Insuring Shariah Based Deposits

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InsuringShariah BasedDeposits

MohdPisal Zainal,Ph.D.JointDirectorofResearch

InternationalCenterforEducationinIslamicFinance(INCEIF)

Preparedfor

TheDepositInsuranceConferenceintheMENARegion:

EnhancingConfidence

November18 19,2009


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OutlineofthePresentation


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IslamicFinance101

WhatisIslamicFinance?

Afieldofstudyandprofessionalpracticethatconcernstheshariah compliancestatusof,interalia,economics,banking,takaful,assetandinvestmentmanagement,unittrust,wealthplanningactivitiesandbusiness

(Prof.Saiful Azhar Rosly,2008)

isfoundedonshariah principleswhichexpressanexplicitintentiontomeetthefinancialneedsofparticipantswithintegrityandinmannerthatisjust,fair,trustworthyandhonest,whileensuringamoreequitablewealthdistribution

(PrimertoIslamicFinance,MalaysiaInternationalIslamicFinancialCenter(MIFC),BankNegaraMalaysia,2008,p.50.)


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IslamicFinance101 WhatexactlyareShariah Principles?

BasicPrinciples SourcesoftheIslamiclaw(shariah):

TheHolyQuran;

Thetraditionsorknownpractices(Sunnah)oftheProphet

Muhammad(peacebeuponhim);

Consensusofthelearnedscholars(Ijma);and

Analogy(Qiyas),


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Thus,IslamicfinancedealswithstructuringoffinancialproductsorfinancialtransactionsthatareinaccordancewiththeIslamiclaw

(shariah); Primarily,Islamicfinanceconcernswiththe:

Promotionofsocialwelfareandjustice,equitabledistributionofwealth;

Profitandlosssharingbetweenthecapitalproviderandtheentrepreneur;

Theexistenceofanunderlyingasset,i.e.theobligationtobackallinvestmentswithrealassets;

Moneyisnotconsideredasanassetclassbecauseitisnottangible;

therefore,

it

may

not

earn

a

return;

and Thetransactionsarebasedonthefollowingprinciples:

Trade(bay);

Leasing(Ijarah);and

JoinVenture(Musyarakah) andcombinationsofthesebasiccontracts.

IslamicFinance101


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Primarily,Islamicfinanceconcernswiththe:

Prohibitionofactivitiessuchas:

Riba (usury,prohibitedgains);

Gharar(uncertaintyorhazardcausedbylackofclarity

regardingthesubjectmatterorthepriceinacontractorexchange);

Maisir/Qimar(gambling,gamesofchance);and

Exploitation,amongothers.

IslamicFinance101


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UnderlyingaimsofIslamicfinance thesameasthoseofconventionalfinance

Toutilizethefundsofsurpluseconomicunitstofacilitateinvestmentandassetallocation;

Tofacilitatetrade;

To

provide

financial

services;

and

Tocreateinvestmentopportunities.

IslamicFinance101

ToCreateeconomicefficiency


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Thedifferenceis themannerinwhichthey

proceedtomeettheobjectives..

Islamicfinance: The basis is equity (through profit

andlosssharingschemes)andrental

income

Dealsinphysicalassets

Assumes the risks of the purpose

of the funds he is investing in and

shares in preagreed ratios in the

resultantprofitorloss

Assumesbusinessandoperational

riskinexchangeforprofits.

Conventionalfinance: Thepillarisdebt(throughinterest)

Dealsinphysicaland paper

assets

Assumes the risk of default of the

entityorpersontowhomheisadvancing

funds.

Receives the interest payable on the

loan

IslamicFinance101


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WhyistheIslamicfinancebecometheinthingtoday?

Isthisregionalorglobalphenomena?


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RaisonD'treofIslamicFinance TheriseofHNWIs andGovernmentsurpluses

duetotheincreaseinpetrodollar(Ernst&YoungsTheIslamicFundsandInvestmentsReports,2007,2008and2009)


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GlobalAverageOilPriceandTotal

NominalGDPintheGCC

Source:

Ernst

&

Young.

Islamic

Funds

and

InvestmentReport2009


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GlobalAverageOilPriceandCurrent

AccountBalancesoftheGovernmentsintheGCC

Source:

Ernst

&

Young.

Islamic

Funds

and

InvestmentReport2009


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TheRaisonD'treoftheRiseof

IslamicFinance TheneedforMuslimstoconducttheirfinancialactivitiesin

accordancewiththeIslamicLaw(shariah); Muslimsmadeupaboutonefifthoftheworldspopulation,a

smallfraconof1.3billionMuslimscommandsquiteasizeablemarket;

TheavailabilityofvarietyofIslamicfinancial

products/instruments; Competitiverateofreturns/profitsonIslamicfinancial

products;and

Post9/11. AccordingtoForbes(April21,2008),about$200billionworth

offundsoriginatedfromtheMiddleEastfledtheStates.


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Howbigaretheassetsconsideredto

beshariah compliant?Wherearetheseassetsconcentrated?

Whatarethegrowthpotentialforthe

shariah basedassetsclass?


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IslamicFinanceIndustry:FactsandFigures

Regionaland

Global

Growth

Totals

($M)

2006 2007 %Change 2008 %Change 2009 %Change

GCC 127,826.6 178,129.6 39.4 262,665.4 47.5 353,237.5 34.5

NonGCC

MENA

136,157.6 176,822.2 29.9 248,264 40.4 315.090.5 26.9

MENATotal 263,984.2 354.951.7 34.5 510.929.4 43.9 668,328.5 30.8

SubSaharan

Africa

3039.3 4708 54.9 6662.1 41.5 8369.7 25.6

Asia 98,709.6 98,709.6 20.9 86,360.3 27.6 106,797.3 23.7

Australia/Eur

ope/America

20,300.2 21,475.7 5.8 35,105.2 63.5 38,654.8 10.1

GlobalTotal 386,033.3 500,481.9 29.7 639,076.9 27.7 822,135.1 28.6

%ofMENAtoGlobal

68.4 70.9 79.9 81.3

Source:TheBankers Top500IslamicFinancial

Institutions 2009.


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IslamicAssetsintheGCC,2009

Source:TheBanker. Top500IslamicFinancial

Institutions 2009.


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Islamic

Finance

Industry:

Facts

and

Figures


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Top25IslamicFinancial

InstitutionsInstitutions CTRY $M

1 BankMelli IRA 59,621.8

2 Al

Rajhi KSA 43,981.3

3 BankSaderat IRA 43063.0

4 BankMellat IRA 41,650.6

5 KuwaitFinanceHouse KWT 40,002.7

6 BankTejarat IRA 31,807.6

7 BankSepah IRA 26,378.0

8 DubaiIslamicBank UAE 23,941.4

9 ParisianBank IRA 18,319.0

10 BankKeshavarzi IRA 16,675.0

11 HSBCAmanah UAE 16,537.0

12 Nat.CommercialBank KSA 16,135.5

13 AbuDhabiIslamic UAE 15,832.1

Institutions CTRY $M

14 BankRakyat MYS 13,081.0

15 Saudi

British

Bank KSA 12,228.0

16 AlBaraka Banking BAH 11,511.3

17 Riyad Bank KSA 10,809.1

18 Maybank Islamic MYS 10.666.6

19 Eghtesad Novin Bank IRA 10,237.9

20 QatarIslamicBank QTR 9,215.1

21 ArabNationalBank KSA 8,933.3

22 EmiratesNBD UAE 8433.5

23 BIMBHoldings MYS 7459.9

24 BankAlJazira KSA 7338.6

25 EmiratesIslamic UAE 7193.6

Source:TheBanker.Top500IslamicFinancialInstuons2009.


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Top20

By

Countries

Country $M

1 Iran 293,165.8

2 SaudiArabia 127,896.1

3 Malaysia 86,488.2

4 UAE 84,036.5

5 Kuwait 67,630.2

6 Bahrain 46,159.4

7 Qatar 27,515.4

8 UK 19,410.59 Turkey 17,827.5

10 Bangladesh 7453.3

Country $M

11 Sudan 7151.1

12 Egypt 6299.7

13 Pakistan 5126.1

14 Jordan 4621.6

15 Syria 3838.8

16 Iraq 3815.0

17 Indonesia 3388.2

18 Brunei 3201.419 Yemen 1318.3

20 Switzerland 1040.6

Source:TheBanker.Top500Islamic

FinancialInstuons2009.


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WhatisthestructureofanIslamic

FinancialSystem?

Howfinancialproductsclassifiedas

Islamicorotherwise?

WhoaretheShariah Board

Members?


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OverviewofIslamicFinancialSystem:

TheCaseofMalaysia


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ExamplesofApprovedIslamic

FinancialContracts Ijarah (Leasing)

Bai Istijrar (SupplySide)

Bai Wafa (SaleandRepurchase) Ijarah Thumma Bai (LeasetoPurchase)

Mudharabah (ProfitSharing)

Musharakah (ProfitandLossSharing)

BaiInah (SalewithImmediate Repurchase) Bai Salam (AdvancePurchase)

BBA(DeferredPaymentSale)

Istisna (PurchaseOrder)

Murabahah (CostPlusSale)

Qardh Hasan (BenevolentLoan)


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SecuritiesCommissionMalaysia DowJonesIslamicMarket(DJIM) FTSEGIIS

TanSriSheikhGhazali Hj Abdul

Rahman (Chairman)

Shaykh AbdulSattar AbuGhuddah Sh.Essam Ishaq

Tun Dato'SeriAbdulHamid Haji

Mohamad

Shaykh Nizam Yaquby Sh.Dr.MohammedAkram Laldin

Datuk Hj.Md Hashim Hj Yahaya Shaykh Dr.MohamedA.Elgari Sh Dr.Yousuf Alshubaily

Sahibus Samahah Dato'Hassan Hj

Ahmad

Shaykh Yusuf Talal DeLorenzo Sh.Dr.Mohd Daud Bakar

Dr.Mohd Daud Bakar Shaykh Dr.Mohd Daud Bakar

Dato'Dr.AbdulHalim Ismail

Prof.Dr.AbdulSamat binMusa

Assoc.Prof.Dr.AbdulHalim

Muhammad

Assoc.Prof.Dr.Ismaae Alee

Assoc.Prof.Dr.Shamsiah

Mohamad

MembersofShari'ah Supervisory

Boards/Council


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FTSEGIIS Methodology

Source:www.ftse.com/shariahAccessed:September22,2009


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FTSEGIIS Methodology


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NewProductApprovalProcess:A

GenericCase

NotApproved

Source:Schoon,Natalie.IslamicBankingandFinance.London:Spiramus Press,2009,p.138.


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ChangestoExistingProductStructure:

AGenericCase

Source:Schoon,Natalie.IslamicBankingandFinance.London:Spiramus Press,2009,p.139.


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ProductApproval

Process:TheCaseofBank

NegaraMalaysia

(BNM)


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Whattypesofdepositsavailable

underIslamicbankingsystem?Whatistheshariah positionon

insuringdeposits?


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Islamic

Banks Sources

of

Funds Islamicbankingfunds;

Customers deposits

Corporatebankingactivities;and

Treasuryactivitiesorplacements.

l d


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ComparisonsBetweenIslamicand

ConventionalBankingSystemsItems Islamic ConventionalNominalValueGuaranteeof:

Savingdeposits

Demanddeposits

InvestmentDeposits

NoGuarantee FullGuarantee

Equitybasedsystemwherecapitalisatrisk Yes No

Mechanismtoregulatefinalreturnsondeposits Dependingonbanks

performance/profits

frominvestment

Irrespectiveofbanks

performance/profits

frominvestment

Rateofreturnsondeposits Uncertain,not

guaranteed

Usuallycertainand

canbeguaranteed

PLSprinciple Yes No

UseofIslamicmodesoffinancing:

PLSandnonPLS

Yes N/A

Useofdiscretionbybankswithregardtocollateral Possibleforreducing

moralhazardinPLS.

YesinnonPLS

Yesalways

Bankspoolingofdepositorsfundstoprovidedepositors

withprofessionalinvestmentmanagement

Yes No

Source:Errico &Farahbaksh.1998.IslamicBanking:IssuesinPrudentialRegulations&Supervision.

TheIMFWorkingPaperNo.98/30.


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Deposits

of

the

Islamic

Banks ThreewidelyusedcontractsforIslamic

(SavingsandChecking)Depositsare: AlWadiah Amanah/Trust

AlWadiah Yad Dhamanah (safekeepingwith

guarantee)

Mudharabah ProfitandLossSharing(PLS)

Qardul Hassan BenevolentLoan/Fund


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Thesecontractsarethenappliedtothreetypesofdeposits: DemandDeposits

MostlycheckingaccountswhereIslamicbanksarenotobligedtopayprofit.However,banksdoprovidetokenofappreciationknownashibah todepositors;

Contractedeitheralwadiah yad dhamanah (safekeepingwithguarantee)ormudharabah (ProfitSharingorsometimereferredtoasProfitandLossSharing)

GeneralInvestmentDeposits Mudharabah

SpecificInvestmentDeposits Mudharabah

Deposits

of

the

Islamic

Banks


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CapitalGuarantee

NoCapital

GuaranteeShouldshariah baseddepositsbeinsured?

Deposits

of

the

Islamic

Banks


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ShouldShariah BasedDepositsBe

Insured? AlWadiah Yad Dhamanah Accounts(Custodyorsafekeepingwith

guarantee) Accordingthethe ResolutionoftheIslamicFiqh CounciloftheOIC,the

liabilitytoreturntheloan(currentdeposit)willnotbeaffectedbythebankssolvencyorotherwise, thebankwillpaytheamountofthedepositirrespectiveofitsprofitorloss;

Therefore,suchaccountsarenoteligibleforashareinprofits,astheyarenotsubjectedtoriskandthereshallbenoreturnpayabletothem;

AnIslamicbankmayprovidegifts(hibah).Thispracticevaryfromcountrytocountry,orbanktobank.

Mudharabah InvestmentsAccounts Depositorswithmudharabah (PLS)accounts,eithergeneralorspecific

accountsarewillingtotaketherisksassociatedwiththeinvestmentprojectstakenbythemudharib (entrepreneurs)inordertogainpositivereturns;

TheprincipleofNorisk,noreturn(AlGhunm bil Ghurm)applies thatis,earningprofitislegitimizedonlybyengaginginaneconomicventure,risksharingandtherebycontributingtotheeconomy;

Isinsuringthesetypesofdepositscompatiblewithshariah rulings?


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BackgroundofInsuringShariah Based

Deposits TurkeyissaidtobethefirstcountrytoofferIslamicdepositinsurance

schemein2003;

This

scheme

only

invests

the

deposit

insurance

pool

according

to Islamic

investmentprinciples;

TheschemeismanagedbytheAssociationofSpecialFinanceHousesofTurkeybutregulatedbytheBankingRegulationandSupervisionBoard;

MalaysiaandIndonesiahaveintroducedtheIslamicDepositInsurance

parallel

with

the

conven

onal

counterpart

in

2004/2005; TheIADIhasestablishedIslamicDepositInsuranceGroup tostudyIslamic

depositinsuranceissuesandexpectedtocompletetwodraftsoninsuringIslamicdeposits: ApproachesinDesigningIslamicDepositInsurance;and

DepositInsurance

from

the

Shariah Perspective

TheMDIChashostedaConferenceonIslamicFinanceandIslamicDepositInsuranceataGlance,inAugust2008.

What Are Types of Deposits Covered


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WhatAreTypesofDepositsCovered

UnderDepositInsurance:TheMalaysian

CaseInsuredDeposits UninsuredDeposits

Fixeddeposits,currentaccounts,savings

accounts,jointaccountsandtrustaccounts

Conventionalstructuredproductsthatare

notprincipalguaranteed

AllIslamicdeposits* DepositspayableoutsideMalaysia

Principalguaranteedconventional

structureddeposits

Interbankmoneymarketplacements

Foreigncurrencydeposits Negotiableinstrumentsofdepositheldby

banks

Negotiableinstrumentsofdepositheldby

nonbanks.

Repurchaseagreements

Source:www.pidm.gov.my

*AnIslamicdepositinsurancefund,fundedbypremiumscollectedoninsured

Islamicdeposits,willbeseparatelymaintainedtoensurethatthecoverageaccorded

toIslamicdepositsfullycomplywithShariah principles.


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Insurance

Premium:

The

Case

of

MDIC Annualpremiumsareassessedbasedonthe

amountof

insured

Islamic

deposits

held

as

at

31Decemberoftheprecedingyear.

2005 2007:

Thepremiumswereassessedonaflatratebasis,i.e.0.06%ofTotalInsuredDeposits.

2008onwards:

MDICimposeslevypremiumsonmemberinstitutions

atdifferentialrates,basedonthememberinstitutionsriskprofile.


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InsurancePremium:TheCaseofMDIC

FirstPremium:Anewmemberinstuon[asdefinedinregulaon2oftheMDIC(DifferentialPremium

Systems)Regulaons2008]holdingIslamicinsureddepositsorconventionalinsureddeposits,therateforthefirstpremiumforsuchnewmemberinstitutionshallbethesameasthepremiumratefor

category1; TransitionalintoDifferential

Premium:Inrespectoftheassessmentyearof2008only,theannualpremiumrateforpremiumcategory3willapplytoanymember

institutionclassifiedinpremiumcategory4.

Source:www.pidm.gov.my andMDIC.AnnualReport2008.

H D th D it I


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HowDoestheDepositInsurance

Work?TheCaseofMDIC ToensurethattheIslamicdepositinsurance

system

complies

with

Shariah principles,

deposit

insurance(theinsurancecontract)isbasedontheconceptsofKafalah (guarantee)andTabarru(donation);

Inlinewiththeseprinciples,therelevantmemberinstitutionsmakedonationstotheMalaysiaDepositInsuranceCorporation(MDIC),whichthenprovidesdepositorswithcoverageandensurespayoutsintheeventoffailure.


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Shariah ViewsonDepositInsurance

TheObjectivesofDepositInsuranceforIslamicBanks; Thepublicconfidencefactorisparamounttoprotectdeposits

andultimatelyensurestabilityofanybankinginstitution.Oneofthesafetynetarrangementstoprotectthebankingsystemisthroughthedepositinsurancescheme;

Themainobjectiveofthedepositinsuranceschemeinthebankingsystemistominimizedepositors riskoflosingtheir

deposits; InIslamicbanking,theimplementationofdepositinsurance

schemeisequallyimportant,toensurethattheIslamicbankingdepositsareabletocompete withtheconventionaldeposits,inattractingcustomers;

ThemainissuehereiswhetherIslamicbankinginstitutionscanapplythesamefacility.


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Last

Words ThepositiontakenbytheBNMs Shariah Advisory

CouncilisintandemwiththeIADIs viewthat SinceinvestmentdepositswithPLSarrangementsform

thebulkofIslamicdeposits,thesystemmightloseitseffectiveness andhavedifficultyinmaintainingthepublicconfidence ifsuchdepositsarenotcoveredunderthe

system... (IADI.ResearchLetter

,Vol.

1,

Issue

3,

July

18,

2006)

Ineithersystem,adepositinsurancesystemmayleadtotheclassicproblemofmoralhazard;

Howtomitigatetheproblemofmoralhazardand

otherrelatedproblemsassociatedwithdepositinsurancearebeyondthescopeofthepresentdiscussions.


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Summary

&

ConclusionsLastwords;

CommentsandSuggestions;


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ThinkingofBecominganEconomist?

Courtesy:http://gregmankiw.blogspot.com/

September02,09

ThinkAgain


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ThankYou

[email protected]

www.inceif.org


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FurtherReadings

BankNegaraMalaysia.Shariah ResolutionsinIslamicFinance.KualaLumpur:March2007.

DemirgKunt,

Asli,

Baybars Karacaovali,

and

Luv Laeven.

Deposit

InsuranceAroundtheWorld:AComprehensiveDatabase.

Elgari,MohammadAli.GuaranteebytheIslamicBankoftheInvestmentDeposit.J.KAU:IslamicEcon.,Vol.16,No.2,2003,pp.2327.

Ernst&Young.IslamicFundsandInvestmentsReport.Variousyears.

IADI.WhatistheNatureofIslamicBanking?ResearchLetter.Vol.1,Issue3,July18,2006.

McLeod,RossH.IndonesiasNewDepositGuaranteeLaw.AustralianNaonalUniversity.2005.

TheBanker.Top500IslamicFinancialInstuons.Variousyears.

www.pidm.gov.my

Shariah Rulings:


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Shari ah Rulings:

CapitalGuaranteevs.Protection AAOIFI(Shariah StandardNo.13)

Thecapitalproviderispermittedtoobtainguaranteesfromthemudharib thatareadequateandenforceable.Thisiscircumscribedwithaconditionthatthe capitalproviderwillnotenforcetheseguaranteesexceptincasesofmisconduct,negligenceorbreachofcontractonthepartofmudharib.[6/0]

Dallah AlBaraka Itisnotpermissibleforaninvestortodemandfromtheentrepreneur(mudharib)topayhima

fixedpercentageofthevalueofthecontract,besidesthecapitalsum,irrespectiveoftheamountofinvestmentinvolvedorwhethertheprojectisprofitableorinloss.Suchacontractisunlawfulbecauseitinvolvesaguaranteefromtheentrepreneurrespectingthecapitalsum,whereasamudharib isatrusteeandcannotbeheldresponsibleforthecapitalsum exceptincasesoftransgressionornegligence.[alBaraka firstsymposium,FatwaNo.2]

Majelis Ulama Indonesia Inprinciple,thecapitalshouldnotbeguaranteesunlessthelossofcapitaliscausedbythe

negligenceoftheentrepreneur.[FatwaNo:07/DSNMUI/IV/2000]

Insuring Shariah Based Deposits

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