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An Introduction to Islamic Banking and Finance The history, role and future of Islamic Banking

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Title: An Introduction to Islamic Banking and Finance The history, role and future of Islamic Banking


1
An Introduction to Islamic Banking and Finance
The history, role and future of Islamic Banking
  • Warren Edwardes, ceo, Delphi Risk Management Ltd
  • Presentation to The Financial Services and
    Banking Department of the Dubai Men's College
  • at The Institute of Islamic Banking Insurance
  • London, 19th April 2004
  • Full article on http//dc3.co.uk/islamicbanking.h
    tm
  • Islamic banking news http// dc3.co.uk/ibnews

2
Quotes
  • Happy the man who far from schemes of business,
    like the early generations of mankind, ploughs
    and ploughs again his ancestral land with oxen of
    his own breeding, with no yoke of usury on his
    neck.
  • Roman philosopher, Horace
  • Julius Caesar limited interest to 8 1/3

3
Quotes
  • Neither a borrower nor a lender be For loan oft
    loses both itself and friend and borrowing dulls
    the edge of husbandry.
  • Shakespeares hamlet, a Danish father advising
    his son
  • UK usury laws on excessive interest abolished in
    1854
  • South Africa and US (except Virginia and
    Delaware) have usury laws

4
Quotes
  • Those who devour usury will not stand except as
    stands one whom the evil one by his touch hath
    driven to madness. That is because they say
    "trade is like usury but Allah hath permitted
    trade and forbidden usury.
  • The Koran Surah 2, verse 275

5
Latin Jargon used by lawyers
  • In haec verba
  • Verbatim
  • nunc pro tunc
  • Retroactive
  • Caveat emptor
  • Let the buyer beware

6
Greek Jargon used by derivatives dealers
  • Delta
  • Sensitivity of an option price to changes in the
    price of the underlying equity
  • Theta
  • Sensitivity of an option price to changes in time

7
Arabic Jargon used by Islamic bankers
  • Alwadiah
  • Safe keeping
  • Baimuajjal
  • Deferred-payment sale
  • Baisalam
  • Pre-paid purchase

8
Jargon Arabic - used by Islamic bankers
  • Ijara
  • Leasing
  • Muqarada
  • Mudaraba
  • Mudaraba
  • Profit-sharing

9
Jargon Arabic - used by Islamic bankers
  • Murabaha or Shirka
  • Cost-plus or mark-up
  • Musharaka
  • Equity participation
  • Qard Hasan
  • Benevolent loan (interest free)

10
Overview
  • Hallal vs. Haram
  • Not just about Hallal mutton curry but also about
    a way of life
  • This is including finance
  • Interest, usury, riba used interchangeably
  • Essentially three dimensions of Islamic products
  • Riba free - Profits and loss sharing PLS
  • Riba free - Mark up
  • Ethical dimension

11
Overview Profit Loss Sharing
  • Profit Loss Sharing
  • basically, no pain no gain
  • Venture capital, non-recourse project finance,
    equity investment vs lending
  • US / UK banking vs German, Japanese, Spanish
    banking

12
Overview - Markup
  • Mark up - predetermined profit.
  • Predominates 87 Pakistan, 63 Iran
  • Investors risk aversion
  • Borrowers protection of equity interests
  • Tax similarities - interest versus capital gains
    tax
  • Interpretations change
  • Treasury bills, foreign exchange, zero coupons,
    circular transactions.
  • Various jurisdictions / opinions
  • Gulf, Malaysia, London

13
Overview - Ethics
  • Ethical dimension - undesirable investments
    sectors
  • Tobacco
  • Alcohol
  • Armaments
  • Gambling
  • Charitable aspects
  • Interest donated to charity
  • Can the borrower afford to repay?
  • Faith does not mean soft option.

14
Brief History
  • 1963 Egypt interest free savings banks
  • Not overtly Islamic - invested in trade and
    industry
  • Share of profits
  • 1971 Egypt Nasr social bank
  • Still no overt reference to Islam
  • 1975 Islamic development bank
  • Jeddah. Conference of Islamic finance
    ministers1973
  • Fee based and PLS
  • Revolving capital

15
Brief History
  • 1970s Dubai Islamic bank, Faisal Islamic bank
    of Sudan / Egypt, Bahrain Islamic bank
  • Malaysia, Philippines, Nigeria, Indonesia
  • Islamic finance house, Luxembourg, DMI Geneva, Al
    Rajhi London
  • Denmark, Australia, south Africa
  • HSBC Amanah fund, ANZ first ANZ International
    Murabaha ltd., IBU of United Bank of Kuwait.

16
Riba is more than Usury
  • US, South Africa, UK
  • Excessive interest
  • Early repayment penalty
  • Active vs passive lending
  • Pawn broking / money lending vs modern banking.
  • No distinction between fair and unfair interest
  • Trade is allowed
  • Repayment only if borrower is able to?

17
Why?
  • Pork etc.
  • Property rental - Hallal
  • Real benefit, wear and tear
  • Capital rental - Haram
  • Gold for gold, barley for barley Inflation
    indexed?
  • Equity/debt hybrid profit sharing? Undated
    preference shares? Section 233 loans?
  • Unearned income taxed at 97 in the UK

18
Key Islamic Financial Instruments PLS
  • Mudaraba / Modaraba
  • PLS no pain no gain
  • Rabbulmal - capital provider / investor
  • Mudarib - entrepreneur / borrower
  • Profits split between Rabbulmal and Mudarib as
    agreed
  • Losses only to financier.
  • Looks like non-recourse project finance

19
Key Islamic Financial Instruments PLS
  • Shirka
  • Generalised Mudaraba
  • More than 2 parties
  • Non contractual - Al Milk,
  • Contractual Ul Uqud
  • Looks like syndicated non-recourse project finance

20
Key Islamic Financial Instruments PLS
  • Musharaka / Mosharaka
  • Equity investing
  • Limited partnership
  • Profits distributed according to pre-agreed
    formula
  • Fair share of profits? 95 to investor?
  • Looks like normal equity investments or fund
    management
  • Sounds like shares
  • Loss sharing? Limited liability to investment.

21
Key Islamic Financial Instruments PLS
  • Al- Wadiah
  • Retail savings account
  • Cheque books bill payments, credit cards etc.
  • Dividend paid subject to profits through the year
  • Only profits no loss of capital
  • Short term accounts
  • Looks like with profits bonds
  • Other retail
  • Prizes, gifting of interest to charity, no
    transaction fees

22
Key Islamic Financial Instruments Mark-up
  • Murabaha / Morabaha
  • Mudaraba / Musharaka on bank liability side
  • Murabaha / Morabaha on asset side.
  • Locked-in return
  • Bank buys asset on behalf of client / borrower
    and then sells it for deferred payment
  • Title transfers at outset or on payment at
    maturity
  • Interest into capital gains? Use of Libor
  • Sounds like Repo a sale and repurchase agreement

23
Key Islamic Financial Instruments - mark-up
  • Baimuajjal
  • Property financing on a deferred basis
  • Payment in instalments or lump sum with mark-up
  • Predetermined profit.
  • Ijara
  • Leasing type transaction
  • Title stays with lessor
  • Option to buy goods on maturity of contract
  • Ijara wa iqtina is renting then purchase

24
Key Islamic Financial Instruments - Mark-up
  • Baisalam
  • Manufacturers financing of production
  • Bank buys and pays for goods at a discount before
    manufacture
  • Commodity futures contract? A derivative?
  • Similar to Bankers Acceptance BAs
  • Al Bay Bithaman Ajil
  • BBAs popular in Malaysia
  • Financing sales by deferred instalments
  • Trade not debt

25
Key Features of Islamic Banking
  • Interest free
  • Trade related and perceived need for funds
  • Pure form of Islamic Banking? - equity related
  • Avoids exploitation - no usury
  • Ethical investments
  • Alcohol, tobacco, gambling, armaments,
    pornography etc

26
European Retail Islamic Banking
  • mainly high net worth
  • 7 million Muslims in Europe
  • 1.2 Mio UK, 3 Mio France, 2.9 Mio Germany
  • so why minimal penetration?
  • Poor image, Mystery, Risk aversion, tax issues.

27
Conclusion
  • Growth market for strongly capitalised banks
  • Islamic investors are risk averse
  • Aware of rating agencies
  • Top banking brand names such as HSBC, ANZ, UBK
    have an advantage - I believe
  • But local banks need to try harder with
    relationship and innovation
  • Speech not about economics or social science
  • Idea is to encourage growth and achieve
    reasonable profit for capital invested
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