Study on Islamic Finance and Products.

Mohammed Saleem .OA salimvettom@gmail.com

Objective of the Study
Primary objective
To study the Islamic financial system, its products and merits.
Secondary objective To study the use these financing techniques To analyze the f
eature of Islamic products with conventional financial products.
Financial System
The system that allows the transfer of money between savers and borrowers. Instr
uments & Institutions to transfer funds from saving surplus units to saving defi
cit units in the most efficient manner. It facilitates intermediation between sa
vers (fund provider) and investors ( fund user)
Financial System Efficiency
Promotion of efficiency is the primary goal of every Financial System. It is mea
sured in terms of efficiency achieved in mobilizing savings from saving surplus
units in the economy and in allocating these funds among saving deficit units. I
ncrease in the range of financial assets and instruments would improve efficienc
y in mobilization of funds.
For Improving Allocational Efficiency it Needs
Less transaction cost Simplified transaction system Availability and accuracy of
information Should be a stable system.
Islamic Fianacial System
Financial institutions and instruments which are functioning on the basis of dir
ections and rules in shariah (a set of rules that governs every aspect of Islami
c life) are known as Islamic financial system. In conventional finance there is
a tug of war between ethics and efficiency. In Islamic finance ethics dominate a
ll the concerns. The Shari'ah specifies, inter alia, rules that relate to the al
location of resources, property rights, production and consumption, and the dist
ribution of income and wealth
Shariah Prohibits
Riba: which is taking or giving of interest Masir : which is involvement in spec
ulative and gambling transactions Gharar : which is uncertainity about the terms
of contract or the subject matter, eg. Prohibits selling something which one do
es not own. Investment in business dealing in alcohol, drugs, gambling, armament
s, etc. which are considered unlawful or undesirable.
Why Interest/ Riba Prohibited
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Prohibition of interest is not limited to Islam it is prohibited in Judaism and
Christianity Key objective is to ensure SOCIAL JUSTICE Money is only a medium of
exchange, no value in itself. Therefore should not be allowed to give rise to m
ore money, via fixed interest payments, simply by being put in a bank or lent to
someone else Results in concentration of wealth Interest can leads to injustice
and exploitation in society.
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Principle of Islamic Finance
Freedom to contract Freedom from Riba Freedom from Algharar Freedom from gamblin
g and unearned income Freedom from price control and manipulation Mutual coopera
tion and solidarity
Global Islamic Finance Industry
1963: Mit Gamir Project, Egypt. 1975: IDB, Jeddah 1975: Dubai Islamic Bank Growt
h Rate : 10-15% 300 Institutions over 75 countries USD 800 billion under managem
ent. Expected tocontinue with assets growing USD 1 trillion by 2010. Islamic Win
dow : ABNAmro, HSBC, City Bank
Islamic Finance Products
Investment Financing Trade Financing Lending
Musharakah ( Joint Venture)
Musharaka is similar to a joint venture, whereby two parties (an Islamic Financi
al Institution and a Client) provide capital for a project which both may manage
. Profits are shared in pre-agreed ratios but losses are borne in proportion to
equity participation
Client Business Venture
Bank
Profit / Loss
Mudaraba – Trustee Partnership
Mudaraba is a contract between two parties: One of them provides finance ( Rab u
l maal) & other uses his labour and expertise (Mudarib). Profit, if earned, is d
istributed between the two parties in accordance with the ratio as per the agree
ment. Financial Loss, if suffered is borne by the investor only.
Client
Bank
Business Venture
Profit
Loss
Murabaha ( Mark upSales)
The client orders an Islamic Bank to purchase certain goods at a specific cash p
rice The Bank purchase these goods from the supplier and sells to the client at
a marked – up price ( Cost + Profit). The differed price may be paid up on lump
sum or in installment
Cost + Profit
Goods / Ownership
Cost Ban k
Client
Ijara ( Lease)
A contract under which an Islamic bank finances equipment, building or other fac
ilities for the client against an agreed rental. The ownership remains with the
lessor bank and can be transferred on predetermined basis.
Salam ( Forward Selling)
Salam means a contract in which advance payment is made for goods to be delivere
d later on. The seller undertakes to supply some specific goods to the buyer at
a future date in exchange of an advance price fully paid at the time of contract
.
Istisna
It is a contractual agreement for manufacturing goods and commodities, allowing
cash payment in advance and future delivery or a future payment and future deliv
ery.
Qard Hassan ( Charitable Loan)
It is an interest free loan. Only loan permitted by Shariah. The loans are made
from the pooled donations of the members, Zakat and are generally granted to tho
se who are facing emergency personal crisis.
Activity Client approaches Bank for loan and offers collateral security. Bank le
nds an amount to client. Client repays amount to Bank (with or without administr
ative expenses) in part or in full
TAKAFUL (INSURANCE)
Takaful, the Islamic alternative to insurance, is based on the concept of social
solidarity, cooperation and mutual indemnification of losses of members. It is
a deal among a group of persons who agree to jointly indemnify the loss or damag
e that may inflict upon any of them, out of the fund they donate collectively.
What Distinguishes Islamic Banking
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Transactions are asset-based It is socially-responsible banking because it opera
tes under Shariah restrictions Does not permit financing of prohibited goods / I
ndustries It starves evil out of the society Ethics and moral values play a majo
r role in investment decisions. Not a choice but a must
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Distinguishing Features
Conventional Banking - Conventional banking prices money. Islamic Banking - Isla
mic banking prices goods and services which creates real wealth in the society l
eading to economic well-being. - Is based on profit sharing on deposits side, an
d on profit on assets side.
- Is based on fixed return on both Sides of the balance sheet.
Distinguishing Features
Conventional Banking - Does not involve itself in trade and business Islamic Ban
king - Actively participates in trade and production.
- Depositors get a fixed rate regardless of the bank’s profitability, thus insul
ating them from the bank’s true performance.
- Profit is shared with the depositor, higher the bank’s profit, higher the depo
sitors income.
Basic Difference between Islamic and Conventional Modes of Finance Conventional
money Bank money + money (interest) Client
Basic Difference between Islamic and Conventional Modes of Finance Islamic
Bank Goods & Services money Client
Performance of Islamic Finance
In comparison with conventional banking systems, Islamic bank’s assets and depos
its have grown at GR of 20-22% while those of conventional banks have grown at a
rate of 11% for the period 2002 – 2005.
Key Isuues Taxation & Legal Issues Risk Management Regulatory Issues Fragmentati
on
Conclusion
Islamic Finance assures Equitable distribution of risks and rewards among the st
akeholders Inculcating market discipline and higher ethical standards given its
emphasis on non-exploitation and social welfare. It may be observed that Islamic
finance is far more interesting and complex than conventional finance as far as
financing techniques are concerned.
it is in the area of assets rather than in liabilities that the practices of Isl
amic banks are more diverse and complex than those of conventional banks. it is
generally believed that Murabahah is the most widely used technique and that the
majority of the financing provided by Islamic banks goes to short-term trade an
d the financing of real estate.
THANK YOU…