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Recent Developments In The Theory And Practice Of Islamic Banking And Finance. Humayon Dar Loughborough University. References. El-Gamal, M. A. 2000 A Basic Guide to Contemporary Islamic Banking and Finance. ONLINE RESOURCE http://www.ruf.rice.edu/~elgamal/files/primer.pdf

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recent developments in the theory and practice of islamic banking and finance

Recent Developments In The Theory And Practice Of Islamic Banking And Finance

Humayon Dar

Loughborough University

references
References
  • El-Gamal, M. A. 2000 A Basic Guide to Contemporary Islamic Banking and Finance. ONLINE RESOURCE

http://www.ruf.rice.edu/~elgamal/files/primer.pdf

  • Al-Jarhi, M. A. and Iqbal, M. 2001 Islamic Banking: Answers to Some Frequently Asked Questions. Jeddah: IRTI.
lecture plan
Lecture Plan
  • Introduction
  • Models of Islamic banking and finance
    • Earlier models
    • Later models
  • Practice
    • Pre-1980
    • 1980-1990
    • 1990 onwards
lecture plan4
Lecture Plan …
  • Recent developments
  • Change in thinking/emphasis
  • Future
  • Conclusions
introduction
Introduction
  • Banking and finance in commensurate with the Shariah – Islamic law
    • Shariah-compliant banking?
    • Halal banking?
introduction6
Introduction…
  • Banking and finance as an integral part of an Islamic economic system
    • Banking and finance to achieve policy objectives of an Islamic system?
    • Social Banking?
introduction7
Introduction…
  • Spread all over the world
  • Over 50-75 countries
  • About 250 Islamic financial institutions
  • $200-$800 billion in size
  • Average annual growth of 15%
how did it all start
How Did It All Start?
  • It is a modern banking style:

post-1950 phenomenon

  • Egypt (1963), Malaysia (1963) and Pakistan (1965)

early experimentation

  • Malaysia stands out

Pakistan and Egypt left behind

  • The Middle East as a hub of Islamic Finance
what was the initial thinking
What Was The Initial Thinking?
  • Ills of interest highlighted

interest-based financial system: a cause of under-development

  • Need for an Islamic alternative

socio-economic development, equity and justice etc emphasised

  • Idea of social or community banking

Mit Ghamr was a social bank

what was the initial thinking10
What Was The Initial Thinking?
  • Development motive was at the heart of Islamic banking thinking

Islamic Development Bank (1974)

modelling islamic banking and finance
Modelling Islamic Banking And Finance
  • Modelling of Islamic banking shifted the emphasis from social banking to profit loss sharing and profit-motive
  • Two-Tier Mudaraba Model

profit motive emphasised

  • Conventional banking style was adopted as a way forward

private banks or special Islamic banks (1974 - )

practice
Practice …
  • Murabaha or fixed-return modes dominated

PLS marginalised

  • Idea of social/ community/ development banking faded away
  • Era of Islamic commercial banking

earning profit as opposed to charging interest

practice13
Practice…
  • Anglo-Saxon model of banking
  • Profitability as a yardstick of success
current issues
Current Issues
  • Transition from interest-free paradigm to asset-based paradigm
  • Pricing of Islamic financial products
  • Screening principles for investing in equity and stocks
current issues15
Current Issues…
  • Financial innovation
  • Regulation of Islamic financial services
  • Towards a theory of Islamic financial firm
interest free versus asset based
Interest-Free Versus Asset-Based
  • Interest-free banking was a hallmark of Islamic finance

pre-1990 emphasis

  • Institutionalisation of Murabaha

post-1990 phenomenon

  • Return on asset-backed financial assets is acceptable
an example
An Example!
  • I need £100,000 for a business venture for a period of one year.
  • I have got two options
  • Borrowing at a rate of interest of 7%
  • Going Islamic way

First is not acceptable to my Shariah Advisor

What about the second?

option 2
Option 2
  • My advisor issues securities worth £100,000 on my house
  • The securities are sold to a third party with a buy-back clause of one year
  • The buyer then rents the house to me for one year on a rental equivalent to 7% of the stocks’ worth (£100,000)
option 219
Option 2…

Is it acceptable?

YES…

This is what we do in securitisation!!!

what s the difference
What’s The Difference?
  • Option 1 involves Riba while Option 2 involves trade

Probably right

But…

Are they really different?

Yes…

Probably not…

options 1 and 2 compared
Option 1

Pure monetary phenomenon

Return on money – riba

Straight forward

Cheap

Option 2

Trade of a physical item is involved

Return on investment in property – rental

Involves some sort of innovation

Costly

Options 1 And 2 Compared
but are they really different
Option 1

Return on money

Option 2

Return on securities

But Are They Really Different?
there are other ways
There are Other Ways…

$100 (cash)

Party C

Party B

$105 (credit)

£100 cash

Party A

result
Result

Asset-based financing has become a hallmark of Islamic banking and finance in the 21st century

pricing of islamic financial products
Pricing Of Islamic Financial Products
  • Interest remains relevant
  • Benchmarking with LIBOR, KLIBOR
  • Positive correlation between interest and prices of Islamic financial products
  • Normally a “mark-up” over the benchmarked interest
consequently
Consequently…
  • Demand for Islamic finance remains sluggish at a grassroots level
  • Islamic finance’s focus remains on the so-called “captive market”
  • Islamic finance as an elitist phenomenon
  • Is it supply-driven?
principles of islamic investing
Principles Of Islamic Investing
  • Investing in stocks in a Halal/ Islamic way
  • Dow Jones and FT Islamic Indices
  • Full details available on the respective websites

http://www.djindexes.com

http://www.ftse.com/indices_marketdata/ground_rules/global-islamic-ground-rules.pdf

  • Islamic investment/ mutual fund industry
financial innovation
Financial Innovation
  • Strong need for financial innovation for further growth in Islamic finance
  • Securitisation
  • Sukuk structures
the ijara sukuk
The Ijara Sukuk

Rental payments/

coupons

Buys back the assets

at maturity

Sells the assets

Cash

Islamic Issuer

Islamic Investors

SPV

Lease

agreement

Certificates of

participation

Rental payments

Re-imbursement of

100% of the issue

price at maturity

Direct recourse

the mixed assets sukuk
The Mixed Assets Sukuk

Transfer of Murabaha

Deals (1)

Cash

Islamic Ultimate Borrower

Islamic Investors

SPV

Purchase of

the assets

(1+2)

Certificates of

participation

Transfer of leased

assets or to be

leased to issuer (2)

Fixed payment of

the return on the

assets

Direct recourse

regulation of islamic financial services
Regulation of Islamic Financial Services
  • Separate regulatory framework for Islamic finance is considered a necessity
  • AAIOFI
  • IFSB
towards a theory of the islamic financial firm
Towards A Theory Of The Islamic Financial Firm
  • Definition(s)
  • Objectives
  • Analysis
future of islamic finance
Future Of Islamic Finance
  • Not much different from conventional finance
  • Need for re-direction
  • Need for genuine innovation
  • Future lies in Islamic homelands and not in the Western financial centres
conclusion
Conclusion

Thank you