Name AQIB BBHM-F19-067 BBA-5A

Significance

Although there are differences between Islamic banking and "conventional" banking, there are
some fundamental principles that apply equally to both. In particular, rigorous risk management
and sound corporate governance help to ensure the safety and soundness of the international
banking system. In the light of the growing importance of Islamic banks and Sharia-compliant
financial innovation, the increasing integration of Islamic financial services into global financial
markets serves to strengthen this point.The Basel II framework improves the risk sensitivity and
accuracy of the criteria for assessing banks' capital adequacy. This framework is fundamentally
about stronger and more effective risk management grounded in sound corporate governance
and enhanced financial disclosure, the importance of which has been underscored by the recent
problems that have arisen in the banking industry worldwide. The guidance provided by the
Islamic Financial Services Board (IFSB) is a useful contribution to the realisation of these global
goals. It will support the establishment of resilient financial market infrastructures and sound and
robust core Islamic financial institutions operating according to safe and sound risk
management practices.

As an associate member of the IFSB, the BIS has been actively supporting the IFSB's mission
and initiatives since the Board began operations in 2003. The Basel Committee on Banking
Supervision, which is hosted by the BIS, is increasingly looking beyond its membership to
enhance cooperation with non-member countries and organisations with related interests and
similar goals. The Committee's outreach to non-member countries is part of an initiative to
promote the development of sound supervisory practices and to accommodate the growing
importance and sophistication of non-member banks.The BIS and the Basel Committee have
been strong supporters of the IFSB through participation in IFSB working groups, such as the
capital adequacy group, and by providing speakers for conferences and other events. I believe
that the active and productive dialogue between the Basel Committee and the IFSB will
continue to benefit both of our organisations. Professor Rifaat and members of the Basel
Committee's Secretariat have recently held fruitful discussions, and continue to strengthen the
cooperation between the IFSB and the Committee.In my remarks today, I will not address the
specifics of Islamic finance and how it differs from conventional banking. Instead, I would like to
focus on two elements of banking supervision that Islamic and conventional banking have in
common. That is, appropriate levels of risk management and corporate governance, which help
to ensure the safety and soundness of the international banking system.
As I am sure you heard yesterday and will also hear today, there has been significant growth in
Islamic financial services in recent years and there is every reason to expect that this growth will
continue at a rapid pace. Clearly, there is expanding demand for these products, and a closely
associated desire on the part of banks, including non-Islamic banks, to provide Islamic financial
services.
Although it is still modest in size relative to conventional retail banking, Islamic retail banking is
rapidly becoming more visible. This is particularly true in the Middle East and Asia Pacific
regions, where a number of Islamic banks and banking units have been opened in recent years.
There are also Islamic banks and asset managers in key international financial centres of the
United Kingdom and the United States.The growth in Islamic finance is also visible in the
expanding range of services and products that comply with the basic precepts of Sharia law.
One example is the burgeoning global market interest in Islamic bonds - Sukuks - many of
which are increasingly being issued and bought outside the Islamic world. This suggests that
non-Islamic investors in general are becoming comfortable with Sukuks. The broadening appeal
of Islamic finance is also evident in the move by large international banks and other private
sector financial institutions to provide Islamic financial services. This includes the establishment
of exchange-traded funds that are screened to ensure their conformity with Islamic investment
principles, as well as offering "takaful" - or Islamic insurance.Although the elements that are
usually emphasised at conferences like this are differences between Islamic banking and
"conventional" banking, there are some fundamental principles that apply equally to both. For
example, I can point to the necessity of strong corporate governance, rigorous risk management
and sound capital adequacy requirements as essential ingredients to ensure the safety and
soundness of any financial system. The increasing integration of Islamic financial services into
the global financial fabric only strengthens this point.

Role

The prohibition of interest in Islam and the aspiration of Muslims to make this prohibition a
practical reality in their economies, have led to the establishment of Islamic financial
institutions IFIs. As a result, Islamic finance has grown in response to demand, especially
from the Middle East’s Gulf region. This approach to economics, and particularly to
commercial exchange, has gained traction in recent decades. In fact, a robust and widespread
movement has arisen to position Islamic finance and IFIs globally as viable competitors to
conventional finance and banking. In great part, the cause of this change lies is traditional
supply and demand. The worldwide resurgence of Islamic teaching has driven demand for
Islamic finance and for the creation of Islamic financial institutions. 3 Islamic finance is a
demand-driven entity whose customers are both the Muslim population and non-
Muslims.4 This demand has created its own supply to fill the market gap. This chapter
explores the role of profit-and-loss sharing (PLS) in IFIs for economic development, and how
that role differs from conventional finance.Finance is a branch of economics concerned with
providing funds to individuals, businesses, and governments. Finance allows these entities to use
credit instead of cash to purchase goods and invest in projects. For example, an individual can
borrow money from a bank to buy a home or an industrial firm can raise money through investors
to build a new factory. Governments can issue bonds to raise money for projects. Finance plays
an important role in the economy. As banks, credit unions, and other financial institutions provide
credit, they help expand the economy by directing funds from savers to borrowers. Islamic finance
has been practiced in some form since the inception of Islam, its practice in modern financial
markets became recognized only in the 1980s, and began to represent a meaningful share of
global financial activity only around the beginning of this century. In recent years, significant
interest in Islamic finance has emerged in the world's leading conventional financial centers,
including London, New York, and Hong Kong, and Western investors are increasingly
considering investment in Islamic financial products. The organizing principle of Islamic finance
in an Islamic economy is transaction based on exchange, where real asset is exchanged for real
asset. By focusing on trade and exchange in commodities and assets, Islam encourages risk
sharing, which promotes social solidarity. The features of an Islamic economy will change the
behavior of society. There will be greater consultation; hence there will be no impulsive-
 compulsive reaction in financial dealings. At the same time, the labor force in an Islamic
economy will work under a rule of trust and full understanding of contracts and obligations.
Workers also share in the gains achieved through the risk, based on productive efforts, which is
a better incentive system than a fixed wage. Workers will be treated with respect, which reflects
the importance of human dignity in Islam. This paper is organized as follows: chapter one
discusses the epistemological roots of conventional and Islamic finance. Chapter two provide a
perspective of conventional modern economists. Chapter three provides a brief taxonomy of the
foundational Islamic market principles and evaluates them in the context of institutional and
behavioral economics in the context of Knightian uncertainty. Chapter four accounts for finance
and development in Islam from a historical perspective. Chapter five discusses the evolution of
the concept of economic development. Chapter six provide an Islamic perspective on financial
inclusion and argue that the core principles of Islam place great emphasis on social justice,
inclusion, and sharing of resources between the haves and the have-nots. Chapter seven
addresses financial inclusion. Chapter eight provide insight into Islam's perspective on social
safety sets and social insurance. Chapter nine examines Islamic capital markets in a global
context. Chapters ten examines the problems of primary and secondary aspects of the
conventional stock markets and their critiques of corporate governance. Chapter eleven give a
realistic view of the current state of affairs in Organization of Islamic Conference (OIC)
countries. Chapter twelve addresses key economic policy challenges in the context of the
Islamic economic and financial system.

Importance
Islam is not only a religion in the ordinary sense of the word, but a complete system of life.
While other religious codes provide guidance only for the relation between man and his Creator,
Islam guides man in his relationship with God and gives him the norms which govern his
temporal existence, since Islam is concerned with the spiritual, political, social economic, moral
and all other material aspects of the human being.

Islamic banking is banking or banking activity that is consistent with the principles of Islamic law
(Shariah) and its practical application through the development of Islamic economics. Shariah
prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Riba
or usury) for loans of money. Investing in businesses that provide goods or services considered
contrary to Islamic principles is also Haraam (forbidden). While these principles were used as
the basis for a flourishing economy in earlier times, in the late 20th century that a number of
formal Islamic banks were formed to apply these principles to private or semi-private
commercial institutions within the Muslim and Non-Muslim Communities.

The growth of the Islamic finance industry was remarkable in the last decade and in certain
parts of the world its growth is extraordinary. According to Ernst & Young’s inaugural World
Islamic Banking Competitiveness Report 2011, Islamic banking assets with commercial banks
globally will reach US$1.1 trillion in 2012, a significant jump of 33% from their 2010 level of
US$826 billion. The Islamic banking assets in the Middle East and North Africa (MENA) region
increased to US$416 billion in 2010, representing a five year Compound Annual Growth Rate
(CAGR) of 20% compared to less than 9% for conventional banks and these Islamic banking
 assets are expected to reach to US$2.8 trillion by the year 2015. As new geographies open up
to Islamic banking, the MENA Islamic banking industry is expected to more than double to
US$990 billion by 2015.Based on estimates of the International Monetary Fund (IMF) (2010),
there are more than 390 Islamic banks and institutions spread across 75 countries. Based on
the Islamic Development Bank records, the average annual growth rate of Islamic financial
institutions assets during the period 1995-2010 was estimated to be within the range 10-15%.
The main reason for the growth stem from a number of sources:Muslims worldwide are starting
to use Shari’ah compliant products that were not previously available to them;- Due to the
increase in oil wealth of the Muslim nations in the Middle East and their decision to use Shari’ah
compliant products, western governments and conventional financial institutions are considering
using Islamic Finance Due to their escalating competitiveness and focus on ethics, Islamic
products are attracting not only Muslims but non- Muslims as well. Islamic Finance has no way
to leave in any time soon as Islam is the fastest growing religion in the world and is the second
largest religious group in the UK, USA and France.The GCC countries account for nearly 56
percent of the total Islamic banking assets. Based on Mckinsey projections, by 2015, more than
half of financial services provided are expected to become Shari’ah complaint in the GCC
countries.

Objective

Islamic banking has been defined in a number of ways. The definition of Islamic bank approved
by the General Secretarial of the OIC is staled in the following manner. “An Islamic bank is a
financial institution whose status, rules and procedures expressly state commitment to the
principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of
its operations.” Dr Shawki Ismail Shehta viewing the concept from perspective of an Islamic
economy and the prospective role to be played by an Islamic bank therein opines that “It is
therefore, natural and, indeed, imperative for an Islamic bank incorporate in its functions and
practices commercial investment and social activities, an institution design to promote the
civilized mission of an Islamic economy.” Dr. Ziaul Ahmed says, “Islamic banking is essentially a
normative concept and could be define conduct of banking in consonance will the ethos of the
value system of Islam.”

It appears from the above definitions that Islamic banking is a system of financial intermediation
that avoids receipt and payment of interest in its transactions and conducting operations in a
way that it helps achieving the objectives of an Islamic economy. Alternatively, this is a banking
system whose operation is based on Islamic principle transactions of which profit and loss
sharing (PLS) is a major feature ensuring justice equity in an economy. That is why Islamic
banks are often known as PLS-banks.

Conventional banking is essentially based on debtor-creditor relationship between depositors

and the bank in the one hand and between the borrowers and the bank on the interest is
considered as the price of credit, reflecting the opportunity cost of money. Islam, on the other
hand, considers loan to be given or taken, free of charge, to meet contingency and that the
creditor should not lake any advantage of the borrower. The money is lent out on the basis of
interest, more often it happens that it leads to some kind of injustice. The first Islamic principle
underlying such kinds of transactions is that “deal not unjustly and ye shall not be dealt with
unjustly”. Hence, commercial banking in an Islamic framework is not based on debtor-creditor
 relationship.The second principle regarding financial transactions in Islam is that there should
not be any reward without risk-taking. This principle is applicable both to labor and capital. As
no payment is allowed to labor unless it is applied to work, no reward for capital should be
allowed unless it is exposed to business risks.Thus, financial intermediation in an Islamic
framework has been visualized on the basis of the above principles. Consequently financial
relationships in Islam have been participatory in nature. Several theorists suggest that
commercial banking in an interest-free system should be organized on the principle of profit and
loss sharing. The institution of interest is thus replaced by a principle of participation in profit and
loss. That means, a fixed rate of interest is replaced by a variable rate of return based on real
economic activities. The distinct characteristics which provide Islamic banking with its main
points of departure from the traditional interest-based commercial banking system are: (a) the
Islamic banking system is essentially a profit and loss sharing system and not merely an
interest-free (Riba) banking system; and (b) investment (loans and advances in conventional
sense) under this system of banking must serve simultaneously both the interest of the investor
and those of the local community. The financial relationship as pointed above is referred to in
Islamic jurisprudence as Mudarabah.