sukuk structure risk islamic finance and systemic stability

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    Structural Risksin Sukuk designs

    Dr. Tariqullah Khan,

    Professor of Islamic Finance

    http://www.qfis.edu.qa/
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    Sukuk as engineered and

    structured products

    Architectssetting the principles,

    norms and guidelines (Shariah &

    legal scholars);

    Engineers - (product developers &

    arrangers)

    Plumbers - (other professionals)

    Influencersindependent

    scholars, Muftees, media

    Investors and users

    Ethical principles;

    Faith and social norms;Best practice standards;

    Operational

    guidelines and

    documentation

    Architectural

    Elements of design

    Architectural players

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    structural risks are totally

    undesirable

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    Narrow but

    stable

    Unstable but

    not narrow

    Noise among players increases vulnerability

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    Preconditions for

    structural/architectural stability

    Consensus among lead

    architectural players about

    key architectural elements

    Non-existence

    of noise

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    Noisy architecturalplayers

    and

    structural risk in thedesign of Sukuk

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    Promise to repurchase the Sukuk assets at

    the initial price is not permissible

    Noisy architectural players

    example 1

    Sukuk and their Contemporary Applications open source document 2007 by

    Muhammad Taqi Usmani, President of the AAOIFI Shariah Council

    Promise to repurchase the Ijarah Sukuk

    assets at the initial price is permissible

    AAOIFI Sukuk Resolution 2008

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    OIC Fiqh Academy

    Resolution No. 188 (2012) of OIC Fiqh Academy on the subject of Sukuk

    The issuer or the partner or the agent must not

    undertake any of the following: Purchase of sukuk or their

    assets in their nominal value or for a prefixed price so that

    it ensures the capital. -------------------

    The decisions issued by the Board come into effect from

    the time of its issuance and do not affect the previous

    contracts and from among them are the sukuk.

    Noisy architectural players

    example 2

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    Prospective Holders should note that differentShariah advisers, and Saudi courts and judicial

    committees, may form different opinions on identical

    issues and therefore prospective Holders may wish to

    consult their own legal and Shariah advisers to receivean opinion if they so desire.

    Noisy architectural players

    example 3

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    Structural basis of Financial

    Market Products

    Equity shares Bonds

    Ownershiprisk of the

    asset (price

    risk)

    Credit risk of

    the issuer &

    interest rate

    risk

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    Asset

    pricerisk

    Interest

    raterisk

    Credit

    risk

    Bond

    Equity

    Independent Shariah

    scholars

    Structural risk free Sukuk

    Sukuk

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    Asset

    pricerisk

    Interest

    rate

    risk

    Credit

    risk

    BondEquity

    Paid Shariah Advisors

    Structural risk free Sukuk

    Sukuk

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    Repurchase at

    initial price is

    required

    Repurchase at

    initial price is not

    permissible

    But noisy

    argument

    But firm

    argument

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    More noise No noise

    Independent

    Shariahscholars

    Paid ShariahAdvisors

    Lack of consensus on

    architectural

    elements

    Consensus on

    architectural

    elements

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    Sukuk Structural Riskbundled nature

    of credit, price and return risk

    Sukuk

    Credit

    risk

    Interest

    rate risk

    Asset

    price risk

    Bond

    Equity

    Consequence

    of disputes

    and noise

    between

    Shariah

    scholars

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    Can the market have this

    type of a product?Independent Shariah

    ScholarsNo, because it

    has credit risk and the rate

    of return risk is actually

    interest rate risk

    Paid Shariah Scholars

    No,

    because rating and pricing is

    not possible

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    Structural risk in Islamic bank

    financing

    Independent Team

    Murabahah

    financing is a

    genuine asset

    purchase

    Paid Team

    Tawaruq is acomprehensive

    financing

    mechanism

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    7% interest

    10% interestFinancing Scenario-1: If we make lending as the core

    commercial activity of banks, financing gets out of the real

    economy and this scenario is the real possibility as lending will

    be primarily based on ratings and credit risk.

    5% interest

    15% interest

    BANK Murabahah

    for asset

    $100Tawaruq

    $100

    Tawaruq

    $100

    Tawaruq

    $100

    Tawaruq

    $100

    Tawaruq

    20% interest

    $100 $100 $100 $100 $100

    Pitfall of Tawaruq

    $100

    Financing Scenario-2: If we make genuine Murabahah

    as the core business of banks, this scenario prevails,

    where financing cannot get out of the real economy.

    In this scenario, we can benefit from the advantages

    of the fractional reserve banking system but at the

    same time also avoiding the excessive and unhealthy

    credit creation by banks.

    Financing Scenario -3: But if we make non-genuine

    Murabahah like Tawaruq as the core business, this

    scenario prevails which is almost similar to Scenario -

    1, where financing gets out of the real economy.

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    Structural risks existbecause as if the key

    architectural players areonly independent and

    paid Shariah scholars

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    Structural risks causewealth losses as well as

    hamper growth anddepth of the Islamic

    capital markets

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    Avoiding structural risk

    an imperative for

    Islamic capital marketdevelopment

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    Avoiding structural risk

    for resilience andstability

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    Finance Ministers;

    Central Bank Governors;Islamic Bankers;

    Sukuk Issuers and dealersInvestors

    Independent scholars

    Key architectural

    players are actually

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    Looking ahead - Apex Islamic Finance

    Board is the need to avoid structural

    risks of industry

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    Do you know that Executive Education Program of QFIS offers:

    Course on Sukuk andIslamic Capital

    Markets?

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    Thank you

    tkhan@qfis.edu.qa

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