Wednesday, February 28, 2007

Islamic finance and the FSA-UK (Financial Services Authority)
Howard Davies Chairman, Financial Services Authority
Thank you for the invitation here today, and for giving me the opportunity of setting out the FSA’s approach to financial regulation, in general, and to Islamic finance and Islamic banking, in particular.

It is a good moment to devote some thought and discussion to the way in which Islamic finance fits into the global financial system, and to the way in which it should be regulated, in all its manifestations. One particularly good reason for doing so is that, in recent years, there has been a significant revival of the historic tradition of Islamic banking. Some countries, notably Iran, Pakistan and Sudan, have moved to structure their systems on a purely Islamic footing. In rather more countries, Islamic banks have been established alongside conventional banks on the Western model.

There are no solidly reliable statistics on the size of Islamic finance, but it is clearly of growing importance globally and is attracting increasing attention and visibility. Some commentators estimate that the Islamic banking and finance market has grown at between 10% and 15% annually over the past decade and that it is currently worth between $200 and $500 billion. As President Reagan once memorably remarked, "a billion here, a billion there and pretty soon you are talking real money".

Bahrain and Malaysia are regarded as perhaps the market leaders in the development of international Islamic finance. And indeed both the Bahrain Monetary Agency and Bank Negara Malaysia, the Malaysian central bank, have been among the authorities who have come together to establish the Islamic Financial Services Board. They have been helped by the Islamic Development Bank and the IMF to set up the Board, which aims to promote, disseminate and harmonise best practice in the regulation and supervision of the industry. It will be launched in new premises in Kuala Lumpur on 3 November of this year, in the presence of Prime Minister Mahathir. The FSA has been invited to attend.

We hope it will play an important role in guiding authorities, including our own, which so far have limited experience of regulating Islamic financial institutions. One of the expressed aims of the Board will be to set standards and principles for supervision and regulation, consistent with the Sharia law and principles, and to liaise and co-operate with other standard setters around the world.

In the UK, of course, we do not yet have a large well-developed Islamic financial structure. But there is already a reasonably significant amount of business of various kinds. There are no purely Islamic banks in the UK today, but London is an important centre for Islamic banking products. Some UK banks have Islamic windows. HSBC is one notable example. They, of course, have considerable expertise elsewhere in the world of operating within financial systems in which Islamic banks are their competitors and collaborators. And some banks here use the London Metal Exchange for Murabaha. The customer buys and sells forward a metal on the London Metal Exchange and earns a profit.

But it is fair to say that most Islamic banking in the UK at present is transacted by relatively wealthy individuals or large institutions. Since there is no focused Islamic bank, and some retail sector Islamic products are rather difficult to construct here at present, I would acknowledge that there is a market gap.

There are approximately 1.8 million Muslims permanently resident in the UK. They make up around 340,000 households. A rough estimate suggests that they have, collectively, savings of approximately £1 billion. And in addition to the permanently resident population there are many Muslims who visit the UK. Last year over half a million Muslims came here from the Middle East and Pakistan, spending nearly £600 million during their visits. So the potential market, whether for savings products, borrowing, or simply transaction-related finance is very large.

Against that background, it is perhaps surprising that, in spite of many initial expressions of interest, and much energy expended by knowledgeable enthusiasts, there have so far been no dedicated Islamic banks established in this country. That certainly does not reflect any lack of dialogue between the FSA and the Islamic community. Those links go well back into the time when banking supervision was the province of the Bank of England, and the current Governor has throughout his time of office taken a particular interest in Islamic financial issues. In September 1999, early in my term of office at the FSA, I hosted a meeting with the Citizens Organising Foundation and Representatives from the Islamic community, at which I tried to set out the FSA’s likely new approach to banking regulation and supervision, when we became fully responsible for it, which we did in December last year.

But time has moved on since then. The FSA is now well established as a single regulator for the whole of the UK’s financial system, so it is a good moment to take stock of the way we now operate, of the objectives given to us by Parliament, and the way in which those objectives, and the regulations which flow from them, can be transposed to handle the particular needs and demands of Islamic financial institutions.

You will be pleased to know that I do not plan to take you through all 500 clauses of the Financial Services and Markets Act, passed in the year 2000, and which provides the legal basis for our work. Indeed, I will restrict myself to a few words only about clause 1, which sets out the objectives of financial regulation. We are given four main tasks.

First, we are required to work to maintain confidence in the UK’s financial markets. That has been something of a challenge in recent months, as we have been blown by forces from across the Atlantic.

Our second principal objective is to promote public understanding of the financial system. That is a new role for a regulator. It has taken us into areas of consumer education which previous regulators have not touched. We have developed materials for use in schools to educate children in the principles of finance. That applies from primary schools right up to the 16 –18 age group. We hope that, over time, all that work will have the effect of enhancing financial literacy which is distressingly low in the UK.

Our third objective is to protect consumers of financial services, but bearing in mind their own responsibilities. In other words we are not meant to protect people from any mistaken saving or investment decision they may make. The principle ‘buyer beware" certainly still applies. Under that heading we try to ensure that financial institutions in our care are reasonably sound in financial terms, that they offer fair contracts which can be reasonably well understood by consumers, and that there is an ombudsman scheme, and a compensation scheme, to underpin the market when things go seriously wrong, as they sometimes do in even the best ordered markets.

Our fourth objective is to work to reduce financial crime. That objective has gained particular prominence in the last twelve months as international concerns about money laundering, in particular, have come to the top of the political agenda. It is our responsibility to try to ensure that financial institutions have systems in place which protect them against abuse by those who wish to launder the proceeds of organised crime, or who wish to finance terrorism.

I mention these four objectives, because they underpin everything we do, and we must ensure that however we regulate financial businesses we are contributing to those aims set for us by Parliament.

When we translate that to the arrangements for supervising banks, we require new applicants to meet five - what we call - threshold conditions for authorisation as an institution entitled to take deposits in the UK. Some of those conditions, such as the legal status of a bank, its location etc, are entirely straightforward. And the two key conditions are that a bank must have adequate resources and must have reasonable systems and controls to manage the type of business it wishes to undertake in a reasonably sound and prudent way.

How do these principles apply, or how would they in principle apply to an Islamic bank? I should emphasise that we have not yet received a formal Islamic bank application, though we are aware of some interest in doing so, and as I have said we have held preliminary discussions already about how our conditions might be met.

Perhaps the first important thing to say is that we welcome diversity and innovative developments in the world of finance, such as the growing Islamic finance market. London has prospered over the centuries by providing a congenial home for international financial institutions, and innovation has been its life blood. So we have a clear economic interest, as a nation, in trying to ensure that the conditions for a flourishing Islamic financial market are in place in London. The business opportunity is large and potentially very attractive. We recognise that there are no banks catering specifically to the large and growing UK Muslim population, and I can tell you that in principle we have absolutely no objection to the idea of an Islamic bank on our patch.

But, that said, we will treat applications from Islamic institutions no differently from any other. Of course there has to be a level playing field and it would not be appropriate, or even legally possible for us, to lower our standards for one particular type of institution. Indeed I would strongly argue that since, if it was to be successful, an Islamic bank would need a reputation for capital soundness and proven management, it would in any but the very shortest term be entirely counterproductive to authorise a bank on a different basis from that which we apply to conventional institutions.

But we recognise that, to fit the bill, our requirements would need to be shaped to suit the particular demands of an Islamic bank. Islamic banks differ from conventional banks in four main ways. They offer a rather different range of types of Islamic finance, from Murabaha through Ijarah and Salam to Istisna. I know that there are other – to me – exotic products like sukuks. I am not going to stand here today and tell you that I am expert in these different types of transaction. But, ‘I know a man who is’. And we have a small team in the FSA who have made a study of Islamic banking, and its regulation.

We recognise that the risk sharing characteristics of these Islamic contracts are rather different from those in place in a conventional bank. We recognise that there is a mix of contracts on the liability side. In particular, unrestricted Islamic investment account holders share in the risks of the bank, since their deposits have some of the characteristics of equity stakes. It is entirely reasonable to take some of these defined features into account when looking at the capital structure of the bank. If customers genuinely share risks, and understand that they are doing so, that may reduce the amount of capital required.

We also think it is important for Islamic banks themselves to be clear about the type of products they wish to offer. If we were to authorise an Islamic bank we would look carefully at its business plan, just as we do with any other institution. We want to know that it has understood the nature of its market, the profit opportunities open to it in that market, the nature and intensity of the competition, and the types of products it wishes to offer. For example, will the bank offer capital-certain deposit products or not? In some, but not all, Islamic deposits the client’s capital is generally at risk if the bank loses money, even if it doesn’t fail. If that is so, then it is important potential customers understand that they do not benefit from the deposit protection arrangements in quite the same way as depositors in Western style institutions.

Relevant to this point is the question of whether Islamic banks are truly banks, or are essentially more like fund managers, even though they may offer traditional banking services such as money transmission. I know that this question is one which is often discussed in the Islamic financial community. But I have to say that, now that we are a single regulator, we think it is of rather secondary importance. At least, that is, from a regulatory perspective. Since we have one regulator we have one basic set of conditions for authorisation, which needs to be met by any firm transacting financial business, albeit the details will differ in the case of a fund manager, on the one hand, or a bank on the other.

These differences are, I believe, less important than the similarities. What we are really looking for when we authorise a bank is an organisation which abides by sound principles of corporate governance, which has adequate capital for the risks it plans to take on, and which has a capacity for managing those risks which we believe to be robust. In the case of an Islamic institution, we would include in that advice and assessment of legal and documentation risks, though I think it would not be appropriate, or even possible, for us to check compliance with Sharia law, which is perhaps an additional risk factor which needs to be taken in to consideration. That in our view, is a matter for the institution itself.

Before I finish, I wonder if I might say a word about one particular issue which has been of some concern in the Islamic community, the question of Islamic mortgages and how they might be treated. A working party led by the Governor of the Bank of England, and of which one of my staff is a member, has been looking specially in recent months at the barriers to Islamic mortgages. The main problem we see is that they unwittingly attract stamp duty twice: once when a lender buys a property and a second time when its transferred to the mortgagor. That is a matter for the Treasury and the Inland Revenue to resolve. It seems to me to be the crucial issue to get right, and one on which I cannot offer you a certain answer today.

There is another potential difficulty, though one which I believe to be of somewhat less importance than the stamp duty point.

As far as we can see, the current Basel Capital Accord which governs the principle and practice of banking supervision around the globe today, does not appear to give us discretion for anything other than 100% capital treatment for Ijarah mortgages. For those who find this a baffling statement, perhaps it will clarify things if I simply state that this means a bank would have to carry twice as much capital in respect of an Ijarah mortgage as it would for a conventional mortgage, where the weighting is 50%. While that it is not necessarily a complete block on the development of the market, it certainly would make Islamic mortgages a little more expensive than conventional ones. This is something we are looking at very carefully at present, in conjunction with the Bank and the Treasury. It is a particularly difficult issue because the Basel rules are incorporated into European Union law. We are trying to look in a sympathetic way at the possibility of a different treatment under the existing rules, and we have asked Islamic financial institutions for more information which might conceivably allow us to propose a case for different treatment.

Even if that were to prove impossible, there is help on the horizon. On the 1st of next month the Basel committee will publish a new version of its capital accord, for consultation. And that would allow a more flexible treatment of Islamic mortgages if it goes through on current plans, which would probably remove this competitive disadvantage. I have to say, however, that we do not expect it to be finally approved for use until around 2006, which undoubtedly is a problem for institutions wishing to get into this market at present.

So let me end where I began. We see no objection of principle to the establishment of an Islamic bank in the UK. Indeed, we would welcome a soundly financed and prudently managed Islamic financial institution in this country, which would be good for Muslim consumers, good for innovation and diversity in our markets, and good for London as an international financial centre. But we have to treat applications from Islamic institutions in the way we do those from other, conventional firms, to ensure that they can compete effectively, and in the long term, on a level playing field with conventional finance providers.
Any source

Check this out!

Do check out the new CAP Health Check blog at: Health Check

It will be gathering items from a number of CAP blogs, including this one, and there is also a very useful News Harvester service on relevant topics.Any source

EU's share of global milk production falling

The EU's share of global milk production is falling as a result of the quota system according to Rabobank dairy specialist Mark Voorbegen. Addressing a seminar addressed by Dairy UK, he said that the EU had a 27 per cent share of the global market in 2005, down from the 1995 level of 31 per cent. By 2015 it is forecast to fall to 25 per cent (although by then quotas may have been abolished).

Termination of the EU quota system would become crucial for the long-term global supply/demand balance. Milk volumes in the EU-15 would remain stable in aggregate terms but with some relocation to more favourable areas. There would be a moderate growth in supplies in the accession states.

The UK had a good scale of farming and a good structure but Voorbegen had doubts about its export capabilities and whether it could bring a higher volume of milk into the EU. Just like farmers in Australia and New Zealand, farmers would have to adjust to more milk price volatility in the future.

Rudolf Schmidt, dairy farmer adviser for the German Farmers Union, said that the main challenge in Germany to a competitive dairy industry was from the biofuel industry. An overdependency on subsidies for biofuel 'could drive milk production away.'

Around ten per cent of the German agricultural area, some 1.6 million hectares, are already accounted for by biofuel crops. Moreover, bioenergy was making feed for dairy farmers more expensive.

Just as well they haven't heard the half jocular suggestion that cows should pay a climate change levy for the amount of methane they produce (which has far bigger impacts on global warming per capita than carbon dioxide).Any source

Tuesday, February 27, 2007

GoodBye to the BVI International Business Companies Act. Long live BVI Business Companies Act

On the 1 January of this year the British Virgin Islands Business Companies Act 2004 (the BVI BC Act) became the only Business Companies Act in the jurisdiction, after 2 years of transition period when the old BVI International Business Companies already on the register were permitted to operate under the International Business Companies Act or Companies Act. Now the International Business Companies (IBC) Act, which was enacted in 1984 and brought more than 700 thousand registered companies to the BVI, is completely replaced with the above-mentioned BVI BC Act.

The main changes implemented in the new legislation, which were noticed and most of all discussed by the community a year ago, concerned:
a) new bearer shares regime: The companies are allowed to issue bearer shares, but they must be kept by an Authorised or Recognised Custodian. The owner of the bearer shares must provide the following information to the custodian:
* full name of the beneficial owner of the shares,
* declaration that no other person has an interest in the shares, or full names of any persons having an interest in the shares.
b) the requirement to maintain the Register of Directors at the Registered Office of the IBC in BVI
c) new annual license fees reflecting different approach to companies with or without bearer shares kept fully or partially with BVI Custodian

These measures were enacted to make the British Virgin Islands legislation compliant with the international standards, including the 40 anti-money laundering recommendations of the Financial Action Task Force. The new legislation was also put in compliance with European Union (EU) Savings Tax Directive and EU Code of Conduct on Business Taxation.

However, the above list of changes in the new legislation concerning the BVI financial services is far from being complete. Many offshore specialists may confirm that this legislation is providing other positive changes for financial institutions and corporations, undertaking a wide range of structured, asset and project finance transactions in the British Virgin Islands.

As recently said Christopher Lloyd, a Senior Partner in Walkers’ BVI office: “The new regulations allow corporations much more flexibility in structuring their particular transactions in ways that are most advantageous to their business goals. At the same time, the rules incorporate sophisticated creditor protections.”

The new BVI BC Act also provides for statutory recognition of security over a BVI company's shares, which is usually the key component of complicated multiple-step financial transactions. This is one of the new legislation features that could be especially attractive and useful to financial institutions and corporations, that are looking for undertaking structured, asset, and project finance transactions.
Article any source

Friday, February 23, 2007

BVI the Third in the List of Countries Licenced by the Department of Economic Development of Dubai

The British Virgin Islands are in the top list of countries whose foreign companies and their branches during last year received licences from the Department of Economic Development of Dubai (DED).

The Department of Economic Development was established in 2002 with the purpose to organise, regulate and boost trade and industry in the Emirate of Dubai. Last year it has issued 170 licences to branches of foreign firms; that is about 20% more than the number of licences issued last year.

The maximum number of licences – 24 - was issued to the British companies, German firms were granted 13 licences. British Virgin Islands with 11 licences are the third in the top list. They are followed by Indian and American companies, with 10 and 8 licences respectively. Lebanon is in the top of the list among the Arab countries, with 6 licences issued to businesses from the country, and it is followed by Kuwait (3).

The British Virgin Islands are also among the leaders in providing offshore services in the countries of Arabian world. Recently the well-known offshore law firm Conyers Dill & Pearman has established its Middle East office in Dubai International Financial Centre to provide multi-jurisdictional offshore legal services. Company's specialists in the Middle East office will consult on the matters of corporate and commercial law, hedge funds, private equity and venture capital funds, project financings and securities.

Department of Economic Development has formulated policies and procedures to encourage foreign investments and create the right environment for international investors to do business in Dubai. Mr Ali Ibrahim, Deputy Director General for Executive Affairs of Dubai Department of Economic Development, has commented, “ The Emirate has grown by an average of 12 per cent over the last five years with enterprises in Dubai standing to benefit from the availability of local capital, an evolved financial market and a pool of skilled workforce.”
Article any source

Wednesday, February 21, 2007

British Virgin Islands companies invested more than 1 billion USD in China last month

Just in January 2007, BVI companies have invested 1.02 billion USD in China. The amount of investments allowed BVI to remain the second in the list of countries investing in rapidly growing economy of China. Actually, when the matter concerns Foreign Direct Investments, China is one of the leading countries by the stable growth of Inward FDI, while BVI is one of the leaders by the growth of Outward FDI. Inward FDI in China is growing already for the 7th consecutive year since 1999. Outward FDI from BVI is growing each year since 1990.

It is important to note that in 2006, China attracted the largest amount of foreign direct investments among all developing countries worldwide, and, according to United Nations Conference on Trade and Development (UNCTD) statistics, it has the high 4th total ranking – just behind USA, UK and France. It was achieved in a year when worldwide foreign direct investment totaled 1.2 trillion US dollars, the highest record since year 2000. When analyzing the outward Foreign Direct Investment flows, British Virgin Islands in the previous year was the 16th in the world, behind only such mega economies like USA, UK, Germany, France, China, Canada, Switzerland, Japan.

The leader of the top 10 countries that invested in China in January 2007 was Hong Kong,with 1.677 billion USD. The second investor is British Virgin Islands, with 1.019 billion USD of investments. Next regions in the top list are South Korea (396 million USD), Japan (323 million USD), Singapore (246 million USD) U.S. (236 million USD), Mauritius (191 million USD), Taiwan (136 million USD), Cayman islands (134 million USD), and Samoa (117 million USD). These ten countries accounted for 86.62% of China’s total actual foreign investment.

In January 2007, 3370 new enterprises were established in China, which were directly invested by foreign investors. This is a 10,71% increase if compared to January 2006. Foreign capital consumption in China reached 5.175 billion USD, - the 13.86% increase over January 2006.
Article any source

Tuesday, February 20, 2007

Mohd. Ma’sum Billah (Ph.D.)

This paper highlights various sources that could form the basis of law governing Islamic insurance or takaful. The paper covers primary sources of Islamic law, such as, the holy Qur’an and Sunnah and secondary sources, such as, Ijma, and Ijtihad. Other bases of law, such as, maslahah mursalah, urf, precedence etc. are also examined.

An insurance policy remains valid if none of its aspects contravene the Shari‘ah principles. 2 Hence, every element of an Islamic insurance policy should absolutely be based on the Shari‘ah.3 This section attempts to highlight the sources of Islamic insurance contracts which may be divided into two categories:

Sources In General

The general sources of Islamic law begin with the holy Qur’an and the Sunnah or the Traditions of the Holy Prophet (s.a.w.). These two are regarded as the principal sources of Islamic law. Other secondary sources of Islamic law indeed should strictly be based on these two primary sources. This paper attempts to highlight the sources of Islamic insurance contracts, which may be divided into two categories:

“O you who believe! Obey Allah (s.w.t.) and obey the Prophet (s.a.w.) and those charged with authority among you. If you differ in any thing among yourselves, refer it to Allah and His Messenger, If you do believe in Allah and the Last Day: That is best, and most suitable for final determination.” 4

The Holy Qur’an

There are five hundred verses in the Holy Qur’an, which deal with legal sanctions.5 There are indeed a number of Divine injunctions in the Holy Qur’an, which justify the validity of an insurance contract. The contract of insurance contains the elements of mutual co-operation.6 It is a binding promise, which binds both the insurer and the insured, based on the general principle of contract.7 It also contains the elements of alleviation of hardships and provision of material security and assistance for those who face unexpected risk and peril so to ensure for them a comfortable life.8 All these elements of a contract of insurance are justified by the Qur’anic principles. Thus, the Holy Qur’an is the principal guidance to provide an instrumental justification for the application of insurance contract, as the Holy Qur ’an is a plain statement and guidance for mankind in order for them to be successful in both worlds. This is indicated in the following ayat of the holy Qur’an:

“... it is a plain statement to man, a guidance and instruction to those who fear Allah (s.w.t.)... .” 9
The above provisions render an opportunity for mankind to practise inter alia, insurance policy so long as one does not violate the Divine sanctions either directly or indirectly.

The Sunnah

The Sunnah or Traditions of the Holy Prophet (s.a.w.) is a second source of Islamic law immediately after the Holy Qur’an.10 As regards the justification of an insurance contract and practice, there are indeed numerous traditions justifying the validity and permissibility of its concept and practices. For instance an insurance policy embodies the concept of Tawakkul whereby one should strive hard in overcoming one’s unexpected future risk or peril before leaving one’s fate and destiny in the hands of Allah (s.w.t.). Such a concept has been justified in one of the traditions of the Holy Prophet (s.a.w.), which reads:

“.... Narrated by Anas bin Malik ®, the Holy Prophet (s.a.w.) told a Bedwin Arab who left his camel
untied trusting to the will of Allah (s.w.t.): Tie the camel first and then leave it to Allah (s.w.t.)....” 11

Moreover, an insurance policy aims at protecting the insured from future material constraints upon the occurrence of a particular unexpected future risk. Such idea of protection for those who are in need is justified by the following Tradition of the Holy Prophet (s.a.w.):
“Narrated by Abu Huraira ® the Holy Prophet (s.a.w.) said: whosoever removes a worldly hardship from a believer, Allah (s.w.t.) will remove from him one of the hardships of the day of judgment. Whosoever alleviates from one, Allah (s.w.t.) will alleviate his lot in this world and the next... .” 12

There are also other essential aspects of an insurance contract justified by the Sunnah, such as the fact that an insurance policy originated from the ancient Arab custom of al-Aqilah, which was approved by the Holy Prophet (s.a.w.) during his time.13 Moreover a life insurance policy aims at providing, in advance, material security for the offspring of the deceased (assured) and this is also justified by one of the Traditions of the Holy Prophet (saw) as follows:
“Narrated by Amir bin Saad bin Abi Waqqas ®, The Holy Prophet (saw) said verily it is better for you to leave your offspring wealthy than to leave them poor asking others for help...” 14

Practices of the Companions

Insurance originated from the doctrine of al - Aqilah. During the later stage of the period of the second caliph, Sayyidina Umar, ® the Caliph, directed that in the various districts of the State, lists of Muslim brothers-in- arms should be drawn up. The people whose names were contained in those lists owed each other mutual assistance or co-operation and had to contribute to the payment of diyat (bloodwit) for manslaughter committed by one of their members of their own tribe. 15 This was how Sayyidina Umar ® developed the practices of the doctrine of al-Aqilah.

Ijtihad and Consensus of Opinions among the Islamic Scholars

The idea, meaning and legal characteristics of an insurance policy as practised in the world of today had first been discovered by the famous Hanafi lawyer Ibn ‘Abidin (1784 - 1836) probably in early nineteenth century. The ruling of Ibn Abidin is therefore quoted as follows: 16
“And from our noting, the question about which a large number of inquiries are being made, is also answered and it is that when merchants charter ship owned by the subject(s) of belligerent state, then, together with the charges for the ship, another amount is separately paid to the same or another subject of the belligerent state. This payment is known as “Sokra” or insurance premium and its payment means that in case goods on the particular ship catch fire, or if the ship capsizes or if the person who received insurance premium, is responsible to indemnify the merchant(s) who incurred the loss. An agent of the person receives the insurance premium, resides in the coastal cities of our country as a protectorate, after obtaining permission from the government. He receives the premium amount on behalf of his principals and, in the case of destruction of goods, indemnifies the insured for entire loss”.17
From the above rulings of Ibn ‘Abidin, it is understood that a merchant used to charter a ship from the respective ship owner with a mutual understanding that the charterer would pay an additional amount known as sukra (a premium in today’s practice) in which, if the ship faced any form of risk, the owner, in consideration of the sukra, would provide a reasonable indemnity for the loss suffered by the merchant (charterer). The sukra used to be collected by a nominated agent on behalf of the principal (ship owner) and he (agent) would also settle the indemnity (claimed by the merchant) on the owner’s behalf.

Thus, these rulings could be a basis to justify the Islamic insurance (Takaful) practice of today’s world. For example, in Takaful, the participants resemble the merchant in the above ruling and contributions paid by the participants resemble sukra, while the indemnity provided against the risk is similar to the indemnification in Takaful practice. Also, the mutual understanding held between the merchant and the ship owner is like a Takaful policy agreement between the participants and the operator.

Mufti Mohammed ¡Abduh also agreed to the validity of insurance practices generally.18 In 1906, the Mufti of Egypt, Sheikh Muhammad Baqit also accepted the idea of insurance as laid down by Ibn ‘Abidin.19 There are other Islamic scholars who did not oppose the idea of insurance, such as Muhammad Musa, Ahmad Ibrahim, Khan Muhammad Yusuf Musa, Ahmed Taha Sanusi, Abdur Rahman Isa, Ali Khafif,20 Mustafa Ahmad Zarqa, Dr. Nejatullah Siddiqi to name a few contemporary Islamic scholars who agree on the validity of insurance. However, despite agreement among the above-mentioned Muslim scholars, there are some contemporary Muslim scholars who refuse to accept insurance especially life insurance, based on certain objections. They object to the elements of garar, riba, and so on. 21 The diversification of views among the ‘ulama on this issue will be highlighted in Chapter Three of this work.

Analogical Sources

Analogical sources such as qiyas, istihsan, and istishab could also be used as further justification for the idea and practice of insurance, so long they do not contravene the sanctions of the Holy Qur’an nor the Sunnah of the Holy Prophet (s.a.w.). Allah (s.w.t.) advised people to come up with analogical decisions, if necessary, so long as such analogical decisions are not contrary to the Holy Qur ’an and the Sunnah.22

Masaleh al-Mursalah

The insurance contract we see today was not exactly practised during the time of the Holy Prophet (s.a.w.). However, life, necessity, and the status of human beings has changed with the passing of time and the necessity to practice insurance arose to suit the changing environment, in the sense that there is an urgent need to find a way of providing material security for those who are suffering in the society due to unexpected loss, damage or peril. Hence, insurance is necessary in the public interest so that the victim can be rescued from an unexpected risk, and thus, it is justified by the doctrine of Masaleh al-Mursalah. Even though the practice of insurance could also be based on the said doctrine, its validity is still subject to compliance with the divine principles laid-down in the Holy Qur’an and the Sunnah of the Holy Prophet (s.a.w.). The significance of an insurance practice based on the doctrine of Masaleh al-Mursalah is, inter alia, to ensure a comfortable life, which is also a wish of Allah (s.w.t.) as evident in the following ayat:

“ Allah (s.w.t.) intends every facility for you; He does not want to put you to difficulties....”23


‘Urf means custom, practice or usage of the community. An ‘Urf could also be used as a justification of a particular matter provided that a ‘Urf does not contravene any divine sanction. The initial idea of Islamic insurance practices originated from the Arab’s tribal custom known as al-Aqilah, which was approved by the Holy Prophet (s.a.w.) in a dispute between two women from the tribe of Huzail.24 Hence, it is clear that the ‘Urf (custom) of alAqilah practised by the ancient Arab tribes, and approved by the Holy Prophet (s.a.w.) could stand as a valid justification for the validity of insurance.

There are provisions in the Fiqh which deal with the practices of insurance. For instance, Sayyed Sabeq, in his book Fiqh al-Sunnah, under the section of ‘Shirkatut Tameen’ discusses the validity of insurance contracts. An insurance contract is based on the general principles of Al-`Aqd al-Mudharabah, al-Wakalah, al-Sharikah, and

so on, which have also been discussed in detail in his book.25 There are many other Fiqh sources 26 , which discuss directly or indirectly, partly or wholly, the relevant aspects of insurance.

Relevant Literatures of the Islamic Scholars

There are, in fact, many Islamic scholars who uphold the validity of insurance, as well as the essential procedures and solutions to its practices. For example, in 1982, Abdullah bin Jaid al-Mahmoud wrote a book on insurance entitled Ahkam ‘Uqudut Tamin wa Makaniha Min Shariat al-Deen; in 1989, Saad Abu Zaid wrote al-Tamin binal Khator wal Ibahat, while in 1984, Mustafa Ahmad Zarqa wrote Nizam al-Tamin. In 1969, Dr. Muhammad Muslehuddin wrote Insurance and Islamic Law while Dr. Nejatullah Siddiqi wrote Insurance in an Islamic Economy in 1985.

There are also a number of articles, which have been written by various Islamic scholars. Prof. Shamir Mankabadi who wrote “Insurance and Islamic Law” published in Arab Law Quarterly 1989, is an example. Prof. E. Klingmuller who wrote “The Concept and development of Insurance in Islamic countries” published by Islamic Culture in 1969, is an example of a non-Muslim scholar.

These works written by Islamic scholars portray the validity of insurance practices in the contemporary Muslim world.

Acts of Parliament
based insurance companies established and operating today in the contemporary world, for example, in Malaysia, Sudan, Brunei, Qatar, and Saudi Arabia, to name a few. These Islamic insurance companies have been established and operate based on the Shari’ah based enactment and regulations, approved by the Parliaments of the respective countries. A clear example, among such enactment and regulations is The Takaful Act (Malaysia) 1984 (Act 312) which is one of the Acts of Parliament aimed at controlling insurance practices in Malaysia based on the Shari’ah principles.

Rules of the Shari’ah Supervisory Board

Behind every Shari’ah based insurance company, there is a Council or Board called the Shari’ah Supervisory Board. This Supervisory Board functions as the supervisor of the Islamic Insurance activities run by that particular company to ensure that all these insurance activities operate in accordance with the Divine Principles. For in-stance, the Malaysian Takaful Operation is supervised by a Shariah Supervisory Council by virtue of Section 8
(5) (b) of The Takaful Act 1984. 27 In Sudan, moreover, there is a Shari’ah Supervisory Board which supervises, inter alia, insurance business in the country and it also passed the Rules of the Shari’ah Supervisory Board published by the Faisal Islamic Bank of Sudan (n.d.).


Precedents could also play a role as one of the sources of insurance law and practice. Some Islamic scholars have given particular decisions on several issues of insurance policy and practice. These may be useful to regulate Islamic insurance practices. For instance, the opinion given by Ibn ‘Abidin later became a precedent which influenced Muftis in advising the governmental departments and various bodies on insurance matters.28 Mufti Muhammad ‘Abduh said on many occasions that insurance policy and practices are valid. 29 Besides the precedents set by the independent Islamic scholars, there is also another type of precedent set by the contemporary courts relevant to insurance practices.30 Such precedents could also be considered as a valid source of insurance law.

Unanimous Decision of the Islamic Scholars

There have been numerous conferences on Islamic insurance held worldwide in which Muslim scholars have unanimously agreed on the validity of insurance practices. Some of those conferences are listed as follows:

The Islamic Fiqh Week held in Damascus from 1st - 6 th April in 1961;31 The Seminar held in Morocco on 6th May 1972 which upheld the validity of insurance business with the exception of life insurance business;32 The Second Conference on Muslim Scholars held in Cairo in 1965;33 The Symposium on Islamic Jurisprudence held in Libya from 6th - 11th May, 1972;34 The First International Conference on Islamic Economics held in Makkah from 21st - 26th February, 1976;35

The Islamic Conference held in Mecca in October, 1976;36 The First International Summit on Islamic Insurance held in Dubai on 11th Nov, 1996, and The Labuan International Summit on Takaful (Islamic insurance) held in Labuan, Malaysia, on 19 - 20 June, 1997.

Specific Sources
Principles of Contract

An insurance policy binds the parties unilaterally by an offer and an acceptance in reliance on the principles of contract. The fundamentals required in an insurance policy are the parties to the contract, legal capacities of the parties, offer and acceptance, consideration, subject matter, insurable interest and good faith, most of which are found in the general type of contracts. For example, a contract is a promise by an offer and an acceptance, which must be fulfilled as Allah (s.w.t.) has commanded to the effect:

“O ye who believe! Fulfil your obligations.”37

As for the legal capacity as to age of the parties to the contract of insurance, a minor below the age of 15 (the age of rushd or majority or puberty) is not able to buy a policy unless the guardian holds the full supervision over the policy and also the policy should be for the benefit of the minor.38 Thus, the Takaful Siswa operated under the Syarikat Takaful Malaysia Bhd. allows an infant between the age of the majority and the fifteenth day of birth to hold a Takaful policy for education which is under the supervision of the respective guardian.39 This operational method may be justified by the following Qur’anic sanction:

“Make trial of orphans until they reach the age of marriage; if then you find sound judgment in them, release their property to them; but consume it not wastefully”40
The requirement of minimum age of the parties in an insurance policy is the same as required in general contract. Hence the above principles and other relevant principles relating to contract are basically applied to the formation of an insurance contract.

Principles of Liability

An insurance policy covers losses arising from the death, accident, disaster and other losses to human life, property or business. The insurer (insurance company) undertakes in the policy to compensate against the losses to the agreed subject matter. Such undertaking is considered as vicarious liability. For instance, in the case of ‘Aqilah practised in the ancient Arab tribes approved by the Holy Prophet (s.a.w.) if a person was killed by another from a different tribe either mistakenly or negligently, this would bring a liability to the members of his tribe to pay blood wit to the heirs of the slain.41
Moreover, the rights and obligations in an insurance policy mainly arise from the law of contract and tort. For example, in a case of a motor accident, the operator (insurance company) is liable on behalf of the person who causes that accident (i.e. the insured) to compensate the victim. Here, the operator is bound by the terms stipulated in the proposal to pay that compensation under the principles of vicarious liability under the law of Tort.

Principle of Utmost Good Faith

In an insurance contract, for the enforcement of the policy, the parties involved in it should have good faith. Therefore, non-disclosure of material facts, involvement of a fraudulent act, misrepresentations or false statements are all elements which could invalidate a policy of insurance, Allah (s.w.t.) says:
“....Do not misappropriate your property among yourselves in vanities but let there be amongst you
traffic and trade by mutual good will......”42

Principles of ‘Mirath’ And ‘Wasiyah’

In a life policy, the assured (Muslim) appoints a nominee who must not be an absolute beneficiary. This decision was given in the Fatwa on Succession and Will by The National Council for Muslim Religious Affairs, Malaysia, in 1974,43 and also in Amtul Habib v Musarrat Parveen in 1974.44 In both Fatwa and decision, it was ruled that a nominee in a life insurance policy of a Muslim is a mere trustee who receives benefits from the policy and distributes them among the heirs of the deceased, in accordance with the principles of ‘Mirath’ and ‘Wasiyah’.45 The above Fatwa and the case recently gained statutory weight in the Malaysian Insurance Act 1996, which came in force on January 1st, 1997. S167 (1) provides:
“ A nominee, other than a nominee under subsection166 (1), shall receive the policy moneys payable on the death of the policy owner as an executor and not solely as a beneficiary and any payment to the nominee shall form part of the estate of the deceased policy owner and be subject to his debts and the licensed insurer shall be discharged from liability in respect of the policy moneys paid”.
In the light of this provision, it is concluded that the nominee in a policy nominated by a Muslim policyholder should be treated as a mere executor and not as an absolute beneficiary of the policy.

Principles of Al-Wakalah (Agencies)

The appointment of the agent by the insurer and the broker by the insured are of utmost important. In fact, such appointments are widely practiced for the purpose of making the transaction and dealings between the insurer and the insured more effective. The governing principles for the agents and brokers are laid down in the Mejelle as follows:
“Wakalat is for someone to put business of his on another and to make him stand in his own place in respect of that business.”46

Principles of Dhaman (Guarantee)

In an insurance policy, the insurer undertakes to provide material security for the insured against unexpected future loss, damage or risk. The idea of such guarantee is justified by the principles of ‘Dhaman’ or guarantee under Islamic law. 47 In Fiqh, insurance can only be classed under Dhaman (guarantee), which is governed by some essential conditions. Among them the guarantor can only take upon himself a liability which has fallen or may possibly fall upon a person or property. 48 Thus, Dhaman or guarantee may only be payable to the victim or if the victim dies, to his legal heirs, according to their respective shares in inheritance.49

Principles of al-Mudharabah and al Musharakah

The operation of an insurance policy under Shari’ah is in fact based on the principles of al-Mudharabah financ-ing, which is an alternative to the contemporary interest-based transaction.50 In such financing, one person pro-vides the capital while the other party contributes business skills and both parties mutually agree to share the profits accordingly. 51 However, an insurance policy, is a transaction wherein both parties agree that the participant pays regular contributions and the operator invests the accumulated contributions in a lawful business, in which both the insured and the operator share the profits in an agreed portion. At the same time, the insurer also undertakes to provide the insured with compensation (in consideration of the paid-contribution) against an unexpected future loss or damage occurring on the subject matter of the policy. This is how the principles of al-Mudharabah financing in an insurance policy.

An insurance policy also operates on the basis of the principle of ‘al-Musharakah as both the operator and the participants are partners in the policy run by the insurance company.52

Principles of Rights and Obligations

An insurance policy is based on the principles of rights and obligations arising from humanity and nature. For instance, it is logical and natural for every person in the society to feel obliged to provide material security and protection as a right for themselves, their property, family, for the poor and helpless widows, and for children against unexpected perils and dangers. Such a natural obligation and right could well be justified by the following Tradition of the Holy Prophet (s.a.w.):
“Narrated by Saad bin Abi Waqas ® ... the Holy Prophet (s.a.w.) said ..... it is better for you to leave
your offspring wealthy than to leave them poor asking others for help.....”53
The Holy Prophet (s.a.w.) had also emphasized the importance of providing material security for widows and poor dependents in the following Tradition:
“Narrated by Safwan bin Salim ®, the Holy Prophet (s.a.w.) said: The one who looks after and works for a widow and a poor person, is like a warrior fighting for Allah’s cause or like a person who fasts during the day and prays all the night... .”54

Principles of Humanitarian Law

It is one of the purposes of humanitarian law to inculcate mutual understanding in the community, to protect one against unexpected loss, damage or other forms of risks or hardships. Hence, an insurance policy contributes towards alleviating hardships from a person arising from unexpected material risks, which is of course within the scope of the principles of humanitarian law. This has been justified in the following Tradition of the Holy Prophet (s.a.w.), which reads:
“Narrated by Abu Huraira ®, ...the Holy Prophet (s.a.w.) said ... whosoever removes a worldly grief from a believer, Allah (s.w.t.) will remove from him one of the grieves of the day of judgment. Whoso-ever alleviates a needy person, Allah (s.w.t.) will alleviate from him in this world and the next...”55

Principles of Mutual Co-Operation

In a policy, both the operator and the participant mutually agree to lawful co-operation, in which the participant provides capital (through the payments of contributions) to the operator (insurance company), enabling the insurer to invest the accumulated contributions in a lawful business (on the basis of al-Mudharabah) . Meanwhile, the insurer, in return for the payments of the contributions, mutually agrees to compensate the insured in the occurrence of an unexpected loss or damage or risk on the subject matter. Such mutual co-operation among the parties in an insurance policy has been justified by the Divine principles of mutual co-operation, solidarity and brotherhood.56 Allah (s.w.t.) commanded:
Any source

Monday, February 19, 2007

BVI Securities and Investment Business Act could be enacted this year

There is wide range of regulated financial services available on the BVI: insurance, banking and trust business, mutual funds - each of them is regulated by particular Division of Financial Services Commission - Banking and Fiduciary Services; Corporate Services; Insolvency Services; Insurance; Investment Business. Also there is wide range of regulated entities - registered agents, insurance managers, agents, brokers, accountants, auditors, insolvency practitioners, mutual funds’ administrators and managers etc., all of them being controlled by the Financial Services Commission.

However there are still some niches of financial services that need to be taken under control in the BVI. One of them is forex exchange trading and broker dealing business. It is expected that Investment Business division could take under control these businesses, and currently the Securities and Investment Business Act is being drafted by the BVI authorities. It could be enacted by the third quarter of 2007.

Another financial service sector that should be regulated by the enactment of the Securities and Investment Business Act is hedge funds. The BVI regulator currently has almost no means of getting detailed information on hedge funds that are located in different countries, and has little means how to control them. Currently there are more than 2.5 thousand hedge funds registered in BVI. The jurisdiction has become especially popular for registering funds by US and European fund managers, because of the possibility for non-US and non-European investors to avoid paying taxes on their non-US and non-European investments in their domicile countries.

In accordance to the newly drafted legislative act, funds registered in the BVI could be required to conduct regular audits, have 2 directors and appoint “whistleblowers” to root out fraud. Ruth Chadwick, the investment business director at the Financial Services Commission, has said the legislation was being drafted to keep up with hedge funds investing in "exotic, difficult to value products". She added, “There is much more room for fraudulent-type activity in a professional fund because of this lack of clarity".

Funds would also be required to have two directors, independent of each other, to increase transparency and accountability. Currently there is no such requirement.

Some words about “whistleblower” as far as this doesn’t exist in the US. The act will probably include a clause creating an “authorized representative of a hedge fund in the BVI. This person would act as a whistleblower informing on the facts of breaking the terms of the fund's public placement memorandum, or on detecting any improper asset valuation or trading.

Currently this is quite a questionable idea as far as several lawyers in the BVI are warning that whistleblowing requirement, if not handled carefully, could have a chilling effect on the business in the territory.

Let’s see what will be included in the BVI Securities and Investment Business Act that we will hopefully get presented in 3rd quarter of this year. Notwithstanding the final version of the act, there is no doubt it is needed for the BVI to strengthen its positions in this niche of offshore financial services market, and to keep its popularity and high reputation.
Article any source

Saturday, February 17, 2007

Islamic Banking in Sudan


Unlike the experiences of Iran and Pakistan, Islamic banks in Sudan have been operating in a dual system, i.e., alongside conventional banks. Because of their history and circumstances associated with the inception of some of them, Islamic banks in Sudan do not share the same experience. The Faisal Islamic Bank, Sudan (FIBS), for instance, being the forerunner, started operations in 1978 under a special decree that extended some privileges to it. These were represented by tax holidays, exempted from exchange restriction, exceptions from those articles in the Bank of Sudan law pertaining to interest imposition and exemption from some articles of the Labor Act provided that it adopted a generous pay system (Mudawi 1995, 1995, p.246).

Five Islamic banks are found operating in Sudan as per information published by International Association of Islamic Banks. The banks along with their year of establishment are as follows:
1) Sudanese Islamic Bank, 1983
2) Islamic Bank of Western Sudan, 1983
3) Al-Baraka Bank, Khartoum, 1983
4) Islamic Co-operative Development Bank, 1983
5) Al-Tradamun Bank, 1984.

Although the FIBS was allowed special privileges and it was found to be operating without apparent problems, the rest of the Islamic banks were not provided those facilities. Still they got experience from the operation of FIBS. Their operations were largely prompted by the success of FIBS. FIBS provided these banks with trained manpower and training facilities.

The Islamisation of Banking System

Islamisation of banking system in Sudan was initiated by a presidential order from President Numeiry instructing the Governor of the Bank of Sudan to implement the process immediately. This resulted in an immediate instruction from the Governor to the conventional banks to turn themselves Islamic as from July 1, 1984 allowing them two months’ times. This left virtually no time for advance studies or preparations to be taken by the conventional banks to convert themselves into Islamic. As a result, most of the banks could not do much more than to replace the word “interest” with the word “profit”. The basis of all contractual agreement was made Murabaha. No committee conversed in religious guidance was formed and consulted. Lack of carefulness was also noticed by the incident that no supervisory techniques for Islamic banks were designed by the central bank.

Further, it was the requirement that the central bank would change its philosophy and structure and the way it formulates monetary policy and manages monetary affairs within the framework of Islam. The Bank of Sudan was with the trend but lagged behind since it did not seek right advice in right form at the right time. In spite of that the circulars issued by it had been referring frequently to Islamic financial modalities but the name rather the spirit seemed to be the essence.

The Bank of Sudan maintained the conventional instruments for regulating the money supply. It mainly relied on quantitative control by fixing a random credit ceiling and imposing an across-the board cash ratio on all types of deposits. This has not proven to be an effective way of controlling money supply nor conducive to economic development.

Islamic banks in Sudan have been found to be prudent. They diversified their activities by project, client and economic sector in order to minimize their risky operations in an environment of legal and economic constraints. In spite of the Islamisation of the entire banking system of the country, Islamic banks were singled out and subjected to severe attack. The attack came from official as well as from private circles. This antagonistic environment for Islamic banks in Sudan started under the rule of President Numeiry and prolonged until the military government of Al-Mahdi. During the Numeiry rule the attack did not go beyond accusations by the news media that these banks were behind the famine that struck the country at that time and also behind the shortages in foreign exchange and the high prices of foodstuffs. During the transitional military government and Al-Mahdi government intensity of accusations mounted and tribunals were set up to investigate the accusations.

Problems of Islamic Banks in Sudan

The Islamic banks in Sudan operate in isolation. That means these banks are in the grip of a legally supported system based on a monetary authority (the Bank of Sudan) and subject to many other laws that control activities of the banks.

The first problem come across by these banks was the laws and regulations that were not modified to accommodate their operation. They faced the same types of control and supervision as has usually been used for regulating the activities of the conventional banks. Islamic banks had continuously been pursuing the Bank of Sudan to appreciate that they were different and had to be dealt differently—at least that the reporting forms and their terminology should now be in language used for credit restrictions and cash ratios. As a result of that the Bank of Sudan introduced the terms Musharaka and Mudaraba into its credit policy directives.

Another aspect of the isolation of Islamic banks operating in an interest-based financial setting such as Sudan is the absence of any arrangements for receiving financial support from the Bank of Sudan. This, along with quantitative, restrictive credit policy exercised by the Bank of Sudan, caused those banks to end up with excessive opportunities for utilizing their excess liquidity for very short periods of time or overnight (Ibid, p.247).

Another difficult situation which Islamic banks faced was in the area of staff recruitment. All Islamic banks drew on the staff of the conventional banks to varying degrees when they started their operations. The qualities required by Islamic banks are not only proficiency and integrity, but commitment and sense of belonging. This subjected these banks to the demanding task.
Any source

Friday, February 16, 2007

The UK Parliament Member Promotes Autonomy for the BVI

A member of the UK Parliament Mark Simmonds during his familiarisation visit in the British Virgin Islands has informed about his plans to promote more autonomy for the British Virgin Islands in discussions with his Conservative Party colleagues in the UK.

On February 8, Mark Simmonds addressed members of the Tortola Rotary Club during their weekly luncheon meeting. In his speech he told about the objectives of his visit, one of which was to understand the intricacies of the territory to feed into his party's development of policies regarding the UK/BVI relationship. It is interesting to note that there is another prominent person with the same name Mark Simmonds - Senior Active member of the Rotary Club of Tortola.

Simmonds noted that the subject of the Overseas Territories is not raised in the Parliament as often as it should be, and added that he would like to see improved links between the UK and the Overseas Territories.

"One of the reasons I'm here is to understand more about the opportunities that exist in BVI, and also to go back to the United Kingdom Parliament with a much greater knowledge and be able to cement and improve the links between the UK and BVI and other Overseas Territories," Simmonds said.

The government of the British Virgin Islands is engaged in the talks on constitutional changes with the UK government, the third round of which took place in October. All the negotiations are based on the territory's request for a new constitution, and the points discussed are taken from the report of the British Virgin Islands Constitutional Commission.

The general points discussed include the duties of the Attorney General, the definition of belonger status and the rights of local population. Other issues touched upon in the talks are the creation of the sixth ministerial position, the need for a human rights chapter in the constitution, the functioning of the Executive Council and the reserve powers of the governor. The possibility of establishing a cabinet system of government is also under consideration. The one recommendation already implemented is establishing the position of director of public prosecutions.

Mark Simmonds, the opposition party's shadow minister for international development, has left the Territory on Saturday, after a weeklong visit. Another round of discussions on the constitutional changes will take place in London at the end of February, with Foreign Office Minister David Triesman.
Article any source

Experts look at the past and the future

Commission officials and leading experts on the CAP met under the auspices of the European Network of Agriciultural and Rural Policy Research Institutes (ENARPRI), The Centre for European Policy Studies (CEPS) and the University of Leuven (KUL) in Brussels on Thursday to discuss the past and the future of the CAP. The interesting discussion was conducted on Chatham House terms, but some flavour of it can be given here.


There was concern about an unthinking rush to replace foods crops by biofuels. One view expressed was that they were a disaster with an incredible increase in the surface area covered in the United States. The missing US exports were equivalent to those of Australia and Canada combined. They used a lot of water which was a more precious resource than oil.

Another speaker drew attention to the number of bills before the US Congress on the ethanol issue. It was seen as nothing to do with farm output but with energy independence, although a cynic might also see a link with the early primary in Iowa.
The mandates (obligations) were a recipe for rent seeking and represented bad policy.

The future balance of the CAP

There was some interest in the development of a policy that emphasised food and environmental security policy. Whilst this was not endorsed by all participants, there was a recognition that a spatially diffuse, multi-dimensional environmental challenge was being managed by fragmented private managers. The key market failure was environmental: climate change.

There was concern about the delay to rural policy implied by the effective halt in transfers from Pillar 1 to Pillar 2. Less was now being spent on Pillar 2 than before the budget discussions. The view was expressed that Eastern Europe had little interest in rural policy because it didn't have co-funding money. More generally, member states wanted to re-nationalise the CAP.

The health check was taking shape. It was a tidying up, a simplification. There was a long check list involving a move away from partial decoupling and getting rid of set aside, but none of it was fundamental. The budget review was much more important, coupled with the renewed discussion on the constitution. Quite a few people wanted to cut the CAP budget.

The easiest way of saving money in agriculture would be to cap big farmers which would also make it easier to defend the CAP. It was somewhat alarming to hear one respected presenter claim that the CAP had been steered towards acceptability and respectability by reform.

The Commission view

Invariably on these occasions I lock horns when the Commission and this happened when I suggested that there were limits to the radicalism of the reform which left 46 per cent of the EU budget spent on the CAP. The response was that this was a strange way of addressing this, given that the EU had a tiny budget. CAP spending accounted for one per cent of public expenditure in the whole of Europe. Farmers made up five per cent of employment, ten per cent of the population lived in rural areas and 47 per cent of the European land surface was farmed.

On that logic if, say, small shopkeepers are three per cent of the EU population, they should get three per cent of the budget in handouts. Farming is meant to be a commercial activity. If it is producing positive externalities, it should be rewarded for that, but the delivery of those outputs needs to be clear and demonstrable.

The producer perspective

The producer perspective on this is interesting. They fear paying twice for the Doha Round (although no one would forecast whether there would be a successful conclusion or not). They also see the single payment as 'nominal' and eroded by inflation (which is a strange way of looking at some of the sums paid out). It is also seen by farmers as a transitional payment which will eventually disappear. However, most of those in the meeting thought that market payments would persist after 2013 and even after 2020. The CAP is a resilient beast.Any source

Wednesday, February 14, 2007

Islamic Banking in Iran


Following the revolution in 1979, the Iranian authorities took steps to transform the banking system of the country in a way that it fully corresponds to Islamic Shariah. In February 1981, Bank Markazi (the central bank) took some administrative steps to eliminate interest from banking operations. As a result, interest on all asset-side transactions was replaced by a 4 per cent maximum service charge and by 4 per cent to 8 per cent minimum “profit” rate, depending on the type of economic activity. Interest on the deposits was also converted into a “guaranteed minimum profit”. In the mean time, preparations got underway for enacting comprehensive legislation to bring the operations of the entire banking system in compliance with the Shariah. The legislation, prepared by a high-level commission (comprising bankers, academicians, businessmen, and religious scholars), was passed by the Parliament in August 1983 as the Law for Usury-Free Banking, henceforth to be referred to as “the Law”. The Law required the banks to convert their deposits in line with the Shariah within one year, and their total operations within three years, from the date of the passage of the Law, and specified the types of transactions that must constitute the basis for asset and liability acquisition by banks (Iqbal & Mirakhore 1985).

Bank Liabilities under the New Law

According to the new Law, liabilities acquired by the banks were required to be based on two kinds of transaction:

Qard Hasan deposits: According to the Law, Qard Hasan constitutes current and savings deposits as in the conventional banking system except that they earn no returns. Of course, the banks can offer different kinds of incentives like non -fixed prizes and bonuses in cash or in kind; an exemption from, or a discount in, the payment of commission or fees; and priority in use of banking facilities.

If seen from customers’ perspective, the purpose of these accounts would be to serve as a means of transaction, payment, and liquidity. Banks are to consider the money received in the form of current and savings deposits as “their own resources” and accordingly they can use it but no profits are to be given to the depositors. However, the full nominal value of the depositors is required to be guaranteed by the banks.

Term investment deposits: Banks are authorized to receive two types of investment deposits, short-term and long-term. The deposits differ with respect to the required minimum time limits, three months for short-term and one year for long-term deposits, and with respect to the minimum amount required, Rls. 2,000 for short-term and Rls. 50,000 for long-term accounts.

Banks have to give priority on investment deposits, i.e., depositors’ resources over their own resources, that is, their capital plus Qard Hasan. Banks are also allowed to use a combination of their own and depositors’ resources in an investment project, in which case the bank and the depositor share the resulting profits. A third possibility is for the bank to replace the depositor’s bank in an investment project to serve as a trustee. In this case the profits as well as any capital gains are returned to the depositors and the bank charges only a commission to cover the expenses of administering the accounts. The bank can guarantee and insure the principal amount of depositor’s resources.

In the cases where combined resources of the bank and the depositors are invested, the return to depositors is calculated in proportion to the amount of invested deposits after subtracting the required reserve portion from the base amount. The banks are required to announce their profits at the end of each six months of their operation and transfer the shares of the depositors’ profits to each of their accounts. Deposits withdrawn earn no profits before the minimum time required or reduced below the required minimum.

Modes of Financing and Credit Operations

The Law provides a number of modes of operation upon which financing and credit operations are to be based. The following are in brief the discussions on each mode of operation:

Musharaka (Partnership): The Law recognizes two different forms of partnership: civil and legal. The first is a project-specific partnership of short duration in commercial production, and service activities in which each partner provides a share of the necessary capital, and the assets and properties acquired are held as community property until the end of the life of the partnership. In these cases, the bank’s share in the capital cannot exceed the share of the manager-entrepreneur initiating or directing the project.

The second form of partnership is a firm-specific venture of longer duration in which the bank provides a portion of total equity of a newly established firm or buys into an existing corporation. The banks can participate in the equity of such partnership only after the technical, economic, and financial viability of the firm (or the project) has been appraised and minimum expected rate of profit from the investment appears to be high enough to warrant the undertaking of the venture by the bank. The Bank Markazi determines the maximum amount of equity participation by the bank, and the minimum amount of participation by other partners. The banks are allowed to sell and purchase shares whenever they deem it appropriate.

Direct investment: Banks can invest directly to any economic activities they choose so long as the following requirements are met: (i) banks cannot invest directly in projects in collaboration with the private sector, or in projects that lead to the production of luxury and unnecessary commodities; (ii) the ratio of the initial capital of these ventures to total funds needed must not be less than 40 per cent; (iii) the total fixed capital necessary for undertaking these projects must be provided for by long-term financial resources; (iv) undertakings of direct investment by banks must be based on well-documented evaluation and appraisal of the project, and use of bank resources and investment deposits in direct investment projects is allowed if, and only if the expected return from these projects is sufficient to meet the minimum required rate designated by Bank Markazi; (v) banks must report to Bank Markazi the amount of their own, as well as depositors’ resources allocated to direct investment projects; (vi) once the projects in which the banks have directly invested have begun their productive activity, banks can sell shares to the public; and (vii) Bank Markazi is authorized to investigate and audit direct investment projects in which banks have invested.

Mudaraba: This is a short-term commercial, contractual partnership between a bank and an agent entrepreneur according to which financial capital is provided by the bank and managerial effort by the entrepreneur in order to undertake a specific commercial project. Banks are required to give priority in their Mudaraba activities to co-operatives. Moreover, banks are not allowed to engage in Mudaraba financing of imports with private sectors.

Salaf transactions: To provide firms with the needed working capital, banks can pre-purchase their future output so long as the product characteristics and specifications are determined at the time of the purchase and the agreed price does not exceed the market price of the product at the time of the transaction. Banks, however, cannot sell the product until they have taken physical possession of the same. The delivery date of the product, which is to be fixed at the time of the transaction, cannot exceed one production cycle or one year, whichever is shorter.

Installment purchases: Banks are authorized to purchase raw materials, machinery and equipment for firms and resale the same to them on installment. The volume of raw materials cannot exceed that necessary for one production cycle and the repayment period for the same cannot exceed one year. The price of the product is to be determined on a cost-plus basis. The repayment period for machinery and equipment cannot exceed their useful life, which is considered to begin on the date of their utilization in the production process and the duration of which will be determined by the central bank. Residential housing can also be built and sold by banks on installment.

Lease-purchase transactions: Banks can purchase the needed machinery and equipment, or other moveable or immovable property, and lease the same to firms. While signing contract agreement the firm has to provide guarantee to take possession of the property at the end of the contract period, if the conditions of the contract are fulfilled. The time period involved in this transaction cannot exceed the useful life of the property (to be determined by the Bank Markazi). Banks, however, cannot engage in transactions in which the useful life of the property is less than two years.

Ju’alah (transaction based on commission): Banks may provide or receive services on requirement and charge or pay commissions or fees for such services. The service to be performed and the fee to be charged must be determined at the time of the transaction.

Muzara’ah: Banks may provide agricultural lands that they own or are otherwise in their possession (e.g., as a trust) to farmers for cultivation for a specific period and a predetermined share of the harvest. Banks may also provide seed and fertilizer along with the land if they so require on the same basis.

Musaqat : Banks may also provide orchards or trees that they own or that are otherwise in their possession (e.g., as a trust) to farmers for a specific period of time and a predetermined share of the harvest.

Qard Hasan loans: Banks are required to set aside a portion of their own resources for extending interest-free loans to (i) small producers, entrepreneurs, and farmers who would otherwise be unable to find alternative sources of financing investment and working capital and (ii) needy consumers. Banks are permitted to charge a minimum service fee to cover the administrative cost.

General Regulations Governing Asset Acquisition by Banks

The Law of Usury-Free Banking, along with the promulgation of regulations concerning modes of transactions, specifies additional regulations that govern asset acquisition by banks (Ibid, p.108).

Banks can only extend credits when they are reasonably assured that the principal sum granted and resulting profits are returned within a specific period of time. Banks are responsible for the control and supervision of the activity to which their own resources and/or the resources of their depositors are contractually committed.

Credit can be extended, conditional upon observance of proper procedures that ensure the security of the financial resources extended by the banks. Banks must ensure that the value of physical assets obtained through the use of their resources by their clients and the value of collateral is, at all times, equal to the remainder of the outstanding principal. To this end, banks may take steps to ensure the value of such assets or collateral during the lifetime of the project.

While banks may engage in joint venture projects with other banks, one specific bank must assume the responsibility of supervision and control of the project undertaken. Banks must take necessary steps to ensure that their clients understand that contracts mutually consented to are binding legal documents and will be treated as such by the courts.

Supervision of the Banking System

The Law placed the responsibility of supervision of the entire banking system of the country with Bank Markazi. Bank Markazi can exercise the following means for exercising its authority. It determines:
(a) Legal reserve requirements for various types of bank deposits of the banks;
(b) Bank-by-bank credit ceilings on aggregate and sectoral credit;
(c) Minimum and maximum expected rates of return from various facilities to the banks;
(d) Minimum and maximum profit shares for banks in their Mudaraba and Musharaka activities
(e) Maximum rates of commission the banks are to charge for investment accounts for which they serve as trustees;
(g) The maximum amount of credit facility granted by banks to each applicant;
(h) The ratio of credit facilities granted by each bank to various deposits; and
(j) The maximum amount of commitment made by each bank emanating from open letters of credit, endorsements, issuing guarantees, as well as the type and amount of collateral for such commitments (Ibid, p.109).
Moreover, Bank Markazi is authorized to audit and inspect banks’ accounts and documents and is further empowered to devise additional regulations to enhance its supervisory authority as the need arises to ensure and safeguard against threats of banks’ insolvency. Bank Markazi has developed procedures based on these guidelines for commercial banks to follow their transactions.

The New Monetary Policy

The new Law and its by-laws and regulations have maintained the powers and rights of the monetary policy so far as they are not in contradiction with Islamic principles. In Iran, monetary policy is implemented independently of fiscal policy and follows the same objectives as those followed by classical monetary policy (Mahdavi 1986). To implement monetary policy, except the rate of interest, all monetary policy instruments, such as legal deposits, the global and sectoral ceilings of credit facilities, discount rates, and so on are still applicable in Iran (Mahdavi 1995, p.226).

Along with the elimination of interest rate certain other completely new monetary instruments have been created by the Law and put at the disposal of the monetary authorities. A number of these new instruments included in the Law to perform functions similar to those of the interest rate in implementing monetary policy may be described as below:

Minimum Anticipated Rate of Return (MARR): Anticipated return is future net income arising from certain banking operations. MARR is a yardstick by which to judge the acceptability of credit applications submitted to the bank. In fact, MARR, which reflects the opportunity cost or hurdle rate to finance the opportunities, is one of the new instruments incorporated in the Islamic banking regulations in Iran. The rate may play a major role in implementing monetary policy. Banks are authorized to finance if, and only if, the anticipated calculated rate of return on such financing is at least equal to MARR. In other words, projects whose anticipated calculated rate of return is below MARR are rejected (Ibid, p.227). That means, an increase or decrease in MARR will lead to contraction or expansion of the credit volume granted by banks.

Maximum Rate of Profit (MRP): Another new monetary instrument embodied in the Law is MRP. The monetary policy authorities determine the rate. MRP is used by Islamic banks in Iran as a “mark-up” or “cost-plus” on the price of the assets and/or commodities sold to customers on credit. The MRP has the similar kind of impact as that of the MARR so far as its use as monetary tool.

Unique Features of Islamic Banking in Iran

The unique features of Islamic banking in Iran may be identified in the following contexts (Ibid, p.227).
a) Banks’ Credit Portfolio
One of the main features of an Islamic bank in Iran is the content of its portfolio. Each bank’s portfolio is composed of a vast number of investments in a variety of economic activities e.g., agricultural, industrial, mining, housing, etc. Certainly, such a portfolio is well diversified. The risk and return on such a portfolio would seem to be very close to those of a market portfolio. A portfolio with this feature signifies minimum risk and maximum return. This finally leads to an assured and stable return to the bank’s depositors.
Efficiency is another feature of the said portfolio. Each investment project and/or subject accepted by the bank complies with the standards set up by the monetary authorities. One of the standards is MARR. Thus, the projects with highest rate of return, i.e. the highest efficiency, have priority in credit facilities. Such procedures will eventually force the economic units concerned, and the economy as a whole, towards efficiency.

b) Probability of Losses on Capital
A stable return with low risk on an Islamic bank’s portfolio makes the profit-and -loss account of such a bank in Iran less vulnerable. Hence, the risk on equity capital of these banks will be minimized. Moreover, one should bear in mind that the depositors in an Islamic bank will receive, proportionately, the bank earns. This, in turn, can help banks in avoiding even more losses.

c) Distribution of Income
An Islamic bank’s portfolio in Iran contains a huge volume of investments in the activities of society. The income of those activities is shared, firstly, between the banks and the customers and, secondly, between investment depositors, i.e., a large number of the population in the society.

d) Uses of Banks’ Resources
The mechanism of Islamic banking is such that the resources are used for the purpose of granting credit facilities. The credit facilities are supplied indirectly in the form of assets and/or commodities. Based on these procedures, the financial needs of any sector of the economy are supplied by the banks in exactly the volume dictated by the monetary authorities. As a result, the method of financing of the type as in Iran is of great assistance to the achievement of monetary policy objectives.

e) Supervision and Control
The Islamic banking system in Iran has its built-in supervision and control in both use and repayment of credit facilities. The following phased out procedure automatically facilitates supervision and control. In the phase of study and examination of the application, confirmation of the feasibility of projects and conformity of the application with the rules and regulations ensure the necessary control. During the stage of use of funds, banks act as buyers and sellers, which also gives them control. During the last period of financing, however, supervision is rather difficult. During this stage, the resources if not controlled, may be diverted to other uses. Hence the supervision at this stage needs to be tighter.

Implementation of the Law

Much of the trend in Islamic banking in Iran has been influenced by factors, which have their roots in the pre-Revolutionary economic structure, as well as post-revolutionary external and internal political developments. The post revolution economy had inherited a host of difficult economic problems. Before the revolution, the Iranian economy had become highly dependent on oil revenues as well as on the imports of raw materials, intermediate goods and food. The industrial sector was organized without due attention paid to efficiency or comparative advantage and with very weak forward and backward linkages to the rest of the economy. The agriculture sector, which was producing surplus commodities until late 1960s, began to contract and there was a massive migration of farmers into the cities (Khan & Mirakhore 1989, p.8).
The revolution brought with it a host of economic problems including, inter alia, massive capital flight, which almost led to the collapse of the banking and financial system (Bank Markazi). The problems began to multiply for the economy at a rapid pace as the revolution took place. The economy, already vulnerable to internal and external shocks, faced the freezing of foreign assets, economic sanctions, interruption in production, the influx of nearly two million Afghan refugees, and the war with Iraq, drastic reduction in oil revenues (Behdad 1988, p.p.3-4). Concurrently, the constitution of the Islamic Republic of Iran specified objectives for the economy to be pursued—such as income redistribution, self-sufficiency in production, strengthening the economy, and reduced reliance on oil revenues—all of which required fundamental restructuring of the society’s economic behavior and institutions. The fall in oil revenues, plus the political objective of non-reliance on external financial resources, inevitably meant that the banking system would have to be relied upon to play a role far broader than that of pure intermediation (Khan & Mirakhore 1989, p.8).

The banking system has been used as an instrument of restructuring the economy—away from services and consumption toward production—in four ways. First, credit to the service sector, which constituted 55 percent of the GDP (1984-85), has been drastically reduced to halt its expansion in the short-run and curtailed its size in the medium-term. The policy went into effect during the second phase and continued in the later phase. Second, using all available modes of Islamic financing to help farmers improve and expand production has used bank credit to encourage the growth of the agriculture sector. Coupled with substantial government subsidies for seed, fertilizer, machinery, and crop insurance, the credit policy of the banking system is aimed at reviving the agriculture sector. This policy was initiated during the first phase and strengthened in the later phases. Third, Islamic banking has been used to create incentives for the development of a cooperative sector spanning agriculture, industry, and trade (Ibid, p.9). Cooperatives are given priority in credit allocation and in direct investment as well as in Musharaka financing by the banking sector.

The banking system also has been used as an instrument of income redistribution through the provision of Qard Hasan loans for the needy, financing for the building of low-income housing, and financing for small scale agro-business and industrial cooperatives often without stringent collateral requirements. Additionally, the banking system has financed government deficits, which obviously has distribution impacts. It is clear that with reduction of oil revenues from 27 percent of GDP in 1977/78 to only 4 percent in 1986/87, the banking system has been a major source of finance for achieving many of the social and economic goals of the Islamic revolution.

Given the extraordinary circumstances in which the Iranian economy has found itself since revolution, the performance of Islamic banking since its implementation in 1984 has been remarkably smooth (Ibid, p.9).

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