Financial System Defined

The financial system provides a mechanism whereby an individual, firm or household, who is a surplus spending unit (SSU), may conveniently make funds available to a deficit spending units (DSUs) who intend to spend more than their current income. The key word conveniently the financial system will be so developed and mechanism for transactions so designed and rule and regulations for dealings so formulated that both the supplier and demanders of funds will not face any difficulties while they will be transacting with each other

Islamic Financial System Defined

The Islamic financial system provides a mechanism whereby an individual, firm or household, who is a surplus spending unit (SSU), may conveniently make funds available directly or indirectly to a deficit spending units (DSU) on a participatory basis.

CONSTITUENT AND FEATURES OF CONVENTIONAL FINANCIAL SYSTEM

Mechanism: Based on both Financing mode and Investment mode. Institutions: Commercial Banks, Depository Institutions, Credit Unions, Finance Companies, Merchant Banks, Leasing Companies, Investment Banks, Stock Exchange

CONSTITUENT AND FEATURES OF CONVENTIONAL FINANCIAL SYSTEM

Instruments: (long term) Ordinary Share, Cumulative and non-cumulative preference share, debenture and bonds Instruments: (Short term), commercial paper, CDs, financial paper, marketable securities Reward : Both interest and profit is considered. Profit is considered as reward for equity

CONSTITUENT AND FEATURES OF ISLAMIC FINANCIAL SYSTEM

Mechanism: Based on investment mode, buy mode and Lease mode Institutions: Mudarabah companies, PLS Institutions/banks, Finance companies, Leasing Companies, Investment Banks, Stock Exchange

CONSTITUENT AND FEATURES OF ISLAMIC FINANCIAL SYSTEM

Instruments: Ordinary Sahre, Mudaraba bonds, noncumulative preference share, Short term investment paper, Reward: Profit and Rent

Components of Financial System

Financial Market where SSUs can invest or lend their funds directly to the DSUs. This is called Direct Finance. Examples are market for Stock and corporate bonds. Financial Intermediaries - various institutions such as banks, savings and loan associations and credit unions - that as go-between to link up SSUs and DSUs. Here the linkage between saver and borrower is indirect. This is called Indirect Finance. .

Financial intermediation and its advantages

The process that channels funds from savers to users to make investments is referred to as financial intermediation. Under conventional system financial intermediaries borrow from the savers against a deposit interest rate and lend the same to the ultimate users/borrowers against a leding interest rate higher then the deposit interest rate. Under Islamic system both procurement and disbursement of fund is done on a participatory basis.

The advantages of financial intermediation

It allows smaller businesses (for whom stock and bond issuance is impractical) access to saving funds. Allows savers to purchase assets that are relatively safe and more liquid and also earn interest/profit. financial institutions can pool their funds and diversify their investments, thereby reducing risk to small savers. Saving deposits are insured by regulatory agencies.

Disadvantages of financial intermediation

It increases the cost of financing It deprives the ultimate savers by giving a lower rate of interest/profit It encourages effortless income It helps concentration of wealth It imposes all burden on entrepreneurs

Islamic Attitude towards Financial Intermediation

Islam permits financial intermediation although it prefers direct financing. Islam allows financial intermediation only if it is free of interest. Financial intermediation in Islam is based on sharing of profit and loss. A two-tire Mudarabah system is the model for financial intermediation within Islamic Shariah.