1. Modalities and Regulatory Framework for Islamic Finance Ismail Radwan– Lead Financial Sector Specialist World Bank, April 22 nd, 2010 Transcorp Hilton, Abuja

2. Presentation Overview Introduction to Islamic Finance1 The Growth of Islamic Finance2 Islamic Finance Products3 Regulatory Framework & Challenges4

3. Introduction to Islamic Finance

4. …“God has permitted trading and forbidden usury.” Al Baqarah 2:275 “ And for their taking interest even though it was forbidden for them and their wrongful appropriation of other peoples’ property. We have prepared for those among them who reject faith a grievous punishment” Al-Nisa’ 4:161 Islamic Jurisprudence- Rule of Positive Approach: “Everything in this world is Halal except that which is declared as Haram”

5. Introduction to Islamic Finance Islamic Finance: Finance that adheres to the principles of “Shariah” Prohibition of Riba: No usury or interest Prohibition of Gharar, Maysir and Ghishsh: No gambling, lotteries, speculation, fraud or cheating. Risk must be shared by all parties. Prohibition of investing in haram sectors: weapons, arms trading alcohol, drugs adult entertainment pork related Transactions should be backed by a tangible asset Islamic Finance is ethical finance

7. Judeo-Christian Tradition Thou shalt not lend upon usury to thy brother, Deutronomy 23:19 “He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniquity, hath executed true judgment between man and man, hath walked in my statutes, and hath kept my judgments, to deal truly; he is just He shall surely live, said the Lord GOD” (Ezekiel 18: 8,9) He that by usury and unjust gain increaseth his substance, He shall gather it for him that will pity the poor” (Proverbs 28:8) All the world’s major religions prohibit usury

8. Presentation Overview The Growth of Islamic Finance2 Introduction to Islamic Finance1 3 4 Islamic Finance Products Regulatory Framework & Challenges

9. Source: Islamic Financing: A Practical Perspective, by Khir, Gupta and Shanmugam Growth of Islamic Finance

11. Growing at 15% per year Assets over USD 1 trillion

12. Growth of Islamic Finance 62% of muslims surveyed had either halal only investments or both. Indicates that about 2/3rds of muslims are concerned with having Halal investments

13. Growth of Islamic Finance Global Trends Islam is the fastest growing religion 1996 to 2005, 1.9% growth in population vs. world rate of 1.3% Now a quarter of world population Muslim at 1.8 billion, one third by 2025 Two thirds in Asia, the rest mainly in Africa. Europe has 3% Muslims, more in certain countries (esp France 10%). Indonesia largest muslim population but large populations in India, China and Russia Economic growth rates in Central Asia OIC countries about 10.3% currently and generates 70% of global energy needs. Generally reliant on commodities for economic growth but beginning to diversify

14. Islamic finance not restricted to muslim populations Africa has witnessed an expansion of Islamic banks across the region with Islamic banks currently operating in Botswana, Djibouti, the Gambia, Guinea, Kenya, Mauritania, Niger, Senegal, South Africa and Sudan. Drivers of Growth Supply side: Middle East banking expansion. Higher oil revenues. Post 9/11 repatriation of capital. Expansion into Africa. Global financial crisis (Islamic banks unscathed). Demand side: the growth of Islamic banking is driven by the appeal of a ‘faith based banking system’ that is based on the principles of Shariah. Distrust of conventional banking following numerous scandals and frauds. Growth of Islamic Finance

15. Presentation Overview Islamic Finance Products3 Introduction to Islamic Finance1 The Growth of Islamic Finance2 Regulatory Framework & Challenges4

16. Islamic Finance Products Sukuk Takaful Buying and selling Leasing Contract of works Partnership Investment management Islamic bonds Islamic insurance Future sale Major Islamic Finance Products and their conventional counterparts Basic financial products – not full range of conventional finance

17. Islamic Finance Products Murabaha : Credit Sale Transactions backed by an asset No recognition of money as a commodity (only a medium of exchange)

18. Islamic Finance Products Mudaraba: Investment Management Profit sharing investment accounts bounded by Mudaraba contracts are at the heart of Islamic Finance – treated as hybrid capital by rating agencies.

19. Islamic Finance Products Sukuk essentially amounts to commercial paper that provides the subscriber with ownership or part ownership of the underlying asset: Asset backed note Securitization

20. Islamic Finance Products Explosion in Sukuk products Not just in Islamic countries. German state of Saxony –Anhalt issued a E100m five-year sukuk that was rated AA- by S&P in 2004. UK recognizes sukuk as debt finance which allows issuers to offset payments against their profits when calculating corporate taxes.

21. Islamic Finance Products Problem: Not all Sharia boards agree

22. Presentation Overview Regulatory Framework & Challenges 4 1 Islamic Finance Products3 2 Introduction to Islamic Finance The Growth of Islamic Finance

23. Challenges in development of Islamic finance Regulatory Framework & Challenges

24. Key Challenge is harmonizing the regulatory framework AAOIFI was established in 1990 in Algiers now based in Bahrain. Objectives develop accounting, auditing, governance and Shariah standards for Islamic financial institutions. IFSB: Establish 2002 serves as an international-standard setting body of regulatory and supervisory agencies. Promotes a prudent and transparent Islamic financial services industry through introducing new, or adapting existing international standards consistent with Islamic Shariah principles.

25. Regulatory Framework & Challenges Lots of players in the Islamic financial world… AcronymsOrganizationFunction AAOIFIAccounting and Auditing Organization for Islamic Financial Institutions Accounting and Shariah Standards setting body. ARCIFIArbitration and Reconciliation Centre for Islamic Financial Institutions Dispute resolution. CIBAFIGeneral Council of Islamic Banks and Financial Institutions Trade association of Islamic banks to enhance member institutions’ ability to better serve customers around the world through transparent banking practices. ICDIslamic Corporation for the Development of the Private Sector Part of Islamic Development Bank Group. Established to promoted private sector investments similar to IFC ICIECIslamic Corporation for the Insurance of Investment and Export Credit Islamic Insurance Company providing insurance products for investments and export credits. IFSBIslamic Financial Services BoardStandard setting institution to ensure best practices and help member countries with regulating Islamic financial institutions. IIFMInternational Islamic Financial MarketsTrade Association to promote capital markets. IIRAIslamic International Rating AgencyRating Agency. IRTIIslamic Research and Training InstituteResearch and training arm of Islamic Development Bank. IsDBIslamic Development BankDevelopment institution established in 1975 to promote Islamic finance and economic development. ITFCInternational Islamic Trade Finance Corporation To promote trade among OIC countries through Islamic mode of financing. LMCInstitution to provide liquidity enhancement to the financial system.

26. Regulatory Framework & Challenges CBN Approach to Islamic Finance Regulation Overview A non-interest bank is a bank that transacts banking business, engages in trading, investment and commercial activities as well as provide financial products and services in accordance with the principles and rules of Islamic commercial jurisprudence. Non-interest banking is based on the prohibition of giving or receiving of interest. Key features Deposits: In the form of quasi-capital Earnings from financing: Investment in an underlying asset for onward leasing or sale Revenue: Generated from lease rentals or share of profits on sales Returns: Depositors participate in the share of profits and losses of the bank. Geographic Scope: All 36 states plus FCT Key prudential requirements: Minimum risk weighted asset ratio of 10%. Non-permissible activities: Products and services that are not Shariah compliant.

27. Focus on 5 key pillars: -Capacity Building, Knowledge Management, Sharing and Dissemination; -Advocacy to Influence Policy Direction in Market Development, Regulatory Approaches, New Instruments; -Diagnostic and Analytical Work in Islamic Finance; -Technical Assistance to Support the Development of Islamic Finance in Client Countries; -Islamic Financing by the World Bank Group Regulatory Framework & Challenges World Bank Engagement with Islamic Finance