Islamic Banking and Fi na nee An Integrative Approach Zubair Hasan OXPORD UNIVERSITY PRESS
Contents Oxford Advisory Board Dedication Preface Structure of the Book Acknowledgements About the Author Contents V i//'/' ix xi xvii xix xxi CHARTER 1 Introduction to Islamic Finance 1 1.1 What is finance? 3 1.2 The significance of finance in modern economies 6 1.3 Money and economies 7 1.4 Money and prices 8 1.4.1 Price ievei changes 9 1.4.2 Money supply and price level 11 1.5 Islamic approach to finance 12 1.5.1 The distinctive features of the Islamic approach to finance 13 1.6 Why ban interest? 17 1.6.1 The rationale for prohibition 18 1.7 Overview: the origin and evolution of Islamic finance 20 1.7.1 The rise of Islamic banking 21 1.7.2 A brief historical overview 21 Summary 26 Glossary 27 Key concepts 28 Case studies 28 Test questions 29 Web exercise 30 What next? 30 CHARTER 2 Money Creation and Control 31 2.1 What works as money? 34 2.1.1 Law and money 34 2.2 Money supply: the principles 35 2.2.1 Currency notes 36 2.3 Methods of note issue 37 2.4 Fiscal policy and money supply 38
XXII I CONTENTS 2.5 Credit (money) creation by banks 40 2.5.1 State Intervention 41 2.5.2 Credit creation and Islamic banks 42 2.6 Central banks and credit control 44 2.6.1 Bank rate policy 44 2.6.2 Statutory reserve variations 44 2.6.3 Profit-interest linkage 45 2.6.4 Open market Operations 49 2.6.5 Moral suasion 50 2.7 The ailment and the eure 50 Summary 54 Glossary 55 Key concepts 56 Case studies 56 Test questions 58 Web exercise 59 What next? 59 CHARTER 3 Value of Money and Society 61_ 3.1 Background 63 3.1.1 Socio-monetary development 64 3.2 Inflation 66 3.2.1 Definition and types 66 3.2.2 Inflation growth and employment 68 3.2.3 What causes Inflation? 70 3.2.4 The impact of Inflation 71 3.3 Deflation 72 3.3.1 Consequences of deflation 73 3.4 Islam and cyclical fluetuations 74 3.4.1 Islamic banks and the financial crisis 76 Summary 78 Glossary 80 Key concepts 81 Case studies 81 Test questions 83 Web exercise 83 What next? 83 CHARTER 4 Islamic Finance - The Basics 85 4.1 Islamic finance: why and forwhom? 86 4.1.1 System convergence 89 4.1.2 For whom the bell tolls? 91 4.2 Objectives and principles of Islamic finance 92 4.2.1 Linkage to the real economy 94 4.2.2 Participatory finance 95 4.2.3 Time value of money 96 4.2.4 S/zar/'a/j-compliant versus Shari'ah-based instruments 97 4.2.5 Conclusion 98 4.3 Internationalization 99 4.4 The Performance of Islamic banks 100 4.4.1 Relative efficiency and strength 101 Summary 102 Glossary 104
CONTENTS I xxiii Key concepts 105 Case studies 105 Test questions 106 Web exercise 107 What next? 107 CHARTER 5 Direct Modes of Islamic Finance 109 5.1 Contracts and instruments 110 5.1.1 Legal maxims 112 5.2 Participatory modes 113 5.2.1 Profit-sharing: the theory 114 5.3 Islamic requirements 122 5.3.1 The conventional model 122 5.3.2 Ownership transfer to the customer 125 5.3.3 The MMP model atwork 126 5.3.4 Recap 127 Summary 128 Glossary 129 Key concepts 130 Case studies 130 Test questions 132 Web exercise 133 What next? 133 CHARTER 6 Indirect Modes of Islamic Finance 135 6.1 Direct and indirect modes 137 6.2 Murabahah 138 6.2.1 Murabahah and home financing 139 6.2.2 The markup issue 140 6.3 Leasing or ijarah 142 6.3.1 Hire purchase and rent sharing 143 6.4 Salam 143 6.4.1 Parallel salam 144 6.5 Istisna' 145 6.5.1 Parallel istisna' 146 6.6 Combining modes 146 6.7 The BBA structure 147 6.8 Tawarruq 148 6.9 Benevolent loan (qard hasan) 149 Summary 150 Glossary 151 Key concepts 152 Case studies 152 Test questions 158 Web exercise 158 What next? 158 CHARTER 7 Investment Sukuk- Islamic Bonds 159 7.1 The origin and meaning of sukuk 162 7.2 Bonds, equity shares and sukuk 164 7.3 Structuring the sukuk 165
XXiV I CONTENTS 7.3.1 Mudarabah sukuk 165 7.3.2 Musharakah sukuk 167 7.3.3 Ijarah sukuk 168 7.3.4 Murabahah sukuk 169 7.3.5 Salam sukuk 171 7.3.6 Istisna'sukuk 172 7.4 Sukuk across countries 174 7.5 Benchmarking 175 Summary 176 Glossary 177 Key concepts 178 Case studies 178 Test questions 181 Web exercise 183 What next? 183 CHARTER 8 Markets for Short-Term Financing 185 8.1 Financial markets: introduction 188 8.1.1 Islamic finance potential 189 8.2 Financial intermediation 190 8.2.1 Defining financial mediation 191 8.2.2 Maturity transformation 192 8.3 Types of financial market and their role 193 8.3.1 The money market 194 8.3.2 The cash or spot market 195 8.3.3 The market for derivatives 196 8.3.4 The Interbank market 196 8.3.5 Over-the-counter (OTC) markets 197 8.4 The Islamic money market 197 Summary 199 Glossary 200 Key concepts 201 Case studies 201 Test questions 203 Web exercise 204 What next? 204 CHARTER 9 Long-Term Financing: Capital Markets 205 9.1 Islam and capital markets 207 9.2 Stock markets 208 9.2.1 Share price determinants 209 9.2.2 Speculation 214 9.2.3 Need for regulation 216 9.3 Instruments for Investment 218 9.3.1 Equity shares 219 9.3.2 Investment sukuk 220 Summary 223 Glossary 224 Key concepts 224 Case studies 225 Test questions 226 Web exercise 227 What next? 227
CONTENTS I XXV CHARTER 10 Risk Management 229 10.1 Risk profit and finance 231 10.2 Islam and financial risks 232 10.2.1 Risk treatment 234 10.3 Risk exposure and management 234 10.3.1 Risk management requirements 235 10.3.2 Types of risk 235 10.4 Risk management framework 240 10.4.1 Derivatives and risk management 241 10.4.2 Guidelines of Islamic Financial Services Board 246 Summary 248 Glossary 249 Key concepts 249 Case studies 250 Test questions 251 Web exercise 252 What next? 252 CHARTER 11 Takaful - Islamic Insurance 253 11.1 Insurance: concepts and evolution 255 11.1.1 The evolution of insurance 256 11.2 Basic principles 258 11.2.1 Utmost good faith 258 11.2.2 Insurable interest 258 11.2.3 Indemnity 259 11.2.4 Proximate cause 259 11.2.5 Beneficiary issue 260 11.2.6 Underwriting 260 11.3 Islam and insurance 260 11.3.1 Takaful versus insurance 262 11.3.2 Forms of takaful 263 11.4 Takaful contracts and models 265 11.4.1 Wakalah or the agency model 266 11.4.2 The mudarabah or partnership model 267 11.4.3 The waqf-wakalah model 268 11.4.4 Cooperatives 269 11.4.5 Model selection 270 11.5 Finance risk valuation 271 11.6 He-takaful 272 Summary 273 Glossary 274 Key concepts 275 Case Studies 276 Test questions 278 Web exercise 278 What next? 278 CHARTER 12 Law, Regulation and Governance 279 12.1 Dominance of diversity 282 12.2 Law and Islamic finance 284 12.2.1 Islamic windows and subsidiäres 287 12.3 Regulations: need, complexity and progress 289 12.3.1 Shari'ah-based framework 291
XXVi CONTENTS 12.3.2 The key issues 12.3.3 Companies' Shari'ah Screening 12.4 Governance of Islamic financial institutions 12.4.1 Definition and scope 12.4.2 Shari'ah governance 12.4.3 Participatory finance Summary Glossary Key concepts Case studies Test questions Web exercise Selected Bibliograph^ A Comprehensive Glossary of Terms in Islamic Banking and Finance Index 294 294 300 301 301 302 303 304 305 305 307 308 309 315 345