Foreign Banking and Financial Institutions in the Uae

Foreign Banking and Financial Institutions in the UAE:

Adapting to Islamic Finance Practices

TABLE OF CONTENTS

Content: Page:

1.0 Introduction: Adapting to Islamic finance practices …………………... 1

2.0 Culture-specifics of Islamic finance …………………………………..… 1

2.1 Basic principles …………………………………………………..… 2

2.2 Definition of terms ………………………………………………..... 3

3.0 The UAE setting ……………………………………………………..…… 5

3.1 Regulatory restrictions in Union Law No. (10) of 1980 ………... 8

3.2 Case study: BNP Paribas ……………………………………..…. 11

4.0 Conclusion: Islamic banking and finance opportunities in the UAE ... 13

Appendix

Bibliography

1.0 Introduction: Adapting to Islamic finance practices

In the banking and finance sector of the UAE, Islamic finance practices are the law of the land. Foreign banks, financial institutions (FIs) and investment companies licensed to operate in the country have adapted to the norms. Their core operations are geared towards offering products and services tailor-fitted to the local market and, most importantly, compliant with the culture-specific regulations. All their local counterparts, by virtue of Federal Law No- 6 of 1985, are committed to abide by the provisions of the Islamic Sharia Law, the sanctions of which are derived from the Holy Quran and the sayings of the Prophet Muhammad. Central to the standards set by the Law prohibit Islamic financiers from engaging in transactions that involve interest (riba) and speculation (gharar). By adapting to these practices, foreign banking and financial institutions are assured not only of a niche in the local market but of continued opportunities in the UAE.

2.0 Culture-specifics of Islamic finance

The philosophy and principles behind Islamic finance are outlined in the Holy Quran and the Sunnah (practices and traditions of the Prophet Muhammad) more than 1,400 years ago. Islamic finance is divergent from conventional banking. It is a culture in itself and of its own right. It is based on the principles of equity participation and risk (profit-and-loss) sharing arrangements.

2.1 Basic principles

A conventional bank is essentially a borrower and lender of funds. It offers risk-free or “guaranteed” rate of return to its depositors while in turn, having its borrowers bear all the risk. If a conventional bank is akin to being a conduit of money changing hands at an interest, Islamic finance is more involved in the dynamics of equity through risk (profit-and-loss) sharing. Islamic finance deals with transactions between depositors, on one side, and partnership with entrepreneurs, on the other, when utilizing depositors’ funds in direct investments. All transactions are interest-free.

There is a clear-cut distinction between interest and profit. Interest as a mechanism in conventional banking is derived from profit. It is a subset of profit. It is the profit a conventional bank makes when it lends money and it is the profit a customer receives on deposited funds. In Islamic finance, all transactions involving interest (riba) are forbidden (haram). Rather than lending cash for profit, profit is created by using the underlying commodity or asset in the transaction.

All Islamic financial products share this absence of interest – either assessed or paid. Instead, the investments are set up as leasing arrangements or investments in which money is turned over to third-party trustees who share profits with Islamic depositors. Risks, profit margins and overheads are taken into account when calculating the profit. These are similar considerations as interest-based transactions. All risks are equally shared by the depositor, the banker and the entrepreneur with whom the funds are invested. In this case, all parties gain together, or lose together. Equity is the benchmark and hallmark of Islamic