Dissertation Islamic Finance Shakeel Ahmad

ISLAMIC BANKING AND FINANCE
IN THE CONTEMPORARY WORLD
DISSERTATION
Shakeel Ahmad (shakeeluae@gmail.com)

Facilitator: Dr. H. K. Pradhan (pradhan@xlri.ac.in)
Executive Post Graduate Program (Ex-PGP) in Management

XLRI (http://www.xlri.ac.in), Dubai (http://www.xlri-dubai.net/)
Approved for submission: February 2004
Acknowledgements
I am grateful to Dr. H.K. Pradhan, my guide, for his continuous encouragement that enabled
this study of a subject that had remained within my heart, since early ages. His teachings of
International Financial Management provided insights beyond theoretical concepts, and his
friendly style inspired the quest for excellence. I am thankful to XLRI, an institution that
provided me with the opportunity to pursue this post graduate study in management, for
which this dissertation project was undertaken.
I take this opportunity to express my sincerest gratitude to all the members of Islamic
Banking and Finance Community (IBFnet) in the Yahoogroups mailing list. Islamic finance
community has worked hard in providing a wealth of resources on the internet. They deserve
appreciation and rewards from no less an entity than Allah SWT Himself.
Special thanks go to Dr. Obaidullah, the IBFnet’s founder. This dissertation work would not
have been possible without the special help and encouragement from Dr. Shahid Ebrahim – it
is difficult to express my special thanks for him, in a few words.
Dissertation: Islamic Banking and Finance in the Contemporary World
Program: Ex-PGP (2001-04), XLRI, Dubai Campus
Finally, the time that I devoted on the Ex-PGP, and this project, was taken away from my
family whose support acted not only as facilitator but also was a source of continuous
inspiration.
Exploratory Channel:
Sequence Title Pag
e
1 Introduction 3
2 Why Islamic Banking? 4
3 Islamic Banking and Finance (IFB) Sector, now 6
4 Why is Islamic Banking and Finance (IBF) creating ripples? 6
6 Literature Review 7
7 Islamic Banks 10
8 Brief History 11
9 Concepts behind Islamic Banking and Finance 13
10 Distinguishing Features 13
11 Role of Islamic Banks 14
12 Prohibition of Interest 14
13 Table-2: Comparison between Riba and Profit 15
14 Table-3: Differences between Islamic & Conventional Banking 16
15 Key Islamic Financial techniques/ Products 17
16 Box-1: Islamic Financial Instruments 19
17 Islamic Derivative Products 21
18 Advantages of Islamic Finance 21
19 Box-2: Landmark Islamic finance deal inked 23
20 Perceived Disadvantages of IBFs 24
21 Impediments to the growth of IBFs 24
22 Recommendations to counter Impediments to growth of IBFs 36
23 Latest Developments 38
24 Box-3: How Islamic is Bank Negara’s IIMM? 40
25 Islamic Bonds (Sukuk) Funds 41
26 Box-4: Conventional Investors find Islamic Bonds attractive 41
27 Box-5: US$250 Government Islamic Leasing Securities 42
28 Box- 6: Islamic Development Bank launches bond issue worth $400m 43
29 Box-7: Latest Trends & Challenges 45
30 Box-8: Bahrain: LMC to issue $1.2b bonds 46
31 Rating Agencies 48
32 Basel II Implications 49
33 Important Institutions 49
34 Conclusion 51
35 References 54
36 Appendix-A0: Estimation of TAI for UAE 59
APPENDIX-A: Competitiveness of Banking Sector In Case of Opening Local
37 59
Markets to GCC Banks
38 APPENDIX-B: Islamic Financial Institutions in the World 61
Submitted by: Shakeel Ahmad Page 2 of 76

39 APPENDIX-C: Islamic Equity Funds in the World 68

40 APPENDIX-D: The Dow Jones Islamic Market Indexes 72
41 APENDIX-E1: Assets, Deposits and Loans of 53 Conventional local Banks in GCC 73
42 APENDIX-E2: Assets, Deposits and Loans of 8 Islamic local Banks in GCC 74
Introduction: To start with graphics may not be a novel idea, but if you are associated in
any way with promoting deposits or instruments of a conventional bank anywhere in the
world, these graphics must already have left some alarm bells ringing in your mind. 32.83%
CAGR in Deposits and 24.69% CAGR in total assets over a four-year period in a country
which was written off the books of financial wizards and stock-market punters after the Asian
Currency Crisis. In figure–1, the rapid rise can be seen not in one aspect but in all major
aspects of banking and finance reinforcing the belief that the growth rate witnessed was an all
encompassing one. The question that arises at this moment is whether this growth rate is
450,000 18,000,000
400,000 16,000,000
350,000 14,000,000
300,000 12,000,000
250,000 10,000,000
200,000 8,000,000
150,000 6,000,000
100,000 4,000,000
50,000 2,000,000
0 0
1998 1999 2000 2001 2002
Deposits from Customers Financing of Customers Investments

Revenue Total Assets
Fig-1: Revenue (RM '000) (Left Scale) and Assets/ Investments/ Financing/ Deposits (RM '000) (Right Scale)
for Bank Islam Malaysia Berhad (BIMB), Malaysia’s oldest Islamic bank (established on July 1st 1983)
Source: BIMB Annual Report 2002
sustainable. An answer to that would be premature without looking at the reasons behind this
phenomenon, and whether the same success story is repeated anywhere else in the world.
We will try to answer some of the above questions, and also try to see if the growth in Islamic
banking and finance sector could have been better. If yes, we will try to peep into the reasons
behind less than expected growth.
Much has been written by historians about the feudal lords who by virtue of charging high
interest rates controlled those in desperate need to finance their survival. Financial clout led to
political clout and ended up in enslaving the masses. Before the historians touched upon this
exploitation of the masses, religious scriptures had already warned of usurious acts existing in
the society.
In the Old Testament (King James Version), Exodus, Chapter 22, verse 25:
If you lend money to any of my people that is poor by thee, thou shalt not be to him as an
usurer, neither shalt thou lay upon him usury.
Leciticus, Chapter 25, verses 34-36:

And if thy brother be waxen poor, and fallen in decay by thee; then thou shalt relieve him:
yea though he be a stranger, or a sojourner, that he may live with thee.
Take thou no usury of him, or increase: but fear thy God; that thy brother may live with
thee.
Why Islamic Banking? The New Testament also contains edicts on the same line. Thus
the very mention of usury and the suggestion to avoid indulging in this act in Judaism and
Christianity implies its existence in ancient times and the ills that it carried along for the
society.
Despite the warning against this practice, the system prospered. Modern financial system
learnt a lesson from these religious warnings and tried to adopt a system that limited the
extent of usurious exploitation to a great extent. By creating a market for debt, based upon
‘perfect competition’, it propounded an end to exploitative nature of usury and thus evolved
the system of interest rates which was supposed to be determined by the market forces freely
competing with each other. What we see today is an expansion of the ancient feudal system
into a global arena with nations facing the same plight as did individuals earlier.
From the traditional Jewish lending system of the Shylocks to the Indian feudal system, there
is no need to strain our memories much. What is definitely cause for stress is the false claim
of the contemporary world order to have relieved the masses of this burden of debt. Figures
2a and 2b show how countries, instead of individuals, are getting trapped into slavery. There
is no doubt that Debt to GDP ratio is a robust indicator of the Debt burden of countries. If we
compare the ratios that triggered the 1980s Debt crisis with the levels being experienced, now,
we can see that the situation is no better, and could be enough cause for the unipolar world of
the day. Despite the claim that modern interest-based system is not exploitative or usurious,
because the interest rates or debt-service payments are within limits, Figures 2c and 2d
provide a different picture altogether.

Fig-2a: Debt to GDP Ratios for Developing countries & HIPC Fig-2b: Debt to GDP Ratios of crisis-ridden
countries during the Debt Crisis of 1980s
Fig-2c: Amortization payments Fig-2d: Interest Payments
Source: For Fig-1a: IMF World Economic Outlook 1999 & 2003- Statistical Appendix; For Fig-1b: Sachs and
Larrain (1993)
The transition of the world from a multipolar world order to a unipolar one has not been
without pain and suffering. It is not easy to emphatically pronounce that the cause for this has
been the interest-based system, but nobody should doubt that the cause has been the financial
system as a whole. Interest-based system is one component of the economic system where the
concept of money itself, as a worthless piece of paper carrying immense power, may be ill-
conceived.

Fig-3a and 3b: Interest rates and export prices in Latin America (1972-1986)
Source: Andres Bianchi et al., “Adjustment in Latin America, 1981-86,” in V. Corbo, M. Goldstein, and M.
Khan, ed., Growth Oriented Adjustment Programs, Washington, D.C.: International Monetary Fund and The
World Bank, 1987.
Similarly, the argument that low interest rates cannot cause countries to lose their sovereignty
also does not hold much ground. The diagnosis of the Debt Crisis of early 80s suggests that
even low interest rates (Figure-3a), acting as a trap (particularly when they are floating rate, as
majority of debt was) could cause countries to come down to their knees. Flushed with funds,
due to the sharp oil price increase in 1973-74 leading to booming deposits by Oil-rich
countries, international commercial banks were eager to lend at lower interest rates enticing
the third world to borrow more and more. The debt burden measured by Debt-to-GDP ratio
(Fig-2b) is an indication of the inevitable crisis that was waiting to happen.
The urge to have a system that claims to provide a solution to such financial crises grows after
every financial (monetary, exchange rate, stock market or Debt) crisis. It is not hard to
understand that if the value of money carried its real worth, currency crises could be avoided.
If the paper being traded in stock exchanges were actually trading at their genuine value, with
no speculation, bubbles that occasionally burst would not exist. If the interest-free banking
system could see the light of the day, no debt-crises would occur, as all the financing would
be PLS (Profit-and-Loss Sharing arrangement of Islamic financial system). Islamic banking
and finance based on the Islamic economic system must be taken seriously, therefore.
This paper looks into the realities associated with this system which is growing at a much
faster pace than its counterpart, and is making its conventional competitors stand up and have
a look. The success of the Islamic system can be gauged by the rush among the conventional
banks to open their own ‘Islamic windows’ not just in countries dominated by Muslims but
also in rest of the world. Some of the Western banks already having dedicated Islamic
subsidiaries are: Citibank, HSBC, American Express, ABN Amro, BNP Paribas, Bank of
America, Stantad Chartered, Commerzbank, Barclays, Deutche Bank, ANZ Grindlays,
Golman Schs, Royal Bank of Canada, Pictet & Cie, UBS, Flemings, Merrill Lynch and
Kleinwort Benson. And the list is growing. With countries like Pakistan, Sudan and Iran
adopting 100% Islamic Banking, the prospects of more countries to follow suit rising, the
conventional counterparts cannot sit back and see their market share being eaten away.
Islamic Banking and Finance (IFB) Sector, now : It is difficult to obtain exact
figures on the size of the Islamic financial sector. Without doubt, it is small in comparison to
the conventional financial sector but it is experiencing strong growth. Iqbal and Mirakhor
(1999) report that Islamic banks grew from an asset base of $5 billion in 1985 to a level of

over $100 billion in the late nineties. The chairman of Dubai Islamic Bank and Emirati
Minister for Financial Affairs, Mohammad Khalfan bin Kharbash, recently noted that the
number of Islamic banks has grown from 34 institutions in 1983 to 250 today, operating and
managing assets of $200 billion (Phillips, 2001). The annual growth rate for Islamic financial
institutions varies from 15 to 40 percent annually (Hamwi and Aylward, 1999). Yet, a
comparison of the assets of all Islamic banks to HSBC, just one of the world's largest banks
with assets of $569 billion in 1999 (Azzam, 2000), demonstrates how small the Islamic sector
remains on the world banking stage.
Nevertheless, Islamic banking is spreading and gaining acceptance in both Muslim and non-
Muslim countries. In 1999, the Middle East alone had 12 top-tiered Islamic banks with total
capital of about $1.8 billion and assets of approximately $18 billion. Bosnia Bank
International became operational in March 2001, positioned as a regional Islamic bank for the
Balkan area, with wholesale and retail services in Bosnia (Carvalho, 2001). Many of the
Islamic banks are gaining strength and achieving profits. For example, Al Rajhi Banking and
Investment Corporation posted a net profit in 1997 of $347 million and return on capital of
25% (Hamwi and Aylward, 1999). Bank Al-Jazira, by far the smallest bank in the Saudi
Islamic banking sector, grew profits by forty-one percent in 2000 (MEED, 2001).
Why is Islamic Banking and Finance (IBF) creating ripples?
Looking at the growth rates of IBF in comparison to the conventional banking, the reason
may be obvious (Figure-4).
2002
2001
2000
1999
1998
1997
1996
-40% -20% 0% 20% 40% 60% 80% 100% 120% 140%

Islamic Non-Islamic
Fig-4: Proportion of Islamic Bonds in Malysia v/s Non-Islamic Bonds

Source: Annual Reports of Bank Negara (Central Bank of Malaysia) and Authors’ calculations
Malaysia being a pioneer in expansion of IFB products, our calculations for the CAGR for its
leading bank BIMB (Bank Islamic Malaysia Berhard) between 1998 and 2002 yield the
following results: Deposits grew at 32.4%, Investments at 39.3% and Total assets at 28.3%. It
will be an impossible task for any conventional bank to match these figures during the period.
For the sake of diversity in outlook, we compared the figures for two banks in UAE under the
same ownership - National Bank of Abu Dhabi, a Conventional Bank and Abu Dhabi Islamic
Bank, an Islamic bank. The results are even more astounding, as depicted in Figure-5.
None of the Islamic banks yielded any negative growth rates during the period under study
while thirteen conventional banks in terms of Loans, seven in terms of Assets and eight in

terms of Deposits reported negative CAGR. The data for all these banks are provided in
Appendices-E1 and E2.
Table-1: Comparison of CAGR for 53 conventional and 8 Islamic banks in GCC
Financing (Loans) Deposits Assets
Average CAGR (1999-2001)
Local Conventional Banks 7.3% 7.6% 9.5%
Local Islamic Banks 19.2% 21.4% 18.6%
Western banks and financial institutions, like Chase Manhattan, J.P. Morgan, Goldman Sachs,
Commerzbank AG, Deutsche Bank AG, HSBC, Citicorp and Bankers Trust, have joined the
race for providing Islamic products, but they currently exist in trade and other forms of short-
term finance, mostly. Independent financial institutions based on Shari'ah are also becoming
common for the Western banks and financial institutions. Citicorp’s Islamic banking unit in
Bahrain established in 1996 is an example. Standard Chartered Bank Malaysia Bhd. is
planning to extend its Islamic banking services to become a total money management and
financial provider within two to three years (The Star, May 17, 2001). From less than 10
Islamic mutual funds a decade ago to over 90, now, according to a report by Wall (2001), is
no mean achievement. High-tech fever has not caused Islamic financial Web sites to crop up
and grow along with Islamic Finance.
2,000 6,000
5,000
1,500
4,000
1,000 3,000
NBAD Loans
ADIB Loans
2,000
(Million $
(Million $
500
1,000
0 0
)
1999 2000 2001
National Bank of Abu Dhabi Abu Dhabi Islamic Bank
CAGR (1999-01)Financing
(Loans)DepositsAssetsNBAD10.21%0.2%1
.2%ADIB50.12%69.1%51.45%NBD2.3%1
7.1%14.5%DIB27.3%31.1%28.1%Table-1:
Comparison between Conventional and
Islamic Banks of UAE
Fig-5: Comparison between Conventional and Islamic Banks in UAE (National Bank of Abu Dhabi
v/s Abu Dhabi Islamic Bank); Source: Annual Reports of respective banks

Literature Review: The information on Islamic Banking & Finance is available in many
forms, e.g., PhD dissertations (El-Bdour, 1984; Khan, 1983), books written by leading
academics and practitioners (e.g. Homoud, 1985; Shirazi, 1990), published research in the
form of reports (Ahmad, 1987; Iqbal and Mirakor, 1987) and journal articles (e.g. Erol and
El-Bdour, 1989; Erol et al., 1990; Shook and Hassan, 1988; and Sudin et al., 1994). Because
of Riba, Islamic banks have had to develop financial products which are not in conflict with
the Sharia'h. The task has been achieved by creating a number of special financial products
(Ali and Ali, 1994).
Similar results can be seen when comparing

Dubai Islamic Bank (Islamic) with National Bank
of Dubai (conventional) – two banks under Dubai
Government (Figure-6). Exceptionally larger
growth for the Abu Dhabi Islamic Bank may be
due to its short history – the bank might be
growing at this unprecedented rate because it has
recently come to fulfill the unsatiated need of the
people of Abu Dhabi (or UAE). But, the growth
rate of Dubai Islamic Bank, the oldest Islamic
bank of the modern world, provides enough
empirical evidence in favour of much larger
growth rates for the IFBs.
Another study of fifty-three conventional banks
and eight pure Islamic IBFs in GCC, covering
almost the entire population of local banks in the
region yielded results on similar lines, as listed in
Table-1.
Fig-6: Comparison between Conventional (National Bank of

Dubai) and Islamic (Dubai Islamic Bank) Banks in UAE
Source: Respective Annual Reports
The main thrust of Islamic financial contracts is on profit and loss sharing, which can be
deemed as equity (Musharakah) and hybrid (modified Mudharabah and Ijara) facilities
(Ahmad, 1994). However, the risks of these vehicles are inherently higher than conventional
ones as espoused by Ebrahim (1999). One definition of an Islamic Bank is a bank that, by its
own choice, opts to comply with two sets of law: the law of the Land (Jurisdiction); and the
Islamic Law (Shari'ah). This is why Islamic bankers have two types of legal counsel:
traditional "lawyers" and "Shari'ah Councils" (Al-Bahar, 1996).
"Islam is deeply concerned with the problem of economic development, but treats this as an
important part of a wider problem, that of total human development. The primary function of
Islam is to guide human development on correct lines and in the right direction. It deals with
all aspects of economic development but always in the framework of total human
development and never in a form divorced from this perspective" (Al-Harran, 1993). The
Shari'ah specifies, inter alia, rules that relate to the allocation of resources, property rights,
production and consumption, and the distribution of income and wealth (Iqbal and Mirakhor,
1987).
Islamic banking advances the following set of beliefs: interest as a reward for saving does not
have any basis as a moral foundation; abstinence from spending of present income does not
deserve a financial reward; and to benefit from money is to transform the money into

investments, conditioned to accept risks and bringing the knowledge of other factors of
production together (Presley, 1988).
Rayner (1991) lays down four elements of a contract on a property (mal): they are lawfulness,
existence, deliverability and precise determination. Ebrahim (1999) explains that profits on
Murabahah facilities are generally higher than conventional loans because Islamic
instruments are structured to share the risk of the asset or venture. Hence, the "profits" and
"interest-charge" implied are similar in outcome, although not by design (Iqbal and Mirakhor,
1999; Rosly, 1999). Thomas (1995) is of the view that Riba, Gharar and Maysir manifested
in the conventional system can wreak havoc in an economy as advanced as the USA, as
depicted by the massive failures of US savings and loans institutions of the 1980s. Islamic
banking aims to promote economic growth through risk-sharing instruments whose payoffs
fluctuate with economic output and do not structurally impair the economy in the manner of
excessive fixed-interest debt does in a poor economic environment such as a recession
(Asquith et al., 1994; Andrade and Kaplan, 1998).
The potential of Islamic fixed income securities backed by an Ijara facility is discussed by
Kahf (1997).
Islamic Derivatives: These comprise both Islamic Futures and Embedded Options in a
contract. However, the development of it is largely unrealized (Khan, 1995). Ebrahim (2001)
recommends to design, develop and implement Islamic hedging and risk minimizing facilities
such as Islamic futures (Bai Al-Salam/Istisna), Islamic swaps, etc. (Iqbal, 1999). (Ebrahim,
2000) further recommends to design, develop and implement Islamic facilities that enhance
the competitive ability of Islamic banks and reduce their risk exposure.
The excessive use of credit facilities by Islamic banks globally has drawn the ire of scholars
such as Ahmad (1989) and El-Naggar (1994). Conventional futures are very controversial
with the Ulema - religious scholars (Kamali, 1999). It should be noted that certain Ulema
such as Justice Taqi Usamani have given their verdict allowing contracts with embedded
options (Kahn, 1999).
Part of the study of Erol and El-Bdour (1989), conducted in Jordan, aimed at establishing the
attitude of local people towards Islamic banking. The results suggest that religious motivation
did not appear to play a primary role in bank selection; the opening of new branches was not
an important factor in increasing the utilization of financial services provided by Islamic
banks; while 39.4 per cent of respondents would withdraw their deposits if an Islamic bank
did not generate sufficient profit to make a distribution in any one year, 30.4 per cent would
retain their deposits because the Islamic bank could distribute a higher dividend the following
year.
Gerrard & Cunningham’s (1997) study establishes that, in Singapore, which has a minority of
Muslims in its population, both Muslims and non-Muslims are generally unaware of the
culture of Islamic banking. Also the two separate groups have different attitudes towards the
Islamic banking movement, with the degree of difference depending on the nature of the
respective matter put to them. For example, when asked what they would do if an Islamic
bank did not make sufficient profits to make a distribution in any one year, 62.1 per cent of
Muslims said they would keep their deposits within the Islamic banking movement, while
66.5 per cent of non-Muslims said they would withdraw their deposits.
Much has been written since the early 1960s on the theme of the bank selection process (see,
for example, the published articles of Anderson et al. (1976); Holstius and Kaynak (1995);
Kaynak (1986); Kaynak et al. (1991); Laroche et al. (1986), and the working paper of Chan
(1989)). Erol & El-Bdour (1989) and Erol et al. (1990) compared the bank selection process

in relation to "conventional" and Islamic banks. Sudin et al. (1994) compared responses about
the bank selection criteria of both Muslims and non-Muslims.
In addition to establishing attitudes towards Islamic banking, Erol and his co-researchers
(1989 and 1990) sought to establish, then compare, the bank selection criteria of customers of
conventional and Islamic banks in Jordan. Sudin et al. (1994), among other things, sought to
establish the relative importance of certain bank selection criteria using a sample of Muslims
and non-Muslims, none of whom had to be patronizing an Islamic bank at the time of the
study. The three most important criteria in the bank selection process for Muslims were: first,
"the provision of a fast and efficient service"; second, "the speed of transaction"; and third,
"friendliness of bank personnel". As regards the non-Muslims, the three most important bank
selection criteria were: first, "friendliness of bank personnel"; second, "the provision of a fast
and efficient service"; and third, "the reputation and image of the bank".
ISLAMIC BANKS: An Islamic bank is an intermediary and trustee of other people’s

money like any conventional bank with the possible difference that the payoff to all its
depositors is a share in profit and loss in one form or the other. This difference introduces an
element of mutuality in Islamic banking, making its depositors as customers with some
ownership rights inherent within it. However, in practice, Islamic banks hardly look different
from its conventional counterpart in terms of organisational set-up (Dar and Presley, 2000).
Islamic banking has been defined in a number of ways. General Secretariat of the OIC’s
definition goes like this: “An Islamic bank is a financial institution whose status, rules and
procedures expressly state its commitment to the principle of Islamic Shariah and to the
banning of the receipt and payment of interest on any of its operations” (Ali & Sarkar-1995)
Unlike conventional banks, however, Islamic banks offer PLS accounts, among others, which
do not guarantee a fixed certain return on investment deposits. This leads to a reluctance of
deposit holders, who have no representation in the organisation, to use PLS accounts. The
bank faces a similar problem on the assets side when it comes to investing on PLS.
The essential feature of Islamic banking is that it is interest-free. Although it is often claimed
that there is more to Islamic banking, such as contributions towards a more equitable
distribution of income and wealth, and increased equity participation in the economy (Chapra
l982), it nevertheless derives its specific rationale from the fact that there is no place for the
institution of interest in the Islamic order.
"Although the western media frequently suggest that Islamic banking in its present form is a
recent phenomenon, in fact, the basic practices and principles date back to the early part of the
seventh century." (Islamic Finance: A Euromoney Publication, 1997
Neither a borrower nor a lender be; for loan oft loses both itself and friend and borrowing dulls
the edge of husbandry.
- Shakespeare’s Hamlet - a Danish father advising his son.
UK usury laws on excessive interest abolished in 1854.
South Africa and US (except Virginia and Delaware) have usury laws.
US Federal law allows penalty rates / insurance premiums
Happy the man who far from schemes of business, like the early generations of mankind, ploughs
and ploughs again his ancestral land with oxen of his own breeding, with no yoke of usury on his
neck. (Roman philosopher, Horace)
Julius Caesar limited interest to 8 1/3 %
Those who devour usury will not stand except as stands one whom the Evil one by his touch
hath driven
Submitted by: to madness.
Shakeel AhmadThat is because they say: "Trade is like usury but Allah Page
hath11 of 76
permitted trade and forbidden usury.”
-The Koran: Surah 2, Verse 275
It is simply an accepted fact that there are sufficient Muslim investors and borrowers in both
Islamic and non-Islamic countries to warrant the attention of traditional banks who seek to
serve such clients and capture a potentially profitable slice of a still relatively untapped
market. Just as interesting and useful for non-Islamic bankers are the lessons learned from the
innovation and creativity applied in meeting Islamic criteria.
Some products are more Islamic and than others. The basic principle is that interest - usury or
Riba used interchangeably - is prohibited on the principle of no pain no gain. What a "pure"
Islamic banking seems to be structurally very similar to venture capital finance, non-recourse
project finance or ordinary equity investment. The investor takes a share in the profits, if any,
of the venture and is liable to lose his capital. It involves investing but not lending and
therefore on a systemic basis is similar to the German, Japanese and Spanish banking systems
rather than the British or American systems.
Just as in the process of converting interest into capital gains for tax purposes, early Islamic
investors were content to enter into zero-coupon bonds or discounted Treasury bills and
receive the interest foregone in the form of capital gains.
Beyond the question of interest or Riba lies an ethical issue. Islamic investments exclude
tobacco, alcohol, gaming and other "undesirable" sectors. Islamic investors, by and large, are
motivated in their choice of investments by much the same criteria as their Western ethical
counterparts. The search for acceptable investments is balanced by natural risk-aversion.
Islamic borrowers, on the other hand, also demonstrate a reluctance to give away a share in
the profits of their enterprise. It is not therefore surprising that most of Islamic banking takes
the form of one type of mark-up or other rather than profit-sharing.
An analysis of the products suggests that Islamic banking has six key features:
 free of interest,
 trade-related and there is a perceived "genuine" need for the funds,
 In its purest form, it is equity related,
 meant to avoid exploitation – no usury,
 invests ethically,
 there are retail and wholesale applications.
Under the current interpretation of the rules governing Islamic banking, Usury and Riba are
regarded as synonymous. The prohibition is on interest and not just on usurious interest. In
practice, there appears to be more emphasis on the prohibition and restructuring of interest
than on the potentially exploitative aspect of financing.
Brief History: It is worth noting that there is nothing new or particularly Islamic or
Christian about Usury or interest controls. In 24th century B. C. Manu established a rate
ceiling of 24% in India. Later, Hammurabi, King of Babylon, authored laws around 19th B.
C. established a cap on lending rates. On loans of grain, which were repayable in kind, the
maximum rate of interest was limited to 33 1/3% per annum. On loans of silver, the maximum
legal rate was 20% although it appears that in some cases rates of 25 per cent per annum were
charged. The law remained for most of the next 12 centuries but as with any law "regulatory
arbitrage" took place and was subsequently eliminated. Unfair practices also existed. For
example, creditors were forbidden from calling a loan made to a farmer prior to harvest. If the
crop failed due to weather conditions, all interest on the loan would be cancelled for that year.
In the case of houses, due to the scarcity of wood, a door could be used as collateral and was
considered to be separate from a house. The 6th century Greeks, through the laws of Solon,
lifted all maximum limitations on the legal rate of interest a moneylender might charge. The
temple at Delphi was the "City" or "Wall Street" of the Greek Empire lending money for

interest regularly. Credit regulation was once again part of the legal code at the start of the
Roman Empire. The legal limitation on interest was established at 8 1/3% per in the 5th
century B.C. Julius Caesar’s attempts to control interest rates could well have been the real
reason for his assassination since many the Roman senators were the main moneylenders.
(This section is drawn from Edwardes-2000. The reader is also referred to Armstrong-1987,
for more details).
Back to the present day, quite a few Western countries have Usury laws that prohibit
excessive interest rates. The UK’s usury laws which prevented "excessive" interest were
abolished in 1854. South Africa and the US still have usury laws. Usury results when a lender
charges more than the legal amount of interest permitted in that geographical area. Usury
percentage limits vary by state, in USA, and at least one state, Virginia, has no usury limit.
Today most of the states have had their ability to limit interest rates curtailed by over-riding
US Federal law. Higher than permissible rates have been regarded by US Federal banking
authorities as penalty fees and insurance premiums. And the federal rate limits are high.
(Refer to Edwardes-2000).
In some states there is no restriction on the rates used for lending to incorporated entities. The
controls are often on lending to persons. The usury rate usually is variable depending on
market rates. In September 1998 in North Dakota it was 10.556%. California has recently
imposed strict consumer lending limits. But these only apply to state banks and not to national
banks. The California Constitution allows parties to contract for interest on a loan primarily
for personal, family or household purposes at a rate not exceeding 10% per annum
(compound annual percentage rate). The allowable rate in California is 5% over the amount
charged by the Federal Reserve Bank of San Francisco on advances to member banks on the
25th day of the month before the loan. The usury laws do not apply to any real estate broker if
the loan is secured by real estate. This applies whether or not he or she is acting as a real
estate broker. The limitations also do not apply to most lending institutions such as banks,
credit unions, finance companies, pawn brokers, etc. State laws place limitations on some of
these loans, but at a higher percentage rate than the usury laws listed above. (Refer to
Edwardes-2000).
In the Old Testament (King James Version), Exodus, Chapter 22, verse 25:
If you lend money to any of my people that is poor by thee, thou shalt not be to him as an
usurer, neither shalt thou lay upon him usury.
Leciticus, Chapter 25, verses 34-36:
And if thy brother be waxen poor, and fallen in decay by thee; then thou shalt relieve him:
yea though he be a stranger, or a sojourner, that he may live with thee.
Take thou no usury of him, or increase: but fear thy God; that thy brother may live with
thee.
THE New Testament also contains edicts on the same line. Thus we can see that Judaism and
Christianity are no different in terms of prohibition of usury.
The revival of Islamic banking coincided with the world-wide celebration of the advent of
the 15th Century of Islamic calendar (Hijra) in 1976.
Chronology of recent historical events in the industry:

1963: Egypt interest free savings banks, not overtly Islamic - invested in trade and industry on
the basis of share in profits.

1971: Egypt Nasr Social bank, still no overt reference to Islam.

1973: Conference of Islamic finance ministers.
1975: Islamic Development Bank, Jeddah, fee based and PLS, revolving capital.
1975: Dubai Islamic Bank, UAE, first Islamic Commercial Bank in the world.
1970’s: Faisal Islamic Bank of Sudan / Egypt; Bahrain Islamic Bank; Malaysia, Philippines,
Nigeria, Indonesia; Islamic Finance House, Luxembourg; DMI Geneva; Al Rajhi London,
Denmark, Australia, South Africa; HSBC Amanah Fund; ANZ First ANZ International
Murabah Ltd., IBU of United Bank of Kuwait.
Time payment contracts such as retail installment contracts are not generally treated as loans
and the usury laws normally do not apply to them. There are no limits on finance charges for
the purchase of personal, family and household goods or services at this time. The maximum
interest rate for car loans is almost 22%. Banks also treat interest charges for third party credit
cards such as Visa, MasterCard and American Express as not being subject to Usury law
limitations. (Refer to Edwardes-2000).
It is not surprising to know that the first documented interest-free bank (Agibi Bank) was
established circa 700 BC, in Babylonia, and functioned exclusively on an equity basis.
………..….… Baron-1952
In transactions for the purchase of goods or services which are not for personal, family or
household purposes, there are normally no limits to finance charges except those set by the
parties. Limited liability companies and limited liability partnerships can no longer assert
usury as a defence in civil recovery actions. The usury interest limit that applies to limited
liability companies and limited partnerships has been raised from 30% per annum to 50% per
annum to equate to the level that applies to corporations. (Refer to Edwardes-2000).
But there is a problem with usury laws as can be seen in South Africa. If there is a particularly
risky investment and an interest rate limit, then banks will simply not lend. The poorest will
find themselves deprived of financing, and under a free market there will be a shift to quality
or to those that do not really need financing. Unless there is government imposed mandatory
or tax driven lending to certain sectors or public opinion pressure, certain sectors or
individuals deemed risky by the banks will simply not get the funding required. (Refer to
Edwardes-2000).
The Concepts behind Islamic Banking and Finance:
Distinguishing Features: The economic doctrine of Islam is based on encouraging free
markets, discouraging price controls and forbidding financial contracts based on riba, gharar
and maysir.
Riba (Charging of Interest): Taking or paying of interest (riba) is prohibited by Shariah
(Islamic law). The concept of riba extends beyond interest and usury, and volumes have been
written by scholars to explain the concept. In simple terms, riba can be considered as
exploitation of one party who owns a product (that includes money and capital) and which
another party wishes to acquire. Although interest comes very close to this concept, it is still
better to consider riba as “unfair exploitation”.
Ebrahim (1998) explains that “Riba is expounded by Ibn Qayyim & Al-Jawziyya (n.d.),
another prominent Islamic scholar, to imply (i) any form of unfair trade, market manipulation
or engaging a market participant to trade under duress (riba-al-fadl) and (ii) risk-free debt
contracts (riba-al-nasi'ah). From a financial economist's perspective, riba-al-nasi'ah can be

defined as a risk-free return from an investment vehicle or strategy.” (see also Chapra-1986,
Rahman-1969, Saeed-1995, Thomas-1995).
Gharar (Uncertainty): The existence of uncertainty in a contract is prohibited because it
requires the occurrence of an event which may not ultimately occur. “Full disclosure” by both
parties is the norm in contractual relationships. Any type of transaction where the (i) subject
matter, (ii) the price, or both are not determined and fixed in advance amounts to
“uncertainty”. Thus hedging and dealing in derivatives is not allowed.
Maisir or Speculation: Speculation is equivalent to gambling, and therefore is prohibited.
Derivative transactions like Options, Futures, Swaps and forward contracts (that insure profit)
are considered un-Islamic. They are also considered un-Islamic because for most of them,
rates are determined by interest differentials.
Zaka’h: A taxation system inherent in the Islamic system based on the principles of social
justice and equity.
Implying social justice and general welfare: The basic principle is that everybody should be
able to fulfill at least the basic needs.
Conforming to Shariah: The Quran and Hadith clearly specify the guidelines for individual,
social, organizational, governmental behaviour, and thus become the basic pillar for any
Islamic system, with the banking and financial system being no exception.
Qard-e-hasna (benevolent loan), or Qard Hassan: Qard-e-Hasna means an interest free loan
and is the only type of loan permitted by the Shariah. The loans are made from the pooled
donations of the members and are generally granted to those who are facing emergency
personal crisis. This form of finance is very important part of Islamic financial system and all
members are encouraged to become regular donors so that the fund may be strengthened for
the benefit of all Muslim The guiding principle again is the social justice and general welfare.
Some Islamic banks provide the privilege of interest free loans only to the holders of
investment account with them. Some extend to all bank clients. Some restrict it to needy
students and other economically weaker sections of the society. Yet some other Islamic banks
provide interest free loans to small producers, farmers and entrepreneurs who are not qualified
to get finance from other sources. The purpose of these loans is to help start them their
independent economic life and thus to raise their incomes and standard of living. Banks
usually charge a small fee (say, 1.5%) annually to cover their administrative costs, etc.
Profit and loss sharing (PLS): It is an alternative to interest-based transactions.
Risk sharing: No risk, no gain is the basis.
Prohibited Investments and Permissibility of Activities: Investments should only support
Halal (permitted) activities. So, investments involving products like pork, alcohol,
pornography, arms & ammunitions, Cinema, Tobacco, Conventional Financial Services and
activities like gambling are prohibited.
Hoarding: Hoarding money is considered improper in Islam; money is merely a means of
exchange and should not be treated as a commodity. Islam encourages Trade and Enterprise,
which can generate wealth for the benefits of the community as a whole with PLS as its core.
Role of Islamic Banks: The role of Islamic banks becomes difficult compared to their
conventional counterparts because of the basic principle that m
oney is not supposed to earn interest. This eliminates a major role of the financial institution.
So, what do they do? They invest in viable projects, with reliable borrowers. If the project
succeeds, the banker shares in the profit, if it fails, he suffers the losses.

Prohibition of Interest: Prohibiting the receipt and payment of interest is the nucleus of the
system, supported by other principles of Islamic doctrine advocating risk sharing, individuals'
rights and duties, property rights, and the sanctity of contracts. Similarly, the Islamic financial
system is not limited to banking, but covers capital formation, capital markets, and all types of
financial intermediation. Since prohibition on transactions based on interest payments is the
most important factor and is at the heart of the Islamic financial system, it will be unjust not
to provide some light on it.
The basic philosophy underlying transaction of money is that the one who is offering his
money to another person has to decide whether:
(a) He is lending money to him as a sympathetic act or,
(b) He is lending money to the borrower, so that his principal may be saved or,
(c) He is advancing his money to share the profits of the borrower.
Table-2: Comparison between Riba and Profit
Riba Profit
1. When money is “charged”, its imposed 1. When money is used in productive activity
positive and definite result is Riba (e.g., in trading), its uncertain result is profit.
2. By definition, Riba is the premium paid by 2. By definition, profit is the difference
the borrower to the lender along with between the revenue from production and the
principal amount as a condition for the loan. cost of production.
3. Riba is prefixed, and hence there is no 3. Even if a sharing ratio is agreed in advance,
uncertainty on the part of either the givers or profit is still uncertain, as its amount is not
the takers of loans. known until the activity is completed.
4. Riba con not be negative, it can at best be 4. Profit can be positive, zero or even negative.
very low or zero.
5. From Islamic Shariah point of view, it is 5. From Islamic Shariah point of view, it is
Haram (prohibited). Halal (allowed).
Making Money from Money is not permissible - the basic points of difference between money
and commodity are highlighted to justify this. Money (of the same denomination) is not held
to be the subject matter of trade, like other commodities. Its use is restricted to its basic
purpose i.e. to act as a medium of exchange and a measure of value.
If money is to be exchanged for money or it is borrowed, the payment on both sides must be
equal, so that it is not used for trade in money itself. In short, money is treated as "potential"
capital. It becomes actual capital only when it joins hands with other resources to undertake a
productive activity. Islam recognizes the time value of money, but only when it acts as
capital, not when it is "potential" capital.
Muslim scholars term interest as Riba. Under Shariah, Riba technically refers to the premium
that must be paid by the borrower to the lender along with the principal amount as a condition
for the loan or for an extension in its maturity (Chapra 1985, p.64). In other words, Riba is the
predetermined return on the use of money. In the past there has been dispute about whether
Riba refers to interest or usury, but there is now consensus among Muslim scholars that the
term covers all forms of interest and not only “excessive” interest (Khan 1985, p.52).

The most important characteristic of Riba is that it is the positive and definite result of money
when changed. In other words, when money begets money, without being exchanged for
goods or services, or without indulging in any productive activity, it is called Riba. The basic
characteristics of Riba are:
 It must be related to loan;
 A prefixed amount of money to be paid when due;
 A time is fixed for the repayment; and
 All these elements for repayment are taken as conditions for loan.
Since Interest or Riba has emerged as the basic alternative for Profit, a comparison is justified
between the two (Table-2).
Table-3:
Differences between Islamic & Conventional Banking:
Characteristics Islamic Banking System Conventional Banking System
Guiding Guided by Quranic edicts, Hadeeth, Guided by profit motive alone, with
principle Islamic ethics and Islamic laws. no religious or ethical
considerations.
Ethics of Financing being asset-backed, and Debt burden arising out of
financing meant for productive use helps excessive use of credit leads to
reduce the overall debt burden. bankruptcies, and waste of financial
resources.
Liquidation An Investment Account Holder will Depositors are paid before the
Assets have similar rights as shareholders. shareholders.
Involvement of Equity financing is available to a Commercial banks do not usually
risk & Equity project or venture that involves indulge in equity financing, only
financing profit-and-loss sharing. Risk-sharing venture capital companies and
and profit sharing go together. investment banks do. Conventional
banks carry much less risk, major
part of the risks being transferred to
the borrowers.
Return on Depends on productivity, idle money Even idle money in bank deposits
Capital cannot earn any return. Money is not earns returns.
capital per se, only potential capital1.
Prohibition of The existence of uncertainty in a Trading and dealing in derivatives
Gharar contract is prohibited because it are widely considered as the main
(uncertainty) requires the occurrence of an event source of liquidity in the
which may not ultimately occur. conventional financial, commodity
“Full disclosure” by both parties is and capital markets.
the norm in contracts. Derivatives
trading e.g. options are considered as
having elements of Gharar.
Profit and Loss Most transactions are based on this There is no relationship between
Sharing variable returns, dependent on bank performance and returns to the
lenders’ performance. Greater share depositors or investors, who mostly
of risks forces them to manage risks enjoy a risk-free return.
more professionally, to ensure better Conventional institutions mostly
returns than conventional accounts. act as intermediaries between
Depositors & investors have lenders & borrowers enjoying
1
It becomes actual capital only when it joins hands with other resources to undertake a productive activity. Islam
recognizes the time value of money, but only when it acts as capital, not when it is "potential" capital.

opportunity to earn higher returns almost a risk-free spread.

than in conventional systems.
Zakat It has become one of the functions of Government Taxes perhaps serve
the Islamic banks to collect and the same purpose - mode and rate
distribute Zakat. of charging are different, though.
Compounding The Islamic banks have no provision It can charge additional money
or Interest on to charge any extra money from the (compound rate of interest) in case
interest defaulters. of defaulters.
Money-Market For the Islamic banks, it is For commercial banks, borrowing
Borrowing comparatively difficult to borrow from the money market is the main
money from the money market. source of liquidity.
Developing Since it shares profit and loss, the Since income from the advances is
expertise Islamic banks pay greater attention fixed, it gives little importance to
to developing project appraisal and developing expertise in project
evaluation systems. appraisal and evaluations.
Viability v/s The Islamic banks, on the other The conventional banks give
credit- hand, give greater emphasis on the greater emphasis on credit-
worthiness viability of the projects. worthiness of the clients.
Relationship The status of Islamic bank in relation The status of a conventional bank,
with Clients to its clients is that of partners, in relation to its clients, is that of
investors and trader. creditor and debtors.
Capital No guarantee. Built into the system.
Guarantee
Deposit None An integral component
insurance
Key Islamic Financial techniques: Islamic banking and financial institutions have
developed a wide rage of techniques which allow them to uphold the religious and legal
principles while enabling them, at the same time, to offer viable financial products. The
search is actually still going on to find newer techniques, and for variations based upon the
existing ones to offer more attractive and useful instruments for the investors. The following
list covers many of them, but must not be considered as exhaustive:
Mudaraba (Participation or trust financing): It involves two parties, the managing trustee
(Mudarib) and the beneficial owner (Rub-ul-Maal). Usually the investment account holders
are the provider of funds, and the Islamic Banks are the managing partner (mudarib). The
Islamic Financial Institution may either put up all the funds itself and undertake responsibility
for investing in them, or alternately it can provide funds to a customer who then acts as
Mudarib. The borrower retains a fixed percentage of profits, the Islamic Financial
Institution’s reward is a fixed percentage in the balance of the revenue generated by the
investments and the remainder goes to the investors. Underlying principle is ‘no-pain-no-
gain’, i.e., no one is entitled to any addition to the principal sum if he does not share in the
risks involved. Although profits are shared on a pre-agreed basis, losses are wholly suffered
by the Rub-ul-Maal.
Musharaka (Equity Financing): It is quite similar to the Mudarabah contract. It involves
financing through equity. Here the partners or shareholders for a Project use their capital
through a Joint Venture, Limited Partnership to generate a profit. Profits or losses will be split
between the shareholders according to some agreed pre-formula depending on the investment
ratio.

Difference between Mudaraba and Musharaka Contracts: In a Mudaraba contract, the

managing agent (beneficiary or the borrower, called the Mudarib) does not have any financial
participation. In a Musharaka contract, the agent is a financial partner along with the provider
of fund (Rubb-ul-Maal of Mudaraba contract) sharing the gain or loss at the pre-designated
ratio which is likely to be higher than what he is likely to get in a Mudaraba contract. Thus, in
Mudaraba, the agent acts as a working partner who does not bear any losses and simply
manages the fund (the project in which the fund is invested), whereas in Musharaka, all the
parties are shareholders in the venture.
Murabaha (Cost-plus financing): This technique is extensively used to facilitate trade
financing activities of Islamic Financial Institutions. The Mudaraba and Musharaka
transactions are often seen on the retail liability side of Islamic banks. The asset side whether
retail or wholesale is quite risky. The most common such financial instrument is the 'mark-up'
structure called Murabaha. It sounds quite similar to a "repo" agreement commonly used in
the West.
In a Murabaha transaction, the bank finances the purchase of an asset by buying it on behalf
of its client. The bank then adds a "mark-up" in its sale price to its client who pays for it on a
deferred basis. The 'cost-plus' nature of Murabaha sounds very much like the interest into
capital gains manipulations of tax-avoiders. Islamic banks are supposed to take a genuine
commercial risk between the purchase of the asset from the seller and the sale of the asset to
the person requiring the goods. The bank stands in between the buyer and the supplier and is
liable if anything goes wrong. There is thus some form of guarantee with respect to the
quality of the goods provided by the bank to the end user in the strict form of Murabaha. Title
to the goods financed may pass to the bank's client at the outset or on deferred payment. From
the perspective of modern finance, a Murabaha facility is equivalent to an asset-backed risky
loan. If the capital markets are perfect and all agents in the economy have equal access to
information, then competition between Islamic banks and conventional banks would result in
Murabahah having the same expected return as that of conventional loans.
Baimuajjal (Deferred Payment Sales): The payments for this sale could be either in
installments or a one-off deferred payment as per agreement between the parties at the time of
the sale, and cannot include any charges for deferment. This is like as a Murabaha mode of
investment with an exception that the sale under this cost-plus sale mode of investment is
made on a credit basis rather than cash. It is deemed acceptable to charge higher prices for
deferred payments. Such transactions are regarded as trades and not loans.
Ijara (Operating Lease): It involves leasing of machinery, equipment, buildings and other
capital assets. The financier purchases the asset and leases it to the end-user for an agreed
rental which may be fixed in advance or subject to occasional review by a mutually
acceptable third party, e.g. an international firm of accountants. Insuring of the asset remains
a contentious issue.
Ijara wa iqtina (Financial Lease): This is a leasing structure coupled with a right available to
the lessee to purchase the asset at the end of the lease period (Bay’ al Wafa). The lessee
agrees to make payments into an Islamic investment account (with right to all profits) to be
used in or towards financing the ultimate purchase of the asset. The instrument has been used
increasingly in a range of asset classes including ships, aircrafts, telecom equipment and
power station turbines, etc.
Baisalam or Bai’ Salaf (Purchase with deferred delivery): It is a short-term commodity
finance contract in which the buyer (usually of agricultural or manufactured products) pays
the seller full negotiated price of a product that is promised for delivery at a later date. It has
similarities with the forward contracts of conventional financial systems except that in Islamic

instruments the rate of return is tied to each transaction rather than to a time dimension.
Another difference lies in the fact that in Salam, the buyer pays the entire amount in cash, at
the time of contract. Both the quality and quantity of the sold products are definitely specified
in the contract. The counter-party risk in Al Salam is one-sided as it lies with the buyer alone
(the IBF) unlike the forward contracts in which it affects both parties. Hence, it is expected
that this risk will be priced one way unless a security is provided by the seller. This involves
the bank paying for the producer's goods at a discount before they have been delivered or
even made. Difference of opinion exists on whether the subject of Bai Salam transaction
should be available in the market at the time of the contract or whether it is enough that the
asset will be available at the date set in the contract for delivery. Difference of opinion also
Box-1: Islamic Financial Instruments

Islamic Bank as an intermediary for Mudaraba or Musharaka: Islamic bank depositors
act as Rabbulmals and place funds with the bank. The bank is the Mudarib on its liability
side with respect to the depositors. The bank uses the funds on the Mudaraba or Musharaka
basis or any other Islamically approved basis with clients in search of funding. Here the
bank is the Rabbulmal with respect to the end users of the funds. Under such a scenario the
bank acts as a principal. The bank may also act in an off-balance sheet capacity as a fee-
earning agent on behalf of the fund providers and/or fund seekers or as a traditional fund
manager investing in a diversified portfolio of Musharaka contracts.
Retail Islamic Banking Products: At a retail level, Islamic banks provide current, savings,
and investment accounts.
Alwadiah: It is equivalent of the current account of the conventional banks, and used for
day to day cash management. No return is paid to depositors. Most banks have no charges
for such accounts, and provide facilities similar to any conventional bank. Alwadiah
structures are also used for higher return savings account. Banks may sometimes pay the
savers a return, depending on their own profitability. Savings accounts also are quite
similar except for the absence of interest payments. There may or may not be a service
charge incurred. Losses are not, in practice, passed on to depositors and are absorbed
through the banks' reserves.
Term Deposits: They are considered as investment accounts, and use the Mudaraba format.
Deposits are fixed term and cannot be cashed in before maturity. The profit-sharing ratio
varies between institutions and could be a function of the bank's profitability or that of the
portfolio of end borrowers. In practice there is only profit sharing and no loss sharing for
retail investors. The lower risk means a lower profit share.
There are considerable variations on the Mudaraba principle. The Islamic Bank of
Bangladesh has been offering Profit and Loss sharing (PLS) Deposit Accounts, PLS
Special Notice Deposit Accounts, and PLS Term Deposit accounts. Bank Islam Malaysia
provides wholesale and retail investment accounts both on the PLS principle. The
frequency of payment is another variable. Profits are declared and distributed monthly in
Malaysia, whilst in Egypt there is a quarterly distribution. In Bangladesh and Pakistan
distributions tend to be half-yearly.
A common thread is the short-term liquid nature of the deposits. Long-term mortgage-type
finance hardly exists. The longest-term deposits are being raised in Malaysia. Even there
almost all the deposits are under two years in maturity.
can be seen on the minimum time period between the date of contract and delivery of assets.
The party on the purchase side of the contract may sell the asset back to the party on the sale
side of the contract or to a third party for a profit. The purchaser/ financier may also sell the

assets by way of a parallel Bai Salam contract (a salam contract with a third party) to hedge
the asset-risk or for profit.
The stipulation of full cash prepayment in Al Salam contracts is meant to facilitate working
capital finance wherein the party on the buyer side is the IBF institution. Since full
prepayment is involved, the price paid is lower than the future spot price of the goods in
question unlike the futures or forward price which is always higher than the spot price. An
important feature of Al salam contract is the underlying asset which must be standardizable,
of determinate quality and easy to be quantified.
Istisna and Parallel Istisna: It involves a deferred delivery sale contract similar to salam. It
is also similar to conventional work-in-progress financing of capital projects like construction.
It is also used for trade finance such as pre-shipment export finance. In this contract, the seller
( Al Sani’), based upon an order from purchaser (Al Mustasni’), undertakes to manufacture or
have manufactured/ acquired the subject item (Al Masnoo’) as per purchaser’s specifications.
The price, payment structure and the date of delivery are fixed in advance. In parallel Istisna,
the Al-Sani’ may enter into a second Istisna’ contract (subcontract) with a third party to
manufacture the subject item unless Al Mustasni’ (ultimate purchaser) has stipulated in the
contarct specifically for Al Sani’ to manufacture himself.
Similarity with Bai Salam contract: Sale of a product not available at the time of the deal.
Difference with Bai Salam contract: In Bai Salam, full price for the asset must be paid at
the outset, whereas in Istisna, payment in full or in installments may be made at any
agreed upon time (even beyond delivery date).
Similarity with Ijarah: In Istisna, al-sani’ may either provide the raw material or labour.
The labour part is the similarity with Ijarah.
Arbun or Urboun (Pre-purchase of right to acquire asset): The purchaser makes a deposit (a
down-payment, which may be a fraction of the price) for the purchase of an asset at a later
date on the understanding that, should the sale of the assets not proceed (say, if the purchaser
chooses not to proceed), the seller will be permitted to retain the deposit. Because of its
similarity to an option, it has met with varying levels of approval from the schools of Islamic
jurisprudence. A lot of work will be required to mould the instrument so as to remove any
possibility of speculation ensuring total acceptability.
Khiyar al-shart: This is a sale contract concluded at the time of signing the agreement, but
where one of the two parties to the contract has a right to cancel the sale within a stipulated
time. Cancellation is not contingent upon any uncertain future event. For example, party A
enters into a contract with party B to sell a given quantity of equity stock on an agreed price,
today. Party A has the right to either confirm or rescind the contract by a certain time in the
future (let’s term it as “maturity”). If Pmaturity > Pcontract, A may choose to rescind the contract
and instead sell the stock in the market. The similarity of the exercise features of this contract
with the conventional Put Option invites some controversy.
Al Bay Bithaman Ajil: BBA, popular in Malaysia, is a mark-up sale in which payments are
delayed and made in equal installments. Theoretically, in the contract of BBA the bank sells
the product (a house, equipment or machinery, etc.) to the customer at a mark-up price, whose
content consists of the cost price plus a profit margin. The client may be allowed to settle
payment by installments within a pre-agreed period, or as a lump sum. It is similar to a
Murabaha contract, but with payment on a deferred basis. The BBA facility can also be
utilised for refinancing of assets owned by the Customer, and the proceeds to be utilised for
the Customer’s working capital.

Syndication: Islamic Financial Institutions are increasingly prepared to participate in large

project financing, and are getting ready to compete with their conventional counterparts. The
syndication works on the techniques discussed above, most popular being the Mudarabah
contract modified to suit the technicalities.
Jo’alah: A party undertakes to pay another party a specified amount of money as a fee for
rendering a specified service in accordance with the terms of the contract stipulated between
the two parties. This mode usually applies to transactions such as consultations and
professional services, fund placements, and trust services.
Certificates of sale: It has been suggested that consumers buying consumables on credit
would issue 'certificates of sale' similar to letters of credit. These could be encashed by the
seller at the bank at a discount. This seems very similar in structure to Baisalam.
Prizes and bonuses: Iran and Pakistan have both attempted to fully Islamise the entire
banking. Iran converted to Islamic banking in August l983 with a three-year transition period.
In Iran banks accept current and savings deposits without paying any return. The banks are
permitted to offer bonuses and prizes on these deposits very similar to the UK’s premium
bonds. This is apparently not regarded as gambling by the Iranian Islamic banking units.
No fee accounts: There is a substantial Muslim population in South Africa and they are
serviced by two small Islamic banks. The main product being offered is the "no fee" current
account which is also provided by the conventional banks by arrangement. Transaction
charges are waived and interest is not paid on current accounts.
Gifts: Gifts to depositors are given entirely at the discretion of the Islamic banks on the basis
of the minimum balance. These gifts may be monetary or non-monetary are based on the
banks’ returns.
Non PLS Modes: Non-Profit-and-Loss Sharing Modes. They are used in cases where PLS
modes cannot be implemented, e.g., in cases of small-scale borrowers or for consumption
loans.
Qard Al Hasnah (Beneficence Loans): Zero return loans that Islam edicts for Muslims to
make to the needy. Banks can only charge the borrowers a one-off service fee to cover the
administrative expenses, but this fee cannot be related, by any means, to the loan amount or
its maturity.
Islamic Derivative Products: Salam (Bai Al Salam), Urboun (Arbun) and Khiyar al-
shart are the existing derivative products approved by some schools of Islamic jurisprudence.
Dr. Kenneth Baldwin has suggested some Profit Rate Swaps that replicate the risk
management capability of conventional interest rate swaps, using Sharia-compatible building
blocks (existing and extensively used instruments).
It is generally assumed that the term "Islamic Derivatives" is a contradiction. The
requirements of derivatives and rules of Shariah at first sight are diametrically opposed and all
derivatives are therefore Haram. But it is important to recall the generalised definition we use
of a financial derivative. It is simply a financial instrument that is derived from another
financial instrument or a combination of such instruments. It is argued that as derivatives
"unquestionably" involve interest or interest-based products they are contaminated and should
be prohibited. Well, derivatives only involve interest if one or both parties using the
derivative seek to hedge the derivative. It could be argued that Murabaha could involve
interest if the parties seek to match the interest free but guaranteed return product with an
interest-bearing equivalent. Islamic banking derivatives should be perfectly acceptable so long
as they do not involve interest.

The literature contains hardly any serious criticism of the interest-free character of the
operation, since this is taken for granted, although concerns have been expressed about the
lack of adequate interest-free instruments. There is a near-consensus that Islamic banks
can function well without interest. An International Monetary Fund (IMF) study by Iqbal
and Mirakhor (l987) found Islamic banking to be a viable proposition that can result in
efficient resource allocation.
Advantages of Islamic Finance:
 Efficient allocation of funds: Since allocation of funds by banks will be dependent upon
the soundness of projects under the PLS arrangements, the allocation is more efficient.
 Productive use of capital: Banks are likely to know their fund users better in order to
ensure that the funds are used for productive purposes. In this way, both the fund
providers and the financial intermediary contribute to promoting productive economic
activities and greater financial responsibility. Thus, IBFs would promote economic growth
[Chapra (1998), Siddiqui (1983)]
 Similarly, since banks have no pressure of fixed regular payments on deposits, the
efficiency of allocating resources to profitable and more productive use is further boosted.
 Equitable distribution of wealth: The efficiency in allocation leads to this, and creates
additional wealth as well. Interest distribution is considered unjust and inequitable because
it is not based on any productive use of capital, and it exploits the misfortune of the
borrower (who has run out of money).
 Generation of employment: Productive use of capital implies investments and creation of
jobs. The investment is not dependent upon the cost of capital (and positive NPVs) or time
value of money, hence number of investible projects is likely to be much higher resulting
in larger capital formation.
 Saving in information costs: Being a partner of the entrepreneur (or a firm), the financial
institution has easier and cheaper access to information on matters relating to the firm.
This may make credit rating agencies redundant, and lending more efficient.
 Saving in deposit insurance costs: Risk-sharing concept built into the IBF system, there
will be no need for deposits to be insured.
 Reduction of debt burden: The IBF system of equity financing encourages debt to be
swapped with equity which can help many developing countries get rid of the immense
debt-burden. Instead of rescheduling of existing loans or selling Brady bonds at heavy
discounts, which does not help relieve the pressure much, converting debt to equity
promises a much more fruitful alternative.
 Promoting Ethical behaviour: Because of its strong emphasis on the ethical and moral
dimensions of doing the business and selecting the activities/ commodities to be financed,
the Islamic financing institutions could play an important role in promoting socially
desirable investment and corporate behavior. In this context, it is worth mentioning that
Islamic financing institutions are subject to Shariah (Islamic Law) regulations in addition
to conforming to the conventional regulatory standards. This is further expected to ensure
greater prudence and responsibility.
 Higher profits: Account holders under Islamic finance could expect higher profit from
their investment as Islamic banks are required to share the entire net profit according to
the agreed formula rather than just a portion of the profit, as is the conventional practice.

 Reduction in run-on-deposits: Banks using profit and loss sharing (PLS) to mobilize
resources are less likely to face a sudden run on their deposits.
 More stable economic environment: The perspective of investments is long-term in
comparison to short-term expectations of returns in conventional financial system – this
may result in a more stable economic environment less dependent on business cycles.
 Less likelihood of flight of capital: Under Islamic finance, debt instruments that may be
created through selling goods and services on credit are not readily tradable. This greatly
eliminates the possibility of sudden mass movement of funds from one country to another.
 Reduction in speculative transactions: Examination of daily records of trading in financial
markets vividly shows that institutional participants carry out huge speculative
transactions. More often than not, such transactions are sources of instabilities. In contrast,
Islamic banks and financial institutions are inherently prevented from carrying out such
activities. As a result destabilizing speculations would be significantly curtailed in
financial markets, although liquidity will remain with secondary market trading allowed in
stocks or investment certificates.
 Reduction of inflationary pressures: Under Islamic economics the inflationary pressures
would be reduced to a great extent, as over or under-supply of money with respect of
supply of goods is not allowed (money directly linked to supply of goods in the economy).
 Reduction in unproductive use of borrowings: By eliminating unnecessary and excessive
borrowing (borrowing beyond productive use), risk to lenders is reduced under PLS, as
lending is directly related to project appraisals and feasibility.
 Automatic Shock-absorption: For banks involved in the equity-based system, Khan (1986)
argues that the shocks to asset positions are immediately absorbed by changes in the
values of shares held by depositors in the bank. This makes the real values of assets and
liabilities of banks equal at all times, preventing banking crises. Nienhaus (1986) agrees
with the argument.

 Guaranteed market of practicing Muslims. Islam being the fastest growing religion in the
world further enhances the potential marketability of IBF instruments.
Perceived Disadvantages of IBFs:
Box-2: Landmark Islamic finance deal inked
Khaleej Times: 03 July 2003
DUBAI - In a landmark deal for Islamic finance, Dubai Islamic Bank (DIB), in partnership with ABC Islamic
Asset Management of London, has signed a leasing transaction agreement with the AAA-rated General Electric
of the USA. The transaction involves the purchase of machines and engineering equipment by DIB and ABC
and leased under Sharia principles to General Electric.
"We intend to source more deals with investment grade companies from around the world," Mr Aref Kooheji,
DIB's Executive Vice-President for Investment Banking said. "We pay special attention to the elimination of
risk by means of watertight structures that provide protection against residual risk during the term of the lease."
Mr Kooheji concluded the signing with Mr Duncan Smith, ABC Islamic Asset Management's CEO, in Dubai
recently.
"This is a landmark deal. If General Electric is prepared to go the Islamic financing route, then it's hard to see
how similar multinationals will not avail themselves of this excellent financing facility in the future. This will
give the Islamic industry a tremendous boost," Mr Smith said.
Mr Smith added that the partnership transaction was made possible through cooperation between investment
professionals at DIB and ABC Islamic Asset Management, whose understanding of complex structures, legal
and other matters, particularly Sharia compliance, facilitated smooth cross-border dealings of significance in the
development of investments in the Islamic financial industry.
Abu Dhabi power project signs $1.8b loan deal
Khaleej Times: 3 July 2003
ABU DHABI - A $1.8-billion loan facility was signed here yesterday for the expansion of Abu Dhabi's fourth
independent power and water project in what was described as "the largest project financing ever" in the capital
of the United Arab Emirates.
Project developers International Power of Britain and Japan's Mitsui and Co. and Tokyo Electric Power
Company (Tepco), signed the facility with a consortium of local and international banks to finance the Umm Al
Nar project.
Lead arrangers of the conventional loan include Gulf International Bank, HSBC, Sumitomo, Mitsui Banking
Corporation and National Bank of Abu Dhabi, while Abu Dhabi Islamic Bank lead arranged a $250-million
Islamic tranche.
 With PLS, the role of the bank undergoes a change from being an intermediary trader of
money, earning profits from the margin between lending and borrowing, to being an
investing partner. The role of an investment bank brings in added costs:
o Search cost resulting from the need to decide on the most profitable ventures. With an
Islamic bank required to finance so many different kinds of businesses, acquiring skills
in all of them may be immensely costly.
o Monitoring costs resulting from the need to prevent mishandling of the venture and
fraudulent means (including creative accounting) adopted by borrowers/ partners are in
addition to those involved in conventional financial system.
o Managing costs incurred because of its obligation as a partner in the PLS deals.
 Determination of mechanism for profit sharing in the short-term is difficult in a PLS
system based on returns only from productive deployment of funds. In the absence of a
standard mechanism for profit/ loss sharing (both for short-term as well as long-term), the
possibility of exploitative contracts cannot be eliminated.

 Eliminating interest may reduce the propensity to save (with banks) or invest (considering
the risk associated with returns), thus curtailing economic growth affecting employment
(Pryor-1985), generation of wealth and its distribution. Of course, IBF proponents do not
agree, as an opportunity for equitable sharing of wealth earned from productive activities
could be enough stimulant for investors.
 Dispute settlement mechanism adds to the cost further, as the account put forward by the
borrower (entrepreneur) may not be convincing enough for the banks or other investor
partners. Fixed return of the conventional system has no such costs.
 A risk sharing proposition of IFBs and resulting absence of deposit insurance system
leaves small investors in the risky avenues, particularly when the Islamic financial
institution carries fraudulent intentions.
 Curtailing speculative activities in the secondary market would be extremely difficult
resulting in the same risks and costs that the conventional financial systems carry.
 The mark-up system of most of the non-PLS schemes resembles the interest-based system
to the extent of becoming indistinguishable, sometimes, and provides unscrupulous
financiers opportunity to replicate the conventional system.
 Additional cost of supervision by the Sharia Board: Product development, its offering,
agreements between counterparties, functioning of the IBF system, accounting, etc need to
be Sharia compliant which needs certification by the Sharia Boards resulting in additional
cost burden over the IBF Operators.
 Account holders under Islamic finance could expect higher profit from their investment as
Islamic banks are required to share the entire net profit according to the agreed formula
rather than just a portion of the profit, as is the conventional practice.
Impediments to the growth of IBF: The impediments are being discussed in this paper
after grouping them in seven broad categories: (1) Social Impediments, (2) Economic
Impediments, (3) Financial Impediments, (4) Structural Impediments, (5) Institutional
Impediments, (6) Political Impediments, Technological Impediments, and (7) Religious
Impediments.
1. Social Impediments: Humans are undoubtedly the most important resource endowment
for any country. Their development is the key to the competitiveness of any nation in any
sphere. Even in the field of IBF, it is the level of human development in the promoter nations
that will ultimately steer the IBF into a competitive arena. The Human Developed Index
(HDI) available with the Human Development Report brought out by United Nations
Development Programme (UNDP) is a composite index that measures achievements of a
country in three basic parameters of human development (HDR 2003). These are: (i)
longevity measured by life expectancy at birth, (ii) knowledge, measured by a combination of
the adult literacy rate and the combined primary, secondary, and tertiary gross enrolment
ratio, and (iii) standard of living, measured by GDP per capita.
It is worthwhile, then, having a look (Figure-7) at the HDI of member nations of Organization
of Islamic Countries (OIC), having some kind of IBF (as they are the promoters of IBF), in
comparison with some of the world leaders (promoters of Conventional banking & financial
system).

HDI Score HDI Rank

0.94
0.94
0.94
0.94
0.94
0.94
0.93
1.00 200
0.89
0.88
0.87
0.84
0.83
0.90 180
0.82
0.82
0.79
0.77
0.76
0.75
0.74
0.74
0.74
0.73
0.73
0.80 160
0.72
0.70
0.68
0.65
0.70 140
0.61
0.60 120
0.50
0.50
0.50
0.47
0.46
0.46
0.46
0.45
0.43
0.43
0.50 100
0.40 80
0.29
0.30 60
0.20 40
0.10 20
0.00 0
Belgium
Gambia
Djibouti
Banglade
Nigeria
Guinea
Mauritani
Brunei
Bahrain
Yemen
Niger
Algeria
Canada
Singapore
Malaysia
Tunisia
Albania
Palestine
Kuwait
Saudi
Egypt
Senegal
Lebanon
Pakistan
Oman
Turkey
Qatar
UK
UAE
Australia
Indonesia
Hong
Morocco
Norway
Sweden
Jordan
Iran
Sudan
USA
Fig-7: Human Development Index Scores (left scale) and ranks (right scales)
Source: Human Development Report2003 brought out by United Nations Development Programme (UNDP)
Accumulation of human capital is an indicator of endogenous growth and is often used in

empirical growth models. In most regressions, this variable turns out with a positive
coefficient (Barro, 1991). The highest ranked country among the Islamic countries, in terms
of HDI, is Brunei with a rank of 31, the second highest being Bahrain at 37, both of them with
so small a population that their impact on the development of as important a system as IBF is
not expected to be large. However, in terms of developing a financial market (and related
systems, also in terms of IBF) the maximum effort has been made by Bahrain after Malaysia
(Countries with 100% Islamic Financial system in place, i.e., Iran was placed at 106, Sudan at
138 and Pakistan had a rank of 144 in HDR of 2003). The development in the area is not
likely to bear much fruit unless the promoter countries of IBF take giant steps towards
developing their most important infrastructure element, i.e. the Human Resources. The initial
successes may remain at superficial levels, and sustainability of growth and the challenges
posed to the conventional financial system may remain feeble otherwise. At the moment, it
poses a significant impediment to the growth of IBF.
(a) Societal Impediments: The basic societal fabric builds the psyche of the masses.
Coming out of this box, then, is not easy. After initial leadership over a long period, when
the Islamic society ultimately lost its primacy to the Western world because of their
consistent multi-dimensional development activities, it seems the members of the Islamic
society also lost the motivation to win back. This has had a lasting impact on the society
in all spheres that are cited next. Islamic Financial Institutions as part of this society have
a strong barrier to scale, and along with its parent society has a backlog of many
generations to clear.
Social alienation, particularly in the wake of 11 th September, may detract non-Muslims
even further away from anything Islamic, and act as a major source of impediment.
(b) Educational Impediments: Education is the backbone of any development, and is one
of the most important reasons behind the lost glory of the Islamic society. The absence of
Islamic Banking and Finance from the horizon, for centuries, is pointer enough towards

lack of education and research. However, figure-8 provides the status of education in the
Islamic World represented here by countries of the Organization of Islamic Countries
(OIC) Countries that have IBFs in comparison with some of the world leaders.
In terms of Adult literacy and Education Index (a measure that provides a composite
indicator of the level of education), all the countries in the OIC sample lag behind the
world leaders. In terms of Public Expenditure on education reported as percentage of
respective GDPs, Saudi Arabia’s figure is encouraging as it leads the sample in this
respect (except Yemen, whose ratio could be misleading as the GDP figure is too small)
but also increased from 6.5% in 1990 to 9.5% during 1998-2000 (data refers to the year
during this period for which it was available) which shows its recent commitment towards
educating its citizen. But the scenario in all other countries even in this respect is no
different from what is projected by the Adult literacy or the Education Index.
120% 12%
Adult Literacy Education Index Public Expenditure
100% 10%
80% 8%
60% 6%
40% 4%
20% 2%
0% 0%
Belgium
Gambia
Djibouti
Mauritania
Nigeria
Guinea
Brunei
Bahrain
Niger
Singapore
Canada
Malaysia
Saudi Arabia
Algeria
Kuwait
Egypt
Oman
Senegal
Lebanon
Pakistan
Yemen
UK
Qatar
Bangladesh
UAE
Tunisia
Australia
Norway
Sweden
Jordan
Turkey
Iran
Morocco
USA
Fig-8: Adult Literacy, Education Index (left scale) and Public Expenditure on education (right scale) for selected
countries
Source: Human Development Report 2003 from United Nations Development Programme (UNDP)
The enrolment into educational institutions provides indication towards the future of
education in a country. From the data available in the Human Development Report 2003
(HDR 2003) for 175 countries, we find that, among the OIC countries, only Guyana with
91% enrolment (although its overall HDI rank is a poor 92) was part of the top quartile of
Combined primary, secondary and tertiary gross enrolment ratio, during the year 2000-01
compared with thirty (30) non-OIC members. The second quartile of ranks had twenty
(20) OIC members while the third quartile had seventeen (17) and the last one had sixteen
(16) of them. More than sixty-one percent (61%) OIC members fell in the lower half,
compared with thirty-three percent (33%) of non-OIC members. The full list of 174
countries had 31% OIC members (54 numbers), whereas the lower half of the ranks, based
on combined enrollment, had 45% of them. This presents a gloomy picture not only for
the present but has repercussions for the foreseeable future. Only exponential growth in
enrollments, now, can provide some hope of catching up with rest of the world.
(c) Psychological Impediments: Psychological mindset needs to change for those who
have been using the conventional banks and FIs as well as those for those who have
been abstaining from them due to their anti-usurious beliefs. This tantamounts to a
paradigm shift that is not easy to happen in a short period and it requires a lot of

concerted effort on all fronts. On the other hand, psychological pressure on the Islamic
institutions, in general, from fundamentalist organizations is keeping a check on
declaring innovations that they could launch otherwise.
2. Economic Impediments: Size of the economy is an important indicator of the kind of flow
passing through the banking and financial channels that the IBF have to chase. Considering
that home banking and financial institutions have a clear advantage over foreign
institutions, GDP should be a good indicator for development of these institutions. Looking
at the GDP of the IBF promoter countries (our sample of OIC having some type of IBF)
vis-à-vis rest of the world provides some clue as to why it may be difficult to promote the
IBF in the era of opening economy where they have to compete with the world players too.
The GDP of all the sample Islamic countries put together was less than 17% of the GDP of
800.0
694.5
700.0
600.0
500.0
368.7
400.0
229.6
300.0
209.8
186.5
166.1
161.9
147.7
145.3
200.0
114.1
98.5
88.0
85.6
69.1
58.7
54.7
46.7
100.0
41.4
34.2
32.8
20.0
19.8
16.5
16.7
12.5
7.9
9.3
8.8
4.8
4.1
3.0
2.0
4.6
4.0
1.0
0.6
0.4
0.0
Saudi Arabia
Sudan
Sweden
Senegal
Guinea
Singapore
Gambia
Bangladesh
Hong Kong
Belgium
Djibouti
Indonesia
Kuwait
Brunei
Canada
Algeria
Nigeria
Albania
Niger
Lebanon
Norway
Jordan
Egypt
Malaysia
Mauritania
Australia
Tunisia
Iran
UAE
Morocco
Oman
Yemen
Bahrain
Turkey
Qatar
Palestine
Pakistan
Fig-9: Nominal GDP (2001) of representative Islamic countries compared with some leaders excluding the top 7.
For UAE: Central Bank (UAE) Data; and for Brunei GDP data for 2000 from HDR 2002 has been used.
USA. When we add Japanese GDP to the GDP of USA, the sample Islamic countries do
not reach even 12%. What influence an economy like USA or Japan can have on the
prosperity of a financial system can be seen from this fact. The chart (Figure-9) therefore
excludes USA, Japan, Germany, UK, France, China and Italy the top seven nations
(constituting of 68.75% of World GDP, the world being represented, here, by 170 nations
included in the HDR 2003) so that the remaining figures could be comparable.
3. Financial Impediments:
a. Lack of active capital market: Equity is an excellent source of capital and
organizations are likely to exhaust this source before exploring other means when
planning to acquire, upgrade or produce technology to sell as a product. An absence
of active capital market hinders technology intensive, high capital endeavors as well
as any expansion of such projects. Since acquisition of technology is capital-intensive,
the payback period for which is usually long, whereas bank borrowings seldom
indulge in 100% financing or long-term financing, it is almost an impossible source
for the start-ups, capital markets have proven to be the most successful and feasible
means of financing.

b. Lack of active debt market: The absence of secondary debt market in UAE is also a
serious handicap for the investing community. As a result, debt issues become illiquid
and costly. There is no scope of long term debt financing and with bank financing
catering to short term or medium term finance, it acts as a deterrence to technology
intensive ventures. At the same time, bank finance is mostly suitable for Working
Capital financing rather than Capital Expenditure funding that is required for
Technology-intensive ventures.
c. Lack of Money Market: It is another major impediment leaving the market not just
illiquid and costlier, but also leaves the government devoid of financing its expenses
through a cheaper and liquid medium.
d. Supportive Institutions for Venture Capital Financing: The strongest form of
Islamic financing being the PLS forms of Mudarabah and Musharakah, Venture
Capital financing (VCF) should have been the strongest in the countries that promote
the IBFs, but the reality is surprisingly different. VCF needs institutional support in
terms of an active network of financiers, entrepreneurs, technology promoting
institutions like Private and Government R&D laboratories, Universities, Stock
Exchanges and regulatory framework, etc. A Silicon Valley type network of alliances
is required which is largely absent in the OIC. Some efforts in the direction of
establishing technology parks and business incubators have started in some countries,
but they have a long way to go. For individual small economies it may take a lot of
time to achieve the critical mass, a strong need therefore is for the association of
countries like the GCC or ASEAN to pool their resources.
e. Lack of an active secondary market: Secondary markets are in the process of
evolving and it will take time before they could really provide this market with the
required liquidity. Secondary markets do not just become meeting points between the
investors and the corporates, they become a benchmark for the health of the whole
financial system.
f. Lack of Business incubators: Incubators connect talent, technology, capital and
know-how to leverage entrepreneurial talent, accelerate the development of new
knowledge-based businesses and thus speed up the commercialization of new
knowledge and technology. Although the system has started in some countries like
UAE, it will take time in shaping up to a stage where it could be of real use. There is a
strong relationship between the financial institutions and the business incubators.
Business incubators cannot grow without financial support and growth in the sector
means a growth in demand for the financial sector. Hence a lack of this system, in the
Islamic countries, is an impediment to the growth of IBF system.
4. Structural Impediments:
 Financial Engineering: The structuring of any new system that can pose real
competition to an existing well-established system requires not just a robust structure
to start with but a structure that supports innovation and continual improvement.
Financial Engineering is an integral part of the financial service provider so that
innovative products can be offered regularly to keep the depositors/ investors interest
in the system alive. For a relative newcomer, with variants far less in number and the
scope limited by restrictions by Sharia, Financial Engineering acquires all the more
importance, more so because of the need to differentiate itself from the conventional
products.

 Lack of Islamic credentials of the product: The products based on Sharia Committee
of banks do not necessarily satisfy the psyche of the masses unless backed by religious
edicts and logical reasoning. Currently, all products except those based on Mudaraba
and Musharaka principles leave doubts in the minds of people who want Sharia-
compliant products. The penetration would have been much faster had these doubts
been cleared.
Fig-10a: Customer Deposits of BIMB (Source: Annual Reports)

Fig-10b: Customer Finance of BIMB (Source: Annual
Reports)
 The mark-up system of most of the non-PLS schemes resembles the interest-based
system. As discussed above, if the stronger Islamic instruments based on PLS principles
were dominant, the IBF system could attract more investors to its fold. The current
scenario can be judged from the proportion of funds based on the two types of systems,
namely PLS (stronger Islamic system) and the mark-up type systems (weaker Islamic
system).
It is obvious from Fig-10a that the depositors’ preference is for PLS type deposits (ready
to take larger risk, and choose stronger Islamic products) whereas the banks are more risk
averse and prefer to indulge in Mark-up type financing, as can be seen from Fig-10b. The
Bahrain market’s position is even more tilted towards the non-PLS schemes for deposits.
 Maturity mismatch: It can be seen from the maturity structure for the Bank Islam
Malaysia Berhard (BIMB) that the maturities on the deposit side (Figure-11a) are totally
different from the maturities of the financing side (Figure-11b). The situation of other
IBFs in the world is not much different in terms of maturity-mismatch. This creates
problems in the cash-flow matching, too. Deposits with maturity of more than one year
being less than 1% is a clear sign of lack of investors’ confidence in the system. This may
be as a result of other impediments under discussion.


U
Fig-11a: Maturity structure of Negotiable Islamic Debt Certificates and Mudharabah Fund for BIMB
Source: Anuual Report 2002
Fig-11b: Maturity structure of Customer Financing for Bank Islam Malaysia Berhard (BIMB)
Source: Anuual Report 2002
nclear product proposition or processes: Competing with the conventional counterpart in
marketing abilities is not easy for a relatively new entrant like IBF. Lack of skills that help
in the matter is currently an impediment that can be removed only through learning which
is path-dependent and will take time to set in.
 Additional risks: The PLS mode has its inherent risks similar to those of Venture Capital
Financing or those faced by Equity financiers rather than the Debt financiers. In fact, PLS
modes have in-built risk component wherein the financier has to share the risk of failure
(loss) along with the entrepreneur (the borrower). Even the operational mode is more
complex than the Conventional Debt financing, e.g., calculation of the share in profit and
loss, feasibility and profitability studies of ventures being financed and their continuous
monitoring and audit. Further, PLS modes of financing are not ted to collaterals, as do the
conventional loans.
Even no-PLS modes have unique risks, e.g., the Salam or Bai Salaf contracts expose them
to commodity risk in addition to the credit risk. Similarly, the Ijara contracts differ from
conventional lease contracts in that the leased assets have to be carried on the Balance
Sheet of the Bank which limits the transferability of substantial risks and rewards to the
lessee. The Finance by IBFs are mostly backed by tangible assets whose market value may
not be constant over time. This volatility is in addition to the normal depreciation of assets.
Basel Committee’s recommendation for Capital Adequacy does not incorporate this
volatility. Another example is that of the Displaced Commercial Risk which endangers the
competitiveness of IBFs in the long run. It is the pressure on the IBFs to pay higher returns
than that it is obliged to (as per agreed terms) in order to make its returns more lucrative
than the market returns, this involves paying the investors from its own share of profits
which actually belonged to the IBFs’ sharehlders.

Conventional financiers as well as the investors can use derivative instruments to hedge
various types of risks to a great extent which is largely absent in IBF System, and this poses
a major impediment to the growth of this system unless alternative comparable or better
mechanisms are evolved. Lack of liquidity itself poses a major risk, both for the borrower
as well as for the lender. For detailed insight into unique risks involved in Islamic Banking,
the reader may refer Chapra & Khan (2000) and Hassan (2000).
 Financially weak institution offering the product: In a market with very high prospects for
growth there is always a rush for every Tom, Dick and Harry to adopt a me-too strategy
and entering without having a look at their own credentials. Islamic Financial Institutions
are weaker, in general, compared to the Conventional ones, and the rush to launch a new
institution to grab the fast buck exposes the weakness further. For weaker institutions, it
becomes much more difficult to convince customers on the viability of their products and
services. The need for Sharia Compliance makes the task even more difficult.
 Size of the IBFs: Most of the IBFs are extremely small in size compared with the
multinational banks operating in their markets. All the IBF fund put together does not
match the funds with Multinational banks like HSBC or Citibank. Size carries the power in
the market, and smaller size of IBFs, at present, does prove to be a source of impediment in
that respect.
5. Institutional Impediments:
(a) Absence of a uniform regulatory framework: It is still evolving in some areas whereas in
some other areas it is entirely absent. For example, the oldest of such institutions, AAOIFI
had come out with only 16 financial accounting standards in the ten years since its inception
in 1991 [October issue of the quarterly “Islamic Banking Hub” of Bahrain reports ‘43
standards and statements’ having been issued]. Formation of such organizations is taking time
mainly because of difficulty in developing consensus among Islamic nations, and also because
of difficulty in making the regulations compatible with the conventional regulations.
(b) Lack of acceptance of existing Regulatory bodies: For example, even after twelve years of
existence, the AAOIFI’s standards are mandatory only in Sudan, Bahrain and Jordan. Saudi
Monetary Agency just ‘requests’ Saudi banks to seek guidance from the AAOIFI standards.
Zaher and Hassan (2001) provide a comparative study on the salient features of Islamic
Banking Supervisory Systems in 15 countries.
(c) Absence of an Islamic Financial Network free from ribawee dealings: Networks play a
major role in encouraging a system to grow and sustain the growth over longer terms, in the
absence of which the growth may be lumpy in nature. Mutual cooperation in the networks
helps pooling of resources and optimizing their exploitation to gain competitive advantage.
What is seen today in the IBF world is some pockets of excellence in countries like Malaysia
and Bahrain with a few institutions like Islamic Development Bank (IDB) playing some
inspiring roles, but to bridge the huge gap with respect to the competitors in the conventional
sector, a lot more is required a lot more quickly.
(d) Absence of Islamic Central banks except in three countries (Pakistan, Sudan and Iran) that
have converted their banking system to 100% Islamic. In other countries, even after twenty
eight years of the modern Islamic Banking and Finance experience, dependence on the
conventional systems of the Central banks is a good explanation why the growth in this sector
with immense potential is not happening at the desired pace.
(e) Clash with the mainstream regulations, particularly in the non-Islamic nations. Some
examples: (i) the treatment of Ijara as Lease instead of mortgage, (ii) imposition of taxes
despite the zakat, as an integral part of Islamic system, having the same functionality –

amounting to double taxation effectively, (iii) regulatory fees – double payment due to the
requirement to meet dual regulations.
(f) Limited availability of risk management and analysis tools to hedge against volatility
poses an additional burden for IBFs and results in maintaining higher levels of liquidity.
(g) Lack of trained personnel: With the number of educational institutions and training centres
catering to the need of this rapidly growing segment being limited, non-availability of
qualified personnel who can analyse and manage portfolios is a major impediment.
6. Political Impediments:
 Political pressure, in general, on Islamic institutions from the Western World, particularly
in the wake of 11th September not only affects the system physically but it has an impact
0 20 40 60 80 100
Norway 91
Singapore 89.25
Brunei 87.5
Sweden 86.75
Hong Kong 83.25
UAE 83.25
UK 83.25
Kuwait 81.75
Bahrain 80.75
Oman 80.25
Qatar 78.75
Malaysia 76.25
Saudi Arabia 76.25
Morocco 73.75
USA 73.75
Tunisia 72.75
Jordan 70.25
Egypt 67
Albania 66.75
Yemen 66.5
Gambia 66
Iran 66
Algeria 65.5
Senegal 65
Guinea 62.75
Bangladesh 62.5
Indonesia 59.5
Pakistan 58.5
Niger 57.25
Turkey 56.5
Lebanon 54.5
Sudan 54.5
Nigeria 52.75
Iraq 41.5
Figure-13: ICRG Composite Risk rating for select countries, as in March 2003
Source: ICRG website (www.icrg.com)
on the psyche. For, example, almost every financial transaction (particularly relating to an
Islamic Institution) is being monitored. From UAE, no amount in excess of AED 2,500
can be repatriated without leaving a copy of identity which then goes into the system
under scrutiny.
 Lack of economic, military and political prowess of countries sponsoring the Islamic
Financial system, only adds to the other weaknesses of the system. Freezing of accounts

by the super-powers at short notices, and arbitrarily, is only a symbolic threat to this
institution.
A country’s environment conducive to investments boosts the growth of financial systems.
An environment fraught with risks, on the contrary, impedes it. Many organizations try to
capture countries’ environment to reflect this aspect. Freedom indices like “Index of
Economic Freedom” developed by Heritage Foundation of USA, “Freedom in the World” by
Freedom House (emphasis on Political and civil rights) of USA and “Economic Freedom of
the World” by Frazer Institute of Canada capture the economic environment of countries. All
of them point towards an overall lack of freedom in most of the OIC countries. Erb et. al.
(1996) report country risk analysis being carried out by organizations like (a) Bank of
America World Information Services, (b) Business Environment Risk Intelligence (BERI)
S.A., (c) Control Risks Information Services (CRIS), (d) Economist Intelligence Unit (EIU),
(e) Euromoney, (f) Institutional Investor, (g) Standard and Poor's Rating Group, (h) Political
Risk Services: International Country Risk Guide (ICRG), (i) Political Risk Services: Coplin-
O'Leary Rating System, (j) Moody's Investor Services. They provide ratings that try to
capture ratings based on qualitative and quantitative information into a single index.
In the ICRG composite risk ratings for March 2003, the least risky OIC country (Brunei) was
ranked six (6). The top twenty (20) least risky countries included only three OIC countries
(Brunei, UAE and Kuwait) out of the forty-four (44) OIC countries for which ICRG provides
country risk ratings. Top half had just fourteen (14) countries (32%) whereas the bottom half
had thirty (30) countries (68%) of them.
Table-5: ICRG composite risk ratings for 44 OIC member countries (March 2003)
Top quartile 2nd quartile 3rd quartile Bottom quartile Total OIC countries
Numbers 6 8 15 15 44
Percentage 14% 18% 34% 34% 100%
The trend indicates that OIC member countries are considered as riskier than non-OIC
countries for financial investments. This is also reflected in the incoming Foreign Direct
Investment (FDI) in these countries, and suggests that the Governments and Institutions in
these countries need to do a lot.
7. Technological Impediments: The Islamic world has not kept pace with the developments
in rest of the world. Technology being the backbone of banking and financial system and
the main driver of market power today, lagging behind in technology means
backwardness in every sector of the economy. Various measures of Technological
strength like Technological Achievement Index developed by UNDP is a composite index
providing enough indication of the level of Technology in a country. The promoters of
IBFs, Islamic countries, fall far behind the promoters of conventional financial system.
Other indicators have developed by many other agencies and independent researchers
point towards the same backwardness of the group.
Indicator of new technology diffusion has been considered as ICT (Information and
Communications Technology) by many agencies including UNDP, as this is what has
revolutionized the integration of the world into a global village speeding up innovations by
pooling talents together. Figure-13 represents a comparison between the Islamic world with a
few of the world leaders. The picture is not much different from what is seen with other
indicators. Except for United Arab Emirates (UAE), we hardly see any potential competitors
to the countries promoting conventional systems of banking and finance. The best performer
in Telephone Mainlines per thousand people from the Islamic world is placed at 31st position
with a value of 259. Similarly, in terms of Internet Users per thousand people, the highest

place for an Islamic Country goes to UAE at the 19th position (315 users), next best is
Malaysia at the 26th place (273 users); in terms of Cellular penetration per thousand people,
the highest ranked Islamic country is UAE at the 24 th place with 616 users, but the next best
falls at 32nd position with 460 users. From the chart in Figure-13, we can see that almost half
of the Islamic countries have no significant place. This, then, poses a significant impediment
to the developments in the area of IBF in the modern world driven by ICT.
Technology Achievement Index (TAI), developed by United Nations Development
Programme (UNDP), focuses on achievements of a country as a whole in the technological
1000 800
900 700
800
600
700
600 500
500 400
400 300
300
200
200
100 100
0 0
Belgium
Gambia
Djibouti
Mauritania
Nigeria
Guinea
Brunei
Bahrain
Niger
Canada
Singapore
Malaysia
Saudi Arabia
Algeria
Albania
Kuwait
Egypt
Senegal
Oman
Pakistan
Yemen
Bangladesh
Lebanon
UK
Qatar
UAE
Australia
Tunisia
Indonesia
Sweden
Jordan
Sudan
Norway
Hong Kong
Turkey
Iran
Morocco
USA
Internet users / 1,000 people Mobile Users/ 1,000 people) Telephone Users / 1,000 people)
Figure-13: ICT indicators per 1000 people - Cellular subscribers and Internet users (both left scale) and Telephone
mainline Users (right scale)
arena. The Index has been found to be relevant for the least developed countries to the same
extent as for the most highly developed countries. The index is based upon the four elements:
Technology creation: number of patents per capita and royalty/ license receipts per capita,
Diffusion of recent innovation: internet users as percentage of population, Diffusion of old
innovation: electricity and telephone consumption per capita (logged), Human skills: Mean
years of schooling and gross enrolment in tertiary science and mathematics education (Desai-
2001). Figure-14 compares OIC member countries for which the Index value is available (and
UAE as per authors’ own calculations presented in the Appendix A0) with others.
Archibugi and Coco (2004) have developed a New Indicator of Technological Capabilities for
Developed and Developing Countries (ArCo). This index is an improvement upon the TAI
and UNIDO’s Industrial Performance Scoreboard. This index takes into account more
variables associated with technological change. Similar to TAI, three main components
considered are: (a) the creation of technology, (b) the technological infrastructures and (c) the
development of human skills. Eight sub-categories have also been included. ArCo also allows
for comparisons between countries over time. Figure-14 provides a comparison in this
respect.

0.870
1.0
0.757
0.9
0.726
0.679
0.8
0.568
0.563
0.7
0.6
0.395
0.369
0.5
0.313
0.287
0.277
0.269
0.265
0.4
0.191
0.16 0.151
0.07 0.140
0.3
0.2
0.70
0.61
0.46
0.44
0.26
0.22
0.21
0.73
0.58
0.59
0.40
0.26
0.24
0.17
0.1
0.0
Malaysia
Algeria
Singapore
Senegal
Egypt
Pakistan
UK
UAE
Indonesia
Tunisia
Hong Kong
Iran
Sweden
Norway
Sudan
USA
TAI (2001) Arco Index (2000)
Figure-14: Technological Achievement Index (TAI) and Arco Index

Sources: (a) For TAI: HDR (2001), and authors’ own calculation
For Arco Index: Archibugi and Coco (2004)
8. Religious Impediments: For a detailed treatise on the effect of religion on economic or

development activities, the reader is referred to Noland (2003)
 Lack of consensus on issues: Developing a consensus on any religious matter has always
been a difficult task. It becomes even more difficult when a matter as complex as the
financial system comes up for discussion. Despite Quran being the most lucid religious
book, creative minds tend to interpret the verses to their own benefit. Thus, just on the
matter of interest there are many schools of thought, e.g., although the vast majority
accepts that all forms of interest are un-Islamic and therefore prohibited, one group
believes that only exploitative interest rates fall under the category of Riba, and prohibited
(and what is the dividing line between the exploitative and the non-exploitative?), yet
another group believes that despite the interest declared as un-Islamic, there is no need for
a regulatory system to control dealings in interest and people should be free to follow
whichever system suited them best, postponing God’s judgment for the Last Day (Khan-
2000).
 Absence of a central religious body with universal appeal or control only exacerbates the
matter. Some even argue that religion must not be mixed with the daily lives of people.
But Islam does not distinguish between the two. Although religious faith cannot be forced
upon people, clear guidelines and regulatory mechanisms would help those who wish to
become a part of Islamic way of life.
 Divided House: Despite being the most promising religion capable of maintaining its
structure through guaranteeing a non-modifiable holy book in the form of the Quran, the
world of Islam is divided among sects some of which would like to oppose a proposal just
for the sake of it. The flexibility in religious practices and the heterogeneity in the thought-
patterns of groups could actually act as facilitator of innovation as can be witnessed in
developments in Malaysia, Bahrain and UAE, but the same to diffuse to the rest of the
Islamic world needs a change in paradigm that will need institutional support in limiting
other impediments.

 Rise of fundamentalism: Despite the tenets of Islam being strongly based upon
“tolerance”, and “peace”, the shift from a tolerant society to an intolerant one (whatever be
the reasons) is diverting the attention of Muslim youth away from acquiring knowledge
and making best use of it to prosper in all aspects of human life.
Recommendations to counter the impediments to the growth of IBFs : The
recommendations obviously emerge from the above discussion on impediments. For the
Islamic Financial System to exploit its competitive advantages for maximum benefits, it has
to remove the impediments in its way. It must control the impact of those factors that are not
directly under its control.
Educational: The foremost and urgent requirement is the advancement in the educational
arena supported ably by research work in all areas that can enrich the level of education. It is
important to understand that the people of the OIC region have different socio-cultural and
religious orientations from those in the Western world. Therefore, simply adopting the
Western system may not be so useful. In fact, there is a real threat of an increase in the level
of confusion in the minds of the students if the available systems are not adjusted to suit their
special needs.
The Western educational system has advanced so well that it cannot be dumped without
jeopardizing the educational development of the young generation. Further, it is no use re-
inventing the wheel all over again. Therefore, a framework that can properly adapt the
Western system of education to the local needs of the region in every respect (language,
socio-cultural and religious requirements, educational level of parents, pace of learning, etc.)
is preferable. Development of a workable and sustainable infrastructure requires a lot of time,
effort, investment and will power. Coordination between countries with similar cultural
background, in this respect, and pooling of their resources will help speed up the process of
building the required infrastructure related to research & development of educational media as
well as related to actual imparting of education to the needy. These efforts have to consider
education at all levels. The system has to be attractive enough for the students to reduce their
dropout ratio at all levels. Since dropout ratio is also tied up with the state of economy, efforts
towards making the region’s economy stronger are required. Thus, we can visualize the strong
inter-relationship between various aspects that need attention, all at the same time, in order to
provide a recipe for success. Figure-15 tries to capture this inter-relationship.
Societal and Psychological: The social fabric needs to undergo deep introspection to trace the
reasons behind the declining value systems followed by concerted efforts to build them back
to their original levels where they were so attractive to the outside world that societies as a
whole adopted them voluntarily. This requires a deep-rooted support from institutions and
government agencies. At the psychological level, the confusion in the minds of the modern
youth craving for modern ways of life and at the same time seeking solace in the roots have to
be cleared. Islam is the only religion that clears the air of confusion through an authentic
institution in the form of Quran by clearly recommending Muslims to pursue the worldly
pleasures without compromising with the religious value system. Guidelines cannot be any
clear, which means that there is something wrong with the educational, political, and socio-
cultural systems prevalent today. Thus, there is a need for thorough overhaul.
Economy: Economy is the backbone without which no system can stand on its own, and if it
does seem to do so for a while, it cannot sustain for long. Therefore, there is a need for
accelerating the growth in all spheres of economic activity, at a much faster pace than others,
in order to overtake them soon. This needs efforts to come out of isolation, develop common
markets among member countries, and make a combined effort towards capturing the global
markets backed by competitive products manufactured indigenously. The countries will have

Innovation & Diffusion Systems

Regional Networks & Alliances
National Networks & Alliances
Global Networks & Alliances
Research Establishments
Industry Clusters
Financial
Infrastructure
Political System Technological

Institutional Support Infrastructure
Systems
Educational Factor Market

Infrastructure conditions
Product Market Social &

conditions Cultural Values
Regulatory Economic
Governmental Support
framework Environment
Systems
Communication
Infrastructure
Fig-15: A pictorial representation of the web of relationship that exists between various factors that affect the growth of any
system, including the Islamic Banking and Financial System.
to graduate from their trading paradigm to an all-encompassing capability-building paradigm.

This needs cooperation at all levels for pooling of resources, but demands a lot of sacrifice
from individual nations. Alternative options hardly exist.
Financial: There is an urgent need for an active capital market, an active debt market, an
Islamic money market, Supportive Institutions for Venture Capital Financing and business
incubators, an active secondary market for Islamic debt instruments and Sharia-compliant
equities, etc. to bring dynamism into the Islamic Financial Sector. Dynamic Financial
Engineering is the need of the hour for a nascent financial sector with great potentials. It
needs a lot of effort towards the development of a research base supported by an innovative
educational and training system. Islamic credentials of financial products must be established
in order to gain acceptability and remove any confusion from the minds of those craving for
ethical or Islamic products. Clarity in product propositioning and processes is vital in this
respect. Survival of a banking or financial system is contingent upon controlling the maturity
mismatch in Islamic debt portfolio. Mechanisms need to be devised to contain additional risks
inherent in the Islamic Financial systems. This needs additional efforts from Financial
Engineers to develop Sharia-compliant hedging instruments. It also requires much better
coordination between Sharia Boards and Financial Engineers across borders.

Institutional: A uniform regulatory framework is an ideal proposition, but if complete

uniformity is difficult to achieve in the short run, the existing regulatory frameworks must
attempt to limit the mismatch to the minimum, and continue with their goal of having one
such framework in the long run. This requires the coming together of not only the regulatory
authorities but also the religious scholars on a common platform to sort out any differences
that are natural to exist. These differences can be positively utilized to boost creativity and
innovativeness. Lot of examples exist to take inspirations from. To start with, acceptance of
existing Regulatory bodies is vital, and must be encouraged at all costs. A head-on clash with
the mainstream regulations must be avoided, at least in the beginning, so that the Islamic
financial instruments can be marketed in countries where there is little possibility of
establishing an Islamic regulatory system in the near future.
The wings of institutions must spread to reach every nook and corner of the world which
requires an Islamic Financial Network to be established. Pooling of resources together, and
establishment of an Islamic Central bank with its branches in every country will enhance the
pace of development in the Islamic financial arena, provide strength to match (and later,
supersede) the conventional counterparts, and encourage others to join the bandwagon.
Religious: The whole basis of this sector of financial system is based on religious edicts.
Therefore, it is essential that consensus on issues related to Sharia is established. Since it is
not an easy task for intellectuals to reach an absolute consensus on all issues, a working
mechanism needs to be established to limit misunderstandings to the minimum and exploit the
differences to generate creativity and innovativeness. A central religious body may sound like
a distant dream today, but a Central Sharia Board to deliberate on matters related only to
Islamic Finance should not be so difficult after all, particularly when the ultimate goal is the
same, and the means to reach those goals (Quran and Hadeeth) are the same.
Finally, fundamentalism is the biggest enemy of anything Islamic. Although there is nothing
wrong with the Islamic fundamentals, which are stronger than any other fundamentals, a lot of
misunderstanding exists in the minds of not just the non-Muslims but also in the minds of
Muslims. Lack of education is to blame. Islamic educational system is way behind other
educational systems, and thus is unable to control the damage done to it by unscrupulous
agents from within the community and beyond. It is not difficult for a religion whose
fundamentals are built upon ‘peace’ and ‘patience’ to remove the tag of fundamentalism.
Political: All the recommendations are dependent upon governmental and institutional
support, which makes it extremely important to have a political system that is conducive to
development of Islamic Financial system.
Technological: There is no doubt in any mind that technology is an essential tool to gain
competitive advantage in the modern world. It is an excellent medium to build capabilities
and core competencies. Hence efforts are required not just towards use of latest technologies
but also towards developing, on its own, compatible technologies and continuously upgrading
them to keep ahead of the conventional counterparts. This needs emphasis on research &
development activities and establishment of an infrastructure (soft as well as hard) base.
Technology parks and establishment of a NASDAQ type stock exchange may not seem to be
direct enablers for this purpose, but they would act as catalysts, and provide ingredients for
long-term competitiveness.
Latest Developments: Bahrain Monetary Authority (BMA)’s efforts in establishing
Bahrain as a hub of Islamic Banking, the future support from the planned Bahrain Financial
Harbour and the launch of Dubai International Financial Centre – launched to coincide with
Dubai 2003 (IMF/ World Bank Board of Governors Meet – September 2003), the improved
regulatory controls promised by IIFM, IIRA and IFSB are certainly important developments

in the recent past. Challenges of developing and sustaining the market for Islamic finance is
no easy task, and concerted efforts from many sides are required.
The success of Dubai 2003 and the concurrent International Islamic Finance Forum, have
been an exceptionally large morale booster for the Islamic Financial Community. The Forum
marked coming together of the Institute for International Research (IIR), Dow Jones Indexes,
the Saudi Economic & Development Company (SEDCO), iHilal Financial Services, Dubai
Islamic Bank, Shariah Funds Inc. - a division of US-based Meyer Capital Partners, Oasis
Global Management Company of Guernsey and South Africa and International Brunei
Exchange, etc. Networks and alliances will decide the future of IBFs in a world where the
conventional financial system is quite well entrenched.
Some of the latest developments are briefly discussed hereunder:
(i) Commodity Murabaha (Short-term Inter-bank deposit or placement): “Islamic Banking
& Finance in the Kingdom of Bahrain”, a publication of the Bahrain Monetary Agency
(BMA) provides the structure of Commodity Murababha contract in the Figure-16:
(2)
Broker
BrokerBB Conventional Bank
buys as agent
(5) (4)
Buyer pays on deferred Conventional Bank
payment date sells as agent
Conventional Bank (3)

Conventional Bank Broker
BrokerAA
(Agent)
pays the seller
(6)
Conventional Bank pays
client on deferred payment
date Cash Flow
(1)
Islamic
IslamicInvestor
Investor Client pays
Flow of Commodity
(Principal) Conventional Bank on
(Principal) Value Date
Fig-16: The Structure of a Commodity Murabaha Contract (Source: BMA)
The process of Commodity Murabaha involves a Conventioanal Bank as a commission agent

whose payment to Broker A on the Value Date includes interest for the period between the
buying of Commodity and the deferred paymnet date (Value Date). The commodity provides
the asset backing for the short-term inter-bank deal between the Islamic Bank and the
Conventional Bank. The deal between the two banks involves the Murabaha mark-up only,
and therefore accepted as Islamic. But, the deal does promote payment of interest between the
commodity broker and the conventional bank which raises questions about the validity of
Islamic spirit in the contract. But, Bahraini banks have utilised this innovation extensively ‘to
bridge the liquidity gap’.
(ii) Islamic Credit Cards: Dubai Islamic Bank Visa card provides credit facilities and all the
benefits of a normal credit card without any interest charges. So do other Islamic banks. This
is one sector where it was difficult to imagine how the concept of interest-free credit could
succeed. But, it gives us a picture of the level of convergence that is taking place. For a
detailed discussion on these credit cards, the reader is referred to Darwish (2003).

(iii) Islamic Interbank Money Market (IIMM): Islamic Interbank Money Market (IIMM)
has been operative in Malaysia since October 1998. Liquid money market is an important
issue in the Islamic Financial system. The main concern of financial experts is how to
improve liquidity in the Islamic financial markets with the Islamic concept of money as not
being able to generate any income on its own. Money has to be associated with goods or
service to generate income. Making Money from Money is not permissible – that is the basic
difference between money and commodity. Money (of the same denomination) is not held to
be the subject matter of trade, like other commodities. It can only be used as a medium of
exchange and a measure of value.
If money is to be exchanged for money or it is borrowed, the payment on both sides must be
equal, so that it is not used for trade in money itself. Money is just "potential capital”; to
become real capital it must associate with other resources and undertake a productive activity.
Islam recognizes the time value of money, but only when it acts as capital, not when it is
"potential capital”.
For the conventional banking system, the inter-bank money market serves as an efficient
means to transform excess money into income by short-term placements or overnight lending.
With modern technology assisting such activities almost eliminating geographical barriers,
transaction time and costs, this trade has been on the rise helping achieve great deal of
liquidity in the money market. Interest-based system through inter-bank deals not only helps
tackle the asset-liability mismatch but also allows generation of income out of it.
The Islamic banking system needs to tag some productive activity to every transaction which
becomes an impossible task particularly for overnight trades. This means that Islamic banks
have no motivation to deal in such trades making the money market highly illiquid. Although
regulations can force a bank to part with its excess money to help another bank in need of
cash without charging any interest on it. The Central banks can play an important role in this
respect.
Box-3: How Islamic is the Bank Negara’s IIMM? It is hard to conceive how this innovation by Bank Negara can
fulfill the Sharia obligations. The data provided by the bank on its website presents rates of return on these
Interbank transactions both for Conventional as well as Islamic banks. The doubt that immediately emerges in our
minds is that the “hibah” could just be a cover-up for the interest rates. This doubt would gain strength if there is a
high level of correlation between the two rates (Rates of return on conventional Interbank deals and on Islamic
Interbank deals). The data between October 1998 (inception of Islamic Interbank Money Market) and Novemebr
2003 yielded a very high correlation of 0.95.
Does this mean that this innovation may simply be limited to changing the terminology from Interbank interest rate
to “hibah”?
This may be one reason why interbank conventional rates like LIBOR have finally been accepted as lawful
reference for providing return on “Islamic Bonds”. But, then how can we justify this as lawful as per Shariah? Some
scholars have argued in favour of inflation rates as a reference rather than considering a ribawee reference rate. In
the purely Islamic economy, inflation has no place, but as long as inflation exists because the Islamic Economy
does not exist as of now, inflation could probably be a better reference than LIBOR, or any other Interbank rate. But
then, as of now, the measures available for inflation are not appropriate in the context of banking and finance
because they are based on past data instead of being “dynamic and concurrent”, as argued by Dr. A.L.M. Abdul
Gafoor [in an Email on the IBF Netversity mailing list]. “Therefore a new index to measure the inflation due to
currency depreciation is necessary” [please refer to the book titled "Commercial Banking in the presence of
Inflation", by Dr. Ghafoor]. But some scholars have reservation on even inflation being considered as a reference
for distributing returns on deposits (probably due to inappropriateness of the measures of inflation). Al-Omar and
Abdel-Haq (1996) state that some schools in Islam allow lenders to charge service fees to compensate them for the
administration of the loan. These charges are not proportional to the amount or the term of the loan or inflation.
An example of an institution which adheres to this practice is the Islamic Development Bank.
Bank Negara Malaysia allows Malaysian Islamic banks to participate in the interbank money
market in order to prevent illiquidity. It also participates in open market operations to stabilize

the market. A recent mechanism introduced for accepting “Islamic interbank deposits under
the liquidity management operations based on the Islamic concept” is termed as “Wadiah Yad
Dhamanah (Guaranteed custody). Under this concept, the Islamic banking institutions will
Box-4: Conventional Investors find Islamic Bonds attractive:
Keeping up with the trend, international investors too are becoming increasingly comfortable with the pricing and
structure of the rated, Ijarah sukuks. These transactions have had a maturity of 3 to 7 years. More and more of
European and Asian mutual funds, pension managers, financial institutions and central banks are holding sukuk
paper as part of their diversification strategy. A case in point is the US$ 400 million IDB sukuk, comprising 70%
conventional investors. Similarly, the US$ 700 million Qatar issue is equally split between conventional and
Islamic investors, at 52% and 48% respectively. Geographically, approximately 70% of both of these issues were
placed in Middle East, with the remaining being equally distributed into Asia and Europe. ………… [As in
October issue of the quarterly “Islamic Banking Hub” of LMC, Bahrain]
offer to deposit their excess funds with the Central Bank over a period of time, as agreed
between both parties. As a custodian to the deposits, the Bank is not under obligation to
promise any return to the depositors. However, based on the Central Bank’s discretion, a sum
amount of money may be paid as hibah (gift) to the depositors on the maturity date.” The total
volume of Islamic money market instruments traded in the IIMM reached RM32.7 billion in
the year 2002.
(iv)
Islamic Bonds (Sukuk) Funds: The Islamic Bond market is becoming vibrant with
successful large issues at international levels by Malaysia, UAE, Bahrain and IDB. Fig-4,
showing growth of Malaysian Islamic Bond Market,
provides us with a glimpse of growing Islamic bonds market. Recently, there has been a flurry
of Bond issues by Islamic Financial Institutions, led by Bahrain and Malaysia. The news clip
in Box-8 gives us an idea about the sincerity of the Bahraini Institutions in developing the
primary as well as secondary Bond market. The biggest challenge for the bond market, of
course, is acceptability of the fixed nature of return on these bonds by the Islamic scholars.
The rental return on the Islamic leasing bonds (Ijara sukuk) is 60 basis points over the LIBOR
for six months. Finding it difficult to understand how this bond was any different from a
conventional bond, and whether this could be called an Islamic Bond at all, I posed the
question to Islamic Financial Scholars on ibfnet@yahoogroups.com. [the most successful virtual
discussion forum related to Islamic principles and the IBFs, launched by Dr. Obaidullah of
XIM, Bhubneshawar]. Numerous responses came to the author including one from Dr. M
Shahid Ebrahim (four of his papers are cited in this dissertation). They tried to convince us
that the bond does not lose its Islamic character just because it is pegged to the LIBOR. But
why LIBOR? Simply because, they do not have an alternative. It will take time, but the
growth rate of innovations is encouraging. The only fear is whether we are proceeding on the
right path, or are we straying towards the path followed by our cousins, and falling into a
trap?
A general belief among the Islamic financiers is that any benchmark can be used, in
calculating profit or rent, so that compliance with Shari'a principles is indicated. They think
that as long as the document does not explicitly indicate that the profit or rent is LIBOR but
only the benchmark for calculations is LIBOR, nobody would object. But, it will be too naïve
a belief, as for many of us it is difficult to see a real financial difference between the
conventional and Islamic financing when the actual amount paid by a customer under an
Islamic financing has a link to LIBOR.
Structure of Sukooks in Bahrain:
(a) Al Salam Sukook (Figure-17): These Government securities are equivalent to Treasury
bills, and the margin to the buyers (syndicate of Islamic Banks) is competitive with respect to

returns from other conventional short-term money market instruments. The counterparty and
the market risks involved are the sovereign risks, with Government acting as the seller and
buyer of goods (Aluminium, in the case of Bahrain).
(b) BMA Ijara Certificates: BMA issued these 5 year 5.25% rental return Islamic Leasing
Certificates worth $100 million, on the 3rd September 2001, another first by an Islamic Central
bank. The second sukook (Issue size of $ 70 million) with a maturity of 3 years, annual lease
rental return of 4.52% (paid semiannually) was issued on 27th February 2002.
Steps in an Islamic Leasing (Ijara) Sukook deal:
Commodity Market Salam Sukook: a promise (i) to supply
(Aluminium) fixed amount of Aluminium (x ton) at a
future date, (ii) to sell at x ton Al a
guranteed margin to the market
Advanced payment in lieu of promise (i) on Date-1

Govt of Bahrain Syndicate of banks
represented by BIB
Payment from proceeds of actual Al. sale (ii) in the
market on Date-2 (future agreed date).
Redemption of Salam Sukook
Fig-17: A representative sketch for the Al Salam Sukook of Bahrain Govt.
(i) Central bank, as Mudarib, issues Participation Certificates (backed by Special Purpose
Mudarabah) to the market and collect subscription money.
(ii)The Mudarabah purchases specified tangible assets and Central Bank as Mudarib
executes the deed. Property rights of the assets is transferred to the certificate holders
with the possibility of further transferability of ownership and inherent benefits built-in.
(iii) Purchased tangible assets are then leased out on the basis of Ijara-wa-iqtina to earn
rental income. Mudarib executes the Ijara contract against collaterals & security from the
lessee, and collects rentals. The certificate holders having the property rights on the
assets are the lessors and thus entitled to the rental proceeds.
(iv) Mudarib executes a contract for sale of the leased assets on maturity. Mudarabah is
then liquidated and Sukook redeemed. The leased assets in this Sale deed may be
Box-5: US$250 Government Islamic Leasing Securities:

[As in October 2003 issue of the quarterly “Islamic Banking Hub” of LMC, Bahrain]
The recent US$ 250 million issue of Islamic leasing sukuks, arranged by the Liquidity Management Centre
(LMC) in Bahrain was oversubscribed by 40 percent. The issue was the largest-ever offering of Bahrain
Government’s Islamic sukuks, which is also listed on the Bahrain Stock Exchange. The Ijarah Sukuks
represented assets (Salmaniya Hospital Complex) owned by LMC Sukuk Company a special purpose vehicle
created for the transaction.
The Sukuk company purchased the assets from the government following which the assets were leased by the
government by way of Ijarah Muntahia Bitamlik. This is the Ijarah contract that ends up with the transfer of
ownership of the leased assets to the lessee, for a price represented by the rental payments made by the lessee
over the lease term.
In issuing these Ijarah Sukuk, the Sukuk Company sold these assets to investors who owned the assets after
leasing them to the government for a specified rental price, via the assets purchase contract from the
government, assets lease contract by the government, and the government promised to buyback the assets at its
nominal value at the end of the lease period.
purchased by the lessee or his agent, or any third party at a fixed price on maturity of
Ijara. The property right to the asset is represented by the Ijara certificate.

(v)The Participation Certificates can be traded in the secondary market during the validity
of Mudarabah.
So, how Islamic are these bonds? The debate on how far the fixed rentals/ guaranteed
margins, or a fixed spread over LIBOR in the Islamic sukooks differ from the interest rates of
the conventional bonds will continue. One simple test that can be applied to ascertain whether
or not these returns are same as the interest rates is whether or not the asset or commodity
backing is genuine. Asset or commodity backing can be considered as genuine if it satisfies
the basic tenet of the Sharia, i.e., the transactions actually result in producing the asset or
commodity at some level. The whole cycle of activity does result in some productive
economic activity unless it is purely speculative, in any system whether conventional or
Islamic. But, the test for Islamic sukook deal is whether the economic activity is related to the
asset or commodity that is used as backing for the deals. A cursory look at the whole cycle
leaves an impression that in the whole process, the asset or commodity acts like the
hypothetical Eurodollar deposit used for the Eurodollar interest-rate futures traded on the
Chicago Mercantile Exchange (CME) and the Singapore International Monetary Exchange
(SIMEX). As in the case of the futures, the underlying asset may never actually change hands
in the sukook deals. But jumping to conclusions so easily would be negating all the efforts put
into these excellent innovations accepted by the Sharia Supervisory Boards.
The question whether or not the asset or commodity backing is genuine may not be answered
easily, but what about the fixedness of returns guaranteed by these bonds? The price of an
asset or commodity widely fluctuates in the market due to supply and demand factors in case
perfect competition exists. In such a scenario, the prices can be predicted in the short run
based upon the factors that govern the demand and supply. In case speculative players
dominate the market or in case where cartels exist, which is the case in many product/
commodity markets (particularly in Aluminium) of the contemporary world, how can the
prices be guaranteed? If the future prices cannot be guaranteed, how can a return from a deal
in such products/ projects/ commodities be guaranteed? Is it not speculation? This is one of
the arguments that form the basis for prohibiting a guaranteed return to investors.
The discussion on the BMA’s Al Salam Sukooks (described above) may yield interesting
insights. It provides us with some explanation why the Ijara based bonds are replacing the
Salam based bonds. Under Ijara concept, fixing a rent in advance may not be considered un-
Islamic whereas in Al Salam concept, a fixed rate of return may be termed speculative and
thus may not be allowed. Considering the fact that BMA’s Al Salam Sukooks are based on
Box- 6: Islamic Development Bank launches bond issue worth $400m
[Source: Gulf News dated 03-08-2003]
The Islamic Development Bank (IDB) has announced the successful launch of its debut capital markets' $400
million Islamic Sukuk issue. The issue was increased from the original targeted size of $300 million due to strong
demand.
As the first international Islamic capital markets bond issue by a non-sovereign and only the second such
international Islamic issue, the transaction was priced to yield 3.738 per cent, equivalent to a margin of 16 basis
points (bp) over the five-year mid-swap rate, at the tighter end of the indicated pricing range of 15-20 basis
points.
Citigroup acted as ratings advisor, sole bookrunner and lead manager on the transaction with Abu Dhabi Islamic
Bank (Adib) and Kuwait Finance House (KFH) acting as co-lead managers. HSBC and Nomura International
acted as arrangers.
Aluminium as the underlying commodity, let us examine the fluctuation in the price of
Aluminium during last five years. With Aluminium prices being so volatile, and guided by
large international players, can the sovereign guarantee be sustainable? It is not difficult to
conclude from the guaranteed rate offerings tagged to the recent bond issues that the necessity

to provide the fixed returns as competitive as the returns from conventional securities of
similar maturity may actually be guiding them instead of any forecasting methodologies.
$1,800
$1,700
$1,600
$1,500
$1,400
$1,300
$1,200
$1,100
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Apr-98
Oct-98
Apr-99
Oct-99
Apr-00
Oct-00
Apr-01
Oct-01
Apr-02
Oct-02
Apr-03
Oct-03
Figure-18: Aluminium prices (monthly average) during January 1998 and October 2003
$1,460
$1,440
$1,420
$1,400
$1,380
$1,360
$1,340
$1,320
$1,300
$1,280
1-Aug
8-Aug
15-Aug
22-Aug
29-Aug
5-Sep
12-Sep
19-Sep
26-Sep
3-Oct
10-Oct
17-Oct
24-Oct
31-Oct
Figure-19: Daily Aluminium prices between 01st August and 31st October, 2003
Source for Figure-18 & Figure-19: London Metal Exchange (LME), Cash Settlement and Reference Prices
This may be the main reason why some scholars have termed only two modes of transactions,
Mudarabah and Musharakah as strongly Islamic (Siddiqui-1982, Mohsin-1982, Qureshi-1984,
Qureshi-1985, Chapra-1982). Khan and Mirakhor (1987) argue on the same line and suggest
“all other modes of operations … are recommended only in cases where risk-return sharing
(i.e., Mudarabah and Musharakah) cannot be implemented.”
The size of the disposable funds owned by high networth Arabs is estimated to exceed $11
trillion. After 11th September 2001, in particular, there has been a rush to tap this fund which
used to be mostly invested in the US markets. In this mad rush, is it a possibility that Islamic
Shariah principles are being kept aside or backdoors are being invented in the name of

innovation? A more transparent system will provide better explanation apart from being
helpful in clearing doubts from investor’s minds.
(v) Global Bond Market Growth: As reported by failaka.com,

USD180bn worth of funds were available for investment in Islamic-approved holdings
worldwide as of mid-2002, an amount anticipated to grow by 15% YoY. Some indications of
things to come are provided by the news item in Box-8. Some more developments are
described below.
(vi) When Issue (WI): Players in the Islamic money market of Malaysia are allowed to
perform WI transactions prior to the issuance date of the Islamic securities. WI is a pre-
issuance transaction of debt securities that will be issued in the Islamic debt market to
facilitate players in estimating the appropriate price to bid on the issuance date. The Council
viewed that the WI transaction is allowed based on the permissibility to promise for sale and
purchase transactions …… Bank Negara.
(vii) Sell and Buy Back Agreement (SBBA): The SBBA transaction is permissible, in
Malaysia, as long as it is an outright sale and purchase and enforced by two different
contracts for each transaction. In addition, compensation can only be effected on the party
who defaulted on his promise …… Bank Negara.
(viii) Collateralised Borrowing: The National Shariah Advisory Council of Malaysia
Box-7: Latest Trends & Challenges

Malaysia has become a leader in the world of Islamic banking by choosing the most practical interpretations of
the term. It has invested heavily in developing a Sharia-friendly financial system—one that forbids charging
interest, but that has the regulatory, accounting and compliance standards any investor would expect. The
country’s Islamic financial institutions—which make up about 8 percent of the banking sector—offer services
that mirror and compete with conventional banks. So much so that some question if there is any difference at all.
Such is the overlap that more than half of Malaysia’s Islamic loans go to non-Muslims. “Islamic banking in
Malaysia comes to exactly the same thing as conventional banking,” says one Kuala Lumpur-based banker. “You
cannot operate without a differential between today’s money and tomorrow’s money.” (More Than a Prayer,
By Lorien Holland and Peter Janssen, NEWSWEEK INTERNATIONAL, January, 2003)
ISLAMIC BANKING: THE ROAD AHEAD
The industry faces three main challenges: first, to meet customer expectations in a manner that is profitable to
themselves, and to develop the financial and technical strengths to ensure success of these objectives. Second,
conventional banks are increasingly competing in the Islamic sector, either by the introduction of 'Islamic
windows' within their present structures or by the establishment of subsidiary or associate companies that
operate entirely on Islamic principles. Islamic institutions will need to respond to these competitive pressures
and this will involve questions of substantial enhancement to the capital base of individual institutions or
mergers and consolidations from within the sector.
The recent cross-border mergers between major banks in the US and Europe not only show the direction in
which the industry is moving, but also widens the gap between the capacities of the regional and international
banks. Although recent bank mergers in the Gulf region are a step in the direction of countering this disparity, it
has to be acknowledged that regional banks will not become major players in the international markets until
they themselves start to merge and/or pool their resources. Ayman Dunseath, Gulf Business 30-Dec-02
approved the proposal to introduce the collateral borrowing transaction in the Islamic money
market based on the principle of Rahnu. The transaction is an alternative to the SBBA and the
loan extended is based on the concept of Qardh. Although there is no profit element being
introduced in the transaction, the banks are expected to prefer this transaction due to its
simplicity and its mutual-help feature …… Bank Negara.
(ix) Islamic Securitization: Islamic Securitization in a wider sense is defined as the process
of pooling assets, packaging them into securities, and making them marketable to investors. In

Islamic finance, the concept of securitization is in consonance with what is known as Taskeek
in Arabic, which is a process of dividing ownership of tangible assets, usufructs, or both, into
units of equal value and issuing securities as per their value. The underlying assets, contracts,
Box-8: Bahrain LMC to issue $1.2b bonds
By Mehmood Rafique, Bahrain Tribune, 20 May 2003
FOLLOWING an overwhelming response to the Liquidity Management Centre’s debut $250 million five-year
Islamic leasing bonds, the LMC is poised to issue four leasing bonds of over $1.2 billion by December. ….. "We are
working aggressively to design and launch more and more sukuks or Islamic leasing bonds as part of LMC’s
strategy to create a secondary market for investors," he said, adding that the LMC was established in Bahrain with
the objective of acting as a "market maker" for investors. "The LMC business activities will help to facilitate the
creation of an Islamic inter-bank money market that will allow Islamic financial institutions to effectively manage
their assets and liabilities. Provide short and medium term liquid, tradable, asset-backed treasury instruments
(Sukuks) where Islamic financial institutions can invest their surplus liquidity," he said.
Mohammed Hisham Dafterdar, representing the Islamic Development Bank (IDB) on the board, told the Tribune
that establishment of the LMC in Bahrain would help to mop up the market liquidity. "It is not an overnight job to
create a secondary market for Islamic financial institutions as it takes time. The IIFM and the LMC are working
independently under the umbrella of the BMA but at the same time these organisations complement each other," he
said.
He said that Islamic Financial Standards Board in Malaysia and establishment of Islamic Institutions Rating Agency
were also important organs to support the existing market. "These all are pillars of the Islamic financial market and
we hope that the LMC initiative will trigger the investment opportunities," he explained.
Mohammed S Al Omar said that the LMC would also explore marketing avenues across the Gulf and even beyond
the Middle East region. "The LMC is the only institution which is to act as an agent for Special Purpose Vehicle
(SPV), to establish, to securitise assets, facilitate the sourcing and securitisation of assets acquired from various
sources," he said, adding: "It will also establish lines of liquidity to support the issuance of securitised instruments
(Sukuks)."
"The LMC seeks to develop an active secondary market for short-term treasury products. In doing so, it will
significantly accelerate the development of the Islamic banking industry by addressing the industry’s fundamental
need to develop tradable products and secondary markets," he said.
Aref Al Kooheiji, founding director of the LMC said: "The LMC will enable financial institutions to invest in
quality assets of varying tenors. By securitising a pool of tangible medium and long-term assets acquired from a
variety of sources, the LMC will provide access to a pool of quality assets. The sukuks issued to securitise this pool
will offer enhanced Shrai’a credibility.
"In addition, the LMC will create opportunities for buyers of quality assets that will allow Islamic financial
institutions to finance long term projects that can be liquidated at their discretion.
"Thus having the opportunity to act as both investors (providers of capital) and borrowers (providers of assets) and
will channel their excess liquidity to the benefit of regional economies. Furthermore, LMC will enable Islamic
financial institutions to maintain a tenor mismatch between their assets and liabilities which is fundamental to the
business of banking and imperative if the industry is to remain competitive with its conventional counterpart."
"The LMC will also endeavour to create secondary markets for its products by establishing a consortium of liquidity
providers. The latter will provide impetus to the active trading of sukuks in over-the-counter deals or through the
LMC as Islamic financial institutions gain access to competitively priced liquid instruments.
No individual bank or product currently offers this combination of quality instruments with diversified risk together
with a ready market for trading," he said.
The Liquidity Management Centre (LMC) was established in Bahrain in July 2002. The LMC is a key element of a
larger project to create an International Islamic Financial Market (IIFM).
and payment mechanism, while being commercially viable must be aligned with the
requirements of Sharia. By and large, the Sharia treatment of sukuk is similar to an equity
security where shares are evidence of ownership in a going concern.
Islamic Development Bank’s recent debut issue of US$400 million Islamic sukuks received
overwhelming response from both conventional and Islamic investors around the world. The
issue size originally targeted at US$300 million was increased based on strong demand for the
high quality instrument. The issue is unique in almost all its aspects ranging from the issuer,
the guarantor, the arranger and more importantly the innovative structure of the deal, which is

a combination of securitization of Ijarah, Mudaraba and Istisna contracts with a minimum of

51% on the Ijarah assets.
It should be noted that although some of these securitized financial instruments have been
generally accepted as being in compliance with Islamic principles so that they can be traded in
the secondary market, the negotiability of certain others still remain controversial due to their
legal acceptability or compliance with Sharia. For instance, Murabaha is a transaction, which
cannot be securitized independently to create a negotiable instrument to be traded in the
secondary market. The certificate representing a monetary obligation from a third party or
dayn arising out of a Murabaha transaction can be traded at face value and any difference in
value will be tantamount to riba. However, if the security represents a mixed portfolio
consisting of a number of transactions like Musharaka, leasing and Murabaha, then this
portfolio may issue negotiable certificates, subject to certain conditions.
(a) Securitization of Mudaraba Bonds: AAOIFI’s Sharia standard No-18 defines the
arrangement of Mudaraba bonds as below:
“The issuer of the certificates is the Mudarib, the subscribers are the capital owners and the
realized funds are the Mudaraba capital. The certificate holders own the assets of Mudaraba
operation and profit share as per agreement. The certificate holders, being the capital
providers, bear the loss, if any.”
Mudaraba means an agreement between two parties where one partner gives money to another
for investing in a commercial enterprise. The investment comes from the first partner who is
called "Rab-ul-Maal" while the management and work is the exclusive responsibility of the
other, who is called "Mudarib" and the profits generated are shared in a predetermined ratio.
The objects of a Mudaraba are restricted to only such businesses as are permitted under the
Sharia. The concept of mudaraba is akin to revenue bond financing in the conventional
system. Revenue bonds are generally backed by revenue generated mainly for public sector
projects funded by the bond issue. The bondholders are solely dependent on the revenue
generated by the project being financed and in the event of non-performance of the project,
there is no recourse to the local government’s general treasury fund.
Likewise, the Mudaraba bonds give its owner the right to receive capital at the time the bonds
are liquidated, and an annual proportion of the realized profits in accordance with the
predetermined profit sharing ratio. The Mudaraba bonds can be instrumental in the process of
development financing because it is related to the profitability of the projects.
(b) Securitization of Musharaka: AAOIFI’s Sharia standard No 18 defines the arrangement
of Musharaka bonds as follows:
“The issuer of the certificates is the inviter to a partnership in a specific project or activity.
The subscribers are the partners in the Musharka contract. The realized funds are the share
contribution of the subscribers in the Musharaka capital. The certificate holders own the
assets of partnership and are entitled to profit, if any”.
Musharaka bonds are relatively similar to Mudaraba bonds. The only major difference is that
the intermediary-party will be a partner of the group of subscribers represented by a body of
Musharaka bondholders in a way similar to a joint stock company while the Mudaraba capital
is only from one party. In securitizing a Musharaka arrangement, every subscriber can be
given a participation certificate, which represents his proportionate ownership in the assets of
the venture or project for which financing is being raised.
Subsequent to the acquisition of substantial non-liquid assets, these Musharaka certificates
can be treated as negotiable instruments and can be bought and sold in the secondary market.

There is a strong Sharia opinion against the trading of these certificates if the underlying
assets of the Musharaka are in liquid form (i.e. in the shape of cash or receivables or advances
due from others).
(c) Securitization of Ijarah: Ijarah sukuks have aspects in common with conventional asset-
backed securities and are of particular interest to a broad range of investors representing both
the conventional and Islamic financial communities. Benchmark for lease rentals can be based
on a conventional index such as US$ LIBOR which can be either fixed or floating. Since
Ijarah sukuks evidence the undivided pro-rata ownership of the underlying leased asset, it
could be freely tradable at par, premium or discount. Such flexibilities can allow Ijarah sukuks
to be priced at par with their conventional counterparts. A case in point is the issue of US$
600 million 5-year floating rate trust Ijarah certificates by the Malaysian government in 2002.
The issue was priced flat to the country’s conventional credit curve and attracted no premium
despite being a new deal structure.
Ijarah is a contract, according to which a party purchases and leases out equipment required
by the client for a rental fee. The duration of the rental and the fee are agreed in advance and
ownership of the asset remains with the lessor. The lessor in Ijarah owns the leased assets, he
can sell the asset, in whole or in part, to a third party who may purchase it and may replace
the seller in the rights and obligations of the lessor, with regard to the purchased part of the
asset. Typically, the issuer of the Ijarah certificates acquire assets, transfer its ownership to a
special purpose vehicle (SPV, then sell investors shares in the SPV. The returns on the shares,
which come from leasing out the assets owned by the SPV, could be either fixed or a floater.
Thus, the expected returns are fixed and can be treated as predictable as the coupon on a
conventional bond. A third party can also guarantee rental payments and since the yield is
predetermined, the underlying assets are tangible and secured, the Ijarah certificates can then
be traded in the secondary market.
The securitisation of leasing transactions and the creation of tradable, liquid investment funds
have facilitated Islamic secondary market, which is instrumental in alleviating the liquidity
constraints of Islamic financial institutions.
(x) Islamic hedge fund: At the outset of September 2003, the Saudi Economic and
Development Company (SEDCO) launched the world's first-ever hedge fund compliant with
Islamic Sharia'h law, in conjunction with Saudi Arabian financial services group Permal.
Fund managers Fostman-Leff of New York were responsible for managing the fund which
were expected to start doing business by early October 2003 (as per their press release).
SEDCO has been examining possible alternatives to prohibited derivates. One such
alternative is based on an innovative concept like "stipulated options" - a buyer makes an
advanced partial payment for deferred delivery of a product, and if he decides not to buy this
later, the seller keeps the advance - closest analogy to an option in IBF system. Another such
alternative likely to be used by them is the old concept of Al Salam, where one sells a
commodity to a buyer against full up-front payment for delivery at a future date. An investor
can hedge his downside risk by selling stocks to be delivered later, receive payment in
advance for productive use without bearing the price risk.
SEDCO claims that the fund is fully transparent to investors. An existing Sharia'h compliant
offer from this group is a 5-year medium-term note with 100% principal protection provided
by Societe Generale.
Rating Agencies: Do we need separate rating agencies for the IBFs? Perhaps, yes. We
have seen that the system in its purest form is entirely different from its conventional
counterpart, hence the rating methodology has to be uniquely suited to the IFBs. This will be
important for inter-bank dealings. Credit ratings for customers may not be different simply

because the target customers are mostly the same for both. However, project evaluation
becomes an important and integral role for pure IBFs based mainly on the PLS principles.
This may require specialized technical skills largely absent in the present lot of banks the
world over. Apart from the evaluation of projects, its monitoring during execution and
participation in managing the project may be important to avoid false reporting by the other
party. In an age where creative accounting is considered as creativity rather than sin, costs to
the IBFs may escalate beyond expectations. On the other hand, the benefits resulting from
IBFs are likely to far exceed the costs.
IDB initiated a scheme to establish an Islamic Rating Agency recently called the
“International Islamic Rating Agency”(IIRA) to be incorporated as a profit-making
independent company. IBFs will hold a total of 35% of the capital, the IDB 15%, and 50%
will be held by rating agencies. A working group comprising of representatives from IDB,
AAOIFI, selected Islamic banks and Malaysian Rating Corporation (MARC) has been
formed.
Basel II Implications: The Basel Committee guidelines do not specifically focus on the
Islamic Banking and Financial System, but still the adequacy norms and risk management are
areas that affect them as much as they affect the conventional banks. The BMA has developed
a framework, known as Prudential Information and Regulations for Islamic Banks (PIRI)
which takes into consideration standards developed by AOOFIFI and the Basel Committee's
various guidelines. When the International Islamic Financial Market, being developed in
cooperation with the Islamic Development Bank and other central banks, will be operational
the need to comply with the Basel II regulations would be felt even more.
The main problem for the IBF, today, even after more than twenty eight years in operation is
in defining what they are all about, i.e., the confusion as to whether they are banks, mutual
funds, asset managers, or investment funds. Although some of the regimes regulating Islamic
financial institutions are already very stringent, and some like Bahrain which may claim to be
over-regulated as they have started applying Basel II in terms of liquidity risk issues.
Some implications that can be more easily visualized are as follows:
- Cost implications (mainly for estimation of new risk components like operational risks).
Majority of Islamic banks have no such liberty in investing a large amount for that purpose.
Speculations are rife that banks will need to invest additional amounts (in millions) to comply
with Basel II.
- CAR implications: There is much debate at present amongst western banks if Basel II will
be implemented or not. This is because of the cost implication to implement operational risk
monitoring which may cost billions.
There are views that in western countries it may likely improve the capital risk weighting for
Islamic products. Products like mortgages already benefit from Murabaha structure in terms
of capital risk weighting (50%) but Murabaha is not considered efficient in terms of early
repayment, or determining a profit amount etc. Ijara is the preferred mode at present for
developing mortgage products, but it attracts 100% capital risk weighting. One could argue
that if Islamic mortgages based on Ijara are more efficient, they should attract less capital risk
weighting. The Basel committee is unlikely to allow lesser risk weighting for lease across the
board, as all banks will rush to reap benefits from Islamic leases. Modaraba and Musharika
will continue to still attract 100% capital risk weighting.
Important Institutions supporting the development of IBF:
Institute of Islamic Banking and Insurance:

Dar Al-Maal Al-Islami (DMI): HQ in Geneva

Al-Baraka: HQ in Jeddah.
IIBI Established in 1991
Publications: (a) International Directory of Islamic Banks and Institutions 2000, (b)
International Directory of Islamic Insurance 2000
AAOIFI: The Accounting and Auditing Organization for Islamic Financial Institutions is an
Islamic international autonomous non-profit making corporate body that prepares accounting,
auditing, governance, ethics and Shari'a standards for Islamic financial institutions.
Managed funds: over $200 billion
Agreement of Association signed by Islamic financial institutions on 26 February, 1990 in
Algiers. AAOIFI was registered on 11 Ramadan 1411 corresponding to 27 March, 1991 in the
State of Bahrain.
The International Islamic Rating Agency
The Islamic Financial Services Board
The International Islamic Financial Market, and
The Liquidity Management Center
The Dow Jones Islamic Market Indexes:
Dow Jones Islamic Market World Index
Dow Jones Islamic Market Titans 100 Index
Dow Jones Islamic Market Asia/Pacific Index
Dow Jones Islamic Market Europe Index
Dow Jones Islamic Market Canada Index
Dow Jones Islamic Market Japan Index
Dow Jones Islamic Market U.K. Index
Dow Jones Islamic Market U.S. Index
Dow Jones Islamic Market Technology Index
Some statistics related to the above indices are presented in Appendix-D
FTSE Global Islamic Index Series:
The FTSE Global Islamic Index Series (GIIS) are equity benchmark indices targeted at those
who wish to invest according to Islamic investment guidelines. Islamic investing is growing
by 12-15% per annum, as more and more international investment bodies stake an interest in
this specialist service. The FTSE Global Islamic Index Series addresses this demand by
creating a standard for applicable Islamic equity investing.
Initially pioneered in January 1999 by The International Investor (TII) and calculated by
FTSE, the series was the first truly global Islamic Index series. It was designed to track the
performance of leading publicly traded companies whose activities are consistent with Islamic
Sharia principles.
Due to its success over the past months, the Global Islamic Index Series will now be
incorporated into the FTSE family of indices. Using the FTSE World Index as the universe,
TII applies Sharia principles, following guidelines provided by its Fatwa and Sharia
Supervisory Committee to rule out those companies whose business activities are
incompatible with the Islamic law.
After removing companies with unacceptable core business activities, the remaining list is
tested by a financial-ratio "filter", the purpose of which is to remove companies with an
unacceptable debt ratio. Finally, any "tainted percentage" of any cash dividend received by a
company which is not in accordance with Sharia law is computed, and should be donated to a
proper charity.

Sub-component Indices:
FTSE Americas Islamic Index
FTSE Europe Islamic Index
FTSE Pacific Basin Islamic Index
FTSE South Africa Islamic Index
Sector Screens:
By way of guidance, stocks whose core activities are or are related to the following are
excluded:
a) banking or any other interest related activity
b) alcohol
c) tobacco
d) gaming
e) insurance
f) pork production, packaging and processing or any other activity related to pork
g) activities deemed offensive to the principles of Islam
h) sectors / companies significantly affected by the above
The companies that have incompatible lines of business are removed from the "universe" of
stocks included in the FTSE World Index. Companies classified in other industry groups may
also be excluded if deemed to have a material ownership in, or revenues from, prohibited
business activities.
Financial Screen:
Debt ratio: (exclude companies) if Interest-Bearing Debt divided by Assets is equal to or
greater than 1/3 or 33.33%. Companies that pass these screens are generally eligible for
inclusion in the FTSE Global Islamic indices' investable universe.
Dividend Cleansing: "Tainted dividend" receipts relate to the portion, if any, of a dividend
paid by a constituent company that has been determined to be attributable to activities that are
not in accordance with Islamic Sharia principles and therefore should be donated to a proper
charity or charities.
Sharia Scholars: The screening criteria of the FTSE Global Islamic range of indices is
supported by the credibility of TII's Fatwa and Sharia Supervisory Committee (Sharia Board).
Conclusion: Dr. Ebrahim (1999) argues that the modes of financing selected should not
only avoid riba, gharar and maysir but also be economically efficient. In search of this
economic efficiency, Islamic Banks now participate in a wide financing domain stretching
from simple Sharia-compliant retail products to highly complex structured finance and large-
scale project lending. Muslims (and non-Muslims) can now obtain Islamic credit cards, can
insure themselves and their property Islamically, can invest on line in Islamic funds can track
their investments Islamically and can even get a Sharia-compliant mortgage from a US firm.
Islamic banks are now better positioned than ever to participate not only in large scale
corporate financing but also more complex wholesale transactions such as syndications and
securitization. Bahrain's recent $255mn al-Hidd power financing is a case in point. Lead
arranged by BNP Paribas, HSBC Amanah, Bank of Bahrain and Kuwait and Bank of Tokyo
Mitsubishi, the $55mn Islamic tranche arranged by the Saudi-based Islamic Development
Bank and Kuwait Finance House was hailed as a landmark in regional power finance. KFH
had earlier helped set an inter-creditor agreement precedent when it secured in 1995 a
$200mn Islamic tranche for Kuwait's $1.2bn Equate petrochemical project.

This convergence is evidence of how the Islamic financial sector is part of the globalizing
trend and not rejectionist. In essence, Islamic finance offers another set of well-understood
tools within the understood frameworks of modern banking and finance. - Abdulkader
Thomas
9% 11%
23%
57%
Don't provide good return Can't find a Halal investment

Lack reputation Others
Fig-18: Survey Results – Demand for Islamic Investments in America

Source: www.failaka.com
At first glance, it looks like many techniques that the interest-free banks are practising are
neither in full conformity with the spirit of Shari’ah nor practicable in the case of large banks
(or the entire banking system). Moreover, they seem to have failed to do away with
undesirable aspects of interest, and thus, they seem to have retained what an Islamic bank
should eliminate. This is because these institutions have attempted to start from where the
conventional banking system has left. The innovations, however genuine and worthy, seem to
be swamped within the muddle of well-developed and widely accepted financial system of
conventional banking and finance. For a commoner, it becomes very difficult to distinguish
the Islamic instruments from the conventional ones. The solution lies not in changing the look
or personality (face value) of the conventional instruments – which is the primary reason for
all the confusion – but in evolving afresh. We feel that the basic infrastructure necessary for
building an entirely new structure for the Islamic Financial System is not just available but is
quite strong already. What is needed at this moment is an out-of-the-box thinking even if
sounds like reinventing the wheel. This will require a bold initiative towards a total
unwinding of the current system and a lot of unlearning before we could even conceive of a
reasonable amount of success in clearing the clouds of ambiguity. Even if one concludes that
the resource available with Islamic Financial System is peanuts compared to its conventional
counterpart, there is no need to despair. The ultimate winner is the one who dares to dream.
What is required at the moment is the “strategy as stretch and leverage” that Hamel and
Prahlad (1993) advises.
Haron et al (1994) who pioneered the research on bank patronage in Malaysia found that
almost 100 percent of Muslims and 75% non-Muslims were aware of the existence of Islamic
banks. While applying Haron et al’s study, Gerrard and Cunningham (1997) found that just
like their Malaysian counterparts, Singaporean Muslims were more aware of the existence of
Islamic banking than the non-Muslims. Similarly, this study found no evidence of Muslims
and non-Muslims differing in their bank’s selection criteria. In another study wherein the
respondents were individuals who had financial decision-making authority in the Malaysian

corporate sectors, and 80% of which were non-muslims, Ahmad & Sudin Haron found that
more than 55 per cent perceived that both religion and economics were the patronage factors
in this system. About 50 percent of the respondents believed that Islamic banking products
and services had a good potential to be accepted by customers. About 75 per cent indicated
that Islamic banks in Malaysia however had not done enough marketing in promoting their
products and services to corporate customers. Almost half of the individuals surveyed
believed that the Islamic banking system had a good potential as an alternative to the
conventional system.
The future is definitely bright for the Islamic banking and finance. They have already
established a niche by roping in the Muslim community. And their appeal is expanding,
particularly with the number of proponents of Ethical Banking and Finance on the rise in
other communities. In order to give the conventional system any semblance of competition, it
has to grow out of the niche, and convince everybody not just about the ethical aspects but
also the economic benefits that it carries – in fact it will have to prove that it is more
profitable than its conventional counterpart.

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APENDIX A0: Estimation of TAI for UAE

Estimation of TAI for UAE to compare with TAI values of other countries in HDR (2001) is
shown as below:
(A) Calculation of the Technology Creation Index:
Patent Index = (0.990 - 0)/ (994 – 0) ………………. (1999 figure taken from USPO for
number of Patents) = 0.001
Royalty and Licence fee Index = 0 (assumed to be zero)
Technology Creation Index = (0.000 + 0.001)/ 2 = 0.0005
(B) Calculation of Diffusion of Recent Innovations Index:
Internet Host Index = (20.9 - 0.0)/ (232.4 - 0.0) = 0.090
High and Medium Technology Export Index (ERF-2002) = (16.0 – 0.0)/ (80.8 – 0.0) = 0.198
Diffusion of Recent Innovations Index =( 0.090 + 0.198)/ 2 = 0.288
(C) Calculation of Diffusion of old innovations Index:
Telephony Index = [log {407 (Tel mainlines per 1000 people) + 347 (Cellular mobiles per
1000 people)} – log(1)]/ [log(901)-log(1)] = 0.974
Electricity Index = 1, because its consumption of 9,892 KWH per capita is above the goalpost
(6,969)
Diffusion of old innovations Index = (0.974 + 1.000)/ 2 = 0.987
(D) Calculation of the Human Skills Index:
Mean Years of Schooling Index = (10.5 - 0.8)/ (12.0 – 0.8) years: Expected Years of
schooling from ERF (2002)
= 0.866
Gross Tertiary Science Enrolment Index = (3.2 – 0.1)/ (27.4 – 0.1) = 0.114
Human Skills Index = 0.980/ 2 = 0.490
Technology Achievement Index (TAI ) = (0.0005 + 0.288 + 0.987 + 0.490) / 4
= 0.441
APPENDIX-A: Competitiveness of Banking Sector In Case of Opening
Local Markets to GCC Banks
(Kuwait Foundation For Advancement of Sciences)
Ghanem, AlMahmeed, AlMejren, ElSakka, Paul, Al MASARAF, (the official journal of the
Union of Kuwaiti Banks, Issue no. 2, 2002).
1. Mudaraba and Murabaha services came at the forefront of Islamic banking services.
2. The Islamic financial institutions are seen as a strong competitor for the banks in
Kuwait, now and in the future. Other banks in the GCC countries share the same view
with the Kuwaiti banks.
Recommendations of the Study
By reviewing the weaknesses of the Kuwaiti banks compared to other GCC banks, we
find that the Kuwaiti banks need to take the following actions:
- Explore methods to increase the return on their assets up to the levels prevailing at non-
Kuwaiti banks.
- Increase the level of expenditure on training and human resources development.
- Increase the size of investment in information technology and communications up to the
levels prevailing at non-Kuwaiti banks. - Increase the level of experience for national
manpower.
- Increase the awareness as to the international financial developments and their local
implications.
- Enhance their confidence in the ability to face foreign competition, and upgrade their
readiness to meet the challenges of GCC banks or international banks.

- Exploit the opportunities offered by the GCC agreement on the liberalization of banking
services.
- Increase the attention given to the evaluation and review of training activities, and ensure
the good quality of the training provided to their staff , so as to more positively reflect on
their performance.
- Create more stability for staff in order to avoid the adverse implications of the high
turnover. - Improve staff productivity.
- Study the problem of staff absence and its reasons and treat it more seriously.
- Allocate more financial resources to enhance staff flexibility and reinforce their ability to
work as a team.
- Periodic review of benefits and incentives, so as to ensure staff satisfaction and
consistency of those systems with the standards prevailing in the industry.
- Improve annual planning and control systems.
- Improve FX and foreign operations risks management.
- Develop an IT strategy.
- Upgrade capital adequacy ratio to be in line with the levels prevailing at other GCC
banks.
- Consider the opportunities of merging with other banks, whether local, Gulf or
international.
- Study the opportunities of forming unions with other banks, whether local, Gulf or
international.
- Adopt plans for diversifying products and markets in line with other GCC banks, and
enhance the readiness for expansion in new markets.
- Adopt more intensive plans for automating banking operations in line with other GCC
banks.
- Reinforce relationships with the segments of the general public and multinational
companies, likewise Qatari and Omani banks.
- Strengthen their presence in the areas of advisory and investment services, such as
money markets, capital markets, futures, options, investment portfolios management,
private funds management and investment advisory services.
- Reinforce their Islamic banking services in the areas of Murabaha, Mudaraba,
Musharaka and Istisna.
- Start to use the Smart Cards, and expand in the areas of issuing certificates of deposits
and rendering brokerage services, because their share of these services is the least
among GCC banks.
- Activate the role of foreign exchange services and certificates of deposits in revenues
generation, as these services rank the first at Omani banks and the second at Saudi and
UAE banks.
- Expand services delivery through the internet, likewise the banks in UAE.
- Enhance the role of Musharaka and Istisna services as sources of income.
- Expand in advisory and investment services in the manner mentioned above, as such
services represent an important source of income, particularly investment advisory
services and investment portfolios management. There is also a need for expansion in
futures and options.
- Expansion in insurance services to strengthen the role of these services as a source of
income.
- Establish and enhance the presence in GCC and Arab markets in general, because the
results of the study indicated that the strength of Kuwaiti banks association with their
customers in GCC markets is the weakest, with the exception of Omani banks, and
their association with their customers in Arab markets is also the weakest, with the
exception of Omani and UAE banks.

APPENDIX-B: Islamic Financial Institutions in the World (Source: Islamic

Institute of Banking and Insurance; http://www.islamic-
banking.com/ibanking/ifi_list.php#albania)
1. Albania
a. Arab Albanian Islamic Bank, Tirana
2. Algeria
a. Banque Albaraka D'Algerie, Algiers
3. Australia
a. MCCA (Muslim Community Co-operative, Australia)
b. MCCU (Muslim Community Credit Union)
4. Bahamas
a. Akida Islamic Bank International Ltd
b. Bank Al Taqwa Ltd
c. Dar al Mal al Islami Trust, Nassau
d. Islamic Investment Company of the Gulf Ltd, Nassau.
e. Istishara Consulting Trust, Bahamas
f. Massraf Faysal Islamic Bank & Trust, Bahamas Ltd.
5. Bahrain
a. ABC Investment & Services Co EC
b. Al Amin Co. for Securities and Investment Funds
c. Albaraka Islamic Investment Bank
d. Arab Islamic Bank E.C
e. Bahrain Islamic Bank Bsc.
f. Bahrain Islamic Investment Co. Bsc. Closed
g. Bahrain Institute of Banking & Finance
h. Bank Melli Iran
i. Chase Manhattan Bank N.A.
j. Citi Islamic Investment Bank (Citicorp)
k. Dallah Albaraka (Europe) Ltd
l. Dallah Albarakah (Ireland) Ltd
m. Faysal Investment Bank of Bahrain
n. Faysal Islamic Bank of Bahrain (Massraf Faisal Al Islami)
o. Gulf International Bank BSC
p. Islamic Investment Company of the Gulf
q. Islamic Trading Company
r. ABC Islamic Bank
s. ABN Amro Bank
t. Deutsche Bank Rep office
u. Investors Bank
v. TAIB Bank of Bahrain
w. Turk Gulf Merchant Bank
x. Bahrain Monetary Agency
y. Shamil Bank
z. Khaleej Investment Company
aa. First Islamic Investment Bank
6. Bangladesh
a. Albaraka Bangladesh Ltd (Dallah Al Baraka Group), Dhaka
b. Islami Bank Bangladesh Ltd, Dhaka
c. Faisal Islamic Bank

7. British Virgin Islands

a. Ibn Khaldoun International Equity Fund Ltd
8. Brunei
a. Islamic Bank of Brunei Berhad
b. Islamic Development Bank of Brunei Berhad
c. Tabung Amanah Islam Brunei
9. Canada
a. Islamic Co-operative Housing Corporation Ltd, Toronto
10. Cayman Islands
a. Ibn Majid Emerging Marketing Fund (International Investor Group)
b. Al Tawfeek Co. for Investment Funds Ltd. Subsidiary of Albarka Group
"DBG"
11. Denmark
a. Faisal Finance (Denmark) A/S
12. Djibouti
a. Banque Albaraka Djibouti
13. Egypt
a. Alwatany Bank of Egypt, Cairo
b. Egyptian Company for Business and Trade S.A.E
c. Egyptian Saudi Finance Bank (Dallah Al Baraka), Cairo
d. Gulf Company for Financial Investment
e. Faisal Islamic Bank of Egypt, Cairo
f. Islamic Bank International for Investment and Development, Cairo
g. Islamic Investment and Development Co., Cairo
h. National Bank for Development, Cairo
14. France
a. Algerian Saudi Leasing Holding Co. (Dallah Al Baraka Group)
b. Societe General
c. Capital Guidance
d. BNP Paribas
15. Gambia
a. Arab Gambian Islamic Bank
16. Germany
a. Bank Sepah, Iran
b. Commerz Bank
c. Deutsche Bank
17. Guinea
a. Massraf Faisal al Islami of Guinea, Conakry
b. Banque Islamique de Guinee
18. India
a. Al Ameen Islamic Financial & Investment Corp. (India) Ltd., Karnatka
b. Bank Muscat International (SOAG)
c. Al-Falah Investment Ltd
19. Indonesia
a. Al Barakah Islamic Investment Bank
b. Bank Muamalat Indonesia, Jakarta
c. Dar Al-Maal Al-Islami Trust
d. PT Danareksa Fund Management, Jakarta
20. Iran
a. Bank Keshavarzi (Agricultural Bank), Tehran
b. Bank Maskan Iran (Housing Bank), Tehran

c. Bank Mellat, Tehran

d. Bank Melli Iran, Tehran
e. Bank Saderat Iran, Tehran
f. Bank Sanat Va Maadan (Bank of Industry and Mines), Tehran
g. Bank Sepah, Tehran
h. Bank Tejarat, Tehran
21. Iraq
a. Iraqi Islamic bank for Investment and Development
22. Italy
a. Bank Sepah, Iran
b. International Trading Co. of Africa
23. Jordan
a. Jordan Islamic Bank (Subsidiary of Dallah Al Barka Group)
b. Jordan Islamic Bank for Finance and Investment, Amman
24. Kuwait
a. Gulf Investment Corporation
b. The International Investment Group
c. The International Investor, Safat
d. Kuwait Finance House, Safat
e. Kuwait Investment Co - Dar Al-IsethmarSecurities House
25. Lebanon
a. Gulf International Bank, Bahrain
b. Al Barakah Bank
c. Bank of Beirut
26. Luxembourg
a. Faisal Finance (Luxembourg) S.A
b. Faisal Holding, Luxembourg
c. Takafol S.A
d. Islamic Finance House Universal Holding S.A
27. Malaysia
a. Adil Islamic Growth Fund (Innosabah Securities Sdn Bhd), Labuan
b. Arab Malaysian Merchant Bank Berhad, Kuala Lumpur
c. Bank Bumiputra Malaysia Berhad, Kuala Lumpur
d. Bank Islam Malaysia Berhad, Kuala Lumpur
e. Bank Kerjasama Rakyat Malaysia Berhad, Kuala Lumpur
f. Dallah Al Baraka (Malaysia) Holding Sdn Bhd
g. Lembaga Urusan Dan Tabung Haji (Fund), Kuala Lumpur
h. Malayan Banking Berhad (Maybank), Kuala Lumpur
i. Multi-Purpose Bank Berhad, Kuala Lumpur
j. United Malayan Banking Corp. Berhad, Kuala Lumpur
k. Bank Muamalat Berhad, Malaysia
l. Securities Commission
m. Labuan Offshore Financial Services Authority (LOFSA)
n. Islamic banking & Takaful Dept, Bank Negara Malaysia
28. Malaysian banks with Islamic windows
a. Commercial Banks:
i. Affin Bank Berhad
ii. Alliance Bank Berhad
iii. Arab-Malaysian Bank Berhad
iv. Bank Utama (Malaysia) Berhad
v. Citibank Berhad

vi. EON Bank Berhad

vii. Hong Leong Bank Berhad
viii. HSBC Bank (M) Berhad
ix. Malayan Banking Berhad
x. OCBC Bank (Malaysia) Berhad
xi. Public Bank Berhad
xii. RHB Bank Berhad
xiii. Southern Bank Berhad
xiv. Standard Chartered Bank Malaysia Berhad
b. Finance Companies:
i. Alliance Finance Berhad
ii. Arab-Malaysian Finance Berhad
iii. Asia Commercial Finance Berhad
iv. EON Finance Berhad
v. Hong Leong Finance Berhad
vi. Kewangan Bersatu Berhad
vii. Mayban Finance Berhad
viii. MBf Finance Berhad
ix. Public Finance Berhad
x. United Merchant Finance Berhad
c. Merchant Banks:
i. Alliance Merchant Finance Berhad
ii. Arab-Malaysian Merchant Bank Berhad
iii. Aseambankers Malaysia Berhad
iv. Malaysian International Merchant Bank Berhad
v. Affin Merchant Bank Berhad
d. Discount Houses:
i. Abrar Discounts Berhad
ii. Affin Discount Berhad
iii. Amanah Short Deposits Berhad
iv. BBMB Discount House Berhad
v. KAF Discounts Berhad
vi. Malaysia Discount Berhad
vii. Mayban Discount Berhad
29. Mauritania
a. Banque Alabaraka Mauritaninne Islamique (Dallah Al Baraka Group),
Mauritania
30. Morocco
a. Faisal Finance Maroc S.A
b. The Netherlands
c. Faisal Finance (Netherlands ) B.V
d. Faisal Finance (Netherlands Antilles) N.V
31. Niger
a. Banque Islamique Du Niger, Niamey
32. Nigeria
a. Habib Nigeria Bank Ltd
b. Ahmed Zakari & Co
33. Oman
a. Bank Muscat International
b. Bank Saderat Iran, Muscat
c. Oman Arab Bank

34. Pakistan
a. Al Faysal Investment Bank Ltd, Islamabad
b. Al Towfeek Investment Bank Ltd (Dallah Al Baraka Group), Lahore
c. Faysal Bank Ltd, Pakistan
d. National Investment Trust Ltd., Karachi
e. Shamil Bank
f. Meezan Bank Limited
35. Palestine
a. Arab Islamic Bank
b. Arab Islamic International Bank (AIIB) Plc
c. Cairo Amman Bank
d. Palestine International Bank
e. The Palestine Islamic Bank
36. Qatar
a. Islamic Investment Company of the Gulf Ltd, Sharjah
b. Qatar International Islamic Bank, Doha
c. Qatar Islamic Bank SAQ, Doha
37. Russia
a. BADR Bank
38. Saudi Arabia
a. Albaraka Investment and Development Co., Jeddah
b. Al Rajhi Banking and Investment Corp., Riyadh
c. Arab Leasing International Finance (ALIF) Ltd
d. Faysal Islamic Bank of Bahrain E.C., Dammam
e. Islamic Development Bank, Jeddah.
f. National Commercial Bank Ltd, Jeddah
g. Riyad Bank
h. Saudi American Bank, Jeddah
i. Saudi Holland Bank
j. Bank Al Jazira
39. Senegal
a. Banque Islamique Du Senegal
40. South Africa
a. Albaraka Bank Ltd, Durban (Dallah Al Baraka Group)
41. Srilanka
a. Amana Islamic Bank
b. Amana Takaful Limited
42. Sudan
a. Al Baraka Al Sudani, Khartoum. (Dallah Al Baraka Group)
b. Al Shamal Islamic Bank
c. Al Tadamon Islamic Bank, Khartoum
d. Animal Resources Bank
e. El Gharb Islamic Bank (Islamic Bank for Western Sudan)
f. Faisal Islamic Bank of Sudan, Khartoum
g. Islamic Bank of Western Sudan, Khartoum
h. Islamic Co-operative Development Bank, Khartoum
i. Sudanese Islamic Bank
43. Switzerland
a. Cupola Asset Management SA, Geneva
b. Dar Al Maal Al Islami Trust, Geneva
c. Faisal Finance (Switzerland) SA, Geneva

d. Pan Islamic Consultancy Services Istishara SA, Geneva

e. United Bank of Switzerland (UBS)
f. Pictet & Cie
44. Tunisia
a. Beit Ettamwil al Tunisi al Saudi, Tunis (Dallah Al Baraka Group)
b. B.E.S.T. Re-Insurance (Dallah Al Baraka Group)
45. Turkey
a. Albarakah Turkish Finance House Istanbul
b. Emin Sigorts A.S
c. Faisal Finance Institution, Istanbul.
d. Faisal Islamic Bank of Kibris Ltd, Turkey
e. Ihlas Finance House
f. Kuwait-Turket Evkaf Finance House
g. Asya Finans Kurumu A.S
46. United Arab Emirates
a. Abu Dhabi Islamic Bank
b. Bank Muscat International (SOAG)
c. Dubai Islamic Bank, Dubai
d. Gulf International Bank, Bahrain
e. Islamic Investment Company of the Gulf Ltd, Abu Dhabi.
f. Islamic Investment Company of the Gulf Ltd, Sharjah Subsidiary of Dar Al
Maal Islami Trust
g. National Bank of Sharjah
h. HSBC, Dubai
i. National Bank of Dubai
47. United Kingdom
a. Albaraka International Ltd, London
b. Albaraka Investment Co. Ltd, London
c. Al Rajhi Investment Corporation, London
d. Al Safa Investment Fund
e. Bank Sepah, Iran
f. Dallah Al Baraka (UK) Ltd., London
g. Takafol (UK) Ltd, London
h. Barclays Capital
i. HSBC Amanah Finance
j. ABCIB Islamic Asset Management, Arab Banking Corp
48. United Kingdom banks with Islamic windows
a. ABC International Bank, London
b. ANZ International Merchant Banking, London
c. Arab Bank Plc, London
d. Riyadh Bank , London
e. Citibank International Plc, London
f. Cedel International, London
g. Dawnay Day Global Investment Ltd
h. Global Islamic Finance, HSBC Investment Bank Plc
i. Gulf International Bank Bsc, Bahrain
j. The Halal Mutual Investment Company Plc
k. IBJ International, London (Subsidiary of Industrial Bank of Japan)
l. J. Aron & Co. (Goldman Sachs International Finance) Ltd., London
m. Islamic Investment Banking Unit (IIBU), United Bank of Kuwait, London
49. Ireland

a. Al Meezan Commodity Fund Plc, Dublin

b. Jersey, UK (+534)
c. The Islamic Investment Company, St Helier.
d. MFAI (Jersey) Limited (formerly - Massraf Faysal Al-Islami Ltd, Jersey)
50. United States of America
a. Abrar Investments, Inc., Stamford CT
b. Al-Baraka Bancorp Inc. Chicago
c. Al-Madina Realty, Inc., Englewood NJ
d. Al-Manzil Islamic Financial Services
e. Amana Mutual Funds Trust, State St. Bellingham WA
f. Ameen Housing Co-operative, San Francisco
g. American Finance House
h. Bank Sepah, Iran
i. BMI Finance & Investment Group, New Jersey
j. Dow Jones Islamic Index Fund of the Allied Asset Advisors Funds
k. Failaka Investments, Inc., Chicago IL
l. Fuloos Incorporated, Toledo OH
m. Hudson Investors Fund, Inc., Clifton NJ
n. MSI Finance Corporation, Inc., Houston TX
o. Samad Group, Inc., Dayton OH
p. Shared Equities Homes, Indianapolis IN
q. HSBC, USA
r. MEF Money, USA
s. Islamic Credit Union of Minnesota, (ICUM)
t. United Mortgage
51. Yemen
a. Islamic Bank of Yemen for Finance and Investment, Sana
b. Saba Islamic Bank, Sana
c. Faisal Islamic Bank
d. Yemen Islamic Bank, Sana
e. Yemen National Investment Co., Sana

APPENDIX-C: Islamic Equity Funds in the World

List of Islamic Equity Funds (www.failaka.com)
Inception
Fund Name Fund Manager(s) Fund Promoter(s) Min. Invest
Date
Global Equity Funds
1 Al Baraka Global Equity Mercury Asset Management Al Baraka Investment Bank Dec-97 $25,000
Al Rajhi Banking &
2 Al Rajhi Global Equity UBS Asset Management Jul-96 50 Shares
Investment
Wellington Management Co. National Commercial Bank
3 Al-Ahli Global Trading Equity Jan-95 $2,000
LLP (NCB)
Fremont Investment Advisors
4 Al-Bait Global Equity Securities House Apr-00 $50,000
Inc.
Wafra Investment Advisory Wafra Investment Advisory
5 Al-Bukhari Global Equity Aug-98 $100,000
Group Group
The International
6 Al-Dar World Equities Pictet & Cie Feb-98 $100,000
Investor/Pictet & Cie
7 Alfanar Investment Holdings Worms & Cie/SEDCO Permal Asset Management Dec-97 $5,000
8 Al-Firas Global Equity Arab Bank Plc Arab Bank Plc Oct-00 $10,000
Wellington/Al-Ahli Global
9 Al-Kawthar Fund National Bank of Kuwait Jan-95 $10,000
Trading Eq.
10 Al-Khair Global Equity Fund Pictet & Cie Bank Al-Jazira Sep-98 $5,000
Roll & Ross Asset Al-Tawfeek Co. for Investment
11 Al-Safwa International Equity May-96 $10,000
Management Funds
Schroder Investment Mgmt
12 Arab Investor Crescent Fund Arab National Bank Apr-99 $5,000
Int'l
Global Alliance/Securities
13 Arzaq Investment Fund Securities House Mar-98 $50,000
House
Bank Kanz Global Islamic
14 Bank Kanz Bank Kanz N/A $100,000
Equity
Wellington Management Co.
15 Barclays Global Equity Barclays Private Bank Feb-00 $1,000,000
LLP
Wellington Management Co. Commerical Bank of
16 Caravan Fund Dec-99 $10,000
LLP Qatar/BNP
17 Citi Global Portfolios SSB Citi Asset Management Citi Islamic Investment Bank Oct-97 $10,000
Brown Brothers Harriman & Wafra Invest. Advisory /
18 Dow Jones Islamic Index Fund Jul-99 $10,000
Co. AlTawfeeq
Alliance Capital Management
19 Global Equity 2000 Sub-Fund First Investment Co Mar-00 $10,000
LP
Wellington Management Co. Wellington Management Co.
20 Hegira Global Equity Sep-96 $5,000,000
LLP LLP
HSBC Investment Funds
21 HSBC Amanah Global Equity HSBC Amanah Finance May-00 $5,000
(Lux.) SA
Late
22 Islamic Global Equity * N/A HSBC Bank USA $2,500
2001
23 Miraj Global Equity Royal Bank of Canada Miraj International Investment Aug-98 $10,000

Ltd.
24 Musharaka Equity Fund N/A Riyad Bank Jun-97 $10,000
Parosoli Capital & Finance Parosoli Capital & Finance
25 Parsoli Global Equity Jun-01 £1,000
Ltd. Ltd.
Global Asset Management
26 QIB Global Equities Qatar Islamic Bank N/A
(GAM)
27 SAMBA Global Equity SAMBA Capital Management SAMBA Capital Management Dec-99 $2,000
Malayan Banking & Daiwa
28 SUT Ethical Growth Fund Singapore Unit Trust Ltd. Aug-01 S$1,000
Securities
Malayan Banking & Daiwa
29 SUT Ethical Value Fund Singapore Unit Trust Ltd. Aug-01 S$1,000
Securities
30 TAIB Crescent Global Fund Wright Investors' Service TAIB Bank of Bahrain Mar-00 $100,00
UBS Islamic Fund Global
31 UBS, AG & UBS Brinson UBS Islamic Fund Mgmt Co May-00 $100,000
Equities
North American Equity Funds
National Commercial Bank
32 Al-Ahli US Trading Equity INVESCO Capital Mgmt Inc. Dec-92 $2,000
(NCB)
33 Alfanar US Capital Growth Worms & Cie/SEDCO Permal Asset Management Jun-99 $5,000
34 Alfanar US Capital Value Worms & Cie/SEDCO Permal Asset Management May-99 $5,000
35 Amana Growth * Saturna Capital Saturna Capital Feb-94 $100
36 Amana Income * Saturna Capital Saturna Capital Jun-86 $100
37 Azzad DJIM Index Fund * Azzad Asset Management Azzad Asset Management Dec-00 1,000
38 Azzad Growth Fund LP Azzad Asset Management Azzad Asset Management Feb-98 $50,000
39 Azzad Income Fund Azzad Asset Management Azzad Asset Management Sep-01 $1,000
Dow Jones Islamic Index (US)
41 Allied Asset Advisors Funds Allied Asset Advisors Funds Jun-00 $500
Fund *
42 SAMI Navigator Nova Bancorp Group Nova Bancorp Group Jul-99 C$500
European Equity Funds
43 Al-Ahli Europe Trading Equity Gulf Int'l Bank (UK) Ltd. Nov-94 $2,000
(NCB)
The International
44 Al-Dar Europe Equities Pictet & Cie Feb-98 $100,000
Investor/Pictet & Cie
45 Alfanar Europe Worms & Cie/SEDCO Permal Asset Management Jan-99 $5,000
Commerz Int'l Cap Mgmt/Al-
46 Al-Sukoor European Equity Commerz Bank/Burgan Bank Mar-00 1 Share
Tawfeeq Co.
47 Al-Thoraiya European Equity Lomard Odier & Cie Bank Al-Jazira Sep-99 $5,000
Small Cap & Technology Equity Funds
Al Rajhi Banking &
48 Al Rajhi Small Companies Franklin Mgmt & Lord Abbott Jun-99 200 Shares
Investment
Al-Ahli Small-Cap Trading Wellington Management Co. National Commercial Bank
49 Aug-98 $2,000
Equity LLP (NCB)
50 Alfanar Essex Technology Worms & Cie/SEDCO Permal Asset Management Jun-99 $5,000
51 Orbitex Islamic Comm. & IT Orbitex Management Ltd. Orbitex Management Ltd. Dec-99 $50,000

Fund
TII Small Cap Equity
52 Pictet & Cie The International Investor Dec-96 $100,000
(European)
Balanced, Secured & Other Equity Funds
Abu Dhabi Islamic Bank
53 Al Hilal Fund Mercury Asset Management Apr-00 $10,000
(ADIB)
Al Kawthar Global Equity National Commercial Bank
54 National Bank of Kuwait Sep-99 $10,000
Secured (NCB)
Al Rajhi Banking & Al Rajhi Banking &
55 Al Rajhi Balanced Fund I Nov-98 $5,000
Investment Investment
56 Al Rajhi Balanced Fund II Dec-98 $5,000
Al-Ahli Global Equity Secured Wellington Management Co. National Commercial Bank
57 Nov-99 $25,000
(Series B) LLP (NCB)
Al-Ahli International Equity National Commercial Bank
58 Deutche Bank Feb-00 $25,000
Secured (NCB)
59 Al-Ahli US Equity Secured Deutche Bank Oct-99 $25,000
(NCB)
60 Alkhawarizmi Fund AXA Rosenberg The International Investor Jul-97 $100,000
BHLB Pacific Dana Al Mizan
61 BHLB Pacific Trust BHLB Pacific Trust Mar-01 RM 1,000
(Balanced)
62 Faysal Shield Fund Banque National de Paris Faysal Islamic Bank of Bahrain Nov-99 $100,000
Swiss Alternative Investment
63 Mutajarah Fund (Balanced) Towry Law International Oct-01 $100,000
Strategies Group (SAIS)
Profit Sharing Fund (Aman-1) Al Rajhi Banking & Al Rajhi Banking &
64 N/A $2,000
(secured) Investment Investment
Emerging Market & Country Equity Funds
65 Al Arabi Saudi Co. Shares Arab National Bank Arab National Bank May-93 SR 10,000
Al Rajhi Banking &
66 Al Rajhi Egypt Equity EFG Hermes Jun-97 200 Shares
Investment
67 Al Rajhi Local Share Fund Jul-92 1 Share
Al Rajhi Banking &
68 Al Rajhi Middle East Equity Bakheet Financial Advisors May-98 200 Shares
Investment
69 Al-Ahli Saudi Trading Equity Bakheet Financial Advisors Jun-98 SR 5,000
(NCB)
Al-Dar Eastern Europe The International
70 Pictet & Cie Feb-98 $100,000
Equities Investor/Pictet & Cie
Bank Al-Jazira Invesmtent
71 Al-Taiyibat Fund (local share) Bank Al-Jazira Sep-98 SR 10,000
Services
72 First Arabian Equity 2000 N/A First Investment Company N/A
73 Ibn Majid Emerging Markets UBS Brinson The International Investor Nov-95 $100,000
PrimeCorp. Investment
74 Khaled Ibn el-Waleed Fund Al-Mal Islamic Company N/A
Management
75 Oasis Crescent Fund Oasis Asset Management Ltd. Oasis Asset Management Ltd. Jan-99

Parosoli Capital & Finance Parosoli Capital & Finance

76 Parsoli Islamic Equity 1996
Ltd. Ltd.
Futuregrowth Unit Trust Futuregrowth Unit Trust
77 Pure Specialist Fund Jun-92 R 200
Management Management
Riyad Equity Fund 2 (Saudi
78 Riyad Bank Riyad Bank Nov-96 SR 10,000
Shares)
Asian Equity Funds
Al-Ahli Asia Pacific Trading National Commercial Bank
79 Gulf Int'l Bank (UK) Ltd. May-00 $2,000
Equity (NCB)
80 Al-Mashariq Japanese Equity Julius Baer Asset Management Bank Al-Jazira Apr-00 $5,000
Al-Tawfeek Co. for Investment

81 Al-Nukhba Asian Equity Nomura Investment Bank Jul-98 $10,000
Funds
82 Mendaki Global Fund DBS Asset Mgmt Mendaki Holding Pte. Ltd Sep-97 S$1,000
83 Mendaki Global Fund DBS Asset Mgmt Mendaki Holding Pte. Ltd May-91 S$500
Malaysian Equity Funds
84 Abrar Investment Fund Abrar Unit Trust Managers Abrar Unit Trust Managers 1996
85 Amanah Saham Bank Islam BIMB Unit Trust Mgmt Bhd. Bank Islam Malaysia Bhd Jun-94 500 Shares
PTB Amanah Saham Darul PTB Amanah Saham Darul
86 Amanah Saham Darul Iman Oct-94
Iman Iman
Hijrah Unit Trust Management
87 Amanah Saham Wanita Hijrah Managers Bhd May-98 RM 100
Bhd
BBMB Unit Trust BBMB Unit Trust
88 BBMB Dana Putra Jun-96
Management Management
89 BHLB Dana Al-Ihsan BHLB Pacific Trust BHLB Pacific Trust May-98 RM 500
90 Dana Al-Aiman Mara Unit Trust Mara Unit Trust May-68 RM 100
91 Kuala Lumpur Ittikal Fund Kuala Lumpur Mutual Funds Kuala Lumpur Mutual Funds May-97 RM 1,000
92 Mayban Dana Yakin Mayban Mgt Berhad Mayban Mgt Berhad Nov RM 1,000
93 Pacific Dana Amana Pacific Mutual Fund Trust Pacific Mutual Fund Trust Apr-98 RM 1,000
94 RHB Mudarabah Fund RHB Unit Trust Management RHB Unit Trust Management May-96 500 Shares
95 Tabung Amanah Bakti Asia Unit Trust Berhad Tabung Amanah Bakti May-71 RM 500
Arab-Malaysian Unit Trusts Arab-Malaysian Unit Trusts
96 Tabung Ittikal Arab-Malaysian Jan-93 500 Shares
Bhd Bhd
Islamic Bonds (Sukuk) Funds
97 RHB Islamic Bond RHB Unit Trust Mgt RHB Unit Trust Mgt Jun-00 RM 1,000
Kuala Lumper Islamic Bond
98 Kuala Lumper Mutual Funds Kuala Lumper Mutual Funds Aug-01 RM 1,000
Fund
99 Dahlia Syariah Income Fund Mayban Life Assurance Bhd. Mayban Life Assurance Bhd. Aug-01 RM 1,000

APPENDIX-D: The Dow Jones Islamic Market Indexes

Component
Descriptive Statistics Market Capitalization Data (USD Billion)
Weight (%)
Component Float-
Index Name Number
Full
adjusted
Mean Median Largest Smallest Largest Smallest
Dow Jones Islamic Market Index 1,422 7,603.2 6,591.6 4.6 0.8 234.2 0.0 3.55 0.00
Dow Jones Islamic Market Titans 100 Index 100 4,806.6 4,391.8 43.9 27.5 234.2 4.2 5.33 0.10
Dow Jones Islamic Market Europe Index 271 2,004.2 1,634.2 6.0 0.9 142.1 0.0 8.70 0.00
Dow Jones Islamic Market Asia/ Pacific Index 479 980.2 631.3 1.3 0.4 30.9 0.0 4.89 0.00
Dow Jones Islamic Market Technology Index 292 1,504.5 1,336.5 4.6 0.6 223.4 0.0 16.71 0.00
Dow Jones Islamic Market Canada Index 65 111.0 83.1 1.3 0.7 8.5 0.1 10.28 0.06
Dow Jones Islamic Market Japan Index 192 574.7 401.4 2.1 0.7 30.9 0.0 7.69 0.00
Dow Jones Islamic Market U.K. Index 101 723.7 710.3 7.0 0.9 142.1 0.1 20.01 0.01
Dow Jones Islamic Market U.S. Index 572 4,456.5 4,209.5 7.4 1.4 234.2 0.1 5.56 0.00

Performance Price Return (%) Annualized Price Return (%)
Index Name 1-Month YTD 2002 1-Year 3-Year 5-Year
Dow Jones Islamic Market U.S. Index 0.50 -3.78 -22.59 -24.93 -23.32 -4.34
Dow Jones Islamic Market U.S. Index -0.57 -8.18 -18.27 -24.44 -22.09 -6.77
Dow Jones Islamic Market U.S. Index -3.31 -6.90 -13.95 -22.90 -27.26 0.01
Dow Jones Islamic Market U.S. Index -1.71 -2.48 -39.18 -36.71 -39.45 -6.83
Dow Jones Islamic Market U.S. Index -2.11 2.49 -22.75 -17.92 -30.87 -6.92
Dow Jones Islamic Market U.S. Index -3.63 -7.61 -9.25 -19.35 -28.80 0.69
Dow Jones Islamic Market U.S. Index 0.55 -7.84 -9.25 -19.35 -28.80 0.69

P/E (including P/E (excluding
Fundamentals negative) negative)
Dividend P/ Cash
Index Name Trailing Projected Trailing Projected P/B
Yield (%)
P/ Sales
Flow
Dow Jones Islamic Market U.S. Index 18.42 16.60 19.59 16.91 3.08 1.80 1.42 11.95

Appendix-E1: Assets, Deposits and Loans of 53 Conventional local Banks in

GCC (US$ Millions)
Source: Research Unit of the Institute of Banking Studies, Kuwait
Assets Deposits Loans
Bank/ Year 2001 2000 1999 2001 2000 1999 2001 2000 1999
Abu Dhabi Commercial Bank 7,241.24 6,889.63 6,280.50 5,679.71 5,426.96 4,945.30 4453.6 4703.2 4050
AlAhli Bank of Kuwait 3,859.42 3,772.11 3,818.22 3,254.46 3,163.51 3,210.13 1769.6 1625.1 1679.1
Al-Ahli Bank of Qatar 581.10 720.41 732.53 512.78 654.00 644.62 291.88 333.93 364.73
Al-Ahli United Bank 4,102.72 3,512.35 865.97 3,145.19 2,740.21 713.02 1882.7 1766.3 526.82
Al-Bank Al-Saudi Al-Fransi 10,681.64 10,146.85 8,668.23 9,101.41 8,767.28 7,438.68 4479.7 4304.2 3853.5
Arab Bank for Inv. & Foreign
Trade 1,572.79 1,509.88 1,435.01 1,215.31 1,130.05 1,060.83 348.92 336.1 336.83
Arab Banking Corporation 26,586.00 26,676.00 24,358.00 21,544.00 21,758.00 20,158.00 14225 14039 12903
Arab National Bank 10,784.30 10,052.71 9,466.77 9,196.05 8,714.86 8,360.40 3948.5 3715.3 3445.9
Bahrain International Bank 887.52 1,039.53 966.81 365.95 339.63 353.76 12.36 16.85 17.56
Bahrain Middle East Bank 512.83 620.85 655.58 189.53 271.86 267.56 14.53 12.53 13.12
Bahraini Saudi Bank 595.40 529.86 424.86 482.11 424.52 327.14 329.15 323.31 266.64
Bank Al-Jazira 1,364.41 1,383.23 1,322.26 1,154.20 1,178.03 1,133.66 568.59 556.85 460.65
Bank Dhofar Al-Omani Al-
Fransi 876.61 708.80 680.34 737.09 581.51 556.10 705.96 553.35 513.15
Bank Muscat 3,501.86 3,477.18 1,942.10 2,901.22 2,927.21 1,661.78 2855.9 2592.1 1514.1
Bank of Bahrain & Kuwait 2,928.57 2,815.42 2,734.25 2,322.70 2,190.26 2,094.25 1278.7 1328.3 1344.8
Bank of Kuwait & Middle East 3,519.18 3,379.74 2,949.60 2,941.91 2,800.08 2,434.47 1383.7 1209.4 1095.4
Bank of Sharjah 524.82 514.15 465.52 409.31 404.25 363.43 280.43 298.04 266.81
Burgan Bank 4,839.90 3,721.98 3,777.05 3,994.08 3,141.46 3,195.10 1861.2 1644.5 1545.4
Commercial Bank International 651.76 542.28 469.55 548.74 450.96 390.47 469.47 400.4 357.94
Commercial Bank of Dubai 2,002.46 1,945.28 1,697.09 1,609.16 1,566.68 1,355.11 1237.2 1276.9 1239.7
Commercial Bank of Kuwait 5,504.05 5,056.48 4,530.84 4,278.49 3,822.62 3,646.12 2856 2377.4 1946.3
Commercial Bank of Qatar 1,430.77 1,391.51 1,274.92 1,102.22 1,064.76 1,026.26 749.87 667.37 627.37
Doha Bank 1,786.99 1,514.04 1,391.18 1,562.85 1,325.92 1,227.07 907.97 772.01 746.96
Emirates Bank International 6,405.88 5,335.05 5,605.89 4,622.91 3,671.30 4,554.79 4669.5 3062.9 4049.4
First Gulf Bank 937.99 652.11 556.94 762.82 489.69 408.61 466.91 382.45 356.51
Gulf Bank 6,114.70 5,413.48 5,840.87 5,246.43 4,626.97 5,069.92 3213.5 3067.3 2259.4
Gulf International Bank 15,232.00 15,119.50 15,679.40 10,949.70 11,414.50 11,462.40 3309.4 3923.1 4038
Industrial Bank of Kuwait 1,338.88 1,153.60 1,149.35 160.83 427.13 334.69 334.81 279.53 242.26
Investment Bank 700.28 676.03 607.64 549.59 534.58 478.41 465.6 434.71 399.66
Kuwait Real Estate Bank 2,151.98 2,117.96 1,788.29 1,403.49 1,342.08 1,092.75 1316.9 1192.9 1385.6
Mashreq Bank 6,181.22 6,014.33 5,442.62 5,113.20 5,049.63 4,524.65 2849 2941.5 3039.8
Middle East Bank 673.25 659.81 592.90 467.88 470.06 421.34 324.95 332.13 355.45
National Bank of Abu Dhabi 8,782.33 9,921.12 8,526.32 7,550.78 8,758.01 7,520.84 5538.4 5259.4 4559.7
National Bank of Bahrain 2,867.93 2,753.40 2,628.11 2,426.49 2,280.39 2,078.90 1200.3 1150.2 1068.2
National Bank of Dubai 8,893.32 7,664.57 6,784.70 7,514.11 6,329.01 5,480.48 1957.3 1902.2 1869.6
National Bank of Fujairah 717.79 752.42 667.25 554.03 594.20 522.26 412.89 436.3 386.13
National Bank of Kuwait 14,553.07 13,401.85 12,482.31 12,484.89 11,461.41 10,579.95 5089.3 4580.3 4245.7
National Bank of Oman 2,471.76 2,120.60 2,163.62 2,082.72 1,667.79 1,696.13 1871.3 1670.8 1599
National Bank of Ras Al-
Khaimah 659.93 508.06 492.12 504.75 358.91 346.02 480.34 371.84 358.38
National Bank of Sharjah 557.38 505.20 423.17 355.05 346.67 289.76 355.44 362.01 332.03
National Bank of Umm Al-
Qaiwain 466.00 461.81 478.03 327.56 328.07 346.73 315.35 317.33 329.05
Oman Arab Bank 832.49 718.40 685.22 705.77 594.36 571.16 600.01 591.42 550.62
Oman Housing Bank 429.18 429.15 444.56 16.36 23.08 80.86 412.99 421.62 435.05
Oman International Bank 1,748.80 1,921.68 2,172.34 1,295.70 1,423.04 1,656.34 1187.6 1332 1456.9

Qatar National Bank 7,795.86 6,763.51 6,141.24 6,416.61 5,444.03 4,934.41 5234.8 3744.3 3982.1
Riyad Bank 17,931.71 17,494.69 17,188.55 14,728.05 14,572.26 14,298.21 5657.3 5473.5 5165.6
Saudi American Bank 20,621.20 21,543.73 20,546.25 17,618.37 18,051.68 17,404.47 8984.2 8418 8452.9
Saudi British Bank 11,192.84 11,521.39 9,939.69 9,700.65 10,153.44 8,622.26 4277.5 4620.6 4338
Saudi Hollandi Bank 6,720.04 5,713.56 5,054.27 5,878.18 5,004.67 4,455.20 3067.3 2676.4 2454.2
Saudi Investment Bank 4,072.27 3,634.40 3,525.94 3,340.74 2,973.05 2,944.47 2009.7 2000.6 1885.8
Union National Bank 3,612.72 3,300.15 2,682.51 3,169.94 2,879.03 2,324.94 2155.7 2029.5 1788
United Arab Bank 484.50 464.59 411.46 358.74 350.17 310.47 364.86 341.22 321.91
United Gulf Bank 931.15 712.32 733.01 443.27 385.48 448.08 78.85 93.45 99.73
Appendix-E2: Assets, Deposits and Loans of 8 Islamic local Banks in GCC

(All figures are in US$ Millions)
Source: Research Unit of the Institute of Banking Studies, Kuwait
Assets Deposits Loans

Bank/ Year 2001 2000 1999 2001 2000 1999 2001 2000 1999
Al-Rajhi Banking &
13,815.03 12,997.68 11,448.90 10,542.35 9,785.78 8,661.74 11,275.91 10,520.67 9,243.73
Investment Corp.
Kuwait Finance House 7,733.64 6,632.26 5,817.23 5,779.20 5,065.40 4,388.63 5,875.00 4,937.21 4,092.62
Dubai Islamic Bank 4,175.44 3,205.90 2,543.70 3,573.03 2,661.05 2,077.63 3,399.98 2,595.28 2,096.63
Abu Dhabi Islamic Bank 1,664.61 1,188.18 725.72 1,167.26 804.43 408.24 1,460.42 1,038.86 648.05
Shamil Bank of Bahrain 1,241.90 1,316.34 1,092.05 58.19 64.73 44.3 677.92 580.08 555.91
Qatar Islamic Bank 1,212.82 1,115.02 1,094.23 1,003.48 910.66 902.34 974.20 940.30 860.66
Qatar International Islamic
741.67 576.29 505.45 613.95 467.64 419.24 654.38 507.29 439.33
Bank
Bahrain Islamic Bank 508.47 516.85 414.86 401.54 408.57 366.26 406.30 417.60 354.87

Dissertation Islamic Finance Shakeel Ahmad

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ISLAMIC BANKING AND FINANCE

IN THE CONTEMPORARY WORLD

Shakeel Ahmad (shakeeluae@gmail.com)

Executive Post Graduate Program (Ex-PGP) in Management

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39 APPENDIX-C: Islamic Equity Funds in the World 68

Deposits from Customers Financing of Customers Investments

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Fig-2c: Amortization payments Fig-2d: Interest Payments

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-40% -20% 0% 20% 40% 60% 80% 100% 120% 140%

Fig-4: Proportion of Islamic Bonds in Malysia v/s Non-Islamic Bonds

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1999 2000 2001

National Bank of Abu Dhabi Abu Dhabi Islamic Bank

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Similar results can be seen when comparing

Fig-6: Comparison between Conventional (National Bank of

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ISLAMIC BANKS: An Islamic bank is an intermediary and trustee of other people’s

US Federal law allows penalty rates / insurance premiums

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Chronology of recent historical events in the industry:

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1971: Egypt Nasr Social bank, still no overt reference to Islam.

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opportunity to earn higher returns almost a risk-free spread.

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Difference between Mudaraba and Musharaka Contracts: In a Mudaraba contract, the

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Box-1: Islamic Financial Instruments

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Syndication: Islamic Financial Institutions are increasingly prepared to participate in large

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HDI Score HDI Rank

Accumulation of human capital is an indicator of endogenous growth and is often used in

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Fig-10a: Customer Deposits of BIMB (Source: Annual Reports)

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TAI (2001) Arco Index (2000)

Figure-14: Technological Achievement Index (TAI) and Arco Index

8. Religious Impediments: For a detailed treatise on the effect of religion on economic or

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