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Islamic Banking and
FinanceA Rising Phenomenon
Outline
OverviewEvolutionDefinitionPrinciples
Modes
Today...
Islamic Banking is growing rapidly in the
world by 15-20% annually.
Estimated $270 billion in assets is controlled by Islamic banks of the world (Total asset base of all Islamic banks estimated at $950billion)
Future projection suggests that Islamic banks will hold 40% to 50% of the savings of the world’s 1.67 billion Muslims in 8 to 10 years, according to the International Islamic Finance Forum.
Middle EastIndia
Indonesia
Malaysia
United KingdomNetherlands
United StatesFrance
Germany
More than 500 Islamic banks and investment firms exist globally according to the Bahrain based General Council for Islamic Banks and Financial Institutions.
Islamic Finance and Banking is now worth around US Dollar 1 trillion and is destined to grow more than the rate of conventional
investing, according to analysts at
Deloitte & Touche.
4X
Malaysian based Islamic Financial Services and Saudi Arabian Islamic Development Bank are projecting the
market to grow to
US Dollar 1.6 trillion by 2012.
Why Islamic Finance
Islamic financeindustry continues to escape
thefull force of current economic turmoil.
What is clear is that the rapid growth in
this area of finance and its ethical
foundations make Islamic finance
an increasingly serious alternative
to conventional finance.
The concepts of Islamic Finance have been
around since the origination of Islam itself.
Evolution of Institutional Framework
So what is
Islamic Finance
It is a financial system that is consistent with the principles of Shariah, the sacred law of Islam.
Qur’an Hadith and Sunnah
The Big Question...
How is Islamic Finance different from
Conventional Finance
1stInterest
In traditional finance...
Interest is earned for lending money, and is paid for borrowing money.
In Islamic finance...
Earning Interest is prohibited!
Why? Shariah prohibits usury or lending money at an exorbitant rate of interest (Riba).
RATIONALE FOR THE PROHIBITION:The Qur’an contends that an element of injustice is found intrinsically in interest. It says to give up whatever remains of Riba such that ‘Neither you wrong, nor be wronged.’ (Lit. Al Dhulm)
Some injustices of Riba:-Indirectly encouraging systematic competition amongst participants-Concentrating wealth with the rich at the expense of the poor-Fueling an endless unsustainable disproportionate economic growth
In Islamic finance...
Earning Interest is prohibited!
Why? Shariah prohibits usury or lending money at an exorbitant rate of interest (Riba).
RATIONALE FOR THE PROHIBITION:
Money has no intrinsic value – it is only a measure of value, and since money has no value itself, there should be no charge for its use. Therefore, Islamic Finance is said to be asset based as opposed to currency based.
Other prohibitions:
Masir, which is involvement in speculative and gambling transactionsXGharar, which is uncertainty about the terms of contract or the subject-matter, e.g. prohibits selling something which one does not own
XInvestment in businesses dealing in alcohol, drugs, gambling, armaments, etc. which are considered unlawful or undesirableX
The Big Question Again...
How do they earn in Islamic Finance
2ndRelationship
In traditional finance...
Lends money.Managesdelinquencies.
Receives interest and principal
Lender-BorrowerRelationship
In Islamic finance...
Partners
Provider-User Relationship
3rdProfit and Risk Sharing
In traditional finance...
Lender is guaranteed by the borrower regardless of the project/investment’s outcome.
In Islamic finance...
Risk in any transaction must be shared between at least two parties so that the provider of capital and the user (entrepreneur) share the business risk in return for a share in profit
Islamic
In summary...
Functions and operations are based on Shariah principles
Promote risk-sharing between provider of capital (investor) and user of funds (entrepreneurs)
Conventional Functions and
operations are based on fully man-made principles
Investor is assured of pre-determined rate of interest
Islamic
In summary...
Partners, investor and traders, buyer or seller relationship
Encourage asset-based financing and based on commodity trading
Conventional
Lender-Borrower relationship
Based on money trading. Money is a medium of exchange and not a commodity, its sale and purchase is prohibited in Islam
Islamic
In summary...
Aim at maximizing profit but subject to Shariah restrictions
No right of profit if there is no risk involved. There is profit and loss sharing, provider may lose money in case of loss
Conventional Aim at maximizing
profit without any restrictions
It is almost risk free banking and lender has no risk of losing its money because interest is guaranteed
Product TreeIslamic Modes of
Finance
Partnership Based Modes
Trade Based Modes
Rental Based Modes
Musharaka (Equity
Participation)
Mudaraba (Partnership Financing)
Murabaha (Cost-plus
sale)
Ijarah(Leasing)
Musharaka (Equity Participation)
Partnership Based Modes
The parties involved contribute in varying degrees of assets, technical expertise, etc., and agree to a percentage of the returns as well as the risk.
Mudaraba (Partnership Financing)is very similar to Musharaka and is a trustee type finance contract under which one party provides the labour while the other provides the capital.
Murabaha (Cost-plus sale)
Trade Based Modes
is essentially undertaking a trade with a markup and is used for short-term financing, similar in form to purchase finance.
An example would be a bank purchasing a tangible asset of some sort from a supplier with the resale based on the cost plus an agreed markup. This is most often used to finance property, since the bank would not be allowed to charge interest on any loan. Once such a debt covenant is in place between a bank and the customer, repayments can begin until a completion point where the asset is transferred to the customer. There is no interest rate risk which is essentially covered within the markup percentage, identified at the outset.
Ijarah (Leasing)
Rental Based Modes
is a leasing contract whereby one party leases an asset for a specific amount of time and cost from another party, usually a bank. The bank would bear all the risk and a portion of the installment payment goes towards the final purchase of the asset at the time of transfer of asset. This can also be set up as a lease-purchase contract for the term of the asset’s specified lifetime.
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