3rd ISRA-IRTI-Durham University Strategic Roundtable Discussion (SRD2013)  337

Start Date : 25th August 2014
End Date : 25th August 2014
Venue : Jeddah
Country : Canada
Total participant : 0
Total Interested : 0
Institution :

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Executive Summary

 

The International Shari'ah Research Academy for Islamic Finance (ISRA), in collaboration with the Islamic Research and Training Institute (IRTI) and Durham University, jointly organised the third annual Strategic Roundtable Discussion from 31st March to 1st April, 2013, at the Islamic Development Bank Group Headquarters in Jeddah. The main objective of the Strategic Roundtable is to provide a platform for constructive interaction and discussion among significant stakeholders of the Islamic banking and finance industry, namely Shari'ah scholars, Muslim economists, industry practitioners as well as regulators. In addition, the Roundtable aims to foster mutual understanding and respect among these stakeholders, so that the persistent dichotomy of views can be minimized. This third Roundtable represents a continuation of the discussions of previous years since it is aimed at discussing the theoretical and practical aspects of risk sharing under the theme: “Risk Sharing in Theory and Practice: Fiqh Evidence vis-a-vis Current Reality”.

 

 

 

The opening session commenced with a brief speech by Prof. Dato’ Dr. Mohd Azmi Omar, Director General of IRTI, who welcomed the participants to the event and stressed the importance of the theme under discussion. It is especially relevant at a time when the Islamic finance industry is striving to distinguish itself from the traditional banking model, which focuses on leveraging, derivatives, and speculation, by exploring the possibility of using equity-based instruments, a strategy that may raise several issues related to risk management. Therefore, he was of the opinion that choosing the topic of risk sharing as the theme of this discussion will have a significant effect in moving the industry toward fulfilling its objectives, which are embodied in bridging the gap between the real sector and Islamic finance.

 

 

 

Next, Assoc. Prof. Dr. Akram Laldin, the executive director of ISRA, welcomed the participants and highlighted the importance of organizing such events in which Shari'ah scholars, economists, market practitioners and regulators sit together to discuss issues related to the industry. Furthermore, he shared the opinion of Prof. Dato’ Dr. Mohd Azmi Omar regarding the relevance and importance of the theme and the responsibility that falls on the shoulders of the participants in reaching an agreement, particularly between Shari'ah scholars and economists, on this important issue in order to play a role in moving the industry in the right direction.

 

 

 

Finally, Prof. Dr. Habib Ahmed, the representative of Durham University, pointed to the existence of two realities: first, that the majority of Islamic financing is done using debtbased instruments, and second, that the crisis was a result of excessive debt. With these two realities in mind, Prof. Habib concluded by reminding the participants that one of the objectives of this discussion is to look at the issues which hamper the use of equity-based instruments in practice.

 

 

 

The opening session was followed by the first session, titled “Risk Sharing in Islamic Law: A Conceptual Framework”. The session had one presentation, delivered by Dr. Marjan Muhammad, and three icebreakers: Shaykh Dr. Mohammed Syafii Antonio, Dr. Sami Ibrahim Al-Suwailem and Shaykh Dr. Anas Al-Zarqa. Dr. Marjan’s presentation focused on the definition of risk, its types, the definition of risk sharing, fiqh evidence for risk sharing, risk sharing as an alternative to riba, and risk sharing in exchange-based contracts and in partnership contracts. She concluded her presentation by stating that the fiqh evidence gives a clear indication that risk sharing is not supposed to be only in partnership-based contracts like musharakah and murabahah; rather, it should also be embedded in exchange-based contracts, which are actually the underlying contracts within the partnershipbased contracts.

 

 

 

Following the main presentation of the session, Shaykh Dr. Mohammed Syafii Antonio was the first to comment by stating that the focus should be on risk sharing as compared to risk transfer due to a number of advantages it possesses. First, risk sharing is more just than risk transfer, creating an equitable distribution of income and wealth between the capital provider and the entrepreneur. Risk transfer, on the other hand, continuously transfers wealth from the entrepreneur to the capital provider. Second, the allocation of investible funds is based on the expected profitability of the project whereas in the interest-based risk transfer the allocation is predominantly for the capital provider. Third, risk sharing encourages entrepreneurship, investment and innovation while risk transfer constitutes a guarantee of the capital plus an additional return to the creditor. Finally, he emphasized that for Islamic finance to achieve its potential it has to focus on long-term investment and economic growth and not confine itself to short-term, highly liquid and safe commodity trade and cost-plus sale financing contracts.

 

 

 

The second commenter was Dr. Sami Al-Suwailem, who drew the attention of the participants to the fact that equity is the net worth of the economy and is the shock absorber for any institution or economy as a whole, which is why we have to have a sufficient amount of equity in the economy. Furthermore, he mentioned that there are three ways to deal with risk. The first one is risk sharing, which is the ideal treatment of risk and the opposite of the second option, risk transfer. However, there is something in between, which is risk exchange. This can be done by applying the Islamic instruments of exchange and trade whereby a party gives up something and takes something else, either goods or services. If there is an exchange between two different things, that means there is an exchange of two different risks, because as one party gives up something it gives up its risk, and if it takes up something it also takes on its risk. Finally, Dr. Sami was of the opinion that risk sharing or musharakah requires a different kind of institution, and he called for specialized institutions for financing musharakah. Moreover, in addition to specialized institutions, there is a need for tools to evaluate entrepreneurship and evaluate capabilities to generate added value.

 

 

 

Shaykh Dr. Anas Al-Zarka was the final icebreaker to deliver his comments. He started by saying that the methodology he adopted to discuss the topic was based on looking at the instances of risk sharing in the Shari'ah, namely the Qur’an, Sunnah and fiqh, regardless of what they are called in classical fiqh literature. First, he distinguished between The opening session was followed by the first session, titled “Risk Sharing in Islamic Law: A Conceptual Framework”. The session had one presentation, delivered by Dr. Marjan Muhammad, and three icebreakers: Shaykh Dr. Mohammed Syafii Antonio, Dr. Sami Ibrahim Al-Suwailem and Shaykh Dr. Anas Al-Zarqa. Dr. Marjan’s presentation focused on the definition of risk, its types, the definition of risk sharing, fiqh evidence for risk sharing, risk sharing as an alternative to riba, and risk sharing in exchange-based contracts and in partnership contracts. She concluded her presentation by stating that the fiqh evidence gives a clear indication that risk sharing is not supposed to be only in partnership-based contracts like musharakah and murabahah; rather, it should also be embedded in exchange-based contracts, which are actually the underlying contracts within the partnershipbased contracts.

 

 

 

Following the main presentation of the session, Shaykh Dr. Mohammed Syafii Antonio was the first to comment by stating that the focus should be on risk sharing as compared to risk transfer due to a number of advantages it possesses. First, risk sharing is more just than risk transfer, creating an equitable distribution of income and wealth between the capital provider and the entrepreneur. Risk transfer, on the other hand, continuously transfers wealth from the entrepreneur to the capital provider. Second, the allocation of investible funds is based on the expected profitability of the project whereas in the interest-based risk transfer the allocation is predominantly for the capital provider. Third, risk sharing encourages entrepreneurship, investment and innovation while risk transfer constitutes a guarantee of the capital plus an additional return to the creditor. Finally, he emphasized that for Islamic finance to achieve its potential it has to focus on long-term investment and economic growth and not confine itself to short-term, highly liquid and safe commodity trade and cost-plus sale financing contracts.

 

 

 

The second commenter was Dr. Sami Al-Suwailem, who drew the attention of the participants to the fact that equity is the net worth of the economy and is the shock absorber for any institution or economy as a whole, which is why we have to have a sufficient amount of equity in the economy. Furthermore, he mentioned that there are three ways to deal with risk. The first one is risk sharing, which is the ideal treatment of risk and the opposite of the second option, risk transfer. However, there is something in between, which is risk exchange. This can be done by applying the Islamic instruments of exchange and trade whereby a party gives up something and takes something else, either goods or services. If there is an exchange between two different things, that means there is an exchange of two different risks, because as one party gives up something it gives up its risk, and if it takes up something it also takes on its risk. Finally, Dr. Sami was of the opinion that risk sharing or musharakah requires a different kind of institution, and he called for specialized institutions for financing musharakah. Moreover, in addition to specialized institutions, there is a need for tools to evaluate entrepreneurship and evaluate capabilities to generate added value.

 

 

 

Shaykh Dr. Anas Al-Zarka was the final icebreaker to deliver his comments. He started by saying that the methodology he adopted to discuss the topic was based on looking at the instances of risk sharing in the Shari'ah, namely the Qur’an, Sunnah and fiqh, regardless of what they are called in classical fiqh literature. First, he distinguished between Islamic markets go through a similar crisis of confidence. Furthermore, the speaker also raised a question regarding musharakah mutanaqi?ah and its use in home financing in countries that have a weak institutional framework and whether such an instrument can thrive in such an environment. He concluded by requesting the participants to discuss these questions from a behavioural perspective as well as a policy perspective.

 

 

 

The third and final session of the first day of the Roundtable discussion was titled “The Viability of Musharakah Instruments: A Regulatory Perspective”. The first ice breaker was Dr. Muhammad Syahmi Mohd Karim, who started his presentation by defining the modern application of the musharakah contract and the risk weighting of musharakah from the regulatory capital perspective. He then talked about the potential risks in applying the musharakah contract, which include partnership performance risk/counterparty credit risk, equity investment risk, liquidity risk, Shari'ah non-compliance risk and operational risk. The speaker stressed that managing these risks requires the use of risk governance and risk management processes. Finally, the presentation concluded with a suggestion that IFIs pool their tainted income into one pool. Once this fund is set up, it can be managed by one body, and the fund can be used to give micro-credit based on musharakah. All the good practices, controls and lessons that can be learnt from such an experience can be passed on to the IFIs.

 

 

 

The second ice breaker, Dr. Hylmun Izhar, talked about the objectives of financial regulations before delving into the core of his presentation: the need to identify the optimal portfolio diversification within the Islamic banking and finance industry coupled with the development of incentive-based regulations that will induce the appropriate behaviour by the regulated Islamic financial institutions.

 

 

 

The third and final icebreaker was Dr. Kenneth Baldwin, who expressed the opinion that viability is concerned with information asymmetries underlining the economic risks of musharakah as a business arrangement. Thus, the speaker pointed out that, when talking about the viability of musharakah, there is a need to examine its impact on the bank’s capital adequacy and possible resulting systemic issues. In regards to capital adequacy, the first issue mentioned by the speaker was the application of high asset risk weights, which will be an incentive to state the accounting value of the assets. The other aspect is the existence of any third-party guarantees by which the guaranteed displaces risk to the guarantor, which in turn means that the risk weightage applied is that of the guarantor. Another issue relates to the financing structure mechanism, whereby there is a mismatch between the risk appetite of some of the depositors who are providers of funds to Islamic financial institutions and the underlying risks of the avenues in which those funds are deployed. Finally, the speaker talked about the resulting systemic issues of implementing musharakah and concluded by posing a question that needs to be examined and answered by regulators concerning whether a greater use of musharakah in Islamic financial institutions will act to increase or decrease systemic risks.

 

 

 

The fourth and last session of the Strategic Roundtable Discussion was titled “Promoting Musharakah Instruments in Contemporary Islamic finance: A Way Forward”. The session consisted of four speakers: Shaykh Dr. Mohamed Ali Elgari, Shaykh Dr. Mohd Daud Bakar, Mr Ferdaus Abdullah Toh and Dr. Abdelrahman Al-Zahi. Shaykh Dr. Mohamed Ali Elgari started by differentiating between musharakah as we know it today and the classical contract of shirkah, reaching the conclusion that musharakah is a new arrangement and a new type of contract. Next the speaker described the debate going on between economists and Shari'ah scholars regarding the use of musharakah in Islamic finance. The economists think the industry should strive to achieve one of the primary objectives of Islamic finance and Islamic economy? equitable distribution of wealth and income?through the use of musharakah. On the other hand, the Shari'ah scholars are not very convinced about the approach suggested by the economists because they think that their function is to advise banks about what is permissible and what is not. Therefore, they will not discourage the banks from applying any contract as long as it is done in a Shari'ah-compliant manner. The speaker added that the only hope of reconciling the two views would be by presenting a Shari'ah argument for musharakah. That argument is based on maqa?id al- Shari'ah; however, when the speaker surveyed the literature on maqa?id al-Shari'ah, he found it to be based on ideals, most of which cannot be relied on in terms of policy. As a result, he concluded that the only viable solution is to have institutions other than the traditional banking institutions that are dedicated to musharakah.

 

 

 

The second icebreaker, Dr. Mohd Daud Bakar, started by talking about the limitations of the nature of banking as the vehicle to promote musharakah instruments, which led him to suggest the idea of creating another form of deposits, where the depositors willingly and knowingly agree to place their money for the sake of long-term musharakah financing by the bank. Coming back to musharakah, the speaker mentioned that there are various degrees of risks in musharakah; not only the practical aspects of the project but also the behaviour of the partners and the environment or ecosystem of any particular project. Therefore, there is a need for a theoretical foundation or a comprehensive framework of making musharakah a viable instrument by addressing all the issues confronting a particular real economic project. This is important in order to reconcile the Shari'ah scholars’ view with that of the economists and the players in the real market. He concluded by reiterating the need to have a comprehensive framework to move forward with musharakah, one with a solid foundation of risk management and comprehensive understanding of the issues involved in any project undertaken by musharakah financing.

 

 

 

The third speaker, Mr. Ferdaus Abdullah, talked about promoting musharakah instruments at AFFIN Islamic bank, whereby the bank offers two types of products under the musharakah concept. The first type is on the corporate side, which is the musharakah equity participation mentioned by Mr. Kamarul. The second type is on the consumer side, which is musharakah mutanaqi?ah. In the latter type, customers would normally come to the bank after they have identified a property they want to purchase. The bank will then evaluate the location and the developer before deciding on whether to enter into the partnership or not. The sharing composition in the structure would be a 10% share to the customer and a 90% share to the bank. The bank would then lease its portion of the property to the customer. The customer has to pay periodic installments over time to the bank. These installments consist of two elements: the first is the rental payment, and the second is an incremental purchase of the equity portion owned by the bank. The speaker then pointed out that in Malaysia the selling of Islamic products is much simpler due to several key benefits in promoting Islamic finance, among them is the stamp duty reduction of 20%, the lower penalties charged on defaulters, and the fact that the products offered have both commercial and spiritual benefits. He concluded by saying that the key to minimizing the risk of musharakah is to know the parties that the bank will be dealing with, namely, the customer, the partners and the developer.

 

 

 

The final ice breaker of the session was Dr. Abdelrahman Al- Zahi, who began his presentation by first stating that although risk management instruments do exist theoretically in Islam, such instruments tend to cause more challenges because, if a party feels safe and is not in control of its behavior, it will expose itself to more risks. Thus, the main challenge becomes finding a factor that can control the risk of using risk management. In this regard, the speaker gave the example of the recent financial crisis, which was caused as a result of excessive risk due to the sophisticated risk mitigation instruments that were used by the conventional banking institutions. These institutions, according to the speaker, felt they were safe because of all the risk mitigation techniques they employed, which led them to engage in excessive lending activities, which in turn resulted in the subprime mortgage crisis. Thus, the critical issue is how to control our behavior when we use risk management. The speaker concluded by emphasizing the importance of making sure that we know our partners and of utilizing a reliable mechanism to select them when conducting musharakah.

 

 

 

At the end of the event, the Roundtable participants agreed on the Jeddah Declaration, which provides recommendations based on three broad categories, i.e., regulatory, institutional and product-related.

 

 

 

Prepared by:

Mohammad Mahbubi Ali

Marjan Muhammad

Madaa Mustafa Munjid

 

 

name issn year language pages author Document
Risk Sharing: A Fiqhi Perspective 2013 English Marjan Muhammad
Risk Sharing: A Conceptual Framework from Fiqh Perspective 2013 English Muhamad Syafee Antonio
Jeddah Roundtable Declaration - 3rd SRD 2013 English ISRA,IRTI,Durham University
Risk Sharing in Islamic Law: A Conceptual Framework 2013 English Muhammad Anas Zarqa
Musharakah Project Financing 2013 English Kamarul Ariffin Mohd Jamil
Viability of Musharaka: Regulatory Perspective 2013 English Ken Baldwin
Towards a Viable Musharakah Instrument: A Regulatory Perspective 2013 English Hylmun Izhar
Promoting Musharakah Instruments in Contemporary Islamic Finance 2013 English Ferdaus Abdullah Toh


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