari’ah-compliant contractsassume a degree of trust between the parties,who should be governed by a higher moralauthority. Peer pressure can make borrowersacknowledge their responsibilities, as with

microfinance, and if all those involved in Islamic finance feel they are part of acommunity with shared religious values this should help ensure compliance withcontractual obligations.

For Islamic financing based on traditionalprinciples of profit sharing, such asmudarabah and musharakah, there are alsopotential asymmetric information problemsthat increase risk. The difficulty with profit-sharing arrangements is that there is alwaysthe possibility of the management of thecompany receiving the mudarabah andmusharakah financing overstating or beinglax with control over costs, including itswage costs, which will result in a lower profitbeing reported and shared with the financialinstitution. Rigorous auditing can alleviatethe financial reporting problem, but notnecessarily solve the conflict of interest overcost controls. With mudarabah the problemis compounded by only the financier, the rab-al-mal, bearing any losses, the argumentbeing that the mudarib or entrepreneur haslost his or her time and should not be furtherpenalised. Not surprisingly, this is a realdeterrent to mudarabah and musharakahfinancing.

With murabaha, salam, istisna and ijarafinancing, there can be no additionalfinancial charges levied in the event of late or non-payment since, if an Islamic bankbenefited from such charges, this wouldrepresent an addition to the principal owed and therefore would amount to riba.However, the Shari’ah boards of most Islamicbanks have approved a financial penaltybeing levied in the case of defaults, providedthat the proceeds are given to a designatedcharity; a just solution especially in the caseof unscrupulous defaulters where, arguably,immoral behaviour can be potentiallycleansed through charity. An Islamic bank is also justified in levying additional chargesto cover the costs associated with defaults.

There are, of course, a range of non-financialpenalties that can be applied in the case of apayments default, notably the blacklisting ofdefaulters so that they will not have recourseto financing from any other bank, includingconventional banks. In addition, it is possibleto seek redress through the courts involving

imprisonment or confiscation of passport, thelatter being an especially effective deterrent in the Gulf. Payments safeguards can also beprovided through the sequestration of assets,as murabaha and ijara involve financing realassets which can be seized if default occurs.This is very much a last resort, as an assetseized may not be worth much to thefinancier where it is a particular piece of equipment or commercial facility that was tailored to the client’s need and maytherefore be unattractive to other purchasers.For second-hand equipment the resale valuewill inevitably be limited.

Shari’ah restrictions apply to the type ofassets which can be used as collateral, as they should have usufruct and be halal.Conventional financial assets such as bondsor other securities that pay interest cannot beused as collateral, as an Islamic bank cannothold such assets, and conventional accountsreceivable are also problematic since thecurrent value of these is usually discountedby the interest rate and firms that rely heavilyon income from supplier credits function likeriba-based banks.

In the case of personal Shari’ah-compliantfinancing of a vehicle or home purchase, theamount provided is usually based on salary,with a requirement being that the income ofthe client is paid directly into an accountwith the Islamic bank making the advance. In the event of a default, the bank canimpose limits on personal access to salary until its claims are met.

ConclusionUnder Shari’ah, those facing real problems in meeting financial obligations should betreated with leniency, but that does not implythat Islamic banks should be regarded as a‘soft touch’. Indeed, arguably, they need to be more rigorous in their credit appraisalsystems than conventional institutions, andpractices such as credit scoring to determineeligibility for financing are entirely legitimateunder Shari’ah. Islamic banks are also quitejustified in pursuing cases againstunscrupulous debtors through theconventional courts and under English lawShari’ah-compliant financial contracts will be enforced as long as all the parties havesigned to indicate their consent.

ACADEMIC ARTICLE



Managing liquidity is essential if banks are to maximise theirearnings and control their risks. Conventional banks have theinter-bank market to help manage short- and medium-termliquidity, but what options are available to Islamic banks? DonBrownlow talks to Stella Cox, managing director at DDGI Ltd.

Liquidity management is the art of matchingan organisation’s incoming and outgoingcash-flows so that it can usefully invest anyexcess funds. Such investment needs to bemade in a way that provides a return whilestill allowing the organisation quickly andeasily to convert the investment back tocash. Conventional banks use the inter-bankmarket to buy and sell interest-bearinginstruments amongst themselves to meetliquidity requirements.

This inter-bank market is termed asecondary market because the instrumentsthat are traded are not bought directly fromthe issuers, as they are in primary markets,but are traded among participating banks.In this way Bank A, which has excessliquidity, may buy a ‘Treasury 8%, maturity2009 Gilt’ from Bank B, which wishes toraise cash to meet outgoings. The TreasuryGilt was originally issued by the UKGovernment and bought by an investorbank in what is known as the primarymarket. That note is then traded – starting with the investor bank – and moves backwards and forwards between others as part of the secondary market.

Islamic banks wishing to remain Shari’ahcompliant cannot utilise these interest-bearing inter-bank products. So Islamicbanks have developed alternative Shari’ah-compliant instruments and products. Themost popular have been those based aroundmurabaha, where the financial contracts aresupported by physical assets. The contracts

can be structured to achieve a risk/yieldprofile comparable to an inter-bank deposit.However, murabaha products have asignificant disadvantage in that many arenot particularly liquid and are thereforemore difficult to trade; others, because of Shari’ah stipulation, can not be traded at all.

Historical estimates indicate that up to 80per cent of Islamic banking assets are heldin murabaha and other similar products.The net effect is that Islamic banks cansuffer from asset concentration and fromlarge holdings of short-term, but illiquid,investments. As a result, Islamic banks needto maintain much higher levels of cash tomeet their liquidity requirements than theirconventional banking counterparts. Thisreduces their profitability. Of more concernis the future compliance of Islamic banks tothe Basel II accord, which requires a bank to provide capital according to the riskweighting of its assets.

Most market participants believe that the sukuk is the long-term way forward toenable Islamic banks to manage liquiditythrough a range of maturity profiles whilestill remaining Shari’ah compliant. Thisversatile instrument first appeared inMalaysia around 2000. Despite some initialscepticism in the Middle East, many of thestructures supporting sukuk issues have nowbeen accepted in this region. Although someobservers estimate that the total sukukmarket is now worth around $54 billion,international users only account for around$25 billion. In both Malaysia and theMiddle East, sovereign nations, banks andcommercial businesses have brought tomarket sukuk issues. At sovereign level, the Government of Bahrain has led the way with its regular, consistent issues of sukuk into the market.

However, there needs to be a secondarymarket before the sukuk can become an instrument suitable for liquiditymanagement. Such a secondary sukukmarket will allow banks to buy and thenreadily sell sukuk for cash, depending ontheir liquidity needs. Once this marketexists, Islamic banks will have a trueliquidity management tool that they can

The role of the sukuk inmanaging liquidity issues

ANALYSIS: SUKUK

Stella Cox,DDGI Ltd



use to manage their short- and medium-term investments and to adjust their risklevels.

Traditionally (if this word can be used todescribe such a new instrument), investorsbought part of a sukuk issue with theintention of holding that investment tomaturity. There are a number of reasons for this phenomenon, several of which arelinked to the small size and number ofsukuk issues. For example, there have beenso few benchmark issues, that a significantinvestor could take part in each new onewithout having to liquidate any existingsukuk holding. Also, should that investorsell an existing holding, there are few viablealternative issues with which to replace it.With sovereign issues offering a premiumreturn, there is little incentive to sell prior tomaturity. Without investors selling prior tomaturity, there can be no secondary market.

There are early signs that selling prior to maturity may be about to become more commonplace. In the last few months,several sizeable sukuk issues have attractedinternational attention. Abu Dhabi IslamicBank’s (ADIB) issue in November 2006 of$800 million sukuk bonds was rated A2 byMoody’s and A by Fitch. That issue wasoriginally planned as a $400–$500 millionissue but was increased due to demand. InMarch of this year, Dubai Islamic Bank(DIB) came to market with its first US dollar denominated sukuk worth $750million. That issue gained an A1 rating from Moody’s. Both of these issues werelisted on the Dubai International FinancialExchange and the London Stock Exchange.

No doubt fuelled by their internationallistings and investment grade ratings, these issues attracted investment, not only from Islamic investors but fromconventional investors around the world. In the ADIB issue, for example, the MiddleEast accounted for 50 per cent, Europeaccounted for 37 per cent, Asia accountedfor twelve per cent, and the US one per cent. There were also different types of organisations that invested, with banks accounting for 58 per cent of thetransaction, fund managers 31 per cent,corporates eight per cent and other investors

(including individuals) three per cent. Thepresence of investors from areas other thanthe Middle East, as well as fund managers,suggests that those investments were madefor strategic reasons and not simply to ‘buy-and-hold’. That in turn suggests that the investments will be sold once theirinvestment objectives are met. These saleswill add to the size of the secondary market.

Other factors will need to be present beforea secondary market can be considered to be efficient. These will include regulation,the presence of standard sized instruments,standard settlement procedures, andmarket-makers who are prepared to step in and provide liquidity to the market itself.Over the last 25 years or so, the Islamicbanking community has built infrastructureswhen they have been needed and this isanother such case in point.

Some Islamic banking centres, includingMalaysia and Bahrain, already have much

of the necessary infrastructure in place as a result of hosting parallel Islamic andconventional banking markets. Specifically,in the capital markets space, Dubai andLondon are keen to promote their depth ofmarket expertise, regulators, ready-madepool of investors and market supportprofessionals.

It will take time to build up a deepsecondary sukuk market. More sukukissues, made more frequently, would helpthat growth. Until now, many of the sukukissues have been ‘one-off’ events, introducedto raise money for a specific purpose.Regular and frequent issues with differentmaturity dates – along the lines of Giltissues in the UK or T-Bills in the US – wouldadd depth to the market. That depth wouldfacilitate banks buying and selling sukuk-based instruments ‘on demand’. Once that is in place then Islamic banks will be able to use the sukuk to invest excess cash andmanage liquidity to suit their needs.

The day-to-day management of the assetswill be performed by DIB, as managingagent. It will collect all rental and profitpayments from the lease and musharakahcontracts. It will pay DIB Sukuk Companyan amount sufficient to fund the requiredperiodic distribution amount to the sukuk-holders on each distribution date. Anyexcess payments from the co-ownershipassets will be paid to DIB as an incentivefee, while any shortfalls will be covered by DIB to ensure that the required periodic distribution amount is paid.

DIB has also agreed to purchase the DIB Sukuk Company’s interest in the co-ownership assets at a pre-agreed price on maturity. This will be the source of principal repayment.

In March of 2007, Dubai Islamic Bank(DIB) issued a $750 million sukuk. DIBwas founded in 1975 in Dubai and claimsto be the world’s first fully Islamic bank.For this sukuk issue, it was assisted byBarclays Capital, Citigroup and StandardChartered Bank. The issue gained an A1rating from Moody’s.

The structure of the issue was based ontwo entities, DIB and a special-purposecompany that was set up specifically forthe issue, called DIB Sukuk Company Ltd.That company was the entity that actuallyissued the sukuk certificates to investors(the sukuk-holders). The funds raised areused to buy assets consisting of lease andmusharakah assets (equity participations,profit and loss sharing) from DIB, with the two companies becoming co-owners in the co-ownership assets.

How the Dubai Islamic Bank’sMarch 2007 sukuk issue works

ANALYSIS: SUKUK



The explosive growth in the Islamic banking sector over the last few years may soon bereplicated in the insurance sector. NewHorizon talks to Dr Humayon Dar, CEO of Dar AlIstithmar, a subsidiary of Deutsche Bank group that provides Shari’ah consultancy services to the institutions offering Islamic finance.

The huge demand for Shari’ah-compliantfinancial services has created innovativeservice offerings from the Islamic banks.Nowadays, credit cards, car loans andmortgages are all available to privateindividuals while investment products, manybased around the sukuk and investmentfunds of different types, are available towealthy individuals and corporate bodies.

The housing market, in particular, has seentremendous growth according to Dr Dar.Until recently, banks did not offer mortgagesto individuals but the liberalisation of thefinancial market has meant that theseproducts are now available and Islamicmortgages are becoming very popular.Housing markets across the world haveexpanded but the demand for Islamic homefinance has been even further fuelled by thegrowth in the emerging Muslim economies,particularly those of the Gulf CooperationCouncil (GCC) countries.

Dr Dar thinks the positive image that theavailability of Islamic financial services sendsto the rest of the financial world is enhancedby Islamic scholars working closely withWestern bankers in London, New York andelsewhere. There is evidence that wealthyMuslims tend to invest in Shari’ah-compliantfinancial products when investing locally,although they may be prepared to invest in conventional banking products wheninvesting overseas.

Some of the devices used to support Islamicproducts differ from country to country. Inresponse to the rise in demand for creditcards, Islamic banks in different countrieshave created different models to replicate the economic effects of conventional credit

cards. In Malaysia, for example, Islamiccredit cards can be supported by the bai al-ina or buyback sale. In this the bank and theclient buy and sell a piece of land betweenthem with the difference in the buying andselling prices being used to provide the creditlimit on the credit card.

This is the model used by Bank IslamMalaysia Berhard, the largest Islamic bankin that country. In the Middle East the morepopular contract is the tawaruq which issimilar to the bai al-ina but there are threeparties involved in the buying and selling ofthe underlying asset: the bank, the client anda third party often found through thegeneral marketplace.

In the UAE, credit cards are often providedas a fee-paying service with no underlyingtransaction. Banks provide different classesof card – gold, platinum, etc. – based on theclient’s income with different fee bracketsbased on the type of card.

The explosive growth in demand, and thefledging nature of the Islamic financialmarket means that, as yet, not all businessareas are fully serviced. An example of a relatively difficult area is the TreasuryOperations function within a bank or largecorporation. According to Dr Dar thesemoney market operations are an ‘Achilles’heel’ of Islamic banking and are a rathermore complex area in which to achievecompliance.

In conventional banking circles a bank withexcess liquidity will lend to another bankthrough inter-bank loans. To achieve thesame function while still being Shari’ah-compliant, most Islamic banks will use a

Innovations in Islamic finance

There is nothing religious about Islamic banking – it is a structure that is used to differentiate between halal and haram products

POINT OF VIEW



commodity murabaha. In this both banks instruct a commodity broker – bank A will instruct the broker to buy, say, $100million of commodity and sell it to bank Bon a deferred payment basis. Bank B retainsthe funds obtained from instructing thebroker to sell the commodity for cash on the open market. Repayment occurs at a predetermined frequency agreed by both banks. The sukuk is becoming moreprominent in this market, particularly thoseissued in Malaysia and Bahrain, and thisarea may present future innovations.

Dr Dar feels that the real growth area isoccurring in Islamic insurance or takafulwhich until recently has been a relativelyuntapped market. Some analysts think thatthis sector may prove to be bigger thanIslamic banking.

Part of the demand for these products is in response to directives from financialinstitutions. If an individual obtainsfinancing from a bank for a car or a home, the bank makes it compulsory toobtain insurance. Some of the large Westernbanks are aggressively entering this market.For example, HSBC Bank Malaysia Bhd hasannounced that in the next two years it aimsto at least double the amount of insuranceproducts used by its existing customers.Currently, around 30 per cent of itscustomers use insurance products.

The reinsurance market, where insurancecompanies spread the risk among specialistunderwriters, may also present a growtharea. Although there are four or five smallIslamic reinsurance companies, it is stilllargely dominated by conventional insurance organisations.

The emphasis in Islamic banking up untilnow has been on the Shari’ah complianceaspects and whether the underlying contractcomplies with the law. This is not necessarily

ethical banking though, explains Dr Dar.There is not much similarity between Islamicfinance and ethical investments or sociallyresponsible investing. Ethical banking hasmore of a Western influence. As an example,the Dow Jones screening for Shari’ah-compliant companies includes companiesthat are doing prohibited business, such asmaking or distributing alcohol, or casinos.But there are others which are strange froman Islamic point of view such as tobacco orthe defence industry. ‘There is no consensusin Islam about tobacco,’ says Dr Dar ‘butIslamic funds will not invest in tobaccobecause it is considered unethical – aninference that has come from Westerninfluence’.

Dr Dar feels that the next big event inIslamic banking may be what some peoplerefer to as ‘real’ Islamic banking. Theexisting attempts to conduct business in aShari’ah-compliant way could be called‘halal’ banking rather than Islamic banking.There is nothing inherently Islamic about theoperations of Islamic banks. They are simplydoing business in compliance with Islamiclaw. Islamic banking to some people impliesa social responsibility. ‘Islamic banking sofar has not shown an explicit responsibilitytowards the community in which it serves so possibly this will be the next step – theemergence of banks that are genuinelysocially responsible,’ says Dr Dar. ‘Co-

operatives and mutuality have gone out offashion in the UK but it is something that isneeded in some countries.’ Dr Dar goes onto say that ‘there is nothing religious aboutIslamic banking – it is a structure that isused to differentiate between halal andharam products’.

After such an explosive growth period inIslamic banking, it may be time to pause forreflection while the insurance sector takes up the financial expansion.

Islamic banking so far has not shown an explicit responsibilitytowards the community in which it serves so possibly this will be the next step – the emergence of banks that are genuinelysocially responsible.

POINT OF VIEW

Dr Humayon Dar,Dar Al Istithmar



Healthy Islamic banking sector reaches new heights in Pakistan

The Islamic banking industry is healthy andcontinues to grow in Pakistan. This is thefinding that comes out of a report publishedby the State Bank of Pakistan (SBP). Set up as Pakistan’s central bank followingindependence in 1948, the SBP is theorganisation responsible for running the country’s economy. In its most recentIslamic banking bulletin, SBP has publishedthe figures for the last quarter of 2006, and announced continuing growth for the Islamic banking sector.

Around 90 per cent of the Pakistanipopulation is Muslim, and the provision ofShari’ah-compliant banking products is an

important area to help people comply withtheir faith. The provision of Islamic bankinghas in turn led to an increase in the branchnetwork for Islamic banks. There arecurrently five exclusively Islamic banks inPakistan with a sixth due to start operationslater this year; between them they have 99branches. Add to this 13 other banks whichoffer Islamic banking services and their 58branches, and a healthy backdrop for theindustry with good access to the generalpopulation can be seen.

The last quarter of 2006 was a very goodone for the Islamic banking industry. Figuresfrom the SBP show that the total assetsportfolio within the sector expanded by 24 per cent to just under $2 billion(Rs118.183 billion). The cash held byIslamic banks also increased by a quarter to around $250 million (Rs15.266 billion).These figures show that the growth in theIslamic sector is not matched by Shari’ah-compliant money market instruments, andhence there are excess liquid funds that cannot be properly utilised.

The increase for the last quarter of 2006 is part of a growing trend. Comparing the

Islamic banking assets, deposits, andfinancing and investment over the same lastquarter period for the previous three yearsshows that all areas of Islamic finance areincreasing at an ever improved rate. In thelast year, total assets have increased by $758 million (Rs46 billion), deposits haveincreased by $544 million (Rs30 billion),and financing and investment by $395million (Rs24 billion). These are all goodimprovements for one year, but whencomparing them back as far as 2003, theamount of money as assets and deposits isaround ten times higher, and the financingand investment money is now seven timesthe size it was in December 2003.

The most favoured form of Islamicfinancing in Pakistan is murabaha. Thismirrors a global trend where murabahaleads the field with the majority of Islamicbanks. In Pakistan it accounts for almost 40 per cent of the total financing done byIslamic banking institutions. The secondmost widely used form of financing is ijara.With this accounting for 30 per cent, thesetwo financing models represent nearly three-quarters of the financing from Islamic banks in Pakistan.

Musharakah1%

DiminishingMusharakah

16%

Salam1%

Istisna1%

Others11%

Murabaha40%

Mudarabah0%

Ijara30%

0

20

40

60

80

100

120

Rs

in B

n.

Dec 06 Dec 05 Dec 04

Years

Total Assets Deposits Financial & Invest.

Dec 03

ANALYSIS

State Bank of Pakistan

Mode of Financing Dec 2006Islamic Banking 2003–2006

Graphs adapted from SBP Islamic Banking Bulletin, February 2007



Bank Islam Malaysia Berhad has appointedthree new directors and one alternativedirector, who are all representatives of theDubai Group. The three new directors areSalaam Said Al-Shaksy, managing directorof Dubai Group, Fadel Al-Ali, COO andCFO of Dubai Holding LLC and HashimAl-Dabal, executive chairman, DubaiProperties. Marwan Al-Khatib, director at Dubai Islamic Investment Group, is analternative director to Hashim Al-Dabal.

Al-Shaksy has over 20 years’ experience in finance and investments. He is the vicechairman of board – Muscat SecuritiesMarket, vice chairman of board – ShellMarketing, and a board member of theCollege of Banking and Financial Studies,Oman. Prior to joining the Dubai Group,he was deputy chief executive for BankDhofar, and head of business planning and analysis for Citibank Global Consumer Business in the UAE.

Al-Ali joined Dubai Holding in 2004 asCFO, and was promoted to COO in 2005.Prior to this, he worked for 16 years atCitigroup in various roles, such as head of UAE distribution for Citibank.

Al-Dabal is the executive chairman ofDubai Properties and a board member of Dubai Holding. He has served on the

boards of many of Dubai Holding’s entities,such as Empower, Dubai InternationalCapital and Noor Islamic Bank. Prior to joining Dubai Properties, he was theexecutive director of Dubai Islamic Bank,and also has ten years’ experience withinCitibank.

Alternative director, Al-Khatib, is thedirector of Islamic banking at DubaiIslamic Investment Group. He has over 15 years of finance experience working forAl-Futtaim Group, Mashreq Bank, DubaiChamber of Commerce and DeloitteTouche Tohmatsu.

Bank Negara Malaysia Governor, Tan SriDr Zeti Akhtar Aziz, has been appointed as the fourth chairperson of the IslamicFinancial Services Board Council. The role is on a one-year rotation amongst full members, and Dr Zeti will be in therole for the 2007 calendar year. The deputy chairperson for the year will be Dr Shamshad Akhtar, who is the governorof the State Bank of Pakistan.

Richard Thomas has been appointed asmanaging director of GSH UK. The newUK subsidiary of GSH has been set up inorder to take advantage of the rapid

developments in the UK in all spheres of international Islamic financial services.Thomas has over 28 years of experiencefrom companies such as Saudi InternationalBank and the United Bank of Kuwait. Priorto his appointment at GSH UK, Thomaswas the head of Islamic financial services,and CEO of Islamic asset management andalburaq at the Arab Banking Corporationin London. In addition to his new position,Thomas is also a member of the UKTIFinancial Services Sector Advisory Board; in this capacity he chairs the Sub-Committee on Islamic Financial Services,and advises on Corporate Governanceoversight for the Institute of IslamicBanking and Insurance (IIBI), London.

Tejoori, the Shari’ah-compliant investmentcompany, has made two new seniorappointments. Yaqub Yousuf has beenappointed as non-executive director to theboard. Yousuf has been an advisor to thecompany since its inception in 2005 andnow acts as chairman of the executivecommittee to oversee the company’soperations.

The second appointment is Ilke Tokluas general manager. Most recently she was director of business development atInternational Holdings group. Toklu joinsthe board with experience on a global levelin management consultancy, businessdevelopment and board direction in NorthAmerica, Asia Pacific and the Middle Eastat companies such as Citibank, DubaiHolding and Prudential Securities.

Faiz Azmi, a partner at PricewaterhouseCoopers (PWC) Malaysia, has beenappointed as the inaugural Islamic financeleader of PWC worldwide. Azmi will beresponsible for leading PWC’s Islamicfinance initiatives worldwide. In addition,he serves as a member of the MalaysianAccounting Standards Board’s committeeon Islamic Accounting Standards.

On the move

APPOINTMENTS

Islamic finance specialist, Oliver Agha(left), has been appointed a partner oflaw firm DLA Piper based in its Dubaioffice. Prior to this appointment, Aghawas head of projects at CliffordChance’s Saudi Arabian law firm affiliateAl-Jadaan. In his time there, he worked on some of the most complex Islamicfinance projects in the Kingdom of Saudi Arabia, such as the Rabigh projectfinancing of a petrochemical refinery,and restructuring the first conventionalloan transaction into an ijara Islamicfinance transaction.



The use of the Karachi Interbank Offered Rate (KIBOR) as a benchmark by Islamic banks in calculating the selling price of their commodities in murabaha sale transactions is not onlyjustified, but also necessary, to remain competitive given the current banking industry dynamicsin which Islamic banks have a pretty low share. However, it is not permissible under Shari’ah to price loans using KIBOR, as many conventional banks do. Najmul Hassan, general managerfor coprorate and business development, Meezan Bank, explains the underlying differences in approach.

Unlike conventional banking based oninterest-bearing loans, funds invested in an Islamic bank are used essentially fortrade. The Quran clearly mentions riba in anumber of places (Surah Ar-Rum, Al-Imran,An-Nisa, and Al-Baqra), with a very strongview against such people who indulge in it.The authentic definition from Hadith (withthe chain of transmission being Hazrat Ali)leaves no room for ambiguity: ‘every loanthat draws a gain is riba’.

Many people question whether Islamic finance differs meaningfully fromconventional finance. Outwardly in form,many structures do bear a similarity in a number of respects. The present dayoperating environment is a conventionalone, from market structuring and dynamics,to rate benchmarks and circulation ofmoney, then on to regulatory controls.However, the way these two financialsystems function with respect to coredefining parameters is very different. Many things look the same but are, in essence, fundamentally different.

We begin with basic principles. The one isinterest-based money lending while the otheroperates like a trading house. Where doesthis difference originate? Two core principleslie at the centre – elimination of riba andgharar. Any Islamic transaction needs toassess these two things first and foremost.

Bearing in mind the definition given inHadith, as mentioned above, we can discussthe time value of money and the workings ofpresent day Islamic banks. For this, we haveto look at the differences between the waysin which modern capitalist theory (the basisof interest-based banking) views ‘money’and ‘commodity’ and the principles defined by Islam.

According to capitalist theory, there is nodifference between money and commodity in so far as commercial transactions areconcerned. Accordingly, both are treated atpar and can be sold at whatever price partiesagree upon. With this theory, selling Rs100

for Rs110 or renting Rs100 for a monthlyrental of Rs10 is the same as selling a bag of rice costing Rs100 for Rs110 or renting a fixed asset costing Rs100 for a monthlyrental of Rs10.

Islamic principles differ from this conceptbecause money and commodity havedifferent characteristics. For instance, money

has no intrinsic value but is rather a measureof value or a medium of exchange. It cannotfulfil human needs by itself, but needs to beconverted into a commodity. On the otherhand, a commodity can fulfil human needsdirectly. Furthermore, commodities candiffer in quality while money has nodifferential quality, in the sense that a newnote of Rs1000 is exactly equal in value andquality to an old note of Rs1000. Similarly,commodities are transacted or sold bypinpointing the item in question or at least by giving certain specifications. Money, however, cannot be pinpointed in a transaction of exchange. Even if it could be, it would be of no use to do this since

the different denominations of moneymaking up an equal amount have the same ultimate value.

With these differences in mind, to exchangeRs1000 for Rs1100 in a spot transactionwould make no sense since the money initself has no intrinsic utility or specifiedquality. So, the excess amount on either

The time value of money in Islamic banking

ACADEMIC ARTICLE

According to capitalist theory, there is no difference betweenmoney and commodity in so far as commercial transactions areconcerned. Islamic principles differ from this concept becausemoney and commodity have different characteristics.



side is without consideration and hence notallowed under Shari’ah. The same wouldhold true if we were to exchange theseRs1000 for Rs1100, to be delivered after a period of one month, since the excess ofRs100 would be without consideration ofeither utility or quality but would only berelated to time.

The same is not true when commodities are involved. Since a commodity is known to possess an intrinsic value and quality, theowner of such a commodity is allowed tosell it at whatever price is mutually agreedwith the buyer, provided that, in selling, hedoes not commit a fraud but is subjected to the forces of supply and demand. Thiswould hold true even if the price that ismutually agreed upon is higher than theprevailing market price.

In conclusion, any excess amount chargedagainst deferred payment is riba only whenmoney is exchanged for money, since theexcess is charged only against time. Theproof lies in the fact that, if the debtor fails to repay at the stipulated time, he ischarged extra money. In contrast, where acommodity is being exchanged for money,the seller may take into considerationvarious factors (like the supply and demandsituation, quality, utility, special features and so on) as well as the time of deferredpayment.

It is true that the seller may take account ofthe time factor in increasing the price of hiscommodity in a credit sale, but the increasedprice is being fixed for the commodity andnot exclusively for the time element.

Time is not the exclusive consideration in fixing the price; therefore once the price is fixed it relates to the commodity and not to the time. For the same reason, if thepurchaser fails to pay at the agreed time, theprice would remain the same and under nocircumstances would the seller be allowed to charge more than is actually owed.

Keeping in mind the above discussion, theuse of KIBOR as a benchmark by Islamicbanks in calculating the selling price of theircommodities in murabaha sale transactionsis not only justified, but also necessary, toremain competitive given the currentsituation in which Islamic banks have apretty low share in the banking industry.

We must understand that the use of KIBORas a benchmark to determine the profit is forindicative purposes only and this does notmake the transaction impermissible if all

of the other conditions of a valid sale arefulfilled. It is often the case that a trader,whether a large multinational tradingcorporation or a roadside store, will arriveat a decision on profit or margin rates,having taken into account a number offactors. A major variable of which is thecompetitive environment in which the trader is operating his business.

If a rice trader or a cloth merchant usesKIBOR as the basis for adding profitmargins to the cost of his commodities toarrive at the price, this would not amount to interest or riba and it would not make thetransaction impermissible. The principle issimilar for Islamic banks using the KIBORto arrive at the selling price of theircommodities.

In contrast, conventional banks price theirloans based on KIBOR, which does result inriba since it is an exchange between moneyand money and not a sale transaction inwhich commodities are exchanged withmoney.

It is being questioned in some circleswhether Islamic banks could price theircommodities by applying some otherbenchmark rate. The rationale behind using KIBOR is the banking environment is dominated by conventional banks, which discourages the development of an Islamic benchmark rate.

In the light of this situation, Islamic banks are compelled to use an interest-based benchmark to price their products.This not only ensures stable returns in line with the industry but also assurescompetitively priced products for thecustomers.

As more and more Islamic banks begin tooperate, an inter-bank market betweenIslamic banks will be created and a newbenchmark for the Islamic banking industry will then be able to be developed.

ACADEMIC ARTICLE

Any excess amount charged against deferred payment is riba onlywhen money is exchanged for money, since the excess is chargedonly against time.

Mosque in Karachi, Pakistan

12–14 Barkat House116–118 Finchley RoadLondon NW3 5HTUnited Kingdom

Tel: +44 (0) 207 245 0404Fax: +44 (0) 207 245 9769Email: [email protected]: www.islamic-banking.com

Institute of Islamic Banking & Insurance (IIBI)



April

Diary of EventsMay

15–19: Corporate Governance Forum,DubaiConference to move corporate governancethinking and practice forward in the Middle East.Tel: +97 143 352 437Email: [email protected]/cg

24–25: Annual Islamic WealthManagement Event, GenevaConference focusing on wealth managementfor the Muslim investor.Tel: +44 (0) 20 7868 1717Email: [email protected]

25: Sukuk: Exploring the Phenomena,DubaiConference focusing on the sukuk mode of Shari’ah-compliant financing.Tel: +44 (0) 20 7286 6523Email:contact@middleeastbusinessforum.comwww.middleeastbusinessforum.com/sukuk

7–10: Risk Management in IslamicBanking, Kuala LumpurFour-day training course for riskmanagement within Islamic banking.Tel: +60 321 438 100www.islamicfinancetraining.com/rmib.php

8–9: 4th Annual Middle East InsuranceForum, BahrainThe region’s largest platform for theinternational and regional insuranceindustry to assess the new growthopportunities in the market.Contact: Welma WilliamsTel: +97 143 431 200Email: [email protected]

13–15: Islamic Treasury Simulation, DubaiCourse to help understand keycharacteristics in Islamic banking, and how to develop and implement treasurystrategies.Tel: +60 321 438 100www.islamicfinancetraining.com/IslamicTreasurySimulation.php

15–16: Islamic Finance & Capital MarketConference, Kuala LumpurConference to provide insight into themodus operandi and related issues ofIslamic finance and Islamic capital market instruments.Tel: +60 321 636 990Email: [email protected]

15–16: 4th Islamic Financial ServicesBoard Summit, DubaiSummit looking at the need for a cross-sector approach to the supervision ofIslamic financial services.Contact: Ms Farrah ArisTel: +60 326 984 248Email: [email protected]

CALENDAR

Dubai

Ottawa

17–18: 3rd International Islamic Banking,Finance & Insurance (Takaful) Conference,OttawaConference to educate and introduce Shari’ahconcepts and rules about Islamic banking.Email: [email protected]/conference

22–24: 1st Islamic Banking,Finance and InsuranceAwareness Conference andExhibition Pakistan, Lahore

Conference to educate and introducevarious groups to Shari’ah concepts, rules about Islamic banking, financing and insurance and highlighting successfulapplications worldwide.Tel: +92 042 504 8213Email: [email protected]

22–24: Islamic Finance World NorthAmerica 2007, TorontoConference focused on the key businessdrivers of the Islamic finance business inNorth America.Tel: +1 212 379 6322Email: [email protected]/2007/ifwna



June

18–19: International IslamicBanking & Finance Forum 2007,Singapore

Conference to address the trends,opportunities and challenges facing Islamicbanking.Contact: Bernadine MichaelTel: +60 327 236 604Email: [email protected]/events/cfeventinfo.asp?eventid=11883

July

4: Islamic Finance Conference, LondonA one-day introduction to Islamic finance.Tel: +44 (0) 1354 695 599Email: [email protected]/ifc.html

9–12: Structuring Islamic FinancialProducts, ZurichCourse designed to give an all roundunderstanding of the most important andwidely offered Islamic financial products.Tel: +60 321 438 100www.islamicfinancetraining.com/sifp2007.php

November

26–29: B-Tech Libya: 1st InternationalBanking, Financial Sector & InvestmentExhibition 2007, TripoliExhibition offering the full range ofproducts and services offered by bankingsectors, financial and investment institutionsand insurance companies.www.atex.com.ly/b-techlibya/index.html

20–21: The Sukuk Summit 2007, LondonSummit to provide a platform for issuersand end users to engage with investors,arrangers, listing and rating agencies, and community organisations.Tel: +44 (0) 20 8209 1751Email: [email protected]

25–26: Successful Strategies in Planning, Negotiating &Managing Mergers & Acquisitions,Kuala Lumpur

Conference to address the key steps of pre-M&A stages, from planning andnegotiating, to structuring, financing anddue diligence; and post-M&A issuesincluding HR, change management and communications strategies. Tel: +60 320 703 299Email: [email protected]/project/9436MC_EM.pdf

25–27: 2nd Islamic Finance Summit 2007,Kuala LumpurSummit to explore Islamic investmentopportunities and meet product operators.Contact: Alison McInerneyTel: +65 6514 3173Email: [email protected]

Events endorsed by the IIBI

August

10–12: Structuring InnovativeIslamic Financial ProductsWorkshop, Cambridge

A three-day residential workshop to focuson new developments in Islamic structuredproducts, funds, capital market structuresand retail, corporate and investmentbanking products.Contact: Mohammad ShafiqueTel: +44 (0) 207 245 0404Email: [email protected]

20–23: Structuring Islamic FinancialProducts, JohannesburgCourse designed to give an all roundunderstanding of the most important andwidely offered Islamic financial products.Tel: +60 321 438 100www.islamicfinancetraining.com/sifp2007.php

CALENDAR

Zurich

Singapore

27–28: Middle East Islamic Capital Market,DubaiForum to equip delegates with the strategicinformation to deal with the complexities of Islamic finance.Contact: Bernadine MichaelTel: +60 327 236 604Email: [email protected]/events/cfeventinfo.asp?eventid=12131

27–29: 2nd Annual Bank Marketing andManagement Forum, JordanForum from the Arab Academy for Bankingand Financial Sciences to deliver big-picturestrategies and practical solutions to addressmarketing challenges in the bankingindustry.Contact: Amal MishlawiTel: +96 265 502 900Email: [email protected]/bmmf2.asp


NEWHORIZON January–March 2007GLOSSARY

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

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

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

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

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

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

halalActivities which are permissible according to Shari’ah.

haramActivities which are prohibited according to Shari’ah.

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

ijara sukukA sukuk having ijara as an underlying structure.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

ta’awuniA principle of mutual assistance.

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

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

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

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

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

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

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

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

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