Lehrstuhl für Bankwirtschaft und Finanzdienstleistungen

Prof. Dr. Hans-Peter Burghof with

Ahmad Abu-Alkheil and Ulli Spankowski

Islamic banking & Finance

• Introduction
• Evolution

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Islamic Banking and Finance

Glossary:
Islamic Banking and Finance

Term in Arabic Meaning

Reba Interest
Al-wadiah Safe keeping
Bai'muajjal Deferred-payment sale
Bai'salam pre-paid purchase
Zakat Islamic tax
Halal lawful
Haram unlawful
Ijara leasing
Mudaraba profit-sharing
Mudarib Entrepreneur-borrower
Murabaha Cost-plus or mark-up
Musharaka Equity participation
Qard hasan Benevolent loan (interest free)
Gharar Uncertainty or chance
Sukuk Islamic bond
Qirad Mudaraba
Rabbul-mal Owner of capital
Shariah Islamic law
Shirka Musharaka

Islamic Economics

Islamic economics :

• Is economics in accordance with Islamic law .

Goals of Islamic Economics :

• Broad-based economic well-being with full employment and optimum rate of economic
growth.

• Stability in the value of money to enable the medium of exchange to be a reliable unit of
account and a stable store of value.

• A just return is ensured on investment and development projects.

• Effective rendering of all services normally expected from the banking system.

• Socio-economic justice and equitable distribution of income and wealth

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Islamic Banking and Finance

Rules regarding Islamic finance :

• Any predetermined payment over and above the actual amount of principal is prohibited

•The lender must share in the profits or losses arising out of the enterprise for which
the money was lent
• Making money from money is not Islamically acceptable (Asset Based Financing)

• Gharar (Uncertainty, Risk or Speculation) is also prohibited

• Investments should only support practices or products that are not forbidden

Islamic Banking and Finance

Islamic banking :

A banking system that is based on the principles of Islamic law (also known as Sharia,
and guided by Islamic economics).

Islamic banking distinguishing features:

• Zero interest and capital guarantee (interest-free)

• Multi-purpose and not purely commercial

• Strongly equity-oriented

• Full-reserve banking

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 Islamic Banking and Finance

Types of Islamic financing:

• Trade financing
• Investment financing
• Lending
• Services

Uses Of Funds ( Financing Techniques ):

• Musharaka (finance by way of partnership - Joint Venture)

• Mudarabah (Profit Loss Sharing)

• Murabahah (cost-plus financing)

• Bai'salam ( prepaid purchase)

• Bai' muajjal (deferred payment)

• Istisnaa (manufacturing).

• ijara (Leasing )…

Islamic Banking and Finance

Musharaka :

It means partnership. It involves you placing your capital with another person and both
sharing the risk and reward. The difference between Musharaka arrangements
and normal banking is that you can set any kind of profit sharing ratio, but
losses must be proportionate to the amount invested.

Types of Musharaka :

• Declining-Balance Shared Equity: Commonly used to finance a home purchase,

the declining balance method calls for the bank and the investor to purchase
the home jointly, with the institutional investor gradually transferring its
portion of the equity in the home to the individual homeowner, whose
payments constitute the homeowner's equity.

• Permanent Musharaka:In this form of Musharaka an Islamic bank

participates in the equity of a project and receives a share of profit on a
pro rata basis. The period of contract is not specified. So it can continue
so long as the parties concerned wish it to continue.

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Islamic Banking and Finance

Mudaraba :

Refers to an investment on your behalf by a more skilled person. It takes the form of a
contract between two parties, one who provides the funds and the other who provides
the expertise and who agree to the division of any profits made in advance. In other
words, Islamic Bank would make Sharia’a compliant investments and share the profits
with the customer, in effect charging for the time and effort. If no profit is made, the
loss is borne by the customer and Islamic Bank.

ADCB

Islamic Banking and Finance

(Murabahah (cost-plus financing) :

Murabaha is a contract for purchase and resale and allows the customer to make
purchases without having to take out a loan and pay interest. Islamic Bank purchases the
goods for the customer, and re-sells them to the customer on a deferred basis, adding an
agreed profit margin. The customer then pays the sale price for the goods over
instalments, effectively obtaining credit without paying interest.

Sayyid Tahir

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 Islamic Banking and Finance

Islamic leasing :
Leasing or ijara is also frequently practiced by Islamic banks. Under this mode, the banks
would buy the equipment or machinery and lease it out to their clients who may opt to buy
the items eventually,(Hire Purchase) in which case the monthly payments will consist of two
components, i.e., rental for the use of the equipment and installment towards the purchase
price.

The description given above, contains the following essential ingredients for
outlining the basic rules under Shari'ah:
 That there has to be a valuable use of the asset and transferability of that usufruct.
That the ownership of the asset is retained by the transferor or lessor throughout the
lease period. Consumable cannot be leased.
That the risk and liabilities of ownership lie with the lessor. The leased asset shall
remain the risk of the lessor throughout the lease period. Any loss or harm caused by
factors beyond the control of the lessee shall be borne by the lessor
That the risk and liabilities associated with the use of the asset shall be borne by
the lessee

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Islamic Banking and Finance

Islamic Forward Modes :

• Istisnaa (manufacturing)

Is a contract to acquire goods on behalf of a third party where the price is paid to
the manufacturer in advance and the goods produced and delivered at a later date .

• Bai'salam ( prepaid purchase)

A contract in which advance payment is made for goods to be delivered later on. 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. It is necessary that the quality of the
commodity intended to be purchased is fully specified leaving no ambiguity leading to
dispute.

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Islamic Banking and Finance

Difference between Islamic & Conventional Banking

SUMMARY:

An Islamic bank is a deposit-taking banking institution whose scope of activities

includes all currently known banking activities, excluding borrowing and lending
on the basis of interest. On the liabilities side, it mobilizes funds on the basis of a
Mudarabah or Wakalah (agent) contract. It can also accept demand deposits which
are treated as interest-free loans from the clients to the bank. and which are
guaranteed. On the assets side, it advances funds on a profit-and–loss sharing or a
debt-creating basis, in accordance with the principles of the Sharīah. It plays the
role of an investment manager for the owners of time deposits, usually called
investment deposits. In addition, equity holding as well as commodity and asset
trading constitute an integral part of Islamic banking operations. An Islamic bank
shares its net earnings with its depositors in a way that depends on the size and
date-to-maturity of each deposit. Depositors must be informed beforehand of the
formula used for sharing the net earnings with the bank.

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Islamic Banking and Finance

Difference between Islamic & Conventional Banking

Sayyid Tahir

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Islamic Banking and Finance

Categories of Account :

At the deposit end of the scale, Islamic banks normally operate four broad categories of
account :

• The current account

• The savings account

• Investment accounts

• Special investment accounts

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Islamic Banking and Finance

Islamic Sukuk ( Bonds):

Is commonly described as an “Islamic bond”. which represent an undivided beneficial

ownership of an underlying asset, Sukuk is a Trust certificate in which investor returns
are derived from legal or beneficial ownership of assets . Certificates of equal value
representing proportionate ownership of tangible assets or usufructs or services or of
the assets of a project or in an investment activity. (AAOIFI)

• Kinds of Sukuk :

•Sukuk representing ownership in tangible assets (mostly based on Sale and

Lease back or direct lease)
•Sukuk representing Usufructs or Services (based on sub lease or sale of
services)
•Sukuk representing equity share in a particular business or investment portfolio
(based on Musharakah/ Mudarabah)
•Sukuk representing receivable or future goods (based on Murabaha or
Salam ) Istisna’).

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 Islamic Banking and Finance

Typical Sukuk Structure for sale and leaseback…

Hamad Rasool

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Islamic Banking and Finance

Flow of Funds - Acquisition & Rentals

Hamad Rasool

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 Islamic Banking and Finance

Flow of Funds - Repayment & Maturity

Hamad Rasool

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Islamic Banking and Finance

Sukuk Al-Ijara based Model ( Example)

Hamad Rasool

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 Islamic Banking and Finance

Typical International Sukuk Mechanism – Step

by step…

Hamad Rasool

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Islamic Banking and Finance

Islamic insurance- Takaful

Joint guarantee, Islamic alternative to insurance, is based on the concept of social

solidarity, cooperation and mutual indemnification of losses of members. It is an accord
among a group of persons who agree to jointly indemnify the loss or damage that may be
caused, out of the fund they donate collectively.
Such a contract usually involves the concepts of Mudaraba, Tabarru (to donate for benefit
of others). It is based on the concept of mutual sharing of losses with the aim of
eliminating the element of uncertainty.
Takaful represents an important component in the overall Islamic financial system given
its role in the mobilization of long-term funds and providing risk protection.
Takaful is a way to reduce the financial risk of loss due to accident and misfortunes. In
takaful, the participant would pay particular amount of money as contribution (premium)
partly to risk fund (the participants’ special account) using the concept of tabbaru
(donation) and another party (takaful organization) with a mutual agreement that there
would be a legal responsibility to provide for the participants a financial protection against
unexpected loss, should it happen within the agreed period.

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 Islamic Banking and Finance

Recapitulations in Islamic Money and banking :

1 There is no need to be concerned with supply of money as long as factors of production exist. In other
words, supply of money is closely tied with availability of factors of production. This will necessarily
lead to full employment.
2 In the absence of interest, interest-based loans disappear and banks become "asset" producers.
3 The elimination of interest erodes money whirlpool, as well as any speculative demand for money. This
4- History testifies that rate of profit is much higher than long-term interest rates. In fact, so long as
speculation is permitted they never become equal. Therefore, depositors in Islamic banking system will
enjoy high rates of profit, however volatile. This will somehow bridge the gap among income strata.
5- Risk of depositing in an Islamic banking system is less than that of buying a share in stock market,
This is due to several factors:
(a) deposits and returns to numerous financed projects are being pooled .Further more, risks of these
projects are not of the same kind neither of the same magnitude. It follows that pooled risk is
logically expected to be less than that of one individual share.
(b) Two kinds of deposits can be suggested to depositors; one with variable return and the other with
fixed return. Both of these, of course, shall be compensated for by the pooled returns of the
financed projects.

7- Inflation does not have an adverse effect on the balance sheet of an Islamic bank. This derives from
the nature of profit and loss sharing in which the real values of assets and liabilities would move in the
same direction in the event of economic shocks. Whereas, in case of conventional banking, the
purchasing power of loans decline during inflationary periods. Hence, the Islamic banking protects
depositors against any decline in the real value of their (monetary) assets..
Iraj Toutounchian, Ph.D.

Banking and Finance

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Islamic Banking and Finance

Subjects in Questions

1. Time Value of Money

Islamic principles differ from the capitalist theory as money and commodity have different
characteristics, for instance money has no intrinsic value but is only a measure of value
or a medium of exchange, it is not capable of fulfilling human needs by itself, unless
converted into a commodity.

2. Trading in stocks :

As long as the company’s business and financial position are acceptable, there is no reason
to believe that trading in the company’s shares is not permissible.

3. legal status of loans in Islamic law :

Loans are a charitable contract

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Islamic Banking and Finance

Islamic Windows in the conventional banks :

• Commerz bank
• Deutsche Bank
• HSBC Bank
• Standard Chartered

Deutsche Bank … An Example:

ADCB

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Islamic Banking and Finance

Thank you for attention

For Questions , please contact me at :

alkheil@uni-hohenheim.de

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