Islamic Finance – an introduction

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Islamic Finance: Concepts,
Products, Issues
30 Oct, 2009
Usman Hayat, CFA, FRM
Director Islamic Finance & ESG Investing
Agenda

Islamic finance @ CFA Institute

Big picture & common misconceptions

Concepts & applications

Issues

Q&A
Page 2
Islamic Finance @ CFA Institute
•Growing field, GBOK,
CBOK?
•Academic &
professional
qualifications available
Approach: Integrate in
life long learning
•Publications •Events
(SRP)
•Multimedia
www.cfawebcasts.org
•Globally, 10%
members “interested”,
regional variations
(2009 survey)
Page 3
Old Ideas, Young Industry
2009 AD = 1430 Hijri; but industry barely 40
50s & 60s: initial theoretical work, some
experimentation
70s: DIB, IDB, petrodollars
80s: OIC’s IFA, initiatives
Bahrain, Pakistan, Sudan
in
Malaysia,
90s: AAOIFI, Dow Jones & FTSE indexes,
growth in number & type of funds
00s: IFSB, IIRA, more innovation, credit cards
to hedge funds, more petrodollars
Page 4
Industry Statistics
•Size estimates go up to US $1 trillion (small)
•2007 asset mix, as per IFSL 2009 Report:
Commercial banks (74%) Investment banks (12%)
Sukuk (11%) Funds (2%), Takaful (1%)
•Major countries, as per The Banker: Iran, Saudi
Arabia, Malaysia, Kuwait, UAE, Bahrain, Qatar, UK
•Estimated 300 IFI, 50+ countries
•Industry reports available on the net for free
•Growth story, favorable outlook
Page 5
Common Misconceptions

Practice exclusive to Muslims, modes
exclusive to Islam

No time value of money in pricing

Dominant form of finance in Muslim
countries

No gap between
theory & practice

All Muslims highly sensitive to Shari’a
compliance in finance
Islamic
finance
Page 6
Islamic finance
• Finance that complies with
Shari’a
• Primary Sources
Qura’n (the Holy Book)
Sunnah (or tradition of Prophet
Mohammad)
“The obligation of the Shari’a is to
provide the wellbeing of all
humankind,
which
lies
in
safeguarding their faith, their
human self (nafs), their intellect
(’aql), their progeny (nasl) and
their wealth (mal)”
Al-Ghazali
Page 7
Religion & Economics
•Economics takes human behaviour as given
•Religion seeks to influence human behaviour
– Accountability to
permanent concern
God
should
be
a
– Earning an honest living an act of worship
– Moral economy of Islam (a theoretical ideal)
neither communism, nor capitalism
•Depends on belief in God (which is up to the
individual)
Islamic finance Concepts
•Islamic
commercial
jurisprudence:
human
dealings,
default
ruling
is
permissibility
Test of impermissibility:
_Purpose involves prohibited activities
(socially responsible, ethical)
_Structure involves Riba or Gharar or both
•On riba & gharar: “…the talented jurist Ibn
Taymiyya
…famously
stated
that
two
prohibitions can explain all distinctions
between contracts that are deemed valid or
invalid: those of riba and gharar.” Page 8, “Islamic
Finance: Law Economics, and Practice” (2006) by Mahmoud A. El - Gamal
Riba & Gharar
(simplified)
Riba
•
•
•
•
No perfect translation; excess, usury
Lending money on interest
Absolute prohibition; money not commodity
Why? unnatural? unfair? evidence?
Excessive Gharar
•
•
•
•
No perfect translation; risk, uncertainty
Trading of risk unbundled from an asset
Applies to commutative contacts
Why? disputes? externalities? evidence?
Implication: asset & enterprise, risk-sharing
Application
Riba
Gharar
Capital
Market
_Equity funds: business,
debt & income screening
_Sukuk: ownership of
assets
_Debt trading constrained
Derivatives (or at
least their trading)
largely avoided
Banking
_Trade, lease, share
_No money
borrowing/lending
Sales/leases of assets
after purchases
Insurance Avoid interest bearing
/ Takaful investments
Note: Sin industries to be avoided in all cases
Mutuality (risksharing, solidarity
group)
Opportunities
• Inclusive, simple, tied to real economy
• Small size means growth potential;
petrodollars to invested
• Responsible investments also growing
• More countries
finance
promoting
Islamic
• Industry reports & surveys
suggesting double digit growth
still
Page 12
Challenges
• Covering gap of centuries in decades
• Global economy - lending money, trading risk
• Legal, regulatory, tax issues
• Lack of global Shari’a standards
• Industry requires multidisciplinary expertise
• And the form versus substance debate…
Page 13
Form vs Substance
• Concern
on
similarity
(banking & fixed income)
in
substance
• Profit/rent on trade/lease or price of credit?
• Innovation or replication?
sharing? economic justice?
risk-reward
• Conflict of interest in Shari’a governance?
• Shari’a adjustments:
• AAOIFI statement 2008
• OIC’s IFA resolution on tawarruq 2009
Page 14
Financial Crisis & Islamic Finance
• We did better (Proponents)
• You got hit by real estate (Critics)
• Much noise, but not a sound debate:
What were the reasons toxic products were avoided
by IFI?
Real estate investments business or Shari’a issue?
Can a small segment in the same market be
unaffected in a market wide turmoil?
Page 15
Summary
• Old ideas, young industry, long term future
• Belief in God implies moral economic behaviour
• Avoid sin industries, don’t lend money on interest,
don’t trade risk
• Asset & enterprise required; equity preferred
• Business & career opportunities, lots to happen!
Page 16
Q&A
Page 17
Learning Resources
• Books
• Webcasts/podcasts
• Websites & social media
• Training
• Professional qualifications
• Academic qualifications
Page 18
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