Sharia Banking and the Financial Industry

Indonesia will cut its remaining 2010 debt issue by 26 percent, including scaling back a global sukuk, or Islamic bond, offering after lowering its deficit forecast in light of expected faster growth and stronger revenue. The move to trim Rp 15 trillion ($1.7 billion) off the Rp 58 trillion worth of debt still to be issued spurred longer-dated bond prices as investors bet the deficit cut could lead to a much-sought-after investment-grade credit rating.
Foreigners have bought a record amount of Indonesian bonds this year, drawn by the country’s robust economic growth, hopes of a credit upgrade and expectations that the rupiah will continue to appreciate. The government had a budget surplus in the first half, so it would be reluctant to push a huge global issue this year. The government has raised about Rp 120 trillion in bonds this year, or two-thirds of its original target of Rp 178 trillion.
Its higher-yielding local currency sukuk has seen less demand than conventional bonds, with the Finance Ministry again raising less-than-targeted in an auction on Tuesday because of fears the sukuk market lacks liquidity. The global sukuk will be downsized because up to now the government has still booked a budget surplus. Indonesia has cut its financing by about Rp 37 trillion ($4.1 billion) this year — a cut of 28 percent, including the debt issuance cut — because the government now expects a budget deficit of just 1.5 percent of GDP, versus an earlier projection of 2.1 percent. The cut is equivalent to 3.3 percent of its planned expenditure.

The yield premium on Indonesia’s sovereign sukuk over non-Islamic bonds is down 70 percent since the bonds were sold in April 2009, while Malaysia’s debt rallied to a record as investors gain confidence in the securities. The difference in yield between Indonesia’s 8.8 percent Islamic debt due April 2014 and notes maturing the same year that don’t adhere to the religion’s ban on interest narrowed to 26 basis points from 87 at the time of issue, according to prices from the Royal Bank of Scotland Group.

Indonesia chose three banks on Tuesday to manage the sale of as much as $650 million in Islamic bonds in October after securing credit ratings upgrades from Standard & Poor’s and Moody’s in the past year as the economy recovered. Investors look at Indonesia favorably and there’s the prospect it will become an investment grade issuer.

S&P upgraded Indonesia’s credit rating to BB in March, two levels below investment grade, while Moody’s raised its ranking in September to Ba2, also two notches below. The yield on Indonesia’s dollar-denominated Islamic notes fell to a record low of 3.44 percent on Wednesday, compared with 8.37 percent at the time of issue, and returned 27 percent since the sale on April 17, 2009, according to RBS prices.

The HSBC/NASDAQ Dubai US Dollar Sukuk Index, made up of Islamic bonds from Indonesia to Saudi Arabia, gained 15 percent in the same period. Global sales of notes that comply with the religion’s ban on interest fell 24 percent to $6.6 billion so far this year. Indonesia hired HSBC Holdings, Standard Chartered and Citigroup to manage its second overseas offering of sukuk in October. The extra yield that investors demand to hold Dubai’s dollar sukuk rather than Malaysia’s has widened 30 basis points since May 28 to 409 today, according to data compiled by Bloomberg.

Indonesian government may offer tax incentives for Shariah bond issues and bank deposits to better compete with Malaysia, the world’s top Islamic finance market, the central bank official said on Tuesday. One sweetener being considered would help boost bank capital and another could provide a tax holiday for sukuk (Islamic bond) issues. The country has already removed double taxation on Islamic finance transactions to give the industry a level playing field with conventional banking, but new policy was needed.
To support Islamic banking and finance, it’s not enough just to have tax neutrality. We need also tax incentives like in Malaysia as islamic banking director at Bank Indonesia said on the sidelines of an Islamic-banking conference in Singapore. For investment to come into Indonesia, it is possible to give a kind of tax holiday. Islamic bank assets in Indonesia are just a fraction of total banking assets, while in Malaysia they are close to a fifth.

Indonesia’s Islamic bank assets were Rp 66 trillion ($7.2 billion) as of December, compared with Rp 2,534 trillion for the banking industry as a whole, central bank figures show. In Malaysia, Islamic banking assets totaled about $95 billion. Still, with the world’s biggest Muslim population, Islamic bankers say Indonesia is set for explosive growth. But first, authorities need to lay the right legal and regulatory framework. (more…)

Indonesia is seeking to further develop its Islamic banking sector, looking to tap into the growing market for sharia-compliant financial instruments, though it still has some way to go before being able to match the major players in the segment. In late January, Bank Indonesia officials laid out their plans and projections for the coming year, including a four-point program to strengthen the country’s banking sector and promote growth across the economy.

Along with initiatives to enhance banking resilience, reinforce the supervisory regime, build a better platform for bank intermediation through the improvement of regulation, develop and strengthen rural banks’ roles in micro-finance, there was also the key objective of raising the profile of Islamic banking in the economy. Currently, Islamic banking assets represent only a fraction of the total within the country’s banking sector, with the central bank estimating the year-end figure to be around US$7.6 billion, equivalent to between 2 and 3 percent of total bank assets. While asset levels in the sharia-compliant banking institutions remain low, there has been greater movement in another segment.

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Bay al-Sarf is a contract of exchange of money for money. This contract is tightly regulated under Shari`ah because it can be easily manipulated for the purpose of producing an interest-bearing loan, which is prohibited in Islam.
The rules of bay al-sarf derive largely from the well known hadith (hadith muslim):
“Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt – like for like, equal for equal, payment being made on the spot. If the species differ, sell as you wish provided that payment is made on the spot”.
Gold and silver were the currency of use at the time of the Prophet, peace be upon him, and he approved their use by the act of using them himself. It cannot therefore be said that it is wrong to use gold and silver as money.
Many jurists have used analogy to argue that the hadith on gold and silver represent all forms of monetary medium, and that therefore all forms of currency should obey the rules established for gold and silver exchanges. This position is not however unanimous, and there are those who argue that the rules do not apply to other items, copper for example since copper is not one of the six items mentioned in the hadith (the so-called ribawi items).

Under such an interpretation, an exchange of 10 copper coins today for 12 copper coins tomorrow would not be a riba transaction. Similarly, there are some jurists who argue that because money is to be regarded as gold and silver only, then paper money is not a proper form of money and a loan of 10 paper dollars made today in return for 12 paper dollars to be received tomorrow is not a form of riba. These however are minority views and it should be noted that most jurists do agree that where an item is being used as money by custom (urf) among a local population, it should obey the rules that are stated in the hadith regarding gold and silver.
Based upon the above hadith, it is established that if gold is to be exchanged for gold, the exchange must be made on the spot, with the amounts being of equal quality and quantity. Because both countervalues must be settled immediately, a forward transaction (in which one of the countervalues is delivered at a future date) is not allowed. Given that exchanges must be equal for equal, a ten dollar not cannot be exchanged for nine one dollar notes. Proceeding from here, commissions on currency exchange will be questioned by some scholars because of the contravention of the ‘equal for equal’ ruling.
Other scholars argue that if the monetary system were correctly designed, then money would comprise gold and silver throughout the world (i.e. American money would be made of gold, Malaysian money would be made of gold, etc.) and hence there would be no need for foreign exchange in the first place. Here, the arguments over the Shari`ah position on modern foreign exchange and currency trading are seen to arise because these markets are of themselves built upon un-Islamic foundations.

Islamic financial institutions looking into tawarruq, a controversial Islamic financing structure, should instead consider sukuk ijarah, or Islamic bonds, when looking at options to raise cash, a study said. In its basic form, tawarruq allows the sale of an asset on a deferred payment basis. The purchaser then sells the asset to a third party to get cash. But so-called organised tawarruq has divided scholars who debate whether allowing such transactions via banks still meet syariah laws. In a paper, Tawarruq is gaining popularity in Malaysia and has been established as syariah-compliant. It helps people who need cash on short notice and it is not a loan.

Brunei would start providing tawarruq financing, and it can be done to help people who are in need of cash in the short term. But if Islamic financial institutions need an alternate solution to prevailing liquidity management challenges, they can turn to sukuk ijarah, or Islamic bonds. A local Islamic business consultant thought that The Islamic banking industry must seriously differentiate itself from the conventional banks, not just by replicating conventional products. Tawarruq is being used today as either a liquidity facility (inter bank placement) or a credit facility (credit financing) as it is a highly profitable business.

The First Global Investments, an Islamic investments firm, defines tawarruq as, reverse murabahah. As used in personal financing, a customer with a genuine need buys something on credit from the bank on a deferred payment basis and then immediately resells it for cash to a third party. In this way, the customer can obtain cash without taking an interest-based loan. An analyst said that the use of tawarruq came under scrutiny because people were finding it difficult to find other brokers to sell their tawarruq to, and that was when the banks started to arrange buyers and sellers in order to make the sale, which is prohibited in the syariah context. It is called organised tawarruq and it is not syariah-compliant. Islamic financial institutions should decide to use tawarruq, because it should only be used in extreme cases where no option is available, to avoid interest. Widespread use of tawarruq is harmful to the industry in the long run, stressing syariah boards have to “strictly monitor all tawarruq-based transactions”.

The Organisation of Islamic Conference Fiqh Academy, an Islamic studies academy in Jeddah, Saudi Arabia, in April 2009, ruled that organised tawarruq was “impermissible” due to the arranged nature between the Islamic financial institutions and the people.

Source : The Brunei Times