gousia mir & malik bilal: global financial crisis & islamic equity instruments: a profile of...
DESCRIPTION
Periodic crises appear to be part of the financial systems of dominant and global powers. The 2008 global financial crisis that started in the U.S in late 2007 has given a wide array of impacts to operating and financial performance of many banks all over the world. The severity of the current crisis has led to the evaluation that, world economy has entered a phase of extraordinary instability and its future course is absolutely uncertain. The present work is an attempt to find out the main causes of the current global financial crisis and its overall impact on World economic system. It will also discuss, how Islamic finance industry, sharing a very little portion of the global asset value, managed to escape its institutions from the venomous effects of the current global financial crisis.TRANSCRIPT
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“ GLOBAL FINANCIAL CRISIS & ISLAMIC EQUITY INSTRUMENTS:
A PROFILE OF SURVIVAL”
The Dissertation
Submitted In Partial Fulfillment Of The Requirement For Masters In
Islamic Studies.
Submitted By
Bilal Malik (IS-10-16)
Gousia Mir (IS-10-26)
Under the Supervision Of
Dr. Showkat Hussain
(Assistant Prof Dept. of Islamic Studies)
DEPARTMENT OF ISLAMIC STUDIES
ISLAMIC UNIVERSITY OF SCIENCE AND TECHNOLOGY,AWANTIPORA
(2012)
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ACKNOWLEDGEMENT
All praise be to Allah, the lord of the worlds, who gave us accession of thought to
learn.
This dissertation would have not been possible without the help and support of
many people.
First and foremost we would like to thank Dr. Showkat Hussain, Incharge
Department of Islamic Studies, our dissertation supervisor. We owe a debt of
gratitude to him for his high level of interest, enthusiasm and unending help
throughout the completion of the study.
Secondly, we are thankful to all faculty members of the Department of Islamic
Studies, the non-teaching staff of the said department, the people associated with
SEC(skill enhancement center) for their assistance.
We are also thankful to our friends and batch mates for their valuable suggestions
throughout the study.
At last but not least we are thankful to our parents and family members whose
encouragement and cordial support became a source of inspiration for us.
Gousia Mir Bilal Malik
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TABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTS
INTRODUCTION 1-4
1. GLOBAL FINANCIAL CRISIS:ITS CAUSES & IMPACT
1.1 Globalisation and the global financial crisis 5-6
1.2 Origin of the crisis 6-7
1.3 Causes of the current global financial crisis 7-9
1.3.1 Excessive and imprudent lending 9-12
1.3.2 Securitization 12-15
1.3.3 Regulatory Failure 15-17
1.3.4 Over-Leveraging 17-19
1.3.5 Inherent Stability 19-20
1.4 General Impact of the global financial crisis 20-21
1.4.1 Impact of GFC on finance sector 21-22
1.4.2 Impact of GFC on Conventional finance industry 22-26
1.4.3 Impact of GFC on Islamic finance industry 26-31
2. LITERATURE REVIEW
2.1 Books 32-50
2.2 Articles and Research Papers 51-61
3. ISLAMIC EQUITY INSTRUMENTS
3.1 Islamic Equity Instruments 62-63
3.2 Musharakah (Equity Participation) 63-64
3.2.1 Application and Scope 64-68
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3.3 Murabahah (Cost-Plus Sales) 68-70
3.3.1 Application and Scope 71-73
3.4 Mudarabah (Co-Partnership Sales) 73-74
3.4.1 Application and Scope 74-75
3.5 Ijarah (Lease Contract) 75-77
3.5.1 Application and Scope 77-78
3.6 Takaful (Islamic Insurance) 78-81
3.6.1 Application and Scope 81
3.6.2 Mudarabah Model 81-82
3.6.3 Wakalah Model 82-83
3.6.4 Waqaf Model 83-84
3.6.5 Microtakaful 84
3.7 Sukuk (Islamic Bond) 84-85
3.7.1 Ijarah Sukuk 85-86
3.7.2 Murabahah Sukuk 86
3.7.3 Convertible Sukuk 86-87
3.7.4 Musharakah Sukuk 87
4. RELEVANCE
4.1 Current Position of Islamic Finance Industry: A Brief Review 88-93
4.2 Islamic Banking Investment: A Flourishing Sector 94-98
4.3 Islamic Banking in MENA Region: A Growing Trend 98-100
4.4 Growth of Islamic Takaful Industry 100-103
4.5 Sukuk: A Global Success for Islamic Finance Industry 103-107
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5. CONCLUSION 108-110
6. REFRENCES 111-119
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FIGURES
1. Graph showing chronological list of various crisis. 8
2. Graph showing rise in U.S subprime lending between 2004-2006. 10
3. Graph showing Securitization market activity. 15
4. Leverage ratio of various banks from 2003-2007. 18
5.Initial effects of crisis on conventional and Islamic banks. 29
6. IMF staff estimates and calculations. 30
7. Mechanism of Musharakah contract. 64
8. Mechanism of Murabaha contract. 70
9. Mechanism of Mudarabah contract. 74
10. Diagram of Mudarabah model. 82
11. Wakalah Takaful diagram. 83
12. Graph showing global assets of Islamic finance. 92
13. Graph showing banking assets in Mena region. 100
14. Graph showing Global Takaful Market. 101
15. Graph Showing Global Sukuk Issues. 103
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INTRODUCTION
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INTRODUCTION
Periodic crises appear to be part of the financial systems of dominant and global
powers. The 2008 global financial crisis that started in the U.S in late 2007 has
given a wide array of impacts to operating and financial performance of many
banks all over the world. The severity of the current crisis has led to the
evaluation that, world economy has entered a phase of extraordinary instability
and its future course is absolutely uncertain. Enjoying a unipolar moment
following the collapse of the Soviet Union and the failure of Communism, the
United States was confident that economic liberalization and the proliferation of
computer and communications technologies would contribute to ever-increasing
global economic growth and prosperity. Globalization contributed to the
extraordinary accumulation of wealth by a relatively few individuals and created
greater inequality. The golden years of capitalism ended when U.S President
Nixon in 1971 suspended the convertibility of the US dollars which brought an
end to the fixed exchange rate - the basis of Bretton Wood’s system. The end of
Bretton Wood system diminished the relationship between real money and real
assets and built the market sentiments upon confidence and trust. One can say
that it was a time of transition of capitalism to financialization or finance-led-
capitalism. Under this new economic system financial institutions enjoyed the
right to raise capital for the purpose of creating, selling and trading securities and
derivatives that do not finance industry but rather trade within markets.
The main characteristics of this new economic system as described by Pereira
(2010) are firstly, the increase in the value of financial assets as consequences of
the multiplication of financial assets due to securitization and derivatives.
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Secondly, finance-led-capitalist leads to the innovation of creating fictitious
financial wealth that only helps capitalist renters. It can be seen that under
financialization, credit ceased to exist from bank to business but was channelized
through securities traded in financial markets that are pension funds, hedge funds
and mutual funds. Pereira (2010) stated that the financial crisis was the
consequence of financialization that created fictitious financial wealth that began
in 1980s and the consequence of the neoliberalism, which believed in the transfer
of power from public to private sector, based on self-regulated markets.
The onset of the present crisis can be traced back to July 2007 with the liquidity
crisis due to the loss of confidence in the mortgage credit markets in the United
States. At first, there was uncertainty about the possible spillovers to the rest of
the economy, and there was also discussion about the risks of contagion and
decoupling, that is to say, the capacity of other countries – especially developing
countries – to isolate themselves from the problems originating in the United
States (which is the largest market for many countries). The hope was that the
crisis would be restricted to financial markets, with few repercussions on the real
economy and the rest of the world. This hope was shattered in September 2008
as the crisis entered an acute phase, with strong downward fluctuations in the
stock markets, substantially reduced rates of economic growth, volatile exchange
rates, and squeezes in demand and consumption, leading to falls in industrial
production and decreasing flows of international trade and FDI, and causing
impacts on related areas such as transfer of technology. As a result, many banks
across the world reported financial loss on their financial report due to their
connections with subprime mortgage in the U.S. or were simply affected by
economic recession in their own countries. The impact of the crisis have even
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forced around 123 banks in the U.S. to file for bankruptcy in the year, including
American giant bank Lehman Brother that was never been expected to fail. The
crisis has also been accompanied by increases in unemployment, with
concomitant declining incomes and demand. The situation have encouraged
economic analysts to construe this crisis to be the most severe since the Great
Depression of the 1930s, crude oil prices have seen yet another historical hike
since 2003. It is in the light of these two major global recessions that Islamic
finance has experienced its conception and renaissance. Through the lens of
Islamic economic thought, it is clear that “in the absence of a moral
transformation and change in economic thinking, any effort by governments to be
realistic promotes recession, unemployment, and unrest” (Chapra,1985). This
trend has given rise to an increasing appeal of Islamic finance to Western policy
makers. In fact, besides a remarkable influx in the amount of Islamic banks and
banking units in the Middle East and Asia, Western banking institutions have
commenced offering Shari’ah-abiding financial products. European governments
such as France, Germany, and The Netherlands have voiced their interest in
Islamic finance and instructed policy makers to generate a legal framework in
order to pave the way for Islamic financial products to enter Western financial
markets. What is more, since 1999, the Dow Jones has been issuing financial
information on Shari’ah-adhering companies under the umbrella of the Dow
Jones Islamic Market Indexes, in order to cater toward Muslim investors who
prefer to invest in accordance with the teachings of the Quran.
The present study has been compiled to bring forth the detailed summary about
the causes and the impact of the crisis on both conventional as well as Islamic
financial industry. It will also discuss the nature, mechanism, and scope of some
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significant financing instruments used by the Islamic finance industry. Also a brief
summary has been made with the help of empirical data in order to search out
the current position and relevance of the Islamic finance industry in the current
financial scenario. Overall content of the dissertation has been segmentized into
four chapters as per the subject matter of the dissertation. A brief introduction
has been added up at the beginning and finally a precise conclusion at the end.
Throughout the completion of the study near about 20 books and more than 80
articles have been consulted and the selection of literature was done as per the
relevance with the objective of the study.
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Chapter - 1
GLOBAL FINANCIAL CRISIS:
ITS CAUSES AND IMPACT
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1.1 GLOBALISATION AND THE GLOBAL FINANCIAL CRISIS
Globalization is a multi-dimensional process of economic and structural
transformation that has a variety of meanings and interpretations. It generally
refers to both the increasing flows of capital, goods and resources and knowledge
across national boundaries and to the emergence of a complementary set of
organizational structures to manage the expanding network of international
economic activity and transactions. However defined, globalization has led to the
greater integration of national economies through trade liberalization, financial
sector deregulation and capital account liberalization, and flows of Foreign Direct
Investment (FDI) by Transnational Corporations (TNCs). Globalization has opened
up new opportunities to low and middle income countries, through improved
market access, increased flows of FDI, often integrating them into Global Value
Chains (GVCs) or Global Production Networks (GPNs) and accelerated technology
transfer, both product and process technologies.1
Global financial crisis has been defined as a situation, where in the worldwide
integrated economy, in the form of financial institutions, banks or assets suddenly
lose a large part of their value, generally accompanied by banking panics, stock
market crashes, bursting of financial bubbles, currency crisis and sovereign
defaults.2 The 2007–2012 financial crisis, also known as the Global Financial Crisis
(GFC), is considered by many economists to be the worst financial crisis since the
Great Depression of the 1930s. The ‘sub-prime mortgage crisis’ as it is to be
1 Ludovico Alcorta and Frederick Nixson, The Global Financial Crisis and the Developing World: Impact
on and Implications for the Manufacturing Sector, United Nations Industrial Development Organization,
Vienna, 2011, P.1. 2 Prajpati Trivedi, “Global Financial Crisis: Causes And Consequences”, Indian Forum Riyadh, 2008.
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known, began with the bursting of the housing bubble in the U.S, rocked the U.K,
the Euro zone, East-Asia, and the so-called ‘emerging market economies’ and has
not yet reached its end. The crisis played a significant role in the failure of key
businesses, declines in consumer wealth estimated in trillions of US dollars, and a
downturn in economic activity leading to the 2008–2012 global recession and
contributing to the European sovereign-debt crisis The crisis threatens a
worldwide economic recession, potentially bringing to a halt more than a decade
of increasing prosperity and employment for western economies and potentially
wiping a staggering $1 trillion off of the value of the world economy.3
1.2 ORIGIN OF THE CRISIS
The current global financial crisis is rooted in the subprime crisis which surfaced
few years ago in the United States of America. During the boom years, mortgage
brokers attracted by the big commissions, encouraged buyers with poor credit to
accept housing mortgages with little or no down payment and without credit
checks. A combination of low interest rates and large inflow of foreign funds
during the booming years helped the banks to create easy credit conditions for
many years. Banks lent money on the assumption that housing prices would
continue to rise. Also the real estate bubble encouraged the demand for houses
as financial assets. Surplus inventory of houses and increase in interest rates led
to a decline in housing prices in 2006-2007 resulting in an increased defaults and
foreclosure activity that collapsed the housing market. Consequently, a large
number of properties were up for sale affecting mortgage companies, investment
firms and government sponsored enterprises which had invested heavily in
subprime mortgages. Banks and financial institutions later repackaged these 3 Carol J.William, "Euro Crisis Imperils Recovering Global Economy, OECD Warns”, Los Angeles Times,
May 22, 2012.
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debts with other high-risk debts and sold them to world- wide investors creating
financial instruments called CDOs or Collateralized Debt Obligations.4 In this way
risk was passed on multifold through derivatives trade. Since the collateral debt
instruments had been globally distributed, many banks and other financial
institutions around the world were affected. Thus with the failure of a few leading
institutions in United States, the entire financial system in the world has been
affected.5
1.3 CAUSES OF THE CURRENT GLOBAL FINANCIAL CRISIS
The world economy is still suffering from the crisis, considered the most severe
since the Great Depression, where economic downturn at historic magnitude and
many countries across the globe, irrespective of their development level, are still
under strain dealing with this crisis. The severity of the crisis can be visualized
from the fact that it spilled from the financial sector to the real economy,
including international trade in manufactures commodities and services.
According to one estimate, there have been more than 100 crises over the last
four decades but none could be brought in comparison to the current financial
crisis in terms of consequences.6 There has been burgeoning literature compiled
on the GFC, Which is characterized by agreements and disagreements about its
main causes. The U.S. Senate's Levin–Coburn Report asserted that the crisis was
the result of "high risk, complex financial products, undisclosed conflicts of
interest, the failure of regulators, the credit rating agencies, and the market itself
4 Ross Morrow, “A Critical Analysis Of the U.S. Causes Of The Global Financial Crisis 2007-2008” ,
Marxism Fresh Daily, Jan 4, 2011. 5 Tito Boeri and Luigi Guiso, “The Sub-prime Crisis: Greenspan’s Legacy”, in Andrew
Felton and Carmen Reinhart, eds., The First Global Financial Crisis of the 21st Century, July 2008, p.38. 6 Joseph Stiglitz “Dealing with Debt: How to Reform the Global Financial System”,
Harvard International Review, 2003, pp.54-59.
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to rein in the excesses of Wall Street.7 A healthy bench of economists like
Dell’Ariccia, 2008, Igan, 2009, Leaven, 2010, Danielson, 2008, Alarag, 2009,
Stiglitz, 2009, Butler, 2010 and others have discussed the role of inherent
uncertainty in conventional financial operations in bringing out the current global
financial crisis in the form of subprime lending boom. On the other hand Muslim
economists (e.g., Siddiqui, 2009, Chapra, 2009, Bag siraj, 2009, Hussain, 2010,
Khursheed, 2012) continually refer to the global economic crisis as a result of
interest- based financial operations. As mentioned above that economists view
the current financial crisis as the greatest one that beat the world economy, even
if compared with the great Depression in 1930’s. Ali Sakti’s chronological list of
various crises in graphical form is evident to the above fact.8
Figure No.1 Source: Ali Sakti’s Chronological Crisis Graph9
7 Senate Financial Crisis Report, http://hsgac.senate.gov/public/ , Retrieved April 22, 2011. 8 Miranti Kartika Dewi and Ilham Reza Ferdian, ‘Islamic Finance: A Therapy for Healing the Global
Financial Crisis’ , Centre for Islamic Economics and Business, University of Indonesia, 2009. 9 Ali Sakti, “Islamic Economic: Challenges And Opportunities Of Monetary Authority In The Global
Financial Crisis” Paper presented on Public Lecture Series held by Centre of Islamic Economics and
Business, Faculty of Economics, University of Indonesia, Depok, Indonesia, February 18, 2009.
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Many risk spreads have ballooned, liquidity in some market segments has dried
up, and large complex financial institutions have admitted significant losses.
These events have challenged policymakers, and the responses have varied across
region. The European Central Bank has injected reserves in unprecedented
volumes. The Bank of England participated in the bail-out and, ultimately, the
nationalization of a depository, Northern Rock. The U.S. Federal Reserve has
introduced a variety of new facilities and extended its support beyond the
depository sector. These events have also challenged economists to explain why
the crisis developed, how it is unfolding, and what can be done.10
However, as
always done by a doctor before suggesting any medical treatment to his patient,
it is more significant firstly to observe the ground of the problem. Thus before
discussing the consequences of the GFC or any reformative policy in connection
to smooth functioning of the financial institutions worldwide, it is important to
describe some of the determinant causes responsible for GFC.
1.3.1 Excessive and imprudent lending
Economists have undoubtedly identified a number of causes responsible for the
crisis. The generally recognized most important cause is, however, excessive and
imprudent lending by banks.11
The best example in this regard is US subprime*
mortgage crisis. Intense competition between mortgage lenders for revenue and
market share, and the limited supply of creditworthy borrowers, caused mortgage
lenders to relax underwriting standards and originate riskier mortgages to less
10 Carmen M. Reinhart, ‘The First Global Financial Crisis Of The 21st Century: Introduction’, in Andrew
Felton and Carmen Reinhart, eds., The First Global Financial Crisis Of The 21st Century, July 2008. 11 Mohammad Umer Chapra, “The global financial Crisis: Can Islamic Finance Help?”, New Horizon, Issue
no: 170, Jan-Mar 2009, p.20.
*Subprime loan is a type of loan that is offered at a rate above prime to individuals who do not qualify
for prime rate loans. The loan is usually stipulated with a relatively higher interest rate because it is
often issued to a higher-risk borrower.
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creditworthy borrowers. Most of the US’s banks got indulged in this practice with
an intention to maximize their profits, adopting the policy ‘more credit they
extend, the higher will be the profit’. Prime mortgages dropped to 64% of the
total in 2004, 56% in 2005, and 52% in 2006, meaning that nearly half of the
mortgage originations in 2006 were subprime, Alt-A*, or home equity loans.
Figure No.2 Source: Harvard University Report, 200812
Even the government-sponsored enterprises (GSEs), Fannie Mae and Freddie
Macs**, were caught-up by the apparent glamour of housing market, as they
12 U.S Census Bureau, Harvard University, State of the Nation’s Housing Report, 2008. *Alt-A mortgage loans are made to borrowers with pretty good credit ratings but who do not provide full income
and asset documentation
**U.S government sponsored, biggest underwriter of home mortgages. .
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sought to expand home ownership for the benefits it brings in terms of sustaining
neighborhoods.
It has been observed that lending standards deteriorated around 2004 or 2005.
Families that lacked the income and down payment to buy a house under the
terms of a mortgage were encouraged to take out a mortgage that had a very
high loan-to-value ratio, perhaps as high as 100% (often using second or even
third mortgages). As it became easier to borrow using a home as collateral and as
home prices continued to rise, families started using their homes as an ATM,
refinancing and taking out any equity that had built up. Americans were tapping
into the rising wealth they had in their homes in order to finance consumption.
Greenspan and Kennedy (2007) estimate that homeowners extracted US$743.7
billion in net equity from their homes at the peak of the housing boom in 2005, up
from US$229.6 billion in 2000 and US$74.2 billion in 1991. The increase in house
prices allowed a borrowing spree.13
This policy created a situation of ‘high supply and high demand’ of money in the
market and banks earned a healthy proportion of wealth in the first two, three
years. It was unfortunate that this policy couldn’t help the US mortgage industry,
the world’s best, to go for a long run. By September 2008, average U.S. housing
prices had declined by over 20% from their mid-2006 peak. As prices declined,
borrowers with adjustable-rate mortgages could not refinance to avoid the higher
payments associated with rising interest rates and began to default. During 2007,
lenders began foreclosure proceedings on nearly 1.3 million properties, a 79%
increase over 2006. This increased to 2.3 million in 2008, an 81% increase vs.
13 Martin Neil Baily and Douglas J. Elliott, “The Causes Of The Financial Crisis”, published by World
Scientific Publishing Co. Pte. Ltd In “The International Financial Crisis- Have the Rules of Finance
Changed?”, 2009, pp.61-62.
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2007. By August 2008, 9.2% of all U.S. mortgages outstanding were either
delinquent or in foreclosure. By September 2009, this had risen to 14.4%. The
situation became much worse when banks became reluctant to lend each other
and ultimately the bubble burst-out, resulted constrain in US economy.14
Although it is impractical to single out one factor as being the source of financial
crisis, but it is not wrong to argue that the main cause of financial crisis can be
attributed to the laxity of lending standards adopted by conventional financial
institutions – driven by greed and appetite for higher returns, and facilitated by
the absence of adequate and appropriate government regulatory control. This
easy approach to lending when practiced over an extended period of time and
mixed up with other so called financial necessities like overleveraging, speculation
and securitization leads to risky a lending environment that eventually works
against the interests of both borrowers and lenders alike and ultimately ends up
with an economic downturn.
1.3.2 Securitization
The second ingredient that triggered the current global financial crisis is
securitization, which evolved as a result of un-judged financial innovations.
Historically, banks used only the money they received from depositors to lend to
borrowers. They were not able to obtain money from other sources other than
depositors. However in recent years, banks have been able to rely not only on
depositors but also on the wholesale money markets, where they could borrow
money from other banks and then resell it to their borrowers at a higher interest
rate. This secondary market was in part made possible by the creation of “credit
default swaps” (CDSs). Credit default swaps were widely used, especially by
14 MBA Survey-Q3.2009, http://www.mbaa.org, Nov.2009, Retrieved May 1, 2010.
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insurance companies such as the American International Group (AIG). These
allowed a bank to effectively insure itself against the risk that a borrower might
not pay back a loan. This led to an illusion that loans were now much lower risk
and allowed such loans to be bought and sold. This then led to the creation of
CDOs (collateralized debt obligations), which were bought by banks as interest-
bearing investments. The sub-prime lenders then invented another way of making
money in a sector which was already highly risky and this new technique was
securitization.15
Securitization is a process of financial engineering that allows global investment
to be spread out and separated into multiple income streams to reduce risk.
Securitization became an important component of financial markets in the 1980’s
and was warmly welcomed in finance sector, to be used as a weapon against the
financial crisis.16
This innovation made vast sums of money available to
borrowers. For example, securitization increased the amount of money available
to individuals purchasing homes, leading to unprecedented growth in house
prices. From 2000 to 2005, the percentage of non-conforming mortgages that
became securitized increased from 35% to 60%, and the volume of non-
conforming origination also rose dramatically. Subprime mortgage originations
rose from $160 billion in 2001 to $600 billion in 2006. And many of these
securitized mortgages became re-securitized as backing for CDOs* (Collateral
Debt Obligation). As of October 2006, 39.5% of existing CDO pools covered by
Moody’s consisted of MBS (Mortgage Backed Securities), of which 70% were
15 Abul Hassan, “The Global Financial Crisis and Islamic Banking”, The Islamic Foundation, UK, 2009 16 J. Rasmus, “The Deepening Global Financial Crisis: From Minksy to Marx and Beyond”, Critique, Vol.
36, No.1, pp.5-29.
*CDO is an instrument that redistributes the underlying risks from a mortgage or other assets lying
beneath it.
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subprime or second-lien mortgages and as of June 30, 2008, the MBS market was
worth $6 trillion, more than US Treasury bonds.17
In 2009, an estimated $8.7
trillion of assets globally were funded by securitization.18
Securitization played a main role in spreading the financial risks globally. Once
financial assets, such as debts, were securitized into MBS’s and CDO’s they were
sold to central banks, private banks and wealthy investment funds around the
world. Thus in the name of securitization, debt was sold to a third party, which
would then receive the loan repayments and pay a fee for this privilege. Thus
debt became tradable, just like a car. The ability to securitize debt provided a way
for risk to be sliced, diced and spread, allowing more mortgages to be sold.
Initially securitization process allowed originators of loans and especially of
subprime mortgages to remove part of the associated risks from their balance
sheet and reduced their regulatory capital requirement, as long as interest rate
remained low and house prices appreciated the issue volume of mortgages as
well as other loans massively increased because most of these loans were
securitized the volume of ABS’s, MBS’s and CDO’s rose as well.
17 Charles W. Calomiris, “Not (yet) a Minsky Moment” , in Andrew Felton and Carmen Reinhart, eds., The
First Global Financial Crisis of the 21st Century, July 2008, p.78. 18 “Too Big to Swallow,” Economist, 16 May 2009, 11.
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Figure No.3 Source: Thomson Reuters SMA Graph
The risk embedded in mortgages and especially in related securities was hidden
for quite for some time. However, as interest rates rose and the housing price
tumbled, mortgage delinquency and foreclosure rates drastically increased. The
degree to which mortgage markets impacted financial instruments and financial
markets drastically overcome all market participants’ expectations.
1.3.3 Regulatory Failure
As the global financial crisis unfolded, it was obvious that many of those in the
banking and investment communities did not fully comprehend how the financial
system they created functioned, or the scope and severity of the crisis. The
financial wizards, the best and the brightest from leading business schools, could
not really explain what was happening on Wall Street and in global financial
markets.
The failure of regulators to force financial institutions to follow sound risk
management practices was also one of the most important reasons for the
financial crisis. The widespread belief developed over the past 20 years, that
markets can regulate themselves may have contributed to the regulatory laxity,
which in turn contributed heavily to the crisis, invalidating the argument
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promoted by free market advocates and particularly policy makers of the US
market that “markets are efficient their own” and market forces are capable of
managing and regulating market inefficiencies.19
Describing this theory as a
fundamental misconception regarding modern financial market regulation, the
UNCTD (United Nations Conference on Trade and Development) in its report has
said, the assumption that “markets know best” and that regulators should take a
back seat is a wrong argument.20
The same reality is exposed by Paul Krugman,
laureate of the Nobel Prize in Economics in his book “The Return of Depression
Economics and the Crisis of 2008”, described the run on the shadow banking
system as the "core of what happened" to cause the crisis. He referred to this lack
of controls as "malign neglect" and argued that regulation should have been
imposed on all banking-like activity.21
The housing price bubble, itself as a result
of the deregulation of financial markets on a global scale affirmed the principle,
that competitive markets are not necessarily the best co-ordination tool in the
real world. The market deregulation of international as well as national finance
has been, hence detected as the third major factor responsible for the global
financial crisis. It helped, in accelerating the development of credit overhang and
at the same time has enabled the US economy to contaminate the world.22
The
problem has occurred during an extremely accelerated process of financial
innovation in market segments that were poorly or ambiguously regulated –
19 M.Kabir Hassan, ‘’The Global Financial Crisis &Islamic Finance’’, University of New Orleans ,USA ,2008,
p.2. 20 UNCTAD’s report on “The Global Economic Crisis: Failures and Multilateral Remedies” , Geneva, 19
Mar. 2009. 21 Paul Krugman, “The Return of Depression Economics and the Crisis of 2008”, W.W. Norton Company
Limited, 2009. 22 Jacques Sapir, ‘’From Financial Crisis To Turning Point’’, Real world Economics Review, vol. 46, 2008,
p.34.
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mainly in the U.S. The fall of the financial institutions is a reflection of the lax
internal controls and the ineffectiveness of regulating oversight in the context of a
large volume of non transparent assets. It is indeed amazing that there were
simply no checks and balances in the financial system to prevent such a crisis and
“not one of the so called pundits” in the field has sounded a word of cautions.
There are doubts whether the operations of derivatives markets have been
transparent as they should have been or if they have been manipulated.
Insufficient market regulation results in failure of making institutions financial
situation publicly known (lack of transparency) and also makes it possible for
financial institutions to operate without having sufficient assets to meet their
contractual obligations. There was a general loss of control at all levels, which led
to exponential risk taking at many companies, largely hidden from public scrutiny.
Violations of financial regulations went largely unpunished23
. During the crisis,
market deregulation was at its epitome, added up with financial liberalization,
finally resulted in deepening the effects of the crisis.
1.3.4 Over-Leveraging
The global economy is facing difficult challenges, and such a situation is
attributable to the phenomenon that leverages* markedly increased around the
globe in the periods preceding the current financial crisis.24
Prior to the crisis,
financial Institutions became highly leveraged, increasing their appetite for risky
investments and reducing their resilience in case of losses. Much of this leverage
was achieved using complex financial instruments such as off-balance sheet
23 Frank Partnoy, “Infectious Greed”, New York: Times Books, Issue No. 3, 2003 24 Masaaki Shirakawa: “International Banks Amid Global Financial Crisis”, Bank of International
Settlements Review, 2009, p: 3.
*Leverage allows a financial institution to increase the potential gains or losses on a position or
Investment beyond what would be possible through a direct investment of its own funds.
26
securitization and derivatives, which made it difficult for creditors and regulators
to monitor and try to reduce financial institution risk levels. These instruments
also made it virtually impossible to reorganize financial institutions in bankruptcy,
and contributed to the need for government bailouts.25
Figure No.4 Source: Company Annual Reports (SEC Form)
Leverage ratios of investment banks increased significantly 2003–07. U.S.
households and financial institutions became increasingly indebted or
overleveraged during the years preceding the crisis.26
Free cash used by
consumers from home equity extraction doubled from $627 billion in 2001 to
$1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion
dollars over the period, contributing to economic growth worldwide. U.S. home
mortgage debt relative to GDP increased from an average of 46% during the
25
"The End Of The Affair", Economist, October 30, 2008. 26
Ibid
27
1990s to 73% during 2008, reaching $10.5 trillion.27
Although Banks intended to
make money out of this risky financial technique but unfortunately results
reversed and most of the financial institutions were caught up in bankruptcy.
1.3.5 Inherent Instability
This is the major issue that is contentiously discussed by Muslim economists as
well as healthy band of Western economists as a threat to the stability of world
economy. The crisis has shown that advanced conventional financial systems are
very vulnerable. Financial instability has been a recurring phenomenon in
contemporary economic history, affecting countries with varying intensity. The
current phase of global financial crisis has proved, what Dr. Minksy, Nobel prize-
winning economist, argued, “that the modern finance was far from the stabilizing
force that mainstream economics portrayed: rather, it was a system that created
the illusion of stability while simultaneously creating the conditions for an
inevitable and dramatic collapse”.28
Eminent economists who lived through the
Great Depression fought very hard to establish a banking system capable of
achieving and preserving financial stability. Irving Fisher, a prominent American
economist of the Great Depression era, strongly argued that two dominant
factors were responsible for each boom and depression: over-indebtedness in
relation to equity, gold, or income which starts a boom, and deflation consisting
of a fall in asset prices or a fall in the price level which starts a depression.
27 Colin Barr, "Fortune-The $4 Trillion Housing Headache", http://money.cnn.com, CNN. May 27, 2009
Retrieved May 1, 2010. 28 Rauf Mammadov, Expert views, 36 Global Islamic Finance, January, 2010.
28
American economist, Hyman Minsky, considered that conventional finance
dominated by interest-based debt contracts is inherently unstable. This assertion
is based on a construct known as Financial Instability Hypothesis (FIH), which
posits that stability is inherently unsustainable. A fundamental characteristic of a
conventional financial system, according to Minsky, is that it swings between
robustness and fragility and these swings are an integral part of the process that
generates business cycles. Talking about the working standard of conventional
banks, George Soros wrote, ‘when money is free, the rational lender will keep on
lending until there is no one else to lend to’. Rapidly expanding money and credit
combined with an ideologically-based fierce de-regulation movement which
began in the early 1980s in industrial economies and continued throughout the
next two decades. It put at high risk the financial stability of these countries and
as the result of rapid financial globalization, the rest of the world as well.29
1.4 GENERAL IMPACT OF GLOBAL FINANCIAL CRISIS
The financial crisis began in July 2007, triggered by a dramatic rise in mortgage
delinquencies and foreclosures in the United States, with major adverse
consequences for banks and financial markets around the globe. As the crisis was
worst of its kind, its far reaching repercussions were not seen only in finance
sector but also in real economy as well. According to estimates by the World
Bank, the total world economy contracted by 2.1% in 2009 – an unprecedented
fall in the post-war era. According to a report, in the OECD* area, there was an
29 Abbas Mirkhor and Noureddine Krichene, “ Resilience And Stability Of Islamic Finance”, IDB Jeddah,
2009, pp.1-2.
*The OECD (Organization for Economic Co-operation and Development) is a unique forum where the
governments of 32 democracies work together to address the economic, social and environmental
challenges of globalization.
29
economic contraction of 4.7% between the first quarter of 2008 and the second
quarter of 2009. A plunge in global trade was another sign of the seriousness of
the crisis. Worldwide, the volume of world trade in goods and services fell by 12%
in 2009, according to the WTO.30
Of course, the price of a recession is felt not just
in the economy but also in society. Unemployment hit just under 10% in the
United States in December 2009 (falling back to 9.7% the following month), which
was more than double the 2007 rate of 4.6%. In the euro zone, the figure for
December 2009 was 10%, up from 7.5% in 2007. To put those numbers in
perspective, even by mid-2009, when unemployment in the OECD area stood at
8.3%, it meant an extra 15 million people were out of work compared with 2007.
By the end of 2009, the unemployment rate had risen still further, to 8.8% and is
continuously increasing as was seen in “we, the 99” movement in U.S in August
2011.31
1.4.1 IMPACT OF GFC ON FINANCE SECTOR
The economies in Western countries over the last 30 years have shifted their
focus from industry to services. The service sector now represents over 80
percent of the US economy, with the financial sector being the largest service.
The financial economy is now valued more than the real economy. The size of the
worldwide bond market by 2009 was estimated $45 trillion. The size of the
world’s stock markets in the same year was estimated $51 trillion. The world
derivatives market was estimated at $480 trillion, more than 30 times the size of
the US economy and 12 times the size of the entire world economy by the end of
2009. As a result of globalization financial system has become an interwoven web
30 Brain Keeley and Patrick Love, From Crisis to Recovery, OECD Insights, 2010, p.12. 31 TradingEconomics.com, U.S. Bureau of Labor Statistics, April 2012.
30
in the form of Transnational Financial Organizations and Foreign Direct
Investment plans. As the current financial crisis has hit financial economy it is
obvious that it might have laid serious consequences over the worldwide finance
industry. In the current financial scenario there are only two working industries
at global level, one is centuries old conventional financial system holding 99% of
total global assets and second is newly born Islamic finance industry, just decades
old, holding the remaining 1% of the global asset share. The impact of the GFC on
both industries will discussed separately. Firstly we will analyze the impact of GFC
on conventional banks and financial institutions:
1.4.2 IMPACT OF GFC ON CONVENTIONAL FINANCE INDUSTRY
Economists observed that the difference between the interest rates on interbank
loans and short-term U.S. government debt spread, an indicator of perceived
credit risk in the general economy, spiked up in July 2007, remained volatile for a
year, and then spiked even higher in September 2008. The crisis deepened, as
stock markets worldwide crashed, entering into a severe-impact phase marked by
failures of some prominent American and European banks, like the bankruptcy of
Lehman Brothers, which is the largest in U.S history with Lehman holding $639
billion in assets. The situation prompted a substantial injection of capital into
financial markets by the United States Federal Reserve, Bank of England and the
European Central Bank.32
In October 2007 major failures start to appear in the
world’s financial industry, Swiss banking giant UBS bank has announced losses
$3.4bn from investments linked to sub-prime. In March 2008, the investment
bank and brokerage Bear Stearns collapsed. Following, American banking giant
Citigroup posted a sub-prime loss of $40 billion. US investment bank Merrill Lynch 32
Hussein Alasrag, “Global Financial Crisis And Islamic Finance” , World commerce Review, vol. 36,
2009, pp.31-32.
31
revealed a $7.9 billion disclosure to bad debt. It wasn’t just investment banks that
found themselves in trouble. The biggest insurer in the US, American Insurance
Group (AIG) teetered on the brink of failure due to bad bets it had made on
insuring complex financial securities. It survived only after billions of dollars of
bailouts from Washington.33
A major bond insurer MBIA announced a loss of $2.3
billion. After failing to search for a potential buyer, Lehman Brothers becoming
the first major US investment bank to collapse since beginning of the credit crisis.
The Federal Reserve slashes the key interest rate to by 0.5% to 5.75% at which it
lends banks, warning the financial crisis could be a risk to economic growth. Not
only the US Federal Reserve, the Bank of Canada and the Bank of Japan also begin
to intervene. To improve this situation the European Central Bank subsidized
108.7 billion Euros into the financial market to try to improve liquidity. UK high
risk mortgage providers set to pull out mortgages and increased the cost of
borrowing for UK homeowners with poor credit histories.34
Former Federal Reserve chief Alan Greenspan described the current financial
crisis as "probably a once in a century type of event" and cautioned that this
financial calamity will lead to the closure of major firms. The US House of
Representatives passes a $700bn (£394bn) government plan to rescue the US
financial sector a part of $900bn (£600bn) economic stimulus package. Since the
collapse of Lehman Brothers, the global economy and financial markets have
changed dramatically. The fourth quarter figures for GDP, industrial production,
and exports have started to be released in various countries, and a sharp decline
that could be indeed expressed as “jump off a cliff” has been witnessed
33
Brain Keeley and Patrick Love, From Crisis to Recovery, OECD Insights, 2010, p.18. 34 Riyazi Farook, “Global Financial Crisis Unthinkable Under Islamic Banking Principles”, Islamic Finance
and Banking, Srilanka, 2009, p.2.
32
simultaneously worldwide. The Bank of Japan released the economic outlook,
according to which the median forecast of Japan’s economic growth for fiscal
2009 among Policy Board members was substantially revised downward from
0.6% as of end-October 2008 to -2.0%35
. Extreme market volatility caused a loss of
600 million Euros to French savings bank Caisse d'Epargne during the financial
market crisis. South Korea announced a $130bn financial rescue package to
stabilize its financial markets. The Dutch government funded 20bn Euros
($26.8bn) to protect the financial sector from the credit crisis. Sweden's
government also announced its financial rescue plan, with credit guarantees to
banks and mortgage providers up to a level of 1.5 trillion kroner (£117.2bn,
$205bn). The government also announced it will establish aside 15bn kroner as a
bank stabilization fund.36
In the first few months of the financial crisis, there was the widely held view that
the impact on African countries would be minimal because of their low
integration into the global economy. Recent developments have, however, shown
that the negative contagion effects of the crisis were already evident in the Africa
region. For example, stock market volatility has increased since the onset of the
crisis and wealth losses have been observed in the major stock exchanges. In
Egypt and Nigeria, the stock market indices declined by about 67 percent
between March 2008 and March 2009. Significant losses have also been observed
in Kenya, Mauritius, Zambia and Botswana. The turmoil in African stock markets is
beginning to have significant negative effects on the financial sector and on
aggregate demand. For example, there is growing evidence that it has a negative
effect on bank balance sheets and, if present trends continue, non-performing 35 Ibid, p.3. 36 ibid
33
loans in the banking sector would likely increase, with dire consequences for
financial stability in the region. In Ghana, the ratio of non-performing loans to
gross loans increased from 7.9 per cent to 8.7 per cent between 2006 and the
third quarter of 2008. In Lesotho, it increased from 2 per cent to 3.5 per cent over
the same period.37
The impact of the crisis was equally seen in Asian Banking sector. Most of the
Asian countries, being underdevelopment (referred as Low Income Countries also
as Emerging Market Economies) constitute a large proportion of their GDP* in the
form of ODA (Official Development Assistance) and FDI’s (Foreign Direct
Investment). In response to the crisis, the donors reduced ODA flow in the region
and there was a healthy decline in FDI flow as well. As a result, the top 20 LIC
banks were caught by surprise by the global financial crisis at the height of their
balance sheet expansion and also experienced a sharper decline of deposit
growth in 2008.38
Moreover, amid the current financial and economic crisis, global FDI flow has
shown downward trend and, according to UNCTAD, global FDI fell by 21 percent
annually in 2008, after five years of strong growth and a record level of US$1.8
trillion in 2007. Developed countries witnessed the sharpest downturn of 33
percent while FDI flows to developing countries remained positive in 2008.
However, growth rate decreased from over 20 percent in 2007 to 3.6 percent in
2008. Developing countries in regions like Africa which received huge amount of
37 African Union Commission, “The Global Financial Crisis: Impact, Responses and Way Forward”, 2nd
Joint Annual Meetings of the AU Conference of Ministers of Economy and Finance and ECA Conference
of Ministers of Finance, Planning and Economic Development, Cairo, Egypt, 2009, p.2. 38 Jack Joo K. Ree, “Impact of the Global Crisis On Banking Sector Soundness In Asian Low-Income
Countries”, IMF Working Paper no.115, May 2011, P.10.
*Gross Domestic Product (GDP), is the total market value of all the final goods and services within an
economy in a given year.
34
FDI in recent years faced a sharper decline in FDI mainly triggered by the decrease
in commodity prices, as most of the FDI in these economies was resource
motivated.39
1.4.3 IMPACT OF GFC ON ISLAMIC FINANCE INDUSTRY
The current global financial crisis has not only shed doubts on the proper
functioning of conventional “Western” banking, but has also increased the
attention on Islamic banking. Internationally, Islamic banks appear to have been
more resilient to the primary effects of the global economic turndown and
international financial crisis than conventional banks. The main reason for this
being the inherent nature of Islamic banks, which shun the risky and much
misunderstood financial products and also the fact that it is an asset backed
banking. They tend to avoid the speculative investments, such as derivatives, that
many analysts believe led to the financial crisis affecting conventional banks. For
some observers, Islamic finance serves as a vehicle for recovering from the
international financial crisis. The Islamic banking industry may be able to
strengthen its position in the international market as investors and companies
seek alternate sources of financing.40
However, as Islamic banks operate within a global financial system, they have not
been completely insulated from the recent economic and financial shocks. For
instance, on the one hand, the Islamic financial industry is considered by many to
be less risky because financial transactions are backed by physical assets. On the
other hand, Islamic banks may be more vulnerable to fluctuations in the mortgage
39 Riyazi Farook, “Global Financial Crisis Unthinkable Under Islamic Banking Principles”, Islamic Finance
and Banking, Srilanka, 2009. 40 Stephen Timewell, “A Template For Averting Disaster? - Roundtable,” The Banker, January 1, 2009,
Academic One File, Gale, Library of Congress, accessed February 6, 2009.
35
market, given their high activity in the real estate sector compared to
conventional banks. The recent slowdown in real estate activity in the Gulf-
economies raises concerns about some Islamic banks’ financial positions.41
Some
economists, particularizing their research, have made attempts in this direction.
For example Sat Paul Parashar and Jyoti Vankatesh, in their research paper have
tried to show that Islamic banks have suffered more than conventional banks
during recent global financial crisis in terms of capital ratio, leverage and return
on average equity, while conventional banks have suffered more than Islamic
banks in terms of return on average assets and liquidity.42
Tracing impact of the
crisis on both financing industries i.e. Islamic as well as conventional, Beck et al.
(2010) have compared the two types of banking and their performance across
many countries, during recent crisis and have come up with the conclusion that
though both types of banking were affected by the crisis, Islamic banks had higher
capitalization coupled with higher liquidity reserves, resulted in better
performance of Islamic banks.43
Answering to the question whether Islamic banks were equally affected during
the current global financial crisis or not Dr. Linda Eagle, member of ‘The Edcomm
Bankers Academy’ responds, “Unlike many Western financial institutions, Islamic
banks have remained relatively unharmed during the current global financial
crisis. In fact, Islamic finance has gained a greater acceptance and more
widespread recognition in recent years, as more and more Muslims and non-
41 Shayerah Ilias, “Islamic Finance: Overview and Policy Concerns”, Congressional Research Service, 2010,
p.3. 42 Sat Paul Parashar and Jyothi Venkatesh, “How Did Islamic Banks Do During Global Financial Crisis?”,
Banks and Bank Systems, Volume 5, Issue 4, 2010, P.55. 43 Thorton Beck, Asli Demirgue-Kent and Merrouche Quarda, “Islamic vs. Conventional Banking –
Business Model, Efficiency And Stability”, The World Bank, Development Research Group, Policy
Research Working Paper 5446, October. 2010.
36
Muslims worldwide have taken an interest in Shari’ah-compliant banking products
and services due to its more prudent investment and risk philosophy. In response,
Islamic Banks are starting to open up in many countries across the globe, helping
this segment of the financial industry to continue to flourish. Islamic finance
remained steady in this tough global economy primarily due to the nature of the
industry. According to the laws of Shari’ah, the buying or selling of debt is strictly
prohibited, as well as insurance and investment gains and excessive risk-taking. In
other words, Shari’ah-law does not allow individuals or companies to borrow
money that does not exist – it must be invested into productive enterprises. It is
this more cautious attitude towards money that has kept Islamic banks relatively
safer from the effects of the global financial crisis today compared to their
conventional banking counterparts.44
A new IMF study compares the performance of Islamic banks and conventional
banks during the recent financial crisis, and found that Islamic banks, on average,
showed stronger resilience during the global financial crisis. Figure No.5 provides
a comparison of the average profitability, credit and asset growth in 2008 to its
2007 level (cumulative impact) shows that IBs fared better in all countries, except
Bahrain, Qatar, and the UAE. In four countries (Bahrain offshore, Jordan, Saudi
Arabia, and Turkey), the change in profitability was significant in favor of IBs.45
44 Dr. Linda Eagle, Expert Views, 36 Global Islamic Finance, Jan 2010. 45 Maher Hassan & Jemma Dridi, “The Effects of the Global Crisis On Islamic And Conventional Banks: A
Comparative Study” IMF Working Paper no. 210, Sep. 2010, P.16.
37
Figure No. 5 Source: Maher Hassan & Jemma Dridi, IMF, 2010
The above cited IMF study report suggests that Islamic finance system has a great
potential for further market share expansion and a possible contribution to
market stability through the available credit. Performing well in the first phase of
the crisis, however weaknesses in risk management practices in some of the
Islamic banks led to a larger decline in profitability compared to seen in
conventional banks during the second phase of the crisis. While talking to Arab
News Online, M. Parker has pointed towards the same reality.46
Parker’s
observation can be summed as, the lack of contract standardization, the absence
of instruments to hedge against the volatility in currency and commodity markets,
the incomplete legal framework, and the insufficient expertise at the supervisory
and industry level may weaken the potential of Islamic finance sector and may
affect its reputation. This decline can be visualized in the figure No.6. It was also
46 M. Parker, “Islamic Banks Fared Better During Financial Crisis”, Arab news on-line 19 September, 2010,
Retrieved on 18 February 2011 from http://arabnews.com/economy/islamicfinance/article142384.ece.
38
seen that large Islamic banks fared better than small ones, perhaps as a result of
better diversification, economies of scale, and stronger reputation.47
Figure No.6 Source: IMF Staff Estimates and Calculations48
The global market for Islamic bonds is estimated to be $80 billion currently. After
increasing more than five-fold from 2004 to 2007, global issuance of sukuk hit a
three-year low point in 2008. Sukuk issuance began slowing down in late 2008,
partly due to the global economic turndown, the international sukuk market faced
lower levels of liquidity, resulting from declines in oil prices and reduced
confidence from investor. According to some estimates the total Islamic Bond
Market decline in year 2008 was 24%. Despite current challenges, many analysts
believe that the long-term viability of the Islamic bond market appears strong,
owing to the growing popularity of Islamic financial products, increased
47 Samir Srairi, Imen Kouki, and Nizar Harrathi, “ The Relationship Between Islamic Bank Efficiency and
Stock Market Performance: Evidence From GCC countries”, Center for Islamic Economics and Finance,
Qatar Faculty of Islamic Studies, Qatar Foundation, 2010, P.2. 48 IMF Survey Online, Islamic Banks: More Resilient to Crisis? , October 4, 2010.
39
government interest in Islamic finance, investment and financing needs of the
Gulf countries, and financial institution seeking greater diversification.49
It is relevant to end up this chapter with the evaluations made by Sat Paul
Parashar and Jyothi Venkatesh. After comparing six different ratio’s CAR, CTI,
ROAA, LA/TA and E/TA of Islamic and conventional banking systems for full four
years, and also before and during the crisis, inter and intra group, they have
concluded their research paper in following words, “In conclusion, it may be
stated that Islamic banks did suffer during crisis in terms of lowering of CAR, E/TA
and ROAE, but overall, over four years period, they performed better than
conventional banks”.50
49 Hussein Alasrag, “Global Financial Crisis And Islamic Finance”, , World commerce Review, vol. 36,
2009, p.56. 50
Sat Paul Parashar and Jyothi Venkatesh, “How did Islamic Banks Do During Global Financial Crisis?”, Banks and
Bank Systems, Volume 5, Issue 4, 2010, P.61.
40
Chapter-2
LITERATURE REVIEW
41
2.1 LTERATURE REVIEW
Like all previous crisis, many theories have been proposed to explain the causes
and impact of the current global crisis. A vast literature in the form of books,
articles and research papers was brought to compilation. This chapter will present
a brief review of some books and articles compiled in this direction by Muslim as
well Western experts for socio-professional benefits.
2.2 BOOKS
Book: Contemporary practices of Islamic Financing Techniques
Author: Ausaf Ahmad
Publisher: Islamic Research Training Institute, Jeddah, 1993
Pages: 75
Description
Despite being an evolving industry, the PLS (profit loss sharing) orchestrated and
low risk equity based instruments has potentialised the Islamic financial sector to
uplift its growth curve. The present book is a scholastic endeavour, wherein the
author has examined the nature and operating mechanism of some elementary
financial techniques and their role in bringing up Islamic finance industry in the
contemporary financial scenario.
The book has been divided into six sections including an introductory and
concluding section. In its introductory section, the avoidance of the interest based
transactions has been described as the elementary character which differentiates
Islamic banking from conventional banking. It also provides basic information
42
about the objectives, dimensions and entire structural plan of the study. This
section has direct relevance with the chapter 3rd
of the present study.
In second section “Common practices of Islamic banks in the sources of Islamic
finance” of the book, a detailed description has been made about the services and
practices offered by most of the Islamic banks so to make funds available for
business transactions to gain profit. Current accounts, saving deposits, investment
deposits, joint/general investment account, limited and unlimited investment
deposits, specified investment deposits together with deposit management in
Iran and Pakistan have been also explored under the same section. This section is
relevant to chapter 3rd
and 4th
of the present study.
Islamic financial tools and equity based transactions that formulate the central
body of Islamic banking have been elucidated in detailed account in section third
“common practices of Islamic banks in the uses of funds” of the book. The author
visualizes that, in an Islamic bank, application of funds is being carried out
through these instruments. Mostly operated instruments like Musharakah,
Mudarabah, Ijarah, Murabahah, Bai, Qard al- hasan etc have been fully
elaborated along with their types. This section is in relevance to the chapter 3rd
of
the present study.
Section four “Islamic financing techniques specifically used in Pakistan” and five
“Islamic financing techniques specifically used in Iran” describes the respective
Islamic financing techniques used in Pakistan and Iran, particularly those tools
which have not been covered in earlier sections. Trade, investment and loan
related financial techniques mostly being observed in Pakistan and salaf
transactions, Jua’alah, Musaqat, Muzarah etc in Iranian context have been
43
discussed very skillfully. Last section based on conclusion, summarizes the overall
study and author has ended up with some valuable suggestions with respect to
further research on the same subject. Section no. 4, 5 and 6 are having relevance
with chapter 3rd
and 4th
of the present study.
As all sections of the book are in relevance with the subject matter of the present
study, hence it has cited in both literature review as well as bibliography of the
present study.
Book : From Crisis To Recovery: The Causes, course And
Consequences Of The Great Recession.
Authors: Brain Keeley & Patrick Love.
Publisher: Organization For Economic Co-operation And
Development (OECD) Publishing, France, 2010.
Pages: 144.
ISBN: 978-92-64-06911-4
Description:
2007, 2008, the worst of crisis in the decades ripped through the global financial
systems. Along with massive unemployment, collapse of housing prices and
spread of distress throughout the markets and economics around the world, it
has become a greater threat for economists and finance experts to predict where
global economy might go next. The book under review has been brought to
publication by the publishing unit of OCED (Organization For Economic Co-
operation And Development), intending to provide a strategic response to the
44
above said problem. The book draws on the OCED’s analyses of why the financial
crisis occurred and added to its rapid expansion into the real economy. The book
offers a structural framework, what authors believe is a “Green Growth Strategy”
to guide national and international economic policies. The book also demand
governments to take a stronger lead in fostering production, procurement and
consumption patterns by abstaining opaque frameworks and ensuring
transparency in market working.
The book comprises of seven healthy chapters, each chapter authenticated with
graphics, charts from OECD’s publications and papers as well as quotations from
their direct texts and is ended up information source links.
Chapter first, entitled as “Introduction” is an overview of the actual study. It
makes a reader conversant about what a financial bubble burst means and what
can be its hitting areas. Discussing the recession and its legacies from 2008
onwards, the unprecedented contraction in world economy, the growing
unemployment rate, the excessive borrowing by governments and fall in the
volume of world trade in goods and services have been numerically evaluated
with special reference to OCED countries.
Second chapter “The Roots of a Crisis” deals with the question, what caused a
financial crisis? It also looks at the pressure that built up in global finance in the
years before the crisis struck. In authors observance the factors like easy access to
cheap borrowing, asset price bubble, poor regulation, high securitization in
banking and opaque marketing activities added to global liquidity bubble.
Encompassing the spheres of its affect, it has been found that not only
investment banks were caught in trouble but insurance companies like American
45
Insurance Group, the bigger insurer in US teetered on the brink of failure. It
survived only after billions of bailout from Washington. While locating the birth
place of the current financial crisis, the key economies like Japan and United
States have been pointed out. This chapter is relevant to the chapter 1st
of the
present study.
The third chapter “Routes, Reach, Responses” examines the routes of the
recession, the sphere that it has brought under its affect and the responses from
various sectors to its stimuli. It has also enumerated the factors, which resulted in
the transformation of financial bubble from individual economies to global
economy. Tracing the route of the crisis, it has been observed that the central
route for the current financial crisis is slowdown in “banking markets” which
started with decline in housing prices simultaneously in United States and Japan.
It has also discussed how the “bank crisis” spurred governments and central
banks to respond. This chapter is relevant to chapter 1st
of the present study.
Chapter 4 “The Impact On Jobs” looks at the impact on jobs, including the risk
that the recession will be followed by a jobless recovery that contributes to a “lost
generation” of young people in the work force . Chapter 5 “Pensions And The
Crisis” looks at the impact on pensions: the crisis highlighted issues in both
funding and benefits that population ageing and changing career patterns could
aggravate.
Chapter 6 “New World, New Rule?” considers the push for new rules and
standards in three key areas – financial markets, tax evasion and business and
economic ethics.
46
Finally, Chapter 7 “The Future, Five Questions” examines some longer-term issues
arising from the recession, including rising national debts, the prospects for
turning the recovery into an opportunity for “green growth” and the challenges
facing economics as a profession. Chapter no. 4th
, 5th
, 6th
, and 7th
are in relevance
with 4th
and 5th
chapter of the present study.
Since the subject matter of the book is in relevance to the present study, hence it
has included in the literature review and bibliography as well.
Book : Islamic Finance.
Author: Dr. Venkataraman Sundararajan.
Publisher: SAGE Publications India Pvt. Ltd., 2011
Pages: 291
ISBN: 978-81-321-0706-4 (HB)
Description:
Islamic finance, is a collection of selected writings of Dr. Sundararajan (1945-
2010) edited by Jaseem Ahmad and Harinder S. Kohli. The papers accumulated in
this book, are significant, perceptive and insightful presenting a comprehensive
overview of the Islamic financial architecture. Outlining many complexities in the
development and mainstreaming of Islamic finance industry, that can help it in
becoming a competitive, resilient and an important global financial intermediary.
The chapters in this book are blend that would benefit lay readers, casual
students of Islamic finance and policy makers at national and international level.
47
The chapterization of the book follows a chronological order and has been
structured into three parts. Part 1 consists of the first chapter of the book,
“Current developments and Key Issues in Islamic Finance”. In this chapter the
author has described the basic foundations, core principles and key features of
Islamic finance. It also discusses the structure, size and expanding scope of Islamic
finance industry.
Part 2, comprises of four comprehensive chapters. Chapter 2 “Monetary
Operations and Government Debt management under Islamic banking” focuses
on three critical issues: firstly issuance of government securities under Islamic
finance principles, secondly recent developments in monetary instruments under
Islamic banks and thirdly issues in institutional arrangements for monetary
operations.
Chapter 3rd
“Islamic Financial Institutions and Products in the Global Financial
System: Key Issues in risk Management and Challenges Ahead” addresses various
issues related to risk management policies and also suggests ways to manage the
risks, including invigorating the regulatory and disclosure framework.
Chapter 4th
“Risk Measurement and Disclosure in Islamic Finance and the
Implications of the Profit Sharing Investment Accounts” defines a specific
approach to measure the actual of the risks between share-holders and profit-
sharing investment account holders, based on the value-at- risk methodology.
Part 2nd
ends up chapter 5, titled as “A Note on Strengthening Liquidity
Management of Institutions Offering Islamic Financial Services: The Development
of Islamic Money Markets” focuses on, the rationale for Islamic money markets
development, an overview of factors affecting the money markets including legal
48
and Shari’ah issues, structure and instruments of Islamic lone markets, financial
management and role of monetary operations.
Part 3rd
consists of three chapters. Chapter 6 “Issues in managing Profit
Equalization Reserves and Investment risk Reserves in Islamic Banks” outlines the
main determinants of profit equalization and investment risk reserves and their
relationship to displaced commercial risk.
Chapter 7, “Towards Developing a Template to Assess Islamic Financial Services
Industry (IFSI) in the World Bank-IMF Financial Sector Assessment Program
(FSAP)” describes the structural plan for FSAP’s and IFSI’s.
The voluminous work ends with chapter 8, “Supervisory, and Capital Adequacy
Implications Of Profit-Sharing Investment Accounts In Islamic Finance”. The
chapter describes the main types and characteristics of PSIA’s under mudarabah
contracts. The chapter concludes with suggestions for risk-sharing as well as
implications of these PSIA’s for the supervisory and regulatory authorities.
As all parts of the book are in relevance with the chapter 3rd
and 4th
of the present
study, thus it has been cited in both literature review as well as bibliography.
Book: The Global Financial Crisis: Can Islamic Finance Help Minimize The
Severity And Frequency Of Such A Crisis In The Future?.
Author: Muhammad Umer Chapra
Publisher: Center for Islamic Area Studies at Kyoto University (KIAS),
Japan,2009.
Pages: 51.
49
IBN: 978-4-904039-13-7
Description:
The present book describes the primary causes that contributed about the
present global financial crisis. In authors observance excessive landings, high
leverage speculations and non availability of risk-sharing mechanism are some of
the key factors responsible for the current financial crisis. While analyzing the
question, whether Islamic finance industry could minimize the frequency of the
crisis, the author has come up with the conclusion that, because of its equity
based transactions, risk mitigation policies and market management discipline
Islamic finance industry has a substantial tendency to reduce the financial
instability.
The book has been divided into three chapters. In the first chapter “The primary
causes of the crisis” the author has highlighted those determining factors
responsible for the current crisis that has taken more than three million dollars of
bailout and liquidity injections by a number of industrial countries abate
somewhat intensity of the crisis. Excessive lending, inadequate discipline in
financial markets and excessive leverage have been detected as major causes of
the crisis. This chapter has relevance with chapter 1 of the present study.
Chapter 2nd
“The Islamic Financial System” provides an overview of the Islamic
financial system. It has discussed its themes and objectives as well. This chapter is
in relevance o the chapter 3rd
of the present study.
“Is This of Any Relevance to the Conventional System” has become chapter 3rd
of
this book. This chapter is based on suggestions and recommendations. How
50
financial institutions can minimize the growing speed of current financial crisis by
applying Islamic equity instruments, is central subject of this chapter.
As this book is relevant with the subject matter of the present study, hence it has
been mentioned in literature review as well as bibliography.
Book : The Stability Of Islamic Finance: Creating A Resilient
Financial Environment For A Secure Future.
Authors: Hussein Askari, Zamir Iqbal, Noureddin Krichene and
Abbas Mirkhor
Publisher: John Wiley & Sons (Asia) Pte. Ltd. 2007.
Pages: 256.
ISBN: 978-0-470-82519-8
Description:
This book is a collective effort of four renowned trained Islamic economists,
holding a strong expertise in banking and finance sector. The book is of vital use
both in academics as well as for Islamic financial institutions in sophisticating their
financial operations. The authors argue, that Islamic financial engineering and
financial tools, inheriting a much balanced potential, have attained such a
position where they are able to provide the world a stable and much resilient
financial environment in the twenty-first century. This argument has become
central theme of the book. In this connection the authors have significantly
developed themes that link Islamic finance to existing traditions in economics,
that assess the stability property of Islamic financial instruments and that explain
51
some key Islamic concepts in economist’s terms. Using valid arguments, the
author’s intend to demonstrate, how conventional finance can generate cyclical
instability in credit creation which in turn leads economic booms and busts. While
tracing out the various causes responsible for the worldwide financial crisis, the
book blames that, the monetary expansion in reserve centers leading to
internationalization of the crisis, negligence towards monitoring of monetary
aggregates, lapses in corporate governance and lack of profit-loss scheme are
some of the major causes. The authors also argue that, Islamic financial system is
inherently more stable than conventional system because its equity based
instruments are directly linked to the productivity of the real investments they
finance, and therefore not only enhance social objective of ‘’sharing’’ risks and
rewards, but cushion financial intermediation against the inherent risks of excess,
both in booms and slumps. Excluding the first chapter the overall content of book
is in relevance to the present study and has been included in the literature
overview.
The authors have divided the overall content of the book into thirteen chapters.
In chapter 1, the authors have dealt with the problem of nature of the capital and
the rate of return. Under the same chapter some classical capital theories have
been critically evaluated like the capital theory of Adam Smith and David Ricardo
through the writings of Stanely Jevons, Karl Marx, Eugen Von Bohm-Bawerk, Knut
Wicksell and others.
In chapter 2, 3, 4 and 5, authors have wrestled with the problem of global
financial instability, its origins, its causes, its implications over world economy
and its frequent shift from individual economy to global economy what the
52
authors have cited as ‘internationalization’ of the financial crisis. These chapters
also discuss the interwoven network of inherent causes like Carelessness in
monitoring the monetary systems, uncontrolled bank money creation, beggar-
thy-neighbor policies in pursuit of short economic growth gains, floating exchange
rates and increasing recourse to debt financing responsible for misbalancing the
equilibrium of conventional financial sectors. These chapters are in relevance to
the first chapter of the present study.
In the chapter 6 the main theme of the book: the inherent stability of the Islamic
financial sector, has been discussed with a detailed account. The Islamic financial
system which completely avoids interest and interest based assets, has been
projected and modeled as non-speculative equity ownership that is ultimately
linked to the real sector and where demand for new shares is determined by the
real savings in the economy. This chapter has relevance with third chapter of the
present study.
From chapter No.7 to chapter No.13, authors have overviewed the various
dimensions of Islamic finance. Chapter 7 analyses the theoretical model that deals
with the inherent stability of Islamic finance. Chapter 8 discusses the escape of
Islamic finance from a systemic risk, either at the central banking or financial
institutional level. Chapter 9 reviews the nature of Islamic financial intermediation
and highlights how the combination of such type of banking and markets will lead
to stable financial system. Chapter 10 discusses the risk profile of an Islamic
financial intermediary. In chapter 11 the authors have examined, that the
exclusively debt operations and speculations investments lead towards financial
instability. It also discusses the appropriate safeguards and regulatory framework
53
to strengthen the stability of Islamic finance. Chapter 12 of the book has
visualized the importance of corporate governance for the progress of financial
institutions. Chapter 13 the last chapter of the book, deals with the role and
performance of the Islamic financial intermediaries and Islamic finance
instruments that helped the Islamic finance industry to save its investors as well
as institutions from the disastrous effects of the ongoing financial crisis. This part
of the book is in relevance with the chapter third and fourth of the present study.
The book ends with a healthy conclusion wherein the authors suggest for some
constructive reforms and remedies towards building up a stable economy.
Book : Global Financial Crisis And Islamic Finance.
Author: Hussein Alasrag
Publisher: VDM vesrlag, Germany, 2010.
Pages: 70.
ISBN: 3639252276.
Description:
Economists where hopeful that 2008 crisis would be restricted to financial
markets, with few repercussions on the real economy and the rest of the world.
According to author this hope was shattered in September 2008 as the crisis
entered an acute phase, with strong downward fluctuations in the stock markets,
substantially reduced rates of economic growth, volatile exchange rates, and
squeezes in demand and consumption, leading to falls in industrial production
and decreasing flows of international trade and FDI, and causing impacts on
related areas such as transfer of technology. This book is an attempt to bring
forth the major causes and impact of the current financial and economic crisis. It
54
has also taken a critical evaluation of the claim made by Islamic finance sector
that the Islamic finance and its prospective is a viable alternative to the ailing
global financial sector. As per its subject matter, the author has divided the book
into five chapters.
The ‘introductory’ chapter of the book has taken a brief overview of the origin,
severity and consequences of the current financial crisis on the globally integrated
economy. It also provides a short summary about the Islamic investment and
financing mechanism, together with the multiple reasons for its constant growth
in the recent years.
Chapter 2nd
,“Fundamentals of the Islamic finance” describes nature, principles
and sources of Islamic economics in general and Islamic finance in particular. It
also discusses some basic issues related to the application and interpretation of
its Laws in the current times. Islamic banking, its origin and emergence and some
key financial tools like Murabaha, Mudarabah, Musharakah, Ijarah, Salam and
Sukuk have been also discussed in the same chapter. This chapter has relevance
with the chapter 3rd
of the present dissertation.
Chapter 3rd
,“Nature of the global financial and economic crisis” has explored the
structural causes that helped to bring about the crisis from an Islamic perspective.
It has also taken a detailed account of impact of the crisis, approaches towards
possible solutions and an agenda for a systematic reform. This chapter is in
relevance to the chapter 1st
of the present work.
In Chapter 4th
, “Islamic finance and the global crisis” Sukuk, the most significant
Islamic bond has been brought to full exploration. Some valid suggestions have
been put forward from author’s side, to weaken the list of ‘limitations’ in Islamic
financial sector. According to author, financial engineering, risk management and
55
diversification and development of capital are some dimensions which need an
immediate attention. This chapter is relevant to the chapter 3rd
and 4th
of the
present study.
In the concluding chapter “The global financial crisis: Lessons from and for Islamic
finance” the author has come up with some practical suggestions for both Islamic
as well as conventional system of banking and finance. Firstly author
recommends, that what lessons conventional banks should have derived from the
Islamic banks during crisis and secondly, what innovations Islamic banks should
adopt in order to maintain a constant pace. This chapter is relevant to the chapter
4th
of the present study.
Since overall content of the book, is in close relevance to the subject matter of
the present study, thus it has been included in both literature survey as well as in
bibliography.
Book : An Introduction to Islamic Finance.
Author: Mufti Muhammad Taqi Usmani
Publisher: Adam Publishers & Distributors, India, 2010.
Pages: 246.
ISBN: 81-7435-595-2.
Description:
Due to the growing importance of the Islamic finance, Muslim economists felt a
severe need to bring forth such compilations, which will explore the mechanism
56
and instruments used in the Islamic financial system. The present book is an
endeavor towards the same cause. Based on the collection of different articles
written by the author, it provides basic information about the principles and
precepts of Islamic finance, with special reference to the modes of financing used
by the Islamic banks and non-banking financial institutions. This book comprises
of eight chapters.
Chapter one “Some Preliminary Points” has discussed some basic themes related
to Islamic economics and purpose behind its establishment.
Chapter 2nd
“Musharakah” describes the basic principles of Musharakah and the
scope of its application. The basic problems which may be faced in implementing
it in a modern situation.
Chapter 3rd
“Murabaha” has discussed the Murabaha as vital mode of financing,
its features, the issues involved in its application, the securities guaranteed
against Murabaha price and some basic mistakes in its operation.
Chapter 4th
“Ijarah” deals with principles of leasing. The relationship between
lease and leaser, the commencement of lease, the insurance of the assets and
finally the securitization of Ijarah has been also discussed in this chapter.
Chapter 5th
“Salam and Istisna” provides detailed information Salam as mode of
financing, its contemporary relevance and conditions attached to it. This chapter
also highlights the difference between Salam, Istisna and Ijarah. It has also
discussed Istisna as a mode of financing.
Chapter 6th
“Islamic Investment Funds” attempts to explore the nature of Islamic
investment funds within the premises of Islamic Shari’ah. It also gives detailed
57
account about Equity fund, Commodity fund, Murabaha fund, Bai’-al-dain and
Mixed fund.
Chapter 7th
“The Principle of Limited Liability” aims to explain the concept of
‘limited liability’ and evaluate it from the Shari’ah perspective, to know whether
or not this principle is acceptable in Islamic economics. It has also discussed some
economic institutions like Waqaf, Baitul- mal and Joint stock which are somehow
related to ‘limited liability’.
The last chapter “The Performance of the Islamic Banks” seeks to analyze the
operation of Islamic banks and financial institutions in the light of Shari’ah. It also
highlights what they have achieved and what is yet to achieve.
The overall content of this book is in relevance with the chapter 3rd
of the present
study, hence it has been included in the literature review as well as in the
bibliography.
Book : Understanding Islamic Finance.
Author: Mohammad Ayoub.
Publisher: John Wiley & Sons Ltd, England, 2007.
Pages: 516.
ISBN: 978-470-03069 (HB)
Description:
Introducing Islamic finance in academia is a real commencement towards building
a stable economy within the permits of Shari’ah. Continuing the same objective,
58
this voluminous book ‘ Understanding Islamic Finance’ is also a vital stuff from
author’s side. The author has made every possible effort, in exploring the nature,
workability and practicality of Islamic financial tools and practices in the
contemporary financial scenario.
The author has divided the book into three comprehensive parts. Part first
comprising of four chapters, part second comprising of three chapters and part
third comprising of ten chapters. In chapter 1, 2, 3 and 4 of the part first, the
author has critically analyzed the foundational principles of conventional system
of economy and its applied tools. In authors observance the conventional system
of economy is heavily engulfed by interest based financial policies and debt
financing mechanism which in turn has created an obstacle in observing the socio-
economic egalitarianism all-round the world. Bringing out the portfolio of Islamic
finance the author argues that, because of its inherent numinous character
Islamic finance industry carries a potent capability to ensure socio-economic well-
being. The characteristic features, principles and philosophy of Islamic system of
economy together with its laws and contracts have been elucidated very skillfully.
The rationale behind prohibition of interest (Riba in Qur’anic terminology) has
been also discussed with sound argumentations.
In the part second that includes chapter 5, 6 and 7, the author has presented a
work plan for Islamic banks and financial institutions through which different
financial tools and operations can be undertaken very effectively. Along with
sketching the nature of Shari’ah based financial contracts, the author has also
endeavored to explore their field of application. Some of the significantly beaten
59
financial tools like loan, sale and debt have been discussed within the periphery of
Islamic commercial law.
From chapter no. 8 up to chapter no. 18th
, covers part third of the book. It starts
with a detailed description of both conventional as well as Islamic financial
institutions and also provides a healthy comparison between the two. Chapter no.
9, 10, 11, 12 and 13 is related to Islamic financial instruments including
Musharakah, Mudarabah, Musawamah, Ijarah, Rahn, Murabahah, Tawarruq and
Istijar. Each and every financial tool has been discussed in detail i.e. its
recognition by Shari’ah, its operational standard and its dimensions of
application. Some guiding principles associated with product development issues
and deposit management have been briefly discussed in chapter 14th
. Some of the
vital financial tools like Takaful and sukuk which were lately introduced into
Islamic finance industry have been discussed in chapter no. 14th
and 16th
.
Mechanism of their operation has been also described in relevance to the 21st
century context. Chapter 17th
is based on the cross evaluation of some critical
writings on complied on Islamic finance and finally this voluminous work ends
with a healthy discussion about the prospects and challenges hindering the
streamline flow of Islamic finance industry.
The book has a significant relevance with chapter no. 3rd
and 4th
of the present
study, hence it has been incorporated in both literature review as well as
bibliography.
60
2.3 ARTICLES:
Article: “Structural Causes of the Global Financial crisis: A critical
assessment of the ‘new financial architecture”.
Author: James Crotty.
Publisher: Cambridge Journal of Economics, U.K, 2009.
Volume: 33.
Description:
According to James Crotty, a macro economist and Professor Emeritus of
economics at university of Massachusetts, Amherst, the present financial crisis
has taken the form of cycles in which the deregulation accompanied by rapid
financial innovations has stimulated powerful financial booms that ended in the
global financial recession. Forcing the governments to respond, the crisis took
trillions of dollars to bailout. In this paper the author has analyzed the structural
flaws in the prevailing financial system that helped to bring on the global financial
recession. In authors observance the excessive growth of financial markets in
relation to the non financial economy, increasing complexity in important
financial tools, opaqueness and illiquidity in financial transactions and wide
spread leverage caused a greater contraction in financial institutions. As a result
financial crisis became more threatening. The key structure flaws of new financial
architecture, build on very weak theoretical foundation have been also discussed
by the author in detailed account.
61
In the conclusion, the author has come up with healthy reformative policies for
banks and financial institutions. In order to invigorate the authenticity of the
paper the author has quoted from different journals of international repute. The
article has relevance with chapter 1st
of the present study hence it has been
included in literature review as well as bibliography.
Article : “Islamic finance and global financial stability”.
Author: Dr Zeti Akhtar Aziz.
Publisher: Islamic Financial Services Board (IFSB), 2009.
Description:
The pervasively virulent and far reaching repercussion unleashed by the current
global financial crisis has shaken the foundations of the global financial system. As
a reaction, it has sparkled the international call for the reformation of the existing
financial architecture. Despite this constraint situation, the Islamic financial
industry has been able to weather this first wave of the global financial crisis,
demonstrating its robustness as a stable form of financial intermediation. The
dynamic nature of the Islamic financial system is reflected by its solid growth and
the increased range of its services.
As the role and relevance of Islamic finance in the global financial system gains
significance, it will not only increase its potential to contribute to global financial
stability but also towards strengthening global growth. Financial products and
services and the establishment of new Islamic financial service providers from the
different parts of the world including from the non-Muslim world. The present
paper is as such an attempt to explore the dimensions and conceptual
applicability of the Islamic finance principles in order to overcome the situation.
According to author’s study, with its emphasis on a strong linkage to productive
62
economic activity, its inbuilt check and balances and its higher level of disclosure
and transparency Islamic finance industry offers a more resilient and robust
system of financial operations.
As Islamic finance industry continues to become an integral part of the global
financial system, it will be increasingly exposed to risks of financial stress arising
from global financial instability. In this concern it needs much sophistication, well
balanced risk management and proper liquidity techniques together with
productive financial innovations, which will not go against the ‘maqasid al-
Shari’ah’, the objectives of Shari’ah. As the role and relevance of Islamic finance
in the global financial system gains significance, it will not only increase its
potential to contribute to global financial stability but also towards strengthening
global growth." The article has relevance with chapter 3rd
and 4th
of the present
study and has been included in both literature review as well as bibliography.
Article : “The Relevance of Islamic Principles to Global Financial Crisis”.
Author: Amir A. Rehman.
Publisher: Harvard Law School, Islamic Legal Studies Program, 2009.
Description:
The present paper has been written for a panel discussion on the evolution of
global financial crisis from the current crisis, which was held at Harvard Law
School, Islamic Legal Studies and Islamic Finance Project in 2009. This paper
presents an insight study of, what where the determining causes which resulted
in the transformation of U.S subprime crisis into global financial crisis. It also
describes that whether Islamic financial tools does hold the potential to somehow
63
reduce the intensity of the crisis, together with their relevance in the continuing
crisis situation.
The Islamic financial sector, which according to author is a ‘new global player’, has
not been immune from the current financial crisis but the impact was very less
and to a large extent it managed its institutions as well as investors to escape
from the virulent affects of the current crisis. Several aspects of Islamic Banking,
holding an inherent potential to provide insulation to its mechanism and
operation from the major risks of crisis. As a supportive argument, the author has
cited an official Vatican publication, “ethical principles on which Islamic finance is
based, may bring banks closer to their clients and to the true spirit which should
mark every financial service”. The paper also claims that the relevance of Islamic
financial operations is very significant today and it is believed to grow further due
the three major factors. These are as:
1) The conceptual applicability of principles inherent in Islamic finance.
2) The increasing importance of Muslim economics in an interdependent
global economy.
3) The increasing Shari’ah affinity observed in key Muslim countries.
Among the above mentioned three factors, the author has focused on the first
factor, thus it has become the central theme of the paper and the relevance of
Islamic financial principles from the conceptual perspective has been discussed in
detail. The article has relevance with chapter 3rd
and 4th
of the present study and
has been included in the literature review and bibliography too.
64
Article : “Introduction: the global financial crisis”.
Author: Stephanie Blankenburg and Jose´ Gabriel Palma.
Publisher: Cambridge Journal of Economics,2009.
Volume: 33.
Description:
The current financial crisis that has forced governments, institutions and financial
centers to respond to come up with new a financial structure, which would be
resilient to such long cycles. The present paper is an attempt to take an in-depth
analysis of particulars facets and features of the financial crisis with a breadth of
coverage that spans its antecedents, its immediate causes and its potential
consequences in the longer term. The authors S. Blankenburg and J.G Palma have
much relied on the empirical grounds connected with the growth rate of the
current crisis and net fall in the global economic activity. The paper predicts that
the present financial crisis resulted in 1.3% fall in the overall world-wide economic
activity. Tracing reference from European Central Bank, it has been exposed that
the recession in the European Union state members would be twice bad and EU’s
output is expected to contract by 3.4% in the coming years.
Searching out the far reaching repercussions of ongoing financial crisis, the
authors have referred to the International Labour Organization, which claims that
world-wide unemployment would increase by at least 30 million people in coming
years. Constructive reform proposals and discussions of advocate policy
responses have been also discussed in details. The article has relevance with
chapter 1st
of the present study and has been cited in the literature review and
bibliography.
65
Article: “Lessons We Should Have Learned from the Global Financial
Crisis but Didn’t”.
Author: L. Randall Wray.
Publisher: Levy Economics Institute of Bard College, 2011, U.K.
Paper no: 681.
Description:
The author is a senior scholar at Levy institute of Bard college U.K. The present
research work is actually a recount of the causes and consequences of the global
financial crisis. It also blames that the existing financial system is so fragile that
‘anything’ could have disturbed its overall orchestra .While discussing the primary
causes of the crisis, author’s observance is incoherence with a general adopted
view that the birth place of current crisis is USA, in the form of housing price
bubble. Next part of the paper is based on author’s assessment of the lessons
which financial institutions should have learned from the impact and
consequences of the current crisis. These include, (a) Global financial crisis was
not absolute outcome of liquidity crisis (b) underwriting matters (c) unregulated
and unsupervised financial institutions disrupted the rhythmatic flow of banks
and financial institutions, that led to stagnation of economic activities (d) the
opaqueness in financial transactions.
The paper ends up with a ‘reform agenda’ wherein the author has put forward
some recommendations and suggestions for the financial institutions and in this
area the author has heavily relied on masters like Hyman P. Minsky, Keynes and
66
his followers. The article has relevance with chapter 1st
of the present study
hence has been included in the literature review as well as bibliography.
Article : “Understanding the subprime mortgage crisis”.
Author: Yuliya Demyanyk and Otto Van Hemert.
Publisher: The Review of Financial studies, 2011.
Journal No: 24.
Description:
The subprime mortgage crisis getting birth in USA in 2007, spread very frequently
to the other economies of the world. The crisis spurred massive media attention
as a result of that many different explanations of the crisis have been proffered.
The present article seeks to analyze the quality of subprime mortgage loans by
adjusting their performance for differences in borrower characteristics, loan
characteristics and macroeconomic conditions. The author’s research is evident to
the fact that the rise and fall of subprime mortgage market follows a classic
lending. The paper predicts that the seeds for the crisis were sown long before
2007, but detecting them was complicated by high house price appreciation
between 2003 and 2005 that masked the true riskiness of subprime mortgages.
The paper also makes the contribution towards quantifying how much different
determinants have contributed to the observed high delinquency rates for vintage
2006 and 2007 loans which led up to the 2007 subprime mortgage crisis. The
article has relevance with chapter 1st
of the present study hence it has been
included in the literature review as well as bibliography.
67
Article : “From Financial Crisis to Turning point: How the US Subprime
Crisis Turned into a world-wide One and Will Change the
Global Economy”.
Author: Jacques Sapia.
Publisher: Real World Economics Review, 2009.
Volume No: 46.
Description:
Although most of the economists and financial experts label the present crisis as
‘purely financial’ because the securitization process was definitely a key factor.
But Sapir has observed that the collapse of a specific model of capitalism and the
breakdown of the post-Bretton woods International Monetary order, also played
a an active role in bringing up the crisis. While analyzing the nature of the crisis,
the author claims it to be a ‘three tiered’ process embedded in a particular
context. Credit –over extension, which developed in the United States and also in
UK, Spain and Ireland has been pointed out as the root of the crisis. Viewing the
crisis in a global context, the author observes that the inability of the surviving
Bretton Wood’s institutions, the IMF and the World Bank to check or even
manage the crisis process.
The unsustainable growths in the US economy, the European divergence and the
possible reforms to the crisis have been evaluated empirically. The paper ends at
describing the consequences of the crisis, the re-regulation of financial markets
and the theoretical framework for a new monetary order. The article has
relevance with chapter 1st
of the present study and has been included in the
literature review and bibliography.
68
Article: “Effects of Central Bank Intervention on the Inter-bank Market
during the Subprime Crisis”.
Author: C. M Bruntti, Di Fillippo & J. H Harris.
Publisher: Review of Financial Studies, 2011.
Volume No: 24.
Description:
While the financial crisis created problems for firms, some undoubtedly failed as a
result, and many worried that large swaths of the banking sector would go under.
The present article examines the role of government policies before and during
the crisis towards helping or hurting the both.
Basing their data on the European e-MID market, the authors have observed, how
European Central Bank’s intervention impacted prices, spreads and overall
liquidity. Once the crisis hit, banks became reluctant to lend each other, but the
threat that they would be never paid back was increasingly going up. The
expansion in inter-bank spreads stimulated ECB to provide liquidity through open-
market operations in order to keep the banks afloat. ECB tried this practice
repeatedly practice but this time it did not work. Despite the ECB,s best efforts,
the market continued demanding usually high rates for inter-bank loans. This
situation was apparently taken as a signal that things were worse than previously
suspected. The paper concludes that Central Banks need to rethink how to deal
with markets in crisis time. The article has relevance with the chapter 1st
of the
present study and has been included in the literature review as well as
bibliography.
69
Article : “Islamic vs. Conventional Banking: Business, Model,
Efficiency and Stability”.
Authors: Thorsten Beck, Asli Demirguc-Kunt & Ouarda Merrouche.
Publisher: The World Bank, Development Research Group, Finance
and Private Sector Development Team, Oct. 2010.
Paper No: 5446.
Description:
The current global crisis has not only shed doubts on the proper functioning of
Conventional “western” banking, but also increased the attention in Islamic
banking. The paper describes some of the most common Islamic banking products
and links their structure in the theoretical literature in financial intermediation.
The business model, efficiency quality and stability of Islamic banks and
conventional banks have been assessed with the help of array indicators
constructed from balance sheet and income statement data.
A data based comparison also has been done between the performance of
conventional and Islamic banks during the crisis to test whether one type is better
positioned to with stand large exogenous financial shocks. While Islamic banks
seem more cost effective than Conventional banks in a broad cross-country
sample, this finding reverses in a sample of countries with both Islamic and
Conventional banks. However, conventional banks that operate in countries with
a higher market share of Islamic banks are more cost-effective but less stable.
There is also consistent evidence of higher capitalization of Islamic banks and this
capital cushion plus higher liquidity reserves explains the relatively better
70
performance of Islamic banks during the recent crisis. The article has relevance
with chapter 1st
, 3rd
and 4th
of the present study and has been included in the
literature survey as well as bibliography.
Article : “Islamic Finance: A Therapy for Healing the Global Financial
Crisis”.
Author: Miranti Kartika Dewi & Ilham Reza Ferdian.
Publisher: First Scientific Conference and Challenges of Globalizing
Financial Systems, 2009.
Description:
Being able to endure the implications of the global financial crisis and remain
relatively positive in the midst of the crisis and eventually to emerge as more
equitable and efficient system have raised the profile of Islamic finance and
underscored its capacity to bring stability to the global financial system.
The question whether Islamic Finance can become solution on the current
global financial crisis? Is yet to be explored in a much practical manner. The
present paper has been penned down in the same orientation. The content of the
paper is segmentized into three parts and each part has been illustrated with the
help of figures. Part one, has described nature of the current financial crisis and
its roots. Part second, analyses were the immediate and long-run consequences
of the crisis and also how it took a global shape. The third part of this paper seeks
to highlight whether or not Islamic finance can heal-up the oozing wound of banks
and finance institutions by offering them a much resilient and robust mechanism.
This article has relevance with chapter 3rd
and 4th
of the present study and has
been included in the literature survey.
71
Chapter - 3
ISLAMIC
EQUITY INSTRUMENTS
72
3.1 ISLAMIC EQUITY INSTRUMENTS
Islamic finance has continued to expand and demonstrate its resilience in the
current more challenging international financial environment. This expansion has
been in terms of the increased range of Islamic financial products and services,
the development of the Islamic financial infrastructure and institutions, the
greater maturity of the Islamic financial markets and the more comprehensive
supporting legal, regulatory and Shari’ah framework. Being able to endure the
implications of the global financial crisis and remain relatively positive in the
midst of the crisis and eventually to emerge as more equitable and efficient
system have raised the profile of Islamic finance and underscored its capacity to
bring stability to the global financial system. Islamic financial services, as
measured by Shari’ah compliant assets, is estimated by the UK Islamic Finance
Secretariat (UKIFS) to have reached $1,130bn at end-2010, 21% up on $933bn in
2009. According to a report, Islamic finance assets worldwide continued a long
run of growth to reach an estimated USD$1.3 trillion in 2011, 150% up over the
previous five years.51
The principles of Islamic finance are laid down in the Shari’ah, Islamic law. Islamic
finance, comprising financial transactions in banks and non-bank financial
institutions formal and non-formal financial institutions, is based on the concept
of a social order of brotherhood and solidarity. The participants in banking
transactions are considered business partners who jointly bear the risks and
profits. Islamic financial instruments and products are equity-oriented and based
on various forms of profit and loss sharing. In this chapter we will describe some
51 Islamic Finance, UK Islamic Finance Secretariat Sponsored by Gatehouse Bank, March, 2012, P.3.
73
equity instruments, their scope of application and their contemporary significance
in connection to broadening the spheres of Islamic finance industry.
3.2 Musharakah (Equity Participation)
Musharakah as a financial contract refers to an arrangement where two or more
parties establish a joint commercial enterprise and all contribute capital as well as
labour and management as a general rule. The profit of the enterprise is shared
among the partners in agreed proportions while the loss will have to be shared in
strict proportion of capital contributions. The basic rules governing the
musharakah contract include:
I) Profit of the enterprise can be distributed in any proportion by mutual consent.
However, it is not permissible to fix a lump sum profit for anyone.
ii) In case of loss, it has to be shared strictly in proportion to the capital
contributions.
iii) As a general rule all partners contribute both capital and management.
However, it is possible for any partner to be exempted from contributing labour/
management. In that case, the share of profit of the sleeping partner has to be in
strict proportion of his capital contribution.
iv) The liability of all the partners is unlimited.
74
Figure No.7 Mechanism of a Simple Musharakah contract
3.2.1 Application and Scope
As a mode of finance, an Islamic bank can advance money to a client using the
contract of musharakah. Normally the bank will use the option of being a sleeping
partner. The contract can be more widely used by Islamic funds whereby the unit
holders can assume the role of sleeping partners. The contract can also be used in
securitized assets. An Islamic bank can finance industry, trade, real estate,
contracting and almost all legal enterprises through partnership. Musharakah is
arranged on the basis of a written agreement between the bank and the client for
a specific transaction, consignment, or project or for a fixed period of time that
can be renewed. They can also enter into musharakah with interest-based banks
to carry out operations acceptable in the Shari´ah, provided it is ensured that the
rules and principles of the Shari´ah are observed during the operation of the
75
partnership. A partnership business or its assets can also be securitized, giving
musharakah certificates to the investors. Clients desiring to raise funds for
investment in a large project can use musharakah and offer to sell musharakah
certificates in the market. The musharakah certificate represents the direct pro-
rata (proportional) ownership of the holder in the assets of the project. If all the
assets of the project are in liquid form, the certificate will represent a certain
proportion of money at face value owned by the project, in such cases the
musharakah Certificates cannot be sold in the market except at their face value,
as an increase would fall under the prohibition of Riba under the Shari’ah.
However, after the project is started and has acquired non-liquid assets
representing tangible assets, these certificates can be traded in the secondary
market and above the par value. It is allowed under the Shari’ah, as the subject
matter of the sale is a share in the tangible assets and not in money alone,
therefore the certificate may be taken as any other commodity which can be sold
at a profit or at a loss. In the case of a completed project, the business will involve
a combination of tangible assets and non-liquid assets arising from the sale in
business transactions. In such cases, the Muslim jurists generally find it acceptable
to trade in musharakah certificates, where the musharakah portfolio should not
comprise more than 50% in the form of non liquid assets.
Another form of musharakah, developed more recently, is ‘Diminishing
musharakah’. According to this concept, a financier and his client participate
either in the joint ownership of a property, or piece of equipment, or in a joint
commercial enterprise. The share of the financier is further divided into a number
of units and it is understood that the client will purchase the units of the share of
the financier, one by one, periodically, until all the units of the financier have
76
been purchased by the client so as to make the client the sole owner of the
property or the commercial enterprise.
When used in home financing, musharakah is applied as a diminishing
partnership. In home financing, the customer forms a partnership with the
financial institution for the purchase of a property. The financial institution rents
out their part of the property to the client and receives compensation in the form
of rent, which is based on a mutually agreed fair market value. Any amount paid
above the rental value increases the share of the customer in the property and
reduces the share of the financial institution.52
The Al Baraka Islamic Bank of Sudan also employs musharakah technique to
finance the import of goods. The importer requests the bank to participate in the
import and sale of certain goods. The total cost of importing the goods is declared
and the capital contribution of each party is specified. The cost of the whole
transaction is designated in the appropriate foreign currency. The importer pays a
part of his contribution immediately after the contract has been signed and pays
the rest after receiving the invoices. A special musharakah account is opened at
the bank. The bank then opens a letter of credit in favour of the importer and
pays the full amount to the exporter after receiving the shipment document. The
cost of insurance is charged to the transaction account. The importer is
responsible for the import, clearance and final sale of the goods in question. The
net profits are distributed among the partners in the agreed proportion and any
52 G. Rammal Hussein, Lecturer in International Management in the School of Commerce, University of
Adelaide, 233 North Terrace, Adelaide, South Australia 5005, Australia.
77
loss is shared in the same proportion as the actual capital contribution.53
Musharakah can be also used in trade. In this type of contract the financier
contributes e.g. 60% of the capital for launching a business suppose of readymade
garments. The arrangement may be of two types:
(a) In the first place the arrangement is simply a musharakah where by two
partners invest different amounts of capital in a joint enterprise.
(b) Purchase of different units of the share of the financier by the client. This may
be in the form of a separate and independent promise by the client. The
requirements of Shari’ah regarding this promise are same as explained in the case
of house financing with one very important difference. Here the price of the units
of the financier cannot be fixed in the promise to purchase, because if the price is
fixed before hand at the time of entering into musharakah it will practically mean
that the client has ensured the principal invested by the financier with or without
profit, which is strictly prohibited in the case of musharakah. Therefore, there are
two options for the financier about fixing the price of his units to be purchased by
the client. One option is that he agrees to sell the units on the basis of valuation
of the business at the time of the purchase of each unit. If the value of the
purchase has increased, the price will be higher and if it has decreased the price
will be less. The second option is that the financier allows the client to sell these
units to anybody else at whatever price he can, but at the same time he offers a
specific price to the client, meaning thereby that if he finds a purchaser of that
53
Ausaf Ahmad, “Contemporary Practices Of Islamic Financing Techniques”, Islamic Research and
Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 2010.
78
unit at a higher price, he may sell it to him, but if he wants to sell to the financier,
the latter will be agreeable to purchase it at the price fixed by him before hand.54
3.3 Murabahah (Trustee Partnership)
Murabahah* has become one of the most popular financing techniques among
Islamic banks. It has been estimated that 70 to 80 per cent of the total finance
provided by Islamic banks is through murabahah.55
Murabahah-based financial
operations are practiced by Islamic financial institutions under such various
names as: mark-up, cost plus financing, production support programs, short-term
financing or even, simply, sale-purchase contract. The basic ingredient of
“murabahah” is that the seller discloses the actual cost he has incurred in
acquiring the commodity, and then adds some profit thereon. This profit may be
in lump sum or may be based on a percentage. Islamic bank use the concept of
murabahah sale to satisfy the requirements of various types of financing, such as
financing of raw materials, machinery, equipment and consumer durables as well
as short-term trade financing. As an illustration, a typical murabahah transaction
at an Islamic bank may be described as follows:
i) The client approaches the Islamic bank with the request to finance his specific
requirement, be it the purchase of capital goods, raw materials, machinery,
equipment or a consumer durable.
54 Muhammad Taqi Usmani, An Introduction to Islamic Finance, Adam publishers and distributors, New
Delhi , 2010, pp.91-92. 55 Khalil Jarrar, “Modern Murabaha - A Fiduciary Sale Or A Misnomer?”, Opaleseque Islamic Finance
Intelligence, Issue 1, July 2009.
* Murabahah (also called Bay’ mu’ajjal) refers to a sales agreement whereby the seller purchases the
goods described by the buyer and sells them at an agreed marked-up price, the payment being settled
within a specified time frame, either in installments or lump sum. The seller bears the risk of the goods
until they have been delivered to the buyer.
79
ii) The client not only gives the specifications of the goods but also provides
information about the price, nature and availability of the goods in the market.
The bank, after being convinced of the viability of the project, informs the client
of the margin of profit the bank would like to make on the original price. The bank
may reserve the right to use its own or independent sources to check the
information provided by the client. If the terms and conditions are acceptable to
both parties, a request for a murabahah transaction is signed. In some banks it is
referred to as a "Promise to Buy/Sell" document. It may be mentioned here that
under Islamic law, a promise is not legally enforceable in the same sense as a
contract. The client has a right to change his mind and may decide not to go
ahead with the transaction after all. Since the bank takes further steps to
complete the transaction acting upon this request or promise, the possibility that
the client may go back on his promise introduces an element of risk in the
transaction which is borne by the bank. It may also be mentioned that, although a
promise is not legally binding, Islam strongly encourages its followers to keep the
promises they make. Hence, the probability of a breach of promise is indeed low,
if the contracting parties are motivated by Islamic morality.
iii) Acting upon this request (or promise), the bank purchases the goods specified
and requested by the client, paying the seller directly on a cash basis, either in full
or in part.
iv) At this stage, a contract of murabahah sale is signed between the bank and the
client.
v) The client undertakes to purchase the goods against a profit margin which has
been agreed upon by the client and the bank. The payment of the final price of
the commodity, which includes the price of the commodity paid by the bank to
80
the original seller and the bank's profit, is deferred to a later date. In certain
cases, banks may agree to accept this payment on an installment basis. In such
cases, the client is made aware of the number of installments, the amount of each
installment, the date each installment is due, etc., beforehand.56
The mechanism
of a murabahah financial contract can be viewed in figure No.8 given below,
Figure No.8 Mechanism of a simple Murabahah contract
56
Ausaf Ahmad, “Contemporary Practices Of Islamic Financing Techniques”, Islamic Research and
Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 2010. p.14.
81
3.3.1 Application and Scope
An interesting application of murabahah sale is in the issuing of a letter of credit
(L/C)*. At the Dubai Islamic Bank, letters of credit are opened in the following
manner:
I) The customer requests the bank to open a letter of credit to import goods from
abroad through an application enclosing a proforma invoice and providing all the
necessary details and information.
ii) After securing the necessary guarantee and scrutinizing the application, the
bank opens a letter of credit in favor of the client and sends copies to the
correspondent bank abroad and to the exporter.
iii) The customer endorses a "Promise to Buy" the merchandise. The cost of the
goods and the conditions of delivery are negotiated.
iv) The exporter makes arrangements to export the goods and delivers the
documents to the correspondent bank abroad. The shipment of the good stakes
place and the correspondent bank advises the bank and sends the documents.
v) After the confirmation of the bank's ownership of the goods in question
through the acquisition of related documents an agreement of Sale is signed with
the client57
.
At the Jordan Islamic Bank, murabahah sale is used to finance the purchase of
goods, such as cars, that are subject to mortgage. The individual submits an
application to the bank requesting the purchase of a motor car. He promises to
buy it at a later stage. The bank issues an invoice to the seller who registers the
motor car in the name of the bank. The seller submits the required document to 57
Ibid, p.17.
*A letter of credit is a document that a financial institution or similar party issues to a seller of goods or
services which provides that the issuer will pay the seller for goods or services the seller delivers to a
third party.
82
the bank and receives his payment. The bank sells the car to the purchaser, with
the registration in the name of the purchaser, on a deferred payment basis after
getting an appropriate guarantee. The guarantee condition may stipulate the
mortgage of the car to the bank. Murabahah is also applied to the purchase of
land and buildings in a similar manner.58
The Jordan Islamic Bank also provides finance to individuals in order to enable
them to purchase goods which are not subject to mortgage, such as household
equipment, electrical appliances, etc. The method is essentially the same, the
difference being that in the case of goods which cannot be mortgaged, payment
by the purchaser is deferred on the strength of a promissory note which is
regulated by the bank in accordance with the conditions of the murabahah
contract. The merchandise is delivered to the client by the bank.59
Commodity Murabahah, another form of murabahah is based on the concept of
tawarruq that is, receiving cash for a debt of a higher amount. Commodity
murabahah is the one Islamic money market tool that can help provide liquidity in
the Islamic banking system. There is no other instrument that is as widely used as
commodity murabahah, especially in the short term money markets. According to
Bursa Malaysia’s Islamic markets global head Raja Teh Maimunahiin, it is
estimated that commodity murabahah has an annual turnover of over US$1
trillion. The structure of a common commodity murabahah financing
arrangement goes in a scheme, that a Bank purchases commodity from
Commodity Broker A on spot basis and sells the commodity to the customer on
deferred basis at cost price plus profit margin, then on behalf of the customer
58
Ibid 59
Ibid, p:18.
83
Bank, acting as Wakeel, sells commodity to Commodity Broker B on spot basis on
behalf of the customer.60
3.4 Mudarabah
Mudarabah contract is a form of a business contract in which one party offers
capital and another party undertakes some business with this capital, the former
is termed Rabb al-mal and the latter Mudarib. Figure No.9 is a simplified diagram
that explains the structure of the mudarabah contract. Under this structure, the
Islamic bank accepts deposits through mudarabah contract as an intermediary,
where the depositor enters into a profit sharing partnership or agency contract
with the bank as a Mudarib (partner/agent). Also, as noted previously, the Islamic
bank (as a principal fund-provider) can enter into a partnership or agency contract
with an entrepreneur who only contributes the management skills.61
Thus, the
capital is provided by the fund supplier, who operates as a sleeping partner, and
work is provided by the entrepreneur.62
The following rules must govern all
mudarabah transactions:
1) The division of profits between the two parties must necessarily be on a
proportional basis and cannot be a lump sum or guaranteed return.
2) The investor is not liable for losses beyond the capital he has contributed. The
mudarib does not share in the losses except for the loss of his time and efforts.
3) Briefly, an Islamic bank lends money to a client to finance a factory, for
example, in return for which the bank will get a specified percentage of the
60 Hermione Harrison, “Commodity Murabahah: Concerns, Challenges and Market Appetite”, Islamic
Finance Asia, February 2010. 61 Yongqiang Li, Abdi Hassan, Esse Abdirashid and Bruno Zeller, “Equity Investor Protection And Financial
Performance Of Islamic Banks: An Econometric Analysis”, Center for Islamic Economics and Finance,
Qatar Faculty of Islamic Studies, Qatar Foundation, 2008. 62 A. Archer and A. Abdel-Karim, “Profit-Sharing Investment Accounts In Islamic Banks: Regulatory
Problems And Possible Solutions”, Journal of Banking Regulations, vol.10, 2009.
84
factory's net profits every year for a designated period. This share of the profits
provides for repayment of the principal and a profit for the bank to pass on to its
depositors. Should the factory lose money, the bank, its depositors and the
borrower all jointly absorb the losses, thereby putting into practice the pivotal
Islamic principle that the providers and users of capital should share risks and
rewards.63
Figure No.9 Mechanism of a Simple Mudarabah Contract
3.4.1 Application and Scope
Although it has been widely suggested in the theoretical literature on Islamic
banking that mudarabah can be a viable basis of financial intermediation in an
interest free framework, there are certain difficulties with its contemporary
application. For example, the legal system operating in the country should
provide legal safeguards to the provider of capital so that he can finance projects
63 Hussein Alasrag, “Global Financial Crisis And Islamic Finance ”, University Library of Munich, Germany,
MPRA Paper, 22167, 2011.
85
on the basis of mudarabah. For this and other reasons, the number of banks
providing finance on the basis of mudarabah is not very large. Even among those
banks which use mudarabah as a financing technique, the frequency of its use is
not very high. In view of the dearth of relevant information, it is not easy to
describe the manner in which different Islamic banks practice Mudarabah and
whether there are any differences in these practices. However, some available
information is presented below:
In Iran, mudarabah is considered a short-term commercial partnership between a
bank and an entrepreneur. All of the financial requirements of the project are
provided by the bank and the managerial input is provided by the entrepreneur.
Both parties of the mudarabah agreement share in the net profits of the project
in an agreed proportion. Iranian banks are directed by the monetary authorities
to give priority in their mudarabah activities to cooperatives. Furthermore,
commercial banks in Iran are not allowed to engage in the mudarabah financing
of imports by the private sector. Article 9 of the Law of Usury Free Banking
provides for banks to expand their commercial activities through mudarabah,
within the overall framework of the commercial policy of the government.64
3.5 Ijarah (Lease)
Leasing (Ijarah)* is emerging as a popular technique of financing among Islamic
banks. Some of the important Islamic banks which use leasing as a financing
technique include the Islamic Development Bank, the Bank Islam Malaysia and
64 Ausaf Ahmad, “Contemporary Practices Of Islamic Financing Techniques”, Islamic Research and
Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 2010, pp.23-24.
*Ijarah is a financial contract whereby the owner of an asset, other than consumerable, transfers its
usufruct to another person for an agreed period at an agreed consideration.
86
commercial banks in Pakistan. Like murabahah, lease is not originally a mode of
financing rather it is a simple transaction, however as mentioned it has been used
as a mode of financing by many financial institutions in the current economic
scenario.65
There are two main types of lease under the Ijarah structure. The first
involves a longer term lease which usually ends with the transfer of ownership of
the asset to the lessee (Ijarah wa lqtina), as in a modern finance lease. The second
type of lease is for a shorter term and will usually end with the financial
institution retaining ownership of the asset, in common with an operating lease.
The rental income in this second type of lease will take into account wear and
tear of the asset. To comply with Shari’ah, the leased assets must not be
prohibited items ( for example, machinery for the manufacturing of alcohol) and
must be used in ways deemed lawful by Shari’ah. Like any other contract, a lease
contract has to fulfill all of the conditions of a valid contract stipulated by the
Shari’ah. Muslim economists have designed some rulings to confirm lease as a
valid mode of financing. These rulings are as:
1) Leasing is a contract whereby the owner of something transfers its usufruct
to another person for an agreed period, at an agreed consideration.
2) The subject of lease must have a valuable use.
3) It is necessary for a valid contract of lease that the corpus of the leased
property remains in the ownership of the seller, and only its usufruct is
transferred to the lessee.
4) As the corpus of the leased property remains in the ownership of the lesser,
all the liabilities emerging from the ownership shall be borne by the lesser
65 AIMS-UK Islamic Banking & Finance, www.learnislamicfinance.com
87
but the liabilities referable to the use of the property shall be borne by the
lessee.66
3.5.1 Application and Scope
Under this scheme of financing, the bank purchases a real asset (the bank may
even purchase the asset as per the specifications provided by the prospective
client) and leases it to the client. The period of lease, which may be from three
months to five years or more, is determined by mutual agreement according to
the nature of the asset. During the period of lease, the asset remains in the
ownership of the bank but the physical possession of the asset and the right of
use is transferred to the lessee. After the expiry of the leasing period these revert
to the lesser. A lease payment schedule based on the amount and terms of
financing is agreed upon by the bank and the lessee. The agreement may or may
not include a grace period. According to the Islamic view, the maintenance of the
asset during the leasing period is the responsibility of the owner of the asset, as
the benefit (rental) is linked to this responsibility (maintenance).67
The Al Baraka Investment Company uses the technique of Ijarah wa lqtina‘ to
finance the purchase of large capital items such as property, industrial plants and
heavy machinery. It involves direct leasing where investors in the scheme receive
regular monthly payments which represent an agreed rental. At the expiry of the
lease, the lessee purchases the equipment.
The Bank Islam Malaysia also uses lease purchase contracts. The procedure
adopted is the same as that described above except that the client and the bank
66 Muhammad Taqi Usmani, An Introduction to Islamic Finance, Adam publishers and distributors, New
Delhi , 2010, pp.159-160. 67 Ausaf Ahmad, “Contemporary Practices Of Islamic Financing Techniques”, Islamic Research and
Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 2010, p.24.
88
enter into an agreement at the time of the lease that the client will purchase the
equipment at an agreed price with the provision that the lease rentals previously
paid shall constitute part of the price. The lease purchase arrangement is also
used by Islamic banks in Iran, which purchase the needed machinery, equipment
or immovable property and lease it to firms. At the time of the contract, the firms
guarantee to take possession of the leased assets if the terms of the contract are
fulfilled. The terms of the lease cannot exceed the useful life of the asset which is
determined by the Central Bank of Iran. Banks in Iran are not allowed to lease
those assets whose useful life is less than two years.
What has been described above as a lease purchase arrangement (Ijarah wa
lqtina) is called hire and purchase in Pakistan. a client requests to participate in
this scheme, a "hire purchase" account is opened in his name. The value of the
asset as well as the amount of profit over cost payable by the client to the bank
are recorded as debits. The installment payable by the client has two distinct
components: the agreed rental and a part of the amount of profit. The asset
remains in the ownership of the bank unless all installments have been fully paid.
The ownership title is transferred upon the receipt of full payment. The
installments are so devised that the agreed price is fully amortized during the
useful life of the asset.68
3.6 Takaful (Islamic Insurance)
Takaful*, or Islamic insurance is a relatively new industry. During the past two
decade takaful operations have been opened in many countries throughout the
68 Ibid, pp.25-26.
*Takaful is an Arabic word that means mutual protection and indemnity: one party, while providing help
to others is also identified by them and this idea of mutual protection is in clear contrast to the profit
motive which underlines conventional proprietary insurance.
89
world, primarily in Islamic countries and countries with a large Muslim
community. In the Far East, Malaysia has been at the forefront of takaful
development with Bank Negara taking the lead with the introduction of separate
takaful regulations allowing the takaful business to flourish in that country.
Singapore, Indonesia, Brunei have all followed with the development of takaful
operations. In the Middle East, takaful operations have developed in Saudi Arabia,
Bahrain, Iran, Qatar and Iran with new operations opening up in Egypt, UAE and
Kuwait in recent years. Takaful, similar to mutual insurance, is a risk sharing entity
that allows for the transparent sharing of risk by pooling individual contributions
for the benefit of all subscribers. The global market remains at an early stage of
development with premiums estimated to have reached $16.5bn in 2011. This
includes an estimated $4.5bn generated in Iran where takaful is the compulsory
form of insurance, and Ernst & Young’s estimate of $12.0bn for the rest of the
world .69
The concept of takaful is fundamentally different from conventional proprietary
insurance, although it has affinities with conventional mutual insurance. Takaful is
centered on the principle of mutuality and avoids any commercial contract
between the insurer (insurance company) and the insured (the policy holder).
Thus it is a financial transaction of mutual co-operation between two or more
parties (participants) to protect one of them from unexpected future material
risk.70
Being different in concept and practice, takaful is based on a set of
principles that are both Shari’ah compliant and economically valid. Freeness from
69 Financial Market Series, Islamic Finance, www.thecityuk.com, 2012.s 70 Simon Archer, Rifaat Ahmed Addel Karim and Volker Nienhaus, Takaful Islamic Insurance: Concepts
and Regulatory Issues, John Wiley & Sons (Asia) Pte. Ltd, 2009, p.120.
90
riba, gharar, ghabun (fraud: lack of clarity regarding the object of the contract),
ignorance (al-jahalah) and gambling testifies the validity of takaful.
In a takaful plan, the participant pays a particular amount of money as a
contribution (the premium) partly to a risk fund (the participants’ special account)
under the rubric of tabbaru (donation), and partly to another party (the takaful
company) with a mutual agreement that, the kafil is under a legal responsibility to
provide for the participants’ financial protection against unexpected loss, should
it occur within the agreed period. In the event that no loss occurs to the
participants within the specified period, the participants are entitled to the whole
amount of the paid premium, together with the share of profits made out of the
accumulated paid premiums on the basis of mudarabah financing.71
A takaful
company has the following features:
I) The company is not the one who assumes risks nor the one taking any profit.
Rather, it is the participants, the policy holders, who mutually cover each other.
ii) All contributions (premiums) are accumulated into a fund. This fund is invested
using Islamic modes of investment and the net profit resulting from these
investments is credited back to the fund.
iii) All claims are paid from this fund. The policy holders, as a group, are the
owners of any net profit that remains after paying all the claims. They are also
collectively responsible if the claims exceed the balance in the fund.
71 Adnan Alamasi, “Surveying Developments in Takaful Industry: Prospects And Challenges”, Review
of Islamic Economics, Vol. 13, No. 2, 2010.
91
iv) The company acts as a Trustee on behalf of the participants to manage the
operations of the takaful business. The relationship between the company and
the policy holders is governed by the terms of mudarabah contract. Therefore,
should there be a surplus from the operation, the company (mudarib) will share
the surplus with the participants (rabb al-mal) according to a pre-agreed profit-
sharing ratio.72
3.6.1 Application and Scope
The basic structure of takaful undertaking is designed by Takaful Operator (TO)
from a regulatory perspective, a major concern is how the TO is remunerated for
its services. During the past two decades, three standard models have emerged-
the wakalah model, the mudarabah model and the waqaf model.
3.6.2 Mudarabah Model
This is considered an excellent and praiseworthy model in the market of takaful.
In many ways it goes one better than a mutual insurance model in that no
expenses are charged to the participants’ funds. Another important feature of this
model is that the operator does not share in any surplus, therefore there is no
mudarabah issue to debate. It is very difficult business model as a stand-alone
family/individual life takaful operation (especially as no charging of expenses to
participants fund is envisaged). It is perhaps only really viable where a composite
takaful operation is being considered. It could take many years to realize a
commercial profit from such a business model as it relies on the build-up of
reserves and savings funds. As a stand-alone model, it would lend itself to a
72 Rating Takaful (Shari’ah Compliant)Insurance Companies, A.M. Best Company, www.ambest.com,
January 10, 2012.
92
philanthropic, state-sponsored operation or one where participants provide
capital. In the single example of this model in Malaysia, no expenses are charged
to the participants’ pool. There could be use of this model in Sudan with charging
of expenses to the pool for both family and general takaful.73
Figure No.10 A Simplified Diagram of Mudarabah Model (Abouzaid, 2007)
3.6.3 wakalah Model
In the wakalah model, all relations between TO and the participants are based on
an agency contract, the TO is the Wakeel (agent) who acts on behalf of the
participants (principal) both in underwriting and investment. The wakeel’s
services in both fields are remunerated by fees, which are contractually specified
either as an absolute amount or as percentage of the turnover (that is, the
volume of contributions or of invested funds), but not as a percentage of the
profit of the undertaking. The fees must cover all management costs (not
73
Adnan Alamasi, “Surveying Developments in Takaful Industry: Prospects and Challenges”, Review of
Islamic Economics, Vol. 13, Issue No. 2, 2010.
93
including claims and direct cost of claim handling) plus the profit for the share
holders.74
The best examples of operating wakalah takaful are Al-Jazirah Bank
and Jordan Islamic Insurance. The overall mechanism of wakalah takaful
operation is illustrated in the below given diagram:
Figure No.11 Wakalah Takaful Diagram (Abouzaid, 2007)
3.6.4 Waqaf Model:
Unlike the Al-Mudarabah and Al-Wakalah models, Waqaf operates as a
social/governmental enterprise, and programs are operated on a nonprofit basis.
Under the Waqaf model, the surplus or profit is not owned directly by either the
insurer or the participants, and there is no mechanism to distribute the surplus
funds. In effect, the insurer retains the surplus funds to support the participant
community. This model, with a single surplus fund, is most like a conventional
mutual insurance model. As such, it is rated in a very similar manner to
74 Simon Archer, Rifaat Ahmed Addel Karim and Volker Nienhaus, Takaful Islamic Insurance: Concepts
and Regulatory Issues, John Wiley & Sons (Asia) Pte. Ltd, 2009, p.120.
94
conventional mutual’s. For further information on the rating dynamics of mutual
insurance companies, please see A.M. Best’s “Rating European Mutual Insurance
Companies.” The remainder of the report will highlight the unique elements of
takaful companies following the Ta’awuni model, and how these factors are
incorporated in the rating analysis.
3.6.5 Microtakaful
Another recently applied takaful instrument in the Islamic finance market. It is an
institution that can well serve especially low income people. All takaful products,
like takaful financing, takaful education, fire, pension, etc., can be delivered to
the poor with some modification to allow for low premium contributions
collected on a periodic basis. It seems as an important component in any poverty
alleviation strategy. In Indonesia, partner-agent model is applied for microtakaful
model.75
3.7 Sukuk (Islamic Bond)
In the Islamic capital and money market Sukuk* has emerged as a very important
instrument, over the past decade, not only in the Muslim world but also in the
global markets due to its characteristics. Sukuk issues have expanded strongly in
the past three years, with Zawya Sukuk Monitor reporting a 62% increase in sukuk
issuance to $84bn in 2011 from $52bn in 2010. This follows a recovery from a low
point of $20bn in 2008 to $33bn in 2009. Sukuk made a strong start to 2012 with
$20bn of issuance in January. Sustained growth in the sukuk market demonstrates
appetite for quality issuers of sukuk from both Islamic and non-Islamic investors.
75 A. Haryadi, “Reaching To The Poor with Microtakaful”, Middle East Review of Insurance, July 2007,
pp.62-63.
*Sukuk is a plural of Sakk. Which means “legal documents, deed, check”. It is an Arabic name for
financial certificate but it can be seen as an Islamic equivalent of the conventional bonds.
95
Agreement in 2011 on a debt restructuring for Dubai World has improved
sentiment towards sukuk in general.76
It is asset-backed trust certificates evidencing ownership of an asset or its
usufruct (earnings or fruits). It has a stable income and complies with the principle
of Shari’ah. Unlike conventional bonds, Sukuk need to have an underlying tangible
asset transaction either in ownership or in a master lease agreement. The primary
condition for the issuance of Sukuk is the existence of assets on the balance sheet
of the issuing entity that wants to mobilize its financial resources. However,
identification of suitable asset is the first important step in the process of issuing
Sukuk certificates.77
3.7.1 Ijarah Sukuk
Ijarah forms the most common and simplest form of Shari’ah compliant Sukuk.
The Ijarah Sukuk have all been issued more or less using the same four Shari’ah
compliant contracts, namely, the Purchase Agreement, the Master Ijarah
Agreement, the Purchase Undertaking and the Sale Undertaking. The Ijarah Sukuk
is governed by two more Shari’ah compliant contracts that in a way guarantee the
payment of face value at the end of the term of the Sukuk, or in case of a default
or any other such contingency. It has been also Ijarah based sovereign Sukuk
bearing the same credit rating as that of the issuing country or Ijarah based
corporate Sukuk being rated in line with the debt rating of the entity providing the
purchase undertaking. Ijarah Sukuk are either backed by tangible assets or based
on tangible assets and therefore are tradable and negotiable. Ijarah based
sovereign Sukuk bearing the same credit rating as that of the issuing country or
76 Islamic Finance, UK Islamic Finance Secretariat Sponsored by Gatehouse Bank, March, 2012, P.6. 77 A comprehensive study of the International Sukuk market, International Islamic Finance Market,
www.iifm.net, 1st edition, 2009, p.5.
96
Ijarah based corporate Sukuk being rated in line with the debt rating of the entity
providing the purchase undertaking. Ijarah Sukuk are either backed by tangible
assets or based on tangible assets and therefore are tradable and negotiable.
Ijarah based sovereign Sukuk bearing the same credit rating as that of the issuing
country or Ijarah based corporate Sukuk being rated in line with the debt rating of
the entity providing the purchase undertaking. Ijarah Sukuk are either backed by
tangible assets or based on tangible assets and therefore are tradable and
negotiable.
3.7.2 Mudarabah Sukuk
Mudarabah Sukuk are tradable and negotiable if the Mudarabah assets do not
comprise entirely of the Sukuk proceeds (in which case it will be all liquid assets
and cannot be traded). In most Sukuk, there is a combination of tangible assets
and Sukuk proceeds, plus the Mudarib is allowed to mingle its own assets with
those of the Mudarabah, hence mostly meeting the Shari’ah compliance
requirement of having more than 51% of the assets in tangible form for tradability
and negotiability.
3.7.3 Convertible or Exchangeable Sukuk
Convertible or exchangeable Sukuk certificates are convertible into the issuer’s
shares or exchangeable into a third party’s shares at an exchange ratio which is
determinable at the time of exercise with respect to the going market price and a
pre-specified formula. The convertible or exchangeable feature can be exercised
anytime before maturity and works in the same way as for any conventional
convertible or exchangeable issue. It is permissible under Shari’ah as long as the
conversion price or the exchange price fluctuates with the market price of the
97
shares. An issue would arise where such price is required to be a minimum
amount equivalent to the face value of the Sukuk, however, that is unlikely as it
defeats the very purpose of issuing a convertible security. Some Sukuk combine
exchangeability with another Shari’ah compliant structure such as Mudarabah or
Musharakah. For instance the Dana Gas Sukuk issued in October 2007 is an
exchangeable Mudarabah. Khazanah national’s three issues are only
exchangeable issues, not mingling it with Mudarabah or any other form of
Shari’ah based financing.78
3.7.4 Musharakah Sukuk
Musharakah Sukuk is an investment partnership between two or more entities
which together provide the capital of the musharakah and share in its profits and
losses in preagreed ratios. The Musharakah Sukuk has been next only to Ijarah in
terms of its popularity so far. The Sukuk that had been issued until the AAOIFI
ruling of February 2008 were very similar to the Mudarabah Sukuk structures
except that in place of a Rabb-al-Maal. Mudarib relationship between the Sukuk
holders and the Obligor, there is a Musharik or partnership between the Sukuk
holders and the Obligor.79
78
Ibid, P.39. 79
Ibid, P.40.
98
Chapter - 4
RELEVANCE
99
4.1 CURRENT POSITION OF ISLAMIC FINANCE INDUSTRY: A BRIEF REVIEW
Islamic finance is rooted in Shari’ah law, which prohibits interest-based financial
transactions, gambling high-risk speculation, and financing any form of economic
activity that can be considered detrimental to society. The industry’s modern-day
evolution, beginning in the 1970s to the present day, was still considered an
infant industry at the turn of the 21st century.80
The ascent of oil prices and
petrodollar driven investments, however, accelerated the industry’s expansion in
the early 2000s – a trend that was sustained with robust economic growth in
emerging markets and liquidity in capital markets. Although most of the Islamic
Banking and financial operations are carried out within Middle Eastern and
Emerging countries, some universal banks based in developed countries have
started to satisfy a large demand of Islamic financial products. It is the case in the
United Kingdom and the United States. As the economies around the world
slowly recover from the destabilizing effects of the global financial crisis,
increasing numbers of investors are looking to Islamic financial solutions as a
stable alternative to the fluctuations and uncertainties of current financial
systems.81
To examine and analyze the experience with Islamic finance industry,
in the current financial scenario has become the subject matter of this chapter.
The developments in infrastructure of its financial institutions, its achievements
in creating a better robustness in its applied dimensions, its expansion in terms of
geography and finally its sustainable growth rate in terms of asset ratio has been
described with the help of empirical data collected from various authentic
sources. Proponents claim that Islamic finance contributes to the stability of the
80 Mercy Kuo, “The Emergence of Asia’s Islamic Finance Industry”, Banker’s Academy Briefings, June 08,
2011. 81 Islamic Finance News 2012 Guide, www.IslamicFinanceNews.com, February 2012 , P.30.
100
financial system. During the recent financial crisis, Islamic financial institutions
were affected by the adverse second- round effects of the crisis: when the real
economy contracted, real estate prices got depressed, and in some cases, issues
of Islamic bonds (Sukuk or certificate of ownership) defaulted. However, Islamic
banks generally escaped the worst effects of the 2008 financial crisis, because
they were not exposed to subprime and toxic assets, and had maintained their
close connection to the real sector. Hence, some observers have suggested that
conventional banking can learn from the alternative systems offered by Islamic
finance, which is less skewed toward debt instruments, uses equity for greater
risk sharing, and limits the mismatch of short-term demand deposits with long-
term loan contracts.82
Islamic financial products offer an appealing alternative to conventional
portfolios. In 2002, not long after the tragic events of September 11, 2001, then
U.S. Treasury Secretary Paul O’Neill was quoted as saying, “It took me six months
to realize that Islamic finance was a legitimate way of doing business”—a
statement that aptly captured non-Muslim public sentiments about the industry.
Islamic finance is becoming an integral part of the global finance industry and has
taken its roots in almost all of the Muslim countries but has also been under
discussion and penetration in selective Western and Far Eastern jurisdictions.
According to Dr. Zeti Aziz,” Today the Islamic financial system has evolved
significantly to become a dynamic and competitive form of financial
intermediation in the global financial system. This transformation has been
achieved in an increasingly challenging environment”. She further adds, “Most
significant have been the development of the Islamic financial markets, the 82 Mahmud Mohieldin, “Realizing The Potential Of Islamic Finance”, The World Bank Economic Premise,
Number 77, March 2012.
101
growth in the range of financial products and services, the increasing significance
of the international dimension of Islamic finance, the development of an
international Islamic financial architecture, and the enhanced international inter-
linkages that have been brought about by these developments”.83
The Islamic financial industry comprises of the Islamic capital market which is an
area that has grown to become an increasingly popular sector within the global
financial market. Islamic capital markets have gained considerable interest as a
viable and efficient alternative model of financial intermediation. The demand for
investing in adherence to the principles of the Shari’ah on a global scale have
been spearheading towards making the Islamic financial services industry a
successful sector. This is also an indication of the increasing wealth and major
capacity of investors who are both Muslim and non-Muslim, wishing to invest in
new investment products that serve and meet their individual needs. The Islamic
Capital Market (ICM) refers to the market where financial activities are carried
out in adherence to the Shari’ah financial principles of Islam. The ICM represents
a reflection of religious law in the capital market transactions where the financial
market is free from prohibited activities such as gambling. Indeed, the pace of
development in the Islamic financial market has gathered momentum with the
formation of various international Islamic organizations to study and promote this
alternative market. The Islamic financial capital market runs adjacent to the
conventional financial market and provides the scope for investors to be given the
opportunity for an alternative investment philosophy that is rapidly gaining
acceptance. The fact that the Islamic financial market does not prohibit
participation from non-Muslims creates unlimited upside to the depth and Riba 83 Zeti Akhtar Aziz, “ Islamic Finance: Global Trends and Challenges”, The National Bureau of Asian
Research (NBR), volume 18, number 4, march 2008.
102
(usury), Maisir (gambling) and Gharar (ambiguity). The Islamic capital market
operates as a market to the conventional capital market for capital seekers and
providers. It has played a complementary role to the Islamic banking operations
and systems in creating a well defined, comprehensive Islamic financial market
especially in Islamic financial hubs such as Malaysia.
The ICMs in 2011 have much scope worldwide especially since the Shari’ah-
compliant Islamic finance industry is growing on a global scale. The total
worldwide Muslim population is 1.5 billion, representing a significant 24% of total
world population of 6.3 billion. Shari’ah-compliant assets are growing over the
last 20 years and are representing an estimated US$ 300 billion banking assets &
approximately $400 billion Capital Market. In addition there are over 700 Islamic
financial institutions currently operating in about 75 countries worldwide.84
Out
of these IFI’s there is estimated to be more than 100 Islamic Equity funds
managing assets is in excess of US$500 billion, and still growing by at least 10-15%
annually. In the GCC, liquid wealth with Shari’ah sensitive investors will add more
than US$70b to this pool by 2013.85
The estimated annual growth for the overall
Islamic capital market is 15% to 20% annually which shows the scope for further
progression. Global Islamic Finance assets are predicted to increase 33% from
their 2010 levels to $1.1 trillion by the end of 2012 as Fig. No.12 highlights the
continuity of growth rate from 2006 up to 2011.
84
Islamic Finance News 2012 Guide, www.IslamicFinanceNews.com, February 2012 , P.30. 85Ernest and Young, Islamic Funds and Investments 2011:Achieving growth in challenging times, 7th
Annual World Islamic Funds and Financial Markets Conference (WIFFMC 2011), 2011.
103
Fig. No.12 Source: The Banker, Ernest and Young
The Middle East and North Africa will show signs of increase, with assets rising
$990 billion by 2015 from the $410 billion in 2010. The ICMs can further pave the
way by implementing cross border trading within OIC countries in order to further
diversify and minimize risk and volatility. In addition progressive developments of
information technology can further increase ICM and this is already taking place
due to innovative software solutions such as Path Solutions and iMAL which
provides the latest Islamic Shari’ah-compliant services to cater for the ICM
monitoring and maintenance. An improvement in transparency in the market
needs to be implemented in order to attract an increased number of foreign
investors. There also needs to be more standardization on guidelines in Shari’ah
compliancy in order for the ICM to further progress in the years to come. The
potential of the Islamic finance capital market is huge as the ICM has the potential
104
to reach several trillion USD by 2015. The GCC surplus may continue for the next 4
to 5 years mainly due to oil demands and price which will cause significant growth
in the sector. The unprecedented demand from customers who are both Muslims
and Non-Muslims, is increasing realize the benefits of the Shari’ah markets.
Therefore there is much potential for the ICM.86
While discussing the Euro zone
crisis and future policies of Islamic finance industry in such a financial climate, in
opening address of the 3rd
Annual World Islamic Banking Conference: Asia
Summit, Singapore, Mr. Ravi Memon, managing director of the Monetary
Authority of Singapore, said,” But Islamic finance has a window of opportunity in
the current climate of deleveraging in the global financial system. With its strict
prohibition on excessive leverage, Islamic finance has been spared the worst of
the financial crisis. Islamic banks are well positioned to reach out to new
customers who are in need of financing as many global institutions pull back on
their lending due to the need to repair their balance sheets”.87
Although Islamic
banks received such an opportunity in 2007-2008 also in the form of U.S subprime
mortgage crisis and dealt with it in such a way that motivated investors and
customers to go with it, as parallel system of economy. The less effect of GFC on
Islamic finance industry persuaded economists and finance experts to admit that,
carrying its major functioning in the real estate sector, Islamic finance industry
potentially managed its clients as well as institutions to escape from the
venomous and far reaching repercussions of the GFC.
86 Global Islamic Finance, “The Ultimate Islamic Finance Review 2011”, December - January 2012, p.6. 87 Mr. Ravi Menon, “The next phase in Islamic finance”, BIS central bankers’ speeches , 3rd Annual World
Islamic Banking Conference: Asia Summit (WIBC Asia 2011), Singapore, 5 June 2012.
105
4.2 Islamic Banking and Investment: A Flourishing Sector
Islamic banking is now expanding out of its niche to become a market that could
rival the conventional sector in many countries. It is an increasingly visible
alternative to conventional banks in Islamic countries and in countries with large
Muslim populations, such as the UK. Globally, the assets of these institutions have
grown at double-digit rates for a decade, and some conventional banks have
opened Islamic windows. The International Organization of Securities
Commissions predicts that as much as half of the savings of the world's 1.3 billion
Muslims will be in Islamic financial institutions by 2015.88
Islamic financial services
are nearing $trillion in reported managed assets, with about 700 Islamic financial
institutions(IFIs) spread throughout every region of the world. The Islamic banking
system (IBs) market- that is, the market of the technologies that enable these
financial products to be bought, sold and distributed- is predicted to raise to grow
at 10.9% compound annual growth rate (CAGR) between 2009 and 2014, while
the external IT spending component will have a higher CAGR, at 18.1%. The IBS
market is expected to reach $1.6 billion in 2014. As consumer trust in
conventional banking waned during the recent economic downturn, Islamic
banking enjoyed marked market expansion, Islamic banking is perceived by its
customers as a mutually beneficial partnership, and is regarded by some banks as
an opportunity to re-establish and connection with consumers. Growing demand
is evident for Islamic products from new markets such as African and Western
countries. An increasing number of conventional branch environment, mixing
both conventional and Islamic banking capabilities.
88 Patrick Imam and Kangni Kpodar, “Islamic Banking: How Has it Spread?”, International Monetary
Fund, 2010.
106
The Islamic banking market will continue to grow at a double digit pace. This is
based on:
1) The increasing Muslim populations in particular regions.
2) Newly available assets from unbanked populations and
3) The relatively low effect of the financial downturn in the high economic
growth regions such Middle East and Asia Pacific.89
In the first-half of 2011, the UAE’s Islamic retail banks have been busy in the
promotion of new products and services. In January 2011, Noor Islamic Bank
opened its largest branch for Islamic insurances Noor Takaful which is excelling in
the retail sector. Ajman Bank has recently launched the Mahra Ladies Banking as
“around a quarter of the UAE’s private wealth is controlled by women,” Maryam
Al Shorafa, Head of Ajman Bank’s Ladies Banking, told AME info.com. Dubai Bank,
one of the smallest local banks in the UAE, has also just opened a new branch at
Dubai’s prestigious Jumeira Road. People who drive down the road from the
famous Jumeira Mosque to Burj Al Arab can’t miss the huge building near the
“Miraj” Islamic Art Centre. Also in June 2011 it was reported that, Dubai Islamic
Bank launched access to a new Shari’ah-compliant fund, the Prudential Shari’ah
Opportunities - Asia Pacific Equity Fund. Abu Dhabi Islamic Bank (ADIB) offers 25%
discounts on online transactions for those who open an online brokerage account,
along with the chance to win an iPad, which are all exclusive retail banking
promotions to attract both Muslims and Non-Muslim customers into the Islamic
retail banking sector. Many Islamic financial institutions are tapping into the
Islamic wealth management sector. Abu Dhabi Islamic Bank (ADIB) is one such
example as in September 2010 ADIB launched its specialized wealth management 89 Gartner Research, Islamic Banking: Opportunity or Money Pit For conventional Banks, ITS, Issue: 2,
p.10.
107
services. In 2010 the Islamic retail sector needed more pushing as reported by
Ernst & Young however it is slowly picking up with the advancement of
technology and the Islamic banking industry.
The Islamic Banking sector has progressed tremendously in the last 25 years of its
succession as competition in the banking sector has further intensified due to
globalization and technological advancement. Shari’ah-compliant investments
have continued to attract the attention of global investors and consumers
wanting to utilize Islamic modes of financing. In attempting to meet the demands
of the growing Islamic financial sector the industry has to effectively implement
conventional bank’s use of modern day technology through the use of mobile
internet banking and other current software.
Many Islamic banks are choosing to offer Islamic financial products and services
through mobile internet banking and it is becoming an increasingly popular
method of handling transactions quickly and efficiently. Another key example of
implemented mobile technology facilities in Islamic banks are Dubai Islamic
Bank’s recent launch of Al-Islamic Mobile Banking. Al Islamic mobile banking
allows customers to check their statements on their mobile, carry out
transactions, and check their Murabahah accounts and investment accounts.90
In
Bangladesh, Islamic banking accounts for 65% of total banking assets, in Bahrain
46% and Saudi Arabia 35%. However penetration in other countries is limited with
Islamic banking accounting for only 4% to 5% of total banking assets in Turkey,
Egypt and Indonesia.91
Islamic banks, including those with Islamic ‘windows’, are
now looking to enhance their position in faster growing core regions of Middle
90 Global Islamic Finance, “The Ultimate Islamic Finance Review 2011”, December - January 2012, P.16. 91 Islamic Finance, UK Islamic Finance Secretariat Sponsored by Gatehouse Bank, March, 2012, P.3.
108
East, Asia and Africa. Offering products that are competitive on price and service
could help to generate business not only from Muslims with a preference for
Shari’ah compliant services, but also from Muslims and other customers that
currently use conventional banking services.
Significant international developments in the past year have included:
● Launch in November 2011 by Thomson Reuters of the world’s first Islamic
interbank rate, which is designed to provide an indicator for the average expected
return on Shari’ah compliant short term interbank funding.
● Oman’s decision in May 2011 to permit the establishment of Islamic banks in
the country the last of the six GCC states to do so. The aim is to tap into regional
demand for Shari’ah compliant banking services and other products currently
being met elsewhere in the region and therefore to curtail the current outflow of
investment from Oman.
● Qatar’s move in February 2011 of preventing conventional banks from offering
Shari’ah compliant products through Islamic windows. The boundary is expected
to provide opportunities for Islamic banks to gain market share.
In the UK, the five fully Shari’ah compliant banks were established between 2004
and 2008 and put the UK in the lead in Western Europe. There are also an
estimated 17 conventional banks that have set up windows in the UK to provide
Islamic financial services. HSBC Amanah is the only conventional bank with an
Islamic window to report to The Banker’s survey: its assets of $16.7bn account for
88% of the UK’s identified assets, with a further 6% from BLME and 3% from the
HSBC parent bank. The 22 Islamic banks in the UK substantially exceed that in any
other Western country or offshore centre. The Islamic Bank of Britain (IBB) is a
retail bank and the only Islamic bank with a high street presence having five
109
branches and around 50,000 customers. IBB’s founding shareholder Qatar
International Islamic Bank took full control of the bank in 2011. IBB’s admission to
the AIM market was cancelled in April 2011. The Bank of London and The Middle
East (BLME) is an independent wholesale Shari’ah compliant UK bank based in the
London. BLME’s offering spans corporate banking, treasury and wealth
management that comprises private banking and asset management. BLME aims
to strengthen its services and market penetration in the GCC. QIB UK took on its
new branding in 2010 to reinforce its identity within QIB’s global network. QIB UK
offers a range of Shari’ah compliant financing and investment products for both
Islamic and non-Islamic clients alike. It provides Shari’ah compliant investment
banking services including trade finance, private equity and asset management.
Gatehouse Bank is a Shari’ah compliant wholesale investment bank operating in
capital markets, real estate, asset finance, treasury business and Shari’ah advisory
services. In 2010, Gatehouse Bank completed more than £160m in Shari’ah
compliant real estate acquisitions.92
4.3 Islamic Banking in MENA Region: A Growing Trend
Islamic finance in the Middle East and North African (MENA) countries has now
become an important element in their societies‟ development agendas and it is
also gaining ground in the financial landscape of the region as well as in the
individual countries. It is also a growing business as it caters to the financial needs
of the people without conflicting with their social and religious values.93
The
Islamic banks in the MENA region have achieved strong growth during the years
2003 to 2007 with a CAGR of over 31% in assets. They outperformed the banking
92 Ibid, p.5. 93 Salman Alman Syed Ali, “Islamic Banking In The MENA Region”, Islamic Development Bank – Islamic
Research And Training Institute, February, 2011.
110
system as a whole that registered an average CAGR of about 23.9%. At the end of
2007, there were 20 publicly listed pure Islamic banks in the region with a
combined asset base of USD 148.3 billion.94
Islamic banking assets in the MENA
region have been growing exponentially over the last several years. For example,
in 2004 the proportion of Islamic banking assets of the Middle Eastern banks was
only about 29 percent of the worldwide Islamic banking assets, which grew to 50
percent of the worldwide share in 2008.6 Not only the aggregate but the average
asset per bank has increased in the Middle East as well. Most of this growth was
taking place in the GCC countries, but recently the non-GCC countries are also
witnessing growth of Islamic banking both by establishing domestically
incorporated Islamic banks and by cross-border expansion of GCC based Islamic
banks through their subsidiaries. The Islamic banking sector is not of similar size
and scope across MENA countries. Figure No.13 shows the asset size distribution
for various countries. The assets have been growing in all countries with the
highest growth in Qatar of 48 percent and lowest in Egypt of 10 percent. Lebanon
with an asset growth of 145 percent is an exception as Islamic banks opened in
the country only in 2006, thus, it is starting from a very small base. Saudi Arabia,
UAE and Kuwait stand out as giants in terms of aggregate assets of Islamic banks
while Egypt, Jordan, Yemen, and Lebanon constitute the lower tail with Qatar and
Bahrain in between (see Figure 13).
94 Islamic Banking in the MENA Region, Blominvest Bank, Feb. 2009, P.7.
111
Figure No.13 Source: Islamic Development Bank (2011)
4.4 Growth of Islamic Takaful Industry
Takaful, similar to mutual insurance, is a risk sharing entity that allows for the
transparent sharing of risk by pooling individual contributions for the benefit of all
subscribers. The global market remains at an early stage of development with
premiums estimated to have reached $16.5bn in 2011. This includes an estimated
$4.5bn generated in Iran where takaful is the compulsory form of insurance, and
Ernst & Young’s estimate of $12.0bn for the rest of the world.95
Figure No. 14
shows the growth of takaful premium and takaful assets in Iran and rest of the
world.
95
Islamic Finance, UK Islamic Finance Secretariat Sponsored by Gatehouse Bank, March, 2012, P.7.
112
Figure No.14 Takaful Global Market (Ernst & Young, 2011)
The very first Takaful company called the Islamic Insurance Company of Sudan
was established in 1979. In 2011, there are over 30 registered Takaful companies
worldwide writing Takaful directly and 10 more as Islamic windows or marketing
agencies placing insurance risk with conventional and Takaful companies and the
number continues to grow. In fact the number of Takaful companies is higher as
all insurance companies in Sudan are deemed to operate in accordance to the
Shari’ah principles. In addition, new Takaful companies have been established
recently in Sri Lanka and Tunisia. At least four more Takaful companies are under
formation in the Middle East in countries such as Kuwait, UAE and Egypt. Several
other Takaful companies are being contemplated in various countries such as
Pakistan, Australia and Lebanon. The countries of South Africa, Nigeria, and some
of the former states of the Soviet Union are also contemplating tapping into the
Takaful market.
113
Takaful industry in Bahrain is said to be prospering from last few years especially
in 2011 as people are favoring Shari’ah-compliant methods of Islamic insurance.
Takaful total contributions grew by 16.5 percent to reach BD13.4 million ($35.6m)
in the first quarter of the year compared with BD11.5 million for the same period
last year, according to the Central Bank of Bahrain (CBB). Traditional insurance
still took the largest share of the market, down slightly at BD43.3 million in the
first quarter compared to BD44 million. The Takaful market in Bahrain consists of
27 domestic insurance companies and 11 branches of foreign insurance
companies covering both direct insurance and reinsurance. The recorded data for
the insurance market during the first quarter of the year shows a slight increase
of 1.8 percent in gross written premiums in the quarter up from BD55.7 million to
BD56.7 million. The global Takaful market which has increased potentials for
employees, students and professionals who want to tap into the Islamic insurance
industry. The graph spans from the year of 2006 which shows that the market for
Takaful was at $2.10 billion dollars however the demand for Takaful insurance
has increased year by year and is expected to reach $7.39 billion dollars by 2015 if
it maintains growth in the highly competitive financial insurance industry.
Many countries have various different global markets for Takaful. Malaysia has
the largest market for Takaful premiums reaching 1,220 with Syria with the least
market. It is estimated that the global Takaful premium could be in the region of
US $7.4 billion in 15 years time in 2026, growing at nearly 20% per annum. This is
not an unachievable task as the Malaysian Takaful sector is successfully growing
at 60% annually and the Middle East at 10% annually. With a focused effort on
114
part of the Takaful operators worldwide there can be the potential of a significant
growth of 20% annually.96
4.5 Sukuk: A Global Successes for Islamic Finance Industry
The Sukuk Islamic bonds sector is a global success for the Islamic finance industry
with it growing at subsequently fast rates it is a driving force for the progression
of the Islamic finance industry. Many Muslims and Non- Muslims find Sukuk the
perfect alternative to conventional bonds. The Sukuk market has become an
emerging sector during the years and after the global economic crisis the appeal
for the market increased with many investors turning to utilize Sukuk Islamic
bonds for their projects and investments. Figure No.15 depicts the dynamic
growth of Sukuk industry.
Figure No. 15 Source: Zawya Sukuk Monitor
In reviewing the rapid growth of Sukuk it is imperative to look at the development
which aroused the emerging sector when it was in its infancy. Many countries
around the world such as Qatar have made unprecedented developments in the
Sukuk arena. Malaysia is the global market leader for Sukuk issuance, accounting 96 Global Islamic Finance, “The Ultimate Islamic Finance Review 2011”, December - January 2012, p.16.
0
10
20
30
40
50
60
70
80
90
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Jan-12
Sukuk Global Issues
115
for 63 percent of cumulative Sukuk issuances between 1996 and 2010. Malaysia
issues long-term, local currency Sukuk to fund infrastructure projects and
contribute to financial stability.97
Qatar International Islamic Bank (QIIB) and
HSBC issued US $700 million worth of Trust Certificates (Sukuk) which was due in
the year 2010 and is now progressing in 2011. The proceeds from this issuance
were utilized to finance the construction and development of a major
infrastructure project which was the Hamad Medical City located in Doha, Qatar.
The certificates issued in 2003 were redeemable in 2010, hence, the period for
the issue was seven years. The joint lead managers for the issue were HSBC Bank
and the Qatar International Islamic Bank, with the co-managers being the Abu
Dhabi Islamic Bank, Gulf International Bank, Kuwait Finance House, Commerce
International Merchant Bankers of Malaysia, the Islamic Development Bank and
the Qatar Islamic Bank. Bahrain is another country which is making milestones in
the Sukuk arena and holds many investment opportunities in 2011 for the
facilitation of Sukuk Islamic bonds. Bahrain had an oversubscribed demand for the
Sukuk market as Bahrain’s 750 million sovereign issue attracted an order book of
about $4 billion with a strong demand from the Middle East.
The initial size of the Sukuk offering was $500 million, but the issue was
oversubscribed by almost eight times. As a result, the value of the Sukuk was
raised to $750 million, a Central Bank of Bahrain statement said. “One of the
major reasons behind this issue was to establish a yield curve benchmark for
longer-term Islamic securities,” said Sheikh Salman bin Isa Al Khalifa, executive
director, banking operations, CBB. “This is a testament to Bahrain’s strong credit
and the confidence which International markets place on the kingdom’s financial 97 Mahmud Mohieldin, “Realizing The Potential Of Islamic Finance”, The World Bank Economic Premise,
No. 77, March 2012.
116
sector,” added Sheikh Salman. The GCC and the UAE have made several
milestones throughout the years in the issuance of Sukuk and with the Islamic
financial sector set to rise there is much scope for the countries to further
develop Sukuk issuances. With correct implementation of legislation and
regulatory bodies which support the Sukuk system the Sukuk issuances can be
performed smoothly. Europe has also been making progressive developments in
the Sukuk arena. The Sukuk market in Europe grew by a massive 75% to US $85
billion in total outstanding issues in the first half of 2007. The US $24.5 billion of
funds raised in the first half nearly surpassed the total amount of new issuance in
2006 of US $26.8 billion, according to the Islamic Finance Information Service,
online media partner of the forum.98
In early 2010, the UK House of Commons decided to adopt the Financial Services
and Markets Act 2000 Order 2010. It is aimed at removing barriers and
uncertainty in the regulation of alternative finance investment bonds (Sukuk) and
which the Treasury stresses will reduce compliance and legal costs for these
instruments, and facilitate the issuance of corporate Sukuk in the UK this made it
more accessible to issue Sukuk. Germany and France are also making progressive
developments in Sukuk Islamic bonds. Germany was the first country to issue
Sukuk in Europe as in September 2004 Saxony-Anhalt became the first state
government in Germany and Europe to issue a sub sovereign bond under Islamic
principles. The €100 million bond does not offer interest payments to its investors
and Germany abided by the Shari’ah principles outlined for issuing the first Sukuk.
German banks such as Deutsche Bank, Commerzbank and Dresdner Bank are
already well involved in the sector albeit in overseas markets. Deutsche Bank for
98 Islamic Finance, UK Islamic Finance Secretariat Sponsored by Gatehouse Bank, March, 2012, p.7.
117
instance has co-lead managed MTN issuances for the Jeddah-based Islamic
Development Bank and pioneered the Islamic Equity Certificates with National
Commercial Bank of Saudi Arabia a product which the promoters claimed was the
first Islamic retail product with universal marketing application and capability99
.
Overall the main issuers of European Sukuk in UK, France and Germany exhibit
potential to further develop the Sukuk industry and allow scope for more
issuances to pave the way for Islamic finance as a major sector in Europe. Many
Non-Muslims and Muslims alike have embraced the Sukuk industry in Europe and
are keen to further encourage the development and implementation of laws
which accommodate and make it easy for investors to utilize Sukuk issuances. In
2010 the UAE holds a significant presence in the Sukuk market accounting for 20
percent of the total Global Sukuk market. Global Sukuk issuance totaled $19
billion last year and the UAE also recorded the second highest Islamic loan volume
in the region after Saudi Arabia, the data released at the Reuters Islamic Banking
and Finance Summit in Dubai. America and Canada still have a way to go with
Sukuk as in 2011 not much has been done to facilitate Islamic Sukuk bonds in
comparison to the Middle East and UAE. America launched its very first debut
Sukuk on the 16th of June 2006 which was the East Cameron Gas Sukuk which has
been described as being the most innovative and interesting Sukuk to date. Sukuk
in Canada also flourished between the years of 2009 to 2010 and Siraj Capital
Dubai which had also helped to issue America’s first Sukuk issuance had also been
proactive in launching Canada’s debut Sukuk. One of Canada’s very first major
Sukuk deals was quite recently issued in 2009 as Canada was quite late to tap into
the Islamic financial market. On the 7th of July 2009 Siraj Capital Dubai
99
Ibid, P.8.
118
announced the Bear Mountain Resort Sukuk at the London Sukuk Summit.100
The
Islamic financial sector and is rapidly emerging as a prominent financial sector in
the mainstream. Sukuk issuances which are mainly made from successful Islamic
financial hubs such as Malaysia and the UAE are slowly crossing the borders into
the Western world and soon America and Canada can take a leading role in the
issuances of lucrative Sukuk deals.101
From the above figures, it becomes clear that Islamic finance industry has become
one of the growing financial segments in the international financial system. Its
phase of development that began in earnest as domestic-centric for Muslim
economies, has rapidly transformed in this recent decade to become
internationally recognized and accepted as a competitive and robust form of
financial intermediation by all communities.
100 Islamic Finance News 2012 Guide, www.IslamicFinanceNews.com, February 2012 , P: 8 101 Global Islamic Finance, “The Ultimate Islamic Finance Review 2011”, December - January 2012, pp.16-
17.
119
Conclusion
120
Conclusion
The current global financial crisis, believed to be worst of its kind since Great
Depression 1929, has dramatically changed the values, requirements and
opinions of common masses in general and economists and finance experts in
particular, in viewing the economic performance of banks and financial
institutions. The ‘Credit crunch’ as it has come to be known brought panic and
turmoil in the summer of 2007 to the world’s financial markets causing the United
States’ housing market bubble to burst. The crisis threatens a worldwide
economic recession, potentially bringing to a halt more than a decade of
increasing prosperity and employment for western economies and potentially
wiping a staggering $1 trillion off of the value of the world economy. Economists
analyzed that imprudent lending, high leveraging, unnecessary financial
innovations and speculations are the determinant factors responsible for financial
ripples leading to economic slowdown and the ongoing crisis situation.
Representing the collapse of trillions of dollars of fictitious credit derivatives and
the meltdown of uncontrolled credit growth, the scope of the crisis could reach
unmanageable size. The crisis has shown that advanced financial systems are very
vulnerable and share the character of inherent instability. The global financial
crisis brought to the fore the inadequacy of conventional banking regulations in
general and their capital inadequacy in particular in relation to the risk associated
with their businesses both aspects require serious consideration. The crisis also
vividly highlighted the importance of the stability as a prerequisite for economic
progress.
The Islamic Financial Services Industry is of course part of the broader global
financial system, but it is comprised of instruments, infrastructure, institutions
121
and markets that apply Shari’ah rules and principles in their design and
operations. The Islamic financial system appears to be able to perform
substantially all of the functions associated with typical conventional financial
transactions and it therefore has sub-sectors that are similar to the conventional
financial system. These sub-sectors consist of, among other things, the Islamic
banking industry, the Islamic money market, Islamic capital markets (equity and
bond markets), the Takaful (Islamic insurance) industry and the Islamic
asset/wealth management industry. With global Islamic finance assets projected
to reach $1.6 trillion by 2012, the industry is an emerging force of liquidity and
investment in global markets across multiple sectors – real estate, construction,
financial services, transportation, oil and gas, power and utilities, consumer goods
and telecommunications. The Islamic finance industry, having more than 700
institutions, spread in 75 countries including Europe and America, has covered
15-20% average annual growth rate over the past decade and is projected to
cover 20% annual growth rate over the next five years. While not immune from
the effects of the global financial crisis of 2008-2009, the Islamic finance industry
due to its asset-backed nature of financial operations, has weathered the storm
somewhat better than its conventional counterparts. However the Islamic
financial industry still faces many challenges, many bankers as well as regulators
are assessing the market opportunity, risk management policies, operational
standardization and robustness of the industry. The Islamic financial system, while
just coming out of its niche, if compared to the conventional financial, centuries
old, has proven to have a solid foundation. As Islamic banking and most of its
financial contracts are based on the risk sharing it is intrinsically more stable. If
this intrinsic feature is combined with prudent regulations and supervision and
122
implementation of risk management, transparency and corporate governance
that are up to international standards, Islamic finance industry can virtually
develop into a model alternative to the conventional financial system in attaining
equity, stability and effectiveness. While operating its banking system in the
current financial scenario, Islamic finance industry goes on with the following
structures: (a) Dual system (Malaysia and Indonesia), (b) Dual system with clear
separation between the conventional system and the Islamic system (Bahrain and
Jordan). In a dual-system environment, it is not uncommon to see big global
banks such as HSBC, Citibank, Standard Chartered, Deutsche Bank, BNP Paribas
and ABN Amro setting up Islamic window operations or even Islamic banking
subsidiaries, and (c) Full Islamization of the financial system: virtual absence of
conventional financial institutions, since only full-fledged Islamic financial
institutions are licensed to operate in a country (Iran, Pakistan—making its way in
this direction-- and until recently, Sudan).
A healthy group of economic experts and finance analysts are unanimous in their
opinion that the continuity of financial crisis, firstly hitting U.S and now rocking
the Euro-zone has set the stage for Islamic finance to demonstrate its availability
as a potentially genuine alternative financial system. History teaches that
opportunities presented, can be seized and realized or neglected and wasted. It is
time for Islamic finance industry to seize its movement of opportunity and prove
its inherent tendency towards creating a much resilient financial environment
governed by the Divinely guided regulatory framework.
123
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124
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