AusCif Webinar Introduction to ISLAMIC FINANCE by Almir Colan

Introduction to ISLAMIC FINANCE

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Almir Colan Founder of Australian Centre For Islamic Finance (AusCif) and Lecturer in Islamic Finance at La Trobe University.

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Raising awareness of Islamic Finance –AusCif.com

• Raise the awareness of Islamic Finance in Australia.

• Training Sessions and workshops were conducted (in all major cities in Australia) at La Trobe University, University of Melbourne, Curtin University, University of Canberra, University of Adelaide and so on.

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• Master of Islamic Banking and Finance Course code/s: LMIBF Melbourne La Trobe University’s Master of Islamic Banking and Finance (LMIBF) is

the first course in Australia dedicated to Islamic banking and finance. This cutting-edge coursework masters program is built around a defined body of knowledge of proven relevance to the Islamic finance industry.

http://www.latrobe.edu.au/handbook/2012/postgraduate/law-management/finance/lmibf.htm

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Topics Introduction to Islamic finance • Attitude and mindset • Money - Historic Perspective • Difference between Islamic & conventional bank • Basic modes of Islamic Financing • Key Principles underlying Islamic finance • Prohibition of interest (riba) • Prohibition of uncertainty & speculation (gharar) • Why Islamic finance • New AusCif Initiative • Q&A You can also ask question via AusCif official Facebook page “Islamic Finance

Australia” http://www.facebook.com/Islamic.Finance.Au

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Book of business transactions…

…Sad was a rich man, so he said to 'Abdur-Rahman, "I will give you half of my property and will help you marry." 'Abdur-Rahman said (to him), "May Allah bless you in your family and property. Show me the market."

So 'Abdur-Rahman did not return from the market) till he gained some dried buttermilk (yoghurt) and butter (through trading). … and then Abdur-Rahman came, scented with yellowish perfume.

The Prophet said (to him) "What is this?" He replied, "I got married to an Ansari woman." The Prophet asked, "What did you pay her?" He replied, "A gold stone or gold equal to the weight of a date stone.“ (Bukhari 3:265)

Book of business transactions…

Narrated Abu Huraira:

• ...my emigrant brethren were busy trading in the markets, and my Ansar brethren were busy with their properties. I was a poor man keeping the company of Allah's Apostle and was satisfied with what filled my stomach. So, I used to be present while they (i.e. the emigrants and the Ansar) were absent, and I used to remember while they forgot.

Sahih Bukhari, Volume 3, Book 39, Number 540:

Why start book of business transaction with this narations?

Where do our 'money' principles come from?

Time is… …Money Money is the root of all… …Evil Is this correct from Islamic point of view? No What is?

Story: Father & son

...they say, "Trade is [just] like

interest." But Allah has permitted

trade and has forbidden interest. [Qur’an, Al

Baqarah: 275]


Trade is not like Riba (interest) The Prophet (saws) was asked ‘what form of gain

is the best? on which the Prophet (saws) said, ‘A

man’s work with his hands, and every

legitimate sale’. (Ahmad, No: 1576)

Narrated 'Urwa: That the Prophet gave him one

Dinar so as to buy a sheep for him. 'Urwa bought

two sheep for him with the money. Then he sold

one of the sheep for one Dinar, and brought

one Dinar and a sheep to the Prophet. On that,

the Prophet invoked Allah to bless him in his

deals. So 'Urwa used to gain (from any deal) even

if he bought dust. (Bukhari)

Money - Historic Perspective

The Stone Money of Yap known as Rai

Gold dinar is a bullion gold coin made from 4.25 grams of 24 carat (k) gold.

"Money is such a friend of yours which benefits you only when it leaves

you." -Hasan Al Basri


Imam Al-Ghazali on money:

•They are stones having no intrinsic usufruct or utility, but all human beings need them…

..as judges and mediators between all commodities so that all objects of wealth are measured through them…. •…because money is created for some other things, not for itself. So, the one who has started trading in money itself has made it an objective, contrary to the original wisdom behind its creation…


Functions Of Money

• Medium of Exchange/Unit of account (It is a source of ease, used for pricing goods)

• Measure of Value (Must be converted to something else to become useful. Based on confidence & trust)

• Store of Value (must be storable, portable, recognizable, and divisible)


Delay

Conventional Banks - Money is considered a commodity

Money Exchange/sale

Money

Surplus

The sale of money for money runs contrary to the nature of money as being a medium of exchange, unit

of account and store of value.

EG: bank loans and credit cards


Islamic banks - Money used as a medium of exchange

Money

Profit

Asset

In Islamic finance money must be converted into something useful, which in turn generates profit for the investors.

Linking money to productive purposes brings into action labour and other resources to initiate a process from which goods and services are produced and benefits passed on to society.

• Deal with Money & documents not in goods.

• Money is considered a commodity that can be sold/bought and rented against profit or rent that one party has to pay, irrespective of the use or role of the lent money in the hands of the borrower.

Islamic

Bank

Conventional

Bank

• Deal in goods and documents and not in money.

• Money used only as a medium of exchange for purchasing the goods for the purpose of leasing or selling onward, thereby earning income or profit.

• Hence, profit comes with Risk and Responsibility

Adapted from "Understanding Islamic Finance" M. Ayub, 2007

Musharaka (Equity partnership, Joint Venture)

Investor A

Investor B

Business Venture

$300,000 $700,000

Profit: 30/70 ratio Or any pre agreed

ratio.

Loss: 30/70 ratio

Fixed!


Share of profits

capital

management

Share of profits

Mudaraba (Investment Partnership)

Investor

Mudarib (entrepreneur)

Business Venture

Profit

Profit can not be a fixed amount (for PLS financing) but must be determined by a pre-agreed ratio. In case of loss, the investor loses capital and the mudarib loses time and effort. In the case of proven negligence by the

mudarib, the mudarib may be liable for capital as well.

$130,000 $100,000

Spot payment

Murabaha (cost plus sale)

Bank Goods Supplier

Bank must own the asset before

selling it.

deferred payment

Financing asset purchase

Customer


Lessee

Seller SPV

Issuer /Trustee

Investor 1a Sukuk

1b Cash

2a Sale of assets

2b Price

3a Lease of assets

3b Rentals

3c Periodic payments

Servicing Agent

4 Servicing agreement

Ijarah Sukuk


Basic modes of Islamic Financing – Musharaka (Equity partnership, Joint Venture)

• Eg: purchasing property or assets such as machinery for a factory

– Mudaraba (Trustee/Investment Partnership) • Eg: Bank deposit (saving and investment accounts)

– Murabaha (Cost Plus Sale) • Eg: short term financing

– Ijarah (Leasing) • Eg: Sukuk

– Salam (Deferred Delivery Sale, pre-paid sale) • Eg: agricultural produce

– Istisna (Manufacturing Sale) • Eg: construction and Infrastructure projects

• In addition to the above business activities, Islamic banks may provide services against service charges or management fees.

Islam = “way of life” (Qur’an 5:3)

Set of rules = Shari’ah (Prohibitions, obligations, clarifications and so on)

Objectives of Shariah Preserving:

1. Religion 2. Life 3. Family Progeny 4. Wealth 5. Intellect and honour

Ibadaat (Acts of Worship)

Muamalaat (Interactions with People)

Islamic finance, economy…

What does religion have to do with wealth and economic life? The Story of

Prophet Shu'aib 'alayhis-salaam...

From principles >>> Present situation • 1963 Egypt (town of Mit Ghamr) first savings bank

based on profit-sharing

• 1975 Dubai Islamic Bank (The first modern commercial Islamic bank), Islamic Development Bank (provide funding to projects in the member countries

• 1999 The first index launched - The Dow Jones Islamic Market Index (DJIM)

• Top 500 Islamic Finance Institutions by The Banker (No #1 Al Rajhi Bank)

• 2011 A consortium of Islamic banks and financial industry associations launched the industry's first International Islamic interbank rate (alternative to LIBOR)

Growth and potential • Fastest growing segments of the finance service industry.

• Growing at over 10% - 15% per annum

• Estimated to be worth more than AUD$1.4 trillion

• Assets held by Islamic financial institutions may rise five-fold to more than $5 trillion. (Moody’s Investors Service)

• The world’s Muslim population is expected to increase to 2.2 billion by 2030 or 26.4% of the world’s total projected population.(Projections by the Pew Research Center’s Forum on Religion & Public Life)

How will they do banking? In next 5, 10 or 20 years?


What is Islamic finance?

• Islamic finance represents financial activity that is consistent with the principles of Islamic law or the Shariah, which prohibits unethical, immoral, speculative activities as well as interest, gambling, uncertainty and so on.

• Islamic finance encourages entrepreneurship, mutual cooperation, generosity and a spirit of partnership which connect the capital-owner with real economic activities that may actually contribute to the welfare of society via commerce, manufacturing, construction and so on.


KEY PRINCIPLES UNDERLYING ISLAMIC FINANCE

• Prohibition of interest (riba)

• Prohibition of uncertainty & speculation (gharar)

• Prohibition of forbidden assets (e.g. alcohol, gambling)

• Existence of an underlying asset

• Profit sharing and risk sharing


Riba: Definition

Language/literal meaning of riba?

- Increase

Shariah definition

- Unlawful increase

Correct English translation

- Interest or Usury?


“And Jesus went into the temple of God, and cast out all them that sold and bought in the temple, and overthrew the tables of the moneychangers, and the seats of them that sold doves, and said unto them, It is written, My house shall be called the house of prayer; but ye have made it a den of thieves.” - Matthew; 12-13


Principles of riba

• “Gold with gold, silver with silver, wheat with wheat, barley with barley, dates with dates, and salt with salt; same quantity for same quantity, equal for equal; transaction being made hand to hand (i.e. on the spot payment)” (Muslim).

**Learn more about Debt, Riba & Gharar in our next Webinar www.auscif.com


http://www.auscif.com/

Main types of Riba (interest)

1. Riba Al-Nasee’ah (riba of delay)* - A delay (al-nasee’ah) in the settlement of one or both countervalues

2. Riba Al-Fadl (riba of surplus) - A surplus (al-fadl) in the amount of one countervalue over the other in barter transactions of specific commodities (non-monetary fungible items).

(*Adopted from El-Diwany et al. 2010)


Summary by Imam Nawavi:

1. When the underlying ‘Illah of the two goods being exchanged is different, shortfall/excess and delay both are permissible, e.g. the exchange of gold for wheat or dollars for a car.

2. When the commodities of exchange are similar, excess and delay both are prohibited, e.g. gold for gold or wheat for wheat, dollars for dollars, etc.

3. When the commodities of exchange are heterogeneous but the ‘Illah is the same, as in the case of exchanging gold for silver or US Dollars for Japanese Yen (medium of exchange) or wheat for rice (the ‘Illah being edibility), then excess/deficiency is allowed, but delay in exchange is not allowed. (Ayub 2007, p.52)

**Learn more about Debt, Riba & Gharar in our next Webinar www.auscif.com

http://www.auscif.com/

It goes against mutual cooperation, generosity, and spirit of partnership.

Acquisition of property by wrongful means and harm to the needy.

Removal of the possibility for injustice and exploitation.


Drives the capital-owner away from enterprise and real economic activities that contribute to the welfare of society (e.g. commerce, manufacturing, construction and so on)

Money is meant to be a medium of exchange and standard of value for other goods.

Riba violates the entire rationale behind money and diverts money from doing what it is meant to do.

Some wisdom behind the prohibition of riba (interest/usury)


The Prohibition of Gharar

• Abu Hurairah states, “The Prophet forbade selling by way of tossing stones to settle a sale (Al-Haasah), and the sale of Gharar.” (Muslim)

• What is Gharar?

– Uncertainty, hazard, chance, risk,

delusion, deception, danger, peril…

- to make someone believe something that is false or vain.

- to put someone in a dangerous position due to deception.

- outwardly it looks very attractive but in reality it is something much different.


Examples of Gharar

Ignorance & Lack of Transparency (eg , intercepting traders before they reach market, contracts…)

Deception (eg sale of wet grain)

Selling what you do not have (eg fish in the ocean – not in possession of the item for sale/purchase) – exception is salam/istisna contracts.

Unspecified price, dates, delivery, etc.

Uncertain outcome, quality and quantity.

Complexity in contracts (eg: CDO’s)

Derivative transactions (forwards, futures and options), short selling and speculation.

Gambling (game of chance)

Maisir (game of chance) is regarded as gambling because the outcome is unknown and clearly involves gharar. The practice of Maisir is declared forbidden in Qur’an:

“They ask you about wine and gambling. Say, "In them is great sin and [yet, some] benefit for people. But their sin is greater than their benefit.“ (2: 219)

Gambling involves no skill, basically luck (except for things that involve games e.g. poker).

Maisir or Qimar are extreme form of gharar

EG: short selling and speculation.

Every form of gambling is gharar, but

not all gharar is gambling.

• "We don't know exactly what. They switched it on and immediately they started losing literally $10 million [£6.4m] a minute. It looks like they were buying high and selling low many, many times per second, and losing 10 or 15 dollars each time. And this went on for 45 minutes. At the end of it all they wound up having lost $440 million [£281m].“

• To give you a sense of how fast high-frequency trading can be, in the time it takes Usain Bolt to react to the starting pistol, a high-frequency trading platform could complete about 165,000 separate trades. http://www.bbc.co.uk/news/magazine-19214294

http://www.bbc.co.uk/news/magazine-19214294



Libor (London inter-bank lending rate) scandal

Libor is considered to be one of the most crucial interest rates in finance, upon which trillions of financial contracts rest, and the exposure of its rigging has shocked many beyond the world of finance.

Used to set a range of financial transactions worth an estimated $800 trillion.

http://www.bbc.co.uk/news/business-19199683








• Standard Chartered Bank accused of laundering $250 billion

• Barclays hit with £290m fine over Libor fixing

• HSBC money-laundering scandal almost puts Barclays in shade

• JPMorgan’s ‘whale’ loss swells to $5.8bn

• Swiss banks hoping to atone for decades of complicity in tax evasion

• Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO

In the news: Losing faith with banks

Why learn?

• Umar, the second Caliph and successor to the Prophet Muhammad, stated, “Whoever does not have an understanding of the rules of Islam should not deal in our market” (The Life of Umar, As-Sallabi 2007).

• He also warned, “No one should sell in our marketplace except one who has understanding of the rules of Islam, otherwise he is going to consume riba whether he wants to or not” (ibid).

• “A time will come when one will not care how they gain their money, whether legally or illegally” [Bukhari]


Why learn? • Universal demand for a

fair and just system that is socially responsible and sustainable.

• Change the greedy and inhumane system we have created.

• To provide a stable and secure ethical alternative, especially in these uncertain times.


#Occupy Wall street


#occupy

Wall street

Get high-quality university level education without the heavy price-tag

It is offered via flexible On-line webinars (with up to 12 months access to all webinar recordings).

Cost: (AUD) $195

Course duration: 12 weeks

Start date: 21th November 2012

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New: Auscif Islamic Finance Course

Some of the topics to be covered: • Types of contracts • Business ethics • Prohibitions in Muamalat • Murabaha (Cost-Plus Financing) • Ijara (Islamic leasing) • Salam (Forward Selling contracts) • Istisna’ (Manufacturing Contracts) • Musharakah (Partnership, JV) • Mudarabah (investment) • Investment in Shares • Wholesale Markets and

Investment Funds • Sukuk (‘Islamic bonds’) • For list of all topics go to

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Cost $195 Your Promotion code: webinar30 (30%

discount code valid until 31 October 2012)

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Almir Colan [email protected] www.AUSCIF.com

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AusCif Webinar Introduction to ISLAMIC FINANCE by Almir Colan

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