Doha Chapter of The Institute of Chartered Accountants of India

Demystifying Islamic Banking

Agenda

• Basic Principles of Islamic Banking

• Young but Fast Growing

• Common Misconceptions – Myths

• Islamic Banking – Products

• Regulatory bodies

• Opportunities & Challenges

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Islamic Finance is the outcome of CSR derived from religion and applied to
banking

Co esp
rp on
e

R
at ce

or si
Accountability to God r

at bi
o
rp nan

e S lit
“More-than-profit”
o
C ver Ethical

oc y
mentality

ial
go
profits
(rather than “profits-at-
any-costs”)

Business ethics

Shari`a “code of ethics”

Islamic Finance is capitalism with a moral compass

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Basic Principles of Islamic Banking

Islamic Finance principles consist of core basic tenets

1 If something is immoral, one cannot profit from it

2 To share reward, one must also share risk

3 One cannot sell what one does not own

In any transaction, one must clearly stipulate what

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he or she is buying or selling and what price is being
paid

Removing speculation and creating value-enhancing and sustainable activity

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The industry has developed a comprehensive product offering over its young
history
Development of industry Evolving richness in products

− Development of theoretical framework

1950s − Muslim-majority nation independence structured
products Debt issues
− Egypt and Malaysia pioneering institutions
60s − Establishment of OIC (1969)
insurance
− Islamic Development Bank (1974) and DIB 2000s 1970s
70s − One country-one bank setup
private
− Advancement of Islamic products equity
80s 1990s 1980s
− Full “Islamization” of Iran, Pakistan and Sudan syndications

90s − Entry of global institutions e.g. HSBC Amanah project

− Tipping point reached in some markets
finance structured
00s − Development of industry-building institutions
equity and trade finance

Industry has near like-for-like parity with conventional offering

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In all, the Islamic finance industry is developing a global reach…

Growth Engine

Awakening

Ripe for Growth

Future Markets Source: Standard and Poor’s “The Globalization of Islamic Finance”

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Growing Islamic Banking Share

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Why Islamic financing is flourishing

Strong growth of
GCC economies

Development of Innovative product

Islamic capital markets development
EXPLOSIVE GROWTH
OF ISLAMIC FINANCE
Liberalisation of Market developments
capital markets urging countries and customers
to diversification

Retail customer
commitment

Industry is driven by fundamental factors

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Right positioning and definition of Islamic banking

Banking and finance needs

Standard contracts
Principles sources
– Musharaka (Partnership)
– Religious basic
sources – Mudaraba (Fund management)
– Murabaha (Purchase-resale)
Principles filter
– Ijara ( Lease)
– Istisna’ ( Manufacturing contract)
– Salam -(Forward sale)

Islamic banking and finance solutions

• Prohibition on: • Prohibition of certain investments: • Asset-backed • Credit and debt

– Interest − Sectors (e.g.: alcohol, armaments transactions with products are not
etc.) investments in encouraged
– Speculation − Instruments (e.g. Leveraged real, durable
interest products, toxic assets type assets
of derivatives etc.)

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Common Misconceptions “ Myths”
l Practice exclusive to Muslims, modes exclusive to Islam

l No time value of money in pricing

l Dominant form of finance in Muslim countries

l All Muslims highly sensitive to Shari’a compliance in finance

l Limited products,expensive and too complicated

l Excessive paperwork
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 Islamic Banking
Conventional Banking RIBA FREE

Goods &
Services

Client Client

Riba Money

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 Islamic Banks Scope of Work

Deposit Finance Investments Service Products

Leasing Sales

Lease to Mudarbah
Murabaha Remittance Cars
Current Saving own

Lease Musharakah SMS Shares

Musaomah
service
Deposits Sukuk Call Center Real Estate
Istisnaa
Masraf Net Ticket
Salam
Furniture

Cards

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 Types of contracts

Islamic Banking Tools

Murabaha

Mudharabah Musawamah

IB Tools
Ijarah
Muntahyah
Musharakah Baltamlik-
Lease to
Own

Istisna

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 Islamic
Musaomah
Banking Tools Murabaha A ‫اﻟﻤﺮا>ﺤﺔ‬

it is negotiation and it is not compulsory It is a sale at the same price of goods

to inform the customer of price or agree• 220000 with a known increase to make profit
with him/her about the profit

220000 Bank

20000 200000

220000 Bank

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 Islamic Banking
Istisnaa
Tools Ijarah –
Lease-to-own

• Bank
Construction through Istisna by concluding The bank purchases an asset at the
two contracts: request of the customer and then
I: With its client to construct a tower, a leases it to him/her, with a legal
building or complex for him/her as per promise that the customer will own the
his/her required specifications. Price, asset at the end of the lease term.
duration, installments, the date of hand over,
etc. are stated herein.
II: With a contracting company to construct
the same building with the same
specifications required by the client

Bank Bank

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 Islamic Banking Tools
“Musharakah
SUKUK Mudarabah
“Partnership
• SUKUK • Musharakah “Partnership • Mudarabah “

• Investment certificates , equal value, the

holder participates in the profit or loss. • It is a joint partnership between QIB and • It is a partnership between two parties;
one or more clients with profit/loss one provides money (Proprietor) and
sharing according to capital shares. It the other is responsible for work
can be a permanent partnership or a (Speculator). Then they share profit
diminishing one in which QIB’s shares according to the agreement. Mudarabah
are gradually sold to the Client until
he/she becomes the sole owner

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 Riba & Gharar (simplified)
Riba
• Incremental or excess, usury
• Lending money on interest
• Absolute prohibition; money is not commodity
Excessive Gharar
• Risk, uncertainty
• A gharar-associated contract is one that contains a
degree of risk on the part of any of the counterparties
in a way that could lead to him losing part or all of
right
• Trading of risk unbundled from an asset
• Applies to commutative contracts

Implication: asset & enterprise, risk-sharing

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Examples of Gharar
Major or excessive gharar can be observed in a variety
of financial instruments or transactions, mainly
including:
• Derivatives (forward contracts, futures
contracts, options, and swaps).
• Short selling in stock markets and commodity
markets.
• Sale of debt
• Conventional insurance.

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 Application
Riba Gharar

Capital _Equity funds: business, Derivatives (or at

Market debt & income screening least their trading)
_Sukuk: ownership of largely avoided
assets
_Debt trading constrained

Banking _Trade, lease, share Sales/leases of assets

_No money after purchases
borrowing/lending

Insurance Avoid interest bearing Mutuality (risk-

/ Takaful investments sharing, solidarity
group)

Note: Sin industries to be avoided in all cases 19

Self-regulatory organizations bring credibility through standardization
of practices

AAO-IFI • Benchmark of Islamic accounting standards

(1991) − 56 accounting, auditing, governance and Shariah standards
Bahrain − Enhancing clarity, transparency and harmonisation

IIFM • Development of global Islamic capital and money market

(2001) − Promoting active and regulated trading and capital flows
Bahrain − Catalyzing trading infrastructure, product innovation and information flows

GCIBFI • Promoting industry in theory and practice

(2001) − Disseminating Shariah concepts & multilateral understanding between IFIs and public
Bahrain − Improving IFI practices, cooperation, professionalism and transparency

IFSB • Standard-setting body of regulatory and supervisory agencies

(2002) − Complementing Basel II Capital Accord
Malaysia − Key standards: risk management, capital adequacy & corporate governance

LMC • Creation of active Islamic inter-bank market

(2002) − Creating secondary market for short-term Shariah-compliant treasury products
Bahrain − Enabling IFI management of liquidity mismatch

IIRA • Reference point for IFI ratings

(2005) − Issuing sovereign, credit, Shariah quality and corporate governance ratings
Bahrain − Providing effective tool for informed investment decision-making

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 Industry is reaching mainstream relevance in global financial
system

Relevance in countries with already Relevance to new-comers

developed Islamic banking

• Widens the bankable population and • Reaching a broader market

customer base • Alternative source of funding
− Increases bankable population of economy − Debt issuance with the widest acceptance
− Increases product base in the system − Attract “new-to-industry” investors
− Attracts more deposits/funds from the customers
• Gateway to OIC markets
• Enhances stability of financial model − Regional preference of Islamic investors
− Asset-based framework links financial services − Infrastructure investment opportunities
to real economy

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Opportunities

•Inclusive, simple, tied to real economy

•Small size means growth potential; petrodollars to invested

•Responsible investments also growing

•More countries promoting Islamic finance, UK, south Africa,

etc…

•Industry reports & surveys still suggesting double digit

growth

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 Challenges

•Covering gap of centuries in decades

•Global economy - lending money, trading risk

•Legal, regulatory, tax issues

•Lack of global Shari’a standards

•Industry requires multidisciplinary expertise

•And the form versus substance debate…

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 Financial Crisis & Islamic Finance

•We did better (Proponents)

•You got hit by real estate (Critics)

•Much noise, but not a sound debate:

• What were the reasons toxic products were avoided by IFI?
• Real estate investments business or Shari’a issue?
• Can a small segment in the same market be unaffected in a
market wide turmoil?

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Thank You

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