Sophist Posted February 10, 2005 Islamic finance: unlocking the potential January 2004 With more than 1.2 billion Muslims in the world today it comes as no surprise to learn that Islamic finance/investing has really started make waves. However, is the industry’s true potential now being met or can Islamic investors still expect more to come. Wendy Jackson reports. There are sufficient Muslim investors and borrowers in both Islamic and non-Islamic countries to warrant the attention Islamic finance has been getting since MONEYworks last wrote in depth the subject in December 2001. And also to merit the increasing number of Islamic finance and banking conferences that are now being held every year. The next of which on the agenda is the ‘World Islamic Banking Conference’, held last November in Bahrain. At these conferences much is discussed about the industry and how it can be developed. I caught up recently with Christian R Mouchbahani, a senior director at The National Investor in Abu Dhabi, just after the Islamic Finance Forum, which was held in Istanbul recently, where he discussed the “Opportunities and Challenges of the Islamic Capital Markets.†But first a recap of the fundamentals of Islamic finance. The Koran is feasibly described, at a very basic level, as a set of guidelines by which Muslims lead their lives. For any religion to continue growing there has to be an element of adaptation to the modern world. And so, where the modern world now includes investing, Muslims from all over the world have had to rely on financial institutions to interpret the Koran so that whilst investing they don’t compromise their religious beliefs. Muslim scholars have thus established a set of laws, using the Koran and Hadith, to ensure that even whilst investing Muslims are living their lives in line with Koran. To put it simply, Islamic investing should, therefore, reflect the Islamic principles with which Muslims guide their lives. There are two basic principles for Islamic investing; the absence of interest, usury or Riba - used interchangeably - is prohibited on the basis of no pain, no gain; and secondly, social and ethical features avoiding undesirable investments and enhancing trade. For example, as Muslims cannot drink alcohol or eat pork, nor can they invest in a brewery of pork producing companies. Nor can they invest in a company, whose primary business is involved in Muslim-prohibited activities, i.e. buying a share in companies who are involved in tobacco, gambling or pornography etc… And when it comes to riba it means that Muslims cannot invest in financial institutions where their primary business involves interest based transactions. As such, one can be forgiven for thinking that to invest in an ‘Islamic’ way does not leave a huge amount of choice for Muslim investors – and the billions of dollars that they have to invest. But nowadays this simply isn’t the case. Fund houses are falling all over themselves to launch products aimed at the world's 1.2 billion Muslims. In fact, many Islamic funds are leaving their secular counterparts in the dust, making it a lot easier to persuade investors to jump on board. It’s amazing when you think that just 10 years ago, not even half a dozen Islamic funds existed; today there are more than 100 worldwide. Banks all over the Middle East region are starting to offer Islamic services or are going the whole way and converting all of its operations in accordance with Shari’a law. The first modern Islamic banks opened in the 60s, offering dividends and “profit sharing†rather than interest. A few Western financial institutions such as Citibank started serving the Islamic market in the late 1970s. But it is really only over the past few years that the arena has started to reach its full potential or should we say that financial institutions have at last started to create opportunities for Muslims to invest that whole big pool of money in an Islamic fashion. They have, you might say, started to meet a huge demand that had been ignored for far too long. In 1999 the Dow Jones unveiled the first global stock benchmark for Islamic investors. Called the Islamic Market Index, it follows 660 Shari’a- compliant companies in 34 countries, including Microsoft, Coca-Cola, and BP Amoco. Nowadays many banks are introducing funds tracking this index. And in November 1999 the FTSE introduced its own Islamic indexes working along the same lines. And in the region? Where do I begin? There has been an abundance of exciting launches over the past two years or so. HSBC recently became the first international bank to offer Shari’ah-compliant personal finance products with the launch of its Amanah Current Account and Amanah Personal Finance scheme; the first in a range of personal financial services in the UAE that are compliant with Shari’ah. The current account is similar to a conventional bank account, but the account has no overdraft, debit or credit interest. Money paid is to be administered in accordance with the Shari’ah and won’t be used to generate interest. The personal finance scheme is also Shari’ah-compliant – it avoids charging interest and links to metal trades. It has the same functionality of a conventional loan whilst following the tenants of Shari’ah. It will work by HSBC buying metals from international brokers and selling them on to customers at a pre-agreed price that is payable over an agreed term. The customer appoints the bank to sell the metals to a third party in the market. Proceeds are credited to the customer’s account – at no time does the customer pay interest. It has also this year launched a Shari’ah-compliant mortgage product in the UK for all those UK based Muslims wishing to borrow the money to buy property in an ‘Islamic way.’ Abu Dhabi Islamic Bank (ADIB) launched an innovative new Shari’ah-compliant financing product earlier this year, called Al Khair, based on the Islamic concept known as ‘Al Tawarruq’, which is approved by Fatwa and the Shari’ah Supervisory Board. Al Khair is essentially a consolidation loan and was launched under the banner, “For peace of mind.†At the launch ADIB’s CEO, AbdulRahman Abdul Malik noted that the product is launched in line with the bank’s aim of providing its customers with Shari’ah-compliant banking products and services as well as the bank’s social commitment.†The product aimed to allow customers liquidity to enable them to settle their financial liabilities and conventional loans. The pertinent features of the new loan product are as follows: - the ability to settle all financial liabilities and conventional loans to start a new transparency and steady financial relationship. - A fixed profit rate of 4.6 per cent (based on the Murabaha transaction, which Al Khair financing is based on. - Longer repayment tenor of 72 months, which enables reduction of monthly installments proportion of customer monthly salary. - No administration fees, penalty charges or late payment fees - Reward on early settlement of outstanding amounts - Eligibility to benefit from ADIB’s range of added-value products and services. ADIB has also promised the launch of an Islamic credit card in the last quarter of 2003. Dubai Islamic Bank, the first Islamic bank in the world, has been introducing innovative Islamic banking services to meet the ever-increasing demands of the customers who wish to bank in an Islamic way. And with that has recognised that financing services have become a necessity. With the newly launched ‘Ijarah Services’ the bank provides finance for essential personal needs. It is the bank’s belief that it will continue to develop new and innovative Islamic banking services which support the Islamic banking industry as well as the ever-changing needs in the lives of Muslims in the UAE and beyond. IJARAH SERVICES PROVIDES FINANCE FOR: School and university education; Medical expenses; Holiday and travel. ADVANTAGES OF IJARAH SERVICES: An innovative Islamic solution to cover your essential financial needs; Choice of high quality service providers, from schools to universities, clinics to hospitals and travel and holiday agents; Services at competitive prices; Fulfill your personal financial needs with no added burdens; Repayment in convenient installments; Transparent - no hidden charges, no penalties. DIB also offers a Visa charge card which have up to maximum of 40 days free of credit and its operations are approved by Shari’ah, mobile phone banking in Arabic, full automated ATM machines and a full range of everyday banking – Shari’ah-approved products and services. And finally, the National Bank of Sharjah has recently launched the UAE’s first Islamic credit card in association with Visa International. The new credit card is designed to meet the needs of a large section of the population who require credit card facilities in accordance with the provisions of Islamic Shari’ah. The credit card is expected to fulfil a huge market demand for Shari’ah-compliant financial products. The card, which requires a minimum monthly settlement of only 10 per cent of the utilised credit limit, has been structured competitively and will provide global usage by its cardholder’s at all Shari’ah-approved merchant outlets. Cardholders will be able to utilise Visa's acceptance at millions of point-of-sale locations in 150 countries in addition to cash withdrawal facilities from over 870,000 Visa ATMs worldwide. The card, which will initially be issued in Classic and Gold forms, will offer various benefits including the ability to obtain additional cards for members of families, emergency replacement of lost or stolen cards, and participation in all promotional activities associated with the card. Growing up And so over to Chris Mouchbahani. He sees that there is more to come and says that he sees the need for the ongoing development of the industry in order for it to fulfil its unique potential. “Product diversification is one of the keys to unlock the ongoing development of Islamic commercial banks’ products and services in the local market. Which is what I spoke about at the recent Islamic finance conference in Istanbul.“ He states, “While diverse asset-sales leasebacks in addition to cash management products have been created, the market is characterised by a lack of complex product supply and efficient market clearing mechanisms. In 2002, even Freddie MAC, the large US mortgage entity, financed Shari’ah-compliant home loans for the first time, showing the potential of this market.†In his comprehensive lecture on the topical subject of ‘Opportunities and Challenges of the Islamic Capital Markets’’, Mouchbahani firstly pointed out that “The National Investor is currently creating innovative products, such as one of the first purely Corporate Sukuk Offerings, an Islamic Real Estate Fund, as well as Islamic Financing vehicles for International Institutions.†The company sees the need to start developing niche products such as these for institutions in the region, so that eventually they maybe filtered down to the retail segment to give Muslim investors as much choice as the that available from the conventional products on offer. In his seminar Mr Mouchbahani emphasised the potential liquidity and potential of Islamic Capital Markets, with estimates ranging from US$50 –US$150 billion at an estimated annual growth range of 10 per cent to 50 per cent, but added that the market was vying for the availability of sophisticated capital market and corporate finance product supply. He said that “although some expectations were over estimated and could hurt the healthy growth of the market over the next couple of years, it is clear that there is Islamic Finance capital waiting to be deployed in a Shari’ah-compliant manner. The emerging market remains fragmented with a diverse range of new and not clearly defined players and products. It is estimated that there are around 150 Islamic banks, institutions and a diverse range of boutique advisory firms in the region. Some banks in the Gulf have also been following a trend to convert to Islamic entities. Larger Islamic Institutions are based in the Gulf (UAE, Bahrain, Saudi Arabia, Kuwait), while other markets are emerging in Asia (Malaysia, Indonesia, Iran and Pakistan).†Adding, “that in order to support the healthy growth of the market, globally recognised standards of Islamic capital markets and authorities had to emerge but even more importantly financial professionals, supported by companies and investors, had to supply the market with products and market execution clearing mechanisms.†“From a market practitioner’s perspective the Islamic Finance Market is a market with certain principles, criteria, standards and demand requirements defined by the Shari’ah framework and guidelines that have to be met when structuring or completing transactions, such as equity investments, Sukuks, securitisation or other innovative products, to satisfy business needs and growth.†The challenge, it would seem, is for corporate finance institutions and players to help bridge investor’s faith based capital market demand, while providing faith based strategic financial products solutions to businesses and governments. “Today there are over 100 Islamic equity fund investments using the Dow Jones Islamic Market Index (DJIM) and FTSE Islamic Index and a few private equity funds. There has recently been the issuance of Sukuks (Islamic Bonds) by Malaysia, Bahrain, IDB, Qatar, privately placed products and the emergence cash management products. “There are challenges in the current markets which are a lack of corporate transaction deal flow, lack of precedence; identically named products have variations in structure and mechanisms and sometimes lack of coordination between different market players.†However, he states, “It is expected that the emergence of Islamic capital markets will lead to dis-intermediation and consolidation. Standardisation, regulation, transparency, international players paying attention to the market and increasing local product skills are supporting the healthy growth of the market. “In other words, Islamic Finance solutions can be adapted to a range of financial needs; from equity investments, funds, to different instruments of capital raising, securitisation, managing cash and even unexpected areas such as M&A, while adapting to all Shari’ah-compliant sectors. And therefore the potential for growth is huge.†Muslim scholars The other key to the ongoing success of the industry, is of course that very rare commodity - the Shari’ah scholar with practical knowledge of the world’s financial markets. According to most they are not easy to find and the fear is that without them, the future of Islamic investing may start to wane. Every Islamic bank or institution that offers Islamic funds has to appoint a special Shari’ah board compromising scholars intimately familiar with the intricacies of Shari’ah law. Now finding scholars with a detailed knowledge of Islam’s view of financial systems is not hard. But finding scholars with a deep insight into the workings of the world’s mainstream financial markets is difficult – and for what the likes of Mr Mouchbahani want to achieve the stakes are high if more don’t surface. According to Mouchbahani, it is easy enough for the scholars to judge the merits of a company for Islamic investment. If it is a business associated with forbidden areas, then it is ruled out. But a more complex issue, and not less important to the Muslim investor who wants to make money without breaching rules is the proportion of a company’s revenue that is servicing its annual debt. As we have already discussed devout Muslims do not save in conventional banks because they regard fixed interest payments as usurious. They also do not buy the stocks of companies that carry a corporate debt and pay an annual interest. Which is a fine until you start to put it into practice, at which point it becomes less than straightforward. It is a know fact that the present climate dictates that companies are turning heavily towards debt finance, shown in the increased popularity of corporate bonds. This one aspect alone presents scholars on Shari’ah boards with an acute problem. How much flexibility should they allow? It is clear they do allow some - hence the term "interim tolerance levels", where some degree of interest levels are allowed before the company must transform its financing to follow Shari’ah law. But this judgment requires a deep understanding of financial markets, and not all Shari’ah scholars, even those advising banks and funds, possess this. At the Islamic finance conference held in Dubai at the beginning of year, Rushdi Siddiqui, director of the Dow Jones Islamic Index, admitted that: "Many scholars are competent on Shari’ah matters but not capital markets." And as Mouchbahani pointed out to me, the task of Shari’ah scholars on the boards of banks and funds is getting more complicated. The answer? At the same conference in Dubai, where some of the world's leading Islamic investors gathered, analysts agreed that Shari’ah scholars sitting on special boards should be given training on financial systems and markets and that this is vital for the long-term growth of Islamic banking. It seems, then, that it is the education of Shari’ah scholars in the ways of modern finance stands out as one of the most important issues confronting the Islamic investment industry. If this is confronted and scholars are encouraged seek ways to develop more innovative products then Mr Mouchbahani is right when he says the Islamic finance industry still has far to go. At least in terms of the potential that could be unleashed for Muslim investors throughout the world. Quote Share this post Link to post Share on other sites
Baashi Posted February 10, 2005 Many thanks Sophist. Very informative read. If anyone out there know more about Shari-complaint credit cards plz share. I want to have one. Let's put our hands together and dig info on this. Quote Share this post Link to post Share on other sites
Sophist Posted February 11, 2005 Bashi, this link might be of a help! http://www.getyourmoneyworking.com/ Quote Share this post Link to post Share on other sites
-Serenity- Posted February 11, 2005 ^^^ Thanks. Quote Share this post Link to post Share on other sites
Rahima Posted February 11, 2005 JZK sophist, very much appreciated. Quote Share this post Link to post Share on other sites
