images11While Islamic finance grows at a marked clip in the GCC and Asia, what is its prognosis in Europe?

As we’ll see in this article, a considerable demand exists for Islamic banking products in Europe but to date, for a number of reasons including risk-aversion and conservatism, this need has gone largely unfulfilled.


The Islamic banking market continues to flourish around the world with current estimates suggesting that assets managed by Islamic banks are in excess of $700 billion – predominately concentrated in the Middle East.

It is a fact that there are sufficient Muslim investors and borrowers in both Islamic and non-Islamic countries to warrant the attention of traditional banks that seek to serve such clients and capture a potentially profitable slice of a still relatively untapped market. This is corroborated by the growth of Islamic finance in the US, which has a population of over 7 million Muslims.

The challenge for European financial institutions is how to leverage their banking knowledge and expertise in developing sufficient products and services that fulfill the requirements of their Islamic customer base while being compliant with Islamic finance principles.

Key Islamic financial Instruments

Islam is not only concerned with the relationship between man and God but it is also a system of beliefs, justice, equity, fairness and morality which are the values that underpin the entire Islamic way of life. These beliefs are governed by the body of Islamic principles generally referred to as Shariah, which is used to develop and create Islamic financial products.

The European market size and scope

There are more than 14.74 million Muslims in Europe, of which 1.8 million are resident in the UK plus an additional 72 million in Turkey. There are 360,000 Muslim households in the UK.

The following table illustrates the potential market size in mainland Europe for an Islamic bank, as well as highlights the potential for extra-European expansion in countries such as Turkey.


Population (millions) Muslim Population (millions) Percentage

France 61.00 6.10 10%

UK 60.00 1.8 3%

Germany 83.6 3.25 3.89%

Italy 56.00 1.39 2.5%

Spain 42.10 0.60 1.43%

Belgium 10.70 0.39 3.65%

Sweden 9.30 0.31 3.33%

Austria 8.50 0.22 2.6%

Denmark 5.60 0.19 3.4%

Cyprus 0.95 0.24 25.26%

Turkey 72.10 72.00 99.89%

Switzerland 7.80 0.25 3.2%

Source: OECD World Fact Book 2005

The UK is the first country in Europe to promote and encourage retail Islamic banking and it is in the process of embracing Islamic financial techniques by introducing new laws to facilitate further market entry and practice of Islamic finance in the UK.

According to the Office of National Statistics the UK Muslims by country of origin are in the following proportion:

41% Pakistani

13% Bangladeshi

11% Indian

In a research carried out by The Runnymede Trust, “Islamophobia – a challenge for us all,” the Muslims from Middle East and Africa represent 24% of the total Muslim population in the UK. Islamic banking in Europe will inevitably focus on both the retail and institutional customers as these are the two major dominant players in the market. As the table clearly illustrates there is a significant retail market opportunity in Europe for new retail banks, but in terms of sheer volume of transactions the institutional market provides the more lucrative opportunity for the Islamic banks.

Trends in Islamic Banking in Europe

The UK has taken a major lead in Europe in promoting and encouraging Islamic banking activities but this has mainly focused on retail banking and only more recently on investment banking.

The Financial Services Authorities (FSA) in the UK has only authorized one Islamic retail bank which is the Islamic Bank of Britain (IBB). Although other investors have looked into the retail banking arena, no other dedicated competitors have entered the retail market, mainly due to the level of investment required to acquire the critical mass customers that are needed to ensure the retail bank is profitable. There is potentially one Islamic retail bank in France called Tayseer Bank with is going through the authorization process from regulators and should be operational in the near future.

The major hurdle for IBB and any new Islamic retail bank in the UK and Europe is having banking products that are competitive with conventional products offered by other retail banks. Also, competitive product development provides opportunities for potential new entrants into the market to differentiate themselves and add competitive advantage against existing banks in the market.

More recently in the UK, there have been new Islamic investment banks authorized by the FSA including the European Islamic Investment Bank and the most recent entry, Gatehouse Bank. In total, there are five Islamic investments banks in the UK focusing on institutional investors in Europe and also looking to gain institutional funding from organizations in the Middle East. The Islamic investment banking sector in the UK has flourished enormously with other potential new entrants in the pipeline.

The trend in the UK seems to be that bankers believe it will be more difficult to make profitable businesses from the retail customer base while the institutional market is seen as an area where Islamic banks can make significant inroads into the European market. Further supporting the rise of Islamic banking activities is the fact that the UK government is making a concerted effort to turn London into a global hub for the industry.

Customer Segmentation in Retail Islamic Banking

Developing Shariah compliant retail financial products can be complex, with a multitude of options available. Before embarking on such a route, it is paramount that the target customer base for the product is clearly defined and their needs and priorities are understood. As in European banking, where there is no ‘one size fits all’ approach to product development, the same can be said of Islamic banking, with an array of customer segments each with different product and service requirements as well as brand criteria.

In terms of product, a key differentiator between Islamic banking customer segments is the interpretation of what constitutes acceptable levels of Shariah compliance. The scale is divided between the more traditional and conservative customers on the one side, and those who seek higher levels of Islamic assurance on the other. Certain customer segments are willing to pay a premium for the most compliant Shariah products, whereas others will be more attracted to products that are only part Shariah compliant but offer a more competitive rate. Prior to designing a Shariah compliant product concept, the requirements of the target customer segment should be clearly understood, and the resulting costs and benefits weighed.

In addition to the product, service requirement is another area that will differ between customer segments. Characteristics such as a customer’s age, education, lifestyle and desired relationship with the bank will determine these criteria. Delivering against these is a key element in the proposition and will differentiate banks, which otherwise might offer similar Shariah compliant products.

The community spirit and culture has been lost from banking in the UK and these adjustments in the delivery services have marginalized the small trader and sole proprietor who no longer has a local branch of his/her bank for cash deposits and withdrawals, and the collection/exchange of coins. The Cruikshank Report published in 2000 highlighted the poor service provided by the traditional banking community in the UK. More importantly, the report focused on the high level of charges being imposed by traditional banks on their clients due to cartel structures and difficulties for clients changing banks. The recently published financial results of the major banks show that this position has not changed. The ethos and values offered by retail Islamic banks go against these trends and thus provide a unique selling point against conventional retail banks.

Brand recognition is also a key factor that will differ between customer segments. Certain customer segments will only bank with brands that have a strong history and presence in Islamic countries, whereas other customer segments will be more willing to accept European brands with the right product and service propositions.

As with any new product development, prior to taking a Shariah compliant product to market, the customer segments which form that market must be understood, their product, service and brand criteria defined, and the economic, technical and regulatory feasibility of delivering against them assessed. Only by doing this will banks be able to develop compelling propositions that provide the desired level of return.

The way forward

In the wider context, Islamic finance faces the perpetual challenge that it operates as a subset of conventional finance which is based on fundamentally different premises. While this may be a limiting facet (in that Islamic financial institutions must model their products after conventional models) Islamic financial institutions (IFIs) also have the capacity to innovate within this space. In a sense, the constraints can become boundaries that Islamic finance pushes. Certainly, in the current context of financial intuitions failing the world over, IFIs might be able to showcase their own equitable forms of financing and risk sharing. This in turn may allow IFIs to influence the development of financial systems the world over.

In Europe, the UK is leading the charge to enact laws that embrace Islamic banking. It abolished double stamp duties that until recently hindered the purchase of a property under Islamic principles. The UK Government is reviewing other laws in order to soften the establishment and offering of Islamic banking products and naturally this has opened the doors for European banks to further their focus in this market.

In 2005, Lloyds TSB launched services that provided Shariah compliant banking products to its existing retail customer base, but these products were merely white labeling an existing limited product range, and thus not competitive compared to conventional retail banking offerings in the UK. This was the first major activity from a European bank in this market and has encouraged other banks to evaluate their strategy and to take a closer look at this market.

As the market for Islamic banking grows, there is also a need for IT systems that can accommodate an innovative mix of products and provide an efficient cost effective pricing for banks to offer Shariah compliant products. Currently there is no recognized universal IT system for Islamic banks thus resulting in bespoke systems being implemented which are not necessarily providing the services required by banks, hence limiting their product development capabilities.

A European bank using effective IT systems and developing Shariah compliant products will have the key competitive advantage over their rivals and as a result will, without a doubt, ensure that the bank makes great inroads into this prosperous and growing market.

European banks need to incorporate various aspects of traditional banking with Islamic banking concepts in order to fully capture the Islamic market in Europe. While being compliant with Islamic principles may initially be seen as a hurdle, the potential return and increase in customer base will inevitably outweigh any financial investments and commitments made by the bank.

The main principles of Shariah are:


Interest – the charging of interest or riba is strictly prohibited as it is deemed to be terms of unfair exploitation

Speculation – Shariah does not permit speculation or gambling, thus many institutions are unable to enter into derivative transactions such as swaps, futures and options

Prohibited investments – investments in certain products such as alcohol, pork and gambling activities are deemed inappropriate Profit – profit cannot be assured and the Islamic financial institution must assume at least part of the investment risk, thus a guaranteed return is not applicable in Islamic finance

Uncertainty – there is no concept of uncertainty, thus uncertain investment returns are not permitted.

Islamic institutions raise money mainly through the main banking services, the current accounts and savings accounts that generally comes under the strict law of Shariah, thus being fully compliant.


Following are the main Islamic techniques used in finance:


Mudaraba (Trust Financing): This is a form of partnership in which one partner provides the capital required for funding a project while the other party manages the investments using his expertise.

Ijara (Leasing): The ijara contract is very similar to the conventional lease. Ijara is a contract under which the bank buys and leases out the asset or equipment required by its client for a rental fee. This is commonly used for Islamic mortgages.

Salam (Advance Purchase): This is defined as forward purchase of specified goods for full forward payment. This contract is regularly used for financing agricultural production.

Murabahah (Cost-plus Financing): This technique is used extensively to facilitate the trade finance activities of Islamic financial institutions. The bank will purchase the necessary goods/equipments and then sell on to its clients at cost plus a reasonable profit.

Sukuk (Bond Issue): This essentially amounts to commercial paper that provides the subscribers with ownership in the underlying assets.

There are various types of Islamic finance and all in some form or another are limited by the following observations:

In terms of mortgage, a large deposit is sometimes required then the conventional mortgages

Most observers believe that Islamic mortgages are more expensive than the conventional ones

Monthly payments are high in murabahah, but volatile in ijara

Each transaction can be complex and difficult to convey as there are combination of contracts involved in a single transaction

There is a possibility for “negative equity” in the ijarah mortgage

Absent or underdeveloped international capital market

No market maker mechanism


Article written by Nurul Islam, Founder & Executive Director of the European Bangladesh Federation of Commerce & Industry (EBF) and Director of the Nerissa Group.


Economics of Islamic Banking in India

Syed Zahid Ahmad


In the past few years Islamic finance in general and Islamic investment business in particular have gained considerable ground. Prominent global financial players such as McKinsey and Beary’s Group have introduced Shariah-compliant investment funds. China has recently opened its doors to Islamic banking in order to attract investment of funds from Muslim countries. Islamic banks in China and the UK are attracting even non-Muslim customers in a substantial way.

In India, East Wind has launched an Islamic Index while Reliance Money and Religare have launched Shariah-compliant Portfolio Management Services. Shariah-compliant stocks in the Indian stock market indicate positive trends.

Unfortunately, a great deal of misconception surrounds the issue of Islamic banking in India. Islamic banking is generally believed to be an exclusively religious domain of Muslims and it is feared that the introduction of Islamic banking in the country would lead to financial segregation and that in consequence of the move the country’s scheduled banks might lose Muslim depositors.

It needs to be clarified that the scope of Islamic banking need not be confined to the Muslim community alone; rather, its doors should be open to the wider Indian society. Regrettably, no study has been carried out on the economic viability and sustainability of Islamic banking in India and its potential for inclusive growth.



Islamic banking requires a far greater level of professional expertise compared to conventional banking because it deals more with investment projects than with monetary credit and debit transactions. Indian Muslims lack the requisite professional expertise to run modern commercial banking along Islamic lines. The State Bank of India, which is the country’s leading commercial bank, has the requisite expertise and infrastructure to manage the complex project of Islamic banking.

The Reserve Bank of India’s directions to scheduled commercial banks emphasise lending to the small and micro enterprises. In essence this reflects the significance of the Islamic approach to banking. The majority of borrowers from the unorganised sector are non-bankable due to collateral problems. They actually need equity finance rather than debt finance. The approach of Islamic banking is fundamentally different from the conventional approach in that it emphasizes equity deposits and credits while the instrument of interest is replaced by profit and loss sharing arrangements.

It is likely that even after the introduction of Islamic banking in India the first choice of depositors and investors would be nationalized banks. Indian Muslims also have confidence in nationalized banks. To ensure security of their deposits, the majority of Muslims depositors would prefer to join Islamic banking managed by nationalized banks and not the banks run by Muslims under the pretext of Islamic banking. However, it is expected that foreign investors looking to invest in India through Islamic banking would prefer to avail of the services of foreign banks. As far Indian Muslims are concerned, they have to make serious efforts to find their place in managing Islamic banking because they lack the necessary financial strength, expertise and infrastructure. More importantly, they have poor credibility among the depositors and investors due to the failure of a few financial institutions run along Islamic lines.

There are reasons to believe that Islamic banking, as and when introduced in India, would be helpful on several counts.

The 150 million-strong Muslim community in the country will have no hesitation in participating in banking transactions because the instrument of interest will not be there.

With the introduction of Islamic banking, Indian government will have the diplomatic advantage of financial dealings with Muslim countries and thereby attract trillions of dollars of equity finance from the Gulf countries.

Islamic banking will open new avenues of employment for Muslims and their presence in money and capital markets will improve. At present their presence in the banking sector is far lower than their proportion in the population. For instance, RBI employs 0.78% Muslims and scheduled commercial banks have just 2.2% Muslim employees. Similarly Muslims have a poor presence in NABARD, SIDBI and other financial institutions. Since financial institutions carry out interest-based transactions, many Muslims have reservations about participating in interest-based banking and financial institutions, resulting in their financial exclusion. The introduction of Islamic banking will redress the situation, at least to some extent.

Economic development is a continuous process and at present India has entered into the stage of high-cost economy. Here cost-push type of inflation is unavoidable. On the one hand, prices continue to rise and, on the other, the value of money, expressed in terms of purchasing power, keeps on declining. The continuation of inflation is highly injurious. If not controlled, it causes immense damage. Economists suggest several methods to overcome this problem, including keeping the “cost component” under control. It is here that Islamic banking can come to the rescue of an inflation-ridden economy. Since India’s scheduled commercial banks and other players in the money and capital markets extend debt finance, the interest component of their transactions adds to the rising costs. Since the credit cost is zero under equity finance, the severity of inflation may be minimised.

The continuation of inflation causes severe inequalities of income and wealth distribution. It is possible, through the introduction of Islamic banking, to control such disparities by curbing inflationary tendencies. In addition to this, the dividends shared by depositors and investors on equity finance would help an equitable redistribution of income generated through the financial sector. These are a few positive points which need to be considered by the country’s financial sector regulators.



Islamic Banking and Financial Inclusion

Though we do not have any credible data to compare community-wise financial exclusion in India, the data gathered by the Justice Sachar Committee indicates that around 50% Muslims are financially excluded and that banking is inversely related to the concentration of Muslim population. There are several reasons for this state of affairs. Since Muslims hesitate to enter into interest-based transactions, they try to develop alternative means such as interest-free societies. Their efficacy seems to be limited because of their poor capital base. Viewed from this perspective, the introduction of Islamic banking will help Indian Muslims to mitigate, if not eliminate, their financial exclusion.

The share of Indian Muslims in total savings deposits is 7.4% and their share in credit from banks is 4.7%. If we consider this as a standard proportion in aggregate deposits with and loans from scheduled commercial banks, Indian Muslims annually lose around Rs. 66,700 crores because they have a credit-deposit ratio of 47% as against the national average of 74%. It shows that Muslims lose around 27% of their deposits by not availing as credits. With the introduction of Islamic banking the intensity of this invisible loss to Muslim community will hopefully decline. Muslims avail of just 4% and a mere 0.48% credit from special financial institutions like NABARD and SIDBI respectively. This poor percentage may be partly attributed to the hesitation on the part of Muslims to engage in interest-based transactions.

Indian Muslims are looking forward to interest-free banking in order to avail of credit facilities for their betterment. Since Muslims are unable to start Islamic banks on a large scale on the strength of their meagre resources, the incorporation of Islamic banking principles into conventional banking may add at least 60 millions Muslims to the formal financial sector. This may enable Indian banks to mobilise additional savings worth 1,00,000 crores and extend credit worth over Rs. 2,00,000 crores.

Since Islamic banking focuses on equity deposits and finance, it is expected that stock market will be the most preferred avenue for investments by Islamic banks. Currently the Indian stock market is attracting investments under Shariah Finance schemes. It is expected that a good volume of term deposits with Islamic banks in India will preferably find their way into the Indian stock market. Experience has shown that the stock market is a safe and attractive mode of deploying equity funds. Thus Islamic banks may add additional 6 million new D-mat accounts with expected capital gain of Rs. 60,000 crores from domestic market and around one trillion US dollars through Islamic banks managed by foreign banks in India.

Under Islamic banking, the formal sector economic agents like corporate firms listed with stock markets would be the likely beneficiaries of Islamic banking because their shares would be subscribed through investors at Islamic banks. All the companies listed in stock markets will have additional subscribers who would genuinely subscribe their shares instead of indulging in speculative trading in stocks.

Where public finance is insufficient and debt finance may cause huge budgetary deficits, Islamic banking may help mobilize capital on equity basis to meet huge requirements of a growing economy like ours. With the incorporation of Islamic banking principles, the mobilisation of equity funds would be easier for banks. We must remember that over 50% of our rain-fed lands need irrigation which require huge investments. Further, the total investment in infrastructure in 2006–07 was estimated to be around 5% of the GDP. It has to be 9% of GDP by 2011-12, which requires Rs. 2,07,291 crores in 2006-07 and Rs. 5,74,096 crores by 2011-12 to finance our infrastructure. The total investment amounts to Rs 20,56,150 crore for the 11th five year plan, of which Rs. 14,36,559 crores are supposed to be met from public Investment and Rs. 6,19,591 from private investment. Islamic banking, by mobilizing equity finance from national and international markets, may reduce this burden on the public sector effectively. Once public finances are under control we need not worry about fiscal deficits and their potential inflationary threats.

Since we have no project or viability report on this issue, it would be advisable on the part of government to appoint a committee with a specific mandate to vigorously study the prospects of Islamic banking in India. At the same time it is also necessary that the vocal supporters of Islamic banking should present its case not just as a religious issue but as a broad-based financial alternative which would be beneficial to sections of society, regardless of caste or creed.

source : ios minaret

Recent changes to the Japanese banking regulations on Islamic finance


The Japanese Financial Services Agency recently published the draft of a bill for the amendment of the banking regulations which allows subsidiaries of Japanese banks to conduct certain types of Islamic finance. This article will briefly explain the current situation of Japanese banking regulations and the banking regulations to be amended. Japanese banking regulations with regard to Islamic finance Regulations on banks In principle, Japanese banks are only permitted to conduct the activities that are listed in the banking law and the ancillary activities to such listed activities. Other than permitted exceptions, for example, the banking law does not permit banks to buy products. In a Murabaha (cost-plus-sale) transaction, banks purchase merchandise from a broker, and in an Ijara (lease-to-own) transaction, banks own the merchandise for the leasing period. Under the current banking law, therefore, banks themselves cannot usually participate in Murabaha and Ijara transactions. The new banking regulations do not change the above regulatory situation. Banks are allowed to invest in securities; interests in Mudaraba and Musharaka can be considered securities under the securities regulations. Banks, therefore, are considered to be able to invest in general Mudaraba and Musharaka transactions, provided that their position is considered to be as pure investors. If the bank’s role goes beyond that of pure investor, however, the act might be prohibited under the Japanese banking regulations. If a bank acts as a real-estate adviser to a partnership that gives advice on the types of real estate the partnership should invest in, for example, such act might be prohibited. Banks should take careful note of this. Mudaraba or Musharaka might be treated as subsidiaries or associated companies under consolidated accounting rules if banks invest more than a certain percentage, or have more than a certain level, of controlling rights in the transaction. Some burdensome banking regulations might be applicable to subsidiaries and associated companies of banks. If banks wish to avoid these issues, they should carefully consider how the structure is set up. The new bill and regulations on subsidiaries of banks Subsidiaries of Japanese banks are also prohibited from being involved in activities other than particular kinds of listed activities and ancillary activities. The activities which subsidiaries can deal with are broader than those of banks, and it is notable that there is a possibility that subsidiaries can deal with some types of Ijara and Murabaha, even under the current banking regulations. The FSA recently published a draft of a bill for the amendment of the banking regulations which allows subsidiaries of Japanese banks to conduct “lending” type Islamic finance transactions. This bill is now under public comment procedures and it is likely to come into effect from December 2008. The bill stipulates that subsidiaries can handle such business if the transaction satisfies the following conditions: Regulations on foreign banking subsidiaries of Japanese banks Japanese banks are allowed to have foreign banks (foreign companies that engage in banking business) as subsidiaries (hereinafter “foreign banking subsidiaries”). Japanese banking regulations in principal allow foreign banking subsidiaries to engage in business which is allowed under the respective foreign jurisdiction — provided that such business does not seek to evade the substance of the Japanese banking law. If local regulations permit foreign banking subsidiaries to engage in certain Islamic financial business, therefore, establishing such foreign banking subsidiaries is a possible way for Japanese banks to participate in Islamic financial business. The Japanese mass media conveys the message that the new bill “opens” Islamic finance to Japanese banks; however, the bill does not change any regulations that apply to banks themselves. The subsidiaries will be allowed to conduct “lending” type transactions under the new bill in addition to certain “equity” type Islamic finance which is already permitted under the current banking regulations. The enactment of the new bill is a monumental step because it is the first law which is intended to directly target Islamic finance in Japan. The new bill is hoped to further promote the development of Islamic finance in Japan. So Saito is a partner at Nishimura & Asahi in Tokyo, Japan. He specializes in securitization, Islamic finance, Basel II finance, risk finance, derivatives, acquisition finance, and compliance with banking and securities regulations. He is licensed to practice law in Japan and New York.

  1. The transaction is deemed equal to money lending, although not money lending itself.
  2. No interest should be charged because it is prohibited by religious discipline.


  1. The board that consists of members who have professional knowledge of the religious discipline of such non-lending transactions accepts such transaction.

The bill itself contains some ambiguity, and there are various kinds of Islamic finance transactions, from more “lending” type transactions to “equity” type transactions, therefore, each subsidiary has to decide by itself what kind of transaction falls into the category of “equal to money lending”.

source jurist jp

Islamic banking rules help escape fallout of global woes

Islamic banking has largely escaped the fallout from the global financial crisis, thanks to rules that forbid the sort of risky business that is felling mainstream institutions. But experts say that because of its heavy reliance on property investments and private equity, the booming US$1.0 trillion global industry could be hit if the turmoil worsens and real assets start to crumble.

“In the current financial turmoil, it is interesting to note that Islamic financing may have prevented a majority of the mess created by the conventional banking and financial institutions,” Kuwait Finance House said in a report.

“The outlook for Islamic financing is bright and will likely take the lead in terms of providing funding for major projects as the conventional banking system reevaluates its business model.” The rules of Islamic banking and finance — which incorporate principles of sharia or Islamic law — read like a how-to guide on avoiding the kind of disaster that is currently gripping world markets.

Islamic law prohibits the payment and collection of interest, which is seen as a form of gambling, so highly complex instruments such as derivatives and other creative accounting practices are banned.

Transactions must be backed by real assets — not shady repackaged subprime mortgages — and because risk is shared between the bank and the depositor there is an incentive for the institutions to ensure the deal is sound.

Investors have a right to know how their funds are being used, and the sector is overseen by dedicated supervisory boards as well as the usual national regulatory authorities.

“Islamic banking has, thus far, remained positive, despite the current challenging global financial environment,” said Zeti Akhtar Aziz, the central bank governor of Malaysia, which is Southeast Asia’s leader in Islamic banking.

Zeti said this month that because of the slowing global economy, plans for Islamic “sukuk” bonds had been postponed or scrapped by companies including Kuwait’s Abyaar Real Estate Development Co. and Malaysia’s Perisai Petroleum.

And Jennifer Chang, a partner at Pricewaterhouse Coopers in the Malaysian capital Kuala Lumpur, said that given the extent of the global crisis, Islamic banks may suffer damage despite their strong position.

“Islamic banks, especially in the Middle East, got heavily into private equity and real estate investments, and a lot of loans may be backed by properties. So if the property market goes down, there will be an impact,” she said.

source tcp

London warms to Islamic finance

The land of Adam Smith now teems with a vibrant Islamic banking sector, with even non-Muslims being lured by the model’s promise of transparency and stability.

Shabaz Bhatti is proud to be a devout Muslim – but his plans to remortgage the family home with one of Britain’s new generation of Islamic banks isn’t just about religion.

The 30-something driving instructor wants reliability, and believes Britain’s growing Islamic finance sector offers this in a way that myriad traditional main street banks no longer do.

“It’s simple and straightforward, which is great because … it seems as though interest rates right now could go ballistic,” says Mr. Bhatti, whose parents immigrated to England from Pakistan.

At a time of almost unprecedented financial volatility, Islamic banks are being hailed as bastions of stability. Growing numbers of individuals and companies are now embracing their workings, which are based on Koranic principles.

Using law changes and generous tax breaks, the British government is now attempting to transform London into the Western world’s center for Islamic finance. Conventional banks and financial institutions are also rolling out a range of Islamic finance products.

Globally, the market for Islamic financial services is estimated to have grown more than threefold over the past decade – from around $150 billion in the mid-1990s to $500 billion in 2006.

Keen to tap into this, Britain’s authorities are planning to become the first Western government to issue an Islamic bond – called a sukuk – structured to comply with the sharia law principles of Islamic finance, which forbids all forms of interest payments.

Sharia law also prohibits investing in any enterprises involved with alcohol, gambling, tobacco, and pornography – a fact that nicely dovetails with the growing number of Westerners seeking socially responsible investments.

According to a new study by International Financial Services London (IFSL), an independent organization representing Britain’s financial services industry, Islamic finance will emerge largely unscathed from the current global crisis, largely because its structures make little or no use of many of the complicated instruments blamed for the current problems in conventional finance, such as derivatives and short-selling.

Although Islamic finance does allow for risk-taking, it does not permit excessive uncertainty, known as gharar. All deals to buy or sell are invalid if the object dealt with is not certain and transparent.

When risks are taken, the Islamic financial model insists they are shared. In retail, this involves the customer and their bank sharing the risk of any investment on agreed terms, and dividing any profits between them. Products revolve around principles such as murabaha, a form of credit enabling customers to make a purchase without having to take out an interest-bearing loan. The bank buys the item and then sells it on to the customer on a deferred basis.

Bhatti, who lives in the leafy London suburb of Wimbledon with his wife and young daughter, is currently a customer of Abbey National, a traditional, Western bank. He has had no objection to using conventional Western financial products. However, in the past, the couple were customers of the Bank of Kuwait when they bought a home costing nearly $200,000 in the London district of Croydon.

The Bank of Kuwait valued the house at about $270,000, based on what it was expected to be worth at a later date, and arranged for the family to pay the money back in equal installments over the next 16 years. Now, Bhatti is planning to return to such an arrangement by transferring his conventional mortgage to an Islamic bank.

“With the current economic situation, our plans to go back to Islamic banking are not just about religion, they’re a financial decision. It’s more secure … and it’s clearer for the future,” he says.

More than 26 banks in the UK offer Islamic financial products, including major institutions such as HSBC. Six Islamic banks are wholly compliant with sharia law. A pioneer of Islamic retail banking has been the Islamic Bank of Britain, which has 64,000 account holders and branches in cities including London, Birmingham, and Manchester. The bank recently launched its most competitively priced sharia mortgage to date, offering terms that company executives hope will lure takers beyond its core market of Britain’s 2 million working Muslims.

This country’s growing Muslim community is helping broaden London’s reputation as a financial capital, says Patrick Lamb, an official who joined a British government delegation this week to the World Islamic Banking Conference in Bahrain, where the UK authorities and a range of London-based banks and firms showcased their expertise.

“We have by far the largest concentration of Islamic finance anywhere in Europe,” Mr. Lamb says.

Along with home and retail finance, increasing numbers of companies are also turning to Islamic finance to raise money for expansion, ranging from steel manufacturers to luxury gift firms, which are often owned by Muslims or have Muslim shareholders. Money from wealthy Gulf investors has been pouring into Britain in recent years. There is no more potent symbol of this than the skyline of London’s financial center, known as The City.

A fund from Kuwait spent more than $600 million recently to buy the Willis Building, one of the tallest in the district, while nearly $3 billion is coming from Qatar to finance the building of what will be Europe’s tallest building, a 1,000-foot-tall structure known as the Shard of Glass.

source : csmonitor3259865949_85aa743a0e

CSR for Islamic financial institutions

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is developing a governance standard on corporate social responsibility (CSR) for Islamic financial institutions.

The Auditing and Governance Standards Committee consisting of high level executives from the international Islamic finance industry met at the Bahrain Institute of Banking and Finance (BIBF) to finalise the specific details of the standard.

The standard will highlight the importance of CSR from an Islamic perspective and give guidance to Islamic financial institutions in carrying out its CSR functions.

“With substantive provisions on CSR conduct and disclosure, this standard will open the way for Islamic financial institutions to be recognised for their positive ethical and social activities and further differentiate them from other financial organisations as direct contributors to society,” Centre for Islamic Finance R&D manager Sayd Farook said.

The CSR standard complements AAOIFI’s 68 existing international standards on Sharia, accounting, auditing, ethics, and governance.

AOIFI’s standards are adopted in leading Islamic financial centres across the world including Bahrain, Dubai Islamic Financial Centre, Qatar, Qatar Financial Centre, Sudan, and Syria as well as by the Islamic Development Bank Group.


Is Islamic Finance Panacea for Global Credit Crisis?

“Islamic finance can also reduce the problem of subprime borrowers by providing them loans at affordable terms. This will save billions of dollars that are spent to bail out the rich bankers,” said Chapra, who at present works as adviser at the Islamic Research and Training Institute of the Islamic Development Bank.

Chapra estimated the derivatives market at $600 trillion, more than 10 times the size of the world economy.

“No wonder George Soros described derivatives as hydrogen bombs while Warren Buffett called them financial weapons of mass destruction,” he pointed out. The derivatives include credit default swaps (CDS) worth $54.6 trillion.

The Islamic economist described the present global financial crisis as the worst in four decades. “There is a lurking fear that this might be only the tip of the iceberg. A lot more may come if the crisis spreads further and leads to a failure of credit card institutions, corporations, and derivatives dealers,” he warned.

Chapra urged Muslims to establish a genuine Islamic finance system with proper checks and controls, adding that such a move would encourage others to embrace it.

The Islamic system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through the sale or lease of real assets by means of its sales- and lease-based modes of financing such as murabaha, ijara, salam, istisna and sukuk.

Spelling out the regulatory regimes in the Islamic system, Chapra said: “The asset which is being sold or leased must be real, and not imaginary or notional; the seller must own and possess the goods being sold or leased; the transaction must be genuine with the full intention of giving and taking delivery; and the debt cannot be sold and thus the risk associated with it cannot be transferred to someone else.”

He said the conditions set by the Islamic system would help eliminate most of speculative transactions. “Financing extended through the Islamic products can expand only in step with the rise of the real economy and thereby help curb excessive credit expansion,” he said.

Chapra emphasized the significance of the condition that prevents a creditor from transferring the risk to someone else by selling the debt. “This will help eliminate a great deal of speculative and derivative transactions where there is no intention of giving or taking delivery. It will also help prevent an unnecessary explosion in the volume and value of transactions and the debt from rising far above the size of the real economy,” he added.

It will also release a greater volume of financial resources for the real economic sectors and, thereby, help expand employment and self-employment opportunities and the production of need-fulfilling goods and services.

The discipline that Islam wishes to introduce in the financial system may not materialize unless the governments reduce their borrowing from the central bank to a level that is in harmony with the goal of price and financial stability, Chapra said.

“In the Islamic system, credit is primarily for the purchase of real goods and services which the seller owns and possesses and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully,” he explained.

He said excessive and imprudent lending by banks was the main cause of the current global crisis.

“There are three factors that make this possible: inadequate market discipline in the financial system resulting from the absence of profit and loss sharing (PLS); the mind-boggling expansion in the size of derivatives, particularly CDSs; and too big to fail concept of banks who believe that the central bank would come for their rescue.”

The false sense of immunity from losses introduces a fault line in the system as banks do not undertake a careful evaluation of their loan projects. This leads to an unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, living beyond means, and speculative investment. Unwinding later on gives rise to a steep decline in asset prices, and to financial frangibility and debt crisis, particularly if there is overindulgence in short sales.

Chapra said the subprime mortgage crisis in the US was also the result of excessive and imprudent lending. “Securitization or the originate-to-distribute model of financing has played a crucial role in this. Mortgage originators collateralized the debt by mixing prime and subprime debt. By selling the collateralized debt obligations (CDOs), they passed the entire risk of default to the ultimate purchaser. They had, therefore, less incentive to undertake careful underwriting.”

Consequently a number of banks have either failed or have had to be bailed out or nationalized by governments in the US, the UK, Europe and a number of other countries.

“This has created uncertainty in the market and led to a credit crunch, which has made it hard for even healthy banks to find financing,” he said.

“When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive urge for resorting to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults,” he added.


Islamic Finance: Law, Economics, and Practice

Autors : Mahmoud A. El-Gamal
About the Author
Mahmoud A. El-Gamal is Professor of Economics and Statistics at Rice University, where he holds the endowed Chair in Islamic Economics, Finance, and Management. Professor El-Gamal has also served in the Middle East Department of the International Monetary Fund (1995-96), and was the first Scholar in Residence on Islamic Finance at the U.S. Department of the Treasury in 2004. He has published extensively in the areas of econometrics, finance, experimental economics, and Islamic law and finance.

ISBN-10: 0521741262
ISBN-13: 978-0521741262

Publisher : Cambridge University Press

Introduction to Book
This book provides an overview of the practice of Islamic finance and the historical roots that define its modes of operation. The focus of the book is analytical and forward-looking. It shows that Islamic finance exists mainly as a form of rent-seeking legal-arbitrage. In every aspect of finance — from personal loans to investment banking, and from market structure to corporate governance — Islamic finance aims to replicate in Islamic forms the substantive functions of contemporary financial instruments, markets, and institutions. By attempting to replicate the substance of contemporary financial practice using pre-modern contract forms, Islamic finance has arguably failed to serve the objectives of Islamic law. This book proposes refocusing Islamic finance on substance rather than form. This approach would entail abandoning the paradigm of “Islamization” of every financial practice. It would also entail reorienting the brand-name of Islamic finance to emphasize issues of community banking, micro-finance, and socially responsible investment.

Islamic banking course: a first for Australia

life-bundooraLa Trobe University is planning to introduce the first course in Australia dedicated to Islamic banking and finance, joining a handful of universities in the West embracing this fast-growing segment of global finance.

The Master of Islamic Banking and Finance will provide students with postgraduate training in the technical skills demanded by Global Islamic capital markets and institutions.

Associate Professor Dr Ishaq Bhatti, of La Trobe’s Department of Economics and Finance, says the Masters program will appeal to international students from Asia wanting Islamic financial training in English and to local graduates keen to enter the growing sector in Australia. Several local banks – NAB, Kuwait Finance House, HSBC and Muslim Community Cooperative of Australia are active in the field.

The International Centre of Education in Islamic Finance, a training subsidiary of Bank Negara Malaysia, the equivalent to Australia’s Reserve Bank, will provide industry-based certification for graduates of the La Trobe course, opening up employment opportunities throughout the international banking and finance sector.

‘The Islamic banking and finance market has experienced substantial and unexpected growth in recent years, growing at a rate of ten to fifteen percent per year,’ Dr Bhatti says.

‘Today, more than 260 Islamic financial institutions are operating worldwide, which are claimed to manage assets worth no less than A$500 billion, while the assets held by Islamic financial institutions were only A$8.5 billion in 1985.

‘Such immense growth has brought Islamic finance to the attention of the international banking community, prompting the major banks to set up Islamic financial windows to take advantage of demand for Shariah compliant finance.’

Islamic banking has grown from Shariah law which traditionally bans usury – the charging of interest on loans, Dr Bhatti says. ‘Islamic banking is a community activity. It offers equity and security between lender and borrower. If a borrower runs into financial difficulty, it is the responsibility of the lender to help sort out his problems.’

The bank will reduce payments, offer moratoriums, give free financial planning advice and in some cases pay out the loan through the zakah, a fund set up out of the 2.5 per cent annual contribution from accumulated assets required by Shariah law which seeks to encourage the distribution of wealth.

In his recently-published book, Developments in Islamic Banking, Dr Bhatti calls this approach ‘a paradigm of fairness and equity’, contrasting it with conventional economics which has little interest in promoting benevolent behaviour in the market. The lender in Western financial systems enjoys an exclusive right to get back his rented capital with a predetermined interest income, whereas a borrower may bear interest risks out of all proportion to his abilities.

Islamic banking seeks to redress this imbalance by dividing the risk between lender and borrower. In the more intimate setting of the community, the lender will accompany the borrower and purchase the new car or computer on his or her behalf.

Repayments are set according to a formula which includes the purchase price of the item, the rate of inflation, bank costs and a profit margin. This margin is set at the time of the loan and is not subject to variation.

Similarly, in the case of the residential housing market, the bank will buy a house for the customer and rent it back at market value. Any additional repayments will come off the value of the loan. Western financial institutions have acknowledged the stability of the Islamic banking system and invested heavily in its bonds.

Dr Bhatti makes the point that maximising profit is not the major objective of this system.

‘In the conventional system the bank can lend more than their assets. They then issue bonds which are debit-based products to attract investors.’

Islamic banks are not debt-based but asset-based, he says. This makes their bonds attractive to low-risk investors. Western financial institutions such as Citibank have acknowledged the inherent economic stability of the Islamic banking system and invested heavily in their bonds, Dr Bhatti says.

Rhonda Dredge