Faculty of Business Administration

Introduction to Islamic Banking and Finance

Hassan M. Ibrahim
 Course Objectives:-

The main objectives of the Islamic Banking and Finance

course are to:
 Explain the origins and the most important concepts of
Islamic Finance;
 Expose the participants to a wider range of Islamic
banking and finance instruments available to the industry
players
 Introduce countries where Islamic Finance is practiced
and widely used and share various business experiences;
 Provide general education in the field of Islamic Banking
and Finance;
 Help the development of the Islamic Finance
 Sessions, time and management issues:

Sessions: 1/week/ Sunday

Time: 4:00 - 7:30 A.m
Management Issues:
Attendance: mandatory as per the Faculty of
economics amended rules and regulations
Unjustified absence of 3 session recourse
Plagiarism and cheating whether voluntary or
involuntary should be avoided.
Communication: Set up WhatsApp group
 Continue…

From the historical point of view, Islamic banking

can be divided into three eras
 First era (Early era)
 The early year of Islam until the period of Caliph arRashidin
 Second era (Middle era)
 Stretches from the era of the caliphates until the fall of the
Uthmaniyah Empire.
 Third era (Modern era)
 The era of modern Islamic banking
 Importance of Trade in Islam
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).
 CLASSIFICATION OF
KNOWLEDGE

KNOWLEDGE

Human
Divine Knowledge
Knowledge (Acquired Knowledge )
(Revealed Knowledge)

Arts Sciences

Natural Social
Sciences Sciences
 WHY ISLMIC BANKING

Before explaining the concept “what

is Islamic Banking” the elaboration
of concept “why Islamic Banking”
is very important.
Islam is a complete code of life that
provides guidance regarding each
aspect of life.
 SOURCES AND APPLICATION OF
SHARIAH LAWS

SHARIAH LAWS
(Practices & Activities)

PRIMARY SOURCES SECONDARY SOURCES

Al-QURAN IJMA ULAMA QIAS

(The Holy Book)
Al-SUNNAH
(The Practice of
Prophet Muhammad
[Peace be Upon Him])
(The Consensus of (Analogical deduction
opinion of provided detailed
Islamic scholars) understanding derived from
Al-Quran and
Al-Sunnah)

9
 SHARIAH BASIS

 Three basic elements;

 Aqidah (Faith & Belief),
 Akhlaq (Moralities & Ethics) and
 Shariah (Practices & Activities).
 Shariah-
 Ibadat (Man-to-Allah worship) and
 Muamalat (Man-to-Man activities).
 A significant segment -conduct of a Muslim’s
economic activities within his economic system.
 Within this - the banking and financial system. This
is the root of Islamic banking and finance
 SHARIAH BASIS
11
• Shariah is an Islamic Law, governing the way of life for
human beings
• It consists of two areas; IBADAH and MUAMALAT.
IBADAH governs man to Allah relationship i.e. worship
to Allah (only confined to Muslims)
• MUAMALAT is a Shariah Law covering on man to man
activities, is confined to Muslim and open to be
practiced by non Muslim.
• Shariah Law governing man to man relationship covers
various aspects of life such as family , political,
criminal, economic activities including trade and
finance, etc.
 Shariah Basis
ISLAM

Aqidah Shariah
Syariah Akhlak
(Faith & Beliefs) (Practices & Activities) (Moralities & Ethics)

Ibadah Muamalat
(Man-to-Allah worship) (Man-to-man activities)

Political Activities Economic Activities Social Activities

Banking & Financial

Activities

12
 History of Islamic Banking

The establishment of Islamic bank is in 1960’s.

However, banking activities exist long before the
1960’s in the Islamic history.
 Before the era of Prophet Muhammad p.b.u.h, there
were trade activities conducted in Mecca.
These activities continued even after Islam became
rooted in Mecca and Medina
 Early Era

• Before Prophet Muhammad p.b.u.h received the divine

revelations; Mecca was a city of trade.
• Its business activities continued even after Islam
became rooted there. Example of the activities: Safe-
keeping
• There were activities that not against the Sharia rules
and there were also activities that against it.
With the arrival of Islam, the practice of Riba was no
longer permitted.
• Nevertheless, activities which is not against the
Shariah rules were allowed.
 Introduction to Islamic Banking

The term Islamic banking refers to a banking activity or a

system of banking that is in consonance with the basic
principles of Islamic Shraiah(rules and values set by
Islam). Islamic banking is also known as interest free
banking system as the Shariah disallows the acceptance
of “Riba” or interest rate for the accepting and lending of
money. In Islamic banking system, a business that offers
good interest rates or services is strictly prohibited and it
is in fact considered Haraam(forbidden). Islamic banking
offers the same facilities as conventional banking system
except that it strictly follows the rules of Shariah or Fiqh
al- Muamlat.
 The Origin, History and Evolution of Islamic
Banking

The origin of Islamic banking system can be traced back

to the advent of Islam when the Prophet himself carried
out trading operations for his wife. The “Mudarbah” or
Islamic partnerships has been widely appreciated by the
Muslim business community for centuries but the
concept of “Riba” or interest has gained very little
diligence in regular or day-to-day transactions.
 The Origin, History and Evolution of Islamic
Banking:

The first model of Islamic banking system came into

picture in 1963 in Egypt. Ahmad Al Najjar was the chief

founder of this bank and the key features are profit
sharing on the non interest based philosophy of the
Islamic Shariah. In 1974, the Organization of Islamic
Countries (OIC) had established the first Islamic bank
called the Islamic Development Bank or IDB. The basic
business model of this bank was to provide financial
assistance and support on profit sharing.
 By the end of 1970, several Islamic banking systems have
been established through out the Muslim world, including
the first private commercial bank in Dubai(1975), the
Bahrain Islamic bank(1979) and the Faisal Islamic bank of
Sudan (1977).
Riba
 Literally means ‘increase in’ or ‘addition to’ anything. It is
however not every increase or growth, which is prohibited by
Islam. In shariah, Riba technically refers to the premium that
must be paid without any consideration.
 Islam prohibits riba
 The forbidden Elements:
• Types Of Riba
 According to jurists of Islam Riba have two types.
 Riba Al-Naseah
 Riba Al-Fadl.
Gharar :
Element of uncertainty in a contract ;The Prophet was reported to
have forbidden all transactions involving gharar but did not
specifically state what these constitutes ;
Maisir
 The word ‘maisir’ literally means ‘getting something too easily’
or ‘getting a profit without working for it’ ;
 The Prophet forbade all forms of business in which the
monetary gain comes from mere chance or speculation and not
from work ;
 Principles of Islamic banking

WHAT IS RIBA?
 The word "Riba" means excess, increase or addition, which correctly
interpreted according to Shariah terminology, implies any excess compensation
without due consideration (consideration does not include time value of money).
 This definition of Riba is derived from the Quran and is unanimously accepted
by all the Islamic scholars. There are two types of Riba, identified to date by
these scholars namely 'Riba An-Nasiyah' and 'Riba Al Fadl'.
 'Riba An-Nasiyah' is defined as excess, which results from predetermined
interest which a lender receives over and above the principle (Ras ul Maal).

 'Riba Al Fadl' is defined as the excess compensation without any consideration

resulting from a sale of goods
 Principles of Islamic banking

Speculation
 Another feature condemned by Islamic is economic
transactions involving elements of speculation.
 Buying goods or shares at low and selling them for higher price
in the future is considered to be illicit. Similarly an immediate
sale in order to a void a loss in the future is condemned.
 The reason is that speculators generate their private gains at
the expense of society at large.
 Islamic Versus Western Economics
The Biblical statement that “money is the root of all
evil” might be closer to Islam then the western idea as
discussed by Shaw that “ Lack of money is the root of
all evil”
Mufti Shafee Usmani very eloquently explains: “
There is no doubt that Islam is opposed to
monasticism and considers economic activities to be
permissible, desirable, and even necessary and
required at times.
Economic progress is desirable for men, and the

earning of Halal livelihood is required after the

religious requirements. At the same time it is equally
self evident that the fundamental problem of man is
not economic , and economic progress is not a goal or
objective of life for humans “
 Now we come to our core question

“Islamic banking has been defined as banking in

consonance with the ethos and value system of Islam

and governed, in addition to the conventional good
governance and risk management rules, by the
principles laid down by Islamic Sharia’h”
 LEVELS OF SHARIAH LAWS
1 Wajib An obligatory duty where omission of this Prayer 5 times a day,
duty is punishable. Fasting, Zakat

2 Mandoob Duties and acts that are recommended but Giving donation,
(Sunna) not required. Performance of them is helping people.
required, but the omission is not
punishable.

3 Mubah Indifferent actions, whose performance or Eating, sleeping.

omission is neither rewarded nor punished.

4 Makruh An action disliked yet not punishable but Creating own/

the omission is rewarded. unnecessary rules to
make things difficult.

5 Haram An action which is absolutely forbidden and Gambling, Payment of

is punishable. interest.
25
 Clarification on Nomenclature

Islamic Banking is known by several names:

 Interest free banking (Iran)
 PLS Banking (Pakistan)
 Islamic Banking (Gulf)
 Special Finance Houses (Turkey)
All expressions are used interchangeably.
Is it a contradiction in terms?
DIFFERENCE BETWEEN ISLAMIC AND
CONVENTIOANL BANKING
Islamic Banking
1) The functions and operating modes of Islamic
banks are based on the principles of Islamic
Shariah.
Conventional Banking
1) The functions and operating modes of conventional
banks are based on fully manmade principles (largely
capitalism theory).
Islamic Banking
2) It Promotes risk-sharing between
provider of capital (investor) and the
user of funds (entrepreneurs).
Conventional Banking
2) The investor/lender is guaranteed
of a predetermined rate of interest or
returns.
ISLAMIC BANKS
3)It also aims at maximizing profit but subject to
Shariah restrictions.
 CONVENTIONAL BANKS
 3)Aim at maximizing profit without any restrictions
 ISLAMIC BANKS
 4)In the modern Islamic banking system, it has become one
of the service-oriented functions of the Islamic banks to be a
Zakat Collection Centre and they also pay out their Zakat.
 CONVENTIONAL BANKS
 4)It does not deal with Zakat.
ISLAMIC BANKS
5) Encourage asset-based financing and based
on commodity trading. Money is a medium of
exchange and not a commodity.

CONVENTIONAL BANKS
5) Based on money trading.
Islamic Banking
The status of Islamic bank in relation to its
clients is that of partners, investors and trader,
buyer and seller.
Conventional Banking
Relationship is often defined as that of
creditor-debtor.
ISLAMIC BANKS
Islamic bank can only guarantee deposits for deposit account,
which is based on the principle of al-wadiah, thus the
depositors are guaranteed repayment of their funds, however if
the account is based on the mudharabah concept, client have to
share in a loss position.
CONVENTIONAL BANKS
A conventional bank has to guarantee all its deposits.
 Chapter 1
Overview of Islamic banking and
finance
 INTRODUCTION

The philosophy of Islamic banking and finance

is a set of theories and ideas related to its
understanding.
In this regard, we must;
I. first start with the rules of Islamic Shariah from which the very
idea of Islamic banking has been drawn.
II. Second, monetary and macro theory is required to explain why
Islam considers dealing through the rate of interest as totally
unacceptable, and the economy-wide consequences of such
practice.
III. Third, banking theory itself would be necessary to figure out the
behavior of Islamic banking and finance as well as to
assess its comparative performance
 LEVELS OF SHARIAH LAWS
1 Wajib An obligatory duty where omission of this Prayer 5 times a day,
duty is punishable. Fasting, Zakat

2 Mandoob Duties and acts that are recommended but Giving donation,
(Sunna) not required. Performance of them is helping people.
required, but the omission is not
punishable.

3 Mubah Indifferent actions, whose performance or Eating, sleeping.

omission is neither rewarded nor punished.

4 Makruh An action disliked yet not punishable but Creating own/

the omission is rewarded. unnecessary rules to
make things difficult.

5 Haram An action which is absolutely forbidden and Gambling, Payment of

is punishable. interest.
49
 Clarification on Nomenclature contd.

Some people prefer Islamic Finance House instead

of Islamic bank. (Beit ul amweel)
It is argued that banking is purely Western
Phenomenon
Islamic banking and Islamic finance are also used
interchangeably.
 WHY ISLMIC BANKING IS VERY IMPORTANT

Before explaining the concept “what is Islamic Banking”

the elaboration of concept “why Islamic Banking” is very
important.
Islam is a complete code of life that provides guidance
regarding each aspect of life.
 The primary objectives of Islamic Economic System are as under.

 Equal Distribution of wealth

 Social justice

These objectives can never be achieved in Interest/Riba based

economic systems.
 What is an Islamic Bank?

There is no standard way of defining what an Islamic bank is,

but broadly speaking an "Islamic bank is an institution that
mobilises financial resources and invests them in an attempt
to achieve predetermined islamically -acceptable social and
financial objectives. Both mobilisation and investment of funds
should be conducted in accordance with the principles of
Islamic Shari'a".
 Prohibition of Interest or Usury
 Ethical Standards
 Moral and Social Values
 Liability and Business Risk
Islamic banking has been defined in number of ways.
 What is an Islamic Bank?

Definition of Islamic Banking I

 Islamic banking is a banking system that was developed based on the

sharia (law) of Islam.
 Establishment of business system is based on the Prohibition in the
Islamic religion to collect and borrow with interest or so-called "usury"
as well as investment restrictions for businesses, categorized
illegitimate in Islamic law (such as businesses associated with food
production / "drink unclean", the business un-Islamic media, etc.), where
this can be guaranteed by the conventional banking system
 What is an Islamic Bank?

Definition of Islamic Banking II,

Muhammad, in his book financial institutions of contemporary people
(2000: 62, 63) defines;
 That Islamic Banking is: "Financial institutions are businesses primarily providing
financing and other services, the traffic and circulation of cash payments adjusted
with the implementation of Islamic law".

Definition of Islamic Banking III,

 according to the Encyclopaedia of Islam, Islamic Banking is: "Financial institutions
that give credit and basic business services in the traffic of payment, as well as the
circulation of money that its implementation is adjusted with the Principles of
Islamic legal principles"
 What is an Islamic Bank?

Definition Islamic Banking IV,

 according to Antonio perwataat madja and Muhammad Shafi, the Islamic
Bank is a bank whose implementation by the principles of Islamic law,
especially on ways for doing business in Islam.
 One element that should be shunned in the "business of Islam" is a practice
which has elements of "" usury "."

 Also explained that Islamic Banking is the bank that the ways implementing
the provisions referring to the Qoran and Hadith, by the recommendation and
the ban, which shunned the practice is that it has elements of usury, while
those followed by the implementation of business conducted at the time of the
Prophet or form of business that has been there before, but not forbidden by
the Prophet
 What is an Islamic Bank?

From the explanation about Definition of Islamic

Banking, Islamic Banking has the following
characteristics:
 In Islamic banking, bank relationships with customers is a
contractual relationship (contract) between the investor
fund owner (Shohibul maal) with a investors fund
manager (mudharib) that work together to be productive
and the profits divided equally (Investment mutual
relationship). Thus, it can avoid the exploitative
relationship between the bank and the client or vice versa
between customers and banks.
 Continues………

The primary objective of establishment Islamic

Banking is to spread economic prosperity within the
framework of Islam by promoting and fostering
Islamic principles in the business sector.
The key objective are as below:
I. Offer financial Service
II. Facilitate Stability in Money value
III. Economic Development
IV. Optimum Resources Allocation
V. Equitable Distribution of resources
VI. Optimist Approach.
 Thank You

Any Questions
 THANK YOU
FOR YOUR KIND ATTENTION
THAT’S ALL
FOR TODAY
P R E S E N T E D B Y:
HASSAN MUSE IBRAHIM
UNIVERSITY OF HARGEISA

Hassan Muse @ University of Hargeisa