Wan Mohd Ashraf Adlin

wan_ashraf@msu.edu.my
ISLAMIC
FINANCIAL MARKETS
INTRODUCTION TO
 CONTENT
2

 OVERVIEW OF ISLAMIC FINANCE

 HISTORY AND ORIGIN
 ESTABLISHMENT OF MARKETS LOCALLY
AND INTERNATIONALLY
 ISLAMIC FINANCE: Why and for
Whom?
 Ideas on Islamic finance had always existed in economic
writings, because of the prohibition of interest, gambling and
indeterminacy in contracts.
 Islamic banking theory and practice began to spread rapidly after
the 1970s.
 Today, over 600 Islamic finance institutions (IFIs) operate in
more than 75 countries around the world.
 The value of the assets they control rose from US$300 billion in
2007 to more than US$1.88 trillion by the middle of this year.
 Markets have acquired a measure of sophistication in range and
depth, and the number of retailing and investment products is
increasing.
 Both the private and public sectors have contributed to the
expansion.
4
5
 Among the factors that have contributed to the rapid progress of
Islamic finance, the following deserve specific mention:
 There are 1.63 billion Muslims in the world. They already
constitute 27% of the global population and their numbers are
growing much faster than any other religious group.
 The demand for Islamic finance is expected to rise exponentially
as profit-seeking, proactive investment is now tending to
overtake the negative filtering (or screening for prohibited
activities) of yesteryears.
 Spiraling oil prices have tripled in just the five years ending in
July 2012. Petro-dollars have flooded into the oil-producing
Muslim countries and the Middle East economies have been
booming for decades.  
 There is a visible movement of economic power centres towards
the East.
7

Definition & Philosophy of

Islamic Finance
 What is Islamic Finance?
8

 Provision of financial services on a basis that is

compliant with the principles and rules of Islamic
commercial jurisprudence (fiqh muamalah).

 Hence, to finance the economic activity in an

Islamic framework, we must have institutions
using instruments according to rules and
regulations which are all bound by the shariah.
 DEFINITION OF ISLAMIC FINANCE
9

 Islamic finance, in contrast to conventional finance,

involves the provision of financial products and
services by institutions offering Islamic financial
services (IIFS) for shariah approved underlying
transactions and economic activities, based on
contracts that comply with shariah laws. Shariah, the
basis for finance that meets the religious
requirements of Muslims in line with their ‘aqidah’,
is the factor that distinguishes Islamic finance from
conventional finance. Provision of these shariah
compliant financial products and services must add
value to the real economy.
OVERVIEW: THE ORIGIN AND EVOLUTION OF
ISLAMIC FINANCE

 The first financial institution, known as the baitulmal or the

public treasury, was established by the Prophet (peace be
upon him) himself.
 Umar Ibn al-Khattab, the second caliph, who gave the
institution of baitulmal a distinct entity (in 644 AD) and
identified its sources of revenue, including zakat (a charge
on wealth), kharaj (land revenue), jizia (poll tax), custom
duties, tolls and sadaqa’at or donations.
 It emerged around the middle of the twentieth century, and
gained momentum after the 1960s with the rise of Islamic
revivalist movements across the world.
 The growth pattern and structure of the fast-expanding
Islamic finance differs from country to country, and
common and cohesive elements are yet to be established.
SYSTEM CONVERGENCE
 The pioneers of Islamic finance chose to follow the structures of
conventional banking when introducing the Islamic financial system.
 This allowed the mainstream foreign banks to enter the field through
‘windows’, or establishing exclusive subsidiaries.
 This eventually led to the convergence of the Islamic and
conventional systems.
 The benefits claimed include the following:
 It is believed that convergence has contributed to the rapid
expansion of Islamic finance and has enabled the system to avoid
isolation at global level.
 Product designs were modified to comply with Islamic
requirements.
 Convergence helped to replicate mainstream products.

 Educational institutions in Muslim countries could now easily

configure with mainstream structures to facilitate cooperation for
 Nevertheless, not all see the convergence of the systems as an
unmixed blessing.
 Convergence has, in a way, compelled the Islamic institutions to
adopt global norms and the policy makers have relentlessly pushed
them in that direction.
 As a result, most Islamic financial instruments look as though they
are a sub-set of those used in the conventional system.
 Even as convergence has largely been unidirectional, the impact of
Islamic finance on the conventional system in some measure cannot
be denied.
 First, Islamic finance has added new, even novel, channels that
are supportive of global financial paraphernalia.
 Second, Islamic finance has certainly shifted the attention of
policy makers to moral and ethical concerns in financial
governance and management.
For whom the bell tolls?

 The merits and demerits of convergence apart, there are some

questions of social significance that also need to be addressed.
 One such question is: for whom was Islamic finance conceived by its
pioneers and to what ends? Although they experienced conventional
banks operating around them, Muslims could not utilize their
services because they used interest and adopted other non-Islamic
practices.
 The pioneers of Islamic finance therefore wanted to create banks that
operated in observance of Islamic requirements to serve the Muslim
community.
 Islamic institutions were supposed to help achieve maqasid-al-
Shari’ah, distributive justice, as treated in the Islamic wealth-related
principles.
 These principles cover basic needs (food, shelter, health care, etc.),
the elimination of poverty and the reduction in income inequalities.
 The fulfillment of basic needs was one of the prominent
topics preoccupying writers on economic development
during the 1980s, but it soon paled into insignificance as the
agenda moved towards investment priorities in national
plans, for which the necessary political will was found
lacking for a variety of reasons.
 The reduction in income disparities and poverty eradication
has recently aroused much concern at the domestic and
global levels.
 Islamic banks may find these areas more suitable for action
now that corporate social responsibility is moving up the
policy agenda.
 OBJECTIVE OF ISLAMIC FINANCIAL
SYSTEM
15

 The primary objective of establishing Islamic banks is

to spread economic prosperity within the framework
of Islam by promoting and fostering Islamic
principles in the business sector. Key objectives are
listed below .
 Offer Financial Services.
o Islamic banking statutes and laws strictly in line with
shariah principles for financial transactions, where riba
and gharar are all identified as unislamic.
o The thrust is towards financing on risk-sharing and strict
focus on halal activities. The focus is on offering banking
transactions adhering to shariah principles and avoiding
conventional interest-based banking transactions.
16

 Facilitate Stability in Money Value

o Islam recognize money as a means of exchange and not as a
commodity, where there should be a price for its use. Hence,
riba free system leads to stability in the value of money to
enable the medium of exchange to be a reliable unit of account.

 Economic development
o Islamic banking fosters economic development through utilizes
like musyarakah, mudharabah, etc, with a unique profit and
loss sharing principle. This establishes a direct and close
relationship between the bank’s return on investment and the
successful operation of the business by the entrepreneurs,
which in turn leads to the economic development of the
country.
17

 Equitable Distribution of Resource

o Islamic banking ensures equitable distribution of income and
resources among the participating parties-the bank, the
depositors and the entrepreneur – with its profit sharing
approach which is one of a kind.

 Optimistic approach
o Profit sharing principles encourages banks to go for projects
with long-term gains instead of short term gains. This leads
the banks to conduct proper studies before getting into
projects which safeguards both the banks and investors
interests in total. High returns distribute to the shareholders
maximize the social benefits and bring prosperity to the
economy.
LINKAGE TO THE REAL ECONOMY
 An important feature of Islamic finance is that it serves the real
economy.
 Each financial transaction is to reflect linkage with a real
economic activity.
 Some real good or service must underpin it.
 The difference between the Islamic and conventional financial
systems is not in the existence of the linkage-both systems have
that-but resides in the intention behind each transaction and the
length of the chain that links each transaction.
 In Islamic finance, the transacting parties must intend to transfer
real benefit both ways across the money divide.
 The settlement of price difference alone, in terms of profit or
loss, as in conventional markets, is neither the objective nor
allowable in the Islamic system.
 HISTORICAL LANDMARKS IN ISLAMIC FINANCE DEVELOPMENT

19

1963 • Mit Ghamr, Egypt

1969 • Pilgrims’ Fund Board (Lembaga Tabung Haji), Malaysia

1970 • Oil boom

• Islamic Development Bank, Saudi Arabia

1975 • Dubai Islamic Bank, UAE

1977 • Fatwa issued by the Fiqh Council of Muslim World League in favor of Islamic insurance (takaful)

1978 • Luxembourg Islamic Bank (1st attempt in the West )

• Sudanese Islamic Insurance Company is established as the world’s 1st Takaful company by Faisal
1979 Islamic Bank of Sudan

1983 • Malaysia passes comprehensive legislation on Islamic finance (Islamic Banking Act)

• OIC Islamic Fiqh Academy legitimizes Sukuk which paves the way to the development of Islamic
1988 debt securities

1990 • World 1st sukuk issued in Malaysia (Based on BBA) by Shell MDS worth USD 30 million

1991 • AAOIFI , Bahrain

2002 • IFSB, Malaysia

2011 • International Islamic Liquidity Management (IILM), Malaysia

 FOCUS AREAS
20
 DEVELOPMENTAL FOCUS
21

Institutional &
Regulatory
Development

Enhancement of
Product and market
knowledge and
development
expertise

Legal and Shariah

framework
 WORLDWIDE STATISTICS
22
 MARKETS PERFORMANCE
23
 MARKETS PERFORMANCE
24
 MARKETS PERFORMANCE
25
 STORY OF ISLAMIC FINANCE
26

 Islamic financial system is now a widely used term.

Islamic financial system has emerged in recent decades as
one of the most important trends in the financial world.

 There has always been a demand for financial products

and services that conform to the shariah (Islamic law).

 With the development of viable Islamic alternatives to

conventional banking, there are now shariah compliant
products to meet short term and long term financial
system needs of the customers.
27

 Islamic finance is based on the principles of shariah law.

 The Islamic financial system offers similar functions and

services as the conventional system while abiding by shariah
principles.

 Islamic finance comprises four major areas: the Islamic

capital and money market, the Islamic banking industry and
the Islamic insurance industry or Takaful.

 All areas are closely linked to each other but at varying

degrees of development in terms of maturity and volume.
 FINANCIAL SYSTEM COMPONENT
28

Financia
l
Institutio
n
Financial
Markets
29

 Islamic banking can be regarded as the pioneer of

Islamic finance as it originated in the early 1960’s
whereas Islamic insurance only took about two
decades later.

 The Islamic capital markets are still in its early

years and mostly under developed and illiquid

Islamic Banking Islamic Capital Market

Islamic Money Market Islamic Insurance
 30

 From a faith based perspective, the objective certainly

is to have a comprehensive Islamic financial system
so that there will be no break in what can be called the
shariah compliant supply chain whereby all products
and transactions would be compliant with Islamic law.

 Only Malaysia can currently claim to have a

somewhat comprehensive Islamic financial system.
Islamic capital and money market Islamic banking Islamic insurance
Shariah Fixed- Islamic Shariah Financing Takaful Retakaful
compliant income derivatives/ compliant
equities securities structured deposits,
(shares and (sukuk, products investment
funds) Islamic
bond)
 THE DISTINCTIVE FEATURES OF THE ISLAMIC
APPROACH TO FINANCE
31

 The principles and contracts underlying Islamic

finance products differ from those underlying
conventional products in that all assets and
transaction must be shariah compliant. The basic
principles underlying Islamic finance are partially
driven by the well known prohibitions and
permissible under the shariah;
 No interest (riba).
o In conventional finance, a distinction is made between
acceptable and usurious interest (i.e., excessive rates
of interest). In contrast under Islamic law any level of
interest is considered to be usurious and is prohibited.
32

 No uncertainty (gharar)
o Major uncertainty in contractual terms and conditions
is not allowed, unless all of the terms and conditions
of the risk are clearly understood by all parties to a
transaction. In economies term gharar can be
compared to asymmetric information.

 No gambling (maisir)
o Gambling games of chance or speculation are
forbidden. Gambling is a zero sum which creates no
additional value to the society.
33

 Ethical (halal)
o No investment or transaction with industries or activities that
are prohibited (haram) by the Quran, such as alcohol,
pornography, gambling, and pork-based products. Promote
and establish ethical standards, in line with the objectives of
the shariah.

 Sharing profit and loss

o The operations of Islamic financial institutions are based on a
profit and loss sharing principle with the customers or clients.
An Islamic bank does not charge any interest for the financing
offered to customers but rather participates in yield, resulting
from the use of funds. On the other hand, depositors get their
shares from the bank’s profit based on a pre-determined ratio.
34

 Islamic finance is thus free of any interest bearing

transactions or speculative elements. It is fully transparent
and subject to high ethical standards. Any services, goods or
activities must not contradict the objectives of the shariah.

 We can summarize that Islamic financial institutions are

institution that are based on shariah principles. This shall
include but not be limited to the following Islamic principles;
i. The avoidance of riba (in the broad sense of unjustified
increase or interest).
ii. Prohibition of gharar (uncertainty, risk, speculation).
iii. Focus on halal (religiosity permissible) activities.
iv. More generally the quest for justice and other ethical and
religious goals.
35

 In essence Islamic finance operations are based in Islamic

principles for financial transactions, i.e., risk-sharing and
prohibition of products and services having riba and profit and
loss-sharing are major features, ensuring justice and equity in the
economy.

 The question naturally arises – how does Islamic finance make

money? Although conventional finance relies primarily on interest
based transactions, there are other forms of business activity. In
general business activities are centred on four categories as shown
in the chart below: debt, equity, leasing and trading.
Interest based Renting out an asset or
financing services
Direct ownership Trade of asset, goods
and services
36

 Islamic finance excludes any interest based

transaction, but acknowledges debt based
transactions and promotes equity, trading and
leasing activities.

 Islamic banks do use debt creating instruments. In

fact, a number of Islamic banking products like
Murabahah, Salam or Ijarah create a debt. The
point to stress here is that a debt should not carry
any charge over its principal, as it would be
tantamount to riba (interest).
37

 Indeed, not only Islam, but also Judaism and

Christianity require their followers to shun usury.
The common thread running through all such
condemnations of riba is its exploitative if justly
and fairly earned.

 Profit sharing activities and transactions such as

leasing or trade must be backed by tangible assets,
unlike in the conventional system where the interest
mechanism allows money to earn money without
being linked to real economic asset or activity.
 MALAYSIA
38

 A Success Story
 MALAYSIAN ISLAMIC FINANCIAL
39
SYSTEM
 Comprehensive Islamic financial system covering all financial
sectors.
 Operating in parallel with conventional financial system.
 Diversities of players
 Twelve full-fledged Islamic banking institutions
 2 domestic Islamic banks
 3 full-fledged foreign owned Islamic banks
 7 Islamic banking subsidiaries
 9 takaful operators
 Sound and robust Islamic financial institutions governed by
international best practices.
 Rapid growth with wide range of product and services.
 Retail, corporate & investment banking.
 Internationally integrated with international Islamic financial
system.
 EVOLUTION OF DEVELOPMENT
40

o Gradual and pragmatic

Milestones
1969 1983 1993 2003

Pilgrimage Fund Board

Full-fledged Bank Islam Bank Muamalat Foreign Islamic

Islamic banks Malaysia Bhd. Malaysia Bhd. banks

Conventional banks offer Islamic window

Islamic subsidiary

Islamic Money Markets

Takaful Syarikat Takaful Takaful Nasional, Mayban Takaful, Takaful

Operators Malaysia Bhd. Iklhas, Commerce Takaful

..achieved significant milestones in building comprehensive and integrated Islamic

financial system with diversity of players….
 1ST PHASE : 1963-1992
41

19 19 19 19 19
63 69 80 81 83

•Establishment of
•Pilgrims Fund •Several parties were •July : NSC
the Pilgrims Fund
Board calling for •Set up National Steering submitted their
Board establishment of Committee (NSC), chaired report to
•It is saving combined with Islamic bank due to by Raja Mohar Badiozaman government
mechanism - Pilgrim’s resurgence that •NSC undertake study and
•The first Islamic
happened in the make recommendations to
Malaysian Management Middle East
government on all aspects bank was
Muslim set aside relating Islamic Bank in established in
Fund Board/ •Eg: Malaysian Malaysia, including legal,
regular funds to Malaysia- Bank
Lembaga government had being religious and operational
cover them offered by Bumiputra aspects. Islam Malaysia
Urusan dan Economic Congress to •LUTH take over the Berhad (BIMB)
performing secretarial functions
Tabung Haji set up Islamic Bank in under Islamic
annual this country Banking Act 1983
(LUTH)
pilgrimage
 2ND PHASE : 1993-2000
42

Ma Dec Oct
emb obe
19 y
er r
93 19 199 199
97 8 9
•March: Interest-Free banking
Scheme (IFSB)/ Skim •BNM establish Shariah •Establishment 2nd
Perbankan Tanpa Faedah
(SPTF) was launched on a pilot
Advisory Council (SAC) which
consist of academicians and
•The IFSB/SPTF Islamic Bank, Bank
basis involving Malayan Shariah experts in Islamic
was replaced Muamalat Malaysia
Banking Bhd. , Bank Banking and Takaful
Berhad ( merger
Bumiputra Malaysia Berhad •Role:
with Islamic
and United Malayan Banking •Harmonize different opinion between Bank
Corporation Bhd.
•July: Commercial banks,
in Shariah
•Advise BNM
Banking Scheme Bumiputera
merchant banks and finance •Analyze Shariah aspects of (IBS)/ Sistem Malaysia Bhd. +
companies begun to offer new products submitted by
Islamic banking products and banking institutions and Perbankan Islam Bank Commerce
services under the Islamic takaful companies
Banking Scheme (IBS banks).
(M) Berhad
 3RD PHASE : 2001-2010
43

To
20 20 20
da
01 02 04
y
•March: BNM had launched •Establishment •Financial liberation •Implementing dual
Financial Sector Master
Plan (FSMP) – incorporated of Islamic of Islamic Banking banking system
a comprehensive 10 year sector with the •Become the first
master plan for Islamic Financial issuance of three nation have full-
banking and Takaful
•Declaration of Labuan as Services new Islamic license fledge Islamic
under IB Act 1983, system operating
International Offshore
Financial Centre (IOFC) to Board (IFSB) from Middle East to side-by-side with
promote Malaysia as
International financial
in Kuala Islamic financial conventional
system
Lumpur institution system
 FINANCIAL SYSTEM STRUCTURE IN MALAYSIA
44

Financial Institutions Financial Markets

a) Banking System a) Money & Foreign Exchange Markets :
 BNM • Money Market
 Banking Institutions : • Foreign Exchange Market
- Commercial banks include Islamic banks
- Finance Companies b) Capital Markets:
- Merchant Banks • Equity markets
 Others: • Bond Markets –Public Debt Securities –
- Discount Houses Private Debt Securities
- Representatives Offices of Foreign Banks
- Offshore Banks in Labuan IOFC c) Derivatives Markets:
• Commodity Futures
b) Non-Bank Financial Intermediaries : • KLSE CI Futures
• Provident & Pension Funds • KLIBOR Futures
• Insurance companies include Takaful
• Saving institutions d) Offshore Markets:
• Others: • Labuan International Offshore Financial Centre
- Unit Trusts – Pilgrims Fund Board – Housing (IOFC)
Credit Institutions – Cagamas Berhad –Credit
Guarantee Corporation –Leasing Companies –
Factoring Companies –Venture Capital
Companies.
 Malaysia: the world’s most comprehensive Islamic financial system…
45
Governance Diversified Players
Islamic • Banking
• Legal & Regulatory
Banks & Takaful
– Islamic Banking Act Islamic Companies Islamic – 17 Islamic banks
– Takaful Act Money Capital – 10 Islamic windows
– Government Market Market – 3 International Islamic Banks
Funding Act – 14 International Currency
– Capital Market Malaysian Business Units (ICBU)
Services Act Financial
– Islamic Finance Labuan Capital  Takaful
System
Service Act IBFC market – 8 takaful operators
– 4 retakaful operators
• Shariah Advisory – 7 ICBUs
Money Conventional
Council
market Banks & Insurance
– Central Banking Act
Companies • Fund Management
• Dispute Resolution – 9 Islamic fund managers
– Judicial system: – 35 Islamic fund management
Professional Service Financial Markets windows
dedicated high
court – Legal firm
– Capital Market Infrastructure
– KL Regional Centre – Accounting
for Arbitration – Money Market
– Financial Intermediaries – Payment, clearing and
– Financial Mediation – Foreign Exchange Market
– Financial Advisors settlement, custodian
Bureau – Commodity Market
– Consultancy Service – Principal Dealers
– Bursa Suq Al-Sila
– Listing on Bursa with
authorize exchange status

More than 30 years of experiences in developing Islamic

finance… Courtesy of Bank Negara Malaysia
46

Q&A
47 END OF CHAPTER