Shariah-Compliant Markets: Challenges & Opportunities İbrahim M. TURHAN, Ph.D. Chairman & CEO September 20, 2013

Agenda I. Global Outlook of Shariah-Compliant Finance Global Shariah-Compliant Financial Assets Global Shariah-Compliant Banking Assets Global Shariah-Compliant Capital Markets II. Shariah-Compliant Finance: Challenges Lack of Standardization Conflicts among the opinions of Shariah Boards Lack of enough Expertise and Human Capital III . Shariah-Compliant Finance: Opportunities Asset-based Structure Reduction in Systematic Risk Sukuk: Opportunity for Long-term Funding 20.09.2013 2

Agenda I. Global Outlook of Shariah-Compliant Finance Global Shariah-Compliant Financial Assets Global Shariah-Compliant Banking Assets Global Shariah-Compliant Capital Markets II. Shariah-Compliant Finance: Challenges Lack of Standardization Conflicts among the opinions of Shariah Boards Lack of enough Expertise and Human Capital III . Shariah-Compliant Finance: Opportunities Asset-based Structure Reduction in Systematic Risk Sukuk: Opportunity for Long-term Funding 20.09.2013 3

Global Outlook of Shariah-Compliant Finance Total Shariah-compliant assets consist less than 1% of global assets (USD 332.6 tr) CAGR (2008-2013): 18.4% Growth forecast in global Shariah-Compliant financial assets in 2013: 11% The size of Shariah-Compliant financial assets are expected to reach USD 4 trillion by 2020. Source: Bloomberg and KFH Research Source: Bloomberg and KFH Research 20.09.2013 4

Global Outlook of Shariah-Compliant Finance Shariah-Compliant Financial Assets Source: Bloomberg, KFH Research 20.09.2013 5

Global Outlook of Shariah-Compliant Finance Shariah-Compliant Banking Assets CAGR (2007-2013): 17.7% Source: Bloomberg, KFH Research Source: Bloomberg, KFH Research 20.09.2013 6

Global Outlook of Shariah-Compliant Finance Shariah-Compliant Capital Markets Based on current growth forecast, Shariah-Compliant financial institutions will require at least US$ 400 billion of short term, credible, liquid securities for liquidity and capital management purposes, by 2015. Source: IIFM Database 20.09.2013 7

Global Outlook of Shariah-Compliant Finance Shariah-Compliant Capital Markets Structural Breakdown of International Sukuk Issuance Globally - (2001-2013) Structural Breakdown of Domestic Sukuk Issuance Globally - (2001-2013) Source: IIFM Database Source: IIFM Database 20.09.2013 8

Global Outlook of Shariah-Compliant Finance Shariah-Compliant Capital Markets Source: www.cmalert.com, IFIS, Zawya 20.09.2013 9

Agenda I. Global Outlook of Shariah-Compliant Finance Global Shariah-Compliant Financial Assets Global Shariah-Compliant Banking Assets Global Shariah-Compliant Capital Markets II. Shariah-Compliant Finance: Challenges Lack of Standardization Conflicts among the opinions of Shariah Boards Lack of enough Expertise and Human Capital III . Shariah-Compliant Finance: Opportunities Asset-based Structure Reduction in Systematic Risk Sukuk: Opportunity for Long-term Funding 20.09.2013 10

Shariah-Compliant Finance: Challenges A) Lack of Standardization Lack of harmonization in regulations (Different terminologies, procedures and applications) Does time value of money in Islam exist? Non-standardization of products Market centered (Conventional) vs. Bank centered (Shariah-Compliant) Financial Intermediation in Shariah-Compliant Finance is restricted. 20.09.2013 11

Shariah-Compliant Finance: Challenges A) Lack of Standardization Latent Organized Exchange for Sukuk: 17% of Total Global Sukuk Issued in Stock Exchanges. 65% of Sukuk (issued in organized exchanges) located on outside of Islamic countries. Source: Zawya 20.09.2013 12

Shariah-Compliant Finance: Challenges B) Conflicts among the opinions of Shariah Boards Lack of consensus among scholars (various Shariah boards) Number of Shariah Boards around the World is more than 400 Total number of board membership around the World is 1,141 Diversification in the interpretation of Shariah-compliance. Source: Funds@Work 20.09.2013 13

Shariah-Compliant Finance: Challenges C) Lack of enough Expertise and Human Capital Shortage of human capital A group of 20 prominent Shariah scholars sit on 55% of total Shariah board memberships. Top 2 Scholars hold 85 board memberships. With scholars holding dozens of portfolios, it is impossible for them to have good performance. Source: Funds@Work 20.09.2013 14

Shariah-Compliant Finance: Challenges C) Lack of enough Expertise and Human Capital There are only 123 Shariah-Compliant programs that cover five continents and are distributed over 26 countries. Source: Belouafi, A., Belabes, A., & Daoudi, M. (2012). Geo-education of Islamic finance in the global space. Procedia-Social and Behavioral Sciences, 46, 5335-5339. 20.09.2013 15

Agenda I. Global Outlook of Shariah-Compliant Finance Global Shariah-Compliant Financial Assets Global Shariah-Compliant Banking Assets Global Shariah-Compliant Capital Markets II. Shariah-Compliant Finance: Challenges Lack of Standardization Conflicts among the opinions of Shariah Boards Lack of enough Expertise and Human Capital III . Shariah-Compliant Finance: Opportunities Asset-based Structure Reduction in Systematic Risk Sukuk: Opportunity for Long-term Funding 20.09.2013 16

Shariah-Compliant Finance: Opportunities A) Asset-based Structure Ratios on Balance Sheets: Shariah-Compliant vs. Conventional Banks (Bankscope Data for 2956 banks around the world) Ratio Scaled by Shariah-Compliant Banks(%) Conventional Banks(%) Business Model Non-deposit funding Total funding 3.9 5.5 Gross Loans Total deposits 77.4 71.6 Efficiency Overheads Total assets 2.7 3.5 Cost income ratio 54.1 62.1 Stability Return on assets 1.4 1.1 Equity assets ratio 13.5 10.7 Controls Non-loan earning assets Total earnings assets 41.7 44.5 Fixed assets 2.3 1.9 Source: Beck, T., A. Demirguç-Kunt, and O. Merrouche. (2010). Islamic vs. Conventional Banking: Business Model, Efficiency and Stability. World Bank Policy Research Working Paper 5446. 20.09.2013 17

Shariah-Compliant Finance: Opportunities B) Reduction in Systematic Risk Source: IFSB 20.09.2013 18

Shariah-Compliant Finance: Opportunities B) Reduction in Systematic Risk Source: Ernst & Young 20.09.2013 19

Shariah-Compliant Finance: Opportunities C) Sukuk: Opportunity for Long-term Funding Source: IFIS, Zawya 20.09.2013 20

Shariah-Compliant Finance: Opportunities C) Sukuk: Opportunity for Long-term Funding Source: IFIS, Zawya, Bloomberg, KFHR 20.09.2013 21

Shariah-Compliant Finance: Opportunities C) Sukuk: Opportunity for Long-term Funding Infrastructure Sukuk Issued by Country (2001-2012) Sukuk Issued by Shariah Principles (2001-2012) Source: IFIS, KFHR Source: IFIS, KFHR 20.09.2013 22

Shariah-Compliant Finance: Opportunities Special Case: Turkey Total housing loans in Turkey equal to TL104 billion, by August 2013. Urbanization process of Turkey props the increasing housing loans. Source: CBRT, UN 20.09.2013 23

Shariah-Compliant Finance: Opportunities Special Case: Turkey Under the urban transformation plan, approximately 8 million dwellings are expected to be rebuilt in 20 years. Urban transformation requires approximately USD 800 billion. For liquidity, Turkey needs secondary loan market for housing credits. Shariah-Compliant Finance tools such as Sukuk Issuance would be a solution. Source: Yildirim, Y. (2012). Urban Transformation. Sabahattin Zaim Islam and Economy Symposium. 20.09.2013 24

Shariah-Compliant Finance: Opportunities Special Case: Turkey Source: IFIS 20.09.2013 25

Recent Developments on Islamic Finance Introduction of Sukuk and Equity Repo Market World Bank Islamic Finance Research Center Organization of Islamic Cooperation Member States’ Stock Exchanges Forum S&P/OIC COMCEC 50 Shariah Index Source: IFIS 20.09.2013 26

S&P/OIC COMCEC 50 Shariah vs. DJIM Index Source: Bloomberg 20.09.2013 27