CHAPTER 11: ISLAMIC CAPITAL MARKET

SALIENT FEATURES OF ISLAMIC FINANCIAL MARKET

It is a financial market which operates on Shari'ah principles.
Its basic code of belief suggests:
o Prohibition of riba (interest/usury)
o Prohibition of Short sales
o Prohibition of gambling and speculative trading
o Prohibition of hoarding
o Prohibition of Gharar (excessive uncertainty)
o Prohibition of dealing in unlawful goods and services
ISLAMIC FINANCIAL MARKETS AND INSTRUMENTS
Islamic Financial
Markets

Islamic Banking

Islamic Money
Market

Islamic Capital
Market

Islamic
Deposits

Equity Funds

Islamic
Financing

Sukuk

ISLAMIC FINANCE PRODUCTS

1. Islamic Trade & Corporate Finance Products
o financing of working capital, large projects, exports & imports
2. Islamic Personal Finance Products
o financing of housing, consumer durables, automobiles
3. Islamic Commodities/Agriculture Finance Products
o financing for agriculture related businesses/services

SHORT-TERM ISLAMIC FINANCE PRODUCTS

Working capital financing

Leasing (Ijarah) financing

LONG-TERM ISLAMIC FINANCE PRODUCTS

Project finance
Islamic syndicate finance

ISLAMIC FINANCING
Murabaha

Musharakah

Bay As Salam
Istisna

Ijarah

Wakala

A contract of sale in which the seller declares his cost and profit
Involve the purchase of goods by the bank which then being sold to the
client at an agreed mark-up
Repayments usually by instalments
Financing working capital requirements on daily basis arrangements
between Islamic Bank and client who agree they will share the gross
profit
A sale contract with full prepayment today but delivery in the future
Focus on agricultural products (e.g. palm oil, wheat)
A contract of exchange with deferred delivery, applied to specified
made-to-order items (manufactured goods)
Agree in terms of quality and specifications of goods to be received in
future
Leasing facilities which normally available for financing plant and
equipment; car fleet; trucks and other technical items
Types of leasing transactions: (i) operating lease and (ii) finance lease
Agency contract in which clients who wants to be financed act as agent
of bank to acquire asset then sold to him on credit instalments

CATEGORIES OF ISLAMIC FUNDS

1. Equity Funds
Invest in shares of joint stock companies
Returns in form of capital gains and dividends which are distributed on a pro rata
basis among investors
Four sub-categories:
i. Regular income funds through dividend paid
ii. Capital gain funds through frequent sale and purchase of stocks
iii. Aggressive funds invest in high risk securities for abnormal profit
iv. Balanced funds invest in high quality securities with less risk
2. Ijarah Funds
Used to purchase assets for the purpose of leasing
Rentals received from user are distributed among subscribers of the fund
3. Commodity Funds
The subscription amount is used to purchase different commodities for the purpose
of resale
Profits generated by the sales are distributed among subscribers
4. Murabaha Funds
Closed-end funds whose units are not negotiable in a secondary market because
Islamic Banks portfolio of Murabaha does not own any tangible assets
5. Mixed Funds
Funds in which the subscription amount is employed in different types of
investments like equities, leasing, commodities, etc.
For trading of mixed funds, tangible asset > 51% while liquid assets < 50%
2

SCREENING CRITERIA OF SELECTION OF SHARIAH-COMPLIANT STOCKS

Investee companys capital structure must be predominantly equity based (debt < 33%)
Investee company is prohibited from investing in interest-based (riba) financial institutions
and from dealing in the areas of gambling, alcohol production, etc.
Value of shares of investee company should not less than the value of net liquid assets of
company
RULES OF SHARIAH-COMPLIANT EQUITIES
Basic business should be halal
Total debt divided by 12-month average market capitalization should be less than 33%
Sum of companys cash and interest-bearing securities divided by trailing 12-month average
market capitalization should be less than 33%
Accounts receivables divided by trailing 12-month average market capitalization should be
less than 33%
CORE ACTIVITIES OF SHARIAH NON-COMPLIANT SECURITIES
Financial services based on interest
Gambling and gaming
Manufacture or sale of non-halal products
Conventional insurance, entertainment activities that are not permissible, manufacture of
tobacco-based products
Stock broking or share trading in Shariah non-compliant securities and other activities
deemed non-permissible
ISLAMIC BOND MARKET SUKUK
A Shariah-compliant security or certificate of investment.
It must represent the ownership in the underlying assets or its usufruct.
The Sukuk instruments are issued under following common structures by companies, banks
and governments.
1. MUDARABAH SUKUK (Profit Sharing)

2. MURABAHA SUKUK (Cost plus Sale; Deferred Payment)

3. MUSHARAKAH SUKUK (Partnership)

4. IJARAH SUKUK (Leasing)

5. SALAM SUKUK (Forward)

CONDITIONS IN WHICH SUKUK TRADING IS PERMISSIBLE

1. for Mudarabah/Musharakah Sukuk
Tradable at market price after the start of activity
2. for Murabaha Sukuk
Tradable before sale of the goods to the end-buyer
3. for Salam Sukuk
Not tradable except on the face value
4. for Istisnaa Sukuk
Tradable if funds are converted into assets and before sale to the orderer.

LEGAL, REGULATORY AND LICENSING ISSUES IN SUKUK

1. Tax treatment
Taxes borne by investors and issuers in domestic/ cross borders transactions
2. Trust laws
protection of assets , ring-fencing, investors protection
3. Asset transfer
stamp duties, transaction legal and regulatory approval costs
4. Licensing
ability to issue instruments in different Islamic jurisdictions freely
5. Marketing of Equity funds &Investment certificates
disclosure of risk and return profile of investments to targeted net-worth clients

ISLAMIC FORWARD MARKET

1. A Salam-based forward market
For products and commodities in which a regular market exists
Strictly requires advance payment of price of goods
Delivery of goods is compulsory
2. An Istisna-based forward market
For infrastructural and development projects
Longer term transactions compared to Salam-based forward market
3. A Jualah-based forward market
For service-based activities thus no physical goods qualify

MAJOR CHALLENGES TO DEVELOPMENT OF ISLAMIC FINANCIAL MARKETS

1. Education and awareness
Creating awareness among Muslims and Non-Muslims about the Islamic financial
system.
Potential clients should be provided transparent and accurate description of Islamic
financial products being offered.
Accountability and governance of Islamic banks should be stressed across board.

2. Product innovation and development

Competition with non-Islamic banks would require continuous product
development.
Islamic products must have salient and distinctive features for investors.
Researchers, and Islamic finance product developers must strive for innovation
within confines of Shariah principles through active coordination with religious
scholars.
3. Performance benchmark
Islamic financial institutions use the same benchmarks as that used by conventional
non-Islamic banks.
Islamic funds do not have any benchmark to compare their performance based on
Shariah principles.
Islamic financial system community should set up benchmarks for evaluating
performance of Islamic capital market products that have investors and societys
welfare at its centre.
4. Risk management capabilities
Islamic financial contracts have their own peculiar risks and reward features.
Islamic financial institutions have to identify, unbundle, measure, monitor and
control all the specific risks.
Islamic financial institutions need to have well-developed internal control system to
identify any potential deterioration in the asset quality of the Islamic banking
portfolio.
Sound risk management practices for Islamic financial contracts would provide
comfort and security to the potential investors and boost further growth.
5. Information technology
Information technology can play a major role in development of new Islamic
products or boost attractiveness of current products and strengthen enterprise risk
management.
Islamic financial institutions should use information technology and decision support
systems to capture and store long-term historical data to predict future risk and
return underlying Islamic finance product portfolios.
6. Skilled human resources
Educated, committed and competent personnel, with Islamic ethical values are
needed to educate customers and general public.
Joint efforts by the Islamic financial institutions, scholars, regulators, universities,
and business schools .
INCEIF Islamic finance university in Malaysia.
Degrees/courses in Islamic finance.