Bhatti, Ishaq --- "Sukuk and the bonding of Islamic finance" [2007] MonashBusRw 4; (2007) 3(1) Monash Business Review 17

Sukuk and the bonding of Islamic finance

Ishaq Bhatti

Before Muhammad (peace be upon him) began to spread the message of Islam in 610 CE, Arabia was in the midst of Ayyam al-Jahilliyah, “the Age of Ignorance”.

Within this setting, Muhammad, the last Prophet of Islam, taught the divine revelations of God to those willing to listen, advocating not only tawheed (monotheism) and submission to God, but also ethical responsibilities towards each like the prohibition of riba (interest/usury) which was seen as a wicked financial entrapment to the needy. “O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers.” (2:278, Qur’an, Yusuf Ali translation). With the coming of the 20th century, however, this edict began to punish 20th century Muslims who set about finding innovative ways to conduct financial transactions within shari’ah law. Most successful among these, and of increasing interest to western investors, is sukuk, the Islamic bond.

The sukuk

In the conventional financial market, a bond is a debt-based instrument but in the Islamic financial market, it’s an asset-based one. Because bonds involving interest are against the shari’ah, Islamic bankers invented the sukuk: a non-interest based security providing investors with the ownership of an underlying asset.

The Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI) acknowledged 14 standard types of sukuk bonds, categorised by tradability. These include musharaka (equity participation), mudaraba (profit-sharing) and ijara (leasing) and the non-tradable bonds include murabaha (cost-plans or mark up), and istisna and salam (both types of contracts involving advanced cash payment).

Sukuk’s rising market

The Malaysian government pioneered Islamic finance globally when it issued the first sukuk in 2002 for US$600 million. The Malaysian government effectively offered to finance custom-selected assets to customers for an agreed period of time by purchasing the assets and leasing them.

The sukuk caught on fast and soon after the Durrat Al Bahrain issued a US$120m sukuk for a real estate development project, the government of Pakistan issued a US$600m sukuk. The Emirate Airline sukuk sale in 2006 was the largest ever launched by an airline. Last year, the Ports, Customs and Free Zones Corporation (PCFC) of Dubai launched one for US$3.5 billion that reached a subscription value of more than US$8bn, the largest at that time. Western interest was tweaked and shortly after, the State of Saxony-Anhalt issued a US$100m sukuk to widen its investment prospects. According to one estimate, sukuk investments tripled in 2004 to US$6.7bn and are expected to tip US$10bn this year, giving the market a total of US$70bn (The Financial Times 28 February, 2007).

There are more than 265 Islamic banks or institutions operating in 40 countries with total assets estimated at US$262bn. Western banks such as Citibank, HSBC and National Australian Bank (NAB) are tapping into the market while the UK and Australia’s Victorian government have made legislative changes to allow Islamic banks to operate under shari’ah law with the US expected to follow. Further advancements towards the development of sukuk structures are encouraging the current Islamic financial surge.

According to The Daily Telegraph, 30 January 2007, the UK will soon be the first western country to allow banks to sell Islamic bonds as part of a new drive that gives priority to the expanding area of Islamic banking. “I am able to set out the next stage in our reforms to ensure the tax and regulatory system will encourage the development of shari’ah-compliant products,” Ed Balls, the Economic Secretary to the Treasury, told the sixth Euromoney Annual Islamic Finance summit.

In Australia there are two major Islamic finance and investment companies, the Muslim Community Co-operative Australia and Balance Finance, and the NAB is presently offering scholarships in Islamic Finance that will lay the groundwork for the Australian sukuk.

The sukuk bond is growing rapidly. Its diversity and categories allows it to adjust to a variety of investment scenarios and its unique appeal to the shari’ah conscious investor ensures its on-going successes. It would be foolish for the West not to recognise its impressive growth rate. As long as Islamic nations are developing, investments are inevitable. To exploit this, particularly in the rapidly growing and expanding Gulf region, Western banks would do well to tap into their rich resources using sukuk as the medium.

Cite this article as

Bhatti, Ishaq. 'Sukuk and the bonding of Islamic finance'. Monash Business Review. 2007.; Monash University ePress: Victoria, Australia. http://www.epress.monash.edu.au/. : 17–18. DOI:10.2104/mbr07004

About the author

Ishaq Bhatti

Ishaq Bhatti is Associate Professor in the Department of Economics and Finance School of Business, La Trobe University, Melbourne. He has authored over 60 articles and two books and his third, on interest-free banking, is about to be published.