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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Wiley Finance Series
- Sprache: Englisch
A complete, detailed guide to modern Islamic banking fundamentals
Modern Islamic Bankingprovides a comprehensive, up-to-the-minute guide to the products, processes and legal doctrines underlying Islamic banking. Written by a pioneering practitioner in the field, this book provides thorough guidance and expert-level perspective on the principles and applications of this alternative-banking model. You'll begin by learning the fundamentals, vocabulary and key concepts of Islamic banking, then explore key products including istisna'a, murabaha, musharaka, ijara, sukuk, and salam. Coverage then moves into practical applications of Islamic products to a variety of contexts including asset management, treasury, risk management, venture capital, SME finance, micro-finance and taxation. Regulatory frameworks are discussed in detail, including extensive coverage of post-financial crisis Islamic bank valuation.
Islamic banking has experienced rapid growth over the past decade, a trend that is set to continue given the sector's successful weathering of the financial crisis. This book brings you up to speed on this alternative way of banking, and shows you how it applies within your own current practices.
- Understand the principles of Islamic banking and finance
- Learn the products, vocabulary and key concepts of the field
- Consider the applications in a variety of financial contexts
- Explore the regulatory frameworks and valuation of Islamic banks
Islamic banking practices differ from Western banking in fundamental ways — it's these differences that shielded the sector during the global crisis, but they also require practitioners to understand a whole new set of rules, products and practices. Modern Islamic Banking gives you a solid understanding of the fundamentals and expert insight into modern practical applications.
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Seitenzahl: 390
Veröffentlichungsjahr: 2016
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Table of Contents
Series Page
Title Page
Copyright
Dedication
List of Figures
List of Tables
Acknowledgements
About the Author
Introduction
Chapter 1: Historical Developments
1.1 The History of Finance
1.2 The History of Islamic Finance
Chapter 2: Economic Principles
2.1 Early Economic Thought
2.2 The Prohibition of Interest
2.3 Modern Economics and Banking
2.4 Islamic Ethics
2.5 Contracts and Prohibitions
2.6 Sharia'a and Prohibitions
Chapter 3: Islamic Finance Products Explained
3.1 Definitions
3.2 The Asset
3.3 Transaction Types
3.4 Bond-Like Instruments
Chapter 4: Distribution of Islamic Products
4.1 Distribution Channels and Sharia'a Compliance
4.2 Sharia'a Compliant versus Sharia'a Based
4.3 Competition or Opportunity
Chapter 5: Application of Islamic Products in Retail Finance
5.1 Current Accounts
5.2 Credit Cards
5.3 Deposit Accounts
5.4 Funds
5.5 Mortgage Products
5.6 Personal Loans
5.7 Transfers
Chapter 6: Application of Islamic Products in Treasury
6.1 Interbank Liquidity
6.2 Hedging
6.3 Combination of Transaction Types
6.4 Asset-Based Securities
6.5 Syndication
Chapter 7: Application of Islamic Products in Corporate Finance
7.1 Trade Finance
7.2 Project Finance
7.3 Property Finance
7.4 Leasing
Chapter 8: Application of Islamic Products to Private Equity
Chapter 9: The Role of the London Metal Exchange
9.1 The London Metal Exchange
9.2 Warrants
9.3 LME Base Metals
Chapter 10: Asset Management
10.1 Selection of Sharia'a Compliant Investments
10.2 Types of Funds
Chapter 11: Risks in Islamic Banks
Chapter 12: Governance
12.1 Roles
12.2 Social Responsibilities
12.3 Structures and Variations of Sharia’a Supervisory Boards
12.4 Serving on Multiple Boards
Chapter 13: The Islamic Financial Infrastructure
13.1 Regulatory Institutions
13.2 Socially Responsible Investments and Micro-finance
13.3 The Case for LIBOR
Chapter 14: Capital Adequacy Concerns
14.1 Challenges within the Basel Capital Adequacy Framework
14.2 IFSB Capital Adequacy Standards
14.3 Capital Adequacy for Islamic Banks around the World
14.4 Expected Future Developments in Capital Adequacy
Chapter 15: How to Value a Bank
15.1 The Components
15.2 The Models
15.3 The Special Case of Banks
15.4 The Special Case of Islamic Banks
15.5 Can a Bank be Valued?
Chapter 16: The Future
Glossary
Select Bibliography
Index
End User License Agreement
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Guide
Cover
Table of Contents
Begin Reading
List of Illustrations
Chapter 2: Economic Principles
Figure 2.1 Dimensions of Islam
Chapter 3: Islamic Finance Products Explained
Figure 3.1 Simple
musharaka
transaction
Figure 3.2 Simple
mudaraba
structure
Figure 3.3 Simple
murabaha
structure
Figure 3.4 Operating lease
Figure 3.5 Finance lease
Figure 3.6 Simple
salam
structure
Figure 3.7 Simple
istisna
structure
Figure 3.8 Simple parallel
istisna
structure
Figure 3.9 Parties involved in a letter of credit transaction
Figure 3.10 Simple
arbun
structure
Figure 3.11 Generic
sukuk
structure
Figure 3.12
Sukuk al musharaka
Figure 3.13
Sukuk al mudaraba
Figure 3.14
Sukuk al ijara
Figure 3.15
Sukuk al salam
Figure 3.16
Sukuk al istisna
Chapter 5: Application of Islamic Products in Retail Finance
Figure 5.1 Two-tier
mudaraba
or
wakala
structure for savings accounts
Figure 5.2 Two-tier
mudaraba
or
wakala
structure for fund management
Figure 5.3 Lease for personal finance
Figure 5.4
Murabaha
for personal finance
Figure 5.5 Commodity
murabaha
for personal finance
Chapter 6: Application of Islamic Products in Treasury
Figure 6.1 Simple commodity
mudaraba
structure
Figure 6.2 Commodity
murabaha
, deposit given
Figure 6.3 Commodity
murabaha
, cash and warrant flow
Figure 6.4 Reverse commodity
murabaha
, deposit taken
Figure 6.5 Reverse commodity
murabaha
, cash and warrant flow
Figure 6.6 Tawarruq
Figure 6.7 Two-tier
wakala
structure for liquidity management
Figure 6.8 Exchange of deposits
Figure 6.9 Profit rate swap
Chapter 7: Application of Islamic Products in Corporate Finance
Figure 7.1 Murabaha in trade finance
Figure 7.2 Tawarruq in trade finance
Figure 7.3
Musharaka
transaction in project finance
Figure 7.4
Istisna
in project finance
Figure 7.5 Lease applied to property finance
Figure 7.6 Sale and lease-back applied to property finance
Figure 7.7
Salam
for property development
Figure 7.8
Istisna
in property finance, financing developer
Figure 7.9
Istisna
in property finance, financing end client
Figure 7.10
Tawarruq
in property finance
Figure 7.11 Finance lease
Chapter 8: Application of Islamic Products to Private Equity
Figure 8.1
Musharaka
transaction for private equity
Chapter 12: Governance
Figure 12.1
Sharia’a
approval process for a new product or structure
Figure 12.2
Sharia’a
approval process for changes to an existing product or structure
Figure 12.3 Role of the SAB within the industry
List of Tables
Chapter 1: Historical Developments
Table 1.1 Selected entries from the Code of Hammurabi
Chapter 3: Islamic Finance Products Explained
Table 3.1 Selected word list
Chapter 7: Application of Islamic Products in Corporate Finance
Table 7.1 Rental payment components
Chapter 9: The Role of the London Metal Exchange
Table 9.1 LME base metals
Chapter 11: Risks in Islamic Banks
Table 11.1 Types of risks for conventional banks
Chapter 14: Capital Adequacy Concerns
Table 14.1 Risk weight for
sukuk
in the trading book (IFSB)
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Modern Islamic Banking
Products and Processes in Practice
NATALIE SCHOON
This edition first published 2016
© 2016 John Wiley & Sons Ltd
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Library of Congress Cataloging-in-Publication Data
Names: Schoon, Natalie, author.
Title: Modern Islamic banking : products, processes in practice / Natalie Schoon.
Description: Chichester, West Sussex : John Wiley & Son, 2016. | Series: The Wiley finance series | Includes bibliographical references and index.
Identifiers: LCCN 2015043806 (print) | LCCN 2015049132 (ebook) | ISBN 9781119127208 (hardback) | ISBN 9781119127222 (ePDF) | ISBN 9781119127215 (epub)
Subjects: LCSH: Banks and banking–Islamic countries. | Banks and banking–Religious aspects–Islam. | Finance–Islamic countries. | Finance–Religious aspects–Islam.
Classification: LCC HG3368.A6 S343 2016 (print) | LCC HG3368.A6 (ebook) | DDC 332.10917/67–dc23
LC record available at http://lccn.loc.gov/2015043806
Cover Design: Wiley
Cover Image: © javarman/Shutterstock
To Basil for being my best friend, and for occasionally being patient
List of Figures
Figure 2.1 Dimensions of Islam
Figure 3.1 Simple
musharaka
transaction
Figure 3.2 Simple
mudaraba
structure
Figure 3.3 Simple
murabaha
structure
Figure 3.4 Operating lease
Figure 3.5 Finance lease
Figure 3.6 Simple
salam
structure
Figure 3.7 Simple
istisna
structure
Figure 3.8 Simple parallel
istisna
structure
Figure 3.9 Parties involved in a letter of credit transaction
Figure 3.10 Simple
arbun
structure
Figure 3.11 Generic
sukuk
structure
Figure 3.12
Sukuk al musharaka
Figure 3.13
Sukuk al mudaraba
Figure 3.14
Sukuk al ijara
Figure 3.15
Sukuk al salam
Figure 3.16
Sukuk al istisna
Figure 5.1 Two-tier
mudaraba
or
wakala
structure for savings accounts
Figure 5.2 Two-tier
mudaraba
or
wakala
structure for fund management
Figure 5.3 Lease for personal finance
Figure 5.4
Murabaha
for personal finance
Figure 5.5 Commodity
murabaha
for personal finance
Figure 6.1 Simple commodity
mudaraba
structure
Figure 6.2 Commodity
murabaha
, deposit given
Figure 6.3 Commodity
murabaha
, cash and warrant flow
Figure 6.4 Reverse commodity
murabaha
, deposit taken
Figure 6.5 Reverse commodity
murabaha
, cash and warrant flow
Figure 6.6 Tawarruq
Figure 6.7 Two-tier
wakala
structure for liquidity management
Figure 6.8 Exchange of deposits
Figure 6.9 Profit rate swap
Figure 7.1 Murabaha in trade finance
Figure 7.2 Tawarruq in trade finance
Figure 7.3
Musharaka
transaction in project finance
Figure 7.4
Istisna
in project finance
Figure 7.5 Lease applied to property finance
Figure 7.6 Sale and lease-back applied to property finance
Figure 7.7
Salam
for property development
Figure 7.8
Istisna
in property finance, financing developer
Figure 7.9
Istisna
in property finance, financing end client
Figure 7.10
Tawarruq
in property finance
Figure 7.11 Finance lease
Figure 8.1
Musharaka
transaction for private equity
Figure 12.1
Sharia’a
approval process for a new product or structure
Figure 12.2
Sharia’a
approval process for changes to an existing product or structure
Figure 12.3 Role of the SAB within the industry
List of Tables
Table 1.1 Selected entries from the Code of Hammurabi
Table 3.1 Selected word list
Table 7.1 Rental payment components
Table 9.1 LME base metals
Table 11.1 Types of risks for conventional banks
Table 14.1 Risk weight for
sukuk
in the trading book (IFSB)
Acknowledgements
When I first started to research Islamic finance, the thing I missed most was a book that would give me some indication of how this new type of finance fitted in with other parts of the financial industry. With that not being available, I started to compile a large selection of notes, which eventually made their way into this book. It has been discussed and debated with many people around the world, and it has been proofread and commented on by some of my best friends. I have listened to feedback from students, scholars and practitioners and hope I have not omitted any valuable information.
It all started when I was living in Bahrain and Kuwait, and I owe a lot of what I know about Islamic finance to Professor Simon Archer who supervised my PhD thesis and his co-supervisor Professor Rifaat Abdel Karim. The list of other people who have helped and supported me is too long to include in just a page, and I would be too worried lest I accidentally omitted anyone. Suffice to say, you know who you are and you have my heartfelt thanks and appreciation. Any mistakes, errors and omissions that remain are mine.
About the Author
Natalie Schoon is Principal Consultant with Formabb, providing advisory services and training for financial institutions in Islamic finance, treasury, risk management, and rules and regulations. She is on the board of advisors of Noriba Investing, which manages halal investment portfolios for its clients, and is a visiting fellow at the ICMA Centre in Reading. She is also an accredited trainer for the Islamic Finance qualification offered by the Chartered Institute of Securities and Investments. Natalie is a Chartered Financial Analyst and Certified Anti Money Laundering Specialist, and holds a PhD in Financial Valuations for Banks and Islamic Banks, an MBA in Banking and Finance and a Master of Laws in Islamic and Middle Eastern Law (with Distinction). She has worked for financial institutions including ABN Amro, Gulf International Bank, Barclays capital and the Bank of London and the Middle East. She has designed and implemented Islamic financial structures for a fund lending to agricultural and agriculture-related businesses for a USAID-funded programme in Afghanistan and is currently working on a solution for access to (Islamic) finance for female entrepreneurs.
Introduction
With an estimated size of around $1.5 trillion at the end of 2014, Islamic financial services still form a relatively small part of the overall financial industry. The balance sheets of large conventional banks such as HSBC and Citi, for example, easily exceed double that size. Regardless, the Islamic financial services industry has shown remarkable growth in recent decades, with reported growth rates of 15–20% per annum. This level of growth is expected to continue for the coming years and by far exceeds the anticipated rate of growth in conventional finance. The increase in wealth resulting from the rise in oil prices and the subsequent requirements for investments in oil-producing countries are a large contributor to the expansion of the Islamic finance industry. As a side effect of the current financial crisis, the ethical principles underpinning Islamic financial services have attracted more attention from both Muslims and non-Muslims.
Globally, we see a growth in both number and size of fully Sharia'a compliant financial institutions, as well as the offering of Sharia'a compliant financial products by conventional banks using different distribution channels. Although the term “conventional” is often associated with conservative and low-risk banking, in the context of this book the term “conventional” is used to identify the financial institutions that have long formed the majority of the financial infrastructure and are not specifically based on Islamic principles. As we have seen in the recent period since the end of 2007, these can by no means be labelled “conservative”.
The principles that form the basis of Islamic finance are long-standing and can be traced back through time to the profit- and loss-sharing principles outlined in the Code of Hammurabi in the eighteenth century bc. Philosophers and theologians alike have debated the issues surrounding the justness of exchange and the charging of interest.
The modern-day history of Islamic finance began in the early 1960s with a small mutual savings project in Egypt, and has grown into a multibillion-dollar industry. Although it is too early to say whether Islamic finance will become mainstream, it certainly provides a viable alternative to other banking services.
This book has a number of distinct sections, and starts with the history of finance before looking into more detail at the ethical principles underpinning Islamic financial services and the Islamic law of contract. This is followed by the generally accepted prohibitions in Sharia'a as they relate to finance, and a generic explanation of the best-known Islamic financial products. The transaction types are divided into four main categories: partnership contracts; instruments with predictable returns; other instruments; and bond-like instruments (sukuk).
The theoretical background of the different transaction types is followed by an overview of how these are implemented in practice in retail finance, treasury, corporate finance, private equity and asset management. In addition, less well-known areas of the financial industry such as micro-finance, agriculture finance and cooperative finance will be considered. There is some overlap between the theoretical definitions of the products in Chapter 3 and their application in Chapters 5–8 and 10 to aid the reader. The role of the London Metal Exchange (LME) and the metal warrants is significant, due to their use in commodity murabaha transactions, and is detailed in Chapter 9.
There is, however, more to Islamic banks than just the products and services they provide. Similarly to conventional banks, they inherently run risks as part of their operations. How these risks compare and differ is explored further in Chapter 11. Unlike conventional banks, Islamic banks have an additional body of governance, the Sharia'a supervisory board, whose role it is to ensure, among other things, ex-ante and ex-post compliance with Sharia'a, as described in Chapter 12. Additional regulatory issues are addressed in Chapter 13, followed by capital adequacy and a brief overview of bank valuation in Chapters 14 and 15, respectively. The final chapter sheds some light on what the future may have in store.
Dates in this book refer to the Gregorian (commonly termed “Christian”) calendar, which is based on the rotation of the earth around the sun and consists of 365 days (366 in a leap year). The Islamic (or Hijri) calendar is based on the orbit of the moon around the earth, which adds up to 354.36 days per year. The year count in the Hijri calendar starts at the migration of the Prophet Mohammed and his followers to Medina (Hijra) in the year ad 622. The year ad 2015, for example, equates to 1436 Hijri or 1436 H, which started on 24 October 2014.
CHAPTER 1Historical Developments
The evolution of Islamic finance in modern history is only a small part of overall banking history, and in its current form only spans a period of around 60 years. This does not imply that Islamic finance did not exist prior to the mid-1960s. Comparable to other modes of financing, it has gone through periods of increased as well as diminished popularity, and ceased to exist for long periods of time. This chapter will look at the general history of banking as well as the way Islamic finance has evolved.
1.1 The History of Finance
Financial services have historically always played an important role in the economy of every society. Banks mobilise funds from investors and apply them to investments in trade and business. Although the actual origin of banking is difficult to determine, the history of banking is long and varied, and the financial system as we know it now is generally ascribed to the Florentine bankers of the fourteenth to seventeenth centuries ad.1 The word “bank”, for example, is derived from the Italian word banco (for the merchant's bench). Interestingly enough, the word “bank” also assists in tracing the origins of “bankruptcy”, which relates to the breaking of a merchant's bench in medieval Italy as a signal of failure. Whether it be safe keeping, money changing, investing funds on behalf of others or making other capital goods such as land available at a charge, financial services have been around in some form for a long time. Even pre-dating the invention of money, safekeeping of valuables was long a task ascribed to religious temples. Deposits would initially have consisted of grain, but also other valuable goods such as cattle and agricultural implements, followed by precious metals such as gold. The latter would typically have been stored in a form that was easy to transport such as plates or bars. There were good reasons to store valuables in temples: the continuous stream of visitors would make it difficult for any thief to go about his business unnoticed, in addition to which they tended to be well built, making them secure. Perhaps even more importantly, temples were sacred places that were deemed to provide additional protection against potential thieves.
Evidence exists of priests in Babylon lending money to merchants as early as the eighteenth century bc, and the Code of Hammurabi,2 believed to have been written around 1760 bc, includes laws governing banking operations in ancient Mesopotamia. Although not the first known law, it is the best-preserved one. Table 1.1 provides some examples of the laws in the code that are related to financial services.
Table 1.1 Selected entries from the Code of Hammurabi
Law
Description
48
If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not grow for lack of water; in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.
49
If any one take money from a merchant, and give the merchant a field tillable for corn or sesame and order him to plant corn or sesame in the field, and to harvest the crop; if the cultivator plant corn or sesame in the field, at the harvest the corn or sesame that is in the field shall belong to the owner of the field and he shall pay corn as rent, for the money he received from the merchant, and the livelihood of the cultivator shall he give to the merchant.
50
If he give a cultivated corn-field or a cultivated sesame-field, the corn or sesame in the field shall belong to the owner of the field, and he shall return the money to the merchant as rent.
51
If he have no money to repay, then he shall pay in corn or sesame in place of the money as rent for what he received from the merchant, according to the royal tariff.
52
If the cultivator do not plant corn or sesame in the field, the debtor's contract is not weakened.
119
If any one fail to meet a claim for debt, and he sell the maid servant who has borne him children, for money, the money which the merchant has paid shall be repaid to him by the owner of the slave and she shall be freed.
121
If any one store corn in another man's house he shall pay him storage at the rate of one gur for every five ka of corn per year.
In addition, any compensation for loss of articles in safekeeping and the amount of rent to be paid for having the usufruct3 of land and different species of livestock was clearly defined.
In the Roman Empire, money lenders would conduct their transactions from benches in the middle of enclosed courtyards rather than setting up shops. The ancient Roman money lenders merely converted any currency into the currency of Rome, which was the only legal tender in the city, and are not known to have provided any further financial services.
At the time of the ancient Greeks, bankers not only converted currency but also invested in projects and other businesses. Banking was no longer restricted to temples, and other entities such as money changers also conducted financial transactions including loans, deposits, exchange of currency and validation of coins. Trade finance, in the form of letters of credit, flourished. Money lenders in one city would, against a fee, write a credit note that could be cashed elsewhere in the country, which meant that no coins needed to be carried around on their journey, nor did guards have to be hired to protect it. Interestingly enough, most of the early bankers in Greece were foreign residents, and there is little known about the individual bankers themselves, although records have been found relating to Pasion (c.430–370 bc), originally a Phoenician slave, who rose to be one of the wealthiest citizens in Athens and owned one of the most successful private banks in Athens.4
Credit-based banking spread in the Mediterranean world from the fourth century bc. In Egypt grain has long been one of the most used forms of money, in addition to precious metals. State granaries functioned as banks, and when Egypt briefly fell under Greek rule, the government granaries were transformed into a network of grain banks with a centralised head office function in Alexandria. Payments could be effected by transfers between accounts without any physical money changing hands.
The Romans then perfected the administrative aspect of banking and introduced enhanced regulations of financial institutions, in the wider sense of the word. The practice of charging and paying interest developed further and became more competitive. However, as a direct result of the Romans' preference for cash, the development of the banking system itself was limited. Additional restrictions were introduced on the banking system by theologians and philosophers, mainly due to the fact that the charging and paying of interest was deemed to be immoral. With the fall of the Roman Empire, banking declined significantly in western Europe and did not feature again until the time of the Crusades from the late eleventh century ad.
The Crusades, in combination with the expansion of European trade and commerce, led to an increase in the demand for financial services. As a result of people travelling to a variety of different countries, there was a significant demand for money-changing services. Any service that would make it possible to transfer large sums of money without the complications of having to carry chests full of gold around and requirements for elaborate precautions against theft was particularly in demand. Crusades were expensive and the participants often had to borrow money, which was regularly done by mortgaging land and buildings. The terms were, however, far more favourable to the lender than to the borrower, as a result of which the demand for mortgages deteriorated over time.
The development of international trade led directly to the requirement for a foreign exchange type contract, the first of which was recorded in 1156 in Genoa.5 The use of these types of contracts expanded significantly, not only because of the requirements following the development of international trade, but also since profits from time differences in a foreign exchange contract were not covered by canon laws against usury.
Financial contracts of this time were largely governed by Christian beliefs, which prohibited interest on the basis that it would be a sin to pay back more or less than what was borrowed. In addition, justness of price and fairness were important underlying guiding principles that applied to society as a whole and included financial services. The evolution from an interest-free to an interest-based banking system did, of course, not happen overnight, but was based on a number of factors such as the change from agrarian to commercial economies, the move towards pricing on the basis of supply and demand, decentralisation of the Church, and the recognition of money as a factor of production.6
During the Middle Ages, until the thirteenth century, the Church was the largest single entity possessing significant wealth and was an important lender. However, the impact of the Church declined, and as commerce flourished and generated more wealth than could be reinvested in commerce alone, it was the merchants who lent the money to finance individual and government consumption.7 Initially only lending their own money, some of the merchants became merchant bankers lending both their own capital as well as capital deposited with them by others.
While in most of Europe the Christian prohibition of usury was still in place, charging interest was, however, legalised in Valencia in 1217 and Florence in 1403. The legalisation of interest in Florence was more significant for the development of the banking industry as we know it now since the Florentine bankers, who already had a presence in a number of European countries, started to offer loans and deposits on an interest basis.
In the UK, London was the main centre of trade and hence the majority of financial transactions were executed there, mainly from the many coffee houses in the City. In 1565, the Royal Exchange was established in London to act as a centre of commerce, and some of the banking business moved there too. However, during the seventeenth century stockbrokers were expelled due to their rather rowdy behaviour, and the buying and selling of stocks was again confined to the coffee houses.
In the early part of the seventeenth century Amsterdam started to grow into a major trade hub, which in turn resulted in it becoming the financial centre of the world. It managed to maintain this position until the Industrial Revolution in the late eighteenth and early nineteenth centuries, and was home to the first ever recorded economic bubble, due to tulip mania. The tulip was first brought to Holland in 1593 from the Ottoman Empire, and became so popular that in 1623 a single tulip bulb could fetch as much as 1,000 florins, which was equivalent to 6.7 times the average annual income. By 1636 the price had risen to unsustainable heights, and the bubble burst in 1637 as a result of an absence of buyers and abundance of sellers. Tulip mania8 was only the first economic bubble of its kind. Inflated asset prices have since given rise to a multitude of busts and booms, the most recent ones being the dot.com boom and the subprime mortgage crisis.
The Industrial Revolution put America and the UK firmly on the map of international finance. With this shift of emphasis, the banks in these countries gradually gained importance over time. London and New York became the major financial hubs, later on joined by Hong Kong, Tokyo and Singapore. The main financial centre in the Middle East has long been Lebanon, until the war broke out in 1972 and the banks started to move to Bahrain and later Dubai. Increasing internationalisation in trade, commerce and manufacturing applies to banks as well and was often achieved by a combination of the establishment of new branches and acquisitions. In addition, banks started to offer financial services across the whole spectrum, from retail to wholesale, with the side effect that the once numerous small banks have now mainly merged into a few large conglomerates offering increasingly complex financial solutions. Few relatively small banks remain.
The events of 2007 and 2008, beginning with the subprime crisis, which was largely considered to be an American problem, led to unprecedented liquidity problems and resulted in the bankruptcy of Lehman Brothers9 and the forced sale of others such as Bear Sterns in March 2008 and Merrill Lynch in September 2008.
1.2 The History of Islamic Finance
During medieval times, Middle Eastern tradesmen would engage in financial transactions on the basis of Sharia'a, which incidentally was guided by the same principles of justness in exchange and prohibition of usury that were also applied by their European counterparts at the time. They established systems without interest that worked on a profit- and loss-sharing basis. These instruments catered for the financing of trade and other enterprises and worked very effectively during and after the era known as the Islamic civilisation, which lasted from the late sixth to the early eleventh century ad. Over time, Western countries started to play a more and more important role in the world economy and as a result Western or conventional financial institutions became more dominant.
As the Middle Eastern and Asian regions became important trading partners for European companies such as the Dutch East India Company, European banks started to establish branches in these countries. The finance system they introduced was typically interest-based. On a small scale, credit union and co-operative societies continued to exist but the scale of their activities was very much focused locally on small geographical areas.
Although it was not until the mid-1980s that Islamic finance started to grow exponentially, the first financial company in recent history based on Sharia'a principles was the Mit Ghamr savings project in 1963. This financing project worked on a co-operative basis, and depositors had the right to take out small loans for productive purposes. In addition, the project attracted funds to invest in projects on a profit-sharing basis. The Mit Ghamr savings project was set up to allow the local population to have access to banking services and, where possible, to obtain a return on their money. In 1971 the project was incorporated in Nasser Social Bank. Around the same time as the Mit Ghamr savings project, financial services based on Sharia'a were set up in Malaysia, again to cater for the generally under-banked Muslim population. The earliest financial services offered in Malaysia were savings plans for the pilgrimage (hajj) to Mecca.
In 1975, the Islamic Development Bank was established in Jeddah as a multilateral development bank assisting in mobilising funds for investment for projects in the member states. In the same year, the Dubai Islamic Bank was founded in the United Arab Emirates as the first privately established Islamic bank.
The years since 1975 have seen the establishment of many more banks and the development of the industry into a multibillion-dollar market. It is no longer just small banks offering Islamic finance. These banks themselves are growing, and large conventional banks are offering Islamic finance through their “Islamic windows”. Fully Sharia'a compliant banks and conventional banks are actively working together to offer Islamic finance, utilising some of the structuring and distribution capabilities of the larger banks. As a result, we are seeing increasingly large transactions being structured. As of 2015, in excess of 25 organisations in the UK are offering Islamic financial services, and the Prudential Regulation Authority (PRA) has regulated seven fully Sharia'a compliant financial institutions.10 The UK is well on the way to achieving its goal to become the largest Islamic financial centre outside the Muslim world. France and the Netherlands have both also announced their intention to become the largest centres for Islamic finance, but the required changes to their tax and regulatory systems have not yet started.
The USA, originally hesitant and only permitting Islamic financial services to be offered offshore, has amended its perception and now also allows Islamic financial services on its territory.
1
Green, E. (1989)
Banking: An Illustrated History
. New York: Rizzoli.
2
The Code of Hammurabi was a comprehensive set of laws, considered by many scholars to be the oldest laws established. Although the Code of Hammurabi was essentially humanitarian in its intent and orientation, it included the “eye for an eye” theory of punishment, which is a barbarian application of the concept of making the punishment fit the crime. The Code of Hammurabi recognised such modern concepts as that of corporate responsibility. See also King, L.W. (2004)
The Code of Hammurabi
, Montana: Kessinger Publishing.
3
Usufruct is the legal right to use and derive profit or benefit from property that belongs to another person. It originates from civil law, where it is a real right of limited duration on the property of another. A lease contract, in which one party allows another to use but not own a good, is a form of transfer of the usufruct.
4
Shipton, K.M.W. (2012) Pasion, Athenian banker. In R.S. Bagnall (ed.),
The Encyclopedia of Ancient History
. Hoboken, NJ: John Wiley & Sons.
5
Two merchant brothers borrowed 115 Genoese pounds to reimburse the bank's agents in Constantinople by paying them 460 bezants one month after their arrival in Constantinople.
6
DiVanna, J. (2008) A cloud is a promise, fulfilment is rain,
New Horizon
, 167, 20–22.
7
Supple, B. (1977) The nature of enterprise. In E.E. Rich and C.H. Wilson (eds),
The Economic Organization of Early Modern Europe
. Cambridge: Cambridge University Press: “Commercial enterprise was more a source than a use of capital” (p. 423).
8
Dash, M. (1999)
Tulipomania
. London: Victor Gollancz.
9
Lehman Brothers was officially deemed a defaulting counterparty on 15 September 2008.
10
The fully Islamic institutions authorised and regulated by the PRA are made up of one retail bank (Al Rayan Bank plc), four wholesale banks (European Islamic Investment Bank, Bank of London and The Middle East plc, Qatar Islamic Bank (UK), and Gatehouse Bank), one investment manager (Tejara Capital (UK)) and one insurance company (Cobalt Underwriting).
CHAPTER 2Economic Principles
With the development of early civilisations in Mesopotamia around 3500 bc came the development of cities, empires and monumental buildings. A form of writing based on pictograms was developed and initially mainly used to exchange information about different crops such as the quality and quantity delivered to a temple for safe keeping and any deductions thereof. Taxes were introduced and early economic thought started to develop.
2.1 Early Economic Thought
In ancient times commercial activities were generally not public enterprises but were actively run by the rulers and other parts of the elite such as the officials of the temples and palaces. The profits did not belong to the public but were typically kept by the elite to enhance their own financial position.
The officials of temples and palaces were in any case best placed to be the main entrepreneurs of the era. They not only were closely associated with the royals of the time, but also had good access to information on economic opportunities in local and distant markets, which they obtained from their extensive networks. Most importantly, however, they had access to the capital required to invest in trade and enterprise.
This is not to say that all entrepreneurs of the time were rulers or temple or palace officials. There is evidence of the existence of independent merchants who would act either on their own behalf or as agents for king or temple. The latter gave rise to a very early form of one of the main theories of economics, the principal–agent problem, also known as the problem of devising compensation rules that induce an agent to act in the best interest of the principal. Given the relatively low numbers of independent merchants acting as agents, however, this problem was not too prominent at the time.
As time went on and trade routes expanded, forms of trade finance developed and, as early as the thirteenth century bc, the concept of trade insurance was introduced in Hittite Anatolia and Syria. Anyone killing a travelling merchant was obliged not only to pay compensation, but also to replace the goods the merchant had with him. Partnerships were set up between neighbouring countries, trade flourished, economies developed and concepts of demand and supply and a just price became important factors.
It was during this time that four interlinked themes started to surface: private property, justice in economic exchange and usury, with money or the value thereof linking all of these together. These have since been researched by Greek philosophers, theologians and Islamic scholars alike at different times over the past millennia. At the time, economics was not recognised as a science, but deemed to be a branch of ethics, which is in turn a branch of theology. It took until the Reformation and the subsequent division of religion and state for economics to become a science in its own right.
Money and Usury
Money and usury have always been subject to debate. As detailed in Section 2.2, the prohibition on interest is not new or unique to any particular religion. During the fourth century bc, Aristotle was of the opinion that money was a medium of exchange, but did not have an intrinsic value of its own since it was merely a human social invention with no utility in itself. Following on from that, it was fairly easy to argue that “a lender of money loses nothing of worth when lending it out”. There is no unambiguous basis for the ban on usury in Christianity, but theologians in the early centuries ad argued that the ban on usury was absolute and without exception.
The debate on the value of money and usury has preoccupied philosophers and theologians over the ages. In practice, however, the lending of money did occur, often by applying transaction types that were structured in a way that interest was circumvented, although the lender would always receive some form of compensation.
The change of society away from being largely agricultural, the growth in international trade and the increasing segregation between the state and religion resulted in the ban on usury being revisited, and by the middle of the seventeenth century it was generally abolished throughout western Europe. The onset of the Industrial Revolution led Adam Smith to argue that capital should be seen as a factor of production just like land, labour and buildings and therefore has a cost or rent associated with it. He did, however, argue that the return should not be based on usury but should only reflect the risk and any opportunity cost.
Private Property
Private property and religion has long been a contentious issue. Within the Abrahamic faiths, property is typically deemed to be owned by God with man having “stewardship”, and any property should be made available for public use. Although the same view is to date held by Islamic scholars, the Church turned against this in the early fifth century ad and began to accumulate significant amounts of property.
In the thirteenth century ad many theologians started to turn against the riches of the Church and to insist on vows of poverty. On the other hand, a large number of theologians believed that private property did not have any moral implications but, rather, had positive effects in stimulating economic activity and hence general welfare. This did not, however, mean that all private enterprise was endorsed, and purely seeking profit for the sake of it was still considered to be a serious sin. Like capital, private property in modern economic thought is seen as one of the factors of production, and the notion of stewardship has long disappeared. In Islamic economics, the notion of stewardship still exists and property should be applied to enhance economic activity.
Justice in Economic Exchange
Is it appropriate to make a profit purely from a difference in price? How large can this difference be before it becomes unreasonable? These are the issues that are associated with the principles of justice in economic exchange. The general perception has always been that profits are acceptable as long as the entrepreneur is not motivated by pure gain and the profit (only just) covers the cost of his labour.
It is not all that simple. At the time of the ancient Greeks, Aristotle advocated that “a just exchange ratio of goods would be where the ratio (or price) would be in proportion to the intrinsic worth of each of the goods in the transaction”. This leads to the conclusion that demand and supply are not taken into consideration at all. The Romans, on the other hand, considered demand and supply to be factors in the determination of price. Their view of a just price was any price agreed between contracting parties, without any consideration for intrinsic value.
During the twelfth and thirteenth centuries, Christian theologians amended their view on intrinsic worth and came to the conclusion that intrinsic value is determined by the “usefulness” of a good to one of the contracting parties. And although usefulness is difficult, if not impossible, to determine, the result was that goods were allowed to exchange at different prices in different places and times. An additional definition stating that “one should not charge for a good more than what he would be willing to pay for it himself” was added, perhaps inadvertently leading to the demand and supply mechanisms that govern modern market economies. Although this was the general view, the opposition was of the opinion that price should purely be related to the cost of production, and any prices over and above the cost were deemed to be artificially inflated. However, these price levels did exist at the time and the leap to thinking about the need for competition and immorality of monopolies was easily made.
