Islamic Banking :

A Journey to the Basics

MURAT ÇETİNKAYA
Executive Vice President
Kuwait Turkish Participation Bank

Istanbul
2011
Agenda
1. What does “Islamic banking” stand for?

2. What relevance does Islamic banking have in the modern financial

system?

3. What are the current trends and areas of growth?

4. Where does Turkish experience stand in Islamic banking?

5. Kuwait Finance House (KFH) and Kuwait Turkish Participation Bank

From niche to critical mass

 Increasing market presence

− Growing at 15 to 20% per annum
− Size estimated at USD 900 billion globally
− New markets welcoming Islamic banks and products

 Market-driven proposition
− Retail demand has historically the backbone of the industry
− Sensitivities to principles more visible on retail deposit
− But corporates and even sovereigns showed appetite for the products
− Market-driven product development proved to be successful
− Self-regulating organisations accompanied global Islamic banking boom

 Global scale
− More than 250 Islamic banks worldwide operating in over 75 countries

− A wide range of interest varying from U.K. to Singapore

− Widening customer base including sovereigns to top global corporates
to tap Islamic finance markets
Islamic finance industry is developing a global reach…
Reach and richness

Mainstream relevance
Niche presence
Engaging with regulators
Conceptual exploration
 Russia: China:
Increasing interest Active member
of Islamic
…with worldwide momentum VTB – KFH/LMH
partnership Financial
Services Board
(2004)
Germany:
Kuwait Turk received licence
UK:
for a branch
Five active Islamic
Saxony issues
banks
E100m Sukuk (2004)
Sukuk on its way
Japan:
France : JBIC exploring
Recent declaration Islamic
of Islamic Banking interest Turkey: financing
25 years of opportunities
Kuwait & UAE:
Islamic banking Hub for Islamic (Dec. 2006)
experience banking
Saudi Arabia:
95%+ of new consumer Bahrain: Singapore:
lending is Islamic (2006) Leading Islamic Active in
• Retail market rapidly financial centre, and developing
converting to Islamic housing regulatory Islamic
(2006) bodies finance
Malaysia:
Islamic product and
industry, development
and sophistication leader

Each region is contributing in a unique way

Industry has developed a comprehensive product
offering over its young history
Development of industry Evolving richness in products

− Development of theoretical framework

1950s − First attempts to structure Islamic banking
products
structured commercial
products banking
60s − First institutions emerged to test the market

− Islamic Development Bank (1974) and DIB

70s − One country-one bank setup
insurance
2000s 1970s
− Advancement of Islamic products
80s − Turkish market to welcome Islamic banking private
− Full “Islamization” of banking in some equity 1990s 1980s
countries (Pakistan, Sudan etc.) syndications
− Entry of global institutions & Islamic windows
90s − İncreasing global coverage of Islamic banking
project
finance structured
− Islamic banks achieving strong and stable equity and trade finance
growth globally,
2000s − New products in international markets
− Sukuk market to boom

Industry has near like-for-like parity with conventional offering

Global Deployment of Islamic Products

Mainstream relevance Niche presence Engaging with regulators Conceptual exploration

Breakdown of Islamic Banking

Principles Compliant Assets
Islamic Islamic
Breakdown of Islamic

Takaful
Banking Principles

Worldwide (2003)

equity mutual
Compliant Assets

Sukuk 0.1%
funds funds

Worldwide (2008)
7.0%
2.5% 3.5%

Islamic
banking
86.9%

Source: KFHR Global Islamic Finance Directory 2008

The industry has not yet reached its potential

 Still new markets exist that did not yet meet with Islamic banking and finance

 The global Islamic insurance (Takaful) market is estimated to reach USD 20 billion

 Most Islamic financial institutions are highly liquid, and seek new asset classes
and markets to diversify
– New treasury products and investment securities are to emerge
– Capital markets developments: New sukuk issuances expected to tap the market

 Islamic finance has also gained popularity in Muslim-minority countries

– Germany issued the first Islamic Eurobond (2004)
– Five Islamic banks in UK

 Trends of convergence and conversion

– Islamic banks introducing new products and services to compete with the conventional
banks,
– Conventional banks aiming to tap Islamic banking markets and expand their product base
Why Islamic financing is flourishing

Strong growth of
GCC economies

Development of Innovative product

Islamic capital markets development
EXPLOSIVE GROWTH
OF ISLAMIC FINANCE
Liberalisation of Market developments
capital markets urging countries and customers
to diversification

Retail customer
commitment

Industry is driven by fundamental factors

Islamic framework provides solutions for key limitations
of conventional banking system
Conventional banking issues IFI solutions

• Asset/need-based approach to financing

• Growing consumer indebtedness • Channeling the funds to “real”
− Growing and unhedged risks pose systemic investment needs
problems

• Equitable distribution of risk and reward

• Speculation leading to crises

−
• Prevention of speculation
1997 East Asia Crisis
− Ownership is prerequisite of sale
− 1998 Russia
− Excessive risks are prohibited
− 1999 Argentina
An alternative banking model in development

Suppliers of capital Deposits Profit, not interest,

Debt financing
becomes the basis for
financial intermediation
ijarah, murabaha, Productive
salam, istisna‘ economic actors
Liabilities Assets with capital
Equity financing needs
Investments

mudaraba & musharaka

Key internal issues that need addressing…

• Reducing debt-based products
− Islam permits commercial debt for productive ends
− Debt-based consumer products permitted on basis of need

• Building income-sharing products

− Musharaka is preferred form of financing
Tested strength in the financial crisis

 Islamic banking, a booming $US1 trillion global industry that prohibits speculation and
high levels of debt, has been relatively unscathed by the credit crunch.

 Islamic banking model’s basic principles of

– financing “real” trade and economic activities,
– no financing of speculation
– No engagement in debt trading
– Asset backed and project-financing approach to help hedging risks

 As a result, the lessons from the crisis;

– Islamic banking is inherently stable
– Islamic banks outperformed the conventional financial institutions
Right positioning and definition of Islamic banking - 1

Banking and finance needs

Standart contracts
Principles sources
– Musharaka (Partnership)
– Religious basic
sources – Mudaraba (Fund management)
– Ijma’ (jurist consensus) – Murabaha (Purchase-resale)
Principles filter
– Qiyas (analogy) – Ijara ( Lease)
– Ijtihad (reasoning) – Istisna’ ( Manufacturing contract)
– Salam -(Forward sale)

Islamic banking and finance solutions

• Prohibition on: • Prohibition of certain investments: • Asset-backed • Credit and debt

– Interest − Sectors (e.g.: alcohol, armaments transactions with products are not
etc.) investments in encouraged
– Speculation − Instruments (e.g. Leveraged real, durable
interest products, toxic assets assets
type of derivatives etc.)
Right positioning and definition of Islamic banking - 2

Banking and finance needs

Standart contracts
Principles sources
– Musharaka (Partnership)
– Religious basic
sources – Mudaraba (Fund management)

– Ijma’ (jurist consensus) – Murabaha (Purchase-resale)

– Qiyas (analogy)
Principles filter – Ijara ( Lease)

– Ijtihad (reasoning) – Istisna’ ( Manufacturing contract)

– Salam -(Forward sale)

Islamic banking and finance solutions

• With the development and boom of Islamic banking, it became clear that :

− Islamic banking has roots in religion and ethics but it is not a “religion activity” and “not
confined to Muslim population”
− Islamic banking is not something “from and for GCC or Muslim world”, it is a global concept
− Islamic banking has some limitations and border lines, but it is acknowledged that it can
provide solutions in a wide scope of areas ranging from retail banking to investment banking.
Islamic finance is embedded within values

Integrates a wider
Synthesis of Islamic law
and contemporary finance Client Fulfils range of customer base
affinity with certain sensitivities
aspirations

Builds
systematic
checks on
Ethical Parallel financial
investment Responsibl
trends providers
e finance

Inclusive Alternative – Stability from linking

proposition financial services to the
paradigm
– Open to all-faith clients productive, real economy
– Available to Islamic and – Moral compass for
conventional issuers capitalism

Islamic finance is more than financial contracts

Islamic Financial Institutions are positioned in a “zone
of sustainability”

ECONOMIC SOCIAL
IMPERATIVE IMPERATIVE
ZONE OF
SUSTAINABILITY
Islamic
prohibited businesses NGOs
sectors not-for-profits

Islamic finance characteristics:

• Market-driven yet values-based
• Gradualist and evolutionary nature
• Symbiotic and synergistic relationship with mainstream finance
Self-regulatory organizations bring credibility through
standardization of practices
AAO-IFI  Benchmark of Islamic accounting standards
(1991) − 56 accounting, auditing, governance and Shariah standards
Bahrain − Enhancing clarity, transparency and harmonisation

IIFM  Development of global Islamic capital and money market

(2001) − Promoting active and regulated trading and capital flows
Bahrain − Catalyzing trading infrastructure, product innovation and information flows

GCIBFI  Promoting industry in theory and practice

(2001) − Disseminating Shariah concepts & multilateral understanding between IFIs and public
Bahrain − Improving IFI practices, cooperation, professionalism and transparency

IFSB  Standard-setting body of regulatory and supervisory agencies

(2002) − Complementing Basel II Capital Accord
Malaysia − Key standards: risk management, capital adequacy & corporate governance

 Creation of active Islamic inter-bank market

LMC (2002) − Creating secondary market for short-term Shariah-compliant treasury products
Bahrain
− Enabling IFI management of liquidity mismatch

IIRA  Reference point for IFI ratings

(2005) − Issuing sovereign, credit, Shariah quality and corporate governance ratings
Bahrain − Providing effective tool for informed investment decision-making
Industry is reaching mainstream relevance in global
financial system
Relevance in countries with already
developed Islamic banking
• Widens the bankable population and
customer base
− Increases bankable population of economy
− Increases product base in the system
− Attracts more deposits/funds from the
customers
• Enhances stability of financial model
− Asset-based framework links financial services
to real economy
Relevance to new-comers
•
Reaching a broader market
• Alternative source of funding
− Debt issuance with the widest acceptance
− Attract “new-to-industry” investors
• Gateway to OIC markets
− Regional preference of Islamic investors
− Infrastructure investment opportunities
A number of factors need to be engaged to bring success

• Dedicated people
− Greatest intangible to enable Islamic finance and build its future
− Human capital development: bankers and scholars
Key
enablers • Committed sponsorship
− Academic input to formulate visionary framework and development
− Capital sponsorship to bring plans to life

• Proactive engagement
− Regulators, practitioners and scholars to set a common agenda

Need for co-ordination to enable further development

The way ahead …..

 Current expanding reach and richness of Islamic finance

– Despite the absence of an enabling framework
– But at a cost: culture of exceptions, Shariah credibility, competitive disadvantages

 To build an enabling framework requires concerted efforts

– Collaboration between IFIs, endowed industry institutions and regulators
– Exploration of narrow banking principles

 We must preserve what is distinctive about Islamic finance

– Industry regulations and governance heading towards mainstream globalization
– Balancing different elements of Shariah credibility
Overview of Kuwait Finance House

• Kuwait Finance House K.S.C. (KFH) was established in the State of Kuwait in
1977, as the first bank operating in accordance with the Islamic Banking
principles.

• KFH is listed with the Kuwait Stock Exchange (KSE), with a market capitalization
of US$ 9.55 Billion as of 22 June 2009. Assets total US$ 37 Billion and deposits
amount to US$ 24 Billion as at Q1 2009.

• In the global Islamic arena, KFH is in the forefront of the industry in terms of
Key international presence, spectrum of activities, strategic alliances, networking and
innovation.
Facts
• KFH has been awarded by the Banker Magazine as the World’s Best Islamic
Financial Institution, and for third successive year it has been awarded by
Euromoney magazine as the best Islamic Bank in the Middle East.

• KFH is engaged in providing Islamic banking services, and its spectrum includes
consumer banking, corporate finance, Islamic capital markets, real estate finance,
structured finance, investment portfolios, and other products and services.
Overview of Kuwait Finance House

• One of the largest Islamic banks in the world

• Listed on the Kuwait Stock Exchange:
• Government of Kuwait - 43.0%
• General Public - 57.0%
• Specializing in Corporate, Investment, Private, Commercial and Retail banking
• Direct investment portfolio of approximately US$ 800 million
• Through the direct investment portfolio, KFH has interest in aviation, shipping,
takaful insurance, information technology, real estate construction and
Key
development, logistics, oil and gas and healthcare
Facts • Co- Lead arranged first Euro denominated Sukuk for the German State of Saxony
Anhalt.
• Lead managed first local Kuwaiti sukuk issue for The Commercial Real Estate
Company
Overview of Kuwait Finance House

Key Facts Ratings (JAN ‘09)

• Headquartered in Kuwait with 175 branches

locally and worldwide Agency Short Term Long Term
Rating Rating
• Market Capitalization of US$ 9.55 Bn (June
‘09) Capital A-1 A+
Intelligence
• Asset Size of US$ 37 Bn (31 March ‘09)
Fitch F-1 A+
• Deposits of US$ 24 Bn (31 March ‘09) Moody’s P-1 Aa3
• Total shareholders’ equity of US$ 4.10 Bn S&P A-2 A-
(31 March ’09)
 Overview of Kuwait Finance House

• Ability to structure and close transactions rapidly due to bank’s seasoned

expertise, network, strategic partnerships, financial strength and sound liquidity
position.

• A deeply entrenched brand franchise with subsidiaries in Bahrain, Turkey,

Malaysia, Singapore, Australia, Jordan and Saudi Arabia and affiliates in UAE
and Oman
Competitive
Strengths • Strong underwriting ability: unrivalled access to Islamic deposits in the domestic
& regional market.

• Formation of Liquidity House as an investment house fully dedicated to Sukuk

issuances.

• Strong links with regional and international financial institutions

• presence in the domestic and regional real estate market and proven
transactional expertise in the international arena.

• Recognized and respectable Advisory Board and structuring expertise; KFH

Advisory Board clearances and approvals on structures are in most, if not all,
cases taken for granted by other fellow participants in deals and transactions.
Overview of Kuwait Finance House
One-Stop Islamic Financial Solution Provider
Overview of Kuwait Finance House
Collectively KFH has the expertise and value-added services, capable of delivering the
objectives of the client
STRENGTH & EXPERTISE
• Specialist in ICM
• Strength in the Middle East
• Strong and experienced
leadership team
• Expertise in Islamic banking
principles compliant products
Our Client
DISTRIBUTION CAPABILITIES WEALTH OF EXPERIENCE
• Strong distribution team • 30 years of experience
• Extensive distribution network including global sukuk issuance
and placements
including GCC, Europe and Asia
• Middle East distribution advantage
• Client-centric approach for
every deal/issuance
• Strong relationships with other Islamic
• Ability to innovate and structure
and International banks and
Islamic financing solutions for
investment houses for placements
clients
KFH RESEARCH LIMITED

KFH Research Ltd is the world's first Islamic investment research arm to be established by an
Islamic Bank. A direct subsidiary of Kuwait Finance House, KFH Research was established in 2007,
comprising industry professionals and 'star' research analysts with broad experience in Islamic
finance & global markets. Below is a sample of their reports:
KFH GROUP: A SAMPLE

Next Steps
SOVERIEGN SUKUK ISSUANCES ARRANGED BY KFH

Bahrain Monetary
KHAZANAH NASIONAL Agency
Dubai Civil Aviation UAE Saxony Anhalt Government of Qatar
US$ 750 Mn US$ 250 Mn
Sukuk US$ 1 Bn EUR100 Mn US$700 Mn
Sukuk
Sukuk Sukuk Sukuk
Co-Lead Manager Lead manager
Joint Lead Manager
2006 2003
2004 Co-Lead Arranger Co-Lead Manager
2004 2003
Overview of Kuwait Finance House

Key Facts Ratings (JAN ‘09)

• Headquartered in Kuwait with 175 branches

locally and worldwide Agency Short Term Long Term
Rating Rating
• Market Capitalization of US$ 9.55 Bn (June
‘09) Capital A-1 A+
Intelligence
• Asset Size of US$ 37 Bn (31 March ‘09)
Fitch F-1 A+
• Deposits of US$ 24 Bn (31 March ‘09) Moody’s P-1 Aa3
• Total shareholders’ equity of US$ 4.10 Bn S&P A-2 A-
(31 March ’09)
Overview of KT

Shareholder structure
• Kuveyt Turk began operations in 1989 .
1.05%
• Market share of Kuveyt Turk among participation 9%
banking sector is currently 22.5% 9.00%

• Asset size of Kuveyt Türk is TRL 5.72bn as of

31/12/2008

• Shareholder Equity:TRL689m 18.72%

62.23%
Fitch Ratings
Foreign Currency National
Long Term BB Long Term AAA(tur)
Short Term B Outlook Stable
Outlook Stable Individual D
Kuwait Finance House (62.2%)
Local Currency Support 3
General Directorate of Foundations, Turkey (18.7%)
Long Term BBB- Sovereign Risk
Social Security Institution Kuwait (9.0%)
Short Term F3 Foreign Long Term BB- Islamic Development Bank (9.0%)
Outlook Stable Local Long Term BB Others (1.1%)
Outlook Stable
Supportive anchor shareholder
Supportive anchor shareholder (2008) Strategic benefit
Kuwait Finance House (“KFH”) • Supportive shareholder through difficult times
Total assets : US$38.3bn • Access to and superior understanding of the
Shareholder equity: US$5.8bn Middle East market (instruments and
Gross Profit: US$1.39bn customers)
Net Profit to Shareholders US$ 633m
Branches: 46 • Access to Middle East institutions and liquidity
Funding • Rating agencies look favourably on support
Source: KFH Annual report
KFH Subsidiaries • Better asset-liability mismatch management
• Coordination between KFH group treasuries
Kuwait Turkey enables better hedging of FX exposure at
lower costs
• 1 subsidiary: Kuveyt Turk
• 16 subsidiaries
• Total assets: US$3.8bn

Bahrain Malaysia
• Product innovation
• 1 subsidiary: • 1 subsidiary: Know-how • Investment in product development
Kuwait Finance House Kuwait Finance House • Provision of commercial guidance
(Bahrain) B.S.C. (Malaysia) Berhad
• Total assets: US$3.4bn • Total assets: US$2.7bn

KFH network • Beneficiary of strengthening ties between

Turkey Kuwait Malaysia Turkey and the rest of the world, especially
International with Middle East
Pop.: 74m Pop.: 3m Pop.: 27m
GDP1 (US$): 659bn GDP1 (US$): 111bn GDP1 (US$): 186bn banking • Foreign trade services
• Turkey as a destination of oil-driven capital

• Professional reporting systems at international

Corporate standards
governance • Global expertise at board level
Bahrain
Pop.: 1m • Best-in-class management techniques
GDP1 (US$): 17bn

Source: EIU, Central Bank of Kuwait

(1) Nominal GDP
 Financial overview - profit and loss (IFRS1)

Operating income (TRLm) Net income (TRLm)

7.8% 1.4%
91.2
G R: 4 90 R: 7
CA CA G
80
67.0
70
60
50 40.0
40
30
18.1
20
10
0
2005 2006 2007 2008

(1) Income includes foreign exchange gains / loss

Kuveyt Turk overview
International & Investment
Corporate Retail Banking
• Murabaha / Istisna’as
• Deposits (current / participation
• Financial leasing • Project finance
acc’s)
• Letters of Guarantee • Corporate finance
Products • Loans
• Foreign trade finance (Letters of • Capital markets
• Card business
Credit) • Syndicated Murabaha
• Moneygram
• Foreign trade services

• First international Murabaha

• 39,000 corporate customers
Highlights • 13,000 active credit customers
• 800,000 retail customers
• 59,000 retail SME customers
syndication of US$200m raised for
Kuveyt Turk in 2006
• Operating in 96 countries with
more than 1,000 correspondent
banks

Distribution 120 branches: 119 in branches in Turkey, 1 in Bahrain and 1 Financial Services Branch in Germany

Cash loans by segment – 2008 (%)

Breakdown
of total cash
loans

Total: TRL 4.0 bn

Financial overview – balance sheet (IFRS1)
Total assets (TLm) Total liabilities (TLm)

6,000 5,718 6,000 5,718

14%
5,000
5,000
: 34.3% 31%
CAGR 3,860 9%
3,860
4,000 4,000
2,951 11%
2,951 25% 9%
3,000 3,000 2,363
2,361 9%
24% 5% 10%
2,000 %29 69% 2,000 13% 77%
75% 80%
76% 81%
1,000 71% 1,000 82%

0 0
2005 2006 2007 2008 2005 2006 2007 2008
Net loans Other assets
Deposits Equity Other liabilities

RoAA and RoAE Capital adequacy ratios (TRYm) - CAR

(1) Audited IFRS accounts for 2004-2006-2007 and draft accounts for 2008
Leading platform and innovator
Key Achievements
• First mover advantage in the retail sector1
• Innovative product development
• First participation bank to segment its client
base
Retail
• High customer service levels
• Focus on building long-term client relationships
• Strong brand name and sticky retail base
• Increased focus on small to mid sized
corporates
Corporate • Development of portfolio management system
• Increased focus on letters of guarantee
• First and most advanced investment banking
propositions
International &
• Most dynamic participation bank funding
Investment structure
Banking • Development of international network (branches
& correspondent banks)
(1) Amongst participation banks
(2) Excluding retail SMEs
Results
• 40% participation bank consumer loan market
share
• Retail loans2 account for 25% of portfolio
compared to participation banks average of
17%
• Offers one of the widest range of products
amongst participation banks
• Higher margin business and reduced risk profile
• Increased quantity and quality of clients and
improved profit per client
• Enhanced quality control delivering better
returns
• Larger proportion of non-cash loans
• Funding origination through Bahrain branch
• Executed the first and largest ever international
Murabaha syndication among participation
banks in Turkey (US$200m)
• International network to increase access to Gulf
investors and funding opportunities for clients
• Facilitates increasing share of overseas trade
flows
Performance drive and future upside

Performance
Category Actions taken Future upside
2007 2008

Total cash loans1 • Branch roll-out (Turkey)

29% 37%
(1yr) • Target 25 new branches p.a.
• Bahrain branch
Growth
Non-cash loans/Cash • Target non-cash vs cash of 2:1 by
Loans1 61% %80 • Non-cash lending (↑)
end 2010
• Retail loans (↑)
Loans / deposits 2
108% 106% • Diversify funding further
• Employee incentives
• Business partnerships
• Retail / SME loans (↑) • Enhanced cross-sell
• Non-cash loans (↑) • Disposal of non-core assets
Asset / income
Fee income3 % 79% 88% • Centralised commission • Benefits from training
quality
• Risk management • Gulf market expansion
NPL ratio 4
4.2% 4.8% focus • Correspondent banking network

• Focus on competitive Long-term target RoAE of

Performance - RoAE 19.9% 16.7%
advantages 25%

(1) Gross loans – Annual increase rates (3) Fee & commission income (% of Financing income )
(2) Interbank Loans and Deposits not included. (4) Total impaired receivables / total gross loans
Strategy

Capitalise on advanced
retail / SME franchise

Capture trade flows from Grow local customer base

overseas locations through branch roll-out

Leverage existing customer

Enhance non-cash business base through enhanced
product range / offering

Improve operational
efficiency through cost
control initiatives

Become Turkey’s leading participation bank and one of Turkey’s top 10 banks
 Strategy in International Banking

• Raised US$200m through a syndicated commodity Murabaha transaction for Kuveyt Turk in 2006
Key • Arranged US$240m of international syndications since 2006
highlights • Correspondent banking relationship with around 1,000 financial institutions in 96 countries

Key • Increase market share in international syndicated facilities

• Leverage off KFH relationship and Bahrain branch to drive growth through increased access to Gulf
strategic investors
goal • Expand German representative office into full branch operation

Products International expansion

Means of • Dubai branch expected to be operational

• Focus on increasing quality and size of
achieving international syndications
• Germany representative office awarded
Financial Services branch license in 2009
strategic • Expand treasury function • Expected to add value on fund mobilisation from
Turkish and Muslim population.
goals • Increase international services to retail and
corporate customers • Further expand correspondent bank network in
line with demand for trade finance activities

International expansion and access to Gulf investors key to growing ahead of the market
Let’s move together further ahead to explore
new peaks and horizons of Islamic banking

Thank you
Murat Çetinkaya
EVP, Kuwait Turkish Participation Bank