By Professor Rodney Wilson,
University of Durham, United Kingdom
Introduction
London has become the largest international centre for Islamic finance outside the Muslim World, largely as a result of the City's role as a centre for Middle Eastern and Asian banking. Treasury management facilities are provided on behalf of Islamic banks in the Gulf, and Islamic fund management and promotion is becoming more significant. Possibilities for Islamic electronic financial services are opening up, and London is the major centre for information gathering and dissemination on the Islamic banking industry.
London's role in serving the British Muslim community has been disappointing and despite almost two decades of experience of Islamic financing, there are few retail products available. The aim of this article is to ask why this continues to be the case, to review the limited range of products on offer, and to see if there are any more hopeful signs for the future.
Islamic financial services in the UK
The Muslim community in the United Kingdom numbers more than 1.5 million British citizens and permanent residents, with up to another 500,000 temporary residents including students and visitors. The community is ethnically and linguistically diverse however, and geographically scattered, that makes marketing aimed at attracting the attention of the community a major challenge. The community is increasingly affluent, and comprises a growing number of professionals such as doctors, as well as a substantial small business component.
Although casual evidence suggests there is a greater propensity to use cash for transactions than with the population generally, the demand for banking and financial products is not markedly different from the national picture. Some devout Muslims avoid using conventional interest based banks, and others donate interest earnings to charity in an attempt to purify their income. The majority use conventional financing services, largely because they have little alternative, and tend, like the rest of the population, to have greater trust in large retail financial institutions with established brand names. For Islamic financial institutions to gain acceptance within the community there would need to be a substantial educational and marketing promotion.
HSBC Islamic Financing
In many respects the HSBC is the best placed British retail bank to potentially offer Islamic financial services to the local Muslim community, but so far it has been reluctant to take on the promotional and marketing risks. HSBC's advantage is that it already has an Islamic finance unit and extensive experience through its global operations in this type of business. It has a significant presence in many Muslim countries, including Malaysia, Pakistan and Bangladesh, and has become a major force in Middle Eastern banking since its acquisition of the British Bank of the Middle East. Its network includes six branches in Bahrain, six in Lebanon, fifteen in the United Arab Emirates, nine in Egypt, and five in Oman. HSBC also owns a minority stake in the Saudi British Bank that has 80 branches in the kingdom. These networks give the bank unparalleled business knowledge of different Muslim societies.
In the United Kingdom HSBC is the only high street bank to have a dedicated network of branches to serve the South Asian community with staff who speak Urdu and are themselves part of the community. It has teams of specialist business banking managers who profess to understand the needs of small Asian businesses. Its South Asian network has 11 branches in Blackburn, Glasgow, Harrow, Leeds, Leicester, London (2), Manchester, Preston, Walsall and Uxbridge. Islamic products could potentially be offered through all these branches.
It is however easier for HSBC, like other British retail banks, to offer conventional loans and savings products rather than to introduce differentiated products for a potential market of Muslim clients who do business with the bank in any case. The gains from cross selling Islamic products to existing clients are not thought to be great, and the potential to attract new clients limited due to the inertia of most retail account holders. HSBC therefore has concentrated on serving foreign Muslim clients of high net worth through its international operations, and in serving Islamic banks through wholesale business, rather than the domestic market. The HSBC's Amanah Global Equity Fund is marketed to foreign investors, for example, rather than the British Muslim community.
United Bank of Kuwait's Islamic Investment Banking Unit's Manzil Scheme
The most significant Islamic financial product to be launched for the Muslim community in the United Kingdom was the Manzil home purchase plan. Manzil can be translated as home, or in spiritual terms as the house or dwelling of the soul. The original scheme, which was introduced in 1997, provides for murabaha financing through a trading mark-up contract. The Islamic Investment Banking Unit that runs the scheme is a part of the United Bank of Kuwait, which was established in London in 1966 to serve Kuwaiti overseas financial and commercial interests. In August 2000 it was taken over by the Al-Ahli Commercial Bank, which formed a new institution, the Ahli United Bank. This has been registered as an offshore banking unit in Bahrain with its shares listed on the stock exchange in Manama.
Once the client has chosen a suitable property and agreed a price he approaches the bank for Manzil financing. An application form is completed together with a direct debit mandate for the monthly payments if the request for financing is approved by the bank's credit committee. The client must pay 0.1 percent of the purchase price of the property, or a minimum of £176.25 including VAT, so that the bank can commission an independent valuation of the property. The IIBU will also seek references regarding the client's financial position, usually from an employer or accountant and current bank. The client's solicitor will be expected to liase with the IIBU's solicitor who will seek assurances regarding the legal title of the property, which may involve legal searches.
For murabaha to be legitimate under Islamic law, the bank, as financier of the property, must be the first owner. It is therefore the bank, and not the client, who contracts with the vendor and pays the deposit required when contracts are exchanged. The sale price from the IIBU to the client has to allow for administrative expenses, a return to the bank's investors and a profit margin. The client pays the purchase price through fixed monthly payments over a period of up to 15 years.
The Manzil Ijara Home Hire Purchase Plan
The Manzil ijara scheme, which was introduced in March 1999, has proved much more popular than original murabaha house purchase plans. It is the flexibility that seems to appeal to clients, who can repay larger amounts as and when they can afford to do so to reduce their rental payments. They have the right to purchase the entire property from the bank at any time, but few are likely to choose to do so in the first few years, largely because they lack the funds. Those with the necessary funds to purchase a property outright would not have sought a Manzil home purchase arrangement in the first place.
Under the Manzil ijara scheme the property is registered in the bank's name, not just initially, but throughout the period of the lease that may extend to 25 years. The tenant or lessee agrees at the outset to eventually purchase the entire property, but at the original price that the bank paid without any mark-up. The monthly payments by the client comprise three elements. The first represents the repayments of the funds that the bank has used to purchase the property. The second is the rent on the property, which is the source of the bank's profit. The rent is reassessed annually to ensure the bank is making a reasonable return and adjusted downward to reflect payments already made. The third element of the monthly payment, referred to as insurance rent, is to recover the cost of the insurance that the bank has to pay on the property. Over time the monthly payments may increase or reduce or both, depending on the size of the first repayments element that the client decides he can afford. Early repayment could be potentially unprofitable for the bank, unless it can obtain a higher return by reinvesting the funds.
The Success of the Manzil Scheme
Although there has only been limited marketing effort put into the Manzil schemes there are between 50 and 80 potential clients a week who phone to enquire about Manzil house purchase and a further 40 who respond by email to the Web pages. This translated into around 20 applications per week for Manzil house purchases. The majority of applications are for housing purchase in the South East of England, but there is also a steady stream of enquiries from the Midlands and the North. Because of the different conveyancing system under Scottish law, Manzil financing is not available for house purchases north of the border. A down payment of 20 percent of the value of the property is required for all Manzil financing, which is higher than for conventional mortgages, but ensures that the client has a significant equity stake in the property from the outset. The minimum value of the property purchased is £50,000, which is a very modest sum in relation to property values in the South East, but which has applied to some of the inner city properties acquired in the Midlands and the North.
Under the Manzil ijara scheme clients can convert existing interest based mortgages. The banks shariah board's members, Justices Shaikh Muhammed Taqi Usmani and Shaikh Nizam Yaquby, have approved a conversion plan whereby the IIBU purchases the property from a client for a sum sufficient to repay the current loan plus certain costs and expenses, with the bank's payment being repaid over a period of years by the client. The bank's profit is derived from the rent the client pays over under the ijara wa-Iqtina hire purchase scheme.
Fund Management Possibilities
London is the major European centre for fund management, both for funds listed onshore and offshore funds listed in the Channel Islands, Dublin, Luxembourg and other centres. There are seven Islamic funds that are promoted in the Muslim world but managed from London and four that are both promoted and managed from London. All of these are designed for clients in Saudi Arabia and the Gulf, with the prices denominated in dollars and the funds administered from offshore tax havens. The HSBC Amanah Global Equity Fund is typical of these offerings, being listed in Luxembourg and managed to provide exposure to leading companies worldwide with a particular focus on major multinationals whose primary listing is in New York.
There have been mixed fortunes for Islamic funds managed from London with Kleinwort Bensons' Islamic Fund, the first to be established in 1986, being wound up in 1989 because of poor subscriptions. Flemings Oasis Fund was launched with great promise back in 1996, but was liquidated in 2000 following the take-over by Chase of Flemings. The Institutional Investor of Kuwait, which managed the Ibn Majeed Fund that was listed in Dublin, decided to close its London office in 2000 and focus its operations in the Gulf.
The only sterling denominated fund was the Halal Mutual, also listed in Dublin, and managed by the Gulf based Al Tadamon Group. It was designed to provide income from commodity trading rather than equity investment, the price being fixed at £250, but with the income dependent on trading profits, which in practice was always around 3.6 to 3.8 percent gross, a very modest return.
None of these funds is of much interest to the British Muslim community, who as United Kingdom residents have potential tax liabilities on both income and capital gains, and therefore cannot take advantage of offshore funds. For local Muslims what is required is an Islamic fund that can qualify for tax exemptions under the Individual Savings Account (ISA) scheme. This provides for exemption from capital gains and income tax for up to £7,000 invested in any tax year for qualifying funds in a maxi ISA. This has proved popular with ethical and ecological investors, with funds such as the Friends Provident Stewardship and the Jupiter Merlin Ecology qualifying for this status. Similar on-shore funds that complied with the Sharia law could potentially appeal to British Muslim investors if a major fund management group was willing to take the initiative.
Conclusion
Although London has emerged as the major western centre for Islamic finance so far it has failed to serve the United Kingdom Muslim community. The major retail banks and fund management institutions seem reluctant to take the initiative by promoting shariah compliant products for the local market. Whether the new on-line financial services groups such as ii-online.com or ihilal.com break into this market remains to be seen, but this may be one way forward.
Monday, January 4, 2010
Islamic Investment Products Available In The United Kingdom
Issues and Relevance of Islamic finance in Britain
By Iqbal Khan, Managing Director Head of Global Islamic Finance, HSBC Amanah Finance, UK
Introduction
Philosophical Foundation and Core Concepts
Islamic finance is an ethical, indigenous and equitable mode of finance, which derives its principles from the Quran (The revealed book of Muslims) and tradition of the Prophet Muhammad (pbuh). Shariah law (Islamic law), which is based on the Quran and Sunnah, governs Islamic finance.
It is a trend which is broadening the ownership base, creating more stakeholders and thereby bringing the hope of stability to more than 1.3 billion Muslims spread across the world.
Islamic Finance as a concept is based on themes of Community Banking, Ethical and Socially Responsible Investments and Affinity Marketing. These themes themselves are based on core ideas, which include individual responsibility, reliance on market mechanism, commitment to economic and social justice and mandatory care for the environment. These guidelines also include prohibitions from investing in areas such as Defence and Armaments, Casinos, Breweries - areas which are considered to be value destroyers.
In Islamic Finance Scholars say that everything is allowed except that which has been specifically forbidden. In essence the believing Muslims view of economics is based on Man's obligation to organise his affairs in accordance to the will of God as his representative and vice regent on Earth. The goal is not equality but an avoidance of gross inequality along with an injunction that wealth should not become "a commodity between the rich among you". Islamic Finance is firmly embedded in the commercial, real, value-producing economy.
Early Beginning
The desire of enlightened Muslims to seek the moral equivalent of Modern Capitalism goes back to Egypt in the early 1960s. The pioneering effort, in Egypt, took the form of a savings bank based on profit-sharing in the town of Mit Ghamr. The Islamic Development Bank (IDB) was established in l975 by the Organisation of Islamic Conference (OIC), but it was primarily an intergovernmental bank aimed at providing funds for development projects in member countries. The IDB now also extends to private sector corporates for project and trade finance facilities.
In the mid-seventies, Islamic banks came into existence in Saudi Arabia and the United Arab Emirates. Since then, Islamic financial institutions have emerged in a large number of Muslim countries including Kuwait, Bahrain, Qatar, Turkey, Pakistan, Indonesia and a belt of other IDB member countries. These institutions have taken the form of commercial banks, investment banks, investment and finance companies, insurance companies, etc.
Market sizing
Islamic banking today is an industry that is still evolving. The industry manages approximately $180 Billion dollars today, growing at approximately 15% per annum. The growth of Islamic banking is a result of economic growth in the Islamic world, fuelled primarily by oil wealth. This growth created a growing middle-wealth segment and hence made banking a necessary service to the larger segment of the population rather than a service for the few, as had been the case some 10 to 15 years earlier.
Evolution of Islamic Finance
In the 1970s and 1980s, Islamic banking was characterised by a large number of commercial banks serving retail Muslim customers in their respective countries. However, since the late 1980s a shift towards investment banking has taken place. No where is this better witnessed than in Bahrain, which has the largest number of offshore Islamic investment banks in the Muslim world.
In the early years, investments and products used by most Islamic financial institutions were driven by the concept of Mudaraba (referred to as Trust Financing) and focused on short-term investments. During this period, Murabaha (cost-plus finance) emerged as the most widely used instruments by Islamic banks, accounting for over 80 per cent of a portfolio of an Islamic bank.
During the 1990s Islamic financial institutions have become increasingly more innovative, developing more complex instruments and structures to meet the demands of modern day business. The use of instruments such as leasing and construction finance have become far more widespread. Islamic finance tranches have also been structured into big-ticket syndication.
Equities have only recently opened up as an asset class to Islamic investors, following approval from the Islamic Fiqh (Islamic jurisprudence) Academy in Jeddah, one of the major legal bodies in the Muslim world. Islamic investors are now able to invest in equities subject to certain criteria. Over 100 Islamic equity funds have now been launched since 1995 with Assets under management in excess of $7 billion. Some of these funds are being sold in UK and it would be useful to make their ISA compatible.
The Markets and the Players
More than 2/3rd's of Islamic finance business is currently originated in the Middle East. The GCC countries, with the exception of Oman, are all major markets for Islamic finance. Bahrain is regarded as the hub for Islamic finance. Other major non-GCC markets for Islamic finance include Egypt, Malaysia, Turkey, Indonesia, and Pakistan.
Malaysia operates a dual banking system promoted by the government. This allows conventional financial institutions, investment banks, commercial banks and finance companies to launch separate Islamic banking divisions, competing alongside two Islamic banks, Bank Islam Malaysia and Bank Muamalat Malaysia. Bank Negara Malaysia (the central bank) has its own Shariah Advisory Board, which sets the rules for the entire Islamic banking sector, ensuring uniformity of products and services.
Over 150 Islamic financial institutions now operate in over 40 countries around the world, from commercial banks, investment banks, investment companies to leasing, and insurance companies.
The Products and Structures
Islamic banks around the world have devised many financial products based on the risk-sharing, profit-sharing principles of Islamic banking. For day to day banking activities, a number of financial instruments have been developed that satisfy the Islamic doctrine and provide acceptable financial returns for investors. Broadly speaking, the areas in which Islamic banks are most active are in trade and commodity finance, property and leasing. Almost every Islamic bank has a committee of religious advisers whose opinion is sought on the acceptability of new instruments and services and who have to provide a religious opinion of the bank's activities for year-end accounts.
Britain and Islamic finance
Community Banking
Muslims in Britain and throughout the world aspire to carry out their financial matters in accordance with the principles of Islamic law. Muslims are forbidden from obtaining the various conventional banking and insurance products and services in the forms currently offered due to their incompatibility with the principles of Islamic law.
It is estimated by various surveys that over 2 million Muslims are permanently residing in the UK. The community is predominantly composed of people from the Indian sub continent who have settled in Britain during the 1950s. Beside them, there are also Muslims of Middle Eastern and North African origins. Additionally there is a growing population of indigenous Muslims.
The UK Muslim community has now reached the "Second-Generation" stage. The first wave of immigrants having settled down, the second-generation Muslims are now slowly penetrating the different strata of the British society. It is not uncommon to find successful Muslim lawyers, chartered accountants, bankers, businessmen and even Members of Parliament, both at the House of Lords and the House of Commons.
The third generation of Muslims are also emerging from the educational system and is projected to increase the Muslims' presence in all strata of British society, especially, the educated middle class.
The vast majority of Muslims either is living in rented houses or has taken conventional interest-based mortgages. The total number of Muslim households as estimated by the Muslim Council of Britain is around 500,000. Of the 500,000 households, it is estimated by various market researches that approximately 40,000 families seek financing for home purchases each year.
We have regularly received enquiries regarding the availability of Islamic finance products, in particular Islamically compatible finance to purchase both residential and commercial properties. It is believed that a large number of Muslims have abstained from taking the conventional mortgage because of its incompatibility with the Islamic principles. The needs of these Muslims need to be served immediately.
Beside the market represented by Muslims living in Britain, there is potential for overseas investors to be introduced by HSBC. We understand that a considerable number of Muslims living abroad (mainly in the Middle East) had expressed their desire to own properties in Britain (mainly as a holiday residence) but have been reluctant to embark into an interest bearing financing facility. For these investors an Islamic home financing scheme will offer the opportunity to own a property in Britain.
Islamic Home Financing:
Structure
The potential customer, having identified the property, will approach the Bank to finance the purchase of the property. The transaction structure will be as follows:
- The customer chooses the property for purchase and agrees the purchase price with the owner of the property ("Seller"). The bank buys the property from the Seller at the agreed price. The customer will be requested to provide a deposit against the purchase price, but the Bank will remain the sole registered owner.
- The customer signs a lease agreement with the Bank. The lease will be for a period of up to 25 years with the lease rentals to be reviewed annually to reflect the capital repayment. The terms of the lease agreement will stipulate that in the event of a default the Bank will have the right to repossess and sell the property.
- The customer/lessee will give an undertaking that in the event of a default under the lease agreement, the Bank/lessor will have the right to compel the customer to purchase the property for the purchase price (which shall equal the amount of principal outstanding).
- There will also be an undertaking whereby the Bank/lessor promises to sell the property to the customer/lessee at the end of the agreed lease period (i.e., when the whole of the principal portion has been repaid). There will also be a provision for certain other specified instances including when the customer desires to sell the property.
Islamic Home Financing: Current Impediments
1. Risk Weighting
A key element, which will impact the pricing, is the FSA's approach to risk weighting for this product. FSA has provisionally ruled that the product is to be 100% risk weighted. This is essentially because the transaction is equivalent to a lease and leases are weighted 100%. This assumes that the house remains the property of the Bank throughout the term of the transaction and is treated as a fixed asset on its balance sheet. If we are obliged to weigh at 100% then pricing will be significantly higher than the conventional mortgage rate. Good Muslims should not be penalised for being good Muslims. The Muslims in the United States have approached the Comptroller of the Currency Administration of National Banks ("OCC") to seek the approval for Islamic home finance based on the above leasing structure. The OCC had in 1997 approved the Islamic home financing based on the above leasing structure and ruled, inter alia, that the banks' risks under the Islamic leasing structure are similar to the risks on traditional mortgage loans (see OCC's Interpretive Letter #806). We hope that a similar approval would be granted in Britain.
2. Taxation
The transfer of ownership from vendor to bank at the commencement of the lease and from bank to customer at the end of the lease, may attract the payment of two sets of stamp duty. The second set would arise at the end of the term of the lease at the rate of stamp duty then applicable. The second set of stamp duty needs to be exempted because the true effect of the transfer is similar to the redemption of a conventional mortgage or charge: when the property finally vests with the customer without any encumbrance. If the second set of stamp duty is not exempted, the uncertain cost of the second stamp duty would make the Islamic home financing unattractive and cost prohibitive.
3. Legal Fees
Unlike the conventional mortgage the proposed product would require the appointment of two sets of Solicitors, thereby making the product more expensive. It is suggested that the Law Society should consider giving a general exemption as is done for the mortgage product.
For British Corporates
Britain has always been a major trading partner of the Muslim world. Trade volumes became increasing significant in some parts of the Muslim world in the 1970s following the oil driven economic boom.
The oil boom during this period brought about growth in the domestic economies of the oil producing countries. This brought opportunities for British firms to play a role in building the infrastructure of these countries. Surplus funds from the Muslim world found their way into the safe and stable environments in Britain to be managed by London-based banks.
Similarly, funds have also been channelled into direct investments. Good examples here are Kuwait Investment Office's acquisition of a 20% stake in BP stands out, the acquisition of Lotus the car manufacturers by Proton, the Malaysian car company and purchase of the Hartwell Group by a prominent trading family from Saudi Arabia.
The investment in the London property market by the investors from the Muslim world has historically been very important. Real estate analysts believe that in 1998 alone well over 20% of all such investments came from the Muslim world. In addition, a significant number of Muslim businesses in Britain are also seeking Islamically compatible finance to purchase commercial properties in Britain.
We are witnessing an increasing desire from Muslim investors that these funds be managed and corporate acquisitions be structured under Islamic financial principles. Here UK regulators can play an important role in facilitating the flows of funds and investments into Britain from the Muslim world through the introduction of "Islamic finance friendly" regulation.
UK corporates too, trading with their counterparties in the Muslim world need to be cognisant of the growth of this indigenous and ethical mode of financing and be aware of the characteristics, qualities and benefits of Islamic finance.
For British Exporters
Many of the Muslim countries throughout the world would be classified as developing markets. Consequently, cross-border funding for these countries from western financial markets may be either restricted or limited, thus hindering trade and investment flows between the UK and the Muslim world. Here Islamic financial institutions, who have a greater knowledge and understanding of these markets and consequently the risks, can play key role by providing financing in instances where western commercial financiers would be unwilling to lend.
British exporters and British export credit agencies would benefit tremendously by using this indigenous form of finance to gain access to precious cross-border lines in the 54 Islamic Development Bank Member Countries, These cross-border lines could become a tremendous source of competitive advantage for British exporters.
Today Islamic finance is a trend, which is broadening the ownership base, and creating more stakeholders. It offers a viable financial alternative that may run parallel to conventional finance. Regulators, bankers, asset managers and users of capital in Britain may capitalise on the opportunities afforded by this market and play a proactive role.
London already supports this form of finance by offering products and services through its financial institutions and through leading law firms. The regulatory authorities should come out proactively to introduce regulations which will allow these instruments to be established as an ethical alternative to other instruments which are available in the London financial markets, meeting the needs of Islamic fund providers.
This will require an understanding and appreciation of the roles which these ethical indigenous instruments play in keeping the commercial economy as close as possible to the financial economy. British exporters to the Muslim countries would be in a very favourable position if they could provide not only the exports but also export financing that meets the importers' religious requirements. HSBC is working together with the Export Credits Guarantee Department and other Export Credit Agencies in the EEC to provide Islamically compatible financing and guarantee for exports to Muslim countries. The proactive role of the ECGD is providing Islamically acceptable financing is essential to ensure that British exporters to the Muslim countries have an edge over others. This would lead to more trades between Britain and the Muslim countries, which could lead to a positive contribution to the British economy.
Conclusion
Islamic Finance has mainstream relevance for British Muslims, British Business and British Exporters. It is therefore important that relevant Government Institutions such as ECGD, FSA and DTI should pay attention to this corporate and social responsibility movement, which is becoming increasingly important for both Muslims in Britain and abroad.
Perhaps more important is the demonstration effect which such an effort may have for all of humanity.
Dr. Martin Luther King Jr. described the challenge, which we face:
"Through our scientific genius we have made the world a neighbourhood, now through our moral and spiritual genius we must make of it a brotherhood."
It is in this domain and in bringing the financial economy close to the commercial economy that Islamic Finance can make a real and lasting difference. Britain with its history and culture of trade, commence and community banking is well positioned to benefit from this growing trend of Islamic Finance.
Saturday, December 26, 2009
Islamic Banking Part VI ( Status of Islamic Banking)
Status of Islamic Banking
Islamic banking is no longer a novel experiment. When the concept of Islamic banking with its ethical values was propagated, financial circles the world over treated it as a utopian dream. Having lived for centuries under the ‘valueless’ capitalist economic system, they asked what ethics had to do with finance?
Besides their range of equity, trade-financing and lending operations, Islamic banks also offer a full spectrum of fee-paid retail services that do not involve interest payments, including checking accounts, spot foreign exchange transactions, fund transfers, letters of credit, travellers' checks, safe-deposit boxes, securities safekeeping investment management and advice, and other normal services of modern banking. Islamic banking because of its value-orientated ethos enables it to draw finances from both Muslims and non-Muslims alike.
Islamic banks are evolving financial and investment instruments that are not only profitable but are also ethically motivated. The ever-increasing application and innovation of the methodologies associated with derivative instruments that revolutionized the global financial industry have also led to a global financial crisis because of the excess greed for profit and the immense uncertainty and risk associated with these types of transactions. There are doubts associated with the permissibility of derivative instruments under Islamic finance generally.
Addressing issues to resolve the global financial crisis world leaders called for a set up on the basis of capitalism of entrepreneurship where banks finance economic development in the real economy, as opposed to the set up on the basis of capitalism of speculation whereby banks derive excessive profit from speculative transactions that do not make any contribution to the real economy.
[source: Institute of Islamic banking and Insurance (IIBI)]
Islamic Banking Part V ( Shariah Authenticity & Religious Board)
Shariah Authenticity
Shaikh Yusuf Talal DeLorenzo, Islamic scholar, position is that unless a financial product or service can be certified as Shari’ah compliant by a competent Shari’ah supervisory board, that product's authenticity is dubious. At that point, it will be the responsibility of the individual investor or consumer to determine on his or her own that the product complies with the principles and precepts of the Shari’ah.
Shari'ah Supervisory Board [Religious Board]
Islamic financial institutions must adhere to the best practices of corporate governance however they have one extra layer of supervision in the form of religious boards. The religious boards have both supervisory and consultative functions. Since the Shari’h scholars on the religious boards carry great responsibility, it is important that only high calibre scholars are appointed to the religious boards.
An Islamic financial institution is required to establish operating procedures to ensure that no form of investment or business activity is undertaken that has not been approved in advance by the religious board. The management is also required to periodically report and certify to the religious board that the actual investments and business activities undertaken by the institution conform to forms previously approved by the religious board.
Islamic financial institutions that offer products and services conforming to Islamic principles must, therefore, be governed by a religious board that act as an independent Shari’ah Supervisory Board comprising of at least three Shari’ah scholars with specialised knowledge of the Islamic laws for transacting, fiqh al mu`amalat, in addition to knowledge of modern business, finance and economics.
They are responsible primarily to give approval that banking and other financial products and services offered comply with the Shari’ah and subsequent verification that of the operations and activities of the financial institutions have complied with the Shari’ah principles (a form of post Shari’ah audit). The Shari’ah Supervisory Board is required to issue independently a certificate of Shari’ah compliance.
The day-to-day application of Shari’ah by the Shari’ah Supervisory Boards is two-fold. First, in the increasingly complex and sophisticated world of modern finance they endeavours to answer the question on whether or not proposals for new transactions or products conform to the Shari’ah. Second, they act to a large extent in an investigatory role in reviewing the operations of the financial institution to ensure that they comply with the Shari’ah.
The concept of collective decision-making, in other words, decisions made by more than one scholar, is especially important. Shari’ah Supervisory Boards function is to ensure that decisions are not unilateral, and that difficult issues of finance receive adequate consideration by a number of qualified people.
Shaikh Yusuf Talal DeLorenzo, Islamic scholar, position is that unless a financial product or service can be certified as Shari’ah compliant by a competent Shari’ah supervisory board, that product's authenticity is dubious. At that point, it will be the responsibility of the individual investor or consumer to determine on his or her own that the product complies with the principles and precepts of the Shari’ah.
[source: Institute of Islamic banking and Insurance (IIBI)]
Friday, December 25, 2009
Islamic Banking Part IV ( Pricing Transactions & Ethical Investment)
Pricing Transactions Linked to Interest rate Benchmark
There are continuing debates on whether the spirit of Shari`ah is being violated by the practice of "benchmarking" linked interest rate benchmark such as London Interbank Offered rate (LIBOR) plus an agreed mark-up in also pricing returns on Islamic finance transactions . At a very fundamental level, the reason for the debates is the lack of understanding to clearly discern the difference between the use of LIBOR as a benchmark for pricing and the use of non-Shari’ah compliant assets as a determinant for returns.
However, benchmarking touches upon the integrity of Islamic Finance as a whole, and the concept of Shari’ah-compliance vs Shari’ah-based approach in particular. There are practical challenges delaying a switch to participation-based structures, such as Musharakah and Mudarabah, that require financiers to participate in the underlying asset in a financing transaction.
Islam's Approach to Ethical Investment
Given that many ethical funds have similar characteristics as Islamic funds, it is important for ethical investors attracted by the appeal of Islamic principles as well as the performance of Islamic investments to understand that there are additional prohibitions that must be applied on the products offered. These restrictions which are essentially self-imposed based on belief and conviction act a moral compass; the monitoring of the prohibitions by a Religious (Shari’ah) Supervisory Board may have prevented Islamic financial institutions to deviate from a faith-based system and absorb the shocks within the conventional financial system.
The important principles for Islamic financial instruments for participation and investments that require strict adherence, while providing good returns, are:
- Investments must be free of interest, speculation and gambling, all are considered as forms of exploitation.
- Investments are made in permissible activities.
- Investments must be separately approved by an independent Shari’ah supervisory board to ensure Shari’ah principles are strictly adhered to and deviations and wayward business practice penalized, for example in Islamic finance requires penalties to be paid to charity.
"The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service," the Vatican's official newspaper Osservatore Romano said in an article its latest March 2009 issue.
[source: Institute of Islamic banking and Insurance (IIBI)]
Islamic Banking Part III ( Economics Order, Wealth & Profit-and-Loss Sharing)
Islamic Economics Order
Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as:
- While permitting the individual the right to seek economic well-being, Islam makes a clear distinction between what is halal (lawful) and what is haram (forbidden or unlawful) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious.
- While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it.
- While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat (a tax on wealth that is distributed to the needy).
- While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance.
- Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive.
Wealth and Islam
Islam has a unique dispensation on the theme of wealth, its ownership, distribution and social relationship. Islam enjoins wealth creation not for its own sake.
The theme of Islamic dispensation of wealth is treated as a deeply moral study of self and society. The true nature of wealth in Islam requires social preferences and market exchange mechanisms that are ethicised by human consciousness of the Moral Law. Islam gives precise moral injunctions as to what are, and are not acceptable kinds of wealth. They point out how individual preferences on wealth formation ought to be utilized within the social meaning.
According to Shaikh Yusuf Talal DeLorenzo, well-known and respected Shari’ah advisor and Islamic scholar as well as also author of the three volume “Compendium of Legal Opinions on the Operations of Islamic Banks” the first English reference on the fatwa (religious ruling) issued and published by the Institute, business, in the Qur'anic sense of "profitable trade" or tijarat'un rabihah is business that brings blessings to those who conduct it. Obviously, profits are important as ends, but the means by which those profits are earned are even more important. Indeed, the reason for the emphasis in the Shari’ah on proper transacting is that Islam accords great importance to the economic welfare of society.
Profit-and-Loss Sharing
While Islam employs various practices that do not involve charging or paying interest, the Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilizing the funds at risk on a profit-and- loss-sharing basis. Such participatory modes used by Islamic banks are known as Musharakah and Mudarabah. This by no means implies that investments with financial institutions are necessarily speculative. This can be excluded by careful investment policy, diversification of risk and prudent management by Islamic financial institutions.
The concept of profit-and-loss sharing in an enterprise, as a basis of financial transactions is a progressive one as it distinguishes good performance from the bad and the mediocre. This concept therefore encourages better resource management. The Islamic sukuk system is similar to bonds of capitalist system, but in sukuk, money is invested concrete projects and profit share is distributed to clients instead of interest earned.
[source: Institute of Islamic banking and Insurance (IIBI)]
Islamic Banking Part II ( Permissibility & Interest)
Rules of Permissibility
Muslims believe that all things have been provided by God, and the benefits derived from them, are essentially for man’s use, and so are permissible except what is expressly prohibited in The Qur’an or Hadith. When guidance is not clearly given in he Qur’an there are several other sources of law. For example, guidance can be sought from Fiqh, which means ‘understanding’ and is the science of jurisprudence: the science of human intelligence, debate and discussion
Prohitbition of Interest
Riba best translated today as the charging of any interest, meaning money earned on the lending out of money itself. The prohibition on paying or receiving fixed interest is based on the Islamic tenet that money is only a medium of exchange, a way of defining the value of a thing; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else. The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it.
Money in Islam is not regarded as an asset from which it is ethically permissible to earn a direct return. Money tends to be viewed purely as a medium of exchange. Interest can leads to injustice and exploitation in society; The Qur’an (2:279) characterises it as unfair, as implied by the word zulm (oppression, exploitation, opposite of adl i.e. justice)
There is no real 'lending' in Islam since all 'lenders' obtain ownership interests in the assets that they finance, or earn a profit-share or purely fee-based remuneration. In order for an Islamic bank to earn a return on money lent, it is necessary to obtain an equity, or ownership, interest in a non-monetary asset. This requires the lender to also participate in the sharing of risk.
Individuals and the world as a whole probably know too well the burden of interest and misery and suffering that irresponsible lenders have inflicted on individuals and societies. It has become so completely institutionalised and accepted in modern economies that it is almost impossible to conceive that there are some who completely oppose it and refuse to enter into any transactions that involve interest.
Islam's prohibition of interest and usury was not unprecedented. The early Jewish and Christian traditions also forbade riba. Even the renowned Greek philosopher, Aristotle, condemned acquiring of wealth by the practice of charging interest on money.
“Very much disliked also is the practice of charging interest: and the dislike is fully justified for interest is a yield arising out of money itself, not a product of that for which money was provided. Money was intended to be a means of exchange; interest represents an increase in the money itself. Hence of all ways of getting wealth, this is the most contrary to nature." Aristotle, The Politics, tr. Sinclair, pg. 46, Penguin
“Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deuteronomy 23:19)
“If you lend money to My people, to the poor among you, you are not to act as a creditor to him; you shall not charge him interest.” The Holy Bible (American Standard Bible)
[Jesus said], “If you have money, do not lend it at interest, but give [it] to one from whom you will not get it back.” Gospel St Thomas, V95
Other Key Prohibitions
Islam not only prohibits dealing in interest and investment in unlawful activities that Islam deems harmful to society, but also transactions involving excessive uncertainty (gharar) and all forms of gambling (maysir).
[source: Institute of Islamic banking and Insurance (IIBI)]
Islamic Banking Part I ( Definition & Principles)
The Islamic Financial System
While elimination of "Riba" or interest in all its forms is an important feature of the Islamic financial system, Islamic banking is much more. At the heart of Islam is a sense of cooperation, to help one another according to principles of goodness and piety (but not to cooperate in evil or malice). In essence, it aims to eliminate exploitation and to establish a just society by the application of the Shari'ah or Islamic law to the operations of banks and other financial institutions. To ensure compliance to the Shari'ah, Islamic banks use the services of religious boards comprised of Shari'ah scholars.
Islamic finance may be viewed as a form of ethical investing, or ethical lending, except that no loans are possible unless they are interest-free. Among the ethical restrictions is the prohibition on alcohol and gambling and the consumption of pork. Islamic funds would never knowingly invest in companies involved in gambling, alcoholic beverages, or porcine food products
Its practitioners and clients need not be Muslim, but they must accept the ethical restrictions underscored by Islamic values.
What is Islamic Banking?
Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shari’ah, known as Fiqh al-Muamalat (Islamic rules on transactions). Islamic banking activities must be practiced consistent with the Shari’ah and its practical application through the development of Islamic economics. Many of these principles upon which Islamic banking is based are commonly accepted all over the world, for centuries rather than decades. These principles are not new but arguably, their original state has been altered over the centuries.
The principle source of the Shari’ah is The Qur’an followed by the recorded sayings and actions of Prophet Muhammad (pbuh) – the Hadith. Where solutions to problems cannot be found in these two sources, rulings are made based on the consensus of a community leaned scholars, independent reasoning of an Islamic scholar and custom, so long as such rulings to not deviate from the fundamental teachings in The Qur’an.
It is evident that Islamic finance was practiced predominantly in the Muslim world throughout the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen.
The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the oil producing countries, received a boost due to rationalisation of the oil prices, which had hitherto been under the control of foreign oil Corporations. These events led Muslims' to strive to model their lives in accordance with the ethics and principles of Islam.
Disenchantment with the value neutral capitalist and socialist financial systems led not only Muslims but also others to look for ethical values in their financial dealings and in the West some financial organizations have opted for ethical operations.
Islamic Banking Principles
The Shari’ah prohibits the payment of charges for the renting of money (riba, which in the definition of Islamic scholars covers any excess in financial dealings, usury or interest) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haram, forbidden). While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to apply these principles to private or semi-private commercial institutions within the Muslim community.
"While a basic tenant of Islamic banking - the outlawing of riba, a term that encompasses not only the concept of usury, but also that of interest - has seldom been recognized as applicable beyond the Islamic world, many of its guiding principles have. The majority of these principles are based on simple morality and common sense, which form the bases of many religions, including Islam.
"The universal nature of these principles is immediately apparent even at a cursory glance of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other writers, particularly those writing in the 19th century, have attacked the barbarity of the practice. Much of the morality championed by Victorian writers such as Dickens - ranging from the equitable distribution of wealth through to man's fundamental right to work - is clearly present in modern Islamic society.
"Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century." (Islamic Finance: A Euromoney Publication, 1997)
[source: Institute of Islamic banking and Insurance (IIBI)]
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