Several months ago, in a ground breaking development, His Majesty Sultan Qaboos bin Said approved the establishment of Oman’s first Islamic bank. As the government authorities continue to work through the implementation of His Majesty’s instructions, it is becoming clear that changes and new opportunities are in store not only for the banking sector, but also for related financial sectors such as insurance.
Following His Majesty’s broad-based royal directive, many of the details of implementation have been carried out by government authorities such as the Capital Market Authority (CMA) and the Central Bank of Oman (CBO). For example, the local press recently reported that the CMA had issued important guidance in respect of Islamic insurance, or takaful. The CMA stipulated that conventional insurance companies would not be permitted to run takaful operations in the Sultanate alongside their conventional insurance businesses; any company wishing to offer takaful would be required to convert to a dedicated takaful company, or to open a new dedicated takaful entity.
This article provides a brief overview of takaful, as a basic primer on the Islamic insurance sector.
Insurance with Islamic principles
Essentially, takaful is designed to provide the same benefits to subscribers as conventional insurance –coverage against unexpected or catastrophic losses – while scrupulously adhering to the principles of Sharia (i.e., Islamic religious law). In particular, takaful is structured to comply with the core Sharia tenets prohibiting interest or unjust enrichment (riba), discouraging ambiguity in contractual terms (gharar), and minimizing the speculative nature of transactions (maysair).
Application of these principles to ‘takaful’ structures
In practice, there are two main ways that a takaful insurance scheme follows Islamic principles.
First, the takaful structures itself as a mudaraba (i.e., profit-sharing venture). The policy contract between the takaful operator (i.e., the insurance company) and the subscribers would specify how any operating surpluses that the takaful runs (e.g., excess of subscriber contributions received over monies paid out on claims) shall be divided between the operator and the subscribers. For example, the contract may state that any surpluses shall go 70 percent to the subscribers, as the providers of capital, and 30 percent to the operator, as the provider of services. This structure helps the takaful scheme avoid falling afoul of the prohibition on unjust enrichment.
Second, the takaful will seek to avoid prohibited elements of uncertainty by structuring its subscriber contributions as tabarru (from the Arabic “to donate, contribute or give away”). Under this concept, payments that the takaful makes on claims by a subscriber would be considered a partial donation by the other subscribers of the capital that they have contributed to the takaful.
Wednesday, December 14, 2011
Islamic Insurance Comes to Oman
Thursday, July 14, 2011
Islamic Banking in Oman- Part II
Islamic banking is poised to become a key fixture of Oman’s financial sector, following the recent announcement that His Majesty Sultan Qaboos bin Said has approved the formation of Oman’s first Islamic bank. Last month’s Client Alert provided an introduction to the religious, philosophical and economic principles that underpin Islamic finance. This month, we present an overview of some of the classic Islamic banking structures that are commonly used in jurisdictions where Islamic finance is already well established.
Mudaraba (capital provision)
This is an arrangement between an Islamic bank and an entrepreneur in which the bank contributes the capital to fund an entrepreneur’s company, in exchange for a share of the company’s profits. The two most notable features of a mudaraba are that (i) the bank contributes all of the company’s capital, and the entrepreneur contributes his ideas, technical expertise and management skills but no capital, and (ii) the bank and the entrepreneur share the profits of the company according to a pre-agreed scale, while the company’s losses would be absorbed entirely by the bank. A mudaraba structure is well suited to up-and-coming entrepreneurs who possess exceptional business ideas or talents, but lack the financial resources to get their company off the ground.
Musharaka (joint venture)
Under a musharaka, both the Islamic bank and the entrepreneur contribute capital to the entrepreneur’s company. The company’s profits are shared according to a formula that the parties pre-agree, and losses are apportioned pro rata to the parties’ respective capital contributions. Although management of the company may be however the parties agree, it is common for both the entrepreneur and representatives of the bank to be actively involved. A musharaka structure is well suited for an Islamic bank’s proprietary investment activities.
Ijara (lease)
An ijara is a lease structure in which the Islamic bank will buy a specified asset, and lease it to the banking customer at a specified rental price for a specified length of time. It is important for the terms of the lease to be Sharia (Islamic religious law) compliant – for example, not to charge interest or penalties that would be considered usurious and therefore haram (prohibited). Frequently, an ijara will include the option for the customer to purchase the asset at a specified price at the end of the lease period.
Sukuk (Islamic bonds)
Sukuk, or Islamic bonds, are securities representing an ownership interest in an asset or pool of assets. The assets underlying the sukuk will themselves be structured as Sharia-compliant vehicles – such as mudaraba or musharaka. The payments that sukuk bondholders receive are not designated as interest payments, but rather as returns derived from the profits of the business underlying the bonds.
