Product Development in Islamic Finance
I thought of writing this article in the hope it helps those who have just started in Islamic Finance, and especially those who are involved in product structuring or are considering which part of an Islamic Bank they should join.
The best area to be in an Islamic Bank is “Product Development”. That’s the area that gives you the broadest and deepest knowledge. That’s the area that really challenges all you have assumed. That’s the area that involves all you know and all you need to learn. That’s the area where you can see fairly quickly the result of your work as the product is sold in the market; and hopefully it solves the consumers’ or investors’ current financial problems.
It doesn’t matter whether it’s retail, investment, or finance, as long as it involves structuring. Many divisions within a financial institution have their own product development section. It’s really the area that gives you the broadest and deepest understanding of both Shariah and the client business.
How you really learn is through structuring the deal, from A to Z.
This involves Negotiations with Clients, Discussions with Lawyers, Meetings with Credit Officers, Proposals with Regulators, Writing the Terms & Conditions. That’s how you learn. You have to go through all the details yourself.
Above all, arguing the case in front of the Shariah Committee, learning directly the Forbidden and the Permissible and how they got there, the basis of their approvals, and truly understanding the fundamentals from the Scholars. This is where you learn that so much of what you may have assumed is not quite right.
You learn even more when a structure or parts of it are deemed unacceptable. It forces you back to the drawing board to find a solution.
Lawyers are a great way to learn also. While at first you may think that an agreement under English Law is not relevant to Islamic Finance, think again. The reality is that many aspects of contracts are in fact very similar. Understanding the legal requirements in different jurisdictions helps you structure a better product and use the right language and contract to ensure Shariah compliance. Don’t shy away from engaging with lawyers in a transaction, it’s a great learning experience.
Product Development can be very frustrating because of the many angles you have to ensure, but it’s also the most enjoyable and challenging. There’s no feeling like seeing the success of your work in the branches of your bank.
Reading is very necessary in Product Development. One gets lots of ideas about products and more importantly, possible solutions. But reading about Islamic Finance is just one part of the whole. If you are going to discipline yourself to read, then make sure you read quality work. Many scholars have their own websites where they publish their papers; these are a great place to learn. And of course, don’t ever forget the great scholars of the past; you have over a 1,000 years of scholarly literature.
The scholars of the past were very interesting. They were unencumbered by any of the developments in our modern financial markets. But they did discuss the important issues of their time. You would be very surprised at how sophisticated and detailed they were. These days, many of these books are available free online. Of course, you don’t have to read the whole book; you can just refer to the specific section you’re interested in. You will also be surprised at how many discussions are very similar to our modern day problems.
On the other hand, the works of modern day scholars are directly related to our current financial markets. You will see from their works how they look to the past to make sense of modern day financial issues, and how they put such effort in getting the right ruling for the situation.
I’ve spent much of my career in product development of Islamic financial products. It’s always difficult to summarize a lifetime of experience in a few words, otherwise the article would be too long if one were to list everything, so I’ve chosen what I thought are the most helpful hints that have aided me throughout my experience in Islamic Finance in the area of product development.
- It’s not Forbidden or Permissible because YOU think so. It is when your Shariah Committee says it is. You don’t know enough; they do. Trust them, be humble and learn. Don’t allow your feelings of comfort or discomfort sway you, Shariah has fundamentals, and your committee knows these very well.
- You must first understand all the contracts. And as importantly know exactly the category in which each contract belongs. For example Bai (Sale) and Ijarah (Lease) are within the Mu’awadat category, i.e. commercial exchanges. On the other hand, Hiba (gift or donation) is part of Tabarru’aat category. The difference is that in the second category more Gharar can be tolerated. Rahn (Collateral) is within the Tawthheeqat (Surety) category and only arises based on another deal taking place. It’s important to understand the contracts as well as the categories, as they can be unique in their conditions and can help you when structuring a product.
- Riba is the “Big One”, if you make sure you completely avoid that, you’re easily 80% of the way there. The problem with Riba is its very insidious and sometimes invisible nature. No wonder the great scholars of the past and today spend a lot of time writing about it and explaining it. It has a way of rearing its ugly head. No amount of Riba is acceptable, unlike for example Gharar, which a small amount can be present and acceptable in many situations.
- Gharar is overrated, especially these days, as there are so many regulations in finance as well as Consumer Protection Acts that limit the possibility of it appearing. In addition, lengthy agreements ensure each party is fully aware of all the facts and the duties and responsibilities of each. Let’s put it this way, I have never had a transaction rejected because of Gharar. The same goes for Maysir, you’re hardly likely to encounter it in many financial situations today unless you go looking for it.
- Be Careful of multiple contracts in a deal. Some contracts are forbidden together such a Loan (Qard), and a Sale (Bai’). This one for example you’d find in AAOIFI Standard Number 19 0n Loans (Qard). Others are harder to find. It’s not an automatic NO to have multiple contracts in one transaction, but you have to ensure that the combination does not constitute an illicit act. In fact AAOIFI has a standard for this issue, it’s Standard No. (25) Combination of Contracts. Read and understand it well, it’s very useful.
- In line with point 5 above, the process of the deal is equally important, especially when having combination contracts. Which part of the contract comes first, what needs to be signed first and second, are very important aspects of the deal. The same deal can be forbidden because the process itself creates problems and not the underlying fundamentals.
- Watch out for underlying areas that can make a structure impermissible. Sometimes the overall deal is fine, such as purchasing a building that has existing leases. However, the underlying leases may be to non permitted industries, or the leases have clauses that create a non permissible contract. Sometimes the information is well hidden.
- Review any legal material between parties carefully whilst comparing rights and responsibilities of each against the rules of each known contracts. Many transactions are rejected because these items are not clarified. These clauses in a contract, regardless of how small you may think, may turn an Ijarah into an Instalment Sale Contract.
- Keep the AAOIFI Shariah Standards book handy, it’s very useful to help you avoid pitfalls. It has lots of information on permissible structures within each type of contract. In addition, it clarifies the Shariah basis of each standard in the Appendix of each standard. You can learn a lot from that. In my days this wasn’t available, it would have been really useful.
- If you can, always review other institutions’ Shariah Committee Pronouncements (Fatwas). They can be very useful. These days, they are much easier to get a hold of, many of which are free on the Internet. Some banks even have Apps you can look through. For example ICD a member of the Islamic Development Bank, and Alinma Bank of Saudi Arabia have Apps for their Fatwas. In addition, download the International Islamic Fiqh Academy Fatwas, they are very useful and available online. Their website in Arabic is at http://www.iifa-aifi.org/.
- If you do read Arabic, then download a few old classic Fiqh books as they are really wonderful and filled with valuable knowledge. You will find many structures that you didn’t know existed, or were permissible. A couple of great sites for this are www.feqhbook.com and www.waqfeya.com
- Much more is permissible than you think. Don’t limit yourself by believing everything is forbidden. Remember, the basis of transactions is permissibility unless otherwise proven. So it would be best to make a list of the main Forbidden issues in transactions and study it well, in time it will become second nature.
- Understand clearly from the Shariah Committee or Advisor the reasons for a rejection of your product or structure. Not only is this a learning experience, but also it allows you to fix what has made it forbidden. It’s your job to re-structure the deal, not the Shariah Committee; you’re the product-structuring specialist.
- Don’t worry about the product being similar to a conventional product. This point has been highly exaggerated. The reality is that all financial products are the same, they satisfy a need for a client, and they’re all based on a specific risk and return profile. It’s hardly likely you will create something completely new. Shariah in the end is not in the similarity with another, it’s in eliminating the prohibited. Don’t confuse Form with Function.
- Don’t work on a product just because you can do something in a Shariah-compliant manner if that’s your only motive. In the end, a client or a segment of clients must have a need for this product because it solves their problem at an attractive price. Don’t forget, the product needs to be sold.
I hope the above are helpful to you if you’re in product development in an Islamic Bank. If you’re not, then perhaps it will motivate you to choose this area as I did, and in which I enjoyed my work very much. It was challenging, but it was a great learning experience.