IBF002

ISLAM BANKING OPERATIONS

LECTURE ONE
BY

SANI AINU DUTSINMA

(MANAGING DIRECTOR/CEO) ISLAMIC BANKING AND FINANCE INSTITUTE NIGERIA NO. 50 , YAOUNDE STREET, ZONE 6, WUSE, ABUJA. +2348036570364; +2348023546717 Web: www.islamicbankingnigeria.co Email: info@islamicbankingnigeria.co

AREWA HOUSE, KADUNA NIGERIA OCTOBER 2011

IN THE NAME OF ALLAH, MOST GRACIOUS, MOST MERCIFUL

O believers, fear God, and give up the Interest that remains outstanding if you are believers (278). If you do not do so, then be sure of being at war with God and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it (279). (Surah AlBaqarah 278-279).

LEARNING OBJECTIVES:
At the end of this topic, participants will be able to; 1. Identify the position and importance of Islamic Banking in the Islamic Financial as well as Islamic Economic System. 2. Understand and differentiate the two models of Islamic Banking; that is the Two-tier Mudaraba Model, and the TwoWindow Model. 3. Identify, understand and explain characteristics of Islamic Banks; similarities between Islamic Conventional Banking, as well as structure of Islamic Banks. 4. the the and the

Discuss and analyze the position of Nigerian Non-Interest Banking System in relation to the above topics.

POSITION OF ISLAMIC COMMERCIAL BANK IN ISLAMIC ECONOMIC SYSTEM

1. One of the most dominant issues regarding Islamic Commercial Banks is the misconception as to the nature, objective and functions of such a bank due to: a. Lack of appreciation of the place of the Islamic Commercial Bank within the structure of the Islamic Economic and Financial System. b. Lack of knowledge on the management of commercial banks. c. (sometimes) scanty regard for the requirements of the Shariah principles. 2. The Islamic Commercial Bank is not an embodiment of the Islamic Financial System let alone the whole Islamic Economic System. 3. The Islamic Commercial Bank is just one type of a large number of institutions that should exist within the Islamic Financial System, which in turn should make up a part of the whole Islamic Economic System.

4.

Some Fiqh Jurists have viewed the Islamic Economic System as consisting of three sectors: ISLAMIC ECONOMIC SYSTEM

Siasi (Government) Public Finance Central Bank etc

Ijtimai (Welfare) Baitul-mal (Treasury) Zakat Waqat Sadaqah

Tijari (Commercial) all Private sector Commercial Activities

5.

Within each of these sectors there should be many types of institutions. Every one of these institutions should in turn function on the basis of certain Shariah principles applicable to its operation.

6.

THE TWO CONCEPTUAL VIEWS OF ISLAMIC BANKING

1. From the above argument, we can distinguish two conceptual views of Islamic Banking. a. That Islamic banking is simply a model of banking replacing interest bearing models of finance and banking services with interest-free one. An Islamic bank, within this concept, is a profit maximize,

just like any other commercial entity. While it (Islamic Bank) abides by the rules of Shariah, it is structurally similar to conventional bank. b. The Islamic banking is actually an integral part of the Islamic Economic System. Therefore it is not just a financial concern but an institution for social justice; taking care of the function of financial intermediation as well as fostering cooperation and organizing the collection and distribution of Zakah and alms, etc.

TWO MODELS OF ISLAMIC COMMERCIAL BANK

THE TWO-TIER MUDARABA MODEL & THE TWO-WINDOWS MODEL They are fully in consistent with Islamic rules and guidelines. 1. Two-Tier Mudaraba Model v v The assets and liabilities sides of a bank balance sheet are fully integrated. On the liabilities side, depositors enter into a Mudaraba Contract (i.e. trustee finance contract) with the bank a. Share the overall profit or loss accruing to the banks business. b. Thus, depositors act as financiers by providing funds (Rab-al-mal). c. v Hence, the bank acts as an entrepreneur by accepting the funds (Mudarib) On the assets side, the bank enters into mudaraba contracts with agent/entrepreneurs w ho search for investable funds. a. Agree to share profit with the bank according to a certain percentage stipulated in the contract. b. Thus the bank acts as financier by providing the funds (Rab-ul-mal). c. The Agent/entrepreneur by accepting the funds is the Mudarib .

2.

Two-Windows Models v Under this arrangement, bank liabilities are divided into two-windows: One for demand deposits The other for investment deposits

The choice of the windows is left to depositors v Demand deposits are assumed to be placed as Amana (Safekeeping). Thus, they are considered to belong to depositors at all time. Hence, they cannot be use by the Banks as the basis to

create money through fractional reserves. Consequently, banks must apply a 100% reserve

requirement ratio on demand deposits. v By contrast, investment deposits are used to finance riskbearing investment projects with depositors awareness. Therefore, these deposits are not guaranteed by the bank Thus, reserve requirements are not applied to them. full

CHARACTERISTICS OF ISLAMIC BANKS

A. Prohibition of Interest: They neither borrow nor lend on the basis of interest; whether it is fixed, floating, prepaid, deferred, deducted or in any other form. B. Profit and Loss Sharing: The relationship between Islamic Banks and their costumers is not that of creditor and debtor but one of participation in risks and reward. This basic assumption leads to the following: There is no previously fixed yield on the funds invested with the banks. Similarly, there is no previously fixed return on funds which Islamic Bank creates for other to invest. The yield is only decided, for both sides, in the light of the profit realized from the investments and paid in the ratio of capital participation or an agreed ratio of profit-sharing. C. There is no liability on the Islamic Bank, which is a Mudarib

(Manager of funds) to owners of deposited funds (Rab-al-maal), except is the case of current account, to return their funds in full at the date of maturity, so long as the bank has not been negligent in investing the funds, as these funds share the profits or loss resulting from the projects they invested in.

D.

Low Consumer Lending: o Some Islamic Banks deliberately avoid consumer lending o Some argued that it is the duty of the state through its treasury (Baitul-mal) to cater for (Consumer Loans) basic needs. o Therefore gives limited overdrafts o Some suggest consumer loans to be guaranteed by the stale o Encourage qard hassanat

E.

High Real Sector Investing: Islamic Banks Investments are favorably skewed towards real sector of the economy Responsible financing to socially and economically relevant development projects.

F. G.

Emphasis on Islamic Principles of Morality Low Emphasis on Collateral

SIMILARITIES BETWEEN ISLAMIC AND CONVENTIONAL BANKS

A. Profit-making objectives B. Nature of Banking Services Islamic Banks offer the same banking services provided by conventional banks, although the operational modes differ in some areas. These may include: o Current Account o Saving Account o Investment Account o Clearing Mechanism o Bank Drafts o Bills of Exchange o Travelers Cheques o Letters of Credit o Collections o Remittances o Safe Deposits o Etc.

STRUCTURE OF AN ISLAMIC BANK

An Islamic Bank has to be run like a financial institution which is managing the funds of others. With additional responsibility of investing them only in halal transactions. And without involving in interest

transactions So the structure of an Islamic Bank contains the normal mechanism of controls:An extra organ to supervise the

managements compliance with Shariah requirements.

The Board of Directors: expected To set the banks policies and monitor the managements adherence to them To plan for the future and resolve current problems To give advice, make judgments and oversee the commitment of corporate resources To assess, select and, if necessary, replace top management. To define the responsibilities and limits of authority of the management. The Religious Supervisory Board On a level with the Board of Directors Has over-riding authority and responsibility so far as compliance to the shariah is concerned. Has authority to contradict any decision of the Board of Directors, which, in its opinion, contravenes the Shariah; The Executive Committee Management Sub-committees

THE POSITION OF NIGERIAN NON-INTEREST BANKING SYSTEM

1. Definition: (Section 1.0: (Preamble) Para 4): NIF means a bank or other financial Institutions (OFI) under the purview of the Central Bank of Nigeria (CBN), which transacts bank business, engages in trading, investment and commercial activities as well as the provision of financial products and services accordance with the established non-interest banking principles. 2. Model: (Section 1.0 (Preamble Para 5) Non-Interest banking and finance models are broadly categorized into two:i. Non-Interest Banking and Finance based on Islamic in

Commercial jurisprudence. ii. Non-Interest Banking and Finance based on any other established non-interest principles. 3. Concept (Section 1.0 (preamble) Para 6) Islamic Banking as one of the models of Non-Interest Banking, serves the same purpose of providing financial services as do conventional financial institutions save that it operates in

accordance with the principles and rules of Islamic Commercial jurisprudence that generally recognized profit and loss sharing and the prohibition of interest, as a model.

4.

Structure: (Section 8.0 (Corporate Governance)

All licensed IIFS shall be subjected to: Guidelines on Corporate Governance for Banks in Nigeria issued by the CBN The provisions of the Code of Corporate Governance for Banks in Nigeria issued by the CBN and any subsequent amendments thereto: and All relevant provisions of BOFIA (as amended). All licensed IIFS shall have an internal review mechanism that ensures compliance with the principles under this model. They shall also have an Advisory Committee of Experts (ACE) as part of their governance structure. The detailed

guidelines for the appointment, operation, qualification, duties and responsibilities of members of the ACE are contained in separate guidelines to be issued by the CBN.

My brothers and sisters, we may conclude that, as far model, concept and structure, the Nigerian system Non-Interest is in full

Banking

compliance with the principles of Islamic Commercial Banking.

ALHAMDULILLAH
THANK YOU VERY MUCH