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Acknowledgements
Acknowledgements
First of all, I would like to thank Almighty Allah for everything in my life, Without his guidance I would never be able to accomplish anything in my whole life.
I would like also to thank my mother who has supported me with her prayers, as well as her best dedication. I cannot forget my sister and my brother who had been always beside me.
I am further grateful to thank all my family members, as well as my friends for their support, without you it would be very difficult to overcome all the challenges. I cannot say thanks enough to my beloved fiance, Sarah El-sadany, who has inspired me with her hope, love and support.
Finally, I would like to offer my gratitude to my supervisors Dr. Jger and Dr. Engels for their support and guidance through this thesis.
Students Declaration
Students Declaration
I hereby declare that this thesis is my own original work and that no other than the listed references have been used as sources of information.
I further declare that no part of this thesis has been previously submitted to this or any other institution.
Signature
Abstract
Abstract
The Islamic banking sector has grown rapidly with double digit rates in the past decades. It is further considered the fastest growing segment in the global financial system. Hence, several countries were attracted by the business around the globe. In particular, several western countries who started to realize the potential of its Muslim minorities, and started to open doors for Islamic banks. In consequence, Islamic banks started to spread in several western countries. On the contrary, other European countries with a large group of Muslims did not launch the business yet, such as Germany. The purpose of this thesis is to examine the German market and to investigate whether it is potential for Islamic banking or not. It will further highlight the main opportunities for the future growth of the business, as well as the main challenges facing Islamic banks in the country.
Key words: Islamic banking, Islamic finance, Islamic banks, Market potential, German banks and regulatory framework.
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Table of Contents
Table of Contents
Acknowledgements ................................................................................................... II Abstract ................................................................................................................... IV List of Figures ......................................................................................................... VIII List of Abbreviations ................................................................................................. IX Glossary ................................................................................................................... XI 1. Research Overview ............................................................................................. 1 1.1. 1.2. 1.3. 1.4. 2. Introduction ........................................................................................................ 1 Purpose ............................................................................................................... 3 Research Design & Methodology ....................................................................... 3 Thesis Structure .................................................................................................. 4
Islamic Banking: Introduction and Overview ....................................................... 6 2.1. 2.2. 2.3. History & milestones .......................................................................................... 6 Evolution of Islamic banking ............................................................................... 8 Shariah & Fiqh..................................................................................................... 9 The sources of Shariah.............................................................................. 10
The Prohibition of Riba ..................................................................................... 13 The Prohibition of Gharar and Maysir .............................................................. 14 Halal and Haram concept ................................................................................. 15 Zakat ................................................................................................................. 16
Islamic Modes of Finance.................................................................................. 17 3.1. Profit -and -Loss Sharing Instruments .............................................................. 17 Mudaraba ................................................................................................. 18 Musharaka ................................................................................................ 19
Deferred Sales Contracts .................................................................................. 21 Murabaha ................................................................................................. 21 Forward Sales: Salam and Istisnaa ........................................................... 22
Ijarah - Leasing .................................................................................................. 25 Qard Hasan ....................................................................................................... 27 Retail Banking: Funding Accounts .................................................................... 27 Current Accounts ...................................................................................... 28
3.5.1. V|Page
Table of Contents
3.5.2. 3.6. Saving & Investment Accounts ................................................................. 28
3.6.1. 3.7. 4.
Takaful .............................................................................................................. 32
Corporate Governance In Islamic Banks ............................................................ 36 4.1. The Shariah Supervisory Board (SSB) ............................................................... 37 Functions and Responsibilities.................................................................. 37 The Issue of Fatwa .................................................................................... 38 Characteristics of The Board Members .................................................... 39 Shariah Supervisory Boards & Western Regulators ................................. 41
International Islamic Financial Infrastructure................................................... 42 AAOIFI ....................................................................................................... 42 IFSB ........................................................................................................... 42 IDB............................................................................................................. 43 LMC ........................................................................................................... 43
Islamic Banking & the German Market .............................................................. 44 5.1. 5.2. Muslims in Germany ......................................................................................... 44 Financial Behavior of the Muslim population in Germany ............................... 48 Current Trends .......................................................................................... 48 Market potential for Shariah-compliant products in Germany................ 50
Regulatory Framework of The Financial Entities in Germany .......................... 54 Banking Supervision in Germany .............................................................. 54 Licensing of theIslamic Financial Entities in Germany .............................. 55
Feasible key players in the German market ..................................................... 59 Deutsche Bank AG .................................................................................... 59 Commerzbank ........................................................................................... 60 Kuveyt Trk Participation Bank................................................................. 62
Conclusion ....................................................................................................... 63 6.1. 6.2. Opportunities for the Islamic Banking industry in Germany ............................ 63 Challenges Facing the Islamic Banking Industry in Germany ........................... 64
Table of Contents
APPENDIX 1.2 .................................................................................................................. ix APPENDIX 1.3 .................................................................................................................. xi Appendix2 ............................................................................................................... xii
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List of Figures
List of Figures
Figure 1 Thesis Structure .................................................................................................... 4 Figure 2 Trend in Global Islamic Banking Assets ................................................................ 8 Figure 3 Geographical Breakdown of Total Global Islamic Financial Assets ...................... 9 Figure 4 Mudaraba Model ................................................................................................ 19 Figure 5 Diminishing Musharaka Model ........................................................................... 20 Figure 6 Murabaha Model ................................................................................................ 22 Figure 7 Bai'salam Model.................................................................................................. 24 Figure 8 Istisna'a Model .................................................................................................... 25 Figure 9 Ijarah - Leasing Model......................................................................................... 26 Figure 10 Sukuk issuance .................................................................................................. 30 Figure 11 Structure of a generic ijarah sukuk .................................................................. 31 Figure 12 The global gross Takaful contributions ............................................................. 33 Figure 13 Takaful Mudarbah Model ................................................................................. 35 Figure 14 Muslims According to Region of Origin ............................................................ 46 Figure 15 Muslims according to denomination ................................................................ 46 Figure 16 Age Structure of Muslims According to countries of Origin ............................. 47 Figure 17:Bank preferences for Muslims in Germany with Turkish Background ............. 50 Figure 18 Attitude on Banks in Germany 51 Figure 19 Relevance of Shariah Compliance and Adherence of Islamic principles .......... 52 Figure 20 Importance of Islamic Investments by Religiousness ....................................... 53
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List of Abbreviations
List of Abbreviations A
AAOIFI Accounting and Auditing Organization for Islamic Financial Institutions. Arbitration and Reconciliation Centre for Islamic Financial Institutions.
ARCIFI
B
BaFin Bundesanstalt fr Finanzdienstleistungs-aufsicht (the Federal Financial Super-visory Authority). Buildoperatetransfer.
BOT
C
CIBAFI Council for Islamic Banks and Financial Institutions
G
GCC Gulf Cooperation Council.
I
ICD Islamic Corporation for the Development of the Private Sector. Islamic Corporation for the Insurance of Investment and Export Credit. Islamic Development Bank. Islamic financial instutions. Islamic Financial Services Board. International Islamic Financial Market. Islamic Research and Training Institute.
ICIEC
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List of Abbreviations
K
KFH KTP KWG Kuwait financial house. Kuvyet Trk participation bank. Kreditwesengesetz (the German Banking Act).
L
LIBOR LMC London interbank offered rate. Liquidity Management Centre.
P
PBUH PLS Peace be upon him. profit and loss-sharing.
R
ROE Return on equity
S
SDLT SPV SSB Stamp Duty Land Tax. special purpose vehicle. The Shariah Supervisory Board.
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Glossary
Glossary1
Allah Amana The Arabic word for God. is trust; the contract of amana gives rise to fiduciary relationships and duties. a comprehensive term that applies to the sale transactions, exchange. a deferred payment sale by installments a deferred-payment sale.
Bay (bai)
a pre-paid purchase. legal decisions or opinions rendered by a qualified religious leader (mufti). Islamic jurisprudence, the science of religious law, which is the interpretation of the Sacred Law, Shariah. Muslim jurisprudents who have religious authority. uncertainty, speculation. the technical term for the source related to the Sunna; the sayings - and doings of the Prophet (PBUH), his traditions. The pilgrimage to Mecca. means permitted according to the shariah. means forbidden according to the shariah.
Fiqh
Hajj Halal
Haram
11
The definantions are according to the glossary from Lewis & Algaoud ( 2001) and Ayub (2007).
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Glossary
Ijara contract Ijara wa iqtina a leasing contract. a lease-purchase contract, whereby the client has the option of purchasing the item. means consensus among jurists based on the Holy Quran and Sunna, and one of the four sources of law in Sunni Islam. means the act of independent reasoning by a qualified jurist in order to reach new legal rules. is submission or surrender to the will of God. a contract to manufacture. means gambling, from a pre-Islamic game of hazard. contract is a trustee financing contract, where one party, the financier, entrusts funds to the other party, the entrepreneur, for undertaking an activity. is a jurist who is authorised to issue a fatwa or legal decision on a religious matter. is resale with a stated profit, for example the bank purchases a certain asset and sells it to the client on the basis of a cost plus mark-up profit principle. is a contract for the lease of agricultural land with profit-sharing. contract is an equity participation contract, whereby two or more partners contribute with funds to carry out an investment. a benevolent loan (interest free).
Ijma
Ijtihad
Islam
Istisnaa Maysir
Mudaraba
Mufti
Murabaha
Musaqah
Musharaka
Qard hasan
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Glossary
Qiyas Quran
means analogical deduction. is the Holy Book, the revealed word of God, followed by all Muslims. refers to the owner of capital or financier in a mudaraba partnership agreement (also sahib al-mal). is literally excess or increase, and covers both interest and usury. is Islamic religious law derived from the Holy Quran and the sunna. Certificates of equal value representing undivided share in ownership of tangible assets of particular projects or specific investment activity, usufruct and services. refers to mutual support which is the basis of the concept of insurance or solidarity among Muslims. is a religious levy or almsgiving as required in the Holy Quran and is one of Islams five pillars.
Rabb al-mal
Riba
Shariah
Sukuk
Takaful
Zakat
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Research Overview
1. Research Overview
1.1. Introduction
The negative consequences of the global financial crisis have made both investors and experts rethink the current financial system. Speculation schemes, as well as sub-prime loans, drove the global economy to the so called black hole. Several banks have gone bankrupt and as a result, customers started to lose trust in the current financial system, particularly, in the banking sector (Ernst & Young, 2011). Despite the fact that governments began to pursue restrictive schemes against speculations and credit lending, the situation was beyond recovering. The Eurozone crisis has hit the financial system again, resulting with an ongoing financial crisis, and the reason was still the same. On the other side, the consequences were slightly lighter across the majority of the Muslim countries, especially the ones that are operating according to the Islamic financial system. The Islamic-financial system which based on the elimination of both interest rates (riba) and speculation (gharar & maysir), has been very stable against the global financial crisis. Following the crisis, some Investors started to search for other alternatives than conventional banks. As a result, many investors have switched to Islamic banks, as they could structure profitable products, with a lower risk. Furthermore, Investors started to orient their investments into ethical products, which could be found only in Islamic banks. In 2009, The Vatican announced officially in its newspaper, that banks should learn from the Islamic banking procedures in order to retrieve customers confidence. All the above reasons and more have elaborated to make Islamic banking and finance a hot topic among researchers and experts. Despite the fact that the principles of Islamic banking and finance were set in the 7th century (the Muslims golden age), the phenomenon began to evolve in the past 30years. In particular, in the 1970s , with the rise of the Islamic banks in the GCC area. The sector started to grow rapidly with double digit rates. According to the European central bank (2013, p. 19), Islamic banking has shown annual sustainable growing
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Research Overview
rate by 15-20percent over the past five years, the handled assets by the Islamic banks have reached $1.3 trillion at the end of 2012. Western banks were also attracted by this profitable business. Hence, several banks started to launch Islamic windows in many Arab countries, by offering Islamic financial products through its subsidiaries (mainly GCC region). Moreover, some western countries started to realize the potential of its Muslim minorities, and thus started to launch Islamic financial banks in their countries. The United Kingdom, with a potential market of more than 2 million Muslims, was one of the leaders in Islamic finance and banking business in Europe since 1980s. It was the first Western country to open the doors for Islamic banking with the first established Islamic bank in 1982 (Wilson, 2007, p. 420). Currently, the UK is the centre of Islamic finance in Europe, with $19 billion of reported assets and various banks delivering Shariah-compliant products (UKTI, 2013). Other European countries have also a large group of Muslims as the UK or maybe more; however, Islamic banking did not penetrate its markets yet, such as Germany. The success of the UK raised the question of whether Germany can be also a potential market for Islamic financial products or not. Despite its large Muslim population and its strong economy, no serious actions have been taken to launch the Islamic business till now. Several Islamic banks showed a real interest in launching a subsidiary in Germany, however, regulatory and legal issues are still the major constraints facing the implementation of this business. The Kuveyt Trk Participation Bank was the first bank to take a serious step in the Islamic banking business in Germany. The new Islamic bank has opened its first branch in Mannheim, in 2010, with a limited license issued by BaFin (the Federal Financial Super-visory Authority). However, the bank did not obtain the Full license yet, due to the different regulatory constraints. In this regard, many questions have been raised, such as is Germany really a potential market for this business? What are the opportunities & challenges? This paper will try to investigate about these questions.
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Research Overview
1.2. Purpose
The purpose of this thesis is to examine the German market and to investigate whether it is a potential market for Islamic banking or not. In this context, the paper will scrutinize the financial behavior of the German Muslim population. In addition, the anticipated key players in the domestic market will be outlined. The dissertation will further highlight the main opportunities for the future growth of the business, as well as the main challenges facing the business. In this regard, the regulatory restrictions as well as the other implications facing the business will be discussed. It is important to note that the paper will not discuss further any legal issues.
Dr. Johannes Engels is a Senior Advisor at The Federal Financial Supervisory Authority (BaFin) Germany. He has studied General Economics in Aachen and Cologne; he finished in at University of Cologne with Doctor Degree. He has been working for the Federal Financial Supervisory Authority for twenty two years, in the international dept. for eight years. Since October 2012 he has been the lecturer for Corporate Governance at University of Applied Sciences in Mainz. He has written several publications in the field of Islamic finance.
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Research Overview
Research Overview
Conclusion
This paper is divided into six chapters. This first chapter, is an introductory chapter, which outlines the research objective as well as the methodology and the chapters contents. The second chapter gives a brief overview of the history and the evolution of the Islamic banking, as well as the Islamic legal system (Shariah and Fiqh). In this regard, the main principles of the Islamic finance and banking will be discussed. The chapter is geared to provide the reader with the basic knowledge of the Islamic finance & banking principles for a better understanding of the following sections and chapters. The third chapter introduces the main financial instruments offered by Islamic banks. In this context, the structure of the several products and services will be explained with practical examples presented graphically for understanding their concepts better. Moreover, the chapter discusses other Islamic financial alternatives, such as the Islamic insurance (Takaful) and Islamic bonds (sukuk). Compliance structure and governance of Islamic banks will be discussed in chapter four. The first section will be about the Shariah supervisory board in the Islamic banks and its central role in assessing and monitoring the Islamic banking business. The second section will examine the International Islamic financial infrastructure. In this respect, the most important Islamic international organizations will be addressed. In order to investigate whether the German market has potential for Islamic banking or not, this matter will be analyzed in chapter five. This
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chapter
Research Overview
scrutinizes the Muslim populations in Germany and its financial attitudes and behaviors. In addition, the chapter will highlight the main key players in the domestic market. Finally, the major regulatory and taxation issues facing the implementations of this sector will be discussed. In the last chapter, the research conclusion will be outlined.
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announced the intention to transform their financial system to be governed by Shariah . Additionally, the establishment of the Islamic Research and Training Institute (IRTI) in 1981. Consequently, the IMF started to publish many research papers on the topic, as it became a rapidly grown business. During the 1990s, the Islamic banking business became a hot topic in the western academic world. Moreover, commercial events on the topic took place in several countries. Most
3
President of Egypt (1956-1970), a leader of the Egyptian free officers revolution of 1952.
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The Islamic banking industry has shown substantial growth in the past decade. As part of the Islamic finance industry, Islamic banking accounted for almost 80 percent of the Islamic financial assets with $1.3 trillion assets in 2012 (figure 2), and with 15-20 percent annual growth for the past 5 years (ECB, 2013, p. 19).
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Figure 3 Geographical Breakdown of Total Global Islamic Financial Assets (ECB, 2013, p. 19)
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including. It regulates the relationship between man and Allah (Fiqh Ibadah) concerning worship duties and activities (prayers, fasting, pilgrimage, etc.). On the other hand, it regulates the relationship among people in the society (Fiqh muamlat) (Millar, 2008, p. 5), such as manners and morals, crime and commercial transactions. In the latter case, in business transactions, Shariah acts as a
regulator between the seller and the buyer. In this context, business transactions can be divided into four classes: first, sales (bay), the transfer of a propertys ownership to another entity with a beneficial value. Second, hire (ijara), the transfer of the usufruct of certain property to another entity with a beneficial value. Third, gift (hiba), a gratis transfer of the property. Fourth, loan (ariyah), a gratis transfer of the usufruct (the right to use) of the property. Based on this, almost all financial transactions fall in the context of the latter cases, for instance, deposits, partnerships, guarantee, agency, etc. (Algaoud & Lewis, 2007, p. 38).
The Quran is believed to be a revelation from Allah to his last prophet Mohammed (PBUH) by the angel Gabriel in the city of Mecca. The Quran is considered to be a verbal miracle to prophet Mohammad (PBUH) and an evidence of his Prophecy. The literal meaning of the word Quran is reading or
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Sunnah is the second primary source of Shariah. It means a path, or an example, it refers to the way of prophets Mohammad life as it is practiced in the light of the Quran. Sunnah represents the prophets life on the basis of the sayings, comments and actions approved or done by him (Abdul-Rahman, 2010, p. 66). In fact, the Quran was written and preserved in the life of the prophet Mohammad. The Sunnah on the contrary, was recorded directly after his death by his companions. They started to record all the prophets sayings ( Ahadith, the plural of Hadith ) and doings . In addition, Sunnah is very important to understand the context of the Quranic verses, whereas the verses were revealed based on a certain situations during the life of the prophet (Kettell, 2010, pp. 89-91). 2.3.1.3. Ijma (Consensus)
Apart of the confirmed primary sources of Shariah , the Quran and the Sunnah, there are two secondary sources Ijma and Qiyas. The word Ijma derived from the Arabic verb ajmaa, which means to determine and to agree upon something. Thus, Ijma refers to a consensus on a certain opinion of the prophets early companions and the followed Muslims jurists on a various Islamic matters (Kettell, 2010, p. 92). Actually, Ijma applies just in cases where there is no explicit or clear solution for a certain problem from the Quran or the Sunnah. The process is only done by the Muslim jurists (fuquahaa ) and not by the individuals (Abdul-Rahman, 2010, p. 68). Indeed , Ijma can just occur after the death of the
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Qiyas is the second secondary source of Shariah. It means literally measuring, and can also refer to a comparison to asses equality or similarity between two things (Kettell, 2010, p. 94). In the Islamic context, qiyas is an analogical approach done by Jurists on an original case in order to extract the rules from it, and practice these rules on a new case. Usually, this new case does not have a clear conclusion from the Quran or the Sunnah, and there is no Ijma on it (AbdulRahman, 2010, p. 68). For instance, the use of wine is considered to be strictly condemned according to the Quran, similarly, the use of any other toxicants can fall under the same prohibition as well (Visser, 2009, p. 12). 2.3.1.5. Ijtihad
Ijtihad is considered to be an important source when developing new Shariahcompliant products. In fact, it took over an effective role in developing the Islamic Banking and finance industry. Ayub ( 2007, p. 489) defined Ijtihad as :
[a]n endeavor of a qualified jurist to derive or formulate a rule of law to determine the true ruling of the divine law in a matter on which the revelation is not explicit or certain, on the basis of Nass or evidence found in the Holy Quran and the Sunnah.
Indeed, there are strong debates about ijtihad, which is mostly concerned about who can perform ijtihad, as he should be a very qualified scholar (Millar, 2008, p. 5). Ayub ( 2007, p. 441) further argues that ijtihad is the main cause for the non standardized products across the IFIs, due to the different Shariah interpretation.
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There are other prohibitions governing the business activities side by side with riba, such as gharar (uncertainty) and maysir (gambling) (Visser 2009, p. 45). The latter type, maysir, is derived from the Arabic word usr (ease and convenience), which refers to mass wealth without effort (Algaoud and Lewis 2007, p. 39 ). The prohibition of maysir is to be found in the Holy Quran in many verses, for instance, O you who believe! Khamr, Maysir, Ansab, and Azlam are a filth of Shaytans handiwork. So avoid that in order that you may be successful(Holy Quran, 5:90). In this context, any form of gambling is forbidden in Islam, as it is based on hazards and speculation. Moreover, it is against the concept of fairness in Islamic law (Algaoud and Lewis 2007, p. 39 ). Therefore, Islamic banks are not allowed to engage in any gambling games, lotteries, disproportionate prizes as well as conventional insurance (Ayub, 2007, p. 76). The other type is gharar, which literally means risk or deception( Visser 2009, p. 45). This ban implies that both commercial parties should have a fair deal and to be aware of the real counter value of the business transaction. Professor Mustafa Al-zarqaa defined the forbidden gharar as the sale of probable items whose existence or characteristics are not certain, the risky nature of which makes transactions akin to gambling (Abl-rahman 2010, p.43).
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2.7. Zakat
According to the Islamic faith, Allah owns all wealth and property (Holy Quran, 31:26), private property is given by Allahs trustee to people in order to achieve integration and prosperity in the community (Abl-rahman 2010, p. 32). Justice and equality in the society are major concerns in Islam, everyone should have equal rights, irrespective of their positions, rich or poor (Algaoud & Lewis, 2007, p. 40). Accordingly, Islam designed a new system called Zakah which allows a fair transfer of wealth from the rich to the poor. Zakah literally means purityand cleanliness (Visser 2009, p. 27), it is considered to be one of the five pillars of Islam (Appendix 1.3), which guarantees a fair redistribution of wealth (Algaoud and Lewis 2007, p. 40). It is an obligation for every adult Muslim to pay a percentage of 2.5 per cent on any assets held for one year if it reached a specific agreed amount of money ( nisab in the Arabic language) (Algaoud and Lewis 2007, p.40). Islamic banks are obligated as well for paying zakah in addition to regular income taxes. In consequence, the proceeds from the bank and individuals are to be transferred to special zakah funds established by each bank (Samad, et al., 2005, p. 74).
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Outcome
Positive
3.1.2. Musharaka
Musharaka is a form of financial partnership, where two parties or more agree on launching a set of business, in order to generate profit. Unlike mudaraba, the parties contribute either with equity or labor together, in other words, it is a similar form of a joint venture where the parties have the same rights. Accordingly, they share both profit sand losses based on the equity contribution (Visser 2009, pp. 55-56). Another type of musharaka is Diminishing Musharaka which was developed recently. This mode of finance is used mainly in financing the various types of fixed assets. Under this scheme, both financier and client are participating in the ownership of certain asset with a predetermined equity percentage. The share of the financier is split into a number of units, and the client will purchase unit after unit periodically based on a former agreement. In this sequence, the share of the financier will decrease, whereas the share of the client will increase until he acquires all financiers shares (became the ultimate owner of the asset) (Usmani, 2002, p. 108). For further understanding of the mechanism, an example of diminishing musharaka model from Ayub ( 2007, p. 341) will be explained. Under the latter
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Islamic Bank
Customer
Even though it seems that interest-based and PLS systems are looking alike, there is a significant difference between their mechanisms. Under the latter system, there is no fixed yield, or maybe there is no yield based on the profit, whereas, under the former there is a fixed yield translated into a form of a predetermined interest rate. Moreover, PLS systems represent a physical share of profits and losses, which indicates a strong concern from the both sides in terms of project profitability. In contrast, the interest-based system is just concerned about the default of the loan, in other words, the periodical interest payment regardless of the profit or loss of the other party. For this and other reasons, Scholars asserted that PLS contracts aim to develop and sustain the financial market, as it
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3.2.1. Murabaha
Murabaha is derived from the Arabic word ribh, meaning profit. It is a commonly used instrument by the Islamic financial institutions. In Islamic banks, murabaha is a trade contract between the bank and the client, where the bank purchases a certain good from a third party and resell it to the client with a markup margin. murabaha contracts are commonly used for the financing of machinery, consumer durables, trade supplies and means of transport (Visser 2009, p.57-58). In fact, there are two types of murabaha. Under the first type, the bank purchases the assets/goods and makes them available for sale. Similarly, the second type, also called Murabaha to purchase order, the bank purchases the asset on behalf of the customer based on an agreed promise. The most important concept in this formula is that the bank commits to reveal the original cost of the purchased goods to the client. In addition, both parties must agree on the mark-up margin (figure 6) (Kettell 2010, p. 26-27). In fact, Banks commonly use the London interbank offered rate (LIBOR) as an indicator for the mark-up percentage (Visser 2009, p. 57).
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ownership transfer to the customer Payment of the purchase price + profit margin
Seller
Kmk;lk;
Islamic Bank
Customer
Kmk;lk;
In fact, It can be seen that the respective model operates similarly as the interestbased model, however, several reasons contradict this argument. First, the markup margin is for a service done by the bank (intermediary service), which stands for a certain effort. Second, in contrast with the interest based model, the mark-up is a pre-agreed ratio which not linked to a certain time factor. Therefore, it will not increase if the customer fails to pay in the case of deferred payment. Finally, all risks which might occur before the possession by the customer will be borne by the bank, as he is the owner of the goods (Mirakhor & Zaidi, 2007, p. 52).
According to Shariah, there are basic terms govern any sales contract and prevent any occurrence of gharar. First, The commodity must exist at the time of the sale. Second, the commodity must be owned by the seller at the time of the sale. Finally, after the execution of the contract, there must be a physical transfer of the commoditys ownership from the seller to the buyer as well as the associated risks. However, Some contracts do not fulfil all the latter criteria; nevertheless, they are still accepted by the Islamic Shariah (Ayub, 2007, p. 241). The following will discuss two examples of these contracts, which are Salam and Istisnaa contracts (Ayub, 2007, p. 241).
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Baisalam or salam (also known as forward sale contract) is a trade contract, whereby the seller agrees to deliver a certain commodity in the future with an immediate payment of the buyer. As a result , both parties can benefit from this transaction. The seller covers any liquidity shortage, whereas the buyer gets a cheaper price of the goods, as the price is always cheaper than the market price (Usmani, 2002, p. 126). In fact, Salam has been permitted by the holy Prophet (PBUH) himself under certain terms to prevent any excessive gharar. The main terms are:a specific measure and weigh; a known quality; agreed price with a specific delivery time (Ayub, 2007, p. 242). Baisalam can be used as a way to finance agricultural products and fungible manufactured goods, as well as for small traders as a form of working capital finance (Visser, 2009, p. 61). On the contrary, salam finance is not permitted in the case of gold, silver, and currency trading (Ayub, 2007, p. 244). In practice, the Islamic bank acts as the ultimate buyer (the financier) and the client as the seller. In this sequence, the Islamic bank can practice salam finance in two ways. Firstly, the banks can get a promise from a third party to purchase the commodity with a predetermined price. In this respect, the bank pays a full payment for the first seller, later on when the bank receives the commodity, he will deliver it to the third party with a higher price (figure 7). Alternatively, The bank can enter a parallel salam contract. Parallel salam is two independent contracts which are not linked to each other, whereby, the bank acts as a buyer in the first one and a seller in the other one. In this case, the bank delivers the received goods from the first contract to the buyer of the second contract with a higher price (Usmani, 2002, pp. 128-129). Indeed, guarantees are important in the case of Salam. Therefore, the bank may ask for a specific security or mortgage which can be delivered to the buyer in the case of default (Kettell 2010, p. 76).
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Seller
Kmk;lk;
Islamic Bank
Kmk;lk;
Customer
Kmk;lk;
Ayub (2007, p. 243) argues that Salam contracts are an effective way to stabilize the price in the market as well as protecting both buyer and seller from any speculative transaction. The argument is based on the fact that Shariah prohibits any reselling of Salam contracts before maturity; thus, there will not be any room for speculative actions. 3.2.2.2. Istisnaa
Istisnaa is a trade contract whereby the buyer requires the seller to manufacture a specific item for him. In this context, both parties agree on the price and the delivery date. In principle, the item will be manufactured from the sellers raw material and the payment method can be either lump amount or instalments. Istisnaa is similar to salam contract, as the product does not exist at the time of the contract. However, the payment can be deferred based on the contract agreement, unlike salam (Kettell 2010, p.66). Istisnaa contracts can be used for different modes of finance, for example, house finance, constructing buildings and plants as well as BOT arrangements (Usmani, 2002, p. 134). In theory, both Manufacture (seller) and the buyer can go together in a direct istisnaa contract. However, in practice, the Islamic bank takes over the mediator
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Manufacturer
Islamic Bank
Kmk;lk;
Customer
Figure 8 Istisna'a Model (iFIS, n.d.)
Kmk;lk;
Ijarah is one the major financial schemes in the Islamic financial system. The term is permitted by the majority of Islamic scholars as it was viewed in both the Quran and the Sunnah. Literally, ijarah is derived from the Arabic word al-Ajr which means compensation (Ayub, 2007, p. 279). Ijarah or leasing is a contract
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Seller
Kmk;lk ;
Islamic Bank
Kmk;lk;
Customer
Kmk;lk;
Both ijarah and Ijarah Wa- Iqtina are widely practiced by the Islamic banks; several assets can be leased under this mode of finance, for example, aircrafts
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Qard hasan is a financial instrument without any intention to generate profit, it means literally good loan, and also called a zero-return instrument. Normally, qard hasan is offered as financial assistance for solidarity intentions and social activities. For example, poverty projects and health care projects which mostly run through governments in the Muslim countries. In fact, qard hasans providers are seeking the reward in the hereafter; therefore, there is no intention to make profit out of their deposits. Normally, Full repayment of the loan at the face value is guaranteed by the government (Khan, 2007, p. 294). Islamic financial institutions can also provide qard hasan to individuals; this will be also for social activities and training programs for students who cannot afford studying expenses. For instance, the Islamic development bank offers several academic scholarship programs for students; the repayment of the loan would be in easy installments and after graduation and gainful employment (IDB, 2013).
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The Islamic current accounts are way similar to the conventional accounts. The main benefit from these accounts, is to build an effective relationship with the customer in order to gain his trust and to profit from his/her investments in the future. These types of accounts are held by the trustee of the bank without any interest charges at any level. However, the Islamic bank can charge an administration fee to cover its cost, as well as a penalty fee in case of overdraft. Furthermore, the deposits amount support and strength the banks balance sheet in order to meet the regulatory requirements (Millar, 2008, p. 32). The Islamic current accounts are justified by the Islamic Shariah based on the concept of al-wadiah (trust or safekeeping). Wadia can be defined as setting up an agency contract for the purpose of protecting ones wealth (Lewis & Algaoud, 2001, p. 47). In other words, the bank does not have the right to invest these accounts at any type of investment.
Both conventional and Islamic saving and investment accounts are equal in their nature, but are way different in their mechanism. Under the Islamic saving accounts, the bank guarantees a full repayment of the deposits nominal value with a small return (based on the applied method ). Whereas under the investment accounts, the full repayment of the deposits nominal value is not guaranteed, and the return is higher. The return on the both former types of deposits is not fixed; otherwise it would endure a sort of riba transaction such as in the conventional system. The Islamic saving accounts can operate under several methods. The first method is according to al-wadiah principle (please refer to 3.5.1.), under this scheme the bank invests the deposits in a Shariah complaint business with a pre-permission from the depositors. In return, the bank guarantees a full return of the value with a shared profit. The second method is to deal with the saving deposits as a qard
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3.6. Sukuk
The Islamic capital market has grown expeditiously after the 1990s; it started in the GCC region and spread across Europe and Asia. Several products have been introduced as an alternative to the conventional financial instruments; indeed, the new Islamic products had attracted the worldwide investors. The most famous type of these Islamic instruments is the Islamic bonds, or sukuk. The new sukuk market has been the fastest growing market after Islamic banking. Sukuk refers to certificates of equal value representing undivided share in ownership of tangible assets of particular projects or specific investment activity, usufruct and services (Ayub, 2007, p. 494). At the end of 2012, the value of the outstanding global sukuk recorded $229.4 billion. The latter number has increased due to the new issuances by $131.2 billion (figure10 a). The GCC countries, as well as Indonesia have been the major players in the growth of the sukuk primary market (figure10 b). In fact, it is expected that the demand for sukuk will grow by significant numbers in the next decades (ECB, 2013, pp. 20-22).
Sukuk were developed by Shariah scholars as a substitute for the conventional bonds. In essence, Shariah does not reject the idea of bond investment itself; however, the rejection is related to its mechanism, as it relies mainly on interest
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In contrast, the mechanism of the Islamic sukuk is based on the exchange of an approved asset (for example, the underlying assets could include buildings, hire cars, oil and gas pipelines and other infrastructure components) for a specified financial consideration (Mirakhor & Zaidi, 2007, p. 53). In this regard, Islamic sukuk are based on the several Islamic financial contracts such as mudaraba, murabaha, ijara, etc.. The following section will briefly explain the mechanism of the most famous and important type of sukuk, ijara sukuk .
For better understanding of the mechanism, an example from Mirakhor & Zaidi ( 2007, p. 54) will be illustrated. A corporation wants to raise funds with $50 million for the purchase of a piece of land. The corporation (originator) starts the process through the SPV by issuing sukuk with small denominations (e.g. $10000 each) totalling $50 million. In this respect, the corporation transfers the ownership of the land to the SPV, which will then securitize the asset by issuing certificates to the investors. Consequently, the investors became the real owners of the acquired asset. The funds generated from the sales proceeds will then be transferred to the SPV and further to the corporation. The asset now is leased back to the originator, in other words, the investors became the lessor, whereas the corporation became the lessee. Afterwards, The rent proceeds from the originator is divided between the investors through the SPV. Apart from GCC sukuk market, sukuk had penetrated the western capital markets as well. Germany was the first European country to introduce Ijarah sukuk to the
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3.7. Takaful
The need for insurance coverage by individuals and institutions arose over time. It became the only way to mitigate the several types of risks associated with their wealth and lives. Despite the fact that, the conventional type of insurance is rejected from the Shariah point of view, the IFIs had to find other alternatives in order to fulfil this needy gab. The new Islamic insurance (Takaful) system has been developed over several decades in accordance with Shariah principles. Currently, large number of financial institutions are providing the service with wide acceptance from customers in the Muslim communities (Ayub, 2007, p. 417).The following will briefly discuss the new scheme and its mechanism; furthermore, it will highlight the main differences between takaful and conventional insurance system. Takaful industry which started in Sudan in 1979 has evolved over decades to spread across the Arab and Muslim countries. The rapid growth and success in the Muslim countries made it an attractive investment for the western world as well. Several non Muslim countries started to launch takaful in their countries, such as Germany (Hannover-Re entered both Takaful & re-Takaful insurance in 2007 & 2010 respectively), Britain (the establishment of Salam insurance in 2008) and Switzerland (Swiss-Re in 2009) (E&Y, 2012). According to Halim (2012), The main takaful business is to be found in the GCC region and southeast Asia. Saudi Arabia considered to be the largest takaful market with approximately US$4.3 billion and 51.8 percent of the whole industry. Malaysia contributes with US$1.4 billion while UAE contributes with US$818
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The new insurance Scheme differs substantially from the conventional insurance in terms of concept and mechanism. Khan & Coopers (2008, p. 23) define conventional insurance as an agreement whereby an insurer undertakes (in return for the agreed premium) to pay a policyholder a sum of money (or its equivalent) on the occurrence of a specified event. Even though that Islamic Shariah does not reject the idea of risk mitigation, the rejection of the conventional insurance has been debated between Muslim scholars for other reasons (Hussain & Pasha, 2011). The rejection is based on the idea that conventional insurance involves all prohibited transactions; this includes riba, maysir and gharar ( please refer 2.3. & 2.4.) (Visser, 2009, pp. 102-104). With regard to the involvement of riba, it is directly involved as a result of any excess between the amount of paid premiums and the sum insured, moreover, it is involved indirectly as the insurer normally invest the money in an interest-based business. Concerning gharar and maysir,
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Wakala: the term means agency and refers to the absolute power of attorney where a representative is appointed to undertake trasactions on another persons behalf (Kettell, 2010, p. 232)
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Assist in the product manufacturing process in accordance with developing new products with the banking professionals to increase its
competitiveness. Assist in designing the product manuals which contain detailed procedures for the operation process. Review and monitor any agreements or contracts related to any conducted business inside or outside the bank to guarantee that they are complying with Shariah. Participate in the banks training programs. In this context, employees learn the main aspects of the Islamic finance principles and the Islamic ethics of business transactions (Fiqh Muamlat). In principle, if the SSB has any doubt regarding a specific product or transaction(s), which might not be fully bound by Shariah, the board will try to find other alternative in order to execute the transaction; otherwise it will not processed. In case of any deception from the financial institution, the board will take a serious action towards the underlying transaction. In this regard, any profit generated from the underlying transaction will be transferred to the charity account, in addition, financial penalty will take place for non-compliance as well as adverse publicity (Rammal, 2006). Equally important, at he end of the financial year, the SSB submits an annual report to the banks directors. The report should summarize the boards opinion over the banks business transactions as well as the financial products (AbdulRahman, 2010, p. 78).
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As one of the main components of the Islams banking structure, SSB members are chosen based on specific criteria. The AAOIFs Governance standard No. (1) pointed out that the board must contain at least three members, and should have a high expertise members in economics, and/or law, and/or accounting, etc.. Most importantly, the board must not include any influential person from the institution administration or the shareholders (Al-Qattan, 2008). The IFSB (2009, p. 5) has issued guidelines to strengthen the governance structure of the Islamic financial institutions. In particular, it includes a specific criteria concerning the selection of the SSB members in order to ensure a high level of expertise. The main criteria are summarized in the qualification (competence) and independence of the board members.
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Any SSB member who is responsible for issuing a fatwa is considered to be a mufti5. According to Al-Qattan (2008), such an important role as mutfi requires a high level of qualification on both educational and expertise levels. In particular, he must be a Muslim, adult, pious and knowledgeable person with high capability of Ijtihad (please refer to 2.3.1.5.). In addition, he must be an intelligent character, who can interact with different people and deal with cases of cheating and deceiving. Furthermore, he must be cooperative as he should consult with the other members . Equally important, he must be aware of the societal conditions in general and the country condition in particular, for a better understanding of the several fatwa conditions. The IFSB (2009, p. 13) pointed out that the Islamic financial institutions must provide the SSB members with special training programs mainly in the business and financial transactions. In consequence, the member will be aware of any case from the technical aspect as well as the religious aspect. These factors will contribute to a continuous professional development of the board members (AlQattan, 2008). 4.1.3.2. Independence
According to the AAOIFs Governance Standard No. 1, Shariaa Supervisory Board is an independent body of special jurists in fiqh almuamalat,and can issue fatwas and rulings which shall be binding on the Islamic financial institution (Nienhaus, 2007, p. 136). However, the board independence can be affected by its dual rule, as it acts as an auditor and an employee at the same time. In other words, the dual relationship might lead to a possible conflict of interest. The conflict can be represented in a way that the board will not take any strict opinion against a profitable transaction
5
A mufti is one who reports the rule of Allah on His behalf, or he is the one who is capable of knowing the Shariaa rulings for events with their evidence and who has memorized most fiqh issues.
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Generally, International Financial infrastructure is essential for an effective legal and regulatory framework. Hence, it was mandatory for Islamic banks to have a set of supporting institutions in order to facilitate monetary and financial policymaking at a national level. Furthermore, to coordinate and develop a set of guidelines and best practices to achieve the financial integration. In the following section, the main Islamic international organisations will be successively discussed.
4.2.1. AAOIFI
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic-nonprofit organization that aims to develop standards in accounting, auditing, governance, ethics and Shariah for the IFIs. AAOFI plays a major role in enhancing the industrys human resource by providing professional qualification programs. The organization was founded in 1990 and was officially registered in 1991 in the state of Bahrain. The present membership is 200 members from 45 countries including different participants from the Islamic finance industry regionally and worldwide (AAOIFI, 2010).
4.2.2. IFSB
The Islamic Financial Service Board (IFSB) is an international Islamic organization started its operations in 2003, and based in Kuala Lumpur, Malaysia. The main objective is to promote the Islamic financial system stability through issuing guiding standards to the different sectors of the financial system including banking, capital markets and insurance sectors. The process is mainly conducted through researches in addition to organizing seminars and conferences with the main market players. Moreover, IFSB participates in developing instruments for efficient operational and risk management. IFSBs members are gradually
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The Islamic Development Bank (IDB) is an international financial institution and part of the IDB group, it was founded in 1973 and started officially in 1975. The bank plays an important role in the economical and social development of its member countries and the Muslim communities, according to Shariah principles. In this regard, the bank provides financial assistance in the form of loans and equity capital participation for the productive projects in the repective countries. The present membership is 56 countries, the Banks head office is in Jeddah in the Kingdom of Saudi Arabia, furthermore, the bank has four regional offices (IDB, 2013). IDB group involves 4 main organizations: The Islamic Development Bank IDB, the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), the Islamic Corporation for the Development of the Private Sector (ICD) and the Islamic Research and Training Institute (IRTI) (Iqbal, 2007, p. 361).
4.2.4. LMC
The Liquidity Management Center B.S.C was established in the Kingdom of Bahrain in 2002 (Kettell, 2010, p. 181). The main purpose is to provide liquidity assistance to the Islamic financial institutions. In other words, LMC plays an effective key role in the interbank market by facilitating the surplus funds of the Islamic financial institutions into short and medium term financial instruments. Furthermore, it provides Islamic advisory services as well as sourcing assets from both private and public sectors and transform them to innovative investment instruments (LMC, 2009).
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As Christianity (mainly Protestant and Roman catholic confessions) is the major religion in Germany, Islam represents the second major religion, and the largest minority in the country. In fact, the first Muslims incomers were in the 18th century as a result of military and economic agreement between Germany and the Ottoman empire (Yorulmaz, n.d.). Two centuries after, particularly from 1960s1990s, immigrant waves of guest workers started to enter Germany from several Muslim countries. The immigrants from Turkey, Morocco, Tunisia and Yugoslavia, were expected to stay for a limited time, but they could settle down their conditions to stay in Germany and not to go back to their countries. In fact, there was and still a lack of research concerning the Muslim population in Germany. After 11 September 2001, the German government started to take critical steps in order to analyse the structure of its Muslim population. The
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With regard to the religious affiliation (figure 15), the majority of Muslims from all origins tend to follow the Sunni faith with approximately 74 percent from all origins, except Iranians who are from the Shiite faith. In addition, there are nearly 13 percent following the Alevi faith and 7 per cent following the Shiite faith. The minority of the Muslims group in Germany are following other faiths like Ahmadi, Sulfis/Mystics, Ibadis and other Muslim faiths.
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16 to 24 years old
25 to 64 years old
Indeed, it is essential to analyze the different group religiousness. Based on the study, it can be concluded that religion takes over an important role in the life of the Muslim in Germany. However, it cannot apply equally across the respective groups, for instance, a substantial percentage from origins like Iran and central Asia/CIS identify themselves as not particularly devoted or not devoted at all to religion. Nevertheless, the percentage of people who are devoted to religion is relatively high, 36 percent regard themselves as very strongly religious, whereas 50 percent are quite religious. With reference to the religious activities, one third of the Muslims tend to pray, almost 50% are observing fasting rules and 70 percent are celebrating religious festivals and holidays.
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Muslims in Germany as the largest Muslim population in Europe has attracted many researchers to analyze their financial attitudes and behaviour. However, the majority of the researchers had just focused on Muslims of Turkish origin, as they stand for the largest group of the Muslim community (please refer to section 5.1.). Nevertheless, the rest groups which stands for approximately 37 percent of the Muslim population will be neglected. The following section will analyse the financial behaviour of the Muslim population in Germany who are mainly from Turkish origins.
Figures and numbers about Muslims with Turkish background indicate a potential target group. According to Chahboune & el-Mogaddedi (2008), Muslims of Turkish origin in Germany accounts for 720,000 households with an average of 3,8 persons. Whereas, the average in the German households is 1.8 persons. In this context, the Turkish average net household income is estimated by 1917, while the average for the German household net income is 2596. Furthermore, Turks tend to save as double as Germans with 18 percent saving rate in comparison with 10 percent for Germans. The saving capacity of the Turks accounts for 2.2 billion with 25 billion as an estimated total Muslim wealth (Nienhaus, 2012). Evers & Jung (Hayen, et al., 2005) conducted a study over the Turkish community in Germany, in order to investigate their financial behaviours and demands. In this regard, the research classified the Turkish community into 4 main generations and highlighted the preference of each generation. The first generation who came to Germany between 1960-1973 as guest workers, the rest generations are their children and grandchildren. In fact, the first two generations are likely to preserve their culture and traditional mentality, on the contrary, the third and the fourth absorbed more the German culture equal to their own culture or maybe more.
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20% 76% 4%
Spakasse/Volksbank Home nation bank Third nation bank Host nation bank Dresdner Bank Postbank BMW Bank DAB Bank
Figure 17:Bank preferences for Muslims in Germany with Turkish Background (according to Gleisner, et al., 2010)
Despite the fact that, there is neither a full operated Islamic bank in Germany nor typical Islamic retail banking products or services, the different sectors across Germany have designed special products to attract the country Muslim community (mainly Turks). Different stages have been taken; different marketing campaigns took place across Germany held by Turkish representatives offering materials in the Turkish language. With regard to the telecommunication industry, one of the big companies, E Plus has launched a special mobile service between Turkey and Germany. In the financial service industry, Deutsche bank has offered special branches called Bankamiz. The main purpose is to consult Turkish customers in their language as well as offering free money transfer service to Turkey. Other banks such as HypoVereinsbank (HVB) has served customers in Turkey with the cooperation of the YapiKredi bank. Furthermore, Allianz and
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44.2%
17.2%
0%
20% 1
40% 2
60% 4 5
80% 6
100%
`
Figure 18 Attitude on banks in Germany (according to Farhoush & Schmidt 2011 (p. 251))
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54.4%
17.4%
53.6%
17.2%
20% 1
40% 2 3
60% 4 5 6
80%
100%
Figure 19 Relevance of Shariah Compliance and Adherence of Islamic principles (according to Farhoush & Schmidt 2011 (p. 255))
The study further investigated the anticipated demand, in case of a future existence of Shariah-compliant products in Germany. The analysis showed a potential demand for the several types of investments. For instance, demand for saving accounts will increase from 46 percent to 75 percent, in case of following Shariah principles. Strong effect will hit the Stock investments from 25 percent to 50 percent. Likewise, investments in mutual funds will increase from 25 percent to 52 percent, as well as for other investments. In short, the finding of this study suggests that there is a potential demand for Shariah-compliant products in Germany and that the Muslim community is an attractive target group. On the contrary, The conducted survey results by Evers & Jung (Hayen, et al., 2005) rejected the above assumption. Despite the fact that approximately twothirds of the participants defined themselves as very religious or quite religious, the majority of them saw that it is not important to hold Islamic investments (figure 20). In addition, less than 1 percent of the participants reported that they currently hold an Islamic investment. Similarly, less than 1 percent plan to invest in such a service in the future. In fact, the negative experience of the so-called Islamic holdings in the 1990s, can be the cause of the previous result. These holdings (e.g kombassan and Yimpas) attracted a quite big number of the Turkish community in Germany estimated between 200,000 to
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Not religious 1.0% 1.9% 1.0% Total 0% Very important 10.2% 10%
Rather important
Not important
No comment
On the other hand, Experts such as Zaid el-Mogaddedi (2007) stated that the experience of so-called Islamic holding in Germany must be taken into account when trying to give a correct answer to the question on the market potential for Islamic financial products in Germany. Mr. el-mogaddedi further argues that this experience has demonstrated the financial power of the Turkish community in Germany. Furthermore, it has indicated a strong willingness to invest in such an Islamic products, if structured and marketed correctly. Mr. Nienhaus (2012) also reported that all numbers and figures about Muslims in Germany indicates a potential market for Islamic Banking; however, the unsolved problems of legal, regulatory, taxation and accounting issues are the main problem (please refer to section 5.3.2 ). To sum up, all figures and numbers about the Muslim population in Germany as well as their financial attitudes and demands indicates a potential market for Islamic banking. There might be a doubt from some researches about the expected demand; however, the issue cannot be determined before structuring the right products which can be marketed efficiently.
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The strong integration of the financial markets with the gradual evolution of the financial products across the different sectors in Germany has eliminated the typical variances between banking, financial services and insurance business. For instance, insurance companies started to offer banking products; likewise, financial institutions started to develop new products in accordance with insurance companies. Equally important, the electronic business evaluation made the client cares more about the product regardless of its source, whether a bank or insurance company (Engels, 2010, p. 175). For these reasons, creating a single regulator that supervises the different financial businesses including banking, financial service institutions and insurance companies, was a mandatory action. The new entity, the Federal Financial Super-visory Authority (Bundesanstalt fr Finanzdienstleistungs-aufsicht BaFin) was established in 2002, in order to take over the roles of the three former supervisory agencies, the Federal Banking Supervisory Office (Bundesaufsichtsamt fr das Kreditwesen BAKred), the Federal Securities Supervisory Office (Bundesaufsichtsamt fr den Wertpapierhandel BAWe) and
(Bundesaufsichtsamt fr das Versicherungs-wesen BAV). BaFin aims to ensure market stability and to increase both investors and consumers trust in the financial system. Currently, 1.854 banks, 681 financial services institutions, 592 insurance companies, 30 pensions funds, 6069 domestic investment funds and nearly 78 asset management companies fall under the supervision of BaFin (BaFin, 2013). With regard to the banking supervision, both BaFin and the Bundesbank are collaborating together under the financial stability Act (Finanzstabilittsgesetz FinStabG). Since January2013, the Bundesbank has taken over the role of
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According to the German Banking Act (Kreditwesengesetz KWG), in particular section 39, the use of the term Bank is just for a credit institution holding a license in conformity with section 32. Section 1 further defines the main transactions which shall be conducted by the credit institution, nine types of banking transactions were listed as follows:
1- Deposit business, 2- Lending business, 3- Discount business, 4- Principal broking services, 5- Safe custody business, 6- Guarantee business, 7- Giro business, 8- Underwriting business, 9- E-money business.
Based on the latter criteria, some had argued that the Islamic banking business is not engaged in all of the above transactions. However, such an argument is relatively weak, as the law did not explicitly states whether the bank must fulfil all the above transaction, or must not perform any other type of transactions. Moreover, from commentaries and legal practices, performing at least one or some of the above transactions is enough for qualifying the entity as a bank (Engels, 2010, p. 181). The second major concern relies on the concept of investor protection. In fact, no legal definition was given to the term deposits, deposits were explained by the Banking Act section1 as the receipt of funds from others regardless of the actual repayment of interest. In this respect, the current accounts in the Islamic banks conform to this definition. However, the investment accounts which are
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conventional financial institutions such as the conventional banks, which cannot be applied to the Islamic Banks. Therefore, there should be a serious amendments in the whole accounting and reporting system, which indeed, hard step to be taken by the European authorities (Engels, 2010, pp. 180-181). When asking Dr. Engels about the solution of these problems, he mentioned that these challenges can be overcome in the future, but it needs time and efforts. Dr. Engels further mentioned that Islamic banks must offer some compromises in order to ease the process as in the case of the SSB.
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The German tax regulation is also a major challenge facing the Islamic banking business in Germany. In fact, Based on the current taxation system, any Shariah compliant product will be exposed to different types of taxes. In addition, the possibility for any cost efficiencies will be very hard in comparison with conventional banks (Klein, 2012). The following will focus on one of the main taxation problems, the double taxation treatment. The double taxation problem is mainly facing Islamic banks across the western countries, particularly, in mortgage finance under murabaha mode of finance. Taking the example of mortgage finance, in the conventional banking system, the bank takes over the role of external creditor, where the bank does not acquire the underlying asset at any stage until the final delivery to the customer. In consequence, the underlying process will be taxed just one time (stamp duty tax). On the contrary, Under murabaha finance, in the Islamic banking system, the bank takes over the role of the intermediary between the buyer and the seller. In this respect, two steps will take place. Firstly, the acquisition of the underlying asset from the seller by the bank, Secondly, reselling the asset to the customer (the buyer) with a profit mark-up. In consequence, the latter transaction will be taxed twice (stamp duty tax) at the two steps, which will impose higher costs on Islamic banks (Klein, 2012). Several western countries have tried to solve this problem, in order to attract Islamic banks. One concrete example is the United Kingdom. The UK has taken major steps in terms of tax regulations, in order to ensure that Islamic finance investors have similar tax treatment as conventional investors. For instance, in the case of double taxation issue under the murabaha finance, the legislator considered the latter finance scheme as alternative finance arrangement. In this regard, the bank will be subjected to the stamp duty land tax (SDLT) only once at the acquisition step, whereas, in the second step the mark-up will be regarded as deemed interest (Butt, 2012; PWC 2008).
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The Islamic banking business has attracted many German banks over the past decade. Several German banks started to launch the so called Islamic window across the Muslims countries (mainly GCC region). In fact, they have been very active and successful in this type of business. Thus, In case of Islamic banking implementation, these banks can be major players in the market. The following will highlight the main German banks which operate with an Islamic window across the Muslims countries.
Deutsche Bank AG is one of the leading banks in Germany and Europe, the bank was founded in 1870 with its headquarter now in Frankfurt. According to the Banks figures in 2012, the bank has achieved a net profit of approximately 291 million euros wit A+ rating by Fitch and Standard & Poors ( Deusche bank, 2013). Over a decade, the bank has been a major player in the Islamic finance
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5.4.2. Commerzbank
Commerzbank is one of the leading banks in Germany with approximately 1200 branches across the country. The bank has started to establish a regional footprint in the Islamic finance business since more than one decade. In 1999, Commerz international capital management (CICM), the owned subsidiary by the Commerzbank has launched a new equity fund under the rules of Shariah. AlSukoor European Equity Fund was launched with 100 percent focus on the European equities, in order to attract investors from the middle east. In fact, it was only for institutional investors from the middle east area, however, since 2000 it became accessed by private clients in Germany. Commerezbank searched a
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Lufthansa airlines as their business is engaged with serving alcoholic drinks (Geyer, 2002, p. 264). Unfortunately, in 2005, the fund had to be closed with just 4 million Euro assets. In fact, the failure of the fund was due to several reasons. Firstly, the fund was targeted to GCC region where real estate investment was the most attracting type and not equity investments. Secondly, it was not well targeted to the German investors. Finally, the negative consequences on the stock markets after the September 11th attacks, was a strong hit to the fund (Chahboune & ElMogaddedi, 2008). Commerzbank continued in the Islamic finance business across the GCC region. Indeed, the bank has been concerned about the sukuk markets, in 2011
Commerzbankbank undertook the role of the joint lead manager for the Kuveyt Trk Banks sukuk issuance. The $350 million 5year ijarah sukuk were issued to attract investors across the Middle East, Asia and Europe. Commerzbank presented the issue through its international network , Indeed, the issue was quite successful and was rated at BBB by Fitch rating (Commerzbank, 2012). Commerzbank can be also a critical player in this business in the future, especially in the sukuk sector. In case of launching Islamic banking in Germany, The bank experience in Islamic finance will be a major asset for him in the market.
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Islamic Banking & The German Market 5.4.3. Kuveyt Trk Participation Bank
The Kuvyet Trk participation bank, a Turkish-Kuwaiti bank, has taken critical steps in order to establish the first Islamic bank in Germany. The proactive bank applied for a full banking licence to establish an Islamic bank in Germany. However, The German banking regulator, the Federal Financial Services Authority (BaFin), has just issued a limited banking licence to the respective bank. In consequence, the bank opened its first branch in Mannheim in 2010 (Farhoush & Schmidt, 2011). The limited licence allowed the bank to collect deposits from investors in Germany to be transferred to a PLS accounts in Turkey (GIF magazine, 2013). The bank has been active across the sukuk markets, the first sukuk issuance was in 2010, KTB has issued a US$100 million three-year sukuk wakalah. The second big issuance was in 2011 as mentioned above, The US$350 five-year sukuk Ijarah were managed by different banks and corporations. According to Mr. Uyan, the chief executive of the bank, the bank is planning to open several branches in Germany, in case of full license issuance. Mr Uyan further stated We plan to open branches in Germany, and if this model becomes successful, we could consider going to other European countries. Furthermore, the bank is planning to invest an initial capital of 45 million. The bank is also planning to target the small-medium size enterprises (Sezer & Tuncay, 2012). The banks full license application is still under review with BaFin, however, no decision has been taken till now. Dr. Engels stated that the regulatory concerns regarding the deposit taking as well as the role of SSB are the major causes. However, it will be solved in the long run.
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Conclusion
6. Conclusion
There is no doubt that Islamic banking is a fast growing industry in the world. The overview presented in chapter 2 reflects a stable growth for the future of this business. This is supported by its new approach in doing the banking business, therefore, it has attracted both Muslim and non Muslim investors. The cause is that investors can earn high profits with lower risks, in comparison with conventional banking. Moreover, consumers now are tending to invest more in ethical products, which could be found in the Islamic banking principles as discussed in chapter 2 and 3. With regard to the German market, the Muslim population in Germany is the largest in Europe, and the second largest minority in the country. The different industries across the country have been trying to target the Muslim population, as they believe that it is a potential group. As discussed in chapter 5, religion takes over an important role in the life of the Muslims in Germany. Nearly two thirds of the Muslims have identified themselves as devoted to religion. As a result, this will be a positive trend for accepting Shariah-compliant products in the future. Below are the main opportunities as well as the main challenges for the Islamic banking business in Germany.
Conclusion
Muslims. With regard to the Financial industry, Deutsche bank as well as other banks has already offered private services to the Turkish Muslims (please refer to 5.2.2.). Results and finding from the conducted researches have shown a keen desire to follow Shariah rules from a higher percentage of the Muslim population. Several German banks have been running Islamic windows in the GCC region; hence, they had gained wide expertise in the Islamic finance and banking industry. Indeed, any Islamic bank who will be able to structure the right products for the market, will definitely acquire an appropriate market share (around 5%), away of the competitors. Launching the business will further tie the trade business between Germany and Turkey as well as the other Muslim countries, Moreover, it will provide funding alternatives for the investors.
Conclusion
Islamic banks will have a significant problem with the German respective European accounting, reporting, auditing and monitoring techniques. In fact, amending or changing the respective system will be very hard.
The double taxation treatment for mortgage finance has been one of the main challenges, however, the excellent idea of the silent partnership by Ernst & Young , has solved this issue.
To sum up, the paper has highlighted the main opportunities as well as the main challenges for this industry in Germany. It can be concluded that there is a huge potential for the business in the country, as illustrated in 5.1 & 5.2. The majority of Muslims are keen to invest in Shariah-compliant products. However, the negative impact of the Islamic-holding still an obstacle. Therefore, any Islamic bank must take necessary steps before launching any Shariah-compliant products. Firstly, the bank must change the negative idea about Islamic banking to attract more customers (Muslims and non Muslims). This can be done through implementing different campaigns and conferences across the country, in order to illustrate the mechanism of this new phenomena and the mechanism of the different modes of finance. Equally important, the majority of the latter campaigns should be offered in the customers' native language. Secondly, any bank must understand first the needs of the customers, in order to structure the right products for them. In this regard, the bank must take effective marketing strategies as well as extensive analysis work. Finally, Islamic banks must try to find solutions to settle down all the regulatory issues with the country regulators, in order to start launching the business as soon as possible. Germany as a country still needs to take further steps towards the Islamic banking business, as it will be beneficial for the economy, especially after the European financial crisis. Starting that business in the country will attract more investors who are keen to follow Shariah. Furthermore, it will be the first step to launch other profitable Islamic financial products, such as sukuk, which can further strength the capital market. In fact, German regulators should try to come to a common point with Islamic banks to ease this process. Indeed, The current challenges can be easily solved if the country decided to give this business a
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chance. However, Experts are sure that the business will start in the near future and will be indeed positive for investors as well as for the country.
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References
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Appendices
APPENDIX 1
APPENDIX 1.1 The prohibition of Riba in the Quran6
Surah al-Rum, verse 39 That which you give as Riba to increase the peoples wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold. (30: 39) Surah al-Nisa, verse 161 And for their taking Riba although it was forbidden for them, and their wrongful appropriation of other peoples property. We have prepared for those among them who reject faith a grievous punishment. (4: 161) Surah Al-e-Imran, verse 130 O believers, take not doubled and redoubled Riba, and fear Allah so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey Allah and the Prophet so that you may get mercy. (3: 130) Surah al-Baqarah, verses 275281 Those who take Riba shall be raised like those who have been driven to madness by the touch of the Devil; this is because they say: Trade is just like interest while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to God; but those who revert, shall be the inhabitants of the fire and abide therein forever. (275) Allah deprives Riba of all blessing but blesses charity; He loves not the ungrateful sinner. (276)
6
These are not the only the versus dealing with Riba in the Quran, Riba was mentenioed explicitly in other versus as well.
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O, believers, fear Allah, and give up what is still due to you from Riba if you are true believers. (278) If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it. (279) And if the debtor is in misery, let him have respite until it is easier, but if you forego it as charity, it is better for you if you realize. (280) And be fearful of the Day when you shall be returned to the Allah, then everybody shall be paid in full what he has earned and they shall not be wronged. (281)
1. From Jabir (Gbpwh): The Prophet (pbuh) cursed the receiver and the payer of interest, the one who records it and the witnesses to the transaction and said: They are all alike [in guilt]. 2. From Anas ibn Malik (Gbpwh): The Prophet said: When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually. 3. Zaid B. Aslam reported that interest in pagan times was of this nature: When a person owed money to another man for a certain period and the period expired, the creditor would ask: you pay me the amount or pay the extra. If he paid the amount, it was well and good, otherwise the creditor increased the loan amount and extended the period for payment again.
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4. The holy Prophet (Pbuh) announced the prohibition of Riba in express terms at the occasion of his last Hajj, which was the most attended gathering of his Companions. The Prophet said: Every form of Riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting Riba. I start with the amount of Riba which people owe to my uncle Abbas and declare it all cancelled. He then, on behalf of his uncle, cancelled the total amount of Riba due on his loan capital from his debtors. 5. The holy Prophet (Pbuh) said, Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt like for like, equal for equal, and hand to hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand to hand. 6. Bilal (Gbpwh) once visited the Messenger of Allah (pbuh) with some high quality dates, the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of that of the higher quality. The Prophet (pbuh) said: This is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the others. 7. A man deputed by the holy Prophet (pbuh) for the collection of Zakat/Ushr from Khyber brought for him dates of very fine quality. Upon the Prophets asking him whether all the dates of Khyber were such, the man replied that this was not the case and added that he exchanged a Saa (a measure) of this kind for two or three (of the other kind). The holy Prophet replied: Do not do so. Sell (the lower quality dates) for dirhams and then use the dirhams to buy better quality dates. (When dates are exchanged against dates) they should be equal in weight.
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Appendix2
In the course of this research, several experts in the field of Islamic finance as well as banks representatives were contacted via email, in order to perform an interview about the respective topic. However, there was no answer from all of them except Dr. Johannes Engels. Dr. Johannes Engels is a Senior Advisor at The Federal Financial Supervisory Authority (BaFin) Germany. Dr. Engels has studied General Economics in Aachen and Cologne; he finished in at University of Cologne with Doctor Degree. He has been working for the Federal Financial Supervisory Authority for twenty two years, in the international dept. for eight years. Since October 2012 he has been the lecturer for Corporate Governance at University of Applied Sciences in Mainz. He has written several publications in the field of Islamic finance.
The below interview took place on October 29th, 2013 at Dr. Engels office.
1- As the matter of fact that Islamic banking became a hot topic in Germany for the past years, do you think that Germany will benefit from this business? I can really imagine it, we have several million Muslim citizens in Germany , and that is indeed reflected a great market. There are important Shariah principles which must be followed in Islamic banking (riba, maysir, gharar). Indeed, if we have operated financially according to these principles, we would never experience the different financial crisis. 2- Facts and figures about the Muslim population in Germany have reflected a potential group for Islamic banking, Do you think that Germany can be really a potential market for Islamic banking? Indeed, from the quantity, there is a potential for this business. However, when I look to one bad experience which occurred in the 1990s, where bad Turkish Muslims cheated other Muslims after Friday prayers, in the so-called Islamic holding. As a result, these Muslims had lost their money, and consequently, this bad experience still constitutes a problem . On the other hand, the majority of Muslims in Germany is from Turkey, and from this point, it is still today, not religiously based country. Therefore, Turkish Muslims feel home in our regional banks which are highly preferred more than their home banks. Therefore, I think that, in the short run, it will be possible that an Islamic bank will offer a trading
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business (e.g. import and export business). Indeed, there will an economic niche. Later on, it might a room for retail banking business; however, it should be taken step by step. 3- Several German Banks have launched the so-called Islamic Windows in the GCC region, Do you think that these banks can be key players in this business, In case of further implementation? I think in the long run, if the business shows a successful trend in the market; the German banks will try to play such a similar role. However, I think it will not be in the retail business, except for important clients, where they deal with them in Kuala Lumpur or Dubai. 4- With regard to the regulatory issues, what are the major challenges facing the business implementation? And how can Germany overcome it? We have no general line, when we look at the German banking act (KWG), there is no explicit forbiddance for Islamic banking. In my opinion, the thing is possible when it is not strictly forbidden. I think it is only a different type of calculation in Islamic banking, for instance, deposits and lending mechanism. It is another way to do this business and not forbidden in the KWG. My opinion, it will be possible. There is no general line till now, still there is no final decision about it. I think it will be a soon a final decision , as there is already a full licence application from the Kuveyt Trk bank, which located in Mannheim. There are indeed other concerns which related to the Islamic deposits. According to the EU regulation, each deposit up to 100,000 euros must be fully protected, and this type of deposit insurance system is against Shariah rules. Any Islamic bank must follow these rules, otherwise it will be hard to obtain a banking license. Another issue is the role of the Shariah board (SSB), it is absolutely a need to have a qualified Shariah board. As a supervisor, I highly welcome it when there is a qualified Shariah board. However, I know that in several countries, the SSB is as well included in heading the bank , and it can intervene in th e banks decisions. In the European Union as well as in Germany, Only CEOs are responsible for heading the business, and SSB can take over the role of a Consultant. 5- The Kuveyt Trk bank has entered the market as an Islamic bank, however, it has obtained only a limited license, What are the main reasons for this? And can the bank get a full banking license in the future? The Kuveyt Trk bank is a well known bank in Turkey and operates through highly qualified managers. However, the main issues previously discussed
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(deposits issue & SSB role) are the main reason for not getting a full license till now. Indeed, I hope that it will be successful in the future, in my opinion; it is just a new business in the country, which might face some resistance. However, I am sure that they will get a full license in the future, but it will take some time. Indeed, there should be some compromises from the Islamic banks' side to overcome these issues. For instance, the SSB can be equal to the role of the supervisory boards in the conventional banks, but not more. 6- Tax conditions in Germany also impose some restrictions to Islamic banks? Are there any current solutions for this issue? Under the current taxation system, Islamic banks will be exposed to double taxation treatment in the case of Islamic mortgage finance. In addition, Germany has a different level of taxes according to each region (e.g. 2.5% in Hessen region, whereas 5% in the Rheinland Pfalz region). In fact, it will very difficult to change the taxation system, such as in the UK (one time treatment) and France (double taxation but with a lower level of taxes). However, Ernst & Young has proposed an excellent idea, the silent partnership. In consequence, the bank will only be registered only one time in this process as he acts as a sleep partner. This is simply the solution for the double taxation problem, without changing anything the taxation regulation. 7- Finally, what do you think about the future of the Islamic banking business in Germany? I think in the long run; it will be very successful, as we will have another generation than the one who experienced the Islamic holding in the 1990s.On the other hand, the success of Islamic finance in London (new sukuk issuance ) as well as in Luxemburg, will positively affect the European market. Hence, in the near future, first with a trading business (Import and export), then step by step it will further develop to offer Islamic products and services. I think also that we will see an Islamic index in the stock market in the future. It is not impossible; there are several companies which dont engage with haram business (gambling, pork, weapons, etc.).
P.S. The above mentioned interview reflects only the private opinion of Dr. Johannes Engels and does not automatically display the position of German Federal Financial Supervisory Authority.
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Islam Hamed
Gabriel-von-Seidl-Strae 75, 67550 Worms (Germany) 004917671298135 islam_fathy@live.com Egyptian Male
Work experience
Dates Occupation or position held Main activities and responsibilities 17/09/2012 - 12/02/2013 Lean Coordinator-Intern (Product Development Department) Implement lean tools in the PD department (e.g. Lean meetings, visual boards, 5S and VSM). Monitor PDP/APQP running projects. Support top management in presentations preparation and workshops organization. Coordinate RFQ value stream mapping/analysis project. Development of standards in Project Management. SKF Schweinfurt (Germany) Engineering 03/03/2008 - 31/05/2010 Credit Analyst (Credit Department, retail Banking & SMEs) Manage, direct, and coordinate all activities to implement bank policies, procedures and practices concerning underwriting, applications, and granting or extending / enhancing loans. Analyze customers financial history to grant loans in accordance with risk management in the different products. Assist and support the lending staff with matters of credit policy, guidelines and procedures. Monitor the quality of the loan portfolio. Assist top management in preparing manuals for new credit products. Prepare internal and external reports. Answer branches inquires and dealing with complex issues. Banque Misr Cairo (Egypt) Financial and insurance activities 08/07/2007 - 01/03/2008 Accountant (Engineering Department)
Name and address of employer Type of business or sector Dates Occupation or position held Main activities and responsibilities
Name and address of employer Type of business or sector Dates Occupation or position held
Main activities and responsibilities Prepare journal entries. Complete general ledger operations. Prepare monthly financial reports. Name and address of employer Banque Misr Cairo (Egypt) Type of business or sector Financial and insurance activities
Name and type of organisation providing education and training Dates Title of qualification awarded Grade Principal subjects / occupational skills covered Name and type of organisation providing education and training Dates Title of qualification awarded Principal subjects / occupational skills covered Name and type of organisation providing education and training Dates Title of qualification awarded Name and type of organisation providing education and training
Arabic
Understanding
Listening C2 C1 Proficient user Proficient user C2 Reading Proficient user C2
Speaking
Spoken interaction Proficient user Proficient user Spoken production C2 Proficient user C1
Writing
Proficient user
English German
B2 Independent user C1
Social Engagement