ISLAMIC BANKING VERSUS COMMERCIAL BANKING:PROSPECTS & OPPORTUNITIESA PRESENTATION BY:Dr. Fouad ShakerSenior Advisor & Partner: First East InvestFormer Secretary General: Union of Arab Banks

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGOUTLINEPrincipals and development of Islamic finance

Theory and practice of Islamic financial intermediation

Theoretical & practical differences between Islamic & conventional banking

Comparison of financial ratios of Islamic and conventional banks

Future challenges

Areas for improvement and steps forward

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financePrincipals of Islamic financial system

Prohibition of Interest (RIBA)An excess Any unjustifiable increase of capital whether are loans or sales in the central tenant of the system.Islamic regulations encourage the earning of profit but forbid the charging of interest. Money as a potential capitalIt joins hands with other resources to undertake a productive activity.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeRisk sharingWhen interest is prohibited, suppliers of fund become investors instead of creditors. Investors & financial intermediary relationship is based on profit & loss sharing principals.

Prohibition of speculative behaviorDiscouraging hoarding & prohibits transacting featuring extreme uncertainties.

Sanctity of contractsUpholding contractual obligations & the disclosure as a sacred duty to reduce the risk of asymmetric information & moral hazard.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeSharing-approved activitiesOnly activities that dont violate the rules of shariah qualify for investment.Any business Dealing with alcohol, gambling or casinos is prohibited.

Social justiceIn Principle , any transaction leads to injustice & exploitation is prohibited.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeDevelopment & growth of Islamic finance

Development of Islamic financeA rapidly growth part of the financial sector in the world ( >15% annual growth rate).Not only Islamic countries, more than 300 financial institutions in over 50 countries practice some form of Islamic finance.The market current turnover is estimated to be $350 Billion compared with $5 Million in 1985.Islamic finance industry has reached $1.4 Trillion by the end of 2011, expected to be $4 Trillion over medium term.Global conventional banks (HSBC, Citibanketc.) have setups separate windows to offer Islamic banking services.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeEmergence & evolution of Islamic institutions in recent historyIn Muslim countries:1963, local saving banks was established in Egypt to practice their work on a none-interest bases to enhance the banking habit.After 1974, many Islamic banks were established in different Muslim countries due to the sharp increase of the oil prices.Sudan, Iran, Pakistan started the Islamization of banking system during 1980s.

In the western world:In 1983 Islamic finance house started in Luxemburg. recently, besides establishing Islamic banks, Islamic windows in leading banks pursuing this market very aggressively.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationBasic contracts & instruments

Financing instrumentsUsed to finance obligations arising from the trade and sale of commodities or property and collateralized by the product being financed, such as:MurabahahA bank purchases a product for a customer who doesnt have a capital. Both agree on a profit margin added to the cost, the customer should pay the bank later the whole amount.Bay Al-MuajjilA sale transaction with deferred payment allows the sale of a product on the bases of deferred payment.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationBay Al-SalamThe buyers pays the seller the full price of a product which the seller promises to deliver at a specific future date.IjarahA medium term financial instrument gives something in return for rent, resembles the leasing contract.IstisnahTo facilitate the manufacture of an asset at the request of the buyer. Once the manufacturer undertakes to manufacture the asset for the buyer, the transaction of Istisnah comes into existence.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationInvesting instrumentsVehicles for capital instrument in the form of a partnership.MudarabahA fund management instrument , could be short, medium or long term, whereby an investor entrust capital to an agent to undertake a project.MusharakahAn equity partnership instrument which could be either medium or long term partnership, where two or more persons combine either their capital or their labor to share the profit & losses.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationStructure & components of financial statements for Islamic banks

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationTheoretical Balance Sheet of an Islamic bank based on maturity profile

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationTheoretical Balance Sheet of an Islamic bank based on functionality

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationComposition of an Islamic bank Balance Sheet

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediation

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic financial institutions in practiceEarly forms of Islamic financial institutions were concentrated in commercial banking activities, todays Islamic financial institutions can be divided into the following broad categoriesIslamic banks Could be public or private sector.A hybrid of conventional commercial banks & investment banks, it resembles universal banks.Islamic windowsA setup in a conventional bank that offer Shariah-compliant product.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic investment banks & fundsAiming to capitalize on large investment syndications, market-making and under writing opportunities.Succeeded in developing innovative large-scale transactions in infrastructure finance.Islamic mortgage companiesTargeted at the housing market for Muslim communities in western countries.Four models:Ijarah.Equity partnership (diminishing Musharaka).Murabahah. (sales transaction).Along the lines of corporative societies.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic insurance companies (Takaful)Takaful means mutual or joint guarantee. The participants agree to share their losses by contributing periodic premiums in the form of investment. They have to redeem the residual value of profits after fulfilling the claims and premiums, which is a critical difference between contemporary insurance and Takaful. Takaful is a given solidarity.Mudaraba companiesSimilar to that of closed-end fund managed by specialized professional management companies. Unlike the Islamic bank, they are not allowed to accept deposits. Funded by equity capital. Two types; Multipurpose (more than one investment purpose) and Specific purpose.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent concepts of borrowing, financing & investment

Different modes of borrowingAccording to the state banks of Pakistan 2008, conventional banks average for deposits ranged from 2.09% - 2.30% per annum while borrowing rate average ranged from 11.20% - 11.56%. The difference is 7.82%. Islamic banks average rate on PLS deposits ranged from 3.5% to 3.79%. Profit & loss sharing deposits earn more than 1% higher.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent modes of financingConventional banks high rates of interest on all types of loans. Which may be the cause of the business failure & the default of the loan. Islamic bank provides loans on profit & loss (PLS) bases, and only for production purposes.

Different modes of investmentConventional banks; 50% in government treasury bills, bonds, term finance certificates for security, they suffer badly in case of stock market crash.Islamic banks; can not invest in government bonds. Nevertheless, the Sukuk issued by Islamic government would act as a practical solution for (IB) liquidity.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent visualization of the role of money

Conventional banksUses interest to make money out of money. They use money as a commodity which is bought & sold.

Islamic banksUse money as a medium of exchange to facilitate trade transactions. They supply money to traders to purchase real assets or industrialists to produce value-added products. If finance takers generate profit they will share it with the Islamic bank. If they suffer losses the bank will share the loss.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent attitude of risk sharing & income distribution

Different concepts of risk sharingConventional banks; being interest rates based, their depositors do not share the risk with the bank in case of economic shock. Also banks receive fixed rates from borrowers regardless their losses in case of business failure.Islamic banks; their deposits and investors are ready to share risk with the bank in case of financial shocks. The bank as well, is responsible to take risk in case of business failure.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent approaches of income distributionsThe interest-based financial system is pro-rich and anti poor, unlike Islamic financial system which play a vital role in eradication of poverty through Zakat and profit & loss sharing principle.

Having different objectives and goalsIslamic bank works for all benefit of the overall society and for equitable allocation of resources through credit distribution. While the conventional bank works for a specific class that is rich.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGComparison of financial ratios of Islamic and conventional banksBased on the findings of a recent research in Pakistan on two similar groups of conventional & Islamic banks (Average of 6 banks each group).Earning ratios

RatiosIslamic BanksConventional Banks(ROA) Return on Assets0.079-0.75(ROD) Return on Deposits0.07-0.93(ROE) Return on Equity1.297-2.27(EPS) Earning per Share0.38-0.34

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGComparison of financial ratios of Islamic and conventional banksDebt management ratios

RatiosIslamic BanksConventional BanksDebt / equity2.38.0Deposit times capital3.785.71Debt / assets0.780.85Equity / equity + debt31.317.17

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGComparison of financial ratios of Islamic and conventional banksAsset quality management

RatiosIslamic BanksConventional BanksNPLs / advancesNon-performing loans / advances1.065.88

Provisions / NPLsProvision / non-performing loans47.0940.89NPL / depositsNon-performing loans / deposits1.226.24

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGComparison of financial ratios of Islamic and conventional banksLiquidity ratios

RatiosIslamic BanksConventional BanksEarning assets / total assets95%93%Advances / deposits83%70%Yield on earning assets2.7%1.83%

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGComparison of financial ratios of Islamic and conventional banksSolvency ratios

RatiosIslamic BanksConventional BanksEquity / total assetsCapital adequacy ratio (CAR)21.78%14.59%Equity / deposits36.2%20.09%

The earning assets / deposits143.79115.98

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGCash to deposit ratioInvestment to deposit ratiosBorrowing ratios

RatiosIslamic BanksConventional BanksCash & balance / total deposits11.55%12.55%

RatiosIslamic BanksConventional BanksInvestments / deposits15.39%23.85%Investments / total assets4.37%9.25%

RatiosIslamic BanksConventional BanksBorrowing / total assets4.37%4.25%Borrowing / total deposits5.86%11.92%Borrowing / total advances12.93%16.05%

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGFuture ChallengesLiquidityLiquidity- enhancing financial instruments & the development of capital market.Limited scopeCan benefit from economies of scale &enhancement of scope. Both approaches offer diversification benefits.Concentrated bankingDiversifying their base of depositors, reduce their exposure, introduction of Internet banking, geographical diversity on the liabilities side.Concentrated bankingRisk management framework can be enhanced by improving the transparency in current financial disclosure. Measurement & management of risk need to be supplemented with analytical method.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGAreas of improvement & steps forwardTo enhance Financial Engineering that includes the design, development & implementation of innovative financial instruments, new securities or new process of creative solution to corporate finance problems, provided to be Shariah complaint.There is need to establish supporting institutions to act as a Lender of Last Resort .There is need to achieve Uniformity in, & Harmonization of, Shariah Standards across markets & borders.To develop Fee -Based Services like, Joalah, Wakalah & Kifalah to exploit the full capabilities of Islamic banks by diversifying the scope of non bank financial services.Developing benchmarks based on the rate of return reflecting Islamic modes of financing instead of using interest base benchmarks such as the London interbank offered rate (LIBOR) which has been accepted on an adhoc based.Creating a secondary market to enhance the liquidity, & standardizing contracts, to reduce the risk of asset backed securities.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGStandardizing the operations & instruments will pave the way for pooling assets, much needed for enhancing liquidity in the market.By expanding the scope of services, Islamic bank could spread the fixed costs since they are similar to universal banking in a form of hybrid between commercial & investment banking.Having a Shariah board for every institution is not efficient. A Shariah board for the system as a whole is needed to ensure that rules are defined & enforced in compliance with the contractual obligations to all stockholders. Well developed Islamic capital market will benefit borrowers, institutional investors, together with enhancing the stability of Islamic banks. A well developed Islamic microfinance industry will promote economic development in underdeveloped Islamic countries, also it will economically empowered the poor segments of society since they will be able to move from being non-bankable to bankable, this will expand the base of the depositors & investors.

Areas of improvement & steps forward

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGA FEW WORDS ABOUT FIRST EAST INVEST

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGWe intermediate in trade and investment banking deals and transactions between the Arab countries and Eastern and Central, East Europe & CIS businesses1 - INTERMEDIATE,We support Middle Central, East Europe & CIS businesses trade with the Arab World. We also support Arab Gulf investors identify & explore investment opportunities in Central, East Europe & CIS markets as well as raise capital for financing existing or new business ventures.2 - SUPPORTWe promote Middle Eastern and Central, East Europe & CIS businesses market expansions. We promote their business ideas, business ventures, and existing & new projects. We also promote inward and outward direct investments & portfolio investment between the Arab World and Central, East Europe & CIS businesses.3 - PROMOTEFIRST EAST INVEST . What we do:

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGBUSINESS DEVELOPMENT SOLUTIONSINVESTMENT BANKING SOLUTIONSPrivate placements,Debt structuring,Raising funds,Privatization,Mergers & acquisitions,Corporate restructuring,Spin-offs,Leveraged buyouts, andInitial Public Offering (IPOs).Exploring the initiative, assessing products & capabilities, and preparing the Companys for the initiative,Targeting by identifying the market & clients base,Planning the initiative, and producing an Action Plan,Networking to establish the clients own contacts in local market,Visiting the market & testing the initiative,Cooperating by identifying agents, representatives, and/or Joint Venture partners in the local market, andSelling the Companys products & services to the clients already identified in the Arab World. FIRST EAST INVEST . What we do:

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGFIRST EAST INVEST . Our contact:

ISLAMIC BANKING VERSES COMMERCIAL BANKING

*ISLAMIC BANKING VERSES COMMERCIAL BANKINGTHANK YOU

ISLAMIC BANKING VERSES COMMERCIAL BANKING