Durham Islamic Finance Summer School 2012

Durham Islamic Finance Summer School (DIFSS) is one of the most reputable programmes in Islamic finance at one of the oldest universities in the UK. Although a number of other programmes in Islamic banking and finance pre-existed DIFSS, this programme has proven to be one of the most popular events in the world. Co-developed by Professor Rodney Wilson and Dr Mehmet Asutay, DIFSS today benefits from the dynamic leadership of the latter, with the recent retirement of Professor Wilson.

Dr Asutay has previously been associated with Orientation Courses in Islamic Banking and Finance, organized by The Islamic Foundation, with the help of Islamic Research and Training Institute (IRTI) in the 1990s. These Orientation Courses are no longer offered.

DIFSS 2012 was organised by the Durham Islamic Finance Programme, a joint venture between the School of Government and International Affairs and the Durham Business School. DIFSS is in its seventh year, and it is expected that the 8th event will be bigger and more impressive. This impressive summer school has trained over 300 people from all over the world since 2006. Those who have attended various DIFSS training over the last seven years have benefited from in-depth analysis of Islamic banking and finance from both academic as well as practitioner viewpoints.

Each year the DIFSS attracts a number of leading Islamic finance practitioners from around the industry to share their expertise, experience and knowledge in the area. In addition to the established experts in the field of Islamic banking and finance, a number of PhD students are also given an opportunity to present their research projects to the participants. This is greatly helpful for the PhD scholars, as they benefit from the feedback from the industry players.

This year, the following distinguished faculty shared their expertise and views on Islamic banking and finance from around the world:

• Dr Mehmet Asutay, Director, Durham Islamic Finance Summer School and Director, Durham Centre for Islamic

Economics and Finance, Durham University, UK

• Professor Rodney Wilson, Emeritus Professor of Islamic Banking and Finance, Durham University, UK
• Thomas A. Myers, Founder, President and Chairman of T.A Myers & Co, Denver, USA
• Professor Habib Ahmed, Sharjah Chair in Islamic Law & Finance, Durham Islamic Finance Programme, Durham

University, UK

M. Iqbal Asaria, CBE, Lecturer Aston Business School, Associate Afkar Consultants, UK

• Professor Humayon Dar, Chairman, President & CEO, Edbiz Consulting, UK
• Richard Thomas, CEO, Gatehouse Bank, UK
• Jaizah Otham, PhD Scholar, Durham Islamic Finance Programme, Durham Univeristy, UK
• Maha Alandejani, PhD Scholar, Durham Islamic Finance Programme, Durham Univeristy, UK
• Dr Shehab Marzban, Co-Founder, Shekra, Egypt
• Bilkis Ismail, Counsel, SJ Berwin (MENA) LLP, Dubai & London, UK
• Dieter Girmes, Department of Statistical Science, Univeristy of College London, UK
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• Hanira Hanafi, PhD Scholar, Durham Islamic Finance Programme, Durham Univeristy, UK
• Dr Hashem Al- Nemer, Durham Islamic Finance Programme, Durham Univeristy, UK
• Madzlan Bin Mohamad Hussain, Partner and Head of the Islamic Financial Services Practice, Zaid Ibrahim & Co,

Kuala Lumpur, Malaysia

• Dr Nafis Alam, Assistant Professor of Finance, Univeristy of Nottingham- Malaysia Campus, Malaysia

Dr Zurina Shafii, Director, Islamic Finance and Wealth Management Institute (IFWMI), Universiti Sains Islamic Malaysia (USIM), Nilai, Malaysia.

Dr Mehmet Asutay opened the DIFSS 2012, with an introduction to the role of Islamic finance in developing an Islamic moral economy. Since the third quarter of the last century, a number of attempts were made to develop a new economic model, based on Islamic ethics and morality. Almost all the political movements aiming to achieve this objective failed in different parts of the world. Islamic banking and finance, which emerged in the 1960s in countries like Malaysia and Egypt, however, has prospered and is now considered as an essential building block of the emerging Islamic moral economy.

According to Dr Asutay, Islamic banking and finance must aim at promoting community banking to serve communities and not the markets. It should also have built-in checks and balances on financial institutions to promote social responsibility and ethical initiatives. Islamic finance is based on an alternative ethical financial paradigm that links services to the productive real economy. He lamented, however, that Islamic banking and finance has not developed itself according to

the original vision of the forefathers. Initial experiments with Islamic banking and finance remained true to this vision but it gradually moved away to become a part of the Western model of banking and finance. The emphasis on human development, which was one of the major focuses of Islamic banking models gave in completely to the profit motive, especially in the 1990s when Islamic banking became more mainstream in a number of countries. This is what Dr Mehmet termed as a

social failure of Islamic banking and finance.

He concluded that for Islamic banking to remain relevant to the needs of the Muslims it must develop itself along the lines of community banking. Retaining the Western emphasis on debt financing and continuous aversion to risk sharing can never distinguish Islamic banking from its conventional counterpart. He also argued that restraining the investment areas does not necessarily mean Islamic finance is ethical, as screening of Islamic investments is done with respect to Shari’a rules and not on the basis of ethical or SRI considerations. He concluded by saying that the Islamic banking and finance has a big role to play in economic development, which can be achieved by improving human capital, building wealth distribution channels and promoting a trade block on the level of the Organization of Islamic Conference (OIC).

On the first day of DIFSS 2012, also spoke to

Thomas Myers, Founder and Chairman of T. A. Myers & Co., Denver, USA. He discussed the causes of the global financial crisis, which included excessive lending to households, corporations and governments and funds. He also highlighted the role played by rating agencies in misrating the securitized debt instruments, and the failure of governance at both the institutional and systemic levels. He further mentioned that the Shari’a prohibitions of trading in debt would have avoided the sale of toxic products (securitized debts) as Shari’a does not allow Gharar (speculation). He argued that the role of the

Shari’a committee would have acted as another pair of eyes in preventing such transactions to go through.

While Day One tended towards generality, the second day was far more technical.

Professor Habib Ahmed, Sharjah Chair in Islamic Law & Finance at Durham University contended that the success of Islamic banks depended on new products that must keep up with the changing markets and variegated needs. Innovation is therefore key to success. He broke down the product development system into three main components:

1. Strategy and plans: mission and innovation of the product as to finding the niche and the targeted clients.
2. Structure and resources: innovation requires a certain organizational structure and culture, which must drive innovation.
3. Product development process: it requires different departments to get involved, as there is a need for a smooth flow of activities and information.

The product development process is, therefore, a three-step process and failure of any one of these will result in an unsuccessful attempt of the development of the product.

Professor Ahmed also shared a survey that he and his team had carried out on 20 independent Islamic banks to find out the exact percentage of the products that successfully passed through the three stages of the Product Development Process. These 20 Islamic banks included 17 commercial banks, 2 investment banks and 1 cooperative bank. The results of the survey concluded that on average about 12 percent of the product, ideas pass through the initial stage of Idea Generation; 17 percent of the ideas pass through the second stage of Converting Concept into Product; and about 14 percent of the ideas pass through the Commercialization stage and get materialized. He further highlighted some of the issues with regard to

product development. The product should fulfill the form and spirit of Islamic law including legal and social requirements. He concluded by saying that Islamic finance should focus on Shari’a-based products, which must satisfy both the form and spirit of Islamic law. In his second presentation, Professor Ahmed focused on structuring issues in sukuk issuance. He started his presentation with the definition of sukuk as given by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), according to which sukuk are certificates of equal value representing the receipt of the values of certificates, representing common title to shares and rights in tangible assets, usufructs and services or equity of a given project or equity of special investment activity. AAOIFI identifies 14 types of sukuk that can broadly be classified as asset-based, debt-based, equity-based and agency-based. Asset-based sukuk include ijara (existing owned, existing leased and future assets); debt-based include istisna’ salam, murabaha; equity-based include mudaraba, musharaka, muzara’a (sharecropping), musaqat (irrigation), mugharasa (agriculture); and agency-based include wakala. The features of sukuk are linked to real assets, fixed-term maturity, and fixed or floating return. Tradability depends on the type of sukuk (debt-based sukuk are not tradable). Redemption and protection of principal repayment are

features that very much depend on the underlying structure.

Professor Ahemd mentioned that the first formal sukuk was issued in Malaysia, while the first in GCC was from the government of Bahrain in 2001. The average growth in the sukuk market was 45 percent between 2001 and 2007. The total sukuk issuance for the year 2011 was $94.4 billion, which shows

strong growth in the market after the financial crisis. For the year 2012,

the total sukuk issuance has so far been around $65.33 billion.

Some of the issues and controversies in the sukuk market discussed by Professor Ahmed include:

Critics argue that when the originator/ guarantor and SPV are the same entity, guaranteeing of capital can open the door to riba. However, supporters argue that the SPV is independent of

the originator and guarantee by the originator is by a third party. Similarly, the hardliners stress that the sale of assets must result in the actual transfer of ownership and not just beneficial ownership. He referred to a study undertaken by the Islamic Shari’ah Research Academy (ISRA), which found out that out of 560 cases of sukuk studied, only 2% were actually asset-based. He also argued that smoothening of return to match an expected rate is prohibited, if it results in capital protection

in case of sukuk al- mudaraba and sukuk al musharaka.

Iqbal Asaria, CEO of Afkaar Consulting, is a regular speaker at DIFSS. This year, he once again spoke on his major area of expertise, i.e., takaful and re-takaful. According to him, the total number of providers in the world for takaful and re-takaful, including Windows, is 179. The total contribution pool has reached USD 3.4 billion. The general takaful industry is expanding, with product offerings moving towards the life takaful. The industry is expected to reach soon the mark of USD10.2 billion. This was a comprehensive session, also covering the impermissibility of conventional insurance for Muslims. There are three Shari’a objections including gharar (uncertainty), maysir (gambling) and riba (interest). Asaria explained the conceptual model of takaful where the contributors donate – what is known as tabarru – to a contribution pool. The takaful operator manages the takaful pool contributions from which the operator invests the funds. In the case of a claim, the funds will be covered from the takaful pool. There are three competing models of takaful based on mudaraba, wakala, and waqf . The two bancassurance models were also discussed:

Referral Model: The transaction is done by investment advisors, and product specialists from the insurance company, who are based at bank branches.

Agency model: The bank acts as an agent for the insurer to distribute insurance products for a fee/commission. The bank staff is trained to appraise and sell the products to customers. It requires a high level of product knowledge and selling skills Bancatakaful is very popular in Malaysia, and some other markets, especially in the GCC, are catching on. Challenges facing the industry were also discussed in the presentation.

The most controversial presentations in the last seven DIFSS programmes have been that of Professor Humayon Dar, Chairman, President & CEO of Edbiz Consulting.

His presentation this year was based around his main area of specialization, i.e., innovation and product development. He started his presentation by giving examples of the

three biggest innovations in Islamic banking and finance in the last 40 years, namely murabaha (1970s), sukuk develop Islamic hedging instruments. When discussing the ingredients or secrets of Islamic financial innovation, he emphasised the importance of in-depth knowledge of Shari’a, creativity, awareness of legal issues, access to cutting-edge financial technology and a deep understanding of (1990s) and wa’ad (2000s). Murabaha allowed Islamic banks to offer financing to households and businesses. Sukuk allowed governments and corporates to issue Islamic securities to raise Shari’a-compliant debt. The use of wa’ad allowed Islamic banks and financial institutions to the market trends and needs. According to him,

the objective of Islamic financial innovation has been “developing new financial products for the Islamic financial services industry, which replicate economic effects of the conventional products in a Shari’a compliant way”. Professor Dar contended that not all the innovation in Islamic banking and finance was entirely in line with the spirit of Shari’a. Examples of such innovation are debt trading and buy-back facilities as part of many products on offer in the market. He shared an example where at T0, A owes to B $100 to be paid on a future dateT2 (so B has a debt receivable worth $100 in face value). At T1, B goes to C and sells his debt receivable (worth $100) for $90, which C pays to B at T1 (to receive $100 from A at T2). At T2 A pays $100 to C. The arrangement is manifested in the following Diagram 2.

We understand that this is not a valid transaction, as according to Shari’a one cannot sell and buy debt other than at par value. So according to this example here the debt is being discounted and sold, which is not allowed under Shari’a. How can we make this transaction truly Shari’a compliant is an interesting question. One possible solution is as follows:

If at T0, A owes to B $100 to be paid on a future date T2 (so B has debt receivable worth $100 in face value). At T1, B may appoint C as its agent to collect the debt on its behalf. C also extends a loan of $90 to B at T1. At T2, C collects $100 from A, keeps $90 as payment of its debt, and the remaining $10 as its collection fee. This arrangement is depicted in Diagram

3. While the first example has issues with regard

to trading in debt, there may arise another issue with regard

to riba (interest) in the proposed solution.

When discussing trading in debt, Professor Dar mentioned that trading in debt was not acceptable to the

majority of Muslim jurists. Debt (receivables in the form of cash/money) is considered as money and hence exchanging it with money (in the same currency) is considered as an exchange of money for money. When the same thing is exchanged, then Shari’a requires that it should not be exchanged but in equal quantities or amounts. Furthermore, it is also a strict Shari’a requirement that the money should be exchanged on the spot when the governing contract is sale/trade Dr Dar continued by addressing the future of the industry, highlighting that many observers are critical of what is happening in Islamic retail banking. There is heavy use of tawarruq (and in Malaysia, bai al ‘ina). Furthermore, Islamic home financing products remain Shari’a-compliant versions of its conventional counterparts and most retail banks still shy away from risk-sharing or true profit and loss sharing. One possible innovation that he shared was the time multiple counter-value loans idea introduced in the 1970s by a Pakistani economist, Sheikh Mahmud Ahmad. The idea was discussed with a number of regulators and banks in the 70s but failed to receive recognition. The idea, however, is very simple: every loan is decomposed into its face value and the time for which it is extended. For example, a loan of GBP 1,000 for 30 days is equivalent to a value of 30,000 GBP days

. Hence a loan of GBP 30,000 for one day must be equal to a loan of GBP 1,000 for 30 days.

Other topics discussed were structuring Shari’a-compliant credit default swaps and Islamic options In the final part of his presentation. Dr Dar explained how salam can be used to come up with a Shari’a-compliant forward contract. He mentioned that combining a salam contract with a bai’ mu’ajjal (deferred payment sale) may serve the purpose of developing a Shari’a-compliant forward contract.

Like previous years, the final session comprised of three presentations by PhD students. These included presentations on liquidity management, prediction of banking distress, and bank efficiency. Other presenters included Dr Shehab Marzban, Bilkis Ismail, Dr Hashem Abdullah Al Namer, and Dr Nafis Alam.