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Introduction to Islamic Finance & Banking
World Bank – BRSA - TKBB Joint Workshop on “Innovative Product Development in Islamic Banks”
Istanbul, Turkey March 2, 2017
Zamir Iqbal, PhD. Lead Financial Sector Specialist The World Bank Global Islamic Finance Development Center Istanbul, Turkey email@example.com
Globalization of Islamic Finance…
Source: IFSB Financial Stability Report 2015, KFHR, IMF
Islamic Finance makes into G-20 agenda
2015- The G20 group of major nations has included discussion of Sukuk (Islamic bonds) as an
infrastructure financing tool in its annual agenda, a move that could potentially spur the use of project-
based Sukuk. In addition, Islamic Finance is subject of study under G20 themes of long-term investments
and Financial inclusion.
Brief Modern History of Islamic Finance
Interest in reviving a banking and financial system started in early 1900s.
1950s – Appearance of early writings about problems of conventional
economic systems and how Islam’s principles of economics offer an
1960s – End of colonialism and independence of countries
1970s – Oil revenues (Perto-$) create demand for banking without interest. 1st
Islamic bank in Dubai is established.
1980s – Growth of commercial banking
1990s – Emergence of Islamic funds and investment banking
2000s – Capital markets and Globalization
UK 2010 – The Financial Services and Markets Act 2000
Order 2010 was introduced by Treasury to support
Islamic finance and the issuance of corporate sukuk
within the UK
2012 - The UK Government launched an Islamic Finance
Task Force with the aim of securing London’s status as
the Western hub for Islamic finance
2013 - London hosted the World Islamic Economic
Forum during which the UK Prime Minister announced
plans to issue a Sukuk in 2014 and to turn London into a
global center of Islamic finance.
France 2009 - The amendment of Article 2011 of the French
Civil Code relating to the formation of trusts was
interpreted as an important step towards permitting the
issuance of sukuk out of France
2010 - Revision of specific tax regulations covering
Sukuk, ijarah, istisna and murabaha with a view to
2010 - The Luxembourg Tax Authority published a circular to clarify the tax treatment of murabahah and sukuk transactions, to ensure that
they benefit from the same tax treatment as conventional products
2011 - Luxembourg’s CSSF published a note that clarified that no specific legislation was required for Shariah compliant investment
funds, since Luxembourg’s current law contains no obstacles to it.
Germany 2012 - German banking regulator hosted an Islamic finance conference
in Frankfurt during which the tax treatment of different Islamic
finance products was discussed.
Hong Kong 2014- Hong Kong has raised $1bn in its debut Islamic bond issue.
South Africa 2014- $500m sale was more than four times subscribed, with an order book
of $2.2bn according to the SA Treasury
2016- Opened first Islamic Bank, The Partnership Banking Center in
March 2016. Source: KFH Research
….there is increasing interest in Islamic finance from non-Muslim countries
Recent transactions include sovereign issuance by United Kingdom (UK), South Africa, Hong Kong,
I. MARKET TRENDS
II. HOW ISLAMİC BANKİNG WORKS?
III. REGULATORY AND SUPERVİSORY ENVİRONMENT
IV. STATE OF DEVELOPMENT OF ISLAMİC FİNANCE
I. Market Trends
Source: ICD-Thomson Reuters Islamic Finance Development Report 2016
Islamic Financial Assets
Market Size – Islamic Banking
Source: Financial Stability Report 2016, IFSB
Islamic Banking Share in Total Banking Assets by Jurisdiction (1H2015)
Islamic Financial Assets Have Been Growing Rapidly
Source: ICD-Thomson Reuters Islamic Finance Development Report 2016
Global Islamic Finance Assets by Sector Growth (2012 – 2021, US$ BN)
Composition and Domicile of Islamic Assets
10 Source: Financial Stability Report 2016, IFSB
Breakdown of Islamic Finance Segments by Region (USD billion, 2015 YTD)
Growth of Banking Assets
Source: World Islamic Banking Competitiveness Report 2016, Ernst&Young
II. How Islamic Banking Works?
Reduction of Information Asymmetry (Gharar)
* Prohibits contracts with high uncertainty (Speculation/Gambling)
* Requires Full Disclosure before, during and after the contract
Prohibition of Interest (Riba)
Eliminates Debt contracts and Leverage Materiality
Economic and Social Justice
Wealth, Ownership and Property Rights
Preservation of Property Rights, Protection of Property Rights of Stakeholders, Significance of Rights of the Society
The role of Wealth, Money, and Capital, Sanctity of Contracts
Theoretical foundations of Islamic Financial System
How a banking system is designed without “Interest?”
Prohibition of interest discourages debt and leverage
– Because interest is prohibited, pure debt security is eliminated from the system and therefore suppliers of funds become investors, rather than creditors. The provider of financial capital and the entrepreneur share business risks in return for shares of the profits and losses.
Close linkage with the Real Sector of the economy
Promotes Asset-backed Finance
– The system introduces a “materiality” aspect that links financing directly with the underlying asset so that the financing activity is linked to the real sector activity. There is strong linkage between the performance of the asset and the return on the capital used to finance it.
Similarities with ethical and Socially Responsible Investments (SRIs).
Commonality: Ethical Investing
Substantively: Islamic finance is “ethical finance and investing”.
Consider: Lutheran funds, Roman Catholic funds, “green” funds,
university investment programs (WARF-UW; UC-Berkley).
No investments in:
– Production or distribution of alcohol for human consumption
– Production of tobacco for human consumption
– Prostitution and pornography
– Defense and weapons
– Add constraint on interest-based debt => Islamic investment
Components of Islamic Financial System
Islamic Financial System
Key Contracts – building blocks
Contract Function Description
Amana Custody Trust. Placing something valuable in trust with someone for custody or safekeeping.
Bay’ al-Istisna Order to build Sale in order to manufacture or construct.
Bay-mua’jjal Deferred Payment Sale contract where the price of the product or underlying asset is agreed but the payment in
lump sum or installments is deferred to a specified future date.
Bay’ al-Salam Forward Contract Sale by immediate payment against future delivery. Similar to conventional forward contract
but requires full payment at the time of contract.
Ijarah Leasing A sale contract that is not the sale of a tangible asset but rather a sale of the usufruct (the
right to use the object) for a specified period of time.
Mudarabah Trustee finance
An economic agent with capital (rabbul-mal) can develop a partnership with another agent
(mudarib) with skills to form a partnership with the agreement to share the profits. Although
losses are borne by the capital owner only, the mudarib may however be liable for a loss in
case of misconduct or negligence on his part.
Murabahah A cost-plus-sale
A cost-plus-sale contract where a financier purchases a product, that is, a commodity, raw
material or supplied, for an entrepreneur who does not have its own capital to do so. The
financier and the entrepreneur agree on a profit margin, often referred to as a mark-up
which is added to the cost of the product. The payment is delayed for a specified period of
Equity partnership. It is a hybrid of Shiraka (partnership) and Mudarabah combining the act
of investment and management.
Qard-al-hassan Benevolent Loan Charitable loans with no interest and low expectations of return of principal.