Islamic finance: firms seeking a slice of the growing Muslim market would be well advised to learn its complexities inside out, writes John Willsdon--which is where the CIMA certificate in Islamic finance comes in.
Despite the increasing importance of Islamic finance, its complexities are not widely understood, few institutions offer courses in it and there is no global qualification. This is why CIMA, through its Centre of Excellence, has aligned itself with the International Institute of Islamic Finance to develop a certificate course. By doing so, it will be the first professional body to offer such a qualification.
The CIMA certificate in Islamic finance comprises four modules: Islamic commercial law; Islamic banking and takaful (insurance); Islamic capital markets and instruments; and accounting and analysis of Islamic financial institutions. It will be available internationally and will be assessed electronically. It is aimed at a diverse range of participants, including employers and employees currently operating in the sector and those wishing to move into it. A diploma-level qualification--international Islamic finance: governance and analysis--will be available at a later date. This will be a written exam based on case studies.
It's estimated that 15 per cent of the institute's membership is employed in the finance industry. The most rapid growth in Islamic finance has been in banking--both in Islamic banks and in conventional banks with "Islamic windows". The Islamic capital market has also seen a surge in activity, with a variety of multi-million-pound bonds (sukuks) hitting the headlines. Sukuks are seen as an important way for the Islamic finance market to meet the funding requirements of both the Middle East and South East Asia, which are estimated at 250bn [pounds sterling] and 500bn [pounds sterling] respectively over the next five years. The growth in demand from these two regions has resulted from two factors:
* The massive accumulation of assets in banks operating in the predominately Islamic countries that have benefited from the extraction of energy reserves. The most obvious examples are the Gulf states, along with Brunei, Malaysia and Indonesia.
* A reaction to western financial practices throughout the Muslim world and a move towards comparative practices that adhere to Islamic law (sharia).
It's estimated that there are between 1.5 billion and 1.8 billion Muslims worldwide, of whom a quarter live in countries with a Muslim majority. While most of them currently subscribe to western financial principles, the new developments in Islamic finance may appeal to this group. It's also believed that the socioeconomic ethos underpinning Islamic finance may prove attractive to non-Muslims.
In the UK, banks such as Lloyds TSB and HSBC are offering sharia-compliant accounts and loans, while the government recently changed the law on stamp duty to aid the growth in Islamic mortgages. The Muslim market in the UK is certain to grow, according to a survey commissioned by advertising agency JWT. It accounts for three per cent of the population, it's the country's second-largest faith group and it has the youngest age profile. British Muslims have an estimated total spending power of 20.5bn [pounds sterling].
Investment and trade are central to the Islamic view of wealth creation. Practising Muslims believe that profits should not be earned simply because they have money to lend and someone is prepared to pay them to borrow it. They believe that a lender should profit only as a result of their interaction with an investment. As such, surplus funds held by an individual should be invested only in projects where they will play an active role in sharing the risk if they want to benefit. As a result, individuals or businesses wishing to borrow from those with surplus funds need to be able to trade with the financier, who can then profit from a real trade investment.
With conventional finance, if X needs funds he borrows from Y, who charges X interest based on the amount, the duration of the loan and the perceived risk. With Islamic finance, X and Y need to become trading partners for Y to benefit from the deal. The necessity for both parties to interact in a trading enterprise means that contracts play a key role in the process. They ensure that the participants benefit from trading but not from merely transferring or holding cash balances. The nature of these contracts is central to all aspects of Islamic finance (see panel, next page).
Trading contracts may be the hardest thing for the uninitiated to understand. The problem is not that each contact is derived from practices that have existed for centuries, but that they are expressed in Arabic terms. Contracts that are at the core of Islamic financial products include mudarabah (profit sharing); musharakah (a form of equity partnership investment); murabahah (cost plus mark-up); ijarah (operating lease); and ijarah muntahia bi tamleek (an alternative to hire purchase and finance lease). A range of bolt-on agreements can be included to adjust each deal in order to meet a customer's particular requirements while still complying with sharia principles.
Although there are relatively few verses in the Koran relating to the finance industry, a company must offer products and services that are sharia compliant in order to trade as an Islamic financial institution (IFI). Such compliance must permeate throughout the organisation and its activities. An IFI's customers should use its funding for sharia-compliant purposes only.
The issue of consistency is a big challenge for the industry. Each IFI has its own sharia advisory board, which is an independent panel comprising experts in interpreting the sharia principles governing product terms and conditions. These boards provide integrity by ensuring that the IFIs' policies and instruments don't contravene the principles set under sharia. They are seen as the most important body governing Islamic banking and finance. All of them have the common goal of ensuring compliance, but they will differ over details such as methods of appointment, the legal status of rulings, internal supervision and so on.
The standardisation of products and services in Islamic finance is further challenged by the fact that boards differ in how they interpret the sharia principles. In the case of finance, South East Asia generally takes a more flexible approach than the Middle East. For example, most Gulf states allow only operating leases and not finance leases. This requires the lessor to assume responsibilities as in an operating lease until the transfer of title is executed. It also means that products deemed acceptable in South East Asia may not be adopted in the Middle East. Such differences of opinion are accepted by the Muslim community as long as the scholars involved have used a rigorous method of interpretation (ijtihad) that can be traced back to the primary sources of the Koran, the practices of the prophet Muhammad and juristic views in the past.
A notable development in the market is that an increasing number of non-Muslims are seeking out Islamic financial products. The attraction for them seems to be the ethical basis on which financial decisions are made. When an IFI makes a trading agreement with a customer, it creates a stronger link than that of the normal lender-borrower relationship. If the venture fails, the institution suffers the loss while the customer loses only the time and effort they have spent. An IFI will, therefore, conduct strict due diligence before entering a deal and also work closely with a customer to ensure the success of their enterprise. Also, an IFI wouldn't wish to invest in a deal that could result in the exploitation of any party to it. Business activities should be based on mutual consent and goodwill. All participants should feel that they are benefiting from the arrangement. In addition, ventures involving alcohol, tobacco, gambling, entertainment, weaponry and pork products are excluded.
Another indication of social responsibility is the religious levy of zakat, which Muslims pay on all wealth that's capable of generating a return (excluding their home, furniture, tools of trade and personal jewellery). Zakat payments are distributed to designated beneficiaries, primarily the poor and needy. Such features are proving increasingly attractive to the socially responsible investor, Muslim or otherwise.
How is Islamic finance regulated?
The 1990s and early 2000s saw the development of international standard-setting and benchmarking agencies such as the Accounting and Auditing Organisation for Islamic Financial Institutions, International Islamic Rating Agencies, the International Islamic Financial Market and the Islamic Financial Services Board.
These bodies have produced a variety of standards, guidelines and best-practice notes to aid the harmonisation of practices. They encourage market discipline and ensure transparency through the disclosure of information, as well as facilitating the rating of Islamic financial institutions.
The stance adopted by many of these regulatory bodies is that sharia advisory board decisions should be binding on Islamic financial institutions.
How does sharia affect the industry?
Islamic finance comprises all aspects of banking, insurance and capital markets and has developed over the past 30 years to meet the requirements of sharia. One of the key reasons for its development was the fact that conventional finance did not meet the strict requirements of the religion.
Muslims believe that the pursuits of life, including economic activities, should be conducted in accordance with sharia as revealed in the Koran and demonstrated in the practices of the prophet Muhammad. All forms of guidance and laws, including those related to the finance industry, are derived from these two main sources.
Certain features that exist in conventional finance, such as usury and investments in businesses based on gambling or the consumption of alcohol, are prohibited. The entire chain of operations relating to these banned activities is also equally prohibited, including all aspects of production, storage, transport, marketing and advertising.
In relation to finance and banking, sharia prohibits charging and/or receiving interest; earning profits merely as a result of the passage of time where no active involvement is required; and earning profits based on risk. Clearly, these features are integral to conventional banking practices. Those involved in Islamic finance have had to deconstruct conventional financial products, remove the prohibited features and build in other aspects that achieve similar goals--ie, the safekeeping of assets and the generation of wealth through trading.
How do Islamic financial transactions work in practice?
The rapid growth in Islamic finance has raised challenges for the industry. The requirement for trading agreements, underpinned by sharia-compliant contracts, has resulted in anomalies. A good example is that of a mortgage. With conventional finance, a prospective buyer finds a house and approaches a bank or building society for a mortgage with which to buy it. In return for the loan, the borrower agrees to repay the capital with interest over an extended period.
Because the charging of interest is unacceptable to many Muslims, they instead use a series of contracts (usually based on murabahah) to do the deal. The prospective homeowner chooses a house and informs the financial institution. This then buys the property at the price agreed by the customer and sells it to him for the purchase price plus a mark-up, with payment being deferred over an agreed period. Both transactions comply with the need to trade and neither results in interest payments.
Until recently, Islamic mortgages in the UK faced the prospect of double stamp duty--a charge on each contract--but the government has recently changed the law to ensure that the only stamp duty payment is due on the sum paid to the bank by the purchaser.
John Willsdon is a practice manager in the CIMA Centre of Excellence.
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|Title Annotation:||technical matters; Chartered Institute of Management Accountants Centre of Excellence|
|Publication:||Financial Management (UK)|
|Date:||Sep 1, 2007|
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