Islamic Finance

Islamic Finance
November 27, 2014
What is Islam ?
-
third Abrahamic religion
Word “Islam” means “finding peace with” or
“submission to” God
-
Based upon “Five Pillars”
-
Founded by Prophet Muhammed (570-632)
-
Second largest religion in the world - .9 - 1.4
billion followers (often set at 1.3 billion)
-
Centred around Mecca – spiritual “focus” of Islam
-
Monotheist - incorporates many of the prophets and beliefs
of both Christianity and Judaism.
-
Islamic calendar begins in 622 – the year of the Hijra
Major religious groups as a percentage of the world population in 2005.
Five Pillars of Islam
1. Profession of Faith – “Lal illahah al illallah” – There is
no god but God and Muhammed is his messenger
(shahada)
2. Prayer – 5 times a day facing Mecca
- must ablute before prayer (wudu)
(salat)
3. Fasting – Generally refers to the month of Ramadan
- gives time to reflect on how the poor and
hungry feel
- fasting refers to any intake of solids or
liquids form sunrise to sunset
- Pregnant women,sick and travelers exempt
(sawm)
4. Hajj – every Muslim must perform the Hajj in Mecca at
at least once in his life if financially able
5. Alms or Charity - to the poor
- technically 2.5% of earnings
(zakat)
- additional amounts may be paid
voluntarily (sadaqa)
What is a bank ?
- Takes deposits from account holders
- Lends money to borrowers
- Makes money on “spread”
Eg – Bank has 3,000,000 Kc on deposit – pays 4%
3,000,000 x 4% = 120,000
Manages to lend 90% of the money at 7%
2,700,000 x 7% = 189,000
Profit is “spread” 189,000 – 120,000 = 69,000
So, a bank just makes money on the difference
A bank can offer many other services –
Czech Banking Act on taking deposits:
According to article 5d of the Banking Act (1991)
a) acceptance of deposits from the public,
d) money transmission services,
e) issuing and administering means of payment,
g) trading for own account and for account of clients in:
1. money market instruments,
2. foreign exchange,
3. financial futures and options
4. transferable securities,
i) advice on capital structure, industrial strategy and related questions and
services relating to mergers and the purchase of undertakings,
j) money broking,
k) portfolio management and advice,
l) safekeeping and administration of securities,
m) providing banking information,
n) safe custody services.
According to the same article 5d of the Banking Act (1991)
a bank may not only lend but:
b) lending,
c) financial leasing,
f) providing guarantees,
h) participation in securities issues and
the provision of services related to such issues,
i) advice on capital structure, industrial strategy and
services relating to mergers
Notice that some activities are fee-driven
e.g. Custody services, money transmission,
consultations
While others are more “spread” driven
e.g. deposits vs. lending and leasing
If we look at a typical balance sheet:
Xeno - phobic Corp
Balance sheet as at December 31, 2004
Assets
Cash
5,000
Receivables
20,000
Debt
to third party
Inventory
85,000
Machinery
250,000
Buildings
500,000
Liabilities
Bank loans
Payables
Long Term Loans
Mortgages
10,000
60,000
150,000
300,000
Total Liabilities
520,000
Shareholder's Equity
Debt to owners
Total Assets
860,000
Paid-up Capital
Retained Earnings
200,000
140,000
Total Shareholder's Equity
340,000
Borrowing from third parties (suppliers or banks)
is not the same as from shareholders
Third parties are normally paid interest – a charge that
is almost guaranteed to be paid when possible
Shareholders or owners are normally paid from profits
(dividends) and this is not necessarily paid,
even when possible.
Thus, distance is often kept between bank and the
borrower. The bank takes guarantees (collateral)
to ensure payment of both the principal and the
interest. This often can cripple a company in trouble.
Often squabbling creditors do more damage to a debtor’s
financial well-being as they fight over the assets – this is
one of the big failings of the larger banks. They take little
risk when they lend money.
Banks also ensure the “multiplier effect” -
Islamic Concept of Banking
Money is not an asset, and cannot be used as such to
create wealth (more money)– it is just a measure of
value
Concept of usury (riba)
-
-
-
is related firstly to the fifth pillar of Islam – charitability
- when you have income, you must share it with others.
usury was banned in Old & New Testaments
- was also frowned on historically (Shakespeare)
is seen as a way to get something by doing nothing for it
other than to have a lot of money. It is a form of theft.
in the Koran, it is written that what is taken will be destroyed
and wrongdoers will be punished. What is given will be
multiplied.
when Muslims started to make serious money from oil, they
were not sure about what to do. Definitely, lending profitably
would not be well accepted
many states retained Koranic scholars as advisors
How does it work?
• All lending must be Sharia compliant
• Bank does not charge interest - shares both profits and losses
• Profits divided according to capital invested
• Depositors share profits with bank
• Depositors choose type of investment they want money put in
Some Products
• Sukuk – Islamic type of bond – Profit sharing
• Murabaha - Purchase and resale
• Ijarah – Leasing arrangement
• Salam – Forward payments for goods delivered later
• Ististna’a – Like Salam but for manufactured goods
Are there any advantages?
• Bank and borrower have similar objectives
• Excessive risk-taking is not allowed
• Bank contact is also expert advisor
• Predatory activity in downturn not permitted
• Islamic banks were not affected by Credit Crisis 2008
Are there any disadvantages?
• Bank as partner – loss of control
• Portion of profit might be quite costly
• Cannot invest in certain sectors - alcohol, pork, gambling, etc