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Tuesday, 26 January 2010

Islamic Banking and Profit Fairness

By Lahem al Nasser (asharq alawsat)

Islamic finance is a moral financial model based on divine principles, the most important of which is justice. There are many Quranic verses and Hadiths that deal with this, such as: "We sent aforetime our messengers with Clear Signs and sent down with them the Book and the Balance (of Right and Wrong), that men may stand forth in justice," [Surat al Hadid; Verse 25]. There is also: "And the Firmament has He raised high, and He has set up the Balance (of Justice)" [Surat al Rahman; Verse 7]. God Almighty also said, "Allah commands justice," [Surat al Nahl; Verse 90]. In a Hadith Qudsi the Prophet [pbuh] narrated the word of God, saying "My servants, I have forbidden injustice for myself and I have made injustice forbidden to you. Do not be unjust to one another." Renowned Islamic scholar al-Izz Ibn Abdul-Salam said that Verse 25 of Surat al Hadid represents the essence of Islam.
It is therefore just that profits should not be inflated to the point that this would invalidate the satisfaction [of the customer]. This is the crux of the matter in Islam, and can be seen in the Quranic verse: "O ye who believe! Squander not your wealth among yourselves in vanity, except it be a trade by mutual consent" [Surat al Nisa; Verse 29] and this is regardless of whether the inflated profit [made by the seller] is known to the buyer such as in the event of purchasing from a monopoly, or whether this increase [on the original price] is not known to the buyer, if the seller conceals the original price of the product.

There are several Hadith that prohibit sellers making large profits on the original price of items or services. In the Sahih Muslim collection of Hadith, it was reported that the Prophet [pbuh] said, "No one hoards but the sinner." Muslim scholars explained the term "hoard" in this instance to mean the hoarding of a commodity that people need in order to sell it later at a higher price. This is something that is forbidden in Islam as it restricts the necessities available to the public. In addition to this, Prophet Mohammed [pbuh] also said, "Any Muslim who transgresses against another Muslim and is unjust then he is the sinner." In another Hadith, the Prophet [pbuh] is quoted as saying: "Injustice of a buyer is riba [usury]."

Religious scholars had different opinions with regards to the amount of profit that is permissible to make. Some of them define this precisely, while others judge this according to local customs [and other factors], which is more reasonable. Therefore Islamic finance should operate in a just manner with regards to profits, and avoid outrageous [profit] inflation, particularly with regards to long-term financing, where the rate of profit is calculated by looking at the total amount of money borrowed, and the duration that this money is borrowed for, without taking into account the amount [of this loan] that has already been repaid.

There can be no doubt that profits are inflated in the financial sector, however such dealings are considered illegal under western laws as western banks differentiate between interest and usury. However this is a distinction that is not acknowledged under the provision of Islamic Sharia law. While this does bring to light the extent of the injustice in how profits are calculated in general, what about Islamic Sharia law that is based upon divine justice?

Unfortunately the Islamic banking system which is supposed to be based on just and ethical principles that themselves are based on a divine system that prevents injustice, has transgressed even the limits of the savage capitalist banking system in terms of the profits that it makes on its operations. By doing so, this causes Islamic financial customers, who are acting with a religious and moral motive [in using Islamic financial institutes] to shoulder a heavy burden, as if they are paying a tax on their [religious] commitment. Although juristic schools have managed to put forward reasons for this, I do not believe that such justifications will last for a number of reasons, such as many [Islamic financial] clients recognize the danger that this method of calculating profit represents to the Islamic financial industry as a whole and so they are demanding justice in how such profits are calculated and for this process to conform to principles of Islamic Sharia that prohibit such profit inflation.

Many scholars today sense the danger that that method of calculating profit represents to the Islamic financial industry as a whole, and that as a result of this the Islamic banking industry appears to be a greedy financial industry that is taking advantage of people's needs in an ugly way, contradicting the Islamic Sharia principles that call for the implementation of justice and the prevention of harm. It is an Islamic Sharia principle that one "should neither be harmed nor do harm [to others]" and that [mutual] satisfaction be the focus of business operations, and this is something that will not be achieved when customers are in dire need or ignorant of the manner in which profit is calculated.

The last reason [for this] and perhaps the most important rationale to putting an end to this phenomenon and restoring matters back to normal with regards to the way in which the profits of the Islamic financial industry are calculated is the intervention of regulatory bodies to provide mechanisms for calculating Islamic finance profits, lending rates, etc. This is something that I expect to happen, especially in Saudi Arabia where the mortgage law is expected to come into effect soon. This mortgage law will be consistent with the provision of Islamic Sharia law, and will deal with one of society's most important needs, the provision of housing. Therefore I do not think that the Saudi Arabian Monetary Agency [SAMA] will pass this [inflated] method of calculating profits onto the banking sector without first imposing certain restrictions and specifications, because this lies at the heart of its regulatory operations.

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Luxembourg aims to become hub for Islamic finance

25 January 2010

Luxembourg took an important first step toward developing the Duchy into the latest European hub for Islamic finance, especially Islamic capital markets, when it published last week a new tax circular on the treatment of a whole range of Islamic finance products including murabaha, musharaka, mudarabah, istisna, ijarah, ijarah wa Iktina and sukuk (Islamic bonds).

A circular from the Director of Contributions, the Luxembourg tax authority, describes the major principles and contracts of Islamic finance and their respective tax treatment. According to the preamble of the Circular, "Islamic finance involves financial instruments used by investors who wish to manage their investments observing the values of Islam. The objective of Islamic finance is to share profits and losses between those who provide the capital and those who use it."

The Director of Contributions identifies two Shariah principles that merit particular attention: "Third party" capital providers (such as banks for instance) cannot in principle play a passive role, but must in contrast act as true "partners"; and the prohibition on lending money (with interest) to third parties. The development and listing of these products must rely on real physical assets (real estate, infrastructure projects or even commodities, like oil, aluminum or wheat). They may not rely on other financial products. Any profit from other financial products, particularly interest, would be considered usury (riba), and as a consequence should be purified in accordance with a criteria generally applicable in Islamic finance.

However, Director of Contributions stresses that undertakings for collective investment under Luxembourg law and investing in Islamic assets are excluded from the scope of this circular.

The circular confirms the classification of sukuk as debt for Luxembourg tax purposes. Consequently, yield payments under the sukuk are treated under domestic tax law as deductible interest expenses at the level of the paying entity. In contrast to many other jurisdictions, the circular confirms that no Luxembourg withholding tax is levied on yield payments.

Having regard for its characteristics, says the circular, "a sukuk may be considered similar to conventional financial debt instruments, the remunerations to the bearer of a sukuk being analyzed fiscally in the same way as interest. By likening it in this manner, the remuneration paid to the holder of a sukuk is deductible, when it is shown that it was generated in the interests of the company. The income from a sukuk would thus be likened to income from movable assets within the meaning of Article 97 (1) 3 L.I.R. (or commercial profit). The fiscal provisions in relation to the providers of funds and to profit-sharing bonds (Articles 146 (1) 2 and 3 and 164 (2) L.I.R.) are not applicable to this type of financial instrument."

As regards the application of double taxation agreements, there is a place for recourse, if necessary, to the procedure for the amicable resolution of any difficulties.

The governor of the Banque centrale du Luxembourg, the central bank, Yves Mersch, has expressed support for sukuk as an alternative and cheaper way to raise finance, fueling speculation that Luxembourg's sovereign may be gearing itself for a debut sukuk issuance. In order to facilitate the emergence of a resilient Islamic financial market in Europe, suggested Gov. Mersch recently in Brussels, "we have to adapt and shape the infrastructure and supervisory environment to allow efficient and cost effective trading and clearing for a significant number of investment-grade Islamic financial papers across the whole maturity spectrum. In this perspective, it is worth noting that in the current turbulent period, raising finance through sukuk issuance appears to be cheaper than recurring to conventional bonds due to the burgeoning demand for Islamic instruments."

The circular treats murabaha as a sale agreement. Consequently, in principle, the profit realized on that sale is acquired by the financier from the signature of the agreement and the entire proceeds of the sale are taxable immediately, including the financier's margin, otherwise called its profit.

Nevertheless, to the extent that, on an economic level, the financier's profit constitutes the remuneration for a deferred payment during that period, that profit may benefit from a spread of taxation on the proceeds for continuous or discontinuous services at successive maturities, remunerated in particular by rents. In other words, the profits are taxed on a linear basis over the term of the payment deferment, whatever the reimbursement.

The above benefits, however, are subject to certain conditions, including, the agreement between the parties must clearly highlight the fact that the financier acquired the property in order to resell it, concomitantly or within a period which may not exceed six months, to its client; the agreement must separately indicate the specific remuneration of the financier for its involvement, with the financier's profit constituting the compensation for a payment deferment, the client's acquisition price and the price for acquisition of the property by the financier; the financier's profits must be clearly stated, known and accepted by the two parties to the agreement; the financier's profits must be expressly indicated as being compensation for the service provided by the financier to the client which results from the effective deferment of payment granted to the investor. There may for example be a clause presenting the profits as "compensation for the payment deferment granted to the purchaser by the vendor, the purchaser undertaking to pay the vendor the profit until the date of final reimbursement"; and with regard to accounts and fiscal aspects, the profits must be spread by the financier on a linear basis over the period of the payment deferment, whatever the reimbursement.

Luxembourg over the last few years has been slowly working toward establishing itself as an Islamic finance hub. Indeed, the Duchy has been the laboratory for Islamic finance in Europe since the late 1970s and early 1980s way before London. Today, there are some 15 sukuk listed on the Luxembourg Stock Exchange with a combined value of 5 billion euros; and over 40 Islamic investment funds, largely equity funds domiciled in Luxembourg.

As a further statement of intent, not surprisingly, in November 2009 the Duchy became the first European country to become an associate member of the Islamic Financial Services Board (IFSB), the prudential standard setting body for global Islamic finance. This is impressive given the fact that both the Financial Services Authority (FSA) in the UK and the Central Bank of France have both resisted in acceding to membership of the IFSB, whose other members include the IMF, Bank of China and the Monetary Authority of Singapore.

To further boost its Islamic finance credentials, Luxembourg recently signed double tax treaties with the United Arab Emirates, Qatar, Kuwait and Bahrain. This, in addition to 56 existing tax treaties that include several Islamic countries. On Jan. 12, 2010 Luxembourg for Finance also signed memoranda of understanding with Bahrain and the Dubai International Financial Center to foster strong existing business relationship and further enhance bilateral cooperation and wide-ranging industry development, including in Islamic finance.

Mersch, one of the most proactive European central bankers as far as Islamic financial inclusion is concerned, recently urged his fellow European regulators to "become more familiar with the principles and practices specific to Islamic finance in order to make appropriate supervisory and regulatory judgments" and maintained that the current needs of Europe's 38 million plus Muslims and those interested in faith-based ethical finance have "not yet appropriately been addressed by the conventional banking offering."

In April last year, the government set up a multi-disciplinary taskforce charged with identifying obstacles to the development of Islamic finance in Luxembourg and ways to support its growth. Working groups on Islamic finance were also formed by the Luxembourg Investment Fund Association (ALFI) and Luxembourg for Finance (LFF).

By Mushtak Parker & Marc Theisen (Arab News)

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Tuesday, 19 January 2010

First German Muslim bank prepares to open

Germany’s first Muslim bank is opening in Mannheim, with plans to set up ten branches across the country offering banking services according to the ethical rules of the Koran.

The Kuveyt Türk Beteiligungsbank, based in Istanbul and Kuwait, is renovating its offices in the south-western city ahead of a planned opening in March, when the plan is to offer day-to-day banking services to the large Muslim community in the region.

Although there is already an Iranian finance institute in northern Germany, it is mostly concerned with export businesses, not with individual customers.

Islamic banking means that a fee is paid for a loan rather than interest, and investments are made only in companies considered to conform to Muslim ethics – this bans buying shares in firms which deal with alcohol, pork or weapons. Highly-speculative investments are also not allowed.

The concept could win over non-Muslims too, as far as Zaid el-Mogaddedi, consultant with the Frankfurt-based Institute for Islamic Banking and Finance, is concerned. He said that although Muslim banks had also been affected by the financial problems of the global financial crisis, they had survived relatively unscathed.

This combined with the ethical element made the idea attractive to new customers. “I believe that this business model could serve as a good example for the new regulation of western banks,” he said.

Michael Gassner, from the Central Council of Muslims, said a Muslim bank could also contribute to better integration in Germany. He said around three quarters of the four million Muslims living here felt closely-tied to the Islamic traditions, with a fifth supportive of the idea of Muslim finance.

“Literally put, he who buys a house feels at home,” he said.

source: The Local
picture: a mosque in Cologne

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Friday, 8 January 2010

Bringing Islamic Banking to India

There are more Muslims in India than there are in Pakistan, which is why it is surprising that successive governments have so far done nothing to bring Islamic banking into India. The consequence of such neglect is that millions of observant Muslims are forced to park their savings in dubious entities,because they have been deprived of financial institutions in India that are Sharia-compliant and avoid the payment of interest,because of its ban in the Quran (3:130).

Indeed, the Quran sets forth some very healthy financial principles,such as the avoiding of the giving of finance to unsavoury businesses (5:2), and the showing of compassion to the financially disadvantaged (2;280). As has been pointed out by several scholars,the prohibition of interest is not unique to Islam,but is also found in Judaism and Christianity ( Psalms 15:5, Nehemiah 5:7). However,throughout the world,the giving and taking of interest has become widespread Financial experts estimate that more than $50 billion of funds from the Gulf can flow to India,should Islamic banking institutions be set up in the country. This will generate 2.7 million jobs in the country,both directly and indirectly. At present,almost all the surplus cash of the Gulf countries is parked in London (which, ironically, is the world’s top “Islamic Banking” centre), New York,Zurich and Frankfurt. Naturally,the financial instititions headquartered in these locations would not like to see India emerge as a competitor in the parking of funds from the Gulf.

They are aware of the strong historical and civilisational ties between India and the Arab world,and are nervous that this may result in funds moving away from them. Indeed,many Arabs are justifiably upset that they have suffered a collective loss of $1.3 trillion because of the numerous malpractices of financial institutions in the US and the EU,and would prefer to place their money in India. However,thus far,because of the immense influence that financial entities in the US and the EU have over the Reserve Bank of India and the Ministry of Finance,thus far, the policy changes needed to attract such funds have not come about So pervasive is the influence of US and EU funds over India’s financial policymakers that the Reserve Bank of India significantly slowed down economic expansion in India during 2007-2008 by raising interest rates to levels not seen in more than a decade.

Although the RBI justified this as an anti-inflation measure,they themselves know that such painful steps have no impact on price rise,caused as this is by speculation and by policies that favour the middleman over the producer and the consumer. All that the policy of high interest rates has done was to make several segments in Indian industry less competitive than they were when interest rates were low. The policies followed by the monetary authorities in India have forced several corporates to borrow money from London and other centres in the developed world,at a profit for these centres of 3%.

Small wonder that there is so much pressure on India to prevent the authorities from taking steps that could attract funds from the Gulf. Had the authorities in India encouraged their domestic companies the way policymakers in the US and the EU unfailingly do,India would not have been in today’s situation,when even tiny Taiwan exports double the volume India does Recently,the government of Kerala,a state that has ties with the Gulf that go back for 1600 years,sought to set up an Islamic Banking division in one of their financial institutions. However, a politician having close links with a section of the Hindu religious leadership has got the Kerala High Court to stay the operationalisation of this move.

India’s courts are famously liberal when it comes to granting stays,with some even lasting for decades.In countries such as the US or the UK, stays are granted only after the court is convinced that there exists a strong prima facie case in favour of the individual making the request. In the case of India, stays by a court are granted far more liberally.The Kerala High Court order means that the attempt by the state’s Communist rulers to set up an Islamic banking system in a state where 20% of the population are Muslims may be indefinitely delayed.Bankers in Europe and in the US can rest easy, knowing that it may be a long time before the estimated $1.16 trillion dollars parked in so-called “Islamic Banking” institutions in these locations faces competition from India

Although it is true that several policymakers allow themselves to be unduly infuenced by interested parties operating overseas,the fact remains that overall,India’s policymakers are a patriotic group. Indeed, with all their faults,India’s administrators have done a commendable job in ensuring a modicum of stability in the face of frequent political upheavals.Hence,this columnist is optimistic that it will not be long before India copies the Malaysian model,and brings Islamic banking into the country. Closer economic interaction between India and the Gulf is in the interests of both sides. The GCC countries and India are complementary in their skills and congruent in their interests. The setting up of Islamic banking divisions within the existing banking network in India would ensure a substantial flow of investible funds into the country.

Of course,none of this money would get diverted to industries such as gambling and alchohol, that are barred in Islam. A beginning has been made by the Jamaat-i-Islami Hind,which has set up a committee on Islamic banking under a noted scholar,Mr Abdur Raqeeb. Some influential policymakers within the Congress Party are also active in seeking to overcome the block to Islamic banking that has been artificially created by international interests keen to ensure that India does not take money away from them India is a secular country,and therefore Islamic banking needs to be seen not as a “Muslim” issue,but as one that involves the welfare of each citizen,whether Muslim,Christian, Hindu, Jain, Sikh or Buddhist. After all, the huge volume of remittances from Indians working in the Gulf benefits the entire country and not simply those belonging to a particular religion. Islamic banking therefore needs to be viewed less as a religious right than as a secular advantage. Allowing India’s observant Muslims to gain access to domestic funds that are Sharia-compliant would ensure that they avoid getting duped by unregulated and often dubious entities that seek to profit from their faith. The Islamic world is India’s natural partner,and one way of strengthening such linkages would be through the introduction of Islamic banking in India Indeed,it can be argued that the healthy financial principles mentioned in the Quran were the earliest enunciation of the “mutual fund” concept. Unless mutual gain comes from mutual effort, and unless moral principles are given primacy in decision-making,the wotkd will witness further man-made catastrophes such as the 2008 financial crash.

This was caused entirely by the greed of some 380 individuals, who were the prime movers in the relentless speculation that artificially drove up the prices of commodities such as foodgrains,copper,steel and oil. Sadly, apart from a handful,not one of the 380 have suffered any legal consequence of their devastating economic attack on humanity.Indeed,the Obama administration seems as deferential to them as was George W Bush.Small wonder that speculation in commodities is once again rearing its poisonous head,making the price of oil and other essentials rise despite the weakened state of the international economy. Judging by the way in whuch Barack Obama,Gordon Brown,Angela Merkel and others are obedient to their whims, it looks as though those guilty of causing the distress of hundreds of millions in their insatiable greed for money will once again plunge the world into chaos,and soon.

In such a context,the need to create financial systems grounded on moral values becomes clear.Should Islamic baning entities finally get sanctioned in India,and should they function in the way that is intended,then not only Muslims but Hindus and others will start putting their savings in them. As the sages say, we need to look for good everywhere, so as to reach it everywhere.

(M D Nalapat/Pakistan Observer)

Saturday, 2 January 2010

Islamic Finance To Play Important Role In 2010

KUALA LUMPUR, Dec 31 (Bernama) -- Islamic finance that has garnered tremendous interest in the face of almost two years of global economic crisis, will have an important role to play come 2010.

As world markets come to grasp with the real strength of Islamic finance to withstand the economic turmoil, Islamic countries especially have already used it to strengthen their economic foundation.

Malaysia, being the frontrunner in Islamic finance with over 20 years experience and has gone through three economic crises, must fully exploit the potential of this industry.

Beefing up Islamic finance with a correct mechanism is the only way to go, analysts say.

Next year could be even tougher and any external developments will not only affect the current economic foundation but Islamic finance as well.

In the sukuk market, for example, trading activities and issuances slowed down in 2009 due to lesser issuance of corporate bonds and Dubai's negative credit news.

Among this year's highlights was the five-year US$1.5 billion Sukuk Al-Ijarah issued by national oil corporation Petroliam Nasional Bhd (Petronas).

It marks a new era of bond and sukuk issuances in the country. It was the single largest US dollar issuance by an Asian entity outside Japan this year and also the largest international US dollar sukuk since the US$1.5 billion Dubai Ports issue in 2007.

Known as the Petronas Emas sukuk, it was part of a bond package that also consisted of a US$3 billion conventional bond.

The Petronas Emas sukuk, together with the RM4 billion Sukuk Al-Musharaka issued by Cagamas MBS earlier this year, are listed on Bursa Malaysia and also on the Labuan International Financial Exchange and the Luxembourg Stock Exchange.

Asian Islamic Investment Management Sdn Bhd chief investment officer Chan Cheh Shin said Malaysia had continuously promoted and solidified its efforts to make the country a prominent sukuk player.

Chan, who oversees RM730 million assets under management, said both the government and private sectors had played their part in the issuance of benchmark-size sukuk bonds.

"Local players can and should build on the government effort in promoting Malaysia's name as the Islamic financial hub. The issuer and originator should step up their efforts on issuing and originating debts in the sukuk form," he told Bernama.

He said that as the economy recovers, companies would be more willing to borrow. Thus, sukuk issuance would increase, he said.

The recent policy to allow non-Islamic banks to participate in Shariah-compliance products was also a welcome step in promoting and retaining foreign interest in the industry, he added.

Whether Malaysia is still a forerunner in the global sukuk market, he said:

"Malaysia is way ahead in infrastructure and has a ready pool of investors for sukuk. Thus, it is a serious contender as a hub in Asia. London may dominate the European space."

In Islamic banking, all eyes will be on the country's new recipients of Islamic banking and family takaful licences.

With the new boys jumping onto the bandwagon, competition for a slice of the industry pie would be much tougher and stronger.

Therefore, it is imperative for the existing Islamic banking and takaful players in the country to enhance their ability and create more innovative products suitable for the public.

Bank Negara Governor Tan Sri Dr Zeti Akhtar Aziz recently confirmed that the country had shortlisted two foreign banks to be licensed as mega-Islamic banks with a minimum capital of US$1 billion each.

She said applications for the two mega-Islamic banks were still being processed and an announcement would be made by the end of the first half of 2010.

Currently, Malaysia has 14 wholly-owned foreign banks, both conventional and Islamic, and may give another five banking licenses by 2012.

Islamic banking accounts for 18.8 per cent of Malaysia's total banking assets.

Dr Zeti pointed that the inherent features of Islamic finance were among the factors that contributed to the country's financial stability.

She said Malaysia had continuously been involved in strengthening the Islamic finance architecture to ensure the industry's stability and resilience.

Malaysia is also keen to enhance the international dimension of Islamic finance through linkages not only with international financial centres, but also with those in the emerging countries of the Middle East, Africa, Central Asia and even Latin America.

"It is in the latter areas we believe that economic recovery will be the fastest. Bilateral trade is still important, but we also need strategic alliances and Islamic finance can play an important role in this respect," Zeti said.

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