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Evaluation of the Viability of the Sukuk

This proposal aims to evaluate the current status and the viability of the Islamic financial Securities such as Sukuk as an alternative of the conventional financial securities like Eurobond in the context of the current financial crisis. I will outline the overall aims and objective of the research and discuss the various studies on growth of Islamic finance and decline of conventional finance in the background of the financial crisis. This paper will reflect an overall structure of the whole proposal.


In the financial global market, the Islamic financial services sector is analysed to be gown at double digit rate(Bley& Kuehn, 2005), involving over 200 financial institutions with assets estimated to exceed US$ 200 billion(Al-Dhahiri et al, 2003). Researchers (Hamwi & Aylward, 1999) already has recognised that over the last decade, Islamic banking and finance has experienced global growth rates of 10-15 percent per annum, and has been moving into an increasing number of conventional financial systems at such a rapid pace that Islamic financial institutions are present today in over 51 countries (Sole, 2007 pp:1).

This research is aimed at investigating the practicability of the Islamic Financial system as an alternative to the traditional financial system especially in the context of the recent financial crisis.

The fast growth of Islamic banking and finance raises different important questions: Is the development in Islamic banking and finance a result of the comparative advantages of the Islamic banking concept or is it largely attributable to the worldwide Islamic recovery since the late 1960s (Chong & Liu, 2007). The fact that Islamic laws forbid paying and receiving interest promote all parties in a financial transaction to share the risk and profit or loss of the project (Qorchi, 2005). In an Islamic contract the output and the quality of the project, ensures a more equitable distribution of wealth (Qorchi, 2005).


The overall aim of this research is to review and evaluate significant growth of Islamic finance and financial securities as an alternative of the traditional financial system and financial securities which led to the current financial crisis. The objectives of the research can be further identified as:

(1). the recognition of the basic concepts of conventional and Islamic financial system.

(2). How did studies deal with financial crisis and its effect on the traditional and Islamic banking system.

(3). what are the effects of current financial crisis on traditional bond market?

(4). How does the Islamic Finance response to the crisis?

(5). Is Islamic Securities ―Sukuk‖ feasible?

(6). If Islamic Sukuk is feasible then can it replace the traditional Eurobonds?

(7). If it is not feasible then can it co-exist with the traditional Eurobonds?


Conventional Financial system

Everyone has to contact with the financial system and everyone is very well aware of the financial institution like banks, building securities, and insurance companies, each providing in its own way for every day needs, such as payment facilities through banks, convenient savings and access to home loans from building societies, and car, house, or life insurance. The other financial markets, like the Stock exchange where the securities are bought and sold, are an important market though very few are directly concerned with their activities (Van Harne, 1990). All these financial institutions and markets fit together into a network which comprises the financial system or conventional financial system (Brian, 1992).

The conventional financial system based on debt and the fixed rate of interest. The borrower in gaining the high fixed returns may get default as these bonds and corporate securities are not backed by the assets or gold. The burden and all risk are transferred on the issuer. Therefore in try to get high returns and greed of getting more financial share the conventional borrower and mortgage prices went up which result in the drying up the financial market and major companies got default.

Islamic Financial System

The Islamic financial system makes possible lending, borrowing and investment functions on a risk-sharing basis (Ishaq & Mansoor, 2008).

Islamic finance is fundamentally different from the conventional finance model as it is based on a profit and loss structure (PLS), which requires that a financial institution invest with a client in order to finance their needs, rather than lending money to the client. Because of the inherent risk involved in an investment, the financial institution is entitled to profit from the financial transaction (IBID). (SBP, 2007). Islamic banking and finance industry has been making breakthrough developments to become a truly feasible and competitive alternative to conventional systems at the global level as an industry adding more ethical, competitive, flexible and diversified tools and systems to global financial markets‖ (Ishaq & Mansoor, 2008 pp: 708).

The need for Islamic banking is prompted by three considerations:

(a). An Islamic investor should keep away from alliance with industries forbidden to Muslims: such as; alcohol, gambling, pornography, meat packing (of pork), weapons production, and liquor.

(b). An Islamic enterprise is advised to avoid interest (riba), as well as gambling, and, accordingly, constraints exist on transactions involved in debt securities and in futures and options.

(c). Many Muslim investors tend to be attracted to enterprises monitoring the Islamic ethical and moral standards (O‘Sullivan, 1996).

The Islamic finance industry has grown by about 15 percent on average over the last three years, with more than US$500 billion now lodged in Islamic banks, mutual funds, insurance schemes (takaful), and Islamic branches of conventional banks (Jobst, Kunzel, Mills, & Sy, 2008). Islamic Law prohibits charging interest (Rajesh, K.A & Yousaf, T., 2000).

Islamic banking is currently practiced in more than 51 countries worldwide. In countries such as, Iran, Pakistan, and Sudan, only Islamic banking is practiced whereas other countries, such as Bangladesh, Egypt, Indonesia, Jordan and Malaysia, Islamic banking co-exists with conventional banking (Chong & Liu, 2007).

Therefore Islamic banking, is not limited to Islamic countries as In August 2004, the Islamic Bank of Britain became the first bank licensed by a non-Muslim country to engage in Islamic banking (Chong & Liu, 2007).


Islamic securities have become increasingly popular in over the last five years, both as a means of raising government finance through sovereign issues, and as a way of companies obtaining funding through the offer of corporate Sukuk (Wilson, R., 2008) as Sukuk is to be use as a tool for liquidity management (Wilson. R., 2008), the Sukuk market continues to generate strong interest by new issuers in Muslim and non-Muslim countries.

Sukuk (plural of Sakk) are commonly referred to as an Islamic bond, but a more precise translation of the Arabic word would be an Islamic investment certificate‘‘(Thomas, 2005).

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines the Investment Sukuk as a certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity‘(Norman, T.,2009).

Sukuk is an Islamic financial certificate, similar to a bond in Western finance that complies with Sharia, Islamic religious law. As the traditional Western interest paying bond structure is not permissible, the issuer of a Sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value (investropedia, 2009).

Sukuk are monetised real assets (converting a government debt into available currency, especially issuing securities, that are liquid (easy to convert into cash), easily transferred and traded in the financial market (Adam, 2006).

Likewise the Eurobonds are also liquid assets which are marketable and accepted by all the investors (, 2005). Eurobonds are issued by a government, company shows potential to repay borrowed money at a fixed rate of interest at a specific time. Eurobonds are liquid and trusted bonds as it is backed by a fixed interest rate (ibid).

Sukuk can be examined without any difficulty by international and regional rating agencies which facilitate their marketability (Adam, 2006).

Likewise the Eurobonds are easily rated by the rating agency as these rating agencies rate these securities on the basis of the liquidity and the liabilities not on the basis of the religion and ethics (Standard & Poor‘s, 2009). As the agencies do not rate the securities on the basis of the religion, rather securities are rated on the basis of the quality and the ability of obligator to meet the obligations (ibid).

Same like the similarities in the Islamic and conventional financial securities, there are few differences as well, and on the basis of that one system can be preferred on the other system. Starting from the type, the conventional financial Security is a debenture bond whereas the Sukuk are the Secured securities. Debenture bonds are those securities that is unsecured corporate bond by any mortgage, dependent on the credit of the issuer (Dictionary, 2009).

Whereas the Sukuk are backed by the real assets such as they are attached with the assets which can be turned into tradable in the future or can be replaced by the real assets (Richardson & Abdl-Khaleq, 2007). Eurobonds are paper bonds whereas the Sukuk securities are really assets based security which have potential to convert the security into tradable asset in future.

Secondly, the major difference in Sukuk and conventional bond is the right of ownership. As Sukuk represent the ownership opportunity in existing or well described assets whereas conventional bond represent pure debt on the issuer (Adam, 2006).


The relative success of the Islamic finance is remarkable (Bley & Kuehn, 2005)as islamic finance institution are making progress with the grwoth rate of 15-18% which is double the average growth rate of conventional finacial institutions (Saifi, 2004). We will discuss A review of the litrature on traditional financial system (TFS)and Islamic financial system( IFS) and the security markets. That is devided into sections as will be reviewing the litrature on the decline of the popularity of the TFS and the growth of the IFS over the last two decades. The litrature review basically discuss information of three area on which research will be carried: (a) traditional banking system and its downfall, (b) islamic financial system and its growth, and (c) the empirical investigation of the feasibility of islamic financial securities to alternate the traditional finacial bonds to raise funds for the projects.


The current collapse of banking and financial institutions raised a question as interest rate has long been recognized not only by classical and neo-classical economists but also by contemporary economists as one of the factors that determine the level of savings in the economy. Although there are cases of inconsistent findings, it is a generally accepted opinion that interest rate has a positive relationship with savings (Ahmad & Haron, 1999). Generally, financial institutions perform two functions; one is to collect deposits and the other is to issue loans (Toutounchian, 1996).

Depositors are guaranteed a predetermined return on the nominal value of the deposit by the bank even in most of the cases the deposits are insured (ibid). Hence it can be argued that the traditional financial system plays a passive role in the economy, is operating to face any economic fluctuations (ibid). It is argued that in these banks since the nominal value of the deposits is guaranteed…shocks that can lead to banking crisis can cause divergence between real assets and real liabilities and it is not clear how this equilibrium would be corrected and how long the process of adjustment would take‖ (Mohsin, 1985). This is the real essence of fund intermediary function of a traditional finance (Toutounchian, 1996).

Islamic finance can simply be defined that it is based on the basic principle of the prohibition of the riba as Islamic institutions does not charge interest but rather participates in the yield resulting from the use of the funds( Lewis & Algaoud, 2001).

Ebrahim & Safadi ( 1995) advocates that islamic finance operations are according to the profit and loss sharing principle which are superior financial security to debt for many reasons including risk sharing of the equities (Hamwi &Aylward, 1999.

Liu & Chong(2007) are of the view that the islamic finance is not different from the conventional finance as the unique feature Profit and Loss sharing (PLS) practically is very similar to the TFS as islamic financial products based on the PLS are not interest free beacuse pegged to conventional deposits(ibid).

On the other hand the basic pillar of the conventional financial system is interest rate and fixed income securities have been accepted globally in raising finance for funding large development and capital expenditures (Usmani, 2006). A fixed income security is an investment which provides a return in the form of fixed periodic payments and ultimate returns of principal at maturity (Usmani, 2006).

The motivations of firms that issue global bonds is particularly to test whether firms are motivated to offer bonds in multi-markets to raise more capital, take benefit of being well-known in foreign markets and owing to poor domestic economic conditions (Tawatnuntachai & Yaman, 2008).

The bond market robustness converts into depression when financial crisis which started in 2007 has created the greatest financial dislocation since the Great Depression of the 1930s (Melvin & Taylor, 2009). The Eurobond which are based on fix interest rate and guaranteed of fixed return failed to impress the investors in an auction (Kaminska, 2009).

In addition, the loans rate set in the fixed income market will have large effect on the demand for properties, and thereby prices, one would strongly believe that securitised property prices are determined by the interest rate changes rather than the stock market (Cheong, Wilson, & Zurbruegg, 2009). Financial markets are intergrated now a days and no single economy can avoid the effect of the financial crisis (Chapra, 2007). If the financial system is not responsible for the crisies then why there is a general nervous feeling that ―something is wrong with the financial system‖ (Stiglitz, 2003, p: 54

On the other hand, the Islamic finance manages the affair without involving the pre-agreed interest payment and receipts that replace the interest-based intermediation between the borrower and the lender with profit and loss sharing and equity based link (Bhatti & Khan, 2009).


The credit crunch refers to a sudden shortage of funds for lending, leading to a resulting decline in loans available (Blog, 2008). A Credit Crunch can occur for various reasons such as sudden increase in interest rate, direct money controls by the governments and a drying up of funds in the capital market (Blog, 2008).

The crisis started in 2008 in US supreme mortgage market and widely spread all over the world which raised a question that why this has system collapsed which leads the splillover effects from US sub- prime crisis to UK by far the most transparent and worrying for the authorities that exposed the tension between the central banks with respect to the provision of liquidity support facilities, the difficulties inherent in the economy for dealing with the banking crisis, defects in banking economy regulation and supervision and the glaring flaws in deposit protection arrangements (Maximilian, 2008).

Islamic Finance Response to Crisis

Principles of Islamic Finance

The first principle has an effect on the depositors ‘behaviour and their decision-making process. The choice of action is based not only on the immediate financial returns but also on those returns in the hereafter. Since Islamic banks operate on an interest-free basis and their establishment is designed to improve Muslim communities.

In the case of the second principle that involves wealth, Islam has given a clear guideline to be followed by Muslims.

The essence of Islamic finance summarised by the Charles & Fèvre, 2006 is as following:

Interest rate, taking or receiving on transactions is prohibited.

Capital must have a social and ethical purpose further than pure, unfettered return;

Investments in those businesses which are dealing with alcohol, gambling, drugs or anything else that the Shari’ah considers unlawful and unwanted, are prohibited.

Transactions involving masir (speculation or gambling); gharar, or uncertainty about the subject-matter and terms of contracts are forbidden which includes a prohibition on selling something that one does not own.

As the interest-earning on investments are restricted, Islamic banks obtain their earnings through profit-sharing investments or fee-based returns (Charles & Fèvre, 2006). Traditionally an Islamic bank offers two kinds of services: firstly; it provides services for those on a fee or a fixed charge, such as safe deposits, fund transfer, trade financing, property sales and purchases or handling investments (IBID). Secondly; those that involves joint ventures in investments and the sharing of profits and losses (Charles & Fèvre, 2006).


Methodology is a set of tools, techniques, procedures and investigative methods, used to collect, store, analyse and present information. Scientific methodology involves the development of hypotheses and predictions, investigating the manipulation of particular variables while maintaining all other variables constant, using measurable, objective measures and statistical analyses in order to come to conclusions about the topic under investigation‖ (, 2009). Research can be defined as “something that people undertake in order to find out things in a systematic way, thereby increasing their knowledge� (Saunders et al, 2003). Research methods are the means by which knowledge is acquired and constructed within a discipline. It needs to be both relevant and rigorous in order to be accepted as legitimate within a particular field of knowledge (Harvey & Myers, 1995).whereas Leedy Research methodology can be explained as the process carried out to achieve the overall aim and objectives of the research (Saunders et al, 2003).

What does Research Methodology Include?

The research methodology involves primary data and secondary data. The primary data collected are more consistent with our research questions and research objectives. With the help of primary data the reasons behind consumer behaviour, management decisions or problems faces in internationalisation efforts can be identified (Ghauri & Gronhaug, 2005). According to Hussey and Hussey, (1997, pg.149) ―original data is known as primary data, which is data collected at source‖. Primary research provides information and data which doesn‘t already exist. Some of the methods of primary data collection include: Focus groups, Interviews, Observation and Questionnaires (Saunders et al, 2003). According to Saunders et al., (2007, pg.272) “data that have already been collected for some other purpose, perhaps processed and subsequently stored, are termed secondary data�. Data can be collected internally or externally from the available materials for literature. These materials come from books, journals, articles, research papers, conference proceedings, newspapers, theses and internet sources. It includes both quantitative and qualitative data and they can be used in both descriptive and explanatory research. Within business and management research such data are used mostly in case study and survey-type research (Saunders et al, 2003).

Research Methods

Generally available methodological options for Research are two: qualitative research and quantitative research (Ticehurst & Veal, 2000).

Qualitative Research

The purpose of qualitative research is to describe a certain process or problem, to interpret a particular problem and to develop new theoretical concepts and perspectives, to verify the validity of certain problem, and to evaluate the effectiveness of the chosen particular problem (Leedy, 2005). The qualitative analysis based on meaning expressed through words, symbols, interpretations, actions and behaviour (Thornhill et al, 2003).

Quantitative research

Generally, quantitative research is used to answer the question about relationships among measured variables with the purpose of explaining, predicting, and controlling phenomenon ( Leedy & Ormord, 2005). Whereas, Thornhill et al, (2003) stated that in quantitative analysis, the data is based on meanings from numbers. The collection results in numerical and standardised data and the analysis are conducted through the use of diagrams and statistics (Thornhill et al, 2003).

The aim of the project can be viewed as qualitative, explanatory, and comparative. To fulfil these aims, the study intends to use the qualitative comparative research strategy (Bryman& Bell, 2003). As Leedy & Ormrod (2005) noted that qualitative researchers commonly use triangulation for the validation of the research.

Comparative Analysis

Given the options, qualitative research will be carried out where the literature to be reviewed will be mainly secondary data. The results obtained from the data can be validated by using the above mentioned strategies and comparative analysis which is suggested by Leedy & Ormrod (2005) to fulfil the requirements of research. As the Max Weber (1968) also develop approach for social and economical analysis based on comparative method to identify that the researcher plays primary role in outlining research questions, categorizing elements of analysis, and the topics for comparison rather than assuming an objective separation of the researcher and data, as he is of the view that this kind of approach does not confuse researcher‘s conceptualization of the under research phenomenon and phenomenon itself. Comparative analysis facilitates researcher to investigate the problem from a recognized starting point and the investigate other aspects of the object during analysis (Weber, M., 1968 cited in: Google, 2009)

Data Collections and Methods

In order to achieve the aims and objectives of the research a series of the reviews will be conducted on available literature on Islamic Finance and Conventional finance, particularly the Islamic securities. Islamic source of finance, Al- Quran, Sunna‘ah, Sharia‘a Laws, and Hadiths books have been taken into account to get information about the Islamic financial principles, and the regulations which are applicable to the finance.

This research is based on secondary data which is collected by using research techniques, procedures and instruments such as

1. Journals

2. Books

3. Library‘s web based services such as ABI/Inform, Proquest system, Jstor, Emerald.

4. Newspapers

5. Internet and internet article

As qualitative comparative analysis will allow the researcher to outline the research objectives and categorizing the elements of the analysis and the choice of selection of the topic to analyse. The comparative analysis will helpful throughout the research to investigate the selected topic from a recognised point and researcher will be able to investigate the other aspect of the analysis.

The methodology will be persuaded towards an approach in order to analyse appraise views on the Islamic financial system and Islamic securities in detail as an alternative to the traditional financial system in the context of current financial crisis by presenting and discussing with supervisor as to how he see the future of Islamic and traditional banking following the direction in which it is undertaken.


This research may have few limitations The main concern is the collection of basic qualitative data from reliable sources mainly from university web based sources and Google scholar search materials; the challenge will be the identification of the reliable sources as often there will be situation where the results can vary from source to source. Sorting the reliable data from since the resources have vast options and all of them might not be having the same facts and figures which will be may required more time than expected in research process.

Another limitation that may occur and cause the research to be narrowed and summed up sooner is for the research to miss out on some useful information which would be useful if taken under consideration. As for the vastness of the topic it is a concern that could be distracting as religious validities can be possible but main focus will be managed throughout the research.

This research is a qualitative comparative analysis which is depending on the secondary data that may lead research to be limited as collection of data is generally more time consuming and the time is limited and it is not possible to studied wide range of literature which can make difficult to make a systematic conclusion.

Drawn Conclusion

Comparison of the both system (Islamic Financial System and Conventional Financial System, major will be the Islamic financial securities and conventional bonds) will formed the ground for the conclusion depending on the information gathered from research.

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