EXPLORING NEW MARKETS ISLAMIC FINANCE Presented By: Zayyad A. Said Islamic Finance Consultant Global Mifos Summit 2015 – Grand Hotel Excelsior, Sharjah UAE. 11th March 2015 UNDERSTANDING.
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EXPLORING NEW MARKETS ISLAMIC FINANCE Presented By: Zayyad A. Said Islamic Finance Consultant Global Mifos Summit 2015 – Grand Hotel Excelsior, Sharjah UAE. 11th March 2015 UNDERSTANDING ISLAMIC FINANCE What is Islamic Finance? Its Global Developments? What are the core principles of Islamic Finance? Islamic Financial Instruments / Products Equity products Trade-based products Leasing Products Benevolent Product Is Islamic Finance similar to Conventional Finance? Takaful (Islamic Insurance) INTRODUCTION Islamic Finance may be referred to as a form of lending, mobilizing deposits or capital and investment in accordance with the principles of Shariah or Islamic Law. The system of Islamic Finance was introduced back in 1974 in Egypt with the first Islamic Bank being Nasser Social Bank then followed by Islamic Development Bank in 1975 also in Egypt. Currently there are over 600 Islamic Banks/FIs globally. The framework of an Islamic Financial system is based on elements of Shariah which prohibits Riba (usury) & Gharar (Uncertainty) and permits Risk Sharing. The fundamental concept is that money has no inherent value and should be used as a measure of worth. Shariah compliant investment are structured on the exchange of ownership in tangible assets or services with money acting as the payment mechanism to effect the transfer of ownership Global Development of Islamic Finance: Islamic Finance is fastest growing segment of the Global Financial services Industry. Global Islamic banking assets with commercial banks reached $1.6 trillion in 2013 (2011: $1.3 trillion), representing average annual growth of 17%. Islamic banking grows by 50% faster than overall banking sector in several core markets. Shariah compliant financial assets have been growing at rate 2025% over the last 10 Years estimated at US$ 1.8 Trillion in 2012, That represent only 1.2 % of the global financial system PROHIBITIONS IN ISLAMIC FINANCE Riba (Usury) Gharar (Deception, Speculation) Gambling Prohibit ion In Islamic financial system Money Trading (money is payment mechanism) Unlawful & unethical trade Short Sale (Future or goods you do not own) Monopoly Unfair & Unjust Contracts PRINCIPLES OF ISLAMIC FINANCE All banking products can largely be divided into the following 4 categories: Equity – Direct Ownership Trading – Buying and Selling Leasing – Giving an asset or service on rent Debt – Providing an interest-based loan To simplify it; Islamic Finance permits Equity, Trade and Lease-based Transaction BUT forbids Debt. All Islamic Finance transaction are guided by the following principles: Be interest free Have risk sharing & asset and service backing Have contractual certainty All the elements in the transaction must be ethical. Principle 1: Transaction Free of Interest Interest is prohibited not only in Islam but also by Christians and Jews. Interest prohibition in the Holy Quran has been mentioned in four passages, last revelation being: “Those who devour usury will not stand except as stands one whom the evil one by his touch hath driven to madness. That is because they say: ‘Trade is like usury.’ But Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge). But those who repeat (the offence) are companions of the fire, they will abide therein (forever)” (2:275) The Vatican itself said: “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.” Islam is concerned with the well-being of society, sometimes at the immediate expense of the individual. A single interest-based loan may seem harmless, but an entire economy based on interest can have devastating consequences. Principle 2: Risk Sharing & Asset/Service Backing. The principle in the Shariah that informs our concept of risk-sharing states: “al ghunm bil ghurm,” meaning “there is no return without risk.” Banks knows the concept of risk sharing is common to all equity-based transactions. Islamic Finance is no different, where profit and loss distribution commensurate with investment proportions. Lending cash on interest is not the kind of risk sharing we are talking about as a conventional loan doesn’t have direct equity position even when the bank takes security and gets more involved. In Islamic Finance, the bank actually takes a direct equity position, or buys a particular asset and charges a premium through a trade or a lease. It uses risk mitigants, but not without first taking ownership risk. Principle 3 & 4: Contractual Certainty and Ethical. Contract plays a critical role in Islam. The uncertainty of whether a contractual condition will be fulfilled or not is unacceptable in the Shariah. Contractual uncertainty happens when the basic prerequisite or integral of a contract is absent, such as the existence of the subject matter, the fixing of a delivery date, or the agreement on a price. Conventional insurance, interest, futures and options all contain an element of contractual uncertainty and are thus prohibited. Lastly, Islamic Finance Transactions must be ethical. Meaning there is no buying, selling or trading in anything that is in and of itself is impermissible according to the Shariah. For example: Selling alcohol or tobacco Dealing with conventional banking and insurance Selling of pork Prostitution or other immoral activities and etc. Islamic Modes of Financing Profit & Loss Sharing (Shariah Based) Non-Profit & Loss Sharing (Shariah Compliant) • • • • • Musharakah (Equity participation) Mudharabah (Trustee Financing) Musaqat (Orchard Financing) Muzar’ah (Share of havest) Diminishing Musharakah (Home Financing) • • • • • • Murabahah (Cost plus mark-up) Ijara wa Iqtina’ (Leasing) Bai Muajjal (Spot sales) Bai Salam (Forward Contracts) Istisna Qard el Hasan (Benevolent loan) Musharakah (Equity Participation): Literally mean sharing. Originated from the word “Shirka” which means being a partner. A joint enterprise formed conducting some business in which all partners share profit on pre-agreed ratio. Loss is shared according to the ratio of contribution. Can be terminated anytime by mutual agreement. Conditions of Musharakah to be valid: Agreement must exist stating clearly terms & conditions including management, capital contributions, profit/loss sharing between the partners. Capital can be in cash or asset. Sleeping partner cannot claim share of profit more than his proportionate share of equity. None of the partner can guarantee capital or profit share to any other partner. Mudharabah (Trustee Financing): Type of partnership where skills and capital brought together to conduct business. Provider of capital is called “Rab-ul Mal” and Provider of Skill is a “Mudharib”. Profit is shared according to the agreement. Loss is borne by only Capital provider. Islamic FIs provide capital to financially weak but skilful people to do business and share outcomes with them. Can also be used for deposit collection where the depositors of an Islamic FIs become “Rab-ul Mal” for restricted or unrestricted investments. No one can claim a lump sum amount of profit, it must be based on actual income. Diminishing Musharakah: A form of declining partnership between Islamic FI and client. Generally used to finance real estates. Islamic FI participates in ownership of the asset by contributing required finance. Certain portion must be contributed by the Customer. Under this model; one of the partners (client) promises to buy the equity share of the other partner (FI) gradually until the title to the equity is completely transferred. Buying & selling of equity units must be in a separate contract. Generally Islamic FI rents out its share to the client and earns rental income. Any profit accruing on property is distributed among the co owners according to agreed ratio however losses must be shared in proportion of equity Diminishing Musharakah is used for house financing by IFIs and has successfully replaced conventional mortgages. Murabahah (Cost plus mark-up) This is a cost-plus sale contract whereby disclosure of cost to the buyer is necessary. Under Murabahah; a customer requests the Islamic FI to purchase an asset for him & sell on a deferred payment. Essential feature is that the Islamic FI must purchase required commodity from supplier first and then sell to the customer adding a profit mark-up. Recovery could either be in installment or balloon payment. Amount of installment/price cannot be increased or decreased in case of default or early payment. A penalty may be imposed to create pressure on prompt payment as agreed in the contract. Penalty cannot be included as income for the Islamic FI but must be spent for charity. Murabahah has successfully replaced overdraft and short term loans in conventional financing. Ijara (Leasing): This is a rental contract where Islamic FI leases an asset for a specific rent and period to a client. Ownership risks of the asset are borne by the Islamic FI while expenses relating to use of the asset are the responsibility of the client. Ending Ijara in sale of asset is allowed through a separate contract at completion of term of lease. Contract can be executed prior to purchase & possession of the asset. Consumables cannot be leased out. Right of lessee to use the asset is restricted to lease agreement and/or as per normal course of business. Lessee is liable for any harm to the asset caused by any misuse or negligence on his part. Rentals of joint property are shared according to equity. A joint owner can rent his share only to the co partner. At the completion of Ijara term either asset is returned to Islamic FI or purchased by client “Ijara wa Iqtina”. Bai Muajjal (Spot Sale): Literally meaning deferred / credit sales. Used to finance the customer’s needs by supply of desired commodities. Difference between Bai Muajjal and Murabahah lies in disclosure of cost. Here cost may or may not be disclosed. All other features same as discussed in Murabahah. Bai Salam (Forward Contracts): Form of sale contract whereby Islamic FI purchase goods for spot payment with deferred delivery. Practically used in financing Agricultural needs of farmers. Farmers sell their crops prior to harvesting to IFIs in order to get money to purchase seeds and fertilizers. Generally spot price agreed is lesser than future the actual date of delivery, hence IFIs are making profit. As a matter of practice IFIs are entering into a parallel Salam contract with third party to sell the proceeds once taken over however execution of second contract is not conditional to the fulfilment of first. Qard el-Hasan (Benevolent Loan): This a cash based zero return loan that Qur’an encourages the believers to make to “those who need them”. Generally used for development or social projects. Islamic FIs are allowed to charge a service fee so as to cover the administrative and transaction costs of the loans. Such costs must not be related to the maturity or amount of the loan i.e. putting time value for money or put a mark-up on money. Money is a medium of exchange and not a commodity thus cannot be traded. Is Islamic Finance Conventional Finance?: similar to Islamic FIs operate in the same society with conventional counterparts & perform all functions expected from a financial institution. Islamic FIs assist the business world by providing all services required to run the economy smoothly HOWEVER Philosophy and operations are different. It is a business very much like conventional finance within certain restrictions imposed by Islamic law. All business needs are being fulfilled by Islamic FIs in efficient ways through Murabahah, Ijara, Bai Muajjal, Bai Salam, Musharakah and Mudarabah. Takaful (Islamic Insurance): Takaful is a co-operative system of reimbursement or repayment in case of loss paid to people and companies concerned about hazards. Its paid from a fund which they agree to donate small regular contributions managed on behalf by a Takaful operator. This concept of insurance is based on Islamic Finance principles and observes the rules and regulations of Islamic Law. The principles of Takaful are: Policyholders cooperate among themselves for their common good. Policyholders contributions are considered as donations to the fund (pool). Every policyholder pays his subscription to help those who need assistance. Losses are divided and liabilities spread according to the community pooling system. Uncertainty is eliminated concerning subscription and compensation. It does not derive advantage at the cost of others. For more on Islamic Finance, Contact: Mr. Zayyad A. Said Islamic Finance Consultant P. O. Box 82298 – 80100 MOMBASA, KENYA. Tel: +254 716 615 274 Email: [email protected] Twitter: @zayyad_said Skype: zsaid2011 ?? QUESTIONS & ANSWERS