Milestones in rise of Islamic finance: Reuters

Islamic finance has grown to a $1 trillion industry, after taking off in the private sector in Gulf states such as Dubai in the 1970s.

The sharia-law-compliant system, which prohibits interest, is the national norm in Sudan and Iran, and in a parallel banking system in Malaysia, Bahrain and a few other Gulf States.

Here are some key moments in the modern sector's development:

1950s-1960s: First experimental Islamic banks develop interest-free savings and loans societies in Pakistan and the Indian subcontinent. Egypt and Malaysia see pioneering ventures in 1960s. New banks develop during the 1970s as oil money pours into Gulf states.

1975: First commercial Islamic bank opens, the Dubai Islamic Bank (www.dib.ae). Close to 30 such banks set up over the next decade.

In October 1975, the umbrella Islamic financing institution, the Islamic Development Bank (www.isdb.org) opens in Jeddah, Saudi Arabia. Between 1975 and 2005 it funds more than $50 billion worth of projects in Organization of the Islamic Conference (OIC) member countries.

1979: Pakistan becomes first nation to "Islamize" banking practices at state level. Process continues until 1985.

July 1983: Malaysia opens its first official sharia-compliant bank, Bank Islam Malaysia. Other banks also offer Islamic products and are supervised by the central bank, which is advised by a board of sharia scholars.

For more on this article, please click on the following link: Milestones in rise of Islamic finance: Reuters

The Financial Crisis: A Golden Opportunity for Islamic Banking: aawsat

By Lahem al Nasser

Riyadh, Asharq Al-Awsat-Before the international financial crisis, Islamic banking was marginalized and disregarded by international institutions. International institutions, such as the Basel Committee on Banking Supervision [BCBS] and the International Accounting Standards Board [IASB] that are concerned with financial regulation did not take into account the differences between Islamic banking, and traditional banking, in the setting of these regulations. In addition to this, many Western financial institutions considered the Islamic banking system to be simple and rudimentary, and not attuned to the [modern] times and new [financial] developments such as the innovative and complex financial tools that have dazzled the world. These financial apparatus are based upon mathematical equations and theories formulated by the fore-most mathematicians in the world, some of whom are Nobel laureates hired by large financial institutions to help boost their performance.

The Islamic banking system was looked upon as something that hindered the growth and development of the financial markets of the countries which adopted it. In addition to this, many Western countries viewed it as an ideological financial system based upon religious tenets rather than scientific fact, and therefore deriving its strength and popularity from the faith of those that believe in it, making it inconsistent with contemporary thinking that is based upon empirical knowledge and evidence, thus making it a threat to the principles of Secularism.

However the financial crisis has revealed to the world the invalidity in many of the assets and theories and mathematic equations upon which much of the modern financial system is based. Revealing also that these were the main factors behind the creation, spreading, and impact of the international financial crisis, the likes of which the world has not seen before. This financial crisis caused the collapse and bankruptcy of many firmly established financial institutions, and in the blink of an eye a dozen financial institutions that were internationally regarded as examples of professionalism such as "Lehman Brothers" and "Merrill Lynch" vanished. This crisis not only affected the financial institutions, for its effects expanded to burden many of the economic and industrial institutions as well, such as the pride of the American manufacturing industry "General Motors" which is well on its way to declaring bankruptcy, as well as "Toyota" which has declared losses for the first time in the company's history.

As the financial crisis worsened observers began to notice the stability and resilience of Islamic financial institutions in the face of this, and no Islamic financial institute has yet to declare losses in the financial securities and bonds that were a major cause of the crisis. On the contrary, many Islamic institutions have announced an increase in profits, which resulted in many commending the principles upon which the Islamic banking system is based, and the Shariaa Islamic Laws that regulate it, calling for its introduction to rectify the global financial system. Perhaps the most recent and strongest of these calls was reported in the Bloomberg Agency's report which revealed that the Vatican had stated that Western banks should carefully examine Islamic financial regulations in order to restore confidence amongst their clients at a time of international economic crisis.

This [global financial] crisis that has brought Islamic banking into the spotlight and presented it with a golden opportunity to introduce its fundamental methods and principles and present a practical [financial] model to the world. Islamic banking should capitalize on this opportunity and work quickly in order to expand, and gain a good position itself in the markets that were previously closed to it and which have now become open due to the financial crisis. Islamic banking must therefore seek to exploit the international recognition of its principles and regulatory system by gaining the recognition of international regulatory institutions with regards to its principles and uniqueness by enacting laws to institute [unified] regulatory body such as the BSBS and the IASB.

For more on this article, please click on the following link: The Financial Crisis: A Golden Opportunity for Islamic Banking: aawsat

How Islamic banks make money: The Standard

Rudi Prenzlin

A young man makes his career choice and decides to become a successful banker, just like his father.

He wants to prepare for the role and asks his father: "What must I do to become a successful banker, just like you?"

"Son," says the father, "you must follow these three simple rules: first, don't lend money to those who don't have any; second, don't lend money to those who need it badly; and third, the most important, don't lend your own money."

Sound advice in these troubled times. It is a shame that many of today's bankers either never received this sound advice, or ignored it!

In last week's article, "Credit crunch opens doors for other possibilities" I argued that Islamic banking institutions were weathering the present financial crisis comparatively well as they are insulated from the disasters in the interbank market and the mess in the derivatives markets.

For more on this article, please click on the following link: How Islamic banks make money: The Standard

Islamic banking offers alternative: Inquirer.net

Agence France-Presse

KUALA LUMPUR, Malaysia -- The global economic crisis has handed the Islamic finance sector a "golden opportunity" to show it is a better alternative to capitalism, Malaysia said Monday.

Although capitalism has been pre-eminent for centuries, "it is becoming obvious that there is now more proof of its weaknesses," deputy Prime Minister Najib Razak said in a speech to an Islamic economic conference.

"We Muslims should see the current situation as a golden opportunity for us to prove the power, strength and effectiveness of the Islamic banking and finance system," he said in an opening address.

Islamic banking, a booming $1.0-trillion global industry that prohibits speculation and high levels of debt, has been relatively unscathed by the credit crunch.

The rules of the sector, which incorporate principles of sharia or Islamic law, prohibit many of the risky activities that triggered the crisis that is felling economies around the world.

"An economic system that is not closely linked to real and productive activities is a threat to the entire system," said Najib, who is also finance minister.

For more on this article, please click on the following link: Islamic banking offers alternative: Inquirer.net

Sharia-compliant derivatives - a contradiction in terms?: FT

Posted by Stacy-Marie Ishmael on Feb 11 16:11.

Reuters is running an interesting story on Islamic banks’ struggles to develop hedging tools to cope with market volatility.

Not all Islamic scholars believe the use of derivatives is permitted by Sharia law - which leaves more conservative institutions with “few instruments to guard against wild swings in currency and interest rate movements,” according to the Reuters story.

“To the extent there are not enough sharia-compliant liquidity and risk management products, then clearly Islamic finance would be disadvantaged compared to conventional banks and would be less able to manage their liquidity risks,” said Hussein Hassan, head of Islamic structuring at Deutsche Bank .

The $1 trillion industry bans banking structures that are vague or ambiguous to avoid exploitation — a rule which some argue shuts out the use of common hedging instruments such as currency and interest rate swaps and futures contracts.

There are two major schools of thought on derivatives in the the world of Islamic finance. One view is that derivatives are necessarily speculative, and so would contravene the prohibition on gambling. Scholars who take this approach also tend to argue that since it is not always clear what the underlying assets referenced by a derivative are, use of the product violates the prescription that only tangible assets can be bought or sold.

The second, less conservative view is that derivatives are permitted as long as they are used solely to hedge existing positions.

For more on this article, please click on the following link: Sharia-compliant derivatives - a contradiction in terms?: FT

Islamic Banking in Pakistan

By Saifullah

Banking sector is considered to be one of the important and essential pillars of nation's economy. Present banking system, which is based on the principles of interest, is highly criticised, as it could not offer the appropriate benefits to society. Thus this system is undesirable for lacking to serve human beings and any society. Particularly for Muslims this system is a threat as it operates against the principles and teachings of Islam. Muslim world is one of the major areas where Muslims are struggling and looking for improvement in this field of life. In this regard the elimination of interest from the financial sector is considered to be a major breakthrough. Muslim scholars and many other economists of the world who understand the negative impacts of interest are trying to promote the concept of interest-free banking system as taught by teaching of Islam. By prohibiting interest, Islam has endeavoured to do away with a hideous form of tyranny and injustice prevalent in human society. The institution of interest is a great challenge to all those who are trying to reconstruct the Islamic way of life in modern times. Efforts have been made to develop Islamic banking system and many of the banks operate on the basis of Islamic principles. Yet due to non-availability of the monetary system and Riba-free investment opportunities the Islamic banking system is not free of critics and considered dependent on interest-based system. -Islamic banking system faces a number of challenges. Among the agitating issues the foremost one is that they have not yet been successful in devising an interest-free mechanism to place their funds on a short-term basis. They face the same problem in financing consumer loans and government deficits. Second, the risk involved in profit sharing seems to be so high that most of the banks have resorted to those techniques of financing which bring them a fixed assured return. As a result, there is a lot of genuine criticism that these banks have not abolished interest but have in fact only changed the nomenclature of their transactions. Islamic finance has failed to capture the interest of western writers and it has been developed in isolation from its western counterpart. This deficiency can be rectified by reference to support for prohibition of interest in western literature, in the capitalist economies and evidence on attitudes towards Islamic finance. In Islam, interest is prohibited because the interest on the loan is an augmentation of capital without effort and a false creation of value. The increase of income must result from investment, labour and other activities. There are many arguments about prohibition of interest in Islam. The first argument is that interest rates have no moral foundation. The second is that abstinence from consumption is not a justification of rewards. The third reason is that there is no risk to justify the supplement payment for capital lending if loan is guaranteed. The creditor/debtor relationship is redefined in Islam with the creditor or provider of the funds becoming a partner in the project, assumes the risk activity with the entrepreneur and shares profit at a pre-agreed proportion. It is fairer for the creditor and debtor that they have a share of profits and losses. The creation of incremental wealth justifies the share of profit between the borrower and the lender of money but not fixed return. The banking system of Islamic countries based on Islamic economic principles is fast developing. This system is important due to growth of investment amount in Islamic banks and the consideration given to the system by the Government. Islamic banking is growing rapidly not only in Pakistan but also throughout the world. Islamic banking has a great potential to grow in future in Pakistan and State Bank is committed to the development of this industry. Pakistan has provided a supportive policy and regulatory framework for Islamic banking due to which investors of international repute are coming to establish new Islamic banks in country. The State Bank has set up a dedicated Islamic banking department for the promotion and regulation of this industry. SBP impresses upon the heads of Islamic banks to meet the growing challenges in the development of Islamic banking. The SBP has clarified to the industry there is a level playing field for Islamic Banks and has agreed to look at approaches to develop Islamic interbank market. Steps for Islamization of banking and financial system of Pakistan were started in 1977-78. Pakistan was among the three countries in the world that had been trying to implement interest-free banking at comprehensive/National level. We know that it is a mammoth task; the switchover plan was implemented in phases. Islamic banks face a number of challenges. First, they have not yet been successful in devising an interest-free mechanism to place their funds on a short-term basis. They face the same problems in financing consumer loans and government deficits. Second, the risk involved in profit-sharing seems to be so high that most of the banks have resorted to those techniques of financing which bring them fixed assured return. As a result, there is a lot of genuine criticism that these banks have not established interest but have in fact only changed the nomenclature of their transactions. Of course, it has to be kept in mind that these issues are at their elementary level of discussion. Much work has to be undertaken in terms of procedures, infrastructure and allowing a new framework to develop and mature. The new banking system of Islamic countries based on Islamic economic principles is fast developing. This system is important due to growth of investment amount in Islamic banks and the consideration given to the system by Governments. The developments have encouraged many studies on the Islamic banking system. However, little importance is given to application of modern finance theories to Islamic banks. Islamic economic principles are characterized by the application of managerial techniques and models advanced in the conventional financial framework. Islamic banks operate on a set of principles based on the Islamic law (Shariat). These principles are different from those of conventional banks. Instead of charging a fixed interest rate, Islamic banks use profit sharing principles (PLS) through its two varieties: Musharaka and Mudaraba. Key findings of relating Islamic banking are listed as under: 1. There is a shortage of short-term liquidity management tools and lack of capital markets in the interest-free industry. This hinders the fast growth of the sector. 2. Public appreciate efforts of the State Bank of Pakistan in promoting interest-free banking and wants the government of Pakistan to further facilitate this industry. 3. The current efforts by the government are not sufficient for the industry. Government should take further steps in promoting interest-free banking. 4. Interest-free banking industry has made a promising start with a lot of room for improvement and development. This sector has a great potential of further growth. 5. Results indicate that there is a lack of availability of wide range of interest-free banking products in Pakistan. 6. All the stakeholders of interest-free banking industry in Pakistan prefer interest-free banking to conventional banking system. 7. Interest-free banking requires time to challenge conventional banking in terms of market share and industry volume. 8. To eliminate interest from society, overall economy of Pakistan should be shifted to an interest-free base. 9. Conventional banking system can be converted into interest-free banking system. 10. The two parallel banking systems should run simultaneously and interest-free banking should further be facilitated. 11. People of Pakistan are not satisfied with the Islamic nature of products being offered by the interest-free banking industry and their true compliance with Shariah rules. Interest-free banking is not a new concept anymore. There are financial institutions in the world, which are operating without charging any interest. Even in Pakistan such institutions are in action. However there are hurdles and hindrances, which need to be removed to accelerate the growth of this industry in Pakistan and the world over. While many important issues were highlighted in this paper, it is strongly felt that it would be very helpful for the Islamic banking sector to address the following issues: 1. Planned and scheduled approach: A methodical and market driven approach towards the development of interest-free banking industry involving all the key constituents (including banks, regulators, securities & exchange commission, the Central Board of Revenue, and the Government of Pakistan) should be adopted. This should also facilitate in articulating the short- and long-term growth targets and the expected roles for these targets of this sector. Such a blueprint, publicly available and developed by participation of all stakeholders would be of immense help in growth of the industry. 2. Shariah compliant product range: The interest-free industry should expand its product line to create opportunities for Islamic banks in new markets. There are 12 Islamic modes of financing approved by the State Bank of Pakistan but only a few are functional so far. Innovative steps should be taken to introduce new products based on all the approved modes and consequently identifying new sources for profitable growth of this sector. 3. Capital Market Institutions: In addition to the creation of traditional consumer and commercial banks, efforts should also be made to encourage the creation of other Islamic finance institutions (e.g., investment banks, securities and market firms) and help interest-free banks mange their liquidity in a professional manner. 4. Innovation in Islamic liquidity management: Due to liquidity problems, interest-free banking sector faces a significant strategic and operational disadvantage. A creative focus is required to find ways and needs of Islamic liquidity management. Adopting an integrated Islamic capital market approach might be the right way through which cross border marketability of sukuks and other asset-backed securities. Similarly, integration of conventional and interest-free capital markets as carried out in Arab states would also help in this regards. 5. Partnership with world and institutions: Close relations with other Islamic states of the world should be established to promote this concept and learn from each other's experiences. Also, it would be highly beneficial for Islamic banking sector in Pakistan to maintain close relationship with IDB and IDB-sponsored infrastructure institutions to ensure that we are able to build upon the learning of these infrastructure institutions and, to the extent possible, work with these institutions in developing this sector. 6. Socio-economic factors: The conversion of economy of Pakistan to an interest-free base would have a catalytic effect on the growth of interest-free banking. In this case, both economy and banking would boost each other up resulting in a greater momentum towards growth. Honesty, trust-worthiness, simplicity, truthfulness spirit of sacrifice (Islamic brotherhood) in few important and required traits that should prevail in a society that wants to eliminate the evil of interest. Islamic principles of interest are concerned with issues of fairness and justice rather that of efficiency narrowly defined. These principles focus on the necessity of sharing risk in a fair and stable society, and upon problems of exploitation in markets where power is asymmetric; this is the real Riba Issue. There is a wide scope for interest-free banking system as modern banking system has failed to fill up the income gap and bring socio-economic equability among people, society and even countries and nations. Muslim world is about 25% of world's told population occupying nearly 20% of total area. They own 40% of oil and gas resources; hence there exist a big market for interest-free banking. There is a problem in terms of the lack of Islamically compliant short-term liquidity instruments. There needs to be a truly global-sized liquid inter-bank market where institutions can park their liquidity reserves. Highly ethical, well-regulated and beneficial Islamic financial architecture is possible. Indeed, working in this field with more transparency, with effective corporate governance and with better interaction with relevant international, regional and national institutions, will definitely help all (those) who want to contribute to the welfare of their community as well as to the welfare of the world as a whole. If proper attention and honest efforts are made there is no doubt that an interest-free banking system would increase savings which will result in more investment, more economic growth and above all equal distribution of wealth in Pakistan.

(The Frontier Post)

Islamic finance sector has room to grow: The Star

By Aziz Tayyebi

ISLAMIC banking has, to a large extent, been shielded from the credit crisis which has devastated conventional banking and finance.

As such, many proponents of Islamic banking, such as Deputy Prime Minister and Finance Minister Datuk Seri Najib Tun Razak, have said the principles of Islamic finance could provide concrete and realistic measures to tackle the financial crisis.

However, the Islamic finance industry still has some way to go before it can be a serious alternative to conventional finance and banking. While Islamic finance is growing at a rate of 5%–10% per year, it still only constitutes a small proportion of the global financial services sector, with a market valued at between US$500mil and US$1bil.

For Islamic finance to take a greater share and to expand in other jurisdictions, it needs to focus on a number of key issues and challenges, such as enhanced risk management and product development, syariah standardisation and human capital development. Critically, many risk management tools, such as complex derivatives, are not available to Islamic institutions.

For more on this article, please click on the following link: Islamic finance sector has room to grow: The Star