Market worth billions of dollars with investors more conscious of identity after 9/11
BY Nick Ryan  /  September 7, 2007

September 11 and all that followed did a great injustice to the
Islamic world. While the man on the street may talk about terror and
extremism, most financiers and advisers are aware of a very different
– and far more positive – side to modern Islam.

From the Far East to the Gulf, from the Aston Martin buyout to the
release of state-backed German bonds, Islamically compliant deals are
appearing almost daily.

Whether it be the expansion of Islamic banks and mortgages to Islamic
bonds (Sukuk), lease finance (Ijara), acquisition finance (Ijara wa-
iqtinah), construction finance (Istisna’a – Ijara), or trade finance
(Murabaha), the business pages are full of news of markets awash with
new sharia (Islamic law) backed deals.

Sharia compliant assets worldwide are estimated at $500 billion (R3.6
trillion) according to Standard & Poor’s. They have grown at more than
10 percent a year over the past decade, placing Islamic finance in a
global asset class all of its own. In the Gulf and Asia, Standard &
Poor’s estimates that 20 percent of banking customers would choose an
Islamic financial product over a conventional one with a similar risk-
return profile.

“In the UK, the Islamic mortgage market is estimated at $1.68 billion
and Standard & Poor’s estimates the total potential market [worldwide]
for Islamic financial services could be close to $4 trillion,” says
Dawood Ahmedji, a director at Deloitte & Touche.

Moody’s estimates total Takaful (Islamic insurance) premiums to be
more than $2 billion in 2005, expecting them to top $7 billion by

“The total equity funds under management is $11 billion,” says

“Islamic finance is constantly evolving,” explains Farmida Bi, a
partner and capital markets lawyer with Denton Wilde Sapte.

“It’s only in the past four or so years we’ve seen this explosion in
growth … The rise in oil prices has led to a rise in liquidity in the
[Middle Eastern] area, and investors there and elsewhere are more
conscious of their ‘Islamic’ identity.”

“London is now working very hard to become the centre of Islamic
finance,” she says.

When he was the UK’s chancellor of the exchequer, Gordon Brown spoke
of the UK as the global gateway to Islamic finance. (August 2004 saw
the establishment of the first wholly sharia compliant retail bank in
Europe or the US, the Islamic Bank of Britain.)

It is not just the UK, of course: non-Muslim governments such as Japan
and Singapore are making moves to allow facilitate Islamic finance in
their countries.

But it is the rapid growth of wholesale deals which has the financial
world so excited.

According to Bi, investors in London are now involved, as are all the
major players “you would expect”.

She recently advised Morgan Stanley and Standard Chartered Bank as
joint managers on one of the first rated Shari’ah compliant
residential asset-backed securitisations.

The transaction involved Denton Wilde Sapte working closely with
Emirates National Securitisation in structuring a $210 million asset-
backed issuance of notes on behalf of Tamweel, a provider of
Islamically compliant residential real estate finance in the United
Arab Emirates.

Other famous deals with an Islamic component include the takeover of
Aston Martin – the deal was entirely Islamic – and the takeover of
shipping group P&O, which had a $3.5 billion Islamic finance tranche.

Sukuk is the hot topic in Islamic finance: it is the Sukuk market
which has taken the sector by storm. According to the Islamic Finance
Information Service, total Sukuk issuance in the first half of the
year was $24.5 billion – a 75 percent increase on the same period a
year before.

An avalanche of Sukuk has come in the past couple of years, and this
trend looks set to continue: roughly 50 Sukuk with an estimated
combined value of $17 billion are expected to be issued before the end
of the year.

A further unconfirmed 22 Sukuk, valued at $7.27 billion, could be
issued this year, according to the Zawya Sukuk Monitor.

Sukuk are securitised assets and therefore belong to the category of
asset-backed securities (ABS).

Unlike conventional ABS structures, Sukuk need to have an underlying
tangible asset transaction either in ownership or in a master lease.

In theory, according to its proponents, a solid investment policy of
the borrower results and the vicious circle of raising debts and
running after them in hard times is handled in an ethical and socially
more convenient way. This gives the borrowers time to sort the
situation out.

Sukuk are considered by some as “ethical” investments because under
Islamic law it is “haram” (forbidden) to invest in the arms trade,
alcohol, gambling and other such sectors.

Much recent Sukuk and Islamic finance expansion from the Middle East
has been attributed to the region’s property markets. The mortgage
market in the United Arab Emirates was expected to grow 52.5 percent
to $4.77 billion this year, Dubai-based mortgage lender Tamweel said
in February.

In June this year, a $1.25 billion Sukuk was listed on the Dubai
International Financial Exchange by DIFC Investments, taking the total
value of Sukuk listed on the exchange to $10.43 billion, the highest
of any exchange worldwide.

Saudi Arabia’s fledgling Sukuk market has taken off, too, with deals
increasing in size and asset pools increasing in sophistication.

“We’ve had seven to eight years of growth in the market,” says Adli
Hammad, a senior lawyer and partner with The Alliance law firm, which
advises many western clients in Saudi Arabia.

The trajectory has come due to new regulations put in place by the
Kingdom’s Capital Markets Authority, and privatisation deals involving
Saudi utility firms. Such deals take place under construction and
trade finance Islamic legislation.

Private equity firms are increasingly interested in Islamic finance,
according to Bi, while Islamic derivatives “are also a subject of
great debate”.

“The investments are no longer aimed just at devout Muslims, but sold
at a collection of pension funds and companies looking for an income
stream like any other,” she says.

But Jawad Ali, a partner at King & Spalding law firm, says: “Islamic
finance has a long way to go … It hasn’t been perfected yet and
there’s a lot of room for growth and innovation.

“When I started in this area back in 1994, I spent half my time on it;
now it’s 100 percent. It’s an industry which is here to stay.”

Islamic Banking: Is It Really Kosher?
BY Aaron MacLean  /  April 2007

Muslim scholars say the Qur’an prohibits collecting interest on loans.
But many banks, both global and local, have found clever ways to meet
religious strictures. It’s a system that may be hypocritical, but also

The coverage can be a little bit breathless: “La finance Islamique en
plein boom,” Le Figaro reported in September. Yes, Islamic banking,
structured along the lines that religion decrees, is in full boom. But
is it really banking? And is it really kosher?

Islam prohibits the payment of interest on loans, so observant Muslims
require specialized alternative arrangements from their banks. Many of
the largest global financial companies, including Deutsche Bank and
JPMorgan Chase, have established thriving subsidiaries that strive to
meet these requirements. As a result, optimists speculate that the
common pursuit of lucre-divinely sanctioned, filthy, or otherwise-will
bring bickering civilizations together. They may be right.

Halal Banking
The Islamic aversion to interest collection comes from the Qur’an. Not
that the term “interest” is ever used: the Arabic injunction forbids
something called riba. The Qur’an offers no exact definition of what
riba meant in seventh-century Arabia, the time and place of the
Prophet Mohammed-let alone what the term should mean today. In
particular, the passages are ambiguous on the question of whether riba
refers to all kinds of interest collection, or only usurious interest-
that is, lending practices that are, according to some ill-defined
standard, unfair and exploitative. What is clear in the divine
financial critique is that, whatever riba may be, Jews are doing it.
At one point God warns that they will face a “painful day of doom” if
they keep it up.

This ambiguity was a practical problem for the early Muslim jurists,
who formalized religious rules in a code called sharia. They were
divided on the subject, but as time went on, the weight of consensus
came to rest on the side of prohibiting all interest collection.

The financial instruments that 20th-century Islamic theorists
championed were updated versions of medieval commercial instruments,
still known in the Islamic financial sector by their Arabic names: in
addition to bonds, known as sukuk, there are profit-and-loss sharing
instruments known as musharaka or mudaraba, Islamic leases known as
ijara, and a commercial trade instrument called murabaha, the
flexibility of which has made it extremely popular among Islamic
financial firms.

Banking, as an institution, evolved at the same time as the
unprecedented economic growth in Europe over the past 500 years. That
growth was made possible in part by the codification, in the 12th
century, of a distinction between usury and interest in the Christian

The Islamic world witnessed the development of corporate contract law
and the European banking system from afar. A mixture of traditional
arrangements and, later, imported Western practices prevailed in
Muslim countries. But it wasn’t until the 1960s that anyone tried to
combine the two, governing a modern bank according to Islamic law.

Islamic financial institutions, the argument went, would boost the
economic development of Muslim societies. The fraternal style of
Islamic banking-with its emphasis on equity financing rather than
lending-would enhance social responsibility. In practice, however,
Islamic finance has had to bend to the same pressures as any other
kind of finance. Social, religiously oriented investment in the
development of the Islamic world is something people are more
interested in publicly championing than personally doing. Khalid
Ikram, who represented the World Bank in Egypt, says of Islamic
banking, “it hasn’t had a lot to do with development.”

Pinning down the growth of Islamic banking is a challenge. Whether a
banking system truly counts as halal-that is, compliant with the laws
of sharia, or, in another religious context, kosher-is a religious
question, hard for accountants to answer. Take Iran: should the
country’s whole banking system, which is nominally Islamic, be counted
as part of the sector even though many experts raise questions about
its legitimacy?

The numbers I found were anecdotal. Rodney Wilson, professor of
economics at Durham University in Britain and editor of the essay
collection The Politics of Islamic Finance, estimates total assets
within halal banking systems at just under $500 billion. That’s
roughly the size of Wells Fargo Bank, America’s fourth-largest.
Hussein A. Hassan of Deutsche Bank predicts that Islamic finance will
be the world’s fastest-growing banking sector for years, based on what
he calls a modest estimate of 20 percent annual increases in deposits.

So it’s big business, getting bigger, and those who hesitate to enter
it now risk suffering an expertise deficit later. The number of
professionals trained to structure sharia-compliant products, and of
religious scholars qualified to certify them, is small enough to be
already causing problems. Governments are getting in the game, too:
Japan is planning to become the first non-Muslim country to issue
sharia-compliant bonds; the UK, Gordon Brown announced last summer, is
revising its laws to make London the “gateway” for Islamic finance in
Europe; and Malaysia has proposed substantial tax incentives in its
2007 budget for its Islamic financial sector.

Deutsche Bank, Chase, and HSBC, the giant London-based financial
institution with an extensive presence in Asia, have all entered the
sector within the last ten years. Their moves coincide with rising oil
prices, echoing a phenomenon three decades ago. When the 1970s oil
boom gave Muslims and their governments wealth that seemed barely
countable, Islamic financial institutions bloomed: the Islamic
Development Bank (1975), the Kuwait Finance house (1977), the Faisal
Islamic Bank of Egypt (1977), the Jordan Islamic Bank (1978), and
others. In 1979, Bank Misr, a conventional financial house in Egypt,
became the first mainstream bank to build a halal subsidiary, which in
the late 1990s began to attract more capital than its chief domestic
competitor, the Faisal Islamic Bank.

Oil prices and religious fervor are both on the rise again. This time,
Western financial firms have noticed that you don’t have to be Islamic
to bank in accordance with sharia. All you need is a board of
religious scholars to approve your operation. Muslim is as Muslim

Hussein Hassan of Deutsche Bank is an example of the sort of expert
required. He structures specialized Islamic bonds, or sukuk. For a
bond to qualify as sharia-compliant, there must be an underlying asset
backing it. One cannot simply issue bonds to raise money, the way it’s
been done elsewhere for centuries, in return for a promise of a fixed
rate of return. To be Islamic in nature, the securities that look like
bonds must represent fractions of an equity asset, rather than
fractions of a loan.

According to sharia scholars signing off on the prospectuses, the
practices of the multinationals are fully Islamic. That is good news
for corporations that want to raise money from Muslims, and for the
observant clients themselves. But the potential clientele is by no
means captive. As Hassan put it to me, “money always looks for the
best deal.” if Islamic finance couldn’t provide results close to those
of secular institutions, it wouldn’t exist.

Khalid Ikram, who headed the World Bank’s operations in Egypt in the
late 1990s, looked into the performance of Faisal Islamic Bank of
Egypt (FIBE) back during the early boom days. It turned out that,
despite the bank’s citing “religious fervor” to him as the reason for
its growth, Coptic Christians made up about 10 percent of the bank’s
clients, just as they do of the country’s population. When returns
dropped, so did investment and market share. Egyptians with foreign
capital generally preferred to keep their cash overseas, even though
the returns there were less than the roughly 20 percent returns FIBE
was promising on current accounts. The greater security of foreign
deposits made up for their lower rate of return. The rational profit
motive never lost its place as the key factor in investor behavior.

Timur Kuran, professor of economics and law at the University of
Southern California and author of Islam and Mammon: The Economic
Predicaments of Islamism, points out that investing in sharia-
compliant fashion doesn’t just buy you decent returns-it can also buy
political legitimacy. “Islamic finance didn’t come into its own until
the 1970s. Why during the oil boom? Huge amount of assets,
petrodollars, were accumulating in the sheikdoms and with the Saudis.
These regimes were considered quite illegitimate, and there were a lot
of opposition movements, so they wanted to legitimize their regimes
and invest the money at the same time…. They could claim that they
were promoting Islam and avoiding interest.”

Since the inception of Islamic economics as a distinct discipline in
the 20th century, it has always been held up as a champion of ethical
development. Islamist writers such as Sayyid Qutb and Sayyid Abul-A’la
Maududi envisioned Islamic finance as the economic arm of a new,
sharia-guided political order. Free of the scourge of interest, the
instrument by which fat-cat colonial and imperial capitalists make
money from money, Islamic financial institutions would effectively
become private equity or venture capital firms, providing sorely
needed investment and support for the region’s economy. By investing
in Islamic finance, you weren’t just being pious-you were aiding
development and helping the poor as well.

But the post-capitalist utopia that reliance on these instruments was
meant to inaugurate was dead on arrival. Those involved in the first
wave of Islamic banks realized that equity financing does not make for
a stable banking sector, and, after a series of shocks and bad
investments, they became very conservative. It was a race to the
loopholes-a search for means of sharia compliance less risky than
straight-out equity investing.

The chief loophole was murabaha. Let’s say that you, a small
businessman, wish to go into business selling cars. A conventional
bank would examine your credit history and, if all was acceptable,
grant you a cash loan. You would incur an obligation to return the
funds on a specific maturity date, paying interest each month along
the way. When you signed the note and made the promise, you would use
the proceeds to buy the cars-and meet your other expenses-yourself.
But in a murabaha transaction, instead of just cutting you the check,
the bank itself would buy the cars. You promise to buy them from the
bank at a higher price on a future date-like a futures contract in the
commodities market. The markup is justified by the fact that, for a
period, the bank owns the property, thus assuming liability. At no
point in the transaction is money treated as a commodity, as it is in
a normal loan.

But here’s the catch: most Muslim scholars agree that there is no
minimum time interval for the bank to own the property before selling
it to you at the markup. According to Timur Kuran, the typical
interval is “under a millisecond.” The bank transfers ownership of the
asset to its client right away. The client still pays a fixed markup
at a later date, a payment that is usually secured by some sort of
collateral or by other forms of contractual coercion. Thus, in
practice, murabaha is a normal loan.

Since murabaha must be asset-based, however, it can’t help a small
businessman who needs a working-capital loan, for example, to provide
cash on hand to meet payroll or other expenses. To get such capital
from an Islamic financial institution, an entrepreneur would have to
sell the bank an equity interest in his business. This is far riskier
for the bank and thus much harder to obtain.

The experts tell me that every Islamic bank has at least three-
quarters of its investments structured as murabaha. Even the inaptly
named Islamic Development Bank was, as of the mid-1980s, doing four-
fifths of its business through murabaha, and only 1 percent through
equity transactions.

What the “Islamic” label might mean is left to the beholder. The
sharia scholars make it their business to pronounce only upon the
letter of the law. Like legal practitioners everywhere, they focus on
the technicalities. The spirit, being intangible, tends not to cloud
their rulings. The leading critics of this inconsistency are political
Islamists themselves. Majed Jarrar, a personable young man who studies
electrical engineering, wears a long beard, and is keen to discuss his
faith, recently opened an account with FIBE here in Cairo, only to let
it sit empty. He’s been investigating whether “it’s actually Islamic
or not,” and he doesn’t like what he’s finding.

When I asked him about the sort of innovation that, for example,
Hussein Hassan at Deutsche Bank is involved in, Majed scoffed.
Recalling a similar campaign by a Gulf-based Islamic financial house
(“creative Islamic Solutions” was the slogan), Majed argued that
sharia law is less about innovation than it is about a return to the
ways of seventh-century Arabia.

Despite the zeal of purists like Jarrar, an entire banking sector
without debt would be far too unstable. Such a system has never had to
exist-medieval Islam had extensive regulations governing trade
relations and individual contract law, but there was no banking, so
there were no banking rules.

While no one I interviewed argued that sharia-compliant financing
directly retards economic and social development, there was agreement
that it does much less than the original rhetoric claimed. Not only
are working-capital loans, critical to many small businesses, rare,
but also sharia-compliant transactions tend to be short-term.

Still, there’s something reassuring about the way that the rational
profit motive trumps strict ideology. The willingness to put profit
first is, it turns out, the real shared value that links Islamic and
Western civilizations.

Aaron MacLean lives in Cairo. From 2003 to 2006 he was a Marshall
Scholar at Oxford University, where he researched medieval Arabic



Islamic Banks: A Novelty No Longer
August 8, 2005

Lenders that avoid charging interest, in line with Koranic rules, are
spreading — even among Western institutions

When British banking giant HSBC Group (HBC) began offering mortgages
carefully formulated to meet Islamic banking practices last year in
Malaysia, it was surprised that more than half of its customers were
non-Muslim. What drew these customers to alternative financing that
conforms to the strict dictates of Islam? Bank officials say that
competitive pricing makes their Muslim-friendly mortgages — which
operate more like leases than loans — competitive with traditional
interest-based financing.

It’s all part of a trend in which financial products that comply with
the set of Koranic laws that govern a Muslim’s daily life, or shariah,
are evolving from a novelty into a normal part of doing business in
much of the developing world. “Islamic banking isn’t just for
conservative or radical Muslims. It’s mainstream business now,” says
Ross Mohamad Din, director of HSBC Amanah Malaysia, the bank’s Islamic
division. “That’s why every bank wants a bigger piece of it.”

From Jakarta to Jeddah, 265 Islamic banks and other financial
institutions are now operating in some 40 countries, with total assets
that top $262 billion, according to organizers of the International
Islamic Finance Forum, a semi-annual industry conference. That pot of
money, the investment of which adheres to the Koran’s prohibition
against receiving or paying interest, has been steadily building since
1994, when Malaysia created the world’s first Islamic interbank money
market. Now Islamic banking has broadened its appeal well beyond the
confines of faithful Muslims. Indeed, nearly one-quarter of all
Islamic banking business in Malaysia is being transacted by non-

Islamic finance was long the preserve of specialty banks that handled
shariah-compliant products exclusively, such as Malaysia’s top-ranked
Bank Islam and Saudi Arabia’s Al Rajhi Banking & Investment Corp. But
Western banks, no longer content to leave the market to Islamic
lenders, are competing for a slice of the business. Two years ago,
Citigroup (C ) began providing Islamic mortgages in Malaysia and has
begun training staffers in Indonesia and Pakistan to offer them there.
It also provides Islamic mortgages in Middle Eastern countries such as
the United Arab Emirates. HSBC operates Islamic banking services all
over the Arab world, and they now make up about 10% of its business in
Malaysia. UBS, the world’s top player in wealth management, set up a
stand-alone Islamic private bank last year in Dubai to cater to its
wealthiest Middle Eastern clients. And no wonder. Assets held by
Muslims, led by Gulf Arabs, in all banks — Islamic and otherwise —
are estimated at $1.5 trillion and are growing 15% a year, in large
part because of high oil prices.


Behind the rapid growth in shariah-compliant investments are the
development of new regulations and standards for Islamic financial
services in the past few years. There’s also much more awareness of
Islamic financial alternatives in the Muslim world than ever before,
thanks to stepped-up marketing by banks. Some Western lenders are even
rolling out Islamic financial products in their home markets. Lloyds
TSB Bank PLC (LYG ), Britain’s fourth-largest, recently introduced
Islamic mortgage products to cater to Britain’s 2.5 million Muslims.
“The biggest explosion [in growth] right now is in Islamic consumer
banking and investment products,” says Mohsin Nathani, Citigroup’s
Bahrain-based global head of Islamic banking.

What all Islamic financial products share is the absence of interest
— either assessed or paid. Instead, the investments are set up as
leasing arrangements or investments in which money is turned over to
third-party trustees who share profits with Islamic depositors.

While many countries boast a thriving market for Islamic banking
products, Malaysia has positioned itself as the mecca of Muslim
finance. That has given it bragging rights in a region where it has
long been overshadowed by established financial hubs such as Hong Kong
and Singapore. The Southeast Asian country is home to the Islamic
Financial Services Board (IFSB), a global organization of Muslim
bankers in charge of banking regulation and supervision that also
works closely with the Bank for International Settlements. Islamic
investments accounted for 11% of total banking assets in Malaysia last
year. “By 2007 we expect that to grow to over 15% total banking
assets, and we are targeting at least 20% by 2010,” says Malaysian
Finance Minister Nor Mohamed Yakcop.

There’s more to Islamic finance than alternatives to simple savings
accounts and home loans. Many banks offer Islamic charge and debit
cards, although some Islamic scholars disapprove of them. Unlike
standard cards, these are linked to personal lines of credit so users
are only “borrowing” money from themselves — not the issuing bank.
The banks make money by charging service fees. What’s more, the market
for Islamic bonds hit $30 billon in 2004 and has topped $20 billion so
far this year, the Monetary Authority of Singapore estimates. Recent
issuers of ringgit-denominated Islamic notes include the Asian
Development Bank, Swiss food giant Nestlé, and Saxony-Anhalt in
Germany. That German state became the first European government body
to issue an Islamic bond last year — a $121 million five-year
floating-rate note that provides “rent” in lieu of interest from a
series of government properties that form the bond’s collateral.

Some of the more sophisticated Islamic debt investments include asset-
backed securities, in which Islamic assets such as property are
bundled into bonds. A still newer product is a convertible bond that
morphs into shares of shariah-compliant companies at a given strike

While bankers see Islamic finance as a growth area, they acknowledge
that it’s not for everyone. First, not all Muslims are as fastidious
about how their cash is invested as others — which limits the appeal
of these carefully constructed investments. Some investments have no
interest-free equivalent, which may also crimp the sector’s growth.
Plus, while profit margins on shariah-compliant products are
comparable with interest rates on non-Islamic investments, they often
cost more to set up. And Islamic scholars still differ on key aspects
of shariah, making it difficult to standardize all products across the
Islamic world.

At the same time, given a choice, many Muslims do opt for Islamic-
approved banking. That may eventually eat into traditional financial
services, which is one reason Western banks active in the Muslim world
are so eager to bolster their shariah credentials. “There is a segment
within the current market that would switch to Islamic if the quality
and benefits offered were as good as conventional financial products,”
says Ray Ferguson, CEO of Standard Chartered Bank UAE in Dubai.
Clearly, Islamic finance has moved into the mainstream.

By Assif Shameen in Kuala Lumpur

History of modern Islamic banking

The first modern experiment with Islamic banking was undertaken in
Egypt under cover without projecting an Islamic image-for fear of
being seen as a manifestation of Islamic fundamentalism that was
anathema to the political regime. The pioneering effort, led by Ahmad
El Najjar, took the form of a savings bank based on profit-sharing in
the Egyptian town of Mit Ghamr in 1963. This experiment lasted until
1967 (Ready 1981), by which time there were nine such banks in the


Islamic banking has the same purpose as conventional banking except
that it operates in accordance with the rules of Shariah, known as
Fiqh al-Muamalat (Islamic rules on transactions). The basic principle
of Islamic banking is the sharing of profit and loss and the
prohibition of riba´ (interest). Amongst the common Islamic concepts
used in Islamic banking are profit sharing (Mudharabah), safekeeping
(Wadiah), joint venture (Musharakah), cost plus (Murabahah), and
leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money
to purchase the item, a bank might buy the item itself from the
seller, and re-sell it to the buyer at a profit, while allowing the
buyer to pay the bank in installments. However, the fact that it is
profit cannot be made explicit and therefore there are no additional
penalties for late payment. In order to protect itself against
default, the bank asks for strict collateral. The goods or land is
registered to the name of the buyer from the start of the transaction.
This arrangement is called Murabaha. Another approach is Ijara wa
Iqtina, which is similar to real-estate leasing. Islamic banks handle
loans for vehicles in a similar way (selling the vehicle at a higher-
than-market price to the debtor and then retaining ownership of the
vehicle until the loan is paid).

There are several other approaches used in business deals. Islamic
banks lend their money to companies by issuing floating rate interest
loans. The floating rate of interest is pegged to the company’s
individual rate of return. Thus the bank’s profit on the loan is equal
to a certain percentage of the company’s profits. Once the principal
amount of the loan is repaid, the profit-sharing arrangement is
concluded. This practice is called Musharaka. Further, Mudaraba is
venture capital funding of an entrepreneur who provides labor while
financing is provided by the bank so that both profit and risk are
shared. Such participatory arrangements between capital and labor
reflect the Islamic view that the borrower must not bear all the risk/
cost of a failure, resulting in a balanced distribution of income and
not allowing lender to monopolize the economy.

And finally, Islamic banking is restricted to Islamically acceptable
deals, which exclude those involving alcohol, pork, gambling, etc.
Thus ethical investing is the only acceptable form of investment, and
moral purchasing is encouraged.

Islamic banks have grown recently in the Muslim world but are a very
small share of the global banking system. Micro-lending institutions
founded by Muslims, such as Grameen Bank, use conventional lending
practices, and are popular in some Muslim nations, but some do not
consider it to be true Islamic banking.

Islamic banking should be synonymous with full-reserve banking, with
banks achieving a 100% reserve ratio [2]. However, in practice, this
is rarely the case [3].

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking
products and services (IBS banks) are required to establish Shariah
advisory committees/consultants to advise them and to ensure that the
operations and activities of the bank comply with Shariah principles.

In Malaysia, the National Shariah Advisory Council, which additionally
set up at Bank Negara Malaysia (BNM), advises BNM on the Shariah
aspects of the operations of these institutions and on their products
and services. (See: Islamic banking in Malaysia)

Concepts In Islamic debt banking

Bai’ al-Inah (Sale and Buy Back Agreement)

The financier sells an asset to the customer on a deferred-payment
basis, and then the asset is immediately repurchased by the financier
for cash at a discount. The buying back agreement allows the bank to
assume ownership over the asset in order to protect against default
without explicitly charging interest in the event of late payments or

Bai’ Bithaman Ajil (Deferred Payment Sale)

This concept refers to the sale of goods on a deferred payment basis
at a price, which includes a profit margin agreed to by both parties.
This is similar to Murabahah, except that the debtor makes only a
single installment on the maturity date of the loan. By the
application of a discount rate, an Islamic bank can collect the market
rate of interest.

Bai muajjal

Literally bai muajjal means a credit sale. Technically, it is a
financing technique adopted by Islamic banks that takes the form of
murabaha muajjal. It is a contract in which the bank earns a profit
margin on the purchase price and allows the buyer to pay the price of
the commodity at a future date in a lump sum or in installments. It
has to expressly mention cost of the commodity and the margin of
profit is mutually agreed. The price fixed for the commodity in such a
transaction can be the same as the spot price or higher or lower than
the spot price.

Baihaqi kasi salam

Bai salam means a contract in which advance payment is made for goods
to be delivered later on. The seller undertakes to supply some
specific goods to the buyer at a future date in exchange of an advance
price fully paid at the time of contract. It is necessary that the
quality of the commodity intended to be purchased is fully specified
leaving no ambiguity leading to dispute. The objects of this sale are
goods and cannot be gold, silver, or currencies. Barring this, Bai
Salam covers almost everything that is capable of being definitely
described as to quantity, quality, and workmanship.

Basic Features And Conditions Of Salam

1. First of all, it is necessary for the validity of Salam that the
buyer pays the price in full to the seller at the time of effecting
the sale. It is necessary because in the absence of full payment by
the buyer, it will be tantamount to sale of a debt against a debt,
which is prohibited, as the basic wisdom behind the permissibility of
salam is to fulfill the instant needs of the seller. If the price is
not paid to him in full, the basic purpose of the transaction will be
defeated. Therefore, all the Muslim jurists are unanimous on the point
that full payment of the price is necessary in Salam. However, Imam
Malik is of the view that the seller may give a concession of two or
three days to the buyers, but this concession should not form part of
the agreement.
2. Salam can be effected in those commodities only the quality and
quantity of which can be specified exactly. The things whose quality
or quantity is not determined by specification cannot be sold through
the contract of salam. For example, precious stones cannot be sold on
the basis of salam, because every piece of precious stones is normally
different from the other either in its quality or in its size or
weight and their exact specification is not generally possible.
3. Salam cannot be effected on a particular commodity or on a
product of a particular field or farm. For example, if the seller
undertakes to supply the wheat of a particular field, or the fruit of
a particular tree, the salam will not be valid, because there is a
possibility that the crop of that particular field or the fruit of
that tree is destroyed before delivery, and, given such possibility,
the delivery remains uncertain. The same rule is applicable to every
commodity the supply of which is not certain.
4. It is necessary that the quality of the commodity (intended to
be purchased through salam) is fully specified leaving no ambiguity
which may lead to a dispute. All the possible details in this respect
must be expressly mentioned.
5. It is also necessary that the quantity of the commodity is
agreed upon in unequivocal terms. If the commodity is quantified in
weights according to the usage of its traders, its weight must be
determined, and if it is quantified through measures, its exact
measure should be known. What is normally weighed cannot be quantified
in measures and vice versa.
6. The exact date and place of delivery must be specified in the
7. Salam cannot be effected in respect of things which must be
delivered at spot. For example, if gold is purchased in exchange of
silver, it is necessary, according to Shari’ah, that the delivery of
both be simultaneous. Here, salam cannot work. Similarly, if wheat is
bartered for barley, the simultaneous delivery of both is necessary
for the validity of sale. Therefore the contract of salam in this case
is not allowed.

Hibah (Gift)

This is a token given voluntarily by a creditor to a debtor in return
for a loan. Hibah usually arises in practice when Islamic banks do not
voluntarily pay their customers interest on savings account balances.


Ijarah means lease, rent or wage. Generally, Ijarah concept means
selling benefit or use or service for a fixed price or wage. Under
this concept, the Bank makes available to the customer the use of
service of assets / equipments such as plant, office automation, motor
vehicle for a fixed period and price.

Advantages of Ijarah

The following are the advantage of Ijarah to lessee:

Ijarah conserves capital as it may provide 100% financing.

Ijarah enables the Lessee to have the use of the equipment on
payment of the first rental. This is important since it is the use
(and not ownership) of the equipment that generates income.

Ijarah arrangements are flexible because the terms and rental
provision may be tailored to suit the needs of the Lessee. Therefore,
it aids corporate planning and budgeting

Ijarah is not borrowing and is therefore not required to be
disclosed as a liability in the Balance Sheet of the Lessee. Being an
“off balance sheet” financing, it is not included in the computation
of gearing ratios imposed by bankers. The borrowing capacity of the
Lessee is therefore not impaired when leasing is resorted to as a mean
of financing.

All payments of rentals are treated as payment of operating
expenses and are therefore, fully tax-deductible. Leasing therefore
offers tax-advantages to profit making concerns.

There are many types of equipment, which becomes obsolete before
the end of its actual economic life. This is particularly true in high
technology equipment like computers. Thus the risk is passed onto the
Lessor who will undoubtedly charge a premium into the lease rate to
compensate for the risk. A Lessee may be willing to pay the said
premium as an insurance against obsolescence.

If the equipment use is for a relatively short period of time, it
may be more profitable to lease than to buy.

If the equipment is for short duration and the equipment has a
very poor second hand value (resale value), leasing would be the best
method for acquisition.

Ijarah Thumma Al Bai’ (Hire Purchase)

These are variations on a theme of purchase and lease back
transactions. There are two contracts involved in this concept. The
first contract, an Ijarah contract (leasing/renting), and the second
contract, a Bai contract (purchase) are undertaken one after the
other. For example, in a car financing facility, a customer enters
into the first contract and leases the car from the owner (bank) at an
agreed rental over a specific period. When the lease period expires,
the second contract comes into effect, which enables the customer to
purchase the car at an agreed price.

In effect, the bank sells the product to the debtor, at an above
market-price profit margin, in return for agreeing to receive the
payment over a period of time; the profit margin on the lease is
equivalent to interest earned at a fixed rate of return.

This type of transaction is particularly reminiscent of contractum
trinius, a complicated legal trick used by European bankers and
merchants during the Middle Ages, which involved combining three
individually legal contracts in order to produce a transaction of an
interest bearing loan (something that the Church made illegal).


A contract under which an Islamic bank provides equipment, building,
or other assets to the client against an agreed rental together with a
unilateral undertaking by the bank or the client that at the end of
the lease period, the ownership in the asset would be transferred to
the lessee. The undertaking or the promise does not become an integral
part of the lease contract to make it conditional. The rentals as well
as the purchase price are fixed in such manner that the bank gets back
its principal sum along with profit over the period of lease.


Istisna’a is a contractual agreement for manufacturing goods and
commodities, allowing cash payment in advance and future delivery or a
future payment, and future delivery. Istisna’a can be used for
providing the facility of financing the manufacture or construction of
houses, plants, projects, and building of bridges, roads, and

Mudarabah (Profit Loss Sharing)

Mudarabah is an arrangement or agreement between a capital provider
and an entrepreneur, whereby the entrepreneur can mobilize funds for
its business activity. The entrepreneur provides expertise and
management and is referred to as the Mudarib. Any profits made will be
shared between the capital provider and the entrepreneur according to
an agreed ratio, where both parties share in profits and only capital
provider bears all the losses if occurred. The profit-sharing
continues until the loan is repaid. The bank is compensated for the
time value of its money in the form of a floating interest rate that
is pegged to the debtor’s profits.

Murabahah (Cost Plus)

This concept refers to the sale of goods at a price, which includes a
profit margin agreed to by both parties. The purchase and selling
price, other costs, and the profit margin must be clearly stated at
the time of the sale agreement. The bank is compensated for the time
value of its money in the form of the profit margin. This is a fixed-
income loan for the purchase of a real asset (such as real estate or a
vehicle), with a fixed rate of interest determined by the profit
margin. The bank is not compensated for the time value of money
outside of the contracted term (i.e., the bank cannot charge
additional interest on late payments); however, the asset remains in
the ownership of the bank until the loan is paid in full.

This type of transaction is similar to rent-to-own arrangements for
furniture or appliances that are very common in North American stores.


Musawamah is a general and regular kind of sale in which price of the
commodity to be traded is bargained between seller and the buyer
without any reference to the price paid or cost incurred by the
former. Thus, it is different from Murabaha in respect of pricing
formula. Unlike Murabaha, however, the seller in Musawamah is not
obliged to reveal his cost. Both the parties negotiate on the price.
All other conditions relevant to Murabaha are valid for Musawamah as
well. Musawamah can be used where the seller is not in a position to
ascertain precisely the costs of commodities that he is offering to

Musharakah (Joint Venture)

Musharakah is a relationship established under a contract by the
mutual consent of the parties for sharing of profits and losses in the
joint business. It is an agreement under which the Islamic bank
provides funds, which are mixed with the funds of the business
enterprise, and others. All providers of capital are entitled to
participate in management, but not necessarily required to do so. The
profit is distributed among the partners in pre-agreed ratios, while
the loss is borne by each partner strictly in proportion to respective
capital contributions. This concept is distinct from fixed-income
investing (i.e. issuance of loans).

Qard Hassan (Good Loan)

This is a loan extended on a goodwill basis, and the debtor is only
required to repay the amount borrowed. However, the debtor may, at his
or her discretion, pay an extra amount beyond the principal amount of
the loan (without promising it) as a token of appreciation to the
creditor. In the case that the debtor does not pay an extra amount to
the creditor, this transaction is a true interest-free loan. Some
Muslims consider this to be the only type of loan that does not
violate the prohibition on riba, since it is the one type of loan that
truly does not compensate the creditor for the time value of money

Sukuk (Islamic Bonds)

Sukuk is the Arabic name for a financial certificate but can be seen
as an Islamic equivalent of bond. However, fixed-income, interest-
bearing bonds are not permissible in Islam. Hence, Sukuk are
securities that comply with the Islamic law and its investment
principles, which prohibit the charging or paying of interest.
Financial assets that comply with the Islamic law can be classified in
accordance with their tradability and non-tradability in the secondary

Conservative estimates suggest that over US$500 billion of assets are
managed according to Islamic investment principles. Such principles
form part of Shariah, which is often understood to be Islamic law, but
it is actually broader than this in that it also encompasses the
general body of spiritual and moral obligations and duties in Islam.

Takaful (Islamic Insurance)

Takaful is an alternative form of cover that a Muslim can avail
himself against the risk of loss due to misfortunes. The concept of
takaful is not a new concept; in fact, it had been practiced by the
Muhajrin of Mecca and the Ansar of Medina following the hijra of
Muhammad over 1,400 years ago. Takaful is based on the idea that what
is uncertain with respect to an individual may cease to be uncertain
with respect to a very large number of similar individuals. Insurance
by combining the risks of many people enables each individual to enjoy
the advantage provided by the law of large numbers.

In modern business, one of the ways to reduce the risk of loss due to
misfortunes is through insurance which spreads the risk among many
people. The concept of insurance where resources are pooled to help
the needy does not contradict Shariah. However, conventional insurance
involves the elements of uncertainty (Al-gharar) in the contract of
insurance, gambling (Al-maisir) as the consequences of the presence of
uncertainty and interest (Al-riba) in the investment activities of the
conventional insurance companies that contravene the rules of Shariah.
It is generally accepted by Muslim jurists that the operation of
conventional insurance does not conform to the rules and requirements
of Shariah.

Wadiah (Safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person
deposits funds in the bank and the bank guarantees refund of the
entire amount of the deposit, or any part of the outstanding amount,
when the depositor demands it. The depositor, at the bank’s
discretion, may be rewarded with a hibah (gift) as a form of
appreciation for the use of funds by the bank. In this case, the bank
compensates depositors for the time-value of their money (i.e. pays
interest) but refers to it as a gift because it does not officially
guarantee payment of the gift.

Wakalah (Agency)

This occurs when a person appoints a representative to undertake
transactions on his/her behalf, similar to a power of attorney.

Islamic Equity Funds

Islamic investment equity funds market is one of the fastest-growing
sectors within the Islamic financial system. Currently, there are
approximately 100 Islamic equity funds worldwide. The total assets
managed through these funds currently exceed US$5 billion and is
growing by 12-15% per annum. With the continuous interest in the
Islamic financial system, there are positive signs that more funds
will be launched. Some Western majors have just joined the fray or are
thinking of launching similar Islamic equity products.

Despite these successes, this market has seen a record of poor
marketing as emphasis is on products and not on addressing the needs
of investors. Over the last few years, quite a number of funds have
closed down. Most of the funds tend to target high net worth
individuals and corporate institutions, with minimum investments
ranging from US$50,000 to as high as US$1 million. Target markets for
Islamic funds vary, some cater for their local markets, e.g., Malaysia
and Gulf-based investment funds. Others clearly target the Middle East
and Gulf regions, neglecting local markets and have been accused of
failing to serve Muslim communities.

Since the launch of Islamic equity funds in the early 1990s, there has
been the establishment of credible equity benchmarks by Dow Jones
Islamic market index and the FTSE Global Islamic Index Series. The Web
site monitors the performance of Islamic equity funds and
provide a comprehensive list of the Islamic funds worldwide.

Islamic laws on trading

The Qur’an prohibits gambling (games of chance involving money). The
hadith, in addition to prohibiting gambling (games of chance), also
prohibits bayu al-gharar (trading in risk, where the Arabic word
gharar is taken to mean “risk”).

The Hanafi madhab (legal school) in Islam defines gharar as “that
whose consequences are hidden.” The Shafi legal school defined gharar
as “that whose nature and consequences are hidden” or “that which
admits two possibilities, with the less desirable one being more
likely.” The Hanbali school defined it as “that whose consequences are
unknown” or “that which is undeliverable, whether it exists or not.”
Ibn Hazm of the Zahiri school wrote “Gharar is where the buyer does
not know what he bought, or the seller does not know what he sold.”
The modern scholar of Islam, Professor Mustafa Al-Zarqa, wrote that
“Gharar is the sale of probable items whose existence or
characteristics are not certain, due to the risky nature that makes
the trade similar to gambling.” There are a number of hadith who
forbid trading in gharar, often giving specific examples of gharhar
transactions (e.g., selling the birds in the sky or the fish in the
water, the catch of the diver, an unborn calf in its mother’s womb
etc.). Jurists have sought many complete definitions of the term. They
also came up with the concept of yasir (minor risk); a financial
transaction with a minor risk is deemed to be halal (permissible)
while trading in non-minor risk (bayu al-ghasar) is deemed to be
haram. [5]

What gharar is, exactly, was never fully decided upon by the Muslim
jurists. This was mainly due to the complication of having to decide
what is and is not a minor risk. Derivatives instruments (such as
stock options) have only become common relatively recently. Some
Islamic banks do provide brokerage services for stock trading and
perhaps even for derivatives trading..


Islamabad, Pakistan, June 16, 2004: Members of leading Islamist
political party in Pakistan, the Muttahida Majlis-e-Amal (MMA) party,
staged a protest walkout from the National Assembly of Pakistan
against what they termed derogatory remarks by a minority member on
interest banking:

Taking part in the budget debate, M.P. Bhindara, a minority MNA
[Member of the National Assembly]…referred to a decree by an Al-
Azhar University’s scholar that bank interest was not un-Islamic. He
said without interest the country could not get foreign loans and
could not achieve the desired progress. A pandemonium broke out in the
house over his remarks as a number of MMA members…rose from their
seats in protest and tried to respond to Mr Bhandara’s observations.
However, they were not allowed to speak on a point of order that led
to their walkout…. Later, the opposition members were persuaded by a
team of ministers…to return to the house…the government team
accepted the right of the MMA to respond to the minority member’s
remarks…. Sahibzada Fazal Karim said the Council of Islamic ideology
had decreed that interest in all its forms was haram in an Islamic
society. Hence, he said, no member had the right to negate this
settled issue[6].

Many Muslims and non Muslims alike have opposed these Islamic banks,
claiming that they do deal in interest but merely conceal it through
legal tricks.[citation needed] Indeed, from an economic perspective,
Islamic banks do compensate and charge for the time value of money,
thus paying and receiving what is known in economics as interest. Such
people compare Islamic banking to contractum trinius-a legal trick
devised by European bankers and merchants during the Middle Ages,
designed to facilitate the borrowing of money at a fixed rate of
interest (something that the Church fiercely opposed) through
combining three different contractual agreements that in and of
themselves were not prohibited by the Church. While Islamic law
prohibits the collection of interest, it does allow a seller to resell
an item at a higher price than it was bought for, as long as there are
clearly two transactions.

These arguments and criticism are exactly the same as those used at
the time of Muhammad. The Qur’an addresses this issue in simple terms,
Interest is forbidden by Allah, while trade has been permitted by Him:

“Those who devour usury will not stand except as stand one whom the
Evil one by his touch Hath driven to madness. That is because they
say: “Trade is like usury,” but Allah hath permitted trade and
forbidden usury. Those who after receiving direction from their Lord,
desist, shall be pardoned for the past; their case is for Allah (to
judge); but those who repeat (The offence) are companions of the Fire:
They will abide therein (for ever).” (Surah Baqarah 2:275) –

Hong Kong May Create Islamic Bond Market
By MIN LEE  /  9/11/07

HONG KONG (AP) – Hong Kong’s financial secretary has ordered
regulators to study how to reconcile Muslim financial rules with local
laws in hopes of launching a market for Islamic bonds, according to a
speech transcript reviewed Tuesday.

Secretary John Tsang said he hopes to promote Hong Kong, a popular
stock market for Chinese companies, as a gateway for Middle Eastern
investment in China, according to transcripts from a Monday speech at
a financial conference.

“Islamic finance is an important element of the global financial
system,” he said. “For Hong Kong to be a major international financial
center – not just in the region, but globally – then Islamic finance
must be among our portfolio of products and services.”

Islamic finance is governed by Islamic law, or Shariah, which bans the
collection of interest, trading in risk and investing in gambling,
pork and alcohol businesses. All are components in virtually every
global market.

While conventional bonds are based on the legal relationship between
borrowers and lenders, Islamic bonds are structured as business
transactions. Instead of issuing interest, they revolve around rental
payments and dividends.

It has become increasingly difficult to ignore the financial heft of
Islamic financial markets.

Tsang said the international Islamic financial market is worth $1
trillion and is expected to grow 15 percent annually.

He has said that more than 300 Islamic financial institutions in more
than 75 countries hold assets of more than $300 billion. Islamic
business units of international banks manage an additional $400
billion, he said.

Tsang said he visited Malaysia last month, a major center for Islamic
bonds, to study its Islamic financial system.

Badlisyah Abdul Ghani, chief executive of Malaysia’s CIMB Islamic
Bank, said it makes sense for Hong Kong to get into Islamic financing.

The global dollar-denominated Islamic bond market is worth $24
billion, with Malaysia accounting for up to 70 percent of Islamic
bonds worldwide, Badlisyah said.

“I think any financial center which has the infrastructure that Hong
Kong has would be a good place to do Islamic bond issuance,” he told
The Associated Press.

He said there is interest among Islamic companies to invest in China
and to raise funds for themselves through Islamic bonds issued in Hong

Hong Kong authorities should follow Malaysia’s model and create an
Islamic bond market that coexists alongside the conventional bond
market, Badlisyah said.

Charles Li, a finance professor at the City University of Hong Kong,
said Hong Kong authorities must be careful in balancing local
financial norms and Islamic financial regulations.

“The government should study whether our laws are in conflict with
Middle Eastern banking systems and laws,” Li said. “We can’t interpret
our laws in favor of Islamic culture and practices.”

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