islamic banking in theory and practice

7/31/2019 Islamic Banking in Theory and Practice

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Islamic banking

Islamic banking is banking or banking activity

that is consistent with the principles of Islamic

law (Sharia) and its practical application through

the development of Islamic economic.


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Objective of Islamic Banking

Objective of Islamic Banking is to make positivecontribution to the fulfillment of socio-economic

objectives of the society


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Islamic Bank

Islamic Bank is a financial and social

institution which identifies itself with theprinciples of Shariah, as laid down by Holy

Quran and Sunnah, as regards its

objective, principles, practices andoperations.


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Principles of Islamic Banking

Transactions must be free of interest (riba)

Risk sharing

Goods and services that are illegal (haram) from theIslamic point of view cannot be produced or

consumed.

Activities or transactions involving speculation

(gharar) must be avoided.

Zakat (the compulsory Islamic tax) must be paid.


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Islamization Of Banking In Pakistan

in 1948, Mr. Muhammad Ali Jinnah emphasized the virtues of Islamic

principles and in his address at the inauguration of the State Bank of

Pakistan (SBP), said:

I shall watch with keenness the work of your Organization in

evolving banking practices compatible with Islamic ideas of

social and economic life. We must work our destiny in our own

way and present to the world an economic system based on

true Islamic concept of equality of manhood and socialjustice.


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Islamization Of Banking In Pakistan

In 1977-1978, the process of Islamization of banking

system was started. In October, 1977 the council of

Islamic Ideology was charged with responsibility ofbringing about Islamic economic and banking system.

The Islamic Ideological Council presented its report

in 1980, later there was a criticism on the report too.


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Implementation Of Islamic Banking In

Pakistan Stage-1

Interest was first eliminated from July, 1979 from the

transactions of NIT. Stage-2

From first January, 1981, profit and loss sharing saving

and term deposits was introduced by commercial

banks in place of simple saving and fixed deposit

scheme.


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Stage-3:

In August, 1981, HBFC was allowed to provide finance on rentsharing basis for house building. Students were allowed Qarz-

e-Hasana without interest.

Stage-4:

In 1983, hire purchase system of financing was introduced.

Stage-5:

From July 1, 1984 to December 31,1984 all banks in the

country were to make finance available also on the basis of

Islamic modes of financing in addition to existing interest

based system.


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Stage-6:

From January 1985, all types of finances provided by the bank tothe government and their agencies were permissible on Islamic

basis only.

Stage-7:From April 1985, all types of finances provided by the bank to all

clients were to be on Islamic basis only.

Stage-8:

From July 1985, all deposits were to be on the basis of

participation in profit and loss of banks except current account.


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The Commission for Transformation ofFinancial System (CTFS) was constituted in

January 2000, in SBP to transform the financial

system.

Later in FY02 finance minister declared some

regulations for the elimination of Riba/Interestfrom the financial system of Pakistan.


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SBPs contribution towards Islamic

Banking


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The profit or loss shall be distributed inproportion to the value of shares of each partnerin banking business.

The bank should confine itself to providing capitalto entrepreneurs on Shirakah or Modarba basis.

To enhance its income the bank can provide

various services to the general public orgovernment.


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All decisions regarding the bank shall be taken in consultationwith all its shareholders or representative committee.

The financial liability of the banks shareholders shall be

unlimited.

Every shareholder shall be free to terminate his Shirakah.

At the death of a partner, his Shirakah will come to an end.


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Difference between conventional& Islamic banking


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CONVENTIONAL BANKING

1. Money is a commodity besidesmedium of exchange and store

of value. Therefore, it can be

sold at a price higher than its

face value and it can also berented out.

2. Time value is the basis forcharging interest on capital.

ISLAMIC BANKING

1. Money is not a commoditythough it is used as a medium

of exchange and store of

value. Therefore, it cannot be

sold at a price higher than itsface value or rented out.

2. Profit on trade of goods orcharging on providing service

is the basis for earning profit.


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3. Interest is charged even in casethe organization suffers lossesby using banks funds.Therefore, it is not based onprofit and loss sharing.

4. While disbursing cash finance,running finance or workingcapital finance, no agreementfor exchange of goods &services is made.

3. Islamic bank operates on thebasis of profit and loss sharing.In case, the businessman hassuffered losses, the bank willshare these losses based onthe mode of finance used(Mudarabah, Musharakah).

4. The execution of agreementsfor the exchange of goods &services is a must, while

disbursing funds underMurabaha, Salam & Istisnacontracts.


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5. Conventional banks use

money as a commodity

which leads to inflation.

5. Islamic banking tends to

create link with the real

sectors of the economic

system by using trade

related activities.


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Bank Clientmoney

money + money (interest)

Conventional


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Bank Client

Islamic

money

Goods &

Services


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Business of Islamic Bank


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1. Customers Deposits

a) Current Accounts

(b) Savings Accounts(c) General Investment

(d) Special Investment Accounts

2. Financing

(a) Al-Mudharabah;

(b) Al-Musharakah;

(c) Al-Bai bi Thaman Ajil;

(d) Al-Ijara;

(e) Al-Bai al Takjiri;

(f) Al-Qardul Hasan

C stomers Deposits


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Customers Deposits

Current Accounts

The Bank accepts deposits from its customers looking for the safecustody of their funds and absolute convenience in their use in theform of current accounts on the Islamic principle of Al-Wadiah.

Savings AccountsThe Bank accepts deposits from the customers looking for safe custodyof their funds and a degree of convenience in their use together withthe possibility of some profits in the form of savings account on theIslamic principle of Al- Wadiah. The Bank provides its customers withSavings Pass Books and other usual services connected with SavingsAccounts.


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General investment AccountsThe Bank accepts deposits from its customers looking for investmentopportunities for their funds in the form of general investment accounts on

the Islamic principle of Al-Mudarabah. The deposits will have to be for a

specified period. The Bank acts in this case as the entrepreneur and the

customers as the provider of capital.

Special Investment Accounts

Bank may also selectively accept deposits from its Government or Corporate

customers in the form of Special Investment Accounts. These accounts are

also operated on the principle of Al-Mudarabah.


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Financing

financing under the principle of al-Mudharabah

The Bank may undertake to finance acceptable projects under the

principle of al-Mudharabah. In this case, the Bank is the providerof the capital and will provide 100% financing for the relevant

project. The initiator of the project is the entrepreneur who will

manage the project. The Bank cannot interfere in the management

of the project but has the right to undertake the follow-up andsupervision tasks.


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financing under the principle of al-musharakah

The Bank may undertake to finance acceptable projects under

the principle of al-musharakah. In this case the Bank togetherwith the initiator or initiators of the relevant project will provide

the whole financing for the project in agreed proportions. All

parties including the Bank have the right to participate in the

management of the project but all parties have the option to

surrender such right.


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Financing under the principles of al-bai

Bithamin ajil (deferred sale)

The Bank may finance its customers who wish to

acquire a given asset but to defer the payment for the

asset for a given period or to pay by installments under

the principle of al-bai Bithamin ajil.


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Financing under the principle of al-Ijara (leasing)

The Bank may finance its customers to acquire the right to use

the services of a given asset under the principle of al-Ijara. TheBank first purchases the asset required by the customers.

Subsequently the Bank leases the asset to the customer for a

fixed period subject to lease rentals and other terms and

conditions as agreed by both parties.


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Financing under the principle of al Bai ul Takjiri

The Bank may finance its customers who initially wish to

use the services of a given asset but subsequently to own

the asset under the principle of al-bai ul Takjiri. The

procedure is the same as in ijara or leasing, except that

both parties agree that at a point of time, the customers

will purchase from the Bank the asset-concerned at anagreed price with all the lease rentals previously paid

constituting part of such price.


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Qard al-hassan (Benevolence loan)

A unique product of the Islamic bank, is a zero-return loan (a

negative investment). All Islamic banks are urged or required tomake these benevolence loans to needy and poor people.

if u loan to ALLAH, a beautiful loan, He will double it

to your(Credit)(64:17)


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Other Services

Trade financing including letters of credit and letters of

guarantee.

Islamic Export Credit Refinancing Scheme.

Remittance and transfer of funds.

Sale and purchase of foreign currency.


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Financial assistance from the bank

the central bank,serving both as a lender of last resortas well as provider of refinance, can advance to theapplicant Islamic bank the liquidity requiredascertaining the magnitude of its urgent needs. such aliquidity support operation can be conducted on thebasis of MUDARABAH and MUSHARAKAH.


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Participation in the clearing house

Islamic bank should be allowed to participate in the claearing

house operations.Since participation in the clearing house requires that the

bank should have current account with the central bank, short

term overdraft facilities, free of interest, should be allowed

by the central bank to Islamic bank to cover shortfalls for any

short time period.


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Central banks control

permission to establish banks, to practice banking activities

and to open new branches. Specifying the terms governing the designation of board of

directors.

Commitment to submit required statements to monetary

authorities.


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Correspondence services

Each of them can open an operating account

with no interest.Each of the two banks will collect bills, drafts.

Cheques of other banks.


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Exchange of fundsIslamic banks can accept funds on the basis of MUDARABAH

from conventional bank in the form of an investment accountwith a return. Such return will be same as paid by Islamic bank totheir clients.

joint financing.

A large number of the conventional banks have openedinterest free windows that can be helpful in promotion offinancial cooperation between the interest free and interestbased institutions.


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Exchange of information:

clients dealing with Islamic banks may also be dealing with

commercial bank. There must be exchange of information about

such clients by banks.

Joint training program:

Islamic banks can participate with other banks in the training

programs.


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Current Status of Islamic Banking in Pakistan

While the number and operations of Islamic banks are fast expanding, thissegment of the market is still small relative to the appetite for Islamicfinance.

Pakistan is launching a gradual and steady approach to Islamic banking.

Despite rapid expansion in industry, the share of Islamic banking in thetotal banking system is a modest 3.2%.

It only caters for around 23,000 borrowers through around 170 branchesrelative to the country-wide 5 million borrowers (or 4.8 million excludingmicrofinance borrowers) tapped through 7,700 branches by conventionalbanks.


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Current Status of Islamic Banking in Pakistan

Financing and investment levels of Islamic banks barely range around Rs77

billion, which is below 3% of the total banking systems advances.

On the product side, Islamic banks so far offer about 75% of productscurrently available in conventional banking while clean lending for

consumer financing products, like personal loans and credit cards.

Islamic banks operate exclusively in large cities with some now venturing

into secondary cities but they are absent from rural areas where there isgreat potential for business growth.


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Islamic Banking In Global Scenario

Islamic Development Bank (IDB): First Islamic Bank established in 1975 in

Jeddah, by the persuasion finance ministers

of Islamic Countries with an authorized

capital of 6 billion Islamic Dinars.

56 member countries worldwide.

IDB and Pakistan: Pakistan has 127.26 million Islamic Dinars which

is 3.06% of the whole subscription.

IDB has helped Pakistan in its Nuclear Program.


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Islamic Banks and Financial Institutions

According to the General Council for Islamic Banks and Financial Institutions

there are currently 275 institutions worldwide that follow Islamic bankingand financing principles, collectively managing in excess of $200 billion.

These institutions are spread throughout 75 countries, including Europeand the United States.

Twenty institutions now offer a variety of Islamic financial services in theUnited States.

An increasing number of western financial institutions now offer Islamicinvestment products to Muslim investors.

Growing at the rate of 15percent per annum.

f


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Role of Islamic Banks in Economy

Islamic banks work as a trading concern and financial intermediary toperform interest-free activities.

Islamic banks perform activities in the right direction towards economicdevelopment.

Islamic banks perform a variety of fund-based and non-fund basedfunctions to facilitate their customers.

Islamic banks play a vital role in the economy to promote productive

activities that enhance economic growth and prosperity.

Islamic banks ensure stable economy;fair distribution of income; reduceinjustice; risk sharing,


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What do we need now

Revival of (House of Wealth), a

system which expresses the glorious days of

Muslim rule.

Financial institution for administration of taxes.

Royal treasury of Sultans and Caliphs.

Administered distribution of Zakah.

islamic banking in theory and practice

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