Introduction to islamic banking & finance june 2010 1

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Introduction to Islamic Introduction to Islamic Banking ProductsBanking Products

PRESENTED BYPRESENTED BY

Ali RehmanAli RehmanVice PresidentVice President

Askari Bank Ltd. Islamic Banking ServicesAskari Bank Ltd. Islamic Banking Services

Disclaimer: Views expressed here in a personal capacity.Disclaimer: Views expressed here in a personal capacity.

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ISLAMIC BANKING PRODUCTS & THEIR

OPERATIONAL MECHANISIM

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Islamic Banking

• All transactions are asset-based

• It is socially-responsible banking because it operates under Shariah restrictions

• Does not permit financing of prohibited goods / Industries

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Main Financial Contracts/ Islamic Modes

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Islamic ModeIslamic Mode DescriptionDescription Basis of Shariah Basis of Shariah PermissibilityPermissibility

MurabahaMurabaha Cost + Profit SaleCost + Profit Sale Quran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

Istisnaá Istisnaá Sale on OrderSale on Order Sunnah & Ijma’ConsesSunnah & Ijma’Conses

SalamSalam Commodity SaleCommodity Sale Quran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

IjarahIjarah LeasingLeasing Quran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

MusharakahMusharakah Joint VentureJoint Venture

Profit SharingProfit SharingQuran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

MudarabahMudarabah Trustee Profit Trustee Profit SharingSharing

Quran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

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MURABAHAMURABAHA

Islamic Islamic ModeMode

DescriptionDescription Basis of Shariah Basis of Shariah PermissibilityPermissibility

MurabahaMurabaha Cost + Profit Cost + Profit SaleSale

Quran, Sunnah & Quran, Sunnah & Ijma’ConsensusIjma’Consensus

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MURABAHAMURABAHA

►Murabaha is a particular kind of sale where the seller discloses its cost and profit charged thereon.

►The price in this sale can be both on spot and deferred.

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MURABAHAMURABAHA

►The product of Murabaha that is being used in Islamic banking as a mode of finance is something different from the Murabaha used in normal trade .

►This transaction is concluded with a prior promise to buy, submitted by a person interested in acquiring goods through the institution.

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MURABAHAMURABAHA

►It is called Murabaha to the purchase orderer .

► It is a bunch of contracts completed in steps and ultimately suffices the financial needs of the client.

►The sequence of their execution is extremely important to make the transaction Shariah compliant.

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MURABAHAMURABAHA

►As it is a kind of sale, there must be a seller and buyer and some thing that is bought and sold . The institution is the seller and the client is buyer.

►It cannot be used as a substitute for running finance facility , which provides cash for fulfilling various needs of the client.

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MURABAHAMURABAHA

Step by Step Murabaha

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MURABAHAMURABAHA

1- Promise stage►Stage One (a) for Murabaha

financing 1.Client approach the bank for facility

through Murabaha.

Facility Approved

Bank Client

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MURABAHAMURABAHA► Stage One (b) for Murabaha financing

Client and bank sign an agreement to enter into Murabaha.

Murabaha Facility Agreement

MOU

Bank Client

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MURABAHAMURABAHA

Promise stage►Stage One (c) for Murabaha

financing• Client submit the purchase

requisition to the bank.

Purchase requisition/ Promise to the bank.

Bank Client

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MURABAHAMURABAHA

Agency stage► Client appointed as agent to purchase goods on bank’s behalf

Agreement to Murabaha

Agency Agreement

Bank Client

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MURABAHAMURABAHA

Agency stage Stage Two for Murabaha financing

► Bank gives money to supplier through client’s account for purchase of goods.

Agreement to Murabaha Agreement of Purchase

Disbursement to the Supplier

Bank SupplierClient

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ISTISNAISTISNA

Islamic Islamic ModeMode

DescriptioDescriptionn

Basis of Basis of Shariah Shariah PermissibilityPermissibility

Istisnaá Istisnaá Sale on Sale on Order Order

(Manufacturing (Manufacturing Goods)Goods)

Sunnah & Sunnah & Ijma’ConsesIjma’Conses

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ISTISNAISTISNA► Istisna is the second exception where a sale is

allowed of goods before they come into existence

► It relates to goods that require manufacturing

► If the manufacturer undertakes to manufacture goods with material available with the manufacturer

► It is necessary for the Istisna transaction that price is fixed

► And necessary specifications of the product are defined

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ISTISNAISTISNA

►The Istisna contract creates a moral obligation on the manufacturer But both parties may unilaterally cancel the contract before work starts After work starts, cancellation requires mutual consent.

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SALAMSALAM

Islamic Islamic ModeMode

DescriptioDescriptionn

Basis of Basis of Shariah Shariah PermissibilityPermissibility

SalamSalam Commodity Commodity Sale Sale

(Agricultural (Agricultural Products in Products in Advance)Advance)

Quran, Sunnah Quran, Sunnah & & Ijma’ConsensusIjma’Consensus

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SALAMSALAM

►Salam was allowed by the Prophet (SAW) subject to certain conditions

The basic purpose was to meet the needs of small farmers

Who needed money to grow their crops And to feed their families till the time of harvest.

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SALAMSALAM

►Since, after the prohibition of Riba

They could not borrow money on interest

Hence they were allowed to sell their agricultural products in advance.

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SALAMSALAM

►Salam is where the seller undertakes to supply some specific goods to the buyer

At a future date Against an advance price, fully paid at

spot

Hence, the price / Payment is in AdvanceBut the supply is deferred

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IJARAHIJARAH

Islamic Islamic ModeMode

DescriptioDescriptionn

Basis of Basis of Shariah Shariah PermissibilityPermissibility

IjarahIjarah LeasingLeasing Quran, Sunnah Quran, Sunnah & & Ijma’ConsensusIjma’Consensus

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IJARAHIJARAH

► Ijarah is a term of Islamic Fiqh Literally, it means “To give something on rent”

The term “Ijarah” is used in two situations

1. It means ‘To employ the services of a person on wages’ e.g “A” employs “B” to work at his office, and pays him salary for his work

“A” hires a porter at the airport to carry his luggage

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IJARAHIJARAH

2. Another type of Ijarah relates to paying rent for use of an asset or property

The 2nd type of Ijarah is relevant to our discussion

This Ijarah is analogous to the English term “Leasing”

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IJARAHIJARAH► Rules governing Ijarah are similar to the rules

governing sale► Because in both cases something is

transferred from one person to another

The only difference is:► In case of sale, title of property is transferred

to Buyer

► In case of Ijarah, title remain with the Lessor► Only the use of the property is transferred to

Lessee

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MUSHARAKAHMUSHARAKAH

Islamic Islamic ModeMode

DescriptioDescriptionn

Basis of Basis of Shariah Shariah PermissibilityPermissibility

MusharakMusharakahah

Joint Joint VentureVenture

Profit Profit SharingSharing

Quran, Sunnah Quran, Sunnah & & Ijma’ConsensusIjma’Consensus

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MUSHARAKAHMUSHARAKAH

► Derives from “Shirkah”

► Literal Meaning – Sharing

► In the context of business, it means partnership in a venture Such that the participants share the profit & loss

► In modern banking, Musharakah can provide a viable alternative to interest-based transactions

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MUSHARAKAHMUSHARAKAH

►Interest determines a fixed rate of return

►Return in Musharakah is based on actual profit & loss

Interest-bearing transaction–Financier cannot suffer loss

Musharakah transaction -Financier can suffer loss

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MUSHARAKAHMUSHARAKAH

► Basic rules of MusharakahDistribution of profit:

► The ratio of profit distribution should be agreed at the time of execution of contract

► Otherwise contract is void

► The Profit Sharing will be according to agreed ratio.

► Loss must be shared strictly according to Capital.

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MUDARABAHMUDARABAH

Islamic Islamic ModeMode

DescriptioDescriptionn

Basis of Basis of Shariah Shariah PermissibilityPermissibility

MudarabaMudarabahh

Trustee Trustee Profit Profit

SharingSharing

Quran, Quran, Sunnah & Sunnah &

Ijma’ConsensuIjma’Consensuss

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MUDARABAHMUDARABAH• This is a kind of partnership where one partner

gives money to another for investing in a commercial enterprise.

• The investment comes from the first partner who is called “Rab-ul-Mal” (Investor)

• The management and work is an exclusive responsibility of the other, who is called “Mudarib” (Working Partner)

• Profit is shared as per agreed ratio

• In case of Mudarabah all losses are borne by Rab-ul- Mal

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MUDARABAHMUDARABAH

Types of Mudarabah

1. Al Mudarabah Al Muqayyadah

(Restricted

Mudarabah)

2. Al Mudarabah Al Mutlaqah(Unrestricted Mudarabah)

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MUDARABAHMUDARABAH

Authority of Rab-ul Maal

Rab-ul-Mal has authority to:Rab-ul-Mal has authority to:

a)  Oversee the Mudarib’s activities a)  Oversee the Mudarib’s activities and and

b) Work with Mudarib if the b) Work with Mudarib if the Mudarib consents.Mudarib consents.

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MUDARABAHMUDARABAH

Different Capacities of the Mudarib 1.1. Ameen (Trustee): Ameen (Trustee): The money given by The money given by

Rabb-ul-maal (investor) and the assets Rabb-ul-maal (investor) and the assets required therewith are held by him as a required therewith are held by him as a trust.trust.

2.2. Wakeel (Agent): Wakeel (Agent): In purchasing goods for In purchasing goods for trade, he is an agent of Rabb-ul-maal.trade, he is an agent of Rabb-ul-maal.

3.3. Shareek (Partner): Shareek (Partner): In case the In case the enterprise earns a profit, he is a partner enterprise earns a profit, he is a partner of Rabb-ul-maal who shares the profit in of Rabb-ul-maal who shares the profit in agreed ratio.agreed ratio.

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MUDARABAHMUDARABAH

44. . Zamin (Liable): If the enterprise Zamin (Liable): If the enterprise suffers a loss due to his negligence or suffers a loss due to his negligence or misconduct, he is liable to compensate misconduct, he is liable to compensate the loss.the loss.

55. . Ajeer (Employee):Ajeer (Employee):If the Mudarabah If the Mudarabah becomes Void due to any reason, the becomes Void due to any reason, the Mudarib is entitled to get a fee for his Mudarib is entitled to get a fee for his services.services.

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MUDARABAHMUDARABAH

Termination of Mudarabah► Mudarabah can be terminated any time

by either of the two parties by giving notice.

► If Mudarabah was for a particular term, it will terminate at the end of the term.

► Termination of Mudarabah means that the Mudarib cannot purchase new goods for the Mudarabah. However, he may sell the existing goods that were purchased before termination.

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Islamic banking turns to Islamic banking turns to AfghanistanAfghanistan

►After the success of Islamic After the success of Islamic banking in Pakistan, local banks banking in Pakistan, local banks want to steer towards Afghanistan want to steer towards Afghanistan which is a rapidly emerging which is a rapidly emerging market for the financial industry.market for the financial industry.

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Islamic banking turns to Islamic banking turns to AfghanistanAfghanistan

►Experts related to the industry ,they Experts related to the industry ,they said Islamic banking and insurance said Islamic banking and insurance have shown significant progress in have shown significant progress in recent years in Pakistan, compared to recent years in Pakistan, compared to conventional banks. conventional banks.

►Now, it is time for Pakistan’s banks to Now, it is time for Pakistan’s banks to enter the fast emerging market of enter the fast emerging market of Afghanistan and lead the banking Afghanistan and lead the banking sector in Islamic banking.sector in Islamic banking.

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Islamic banking turns to Islamic banking turns to AfghanistanAfghanistan

►Afghanistan and Pakistan have a Afghanistan and Pakistan have a strong potential for Islamic banking strong potential for Islamic banking

►Afghanistan is interested in Islamic Afghanistan is interested in Islamic banking but it lacks human resources banking but it lacks human resources and technical expertise.and technical expertise.

►We can utilize our potential in We can utilize our potential in Afghanistan Afghanistan

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What distinguishes Islamic banking from conventional banking?

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DocumentsDocuments► ““Conventional Banks deal in Documents”Conventional Banks deal in Documents”

►Transaction Documents (“Loan Creation”)Transaction Documents (“Loan Creation”)

►Security DocumentsSecurity Documents

► ““Islamic Banks deal in Goods and Documents”Islamic Banks deal in Goods and Documents”

►Transaction (Process) Documents (“Debt Transaction (Process) Documents (“Debt Creation”)Creation”)

►Security Documents (similar)Security Documents (similar)

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Basic Difference between Islamic and Basic Difference between Islamic and Conventional Modes of FinanceConventional Modes of Finance

Conventional ModeConventional Mode

Bank Client

money

money + money (interest)

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Basic Difference between Islamic Basic Difference between Islamic and Conventional Modes of Financeand Conventional Modes of Finance

Islamic TransactionIslamic Transaction

Bank ClientGoods & Services

money

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Conventional Vs Islamic EconomicsConventional Vs Islamic EconomicsDifference in Factors of ProductionDifference in Factors of Production

ConventionalConventional IslamicIslamic►LandLand LandLand

►LabourLabour LabourLabour(+Entrepreneur)(+Entrepreneur) (incl. Entrepreneur) (incl. Entrepreneur)

►Capital Capital

Capital Conversion

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Key Misconceptions

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“Islamic banking looks the same as conventional banking”

A halal meat and haram meat may look exactly the same but one is permissible while the other is not

Key Misconceptions

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“A fixed rate of return is not permitted under Islamic Shariah”

Fixed return does not make a transaction halal or haram

For example:

• Profit on trading

• Rent on property

Key Misconceptions

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Onus Shifts!!Onus Shifts!!

ClientHalal

RestaurantOnus

HalalAbattoir/ Butcher

Onus

ClientOnus

Islamic Bank Onu

s

ShariahAdvisor

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►ANY QUESTION?ANY QUESTION?

?

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Jazakumullah!Jazakumullah!

Thank Thank

YouYou

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