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QUESTION 3Discuss the importance of Islamic financial institutions and markets in any economy[Hint: you may look at this problem from the FOUR (4) economic units point of views]. (5marks)

The whole point of IFIs to exist is to deal with the simple reality of mobilization of

resources to allow commerce and moving of funds to take place in the economy.That is based on the understanding from the Black Box Theory.

The point is to mobilize funds from the (1)surplus units(House Holds, Business,Governments, Foreigners) meaning the ones who have excess liquidity, andtransferring the surplus to the parties who are in (2)deficit units, meaning the oneswho are in need of liquidity to address their current circumstances which they are notable to do so with their current strength.

This bridging of surplus and deficit is done through efficient methods where bytransactions can take place quickly. The financial intermediaries, such as banks, take

deposits from their clients (House Holds, Business, Governments, and Foreigners) andthose deposits are then funnelled to the parties who are the deficit units. This is the (3)indirect methodas IFI act as the financial intermediaries to deploy the resources.

Another method to deal with getting liquidity from the surplus to deficit parties is throughthe Financial Markets, also known as the (4)direct method. An example would be thedealing directly with IPOs. So the stock offering is directly from the deficit party to thesurplus party.

QUESTION 4Using examples, explain the concepts of direct and indirect finance in the context

of Islamic finance. (5 marks) NEXT PAGE


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Question 7

A) Critically illustrate qualitative measures of stock screening process (HINT:

use of diagram might be useful. You may illustrate any of the widely used

standards such as the FTSE Global Islamic Index Series (GIIS), the Dow

Jones Islamic Market Indexes (DJIM) or the Malaysian Security

Commission Guidelines. January 2011, (10marks)

Answer

Qualitative measures of stock screening process aims to exclude from the

universe of investable stock, companies that operate businesses that violate

Shariah injunctions. In almost all cases, shares of firms whose primary business

activities are in the following sectors would be deemed as Shariah non-complaint

assets. In other words, qualitative screening process examines the core businessactivities in order to ensure that companies produce goods and services which

are free from elements prohibited in the Quran, and the following diagram shows

the areas which qualitative screening process focuses by taking example of

FSTE.

Company

Products & services

free fromConventional or interest-

based finance

(Riba/interest)

Gambling, gaming, casino

operations & number

forecasting (maysir)

Prohibited goods and services

such as pork, non-halal meat,

alcohol and prostitution

Conventional insurance

(Gharar)

Tobacco

manufacturing or sale


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B) Critically illustrate quantitative measures of stock screening process

(HINT: use of diagram might be useful. You may illustrate any of the widely

used standards such as the FTSE Global Islamic Index Series (GIIS), the

Dow Jones Islamic Market Indexes (DJIM) or the Malaysian Security

Commission Guidelines. January 2011, (10marks)

Answer

Quantitative measures of stock screening process examine the companys financial

statements by filtering the financial ratios. However, companies are indifferent in

analysing financial statements; some just examine the profit and loss account only as in

the case of Malaysian Security Commission Guidelines, and FTSE and DJIM both look

balance sheet and income statement. For instance, FTSE does do examination in the

financial ratios by using its own benchmark and it evaluates the following areas, which

the following diagram depicts:

FTSE

Financial ratio filtering

in Balance Sheet & P&L

Debt/Total Assets important to short term & long term

objectives of economic growth & sustainable developmentLarge reserve back up -> important in protecting a country against unforeseendestabilizing development

2) Actsasabanker&financialadviserto theGovernmentAdvise government on its loan programs. Responsible for trading, registering,setting, & redeeming government securities through its trading & settlementsystem

3) Promotesmonetarystability&sound financialstructure4) Influencesthecreditsituationtothe advantageofthecountry5) Lenderoflastresort6) Shariahsupervisory

Questions: Give examples, explain what it meant by comingling funds. Whycomingling of funds considered non-shariah compliant. Discuss the roles ofIslamic Shariah advisers in resolving the issue. What could be the factors thatconstraint the capacity of Shariah advisers in resolving this problem.

Commingling funds: mixing together between Islamic and conventional funds in term of

deposit insurance corporation practice

Deposit insurance in practice Basic Principle: No Co-mingling of FundsRely on conventional deposit insurance

Islamic deposits are very small, thus no incentives for regulators to enforce the

establishment of deposit insurance scheme

Mixed-pool of funds

Premiums received from conventional and Islamic banks are put in the same

pool and returns on investments are shared based on % of contributions from

each sector

Separate pool of funds

Premiums received from Islamic & conventional banks are put into two separate

pools

Considered no shariah compliant because of the mixing Islamic & conventional funds

The shariah advisor / shariah board is a key element of the structure of an Islamic

financial institution, carrying the responsibility of ensuring that all products and services

offered by that institution are fully compliant with the principles of shariah law.


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Profits generated will bedistributed according to thepredetermined ratio.

the lessee. Lessor retains beneficial

ownership to the equipment. Lessee has possession and use

of the equipment through

payment of rentals over astipulated period of time.

June 2011 Q. 6 (c)

Question3 major roles of non-bank fin. Institutions in promoting financial services industry(e.g. wealth mgt, asset mgt etc)

1. Takaful

Function: A type of joint guarantee insurance mechanism where a large group of people

pool their financial resources together against certain loss of exposures. Based on principles of co-operation, protection, mutual responsibility and avoid

acts of interest and uncertainty. Takaful operator conducts all its affairs in a manner that adheres to Shariah

guidelines. Takaful operators do not have policyholders. They are contributors or

participants, as they are participating jointly in a takaful fund for their mutualbenefits.

Contributors/participants: Owners of the fund.

Product:Family Takaful Has a defined period of maturity. Insured persons commonly make periodic level premium contributions. Contributions will be used primarily for meeting their targeted individual savings

and partly for assisting their families financially when the insured dies. Contributions amount varies among the insured, depending primarily on the sum

(face amount) that each insured targets to accumulate at the end of the coverageperiod and on the age, gender and health condition of the insured.

The takaful operator may set the minimum face amount for this purpose and mayalso set minimum and maximum age limits for participating in this type of policy.

Takaful life insurance is also used for other purposes, including generating fundsfor childrens education, securing a fund in case of mortgagors premature deathand protecting business interest against key employees death. Several takafulpolices now come with hospitalization and disability benefits.


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There is virtually a counterpart takaful life insurance policy for each major type ofconventional life insurance policy, with a difference in how premiums areallocated.

General Takaful

Takaful General Insurance Policy Takaful operators offer coverage, commonly on an annually renewal basis, forfire, automobile, liability, marine, workers compensation, fidelity and even cropinsurance.

Principles employed: principle of insurable interest to minimize the problems ofmoral hazard, i.e., to separate insurance from gambling.

Using the principles of uberrima fides, both takaful and conventional insurers canmake a contract void if there is material misrepresentation concealment orbreaches of warranty made by insured.

Valued policy, actual cash value methods not permitted in takaful.

2. Retakaful Retakaful transfers are commonly classified into proportional and non-proportional arrangements.

Non-proportional arrangements such as excess of loss or stop-lossarrangements may not be suitable because of the existence of uncertainty withrespect to the assessment of losses.

Islamic principles demand for clearly defined joint responsibility throughout thecoverage period.

Retakaful likely to be arranged on a pro-rata basis, e.g. quota share or surplusRetakaful, where the reinsurer becomes a co-insurer of the original risks. If,however, a non-proportional reinsurance arrangement is selected, it could bebased on a strict profit commission plan or on a reciprocal basis. In this regard, itmatters little whether the Retakaful transfer is on a facultative or treaty basis.

Addition: Takaful operations now available in various countries throughout the world

(around 40 operators), primarily in Islamic countries and countries with largeMuslim population.

Industry growth: 10 -20% per year. To enhance global takaful infrastructure, ASEAN Retakaful International (L) Ltd. has been identified as one of the vehicles to

enhance Retakaful arrangements.

3. Fund Management companies

Definition: Fund management companies manage the funds of their clients. Caters for people who either have no time to manage their own funds or are

fearful that they do not know how best to manage their funds, or believe that fundmanagers have the expertise to seek out better yields at lower risk relative to


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Jan 2011 Q.5 (b)

Discuss problems of Islamic financial products harmonization (4 marks)

o Adhering to International Standard setting bodies are purely on voluntary basis -

The primary objective of International Islamic finance regulatory framework is to

promote cross boarder products harmonization. (E.g. AAOIFI, IFSB, IIFM).

However, These International standardsetting bodies do not posses any formal

supranational supervisory authority and its conclusion do not and were never

intended to have legal force.

o Different jurisdiction between countries & Different views by scholars. - Muslim

countries have their own religious bodies which are independent from one

another. They establish their own principles. A particular principle adopted by aspecific country is not necessarily regarded as distinct principle by other

countries. E.g. non-permissibility of BBA in most of the countries but

permissible in Malaysia.

Jan 2010, Question No.10 (b)

This question is basically based on the articles by Shariah scholars hold many positions

in many Shariah Board. I cant find the actual article but it basical ly discussing on

Shariah scholar more than one position sin boards.

b) The number of Shariah scholars serving the IFIs within and between the GCCs

jurisdiction is well documented in the article. This may led to greater

standardization and harmonization of the Islamic products/instruments within and

between GCCs jurisdiction. Do you agree or disagree. Discuss.

Agree Disagree

Minimize diversion of fatwa as the merely the

ame person has derived the fatwa. For example,

ny issue shared and discuss in Bank A will be

hared the same in Bank B. Thus, this will bring

orrelation of same understanding.

Potential conflict of interest Shariah Advisory

firms not only consult but also engage in the

auditing same IFIs Multiple roles and boards

Shariah scholars serve. There will definitely be a

conflict of interest. When a Shariah scholar sits

on the board of a financial institution, he is

basically issuing Fatwa as to how to draft


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something. Some are also Shariah auditors and

legislators of an organization which sets Shariah

standards. They could also play the role of judge

for a particular country. So, while you are on the

board of a financial institution and also the judge

of a high court in that country, there is a

possibility that the case of the financial institution

you are working for might come back to you as a

judge

Credible the scholars on the board are, and

herefore how much would the potential client

ase trust those scholars to ensure everything is

eing done in a Shariah-compliant manner. Theey criteria for any scholar are experience, an

nderstanding of local law and legislation, a

ommitment to the institution and independence

Scarcity of scholars, many are shared by

institutions; this can impact on the quality and

potentially the impartiality of the advice. Most of

the time spends on travelling so do not haveample time to do some research and deep

understanding of the subject matter to be

discussed. Existing scholars under formidable

pressure to deliver approvals promptly. The risk

is that insufficient time is being devoted to legal

documentation governing the structure of

products like Sukuk which can run to hundreds

of pages

his global interaction has an added benefit: itan foster greater harmonization between the

ifferent Shariah interpretations. While every

cholar needs to maintain the independent

uthority to make their own decisions, a shared

nderstanding of how scholars approach their

work can be of great help to an industry that

emains geographically and culturally dispersed.

Most of the scholars holding many positions inmany board are senior in the industry which will

lead to hide new talents of young scholar

onboard who is well versed in economics can

add a lot of value to an existing board. New

talented young scholar might bring something

different views on the current issue. Of course,

mentorship is essential to these new talented

scholars.

Details of Shariah scholars in article will benefitFIs to find scholars most appropriate for

ooperation by analyzing their expertise (e.g.

ector/country exposure), experience, position

.g. chairman), educational background (e.g.

egrees, majors or ongoing professorships),

ompany involvement, and identifying events

Top 2 scholar share 61% of their boardmemberships together. Where is the room for

mentoring and apprenticeship systems when the

same people of similar seniority tend to occupy

the same boards


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hey should attend, at which scholars speak.

hus, this will bring harmonization on developing

ew products.

Opinions:

s ok to hold many positions in other boards.

However, to ensure there is sufficient rooms to

evelop young talented scholars with all the

nowledge to avoid shortage of expertise in

hariah jurisprudence.

Opinions:

Encourage the board to consider appointing at

least one member of the Shariah committee as a

member of the board that could serve as a

bridge between the board and the Shariah

committee

Cross border products harmonization

Advantages

Promote market liquidity - Liquidity flows for efficient resource utilization and

supplementation that apply equally across both conventional and islamic sectors

Harmonize disclosure standards, align distributions and develop mutual

recognition for primary offerings

Mutual recognition of market professionals involves

Promote investment through local intermediaries

Allow local intermediaries to distribute and market products

Build and link infrastructure

Disadvantages

Duplicating or altering existing standards

Compliance burden

Constrain cross border product flows


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The salient features of dual banking system, advantages and disadvantages and discuss

efforts and initiatives taken in promoting IF in those countries where parallel jurisdiction

between Islamic and conventional.

A dual banking system involves the existence of dual laws in parallel for the Islamic as well as

conventional financial institutions. Both banking systems are equally comprehensive and viable.

Malaysia is the best example of dual banking system, full fledged Islamic banking system

operating on a parallel basis with a full fledged conventional system. Not only do the two

systems work on a parallel basis, they also utilize essentially the same set of banking

infrastructure.

The Malaysian model has many advantagescompared to the conventional system.

The Muslims in the countries which have only a conventional systemdo not have the

opportunity to benefit from the facilities of a modern banking system without being

involved in Riba.

In the case of the conventional plus system (conventional system with a few Islamic

banking institutions operating on the fringe of the banking system ex. Saudi Arabia,

Bangladesh, and Bahrain): the services they offer are not as comprehensive and as

sophisticated as the conventional system. The small scale nature of the operations of

the Islamic banking institutions in these countries also make their services less efficient

and more costly compared to the conventional institutions.

In the dual banking system in Malaysia, the Islamic banking system is a full-fledged system

with a large number of products, a large number of institutions and an interbank money

market. The Islamic banking products offered in Malaysia's dual system are therefore much

more sophisticated and cover a wider range of services than the Islamic banking products

offered in the conventional plus system.

In a dual system, therefore, the Islamic banks cannot afford to be complacent, since they

operate in a competitive and dynamic environment. In the single Islamic system model, on the

other hand, the financial institutions would not have a similar incentive to expand the range of

the Islamic banking products as the possibility of domestic customers shifting away to the

conventional system does not rise.


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In addition to wider range of services, the Islamic banking products in the dual system can also

be expected to have a higher level of sophistication compared to the Islamic banking

products in the single Islamic system. In a dual system of banking, such innovations will

quickly find their way to the domestic conventional banking system. The Islamic bankers

operating in the dual system would have no choice but to create similar sophisticated products

on an Islamic basis. This will be an on-going process, whereby the level of sophistication in the

Islamic banking system will continuously be upgraded.

Disadvantagescome from the fact that Islamic Banking in dual-banking system is subjected to

the same supervision and regulatory regimes of a Central bank than for the conventional one.

As IFI have to face competition coming from conventional banks, Islamic bank will have no

choice to copy conventional financial products.

Efforts and initiativesthat can also be applied for pure Islamic banking system:

Deployment of human and financial resources to develop Islamic financial instruments.

Development of secondary market

Strategic alliances have been made between International Financial Exchange and the

Bahrain SE: cross-border and trading of Islamic financial products

Development of the Islamic Capital Market: ex in Malaysia, Introduction in 2005 of the

Citigroup Malaysian Government Securities Index and the DJ RHB Islamic Malaysia

Index


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1. Principles of Islamic Finance - Discuss 5 principles (repeated in Jan 2011 and

Sept 2010)

Prohibition of Riba/ Usury/ Interest.

Riba means extra amount or deferment in the exchange of certain

commodity. Riba is absolutely prohibited in Islamic law. There are two

types of Riba which must be prevented by the player in financial

transactions: Riba Nasa' and Riba Fadl.

Money as potential capital.

What is considered by the objective of Shariah is money as potential

capital, meaning that money becomes capital only when it is invested in a

business. Accordingly, money which is advanced to a business as a loan

is regarded as a debt of the business and not as a capital which is not

entitled to any returns i.e. interest.

Risk-Sharing.

The risks in every business transactions are shared between the parties

who involve in the transaction. It is because one of the objectives of

Shariah is to ensure justice among the people.

Prohibition of speculative behavior.

Islam prohibits all types of Gambling, speculative and extremely uncertainbehavior. Islam seeks protection from deceit, uncertainty, economic

injustice, and ignorance for so it has clearly forbidden all business

transactions, which leads to exploitation and injustice in any form to any of

the parties of a contract.

Sanctity of contracts.

Islamic financial products and services are essentially based on contracts.

The importance of contracts in Islamic financial products and services is

more significant in Islamic finance because these products, unlike

conventional financial system, relate to various forms of contracts. The

elements of contract in Islamic commercial law consist of six elements

comprising of offer, acceptance, offeror, offeree, price, and subject matter.


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2. 4 challenges faced by IF services industry that might impede the growth of the

country.

Cross border product recognition.

Lack of shari'ah standards cross border products acceptance.

Shari'ah scholarsgovernance.

Lack of regulatory or government supports.

Regulating shari'ah scholars.

Lack of qualified Islamic finance professionals, including shari'ah scholars.

Fiscal regime.

3. Compared to other countries, Bahrain and Malaysia are quite successful in promoting Islamic

financial services industry can be attributed to strong government & regulatory supports.

Discuss. June 2011 (5marks)

Success Factors in Malaysia due to:

- Government Support

- Legal/Regulatory Framework

- Education-Public & Industry

Success Factors in Bahrain due to:

- Triggered by hike in Oil Price-Gulf War

o Search for Shariah investment

- High concentration of Islamic Financial Institution

o Creation of Bahrain Financial Harbour (BFH) US 1.3 Billion

- Regulatory Framework:

o Only nation to codified rules for Islamic Fin. Institution

o Most number of Islamic Banks on country basis

o

Bahrain Monetary Agency (BMA)- Prudential Information and RegulatoryFramework (PIRI)

- Supporting institution

o AAOIFI

o Liquidity Management Center (Money market)

o International Islamic Rating Agency


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- Strong Government Support & Commitment to Islamic Finance

o BMA-Sharia Advisory Council

o IIBFTraining institute talent development

o Regular issuance of Sukuk & leasing securities

4. Critically discuss the challenges of introducing Islamic financial services in the non-

Muslim countries (Hint: You may select any countries such as the CIS, Australia, China, and

African countries to substantiate your arguments). (Repeated in Jan 2010) June 2010

(10 marks)

(you can summarize and take important points on below short article)

In Australia

Australia is one of the many non-Muslim nations that have shown a keen interest in establishing

Islamic banking and finance in the country. It is a country closely watched by Islamic finance

scholars and practitioners as the favorable developments have encouraged tapping the Australian

financial market. It can be understood that countrys interest has been further fueled by the

United Kingdoms successful implementation of Islamic finance and growth potential of the

sector. Australia with its vibrant and efficient financial markets undoubtedly is an ideal platform

for Islamic finance to grow.

Muslims are one of the many minorities in Australia, the history of the Muslim Community in Australia

dates from the sixteenth century. Some of "Australia's" earliest visitors were in fact Muslim fishermen

from the island of Makassar from the east Indonesian archipelago (Brief history, 2002). Their population

has seen ups and downs due to reasons of history, economic development and politics. It is only in the

recent decades that the Muslim minority in Australia has become more noticeable (Mirza, 2003). Author

Mirza (2003) also states that in 2001 (the last official census date), there were 281,578 Muslims

representing 1.5% of the total population up from 1.1% in 1996. This number is continuously growing asthe 80% of current Muslim population arrived after 1980s.

As other Muslims around the world, Australian Muslims share the same discomfort of dealing with

conventional banks.As a result, demand for Islamic finance has been growing in the country. Today, the


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Muslim Community Credit Union Ltd (MCCU) and the Muslim Community Co-Operative (Australia) Ltd.

(MCCA) cater to the financial and banking needs of Australia's Muslim minority community (Mirza,

2003). The MCCA operates as a co-operative and specifically deals with investment accounts, where

withdrawals are restricted. The services offered by MCCA are personal and business finance, halal

investments, qard hassan and zakat collections and distributions. This institution has had a tremendous

response from the Muslim community. The MCCA and MCCU are now well established and on the way

to becoming a fully-fledged Islamic Bank (Mirza, 2003). These developments translate in to one that

Australias Muslim community drives the demand for Islamic finance.

In general, Australia is a multi cultural and multi faith society that enjoys high living standards.

Australia, like most developed countries, has an ageing population. As productivity commission

report (2005) indicates the proportion of people aged 65 and over is expected to more than

double over the next few decades. This trend also indicates populations possible inclination

towards ethical investment approach would further increase.

Moreover, this generation is more conscious of the environment and socially responsible

activities is more likely to be interested in ethical investing The concept has already been well

received by many Australians who have a positive view of ethical financial deals. For example,

Australian Ethical Investment (AEI) Limited is on investing in highly ethical companies through

using positive screens for finding companies involved in the renewable energy sector, the

production of natural food, recycling and public/efficient transport providers (Wikipedia).

Company states that baby boomers are converting their socially responsible consciousness of the

1960s into a useful tool to help them determine how they will invest as they near-retirement.

For non-Muslims Islamic finance has the same appeal as ethical investing where Islamic finance

deviates from conventional finance. In this aspect, it would be wise for Islamic financial

institutions to promote the concept of ethical investment which is the very idea of Islamic

finance eagerly endorses. Australia provides the right market for IFIs to introduce these products

that would be widely received by interested parties. In addition, baby boomers would create

perfect conditions for takaful operators to establish their presence in Australian market.

In one of the latest developments in Islamic finance, Australia has expressed its interest in

accommodating Islamic finance in countrys financial framework. Australia has arguably the


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most efficient and competitive financial sector in the Asia-Pacific region, but there are further

opportunities to expand countrys exports and imports of financial services. . This is

complimented by the high recognition of Australias financial sector with Australias financial

system and capital market ranking second among 55 leading nations in 2009 (Freudenberg).

Australia, its location within Asia-Pacific with its large Muslim population combined with its

political stability and prudential banking record provides a competitive advantage in facilitating

greater penetration of Islamic finance (Freudenberg). Australia sits on the doorstep of the some

of the largest Islamic regions in the world and as analysts predict it could become a major

Islamic financial hub in 10 to 20 years time (Lannin, 2007). Standard and Poor's in Australia,

says it expects an Islamic stock market index to be based in Australia within the next few years.

It is noteworthy to mention the views expressed by Australian Assistant Treasurer Senator Nick

Sherry in Doha, Qatar that how keen Australia is to embrace Shariah finance. In a renewed

attempt to make Australias financial infrastructure more attractive government made a range of

recommendations including steps to ensure Islamic finance is enabled in Australia

(Muehlenberg, 2010). According to Muhelenberg (2010) Australian government believes that

this will present opportunities for Australian-based banks and financial institutions to develop

Shariahh-compliant finance products for domestic and international markets. Australian

government report on this regard has made several recommendations including removal of

regulatory barriers to the development of Islamic finance products. The report further

recommended an inquiry by the Board of Taxation into whether Australian tax law needs to be

amended to ensure that Islamic financial products have parity of treatment with conventional

products ((Muehlenberg, 2010). The future potential for Islamic finance is bright and

government concern in promoting Islamic finance would further encourage IFIs to move in to

country.

Among the major issues IFIs would face in a non-muslim country like Australia the current

financial regulations remain a hurdle. While these countries have an interest in

accommodating Islamic finance, a separate regulation dedicated for Islamic finance would be

hard to enforce. The IFIs would be required to operate in existing conventional framework that

will have certain provisions to support Islamic finance. There needs to be tax reforms (amongst


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others) to ensure taxation is responsive and enabling for Islamic finance although not

preferential. However, this raises the fundamental question as to whether it is constitutionally

possible for Australia to implement such tax reforms to encourage and facilitate faith-based

transactions (Freudenberg). The possibility of providing a responsive tax structure must be

studied in the light of Australian constitution.

Common Challenges:

1. Product Development and innovation

Successful financial markets offer the market players, among other factors, a wide array

of products t invest in. this provides adequate flexibility for investors to make investment

decisions. Similarly, for an Islamic financial market to be successful, it must provide the

market players with the range of products that would enable the investors to match their

investment appetite and profile.

2. Building credibility and confidence

The challenge of credibility and confidence in Islamic finance stems from a set of factual issue

combined with a slew of misrepresented beliefs about Islam. Perceptions of Islamic finance

being tainted with terrorist funding and home of anti-money laundering are far from the truth.

3. Skills and expertise

One of the most vexing managerial issues in Islamic finance issues is the lack of skilled

personnel with knowledge and subject matter expertise in banking and Shariah

compliance. The issue has hampered the pursuit of product development efforts and has

also at times resulted in operational losses (Sultan, 2008).

4. Designing an effective money market system

Islamic banks are operationally similar to conventional banks hence they rely on liquid,

short term maturity liabilities to fund asset growth (Sultan, 2008). This compels Islamic

banks to hold substantial liquid assets and excess reserves. This in turn inhibits financial

intermediation. Difficulties in defining rates in these instruments have also constrained

the development of money and interbank markets.

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