Islamic Finance – before and after the market disturbances Date Islamic Finance – before and after the market disturbances Madhukar Shenoy Global Islamic Finance Team PricewaterhouseCoopers 3 March 2010 PwC

Agenda The Islamic finance business model Date Agenda The Islamic finance business model The evolution of Islamic finance Impact of financial crisis on Islamic finance Consequences What do we need, 2010 and beyond?

The Islamic finance business model Date The Islamic finance business model Business modelled around the real economy Avoidance of riba 1 Business models devoid of derivative/synthetic structures Avoidance of gharar 2 Greed eliminated Avoidance of maisir 3

The evolution of Islamic finance Date The evolution of Islamic finance Several new banks emerged in the region and across the globe. Western banks such as HSBC, Citi, UBS etc. entered the fray Egypt, Dubai and Bahrain established contemporary style Islamic banks 1970s 1980s 1990s New millennium We witnessed the birth of contemporary Islamic banking in Cairo and in Dubai in the mid 70s. Bank Misr and Dubai Islamic Bank were pioneers. Soon thereafter several banks were established in the GCC and Bahrain led the pack. Retail to corporate focus Birth of private equity and real estate focused firms Corporate Sukuk issues Government interest Conversions from conventional Takaful growth Bahrain, Malaysia emerged as key centres of Islamic finance

Impact of financial crisis on Islamic finance Date Impact of financial crisis on Islamic finance Housing bubble Subprime Lehman's collapse Contagion effect Loss of confidence Liquidity crisis Subprime Islamic banks had no significant exposure Housing bubble Shari’a compliant investment banks with global exposures impacted most Lehman's collapse Contagion effect Liquidity, asset quality and impairment problems impacted regional banks Loss of confidence Liquidity crisis Funding and capital raising under pressure Dubai events

Financial crisis and impact on Islamic finance Date Consequences Financial crisis and impact on Islamic finance Impact Investment Banking Commercial Banking Private equity Real estate Lack of exits Loss of investors Profit and liquidity pressure Risk (breadth and depth) Interbank liquidity Margins under pressure Capital adequacy Asset valuations Retail Margins under pressure Asset valuations

Financial crisis and impact on Islamic finance Date Consequences Financial crisis and impact on Islamic finance Impact Profitability Liquidity Impairment Lack of exits Margins under pressure Fee earning activities Asset growth Interbank liquidity Mistrust Transparency Fear Capital Credit squeeze Lack of confidence Leverage Regulatory capital decline Increased risk

What do we need, 2010 and beyond? Date What do we need, 2010 and beyond? Robust infrastructure Greater levels of transparency Robust business models A number of initiatives would need to be considered – starting at the grass root level from investor education, to regulatory regimes. The banking system, the regulatory infrastructure should consider the business models that allow Sharia compliant banking in its true spirit keeping in mind the underpinning ethical and social values that Shari’a stands for. One must at all costs consider avoid the system of shadow banking that was witnessed in the recent crisis – investment firms had introduced a parallel banking system. Innovation had resulted in Citi carrying more than double its on balance sheet exposures in Qualifying Special Purpose Entities (QSPEs). At the end of 2007, its on balance sheet mortgages were $313 bn versus $601 bn off balance sheet mortgages as per the 10K filings – an almost 1/3rd 2/3rd split!. Avoiding greed from the system requires much attention. The

From survival to sustainability* Thank you madhukar.shenoy@bh.pwc.com Date © 2010 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP (US). PwC