Treasury Products for Islamic Financial Institutions

By Mark J Lynch and Khalfan Abdallah.

A challenge for all new banks lies in providing a full range of competitive treasury products which help manage not only a bank’s liquidity and hedging positions but also its business divisions and client requirements.

This becomes more challenging when the breadth and complexity of products offered by established financial institutions is considered alongside the Shariah principles that Islamic banks operate by.

However, many have argued that the complexity and lack of transparency of these treasury products played a part in the credit crunch.
Islamic treasury products are required to be transparent and non speculative.

In recent years Islamic banks have invested heavily in product development, particularly in relation to treasury. This article provides a summary of the more frequently used products, their basic structures and what they mean to treasury.

Liquidity management products

1. Commodity Murabahah (Tawarruq).
Based on the Murabahah (trust financing) structure, this has developed to become one of the main short term liquidity management tools used by treasuries. When completing a Commodity Murabahah, commodities are purchased in order to create liquidity. A bank would buy a commodity for US$100 spot and sell them to a client for US$110 on deferred payment terms. The client then sells the commodities back into the market for US$100 to realize the liquidity it requires.

Most Shariah scholars prefer the use of non-precious metals such as those used on the London Metals exchange. With the current low rates in the market, the use of Commodity Murabahah for short-term deals of less than one week has decreased as the cost of purchasing and selling a commodity is prohibitive.

2. Wakalah Investments.
This is a useful liquidity tool between Islamic banks as it operates under the principle of agency agreement and does not have the
added costs of commodity purchase/sale involved. For this reason it is especially cost effective in very short term transactions. This structure is mainly used to mobilise funds from the market for investors whose risk profile prefer lower investment risks. It is also used to manage excess liquidity of Islamic banks.

3. Foreign exchange
Foreign exchange (FX) products such as Spot, FX Forwards, and Swaps are vital for a functioning Islamic treasury. These can be used to manage customers requirements, the banks own liquidity or FX risk.Spot FX (Sarf) is a straightforward product used throughout the industry involving the exchange of one currency for another at an agreed rate for immediate spot delivery. However, the use of FX Forwards in Islamic markets is less prevalent. FX Forwards can be achieved by the use of a Waad (unilateral promise) structure where one party (the promisor) agrees to enter into a Spot FX transaction on a pre-agreed date in the future at a pre-agreed rate.

To complement the growing number of products, Islamic financial institutions have implemented technology solutions that dovetail with services such as foreign exchange. For example, BLME launched an online foreign exchange platform that allows clients to access FX markets over the internet. Speculation and short selling is prohibited in order to comply with Shariah principles.

Another useful FX product is the FX Swap (structured using Waad concept) which allows the bank to effectively fund themselves in one currency using another currency. Forward FX also makes use of the Waad in order to achieve the forward delivery of one currency versus the other.

Additional liquidity management products.

Repo.
‘Repo’ (short for repurchase) involves the sale and buy back of securities in exchange for cash on pre-agreed dates at a known cost price. This product has not been approved by all Shariah scholars but is considered an important development in Islamic markets. The IIFM in 2014 completed to develop a standard for Islamic repo products that will be fully Shariah compliant. A standard contract template for collateralised murabaha transactions, aiming to boost use of a sorely needed liquidity management tool for Islamic finance institutions. The standard will serve as an alternative to repurchase agreements, which are common money market tools used by conventional banks but are largely absent in Islamic finance. In the United Arab Emirates, the first collateralised murabaha transaction occurred in 2011 between National Bank of Abu Dhabi and Abu Dhabi Islamic Bank.

Collateralised murabaha is a cost-plus profit arrangement where by the financier buy the asset at market value and immediately sell the asset to the customer for a mark-up on a deferred payment basis.Because the mark-up price is agreed up front by both parties, this addresses the element of ambiguity, or gharar, a key principle in Islamic finance.

Transactions can be secured by any sharia-compliant assets, including equities and sukuk (Islamic bonds). The standard expressly forbids rehypothecation. The IIFM has previously launched standard contract templates for sharia-compliant profit rate swaps as well as hedging and treasury transactions.

It is acknowledged across the industry that there is a dearth of liquidity management products for Islamic fi nancial institutions. It is critical that Islamic fi nancial institutions have access to high quality liquid instruments such as government issued Sukuk. Without access to such quality liquidity, the requirements laid down by the regulators inthe UK that banks hold a liquid assets buffer adds an expensive burden on Islamic banks. This is not so for the conventional banks. A number of the more established Islamic centres already have regularly issued short term government papers. In the UK, despite some positive steps and encouraging noises from HM Treasury we are still waiting.

Islamic treasuries are under pressure to provide competitive rates against the offerings of Islamic peers and conventional banks. It is vital that Islamic fi nancial institutions have a competitive offering, not only to attract clients per sé but also to be seen as a viable alternative to conventional financing.

Netting
An important development for Islamic treasury departments has been that of netting relationships. Netting agreements allow treasury to offset the payables against the receivables for a specifi c counterparty. This has mutual benefi ts for both parties to the agreement. Netting agreements are permissible for Islamic banks under the Shariah principle of Muqasah (offset of debt).

Islamic Funds.
Traditionally treasuries would not be directly involved in investment funds – whether they be money funds, equity, or property funds however there is a place for liquid money market funds, such as BLME’s $ Income Fund. Money market funds can provide a treasury department with a return better than money market rates with the additional benefi t of being able to access the liquidity at short notice.

Managed account structures.
This product is used by Islamic fi nancial institutions to manage liquidity and is offered to clients as a liquidity management tool. Generally the managed account invests in Islamic products such as a Sukuk with specific risk and return parameters which are set internally or by the client.

Conclusion
The above are a small selection of tools available to the Islamic treasury but collectively they have a huge bearing on a treasury’s
ability to run effi ciently and effectively.

Islamic treasury products have developed tremendously in the past five years as customers demand more sophisticated ways of managing their investments and liquidity. Technology continues to evolve with products now being made available to a much wider, international audience.

Standardization will come but the industry is still nascent and banks continue to use the structures and documentation they created and cater to the needs of their specifi c clients. As the industry matures there will be more cross-fertilization of products, structures and documentation.

After the world economic events of the last three and half years, and amid calls for banks to hold ever more high quality liquidity, it is vital that all countries ensure they provide their banking fraternity with the tools such as Sukuk to enable them to comply.

Critical review of an article titled "Exploring the distinguishing features of Islamic Banking in Tanzania." Part 1.

As promised in my previous post, this is critical review of the article published by Journal of Islamic Economics, Banking .... Vol-10, No1 January-March, 2014, titled "Exploring the distinguishing features of Islamic Banking in Tanzania" written by Henry Chalu, a lecturer Department of Accounting, UDSM. It is an exploratory study that aimed at describing the the extent to which Islamic banks in Tanzania comply with Islamic principles.

Literature Reviews.

The author used mostly the works of Algaoud and Lewis (2001:38) as well as Olson and Zoubi (2008) to describe religious features of Islamic banking. According to Henry, five religious features of Islamic banking identified by Algaoud and Lewis (2001:38) are; first feature is prohibition of interest(riba) in all transactions. The second feature is that business and investments are undertaken on the basis of halal (legal/permitted) activities. The third feature is that maysir (gambling) is prohibited and transactions should be free from gharar (speculation or unreasonable uncertainty). The fourth feature is that zakat is to be paid by the bank for the benefit of society and all activities should be in line with Islamic principles. Finally, there should be a special Sharia board to supervise and advise the bank on the propriety of the transaction. Henry writes that "Olson and Zoubi (2008) classified these five Islamic features into two main principles that govern Islamic banks: prohibition of interest (riba) regardless of the source or form, and risk-sharing as Islamic banks are required to operate under the PLS arrangement. As such in this study, the overview uses the Olson and Zoubi (2008) features for two reasons: first, the features are more pronounced than others; and second these features incorporate other features identified by Algaoud and Lewis (2001)."

Though there are other religious features beyond the five mentioned above, such as sanctity of contract, prohibition on monopoly practices, underselling, speculative hoarding among others (Iqbal and Van Greuning, 2007) the author justifications for using Olson and Zoubi's two features shows author's bias and lack of comprehensive understanding of these other features which are independent but form part of the whole concept of Islamic Banking theory and practices around the world.

Moreover, the author failed to understand or show bias against other modes such as Murabaha, Ijarah, Musawammah, Qardh among others beyond P/S Sharing modes, i.e Musharaka and Mudharaba. Islamic banking practices all over the world shows that these other modes preoccupy largest share of financing and investment portfolio together with P/S Sharing modes. Hence from theory and practice, is inaccurate to assert that Musharaka and Mudaraba are 'two pillars of Islamic banking and finance.' Henry writes that 'from these two pillars this study developed four criteria that were used to assess the level of Islamic banking services in Tanzania. The four criteria are discussed under the subsequent conceptual framework."

Conceptual Framework.

The basis of the study is based on four features grouped into four criteria and considered to be criteria on Islamic banking 'Islamicity', these are: (i) compliance with Islamic principles of finance; (ii) selection of banks’ customers according to Islamic principles; (iii) structuring of conventional banks to follow Islamic principles; and (iv) competence of SSB. These features were used to determine the extent to which the Islamic banks operating in Tanzania were Sharia-compliant. Based on these features, data was gathered, analysed and presented.

I. Compliance with Islamic Principles. There is no doubt that this is significant criteria for Islamic banks. Based on the Islamic principles, Islamic banks differentiates itelf from conventional banks. This criteria evaluates bank's compliance to Sharia rules and principles governing transactions and code of conduct. Based on this criteria, author highlighted three key issues, one being Sharia compliance itself, second observing Islamic accounting and auditing standards, and third making ethical investment. While the first and the third issue is very real distinguishing feature of all times, the second issue is not except where the regulator recognises those Islamic accounting standards. Therefore, 'observing Islamic accounting and auditing standards as an area for the difference between conventional banking and Islamic banking' should be qualified in the sense that wherever central bank or financial regulations of the country has adopted it for Islamic banks. Otherwise, Islamic financial institutions are required to use the system of accounting standards which is mandated by the financial services regulator of the country in which they are based (Mohammed Amin, 2011).Hence, Islamic banks cannot be victimised by following IFRS as a legal requirement on its Sharia compliance status. Moreover, IFRS’s standards are principles based rather than legal based, which makes them applicable to Islamic finance, provided that concerned states issue the appropriate complementary guidelines and obligations(Kaushiq Kodithodika,2011). AAOIFI accounting standards serves as complementary guidelines for Islamic banks eventhough there are areas of great difference between the two standards.

The author writes "The main difference between international accounting standards and Islamic accounting standards is the definition of the bank’s income. Whereas under international accounting standards the income takes into consideration the interest aspect, under Islamic accounting standards, the definition of income is based on the profit aspect." It is not clear why the author, didnot mention that international accounting standards also takes into account profit aspect as Islamic accounting standard do, is this an error of omission or an effort to exegerrate the difference between the two standards?

II.Selection of banks’ customers according to Islamic principles. Henry writes "Although Islamic banks and Islamic banking windows in conventional banks are there to make profits like any other business, they are considered to foster religious faith. Thus, Islamic banks are expected to make sure that they make extra efforts to have customers who not only understand Islamic principles but who are also devoted followers." These words reminded me of AIG case and its ruling in USA, whereby the insurance company was alleged that AIG’s Shariah compliant business promoted religious doctrine. Thanks to Judge Lawrence Zatkoff who dismissed the case and said the plaintiff did not prove that AIG’s Shariah compliant businesses engaged in religious indoctrination. The decision debunks the prevailing myth that Islamic finance is unacceptable and supports the promotion of Islamic faith, whose image has been tainted by fundamentalists.

Leaving AIG case aside, it is hard to conscience with such allegation to Islamic banks which are open to every one, everywhere in the world. Islamic banks are not in theory nor in practice have ever had customer's screening criteria to establish devoted from non devoted followers of Islam to deal with. Author himself has confessed to this reality when he said "Studies in Islamic banking are diverse and none of them has used selection of banking customers as one of criteria for evaluating the distinguishing features
of Islamic services." Never has and never shall it be because such criteria has no basis in Islamic business law. Hence, it is not because Islamic banks wants to have competitive advantage or expand customer base by having non-muslim as customers, rather it is not supposed to do so in first place by Sharia principles. Islamic banks like conventional banks, have customer's with different motives including those with religious motive and such is not an issue or criteria for being Sharia compliant. For example; a catholic may opt for MKOMBOZI BANK not because it is conventional bank but because it is owned by catholic church, hence such religious motive of such customer cannot be yardstick to allege that MKOMBOZI BANK is for devoted catholic customers or is not owned by catholic church. Hence believing that "if the religious underpinnings of the Islamic banks were to hold, then the provision of banking services will be done to Muslims only " and using it as criteria to evaluate islamicity of Islamic banks falls nothing short of senseless spread of malice.

Long history of banking without Islamic banking, had no doubt prompted a large section of Muslims to prefer Islamic banking than else not only because it meets religious requirements but also because it present a fair value proposition to them and to alot of non-Muslims alike.

To continue..

Regulatory impact of Basel III on Islamic institutions

By:Naseeha Mahomed, EY. She is a Manager in Financial Accounting and Advisory Services and is responsible for the Center in Islamic Finance for Africa.cifa@za.ey.com.

Although the structures underlying Islamic finance transactions differ to those for conventional institutions, Basel III makes no clear distinction between Islamic banks and conventional banks. It requires banks to strengthen their capital positions by improving the quality of capital held. This would result in reduced dependency on debt instruments and would provide further insulation in times of financial difficulty. This move is consistent with the business model of Islamic banks. The definition of capital has also been revised under Basel III. Tier 1 capital comprises of common equity, preferred stocks and hybrid securities; Tier 2 capital comprises of subordinated debt and loans; and and Tier 3 has been revoked.

Islamic financial institutions may be better suited to meet the enhanced capital requirements of Basel III, but these banks would also be subject to regulation of the Islamic Financial Services Board, which proposes more stringent criteria in defining capital (or otherlocal regulators, depending on jurisdiction). For Islamic financial institutions, Tier 1 capital would include common equities, as well as other Shari’ah-compliant instruments that have a high degree of loss absorbency. Tier 2 capital would include hybrid instruments that are convertible into equities in addition to general provisions and reserves held for future losses. Islamic banks obtain deposits primarily through a profit sharing investment account (PSIA) that, whether restricted or unrestricted, is not guaranteed by the Islamic bank. The PSIA is merely used as a mechanism for liquidity risk management, hence excluded from regulatory capital. Reserves such as a profit equalization reserve (PER) and an investment risk reserve (IRR)9 would not form part of an Islamic institution’s capital as defined. The IRR and a component of the PER are also excluded, as they comprise equity of the investment holders and not that of the Islamic institution.

Basel III also requires banks to hold more liquid, low-yielding assets to meet short-term funding needs, but this may have an adverse
impact on profitability. Islamic banks may also face challenges in managing liquidity, as there are constraints on borrowing that may limit access to liquid funding. In addition, surplus liquidity cannot be transferred to conventional banks. There is also a need to further develop Shari’ah-compliant liquid instruments, as many of the instruments currently available are not accessible to Islamic institutions due to the interest prohibition.

In comparison with conventional banks, Islamic banks seem to be slightly less impacted by Basel III, as the business model of an Islamic bank is more conservative. These institutions are better capitalized compared with their conventional counterparts; however, challenges do remain, as existing risk management and corporate governance practices may need to be improved. Uniform application across different jurisdictions is also key in ensuring stability within the overall financial system. Islamic banks should ensure that they are actively engaging with Basel III to position themselves strategically in a competitive market.

Blame the Banks not Greece (Edited).

By: CHRIS ARNADE,is a writer and photographer based in New York. He is a former Wall Street trader.

Why is Greece chastised for reckless borrowing while the financial institutions that profited for years seem to get off scot-free?

One of the first lessons I was taught on Wall Street was, “Know who the fool is.” That was the gist of it. The more detailed description, yelled at me repeatedly was, “Know who the fucking idiot with the money is and cram as much toxic shit down their throat as they can take. But be nice to them first.”

When I joined in Salomon Brothers in ‘93, Japanese customers (mostly smaller banks and large industrial companies) were considered the fool. My first five years were spent constructing complex financial products, ones with huge profit margins for us—“toxic waste” in Wall Street lingo—to sell to them. By the turn of the century many of those customers had collapsed, partly from the toxic waste we sold them, partly from all the other crazy things they were buying.

The launch of the common European currency, the euro, ushered in a period of European financial confidence, and we on Wall Street started to take advantage of another willing fool: European banks. More precisely northern European banks.

From ‘02 until the financial crisis in ‘08, Wall Street shoved as much toxic waste down those banks’ throats as they could handle. It wasn’t hard. Like the Japanese customers before them, the European banks were hell bent on indiscriminately buying assets from all over the globe.

They were so willing, and had such an appetite, that Wall Street helped hedge funds construct specially engineered products to sell to them, made of the most broken and risky subprime mortgages. These products—the banks called them “monstrosities” and later the media dubbed them as “rigged to fail”—only would have been created if they had reckless buyers, and the European banks were often those buyers.

When a bank buys an asset it is lending money; the seller is the borrower. In buying various assets European banks were doing what banks are supposed to do: lending. But by doing so without caution they were doing exactly what banks are not supposed to do: lending recklessly.

The European banks weren’t lending recklessly to only the U.S. They were also aggressively lending within Europe, including to the governments of Spain, Portugal, and Greece.

In 2008, when the U.S. housing market collapsed, the European banks lost big. They mostly absorbed those losses and focused their attention on Europe, where they kept lending to governments—meaning buying those countries’ debt—even though that was looking like an increasingly foolish thing to do: Many of the southern countries were starting to show worrying signs.

By 2010 one of those countries—Greece—could no longer pay its bills. Over the prior decade Greece had built up massive debt, a result of too many people buying too many things, too few Greeks paying too few taxes, and too many promises made by too many corrupt politicians, all wrapped in questionable accounting. Yet despite clear problems, bankers had been eagerly lending to Greece all along.

That 2010 Greek crisis was temporarily muzzled by an international bailout, which imposed on Greece severe spending constraints. This bailout gave Greece no debt relief, instead lending them more money to help pay off their old loans, allowing the banks to walk away with few losses. It was a bailout of the banks in everything but name.

Greece has struggled immensely since then, with an economic collapse of historic proportion, the human costs of which can only be roughly understood. Greece needed another bailout in 2012, and yet again this week.

While the Greeks have suffered, the northern banks have yet to account financially, legally, or ethically, for their reckless decisions. Further, by bailing out the banks in 2010, rather than Greece, the politicians transferred any future losses from Greece to the European public. It was a bait-and-switch rife with a nationalist sentiment that has corrupted the dialogue since: Don’t look at our reckless banks; look at their reckless borrowing.


But the bailout was primarily focused on saving the banks, not Greece: Rather than forgive a portion of the Greek debt and hand the banks a loss, Greece was to continue paying its bills. New money was lent by a variety of public sector entities (i.e.The European Commission, the IMF, and the European Central Bank) to pay off the old bills. The banks were consequently made whole, with most of the money from the new loans passing through Greece right back to the banks. For acting as a conduit to a northern European bank bailout, Greece was asked to change its ways—to spend less, tax more, and restructure the public sector.

This did not work. Greece was plunged into an even more dire depression. Two years later it was once again unable to pay its bill and required a new bailout. This time Greece’s debt was cut, roughly by 40 percent, but by then the banks had far less to lose, with many of the loans having already matured and been fully paid.

That first furtive bailout of the banks in 2010 introduced and encouraged a narrative of southern borrowers as the victims of only their own incompetence, sloth, and greed. It allowed the banks to play the role of upset parents to immature children.

That narrative was further encouraged and politicized by passing any future losses from Greece onto the European public, mostly the northern European public, encouraging an us-versus-them mentality. It was policy dressed in nationalism: the antithesis of everything the common currency was supposed to stand for.

Why were the banks, rather than Greece, bailed out in 2010? Why was Greece asked to change its ways and accused of reckless borrowing, rather than the banks accused of reckless lending?

One argument was that Europe was still not closely aligned enough, their regulators not coordinated enough, to pull off such an operation. The louder argument was that the European banks were too vulnerable, fragile, and essential, to suffer losses. Those losses would have propagated around Europe, collapsing other banks and other countries and, ultimately, breaking up the euro zone.

That argument continued: The banks were too central to the operation and health of the economy, no matter how recklessly they had behaved, to punish with losses. It is an argument one hears during a crisis in order to justify bank bailouts, to justify favoring the creditors over the borrowers.* It is a strong argument—because it is true.

Consequently it is also the strongest and best argument for why banks should be heavily regulated and controlled in the first place: to prevent exactly that sort of behavior—before it destroys countries and economies.

Politicians, regulators, and bankers can calculate the immediate costs of bank failures. They can’t calculate the longer-term human toll that follows.

Greece is experiencing immense pain from a depression greater than that of the U.S. in the ‘30s. Poverty, homelessness, suicide, addiction—all have risen. A generation has seen the present diminished, and the future diminished even more.

It is a sad instance of a time-old routine: When lenders and borrowers are at odds, it is the borrowers who are blamed and the borrowers who suffer.

Greek Debt Crisis: EU Should Learn from UAE

By: Dr. Kara Tan Bhala

Dubai’s total debt to GDP is about 132 percent of GDP. Greek debt as a percentage of its GDP is 177 percent. Both countries are over leveraged. Neither has the means to service its debt, without help. Yet, the markets are not overly concerned about Dubai’s debt, but are in utter turmoil over Greek debt. The reason? Dubai, as a member of the United Arab Emirates (UAE), was given debt relief by Abu Dhabi, another member of the federation. Greece as a member of the EU was not given debt relief by any members of its federation. The inference? The EU should be more creative, think outside the standard emaciated IMF model, and consider a solution based on Islamic finance principles that takes the form of generous debt relief.

The EU and UAE are both federations

Like the EU, the UAE is a federation of separate states that are economically integrated with a common market and single currency. Unlike the EU, the UAE is far more politically integrated with a common foreign and defense policy. The country is made up of seven emirates, each governed by an emir. The seven emirs make up the Federal Supreme Council, which is the federal government of the UAE. All responsibilities not granted to the national government are reserved to the emirates. The president of the UAE is the Emir of Abu Dhabi and the prime minister is the emir of Dubai.

Abu Dhabi has sizeable oil and gas reserves and its economy is driven by those two sectors, though it is attempting to diversify into tourism, air transport and services. In contrast, Dubai has far smaller oil reserves and largely depends on tourism for revenues. It is the fifth most popular tourism destination in the world, a position the emirate established through aggressive expansion into infrastructure, hotels, financial services and property development, all promoted by its world-class airline, Emirates, that even Singapore Airlines envies.

Dubai’s bailout

In late 2009, as a result of the global financial crisis, Dubai was unable to service the substantial debts it accumulated in its expansionist drive. The announcement of its imminent debt default caused sharp falls in Asian stock markets. Abu Dhabi acted swiftly, providing a $10 billion bailout to Dubai. Markets recovered, as did Dubai’s economy, thanks to improving tourist numbers and growing trade. Economic growth is averaging 4.6 percent a year between 2012 and 2015. The bailout made it easier for various indebted government related entities (GREs) to restructure their short-term obligations. With the financial heft of Abu Dhabi behind it, Dubai successfully issued $1.25 billion of five-year Islamic bonds (sukuk) in 2009 with a profit rate of 6.396 percent, according to data compiled by Bloomberg. In 2013, Dubai raised another $750 million in 10-year notes at 3.875 percent. These efforts helped, though overleveraging is a problem that lingers.

Fortunately, Abu Dhabi continues to assist Dubai with lightening its debt burden. Last March, the emirate signed an agreement with Abu Dhabi and the UAE central bank to roll over $20 billion of debt for five years. The liabilities consist of $10 billion of bonds owed to the central bank and another $10 billion to the Abu Dhabi government. The fixed interest of the liabilities is 1 percent, which compares with an interest rate of 4 percent on the original loan from 2009. The terms of the new facility are more favorable and the loan is renewable after five years. Note also the flexibility of thought in the deal: it is structured as conventional, interest bearing obligations. Quite a contrast from the intransigence of the EU politicians and their IMF collaborators.

Austerity versus growth

Unlike the EU and IMF, which insist on imposing austerity on forlorn Greece, Abu Dhabi and the UAE bailed out Dubai to promote economic growth for the emirate and the federation. The rollover of debt in 2014 has enabled Dubai to continue spending heavily to develop itself as a regional, if not global, center for finance, trade and tourism. The different economic strategy used by the UAE in its bail out of Dubai seems to be working better than the austerity regime of the EU and IMF. Dubai’s residential property prices increased over 20 percent, and its stock market is up strongly since the end of 2012. Meanwhile, the generous debt relief allows the GREs to work through debt restructurings, selling assets to meet repayment in the next few years. The IMF estimated in January 2014 that Dubai and its GREs had about $78 billion of maturing debt between 2014 and 2017. The rollover of the initial bailout relieves more than a quarter of this amount.

Islamic principles of finance

There are both pragmatic and Islamic reasons for the generous debt relief offered by Abu Dhabi. The government of the UAE most likely did not want foreign holders of Dubai debt to lay claim to some of the most valuable properties in what until 1971 was a desert wasteland called the “Trucial States.” Further, the decision to bail out Dubai, and then offer more debt relief, is driven by principles that underlie Islamic finance.

In conventional modern finance, the (unstated and not intentionally pursued) purpose of finance is to increase economic efficiency. This purpose is achieved through rational self-interest and profit maximization. Benefits, if any, to the community and the social good are by-products and unintended. Conventional finance is silent on the ethics of finance and on its teleology. Economic efficiency is not a stated or desired purpose. Efficiency simply is the outcome of all financial activity.

In contrast, the fundamental purpose of Islamic finance is derived from the Shari’a. The Shari’a is the religious law Allah directly gave to his Prophet (PBUH). As such, the purpose of Islamic finance is ethically driven, because the aim of the Shari’a is also the aim of Islamic finance. Finance is only one part of life and society. The objective of Shari’a is the happiness and well being of the people in this worldly life, as well as in the life Hereafter. Accordingly, the objective of Islamic finance is that people flourish now and on the Day of Judgment before Allah. Islamic finance must contribute to the development and good of the Islamic community. How finance achieves this purpose is guided by principles written down in the Holy Qur’an and other key sources of the Shari’a. Not surprisingly, therefore, the fundamental feature of Islamic finance is socio-economic and distributive justice. As Shari’a is the guide to Islamic finance, the latter contains a comprehensive system of ethics and moral values.

Moral alternative instead of moral hazard

Perhaps not surprisingly, Islamic finance principles state clearly individuals who have trouble repaying their debts should have their obligations made easier for them and not more difficult. It is immoral for a lender to harass or pressure a person who has borrowed money and is unable to repay the loan, if that person has fallen on hard times. Instead, such individuals are deserving of charity.

Accordingly, the bail out and subsequent debt relief for Dubai was done for the good of the community, or in Christian terms, for the common good. Perhaps, therefore, the EU and IMF should stop thinking of Greek debt in terms of mere moral hazard and economic efficiency, and start considering more generous debt relief as a moral alternative.

Source:
http://sevenpillarsinstitute.org/case-studies/greek-debt-crisis-eu-should-learn-from-uae.

Exploring the distinguishing features of Islamic Banking in Tanzania.

By:Henry Chalu, Lecturer, Department of Accounting , University of Dar es Salaam, Tanzania

Source:Journal of Islamic Economics, Banking .... Vol-10, No1 January-March, 2014.

ABSTRACT.

Despite its growth, Islamic banking has not escaped criticisms that Islamic banks are not really Islamic. To address that gap, this study was conducted to assess the distinguishing features of Islamic banks in Tanzania. This study used four criteria: compliance with Islamic principles of finance; selection of customers for Islamic banking; structuring conventional banks to follow the Islamic principles as well as competence of Sharia Supervisory Board (SSB) to guide and advise banks. Using descriptive analysis from 60 respondents (customers and officials of two conventional banks which have introduced Islamic banking), the study found that there is limited awareness in case of compliance with Islamic principles of finance as selection of customers is not purely based on Islamic principles and hence limited religious influence, limited structuring of banks to comply with Islamic principles as well as moderate competence of SSB. On the basis of current findings, the study, therefore, concludes that it is very difficult for these banks operating in Tanzania to be termed as really Islamic.


The article can be downloaded on the internet. In the near future i shall critically review this article, Insha Allah.

Why Islamic banking remains elusive in Uganda

Source: Sunrise.ug. Published Jan 2015.

The introduction of Islamic banking in Uganda has been pending for well close to a decade now raising concern among different sections of the population that there could be some ill-motive to block or frustrate it as an alternative to other costly sources of finance.

During events to commemorate Bank of Uganda’s 40th anniversary in 2006, President Museveni pledged his government’s commitment to facilitate the introduction of Islamic banking in Uganda. Eight years down the road, the government is yet to amend necessary laws that incorporate Islamic banking principles.

The delayed acceptance of Islamic banking in Uganda has created a sense of marginalization especially among muslims who look at the model as one that conforms to their faith. But also some business people are looking forward to it as a badly-needed alternative to the existing financing options which they say are out of reach. Many are asking why in Uganda, when a similar arrangement has been permitted in other East African countries like Kenya, Tanzania and Rwanda?

In an attempt to understand the reasons for the delayed roll-out, The Sunrise has interacted with a number of stakeholders including traders and bankers and officials from Islamic financial institutions some of who note that there is a lack of enthusiasm from among muslim leaders to push for the adoption of the financing model.

But perhaps one of the biggest obstacles facing Islamic banking, The Sunrise has found out, is that lack of a clear understanding of its core principles since they differ radically from conventional banking models.

According to Dr. Abdelkader Chachi, the Professor at the Saudi Arabia based Islamic Research and Training Institute, Islamic banking refers to a system of banking consistent with the principles of Islamic law (Shari’ah).

According to the International Monetary Fund (IMF) Islamic banking is based upon the principle of profit and loss sharing (PLS) and the avoidance of interest rate-based commitments and contracts that entail excessive risks and finance activities prohibited under Islamic principles.

Under the PLS arrangement, what would be a lending rate in conventional lending, is replaced by a rate of return on investment which is determined after the end of the project. In this arrangement, the profits are shared between the borrower and the lender.

Furthermore, Islamic banking is based upon the principle of exchange of ownership in tangible assets or services, a process where money only serves to facilitate the payment mechanism to implement the transfer.

“Islamic banking does not allow the creation of debt through direct lending and borrowing because credit can only be provided through lease or sale-based financing. Even in these cases, Islamic financial principles demand that the asset sold or leased should be real and that the seller or the lessor should own this asset before the transaction,” says IMF.

IMF adds that while the Islamic banking model minimizes excessive risk-taking by financial institutions, in case of a downturn in the real economy, the profitability of Islamic banks gets affected because of the inherent system of shared risk.

Progress in Uganda

“Islamic banks are required to know the project and use of funds, leading to close relationships with entrepreneurs and the likelihood that funds are allocated for the stated investment,” writes IMF.

Statements from different government officials appear to suggest that some progress has been made to embrace the Islamic banking model.

Finance Minister Maria Kiwanuka told a meeting held in Kampala last week that: “The cabinet has agreed to allow this type of banking. It was forwarded to the Parliamentary committee responsible and if MPs pass the bill into law, then we shall roll it out.”

Kiwanuka added that the government is supportive of the model as it offers numerous advantages not just to the lenders and borrowers but also to the general economy. Islamic financial institutions for example offer many governments the opportunity of tapping into their deep pockets, by issuing bonds or (Sukuk). In Kenya, the country’s two financial institutions that operate the Islamic financing model, have participated in Sukuks – (read invested in bonds.)

Another product offered by Islamic financial institutions is the so-called Murabaha – a modality by which a bank buys goods and sells to a customer on a deferred basis. Many countries like Kenya have had to revise their laws to permit banks to engage in wholesale buying of goods.

The Deputy Governor of the Bank of Uganda Dr. Louis Kasekende recently presented a paper at Serena Hotel in which he stated that the central bank is prepared for Islamic banking.

He pointed out that BoU has already engaged the Muslim community through the Uganda Muslim Supreme Council (UMSC) to provide sensitization to the public about Islamic banking. He added that the Islamic University in Uganda as well as the Uganda Institute of Banking and Finance have been engaged to review their curricula to include courses tailored towards Islamic Banking.

“BoU is in the process of engaging a consultant to develop a comprehensive Regulatory and Supervisory Framework for Islamic Banking and the consultant will also identify the necessary modifications to the tax Regime and BoU will liaise with the relevant authorities to explore ways of accommodating the unique features of Islamic Banking in the tax laws,” said Kasekende.

Dissatisfaction

Despite steps being taken by the government, some sections of the Muslim community feel the government is dragging its feet on what they consider a vital vehicle for mobilising capital.

A group of youthful educated muslims has formed a pressure group to push for the authorization of Islamic banking in Uganda.
The committee is chaired by one Jawad Mbogo and deputized by Hashim Miganda who have vowed for the push for the government’s approval of Islamic banking in Uganda. Miganda argues however that their efforts are frustrated by the reluctance of senior muslim leaders to throw their weight behind efforts to introduce Islamic banking.

Miganda said: “Many people think that an Islamic bank will one day drop from heaven and land in Uganda without determined individuals ever standing up to play their role,” Miganda said Many people think things will just fall into place.”

He added that with support of the UMSC leadership, his group is determined to provide leadership. “All we want is UMSC to endorse us and we shall do the rest,” Miganda said explaining that they have already secured a group of investors ready to inject money when the first Islamic financial institution is opened inUganda.

“The purpose of this committee is to inform the Uganda Mufti and indeed the Muslim Community that we have heard what our UMSC leader (His Excellence, The Mufti) has been preaching us over the years and we have decided to be practical. Our goal is to ensure that we organize individual Muslims and Islamic Organizations within and outside the country to support the formation of an Islamic Banking Institution in the country,” partly reads a report issued by committee recently.

Opposition from ordinary banks?

Some sections of Kampala’s business community who spoke to The Sunrise opine that the idea of Islamic banking may be facing resistance from conventional banking institutions allegedly for fear of facing tight competition on lending.

“It is understandable for conventional banks to fear any institution lending interest-free loans to give them a run for their money,” said Sentamu Kaddu, the General Secretary of the Kampala City Traders Association (KACITA).

“I can’t imagine how doing business in Uganda would ease if Islamic banking was introduced tomorrow. And I wonder how I would continue borrowing unfriendly loans with prohibitive interest rates. ” He added.

But the Executive Director of the Uganda bankers Association Emmanuel Turyamuhika Kikoni has dismissed the allegation of possible competition as baseless and untrue explaining that conventional bank managers will also be at liberty to operate Islamic bank windows when that time comes after all.

Kikoni has however cautioned those intending to open up Islamic banking ventures to tread carefully in risky areas such as agriculture where he warns that vagaries of whether make it difficult to determine the margin of profit a business venture is likely to fetch over a time.

“If for example a profit-based bank lends out Ushs10 million to a client to grow maize and it fails due to a bad whether, the next thing will be loss-sharing which definitely affects that bank.” Kikoni warned.

Despite its promises and claims by its supporters, Islamic banking institutions still hold a tiny fraction of the world’s total assets. According to the IMF, Islamic banks control just under one percent of the world’s financial assets.

KITABU "KOSA LA BWANA MSA" NA WASHAURI WA BENKI ZA KIISLAMU.

Wiki moja iliyopita nilisoma kitabu cha riwaya nzuri kikiitwa 'KOSA LA BWANA MSA' na katika kufikiria mkasa wa riwaya hiyo na kosa halisi la bwana Msa, nimeona ni vyema mafunzo ya kisa hiki yakaelezwa na kuzingatiwa na washauri wa benki za Kiislamu na hata washauri wa katika maeneo mengine.

Kwa ufupi sana, mwandishi wa riwaya hiyo alionesha kwa uhodari mkubwa kuwa kosa moja la Kisharia ( Sheria za Muumba kwa watu), linaweza kusababisha makosa mengi na hiliki kwa mhusika au jamii kwa ujumla. Bwana Msa ambaye ni mpelelezi alijitwika Usheikh na kutoa fatwa ambayo ilisababisha mke wa mtu, kuolewa na mwanaume mwingine, akazaa naye na kurithi mali ya mwanaume huyo ilihali yeye alikuwa bado ni mke halali wa mtu mwingine. Zaidi ya hayo, ni kuwa mwenye mke alidhurika sana na hata karibu kuwa mwendawazimu kwa kupotelewa na mkewe aliyempenda kwa dhati. Kosa la Bwana Msa, ni kuwa alisema kuwa iwapo mwanamke kaolewa na mwanaume kwa jina ambalo sio la kusajiliwa au ajulikanalo kwalo, basi ndoa hiyo si sahihi. Na kwa msimamo wake huo, ilimpelekea mke baada ya mizonge ya kifamilia ya mume wake huyo aliyemuoa kwa jina tofauti, aliamua bora aolewe na mwanaume mwingine, akazaa na yeye na kuja kurithi mali yake. Uzuri ni kuwa mwishowe Bwana Msa anakumbuka kosa lake na kuomba radhi na msamaha kwa wote waliodhurika kwa kosa lake ili aweze kupata msamaha kwa mola wake.

Funzo kubwa linalopatikana katika kitabu hiki ni kuwa, washauri wowote wanatakiwa kuwa na ujuzi wa kile wakisemacho kuwambia wengine hususani linapokuwa suala hilo linahusu Sharia ya Mola Mtukufu. Iwapo hili halitozingatiwa, mshauri ajue si tu kuwa ni mtu mmoja anayeweza kuathirika na kosa lake bali watu wengi au jamii nzima. Hivyo ni muhimu sana tena sana, washauri wa masuala ya Kisharia katika benki za kiislamu au idhaa na taasisi za Kiislamu, kuwa waangalifu sana na makosa yanayoweza kutokana na ushauri wao na ikawa ni muhali sana kuweza kurekebisha kosa hilo baadaye hata ikiwa ni kwa kuomba radhi. Waswahili wamehadharisha " Maji yamkishamwagika hayazoleki" Tena ikiwa maji hayo ni masuala ya pesa na kuchuma mali, ni jambo gumu sana kurekebishika.

Pamoja na ukweli huu kuwa kusahihisha makosa katika uchumaji wa mali nakadhalika ni jambo zito, mshauri asione aibu kukiri kosa lake kwa wale aliowashauri na kutafuta namna ya kurekebisha athari ya ushauri wake, ili kuwaongoza waathirika namna ya kurejea katika njia sahihi. Jambo hili ni muhimu si tu kwa kujivua dhimma juu ya yale yaliyochumwa, bali ili kupatikana msamaha wa Mola. Akumbuke mshauri kuwa, watu wa motoni (mola atuhifadhi nao), watasema na kumuomba Mola awaongezee adhabu wale waliowapoteza katika kufanya maamuzi.

Hivyo ni wajibu kwa washauri, kuwa waangalifu mno katika kazi zao na kumuogopa Mwenyezi Mungu wasije wakatokwa na machozi ya damu siku ya kuhesabiwa na haitomfaa mtu majuto yake. Mola atufanyie wepesi na azinyooshe kalamu zetu na maneno yetu, katika kuandika na kusema yaliosawa na haki. Ameen.

Being Completely Compliant

By:Prof. Datuk Dr. Syed Othman Alhabshi.

Today, we are all but familiar with the Islamic traditions through the advent of Islamic banking, finance and capital market, despite the dismal image of Islam that has been painted by those who do not know or do not intend to know about it.

I firmly believe that the success of Islamic finance today is because the explicit vision of an economy embedded in prescribed rules of behaviour that the Qur’an has provided to mankind is the truth, the whole truth and nothing but the truth. So much so, many writers such as Abbas Mirakhor, Hussein Askari, Zamir Iqbal and others have openly stated that “compliance with these rules assures sustainable development and growth”.

The Qur’an does not have a long list of don’ts neither does it provide a long list of do’s. But the little that it gives is enough to enrich economics and finance. I just share here a few of these rules of behaviour. The first is the property-rights which empower all humans to access Allah-created resources. The rules of property-rights would form the legislative basis for redistributive measures where the less able has the legal right to redeem from the income and wealth of the more able. Would it be possible to have 1.4 billion people on this planet out of 7 billion live on USD1.25 per day, and 22,000 children die of poverty daily if the property-rights of Islam are being fairly implemented? The same rules also prohibit abuse, waste and wanton destruction of resources, giving clear implications on the environment.

Second is the principle of sharing. The prohibition of interest which incidentally is prohibited by all known religions, transforms risk shifting or transfer to risk sharing. In particular, the sharing of risks in life brings people together leading towards social solidarity and unity of mankind as a corollary of the Unity of the Creator. It is worth noting that Kenneth Arrow’s theory of risk bearing (Arrow 1971) is essentially a theory of risk sharing in that it requires that the risks of the economy are allocated among participants in accordance with their respective degree of risk tolerance. Risk sharing will also relieve human societies of the heavy burden of debt, one of the main causes of financial and economic crises of the modern day.

Thirdly, the market has an important subsidiary role of requiring the participants to internalise the rules of behaviour before entering it. This requirement has been amply emphasized by Al-Ghazali so that mistakes can be minimised. Additional rules govern the market operations, such as free entry and exit, full disclosure of information and transparency. Rules also provide remedies for such problems as annulment of contracts in case of cheating, short changing through measures and weights and asymmetry of information. These rules, if well enforced, will produce a very fair competitive market as was the case during the early periods of Islam. Today we have not been able to emulate such practices anymore. Price control needs to be continuously implemented.

Thus we see how enriching the economy will be with ideas from religions. Whilst what I have outlined is still very generic, I like to take this opportunity to offer a solution, particularly to CEOs of any company who essentially are responsible for the whole organisation’s operations. My thesis is that, if any of the operations under our purview are not rule compliant, what answer do we have for the Creator when our turn comes to meet Him personally. Reflecting upon this issue is very scary indeed because we never thought this issue will be in the list of things we need to answer for.

At the moment, when we raise funds through sukuk, we feel satisfied that we are complying with the dictates of Shariah like a fad or fashion. However, when we insure buildings or assets we do not think of takaful. When we park our extra cash we do not think of parking in Shariah compliant money market. When we invest, we only choose investments that give the highest yields, whether such yield is Shariah compliant or not is not our concern.

I remember when I was the President and CEO of a private university, the parent company which was run by 90% Muslims wanted to charge me 12% interest for a loan that I needed during our early years of operation. I told the CFO, “Shall I tell Allah Almighty that you compel me to accept this offer of loan with 12% interest when I meet Him later?”

In fact, when I was serving a so-called Islamic organisation, we were considering insuring the building that was just completed. The management was collecting quotations from insurance companies. No one thought of insuring the building with a takaful company. I plucked up courage and voice my concern because I was not considered as part of operations staff. So it was decided that a quotation from two existing takaful companies should be obtained. In the meeting the following month, again the conventional insurance company was about to be picked up because no one was sensitive to the need to employ the takaful company. What more when the takaful company quoted slightly higher price. I objected and eventually the buildings were insured with a takaful company. Similarly when we deal with others we do not practice justice and fairness, what more benevolence and yet we feel satisfied just because we consider our operations have nothing to do with being Islamic.

I am raising this concern simply because many have not realised that by being completely rule compliant, the whole organisation will be compliant, including all its assets and net worth. It will also increase the total Shariah compliant assets of society, which at the moment for Islamic financial institutions assets stand only at 0.8% of the total global financial assets.

How Can Islamic Finance Move Forward?

By Prof Abbas Mirakhor, First Holder of INCEIF Chair of Islamic Finance.

The most important lesson Islamic finance can learn from financial crisis of recent years is to reduce over-reliance on debt-based instruments and to introduce more risk-sharing instruments. This is not to say that instruments such as murabahah are not Islamic. They are. However, we should not be overly reliant on it.

The derivatives world is explained by the theory of spanning, where one basic instrument can be spanned into infinite numbers of instrument, like a peacock’s tail that has one base but can expand widely. Robert Shiller, a professor of economics at Yale University, is an advocate of risk-sharing instruments. He argues risk-sharing has much to contribute to the growth of economies and to social solidarity. One practical way of implementing risk sharing in the economy is to start with the use of participation instruments to finance government developmental projects: agricultural development, infrastructure development and the like. The government can issue participation securities in infrastructural projects such as highway construction projects. This way the development expenditure will be funded by the people of the country. Asian countries, well known for their high savings ratio, represent fertile grounds to explore this option.

One impediment to risk sharing that always comes to mind is the element of trust often missing or weak in many societies. For risk-sharing instruments to work, the partners in the project must be trustworthy, which unfortunately is not always the case in today’s world. How should one manage this problem?

The answer relates to the issue highlighted above – regulation. Policy can create strong regulation and supervision as credible institutions with potential to substitute for weak trust. In a development project, for example, good project management aspects must be introduced from selecting qualified contractors to management of collection in the project. This introduces a disciplined form of financial management for the government. Instead of issuing a debt-based bond to raise funding, participation securities can be issued to raise funds for specific projects. The return to the investors is dependent upon the performance of the project. The cash flows in the project are ring fenced and used to pay the investors.

This instrument cannot, however, be offered to the commercial banking large customers. Usually such debt instruments are issued in large denominations where only large financial institutions and high-net worth individuals can purchase them.

Participatory instruments must be small-denominated market-based instruments, exchange-listed securities. This is important to provide liquidity for the small investors. If an investor wants to exit the investment, he can do so by selling his/her certificates to other investors. This process should start with government projects, as it provides a sense of security to the investors. People trust the banking system because the government stands behind it. The same sense of security can be deployed to kick-start this type of risk-sharing instrument.

This approach not only reduces the burden of budget deficit on government books, it also provides an alternative investment instrument for the masses instead of a guaranteed bank saving or risky equity shares. Participation securities provide moderated equity-like return with a reasonable sense of assurance form the government.

Although the suggestion is simple on paper, a number of practical implementation procedures must be put in place to ensure the success of this undertaking. If there is political will to support this instrument, it will provide an ideologically neutral investment instrument for Muslims and non-Muslims alike.

Is interest-rate benchmarking good enough?

By Prof. Saiful Azhar Rosly, Director, Consultation and Executive Programme

At the recent industry talk at INCEIF on Sukuk, a student asked the speaker Prof. Datuk Rifaat Abdul Karim about interest-rate benchmarking. In reply, he said that there is no issue about the interest-rate benchmarking. It is normal practice of Islamic financial institutions (IFIs) today to benchmark profit rates of Islamic financial instruments to LIBOR or in the case for Malaysia, KLIBOR.

We can refer to the Al-Baraka Fatwa on interest rate benchmarking, “There is no prohibition in relying on the interest rate benchmarking in pricing the Islamic products of which such use of benchmark does not contradict the products’ nature of conforming to the Shariah upon its usage”.

In other words, interest-rate benchmarking is permissible as long as the financial instruments do not involve loans or qard. Other solid reason is the absence of any worthwhile representative Islamic financial benchmark.

While not rejecting interest-rate benchmarking, Shaykh Taqi Usmani reminded us that, “It is however true that the Islamic banks and financial institutions should get rid of this practice as soon as possible, because, firstly, it takes the rate of interest as an ideal for a halal business which is not desirable, and secondly because it does not advance the basic philosophy of Islamic economy having no impact on the system of distribution. Therefore Islamic banks and financial institutions should strive for developing their own benchmark”.

Putting fiqh issues aside, interest rate benchmarking in Islamic finance today is even more doable given that most of the modes of financing are based on credit sales in the likes of commodity murabaha, tawaruq, bay enah, al-bai bithaman ajil, murabaha, ijara, istisna and salam.

As pricing of financial instruments is based on risks carried by the Islamic banks, major risk in Islamic credit sales is primarily associated with credit risk and so does risk in interest-bearing loans. Hence, between Islamic credit sales and loans, we are comparing them like an apple for an apple.

However, when Islamic finance is propelled by risk-sharing and true sale credit financing, a new risk emerges namely business risk. In this respect, interest-rate benchmarking may not be good enough for Islamic finance given that interest-bearing loans do not carry business risk.

Usury, Profit and Time Value of Money (TVM)

By Prof. Saiful Azhar Rosly,
Director of Consulting and Executive Programme (CEP)

Bearing in mind that interest-rate benchmarking is not prohibited in Islamic finance, it is timely to raise the TVM issue. Apparently no explicit fatwa is available to address this matter, except for some dalils quoted in the middle of this page.

Conceptually, TVM deals with our preference to spend our money in a certain time horizon, say whether to spend it today or in the future. Those who prefer to spend it today believe that doing so will give him more satisfaction compared with doing it say, tomorrow. Making such a choice is actually matter of personal preference defined by the environment around us rather than a rule to be dutifully obeyed.

The interest rate system came into being when those who are offered to lend out money and hence postponing their current spending are compensated with interest for the loss of foregoing it i.e the consumption today. This is how conventional thinking uses TVM or to be more specific, positive time preference (PTP) to justify the receipt and payment of interest rates.

The Islamic position of TVM can be appreciated by examining the evidences from early Islamic scholars about profits generated from credit sales, some of which are given below:
1.Price will possibly rise due to its deferred payment (Badai’ as-Sonaie, Al-Kasani, 5/187)
2.“The deferment for some period of time has a value in the price” (Bidayatul Mujtahid, Ibn Rush Al-Hafid, 2/108)
3.“The period is part of the price” (Fatawa Ibn Taimiya, 29/499.
4.“This is the evidence that the period of time in sale and purchase (al-bay) has its portion in the price; and it is permissible for sale and purchase contracts” (Al-Mughni, Ibn-Qudamah, 6/385)

These evidences suggest that profits can be gained by the trader when the buyer pays for the goods in the future at the higher price. The difference between credit and cash price constitutes the TVM or we can call it time value in price (TVP) instead. However, this will hold only when the transaction is based on sale and purchase contract (al-bay) and not from a loan (qard). Otherwise interest as riba will be implicated here.

This leads us to the interest benchmarking issue where TVM in conventional thinking is a consequence of lending and borrowing of monies while in Islamic finance it deals with trading and commerce (al-bay).

For example, the yield on the 3-month Treasury bill constitutes the true time value of money (TTVM) as the government security is free from default. This is the pure interest rate or opportunity cost of money which the interest benchmarking is based on. The BLR or now known as base rate (BR) is the cost of funds that the bank uses, say 3-month FD plus a spread that consists of the overhead and statutory costs of holding reserves to charge borrowers minus the credit risk spread. Interest rate benchmarking also uses the 3-month FD or 3 month-Kuala Lumpur interbank offer rate (KLIBOR) to price the Islamic credit sales.

The point raised here is that the interest benchmarking may be a right thing to do when the risks associated with Islamic credit sales is similar to the risks in loans. This however is arguable when the Islamic credit sale characterises a structure that evidences the inherent nature of trading which is the holding of business risk. When none of the Islamic credit sales are exposed to business risk, it is quite accurate to pursue the interest rate benchmarking in determining the profit rates.

Value and Profit

By Prof. Saiful Azhar Rosly, CEP

The business of Islamic Finance is all about value driven profit. Value is defined and embodied in the purpose of the Shariah (Maqasid al-Shariah) while the right to profit is explained by property (mal), work (kasb) and responsibility (daman). Value deals with ethical principles and moral conduct of Islamic finance stakeholders in their pursuit of profits. This should be in line with the Shariah principle of al-ghorm bil ghuni meaning that “with profit comes risk”.

It is commonly understood that the purpose of the Law or Shariah is to protect the interest of the general public among which include the protection of property (mal). The Shariah protects property in many ways. One is to ban human conduct that thrives on the suffering of other people. The prohibitions on riba and gambling are two strong examples. The Shariah also accorded rights to property by way of trade, work and inheritance. Through trade, ownership of property is passed from seller to buyer so that the latter can freely dispose-off the property, when needed.

Islamic finance is often plagued with this issue of property ownership. Unable to cope with this problem suggests that the Maqasid of Shariah is not fulfilled yet. The Islamic business may not reflect true label, if this problem persist still.

But things have improved lately. To accord property rights, the inter-conditional clause (ICC) in enah sale has been banished. We saw evidences of commodity transfer in commodity murabaha transactions via ownership certification letter. Some Sukuk applied asset-back securitization structure involving true sale of assets by the originator to the special purpose vehicle (SPV).

Despite all of the above, a lot more insightful work is expected from all Islamic finance stakeholders. One is the ethical dimension of business which is the sharing of risk and the taking of risk as amplified by the legal maxim äl-ghorm bil ghuni. For instance, in commodity murabaha which is increasingly popular today, risk associated with the sales of commodities is practically zero. The only visible risk is credit risk that arises from the debt created from the sale. We also notice that commodity murabaha placements offer guarantees to both principle deposits and returns. While Shariah compliance is visible in contracts (áqd), less evidences on risk-taking is a point of concern.

HALAL WAYS TO USE A CHEQUE.

It sounds strange to some Muslims when such a subject is put on the spot light as one wonders "Halal (Permissible) Ways to Use a Cheque", is there non-halal ways of using a cheque? Because it remains a question, this brief article seeks to provide an answer or clarity on Sharia rules applicable on these instrument.

INSTRUMENT DEFINED.

A cheque is a certificate or paper issued in aperticular form containing an order issued by a person(payer) to another person (payee) to pay a certain sum of money to a third person (beneficiary) when the it is presented. In banking industry, cheque books containing 25, 50 or more is issued to current account holders as a safe payment instrument for either paying third party or self.

HALAL WAYS TO USE A CHEQUE.

According to AAOIFI Sharia Standard no 16 Commercial Papers, it is permissible to use a cheque in the following types of transactions and situations.

1. A cheque where the payer has a balance in his/her account drawn against himself or for the third party.
2. A cheque where the payer has no balance in his/her account drawn against himself or for the third party provided that such withdrawal doesnot lead to be charged 'Riba (interest)' by way of what is called an overdraft.
3. It is permissible to do endorsement in a cheque, provided the endorsement fulfil legal conditions and regulations.
4. A cheque can be used by the payer to purchase goods to be delivered later ( on maturity of the cheque) or on spot.
5. A cheque where the payer has a balance is permitted to use it in transaction that stipulate possession such as the exchange of currencies, the purchase of gold or silver.

It is not permitted to use a cheque in the following situations and transactions.

1. If the cheque will lead to withdrawal while there is no balance in the account and hence obliged to pay interest. Normally, Banks will not accept cheques drawn upon them by clients with no balance except by charging interest along the value of the cheque.
2. It is not permitted to discount cheque i.e receive less than the value of the cheque.
3. It is not permitted to use cheque that is not paid promptly (same day)for purchase of transactions that stipulate possession such as the exchange of currencies as well as the pruchase of gold or silver.

With above clarity, i hope we shall ensure the use of cheque is in permissible way and not otherwise.

May Allah accept our Sawm and Ramadhan Mubarak.

Mudarabah and the Debt Dilemma

By Prof. Dr. Obiyathulla Ismath Bacha, Professor of Finance

Debt appears to be at the root of every financial/banking crises. In a now famous study, Rogoff and Reinhart (2010) show that every single financial crisis in the last hundred years has been caused by excessive debt. That, governments of not just poor countries but the biggest and mightiest economic super powers have been brought to their knees, shows how risky an overreliance on debt can be. The huge social costs and negative externalities of debt induced crises is now abundantly clear. Notwithstanding the huge costs that societies have had to pay for their excesses with debt, global addiction to debt appears unabated.

In a recent paper, Adair Tuner and Susan Lund argue that since the 2008 crisis, global debt has grown by US$57 trillion, a growth rate exceeding GDP growth. Government debt alone has increased by US$25 trillion with most of it in developed countries. The debt to GDP ratio is higher today than on the eve of the crisis in 2007. Worryingly, even in the developing world the buildup in debt is at record levels. This is clearly untenable.

In the absence of fiscal surpluses, governments have had to rely on unprecedented monetary easing to avoid a downward tailspin. While we may have avoided the abyss, we have little to show in terms of growth. Slow growth and minimal returns, we are told, may be the new normal.

What the world needs is growth without leverage (debt). For this, we need new thinking, outside the realm of conventional economics. And this may be where, Islamic finance can help, specifically the risk-sharing contracts Mudarabah and Musharakah.

The Mudarabah in particular is a hybrid instrument sharing the features of both debt and equity. What makes it particularly suited for today’s conundrum is that, it has the risk-sharing features of equity but not the leverage inducing feature of debt. Unfortunately, the Mudarabah story has not been well-told. At least, not in a way that will make corporate treasurers see how the debt-equity trade off they have been manacled to, becomes irrelevant with Mudarabah. Similarly policy makers in governments are not aware that financing infrastructure without leverage could be possible with Mudarabah-based sukuk.

For corporations, debt, though riskier is more attractive than equity because it’s cheaper and more importantly avoids earnings and ownership dilution. The dilution which is also perpetual is probably the most painful part of equity issuance. In Mudarabah, a financier (rab-ul-mal), provides funding to a mudarib based on a predetermined PSR (profit sharing ratio). In an 80/20 PSR, the mudarib keeps 80% of profits earned and the 20% goes to the funder. Like dividends he does not pay if there are no profits. When a corporation in need of funding an investment, considers Mudarabah in-lieu of debt, a number of benefits arise. First and foremost there is no increase in financial leverage as there are no fixed charges. As a result, the corporation’s overall riskiness may actually be lowered because there is now lower propotion debt in the capital structure. However, given the PSR, there will be earnings but not ownership dilution. There are two reasons for this. First, only profits accruing from the newly funded project is to be shared, not all earnings. This is unlike new equity which has a claim on all earnings, not just that of the new project.

Second, the Mudarabah funder only has ownership claims on the asset he funded, not the other assets of the firms, as is the case with new equity. Furthermore, the claim is terminal, like debt. Existing equity holders continue to own all the assets they currently own and take the bigger share of the profits accrued from the newly funded project. Viewed this way, Mudarabah financing effectively changes the debt-equity tradeoff, makes debt much less attractive and would be best suited to get the world out its current rut.

Indeed, in its earlier evolution, as the commenda in medieval Europe, Mudarabah funded the renaissance and in a later form, as venture capital in Silicon Valley. Given its risk sharing features, Mudarabah could yet again, in a revised form, offer the world a potential way out.