Islamic Banking in Azerbaijan
Baku, Azerbaijan
16th – 17th September 2008
Introduction
- Short History of Islamic Banking……………………………………………..3
- Classical Islamic Banking……………………………………………………………3
- Modern Islamic Banking……………………………………………………………..3
- Emerging Islamic Capital Markets………………………………………………….4
- Basic of Islamic Banking……………………………………………………..6
- Major modes of Islamic financing……………………………………………8
- Islamic Micro-financing ……………………………………………………..11
- Islamic Banking in Azerbaijan………………………………………………16
- TuranBank practice in Islamic Banking (ICD’s fund utilization)…………17
- TuranBank’s role……………………………………………………………………..17
- Clients role…………………………………………………………………………….17
- Disbursement procedure…………………………………………………………….19
- Collection procedure…………………………………………………………………20
Classical Islamic Banking
- 8th – 12th Century
- Early forms of proto-capitalism and free market
- Caliphate regime (from the Arabic ‫ خالفة‬or khilāfa, was the Islamic form of
government representing the political unity and leadership of the Muslim world).
- Earliest trade activity elements of the Middle ages were mainly in Spain,
Mediterranean and Baltic states.
Modern Islamic Banking
- Early of 1960s led to establishment FI in Egypt and Malaysia.
- In 1972, the Islamic Development Bank was set-up with the mission to provide
funding to projects in the member countries.
- The first modern commercial bank, Dubai Islamic Bank opened it doors in 1975.
- By the 1990s, Islamic banking had attracted the attention of several western
commercial banks
- There are more than 300 financial institutions operating on the basis of noninterest based instruments in more than 75 different countries
Emerging Islamic Capital Markets
- Developing process started during 1980s and 1990s
- Primary instruments included
• cost-plus-sale or purchase finance (Modaraba’);
• leasing (Ijara’);
• trust financing (Modaraba’); and
• equity participation (Musharika’).
• - Main emerging markets includes: Middle-East, South-East Asia, South Asia,
and North Africa
- Islamic funds in Global Financial institutions is said to be at US$1.3 trillion while
the Islamic Financial Market is estimated to be US$400 billion in size, with an
annual growth rate of 12% - 15 %
- More than 100 Islamic Equity Funds managing assets in access over US$5.0
billion
- Estimated annual growth for Islamic Capital Market is
between 15% to 20%
Emerging Islamic Capital Markets
- The total worldwide Muslim population is 1.5 billion, representing
a sizeable 24% of total world population of 6.3 billion
- Shari'a-compliant assets, growing over the last 20 years, represent
an estimated US$ 300 billion banking assets & approximately
$400 billion Capital Market
Basic of Islamic Banking
An Islamic banking and financial system is a rule-based system comprising a set of
rules and laws, collectively referred to as Sharia’ governing economic, social,
political and cultural aspects of Muslim societies.
Sharia originates from:
- The Quran (Moslems’ holy book)
- Sunna (prophet Muhammad preaching and practise)
- Ijtihad (the opinion of Islamic jurists on particular issue)
- Ijma (the consensus of the Islamic community on a particular issue)
- Qiyas or analogy (the application of accepted principles by analogy to new cases)
not a source relied upon by all schools
The central tenet of the financial system is the prohibition of Riba – a term literally
meaning “an excess” and interpreted as “any unjustifiable increase of capital
whether through loans or sales”.
Basic of Islamic Banking
Other principles of Islamic doctrine:
- Advocating risk sharing;
- Promotion of entrepreneurship;
- Discouragement of speculative behaviour;
- Preservation of property rights;
- Transparency; and
- The sanctity of contractual obligations.
The system can be fully appreciated only in the context of Islam’s teachings on the
work ethic, wealth distribution, social and economic justice, and the expected
responsibilities of the individual, society, the state and all stakeholders.
Major Modes of Islamic financing
Mudarabah: A form of partnership where one party provides the funds while the
other provides expertise and management. The latter is referred to as the Mudarib.
Any profits accrued are shared between the two parties on a pre-agreed basis,
while loss is borne by the provider(s) of the capital.
Shirkah: A contract between two or more persons who launch a business or
financial enterprise to make profits. In the conventional books of Fiqh, the
partnership business has been discussed under the option of Shirkah that, broadly,
may include both Musharakah and Mudarabah.
Murabaha: Literally it means a sale on mutually agreed profit. Technically, it is a
contract of sale in which the seller declares his cost and the profit. This has been
adopted by Islamic banks as a mode of financing. As a financing technique, it can
involve a request by the client to the bank to purchase a certain item for him. The
bank does that for a definite profit over the cost which is stipulated in advance.
Musawamah: Musawamah is a general kind of sale in which price of the
commodity to be traded is bargained between seller and the purchaser without any
reference to the price paid or cost incurred by the former.
Major Modes of Islamic financing
Musharakah: Musharakah means a relationship established under a contract by
the mutual consent of the parties for sharing of profits and losses in the joint
business. It is an agreement under which the Islamic bank provides funds which
are mixed with the funds of the business 6 enterprise and others. All providers of
capital are entitled to participate in management, but not necessarily required to do
so. The profit is distributed among the partners in pre-agreed ratios, while the loss
is borne by every partner strictly in proportion to respective capital contributions.
Bai‘ Muajjal: Literally it means a credit sale. Technically, a financing technique
adopted by Islamic banks that takes the form of Murabaha Muajjal. It is a contract
in which the seller earns a profit margin on his purchase price and allows the buyer
to pay the price of the commodity at a future date in a lump sum or in instalments.
He has to expressly mention cost of the commodity and the margin of profit is
mutually agreed. The price fixed for the commodity in such a transaction can be
the same as the spot price or higher or lower than the spot price.
Bai′ Salam: Salam means a contract in which advance payment is made for goods
to be delivered later on. The seller undertakes to supply some specific goods to
the buyer at a future date in exchange of an advance price fully paid at the time of
contract.
Major Modes of Islamic financing
Leasing (Ijarah, Kira'): Letting on lease. Sale of a definite usufruct of any asset
in exchange of definite reward. It refers to a contract of land leased at a fixed rent
payable in cash and also to a mode of financing adopted by Islamic banks. It is an
arrangement under which the Islamic banks lease equipments, buildings or other
facilities to a client, against an agreed rental.
Operating Lease (Ijarah-wal-Iqtina‘): A mode of financing, by way of Hirepurchase, adopted by Islamic banks. It is a contract under which the Islamic bank
finances equipment, building or other facilities for the client against an agreed
rental together with a unilateral undertaking by the bank or the client that at the
end of the lease period, the ownership in the asset would be transferred to the
lessee.
Islamic Microfinancing
Islamic Alternatives to Microfinancing
Different alternatives:
- Islamic MFIs
- Islamic Banks
- Specialized Institutions
Group based microfinancing can be used
Islamic MFIs – Features (1)
Islamic MFI retains the basic operational format of MFIs
- Going to the clients
- Weekly/Monthly Repayments
- A social/development program (to fulfil the social role of Islamic finance)
Islamic Microfinancing
IMFIs have some distinguishing features:
- Sources of Funds
Other than external sources, can also use funds from zakah,
awqaf, and other forms of charities
- Use of funds (Mode of Financing)
Sale based and hiring modes (murabahah, salam, ijarah)
Profit-sharing modes (Musharakah and mudarabah)
Islamic Microfinancing
Islamic MFIs-Features (2)
- Amount transferred to the poorest
As Islamic modes are sale based the price of the asset is paid (no
deductions are allowed)
- Group Dynamics
Islamic values of brother/sister-hood improves cooperation among the
group members
- Financing the poorest
Zakat and other charities can supplement MFI activities (non-diversion
of funds)
Islamic Microfinancing
Islamic MFIs-Features (3)
- Social Development Program
behavioral, ethical, and social aspects in light of Islamic teachings
- Targeting the family through women
Spouse co-signs the contract
Dealing with women more efficient and convenient
Women disseminate knowledge to children
- Dealing with Arrears/Default
Less aggressive and use Islamic teachings to recover loans
Islamic MFIs and Sustainability
- Mitigating Credit Risk (CR)
CR mitigated by social collateral (group-based lending)
- Solving Moral Hazard (MH) Problem
As asset/good given instead of Cash, chances of diversion and default
decreases
- Economic Viability
High administrative costs
Reasonable finance costs
- Islamic MFIs can resolve the CR problem and the MH problem, but not
the Economic Viability problem
Islamic Banking in Azerbaijan
- First bank in Azerbaijan operating on a non-interest basis and also under Islamic
principles is Kauthar Bank.
- ICD (Islamic Corporation for the Development of the Private Sector – Islamic
Development Bank affiliate) is the First international Islamic financial institution
which defined credit lines to the Azeri Bank under Islamic principles.
- Currently Azerbaijan which are presents Islamic Banking tools to there are 7
banks in clients and also 5 of them utilize ICD’s line of financing for the USD 20
mln.
- TuranBank
- International Bank of Azerbaijan
- Rabitabank
- UniBank
- Bankstandard
- Kauthar Bank
- AmrahBank
- ICD invested to equity of Caspian International Investment Company initially
USD 3 mln. which will be increased in 2009 to the USD 70 mln.
TuranBank’s practice in Islamic Banking
All presented practise are based on Murabaha mode of financing and mainly
implemented under ICD’s line of financing.
TuranBank’s role:
- Identify and apprise clients & sub projects;
- Prepare all legal documentation (Murabaha agreement);
- Disburse to suppliers;
- Follow-up project implementation and post implementation monitoring;
- Ensure on time collection from clients and transfer of payments to ICD;
- Guarantee full payment to ICD;
Client’s role as authorized by Murabaha Agreement Terms:
- Procure and take delivery of assets (refer to Murabaha agreement for full details)
- Commit to purchase assets from ICD (promise to buy)
- Commit to payment
The structure of the Line
The ICD
Identification, appraisal,
recommendation
Operational
Account
Disbursement
Supplier
Guarantee
TuranBank
Collateral / security
Agency fee
ICD Escrow
Account
Guarantee commission
Client
Repayment
Disbursement Procedure
Disbursement according to project req.
ICD
Letter of acceptance
1. Project Proposal
2. Disbursement request
3. Undated receipt
4. Letter of Guarantee
TuranBank
Operational Account
Disbursement within 30 days
ICD is notified immediately
1. Identification
2. Appraisal
3. Structuring the deal
4. Collateral package
5. Fix murk-up
6. Prepare documentation
Supplier
Client / Sub-Project
Collection Procedure
ICD
Principal + ICD murk-up
Notification
FITuranBank
Escrow Account
Repayment to Escrow
account
Client / Sub-Project
THANK YOU FOR YOUR ATTENTION!!!