in the name of allah, the beneficent, the merciful...

Journal of Islamic Banking and Finance Jan – March 2013 1

IN THE NAME OF ALLAH, THE BENEFICENT,

THE MERCIFUL

O ye who believe Fear God and give up what remains of your demand for usury if ye are indeed believers.

If ye do not, take notice of war from God and His Apostle. But if ye turn back ye shall have your capital sums. Deal not

unjustly, And ye shall not be dealt with unjustly.

SURA AL BAQARA II VERSE 278-279

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The articles published in this Journal contain references from the

sacred verses of Holy Qur’an and Traditions of the prophet (p.b.u.h) printed for the understanding and the benefit of our readers. Please maintain their due sanctity and ensure that the pages on which these

are printed should be disposed of in the proper Islamic manner

2 Journal of Islamic Banking and Finance Jan – March 2013

Journal of Islamic Banking and Finance

Volume 30 Jan. – Mar. 2013 No. 1

Founding Chairman Muazzam Ali (Late) Former -Vice Chairman Dar Al-Maal Al-Islami Trust, Geneva, Switzerland Board of Editorial Advisors Ahmed Ali Siddiqui Mufti Bilal Qazi S. A. Q. Haqqani Dr. Hasan uz Zaman Dr. Mohammad Uzair Altaf Noor Ali (ACA)

Chairman Basheer Ahmed Chowdry

Editor Aftab Ahmad Siddiqi

Associate Editor Mazhar Ali

Co-ordinator Research & Marketing Mohammad Farhan

Business Executive A. N. Haqqani

Published by International Association of Islamic Banks Karachi, Pakistan. Ph: 35837315 Fax: 35837315 Email: ia _ ib @ yahoo.com

Registration No. 0154 Printed at M/S Maaz Prints, Karachi

International Advisory Panel

Professor Dr. Md. Ma’sum Billah Corporate Advisor & Consultant to Global Islamic Banks & Financial Market. Malaysia.

Professor Dr. Rodney Wilson School of Government and International Affairs, Durham University, UK

Dr, R. Ibrahim Adebayo Department of Religions, University of Ilorin, Nigeria

Prof. Dr. Zubair Hasan The Global University of Islamic Finance, Kuala Lumpur, Malaysia Dr. Waheed Akhtar Assistant Professor, Comsats Institute of Information Technology (CIIT), Lahore, Pakistan Dr. Manzoor Ahmed Al-Azhari, PhD Legal Policy (Shariah Law) Chair, Department of Islamic Studies, Institute of Religious Education & Research, (IRER) HITEC University Taxila Cantt, Pakistan. Professor Dr. Khawaja Amjad Saeed FCA, FCMA Hailey College of Banking & Finance University of Punjab, Lahore, Pakistan

Dr. Mehboob ul Hassan Professor, Department of Business Administration Sindh Madarsatul Islam University, Karachi, Pakistan Mr. Salman Ahmed Sheikh External Reviewer Bankers Academy USA, Research Associate & Faculty Member IBA Karachi and also Heads of Islamic Economics Project Prof/ Dr. Habib ur Rahman Head Business Administration Deptt Sarhad University of Science & Information Technology, Peshawar, Pakistan Dr Muhammad Zubair Usmani Jamia Daraluloom Karachi


Journal of Islamic Banking and Finance

Volume 30 Jan – March 2013 No. 01

C O N T E N T S

1. Editor’s Note…………………………………………………………………....7

2. Islamic Banking Industry – Growing amid challenges ..................................... 13 By Ahmed Ali Siddiqui

3. Why Murabaha (Cost-Plus Finance) is Allowed Whereas Lending on Interest is Prohibited in Islam. ..................................................................... 19 By Syed Zahid Ahmad

4. Response to Meera’s critique of the ZDBM ..................................................... 24 By Prof. Dr. Zubair Hasan

5. Adoption of AAOIFI Shariah Standards: Case of Pakistan .............................. 30

6. Islam and Environmental Economics ............................................................... 35 By Salman Ahmed Shaikh

7. An Analysis of Bankers Competency in the Context of Marketing Strategies Employed in Islamic Banks of Pakistan ........................................... 44

By Qaiser Imtiaz & Mohammad Shahid

8. Capitalism, Globalization and Islamic Economic System ................................ 52 By Muhammad Zeeshan Farrukh

9. Beneath the Failed Islamic Financial Institution – was it a Failure of Islamic Finance. ............................................................................................ 58 By Imran Hussain Minhas

10. Shari’ah Compliance in Modarabas .................................................................. 66 By Mohammad Samiullah

11. Interest-Free Financing in USA ........................................................................ 72 By Dr. S.M.Hasanuzzaman

12. The Role of None Interest Banking in National Economy Development ......... 85 By MOBOLAJI, Hakeem Ishola Ph. D.

13. Country Models .............................................................................................. 100 Kuwait Egypt 14. News Monitor ................................................................................................. 105

15. Islamic Banking Glossary ............................................................................... 107


Editor’s Note This is an article on “Islamic Banking Industry – Growing amid challenges”

written by Ahmed Ali Siddiqui, the synopsis focuses on various aspect of Islamic banking, its global growth trend and the differences between Islamic financial and conventional institutions, further pointed out some of the challenges, faces Islamic banking industry in current scenario. Islamic banking has proved over time that it is based on firm and sound economic principles and has a good potential for become an alternative system of banking especially in view of the global financial crises. However, there is a need for dedicated research, development of sound legal, regulatory framework repeals and modify the existing laws to provide better products and quality service within the ambit of Islamic laws to develop an economic system truly reflective of the sacred principles of Islam, all stakeholders should understand the limitations at this stage and work towards its advancement.

This is an article on “Why Murabaha (Cost-Plus Finance) is Allowed Whereas Lending on Interest is Prohibited in Islam” by Syed Zahid Ahmad. The author has tried to dispel the notion of those who oppose ban on interest that trade is like usury and Murabaha is noting but a mask to earn interest and yet claim innocence from the sin. However the article has rebutted the accusations and given some disarming arguments. A difference of a practicle bargain in Murabaha and loan on interest has been illustrated and also operational differences between the two have been illustrated. These two illustrations have made a valuable contribution in establishing viability of Morabaha as interest less transaction.

This is an article on “Response to Meera’s critique of the ZDBM” by Prof. Dr. Zubair Hasan, previously his article title “Diminishing Balance Model for Islamic Home Finance” proposing a new model for Islamic home financing, showing its advantages, published in issue No. 3 2011 of JIBF. Prof Dr. Ahmad Kameel Meera of ILUM has some observation on the article and criticized, the critique published in the ISRA Journal issue 2 Dec 2012.

Prof. Dr. Zubair Hasan has quoted three main points of criticism on the article and given detailed explanation in the aforesaid article.

This is an article on “Islam and Environmental Economics” by Salman Ahmed Shaikh. It limelights the philosophy of Islamic economics which is not confined to finance only but it covers a wide spectrum of human activities which being bereft of ethical checks have brought forth the adverse consequences for mankind. It has


resulted in concentration of wealth in a few hands who are waluing in wealth while the rest have been reduced to abject poverty Even ecology has been badly effected and its evil results are not only a source of misery in the present age but will persist till future generations.

As per Islam, the present worldly system comprising of poor and wealthy is meant by God to test both of them whether they obey his commands and follow this guidelines and take notice of the pricks of their conscience which God provided in each individual to prevent him from going astray. He also sent prophets to disseminate his teaching among mankind.

God has issued instructions to human beings for every field of their activities - be it marketing or any other department so that by compliance of his commandments justice may prevail and no entity which may be a tree, a sparrow, a man, water, energy whatsoever is not misused and their prevails in the world calm and quite and no body suffers cruelty and or any other kind of excess.

This is supported by extensive quotation fro the scriptures. The present day scenario of the world is that terrible sea and wind storms lash the countries upset the economy of the world and severe turmoil in financial world war and pestilence have become the order of the day. These are the punishment of God for disobedience of his guidelines. Mankind should wake up and make amends before they have to face complete destruction.

This is an article on “An Analysis of Bankers Competency in Context with Marketing Strategies Employed in Islamic Banks of Pakistan” The article is a joint out put of two authors 1) by Qaiser Imtiaz & 2) Mohammad Shahid. It assesses competence of marketing strategies used by Islamic banks. The study is confined to Islamic banks whose employees’ views have been obtained.

Samples size was 180 employees who were selected for Islamic banks. A questionnaire having 59 items was developed and interviews of the employees were also conducted. The data from both exercises were compared and their validity and consistency made them acceptable. The article also carries charts showing employees by gender and also bank manager and officers by years of experience. T test was also conducted and it was revealed that there was no noticeable difference between the views of less and more experienced personnel on the subject under study. The bank staff has been trained by the employer bank and they know the marketing policy and have been daily dealing with customers.

Lastly the article has made the recommendations as under:-

1) Standardized excellent service of Islamic banks be provided to customers. 2) Open more Islamic banking branches. 3) As the I.B does not guarantee profit and suitable return on investment, this

discourages the account holder from shifting from conventional banks to Islamic banks.

4) Deposit should be collected on Profit and Loss basis. 5) Launching of consumer products should be expedited.


This is an article on “Capitalism, Globalization and Islamic Economic System” by Muhammad Zeeshan Farrukh. The article has attempted to show that the Islamic economic system and all economic systems which were born the west are poles apart.

Capitalism and globalization are the two systems which were introduced by the west. Both these systems stick to secularism which means that they do not accept any religious interference in the matters which have no concern with religion but relate to some other discipline like economics. All the system are based on interest and their sole aim is to earn as much as possible irrespective of the fact that this practice may lead to concentration of wealth in a few hands and the general populace may suffer the pangs of poverty and live a miserable life. While the wealthy wallow in their wealth and utilize it to earn more and more. Thus in short it is a system which is anti common people and pro-rich. It causes unjust distribution of wealth and the rich get richer and poor further descend into poverty resulting in the present wide gaping the chasm between the poor and rich owing to the irreligious economic systems. The article further enunciates the details of Islamic economic system which is based on Shariah, the compendium of commandments of God and saying of Holy Prophet. In Short Islamic system is based on ban on interest in any form whatsoever, trade in Haram Merchandise, gambling and speculation. God has issued instructions that no body should attempt to earn wealth unscrupulously but it should be done ethically. They should make it a point to see that no one was harmed by their activities and welfare of the people has the highest priority in the system. Any disobedience of the instructions carries severe punishment hereafter.

According to Islami life of the world is only a temporary but Hereafter has immoderately, comforts and happiness and the Muslims must naturally have their preference for the Hereafter. Therefore they should carry out all the godly commandments and the saying of the Holy prophet and should not get lured by the dazzle of the worldly reaches and attractive sins but should patiently await the reward of Hereafter.

This is an article on “Beneath the Failed Islamic Financial Institution – was it a Failure of Islamic Finance” by Imran Hussain Minhas. The article states that with the start of Islamization of economy of Pakistan in 1980, Modaraba business was also permitted. Due to tax concession by Government this segment attracted a wide spectrum of big business men but 30 years back when these were established there was no proper criteria for regulator, director and and management and most of the companies were headed by inexperience close relatives of the sponsor were incompetent to run the business. The result was that 23 non banking financial institutions were adversely affected out of which 8 were complete failure and the rest were merged with others.

The article has further enumerated quite a number of root causes for the failure of the companies.

The Islamic financial system now is working quite satisfactorily and even the 26 NBIFIs are prospering. Islamic banking and finance, Islamic pension fund, Sukuk,


Takaful are growing at 20 percent per annum and their combined assets reached 11 billion. The regulatory system has improved and there is no case of defaults.

These views and opinions are author’s own and not the institution (SECP).

This is an article on “Shariah Compliance in Modarabas” by Muhammad Samiullah, focusing on the concept of Modaraba, development of its legal and regulatory conceptual frame work. The Modaraba Association of Pakistan have adopted various measures to project the real and functional strengths of Modarabas, playing a vital role in image building of the sector as an important component of Islamic Financial regime. The Modaraba sector being the pioneer in providing Islamic financial services in Pakistan is an important segment of the financial sector. Author views that the acceptance of Modarabas sector as a responsible Shari’ah Compliant entity by the Islamic banks, Islamic Mutual Funds, Takaful companies, a vast niche market opportunities are available to the sector next step to get all operative Modarabas include in KMI-100 Index and KMI-30 index to give an opportunity to trade in Stock Exchange as a Shariah Compliant entity, thereby accepting the sector in the Islamic world.

This is an article on “Interest-Free Financing in USA” written by S. M. Hasanuzzaman, the article comprehensively cover the various aspect of interest free financing in USA and identified five institutions working on Shariah principles, methodology, these are Lariba Finance House, California, Devon Bank Illinois, Guidance Bank, Virginia, and University Islamic Financial, Michigan and Ijara Loans, Texas. Residential financing tops the list of financing activity in all five institutions. Lariba also finances auto, businesses and equipment while UIF provides many banking services. Ijara Finance offers investment opportunities based on Ijara and Murabaha as well as sukuk-al-Ijara contracts.

This is an article on “The Role of None Interest Banking in National Economy Development” by MOBOLAJI, Hakeem Ishola, discusses a preliminary study that attempts to analyze the role of non interest banking (NIB) in national economic development in Nigeria. It uses a theoretical construct and employs a discourse technique for the analysis. The paper suggests that NIB has potentials of enhancing financial inclusion and social capital in the country while reducing the cost of and risk associated with financial transactions. Through its operational modalities, it may also enhance financial depth and breadth and capable of improving financial effectiveness and efficiency which are needed for national economic development. NIB reduces asymmetry and facilitates entrepreneurship and innovation. For the NIB to fully realize its potentials and impact on the economy, some challenges have to be attended to such provision of a well structured regulatory framework on NIB to guide against abuses and ensure uniformity in practices, manpower development, more public enlightenment and standardization of accounting procedures to accommodate NIBs among others. The existence of NIB only put the country among countries with dual banking systems, combining the ethical feature of the NIB and the financial innovation of the conventional banking system, the existence of the two


systems would further enhance the potential impact of the financial sector in facilitating economic development as the two systems should be seen as complementary and not substitute.

Disclaimer

The authors themselves are responsible for the views and opinions expressed by them in their articles published in this Journal.

Readers Comments ● Asghar Nizami, Principal, HITECH, Taxila Cantt.

“We feel pleasure to mention that the magazine is read with keen interest by our scholars and readers”.

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● Syed Zahid Ahmad, Assistant Secretary General, All India Council of Muslim Economics Upliftment Limited Trust and Founder, Economic Initiatives, Mumbai (India).

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Islamic Banking Industry – Growing Amid Challenges

By By: Ahmed Ali Siddiqui *

ABSTRACT Islamic banking has proved over time that it is based on firm and sound economic principles and has a good potential for become an alternative system of banking especially in view of the global financial crises. However, there is a need for dedicated research & steps from the government to develop a sound legal and regulatory framework for Islamic financial industry. Attempts should be made to modify the existing structure to provide better products and quality service within the ambit of Islamic laws. While interest-based banking has taken hundreds of years to mature to the level where it is today, expecting the same maturity from Islamic banking in its nascent stage will be expecting too much. To develop an economic system truly reflective of the sacred principles of Islam, all stakeholders should understand the limitations at this stage and work towards its advancement.

Key Word: Global growth trend, Challenges, Key differences between Islamic & Conventional banks

Islamic Banking and finance growth has generated considerable interest in the financial world in recent years. The concept of Islamic banking has received encouraging response from different corners of the globe as one discovers its ideological dimensions and practical significance. Given its ability to offer innovative financial solutions for basic financial needs in under-served markets especially in the Muslim worlds to complex financial requirement of the modern times, it is seen as a socially responsible and ethical banking model with considerable growth potential. In the Muslim world and increasingly in the West, significant

* The author - Ahmed Ali Siddiqui, currently working with Meezan Bank as an

Executive Vice President/Head of Product Development & Shariah Compliance. He is also visiting faculty member of IBA/hold position of Senior Vice Chairman of Islamic Banking & Takaful Committee of FPCCI / member of several working groups on Islamic Banking, State Bank of Pakistan. E-mail: [email protected]


segments of the institutional and retail markets are choosing Islamic finance for their financing and investment needs. Islamic financial system also draws it strength form it being asset backed nature and directly linkage to the real economic transactions and avoidance of any element of interest and speculative activity.

Building on the very basic of Islamic teaching & philosophy, Islamic Economics thoughts accept that every human being needs involvement in some kind of economic activity for survival and it is a legitimate right for every individual. Thus Islamic banking is focused to provide an ideologically superior model to the modern day economic problems and aims for the establishment of a just & fair society. The central philosophy emerges from the divine guidelines allowing trade as an alternative of Riba or usury.

And Allah has permitted trading and prohibited riba. (Al-Baqra)

Islamic Banking & Finance - Global Growth Trends The impressive growth track of Islamic banking over the last few years has

created high expectations in the stake-holders and has compelled the major players of the banking industry, investors as well as regulators and government to view it as a separate segment in the banking industry. Keen interest in this discipline has already extended beyond Islamic countries and to non-Islamic financial institutions. In the recent times, the global financial services industry is witnessing a sharp rise in the demand for Islamic financial services. Today, more than 700 Islamic Financial Institutions are operating across the globe with around $1.2 trillion assets under management in more than 85 countries. Financial Institutions from Middle East, Far East, US and Europe to Africa, South and Central Asian republics are offering Islamic banking services. The industry is growing at a rate of roughly 15-20% percent per year, and could serve 40 to 50 percent of the world's Muslim population within a decade. According to a recent estimate by Standards & Poors the market potential for Islamic banks is estimated at $ 4 trillion.

Recently countries like Oman, Nigeria, Tanzania, Uganda & Maldives have opened their doors for Islamic finance and encouraging new and existing financial institutions to offer Islamic financial services to their customers.

Understanding The Difference: When we look at the differences between Islamic Financial Institutes and the

Interest-based conventional Institutes, we find out that the differences are on three levels:

1. Conceptual & Socio-religious level 2. Business model & Governing framework 3. Product Level Implementation

Without a clear understanding of these differences, some people, even experts tend to make a common mistake of equating Islamic banks with other conventional banks with mere change of name


Key differences between Islamic banks & conventional interest based banks At Conceptual & Socio-Religious level - Islamic banks (IB) are not money

lending institutes but they work as a trading/investment house.

- Islamic banks work under the socio-religious guidelines that prohibit charging and paying interest and avoid all impermissible transactions like gambling, speculation, short selling & Sale of debts & receivables.

- Islamic banks do not permit financing to industries which can cause harm to the society such as alcohol, tobacco etc.

- Conventional Interest based banks (CB) are in the business of lending borrowing money based on interest.

- In CB we see no such restrictions. Interest is the back-bone of this system and short sale, sale of debts and speculative transactions are common.

- In CBs all type of industries are

financed, only businesses deemed illegal by law of land are not supported.

At Business Model & Governing Framework - IBs business model is based on

trade, thus IBs need to actively participate in trade and production process and activities.

- IBs have a strong Shariah governing framework in terms of Shariah Advisor &/or Shariah Supervisory Board, which approves the transactions & product in the light of the Shariah rulings

- On the other hand, generally CBs did not involve themselves in trade and business as they act only as a money lender.

- In CBs no such framework is present and actually it is a key litmus test to judge the claim of those who fails to see differences between IBs & CBs

Product Level implementation - Islamic banking products are usually

asset backed & involve trading of assets, renting of asset and participation on profit & loss basis.

- IBs recognize loan as a non commercial and exclude it from the domain of commercial transaction. Any loan given by IBs must be interest free.

- CBs treat money as a commodity and lend it against interest as its compensation

- In CBs almost all the financing & deposit side products are loan based.

Growth Of Islamic Banking In Pakistan In Pakistan, we have seen steady growth of Islamic banking during the last

decade when the first license for Islamic commercial banking was given in 2002 to Meezan Bank. Alhamdolilah, since 2002 the progress and success of Islamic Banking in Pakistan has been admirable despite all challenges. Currently there are seventeen financial institutions licensed by State Bank of Pakistan to offer Islamic


financial services including five licensed full fledged Islamic Banks and twelve Islamic banking windows of conventional banks operating with more than 950 branches in different cities of Pakistan. During the year, addition of 2 new Islamic banking windows are expected to start their operations The expanding branch network and offering of Islamic financial products and services by the large conventional banks will boost the growth of Islamic banking and would increase its reach to the under served population that are sensitive to Riba.

150289

515651 751

886 990

2006 2007 2008 2009 2010 2011 2012

Total No. of islamic banking Branches

According to the SBP figures of June 2012, the market share of Islamic

banking in terms of overall banking deposits the Islamic Banking share stands at 8.9% at Rs. 603 billion up from the June 2011 figures of 7.6%. Islamic banks are now offering competitive saving and deposit products that are targeted to all segment of the society including senior citizens, pensioners, household and even for kids and teens. In the recent years, despite competition from conventional counter parts and government saving plans Islamic banks are witnessing healthy growth in their deposits figures and customer base.

In terms of financing transactions, the challenge is much greater for Islamic

banks as Islamic banking modes are either trade based (like Murabaha – buying and


selling of raw material and assets, Istisna – manufacturing contracts) or rental based for assets owned by Islamic banks (like Ijarah or Diminishing Musharakah) or partnership based (like Musharakah or Mudarabah – where sharing in profit or loss is done). However, Islamic bank are working their way up by focusing on research and new product development and now we can find Islamic financing solutions starting from microfinance and SME clients, agri-industry, middle market customers and large corporate houses to large infrastructure and projects. In Pakistan, the Islamic banking assets now constitutes more than 8.2% share of overall banking industry’s assets and now stands at of Rs. 711 billion.

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2007 2008 2009 2010 2011 2012

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Growth of Market Share for Islamic banks

In terms of profitability, the Islamic banking industry has shown stable

progress and the Return on Asset (ROA) and Return on Equity (ROE) of the Islamic banking industry is recorded at 2 percent and 17 percent as on Dec 2011 surpassing the overall banking system averages of 1 percent and 15 percent respectively.

KEY DRIVERS FOR GROWTH AND COMPETITIVENESS NEW CHALLENGES FOR THE INDUSTRY

Some key drivers for growth and competitiveness of Islamic banking industry includes o Product Innovation, Development and Research. o Flexible and practical application and enforcement of Shariah

principles and injunctions and its acceptability by public. o Creation of global financial hubs and regulators’ support for Islamic

finance industry. o Separate governance and prudential regulations and supervisory

guidance for Islamic banks o Development and adoption of simple, standard and cost effective legal

frameworks for contracts associated with the new and hybrid products.


With all the success and growth – Islamic Banking Industry is still in its childhood stage and there is a long way to go. This industry has to overcome many challenges in order to achieve a larger market share and sustain its growth.

Some of the challenges that the Islamic banking industry faces today includes:

o Lack of awareness & skepticism at different levels – including investors, bankers, regulators, researchers & customers.

o Being a new industry, a major challenge in its growth is the worldwide shortage of trained Human Resource in Islamic banking & finance.

o Limited number of Shariah Scholars that create over-reliance and raise questions about Shariah compliance of the institutes involved.

o Focus efforts needed for New Product Development & Research

o Solutions for Liquidity Management & creation of Islamic Inter-bank Market

o Absence of a separate Regulatory, Legal & Risk Management framework to cater the specific need of Islamic banking Institutes.


Why Murabaha (Cost-plus Finance) Is Allowed Whereas Lending On Interest Is

Prohibited In Islam? By

Syed Zahid Ahmad *

Abstract Opponents of ban on interest have been accusing Murabaha, the Shariah approved methodology of trade from the earliest times to be no different from earning interest. They also viewed earning through trade to the quite similar to lending on interest and dubbed trade as usury. However the Holy Quran has repeatedly expressed in forceful terms against the practice of Riba and permitted trade. The article has limelighted twelve particular differences between loan on interest and Murabaha. It has also illustrated the economic advantages of cost plus finance over lending on interest. It has also enumerated several other advantages of the system.

KEY WORDS: Hypothetical, Usury, Exploitation, Liquidity, Participatory Finance.

Introduction

Votaries of interest emphatically claim that trade is also like lending on interest and especially the Shariah method of Murabaha is their target which they claim to be only a subterfuge to prevent the exposure of its real face. The article has discussed the matter in great detail and shown that the opponents claims are untenable; Murabaha has no semblance of interest at all.

The argument that earning profit through Murabaha (Cost – plus finance) is like earning interest by lending money (where profit is fixed like rate of interest on loan) is indeed an age old debate which has also been pointed out 1,434 years ago in the holy Quran. * The Author Syed Zahid Ahmad is an Assistant Secretary General, All India Council of

Muslim Economics Upliftment Limited Trust and founder, Economic Initiatives, Mumbai (India)


“Those who devour usury will not stand except as stand one whom the Evil one by his touch hath driven to madness. That is because they say: “Trade is like usury,” but Allah Hath permitted trade and forbidden usury. Those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for Allah (To Judge); but those who repeat (the offence) are companions of the Fire: They will abide therein (for ever).” (Al Quran 2:275)

Money lenders have been trying to claim that earning through trade is like earning interest on loan, but ‘by permitting trade and prohibiting interest’ Islam clearly declined the disbeliever’s view that ‘trade is like usury’. Murahaba is basically a trade activity (quite different from lending money on interest) because under Murabaha the financier purchases and sells goods on credit after adding a margin of profit over the cost of purchase; whereas under interest based lending financier does not take part in any economic activity, but just lend money and get back along with interest over principal amount after set time.

There are around 10 Quranic verses and 23 Hadith on prohibition of Interest (Riba) of different nature. According to Shariah, Riba technically refers to the "premium" that must be paid by the borrower along with the principal amount as a condition for the loan or for an extension in its maturity. So, Riba has the same meaning as interest in conventional banking in accordance with the consensus among all Islamic schools of thoughts. There are two major types of Riba in Shariah. The first (Riba al Nasiah) describes prohibition of lending money on interest whereas the second (Riba al Fadl) prohibits all unfair commercial transactions that leads to exploitation. Since Murabaha does not fall under any category of Riba described in Hadith, it can not be rated alike lending on interest. Furthermore there are operational differences between lending money on interest and cost plus finance.

Lending Money on Interest Cost Plus Finance (Murabaha) 1. Financier lends money to earn

interest over principal amount without bearing risks associated with the borrower’s economic activity.

1. Financier practically doing trade by purchasing and selling goods on credit at a price set after adding profit margin over cost of purchase.

2. Money is considered a kind of asset and accumulation of monetary asset is made out of monetary asset without changing its form from money to goods.

2. Money is treated as means to measure value of goods and medium of exchange. Value of goods may enhanced only after selling the bought goods to customers.

3. Financier has nothing to contribute towards Government revenue.

3. Financier pays sales tax on trade volume to the Government.

4. Financier does not interfere in business activity of the borrower and do nothing to help the borrower get competitive prices for sought goods or commodities.

4. Financier bargains with the supplier to avail discount in price of goods so as to offer competitive prices of the goods to the customers.


5. Financier has nothing to do with quality of the goods sought by its customer.

5. Financier bears associated risks on quality of the goods sold to its customer.

6. Through lending loan on interest the Financier increases customer’s demand force which may inflate the economy with limited resources for suppliers.

6. Purchase and sell by financier boosts production process and flow of liquidity from the customers to the bank reduces inflation by slicing purchasing power.

7. Rate of interest on loan amount is related to time factor.

7. There is no interest and the price value of sold goods is not related to time factor.

8. Borrower need to repay the installment of interest and principal on due dates.

8. Customer is supposed to repay part of total price value of goods on due dates.

9. Financier does not allow the borrower to reschedule the installment on due dates even in case of any genuine financial crisis. Penalty may be charged for that.

9. In case of genuine financial crisis, the financier does allow the buyer to reschedule the due installment dates without any penalty.

10. Financier need not to get any registered sale tax number.

10. Financier need to obtain registered sales tax number.

11. Financier has nothing to do in collection and submission of sales tax.

11. Financier used to pay and charge sales tax; and submit to sales tax department.

12. Financier need not to have any purchase officer with specialization in trade.

12. Financier does need to have purchase officer with specialization in trade.

Besides above operational differences it is important to analyze and evaluate the impacts of interest based lending and cost plus finance on the economy. Interestingly Cost plus Finance has the potential to increase economic growth by pushing consumption, production and Government revenue with putting customers demand forces under control with flow of liquidity from customer to bank segment.

We can evaluate the differential impact of interest based lending and cost plus finance by a hypothetical study. Suppose there are two types of banks in our economy. One is lending on interest and other is offering cost plus finance. Both can offer same rate of returns to their depositors (e.g. 8% annual interest or dividend to the depositors) and charges 15% annual interest on loans or adds 15% profit margin (over cost of purchase) in case of cost plus finance. Since bank extending cost plus finance with intention to get competitive quote for the goods, bargains with the supplier and pass on the discounts to the buyer, it helps the customer pay less for availing required goods; and also provides more revenue to the Government.

After evaluating an experience to provide 264 liter capacity of Godrej brand refrigerator to a small retailer (who needed that to store cold drinks and ice candies


for sale) in Parbhani district of Maharashtra (India), we observed that though cost of Refrigerator was more for the retailer through Cost plus Finance, the retailer preferred it over borrowing loan from bank. Following table may help us analyze economic advantage of Cost plus finance over lending on interest

Financial and Economic Transactions

Lending on Interest

Cost Plus Finance

Refrigerator cost for the Wholesaler (including taxes) 16,087.50 16,087.50

Price quoted by Wholesaler to the Retailer (after bargaining) 17,500.00 17,500.00

Price charged by Wholesaler to Bank after bargaining - 16,700.63

Discount in price by Wholesaler for Bank (4.6%) - 799.38

Profit margin added by Bank over cost of purchase (15% of cost) - 2,226.75

Price (including taxes) offered by Bank for sale to the Customer - 19,205.72

Amount of loan if customer need to avail from Bank 17,500.00 -

Comparative Advantage in Refrigerator’s Price for Retailer 1,705.72 (1,705.72)

Total amount need to repay by the customer to the Bank 20,125.00 19,205.72

Comparative Cost of Credit the Retailer need to pay 2,625.00 1,705.72

1. Income earned by Wholesaler 1,412.50 613.13 2. Revenue for Bank (15% interest

or profit on purchase value) 2,625.00 2,505.09

3. Amount shared by Bank with Depositors (8% of deposits) 1,400.00 1,336.05

4. VAT received by the Government from Wholesaler / Bank 1,787.50 2,133.97

5. Amount spent by Bank for execution (5% of actual finance) 875.00 835.03

6. Net Income by Bank after expenditure (2% of actual finance)

350.00 334.01

Total Value Addition (Income earned by all economic units) 8,450.00 7,757.28

Average Income earned by each economic unit 1,408.33 1,292.88

Wholesaler’s advantage in gross earnings 799.38 (799.38)


Government comparative advantage in terms of revenue (346.47) 346.47

Financial Advantage to the Retailer (Bank’s Customer)

(919.28) 919.28

Percentage financial advantage for the customer

(5.25%) 5.25%

The above statistics shows how cost plus finance not only helps the customer save 5.25% of financial resources, but also increases Government revenues in terms of sales tax. Since the bank dealing in cost plus finance, bargains with the supplier, the profit margin for the supplier reduces and its advantage passes on to the customer. Nevertheless the supplier eagerly supplies the Refrigerator at lower price considering the bank as an agency to promote sale volume (with its customer base needs) and ultimately raising income potential for the supplier through sale for more customers channelizing through cost plus finance by the bank.

Besides financial aspects, it is interesting to notice the flow of liquidity under cost plus finance mechanism compared to interest based lending. Since interest based lending enhances purchasing power of the customers, there is challenge to manage demand pull inflation in the economy with constant supply. Though the payment for purchase of goods by the customer induces the producer increases the productivity, more interest based lending to new customers further increases the demand side inflation in the market. So the potential of fall in prices by increase in productivity is being nullified by increase in demand pull inflation. So, we cannot handle inflation through interest based lending. However the practice of cost plus finance by banks can help us to -

● Increase in consumption (as the consumer take goods from bank on credit) to increase potential for economic growth rate.

● Decrease in prices as purchase of goods by bank allows the supplier to produce more; and increase in productivity with constant demand would lead to fall in prices.

● Control in demand side inflation because the customer do not get liquidity rather would need to repay value of bought goods back to the bank; and the customer need to transfer access of income over expenditure to repay cash to the bank.

We hope that the RBI would introduce cost plus finance as an optional product with intention to keep inflation under control seeking increase in economic growth rate. Hopefully this product would be termed as part of Participatory Finance instead of Islamic Banking to keep it secular. Hopefully money lender would not argue again and again that trade is like lending on interest.


Response To Meera’s Critique Of The ZDBM1

By Prof. Dr. Zubair Hasan*

ABSTRACT This paper responds to the criticism of the Zubair’s Diminishing Balance model for Islamic home financing that Ahmad Kameel Meera published in the ISRA Journal. The response argues that most of the comments of Meera are frivolous and misplaced. It reiterates that the ZDBM is much different from other models; it is cheaper for the customer without being costlier to the bank. It is more efficient in resource allocation and improves liquidity in the financial system. However, the mathematical appendix is a positive contribution of the paper.

Key words: Islamic home financing, conventional model; BBA; MMP; ZDBM; Segmental murabahah

1. Introduction Ahmad Kameel Meera has published an article in the current issue of ISRA

Journal (2012) which “criticizes a new Islamic home financing model” based on diminishing balance as proposed in Hasan (2011) and named the ZDBM. For brevity, I shall refer to Meera’s work as the Critique.The main points of criticism it contains are as follows (P.7).

1. ZDBM is similar to the conventional interest based loan, or at best, similar to the murabahah-based bay bi thamanajil (BBA).

2. It is not cheaper to the customer. On the contrary, it is potentially more burdensome to him, particularly when it comes to early settlement.

3. Musharakah Mutinaqisa program for home financing or the MMP is superior to the ZDBM and is recognized as fully Shari’ah compliant. I shall deal with these observations in that order and show how the demonstrations

in the Critique are at variance with the perceptions of its author.

* Author – Prof. Dr. Zubair Hasan, Professor of Economics and Finance, INCEIF: The

Global University of Islamic Finance, Malaysia. 1 The views expressed are of the author and need in no way be associated with INCEIF

the Global University of Islamic finance where he currently works. Since the ISRA Journal does not accept as a policy comments on the material it publishes; this response is put on the internet as a short working paper.


II. Non-Similarity With Other Models All home financing models would have, as they do, some similar requirements. For

example, the need for pricing, installment fixation, loan repayment and the like are common to them all. Similarities, however, need not make their substance also the same. For differences the models must be compared on the logic of their structuring and on the basis of legal observance and social efficacy of their consequences. One such similarity Meera indicates between the BBA and ZDBM. He says “ ZDBM would face problems similar to those encountered in BBA financing particularly when it comes to early settlement, the balance of financing can even be more than the original financing amount (P.7)”2 Presumably, problems of the sort could arise if the murabahah is initially contracted on the full value of the deferred payment as in BBA. However, in the ZDBM murabahah is segmental; it applies to individual installments, not to their collectivity. That is why, ZDBM is a sort of financial innovation. It has no similarity with BBA3.

Interestingly, the issue of similarities the Critique highlights has caused some serious inconsistencies in the formulation of its own arguments. Its Tables supply ample material to help fillip the proposition in the reverse direction. Table 1 below is drawn using data from Tables 1 and 3 of the Critique. We use the column identification as given in these tables. Columns B, C, D and E in Section 1 correspond to columns B1, C1, D1 and E1 in Section 2 of the Table.

Tab1e 1. ZDBM is different from other models which have identical structures and results SECTION 1 SECTION 2

source: Meera’s Tables 1 and 3.

2 Meera shows how this could happen in the case of BBA on P. 12 but he does not show

why and how this would happen in the ZDBM. 3. The focus of writings Meera reviews has been the comparison of MMP with the ZDBM. As

such we shall skip over the references to BBA in the critique unless essential.


The scrutiny as to why the details of the models – conventional and the MMP – in Section 1 are identical and why those for the ZDBM in Section 2 are so different from them would help clarify many misconceptions the Critique contains. The departures signify qualitative differences supportive of the Diminishing Balance Model.

To Meera, the ZDBM looks cheaper because earlier installment payments are larger compared to those in the MMP. He then goes on to show(PP.17-19 Tables 5 and 6) as to how the variationsin installment amount would affect the return on capital. But mathematics devoid of logic cannot create an argument albeitit can help build or destroy its reasoning. Amortization in the ZDBM at a uniform rate derives its justification from the Islamic norms of equity and fair play; the rate is not arbitrarily fixed.

It may well be noted that researches have confirmedtheuniform amortization payments as the best from the view point of ownership transfer to the customer (Chambers et al 2007). One disputing the claim has to show that any departure from uniformity in return of capital amounts could give logically better results on the touchstone of justice to the customer.

Finally, the claim that ZDBM is cheaper for the customer is confirmed by footnotes to tables 2 and 4 of the Critique. For both the conventional and MMP the average annual return for the bank is 4.72% while it is 4.20% in the case of ZDBM. But the IRR in either case remains the same at 8% a year. The reason is that the sum of funding deposits -- the outstanding balances -- is proportionately reduced in the ZDBM. Hasan (2012) provides the proof summarized as under.

891.03773133600

943270840000

Re

MMP

ZDBMCapitalonturnDeposisFundingModels

Thus, the ZDBM is not only cheaper; it is also more efficient than the MMP: it absorbs fewer resources and to that extent improves liquidity in the financial system. In this context, Meera raises two interesting questions. First, the IRR in all models being the same, 8% a year; why the bank would not be indifferent to a choice between them? A more relevant question would perhaps be why would the bank not be attracted to the ZDBM to please the customers with lower payments without incurring any additional costs in the shape of lower rate of return; would it not give Islamic banks a competitive edge over their conventional rivals?

The second question of Meera is: from where Hasan got the 8% rental rate for the ZDBM and how? The question looks frivolous in the present context. Using the same rate, whatever be the percentage, is a methodological tool in model comparisons not an operational reality. In their illustration La-riba also fixes the rate at 8% a year. This helped me discover that they too are using the Excel formula. Meera himself uses 8% for all models in his Critique for comparing results.

III. Excel Formula And Compounding: Impact On MMP Meera (2012 and with Razak 2009) concedes that the results in the MMP and

conventional model would be identical if the rate of interest and the rental rate were identical but he does not explain why? The reason is not that the rates used are identical.


(1)11

10

n

n

rrr.PA

The reason is that both models use the same Microsoft Excel amortization formula for the determination of the periodic installment payments. This formula is given below

Here, A = Installment amount the customer has to pay per time unit to the bank P0 = Bank’s contribution (loan) to the purchase price of the house r = the rate of interest payable on outstanding loan per period n = number of time units the payment period is divided; be it a week, a

month or a year.

I have shown in a recent paper that this formula involves compounding of interest (Hasan 2012). It adds the current period interest to the preceding period balance for calculating the current period balance. The simplified formula for determining the current period outstanding balance (Pn) is derived to be as under.

Pn = Pn-1 (1 + r) – A (2)

Based on this formula the compounding process is explained by the following simple Figure 1 using the data from Table 1 above.

A further un-Islamic consequence of using this formula additional to

compounding is that until the successful completion of the contract the rate of ownership transfer to the customer remains lower with reference to amounts paid. It is obvious in the conventional model and would be so in the MMP if compounding is unavoidable. In the ZDBM the two rates stay identical all through. Table 2 and Figure 2 provide the evidence on the point.

Table 2: Home ownership transfer to the customer in conventional and MMP finance

Payment rate % 1 2 3 4 5 6 7 8 9 10 Payment rate % 5 10 15 20 25 30 35 40 45 50 Ownership rate % 3.25 6.85 10.48 14.36 18.19 22.27 26.52 30.94 35.54 40.32

Semi-annual units 11 12 13 14 15 16 17 18 19 20 Payment rate % 55 60 65 70 75 80 85 90 95 100 Ownership rate % 45.29 50.46 55.83 61.42 67.24 73.26 76.56 86.12 92.92 100


0

20

40

60

80

100

120

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Ownership transfer to the customer: ZDBM and MMP compared%

Half -yearly payment units

All models payment %

Ownership transfer % in the Conventional and MMP

Figure 2: Conventional MMP home financing transfers ownership to customer at a slower than the payments rate

The explanation of this difference is as follows: In the case of conventional models the semi-annual installment amount is the same (RM 5886.54). In the ZDBM, the corresponding amount is the return of capital (RM 4000) that remains unchanged. The uniformity in either case indicates 1/20 or 5% payment per time unit. This fixes the second row of Table 2 common to all models. However, the ownership transfer rate to the customer with reference to the semi-annual outstanding balance is the same for the conventional and the MMP models but different from that for the ZDBM.

For the conventional and the MMP models, we find it as follows. Divide the outstanding balance in column C of Table 1 by the total loan amount. Deduct the fraction so obtained from 1 and convert the result to a percentage. This has given us the bottom row of Table 2. Performing the same operation on column C1 of the table, we get the same rates as in row 2 of that Table. Thus we find that there is slower ownership transfer in the MMP compared to the ZDBM. The reason is a disproportionately higher allocation from installment payments to return of capital compared to return of capital in the MMP; half-way through in our example the split between the two is about 60:40 percent. In contrast, if the same procedure is applied to the outstanding balance C1 in the ZDBM, we find that the balance diminishes at the same rate at which the return of capital increases. Thus, the ownership transfer to the customer is pro rata.

However, if we go by the equity, the ownership transfer in the MMP can be claimed as pro rata. But the claim would be tenable only on allowing the compounding of return to enter the picture. Interestingly, provision of 100% bank financing for house purchase is no problem under the conventional model or the ZDBM (Hasan 2011) but one has to explain how MMP would operate if the customer has nothing to invest; how the initial ownership ratio would for example be determined? Unlike the BBA, the participatory model (MMP) has yet to face the litmus test of the courts. I am skeptical if it would be able to withstand the scrutiny when the time comes.


Iv. Concluding Remarks It comes about that on the Islamic requirements of avoiding interest, more so

the compounding, and for the observance of justice - to each his due without delay - the MMP using the Excel formula, following the current practice is non-compliant and must be replaced with a better alternative like the ZDBM. The readers may refer to Hasan (2012) for detailed comparison of the two models. Finally, I must express my appreciation for Meera’s valuable contribution and especially for the Appendix in his paper that neatly presents mathematical formalization of concepts in the ZDBM.

References American Finance House – LARIBA: Financing alternative to the conventional, Riba

System, Lariba.com Home Financing – Accessed on 24.10.2011

Chambers, M. S, Garage, C and Sehlagehauf, D (September 2007): Mortgage contracts and housing tenure decisions, Working Paper, Federal Reserve Bank of St. Louis (Research Division), pp. 1-40.

Hasan, Zubair (2012): Islamic norms, Excel formula and Islamic home financing models, working paper, MPRA # 4835 ‘Zubair Hasan at IDEAS.

HasanZubair (2011): Islamic home finance in the social mirror, ISRA: International Journal of Islamic Finance, Vol. 3, No.1 June.

Meera, A. K. M &Razak, D. A (2009): Home financing through the Musharaka hMutanaqisah contracts: some practical issues, JKAU: Islamic Economics, Vol. 22, No.1, pp. 3-25.

Meera, A.K (2012): A critique of diminishing balance method of Islamic home financing, ISRA International Journal of Islamic Finance, Vol. 4 Issue 2 December.


Adoption of AAOIFI Shariah Standards: Case of Pakistan.

Introduction Harmonizing and standardizing

Shariah practices and procedures of global Islamic financial institutions is considered essential for sustainable growth of the industry. To this end, various global Islamic organizations have strived towards forming standards and procedures that are not only Shariah compliant but are also acceptable by conventional regulators. Bahrain based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is one of such globally recognized international bodies that prepare Shariah based accounting, auditing, governance, ethics and Shariah Standards for the Islamic financial industry (see Box 2 for details). AAOIFI based standards are generally considered to be globally acceptable and are adopted in various jurisdictions of the world including the Kingdom of Bahrain, Jordan, Lebanon, Qatar, Sudan and Syria. Pakistan also remained committed to provide an internationally acceptable regulatory structure and in the first phase has adopted four AAOIFI Shariah Standards after tailoring them in accordance with the legal and regulatory framework of the country. Other Shariah standards are also under consideration for implementation in the country with necessary amendments/clarifications if any.

. Source: SBP Islamic Banking Bulletin April-June 2012

Box: 2 The Accounting and Auditing O r gani z a t i on f or Is l a mi c Fi nanc i a l Institutions (AAOIFI):

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an independent body dedicated to the development of international standards applicable for Islamic financial institutions. The Bahrain-based organization was registered as an international autonomous non-profit making corporate body in 1991 and started producing standards in 1993. AAOIFI is supported by institutional members including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry. To date AAOIFI has developed standards related to accounting (26), auditing (5), governance (7), ethics (2) and Shariah (45) for Islamic financial industry.


Murabaha To Purchase Orderer (Shariah Standard 8) In general terms, Murabaha means sale of goods by a person to another under an

arrangement whereby the seller is obliged to disclose to the buyer the cost of goods sold either on cash basis or deferred payment basis and a margin of profit is included in the sale price of goods agreed to be sold. However, in Islamic banking when Murabaha is used as a mode of finance it is slightly different as in this case the transaction is concluded with a prior promise to buy, submitted by the person interested in acquiring goods through the institution. Such transaction is generally referred to as Murabaha to the purchase orderer.

AAOIFI Shariah standard (8) addresses this mode of transaction and tries to explain the rules for such transaction, the various stages that form part of this transaction along with the Shariah requirements that need to be observed by Islamic financial institutions for executing this transaction. Accordingly the standard is explained through clauses in the following sequence:

Procedures prior to the contract of Murabaha: All steps that need to be fulfilled before execution of the Murabaha contract are explained in this clause which is further divided into following sub- clauses.

● The customer's expression of his wish to acquire an item through the institution (4 sub-clauses) ● The position of the Institution In respect to the application of the

customer for Murabaha to the purchase orderer (6 sub-clauses) ● The promise from the customer (5 sub-clauses) ● Commissions and expenses (5 sub-clauses) ● Guarantees related to the commencement of the transaction (6 sub-clauses)

● Acquisition of title to, and possession of, the asset by the institution or its agent: The acquisition of the asset or good by the institution prior to its sale by means of Murabaha to the purchase orderer ● The institution's taking possession of the asset or good, prior to its sale by

Murabaha to the purchase orderer ● Conclusion of a Murabaha contract ● Guarantees and treatment of Murabaha receivables

The standard concludes by providing 5 Appendices related to the Shariah standard. These Appendices are related to:

● Appendix A: Notice for Purchase of goods / assets by the agent ● Appendix B: Notice of the acceptance by the institution ● Appendix C: Brief history of the preparation of the Standard ● Appendix D: Basis of the Shariah rulings ● Appendix E: Definitions


Adoption Of Murabaha To Purchase Orderer Standard In Pakistan: As stated earlier, Pakistan has adopted four AAOIFI Shariah Standards after

tailoring them in accordance with the legal and regulatory framework of the country. In case of Murabaha to Purchase Orderer, State Bank of Pakistan after consultation with local stakeholders, made further clarifications and amendments in various clauses of the Standard that are discussed below:

Original Clause Amendment Clarification Reason (if any) It is essential to exclude any prior contractual relationship between the customer who is the purchase orderer and the original supplier of the item ordered, if any, regarding the supply of the item. It is a requirement of M urabaha to the purchase orderer that the transaction between the two parties must genuinely, not fictitiously, exclude any prior contractual relationship.

The phrase, ―prior contractual relationship ||. shall refer to ―prior sale contract | |.

It is not permitted for the institution and the customer to agree to form a musharaka in a project or a specified deal together with a promise from one of them to buy the other's musharaka participation by means of M urabaha on either spot or deferred payment terms. However, it is permissible for one partner to promise to purchase the other's musharaka participation at market selling price or at a price to be agreed upon at the time of sale provided a new contract is drawn up. This sale may be on spot or on deferred payment terms.

This clause is not applicable to Shi rkat ul Milk.


It is not permissible that the document of promise to buy (signed by the customer) should include a bilateral promise which is binding on both parties (the institution and the customer).

Currently, in the context of M urabaha in Pakistan, a bilateral promise / agreement is permissible.

Master M urabaha agreements contains bilateral covenant regarding purchase of the asset.

It is permissible for the institution to take urbon (earnest money) after concluding the M urabaha sale with the customer. This may not be done during the contractual stage at which the customer has given his promise to purchase. It is preferable that the institution return to the customer the amount that remains after deducting the actual damage incurred from the U rbon as a result of the breach, namely the difference between the cost of the item to the institution and its selling price to a third party.

The institution shall return to the customer the amount of U rbon (earnest money) after deducting the actual damages incurred.

In order to ensure that actual damages incurred by the bank are recovered from U rbon the use of word permissible should be replaced by mandatory. Hence an explanatory note was added.

The original principle is that the institution itself purchases the item directly from the supplier. However, it is permissible for the institution to carry out the purchase by authorizing an agent, other than the purchase orderer, to make the purchase; and the customer (the purchase orderer) should not be appointed to act as an agent except in a situation of dire need. Furthermore, the agent must not sell the item to himself. Rather, the institution must first acquire title of the item and then sell it to the agent.

The agent shall not consume or sell, goods purchased on behalf of the institution until such goods are sold by the institution to the customer.

Clarification for the word dire need was necessary. Thus it was suggested in such special case where cash is provided on dire need basis an explanation, approved by Shariah advisor should be provided by the bank. Hence clarification was provided.


In cases when the customer is authorized to purchase the item as the institution's agent, it is obligatory to adopt procedures which would ensure that certain conditions are observed. These conditions include the requirement that: (a) the institution itself must pay the supplier, and not pay the price of the item into the account of the customer as agent. (b) the institution should obtain from the supplier the documents that confirm that a sale has taken place.

The payment mechanism presently adopted by Islamic Banking Institutions, whereby the supplier is paid by the bank through the transaction account opened in the name of agent and the customer may also acts as an agent, achieves the rationale behind this clause. However, in exceptional cases where the agent has to be given cash for onward payment to supplier, the matter can be decided by the Shariah Adviser and his specific approval would be required for this purpose.

Current practice followed by Islamic banks in the country regarding payments made to the supplier achieves the objectives of this clause. Hence amendment was made for clarification purposes.

Apart from the above mentioned amendments/clarifications in various clauses of

the Shariah standard, two appendixes i.e. Appendix A (Notice for Purchase of goods / assets by the agent) & Appendix B- (Notice of the acceptance by the institution), were also amended and it was decided that the Model Murabaha Facility Agreement, shall be followed instead of these two appendices.

Sources: ● Shariah Standards for Islamic Financial Institutions, AAOIFI (2010)

● Website of State Bank of Pakistan (www.sbp.org.pk)

● Website of AAOIFI (http://www.aaoifi.com)

http://www.islamicbanker.com/aaoifi-standards


Islam And Environmental Economics By

Salman Ahmed Shaikh* ABSTRACT Economic choices influenced by animalistic instincts in an ethically neutral framework has not only resulted in huge disparity in distribution of income, wealth and standard of living, but, as we now realize, it has also resulted in unprecedented loss to ecology and environment with catastrophic consequences for future generations. More than ever, Economics as a discipline of knowledge needs an ethical base to rekindle spiritual rationality that can enable us to take into account equity considerations more explicitly. This paper explains how Islamic economics can help in bridging the gap. Section 1 explains the philosophy of Islamic economics and the role of market mechanism in an Islamic economy. Section 2 explores briefly the environmental issues faced currently and provides a brief literature review. Section 3 discusses the teachings of Islam on different environmental issues and how Islamic teachings can help in encouraging and reinforcing environmental friendly choices and behavior.

Keywords Environmental Economics, Resource Economics, Welfare Economics, Climate Change, Stern Review, Islamic Economics

JEL Codes Q2, Q3, Q5, I3

1. Philosophy Of Islamic Economics As per Islam, this worldly life is a test for humans. Design of this test requires

human interdependence which then requires difference in ranks, i.e. endowments, abilities etc. This consequently results in difference in wealth and incomes people have. But, then, both, the rich and the poor as part of this test are going to be judged on the basis of how they each individually act on the benchmarks of thankfulness, patience, obedience and upholding ethical guidelines prescribed by their Creator for * The Author Salman Ahmed Shaikh is a Full Time Faculty (Economics & Finance) at

Institute of Business Administration, Karachi, Pakistan. He is pursuing his PhD in Economics. He is author of “Proposal for New Economic Framework” and he has written several dozen research papers and articles in the area of Islamic Economics and Finance.


them through an inbuilt conscience and through guidance provided via sending Prophets (peace be upon them all).

Humans are much more than utility maximizing machines. They are capable of using both material rationality and moral rationality to differentiate right from wrong and need reinforcement to adopt virtues influenced by an inner urge other than just material interests.

This inner urge can be reawakened by looking beyond utility maximization models to re-acknowledge the principal fact that humans are moral being than just an instrument for maximum material advancement for self.

History of economic man is fascinating. He has used the nature’s blessings to find and create new and innovative ways of maximizing utility. But, nonetheless, at all points in time, he does not feel satiated. He remains poor ‘relatively’ to the limitless desires and nature’s limitations. The dream of being absolutely apart only remains a dream in everyone’s life. But, then, everyone achieves it one day. There is one place that everyone reaches where he is not accompanied by anyone. It’s his or her grave. Belief in life hereafter is the only thing that gives meaning to this world and life and this is the most important pillar of Islamic economics.

1.1 Market Mechanism In An Islamic Economy In an Islamic economy, market mechanism is filtered by divine injunctions.

The divine injunctions are binding, but they do not disallow market mechanism to work after following these injunctions.

All that these divine injunctions do is to regulate certain actions, provide broad guidelines and through which certain restrictions are imposed on humans for their own benefit. But beyond that, market mechanism is allowed to work and in fact regarded as a just way of organizing economic exchange in society.

1.2 Islam & Welfare Economics In the mainstream economics, utility (satisfaction) is assumed to be attained

when the person consumes the material goods and services which bring satisfaction. Even though, there is room in utility maximization models to incorporate empathy, altruism etc, but, the models remain neutral and perhaps rightly so as long as their objectives are confined to ‘description’ and ‘prediction’ than ‘prescription’.

With belief in Allah, a Muslim's scope of life and objective is different. His principal goal is to seek Allah's pleasure and succeed in the life hereafter. So, a Muslim is supposed to make every decision in a way to seek Allah's pleasure rather than pursuing self-pleasure and satisfaction “as an end in itself”.

As per Islam, this world is a place for test and this test requires some people to be privileged and some to be deprived. The deprived and privileged are both tested for patience and thankfulness to Allah and how they take care of society and its needs. Hence, this worldview put the focus of all human beings towards the fact that material resources they enjoy are all blessings of Allah and these are instruments for this test.


Islamic economics incorporates ethical values and excludes from the consumption bundle various goods which bring either private loss or welfare loss to the society. Furthermore, the ethical values in Islamic economics are more comprehensive.

Second, Islamic economics brings a long term perspective to the pursuit of self-interest by informing humans about the positive and negative consequences of their actions and choices in the life hereafter. Resultantly, an Islamic economy will have to rely less on regulation and legal governance to encourage ethical behavior.

As per Islam, the tendency to seek worldly pleasures from certain goods and services is natural. The test is to nurture one’s conscience and fight these tendencies so that they do not grow beyond a certain level. This test is for each person in individual capacity. We cannot completely deny those tendencies. Neither Muhammad (peace be upon him) nor the pious caliphs (rta) used any means other than moral persuasion to inculcate a parallel righteous behavior alongside these natural tendencies so that they remain mere tendencies, i.e. weak enough to not influence important choices humans make in matters involving a moral issue.

Rather than complimenting humans in their animalistic instincts to keep having one-eyed focus on material well-being only, Islam inculcates piousness, kindness, cooperation and communal responsibility in humans. In some instances, Islam guides explicitly to avoid extravagance, lavishness and using certain products and services which harm a human’s ethical existence and well being either individually and/or harm the society in the process.

Religion provides such meaningful conditioning which enables bringing the right balance between human aspirations and their physical limits. Religion also promises salvage from the limitedness of this worldly life in heaven which will be awarded to the most righteous people. This, in turn, provides a permanent incentive to choose righteous behavior as an end with the hope and fear of deterministic results in life hereafter.

Economics says that there is a tradeoff in every resource use as any resource has alternate uses. One may feel that striving for success in life hereafter would require a drastic tradeoff between material pursuits and following Allah’s will. Indeed, if material lust is preferred over Allah’s will, there will be permanent loss in life hereafter, but that does not preclude us from not having the ability to benefit from Allah’s blessings in this world.

Islam does not discourage seeking Allah’s bounty in the temporal world. One prayer in Quran reads as follows:

“…But of mankind there are some who say: “Our Lord! Give us (Your Bounties) in this world!” and for such there will be no portion in the Hereafter. And of them there are some who say: “Our Lord! Give us in this world that which is good and in the Hereafter that which is good, and save us from the torment of the Fire!”

(Al-Baqarah: Verse 200-201)


In economics terminology, Islam does not ask us to have a corner solution when the two goods in question are ‘worldly benefits’ and ‘investment for life hereafter benefits’. Islam does not require us to completely abstain from blessings of this world, but to have a balanced life and a balanced composition of the two goods mentioned above.

Afterlife accountability encourages observing ethical values which are not easily enforceable through legal systems made by humans after all. Question of fairness and equity can only be sufficiently dealt with and incorporated into the preferences and behavior with belief in religion. Islam besides having a comprehensive perspective on justice, also recommends ‘Ihsan’ which requires people to bring about fairness and equity with resources they have as blessings of Allah and which they should regard as a trust and act always with spiritual rationality of afterlife accountability.

2. Environmental Issues & Economics In a World Bank report, it was highlighted that the use of energy per capita in

high income countries is more than 5 times as much as in developing countries, and with only 15% of the world’s population, high income countries use more than half of its energy (World development Indicators, 2006).

In Stern Review, it was highlighted that United States is found to be the most polluting country in the world together with Europe which accounts for around 70% of World’s pollution.

Mortazvi (2004) pinpoints the root of the problem and states that the concern over the tragedy of the commons emanates from the fact that Western economics has become a discipline devoid of values. Exploitation of the natural environment can be abated when individuals consider intergenerational welfare and justice to be important factors in their economic decisions. Islamic economics, unlike its Western counterpart, is a value-driven discipline replete with moral values that limits individual’s consumption, and imposes significant social and religious responsibilities on individuals as guardians of the natural environment for future generations.

Khalid (2002, pp. 332) explaining the effect of growth led by fiat money expansion that has speedily deteriorated the environment writes:

“These tokens of value that we create from nothing and use everyday grow exponentially ad infinitum. But we know that the natural world, which is subject to drastic resource depletion, has limits and is finite. This equation is lopsided and the question is for how long can we continue to create this infinite amount of token finance to exploit the real and tangible resources of a finite world? Looked at from this perspective, money, as the modern world has contrived it, assumes the characteristics of a virus that eats into the fabric of the planet. The consequences of this become visible as global environmental degradation.”

Hassan (2006) shares the same line of thought and states that in the international arena, nothing can help except realization of common danger, discipline


and sacrifice for common good. Free riding can hardly be condoned. Instead of preservation and restraint, we are borrowing from the future to consume now via the credit card culture. In a word, we are jeopardizing the future of our children let alone leaving them in at least the same position as ours.

ASTRÖM (2011) explains that one of the problematic points of view of today’s generation is that they have the rights of limitless ownership without taking into account the responsibilities towards society and humanity.

Na’iya (2007) suggests that the effective solution to the environmental problems lies on the overall worldview which spells out the relationship between man, nature and his Creator as well as the implications of one’s actions in the hereafter.

3. Islam & Environmental Economics With the concept of afterlife accountability, Islam immensely influences

intertemporal choice and behavior. It helps in private economic agents (consumers, producers etc.) modifying their actions in such a way that takes the externalities into consideration and also their own welfare, both in this world and afterwards. Afterlife accountability stimulate positive change in behavior in a much more comprehensive and permanent manner than any regulation or material incentive could possibly do.

Below, we mention several verses from Quran and sayings of Prophet Muhammad (peace be upon Him) which discuss the responsibilities to the environment.

3.1 Incorporating social cost in private actions Prophet Muhammad (peace be upon Him) said:

“I swear by Allah, one cannot become fully Muslim until he (or she) likes for others whatever he (or she) likes for himself (or herself).”

(Sahih al-Bukhari, Vol. 1, p. 14)

Prophet Muhammad (peace be upon Him) said:

"He who cuts a lote-tree [without justification], Allah will send him to Hellfire."

(Narrated in Al-Tirmidhi, Hadith No. 5239)

3.2 Promising private rewards to socially desirable actions Prophet Muhammad (peace be upon Him) said:

“There is none better amongst the believers who plants a tree from which a person, or an animal eats thereof. It is regarded as having given a charitable gift for which there is great recompense.”

(Narrated in Sahih Al-Bukhari, Vol 3: 513)


“Whoever plants trees, God will give him reward to the extent of their fruit.”

(Narrated in Musnad, v, 415)


3.3 Ensuring Equity, Absolute Justice & MSB=MSC The Holy Quran says that:

“He who does good of an atom's weight, he will see it. And he, who does ill of an atom's weight, he will see it.”

(Az-Zilzaalaha: Verse 7-8)

3.4 Promising private rewards to socially desirable actions Prophet Muhammad (peace be upon Him) said:

“Whoever reclaims and cultivates dry, barren land, will be rewarded by God for the act. So long as men and animals benefit from it, He will record it as almsgiving.”

Al-Munawi, Fayd al-Qadir, vi, 39; Haythami, Majmau al-Zawaaid, iv, 67-8.


“If a Muslim plants a tree or grow grains and a bird, a person or an animal eats from it, it will be counted as a charity for him.”

(Bukhara, "al-Khars ve'l-Muzara", Muslim, "Musakaat", H. No: 12)


“Whoever plants a tree and diligently looks after it until it matures and bears fruit, will be rewarded.”

(Narrated in Ahmad b.Hanbal, Musnad, IV, 61, 374)


“Whoever plants a tree and it matures, Allah plants a tree in paradise for that person.”

(Narrated in Ahmad b.Hanbal, Musnad, IV, 61)


"If the Hour is imminent and anyone of you has a palm shoot (to plant) in his hand and is able to plant it before the Hour strikes, then he should do so and he will be rewarded for that action."

(Narrated in Sahih Al-Bukhari)


"Removing harmful things from the road is an act of charity (Sadaqah)."

(Narrated by Abu Dharr Al-Ghafari)


"A good deed done to a beast is as good as doing good to a human being; while an act of cruelty to a beast is as bad as an act of cruelty to human beings," and that: "Kindness to animals was promised by rewards in Life Hereafter."

(Mishkat al-Masabih; Book 6; Chapter 7, 8:178)


3.5 Protection of Bio-Diversity Prophet Muhammad (peace be upon Him) said:

“On the day of Judgment, Allah will ask those who kill a sparrow unfairly.” (Narrated in Muslim, Hadith No 57)


"If anyone wrongfully kills even a sparrow, let alone anything greater, he will face God's interrogation."

(Narrated in Mishkat al Masabih)

It is narrated in Sahih Muslim that:

“A man suffered from intense thirst while on a journey. He found a well, came to it, drank (water) and then came out. Suddenly, a dog appeared with its tongue out due to thirst. The man said: This dog has suffered from thirst as I had suffered from it. He reached down the well and brought water for the dog. So, Allah appreciated this act of his and pardoned him. Then, the companions asked: ‘O Allah’s Messenger, is there reward even for (serving) such animals’? Prophet Muhammad (pbuh) said: ‘Yes, there is a reward for the one who makes a service to any living being.’”

(Narrated in Sahih Muslim: Book #26, Hadith No. 5577)

“The Prophet (pbuh) was asked whether acts of charity even to the animals were rewarded by Allah or not. He replied: 'yes, there is a reward for acts of charity to every beast alive.'”

(Narrated by Abu Huraira, Bukhari, 3:322. Also Muslim, Vol. 4; Hadith No. 2244)

Prophet Muhammad (pbuh) said:

“The one to whom his horse is a source of reward and who keeps it in the path of God, and ties it by a long rope in a pasture or a garden. Such a person will get a reward equal to what the horse’s long rope allows it to eat in the pasture or the garden. And if the horse breaks its rope and crosses one or two hills, then all marks of its hoofs and its dung will be counted as good deeds for its owner. And if it passes by a river and drinks from it, then that will also be regarded as a good deed on the part of its owner.”

(Narrated in Sahih al-Bukhari, 3:559)

It is narrated in Sahih Muslim that:

“We were on a journey with the Messenger of God, and He (peace be upon Him) left us for a while. During his absence, we saw a bird called Hummara with its two young and so we took the young ones. The mother bird was circling above us in the air, beating its wings in grief, when the Prophet Muhammad (peace be upon Him) came back and said: ‘Who has hurt the feelings of this bird by taking its young? Return them to her!’”

(Narrated in Sahih Muslim)

“The Prophet Muhammad (peace be upon Him) was seen wiping the face of his horse with his gown. When asked why He was doing that, He replied: ‘Last night, I was reprimanded by God for having neglected my horse.’”

(Narrated in Muwatta Imam Malik)


In order to protect land, forests and wildlife, the Prophet Muhammad (peace be upon Him) created inviolable zones known as hima and haram, in which resources were to be left untouched. Hima applies particularly to wildlife and forestry and usually designates an area of land where grazing and woodcutting are restricted, or where certain animal species are protected.

3.6 Conservation of Natural Resources The Holy Quran says:

“But waste not by excess: for Allah loveth not the wasters.” (Al-Anam: Verse 141)

When the Prophet Muhammad (peace be upon Him) saw Sa’d performing wudu, He (peace be upon Him) said: “What is this? You are wasting water.” Sa’d replied: “Can there be wastefulness while performing ablution?” The Prophet Muhammad (peace be upon Him) replied: “Yes even if you perform it in a flowing river.’”

(Narrated in Ibn-e-Maja)


“(Among the)... three types of people with whom God, on the Day of Resurrection, will neither exchange words, nor look at ... is the one who possesses an excess of water but withholds it from others. God will say to him: ‘Today, I shall withhold from you my grace as you withheld from others the excess of what you had not yourself created.”

(Narrated in Sahih Al-Bukhari)

3.7 Informing About Value of Natural Resources In one verse, the Holy Quran says:

“Say: Have you considered, if your water were one morning to have seeped away, who then could bring you clear-flowing water?”

(Al-Mulk: Verse 30)

Conclusion In development economics literature, it has been recognized that humans are

the means as well as an end to the growth process. However, the growth experience has led to unprecedented levels of poverty and inequality of income and wealth. Historically, at a given point in time on this earth, there may not have been such disparities in standard of living between various parts of the world as we see now. When ethical neutrality has led us to be oblivious of taking care of our people in our own lives, it is no surprise that it has led to even more apathetic behavior related to our relation with environment that has important implications for the welfare of future generations. This paper has attempted to explain how Islamic economics with its distinctive ethical principles can fulfill this need and encourage as well as reinforce environmental friendly choices and behavior.

Lastly, we mention a verse from Holy Quran which warns us that on the day of judgment, the seemingly free natural resources we use and exploit can be and will be


made alive to speak of the treatment they received from us on the day when nothing else can be more disadvantageous than to have sins we carry forward to the day of judgment.

“When the Earth is shaken with a violent shaking, and the Earth throws out her burdens, and man says: ‘What has befallen her?’ - on that Day, she shall tell her story!”

(Az-Zilzaalaha: Verse 1-4)

References ASTRÖM, Z. Hafsa (2011). ‘Paradigm Shift for Sustainable Development: The

Contribution of Islamic Economics’. Journal of Economic and Social Studies. Vol 1 (1), pp. 73-82.

Hassan, Zubair. (2006). ‘Sustainable Development from an Islamic Perspective: Meaning Implications and Policy Concerns’. Journal of King Abdul Aziz University: Islamic Economics, Vol. 19 (1), pp: 3-18.

Khalid, M. Fazlun (2002). ‘Islam and the Environment’. Social & Economic Dimensions of Global Environmental Change, Encyclopedia of Global Environmental Change, Vol (5), pp 332–339.

Mortazavi, Saeed (2004). ‘Islamic Economics: A Solution for Environmental Protection’. Trade, Growth and the Environment. Oxford University.

Na’iya, I. Ibrahim (2007). ‘Environmental Issues & Islamic Economics: Nature & Solutions’. Proceedings of the 2nd Islamic Conference. Islamic Science University, Malaysia.

Stern Review: The Economics of Climate Change.

The World Bank (2006). “World Development Indicators”.


An Analysis Of Bankers Competency In The Context Of Marketing Strategies

Employed In Islamic Banks Of Pakistan By

Qaiser Imtiaz* &

Mohammad Shahid

Abstract The study attempts to gauge the bankers competency in context with marketing strategies employed in the Islamic banking industry of Pakistan. The research was conducted in Islamic banks to analyse the views of employees about marketing practices (product, price, place, promotion and people) of Islamic banking, working experience and the training provided in Islamic banks in Pakistan. The research was confined to the employees of Islamic banks. The analysis would strengthen the knowledge related to marketing strategies. It was found out their less and more experienced employees have the potential in diverse kind of marketing practices. More experienced employees have a vast experience with relevance to marketing strategies. It is recommended that Islamic banking system standardize the marketing practices as per Islamic principles. Staff development programs would be designed to enhance the professional competence of employees.

Key words: Bankers, Competency, Marketing Strategies, Islamic Banks

Introduction The purpose of the study was to analyse the competency of bankers in the

context of marketing strategies employed in Islamic Banks of Pakistan. The study was designed to investigate the existing marketing strategies practiced by bankers in Islamic Banks situated in Karachi. The study would significantly help the authorities * Authors: Qaiser Imtiaz & Mohammad Shahid, M. Phil, are Research Scholars,

associated with Hamdard Institute of Education and Social Sciences, Hamdard University, Karachi Pakistan.


concerned to devise appropriate policies to strengthen the marketing practices. It would help the bankers in enhancing their capabilities. Banks can promote their products by identifying the customer`s needs. Banking with Islamic marketing strategies promote benefits and reduce problems. It identifies the factors related to success and failure of the implementation process. Further it has a positive effect on better standard of customer relationship. Customer relationship management plays a significant role in attracting the customers.

The consumer banking has flourished in Pakistan in previous decade. The phenomenal progress from State Bank of Pakistan to reschedule the banking sector as per market needs and consumer demands. Islamic banking business focuses on all stages of marketing and services. The Islamic moral philosophy has encouraged the dealing between Customer Relation Advisor (CRA) and customer of Islamic Banking.

Researcher interviewed few bank employees to identify the issues related to marketing practices.

They responded that in presence of conventional banking market, expectations of customers are too high to fulfill especially due to the unavailability of enough products catering Shariah compliant financial services. The main barrier in Pakistan is untrained staff for example Customer Relationship Officer in Islamic based banks, they come from conventional banks and act upon as they did there. To understand and promote the level of Islamic banking in macro level among the customers concrete steps would be taken. Tactics of Sales and Marketing staff should be groomed as per Islamic culture and norms. Least interest of frontline marketing staff in acquiring knowledge of Islamic banking products. Procedural constraints of various financing products to ensure Shariah compliance during a financing facility. Customers get disturbed when official ask them to provide number of documents for every transaction while obtaining financing facility from Islamic banks.

The obstacles are lesser when it comes to the marketing of Islamic banking products. However, when it comes to competing with commercial banks, there are some areas to be considered i.e. expression used in the advertisement, cannot highlight much of the incentives for the customers in terms of earning profits on investments etc.

Showing an advertisement on television channel becomes doubtful to people as most of them think that television is a source of non Shariah compliant activities. Marketing is restricted as the Islamic banking does not entertain those people whose money or business is non Shariah compliant. Marketing is restricted to a pattern and criticism is much more there in Islamic Banking as compared to conventional bank marketing.

Customer facilitation desk need to be more equipped with Shariah knowledge. Customer services department more focused and improved to achieve the top level standard as compared to conventional banks. The staff need to improve the knowledge of Islamic banking products on continuous basis.


Islamic Banking Interest is forbidden in Islam Thus, the Islamic banks and conventional banks

the basic difference is that Islamic banks are interest-free banking, bank interest and conventional banks (Kahf, 2006). Although the interest and profit is very clear concept, but many of them misunderstood. Interest and profit is the difference between the basic interests of the reward money and profit return on capital investment. In other words, money, interest and capital investments generate profits (Toutounchian, 2004).

Islamic Banking In Pakistan Before partition Muslims of subcontinent did not participate actively in the

banking sector. At that time there were a few Australasian Banks established in Lahore. In 1941, Habib Bank came into being and it was run by the Indian subcontinent's Muslims.

Before the independence of Pakistan, all of the financial system was mostly of British base. In the early decades, the Government devise policies to strengthen the banking system in Pakistan. State Bank of Pakistan was established in 1948. National Bank of Pakistan in 1950 entered into the banking system of Pakistan which became landmark in the history of banking industry of Pakistan.

Islamic banks have tremendous growth over the past 20 years. There is a shift from the conventional banks to the number of Islamic banks in Pakistan. The Islamic Banking Industry in Pakistan consists of five full-fledged Islamic Banks. viz: Meezan Bank Limited, Al Baraka Islamic Bank (Pakistan) Limited, Dubai Islamic Bank Pakistan Limited, Burj Bank (Formerly Dawood Islamic Bank Limited) and BankIslami Pakistan Limited with 841 Islamic Branches of Conventional Banks and Sub Branches of full-fledged Islamic Banks. Their cumulative deposit portfolio is Rs.463 billion. (SBP, Islamic Banking Bulletin, September, 2011). Islamic banks are trying to fulfill shariah based needs of their customers with innovative products and services to market competition requirements.

Literature Review Richard et al., (2005) described marketing as process of planning and

implementing the innovative idea. It helps to evolve strategies to market products and services. The process would help in satisfying customers and institutionals goals.

Islamic bank's marketing strategy-makers should take care of the 4Ps of marketing, ie product, price, place and promotion. Islamic bank's marketing strategies are hidden in four components. Viz.

Product Ethісаl іѕѕueѕ ѕurroundіng the mаnаgement of рroduсtѕ аre сentrаl to

mаrketіng beсаuѕe the mаrketіng рroсeѕѕ generаlly begіnѕ wіth а рroduсt (broаdly defіned to іnсlude goodѕ, ѕervісeѕ, or іdeаѕ). The moѕt сommon ethісаl сonсernѕ іn thіѕ аreа рertаіn to the ѕаfety of рroduсtѕ. (Hair et al., 1998).

Islamic banks mainly use the two products namely, (Ijarah) rental and (Murabaha) cost-plus to perform their business. Islamic banks should bring more


innovative products in the market to pursue their customer which may differ from the conventional bank.

Price Рerhарѕ no аreа of mаnаgerіаl асtіvіty іѕ more dіffісult to аѕѕeѕѕ fаіrly аnd to

рreѕсrіbe normаtіvely іn termѕ of morаlіty thаn the аreа of рrісіng. The gіven рrісe of а рroduсt or ѕervісe сommonly reѕultѕ from the сonfluenсe of three fасtorѕ: demаnd, сomрetіtіon, аnd сoѕt. Eасh of theѕe fасtorѕ саn be сentrаl to ethісаl queѕtіonѕ аbout рrісіng fаіrneѕѕ. (Kotler and Armstrong, 2010). Deѕріte beѕt effortѕ of mаrketerѕ, the аreа of ѕаleѕ wіll сontіnue to hаve іtѕ ѕhаre of ethісаl сontroverѕіeѕ. Ѕаleѕ аre the moѕt сommon entry-level рoѕіtіon іnto the fіeld of mаrketіng.

Most people in Pakistan belong to the middle class are very sensitive about the cost. Competition are more severe day by day many banks have are in the Islamic banking industry and the bargaining power of people is very high, so people are now more option they can opt the particular service on basis of price. Islamic banking products and services should be better than the price of conventional banks or at least with the conventional banks.

Placement The dіѕtrіbutіon element of mаrketіng іnvolveѕ the entіre ѕuррly сhаіn from

mаnufасturer through wholeѕаlerѕ аnd dіѕtrіbutorѕ (іnсludіng retаіlerѕ) on to the fіnаl сonѕumer. Аt eасh рoіnt іn the ѕuррly сhаіn, beсаuѕe there аre eсonomіс іnterасtіonѕ between theѕe vаrіouѕ раrtіeѕ, the рotentіаl for ethісаl іѕѕueѕ to oссur іѕ quіte сommon. (Kotler and Armstrong, 2010). The objective of Allocation of Product in Islamic Marketing principles is satisfying the customer ethically and strengthen the standard of living (Hassan, et al., 2008).

In Pakistan Banks mostly located in urban areas. To promote the network of Islamic banks in rural areas and small town there is need to spread the branch in wide range. Islamic Banking Industry Meezan Bank Ltd has honor in expansion of its branch network. Their branch network increased to 275 branches in 83 cities (www.meezanbank.com). Islamic banks should expand their branch network and give special attention to urban and rural areas.

Promotion Аdvertіѕіng іѕ а ѕіgnіfісаnt eсonomіс forсe іn the world eсonomy, wіth globаl

аd ѕрendіng рrojeсted to be well over $300 bіllіon іn саlendаr yeаr 2005. The vіѕіbіlіty аnd mаrketрlасe іnfluenсe of аdvertіѕіng іѕ ѕo greаt thаt mаny сonѕumerѕ thіnk of аdvertіѕіng аѕ ѕynonymouѕ wіth mаrketіng. (Kotler and Armstrong, 2010).

The main promotion of Islamic banking is foundation on religion base. Approx 98% of Pakistan's population is Muslim. However, in our study, we found that only 15% -20% of the customers of Islamic banks are step forward for the name of Islam. Their marketing strategy should be very positive, accordance with conventional banks and as per Shariah compliance. They should create awareness and insight among the customers about the product and services of Islamic Banks.

Booms and Bitner’s have exclusively expanded the feature of marketing mix and stated that: (http://:www.valuebasedmanagement.net)


People People are directly or indirectly involved in the practices for consumption of

product or services. They may are worker, employee or consumer, which greatly value their effort.

Process An essential factor of marketing strategy is process flow of job and activities

by which services are executed.

Physical Evidence The climate of business which delivered the best possible services to their

customer with great satisfaction.

Methodology The overall strategy of research was survey. The population comprised of the

Islamic bank employees. The bankers from outside Karachi are also part of the sample but due to numerous reasons there ratio is lower than the respondents from the city of Karachi. A questionnaire was developed for bank employees. The questionnaire for bank employees was comprised of 59 items. The items of the questionnaire were drawn from the content field in consultation with the experts, review of the literature and the judgment of the researcher. The procedure ensured the content validity of the questionnaires. The items of the questionnaire were drawn from the content field in consultation with the experts. An interview schedule was also organized. In the process of interview, major questions were followed by subsidiary questions to suit the dynamics of the interview. The interviews were personally conducted by the researcher in a meticulously intensive fashion. The data obtained from interview were compared with the data achieved from the questionnaire and hence the validity and consistency of the questionnaire were found acceptable.

Stratified random sampling design was adopted. The sample size was 180 bank employees from the Islamic banks of Pakistan. The breakdown of the sample is mentioned below:

B A N K BY G E N D E R

SOUTH CENTRAL NORTH TOTAL

ISLAMIC BANKS MALE 125 17 14 156

ISLAMIC BANKS FEMALE 18 3 3 24

TOTAL 143 20 17 180 ----------------------------------------------------------------------

Data Analysis Table with frequencies and percentages were used for description of data. For

statistical inference, t test of significance was used.


Table and Pie Chart shows the distribution of Bank Officers & Managers of Karachi by Years of Experience.

Table Distribution of Bank Officers & Managers of Karachi by Years of Experience

YEARS OF EXPERIENCE FREQUENCY PERCENTAGE

LESS THAN 5 YEARS 49 27

5 YEARS AND ABOVE 131 73

TOTAL 180 100

It is clear that 73% of the Bank Officers & Managers were 5 Years and

above and 27% having less than 5 years experience.

Application of t-test There will be no significant difference in the views of less experienced and

more experienced bank officers towards the competency of bankers in context with marketing strategies employed in Islamic Banks of Pakistan.

Analysis of the Problem 1. Ho : µ1 = µ2

2. H1 : µ1 ≠ µ2

3. α : 0.05

4. Test Statistics : t-test

t = X1-X2

SEX 1-X 2

5. Decision Rule : Reject Ho if computed t > 1.96

27%

73%

LESS THAN 5YEARS 5 YEARS &ABOVE


Referring to Table t, we find that the tabulated value of t = 1.96, with df = 178 at α = 0.05 is greater than the computed value of t = 1.25. Therefore the null hypothesis is upheld and it is concluded that there is no significant difference between the less experience and more experience towards the competency of bankers in context with marketing strategies employed in Islamic Banks of Pakistan..

From the analysis of the table, it is clear that the less experienced and more experienced towards the competency of bankers in context with marketing strategies are same.

Conclusion The views of the less experienced and more experienced bankers were

satisfactory regarding customer satisfaction in Islamic marketing ethics. They administrated their job as per their capability and proficiency. they have been professionally trained from the same banking institution. Bank Officers understood the principles of Islamic marketing ethics and have been directly dealing with the customers.

Recommendations The subsequent recommendations are furnished:

Promote The Islamic Marketing Practices In Pakistan In Pakistan the implementation of Customer Relationship Management

practices are to be focused. Customer Relationship Management is a desk where they deal the task of consumer outlet by adding related data about their customers with providing efficient services. It is recommended that standardized excellent service of Islamic bank to magnetize the great number of customers.

Extend The Network Of Islamic Banks Branches It is true that Islamic banking in Pakistan are robustly impetus, but as compare

to conventional they are far behind, It is recommended that Islamic bank branches network should be expand and enlarge over the country to facilitate the customer under the dimension of Islamic banking sector.

Give The Lucrative Profit To Their Customers Of Islamic Banks The major problem faced by Islamic banking is the hesitance of people to

switch to Islamic banking structure from conventional keeping in view that it does not guarantee profits or a healthy return on investment.

It is recommended to collect deposits from the people on profit-and-loss sharing basis. The reputable strategy possible through the momentum growth of volume business of bank with the greatest satisfaction of customer is significant the profit of the business.

Enhancement Of Education And Eliminate Unemployment It is recommended that formulate the education policy to promote the Islamic

Banking education which reduce the unemployment chaos in economic phenomenon.


Innovative Strategies To Attract Customers It is recommended that the marketing strategy is innovative which attract the

customers, launching of consumer products raise the standard of living of the customers.

References Hair, J.F., Anderson, R.E., Tatham, R.L., Black, W.C. (1998), Multivariate Data

Analysis, 5th ed., Prentice-Hall, Englewood Cliffs, NJ.

Hassan, A., Chachi, A.K. and Latiff, S.A. (2008) “Islamic Marketing Ethics and Its Impact on Customer Satisfaction in the Islamic Banking Industry” J.KAU: Islamic Econ., Vol. 21 No. 1, pp: 23-40

http://:www.meezanbank.com

http://:www.valuebasedmanagement.net

Kahf, M. 2006.Islamic Banks at the Threshold of the Third Millennium, Available at http://www.kahf.net

Kotler, P., Armstrong, G. (2010), Principles of Marketing, 13th ed., Pearson Prentice-Hall, Upper Saddle River, NJ.

Richard M.S. Wilson, and Colin Gilligan, Third Edition (2005) “Strategic Marketing Management Planning, implementation and control

State Bank of Pakistan, (September, 2011), “Islamic Banking Bulletin”, Vol. 5 No.4

Toutounchian, I. 2004. New Horizon: Islamic Banking, A last Ditch to save Capitalism. The institute of Islamic Banking and Insurance. London


Capitalism, Globalization & Islamic Economic System

By Muhammad Zeeshan Farrukh*

ABSTRACT This paper explains the principles of Islamic economic system by differentiating conventional and Islamic economic systems. It is proved that there is an absolute clash between the secular and Islamic concept of economics as the one is self-centric while the other is based upon the welfare of the society respectively. The main reason of this attitude is the concept of a’akhirah (life after death) in Islamic economics but no such concept in western or secular concept, because the secular economic concept separates the religious thought from the worldly life. It is a pity fact that the present globalized world has been captured in the evil of self-centric economic system i.e. Capitalism.

The main objective of Islam is to establish and maintain a welfare state which can be achieved by equitable distribution of wealth therefore Islam gives secondary importance to but the secular concept gives primary importance and wealth accumulation is the main objective of this concept.

In this paper, the point of view has been explained with references from the Qura’anic verses and Ahadith. It has been explained that Islamic Economic System is not the name of implementation of just few Islamic Economic principles and modes in a society but it has linkage with the whole religion otherwise the fruits of this system could not be obtained.

As far as prevalent Islamic Financial system is concerned, it is a good step towards the implementation of Islamic economic system but there is a requirement of seriousness in this context so that there is an obligation upon every Muslim to play a part to implement Islamic economic system.

Key Words: Capitalism, Globalization.

* Author – Muhammad Zeeshan Farrukh is working as Product Manager, UBL Ameen

Islamic Banking: The Islamic Banking Division of United Bank Limited, Karachi, Pakistan)


Introduction Any economic system has a great impact upon the individuals and society. In a

present world, when we talk about western economic system or capitalism, we have to think that we are not just talking about an economic system only but an ideology and thinking of living in this world. Likewise, when we talk about implementation of Islamic Economic System, it is also a matter of implementation of Islamic values for which all the members of the society must strive with full faith.

The present world is the world of advancement of technology, complexity of business transactions and rapidly spreading ways of communication among the nations. Consequently, people of the world have been coming near to each other and distances are being curtailed day by day. Therefore, we have been hearing the word “Globalization” that is leading the whole world towards one economic system i.e. Capitalism and in a true sense, one structured way of life that has never concern with religion and spirituality but the implementation of secular thoughts for living that carry many flaws and serious contradictions with Islam about which Muslims should consider and understand in a serious manner. A sensible Muslim can never accept the ideology that has contradiction with Islamic thoughts. If we think seriously, Globalization is the order of secular way of living that is being imposed upon the world.

Discussion According to Islam, all resources in this world belong to Almighty Allah and

people may get and use these resources as a vicegerent of Allah according to His commandments so the acquiring of wealth should not be the main mission and primary concern of a Muslim but to obey the commandments of Allah and to implement His will. Islam does not discourage economic activities as these are necessary for human life but dislikes the moment when the earning of wealth becomes the main ambition of life and people forget the commandments of Allah. This behavior leads to exploitation, selfishness and greed in the society and people become self-centered without considering the fact that they would never stay in this world but for few days. As Almighty Allah states in the Qura’an:

Whatever ye are given (here) is (but) a convenience of this life: but that which is with Allah is better and more lasting: (it is) for those who believe and put their trust in their Lord.1

According to Islam, the status of this world is very inferior because this world is temporary place for all human beings where the people should follow the commandments of Almighty Allah. If they would not follow the commandments, they would face the punishments in the Hereafter (a’akhirat). So, the life Hereafter would be the eternal life where they would face the results according to their deeds done in this temporary life. At once, the Prophet Muhammad (SAW) was walking with their companions. While walking, he found a dead lamb with very short ears. He (SAW) asked their companions whether anyone wanted to buy it for a dirham. The companions told that they would not like to possess it even if it were alive due to

1 Al-Qur’an (42:36) Translation by Yusuf Ali, Retrieved from corpus.quran.com.


defect in it. At this point, the Prophet Muhammad (SAW) said: “By Allah, this world is more insignificant in the eye of Allah as it (this dead lamb) is in your eye”.2 (Sahih Muslim, Jam’a Tirmidhi, Sunan Ibn Majah). At one occasion, the Prophet Muhammad (SAW) said: “My stay in this world is like that of wayfarer who stopped to relax under the shade of a tree and then moved on and left to it”.3 (Jam’a Tirmidhi, Sunan Ibn Majah)

The West has separated religion from political, social and economic life of the people and, wants to confine religion only to churches and worship places etc. because religion imposes ethical and moral restrictions in daily life which have been refused by the West. Since the religious issues have been completely separated from economic activities and capitalism has not any concern with life Hereafter, the people have no concern with good or bad activities and they look at their own benefits only. This thinking leads to social unrest, exploitation and severe concentration of wealth which leads to poverty and shameful behavior with humanity as we can see in the present world even in those parts of the world whom we say as the most civilized and developed parts of the world.

According to the Census Bureau’s report, the income gap between the wealthiest 20 percent of American households and the rest of the country grew sharply in 2011.4 Food & Agriculture Organization of the United Nations (FAO) estimates that a total of 925 million people are undernourished in 2010 and developing countries account for 98 percent of the world’s undernourished people.4 According to Rural Poverty Report 2011, 1.4 billion people in developing countries live on $1.25 a day or less.5 At the occasion of World Economic Forum 2011; Min Zhu, a special adviser at the International Monetary Fund and a former deputy governor of the People’s Bank of China told: “The increase in inequality is the most serious challenge for the world. I don’t think the world is paying enough attention.”6

According to capitalism, everybody has to live with complete “Freedom” because every person has its own life and he may live his life according to his own will and full freedom and independence and no one person can impose his thoughts to any other person. On the other hand, the word “Islam” means submission i.e. submission to the commandments of Almighty Allah. At this point, Islam and West have separated from each other absolutely.

As far as Islamic Economic System is concerned, Islam encourages mutual help among the members of the society. The teachings of Islam bring an enthusiasm among Muslims to follow the commandments of Almighty Allah and abolish the

2 Muhammad Akram Khan. (1989), p.17, Economic Teachings of Prophet Muhammad

(may peace be upon him), Islamabad, Pakistan: International Institute of Islamic Economics.

3 Muhammad Akram Khan. (1989), p.17, Economic Teachings of Prophet Muhammad (may peace be upon him), Islamabad, Pakistan: International Institute of Islamic Economics.

4 Sabrina Tavernise, (September 12, 2012), U.S. Income Gap Rose, Sign of Uneven Recovery, published in New York Times. Retrieved from www.nytimes.com

4 http://www.fao.org/docrep/012/al390e/al390e00.pdf 5 www.thp.org 6 www.telegraph.co.uk


greed for wealth because people think that if this world has no importance so why they do strive for making this world the best and why not work for the eternal life. If the people would retain this thinking in mind, they would not want more and more wealth but want only to live according to their needs. If they would earn more wealth, they try to give the big share from their wealth to the needy and other charitable concerns because Allah encourages charity very much:

Those who spend their substance in the cause of Allah, and follow not up their gifts with reminders of their generosity or with injury, for them their reward is with their Lord: on them shall be no fear, nor shall they grieve.7

In this way, the resources and wealth would not be concentrated in few hands. Islam has provided a ready-made flawless mechanism to mankind for a poverty reduction and eradicating concentration of wealth. Islam has taught us economics not only on the personal level but also on the level of state that the state could work for the prosperity of the people. In this regard, Islam has highlighted the sources of income and areas of expenditure for the government. We need only to modify and implement it according to society and then the present world could see the miracles of this system.

It is a fact that Islam is a complete code of life and Islamic Economic System is one section of this whole code. It is not possible that we obey one aspect of this code and ignore the other aspects that have also been connected with the former aspect. In this way, we could never get the advantages of this precious code of life neither spiritually nor materially. Therefore, Islamic Economic System is not the name of implementation of just few Islamic Economic principles and modes in a society but it has linkage with the whole religion even with the prayers as we have to stop economic and social activities after Juma’a Aza’an and we have to set aside all economic activities for offering five time prayers. Therefore, the Muslims have to formulate an ideal Islamic state for an ideal Islamic Economic System and must follow every aspect of Islam as we could only get the fruits of this revealed system when we would obey the commandments of Almighty Allah as a whole and obey this sacred order of Almighty Allah:

O ye who believe! Enter into Islam whole-heartedly; and follow not the footsteps of the evil one; for he is to you an avowed enemy.8

Islam has declared “Halal” and “Haram” (“Allowed” and “Not Allowed”) that we have to follow in economic transactions and in our routine daily life. We cannot purchase and sell Haram item and we cannot earn income from Haram means like gambling, stealing, prostitution, painting of living beings etc. as mentioned and declared in Qura’an and Sunnah. We cannot eat or drink HARAM item and commodity like wine and pork etc. as declared in Qura’an and Sunnah. If any Muslim commits a sin of drinking wine, he would be liable for punishment from a state. In Islamic Economic System, interest is prohibited as it leads to exploitation and creates significant gap between rich and poor classes. We cannot do marketing of our products with obscenity and vulgarity as it is common in the whole world. Besides these, there are many other restrictions that Muslims have to follow and obey 7 Al-Qur’an (2:262) Translation by Yusuf Ali, Retrieved from corpus.quran.com. 8 Al-Qur’an (2:208) Translation by Yusuf Ali, Retrieved from corpus.quran.com.


for a better society. On the other hand, when we talk about capitalism and western economic system, we find no such restrictions but this system gives a free hand to earn more and more wealth. The difference is very obvious between two systems as a system with unlimited freedom and system with moral restrictions could not be run side by side. So, we can determine whether any similarity between these two systems.

In the present world, the banking sector has a vital role to run the wheel of economy and business. This sector has a great impact not only upon the individuals and corporate sector of a country but it has also an importance regarding international trade. Besides banking sector, other financial institutions have also take part to run the economy. Therefore, there is a crucial need of Islamization of these financial institutions. Unfortunately, the system of conventional banking and financial institutions is based upon interest which is the evil for society. There are serious denunciations and orders against interest in Qura’an and Sunnah:

“O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers. If ye do it not, Take notice of war from Allah and His Messenger: But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly.”9

The Prophet Muhammad (SAW) said, “Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother.” (Ibn-e-Majah)10

The Muslim scholars and financial experts have done very well research in this regard to change and convert this complex financial system according to Islamic principles and present Shariah-compliant solutions in the light of Qura’an and Sunnah as Islamic teachings are complete in all respects and Islam can provide solutions of all economic problems. The Islamic banks and financial institutions have been practicing and following the guidelines formulated by scholars and financial experts all over the world. Even though a lot of work has been done in this regard, the more is also required. The Islamic banks and financial institutions could be the first step towards Islamization of economic system if the intention of owners, management and staff would not only be making profit but to take part into the scared mission of implementing Islamic economic system. If there is no such intention and Islamic financial institutions would only strive to make more and more profit rather than considering the sacred mission of implementing Islamic Economic System, the real Islamic transactions and research for better Islamic products could not be done and consequently, the purpose would not be achieved.

Besides Islamic Banking and finance system, the government should also consider about the other aspects of Islam and Islamic economic system because Islamic Banking and Finance system would not be fruitful until the environment of the society would not help it. It should be kept in mind that everything cannot be done from the platform of Islamic Banking and Finance system as I have said earlier that we can only get fruits when we implement Islam as a whole.

9 Al-Qur’an (2: 278,279) Translation by Yusuf Ali, Retrieved from corpus.quran.com. 10 Dr. Muhammad Imran Ashraf Usmani (2002), p.40, Meezan Bank’s Guide to Islamic

Banking, Karachi, Pakistan: Darul Ishaat.


Conclusion As we have to survive in this world of globalization, we must first consider

about the increasing tendency of global system that is binding the whole world in its powerful grip and then formulate the policies for tackling this horrible system because we have been entangled in this system in such a way that we cannot get away from this system so easily and overnight. For this purpose, planned and step-by-step procedures towards Islamization of the economy and society are crucial.

I think that the proper implementation of Shariah and Islamic Economic System is the responsibility of every Muslim. Every work cannot be done by the government. When we try to become a true Muslim and understand the soul and message of Islam, we would not face too many difficulties in the way of implementation of Islamic economic system even in this period of globalization. In this way, we can collectively present an ideal economic system for which this world is seeking. We must not waste time in pointing out similarities between Islamic and other economic systems. We must strive and look for only implementing Islamic economic system as it is the matter of our faith.

Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of UBL or other.

BIBLIOGRAPHY Books

Muhammad Akram Khan. (1989), p.17, Economic Teachings of Prophet Muhammad (may peace be upon him), Islamabad, Pakistan: International Institute of Islamic Economics.

Dr. Muhammad Imran Ashraf Usmani (2002), p.40, Meezan Bank’s Guide to Islamic Banking, Karachi, Pakistan: Darul Ishaat.

Websites Al-Qur’an (42:36) Translation by Yusuf Ali, Retrieved from corpus.quran.com.

Sabrina Tavernise, (September 12, 2012), U.S. Income Gap Rose, Sign of Uneven Recovery, published in New York Times. Retrieved from www.nytimes.com

http://www.fao.org/docrep/012/al390e/al390e00.pdf

www.thp.org

www.telegraph.co.uk

Al-Qur’an (2:262) Translation by Yusuf Ali, Retrieved from corpus.quran.com.

Al-Qur’an (2:208) Translation by Yusuf Ali, Retrieved from corpus.quran.com.

Al-Qur’an (2: 278,279) Translation by Yusuf Ali, Retrieved from corpus.quran.com.


Beneath The Failed Islamic Financial Institutions – Was It A Failure Of Islamic

Finance? By

Imran Hussain Minhas *

ABSTRACT Islamic financial institutions made a good start and developed at a remarkable pace in the first instance. However after only a brief period there was a set back in non banking financial institutions. The article is devoted to find out the factors which caused the debacle.

Key Words: Classified portfolio, under capitalized high leveraging, Ruthless expanding.

Financial institutions are the financial intermediaries that play a key role in the economy of any country by directing the flow of savings of the people towards large corporations and enterprises. The financial institutions provide trust and confidence to the savers of money and bridge the gap between savers and the users of the money.

Confidence and trust of the savers on the financial system and intermediaries are critical for the economy and capital formation of a country. Where the element of distrust arises on the financial system it leads to the financial crises in the economy and the shattered confidence on a financial institution leads to the loss of that institution. In case of failure of any financial institution people tend to be more cautious about strength of the financial system and the security of their hard earned money. In the state of distrust the Government or government’s regulatory arms need to play their role for confidence building of the stakeholders and depositors by different regulatory tools which could adequately minimize the risk of loss and ultimately the failure of any financial institution.

When an Islamic Financial Institution (IFI) fails people more rapidly lose trust on the Islamic financial system as compared to the conventional one. Reason being,

* The Author – Imran Hussain Minhas is a Joint Director, Securities and Exchange

Commission of Pakistan (SECP), Free Lance Writer and Visiting Associate Professor of renowned University of Pakistan. E-Mail: [email protected]


the conventional financial industry due to its long existence, performance and strong regulatory framework is mature enough to keep the confidence of depositors and answer the causes of failure of any financial institution. On the other side the modern Islamic financial industry is at its epoch and is still considered at its takeoff phase. The failure of any Islamic financial institution raises lots of doubts and questions on the future, viability and adoptability of Islamic finance, especially from its critics.

Therefore, it is crucial for the regulators and the users of the Islamic financial products to understand the root causes of the failure of any financial institution. To the larger extent the causes of failure of IFIs are similar to the conventional counterparts yet the IFIs may also fail if the people realize that they are not working according to the principles of Shariah. In general a financial institution fails when:

● It is mismanaged due to greed and carries huge portion of infected portfolio.

● It is undercapitalized and fails to fetch low cost funding. ● It lacks competent management. ● The systems, procedures and internal controls do not work as required.

A large number of financial institutions start operations and majority of the takeoffs get smooth flight toward their ultimate destination but only a few meets bad fate. Among the failed institutions the above reasons are common. Now the question is ‘can we consider the above factors as key to the failures’? The answer might be ‘yes’, as in number of cases the IFIs failed due to multiple reasons coupled with the above reasons. Let’s take the example of twenty three closed Non-Banking Islamic financial institutions in Pakistan, out of which eight were totally failed and wound up whereas the rest of the entities were merged with the other existing financial institutions.

In Pakistan, Islamisation of the economy was started in early 80’s and the concept of Modaraba was legalized to conduct the business of Islamic finance under the umbrella of Modaraba Management Companies, registered as Mudarib with the Registrar Modaraba, Securities and Exchange Commission of Pakistan. These Management companies manage ‘Modarabas’ (NBIFIs), which are pooled with the general publics’ money, who are called certificate holders (the Rabb-ul-Maal) of the Modarabas.

The concept and structure of the NBIFIs attracted the major business groups of the country due to a major tax incentive which was announced by the Government of Pakistan. These entities provided a very good platform to conduct Shariah compliant business and emerged as small and medium sized financial institutions. In the initial fifteen years a rapid growth in this business of Modaraba was recorded and total numbers of registered MMCs were reached at 51 and the floated NBIFIs were also over 50. In terms of numbers it was peak time of the NBIFIs whereas their assets had grown to US$ 425 million whereas the total profits had touched to US$ 108 million.

Unfortunately the NBIFI sector could not continue its growth for a longer period and soon after the 1996 the fall back of NBIFIs started and a large number of


closures were witnessed in the country during the next fifteen years. Twenty three of the NBIFIs stopped their operations in Pakistan and the reasons were heavy losses, mismanagement and misappropriation of the certificate holders’ money by the Mudarib. Out of the closed NBIFIs:

1. Fifteen of the NBIFIs were merged into the existing operative NBIFIs to stop further losses and create synergies to give some benefits to their certificate holders.

2. Seven NBIFIs were wound up due to mismanagement, misappropriation of funds and greed of the Mudaribs.

3. One of the NBIFI was fully involved in the stock market operations and wound up due to heavy losses by investing in the highly volatile scripts.

Why The Islamic Financial Institutions Failed – Major Causes There are multiple factors which lead to the winding up of eight NBIFIs in

Pakistan. A study of the failed NBIFIs reveals that there was no single overriding factor to the failure of these financial institutions. However, some common and major causes of the failure were noticed, which are:

1. Incompetency of Board of Directors (BoD) and Senior Management – It is imperative for the success of any business that, the BoD and senior management, who are entrusted to run the operations of the business, must be competent enough. A competent management is expected to perform the following functions for the business, which were never performed by the management of the failed NBIFIs:

a) Provide vision and prudent future planning. b) Implement proper risk management policies. c) Sincerely involve in major decision making. d) Ensure effective internal control and regulatory compliance.

Thirty years back, when the NBIFIs were established in Pakistan there was no fit and proper criterion from the regulator, for the directors and senior management of the NBIFIs due to which most of the management companies were headed by the close relatives of the sponsors. The CEOs and directors of the Board were family members of the sponsors and were incompetent to run the business of NBIFIs.

2. Under-capitalization - Undercapitalization is a state where any institution does not have sufficient funds or access to the required funds to pay its obligations, or to expand and operate business profitably. In lots of cases low capital base or under capitalization of the financial institutions may pour cold water on the investment. The financial entities having low capital base are always at high risk of default as they don’t have sufficient cash flows to meet their obligations and resilience against the losses.

Most of the failed NBIFIs were undercapitalized as there was no minimum capital or capital adequacy requirement from the regulator. Soon after the start


of business it was realized that these NBIFIs were undercapitalized and facing the problem of sheer capital inadequacy. The increasing operational costs and losses made the NBIFIs unable to offset their future profits with the present losses. The low capitalization had weakened the shock absorbance capacity of the NBIFIs and had stopped the growth of their business.

3. High Ratio Of Infected And Classified Portfolio – Infected or classified portfolio means a pool of investments and facilities which is questionable in terms of the full recovery of principal balances and accrued profit thereon. The high risk facilities, which were extended by the incompetent management especially to their associates, started defaults which were mostly willful. The management, instead of making recovery efforts, wrote them as bad debts which turned into a huge bad portfolio that reversed the growth of the NBIFIs and the resultant losses eroded all the equity and reserves of NBIFIs. The shocks were so bigger that the NBIFIs could not bear them and ultimately went into bankruptcies and winding ups.

4. Weak Internal Controls, Absence Of Risk Management Policies And Ruthless Spending – Internal controls are the techniques, methods and procedures which are adopted to safeguard the business assets and to ensure compliance and accuracy of the data and information submitted to the management, stakeholders and the regulator. Weak internal control can never ensure a longer life to any organization; it ultimately opens path to fraud, forgeries and mismanagement of funds.

Weak internal controls and absence of risk management policies were another cause of the failure of those NBIFIs. Inaccuracy in financial statement and data, non-segregation of duties, absence of risk management policies and one man show in the business are the sign of weak internal controls and all these issues were common in the failed NBIFIs. For the weak internal controls, which were apparent from the misreporting, presenting false statement of accounts and other regulatory violations, these NBIFIs were penalized by the regulator at number of times.

The effective risk management policies ensure better internal control and security to the investor’s money but there were no such policies in those NBIFIs. Without any risk management policies and prudential regulations from the regulator these visionless managers extended facilities to associated undertakings and family business of the director and the CEOs without any collateral and put the NBIFIs to high risk of counterparty default.

The management in these entities was centralized and autocratic and all the decisions were taken by a single person mainly the CEO which remains unchecked and unquestionable as the Rabb-ul-Maal had no right to vote and elect their directors. This gave a free hand to the CEOs’ to fix their high remuneration and spent lavishly the hard earned money of the investors on their personal needs of luxury nature and frivolous activities.

5. High Leveraging, Asset Liability Mismatch And Non-availability Of Low Cost Funds – When the bad portfolio of one highly leveraged institution


increases it ceases its ability to pay off its obligation toward the other financial institutions at one end and it affects the liquidity of the lending institution on the other end. If the lending institution does not prepare any contingency plan for such situation it hampers its ability to pay off its obligation to its lending institution and so on. Such a chain creates a systemic risk which threatens the stability of the financial markets.

Sometimes financial institutions borrow heavily to finance their investments. In such financing the spread is normally very low therefore a small bubble in the investments disturbs the cash flows of the financial institutions. The unplanned institutions do not make any arrangements for such bubbles which lead to the bankruptcy of the institution. This actually happened with the unsuccessful NBIFIs.

Another problem to these entities was the non-availability of low cost funds. Due to disparity between the liabilities and assets, the NBIFIs were forced to recall and stop rollovers of their short term facilities to fund their long term investments but most of the clients were unable to repay the facilities on the call and resultantly the NBIFIs made defaults in repayments of their obligations. The situation was further deteriorated when a huge amount of facilities got stuck up due to non-payment of profits and principles.

6. Moral Hazards – Frauds And Greed – Another major cause of the failure of the NBIFIs was the fraud, corruption and greed of the management. The management intentionally deceived the Rabb-ul-Maal for personal gains. The management breached the trust of certificate holders and looted their money by illegal lending to their associated companies and businesses by violating the regulatory provisions. In all such financing they were aware of the facts that this investment will never come back. Consequently most of the associates made both; natural and willful defaults and the NBIFIs lost their total investments.

The Management showed inflated Balance Sheets by creating fictitious financial assets without any real economic activity. They deceived the certificate holders by transferring the real assets of the NBIFIs to their personal businesses. They kept on enjoying on the funds of Rabb-ul-Maal by investing them into their personal business and showing continuing losses to the NBIFIs. Their extreme greed dominated all the ethical considerations and finally a large number of NBIFIs were wound up and the certificate holders lost their money in these ventures.

7. Regulatory Failure And Non-Compliance Of Shariah – We must admit that weak regulatory framework had also played a key role in the failure of large number of NBIFIs. It provided the opportunity to the Mudarib to play with the money of general public. Due to non availability of Shariah compliance mechanism improper regulatory control; incompetent and corrupt management of NBIFIs exposed the financial institutions to high category of regulatory risk.

Excess and less both type of regulations are dangerous for the financial institutions. In case of excessive regulations the financial institutions lose their


legitimate business due to excessive regulatory requirements like investment in Government securities, cash reserve and capital adequacy requirements, restriction on certain types of investments, caps on per party exposure and restrictions of taking exposures of certain types of ventures etc. But in case of insufficient regulations the financial institutions lose their money by investing in the high risk ventures.

At that time the NBIFI sector of the country was operating with the insufficient regulation as there was no capital adequacy or minimum equity requirements, no cash reserves, no fit and proper criteria for the promoters and directors, no Shariah compliance, no risk management guidelines and no prudential regulations etc. Taking the benefit of regulatory failure the management operated the NBIFIs in high risk and held insufficient, fictitious and low quality assets, showing them as high quality assets in the books.

The management of those NBIFIs operated the entities against the injunctions of Islam whereas the money from the public was collected in the name of Islam. This was the cruelest part of the whole picture as due to the un-Islamic practices these NBIFIs lost their trust, reputation and ability to raise further funds as Islamic financial institutions.

It is also true that no institution can survive where the management is greedy, dishonest and corrupt. All risk management and regulations are failed before such management. The regulator can only introduce some check and balances but it is not a guarantee for the fool proof system.

The above seven factors are not the only ones that affect the success or failure of an Islamic financial institution, but in number of studies and reports they appear near or at the top of the list of failures of NBIFIs and the same is true for all financial institutions. The above factors of failure are interlinked and apparently are not very technical issues but require prudence, experience and training to overcome. Besides above factors, research and development, review of existing product lines and introduction of new products are also important factor for the promotion and growth of a financial institution. It is necessary that the existing product lines be reviewed and new products be launched to meet the customer needs. The failed NBIFIs never changed themselves according to the needs of fast and ever changing Islamic financial market of the world. Incapacity of the management was also one of the reasons for no research work.

Was It A Failure Of Islamic Finance? It is also true that during 90’s the Islamic financial industry of Pakistan was at

evolving stage and the concept of IFIs and Islamic products was new to the people. The entrepreneur failed to correctly understand and implement the NBIFI’s model as a vehicle to their business. There is no doubt that a successful institution is the result of untiring hard work of a competent BoD and top management. The top management needs to be involved from the start as their continuous effort is a key throughout the development of an institution. The failed IFIs were actually the failure of the BoD and top management as they never involved in the major decision making of the NBIFIs. It is imperative that professional directors set a clear vision, objective


and Shariah compliance mechanism for the IFI. Experience showed that only those NBIFIs were failed whose managements were incompetent, corrupt and least concerned towards Shariah compliance and benefit of the certificate holders. This was one of the major causes of their failure.

Most of the failed NBIFIs were also undercapitalized and they were facing the problem of capital inadequacy which had weakened their shock absorbance capacity. The failed NBIFIs were unable to offset their future profits with the present losses due to undercapitalization which lead to the forced defaults and bankruptcy of the NBIFIs. Had those institutions been properly capitalized the results might have been different.

Absence of risk management policies and weak internal controls were the other causes of failure of those NBIFIs. Weak internal controls open path to fraud, forgeries and mismanagement of funds which happened with the failed NBIFIs. This was also the failure of the management and not the Islamic financial system.

In the financial decisions, a good manager very well knows that lending to someone who is bankrupt and has no collateral to offer, has a high probability of default as compared to a debtor with good standing and acceptable good credit and security. The managers of NBIFIs never followed the principles of lending which turned the portfolio into contagion and non-recovery of facilities created asset liability mismatches here again it was the failure of the management and not of the system.

We must admit that the weak regulations of that era, non-existence of Sharia compliance structure, were also responsible for the defaults but this area has now sufficiently been addressed to strengthen the NBIFIs in Pakistan.

Another major reason of the above failures of NBIFIs was their handsome investment in the listed securities which lost the value due to stock exchange crash. The stock market performed very well till the year 1995 but in 1995-1996 the stock market lost 27 percent of its value due to political unrest and discouraging economic outlook of the country.

Due to the above reasons we cannot say that it was failure of the Islamic financial system rather it was a failure of the management. We get further support to our conclusion as a large number of Islamic financial institutions which started their operations over 25 years back are still working in Pakistan. The rapid expansion and growth of Islamic Banking and finance in the last decade, with the compound rate of around 20 percent in Pakistan and rest of the world is also a clear indication of the viability of the system and its ability to face the modern challenges of financial sector. Moreover, eagerness of the people towards Islam, their hatred for Riba, inherent strength and roots of Islamic financial system and untiring hard work of the efficient Mudarib have still kept the twenty six NBIFIs alive in the country. These IFIs are performing and growing day by day. The assets of NBIFIs have touched a high figure of US$ 300 million at the end of March 2012. The Dividend payout history is tremendous and 70 percent NBIFIs every year pay dividends to their certificate holders and some of NBIFIs have a track record of over 20 years of continuous payment of dividend. The dividend payout ratio varies from 2 percent to


70 percent annually on case to case basis. We can hardly found any other sector with such a consistent payout to their share holders.

In addition to the NBIFIs, the Islamic banking and finance, its outreach and client network is growing in multiple dimensions at a very rapid pace in Pakistan. During the last decade Islamic banks, Islamic Mutual funds, Islamic Pension Funds, sukuk and Takaful have also started their operations in Pakistan and are growing with a fast pace of over 20 percent per annum. At present the total Shariah compliant assets (Islamic Banking, Non-Banking, Takaful and Sukuk) of Pakistan are over US$ 11 billion.

The regulators have also strengthened the regulatory regime for the Islamic financial institutions as well. Due to the strong regulatory framework now there is not even a single default, except the cases discussed above, in the Banking and nonbanking Islamic financial sector.

Disclaimer: "These views and opinions are of the author, and not that institution (SECP)"


Shariah Compliance In Modarabas By

Muhammad Samiullah*

ABSTRACT Modaraba companies & modaraba (Floatation & Control) Ordinance, 1980 was promulgated in June, 1980, Moadaraba Rules in 1981 and Prudential Regulations for Modarabas were issued in 2004. First Modaraba floated in July, 1980. Shariah Compliance & Shariah Audit Mechanism (SCSAM) introduced in February, 2012 by SECP. Objectives of SCSAM is to strengthen the shariah compliance of Modarabas. NBFI & Modaraba Association of Pakistan plays a vital role in implementation of SCSAM

The Modaraba Sector being the pioneer in providing Islamic financial services in Pakistan is an important segment of the financial sector. Shariah Advisors have been appointed to monitor day to day transactions and ensure shariah compliance.

KEY WORD: Shariah Compliance in Modaraba

Introduction The concept of Modaraba as a shariah compliant mode of financing was

evolved and introduced as an institutional framework in Pakistan with proper legislation, regulatory and monitoring structure and operating guidelines as back as in 1980. This privilege of translating the concept into an institutional and properly regulated structure is unique to Pakistan. In fact, the Modarabas, as Islamic financial institutions are the fore-runners of Islamic banking and mutual funds in Pakistan.

The Modaraba Companies & Modaraba (Floatation & Control) Ordinance, 1980 was promulgated in June, 1980. Initially the Modarabas were also regulated by the Central Bank like other financial institutions. Later on, the responsibility was entrusted to the Securities & Exchange Commission of Pakistan. The office of the Registrar Modaraba, being a part of SECP, monitors and controls the sector through rules, regulations and guidelines. The Modarabas are subjected to reporting requirement, prudential disciplines and on site audit like the rest of the financial * The Author, Muhammad Samiullah, is a banker, holds a Master Degree in Economics,

Law Graduate, PGD in Islamic Banking & Finance from CIE, Karachi, working as Secretary General, NBFI & Modaraba Association of Pakistan.


institutions. A properly constituted Religious Board approves and guide the functional integrity of the Modarabas for shariah compliance. No modaraba can undertake any modes of business or execute any form of agreements other than those which are specifically approved by the Religious Board.

The Modaraba sector being the pioneer in providing Islamic financial services in Pakistan is an important segment of the financial sector. However, the immense potential of the modaraba concept has not been fully utilized primarily due to lack of awareness on the part of the investors and lack of enthusiasm by most of the market operators.

Initially the business of the modaraba sector was restricted to only three basic products i.e. Ijarah, Musharaka and Murabaha. No efforts were made to innovate and design new products neither by the market operators nor by the regulators. There was a need to design new innovative Islamic business products to capture the market for a consistent growth of the Modaraba Sector.

The first modaraba was floated in July, 1980 and then came a boom and total number of Modarabas at one time went up to as high as 52. These Modarabas were not only trend setters of Islamic modes of financing in a pre-dominant conventional financial system in Pakistan but also built confidence among the general public regarding the practice of Islamic modes of financing.

Though Modarabas had been working since 1980 as Islamic Financial Institution in Pakistan, the real boost to the Islamic financial sector came when the Islamic Banks as well as Islamic windows of the Conventional banks started operating in Pakistan. The Modaraba sector could not project its presence due to its small size and operational variety even to the extent that Al-Meezan Investment Management Limited included Modarabas in the list of Shariah non-compliant entities o for the Islamic institutions to do business with or to make any investment in them.. As a result , Islamic Banks did not allow Modarabas to avail any financing facilities from them.

Under the circumstances, Modaraba Association of Pakistan took an initiative and adopted various measures to project the real and functional strengths of Modarabas and to neutralize the ill-founded negative perception about them, particularly the Islamic banks and mutual funds:

● Arranged meetings with the management and Shariah Advisor of Al-Meezan Investment Management Limited and arranged removal of the name of the modaraba from the list of prohibited companies displayed on their website.

● Revised the existing agreements of Ijarah, Musharaka and Murabaha. ● Introduced Nine model agreements included Diminishing Musharaka, Ijarah,

Salam, Istisna, mudarabah, musawamah, Musharaka, Murabaha, Syndicate Mudarabah, Syndicate Musharaka and Islamic CFS Murabaha and submitted to the Registrar Modaraba for the approval of the Religious Board.

On 19th March, 2008, a delegation of Modaraba Association of Pakistan made a detailed presentation to the Religious Board chaired by Justice (R) Mian Mahboob Ahmed. After detailed deliberations, nine agreements were approved by the


Religious Board, the texts of these agreements were issued by the Registrar Modaraba through Circular No.6 of 2008 dated May 08, 2008. The Religious Board also approved the conceptual framework for issuance of Sukuk by Modarabas.

Inspite of all these efforts by the Association, l there were still reservations , particularly on the part of Islamic banks, on the plea that day to day transactions of Modarabas were not sufficiently transparent without a specific certification from a recognized Shariah scholar although no Modaraba could execute any contracts except those duly approved by the SECP Religious Board.

In this backdrop, Registrar Modaraba took an historic initiative and issued a comprehensive Shariah Compliance and Shariah Audit Mechanism (SCSAM) in February 2012 after extensive consultations with the Association and market operators which provided a detailed framework for compliance of Shariah principles, involvement of competent Shariah scholars for verification of business operations and publication of a certificate of Shariah compliance in the financial accounts of Modarabas. It was recognized that the need for Shariah compliance for Modarabas is of paramount importance to give credibility and respectability to the Modaraba sector as an active component of the Islamic financial regime. In order to ensure that the inflows and outflows of the resources of Modarabas are free from Riba, Qimar and Gharrar the guidelines were finalized and issued by the Registrar Modaraba through Circular No.08 of 2012 dated 3rd February, 2012.

These guidelines will improve the quality of existing compliance and eliminate the risk of any inadvertent violation of shariah principles by the Modarabas. It is an important step towards the enhancement of the image of Modarabas as a responsible component of Islamic Financial Industry and will help build their business links with Islamic Banks, mutual Funds and Takaful Companies.

SHARIAH COMPLIANCE GUIDE In terms of “Shariah Compliance & Shariah Audit Mechanism” Modarabas are

required to appoint a Shariah Advisor who will look after their shariah issues and provide them guidelines on an on-going basis. The mechanism also requires setting up shariah compliance structure by Modarabas which can ensure compliance at every stage on a continuous basis. Keeping this need in view, NBFI & Modaraba Association of Pakistan prepared a “Shariah Compliance Guide for Modarabas” to help Modarabas in setting up their shariah compliance mechanism. This Guide is meant for the use of management and functionaries of Modarabas and its objective is to provide guidelines for the policies, procedures and strategies that help in ensuring Shariah compliance in business operations of the Modarabas.

This Guide will also explain the functions of Internal Shariah Auditors and Shariah Advisors and their mutual coordination so as to ensure a systematic and uniform pattern of Shariah Compliance throughout the sector.

OBJECTIVES The objectives of the “Shariah Compliance & Shariah Audit Mechanism” are:

● Introduction of mechanism for strengthening the shariah compliance by the Modarabas, in letter and spirit;


● Assurance of Shariah compliance in the systems, procedures, policies adopted by the Modarabas, financial products or services offered by Modarabas, agreements entered into by the Modarabas, and the screening process for the investment in shares/securities;

● Assurance of the use of the standard agreements approved by the Religious Board;

● Mitigation of the reputational and operational risk and enhancing the image and operational framework of Modaraba as Islamic Financial Institution;

● Introduction of the process for purifications of dividend income, the mechanism for the management of charity, procedure for appointment of Shariah Advisor, and to identify the avenues for the investment of surplus funds;

● Assurance of Shariah objectives of Islamic Laws in financial transaction made by Modarabas through introduction of internal shariah audit system;

To achieve these objectives, this Guide would serve as an operating tool for the Modaraba.

SHARIAH COMPLIANCE FUNCTIONS: As per Shariah Compliance Mechanism, the functions will be carried out at

two levels:

a) Appointment Of Shariah Advisor: The appointment of Shariah Advisor is an important step forward to improve Shariah Compliance of Modarabas. Within the overall policies, guidelines and documentation prescribed by the SECP Religious Board, the Shariah advisors shall ensure and provide guidance on operational level and also assist in searching solutions for product structuring and development of practical procedures for execution of transactions according to Shariah discipline.

b) For strengthening Shariah compliance in the daily transactions internally, it has been provided that the Internal Auditor should be equipped with proper shariah training to perform shariah audit on a continuous basis in coordination with Shariah Advisor. The Internal Shariah Auditor would perform shariah compliance functions in terms of practical application of the guidelines of Religious Board and Shariah Advisor to perform his supervisory duties.

Role Of NBFI & Modaraba Association Of Pakistan: The co-ordination role of NBFI & Modaraba Association of Pakistan is an

important factor in assurance of regulatory and shariah compliance by the Modaraba Sector in a uniform and sustained manner. The Association plays a pivotal role in this regard, in coordination with the members and the Registrar Modaraba:

a) Image Building Of The NBFI & Modaraba Sector: The Association firmly believes that the meticulous implementation of Shariah Compliance Mechanism shall help in image building of the sector as a


responsible component of the Islamic financial regime which, in turn, will gain confidence of all stakeholders, Islamic banks, mutual funds and especially the general public.

b) Co-ordination Amongst The Shariah Advisors : The Association co-ordinates with and amongst the Shariah Advisors of Modarabas, to ensure implementation of the Shariah Compliance Mechanism and to formulate guiding policies and procedures for satisfactory and easy abidance of requirements of shariah.

c) Periodical Review Of The Sector : The Association shall review the progress of the Shariah Compliance Mechanism based on the observations and recommendations of Shariah Advisors and the feedback received from its members.

d) Arrangement Of Training Programs: The Association believes in a continuous skill development process. For this,

training and refresher programs for staff and management of Modarabas would be conducted from time to time.

e) Dispute Resolution: The Association facilitates in resolution of any disagreement between the

management and the Shariah Advisors on any specific issues in line with the decisions and directions of the Registrar Modaraba in the similar cases.

f) Publications (i) The Association has published “Shariah Compliance Guide” for

Modarabas. This Guide is a consultative document to facilitate and promote a culture of shariah compliance in the Modaraba Sector.

(ii) The Association has also compiled all the agreements approved by the Religious Board, in a booklet form, titled “Model Financing Agreements for Modarabas”

(iii) It is the endeavor of the Association to disseminate more and more information to the stakeholders to strengthen the knowledge base about the shariah compliance.

With the implementation of “Shariah Compliance and Shariah Audit Mechanism” (SCSAM), the Modaraba Sector has achieved the following :-

● Transparency and clarity has been witnessed in the day to day transactions of the Modarabas.

● Uniform agreements are being used by the Modarabas for undertaking various types of Islamic modes of financing.

● To a great extent, elements of Riba , Qimar, Gharrar have been eliminated from their transactions.

● Dealing with the conventional banks and institutions have been eliminated to a greater extent and are being shifted to the Islamic Banks


● Islamic Banks, Islamic Mutual Funds and Takaful Companies have accepted Modarabas as a shariah compliant entity and started developing business relationships with the Modarabas thereby extending financing facilities to the modaraba sector.

FUTURE OF MODARABA SECTOR: In view of the acceptance of Modaraba Sector as a responsible shariah

compliant entity by the Islamic Banks, Islamic Mutual Funds and Takaful Companies, a vast niche market has been opened to this sector which will help resolve its issue of resource mobilization. In addition Modarabas would be able to enhance their scope of work and diversify their activities.

One of the important task ahead us is to get the names of all Modarabas included in KMI-100 index and KMI-30 Index so that Modarabas may be traded in the stock market as a shariah compliant entity thereby accepting the sector in the Islamic world.


Interest-Free Financing In USA By

Dr. S.M.Hasanuzzaman*

Abstract There are so far five interest-free financial institutions in the US. They are: Lariba Finance House (California, 1991), Devon Bank (Illinois, 2003), Guidance Bank (Virginia, 2002), University Islamic Financial (Michigan, 2003) and Ijara Loans (Texas, 2005). Residential financing tops the list of financing activity in all the five institutions. Lariba also finances autos, businesses, and equipment. UIF provides many banking services. Ijara Finance offers investment opportunities based on ijara and murabaha as well as sukuk-al-ijara contracts.

The modus operandi of Lariba bank is declining partnership of the usufruct of the property with a concept of joint ownership. Devon Bank advances its funds on the condition of murabaha (except in three states where it also practices leasing). The ownership of the purchased property is placed in a holding company. Guidance works on the basis of co-ownership till such time as the customer pays off the entire amount of Guidance’s share. The customer pays rent of the Guidance’s share in equity. UIF has adopted both murabaha and ijara. Ijara Finance practices lease-to-own, with the rights of ownership vested in a trust. Late payment is penalized in all the cases. Similarly all expenses, taxes and insurance premium are paid by the customer alone, irrespective of the ownership of the property during this process. The sources of funds of all the five institutions are largely the government sponsored Freddie Mac or Fannie Mae or both.

The case for sharia compliance is different in different cases. Guidance has a very impressive list of its sharia supervisory board and consists of Sheikh Taqi Usmani, Abu Sattar Abu Ghudda, Sheikh Nizam Yaqubi, Sheikh yusuf Talal DeLarenzo, Mohammad al-Gari and Imran Usmani. Devon Bank claims to have

* The Author - Dr. S.M.Hasanuzzaman is a renowned scholar, researcher, author of

number of books/research paper and articles on Islamic Banking & Finance and on other subjects. He is a member of JIBF Board of Editorial Advisor, Ex Chief Research Department, Stat Bank of Pakistan.


independently developed the product by using the writings of an internationally known scholar on Islamic finance (name not given). Lariba devised its programme in light of the fatwas published in Arabic and the methodology outlined by Sheikh Taqi Usmani. UIF claims to enjoy the support of Sheikh Nizam Yaqubi, Sheikh Yusuf DeLarenzo and Dr. Ahmad Shleibak. Ijara Loans programme was created by a Board of internationally recognized sharia scholars in 1996. Sheikh Mufti Umar Ismail is their sharia advisor and Mufti Muneer Akhoon is the chairman of sharia advisory board.

Key words: Interest-free, USA, Mortgage financing

The paper does not start with the prolepsis that interest has been eliminated from commercial banking and that so many Islamic banks throughout the world and Islamic counters of conventional banks have been Islamized. The entire system of murabaha adopted by “Islamic commercial banks” represents a dramatic performance of dialogue and documentation about purchase, sale, lend, borrow, transfer of goods, rights and liabilities, and pretending as principal and agent, knowing that they are staging an unrehearsed play. The simple fact is that the purchaser has an eye to bank’s money for purchase of the goods from the actual vender. He is short of funds and agrees to play this drama with the banker so that he can make use of bank funds. The banker, on his part, knows that only this drama will act as corpus delicti and create the impression of abstinence from interest on loans.

In the US there are no Islamic commercial banks in real sense of the term. The number of Muslim population is said to be more than six million which forms about two percent of total population. The financial institutions here finance home purchase or leasing autos or equipment. Only a few also act as investment banks. Islamic mortgages make a tiny fraction of the more than $ 2 trillion annual US residential mortgage market. HBSA Bank USA which wrote about $50 million in Islamic mortgages since 2001 stopped offering them due to poor demand. The United Bank of Kuwait left the market place after merger with Al-Ahli Commercial Bank of Bahrain in 2000 having written only about 50 mortgages. Now there are five such institutions:

Lariba Finance House Devon Bank Guidance Bank University Islamic Financial Ijara Loans In the following lines we give a brief account of the functioning of these

banks1:

LARIBA Lariba Bank, based in Pasadena, California, was founded in 1987 and is said to

be the oldest interest-free institution in the USA. Lariba started promoting itself as an interest-free financial company as opposed to an Islamic Bank in 1991, to promote

1 - Most part of this article is based on the respective websites of the institutions.


the business beyond the Muslim community. Currently 90 % of its customers are said to be non-Muslims. It is engaged in financing mortgages, auto financing equipment financing and trade financing.

Mortgage Financing The home financing model of Lariba is based on declining participation in the

usufruct. The maximum amount of financing is $3million and the maximum period of the transaction is 30 years. The procedure is that the client chooses a house and approaches Lariba to buy it for the client, agreeing that Lariba will retain its share of the usufruct (manfaah) of the property to the extent of its share in investment. Lariba conceptually purchases the property jointly with the client. Lariba would authorize the client to act as its agent (wakeel) to select, negotiate the price of, and purchase the property.

Lariba authorizes the client to undertake the purchase of the property from the vendor and record the title (register it) directly into his name. The client becomes the owner of the house while Lariba retains its share of the usufruct.

The client offers to buy and Lariba accepts to sell its share of usufruct immediately at the same price. The value of the sale is paid in monthly installments over a period of time up to thirty years without adding any interest.

Lariba and the client agree to perfect a lien (implied co-ownership) on the property to share in the rental value of the property in proportion to their share in capital. The rental value of this property is determined by the rental value of similar property in the area where the property is located.

The Lariba model analyses the rate of return on investment in the property. There are three possible outcomes from this analysis which affect Lariba’s decision to finance. They are:

If the return on investment (ROI) is higher than the return expected by investors, Lariba decides to finance and reduces the rent in order to make the monthly payment compete with riba-based banks.

If the return on investment is much lower than what the investors are expecting (say 2% while the competing investments yield 6%), Lariba declines the investment.

If ROI is marginally lower than the expected return by the investors (say 5% and our investors expect 6%), Lariba advises the client to renegotiate the price lower.

The respective shares in the right to enjoy the usufruct are determined by share in investment by the parties. Thus the client’s amount of repayment of a part of Lariba’s investment decreases Lariba’s share in usufruct and increases client’s share in investment and hence usufruct. This continues until the client pays off the entire amount of investment made by Lariba. Thus he will enjoy hundred percent of the usufruct terminating the relationship between parties. A minimum of 5% is acceptable as down-payment but in this case the customer will have to purchase private mortgage insurance. To avoid this, 20% down-payment is recommended. The procedure does not involve any partnership fees. There are also no hidden


charges or fees. The title of the house is registered in customer’s name from day one. He can sell the house any time he wishes to do. The customer has the right to take away the entire capital gain. In case there is a loss, it will be borne by Lariba and the investor. The same principle applies if the customer fails to pay his installments.

While it uses standard legal documents as required by US mortgage industry procedures and US Standard Government Mortgage Law, it supplements them with Lariba agreement. The agreement documents the process they use to calculate the payment and rental value agreed upon. They declare in the Lariba agreement that riba /interest charging or paying is haram.

Source Of Funds Lariba does not borrow money from Freddie Mac/Fannie Mae2 nor sell its

loans. They are investors in Lariba financed homes. Every single home is presented to them on line for approval or disapproval. If approved, Lariba would forward the money from its own funds to purchase the house and would be paid within a week or less by Freddie Mac/Fannie Mae. Lariba does not charge any interest for using own money during this week’s time.

Auto Financing This is done on the basis of lease to purchase. Lariba determines the monthly

rental value of a similar auto by surveying the car dealers or rent-a-car agencies. The client, on his part, also does the same. Both parties on the basis of these surveys agree on a monthly lease/rental rate. Lariba calls it “Marking the item to the Market” which directly reflects the utility that is a function of the economy of an area. Lariba purchases this item jointly with the client. The client agrees to buy back Lariba’s portion over a period of time called repayment of capital to the company. The financing agreement consists of two parts: the first is a loan agreement under which the client returns the capital and the second is a lease agreement based on an agreed rate, based on the declining equity stipulated by the return-of-capital pay back agreement.

Based on the agreement detailed above, a promissory note is drawn. It details the monthly payments representing the repayment of capital portion and the return on capital (lease) portion. To comply with US regulatory requirements and U.S. banking system rules, the monthly payment streams are plugged into a traditional amortization program to calculate an implied interest rate. This allows lariba to satisfy the “Truth-in-Lending” and “Full and Complete Disclosure of Implied Interest Rate” laws as required by U.S. banking and lending requirements.

Business Financing A person or a group of persons who want to start a new business should have at

least three years of prior business experience in the business he/they want to pursue. It is recommended that interested entrepreneurs pursue nationally recognized name brand service facilities. For example gas or service stations, KFC restaurants, medical and dental facilities. Lariba offers either of the two proposals:

2 - See Annexure for a note on Freddie Mac and Fannie Mae.


Joint venture or musharaka: Under this model the business owner enters an agreement with Lariba to buy the business according to a pre-agreed basis of co-ownership. The operator agrees to operate the business for a fee. The profit is distributed between the two parties according to a pre-agreed formula. The operator may include in the agreement his right to purchase the business after a certain period according to a specific formula.

Lease-to-Purchase: Under this model the client/the operator opts to buy-back the shares of the company at cost over a period. The lease rate of such a business is evaluated professionally by both the parties which leads them to agree upon an acceptable monthly lease rate.

The monthly payment is calculated based on the same principles used in the “Lease-to-Purchase” agreement explained in home financing.

Trade Financing Lariba also meets short-term working capital requirement of traders on the

basis of murabaha. It can also use it in financing imports/exports, purchase of raw material and financing inventory.

Equipment Financing The model used to finance the purchase of equipment is the lease-to-purchase

model. The terms and conditions of the model almost resemble the details already explained under auto- financing.

Sharia compliance Of Lariba Products The model pioneered and patented by American Finance House, Larib a,

follows exactly the same steps outlined in two sources:

The original source, which was a series of fatwas in Arabic, issued since 1990 by a group of distinguished scholars including His Eminence Sheikh Yusuf Al-Qaradawi and were published by Dallah Al-barakah pioneering Islamic Finance and Banking Company, and

The subsequent similar methodology outlined by Sheikh Muhammad Taqi Usmani, in English, in his book that was published in 1998.

Devon Bank Based in Chicago, Illinois, the bank generally offers financing on the basis of

residential and commercial murabaha and residential and commercial ijara although the option that is presently available is residential murabaha in most of the states.

Residential Murabaha Residential murabaha financing involves a cost plus sale of the property to the

customer. The procedure is that you identify the home that you would like the Bank to purchase on your behalf. The bank will buy the property at the closing and assume the risk of loss. It immediately sells the property to you for a fixed price it paid plus its profit. The profit is established in advance and is based on current


mortgage market rate. This total price is then paid by you to the bank in an initial down payment (10 percent of price) and in fixed installments over an agreed upon period of time. All payments are scheduled at the beginning of the transaction and do not change. You gain full ownership of the property at the closing.3 The payments you make will be identical to a conventional fixed rate mortgage, although the murabaha transaction is a distinct legal arrangement that is different from a conventional interest-bearing mortgage. This is the most readily available product, and has a few additional costs over those of a conventional mortgage.

Residential Ijara Residential ijara financing is a “rent to own” sale of the property to the

customer which takes the following form:

Identify the home you would like the Bank to purchase on your behalf.

Negotiate the price and other aspects of the purchase.

Make any initial payment of earnest money (generally a minimum of 10 percent of the purchase price) to reserve the home. The maximum amount of advance is $ 417,000 for a period of 30 years.

The bank purchases the property and places ownership in a holding entity. You agree to purchase the property over time, at cost. Title of the property is transferred to you after you pay the full cost of the property, over time. Because you are using the property you do not own, you have to pay rent. You may choose the rental adjustment period as monthly, yearly etc. This mode is said to be very flexible but complex and has some additional costs to establish and maintain the arrangement. The payments you make will be very similar to those that you would make on a conventional adjustable rate mortgage.4 If there is sufficient value in the property you may also use it to establish sharia-compliant line of credit.

Residential Musharaka Residential musharaka financing is also rent to own sale of property to the

customer. Under this mode you identify the home you would like the Bank to purchase on your behalf. You negotiate the price and other aspects of the purchase. Then you make any initial payment of earnest money to reserve the house. The bank

3 Closing refers to the meeting between buyer, seller and lender or their agents where the

property and funds legally change hands. It is also called settlement. Closing costs usually include an origination fee, discount points, appraisal fee, title search and insurance, survey, taxes, deed recording fee, credit report charge and other costs assessed at settlement. The costs of closing are about 3 percent to six percent of the mortgage amount. (http://www.lowlender.com/mortgageTermglossary.php) accessed on 15-11-2012

4 Adjustable rate mortgage (ARM) is a mortgage in which the interest rate is adjusted periodically based on a selected index, also sometimes known as the renegotiable rate mortgage, the variable rate mortgage or the Canadian rollover mortgage. (http://www.lowlender.com/motgagetermglossary.php) accessed on 16-11-2012


purchases the property and you agree to purchase the property over time, at cost. Because you are using the property you do not own, you also pay rent on the financier’s portion of the property. You may choose the rent adjustment period—monthly, annually, etc. as an equity based product, you and financier are co-owners and thus share any profit or loss upon your sale of the property based on your percentage of ownership. The comparative merits and demerits of the mode are the same as in the case of residential ijara.

Late Payment Penalty Late payments warrant for a penalty to motivate prompt payment. The Bank

deposits collected late payment penalties into an account to offset its costs and donate any funds left over to charity. In case of a customer’s hardship, however, late payment is condoned.

Among the products explained above residential murabaha is offered in most of the states while residential ijara is offered only in three states. Musharaka is not so far offered anywhere.

Sharia-Compliance Devon Bank independently developed its Islamic finance products using the

writings of an internationally known Islamic finance scholar (name not given) as a blueprint. The products were created by an officer of Devon Bank who has earned a post-graduate Diploma from the Institute of Islamic Banking and Insurance in London. The details of the initial murabaha and ijara products were reviewed by the honorable Mufti Muhammad Nawal-ur-Rahman and the Shariah supervisory Board of America, located near Devon Bank’s main office in the Chicago neighborhood. After requested changes were made by the Bank, a fatwa was issued by the Shariah Board approving these products. The Bank has also discussed its products with religious advisors in several US states and overseas. They have received a fatwa from Dr. Main Al-Qudah who has researched in Islamic mortgages and published a paper.

Guidance Residential Established in 2002 in Virginia, Guidance LLC is a wholly owned subsidiary

of Guidance Financial Group, LLC. The following is its financing procedure which they term as Declining balance Co-ownership Program

The Pocedure The home buyer and Guidance agree to be co-owners in the property.

The two parties buy the home, and ownership in the property is determined by each party’s down payment.

The home buyer makes monthly payments to Guidance. Part of the payment is a utility fee for full use of the home, and the rest is a payment to increase the buyer’s ownership in the property.

Over the course of the arrangement, the home buyer purchases Guidance’s entire ownership stake and becomes the sole owner of the property.


In order to achieve over time full home ownership, the customer commits to buy Guidance’s share of the property over a period of 15, 20 or 30 years. In case the customer decides to move out of the property before the end of the financing period, the customer can do so by first acquiring Guidance’s remaining ownership share and then, in a second step, turning around and selling the property in the market. And now because the owner is 100 % owner of the property he will retain the full gain resulting from the sale or bear the loss if any.

Late Payment Penalty In case the customer delays in payment of his installment, a fixed amount of

$50 by way of late fee is charged but not interest. This fee, according to Guidance, is allowed by Sharia scholars because it is a fee that covers the expenses involved in pursuing the collection of a late payment.

Replacement of Mortgage The model is available not only for those who want to buy a home but also for

those who want to replace an existing mortgage. Under this arrangement, an appraisal will be done to determine the value of the home. For example, a home is appraised at $ 100,000 and has an existing mortgage with a balance of $ 70,000. Guidance would pay off the mortgage balance. Since the home was appraised at $ 100,000, Guidance would now be 70% owner of the home. Hence the sharing in lease money will be effected.

Failure In Monthly Payments In the event of failure in making monthly payments, a specialized team of the

Guidance will try to work out a satisfactory arrangement to accommodate the customer’s circumstances and allow for the continuation of the co-ownership relationship. At the same time the team is also responsible to protect the rightful position of the customer’s co-owner. If the customer fails to abide by his commitment, the co-ownership agreement allows the co-owner to foreclose and sell the property in order to reclaim its rights. After the co-owner has been compensated, any surplus from the sale proceeds would be given to the customer.

Forced Sale Guidance takes into account a situation in which the government, during the

currency of the contract, wants to acquire the land on which the house stands. In that case, the co-ownership agreement specifically stipulates that the two co-owners would share the gains or losses from such a forced sale according to their ownership shares. As a result Guidance may end up with proceeds that fall short of the amount of financing it had provided, in contrast with what would be owed under a conventional mortgage loan.

Payment Of Taxes And Insurance As regards the responsibility for the payment of state taxes and insurance

claims, it is the customer who is exclusively treated to bear this entire burden. Guidance is totally unconcerned with these responsibilities. The logic behind payment of taxes is that the quid pro quo of these taxes is enjoyed only by the


customer. As a result he should also bear the burden of these taxes. As regards home insurance it is typically offered as a standard package that includes three types of coverage:

Property hazard coverage, which protects against damage to the structure of the home. Personal possession coverage, which protects against damage to the contents of the home.

Personal liability coverage, which protects against a third party liability. In principle, Guidance and the customer should jointly be responsible for the

cost of property hazard coverage. Guidance shirks off the responsibility on account of difficulty in separation of the two kinds of coverage and because it is more expensive.

Source Of Funds Guidance obtains external funding for the programme through an agreement

with Freddie Mac, a corporation chartered by Congress to support the home financing market. In this agreement Freddie Mac makes investments to take a co-ownership stake in properties financed under the programme. At a second stage Freddie Mac creates Sharia-compliant securities invested in the co-ownership assets. These securities will be offered by Guidance to Islamic Banks and other Islamic capital market participants around the world.

Sharia Compliance Guidance has a very impressive list of the members of the Sharia Supervisory

Board and has reproduced copies of fatwas on different aspects of functioning that could raise doubts. The list contains the following names:-

Justice Muhammad Taqi Usmani Dr. Abdul Sattar Abu Ghuddah Shaykh Nizam Yaqubi Shaykh Yusuf Talal DeLarenzo Dr. Mohammad Elgari Dr. Muhammad Imran Usmani .

University Islamic Financial University Islamic Financial has been in business since 2003 with its main

office at Ann Arbor, Michigan. It is a majority owned subsidiary of University Bank (member FDIC) which offers Sharia compliant banking and home financing products and services. The deposits earn variable profit but not fixed interest. These deposits are invested in Islamic mortgages.

Banking Products The following are its banking products: Sharia compliant savings/checking accounts Profit-sharing Money Market


Profit-sharing Certificates of Deposit Free Personal Checking Accounts Business Checking Accounts Free Internet Banking and Bill Pay Free ATM/Debit Card, Direct Deposit

Home And Real Estate Financing It offers Sharia-compliant home financing and commercial real estate financing

on the basis of murabaha (installment sale) and ijara (redeemable lease). In 2010 these products were being offered in 12 States.

Murabaha Sale In murabaha sale or marked up sale, the customer chooses a property which

the University Islamic Financial Corp. acting as agent to University Bank purchases for the customer and sells it to him at a marked up price. At the closing the customer makes his down payment (a minimum of 12 % of the cost of property) towards the acquisition price. This is the initial down payment which, in certain cases, may be as low as 5%. Home financing is free from any note or mortgage as is the case in conventional mortgage. Standard costs associated with the murabaha include fees for appraisal of property, credit report, survey of property, application processing, recording title, insurance and standard property sales settlement cost. In order to ensure that all payments are paid in time the customer has to maintain an escrow account against which UIF makes regular payments of all charges, taxes and insurance. In case the customer fails in making regular payments as contracted, the investor will take title and possession of the property. Should the property be sold for more than the customer owes, the profit will go to the investor subject to applicable law.

Lease To Own Lease-to-own mode is adopted in the case of commercial financing like

professional offices, multifamily residences and non-profit earning commercial pursuits. The maximum financing limit in the case of commercial financing is $2.6 million and in case of non-profit pursuits, it is $1.0 million. Maximum period of financing is 20 years. The procedure is that the customer selects the property and an independent trust acquires it and rents it to the customer. At closing the customer makes his down payment towards acquisition price. This is the customer’s initial payment on account which may be as low as 25%. This payment on account represents the customer’s beneficial rights in the property. His monthly payments include rent and a further payment on account, thereby increasing his beneficial rights. The customer can acquire full title to the property when the sum of his payments on-account equals the original purchase price. UIFC accepts applications up to 1.3 million with a minimum of 25% as initial payment on account.

Sources Of Funds Money that UIFC uses comes from one of the three sources: the bank’s broad

sources of funds; the capital markets (government sponsored investors in mortgages and their alternatives, large international investors including Islamic and western banks serving Muslim clients, and so on); and, in the case of UIFC through University Bank, an Islamic profit-sharing deposit programme which seeks to invest in mortgage alternative. (In the parenthesis “the source of government sponsored investors in mortgages” perhaps means Fannie Mae and Freddie Mac which are entered in the forms of Uniform Residential Loan Application.)


Bank Accounts And Term Deposits Profit-sharing deposit accounts are available only at University bank at Ann

Arbor, Michigan, to assist consumers who seek a Sharia permissible yield on their deposits.

Money market savings accounts offer limited checking and withdrawal facility. Minimum balance to open this account is $ 1000. Balances in these accounts are FDIC insured up to $ 250,000. One can access this account with free internet banking service, pay his bills with free internet bill pay and make withdrawals through 37,000 surcharge free ATM machines.

University Islamic Financial Corporation through University bank also offers Sharia-compliant Certificates of Deposit for 1, 2, and 5 year maturity. Earnings on these Deposits are variable and are paid quarterly. Minimum balance to open an account is $ 500 and is FDIC insured up to $250,000.

UIFC also takes part in Muslim community welfare programmes by providing assistance to non-profit organizations like masjids, Islamic schools and Islamic centres. This assistance forms a percentage of the deposits made by Muslims towards main deposit products. (Apparently this also gives the Muslim community an incentive to open such accounts with the Bank).

Sharia Compliance UIFC claims to enjoy the support of religious doctors like Shaykh Nizam

Yaqubi, Shaykh Yusuf DeLorenzo and Dr Ahmed Shleibak, and has produced copies of their fatwa for the SHAPE Agency5 murabaha for home acquisition, SHAPE redeemable Lease Process and UIF commercial redeemable lease process. It also claims to maintain an active team of Sharia scholars and auditors on its staff. It has also produced testimonials by Directors of Islamic Centres and imams etc. from Michigan, Virginia, New Jersey, and California.

Ijara Loans Set up in 2005, Ijara loans claims to have spread its business in all the 50 States

of USA and in Canada. It provides home finance up to $ 3 million6. The programme works as follows:-

The individual selects the property. Pays the required on account payment (traditionally called down payment),

which could be 3.5 % to 20% or higher if the individual chooses to do so. An independent trust holds the title to the property. The house can be leased for 10, 15, 20, or 30 years, depending on the individual

choice.

5 Shape Financial Corporation: headquartered in Vienna, Virginia, USA. Is a leading

knowledge source for Islamic banking and finance. A member of Alshaya Group international, SHAPE has offices in Kuwait and South East Asia serving global markets. Initial fatwa for SHAPE products have been produced by Sh. Yusuf DeLorenzo and Sh. Nizam Yaquby. These have been subsequently reviewed by other scholars including Dr. Muhamed Shleibak and Sh. Muhamed Becic.

6 Personal communication dated 20-12-12, by Mr. Shoeb Sharief, overall in charge of Ijara Loans.


The lessee pays monthly rent to the trust, also called on-account payments. The trust will pay real estate taxes and property taxes on behalf of the lessee and add these to the monthly rent. At the end of the lease period, the title is transferred to the lessee for a fee of $1.

Should the personal situation for the lessee change and he or she is in a need to sell the house, the trust is informed of this need and an arrangement is made to sell the house. If there is a profit the lessee keeps 100% of the profit. If there is loss the lessee bears the first loss.

In addition to the closing/conversion fee, there is a $20 per month Admin fee in every transaction.

The basic difference between a sharia Ijara wa iqtina Islamic loan process and a conventional lease is that Ijara process obligates the Trust (seller) to sell the property to you under a promise to purchase, while the same contract (under conventional lease) entitles the customer to purchase the property, the customer is not obligated to do so.

The purchase price agreed to in the promise to purchase is equal to the original purchase price less the down payment made by the customer plus $ 1.00. Traditional amortization calculations are utilized to determine the exact monthly payments. The mathematical formulas are acceptable as there are no sharia issues with these calculations. The major difference between a traditional mortgage amortization and an ijara transaction is that the ijara transaction is based upon a reverse amortization calculation.

Unlike a typical rental property lease, the customer is responsible for all the maintenance of the property, and has all other rights and duties of a home-owner. He can sell the property any time he wishes, like a home-owner, because once the customer has fulfilled the obligations under the lease or promise to purchase; he has become the owner of the property. Under the sharia, the gain or loss is shared by the parties in a transaction according to their percentages of ownership. The ijara transaction abides by this principle, in that at the time of realization of the gain or loss, there is only one owner of the property, and that is the customer because at the time of sale the trust will transfer to him the title of the property.

It is interesting to note that Ijara loans has recommended murabaha only for something that is short-term and discarded the mode for long-term estate transaction. The reason it assigns to it is that murabaha is essentially an installment sale in which the financier will purchase the item, mark it up and then divide the mark up price over time. The purchaser will then make the agreed upon installment payments.

Sources Of Funds Ijara loans has also invited people to participate in Islamic finance investment

opportunities that are sharia-compliant, secure and offer exceptional returns. These investments are based upon ijara, musharaka7 or murabaha finance arrangements and suit existing businesses with expansion needs. It underwrites all investments to the highest standards and guarantees the performance of the companies it finances. Its subsidiary, Ijara Capital Inc has several equity opportunities where minimum 7 On the objection as to how they could guarantee a return on investment based on

musharaka, they have assured this writer to delete the word.


investment is $ 50,000. Ijara Capital Partners LLC is currently offering 3,5,7, and 10-year Sukuk al-Ijara contracts with a minimum investment of $ 1,000. In case of Jumbo Sukuk contracts, it needs a minimum of $100,000 plus. The current yields are:

3-year Sukuk=3.35% 5-year Sukuk=3.875% 7-year Sukuk=4.45% 10-year Sukuk=5.15%

Sharia Compliance Ijara loans claims that their Home financing programme was created by a

Board of internationally recognized sharia scholars in 1996. The programme complies with Islamic finance guidelines and is free of riba and gharar. The original documents which bear Mufti Akhoon’s signature are available for comparison with the documents currently being used. Ijara loans is currently in the process of updating/ adding new members to their sharia board. Currently Sheikh Mufti Mohammed Umar Ismail, a former student of Justice Taqi Usmani, is their sharia advisor, and Mufti Muneer Akhoon is the chairman of their sharia Advisory Board.

Annexure Fannie Mae

The Federal national Mortgage Association (Fannie Mae) was founded in 1938 as a government-sponsored enterprise to provide local banks with Federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. In 1968 it converted to a privately held corporation to remove its activity and debt from Federal budget and to expand the secondary mortgage market by securitizing mortgages in the form of market backed securities, allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on thrift.

Freddie Mac In 1970 federal government authorized Fannie Mae to purchase private

mortgages and created the Federal home Loan Mortgage Corporation known as Freddie Mac, to compete with Fannie Mae and facilitate a more robust and efficient secondary mortgage market. Freddie Mac pools the mortgages it purchases from lenders across the country and packages them into securities that can be sold to investors. These investors include the lenders themselves, pension funds, insurance companies, securities dealers, commercial and central banks, and others.

Freddie Mac’s debt funding programme is well established, and offers investors a wide range of short-, medium- and long-term investment vehicles.


The Role Of Non Interest Banking In National Economic Development

By MOBOLAJI, Hakeem Ishola (PhD)*

ABSTRACT This is a preliminary study that attempts to analyze the role of non interest banking (NIB) in national economic development in Nigeria. It uses a theoretical construct and employs a discourse technique for the analysis. The paper suggests that NIB has potentials of enhancing financial inclusion and social capital in the country while reducing the cost of and risk associated with financial transactions. Through its operational modalities, it may also enhance financial depth and breadth and capable of improving financial effectiveness and efficiency which are needed for national economic development. NIB reduces asymmetry and facilitates entrepreneurship and innovation. For the NIB to fully realize its potentials and impact on the economy, some challenges have to be attended to such provision of a well structured regulatory framework on NIB to guide against abuses and ensure uniformity in practices, manpower development, more public enlightenment and standardization of accounting procedures to accommodate NIBs among others. The existence of NIB only put the country among countries with dual banking systems, combining the ethical feature of the NIB and the financial innovation of the conventional banking system, the existence of the two systems would further enhance the potential impact of the financial sector in facilitating economic development as the two systems should be seen as complementary and not substitute.

KEYWORDS: Banks, Economic Growth, and Africa JEL CLASSIFICATION: G21, O4, O55

Introduction A bank is any financial institution that mobilizes savings and channels same to

productive units. In discharging these functions, the banks perform three * The Author-MOBOLAJI, Hakeem Ishola (PhD), Department of Economics,

University of Ilorin, Kwara State. He is the pioneer chairman of Al-Barakah Microfinance bank at 67, Ladipo street, Lagos


transformations, Risk, liquidity and maturity transformations. Risk transformation in terms of providing a safety net for surplus unit, and thus hedges depositors against any potential security risk, such as theft, fire etc. It ensures liquidity transformation, through reduction of search cost for a potential borrower, thus, the bank provides an access to credit facility, and thus provides a consumption smoothing against income shock of a deficit unit or borrower. It performs the maturity transformation by guaranteeing both the saver and borrower of immediate fund when it is needed, more so, that often borrowers want to borrow for long period and lenders only want to lend for short period, the banks guarantee both parties of their fund at the period of maturity or when they need it. Thus, acts as an investment smoother for long term development projects. Hence, for these roles, the bank becomes an important financial institution for enhancing growth and development in an economy

The paper is divided into five sections, the first section contains the introduction, section 2 has the conceptual framework, section three gives non-interest banking in Nigeria and section four concludes the paper.

2.0 Conceptual Framework This section discusses the transmission mechanism between banks and

development, interest rate

2.1 Transmission Mechanism Between Banks And Development Goldsmith (1969), Mckinnon 1973, and Shaw (1973) suggest that the channel

of transmission of banking system to growth is through the efficiency of investment. Greenwood and Jovanovic (1990) view financial intermediaries as processor of information by directing the flow of an economy’s resources toward investment with the highest return. Bencinvenga and Smith (1991), show that the potential economic benefit of financial intermediation is only in the manner in which financial intermediaries allocate savings.

Levine (1997) argues that the main transmission of financial activity to economic development is through the fact that financial system improves risk reduction, facilitates efficient resource allocation, enhances access to financial information on investments, increases saving mobilization and monitors contract compliance.

Saint Paul (1992) also identifies another link between finance and growth is through technological choice. With his theoretical model, he shows that underdeveloped financial market can lead to agents investing in less specialized industries. He then concludes that this can lead to multiple equilibria, a low equilibrium with underdeveloped financial markets and unspecialized technology and a high equilibrium with developed financial markets with specialized technology.

According to Ang (2008) two channels through which finance can influence growth are the capital accumulation and the total factor productivity (also known as the quantitative and qualitative channels, respectively). The former suggests that economic growth depends on capital accumulation through domestic credit and foreign capital investment. An efficient financial system is needed to mobilize savings and channel it to productive ventures. The latter suggests that efficient


financial system boosts economic development through provision of credit facilities to facilitate human capital accumulation and development of technology-intensive industries.

Financial intermediaries enhance investment and growth through its informational role (Greenwood and Jovanovic 1990). Savings are allocated more efficiently; hence higher productivity of capital is possible through financial intermediaries. The risk–sharing role of financial intermediaries also allows them to pool the liquidity risk of depositors and invest funds in more illiquid and productive projects (Diamond and Dybvig, 1983) Levine (2004).

In short, a good financial institution impacts positively on economic development through enhancing domestic savings, facilitating productive investments and efficient resource allocation. Other channels include improving acquisition of technology and enhancing human capital accumulation while reducing information, enforcement and transaction cost. Thus, financial institutions act as a catalyst for economic development (See Mobolaji 2010 for further details)

However, the way the conventional banking institutions have attempted to perform these functions has been a serious source of concern, since it is premised on the institution of interest rate which is less humane in outlook and exploitative in practice. This has led to financial exclusion, low financial depth and poor access to financial services with its attendant negative impacts on the economic development of several countries1.

Honohan (2008) observes that, not only is “Africa the region in which finance looms largest, but in Africa finance is the number one barrier”. He further observes that after a decade of financial reforms, financial sector development in AFRICA is still constrained by four pervasive challenges: lack of scale economies, dominance of the informal sector, governance problem and scale shocks to the system.

One of the most controversial issues in the conventional practice is the institution of interest rate. The imposition of interest rate has further worsened financial exclusion on two bases, one it is highly exploitative and secondly it is morally and religious detestable, unfortunately there seems to be no generally acceptable rationale for imposition of interest rate in the literature or it is simply inconclusive in the literature.

2.2 Interest Rate: A Controversial Concept In Economics The origins of “interest” are deeply connected to the changing meaning of

“usury.” Canon law in the Middle Ages forbade usury, which was generally interpreted as a loan repayment exceeding the principal amount. The modern word “interest” derives from the Medieval Latin interesse. The Oxford English Dictionary

1 The results of the EFInA Access to Financial Services in Nigeria 2010 survey showed

that 39.2 million Nigerians representing 46.3% of the adult population are financially excluded. Only 25.4 million Nigerians are banked representing 30.0% of the adult population. The main barriers for financial exclusion includes unemployment and distance to bank branches, some Muslims are also excluded from accessing conventional interest-based banking institutions in observance of the prohibition against Riba (Basheer,2011)


explains that interesse originally meant a penalty for the default on or late payment of an otherwise legitimate, non-usurious loan. As more sophisticated commercial and financial practices spread through Europe. Over time, “interest” became the generic term for all legitimate and accepted payments on loans.

The concept of interest rate which has undergone several stages in contemporary economic thinking, started in early 16th century with wide condemnation, to the era of Adam smith with a maximum rate of 5%, to 18th century position of Jeremy Bentham of total elimination of interest rate ceiling. It also started with many states restricting it on loans between persons and corporations, others out rightly condemn it, but now it has been defined as a rental income of money.

The concept of interest rate has gone through four stages, starting with a stage of wide condemnation from early to 17th centuries, to a stage of restrictive permission in the late 18th century. This later became a basis for financial transactions in the 19th to 21st century, and in the late 21st century, there was a resurgence of the call to zero interest rate (see Schumpeter 1934)2. This concept remains inconclusive in the literature. Persky (2007) concludes that the controversial concept is a modest dispute between a failing master (Smith died in 1790) and an over-eager disciple (Jeremy Bentham)

Some Economists (Classical) rationalize interest rate on the basis of abstinence theory, as it is considered as a compensation for waiting or delayed consumption or sacrifice of savers, Keynessian rationalize it on time preference theory of money, suggesting that a rational economic agent prefers the present to the future, thus he needs to be compensated for discounting his future holding, hence it is a compensation to the lender and impatient cost to the borrower. However, these positions have been faulted by Siddiqi (1978), suggesting that this position suggests that there is no existence of a voluntary sector., where individuals advance a good without anticipating a reciprocal benefit. Hausmann and Macpherson (2000) aptly demonstrate that individuals engage in so many economic activities not for their pecuniary interest only but for other social and personal considerations (example people donate blood not for material benefit but for other considerations).

From a religious perspective, the institution of interest and its application on financial transaction is condemned in both Christianity and Islam. References to this in the Bible include Luke 6:34-35; Levictus 25:36-37, Exodus 25:25). The verses in the Qu’ran that support same include Q30:39; Q4:161; Q3:130 and then Q2:275-278. However, the Jewish as shown in Deuteronomy 23:19-23 that mildly allows for discriminatory practice, suggesting it can be imposed on commercial transactions involving non-Jews, and this has received world condemnation.

2.3 The Conventional Practice And Its Attendant Effects In The Economy Due to the above, this section briefly outlines some economic rationale for the

abolition of interest rate:

2 For a detailed analysis on the metamorphosis of interest rates, (see Persky, 2007).


The classical economists contend that interest enhances savings but discourages investment (IS), Hicks 1933 argues that there is an inverse relationship between investment and interest rate, and there is positive relationship between investment and economic growth or development. Thus, while, high interest rate discourages investment and thus, lowers economic growth and development. Though, the theory suggests high and direct relationship between interest rate and savings, however, in many developing countries in general, and in Nigeria in particular, that interest rate elasticity to savings is zero, suggesting many savers do not save because of interest rate but for other reasons (See The TATOO debate 1973-4).

Imposition of Interest rate on consumption loan may further worsen income inequality, as it may transfer wealth from the deficit unit (borrower who eventually pays the principal and the interest element) to the surplus unit (saver, who receives his principal amount saved plus interest income). It may also create an idle class of people, who earn income from accumulated wealth (earns interest on fixed deposit).

Interest paid on loan is considered as a cost of capital, and thus, for a firm it is regarded as an increase in cost of production, which sometime could be transferred to the final consumer through high prices, especially when the products are fairly inelastic. One of the most critical problems of interest rate is that it imposes unilateral risk on the customer or borrower and sometimes through this, strangulates entrepreneurship and stiffens innovation. In contrast to the NIB, where risks are mutually shared by the parties involved.(See Glossary for meaning of some of the financing modes available).

As earlier stressed, one of the channels by which financial institution enhances development is through funding of low-return but socially relevant projects, however the institution of interest rate discourages this, as the low return may not be adequate to wipe the interest-cost element and other incidental costs.

At Individual level, it may further worsen financial exclusion, lost of self-esteem and freedom, due to high debt profile. At firm’s level, it may increase cost of production, reduce capacity utilization and discourage investment. At national level, interest rate may worsen both internal and external debt burden. At international level, it may lead to unequal trade relations; make some economies vulnerable to external manipulations (especially of the donor or funding agencies).

Minsky (1991) considered financial instability to be endogenous to conventional financial system. This is premised on the fact that the market is characterized by asymmetry information. His core model is known as financial instability hypothesis (FIH), which simply declares stability is inherently unsustainable.

Thus, due to these factors, many economists actually call for zero interest rate. Hence non interest financial institution is actually a veritable alternative. It would enhance financial inclusion, broaden financial depth in the country

2.4 The Concept Of Economic Development Thirwall (2006) defines economic development as the process of economic and

social transformation within countries. This process often follows a well-ordered sequence and exhibits common characteristics across countries. Previously, it


connotes growth target with little regard to the beneficiaries of growth or the composition of output. However, it is obvious that, societies are not indifferent to the distribution consequences of economic policy. Thus, later scholars argue that a concept of development is required that embraces the major economic and social objectives and values that societies strive for.

Sen, (1999) defined development in terms of the expansion of entitlements and capabilities. He defines entitlements as ‘the set of alternative commodity bundles that a person can command in a society using the totality of rights and obligations that he or she faces and entitlements generate the capability to do certain things.

Thus, Goulet (1971) distinguishes 3 core values or basic components of development (Life-sustenance, self-esteem and Freedom. Life sustenance focuses on the provision of basic needs. No country is considered developed if it cannot provide its entire people with basic needs as housing, clothing, food and minimal education. Thus, the objective of development is to raise people out of primary poverty and to provide basic needs simultaneously.

Self esteem is associated with self-respect and independence. No country is developed if it does not have power and influence to conduct relations on equal terms. Eradication of feeling of dominance and dependence associated with inferior economic and political status. Also Freedom from 3 evils of “Want, Ignorance and Squalor” People are not free until they can freely exercise the right to choose. Thus, material development enhances the range of human choice open to individuals and societies. These three values are inter-related, such that lack of self-esteem and freedom result from low levels of life sustenance which all lead to self-perpetuating chain of poverty or Galbraith (1980) accommodation of poverty. Sen (1999) views freedom as the primary objective of development and principal means of achieving development. Development consists of the removal of various types of unfreedom that leave people with little choice and opportunity. Major categories of ‘unfreedom’ include famine, under nourishment, poor health and lack of basic needs, lack of political liberty and basic civil rights, and the real freedom that people enjoy. Hence, the growth of per capita income is only a means to that end and not an end itself.

Thirwall, combined Goulet’s and Sen’s concepts of development, by observing that development occurs when there has been an improvement in basic needs, when economic progress has contributed to greater sense of self-esteem for the country and individuals within it, and when material advancement has expanded people’s entitlements, capabilities and freedom. However, most ingredients of development are not measurable; thus, condition of being developed is as much a state of mind and not physical condition measurable by economic indices alone.

Thirwall (2006) further argues that economic development should be thought of in terms of the expansion of entitlements and capabilities that are not well captured by aggregate measures of output growth.

Todaro and Smith (2003), strongly argues, that economics needs to be viewed in the much broader perspective of the overall social system of a country (which includes values, beliefs, attitudes towards effort, risk taking, religion and the class system), if development mistakes of the past are to be avoided that stem from implementing policy based on economic theory alone.


Thus, it can be observed that the concept of development has undergone different stages, ranging from seeing development as purely an economic concept to the stage of seeing it as a complex interaction of human values, social and political system. Hence this comprehensive notion of development may be difficult to simply measure in terms of economic variable(s). Though, economists often use the economic measure of growth (Real GDP growth rate) or real Gross National Income per capita as indicators for growth and development however this has been argued to be inappropriate (Thirwall 2006). In conclusion, Todaro (2003) argues that development is not purely an economic phenomenon, but a multidimensional process involving the re-organization and re-orientation of entire economic and social system.

Furthermore, many national economic development goals are to promote freedom, enhance choice, entitlement and capabilities and restore self-esteem and dignity in personal, social and economic relations both at national and international level. Any system that fails to align with these goals may only lead to sub-optimal national development.

From the above, the conventional banking practice may only restrict choice and entitlement, whereas the promotion of NIB would enhance financial choice and inclusion, needed for economic development. It may also promote development through reduction in cost of financial transaction. Thus, Chapra (2009) observes that the global crisis witnessed such a tremendous dimension, due to the level of fragility and instability in the conventional banking practices. This instability has been caused by incessant financial engineering, excessive speculation and abuse of free market syndrome. (See Truman 2009). This then called for the need for an alternative framework, the non-interest banking and its impact on national economic development. Moreso, that the Islamic Financial services Industry has proven relatively resilient compared to its conventional counterpart during the global financial crisis (Sanusi, 2010).

3.0 Non-Interest Banking (NIB) In Nigeria 3.1 Historical Evolution Of Nib In Nigeria

The non-interest banking is any financial institution that exercises banking practices without the institution of interest rate. There are two types, non-interest bank according to Islamic values, and other based on other values.

The first modern experiment with non interest banking can be traced to the establishment of the Mit Ghamr Savings Bank in Egypt in 1963. During the past four decades, however, non-interest banking has grown rapidly in terms of size and the number of players. Non- interest banking is currently practiced in more than 50 countries worldwide especially in the Middle East. In August 2004, the Islamic Bank of Britain became the first bank licensed by a non-Muslim country to engage in non-interest banking. The HSBC, University Bank in Ann Arbor and Devon Bank in Chicago offer Islamic banking products in the United States. Sanusi (2010) observes that recent industry estimates show that non interest Banking is growing at a rate of 10-15% per year and with signs of consistent future growth.

Though NIB evolved in the late 60s and mid 1970s in the Middle East, it however commenced to Nigeria in 1991, with the promulgation of Decree 25, 1991


of Banking and other Financial Institutions Decree (BOFID), after 100 years of conventional interest-based banking system which started in 1892. The BOFID allows the setting up of banks on the basis of profit and loss sharing mode with a minimum paid up share capital of N50 million. However, 20 years later, the NIB is yet to be fully operationalised. Though, the framework for the NIB was in 2009, through professor Soludo, the then CBN Governor. Though, a number of attempts were made, such as Habib Nigerian Bank limited (now Bank PHB Plc) was licensed in 1992 to offer non-interest banking services on a “window basis” but actually commenced operations in 1999. Jaiz International bank plc was licensed in 2004, the bank was granted approval in principle, but could not commence operation before the recapitalization of banks in 2005, which changed the required minimum capital base to N25.0 billion from N2billion in 2004. Fakiyesi (2011) observes that the first full-fledged Non-interest microfinance bank Al-Barakah microfinance in Lagos. Recently, Jaiz bank, Standard Chartered and Stanbic IBTC banks have been given license to commence operation of NIB in the country.

3.2 Non-Interest Bank (NIB) And Development 3.2.1 Non-Interest Bank (NIB) : An Effective Route To Ideal Financial

Sector In Nigeria Poldermans and Philippe (2008) observe that the ideal financial sector should

display at least six core desirable features in line with World Trade Organization definition of a financial sector. These are financial depth, financial breadth; financial efficiency; financial effectiveness; regulatory sophistication and financial life cycle for it to serve as a catalyst for growth and development.

Collectively, they represent the benchmark, or the target. If the national – or regional – financial sector has all six pillars well developed and under control, it approximates an ideal financial sector. The financial depth connotes ability of the sector to mobilize financial resources from the economy; the financial breadth relates to the ability of the sector to offer several quality products and facilitates substantial choice. The willingness of the sector to provide affordable quality services is called financial efficiency indicator, the need for a good financial sector to be safe, stable and well regulated to meet the regulatory sophistication. A good system must have a defined progressive path known as financial life cycle. The existence of NIB would possibly enhance financial depth by enhancing financial inclusion and increasing financial resources mobilization. The NIB would also enhance financial breadth of the country by providing several quality products (see Table 3 for different NIB products), hence improving financial choice available to customers. Through zero interest rate and mutual risk sharing, the NIB offers affordable financial products. The NIB is a highly regulated system, the screening process is premised on religious value (existence of a shariah Board) either at the stage of product design or implementation, this strong regulatory framework ensures market discipline and enhances stability of the system, thus, NIB is a safe, stable and well regulated financial institution that meets the regulatory sophistication criterion.

The gradual growth of NIB in many Muslim and Non-Muslim countries suggest that the institution has a progressive path and a sustainable financial life cycle.


Table 1: Nigerian Banking Sector In Brief Year No of

Banks Urban

Branches Rural

Branches Abroad Total Financial

Breadth / choice

Financial Efficiency

Regulatory and stability

1960 12 154 4 2 160 Interest based Low Low




2000 54 1466 714 5 2185

NONE, but

interest based

Low Low

2004 89 2765 722 5 3492 NONE improving Improving 2008 24 3897 NONE improving Improving

Computed: From Cbn Statistical Bulletin (2008) The benchmark for financial depth according to the authors is 200-600 banks

per a million population, thus, a bank to serve 5000 customers, expectedly, Nigeria, with an estimated population of 150 million, would need an average of 30,000 banks. However, our branch networks are far less. Also, substantial number of the banks reside in the urban centers as against rural where majority reside. The existence of NIB, would improve banking coverage and access.

In essence, the introduction of non-interest banks would enhance the financial depth and broaden financial products options and enhances financial inclusion and improves financial efficiency and effectiveness in the country and in the long run impact positively on national economic development.

3.2.2 NIB And Financial Stability: The recent global crisis was driven by a number of causes, among them is the

incessant transformations in the financial system called Financial Engineering (Truman 2009), financial expropriation (systematic extraction of financial profits) Lapavitsas (2009), the abolition of the Glass-Steagall Act in 1999 (in force since 1933), which formally enabled commercial banks to engage in riskier investment banking practices, created opportunities for banks to trade on their own account and inadequate market discipline, too big to fail syndrome (Chapra 2009).

However, Chapra (2009), siddiqi (2009) all argue that the non-interest banks exercise more market discipline, and thus were not totally destabilized during the shock. Chapra (2009) finally concludes that the non-interest banks are more resilient to shocks than the conventional banks, due to their ethical funding approach, avoidance of excess leverage and speculative financing, regulated financial innovativeness as well as asset-backed financing (See Mobolaji 2011 for details).


3.2.4 NIB And Dual Financial Sector In Nigeria Nigeria is characterized by dual financial sectors, the formal and informal, the

formal is relatively more stable but has low banking patronage due to high cost and bureaucratic procedures, the large informal sector is less stable but have few exploitative institutions, thus, the existence of NIBs would provide additional financial option through its numerous financial instruments. EFInA survey (2010) reports that about 70% of Nigerian adults have no bank accounts and 46.3% of male adults are financially excluded. This exclusion is partly due to income shock, unemployment and religious constraints.

3.2.5 NIBs And ECONOMIC AGENTS HOUSEHOLD: it may provide an alternative portfolio of holding financial

assets, broadens financial choice and inclusion. With it, some Muslims can conveniently partake in the financial sector. In UK for example, the UK Government Support for Islamic Finance, according to Lord Eddie George, Governor of the Bank of England (1993-2003), is for two principal reasons enhancing financial inclusion and business benefits to UK.

BUSINESS/FIRM: NIBs may encourage emerging small and Medium Enterprises through mutual risk sharing and promotion of entrepreneurship. For example, one of the financing Modes of NIB is Mudharabah, profit and loss where both where both the entrepreneur’s idea and labour effort is rewarded along the capital contribution of the financier according to an agreed ratio.

GOVERNMENT: NIB could encourage real sector development. Many of the government initiatives in the real sector can be financed at a low cost or zero interest, but on long term profit and loss sharing which would benefit both parties. A sukuk bond for example as being practiced in Malaysia London and other countries could help in real sector development for fairly long period. The NIB through its Sukuk (Islamic Bond) can partner with the government to finance several other government initiatives in the real sector on a relatively long-term basis.

3.2.6 NIBs And Social Capital Sec 16 (1) (b) of the Federal Constitution states: The State shall, within the

context of the ideals and objectives for which provisions are made in this Constitution control the national economy in such manner as to secure the maximum welfare, freedom and happiness of every citizen on the basis of social justice and equality of status and opportunity. Thus, NIBs would enhance public confidence in the sector and promote ‘equality of status and opportunity’. This public confidence is needed to promote national economic development, as it is a basis of social capital and citizen’ genuine passion for national development (patriotism.).

This can be facilitated through the implicit mutual risk sharing profile of non interest bank, where financial support is equated to entrepreneurial skill, especially in the Mudarabah financing mode, where the business idea is valued as much as the financial contribution of the bank. And in case of any loss, individuals are indemnified to suffer only labour loss. This is in direct comparism with the conventional banking system, where the borrowers bears both the human and


financial loss, and thus, have his welfare worsened in case of any loss, as there is unilateral risk shifting rather than mutual risk sharing in NIB.

Non-Interest Banking Is Set To Achieve Financial Inclusion. Financial Inclusion is a constitutional right of every citizen and must be

respected. It is also a sensible public policy. The existence of NIB widens financial choice and enhances financial inclusion. NIB could also reduce capital flights as it could create avenues for a clement investment environment with low cost and adequate returns.

3.3 Non interest Banking And Some Challenging Issues In Nigeria’s Financial System For the NIB to fully realize its potentials and impact more on the economy,

some of the following challenges have to be attended to. These include well structured regulatory framework on NIB to guide against abuses and ensure uniformity in practices. The framework should equally spell out clearly the relationship between these banks and other conventional banks. The money market has to be restructured to accommodate transactions of assets in a non-interest bearing modes. In the same vein, the capital market may be rearranged to allow the NIBs to seek for long term and medium term funds and provision of non-interest bonds would facilitate further financial intermediation. Other challenges include dearth of specialists, competition with other conventional banks, poor public awareness, unstable macroeconomic environment standardization of accounting procedures etc. All these challenges are however, surmountable, considering the relative importance of this sector.

4.0 Concluding Remarks The non interest banking provides an alternative financial intermediary for

mobilizing and allocating resources. Through its operational modalities, it enhances financial inclusion, financial depth and breadth and capable of improving financial effectiveness and efficiency which are needed for national economic development. Because often such NIBs are often asset backed it is more stable less fragile like the conventional banks that are asset based. NIBs are ethical investment banking outlets, and enhance mutual risk sharing between investor and banks; this reduces asymmetry and facilitates entrepreneurship and innovation. In NIBs, more market restraints and discipline are likely to operate.

Though NIB is relatively new in Nigeria but has gained a momentum across the globe. It is in operation in more than fifty countries in the world, including in the Middle East and some other parts of the world like United Kingdom, United States of America, Switzerland, South Africa, Morocco, Libya etc. The recent global financial crises have made several countries in the world to reconsider the practice of Non-interest banking alongside the conventional banks.

A little caution has to be exercised while interpreting the analysis of this paper, as the paper has only presented a preliminary analysis of the role of NIB in economic development. Some of these potential impacts may have contemporaneous impact and other have future effects. Thus, enough time has to be given for the impact to


fully mature or observed in the economy, due to fewness of the number of NIBs and its level of development.

Furthermore, these effects can only be harnessed if the system is faithfully implemented and there is a strong regulatory framework in place to check abuses and arbitrariness. Due to the relative newness of the system (NIB) in Nigeria and dearth of reliable data, it is a bit difficult to conduct an empirical study in this paper; however, this can be further explored by further research in this area.

The existence of NIB only put the country among countries that offer dual banking system, ( combining the ethical feature of the NIB and the financial innovation of the conventional banking system, the existence of the two systems would further enhance the potential impact of the financial sector in facilitating economic development as the two should be complementary and not substitute.

Finally, NIB is an ethical system based on religious values, with a fundamental requirement that financial transactions are linked to real economic activity or real sector development. This system has to be embraced in its entirety, if NIB would contribute towards economic development.

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Goldsmith, R W (1969). Financial Structure and Development. New Haven. CT: Yale University Press.

Goulet, Denis. 1971. The Cruel Choice; A New Concept in the Theory of Development. New York: Atheneum.

Greenwood, J and Jovanovic, B (1990) “Financial Developments, Growth and the Distribution of Income”, Journal of Political Economy, 98, 1076-1107

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Hausmann, D and Mcpherson, M (2000). Economic Analysis and Moral philosophy. Cambridge: Cambridge University Press

Honohan, P and Beck, T (2007) Making Finance work in Africa. Woshington, DC: The World Bank.

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Persky, J (2007) Retrospectives from USURY to Interest: Journal of Economic Perspectives , Vol 21, NO 1, winter PP 227-36

Poldermans, R and Philippe, J (2008) “Study on the Integration of The Financial Sector in the ECOWAS Region” Final report submitted to ECOWAS.

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APPENDIX: Table 2: World Interest Rate At A Glance

. Country/Central Bank Last Meeting Current Interest Rates

Previous Interest Rates

Egypt Sept ,2009 8.25% 8.5%

South Africa Oct 2010 5.5% 6.5%

HongKong SAR Dec , 2008 0.5% 1.5%

India July 2011 8% 7.25%

Japan Dec 19,2008 0.1% 0.3%

Korea, Republic of Mar, 2011 3% 2.25%

New Zealand Mar, 2011 2.5% 3%

Taiwan Dec 2010 1.6% 1.5%

Czech Republic May,2010 0.75% 1%

European Monetary Union July, 2011 1.5% 1.25%

Iceland Feb, 2011 4.25% 4.5%

Norway May, 2011 2.25% 2.0%

Poland June,2011 4.5% 4.25%

Slovakia Mar 13, 2009 1.75% 2.25%

Sweden Oct 2010 1.0% 0.75%

Switzerland Mar 2009 0.25% 0.5% United Kingdom Mar , 2009 0.5% 1%

Turkey Jan, 2011 6.25% 6.5%

Canada Sept,2010 1% 0.75%

USA Dec 16, 2008 0.25% 1.0%

Brazil July, 2011 12.5% 12.25%

Source: Google July, 2011


Table 3: Nib Financing Instruments And Economic Agents

S/N Potential Beneficiary

Term Meaning

1 Households and Firms

Musharakah A partnership contract between two or more parties each contributing capital.Any profit or loss is shared according to agreed ratio.

2 Households and Firms

Mudharabah A profit sharing contract where one party contributes his entrepreneurial efforts while the other provides the capital. Profits are shared according to an agreed ratio, while any loss is exclusively borne by the financier after necessary due diligence has been observed by the entrepreneur

3 Household Empowerment

Murabahah A sale contract involving the bank selling an asset to a customer at a cost plus margin

4 Firm/Industrial sector Development

Ijara Sale and lease-back of asset , generally for long term financing

5 Firm/Industrial sector Development

Istisna A purchase order contract of assets whereby a buyer places an order to purchase an asset to be delivered in the future. This is useful for manufacturing/ industrial financing

6 Firm/ Agricultural sector

Salam Very useful for agricultural product financing

7 Government Sukuk Islamic Bond used for long term government finances and development projects


Country Model: Kuwait Introduction:

Islamic financial services in Kuwait can be traced back to more than 30 years with the establishment of Kuwait Finance House (KFH), the first financial institution in the country to operate in accordance with Islamic Shariah. Up till 2003, Kuwait Finance House remained the only institute offering Islamic financial services. However, following amendments in Central Bank Law (1968) in 2003 by including provisions for Islamic banking, new players entered the Islamic financial industry.

Presently Islamic financial services are offered in Kuwait by Islamic commercial banks as well as Islamic investment companies. According to Central Bank of Kuwait Annual Report 2011-12, there are 6 Islamic banks operating in the country (5 local and 1 foreign) along with 51 Islamic investment companies. In terms of market share, Islamic banking assets as share of overall banking assets constitute around 31 percent9.

Islamic Banking Regulations: The Central Bank of Kuwait regulates Islamic banking industry in the country

under Central Bank of Kuwait Law. Section 10 of the Central Bank of Kuwait Law (Article 86–100) provides the legal provision pertaining to the rules and controls of Islamic Financial Institutions. The above mentioned articles not only provide definition of an Islamic bank but also provide regulatory and supervisory framework for Islamic banking and explicitly requires all such activities to be in accordance with Shariah principles.

Shariah Supervisory Board: Central Bank of Kuwait Law requires the establishment of an independent

Shariah Supervisory Board (SBB) for all Islamic financial institutions in the country. All banks are required to have at least three members in the Shariah Supervisory Board (SBB) who are responsible for providing ruling on the validity of various banking transactions in accordance with Shariah principles. The Shariah Supervisory Board (SBB) is also mandated to submit an annual report to the general assembly of their respective banks and provide their opinion on the overall operations of bank with respect to Shariah compliance. The Shariah report is required to be included in the annual report of respective bank.

It is important to note that Central Bank of Kuwait does not have a central Shariah Board. Thus in case of conflict of Shariah opinions among members of Shariah Supervisory Board (SBB) of a certain bank such matters are referred to the

9 World Islamic Banking Competitive Report 2011-12 Source: SBP Islamic Banking Bulletin April-June 2012


Fatwa board in the Ministry of Awqaf and Islamic Affairs, that serves as the final authority in all Shariah matters related to Islamic banking.

Islamic Banks Supervision: In terms of supervision, Central Bank of Kuwait follows a consolidated

supervisory regime for both conventional as well as Islamic banks. All banks are required to follow Basel capital requirements. However, owing to separate nature of Islamic banking compared to conventional banks, a manual for Islamic banks titled ―Instructions manual, for Islamic Banks Supervision || has been prepared. The above mentioned manual includes three chapters namely (a) instructions on the registration system of Islamic banks, (b) law, instructions, regulatory and supervisory regulations and (c) periodic data and statistics of Islamic banks. Importantly, serious considerations are being given towards adopting a separate Islamic banking law for Islamic banks in the country.

The Kuwait Finance House As stated earlier Kuwait Finance House was the first institution to operate in

the country in accordance with Islamic Shariah. The Kuwait Finance House remained exempted from central bank’s regulations for more than twenty years since its inception. Such freedom allowed Kuwait Finance House to engage in a wide range of Shariah compliant products which were not confined to banking but also included areas like real estate, automobiles, trade finance and investment portfolios.

Kuwait Finance House has also engaged in investment activities in major markets of US, Europe and South East Asia through alliances with major global banks and financial institutions including Citibank, Deutsche Bank, JPMorgan, Chase, BNP Paribas, ABN Amro, HSBC, and Islamic Development Bank. Importantly Kuwait Finance House has established fully owned, independently functioning banks in Turkey, Bahrain, and Malaysia apart from representative offices in Singapore and Melbourne. Given its global presence and wide range of products, Kuwait Finance House is considered as a leading player in the Islamic banking and finance industry.

Kuwait Sukuk Market: Despite having strong infrastructure for Islamic banking and finance, Kuwait

has as yet not penetrated the global Sukuk market. According to International Islamic Financial Market Sukuk report there were only 9 global Sukuk issuances by Kuwait up till 2010 which collectively amounted US$ 1.58 billion; 3 percent of the global Sukuk issuances. One of the major reasons cited for this relative inactivity in the global Sukuk market is the lack of comprehensive legal framework for Sukuk issuances in the country. It is, however, pertinent to note that government of Kuwait is presently working with lawmakers for developing a conducive legal framework for Sukuk issuances. The government has already established Capital Markets Authority in 2011 aimed at improving the overall working of Kuwait’s capital markets. Going forward such actions are likely to result in improving Sukuk market activity in the country.


Sources: Zulkifli Hasan (2010), ―Regulatory Framework of Shari’ah Governance

System in Malaysia, GCC Countries and the UK, Kyoto Bulletin of Islamic Area Studies, 3-2 (March 2010), pp. 82–115

M. Umer Chapra and Tariqullah Khan (2000), ―Regulation and Supervision of Islamic banks||, Occasional paper # 3, Islamic Development Bank and Islamic Research and Training Institute

Website of Central Bank of Kuwait Website of Kuwait finance House World Islamic Banking Competitive Report 2011-12 Global Islam financial Review (2010 and 2011), BNM Islasmic IIFM Sukuk report 2nd Edition, 2011.


EGYPT

Introduction: The Arab Republic of Egypt the most populous of Middle East is considered

as a diversified economy having the largest and oldest banking sector of the region. Islamic banking in its today’s context was initiated with the emergence of the first interest free Saving bank; Mit Ghamir bank in Egypt in 1963. Today, three Islamic banks; Faisal Islamic Bank of Egypt; Al Baraka, and National Bank for Development, one investment bank (Ridge Islamic capital)3

, 11 Islamic banking operating windows and nine takaful companies are operative in the country.

Historical Evolution Mit Ghamir bank of Egypt is considered as one of the earlier efforts of Shariah

complaint banking in the world though the bank never marketed itself as an Islamic bank. Mit Ghamir bank was set up in rural areas focusing on providing interest free loans to poor farmers to meet their basic needs and cash flow requirements for farming. The bank was operating successfully and attracted other institutions to offer interest free financial services. However, all these institutions were closed down in 1968 due to political reasons. In 1971, Nasser Social Bank (NSB) was established on a similar interest free model with the objective of serving as welfare institution; NSB also did not have any reference of Shariah in its charter.

The changed political landscape in Arab world along with boom in oil prices persuaded Egyptian government to facilitate the development of Islamic banking in the country. The significant development in this process was enactment of a special law in 1977 that paved the way for establishment of the first commercial Islamic bank; Faysal Islamic bank. Faysal Islamic Bank started its operations officially in 1979 and initially operations were concentrated in urban cities and were mainly dollar dominated. The bank also offered various social services through Zakat fund.

As a result of open door policy of Egypt during the decade of eighties, Islamic Money Management Companies (sharikarat tawzif alamwal al Islamiyya) dominated the financial sector in the first half of the decade. However these companies were not regulated by the central bank or any other regulatory authority and therefore were not obliged to follow any restrictions or disclosures. As a result these institutions were able to offer profit rates better than banks and catered to the needs of faith sensitive clients. Decline in oil prices towards the end of decade of eighties started negatively affecting Egyptian economy, consequently the operations of IMMCs as well. The sudden change in the policy of government to restructure IMMCs as joint stocks as well as for them to maintain excess deposits with central bank under the new special law of 1988 resulted in the collapse of many of these institutions. Millions of Egyptians were adversely affected by these schemes leaving an extreme negative impact on Islamic financial industry as a whole. Moreover the declaration of few prominent Shariah scholars of Egypt that announced some financial interest

3 .http://www.bloomberg.com/news/2012-09-19/ridge-capital-rides-on-egypt-s-islamic-

finance-growth-potential.html Source: SBP Islamic Banking Bulletin July-September 2012


permissible for Muslims also resulted in shaking the confidence of demand side of Islamic banking industry. .

During the decade of 90’s two other banks; Al Baraka44

and National Bank for Development5

5 started offering Shariah complaint financial services in the country.

Today the Islamic banking industry of Egypt consists of 15 banks; three full fledged Islamic banks, one Investment bank and 11 Islamic banking operating windows of Conventional banks. Complementing the growth of Islamic banking industry globally, some changes in political scenario is convincing the Egyptian government for creating conducive environment for the development of Islamic financial industry

Recently the government has announced its desire for issuance of Sukuk along with an enabling act. This kind of positive inclination has started showing results as big groups like Abu Dhabi Islamic Bank and Bahrain’s Al Baraka Banking Group have started investing in Egyptian banks which can catalyse the development of Islamic finance market in Egypt. The growth of Islamic banking industry is also being complemented by the development of Takaful; Shariah complaint insurance, industry. At present nine takaful companies are operational in the country with Saudi Insurance House being the first one. The government is making concerted effort as it intends to increase the share of Islamic finance from 5 percent to 35 percent within five years6.

Conclusion The pace of growth of Islamic finance in Egypt remained slow due to lack of

official support and relatively lower demand. However, the potential for the growth of industry is huge as at present the significance of Islamic finance has been acknowledged domestically with growing global industry in addition of Egypt being the 6th most populous Muslim country having financial inclusion.

Sources:

Warde, I. (2000), Islamic Finance in the Global Economy, Edinburgh University Press, Edinburgh.

Abdullah Mouawad, S.G.(2009);The Development of Islamic Finance: Egypt as A Case Study, Journal of Money Laundering Control, Vol. 12 No. 1, 2009. Global Islamic Finance Report (2010), BMB Islamic, UK Limited Global Islamic Finance Report (2011), BMB Islamic, UK Limited Website: Faisal Islamic bank of Egypt; http://www.faisalbank.com.eg/FIB/faisal_en/About_0.jsp Website National Bank for development; http://www.nbdegypt.com/about-nbd/aboutnbd Website Albarak Egypt; http://www.albaraka-bank.com.eg/about-us.aspx Website: Egypt State Information Service (YOUR Gateway to Egypt; http://www.sis.gov.eg/En

4 Saudi owned group 5 Owned by Abu Dhabi Islamic Bank 6 Source: Thomson Reuters http://in.reuters.com/article/2012/11/12/ idINL3E8MC1AA20121112


News Monitor. Annual Financial Statement Disclosures For Islamic Banks Further Improved By SBP

Keeping in view the requirement of Islamic banking institutions in the country, State Bank of Pakistan has issued guideline for revised format of Annual Financial Statements for full fledged Islamic Banks and Islamic banking windows. After this revision, a new line item “Islamic Financing & Related Asset” will replace the “Financing” heading, providing more clarity This improvement would also result in clear representation of the financing position of Islamic banking by including Advance to suppliers and trade inventories under the consolidated heading of Islamic Financing & Related Asset and would also present a fair picture of Islamic banking ADR. This change will also provide a better tax treatment for all the players of the industry. This improvement was made based on the suggestions provided by Meezan Bank Limited.

Burj Bank Reaches A Network Of 75 Branches December 31: 2012 Burj Bank’s Management team and nationwide staff

celebrated a 75 branch network as the year 2012 reached conclusion. The Bank’s new state of the art branches in prominent locations across Pakistan have become a benchmark of innovation & the Bank also relocated 4 of its existing branches to higher net worth locations. The Bank has also launched 3 dedicated Corporate Banking branches and 3 Priority Banking Centers in the metropolitan cities. During this period, Upon completion of the branch network of 75 branches, Mr. Ahmed Khizer Khan, President & with the Burj Bank is committed to providing the highest standards of service delivery. Our new state of the art branches will play a very important role in enhancing the customer experience. These 25 new branches are just the collective passion beginning of our expansion journey. Inshallah, CEO of Burj Bank proudly stated “As the fastest growing Islamic Bank in Pakistan, & devotion of our team we will soon make Burj Bank the Islamic Bank of Choice in Pakistan & beyond”. Source: http://www.burjbankltd.com/news First Ever Air Time Sukuk Concept In Pakistan Approved By The Shariah Board Of Meezan Bank

Meezan Bank held its 19th Shariah Supervisory Board meeting at the Darul Uloom Korangi, Karachi. The meeting was chaired by world’s renowned Islamic Scholar, Justice (Retd.) Mufti Taqi Usmani and attended by Sheikh Essam M. Ishaq, who specially came from Bahrain for this particular meeting and Dr. Muhammad Imran Usmani, Shariah Advisor of the Bank. The senior management of Meezan Bank including Mr. Irfan Siddiqui – President & CEO, & Mr. Ariful Islam - Chief Operating Officer other team members were also present. .Source: The news included here is on the basis of information obtained from local and international print and electronic media.


The board approved the concept for the first ever Air Time based Sukuks to be issued in Pakistan. The concept involves purchase of air time from the cellular companies and its securitization. The board also approved detailed guidelines for Islamic Banks related to sharing of security with other conventional banks for long term Islamic project & structured financing. The SSB also approved the Premium Banking initiative of the bank after detail discussion. The meeting ended with a vote of thanks and members prayed for the success of Islamic banking in Pakistan.

SBP Sub-Committee In Process Of Developing Alternative To SWAPS For Islamic Banks

The Second meeting of SBP Shariah Board Sub-Committee on ‘Shariah Compliant SWAP Structure’ was held at SBP on January 17, 2013. Mr. Ahmed Ali informed that MBL’s Treasury has been engaged in FX outright buying & selling transactions both in ready and forward for the last 2 years without any routing. The committee was amazed with MBL’s innovative approach. The committee included Treasurers and Shariah Advisors of other Islamic Banks. The meeting ended on the note that the Shariah scholar members of the Committee would forward their recommendations to IBD.

Islamic Banking Assets May Surpass $1.8 Trillion In 2013: E&Y DUBAI: Islamic banking assets with commercial banks globally grew to $ 1.3

trillion in 2011 and, one potential scenario projects it to reach $ 1.8 trillion in 2013, representing average annual growth of 17 per cent, says a report.

According to Ernst & Young's World Islamic Banking Competitiveness Report 2013, Islamic banking assets with commercial banks globally grew to $ 1.3 trillion in 2011, suggesting an average annual growth of 19 per cent over past four years (24 per cent in 2011). The top four markets account for 84 per cent of industry assets.

"The Islamic banking growth story continues to be positive, growing 50 per cent faster than the overall banking sector. High potential international markets - each in different stages of development and therefore requiring different penetration strategies - include Saudi Arabia, Malaysia, Qatar, Turkey and Indonesia," said the report.

This year, E&Y has launched the EY Islamic Banking Universe that tracks industry performance across core Islamic finance markets with a combined GDP of $ 5 trillion in 2011.

Islamic banking assets are forecast to grow beyond the milestone of $ 2 trillion by 2014, the report added. Islamic banks continue to grapple with multiple challenges relating to sub-scale operation, asset quality, negative operating income from core activities and a weak risk culture, it said, adding "the severity of performance challenge has prompted several institutions to initiate wide-ranging transformation programs."


Glossary: Islamic Terminology Fatwa

A ruling made by a competent a Shariah scholar on a particular issue, where fiqh (Islamic jurisprudence) is unclear. It is an opinion, and is not legally binding.

Fiqh Islamic jurisprudence. The science of the Shari’ah. This is an important source

of Islamic economics.

Gharar Lit: uncertainty, hazard, chance or risk. Technically, sale of a thing which is

not present at hand; or the sale of a thing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does not know whether it will come to be or not.

Halal Activities; which are permissible according to Shari’ah.

Haram Activities, which are prohibited according to Shari’ah.

Ijara A leasing contract under which a bank purchases and leases out a building or

equipment or any other facility required by its client for a rental fee. The duration of the lease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

Ijara sukuk A sukuk having ijara as an underlying structure.

Ijara wa iqtina The same as ijara except the business owner is committed to buying the

building or equipment or facility at the end of the lease period. Fees previously paid constitute part of the purchase price. It is commonly used for home and commercial equipment financing.

Istihsan In Islamic jurisprudence, it refers to departure from the application of a ruling

on an exceptional basis by taking a lenient view of an act that may otherwise cause unfairness or distress.


Istisna A Contract of acquisition of goods by specification or order, where the price is

fixed in advance, but the goods are manufactured and delivered at a later date. Normally, the price is paid progressively in accordance with the progress of the job.

Maysir Gambling – a prohibited activity, as it is a zero-sum game just transferring the

wealth not creating new wealth.

Mudarabah A form of business contract in which one party brings capital and he other

personal effort. The proportionate share in profit is determined by mutual agreement at the start. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour.

Mudarabah sukuk A sukuk having mudarabah as an underlying structure.

Mudarib In a mudarabah contract, the person or party who acts as entrepreneur.

Murabaha A contract of sale between the bank and its client for the sale of goods at a

price plus an agreed profit margin for the bank. The contract involves the purchase of goods by the bank which then sells them to the client at an agreed mark-up. Repayment is usually in instalments.

Musharakah An agreement under which the Islamic bank provides funds which are mingled

with the funds of the business enterprise and others. All providers of capital are entitled to participate in the management but not necessarily required to do so. The profit is distributed among the partners in predetermined ratios, while the loss is borne by each partner in proportion to his contribution.

Rab-al-maal In a mudarabah contract the person who invests the capital.

Retakaful Reinsureance based on Islamic principles. It is a mechanism used by direct

insurance companies to protect their retained business by achieving geographic spread and obtaining protection, above certain threshold values, from larger, specialist reinsurance companies and pools.

Riba Lit: increase or addition. Technically it denotes any increase or addition to

capital obtained by the lender as a condition of the loan. Any risk-free or “guaranteed’ rate of return on a loan or investment is riba. Riba, in all forms, is prohibited in Islam. Usually, riba and interest are used interchangeably.

Sadaqah Charitable giving.


Salam Salam means a contract in which advance payment is made for goods to be

delivered later on.

Shari’ah Refers to the laws contained in or derived from the Holy Quran and the Sunnah

(practice and traditions of the Prophet Muhammad (PBUH).

Shari’ah board An authority appointed by an Islamic financial institution, which supervises

and ensures the Shari’ah compliance of new product development as well as existing operations.

Shirkatulmilk Partnership by ownership, which could be automatic as in the case of

inheritance by two brothers, or optional such as two persons purchasing a property jointly (not for a commercial purpose).

Shirkatulaqd A contract between two or more persons who launch a business or financial

enterprise to make profit, Generally it is termed as ‘shirkah’. Specifically, it has to be distinguished from shirkatulmilk, in which two or more persons become partners in the ownership of an asset not for business.

Sukuk Similar characteristics to that of a conventional bond with the key difference

being that they are asset backed; a sukuk represents proportionate beneficial ownership in the underlying asset. The asset will lie leased to the client to yield the return on the sukuk.

Ta’awuni A principle of mutual assistance.

Takaful A form of Islamic insurance based on the Quranic principle of mutual

assistance (ta’awuni). It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members.

Wakala A Contract of agency in which one person appoints someone else to perform a

certain task on his behalf, usually against a certain fee.

Waqf An appropriation or tying-up of a property in perpetuity so that no propriety

rights can be exercised over the usufruct. The waqf property can neither be sold nor inherited nor donated to any one.

Zakat An obligation on Muslims to pay a prescribed percentage of their wealth to

specified categories in the society, when their wealth exceeds a certain limit. Zakat purifies wealth. The objective is to take away a part of the wealth of the well-to-do to distribute it among the poor and the needy.


Arboun An Islamic version of option, a deposit for the delivery of specified quantity of

a commodity on a predetermined date.

Bai al-ina This refers to the selling of an asset by the bank to the customer on a deferred

payments basis, then buying back the asset at a lower price, and paying the customer in cash terms.

Bai bithaman ajil Sale of goods on a deferred payment basis credit sale, another term used for

such sales is bai muajjal. Equipment or goods requested by the client are bought by the bank which subsequently sells the goods to the client at an agreed price which includes the bank’s mark-up (profit).

Hajj Pilgrimage to Mecca. Hajj is a duty on every Muslim who is financially and

physically able to carry it out, at least once in his lifetime, Hajj is performed in the month of Zulhajjah the last month of the Islamic calendar.

Ibaha Lit: permissibility. Ibaha refers to the rule that every economics transaction is

mubah (permissible) unless expressly and specifically forbidden by shari’ah.

Kafalah Lit: responsibility or suretyship. In kafalah, a third party becomes surety for the

payment of debt. It is a covenant/pledge given to the creditor that the debtor will pay the debt or any other liability.

Qard hasana An interest-free loan given either for welfare purpose or for fulfilling short-

term funding requirements. The borrower is only obligated to pay back the principal amount of the loan.

Qimar Lit: gambling. Technically, an agreement in which possession of a property is

contingent upon the occurrence of an uncertain event.

Rahan Collateral; technically, it means to pledge or lodge a real or corporeal property

of material value as security for a debt or pecuniary obligation so as to make it possible for the creditor to recover the debt, in case of non-payment, by selling the pledged property.

Ramadan It is the ninth month of Islamic calendar, during which Muslims fast; it is also a

time for reflection, intensive prayer and self-restraint.

Tabarru A donation covenant in which the participants agree to mutually help each

other by contributing financially.


Tawaruq A sale of a commodity to the customer by a bank on deferred payment at cost

plus, profit. The customer then sells the commodities to a third party on spot basis and gets instant cash.

Umra Lit: visiting or attending. It is a mini-pilgrimage to Mecca which is not

compulsory, but highly recommended, and can be performed at any time of the year.

Musharakah, Diminishing An agreement which allows equity participation and sharing of profit on a pro

rata basis, but also provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers the ownership of the asset to the participants.

Amanah Lit: reliability, trustworthiness, loyalty, honesty, Technically, it describes a

business deal where one party keeps another`s funds or property in trust.

Usufruct A legal right to use and derive profit from property belonging to someone else

provided that the property itself is not damaged.

Wa’ad A promise to buy or sell certain goods in a certain quantity at a certain time in

future at a certain price. It is not a legally binding agreement.

Mufti An Islamic scholar, who interprets or expounds Islamic law and gives fatwa.

Wakil In a wakala contract, a representative (agent) who acts on behalf of the

principal/investor.

Sunnah It refers to the sayings and actions attributed to Prophet Muhammad (PBUH).


Note to contributors

Journal of Islamic Banking and Finance is an official publication of International Association of Islamic Banks Karachi, Pakistan. It is a refereed quarterly journal, as well as a pioneer in the field of Islamic banking and finance being published since 1984. It provides a forum for researchers, particularly in Islamic Banking and Finance, wishing to share their expertise with a vast intelligentsia in the form of articles, research and discussion papers and book reviews. Major areas of interest for the journal include: (i) Theoretical issues in banking and financial industry specially from Islamic perspective; (ii) Empirical studies about the Islamic banking and financial institutions; (iii) Survey studies on issues in Islamic banking and financé; (iv) Analytical studies of applied Islamic banking; (v) Comparative studies on Islamic and conventional banking systems; and (vi) Short communications and interviews investigating the perceptions of leading bankers and banking experts as well as policy makers. Articles Submission:

The contributors are requested to observe the following rules. Articles should be typed in M.S. Word and restricted to 10 to 15 pages of A-4

size paper. We accept original contributions only and if the material is taken from some book or any other source, the source may be mentioned. The editorial team does not assume any liability for the views of the writers expressed in their articles nor may necessarily agree with their views.

The articles should be submitted before start of the first month of each quarter, beginning from January, April, July & October enabling review and approval of the material by the editorial board for publication in the issue in hand.

If the editorial Board is of the opinion that the article provisionally accepted for publication needs to be revised, shortened, or the particular expressions therein need to be deleted or rephrased, such opinions will be communicated to the author for appropriate action. The author may also be requested to recast any article in response to the comments made thereon by the reviewers.

The numbering of footnotes will be consecutive, and the footnotes themselves will be placed at the end of the article.

The author (s) of articles published will receive 2 complimentary copies of the Journal of Islamic Banking & Finance and the IAIB reserves all rights in the material published in the Journal.

Abstract: The articles should contain well summarized abstracts between 100 to 200

words, covering the subject matter of the articles, its conclusion and the result arrived at, with key words. Tables And Figures:

Figures, tables and boxes should be numbered consecutively in Arabic numeral (i.e figure 1, figure 2 and Table 1 & Table 2) Book Review:

New books (on Islamic economics, finance and banking, as well as on issues and problems of economic development) will be reviewed in the Journal on request. Authors/publishers may send two copies of each book to the editor for purpose of review.

All communications should be addressed to the editor.


Journal Of Islamic Banking and Finance

Publication Date: 1984 (Pioneer in field of Islamic Banking & Finance in Pakistan)

Frequency: Quarterly (Refereed/Peer Reviewed) Registration: ISSN 1814-8042

Index Islamicus (Indexing/Abstracting Service) Circulation: Worldwide include IMF, World Bank, Central Commercial

Banks, Universities, Educational Institutions, and Public Libraries in Pakistan/abroad, Individuals, Scholars, Jurists etc.

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Quarterly Journal of Islamic Banking and Finance

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