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Islamic Finance: An Industry Overview
- 1. Islamic FinanceIndustry Overview Junaid Mirzajunaid@islamicfinanceboard.com
- 2. Outline Size of the Industry Overview of History and Development Islamic Finance and the Economic Crash of 2008 Islamic Finance vs. Conventional Finance 2
- 3. Industry Size & Composition Size: Current: 300+ institutions - US $700 billion Expected: $1.4 trillion industry by 2010 Composition: Islamic financial institutions $178.5 B Conventional banks’ Islamic window $200 B Islamic capital markets $300 B Takaful assets $20 B Non-banking financial institutions $ 9-12 B Source: The Islamic Financial Services Industry - Ten Year Master Plan (2006-2015) by IFSB, IRTI and IsDB IFSB: Islamic Financial Services Board, IRTI: Islamic Research & Training Institute, IsDB: Islamic Development Bank
- 4. Snapshot of Global Islamic Finance
- 5. Is Islamic Finance new? Based on the Quran and Sunnah An important branch of mu’amalat Impact of colonialism Post-colonial era and the need to provide halal alternatives 1.08
- 6. Is Islamic Finance new?
- 7. Is Islamic Finance new? 1.09 Primary motive: prohibition of Riba First experiments in Malaysia and Indonesia in 1960s Impact of oil wealth of the 1970s Key Question: How does an Islamic financial institution operate in a society where other Islamic systems are not in place?
- 8. June 1, 1975 Sunday
- 9. Early Western criticisms 1.10 Infinite demand and zero supply for loanable funds Incapable of equilibrating demand for and supply of loanable funds No incentive to save No investment and no growth Monetary policy would not be feasible since instruments for managing liquidity would not exist Islamic finance would result in one-way capital flight
- 10. Response to criticisms 1.11 A modern financial system can be designed without the need for an ex ante positive nominal fixed interest rate and no satisfactory theory could explain the need for an ex ante positive nominal interest rate The failure to assume an ex ante positive nominal interest rate does not necessarily mean zero return on capital The return on capital is determined ex post, and the magnitude of the return is determined on the basis of the return to the economic activity in which the funds are employed The expected return is what determines investment
- 11. Response to criticisms The expected rate of return and income are determinants of savings Positive growth is possible in such a system Monetary policy would function as in the conventional system, its efficacy depending on the availability of instruments designed to manage liquidity In an open-economy macroeconomic model without an ex ante fixed interest rate, but with returns to investment determined ex post, the assumption of a one-way flight of capital is not justified
- 12. Response to criticisms In fact, the researchers and scholars argued, an Islamic financial system is superior to the conventional system because: It promotes symmetry of risks and rewards It is more stable Source: “Risk Analysis for Islamic Banks” by Hennie van Greuning and Zamir Iqbal (World Bank) 1.12
- 13. History of Islamic Banking (1) 1960s: 1961-64 Mitghamr Saving Associations Egypt 1967 Tabung Haji (Pilgrimage Fund) Malaysia 1970s: 1975 Islamic Development Bank (IsDB) Saudi Arabia Dubai Islamic Bank UAE 1976 1st Islamic Economics Conference Saudi Arabia 1977 Kuwait Finance House (KFH) Kuwait Source: The Islamic Financial Services Industry - Ten Year Master Plan (2006-2015) by IFSB, IRTI and IsDB IFSB: Islamic Financial Services Board, IRTI: Islamic Research & Training Institute, IsDB: Islamic Development Bank
- 14. 1980s: Pakistan, Iran, and Sudan announced to transform their overall financial systems to be in compliance with the Shariah 1981 - Islamic Research and Training Institute (IRTI) Saudi Arabia 1983 - 1st Islamic Bank in Malaysia established Malaysia 1984 – 1st Takaful (Islamic insurance) Operator Malaysia 1990s: Major financial institutions offer Islamic Finance (ie Citigroup, HSBC) Formation of AAOIFI, the 1st Islamic accounting body Bahrain Harvard Islamic Finance Forum established USA Launch of Islamic indices like Dow Jones Islamic USA History of Islamic Banking (2) Source: The Islamic Financial Services Industry - Ten Year Master Plan (2006-2015) by IFSB, IRTI and IsDB IFSB: Islamic Financial Services Board, IRTI: Islamic Research & Training Institute, IsDB: Islamic Development Bank
- 15. Year 2000 and beyond: Issuance of 1st Global Sukuk Bonds Malaysia Islamic Infrastructure institutions established: Islamic Financial Services Board (IFSB) in Malaysia International Islamic Financial Market (IIFM) International Islamic Rating Agency (IIRA) (General) Council of Islamic Banks and Financial Institutions (CIBAFI) Arbitration and Reconciliation Centre for Islamic Financial Institutions (ARCIFI) History of Islamic Banking (3) Source: The Islamic Financial Services Industry - Ten Year Master Plan (2006-2015) by IFSB, IRTI and IsDB IFSB: Islamic Financial Services Board, IRTI: Islamic Research & Training Institute, IsDB: Islamic Development Bank
- 16. Rise in popularity 1940s and 50s: development of theory 1960s: first Islamic banking efforts 1970s and 80s: more organized commercial banking, trade finance, syndication, Islamic conglomerates 1990s: Concentrations of Islamic banks growing in selected countries, hard asset private equity fund management 2000s: Structured sukuk and capital market development, mega project finance, large commercial banks, Islamic derivatives 16
- 17. Rise in popularity1992 Survey in the U.K
- 18. Rise in popularity1994 Study of Malaysian Customers
- 19. Historical Growth Factors 1975 – 1990 Resource boom Theoretical musings and experimentation Response to challenges 1991 – 2000 Regulatory recognition and encouragement Growth of tiger economies Development of infrastructure 2001 – 2007 Resource wealth and surplus liquidity Sukuk market development Islamization and religiosity Real estate boom Further infrastructure development 19
- 20. But what happened in 2008? 11/18/2009 20
- 24. Did Islamic Finance really fare better in this economy?
- 26. Why did it fare better? Conventional Finance Interest creates an artificial money supply Sell money when you have none Sell assets before they exist Push all the risk to the borrower Islamic Finance Interest free system that forces risk sharing No profit without risk Money advanced is always backed by real assets and services Contractual certainty
- 27. Where do we go from here? Strong rebound in the Islamic finance market No signs on interest in Islamic finance abating – in fact, it is growing Growth rate forecasts of 20 to 30 percent per annum for the near term future Western world increasingly looking at Islamic finance Western governments Financial institutions Corporations 27
- 28. Why in the West? Better business model? More fair and equitable? A growing Muslim population? Dollars and cents? Capital in the Middle East?
- 29. Islamic Financial Institutions in the Western Countries
- 30. Providers of Islamic financial education?
- 32. Where do we go from here? 32
- 33. End of Session 1 33
Editor's Notes
- -Commercial code is Islam was developed based on certain principles laid down in the primary sources-Islamic financial law was dealt with and developed as a branch of mu’amalat by Muslim scholars in the Middle Ages-While banks and other financial institutions existed in the medieval Muslim countries, it was not until the colonial era that Muslim countries were first introduced to the modern Western bankThe traditional modes of financial institutions in Muslim countries largely disappeared under the colonial onslaught and were replaced by Western banks-In the post-colonial era the need was felt to revive Islamic finance—especially in the context of banking—to provide a halal alternative to the Muslim populous-Muslim scholars and activists started discussing an interest-free banking system in the late 19th century Muhammad ‘Abdu and Rashid Rida (1890s)Hasan Al-Banna and Abul ‘Ala Mawdudi (1940s)
- Minority opinions have existed to allow paying or taking of interest, but have been denounced by the greatest majority of jurists in every eraEbusuudEfendi, the Mufti of Istanbul between 1545 and 1574 CE allowed for interest-taking by awqaf as a practical matter of necessity. Muhammad SayyidTantawi, Grand Mufti of Egypt and now Sheikh-al-Azhar, in 1989 and again recently.First Islamic institutions established in Malaysia and Egypt in the 1960sA number of small ‘Islamic banks’ mushroomed all over the Middle East in the 1970sResulted in a concentrated scholarly effort to research and develop the theoretical foundations of modern Islamic finance and bankingKey issue: how does an Islamic financial institution operated in a society where other Islamic systems are not in place (refer back to the Traditional Islamic Conception)First commercial Islamic bank in UAE in 1974Islamic Development Bank in Saudi Arabia in 1975Though the primary principles of Islamic finance were well established, operating in the modern global economy poses new challenges to Islamic finance and Muslim jurists resulting in constant debate and development in the field of Islamic financial law
- Based on “Risk Analysis for Islamic Banks” by Hennie van Greuning and Zamir Iqbal (World Bank)With the establishment of first Islamic banks, western economists and analysts made a number of arguments against the feasibility of a banking system that operates without interestZero interest would result in infinite demand and zero supply for loanable fundsSystem would be incapable of equilibrating demand for and supply of loanable fundsZero interest would mean no incentive to saveZero interest would mean no investment and no growthMonetary policy would not be feasible since instruments for managing liquidity would not exist without a predetermined, fixed rate of interestCountries implementing Islamic finance would see one-way capital flight
- By 1988, these arguments were countered when research based on modern financial and economic theory showed:A modern financial system can be designed without the need for an ex ante positive nominal fixed interest rate and no satisfactory theory could explain the need for an ex ante positive nominal interest rateThe failure to assume an ex ante positive nominal interest rate does not necessarily mean zero return on capitalThe return on capital is determined ex post, and the magnitude of the return is determined on the basis of the return to the economic activity in which the funds are employedThe expected return is what determines investmentThe expected rate of return and income are determinants of savingsPositive growth is possible in such a systemMonetary policy would function as in the conventional system, its efficacy depending on the availability of instruments designed to manage liquidityIn an open-economy macroeconomic model without an ex ante fixed interest rate, but with returns to investment determined ex post, the assumption of a one-way flight of capital is not justified
- It promotes symmetry of risks and rewardsConventional system has the debtor carrying the greatest risk with the lender having government support in enforcing the contractIt is more stableConventional system has an inherent maturity mismatch between liabilities (short-term deposits with guaranteed nominal values) and assets (long-term investments without guaranteed nominal values)
- CitigroupHSBCDeutsche BankUBSABN AMROStandard Chartered Bank
- In a surveyconducted in theUK,Omer (1992) found a high levelof ignorance among the 300 interviewedMuslimswith regard to what constitutes acceptable Islamic finance principles. He reported that the higherthe religious commitment and the lower the level of general education, the stronger the preference forIslamic over conventionalfinance.
- Haron,Ahmad and Planisek (1994) found that the selectioncriteria ofMuslim bank customers inMalaysia was largely based on non-religious aspects, such as serviceefficiency, transaction speed, and the friendliness of bank personnel. Evenwith these results, some 40% ofthe respondents indicated that religionwas a prime reason for using Islamic banking services. They notedthat although therewas a high levelof awareness of Islamic products, there was a poor understanding ofthe differences between Islamic and conventional banking, as well asweak knowledge regarding Islamicproducts and services.Nasser, Jamal, andAl-Khatib (1999), surveying 206 bank customers on Jordan, added a bank’s reputationand perceived levelof confidentiality to this list of selection criteria noted in the Haron et al (1994) study.Again, as in the earlier case, the researchers noted a high level of ignorance regarding specific Islamicproducts,with70%of the respondents stating that religion was a very important reason for themto selectan Islamic bank.Similarly, Gerrard and Cunningham (1997) found no difference betweenMuslims and non-Muslims onbank selection criteria.They do note, however, that nearly 25%of the respondents indicated that religionwas to the sole basis for choosing an Islamic bank. These primary findings are in contrast to Metawa andAlmossawi (1998)who interviewed 100 Islamic bank customers in Bahrain and found that the singlemostimportant factor for the selection of an Islamic bank is the Sharia-based principles that govern thesefinancialinstitutions.Hamid andNordin (2001) surveyed Malaysian commercialbank customers, finding a a high awareness ofIslamic banking but poor self-reported knowledgeofspecific Islamic products, includingpoor understandingof the difference between Islamic and conventionalbanking. In another studyof Malaysian commercialcustomers and their views of Islamic financial services,AhmadandHaron (2002) noted that 65%of therespondents admitted to having limited knowledge of Islamic banking,while at the same time indicating thatthey believed the concept had good potential in theMalaysian market.
- The last two years have had a devastating effect on economies of the world; A massive economic collapse led by the financial sector; One silver lining – it forced the world to take a hard look at the financial system that caused the crash and start asking: is there an alternative system that might be better? Are the assumptions that we have for so long taken as fact about how the economy is run, how the economy must be run, in fact true? Is there a better way of doing business?