[Song Seungseop's Financial Light] 'Sukuk' in Islamic Countries Where Interest Playing Is Prohibited

Islamic Bonds Prohibited from Interest by Sharia Law
Bypass Route 'Sukuk' Discovered for Issuance
Method Inserting Real Transactions as Intermediate Step
Despite Advantages of Oil Money Inflow and Investment Diversification
Korea's Conservative Christian Opposition Causes Failure

Bahraini Dinar [Image source=Yonhap News]

Last week, a domestic construction company in Korea made news by issuing a 'Sukuk'. The term Sukuk, unfamiliar to many Koreans, refers to bonds issued by Islamic countries. But did you know that Sukuk has a very unique history and structure? In Korea, there was even an incident where members of the National Assembly were collectively threatened because of Sukuk. What are the characteristics of Sukuk, and why do companies want to issue them?

Sukuk originally referred to documents indicating rights, obligations, or financial contracts within Islamic culture. Simply put, you can think of it as an Islamic-style check or promissory note. It contained details about when the contracted money would be paid to the counterparty. According to historians, the first Sukuk transaction was confirmed in Damascus, the capital of Syria, in the 7th century. Muslim merchants actively used such Sukuk from around the 9th century.

Sukuk officially became a term referring to bonds issued by financial institutions around 1988. The Organization of Islamic Cooperation (OIC) legalized the use of Sukuk in response to the need for liquidity tools for financial companies. At the end of the 1990s, the Malaysian company 'Shell' issued the first modernized Sukuk, and in 2000, the Sudanese government issued Sukuk at the national level. In 2001, the Central Bank of Bahrain issued a $100 million Sukuk.

Islamic Sharia Law Prohibits Interest... So What About Bonds?

Logo of the Organization of Islamic Cooperation (OIC)

But something seems odd. Why did international organizations have to legalize bonds? And only by the 1990s? It is hard to readily accept that the bond system, which was already used in developed and developing countries, was only accepted then.

To understand this, you need to know about Islamic law, 'Shariah'. Not all bonds issued in Islamic cultural areas are considered Sukuk. They must be financial products that comply with the spirit of Shariah. A Shariah committee composed of jurists checks each product to ensure there are no violations of the law. Even after issuance, the committee monitors and supervises the bonds, and if any violation of the law is detected in the bonds or bond transactions later, the funds are reclaimed.

The biggest issue is the act of lending money and receiving interest, which Shariah prohibits. Shariah defines such acts as unearned income and forbids them. Compensation should only be earned through legitimate labor or investment. Therefore, in principle, issuing bonds was difficult because the nature of bonds is to receive money and later return the principal with interest.

The Islamic Workaround 'Sukuk'... Because Rent Is Allowed

Example of Sukuk Structure. Source=FSB Research Institute

So how does Sukuk fulfill the role of bonds? It uses real transactions. Imagine Company A wants to borrow money from Muslims. Company A cannot directly borrow money from Muslims because it would have to pay interest, which Muslims cannot receive. Instead, Company A sells a building to Muslims. The company continues to use the building but pays monthly rent to the Muslims. Shariah does not prohibit rent. Company A uses the money received from selling the building (investment funds) and pays monthly rent (interest). At the agreed time, the company repurchases (redeems) the building.

The issuance of Sukuk began to attract attention with the growth of Middle Eastern countries. Many Middle Eastern countries are rich in oil dollars. Through Sukuk issuance, companies can attract funds from these wealthy Middle Eastern countries. It also has the advantage of diversifying funding sources, which have been concentrated in the US and European developed countries, thereby spreading risk. As in the case of Company A, Sukuk investors own the underlying assets, so they tend not to withdraw abruptly even during crises.

Of course, Sukuk is not without drawbacks. Because real transactions are involved, its structure is more complex than traditional bond systems. Moreover, tax burdens may increase. Although Company A took these actions to receive investment funds, strictly speaking, it sold real estate. Naturally, it must pay taxes related to the sale. Depending on what assets are traded and how, capital gains tax, value-added tax, and acquisition/registration taxes may apply.

"If Sukuk Passes, There Will Be a Presidential Resignation Movement and Lawmaker Defeats"

Dato' Yusri Yusoff, then CEO of the Malaysian Exchange, is giving a speech at the Islamic Finance International Conference held at Lotte Hotel Seoul in November 2009.
[Image source=Yonhap News]

Korea also once showed great interest in Sukuk. In January 2009, former President Lee Myung-bak stated in a congratulatory speech at an 'Islamic Finance Seminar' that "Islamic finance is attracting global attention as a new source of funds and investment in the international market." Two months later, the Ministry of Strategy and Finance, Financial Services Commission, Ministry of the Interior and Safety, and Financial Supervisory Service formed a task force. In September of the same year, they announced support measures for introducing Islamic funds and submitted a bill to amend the Restriction of Special Taxation Act to the National Assembly.

Domestically, there was strong opposition to Sukuk, mainly from conservative Christian groups. Reports even emerged that Yoido Full Gospel Church's senior pastor at the time, Cho Yong-gi, said that "if the government continues to push the Islamic bond law, there will be a movement to impeach President Lee Myung-bak." Members of the National Assembly on the Planning and Finance Committee received threatening messages, and representatives of Christian organizations said they would campaign against lawmakers who supported the Sukuk law.

Editor's NoteFinance is difficult. Confusing terms and complex backstories are intertwined. Sometimes, you need to learn dozens of concepts just to understand one word. Yet finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even those with no financial knowledge can immediately understand these 'light' stories that illuminate the 'light' of finance.

This content was produced with the assistance of AI translation services.