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Islamic Finance Within Conventional Banking System

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Islamic Finance Within Conventional Banking System Opportunities and Challenges 02 July 2010 III Astana Economic Conference By Musa Abdul Malek – PowerPoint PPT presentation

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Title: Islamic Finance Within Conventional Banking System


1
Islamic Finance Within Conventional Banking
System Opportunities and Challenges
02 July 2010
III Astana Economic Conference By Musa Abdul
Malek Executive Director and CEO HSBC AMANAH
Malaysia
2
CONTENTS
Overview of Islamic Finance



Islamic Finance Success Recipe
Models for Establishing Islamic Finance
Islamic Finance Window Operations
Challenges in Islamic Finance
3
OVERVIEW OF ISLAMIC FINANCE
4
OVERVIEW OF THE ISLAMIC FINANCE INDUSTRY
Each region is contributing in a unique
way with worldwide momentum from retail to
regulator involvement Examples Malaysias
Islamic Banking Act 1983 and the Banking
Financial Institutions Act 1989 are enacted as
separate statutes Kuwait adopted a new
regulatory framework for Islamic finance in 2003,
by introducing a new section into the Central
Bank Law of 1968
HIGH
LOW
Note Circle sizes denote estimated size of the
Islamic financial market in these respective
countries
Source HSBC Amanah, Illustrative Comparison
Model for the development of Islamic Markets and
Regulations
5
OVERVIEW OF ISLAMIC FINANCE
Islamic Finance In The Last 30
Years
  • Islamic finance has followed in the wake of
    innovations in the global financial services
    industry
  • A natural progression of the Islamic finance
    industry
  • competitive retail offerings
  • sophisticated corporate banking products
  • innovative project finance solutions

6
ECONOMIC GROWTH IN SOME GEOGRAPHIES
Prioritization Country Total Population (m) ( Muslim) GDP ( real change per annum)
Prioritization Country Total Population (m) ( Muslim) 2008 2009f 2010f 2011f 2012f
(Tier 1) Saudi Arabia 24 (99) 4.3 -0.1 3.9 5.9 5.2
(Tier 1) UAE 5.2 (76) 7.0 -1.2 4.3 6.4 6.1
(Tier 1) Malaysia 26 (60) 4.6 -3.8 6.3 6 6.0
Tier 2 Qatar 1.2 (77) 15.2 9.8 8.82 9.4 7.5
Tier 2 Bahrain 1.0 (98) 8.1 5.6 6.02 5.4 5.0
Tier 2 Pakistan 176 (97) 0.6 2.4 2.9 4 4.0
Tier 2 Indonesia 240 (88) 6.1 3.8 5.3 6.2 6.1
Tier 2 Brunei 0.4 (64) 0.61 na na Na Na
Tier 2 UK 61 (3) 0.7 -3.8 1.6 1.8 2
Tier 2 Bangladesh 29 (88) 6.22 6.02 6.22 6.5 6.4
Tier 2 Egypt 75 (85) 7.2 4.3 4.1 6.4 7
Tier 3 Turkey 77 (97) 1.1 -4.4 2.0 3.5 6
Tier 3 China 1300 (2) 9 8.5 9 8.5 8.5
Tier 3 India 1100 (13) 7.5 6 7.5 7.2 7.2
Tier 3 Iraq 29 (97) na na na na na
  • Of the total 1.6 billion Muslims globally, there
    are approximately 640 million in tier 1 2
    markets.
  • Today, there are more than 390 Islamic banks and
    institutions spread across 75 countries.

Source HSBC Group economic forecast.
INDUSTRY COMMENTATORS SEE ISLAMIC FINANCE
INDUSTRY CONTINUING ITS RAPID GROWTH
Total Global Islamic banking assets growth (USD
bn)
Banking Assets in key markets (USD bn)
13
CAGR 202
37
5
CAGR 28
13
640
4
7
2
1
Sources The Banker, Oliver Wyman 1 2007 2008
asset figures are based from The Banker 2
Oliver Wyman growth estimates
Note Key markets include Tier 1 and 2 markets
Source The Banker, Central Bank Reports
7
RISING ISLAMIC PENETRATION WITH GROWTH ACROSS
DIFFERENT INDUSTRY SECTORS
Islamic Retail Banking Assets (USD bn)
CAGR 22
Being validated bottom up with Countries
Source Oliver Wyman
Islamic Wholesale Banking Assets (USD bn)
CAGR 19
Source Oliver Wyman Note Wholesale includes
corporates, wealth funds and private clients.
Global Islamic Mutual Fund Assets (US bn)
Islamic Gross Takaful Contributions (USD m)
CAGR 12
CAGR 12
Source Ernst Young
Source Cerulli Associates Report
8
ISLAMIC FINANCE SUCCESS RECIPE
9
ISLAMIC FINANCE PROPOSITION Success Recipe
Success Recipe
  • Majority or good percentage of population are
    Muslim
  • Market have strong demand for Shariah proposition
    but no issue to consider conventional
  • Government resolute in pursuing Islamic finance
    agenda and introduce conducive regulatory
    framework eg. Tax, legal etc.
  • Central Bank able to regulate Islamic financial
    institutions
  • Decide and provide guidelines on Shariah issues
  • Treatment of balance sheet - segregating or
    co-mingling
  • Provide framework to support and regulate the
    institutions
  • One stop centre to resolve issues by industry
    players
  • Sufficient talent to manage the business both the
    Shariah scholars and practitioners

10
MODELS FOR ESTABLISHING ISLAMIC FINANCE
11
VARIOUS MODELS FOR CONSIDERATION
Stand Alone Islamic Finance
Comprehensive infrastructure to support the
business

License only to do Islamic finance business
Islamic Subsidiary
Leverage infrastructure
from the parent infrastructure
Separate Board of Directors
Subsidiary of the existing conventional in the
country
Supervise the operations to
ensure Shariah compliance
Using the main Bank
infrastructure to support
the business
Islamic window
Structure Islamic products for distribution by
conventional branches
A division within the existing conventional bank
12
ISLAMIC WINDOW OPERATIONS
13
ISLAMIC WINDOWS OPERATIONS
  • A division within the conventional bank
  • Preferably to be headed by a Muslim
  • Need to set up Shariah Committee and Shariah
    department to ensure business undertaken is
    Shariah compliance
  • Minimum to have own product development team and
    dedicated IT team
  • Sharing the same system platform tweak to meet
    with Shariah
  • Accounting treatment eg. penalty fee not
    compounded
  • Wordings on the statement and advises must be
    Shariah compliance
  • Leverage from existing infrastructure thus cost
    to do the business is lower
  • Preferable for the balance sheet to be separated

Windows Operations
14
ISLAMIC WINDOWS OPERATIONS
  • ADVANTAGES
  • Sharing the same infrastructure
  • Sharing the same system platform tweak to meet
    with Shariah
  • Cost to do the business is lower
  • Inclusive proposition
  • DISADVANTAGES
  • Always guided by the conventional banking way
  • Business requirements may conflict with Shariah
  • CHALLENGES
  • Awareness on Islamic finance amongst the internal
    customers is low
  • Shariah compliance to be the main driver for the
    business
  • Potential canabalising the conventional business

Windows Operations
15
CHALLENGES IN ISLAMIC FINANCE
16
CHALLENGES IN ISLAMIC FINANCE
Meeting evolving consumers demand
Challenges
Strategy and Plan to develop the right business
model
Comprehensive Shariah Governance Audit
Legal, Regulatory Accounting Framework
Information system to cater to Islamic Finance
transactions
Risk Management
Replication v. Authenticity
Willingness to invest in Human Capital Development
Wealth Management
17
SHARIAH GOVERNANCE AND FRAMEWORK
18
SHARIAH COMPLIANCE IS FUNDAMENTAL IN ISLAMIC
BANKING AND FINANCIAL INSTITUTIONS
IFSB
  • Islamic Financial Services Board (IFSB) Guiding
    Principles of Risk Management indicates
  • Shariah Compliance is categorised as higher
    priority in relation to identified risks and
  • There must be a comprehensive and sound Shariah
    Compliance framework and mechanism in place.

19
MEMORANDUM ARTICLES OF ASSOCIATION OF MOST
ISLAMIC FINANCE INSTITUTIONS PROVIDE
Compliance
The business of the Company will be transacted in
ACCORDANCE with the
Islamic Principles
Rules
Practices
In this respect, the Company is PROHIBITED from
carrying out any transactions which involve any
elements that are not in compliance with the
Islamic principles, rules and practices.
20
SHARIAH STRUCTURE
Shariah Committee
  • Term Of Reference of Shariah Committee
  • Rulings of Shariah Committee

Shariah Structure
  • Shariah Advisory Development
  • Shariah Compliance Review
  • Shariah Research

Shariah Dept
Internal Policies, Procedures, Guidelines,
Manuals, Matrix Certificates
  • Shariah Compliance Manual
  • Guidelines on the Shariah Committee
  • Shariah Compliance Certificate
  • Guidelines on Services Transactions

21
LEGAL, REGULATORY ACCOUNTING FRAMEWORK
22
LEGAL, REGULATORY ACCOUNTING FRAMEWORK
23
LEGAL FRAMEWORK Need a robust structure
  • Ensure compliant with Shariah but yet enforceable
    under applicable secular law
  • Current transactional practise with respect to
    existing legal opinion
  • - Different islamic jurisprudence interpret
    Shariah differently
  • - Lack of binding precedents and published
    decision
  • - Is Shariah compliance considered in
    judgement eg Zulkifli vs Affin Bank (Malaysia),
  • Investment Dar vs Lebanon Blom Bank
  • Untested certainty/predictability for Shariah
    compliant transactions in different jurisdiction
  • Willing to change to accommodate Shariah
    requirements eg. legal ownership over home
    financing if structure based on Ijarah or
    Musyarakah

Legal
24
REGULATORY FRAMEWORK Flexible yet decisive
  • Willing to change the act to accommodate Islamic
    Finance
  • - Land Code
  • - Tax issue eg. VAT, property gain tax
  • Propose to adopt tax neutrality

Regulatory
25
ACCOUNTING FRAMEWORK (AAOIFI vs IFRS)
  • AAOIFI
  • Develop the accounting, auditing and banking
    practices through relating to the activities of
    the Islamic Financial Institutions (IFIs)
  • Prepare, promulgate and interpret accounting and
    auditing standards for IFIs in order to harmonize
    the accounting practices and auditing procedures
  • Review and amend the accounting and auditing
    standard for IFIs to cope with developments in
    the accounting and auditing through practices

Accounting 1
26
ACCOUNTING FRAMEWORK (AAOIFI vs IFRS)
  • IASC Foundation and IASB
  • To develop a single set of high quality,
    understandable, enforceable and globally accepted
    international financial reporting standards
    (IFRS) through its standard-setting body of IASB
  • To promote the use and rigorous application of
    those standards
  • To bring about the convergence of national
    accounting standards and IFRS to high quality
    solutions
  • Main Differences AAOIFI and IFRS
  • AAOIFI
  • Specific for Islamic industry
  • Accounting, Auditing, Ethics, Governance Sharia
  • IFRS
  • Entire economic social activities
  • Specific to accounting

Accounting 2
27
ACCOUNTING FRAMEWORK (AAOIFI vs IFRS)
  • Consideration
  • Standalone and fully Islamic Group AAOIFI
  • Subsidiary with conventional parent IFRS
  • Window IFRS
  • Rationale for window to adopt IFRS
  • Consolidation
  • Accounting treatment eg. Unrestricted investment
    as a separate item instead of presented as
    liabilities (along with other liabilities) in
    IFRS

Accounting 3
28
RISK IN ISLAMIC FINANCE
29
RISK MANAGEMENT IS
Embedded within the conventional business risk
management framework
Shariah Risk Management
  • Non-compliance with Shariah rules and regulations
  • New product due diligence including
    simplification of product complexities
  • Application of Late Payment / Penalty for default
    in a Shariah compliance manner
  • Advise on debt restructuring
  • Changes in fatwa resulting in existing product
    being non-compliance
  • Advising / guiding with ongoing Shariah
    requirements
  • Credit Risk
  • Market Risk
  • Insurance Risk
  • Sustainability Risk
  • Liquidity Risk
  • Pension Fund Risk
  • Residual Value Risk
  • Reputation Risk
  • Operational Risk
  • Accounting
  • Business Continuity
  • Fiduciary
  • Fraud
  • Information
  • Legal
  • Compliance
  • Operations
  • People
  • Tax
  • Technology

30
MAJOR SHARIAH RISKS
ACTIONS
RISKS
Concentrated reliance on a single broker for
transacting commodity murabaha (substantial
Global Business is based on this structure)
Identification of new brokers required and find
alternative to existing commodity (eg. Bursa Al
Sila)
Major Risks
Untested legal infrastructure (case laws or court
proceedings) supporting products
Using experienced legal counsel for preparing
documentation and structures
Credibility of Commodity Murabaha / Tawarruq
structure questionable
Looking to diversify to other structures. To
address concerns raised.
Manual Processes increase operational risks
Rationalisation of product range. Long term,
automation and standardisation required
Lack of inter-bank market creates challenges in
matching assets and liabilities
This has to be addressed and financial linkages
required
31
Thank You
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