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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 protected]

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  • Introduction to Islamic Finance & Banking

    World Bank – BRSA - TKBB Joint Workshop on “Innovative Product Development in Islamic Banks”

    Istanbul, TurkeyMarch 2, 2017

    Zamir Iqbal, PhD.Lead Financial Sector SpecialistThe World Bank Global Islamic Finance Development CenterIstanbul, [email protected]

  • 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

    removing discrepancies


    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,

    and Luxemburg.

  • Roadmap





  • 6

    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

    10Source: 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

  • 12

    II. How Islamic Banking Works?

  • Risk


    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

    Risk sharing

    – 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

    – Gambling

    – Prostitution and pornography

    – Defense and weapons

    – Pornography

    – Add constraint on interest-based debt => Islamic investment

  • Components of Islamic Financial System


    Islamic Financial System

    Non-banking Financial


    Takaful (Insurance)

    Micro-financial institutions

    Leasing Companies

    Project Finance

    Private Equity


    Commercial Banking

    Investment Banking

    Capital Markets

    Sukuk market

    Stock Market

    Mutual Funds

    Money Markets

  • 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 PaymentSale 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 ContractSale by immediate payment against future delivery. Similar to conventional forward contract

    but requires full payment at the time of contract.

    Ijarah LeasingA 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.

    MudarabahTrustee 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.

    MurabahahA 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.

    Sukuk Islamic BondPlural of the Arabic word Sakk meaning certificate, reflects participation rights in the

    underlying assets.

    Takaful Insurance Insurance contract through mutual or joint guarantee.

    Wikala AgencyRepresentation. Entrusting a person or legal entity (Wakil) to act on one’s behalf or as one’s


  • Islamic Financial Intermediation (Banking)


    Trade Financing, Leases,


    Partnerships (mudarabah and musharakah)

    Securities Investments



    Demand Deposits

    Investments by Depositors


    Key Highlights

    Depositors are investors rather than lenders

    Risk Sharing through Profit and loss sharing.

    Assets and Liabilities are matched.

    Ethical and socially responsible assets

  • A Stylized Balance Sheet of an Islamic Bank

    Assets Liabilities

    Trade Financing

    (Salaam, Morabahah) Demand Deposits

    (Amanah/ Waad)

    Leasing / Rentals

    (Ijarah / Istisna) Investment Accounts

    (Mudarabah)Profit/Loss Sharing


    ( Mudarabah) Special Investment Accounts

    (Mudarabah)Equity Investments

    ( Musharakah)

    Fee for Services Capital



  • 20

    III. Regulatory and

    Supervisory Environment

  • Key Stakeholders


    Islamic Development Bank Group (IDB, ICD, IRTI, ICIEC, ITFC)

    Islamic Financial Services Board (IFSB)

    Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI)

    Multilaterals (The World Bank Group, IMF, Asian Development Bank)

    International Islamic Financial Markets (IIFM)

    International Islamic Rating Agency (IIRA)

    International Center for Education in Islamic Finance (INCEIF)

  • Islamic Financial Services Board (IFSB)

    IFSB is an international standard-setting organization with a membership of 185 participants, whose work complements the work of the Basel Committee on Banking Supervision, International Organization of Securities Commissions and the International Association of Insurance Supervisors. As of early 2014, the IFSB has issued 17 Standards, 5 Guidance Notes and 1 Technical Note for the Islamic financial services industry.

    Approved Standards1. Risk Management2. Capital Adequacy3. Corporate Governance4. Transparency and Market Discipline5. Supervisory Review Process6. Governance for Collective Investment Schemes7. Special Issues in Capital Adequacy8. Guiding Principles on Governance for Islamic Insurance (Takaful) Operations9. Conduct of Business for Institutions offering Islamic Financial Services10. Guiding Principles on Shariʿah Governance System11. Standard on Solvency Requirements for Takaful Undertakings12. Guiding Principles on Liquidity Risk Management13. Guiding Principles on Stress Testing14. Standard On Risk Management for Takaful Undertakings15. Revised Capital Adequacy Standard16. Revised Guidance on Key Elements In The Supervisory Review Process of Institutions Offering Islamic

    Financial Services17. Core Principles for Islamic Finance Regulation (Banking Segment)

  • Islamic Financial Services Board (IFSB)

    Standards under Development

    1. Revised Guidance on Key Elements in the Supervisory Review Process of Institutions Offering

    Islamic Financial Services (excluding Islamic Insurance (Takaful) Institutions and Islamic

    Collective Investment Schemes)

    Guidance Notes and Technical Note

    1. Recognition of Ratings on Shariʿah-Compliant Financial Instruments

    2. Guidance Note in Connection with the Risk Management and Capital Adequacy Standards:

    Commodity Murabahah Transactions

    3. Guidance Note on the Practice of Smoothing the Profits Payout to Investment Account Holders

    4. Guidance Note in Connection with the IFSB Capital Adequacy Standard: The Determination of

    Alpha in the Capital Adequacy Ratio

    5. Guidance Note on the Recognition of Ratings by External Credit Assessment Institutions

    (ECAIS) on Takaful and Re-Takaful Undertakings

    6. Development of Islamic Money Markets (Technical Note)

  • Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

    The Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) is an Islamic

    international autonomous non-for-profit corporate body that prepares accounting, auditing, governance,

    ethics and Shari'ah standards for Islamic financial institutions and the industry.

    Issued Standards

    Accounting Standards

    Auditing Standards

    Ethics Standards

    Governance Standards

    Shari’ah Standards

    Guiding Notes

    Guidance Note on First time Adoption of AAOIFI Accounting Standards by an Islamic Financial


  • Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

    ACCOUNTING STANDARDSConceptual Framework FOR Financial Reporting by Islamic Financial InstitutionsFAS 1- General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial InstitutionsFAS 2- Murabaha and Murabaha to the Purchase OrdererFAS 3- Mudaraba FinancingFAS 4 - Musharaka FinancingFAS 5- Disclosure of Bases For Profit Allocation Between Owners’ Equity and Investment Account HoldersFAS 6- Equity of Investment Account Holders and their EquivalentFAS 7- Salam and Parallel SalamFAS 8- Ijarah and Ijarah Muntahia BittamleekFAS 9- ZakahFAS 10-Istisna'a and Parallel Istisna’aFAS 11- Provisions and Reserves FAS 12-General Presentation and Disclosure in the Financial Statements of Islamic Insurance CompaniesFAS 13- Disclosure of Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance CompaniesFAS 14- Investment FundsFAS 15- Provisions and Reserves in Islamic Insurance CompaniesFAS 16- Foreign Currency Transactions and Foreign Operations FAS 17- InvestmentsFAS 18- Islamic Financial Services offered by Conventional Financial InstitutionsFAS 19- Contributions in Islamic Insurance CompaniesFAS 20- Deferred Payment SaleFAS 21- Disclosure on Transfer of AssetsFAS 22- Segment Reporting FAS 23- ConsolidationFAS 24- Investments in AssociatesFAS 25- Investment in Sukuk, Shares and Similar InstrumentsFAS 26 - Investments in Real Estate


    A S 1- Objective and Principles of AuditingA S 2- The Auditor’s ReportA S 3- Terms of Audit EngagementA S 4- Testing for Compliance with Shari’a Rules and Principles by an External AuditorA S 5- The Auditor’s Responsibility to Consider Fraud and Error in an Audit of Financial Statements


    G S 1-Sharia Supervisory Board: Appointment, Composition, Report G S 2- Shari’a ReviewG S 3- Internal Shari’a ReviewG S 4- Audit & Governance Committee for Islamic Financial InstitutionsG S 5- Independence of Shari’a Supervisory BoardG S 6- Statement on Governance Principles and Disclosure for Islamic Financial Institutions G S 7- Corporate Social Responsibility Conduct and Disclosure for Islamic Financial Institutions


    Code of Ethics for Accountants of Islamic Financial InstitutionsCode of Ethics for the Employees of Islamic Financial Institutions

  • Legal Framework for Islamic Financial Institutions (IFIs)



    Some countries like Iran, Kuwait, Malaysia,

    Sudan, Turkey, UAE and Yemen have

    enacted specific laws to regulate the

    establishment of IFIs.

    Same laws of




    of IFIs

    In other countries, IFIs are established by

    the same laws of conventional banks.


    s r


    ting I


    In all the countries in which they operate,

    IFIs are supervised by their respective

    supervisory and regulatory bodies.

  • 27

    IV. State of Development of Islamic Finance

  • Islamic Finance Indicator

    Which Countries have the best developed Islamic Economy for Islamic Finance?











    0 20 40 60 80 100 120 140 160 180 200



    United Arab Emirates

    Saudi Arabia








    Source: State of the Global Islamic Economy Report 2015/16, Thomson Reuters


    1. Financial (Size of Islamic Finance Assets and Number of Islamic Finance Institutions)

    2. Governance (e.g. Regulation for Islamic Finance and Disclosure Index Score)

    3. Awareness (Number of Related News Articles, Islamic Finance Education Institutions, Research papers, and events)

    4. Social (Value of Zakat and Charity and CSR Disclosure Index Score)

  • Adoption of IFSB Standards

    Number of Countries which adopted IFSB Standards

    Source: Comparative Study on the Implementation of Selected IFSB Standards,

    IFSB Working Paper Series, WP-04/10/2015, October 2015

  • Adoption of AAOIFI Standards

    Source: AAOIFI website

    AAOIFI auditing, governance and ethics

    standards are not part of mandatory

    regulatory requirement for Islamic

    finance. Instead, these standards are used

    voluntarily by leading Islamic financial

    institutions across all major Islamic

    finance jurisdictions.

    Mandatory regulatory

    requirement in jurisdictions

    As basis of of national

    accounting standards in










    Bahrain Bahrain Indonesia Indonesia

    Oman Jordan Malaysia Pakistan

    Pakistan Oman

    Sudan Qatar

    SyriaQatar Financial










    In other jurisdictions including Brunei,

    Dubai International Financial Centre,

    France, Egypt, Jordan, Kuwait, Lebanon,

    Saudi Arabia, Qatar, Qatar Financial Centre,

    South Africa, United Arab Emirates and

    United Kingdom as well as in Africa,

    Central Asia and North America, AAOIFI

    Shari’ah standards and/or AAOIFI

    accounting standards have been used

    voluntarily as basis of internal guidelines by

    leading Islamic financial institutions.

  • Islamic Finance Sub-Indicators

    Source: Islamic Finance Development Report 2015, ICD-Thomson Reuters



    Indicator Value

    Malaysia 100

    Pakistan 100

    Bahrain 100

    Nigeria 100

    Indonesia 100

    Iran 83

    Maldives 67

    Unidet Arab Emirates 67

    Qatar 67

    Sudan 67

    Brunei Darussalam 67

    Kazakhstan 67




    Indicator Value

    Bahrain 142

    Malaysia 116

    Kuwait 106

    Bangladesh 92

    Sudan 89

    Oman 70

    Indonesia 57

    Pakistan 56

    Lebonan 53

    Egypt 48



    1- BAHRAIN 93

    2- MALAYSIA 90

    3- KUWAIT 67

    4- PAKISTAN 66

    5- OMAN 62

    6- INDONESIA 58

    7- SUDAN 54


    9- QATAR 52

    10- MALDIVES 48

  • Thank You

    For your further questions please contact:

    Zamir Iqbal

    World Bank Global Islamic Finance Development Center

    T: +90 212 385 3443

    E-mail: [email protected]

    mailto:[email protected]

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