Islamic Banking : A Journey to the Basics

1. Islamic Banking : A Journey to the Basics MURAT ÇETİNKAYA Executive Vice President Kuwait Turkish Participation Bank Istanbul 2011

2. Agenda • What does “Islamic banking” stand for? • What relevance does Islamic banking have in the modern financial system? • What are the current trends and areas of growth? • Where does Turkish experience stand in Islamic banking? • Kuwait Finance House (KFH) and Kuwait Turkish Participation Bank

3. From niche to critical mass • Increasing market presence • Growing at 15 to 20% per annum • Size estimated at USD 900 billion globally • New markets welcoming Islamic banks and products • Market-driven proposition • Retail demand has historically the backbone of the industry • Sensitivities to principles more visible on retail deposit • But corporates and even sovereigns showed appetite for the products • Market-driven product development proved to be successful • Self-regulating organisations accompanied global Islamic banking boom • Global scale • More than 250 Islamic banks worldwide operating in over 75 countries • A wide range of interest varying from U.K. to Singapore • Widening customer base including sovereigns to top global corporates to tap Islamic finance markets

4. Islamic finance industry is developing a global reach…

5. China: Active member of Islamic Financial Services Board (2004) Germany: Kuwait Turk received licence for a branch Saxony issues E100m Sukuk (2004) Russia: Increasing interest VTB – KFH/LMH partnership …with worldwide momentum UK: Five active Islamic banks Sukuk on its way Japan: JBIC exploring Islamic financing opportunities (Dec. 2006) France : Recent declaration of Islamic Banking interest Turkey: 25 years of Islamic banking experience Kuwait & UAE: Hub for Islamic banking • Saudi Arabia: • 95%+ of new consumer • lending is Islamic (2006) • Retail market rapidly converting to Islamic (2006) Singapore: Active in developing Islamic finance Bahrain: Leading Islamic financial centre, and housing regulatory bodies . Malaysia: Islamic product and industry, development and sophistication leader Each region is contributing in a unique way

6. structured products insurance 1970s 1970s private equity 1980s 1980s project finance equity Industry has developed a comprehensive product offering over its young history Development of industry Evolving richness in products • Development of theoretical framework • First attempts to structure Islamic banking products 1950s commercial banking • First institutions emerged to test the market 60s • Islamic Development Bank (1974) and DIB • One country-one bank setup 70s 2000s • Advancement of Islamic products • Turkish market to welcome Islamic banking • Full “Islamization” of banking in some countries (Pakistan, Sudan etc.) 80s 1990s syndications • Entry of global institutions & Islamic windows • İncreasing global coverage of Islamic banking 90s structured and trade finance • Islamic banks achieving strong and stable growth globally, • New products in international markets • Sukuk market to boom 2000s Industry has near like-for-like parity with conventional offering

7. Global Deployment of Islamic Products Mainstream relevance Niche presence Engaging with regulators Conceptual exploration Breakdown of Islamic Banking Principles Compliant Assets Worldwide (2003) Breakdown of Islamic Banking Principles Compliant Assets Worldwide (2008) Source: KFHR Global Islamic Finance Directory 2008

8. The industry has not yet reached its potential • Still new markets exist that did not yet meet with Islamic banking and finance • The global Islamic insurance (Takaful) market is estimated to reach USD20 billion • Most Islamic financial institutions are highly liquid, and seek new asset classes and markets to diversify • New treasury products and investment securities are to emerge • Capital markets developments: New sukuk issuances expected to tap the market • Islamic finance has also gained popularity in Muslim-minority countries • Germany issued the first Islamic Eurobond (2004) • Five Islamic banks in UK • Trends of convergence and conversion • Islamic banks introducing new products and services to compete with the conventional banks, • Conventional banks aiming to tap Islamic banking markets and expand their product base

9. Why Islamic financing is flourishing Strong growth of GCC economies Development of Islamic capital markets Innovative product development EXPLOSIVE GROWTH OF ISLAMIC FINANCE Market developments urging countries and customers to diversification Liberalisation of capital markets Retail customer commitment Industry is driven by fundamental factors

10. Islamic framework provides solutions for key limitations of conventional banking system Conventional banking issues IFI solutions • Asset/need-based approach to financing • Growing consumer indebtedness • Growing and unhedged risks pose systemic problems • Channeling the funds to “real” investment needs • Equitable distribution of risk and reward • Speculation leading to crises • 1997 East Asia Crisis • 1998 Russia • 1999 Argentina • Prevention of speculation • Ownership is prerequisite of sale • Excessive risks are prohibited

11. Equity financing mudaraba & musharaka Debt financing ijarah, murabaha, salam, istisna‘ Key internal issues that need addressing… • Reducing debt-based products • Islam permits commercial debt for productive ends • Debt-based consumer products permitted on basis of need • Building income-sharing products • Musharaka is preferred form of financing An alternative banking model in development Suppliers of capital Deposits Profit, not interest, becomes the basis for financial intermediation Productive economic actors with capital needs Liabilities Assets Investments

12. Tested strength in the financial crisis • Islamic banking, a booming $US1 trillion global industry that prohibits speculation and high levels of debt, has been relatively unscathed by the credit crunch. • Islamic banking model’s basic principles of • financing “real” trade and economic activities, • no financing of speculation • No engagement in debt trading • Asset backed and project-financing approach to help hedging risks • As a result, the lessons from the crisis; • Islamic banking is inherently stable • Islamic banks outperformed the conventional financial institutions

13. Principles filter Right positioning and definition of Islamic banking - 1 Banking and finance needs Standart contracts Principles sources • Musharaka (Partnership) • Mudaraba (Fund management) • Murabaha (Purchase-resale) • Ijara ( Lease) • Istisna’ ( Manufacturing contract) • Salam -(Forward sale) • Religious basic sources • Ijma’ (jurist consensus) • Qiyas (analogy) • Ijtihad (reasoning) Islamic banking and finance solutions • Prohibition on: • Interest • Speculation • Prohibition of certain investments: • Sectors (e.g.: alcohol, armaments etc.) • Instruments (e.g. Leveraged interest products, toxic assets type of derivatives etc.) • Asset-backed transactions with investments in real, durable assets • Credit and debt products are not encouraged

14. Principles filter Right positioning and definition of Islamic banking - 2 Banking and finance needs Standart contracts Principles sources • Musharaka (Partnership) • Mudaraba (Fund management) • Murabaha (Purchase-resale) • Ijara ( Lease) • Istisna’ ( Manufacturing contract) • Salam -(Forward sale) • Religious basic sources • Ijma’ (jurist consensus) • Qiyas (analogy) • Ijtihad (reasoning) Islamic banking and finance solutions • With the development and boom of Islamic banking, it became clear that : • Islamic banking has roots in religion and ethics but it is not a “religion activity” and “not confined to Muslim population” • Islamic banking is not something “from and for GCC or Muslim world”, it is a global concept • Islamic banking has some limitations and border lines, but it is acknowledged that it can provide solutions in a wide scope of areas ranging from retail banking to investment banking.

15. Islamic finance is embedded within values Synthesis of Islamic law and contemporary finance Client affinity Fulfils aspirations Integrates a wider range of customer base with certain sensitivities Builds systematic checks on financial providers Parallel trends Responsible finance Ethical investment Inclusive proposition Alternative paradigm • Stability from linking financial services to the productive, real economy • Moral compass for capitalism • Open to all-faith clients • Available to Islamic and conventional issuers Islamic finance is more than financial contracts

16. SOCIAL IMPERATIVE ZONE OF SUSTAINABILITY Islamic businesses NGOs not-for-profits Islamic Financial Institutions are positioned in a “zone of sustainability” ECONOMIC IMPERATIVE prohibited sectors Islamic finance characteristics: • Market-driven yet values-based • Gradualist and evolutionary nature • Symbiotic and synergistic relationship with mainstream finance

17. Self-regulatory organizations bring credibility through standardization of practices AAO-IFI (1991) Bahrain • Benchmark of Islamic accounting standards • 56 accounting, auditing, governance and Shariah standards • Enhancing clarity, transparency and harmonisation IIFM(2001) Bahrain • Development of global Islamic capital and money market • Promoting active and regulated trading and capital flows • Catalyzing trading infrastructure, product innovation and information flows GCIBFI(2001) Bahrain • Promoting industry in theory and practice • Disseminating Shariah concepts & multilateral understanding between IFIs and public • Improving IFI practices, cooperation, professionalism and transparency IFSB (2002) Malaysia • Standard-setting body of regulatory and supervisory agencies • Complementing Basel II Capital Accord • Key standards: risk management, capital adequacy & corporate governance LMC(2002) Bahrain • Creation of active Islamic inter-bank market • Creating secondary market for short-term Shariah-compliant treasury products • Enabling IFI management of liquidity mismatch IIRA(2005) Bahrain • Reference point for IFI ratings • Issuing sovereign, credit, Shariah quality and corporate governance ratings • Providing effective tool for informed investment decision-making

18. Industry is reaching mainstream relevance in global financial system Relevance to new-comers Relevance in countries with already developed Islamic banking • Widens the bankable population and customer base • Increases bankable population of economy • Increases product base in the system • Attracts more deposits/funds from the customers • Enhances stability of financial model • Asset-based framework links financial services to real economy • Reaching a broader market • Alternative source of funding • Debt issuance with the widest acceptance • Attract “new-to-industry” investors • Gateway to OIC markets • Regional preference of Islamic investors • Infrastructure investment opportunities

19. A number of factors need to be engaged to bring success • Dedicated people • Greatest intangible to enable Islamic finance and build its future • Human capital development: bankers and scholars • Committed sponsorship • Academic input to formulate visionary framework and development • Capital sponsorship to bring plans to life • Proactive engagement • Regulators, practitioners and scholars to set a common agenda Key enablers Need for co-ordination to enable further development

20. The way ahead ….. • We must preserve what is distinctive about Islamic finance • Industry regulations and governance heading towards mainstream globalization • Balancing different elements of Shariah credibility • Current expanding reach and richness of Islamic finance • Despite the absence of an enabling framework • But at a cost: culture of exceptions, Shariah credibility, competitive disadvantages • To build an enabling framework requires concerted efforts • Collaboration between IFIs, endowed industry institutions and regulators • Exploration of narrow banking principles

21. Overview of Kuwait Finance House • Kuwait Finance House K.S.C. (KFH) was established in the State of Kuwait in 1977, as the first bank operating in accordance with the Islamic Banking principles. • KFH is listed with the Kuwait Stock Exchange (KSE), with a market capitalization of US$ 9.55 Billion as of 22 June 2009. Assets total US$ 37 Billion and deposits amount to US$ 24 Billion as at Q1 2009. • In the global Islamic arena, KFH is in the forefront of the industry in terms of international presence, spectrum of activities, strategic alliances, networking and innovation. • KFH has been awarded by the Banker Magazine as the World’s Best Islamic Financial Institution, and for third successive year it has been awarded by Euromoney magazine as the best Islamic Bank in the Middle East. • KFH is engaged in providing Islamic banking services, and its spectrum includes consumer banking, corporate finance, Islamic capital markets, real estate finance, structured finance, investment portfolios, and other products and services. Key Facts

22. Overview of Kuwait Finance House Key Facts • One of the largest Islamic banks in the world • Listed on the Kuwait Stock Exchange: • Government of Kuwait - 43.0% • General Public - 57.0% • Specializing in Corporate, Investment, Private, Commercial and Retail banking • Direct investment portfolio of approximately US$ 800 million • Through the direct investment portfolio, KFH has interest in aviation, shipping, takaful insurance, information technology, real estate construction and development, logistics, oil and gas and healthcare • Co- Lead arranged first Euro denominated Sukuk for the German State of Saxony Anhalt. • Lead managed first local Kuwaiti sukuk issue for The Commercial Real Estate Company

23. Overview of Kuwait Finance House Key Facts Ratings (JAN ‘09) • Headquartered in Kuwait with 175 branches locally and worldwide • Market Capitalization of US$ 9.55 Bn (June ‘09) • Asset Size of US$ 37 Bn (31 March ‘09) • Deposits of US$ 24 Bn (31 March ‘09) • Total shareholders’ equity of US$ 4.10 Bn (31 March ’09)

24. Overview of Kuwait Finance House Competitive Strengths • Ability to structure and close transactions rapidly due to bank’s seasoned expertise, network, strategic partnerships, financial strength and sound liquidity position. • A deeply entrenched brand franchise with subsidiaries in Bahrain, Turkey, Malaysia, Singapore, Australia, Jordan and Saudi Arabia and affiliates in UAE and Oman • Strong underwriting ability: unrivalled access to Islamic deposits in the domestic & regional market. • Formation of Liquidity House as an investment house fully dedicated to Sukuk issuances. • Strong links with regional and international financial institutions • presence in the domestic and regional real estate market and proven transactional expertise in the international arena. • Recognized and respectable Advisory Board and structuring expertise; KFH AdvisoryBoard clearances and approvals on structures are in most, if not all, cases taken for granted by other fellow participants in deals and transactions.

25. Overview of Kuwait Finance House One-Stop Islamic Financial Solution Provider

26. Overview of Kuwait Finance House Collectively KFH has the expertise and value-added services, capable of delivering the objectives of the client Our Client STRENGTH & EXPERTISE DISTRIBUTION CAPABILITIES WEALTH OF EXPERIENCE • Specialist in ICM • Strength in the Middle East • Strong and experienced leadership team • Expertise in Islamic banking principles compliant products • Strong distribution team • Extensive distribution network including GCC, Europe and Asia • Middle East distribution advantage • Strong relationships with other Islamic and International banks and investment houses for placements • 30 years of experience including global sukuk issuance and placements • Client-centric approach for every deal/issuance • Ability to innovate and structure Islamic financing solutions for clients

27. KFH RESEARCH LIMITED KFH Research Ltd is the world's first Islamic investment research arm to be established by an Islamic Bank. A direct subsidiary of Kuwait Finance House, KFH Research was established in 2007, comprising industry professionals and 'star' research analysts with broad experience in Islamic finance & global markets. Below is a sample of their reports:

28. KFH GROUP: A SAMPLE Next Steps

29. SOVERIEGN SUKUK ISSUANCES ARRANGED BY KFH Bahrain Monetary Agency US$ 250 Mn Sukuk Lead manager 2003 KHAZANAH NASIONAL US$ 750 Mn Sukuk Co-Lead Manager 2006 Saxony Anhalt EUR100 Mn Sukuk Co-Lead Arranger 2004 Dubai Civil Aviation UAE US$ 1 Bn Sukuk Joint Lead Manager 2004 Government of Qatar US$700 Mn Sukuk Co-Lead Manager 2003

30. Overview of Kuwait Finance House Key Facts Ratings (JAN ‘09) • Headquartered in Kuwait with 175 branches locally and worldwide • Market Capitalization of US$ 9.55 Bn (June ‘09) • Asset Size of US$ 37 Bn (31 March ‘09) • Deposits of US$ 24 Bn (31 March ‘09) • Total shareholders’ equity of US$ 4.10 Bn (31 March ’09)

31. Overview of KT Shareholder structure • Kuveyt Turk began operations in 1989 . • Market share of Kuveyt Turk among participation banking sector is currently 22.5% • Asset size of Kuveyt Türk is TRL 5.72bn as of 31/12/2008 • Shareholder Equity:TRL689m

32. Funding • Supportive shareholder through difficult times • Access to and superior understanding of the Middle East market (instruments and customers) • Access to Middle East institutions and liquidity • Rating agencies look favourably on support • Better asset-liability mismatch management • Coordination between KFH group treasuries enables better hedging of FX exposure at lower costs Kuwait Turkey • 16 subsidiaries • 1 subsidiary: Kuveyt Turk • Total assets: US$3.8bn • Product innovation • Investment in product development • Provision of commercial guidance Know-how Bahrain Malaysia • 1 subsidiary: • Kuwait Finance House (Bahrain) B.S.C. • Total assets: US$3.4bn • 1 subsidiary: • Kuwait Finance House (Malaysia) Berhad • Total assets: US$2.7bn International banking • Beneficiary of strengthening ties between Turkey and the rest of the world, especially with Middle East • Foreign trade services • Turkey as a destination of oil-driven capital Turkey Kuwait Malaysia Bahrain Pop.: 27m GDP1 (US$): 186bn Pop.: 3m GDP1 (US$): 111bn Pop.: 74m GDP1 (US$): 659bn Pop.: 1m GDP1 (US$): 17bn Corporate governance • Professional reporting systems at international standards • Global expertise at board level • Best-in-class management techniques Supportive anchor shareholder Supportive anchor shareholder (2008) Strategic benefit Kuwait Finance House (“KFH”) Total assets : US$38.3bn Shareholder equity: US$5.8bn Gross Profit: US$1.39bn Net Profit to Shareholders US$ 633m Branches: 46 Source: KFH Annual report KFH Subsidiaries KFH network Source: EIU, Central Bank of Kuwait (1) Nominal GDP

33. Financial overview - profit and loss (IFRS1) Operating income (TRLm) Net income (TRLm) CAGR: 47.8% CAGR: 71.4% • (1) Income includes foreign exchange gains / loss

34. Kuveyt Turk overview Corporate Retail International &Investment Banking Products • Murabaha / Istisna’as • Financial leasing • Letters of Guarantee • Foreign trade finance (Letters of Credit) • Foreign trade services • Deposits (current / participation acc’s) • Loans • Card business • Moneygram • Project finance • Corporate finance • Capital markets • Syndicated Murabaha • 39,000 corporate customers • 13,000 active credit customers • 800,000 retail customers • 59,000 retail SME customers • First international Murabaha syndication of US$200m raised for Kuveyt Turk in 2006 • Operating in 96 countries with more than 1,000 correspondent banks Highlights Distribution 120 branches: 119 in branches in Turkey, 1 in Bahrain and 1 Financial Services Branch in Germany Breakdown of total cash loans Cash loans by segment – 2008 (%) Total: TRL 4.0 bn

35. Financial overview – balance sheet (IFRS1) Total assets (TLm) Total liabilities (TLm) CAGR: 34.3% RoAA and RoAE Capital adequacy ratios(TRYm) - CAR • Audited IFRS accounts for 2004-2006-2007 and draft accounts for 2008

36. Key Achievements Results Retail • First mover advantage in the retail sector1 • Innovative product development • First participation bank to segment its client base • High customer service levels • Focus on building long-term client relationships • Strong brand name and sticky retail base • 40% participation bank consumer loan market share • Retail loans2 account for 25% of portfolio compared to participation banks average of 17% • Offers one of the widest range of products amongst participation banks Corporate • Increased focus on small to mid sized corporates • Development of portfolio management system • Increased focus on letters of guarantee • Higher margin business and reduced risk profile • Increased quantity and quality of clients and improved profit per client • Enhanced quality control delivering better returns • Larger proportion of non-cash loans International & Investment Banking • First and most advanced investment banking propositions • Most dynamic participation bank funding structure • Development of international network (branches & correspondent banks) • Funding origination through Bahrain branch • Executed the first and largest ever international Murabaha syndication among participation banks in Turkey (US$200m) • International network to increase access to Gulf investors and funding opportunities for clients • Facilitates increasing share of overseas trade flows Leading platform and innovator • Amongst participation banks • Excluding retail SMEs

37. Total cash loans1(1yr) 29% 37% Non-cash loans/Cash Loans1 61% %80 Loans / deposits2 108% 106% Asset / income quality • Retail / SME loans (↑) • Non-cash loans (↑) • Centralised commission • Risk management focus Fee income3 % 79% 88% NPL ratio4 4.2% 4.8% Performance drive and future upside Category Performance Actions taken Future upside 2007 2008 Growth • Branch roll-out (Turkey) • Bahrain branch • Non-cash lending (↑) • Retail loans (↑) • Employee incentives • Target 25 new branches p.a. • Target non-cash vs cash of 2:1 by end 2010 • Diversify funding further • Business partnerships • Enhanced cross-sell • Disposal of non-core assets • Benefits from training • Gulf market expansion • Correspondent banking network Performance - RoAE Long-term target RoAE of 25% 19.9% 16.7% • Focus on competitive advantages (3) Fee & commission income (% of Financing income ) (4) Total impaired receivables / total gross loans • Gross loans – Annual increase rates • Interbank Loans and Deposits not included.

38. Strategy Capitalise on advanced retail / SME franchise Capture trade flows from overseas locations Grow local customer base through branch roll-out Enhance non-cash business Leverage existing customer base through enhanced product range / offering Improve operational efficiency through cost control initiatives Become Turkey’s leading participation bank and one of Turkey’s top 10 banks

39. Strategy in International Banking Key highlights • Raised US$200m through a syndicated commodity Murabaha transaction for Kuveyt Turk in 2006 • Arranged US$240m of international syndications since 2006 • Correspondent banking relationship with around 1,000 financial institutions in 96 countries Key strategic goal • Increase market share in international syndicated facilities • Leverage off KFH relationship and Bahrain branch to drive growth through increased access to Gulf investors • Expand German representative office into full branch operation Products International expansion Means of achieving strategic goals • Focus on increasing quality and size of international syndications • Expand treasury function • Increase international services to retail and corporate customers • Dubai branch expected to be operational • Germany representative officeawarded Financial Services branch license in 2009 • Expected to add value on fund mobilisation from Turkish and Muslim population. • Further expand correspondent bank network in line with demand for trade finance activities International expansion and access to Gulf investors key to growing ahead of the market

40. Let’s move together further ahead to explore new peaks and horizons of Islamic banking Thank you Murat Çetinkaya EVP, Kuwait Turkish Participation Bank