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Introduction
à   

Ô Financial system can be defined as processes and
procedures used by a firm's management to exercise
financial control and accountability.

Ô The principal role of a financial system is to bring


together economic agents with surplus financial resources
and those with net financial needs.
Ô The parties can be brought together directly or indirectly.
Ô The parties with excess financial resources directly finance
those with financial needs are known as direct finance.
Ô If the parties with indirectly finance with financial needs
through intermediaries are known as indirect finance.
   

The main constituents of financial system are:
Ô ’. Money
Ô 2. Financial Instruments
Ô 3. Financial Market
Ô 4. Financial Institutions
Ô 5. Central Bank

Ô inancial Institutions: The modern name of Financial


Intermediary (FI), because it mediates or stands between users and
providers of Fund and helps transfer of funds from one to another.
The financial system helps production, capital-accumulation, and
growth by
Ô ¦ncouraging savings,
Ô Mobilizing them, and
Ô Allocating them among the alternative uses and users.
   


Ô inancial Instruments:
Ô bank deposits, life insurance policies, mutual fund unit
certificates.
Ô Share of bank is a secondary instrument.

Ô inancial Markets:
Ô Financial markets are ones in which funds are transferred
from those who have excess funds available to those who
have a shortage.
ë   
  

’. The saving function provides a potentially profitable and relatively


low- risk outlet for the savings of the people;

2. liquidity aspect provides a means of raising funds by converting


securities and financial assets in the form of cash;

3. payment technique provides mechanism for making payments for


purchase of goods and services to meet the needs;

4. policy determination provides a channel for Government Policy to


achieve the goals of high employment, low inflation, economic
growth and stability;
ë       

. wealth creation provides means to preserve purchasing


power until the resource is needed at a future date for
spending on goods and services;
^. credit supply provides a continuing supply of credits for
business, customers and government to support both
consumption and investment;
7. risk avoidance provides means to protect business,
consumers and government against risks to people, property
and in come;
8. investment opportunities provides opportunities for
investment of surplus funds in various profitable as well as
risk- controlled sectors of the economy for equitable
mobilization of economic resources and production of
essential commodities to maintain a just living standard of
the people of the society, etc.
  

Ô Islamic finance is emerging as a rapidly growing part of the financial
sector in the Islamic world.
Ô Islamic finance is not restricted to Islamic countries, but is spreading
wherever there is a sizable Muslim community.
Ô The Islamic financial system is founded on the absolute prohibition
of the payment or receipt of any predetermined, guaranteed rate of
return.
Ô This closes the door to the concept of interest and precludes the use
of debt-based instruments.
Ô The system encourages risk-sharing, promotes entrepreneurship,
discourages speculative behavior, and emphasizes the sanctity of
contracts.
º
         

Ô ºature:
Ô absence of interest- based financial institutions/transactions,
doubtful transactions,
Ô stocks of companies dealing in unlawful activities,
Ô unethical or immoral transactions such as market
manipulations, insider trading, short- selling, etc.

Ô Ñ ectives:
Ô based on Islamic Law,  , which is to be treated as an
important vehicle to transfer funds from the surplus to the
deficit units.
     

Ô The term ³Islamic Finance´ refers to a system of financial


activity that is consistent with Islamic law (Shariah)
principles and guided by Islamic economics.

Ô Islamic law prohi its usury, the collection and


payment of interest, also commonly called ri a in
Islamic discourse.

Ô Islamic law prohibits investing in usinesses that are


considered unlawful, or haraam.
   
 
3 inancingproducts
Profit sharing financing products:

Musharakah Ô ¦quity participation, investment and management from all partners;


[  Ô profits are shared according to a pre-agreed ratio;
Ô losses according to equity contributions.

Mudarabah Ô A profit-sharing partnership to which one contributes the capital and the other
[  the entrepreneurship; or
Ô the bank provides the capital, the customer manages the project.
Ô Profit is shared according to a pre-agreed ratio

Qard Hasan Ô Charitable loans free of interest and profit-sharing margins, repayment by
 installments.
Ô A modest service charge is permissible.

Wakalah Ô An authorization to the bank to conduct some business on the customer¶s behalf
[
 

Hawalah Ô An agreement by the bank to undertake some of the liabilities of the customer
[
 for which the bank receives a fee.
Ô When the liabilities mature the customer pays back the bank
   
 
Ôdvance purchase financing products:

Murabahah Ô A sales contract between a bank and its customers, mostly for trade
[  financing.
Ô The bank purchases goods ordered by the customer;
Ô Customer pays the original price plus a profit margin agreed upon by the
two parties.
Ô Repayment by installments within a specified period

Istithna¶ Ô A sales contract between bank and customer where the customer specifies
  goods to be made or shipped,
Ô Which the bank then sells to the customer according to a pre-agreed
arrangement.
Ô Prices and installment schedules are mutually agreed upon in advance.

Mu¶ajjal Ô Purchase with deferred delivery;


Bai Salam Ô A sales contract where the price is paid in advance by the bank
  Ô the goods are delivered later by the customer to a designee
   
 
Ôdvance purchase financing products: continuing
Ijarah Ô Lease and Hire Purchase;
 Ô A contract under which the bank leases equipment to a customer
for a rental fee;
Ô At the end of the lease period the customer will buy the
equipment at an agreed price minus the rental fees already paid.

3  
 

Wadi¶ah €eposits, including current accounts (giro wadi¶ah)


[ 
Mudarabah €eposit products based on revenue-sharing between
[  depositor and bank, including savings products
withdrawable at any time and time deposit products

Qard al-Hasanah Usually for charitable purposes


3
 
 

Tadamun, Takaful  -   Islamic insurance with joint risk-sharing

3    




Baitul Qirad !"# $ House of loans

Kafil %Tadamun,
 Takaful  -  Guarantor
 Islamic insurance with joint risk-sharing

Infaq &%'  ¦xpenditure

Mudharib  The project in a mudarabah contract

Shirkah [ -[( Partnership

Rahn ) Collateral agreement

Sadaqaat *"+, Worship

   


 
3    
3   

Shar'iah [( - Islamic law

Shirakah fi al-uqood Voluntary contractual agreement for joint investment


 ./ 0 [ ( and the sharing of profits and risks.

Takaful  Solidarity, mutual support as the basis of insurance

Wakil   Agent

Zakat 1 2 Obligatory charity, Islamic tax

   


 
G    


Ô Islamic financial system is a set of rules and laws,


collectively referred to as 6  ,

Ô  originates from the rules dictated by the  


and its practices, and explanations rendered (more
commonly known as  ) by the Prophet
Muhammad.

Ô Further rules is provided by scholars in Islamic


jurisprudence within the framework of the   and
 .
G    

’   


Ô , a term literally meaning "an excess" and interpreted as "any
unjustifiable increase of capital whether in loans or sales".
Ô More precisely, any positive, fixed, predetermined rate tied to the
maturity and the amount of principal is considered  and is prohibited.

À  .
Ô As interest is prohibited, suppliers of funds become investors instead of
creditors.
Ô The provider of financial capital and the entrepreneur share business risks
in return for shares of the profits.

× 
  
 
Ô It becomes actual capital only when it joins hands with other resources to
undertake a productive activity.
Ô Islam recognizes the time value of money, but only when it acts as
capital, not when it is "potential" capital.
G    

î   


.
Ô An Islamic financial system discourages hoarding
Ô Prohibits transactions featuring extreme uncertainties, gambling, and
risks.

   
Ô Islam upholds contractual obligations and the disclosure of information
as a sacred duty.
Ô This feature is intended to reduce the risk of asymmetric information and
moral hazard.

^. Shariah-
 
.
Ô Only those business activities that do not violate the rules of 6 
qualify for investment.
Ô For example, any investment in businesses dealing with alcohol,
gambling, and casinos would be prohibited.

  

Ô 
      
3mura aha:

Ô One of the most widely used instruments for short-term financing


is based on the traditional notion of purchase finance.

Ô The investor undertakes to supply specific goods or commodities,


incorporating a mutually agreed contract for resale to the client
and a mutually negotiated margin.

Ô Around 75 percent of Islamic financial transactions are cost-plus


sales.

  

Ô ÿ
  3iara.
Ô Another popular instrument, accounting for about ’
percent of Islamic financial transactions, is leasing.

Ô Leasing is designed for financing vehicles, machinery,


equipment, and aircraft.

Ô €ifferent forms of leasing are permissible, including


leases where a portion of the installment payment goes
toward the final purchase (with the transfer of
ownership to the lessee).

  
Ô    


 3mudara a.
Ô This is identical to an investment fund in which managers handle
a pool of funds.

Ô The agent-manager has relatively limited liability while having


sufficient incentives to perform.

Ô The capital is invested in broadly defined activities, and the terms


of profit and risk sharing are customized for each investment.

Ô The maturity structure ranges from short to medium term and is


more suitable for trade activities.

  

Ô ¦   3musharaka.


Ô This is analogous to a classical joint venture.

Ô Both entrepreneur and investor contribute to the capital


of the operation in varying degrees and agree to share
the returns in proportions agreed to in advance.

Ô Traditionally, this form of transaction has been used for


financing fixed assets and working capital of medium-
and long-term duration.

  
Ô 

Ô €eferred-payment sale (   
) and deferred-delivery sale
(6
) contracts, in addition to spot sales, are used for
conducting credit sales.

Ô In a deferred-payment sale, delivery of the product is taken on the


spot but delivery of the payment is delayed for an agreed period.
Ô Payment can be made in a lump sum or in installments, provided there
is no extra charge for the delay.

Ô A deferred-delivery sale is similar to a forward contract where


delivery of the product is in the future in exchange for payment on
the spot market.
 
      
asisofifferences CS IS

Religiouselief Secular and separates religion Belief in unity of God and


from other parts of human life relates this belief to economic
life of a man.

reedomof Ô In socialism govt. enjoys Restrictive freedom is allowed


conomicactivity economic freedom in the light of Shariah both by
Ô In capitalism individuals the Govt. & / or individuals.
enjoys freedom.

Ñwnershipof Ô In Socialism - state Ô Allah is the exclusive owner.


means ownership is recognized. Ô Man is the caretaker of the
Ô In capitalism ± individual property.
ownership is recognized.
 
      
asisofifferences CS IS
Goalsoffinancial Ô In socialism - profit of the Ô Welfare of both here and
system society, hereafter.
Ô In capitalism - Individuals
profit.
Competition Ô In socialism ± No Ô Logical competition and
competition financial cooperation.
Ô In capitalism ± logical &
unethical competition

asisofeconomic Ô Capitalism ± Unequal riba or Ô Interest free,


system interest Ô Zakat &
Ô Compensation based.

Sourcesofthe Ô Intellectual¶s brain storming Ô €evine book µAl Quran¶ &


system of the economic problems of prophet¶s speeches.
men¶s life.
 
      
asisofifferences CS IS
Result Capitalism concentration of Maximum & equitable distribution
income & economic power in few of economic opportunities and
hands inefficiency. higher production in the society.

Socialenvironmental €o not consider the social & ¦nsure social & environmental
welfare environmental welfare. welfare.

Ñwnerexceptionin €ividend or part of profit in case Part of profit or loss.


respectofinvestment. of equity financing.

Lenderor ank¶s Interest Profit or loss sharing.


expectationintermsof
de tfinancing

Modesofinvestment Loan, overdraft & cash credit. Mudarabah, musharaka, murabaha


etc.
 
      
asisofifferences CS IS

Wealthdistri ution Socialism ± equal ¦quitable

asisofeconomic Capitalism ± Unequal riba or Interest free, Zakat & compensation


system interest based.

Sourcesofthesystem Intellectual¶s brain storming of €evine book µAl Quran¶ & prophet¶s
the economic problems of men¶s speeches.
life.

Result Capitalism concentration of Maximum & equitable distribution of


income & economic power in economic opportunities and higher
few hands inefficiency. production in the society.
 
      
asisofifferences CS IS

Socialenvironmental €o not consider the social & ¦nsure social & environmental
welfare environmental welfare. welfare.

Ñwnerexceptionin €ividend or part of profit Part of profit or loss.


respectofinvestment. in case of equity financing.

Lenderor ank¶s Interest Profit or loss sharing.


expectationintermsof
de tfinancing

Modesofinvestment Loan, overdraft & cash Mudarabah, musharaka,


credit. murabaha etc.