Islamic Banking
Bulletin
September 2006
Prepared By
Mr. Imran Ahmad
Ms. Sumera Baloch
Islamic Banking Department
State Bank of Pakistan
September 2006
State Bank of Pakistan
Islamic Banking Bulletin
Islamic Banking Sector
Islamic Banking Bulletin gives an overview of the Islamic
Banking Industry and
provides information
regarding the developments taking place in
this industry locally
and internationally.
An article pertaining
to Islamic Banking &
Finance is also presented as an annexure
(Annexure-II)
with
this report.
Inside this issue:
Bank in Focus
2
Book in Focus
3
Product in Focus
3
Issues in Islamic
Banking
5
Upcoming Events
6
Developments at IBD
7
IERS
7
Local News
8
International News
9
Structure of the
Islamic Banking
Sector
Balance Sheet
Structure
The Islamic Banking Sector continued to grow which is reflected by
the increasing branch network of the Islamic Banking Institutions.
The network details can be seen in the Annexure-I.
The Balance Sheet footing of the Islamic Banking Industry kept on
increasing. The total assets portfolio in the Islamic Banking Sector
expanded by 0.59% to Rs. 89.350 billion in August 2006 from Rs.
88.828 billion in July 2006. Total loans and advances, net of provisions comprised of 57.18% of total assets and stood at Rs. 51.093
billion in August 2006 compared with Rs. 50.748 billion or 57.13%
of total assets in July 2006. Advances as a percentage of total assets
have increased by a nominal percentage. Total assets have increased
due to substantial increase in other assets.
Deposit liabilities increased by 1.56% % to Rs. 62.188 billion as at
the end of August from Rs. 61.231 billion in July 2006.
Due to the dominant position of advances on asset side, the credit
to deposit ratio was 82.15%. a high credit to deposit ratio exposes
industry to a fairly high degree of credit risk.
Islamic Banking Sector equity and Islamic Banking Fund increased
by 0.14% to Rs. 12.591 billion from Rs. 12.574 billion.
Cash and Liquidity Position
Cash held by Islamic Banking Institutions at the State Bank of Pakistan increased by 0.71% to Rs.9.494 billion from Rs. 9.427 billion. It
averaged 15.27% of deposit liabilities in August 2006 which was
15.40 % in the month of July 2006. Cash Reserve Requirement
(CRR) for the Islamic Banking Institutions is 7% as per BSD Circular
No. 10 dated July 22, 2006. Islamic Banking Institutions on the liquidity front are consistently meeting their CRR and SLR requirements and significant amount is kept as cash and balances with
other banks.
Profitability
Unappropriated / unremitted profit for the month of August increase by 1.42% to stand at Rs. 1.042 billion compared to last month
which was at Rs. 1.027 billion. Due to higher volume of business,
profitability indicators have also improved. .
Bank in Focus: Meezan Bank Limited
Meezan Bank Ltd is the First Islamic Bank to be given Islamic Banking License in Pakistan. The license was issued on 31.01.2002. First
Branch of the Meezan Bank opened on 17.04.2002 at Ground Floor, Block B,FTC Building Sharah-e-Faisal , Karachi.
Following Product Range is being offered by Meezab Bank Limited
Deposit Products
Mudarabah based Deposit Products
Mission: “To be a premier Islamic
TRANSACTIONAL ACCOUNTS
– Rupee Saving accounts
- Dollar Saving accounts
- MIIDA
- Karobari Munafa Account
- KMA Plus
ISLAMIC TERM DEPOSITS
Riba Free Certificates of Islamic Investments COIIs
Monthly Mudarabah Certificates
Dollar Mudarabah Certificates
Meezan Amdan Certificates
- Long term deposit product for Pension & Gratuity Funds
Meezan Providence Certificates (MPCs)
Bank offering a one-stop shop for
innovative value-added products
and services to our customers
within the bounds of Shariah,
while optimising the stakeholders’
value through an organizational
culture based on learning,
fairness, respect for individual
enterprise and performance.”
RETAIL ASSET PRODUCTS
First Islamic Car Financing scheme – Car Ijarah (New & Used Cars as well as Motorcycles)
First Islamic Housing Finance scheme – Easy Home (with 4 variants: Buy, Build, Renovate & Replace )
CORPORATE & SME
Corporate Murabaha (PKR & USD) – for Short Term Financing
Diminishing Musharakah- Long Term Financing for Plant & Machinery, Commercial Premises
Corporate Ijarah- Long Term Financing for Fixed Assets
Shariah Compliant Schedule of Charges
STRUCTURED FINANCE
Pakistan’s first Musharakah Term Finance Certificates – Sitara MTFCs
Fayzan Manufacturing Mudarabah with ICI
Govt. of Pakistan’s Global Sukook
TRADE FINANCE
Import Financing through “Import Murabaha & Musharakah”
Sight & Usance LCs - Shariah Compliant alternative
Shariah Compliant alternative of Bill Discounting
Islamic Export Finance Scheme – based on Musharakah
Meezan Islamic Institution Deposit Account (MIIDA)
TREASURY OPERATIONS
Exchange Risk Hedging – through Forward Promise
FX dealings under Bai Salam & Bai Surf rules
LIQUIDITY MANAGEMENT
Special Mudarabah based account for other Islamic banks for short term liquidity mgmt.
Pakistan first Shariah compliant Musharakah & Mudarabah based solutions for Acceptance of funds from
Inter-bank Money Market
Special Musharakah based Deposits for banks & Corporate sector.
MUTUAL FUND:
Shariah Compliant Screening Criteria for Investment in Stocks
Meezan Islamic Fund – Largest Shariah Compliant Mutual Fund of Pakistan
Meezan Balanced Fund – First Islamic Balanced Fund.
TAKAFUL
Pakistan’s first Shariah compliant Islamic way of Insurance- FIRST TAKAFUL-A joint venture of Meezan Bank and Pak Kuwait
Page 2
Core Marketing Functions of Meezan Bank
• Achieve strong and continuous brand awareness in the market.
• Highlight MBL as a full-fledged commercial bank.
• Effectively support core product lines to enhance acquisition.
• Promotion of key distribution channels.
• Reinforce our key USP of absolute Shariah Compliance through market education.
Human Resource Capacity Building
• Special focus on Islamic Banking training of Meezan Bank staff
• Special module developed for
• Islamic banking, Product training, documentation & Shariah Standards
• Full day advance workshop are organized for Branch Manager, Corporate RMs etc
• 4-month Islamic Banker Certification Program have been launched
• Regular training sessions & seminars with NIBAF, EPB, IBP, NIPA, CIE etc
• Developed graduate level courses for IBA, IQRA, LUMS and other universities
Future Plan
• Establishment of full fledge International Training Institute for Islamic banking - to provide training to MBL Staff,
other Islamic banks & general public
Book in Focus: An Introduction to Islamic Finance, Muhammad Taqi Usmani
Islam does not deny the market forces and market economy. Even the profit motive is acceptable
to a reasonable extent. Private ownership is not totally negated. Yet, the basic difference between
capitalistic and Islamic economy is that in secular capitalism, the profit motive or private ownership
are
given
unbridled
power
to
make
economic
decisions.
Their liberty is not controlled by any divine injunctions. If there are some restrictions, they are
imposed by human beings and are always subject to change through democratic
legislation, which accepts no authority of any super-human power.
This attitude has allowed a number of practices, which cause imbalances in the society. Muhammad Taqi Usmani writes about these imbalances and tries to provide a cure using Islamic concepts of finance.
Islamic Modes of Finance: Murabaha
The term “Islamic Modes of Finance”’ is defined as follows:
“The systematic and detailed Shariah rules that govern the contractual relationship of an investment activity that can be applied for attracting money capital” (Fahmy & Sarkar).
Bai-Murabaha
Meaning of Murabaha
The terms "Bai-Murabaha" have been derived from Arabic words Bai and Ribhun. The word
'Bai' means purchase and sale and the word ‘Ribhun’ means an agreed upon profit. “BaiMurabaha" means sale for an agreed upon profit. Bai-Murabaha may be defined as a contract
between a buyer and a seller under which the seller sells certain specific goods permissible unPage 3
Surat Al-Baqarah, (Verses 278 &
279), what can be translated as,
"O you who believe! Fear Allah
and give up what remains (due
to you) from riba (from now
onward), if you are truly believers. And if you do not do it, then
take a notice of war from Allah
and His Messenger but if you
repent, you shall have your capital sums. Deal not unjustly, and
you shall not be dealt with unjustly."
Islamic Shariah and the Law of the land to the buyer at a cost plus an agreed upon profit payable today or on some date in
the future in lump-sum or by installments. The profit may be either a fixed sum or based on a percentage of the price of the
goods.
Types of Murabaha
In respect of dealing parties Bai-Murabaha may be of two types:
•
•
Ordinary Bai-Murabaha, and
Bai-Murabaha order on and Promise.
Ordinary Bai-Murabaha is a direct transaction between a buyer and a seller. Here, the seller is an ordinary trader who purchases goods from the market in the hope of selling these goods to another party for a profit. In this case, the seller undertakes the entire risk of his capital investment in the goods purchased. Whether or not he earns a profit depends on his ability to find a buyer for the merchandise he has acquired.
Bai-Murabaha order on and Promise involves three parties - the buyer, the seller and the bank. Under this arrangement,
the bank acts as an intermediary trader between the buyer and the seller. In other words, upon receipt of an order and
agreement to purchase a certain product from the buyer, the bank will purchase the product from the seller to fulfill the
order.
There are some important features of Bai-Murabaha as given below.
Important Features of Murabaha
• A client can make an offer to purchase particular goods from the bank for a specified agreed upon price, includig the
cost of the goods plus a profit.
• A client can make the promise to purchase from the bank, that is, he is either to satisfy the promise or to indemnify any
losses incurred from the breaking the promise without excuse.
• It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify any
losses that may result.
• Documentation of the debt resulting from Bai-Murabaha by a Guarantor, or a mortgage, or both like any other debt is
permissible. Mortgage/Guarantee/Cash Security may be obtained prior to the signing of the Agreement or at the time of
signing the Agreement.
• Stock and availability of goods is a basic condition for signing a Bai-Murabaha Agreement. Therefore, the bank must
purchase the goods in accordance with the specifications of the client, thereby taking ownership of the goods before
signing the Bai-Murabaha agreement with the client.
• Upon acquiring the goods, the bank assumes the risk of ownership. In other words, the bank is responsible for damages,
defects, and /or spoilage to the merchandise until such time that it is actually delivered to the buyer.
• The bank must deliver the goods to the client at the date, time, and place specified in the contract.
• The bank sells the goods at a price above the cost to obtain a profit. The sale price that is charged by the bank is agreed
upon in the Bai-Murabaha. The profit can be stated in terms of a flat dollar amount or on a percentage of the purchase
price. If a percentage is used, the percentage shall never be expressed in terms of time, in order to avoid confusion that
the price is a form of interest (Riba), which is not allowed.
• The price agreed to in the agreement is binding on both parties.
• It is permissible for the bank to contract with a third party to buy and receive the goods on its behalf. This agreement
must be a separate contract.
These features make Bai-Murabaha distinctive from all other modes of Islamic Investment.
Application of Bai-Murabaha
Murabaha is the most frequently used form of finance in Islamic banking throughout the world. It is suitable for financing
the different investment activities of customers with regard to the manufacturing of finished goods, procurement of raw
materials, machinery, and other required plant and equipment purchases.
Page 4
Issues in Islamic Banking: Liquidity Management
In a conventional banking system, the treasury has to manage the bank’s cash flow to maximise the profit generating potential of the front lines, and to protect the balance sheet and P&L statement from erosion due to market risk. To achieve
this all current and future cash flows are to be identified and priced at market levels. The excess liquidity is to be managed
through mainly four ways;
(1) Lending the surplus in the inter-bank network,
(2) Invest in government securities,
(3) Lend to corporate customers,
(4) Keep the excess funds at 0 percent return. The first three ways involve interest and Islamic Banks cannot utilise these
options.
From a liquidity management perspective, Islamic banking have to come a long way. Today, many more multinational
companies (MNCs) are exploring the potential to optimise their liquidity across the globe and are making useful improvements in the management of their day-to-day liquidity problems.
Liquidity risk encompasses risks arising out of gaps in applications and available resources, mismatching of tenors of
sources, and application of funds, not meeting prudential liquidity requirements, lack of access to the market etc.
For this, the conventional bank’s treasuries used to place the excess funds overnight in money market but the Islamic banks
cannot do this because of Shariah constraints.
Surplus liquidity with Islamic banks cannot be easily transferred to conventional banks since the Islamic banks do not accept interest, however there is room for exchange of surplus funds among the Islamic banks on a Mudarabah / Musharakah
basis. The greater the number of Islamic banks and wider their activities, the greater will be the scope of cooperation in
this field.
In general, to manage liquidity effectively, you need visibility of your cash positions, good forecasting, a way to concentrate
your funds, and the ability to negotiate FX and get it done before cut-off times. The challenges, with liquidity management
in Islamic Banks, are not just regulatory ones. It may currently be difficult to manage the excess liquidity but it will soon be
possible as steps are being taken to make a liquidity management structure for Islamic banks / divisions .
Investments will be made in equity or mutual funds and in any Shariah compliant Islamic product available in the market
at that particular time or to invest the excess funds with other Islamic banks. An ‘Islamic Collective Investment Scheme’
can then be introduced to collectively manage the problem of excess liquidity.
State Bank of Pakistan has formed a Task Force to map out a plan for introducing short term and medium term liquidity
management products based on innovative Islamic Structures that would enable Islamic Banking Institutions in Pakistan to
manage liquidity matters.
Terms of Reference of this task force includes structuring of Islamic Instruments for short term liquidity management,
comparative study of such Islamic Instruments issued by other countries, practices of IIFS in meeting SLR by Central
Banks, structuring of Shariah compliant instruments for money market operations, introduction of Islamic instruments
using securitization techniques, examination of these instruments from regulatory, legal and operational requirements,
preparation of recommendations on modes and methods for issuance of these instruments, reporting mechanism of these
instruments, identifying instruments which can be used by the Government of Pakistan, etc.
Page 5
Upcoming Events & Training
Title
Organisation
Islamic Real Estate Asia 2006
Location of Organisation
Singapore
Event Dates
From: 11/9/2006 to: 12/9/2006
Location of Event
Grand Copthorne Waterfront Hotel, Singapore
Event Details
Finance IQ is proud to bring you the first and only Islamic Real Estate conference to take place in Asia. Taking place
11-12 September the conference brings together leading experts in Islamic finance and real estate not just from Asia,
but from all over the world. For more information please contact Andrew Thake at (65) 6722 9388, email – [email protected] or log on to www.iqpc.com.sg/AS-3378
Title
Organisation
Fundamentals of Islamic Banking & Finance
Location of Organisation
Malaysia
Event Dates
From: 11/9/2006 to: 14/9/2006
Location of Event
Jakarta
Event Details
The 4-day programme will explain the background and most important characteristics of Islamic finance. The course
will go on to examine the most commonly structured products, including capital markets instruments. http://
www.islamicfinancetraining.com/fibf.php
Title
World Islamic Infrastructure Finance Conference
Organisation
MEGA
Location of Organisation
United Arab Emirates
Event Dates
From: 5/11/2006 to: 6/11/2006
Location of Event
Doha, Qatar
Event Details
The 1st Annual World Islamic Infrastructure Finance Conference will bring together Investors, Project Developers,
Conventional & Islamic Financial Institutions with key Government agencies in order to fast-track infrastructure development. The theme of this major world conference will tackle how conventional and Islamic institutions can better
collaborate in order to meet the huge demands for project finance.
Title
Organisation
Islamic Financial Engineering & Advanced Products
Location of Organisation
Malaysia
Event Dates
From: 6/11/2006 to: 9/11/2006
Location of Event
Dubai
Event Details
The course will enable delegates to develop a detailed understanding of core products such as Sukuk and Ijarah, as well
as requisites for Islamic financial engineering and the contracts involved. The course will also cover in detail contracts
for project financing and Islamic swap structures and uses. http://www.islamicfinancetraining.com/feap.php
Title
Organisation
Location of Organisation
Third International Business Conference
World Business Institute
Australia
From: 20/11/2006 to: 22/11/2006
Melbourne, Australia
Papers, abstract and case studies relating to all areas of Islamic Banking, Islamic Finance, Islamic Insurance (Takaful),
Islamic leasing, Islamic Ethics, Islamic Economics, Islamic concepts of Management, Marketing and Accounting are
invited from the researchers, students and practitioners. There are outstanding doctoral research awards and best paper
awards. Please visit www.worldbizconference.com for more information.
Event Dates
Location of Event
7
EventPage
Details
Finance IQ - A Division of IQPC Worldwide
Islamic Finance Training
Islamic Finance Training
Developments at State Bank of Pakistan
IFSB Task Force Meeting
The Islamic Financial Services Board (IFSB) is an international-standard setting body of regulatory and supervisory agency having vested interest in ensuring the soundness and stability of the Islamic financial services industry. To strengthen and streamline the statistical information on the Islamic financial services industry (IFSI)
worldwide, IFSB Task Force on “Prudential Islamic Finance Database” had its first meeting at Hotel Sheraton, Karachi on Wednesday August 23, 2006 under the patronage of State Bank of Pakistan which is a founding member
of the IFSB.
Business Review Meeting
•A Business Review Meeting was conducted on 17th August 2006 at the Board Room of the Learning Resource
Center of the State Bank of Pakistan, Karachi for the purpose of reviewing the performance of Islamic Banking
Business of Meezan bank. In the meeting following points were in focus:
•Products being offered
•Performance Review
•Marketing Plan
•Human Resource Capacity Building
•Service Standards
•Charity Fund
Projects submitted by the Internees
Internship of the five Internees assigned to the Islamic Banking Department completed on 16th August 2006. They
presented the following projects:
• Micro Finance in context of Islamic Banking
• Marketing & Promotion of Islamic Banks in Pakistan
• Importance of Corporate Governance in Islamic Banking
• Comparative Analysis of Islamic Banking Industry
Islamic Export Refinance Scheme
The State Bank has been striving to ensure that the credit requirements of the genuine exporters from the banking system are not effected. In order to ensure smooth
flow of credit to the genuine exporters the SBP has already put in place necessary
mechanism under its Export Finance Scheme (EFS), which has been in operation
since 1978. The recent developments relating to the introduction of specialized Islamic banking institutions have made it imperative for us to formulate a Scheme to
enable the exporter to avail SBP’s refinance through the newly established Islamic
Commercial Banks against eligible commodities. Accordingly, we have designed a
new Scheme styled as Islamic Export Refinance Scheme (the Scheme). Islamic Export Refinance Scheme was initiated in 2002 through Board approval. The said
Scheme shall also be utilized by the dedicated branches of the commercial banks
that would work as stand alone branches for providing the Islamic Banking Products
and Services, for availing refinance against financing facilities provided by them to
exporters for eligible commodities.
Page 7
International News
Islamic banking in foreign currencies soon
Bank Negara will issue new conditional licenses under the Islamic Banking Act and Takaful Act to allow qualified
local and foreign lenders and even takaful operators to conduct the full range of Islamic banking and takaful business in foreign currencies, said governor Tan Sri Dr Zeti Akhtar Aziz.
The move, she said, would augment Malaysia’s position as it strengthened itself as an international Islamic financial hub and, at the same time, “enhance the capabilities of foreign players that have identified Malaysia as a centre to serve the regional markets.”
“Islamic financial products and services that are transacted in international currencies may now be conducted
from anywhere in Malaysia,” Zeti said in her opening address at the Malaysian Islamic Finance Forum 2006.
StanChart, Bank Islam seal world's first Islamic hedging tool
Standard Chartered (StanChart) Malaysia Bhd and Bank Islam Malaysia Bhd have introduced the world's first Islamic financial hedging tool to facilitate their in-house risk management.
The two banks can now better manage their portfolio of risks by benefiting from lessened exposure from either
fixed or floating rates stemming from a Wiqa Forward Rate Agreement (WFRA).
WFRA enables a floating rate-based profit payment to be exchanged for a fixed profit payment for a specific time
period, or vice versa.
Under the deal signed between the two banks on August 15, Bank Islam will hedge RM130 million worth of financial assets over three years, using StanChart's Islamic hedging facility.
Bank Negara: Need to resolve Shariah matters
Bank Negara plans to launch initiatives for the harmonisation of different Shariah interpretations and called for
the stepping up of dialogue among scholars around the globe. “Let us debate, confront the issues and hopefully
come out with solutions to these long outstanding issues,” deputy governor Datuk Mohd Razif Abdul Kadir said in
his closing address.
“We are assembling a group of prominent scholars across the globe to confront issues concerning Islamic banking
and finance. So now is the time for us to take these Shariah issues seriously,” Razif said. The harmonisation of
syariah interpretations would greatly enhance the markets, products and liquidity of the Islamic banking and finance sector, he said.
BIBD, BLNG to issue first corporate Islamic bonds
In realising the first-ever corporate issue of Islamic bonds or 'Sukuk Al-Ijarah', Bank Islam Brunei Darussalam
Berhad (BIBD) as an integral part of the financial community in the country is proud to be working together with
Brunei LNG Sdn Bhd (BLNG) and the Ministry of Finance.
The first syariah-compliant financial instrument based on the Sukuk Al-Ijarah concept in collaboration between
BLNG and BIBD was launched in a signing ceremony held at the BIBD Headquarters in the capital.
Page 9
Japan set to enter Islamic banking
The government-backed JBIC said it was studying the possibilities of issuing Islamic bonds to help Japanese businesses diversify their fund raising
Japan is looking to become the first major industrialized nation to issue Islamic bonds in hopes of attracting
money from oil-rich Muslim countries, a bank official said yesterday.
Islamic financial practices ban the payment or receipt of interest or any transactions that include alcoholic beverages or gambling, which are banned by the Koran.
"The bank is studying the possible issuance of the bond with Malaysia," said Hiromi Inukai, a spokeswoman of the
government-backed Japan Bank for International Cooperation (JBIC).
"The bank has had talks with the central bank of Malaysia with the intention to attract ample petro-dollars not
only to Japan but also to the whole of Asia," she said.
She declined to give further details such as how much of the bond JBIC officials, with the support of the finance
ministry, would place with Bank Negara Malaysia, the Malaysian central bank, and when.
Japanese news reports have said that the JBIC has formed an advisory board of Islamic legal scholars to study Islamic financial practices.
Moscow bank wins $20m Murabaha facility
The UK-based global trade finance group CCH International, through its German subsidiary, CCH Europe GmbH,
has arranged a debut Dh73.45 million ($20 million) Murabaha facility for Globexbank in Moscow financed by an
unnamed GCC-based Islamic bank.
This is the first Murabaha facility extended to a Russian institution by an Islamic bank, said a report in the Arab
News quoting managing director of CCH International Eren Nil.
"Islamic financial institutions have virtually no exposure to Russian risk and therefore the market is of great interest to CCH. Given the size of the Russian market and its need for liquidity, we are confident of arranging further
Shariah-compliant transactions for Russian institutions in the future," Nil is quoted to have said.
The facility, which is guaranteed by Globexbank, is being used to supply and sell goods at an agreed price, plus a
profit markup, to a client of the bank, the report added.
For any query please contact:
Imran Ahmad
Joint Director
[email protected]
2453711
Sumera Baloch
Regulating Officer
[email protected]
2453724
Page 10
Mission
To Make Islamic Banking the banking of first choice for the providers
and users of financial service
Islamic Banking Department was established on 15th September,
2003 and has been entrusted with the huge task of promoting &
developing the Shariah Compliant Islamic Banking as a parallel
and compatible banking system in the country.
Annexure-1
Number of Licensed Islamic Banks and
IBBs as at 08.09.2006
No.
of
Bank's Name
Branches
A) Islamic Banks
1 Meezan Bank Limited
42
2 Albaraka Islamic Bank
9
3 BankIslami Pakistan Limited
6
Dubai Islamic Bank Pakistan
4 Limited
8
Emirates Global Islamic Bank
5 Limited*
6 First Dawood Islamic Bank*
Total of A
65
B) Islamic Banking
Branches
1 Muslim Commercial Bank
5
2 Bank of Khyber
5
3 Bank Alfalah Limited
19
4 Habib Bank AG Zurich
2
5 Standard Chartered Bank
3
6 Metropolitan Bank
1
7 Bank Al Habib Ltd.*
1
8 Habib Bank Ltd.*
1
9 Soneri Bank Limited
2
10 Prime Commercial Bank
2
11 Askari Commercial bank
4
Total of B
45
A+B
110
* These two banks are expected to start operations
soon.
Page 11
Local News
Islamic banking flourishing in country
The Islamic banking has captured 2 percent market share in only three-year period in the country due to rapid
growth of this industry. This was stated by Pervez Said, director, Islamic Banking Department, State Bank of Pakistan (SBP), while speaking at a seminar on "Efficiency, Diversity and Competition in Islamic Banking and Insurance Industry", organised by the Institute of Business and Technology at a local hotel on Saturday.
He said that four full-fledged Islamic banks are operating in the country, while a couple of license applications of
Islamic banks are in pipeline. Pervez said the Islamic banking operation was started in Malaysia in 1983 where the
market share of Islamic banking is 11.6 percent while in Indonesia Islamic banking operation was launched in
mid-90s and its market share is 1.34 percent. In Pakistan, its operation was started in 2003, he said, adding the
Islamic banking has captured 2 percent market share in only three years, which is good achievement.
He said that the growth of Islamic banking was resulted due the attractive policies of the present government.
Pervez said the central bank wants to run a parallel Islamic banking system with the conventional system and
provide
opportunity
to
the
people
to
choose
any
system,
which
they
like.
SBP governor opens Dubai Islamic Bank branch
State Bank of Pakistan (SBP) Governor Dr. Shamshad Akhtar inaugurated Dubai Islamic Bank's Karachi branch at
Cloth
Market.
"Given Dubai Islamic Bank's international stature and regional presence, we anticipate that the bank will bring to
Pakistan the required technology, instruments and institutional framework, so as to set the standard for other Islamic banks to follow", said the SBP Governor after inaugurating the branch premises.
"We have observed phenomenal growth in the Islamic banking industry in a short period of time as Islamic banking has evolved as an institution to help achieve financial sector growth in a Muslim country as Pakistan", she
added.
Later, the SBP Governor and Advisor to the SBP Governor on Islamic banking, Pervez Said, were given a tour of
the branch premises by a delegation of Dubai Islamic Bank, including Chief Executive Officer (CEO) Saad Zaman
and Deputy CEO M. A. Mannan; during which network expansion plans of the bank were discussed.
Dow Jones Indexes and JS Group to Launch Islamic Index for Pakistan
Dow Jones Indexes, a leading global index provider, and JS Group, Pakistan's premier financial group, today announced the launch of the Dow Jones-JS Pakistan Islamic Index. The index measures the performance of companies in the Pakistani stock market that pass screens for compliance with Islamic principles.
The Dow Jones-JS Pakistan Islamic Index is designed to serve as an underlying index for investment products such
as mutual funds, exchange-traded funds (ETFs) and other investable products. This is the first time that a dedicated Islamic Index for Pakistan has been launched by a major global index provider.
Page 8
Islamic finance
Emerging Islamic
CAPITAL MARKETS a quickening pace and new potential
by Zamir Iqbal and Hiroshi Tsubota, The World Bank
Describing the Islamic financial system simply as ‘interest-free’ does
not do justice to the system. Promotion of entrepreneurship,
preservation of property rights, transparency and the sanctity of
contractual obligations, which are crucial to any sound financial
system, describe its essence. Today, Islamic financial and banking
activities have reached an impressive size of over US$250bn, as
compared to a meagre US$6bn in the early 1980s. Market participants
and policy makers are increasingly paying attention to its potential
and how to take advantage of the opportunities presented.
The term ‘Islamic finance’ or ‘Islamic financial system’1
as to comply with Islamic principles. But it was not until
is not as uncommon today as it was two decades ago
the first wave of oil revenues in the 1970s and the
when financial institutions in several Muslim countries
accumulation of petro-dollars which gave momentum to
started exploring ways to operate a banking system
this idea, that the Middle East saw a mushrooming of small
prohibiting the payments and receipts of interest. Islamic
commercial banks competing for surplus funds. At the same
modes of financing have been in practice in some form
time, interest grew in undertaking theoretical work and
or other since the early history of Islam. Throughout the
research to understand the functioning of an economic and
Middle Ages, Islamic merchants became indispensable
banking system without the institution of ‘interest.’
middlemen for fostering trade through development of
Continuing demand throughout the 1980s led to
sophisticated credit instruments in Spain, the
sustainable growth and, by the 1990s, the market for
Mediterranean and Baltic states.
Islamic financial products had attracted the attention of
In modern banking history, an interest in the revival of
several western commercial banks, which started to offer
Islamic modes of financing emerged in several Muslim
specialised financial services to high net worth
countries, during their post-colonisation period. In the early
individuals and later at the retail level through ‘Islamic
1960s, independent but parallel attempts in Egypt and
windows.’ Today, there are more than 240 financial
Malaysia led to the establishment of financial institutions,
institutions operating on the basis of non-interest based
which were designed to operate on a non-interest basis so
instruments in more than 40 different countries.
5
Islamic finance
•
discouragement of speculative behaviour;
BASICS OF ISLAMIC ECONOMIC AND FINANCIAL
•
preservation of property rights;
SYSTEMS
•
transparency; and
•
the sanctity of contractual obligations.
An Islamic economic and financial system is a rule-based
The system can be fully appreciated only in the context
system comprising a set of rules and laws, collectively
of Islam’s teachings on the work ethic, wealth
referred to as Sharia’ governing economic, social,
distribution, social and economic justice, and the
political and cultural aspects of Muslim societies. Sharia’
expected responsibilities of the individual, society, the
originates from the rules dictated by the Quran, from the
state and all stakeholders.
practices of the Prophet Muhammad, and further
elaboration of the rules by scholars in Islamic
jurisprudence through the process of deduction (Qiyas)
EMERGING ISLAMIC CAPITAL MARKETS
and consensus (Ijma’). Over time, four different schools
of thought – Hanafi, Maliki, Shafei and Hanbali have
During the 1980s and 1990s, Islamic financial institutions
emerged with some variations on the rules depending on
were able to mobilise funds successfully through deposits
respective interpretations.
invested in a handful of financial instruments, dominated
The central tenet of the financial system is the
financial institutions included
excess” and interpreted as “any unjustifiable increase of
•
cost-plus-sale or purchase finance (Modaraba’);
capital whether through loans or sales.” More precisely,
•
leasing (Ijara’);
any positive, fixed, predetermined rate tied to the
•
trust financing (Modaraba’); and
maturity and the amount of principal (i.e., guaranteed
•
equity participation (Musharika’).
regardless of the performance of the investment) is
Due to market conditions, lack of liquid assets and
considered Riba and is prohibited. The general consensus
other constraints, the composition of Islamic financial
among Islamic scholars is that riba covers not only usury
institutions’ assets stayed fairly static and heavily focused
but also the charging of “interest” as widely practiced.
on short-term instruments (mainly commodity finance).
This prohibition is not to be confused with a rate of
By the late 1990s, there were many calls for the
return or profit on capital, as Islam encourages the
introduction of new products and the promotion of
earning and sharing of profits, because profit,
financial engineering.2 Main areas of concern were the
determined ex post, symbolises successful
lack of liquidity, a lack of portfolio and risk management
entrepreneurship and the creation of additional wealth;
tools and the absence of derivative instruments.
whereas interest, determined ex ante, is a cost that is
One of the impediments to growth was the lack of
accrued irrespective of the outcome of business
understanding the fast changing landscape of modern
operations and may not create wealth if there are
financial markets as well as the intricacies of rules
business losses.
demanded by the Sharia’. The task was further
Undoubtedly, prohibiting the receipt and payment of
6
by trade financing. Activities on the asset side of Islamic
prohibition of ‘Riba’ – a term literally meaning “an
complicated by the different schools of Islamic thought
interest forms the nucleus, but it is supported by other
in various parts of the globe. Nevertheless, by the late
principles of Islamic doctrine;
1990s, Islamic financial institutions had realised that the
•
advocating risk sharing;
development of capital markets was essential for their
•
promotion of entrepreneurship;
survival and further growth. Meanwhile, deregulation
Islamic finance
and liberalisation of capital movements in several
conventional debt securities. The result is that within a
countries led to close cooperation between Islamic
short span of less than five years, the market for Sukuk
financial institutions and conventional financial
have reached an impressive size of US$30bn which
institutions in order to find solutions for liquidity and
includes several sovereign and corporate issues (see
portfolio management. The result was two distinct
Exhibit 1 - notable transactions in the first half of 2005).
developments – the introduction of equity funds which
were compatible with Sharia’ and the launch of Islamic
asset-backed securities more commonly known as Sukuk.
WHAT IS A SUKUK?
Whereas Islamic equity funds became popular with
investors who had a risk appetite for equity investment,
The idea behind a Sukuk is simple. Prohibition of interest
Islamic financial institutions, driven by the nature of their
virtually closes the door for a pure debt security but an
intermediation, kept demanding securities which could
obligation which is linked to the performance of a real
behave like conventional fixed-income debt securities but
asset is acceptable. In order words, Sharia’ accepts the
also comply with Sharia’. In addition, Islamic financial
validity of a financial asset which derives its return from
institutions wanted to extend the maturity structure of
the performance of a real asset. The word Sukuk (plural of
their assets beyond the typical short-term maturities
the Arabic word Sakk meaning certificate) reflects
provided by trade-finance instruments. This led to the
participation rights in the underlying assets. The design of
creation of Sharia’ compliant asset-backed securities,
the security is derived from the conventional securitisation
Sukuk, which have risk/return characteristics similar to
process in which a special purpose vehicle is set-up to
Exhibit 1
Notable transactions in the first half of 2005
Country
Issue date
Amount
Maturity
(year)
Type
Bahrain
Pakistan
February-05
January-05
BD30m
US$600m
5
5
Ijara’ (Leasing)
Ijara’ (Leasing)
Islamic Development Bank
Supranational organisation
June-05
US$500m
5
Sukuk
The World Bank
Supranational organisation
April-05
M$760m
5
Bai’ Bithaman Ajil (BBA)
(deferred-payment sale)
PLUS Expressways Bhd
Malaysia
June-05
M$2,410m
11 - 14
Bai’ Bithaman Ajil (BBA)
(deferred-payment sale)
CIMB
Jimah Energy Ventures
Malaysia
May-05
M$405m
6 - 16.5
Istisna’ (purchase order)
Commercial Real Estate Company
Kuwait
May-05
US$100m
5
Ijara’ (leasing)
Time Engineering (Musyarakah
One Capital Bhd)
Malaysia
April-05
M$566.55m
1-5
Musharika’ (profit and
loss-sharing
Ammercchant Bank Berhad, RHB
Sakura Merchant Bhd, MIMB,
Kuwait Finance House, Liquidity
Management Centre
CIMB
Durrat Sukuk Company BSC
Bahrain
January-05
US$152.5m
5
Istisna’ and Ijara’ Sukuk
Issuer
Sovereign
Government of Bahrain
Government of Pakistan
Supranational
Manager(s)
Bahrain Monetary Agency
Citgroup, HSBC Amanah
HSBC Amanah, Deustche Bank,
CIMB, Dubai Islamic Bank
CIMB, ABN Amro Bank Bhd
Corporate
Kuwait Finance House
Source: Compiled from various market sources
7
Islamic finance
Anatomy of a Sukuk
Exhibit 2
Fund mobilising entity
Credit enhancement
Guarantor
Special purpose Modaraba’
SPM/SPV
Pool of assets
(Ijara’/leases)
Assets
Liabilities
Ijara’ assets
(leases)
Sukuk
certificates
Servicing
Investors: Islamic,
conventional institutional investors,
pension funds, etc.
Source: Iqbal, 1999
acquire assets and to issue financial claims on the asset.
The majority of Sukuk issued to date are based on two
Such financial claims represent a proportionate beneficial
classes of assets. The first class of assets fall into financial
ownership for a defined period when the risk and the
claims created out of a spot sale (Salam) or a deferred-
return associated with cash-flows generated by an
payment sale (bay’ mu’ajjal) and/or a deferred-delivery sale
underlying asset, is passed to Sukuk holders (investors).
(bay’salam) contract, whereby the seller undertakes to
The core contract utilised in the process of securitisation
supply specific goods or commodities, incorporating a
to create a Sukuk is an Islamic contract of intermediation
mutually agreed contract for resale to the client and a
known as Modaraba’ (trust financing), which allows one
mutually negotiated margin.
party to act as an agent (manager) on behalf of a principal
8
Salam-based Sukuk have proved to be a useful
(capital owner) for an agreed fee or profit-sharing
investment vehicle for short-term maturity since underlying
arrangement. The contract of Modaraba’ is used to create a
commodity financing tends to be for a short-term tenor
Special Purpose Modaraba’ (SPM) entity, similar to the
ranging from three months to one year. However, due to the
conventional Special Purpose Vehicle (SPV), to play a well-
fact that the Sukuk results in a pure financial security and
defined role in acquiring certain assets and issuing
is somewhat de-linked from the risk/return of the
certificates against the assets. The underlying assets
underlying asset, Sharia’ treats it as a pure debt security.
acquired by SPM need to be Sharia’ compliant and can
Consequently, many investors, including those in the GCC
vary in nature. Depending upon the nature of underlying
countries cannot trade these Sukuk in the secondary
assets and the school of thought, the tradability and
market, either at a discount, or at a premium. Trading will
negotiability of issued certificates is determined.
introduce a mechanism to indulge in Riba or interest in the
Islamic finance
transaction. Due to this restriction, investors tend to hold
investment needs, they would have to access external
Salam-based Sukuk up to the maturity of the certificate.
sources of financing.
In order to provide longer-term maturity and limited
Furthermore, Muslim stakeholders in middle-income
tradability and negotiability to investors, a second class
countries are increasingly expressing their preference for
of Sukuk is based on leasing (Ijara’). An Ijara’
Sharia’ compliant financing. Borrowers, especially public-
instrument is one of the instruments which bears the
sector institutions, are starting to reflect their stakeholders’
closest resemblance to a conventional lease contract and
voices in the implementation of financial operations. In
offers flexibility of both fixed and floating-rate payoffs.
turn, financial intermediaries, including private-sector
The cash-flows of the lease including rental payments
commercial and investment banks, as well as development
and principal repayments are passed through to
finance institutions, are likely to start paying more
investors in the form of coupon and principal payments.
attention to such ‘non-financial’ needs of their clients - in
Ijara’-based Sukuk provide an efficient medium-to
addition to satisfying these borrowers’ funding needs, in
long-term maturity mode of financing.
order to stay successful in the marketplace.
For the Multilateral Development Banks (MDBs), such as
the World Bank, the development of Islamic capital
CURRENT MARKET ENVIRONMENT
markets will be a highly relevant topic. Firstly, MDBs are
deeply involved in infrastructure finance in their
Islamic capital markets are now gaining the momentum to
borrowing member countries and would therefore naturally
grow into a vibrant marketplace, especially for emerging
be interested in the emerging Islamic capital market as a
market borrowers in the regions of the Middle-East,
new and alternative source of financing. Secondly, by
South-East Asia, South Asia and North Africa.
channeling the funds available in Islamic financial markets,
On the supply side, the volume of Islamic investments
which are mostly based in the countries with high savings
– with a preference for Sharia’ compliant instruments –
such as the GCC countries and Malaysia, to finance
has grown to form a critical mass that can support a
investments in developing countries, MDBs can create a
well-functioning and efficient capital market. It is
new model for international development cooperation
evolving into a truly international market. Not only
while responding to the stake-holders’ voices on both sides.
highly rated borrowers such as the Multilateral
Thirdly, MDBs can promote financial stability by
Development Banks (for example, the World Bank), but
encouraging the development of Islamic capital markets to
also developing country borrowers with lower credit
enhance liquidity, and enabling Islamic financial
ratings, such as Pakistan, have successfully raised a
institutions to have more diversified portfolios and sound
considerable volume of funds in this market.
risk management. Furthermore, this could also provide the
On the demand side, countries in the developing world,
especially the middle-income countries, will require a
momentum to integrate the Islamic financial markets
within the framework of the international financial system.
significant volume of investments in infrastructure over
the next decade. To illustrate, for Indonesia alone,
additional infrastructure investments of US$5bn (2% of
GOING FORWARD: CHALLENGES AND POLICY
GDP) are required annually, to reach a 6% medium-term
ACTIONS NEEDED
growth target, as estimated by the World Bank.3
Because the domestic capital markets of these borrowers
In the near future, it is most likely that structures which
are often not deep enough to satisfy their large
provide investors with a pre-determined return as well as
9
Islamic finance
full recourse to the obligor (such as Ijara’ and
Investors, on the other hand, can significantly support
Murabaha’) would have more market potential than other
market development by expressing their preference for
structures. As discussed earlier, this will be driven
Sharia’ compliant instruments more concretely, namely
primarily by investor preferences, but a large proportion
in terms of their bid prices. For intermediaries, they can
of potential borrowers would also prefer to lock-in their
lead the process to reduce transaction costs, perhaps
borrowing costs rather than engage in pure profit
through further standardisation of transaction schemes
sharing schemes.
and instruments.4
While the overall market background appears
Sharia’ scholars can also play an important role. It is
promising, certain obstacles and constraints may lie
essential that multi-disciplinary expertise, covering topics
ahead and market participants and regulators need to
ranging from theological interpretation to financial
take concrete steps to support market take-off.
structuring, be developed through knowledge-sharing,
Firstly and most importantly, market development
cross-training and acquiring an understanding of the
requires a strong sponsorship and leadership of the host
functioning of markets. To stimulate cross-border
country government, especially on legal and regulatory
activities in the primary as well as secondary markets,
issues. For example, for an Ijara’ transaction, the owner of
the acceptance of contracts across regions and across
operating assets needs to enter into a leasing transaction.
schools of thought and markets will also be helpful.
While the owners of operating assets are often the
government itself or its related public-sector bodies, the
relevant laws and regulations in the host country may not
CONCLUSION
allow these public-sector bodies to pledge or lease assets
needed to structure an Ijara’ transaction. This is a
In the wake of the current wave of oil revenues and
fundamental point; the host country’s policy actions to
increasing demand for Sharia’-compliant products,
promote such Islamic finance will be a key prerequisite for
Islamic capital markets are emerging at a quickening
the market to develop further.
pace and stakeholders are starting to realise the potential.
Furthermore, borrowers, investors as well as
international fora, such as establishment of accounting
now, Islamic transactions often face a competitive
standards and regulatory bodies, are all steps in the right
disadvantage to conventional bond issues in terms of
direction.5 However, for the market to grow further, it
cost-efficiency. Each new issue incurs higher levels of
also needs strong leadership and constructive policy
legal and documentary expenses as well as distribution
actions of host governments, to enable market
costs; and involves examining structural robustness in
participants to originate Islamic finance transactions.
addition to evaluating the credit quality of the obligor.
10
Development of institutional infrastructure in the
intermediaries need to nurture the market patiently. As of
Well-developed Islamic capital markets will not only be
Also, since the terms available in Islamic capital markets
beneficial for borrowers and institutional investors, they
are mostly derived from the pricing levels in the more
can also further enhance the stability of Islamic financial
liquid conventional bond markets, there is no inherent
institutions, providing them with improved portfolio,
funding cost advantage for borrowers tapping Islamic
liquidity and risk management tools. Ultimately, all these
markets. Borrowers, therefore, would need to formulate a
developments will contribute to integrating Islamic
comprehensive, long-term and strategic view on how to
financial markets, as well as the people who form these
reduce the overall funding cost by tapping Islamic
markets, into the framework of the broader conventional
markets, rather than focusing on a single transaction.
international financial system.
Islamic finance
Notes:
The World Bank Jakarta Office (2004), “Indonesia – Averting an Infrastructure Crisis: A
1. For a further description of Islamic financial systems refer to Iqbal (1997).
Framework for Policy and Action”, Jakarta, Indonesia.
2. See Iqbal (1999) and Iqbal and Mirakhor (2002).
3. Indonesia – Averting an Infrastructure Crisis: A Framework for Policy and Action, The World
Bank, 2004.
4. For example, in the Malaysian market, market participants have developed a few well
standardised structures, such as Bai’ Bithaman Ajil. Structuring as well as distribution costs for
these standardized Islamic deals in Malaysia are now reduced to a competitive level, making
them a viable alternative to conventional debt instruments.
5. These institutions include Islamic Financial Service Board (IFSB), Accounting and Auditing
Organization of Islamic Financial Institutions (AAOIFI), Liquidity Management Center (LMC),
International Islamic Financial Markets (IIFM) and International Islamic Rating Agencies (IIRA).
References:
Iqbal, Zamir (1997) Finance and Development, International Monetary Fund,
Washington, D.C. June, http://www.imf.org/external/pubs/ft/fandd/1997/06/pdf/iqbal.pdf
Hiroshi Tsubota and Zamir Iqbal
Zamir Iqbal and Hiroshi Tsubota are
Principal Financial Officers in Quantitative Strategies,
Risk and Analytics (QRA), and Banking, Capital Markets
Iqbal, Zamir (1999), “Financial Engineering in Islamic Finance,” Thunderbird
and Financial Engineering (BCF) departments of the
International Business Review, Vol 41, No. 4/5, July-October 1999, pp. 541-560.
World Bank Treasury in Washington, DC.
Iqbal, Zamir and Abbas Mirakhor (2002), “Development of Islamic Financial
Institutions and Challenges Ahead,” in Simon Archer and Rifaat Abdel Karim (eds.)
Islamic Finance: Growth and Innovation, Euromoney Books, London, UK.
For further information,
please e-mail: [email protected] or
[email protected]
Views expressed in the article are of the authors and do not reflect views of the Board of Directors and of the World Bank Group. Authors wish to thank Hennie Van Greuning, Doris Herrera-Pol, and
Kenneth Lay for their comments.
11