Islamic Banking

Group No 2 Roll No 7-12 7-

Flow Of Presentation
‡ Introduction ‡ What Is Islamic Banking ‡ Islamic Banking Principle ‡ Prohibitions ‡ Difference between Islamic Banking and Conventional banking. ‡ Islamic Banking products and services ‡ Controversies ‡ Status and challenges for Islamic Banking

‡Introduction

‡ Islam has given an immense importance to Trade ‡ The nobility of this profession is obvious from the fact that it was the chosen profession of prophet Muhammad (PBUH). ‡ Before explaining the concept of ³What is Islamic banking´ the elaboration of ³Why Islamic Banking´ is very important. ‡ Islam is a complete code of life that provides guidance regarding each aspect of life.

Why Islamic Banking ‡ The primary objectives of Islamic economic system are as under ‡ Equal distribution of wealth ‡ Social Justice ‡ These Objectives can never be achieved in interest based economic system. .

in addition to the conventional good governance and risk management rules. by the principle laid down by Islamic sharia¶h´ .e. What is Islamic Banking? ‡ ³Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed.Now we come to core question i.

Islamic Bank Principles ‡ Islamic Banking operates in accordance with the rules of Sharia¶h. ‡ As well as investing in business that provide goods or services considered contrary to its principle. . ‡ The Sharia¶h prohibits the payment of charges for the renting of money for specific term. ‡ The principle source of the Shariah is the Quran followed by the recorded saying and actions of prophet Muhammad ±the Hadith. known as Fiqh al-Muamalat al(Islamic Rules of Transactions). Hadith.

interest in a nonnonmonetary asset. meaning money earned on the lending out of money itself ± Money in Islam is not regarded as an asset. it is necessary to obtain an equity. ± Interest can leads to injustice and exploitation in society. or ownership. . fee± In order for an Islamic bank to earn return on money lent. Money tends to view purely as medium of exchange. ± There is no real lending in Islam since all lenders obtain ownership interest in assets that they finance or earn profit share or purely fee-based remuneration. ± The lender also participate in the sharing of risk.Prohibitions ‡ Prohibition of Interest (Riba) (Riba) ± Riba means the charging of any interest.

.Other key Prohibitions ‡ Not only prohibits dealing in interests and investments in unlawful activities that Islam deems harmful to society. ‡ But also transactions involving excessive uncertainty (gharar) and all forms of gambling (maysir).

finance and economics. in addition to the knowledge of modern business. ‡ It comprises of at least 3 sharia¶h scholars with specialized knowledge of the Islamic laws for transacting.Religious board (Sharia¶h Supervisory Board) ‡ In order to adhere the best practices of corporate governance. an extra layer of supervision in the form of religious board is done. . ‡ Responsible to give approval that banking and other financial products and services offered comply with shariah and subsequent verification of operations and activities in comply with sharia¶h principle. ‡ The religious board have both supervisory and consultative functions.

Difference Between Islamic and Conventional Banking Islamic Banking ± Conventional Banking ± Functions and operations are based on Functions and operations are based on Sharia¶h principles fully man made principle. its sale and purchase is prohibited in Islam ‡It is almost risk free banking and depositor has no risk of losing its money bcos interest is guaranteed. buyer or seller relationship Encourage asset based financing and based on commodity trading. Money is a medium of exchange and not a commodity. investors and traders. Aim at maximizing profit without any restrictions Creditor-debtor relationship. Based on money trading. Aim at maximizing profit but subject to sharia¶h restrictions Partners. Investor is assured of predetermined rate of interest. The profit and loss sharing depositor may lose money in case of loss . No right of profit if there is no risk involved. Promote risk sharing between provider capital (investor) and user of funds (entrepreneurs).

Islamic Banking Products and services ± ‡ ‡ Islamic banking was undertaken in Egypt. but in last few yrs industry is see strong development in new products and services. Dubai Islamic bank. 10- ‡ ‡ . opened in 1975. in the form of savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. profitThe 1st modern commercial Islamic bank. IB growing at a rate of 10-15% per year. Initially product offered were basic and strongly founded on conventional banking products.

and the far east. Germany. etc As well as an additional 250 mutual funds that comply with Islamic principles. ‡ ‡ ‡ ‡ .g. Citibanks etc). Conventional foreign banks ( e. Europe. held annually in Bahrain since 1994 and is most significant gathering of Islamic banking and finance leaders in the world.Islamic Banking Products and Services ‡ Islamic Banking is not limited only to the Muslim nations in the middle east but covers vast area spanning USA. having funds under management greater than one trillion US dollars. Grindlays. More than 450+ Islamic banks are operating from China to USA. The world Islamic banking conference. Switzerland. HSBC. Luxembourg. are dealing in Islamic Products through their Islamic units in UK. Standard Chartered Bank.

Islamic Banking Products and services ‡ Currently available Islamic Banking Products and services are: ± Partnership based modes of financing ± ‡ Musharaka Finance and Mudaraba Finance ± Trade Based Modes of financing ± ‡ Murabaha Finance. Diminishing Musharaka Finance. Salam Finance ± Rental Based Modes of Financing ± ‡ Ijarah Finance. .

.‡ Partnership based mode of financing ± ± Musharaka Finance ± ‡ Both the bank and the customer contributes towards the capital of the enterprise. which may be different from the proportions of capital contributed. ‡ Any Losses of the enterprise will be borne by the customer and bank according to their capital contribution. ‡ The customer and the bank shares in the profits according to the agreed proportion.

The structure of Musharaka Contract Islamic Bank Partner (Customer) 60% Ownership 40% Ownership Musharaka .

‡ The balance of the profit of the enterprise is payable to the bank. ‡ If the enterprise make a loss. ‡ The customer contributes only entrepreneurship.‡ Partnership based mode of financing ± ± Mudaraba Finance (Passive Partnership) ‡ The bank provides to the customer all the capital to fund a specific enterprise. the bank has to bear the all the losses unless the loss has resulted from . ‡ The customer is responsible for the day to day management of the enterprise and is entitled to deduct its management fee from the enterprise profit.

Mudaraba Finance (Passive Partnership) (Mudarib) Investor of Capital CLIENT Payment of Mudarabah Capital CLIENT Periodic proportionate Profits / Return of Capital (Mudarib) Distributor of Profits Earned INVESTMENT / TRADING ACTIVITIES Earning of Profits .

‡ The period covering the deferred payments is effectively the period of financing.‡ Trade based modes of FinancingFinancing± Murabaha Finance ‡ The bank buys an assets from the vendor ‡ The customer then buys the assets from the bank at a mark up price. . which is payable on a deferred payment basis. ‡ The title to the asset is transferred to the customer at the time of purchase but usually the customer provides the same or other assets as collateral to the bank for the period of financing.

The structure of a Murabaha Contract Transfer of title to bank VENDOR ISLAMIC BANK Transfer of title to customer CUSTOMER Payment of purchase price (P) Payment of marked up price (P + X) .

‡ It is primarily a deferred delivery sale contract usually used for commodity finance. . It is similar to a forward contract where delivery is in the future in exchange for spot payment.‡ Trade based modes of FinancingFinancing± Salam FinanceFinance‡ A salam is short term agreement in which a financial institution makes full pre-payments for prefuture delivery of specified quantity of goods on a specified date. ‡ To mitigate the asset risk a financier can enter into parallel Salam.

The structure of a Salam Contract Delivery of asset at future date Delivery of asset At future date COMMODITY OWNER ISLAMIC BANK CUSTOMER Advance payment of purchase price (P) Advance payment of purchase price .

‡ Title passes to the customer under a lease ending with transfer of ownership. ‡ The bank then leases the asset to the customer. ‡ The title of the asset remains with the bank under as operating ijarah. at the end. either gradually over the period of the contract.‡ Rental Based Mode of Financing ± ± Ijarah Finance ± ‡ The bank buys the asset from the vendor. ‡ Periodic rentals are collected by the bank. .

The structure of an Ijarah Contract Transfer of title to bank Assets leased to customer ² title does (not) pass at end of lease term VENDOR ISLAMIC BANK Payment of purchase price CUSTOMER (Lessee) Ijarah Installment .

‡ The customer and the bank share in the profits according to the agreed proportion. the customer buys out the bank¶s share over a period of time.‡ Rental Based Mode of Financing ± ± Diminishing Musharaka FinanceFinance‡ Under a µDiminishing´ Musharaka. .

‡ However. ‡ For a defined period the risk and returns associated with the cash flows generated from the assets belongs to the sukuk holder.‡ Some others products and services ± ± Sukuk (Islamic Bonds) ‡ Is the Arabic name for a financial certificate. . interest bearing bonds are permissible in Islam. fixed income. ‡ It represents proportionate beneficial ownership.

The structure of a Sukuk Contract TRANSFER OF ASSETS ISSUE OF SUKUKS CUSTOMER ISLAMIC BANK INVESTORS CASH CASH .

. when depositors demands it. ± Is based on the idea that what is uncertain wrt an individual may cease to be uncertain wrt large no of similar individuals. ± The bank guarantees refund of the entire amount of the deposit. ‡ Wadiah ±Safe keeping ± A bank is deemed as a keeper and trustee of funds.‡ Takaful (Islamic Insurance) ± ± Is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortune. ± Insurance by combing the risks of many people enables each individual to enjoy the advantage provided by the law of large number. or any part of the outstanding amount.

± The total assets manage this funds exceed US$5 billion and growing by 12-15% per annum. ± The website failaka. ± Appr. ± IQF launch in 1990 and establishment of credible equity benchmark by Dow Jones Islamic market index (In 1999) and the FTSE global Islamic Index Series. 12± Target market for Islamic funds are Malaysia. 100 Islamic equity funds worldwide.com monitors the performance of Islamic equity funds and provide a compressive list of Islamic funds worldwide. middle east and gulf regions etc. .‡ Islamic equity Funds ± ± Is one of the fastest growing sectors within Islamic financial system.

.Status of Islamic Banking ‡ IB is no longer a novel experiment. ‡ With its value oriented ethos enables it to draw finances from both Muslims & Non-Muslims Nonalike. ‡ IB evolving in financial and investment instruments that are not only profitable but also ethically motivated.

‡ Initially registered as non banking finance company and later get transformed into full Fledged Shariah compliant bank.Status Of Islamic Banking ‡ The first Islamic bank in the country with the active involvement of Kerala Govt. is likely to start operations in Kochi by 2010. . ‡ The kerala Industries department is actively involved in the new initiative.

If bank suffers a loss it has to be transferred to depository directly. ± Amendment of existing laws ± ‡ IB has some kind of resemblance to universal banking. speedy and supporting Islamic legal system. . This fear of loss leads to withdrawal of funds. Therefore depositor should be provided with some kind of protection. ± Disclosure of Assets ± ± PLS deposits ±Since IB based on principle of profit and loss. ± Islamic Banking Court ‡ To ensure a proper. amendments in existing laws are required to proclaim Sharia¶h compliant law for resolution of disputes through special courts. therefore laws and regulations have to be amended accordingly to accommodate new concepts wherein banking companies can engage and prohibition of trade.Challenges For Islamic Banking ‡ Legal Support ± Thr.

accounting and auditing standards should be applied to them. . creating a big risk for them being traders in reality. ‡ Benchmark ± ± No product different due to using same interest based benchmark unlike conventional.Challenges For Islamic Banking ‡ Risk ± ± The nature of risk in IB is different from those of conventional banking and therefore some special prudential. ‡ Islamic future exchange ± ± Most of the products in IB are based on Goods and commodities while prices and currency rates goes up and down frequently. they are in need of derivative products and consequently of future exchanges. To hedge the risk.

‡ Thank You .