Sharia Banking and the Financial Industry

BRI Syariah, a subsidiary of state-owned Bank Rakyat Indonesia, has launched a new product that allows its customer to buy gold in installments, in a bid to draw broader segments of the population to Islamic banking. The bank plans to provide Rp 400 billion ($46.4 million) in financing for customers to buy gold. The first scheme of its kind in Indonesia, Precious Metal Ownership (KLM) is intended to appeal to the young, middle-class population because of its long-term investment appeal, with customers able to pay in installments from six months to 15 years. With this facility, customers can buy gold at the current price and pay that in monthly installments. The product utilizes two Shariah contracts, qardh and ijara . Under qardh, the bank loans money to the customer to buy the gold, and the debtor is only required to repay the amount borrowed. The customer must keep the physical gold in the bank’s vault which, under ijara, is rented out by the bank.
Islamic finance must match the level of service and innovation of conventional banking and that means taking unique approaches. At the end of May, BRI Syariah’s total financing was almost Rp 6 trillion, about a third of which came from consumer financing. The high target will erode the lender’s capital adequacy ratio to 15 percent by the end of this year. As of May, its capital adequacy ratio was at 20 percent. Although the bank has the full support from its parent company, it did not rule out selling sub-ordinated sukuk to bolster its capital.

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With the Islamic finance industry worth an estimated $1 trillion and growing rapidly, it is no surprise that several Asia-Pacific nations are among a growing band of countries worldwide to signal their intention to carve out a larger share of the market. Malaysia, Indonesia and Singapore, along with Hong Kong, have set their sights on becoming hubs for Islamic finance, where investments are made according to Islamic principles. (Under Shariah, or Islamic law, charging interest and making investments in industries such as gambling and alcohol are forbidden.) While their sectors may be at varying stages of development, they are facing a common predicament: a shortage of professionals skilled in Islamic finance. Education institutions around the Asia-Pacific region, like their counterparts in the Middle East and Europe, are seeking to fill that gap by adding Islamic finance specialization to their master’s programs in business administration and elsewhere. The number of such courses available in those countries to the most developed Islamic finance sector in the region, is growing rapidly. (more…)

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Ratings agency Standard & Poor’s stated that Islamic bond offerings may accelerate in the next 18 months, led by first-time issuers in Asia, after the region accounted for the most sukuk sold this year. While issuance of sukuk, or Islamic bonds, are down 17 percent globally this year, Asianborrowers issued $5.3 billion, about 68 percent of the total $7.8 billion worldwide. Sales from companies in the Persian Gulf dropped 24 percent to $2.5 billion so far in 2010 — the lowest level since 2005 — after Dubai World, one of the three main state-owned business groups in the United Arab Emirates, announced plans to restructure debt in November.

One credit analyst and joint chair of the Islamic finance working group at S& P in Paris stated that Sovereigns, particularly from Asia, are pushing for the revival of the sukuk market. Additional countries, or issuers domiciled in countries new to Islamic finance, to tap the sukuk market in the near future was expected. Likely, it will be within the next 18 months.
The Philippines’ state-owned Al-Amanah Islamic Bank is exploring a sale, according to bank president Armando Samia. Economic growth in developing Asia, including Malaysia and Indonesia, will accelerate to 9.2 percent this year from 6.9 percent in 2009. Middle Eastern economies may expand 4.5 percent compared with 2.4 percent, according to estimates by the International Monetary Fund.
Governments are tappinglocal and international sukuk markets to help set benchmark rates for corporate bond sales. The debt is typically backed by assets or cash flow because Islamic law bars interest payment. Instead, investors earn profits from the assets.

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• IMAGE SUKUK

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…)

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Despite the Dubai World debacle, Islamic finance remains an area of interest for Australian investors. When General Electric became the first major United States company to enter the sukuk market, it seemed Islamic finance was finally heading for its day in the sun. While the global financial crisis had shaken the western world, according to Bursa Malaysia global head of Islamic markets Raja Teh Maimunah, the Islamic market had escaped relatively unscathed.
“It has been really interesting times in the last nine to 12 months as we’ve seen the landscape change due to what I would call the western financial crisis, but everybody just calls it the global financial crisis,” Maimunah said.
“Governments in non-Islamic markets that never used to have any interest in Islamic finance are beginning to show interest and we have had calls inviting us to all corners of the earth.” One of the stumbling blocks in melding modern finance with Islamic law had been the prohibition of the payment of interest, according to a report in The Wall Street Journal. But the GE Capital deal, which involved a five-year, $500 million Islamic bond, signalled a bright beginning. “We intend to be regular issuers in the sukuk market and are heartened by the support we have seen in this first transaction,” GE Capital senior vice president Kathy Cassidy told The Wall Street Journal. And Siraj Capital chief executive Ibrahim Mardem-Bey said the transaction was a “big deal”. “People in the industry have been eagerly awaiting something good like this to reignite the market,” However, mere days after the transaction was made public, property developer Dubai World announced it was seeking to delay debt repayments, with its property unit, Nakheel, seeking a standstill agreement on a US$3.5 billion ($3.8 billion) bond due for repayment on 1 December. (more…)

An alternative for the contemporary insurance contract. A group of persons agree to share certain risk (for example, damage by fire) by collecting a specified sum from each. In case of loss to anyone of the group, the loss is met from the collected funds.

A Takaful company has the following features:

i) The company is not the one who assumes risks nor the one taking any profit. Rather, it is the participants, the policy holders, who mutually cover each other.

ii) All contributions (premiums) are accumulated into a fund. This fund is invested using Islamic modes of investment and the net profit resulting from these investments is credited back to the fund.

iii) All claims are paid from this fund. The policy holders, as a group, are the owners of any net profit that remains after paying all the claims. They are also collectively responsible if the claims exceed the balance in the fund.

iv) The company acts as a Trustee on behalf of the participants to manage the operations of the Takaful business. The relationship between the company and the policy holders is governed by the terms of mudarabah contract. Therefore, should there be a surplus from the operation, the company (mudarib) will share the surplus with the participants (rabb-al-mal) according to a pre-agreed profit-sharing ratio.