Assignment

ON
Submitted To :

Sir Shahzad Sadiq

Submitted By:

M.Asif Iqbal

M.Hamza Afzal

M.Ihtasham Akbar

M.Hamza Ali

Class:

BBA(Hons) 8th

Section:

A (Morning)

University of Education Lahore Multan Campus

 Islamic Banks Performance in Industrial lending.
Introduction: Commercial & Industrial (C&I) Lending C&I Lending
Defined:
A commercial and industrial (C&I) loan is any loan made to a business or corporation, as
opposed to an individual. Commercial and industrial loans provide either working capital or
finance capital expenditures such as machinery or a piece of equipment. This type of loan is
usually short-term in nature and is almost always backed by some collateral.

As of May 2020, businesses and corporations in the Pakistan have taken out more than $2.5
billion in C&I loans. These industry loans have become more popular over the last 20 years, as
they provide a means for smaller businesses to generate working capital or finance expenditures.

Any type of loan made to a business or corporation and not to an individual. Commercial and
industrial loans can be made in order to provide either working capital or to finance major capital
expenditures (such as equipment).This type of loan is usually short-term in nature and is almost
always backed with some sort of collateral. Renewed emphasis on C&I Lending versus
Commercial Real Estate Lending due to changes in the Commercial Real Estate market.

Change of Supply & Demand for Commercial Real Estate Loans

Change of attitude of Banking Regulators- FED, FDIC, OCC, State Shift Back to Original
Banking Roots!

Commercial & Industrial (C&I) Loan Products & Structure

a) Working Capital Line of Credit:
12 months, interest only
b) ABL Facility:
12 months, interest only 6 An asset based business line of credit is usually designed for the same
purpose as a normal business line of credit - to allow the company to bridge itself between
the timing of cash flows of payments it receives and expenses.
A non asset based line of credit will have a credit limit set on account opening by the accounts
receivables size, to ensure that it is used for the correct purpose. An asset based line of credit
however, will generally have a revolving credit limit that fluctuates based on the “actual”
accounts receivables balances that the company has on an ongoing basis. This requires the
lender to monitor and audit the company to evaluate the accounts receivables size, but also
allows for larger limit lines of credits, and can allow companies to borrow that normally
would not be able to. Generally, terms stipulating seizure of collateral in the event of default
allow the lender to profitably collect the money owed to the company should the company
default on its obligations to the lender.
Other Financing: Factoring
c) Equipment Financing:
1. Loans: 3, 5, 7, 10 year amortization
2. Leases: 3, 5, 7, 10 year amortization
Note Payable (regular promissory note)
TRAC Lease
This lease contains a Terminal Rental Adjustment Clause (TRAC) that guarantees your business a
certain residual price for the vehicle when the lease expires. This is the most common type of
lease for business owners who want the option of buying the vehicle for a pre-determined
price at the end of the lease.
“True” Lease Leasing commercial equipment with a True Lease or Tax Lease means you will not
have legal ownership of equipment, but will have use of such equipment for the term defined
in the lease. If the equipment you need is subject to rapid advancements in technology, such
as computers, the Tax Lease/True Lease is could be the best option. Financing commercial
equipment with this lease option can mean lower monthly payments and in many cases tax
deductions for lease payment amounts. (Lessor often retains “depreciation” rights).
d) Related Products & Structure
1. Letters of Credit (“carve out” of RLC)
a. Standby b. Commercial
2. Bridge/Bullet Loan
3. Seasonal Loan
Underwriting C&I Loans
a) Credit Scoring
b) Full-Underwriting
1. Basic Underwriting:
Loan Purpose, Loan Amount, Sources of Repayment, Guarantor Support, Collateral Issues,
Management Assessment, Risk Factors & Mitigation of Risk
2. Financial Statement Analysis
3. Tax Return Analysis c) SBA Guarantee

Documentation & Collateral Concerns of C&I Loans

a) Standard:
1. Promissory Note
2. Business Loan Agreement
3. Corporate/LLC Resolutions
b) Collateral Position:
1. Security Agreement
2. UCC-1 filing (General description or specific)

Managing the C&I Loan Porfolio

a) More “run-off” than Commercial Real Estate
b) More “time, money, and productivity” to create C&I “assets” than Commercial Real Estate
Lending (on a dollar per dollar basis) c) C&I Lending: More diverse, less concentration, in
theory, less risk!
d) C&I Lending: Can be “niche” player- specialist!
C&I Lending Scenarios
You are a VP-commercial loan officer and have worked for most of your banking career with large,
“income producing,” commercial real estate loans. With the “downfall” of the local
commercial real estate market, you have been reassigned to work almost exclusively with
C&I lending clients providing lines of credit and equipment financing (including “work-out”
situations). You realize that you have not worked on a “single” line of credit or equipment
deal in over 12 years.

Measuring the Performance of Islamic Banks .

INTRODUCTION.

The objective of this chapter is to describe fundamental concepts of Islamic finance along with
brief history of conventional and Islamic banking. Different modes and products of Islamic
finance are explained briefly to provide an introduction. This chapter also presents an overview
of the historical and current status of Islamic banking in Pakistan.

BANKING HISTORY OF THE WORLD

Ancient history of the world unfolds that in early ages temples were considered to be the safe
and sacred places for storing valuables - specially grain, gold, silver and other metals. In 18th
century BC priests used to offer loans. Code of Hammurabi is considered to be the first formal
law for financial services. In Roman Empire and ancient Greece, moneylenders used to provide
services for loans, deposits and investments along with converting money into local legal tender.
Extended travelling, across the continents- during Crusades and flourished international trade,
emphasized the need of financial services institutions. However, these financial services were
provided majorly by churches and were strictly interest free under the influence of Christianity
that prohibited extra payback. Valencia and Florence were the first cities, which awarded interest
a legal status in 1217 and 1403 respectively; and Florentine bankers started offering loans in
Europe on interest basis. These Florentine bankers used to sit for financial transactions on
benches covered with green cloth; that is why today’s word “Bank” is derived from Italian word
Banco which means bench (Schoon, 2009).

BANKING HISTORY OF PAKISTAN

The areas comprising of Pakistan had only 10 to 12 % of bank credit/ deposit of undivided India.
Only 500 branches, out of 3500 bank branches of united India, were operating in this region.
HBL is the only bank, existing in current scenario, which was established in 1941 before
independence of Pakistan. It shifted its head office from Bombay to Karachi after independence.
MCB and NBP were established in 1948 and 1949 respectively. SBP (State Bank of Pakistan)
was inaugurated in 1948 as the central bank of Pakistan. In 1974, banking sector of Pakistan was
nationalized. However, this policy was reverted in 1991, and denationalization and deregulation
brought very positive effects on banking industry. From 2000 onward, there has been a
tremendous growth in this sector. More than 50 banks are currently working in Pakistan.

HISTORY OF ISLAMIC BANKING

There are different types of legal modes of financing, which remained in practice in Islamic
history. Mudarabah and Musharakah are the most primitive ones. Prophet Muhammad (Peace Be
Upon Him) himself practiced Mudarabah agreement with Hazarat Khadija (May Allah Be
Pleased With Her). Many Muslims used to do business on Musharakah basis at that time.
Deposit acceptance, on the basis of trust, was a type of banking activity practiced in the early
days of Islam. Even non-Muslims and rivals of Islam used to deposit their valuables with Prophet
Muhammad (Peace be upon Him) and Abu Bakr Sedique (May Allah be pleased with Him).
People also used to deposit their valuables with Syedna Zubair bin Awwam (May Allah be
pleased with Him) in trust. But he accepted these as loan not as trust, so that he may remain
responsible of returning even in case of damage and able to use them in his own business. The
earliest references to the reorganization of banking on the basis of profit sharing rather than
interest are found in Qureshi (1946), Siddiqi (1948) in the late forties, followed by more
elaborate exposition of Mawdudi ([1950]1961) and Ahmad (1952). Muhammad Hamidullah in
his 1944, 1955, 1957 and 1962 speeches proposed a banking system based on the concept of
Mudarabah (profit and loss sharing). First International Conference on Islamic Economics in
Mecca held in 1976. Ahmad El Najjar established pioneer saving bank on the basis of profit
sharing in the Egyptian town of Mit Ghamr in 1963. This experiment led to the creation of the
Nasser Social Bank in 1971 under the control of Egyptian government. Although the bank is still
active, its objectives are more social than commercial. Inspired from the idea of Nasser Social
Bank, a group of Muslim businesspersons established the first private interest-free bank: the
Dubai Islamic Bank in 1975. However, the UAE and Kuwait governments also contributed 20%
and 10% respectively (Iqbal and Molyneux, 2005). The Islamic Development Bank, an inter-
governmental bank established in 1975 as a result of Conference of the Finance Ministers of the
Islamic Countries held in Jeddah, in 1973. Two more private banks were founded in 1977 under
the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti
government set up the Kuwait Finance House. Bahrain Islamic Bank was licensed in l979 by the
Bahrain government and now Bahrain has largest number of Islamic financial institutions (26
Islamic banks and financial institutions). Jordan Islamic Bank for Finance and Investment is
operating since September 1979.

Islamic Banking in the World

Where conventional banking today is facing challenges due to international financial crisis,
Islamic banking is growing at a wonderful rate of 15 % globally (Rosly, 2005). This extra
ordinary growth has encouraged conventional banks world over to offer this type of banking in
“Islamic windows”. Giant banking groups are leading this move. Citi Corp. has opened Citi
Islamic Investment Bank in Bahrain. In USA, UK, Germany and several other developed
countries, conventional banks including Citi, HSBC and Chase Manhattan have started Islamic
banking operations. Even many multinational corporations including IBM and General Motors
are adopting Islamic leasing for their financial needs (Samad, Gardner and Cook, 2005)

Islamic Banking in Pakistan

Foundation for the establishment of Islamic financial institutions is provided in Article 38(f) of
the Constitution of the Islamic Republic of Pakistan of 1973 that emphasizes the state to
eliminate Riba as soon as possible. In 1977-78, after the takeover of Zia ul Haq, Islamic banking
started in Pakistan with the elimination of interest from specialized institutions. In 1980, Council
of Islamic Ideology (CII) presented report on elimination of interest. Participation Term
Certificate (PTC) was introduced as a new interest free instrument. Mudarabah companies were
allowed to introduce Mudarabah certificates in financial market, under an ordinance. In 1985,
commercial banks converted their saving accounts from interest based to profit and loss based.
However, in 1991 Federal Shariah Court declared interest based banking practices in Pakistan as
Un-Islamic. Commission for Transformation of Financial System established in State Bank of
Pakistan in order to the establishment of legal structure for the Islamization of banking system of
Pakistan.

Till September 2010, Meezan Bank Limited, Al Baraka Bank (Pakistan) Limited1, Dawood
Islamic Bank Limited, Bank Islami Pakistan Limited and Dubai Islamic Bank Pakistan Limited
are full-fledged Islamic banks while twelve local and foreign banks have established 197 Islamic
branches in addition to 10 Islamic sub branches.

DIFFERENCE IN CONVENTIONAL AND ISLAMIC BANKING

Sources of income of conventional banks are interest spread and income from off balance sheet
activities. Interest spread is the difference between the interest charged on loans, and the interest
paid on deposits whereas income from off balance sheet activities includes service income,
brokerage and fee income. On the other hand, [44] Islamic banks earn revenue from the profit
sharing financing, and pay profit share to the depositors. Fee income for different services is an
important source of income of Islamic banks. Depositors are not guaranteed a specific pre-
determined interest income on their deposits, rather they become shareholders of bank or any
specific deal (Al-Omar and Abdel-Haq, 1996). Islamic banks are not allowed to finance any
Haram (illegal with reference to Islamic rules) business; no matter how profitable it is.

Principles of Islamic Banking and Finance

 Given that basic sources of Islamic jurisprudence are Quran, Sunnah, Qiyas and Ijtehad; Islamic
finance is also based on the principles derived from these sources. Islamic banking and finance is
based on the following principles (Samad, et al., 2005): I. Strict prohibition of Riba (interest) in
every transaction II. Compulsory payment of Zakat III. Prohibition of speculation and extreme
risk (Gharar) IV. Strict prohibition of production and consumption of Haram (illegal)
commodities.

Prohibition of Riba (Interest)

Prohibition of interest is the core of Islamic financial system. Chapra (2000) and Dar and Presley
(2000), among others, highlighted the reasoning of interest prohibition and need for profit and
loss sharing in Islamic finance. [45] “Riba” is any addition or increase and it may be described as
“any excess compensation without due consideration”. Islamic Shariah has pointed out two types
of interest Riba Al-nasi’ah and Riba Al-fadl. First type is advance fixing of extra payment
whereas, second is related with hand-to-hand selling and purchasing with extra payment; but
there is no exception in prohibition for both types because first type uses money as a source of
earning rather than a medium of exchange, and second may cause injustice and exploitation.
Former is the basic type of Riba, it is related to any predetermined amount additional to the
principal paid by borrower. It is also known as Riba Al Quran, as identified in Quran. Lateral
type is extra amount during the selling process achieved without consideration; also known as
Riba Al Hadees, for its declaration in Hadees (Usmani, 2002b).

“Those who benefit from interest shall be raised like those who have been driven to madness by
the touch of the Devil; this is because they say: “Trade is like interest” while God has permitted
trade and forbidden interest.” Surah Albaqra (2:275)

“O ye who believe! Be afraid of Allah and give up what remains (due to you) from Riba (usury)
(from now onwords) if you are (really) believers” Surah Albaqra (2:278). “And if you do not do
it, take notice of war from Allah and His messenger! But if you repent, you shall have your
capital sums. Neither should you commit injustice nor should you be subjected to it.” Surah
Albaqra (2:279).

“And that which you give in gift (loan) (to others), in order that it may increase (your wealth by
expecting to get a better one in return) from other people’s property, has no increase with Allâh;
but that which you give in Zakât (sadaqa - charity etc.) seeking Allâh’s Countenance, then those,
they shall have manifold increase” Surah Ar-Rum (30:39).

MODES OF ISLAMIC FINANCING:

Dar (2003) identifies four major classes of Islamic financial products:

a) investment-based
b) sales-based

c) rent-based

d) service-based Islamic banks working in many countries are offering variety of products in
relevancy of their corresponding commercial and cultural requirements. But these products are
developed on the underlying principals of Islamic philosophy. These products may be
categorized into following major modes of Islamic financing (Usmani, 2002b; Zaher and Hassan,
2001):

Investment Based Financing

Mudarabah In Mudarabah

financier (any person or bank), called Rab-ul-Maal, provides capital to an agent (Mudarib) for
any business project. Agent provides his labor and expertise, [51] and is responsible for running
the business, and financier has no role in management; hence also known as trust financing.
Profit is shared on any mutually agreed ratio but no fixed income is guaranteed. In case of loss,
bank loses its investment while entrepreneur looses the reward for his effort. Financier is not
responsible for more than its capital. Agent, however, may be forced to pay the loss if it is
proven that his negligence was the cause of loss. It is similar to the limited partnership in
Western business, which is suitable for short-term projects. Mudarib works in the capacity of
partner, agent and trustee of the financier being liable for the loss due to some carelessness or
malpractice.

Musharakah

Musharakah is the combination of Shirkah and Mudarabah. Shirkah means sharing or

partnership which may be in property (Shirkat-ul-Milk) or by contract (Shirkat-ulAqd). In
Musharakah, akin to equity stake joint venture, two parties combine capital for a business
project; business is run under the supervision of one or both the parties; and profit or loss is
shared on any predefined ratio whereas this ratio may not be similar to the capital contribution.
Financier is not ensured of any fixed rate of return rather actual profit is divided. Financier may
also suffer loss; however, distribution of loss is based on equity share. Both the parties may
combine in management of business and posses unlimited liabilities. Working of Islamic banking
is a blend of Shirak.

Diminishing Musharakah:

In this mode of financing, financier and client are involved in a partnership agreement for any
project (purchase of machinery, property or to run any enterprise) where earlier has larger share
as compared to later and these shares are divided into units. It is however decided that client will
periodically purchase these shares to become owner of the subject, ultimately. The subject is
handed over to client who is liable to pay it. This earning is divided into both parties according to
their respective shares. When client buys any unit of financier’s ownership, his share diminishes
and the distribution of rent is readjusted. Eventually, client becomes sole owner and then this
partnership ends. It is suitable for long-term big projects and is considered as the purest form of
Islamic finance.

Rent Based Financing

Ijarah (Lease agreement)

In this mode of financing, Islamic bank purchases an asset and leases it out to lessee on a
specific rent for a specific period without option of ownership to lessee at the end of contract.
Bank is responsible for the maintenance of the asset. It is similar to the operating lease contract
in western business. Unless caused by the negligence of lessee, any destruction is on the part of
bank. Subject of Ijarah may be any valuable but not any consumable things e.g. wheat, money.
Lessor is liable for ownership liabilities. However, subject may be insured through Islamic
Takaful to minimize risk.

Ijara Wa‐iqtina (Leasing with promise to gift)

Bank purchases an asset and rents it out to lessee on a specific rent for specific timeperiod. After
this period, ownership of this asset is offered to lessee. Promise to gift is not part of main
agreement rather written in separate unilateral agreement. This contract is similar to capital or
financial leasing agreement. There is lack of consensus among general public and Islamic
scholars on the validity of Marbaha, Ijara, Ijara Wa-iqtina and Istisna as pure Islamic products,
due to their fixed return nature. Muslim scholars warn against widespread use of these
markupbased products due to their closeness to conventional interest based products despite [55]
being permissible. Nevertheless, Islamic banks, now a days, are extensively relying on these
products.

PERFORMANCE COMPARISON OF ISLAMIC AND CONVENTIONAL

BANKS
Majority of empirical research on conventional- and Islamic banking- is related with single
group without controlling for other group making. Hence it is not possible to compare the
relative performance of two groups (Johnes, et al., 2009) for different stakeholders. Like single
group performance measurement, alternate methodologies have been used for comparative
analysis of Islamic and conventional banks in previous literature. Olson and Zoubi (2008)
applied 26 ratios for differentiating performance of Islamic and conventional banks in GCC
regions on the grounds of profitability, efficiency, [113] asset quality and risk. Additionally, they
also applied these ratios into logit, neural network and k-means classification models to highlight
that there were no significant difference in the performance of both types of banks. They further
pointed out the use of non-linear techniques as better tool for performance comparison. Frontier
analysis based on parametric (econometric) or non-parametric (mathematical programming)
approach are applied in most of the recent studies on performance comparison of Islamic and
conventional banks in various parts of the world. However, some researchers still use ratio
analysis for performance comparison of different categories of financial institutions either due to
its use in financial analysis by various stakeholders, or as a compliment to the frontier approach.
Iqbal (2001) combined ratio analysis with trend analysis and compared the performance of
Islamic banks to that of a group of conventional banks located in the same country with their
Islamic counterparts. Two studies based on cost efficiency comparison of Islamic and
conventional financial institutions in Turkey (El-Gamal and Inanoglu, 2004; El-Gamal and
Inanoglu, 2005) employing parametric SFA and nonparametric DEA methods respectively,
found that Islamic firms were more efficient than conventional counterparts because of asset
based financing and hence facing lesser burden of non-performing loans; whereas the production
technology was same in both the groups. Applying SFA, DEA and conventional ratio analysis
methods, Hassan (2005) conducted a study on the efficiency comparison of Islamic and
conventional banks using cost, profit and x-efficiency scores of global Islamic and conventional
banking. In terms of cost efficiency, he found that allocative inefficiency was the main source of
inefficiency. In comparison to conventional [114] banks, Islamic banks were more efficient in
terms of DEA profit efficiency but less efficient in terms of SFA cost efficiency. He also found
that DEA efficiency scores and conventional ratio measures of performance (ROA, ROE etc.)
were correlated and might be used alternatively. Johnes, et al. (2009) compared the performance
of Islamic and conventional banks in GCC countries during 2004-2007 using ratio analysis, DEA
and Malmquist Index. On the basis of ratio analysis, they found that profit and revenue
efficiency of Islamic banks were significantly better than conventional banks, but cost efficiency
of later group was better. DEA results however, indicated a higher average efficiency score for
conventional banks. Most important conclusion of this article, based on correlation, was that
various methods used for performance comparison namely ratio analysis and frontier approach
are not alternate but compliments of each other. Islamic banks are performing competitively with
reference to their conventional counterparts. In this regard, a study was conducted in Pakistan to
evaluate relative performance.

Shahid, Rehman, Niazi and Rauf (2010) found no statistically [117] significant difference
between the mean efficiency scores of samples of five Islamic and five conventional banks in
Pakistan, though technical efficiency of conventional banks was higher than Islamic but scale
and cost efficiency scores were at par. This paper used Constant and Variable Return to Scale
tools of non parametric DEA model to calculate technical, cost and scale efficiency scores. Using
intermediation approach, they took deposits and capital as inputs but ignored labor. Labor has
been used as a crucial input in various previous studies. They analyzed only the technical and
cost efficiency of banks while ignoring other important aspects of performance of banks; neither
had they tried to find out the determinants of efficiency differences between the two groups.
They did not compare productivity growth. Another serious limitation of this study is the use of
only 10 banks in the sample.