It has been observed worldwide that there has been a convergence between the conventional banking and the Islamic banking.

ENGR. KHALED QAYUM, Askari Leasing Ltd
July 31 - Aug 06, 2006

Islamic Banking has emerged as one the fastest growing areas of finance. It has been accepted as the mainstream banking and is no longer considered a chimera as was thought to be at one time. It is indeed a testament to the success of Islamic Financial Institutions that they are opening up in all countries at a rate which is truly remarkable. At the same time there are major business houses that have switched all of their banking operations from conventional banking to the Islamic Banking. These steps probably were motivated because of payback in the afterworld. However, these businesses claim that Lord Almighty has been benevolent even in this world and their profitability has increased considerably, ever since they took such steps.

World wide it has been observed that there has been a convergence between the conventional banking and the Islamic banking. It was once observed by one of the experts that the conventional banking had only one mode i.e. credit and look what they have done with it. Now, Islamic Finance has many more to offer - Modaraba, Murabaha, Ijara, Musharaka, Salam, and so on. When the Islamic bankers set their ingenuity at work, look what they can do with it.

Today, it has been observed that for almost every credit product there has been a similar Islamic banking product which is available for the Islamic banking consumer to use. This is the success of Islamic bankers. They have worked on developing the structures which are compliant with the Shariah, meet the needs of the customers and can also work as required in the banking environment.

Currently one of the hottest areas of interest in Islamic investment banking is of Sukuks. The Sukuks are Islamic form of bonds which are asset based. It has increasingly been used to raised funding both for government finance and also for corporate finance. The public demand for these securities is quite large and internationally the aggregate value of Sukuks for the year 2005 is estimated to be USD 6.4 billion.

On the other hand, to date the world's largest Sukuk was listed on the Dubai international financial exchange on January 26, 2006, with great fanfare was of British pound sterling 3.9, recommended takeover of P & O. The issuer of the Sukuk was PCFC Development - a special purpose vehicle formed by the ports customs and Freezone Corporation. The issuer entered into a profit sharing / Musharaka with PCFC and declared a trust under English law over certain of its assets, such as its rights to share in the profits of the partnership, in favor of the holders of trust certificates issued.

And again, it is reportedly a fraction of what the total market is expected to be. The future is expected to be far bigger. Sukuk market is getting exciting in Pakistan also. The most recent entry is in Pakistan where Sitara Group is trying to raise funding for its new capital expenditure through Sukuk offering.

What are Sukuks? How do they differ from the conventional bonds and what make them attractive? How are they structured?

Sukuks are form of debt securities which are compliant with Islamic Shariah. They are part of Islamic banking products and as evident from the current situation gaining rapidly in their popularity. Islamic Shariah abhors Riba and other activities the practice of which are repugnant to Islam. Hence, broadly speaking, Sukuks cannot be issued or structured around anything which involve any such activities. A fundamental requirement of Sukuk is that income from it must be related to the purpose for which the funding is used and cannot simply comprise interest. Securities must be backed by real underlying assets.

Assets must also be identifiable or specifically earmarked. Hence Islamic Investment Certificates such as Sukuk represent the ownership of a proportionate part of the assets and the bond holders assume a proportional part of the risk which accompanies it. This entitles them to receive them income from the Sukuk. This in structure and concept is entirely different from the conventional debt securities, i.e., bonds, wherein, no risk is assumed by the bond holders. The only risk assumed by the bond holder is the risk of default. Secondly, an important condition for Sukuks is that there has to be always an underlying asset, whereas in conventional bond there may not be an underlying asset. This automatically makes Sukuks more secure and more attractive from the investor's point of view. This has not been lost even on the conventional bankers and was noted by the independent rating agency Standard & Poor in a moot held in London in January 2006.


The Sukuks can be structured in a variety of manner. They can be done based on Salam structure, diminishing Musharaka structure, Ijara structure, etc. These structures typically involve creation of a special purpose vehicle (SPV) created as a legal entity. In Salam structure, the SPV is created for the duration of the Sukuk, with the sole purpose of administrating the payments made to the investors and holding the title to the assets on which the Sukuk is based. The SPV can be regarded as a non profit making trust. In the first stage the issuer transfers the title to the SPV, which in turn issues certificates of participation to the investors who in turn may be Islamic banks, Takaful companies, investment companies that want to hold their assets in Shariah compliant form.

These certificates of participation represent undivided right to an interest in the assets, which cannot be sold to another party for the duration of Sukuk. In return for the certificates of participation the investors make an upfront payment which entitles the investors to a future refund of the investment plus a fixed markup agreed in advance, or an upfront that designates the structure as a Salam structure.

The initial cash collected by the SPV, provided by the investors, is used to make payment to the issuer in return for an undertaking to deliver the asset at the maturity. At that stage, say after three months, the SPV takes the asset and sells it back to the issuer. The proceeds from this sale are used to reimburse the cash provided by the Islamic investors, and provide them with the pre-agreed markup return in relation to their investment. The investors have to surrender their certificates in order to obtain the return on investments, thus losing their claim on the assets.

With the Ijara structure the prime function of the SPV throughout its life is to manage the assets, in particular the receipt of rents from the clients for the leased assets and the payment to the Sukuk investors. When the Sukuk matures the SPV no longer has a role and ceases to exist as an entity. Thus in a Ijara structure the strength of the Sukuk is the ability of the client to make the rental payments to the SPV. This makes it simple and attractive.

The diminishing Musharaka Sukuk is similar to the Ijara Sukuk. The issuer sells the assets involved to the SPV while entering a partnership rather than a leasing agreement. The Islamic investors pay out cash as before but receive certificates of partnership rather than simply certificates of participation. The issuers and investors are both partners in the SPV but the share of the investors is to diminish over the time period, as the name implies, and the payments are made by the issuer to repurchase the asset. It is due to these payments that the income of the Sukuks is generated.


Crystal Ball gazing has gone out of style, however, with whatever modicum of intelligence one can lay one's hands on, it is rather safe to say that the Sukuks are bound to increase considerably in size. They are easy to understand, relatively flexible and have a demand which is constantly growing. Something noteworthy about Islamic Banking is that it is appealing intrinsically. The model is C2B, i.e., Consumer to Business and not other way around. This has been the key to success of Islamic Banking. Sukuks are sound Islamic investment banking products and we can expect to see more of them in future.