Islamic markets

Francisco Alcoba Cruz
Raúl Martínez-Avial Jiménez

Outline
 Bases of Islamic Markets
 Role of Women in Islamic Markets
 Evolution of Islamic Markets through History
 Investment and Finance
 Islamic Banking
 Money Laundering
 SME’s
 Rating Agencies
 Financial Crisis
 Malaysia

Bases of Islamic
Markets
-

Bases of Islamic Markets
 Islamic Finance is based on Shariah:

Shariah lexically means a way or path. In Islam
Shariah refers to the divine guidance and laws given by
the Holy Quran, the Hadith (sayings) of the Prophet
Muhammad and supplemented by the juristic
interpretations by Islamic Scholars. Shariah
embodies all aspects of the Islamic faith, including
beliefs and practices.


Source: Islamic World Students

 Shariah law is based on:

1. Prohibition of interest (Riba)
2. Risk sharing
3. Prohibition of speculative behavior (Gharar)
4. Sanctity of contracts
5. Investing in unlawful business (Haraam)

 Riba:
It’s the main principle of Islamic law. Riba, which means
“excess” , interpreted as “any unjustifiable increase of capital
whether in loans or sales” is the central doctrine of the system.
Indeed, any positive, fixed, predetermined rate tied to the maturity
and the amount of principal is considered Riba and therefore totally
forbidden.
Riba also covers the charging of interest. Because interest is
prohibited, fund suppliers are considered as investors and not as
creditors.

 Risk Sharing:

Investors share business risk as they share the
profit. Money is considered as a medium of
exchange. So, charging interest on loans is
considered unjust since money is viewed as an
intermediary between goods.

 Gharar:
Excessive uncertainty and speculative behavior are totally
prohibited. An islamic financial system discourages hoarding
and prohibits transactions that involve extreme
uncertainty, gambling and risk. Gambling (Maysir) invokes
enmity among the parties. Gharar involves a sense of legal
trepidation. Commercial gain itself is not prohibited but
uncertainty is forbidden. Therefore, taking economic
initiatives that do not involve uncertainty is not that easy.

 Sanctity of contracts:
Islam holds the contractual obligations and the
disclosure of information as a sacred duty
Reduce the risk of asymmetric information and moral
hazard
 Investing in unlawful business (Haraam):
Only Shariah approved activities are allowed.
They do not violate the rules of Shariah qualify for
investment, which means that investing in unethical
sectors such as casinos, tobacco companies, wine,
alcohol and sex-business is totally prohibited.

Shariah Compliance
 All of Islamic financial products and services all over the
world have to be Shariah Compliant ( Obey Shariah
principles)
 The Shariah Advisory Council of Bank Negara
Malaysia (SAC) was established in May 1997 as the highest
Shariah authority in Islamic finance in Malaysia. The SAC
has been given the authority for the ascertainment of
Islamic law for the purposes of Islamic banking business,
takaful business, Islamic financial business, Islamic
development financial business, or any other
business, which is based on Shariah principles and is
supervised and regulated by Bank Negara Malaysia

Role of Women in Islamic
Markets
-

Tradition

Progress


Evolution of Islamic Markets
through History
-

IM through History
 Muslims have a great trade and business tradition.
Their holy book, the Qur'an, tell them to do it.
 So they have been in business world since ever


IM through History
 The founding of the first large Islamic banks in the
1970s, including Dubai Islamic Bank and Albaraka
Banking Group, is generally considered to mark the
birth of modern Islamic finance

 The industry’s growth, however, really began to
accelerate in the early 1990s, bolstered in large part by
liquidity in the Gulf from one crucial source: oil.

IM through History
 The influx of capital generated by rising oil prices has
spurred massive investment in infrastructure and real
state development projects in the Gulf Cooperation
Council (GCC) states of Bahrain, Kuwait, Oman,
Qatar, Saudi Arabia and the United Arab Emirates,
driving demand for sukuks (Islamic bonds) and loans.
 There were some difficulties of adaptation in the
North of Africa to Shariah because of
misunderstantings but nowadays NA is a completely
integrated Islamic Market

IM through History
 Countries such as Jordan, Tunisia and the Sudan, in
contrast, have welcomed Islamic finance as an
opportunity to foster economic development.

 Gradually those nations with mainly Muslim
populations that had hesitated to permit Islamic
banks have started to embrace such institution
(i.e. Tunisia and Morocco)

IM through History
The biggest step; Non-Muslim Countries:

Step by step, Islamic Finance has been growing during
all these years and it getting more present in countries
with muslim population but which are not mainly
Muslim countries.
Here we find some successes and failures of IF in these
nations

IM through History

The first Islamic mortgages in Europe were
offered in 1988 by Al Baraka Bank to Gulf Arabs
for properties in London, with the mortgages
structured through an ijara rental contract.

IM through History
In Spain, Bancorreos, the entity created by the Post and
Deutsche Bank, offers financial products adapted to more
than a million Muslims living in our country, with interests
ranging from 0% to 3% interest, that the latter peak Islam
allows. For now, the bank offers other Islamic products.
Also Caixa Banco Santander offer Islamic mortgages at
interest 0, although the difficulties in launching these
products, which have had to be approved by Islamic
committees, and what little savings they currently are in
the hands of Muslims in our country suggest that now
multiply the offer despite rumors of the imminent opening
of a wholly Islamic bank in Spain.

IM through History

Not only finances are present in non-
Muslim Countries. Recently the Muslim
population gave the current president
of French Republic, Mr. Hollande, the
necessary votes to win the elections

IM through History
But everything is not success, Islamic Finance also
have to make some more efforts in another non
Muslim countries. For example, on May 27th 2012
it was published in an Spanish newspaper:

“Kansas approves a preventive law
against Shariah”

Investment and Finance
-

Debts Based
 Murabaha: (Buy-sell arrangement)Essentially works by
borrower asking lender to purchase asset on the
understanding that after lender has purchased asset,
borrower will purchase asset from lender.

 Bai’ al-Inah: (Sale and buy-back) Lender purchases
asset on behalf of borrower. Borrower purchases asset from
lender on deferred payment basis. Asset is immediately
resold to lender for cash at discount. Preferred financing
mechanism if there is any danger that lender will become
insolvent.

Debts Based
 Bay Salam:(LIBOR plus margin) It can be used to provide
working capital. The main difference with Murabaha is
that, while the financier still buys an asset, the delivery is
deferred. Usually, the financier will receive a discount for
advance payment typically calculated by reference to a
benchmark
 Istisnaa :(custom manufacturing) Is a sales contract for
custom manufactured goods which may be used for public and
private project financing. To produce, the seller uses his own raw
materials.

Equity Based
 Musharakah: (Partnership or joint venture financing) An
arrangement between a lender and a borrower where both
parties agree to make a capital contribution towards financing a
commercial operation. Parties agree to share profits from the
arrangement at a pre-agreed ratio. Losses from the arrangement
need to be shared pro-rata to the capital contributions of each of
the parties.
 Mudarabah: (Profit sharing)Islamic investors agree that a
Mudhareb (trustee) will provide skill and expertise. Mudhareb
agrees to hold and manage the assets for Islamic investors. In
return for providing services, Mudhareb earns an agreed share of
profits from the assets managed on behalf of Islamic
investors. Mudhareb cannot claim any right to the assets - merely
acts as manager and trustee of assets.

Leasing
 Ijarah: (Leasing)It’s a leasing agreement in which the bank
buys an asset for a customer and then leases it back over a
specific period. The customer has to pay a rent, representing an
agreed profit typically calculated upon a benchmark, such as the
libor + a margin. The difference between Ijara and a conventional
finance lease is the increased risk that the financier takes in
relation to the asset.

 Ijara-wa-iqtina: It’s the same contract but the customer is
allowed to buy back the item when the contract ends

Services
 Hawala: Literally: bill of exchange, promissory note, check
or draft. Technically: the debtor passes the responsibility for
payment of its debt to a third party who is himself his debtor.
Responsibility for payment lies and ultimately to a third party.
The Hawala is a mechanism for settling international accounts
by book transfers. It removes a large extent the need for physical
transfer of cash.
 Kafala: Underwriting agreement by which third guarantees the
debt of an agent in debt. The responsibility for the debt vis-à-vis
the creditor returns and the two counterparties of the contract.
As for the contract Hawala, Kafala does not generate fees beyond
administrative costs.

Services

 Rahn: Contract under which an agent provides a debt via a
collateral (pledge). This type of contracts designed to
mitigate counterparty risk borne by the creditor. The
advantage of this contract is that it allows the agent to
present a property in his possession as collateral while
keeping its use and run property

 Wadiah: (Safe-keeping) Agreement between two parties
where on agrees to look after the property of
another. Concept is used to take deposits of money, where
bank acts as custodian of money deposited by customer.
Bank agrees they will refund sums deposited “on call”, i.e.
on demand.

Sukuk - Bonds
 They are Islamic bonds. They are medium or
long term, islamically compatible trust
certificate backed by certain approved
assets, usufructs or services .
 What makes a sukuk acceptable under shariah law is
that it must be backed by a real asset such as a piece of
land, a building or an item of equipment, and
therefore when sukuk are bought and sold the
purchaser and seller are dealing indirectly in a real
asset, and not simply trading paper.

Sukuk - Bonds

Source: Emerging of Islamic Finance

Sukuk – Bonds vs Eurobonds
 There are certain differences between conventional bonds
and Sukuk. A bond represents the issuer’s pure
debt, while Sukuk represent ownership stake in
an underlying asset. An Ijarah contract that is often
used to structure sovereign Sukuk creates a lessee/lessor
relationship which is different from a lender/borrower
relationship.
 Because of the segmented market structure, Sukuk
offer lower returns compared to conventional
bonds.
 Sukuk are also illiquid instruments compared to
conventional bonds due to the lack of secondary
market activity.

Islamic Banking- Difference between
conventional banking and Islamic banking

money

Bank Client

money + money (interest)

Conventional

Source: Islamic Banking Glossary

Islamic Banking- Difference between
conventional banking and Islamic banking

Bank Goods & Client
Services

money

Islamic

Source: Islamic Banking Glossary

Conventional Banking Islamic Banking
Money is a commodity besides medium of Money is not a commodity thought it
exchange and store of value is used as a medium of exchange and
store of value

Time value is the basis for charging interest Profit on trade of goods for charging on
on capital providing service is the basis for earning
profit

Interest is charged even in case the Islamic bank operates on the basis of
organization suffers losses by using bank’s profit and loss sharing
fund

While disbursing cash finance, running The execution of agreements for the
finance or working capital, no agreement exchange of goods & services is a
for exchange of goods & services is made. must while disbursing funds under
Murabaha, salam & Istisna contracts

Conventional banks use money as a Islamic banking tends to create link with
commodity which leads to inflation the real sector of the economic system
by using trade related activities.

Conventional banks Islamic Banks
The investor is assured of a pre determined In contract it promotes risk sharing
rate of interest between provider of capital (investor)
and the user of funds (entrepreneur)
Lending money and getting it back with Compounding calculation is strictly
compounding interest is the fundamental prohibited under Islamic banking system
functions of the conventional banks

It can charge additional money incase of The Islamic banks have no provision to
defaulters charge any extra money from the
defaulters.
Conventional banks invest their deposit in Islamic banking only deals in Halal
interest based modes products and services, all transactions
must be in SHARIAH COMPLIANCE

The status of a conventional bank, in The status of Islamic bank in relation to its
relations to its clients, is that of creditors clients is that of Partners, Investors, and
and debtors. Trader, Buyer and Seller.

A conventional bank has to guarantee of Islamic banks cannot guarantee of all its
all its deposits. deposits.

SME’S
Small and medium enterprises (SME) sector
has a great potential for expanding production
capacity and self-employment opportunities.
Enhancing the role of financial sector in development
of SME sub-sector could mitigate the serious problems
of unemployment and low level of exports.
It can safely be said that Islamic banking has a
great potential of playing an effective role in the
development of a country.

SME’S
 THE PRINCIPLES OF ISLAMIC ETHICS IN SMALL
AND MEDIUM ENTERPRISES (SMEs)

Justice (‘Adl): Means to treat people equally is a
pre-requisite of fairness and justice.
Truthfulness (Sidqun): Is a basic ethical value of
Islam. Islam is, in a way, the other name of truth. Allah
speaks truth, and commands all Muslims to be straight
forward and truthful in their dealings and utterances.

SME’S
Benevolence (Ihsan):As far as kindness is concerned,
benevolence to others is defined as an act which benefits
persons other than those from whom the act proceeds
without any obligation. It also means fineness, proficiency
or magnanimity in dealing with others
Sincerity (Ikhlas): Is generally understood to be truth in
word and act.
Trust (Amanah/I’timan): Trust makes cooperative
endeavors happen. Trust is a key to positive interpersonal
relationships in various settings because it is central to how
we interact with others

Rating Agencies
 Islamic countries are mainly evaluated by one specific
agency :

“ The Islamic International Rating Agency”
-
“ ”

Rating Agencies
 Main pros of “IIRA”:

 Knowledge of region
 National / international scale rating
 Providing Sharia quality rating
 Investors/stakeholders want independent opinion on
credit worthness of sharia compliant institutions &
products

Rating Agencies: Scale
Long Term Rating Short Term Rating
AAA.ns* A-1+.ns
AA.ns A-1.ns
A.ns A-2.ns
BBB.ns A-3.ns
BB.ns B.ns
B.ns C.ns
CCC.ns D.ns
*The initials of the country for which a national scale rating
CC.ns is assigned will be substituted for “ns” in the above ratings

C.ns
D.ns

Source: Islamic International Rating Agency

Rating Agencies
It is important not to forget that IIRA is not the only Rating Agency
that evaluates Islamic Markets :

 S&P’s in 2006 were the first non- islamic rating agency in
evaluating Islamic Markets.
Standard & Poor’s was recognized for its work assigning ratings on
Sukuk issues by DIFC Investments and the Jebel Ali Free Zone,
which were named Deal of The Year and Best Sukuk, respectively.

 Moody’s Investors Service has been voted “Best Islamic Rating
Agency” in Islamic Finance News 2008 Awards poll. The award
recognises Moody’s superior ratings coverage of Islamic financial
institutions ans Sukuk transactions during 2008

Financial Crisis

Global
Financial
Crisis

Financial Crisis
Globalization

Global Financial Crisis

Everybody Affected

Financial Crisis
 But the Islamic Markets were not so affected because
their trades and business relations are based on
Shariah; and this means:

 No interest
 Speculation not allowed

 No loans among Banks

Financial
No Toxic Assets

Liquidity

Lack of Non-Payment Risk

Financial Crisis
S&P rated: 19 rated A

24 Stable
Trend

33 Islamic 5 rated A+
Banks
Analysed

9 Negative
Trend

Financial Crisis

“More than 300 Islamic Banks from all over
the world had a value of 100.000 US$M and it
is expected to double their value by 2013”

Financial Crisis
One last issue:

Are Islamic Finance that stable just
because of their followed system
(Shariah)? Or is because the world
needs them?

Malaysia
 Capital: Kuala Lumpur
 Language: Malaysian
 Government: Federal constitutional elective monarchy
and Federal parliamentary democracy
 Ethnic groups : 50.4% Malay 23.7% Chinese
11.0% Indigenous 7.1% Indian
7.8% Other
 Currency: Ringgit (RM)
 Population: 28.859.154

Malaysia

Source: Islamic Financial Times

Malaysia
Relation with Islamic Markets:
 The industry found a powerful ally across the Pacific
in Muslim Asia
 It provided a means for the government to reach out to
the underserved segment of its society by offering
basic banking and insurance products that were
compatible with Shariah principles
 Malaysia has issued new licenses to foreign fund
managers and stockbrokers, and has increased the
issuance of licenses in Islamic banks and takaful
(Islamic insurance) companies

Malaysia
 The growth in Islamic finance in Malaysia has been
supported by a significant investment in human
capital;
 International Centre for Education in Islamic Finance
(INCEIF)
 In 2008 Malaysia established the International
Shariah Research Academy (ISRA) to conduct
Shariah research on contemporary Islamic finance
issues

Malaysia
 Malaysia has succeeded in developing a system that
operates in parallel with conventional finance.
 The main Islamic financial organizations are;
 Bank Negara Malaysia ( Central Bank)
 Bank Islam Malaysia Berhad
 Bank Bumiputra Malaysia Berhad Traditional Banks
 Malayan Banking Berhad that also offer
 United Malayan Banking Corporation Berhad Islamic Banking
 To develop Islamic banking in Malaysia, were created and
developed the so-called as IIMM (Islamic interbank
market) and the ICM or Islamic Capital Market.

Malaysia
 Nowadays information:

 Islamic banking assets in Malaysia, the world’s biggest market
for Shariah-compliant debt, rose 16 percent last year (2011)
after the government approved new licenses and eased
restrictions on foreign ownership, the central bank said.

 Assets that comply with Islam’s ban on interest increased to
350.8 billion ringgit ($116 billion) and accounted for 21
percent of the total banking system, according to Bank
Negara Malaysia’s 2010 annual report published in Kuala Lumpur
today

Malaysia
2011 Sukuk Issues :

Thank you for your attention
-

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