Exploring the Optimal Method of Penetration into the Saudi Islamic Investment Banking sector

Exploring the Optimal Method of Penetration into the Saudi Islamic Investment Banking sector
Banker Middle East Magazine
By Mohammed Khnifer (MSc,MBA,CIFP)

This research paper highlights the potential which lies within the opportunities offered by the under-developed Saudi Islamic investment banking sector.

Exploring the Optimal Method of Penetration into the Saudi Islamic Investment Banking sector

Muslim BRIC has arrived

Muslim BRIC has arrived
By Rushdi Siddiqui
Business Times
April 2011

"On April 4, Thomson Reuters, along with their partners, IdealRatings, and World Halal Forum launched the SAMI Halal Food index. The SAMI Halal food index stands for Socially Acceptable Market Investments.

The index is about the beginning of convergence between Islamic finance and Halal industry. But, more importantly, its about Muslim country inward investing as Muslims, presently as 'consumer investors' in these halal food firms become shareholder investors.

Now, within the 'BRIC context,' SAMI stands for Saudi, Ankara, Malaysia and Indonesia. Without getting into the multitude of economic and financial numbers for these four countries on GDP growth, inflation, foreign direct investment, exports, debt capital market development, population growth patterns, and so on, we have a compelling established emerging market that happens to be Muslim countries on the old Silk Road."

Read more: Muslim BRIC has arrived

Muslim BRIC has arrived

ISRA Journal - Volume 2

ISRA International Journal of Islamic Finance
Volume 2, Issue 2
December 2010

Volume 2 of the ISRA journal is now available online, you can find the table of contents here and download individual articles directly from their site, these include:

Academic Articles:

Juristic Analysis of the Profit Distribution Method
New Musharakah Model in Managing Islamic Investment
An Overview of Shari'ah Issues Regarding the Application of the Islamic Letter of Credit Practice in Malaysia
Case Studies of the Practice of Nomination and Hibah by Malaysian Takaful Operators
An Empirical Investigation into SMEs’ Perceptions of Credit Guarantee Corporation (CGC) Malaysia Berhad: A Case Study of the Islamic Guarantee Scheme in Malaysia

Practitioner's Articles:

Islamic Liquidity Management – The Malaysian Experience

Research Notes:

Shari'ah Parameters of Hiyal in Islamic Finance
Analytical Study of the Interaction Between Fatawa, Shari'ah Rulings, Resolutions and Conventional Laws in Contemporary Islamic Finance in Malaysia with Cross Reference to the Practices in Saudi Arabia, Pakistan and the Sudan
Capital Requirements and Banking Behaviour for Islamic Banks

ISRA Journal - Volume 2

Financial Intermediation in Muslim Community - Issues & Problems

Financial Intermediation in Muslim Community - Issues & Problems
Ibrahim S. Alomar
Department of Economics, Qassim University, Saudi Arabia
2005

Abstract: "It is widely known that Muslim society inherited an interest based financial intermediation system from others instead of developing their own banking system. However, Muslim Economists and scholars around the world made efforts to have and develop their own financial intermediation since there was no initial working model to act upon, except the belief that interest-based financial intermediation might be replaced by an Islamic one on the basis of profit and loss sharing. During the last four decades, Islamic financial intermediation industry became a reality that the Muslim society around the world can see and practice. However, the Islamic financial intermediation in the world has been facing numerous problems & challenges. It raises a number of issues and potential problems which can be seen from the macro and micro operational point of view. Developing the Islamic financial intermediation depends on clarifying these issues and presenting them in order to focus on them studying and remedying. This paper aims to cover the ground of issues of Islamic financial intermediation that rose during its short age. Such issues prevent Islamic financial intermediation from its operating with its full efficiency level. Even no attempt to remedy these issues, presenting these issues and problems and classifying them according to their type is very valuable for sustained growth and development of the Islamic financial intermediation. Such work is a valuable contribution to build the Islamic financial intermediation industry on sound theoretical foundations."

Financial Intermediation in Muslim Community - Issues & Problems

Islamic Project Finance in The Kingdom of Saudi Arabia

Islamic Project Finance in The Kingdom of Saudi Arabia
Craig Nethercott and Mohammed Al Sheikh – White & Case llp
Hissam Kamal and Sheikha Al Sudairy – HSBC Saudi Arabia Limited
July 2006

"...there was a common scepticism as to whether the products applied in Qatar, Oman and elsewhere in the Gulf could be used in Saudi Arabia. The full spectrum of Islamic financing products is commonly utilised in Saudi Arabia (mostly in retail banking), but never before had an Islamic financing product been used in a multi-sourced financing."

Islamic Project Finance in The Kingdom of Saudi Arabia

Incentive Compatible Contracts: The Islamic View

Incentive Compatible Contracts: The Islamic View (A Discussion Paper)
Issam Tlemsani
Robin Matthews
Kingston Business School
2001

Abstract: "The twentieth century has witnessed resurgence in the observance of fundamental Islamic practices around the world. The Islaimization of the financial sectors of many Muslims countries was a natural consequence of this resurgence, and the degree of Islamization varied dramatically across countries with Muslims populations. The Islamic Republic of Iran and Pakistan are at one extreme, where the entire financial sector has been made officially Islamic according to their central banks. Malaysia, Saudi Arabia, and some other Arabs countries have developed a hybrid financial system where Islamic banks coexist with regular financial institutions, and the monetary authorities of those countries regulate both types of financial institutions. This increase in the practice of Islamic banking transformed Islamic economics from a sub-field of Islamic jurisprudence and comparatives systems into one which interacts positively with mainstream economics theory. In this paper we present a basic theoretical understanding of the concept of Riba/interest, the key principle of Islamic banking. We explore the basic principles of Islamic banking, the tools of interest free banking and how Islamic banking can be implemented in a hyper-competitive environment."

Incentive Compatible Contracts: The Islamic View

Islamic Marketing Ethics

Ethics, governance, corporate behaviour, branding - all in all, how does one combine marketing and Islamic finance? On the other hand, what is the level of recognition and validity given by Muslim customers to Shariah compliant investments? How does one determine the level of preference for a compliant solution versus a conventional one? Is there such a preference or is it perceived as a penalty on financial performance? Is there a way to quantify all this? Can this methodology be applied to other services beyond banking products (from insurance & car financing to food, clothing, etc?). A vast topic indeed!

This specific piece from KAU provides a good starting point for discussion. Note the original link to the paper is broken, shown here is a mirror link.

Islamic Marketing Ethics and Its Impact on
Customer Satisfaction in the Islamic Banking Industry
Abul Hassan, Abdelkader Chachi, Researcher, Islamic Economics Research Centre, King Abdulaziz University, Jeddah, Saudi Arabia, and
Salma Abdul Latiff, Director of Centre for Islamic Banking, Finance and Management, University Brunei Darussalam.

With thanks to Joy Abdullah for suggesting the topic.

Islamic Marketing Ethics

Binding Wa'd - Is it Permissible?

Here is some background information on wa'd as part of our Linkedin discussion, the reason we are highlighting this item is the fact that a variety of products/solutions are based on wa'd and we are bound to see more products coming into the market using this type of contract. The issue is mainly whether or not you can pay for a promise (or more broadly whether you can provide some type of consideration for a promise), since the wa'd in its simple form is no more than a unilateral promise.

The Binding Unilateral Promise (wa’d) in Islamic Banking Operations: Is it Permissible for a Unilateral Promise (wa’d) to be Binding as an Alternative to a Proscribed Contract?
Rafic Yunus Al-Masri
Assistant Professor, Islamic Economics Research Centre
Faculty of Economics, King Abdulaziz University
Jeddah – Saudi Arabia

Binding Wa'd - Is it Permissible?

Paper: Shariah Compatible Futures

Sharia Compatible Futures

Abdul Rahim Al-Saati
Associate Professor
Economics Department
King Abdulaziz University
Jeddah – Saudi Arabia

With thanks to Charles Stromeyer for highlighting the paper.

Paper: Shariah Compatible Futures

Stock Market Volatility Transmission in Malaysia: Islamic Versus Conventional Stock Market

Another empirical study from KAU's Islamic Economics Research Centre, which delves not just on a comparison between conventional and Islamic equities, but also on the impact that interest rate fluctuations have on either one.

Stock Market Volatility Transmission in Malaysia: Islamic Versus Conventional Stock Market
Rosylin Mohd. Yusof and M. Shabri Abd. Majid
Islamic Economics Research Centre
King Abdul Aziz University, Jeddah, Saudi Arabia

Abstract: "This study attempts to explore the extent to which the conditional volatilities of both conventional and Islamic stock markets in Malaysia are related to the conditional volatility of monetary policy variables."

"The study finds that interest rate volatility affects the conventional stock market volatility but not the Islamic stock market volatility. This highlights the tenet of Islamic principles that the interest rate is not a significant variable in explaining stock market volatility."

Stock Market Volatility Transmission in Malaysia: Islamic Versus Conventional Stock Market

Islamic Microfinance Report - IDLO

A rather recent report (February 2009) authored by Allen & Overy giving an overview of Islamic microfinance for the International Development Law Organisation (IDLO), with an interesting review of microfinance initiatives across the Middle East and Southeast Asia (from Pakistan all the way to Indonesia). The report goes on to provide a review of basic Islamic law principles governing the provision of Islamic finance products and services (including a brief anlaysis of "Defaulting on Personal Debt in the United Arab Emirates and Saudi Arabia").

Islamic Microfinance Report - IDLO

Allen & Overy LLP

International Development Law Organisation (IDLO)

February 2009

Islamic Microfinance Report - IDLO

Ernst & Young - World Takaful Report

Apologies for the lag in highlighting this but somehow it managed to slip through the cracks, here we include the Takaful Report compiled by Ernst & Young for both 2008 and 2009. These provide a good overview of what has got to be a crucial driver for Islamic finance - both at the retail/consumer level (i.e. Takaful policyholders and local market penetration) and at the institutional/investor level (i.e. when one considers that Takaful operators must allocate their entire portfolios/trusts into Shariah compliant instruments). Plenty of statistics to digest here, but the most intriguing statistics are the countries not yet reflected. For instance, Saudi Arabia claims top spot as the largest Takaful market in the ME region, but little mention is given to either Egypt or Turkey which have significant "dormant" industries; similarly Malaysia is the largest market in Southeast Asia but the opportunity set is vast when one considers Indonesia and India (two major Muslim countries by population) as untapped.

Ernst & Young - World Takaful Report

New Theories of Riba I

Dr Azeemuddin Subhani has, in the relatively short period of time since his masterpiece came out, made a significant impression on the Islamic Finance community. But rather than to rehash his contributions, below we give a link to his New Horizon Interview of 2008, and in coming weeks, Insh'Allah, we will have the pleasure of providing links to his very delving works.

Interview: A New Take On Riba, New Horizon, July 2008.

Dr Azeemuddin Subhani spent nearly three decades working as a financial advisor in the Saudi oil ministry. Though he worked in a conventional financial environment, he nevertheless harboured a passion for Islamic finance and law. When he retired in 1999, he took the opportunity to study it at McGill University in Canada. He finished a PhD in Islamic Law and Finance in April 2007. He has since presented his thesis, in which he provides a new definition of the concept of riba, at Harvard Law School in the US, where it is currently being edited for publication. Dr Subhani has been publicising it for a couple of months now, in which time Sheikh Nizam Yaqubi, a prominent Shari’ah scholar, has offered to translate it into Arabic and distribute it to libraries across the Arabic world. Others have offered to translate it into Turkish and Urdu. Here, Dr Subhani explains to NewHorizon what he thinks the true meaning of riba is all about.


Please stay tuned for more by Dr Subhani.

New Theories of Riba I

Shariah Compliant Short-Selling: Mechanism 3

Short-Selling Through Salaam/Salaf

The Malaysian SC recently proposed mechanisms for short-selling through Salaam, something that has been proposed as well as the short-selling mechanism on the Newedge Platform (with presumably exactly the same mechanism), but only gaining currency within Saudi Arabia.

AAIOFI gives details to the Salaam contract in its 10th standard on Salaam sales, but states in Standard 21 Financial Paper (Shares & Bonds) that although the salaam sale may work for fungible commodities, they specifically restrict the use of the salaam sale for short-sales of shares. This judgement put a damper on the use of salaam sales for shorting, but the SC goes into some detail on the exact rationale for the use of the Salaam.

Much of it boils down to issues of fungibility and availability. The SC's justification is in three parts,

1. when shares are not considered too specific an item ('ayn mu'ayyan), i.e., they can be specified as fungible
2. salaam permitted provided object's category, type, and the date of delivery are described (i.e., the contract must specify terms to be fulfilled so the contact can be filled without dispute)
3. delivery can be ascertained (i.e., there is a market for them)

All of these must be fulfilled for the case of commodity salaam, but for shares in particular there has been dispute about whether they are mal mithly (fungible items) or mal qimy (specified items).

Jurists usually specify that salaam is approved when the subject matter is mitly or homogeneous, i.e., objects that can be precisely determined in terms of quality and quantity (see e.g., Bus Fin Review, see Saiful Azhar Rosly and Hamdan Hj Ismail, Salaam as Mode of Agricultural Finance in Malaysia: An Analysis of Risk-Taking Behavior of Contracting Parties for a succinct summary of terms of salaam contracts or Md Ayub, p 244). Correspondingly, most jurists specify that salaam is disapproved for mal qimy. The problem with mal qimy and mal mithly is that objects can only be one or the other, they cannot be mithly some of the time and qimy the rest.

Surprisingly there are some jurists who see shares as mal qimy. I personally see this as wrong-headed. It is not unlike saying that dollar bills are specific since they have different serial numbers. Of course there can be specific categories/classes of shares and shares may not be fungible across classes. Nonetheless, if the salaam contract specifies 100 Class B Shares of XXX Company to be delivered 3M from now, then I would claim it is legitimate as long as the market for these shares is functioning.

They cite the example of a salaam on livestock (which I believe is considered to be mal qimy, i.e., usually nonfungible). Hanafis prohibit salaam sales of animals based on a relatively weak hadith. Malikis, Shafiis and Hanbalis allow it based on qiyas (analogy) of the Prophet (saws) allowed borrowing of a camel. These three schools allow salaam sale of animals conditioned on the specification of its genus, age, gender, color and approximate size (see for example Zuhayli, vol 1, p 251).

[Deleted in Original Posting] In other words, the SC rule that the illah or effective cause of prohibition of bay' as-salaam on certain articles is not whtether they are mal mithly or mal qimy but rather whether the article can be described in enough generality but with correct specification (or 'ayn ghair mu'ayyan) so that there is no dispute when it comes to delivery. The SC thus claim that mal mithly or mal qimy are both possible objects of sale in a salaam sale. This is a clear extension of the standard view of salaam, but it incorporates salaam on mal mithly and salaam on animals (legimated according to Hanafi, Maliki, and Shafi'i as mentioned above) under one umbrella. This qiyas (analogical ruling) gives greater possibilities when it comes to possible deliverables.

Some space is devoted to market failure. The interesting note is that short-sale through salaam will be different to a conventional (naked or otherwise) short-sale because in the former, a 'squeeze' or lack of availability means that the salaams are unwound according to prespecified conditions, i.e., there is not a possibility of a fail, while in conventional shorts, fails are a common market occurence, and squeezes can lead to extreme distortions. This is definitely an area where Islamic Finance can better its Western counterpart.

Comments, Criticisms and Corrections welcome. Please post here and not just on LinkedIn Forum.

(and, blog readers do take a look at LinkedIn group Global Islamic Funds & Sukuk for generally interesting and intelligent debate on this and many more topics)

Shariah Compliant Short-Selling: Mechanism 3

The Employment of Shari'ah Scholars by Businessmen

Recently came across this article & discussion (in Arabic) from KAU's Islamic Economics Research Centre and wonder if anyone would have come across an English translation. Again we have some very interesting feedback within the Linkedin discussion forum.

The Employment of Shari'ah Scholars by Businessmen
Rafic Yunus Al-Masri
Islamic Economics Research Centre
King Abdul Aziz University, Jeddah, Saudi Arabia

The english excerpt raises some very interesting issues as they relate to agency costs and alignment of interests:

"Abstract. Can a Faqih work as an adviser for a businessman and get paid a salary from him? Why did the Shari'ah scholars prohibit taking a reward for fatwa? Is this salary similar to bribe? Is it permissible for a Faqih to absolutely defend his employer, whether the right is with him or with his opponent? Can a Faqih simply become a means to legitimize the work of the employer? Do the capital owners and businessmen really resort to scholars in order to commit themselves with the legal requirements or they do so just for promoting and marketing their products in religious communities? Is it permissible for the capital owners and businessmen to consult only with the scholars whose fatawa are expected to serve their benefits? For example, is it possible for a Faqih to pass a judgment or give an advice against his employer for the benefit of his employee? Is it possible for the employer to abide by the judgment of the Faqih if it is not in his favour? Do the members of the Shari'ah Boards in Islamic financial institutions work for the benefit of the institutions or for the benefit of the public? How can these bodies gain public confidence? This paper presents brief answers to these questions."

The Employment of Shari'ah Scholars by Businessmen

Shariah Compliant Call Option: Mechanism 1

Call Option using Set-Off


Calls through debt set-off (muqaddasah). AAIOFI shariah standard number 3 states that setoffs are possible as long as they involve the same counterparties (e.g., I owe you and you owe me) and the notional is the same and the maturity is the same. These can even be made contractual. There is also some leeway if notionals are different and maturities are different. Here we stick with the basic set-off.

In the diagram above we see the cashflows for a call-option. This structure was used for Principal Protected Commodity Notes (just adding on a separate SPV with murabaha to synthesize the zero-coupon bond) by some large commercial Saudi banks and super-large continental European banks.

• Investors puts up $C (call premium) at t=0, which is supplemented with the Murabaha (effectively borrowing $(K-C) strike price less call premium-worth of a commodity at time t=0).
  
• The commodity is sold on the open market to raise $(K-C).
  
• The premium and proceeds of commodity sale with total value of $K are invested in a Bay-al-Salaam contract.
• This Salaam contract is used as collateral (through a "pledge") for the Murabaha and recourse to the SPV is limited to this Salaam contract.
• At maturity, the commodity is delivered and will be sold (on the open market) under a separate wakala arrangement.
  

Now there are two possible scenarios at maturity t=T

1. Commodity price P>K the strike. Commodity is delivered into salaam, sold, proceeds used to cover the monies owed in murabaha, and remainder $(P-K) is paid to investor.
2. Commodity price P the strike. In this case, the commodity is delivered and sold, but proceeds cannot cover the murabaha and the bank will exercise its recourse to receive the value from the proceeds of the salaam sale. SPV is wound down with no further recourse.
   

Effectively, investor receives max(P-K,0) at time t=T, the payoff of a call option.

IMHO, I see no loopholes in this. Debt set-off is allowed and it can be contractual. Here, the salaam and the murabaha have the same maturity and same notional, so what is owed on one can be used to offset the other by contract with no further recourse or implications. The SPV and pledge allow is to take place from an English Legal perspective.

Comments please!

Shariah Compliant Call Option: Mechanism 1