New Jersey

Mumbai

Chennai

Bangalore

Dubai

London

New Jersey

Mumbai

Chennai

Bangalore

Dubai

London

New Jersey

Mumbai

Chennai

Bangalore

Dubai

London

By

Zeeshan S. A. Associate Test Lead Maveric Systems

Contents
What is Islamic Banking? Definition Key Features of Islamic Banking Difference bt Islamic and Conventional Banking Brief History of Islamic Banking Structure Of Islamic Banking What is Riba (Interest) Basic Features of Islamic Banking Murabaha Musharakah Mudaraba Ijarah Istisna Wadiah

Contents
What is Islamic Banking? Definition Key Features of Islamic Banking Difference bt Islamic and Conventional Banking Brief History of Islamic Banking Structure Of Islamic Banking What is Riba (Interest) Basic Features of Islamic Banking Murabaha Musharakah Mudaraba Ijarah Istisna Wadiah

Continued
Basic contract Types in Islamic Banking
Contracts of Exchange (Murabaha, Istisna) Contracts of Security (Kafalah) Contracts of Partnership (Mudaraba, Musharakah) Contract of Safe Custody (Wadiah) Contracts of Usufruct Utilization (Ijarah) Contracts of Agency (Wakalah)

Products of Islamic Banking

Assets Liabilities

Mapping of Islamic product to conventional products

Deposit products Financing Products (Equity based) Financing Product (Debt based)

Other Financing Product (Debt based)

Continued
Financing Product (Debt based) Fee-based Financial Products

Islamic Securities
Islamic Alternatives of Insurance

Financial Institutions Offering Islamic Banking and Financial Services

Glossary
Reference

Definition
A Banking system that is based on the principles of Islamic law (also known as Shariah) and guided by Islamic economics. Two basic principles behind Islamic banking are the sharing of profit and loss and the prohibition of the collection and payment of interest. (interest is not permitted under Islamic law). Financial services that meet the requirements of the Shariah, or Islamic law .

Key Features of Islamic Banking

Interest free Avoids exploitation - no usury Ethical investments Alcohol, tobacco, gambling, armaments, pornography etc all haram (Prohibited)

products.

Difference bt Islamic and conventional Banking

Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.

Difference bt Islamic and conventional Banking

Conventional Banking Islamic Banking

The functions and operating modes of conventional banks are based on fully current economic principles. The investor is assured of a predetermined rate of interest. It aims at maximizing profit without any restriction. It does not deal with Zakat.

The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. It promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). It also aims at maximizing profit but subject to Shariah restrictions. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

Difference continued
Lending money and getting it back with compounding interest is the fundamental function of Participation in partnership business is the fundamental function of the Islamic banks. So we

the conventional banks.

It can charge additional money (penalty and compounded interest) in case of defaulters Very often it results in the banks own interest becoming prominent. It makes no effort to ensure growth with equity.

have to understand our customers business very

well. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount

of compensation and these proceeds is given to

charity. Rebates are give for early settlement at the Banks discretion. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

Difference continued
For interest-based commercial banks, borrowing from the money market is relatively easier. For the Islamic banks, it must be based on a Shariah approved underlying transaction.

Since income from the advances is fixed, it gives

little importance to developing expertise in project appraisal and evaluations. The conventional banks give greater emphasis on credit-worthiness of the clients.

Since it shares profit and loss, the Islamic banks

pay greater attention to developing project appraisal and evaluations. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.

Difference continued
The status of a conventional bank, in relation to its clients, is that of creditor and debtors. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and

A conventional bank has to guarantee all its

deposits.

seller.
Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed

repayment of their funds, however if the account is

based on the Mudaraba concept, client have to share in a loss position..

Structure Of Islamic Banking:

Structure of Islamic Banking

The Islamic Financial Services Board (IFSB) is an international standard-setting organization that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors Established in 2002,Head office is in Kuala Lumpur .

The 164 members of the IFSB include 41 regulatory and supervisory authorities as well as
International Monetary Fund, World Bank, Bank for International Settlements, Islamic Development Bank, Asian Development Bank, Islamic Corporation for the Development of Private Sector and 117 market players and professional firms operating in 33 jurisdictions.

Brief History of Islamic Banking

1963 Egypt interest free savings banks
Not overtly Islamic - invested in trade and industry

Share of profits

1971 Egypt Nasr social bank 1975 Islamic development bank Jeddah. Conference of Islamic finance ministers1973 Fee based and PLS Revolving capital 1970s Dubai Islamic bank, Faisal Islamic bank of Sudan / Egypt, Bahrain Islamic bank Malaysia, Philippines, Nigeria, Indonesia Islamic finance house, Luxembourg, DMI Geneva, Al Rajhi London

Brief History..
Islamic finance house, Luxembourg, DMI Geneva, Al Rajhi London Denmark, Australia, south Africa HSBC Amanah fund, ANZ first ANZ International Murabaha ltd., IBU of United Bank of Kuwait.

What is Riba ? Why prohibited?

In Arabic language Riba means to excess or increase, In the Islamic terminology Riba (interest) means effortless profit or that profit which comes free from compensation or that extra earning obtained that is free of exchange. Interest. Riba covers any return of money on money - whether the interest is fixed or floating, simple or compounded, and at whatever the rate. Riba is strictly prohibited in the Islamic tradition. Shariah considers interest hinders social parity as a result the poor grow poorer and the rich, richer.

Basic Features of Islamic Banking

Murabaha: Refers to a particular kind of sale. If a seller agrees with his purchaser to provide him a specific commodity on a certain profit added to his cost, it is called a "Murabaha" transaction. The basic ingredient of "Murabaha" is that the seller discloses the actual cost he has incurred in acquiring the commodity, and then adds some profit thereon. This profit may be in lump sum or may be based on a percentage. Murabaha / Murabaha on asset side.
Murabaha on asset side. Bank buys asset on behalf of client / borrower and then sells it for deferred payment Sounds like Repo a sale and repurchase agreement

Musharakah
Musharakah: is a word of Arabic origin which literally means sharing. In the context of business and trade it means a joint enterprise in which all the partners share the profit or loss of the joint venture. Musharakah is based on the actual profit earned by the joint venture The financier in Conventional loan cannot suffer loss while the financier in Musharakah can suffer loss, if the joint venture fails to produce fruits. The proportion of profit to be distributed between the partners must be agreed upon at the time of effecting the

contract. If no such proportion has been determined, the contract is not valid in Shariah.
The ratio of profit for each partner must be determined in proportion to the actual profit accrued to the business, and not in proportion to the capital invested by him. It is not allowed to fix a lump sum amount for any one of the partners, or any rate of profit tied up with his investment.

Mudaraba
It is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner who is called "rabb-ul-mal", while the management and

work is an exclusive responsibility of the other, who is called "mudarib".

Difference bt Mudaraba and Musharakah

The investment in musharakah comes from all the partners, while in mudarabah, investment is the sole responsibility of rabb-ul-mal.

In musharakah, all the partners can participate in the management of the business and can work
for it, while in mudarabah, the rabb-ul-mal has no right to participate in the management which is carried out by the mudarib only. In musharakah all the partners share the loss to the extent of the ratio of their investment while in mudarabah the loss, if any, is suffered by the rabb-ul-mal only, because the mudarib does not invest anything. His loss is restricted to the fact that his labor has gone in vain and his work has not brought any fruit to him. The liability of the partners in musharakah is normally unlimited. Therefore, if the liabilities of the business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all the partners.

Ijarah
Ijarah: Lexically, it means 'to give something on rent'. In the Islamic jurisprudence, the term 'Ijarah' is used for two different situations. In the first place, it means 'to employ the services of a person on wages given to him as a consideration for his hired services." The employer is called 'mustajir' while the employee is called 'ajir'. The second type of Ijarah relates to the usufructs of assets and properties, and not to the

services of human beings. 'Ijarah' in this sense means 'to transfer the usufruct of a particular
property to another person in exchange for a rent claimed from him.' In this case, the term 'Ijarah' is analogous to the English term 'leasing'. Here the lessor is called 'Mujir', the lessee is called 'mustajir' and the rent payable to the lessor is called 'ujrah'.

Features of Ijarah
The rules of Ijarah, in the sense of leasing, is very much analogous to the rules of sale, because in both cases something is transferred to another person for a valuable consideration Leasing is a contract whereby the owner of something transfers its usufruct to another person for an agreed period, at an agreed consideration. The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased. It is necessary for a valid contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee.

Istisna
Istisna: kind of sale where a commodity is transacted before it comes into existence. It means to order a manufacturer to manufacture a specific commodity for the purchaser. If the manufacturer undertakes to manufacture the goods for him with material from the manufacturer, the transaction of istisna comes into existence. But it is necessary for the validity of istisna that the price is fixed with the consent of the parties and that necessary specification of the commodity (intended to be manufactured) is fully settled between them.

Wadiah
Wadiah: In Islamic finance, Wadiah defines a bank as keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the whole deposit amount, or any part of the outstanding amount, when the depositor demands for it. The deposit. The depositors are not entitled to any share of the profits but the depository may provide returns to the depositors as a token of appreciation. Basic Features of Wadiah are;
It is Retail savings account Cheque books bill payments, credit cards facilities. Only profits no loss of capital Looks like profits bonds

Basic Contract Types in Islamic Banking

Contracts of Exchange (Murabaha, Istisna) Contracts of Security (Kafalah) Contracts of Partnership (Mudaraba, Musharakah) Contract of Safe Custody (Wadiah) Contracts of Usufruct Utilization (Ijarah) Contracts of Agency (Wakalah)

Products Of Islamic Banking

Assets: Mudharabah facility Musharakah facility Liabilities: Wadiah Deposits Mudarabah Deposits

Mapping of Islamic Product with Conventional Products

Deposit products
Wadiah Deposits Mudaraba Deposits

Financing Products (Equity based)

Mudaraba facility Musharakah facility Decreasing Musharakah facility

Financing Product (Debt based)

Murabaha and BBA facilities Working Capital Financing Leasing Ijarah facility

Other Financing Product (Debt based)

Salam facility Istisna facility Recurring sale (istijrar)

Financing Product (Debtbased)

Repurchase (Bay al-Einah) Bill Discounting facility (Bay aldayn) Tripartite Sale (Tawarruq)

Fee-based Financial Products

Letter of Credit Letter of Guarantee

Islamic Securities
Sukuk al-Murabaha Sukuk al-Ijarah Sukuk al-Salam Sukuk al-Istisna Sukuk al-Mudaraba

Insurance and Islamic Alternatives

Tabaru-based Takaful Mudharabah-based Takaful Wakalah-based Takaful

Financial Institutions Offering Islamic Banking and Financial Services

Financial Institutions Offering Islamic Banking and Financial Services

Financial Institutions Offering Islamic Banking and Financial Services

Financial Institutions Offering Islamic Banking and Financial Services

TABLE: LATEST ENTRANTS - ISLAMIC FINANCIAL SINCE 2006

Financial Institutions Offering Islamic Banking and Financial Services

TABLE: LATEST ENTRANTS - ISLAMIC FINANCIAL SINCE 2006 CONTD

References
Interest-free Commercial banking; ALM Abdul Gafoor, 1995 Riba Put On Trial and Retrial: Pakistans Case, www.sbp.gov.pk Financial Sector Masterplan; www.bnm.gov.my Towards Establishing Malaysia as a Regional Islamic Capital Market:Thesis Proposal; Roslily Ramlee, IIUM, March 2005 (unpublished) Regulating Islamic Financial Institutions: Nature of the Regulated; Hawary, Iqbal, Grais, World Bank Policy Research Paper 3227, March 2004. Current Trends & Prospects of the Islamic Banking & Finance Sector; Syed Alwi, article written in conjunction with KL Islamic Finance Forum (KLIFF) by CERT, Mandarin Oriental Hotel Kuala Lumpur, December 2004. Risk Management and Governance in Islamic Financial Services; Syed Alwi, Seminar on Risk Management in Islamic Financial Services by CERT, Istana Hotel Kuala Lumpur, April 2005.

Thank You