Introduction to Islamic Banking and Finance: Principles and Practice M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni - PowerPoint PPT Presentation

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Introduction to Islamic Banking and Finance: Principles and Practice M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

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Title: Introduction to Islamic Banking and Finance: Principles and Practice M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni


1
Introduction to Islamic Banking and Finance
Principles and PracticeM. Kabir Hassan, Rasem
N. Kayed, and Umar A. Oseni
Chapter 7Islamic Bonds
2
Learning Objectives
  • Upon the completion of this chapter, the reader
    should be able to
  • 1. Understand what sukuk is, its historical
    origin and benefits, and the distinguishing
    features of sukuk from conventional bonds
  • 2. Understand how Islamic bonds are structured,
    and distinguish between different types
  • 3. Be familiar with the AAOIFI standards on
    Islamic bonds, and the characteristics of
    investment sukuk and Shariah rulings defined by
    these standards
  • 4. Differentiate between sovereign and corporate
    ratings of Islamic bonds, and the methodology
    used to rate products

3
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • Sukuk an Arabic term for financial certificate
    it is the Islamic equivalent of bond
  • Sukuk asset-backed instruments, and tradable
    Shariah compatible trust certificates
  • AAOIFI defines Sukuk as
    Certificates of
    equal value representing undivided shares in the
    ownership of tangible assets, usufructs and
    services or (in the ownership of) the assets of
    particular projects or special investment
    activity (AAOIFI 2008, p. 307)
  • The IFSB defines Sukuk in its Capital Adequacy
    Standard (IFSB-2) as certificates that represent
    the holders proportionate ownership in an
    undivided part of an underlying asset where the
    holder assumes all rights and obligations to such
    asset

4
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • A Brief History of Sukuk
  • Sak, the singular form of sukuk was used to
    refer to documents or certificates representing
    obligations, contracts, conveyances of rights
    executed in conformity to the principles of
    Shari'ah
  • The earliest usage of the sukuk receipts relates
    to the method of payment of the soldiers during
    the Umayyad Caliphate in the 1st century of the
    Islamic calendar where soldiers were given
    commodity coupons in place of cash
  • During the medieval period, sak was used as the
    main instrument for transferring obligations
    arising from commercial transactions, thus
    reducing movement of cash between cities

5
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • A Brief History of Sukuk
  • In the modern practice of Islamic finance, sak is
    used to provide alternative funding for financing
    projects through asset securitization
  • The Islamic Fiqh Academy of the Organization of
    Islamic Cooperation (OIC) ruled for legitimacy of
    the concept of sukuk

6
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • Benefits of Sukuk
  • 1. Among the best ways of financing large
    enterprises beyond the ability of a single party
    to finance
  • 2. Provide an ideal means for investors seeking
    to deploy streams of capital and at the same time
    are able to liquidate their positions with ease
    should the need arise
  • 3. Manage liquidity for banks and Islamic
    financial institutions
  • 4. A means for the equitable distribution of
    wealth

7
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • Advantages of Sukuk include
  • Diversification of fund sources
  • Secondary liquidity
  • Creation and enhancement of profile on the
    international market
  • Infrastructural development in Muslim countries
  • Pricing benchmark
  • Sizeable financing

8
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • Differences Between Sukuk and Conventional Bonds
  • 1. Conventional bonds are contractual debt
    securities, while sukuk represent the undivided
    ownership of each of the sukuk holders in the
    underlying asset
  • 2. Returns in conventional bonds comes in
    interest (coupon) and the principal amount
    whereas in sukuk, the return is in profits
  • 3. In conventional bonds, the contractual
    relationship between issuer and investor is
    debt/credit, while it is a partnership
    relationship in sukuk

9
What are Sukuk?
Learning Objective 7.1 Understand what sukuk is,
its historical origin and benefits, and the
distinguishing features of sukuk from
conventional bonds.
  • Differences Between Sukuk and Conventional Bonds
  • 4. Sukuk holders have ownership rights in the
    underlying asset, while conventional bonds
    merely represent a debt certificate
  • Sukuk must be asset-backed, while conventional
    bonds may be backed by financial assets such as
    receivables, which are not allowed in the case
    of sukuk
  • (Refer to Table 7.1 in the text book for major
    differences between Sukuk and Bonds)

10
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Types and Structure of Islamic Bonds
  • Sukuk can be of many types depending on the types
    of Islamic finance products used in its
    structuring
  • AAOIFI identified fourteen major sukuk-structured
    products (Table 7.2 in the textbook)
  • Sukuk have been classified as
    - Tradable
    sukuk
    - Non-tradable sukuk
    - Debt
    based suluk
    - Equity based
  • (Refer to Table 7.3 of the textbook for
    classification of sukuk according to types)

11
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • The Most Common Investment Sukuk
  • Mudarabah Sukuk (Trust Investment Bonds)
  • Musharakah Sukuk (Partnership Investment
    Bonds)
  • Ijarah Sukuk (Leased Asset Bonds)

12
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • The Fourteen Sukuk Structures of AAOIFI
  • 1. Sukuk ijarah (leased assets certificates)
  • 2. Sukuk ijarha mausufa bi dhima (forward lease
    certificates)
  • 3. Sukuk manfaa ijarah (usufruct of a lease
    certificate)
  • 4. Sukuk manfaa ijarah mausufa bidhima (usufruct
    of a forward lease certificate)
  • 5. Sukuk milkiyat-al-khadamat (ownership of
    services certificates)
  • 6. Sukuk al-salam (forward contract certificates)
  • 7. Sukuk al-istisnaa (manufacturing certificates)

13
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • The Fourteen Sukuk Structures of AAOIFI
  • 8. Sukuk al-murabahah (cost-plus certificates)
  • 9. Sukuk-al-musharakah (partnership certificates)
  • 10. Sukuk al-mudarabah (trustiInvestment
    certificates)
  • 11. Sukuk al-wakalah (investment agency
    certificates)
  • 12. Sukuk al-muzraa (sharecropping certificates)
  • 13. Sukuk al-musaqa (irrigation certificates)
  • 14. Sukuk al-mugharasa (agricultural
    certificates)

14
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Structuring of Islamic Bonds
  • The replication of conventional bond features
    excluding characteristics impinging on
    fundamental principles of Shariah in commercial
    transactions e.g. prohibition of riba and gharar
  • The process of modelling and structuring Islamic
    bonds requires basic knowledge of major Islamic
    finance products e.g. mudarabah, musharakah,
    ijarah, murabahah, wakalah
  • Islamic finance experts developed, modeled and
    structured finance products through Islamic
    financial engineering

15
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Mudarabah Sukuk (Trust Investment Bonds)
  • Investment sukuk representing ownership of units
    of equal value in the Mudarabah equity
  • Registered in the names of the sukuk holders on
    the basis of undivided ownership of shares in the
    Mudarabah equity
  • Usually structured as an agreement between the
    rabb al-mal who provides the capital and the
    entrepreneur which may be an investment company
    or a Special Purpose Vehicle (SPV)
  • Returns shared in accordance with the percentage
    of share ownership of each sukuk holder
  • Losses are borne by financiers but necessary
    measures mitigate risks (through the process of
    securitization)

16
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Basic Features of Mudarabah Sukuk (MS)
  • As articulated in the Resolution of the
    Islamic Fiqh Academy of the OIC in its fourth
    session in 1988
  • 1. Mudarabah Sukuk (MS) represent common
    ownership and entitle holders to share in
    specific projects against which the MS have been
    issued
  • 2. Contract based on the official notice of the
    issue or the prospectus, which must provide all
    information required by Shariah for a Qirad
    contract
  • 3. The MS holder is given the right to transfer
    the ownership by selling the sukuk in the
    securities market at his/her discretion

17
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Basic Features of Mudarabah Sukuk (MS)
  • The sale of MS must follow the rules listed
    below
  • -If mudarabah capital is in money, the trading
    of MS will be like the exchange of money for
    money and it must satisfy the rules of Bai al
    Sarf
  • -If the mudarabah capital is in debt, it must be
    based on principles of debt trading in Islamic
    jurisprudence
  • - If capital is a combination of cash,
    receivables, goods, real assets and benefits,
    trade must be based on the market price evolved
    by mutual consent

18
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Basic Features of Mudarabah Sukuk (MS)
  • 4. The manager/SPV who receives the funds
    collected from the subscribers to MS can also
    invest his/her own funds
  • 5. Neither prospectus nor MS should contain a
    guarantee, from the issuer or the manager of the
    fund, for the capital or a fixed profit, or a
    profit based on any percentage of the capital
  • Accordingly
  • (i) the prospectus, or the MS issued pursuant to
    it, may not stipulate payment of a specific
    amount to the MS holder (ii) profit is to be
    divided, as determined by applying the rules of
    Shariah
    (iii) the profit
    and loss account of the project must be
    published and disseminated to MS holders

19
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Basic Features of Mudarabah Sukuk (MS)
  • 6. It is permissible to create reserves for
    contingencies, such as loss of capital, by
    deducting from the profit a certain percentage in
    each accounting period
  • 7. The prospectus may also contain a promise made
    by a third party, to donate a specific sum,
    without any counter benefit, to meet losses in a
    given project, provided such commitment is
    independent of the Mudarabah contract
  • (The Resolution of the Islamic Fiqh Academy of
    the OIC in its fourth session in 1988)

20
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Figure 7.1
  • Structure of
  • Mudarabah Sukuk

21
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Steps Involved in the Structure of Mudarabah
    Sukuk
  • A company which needs liquidity establishes an
    SPV
  • The SPV issues sukuk certificates to
    investors/sukuk subscribers
  • Cash generated used as capital in Mudarabah
    contract between SPV and an organisation
    appointed to manage the business
  • The Mudarabah business is carried out and profits
    are periodically distributed among the two major
    parties the company and the SPV
  • The SPV pays the investors/sukuk holders
    according to the units of their individual shares
    in the invested capital

22
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Musharakah Sukuk
  • Musharakah Sukuk are investment bonds which
    represent the ownership of the partnership equity
  • Musharakah Sukuk can be used for the mobilization
    of funds for new project, develop an existing
    project or finance a huge business activity based
    on joint venture contracts
  • The Musharakah certificate given to all sukuk
    holders represent their proportion of ownership
    in the assets of the project being undertaken
  • The Musharakah certificates are treated as
    negotiable instruments which are tradable in the
    secondary market they can be bought and sold in
    the capital markets

23
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Musharakah Sukuk
  • The structure of a Musharakah Sukuk is based on
    the joint venture partnership
  • Profit is shared according to an agreed
    predetermined ratio
  • Any loss is shared according to the individual
    contribution of the parties/sukuk holders
    involved
  • Every subscriber is entitled to participate in
    the management of the business if he or she
    wishes

24
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Insert Figure 7.2
  • A Musharakah Sukuk Structure

25
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Ijarah Sukuk
  • Ayub (2007, pp. 400-401) defines ijarah sukuk as
    the securities representing ownership of
    well-defined and known assets tied up to a lease
    contract, rental of which is the return payable
    to the sukuk holders
  • The contract of ijarah has been
    - Structured
    and transformed as a competitive bond in the
    secondary market
  • - Structured to allow the mobilisation of funds
    for development of long term infrastructure
    projects via the issuance of ijarah sukuk
  • - Used as securitization of a tangible asset
    e.g. a hospital or airport

26
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Different Variations Ijarah Sukuk
  • 1. Sukuk of ownership in leased asset
  • - It is issued with the sole aim of selling the
    asset to the sukuk holders through the transfer
    of title
  • - The sukuk holders jointly own the asset
    through undivided ownership and are entitled to
    profits and losses accordingly
  • - This form of ijarah sukuk can be used for the
    purchase of a new asset

27
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • 2. Sukuk of ownership of usufructs of assets
    - It is issued to conferring the right of
    usufruct in the sukuk holders where they become
    joint owners
  • - The sukuk holders only become owners of
    usufruct (manfaa) of the assets since the
    owners of asset have leased its usufruct to the
    sukuk holders
  • - Sukuk holders can also sublease the usufruct
    of the asset to a third party
  • 3. Sukuk of ownership of services
    - Issued to
    subscribers to confer the ownership in such
    services to the sukuk holders
    - The sukuk holders may also
    sublease such services to a third party

28
Structuring Islamic Bonds
Learning Objective 7.2 Understand how Islamic
bonds are structured, and distinguish between
different types
  • Figure 7.3
  • Ijarah Sukuk Transaction

29
AAOIFI Standards for Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • Characteristics of Investment Sukuk
  • Certificates represent the rights and obligations
    of the owner
  • Common share in the ownership of the underlying
    asset
  • Shari'ah compliance
  • Trading of investment sukuk and the rights they
    represent
  • Return and losses are commonly shared by
    certificate holders

30
AAOIFI Standards for Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • Shariah Rulings and Requirements
  • Shariah rules and requirements contained in
    AAOIFI Standards of sukuk are classified into two
    categories
  • - Shariah requirements in the issuance of
    investment sukuk
  • - Shariah rules in trading in investment sukuk

31
AAOIFI Standards for Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • Significant AAOIFI Pronouncement on Sukuk in 2008
  • Guidelines on sukuk issued earlier by AAOIFI have
    generated controversy among Shariah scholars,
    market players and investors
  • The AAOIFI Pronouncements on sukuk in 2008
  • - Do not stand as substitutes for the earlier
    guidelines - They are merely
    clarifications/directives on guidelines to avoid
    misapplication of requirements for issuance of
    investment sukuk and the Shariah rulings for
    their trading in the Islamic capital markets

32
Rating of Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • Ratings of Islamic Bonds
  • Bond credit rating is the assessment of the
    credit worthiness of a corporations debt issues
    or government bonds. The designated grades range
    from AAA which is considered as the highest
    grade to C
  • Credit rating allows potential investors to make
    informed decisions before subscribing to debt
    securities.
  • There are over 50 rating agencies that have been
    established across the world. The leading global
    rating agencies include, Moody's Standard
    Poor's, and Fitch Rating of Islamic Bonds

33
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Ratings of Islamic Bonds
  • Different countries have their own rating
    agencies, such as Malaysia, India, Bangladesh,
    and Sri Lanka
  • The two popular classifications of bonds while
    rating their quality are
  • - investment grade bonds
    - junk bonds
  • The Islamic International Rating Agency (IIRA)
    which was established by the IDB began operations
    in 2005 and has since been striving to ensure
    quality in the Islamic finance industry

34
Rating of Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • Types of Islamic Bonds Ratings
  • Islamic bonds can be rated on two bases
    -
    Sovereign
    - Corporate
  • First Sovereign Ratings
  • Sovereign credit rating is the credit rating of a
    sovereign entity such as a national government
  • The risk level of the regulatory, political,
    economic and legal atmosphere comprises a crucial
    factor in sovereign credit ratings  

35
Rating of Islamic Bonds
Learning Objective 7.3 Be familiar with the
AAOIFI standards on Islamic bonds, and the
characteristics of investment sukuk and Shariah
rulings defined by these standards.
  • In the country risk rating, Euromoney Country
    Risks consider the following factors in the
    ranking of countries by risk

    - Political risk
  • - Economic performance/projections
  • - Structural assessment
  • - Debt indicators
  • - Credit Ratings
  • - Access to bank finance
  • - Access to capital markets

36
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • IIRA Ratings
  • The six basic categories used by IIRA in
    analysing sovereign sukuk and the likelihood of
    any default on debt obligations at maturity are
  • - Politics and Policy Continuity
  • - The EconomyStructure and Growth Prospects
  • - Budgetary and Fiscal Policy
  • - Monetary Policy and Flexibility
  • - The External Accounts
  • - Internal and External Debt

37
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Figure 7.4
  • First Page of IIRA Sovereign Ratings of Turkey
    in 2008

38
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Types of Islamic Bonds Ratings
  • Corporate credit rating is a credit worthiness
    rating in form of financial indicator to
    potential investors of debt securities such as
    sukuk
  • Corporate credit ratings play a significant role
    in the economy of a country and, more
    importantly, it promotes stability and
    sustainability in the financial industry
  • The level of risk surrounding a business entity
    determines the confidence prospective investors
    will have in it
  • Corporate entities must adopt best practices
    (reducing their risk level, demonstrating
    ability to meet financial obligations)

39
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • In the Islamic financial markets, corporate
    ratings involve
  • - Bond/sukuk ratings
  • - Banks financial strength ratings
  • - Shariah quality ratings
  • - Corporate governance ratings
  • - Real estate ratings etc

40
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Rating Products and Methodology
  • The rating products in Islamic financial markets
    consist of all types of issuers and sukuk issues.
    The IIRA identified the following eight major
    rating products
  • - Sovereign Ratings
    - Issuer Ratings

    - Bond/sukuk Ratings
    - Insurer
    Financial Strength Rating
    - Banks Financial Strength Rating

    - Shari'ah Quality Ratings
    - Corporate
    Governance Ratings

    - Real Estate Ratings

41
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Sovereign Ratings
  • A reliable third party gives an opinion on the
    feasibility of the repayment of the issuer or an
    issue of its financial obligations within the
    record time
  • The general rating of countries as sovereign
    entities is first carried out before the rating
    of particular issue or institution
  • Methodology
  • Involves both qualitative and quantitative
    factors
  • Assessing the likelihood of default on debt
    obligations for sovereign sukuk

42
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • IIRA considers the following six analytical
    categories while assessing the likelihood of
    default on debt obligations for sovereign sukuk
  • - Politics and Policy Continuity
  • - The EconomyStructure and Growth Prospects
  • - Budgetary and Fiscal Policy
  • - Monetary Policy and Flexibility
  • - The External Accounts
  • - Internal and External Debts

43
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Issuer Ratings
  • Rating sukuk issuer with special emphasis on
    ability to fulfill its financial obligation
  • Non-financial organs such as the corporate and
    Shariah governance of the entity from the
    bond/sukuk ratings
  • Methodology
  • In rating the issuer
  • - Non-financial organs rated with particular
    regards to credit worthiness and continued
    ability to fulfil debt obligations to
    stakeholders
  • - Overall financial and institution credit
    worthiness of issuer determines level of
    investors confidence potential

44
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Bond/Sukuk Ratings
  • Rating of sukuk in financial markets is as
    important to investors as to the issuer
  • Investors aspire to receiving dividends in a
    timely manner after subscribing to sukuk
  • Methodology
  • Documented terms and covenants of the issued
    sukuk are evaluated and the risk/return is
    measured
  • Viability of such sukuk in the secondary market
    will proportionally increase the number of
    subscribers

45
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Insurer Financial Strength Ratings
  • Financial strength of the insurer of the sukuk
    will help in avoiding or mitigating risks
  • Insurer of the sukuk must have corporate ability
    and requisite financial strength to meet
    contractual obligations
  • IIRA aims to be a source of reliable information
    and ratings, encouraging growth of a financially
    strong insurance industry
  • IIRA believes it has a vital role encouraging
    prudent management of insurance companies and
    improving the industrys strength for the benefit
    of all stakeholders

46
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Insurer Financial Strength Ratings
  • Methodology
  • IIRA assesses

    - The current financial strength and the
    sustainability of such financial strength of the
    insurance company
  • - The capability of the insurance company to meet
    the obligations of the policy holders and other
    contract holders such as the shareholders
  • Qualitatively, the country risks of the domicile
    of such company as well as its business profile
    are analysed

47
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Banks Financial Strength Rating
  • IIRA adopts global financial practices in rating
    both Islamic and conventional financial
    institutions
  • The main issues in banks financial strength
    ratings is investment quality and credit
    worthiness
  • The key subject headings in IIRAs asset quality
    analysis are - Banking Environment
    - Credit or
    Investment Policies and Loan Administration
    Procedures
    - Portfolio
    Composition and Characteristics
    - Risk Management
    Practices
    - Lending History and Performance
    - Forecasting the
    portfolio and quality
    - Analytical conclusions regarding economic
    values

48
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Banks Financial Strength Rating
  • Methodology
  • Fundamentals for assessment of banks financial
    strength
  • - Market assessment
    - Consideration of
    factors determining asset quality
    - Liquidity and fund management
    - Asset/Liability
    management
    - Capital adequacy
    - Adjustments to
    achieve economic reality
    - Finance, information systems, planning
    disciplines- Earnings Performance

    - Ownership and management performance,
    reflecting all the above

    - Emphasis on ability of financial institution to
    make profits and pay dividends

49
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Shari'ah Quality Ratings
  • Seek to assess the level of Shariah compliance
    of Islamic financial institutions, corporate
    entities or conventional financial institutions
    offering Islamic financial services or products
    such as sukuk
  • The Shariah quality rating aims at informing the
    investing public on the level of compliance of
    certain corporate entities with the requirements
    of the Shariah

50
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Shari'ah Quality Ratings
  • Methodology
  • Assessing levels of compliance of financial
    institutions or corporate entities with the
    requirements of the Shariah
  • - Authentication of products and services
  • Safeguards against comingling of funds in the
    case of an Islamic window or branch of a
    conventional financial institution
  • Code of ethics adopted by the institution
  • Policy of the calculation of profit or loss and
    the consequent sharing of same

51
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Corporate Governance Ratings
  • Prospective investors consider the ratings of
    corporate governance/corporate entities before
    investing
  • IIRA issues an independent opinion of available
    managerial structure and practices though variety
    of characteristics e.g.

    - Transparency and adequate disclosure
    - History,
    board performance, demonstrated trustworthiness

    - Management who is the actual
    governor (CEO or executive team)

    - Effectiveness the top management team/process

    - Shareholders

52
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Corporate Governance Ratings
  • Methodology
  • Best practices in the corporate governance rating
    of corporate entities are used as benchmarks for
    assessment rather than using standards of
    particular country/jurisdiction
  • The level of fairness, transparency,
    responsibility and accountability are considered
    key in the evaluation process
  •  

53
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Real Estate Ratings
  • IIRAs rating on real estate pertains to the
    overall rating of the developer and is not a
    rating of a particular project unless a specific
    project rating is requested
  • The rating is assigned after taking into
    account
  • - Market characteristics
  • - The organizational structure and management
    quality of the developer
  • - Assessment of each of the projects in the
    portfolio the developer is executing

54
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Real Estate Ratings
  • Methodology
  • The real estate rating methodology designed by
    IIRA aims at providing the stakeholders with a
    balanced view of the strengths and weaknesses of
    the developer and to create a healthy environment
    in the industry
  • IIRA will analyze all on-going projects of the
    developer and arrive at an overall rating of the
    developer
  • The developers activities such as the
    performance of its architects, engineers,
    contractors, and other necessary personnel are
    rated accordingly

55
Rating of Islamic Bonds
Learning Objective 7.4 Differentiate between
sovereign and corporate ratings of Islamic bonds,
and the methodology used to rate products
  • Rating Symbols and Definitions
  • Rating agencies convey respective opinions or
    decisions to the investors and other stakeholders
    through the use of symbols
  • Level of credit worthiness or the grade is
    determined by certain symbols
  • The IIRA has two major categories of rating
    symbols - The International Scale
    Ratings focuses on foreign- currency debt,
    external account liquidity, and factors
    affecting a countrys balance of payment
  • - National Scale Ratings emphasises on the
    capacity of a government and other institutional
    borrowers within a country to meet their local
    currency debt obligations

56
Key Terms and Concepts
  • Corporate credit rating
  • Equity-based sukuk
  • Debt-based sukuk
  • Foreign direct investment
  • Ijarah
  • Islamic capital market
  • Islamic financial engineering
  • Junk bonds
  • Mudarabah Sukuk
  • Mudarib
  • Negotiable sukuk
  • Non-tradable sukuk
  • Rabb al-mal
  • Riba
  • Secondary market
  • Sovereign credit rating
  • Sukuk
  • Tradable sukuk
  • Trust certificate
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