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ISLAMICFINANCE:PRINCIPLEANDOPERATION
Zulkifli Hasan
1
Contents
• Introduc+on• BetweenAspira+onandReality• IslamicFinance:PrincipleandOpera+on• Challenges• ConcludingRemarks 2
• GlobalIslamicbankingassetsreachUSD1.8trillion(17%averageannualgrowthandIslamicfinancewillbeabletoMpUSD6.5trillionbytheyear2020).
• Islamicbankinggrowth:1.9MmeshigherthanconvenMonal2009-2013.
• DespitethegrowthandtransformaMon,therearenumerouscriMcismsonthecurrentpracMceofIslamicfinance,whichhaveledtoseriesofquesMonsastothedisMncMvenessofIslamicfinancewithitsconvenMonalcounterpartsandthegrowingfrustraMonontheethicalissuesbeyondthelegalrealmofShari’ah-compliance.
• Shari’ahcompliantfundsuffereddifficulMesin4yearsduetolackofinnovaMon(USD584bnin2015/USD2.4bnin2014).
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Introduction
Between Aspiration and Reality: 40 Years After Its Inception
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A study by Beloufi et al (2015) on 40 researchesbetween 1983-2013 found a significant divergencebetweenthetheoryandprac+ceofIslamicfinance.
AOer40Years?
5
2015
MarketShare Customers TotalAssets
4Marketswith30%MarketShare
Lessthan100millioncustomers(2.5bnnobank’saccount,1bnyouthacrossOIC)
3trillion(GlobalfinancialassetUSD300trillion)
2021
20marketswith40-50%MarketShare
250millioncustomers
9trillion
IMFReport2017
• Islamicbanking(IB)conMnuestogrowrapidly,insizeandcomplexity,posingachallengetosupervisoryauthoriMesandcentralbanks.
• ProgresshasbeenslowindevelopingIB’sliquiditymanagementandmoneymarkets.
• hybridfinancialproductsinIBhaveemergedthatreplicateaspectsofconvenMonalfinanceinanIBcontext,raisingfinancialstabilityconcerns.
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Islamic Bank Share of Total Assets & Deposits
Country Assets% Deposits%
SaudiArabia 48.9 N/A
Kuwait 44.6 47.3
Bahrain 27.7 47.8
Qatar 23.6 35.7
UAE 21.4 32.8Malaysia 20.7 29.4Pakistan 9.5 11.4Turkey 5.9 7.1
Indonesia 5.5 11.4
AssetandDeposit
8
Bank Assets$billion
Deposits$billion
Overseasfocus
AlRajhi 74.6 61.6 Malaysia
KuwaitFinanceHouse
57.3 35.8 Turkey
MaybankIslamic 38.0 25.3 Indonesia,Singapore
DubaiIslamicBank 30.8 21.6 Pakistan
• ThetotalnumberofShari’ahscholarsreached952covering652IFIsinmorethan46countries.
• 75%withinthetop10countries(MalaysiaBangladeshIndonesiaKuwaitSaudiArabiaBahrainSudanUAEPakistanOman)
• 41%intheGCCregion.• 26%SouthEastAsia• 16%inSouthAsia• 11%inMENAna+ons• 2%Europe
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PresentNumberofScholars
HighConcentra.ononFewScholars
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• 10Shari’ahscholarsserveinapproximately497IFIsrepresen+ng76%thetotalIFIswithShari’ahboards.• 3scholarswiththehighestnumberofboardmembershipsserveabout40%ofIFIsglobally.• Thenumberofins+tu+onsincreasesandtheamountofworkincreases.• Thereisdeficiencyofabout1700Shari’ahboardmembers,wherebyitisexpectedthattherequirementforShari’ahscholarswillriseto3000innext5yearsif5%growthisassumedinthenumberofIFIs.• SuccessionPlan–Seriousac+onrequired• PerformanceAssessment(Collec+ve&Individually)
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Shari’ahScholarsAroundtheWorld
Countries NumberMalaysia 203Bangladesh 173Indonesia 131Kuwait 70SaudiArabia 68Sudan 60Bahrain 60UAE 57Pakistan 43Oman 32Qatar 30
• “Iwouldliketotellyou,inallfrankness,thatifIweretostartalloveragain, I would not choose the bank as a framework for theapplica+on of Islamic teachings in the field of economy andinvestment.Iwouldlookforanotherframework,whichisfullyinlinewiththeShari’ahprinciplesregula+nginvestment.Thisisduetothefactthatwehavenotbeensa+sfiedwithtakingonlythenameofthebank but also its basic concept, namely, that it is a financialintermediary. So, we have not been able to find for our financialins+tu+onsaconceptandapajern,whichgoesbeyondtheissueoffinancial intermediary. This has led to the fact that the preferredinvestmentpafernsof Islamicbankshavebecomeamixofa loanandaninvestment.Itisamix,whichhasmostofthecharacterisMcsofariba-basedloanandtheflawsoftheWesterncapitalistsystem.It fails tohighlightthefeaturesof Islamic investmentbasedonrisk-sharingandreal investment. Itdoesnotrecognizetheguaranteeofthecapitaloritsreturn.”
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SheikhSalehKamel
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Critiques on Islamic Finance
Themes CriMques
Objectives of Islamic law.
Islamic in Islamic finance should relate to the social and economic ends of financial transactions rather than the contract mechanics through which ends are achieved.
Excessive debt.
The disproportionate percentage of debt-based instruments as compared to equity-based.
Relying on legal fiction.
In developing a fiqh muamalat caution must therefore be exercised for it is all too easy, when creating and then relying on legal fiction, to fall into the pit of complacency and inadvertently developing a fiqh hiyal.
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Critiques on Islamic Finance Themes CriMquesLack of social dimension and poor record of corporate social responsibility.
Lack of commitment of Islamic finance industry to support developmental agenda and corporate social responsibility.
‘The doctrine of shareholders’ value, which is the bedrock of capitalistic market, has been shown to be the basis of Islamic finance practices’.
Identical to the conventional banking.
“The ‘applied business model’ of IBs is almost identical to the conventional interest-bearing one. It is neither a ‘two-tier mudharabah’ nor a wakalah (agency) based model but rather a specially ‘engineered’ debt model. The framework adopted in the development of Islamic financial instruments has been to design products in such a way that these are almost equivalent in economic and risk characteristics to conventional debt instruments”.
Lack of authenticity and operates within Neo-classical economics.
“Rather than being part of the Islamic political economy, Islamic finance has been pursuing policies away from the theoretical underpinnings and systemic understanding of Islamic economics and has located a surrogate financial framework in neo-classical economics”.
Themes CriMquesOver legalistic approach.
“From the legalistic perspective, it is argued that interest is haram for being unjust and exploitative. However these concerns are merely rhetorical, as the new institutions in question have become too cozy with their own exploitative environment about which they are mute. Islamic finance is delinked from the broader goals of development and poverty alleviation” (Farooq, 2007).
Islamic finance is experiencing a “formalist deadlock” where the industry is more concerned with formal adherence to Islamic law instead of promoting Islamic ethical values (Balz, 2008).
“The current trend reduces Islam and its Shari’ah to their legal dimension rather than seeing them within a greater civilizational framework” (Haneef, 2009).
“Shari’ah scholars approach the issue from a microeconomic perspective, and reflect on how an IB, as a financial firm, should conduct its transactions according to fiqh rules; they do not see it in a macroeconomic terms, with IB, as financial intermediaries, meeting the financing needs of society” (Siddiqi 2000).
• Nega+vepercep+onbythegeneralpublic.• MuslimConsumerAssocia+onofMalaysia(PPIM)reportedthattheyhavereceivedmorethan4000reportsfromconsumersbetween2003-2012oftheirdissa+sfac+onwithIFIs.ThePPIMclaimedthattheIFIshaveabusedtheword‘Islam’forthepurposeofprofitmaximiza+onwithouttakingintoconsidera+ontheethicalaspectsofdoingbusiness.
• TherearemanycaseswherethecustomersneedtopaythewholeamountofsellingpricetoIFIseventheconstruc+onprojectwasclearlyabandoned.
16
Nega+vePercep+on
IslamicFinance:PrincipleandOperaMon
17
“EverythingthatlapsesoutfromjusMceintoinjusMce,andfrommercyintoitsopposite,andfrommaslahahtomafsadah,andfromwisdomintothefrivolous,doesnotbelongtoShari’ah,evenifitisinductedintoitbyinterpretaMon”(Ibnal-Qayyim).
• STAGE1:FocusonhowtomigrateMuslimfromprac+cingriba.Thefocuswastofindhalalsolu+onbyreplica+ngcertainfeaturesofconven+onalproductwithsomehiyaltoquicklymigratetheprac+cefromriba.
• STAGE2:FocusontobegenuinelybasedonShari’ahbyremovingexcessivehiyalintheirprac+ce.
• STAGE3:ConcernwiththeTAYYIBdimensionofhavinga“goodandresponsiblefinance”.Thepermissibilityofatransac+onwillnotonlydependonthepillarsofavalidcontractbutalsoonthevalues,ethics,outcomeorconsequencesofthetransac+ons.
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StagesofIslamicFinance
IslamicFinanceisMorethanFinancialContract
Tenet-BoundFundamentalstenetsderivedfromShari’ah
Principles-BoundConceptisgroundedonethicsandvalues
Real-economyLinkedAsset-backedtransac+onswithinvestmentsinreal,durableassets
Society-ServiceServingcommuni+es,notmarkets
– Blameworthy:• Riba• Gharar• Maisir
+Praiseworthy• Risk• Ethics
TheBasisofFiqhMuamalat
RibainConven+onalBanking
• Onthebothsidesoftheconven+onalbanksRibaexists:
• OntheLiabili+esSide,throughborrowingfromdepositorsonfixedandguaranteedreturn
• OntheAssetsside,throughlendingonInterestbasis.
• Onthetreasuryside,throughlendingandborrowing.
TypesofUqud
Legality Purpose Reciprocity Validity Executability
ModernClassifica+on
• PartnershipBased• Exchange-Based• Securitycontracts• CharitableContracts• AgencyContract• Suppor+ngContracts
PartnershipBasedContracts
• Mudharabah• Musharakah
ExchangebasedContracts
• Murabahah• BayalIs+sna’• BayalSalam• BayalDayn• BayalSarf-• BayalInah• BayalTawarruq• Ijarah• BayalIs+jrar
SecurityContracts
• Kafalah(guarantee)• Alrahn(mortgage)
CharitableContracts
• Hibah• Wadiah(Deposit)
Suppor+ngContracts
• Muqasah• Ibra• Wa’d
1. Product Initiative
7. Periodic Shari’ah review
8. Annual Shari’ah review
6. Dissemination of Shari’ah rulings
5. Shari’ah ruling 4. Shari’ah review of the documents
3. Legal Documentation and Product Proposal
2. Preliminary Shari’ahAnalysis
ProductDevelopment
ProductDevelopmentStage1
30
• Marketresearch• Benefitanalysistobanksandclients
• Productconcept&opera+on• Balancingofrisk• Marke+ngchannel• StandardOpera+ngmanual• Feedbackfromstakeholders/commijee
• Shariahstandardsandparameters
ProductConcept&Framework
Shari’ahParametersandGuidelines
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• Forthepurposeofharmonisa+onandconsistency,thestandardsepngagenciesandregulatorshaveissuedseveralShari’ahparametersandguidelinestoIFIsasguidanceandreferencetopromoteharmoniza+onandstandardiza+onofIslamicfinanceprac+ces.
• Thesestandardsincorporatevalue-orientedaspectsofIslamicfinanceprac+cesandputcertainrequirementstoensureeachfinancialtransac+onisgenuineandvalid.
ProductDevelopmentStage2
32
• Riskassessmentofproducton• Marketrisk• StructuralRisk• Documenta+onrisk• Peoplerisk• Proposedmi+ga+onofrisk• Endorsementoftheproduct• Shari’ahcompliancerisk
Evalua+onofProductRisk
33
“TheriskoflossresulMngfrominadequateorfailedinternal processes, people and systems or fromexternal events, which includes legal risk andShariahnon-complianceriskbutexcludesstrategicandreputaMonrisks”.“The risk that arises from the Bank’s failure tocomply with the Shariah rules and principlesdetermined by the relevant Shariah regulatorycouncils.”
Shari’ahComplianceRisk
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1STLINEOFDEFENSE
LineManagementandallstaff
3RDLINEOFDEFENSE
InternalAudit(IncludingShariahAudit)2NDLINEOFDEFENSE
Opera+onalRiskMgmtDept,Compliance,Shariah
ComplianceRiskManagementUnit,
Opera+onalRiskControlCommijee
RESPONSIBLEforongoingoversight of risk and control atdaytodayworklevel
ESTABLISHandmaintainORMandSCRM
Framework,assessingmonitoring,repor+ng
&controllingriskonabankwidelevel
PROVIDEINDEPENDENTASSURANCEtoBoardofDirectorsandSeniorManagementthatRisk
Managementprocessesandtoolsareeffec+vely
implemented.
ManagingSCRisa“collecMveresponsibility”“3linesofdefenses”concept
ProductDevelopmentStage3
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• ManagementRiskCommijee• Shari’ahCommijee• BoardRiskCommijee• (Ministry’sapprovalwheremandateisexceeded)
• BoardofDirector• Regulator• Launch
Approval
Post-Approval
• Dissemina+onofShariahrulings• ShariahReview• ShariahAudit• ReviewofShariahRulings• ShariahNon-complianceRepor+ng.
36
PenalMes
37
FormofPenalMes PenalMes
AdministraMve theBNMmaymakeanorderinwriMngrequiringthepersoninbreachtocomplywithorgiveeffecttoortodoornottodoanyactinordertoensurecompliancewithsuchprovision
Monetary suchamountastheBankconsidersappropriate,notexceeding(RM5mil-bodycorporateorRM1mil-individual);
CriminalOffence
Upto10yearsimprisonmentor5-50millionringgitfineorboth
Challenges
38
39
Themes RemarksCompeMMveness Equal the conven+onal product in
benefits.
Price Islamicfundingmaycostmore.Benchmarkagainstconven+onal.
Process Processandopera+onslightlylongerandrequireaddi+onaldocument.
Flexibility Interchangeability of Shari’ah conceptsto be at par with the conven+onalproducts.
Non-Compliance To simplify opera+on, some processmaybeomijed.E.gexecu+onofblankLejeroffer
40
Profitability Some charges may not be avail to Islamicproducts e.g commitment fees, lowercompensa+onfee.
MarketDifferences
Differences in Shari’ah concepts in variousmarkets. E.g Bai Al Dayn not acceptable bymanymarketorevenbanksinM’sia.
ProductAwareness
PublicawarenessonIslamicfinanceiss+lllacking.Indifferenceaptude
PosiMveValues
Islamic principles advocates fairness and just.Ideally, genuine defaulters to be givenconcessions,butnotbeingdoneinsomeIFIs.
41
ProductRisk Riskinsomeconceptsarehigherthantheconven+onalproduct.E.gMurabahah(riskofnonacceptanceofgoods by customer) Is+sna’ (non-comple+onofprojects).All possible risk to be iden+fied andproperlymi+gated.
LegaldocumentaMon
An extended version of conven+onaldocument. Too much influence on theprevious prac+ce. Market wants simpledocumenta+on
ModifiedConcepts
Investmentproductse.gpureMusharakahcannotbedonewithoutmodifica+on.
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Shari’ahRisk Product development and opera+on requiresShari’ahCommijee’s endorsement and requires indepth study. Conven+onal banking can transact onanything.Non-Shari’ah compliant may lead to “haram”income whichrequiresthebanktoforgotheprofitearned.
BalancingofBusinessandShari’ah
Some business areas are out of bound in Islamicfinance.
People Changesinincep+onofIslamicfinanceknowledgeandvaluesamongststaff.
TechnologicalAdvancement
EfficientdigitalbankingsystemthatcomplywiththeShari’ahprinciples
CaseStudies
43
• Insteadofintroducingandempoweringmudharabahtoportraythetruespiritofinvestment,IFIsontheotherhandarenowmigra+ngtotawarruq.
• Inordertosupporttheini+a+vetopromoteequity-basedproducts,theMalaysiangovernmentbackedtheInvestmentAccountPlauormwithanini+alstart-upfundforRM150million.LembagaTabungHajialsoallocatedRM200millionfortheestablishmentoftheShari’ahcompliantRestrictedInvestmentAccount.
• 6IFIshavepar+cipatedinthisini+a+ve.TheseinvestmentaccountproductsarestructuredundertheprinciplesofMudharabahandwakalah.
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Risk Sharing Initiative
Concluding Remarks
45
• (1)DevelopmentofrobustenablingframeworkatnaMonallevel;
• (2)Legal:regulatoryreformstocreatea“levelplaying-field”;
• (3)PoliMcalsupport:industrybuildinginsMtuMonsarekeytobringingstandardizaMon;
•(4)Economics:towardsanindependentbankingsystem;and• (5)TalentRecruitment.
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EnablingEnvironmentistheKeytotheOn-goingDevelopment
THANK YOU