Transcript Slide 1

ISLAMIC BANKING VERSUS COMMERCIAL BANKING: PROSPECTS & OPPORTUNITIES

A PRESENTATION BY:

Dr. Fouad Shaker

Senior Advisor & Partner: First East Invest Former Secretary General: Union of Arab Banks

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OUTLINE

Principals and development of Islamic finance Theory and practice of Islamic financial intermediation Theoretical & practical differences between Islamic & conventional banking Comparison of financial ratios of Islamic and conventional banks Future challenges Areas for improvement and steps forward ISLAMIC BANKING VERSES COMMERCIAL BANKING

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Principals and development of Islamic finance

I.

Principals of Islamic financial system

1) Prohibition of Interest (RIBA)

“An excess” Any unjustifiable increase of capital whether are

loans or sales in the central tenant of the system.

Islamic regulations encourage the earning of profit but forbid the charging of interest.

2) Money as a potential capital

It joins hands with other resources to undertake a productive activity.

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Principals and development of Islamic finance

3) Risk sharing

When interest is prohibited, suppliers of fund become investors instead

of creditors. Investors & financial intermediary relationship is based on profit & loss sharing principals.

4) Prohibition of speculative behavior

Discouraging hoarding & prohibits transacting featuring extreme uncertainties.

5) Sanctity of contracts

Upholding contractual obligations & the disclosure as a sacred duty to reduce the risk of asymmetric information & moral hazard.

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Principals and development of Islamic finance

6) Sharing-approved activities

Only activities that don’t violate the rules of shariah qualify for

investment.

Any business Dealing with alcohol, gambling or casinos is prohibited.

7) Social justice

In Principle , any transaction leads to injustice & exploitation is prohibited.

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Principals and development of Islamic finance

II. Development & growth of Islamic finance

1) Development of Islamic finance

A rapidly growth part of the financial sector in the world ( >15% annual

   

growth rate).

Not only Islamic countries, more than 300 financial institutions in over 50 countries practice some form of Islamic finance.

The market current turnover is estimated to be $350 Billion compared with $5 Million in 1985.

Islamic finance industry has reached $1.4 Trillion by the end of 2011, expected to be $4 Trillion over medium term.

Global conventional banks (HSBC, Citibank…etc.) have setups separate windows to offer Islamic banking services.

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Principals and development of Islamic finance

2) Emergence & evolution of Islamic institutions in recent history

In Muslim countries:

o

1963, local saving banks was established in Egypt to practice their work on a none-

o o

interest bases to enhance the banking habit.

After 1974, many Islamic banks were established in different Muslim countries due to the sharp increase of the oil prices.

Sudan, Iran, Pakistan started the Islamization of banking system during 1980s.

In the western world:

o

In 1983 Islamic finance house started in Luxemburg.

o

recently, besides establishing Islamic banks, Islamic windows in leading banks pursuing this market very aggressively. ISLAMIC BANKING VERSES COMMERCIAL BANKING

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Theory & practice of Islamic financial intermediation

I.

Basic contracts & instruments

1) Financing instruments

Used to finance obligations arising from the trade and sale of commodities or property and collateralized by the product being financed, such as: a)Murabahah

A bank purchases a product for a customer who doesn’t have a capital. Both agree on a profit margin added to the cost, the customer should pay the bank later the whole amount.

b)Bay Al-Muajjil

A sale transaction with deferred payment allows the sale of a product on the bases of deferred payment.

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Theory & practice of Islamic financial intermediation

c)

Bay Al-Salam The buyers pays the seller the full price of a product which the seller promises to deliver at a specific future date.

d) Ijarah

A medium term financial instrument gives something in return for rent, resembles the leasing contract.

e) Istisnah

To facilitate the manufacture of an asset at the request of the buyer. Once the manufacturer undertakes to manufacture the asset for the buyer, the transaction of Istisnah comes into existence.

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Theory & practice of Islamic financial intermediation

2) Investing instruments

Vehicles for capital instrument in the form of a partnership.

a)Mudarabah

A fund management instrument , could be short, medium or long term, whereby an investor entrust capital to an agent to undertake a project.

b)Musharakah

An equity partnership instrument which could be either medium or long term partnership, where two or more persons combine either their capital or their labor to share the profit & losses.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial intermediation

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Structure & components of financial statements for Islamic banks ISLAMIC BANKING VERSES COMMERCIAL BANKING

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Theory & practice of Islamic financial intermediation

Theoretical Balance Sheet of an Islamic bank based on maturity profile

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Theory & practice of Islamic financial intermediation

Theoretical Balance Sheet of an Islamic bank based on functionality

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Theory & practice of Islamic financial intermediation

Composition of an Islamic bank Balance Sheet

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Theory & practice of Islamic financial intermediation

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Theory & practice of Islamic financial intermediation

III. Islamic financial institutions in practice Early forms of Islamic financial institutions were concentrated in commercial banking activities, todays’ Islamic financial institutions can be divided into the following broad categories

1) Islamic banks

Could be public or private sector.

A hybrid of conventional commercial banks & investment banks, it resembles universal banks.

2) Islamic windows

A setup in a conventional bank that offer Shariah-compliant product.

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Theory & practice of Islamic financial intermediation

3) Islamic investment banks & funds

Aiming to capitalize on large investment syndications, market-making

and under writing opportunities.

Succeeded in developing innovative large-scale transactions in infrastructure finance.

4) Islamic mortgage companies

Targeted at the housing market for Muslim communities in western

countries.

Four models: 1. Ijarah.

2. Equity partnership (diminishing Musharaka).

3. Murabahah. (sales transaction).

4. Along the lines of corporative societies.

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Theory & practice of Islamic financial intermediation

5) Islamic insurance companies (Takaful)

Takaful means mutual or joint guarantee. The participants agree to share their losses by contributing periodic premiums in the form of investment. They have to redeem the residual value of profits after fulfilling the claims and premiums, which is a critical difference between contemporary insurance and Takaful. Takaful is a given solidarity.

6) Mudaraba companies

Similar to that of closed-end fund managed by specialized professional

management companies. Unlike the Islamic bank, they are not allowed to accept deposits. Funded by equity capital. Two types; Multipurpose (more than one investment purpose) and Specific purpose.

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Theoretical & practical differences between Islamic & conventional banking

I.

Different concepts of borrowing, financing & investment

1) Different modes of borrowing

According to the state bank’s of Pakistan 2008, conventional banks average for deposits ranged from 2.09% - 2.30% per annum while borrowing rate average ranged from 11.20% - 11.56%. The difference is 7.82%. Islamic banks average rate on PLS deposits ranged from 3.5% to 3.79%. Profit & loss sharing deposits earn more than 1% higher.

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Theoretical & practical differences between Islamic & conventional banking

2) Different modes of financing

Conventional banks high rates of interest on all types of loans. Which may be the cause of the business failure & the default of the loan. Islamic bank provides loans on profit & loss (PLS) bases, and only for production purposes.

3) Different modes of investment

Conventional banks; 50% in government treasury bills, bonds, term

finance certificates for security, they suffer badly in case of stock market crash.

Islamic banks; can not invest in government bonds. Nevertheless, the Sukuk issued by Islamic government would act as a practical solution for (IB) liquidity.

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Theoretical & practical differences between Islamic & conventional banking

II. Different visualization of the role of money

1) Conventional banks

Uses interest to make money out of money. They use money as a commodity which is bought & sold.

2) Islamic banks

Use money as a medium of exchange to facilitate trade transactions. They supply money to traders to purchase real assets or industrialists to produce value-added products. If finance takers generate profit they will share it with the Islamic bank. If they suffer losses the bank will share the loss.

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Theoretical & practical differences between Islamic & conventional banking

III. Different attitude of risk sharing & income distribution

1) Different concepts of risk sharing

Conventional banks; being interest rates based, their depositors do not

share the risk with the bank in case of economic shock. Also banks receive fixed rates from borrowers regardless their losses in case of business failure.

Islamic banks; their deposits and investors are ready to share risk with the bank in case of financial shocks. The bank as well, is responsible to take risk in case of business failure.

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Theoretical & practical differences between Islamic & conventional banking

2) Different approaches of income distributions

The interest-based financial system is pro-rich and anti poor, unlike Islamic financial system which play a vital role in eradication of poverty through Zakat and profit & loss sharing principle.

3) Having different objectives and goals

Islamic bank works for all benefit of the overall society and for equitable allocation of resources through credit distribution. While the conventional bank works for a specific class that is rich.

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Comparison of financial ratios of Islamic and conventional banks

Based on the findings of a recent research in Pakistan on two similar groups of conventional & Islamic banks (Average of 6 banks each group).

1) Earning ratios

Ratios Islamic Banks

(ROA) Return on Assets (ROD) Return on Deposits (ROE) Return on Equity (EPS) Earning per Share 0.079

0.07

1.297

0.38

Conventional Banks

-0.75

-0.93

-2.27

-0.34

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Comparison of financial ratios of Islamic and conventional banks

3) Debt management ratios

Ratios Islamic Banks Conventional Banks

Debt / equity Deposit times capital Debt / assets Equity / equity + debt 2.3

3.78

0.78

31.3

8.0

5.71

0.85

17.17

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Comparison of financial ratios of Islamic and conventional banks

2) Asset quality management

Ratios

NPLs / advances Non-performing loans / advances Provisions / NPLs Provision / non-performing loans NPL / deposits Non-performing loans / deposits

Islamic Banks

1.06

47.09

1.22

Conventional Banks

5.88

40.89

6.24

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Comparison of financial ratios of Islamic and conventional banks

4) Liquidity ratios

Ratios

Earning assets / total assets

Islamic Banks

95%

Conventional Banks

93% Advances / deposits 83% 70% Yield on earning assets 2.7% 1.83%

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Comparison of financial ratios of Islamic and conventional banks

5) Solvency ratios

Ratios Islamic Banks Conventional Banks

Equity / total assets Capital adequacy ratio (CAR) Equity / deposits 21.78% 36.2% 14.59% 20.09%

The earning assets / deposits 143.79

115.98

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6) Cash to deposit ratio

Ratios

Cash & balance / total deposits

7) Investment to deposit ratios

Ratios

11.55%

Islamic Banks

Investments / deposits Investments / total assets

8) Borrowing ratios

Ratios Islamic Banks

15.39% 4.37% Borrowing / total assets Borrowing / total deposits Borrowing / total advances

Conventional Banks

12.55%

Conventional Banks

23.85% 9.25%

Islamic Banks

4.37% 5.86% 12.93%

Conventional Banks

4.25% 11.92% 16.05%

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Future Challenges

1) Liquidity

Liquidity- enhancing financial instruments & the development of capital market.

2) Limited scope

Can benefit from economies of scale &enhancement of scope. Both approaches offer diversification benefits.

3) Concentrated banking

Diversifying their base of depositors, reduce their exposure, introduction of Internet banking, geographical diversity on the liabilities side.

4) Concentrated banking

Risk management framework can be enhanced by improving the

transparency in current financial disclosure.

Measurement & management of risk need to be supplemented with analytical method.

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Areas of improvement & steps forward

     

To enhance

Financial Engineering

that includes the design, development & implementation of innovative financial instruments, new securities or new process of creative solution to corporate finance problems, provided to be Shariah complaint.

There is need to establish supporting institutions to act as a

Lender of Last Resort

.

There is need to achieve

Uniformity in, & Harmonization of, Shariah Standards

across markets & borders.

To develop

Fee -Based Services

like, Joalah, Wakalah & Kifalah to exploit the full capabilities of Islamic banks by diversifying the scope of non bank financial services.

Developing

benchmarks based on the rate of return

reflecting Islamic modes of financing instead of using interest base benchmarks such as the London interbank offered rate (LIBOR) which has been accepted on an adhoc based.

Creating a secondary market

to enhance the liquidity, & standardizing contracts, to reduce the risk of asset backed securities.

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Areas of improvement & steps forward

    

Standardizing the operations & instruments

will pave the way for pooling assets, much needed for enhancing liquidity in the market.

By

expanding the scope of services

, Islamic bank could spread the fixed costs since they are similar to universal banking in a form of hybrid between commercial & investment banking.

Having a Shariah board for every institution is not efficient.

A Shariah board for the system as a whole

is needed to ensure that rules are defined & enforced in compliance with the contractual obligations to all stockholders.

Well developed Islamic capital market

will benefit borrowers, institutional investors, together with enhancing the stability of Islamic banks. A

well developed Islamic microfinance industry

will promote economic development in underdeveloped Islamic countries, also it will economically empowered the poor segments of society since they will be able to move from being non-bankable to bankable, this will expand the base of the depositors & investors. ISLAMIC BANKING VERSES COMMERCIAL BANKING

33 A FEW WORDS ABOUT … FIRST EAST INVEST ISLAMIC BANKING VERSES COMMERCIAL BANKING

FIRST EAST INVEST …. What we do:

34 1 - INTERMEDIATE,

We intermediate in “trade” and “investment banking” deals and transactions between the Arab countries and Eastern and Central, East Europe & CIS businesses

2 - SUPPORT

We support Middle Central, East Europe & CIS businesses trade with the Arab World. We also support Arab Gulf investors identify & explore investment opportunities in Central, East Europe & CIS markets as well as raise capital for financing existing or new business ventures.

3 - PROMOTE

We promote Middle Eastern and Central, East Europe & CIS businesses’ market expansions. We promote their business ideas, business ventures, and existing & new projects. We also promote inward and outward direct investments & portfolio investment between the Arab World and Central, East Europe & CIS businesses .

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FIRST EAST INVEST …. What we do:

BUSINESS DEVELOPMENT SOLUTIONS

       Exploring the initiative, assessing products & capabilities, and preparing the Company’s for the initiative, Targeting by identifying the market & clients base, Planning the initiative, and producing an Action Plan, Networking to establish the client’s own contacts in local market, Visiting the market & testing the initiative, Cooperating by identifying agents, representatives, and/or Joint Venture partners in the local market, and Selling the Company’s products & services to the clients already identified in the Arab World.

INVESTMENT BANKING SOLUTIONS

         Private placements, Debt structuring, Raising funds, Privatization, Mergers & acquisitions, Corporate restructuring, Spin-offs, Leveraged buyouts, and Initial Public Offering (IPOs).

ISLAMIC BANKING VERSES COMMERCIAL BANKING

FIRST EAST INVEST …. Our contact:

36 Cairo, Egypt – Head Quarters First-East Invest Company

Flat # 12, Block 21 District 3, 6 th of October, Giza ,Egypt Tel : + 20 (2) 3835 7677 Email : [email protected]

Web : www.firsteastinvest.eu

Vilnius, Lithuania – Rep. Office First-East Invest Company

16 – 4, Rudninku g.

Vilnius, Lithuania Tel : + (370) 646 54 795 Email : [email protected]

Web : www.firsteastinvest.eu

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THANK YOU

ISLAMIC BANKING VERSES COMMERCIAL BANKING