Demystifying Islamic Finance Leasing Life Conferences The New Horizon: Islamic Leasing’s Rising Star 27 April 2004 1/27 Warren Edwardes Demystifying Islamic

Warren Edwardes

Demystifying Islamic Finance Leasing Life Conferences The New Horizon: Islamic Leasing’s Rising Star 27 April 2004

1/27

Demystifying Islamic Finance

• Warren Edwardes, ceo, Delphi Risk Management Ltd

• Islamic Leasing’s Conference

• Millennium London Mayfair Hotel London W1

• 27th May 2004

• Full article on: http:// dc3.co.uk/islamicleasingintro.htm

• Islamic banking and finance news: http:// dc3.co.uk/ibnews

• Contact: [email protected]

Warren Edwardes


2/27

QuotesHappy the man who far from schemes of

business, like the early generations of mankind, ploughs and ploughs again his ancestral land with oxen of his own breeding, with no yoke of usury on his neck.

Roman philosopher, Horace

Julius Caesar limited interest to 8 1/3 %

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QuotesNeither a borrower nor a lender be; For loan oft

loses both itself and friend and borrowing dulls the edge of husbandry.

Shakespeare’s «hamlet», a Danish father advising his son

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QuotesThose who devour usury will not stand except

as stands one whom the evil one by his touch hath driven to madness. That is because they say: "trade is like usury but Allah hath permitted trade and forbidden usury.”

The Koran: Surah 2, verse 275

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Jargon: Latin used by lawyers

• In haec verba

– Verbatim

• Nunc pro tunc

– Retroactive

• Caveat emptor

– Let the buyer beware

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Jargon: Greek used by derivatives dealers

• Delta

– Sensitivity of an option price to changes in the price of the underlying equity

• Theta

– Sensitivity of an option price to changes in time

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Jargon: Arabic used by Islamic bankers

• Ijara

– Leasing

• Muqarada

– Mudaraba

• Mudaraba

– Profit-sharing

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• Alwadiah

– Safe keeping

• Baimuajjal

– Deferred-payment sale

• Baisalam

– Pre-paid purchase

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• Murabaha or Shirka

– Cost-plus or mark-up

• Musharaka

– Equity participation

• Qard Hasan

– Benevolent loan (interest free)

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Overview

• Hallal vs. Haram

– Not just about Hallal Chicken Tikka Masala but also about finance

• Interest, usury, riba used interchangeably but are different

• Essentially three dimensions of Islamic finance1. Riba free - Profits and Loss Sharing PLS

2. Riba free – trade related mark up

3. Ethical dimension

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Overview – 1. Profit & Loss Sharing

• Profit & Loss Sharing

– basically, no pain no gain

• Venture capital, non-recourse project finance, equity investment vs lending

• US / UK banking models vs German, Japanese, Spanish banking

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Overview – 2. Markup

• Mark up - predetermined profit.– Predominates 87% Pakistan, 63% Iran– Investors’ risk aversion– Borrowers’ protection of equity interests

• Tax similarities - interest versus capital gains tax• Interpretations change

– Treasury bills, foreign exchange, zero coupons, circular transactions.

• Various jurisdictions / opinions– Gulf, Malaysia, London

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Overview – 3. Ethics

• Ethical dimension - undesirable investments sectors

– Tobacco, Alcohol, Armaments, Gambling

• Charitable aspects

– Interest donated to charity

– Can the borrower afford to repay?

– Faith does not mean soft option for bankers. No easy touch

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Riba is more than Usury

• Excessive interest– UK usury laws on excessive interest abolished in 1854

– South Africa and US (except Virginia and Delaware) have usury laws

• Early repayment penalties

• No distinction between fair and unfair interest

• Trade is allowed

• Repayment only if borrower is able to?

• Section 233 loans – dividends or interest

• “Unearned” income taxed at 97% in the UK

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Key Islamic Financial Instruments PLS

• Mudaraba / Modaraba

– PLS no pain no gain

– Rabbulmal - capital provider / investor

– Mudarib - entrepreneur / borrower

– Profits split between Rabbulmal and Mudarib as agreed

– Losses only to financier.

• Looks like non-recourse project finance

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• Shirka

– Generalised Mudaraba

– More than 2 parties

– Non contractual - Al Milk,

– Contractual Ul Uqud

• Looks like syndicated non-recourse project finance

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• Musharaka

– Equity investing

– Limited partnership

– Profits distributed according to pre-agreed formula

– Fair share of profits? 95% to investor?

• Looks like normal equity investments or fund management

• Sounds like “shares”

• Loss sharing? Limited liability to investment.

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Key Islamic Financial Instruments PLS• Al- Wadiah

– Retail savings account

– Cheque books bill payments, credit cards etc.

– Dividend paid subject to profits through the year

– Only profits no loss of capital

– Short term accounts

• Looks like with profits bonds

• Other retail

– Prizes, gifting of interest to charity, no transaction fees

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Key Islamic Financial Instruments – Mark-up

• Murabaha

– Mudaraba / Musharaka on bank liability side

– Murabaha / Morabaha on asset side.

– Locked-in return

– Bank buys asset on behalf of client / borrower and then sells it for deferred payment

– Title transfers at outset or on payment at maturity

– Interest into capital gains? Use of Libor

• Sounds like “Repo” a sale and repurchase agreement

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Key Islamic Financial Instruments - mark-up

• Baimuajjal

– Property financing on a deferred basis

– Payment in instalments or lump sum with mark-up

– Predetermined profit.

• Ijara

– Leasing type transaction

– Title stays with lessor

– Option to buy goods on maturity of contract

– Ijara wa iqtina is renting then purchase

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Key Islamic Financial Instruments - Mark-up

• Baisalam

– Manufacturers financing of production

– Bank buys & pays for goods at a discount before manufacture

– Commodity futures contract? A derivative?

– Similar to Bankers Acceptance – BAs

• Al Bay Bithaman Ajil

– BBAs popular in Malaysia

– Financing sales by deferred instalments

– Trade not debt

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Key Features of Islamic Banking

• Interest free

• Trade related and perceived need for funds

• Pure form of Islamic Banking? – profit & loss sharing

• Avoids exploitation - no usury

• Ethical investments

– Alcohol, tobacco, gambling, armaments, pornography etc

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Demystifying Islamic Finance

• Warren Edwardes, ceo, Delphi Risk Management Ltd

• Islamic Leasing’s Conference

• Millennium London Mayfair Hotel London W1

• 27th May 2004

• Full article on: http:// dc3.co.uk/islamicleasingintro.htm

• Islamic banking and finance news: http:// dc3.co.uk/ibnews

• Contact: [email protected]

Documents

Demystifying Islamic Finance Leasing Life Conferences The New Horizon: Islamic Leasing’s Rising Star 27 April 2004 1/27 Warren Edwardes Demystifying Islamic