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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 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 • Al-Jarhi, M. A. and Iqbal, M. 2001 Islamic Banking: Answers to Some Frequently Asked Questions. Jeddah: IRTI.
Lecture Plan • Introduction • Models of Islamic banking and finance • Earlier models • Later models • Practice • Pre-1980 • 1980-1990 • 1990 onwards
Lecture Plan … • Recent developments • Change in thinking/emphasis • Future • Conclusions
Introduction • Banking and finance in commensurate with the Shariah – Islamic law • Shariah-compliant banking? • Halal banking?
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?
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? • 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? • 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 Thinking? • Development motive was at the heart of Islamic banking thinking Islamic Development Bank (1974)
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 … • 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
Practice… • Anglo-Saxon model of banking • Profitability as a yardstick of success
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 Issues… • Financial innovation • Regulation of Islamic financial services • Towards a theory of Islamic financial firm
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! • 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 • 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 2… Is it acceptable? YES… This is what we do in securitisation!!!
What’s The Difference? • Option 1 involves Riba while Option 2 involves trade Probably right But… Are they really different? Yes… Probably not…
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
Option 1 Return on money Option 2 Return on securities But Are They Really Different?
There are Other Ways… $100 (cash) Party C Party B $105 (credit) £100 cash Party A
Result Asset-based financing has become a hallmark of Islamic banking and finance in the 21st century
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… • 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 • 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 • Strong need for financial innovation for further growth in Islamic finance • Securitisation • Sukuk structures
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 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 • Separate regulatory framework for Islamic finance is considered a necessity • AAIOFI • IFSB
Towards A Theory Of The Islamic Financial Firm • Definition(s) • Objectives • Analysis
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 Thank you