BWFS 2023 ISLAMIC FINANCIAL MANAGEMENT

TOPIC 3.0 ISLAMIC FINANCIAL INSTITUTIONS

Topic Outlines
3.1 Commercial/Islamic Banks 3.2 Islamic Merchant/Investment Banks 3.2 Takaful Operators 3.2 Islamic Funds Management Company

Learning Objectives/Outcomes
Explain the Islamic financial institution:
Commercial/Islamic banks Islamic Merchant/Investments banks Takaful operators Islamic funds management company

Students should be able to:

Realize that numerous institutions make up the financial system Understand the role of each individual institution Take note of the variation in the history and function of each institution Trace the evolution of each institution, as each institution converges into the universal bank mould.

Organization of the Presentation

Overview Historical Development Organizations Functions Products and Services

Financial Institutions
Commercial/Islamic Banks Merchant/Investment Banks Finance Companies Takaful Companies Fund Management Companies Cooperative Banks Saving Institutions Pension Fund Economic Development Institutions

The Islamic Financial System

History

History

Organization
Commercial/Islamic Banks Merchant/ Investment Bank 1. Dubai Islamic Bank: First commercial bank mandated to operate in adherence to Shariah rules and principles. 1. Evolved when commercial banks were thought off as retail businesses and merchant banks took up the need for wholesome business. 2. Current trend: Merchant banks becoming investment banks. Investment banking is a broader version of merchant banking with discounting possibilities as well. 1. Takaful operations now available in various countries throughout the world (around 40 operators), primarily in Islamic countries and countries with large Muslim population. 2. Industry growth: 10-20% per year. 3. To enhance global takaful infrastructure. ASEAN Retakaful International (L) Ltd. has been identified as one of the vehicles to enhance retakaful arrangements.

Takaful Operators

Organization
Fund Management Companies 1. Fund Management companies manage the fund of their clients 2. Caters for people who either have no time to manage their own funds or are fearful that they do not know how best to manage their funds, or believe that fund managers have the expertise to seek out better yields at lower risk relative to themselves. 3. Within the Islamic sphere, equity funds have been the most popular.

List of Islamic Banks

List of Commercial Banks

List of Investment Banks

List of Takaful Operators

List of Fund Management Companies

Functions
Commercial/Islamic Banks 1. Islamic commercial banks play the role of intermediaries. 2. Flow of fund is indirect. 3. Funds are bought by offering a variety of deposit products and funds are sold through a variety of financing products.

Merchant/ Investment 1. Historically, merchant banks catered for activities Banks involving large amounts, or amounts too large for commercial banks to handle. Hence their forte was limited to activities such as syndication. 2. The business of merchant banks expended to include underwriting and advisory services. 3. Their fee-based activities became so substantial that deposit taking and loan making, albeit in substantial quantums, became relegated to the sidelines.

Functions
Takaful Operators 1. A type of joint guarantee insurance mechanism where a large group of people pool their financial resources together against certain loss of exposures. 2. Based on principles of co-operation, protection, mutual responsibility and avoid acts of interest and uncertainty. 3. Takaful operators conducts all its affairs in a manner that adheres to Shariah guidelines. 4. Takaful operators do not have policyholders. They contributors or participants, as they are participating jointly in a takaful fund for their mutual benefits. 5. Contributors/participants: Owners of the fund. 6. A takaful operator manages and operates the fund on the participants behalf. In the event a contributor suffers a financial loss, he or she is paid an amount from the takaful fund, in accordance with the basis of underwriting principle of insurance.

7. By signing a takaful contract, each contributor agrees to uphold the spirit of co-operation and mutual solidarity and help each other through the takaful system. 8. Takaful works both as (1) savings instrument where participants set their own target amount to accumulate over a certain period, (2) a protection mechanism in which all participants guarantee each other against events that would alter their financial status. Fund Management Companies 1. Tend to target high net worth individuals and corporate institutions 2. Clients pay the stipulated amount pooled together with the funds of other clients 3. Then, invested by specially trained personnel who are supposed to be able to identify investments with high yields and low risks Shariah compliant investments 4. The fund manager is in a position to diversify the portfolio, lowering risk 5. The returns are distributed to the investors, after deduction of administrative charges incurred in managing the fund

Products and Services

Commercial/Islamic Banks:
Equity-based products, e.g. Trustee partnership (mudharabah) facility, joint venture (musharaka) facility and declining partnership (musharakah mutanaqisah). Debt-based products, e.g. cost plus sale (murabahah) with deferred payment (baibithamanajil) facility, leasing (ijarah) facility, deferred delivery sale (salam) facility, manufacture-sale (istisna) facility, recurring sale (istijrar) facility, benevolent loan (qard).

Products and Services

Merchant/Investment Banks
Islamic Securities Islamic Asset-Backed Securitisation Islamic structured finance Syndications and other fee-based activities using acceptable Islamic principles, which includes Bai Bithaman Ajil, Murabahah, Ijarah, Istisna, Mudharabah, Qardhul Hasan, Bai Inah and Kafalah.

Products and Services

Takaful Operators
Family Takaful Policy
1. 2. 3.
4.

5. 6.

7.

Has a defined period of maturity. Insured persons commonly make periodic level premium contributions. Contributions will be used primarily for meeting their targeted individual savings and partly for assisting their families financially when the insured dies. Contributions amount varies among the insured, depending primarily on the sum (face amount) that each insured targets to accumulate at the end of the coverage period and on the age, gender and health condition of the insured. The takaful operator may set the minimum face amount for this purpose and may also set minimum and maximum age limits for participating in this types of policy. Takaful life insurance is also used for other purposes, including generating funds for childrens education, securing a fund in case of mortgagors death. Several takaful policies now come with hospitalization and disability benefits. There is virtually a counterpart takaful life insurance policy for each major type of conventional life insurance policy, with a difference in how premiums are allocated.

Products and Services

Takaful General Insurance Policy
1. Takaful operators offer coverage, commonly on an annually renewal basis, for fire, automobile, liability, marine, workers compensation, fidelity and even crop insurance. 2. Principles employed: principle of insurable interest to minimize the problems of moral hazard, i.e., to separate insurance from gambling. Using the principles of uberrina fides, both takaful and conventional insurers can make a contract void if there is material misrepresentation concealment or breaches of warranty made by insured. 3. Valued policy, actual cash value methods not permitted in takaful.

Products and Services

Takaful Reinsurance
1. 2. Retakaful transfers are commonly classified into proportional and nonproportional arrangements. Non-proportional arrangements such as excess of loss or stop-loss arrangements may not be suitable because of the existence of uncertainty with respect to the assessment of losses. Islamic principles demand for clearly defined joint responsibility throughout the coverage period. Retakaful likely to be arranged on a pro-rata basis, e.g. quota share or surplus retakaful, where the reinsurer becomes a co-insurer of the original risks. If, however, a non-proportional reinsurance arrangement is selected, it could be based on a strict profit commission plan or on a reciprocal basis. In this regard, it matters little whether the retakaful transfer is on a facultative or treaty basis.

3. 4.

Comparing Takaful to Conventional Insurance

Issue Organization Principle Basis Value Proposition Laws Conventional Insurance Profit for shareholders Risk Transfer Profits maximization Secular/Regulations Takaful Mutual for participants Co-operative risk sharing Affordability and spiritual satisfaction Sharia plus regulations

Ownership Management status Form of Contract

Shareholders Company Management Contract of Sale

Participants Operator Cooperative, Islamic contracts of Wakala or Mudarbah with Tabarru (contributions)
Sharia compliant, Riba-free

Investments

Interest based

Surplus

Shareholders account

Participants account

Misconceptions about Takaful

Misconception 1
Risk Protection (insurance) is against Tawakkal (total dependence upon Allah (SWT)).

Response
In a Hadith narrated by Anas bin Malik, one day Prophet Muhammad (PBUH) noticed an Arab Bedouin leaving his camel untied. He asked the Bedouin, Why dont you tie down your camel?

The Bedouin answered, I put my trust in Allah (SWT). To which the Prophet (SAW) replied, Tie your camel first, then put your trust in Allah (SWT). <Tirmidhi>

. . . Misconceptions about Takaful

Misconception 2

All risk Protection (insurance) is Haram (prohibited)

Response

Fiqh Council of World Muslim League resolution and Fiqh Council of Organization of Islamic Conference in Jeddah resolved that, conventional insurance as presently practiced is Haram, and that, cooperative insurance (Takaful) is permissible and fully consistent with Shariah principles.

. . . Misconceptions about Takaful

Misconception 3

All insurance contracts seek to maximize profits, which takes benefits away from the policy holders
Response

Takaful operators are mutual or cooperative entities and they aim for Community well being and self-sustaining operations.
Under the Takaful Wakalah Model, the surplus in the fund is returned entirely to the policy holders.

. . . Misconceptions about Takaful

Misconception - 4

All types of insurance are a form of Gambling or Wagering, which is forbidden in Islam
Response

Risk or Uncertainty can be divided into two classes: Pure Risk (involves the possibility of loss or no loss) Speculative Risk (involves the possibility of loss, no loss or gain) Takaful insures only Pure Risks and the claims are paid in the event of Loss to cover repairs, damage, replacement of property, or an agreed fixed sum.

Takaful Through Time

A chronology of developments

. Takaful Through Time

S. NO. EVENTS Prophet Muhammad (PBUH) validated a system of community self help and financial assistance which later developed into Takaful. Unanimous decisions by Muslims & Fatwa issued by National Religious Council of Malaysia. DATE At the start of Hijri (During the 7th Century CE)

1972

First International conference on Islamic Economics was held in Makkah.

1976

Fatwa issued by Higher Council of Saudi Arabia in favour of Islamic Insurance model.

1977

Development of Takaful in modern times by establishing the first Takaful Company in Sudan.

1979

First National Reinsurance in Sudan.

1979

. Takaful Through Time

S. NO. EVENTS DATE

Establishment of The Islamic Arab Insurance Company in Saudi Arabia which was later relocated in UAE.

1979-80

Dar Al Mal Al Islami Trust, Switzerland.

1981

Saudi Islamic Takaful and Re-Takaful Company, Bahamas.

1983

10

Islamic Takaful Company in Luxembourg.

1983

11

Development of Takaful in modern times by establishing the first Takaful Company in Malaysia. Takaful Act, an act passed to provide for the registration and regulation of Takaful business in Malaysia.

1984

12

1984

. Takaful Through Time

S. NO. EVENTS DATE

13

Takaful Islamic Insurance and Takaful Islamic Re-Insurance in Saudi Arabia and Bahrain respectively.

1985

14

Saudi Takaful Ltd., the first dedicated Re-Takaful in Tunisia.

1985

15

International Cooperative & Mutual Insurance Federation ( ICMIF ) started interacting with Takaful operators in a proactive manner.

1990's

16

Takaful Bangunan IBB, Brunei Darussalam.

1993

17

PT Syarikat Takaful, Indonesia.

1994

. Takaful Through Time

S. NO. EVENTS DATE

18

Syarikat Takaful, Singapore.

1995

19

Islamic Insurance Company, Qatar.

1995

20

ASEAN Takaful Group evolved into ASEAN Retakaful International (ARIL) in Labuan, Malaysia.

1997

21

Establishment of Dubai Takaful Insurance Company, UAE.

1997

22

Establishment of Trinidad-Tobago Takaful Friendly Society.

1999

23

Establishment of Amana Takaful in Sri Lanka.

1999

. Takaful Through Time

S. NO. EVENTS A code of Ethics was developed for the Takaful Industry by Takaful Malaysia and Takaful Nasional. DATE

24

2000

25
26 27

Al Aman Takaful, Lebanon.

Incorporation of Pak-Kuwait Takaful Company Ltd., the first Islamic Insurance operator in Pakistan. International Takaful conference held in London to promote Takaful business. A paper was published by Bahrain Monetary Agency (BMA) which proposed rules to regulate the Takaful and ReTakaful industry. Takaful Insurance forum organized by Egyptian Insurance Supervisory Authority (EISA) was held for the recognition of a growing interest in Takaful scheme. SECP notifies Takaful Rules in Pakistan.

2002
2003 2003

28

2004

29

2005

30

2005

Takaful Models

Mudarabah Model
The surplus is shared between the participants with a takaful operator. The sharing of such profit (surplus) may be in a ratio 5:5 , 6:4 etc. as mutually agreed between the contracting parties. Generally, these risk sharing arrangements allow the takaful operator to share in the underwriting results from operations as well as the favorable performance returns on invested premiums.

Mudarabah Model

Profits attributable to Shareholders

Company

Companys Admin. & Mangt. Expenses

Investment By Company

Profit From Investments

Participant

Takaful Contribution paid by Participant

Companys Share from Surplus General Takaful Fund General Takaful Fund
Operational Cost of Takaful

Surplus (Profit) Participants Share from Surplus

Wakalah Model
Cooperative risk sharing occurs among participants where a takaful operator earns a fee for services (as a Wakeel or Agent) and does not participate or a share in any underwriting results as these belong to participants as surplus or deficit. Under the AlWakala model the operator may also charge a fund management fee and performance incentive fee.

Wakalah Model
Company (Capital)
Wakala Fee (30% to 35%)
Profit From Investments Mudarib's Share of PTFs Investment Income

Management Expense of the Company

Profit/Loss attributable to Shareholders

Takaful

Contribution
paid by Participant

Investment by the Company

Investment Income Sharing on Mudaraba Basis

Participants Takaful Fund

General Takaful Fund

Investment Income

Operational Cost of Takaful/ ReTakaful

Reserves

Surplus (Profit)

Surplus Distribution to Participants

Wakalah -Waqf Model

It is a WAKALAH model with a separate legal entity of WAQF in-between.

The relationship of the participants and the operator is directly with the WAQF fund. The operator is the Wakeel of the fund and the participants pay contribution to the WAQF fund by way of Tabarru. The contributions received would also be a part of this fund and he combined amount will be used for investment and the profits earned would again be deposited into the same fund which also eliminates the issue of Gharar. Losses to the participant are paid by the company from the same fund. Operational expenses that are incurred for providing Takaful services are also met from the same fund.

Wakala-Waqf Model
Company (Capital)
Wakala Fee (e.g. 30% to 35%)
Investment Income Mudarib's Share of PTFs Investment Income

Management Expense of the Company

Profit/Loss attributable to Shareholders

Initial Donation to create WAQF Fund Investment by the Company

Investment Income Sharing on Mudaraba Basis

Contribution by Participant

WAQF Fund

Investment Income

Operational Cost of Takaful/ ReTakaful

Reserves

Surplus (Profit)

Surplus Distribution to Participants

Products and Services

Fund Management Companies
1. The Islamic equity funds market is one of the fastest growing sectors within the Islamic financial system. 2. There are approximately 100 Islamic equity funds worldwide. 3. Growth of total assets managed: 12-15% per annum. 4. Since the launch of Islamic equity funds in the early 1990s, we have seen the establishment of credible equity benchmarks by Dow Jones Islamic market index and the FTSE Global Islamic Index Series. 5. List of Malaysian Approved Islamic Funds: http://www.sc.com.my/main.asp?pageid=252

Questions, Suggestion, and/or Comments? Thank you