IslamIc FInance In asIa: Development, Growth anD opportunItIes

IslamIc FInance In asIa: Development, Growth

anD opportunItIes KFH Research LtdKDNPP15024/03/2013 (031903) November 2013

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Contents

1. Global Islamic Finance: Growth, Development & Prospects

The growth and future prospects of the Islamic finance industry is reflected through the strong performance of the Islamic finance markets over the years, combined with growing participation of the international financial community and key multilateral development entities.

2. Economic and Financial Dynamics of Asia

All sub-regions within Asia witnessed healthy growth rates during 2006-2012 in terms of GDP per capita on a purchasing power parity basis. In future, the region’s largest economies are expected to display considerable growth differentials. Overall, momentum will pick up in 2014, led by improving import demand in advanced economies. Ultimately, Asia’s policymakers face a delicate balancing act in guarding against a build-up of financial imbalances and managing a transition to rebuilding policy space while delivering appropriate support for growth.

3. Islamic Finance in Asia

The Islamic financial industry in Asia is dominated by Islamic banking and sukuk segments, which have driven Asia’s robust growth trajectory in recent years, accounting for a combined value of over USD340bln or 20% of global Islamic financial assets. Islamic asset management remains a nascent but budding industry in Asia. The takaful industry that accounts for a less than 1% share of Asia’s Islamic financial assets offers considerable potential for growth in the near future. This chapter analyses the Islamic financial industry in Asia by segments (banking, capital markets and takaful) and by sub-regional performances.

4. Islamic Finance: Catalyst for Inclusive Growth

Islamic microfinance still represents a niche and nascent sector of Asia’s total microfinance reach. Yet, the sector has immense potential to address poverty issues in Asia, particularly among the large Muslim population residing in this region. Islamic microfinance products which promote risk-sharing principles are ideal to encourage entrepreneurial spirit among the low income segments of society as profit payments are subject to actual business activity returns.

Factsheet: The Philosophy of Islamic Finance

Islamic financial institutions endeavour to provide economically viable financing alternatives in the global financial system, framed within the boundaries set by Shari’a principles. Shari’a requires gains from investments to be derived in an ethical and socially responsible manner that complies with the teachings of Islam. Islamic financial mechanisms aim to promote profit and loss sharing structures to ensure contracting parties share the risks of venture amongst themselves which leads to healthier economic relationships. Over the years, the Islamic financial industry’s services are increasingly being utilised by both Muslims and non-Muslims alike.

3 - 16

17 - 24

25 - 44

45 - 54

55 - 64

Global IslamIC FInanCe: Growth, Development

& prospeCts

Islamic Funds3.83%

Sukuk14.16%

Takaful1.02%

Islamic Banking80.99%

Reached USD150bln

Expected to reach USD1.8tln

Expected to surpass the USD6.5tln mark

Mid-1990s2013

2020

Success of Islamic Finance

• More than 700 financial institutions across 75 countries offering Islamic financial services

• Islamic finance assets have expanded from USD150bln in 1990s to reach USD1.7tln as at 1H2013

• Islamic banking industry generated strong growth with CAGR of 20.4% during 2007-2012

• Sukuks have emerged as a productive new asset class, providing an avenue for issuers to tap into alternative sources of funding. Sukuks outstanding reached USD245.3bln as at 1H2013

Global Islamic Financial Assets

Composition of Global Islamic Financial Assets

The Islamic financial industry has grown substantially over the last few decades and today is one of the fastest growing sectors of the international financial system. The proposition for Islamic finance manifests itself in the robust growth of assets from USD150.0bln in the mid-1990s to approximately USD1.9tln forecasted for the end-2013. It is estimated that the value of global Islamic finance assets will reach an impressive USD6.5tln mark by 2020. Assets with Islamic banks and Islamic banking windows have grown at a CAGR of 20.4% between 2007 and 2012. From being a novelty, Islamic finance has advanced to become an attractive alternative to the conventional financial system.

In the early stages of development in the 1980s and 1990s, the industry’s concentration was mainly in the Middle East and South-East Asia or predominantly Muslim based countries. However, since then, the Islamic finance industry has grown in sophistication with its geographical dispersion spanning across 75 countries. Many new jurisdictions are working on measures to enable the introduction of Islamic finance in their financial territories. Islamic banking has been the starting point for jurisdictions that wish to respond to the needs of the people for faith-based finance. From only basic banking services in 1990s, the industry has grown to develop other segments of financial markets including sukuk (Islamic bonds), asset management, and takaful (Islamic insurance). Since then, the industry has evolved to provide a range of products to retail and corporate customers, meeting the varying needs of the market.

The Islamic banking segment continues to dominate the global portfolio of Islamic financial assets accounting for an 80.4% share in 2012. The sukuk sector follows next and is rapidly increasing in popularity, as evidenced by large and more frequent issuances coming to the market. Takaful remains a nascent industry, constituting only a 1% share of the global Islamic financial assets as at end-2012. The Islamic funds sector is also growing fast with assets under management worth USD68.9bln as at May-2013. The sector has steadily grown four-folds from about 285 Islamic funds in 2004, to nearly 1,024 Islamic funds as at May-2013.

Asia is a pivotal part of both the global economy and Islamic financial system, operating as a driving force of world economic growth. At present, the Islamic financial landscape in Asia is dominated by Islamic banking and sukuk sectors, which have driven Asia’s robust growth trajectory in recent years, accounting for a combined value of over USD340bln or 20% of global Islamic financial assets. Islamic asset management remains a nascent but budding industry in Asia which has seen steady growth post-financial crisis. The takaful industry accounts for less than 1% of regional Islamic financial assets, despite a significant growth in the number of takaful operators, highlighting considerable potential growth for the future.

5 ISLAMIC FINANCE IN ASIA: DEVELOPMENT, GROWTH AND OPPORTUNITIES

Global IslamIc FInance: Growth, Development & prospects

Islamic Finance Landscape in Asia

Islamic Banking Islamic Funds AuMSukuk Outstanding Takaful

USD171.8bln46.8%

USD24.2bln6.6%

USD168.5bln45.9%

USD3bln0.8%

Source: KFHR*percentage of Asian Islamic Financial Assets

There are tremendous opportunities for Asia to expand the Islamic finance industry in order to support the fast growing economies of the region. Islamic finance is able to support many strategic areas namely financial inclusion, infrastructure investment needs, insurance penetration as well as further attracting funds inflow into the region. Asian markets are home to a large Muslim population, which facilitates a ready market for the introduction and distribution of Shari’a-compliant products and services, particularly for retail banking and takaful. The progress that Asian countries have made represents more opportunities for the region to benefit from this rapidly growing Shari’a-compliant industry. Chapter 3 provides a detailed analysis on Islamic banking, capital markets and takaful in Asia, with sub-regional analysis of each segment.

Asian Countries with Large Muslim Population

Indonesia

Pakistan

Sri Lanka

205mln (88.1%)

178mln(96.4%)

India177mln(14.6%)

Bangladesh148mln(90.4%)

Malaysia17mln(61.4%)

1.7mln(8.5%)

Source: Pew Research Center, 2010*Percentage of total country population

Growth Factors Influencing the Increasing Demand and Supply

Since the onset of the global financial crisis, financial authorities have started to focus on the relationship between financial services and real economic fundamentals in order to revive global and domestic financial stability. This awareness, to a certain extent, has benefited the Islamic finance industry as a growing number of stakeholders are now exploring Islamic finance and ethical finance, which

are seen as potential remedies for excessive leveraging and speculative activities not backed by real economic fundamentals. In addition, Islamic finance is also seen as an alternative mechanism that can continue to generate robust economic growth by supporting economic activities from funds raised through Islamic financial instruments such as sukuks.

6ISLAMIC FINANCE IN ASIA: DEVELOPMENT, GROWTH AND OPPORTUNITIES


1,800

1,600

1,400

1,200

1,000

800

600

400

200

0

US

D b

ln

2007 2008 2009 2010 2011 2012 2013F

Global Islamic Banking Assets

GrOwTh FACTOrS

Value propositions of Islamic finance

Regulatory support

Financing gap

Tap wider base of wealth

Increasing demand

Factors Contributing to the robust Growth of Global Islamic Financial Assets

Growing demand from Muslim population for

Shari’a-compliant financial solutions,

reinforced with a growing desire for ethical-based

financing solutions.

Support from facilitative governments and regulatory bodies. Incentives are also

introduced to accelerate the growth of the industry.

Different contractual modes in Islamic finance are able

to cater for the wide spectrum of risk profiles, ranging from the low risk

sales and lease-based modes to the higher riskequity-based modes of

financing.

Islamic financial instruments can act as potential tools to reduce the financing

gaps and act as alternative fund raising mechanisms to boost economic activities.

Abundant liquidity flows from the

recycling of petrodollars

generated by high oil prices over the

years.

Fundamentally, Islamic finance shares similar objectives as the conventional system in terms of enabling individuals to acquire property and goods, facilitating trade, providing capital for business start-ups / existing businesses as well as to embark in real sector projects and investments. However, Islamic financing structures are based on principles that ensure transactions are linked to real economic activities and promote transparent dealings between involved parties, while avoiding excessive leveraging.



Global Islamic Banking Industry

The Islamic banking industry is the biggest segment of the global portfolio of Islamic financial assets contributing an 80.4% share of total assets as at end-2012. With nearly 75 countries around the world offering Shari’a-compliant banking, the industry has experienced strong growth over the past five years, recording a CAGR of 20.4% during 2007-2012. Islamic banking total assets are expected to reach over USD1.5tln as at end-2013.

Global Islamic Banking Assets (2007-2013F)

1,800

1,600

1,400

1,200

1,000

800

600

400

200

0

US

D b

ln

2007 2008 2009 2010 2011 2012 2013F

Global Islamic Banking Assets by region (2011-2012)

USD bln

0 200 400 600 800

2012

Africa

Asia

GCC

MENA (ex. GCC)

Others

2011

Source: IFIS, Zawya, Bloomberg, KFHR

The regional frontrunners in the Islamic banking segment are MENA (including the GCC) and Asia. On an individual country-level of leaders are Saudi Arabia, Malaysia, United Arab Emirates, Kuwait, Qatar, and Turkey. Of special interest is the progression seen in the products and services offered by Islamic banking institutions. The range of products has evolved in sophistication in tandem with the overall development of the industry: from financing, savings and investment products to trade finance, treasury services, commercial real estate and more. Retail and corporate clients alike stand to benefit from the innovative spirit of the budding Islamic banking industry.

Key Islamic Banking Markets* (1h13E)

Country

Islamic Banking Assets

(USD bln)

Share of Global Islamic

Banking Assets (%)

Saudi Arabia 237.2 16.7Malaysia 127.8 9.0UAE 91.5 6.5Kuwait 78.6 5.5Qatar 55.2 3.9Turkey 42.2 3.0Bahrain 26.0 1.8Indonesia 21.1 1.5Pakistan 8.5 0.6

Source: Central Banks, Government institutions, Ernst and Young, CEIC database, KFHR* Including assets of full-fledged Islamic banks, Islamic banking subsidiaries and Islamic

windows



Global Sukuk Market

Sukuks are gaining greater acceptance as a mainstream financial instrument while becoming a feasible alternative to conventional bonds, proven by the large number of funds raised by both corporate and sovereign issuers, including for large infrastructure projects. The sukuk market has experienced tremendous growth over the years. By the end-2012 a total of USD131.2bln worth of sukuks were issued, representing a y-o-y increase of 59.9%. Since 2007, total yearly issuances have grown at a CAGR of 23.3%.

Global outstanding sukuk reached USD249.4bln as at end-3Q13, up 8.8% from USD229.3bln as at end-2012 and 11.7% y-o-y. Malaysia stands out as the only secondary sukuk market above USD100bln while Saudi Arabia, UAE, Qatar and Indonesia follow significantly behind. Turkey continues to build up its secondary market, growing 195.5% since the end-2012, while Indonesia and Saudi Arabia have seen growth of 32.8% and 29.1% YTD, respectively.

Total Sukuk Issuance (1h13)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2005 2006 2007 2008 2009 2010 2011 2012 1H13

US

D m

ln


Growth Factors

Lower Costs of raising Funds

Strong Demand for Fixed Income Investments

Upscale in Sovereign Issuances

Debut Sukuk from New Jurisdicitions

Capital Flows to Emerging Markets


Sukuk Issuances by Domicile (9M13)

Malaysia67.76%

Saudi Arabia12.22%

UAE8.44%

Indonesia5.19%

Turkey2.95%

Bahrain1.45%

Qatar0.90%

Pakistan0.72%

Brunei0.13%

Mauritius0.13%

Kuwait0.07%


Sukuk Issuance by Currency (3Q13)

IDR3.8%

PKR0.8%

USD13.9%

BHD1.2%

MYR74.0%

SAR5.1%

TRY0.7%

Others0.6%




Sukuk Outstanding (as at end-3Q13) and YTD Growth by Domicile

5

33

3

5

429

15

195

12

0

1

10

100

1,000

0

1

10

100

1,000

Bah

rain

Indo

nesi

a

Jord

an

Kuw

ait

Mal

aysi

a

Pak

ista

n

Qat

ar

Sau

di A

rabi

a

Sin

gapo

re

Sud

an

Turk

ey

UA

E

UK

US

Oth

ers

US

D b

ln

Amount Outstanding % Change (YTD) (RHS)

0

%

Source: Bloomberg, IFIS, Zawya, KFHR

Sukuk by Maturity Trend

9M13

2012

2011

2010

2009

2008

0 10 20 30 40 50 60 70 80 90 100

<1 year >10 year1-3 years 3-5 years 5-10 years%

Source: Bloomberg, IFIS, Zawya, KFHR

Global Islamic Funds Industry

Starting with 285 funds in 2004, the number of Islamic funds has grown up to 1,024 funds in May 2013, equivalent to an average annual growth of 11.2%. Islamic funds total assets under management (AuM) valued USD68.9bln in May 2013 compared to only USD200mln in 2000, equating to an average annual growth of 62.1%. At this asset size, Islamic funds represent approximately 4.2% of global Islamic finance assets - the third largest behind Islamic banking and sukuk sectors.

As at end-2012, the total number of Islamic funds climbed by 15.5% y-o-y to 1,012 against 876 funds registered one year earlier. This reflects the improving sentiment following the expected global recovery from the recent crisis. Meanwhile, the Islamic funds’ AuM also rose convincingly, after charting a growth rate of 14.3% y-o-y to USD65.9bln as at end-2012. The upward trend in the number of managers offering Shari’a-compliant investments worldwide demonstrates the increasing diversity of the industry in terms of asset classes and geographies. Other significant factors driving the Islamic funds industry include the steady increase in global high net worth individuals (HNWIs). The rising wealth in the GCC and Asia, following their resilient economic performance and elevated commodity prices, has also anchored the popularity of Islamic funds. Premised on this, the Islamic funds industry is poised to expand further in the near -term; and hence, record a decent growth and return in 2013.

Global Islamic Funds Growth Trend (2005-2013F)

2008

2009

2010

2011

2012

17-M

ay0

200

400

600

800

1,000

1,200

0

20

40

60

80

No.

of F

unds

AuM

US

D b

ln

AuM (LHS) Cummulative No. of Funds (RHS)

Islamic Funds: New Launches and Total (2005-2012)

0

20

40

60

80

100

120

140

160

180

0

200

400

600

800

1,000

1,200

2005

2006

2007

2008

2009

2010

2011

2012

No.

of N

ew F

unds

Cum

ulat

ive

No.

of F

unds

Cummulative No. of Funds (RHS) New Funds

Source: Bloomberg, Eurekahedge, KFHR



Number of Islamic Equity New Launches (2007-2012)

70

60

50

40

30

20

10

0

No.

of L

aunc

hes

2007 2008 2009 2010 2011 2012

Source: Bloomberg, IFIS, KFHR

Equity remains the largest portion of fund assets by asset class. The growth of Islamic equity funds began in the 1990s, in tandem with the time when the global equity market witnessed one of its best performances. This led to a wider spread of Islamic funds being established, which in turn resulted in many product proliferations and innovations. The top 20 global Islamic equity funds have AuM totalling USD26.3bln as at end-2012. Equity funds represent approximately 54.3% of total Islamic fund’s AuM, marking them as the largest in the Islamic fund’s universe.

Top 20 Global Islamic Funds: Total returns (2012)

Fund Name Asset Class Focus Country Total return (1-Year)APIF-Equity Sub-Fund Equity Pakistan 57.6%Atlas Islamic Stock Fund Equity Pakistan 54.2%JS Islamic Fund Asset Allocation Pakistan 53.4%Meezan Tahaffuz Pension Eqy Equity Pakistan 48.7%Meezan Islamic Fund Equity Pakistan 48.1%Al-Meezan Mutual Fund Ltd Equity Pakistan 47.6%JS Islamic Pen Sav-Equity Equity Pakistan 46.5%Meezan Balanced Fund Asset Allocation Pakistan 46.3%Pk Intl Element Isl Asset-Al Asset Allocation Pakistan 40.3%UBL Shari’a Stock Fund Asset Allocation Pakistan 39.9%HBL Islamic Stock Fund Equity Pakistan 35.5%HS Banq Msr Al Hessn Fund Iv Equity Egypt 32.7%Comgest Growth Europe Sh-Eur Equity Ireland 31.9%Comgest Growth Europe-Eur Equity Ireland 30.4%HC Sanabel Fund-Acc Money Market Egypt 30.1%Nafa Islamic Multi Asset Fd Asset Allocation Pakistan 30.1%Askari Islamic Asset Alloc-C Asset Allocation Pakistan 29.8%Askari Islamic Asset Alloc-B Asset Allocation Pakistan 29.2%Mfc Islamic Long Term Equity Equity Thailand 28.9%Ktam-Krung Thai Shari’a Ltf Equity Thailand 26.7%

Source: IFIS, Bloomberg, KFHR

Overall, Islamic funds have evolved into wealth management vehicles that cater to investors who want exposure to capital markets inside a Shari’a framework. Moving forward, both the demand for and supply of Islamic funds is expected to grow given the mounting wealth and preference for Shari’a solutions. Furthermore, the rising wealth in Muslim nations, especially in the emerging

economy and rich-oil countries, has helped drive investable assets to new heights. Future demand is expected to be generated from the growing attraction of Islamic funds for diversification in an uncertain economic environment, the growing preference for Islamic alternatives and the vast opportunities to utilise Islamic funds to benefit from uptrends in various asset classes.



Global Takaful Industry

Takaful is Shari’a-compliant insurance based on the principles of cooperative risk sharing, mutual responsibility, mutual protection, and solidarity among groups of participants. The risk pool is managed by the takaful operator which is run on a commercial basis with corporate responsibilities towards its stakeholders, that is, the participants, employees and shareholders.

The global takaful industry has experienced strong double-digit growth rates in recent years with worldwide gross takaful contributions estimated to have amounted to USD17.2bln as at end-2012, reflecting a 16.2% y-o-y growth while recording an impressive 18.1% CAGR during the last 5 years (2007-2012). Moving forward, it

is forecasted that the global takaful industry will surpass the USD25bln milestone by the year 2015, although the CAGR is expected to slow down to 12.8% during the period 2010-2015F. Nonetheless, the global takaful industry is still at its infancy and its assets constitute a small portion of the global portfolio of Islamic financial assets. The potential for takaful products to gain market share, however, is tremendous given that large segments of the market in leading Islamic financial jurisdictions remain untapped and are mainly dominated by conventional insurance providers. In 2013, it is forecasted that the total gross takaful contributions will amount to approximately USD19.3bln, or a 1.02% share of the global Islamic financial assets.

Global Islamic Finance Assets by Segment (2013F)

Islamic Banking, 67%

Sukuk,14.16%

Islamic Funds,3.83%

Takaful,1.02%

Global Gross Takaful Contributions (2007-2015F)

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012E 2013F 2015F

US

D b

lns

Source: IFIS, Zawya, Bloomberg, KFHR Source: World Islamic Insurance Directory, E&Y, KFHR

Currently, the global takaful industry is mainly concentrated in the GCC and Southeast Asia regions with Saudi Arabia, Malaysia and United Arab Emirates continuing to be the key leading markets. Based on 2012 estimates, Saudi Arabia represents the largest takaful market, hosting 51% of global gross takaful contributions (excluding Iran). The opportunity for takaful operators to develop and expand on market share varies with the respective jurisdictions they are based in. For instance, key takaful markets such as Saudi Arabia and United Arab Emirates have recently

witnessed a slowdown in annual growth rates of gross takaful contributions as compulsory health insurance provision by the respective governments has been completed in the past few years. Alternatively, emerging markets such as Pakistan and Indonesia, which have lately witnessed regulatory initiatives in favour of Islamic financial products, present promising opportunities for takaful operators to penetrate into and capture a bigger market share.



Global Gross Takaful Contributions by region (2012E)

GCC, 67%

GCCSouth-Eastern AsiaAfrica

South AsiaOthers (ex-Iran

South-Eastern Asia,25%

Africa, 5%

South Asia,2% Others (ex-Iran),

1%

Global Gross Takaful Contributions (2007-2012E)

12,000

10,000

8,000

6,000

4,000

2,000

0

US

D m

lns

2007

GCC

2008 2009 2010 2011 2012E

South-Eastern Asia Africa

South Asia Others (ex-Iran)

2847

992276 7622

3753

1234295 12333

4973

1531378 193

34

5684

1936

432 20274

6396

2246

472 21586

7348

2721

527227

136

Source: World Islamic Insurance Directory, E&Y, KFHR Source: World Islamic Insurance Directory, E&Y, KFHR

Comparison between Insurance and Takaful

Insurance TakafulConcept • Arisk-transfermechanism • A socially more responsible task of

risk-sharingContract • An exchange contract (sale and

purchase) between insurer and insured

• A combination of Tabarru’ contract (donation) and agency or profit- sharing contract

responsibility of policyholders/participants

• Policyholders pay premium to the insurer

• Participants make contributions to the scheme

Liability of the insurer/operator

• Insurer is liable to pay the insurance benefits as promised from its assets (insurance funds and shareholders’ fund)

• Takaful operator acts as the administrator of the scheme and pays the takaful benefits from the takaful funds

• In the event of deficiency in the takaful funds, takaful operator will provide Qard Hassan to rectify the deficiency. This loan is to be recovered from future underwriting surpluses

Investment of fund • There is no restriction apart from those imposed for prudential reasons

• Assets of the takaful funds are invested in Shari’a-compliant instruments

Source: BNM, KFHR



Global Islamic Financial Ecosystem

The Ecosystem of the Islamic Financial Services Industry

Global Islamic Financial Assets: USD1.6tln (2012)

IslamicBankingAssets,80.38%

Sukuk,14.48%

363 full-feldged Islamic financial institutions, 108 Islamic windows, 200 takaful operators

Takaful,1.09%

IslamicFunds Assets,4.05%

Islamic Banking

Assets with Islamic banks and Islamic banking windows have grown at a CAGR of 40.3% between 2004 and 2011 to reach USD1.1tln.

Rating agenciesIIRA, Moody’s, S&P,

Fitch, RAM Ratings...

Stock exchanges, commodity trading

plaformsBSAS, IIFM, CMTP....

Training, education, research

BIBF, IRTI, KFH Research, IBFIM,

INCEIF, Universities...

Information services, media,

associationsDow Jones, FTSE, MSCI, Thomson

Reuters, RedMoney...

Global Islamic Financial Infrastructure Infrastructures e.g. IFSB, IILM, AAOIFI, IIFM

Multilateral Development Institutions

Ministries and Regulatory Bodies

Shari’a Authorities and Scholars

Takaful & retakaful

Global takaful total contribution is estimated to be USD12bln in 2012 with an average annual growth of 20%.

- From 2004 to end 2012, Sukuk issuances increased at a CAGR of 45.2% from USD6.6bln to USD131.2bln.

- Islamic funds grown from 285 to 1,012 funds with assets under management of Islamci funds grew to USD64.1bln as at 2012.

Islamic Capital Market

The global Islamic financial industry has entered into its fifth decade of existence in the modern financial sphere. The industry has emerged as one of the most important financial developments and is gradually making ways into mainstream finance. Today, there are 716 Islamic financial institutions operating in more than 75 countries, according to the Bankers Survey 2012. 511 of these financial institutions operate as full-fledged Islamic financial institutions, while the rest are Shari’a-compliant windows.

In parallel with growth and participation of various entities in the Islamic finance industry, catalyst institutions like research and advisory houses that promote innovation, business advancements and sharing of resources are also emerging to complete the value chain of the overall industry. Many higher academic and training institutions around the world are now offering education programmes in Islamic finance. Rating agencies have established dedicated teams specialised in rating Islamic financial instruments and institutions. Other ancillary service providers, for instance Shari’a index providers, have

established operations or expanded their services to support the growing needs of the industry.

The industry undoubtedly is still small compared to the entrenched conventional system, however continuous improvements in the overall Islamic finance architecture, development of Islamic financial centres as well as promoting greater awareness via education and training are being done vigorously in key Islamic finance jurisdictions. In addition, efforts to strengthen market linkages to facilitate internationalisation of Islamic finance will continue to be the key focus in order to have a more efficient mobilisation and allocation of funds across regions. This trend will also strengthen the international financial and economic interlinkages between jurisdictions, bringing with it mutually reinforcing gains. It is also expected to influence the patterns of global financial and economic integration, in particular, facilitating the revival of financial and economic integration between Asia and the Middle East and between emerging economies and the more established financial markets, thereby contributing towards a more balanced growth in the global economy.



The progress of the industry is also fuelled by the commitment and support by various regulatory bodies, government institutions and multilateral organisations. These organisations have been instrumental in introducing a substantial number of initiatives aimed at maximising the huge potential of Islamic finance, while enhancing

its long-term resilience and inclusive growth. Among the key global bodies supporting the Islamic financial industry are the Islamic Financial Services Board (IFSB), Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the International Islamic Liquidity Management (IILM) Corporation.

IILM was established with the aim to issue Shari’a-compliant financial instruments in order to facilitate cross-border Islamic liquidity management. Membership of IILM is open to central banks, monetary authorities as well as financial regulatory authorities, government ministries and agencies that have regulatory oversight of finance or trade and commerce, and multilateral organisations. In August this year, IILM issued their inaugural USD490mln sukuk having a 3-month tenure. The dollar-denominated sukuk were fully subscribed and were priced at 30 basis points over the London Interbank Offered Rate.

AAOIFI is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shari’a standards for Islamic financial institutions and the industry. As an independent international organisation, AAOIFI is supported by institutional members (200 members from 40 countries, so far) including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry. Total of 88 standards have been issued to date: (a) 48 on Shari’a, (b) 26 on accounting, (c) 5 on auditing standards, (d) 7 on governance, (e) 2 on codes of ethics.

IFSB is an international standard-setting organisation that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors. To date, IFSB has issued 18 standards and guidance notes in various areas including, among others, capital adequacy, risk management and corporate governance. As at April 2013, the IFSB has a total of 187 members comprising of 56 regulatory and supervisory authorities, eight international inter-governmental organisations and 123 market players, professional firms and industry associations operating in 43 jurisdictions. IFSB has also been instrumental in leading global initiatives for developing Islamic finance infrastructure and support institutions. IFSB facilitated the work in establishing the IILM, which was launched in October 2010.

ISLAMIc FInAncIAL SeRvIceS BOARD (IFSB)

AccOunTInG AnD AuDITInG ORGAnIzATIOn FOR ISLAMIc FInAncIAL InSTITuTIOnS (AAOIFI)

InTeRnATIOnAL ISLAMIc LIquIDITy MAnAGeMenT cORPORATIOn (IILM)



Islamic finance in Asia: Sets to thrive with joint efforts of ADB and IFSB

The World Bank and Islamic Development Bank (IDB) signed a Memorandum of Understanding (MoU) in October 2012 to set out a framework for collaboration between the two parties and to lend support to global efforts in the development of Islamic finance.

The African Development Bank (AfDB) and the International Islamic Liquidity Management Corporation inked a MoU to build robust partnership to promote liquidity management. This MoU will offer benefits to the AfDB and its Regional Member Countries

The International Islamic Liquidity Management Corporation inked a MoU with the Asian Development Bank to strengthen cooperation between the two organisations in promoting global cross-border Shari’a-compliant liquidity management.

300

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Min

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Indi

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Nig

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Egyp

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Iran

Turk

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Afgh

anis

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Iraq

Top 10 countriestotal: 1.42bln

In promoting the development of Islamic finance in common developing member countries, the Islamic Financial Services Board (IFSB) and the Asian Development Bank (ADB) entered into a Memorandum of Understanding (MOU) in October 2012. This marks an important milestone for the advancement of the Islamic financial industry particularly in the areas of financial inclusiveness and infrastructure financing as well as to strengthen both organisations’ ability to jointly support the policy, institutional and capacity requirements for a more resilient Islamic financial sector.

The ADB has been driven by an inspiration to improve people’s lives in Asia and the Pacific since its establishment in 1966. ADB’s Developing Member Countries (DMCs) represent approximately 80% of the world’s Muslim population. ADB has 14 member countries that have a majority Muslim population as well as other members with a sizeable Muslim population, namely India, PRC, the Philippines, Sri Lanka and Thailand. Realising the potentials of Islamic finance to develop these economies, the ADB sees the potential to improve financial inclusion of ADB DMCs, particularly in countries like Afghanistan, Bangladesh, Indonesia, and Pakistan.

Islamic finance can provide access to the unbanked groups while promoting financial stability in developing Asia through its alternative and ethical financing mechanisms. Islamic microfinance is one segment likely to address poverty issues among Muslim population in Asia, as the segment supports entrepreneurial spirit among the low income segments of society.Islamic finance has transcended beyond traditional jurisdictions and is not restricted for serving Muslim population alone, as the

Largest Muslim Population by Country: 2030F

principles and values are appealing to all those looking for ethical-based banking & finance. More importantly, this thriving has potentials for supporting Asia’s booming economic needs. Islamic finance, through sukuk and syndicated financing, could support Asia’s needs to invest a total of around USD8tln in overall national infrastructure requirements between 2010 and 2020.

The participation of ADB in Islamic finance is not new. ADB, together with IDB in 2009, launched a USD500mln Islamic infrastructure fund to invest in 12 countries that are borrowing members of both banks. Furthermore, ADB has also been involved in advising and assisting DMCs, through Technical Assistance and loans, providing credit enhancements in non-sovereign transactions, and on capital markets development for Islamic financial institutions including development of appropriate supervisory and regulatory laws and frameworks.

Global Cooperation to Facilitate Progress of the Industry

Multilateral organisations, regional development banks and other international organisations have been instrumental in supporting the development of the global Islamic financial industry. Over the years, these entities have been strengthening cooperation and enhancing their synergy to fulfil their common agenda. Among others, below are several cooperation and agreements that have been initiated to support the industry.

Source: Pew Research Centre



eConomIC anD FInanCIal DynamICs oF asIa

2006 2007 2008 2009 2010 2011 2012 2013E 2014F

12

10

8

6

4

2

0

% y

-o-y 6.2 6.3

Key highlights:

• The region’s largest economies will displayconsiderable growth differentials. Overall momentum will pick up in 2014 led by improving import demand in advanced economies. Zooming into Japan, accelerating economic growth can be supported by the introduction of anti-deflation policies and potential structural reforms to be enforced by the newly established government as part of Prime Minister Shinzo Abe’s third arrow of the economic revival plan. Meanwhile in China, economic conditions will continue to exert its influence in shaping the outlook for the region, as the economy’s business ties have increased with almost every country in Asia. An economic expansion trajectory in China has shifted lower on a structural basis; however, the fears of a marked slowdown have finally subsided, with near-term potential growth rates stabilizing in the 7.5%-7.7% range. The country averaged growth of around 10% a year in the past three decades, propelling it up the list of the biggest economies, generating wealth for its growing middle class and boosting global trade. Meanwhile, India has suffered from a substantial deceleration in economic activity on the grounds of

Asia: GDP Growth Trend and Projections (2006- 2014F)

Source: Bloomberg, KFHR

• Asia’spolicymakersfaceadelicatebalancingact in the near term: guarding against a build-up of financial imbalances and managing a transition to rebuilding policy space while delivering appropriate support for growth. Underpinned by the backdrop of uncertain growth prospects, Asian central banks in 2012 maintained their already low policy rates or reduced them further. With inflation remaining low and stable, this accommodative stance has been welcome. But financial imbalances are often persistent and cannot be easily unwound, and output levels are close to or slightly above trend in most economies; hence, monetary policymakers should stand ready to respond early and decisively to any prospective risks of overheating. However,

severe macroeconomic imbalances that will not be quickly disregarded. On the flip side, South Korea has emerged as one of the most solid regional economies. Several Southeast Asian countries continue to enjoy the benefits of solid domestic demand growth (such as Thailand, Malaysia, and Hong Kong) that reflects favourable inflation environments, supportive labour market conditions, rising incomes, and pro-growth monetary policy.

the need and direction for future monetary policy action differs substantially across Asian economies, mainly in line with differing exposures to shifting growth risks and risks to financial stability from past stimulus.

In emerging Asia, macro-prudential measures will also have to play an important role where credit growth remains too rapid and could pose problems for financial stability, especially if accompanied by persistently strong capital inflows. In general, Asia has buffers to cope with such risks, as banking and corporate sector balance sheets remain generally sound, but these imbalances require careful monitoring and adequate supervision.

Economic and Financial dynamics oF asia


In East Asia, Hong Kong currently has the highest GDP per capita, standing at USD47,556 as at 2012, vs. USD40,003 in 2006, representing an 18.9% jump. However, in terms of growth rates, China’s GDP per capita jumped 93.9% from USD4,748 in 2006 to USD9,210 in 2012, reinforcing China’s status as a middle-income nation. That said, the rapid growth has not fully transformed the lives of the Chinese people as a fast-rising yuan and property prices had offset the increase of GDP per capita growth.

In South Asia, the Maldives takes the top spot, with GDP per capita at USD7, 310, with Bhutan comes in second place at USD7, 075. India, considered an economic giant in Asia, had its GDP per capita grow 55%, from USD2,541 in 2006 to USD3,950 in 2012. Despite the healthy growth rate, the fact remains that India’s GDP per capita continues to be quite low, and the country is still the poorest amongst the G-20 countries.

In Southeast Asia, Singapore has the highest GDP per capita, at USD61,803 in 2012 from USD49,310 in 2006, representing a 25.3% increase. Meanwhile, Brunei’s GDP per capita, a country rich in oil and natural gas, stands at USD55,007 in 2012 from USD51,937 in 2006. Meanwhile, the average GDP per capita of four of the five prominent ASEAN countries (ASEAN 5) that consisted of Indonesia, Malaysia, Philippines, and Thailand increased by 34.2% in the same period, driven by favourable economic developments and implementation of reforms. Average GDP per capita for these four countries now stands at USD9,311 in 2012, from USD6,939 in 2006.

The Pacific is still the sub-region in Asia that has the lowest GDP per capita at USD4,313 (as at 2011), from USD3,678 in 2006, although there are wide variations amongst the countries. For example, Timor Leste’s GDP per capita is USD9,052 in 2011, while Kiribati’s GDP per capita is USD2,333.

Asia: Monetary Policy Directions (3Q12-4Q13F)

Interest rateEnd

3Q12End

4Q12End

1Q13End

2Q13End

3Q13FEnd

4Q13FEnd

1Q14F

China lending rate 6.13% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00%

Hong Kong base rate 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%

India repo rate 7.75% 8.00% 7.75% 7.25% 7.50% 7.36% n.a.

Indonesia reference rate 5.75% 5.75% 5.75% 6.00% 7.25% 7.38% 7.25%

South Korea 7-day repo rate 2.75% 2.75% 2.75% 2.50% 2.50% 2.50% 2.50%

Malaysia overnight rate 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00%

Philippine reverse repo rate 3.75% 3.50% 3.50% 3.50% 3.50% 3.50% 3.63%

Singapore 3-month rate 0.40% 0.38% 0.38% 0.37% 0.36% 0.40% 0.43%

Thailand 1-day repo rate 2.95% 2.70% 2.70% 2.45% 2.50% 2.50% 2.50%

Source: Bloomberg, CEIC, KFHR

• Between2006and2012,allsub-regionswithinAsiawitnessed healthy growth rates in terms of GDP per capita on a purchasing power parity basis.



Asia: Average GDP Per Capita at PPP (2006-2012)

Asia’sSub-regions Average GDP per Capita at PPP (current USD)

2006 2008 2010 2012

Central and West Asia USD3,738 USD4,592 USD4,867 USD5,982

East Asia USD20,205 USD22,801 USD24,661 USD27,234

South Asia USD3,032 USD3,600 USD3,717 USD4,666

Southeast Asia USD13,629 USD14,442 USD15,295 USD16,528

The Pacific USD3,678 USD4,304 USD4,266 USD4,313*

Source: ADB

Sovereign Credit ratings: Foreign Currency Long Term ratings

Country Moody’s S&P Fitch

Australia Aaa AAA AAA

China Aa3 AA- A+

Hong Kong Aa1 AAA AA+

India Baa3 BBB- BBB-

Indonesia Baa3 Ba1 BBB-

Japan Aa3 AA- A+

Malaysia A3 A- A-

Philippines Ba1 BBB- BBB-

Singapore Aaa AAA AAA

South Korea Aa3 A1 AA-

Thailand Baa1 BBB+ BBB+

Source: Bloomberg

• Sovereign debt sustainability is not a subject of significant concern in most countries within Asia, particularly as compared with many other emerging market peers. Nevertheless, the current fiscal situations in Japan and India have declined, prompting all major international credit rating agencies to place these countries’ ratings on review for a possible downgrade in the near term. In Japan’s case, sovereign indebtedness has reached significant levels, with the country’s general government gross debt equivalent to 245% of GDP, the worst debt ratio amongst the world’s ten largest economies. Given the nation’s weak public finances, failure to restore long-term fiscal discipline would put negative pressure on Japan’s sovereign credit ratings. The rest of the region counts on very manageable debt sustainability indicators and a stable rating outlook. Rising household debt burdens (Thailand, Malaysia, Australia), together with rapidly increasing home prices in some economies pose a risk of unsustainable economic imbalances that may require intensified intervention by local monetary authorities.

*as of 2011Central and West Asia: Afghanistan, Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Pakistan, Tajikistan, Turkmenistan, UzbekistanEast Asia: China, Hong Kong, South Korea, Mongolia, TaipeiSouth Asia: Bangladesh, Bhutan, India, Maldives, Neal, Sri LankaSoutheast Asia: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam The Pacific: Fiji, Kiribati, Micronesia, Papua New Guinea, Samoa, Solomon Islands, Timor Leste, Tonga, Vanuatu



1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012

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Central and West Asia East AsiaSouth Asia Southeast AsiaThe Pacific

Asia: Age Dependency ratio (1990- 2012)

Source: ADB, KFHR

highlight: Demographics in Asia

Asia is the world’s largest and most populous continent with a population of 4.3 billion people making up 60% of the world’s current human population. With roughly 1.4 billion and 1.2 billion people respectively, China and India currently account for 36.3% of the world’s population. In the next 30 years, they are expected to account for roughly the same share of world population. Nevertheless, the overall numbers hide the fundamental changes that will have occurred by then. The bulk of population growth in Asia over the next three and a half decades will be in South Asia, a result not of high birth rates but of the large number of people in the childbearing ages, itself the product of past higher levels of fertility.

Population transition creates investment and human capital opportunities: The falls in birth rates across Asia mean that today there is a concentration of population in most Asian countries in the working ages. Economists call this feature of population transition in Asia the demographic dividend because it provides the opportunity for more productive investment of capital and for a stronger focus on developing the human capital of the next generation of workers, both essential features of economic development. Economies like Japan and the Asian tiger economies of South Korea and Taiwan benefited from the demographic dividend during their earlier periods of high economic growth. Capturing the demographic dividend is now a major objective in the progress of development in countries such as Malaysia, Thailand, Indonesia and China. The economies of South Asia and elsewhere also need to ensure that they capitalise on this source of growth potential.

Overall, being the most populous region in the world, Asia’s favourable demographic structure, comprising a significant young population and a rising middle income segment, constitutes a huge and growing consumer market, which can heighten the demand for a wider

Top 10 Asian Countries by Population (as of 2012)

rank Country Population

1 China 1,354,000,000

2 India 1,213,400,000

3 Indonesia 247,200,000

4 Pakistan 180,700,000

5 Bangladesh 152,500,000

6 Japan 127,600,000

7 Philippines 95,800,000

8 Vietnam 88,800,000

9 Iran 76,789,000

10 Turkey 76,081,000

World 7,080,100,000

Source: ADB, country sources, IMF, UN

spectrum of Islamic financial products and services, thus increasing opportunities in retail and investment banking, takafull and fund and wealth management businesses in the region.



0 2 4 6 8

Total Replacement New capacity

Energy

Telecommunications

Transport

Water and Sanitation

TOTAL (2010 - 2020)

Infrastructure requirements in Asia,2010–2020 (USD tln)

Source: ADB

Growth of Local Bond Markets (Q2 2013 y-o-y)

Foreign holdings in LCY Government Bonds of Selected Emerging Markets Foreign Currency Bonds Outstanding

0 5 10 15 20 25 30 35

ChinaHong Kong, China

IndonesiaKorea

MalaysiaPhillippinesSingapore

ThailandVietnam

Emerging Asia

Corporate Government Total Growth

35

30

25

20

15

10

5

0

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

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Jun-

13

Indonesia

% o

f tot

al

Japan Korea Malaysia Thailand

39600 39965 40330 40695 41061 41426

CN HK ID JPKR MY PH SG

THVN

180

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60

40

20

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US

D b

ln

Source: Asia Bond Monitor, KFHR

TrendsofAsia’sGrowingBondMarket

• EmergingEastAsia’slocalcurrencybondmarketsareexpanding. The domestic corporate bond market has been the growth driver for the Emerging Asia LCY bond market as a whole over the past few years

• Foreign holdings of LCY Government Bonds inEmerging Asia continues to rise particularly in Indonesia and Malaysia

• Foreign currency bonds outstanding in China, HongKong, Korea and Japan have increased over the years.

• Asia-based sovereign wealth funds have shown remarkable growth in assets under management, with the assets of these sovereign wealth funds growing, on average, by 19% since 2012. This is impressive in comparison to the average 6% growth in assets under management exhibited by Middle Eastern sovereign wealth funds. According to a recently released report, sovereign wealth funds (SWFs) globally have added over USD750bln to their total assets under management over the last year, from USD4.62tln in 2012 to USD5.38tln in 2013. Despite only representing 22% of sovereign wealth funds globally by number, Asia-based sovereign wealth funds now account for a significant 47% of the global aggregate sovereign wealth fund assets.

• Massive infrastructure needs for domestic and regional projects: Between 2010 and 2020, Asia needs to invest a total of around USD8tln in overall national infrastructure projects and an additional USD287bln in specific regional infrastructure projects.

Strengthening bond markets, promoting public-private partnership, and improving financial environment to spur foreign investment flows are among the focus of Asian government and financial authorities to support the large infrastructure financing requirements.



IslamIc FInance In asIa

The Islamic finance industry has grown substantially over the last few decades underpinned by the following factors:

Rising Muslim population and encouraging demographics. Rapid Muslim population growth worldwide and improving living standards will anchor the popularity of Islamic finance as a keen alternative to the conventional financing mechanism. In addition, investors from the Middle East and Asia are increasingly seeking to invest in products that are in sync with their religious beliefs. Surveys suggest that half of the Muslims worldwide would opt for Islamic finance if given reliable alternative to conventional services

Governments’ effort to develop Islamic financial markets. Active role by jurisdictions around the world to promote the development of Islamic financial markets in their respective countries in line with the efforts to boost investments and achieve sustainable funding to enhance economic growth by tapping huge liquidity from oil and commodity producing countries.

Ethical character and financial stability of Islamic financial products. Islamic financial products have an ethical focus (notably excluding investment in alcohol and gambling) with risk profile that appeal to wider ethical conscious investors. There is also increasing awareness of Islamic finance as an “alternative” mode of financing vs. the conventional financial markets in line with efforts to promote the global financial stability. Following this, various multilateral organisations have embarked on extensive studies/research with the Islamic finance proposition as a viable alternative financial system.

Islamic Banking (1H13E)

Malaysia81%

Indonesia13%

Pakistan5% Others

1%

Sukuk Outstanding (3Q13)

Hong Kong0.05%

Indonesia8.3%

Kazakhstan0.05%

Malaysia88.1%

Pakistan3.1%

Singapore0.4%


Islamic Funds AuM (2012)

0 3

120.84

6 9 12 15 18 21

Malaysia

USD bln

Pakistan

Indonesia

Singapore

Takaful Contributions (2011)

-200400600800

1,0001,2001,4001,6001,800

11.3 0.1

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Pak

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Sri

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Islamic finance offers huge potential for the Asian market moving forward. Given the unique asset-based nature and risk sharing value proposition, Islamic finance can be utilised for greater integration with the real economy and improve the overall economic balance between emerging and frontier markets. Asian markets also support a significant Muslim population, which facilitates a ready market for the introduction and distribution of Shari’a-compliant products and services.

The development of Islamic finance in Asia has provided a number of opportunities that can help develop and sustain future growth in the region, which include:

• Theenhancementofliquidityandriskmanagementcapacity of Islamic finance industry players.

• The further development of Islamic financialinfrastructure in under-developed markets.

• Creating a platform for international cooperationamong regulatory bodies.

• Facilitation of further cross-border activities withinthe region and to take advantage of the benefits and opportunities of constituent countries.

With the expectation that it’s double digit growth will continue, Islamic banking assets are poised to reach USD1.5tln by the end of 2013. Asia is likely to be a main driver of this growth given the untapped potential in Indonesia, Bangladesh and India, as well as the continuous uptake in Malaysia and Pakistan. Sukuk market in Asia continue to progress at a remarkable pace and is expected to see further growth as numerous nations press on with regulatory developments and legislative inroads, allowing more issuers to tap the market and access funding.

The Islamic funds industry is expected to have a bright future supported by sustained economic growth from high-saving countries that will overall drive the demand for Shari’a-compliant investments. These will be the main impetus for the sub-sector to reach a forecasted value USD67.8bln by the end of 2013. Growing wealth and economic development in Asia also stands as a key factor for growth in the takaful industry. Anchored by growing demand worldwide and relatively low penetration rate, takaful contributions are expected to surpass USD25bln by 2015. Takaful products are available in more than 30 countries today and this number is expected to grow steadily in the near future.

The Asian map of Islamic banking geography has expanded with a number of new and potential entrants into the radar. Realising its sizable market potential for Muslim and non-Muslim banking customers alike, many stakeholders including both public and private entities are intensifying efforts to make quick progress to remain ahead in the Islamic finance industry. Among the developed Islamic banking jurisdictions in Asia are Malaysia, Indonesia, Pakistan and Brunei. Malaysia is one of the global leaders for Islamic financial services and held an estimated 9% share of the global Islamic banking assets as at 1H13. Comparatively, Indonesia, Pakistanand Brunei have smaller shares, but their growth and regulatory developments in recent years have enabled them to be on route to expanding on their volume of Shari’a compliant banking assets. Other growing jurisdictions

for Islamic banking services include Bangladesh, Sri Lanka, and Brunei which, although ventured into Islamic banking early on, are yet to maximise their potential which could rightly enable them a ‘developed’ Islamic banking jurisdiction status. In other parts of Asia, several territories with largeMuslimpopulations,suchas India,ChinaandmostoftheCommonwealthofIndependentStates(CIS),remain largely untapped, which highlights new market opportunities for Islamic financial institutions to penetrate into. East Asian powerhouses e.g. Japan, Hong Kong and South Korea have also shown interest in developing Islamic banking markets locally. In terms of Islamic banking assets in Asia, as at end-2012, Malaysia contributed 74.2%of the regional Islamic banking assets (USD171.8bln), followed by Indonesia (10.4%) and Pakistan (4.7%), while other countries contributed the remaining 10.7%.

Islamic Banking Industry in Asia



Asian Islamic Banking Industry: Presence and Stages of Development1

BruneiIndonesiaMalaysiaPakistan

BangladeshSingaporeSri Lanka

AfghanistanAzerbaijanHong KongKazakhstanKyrgyzstanJapanMaldivesPhilippinesThailand

ChinaIndiaSouth KoreaTajikistanTurkmenistanUzbekistan

Deve

lope

D

Grow

inG

new

pote

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l

Source: KFHR

In terms of Islamic banking assets in Asia, as of end-2012, Malaysia contained 74.2% of the regional total of USD171.8bln, Indonesia – 10.4%, Pakistan – 3.7%, while other countries constituted the remaining 11.7%.

Asian Islamic Banking Industry: Top Countries by Asset Size (2012)

Malaysia

USD 127.4bln

Indonesia

USD17.8bln

Pakistan

USD6.4bln

Source: Central banks, Islamic banks, Zawya, IFIS, Bloomberg, KFHR

1 Developed Islamic banking markets are jurisdictions of substantial asset value (vis-à-vis respective domestic banking industries) and legal, regulatory and tax environment conducive to Islamic banking operations. Growing – jurisdictions with a growing Islamic banking assets share where legal, regulatory and tax reforms are being implemented. New – countries with basic Islamic banking infrastructure in place with one or few operational Islamic banking institutions. Potential – states where the introduction of Islamic banking is being considered or where the Islamic banking specific legislation is being drafted.

Islamic Banking in Eastern Asia

Japan: Japan’s involvement in Islamic finance started in 2006 when the Islamic Finance Research Group was set up at the request of the Ministry of Finance to conduct a study on the viability of introducing Islamic finance in Japan. Since then, Japan has facilitated Islamic finance offerings through changes made to the Order for Enforcement of the Banking Act in 2008, allowing subsidiaries of Japanese banks to engage in Islamic banking services. As a result, Japanese financial institutions are now allowed to offer Islamic financial services where products based on primarily ijarah (lease) structures are accorded equal tax treatment as with conventional lease-based products. Additionally, Islamic trade financing is of special interest to

Japanese financial institutions, seeing the country’s close relationshipwith theGCC in termsof commodity trade.The Bank of Tokyo-Mitsubishi UFJ, Mizuho CorporateBank, and JapanBank of InternationalCooperation areamong the major industry players in Japan that are offering Islamic financial services in and beyond their own shores. Japan’s reputation as one of the leading syndicated loan markets in the world creates another window of opportunity for Islamic banking business. As such, in late 2012, Bank of Tokyo-Mitsubishi UFJ and Sumitomo Mitsui Banking arranged a syndicated financing of USD184mln for a maritime shipping company affiliated with the Brunei government.



Pakistan

Maldives

178mln(96.4%)*

India177mln(14.6%)

Bangladesh148mln(90.4%)

Afghanistan29mln(99.8%)

0.3mln(98.4%)

Sri Lanka1.7mln(8.5%)

Muslim Population in South Asia

Source: Pew Research Center, 2010*Percentage of total country population

China: China, home to a religiousminority of 23millionMuslims plans to set up an Islamic banking framework and its first Islamic bank in 2014. At present, the supply of Islamic financial products and services in the country are more on capital market instruments such as sukuks and Shari’a-compliant equity portfolios, most of which are traded through the Hong Kong financial market.

Hong Kong: The Hong Kong Monetary Authority (HKMA) has made no secret of its aspirations to develop Hong Kong as an Islamic finance hub, particularly in the capital markets segment. Being a gateway into the mainland Chinese markets for international investors while anoutboundgatewayforChineseenterprises,thejurisdictionoffers immense potentials for the expansion of the Islamic finance industry. Not surprisingly, a lot of Islamic financial assets with exposures to China are domiciled in HongKong. The number of banks in Hong Kong offering Islamic banking services (mainly in wholesale banking and asset management) is increasing; among the active players are Hong Leong Bank – the first bank in Hong Kong to launch Islamic banking in 2008, Bank of Ying Kou and CIMBIslamic.

Growth Drivers of Islamic Finance in China

• Substantial trade flows between China andMuslim majority countries have generated interest inChinesebusinessesthatcanprovideproductsand services that meet the Shari’a requirements.

• A Muslim population of over 23 million that isunderserved by the existing financial services sector.

• International demand for Shari’a-compliantfinancial services has increased substantially over the years, which has in turn sparked interest in opportunitiesinChinaonthebackofthecountry’sstrong economic growth.

• Competition amongst international financialcentres to become a regional gateway for

Islamic Banking: Entrance Timeline

2006 Japan

2008 Hong Kong

2014F China

Source: KFHR

Islamic Banking in South-Central Asia

Most countries inSouth-CentralAsia have largeMuslimpopulations which makes these markets naturally attractive in the retail Islamic banking sense. Many of them also possess promising economic potentials which open the door to even greater proliferation of Islamic banking in the region.

Afghanistan: Nine commercial banks, including two state-run banks, are currently offering Islamic banking services in Afghanistan. Still, the conservative Muslim population of the country remains largely unbanked and it is estimated that around USD30bln in circulation is currently untapped by the banking sector. The country’s central bank has been working on the introduction of the Islamic banking law since early 2011, in efforts to further promote the Islamic banking sector that generates greater trust and acceptability amongst the populace than its conventional counterpart.



Bangladesh: Bangladesh entered the Islamic banking system in 1983 with the establishment of Islami Bank Bangladesh. Governing Islamic banking in the country is primarily the Guideline for Islamic Banking issued in November 2009, as well as few amendments of the existing laws made by the central bank. Presently, there areeightfully-fledgedand16windowinstitutionsrenderingIslamic financial services in Bangladesh. The Islamic banking sector currently makes up a 25% share of the total domestic banking assets while in terms of financing, about one third of its financing portfolio is directed towards small and medium industrial and agricultural enterprises. Of other recent news is the government’s launching of a separate money market for Islamic banks. In addition, the BangladeshBank(CentralBank)introducedarefinancingscheme of BDT1bln (or USD12.9mln) in October 2013 for Islamic banks and windows to facilitate investment in the country's agro-based product processing industries and small enterprises.

India: Islamic finance can offer tremendous opportunities to the world’s second fastest growing economy, India, to meet its funding requirements as the country seeks to consolidate its position in the global economic and political environment. This year, the Reserve Bank of India permitted the state Kerala government to launch a non-banking financial institution based on the principles of Islamic finance. It is yet to be seen whether RBI will amend its banking laws to allow Islamic banking institutions to take root in the country. Research has indicated that a sizable portion of the Muslim population in South Asia prefer to utilise banking services that conforms to their religious values. Therefore, the potential demand for Islamic financial products in India is tremendous since it is home to the third largest Muslim population (after Indonesia and Pakistan) in the world.

Maldives: Maldives, the smallest country in Asia in terms of both population and land area. Its first and only Islamic banking institution, Maldives Islamic Bank, started operations in 2011. Recently, to facilitate Islamic liquidity management for the bank, the government of Maldives has issued USD9.75mln in wakalah bi istithmar papers.

Pakistan: Serving the customers in Pakistan, considered the birthplace of modern Islamic economic thought, are 14 Islamic banking institutions (9 of which are windows) which came to existence as a result of a gradual implementation of Islamic financial principles in the early 1990s. The total assets inside these Islamic banks were worth an estimated USD8.5bln as at 1H13, or 0.6% of the global aggregate of Islamic banking assets. Of some recent developments: the central bank has prepared the second Islamic Banking Strategic Plan for 2013-2017 aimed at increasing the market share of the Islamic banking sector to 15% from current 10%. The agriculture sector in Pakistan remains as one of the key economic drivers of the country and Islamic finance has potentials to provide necessary financing through Shari’a microfinance products to support this sector.

Sri Lanka: Islamic banking took root in the island country 15yearsagoandisrepresentedtodaybyonefull-fledgedIslamic commercial bank, five Islamic banking windows and three finance company windows. Overall, in 2012, Islamic financial assets in Sri Lanka accounted for 3% of the total financial assets of the country. In a recent development, Sri Lanka Banks Association is forming an Islamic banking committee tasked with resolution of regulatory, tax and operational issues faced by local Islamic banks.



isla

mic

Ban

kinG

in c

entr

al a

sia Kazakhstan

Tajikistan

Uzbekistan

Kyrgyzstan

Turkmenistan

Kazakhstan, the energy backed powerhouse of Central Asia, was the first country in the CIS to adopt legislation on Islamic banking and finance in 2009. Its first Islamic bank, Al Hilal Islamic Bank, was set up in 2010 and currently offers a limited range of retail services; its total assets in 2011 were worth USD73.3mln. In March 2012, the government drafted a road map to position the country’s Islamic finance industry as the regional hub.

Tajikistan presents a number of lucrative investment opportunities for regional Islamic banking players. With initial research initiatives in 2011 by the National Bank of Tajikistan, at present the country is drafting an Islamic banking legislation. In the meantime, two Tajik banks have already introduced Islamic banking pilot projects worth USD15mln.

Uzbekistan has also expressed interest in Islamic banking. Since early 2013, local Hamkor Bank has started exploring the addition of Islamic banking products and services to its current portfolio of offerings.

The small land-locked country of Kyrgyzstan was the first in Central Asia and the greater CIS to modify its banking legislation to allow for Islamic banking activities. EcoIslamic Bank, the country’s first Islamic commercial bank, was established in 2008 with support from the Islamic Development Bank (IDB). By 1Q13, the bank held USD65mln in total assets.

Turkmenistan has a long history of fruitful cooperation with the IDB – an active regional Islamic lender – and the Islamic Corporation for the Development of the Private Sector (ICD) and in the future, through development of the Islamic banking infrastructure, hopes to attract more investments from member countries of the Organisation of Islamic Cooperation (OIC) for local energy and industrial projects.

Source: Zawya, Islamic banks, KFHR

Islamic Banking in South-Eastern Asia

Many of Asia’s leading Islamic banking markets are from the South-Eastern Asia. Malaysia is the undisputed leader while Indonesia is fast catching up.

Malaysia: Islamic banking in Malaysia is the most advanced in Asia underpinned by robust legal and regulatory environment and other supportive infrastructure. During 2007-2012, the Malaysian Islamic banking sector grew at aCAGRof 19.5%.As at end-August 2013, the Islamicbanking sector continued to expand, growing by 10.1% YTD to RM420.2bln to account for 20.6% of the banking system’stotalassets.Concurrently, total Islamicbankingdeposits and financing increased to RM328.5bln (+7.2%) and RM264.3bln (+11.7%), respectively, during the same

Islamic Banking System in Malaysia: Key Financials

57911131517192123

050

100150200250300350400450

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Aug

-13

%RM

bln

Total Assets Total DepositsTotal Financing Market Share of Assets (RHS)

Source: BNM Monthly Statistical Bulletin, KFHR



Islamic Banking: Domestic Market Share

Indonesia5%

(1H13E)

Malaysia20%

(2012)

Brunei40%

(2011)

Source: Central banks, Zawya, KFHR

Indonesian Banking Sector: Total Asset Growth

0

10

20

30

40

50

60

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

2005 2006 2007 2008 2009 2010 2011 2012

%IDR

tln

Conventional Assets

Islamic Banking AssetsConventional Assets Growth (RHS)

Islamic Banking Assets Growth (RHS)


period. By 2020, Malaysia targets a 40% share for its Islamic banking sector. To further improve the banking legislation of the industry, Malaysia has enacted a new comprehensive Act, the Islamic Financial Services Act that has come into effect in June 2013.

Brunei: Islamic banking took off in Brunei with the establishment of Islamic Bank of Brunei in 1993. In 2011, Islamic banking assets reached USD5bln which accounted for about 40% of the total domestic market share. In the next three to four years, Islamic banking institutions are expected to gain a 55%-60% share of all banking assets in Brunei. The total assets of Bank Islam Brunei Darussalam – the sole domestic fully-fledgedIslamic bank in the sultanate – reached USD4.6bln in 2012.

Indonesia: The Islamic banking system in Indonesia is developed within a dual-banking system framework under the Indonesia Banking Architecture (Aristektur perbankan Indonesia) Guideline. After a developmental plan namely the Blueprint of Islamic Banking Development, the country’s commitment was followed by the enactment of the National Act No.21/2008, ratified in July 2008, which provides an adequate legal foundation for the development of Islamic banking, and hence accelerating its growth. In 2012, Bank Indonesia has further identified key areas of focus in advancing the Islamic banking industry where policies and initiatives will be directed on enhancing banking intermediation with real economy, product development, education and communication as well as the regulatory and supervisory framework.

Islamic banks in Indonesia consist of Islamic commercial banks, Islamic business units and Islamic rural banks (BPRS). As at year-end 2012, Indonesia’s 35 Islamic banking institutions (24 of which are windows) held USD17.8bln in total assets. Indonesia, being home to the largest Muslim population in the world (about 209 million) and exhibiting robust economic fundamentals, offers an enormous growth opportunity for the local Islamic banking sector which constituted an estimated 5% of the total banking sector as of 1H13.

Singapore: Several foreign Islamic banking entities operate in Singapore. Despite presently holding only a small share of the global Islamic banking industry, experts see Islamic banking assets in Singapore to grow at 15%-20% per year for the next three to five years. Islamic banking institutions in Singapore are regulated through a number

of amendments to existing regulations and several related guidelines. The Monetary Authority of Singapore, in accordance with the recommendations of the Economic StrategiesCommitteein2010,hasintroducedanumberof tax and other incentives aimed at promoting Islamic banking. Popular products and services are mostly in investment and wholesale banking (including syndicated financing and trade financing). For retail consumers, a number of Shari’a compliant products and services have been made available over the past few years. Nonetheless, Shari’a compliant wholesale and investment banking products are likely to drive Islamic banking in Singapore as Singapore capitalises on its reputation as a global financial centre.

Philippines: The Philippines’ central bank is pushing several important initiatives in legislation, regulation and taxation to promote Islamic banking in the country. In the meantime, the country’s sole Islamic bank, Al-Amanah Islamic Bank (with mere USD17.2mln in total assets in 2011), is in the process of being privatised by the Development Bank of the Philippines.



Thailand: In Thailand, Islamic banking services were made available in 1998 when the Bank for Agriculture and Agricultural Cooperatives setup an Islamicwindow.Today, however, there is only one Islamic bank operating in the country: the state-owned Islamic Bank of Thailand, established in 2002. The bank now has an asset base of USD3.3bln in 2012 and is planning a capital expansion of USD234.9mln.

Islamic banking is undoubtedly a rapidly growing segment of the financial systems across Asia. In some Asian jurisdictions – specifically, in Malaysia, Indonesia, Pakistan and Brunei – Islamic banking has had a long history of progressive development in terms of enabling legal and regulatory environment, accommodating tax regimes, active liquidity and risk management, and leading research and training programmes. Realising the potential of burgeoning Islamic banking business, global financial centres such as Singapore, Hong Kong and Japan, where investment and wholesale Islamic banking services are now in high demand, have also ventured into Islamic finance. The entrance of emerging economic giants of ChinaandIndiaintotheIslamicbankingspherewillusherin an even brighter future for the industry. In particular,

Islamic Banking in the Philippines and Thailand: Governmental Goals

Philippines

Thailand

• Tocatertothebankingneedsof5millionFilipinoMuslims

• To bolster economic development of the predominantlyMuslim Autonomous Region in Muslim Mindanao (ARMM)

• Tocatertothebankingneedsof7millionThaiMuslims

• To bolster economic development of the predominantlyMuslim Southern Thailand

Source: KFHR

impending Islamic banking involvement of Chinesefinancial institutions has attracted considerable global attention,forthismovewillopenChina’shugeuntappedhuman and funding resources to Islamic banking players and introduce an exciting new era in the economic relationshipofChinawiththeMuslimworld.

Sukuk Market in Asia

The sukuk markets in Asia have been sparked by a series of developments and commitments from potential players in the last five years. A number of new jurisdictions have been home to sukuks issuance during 2012 as government and particularly corporates eye the opportunity to secure lower funding costs and diversify funding sources. Malaysia has maintained its dominance in sukuk issuances over the years globally, with countries from the Gulf region catching

up. Malaysia held approximately 70.5% of global sukuk market share as at 1H13 followed by Indonesia (5.19%), Pakistan (0.72%) and Brunei (0.13%). Among other countries that have issued sukuks in Asia are Singapore, Kazakhstan, and Hong Kong. Malaysia, being a leader in global sukuk issuances, has also made progress in cross border issuances as part of the efforts to facilitate greater mobilisation of funds across regions.

Asian Sukuk Issuances: Top Countries by Issuances

• 9M13E: USD58.1bln• 2012: USD97.1bln

Malaysia

• 9M13E: USD5.5bln• 2012: USD5.9bln

Pakistan

• 9M13E: USD5.5bln• 2012: USD5.9bln

Indonesia

• 9M13E: USD237mln• 2012: USD238mln

Brunei

• 9M13E: USD118mln• 2012: USD384mln

Singapore




Sukuks as Alternative to Support Asia’s Infrastructure Needs

2 Developed Islamic sukuk markets are jurisdictions of substantial asset value and legal, regulatory and tax environment conducive to sukuk issuances. Growing – jurisdictions with a growing sukuk market share where legal, regulatory and tax reforms are being implemented. New – countries with basic sukuk infrastructure in place with one or few sukuk issuances. Potential – states where the introduction of sukuk regulatory framework is being considered or where the sukuk specific legislation is being drafted.

Asian Sukuk and Islamic Funds: Presence and Stages of Development2

MalaysiaIndonesia Pakistan

SingaporeBrunei

Hong KongKazakhstanMaldives

AfghanistanChinaPhilippinesThailandJapanIndiaSouth KoreaUzbekistan

Deve

lope

D

Grow

inG

new

pote

ntia

l

Source: KFHR

Sukuks have played a crucial role in funding the infrastructure sector over the past decade, with proceeds raised from issuances being utilised for both low and high profile projects. The very nature of sukuks, combined withtheirflexibility,allowthemtobestructuredinvariousways. This has attracted corporate and sovereign entities to choose Islamic bonds as a viable alternative financing instrument. The infrastructure sector has seen a large portion of the raised sukuks funds directed to development projects around the globe, largely driven by infrastructure projects from both the GCC andSoutheast Asian regions. During this year, infrastructure sukuks issuance represented 21.2% of total global sukuk issuances. Malaysia led the cohort of countries with infrastructure issuances worth USD20.37bln or 73.24% of all sukuk issuances in the year 2012. Saudi Arabia ranked second with issuances worth USD6.08bln or 21.9% of all sukuks issuance in the same year. Other notable countries that have issued infrastructure sukuks include United Arab Emirates, Indonesia, Pakistan, Kuwait and Brunei.

Using infrastructure sukuks, Asian economies can partly

support the huge infrastructure investment needs in Asia. It is reported that in ten-year period from 2010-2020, the 32 ADB developing member countries are expected in need of USD8.22tln for infrastructure investment. With this estimation, the amount needed for investment annually will reach up to USD747bln over 2010-2020. About 68% of the total investment is needed for new capacity investments in infrastructure while the remaining 32% is allocated for replacement of existing assets. East and Southeast Asia will need the most funds by the end-2020 as both countries require about 66.55% of total Asia infrastructure investment needs.

Infrastructure sukuk can be structured using various types of Shari’a contractual principles. Among the foremost principles utilised are Musharakah, Ijarah and Murabahah. Collectively, these three structures accounted for morethan 79% of all issuances during 2H2010 till 1H2013. The central merit of Musharakah sukuk is that it promotes principles of risk sharing where investors and issuer agree to share profits and absorb losses based on actual outcomes of the underlying business activity.



National Infrastructure Investment Needs in Asia: 2010-2020

Sub Region% of Total Asian Investment Need

Estimated Investment Need (USD mln)

Total Investment per Year

Central Asia 4.544 373,657 33,969East and Southeast Asia 66.553 5,472,327 497,484South Asia 28.829 2,370,497 215,500The Pacific 0.073 6,023 548Total 8,222,503 747,500

Source: ADB/ADBI

Infrastructure Sukuk Issuances by Country

0

5,000

10,000

15,000

20,000

25,000

30,000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

1H20

13E

US

D m

lns

per

year

Malaysia UAE Indonesia Pakistan

Saudi Arabia Kuwait Other

Source: IFIS, KFHR

Sukuk Market in Eastern Asia

Japan: Japan has made regulatory amendments through the Japanese Asset Securitization Law which came into effect on 24 November 2011, allowing tax exemption to sukuk Ijarah investors which accorded a level playing field between conventional and Islamic instruments. However, the contribution of Japan in the sukuk sector has been through offshore listings and a number of Japanese firms have chosen Malaysia as their domicile for sukuks issuances.AeonCreditbecame thefirst Japanese corporation to issue Malaysian Ringgit-denominated sukuk in 2007 with a face value of MYR400 mln. Other corporations to issue sukuk in Malaysia include Toyota Capital Services which issued MYR1bln Islamicinstruments to fund its auto Islamic leasing business while Nomura asset management was the first Japanese firm to issue global “Emas” sukuk worth USD100mln.

Mainland China and Hong Kong SAR: While regulatory changes have been introduced in the Hong Kong Special Administrative Region in order to develop the island as a hubforsukukissuances,inmainlandChina,therehasbeenlittle scent of firm government support that would allow for greater traction in developing Islamic finance. Hong Kong

has taken few initiatives to support the development of a domestic Islamic capital market by amending its tax and stamp duty on July 2013 through the Inland Revenue Department. The amended regulation provides sukuk issuances a comparable tax framework as with conventional bonds. Under this amendment, sukuk issuers and investors will not be subjected to additional tax and stamp duty charges on the sale-purchase/lease transactions.

As a result, a number of corporations and sovereign/quasi-government entities have used Hong Kong as a platform for issuing RMB denominated sukuk. Hong Kong is currently regarded as an international gateway betweenChinesecorporationsandtherestoftheworld.There have been a few sukuk issuances involving the ChinesemarketsinHongKong.Forinstance,in2011,thesovereign wealth fund of Malaysia (Khazanah Nasional) issued a RMB500mln (USD80.2mln) sukuk in Hong Kong. The transaction drew a demand of 3.6 times of the book size. Thus in the near future, Hong Kong may continue toserveastheplatformfor linkingChinesecorporationswiththeIslamicfinancial institutionsuntilChinadevelopsits own Islamic capital market framework.



Sukuk Market in South-Central Asia

Sukuk Market in South-Eastern Asia

Pakistan: Pakistan ranked the third among Asian countries in sukuk issuances. To date USD440mln worth of sukuks has been originated from the country. Pakistan has introduced several regulatory initiatives for its Islamic capital market such as the introduction of incentives for the income of a collective investment scheme, real estate investment trust (REIT) and Mudharaba is exempt from tax if 90% of the profit is distributed as dividend.

Kazakhstan: In 2012, The Development Bank of Kazakhstan have issued MYR-denominated sukuk programme in Malaysia worth of MYR1.5bln. This transaction represents the first ever Sukuk issue out of the Commonwealth of Independent States. The transactionalsorepresentsthefirstissuerfromtheCISregiontotapthe Malaysian market. Kazakhstan parliament approved changes allowing the ministry of finance to issue its first sovereign sukuk amounting to USD500mln to finance

Sukuk Issuances in Pakistan

0200400600800

1,0001,2001,4001,6001,8002,000

US

D m

ln

2007 2008 2009 2010 2011 2012 9M13

Source: KHR

road construction in 2011. Kazakhstan stands as the secondCISmajoroil producer,which require significantinvestment for exploration activities and constructions of infrastructure projects.

Sukuk Issuances in South-Eastern Asia (2011-1H13)

2011 2012 1H13Malaysia

60,921

97,079

41,454

Indonesia

2,594 5,9963,173

Brunei

1,863 1,011 4410

20,000

40,000

60,000

80,000

100,000

120,000

US

D m

ln


Malaysian Sukuk Issuance Value by Issuer Type

0

5

10

15

20

25

30

Corporate Government Related Entity Sovereign

US

D b

ln

1H12 1H13

Source: IFIS, Bloomberg, Zawya, KFHR

Malaysia: Malaysia remains at the vanguard in global sukuk issuances, constituting 67.8% and 90.3% of the global and Asian primary sukuk markets respectively. Furthermore, Malaysian sovereign sukuk led the market, totalling USD30.8bln or 46.3% of the total primary market value during the 1H13, 13.9% higher than 1H12. Over the six months of 2013, the Malaysian ringgit continued to dominate the currency used for the issuances, with a total of USD46.4bln or 70% of total issuances in comparison to 74% in 2012 and 69.3% in 2011.

Malaysia’s secondary market is by far the largest globally, totalling USD148.2bln, marginally up from USD143.9bln as at end-2012.

Indonesia: Indonesia ranked as the second largest market after Malaysia in terms of issuance size, with a total of USD5.9bln worth of primary market issuances in 2012, or 4.57% and 8.48% of the global and Asian sukuk market share, respectively. In April 2009, the Indonesian government announced its inaugural USD-denominated sovereign sukuk under the programme of (PPSI I) with a tenure of five-year and was priced at par. Since then, the country has issued a further three sovereign USD sukuk. As at end-1H13, there are four sovereign sukuk outstanding, namely;



1. Indonesia Global Sukuk I (USD650mln),2. Indonesia Global Sukuk II (USD1bln),3. Indonesia Global Sukuk III (USD1bln), and4. Indonesia Global Sukuk III Tranche 2 (USD1.5bln)

Indonesia is rated BBB- (or equivalent) by Moody’s and Fitch, putting it in the same risk category as countries such as Turkey, the Philippines and India. The yield of the country’s benchmark issuances have risen sharply this year on concerns over a record current-account deficit and falling foreign-exchange reserves pushed up borrowing costs.

Brunei: Islamic capital market in Brunei dates back to 2006. The sultanate debut issuances was BND92mln worth of sovereign sukuk and subsequently in the same year Brunei Liquefied Natural Gas and Bank Islam Brunei Darussalam issued USD-denominated sukuk worth of USD100mln.

Indonesian Sukuk (2022) Yield

2.02.53.03.54.04.55.05.56.06.57.0

Nov

-12

Dec

-12

Jan-

13

Feb

-13

Mar

-13

Mar

-13

Apr

-13

May

-13

Jun-

13

Jul-

13

Aug

-13

Sep

-13

%


Islamic Funds Industry in Asia

Islamic funds registered in Asia are primarily dominated by Malaysia with a total of 167 funds registered in 3Q13, followed by Indonesia (21), Pakistan (20) and Thailand (2). Malaysia is the second largest market by AuM with approximately USD20.5bln in assets or 31.1% of the industry total. Malaysia’s Islamic finance industry benefits from a well-regulated environment, with a transparent legislative system and supporting infrastructure. This makes it a particular prime destination for wealth management, and in particular Islamic wealth management given the domestic population demographics as well as its regional

positioning both geographically and as a hub for Islamic finance.

Asia is an important part of the growing global wealth in recent years, as strong fundamental economic growth has produced a larger number of high net worth individuals and created the need for more wealth management products. The Asia pacific region accounts for 20% of total global household wealth as at 1H13, translating into USD48.1tln, signifying huge potential for the Islamic funds industry to capture the huge untapped potential.

Net Funds Inflow into Asia Regional Equity Market (2012)

Country (in USD mln) 1Q12 2Q12 3Q12 4Q12 Main Equity Index

Main Equity Index Performance 2012

(y-o-y)Malaysia 1,647 343 1,722 656 FBMKLCI 10.3%Korea 2,694 2,082 2,131 2,504 KOSPI 9.4%Thailand 9,641 5,332 13,323 15,068 SE of Thailand Index 35.8%Indonesia 1,092 219 1,733 1,703 JCI 12.9%Philippines 430 1,665 2,180 2,548 PSEi 32.9%India 8,866 8,561 16,373 24,548 SENSEX 26.7%Taiwan 4,933 (761) 2,758 n.a TAIEX 8.9%



Takaful Market in Asia

The development and growth of Islamic finance in Asian countries represents strong opportunities for takaful operators to expand their geographical outreach in the region given that many of these Asian countries are emerging markets with relatively large populations, strong economic growth performances and generally low insurance penetration rates. Particularly, world’s fastest growing economies of China and India have insurance-to-GDP

penetration rates of 3.8% and 5.1% respectively. These figures show the large untapped potential available for the insurance sector in these emerging Asian economies. With the keen interest of many of these countries in introducing Islamic finance in their economies, takaful operators have remarkable opportunities to penetrate these markets and contribute towards expanding the global share of Islamic financial assets.

Insurance Penetration Rates as a % of GDP in Selected Asian and GCC Countries (2011)

Name of Country Insurance Penetration Name of Country Insurance PenetrationKuwait 0.50% United Arab Emirates 2.00%Pakistan 0.70% China 3.80%Qatar 0.80% Thailand 4.30%Saudi Arabia 0.80% India 5.10%Bangladesh 0.90% Malaysia 5.10%Oman 1.10% Singapore 6.20%Turkey 1.30% Japan 10.10%Indonesia 1.50% Hong Kong 11.50%

Source: Arab Insurance Market Review, E&Y, KFHR

At present, the takaful industry in Asia is firmly established in Malaysia, which contributes the major chunk of Asia’s takaful market contributions. However, other countries from South and Southeast Asia such as Bangladesh, Pakistan, Indonesia and Brunei are fast catching up, capitalising on their established regulatory frameworks that help support the growth and expansion of the domestic

takaful industry. In comparison, newer jurisdictions such as Afghanistan and Kazakhstan have also witnessed introduction of takaful products in the country. Additionally, huge potentials to offer takaful services exist in other Asian countries considering Islamic finance such as Azerbaijan, China,HongKong,Japan,KyrgyzstanandPhilippines.

Asian Takaful Industry: Presence and Stages of Development3

3 Developed takaful markets are jurisdictions of substantial takaful contributions and legal, regulatory and tax environment conducive to takaful operations. Growing – jurisdictions with a growing takaful contributions share where legal, regulatory and tax reforms are being implemented. New – countries with basic takaful infrastructure in place with one or few operational takaful institutions. Potential – states where the introduction of takaful products is being considered or where the takaful specific legislation is being drafted.

Malaysia

BangladeshBruneiIndonesiaPakistanSingaporeSri LankaThailand

AfghanistanMaldivesKazakhstan

AzerbaijanChinaHong KongJapanKyrgyzstanPhilippines

Deve

lope

D

Grow

inG

new

pote

ntia

l

Source: KFHR



Among the key takaful business lines in major markets, based on 2011 estimated statistics, family and medical takaful products were most commonly purchased across all regions followed by motor takaful and then property and accident takaful. The marine and aviation business line, which requires substantial amounts of coverage in value, remains a small sector possibly due to the small-scale operations of most operators which restrict their financial ability to provide protection to larger value projects.

A notable factor, possibly limiting the full development potential of the global takaful industry is the lack of large-scale operators which are capable of offering cross-border services and driving the internationalisation of the industry. A mega operator with large operations and market share can provide much needed leadership and innovation to the industry, leading to enhanced efficiency and creativity of the industry’s products. With the exception of Saudi Arabia and Malaysia, most takaful operators are regarded to lack scale in operations. Based on estimated 2011 statistics, the chart below indicates the average gross contribution per operator in USD millions across various regions. Takaful operators need to exploit on the largely untapped potential across global markets as the industry in current conditions is mainly concentrated in specific jurisdictions and in limited segments and business lines.

One valuable segment where takaful operators could target for future growth in the Asian region is the healthcare sector. The issue of healthcare funding is alarming many governments and individuals alike in Asia as surveys have revealed most people feel they are generally unprepared for the financial impact of future medical and disability costs. The situation is worsened with the low rates of insurance policy subscriptions by the population in general across these countries. Based on a 2012 study commissioned by Swiss Re, the health protection gap (defined as the difference between the levels of healthcare costs which would be required to meet consumer needs, versus the amount that would be spent to cover those

Key Takaful Business Lines in Major Markets (2011E)

25%

27%

11%

21%

20%

6%

7%

3%

3%

47%

50%

80%

0 20 40 60%

80 100

MENA

ASEAN

South Asia

Motor Property and AccidentMarine and Aviation Family and Medical

Source: World Islamic Insurance Directory, E&Y, KFHR

Takaful Operator Statistics by Region (2011E)

9

36

12

29

43

11

34

10

13

18

22

34

145

145

0 20 40 60 80 100 120 140 160

Others (ex-Iran)

Africa

South Asia

ASEAN (ex-Malaysia)

GCC (ex-Saudi)

Malaysia

Saudi Arabia

USD mlns

Average Gross Contributions per Operator No. of Operators

Source: World Islamic Insurance Directory, E&Y, KFHR

costs in the Asia Pacific region could reach USD197bln by 2020, with the biggest health protection gaps being inChina,India,JapanandSouthKorea.Themaintakafulmarkets in Asia Pacific are also not spared, with Malaysia and Indonesia facing gaps of USD4.1bln and USD8bln respectively. Hence, despite the share of family and medical takaful contributions being the highest, there still remain substantial avenues for takaful operators to expand on family and medical products market share in Asia.

Takaful operators have strong

opportunities to expand on family and medical business lines particularly in South-

Eastern Asia and Eastern Asia.

Studies have indicated the health protection gap in the Asia Pacific region could reach USD197bln by 2020.

The biggest health protection gaps by 2020 will be in China, India, Japan and

South Korea.



Apart from the various government institutions supporting the industry’s development, notable on-going efforts are made by multilateral Islamic finance bodies such as the Islamic Financial Services Board (IFSB) headquartered in Malaysia and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), headquartered in Bahrain. By providing guiding principles and governance standards tuned to the changing global environment,

these institutions help takaful operators in adjusting their financials to maintain the company’s health and viability while providing benchmarks for auditors and other stakeholders to assess the operator. The following sections of the report now presented detailed analysis on the global takaful industry performance across sub-regions and individual countries in Asia.

Takaful in South-Eastern Asia

Currently,takafulproductsareavailable infiveSoutheastcountries namely Malaysia, Indonesia, Brunei, Singapore and Thailand. A sixth country Philippines is working on drafting takaful regulations with an intention to introduce takaful products in the country. As with other sectors of Islamic finance in South-Eastern Asia, takaful market is dominated by Malaysia which generated approximated

USD2bln worth of takaful contributions in 2012. A distant second came Indonesia with a USD666mln gross takaful contributions although its growth has been phenomenal in recent years. The other countries however have substantial amounts of untapped potential business in the takaful sector which Islamic financial institutions should genuinely look to capture.

Share of South-Eastern Asia Gross Takaful Contributions by Country

Malaysia, 71%

Indonesia, 24%

Others, 5%

841 992 11551450 1595

193184172

251

290529

666

6770

125

196

122

124

0

500

1,000

1,500

2,000

2,500

3,000

2007 2008 2009 2010 2011 2012E

US

D m

lns

Malaysia Indonesia Others

Source: World Islamic Insurance Directory, E&Y, KFHRNote: Others includes Singapore, Thailand and Brunei

The major chunk of South-Eastern Asia (SEA) takaful market contributions comes from Malaysia which currently holds 71% share of total SEA contributions. Malaysia is the second largest takaful market in the world posting phenomenal growth rates in recent years with gross takaful contributions estimated at USD1.931bln as at end-2012, reflecting a 21% y-o-y growth. Duringthe 2007-2012 periods, the Malaysian takaful industry experienced aCAGR of 18.09% in gross contributions.The potentials for further expansion in the takaful sector in Malaysia is tremendous since Malaysia has a relatively under-insured population with an insurance-to-GDP

penetration rate of about 5.1%. This factor, combined with increasing awareness about insurance/takaful products among the population indicates a sizeable untapped market for the takaful operators to target in the near future.

On the other hand, Indonesia has been rapidly emerging to catch up with the growth expansion of the global takaful industry. As at end-2012, gross takaful contributions in IndonesiawereestimatedatUSD666mln,reflectinga26%y-o-y growth. During the years 2007-2012, the Indonesian takafulindustryCAGRisanimpressive51.3%,largelydueto starting from a smaller base value of contributions, which



were a mere USD84mln in 2007. Being the most populous Muslim nation, the existing takaful penetration rates of about 2% speak volumes on the untapped potential for expanding takaful products in the country. Moreover, it is estimated that nearly 80% of Indonesian are uninsured and Indonesia’s insurance-to-GDP penetration rate is about 1.15%. Hence, the outlook for the takaful industry in Indonesia appears bright on the back of a strong expected demand for insurance products in the near future.

Among other Southeast Asian nations, takaful products are offered in Brunei, Singapore and Thailand. However, the growth in these countries, although decent with a 2007-2012CAGRof13.1%,lacksscaleandcollectivelythesecountries are estimated to have generated USD124mln in contributions in 2012.

In Brunei, the takaful industry went through major changes in recent years with the passage of the Takaful Order of 2008 which stipulated different requirements for Takaful operators to carry out Keluarga (Family Takaful) and Takaful Am (General Takaful). Subsequently, two of Brunei Darussalam’s three sharia-compliant insurance firms – Takaful IBB and Takaful BIBD – merged to form Syarikat Takaful Brunei Darussalam in 2010. The other takaful operator is the Insurans Islam TAIB and together these two entities provide takaful services in the tiny oil-rich country. The gross takaful contributions in Brunei were valued at USD84.2mln in 2010 and these represented approximately 33% of all insurance contributions in that year. General takaful policies covering motor, property and other business insurance accounted for more than 80% of total takaful contributions in the market. The comparatively low share of contributions from family and health coverage policies are largely due to the extensive medical services provided by the government. In order to further drive sales of their products, the two takaful firms in recent years have conducted road shows and information briefing sessions

with the members of public along with holding exhibitions in shopping malls, schools and community centres.

In Thailand, Islamic finance took root beginning 2002 when the Islamic Bank of Thailand Act was passed in 2002, and the bank itself subsequently came into existenceayearlater.Laterin2008,theThaiCentralBankissued a notification allowing commercial banks to offer Shari’a-compliant banking services. In terms of the takaful industry, there appear to be four companies offering takaful services in Thailand: Muang Thai Takaful, Finansa Life Assurance, Dhipaya Insurance Public CompanyLimited and Kamol Sukosol Insurance Co. The majorchallenge to the expansion of Islamic finance in Thailand is the lack of awareness among Thai consumers of Islamic financial products. Nonetheless, with a low insurance-to-GDP penetration rate of about 4.3%, Thailand offers strong opportunities for the growth of insurance product sales in the country. Takaful operators will need to engage in massive nationwide awareness campaigns regarding the concept of takaful and its benefits to promote the development of the industry.

Singapore aims to ambitiously develop itself as an offshore Islamic financial hub, capitalising on its status as a leading international financial centre. In terms of takaful services, the country currently only hosts one retakaful company and the Monetary Authority of Singapore is encouraging development of the takaful sector in the country.

And finally, takaful products are expected to be made available soon in Philippines as the Insurance Commission of the Philippines is working to introducetakaful regulations. The commission aims to provide takaful products to the Filipino Muslims affected in the calamity-hit island of Mindanao and to realise this, will be consulting with experts in Islamic banking and insurance.



South-Central Asia

Country Developments

Afghanistan The insurance market in Afghanistan is in its infancy and largely under-developed, yet has enormous potential for growth.

The market is regulated by the Afghanistan Insurance Authority (AIA) which sits under the umbrella of the Ministry of Finance.

As of 2011, the Afghanistan Insurance Authority reported annual premiums of over USD10mln. To date, there are three known takaful products in Afghanistan: Group Family Takaful policy for

the 333,260 (as of December 2011) public employees; Takaful policy for insuring properties used as collateral for Islamic financing; and a Fleet Motor Plan with a takaful policy whose benefits include damage to the car and liability to third parties.

The road ahead for the industry is full of challenges as Afghanistan needs to introduce prudent and comprehensive regulatory frameworks to support the development of the Islamic financial industry along with nationwide awareness campaigns regarding the concept of takaful and its benefits.

Bangladesh The Takaful industry was formally introduced in Bangladesh in 1999 and since then has strongly positioned itself to emerge as one of the fastest growing industries within the insurance sector.

The industry which began with one non-Life Takaful operator in 1999, has grown into six fully-fledgedTakafuloperatorsand13windowoperationsofconventionalinsurersthatofferawiderange of life and non-life Takaful products as of 2012.

In terms of gross takaful contributions, premiums have increased from BDT1.4bln (USD16.9 mln)in2004toBDT10.6bln(USD128.5mln)in2010,markinganimpressiveCAGRof33.62%during 2004-2010 while reaching 15% of total premiums of the insurance sector in 2010.

Bangladesh has an insurance-to-GDP percentage penetration rate of 0.8% which is one of the lowest in Asia.

Hence, with the progress achieved so far and largely untapped insurance market, the takaful industry has strong future potentials and is expected to become an increasingly important component of the Islamic financial system in Bangladesh.

Kazakhstan KazakhstanbecamethefirstcountryintheCISregiontoadoptlegislationonIslamicbankingand finance in 2009, following the outbreak of the global financial crisis.

In 2011, it made further amendments and additions to its legislative acts in order to support the development of the Islamic financial industry.

The industry is still at its very infant stages. Kazakhstan currently has only one takaful company called “Takaful: Halal Insurance”.

However, the outlook for the industry looks bright on the back of a firm government mandate to develop Islamic finance in the country including takaful.

The Kazakh government drafted a 41-point road map in March 2012 to develop the country’s Islamic finance industry. In addition, the country has formulated Vision 2020 to make its capital Almaty as the regional centre for Islamic finance.

Maldives TheMaldivianIslamicfinancialsectoriscurrentlyatanascentstagewithonlyonefull-fledgedIslamic bank, Maldives Islamic Bank; one Islamic finance window, HDFC Amna; and oneTakaful company, Amana Takaful Maldives.

The sole takaful company, Amana Takaful, generated gross takaful contributions worth USD4.65mlnin2012,reflectinga66%y-o-ygrowth.Thestrongy-o-ygrowthisreflectedthegrowing appetite for takaful products in the country.



Country Developments

Pakistan The Pakistani insurance sector presents abundant opportunities for takaful providers to penetrate into as the economy currently posits one of the lowest insurance to GDP percentage penetration rates of 0.7% globally, based on 2012 statistics.

However, the market is dominated by conventional insurance products which hold approximately 97% share of total insurance contributions. As of 2011, the gross takaful contributions in Pakistan amounted to just over USD40mln.

The subdued growth could largely be due to an earlier regulatory policy which restricted conventional operators from introducing takaful windows.

Henceforth,inJuly2012,theSecuritiesandExchangeCommissionofPakistan(SECP)draftednew takaful rules which allowed entry of conventional players to operate takaful windows. Such a move is highly expected to broaden the market share of takaful products since the conventional insurance providers have a much wider branch network and a larger sales force across the country.

Sri Lanka Asof3Q13,SriLankahasonefully-fledgedIslamicbank,twodomesticcommercialbankswithIslamic windows, a takaful operatpr, and several Islamic leasing companies.

SriLanka,likeitsotherSouth-CentralAsianneighbours,hasarelativelylowinsurance-to-GDPpercentage penetration rate of 1.2%. Therefore, the potential for developing and expanding on takaful products in the country are substantial.

The Muslim community in Sri Lanka is economically strong contributing as much as 20% of GDP despite being 9% of the total population.

In addition, it is regarded that as much as 25% of Islamic finance customers in Sri Lanka are non-Muslims. Hence the market has substantial opportunities for takaful operators to explore and penetrate upon.

As of 2012, the sole Sri Lankan takaful operator generated USD16.5mln in gross takaful premiums,reflectinga33%y-o-ygrowthrate.



IslamIc FInance: catalyst For

InclusIve Growth

Pursuing inclusive growth by building an inclusive financial system has been the key focus of almost all Governments and multilateral institutions as measures to improve living conditions, particularly in the developing world. Following the onset the global financial crisis, there is growing awareness concerning the need for new forms of partnership required to accelerate financial inclusion. Financial inclusion includes microfinance, SME finance, and other provisions of financial services to less privileged individuals.

In Asia, inclusive growth, defined as economic growth with equal opportunities, is one of the three strategic objectives of the Asian Development Bank (ADB)1. To achieve the vision of an Asia-Pacific region free of poverty, as laid out in ADB’s guiding Strategy 2020, the multilateral institution supports pro-poor growth in its Developing Member Countries (DMCs) that is inclusive, environmentally sustainable, and draws on the region’s increasing levels of cooperation and integration. ADB supports partner governments, commercial and rural banks, cooperatives and semi-formal institutions, including non-government organisations, to ensure permanent access to institutional financial services for the region’s low-income people and their micro and small businesses.

Source: EIU, KFHR

About 90% of the 180 million poor households in the Asia-Pacific region still lack access to institutional finance2. Financial services enable poor and low income households to take advantage of economic opportunities, build assets, and reduce their vulnerability to external shocks that adversely affect their living standards.

MICROFINANCE

DEVELOPMENTS

Pakistan

The Securities and Exchange Commission of Pakistan (SECP) issued draft rules for microfinance in 2013 on basic rules of the segment and also client-protection requirements.

Bangladesh

Bangladesh is among the mature microfinance markets in Asia and is home to three of the world’s largest providers of microfinance: Grameen bank, BRAC and ASA.

India

Microfinance total loan growth is estimated to have risen 30% y-o-y in FY2012/2013. The Reserve Bank of India’s (RBI) regulatory approach has been flexible and pragmatic. Following the removal of 26% interest-rate cap in 2012, the RBI has fixed the margin cap for all non-bank financial companies at 12% from May 2013 to March 2014.

China

Microfinance institutions in China includes: 6700 Micro-Credit Companies (MCCs), 800 Village and Township banks (VTBs), 2411 in total of Rural Credit Co-operatives (RCCs), Rural Co-operative Banks (RBs) and Rural Commercial Banks (RCBs).

Thailand

Microfinance in Thailand is a government-sponsored activity. Thailand’s Village Fund (VF) is one of the world’s largest micro-credit schemes, leaving little room for the development of private-sector MFIs. There are 13 million VFs at end-2012.

Cambodia

The Credit Bureau of Cambodia (CBC) was set up to resolve indebtedness resulting from multiple borrowings and market saturation.

Indonesia

Indonesia’s microfinance industry is among the largest in the world with over 50,000 MFIs.

Snapshot of Key Microfinance Developments in Selected Asian Countries

1Asian Development Bank (ADB), “Strategy 2020: Working for an Asia and Pacific Free of Poverty”, April 2008

2Asian Development Bank (ADB), “Microfinance: Financial Services for the Poor”, http://www.adb.org/sectors/finance/microfinance

IslamIc FInance: catalyst For InclusIve Growth


MENA, 72

Europe and Central Asia, 3East Asia

and Pacific, 164

South Asia, 12

Sub Saharan Africa, 4

Village/Ruralbanks,77%

NGOs, 10%

NBFIs, 5%

Cooperatives, 4%

Commercial Banks, 3%

Other,1%

Qard-HassanUSD156mln,25%

Musharaka/MudarabaUSD40mln,6%

SalamUSD2mln,0%

OtherUSD17mln,3%

MurabahaUSD413mln,66%

Institutions Offering Shari’a-Compliant Microfinance Products by Region

Source: CGAP, KFHR

Global Islamic Microfinance

Microfinance is a powerful tool to alleviate poverty. It suggests provision of financial services to low-income people who have limited access to formal financial services. Microfinance funding extended usually involves a small amount, enough to assist the poor in establishing, sustaining or expanding small self-supporting businesses. The-exclusion of low-income households from financial system is seen as a primary factor of their inability to participate in development process which consequently hinders the pace of economic growth. Accessibility to services such as venture capital, credit, savings, insurance and remittance in a micro-scale is integral in fostering a sustainable living for the poor. The provision of financial services to them will help to increase household income, economic security, reduce vulnerability and stimulates local economies.

In Muslim countries, Islamic microfinance still accounts for a very small portion of the country’s total microfinance outreach. Notwithstanding that, an estimated 1.28 million clients use Shari’a-compliant microfinance services, a four-fold increase since 2006, according to the survey released in April 2013 undertaken by Consultative Group to Assist the Poor (CGAP). It is reported there are now 255 Islamic microfinance institutions around the world, with a total outstanding loan portfolio amounting to USD628mln. Approximately 70% of the providers of Islamic microfinance services are from East Asia and Pacific and South Asia regions.

The offering of Islamic microfinance is primarily targeted to combat poverty particularly within Muslim countries. Unfortunately Islamic microfinance remains less attractive and has been experiencing slow growth mainly due to lack of profitability and inherent risk within this segment. The slow growth in Islamic microfinance is also contributed due to the fact that SME and micro financing are being provided by specialised institutions such as non-governmental organisations, and not by Islamic banks, despite the many elements of microfinance which can be considered consistent with the broader objectives of Islamic banking.

Nevertheless, opportunities for Islamic micro financing are vast, underpinned by strong economic growth in emerging markets and improved living standards of low income earners. In addition, government support to alleviate poverty, combined with innovative Shari’a-compliant product structuring helps in expanding market potential for Islamic microfinance products.

Type of Contracts Used in Offering Shari’a-Compliant Microfinance Products

Types of Institutions Offering Shari’a-Compliant Microfinance Products by Region

Source: CGAP, KFHR

Source: CGAP, KFHR



300

250

200

150

100

50

0

Min

Paki

stan

Indo

nesi

a

Indi

a

Ban

glad

esh

Nig

eria

Egyp

t

Iran

Turk

ey

Afgh

anis

tan

Iraq

Largest Muslim Population by Country: 2030F

• Needeasyaccesstofinancialservices

• Prefertimelyandadequatecrediton commercial basis vs. subsidised credit

• Perceiveformalsavingsasasaferand more rewarding service

• Risksharingmethod

• LinkwithNGOsandCBOsasacost effective means of reaching out to the poor and open untapped markets

• Formulatesupportivepolicyand regulatory environment

• Actascatalystsofchange

• Involvecommunityassets

• Combinesocialandeconomicagenda

• Sustainabilityisthecorefactorin development

The poor

Islamic financial

institutionsGovernment

NGOs/ CBOs/ SHGs

Source: Pew Research Centre, KFHR

Islamic Microfinance in Asia: Vast Room for Growth

Islamic microfinance has potentials to expand financial inclusion at unprecedented levels throughout the Muslim world. Among the world’s top 10 nations with largest Muslim populations are five Asian countries. These give countries are home to 1 billion Muslims. By 2020, it is estimated more than 60% of the global Muslim population would be residents in Asia.

According to a survey by CGAP conducted in 2011, an estimated 1.28 million clients in 19 countries use Shari’a compliant microfinance services and approximately 82% of these clients reside in only three countries namley Bangladesh (445,000 clients), Sudan (426,000 clients) and Indonesia (181,000 clients). The opportunities for Islamic microfinance are vast, underpinned by strong economic growth in emerging markets. Government ambition to reduce poverty levels and enrich the standard of living, the growing preference for Shari’a-compliant products, and a large bourgeoning Muslim population are among the factors propelling growth in Islamic microfinance. For the industry to reach its full potential in eliminating poverty,

governments across the developing world and regulators should consider integrating Islamic microfinance into the country’s mainstream banking and financial system. This will help to create greater awareness of Islamic microfinance products, encourage product innovation and improve access to microfinance.

Islamic Microfinance: The New Paradigm

CBOs – Community-based organisations; SHG – Self-Help GroupsSource: Unicons, KFHR



Globally, several initiatives to promote Islamic microfinance have been initiated. For example, Islamic Microfinance Network (IMFN), a not-for-profit organisation was formed in 2009 by a group of Islamic microfinance institutions, dedicated for the development and promotion of the Islamic microfinance industry through innovation, Shari’a compliant product development, institutional capacity building, donor linkages and up-scaling of the Islamic Microfinance Institutions. The Network also focuses on raising public and institutional awareness regarding Islamic Financial Systems. IMFN envisions developing and enhancing the role of Islamic microfinance institutions as an apex global network against poverty. The Network aims to seek the support of the national and international Islamic Microfinance Institutions in developing standardized, coordinated and transparent Shari’a compliant products and procedures for alleviating poverty.

Building an inclusive growth through Islamic finance is now an area of interest of many policymakers. Access to financial services plays a critical part in development by facilitating economic growth and reducing income inequality. Moving forward, the industry is expected to explore on product and process innovation to offer best suited partnership financing to cater for specific needs of lower-income population and at the same time to clearly define market segment while developing robust risk assessment models to better penetrate unbanked segment.

Favourable demographic structures combined with a rising middle income segment represents a vast and growing consumer market, which can heighten the demand for a wider spectrum of Islamic financial products and services

Islamic Microfinance in Indonesia

Country Snapshot

Population 251,160,124 (July 2013)

Urban Population 50.7%

GDP 6.2%

GDP (PPP Per Capita) USD5, 100 (2012)

GDP by Sector Agriculture: 14%, Industry:47%, Services:38.6%

Unemployment Rate 6.1% (2012)

Population Below Poverty Line 11.7% (2012)

Inflation 4.3% (2012)

Source: World Bank, KFHR

As of 2013, Microfinance in Indonesia comprises of approximately 7,000 formal and 50,000 semi-formal microfinance units serving more than 55 million depositors and 34 million borrowers. Indonesian microfinance industry is considered as the largest microfinance institution in the world, however its contribution to the national GDP is relatively average as it only constitutes 34% of Indonesia’s GDP.

Indonesia: Microfinance Industry (2013)

Total MFIs 85

Gross Loan Portfolio USD11.2bln

Average Loan Balance per Borrower USD1550

Number of Active Borrowers 722,272

Deposits USD13.1bln

Number of Depositors 974,633

Source: Mixmarket, KFHR



Today, Indonesia has a wide variety of microfinance services’ providers, which can be divided into two broad categories:

Indonesia Islamic Rural Bank (BPRS) Statistics

2008 2009 2010 2011 2012 1H13

No. of Institutions 114 131 139 154 158 159

No. of bank office 202 223 286 364 401 397

Asset (IDR billion) 1.693 2.1 2.7 3.5 4.7 5.2

Financing (IDR billion) 1.3 1.6 2.1 2.7 3.6 4.2

Deposits (IDR billion) 0.6 1.3 1.6 2.1 2.9 3.2

NPF (%) 8.4% 7.0% 6.5% 6.1% 6.2% 7.3%

ROA 2.8% 5.0% 3.5% 2.4% 2.6% 3.0%

ROE 14.8% 21.6% 14.3% 16.1% 20.5% 24.1%

Source: Bank Indonesia

The Indonesian government has been actively promoting Islamic microfinance, in line with the nation’s Blueprint of Islamic Banking Development. Islamic rural banks in the country play a pivotal role in nurturing and developing the emerging Indonesian economy by providing financing to small and medium-sized enterprises (SMEs) through working capital solutions utilising the Shari’a-compliant contracts. Financing to SMEs signified 55.92% or IDR68.66tln out of the total financing portfolios of Islamic commercial banks, Islamic business units and Islamic rural banks combined.

Bank Perkreditan Syariah (BPRS) or Islamic rural bank was launched in 1991 as a result of the ruling declared by the Majelis Ulama Indonesia (Indonesian Ulama Council) regarding the prohibition of Riba (interest rates). Aiming to support the community and entrepreneurs, BPRS’s main activities focus on serving small businesses and communities in rural areas. BPRS operates under the supervision of Bank Indonesia. Under the National Act No.21/2008, BPRS is defined as a bank that operates and conducts business

Banking Sector

• BankRakyatIndonesia.Thegovernment-ownedbankspecialisesinsmallscaleandmicrofinancestyleborrowingandlending

• Ruralbankswithmainactivitiesfocusonservingsmallbusinessesandcommunitiesinruralareas

Non Banking Sector

• Formalcategorywhichincludescooperative,ruralcreditfinancinginstitutions,pawnshops,andruralcreditassociations

• InformalcategoryincludesMFIscarriedoutbyNGOsandself-helpgroups

The outlook for Islamic microfinance in Indonesia remains positive, underpinned by the country’s large Muslim population as well as the government’s effort to alleviate poverty and develop the Islamic finance industry. Key success

in accordance with Shari’a principles, and only licensed to accept deposits, transfer funds and offer financing facilities. BPRS is not authorised to offer payment services and its operations are constrained to an entitled district area. BPRS had a promising start in early 1990s, with 78 BPRS opened across the nation between 1992 and 1998. After decades of development, BPRS remained a small portion of the rural banking sector in Indonesia as well as the overall size of the Islamic banking industry in the country, with a total asset amounting of IDR5.2bln, constituting only 2.32% of the country’s Islamic banking assets overall. By the end of 2012, there were 158 BPRS established with assets amounting to IDR4.6tln (USD477mln) or approximately 7% of its conventional counterpart. Total assets of BPRS have grown rapidly, recording a growth of 8.9% y-o-y and 10% y-o-y by the end of 2012 and 1H13 respectively. Moreover, BPRS have booked a total revenue of IDR350bln (USD36.3mln) in 1H13, recording a growth of 41% y-o-y which is relatively higher compared to the same period of the previous year. (2012: 24% y-o-y).

factors include increasing product awareness and reach, particularly in the rural areas, providing affordable products and services, and tailoring the products and services to meet the customers’ requirements



Islamic Microfinance in Bangladesh

Country Snapshot

Population 163,654,860 (July 2013)

Urban Population 27%

GDP 6.4%

GDP (PPP Per Capita) USD2,100 (2012)

GDP by Sector Agriculture: 17.5%, Industry:28.5%, Services:53.9%

Unemployment Rate 5% (2012)

Population Below Poverty Line 31.5% (2012)

Inflation 8.7% (2012)

Source: World Bank, KFHR

Bangladesh: Microfinance Industry (2013)

Total MFIs 73

Gross Loan Portfolio USD2.3bln

Average Loan Balance per Borrower USD115.6bln

Number of Active Borrowers 20.6 million

Deposits USD1.8bln

Number of Depositors 27.8bln

Source: Mixmarket, KFHR

LeadingIslamicmicrofinanceproviderinBangladesh,IslamiBankBangladeshLimited(IBBL)in1995launcheditsIslamicmicrofinance programme called the Rural Development Scheme (RDS). The main objective of RDS is to eliminate rural povertybyadoptingacommunitydevelopmentapproach,providingsmallandmicroinvestments.Asat2010,IBBLhasdisbursed investments a totalling of USD504.9mln.

IIBL-RDS Performance Indicators (2005-2009)

2006 2007 2008 2009

Active Customers 409,575 526,725 577,740 492,475

Active Borrowers 295,012 350,278 321,484 312,036

AverageLoanSize(Taka) 10,731 12139 13963 18800

OnTimeRecoveryRate(%) 99 99 99 99

Financial Self-Sufficiency (%) 122 115 100.2 109

OperatingSelf-Sufficiency(%) 197 213 163 181

Source: KFHR

Althoughonlyroughly8%ofIBBL’sassetsarededicatedtomicrocreditactivities,thebankhasinnovatedwaystofurtherexpand activities to a larger number of lower income groups and small business. Initiatives include the following:

• Depositaccountsfornominalamounts• Welfaredepositschemesforcashwaqfandhajj• Selectedsavingschemesforwomenempowerment• Introductionoffarmersaccountsandstudentaccounts



Despite some level of success in enhancing financial inclusion among the Bangladeshi population, there is still significant room for growth. In 2010, Bangladesh Bank observed that financial inclusion had increased to 56.43% of the population from 39.76% in 2004. According to a recent study by the Institute of Microfinance (InM), around 66% of the households in Bangladesh now have access to services including credit, savings and insurance from banks or microfinance institutions (MFIs) and cooperatives.

The principles of Islamic finance strongly support the growth of Islamic microcredit through the sharing of values and objectives in which the empowerment of people to better living conditions and remove difficulties are encouraged to produce a prosperous society. Growth is likely to continue as the Bangladeshi economy develops in line with both the economic and religious needs of the Bangladeshi population. And indeed the Islamic microfinance sector may take the opportunity to prove itself as a successful financing tool to produce results that can be replicated by other regions around the world.

Islamic Microfinance in a Nutshell

At present, the supply of Islamic microfinance is currently concentrated in a few countries, mainly Indonesia, Bangladesh and Afghanistan. Experience of various countries illustrates that although microfinance models are a flexible tool that can be replicated anywhere in the world, the models need to be tailored to suit the local socio-economic as well as cultural characteristics in a particular country for them to be a success. In countries with large Muslim populations such as Afghanistan, Indonesia, Syria and Yemen, there is a tendency for some of the borrowers to switch over to Islamic microfinance products if such products are made available.

In general, the opportunities for Islamic microfinance are vast, underpinned by the following factors:

• Strong economic growth experienced by Muslim countries will be translated into increased opportunities and hence greater role that can be played by Islamic banks/ MFIs moving forward.

• Top-down support. Governments’ ambition to reduce poverty level, enrich the standard of living and create a vibrant small- and medium-scale enterprise sector which drives GDP growth.

• Preference for Shari’a-compliant products. In countries with large Muslim populations such as India, Indonesia, China and Bangladesh, there is a greater awareness for some of the borrowers of Islamic microfinance products as they are being made available.

• Large Muslim population. Regions with sizeable Muslim populations continue to offer the best opportunities for Islamic banks/ MFIs. This includes Asian countries such as Indonesia, Malaysia, Pakistan and India, as well as African countries.

However, challenges that need to be overcome include:

• Lackofeducationandawarenesscampaigns,aswellas product reach.

• Formulatingproductswithlowoperatingcosts.

• Lack of knowledge and expertise of Islamicbanks to undertake microfinance activities without compromising their institutional viability, competitiveness and sustainability.

• Absenceofregulationsaswellaseffectivepoliciestosupport the microfinance industry.

For the industry to develop further, Islamic microfinance should be integrated into a country’s mainstream banking and financial system. This will help to create greater awareness of products, encourage product innovation, improve access to microfinance, widen and strengthen the distribution channels, as well as result in standardisation of regulation and improved transparency.



Factsheet: the PhilosoPhy oF islamic Finance

No to excessive

uncertainties (Gharar)

No to interest

rates (Riba)

No to Gambling (Maysir)Islamic finance discourages

hoarding & promotes commercial transactions to commensurate with the risks or stake in the economic activity.

Islamic finance upholds contractual obligations & disclosure of information, which in turn reduces the risk of asymmetric information and moral hazard.

Islamic Financial System

The Islamic financial system is fundamentally based on guiding principles derived from sources of Islamic Law known as Shari’a. Shari’a in Arabic is a term which implies ‘the way of life’. Akin to its meaning, Shari’a provides guiding principles in all aspects of daily life including economic activities. From the economic point of view, Shari’a requires gains from investments to be derived in an ethical and socially responsible manner that complies with the teachings of Islam.

Islamic financial institutions (IFIs) endeavour to provide economically viable financing alternatives in the global financial system, framed within the boundaries set by Shari’a principles. These principles aim to remove harm and injustice from the financial system while ensuring

financial services are linked to the real economy. Over the years, Islamic financial industry’s services are increasingly being utilized by both Muslims and non-Muslims alike. These institutions run parallel to the conventional financial institutions and more or less perform all those functions which a modern financial institution is expected to provide. The difference lies in their philosophies and operations. The fundamental philosophy behind the conventional banking system is the use of ‘interest rate’ which provides an opportunity for lenders with surplus funds to earn fixed rates of returns by loaning their funds out to borrowers who must repay the borrowed amount and an additional price (interest rates) at a future date. On the contrary, Shari’a law prohibits ‘Riba’ (interest rates) as it does not recognise money as a commodity to be traded for profits.

Key Characteristics of the Islamic Financial System

Source: KFHR

Factsheet:the PhilosoPhy oF islamic Finance


Apart from Riba, other elements prohibited in financial transactions are excessive uncertainties in contractual performance (Gharar), and gambling/chance-based outcomes in transactions (Maysir). In addition, transactions involving activities deemed impermissible in Islam such as alcohol brewery, pornography, conventional finance transactions, gambling and casino operations are prohibited. Moreover, the financial contracts must be free from any sort of coercion, corruption, falsehood and the contracting parties must express their free mutual consent in accepting a deal.

The Islamic financial system aims to achieve socio-economic justice and fairness while emphasizing on the

need for mutual consent and harmony among contracting parties. Shari’a prohibits any increase in returns from commercial transactions without the reward seekers sharing the risks or stake in the economic activity. As a result, returns on investments must be based on underlying economic activities and/or assets based on which the contractual relationship between transacting parties is structured. Islamic financial mechanisms aim to promote profit and loss structures to ensure contracting parties share the risks of venture among them which leads to healthier economic relationships. A fundamental reason for widespread bankruptcies during crisis periods is the legally binding liabilities of corporations to service their debts outstanding according to the pre-determined rates.

Salient Features of the Islamic Financial System

Salient Features

• Strictprohibitiononinterest-basedlendingandthefinancingofgamblingtypesoftransactions,andunethical goods and services

• Islamic finance discourages hoarding and prohibits transactions with extreme uncertainties andgambling

• DepositscaneitherbebasedonQard (interest-freebutprincipalprotected loans),profit-sharingorprofit and loss sharing

• Equity participation, temporary equities, credit sales, leasing and other suitably designed modesreplace interest-based finance, thus promoting the practice of risk sharing

• Financial engineering to design new products and instruments must comply with the Shari’arequirements

• Privatepropertyandfreemarketsarebasictotheeconomicsystem.Anytransactionleadingtoinjusticeand exploitation is prohibited

• Islamicfinanceupholdscontractualobligationsandthedisclosureofinformation,whichinturnreducesthe risk of asymmetric information and moral hazard

Source: KFHR



Risk-sharing philosophies

Transactions linked to the real-sector

During economic downturn, Islamic

financial system likely to be resilient as all parties share in the risks of low returns/losses derived

from real activities

Source: KFHR

Islamic financial system also requires transactions to be linked to the real-sector, leading to productive economic activities that generate income and wealth. As a result, the Islamic financial system aims to enforce a closer link between financial transactions and real productive assets. This philosophy can prevent build-up of a highly leveraged financial sector, multiplied several times over the real value of the underlying tangible assets. Many of the toxic speculative assets such as derivatives which were widely responsible to aggravate the global

financial crisis are impermissible in Islamic finance due to the absence of real underlying assets supporting the products structuring as well as the gambling/zero-sum outcomes of these contracts. Based on at least one estimate, the global derivatives market notional value is welloverUSD1,000tlnor20timeslargerthantheworldeconomy. It is impossible to gauge how big the risk to the global economy is from this since the derivatives market are largely unregulated and most products are traded over-the-counter (OTC).

Islamic Financial System Philosophies and Economic Resilience

The following are some of the Islamic financing concepts currently utilised in the market:

Islamic Financing Concepts

Qard (interest-free loan)

A loan extended on a goodwill basis and the borrower is only required to repay the principal amount borrowed. However, he may pay an extra amount at his absolute discretion, as a token of appreciation. This mode of financing is generally used as one of the means of fulfilling the social responsibility of Islamic banks. Such loans are given to for welfare purpose and for projects expected to have a significant socio-economic impact, having a long implementation period, and which may not be revenue generating.



Islamic Financing Concepts

Ijarah (leasing)

Refers to an arrangement under which the lessor leases equipment, building or other facilities to a client at an agreed rental fees or charges, as agreed by both parties. The ownership of the asset remains in the hands of the lessor. However, after the end of the rental period, the ownership of the asset is generally transferred to the lessee.

Ijarah Thumma al-Bai’ (leasing and subsequently purchase)

Refers to an Ijarah (leasing/ renting) contract to be followed by Bai’ (purchase) contract. Under the first contract, the hirer leases the goods from the owner at an agreed rental over a specified period. Upon expiry of the leasing period, the hirer enters into a second contract to purchase the goods from the owner at an agreed price.

Bai’ Bithaman Ajil (deferred payment sale)

Refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties.

Istisna’ (commissioned manufacture)

A contract under which one party buys the goods and the other party undertakes to manufacture the goods, according to agreed specifications, price and within a certain time. It is used to finance construction and manufacturing projects, and also enables banks to finance working capital.

Mudharabah (profit and loss sharing)

Refers to an agreement made between a capital provider and another party, known as the Mudharib (manager) who acts as the entrepreneur. This arrangement will enable the entrepreneur to carry out business projects and profits are distributed based on a pre-agreed profit sharing ratio. In the case of losses, the losses are borne by the provider of the funds, unless it is due to negligence, misconduct or violation of the conditions agreed upon by the entrepreneur.

Murabahah (cost-plus financing)

A form of contract under which the bank agrees to fund the purchase of a given asset or goods from a third party at the request of its client, and then resell the assets or goods to its client with a mark-up profit and generally with a deferred payment. Such sales contract is valid on the condition that the price, other costs and the profit margin of the seller are stated at the time of the agreement of sale.

Musharakah (joint venture)

Refers to a partnership or joint venture for a specific business, whereby the distribution of profits will be apportioned according to an agreed ratio. In the event of losses, both parties will share the losses on the basis of their equity participation.

Bai’ al-Dayn (debt trading)

Refers to the buying and selling in the secondary markets of debt certificates, securities, trade documents and papers which are Shari’a-compliant. Only documents evidencing real debts arising from merchant transactions are traded.

Bai’ Salam (future delivery)

Refers to an agreement whereby payment is made in advance for delivery of specified quantity and quality of a commodity or goods, to be delivered on a specific date and at an agreed price.

Bai’ al-Inah (sell and buy back)

It refers to a contract which involves sell and buy back transactions of an asset by a seller to the customer. The seller will sell the asset on cash basis but the customer will buy back the asset on deferred payment at a price higher than the cash price.

Source: KFHR



Issuance of Sukuk

Issuers

Investors

• Mobilisefunds

• Widen anddiversify its investor basewhich could lead to acompetitive and sometimes lower pricing

• Providetheopportunitytoinvestinanewassetclass

• Createanavenueforamoreefficientandeffectiveallocationofcapital

• Facilitate the channeling of surplus savings into ethicalinvestments

Sukuks Defined

Sukuks are defined by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) as certificates of ownership in a pool of underlying assets, in which the certificates are of equal value. Sukuks are issued with the aim of using the mobilised funds for establishing a new project, developing an existing project, or financing a business activity as per the respective shares.

Reasons for Sukuk Issuance

Initially, Islamic securities (sukuks) were introduced as an Islamic alternative to the conventional bonds which function more as fixed-income instruments. However, as the sukuk market develops, it becomes increasingly distinct from conventional bond instruments. Under the mechanics of sukuk, returns to investors or sukukholders represent rights to receive payments from

Source: KFHR

a trade transaction, ownership of a particular asset, or a business venture. In contrast, the returns to conventional bondholders represent the right to receive indebtedness for borrowed money. In addition, a sukuk does not pay interest but generates a return through actual economic transactions in the form of sharing or leasing assets.

Sukuk vs. Conventional Bond

Parameter Sukuk Conventional bond

Issuer • AsukukissuershallbeengagedinShari’a-compliant business activities

• An issuer of conventional bonds is notlimited in its business activities

Investor base • Enjoys a wider investor base from bothIslamic and conventional investors

• Conventional bonds can only tap theconventional investors

Ownership • Investors take direct ownership of anunderlying asset or pool of assets

• Aconventionalbond ispurely thefinancialdebt of the issuer

Administrative cost • AdditionalfeesintermsoflegalandShari’aadvisory fee

• No additional administrative costsassociated with conventional bond issues

Financing cost • A larger pool of sukuk investors createsmore demand, hence may help to achieve slightly more competitive pricing

• Acomparativelysmallerpoolofconventionalbond investors suggests that there is less demand for the paper

Source: Islamic Banks, KFHR



Sukuks are now being issued in many regions of the world which have very different legal systems. The growth in demand over recent years raises challenges to the sukuk market which has led to slight differences in certain aspects of sukuk issuance among the range of jurisdictions.

A prime example of this is allowable underlying assets in a sukuk transaction. Under the Malaysian jurisdiction, debt receivables are considered a permissible asset class for securitisation according to the Shari’a Advisory Council (SAC) of Securities Commission (SC) Malaysia.

AAOIFI: Characteristics of an Investment Sukuk

• Investment sukuk are certificates of equal value issued in the name of the owner orbearer in order to establish the claim of the certificate owner over the financial rights and obligations represented by the certificate

• Investment sukuk represent the common share in the ownership of the assetsmadeavailable for investment, whether these are non-monetary assets, usufructs, services or a mixture of all of these plus intangible rights, debts and monetary assets

• Thesesukukdonotrepresentadebtowedtotheissuerbythecertificateholder

• InvestmentsukukareissuedonthebasisofaShari’a-nominatedcontractinaccordancewith the rules of Shari’a that govern their issuance and trading

• Thetradingofinvestmentsukukissubjecttothetermsthatgovernthetradingoftherightsthey represent

• Theownersofthesecertificatessharethereturnasstatedinthesubscriptionprospectusand bear the losses in proportion to the certificates owned (held) by them

Source: AAOIFI, KFHR

Note:MissingfromtheAAOIFIstandardsarefinancialassetsanddebtsaspossibleunderlyingassets.Thismeansjurisdictionsadoptingthe AAOIFI standards will inevitably be utilising different sukuk structures and thus different methods of raising investor’s funds, than jurisdictions which rely on local law.

Types and Definitions of Selected Sukuk Structure

Type of sukuk Definition

Ijarah(Certificate of ownership in leased asset)

• Thesearecertificatesthatcarryequalvalueandareissuedeitherbytheownerofaleasedasset or an asset to be leased by promise, or by his financial agent, the aim of which is to sell the asset and recover its value from subscription, in which case the holders of the certificates become owners of the assets.

• Thesesecuritieswouldsuittheclassificationofasset-basedbecausetheleasedassetwillbe transformed into units of proportionate ownership to be subscribed by the investors.

Sukukdefined

What do they represent

Issuance

Trading

Return




Manfaah(Certificate of ownership of usufructs of existing assets)

• Certificatesofequalvalueissuedbytheownerofanexistingasseteitheronhisownorthrough a financial intermediary with the aim of subleasing the usufruct and receiving the rental from the revenue of subscription so that the holders of the certificates become owners of the usufruct.

• These are also part of asset-based securitisation though the asset is in the form ofusufruct and services.

Intifa’(Certificates of ownership of usufructs of described future assets)

• Thesearedocumentsofequalvalueissuedforthepurposeofleasingouttangiblefutureassets and for collecting the rental from the subscription revenue so that the usufruct of the described future asset passes into the ownership of the holders of the certificates.

• Thesearedeemedtobepartofassed-basedsecuritisationthoughtheunderlyingassetis the future services that are to be performed in the future.

Milkiyyat Al-Khadamat(Certificates of ownership of services of a specified supplier)

• Thesearedocumentsofequalvalueissuedforthesakeofprovidingorsellingservicesthrough a specified supplier (such as educational programmes in a nominated university) and obtaining the value in the form of subscription income, in which case the holders of the certificates become owners of the services.

• SimilartotheotherIjarah-basedsecurities,thesesecuritiescomeunderthepurviewofasset-based securitisation.

Al-Khadamat Al-Mawsufah fi Al-Zimmah(Certificates of ownership of services to be made available in the future as per description)

• Thesearedocumentsofequalvalueissuedforthepurposeofprovidingfutureservicesthrough described provider (such as certain prescribed educational benefits from university without naming the educational institution) and obtaining the fee in the form of subscription income so that the holders of the holders of the certificates become owners of the services.

• Services,thoughtobeprovidedinthefuturearedeemedasanassetthusmakingthissecurity a type of asset-based securitisation.

Salam(Salam Certificate)

• ThesearedocumentsofequalvalueissuedforthepurposeofmobilisingSalamcapitalso that the goods to be delivered on the basis of Salam basis come to be owned by the certificate holders.

• TheSalamsukukrepresenttheownershipoftheinvestorsintheassettobedeliveredinthe future.

• TheseSalamsukukcanbe issuedbutarenot tradedevenon thebasisofpar valuebecause the Salam asset which is represented by the Salam sukuk cannot be sold to another party without the initial buyer taking possession of the asset.

Istisna’ (Isitsna’ Certificates)

• These are certificates of equal value issued with the aim of mobilising funds to beemployed for the production of goods so that the goods produced come to be owned by the certificate holders.

• Thisdefinitionreferstothesukukthatrepresentstheproportionateownershipintheassetto be constructed. This is an asset-based structure until the asset is delivered to the buyer.

• AspracticedinsomejurisdictionslikeinMalaysia,Istisna’sukukreferstodebtsecuritisationthat is the receivables owing to the contractor. This type of issuance, from an international Shari’a standpoint, cannot be traded freely as it reflects debt trading instead of asset-trading.




Murabahah (Murabahah Certificates)

• Thesearecertificatesofequalvalue issued for thepurposeof financing thepurchaseof goods through Murabahah so that the certificate holders become the owners of the Murabahah commodity.

• SimilartoIstisna’sukuk,thisdefinitionreferstoanactivityofpoolingmoniestopurchasea commodity to resell the same to another party under Murabahah sale. This sukuk if issued is an asset-based securitisation.

• However,aspracticedinMalaysia,Murabahahsukukmayrefertothesecuritisationofthe seller’s receivables. This issuance cannot be traded except on face value principle in accordance with AAOIFI Shari’a standards because Murabahah receivables connote debt or financial obligation which is deemed to be money in character.

Musharakah Certificate

• Thesearecertificatesofequalvalueissuedwiththeaimofusingthemobilisedfundsforestablishing a new project, developing an existing project or financing a business activity on the basis of any of partnership contracts so that the certificate holders become the owners of the project or the assets of the activity as per their respective shares.

• TherearethreemodesofissuingsecuritiesbasedonMusharakahconcept:

(i) Musharakah sukuk (Participation Certificates). These are certificates representingprojects or activities managed on the basis of Musharakah by appointing either one of the partners or another person to manage the operation.

(ii) Mudharabah sukuk (Issuer is the mudharib or manager). These are certificates that represent projects or activities that are managed on the basis of Mudharabah by appointing the mudharib for the management of the operation.

(iii) Wakalah sukuk (Investment agency sukuk). These are certificates that represent projects or activities that are managed on the basis of investment agency by appointing an agent to manage the operation on behalf of the certificate holders.

Istithmar • Thesearethesukukwhicharehybridinnature.Theycombinebothfinancialassetssuchas Murabahah receivables and tangible assets such as Ijarah leased asset according to a proportionof70:30respectively.

• The issuanceof thesesecuritieswhichwas initiatedbythe IslamicDevelopmentBankwas a breakthrough in addressing the issue of receivables securitisation.

• These securities have been deemed as asset-based securitisation and therefore aretradable in the secondary market without any Shari’a constraint in trading these securities.

Source: INCEIF

Islamic finance attempts to forge closer links with the real economic activities in order to provide more robust, equitable and ethical financial products for all consumers regardless of religious affiliations. Many experts and Islamic economists genuinely believe that the Islamic finance principles of risk-sharing are robust solutions to the world’s financial catastrophes. Being relatively small, as Islamic financialassetsonlyconstitute1.6%oftheglobalfinancialassets, it may not have been able to curtail the adversities of the global financial system as yet. However, with growth

ratesaveraging15%to20%overthepastdecade,Islamicfinance has potentials to develop into a material sector of the global financial system, enabling it to demonstrate its abilitytoenhanceeconomicresilience.Withitsimpressivepast growth record and promising future outlook, Islamic finance could well be on its path to provide solutions to the global financial instability and help mitigate financial catastrophes as were witnessed during the global financial crisisof2008-09.



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