Prof. Saiful Azhar Rosly, Ph.D International Center for Education in Islamic Finance (INCEIF)

1. Islamic Capital MarketsIB1006 CIFP1PreExamination Session12th April 2009Maytower Hotel and Apartment, KL Prof. Saiful Azhar Rosly, Ph.D International Center for Education in Islamic Finance (INCEIF) saiful@inceif.org

2. Final Examination (80%) • Part 1 : MCQ 20 questions 20 marks • Part 2: Short-Essays 5 questions 5 x 4 = 20 marks • Part 3: Long Essays 3/5 = 3 x 20 = 60 marks

3. Pre-exam sessions • Definition capital market • Demand and Supply of capital • CAPM • Stocks • Unit trust • Sukuk • REITS • Derivatives

4. Global Financial Turmoil

5. Islamic Banking Challanges

6. Subprime Crises: Lessons for Islamic Finance

7. Islamic Financial Market

8. 5 Basic Shariah Principles in Financial Transactions #1 Prohibition of Riba

9. Islamic Bonds

11. Role of Sukuk in Economic Development

12. Corporate Finance – Demand for Capital

13. Cost of Capital

14. Capital Structure

15. Sukuk – Moving Forward

16. Shariah Compliance: Consistency is Critical ‘AQAD Principles MAQASID Benefits vsdisbenefits LEGAL/CONTRACT DOCUMENTATION Protection of Rights FINANCIAL REPORTING AAOIFI/IFSB/IFRS

17. Shariah Compliant Parameters • Aqad-based– Contract-based • Maqasid al-Shariah(purpose of the Law) – impact on society • Financial Reporting – actual strength and performance of companies • Legal documentation – identification and recognition of rights and obligations of contracting parties.

18. Approved Islamic Finance Products • BBA Home Financing • Bay InahHome Financing • Bay InahPersonal Financing/Overdraft/credit card • Tawarukmunazampersonal financing • Commodity murabaha • Ijarahthummaal-bay • Bai-bithamanAjil Islamic Debt Securities (BAIDS) • Discounted Bay al-daynMuNif • SukukIjarah • SukukMusharakah Islamic Bonds

19. Challenging issues in AQAD-based Islamic Finance Products • Benchmaking profit rate against interest rate (LIBOR,KLIBOR). • Profit Equalization Reserve (PER) – displaced commercial risk • Sale with condition to buyback at predetermined price between two and three parties. • Profit generated over installment payments – time value of money • Penalties on delayed payments • Benchmakingsukuk rates against LIBOR • Musharakah with Purchase undertakings – fixed profit to one party only. • IjarahSukuk - Sale with repurchase agreement at par value and not mark-to market • IjarahSukuk – Ownership of asset by SPV • Profit-rate swaps – speculation or gambling?

20. #1 AQAD Method

22. Contract of Sale • Example: Murabaha/BBA Sale • Buyer and Seller eg. Seller owns asset/subject matter before making sale 2. Subject matter eg. Mal mutaqawim – property with usurfruct 3. Price eg. Set on the spot 4. Offer & Acceptance eg. Verbal or in writing

23. Method #2: Maqasid al-Shariah/Objective of Shariah To protect the interest of the public (society)- maslahah al-ammah by: 1. removing the harm ( ibqa) 2. securing of benefits (tahsil)

24. #2 Maqasid Method

25. Objective of Shariah Islamic financial products as defined by AQAD methodology, should contain more benefits (masalih) and less or no harm (madarah). “ in gambling (maisir) and liqour (qimar), there are some sins and some profits. But the sins are greater than the profits” (Al-Baqarah: 168).

26. “ in Gambling (maisir) and Liqour (qimar), there are some sins and some profits. But the sins are greater than the profits” (Al-Baqarah: 168). Gambling & Liqour

27. Riba

28. Al-Bay

29. Financing BBA

30. Plain BBA

33. Downside (Madarrah) of Credit-Financing

34. The upside (Manfaat) of Credit-Financing

35. Maqasid • To analyse(theoretical) and measure( empirical) impacts of financial intermediation based on aqad-based Shariah compliant products. • Efficiency studies • Profitability studies • Studies on Consumer welfare and protection • Studies on Financial stability

36. Maqasid – protecting public interest. • Aqad-based products (ABP) SHOULD contain more benefits and less harm. • What if, it was proven than they (ABP) contain more harm than good? eg. Abandon projects – customer cannot make recourse against bank as selling party? Defaulted BBA customer are required to make settlement based on the selling price. Sale with no transfer of ownership. Giving away clean inah personal financing at high profit rates– a way towards subprime inah? Conflict between Aqad and Maqasid?

37. Method #3: Financial Reporting • Proper recording of transactions to evident TRUE SALE. • BBA – bank must put BBA asset on balance sheet prior to sale. I week, 1 month it depends. • Once sold, it is recorded as BBA receivables. • AITAB assets should be on banking book as leasing assets but now treated as “financing and advances”. • External auditors (PWC, KPMG etc.) are not required by the authority to conduct Shariah audit. And they may not be not capable to do so. Conflict between AQAD and financial reporting?

38. Islamic Bank Average Balance Sheet

39. 1st October 2008 15 October 2008 • 1/9/2008 Bank purchases Property from Vendor for $200,000 • 15/9/2008 Bank Sells Property to Customer for $280,000

40. ‘Do not Sell what you don not Own” Hadith (Sahih Bukhari) High Court Judge Datuk Abdul Wahab Patail says that the sale element in BBA sale is not a bona fide sale BBA Legal Documentation Sale and Purchase Agreement (SPA) Property Purchase Agreement (PPA) Property Sale Agreement (PSA) Deeds of assignment/Charge 2. Bank do not have legal + beneficial ownership of property to make a valid sale 1. No transfer of title from Customer to Bank

41. Basel II and IFSB • High risk-weights for Musharakah Financing to imply that bank bears business risk and the general investment account holders (GIA) do not. • Recent PSIA guidelines will test risk appetite of depositors.

42. Method #4: Legal Documentation • BBA should be documented as a true sale and not as a loan. (Dato’ Nik vs. BIMB) • Ijarah should be documented as operating lease and not a loan (Tinta Press vs. BIMB) • Islamic bank has not practice fairness compared with conventional bank (Affin bank vs Zulkifli). Conflict between AQAD and documentation of AQAD?

43. ‘Do not Sell what you don not Own” Hadith (Sahih Bukhari) High Court Judge Datuk Abdul Wahab Patail says that the sale element in BBA sale is not a bona fide sale BBA Legal Documentation Sale and Purchase Agreement (SPA) Property Purchase Agreement (PPA) Property Sale Agreement (PSA) Deeds of assignment/Charge 2. Bank do not have legal + beneficial ownership of property to make a valid sale 1. No transfer of title from Customer to Bank

44. Shariah Compliance: Consistency is Critical ‘AQAD Principles MAQASID Benefits vsdisbenefits LEGAL/CONTRACT DOCUMENTATION Protection of Rights FINANCIAL REPORTING AAOIFI/IFSB/IFRS

45. Islamic Finance

46. Islamic Way of Life in Business

47. Islamic Way of Life in Business

48. Against Islamic Norms

49. Islamic Bonds and Sukuk

50. ABC Balance Sheet Current Asset Cash $8,000 Account receivable $120,000 Marketable securities $20,000 Inventory $110,000 Fixed Asset $250,000 Total Asset $508,000 Current Liabilities $108,000 Long-term liabilities $190,000 Owner’s Equity $210,000 Total liabilities and Owner’s equity $508,000