1. Securitization in Islam

2. Nature of securitization
Securitization is a process that involves pooling, packaging and transformation of financial assets into securities.
It is a way of imparting liquidity to financial assets as securities are relatively more easily tradable than the assets.

3. Basic structure of securitization
Securitization of loans and other assets is a simple way of raising additional funds.
The financial institution from which the assets are pooled is called the originator.
The assets are then sold and passed on to an issuer, called a special purpose entity (SPE).
A trustee is usually appointed to ensure that the issuer fulfills all the requirements of transfer of assets and provides all related services promised earlier.
Credit guarantee or enhancement is provided by independent financial institution(s) as added protection to security holders.

4. Cont’d…
A liquidity provider may supply back-up liquidity in the form of liquidity guarantees or enhancement.

6. Islamic evaluation of conventional securitization
Bakar (1996) considers that al-suyulah (liquidity) has been an integral part of Islamic commercial law.
The underlying asset base in the case of conventional securitization includes loans and other receivables that involve riba. Obviously, this is not permissible.
Only a pass-through with an underlying pool of assets structured as equity or leasing that do not make use of interest either explicitly or implicitly would qualify in the Islamic framework.

7. Cont’d…
Credit enhancement is an integral part of the securitization process. When credit enhancement is for a fee that is related to the quantum of facility, this comes dangerously close to riba and is rightly frowned upon by shari’a scholars.
Liquidity enhancement too comes under a cloud in the Islamic framework. While this is easily achieved in an interest-based scenario, the Islamic framework provides for short-term qard hasan or interest-free loans.

8. The Islamic alternative
The SPE in Islamic securitization could take the form of a mudaraba comprising investors and the securitizing company as the mudarib. The mudarib may legitimately claim its share in the surplus. Alternatively, the securitizing company may act as an agent or wakil of all the investors (that are organized as a musharaka company).

11. Islamic securitization in practice
The first phase occurred in the 1990s with the popularization of Islamic Private Debt Securities (PDS) in Malaysia. The PDS were primarily based on securitization of murabaha receivables. The market for such PDS witnessed a lot of activity because of a more liberal interpretation of fiqh by Malaysian jurists permitting sale of debt (bai-al-dayn) at a negotiated price.

12. Cont’d…
Ijara-based securitization was then seen as an ideal alternative for structuring debt securities. Such securitization took off in a big way with the issue of ijara certificates by the Bahrain Monetary Agency (BMA). The BMA issued, in 2001, Islamic Leasing Certificates with a five-year maturity to the value of $100 million. This issue, with bond like characteristics, is the first of its kind by a Central Bank in the world.

13. Conclusion
Securitization is a means to provide liquidity to financial assets and the need for liquidity is recognized by shari’a. A review of the theory and practice of Islamic securitization reveals that the Islamic framework indeed provides for securitization to be undertaken in a shari’a-compliant manner.
The foremost requirement is that the underlying asset pool must not comprise interest-based assets, such as conventional loans or receivables.

14. Cont’d…
Of the three commonly found securitization structures, the pass-through structure is closest to satisfying a strict interpretation of Islamic norms. The pay-through, the ABB and the commercial paper involve debt, and make explicit use of interest. Therefore, only a pass-through with underlying pool of assets structured as equity, or ijara that do not make use of interest either explicitly or implicitly, would qualify in the Islamic framework.