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Islamic Banking System and 

Operation I
Prof. Saiful Azhar Rosly   saiful@incif.org
International Center For Education in Islamic Finance (INCEIF)
Content
1. Introduction to Islamic Banking Operations

2. Shariah Framework

g y
3. Regulatory Framework

4. Legal Framework

5. Financial Statements of Islamic banks

6. Islamic Banks in the Muslim World

7. Lessons from Subprime Crisis and Financial Turmoils
Islamic Financial Market
Islamic Financial Market

Islamic Financial 
Market

Direct Financial 
Indirect Financial
Indirect Financial 
Market
market
(Capital Market)

Sukuk Equity Unit Trust


Bank Takaful
Takaf l Venture 
Vent re
65% 85% Mutual Funds
13% 5% Capital
SC Screening SC Screening 7%
Islamic Banking 2008
Islamic Banking 2008
• The
The Islamic banking assets have expanded by 23% to 
Islamic banking assets have expanded by 23% to
RM234.9 billion compared with a year ago. 
• The Islamic banking industry now accounts for 16.7% 
g y
of total assets in the industry. 
g
• Similar trends can be observed in the growth of 
deposits that have reached RM180.4 billion, an 
increase of 27.7% during this period
• Total financing has also increased by 24.5% to 
RM143.4 billion. 
The Teaching of Islamic Finance
The Teaching of Islamic Finance

Two Approaches

General Framework of Islamic 
1. Shari’ & Tabi’
Finance

Tabi’ Shariah Framework


Shariah Business Plan Regulatory Framework
L l + Ethi l
Legal + Ethical O
Operations
ti Legal Framework
Legal Framework
EQUITY Performance Risk –Return
EFFICIENCY Performance
Islamic Financial Market
Islamic Financial Market
Shariah Regulatory 
Framework Framework

Fiqh Academy  
Basel II
Basel II
M k h
Mekah

Islamic Financial 
AAOIFI B h i
AAOIFI, Bahrain S i B d
Service Board 
(IFSB)

Bank Negara 
Shariah
Sh i h Bank Negara 
B kN
Supervisory Board,  Malaysia
Malaysia
Shariah Framework

Shariah

Aqidah Akhlak Muamalat

Man with Allah 
swt Man among 
5 Pillars of Iman
5 Pillars of Iman
Man
5 Pillars of Islam
Shariah Framework
Shariah Framework

5 Shariah Principles

5. Prohibition on 
3.Avoidance  4.Prohibition  the production and 
1 Prohibition  2.Application 
of Gharar in  of Gambling  servicing of 
of Riba of Al‐Bay prohibited 
Contracts ((maisir)) commodities
New Parameters in Shariah Compliance 
FFramework: Consistency is Critical 
k C i i Cii l

‘AQAD
Principles

LEGAL/CONTRACT 
MAQASID DOCUMENTATION
Benefits vs disbenefits
Benefits vs disbenefits P t ti
Protection of Rights
f Ri ht

FINANCIAL
REPORTING
AAOIFI/IFSB/IFRS
Approved Islamic Finance Products
Approved Islamic Finance Products
• BBA Home Financingg
• Bay Inah Home Financing
• Bay Inah Personal Financing/Overdraft/credit card
• Tawaruk munazam personal financing
• Commodity murabaha
• Ij h th
Ijarah thumma al‐bay
lb
• Bai‐bithaman Ajil Islamic Debt Securities (BAIDS)
• Discounted Bay al‐dayn MuNif
Discounted Bay al‐dayn MuNif
• Sukuk Ijarah
• Sukuk Musharakah
Challenging issues in AQAD‐based Islamic 
Fi
Finance Products 
P d
• Benchmaking profit rate against interest rate (LIBOR,KLIBOR).
• Profit Equalization Reserve (PER) –
( ) displaced commercial risk
• Sale with condition to buyback at predetermined price 
between two and three parties.
• Profit generated over installment payments –
Profit generated o er installment pa ments time value of 
time al e of
money
• Penalties on delayed payments
• Benchmaking sukuk rates against LIBOR
Benchmaking sukuk rates against LIBOR
• Musharakah with Purchase undertakings – fixed profit to 
one party only.
• Ijarah Sukuk 
Ijarah Sukuk ‐ Sale with repurchase agreement at par value 
Sale with repurchase agreement at par value
and not mark‐to market
• Ijarah Sukuk – Ownership of asset by SPV
• Profit‐rate swaps –
p speculation or gambling?
p g g
Method #1: The AQAD‐BASED
Method #1: The AQAD BASED 
• Shariah compliance implies fulfilling the 
Shariah compliance implies fulfilling the
requirement of AQAD.
4 Requirement of Contracts
4 Requirement of Contracts
1. Agents of Contract
2 Objective of Contract
2. Objective of Contract
3. Subject Matter of Contract
Pi
Price
4. Offer and Acceptance
Aqad
q

Agents of 
Agents of Objective 
Objective Subject 
Subject Offer & 
Offer &
Contract of Contract Matter Acceptance
Sale (Al‐Bay’)

Transfer of 
Price set on the 
Price set on the
Buyer & Seller Ownership from  Property
spot
Buyer to Seller
Contract of Sale
Contract of Sale
• Example: Murabaha/BBA Sale

1. Buyer and Seller
eg. Seller owns
S ll asset/subject matter before making 
t/ bj t tt b f ki
sale
2.  Subject matter
j
eg. Mal mutaqawim – property with usurfruct
3.  Price
eg. Set on the spot
S h
4.  Offer & Acceptance
eg Verbal or in writing
eg. Verbal or in writing
Method #2: Maqasid al‐Shariah/Objective 
Method #2: Maqasid al Shariah/Objective
of Shariah

To protect the interest of the public (society)‐ maslahah al‐
ammah by:

1. Removing the harm ( ibqa)
1 Removing the harm ( ibqa)
2. Securing of benefits (tahsil)
Maqasid
Shariah

Protecting 
Public Interest

Removing the 
Removing the Securing the 
Securing the
Harm Benefit
Objective of Shariah
Objective of Shariah
Islamic financial products as defined by AQAD 
p y Q
methodology, should contain more benefits 
(masalih) and less or no harm (madarah).

“ in gambling (maisir) and liqour (qimar), there 
are some sins and some profits But the sins
are some sins and some profits. But the sins 
are greater than the profits” (Al‐Baqarah: 
168).
)
Manfaat Mudarat
“ in gambling (maisir) and liqour (qimar),
there are some sins and some profits. But
the sins are greater than the profits”
f (Al-
(
Baqarah: 168).
Manfaat Mudarat

Riba
“ in Gambling (maisir) and Liqour (qimar),
there are some sins and some profits. But
the sins are greater
g than the profits”
p (Al-
(
Baqarah: 168).

Mudarat Manfaat
Sins Profits
Mudarat Manfaat

Riba
Mudarat Manfaat
Mudarat > 
>
Manfaat

HARAM
Mudarat < 
<
Manfaat

HALAL
Downside (Madarrah) of Credit‐Financing
Downside (Madarrah) of Credit Financing

MACRO MICRO

Economic Bubbles Bankruptcy

Subprime Loans Foreclosure

Financial Turmoil
Financial Turmoil Unemployment
The upside (Manfaat) of Credit‐
Financing

MACRO MICRO

Allocation of Capital
p Wealth creation

Economic Growth Rich becoming richer

Leisure luxury and lifestyle


Leisure, luxury and lifestyle
Maqasid
• To analyse(theoretical) and measure( 
To analyse(theoretical) and measure(
empirical) impacts of financial 
intermediation based on aqad‐based Shariah 
compliant products.
1. Efficiency studies
2. Profitability studies
3. Studies on Consumer welfare and protection
Studies on Consumer welfare and protection
4. Studies on Financial stability
Maqasid – protecting public interest.
Maqasid  protecting public interest.
• Aqad‐based products (ABP) SHOULD contain more benefits and less 
harm.

• What if, it was proven than they (ABP) contain more harm than good?
eg Abandon projects customer cannot make recourse against bank 
eg. Abandon projects – customer cannot make recourse against bank
as selling party?
Defaulted BBA customer are required to make settlement based on the 
selling price.
gp
Sale with no transfer of ownership.
Giving away clean inah personal financing at high profit rates– a way 
towards subprime inah?

Conflict between Aqad and Maqasid?
Method #3: Financial Reporting
Method #3: Financial Reporting
• Proper recording of transactions to evident TRUE SALE.
• IFRS – Transparent, consistent and comparable 
information
• BBA – bank must put BBA asset on balance sheet prior to 
sale. I week, 1 month it depends.
l I k 1 th it d d
• Once sold, it is recorded as BBA receivables.
• AITAB assets should be on banking book as leasing assets 
b
but now treated as “financing and advances”.
d “fi i d d ”
• External auditors (PWC, KPMG etc.) are not required by 
the authority to conduct Shariah audit. And they may not 
be not capable to do so
be not capable to do so.

Conflict between AQAD and financial reporting?
Islamic Bank Average Balance Sheet
Islamic Bank Average Balance Sheet
Assets Liabilities

Murabaha/BBA Wadiah Dhamanah deposits

AITAB Profit Sharing Investment Acct

Islamic Securities/Sukuk Capital
1st October 2008

Assets Liabilities

FIXED ASSET
1. BBA asset  

15 October 2008
Assets Liabilities

CURRENT ASSET

2. BBA Receivables Profit in‐Suspense

1. 1/9/2008 Bank purchases Property from Vendor


for $200,000

1. 15/9/2008 Bank Sells Property to Customer for


$280,000
Basel II and IFSB
Basel II and IFSB
• High
High risk
risk‐weights
weights for Musharakah Financing to 
for Musharakah Financing to
imply that bank bears business risk and the 
general investment account holders (GIA) do
general investment account holders (GIA) do 
not.
• Recent PSIA guidelines will test risk appetite of 
Recent PSIA guidelines will test risk appetite of
depositors.
Method #4: Legal Documentation
Method #4: Legal Documentation
• BBA should be documented as a true sale and not as a 
s ou d be docu e ed as a ue sa e a d o as a
loan.  (Dato’ Nik vs. BIMB)

• Ijarah should be documented as operating lease and not 
a loan (Tinta Press vs. BIMB)
• Islamic bank has not practice fairness compared with 
conventional bank (Affin bank vs Zulkifli).

Conflict between AQAD and documentation of AQAD?
‘Do
Do not Sell what you don not Own”
Own
Hadith (Sahih Bukhari)

High Court Judge Datuk Abdul Wahab Patail says that the
sale element in BBA sale is not a bona fide sale

BBA Legal Documentation


BBA Legal Documentation

1. Sale and Purchase Agreement (SPA)
2. Property Purchase Agreement (PPA)
3
3. Property Sale Agreement (PSA)
Property Sale Agreement (PSA)
4. Deeds of assignment/Charge
2. Bank do not have
legal + beneficial ownership
1. No transfer of title from Customer to Bank of property to make a valid sale
Regulatory Framework
Regulatory Framework

Basel 2, IFSB, AAOIFI, Central Banking
Islamic Financial Market
Islamic Financial Market
Shariah Regulatory 
Framework Framework

Fiqh Academy  
Basel II
Basel II
M k h
Mekah

Islamic Financial 
AAOIFI B h i
AAOIFI, Bahrain S i B d
Service Board 
(IFSB)

Bank Negara 
Shariah
Sh i h Bank Negara 
B kN
Supervisory Board,  Malaysia
Malaysia
Islamic
Islamic 
Banking Act 
(IBA)1983

“Islamic bank” means any company which 
carries on Islamic banking business and 
holds a valid license; and all the offices 
and branches of such a bank shall be 
deemed to be a bank”
deemed to be a bank

“Islamic banking business” means banking 
business who aims and operations do not 
involve any element which is not allowed by 
involve any element which is not allowed by
the Religion of Islam”
“Element which is not allowed by the Religion of Islam”  
(IBA 1983)
(IBA 1983)

5 Shariah Principles
5 Shariah

Prohibition 
on the 
Avoidance of  Prohibition 
1 Prohibition  Application  production 
Gharar in 
in of Gambling
of Gambling 
of Riba of Al‐Bay and servicing 
Contracts (maisir)
of prohibited 
commodities
Islamic Banking Act 1983
Islamic Banking Act 1983

2. Financial requirement and 
4. Restriction on Business
duties of Islamic banks

1. Licensing of 
Islamic banks
l b k

3 Ownership control and


3. Ownership, control and  5 Powers of supervision and
5. Powers of supervision and 
management of Islamic  control over Islamic banks
banks
Islamic Banking Under IBA 1983
Islamic Banking Under IBA 1983
Asset Liabilities Financing Deposit
Financing Wadiah 
Financing
Dhamanah Mortgage
Saving
Savings Hire‐Purchase
Personal, enterprise
,
Operation PSIA
al Leasing Leasing PSIA

JV
Stocks
Venture capital Private Equity
Sukuks Capital

Property

MORE OUTPUT IN THE BANKING BOOK
Anglo‐Saxon Islamic Banking
Wall between commercial and investment banking
W ll b i l di b ki
US : Glass ‐ Steagall Act 1938   Malaysia: BAFIA 1992
Financing Deposit
Mortgage Saving
Hire‐Purchase PSIA
Personal
Securities

Islamic 
Banking

Venture  Private 
Leasing Brokerage Property Unit Trust
Capital Equity
Conventional to Islamic
Conventional to Islamic
IBA 1983: No Wall between Commercial and
Islamic Banking and BAFIA 1989 Investment banking

A t
Asset Li bilit
Liability A t
Asset Li biliti
Liabilities
Mortgage Saving Financing Wadiah 
Hire‐Purchase PSIA Mortgage Dhamanah
HP Savings
Personal Personal
Sukuks
Operation PSIA
al Leasing
JV
Stocks
Sukuks
Universal Banking: Economies of Scale and Scope
g p

Less Cost 
More Outputs Higher Profits
per Unit
IBA 1983

Buy and sell assets and 
Buy and Sell common 
properties ‐ BBA,  Buy assets and leasing of  Fee‐Based Financial  Private Equity
stocks ie Joint ventures – Fund Management
Murabahah, Salam,  assets – Ijarah Services
Musyarakah,mudarabah
Istisna’
Islamic Banking Act 1983 on Shariah
advisory body

“that there is in the article of association of the bank concerned, provision for the
establishment of a Syariah advisory body to advise the bank in the operation of its
banking business in order to ensure that they do not involve any element which is not
approved by the Religion of Islam”
Islam
Role of Shariah Supervisory Board
Role of Shariah Supervisory Board
To study fatwas
Supervise
previously issued
activities of
by SSB of
member banks to
member banks
ensure they are in
and how these
conformity with
fatwas conform to
Sh i h rulings
Shariah li
Shariah rulings

To issue fatwas
(religious legal Settlement of 
opinions) on
litigation against 
financial products
and banking Islamic bank?
operations
Role of Shariah Supervisory Board
Role of Shariah Supervisory Board
Determination of profit-
profit
A
Accounting
ti policy
li
sharing ratio between
adopted by banks
banks and clients

Others Duties

Determining the income


Determining the
distributed and expenses
calculation and payments
to be borne byy depositors
p
of zakat
Role of Shariah Committee (SC) in Islamic banking 
subsidiaries/windows
b idi i / i d

• Interpretations and enforcement of the application of the Islamic laws, 
principles and traditions on all of the business operations of Islamic banks.
i i l d di i ll f h b i i fI l i b k
• To decide on the Shariah aspect of a new type of transaction envisaged and 
also to explain the opinion given in light of Islamic principles
• To submit annually a written report to the shareholders to the effect that they
To submit annually, a written report to the shareholders to the effect that they 
have discharged their obligations.
• To ensure that zakat payment is correctly calculated and distributed.
Banking
Practisioners BNM Shariah Muftis
Advisory S e i
Supervisory B d
Board Sh i h
Shariah FATWA
BNM officials Scholars

Bank Negara
g
Malaysia – Islamic
Banking Department Usul-Fiqh

Qawaid
Fiqhiyyah
Proposals
Fiqh
Muamalat
ISLAMIC BANKING DIVISION
- Commercial bank
Finance company
Merchant bank

Islamic New Shariah


Banking Islamic Committee
Consultants Instrument
Legal Framework
Legal Framework

Tax Law
Contract 
Tax Neutrality
Documentation

Tax on leasing, 
murabahah
murabahah,  Litigation
assets
Products and Services
Products and Services

Islamic Banking
Simple Bank Organization
Simple Bank Organization

Board of 
Di t
Directors
Shariah Advisory 
Committee 
CEO

Risk 
Corporate Retail Investment ICBU
Management
The Conventional Banking Business
The Conventional Banking Business
Banking Firm 

Banking Firm
Asset Liability
$160b $160b

$20b
Capital $20b

Non‐Banking
Non Banking Firm
Firm
Asset Liability

$20b C i l $20b
Capital $20b
Bank as Financial Intermediary
Bank as Financial Intermediary
Banking  is a business based  It can borrow 8 times its 
on Leveraging
g g Capital 
p
1. CAR  8%
1a. Bank Capital $20b
2 Borrowing
2. Borrowing $160m@5%
3. Lending $160@10%

4.Revenue $160m x 0.1   =   $16b
5. Cost of deposits $160m x 0.05 =  $8b
6. Overhead
6. Overhead $3b
7. Provisions $1b
8. Profit $16b – ($8b + 3B + $1b) = $4b

9. ROE $4b/$20b = 20%
10. ROD 5%
Islamic Banking
Islamic Banking 
ISLAMIC BANKING
OPERATIONS

ASSET-BASED PROFIT-SHARING FEE-BASED

Qirad/Musharaka
(partnership)
Istisna’ Kafalah
Murabaha Ijara
(sale (guarantee)
(deferred (leasing)
sale)) by order)
Al Bay
Al‐Bay’
Spot Deferred (Muajjal)

C
Cost-Price
Pi + M k
Mark-up = Selling Price

‘IWAD

Ghurmi
Kasb Daman
(eg.ownership
risk) (Value-added) (Liability)
Al Bay’
Al‐Bay

Spot (=$100) Discount (<$100) Deferred (Muajjal) >$100


Mutlak Wadhiah

$1000 + $100 = $1100

‘IWAD

Ghurmi Kasb Daman


(eg.ownership risk) (Work &Effort) (Liability)
1.Al-Bay’
2.Al-Ijarah
j RISK
3.Salam (Ghurmi) ISLAMIC NORMATIVE
4.Istisna’
5.Mudarabah THEORY OF
6. Musyarakah
PROFIT

= ‘IWAD WORK &


PROFIT (Equivalent countervalue) EFFORT
(Kasb)

LIABILITY
(Daman)
Risk
(Ghurmi)

Profit
Work & Effort Responsibility
p y
(Kasb) (Daman)
Murabaha Financing : 
Determination of Islamic Bank’ss 
Determination of Islamic Bank
Profit Rate
Time Value of Money Reconsidered
Murabaha Financing
Murabaha Financing

Murabaha
Selling Price
Selling Price

Profit Margin
g
Cost Price Profit rate x 
$
$Facility x tenor
y
Murabaha Financing
Murabaha Financing

Profit Rate

Cost of
Cost of  Risk‐
Risk
Overhead
h d
Deposit Premium
Interest‐bearing
Interest bearing Loan
Loan

Interest 
Rate

Cost of
Cost of  Risk‐
Risk
Overhead
h d
Deposit Premium
Cost of Deposit

Risk Free rate
True Time Value  Risk Premium
of Money
Time Value of Money
Time Value of Money
Islamic Perspective
TIME VALUE OF MONEY

Time Preference indicates the extent of a family’s preference 
for current consumption  over future consumption 

1. Positive Time Preference
1 Positive Time Preference
Money today is worth more than money tomorrow

2. Negative Time Preference
Money today is worth less than money tomorrow

3. Neutral Time Preference
Money today is equivalent to money tomorrow
Money today is equivalent to money tomorrow
Positive 
$
$1now > 
time
time 
preference $1future

Neutral 
N t l
$1now = 
time 
preference $1 future

Negative 
$1now < 
time
time 
preference $
$1future
Time Value of 
Ti V l f
Money

Positive Time 
Neutral Time  Negative Time 
Preference 
Preference Preference
(PTVM)

Capitalism: 
Islamic PTVM 
PTVM leads to
PTVM leads to 
l d
leads to hibah
hb h
interest
Time Value of Money
Time Value of Money
• Principle = Present value = $1000 
p $
• Interest = 10% per year = $100
• y
Tenure = 1 year
• Future value = Present value + interest
• $1000 = $1000 + $100
• FVt = PV0 (1 + i)t
• i>0 ; FV > PV  i.e.Positive time preference
• i=0 ; FV = PV i.e. Neutral time preference
• i<0; FV < PV i.e. Negative time preference
Time Value of Money
Time Value of Money
• Positive Time Preference
Positive Time Preference
• Dollar now worth more than dollar tomorrow.
• Why? Future is uncertain
Why? Future is uncertain.
• Lenders stand to lose if loan is paid without 
any fixed surplus
any fixed surplus
• Surplus paid due to delaying payments i.e. the 
time factor rationalizes interest payments
time factor rationalizes interest payments.
• No other factor explains interest charges other 
than time taken to pay up
than time taken to pay up.
Increments in Islamic Loans
Increments in Islamic Loans
• Islamic
Islamic loan 
loan – the debtor sets the increment
the debtor sets the increment
• The increment in lawful halal = hibah
the best among you is he/she who pays a handsome 
• “the best among you is he/she who pays a handsome
debt” (Hadith Sahih)
• “the
the best among you is he/she who upon settling 
best among you is he/she who upon settling
his/her debt, pays more (Hadith Sahih)
• The increment is set or declared on maturityy
• The increment is not contractual or fixed upfront
• The increment is voluntary
The increment is voluntary
Islamic time value of money
Islamic time value of money
• Delay in payment can allow seller to increase price
• But increase in price must be accompanied with ‘iwad i.e. (an 
equivalent countervalue)
• Seller must own asset for making the sale
g
• Buyer owns the asset after sale eventhough payment is made 
by installment
• Seller holds no right to put the asset under charge.
g p g
• Under charge = buyer places the purchased asset as collateral 
but enjoying the usurfruct at the same time
• Buyer can place a colleteral (rahn) over the credit payment
Buyer can place a colleteral (rahn) over the credit payment
• Seller can sell the asset to a third party even before 
completing payment. 
• Seller must provide warranties on the asset sold
Seller must provide warranties on the asset sold
Simple interest‐bearing loan
i>0
Loan = $10,000
$ ,
Debt = $11,000
Debt > Loan
Total payment to Maybank = P + iP 
Total payment to Maybank  P + iP
0 Year 1

Ali receives $10,000 Ali repays


from Maybank Maybank
$11,000

T l repayment to Maybank
Total M b k=P Principal
i i l + iinterest = P + iP = P (1 +II )
Simple Loan i>0
Simple Loan  i>0

Total payment to Maybank = P + iP 

0 Year 1

Ali receives $10,000 Ali repays


from Maybank Maybank
$11,000

T l repayment to Maybank
Total M b k=P Principal
i i l + iinterest = P + iP = P (1 +II )
Discount Bond
Discount Bond

Implicit interest rates = 10%


Discount price = $10,000/1.10 = $9091

Year 1
0

Borrower receives
i $9091
$ Borrower repays
From discount bond $10,000
Islamic Loan
i 0
i=0 
Loan = $10,000 ; Debt = $10,000
L
Loan = Debt
D b
Total payment to Maybank = P + 0P 
Total payment to Maybank  P + 0P
0 Year 1

Ali receives $10,000 Ali repays


from Maybank Maybank
$10,000

T l repayment to Maybank
Total M b k=P Principal
i i l + 0 = P + 0P = P (1 +0
0)
Increments in Conventional Loans
Increments in Conventional Loans
• Conventional
Conventional loan 
loan – the creditor sets the 
the creditor sets the
increment
• The increment in unlawful haram = riba
The increment in unlawful haram = riba
• The increment is set upfront 
• The increment is determined in the letter of 
loan offer
• The increment is contractual i.e. legal action 
on borrower if he fails to pay up.
p y p
Risk and Riba
Risk and Riba
• Bank
Bank is compensated for the risks it 
is compensated for the risks it
undertakes
• Risk is the volatility of net cash flows of the 
Risk is the volatility of net cash flows of the
firm
• Bank profitability  depends on the 
B k fi bili d d h
management of risks
• Riba is profit acquired without holding risks in 
sourcing capital.
• Riba is the compensation for waiting and not 
compensation for risking own capital.
The Prophet Muhammad (saw) enjoins debtor to pay more 
Th P h M h d( ) j i d b
but on voluntary basis because he (saw) foresees the 
problem/uncertainties falling upon the creditor who has to 
bear:

• Risk of default
Ri k f d f lt
• Risk of inflation
• Opportunity cost of the loan

Since a creditor faces the above uncertainties, given an 
option to spend the money today or in the future, he 
p p y y
will choose the former. In this way, he holds positive 
time preference (PTP) outlook.
Why pay more on Qard Hasan?
Wh Q dH ?
To say “thank you” –
y y expressing 
p g
one’s GRATITUDE
• Opportunity Cost: The creditor foregoes 
opportunity of earning income from the 
money given away as loan
• Inflation risk: The creditor may lose out when 
y
the payments holds lower purchasing power 
due to inflation
Islamic recognizes that $1 today 
$
is worth more than $1
is worth more than $1 
tomorrow
• B
But compensation for abstinence is not 
t ti f b ti i t
contractual  ie not set when the loan contract is 
made
• Compensation is voluntary
• Compensation known only when the debt 
Compensation known only when the debt
matures
Qard Hasan
Qard Hasan
Why Pay 
Why Pay
More?

Gratitude

Inflation

Opportunity 
cost
Asset Liability

Loans Deposits
The Banking Business

Profit = (rL1 x L1) – (rd1 x D1)


= (0.1
(0 1 x 20m) – (0.05
(0 05 x $20m)
= $2m - $1m = $1 million

Market for Loan (Financing) Market for Deposit

SL r
r Sd

rL1

10%
rd1
5%

DL Dd

L1 Loan D1 Deposit
$20m $20m
Average Balance Sheet: Islamic Banking
g g

Asset Liability

Al-Bai-bithaman Ajil Al-Wadiah Dhamanah


Al-Murabahah Al-Mudarabah Investments
Al-Ijarah
j
Salam
Istisna
Al Musharakah
Al-Musharakah
Al-Mudarabah
C. Deposits
C. Deposits
• Current Account
Current Account • Wadiah Dhamanah
Wadiah Dhamanah
• Savings Account • Wadiah Dhamanah
• Investment Account
Investment Account
• Islamic NICD • Mudarabah
• Bay al‐Dayn
Bay al Dayn
D. Financing
D. Financing
• Home‐financing
Home financing • Bai‐bithaman Ajil
Bai bithaman Ajil
• Auto‐financing • Al‐Ijarah Thumma Al‐bay
• Bay’ al‐’inah
• Personal financing • Wakalah LC
• Trade financing • Murabahah LC
• K f l h LG
Kafalah LG
• Islamic accepted bills.
• y
Bay’ al‐’inah
• Credit card
Treasury
• Islamic money
Islamic money‐market
market
• Statutory reserve requirement
• S
Statutory liquidity requirement
li idi i
• Asset‐liability Management
• Risk Management
Islamic Bank’ss Average Balance Sheet
Islamic Bank Average Balance Sheet
Asset Liability

Cash Wadiah Dhamanah Current 
Account
BBA Home Financing Wadiah Dhamanah Savings 
Account
AITAB Car Financing Restricted Mudarabah 
Account
Bay al‐Inah Personal Financing
B l I hP l Fi i U
Unrestricted Mudarabah 
t i t dM d b h
Enterprise Financing Account
Government Islamic Securities Commodity Murabahah
Negotiable Islamic Certificate
Negotiable Islamic Certificate 
of Deposits
Sukuk

Fixed Assets Shareholders’ Capital
Income Statement
‘R
‘Reward comes with Risk”
d i h Ri k”
Islamic Banking

Profit and Loss
Revenues $500m
Cost of Funds $200m
Gross Profit $300m
Overheads $80m
Provisions for NPF $10m
Profit Equalization Reserve $5m
Profit Before Tax and Zakat $200m
Tax and Zakat $
$60m
Net Profit $140m
BALANCE SHEET
BALANCE SHEET
ASSETS
• Cash and short‐term funds
• Deposits and placements with banks other financial institutions
• Dealing securities
• Investment securities
• Financing , advances and other loans
• Other assets
• Bills receivable 
• Statutory deposits with Bank Negara Malaysia
• Investment in subsidiary companies
• Investment in associated company
• Property , plant and equipment
TOTAL ASSETS

LIABILITIES AND SHAREHOLDERS’ FUNDS
• Deposits from customers
• Deposits and placement of banks (PSIA,commodity murabaha,NICD)
• And other financial institutions
• Bills payable
• Other payables
• Subordinated financingg
• Zakat and taxation
• Deferred tax liabilities
TOTAL LIABILITIES

• Share capital
• Reserves

• SHAREHOLDERS’ FUNDS
SHAREHOLDERS FUNDS
TOTAL LIABILITIES AND SHAREHOLDERS’ FUNDS
• COMMITMENTS AND SHAREHOLDERS’ FUND

• Capital Adequacy
• Core capital ratio before proposed dividends
• Risk‐weighted capital ratio before proposed dividends
• C
Core capital ratio after proposed dividends 
it l ti ft d di id d
• Risk‐weighted capital ratio after proposed dividends
Islamic Bank as a Financial Intermediary
1. CAR  8%
1a Bank Capital
1a. Bank Capital $20b
2. Investment Deposit  $160m@ex post
(Partnership)
Transaction Deposit
p
3. Financing  (Trade) $160@10%

4 Revenue
4.Revenue $160m x 0 1 = $16b
$160m x 0.1   =   $16b
5. Cost of deposits $160m x 0.05 =  $8b
6. Overhead $3b
7. Provisions $1b
8. Profit $16b – ($8b + 3B + $1b) = $4b

9. ROE $4b/$20b = 20%
10. ROD 5%
Asset Liability

Asset‐based financing Transaction Deposit
Murabahah/BBA
AITAB
Ijarah
Istisna
Salam
Tawaruq
Bay inah

Partnership/Contract Financing Investment Deposit
Musharakah Restricted PSIA
Mudarabah Unrestricted PSIA

Fee‐based financing Commodity Murabaha
Wakalah

Investment
Sukuks

Fixed Assets

Tier 1 Capital  Common Stocks

Tier 2 
Capital Preference Shares
Reserves
Murabaha: 1st November 2008: Bank Buys and 
H ld A
Holds Asset
Asset Liability
Current Asset
Current Asset
Fixed Asset
Murabaha asset
ISLAMIC BANKING 
I
Income‐Statement
S
• Income derived from investments of depositors fund
• Allowance for losses on financing
• Profit equalization reserve
• TOTAL DISTRIBUTABLE INCOME
• Loss/income attributable to shareholder
/
• Income derived from investment of shareholders’ fund
• TOTAL NET (LOSS)/INCOME
• P
Personal expenses
l
• Other overhead expenses
• (LOSS)/PROFIT BEFORE ZAKAT AND TAX EXPENSE
• Zakat
• Tax expense
• NET(LOSS)/PROFIT FOR FINANCIAL YEAR
Per
rcentage

C
as
A h
dv an
an d
ce ca
s s
to eq

0
10
20
30
40
50
60
ot ui
he va
r le
fin n
an
ci
al
M in
ur st
ab itu
ah tio
a/
A
l-B
ai
'B
ith
am
an
A

In
a
S
al
am
/Is
tis
na

M Ija
us ra
ar
ab
a/
M
uq
ar
ad
a
In
ve
st
m
en
t M
in us
se ha
cu ra
rit ka
ie
s/
co
m
pa
ni
e
Consolidated Balance Sheets of Islamic Banks in GCC and Malaysia
Regional Balance Sheet Comparison

O
th
er
s
GCC
y
Malaysia
International Outlook of Balance Sheet Items

C
Consolidated
lid t d Balance
B l Sheet
Sh t Items
It off Islamic
I l i Banks
B k in
i GCC and
d Malaysia
M l i combined
bi d

9%
Cash and cas
17% equivalent
3% Advances to other
financial institutions
Murabaha/ Al-
Bai'Bithaman Ajil
Ina

Salam/Istisna

Ijara

Musaraba/Muqarada
12%
Musharaka

Investment in
securities/companies
Others
1%
1%

6%
47%

4%
0%
International Outlook for Sources of funds

Sources of funds of Islamic Banks in GCC and Malaysia (combined)

Deposits from other financial


Others Institutions
9% 4%

Shareholders equity
11%

Current Accounts
28%

Investment/Savings accounts
48%
To Be Continued
To Be Continued..

Thank You