FIN 411:

Islamic Financial Institutions

Dr. Mohammad Selim

 Introduction to Islamic Banking

• Islamic banking and finance is known as Shari’ah-

compliant.
• It is presumed to be based on Shari’ah.
• Shari’ah is often equated with Islamic Law. However, this
can be misleading.
• Shari’ah is broader than Islamic Law. Islamic law is
better understood as fiqh.
Sharia is same as Fiqh
 Introduction to Islamic Banking

• Islamic banking and finance (IBF) offers similar functions and

services as conventional banks, subject to primarily two basic
principles:

• 1. Key prohibitions
– Riba (commonly equated with interest)
– Gharar (commonly mentioned as uncertainty)
– Maisir/Qimar (commonly known as gambling or speculation)
– All Haram products like wine, pork…
– Question 1: What are the key prohibitions? Explain.

• 2. Profit-loss (and thus risk) sharing and other methods

(exchange and service based).
 Introduction to Islamic Banking

• Definition of Islamic Banking

• An Islamic bank is a financial institution that operates with the objective to
implement the economic and financial principles of Islam in the banking
arena. Question 2: Define Islamic Finance

• According to OIC:
An Islamic bank is a financial institution whose statutes, rules and procedures
expressly state its commitment to the principle of Syariah and to the banning of the
receipt and payment of interest on any of its operations…(Ali and Sarkar 1995)

• According to the Islamic Banking Act 1983, Malaysia:

an Islamic bank is … a company which carries on Islamic banking business. Islamic
banking business means banking business whose aims and operations do not
involve any element which is not approved by the religion of Islam…. (Islamic
Banking Act 1983)
 Introduction to Islamic Banking

• In essence, Islamic banking operations are:

–based on Islamic principles for financial transactions, that is, risk-

sharing and prohibition of products

–services having prohibition of riba and profit- and loss-sharing as

major features and other halal (permissible) products and services

–for ensuring justice and equity in the economy.

 Introduction to Islamic Banking

• Islamic finance objectives

 Question 3: What are the 6 objectives of Islamic
Finance?
 Offer financial services
 Facilitate stability in money value
 Economic development
 Optimum resource allocation
 Equitable distribution of resources
 Optimizing approach
 Introduction to Islamic Banking

• Islamic finance principles

 Introduction to Islamic Banking

• Islamic finance principles

 Prohibition of Riba
 Equity participation
 Money vs. ‘Potential Capital’
 Prohibition of Gharar
 Sanctity of Contracts
 Shari’ah-compliant activities
 Introduction to Islamic Banking

• Islamic economics
• Question 4: What are the goals and objectives of Islamic
Economics?
 Socio-economic Justice and Equitable Distribution
 Prohibition of Trading of Forbidden Objects
 Trusteeship
 Prohibition of hoarding
 Spirit of cooperation
 Duality of risk: Risk sharing and sharing of benefits by all parties involved.
 No gain without either effort or liability
 Introduction to Islamic Banking

• Advantages of Islamic finance

• Question 5: What are the advantages of Islamic Finance?
 Justice and fairness
 Liquidity
 Better customer relations
 No fixed obligations
 Transparency
 Ethical and moral dimensions
 Avoidance of destabilizing speculation
 Banking for all

• There is a significant gap between ideals and the reality.

 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 Medieval period (not much change)
 Modern day experiments
 Launching of IBF industry
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 The Era of the Prophet

 The Period of Orthodox Caliphate (632 – 661 C.E.)
 Period of the Noble Companions and the Succeeding Generations
 The Umayyad and Abbasid Eras
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 The Era of the Prophet

 Question 6: Explain the five mode of financing which were practiced during the golden period of Prophet
SASs
• Trade was widespread in Arabia during that period and many
instruments/contracts used today were also in practice during the Prophetic era:
• Shirkah (partnership) based on profit-and-loss sharing (PLS)
• Qard hasan (benevolent loan)
• Salam (Forward) contract
• Sarf (exchange of money), i.e. gold for gold and silver for silver at the same
sitting
• Ijarah (leasing)
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 The Period of the Khulafa-i-Rashideen (632 – 661 C.E.)

• Questions 7: What are the major contributions of the 4 Caliphs? Explain.
• Abu Bakr Siddiq (632 – 634)
Zakat related conflict. Consolidation of the state.
• Umar ibn Al-Khattab (634 – 644)
Major reforms in public finance administration and policies
The introduction of a centralized and permanent treasury (Bait al-mal)
• Uthman ibn Affan (644 – 656)
The introduction of the first Muslim coins
• Ali ibn Abi Talib (656 – 661)
Consolidation of the past achievements and broader expansion
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 Period of the Noble Companions and the Succeeding Generations

marked by:

• Building on the reforms introduced by the Prophet (PBUH)

• Tremendous increase in commercial interaction between merchants in the Islamic

state and elsewhere

• Further development of fiqh (Islamic jurisprudence)

• Advanced economic reforms based on self-exerted judgment (ijtihad)

 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Early days transactions

 The Umayyad and Abbasid Eras

• Issuance of the first Islamic dirham (containing the crescent, the star, and
bismillah)

• Shifting of the Treasury House to Damascus, capital of the Umayyad, where a

bigger building was designated as Bait al-Mal

• The Treasury House still significant during the Abbasid period and Mamluk era

• The dinar and dirham still used as mediums of exchange

 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Modern-Day Experiments of Islamic Finance marked by:

 The Ottoman Empire’s fall resulting in fragmentation of Muslim nation into

different countries

 Prevalence of interest-based banking and finance system

 Lack of awareness among Muslim communities across nations on whether

to return to Islamic roots

 Experiments in Islamic finance in Egypt, Malaysia, and Pakistan: the basis of

modern Islamic banking and finance
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Modern-Day Experiments of Islamic Finance:

 Experiments during 1960s

• Question 8: What are the experiments of Islamic Finance in 1960s?
• Initial Reforms in the Banking Industry in Pakistan in 1962
• Mit Ghamr Local Savings Bank in Egypt of 1963 (“the first modern-
day trial of Islamic banking”)
• The Malaysian Pilgrims Savings Board, Tabung Haji of 1969
(managing savings of prospective pilgrims by investing in Sharī’ah-
compliant investments)
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Modern-Day Experiments of Islamic Finance:

 Two pivotal developments in 1975

• Question 9: What are the major development in the field of Islamic
Finance in 1975?
• Ans:
• Founding of Islamic Development Bank (IDB)
• Launching of Dubai Islamic Bank (DIB)
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Modern-Day Experiments of Islamic Finance:

 Islamic Development Bank (IDB) and its functions

Question 10: What are the functions of IDB? Explain.
• To participate in equity capital and to grant loans
• To provide financial assistance to member countries
• To establish and operate special funds for specific purposes
• To accept deposits and to mobilize financial resources through Sharī’ah
compatible modes
• To promote foreign trade, especially in capital goods, among member
countries
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Modern-Day Experiments of Islamic Finance:

 Launching of Dubai Islamic Bank (DIB)

The first fully-fledged Islamic world commercial bank in 1975. Operates five main
business groups:
• Question 11: What are the 5 areas Islamic Banks will specialize and why?
– Retail banking
– Corporate banking
– Real estate
– Investment banking
– Proprietary trading investments
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 The Development of Islamic Banking and Finance

Industry
• Question 12: What are the chronology or main high lights of events in the
history of Islamic Finance?
• Emergence of the modern Islamic banking and finance industry in the 1960s
• Gradual expansion of the Asian markets between the 1980s and ‘90s
• Introduction of Islamic insurance (takaful)
• Introduction of project financing with the support of the IDB
• Introduction of sukuk (Islamic bonds) and equities markets in the 1990s
• Internationalization of Islamic banking and finance from the early 2000s
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance Industry

 Question 13:What are the 4 major components of IBF?

The four major components of the Islamic banking and finance

industry are:

• Islamic banking
• Islamic capital markets
• Takaful
• Islamic non-bank financial institutions

These form the Islamic financial architecture and infrastructure

 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance Industry

• Islamic banking

The Islamic banking component:

– Deposit-taking and finance of institutions to meet needs of Muslim
customers and investors

– May be:
- Fully fledged Islamic banks
- Islamic subsidiaries or
- ‘Windows’ of conventional banks
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance

Industry
• Islamic Capital Market, where investment activities do not contradict the
principles of the Shari’ah: free of riba, gharar and maysir

– The market players include:

- Brokerage houses
- Investment banks
- Fund management institutions
- Islamic asset management institutions
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance Industry

 Takaful (Islamic Insurance)

• Takaful based on mutual cooperation, common welfare and general good of

society
• Development of modern takaful began with debates about legality of
conventional insurance schemes
• Controversy resolved by the Islamic Fiqh Academy in Resolution No. 9 of 1985
• Takaful and retakaful significant in managing and mitigating risks in Islamic
banking and finance
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance Industry

 Islamic non-banking financial institutions

• Islamic financial institutions that play a facilitative role in Islamic society

ensuring economic development through non-bank financing

• They support liquidity needs of major agents in the economy

• They include: finance companies, Islamic housing cooperatives, Islamic

microfinance institutions, waqf management institutions, private
equity /venture capital firms, hajj and zakat management bodies
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Components of Islamic Banking and Finance Industry:
Support organizations
• Various international bodies established to study, promote, develop and set standards
for Islamic finance products include:
• Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).
(Bahrain based: Focused on development of Shari’ah and Accounting Standards)
• Islamic Financial Services Board (IFSB) (Malyasia based: Focused on Regulatory
standards)
• International Islamic Financial Market (IIFM) (Bahrain based: Focused on
standardization of documentation)
• International Islamic Rating Agency (IIRA) (Bahrain based: Focused on rating of
Islamic financial institutions)
• International Islamic Fiqh Academy (IIFA) (Jeddah based; General Fatwa issuing
body)
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Growth of Islamic Finance Industry
• Islamic banking and finance being integrated into the global
economy

• The practice of Islamic banking and finance has now been accepted
as an alternative to conventional financial systems

• Acceptance attracts new non-Muslim experts, professionals and

financial institutions
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Growth of Islamic Finance Industry

• The industry has more than tripled in size since 2006

• By end of 2018, total estimate of Shari’ah-compliant assets was US

$2.5 trillion

• Rapid growth experienced in the Gulf Cooperation Council (GCC)

countries over the last decade

• Growth and expansion of Islamic finance industry continued at the time

of global financial crisis
 Introduction to Islamic Banking

• Origins and Historical Overview of IBF

 Multinational Islamic Banks
The main multinational Islamic banks are:

• Islamic Development Bank (IDB) - 1975

• Jordan Islamic Bank – 1978/1979
• Faisal Islamic Banks in Egypt and in Sudan – 1977/1978
• Kuwait Finance House - 1977
• Al Rajhi Bank – 1987
• Al-Baraka Banks - 1992