Islamic Banking, Finance and InvestmentDr. Salah Almajthoob
Oman, 14 March 2018
Session 1: Key Concepts of Islamic BankingDr. Salah Almajthoob
Part 1. General Introduction to Islamic Banking
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Introduction
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This presentation is about the basics of Islamic Banking
Goal is to understand what is Islamic Banking
A practical approach
Islamic Finance Market
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Quick history
The first Islamic bank is Dubai Islamic Bank, 1975
Followed by Kuwait Finance House, 1977
Al Baraka Bank, 1978
Bahrain Islamic Bank, 1981
Today the size of Islamic Finance is $2.4 trillion (Thomson Reuters)
Growth rate of 14% during the last 15 years
The Sukuk outstanding value $366 billion (IIFM)
Major centers are the GCC, Malaysia and UK
Growth of Islamic Finance
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Global Islamic Finance Report 2017Islamic Finance Development Report 2017
Islamic Banking in Oman
The Royal Decree No. 69/2012 amended the banking law to include Islamic banking at licensed banks through either specialized banks or independent entities at the existing commercial banks.
Islamic Banking has 11% market share
Overall assets OR 3.3 million
Two Islamic Banks
1. Bank Nizwa, 2012
2. Alizz Islamic Bank, 2012
Six Islamic Banking Windows
1. Maisarah (Bank Dhofar)
2. Meethaq (Bank Muscat)
3. Muzn (National Bank of Oman)
4. Al Yusr (operated by Oman Arab Bank)
5. Sohar Islamic (Bank Sohar)
6. Al Hilal Islamic Banking (Ahli Bank)
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Conventional Banks
BankDeposits Loans
Other Banks(Treasury)
Source Funds Utilize Funds
Manage LiquidityInvestment
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Basics of conventional banks
Features of Conventional Banks
Buy and sell money
Money is the commodity
Buy low, sell high and keep the spread
A mediator between those who have excess funds and those who need funding
Risk free interest
Continuous accumulation of interest
Complex treasury transactions
Fee based services
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BankDeposits Loans
Other Banks(Treasury)
Conventional Banking and Islamic Principles
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The basic principle of charging interest on a loan is not allowed in Islamic Sharia
In fact many of the business activities performed by conventional banks are not allowed in Islamic Sharia
Conventional banking is not aligned with Islamic principles
Riba (Usury) is Forbidden
منا البيع مثل الراب وأ حل هللا البيع وحرم الراب﴾ سورة البقرة : قال تعاىل 275﴿ذكل بأ هنم قالوا ا
”That is because they say trading is only like usury, and Allah has allowed trading and forbidden usury“ [2:275]
Conventional banking is based on usury
Usury is forbidden in Islam in the strongest language
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Islamic Sharia Issues
Forbidden Transactions
Riba (usury) is forbidden
Gharar (ambiguity) is forbidden
Trading debt is forbidden
Must share the risk
Forbidden activities
Alcohol
Tobacco
Riba based financing
Pork
Entertainment
Arms
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Banks are still needed
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We still need financing and other banking services
Therefore, we need banks that adhere to the principles of Islamic Sharia
These banks provide the same services provided by conventional banks but in a Sharia compliant way
We call them Islamic Banks or Islamic Sharia Compliant Banks
How to build an Islamic Bank?
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The solution is to trade, i.e., buy and sell at a deferred price with a mark-up.
Most usury transactions are converted to a sale at a deferred price.
Financing in general is performed through buy and sell at a deferred price transactions
Invest the money of depositors as partners and have them share the risk
Look in the books of Fiqh for trading and financing transactions and use them
Islamic Banking Transactions
Islamic Bank
Deposits Loans
Other Banks (Treasury)
QardMudarabaReverse MurabahaWakala
MurabahaIjaraMusharakaSalamIstisnaTawarruq
Commodity MurabahaWakalaSukuk
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Step 1. Replace usury based transactions with Sharia compliant transactions
Islamic Banking Products
Islamic Bank
Deposits Loans
Other Banks(Treasury)
• Current Account (Qard)
• Saving Account (Mudaraba)
• Term Deposit (Mudaraba)
• VIP Deposit (Reverse Murabaha)
• Wakala Deposit (Wakala)
• Car Financing (Murabaha)
• Real Estate Financing (Murabaha)
• Real Estate Financing (Ijara)
• Cash Financing (Tawarruq)
• Placement and Borrowing (Commodity Murabaha)
• Placement and Borrowing (Wakala)
• Investment (Sukuk)
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Step 2. Build Islamic banking products based on Islamic transactions
Features of Islamic Banks
Buy and sell goods not money
Profit is generated through the buying and selling process
Still a mediator between those who have excess funds and those who need funding
Not just a bank; a merchant and a trader
Goods are the commodity
More risk sharing
Fee based services
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Islamic
BankDeposits Loans
Other Banks
(Treasury)
Islamic Banking Window
A conventional bank that wants to offer Islamic finance solutions to its customers establishes an Islamic arm
The Islamic arm types differ depending of the level of integration and independence
Integrated Islamic Window
Autonomous Islamic Window
A separate Islamic subsidiary
Integration/independence factors include
Comingling of funds or not
Separate operation/treasury or not
Separate branches or not
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Islamic Banking Window
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Bank(parent)
Deposits Loans
Other Banks(Treasury)
Islamic Window
Deposits LoansIslamic Transactions Only
Conventional Transactions
Capital and revenue
Deposits must be invested using Sharia complaint instruments
Islamic Financial Transactions
Islamic law has a section called Fiqh al-Muamalatthat regulates financial and business transactions
Islamic law has many financial contracts that were used for buying and selling before the advent of banks
Now we use these contracts for financing
Islamic Finance in essence is in general buying and selling
Common Islamic Law financial contracts
Murabaha
Mudaraba
Musharaka
Ijara
Istisnaa
Salam
Wakala
Tawarruq
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AAOIFI Sharia Standards
What are the Sharia Standards?
Sharia standards tells us what is allowed and what is forbidden
40 different standards and more are on the way
Written in a legal style
Formulated by a committee of renowned scholars from many Muslim countries
Endorsed by many banks
Enforced by several central banks
Highly recommended
Popular Sharia Standards
Murabaha
Ijara
Wakala
Istisnaa
Salam
Tawaruq
Stocks and Bonds
Sukuk
Takaful
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AAOIFI Accounting Standards
What are the Accounting Standards?
Several types
Accounting
Auditing
Governance
Ethics
More than 35 standards
Prepared by professional accountants and Muslim scholars
Covers needs of Islamic banks
How to record, how to value and how to recognize profit (loss)
Popular Accounting Standards
Presentation and Disclosure
Murabaha
Ijara
Istisnaa
Salam
Auditors report
Sharia Review
Code of Ethics
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Retail vs. Investment Islamic Banks
Retail Banks
Islamic alternative to conventional banking
Deposits and financing
Focus on retail and corporate customers
Profit through the spread & fee based services
Sustainable business model
Investment Banks
Some are investment arms of retail banks for offering investment products.
While others are private equity firms but call them selves investment banks for marketing purposes
Some are true investment banks offering investment banking services; M&A, raising equity and raising debt.
Private Equity firms acquire assets, put them into funds then placing those funds
Focus on institutional investors, family offices and high net worth individuals
Profit through markup & asset management fees
Many questions about the sustainability of the business model
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Sharia Supervisory Board
Every Islamic Bank has a Sharia Supervisory Board
The task of this board is to oversee Sharia compliance
Formed by knowledgeable Muslim scholars
Internal Sharia Department role is similar to Internal Audit but its scope is Sharia Complaince
Governance standards determine the roles and responsibilities
Managing the bank is still the responsibility of Management (Board and executive management)
Sharia compliance is also the responsibility of Management NOT the Sharia Board
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Part 2. Financing Products
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Introduction
The Financing Methods are the Sharia compliant contracts used to finance a customer
Common methods
Murabaha
Ijara
Diminishing Musharaka
Salam
Istisnaa
Tawarruq
The Sharia complaint financing methods have a similar cash flow that is similar to the conventional methods.
The contracts though are dramatically different. The effect is usually seen in the case of a default
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Murabaha Financing
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Introduction to Murabaha Financing
The most common way of financing in Islamic Banks
Most car loans, short term and medium term real estate financing are Murabaha financing
Easy to implement
The concept is based on a traditional Islamic financial transaction from Fiqh al-Muamalat
Two sales contracts; the first is spot and the second is deferred
Has other variations
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Basic Murabaha
A purchaser buys certain goods from a seller
The seller declares to the purchaser the cost and the profit; 'honest declaration of cost and profit‘
The Seller already owns the goods when he is approached by the purchaser and during the time of price negotiation and contracting
Not of much use in practice
Seller Purchaser
Goods
Price = Cost + Profit
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Murabaha Definition
Definition: The sale of goods at cost plus a declared profit (markup).
Murabaha is defined as a particular kind of sale, compliant with Sharia, where the seller mentions the cost he has incurred on the goods to be sold and sells it to the purchaser by adding some profit or mark-up.
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Murabaha for the Purchase Orderer
In practice Murabaha needs three parties: Seller, Purchaser and a Financial Institution.
The purchaser requests that the Financial Institution buys the goods from the Seller then sell it to the Purchaser
Seller Purchaser
Goods
Price = Cost + Profit
(on credit)
Financial
Institution
Goods
Price = Cost
(Cash based)
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Murabaha for the Purchase Orderer: The Process
Three Step Process
Step 1: The purchaser requests that the Financial Institution buys the goods from the Seller then sell it to the Purchaser.
Step 2: the Financial Institution buys the goods from the Seller and pays him in cash.
Step 3: the Purchaser buys the good from the Financial Institution for the cost price plus profit. The sale is on usually credit basis.
Seller Purchaser
Goods
Price = Cost + Profit
(on credit)
Financial
Institution
Goods
Price = Cost
(Cash based)
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1
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Murabaha for the Purchase Orderer: Legal Documents and Roles
Step 1
A Request by the purchaser to the Financial Institution to buy certain goods
A Promise to buy the goods once bought by the Financial Institution.
An Undertaking (Wa’ad) by the purchaser in favor of the Financial Institution
Binding or non-binding; with obligation to buy or without
Step 2
The first sales contract (spot exchange)
The Financial Institution is the buyer and the Seller is the seller
Step 3
A second sales contract (deferred payment)
This is the Murabaha contract
The Financial Institution is the seller and the Purchaser is the buyer
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Murabaha as a Financing Tool
A purchaser needs financing to buy certain goods
The Financial Institution buys the goods for cash and sells it to the purchaser on a deferred payment (a deferred lump sum or in a series of installments)
Usually used for short & medium term financing
A fixed profit rate is agreed upon on day one
Payment plan calculated using the amortization table
The purchaser owns the goods once the second sale contract is signed
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Murabaha as a Financing Tool
Similar to fixed rate unsecured loan in conventional banking.
The bank is taking the credit risk of the cusomer.
Very popular for auto financing, short term real estate financing and trade finance.
Some unwarranted criticism regarding having a large percentage of booked assets as Murabaha
This is a strategy and a product mix issue NOT a Sharia issue
Murabaha has both a Sharai and an Accounting AAOIFI standards
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Amortization Table for Murabaha
Payment Number
Payment DateBeginning Balance
Payment Principal Profit Ending
1 1/4/2016 10,000.000 1,365.098 1,165.098 200.000 8,834.902
2 1/7/2016 8,834.902 1,365.098 1,188.400 176.698 7,646.502
3 1/10/2016 7,646.502 1,365.098 1,212.168 152.930 6,434.334
4 1/1/2017 6,434.334 1,365.098 1,236.411 128.687 5,197.923
5 1/4/2017 5,197.923 1,365.098 1,261.140 103.958 3,936.783
6 1/7/2017 3,936.783 1,365.098 1,286.362 78.736 2,650.421
7 1/10/2017 2,650.421 1,365.098 1,312.090 53.008 1,338.331
8 1/1/2018 1,338.331 1,365.098 1,338.331 26.767 (0.000)
Principal: SAR 10,000, Rate: 8%, Period: 2 years, Quarterly payments
Total Profit: 920, Quarterly Installment: 1,365
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Murabaha Conditions
Cost must be known to purchaser (customer)
The first contract must be valid (completed)
No usury in the contracts
Financial institution must disclose any fault/damage that occurred after the (first) purchase and all what is related to being a fault
Financial Institution must disclose the terms of payment in the first contract
No increase in the price if there is a default or delay
Fines can be applied but should cover cost and the rest should be paid to charity
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Murabaha or Musawama
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In Murabaha a discount in price after sale still belongs to the end customer
This is a Sharia Issue
Musawama is a similar contract were the bank doesn’t reveal the original price and you keep any future discounts to the institution
Musawama if you trade; used by banks who trade by them selves.
Murabaha when you don’t
Ijara Financing
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Introduction to Ijara
Ijara is the act of leasing as asset
Ijara is considered a sale contract; The seller is the lessor and the buyer is the lessee.
The sold item is the benefit of an asset; the usufruct.
The price is the rent payment
Ijara is used as a financing tool in a lease-to-own manner
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Ijara as a Financing Tool
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A purchaser needs financing to buy a certain durable item.
The Financial Institution buys the asset for cash and lease it to the purchaser over a specific period
Through lease-to-own method the ownership of the asset is transferred to the lessee at the lease end
Usually used for medium & long term financing
The rate can be fixed or floating through having a different rate for every period
Very popular for long term real estate financing, and equipment financing
Ijara Process
Three Step Process
Step 1: The Purchaser requests that the Financial Institution buys the durable goods (fixed asset) item from the Seller
Step 2: the Financial Institution buys the goods from the Seller and pays him in cash
Step 3: the Financial institution (lessor) leases the item to the Purchaser (lessee). At the end of the lease the ownership is transferred to the lessee.
Seller Lessee
Durable goods
Price = Cost
(Cash Based)
Lessor
Durable Goods
Rent
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Definition and Elements of Ijara
Definition of Ijara
“Ownership of the right to the benefit (usufruct) of using an asset for a specific period in return for consideration”
Elements of Ijara
Wording
Offer
Acceptance
Contracting Parties
Lessor
Lessee
Subject of the contract
Rent
Benefit (usufruct)
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Subject Matter
Benefit
Types of Benefit
Benefit (usufruct) or Service (labor)
Condition of Benefit
Doesn’t consume the asset
Permissible benefit
Lessee is capable of utilizing the benefit
Clearly specified with no room for disputes
Specifying the Benefit
A specific particular asset: Ijara becomes nullified if the asset is impaired.
A generic described asset: If the benefit of the asset is impaired during the lease, the lessor will provide a replacement.
Rent
Rent must be clearly specified and known to both parties
Rent amount is flexible (conditional)
Entitlement of rent is tied to availability of the benefit not by the contract itself
Rent is an indivisible amount. Just rent without a profit and a principal
Rent can be paid in advance, deferred, paid in installments
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Contracting Parties Obligation
Lessor’s Obligations
Making the leased asset available
Guarantee the asset
Maintenance of the asset
Major maintenance needed to make the benefit available to the lessee must be performed by the lessor
Operating and periodical maintenance can be performed by the lessee
Lessee’s Obligations
Proper and professional usage of asset (fiduciary capacity)
Payment of rent
Not liable in the case of impairment due to Force Majeure
Liable if damage is due to misconduct or negligenece
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Maintenance of the Leased Asset
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The lessor is responsible for the defects throughout the Ijara period unless such defects are due to the lessee’s misconduct or negligence.
It is not permissible to have the lessee pay for the maintenance (unknown extra to the rent)
The lessor should maintain the asset and carry out all repairs
However, the lessee can be asked to carry out the maintenance if
Operating maintenance
Periodic maintenance
Known amount maintenance (add to rent)
Maintenance that is a must in order to provide the usufruct (benefit) must be paid by the lessor
Types of Ijara Muntahia Bittamleek(Lease to Own)
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IMB through Gift
IMB through sale at end for a token consideration
IMB through sale at end for an specified amount
Sale and Lease back
Ijara Issues
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Calculation of Ijara can use the same amortization table used for Murabaha (Standard amortization table)
The asset is on your balance sheet and you will need to depreciate the asset
More complex to implement than Murabaha
In some counties the sales tax (Stamp Duty Land Tax) is paid twice; at the beginning of the Ijar and at the end
The bank takes the asset risk
Ijara has a Sharia and an Accounting AAOIFI standards
Diminishing Musharaka Financing
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What is Musharaka
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A form of partnership between the Islamic bank and its clients whereby each party contributes to the capital of partnership in equal or varying degrees to establish a new project or share in an existing one and whereby each of the parties becomes an owner of the capital on a permanent or declining basis and shall have his due share of profits.
However losses are shared in proportion to the contributed capital.
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Constant & Diminishing Musharaka
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Constant Musharaka
A Musharaka in which the partners’ shares in the capital remain constant throughout the period as specified in the contract
Diminishing Musharaka
A Musharaka in which the Islamic Bank agrees to gradually transfer to the other partner the banks share in the Musharaka. The Bank’s share declines and the other partner’s share increases until the latter becomes the some proprietor of the venture
Financing Through Musharaka
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A financing technique based on partnership
Usually diminishing Musharaka
Used for long term financing when we cannot use Ijara
The bank sells its shares gradually at a profit.
Diminishing Musharaka Example
House Price (USD) 200,000 Rate (Annual) 8%
Down Payment 50,000 Tenor (years) 4
Financing Amount 150,000 Payment Frequency monthly
Initial Customer Share 25.00% Payment per month 3,661.94
Initial Bank Share 75.00%
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Example (cont.): Diminishing Musharaka Table
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Month Beginning BalanceMonthly Payment
Principal ProfitEnding Balance
Share bought
Total Partner Share
1 150,000.00 3,661.94 2,661.94 1,000.00 147,338.06 1.33% 26.33%
2 147,338.06 3,661.94 2,679.68 982.25 144,658.38 1.34% 27.67%
3 144,658.38 3,661.94 2,697.55 964.39 141,960.83 1.35% 29.02%
4 141,960.83 3,661.94 2,715.53 946.41 139,245.30 1.36% 30.38%
5 139,245.30 3,661.94 2,733.64 928.30 136,511.66 1.37% 31.74%
6 136,511.66 3,661.94 2,751.86 910.08 133,759.80 1.38% 33.12%
7 133,759.80 3,661.94 2,770.21 891.73 130,989.59 1.39% 34.51%
8 130,989.59 3,661.94 2,788.67 873.26 128,200.92 1.39% 35.90%
9 128,200.92 3,661.94 2,807.27 854.67 125,393.65 1.40% 37.30%
10 125,393.65 3,661.94 2,825.98 835.96 122,567.67 1.41% 38.72%
11 122,567.67 3,661.94 2,844.82 817.12 119,722.85 1.42% 40.14%
12 119,722.85 3,661.94 2,863.79 798.15 116,859.06 1.43% 41.57%
Diminishing Musharaka Table for the first 12 months
Deminishing Musharaka Issues
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Complex to implement
Should not be used at the first two years of operations due to its complexity
Used only when we cannot use Ijara, e.g., the benefit (usufruct) is not available
TawarruqTAWARRUQ AND OTHER FORMS OF CASH FINANCING
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Cash Financing
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Cash financing is possible in Islamic finance through a complex three step process
Tawarruq is the most common type of cash financing
A family of similar transactions
Tawarruq
Reverse Murabaha
Treasury Borrowing (Money Market Transaction)
Treasury Financing (Money Market Transaction)
All these transactions are identical in nature. The only difference is the roles
Tawarruq
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A method where the financial institution, either directly or indirectly, will buy an asset and immediately sell it to a customer on a deferred payment basis.
The customer then sells the same asset to a third party for immediate delivery and payment,
the end result being that the customer receives a cash amount and has a deferred payment obligation for the marked-up price to the financial institution.
The asset is typically a freely tradable commodity such as platinum or copper.
Gold and silver are treated by Sharia as currency and cannot be used.
Tawarruq: The Process
Three Step Process
Step 1: The Bank buys the goods from the Seller at cost and pays him in cash
Step 2: The Customer buys the goods from the Bank at cost plus profit and pays in installments (deferred payment).
Step 3: The Purchaser buys the good from the Customer at cost and pays him in cash
The customer has the cash ($10,000) and he needs to pay the debt ($12,000) to the bank in installments.
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Price = Cost
(Cash Basis)
Price = Cost + Profit
(On Credit)
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Price = Cost
(Cash Basis)
Bank CustomerSupplier Purchaser
Goods Goods Goods
Tawarruq
Tawarruq is a financing transaction in which the bank finances the customer with cash through a three step process.
The customer pays back to the Bank in monthly installments
Used for consumer finance
Tawarruq Cash Flow
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M1 M2 M3 M4 M60
Monthly Installments
Reverse Murabaha: The Process
Three Step Process
Step 1: The Customer buys the goods from the Seller at cost and pays him in cash
Step 2: The Bank buys the goods from the Customer at cost plus profit and pays him at the maturity of the deposit tenor.
Step 3: The Purchaser buys the good from the Bank at cost and pays him in cash.
The Bank has the cash ($1,000,000) and he needs to pay the principal plus profit ($1,020,000) to the Customer at maturity.
Price = Cost
(Cash Basis)
Price = Cost + Profit
(On Credit)
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Price = Cost
(Cash Basis)
Custome
rBankSupplier
Purchase
r
Goods
Goods
Goods
Reverse Murabaha
Reverse Murabaha is a deposit transaction in which the customer puts a deposit with the bank and gets the principal plus Profit at the maturity date of the deposit
Same process as Tawarruq but the roles are reversed
The Bank pays back to the Customer in a single bullet payment that includes principal and profit
Used for large deposits by high net worth individuals usually $1 Million and above
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Maturity
Date
Principal
Profit
Reverse Murabaha Cash Flow
Treasury Borrowings & Placements
Three Step Process
Step 1: Bank 1 buys the goods from the Seller at cost and pays him in cash
Step 2: Bank 2 buys the goods from Bank 1 at cost plus profit and pays him at the maturity of the deposit tenor.
Step 3: The Purchaser buys the good from Bank 2 at cost and pays him in cash.
Bank 2 has the cash ($10,000,000) and he needs to pay the principal plus profit ($10,200,000) to Bank 1 at maturity.
Price = Cost
(Cash Basis)
Price = Cost + Profit
(On Credit)
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Price = Cost
(Cash Basis)
Bank 1
Placemen
t
Bank 2
BorrowingSupplier Purchaser
Goods
Goods
Goods
Treasury Money Market Transactions
Treasury Money market transactions are Placements and Borrowings
In Placements the bank puts the cash with another bank and gets the profit at maturity
In borrowings the Bank borrows the cash from another bank and pays the other bank principal plus profit at the maturity date
Borrowings and Placements are the same thing; only the roles are reversed
Used for large amounts by two different banks through their respective treasury departments
This is the Islamic way of doing money market transactions
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Maturity
Date
Principal
Profit
Borrowings & Placements Cash Flow
Cash Financing Differences
The Difference is Roles
All the cash financing transactions are identical but the difference is in the Roles of two parties
One party is giving the cash and the other party is getting the cash
Cannot do it directly because it will be Riba
Many scholars would prefer if the transaction using local goods not international, e.g., London, based goods
Different names
All these names are different forms of Tawarruq or Cash Financing
Tawarruq
Reverse Murabaha
International Murabaha
Commodity Murabaha
Money Market Transaction
Treasury Placement
Treasury Borrowing
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Part 3 Deposits
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Overview
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This section is about the basics of Islamic Banking
Mudaraba
Wakala
Deposits in an Islamic Bank
Mudaraba based deposits
Profit Distribution
Wakala based deposits
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Deposits in an Islamic Bank
Deposits at an Islamic Bank are mainly the following types
Mudaraba
Wakala
Reverse Murabaha
Most deposit accounts are Mudaraba based
Mudaraba is usually invested in financing activities and in Sukuk
Mudaraba has no capital guarantee
Mudaraba requires a sophisticated profit distribution mechanism
Wakala was introduced in the last few years
Wakala is usually invested in the treasury
Profit distribution for Wakala is straight forward
Wakala amounts are usually large while Mudaraba are small to medium
Reverse Murabaha are the largest in terms of amount
All are low risk low return instruments
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What is Mudaraba
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Mudaraba is a partnership in profit between capital and work
The first party will provide the funds
The second party will provide the work
Profit will be shared between the two parties
An old investment and financing technique
Applications in financial institutions
Deposits: These are called “equity of investment accountholders” in retail banks; they are saving accounts & time deposits.
Used to be called “Unrestricted investment accounts (URIA)”
Investment Accounts in investment banks (private equity firms). These are Restricted Investment Accounts.
Mudaraba Deposits
The bank is the Mudarib
The customer is Rab-ul-Mal
The Mudaraba pool is the pool of money deposited in Mudaraba deposit accounts
Called equity of investment accountholders
Invested in low risk retail and corporate financing and Sukuk
Accounts
Saving Accounts
Time deposits
Calculation and distribution of profit is complex
No capital guarantee
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Mudaraba; Restricted & Unrestricted
Restricted
Used for high risk investment accounts by investment banks (private equity firms)
The investment agreement imposes restrictions on where, how and what to invest in.
Usually invested in private equity, venture capital and real state projects
Cannot be commingled with banks other funds
Off balance sheet
Unrestricted
Used by retail banks for low risk saving accounts and time deposits
The banks invests the fund in a way the bank deems appropriate without restrictions to where and how (still must be low risk)
Usually invested in retail financing, corporate financing and Sukuk
Usually commingled with bank other funds
On balance sheet at the Equity of Investment accountholders (URIA) item
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Parties
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A Mudaraba contract has two parties
Rab-ul-Mal
Mudarib
Rub-ul-Mal is the provider of funds
Mudarib is the funds manager
Both must be eligible to act as principle and as agent
Contract
There are three elements in every Islamic finance
The names under every element are different depending on the type of the contract
Wording
Offer
Acceptance
Contracting Parties
Rab ul Mal
Mudarib
Subject of the Contract
Funds
Work
Profit
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Capital (Funds)
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Capital is the amount of money given by Rab ul Mal to the Mudarib for the purpose of investing in the Mudaraba activity.
Capital should be known; amount and type
Capital should be in cash but also it could be assets
Capital cannot be debt (financial assets)
If the Mudarib contributes capital (in addition of Rab ul Mal) then he is a Mudarib and another Rab ul Mal.
Work
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Work is the exclusive right of the Mudarib.
No fee is paid for the Mudarib for his work. Can charge a fee for other services.
Rab ul Mal should not restrict the Mudarib in way that prevents him from achieving the goals of Mudaraba.
Mudaraba could be restricted or unrestricted.
Restricted in terms of the business activity, business location, business sector, timing, etc.
Profit
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Profit is the amount earned in excess of the capital
No profit is distributed before the capital is returned to Rab ul Mal
For a continuous Mudaraba done in phases/stages periodic valuations with profit distributions are fine. Future losses can affect capital, realized undistributed profit and even already distributed profit.
The end objective of Mudaraba is Profit
Profit should be distributed to both parties
The distribution ratio
must be known to both parties
Must be a percentage
The percentage can be renegotiated at later stages
Losses
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Losses are only borne by Rab ul Mal
Mudarib does not bear any loss unless the loss was due to his misconduct or negligence
A loss is considered a decrease in the Mudaraba capital
Periodic losses in the course of continuous Mudaraba shall be set off against realized undistributed profit, capital and previously distributed profits,
i.e., Mudarib should get no profit if Rab ul Mal does not get his capital back.
Claw back call of profit
Guarantee in Mudaraba
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Guarantee refers to the responsibility of the Mudarib to return the capital to Rab ul Mal regardless of the outcome of the business activity and under all circumstances
Guarantee is NOT allowed in Mudaraba except in the case of misconduct and negligence
Rab ul Mal can ask for a guarantee that he can utilize if there is a misconduct and negligence. This is called Betrayal Guarantee.
Profit Distribution in Retail Banks
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The distribution of profit in retail banks means the distribution of the returns of the Mudaraba based deposits to the deposit accounts
Mudaraba based deposits are saving accounts and time deposit accounts
Current accounts (checking accounts) are not part of URIA
Sources & Uses of Mudaraba Deposits
Sources of Mudaraba Deposits
A bank needs deposits to have more cash.
Depositors are Rab ul Mal
To attract deposits a bank will provide the depositors with returns (profit). This is the Mudaraba profit to Rab ul Mal
Types of deposits
Saving accounts
Time deposits; 1, 3, 6 & 12 months
Uses of Mudaraba Deposits
The bank will take is cash and the cash of the depositors and use it in banking activities at higher rate of return
Bank is Mudarib
The profit of the financing is the return of Mudaraba. To be distributed between the depositors and the bank
Uses of Deposits
Retail financing; home and car financing
Corporate financing
Sukuk
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Other factors in the Profit Distribution
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Reserve
We don’t always distribute the whole profit. We have a reserve account that takes a percentage of the profit during the periods where profit is high
When profit is low the reserve account can be enhanced using the reserve
Expenses
The bank can charge part of the banking activities related to the Mudaraba activities
Must be other than the direct work of the Mudaraba
Provisions
A provision will make the profits less
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Mudaraba Pool of Funds (in Retail Banks)
MudarabaPool
Saving
Time Deposit1 month
Car Financing
Home Financing
Corporate Financing
Sukuk
Time Deposit3 month
Time Deposit12 month
Deposits(Liabilities)
Financing(Assets)
Reserve
Bank
Bank is both a Mudarib & Rab-ul-Mal (Partner)
Expenses
Profit Distribution Diagram
ADIB Bank—Customer Profit Rate For Jan 2018
Tier 5 K - 10 K 10 K - 25 K > 25
AED & USD 0.36% 0.37% 0.38%
EUR 0.36% 0.37% 0.38%
GBP 0.36% 0.37% 0.38%
Tier 10 K-250 K 250 K-1 M 1 M-5 M 5 M-10 M > 10 M
1 Month 0.56% 0.56% 0.56% 0.56% 0.59%
3 Month 0.58% 0.58% 0.58% 0.58% 0.61%
6 Month 0.60% 0.60% 0.60% 0.60% 0.69%
9 Month 0.63% 0.63% 0.63% 0.63% 0.73%
12 Month 0.68% 0.68% 0.68% 0.68% 0.78%
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•Above are the actual profit distribution rates for January 2018. Future month
profit distribution rates, if any, may vary.
Please note that profit distribution to the Savings account's are on quarterly
basis.
Saving Accounts Time Deposits Accounts
Above are the actual profit distribution rates for January 2018. Future month profit distribution rates, if any, may vary and will be made in accordance with the ADIB’s Banking Services Agreement.
Mudaraba Deposit Example
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Mudaraba Type
Amount (Monthly minimum Balance)
weight (Percentage
Invested)Amount Invested Profit
Mudarib Share
Bank (Mudarib) Profit
Customer (Rab ul Mal)
Profit
Rate of return
Saving Account 40,000,000 30% 12,000,000 89,000 25% 22,250 66,750 2.0%
TCD 1 month 20,000,000 60% 12,000,000 89,000 25% 22,250 66,750 4.0%
TCD 3 month 25,000,000 70% 17,500,000 129,792 25% 32,448 97,344 4.7%
TCD 6 month 30,000,000 80% 24,000,000 178,000 25% 44,500 133,500 5.3%
TCD 12 month 10,000,000 90% 9,000,000 66,750 25% 16,688 50,063 6.0%
Assume that the rate of return is 8.9%This slide shows how to calculate the rate of return for each Mudaraba Deposit Account type.
Example: (cont.) Calculation of the Investment rate of return
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Investment TypeAllocation
Rate of Weighted Rate
Return
Credit Cards 10% 15% 1.500%
Car Financing 25% 8% 2.000%
home Financing Ijara 45% 9% 4.050%
home Financing 10% 8.50% 0.850%
Sukuk 10% 5% 0.500%
Total (Rate of return) 8.900%
Wakala Deposits
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Wakala
Wakala is an agency contract
Wakala is used as a tool for investment
A restricted Wakala for investment purposes
Provider of funds is called al-Muwakil
Agent is called al-Wakeel
Wakala fees
Fixed fee
Percentage of funds
Performance fee
Beyond a hurdle rate fee
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Wakala Deposits
Sometimes its called Wakala Treasury Deposit Account
The account is operated under the Islamic Finance principle of Wakala which is an “agency agreement” where the bank would act as the agent to achieve an agreed expected rate of profit for an agreed number of days.
The bank is the agent of the customer, i.e., the bank is the Wakeel
The bank fees are any extra profit beyond the expected return rate
Invested in the treasury activities
Profit is paid at the maturity of the deposit
Minimum amount is usually medium to high
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Mudaraba vs. Wakala
Wakala is more flexible than Mudaraba
Profit Distribution for Mudaraba requires a sophisticated software application. Profit distribution in Wakala is easier to implement.
The difference between the two is that with a Mudaraba all the profit is divided between the parties, whilst with a Wakala the investor receives only the agreed ratio against investment. Anything made above that ratio is kept by the financial institution and not given to the investor.
Reverse Murabaha is given to VIP customers and requires a large deposit ($1 million and above)
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Session 2: Financial Statements of an Islamic Bank
Overview
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What are Financial Statements
Who uses them and why
Balance Sheet
Income Statement
Cash Flow Statement
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Financial Statements
What are Financial Statements
Financial statements are formal records of the financial activities of a business
Status of Business
Performance of Business
Cash
Ownership
Basic Financial Statements
Balance Sheet
Income Statement
Cash Flow Statement
Statement of Changes in Equity
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Users of Financial Statements
Owners and managers require financial statements to make important business decisions that affect its continued operations.
These statements are also used as part of management's annual report to the stockholders.
Prospective investors to assess the viability of investing in a business.
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital. or extend debt securities.
Government entities (tax authorities)
Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.
Media and the general public
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Company
Financial
Statements
Financial Statements of Islamic Banks
Islamic banks have their own financial statements that resemble typical financial statements
Financial institutions
Assets are financial assets
Liabilities are deposits. In Islamic banking this is a special type of liabilities.
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AAOIFI Accounting Standards
Usually, each product has its own Accounting standards: Murabaha, Ijara, etc.
For the financial statements we use two items from the AAOIFI Accounting Standards
Conceptual Framework for Financial Reporting by Islamic Financial Institutions
General rules
Standard 1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions
Rules related to the presentation of financial statements
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Typical Balance Sheet (Financial Position)
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Basic Equation of Accounting
Assets = Liability + Owner’s Equity
Balanced equation, always
A Balance Sheet is made on a certain date in time
A Balance Sheet is a snapshot in time
What the company has at date xxx
What the company owes at date xxx
What the company is worth at date xxx
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Typical Balance Sheet (Financial Position) Format
Assets
Cash X
Accounts Receivable X
Inventory X
Supplies X
Prepaid Expenses X
Total Current Assets A
Fixed Assets (at Cost) X
Depreciation (X)
Net Fixed Assets B
Total Assets A + B
Liability & Owner’s Equity
Accounts Payable X
Accrued Expenses X
Unearned Revenue X
Total Current liabilities C
Long term debt D
Total Liabilities E = C+D
Capital F
Retained Earnings G
Owner’s Equity H = G+F
Total Liability & Owner’s Equity E+H
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Typical Assets
Assets could be cash, stocks, buildings, rights to collect cash, ..
Assets have value that must be quantified
Some assets are tangible while some assets are intangible like Patents.
The assets are usually ordered in their order of liquidity.
Assets
Current Assets
Long Term Investment
Intangible Assets
Fixed Assets
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Typical Assets
Current Assets: Assets expected to be converted to cash or used up within 12 months
Cash
Cash Equivalent (short term securities)
Accounts Receivable
Inventories
Prepaid expenses (supplies & insurance)
Long term investments
Investments in Stocks and Bonds (Sukuk)
Real estate investments
Intangible Assets
Patents
Copyrights
Trademarks
Fixed Assets
Land & Buildings
Machinery & Equipment
Less: Depreciation
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Typical Liabilities
Liabilities are economic obligations of the enterprise, such as money that the corporation owes to lenders, suppliers, employees, etc.
Most companies do not depend solely on the equity for financing
In fact owner’s equity is less than debt in most companies
Liabilities
Current Liabilities
Long Term Liabilities
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Typical Liabilities
Current Liability
Obligations that the company is to pay within the coming year.
Accounts Payable
Bills to other companies for items bought on credit
Current portion of the long term debt
The amount of a long term debt that must be paid within the coming 12 months
Accrued expenses
Expenses incurred but not yet paid like rent and salaries
Long term liability
Obligations that a company expects to pay after one year.
Bonds (Sukuk)
Mortgage payments
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Owner’s Equity
Owner’s Equity
Capital
The amount of capital collected from share holders
Retained Earnings
Retained Earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends.
Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or accumulated deficit.
Retained earnings and losses are cumulative from year to year with losses offsetting earnings.
Owner’s Equity
Capital
Retained Earnings
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Statement of Financial Position (Balance Sheet) of an Islamic Bank
The Statement of Financial Position for an Islamic bank is described by AAOIFI Financial Accounting Standard 1 (FAS 1).
Assets must reflect the financing products the bank has offered.
Debt based financing
Partnership based financing
Ijara based financing
Investments
Liabilities must reflect the deposits of the clients
Current account
Partnership based investment accounts
Agency based investment accounts
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Statement of Financial Position (Balance Sheet) of an Islamic BankAssets
a) Cash and cash equivalent
b) Receivables (Murabaha, Salam and Istisnaareceivables)
c) Investment securities
d) Mudaraba financing
e) Musharaka financing
f) Investments in other entities
g) Inventories
h) Investment in real estate
i) Assets acquired for leasing (Ijara assets)
j) Other investments
k) Fixed assets
l) Other assets
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Statement of Financial Position (Balance Sheet) of an Islamic BankLiabilities
a) Liabilities
b) Equity of Investment Accountholders
c) Owners Equity
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Islamic Bank Balance Sheet
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Assets = Liability + Equity of Investment Accountholders + Owner’s Equity
+ +++ + =
Equity of investment accountholders
Owner’sEquity
Investments
Financing
LiabilitiesCash
Other Assets
Assets on the Balance Sheet
Financing
Those are the Islamic finance tools to provide financing to clients
Murabaha, Ijara, Musharaka, Salam, Istisnaa, etc.
Usually the largest element on the asset side for a balance sheet
The main source of income for an Islamic retail bank.
Investments
Those are usually Sukuk, Stocks and subsidiaries
Sukuk are the most important part. They are used for liquidity management and can be very profitable sometimes.
Stocks are usually for low companies
Subsidiaries can be other companies usually financial, insurance and real estate companies that the banks owns partially or fully.
Sometimes you might have some real estate investments on the balance sheet. This is dependent of the Bank Strategy.
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Equity of Investment Accountholders
The equity of investment account holders is an item that is between the liabilities and owner’s equity on the balance sheet.
Its an unrestricted investment account
Only for Islamic banks
The largest item on the balance sheet
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Income Statement
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An Income Statement measures the profit or loss over an accounting period
The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.
An Income Statement represents the performance of a company over a period of time.
This contrasts with the balance sheet, which represents a single moment in time.
Income Statement form depends on the type of business
Typical Income Statement Format
This is the format for an Income Statement for a merchandising company
Service companies and financial institutions will have slightly different formats
The top line is the total sales
The bottom line is the net income
Income StatementFrom 1st of Jan . till 31st of Dec.
Sales Revenue X
Cost of Goods Sold (X)
Gross Profit A
Sales & Marketing X
General & Administration X
Operating Expenses B
Income from Operations C = A – B
Other Revenues D
Other Expenses E
Net Income C+D – E
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Income Statement for Islamic Bank
Islamic Banks will have three main sources of income
Financing
Investment
Services
Notice that the bank needs to pay the depositors their profit.
Income Statement (From 1st of Jan . till 31st of Dec.)
Income from Financing X
Income from Investment X
Income from Banking Services X
Profit on Equity of Inv. Accountholders (X)
Total Income A
Staff Cost (X)
Sales & Marketing (X)
General & Administration (X)
Operating Expenses B
Income from Operations C = A – B
Other Revenue D
Other Expenses E
Net Income C + D – E
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Cash Flow Statement
Cash is very important for the continuity of a business
Companies can be profitable but have no cash
Cash flow statement reports cash receipts, cash payment and net changes in cash
Operating activities: Net income cash
Investing activities: Acquiring fixed assets and giving loans
Financing activities: Getting loans and paying dividends
Cash Flow Statement
Operating Activities
Investing Activities
Financing Activities
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Cash Flow Statement
Operating Activities
Income statement items
Adjust for noncash expenses e.g. depreciation
Investing Activities
Inflow: sale of fixed asset
Inflow: collection of debt
Financing Activates
Inflow: sale of common stocks
Inflow: Issuance of long term debt (sukuk)
Outflow: Dividends
Cash Flow StatementFrom 1st of Jan . till 31st of Dec.
Cash flow from operating activities
========= X
========= X
Net cash flow from operating activity A
Cash flow from investing activities
========= X
========= X
Net cash flow from investing activities B
Cash flow from financing activities
========= X
========= X
Cash flow from financing activities C
Net Increase in cash D = A+B+C
Cash at beginning of period E
Cash at end of period E+D
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Examples of Financial Statements
Albaraka Bank Bahrain
Kuwait Finance House -- Bahrain
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Session 3. Islamic Investments
Stocks
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Investing in Stocks
Stocks
We can invest in the stocks of all sharia complainant companies.
As for the none Sharia compliant companies we follow the screening criteria from AAOIFI or the Islamic Dow Jones
AAOIFI criteria (Sharia Standard 21)
Islamic Dow Jones criteria
For these approved stocks we must purify our profit regularly by giving it to charity
Ideal Ratings automates the screening process
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Islamic Dow Jones Criteria
Sector Based Screening of Stocks
Based on the Shariah Supervisory Board established parameters, the businesses listed below are inconsistent with Shariah law.
Income from the following impure sources cannot exceed 5% of revenue.
Alcohol
Tobacco
Pork-related products
Conventional financial services (banking, insurance, etc.)
Weapons and defense
Entertainment (hotels, casinos/gambling, cinema, pornography, music, etc.)
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Islamic Dow Jones Criteria
Accounting Based Screening of Stocks
After removing companies with unacceptable primary business activities, the remaining stocks are evaluated according to several financial ratio filters.
The filters are based on criteria set up by the Shariah Supervisory Board to remove companies with unacceptable levels of debt or impure interest income.
All of the following must be less than 33%:
Total debt divided by trailing 24-month average market capitalization
The sum of a company’s cash and interest-bearing securities divided by trailing 24-month average market capitalization
Accounts receivables divided by trailing 24-month average market capitalization
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Equity Screening Solution from Ideal Ratings
Ideal Ratings is US and Egypt based company that provides Islamic investment solutions
IR developed a research methodology to accurately analyze companies’ business activities and revenue breakdown, by mixing the manual research approach and the automated classification techniques
Covers more than 40,000 equities in over 160 countries.
IR research team analyzes companies to identify more than 32 unique categories of Shariah non-compliant activities that cover most of the global Shariah guidelines.
AAOIFI based but also includes other optional filters like sustainability
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Equity Screening Solution from Ideal Ratings
Fund managers utilize this screening platform that enables them to identify their investable universe based on their own customized ethical, Shariah and investment guidelines.
IR developed a Shariah/Islamic purification engine to ensure that fund managers are able to accurately purify their funds and portfolios more frequently (weekly, monthly, quarterly etc…) and
The exact purification value can be calculated, which would have an outstanding impact on the funds returns.
Subscription based service and a free app for individuals
See Fedex and Boing reports
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Islamic Equity Funds
Equity funds are funds of approved Stocks
There are many of these funds around the world; actively managed funds and index funds
Case study: Jadwa GCC Index Fund (Saudi Arabia).
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Islamic Indexes
S&P Shariah
The S&P Shariah indices provide investors with a comprehensive set of Shariah-compliant investment solutions.
Representative of each market, with high correlations to their underlying indices, each index offers a comparable investable portfolio while adopting explicit, transparent selection criteria as defined by Islamic law.
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Dow Jones Islamic Market
The Dow Jones Islamic Market™ Index series includes thousands of broad-market, blue-chip, fixed-income and strategy and thematic indices that have passed rules-based screens for Shariah compliance.
Launched in 1999, DJIM World was the world’s first global Shariah-compliant benchmark.compliance concerns Muslim investors would otherwise face in constructing Islamic investment portfolios.
Sukuk
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Basics of Sukuk
125
Sukuk is the Islamic version of bonds
Sukuk is a way for Islamic organizations to issue an instrument similar to a tradable Western bonds, while still being Sharia compliant. Sukuk in general may be understood as a Sharia compliant ‘Bonds’.
Sukuk gives the same cash flow behavior of bonds
Sukuk are financial securities that represent a proportional or undivided interest in an asset, or pool of assets, and the claim embodied in Sukuk is not simply claim to a cash flow but an ownership claim.
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Sukuk Design
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We have designed Sukuk as a structured product using ideas from Bonds, Securitization and Islamic Sharia
Sukuk
Structure
(Securitization)
Cash Flow
(Bonds)
Transactions & Rules
(Sharia)
Sukuk Cash Flow
Sukuk cash flow is identical to bond’s cash flow
Sukuk Proceeds: Initial payment by investor to the Sukuk issuer
Profit: Periodical payments paid back to the investors usually every 6 months.
Principal Payback: Final payment at maturity, e.g., after 5 years. Final payment is called dissolution payment.
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y1 y2 y3 y4 y5
Sukuk Proceeds paid by Sukuk Holders (Investors)
Periodical Payments to Sukuk Holders
Dissolution Payment paid to Sukuk Holders
Basic Sukuk Structure
Seller
Investors(Sukuk Holders)
Purchaser
Issuer
Servicer
Dissolution Payment
Periodical Payments
Sukuk Proceeds
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Structure Cash Flow Relationship
Seller
Investors(Sukuk Holders)
Purchaser
Issuer
Servicer
Dissolution
Payment
Periodical
Payments
Sukuk
Proceeds
y1 y2 y3 y4 y5
Buy
Sell
Utilize
1
2
3
129
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Sukuk Features
Sharia Compliance
Debt with interest is not allowed in Sharia
Sukuk is a structured product that is Sharia Complaint and have similar features to Bonds
AAOIFI Sharia Standard for Sukuk
Many types of Sukuk based on the contract type
Contract Type is one of the types used in Fiqh Al Muamalat
Cash Flow
Similar to Bonds
Structuring Sukuk
A structured product with several entities
Tradability
Some Sukuk types are tradable while others are not
Secondary Market
Listing
Sukuk can be listed today in several securities exchanges
Rating
Islamic Capital Market
Risk Management
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Sukuk Buyers and Sellers
Buyers
Treasury departments in Islamic banks
Pension funds
Insurance and Takaful companies
Asset management firms
Wealth management
High demand in general
Investment allocation and liquidity management thinking
Sellers
Governments
Semi-Government
Corporates
Banks (Tier 2 Capital)
Supply depends on market conditions
Project finance thinking
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Sukuk ExampleDubai Islamic Bank 2023
Type: Ijara
Issue Size: $1 billion
Profit rate 3.625%
Currency: USD
Maturity: 06 February 2023
Country of Issue:
United Arab Emirates
Tenor: 5 years
Issue Date: 06 February 2018
Exchanges: Irish Stock Exchange , Nasdaq Dubai/DFM ,
Arrangers:Bank ABC, Dubai Islamic Bank, First Abu Dhabi Bank, HSBC, J. P. Morgan, KFH Capital, Sharjah Islamic Bank and Standard Chartered Bank
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Real Estate Investment
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Real Estate Funds
Real estate funds are very popular way for investment in the GCC region
The fund would consist of a single real estate asset or a portfolio of real estate assets
Sharia Compliance: A real estate investment/fund must be Sharia complaint from the start. This means that certain properties cannot be part of the fund. This prohibited list includes the following:
Hotels that sell or serve alcohol.
Bars and liqueur stores.
Banks and most financial institutions.
Night clubs and adult entertainment facilities.
Gambling facilities
Please note that supermarkets are allowed in general even if they sell alcohol.
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Property Types
Property Types: Most clients prefer a portfolio of properties not just a single big property. Type of assets attractive to local clients
Logistics and warehousing
Retail shops
Student housing
Nursing homes
Office building with single tenant.
Multifamily apartments.
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Real Estate Funds
Underlying Asset Class:
Income Generating existing Assets: This asset class is the most requested class.
Real Estate Development Projects.
A Mix of Existing and Development: This is used sometimes to get a recurring income and increase the return at the same time.
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Leveraging the Fund
Leveraging the real estate fund through debt is very typical in most real estate funds to increase the return.
The borrowing can be from the local market to get a low cost of funding.
In most cases there will not be Sharia compliant borrowing. In this case the fund can still use a specific legal structure to segregate the non-compliant debt from the asset income. Legal firms working in this area have already developed structures that does that.
Typically, the leverage rate LTV can be from 50% to 75%.
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Tax Efficient Structure
Funds related to assets within the GCC usually don’t need a tax efficient structure.
For assets residing in the US and Europe we must use a tax efficient structure to decrease the tax
The fund must be designed from inception to be marketed to GCC investors.
Due to tax regulations in the US/Europe the fund must be structured using a tax efficient structure that reduces the amount of tax paid by the fund. By doing so the return to the GCC investors will be higher.
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Examples
Jadwa AlBasateen Real Estate Investment Fund
Markaz Real Estate Fund
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Real Estate Investment Fund (REIT)
A Real Estate Investment Trust (REIT) is a company that owns, and in most cases operates, income-producing real estate assets.
REITs are listed and traded on major exchanges just like stocks.
REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, and hotels.
REITs generally must pay out an amount equal to at least 90% percent of their income in the form of dividends to shareholders.
A REIT is an income generating asset.
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Islamic REIT
The structuring of Islamic REITs will be the same like the conventional REITs except for the Shariah Guidelines and principles that must be followed
Contracts and principles used.
Managing the REITs:
Utilization of the real estate must be Shari`ah compliant, including tenancies & sub-tenancies
Financing of the acquisition / development of the real estate should be Shari`ah Compliant
Investment of cash / liquidity must be made in Shari`ah compliant instruments
Insurance scheme for protecting the real estate should also be Shari`ah compliant
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REIT Structure
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Islamic REITs are Becoming Popular
Islamic Real Estate Investment Trusts (IREITs) are increasingly becoming popular as an investment vehicle that is much more flexible and diversifying than direct exposure to real estate with similar yields.
The world’s first Islamic REIT created upon such principles was the Malaysia-based Al Aqar KPJ REIT, launched in June 2006. It invested in domestic hospitals.
This was followed by several REITs in Malaysia
While the first REIT in the GCC was actually launched in Kuwait in 2007 as Al Mahrab Tower REIT, it remained a closed and non-listed.
Several GCC REITs were launched but they were closed and non-listed
In 2017 REITs became more popular in the GCC. Several GCC REITs were launched or listed in 2017 and 2018.
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GCC Islamic REITs
Emirates REIT: launched in Dubai in 2011 as the UAE’s first REIT and listed on Nasdaq Dubai in April 2014. The world’s largest Islamic REIT. The trust reported total assets of $773 million (Dh2.83 billion) and a market capitalization of $333 million.
Emirates NBD, Dubai’s largest bank, listed its own Islamic REIT called ENBD REIT on Nasdaq Dubai on March 23 2017, raising about $100 million. Today it has $460 million of AUM.
Riyadh REIT was launched in 9 June 2015, and listed in 13 November 2016. Its managed by Riyad Capital (Saudi Arabia).
Jadwa REIT Alharamain Fund (Saudi Arabia).
Al Jazira Mawten REIT (Saudi Arabia)
Wasatah REIT (Saudi Arabia)
Eskan Bank REIT (Bahrain)
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Private Equity Funds and Venture Capital
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Private Equity Funds
Private equity funds are funds that usually acquire privately owned businesses
They grow the portfolio companies for several years then they sell them at a premium
Islamic private equity funds can only acquire companies that are Sharia complaint
The debt structure has to be Sharia complaint too.
These funds are usually high risk high return funds and offered to sophisticated investors only
The fund is usually managed using a Mudaraba agreement where the fund manager is the Mudarib and the investors are Rab al-Mal.
Usually involves complicated tax efficient structures
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A Basic Private Equity Structure
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Private Equity in the GCC
The GCC based private equity firms flourished in the 90s and 2000’s.
Started as a platform to invest GCC funds in the US and then GCC investments took place in the 2000’s.
Most of them did not recover after the financial crisis of 2008/2009.
Gradually some of them are having a come back.
The business model was based on huge markup fees.
This model is obsolete.
It did not align the interest of the investor with the interest of the financial firm
More realistic and transparent fees are offered today.
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Venture Capital
Venture capital investments are becoming very popular recently in the GCC
Local startups
Islamic versions of the standard contracts have been developed.
Very risky asset class.
VC / Entrepreneurship eco system is developing very fast in the region.
Most startups are Sharia compliant in nature.
Most of the investment is equity investment.
Different types of shares is the main challenge to VC deal from a Sharia point of view
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VC Sharia Issues
Equity finance
Convertible debt
Preferred shares
Warrants
Liquidation and sales preference
Transfer restrictions (lockups)
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Venture Capital Funds in the GCC Region
Middle East Venture Partners (MEVP)MEVP is a Middle East-focused venture capital firm with offices in Beirut, Dubai and Silicon Valley.
STC VenturesSTC Ventures is a venture capital fund funded by Saudi Telecom Company (STC) and managed by IRIS Capital. Focuses on investments in IT, telecommunications, and digital media.
Wamda CapitalWamda Capital is a Dubai based venture capital firm with FadiGhandour, founder of Aramex at the heart of its operation.
Aramco’s WaedWa’ed, Aramco’s entrepreneurship arm was established in 2011 to promote entrepreneurship in Saudi Arabia.
BECO CapitalBECO Capital is a technology-focused venture capital. Founded in 2014 with its headquarter in Dubai.
500 Falcons500 Falcons is a new $30 million venture capital fund established in Qatar through a partnership between Qatar Foundation Research & Development (QF R&D) and “500 Startups” from the USA.
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Wealth Management
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Wealth Management in Islamic Banking
Most Islamic banks today offer wealth management services to its clients
This allows the clients to invest in several financial products that are Sharia complaint
Stocks
Sukuk
Funds (equity and fixed income funds)
ETF
REIT
Liquid low and medium risk products
The bank can manage the portfolio or the client can manage the portfolio himself
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ADIB Wealth ManagementFour Investment Options
AggressiveBalanced
Ultra Conservative Conservative
Wahed Invest Robo-Advisory
Wahed Invest is a wealth management company based in the US
A Fintech company
Wahed Invest uses a Robo-Advisory to select the right portfolio for the client depending on the risk profile of the client
Technology based
Minimum investment is $100.
Sharia complaint
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Wahed Invest Portfolio Offerings
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