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Islamic banking and finance in Pakistan commenced in 1977-78 with the elimination of interest in compliance with the Principles of Islamic Shariah in Islamic banking practices. Since then, amendments in financial system to allow the issuance of new interest-free instrument of corporate financing, announcement of ordinance to permit the establishment of Mudarabah companies and floatation of Mudarabah Certificates, constitution of Commission for Transformation of Financial System (CTFS), and the establishments of Islamic Banking Department by the State Bank of Pakistan are some o the key steps taken place by the governments. Over the last few decades, the Muslims have been trying to restructure their lives on the basis of Islamic principles. They strongly feel that political & economical dominance of the west during the past centuries has deprived them of divine guidance, especially in the socio-economic fields. The aim of this study is to examine and to evaluate the performance of the Islamic banks in comparison with that of conventional banks. The study evaluates performance of the Islamic banks in profitability, liquidity, risk, and efficiency for the period of 2005-2008 for some banks for some period of 2007-2008 as the data was of there two years. Financial ratios (11 in total) such as Return on Asset (ROA), Return on Equity (ROE), Loan to Deposit ratio (LDR), Loan to Assets ratio (LAR), Debt to Equity ratio (DER), Asset Utilization (AU), and Income to Expense ratio (IER) are used to assess banking performances. The study found that Islamic banks are performing well and are going in right direction but are less profitable excluding MBL, more solvent (less risky), and also less efficient comparing to the conventional banks. However, there was no significant difference in liquidity between the two sets of banks. The reasons are due to the facts that conventional banks have longer history and experience in doing banking business and hold dominating position in the financial sector with its large share in the overall financial assets , as compared to Islamic banks, which in true sense, started only a few years back with all letter and spirit.
CHAPTER 1 INTRODUCTION
Islamic banks appeared on the world scene as active players over two decades ago. But "many of the principles upon which Islamic banking is based have been commonly accepted all over the world, for centuries rather than decades". The basic principle of Islamic banking is the prohibition of Riba- (Usury - or interest): "While a basic tenant of Islamic banking - the outlawing of riba, a term that encompasses not only the concept of usury, but also that of interest - has seldom been recognised as applicable beyond the Islamic world, many of its guiding principles have. The majority of these principles are based on simple morality and common sense, which form the bases of many religions, including Islam. "The universal nature of these principles is immediately apparent even at a cursory glance of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other writers, particularly those writing in the 19th century, have attacked the barbarity of the practice. Much of the morality championed by Victorian writers such as Dickens - ranging from the equitable distribution of wealth through to man's fundamental right to work - is clearly present in modern Islamic society. "Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century." (Islamic Finance: A Euro money Publication, 1997) It is evident that Islamic finance was practiced predominantly in the Muslim world throughout the middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen.
The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the oil producing countries, received a boost due to rationalization of the oil prices, which had hitherto been under the control of foreign oil Corporations. These events led Muslims' to strive to model their lives in accordance with the ethics and philosophy of Islam. Disenchantment with the value neutral capitalist and socialist financial systems led not only Muslims but also others to look for ethical values in their financial dealings and in the West some financial organizations have opted for ethical operations. Islam not only prohibits dealing in interest but also in liquor, pork, gambling, pornography and anything else, which the Shariah (Islamic Law) deems Haram (unlawful). Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as: 1. While permitting the individual the right to seek his economic wellbeing, Islam makes a clear distinction between what is Halal (lawful) and what is haram (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious. 2. While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it. 3. While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat. 4. While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to
prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance. 5. Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive.
1.1 THE CONCEPT OF RIBA AND SALIENT FEATURES OF ISLAMIC FINANCIAL SYSTEM 1.1.1 RIBA IN QURAN & SUNNAH
The debate on definition of Riba particularly in context of present interestridden economic and financial system is almost settled among overwhelming majority of the Islamic scholars since late 1970s. Considering that modern institutionalized form of interest falls under absolute prohibition of Riba, efforts have been going on for about three decades for introducing Islamic banking system. However, still there might be some confusion in the minds of some individuals. It is pertinent; therefore, too briefly desirable as to what is Riba as prohibited by Islam. From the Holy Quran, order of revelation on Riba is as follows: “And whatever Riba you give so that it may increase in the wealth of the people, it does not increase with Allah” (Makki; 30: 39). “And because of their (Jews) charging Riba while they were prohibited from it” (Madani; 4: 161 ;). “O those who believe do not eat up Riba doubled and redoubled”. (Madani; 3:130). (The Shariah Advisory Board Judgment (Justice Taqi Usmani’s Part) says: “This Verse contains a clear prohibition for the Muslims and it can safely be said that it is the first Verse of the Holy Qur’an through which the practice of Riba was forbidden for the Muslims in express terms. ”).
Verses in Sura Al-Baqarah (after conquest of Makkah); these Verses not only describe the prohibition of Riba, but also give a comprehensive definition of Riba as given below: “Those who take riba will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they say: Trade is just like Riba; whereas Allah has allowed (profit from) trade and prohibited Riba. So, whoever receives an advice from his Lord and stops (from taking Riba), he is allowed what has passed, and his matter is up to Allah. And the ones who revert back, those are the people of Fire. There they would remain forever. Allah destroys Riba and nourishes charities. And Allah does not like any sinful disbeliever”.
(11:275,276). “O you who believe. Fear Allah, and give up the Riba that remains outstanding if you are (in truth) believers”. (11:278).“If you do not do so, then be sure of being at war with Allah and his Messenger. But, if you repent, then you have your principal. Wrong not, and you shall not be wronged”. (11:279) (Some exegetes explain the phase ‘Laa tazlimoona wa laa tuzlamoon’ as without inflicting or receiving injustice meaning that ‘without increase or diminution’ where both an increase or a decrease of the amount returned relative to the amount lent would be considered injustice). (See Al-Tabari, Jami′ Al-Bayani: Verse: 2:279) And if there be one (the debtor) in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. wronged”. (11:280,281). The Holy Prophet (Peace be upon him) said, “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt – like for like, equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand-to-hand.”(Sahih Muslim). A man employed by the Holy Prophet (Peace be upon him) in Khaybar brought for him janibs (dates of very fine quality). Upon the Prophet’s asking And they shall not be
The Holy Prophet replied. P: 115). nor between returns or bonus on loans for consumption and those for production purposes and so on. (Translation of the Holy Qur’an by Allama Yusuf Ali.him whether all the dates of Khaybar were such. Sometimes. between ‘reasonable’ and ‘exorbitant’ rates of interest and thus what came to be regarded as the difference between usury and interest. the man replied that this was not the case and added that ‘they exchanged a sa’a (a measure) of this kind for two or three (of the other kind)’. it is claimed that ‘Riba’ is not defined clearly in the Holy Qur’an. only a particular form (on consumption loan) was prohibited. a number of Muslims have been interpreting it in a manner which is radically different from the understanding of Muslim scholars throughout the last fourteen centuries and that is also sharply in conflict with the categorical statements of the Holy Prophet (peace be upon him). The Verse II:279. “Do not do so. More than enough material has now come on the record to prove that commercial and 7 . Owing to the fact that interest is a focal point in modern economic life. Some people argue that there was no Commercial Interest in Arabia. any excess on the capital is Riba (interest). USA. but the claim is not substantiated. as given in the previous section. in so far as prohibition is concerned. defines ‘Riba’ being anything over and above the principal of a loan or debt. and specially that it is embedded in operations of existing financial institutions. Sell (the lower quality dates) for Dirhams and then use the Dirhams to buy Janibs. 1989 by IIIT. According to Islamic teachings. (When dates are exchanged against dates) they should be equal in weight. Revised Edition..” (Sahih Al-Bukhari). This also is not correct according to the Supreme Court’s Judgment: “It is not to say that commercial or productive loans were not in vogue when Riba was prohibited. From Farewell Pilgrimage Address of Holy Prophet (Peace be upon him): “Riba is forbidden and you will be entitled to recover your principal amount …. Allah has decreed that there should be no Riba and I am remitting the amount of Riba which my uncle Abbas has to receive”. Islam accepts no distinction.
especially of Makkah. to the extent that Justinian.productive loans were not foreign to the Arabs. NATURE AND TYPES OF RIBA Riba is mainly divided into two types i. it is not correct to say that the prohibition of Riba was restricted to the consumption loans only and it did not refer to the commercial loans. Interest in all modern banking transactions falls under Riba Al-Nasia. the distinction between consumption loans and productive loans in this respect is contrary to the well-established principles”. The latter is also termed as Riba Al-Qur’an. had constant business relations with Syria.2.548). The SAB has proved that commercial interest was prevalent at the time of revelation of Holy Qur’an and concluded: “It is thus clear that the permissibility of interest can neither be based on the financial position of the debtor.e.546-557). Quality premium in exchange of low quality with better quality goods (Riba Al-Fadl) is prohibited e. Riba Al-Fadl and Riba Al-Nasia. wheat for wheat. Therefore. (SAB: Pp. The Arab trade caravans used to export goods to and import other goods from Syria. and therefore. about prohibition of which there is consensus of Ummah.D) had to promulgate a law determining the rates of interest which could be charged from different types of borrowers. in exchange of dates for dates. one of the most civilized provinces of the Byzantine Empire. nor on the purpose for which money is borrowed." (SAB: Pp. etc.557).g. 1. the Byzantine Emperor (527-565 A. The Arabs. The concept of Riba Al-Fadl refers to sale transactions while Riba Al-Nasia refers to loan transactions. All kinds of commercial. (SAB: Pp.549). Production/commercial loans did 8 . “The above material is more than enough to prove that the concept of commercial loans was not alien to the Holy Prophet (Peace be upon him) or his companions when Riba was prohibited. and that loans were advanced for productive purposes both before and after the advent of Islam. industrial and agricultural loans advanced on the basis of interest were prevalent in the Byzantine Empire ruling in Syria. (SAB: Pp.
fall within the definition of Riba.3. 1. However. either in banking transactions or in private transactions. is against the Injunctions of Islam as laid down in the Holy Qur’an and Sunnah and in order to bring it in conformity with Shariah it has to be subjected to radical changes. would involve Riba. Any interest stipulated in government borrowings acquired from domestic or a foreign source is Riba and clearly prohibited by the Holy Qur’an. an institutionalized form of gift and the practice with preconceived notion of addition that takes the form of a system. based on interest. EARLY REPAYMENT REBATE In case a debtor makes payment earlier than the due date can he be given any rebate in the amount payable is an issue of crucial importance in Islamic banking and finance. 1. All prevailing forms of interest. In this respect the question arises whether banks can give some rebate to the clients. 3.exist at the time of Holy Prophet (Peace be upon him) that involved Riba AlNasia or interest in various forms. PAKISTAN The SAB of the Supreme Court of Pakistan declared: 1. RIBA ACCORDING TO SHARIAH COURT. In normal Murabaha or leasing operations of Banks some clients may want early payment of their liabilities to the bank. 9 . 2. In the Pakistan’s NIB system of 1980s the banks used to charge mark up of extra 210 days with the provision that the extra charge would be remitted if the client pays the Murabaha receivable on due date. even if undetermined.4. The Shariah Court declared the rebate as un Islamic. Repaying a loan in excess of principal but without any explicit or implicit precondition is established form the Sunnah of the Holy Prophet (Peace be upon him). The present financial system.
1344 H. 2. has observed that the former two instances related to debt not yet due while the latter was due debt (Dayn al Haalah). 28 Al Jassas. you got yourself involved in Riba and made the other devour Riba. Pp. Malik and Abu Hadrad (rata) according to which the former waived half of the debt on recommendation of the Holy Prophet (sasm). 50. Shah Waliullah. When the Holy Prophet came to know. Sunan al Kubra. the jurists have differentiated the two categories of loans i. Al Musawa min Ahadith al Muawatta.3 1 2 3 Baihaqi. Duyoon Haalah (loans or debts that have become due or could be called back any time.1 Going into details. Kitab al Buyoo Vol. 51 10 . He felt need of money when the Holy Prophet sent him along with a delegation. P. He also explains that time of repayment cannot be stipulated in case of Qard while in case of credit sale (and Dayn) payment time can be settled in the contract.) and Duyoon Mu’ajjalah (time of payment settled among creditor and debtor and the debt is not yet due). Ahkamul Quran.e. Miqdad bin Aswad said that he gave someone a qard of hundred Dinars. Vol. Pp. in Musawwa. He asked the debtor to remit ten and pay ninety Dirhams.2 It means that if a debt has become due and it has not yet been paid. 6. he said. say that it should not be made a condition. Remission of a part of liability in due loans is allowed by almost by all jurists on the rationale that in such loans. Vol 2. Two traditions have been reported by Imam Baihaqi. In this respect also Fuqaha. (ii) A Companion. 387-392 Waliullah. referring to the above two and the tradition of Ka´ab b. based on Hadith reported by Imam Bukhari as described above. Urdu Translation. the Prophet said.On the subject of remitting a part of the debt against early payment and other concessions to debtors we come across three traditions of the Holy Prophet (sasm). he was told that debts are owed to some of them that have not become due. delay is not the right of the debtor. ‘Da´awoo wa Ta´ajjloo’. He accepted and paid ninety Dirhams. the creditor could remit a part of the amount for early payment. Briefly these traditions are: (i) When the Holy Prophet (sasm) expelled Bani al Nadhir from Madina.
It leads to ever increasing share of risk free capital vis-à-vis risk based equity capital. there is a basic difference between Islam and capitalism in regard to the treatment of money capital as a factor of production. Justice demands that provider of money capital should share the risk with the entrepreneur if he wishes to earn profit. But interest on loans taken for productive purposes is also prohibited because it is not an equitable form of transaction (C. Ziauddin: 1997). money capital is treated at par with labour and land. Thus. each being entitled to a return irrespective of profit or loss. resulting in business failures. The unproductive and wasteful spending both by individuals and the 11 .making a class of people richer and leaving others poorer and oppressed. charging of a fixed and pre-determined rate of interest on loans for productive purposes cannot be morally justified. 1980).I. The logic as to why the religions including Islam have prohibited interest is that it exerts disastrous effects on the human societies by reinforcing the tendency of wealth accumulation in fewer hands. When money is invested in a productive undertaking the quantum of profits that may accrue is not known beforehand and there is also the possibility of a loss. The rationale for prohibition of charging interest from someone who is constrained to borrow to meet his essential consumption requirements is obvious. this is not so in Islam which treats money capital at par with enterprise. The interest based financial system is creating un-repayable debt . The Old and the New Testaments had similarly prohibited it. Whereas in the capitalistic system. unemployment and ultimately to gross inequalities of income and wealth that are bound to end-up in social strife and economic chaos.I. The Greek and Roman thinkers had forbidden interest in their days. Therefore.1. Islam is opposed to exploitation in every form and stands for fair and equitable dealings among all human beings.5. (Ahmad. WHAT INTEREST DOES: THE RATIONALTE FOR PROHIBITION The prohibition of interest is an issue concurred upon not only by Islam but all revealed religions of the world and the majority of ancient philosophers.
governments. a major part of funds which finance business needs in the US. for example. are raised as equity (and not loans) on the open market that is. Kester (1986) lists debtto-equity ratio for major categories of business in the US and Japan. According to the World Economic Outlook. Even in the developed countries. They owe Dollars. becomes a recipe for total economic instability. total debt as a percentage of GDP has been on the increase over the last 30 years or so. Their ratio to exports of goods and services was 140% and 23% respectively. The governments raise taxes without providing social amenities or quid pro quo. This amount of debt would be reduced even further were it not for the artificial tax advantage of debt-based financing in these countries (since interest payments can be 12 . total external debt and debt service payments of developing countries were US$ 2. does not play any critical role in the modern investment and business spending. It has been proved by empirical evidence that credit.068 billion and US$ 343 billion respectively at the end of 2000. The cost incurred in the form of interest has to be paid by the government through increasing rates. a position which is not sustainable. The foreign exchange earnings. and shows that most of these ratios are substantially below unity. The system. which the interest-based and easily available credit has the tendency to promote. including export proceeds and remittances of workers abroad are also consumed in debt servicing. so that equity financing is much more prevalent than debt financing. Today all developing countries are caught up in a sophisticated debt trap owing to the most striking feature of interest-based mechanism: yesterday’s debt can be repaid by taking out more debt today. compared with equity. Therefore. This affects the poor and the middle class comprising major part of the population and thereby. common stocks. the level of national savings. real investments and the employment opportunities in almost all countries around the world. taxes and prices of consumption goods and utilities. combined with inflation. has led to a decline in savings. Contrary to popular misconception. they resort to heavy taxation or to further borrowing for servicing the previous obligations. but they cannot create Dollars as the US banking system can create.
generally earn a high return out of which very small portion is shared with the banks. bankruptcies and stagflation. Ribacommonly known as interest is a certain increase taken as premium from the debtor or a cost accrued irrespective of the outcome of the business. 1. Actually. Khan (1986) has shown that interest based credit increases the risk of banking crises. Industrialists invest a meager share from their own resources and borrow 80 per cent or even more from the banks or DFIs. Why a person will invest his own resources for establishing a factory wherein he will have to deal with unionized labor and many other problems when he can earn a high return by investing money in any risk-free financial paper issued by the government to meet mostly its revenue expenditures. PHILOSOPHICAL BASIS OF ISLAMIC ECONOMICS AND FINANCE The structure of Islamic finance revolves around prohibition of any predetermined return derived on loan/debt (Riba) and legality of profit. however. the debt-equity ratio is 70: 30 or even 80: 20. This system has built-in tendency for increase in risk free capital vis-à-vis the risk-based capital. 13 . It results in business failures. If collateral is sufficient. It represents the return on transactions involving exchange of money for money.written off). Another main prohibition is Gharar which refers to uncertainty about subject matter or price of the contracts that leads to disputes and wrongful acquisition of benefits by one party and undue loss to the other. This results in recession. on account of delay in payment. modern banks would finance projects even with poor feasibility. unemployment. the part of equity is even lesser and majority of the business/industrial community use almost the borrowed money.6. Interest-based system generates unemployment because capital and the wealth flow to the direction of high and risk-free return without regard to the efficiency of the fund borrowing sectors. In Pakistan. or the addition. It has been prohibited as it generates imbalances in the economy. to the agreed price on sale debts/ debts. Mohsin S.
will be considered only a monetary or financial transaction where only funds exchange hands with a guarantee for repayment in full and in the same 4 Labor means both human bodily and mental exertion. However.All gains to the principal are not prohibited. should be associated with tangible real assets. time has value that can be discounted in case of credit sales only through adjustment in price. capital owner will bear the loss while the manager’s labor would go wasted. Profit symbolizes entrepreneurship and creation of additional wealth. in order to be permissible. While return from loan/debt is prohibited. (Al. 14 . can reduce his claim of debt. earning of profit depending upon the outcome of the business is permissible. as described above. the value of paper money or debased money is determined by the official commitment and not by its physical content. in money and finance. Keeping in view the above. The provider of funds is an entrepreneur manage the as well. It does not have opportunity cost as in the conventional interest based setup. Profit has been recognized as ‘reward’ of capital. he will have a share in the profit while the latter. Vol. While value of bullion money is represented by content. the manager of the business will get ‘wages’ in the form of share in the profit. No other factor can be made to bear the burden of the loss risk on capital. when a debt becomes due. He will get and profit/loss 4 for capital his to capital any and other wage/remuneration for his entrepreneurship/labor . the creditor. 693) In the context of Islamic economics a loan. In Islamic framework money itself is not recognized as capital and as such it cannot earn a profit in itself. But liability of risk of loss rests with capital itself. it can be said that financing for the purpose of earning return has to be related to certain assets exposed to direct or indirect business risk. In case he does not business himself provides individual/group of individuals for any business. But if the business suffers loss. Giving a rebate to the debtor before the debt is due is also not permissible according to the Fuqaha. Money is treated as potential capital .it becomes capital only when it joins hands with other resources to undertake productivity. at his own discretion. P. not through interest. Thus. Islam permits gainful deployment of surplus resources for enhancement of their value.Zohaely. Financial transactions.4.
coins. its price will be paid to the lender (Al-Jaziri. The Holy Prophet (Peace be upon him) in a famous Hadith has prohibited mutual exchange of certain goods except equal for equal and/or hand to hand (quoted in subsequent section of this Chapter). Vol:2. If the borrowed commodity is fungible as the currency notes are. however. buying and selling a financial document will not be an investment because no real activity is involved in this exchange. If commodities are exchanged for one another (similar or different) the rules will be different from the situation when these are exchanged for currency notes. Similarly. In loan transactions. and in case the similar is not available. The excess has been termed as Riba. Currency notes represent thaman (price) and trading in thaman has been declared by the Holy Prophet (Peace be upon him) as usurious except when exchanged hand to hand and equal for equal (in case of similar currencies). one Ton of wheat or 1000 rupees will be repaid. the condition of excess payment of either is prohibited even when it is a transaction of sale. any excess shall be usurious. P: 679). But using the funds borrowed on interest for buying or building a physical asset will not be a permissible activity. As such. According to the Hanafites. In the case of two similar goods. not loan. The Islamic Shariah has given some rules for exchange of currency and goods. 5 15 . Other schools of Islamic Fiqh. allow lending of every kind of property. However. and in the case of non-fungible goods the loan contract will be made in terms of money5. any return on investment is permissible and allowed. exactly its similar is to be repaid. while earning on loans is prohibited for the reason of being interest. Thus if one Ton of wheat or 1000 rupees are borrowed. Thus purchasing a bond issued by the Government or any corporation or making a deposit in a conventional bank will not be considered investment because they are merely financial transactions and no real activity is involved. exchange must be of equal amounts. if the funds are used to purchase real goods or services and then sell them on profit then this use of funds will be treated as investment. On the other hand investment in Islamic context is not merely a financial or monetary transaction in which transfer of funds is the only activity. only the fungible goods may be lent or borrowed. Investment will be considered only if it is a part of real activity or is itself a real activity.
if cleansed of these elements. gambling. as for example. gambling. the exchange has to take place instantly and not on deferred basis. In addition to maintenance of law and order and administration of justice. sale of gold for wheat (the former being medium of exchange and the latter. therefore.Explaining relevance of this Hadith.. edibility). when the commodities are similar. Important Shariah maxim: “Al Kharaj bil Daman” or “Al Ghunm bil Ghurm” or “laa ribh maa laa yadhman” is the criterion of legality of any return on capital meaning thereby that assumption of business risk is a pre-condition for acquisition of any profit over the principal. would be Islamic. education and medical facilities in so far as its resources permit.g. The current practice of financial institutions. Transactions of contemporary stock markets. that when a sale transaction is taking place among Nuqud or currencies of similar nature. both are permissible. clothing. Imam Nawavi. It refers to the fact that the productive role of invested fund that justifies return on it in a real activity is the willingness and ability to bear the risk of a potential loss. the State has to ensure social security and provide for basic needs of the people including food. lotteries. Reward should depend on the productive behavior implying that interest. The State has to play a complementary role. or even dissimilar nature. says that when the effective cause (‘illah) of prohibition of exchange of two commodities is different. There are numerous traditions of the Holy Prophet (Peace be upon him) to the effect. gold for gold or wheat for wheat. then excess/deficiency is allowed while the delay in payment is not allowed. e. It is imperative. interest. markets of futures & options are un-Islamic because of the elements of Gharar. excess/deficiency and delay in payment both are prohibited. etc. Risk involved in partnership finance is far more than that 16 . insurance companies. shelter. Coercive State action curbs the freedom of the individual and detracts from the Islamic character of the system. etc. shortfall or excess and delay in payment. are prohibited. an eminent commentator of Sahih Muslim. when the commodities are heterogeneous but the ‘illah is the same as in the case of sale of gold for silver (the common ‘illah being their use as medium of exchange) or of wheat for rice (the common ‘illah being edibility).
In case of business failure. from their clients. While the full business risk category represents the real instruments of Islamic finance. for example. liability of the shareholders of Joint Stock Public Company is limited. As regards currency futures. The concept of forward trading can be used only for promoting real productive and exchange purposes and not for making speculative gains. some scholars forbid them while 17 . In Salam or Murabaha. The partners of a business conducted on the basis of Shirkah are at liberty to determine. forward foreign exchange operations with delayed payment of any of the currency of exchange and most types of financial futures are not available in the Shariah compliant system because these instruments are a part of hedging strategies of interest-based system. the ratio of profit allocated for each of them.involved in trading modes like Murabaha or Salam and Ijarah. This aspect has not only a great potential for developing agricultural and rural micro finance market but also for making future of majority of people living in rural areas. Spot foreign exchange market can function without any problem. Islamic economics has the provision of risk mitigation through forward trading on the basis of Salam. and if Musharakah goes under loss. with or without security. not money. However. The loss suffered by each partner must be exactly in the proportion of his investment. They cannot sell commodities purchased through Salam before the same are actually delivered to them. However. Buying/selling on credit. According to Shariah Rules. with the condition that credit transactions should not involve any addition or enhancement to the principal amount of loan or debt. the banks will receive (or deal in) certain commodities. liability of the partners in a partnership firm is unlimited (not limited to the invested amount) since a partnership is not a legal person like a limited liability company. all liabilities in excess of remaining assets are to be shared proportionally by the partners. with mutual consent. Futures trading in commodities like gold and silver that serve as thaman is forbidden. Istisna’a and Joa’alah. and lending is permissible. the low risk category is secondary and requires many conditions to be fulfilled to be really differentiated from interest based operations.
c. the Jeddah based Council of the Islamic Fiqh Academy of the OIC in its Fifth session (10 – 15 December 1988) held that: a. contentment and leniency. d. to ethics recommended by Shariah. concealment of actual features and benefits which are detrimental to well being of the society and individuals. deceit. excessive price increase and fraud. About principles regulating operations in the market. The first is where one currency is delivered on spot and the other is delayed. Shariah texts have spelt out the necessity to keep the transactions away from illicit acts like fraud. The basic principle in the Qur’an and the Sunnah of the Holy Prophet (Peace be upon him) is that a person should be free to buy and sell and dispose of his possession and money. the business environment and the nature of the merchant and of the goods. involves the future exchange of both currencies at the previously agreed rate.7. and economic and commercial 18 . The second one. the causes of defects. the government should intervene by applying adequate means to get rid of these factors. that is permitted. In this case. b. cheating.others distinguish between the two cases. unless there is trade based on mutual acceptance’). such as moderation. which provide bases and limits for all kind of business in general. however. It is generally left to the merchants themselves. Government should not be involved in fixing prices except only when obvious pitfalls are noticed within the market and the prices due to artificial factors. SHARIAH BOUNDARIES FOR FINANCIAL TRANSACTIONS The Islamic Shariah has enunciated a set of principles. within the framework of Islamic Shariah in accordance with the divine Command: (‘O you who believe! Consume not each other’s property in vanities. Care should be given. this is forbidden. forgery. 1. There is no restriction on the percentage of profit which a trader may make in his transactions.
Islamic law has prescribed a number of boundaries. For that purpose. a hazard or uncertainty to become prohibited (Gharar) would be major. about the quantity of the object and the price. Gharar includes ambiguity/ uncertainty about the ultimate of a contract and the nature and/or quality and specifications of the subject matter of the contract or the rights and obligations of the parties. such as in the case of Salam a number of conditions are required to be fulfilled. The commodity must be clearly known and its quantity must be determined to the contracting parties. A sale or any other business contract which entails element of Gharar is prohibited. Darar.transactions in particular. ignorance of the time of payment in deferred sales. In order to avoid inequitable gains and injustice.g. which are to be avoided in commerce or business transactions.g. Shariah clarifies elements. saying I sell you one of the houses of this project without specifying that house. Gharar. The basic attributes of the merchandise should consist of pure materials which should be objects of intrinsic/ legal value having some use. indicating more than one prices or option in a contract unless one is specifically chosen. Principles enunciating justice. 19 . It is prohibited to sell any undeliverable goods. contracting on a nonexistent object and/or inability to deliver the object. it should affect the principal aspects of the contract. Jahl. lack of specification of the item being sold. Examples of Gharar are: ignorance about the species being sold. According to Shariah scholars. Riba and Gharar are the two main prohibitions. Maysir and Qimar (gambling) define invalid and voidable contracts and demarcate the limits which should not be crossed. and it may not be the need of any valid contract like that of Salam and Istisna’a. free consent and honesty on the part of the parties to a contract. As a rule. avoiding fraud. Gharar can be avoided if some standards of certainty are met. The vendor must be able to deliver the commodity to the purchaser. involved in sale contracts. Islamic law does not recognize transactions that have a proven illegitimate object or purpose. as mentioned above. mutual help. Further details about Gharar are given in the next part of the Chapter. remunerative e. misrepresentation and misstatement of facts and negation of injustice or Zulm provide grounds for valid contracts. Principles providing for prohibition of Riba. e.
or without undertaking any liability against it.91). Further. having entitlement to that money or benefit. All financial transactions must be representation of real transactions or sale of goods. the Hadith literature discusses this act generally in the name of “Qimar”. A person puts his money at stake wherein the amount being risked might bring huge sums of money or might be lost or damaged. by way of game of chance. trustworthiness/ truthfulness in business transactions and generosity in bargaining. a lottery in which coupons or tabs are given and inducement or incentives are provided by an uncertain and unknown event depending on chance. lies and hiding facts in any bargains. Qimar also means receipt of money. but the prizes to be given are related to interest generated from capital accumulated through it. ‘Maysir’ derived from ‘Yusr’ means wishing something valuable with ease and without paying an equivalent compensation (‘iwad) for it or without working for it. According to Pakistan’s Federal Shariah Court (FSC). Dharar means inflicting any undue loss or damage on the other party of the contract. As all transactions involving interest payments are strictly prohibited. is also repugnant to the injunctions of Islam. The words Maysir and Qimar are used identically in Arabic language.g. by resorting to chance. benefit or usufruct at the cost of others. debt contracts cannot be sold at discount. While the word used in the Holy Qur'an for prohibition of gambling and wagering is “Maysir” (2:219 and 5:90. It also requires avoiding fraud in business or trade. Present day lotteries are also a kind of gambling.Jahl (ignorance) is a part of Gharar and means lack of clear understanding of the specifications about the very nature of the contract or the subject matter. the difference between Maysir and Qimar is that the latter is an important kind of the former. or disproportionate prizes are distributed by drawing of lots or where a participating person intends to avail a chance at prizes is repugnant to the injunctions of Islam. transaction should conform to certain ethical standards e. services or benefits (except Qard-e-Hasan). like false swearing. and exchange transactions of money or goods representing money like gold and silver must be hand-to-hand and equal for equal. According to the jurists. FSC adds that a scheme wherein the investors’ money is safe and intact. 20 .
‘Gharar’ means hazard. ‘Gharar’ is the sale of a thing which is not present at hand or the sale of a thing whose ‘Aqiba’ (consequence) is not known or a sale involving hazard in which one does not know whether it will come to be or not. e. p. cf Ibn Abidin. 11 21 . majority of the jurists includes both unknown and the doubtful to render a transaction Gharar based and thus prohibited. as sale of a fish in the water. 10.8 INVOLVEMENT OF GHARAR Gharar is one of the main factors that make a transaction un-Islamic.8 However. 4. IRTI. This uncertainty relates to existence of the subject matter. (iv/147) 8 Al-Muhallah Vol. Raddul Mukhtar. 3. 48 Al-Dhareer. includes: Two Sales in One Down-Payment (‘Arboon’) Sale. IRTI. rights/benefits to the parties and the Some jurists apply it to the cases of On the other hand Zahiri School of doubtfulness or uncertainty. See Al-Dhareer. 2. consequences of the contract. Siddiqi Al-Ameen. Hassan. 1997. chance. stake or risk (khatar). Pp. The “Pebble”.i 1. Siddiqi Mohammad al-Ameen Al-Dhareer has classified the principles covering Gharar under the following heads9: I. IRTI (IDB). Specifically. 343. 1. Particularly. IDB. “Touch” and “Toss” Sales. the Malikites widen the scope of Gharar on the basis of which eminent contemporary scholar Sh. 9-11. jurists slightly differ about coverage of Gharar6. Suspended (Mu´allaq) Sale. whether or not something will take place. 1993. 47. This excludes the ‘unknown’ objects.g. 389. In the legal terminology of the Fuqaha. 10. Viii. pp. Abdullah Alvi. 439 9 Al-Dhareer. 6 7 Gharar in the terms and essence of the contract. Pp. pp.7 Thought applies it only to the unknown to the exclusion of ‘doubtful’. Thus according to Ibn Hazm Gharar in sales occurs when the purchaser does not know what he has bought and the seller does not know what he has sold.otherwise it would mean exchange of money for money that is subject to all rules relating to Riba. As such. or a bird in the air. 1997. it relates more to ‘uncertainty’ than to risk as we use in commercial terminology. 1997.
2. Not Seeing the Object. BULLION TRADE AND DELIVERY EXCHANGE OF CURRENCIES Shariah has enjoined special rules regarding exchange of monetary values (Bai al-Sarf) according to which Nuqud (things representing money) on both sides in exchange of fungible goods must be equal for equal and hand to hand.e. If gold is sold for silver or the reverse. 5. Contracting on a Non-Existent Object. is sold for an article of the same kind. 7. gold or silver. Sales. but the delivery of the articles must be at the time of the transaction. in the following cases: 22 . Ignorance of the Genus Ignorance of the Species Ignorance of the Attributes Ignorance of the Quantity of the Object Ignorance of the Specific Identity of the Object. 1. These articles are treated as price. Future Sale Gharar in the object of contract.9. II. 6. 3. Ignorance of the Time of Payment in Deferred Inability to Deliver the Object. 8.iii This includes: 1. It makes no difference whether gold or silver is sold in the shape of coins or ornaments or otherwise. If any article of the species of price. Islamic law does not require equality in the bargain.5. OIC Fiqh Academy in its Ninth session (1-6 April 1995) resolved the following regarding crediting a sum of money in the bank account of a customer. 9. because of the very nature of these precious metals. These conditions were imposed for avoiding the effect of the application of Riba. i. Islamic law requires that there must be simultaneous delivery and those articles must be equal in weight to one another. 4.
either directly or through a Bank transfer. Where a sum of money has been credited to the account of the customer. debits a sum of money from his own account and credits it to another account. Some scholars have suggested the use of Salam in Fulus. because these principles are the safety valve against economic disaster. the forward sale or purchase of currencies in the form of Salam is not a valid contract. Where the bank. Sunnah and Ijma’. The Academy in its Eleventh session (14-19 November. However. the paper money can be used only as price. and it is not permissible. As described earlier. still. on order of the customer. Qur'an. it cannot serve as a commodity to be sold in Salam.1. provided that it does not exceed usual period normally allowed in such transaction. no matter whether it is credited in favor of the same customer or in favor of any other person. 2. The commodity is to be deferred in Salam and if the price is also 23 . either in the same bank or in another bank. But it is necessary for the banks to keep in view the Islamic rules governing the contract of “Sarf”. 3. to fix a date for exchanging them. in accordance with the principles of Islamic Shariah. If such crediting takes some time to enable the beneficiary to draw the amount so credited. 1998) resolved: “It is not permissible in Shariah to sell currencies by deferred sale.” This is evidenced in The Academy observed that contemporary money transaction are major factors behind the financial crises and instability in the world and recommended: “It is incumbent upon Muslim governments to exercise control over money markets and to regulate their activities relating to transactions in currencies and other money related transactions. in another currency. However. the beneficiary of such crediting cannot deal in the currency during the allowed period until the crediting takes its full effect by enabling the beneficiary to draw the amount. Where a customer contracts a sale of “Sarf” by purchasing a currency for another currency standing in his own account. The counter values to be exchanged in Salam include price on the one hand and the commodity on the other. this delay can be allowed.
advance. Different types of reference scales are needed for different kinds of financial contracts.2 IJARAH 24 .11 MAJOR ISLAMIC MODES OF FINANCING Following are the main modes of Islamic banking and finance: 1.11. it is a contract of sale in which the seller declares his cost and profit. which is stipulated in 1. it will be a currency transaction which cannot be made through Salam because such exchange of currencies requires simultaneous payment on both sides while in Salam. Islamic banks have adopted this as a mode of financing. 1. Accordingly. the Salam contract will mean the exchange of debt against debt which is prohibited. there is only one reference rate (interest rate). through the Central bank Mudarabah ratio or Interbank Mudarabah ratio. 3. While for Conventional finance. 1.10. REFERENCE RATES 1. If price in Salam is US $ for example.1 MURABAHA Literally it means a sale on mutually agreed profit.deferred. Technically. it involves a request by the client to the bank to purchase certain goods for him. 4. Sharing ratio reference scale.11. The bank does that for a definite profit over the cost. delivery of the commodity is deferred. Islamic finance will have two basic groups of financial contracts: debt/semi-debt contracts and non-debt (equity) contracts. Price mark up/rent reference scale possibly through the yield on Government security. b. there can be two reference scales: a. and the commodity to be sold is Pak Rupee. As a financing technique. 2. The parties negotiate on the margin or the rate of profit on the cost. Reference rates would be needed for financial markets and intermediaries for executing and pricing the trade and leasing contracts.
building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period.Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken.11. it is different from Murabaha in respect of pricing formula. 25 . Unlike Murabaha. roads and highways. the ownership in the asset would be transferred to the lessee. or for the effort or work proposed to be expended. In other words.11. plants. Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons. 1. 1. allowing cash payment in advance and future delivery or a future payment and future delivery. Both the parties negotiate on the price.5 ISTISNA’A It is a contractual agreement for manufacturing goods and commodities. Istisna can be used for providing the facility of financing the manufacture or construction of houses. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.4 MUSAWAMAH Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. projects and building of bridges. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. seller in Musawamah is not obliged to reveal his cost. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell. Thus. All other conditions relevant to Murabaha are valid for Musawamah as well.3 IJARAH-WAL-IQTINA’ A contract under which an Islamic bank provides equipment.11. 1.
while the loss is borne by each partner strictly in proportion to respective capital contributions. 1. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. Any profits accrued are shared between the two parties on a preagreed basis. while loss is borne only by the provider of the capital.11. silver or currencies. 1. It is an agreement under which the Islamic bank provides funds. which are mixed with the funds of the business enterprise and others. Barring this. it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal. In case of Murabaha-Muajjal. The profit is distributed among the partners in pre-agreed ratios. but not necessarily required to do so. which is 26 . The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.6 BAI’MUAJJAL Literally it means a credit sale. it has to expressly mention cost of the commodity and the margin of profit is mutually agreed. 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. All providers of capital are entitled to participate in management. The objects of this sale are the general goods and cannot be gold.1. Technically.11. Bai′ Salam covers almost everything.7 MUDARABAH A form of partnership where one party provides the funds while the other provides expertise and management.9 BAI’SALAM Salam means a contract in which advance payment is made for goods to be delivered later on. It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. 1.11. The latter is referred to as the Mudarib.11.8 MUSHARAKAH Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business.
CHAPTER 2 LITERATURE REVIEW 27 . quality and workmanship.capable of being definitely described as to quantity.
Mr. He has rejected all economic theories in support of interest without giving any rational. 28 . and Maulana Justice Muhammad Taqi Usmani. Justice Munir A Shaikh. Dr.1. Justice Khalil-ur-Rahman. if some method of exchanging stocks on their par value is worked out. their trading should also be considered as riba in barter loans. since stocks are treated as the subject matter of joint-stock companies and their price changes too often. However. and any rate above the zero rate is a usurious rate of interest. Justice Wajeehuddin Ahmad. He further suggested that it would be possible to run modern system of banking without interest but he did not put any solution in that book or refer to any alternate mode of financing. “In modern finance.” Introduction Pp.” He discusses riba on the basis of Quranic verses and Hadith. Anwar Iqbal Qureshi (1944) in his book “Islam and The Theory of Interest” reprinted in 1991 writes that Islam has fixed a zero rate of interest. Mudarabah. He has recommended that Government should nationalize all banks and Insurance companies to run their working interest free. In 1999 the Shariah Appellate Bench comprising of Mr. Musawamah. Murabaha. Muhammad Mazhar Iqbal (2003) in his paper “A Broader Definition of Riba” put a step forward saying. and Istisna. Salam. Ijarah. The Commission for Transformation of Financial System set up in the State Bank of Pakistan in pursuant to the Supreme Court Judgment on Riba dated December 23. He has suggested that lending to the needy people should be done from Bait-ul-Mal (Government Treasury) in the form of Qard-e-Hasna. In a judgment in 1991 the Federal Shariah Court of Pakistan declared the laws allowing interest repugnant to Islam10. The Federal Government of Pakistan and certain banks and financial institutions filed 67 appeals against this judgment in the Shariah Appellate Bench of the Supreme Court. State Bank of Pakistan provides these modes of financing to get 10 See “The Text of the Historic Judgment on Interest.Dr. then their exchange needs not involve riba in barter loans. 1999 approved essentials of Islamic modes of financing including Musharakah. Mr. gave a decision against riba and declared all kinds of interest equal to riba and unlawful.
corruption. in business transactions. Muhammad Sayyid Tantawi. Further. In response of this letter Dr. interest. Hasan Abbas Zaki. Miriam Sophia Netzer (2004) in her paper “Riba in Islamic Jurisprudence: The Role of ‘Interest’. Aqdas Ali Kazmi (2004) in his article in The News “Islamic Economics and the Debate on Interest –I & II” had concluded about interest prohibition “By disowning a useful and effective instrument of economic management. Dr. Rasul Shams (2004) in his paper “A Critical Assessment of Islamic Economics” writes that those who defend the view of interest free banking as Islamic banking refer to Quran and ban all forms of interest including modern bank interest. in Discourse on Law and State” Pp. “Investing funds with banks that pre-specify profits or returns is Islamically Legal. ‘interest. Dr. But still there are no prudential regulations from the State Bank of Pakistan to regulate Islamic Banks.comments of Banking industry and students at its web site. and there is no haram therein”. Rasul Shams declares the difference in the meaning of Ar-Reba (Usury) and Rebhe (Interest) so the translation is a cause of misunderstanding. By focusing on elimination of the ‘in eliminable’ and the ‘inevitable’ i. We have doubts about this interpretation of Quranic verses. in Discourse on Law and state” writes that Shariah compliant financial instruments are those that do not contravene prohibitions in Islamic revelatory texts against ‘riba’.’ and ‘Gharar’ (speculation).44. Chairman of the Board of Directors of the Arab Banking Corporation11. exploitation of the underprivileged and myriad other forms of the real and the manifest riba continue to infest the Muslim world and fail to attract the full attention of the Muslim scholars.” See “Riba in Islamic Jurisprudence: The Role of ‘Interest’.e. sent a letter dated 22/10/2002 to the Grand Imam Dr. Islamic economists may not be doing any service to the cause of Islam and Islamic economic system. Muhammad Sayyid Tantawi writes. immense energies are being wasted while phenomena like bribery. 11 29 . Rector of Al-Azhar and asked for a fatwa about the working of commercial banking.
Aqdas Ali Kazmi. limited products and inability to meet with all the requirements of corporate loans and services. According to Atif Malik (2002) more than a billion of Muslims are living around the globe that would be willing to invest their surplus fund. determination and innovative ideas. In fact Islamic banking is accompanied with different ambiguities and queries in the people’s mind. It is moving ahead slowly to become more easy and practical choice over conventional banking.According to Dr. but it has not made the headway as it should have due to lack of public awareness. Habibur Rahman (2002) observes that throughout the world every year new banks and financial institutions based on Islamic Shariah are coming up and some conventional 30 . and Muslim Commercial Bank) have got issued licenses for Islamic banking and opened their separate Islamic banking branches. Islamic banking industry is a vast industry and there are tremendous opportunities to attract investments.. All that is required is persistence. Muhammad Ayub (2008) says that Shariah compliance of the Islamic financial institutions is of vital importance for integrity and credibility of Islamic banking industry. In Pakistan two Islamic banks (AlBaraka Islamic Bank and Meezan Bank) are exclusively operating in Islamic banking whereas three commercial banks (Bank Alfalah Ltd. So it is ideal time for Islamic banking industry to gear up its resources to attract them. Some wrote the bank interest as halal and others haram according to Shariah and so two different schools of thought developed. As Islamic banks could fail as much due to non compliance with principles. Noor Ahmed (2007) says Islamic banking has great potential for growth. as it cannot perform all functions of interest in the economy. Faysal Bank. as for financial imprudence. Profit and Loss Sharing is not a substitute of the interest rate. therefore it has to be ensured that the activities of the Islamic banks comply with Shariah principles. In the opinion of Sheikh Nazim (2002) for all those (especially conventional banks) who wishes to start Islamic investment it is necessary to comply with the governing Shariah rules and its provisions. Consequently different people have different viewpoints.
In the view point of Tahir (2005) Islamic banking is going through transition phase. Shamshad Akhtar (2008) concludes that development of Islamic prudential regulatory and supervisory framework. No Islamic bank has yet failed. auditing and governance standards will facilitate adoption of unified principles for the development. The investment in Islamic financial institutions provides potential opportunity for profit in proportion to the risk assumed to satisfy the different demands of participants in the contemporary environment and within the guidelines of the Shariah and the profit earned through rental sharing. operation and regulation of Islamic financial services. The system has so far achieved two significant points to its credit. It may survive by working with more transparency. regional and national institutions and it will definitely help all those who want to contribute in the welfare of the people around the globe. institutional framework and evolving approaches for supervision systems will help build confidence among investors and customers. Siddiqui (2005) says that profit and loss sharing aspect of Islamic banks can play vital 31 . Even by conventional standards Islamic banking has outweighed its traditional counterpart in the last two decades of the last century. utilizing the funds at risk on a profit and loss sharing basis. New challenges are emerging for redrafting the rules. will pave the way for development of Islamic finance. Shamshad Akhtar (2007) says that IFBS’s efforts to developing Islamic regulations as well as accounting. 1. Noor (2007) says that Islamic financial system employs the concept of participating in Halal business opportunities. with effective corporate governance and with better interaction with relevant international. Mudarabah.banks have already opened their Islamic Banking windows because of the inherent strength of the system. services charges may be termed as equalizer instead of mark up of Shariah complaint return. 2. while tweaking the regulations to accommodate special risk characteristics of the Islamic finance. which subscribes to Basel standards for conventional banking.
He has given through information about investment-based. One of the key aspect of Islamic mode of financing is the concept of trust between the borrower and the lender. In this ideal situation different products have been proposed and implemented by different market players from time to time and academic world has been keeping an eye on this for some time now. Like there are some studies which are primarily focus on only one or two financial products and their progress in the market. in this system the ideal situation is that in which both the parties enter in to an agreement where they have full commitment to their cause (which in this case is to conduct a business concern and to make that a profitable concern). There are some studies which have concentrated on the topic of different financial products that have been evolved in the efforts of presenting a workable Islamic financial system. For example the concept of P&L (Profit and Loss sharing) is been very well studied subject in Islamic financial world.role in eradicating the negative effect of interest and can benefit the people in real terms. but the measurement of efficiency of Islamic financial institutes have been a week point in those studies. not much work is done on 32 . the rational behind the prohibition of interest in Islamic society. In the past studies about Islamic banks have been carried out on many diverse topics ranging from social and ethical aspects to rather descriptive kind of studies like why it is important to have interest free financial system. Despite the fact that there have been lots of works undertaken on Islamic financial system. rent-based and service-based investment alternative in Islamic banking system. People have talked about the difference between Islamic banks and conventional Islamic banks and their products. A lot of work has been done by Islamic financial institutes to work out different financial instruments that can on one hand be good enough to satisfy the every increasing demand of corporate and individual customers and on the other hand to meet the requirements laid down by Shariah. sale-based. they have given detail aspect of this and given detail accounts of different types of financing alternatives of interest in Islamic banking system based on the principle of P&L.
A common problem faced by all the researchers in this field. Some people have argued that Islamic banks can survive even in conventional banking environment in which PLS mode of financing is less dominant. is that unlike other industries the banking sector’s inside financial highlights are not that much easily accessible specially the lack of data that is available about Islamic banks. but these Islamic since can not earn profit on these reserves because of the interest factor involved in it) they lack behind in terms of efficiency as compare to conventional Commercial Banks. pool risks and facilitate transactions.these lines as compare to studies that have been focused on other aspects. Different statistical tools have been employed by researchers to find out results. They have investigated the relationship between banks profitability and spread. From the previous studies we can figure out that there are 33 . It is therefore been suggested by him that the reserve ratios of Islamic banks should not be like those of non Islamic banks but it should be some rational amount keeping in view the nature of business and the way these banks do their business. Lots of study in Islamic banking sector has been focused on the fact to find out the viability of Islamic banks and their ability to mobilize the savings. The writers have tried to focus their studies on the implications of external factors on the profitability of banks after controlling the financial and economics structure indicators. Some studies have focused on the policy implications of interest free financial system. One major aspect that he pointed out in his research is that since Islamic banks do not earn profit on their reserves (that every bank has to maintain with the central bank of the country. Some researchers have tried to find out a relationship between bank characteristics and overall financial environment that affects the bank’s performance. Studies have been made to establish a relationship between profitability and banking characteristics. portfolio maintain by banks and the measures to ensure the best possible return on their investment (Deposits). He has argued that Islamic products have different risk characteristics and consequently different prudential regulation should be erected. “Data Envelopment Analysis” is one of the most widely used tools in this respect.
some certain points that have been explored. These points can be summarized in following headings.
In these kinds of studies the writers have laid stress on the fact and need of why there is a need to have a separate financial system for Muslims or, what it is that make the Islamic financial system different from conventional financial system. These studies have been mainly theoretical and have laid stress on the social and ethical aspect of interest. Almost all of these studies have concluded at least one single point i.e. interest is a basis of an unequal and unjust system that provides opportunity for rich people to get even richer and puts extra pressure on poor people who can not survive with out having borrowed money. This is kind of an exploitation system where the have ones exploit the needs of have knots with their ability to provide enough liquidity to fulfill their needs and than earn extra money with out even risking their principle amount, which puts the borrower really of back foot.
2.2. FINANCIAL PRODUCTS FINANCIAL INSTITUTES
Few studies have focused mainly on different financial products that the Islamic banks have devised during the evolution period, these banks have develop many new products that are both compliant with the needs of customers and to that of Islamic Shariah as well. Islamic banks have to be really innovative to come up with the products that they could present to their customer, who were quite use to the products that were presented to them by conventional banks and those products should not involve the element of interest in them as interest is not allowed in Islamic mode of financing. For this reasons they have to twist and turn different conventional products in order to make them in line with demands to Islamic Shariah. The given detail aspect of this and given detail accounts of different types of financing alternatives of interest in Islamic banking system based on the principle of P&L. He has given through information about investment based,
sale-based, rent-based and service-based investment alternative in Islamic banking system.
2.3. MEASURE OF EFFICIENCY
Different authors have tried to evaluate the efficiency of Islamic banks with different sets of tools, and have used different approaches. Like some of them have used only internal factors like ratio analysis and balance sheet item’s trends to measure their proficiency. Some people have used the concept of Data Enveloping Analysis with internal and external factors effecting the profitability and efficiency of banks. Some people have used the statistical tools such as T-test, correlation between different variables to find a link between the factors that determine the profitability of Islamic Banks.
2.4. FUNDS MOBILIZATION EFFICIENCY
Few studies in Islamic banking sector has been focused on the fact to find out the viability of Islamic banks and their ability to mobilize the savings, pool risks and facilitate transactions. Some studies have focused on the policy implications of interest free financial system. Some researchers have tried to find out a relationship between bank characteristics and overall financial environment that affects the bank’s performance.
2.5. POLICY IMPLICATIONS
Due to that fact the operations of Islamic banks differ from those of conventional banks and their commitment to not to charge and pay interest puts them in different case scenario, where they have different needs and separate set of regulations to govern their workings. Some of the regulations that were made for conventional banks hurt the operations of Islamic bank quite badly. E.g. as Islamic banks do not charge interest and nor they pay fix amount of interest on their loan they can not maintain huge amounts of reserves just to fulfill the statuary reserves condition. This high level of reserves deprives these Islamic banks to advance more loans, so as to keep their profit earning cycle going and properly employed their reserves.
2.6. SHORTFALL IN LITERATURE
The early studies about this topic were not conclusive enough, especially those which were more concern with the statistical aspects of performance. One of the major reason for these studies for not to be that much comprehensive enough is the fact that they did not had enough and comprehensive data available with them to perform those studies. What ever data that was available at that time was more kind of general information that is standard in financial institutions. Inability of the researchers or their lack of interest to compare the financial figures of Islamic banks with conventional banks is one major point that is lacking in some previous studies. There have been some studies where the researchers have compare the performance of two or more Islamic banks but most of the time the banks were either in same country or they were of the same group i.e. Islamic banks but very few people have tried to compare the banks from two different segments of market, namely Islamic banks and conventional commercial banks. People do have studies that were broader in their perspective like people have selected Islamic banks in one whole region or in some instances more than one geographical region,.
CHAPTER 3 DATA AND METHODOLOGY 37 .
liquidity ratios. Where for one group of banks. as the environments in which these banks were operating were totally different from each others. This made them difficult to compare and get the desired results. We will try to relate and compare the performance of the two banking groups to find the possible answer. Various indexes have been provided by financial management theories for measuring bank’s performance.The study is aimed at comparative financial performance of Islamic banking and conventional banking in Pakistan. This gives us an idea of how these two different set of banks which are working in the same field but in different working environment. The banks have been selected on the basis of their total assets as it is important to have banks with similar structure to make the evaluation of the comparative results easy. To tackle this problem the researchers have to device and include different control variables in their data. To measure performance of banks financial ratios have been used quite commonly and extensively in the literature. Selecting the banks was a slick process as most of the banks had already been used for different studies in past either on the basis of only one kind of banks i. Unlike other efforts where researchers have only used the data of Islamic banks we in this report have included both Islamic as well as conventional commercial banks in the set of data. This cross group examination will help us to understand how the Islamic banks (which are generally thought as not been good performer) are working and performing in comparison to conventional banks. The groups consist of the Islamic banking group and the other one is the conventional banking group.e. Using accounting ratios is one of them. In this report we’ve performed the ratio analysis on the data obtained from the balance sheets of the banks and have grouped the ratios in different sets of ratios which are profitability ratios. Islamic banks or on the basis of their location as they were located in different geographical regions. interest is the basic pillar of their working while for other it’s totally restricted. risk & solvency ratios and 38 .
For any bank. Return on Assets (ROA). There are some core methods been used by most of the studies and these methods include the method of evaluating internal performance by analyzing accounting data. Return on Equity (ROE). ROA shows the profit earned per rupees of assets and most importantly. i. (Basher. 2000) Evaluation of bank’s performance is a complicated procedure that involves the assessment of internal operations and external activities. ROA and ROE have been used in most studies about structural performance and are included here to reflect the bank’s ability to generate income from nontraditional services.e. reflects the ability of management to utilize the financial and real investment resources of banks to generate profits. Financial ratios usually provide a broader understanding of the bank’s financial condition since they are constructed from accounting data contained on the bank’s balance sheet and financial statement. In past various methods have been used in different studies to evaluate the performance of banks. The analysis of the data concentrates on the figures of Islamic banks mainly because these are the main objective of this research to find answers for this set of banks. The ratios are helpful in determining the efficiency of banks in effectively using their assets in productive activities and return on equity. a number of financial ratios are usually used to measure the performance of financial intermediaries. Large size of bank provides it a greater ability to diversify itself. ROA depends on the bank’s decisions about its policy as well as the factors beyond control relating to the economy and government 39 .efficiency profitability ratios. In general. In order to measure the operating efficiency of banks we’ll be looking the operating ratios of banks. it also helps to control the cost factor of its operations as well. Another key management element that many studies have found to be a primary factor in assessing bank performance is operating efficiency. net income. One of the major reasons of selecting the total assets of the banks is to measure the overall performance of bank is that size of the bank provides more effective control over its ability to counter any setback or problem faced in its financial operations. Both measures are closely tied to the key item in the income statement.
the study uses 11 financial ratios for the bank’s performance. and (d) efficiency ratios. Many regulators believe return on assets can best measure the efficiency of banks. reflects how effectively a bank management is using shareholders funds. ROE. Bank’s efficiency and ability to sustain in hostile conditions depends upon how well diversified they are in their capital structure. guidelines. on the other hand. If a profitability ratio is relatively higher as compared to the competitor(s). then it is taken as indicator of improve performance of the bank. Research applies these criteria to judge 40 . these ratios indicate firm’s profitability after taking account of all expenses and income taxes. PROFITABILITY RATIOS Broadly. More specifically. the efficiency of operations.1. These ratios are generally considered to be the basic bank financial ratio in order to evaluate how well bank is performing in terms of profit. In order to see how Islamic banks have performed in comparison with the conventional banks over 4 years and 2 years. most banks utilize financial leverage heavily to increase return on equity to a competitive level. (c) risk and solvency ratios. the ratios of return on its assets and equity. accounting profits are the difference between revenues and costs. or previous years’ same ratios. A bank’s ROE is affected by its ROA as well as by the bank’s degree of financial leverage (equity/ asset). profitability on assets and to shareholders of the firm. 3.regulations. (b) liquidity ratios. firm pricing policies. Since returns on assets tend to be lower for financial intermediaries. Profitability is considered to be the most difficult attributes of a business to conceptualize and to measure. net income to total assets and banks income to equity. These ratios are broadly categorized into four groups: (a) profitability ratios. industry averages. Profitability of banks are been measured through Profit margin against total assets of bank. These ratios are helpful and used to assess the ability of the business to generate earnings in contrast with its all expenses and other relevant costs during a specific time period.
ROA is calculated as under: ROA = Net profit after tax / Total Assets 3. Return on Equity (ROE). It measures and tells how much the firm is earning after tax for each rupee invested in the firm. ROE is net earnings per rupee equity capital.the profitability of the two banks: Return on assets (ROA). and Profit Expense Ratio (PER). Return on Equity (ROE) Return on equity indicates the profitability to shareholders of the firm after all expenses and taxes.1.3. ROA can be increased by firms either by increasing profit margins or asset turnover but they can’t do it simultaneously because of competition and trade-off between turnover and margin.1. ROE is calculated as under: ROE = Net profit after tax /Shareholder’s Equity 3. Generally.2. In other words. Usually. This will always be the case as long as the ROA (gross) is greater the interest rate on debt.1. however. higher ROE means better managerial performance. It is a common measure of managerial performance as it measures how much the firm is earning after tax for each rupee invested in the assets of the firm. Financial leverage creates an important difference between ROA and ROE in that financial leverage always magnifies ROE. moreover. By and large. a higher ratio means better and improve managerial performance and efficient utilization of the assets of the firm and lower ratio is the indicator of inefficient use of assets. It measures net earnings per unit of a given asset. Return on Assets (ROA) Return on assets indicates the profitability on the assets of the firm after all expenses and taxes. there is higher ROE for high growth companies.1. how bank can convert its assets into earnings. 3. Profit to Expenses Ratio (PER) 41 . a higher return on equity may be due to debt (financial leverage) or higher return on assets.
3. to avoid experiencing financial suffering. the higher liquidity ratios mean bank has larger margin of safety and ability to cover its short term financial obligations. The ratio indicates to what extent bank is efficient in controlling its operating expenses. Liquidity ratios measure the ability of the firm to meet its short term financial obligations. The ratio measures the amount of operating profit earned for each rupee of operating expense. the loan means the advances for the conventional banks and financings for the Islamic banks. Liquidity is important for the bank to avoid defaulting on its financial obligations and. operating profit is defined as earnings before taxes and operating expenses means total non-interest expenses. and Loan to Asset Ratio (LAR).2. Loan to Deposit Ratio (LDR) Loan to deposit is the most important ratio to measure the liquidity condition of the bank. This is because Islamic banks are prohibited to extend loans and earn interest (Riba) and restricted to follow Islamic Shariah Principles while conducting their banking business operations so the only way the Islamic banks can utilize their deposits is to provide 42 . thus. maintain cash position. Because saving accounts and transaction deposits can be withdrawn at any time. Measures of liquidity are: Loan to Deposit Ratio (LDR). Banks can get into liquidity problem especially when withdrawals exceed new deposit significantly over a short period of time. and collect receivables. Generally. so there is high liquidity risk for both the banks and other depository institutions.2. Cash & Portfolio Investment to Deposit Ratio (CPID). PER is calculated as under: PER = Profit after tax /Operating Expenses 3.1. In our research. A higher PER means bank is cost efficient and is making higher profits.It measures the operating profitability of the bank with respect to its total operating expenses. LIQUIDITY RATIOS Liquidity ratios indicate the ability of the firm to meet its recurring financial obligations. Here.
financings through different Islamic financial products. Bank with Low LDR is considered to have excessive liquidity, potentially lower profits, and hence less risk as compared to the bank with high LDR. A high LDR indicates that a bank has taken more financial stress by making excessive loans and also shows risk that to meet depositors’ claims bank may have to sell some loans at loss. LDR is calculated as under: LDR = Loan / Deposits
3.2.2. Cash & Portfolio Investment to Deposit Ratio (CPIDR)
Another ratio to measure the liquidity of the bank is the cash and portfolio investments to deposit ratio. The higher the ratio the better is the liquidity position of the bank, therefore, the more is the confidence and trust of the depositors in the bank as compared to the bank with lower CPIDR. This ratio serves two purposes. First, it boosts the trust of the depositors in the bank as the depositors know that bank is not only having enough cash but also made some investments in securities portfolio and supposedly earning some positive returns on those portfolio investments. Secondly, they feel confident that in need of cash bank may sell these portfolio investments at any time in the secondary market which is readily available for this purpose. CPIDR is calculated as under: CPIDR = Cash & Portfolio Investments / Deposits
3.2.3. Loan to Asset Ratio (LAR)
Just like LDR, loan to assets ratio (LAR) is also an important ratio that measures the liquidity condition of the bank. Whereas LDR is a ratio in which liquidity of the bank is measured in terms of its deposits, LAR measures liquidity of the bank in terms of its total assets. That is, it estimates the percentage of total assets the bank has invested in loans (or financings). The higher is the ratio the less the liquidity is of the bank. Similar to LDR, the
bank with low LAR is also considered to be more liquid as compared to the bank with higher LAR. However, high LAR is an indication of potentially higher profitability and hence more risk. LAR is calculated as under: LAR = Loan / Total Assets
3.3. RISK AND SOLVENCY RATIOS
Risk and solvency ratios are referred to as gearing, debt or financial leverage ratios. The degree to which a firm relies on debt financing rather equity is related with financial leverage. These ratios determine the bank probability that the firm default on its debt contacts. As the debt a firm is more, the higher is the chance that firm will become unable to fulfill its contractual obligations. In short, higher levels of debt can lead to higher probability of bankruptcy and financial distress. Although, debt is an important form of financing that provided significant tax advantage, it may create conflict of interest between the creditors and the shareholders. If the amount of assets is greater than amount of its all types of liabilities, the bank is conceived to be solvent. Deposits normally constitute liability for any type of bank whether Islamic or conventional. Borrowed money in either form12 stands second among total liabilities for almost all banks except all Islamic banks which are prohibited by Islamic Shariah from taking or giving any kind of interest-based debts13. To estimate risk and solvency of the bank, measures which usually used are: Debt-Equity Ratio (DER), Debt to Total Assets Ratio (DTAR), and Equity Multiplier (EM).
3.3.1. Debt-Equity Ratio (DER)
DER is one of the tools which measures the extent to which firm uses debt. It measures and evaluates ability of the bank capital to absorb financial shocks.
Either by issuing debt or borrowing from other financial institutions. A form of debt which is non-interest based called “Qard-e-Hasan” is permitted under Islamic Shariah (See badralislami.com for definition).
In case, creditors default in paying back their loans or the asset values decrease bank capital provides shield against those loan losses which are disturbing the financial position of the bank. A bank with lower DER is considered better and improved as compared to the bank with higher DER. DER is calculated as under: DER = Total Debt / Shareholder’s Equity
3.3.2. Debt to Total Assets Ratio (DTAR)
This ratio measures the amount of total debt firm used to finance its total assets. It is an indicator of financial health and strength of the bank. This provides information about the solvency and the ability of the bank to obtain additional financing for potentially attractive investment opportunities. A higher DTAR means bank has financed most of its assets through debt as compared to the equity financing. Moreover, higher DTAR indicates that bank is involved in more risky business. DTAR is calculated as under: DATR = Total Debt / Total Assets
3.3.3. Equity Multiplier (EM)
EM tells that how many times the total assets are of the shareholders equity is measure by equity multiplier. Moreover, it indicates the amount of assets per rupee of shareholders equity. Higher value of EM entails that bank has used more debt to convert into assets with share capital. Generally, the higher is the EM the greater is the risk for a bank. EM is calculated as under: EM = Total Assets / Total Shareholder’s Equity
3.4. EFFICIENCY RATIOS
AU is calculated as under: Asset Utilization = Total Income / Total Operating Expenses 46 . 3. IER is calculated as under: IER = Total Income / Total Operating Expenses 3. effectiveness of the inventory management practices. High IER is preferred over lower one as this indicates the ability and efficiency of the bank in generating more total income in comparison to its total operating expenses.1. Total income in the research is defined as net spread earned before provisions plus all other income while the Other Expenses in the income statement are treated as total operating expense for the study. A higher value of these ratios is taken as good indicator which means firm is doing well.2. quality of receivables and how successful the firm is in its collections. Total revenue of the bank in this study is defined as net spread before provision plus all other income. and efficiency of firm in controlling its expenses. the bank is not using its assets to their capacity and should either increase total revenues or dispose of some of the assets.Efficiency ratios measure how effectively and efficiently the bank is managing and controlling its assets. The bank is presumably said to using its assets effectively in generating total revenues if the AU ratio is high. Asset Utilization (AU) How effectively the bank is utilizing all of its assets is measured by assets utilization ratio. and Asset Utilization (AU). This is the most commonly and widely used ratio in the banking sector to assess the managerial efficiency in generating total income vis-a-vis assuring its operating expenses. If the ratio of AU is low. It indicate the overall effectiveness of the firm in utilizing its assets to generate sales.4. the promptness of payment to suppliers by the bank. Income Expense Ratio (IER) Income to expense is the ratio that measures amount of income earned per rupee of operating expense.4. Ratios used to measure efficiency of the bank are: Income to Expense Ratio (IER).
JS Bank Limited.5. The main point of similarity while choosing the banks was the amount of total assets. • • • • • • Meezan Bank Limited. Soneri Bank Limited. Primary data and secondary data. The banks that are been reviewed in here are following. which 47 .e. DATA The data used in this research includes financial figures of six banks three of them are Islamic Banks and three are conventional commercial banks which are referred as non Islamic bank in this study. There are two parts of data been used in this report i.e.e. For some detail figures annual reports of the banks had to be consulted in order to calculate the various ratios. Islamic and Non Islamic Banks) with roughly same size of total assets. the banks should be similar in nature. Al Baraka Islamic Bank. The selection of banks was made keeping in mind the homogeneity of market i.3. First Women Bank Limited. for this reason we selected banks in pairs i. Similar in nature means that they should be roughly of same size in terms of business volume. Dawood Islamic Bank Limited. total assets etc.e. for this reason the problem faced was that it was hard to find six banks of different nature (i.
156 419.186 61.374 1.713.554 41.576.877.027.028 10.644.131.188 992.339 54.264 1.866 Total Income Total Operating Expenses Total Operating Revenue 633.156 2.301.409 604.769.311 48 .940 633.713.490 27.768.311 39.233.501 67.903 1.481 70.240 611.441 5.822 2.956.188 34.764.886 22.593 2008 621.014 718.471.341.651.1: SUMMARY STATISTICS FROM BALANCE SHEET OF MEEZAN BANK LIMITED MEEZAN BANK LIMITED (Rupees in ‘000) 2005 Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt 2006 604.675.719.949 79.411.910 169.740.455 30.031.767 2007 963.286.276.353 5.070 6.449.092 2.097 992.928 1.582.438.023 169.756.251 27.116 780.016 34.559 5. Likewise if we are looking to a bank from Non Islamic banking sector which has total assets of around three thousand million rupees an Islamic bank with similar size of total assets has been chosen.are quite similar to each other in terms of total assets.970.675.897.187 85.938 1.710 14.178.875 5.606.535.763.623 4.394 2.116 19.262 3. TABLE 3.251 46.
534 3.948 2.031 6.657 3.184.900 73.727 9.888.063.566.2: SUMMARY STATISTICS FROM BALANCE SHEET OF DAWOOD ISLAMIC BANK LIMITED DAWOOD ISLAMIC BANK LIMITED (Rupees in ‘OOO) 2007 Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt 2008 32.710 4.259 Total Income Total Operating Expenses Total Operating Revenue 49 .877 5.850.762 380.045.146 5.652.491.752 2.TABLE 3.161 60.085.318.091 60.259 3.639.579 32.723.646 51.231 32.381 1.552 434.111 5.031 166.111 51.393 418.
248.191 245.585.153.4: SUMMARY STATISTICS FROM BALANCE SHEET OF SONERI BANK LIMITED SONERI BANK LIMITED 50 .197.446.480.360 400.533 314.632.400.456 400.528 22.TABLE 3.3: SUMMARY STATISTICS FROM BALANCE SHEET OF AL BARAKA ISLAMIC BANK AL BARAKA ISLAMIC BANK (Rupees in ‘OOO) 2007 Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt 2008 (73.832.810 18.808 327.045 327.377.348 Total Income Total Operating Expenses Total Revenue TABLE 3.428 21.124.825 19.159 3.336.077.878 1.191 572.549 16.217 78.964.113 2.566 3.542 12.348 335.157) 24.826 2.922 1.545 14.
181.901 35.646.625 920.037.914 1.854.729.858 1.674 5.(Rupees in ‘OOO) 2005 Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt 2006 985.032 32.412.052.448.345.117.448.449 60.154.575.421 1.032 1.053.441.290 1.724.233 TABLE 3.233 47.739.755 14.445 2008 701.000.581 1.749 953.041 80.080 3.334 76.508 4.243.5: SUMMARY STATISTICS FROM BALANCE SHEET OF JS BANK LIMITED JS BANK LIMITED (Rupees in ‘OOO) 2007 51 2008 .229 1.544 47.476.128 5.293.580 801.400.000.864.955.608 16.006 2007 1.436.302 16.685 40.207 974.491 5.233 63.562 70.685 953.666 1.624 58.352.901 1.951.254 6.977.965.605.150.861.205 19.175 1.060 6.400.868 Total Income Total Operating Expenses Total Operating Revenue 1.364 61.298 70.253 65.647 5.771 1.551.248 53.177 73.229.390.476.194.634.801.
367 9.225 983.965 98.221) 54.770 21.020 7.235 5.963 13.247 6.327.721 157.945 35.784.752 5.309.351 (62.576 52 .367.199 15.802 5.959 16.628 111.431 20.917 6.475.536 15.285.627.273 977.141.303.985.Net Profit After Tax Total Assets Shareholders Equity Profit before Tax 35.898 1.351.225 Total Operating Expenses Advances/Loans Deposit Cash Portfolio Investment Total Debt Total Income Total Operating Revenue TABLE 3.784 111.221) 736.294.699.887 8.014 (220.127.116.11: SUMMARY STATISTICS FROM BALANCE SHEET OF FIRST WOMEN BANK LIMITED FIRST WOMEN BANK LIMITED (Rupees in ‘OOO) 2007 Net Profit After Tax Total Assets 2008 106.
135.569.063.25% 0.249 3.69% -0.507 7.939.30% -0.059 8.04% 0.332 537.12% 10.897.116 18.104.22.1680 3.096.688 623.330 5.028.264.610 190.422 339.93 2007 0.30% -0.7: RATIO ANALYSIS OF JS BANK AND AL BARAKA ISLAMIC BANK LIMITED (AIBL) JS BANK RATIOS Return on Assets Return on Equity Price Earning Ratio AIBL 2007 1.443 373.422 1.929 2.443 Total Operating Expenses Advances/Loans Deposits Cash Portfolio Investment Total Debt Total Income Total Operating Revenue RATIO ANALYSIS STATISTICS FOR REVIEW TABLE 3.130 238.113 2008 -0.95% 0.Shareholders Equity Profit before Tax 1.304.800 190.57 3.14 53 .084 2008 0.17% 0.308 575.640 7.088 6.
34% 53.86% 2.76% 2007 0.39% 0.35% TABLE 3.19 1.01% 8.19 DIBL 2008 1.83 75.51 1.85% 31.85% 2.81% 59.42% 41.80% 0.048 0.42% 9.41% 23.95 0.45% 3.17% 44.57 1.091 0.61% 3.02 1.42% 57.92% 9.09 90.74 0.70 9.8: RATIO ANALYSIS OF FIRST WOMEN BANK LIMITED (FWBL) AND DAWOOD ISLAMIC BANK LIMITED (DIBL) FWBL RATIOS Return on Assets Return on Equity Price Earning Ratio 15.27% 63.22% 10.36% 0.77% 1.94 74.02 88.32% 78.18% 27.138 54 .15% 2007 1.Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization 47.08 0.33% 0.88% 74.74% 2008 0.
82% 1.90% 6.68 87.3% 2008 0.14 10.49 2005 1.66% 34.31 0.34 57.54% 54.28.48% 1.40 16.09% 7.44% 55.1% 0.46 84.75 18.45% 2006 1.24% 5.9: RATIO ANALYSIS OF SONERI BANK LIMITED SONERI BANK LIMITED RATIOS Return on Assets Return on Equity Profit Expense 24.38% 48.Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization 40.74% 58.9% 0.34 0.1% 1.87 0.63% 47.39% 2007 1.76% TABLE 3.97% 1.4% 2.88% 8.87 46.17 0.47% 52.8% 111.20% 1.98% 45.95% 1.58 5.67 8.43 1.74 1.38% 0.58.87% 55 .
8% 77.10: RATIO ANALYSIS OF MEEZAN BANK LIMITED MEEZAN BANK LIMITED RATIOS Return on Assets 2005 1.278 10.46% 1.66 1.72% 56 .34 1.81% 66.30% 2007 1.37% 2006 1.60 43.43% 2008 0.68 12.62 1.11 11.20% 15.60% 50.20% 58.80% TABLE 3.51 12.28% 2.50 93.40% 91.03% 41.96% 67.80 13.Ratio Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization 2.07% 91.07% 52.57% 42.2% 50.54 11.63% 31.18% 16.33% 66.63 0.07% 92.93% 1.
80% 0.84% 0.Return on Equity Profit Expense Ratio Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization 14.35% 29.36 56.55% 64.44% 51.50 92.51% 11.99% 13.76 89.80 2.74 91.47% 25.74% 9.75 78.47% 10.99% 58.45 0.64% 9.40% 12.72 63.14% 10.70% 24.30 90.88 86.35% 9.84 1.11% 0.10 2.76 1.10% 46.74 0.66% 12.18% 57 .21% 8.32 0.47% 16.70% 0.62% 28.68 3.
CHAPTER 4 EMPIRICAL RESULTS 58 .
In the next year Meezan bank has performed very well raising its ROA to 1.30% 2008 0.452%.43% 1.1 Return on Assets (ROA) In the comparative study of the two banks we find that ROA of Meezan bank has remained stable in comparison to Soneri bank whose values oscillate more than the Meezan bank. on the other hand the soneri bank’s trend remain decreasing and reached to 1.3% but in the year 2008 the ROA of Meezan bank decreased to the half of its previous year value which was due to expansion of its branch network. In year 2005 ROA of the MB is 1.37% 1.45% 2006 1.Its expenses on the establishment of branches and assets are more due to which its return has reduced.30% 1.1.In the next year ROA of both the banks reduced but the trend of the soneri bank was more adverse as compare to the Meezan bank.43%. Table 4.MEEZAN BANK LIMITED (MBL) & SONERI BANK LIMITED (SBL) 4. Though it was good in year 2005 and 2008.1 ROA MBL SBL 2005 1.39% 2007 1.1 PROFITABILITY RATIOS 4.37% whereas of SB is 1.87% 59 . but soneri bank has its setup since 1992 and on the other hand Meezan bank has been established in 2000.72% 0.
On the other hand in year 2006 ROE of the soneri bank has declined by 6%. Table 4.1.1%.2 Return on Equity (ROE) ROE is the indicator that how much a bank has earned from its equity. Moving towards year 2008 ROE of the banks have declined but the decline in the value of Meezan bank is more than the soneri bank due to the establishment of new branches and expansion of branch network for which they have to incur more expanses.2 60 . whereas the ROE of Meezan bank declined by 2% which shoes the prudency of the Islamic procedures and in the year 2007 Meezan bank has performed very well as compared to the soneri bank as its ROE was 16.1 4.Figure 4.84% and soneri bank’s value of ROE was 16. When we compare the values of these two banks we see that in year 2005 ROE of the soneri bank is much better than the Meezan bank.
ROE MBL SBL 2005 14.2 4.20% 2006 12. Table 4.49 61 . The reason is that the Meezan bank has to incur more operating expanses as it relatively new entrant in the market as compared to the soneri bank.14 2008 0. PER of the soneri bank is better than the Meezan bank.3 Price to Expense Ratio (PER) Profit to expense ratio shows that how much expanses bank has incurred against their profit.70% 18.36 0.84% 16.40 2007 0.75 1.10% 2008 9.1.10% Figure 4.3 PER MBL SBL 2005 0.88 1.75 2006 0.11% 24. But the trend of soneri bank is more declining in comparison to the Meezan bank which shows the stability of the resources of Meezan bank.72 1.97% 2007 16.80% 10.
On the other hand Meezan bank has the decreasing trend as its value declined from 86% to 78. whereas the soneri bank showed the oscillating behavior. from 66. while the soneri bank has the trend of stable ratios but increased in the year 2008 by 11% i. When we move towards year 2006 Meezan bank has declined the value of ratio considerably showing that it is effectively operating its liquidity. While going through the data of two banks we saw that the Meezan bank has consistently declining trends. The lower the LDR ratio the more prudent is bank in liquidity management.e.1 Loan to Deposit Ratio (LDR) Loan to deposits ratio indicates that how much the bank has ability to absorb the shocks of liquidity crunch.8% to 77.2 LIQUIDITY RATIOS 4.2%.2.3 4.47% in year 2006 and continuing the 62 .Figure 4. As in the year 2005 LDR ratio of the Meezan bank is quite higher than the soneri bank.
35% in 2007 and reached to 56062% in year 2008 which shows the prudency of the procedures of Islamic banking.2.20% Figure 4.2 Cash Portfolio Investment to Deposits Ratio (CPIDR) This ratio is the pictorial of the cash and portfolio investment strength over deposits to meet its liquidity obligations.70% 67.57% in year 2005 and has fallen down to 31.80% 2008 56.Which shoes that conventional bank is continuously decreasing its liquidity. Now if we compare it with the Islamic bank its values of all the years are lesser than that of the conventional bank 63 .81% 2007 63. It was 43.4 LDR MBL SBL 2005 86.decline it declined to 63.96% in year 2008. Table 4.47% 66.35% 66.62% 77.33% 2006 78.4 4. If we see the trend of the conventional bank we will come to know that it is continuously following the downward trend from year 2005 to 2008.
In the year 2007 LAR of Islamic bank further 64 .40% 43.63% 2008 28.5 CPIDBR MBL SBL 2005 24.5 4.21% where as conventional bank has 50. but if we see the trend of Islamic bank its showing positive trend over the years and its just because that Islamic procedures are more prudent.96% Figure 4.55% 31.07% indicating a lesser change in this year. Conventional banks data reveals that due to poor and non prudent procedures it has to face the declining trend.06%.70% 42.whose main reason is that Islamic bank does not have vast or qualified market for investment therefore Islamic banks have mostly to rely on their modes of financings as its also a type of investment for them. Then in year 2006. LAR of Islamic bank decreased to 58.2.35% and of conventional bank is 50.57% 2006 25. Table 4.64% 41.03% 2007 29.3 Loan to Asset Ratio (LAR) In loan to asset ratio Islamic bank has shown positive and good results over the number of years as though the values in 2005 is 64.
8% which shows that major position of the assets of the conventional bank is based upon its advances so the conventional bank is more exposed to financing or credit risk.decreases to 51.3.20% 2008 46.6 LAR MBL SBL 2005 64.2% indicating an increase. More the value of DER shows that the bank is more exposed to the shocks of financial 65 . Table 4.35% 50.3 RISK & SOLVENCY RATIOS 4.1 Debt to Equity Ratio (DER) This ratio shows that how much the debt burden is () over its equity.21% 50.07% 2007 51.60% 2006 58.47% showing a comparative decrease where as conventional banks LAR goes to 52.80% Figure 4. Moving towards the year 2008.47% 52.6 4.66% 58.66% showing a consistent decrease in the ratio showing that Islamic banks are performing better as its financial position reveals and conventional bank moves to increasing trend up to 58. LAR of Islamic bank further decreases to 46.
DER of the conventional bank over the four years is showing that its trend has been downward which shows that bank is making itself to absorb the financial shocks expected in the upcoming years.crisis.74% in year 2006.51 2006 8.76 12.30 15.60 Figure 4.28 2008 12.3. One of the reasons of this oscillation is the injection of more deposits by public into Meezan bank due to its Islamic products and the equity was not yet increased considerably with respect to change in the debt.7 DER MBL SBL 2005 9.50 10. Table 4.7 4.2 Debt to Total Assets Ratio (DTAR) Debt to total assets ratio reveals the strength of assets over debts owed by the bank. Whereas the Islamic bank’s values over the 4 years are lower than the conventional bank but it oscillates in year 2007 and 2008.07% and Islamic bank is at 89. In the analysis it is found that conventional bank is standing at 92. In the year 2007 66 .74 11.54 2007 10.
Table 4.00% 93.4% and Islamic bank is at91.conventional bank is at 91. In 2008 the Islamic bank has slightly higher value as its core deposits increased in 2007 and 2008 due to which this ratio increased.8 4.74% 92.3 Equity Multiplier (EM) With the study of equity multiplier it can be assessed easily that Islamic bank has been increasing the asset strength depending upon its equity.99%.07% 2007 91.99% 91.5% and in the year 2008 conventional bank is at 91.8 DTAR MBL SBL 2005 90. In the study of trends from year 2005 to 2008 the conventional banks ratio is 67 .20% Figure 4. This shows the good position of Islamic bank over the years.51% 91.40% 2008 92.2% and Islamic bank is at 92.07% 2006 89.3.
76 13.62 then decreased to 12.9 4.consistently decreasing from 16.45 in 2008.62 in 2005 to 13.4 EFFICIENCY RATIOS 4.45 11.62 2007 11.32 16.63.1 Asset Utilization (AU) Overall the utilization of assets of Islamic bank is more attractive and strong during the year from 2005 to 2008.74 12. Only in the year 2006 it declined and in the remaining years the performance of the Islamic bank remained better than the conventional bank. Conventional bank has downward trend 68 . Table 4.66 2006 9.63 Figure 4.4.9 EM MBL SBL 2005 10.62 and ultimately fell to 11.34 2008 13.66 to 13. On the other hand the Islamic bank’s ratio increased from 10.
10% 1. Table 4.44% 2.28% 2006 2.10 4.from year 2005.99% 2.2 Income to Expanse Ratio (IER) In the study of income to expanse ratio it is analyzed that the Islamic bank has the stable expanse position within a particular range. On the other hand the conventional bank has to bear the ups and downs in management of its 69 .46% of conventional bank.46% 2007 2.93% 2008 3.18% in comparison to the asset utilization of conventional bank which was decreased to 1.18% Figure 4.4.44% in 2006 against 2.10 AU MBL SBL 2005 1.18% 1.This is the implication of the prudency of prudent procedures of Islamic banking which allows the Islamic bank to maintain a good growth relative to conventional bank which is declining since the financial crunch has started.18%. but in year 2005 the asset utilization value of conventional bank is comparatively higher than Islamic bank but moving towards year 2006 the difference of asset utilization start reducing as Islamic bank reaches to 2. Which shows positive growth trend in Islamic bank? In the year 2008 asset utilization of Islamic bank increased to 3.
80 2006 1.11 70 .50 Figure 4.11 IER MBL SBL 2005 0. the reason is that the Islamic bank has to develop the structure and inject procedures and also the Islamic bank cannot take the penalty to the income side because of which the Islamic bank looses that position of income.operating expanses as well as operating revenues thus it shows that the financial shocks during the years form 2005 to 2008 affected conventional banks more as compare to the Islamic banks.80 1.84 1. Table 4.10 1.11 2008 0.68 2007 0. In year 2008 no doubt conventional bank has performed a little better.68 0.
5. Nevertheless.12% 2008 0.5 PROFITABILITY RATIOS 4.12 71 . Financial results of 2009 of Islamic bank and conventional bank will reveal whether what trend of conventional banks ROA would continue and ROA of Islamic bank would increase or decrease. it has avoided the loss and its position is better in financial year 2008. So. Table 4.AL BARAKA ISLAMIC BANK (ABIB) & JS BANK LIMITED (JSBL) 4.17% 1.30% Figure 4. Where as JS Bank is a local bank and newly established.25% -0.1 Return on Assets (ROA) The result indicates several important points of comparison of ROA between Islamic bank and conventional banks. both types of banks are experiencing difficulties in profitability. This indicates that in financial year 2007.12 ROA JS BANK AL BARAKA 2007 0. banking sector in Pakistan is growing significantly but considering the last 2 years trend in ROA. ROA of Islamic bank is better in comparison to conventional bank which has recovered in the financial year 2008 and Islamic banks has to face loss during the financial year 2008 because of international financial crunch as AlBaraka Islamic Bank is multi-national bank.
0.69% which is recovered in financial year 2008 up to the value of 0.5. Table 4. ROE is quiet higher of Islamic bans up to 10.69% 10. Therefore. we underpin some important points to consider. from the study of ROE of both conventional banks and Islamic bank.04% in comparison to conventional bank i.e.4. its ratio has gone in negative value showing the loss occurred in that year on equity.30% 72 .04% 2008 0.95% -0. The result shows that in financial year 2007.13 ROE JS BANK AL BARAKA 2007 0.2 Return on Equity (ROE) Similar to ROA.95% and Al-Baraka has to face the loss.13 Figure 4.
its value is favorable but in financial year 2008.93 over its operating expenses.3 Price to Expense Ratio (PER) The analysis of PER indicates that Bank Al-Baraka has good revenues in financial year 2007 which was 0.084 0.113 -0.4. -0. Table 4.e. This shows positive trend but overall Islamic bank has strong position in comparison to conventional bank.084 and recovered in financial year 2008 with a PER 0.6.113.14 PER JS BANK AL BARAKA 2007 -0. its expenses have increased and it is also suffer loss due to which is depicts the negative impact i.140 where as JS Bank has the negative operating revenue in financial year 2007 -0.1 Loan to Deposit Ratio (LDR) 73 .140 Figure 4.6 LIQUIDITY RATIOS 4. Therefore.930 2008 0.14 4.5.
85%. Table 4.e.15 LDR JS BANK AL BARAKA 2007 47.42% 78.e.15 4.41% Figure 4. 27.88% and Bank Al-Baraka also decreased its CPIDR to 23.e.6. Bank Al-Baraka has more financing as compared to conventional bank i.18% 2008 63.34% 74. Overall the liquidity position of conventional bank is better than Islamic bank in the context of 74 .27% which is far better than that of Bank Al-Baraka i. it has higher LDER with lower increasing trend but conventional bank has lowered LDR with higher increasing trends. In financial year 2007 JS Bank has CPIDR i. JS Bank. From the results we can say that Islamic bank is more exposed to risk and for this reason it has suffered loss in financial year 2008.e. So. 53.32% but in financial year 2008 CPIDR of JS bank has decreased to 41.Islamic Bank i.2 Cash & Portfolio Investments to Deposit & Borrowings Ratio (CPIDBR) Islamic bank lower CPIDR because it has not such venues where the funds can be invested therefore their finances are more where as conventional banks have more options for investment.
27% 27.01% to 59.85% Figure 4.16 4.e.e.6.88% 23. Table 4. 57.investment but we consider the Islamic financing as an investment which can change the results of banks liquidity.32% 2008 41.16 CPIDBR JS BANK AL BARAKA 2007 53.85% where as Islamic bank has also the increasing trend but with lower rate i.86% to 44.3 Loan to Asset Ratio (LAR) LAR of conventional bank is lower in comparison to Islamic bank but with higher increasing trend i. 31.42%. If we consider the argument of financing as an investment in islamic banking overall 75 .
e. and Dimishing Musharaka and standing second.17 4.42% Figure 4. Analysis of LAR indicated that Murabaha has been the most famous and mostly used mode of financing followed by Ijara.85% 59.position of Islamic bank will become better.7 RISK & SOLVENCY RATIOS 4. export refinance under Islamic scheme. third. Table 4.86% 57.01% 2008 44.1 Debt to Equity Ratio (DER) In comparison to both we will come to know that equity of conventional bank i.e. Bank Al-Baraka. and fourth respectively in a row.17 LAR JS BANK AL BARAKA 2007 31. JS Bank is better than that of Islamic bank i. JS Bank DER in financial year 2007 is 2.94 times which decreases to 2.7.83 times in 76 . As.
2 Debt to Total Assets Ratio (DTAR) As result indicates that. Islamic bank have more ratio of debt then its equity therefore its total debts are more than the conventional bank and has the higher value than the conventional bank and its assets are mostly generated by its debts.45% which 77 . Therefore.18 DER JS BANK AL BARAKA 2007 2.02 2008 2.83 9. conventional bank has low DER in comparison to Islamic bank who mostly depend upon deposits of the customers exposing itself to more risk.18 4.02 times which increases to 9.09 time sin financial year 2008. A bank with lower DER is considered better as compared to the bank with higher DER.09 Figure 4.financial year 2008 where as Bank Al-Baraka has DER in financial year 2007 is 8.94 8.7. Table 4. In financial year 2007 the JS bank has DTAR 74.
Therefore.61% 90. equity multiplier. Table 4.slightly increases to 75.22% Figure 4.22%.92% 2008 75.45% 88.19 DTAR JS BANK AL BARAKA 2007 74. its EM is higher than that of 78 . further proves that Islamic bank has utilize its equity lesser and its debts more for the generation of its finances and investment.92% which also increased with a slight change in 2008 with 90.3 Equity Multiplier (EM) The analysis of another measure of risk.7.61% in financial year 2008 and on the other hand Bank Al-Baraka has DTAR 88.19 4.
1 Asset Utilization (AU) 79 .8 EFFICIENCY RATIOS 4.83 9.02 2008 2.02 times in 2007 which increases to 9.94 times which decreased to 2.20 EM JS BANK AL BARAKA 2007 2. Bank Al-Baraka has EM 8. On the other hand.conventional bank and JS Bank mostly depends upon its equity as its EM value is low with decreasing trend as in 2007 it was 2.8.09 Figure 4.83 times in 2008.20 4.94 8. Table 4.09 times in 2008 as the higher the EM the greater is the risk for the bank.
17% 1.42%.2 Income Expense Ratio (IER) 80 .81% which in 2008 is 1.This ratio tells us how much effectively banks are using the assets.17% than that of 2008 is 0.35%. the Bank Al-Baraka has earned handsome profit and JS Bank has lesser profits to its assets during the fiscal year which shows that in 2007 AU was 0.21 4. Here.21 AU JS BANK AL BARAKA 2007 0.35% Figure 4.8. AU of Bank Al-Baraka is better than JS bank because in 2007 AU was 1.81% 2008 0.42% 1. Table 4. Overall position of the Islamic bank is better than conventional bank during the both financial years.
19 times which decreases to 0. As.22 IER JS BANK AL BARAKA 2007 0.57 times in 2008.19 2008 0.The position of Islamic bank is better as it has lower expenses in both financial years in comparison to conventional bank which may be for the new establishment and branch network and its set up.48 times which decreases to 0. On the other hand.22 81 . From this result. we can say that overall position of Islamic bank is stable with higher revenue to lesser expense but the trend is decreasing because of the loss occurred in the financial year 2008.09 in 2008.09 0. Table 4. JS Bank has IER in 2007 is 0.57 Figure 4. Bank AlBaraka has PER in 2007 is 1.48 1.
DIBL ROA is 0. banking sector in 82 . Financial results of 2009 of Islamic bank and conventional bank will reveal whether what trend of conventional banks ROA would continue and ROA of Islamic bank would increase or decrease.DAWOOD ISLAMIC BANK LIMITED (DIBL) & FIRST WOMEN BANK LIMITED (FWBL) 4.9 PROFITABILITY RATIOS 4.9.1 Return on Assets (ROA) In financial year 2007.74% which is slightly less in comparison to FWBL but if we see the trend of 2008 ROA of DIBL has increased where as FWBL has decline which shows the prudency of Islamic procedures. ROE is less as compared to FWBL. DIBL ratio is less because it has started new operations in Islamic banking for which he has to incur a lot of capital on development of branches. Nevertheless. Therefore.
both types of banks are experiencing difficulties in profitability.Pakistan is growing significantly but considering the last 2 years trend in ROA.77% 1. Table 4.2 Return on Equity (ROE) 83 .23 ROA DIBL FWBL 2007 0.23 4.76% 2008 0.9.74% 1.45% Figure 4.
9.80% 9.From the study of ROE of both banks.24 ROE DIBL FWBL 2007 1. Table 4. DIBL has ROE 1.39% which increases to 1. we see that ROE of DIBL is quiet lesser than FWBL as FWBL has started his operations for more than eleven years and DIBL is new entrant to market.80% in 2008.24 4.39% 15. In 2007.36% which decreases to 9. On the other hand FWBL has ROE in 2007 is 15.33% Figure 4.3 Price to Expense Ratio (PER) 84 .33% in 2008. The DIBL has just reached to the break even point but if we see the trend of both as per financials we can observe that there is increasing trend in the Islamic bank and vice versa.36% 2008 1.
Table 4.According to the analysis. PER of FWBL is little better.25 4. DIBL has decreasing trend of PER because in 2007 it was 0.19 times than that of 0.70 2008 0.51 times in 2008.51 Figure 4.10 LIQUIDITY RATIOS 85 . FWBL has also decreasing trend as PER is 2007 was 0.25 PER DIBL FWBL 2007 0.70 times which decreases to 0.19 0. During the analysis it is observed that DIBL has incurred expenses for its new establishments and branch network due to which its expenses are more as compared to its earnings.14 0.14 times in 2008 which shows that it is decreasing.
The main reason is that there are lesser options for investment in Islamic banking as compared to financial market.2 Cash & Portfolio Investments to Deposit & Borrowings Ratio (CPIDBR) 86 . banks have to rely on their finances as there is also a type of investment not a loan as in conventional bank.63% Figure 4.4.1 Loan to Deposit Ratio (LDR) From this ratio.10.90% 40. We observed that LDR of Islamic bank is higher as compared to conventional bank. we can see the trend of both banks.26 4.38% 55.47% 2008 111.26 LDR DIBL FWBL 2007 128. Therefore.10. By observing the trend of LDR we can see that DIBL shows declining trend which means its position is getting better and the trend of FWBL is increasing. Table 4.
In 2007.44% which decreases to 47. Table 4.27 CPIDBR DIBL FWBL 2007 58.10.82% Figure 4. CPIBDR was 58.80% 52.66% 47.80% which decreases to 48.3 Loan to Asset Ratio (LAR) 87 .44% 2008 48.66% showing a decrease where as FWBL CPBIDR in 2007 was 52.82% also showing a decrease but on the whole trend of both banks is declining and conventional bank declining impact is more.27 4.CPIDBR shows the liquidity position of the bank and if we can see that trend we will observe that liquidity position of Islamic bank is better and higher from conventional bank in both years.
24% Figure 4.28 LAR DIBL FWBL 2007 54.09% which increases to 45.38% which increases to 58.LAR indicates that FWBL is performing well but the trend is increasing at a higher which shows the more impact of liquidity in conventional banking.95% 45. LAR of DIBL in 2007 was 54. But if we observe the trend of Islamic bank it is also increasing but at a lower rate.38% 34. result indicates that position of conventional bank is better but the trend of Islamic bank is quiet positive.95 % in 2008 showing an increase where as FWBL LAR in 2007 was 37.28 4.09% 2008 58.24%. On the whole. Table 4.11 RISK & SOLVENCY RATIOS 88 .
87 7.34 5.11.2 Debt to Total Assets Ratio (DTAR) 89 .68 times in 2007 and 5.87 times in 2007 and 1.68 2008 1.29 DER DIBL FWBL 2007 0.1 Debt to Equity Ratio (DER) DER indicates that Islamic bank DER is 0.46 times in 2008.46 Figure 4.29 4.11. Table 4. Where as DER of FWBL is 7.34 times in 2008. This indicates that Islamic bank is relying on its capital and able to absorb the financial shocks where as conventional bank has the higher ratio which makes the conventional bank to expose itself to higher risk.4.
90% in 2008.88% which decreases to 84.90% Figure 4.40% in 2008 showing an increase where as DTAR of conventional bank in 2007 was 87.40% 84.11.30 4. Table 4.88% 2008 57.48% which increases to 57.3 Equity Multiplier (EM) 90 .48% 87.30 DTAR DIBL FWBL 2007 46.This ratio shows that DTAR of conventional bank is consistently higher than Islamic bank and it makes conventional banks more risky and less solvent than Islamic bank. As DTAR of Islamic bank in 2007 was 46. If we compare the values of two years Islamic banks are exposed to lesser risk as its debts are lesser to their total assets as of conventional bank.
87 times which increases to 2.74 2008 2. Table 4.34 times in 2008.43 Figure 4.1 Asset Utilization (AU) 91 .Islamic bank have lesser values which indicates that Islamic bank have converted lesser assets through their debts.12.34 6.12 EFFICIENCY RATIOS 4.74 times which decreases to 6. EM of FWBL in 2007 was 8. EM of DIBL in 2007 was 1.31 EM DIBL FWBL 2007 1.87 8. But conventional bank trend is different as multiplier is higher for both years with the declining trend which expose the conventional bank at more risk.43 times in 2008.31 4.
76% and AU of FWBL in 2007 was 5.98% 2008 0.12. conventional bank is far better than the Islamic bank because Islamic bank has made its new setup and its revenues are lesser where as conventional bank is in market for longer time period and its revenues are better because it has lower establishment cost.As from the AU results of both banks.54% in 2008 showing positive performance of conventional bank. Table 4.74% 5.32 AU DIBL FWBL 2007 0.32 4. AU of DIBL is 0.54% Figure 4.98% which increases to 8.2 Income Expense Ratio (IER) 92 .74% in 2007 which changes in 2008 with little margin and move up to 0.76% 8.
17 times in 2008 showing a decrease where as IER of FWBL is 1.33 93 .17 1. From the calculations it is observed that IER of DIBL in 2007 was 0.67 Figure 4.67 times in 2008 showing that conventional bank is performing well.31 1.58 2008 0.58 times in 2007 which increases to 1. On the other hand.33 IER DIBL FWBL 2007 0.31 times which decreases to 0.The ratio depicts that conventional bank is performing well as their operating expenses are lesser in comparison to their operating revenue because of their establish set up. Table 4. DIBL is new entrant and its ratio is quiet lesser due to the expansion of the branches.
CHAPTER 5 CONCLUSION AND SUGGESTIONS 94 .
tools been used to find out the answers to the questions similar to these ones. The results of our test on data were in line with most of the previous studies that we have consulted for the preparation of this report. The banks which started their operations from 2006 onwards were suffering loss because they have to spend a large amount of money on their branch operations as to expand the branches. This also indicates that the bank has ability to get higher return on their total assets and loan. They are handling the situation in correct manner which conventional banks are not handling in that specific and correct manner. However.1. This research was intended to find the answer to the question how good Islamic banks are performing as compare to conventional commercial banks? To find an answer past studies were consulted to get an idea of what sort of research work has been done on this topic the methods that they applied.In this chapter we are going to look at the conclusion that we can drive from the data analysis of our selected data. This shows us that they are able to get more and better rate of repayments in time from there customers. One of the results also indicates that Islamic banks ability to have stiff control over their advance policy which is represented by the ever improving position on provision for doubtful debts. Islamic banks which operated their operations from financial year 2006 are relatively compared when with conventional banks were going in loss but overall they will recover as financial crunch is moving in the economy. This strength of theirs gives them the opportunity to give more advances to their customers. the Islamic banks are showing positive signs of progress and stability. Islamic banks are 95 . and in the mean time they relaxed from the pressure of having more leverage. 5. Following the methods that’s been used by previous renowned researchers we used the similar techniques to find the performance efficiency of these banks. Islamic banks major strength is that their ability to generate enough equity to fulfill the needs of the customers as compare to Conventional banks. CONCLUSION The results obtain from this research indicates that Islamic banks are working in the right direction and are performing better. Therefore. The ratio analysis indicates that almost all the results were in line with the conventional banks.
Ijarah. The difference in results is largely due to the fact that Islamic banking has longer history but in Pakistan where full-fledged Islamic banking started merely few years back. Islamic modes of financing are helping the Islamic banks to work efficiently and consistency in their performance. or manufacturing contracts. the provision of capital in a partial equity partnership. The main principles if Islamic finance includes the prohibition of Riba and the removal of debt based financing from the economy. and larger share in the Pakistan financial sector. they are also less keen in providing venture capital kind of finances (Mudarabah). By employing Islamic principles. their different products and ethnicity in the light of Islamic laws. Both are performing the same functions and Islamic banks are considered that they are just like conventional banks. Moreover. A closer review of the balance sheets of banks reveal that Islamic banks are more in the business of providing short term funds and advances. Murabaha. Bai Salam. vast experience of learning from the financial markets mechanisms. It is important to remember that in Islamic view. the main financial instruments in Islamic finance are Mudarabah. which is the result of unawareness. it is important that intensified efforts are made for publication education and awareness regarding the distinctive characteristics of Islamic banks. lease financing. This is a misperception. It will be helpful in building the trust and boost the relationship and confidence and more important customer satisfaction. fixing the rate of profit alone is not allowed but fixation of profit & loss both is quite permissible and inline with Shariah compliance. The amount of profit can not be predetermined according to Islamic Shariah. deferred payments on products. On the other hand there are many people who believe that there is no major difference between the Islamic and conventional banks. deeper roots. an instrument for financing the purchase of goods. Istisna. Bai’ Muajjal.working prudently as it reflects the true picture of Islamic financing. fully equity partnerships. Therefore. Musharakah. but one can fix the rate of distributing the profit or loss of the concern according to their respective shares in the business. Considering 96 . advance sale contracts. conventional banking has a longer history.
One of the major problems that Islamic bank facing is that they have high general and administration cost which is creating hurdles in their profitability. when there will be more Islamic banks to study and longer time period. we expect Islamic banking of Pakistan to be equally or even better in performance than conventional banking in the foreseeable future. The suggestions are related to both internal as well as external fronts. In the end. we don’t find the results of our study surprising. The Islamic banks no longer can relay heavily on advances business but they should also look that how they can capture the retail banking sector as well. Therefore. By then. For small level customers the bank will have to find the innovative products. for future studies. 5. a similar study would generate better insight on the issue of performance comparison and provide solid evidence one way or another.these facts of the matter. As few Islamic banks are new entrant to market therefore they are not earning as much as conventional banks are earning. Islamic banks first have to create awareness about the products which they are offering to the customers. as the time passes. This may be because of the State Bank of Pakistan regulations as to expand their network and it also tells us that banks are not doing enough to ensure the quality of their advances and for their repayment. 97 . Islamic banks have to improve their range of products to attract thee customers and more necessarily to satisfy them. On internal front. debit card etc. SUGGESTIONS In the end. they will have to do more financing in long term basis and will also have to strengthen the projects financing sector of their business. the way Islamic banking sector is improving and growing in Pakistan. we would gladly join the discussion again. However. we would like to give some suggestions so that the Islamic banks can improve their efficiency as to increase the profitability of the banks. As the analysis revealed that Islamic banks are more in the business of providing short term financing. These products may include products like finances for consumer items.2. in this way Islamic bank will truly have to strengthen up their ijarah part of the business and will have to make provisions for loans and for the small items as well.
There are certain things which are to do by Islamic banks but it is not completely in the control of these banks. In this regard so as to decrease the statutory reserve requirement for Islamic banks as this affects their operational capability and efficiency. we are talking about the requirements of reserves that these Islamic banks have to maintain with the central bank according to the regulations. It will be helpful for the banks as it provide them with more equity which will result in increase in their ability to provide loans to its customers which will result in increase profitability. It relates to the prudential regulations been implied by monitoring authority known as State Bank of Pakistan. Here.it is suggested that the Islamic banks should devise such tools to decrease this high amount of general and administration cost. government can play a significant role as it will be helpful for Islam banks to depict the true picture of Islamic banking in Pakistan. In case of conventional banks central bank pays them a certain amount of interest on this reserve but as far as Islamic banking is concerned we know that they cannot take interest as it is prohibited therefore. it’s very difficult for Islamic banks to compete conventional banks on equal grounds. 98 . Here. The government should make some arrangements and develop policy for Islamic banks as they should relax the reserve requirements for these banks.
CHAPTER 6 99 .
APPENDIX 100 .
6. On the other hand. Murabaha. Venture Capital. Commercial Bank’s All these Islamic banking products are discussed in detail in the following pages so the reader can understand the uniqueness of these products. however. Product. M. 101 . (Usmani. • • • • • Musharakah. loaning without any charges over and above the principal amount.e. Leasing. in view of the problems faced in practically applying the PLS system (1980 Pp9. 2002). Following are the main Islamic alternatives of the conventional banking products. Treasury Bill. 2000) (Ayub. However. highlighted that “though the alternative methods are free of the interest element in the form in which they are specifically laid down in its report. Salam Ijarah. Taqi.4. therefore imperative that the use of these methods should be kept to the minimum extent that may be unavoidably necessary under the given conditions and that their use as general techniques of financing must never be allowed. Mudarabah.10) a number of other alternatives have been mentioned by the CII as also by other Shariah scholars. Islamic Bank’s Product. Future Contracts. are no more than a possible best solution from the ideal Islamic economic system’s point of view. there is also a danger that they could eventually be misused as a means for opening a back door for interest along with its attendant evils. Pp. The council. Venture Capital. It is.1 ALTERNATIVE MODE OF FINANCING IN ISLAMIC BANKING As per indication of the Council of Islamic Ideology (CII) (1980.5) the ideal and real alternatives to lending on interest under an Islamic economic system are profit/loss sharing (PLS) or qard-e-hasan i.
4. In Musharakah (similarly to Mudarabah). Power of appropriation in the property and participation in the affairs of the Musharakah may be un-proportionate to the investment of capital by the partners. 50 or 60.6. 6. or any rate of profit tied up with his investment. The equal contribution of funds by the partners is not necessary.2 MUSHARAKAH/ SHIRAKAH 1. Musharakah is a term used by the scholars both for broad and limited connotations. Musharakah refers to a relationship established under a contract by the mutual consent of the parties to share the profits and losses arising from a partnership business. This arrangement is also permissible according to the jurists. In the early books of Fiqh. For example distribution of profit on 50. 7. Fixation of a lump sum amount for any of the partners is not allowed. Technically. 3. 5. All assets of Musharakah are jointly possessed in proportion to the contribution of each partner. the business under partnership has been discussed mainly under the caption of Shirakah. Profit can be divided unequally and un-proportionately to the capital invested on the basis of work to be conducted for Musharakah. management. skill and goodwill and capital from both the partners. merger of various partnership firms is also allowed. A person can become a partner of a running concern having fixed assets by investing capital in cash/kind. 2. 40 basis. but the loss must be divided exactly in accordance with the ratio of capital invested by each of the partners. 102 . the profit distribution ratio may differ from investment ratio in the total capital. Partnership business can also be conducted by contributing labor.
these certificates can be traded in the secondary market. 10. Banks can use the Musharakah instrument for working capital financing. Profit. particularly for financial intermediaries. in the case of Musharakah agreements with their customers. can be based on the concept of 'Diminishing Musharakah' (DM). if the liabilities of the business in excess to its assets and the business go in liquidation. A partner cannot guarantee the other partners. in excess of the ratio of capital contribution can be divided on the basis of work done for the Musharakah. The participatory contracts that can be more suitable for ongoing projects. 9. the banks can obtain a pledge of security or guarantee to ensure safety and properly handle the Musharakah business. However. 11. In a traditional manner the liability of the partners in Musharakah is unlimited. 14. In the Diminishing Musharakah contract. 6. and no other partner shall work for the Musharakah. When the project is started by acquiring non-liquid assets. Musharakah can be based on a written agreement between the bank and the client for a specific transaction or for a fixed period of time that can be renewed if required.8. import and export financing and for other types of single transactions. a party after participation in ownership of any 103 . Therefore. all the exceeding liabilities shall be borne proportionately by all the partners. Firms desiring to raise funds for investment can offer to sell Musharakah Certificates in the market. 12. The partners may agree upon a condition that the business shall be managed by any one of them.2. project financing. If all the partners agree then each one of them shall be treated as the agent of the others in all the matters of business. 13.1 DIMINISHING MUSHARAKAH 1.
and selling by one partner its share to the other partner(s). A contract between partners to create a joint ownership. A DM contract can be consistent of two or three sub contracts. Financing partner gives units of his share to the client on lease. It is a new type of contract suggested by contemporaneous jurists keeping in view the problems sensed while discussing the traditional Musharakah /Mudarabah principles in the long run economic perspective. Partner (client) will go on purchasing the units of ownership of financing partner periodically at the mutually agreed price. that arrangement cannot be held to be contingent or conditional. 3. the rent will go on decreasing. c. for example. Sequencing of contracts should be:a. 6. leasing by one partner its share in the asset to the other partner(s). The financing partner will give his undivided share on lease to the partner using the house. partnership by ownership between two or more persons. Three separate contracts are entered into in such a way that each contract is independent of the other two contracts. b. In case purchasing of a house. Accordingly.business/project can liquidate its investment periodically from the ongoing business. 5. In typical Mudarabah financing. i. one party provides the necessary capital and the other provides human capital needed for the economic activity to 104 . a joint ownership (Shirkatul Amwal) can be created for the purpose of Diminishing Musharakah.3 MUDARABAH 1. We can deduce from the contemporary juristic opinions that an arrangement in which any of the parties promise to purchase or sell the leased asset. 4. 2.e.
mutual funds or any other institutions or persons by whatever name called. a group of persons. or a legal entity and a corporate body. Rabbul Mal shall provide his investment in money or goods. a multi purpose or a specific purpose. industry. 8. unless otherwise specified in the Mudarabah contract. The profit shall be divided according to the proportion agreed at the time of contract and no party must be given a predetermined amount of return. Mudarabah is also a type of Shirakah when used as a broad term. For the Mudarib. the loss is in terms of his un-rewarded labor or entrepreneurship. Profit of a Mudarabah project can also be 105 . Mudarabah can be of various types. and according to majority of the contemporary scholars. 5. According to majority of jurists. depositors and the enterprises. other than receivables. etc. negligence or misconduct.e. unit trusts. A Mudarib who is running the business can be a person. but it provides the basis of the relationship between banks. 7. or for a fixed period. at a mutually agreed valuation which shall be placed at the disposal of the Mudarib. The liability of Rabbul Mal is limited to his investment. 2. The contract of Mudarabah is (also known as Qirad/Muqaradah) can be traditionally applied to commerce alone. Mudarabah shall include banks. perpetual. can be applied in all sectors of the economy like trade. The Mudarib can invest his funds in the business of Mudarabah with the permission of Rabbul Mal. restricted or unrestricted and close or open-ended in accordance with the conditions respective to each of them. 4. 6. agriculture. i. 3.be conducted. Rabbul Mal will have to suffer the operational loss unless it is proved that the Mudarib has been guilty of fraud.
3. on the basis of shares of equal value. Ownership remains valid throughout the duration of the project from its beginning to its end. c. that offer is conveyed by subscription and acceptance by approval of the issuing authority. The prospectus must provide all data required by Shariah for the "Qirad" contract (the Mudarabah). 2. 3. for whose establishment or financing it has been issued.two names of the same mode of business). since the Mudarib has authorized to do so once the 106 . Mudarabah contract must present a joint share in the project.reinvested. The term 'Mudarabah Certificates' is used in place of 'Mudarabah bonds'. 9. Mudarabah Certificates are investment instruments which call up the Mudarabah capital by floating certificates in the market. The Mudarabah certificates must be negotiable at the end of the subscription period. as an evidence of capital ownership. it can be agreed by both parties that no party shall terminate the contract during a specified period excluding some particular circumstances. At the time of entrance into Mudarabah contract. 1988) resolved the following in respect of Mudarabah or Muqaradah Certificates (Muqaradah is synonymous with Mudarabah . 1. In general the formula acceptable to Shariah for Mudarabah Certificates must consist of the following elements: a. registered in the name of their owners. regarding Mudarabah Certificates. is concluded on the basis of the terms defined in the prospectus. b. The contract. 6.1 MUDARABAH CERTIFICATES Islamic Fiqh Academy of the OIC in its fourth session (February 6-11. It also refers to the arrangement of combining Musharakah and Mudarabah.
his ownership in the project is limited to the extent of his subscription. collected from subscription prior If the Mudarabah capital becomes debts. taking into account the following rules prescribed by Shariah: o o If the Mudarabah capital. in conformity with the principles of supply and demand. the issuing authority makes an announcement or an offer to the public. certificates should be negotiated according to the rules applied to loans. the guarantee condition is void. o If the Mudarabah capital is converted into mixed assets. 6. The Prospectus of Mudarabah contract issued pursuant to it should not contain any statement obligating a sale. Mudarabah to its use in the project. at a given period of time. and subject to the approval of contracting parties. e. 5. However. The one who receives the funds collected from the subscribers to the certificates. is still in the form of cash. Mudarabah certificates may be negotiated at the price agreed upon provided the major part of the capital is in the form of goods and benefits. benefits. Mudarabah Certificates can be exchanged in stock markets. for the capital or a fixed profit or a profit based on a percentage of the capital. the Mudarabah contract may include a promise to 107 . debts. for investment in the proposed project is called "Mudarib". if they are regularized by the rules prescribed of Shariah. They can also be negotiated if. 4. from the manager of the funds. goods. Considering the preceding rules of exchange. d. even if conditional or related to future.g. Neither the prospectus nor the Mudarabah contract should contain a guarantee. If such clause is provided explicitly or implicitly. and the Mudarib is entitled to a profit equal to that of a similar Mudarabah. cash.certificates have been issued.
sell and. 6. Such penalty shall not constitute bank's income and shall be utilized for charitable purposes only. 108 . he will pay certain amount of penalty for a charitable purpose.. sale is affected only on a contract basis. it also becomes Muajjal. Murabaha can be used only where a commodity is intended to be purchased by the customer. In order to ensure that the buyer pays the installments promptly. Banks must make sure that all these stages have been really observed and every transaction is effected on its due time. Murabaha cannot work if funds are required for some other purpose. at a price fixed by qualified experts and agreed upon by the two parties. The parties negotiate the profit margin on cost and not the cost. Murabaha arrangement by banks is practically a package of different contracts which come into play one after another at their respective stages. in such case. As a seller the bank may ask the client (buyer) to furnish a security for payment of the price whether in the form of mortgage or in the form of a lien or a charge on any of his existing assets. he may be asked to promise that in case of a default. Murabaha refers to reciprocally specified margin of profit (mark-up) in the transaction of sale where the cost of the commodity is known to the buyer.4 MURABAHA WITH DEFERRED PAYMENT 1. 2. 6. The idealistic way is that the bank purchases the commodity itself directly form the supplier and after taking its delivery. If payment of the sale price is deferred. 3. Banks should make sure that the client really intends to purchase a commodity which may be subject of Murabaha. resells it on Murabaha basis. 5. 4.
Date of delivery must be well set either by linking it to a specific date or to an event whose happening is an absolute certainty although the date of its occurrence may be subject to a slight variance. banks may credit the seller's account or issue a pay order.6. like raw materials. provided it does not result in a conflict. Salam is a sale whereby the seller contracts to supply some specific goods to the buyer at a future date in exchange for an advance price fully paid on spot.5 SALAM (ADVANCE PAYMENT . agricultural produce or manufactured goods. The quality of the commodity that is intended to be purchased should be fully specified leaving no ambiguity leading to dispute. yet the payment of hard cash is not necessary. 109 . which is expressly prohibited by the Holy Prophet (Peace be upon him). It may include any marketable goods with definable features. 6. They cannot sell commodities purchased through Salam before they are actually delivered to them. it will be equivalent to a sale of debt against debt.DEFERRED DELIVERY OF GOODS) 1. The banks will receive certain commodities. The buyer should pay the full price to the seller at the time of finalizing the sale. Although the buyer has to pay the full price at the time the Salam contract is finalized. Salam can be applied in those commodities only that are easily available in the market and whose quality and quantity can be specified exactly. from their clients. in favor of the seller. 5. not money. 8. Price in Salam can be lower than the spot sale price. which will be en-cashable on demand. 4. 7. 2. 3. Otherwise. Seller and the buyer can agree on any price at their free will.
In case such commodity is leased out. it will be considered as a loan and all the rules concerning the transaction of loan shall accordingly apply. the principal of leased commodity remains in the ownership of the lessor and only its legal right is transferred to the lessee. etc. which cannot be used without consuming the same. In case any injury is caused to the leased assets by any misuse or negligence on the part of the lessee. 6. cannot be leased out like money. no matter whether the lessee has started its use or not. eatables. It can be mutually agreed in the agreement that the rental will be increased by a specified amount/proportion after specified intervals. 2. Bank may also purchase the asset as per specifications provided by the prospective lessee. in working condition. the owner of the asset. fuel.6 IJARAH (LEASING) 1. The lessor cannot increase the rental for any phase one-sidedly. 3. he will be liable to compensate the lessor for the injury. maintenance of the asset. 5. Thus. Any thing. during the lease period is responsibility of the bank. The lessee can be asked to pay any advance that will have to be adjusted from the rental after 110 . Ijarah can be used as a financing technique when a financier may buy and rent a productive asset to a person short of funds and in need of such asset. The lease period shall not commence from the date the payment is made by the lessor to supplier of the asset. it is agreed for each phase while finalizing the lease. is delivered to the lessee. as the benefit (rental) is linked to the responsibility. 4. but from the date the asset. All liabilities rising from ownership are contained by the lessor. In Ijarah/Leasing.6. Any rent charged on this invalid lease shall be treated as interest charged on a loan. other than routine operation expenses. Different amounts of rental can be agreed for different phases during the agreed lease period.
Among two types of leasing. the financial institutions calculate the total cost of equipment and add the specified interest that they plan to claim on such amount during the lease period. the contract will remain valid. 9. However. operating lease and finance lease. there can be a unilateral promise to gift or sell the asset at end of the lease period subject to following conditions (sic): (a) Firstly. etc. While fixing the rent of the financed equipment. i. will pay certain amount of penalty to be used in charity.e. The lessee can be asked to undertake that. 10. the promise should be recorded in a separate document but not in Ijarah contract (b) The promise should not be binding on both parties 111 . the lessee will be liable to pay rent up to the date of termination and handing over the asset to the lessor. This is because one transaction cannot be tied up with another transaction so as to make the former a precondition for the other. The lessor is liable to pay all expenses like freight. In case of termination. only the former is permissible which is a hire arrangement whereby rentals are dealt with in the Profit and Loss Account and the asset is shown in the balance sheet of the lessor. in case of failure to pay rent on its due date. The finance lease is akin to an arrangement of financing whereby accounting takes the form as the user. the lease cannot be terminated one-sidedly. 7. 8. Any express or implied condition stating that the asset will go into the ownership of lessee at the end of the lease period is not in accordance with the Shariah principles. The leasing contract will be terminated if the asset finishes giving the service for which it was rented.its being due. He shall not be liable pay the rent for the remaining period. as suggested by QIC Fiqh Academy. If the asset is damaged during the period of the contract. incurred up to the time of delivery to the lessee. If the parties to the lease do not violate the terms of the agreement. custom duty. but it can be repaired and make usable. has in real sense purchased the asset.
because in that case it will be a full contract ascribed to a future date. REFERENCES 112 . which is not allowed in the case of sale or gift.
The International Association of Islamic Banks Karachi. 9. Journal of Islamic Banking & Finance. Performance of Islamic Banking in Pakistan. Journal of Islamic Banking & Finance. Noor Ahmed (2007). Yaquby. Siddiqui. pp 21-23. State Bank of Pakistan. October-December. April-June. The International Association of Islamic Banks Karachi. pp 13-22. Journal of Islamic Banking & Finance.pk 8. Islamic Finance Emerging Challenges of supervision. Journal of Islamic Banking & Finance. The International Association of Islamic Banks Karachi. Shariah Board.1. Islamic Banking Bulletin February 2007 pp 112.org. pp 63-69. Memon. Sayyid (2005). The International Association of Islamic Banks Karachi. Islamic Banking Issue To Be Addressed. Ayub. Islamic Banking Bulletin September 2006 pp 1-19 website: www. vol. Journal of Islamic 113 . pp 187-203. The International Association of Islamic Banks Karachi. April-June pp 22-32. 4.2. Rahman. 6. autumn. vol. BIZTEK. Journal of Islamic Banking & Finance. Shamin Ahmed (2005). Jan-March. Islamic Banking Bulletin Jan-Mar 2008 pp 1-23. pp 8-15. Shah Muhammad Habibur (2002). 3. Sheikh Nazim (2002). pp 25-37. spring. Understanding & Eliminating Riba: Can Islamic Financial Instruments Be Meaningfully Implemented? Journal of Management & Social Sciences. BIZTEK. Islamic Banking and Its Operations Shariah Requirements for Conventional Banks. 7.3 No. Memon. Journal of Management & Social Sciences. Shariah Compliance and Related Issues In Islamic Banking. 2. Noor Ahmed (2008). Tahir. Shamshad (2007) .3 No.sbp. Future of Islamic Banking. 5.2. Muhammad (2008). Islamic Banking Present & Future Challenges. Akhtar. Oct-Dec.
English Translation from these Ahadith is been abstracted fro the following websites. 17. pp 58-62. 1 No. Muhammad (2002) Islamic Bankinh and Finance Theory and Practice. 14.Iqbal. are collection of Ahadith and are quoted in dissertation with their respective No. Pakistan.The Council of the Islamic Fiqh Academy.At Sahih Muslim.(2000) ‘ Introduction to Islamic Finance’ Idaratul Ma’arif.Zaidi. State Bank Printing Press.Ayub. Vol. 11. Saudi Arabia. Italy. Sahih Al Bukhari. Karachi May 2000. Abdullah. Sunan Abu-Dawood.Al-Dhareer. Al Tirmizi.Maudoodi. Abul A’la.2. Musna Ahmed. in the relevant book. Karachi. Government of Pakistan Printing Press Islamabad. June 1980. 15.asp.org/PubAIIE. Available at http://www. ‘Sood’ Islamic Publications. Oct-Dec. 13. ‘Stabilization and Growth in an Open Islamic Economy’. Yousaf Ali. 12. Miskkat Al Masabih. Jeddah. (1997). Al-Madina. Lahore. Sahih Al-Tirmizi. IDB. 16.Usmani. Al-Gharar in Contracts and Its Effects on Contemporary Transactions. 18. ‘Resolutions and Recommendations’ (1985-2000). 9-10 September. S. M. English Translation of Holy Quran Published by: King Fahad Holy Qur’an Printing Complex. Accessed October 2006. 1991. The International Association of Islamic Banks Karachi. ‘Report on Elimination of Interest from the Economy’. 10.irtipms. Government of Pakistan. 114 . Muhammad Taqi. Islamic Research and Training (IRTI).Qur’an. Review of Islamic Economics. 2000.Banking & Finance.The Council of Islamic Ideology. Iqbal and Abbas Mirakhor. 19. (2003) “Islamic Banking in Theory and Practice” International Banking Conference 2003 Prato.
Imran Ashraf. 2000.pk 25. Functions. Muhammad Ashraf Publishers & Booksellers. April 2004. http://www. Farooq. “State Bank of Pakistan: Evolution. Qureshi. 24. 23. Pakistan. Muhammad.shtml 115 . “The Holy Qur’an: Text. M.com/hadith/riba_usuary. Karachi. Translation & Commentary”. Iqbal.htm 22.State Bank NEWS Monthly.org/publication/encyclopedia/html/taqlid.I.sbp. www. Sh. State Bank of Pakistan. Yusuf.albalagh.org.Ibn http://www. Dr. Pakistan. 1991. Abdullah.net 20.sunnah. www. 26. State Bank of Pakistan. 1979. 2000.net/Islamic_economics/riba_judgement. 21.html http://etori. Maja.road-to-heaven.sbp.pk Supreme Court of Pakistan Judgment “The Text of the Historic Judgment on Interest”. Sh.Ali.Usmani. Ayub. 2004. 27. and Organization”. Publications. First Edition.htm http://muttaqun.org. “Islam and the Theory of Interest”. “Islamic Banking and Finance: Theory and Practice” State Bank of Pakistan. 7Aibak Road (New Anarkali).html http://www. Muhammad. 28. “A Guide to Islamic Banking” IBP.http://www. I. Lahore. Arby. 7-Aibak Road (New Anarkali).com/riba. Lahore. Anwar. Chundrigar Road. Pakistan.islamonline.tripod.com/on-interest. Muhammad Ashraf Publishers & Booksellers. Karachi.
M. Aqdas. Shams. Kazmi.. Dr. Neuer Jungfernstieg 21-20347 Hamburg.M. “Banking Law and Practice” IBP (Institute of Bankers Pakistan). 2002. Germany. Daily “The News” 10th March.html 116 . 32.http://www. 30.Rasul. 2004. Hamburgisches Welt-Wirtschafts-Archiv (HWWA). Hamburg Institute of International Economics.net/economic/sources. “A Critical Assessment of Islamic Economics” HWWA Discussion Paper#281.. 31.islamic-world. and 16th March 2004. “Islamic Economics and the Debate on Interest”. Ali.29.Malik.
GLOSSARY 117 .
Hadith: Report of Sunnah. Gharar: Uncertainty. sale of a thing. Mudarabah: Profit Sharing. Quran: Devine Book of Islam. Haram: Anything prohibited by the Shariah (unlawful). 118 . chance or risk. Ijarah: Leasing. Rebhe: Interest. allowing cash payment in advance and future delivery or a future payment and future delivery. Mudarib: Entrepreneur-borrower. Musharakah: Equity Participation. Murabaha: Cost-plus or mark-up. Bai’ Muajjal: Deferred payment Sale. which is not present at hand.Ahl al-ilm: Educated. Bai’ Salam: Pre-paid purchase. The science of the Shariah. literally ignorance. Fatwa: Islamic legal opinion. Fiqh: Islamic law. Qard-e-Hasna: Benevolent loan (interest free). hazard. It is an important source of Islamic economics. Istisna: It is a contractual agreement for manufacturing goods and commodities. Ijarah-wal-Iqtina: Hire purchase. Halal: Anything allowed by the Shariah (lawful). Jahiliyah: Pre-revelation. Musawamah: Musawamah is a general kind of sale.
Khatar: Stake or Risk. Sunnah: Custom. Shirkah: Musharakah. 119 . Technically. Aqiba: Consequence. Bai Sahih: Valid Sale. or his personal acts or sayings of others. Riba: Usury or Interest. Nuqud: Things Representing Money. Mabe’e: Subject Matter. it refers to the utterances of the Prophet Muhammad (SAWW) other than the Holy Quran knows as Hadith. Bai Baatil: Void Sale. Riba Al-Nasia: Loan Transaction. Aqd: Contract.Riba: An excess or increase (Usury). Qimar: Gambling. Bai Al-Sarf: Exchange of Monetary Values. Shariah: Islamic Law. factly approved by the Prophet. Riba Al-Fadl: Sale Transaction. FSC: Federal Shariat Court. Thaman: Price. Takaful: Mutual support which is the basis of the concept of insurance or solidarity among Muslims. habit or way of life. Bai: Sale.
Salt. Amwal-e-Ribawiya: Six commodities in Fiqh terminology i.e. Barley. Date. Al-Fahsha: Corruption or Immorality. Jahl: Ignorance. Khinzeer: Pork. Bai Makrooh: Valid but dislike sale. Khamar: Liquor. Gold. Sood-e-Mufrid: Simple Interest. Bai Fasid: Existing sale but void due to defect. Sarfi Sood: Usury (Interest on loan for personal need and expenses). Maysir/Qimar: Word Used for prohibition of gambling and wagering. 120 .Dharar: Two inflict any undue loss. Arboon: Down Payment. Tijarti Sood: Commercial Interest. Iwad: Compensation. Rabb-ul-Mal: Person who invests his capital. Silver. Wheat. Sood-e-Murakkab: Compound Interest. Muallaq: Suspended.
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