Study on Islamic Finance and Products.

Mohammed Saleem .OA salimvettom@gmail.com

Objective of the Study
Primary objective

To study the Islamic financial system, its products and merits.
Secondary objective To study the use these financing techniques To analyze the feature of Islamic products with conventional financial products.

Financial System
The system that allows the transfer of money between savers and borrowers. Instruments & Institutions to transfer funds from saving surplus units to saving deficit units in the most efficient manner. It facilitates intermediation between savers (fund provider) and investors ( fund user)

Financial System Efficiency
Promotion of efficiency is the primary goal of every Financial System. It is measured in terms of efficiency achieved in mobilizing savings from saving surplus units in the economy and in allocating these funds among saving deficit units. Increase in the range of financial assets and instruments would improve efficiency in mobilization of funds.

For Improving Allocational Efficiency it Needs
Less transaction cost Simplified transaction system Availability and accuracy of information Should be a stable system.

Islamic Fianacial System
Financial institutions and instruments which are functioning on the basis of directions and rules in shariah (a set of rules that governs every aspect of Islamic life) are known as Islamic financial system. In conventional finance there is a tug of war between ethics and efficiency. In Islamic finance ethics dominate all the concerns. The Shari'ah specifies, inter alia, rules that relate to the allocation of resources, property rights, production and consumption, and the distribution of income and wealth

Shariah Prohibits
Riba: which is taking or giving of interest Masir : which is involvement in speculative and gambling transactions Gharar : which is uncertainity about the terms of contract or the subject matter, eg. Prohibits selling something which one does not own. Investment in business dealing in alcohol, drugs, gambling, armaments, etc. which are considered unlawful or undesirable.

Why Interest/ Riba Prohibited

Prohibition of interest is not limited to Islam it is prohibited in Judaism and Christianity Key objective is to ensure SOCIAL JUSTICE Money is only a medium of exchange, no value in itself. Therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else Results in concentration of wealth Interest can leads to injustice and exploitation in society.

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Principle of Islamic Finance
Freedom to contract Freedom from Riba Freedom from Algharar Freedom from gambling and unearned income Freedom from price control and manipulation Mutual cooperation and solidarity

Global Islamic Finance Industry
1963: Mit Gamir Project, Egypt. 1975: IDB, Jeddah 1975: Dubai Islamic Bank Growth Rate : 10-15% 300 Institutions over 75 countries USD 800 billion under management. Expected tocontinue with assets growing USD 1 trillion by 2010. Islamic Window : ABNAmro, HSBC, City Bank

Islamic Finance Products
Investment Financing Trade Financing Lending

Musharakah ( Joint Venture)
Musharaka is similar to a joint venture, whereby two parties (an Islamic Financial Institution and a Client) provide capital for a project which both may manage. Profits are shared in pre-agreed ratios but losses are borne in proportion to equity participation

Client Business Venture

Bank

Profit / Loss

Mudaraba – Trustee Partnership
Mudaraba is a contract between two parties: One of them provides finance ( Rab ul maal) & other uses his labour and expertise (Mudarib). Profit, if earned, is distributed between the two parties in accordance with the ratio as per the agreement. Financial Loss, if suffered is borne by the investor only.

Client

Bank

Business Venture

Profit

Loss

Murabaha ( Mark upSales)
The client orders an Islamic Bank to purchase certain goods at a specific cash price The Bank purchase these goods from the supplier and sells to the client at a marked – up price ( Cost + Profit). The differed price may be paid up on lump sum or in installment
Cost + Profit
Goods / Ownership

Cost Ban k

Client

Ijara ( Lease)
A contract under which an Islamic bank finances equipment, building or other facilities for the client against an agreed rental. The ownership remains with the lessor bank and can be transferred on predetermined basis.

Salam ( Forward Selling)
Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract.

Istisna
It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery.

Qard Hassan ( Charitable Loan)
It is an interest free loan. Only loan permitted by Shariah. The loans are made from the pooled donations of the members, Zakat and are generally granted to those who are facing emergency personal crisis.
Activity Client approaches Bank for loan and offers collateral security. Bank lends an amount to client. Client repays amount to Bank (with or without administrative expenses) in part or in full

TAKAFUL (INSURANCE)
Takaful, the Islamic alternative to insurance, is based on the concept of social solidarity, cooperation and mutual indemnification of losses of members. It is a deal among a group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them, out of the fund they donate collectively.

What Distinguishes Islamic Banking

Transactions are asset-based It is socially-responsible banking because it operates under Shariah restrictions Does not permit financing of prohibited goods / Industries It starves evil out of the society Ethics and moral values play a major role in investment decisions. Not a choice but a must

Distinguishing Features
Conventional Banking - Conventional banking prices money. Islamic Banking - Islamic banking prices goods and services which creates real wealth in the society leading to economic well-being. - Is based on profit sharing on deposits side, and on profit on assets side.

- Is based on fixed return on both Sides of the balance sheet.

Distinguishing Features
Conventional Banking - Does not involve itself in trade and business Islamic Banking - Actively participates in trade and production.

- Depositors get a fixed rate regardless of the bank’s profitability, thus insulating them from the bank’s true performance.

- Profit is shared with the depositor, higher the bank’s profit, higher the depositors income.

Basic Difference between Islamic and Conventional Modes of Finance Conventional
money Bank money + money (interest) Client

Basic Difference between Islamic and Conventional Modes of Finance Islamic
Bank Goods & Services money Client

Performance of Islamic Finance
In comparison with conventional banking systems, Islamic bank’s assets and deposits have grown at GR of 20-22% while those of conventional banks have grown at a rate of 11% for the period 2002 – 2005.

Key Isuues Taxation & Legal Issues Risk Management Regulatory Issues Fragmentation

Conclusion
Islamic Finance assures Equitable distribution of risks and rewards among the stakeholders Inculcating market discipline and higher ethical standards given its emphasis on non-exploitation and social welfare. It may be observed that Islamic finance is far more interesting and complex than conventional finance as far as financing techniques are concerned.

it is in the area of assets rather than in liabilities that the practices of Islamic banks are more diverse and complex than those of conventional banks. it is generally believed that Murabahah is the most widely used technique and that the majority of the financing provided by Islamic banks goes to short-term trade and the financing of real estate.

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