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Recent Developments In The Theory And Practice Of Islamic Banking And Finance
Humayon DarLoughborough University
References
El-Gamal, M. A. 2000 A Basic Guide to Contemporary Islamic Banking and Finance. ONLINE RESOURCE
http://www.ruf.rice.edu/~elgamal/files/primer.pdf
Al-Jarhi, M. A. and Iqbal, M. 2001 Islamic Banking: Answers to Some Frequently Asked Questions. Jeddah: IRTI.
Lecture Plan
Introduction Models of Islamic banking and
financeEarlier modelsLater models
PracticePre-19801980-19901990 onwards
Lecture Plan …
Recent developments Change in thinking/emphasis Future Conclusions
Introduction
Banking and finance in commensurate with the Shariah – Islamic lawShariah-compliant banking?Halal banking?
Introduction…
Banking and finance as an integral part of an Islamic economic systemBanking and finance to achieve
policy objectives of an Islamic system?
Social Banking?
Introduction…
Spread all over the world Over 50-75 countries About 250 Islamic financial
institutions $200-$800 billion in size Average annual growth of 15%
How Did It All Start?
It is a modern banking style: post-1950 phenomenon
Egypt (1963), Malaysia (1963) and Pakistan (1965)early experimentation
Malaysia stands outPakistan and Egypt left behind
The Middle East as a hub of Islamic Finance
What Was The Initial Thinking?
Ills of interest highlightedinterest-based financial system: a cause of under-development
Need for an Islamic alternativesocio-economic development, equity and justice etc emphasised
Idea of social or community bankingMit Ghamr was a social bank
What Was The Initial Thinking?
Development motive was at the heart of Islamic banking thinkingIslamic Development Bank (1974)
Modelling Islamic Banking And Finance
Modelling of Islamic banking shifted the emphasis from social banking to profit loss sharing and profit-motive
Two-Tier Mudaraba Modelprofit motive emphasised
Conventional banking style was adopted as a way forwardprivate banks or special Islamic banks (1974 - )
Practice …
Murabaha or fixed-return modes dominatedPLS marginalised
Idea of social/ community/ development banking faded away
Era of Islamic commercial bankingearning profit as opposed to charging interest
Practice…
Anglo-Saxon model of banking Profitability as a yardstick of
success
Current Issues
Transition from interest-free paradigm to asset-based paradigm
Pricing of Islamic financial products Screening principles for investing in
equity and stocks
Current Issues…
Financial innovation Regulation of Islamic financial
services Towards a theory of Islamic financial
firm
Interest-Free Versus Asset-Based
Interest-free banking was a hallmark of Islamic finance pre-1990 emphasis
Institutionalisation of Murabaha post-1990 phenomenon
Return on asset-backed financial assets is acceptable
An Example!
I need £100,000 for a business venture for a period of one year.
I have got two options1. Borrowing at a rate of interest of
7%2. Going Islamic way
First is not acceptable to my Shariah AdvisorWhat about the second?
Option 2
My advisor issues securities worth £100,000 on my house
The securities are sold to a third party with a buy-back clause of one year
The buyer then rents the house to me for one year on a rental equivalent to 7% of the stocks’ worth (£100,000)
Option 2…
Is it acceptable?
YES…
This is what we do in securitisation!!!
What’s The Difference?
Option 1 involves Riba while Option 2 involves trade
Probably rightBut…Are they really different?Yes…Probably not…
Options 1 And 2 Compared
Option 1 Pure monetary
phenomenon Return on money –
riba
Straight forward
Cheap
Option 2 Trade of a physical
item is involved Return on
investment in property – rental
Involves some sort of innovation
Costly
But Are They Really Different?
Option 1 Return on money
Option 2 Return on
securities
There are Other Ways…
Party C Party B
Party A
$100 (cash)
$105 (credit)£100 cash
Result
Asset-based financing has become a hallmark of Islamic banking and finance in the 21st century
Pricing Of Islamic Financial Products
Interest remains relevant Benchmarking with LIBOR, KLIBOR Positive correlation between
interest and prices of Islamic financial products
Normally a “mark-up” over the benchmarked interest
Consequently…
Demand for Islamic finance remains sluggish at a grassroots level
Islamic finance’s focus remains on the so-called “captive market”
Islamic finance as an elitist phenomenon
Is it supply-driven?
Principles Of Islamic Investing
Investing in stocks in a Halal/ Islamic way
Dow Jones and FT Islamic Indices Full details available on the
respective websiteshttp://www.djindexes.com
http://www.ftse.com/indices_marketdata/ground_rules/global-islamic-ground-rules.pdf
Islamic investment/ mutual fund industry
Financial Innovation
Strong need for financial innovation for further growth in Islamic finance
Securitisation Sukuk structures
The Ijara Sukuk
Islamic Issuer SPV Islamic Investors
Sells the assets
Certificates of participation
Cash
Lease agreement
Rental payments
Rental payments/coupons
Buys back the assets at maturity
Re-imbursement of 100% of the issue price at maturity
Direct recourse
The Mixed Assets Sukuk
Islamic Ultimate Borrower SPV Islamic Investors
Certificates of participation
Cash
Transfer of leased assets or to be
leased to issuer (2)
Transfer of Murabaha Deals (1)
Fixed payment of the return on the
assets
Direct recourse
Purchase of the assets
(1+2)
Regulation of Islamic Financial Services
Separate regulatory framework for Islamic finance is considered a necessity
AAIOFI IFSB
Towards A Theory Of The Islamic Financial Firm
Definition(s) Objectives Analysis
Future Of Islamic Finance
Not much different from conventional finance
Need for re-direction Need for genuine innovation Future lies in Islamic homelands and
not in the Western financial centres
Conclusion
Thank you