OVERVIEW OF THE

ISLAMIC FINANCIAL Dr. Irum Saba

SYSTEM
 The Structure of the Islamic Financial
System
FLOW OF
FUNDS FINANCE
DIREC
TEXT HERE FINANCIAL
T MARKETS

FUNDS
LENDERS BORROWERS
SAVERS SPENDERS

RETURN TEXT HERE

S
INDIRECT FINANCIAL
FINANCE
INTERMEDIARIES

Source: Islamic Financial System: Principles and Operations

 The Structure of the Islamic Financial System
Surplus Fund
Islamic Equity Market Units (DFUs)

In line with
Islamic Banks Mudarabah Companies Shariah rules,
Islamic principles and
Financial framework
Institutions
Deficit Fund
Islamic Insurance Sukuk Market Units (DFUs)
(Takaful) Companies
Islamic Mutual Funds
 TRANSACTION COSTS

Financial
Legal Accounting Administrativ
Structurin
Documentation Treatment e Follow up
g

Investors want to reduce

Channeling of funds transaction costs without
has high transaction sacrificing financial
costs quality.

Financial intermediaries have economies of scale so they can

facilitate the flows of funds from surplus fund units (SFUs) to
deficit fund units (DFUs) at reduced transaction costs.
 WHAT DO ECONOMIES OF SCALE
ALLOW
Constitutional
IFIs to ACHIEVE?
Reduce
weakness of
investment risk
financial
markets
Asset
Transform short Transformation
Risk
term liabilities
Transformation
into long term
assets

Balance sheet Diversification

risk
 ECONOMIC INFORMATION
TRUST REQUIRES MARKET INFORMATION
ABOUT DFUs

Past Track Records

Economic information is the
lifeblood of the financial system
SFUs need to trust DFUs for
flow of funds to be possible
Current Financial
Information efficiency allows Position
easy and speedy flow of funds
Future Investment
Prospects
ISLAMIC FINANCIAL MARKETS

Equity Bonds
(Similar to (Non Islamic due
Mudarabah) to interest)

Security
Financier Financee
(Security (Security
Holder) Issuer)
Price
(Mone
y)
 GHARAR: SALE OF BIRDS IN
THE SKY
Excessive uncertainty: impossible to
eliminate all but excessive is not allowed
Violates Shariah condition of full
knowledge at time of contract
Prohibition ensures welfare
generates from a trade
SOURCES OF
GHARAR
Uncertainty in the financial
structure of security: value
derived from uncertainty e.g.
derivatives
Lack of key information about
the contract e.g. not deciding
PSR
Lack of external market
information
 TO ELIMINATE GHARAR

Probe into financial

Information Sound information Helps dealers
information about
sifting is systems are and regulators
structure and
necessary important
market
 ROLE OF FINANCIAL
INSTITUTIONS
Financial intermediation
01
Information collection and processing
• Increases efficiency

02 • Maximizes return on investments

• Reduces transaction costs through economies of scale

Asset transformation
03
Risk transformation
04
Deregulation, liberalization, complexity and volatility of financial markets resulted in
search by FIs for new products that would facilitate the mitigation, transfer and risk
DISTINCT FEATURES OF IFIs
01 Financial Intermediation

02 Risks

03 Return

Shariah Governance
04 Framework
FINANCIAL INTERMEDIATION

Conventional Islamic

Bank Goods & Client

Services

money

IFIs use equity as well as debt based financial

instruments for mobilization and use of funds.
RISKS
 RETURN
CONVENTIONAL ISLAMIC
BANKS BANKS

In Conventional banks deposits IFIs deposits are based on

principal and return is guaranteed Musharakah and Mudarabah. Profit
on deposits is not guaranteed.
 ISLAMIC FINANCIAL
INSTRUMENTS
Financial Instrument: contract with terms, conditions, risk and return

Based on interest,
Conventional No Riba, Gharar
Instruments Islamic and Maysir and only
earn through Instruments
interest rate Shariah permissible
spread products

Islamic financial instruments may look like mirror image of

conventional ones, their underlying features, contractual
relationships, mechanisms and implications are not identical.
 ISLAMIC FINANCIAL
INSTRUMENTS
Istisna Murabaha

Mudarabah Salam
Mobilizatio Investmen
n of funds t of funds
Wakalah Musharakah

Wadiah Ju'ala Ijarah

h
 DEVELOPING ISLAMIC
FINANCIAL INSTRUMENTS
Existing conventional
instruments that are
generally acceptable
from the Shariah point Adaptive Approach
of view are modified
and further enhanced
by removing any
prohibited elements to
make it valid
Innovative Search for new and
Approach innovative instruments
USES OF ISLAMIC FINANCIAL
INSTRUMENTS USED FOR

 Trade financing
 Liquidity
Mudarabah Management
 Project Financing
Wadiah
 Working Capital
Musharakah
Financing
Wakalah Istisna Murabaha

Ijarah
Salam Diminishing
Musharakah
 THANK YOU
ANY QUESTIONS?