POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise MARCH 2012 • Number 77 JUN 010 • Numbe 18 67644 Realizing the Potential of Islamic Finance Mahmoud Mohieldin Islamic finance has been growing rapidly in recent years. Motivated by a heightened interest in financial instruments that emphasize risk sharing, it has been attracting greater attention in the wake of the recent financial crisis. This class of instru- ments appears to have avoided many of the most severe consequences of the crisis. Several features underpin the expansion and performance of Islamic finance. Addressing key regulatory and governance issues will be essential for Islamic finance to achieve its full potential. Several multilateral development institutions, including the World Bank, have longstanding programs to support the development of the industry and have used Islamic instruments, to varying extents, to tap capital markets. In the coming years, Islamic finance could account for a substantial share of financial services in several countries, meeting the preferences of significant numbers of people, enhancing financial inclusion and intermediation, and contribut- ing more broadly to financial stability and development. Islamic Finance: What Is Different? The concept of Islamic or Shariah-compliant finance is based 2. Calls for bank deposits to be collected on a profit/loss- on core tenets of Islam concerning property rights, social and (PLS) sharing basis rather than fixed predetermined liabil- economic justice, wealth distribution, and governance. One of ities. All profits and/or losses on the asset side are to be the key features of the system is prohibition of riba (interest) passed through to the investors (depositors) on the liabili- and gharar (ambiguous contracts or deals) (Kabir and ties side (Dar and Presley 2000, 1; Ayub 2007). Mahlkrecht 2011, 74; El-Gamal 2009, 58–60). There is con- 3. Promotes financing of trade and exchange of goods and sensus among scholars that the prohibition of interest is not services to ensure a close link between the real economy limited to usury but refers to interest on debt in any form and the financial sector, because all financial contracts (Iqbal and Mirakhor 2011, 10). The prohibition of gharar1 is should be backed by assets or transactions/activities in the to discourage excessive uncertainty in contracts, enhance dis- real economic sector. closure, and proscribe all forms of deception. In addition to the 4. Upholds property rights for the individual and society,and prohibition of riba and gharar, Islamic finance has seven key clarifies the sources of individual ownership. 2 precepts. Implemented fully, Islamic finance: 5. Mandates fulfillment and sanctity of contracts that deal 1. Eliminates pure debt securities from the financial sys- with trade in goods and services, as well as transfer of own- tem, replacing interest by the rate of return earned ex ership and honoring of debt obligations (Ayub 2007, post on contracts of exchange or risk sharing. chapter 5). 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise 6. Emphasizes principles of morality and ethics in business of financing and an underlying asset also helps limit leverage. conduct, proscribing illicit activities according to Shariah The sharing of risk and reward (al ghonm bel ghorm) implies that (El-Ghazali 2002), and mandating that all economic ac- long-term targets become more important and excessive short- tivities be governed by rules of fair dealing and justice.3 term risk taking is discouraged (El-Ghazali 1986, 65). Finan- 7. Advocates the sharing of risk and reward between the cial institutions are more like business partners with their cli- rich and the poor through specific instruments of re-dis- ents, and have stronger incentives to evaluate funding requests tribution. carefully and exercise prudence in extending such financing. These elements constitute an alternative approach to con- As business partners, financial institutions are more likely to ventional finance. Since their development in the mid-1970s,4 assist borrowers in working through bad times, thus lowering Islamic financial institutions have increasingly provided attrac- the pressure to sell assets at “fire-sale� prices. This protects the tive channels for financial intermediation and have grown rap- system against a general fall in asset prices and reduces the prob- idly, especially in the last decade (Hassan and Dridi 2010, 8). ability of cascading defaults. The sharing of losses reduces the probability of contagion to the rest of the financial system. Islamic Finance and Financial Stability Moreover, Islamic finance protects the exchange/transaction Proponents claim that Islamic finance contributes to the stabil- role of a banking system by limiting the risk on deposit balances ity of the financial system. During the recent financial crisis, (Mohieldin 1995, 4). Islamic financial institutions were affected by the adverse sec- ond-round effects of the crisis: when the real economy con- Shariah-Compliant Financial Assets Have tracted, real estate prices got depressed, and in some cases, is- Been Growing Strongly sues of Islamic bonds (Sukuk or certificate of ownership) Global Shariah-compliant financial assets have increased sig- defaulted. However, Islamic banks generally escaped the worst nificantly over the past three decades, reaching about US$1 tril- effects of the 2008 financial crisis, because they were not ex- lion in 2010 (figure 1), up from about US$5 billion in the late posed to subprime and toxic assets, and had maintained their 1980s. Banking assets account for the bulk of this increase, close connection to the real sector. Hence, some observers have complemented by Sukuk and assets under management suggested that conventional banking can learn from the alter- (AUM). Banking assets have been growing rapidly for several native systems offered by Islamic finance, which is less skewed decades and rose from about US$386 billion in 2006 to toward debt instruments, uses equity for greater risk sharing, US$939 billion in 2010 (figure 1). Preliminary estimates sug- and limits the mismatch of short-term demand deposits with gest that they climbed further to about US$1.1 trillion in 2011 long-term loan contracts (Rogoff 2011,1). (Deutsche Bank 2011, 5). In recent years, growth in Islamic fi- The performance and relative stability of Islamic financial nancial assets has generally outperformed conventional finan- institutions during the crisis stems from the distinctive fea- cial instruments, particularly following the onset of the finan- tures of the instruments they offer. As mentioned above, Islam- ic finance emphasizes asset backing and the principle of risk cial crisis that has been gripping the world since 2008. sharing, ensuring a direct link between financial transactions The global market in Sukuk has expanded rapidly during and real sector activities. The return on savings and investment this period. Sukuk, or Islamic bonds, are certificates of owner- is closely linked (determined by the real sector, not the financial ship that are based on the concept of joint ownership of an asset sector), giving Islamic finance instruments a flexible adjust- by several financiers, giving it features more like securitized eq- ment mechanism in the case of unanticipated shocks. The ad- uity-type financing. After dipping with the start of the global justment mechanism ensures that the real values of assets and financial crisis in 2008, the total volume of issuances more than liabilities will be equal at all points in time, and prohibits exces- doubled to reach roughly the equivalent of US$48 billion in sive risk taking, thereby avoiding several forms of complicated 2010 (figure 2). Markets absorbed an average of 800 new issu- securitization. Ex post, Islamic finance is also more equitable, ances a year during 2009 and 2010, driven by a heightened de- because investors or partners share in the outcome of the part- mand for asset-backed instruments. In the first 10 months of nership, be it profit or loss (Chapra 2008, 16). 2011, the total volume of Sukuk issuances rose further to about Whether both partners provide capital and have the right US$50 billion. Although the Sukuk market is small compared to manage the project (musharakah), or one partner provides to conventional fixed-income or securitized products, the weak- the capital and the other works with it (mudarabah), there is an er performance of conventional instruments during the crisis is emphasis on equitable risk allocation among partners. The combining with a greater recognition by issuers that Sukuk are same principals are extended in the mutual insurance contracts a feasible alternative to boost market appetite. (takaful), which also have a mechanism for fair risk sharing Malaysia is the global market leader for Sukuk issuance, ac- among participants. counting for 63 percent of cumulative Sukuk issuances be- Reliance on equity-type financing arrangements helps re- tween 1996 and 2010 (figure 3). Malaysia issues long-term, lo- strain excessive leveraging. The close link between the amount cal currency Sukuk to fund infrastructure projects and 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 1. Global Shariah-Compliant Financial Assets Islamic financial instruments are currently available 1,200 in at least 70 countries, with widely varying shares of banking services compared to conventional equivalents. 1,000 The recent financial crisis affected the asset quality of US$ billions 800 conventional banks adversely. In contrast, as shown in re- 600 cent research, Islamic banks had higher asset quality, 400 were better capitalized, and more likely to continue their 200 financial intermediation role during the crisis than their 0 conventional counterparts (Beck, Demirgüç-Kunt, and 2006 2007 2008 2009 2010 Merrouche 2012, 20). banking assetsa Sukuk outstandingb AUMc The growth of Islamic banks has been significant Sources: (a) Deutsche Bank 2011; (b) International Islamic Financial Markets database, during the past five years. For example in Qatar, the assets March 2012; and (c) Ernest & Young 2011a. of Islamic banks expanded by 43 percent during 2006– 10, substantially faster than the growth in assets of con- Figure 2. Global Sukuk Issuances ventional banks, and constituted around 23 percent of 60 900 the country’s total banking assets in 2010. Turkey’s Is- volume (US$ billions) number of transactions 800 lamic banking sector also grew rapidly compared to con- 50 700 ventional counterparts (figure 4). 40 600 500 Islamic mutual funds come in different flavors, 30 dominated by equity, leasing, and commodity funds. 400 20 300 The growth of such AUM has slowed since 2008, after 200 10 expanding by more than 20 percent a year in the first half 100 0 0 of the decade. The sector remains dynamic, however, 2006 2007 2008 2009 2010 with the number of Islamic funds reaching 699 in mid- sovereign corporate 2011, compared with 608 in 2009 (Ernest & Young quasi-sovereign number of Sukuk issuances 2011a, 2). (right vertical axis) In addition to banking, AUM, and capital markets, Source: Islamic Finance Information Services Database, October 2011. there is a very vibrant industry of Shariah-compliant fi- nancing in other asset classes such as venture capital, pri- Figure 3. Cumulative Sukuk Issuances (1996–2010) vate equity, and project finance. Several major infrastructure projects are being financed through Shariah-compliant modes Pakistan others Qatar 1% of financing. Kuwait Indonesia 2% 2% It is worth noting that the World Bank Group has sought 1% 3% Bahrain to support Islamic finance through a variety of initiatives, rang- 4% ing from academic research to execution of transactions. En- Saudi Arabia gagement on technical assistance, advice, and outreach has cen- 8% tered on collaboration with standard-setting institutions like the Accounting and Auditing Organization for Islamic Finan- United Arab Emirates cial Institutions (AAIOFI) and the Islamic Financial Services 16% Malaysia Board (IFSB), as well as work at the country level. The World 63% Bank Group has also tapped Islamic financial markets. The Source: Islamic Finance Information Services Database, October 2011. Multilateral Investment Guarantee Agency completed a trans- action in Indonesia in FY11, using a murabaha instrument in- volving exposure of some US$450 million to improve the qual- contribute to financial stability. The countries of the Gulf Co- ity of the mobile network and increase population coverage. operation Council (GCC) hold almost 31 percent of global The International Bank for Reconstruction and Development market share in Sukuk, and several large transactions, like launched a five-year RM760 million Islamic bond in 2005, us- Dubai’s issuance of a US$3.5 billion Sukuk in 2006 and Qa- ing the well-tested format of bai bithaman ajil, which had previ- tar’s issuance of a US$9.1 billion Sukuk in 2011, are demon- ously been used successfully by the International Finance Cor- strating the large potential of Sukuk as a viable way to finance poration (IFC), also in the Malaysian market. Recently, IFC also large projects. Saudi Arabia is also considering expanding Su- issued Sukuk against a portfolio of leases, which was well re- kuk as a vehicle to fund its future infrastructure investments. ceived in the market. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 4. Growth of Islamic Banking and Conventional Banking At present, conventional debt often receives advantageous tax Assets in Selected Countries (2006–10) treatment (encouraging leverage), while some Islamic finance Islamic assets products face double taxation, especially investment income 50 annual growth rate) percent (compound total assets 43 generated from Sukuk. Malaysia and Thailand took fundamen- 40 33 32 tal steps to ensure that Islamic financial transactions operate on 30 27 24 21 a level playing field and are treated equally for tax purposes. In 20 19 19 17 15 9 10 13 Malaysia, this principle has extended to ensuring that profits, 10 5 asset transfers, and expatriation of profits by foreigners are 0 treated equally, whether occurring under conventional or Is- ia sia ey ia AE r ian Ar udi ta lamic financial contracts. In Thailand, a package of proposed ab ys rk ne Qa U ed ala Sa Tu do m M tax changes for Sukuk issuances has been introduced to address In Source: Deutsche Bank 2011, 10. the main hurdles faced by Sukuk issuers: (i) exempting the originator from income tax, value-added tax, special business Challenges and Prospects tax and stamp duty, and (ii) treating investment income from Several challenges need to be addressed in order to realize the Sukuk, or capital gains from selling Sukuk, the same as conven- full potential of Islamic finance, including: improving regula- tional counterparts for the purpose of computing annual in- tory oversight, rebalancing tax treatment, strengthening insol- come tax (Kuwait Finance House 2011, 11). vency frameworks, promoting standardization, ensuring ade- Lack of standardization and cohesion, especially in Sukuk quate liquidity, and establishing sound risk-management products, hinders the growth potential of Islamic finance and practices. Knowledge sharing can play an important role in un- deprives the market of an organized structure to facilitate sec- derpinning initiatives in all of these areas. ondary trading and liquidity. For example, the industry would Sound regulation is essential for a well-functioning finan- benefit from more widely accepted benchmarks and indices. cial sector. More effort is needed in order to ensure effective Innovation and knowledge sharing between various market regulation of Islamic financial institutions. Initiatives to im- players are essential to facilitate the standardization and unifi- prove the regulatory framework have varied from minimal al- cation of global markets for Islamic financial products. terations in the United Kingdom, to a dual approach in Bahrain A challenging area in generating adequate liquidity is the and Oman. Under the dual approach, conventional banks and divergence between fully guaranteed Sukuk by sponsors (for Islamic banks are chartered and supervised separately, giving Is- example, corporate bonds), partially guaranteed Sukuk, and lamic banks greater autonomy and banning conventional banks those that are not covered by any guarantee. Infrastructure from offering Shariah-compliant services. Issues of compliance companies that are looking to raise funds to finance projects are and standardization in Islamic finance are being remedied more likely to adopt Sukuk structures with full guarantees. In through internationally recognized standard-setting bodies for the case of stand-alone infrastructure projects, asset-backed Su- Islamic accounting and auditing (AAIOFI) and supervision kuk with no guarantees from the sponsors may be more attrac- (IFSB). The mandate of these organizations is to promote com- tive. The challenge is that these structures are uncommon and mon risk-management, accounting, and governance standards. poorly understood. Although investors seem keen to invest in Addressing these factors is helping to lower entry barriers and Sukuk that will give creditors control of the underlying assets in facilitating product development and innovation, essentially by the event of a default, the market is underdeveloped, partly be- allowing conventional banks to use their existing networks to cause Sukuk transactions without guarantees tend to be length- provide Shariah-compliant financial services. ier, costlier, and more complex. This is an area that needs inno- The rapid expansion in the use of Shariah-compliant in- vative solutions based on sharing knowledge of what can work struments has increased the urgency to improve exit rules in on the ground. the event of Islamic financial institution insolvency. There is While the theoretical framework of Islamic finance and the also a need to establish reliable mechanisms for dealing with main principles provide an alternative paradigm and guidance Sukuk defaults, as well as transparent frameworks to address to practical solutions for funding requirements of economic ac- adverse outcomes, with special adaptations for risk sharing. Set- tivities, many aspects of the practice of Islamic finance suffer ting up these mechanisms requires the specification of parties’ from emulation and reengineering of conventional instru- rights under Shariah-compliant finance, especially in the case ments. This has resulted in inefficient replications of conven- of cross-border transactions. More work is needed to ensure tional instruments and higher transaction costs.5 convergence between best insolvency practices on the conven- Moreover, the challenges associated with Basel III compli- tional and Shariah-compliant sides. ance and concerns about liquidity risk management need to In many countries, leveling the playing field with respect be addressed. By relying on equity-based finance, Islamic to the tax treatment of financial instruments is an urgent need. banks incur a higher cost of capital, since by definition they 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise hold more equity than conventional banks. This places Islam- Concluding Remarks ic financial institutions at a disadvantage under Basel III’s new During this ongoing period of rapid growth in Islamic finance, core tier 1 capital requirements. The current standards of the market participants need to maintain the quality of their ser- IFSB and the Bank of International Settlements are in agree- vices and avoid letting actual practices drift away from core ment on Basel III’s guidelines on asset risk weighting, credit principles of Islamic finance. As detailed earlier in this note, risk mitigation, market risk, operational risk, and eligible capi- these emphasize avoidance of riba and gharar; adherence to the tal for Islamic financial institutions. Still, more work is needed principles of risk sharing; respect for property rights and con- to find a greater convergence on the rules governing risk tractual obligations; and pursuit of good governance. Taken to- weighting and the treatment of investment accounts in Islam- ic banks. gether, these will sustain the link between the financial sector Islamic financial services are overly concentrated in the and the real sector. banking business, yet nonbank financial instruments, such as A meaningful development of the practice of Islamic fi- mortgages and mutual insurance takaful, are growing rapidly, nance will require abandoning the mechanical emulation of especially in Southeast Asian markets (Ernst & Young 2011b, conventional instruments and packaging them as seemingly Is- 12). For example, gross takaful contributions expanded by 67 lamic financial instruments. Investments in human capital and percent in Indonesia in 2009. Key challenges to the future research and innovation are also necessary to facilitate the de- growth of the nonbank financial instruments are limited com- velopment of Islamic finance solutions and products to re- petition and lack of diversification. More work is also needed spond to economic needs and financing requirements. on consumer awareness and financial literacy. The Islamic By addressing the challenges noted above, Islamic finance mortgage industry is also underdeveloped. Strong growth can could increasingly meet the preferences of local cultures and be expected in the GCC going forward, spurred by the increas- boost financial inclusion and intermediation. Islamic finance ingly affluent younger generations (about 65 percent of the could also help mobilize financing for small and medium enter- population in the GCC is under the age of 30) and the advent prises, as well as long-term funding for infrastructure and other of the institution of freehold property. Recent estimates show development projects, which are critical for accelerating sus- that Saudi Arabia alone may see Islamic mortgage assets rise to tainable and inclusive growth.6 US$100 billion in the coming years. So far, Islamic finance has been driven predominantly by Despite the aforementioned challenges, the prospects for supply-side factors and considerations. However, as highlight- the expansion of Islamic finance are strong. Entrepreneurs in ed above, there are important factors from the demand side the business sector are demanding more Shariah-compliant that are likely to change the dynamics of the practice of Islam- products to finance their investments. Meanwhile, there are im- ic finance. One of the factors worthy of monitoring in the near portant factors that continue to contribute to the growth of Is- future is the growing demand for Islamic financial products lamic finance (Mohieldin 2012, 1): by entrepreneurs across sectors and with different sizes of op- 1. The commodity boom has generated surpluses in some erations. The second factor is a potential rise in demand by Muslim countries that need to be allocated through finan- sovereign and quasi sovereign entities in accessing Islamic cial intermediaries and sovereign wealth funds. capital markets. This would help advance some Islamic fi- 2. Through quality improvements and the development of nance products that were developed in theory, but had little new instruments, Islamic finance is increasingly consid- chance of being implemented in practice, such as mudarabah ered a practical alternative to conventional instruments for and musharakah. Moreover, with greater emphasis on risk savers and investors. sharing, Islamic finance could contribute meaningfully to fi- 3. Conventional multinational financial institutions are of- nancial stability. fering Islamic windows and have increased their Islamic About the Author finance operations and portfolios to meet growing demand in London, Luxembourg, and other capitals. Mahmoud Mohieldin is Managing Director, at the World Bank, 4. The formation of Shariah-compliant indices for compa- Washington, DC. The views expressed are personal and should nies listed in stock markets is boosting the demand for Is- not be attributed to the World Bank. lamic finance. Notes 5. Recent political developments in several majority Muslim countries point to a growing role for Islamic financial in- 1. El-Gamal (2009, 58–60) provides a definition of gharar, struments. distinguishing between major and minor forms, and quotes 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Mustapha Al-Zarka’s definition of gharar as “the sale of proba- Kabir, H., and M. Mahlkrecht, eds. 2011. Islamic Capital Markets: ble items whose existence or characteristics are not certain, the Products and Strategies. West Sussex, UK: John Wiley & Sons. Kuwait Finance House. 2011. “Global Sukuk Report 3Q 2011.� risky nature of which makes the transaction akin to gambling.� October 21. 2. Tripp (2006, 57) cites Abd El-Qader Awdah, “Islam [is] a Mawdudi, S. 2011. First Principles of Islamic Economics. Leicester- religion which concern[s] itself in some detail with the ques- shire, UK: The Islamic Foundation. tion of property and mentions that it ‘had been the subject of Mohieldin, M. 1995. “On Formal and Informal Islamic Finance certain defining in junctions from the outset of the Islamic rev- in Egypt.� Paper presented at Middle East Studies Association elation.’� meeting, Washington, DC, December 6–10, 1995. ———. 2012. “Islamic Finance Unbound.� Project Syndicate, January, 3. Mawdudi (2011, 34–42) refers to the distinction between http://www.project-syndicate.org/commentary/mohieldin2/ lawful and all prohibited means of livelihood with reference to English. the Quran; see also Ayub (2007, 64). Mohieldin, M., Z. Iqbal, A. Rostom, and X. Fu. 2011. “The Role of 4. For a brief discussion of the evolution of Islamic financial in- Islamic Finance in Enhancing Financial Inclusion in Organiza- stitutions, see Mohieldin (1995). tion of Islamic Cooperation (OIC) Countries.� WP5920, World Bank Policy Research Working Paper Series, Washington, DC. 5. El-Gamal (2009) highlights several examples of such “reengi- Rogoff, K. 2011. “Global Imbalances without Tears.� Project Syn- neered financial instruments� and suggests an alternative path dicate, March, http://www.project-syndicate.org/commentary/ for developing Islamic financial instruments. rogoff78/English. 6. For a discussion of Islamic finance and financial inclusion, Tripp, C. 2006. Islam and the Moral Economy: The Challenge of Capi- see Mohieldin and others (2011). talism. Cambridge, New York: Cambridge University Press. References Annex I: Glossary of Key Terms for Islamic Financial Instruments Ayub, M. 2007. Understanding Islamic Finance. West Sussex, UK: John Wiley & Sons. Based on standardized Islamic Financial Definitions by Beck, T., D. Demirgüç-Kunt, and O. Merrouche, 2012. “Islamic vs. the Accounting and Auditing Organization for Islamic Financial Conventional Banking: Business Model, Efficiency and Stabil- Institutions and Islamic Financial Services Board ity.� WP5446, World Bank Policy Research Working Paper Bai bithaman ajil is a sale of goods on a deferred payment Series, Washington, DC. basis at a price that includes a profit margin agreed to by both Chapra, U. 2008. “The Global Financial Crisis: Can Islamic Finance Help Minimize the Severity and Frequency of Such a Crisis in parties. the Future?� Paper for the Forum on the Global Financial Cri- Mudarabah is a partnership in profit between capital and sis, held at the Islamic Development Bank, Jeddah, October 25. work. It may be conducted between investment account holders Dar, Humayon A., and R. Presley. 2000. “Lack of Profit and Loss as providers of funds and the Islamic bank. The Islamic bank Sharing in Islamic Banking: Management and Control Imbal- announces its willingness to accept the funds of investment ac- ances.� International Journal of Islamic Finance 2(2): 3–18. Deutsche Bank. 2011. Global Islamic Banking Report. November. count holders, the sharing of profits being as agreed between the London, UK. two parties, and the losses being borne by the provider of funds, El-Gamal, M. 2009. Islamic Finance: Law, Economics and Practice. except if they were due to misconduct, negligence, or violation Cambridge, UK: Cambridge University Press. of the conditions agreed upon by the Islamic bank. El-Ghazali, A. 1986. “Lecture Notes on National Accounting.� Murabahah is a sale of goods with an agreed upon profit Mimeo [in Arabic], Faculty of Economics and Political Science, mark up. There are two types of murabahah sales: an example of Cairo University. El-Ghazali, M. 2002. Islam and Economic Conditions [in Arabic]. the first type is when an Islamic bank purchases goods and makes Cairo, Egypt: Nahdet Masr Publishing Co. them available for sale without any prior promise from a custom- Ernst & Young. 2011a. Islamic Funds & Investments Report 2011: er to purchase them. An example of the second type is when an Achieving Growth in Challenging Times. June, Islamic bank purchases the goods ordered by a customer from a http://www.ey.com/Publication/vwLUAssets/IFIR_2011/$FILE/ third party and then sells these goods to the same customer. In IFIR_2011.pdf. the latter case, the Islamic bank purchases the goods only after a ———. 2011b. The World Takaful Report 2011: Transforming Operating Performance. April, http://www.ey.com/Publication/ customer has made a promise to purchase them from the bank. vwLUAssets/World_Takaful_report_April_2011/$FILE/ Musharakah is a form of partnership between the Islamic WTR2011EYFINAL.pdf. bank and its clients whereby each party contributes to the capi- Hassan, M., and J. Dridi. 2010. “The Effects of Global Crises tal of the partnership in equal or varying degrees to establish a on Islamic and Conventional Banks: A Comparative Study.� new project or share in an existing one, and whereby each of the WP10201, International Monetary Fund Working Paper Series. Iqbal, Z., and A. Mirakhor. 2011. An Introduction to Islamic Finance: parties becomes an owner of the capital on a permanent or de- Theory and Practice, 2nd ed. Singapore: John Wiley and Sons clining basis and shall have his due share of profits. However, (Asia). losses are shared in proportion to the contributed capital. 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Sukuk are certificates of equal value representing undi- losses arising from identified risks. Under this arrangement, vided shares in ownership of tangible assets, usufruct and ser- participants contribute a sum of money as a commitment into vices, or (in the ownership of) the assets of particular projects. a common fund that will be used mutually to assist the mem- Takaful is an arrangement for joint guarantee, whereby a bers against a specified type of loss or damage. group of participants agrees to support one another jointly for The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 7 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise