Overview
According to the report of Kronfol (2014), the Islamic finance industry will continue to grow at almost 20% annually with the growth of investors interested in Shariah-compliant securities and products. Islamic banking is established to meet the growing banking needs and demands of Muslims for a Quran-based and religious-based banking products or services. In fact, Western investors are also starting to understand the value of Islamic banking and more are willing to try the advantages that these products or services can provide.
Obaidullah (2005) noted that the "raison d'etre of a financial system is to transfer funds from savings-surplus units to savings-deficit units in the economy (p.3)." In a sense, it allows the bridging of the available funds savers and investors. The Islamic financial system still follows this system but with distinct characteristics. Mainly, Islamic finance has no concept of time value of money. In a sense, the value of money today is the same as its value in three months (Malkawi, 2011). This feature devalues interest out of the financial system. Secondly, the Quran directly prohibits the collection of interest or riba to avoid the exploitation of others or the Western type of usury. In this regard, interests are considered unlawful, thus should not be exacted from the people. Thirdly, risk taking is also eliminated out of the Islamic financial system. Fourth, exchange of money should only happen when the product being sold or bought is physically present. And lastly, Islamic finance demands that risks should be shared as well as profit. This characteristic of Islamic finance changes the way investments are made following Shariah compliant products.
There are five general Islamic compliant financial products: murabaha, ijara, sukuk, musharaka, and mudaraba. Murabaha is a cost plus margin contract wherein the bank purchases product for a client and then charges an additional agreed upon fee for the said transaction. Ijara is a type of debt-financing financial instrument that is used to lease equipment or real estate to business organizations. The third is sukuk, which is an asset-backed final debt product. This is commonly used in business transactions because it provides a capitalization option for businesses. Musharaka, on the other hand, is an equity based product that allows contribution of money to parties and the venture for investment. Lastly, the mudaraba is used to create a financial capital system that will allow rewards to be shared with all parties.
Features of Sukuk
One of the most popular Islamic finance products is sukuk. While 10 years ago, sukuk market was pegged at $9.6 billion, in 2013 it grew up to $269.4 billion with positive exponential growth in the next few years (Kronfol, 2014). Kronfol (2014) affirmed the investment-positivism that sukuk can give to both Islamic and non-Islamic investors who want to diversify their investments. With the massive returns of their fixed-income assets, sukuk also provides a volatile environment in this atmosphere of growing interest rate. In the same manner, sukuk can also provide investors opportunities to take part in the growing economy of the GCC. While these markets are not well represented in traditional banking system, sukuk provides better ways to invest in the GCC.
Sukuk is a form of bond, though in Islamic terms, that allows bundle leasing of transactions, but still follows the highly-rated bond system. According to Hassan (2006), sukuk is a new source of funds for businesses that are looking for financial capital. With funds that are sitting in most Islamic banks, sukuk provides a way to make use of these funds and generate revenue from these while strictly following the Islamic convention on finance.
By definition, sukuk is a debt financial Islamic product that is asset-backed, stable-income, tradable, and Shariah compliant (Hassan, 2006). Mainly, this Islamic financing product is Shariah compliant. This means that the product does not bear interest or does not come across the value of gambling which is directly prohibited in Quran. In the same manner, sukuk also shares risks and profits with the financial institution and not just the depositor of the bank. It is important to note that in Islamic finance perspective, one cannot just invest on products and ventures without making sure that they are properly examined for Shariah compliance.
Foremost, sukuk is an asset-backed debt financing instrument. This means that before financial institutions can provide loans or invest funds that are in their vault, these funds should be backed up by assets (Wilson, n.d.). Wilson (n.d.) wrote that when sukuk are traded "investors are buying and selling the rights to an underlying real asset, usually a piece of real estate or a movable asset such as equipment or vehicles." For instance, the first country to issue sukuk as a debt financing equity was Malaysia. When Malaysia issued sukuk, it was backed up with state-owned land. In this process, those who buy sukuk instruments are indirect owners of the assets backing up the instrument.
Second, sukuk provides a stable income to the sukuk holders. Instead of having a specific interest rated added to the amount being the value of the instrument, sukuk provides holders a specific amount of money added to the value of the asset being indirectly owned. It should be noted that the income definition of sukuk depends on the type of sukuk being made. For instance, the ijara sukuk is linked to the LIBOR of the country which varies from time to time. In this sense, the stability of income is present, but the amount of income is not provided for. But still this is within the Shariah financial fatwas because it shares risks with the financial institution and it eliminates fixed value of interest rates.
Hassan (2006) noted that sukuk investors have the right to know about their investments. Because they are indirect owners of the property or asset backing sukuk instrument, they also have the inherent right to know its process and growth. This is very different from the conventional banking system wherein the investor only knows about the interest generated by the investment. In Islamic finance, investors must have the right to know about their investments because the bank or the financial institution does not own the investment, but rather acts as the manager of the assets or the investment made.
The good thing about sukuk, according to Hassan (2006), is its allowance for projects to be invested on. In Qatar, sukuk issuance was made to fund a hospital. This is also true with Malaysia’s issuance of sukuk. Because of the fact that these projects will have an asset after investment, this is plausible in sukuk and it allows the government to provide funding for development projects that may take long to make money or profit. In fact, several countries have used sukuk to raise capitalization for projects that have long lasting impact to the infrastructure development of their country. Other investments were on telecommunication, power and energy transmission, agriculture, medical research, and others.
There are several types of sukuks issued at the moment. According to Kronfol (2014), out of these handful sukuks, there are three that are most popular in terms of issuance volume. First, sukuk al ijara is a sale and leaseback instrument that utilizes revenues of the underlying asset backing the sukuk to pay investors. Second, sukuk al musharaka is profit-sharing partnership with agreed-upon rate. If there are losses, it will also be shared by all partners of the contract. Lastly, sukuk al murabaha is a contractual agreement between the financial and the customer. In this system, the financier buys a property or asset then sells to a customer for a mark-up.
Concerns of Sukuk
While sukuk remains as the most popular Islamic financial product with staggering growth over the years, sukuk has been expanded into several products (the three most popular ones are discussed earlier). This results to questions on Shariah-compliance of this Islamic product. Sukuk is not a conception of the shariah scholars working as a board, but it has been approved by shariah boards. Mainly, the concern is about over pricing. While sukuk al mudaraba is a profit and loss sharing product, ijara sukuk is a form of rent which is dependent on LIBOR and SAIBOR, which could be deemed as a proxy of the interest rate system. As explained earlier, interest is eliminated in Islamic finance, but LIBOT and SAIBOR can be considered as interest rates that can be applied on the product.
Another concern springs from the definition. Sukuk must be an asset-backed up instrument, but financial institutions may keep part of sukuk funds that put into an asset for back up or support. The logic behind this reaction is that when asset value may fluctuate, it would be hard for financial institution to meet demands of their clients. To avoid this, instead of having a full 100% sukuk back-up instrument, a portion is kept back. In a sense, financial institutions are reducing exposure to the market as the original logic of the investor who does not want market exposure to avoid high risks and just invest in sukuk, wherein financial institutions still invest on real estate.
References
Hassan, A. (2006). Islamic Features of a Sukuk. MIR Takaful Investment.
Kronfol, M. (2014). Sharia-compliant sukuk make good investment sense. Retrieved from http://www.iol.co.za/business/opinion/sharia-compliant-sukuk-make-good-investment-sense.1758159#.VC8vzhZwI4Q
Malkawi, B. (2011). “Financial Derivatives in the West and in Islamic Finance.” The Banking Law Journal.
Volume 128, Issue 1, 2011, pp. 50-71.
Obaidullah, M. (2005). Islamic Financial Services. _________________________________.
Wilson, R. (n.d.). Islamic Capital Markets: The Role of Sukuk. Q Finance.
