Islamic Banking

Goodness is the only INVESTMENT which never fails

History of Islamic Banking

Islamic Banking is a system of banking that operates in accordance with the

rules of Shari’ah (Islamic Law), known as Fiqh al-Mu’aamalaat (Islamic

Commercial Law). Islamic Banking is based on Islamic Commercial Law, which

was founded over 1400 years ago. Therefore Islamic Banking was existent at

that time.

Modern Islamic Banking grew due to the desire of Muslims to fashion all

aspects of their life in accordance with principles of their faith.

History of Islamic Banking

History of Islamic Banking

The first modern experiment with Islamic Banking was undertaken in Mit Ghamr, Egypt by Dr Ahmad Elnaggar. The pioneering effort, led by Ahmad Elnaggar, took the form of a savings bank based on profit-sharing in 1963.

In 1971, the Mit Ghamr Savings project became part of Nasser Social Bank.

In 1975, the Islamic Development Bank was initiated with the mission of providing funding to projects in the OIC member countries. The first modern commercial Islamic Bank, Dubai Islamic Bank, opened its doors in 1975. In the early years, the products offered were basic and replicated conventional banking functions in a Shari’ah compliant manner.

Within a ten year period 1975-1985, 27 more Islamic Banks were established. Also by 1985, many conventional banks offered Islamic Banking products or opened Islamic window banks.

By the year 2000 there were more than 200 Islamic

Financial Institutions worldwide

Demographics

How many and where:

Islam is a major world religion.

The Muslim population ranges from 1.3 billion to 1.8 billion.

Muslims are found all over the world, of every nation, colour and race.

Between 30–40 countries are Muslim-majority and Arabs account for around 20% of all Muslims worldwide.

South Asia and Southeast Asia contain the most populous Muslim countries, with Indonesia, India, Pakistan, and Bangladesh having more than 100 million adherents each.

There are approximately 20 million Muslims in China.

In the Middle East, the non-Arab countries of Turkey and Iran are the largest Muslim-majority countries.

In Africa, Egypt and Nigeria have the most populous Muslim communities.

Islam is the second largest religion and the fastest

growing religion in the world.

So What is Islamic Finance?

Islam

Aqidah

(Faith & Belief)

Shari’ah

(Practices & Activities)

Ibadah

(Man-to-God worship)

Muamalat

(Man-to-Man

Relationships)

Political Activities

Economic Activities

Other Economic Activities

Banking & Financial Activities

Social

Activities

Akhlaq

(Moralities & Ethics)

Shari’ah

Qur’aan

Primary Source

Sunnah Primary Source

Ijtihaad

Secondary Source

Ijma’ Secondary Source

Islamic Banking Values, Ethics & Principles of Islamic Economics

General Islamic commercial ethics:

Ensure honesty & fair trade, abstain from hoarding, cheating & illegal activities.

Do not lie, or make false promises to sell your goods.

Do not deceive others.

Abstain from goods and services that have a negative influence on society.

Maintain justice in all dealings, and treat all equally.

Disclose the faults of goods been sold.

Avoid hoarding and creating a monopoly.

Avoid the sale of Haraam (prohibited) items.

Islamic Banking Values, Ethics & Principles of Islamic Economics

1. Freedom to contract.

2. Freedom from price control.

3. Entitlement to equal, adequate and accurate information.

4. Freedom from Riba.

5. Freedom from Gharar.

6. Avoid hoarding.

7. Avoid selling forbidden (Haraam) items.

Important principles of Islamic Economics

The Salient Features

Interest Free

The need for an Underlying Asset

Avoidance of Uncertainty or Gambling

Profit & Loss Sharing

Shari’ah Compliance

Prohibition on Unlawful Goods & Services

Rights & Responsibilities of both banks & customers

IFS enjoys features not found in conventional

banking:

Islamic Finance The Basic Equation

Islamic Principles

& the Assertion

of Religious Law

Risk & Profit

Sharing

Substance Over Form: Real Economic

Transaction & Asset Backed

Social Justice &

Ethical Value

Prohibited Activities &

Elements

Islamic Finance

Four Influential Islamic Organisations in

the development of the Islamic Finance Industry

The Islamic Fiqh Academy of Jeddah (IFA)

The Islamic Fiqh Academy of India (IFA)

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

Islamic Financial Services Board (IFSB)

Operating structures of Islamic Banks

Fully - Fledged Islamic Banks

Subsidiaries

Branches

Windows

Model

There are four operating structures of Islamic Banks currently:

Islamic Finance Industry Steady Progress

Market Potential-Positioned for Growth

SA Islamic Financial Services Landscape

Islamic Banks:

Absa Islamic Banking

FNB Islamic Finance

HBZ Bank

Albaraka Bank

Islamic Asset Managers:

Stanlib

Kagiso

Element Investment Managers

Futuregrowth/Omigsa

Advantage Asset Managers

27Four Investment Managers

Oasis Asset Management

Symmetry

Sentio

Sanlam Private Investment Managers

Banks offering a Shari’ah compliant service/product:

Nedbank Capital

Standard Bank

Invested

Macquarie

Islamic Insurance:

Absa Takaful

Shari’ah Compliance

Shari'ah Compliance

Shari’ah Compliance

AAOFI Resolution

Governance standard no.1:

Definition of a Shari’ah Supervisory Board

A Shari’ah Supervisory Board is an independent body of specialized jurists in Fiqh al-

Mu’aamalaat (Islamic commercial jurisprudence). However, the Shari’ah Supervisory

Board may include a member other than those specialized in Fiqh al-Mu’aamalaat, but

who should be an expert in the field of Islamic Financial Institutions and with knowledge

of Fiqh al-Mu’aamalaat. The Shari’ah Supervisory Board is entrusted with the duty of

directing, reviewing and supervising the activities of the Islamic Financial Institution in

order to ensure that they are in compliance with Islamic Shari’ah rules and principles. The

fatwas and rulings of the Shari’ah Supervisory Board shall be binding on the

Islamic Financial Institution.

Appointment of a Shari’ah Supervisory

Board and fixing it’s Remuneration

Every Islamic Financial Institution shall have a Shari’ah Supervisory Board to be appointed by the shareholders in their annual general meeting upon the recommendation of the Board of Directors taking into consideration the local legislation and regulations. Shareholders may authorise the Board of Directors to fix the remuneration of the Shari’ah Supervisory Board. The Shari’ah Supervisory Board and the Islamic Financial Institution should agree on the terms of engagement. The agreed terms would need to be recorded in the appointment letter. The Shari’ah Supervisory Board should ensure that the Islamic Financial Institution documents and confirms the Shari’ah Supervisory Board’s acceptance of appointment. The letter of appointment of Shari’ah Supervisory Board should generally include reference to the compliance of the Islamic Financial Institution with Shari’ah rules and principles. The Shari’ah Supervisory Board shall appoint from among its members or any other person a supervisor(s) to help in performing its duties.

The Shari’ah Supervisory Board shall consist of at least three members. The

Shari’ah Supervisory Board may seek the service of consultants who have

expertise in business, economics, law, accounting and/or others. The Shari’ah

Supervisory Board should not include directors or significant shareholders of

the Islamic Financial Institution.

The dismissal of a member of the Shari’ah Supervisory Board shall require a

recommendation by the Board of Directors and be subject to the approval of

the shareholders in the general meeting.

Composition, Selection and Dismissal of a Shari’ah Supervisory Board

The Independence of the SSB

The IFSB states: "To safeguard the credibility and integrity of the Islamic

Financial Services industry at large and the Islamic Financial Institution in

particular, the professionalism and independence of the Shari'ah Scholars

must be upheld with the highest respect."

Practice

The rulings issued by the SSB will be binding on the Islamic Financial

Institutions. These rulings may also be made available to the public, and

Islamic Financial Institutions may also allow customers access to the rulings

issued by their SSB as part of their customer service.

Roles & Responsibilities of the Shari’ah Supervisory Board

1. The SSB will review and approve the legal and operational structure of the products. 2. The SSB is entrusted with the duty of directing, reviewing and supervising the activities of the

Islamic Financial Institution. 3. Provide a certificate (the “Compliance Certificate”) declaring the product/s to be in compliance

with Shari'ah. 4. Undertake a quarterly audit/review of the products to ensure its operational activities and all

investment transactions of the Islamic Financial Institution are in conformity to Shari'ah. 5. Attend the Shari'ah Board meetings. 6. Approve the allocation of profits and losses; including the Profit Equalization Reserve and the

Investment Risk Reserve. 7. Approve the calculation of impermissible income and its purification process. 8. To supervise and audit transactional procedures. 9. To supervise in the development of innovative Shari'ah-compliant investment and financing

products and services. 10. Issue a SSB report confirming that the SSB have conducted a Shari’ah review and the findings of

the review are outlined (normally incorporated in the annual report). 11. Supervising Islamic finance training for staff.

Products /Services Offered by Islamic Investment Banks

Sukuk (Islamic Bonds)

Private Equity and Venture Capital

Shari’ah compliant Equities

Liquidity Management/Money Market instruments

Islamic Bonds - Sukuk

Sukuk are often referred to as Islamic Bonds: Islamic investment instruments that are

registered in the name of their holders. Sukuk holder's funds are combined to obtain

profits. Sukuk holders not only have a right to revenue, but are also owners of the

underlying asset.

Sukuk holders would participate in the profits or losses of the investment

proportionate to their ownership of the assets. A Sukuk holder will also be exposed to

ownership risks. In its simplest form Sukuk is a certificate evidencing ownership of an

asset or its usufruct and was developed by Shari'ah experts for the express purpose of

answering the financial world’s demand for a Shari'ah compliant debt instrument.

Sukuk Al Ijaarah Structure

Company SPV Issuer

Trust Sukuk Holders

Sukuk

Cash

1

Re-purchase Agreement

Sells Sukuk assets

Cash

Lease

Lease Rental

Servicing/Managing Agreement

Independent Trustee

Beneficiaries 2

3

2

3

4

1

Cash Flow Considerations

1. The SPV Issuer [Trust] issues Sukuk to investors for cash..

2. The SPV Issuer [Trust] purchases the specified assets (the “Assets”) at a specified price and on a particular payment date. The SPV Issuer [Trust] takes possession and ownership of the Assets pursuant to a Sale Agreement. Exact title to be purchased will be dependent on Tax and Registration considerations

3. The Trustee of the SPV Issuer [Trust] will be an independent entity which will manage the Assets for the benefit of the Sukuk holders (who will be beneficiaries of the SPV Issuer [Trust])

4. The Company leases the Assets for a term corresponding to the tenor of the Sukuk. Lease rental is equal to the cost of credit for Borrower

5. The Company undertakes to service the Assets and to be responsible for maintenance/insurance

6. At maturity the Company agrees to re-purchase the Assets from the SPV Issuer [Trust] at a specified price. If an event of default occurs, then the Company will re-purchase the Assets and the proceeds will be distributed to the Sukuk holders , failing which, the Trustee will have a contractual claim against the Company through the Purchase Undertaking for the benefit of the Sukuk holders.

7. The Sukuk carry the Company risk and should be priced according to the Company’s current bonds.

Comparison between Sukuk and

Conventional Debt Securities

Sukuk

The Sukuk is a participation in the ownership of the company issuing the Sukuk.

Each Sakk (singular of Sukuk) represents an ownership of the underlying asset.

Sukuk holders have the right to profits but also bear losses.

Sukuk are proof/evidence of ownership or beneficial ownership of asset.

The maturity of a Sukuk corresponds to an underlying project or activity.

The Sukuk issue prospectus includes all the Shari'ah rules related to the

issue. The Sukuk manager is required to

abide by the Shari’ah rules

Conventional Debt Securities

The holder of securities does not incur the damages and losses suffered by the company. The rights of the securities holders are not linked to the assets of the company.

These securities represent a share in the financing process through usurious practices.

The term of the securities does not necessarily correspond to the term of the underlying project.

The issue prospectus does not include Shari’ah constraints.

Considerations of the ‘Sukuk Al Ijaarah’

The specifications of the specified assets should be clear and unambiguous

The purchase price and payment date from the issuer should be described fully. The purchase price could be paid immediately or on an instalment basis – based on timing of commissioning, funding is likely to be immediate.

The rentals to be paid by the Company to the SPV Issuer [Trust] should be agreed upon. The rentals could be variable with a floor and ceiling, but will be based on the costs of the SPV Issuer [Trust]. The rental could also be benchmarked to the interest rate

The SPV will remain the owner of the specified assets after installation until the end of the lease period, thereafter the Company will purchase via the purchase undertaking

The Company will undertake to purchase the specified assets at the end of the lease period

The operational expenses and routine maintenance will be the responsibility of the Company

Risks Solutions The SPV Issuer [Trust] remains the owner of the assets

for the entire duration of the lease period

The SPV Issuer [Trust] will have to insure the assets with a

Takaful company, or the Company will be appointed as an

agent to insure. The latter is the more likely solution

The Company defaults in lease payments This will trigger an Event of Default and will result in the

Company having to repurchase the assets under the purchase

undertaking failing which the Trustee will be entitled to realize

the assets and distribute the proceeds to the Sukuk holders

The specified assets depreciate in value The Company undertakes to re-purchase the assets at their

original purchase price. This is specified upfront when the

Sukuk are placed

Global Sukuk Market Update

30

Sovereign and quasi-sovereign issuers remain well-received by Sukuk investors

0

5

10

15

20

25

30

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

YTD

(US$bn) Sovereign / Quasi-sovereign Corporate Financial

Date Sovereign Size

(US$mn) Tenor (Years)

Asset Type Details

28 Jun 11 Malaysia 1,200 5

Combination Leasable assets, shares and Shariah compliant commodities 800 10

27 May 10 Malaysia 1,250 5 Building A selection of hospitals from a pool of 12

28 Oct 09 Dubai 1,250 5 Infrastructure Airfield infrastructure, storm water drainage system, Emirates Operations

Tunnels/ GSE Tunnels, others

22 Jul 09 Ras Al Khaimah 400 5 Road Road network with all construction made. King Faisal Road 1, 2, 3 and Muntasir

Road 4

09 Jun 09 Bahrain 750 5 Land Piece of land earmarked for industrial development in Hidd industrial area

16 Apr 09 Indonesia 650 5 Building Portfolio of government properties (including buildings, improvements and

fixtures)

07 Mar 08 Bahrain 350 5 Land Plot of land comprising a total area of 350,124 square metres and has an

extension of 652 x 537 metres

19 Jan 05 Pakistan 600 5 Road Lahore-Islamabad Motorway (including 32 km links and the Lahore Bypass)

28 Oct 04 Dubai 1,000 5 Airport Terminal 1, Airport Expo Center Complex and Dubai Cargo Village Complex

02 Jun 04 Bahrain 250 5 Land Part of the plot of land number 93567, Tabo No. 1986/4965

08 Oct 03 Qatar 700 7 Land Plot of land intended for the proposed development of Hamad Medical City

measuring approximately 337,540 square meters located in Doha, Qatar

23 Aug 02 Malaysia 600 5 Land Four parcels of land located in and around Kuala Lumpur, totaling 170.3 hectares

USD Sukuk Sovereign Transactions

Sukuk Market Commentary Sukuk Issuance by Issuer Type

Phenomenal growth in

the last decade

Sovereign and quasi-sovereign issuers remain well-received by Sukuk investors

The market is dominated by Malaysian issuers with a 65% market share followed by Middle East issuers with a 26% market share

Indonesia’s Sukuk market is also growing with a nominal amount of US$6.2bn as of May 2011 and an annual growth of 9.3% in 2010

Continued growth in this market is expected due to more attractive structures, ample liquidity in Asia and high oil prices fuelling another petrodollar boom in the Middle East

2011

Demand >

Supply

Robust Sukuk Pipeline

Timing Issuer Sukuk

Structure Country Currency Size (mn) Tenor

2011 Al-Amanah Islamic Investment Bank Al Ijaarah Philippines USD 1,000 5 years

2011 IDB Trust Services Limited Al-Wakala Saudi Arabia USD 600 -

2011 Islamic Bank of Thailand Unknown Thailand USD 150 5/7 years

2011 JBIC Murabaha Japan USD 150-200 7 years

2011 Government of Indonesia Unknown Indonesia USD 1,000 -

2011 Republic of Tatarstan Unknown Russian Federation USD - -

2011 Government of Palestine Al Ijaarah Palestinian Territories USD 50 -

2011 Saudi Electricity Company Unknown Saudi Arabia USD 1,000 – 1,500 -

2011 Masraf Al Rayan Unknown Qatar USD 1,000 -

2011 Al Baraka Banking Group Unknown Bahrain USD 300 5 Years

2011 VTB Bank Unknown Russian Federation USD 100 - 200 -

2011 Japan Bank for International Cooperation Sukuk Murabaha Japan USD 150 - 200 7 Years

2011 Bank Syariah Muamalat indonesia Unknown Indonesia USD 50 - 100 -

2011 Islamic Development Bank Al-Wakala Bel-

Istithmar Saudi Arabia USD 600 -

A wide range of issuers are looking to access the USD Sukuk market this year

Timing Sukuk Name Sukuk

Structure Country Currency Size (mn) Tenor

2011 Multi Nitrotama Kimia Al Ijaarah Indonesia IDR - -

2011 Adhi Karya (Persero) Murabaha Indonesia IDR 12 -

2011 Bank Pembangunan Daerah Sumatera Barat Murabaha Indonesia IDR 12 -

2011 Bank Mega Al Ijaarah Indonesia IDR 35 - 58 -

2011 Indonesia Comnets Plus Murabaha Indonesia IDR 12 -

Many Indonesian corporates are also exploring the IDR Sukuk market

Sukuk Pipeline for Africa

Tunisia

Algeria

Libya

Nigeria

Senegal

Kenya

South Africa

Egypt

Fundamental requirements for Private Equity and Venture Capital

1. Underlying asset/business should be compliant

Conventional financial institutions, which are interest based, including banks, insurance companies, brokerage and finance houses, leasing companies;

Gambling, gaming or casinos;

The manufacturing, packing and distribution or sale of non-Halaal food and beverages, particularly pork and alcoholic or other intoxicating products, restaurants and supermarkets are also analyzed;

Entertainment including cinemas, hotels, pornography, adult entertainment, publications and music, and the production or distribution or sale of such entertainment, such as television channels and radio stations;

The manufacturing and sale of weapons or military equipment,

The manufacturing, packing and distribution or sale of tobacco products (not universal);

Other immoral or unethical activities.

2. The contracts and underlying structure should be compliant

3. Appointment of Shari’ah Supervisory Board

Private Equity and Venture Capital Mudhaaraba

PROFITS

LOSSES

1

1

4

3

5

2

Private Equity and Venture Capital Musharaka (Partnership)

PROFITS

LOSSES

1

3

2

4

1

The Islamic Stock/ Equities Selection Process

This process comprises of two screens:

THE INDUSTRY

SCREEN

THE

FINANCIAL

SCREEN

The Financial Screen

AAOIFI Dow Jones F.T.S.E

Total interest bearing debt should be <

30% of the market capitalization

33% of the average market capitalization

Cash & interest bearing securities should be <

30% of the market capitalization

33% of the average market capitalization

33% of total assets

Liquid assets should be < 70% of total assets 45% of total assets

Accounts receivable should be < 33% of the average market capitalization

Interest and other impermissible income should be <

5% of total income

Liquidity Management / Money Market Instrument

Equity or Commodity Muraabaha

An Islamic fund manager is not permitted to create a portfolio of conventional debt

securities as they involve Riba. All types of conventional debt funds, such as bond

funds, money market funds etc, are impermissible for Islamic investors.

An Islamic alternative to debt funds may be developed; where funds are invested in

Muraabaha operations. After selling a commodity on Muraabaha, the purchase price

becomes a debt, which is specified. The returns on such a fund are therefore

predetermined, similar to a conventional debt instrument. The fund will bear the risk

of owning physical assets, though for a very short period.

Muraabaha Funds or Money Market Instrument

1

1 2 3

4

5

Thank you