Fundamentals of islamic finance and banking

Fundamentals of Islamic Finance and Banking Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more For a list of available titles, visit our website at www.WileyFinance.com Fundamentals of Islamic Finance and Banking SYEDA FAHMIDA HABIB This edition first published 2018 © 2018 Syeda Fahmida Habib Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at www.wiley.com All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Designations used by companies to distinguish their products are often claimed as trademarks All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners The publisher is not associated with any product or vendor mentioned in this book Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose It is sold on the understanding that the publisher is not engaged in rendering professional services and neither the publisher nor the author shall be liable for damages arising herefrom If professional advice or other expert assistance is required, the services of a competent professional should be sought Library of Congress Cataloging-in-Publication Data Names: Habib, Syeda Fahmida, author Title: Fundamentals of Islamic finance and banking / by Syeda Fahmida Habib Description: Chichester, West Sussex, United Kingdom : John Wiley & Sons, 2018 | Series: Wiley finance series | Includes bibliographical references and index | Identifiers: LCCN 2018014020 (print) | LCCN 2018014740 (ebook) | ISBN 9781119371045 (pdf) | ISBN 9781119371038 (epub) | ISBN 9781119371007 (pbk.) Subjects: LCSH: Finance—Religious aspects—Islam | Finance—Islamic countries | Banks and banking—Religious aspects—Islam | Banks and banking—Islamic countries Classification: LCC HG187.4 (ebook) | LCC HG187.4 H33 2018 (print) | DDC 332.0917/67—dc23 LC record available at https://lccn.loc.gov/2018014020 Cover Design: Wiley Cover Images: © Denis Burdin/Shutterstock; © Aun Photographer/Shutterstock; © Wang An Qi/Shutterstock; © Pichu/Shutterstock Set in 10/12pt SabonLTStd by SPi Global, Chennai, India Printed in Great Britain by TJ International Ltd, Padstow, Cornwall, UK 10 9 8 7 6 5 4 3 2 1 This book is dedicated to my parents, my friend and husband Anwar Habib, my daughter Anika and son Ishraq, my sister Fauzia and my many, many students, who have always inspired and motivated me Thank you all for being my family and for being there for me always, with your love and trust in me Contents List of Figures xv List of Tables xvii Acknowledgements xix About the Author xxi Preface xxiii About the Website CHAPTER Introduction to Islamic Finance and Islamic Economics xxv Introduction 1 Creation of Money and Conventional Finance and Banking Definition of Islamic Finance and Banking Distinctive Features of Islamic Finance Economics and Islam Economics in Ancient Times Modern Economics Islamic Economics History of Islamic Economic Thought Principles of Islamic Economics Islam’s Solution to the Classic Economic Problem Islam and the Welfare Economy Property Ownership in Islamic Economics Zakat and Sadaqah Ban on Interest versus Cost of Capital in Islam Conventional Economics versus Islamic Economics Evolution of Islamic Finance 11 Early Days 11 Birth of Modern Islamic Finance 12 Institutional Developments During the Revival of Modern Islamic Finance 12 vii viiiContents The Mit Ghamr Experiment Tabung Haji Islamic Development Bank Dubai Islamic Bank Rapid Growth of the Islamic Finance and Banking Industry Islamic Finance and Banking in Muslim Communities and Countries Islamic Finance and Banking in Non-Muslim Countries Sub-sectors in the Islamic Finance and Banking Industry Current Status of Modern Islamic Finance and Banking Timeline of Development of Contemporary Islamic Finance and Banking Key Terms and Concepts Chapter Summary CHAPTER Shariah Law and the Shariah Supervisory Board Introduction to the Islamic Law – Shariah Sources of Shariah Schools of Islamic Jurisprudence Ethics in Shariah-Compliant Business and Finance Major Shariah Prohibitions and Principles and their Implications Prohibition of Interest or Riba Prohibition of Uncertain Dealings or Gharar Prohibition of Speculative Behaviour or Maysir Shariah Supervisory Board (SSB) Introduction to the SSB Formation of the SSB Status of the SSB Within the Industry Functions of the SSB Corporate and Shariah Governance Shariah Governance Process Key Terms and Concepts Chapter Summary CHAPTER Islamic Banking versus Conventional Banking Introduction to Islamic Banking Islamic Banking versus Conventional Banking Similarities Between Conventional and Islamic Banks Differences Between Conventional and Islamic Banking Relationship with the Central Banks Risks of Banks – Generic and Specific to Islamic Banks Generic Risks Risks Specific to Islamic Banks Financial Intermediation 13 13 14 14 14 15 16 16 17 18 21 21 27 27 28 29 30 31 31 32 33 34 34 35 36 36 38 38 39 39 47 47 49 49 49 50 51 51 52 54 Contents The Definition of Financial Intermediation Conventional Financial Intermediation Islamic Financial Intermediation Islamic Financial Intermediation Models Distribution of Islamic Banking Products Conventional versus Islamic Financial Intermediation Balance Sheet of an Islamic Bank – Sources and Uses of Funds by an Islamic Bank Sources of Funds Application of Funds Contracts in Shariah Law Contracts of Exchange in Shariah-Compliant Commerce and Finance Common Islamic Banking Products Retail Islamic Banking Products Corporate Islamic Banking Products Financial Accounting in Islamic Banking Objectives of Islamic Financial Accounting Features of Islamic Financial Accounting Challenges Faced by Islamic Banks Islamic Finance and the Financial Crisis International Islamic Regulatory and Standard Setting Bodies Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Islamic Financial Services Board (IFSB) Liquidity Management Centre (LMC) and International Islamic Liquidity Management (IILM) International Islamic Financial Market (IIFM) International Islamic Rating Agency (IIRA) General Council for Islamic Banks and Financial Institutions (CIBAFI) International Islamic Centre for Reconciliation and Commercial Arbitration for Islamic Finance Industry (IICRCA) Islamic Development Bank (IDB) International Islamic Fiqh Academy Key Terms and Concepts Chapter Summary ix 54 54 54 56 58 58 59 59 60 61 62 63 63 64 65 66 66 67 68 68 69 69 70 70 70 71 71 71 72 73 73 CHAPTER Murabaha 79 Introduction to Murabaha Conditions Related to Murabaha Calculation of Murabaha Profit The Murabaha Process Practical Applications of Murabaha 79 81 83 83 85 xContents Tawarruq, Reverse Murabaha or Commodity Murabaha Challenges and Problems Associated with Murabaha Comparison of Murabaha with Conventional Loans Key Terms and Concepts Chapter Summary 85 86 88 90 90 CHAPTER Mudaraba 95 Introduction to Mudaraba Use of Mudaraba for Financial Intermediation of Islamic Banks Profit Calculation in Mudaraba Provisions and Reserves Related to Mudaraba Mudaraba as a Limited Recourse Debt Finance Types of Mudaraba Shariah Conditions Related to Mudaraba Additional Conditions Related to Mudaraba Challenges and Problems Related to Mudaraba Practical Applications of Mudaraba Comparison of Mudaraba with Interest-Based Conventional Banking Accounting Issues Related to Mudaraba Key Terms and Concepts Chapter Summary 95 96 97 98 99 99 100 101 102 102 102 104 104 105 CHAPTER Musharaka 111 Introduction to Musharaka Types of Musharaka Shariah Rules and General Principles Guiding Musharaka Contracts Problems Related to Musharaka Practical Uses of Musharaka Examples of the Use of Diminishing Musharaka Securitization of Musharaka Comparison of Musharaka with Interest-Based Financing Comparison of Musharaka with Mudaraba Financing Key Terms and Concepts Chapter Summary 111 112 114 115 116 118 121 121 122 123 123 CHAPTER Ijara 129 Introduction to Ijara Ijara in Islamic Banks Types of Ijara Ijara, Regular Ijara or Operating Lease 129 130 130 130 Contents Ijara wa Iqtina, Ijara Muntahia Bittamleek or Financial Lease Ijara Thumma al Bay Shariah Rules and General Principles Guiding Ijara Contracts and their Characteristics Documentation Related to the Ijara Contract Main Differences Between Ijara and a Conventional Lease Differences Between Ijara and a Conventional Loan Contract Differences and Similarities Between Ijara Wa Iqtina and Diminishing Musharaka Practical Applications of the Ijara Contract Calculation of Lease Rentals Practice Calculations Key Terms and Concepts Chapter Summary xi 131 132 132 136 136 138 139 139 139 139 140 140 CHAPTER Salam 145 Introduction to Salam Important Characteristics of the Salam Contract History of the Salam Contract and its Shariah Acceptability Benefits of the Salam Contract Role of Islamic Banks in Salam and the Parallel Salam Contract Salam and Parallel Salam Diagram and Process Practical Application of Salam A Practical Example Problems Related to Salam Contracts Comparison of Salam Contract with Conventional Banking Key Terms and Concepts Chapter Summary 145 146 147 148 148 149 150 150 151 151 151 152 CHAPTER Istisna 155 Introduction to Istisna Shariah Rules and General Principles Guiding Istisna Contracts and their Characteristics Role of Islamic Banks in Istisna and Parallel Istisna Description of the Process Problems Related to Istisna and Parallel Istisna Comparison of Istisna with Interest-Based Finance, Salam and Ijara Difference Between Salam and Istisna Comparison of Istisna with Ijara Practical Application of Istisna Key Terms and Concepts Chapter Summary 155 156 158 159 160 161 162 163 163 164 164 268Glossary Tabarru  In Takaful the participants not just pay a premium to purchase the risk protection against any uncertain risk, rather they contribute their premium as a donation or gift into the Takaful fund Such a donation of the premium is aimed not only at providing loss protection for the participant but for others too in the group, thus including cooperative risk protection, social responsibility and caring for others in the process Takaful  A form of mutual help – the insured jointly guarantee each other Takaful model  In the case of a Takaful operator, its income and profit or loss scenario can be different depending on its operational structure Takaful operator  A registered and licensed body or corporation responsible for managing the operations of the Takaful fund on behalf of the participants Temporary Musharaka  This kind of Musharaka involves a single transaction or short-term financing, which concludes within one year The Musharaka could be renewed each year if required Common uses of temporary Musharaka are working capital financing Tradable Sukuk  Those Sukuks that represent ownership in tangible assets or in an enterprise that can be bought or sold at the Islamic capital market – for example Ijara, Mudaraba and Musharaka Sukuks Two-tier Mudaraba  In Islamic financial intermediation, the Islamic bank executes a Mudaraba contract with the depositors, where the depositors are the Rab al Maal while the bank acts as Mudarib or entrepreneur On the other hand, the Islamic bank enters a second Mudaraba contract with the users of the funds, the borrowers or entrepreneurs In this Mudaraba the bank acts as the Rab al Maal and the fund user is the Mudarib This is called the two-tier Mudaraba of Islamic financial intermediation Two-windows model  This model is almost the same as the two-tier Mudaraba, the only difference being that it has a reserve requirement The model divides the liability side of the bank balance sheet into two windows, one for demand deposits requiring 100% reserve and the other for investment deposits which have no reserve requirement Ujrah  This is the consideration or rent that the lessee pays to the lessor for the right to use and derive benefit from an object owned by the lessor Underwriting deficit  This is the shortfall of the contributions made by the participants to meet the deductions of all claims and all expenses and management fees for the Takaful operator Underwriting surplus  This is the excess that remains from the contributions made by the participants after the deductions of all claims and all expenses and management fees for the Takaful operator Usufruct  The right to the usefulness of an asset owned by someone else Utmost good faith  In case of all forms of insurance, all relevant information related to the uncertain risky event and its relationship to the insured is best known to the insured rather than the Takaful operator, and due to this imbalance in available information the parties need to have trust in each other By law the Takaful operator accepts the information from the insured on good faith and it is the responsibility of the insured to be truthful and if they are not, all liability arising from the risky event is theirs Wad  A unilateral promise, made by one party to another, binding only on the promisor not on the promisee According to the Islamic Fiqh Academy, promises in commercial transactions are binding even if they are one-sided and if they cause the promisee to incur some liabilities Wadia  Islamic banks accept the funds in demand deposits as Wadia (deposit), which involves safekeeping Legally, Wadia authorizes the Islamic bank to keep the funds of the customer in their safe custody on explicit or implicit terms In contemporary Islamic banking, the Wadia contract is combined with the contract of guarantee or Dhaman, to provide the same functionality as conventional current and savings accounts In this case, the bank provides a guarantee of the deposited amount Glossary 269 Wakala  These are agency contracts for a specific work to be done by one party on behalf of another Examples of Wakala contracts include brokerage services, funds management, insurance underwriting, etc Wakala model  Based on the Wakala or agency concept The participants are the principal and the Takaful operator acts as agent or Wakeel The Takaful operator earns an agency fee for their services and may also earn an incentive in the form of a performance fee Waqf  This is a charitable endowment under Shariah law and involves donating an asset for the common good of Muslim society or for religious purposes, with no intention of reclaiming the asset Waqf model  A special Takaful model developed for non-profit Takaful activities for the government or other non-profit organizations The Takaful fund’s surplus is neither distributed to the participants 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131, 176, 185, 189, 211, 218 adverse selection risk 53 ajr 129 Al Azhar 35 Al Khattab, Umar ibn 1, 29 Al Khawarizimi Colleges and Westford School of Management in the UAE 250 Al Manfaah 130 Al Masnu 156 Al Mawdudi, Abul Ala 6, 241 Al Medini 35 Al Musania 156 Al Mustasni 156 Al Rajhi Banking and Investment (Saudi Joint Stock Company) 20 Al Rajhi Trading and Exchange Corporation 20 Al Rayan Bank 16, 20 Al Siddique, Abu Bakr 11, 29 Al-Adl Al-Ihsan Alwi, Dr Sharifah Faigah Syed 63 Amanah 58, 60, 97 Amanah Bank 16 Ansar Financial and Housing Cooperative 16 application of funds 60–1 Aquila 169, 174 Arab Banking Corporation of Bahrain 163 Arab Islamic Insurance Company 171 Arbun 63, 84 Aristotle 4, 5, 242 Asset-backed Sukuk 227 Asset-based Sukuk 227 Badr al-Islami 58 Bahrain Central Bank 15, 185 Bahrain Islamic Bank 16, 19, 70, 171 Bait-al-Maal 9, 11 balance sheet 59–61 application of funds 60–1 sources of funds 59–60 current accounts 59–60 investment accounts 60 savings accounts 60 bank–client relationship 50 Bank Islam Malaysia 13, 15, 20 Bank Islami Bangladesh 20 Bank Muamalat 20 Bank of England 16 Bank of International Settlements (BIS) 66 Barclays Bank 18, 20 barter system Basel regulations 68 Bedouin 170 beneficiary 173, 178, 179 bilateral or simple Mudaraba 99 binding promise 82 BNP Paribas 20 BOT (build, operate and transfer) financing 65 buy-back condition 88, 147 capital market 205–6 Islamic perspective 208–10 Shariahcompliant stocks 208–9 dealing with non-compliant stocks 209–10 central bank, relationship with 50–1 Centre for Research in Islamic Economics 19 Chapra model 253 cheque clearing services 51 Christianity ethics 31 on private property prohibition of interest in 241 on usury Citi Islamic Investment Bank, Bahrain 58 Citibank 17, 20 Citigroup 58 classic economic problem clear financial segregation 173 client credit risk 52 client selection, prudent Fundamentals of Islamic Finance and Banking, First Edition Syeda Fahmida Habib © 2018 Syeda Fahmida Habib Published 2018 by John Wiley & Sons, Ltd 277 278INDEX close-ended fund 211–12 command economy Commenda 11 commodity market 206 Conference of Foreign Ministers of Islamic Countries, Third 19 constant or permanent Musharaka 112 contracts in Shariah law 61–2 contracts of exchange in Shariah law 62–3 conventional economics vs Islamic economics 9–10 conventional finance versus Islamic finance 242–3 conventional insurance 191–2, 217 conventional lease 136–8 cooperative savings bank economics 13 corporate governance 38 cost of capital Council for Islamic Banks & Financial Institutions 20 credit cards 63–4 credit risk 216 of banks 160 client 52 seller’s default 151 Credit Suisse 20 currency risk 52 current accounts 49, 59–60 Dallah Albaraka Group 16 Dar Al-Maal Al-Islami Trust 20 Darul Uloom, Deoband 35 Darul Uloom, Karachi 35 Daruriyyat 28 debt-based Sukuk 226 declaratory rulings 27–8 default after delivery 157 default before delivery 157 default risk 53 of banks 160 derivative market 206 Deutsche Bank 20 Dhaman (Dhamanah) 60, 62 diminishing Musharaka 113 Dow Jones Islamic Market Index 210 Dubai Islamic Bank 14, 19, 21, 70, 171, 246 Dururah 29 El-Najjar, Dr Ahmad 13, 19 equity-based Sukuk 226 equity investment risk 53 exchange traded fund (ETF) 212 Faisal Finance House 16 Faisal Islamic Bank of Egypt 19 Faisal Islamic Bank of Sudan 19, 171, 246 Family Takaful 173, 178–9 Fidya 174, 199 financial intermediation conventional 54 conventional vs Islamic 58–9 definition of 54 Islamic 54–5 two-tier Mudaraba 56–7 two-windows model 57–8 Wakala model 58 financial screening 209 Financial Services Authority (UK) 16 Fiqh 28 Fiqh al-Muamalat 61 foreign exchange market 206 FTSC Global Islamic Index 210 Fuqaha 28 GAAP 65 General Council for Islamic Banks and Financial Institutions (CIBAFI) 71 General Takaful 177 Gharar 31, 32–3, 39, 48, 146,170, 171, 172, 207, 208 Gharar Fahish 33 Gharar Yasir 33 global financial crisis (2007–2008) 68 Global GCC Islamic Index 210 goldsmiths Great Depression 68 Gulf Cooperation Council (GCC) countries Hadith 28, 29 Hajiyyat 28 Hajj 13, 17 Hajj management bodies 68 Halal 7, 30, 97, 99, 130 Halal trade Hambali 30 Hanafi 30 Hanover Re 176 Haram 28, 30, 207 Hawala 63 Hiba 61 history of banking conventional 2–3 Islamic 1–2 history of economics 4–7 in ancient times 4–5 modern 5–6 Islamic 6–7 HSBC 17, 20 HSBC Amanah 16, 58 hybrid model (Mudaraba–Wakala) 181, 185 Ibadat 28 Ijab 129 Ijara (leasing) 11, 61, 67, 129–41, 208 Index documentation 136 Ijara agreement 136 undertaking to purchase leased asset 136 in Islamic banks 130 practical contract 139 calculation of lease rentals 139 Shariah rules and 132–6 Majur or Ijara asset 132–6 types of 130–1 vs conventional lease 136–8 vs conventional loan contract 138 Ijara fund 213 Ijara Muntahia Bittamleek 130, 131–2 Ijara Sukuk 220–1, 230 Ijara Thumma al Bay 132 Ijara wa Iqtina 130, 131–2 vs diminishing Musharaka 139 Ijma 29, 39 Ijtihad 11, 28, 29 Ikhtiyar 29 Inan or limited Musharaka 112 income distribution, purification of 210–11 Indemnity 173 Industrial Revolution 3, industry screening 209 initial public offering (IPO) 212 insurable interest 173 insurance conventional 191–2, 217 Islamic 68 insurance claim 174 insurance premium 174 interest rate risk 52 International Accounting Standards Board (IASB) 66, 69 International Association of Islamic Banks, 253 International Centre for Education in Islamic Finance (INCEIF) in Malaysia 250 International Conference on Islamic Economics, First 19 International Financial Reporting Standards (IFRS) 65–6, 68 International Financial Services Board (IFSB) 15 International Institute of Islamic Banking and Finance in London 250 International Islamic Centre for Reconciliation and Commercial Arbitration for Islamic Finance Industry (IICRCA) 71 International Islamic Financial Market (IIFM) 20, 70 International Islamic Fiqh Academy 72 International Islamic Insurance Company 171 International Islamic Liquidity Management (IILM) 70–1 279 International Islamic Rating Agency (IIRA) 70–1, 229 International Islamic regulatory and standard setting bodies 68–72 International Islamic University, Islamabad 250 International Islamic University, Kuala Lumpur 35, 250 International Organization of Securities Commissions (IOSCO) 66 investment accounts 13, 60 investment markets and products 205–7 investment risk reserve (IRR) 56 Islamic asset and fund management 210–11 Islamic balanced fund 213 Islamic Bank of Asia 16 Islamic Bank of Britain 16, 20 Islamic banking 16, 47–8 birth of 12 challenges faced by 67, 248–9 core objectives 48 current status 17–18 definition of 3–4 development timeline 18–20 distinctive features 3–4 future of 254–5 global achievements 247–8 global growth of 243–5 growth of 14–15 history of 2–3 in the Middle East and the GCC 246 and Muslim community 245–6 in Muslim countries 15–16 in non-Muslim countries 16 periods of 14–15 in South and South-East Asia and beyond 247 sub-sectors 16–17 vs conventional banking 3, 4, 12–13, 15, 49–51 Islamic banking products 63–5 corporate 64–5 bank guarantees 64 banker’s acceptance 64 bill of exchange 64 letter of credit 64 project finance 65 syndication 65 trade finance 64 retail 63–4 credit cards 63–4 current, savings and investment accounts 63 home financing 64 personal loan 64 Islamic banks, challenges faced by 67 default penalty 67 global auditing standards 67 lack of skilled employees 67 partnership ventures 67 280INDEX Islamic banks, challenges faced by (Continued) profit and loss system 67 regulatory issues 67 and Salam and parallel Salam 148–9 Shariah scholar confusion 67 Shariah scholar, multi-skilled, shortage of 67 taxation 67 Islamic capital markets 17, 68 risks and challenges in 216 credit risk 216 fiduciary risk 216 foreign exchange risk 216 liquidity risk 216 market risk 216 Shariah non-compliance risk 216 Islamic commodity fund 212 Islamic cooperative savings bank accounts 13 Islamic debt fund 212 Islamic Development Bank (IDB) 14, 19, 21, 71, 229, 246, 250 Islamic economics 6–7 Islamic equity fund 213 Islamic ETFs (I-ETFs) 212 Islamic finance challenges faced by 248–9 current status 17–18 definition of 3–4 development timeline 18–20 distinctive features 3–4 future of 254–5 global growth of 243–5 growth of 14–15 and Muslim community 245–6 in Muslim countries 15–16 in non-Muslim countries 16 periods of 14–15 sub-sectors 16–17 Islamic finance, evolution of 11–14 early days 11–12 birth of modern 12 institutional developments 12–13 Islamic finance companies 17 Islamic Finance House, Luxembourg 19 Islamic financial accounting 65–7 Islamic financial institutions (IFIs) 34, 38–9, 40 Islamic Financial Services Act (Malaysia) 2013 176 Islamic Financial Services Board (IFSB) 20, 69–70, 98, 176 Islamic Fiqh Academy of the OIC 211 Islamic Foundation, Leicester 250 Islamic housing cooperatives 17 Islamic insurance 68 Islamic Insurance Company 171 Islamic investments 207–10 types of fund 212–13 vs conventional investments 217 Islamic law 11 Islamic leasing and factoring companies 17 Islamic mercantile law 11 Islamic microfinance 17 Islamic non-bank financial institutions 17, 68 Islamic private equity 213 Islamic Real Estate Investment Trusts 213–14 vs Real Estate Investment Trusts 214–15 Islamic Research and Training Institute (IRTI) 20, 71, 250 Islamic Shariah scholars 35 Islamic unit trust or mutual fund 211–12 Islamic venture capital 213 Islamic window 14, 16 Ismail model 253 Istihsan 29 Istishab 29 Istisna 32, 61, 62, 67, 79, 32 Islamic banks and 159 Istisna and parallel Istisna process 159–60 practical application 163–4 buy, operate, transfer (BOT) 163–4 parallel phased Istisna (PPI) 163 problems related to Istisna and parallel Istisna 160–1 Shariah rules and 156–8 asset specifications 156 cancellation or termination of contract 157 default 157 after delivery by buyer 157 after delivery by seller 157 before delivery by buyer 157 before delivery by seller 157 delivery 156–7 exception to valid sales contract 156 independent of Istisna and parallel Istisna contracts 158 insurance of asset 158 material sourcing 156 payment options 157 penalty 157 price 156 security or collateral 157 vs Ijara 163 vs interest-based finance, Salam and Ijara 161 vs Salam 162–3 Istisna Sukuk 222 Jaafari 30 Jakarta Islamic Index 210 Jizya 11 Jordan Islamic Bank 19, 171 Judaism ethics 31 prohibition of interest in 241 Index junk bonds 229 justice in economic exchange Kafala (kafalah) 63 Keynes, J M 68 Kharak 11 Kuala Lumpur Composite Index 210 Kuwait Finance House 19, 70, 246 Lariba 16 lead bank 65 lease and hire purchase 64 lease purchase agreement 64 lender of last resort 50 LIBOR 87, 131, 132 Liquidity Management Centre (LMC) 20, 70–1 liquidity or funding risk 51 Majur 130 Makruh 28 Maliki 30 market economy market price risk 52 market risk 151 markup or profit 82 Masayil Al Maslahah 29 Mashreq Bank, UAE 58 Maslahah 28, 29 Masraf al Rayan of Qatar 16 Maysir 31, 33–4, 39–40, 48, 170, 171, 172, 207, 208 medium of exchange 2, 3, 5, 7, merchants Merrill Lynch 20 mismatch of quality and quantity 151 Mit Ghamr 2, 13, 19, 21 Mit Ghamr savings project 13 Mit Ghamr Social Bank 246 mixed market economy mixed socialist economy money lenders money market 205–6 Islamic perspective 207–8 money, creation of 2–3 moral hazard risk 53 Morgan Stanley Capital Index (MSCI) 210 Murabaha (deferred payment sale) 64 Muajir (lessor) 129 Muamalat 28 Muawadat 62 Mubah 28 Mudaraba (trust financing) 11, 18, 50, 54–6, 60, 61, 67, 95–104, 112, 208 accounting issues 104 additional conditions related to 101 challenges and problems related to 102 281 investment risk reserve 98 as a limited recourse debt finance 99 practical applications 102–4 profit calculation 97–8 profit equalization reserve 98 Shariah conditions related to 100–1 two-tier 96 types 99–100 use for financial intermediation of Islamic banks 96–7 Mudaraba al Muqayyadah (restricted Mudaraba) 99 Mudaraba al Mutlaqah (unrestricted Mudaraba) 99 Mudaraba model 181 Mudaraba Sukuk 224–6 Mudarib 55, 56, 57, 95, 96, 98, 99, 183, 185, 186 Mufawada (unlimited Musharaka) 112 Multilateral Mudaraba 100 Munich Re 176 Murabaha (trust sale) 61, 62, 67, 79–89, 208 calculation of profit 83 challenges and problems associated with 86–8 conditions related to 81–2 contract (diagram) 81 ordinary 80 practical applications 85 process 83–4 sale with a promise (Murabaha to the purchase order) 80 Tawarruq (reverse Murabaha) 83 or commodity Murabaha 85–6 vs conventional loans 88–9 Murabaha process 83–4 Murabaha sale with a promise 80 Murabaha Sukuk 223–4 Musawama (bargain sale) 62, 80 Musharaka (joint venture) 11, 50, 55, 60, 61, 67, 111–24 practical uses of 116–21 agriculture finance 118 credit facilities 117 domestic trade 117 house purchase 118–19 import finance 117 letters of credit 117 securitization 121 service sector 119–20 vs interest-based financing 121–2 vs Mudaraba financing 122–3 working capital finance 116–17 problems related to 115–16 Shariah rules and 114 types of 112–13 Musharaka Al Milk 113 282INDEX Musharaka Muntahiya Bittamleek (diminishing Musharaka) 113, 118 examples of 118–20 house purchase 118–19 service sector 119–20 Musharaka Mutanaqisa 113 Musharaka Sukuk 226–7 hybrid or pooled Sukuk 226 pure Ijara Sukuk 226 Zero-coupon non-tradable Sukuk 226 Muslam 145 Muslam Fihi 145 Muslam Ileihi 145 Muslim legal scholars 12, 242 Muslim population 17 Mustahabb 27 Mustajir (lessee) 129 mutual insurance 190–1 Nasr Social Bank 13, 19 Nasser Social Bank in Cairo 246 National Company for Cooperative Insurance 171 non-compliant stocks 209–10 non-tradable Sukuk 226 obligatory rulings 27–8 oil boom and oil embargo 14, 246 open-ended fund 211 operating lease or regular Ijara 130–1 operating risk 52 Ordinary Murabaha 80 Organization of Islamic Cooperation (OIC) 14 Organization of Petroleum Exporting Countries (OPEC) 245 overdrafts 60 Pak Kuwait Takaful Limited 175 Pakistan Meezan Islamic Fund 210 Parallel Istisna 159–60 problems related to 160–1 Parallel Salam 148–9 diagram and process 149–50 participants 170, 171, 172 performance risk of banks 160–1 permanent Musharaka 112 personal loan 64 petrodollars 12 Philippines Amanah Bank 19 planned economy population, Muslim 17 private equity firms 17 private property productive investment profit and loss-sharing (PLS) 3–4, 12, 48, 50 profit equalization reserve (PER) 56, 98 prohibition of interest see Riba property ownership purification of income distribution 210–11 Qabul 129 Qard Hasan (benevolent loan) 11, 61, 180, 183, 184, 185, 190 Qatar Foundation 250 Qatar Takaful Company 16 Qiyas 29 Quran 3, Rab al Maal 54, 55, 56, 57,l 95, 96, 97, 98, 99, 181, 183, 184 Rahn 63 Ras al Maal 145 rate of return risk 53 real assets, link to real estate investment trust (REIT) 213–14 vs Islamic Real Estate Investment Trusts 214–15 regulatory environment 249 reinsurance 197–8 religious basis of islamic finance Religious Board 35 re-Mudaraba 100 Retakaful 190 Riba 9, 31–2, 39, 48, 86, 170, 172, 207 prohibition of 3, 5, 18 Riba al Fadl 32 Riba al Nasiah 32 Ribawi 146 Ribh 83 risk of holding excess liquidity 52 risks of banks generic 51–2 specific to Islamic banks 52–3 S&P Global Investable Shariah Index 210 Sadaqah 7, 8–9, 11, 21, 207 Salaam Insurance Company 176 Salam (forward contract) 11, 32, 61, 62, 67, 79, 145–52 benefits of 148–9 buy-back condition 147 delivery date and place 146–7 diagram and process 149–50 goods suitable for Salam 146 history of, and Shariah acceptability 147–8 Islamic banks and Salam and parallel Salam 148–9 penalty 147 practical application 150–1 price of Salam contract 146 problems related to 151 283 Index Salam and parallel Salam diagram and process 149–50 security and guarantee 147 termination 147 vs conventional banking 151 Salam Sukuk 223 Sarf 62 savings account 13, 60 scarcity of resources 7, 10 seller’s default 151 settlement or payment risk 52 Shafi 30 Shariah Advisory Committee 35 Shariah Board 35 Shariah Committee 35 Shariah compliance risk 53 Shariah Control Committee 35 Shariah Council 35 Shariah governance 38–9, 216–17 Shariah law 1, 2, 3, 27–8 ethics 30 prohibitions and principles 31–4 schools of Islamic jurisprudence 29–30 sources of 28–9 Shariah screening process for stock selection 209 Shariah Supervisory Board (SSB) 34–6, 40 Board of Directors (BOD) 35, 36 Charter 35 formation of 35 functions of 36–8 in Islamic investment 216–17 status within industry 36 Shariah-compliant stocks 208–9 Shiite school of thought 29, 30 Shirkah 62 short selling 207 Siddiqui, Mohammad Nejatullah Smith, Adam 5, 21 Social responsibilities of Islamic finance 253–4 social welfare 8–9 sources of funds 59–60 Special purpose vehicle (SPV) 218 Standard Chartered Bank 17 Standard Chartered, Pakistan 58 Sudanese Islamic Insurance Company 19, 171 Sukuk 88, 208 characteristics 218–19 controversy related to 227–8 history of 218 investment process 218 manager guarantee 220 ownership 218 parties in 219 payments 219 profit and loss 219 rating 219, 229 restrictions on 220 security 219 Shariah compliance 219 Shariah implications 228 trading 219 trading on secondary markets 229–30 types of 220–6 underlying asset 218 vs conventional bonds 230–4 vs Shariah-screened shares 234 Sunnah 28, 29 Sunni schools of thought 29, 30 Swiss Re 176 Taawun 172 Tabarru 172, 173, 183 Tabung Haji (Pilgrims Fund Corporation) 13, 15, 19 Tahsinniyyat 28 Takaful (Islamic insurance) 16, 169–200, 207 as alternative to conventional insurance 170–1 background 169–70 challenges faced by 176–7 conventional mutual insurance and 190–1 development of 174–6 during time of the Prophet 174 18th and 19th centuries 174 20th century 174–5 21st century 175–6 operational structure 180–1 parties in 171–2 pure Wakala model 181–3 pure Mudaraba model 183–4 Retakaful 196–8 Shariah rules and 172–4 clear financial segregation 173 compliance with Shariah law 172–3 indemnity 173 insurance premium and claim 174 key conditions of 173 significant insurable interest 173 Taawun 172 Tabarru 172 utmost good faith 174 types of 177–9 family Takaful 178–9 general Takaful 177 underwriting surplus or deficit and technical provisions 189–90 vs conventional insurance 191–6 Wakala and Mudaraba Combined or hybrid model 185 Waqf-Wakala-Mudaraba model 185–7 Takaful companies 68 Takaful model 181 comparison of 187–8 284INDEX Takaful operator 181 Takaful scheme 56 Temporary Musharaka 112 Tradable Sukuk 226 Two-tier Mudaraba 56–7, 100 Two-windows model 57–8 UBS 17, 20 Ujrah 129, 132 Ulema 28 Ummah 27 underwriting deficit 189–90 underwriting surplus 189–90 University Islamic Bank 16 usufruct 221 usury utmost good faith 174 venture capital firms 17 Wad 61 Wadia 60, 62, 117 Wajib 27 Wakala (agency) 11, 18, 60, 62, 208 Wakala model 181 Waqf (charitable endowments) 9, 17, 62, 207 management institutions 57 Waqf model 181 Wassiyyat 62 welfare economy 8–10 Wujuh 112 Wujuh Musharaka (partnership of goodwill) 112 Zakat 7, 8–9, 11, 13, 21, 67, 97, 207, 210 management bodies 17, 68 ... Standing of Islamic Finance and Banking Background of Modern Islamic Finance and Banking Conventional versus Islamic Finance Global Growth of the Islamic Finance and Banking Industry Islamic Finance. .. Finance and Banking and the Muslim Community Banking and Islamic Banking in the Middle East and the GCC Banking and Islamic Banking in South and South-East Asia and Beyond Achievements and Opportunities... xxv Introduction 1 Creation of Money and Conventional Finance and Banking Definition of Islamic Finance and Banking Distinctive Features of Islamic Finance Economics and Islam Economics in Ancient