ISLAMIC DEVELOPMENT BANKS & SUKUK SYSTEM – 21.05.2015

Şebnem ŞAKAR, Seda ÇELEBİ, Atiye SAĞLAM, Esra Ezgi ERTAN

AGENDA • Definition of Islamic Economics

• The Economic Role of State

• Theory of Islamic Banking

• Principles of Islamic Banking• Islamic Development Banks &

Members• Account Available to Customers

• SUKUK - History

• Benefits of SUKUK

• Types of SUKUK

• SUKUK in Turkey

Definition of Islamic Economics According to Hasanuz Zaman,

‘Islamic economics is the knowledge and application of injunctions and rules of the Shariah (Islamic Principles) that prevent injustice in the acquisition and disposal of material resources in order to provide satisfaction to human beings and enable them to perform their obligations to Allah (God) and society’.

It is economics that is governed by Islamic rules and principles which tend to achieve the well-being for individuals and society as a whole.

THE ECONOMIC ROLE OF THE STATEThe state in Islamic economics is committed to implementing and maintaining ethics in society. The state is responsible for :

• gathering Zakat and distributing it in favor of the needy. Also, it has to ban and prevent dealing with Riba among people and firms.

• supervising and controlling the market. It has equally to intervene in order to avoid monopoly and injury.

Islamic banking performs the same essential functions as banks do in the conventional system, except Islamic banks need to do business in accordance with the rules and principles of Islam.

It is based on interest free banking that conforms to the Islamic law or Shariah that prohibits interest on all types of loans. The principle is profit and loss sharing. Both the supplier of the capital and the borrower share the risk and both suffer together when returns are poor. Islamic banks will fit only if one replaces “interest rates paid” with “profit-shares and fees”.

Islamic banking operates in many countries including Bahrain, Pakistan, Jordan, Iran, Sudan, United Kingdom, Singapore and Malaysia. Over recent decades the Islamic banking industry

has emerged as one of the fastest growing industries and has spread to all corners of the globe, receiving wide acceptance from Muslims and non-Muslims.

There are three main reasons for prohibition of interest according.

1. Riba is unfair Traditional relationship between borrower and lender is on interest, borrower has chance to receive all the profit or the risk to face all the losses that occur, whereas lender earns money what so ever. 2. Riba is exploitative It is exploitative because favoring rich, as surplus of money and it force needy and poor to borrow. 3. Riba is unproductive Money should be used in economic ventures and contribute to the economy and enhance welfare.

RIBA (INTEREST)

1963 - The first modern bank like that was established in Egypt “Mit Gamr-in”. 1975 - The Islamic Development Bank was established and Turkey was one of its establishers. 1985 - Albaraka Turk.1985 - Faisal Finans (Family Finans) Ulker group took over. 1989 - Kuwait Turk.1991 - Anadolu Finans - became Turkiye Finans. 1995 - Ihlas Finans. Went out of business.1996 - Bank Asya. The only local capital Islamic bank.

Current Market Share in Turkey is around %5.5.Projected market share in Turkey by 2023 is %15.

The Islamic Development Bank (IDB) is a

multilateral development financing

institution located in Jeddah, Saudi Arabia.

It was founded in 1973 by the Finance

Ministers at the first Organisation of the

Islamic Conference (now called the

Organisation of Islamic Cooperation) with

the support of the king of Saudi Arabia at

the time (Faisal), and began its activities on

20 October 1975.

There are 56 shareholding member states.

Mohammed bin Faisal is the former

president of the IsDB.

The present membership of the Bank consists of 56 countries.

The basic condition for membership is that the prospective member country should be a member of the Organisation of Islamic Cooperation (OIC), pay its contribution to the capital of the Bank and be willing to accept such terms and conditions as may be decided upon by the IsDB Board of Governors.

Ranked on the basis of paid-up capital (as of August 2012),[5] majorshareholders include:

• Saudi Arabia (26.5%)• Libya (10.7%)• Iran (9.32%)• Egypt (9.22%)• Turkey (8.41%)

• United Arab Emirates (7.54%)• Kuwait (7.11%)• Pakistan (3.31%)• Algeria (3.31%)• Indonesia (2.93%)

MEMBERSHIP

10

Principals of Islamic Financial System1) Prohibition of Interest (RIBA)

“An excess” Any unjustifiable increase of capital whether are loans or sales in the central tenant of the system.

Islamic regulations encourage the earning of profit but forbid the charging of interest.

2) Money as a potential capital It joins hands with other resources to undertake a productive

activity.

3) Risk sharing When interest is prohibited, suppliers of fund become investors

instead of creditors. Investors & financial intermediary relationship is based on profit

& loss sharing principals.

3) Prohibition of speculative behavior Discouraging hoarding & prohibits transacting featuring extreme

uncertainties.4)Sanctity of contracts

Upholding contractual obligations & the disclosure as a sacred duty to reduce the risk of asymmetric information & moral hazard.

5)Sharing-approved activities Only activities that don’t violate the rules of shariah qualify for

investment. Any business Dealing with alcohol, gambling or casinos is

prohibited.6)Social justice

In Principle , any transaction leads to injustice & exploitation is prohibited.

Principals of Islamic Financial System

ACCOUNT AVAILABLE TO CUSTOMERS The main accounts available to customers according to: I. Demand deposit accounts (known as current accounts) Don’t earn any income from depositor directly or indirectly

II. Saving accounts In Islamic banking these funds are used in short range investment projects and ventures and can be withdrawn at any time.

III. Investment accounts In this kind of account investor deposit their money and want to be invested by Islamic bank, under their supervision.

SUKUK - Overview Sukuk in general may be understood as a Shariah compliant

‘Bond’. In its simplest form sukuk represents ownership of an asset or

its usufruct. Sukuk were used by Muslims in the Middle Ages as papers

representing financial obligations originating from trade and other commercial activities

Major development during the 90s Pioneered in Middle East & Malaysia

Sukuk Vs. Conventional BondsSUKUK CONVENTIONAL BONDSSukuk indicate ownership of an asset

Bonds indicate a debt obligation

The assets that back sukuk are compliant with Shariah

Assets backing bonds may include products or services that are against Islam.

Sukuk are priced according to the value of the assets backing them

Bond pricing is based on credit rating

Sukuk can increase in value when the assets increase in value

Profits from bonds correspond to fixed interest, making them Riba

When you sell sukuk, you are selling ownership in the assets backing them.

The sale of bonds is the sale of debt.

Development of Sukuk - Global

1990 2002 2009 2011 2011 2014

First corporate Sukuk by

Shell Malaysia(USD33mn)

World’s first global Sukuk by

Govt. of Malaysia

(USD600mn)

First global Sukuk

by Govt. Of Indonesia

(USD650mn)

Largest global Sukuk

by Govt. of Malaysia

(USD2bn)

2nd global Sukuk by

Govt. ofIndonesia (USD1bn)

First Sukuk in US backed

by oil and gas assets

(East Cameron Gas)

Development of Sukuk - Turkey

2010 2012 2013 2014

First Formal Provisions for

sukuk by CMB - Capital Markets Board of Turkey

(April 2010)

First Sukuk Issuance

by Kuveyt Turk Katilim Bankasi A.S.

(Kuveyt Turk) August, 2010

First sukuk issuence based on a portfolio of state-owned real property assets

USD 7.5 billion transaction was well

received by investors

around the world

TRY-denominated Treasury sukuk is

accepted as a collateral asset in

open market operations by the

Central Bank of Turkey

Bank Asya, first Turkish Islamic bank to issue a domestic sukuk

Under the Communiqué, Turkish corporates can now access a new pool of

investors through Islamically structured

instruments previously unavailable to them.

Sukuk Issuance Trends

2006 2007 2008 2009 2010 2011 2012 2013 1H140

20

40

60

80

100

120

140

23

42

1928

41

82

132

119

66

$ bln

Sukuk Issuance By Sectors

Sukuk Issuance By Structure

Uses of Sukuk Funds

Project Specific

• Money raised through sukuk

• Qatar Global Sukuk issued for construction of Hamad Medical City

Asset Specific

• Resources are mobilize by selling the beneficiary right of the assets to the investors

• Ex: Government of Malaysia raised US$ 600 million through Ijara sukuk Trust Certificates in 2002

Balance Sheet Specific• Ex: The Islamic

Development Bank (IDB) sukuk issued in August 2003. The IDB mobilized these funds to finance various projects of the member countries. The IDB made its debut resource mobilization from the international capital market by issuing US$ 400 million five-year sukuk due for maturity in 2008.

Types of Sukuk

Types of Sukuk

Sukuk Salam

Sukuk Musharaka

hSukuk Istisna’

Sukuk Ijarah

Sukuk Murabaha

h / BBA

The most important and common among those are Ijarah, Salam and Istisna. Among the fourteen eligible Sukuks identified by the AAOIFI

Sukuk Ijarah

Ijarah is defined as a manfaah (usufruct) type of contract whereby a lessor (owner) leases out an asset or equipment to its client at an agreed rental fee and pre-determined lease period upon the aqad (contract). The ownership of the leased equipment remains in the hand of a lesssor

Key Features of Underlying Structure The consideration (Rentals) must be at an agreed rate and agreed

period;

The subject of the ijara must have a valuable use

The ownership of the asset(s) must remain with the Trustee and only the usufruct right may be transferred to the originator

The Originator (as lessee) cannot use an asset for any purpose other than the purpose specified in the ijara (or lease) agreement

The asset(s) must be clearly identified in the Ijara

Key Features of Underlying Structure Rental must be determined at the time of contract for the

whole period of the ijara. Although it is possible to split the term of the ijara into smaller rental periods

If there has been a Total Loss, the Trustee may have the right/ability to substitute or replace the affected asset

If a Total Loss is caused by the misuse or negligence of the Originator, the Originator will be liable to compensate the Trustee for depreciation

Structure of Sukuk Ijarah

Steps Involved In The Structure1.The obligator sells certain assets to the SPV at an agreed pre-determined purchase price.

2. a. The SPV raises financing by issuing Sukuk certificates in an amount equal to the purchase price. b. This is passed on to the obligator (as seller).

3. A lease agreement is signed between SPV and the obligator fora fixed period of time, where the obligator leases back the assets as lessee.

4. a. SPV receives periodic rentals from the obligator; b. These are distributed among the investors i.e. the Sukuk holders.

5. At maturity, the SPV sells the assets back to the seller at a predetermined value. That value should be equal to any amounts still owed under the terms of the Ijara Sukuk

6. Upon maturity, the Investor will get back the principal amount.

SUKUK APPLICATIONS

KuveytTürk

Established 2 billion Ringgit sukuk program in Malaysia – 31.03.2015

Issued a five-year Sukuk of $500 million with a return rate of 5.162 percent – 26.06.2014

Receiving orders from over 170 accounts, a clear indication of Kuveyt Türk’s well-diversified investor base – 26.06.2014

SUKUK APPLICATIONS

Oversubscribed, with value of subscription reaching $750m. The Sukuk represents Albaraka Türk's second international Sukuk issuance following the issuance of their Tier 2 Sukuk in 2013.

Type:Bereket Varlik Kiralama Wakala Murabahah

Issue Size: $350,000,000 (350 Million Dollars)Currency: USDMaturity: 30 June 2019Country of Issue: TurkeyTenor: 5 YearsIssue Date: 01 July 2014Sukuk Rating: BB by Standard & Poors.

SUKUK APPLICATIONS

Bank Asya, first Turkish Islamic bank to issue a domestic sukuk

On 28 March 2013, Asya Katilim Bankasi A.Ş. (Bank Asya) issued the first Tier 2 subordinated sukuk out of Europe and the Middle East

The yield on the lender’s sukuk due March 2023 has surged 886 basis points this year to 18.6 percent, the highest rate among dollar-denominated Islamic bonds that haven’t defaulted, according to data compiled by Bloomberg.

THANK YOU

Şebnem ŞAKAR, Seda ÇELEBİ, Atiye SAĞLAM, Esra Ezgi ERTAN