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  • Introduction to

    Islamic Banking

    Salman Ahmed Shaikh

    Research Associate, IBA

    www.islamiceconomics.viviti.com

    www.islamiceconomicsproject.wordpress.com

    http://www.islamiceconomics.viviti.com/http://www.islamiceconomicsproject.wordpress.com/

  • HISTORY OF ISLAMIC BANKING Islamic banking and the field of Islamic finance has

    grown appreciably since 1960.

    In Egypt, first Islamic savings bank was establishedbased on the principle of profit-sharing at Mit Ghamr in1963.

    The Islamic financial system in Malaysia was firstintroduced in 1963. Subsequently, Bank Islam MalaysiaBerhad (BIMB) commenced business on July 01, 1983.

    In 1975, the Islamic Development Bank was establishedto provide financing to projects in the member countries.

    Islamic Economics Project

  • HISTORY OF ISLAMIC BANKING

    Dubai Islamic Bank was the first modern commercialIslamic bank founded in 1975.

    Indonesia's first Islamic bank was Bank Muamalat,established in 1991.

    In Bahrain, first Islamic commercial bank wasestablished in 1978.

    Islamic Economics Project

  • OVERVIEW OF ISLAMIC BANKING

    Islamic Finance is a growing industry which is constantlyevolving and has been competitive to reach and sustainits growth momentum amidst even the Great Recessionand beyond.

    Assets of the global Islamic finance industry areestimated to grow to around $1.6 trillion by 2012(Source: Reuters).

    Some reports suggest that assets held by Islamicfinancial institutions may rise five-fold to more than $5trillion (Source: Moodys Investor Service).

    Islamic Economics Project

  • OVERVIEW OF ISLAMIC BANKING

    According to CIMB Group Holdings, Islamic finance is thefastest-growing segment of the global financial system.

    Vatican said banks should look at the rules of Islamicfinance to restore confidence amongst their clients at atime of global economic crisis. (Source: Osservatore official Vatican newspaper, March 04, 2009).

    Islamic Finance industry is an emerging and growingindustry. Islamic financial industry beyond banking hasachieved financial deepening in Asset Management,Investment Banking, Public Finance, Structured Financeand Insurance.

    On the geographical level too, Islamic banking has grownfrom Middle East to Europe and now is well positioned inSouth Asian markets as well.

    Islamic Economics Project

  • OVERVIEW OF ISLAMIC BANKING

    The market value of Islamic banking industry currently stands at $1 trillion.

    There are quite a few banks in the west who are workingextensively in this area to provide an alternative to theclients as the global economy goes through the financialslump.

    Few banks to mention over here are HSBC, UBS, CreditSuisse, Deutsche Bank, BNP Paribas, Citi bank, Barclays,RBS etc.

    Islamic Economics Project

  • ISLAMIC BANKING IN PAKISTAN

    During the period of Zia ul Haq, extensive reforms werecarried out in financial system to make financialinstitutions comply with Islamic principles in theirproduct offerings.

    In February of 1980, Council of Islamic Ideologypresented a comprehensive report on the elimination ofInterest.

    Operations of specialized financial institutions likeNational Investment Trust (NIT), Investment Corporationof Pakistan (ICP), and House Building FinanceCorporation (HBFC) were transformed to comply withIslamic principles.

    Islamic Economics Project

  • ISLAMIC BANKING IN PAKISTAN

    Banks started offering profit and loss accounts and someShariah Compliant financing schemes on a limited scale.

    Federal Shariat Court in 1991 ruled against thecompliance of the product offerings of banks with Islamicinjunctions.

    Supreme Court gave a historic verdict on interest onDecember 23, 1991 declaring all interest basedoperations to close down.

    Islamic Economics Project

  • ISLAMIC BANKING IN PAKISTAN

    Al-Meezan Investment Bank was established in 1997,which later became Meezan Bank, as the first full fledgedIslamic commercial bank established in 2002.

    SBP Islamic Banking Department was established on15th September, 2003 with the task of promoting &developing the Shariah Compliant Islamic Banking as aparallel and compatible banking system in the country.

    Since then, Bank Islami, Dubai Islamic Bank, FirstDawood Islamic Bank, Bank Al-Barakah and EmiratesGlobal Islamic Bank have started their operations as fullfledged Islamic banks.

    Islamic Economics Project

  • ISLAMIC BANKING IN PAKISTAN

    Islamic Economics Project

  • ISLAMIC BANKING IN PAKISTAN

    Islamic Economics Project

  • ISLAMIC MODES USED IN DEPOSIT PRODUCTS

    Qard

    Wadiah

    Musharakah

    Mudarabah

    Islamic Economics Project

  • QARD

    Qard means to give anything having value to the other with thecondition that same or similar amount of that thing would be paidback on demand or at the settled time.

    It is that loan which a person gives to another as a help, charity oradvance for a certain time.

    The repayment of loan is obligatory.

    Islamic Economics Project

  • DIFFERENCE BETWEEN QARD AND AMANAH

    The repayment of Qard is obligatory even if the borrowed amountor thing is destroyed by natural calamity.

    Amanah can not be used by Ameen.

    Qard can be used for meeting expenses and investment by theborrower.

    Islamic Economics Project

  • WADIAH

    It refers to the deposited property/funds.

    An Islamic bank acts as the trustee of depositors' funds.

    It guarantees to return the deposited property on demand.

    The bank may hibah any part of benefit it received from thedeposited property.

    Islamic Economics Project

  • MUDARABAH

    It is a partnership in which there are two partners i.e.Rabb-ul-Maal and Mudarib.

    Rabb-ul-Maal is the investing party which contributescapital in the partnership.

    Mudarib is the working party which contributes byrendering services in the partnership.

    Islamic Economics Project

  • ROLE OF RABB-UL-MAAL

    Rabb-ul-Maal is the investing party which contributescapital in the partnership.

    In case of profit, Rabb-ul-Maal shares in profit based onprofit sharing ratio agreed between the Rabb-ul-Maal andthe Mudarib.

    In case of loss, Rabb-ul-Maal bears the complete risk ofall financial losses.

    Islamic Economics Project

  • ROLE OF MUDARIB

    Mudarib is the working party which contributes servicesin the partnership.

    In case of profit, Mudarib shares in profit based on profitsharing ratio agreed between the Rabb-ul-Maal and theMudarib.

    In case of loss, Mudarib loses the remuneration for hisservices.

    Mudarib is entitled to receive Ujrat-e-Misl (equivalentwage) if the loss is not caused by his willful neglect.

    Islamic Economics Project

  • PROFIT SHARING MECHANISM

    In Mudarabah, profit sharing ratio has to be agreed atthe start of the Mudarabah contract.

    Profit Sharing ratio does not need to be equal for bothparties.

    Profit sharing ratio in Mudarabah is not the same as losssharing ratio.

    Rabb-ul-Maal bears all the financial losses if loss occurs.

    Neither partner is allowed any fixed profit. Profit sharingratio is applied to the actual profit earned.

    Islamic Economics Project

  • PROFIT SHARING MECHANISM

    Islamic Economics Project

    Category Deposit (Rs.) Weightage Weighted Average Profit Rate

    Savings 3,000 0.1 300 57 1.89%

    1 Month 1,000 0.3 300 57 5.66%

    3 Months 3,000 0.5 1,500 283 9.43%

    6 Months 6,000 0.6 3,600 679 11.32%

    1 year 7,000 0.7 4,900 924 13.21%

    Total 20,000 10,600 2,000

  • MUDARABAH IN LIABILITY PRODUCTS

    Mudarabah is widely used in Islamic Finance in liabilityproducts.

    Islamic banks use Mudarabah contract while offeringremunerative deposit products.

    Mudarabah is used in offering both checking and nonchecking remunerative deposits by Islamic banks.

    The accountholders (depositors) are Rabb-ul-Maal andBank acts as Mudarib.

    Islamic Economics Project

  • MUDARABAH IN LIABILITY PRODUCTS: CONTINUED

    Since the depositors are large and vary with respect toamount of investment and tenure of their investment,weightage mechanism is used besides profit sharingratio.

    Weightage mechanism is used to allow more profitdistribution to depositors who have kept funds for alonger tenure. This is strictly dependent upon occurrenceof profit which is not guaranteed.

    Horizontal distribution between depositors is done basedon weightage mechanism after vertical distributionbetween Mudarib and Rabb-ul-Maal (as a category) hastaken place.

    Islamic Economics Project

  • MUDARABAH IN ASSET PRODUCTS

    Mudarabah in Asset side products i.e. in providingfinance is rarely used by Islamic banks.

    On a limited scale, Islamic banks use Mudarabah intreasury placements.

    The reason for the rare use of Mudarabah in providingfinance is lack of documentation, lack of trust and thefact that risk of all financial loss has to be borne byRabb-ul-Maal alone.

    Islamic Economics Project

  • MUSHARAKAH

    It is a partnership in which partners invest as well asperform services for the firm.

    In Musharakah, there is no limitation on partners as towho can work and who can invest.

    Each partner can invest as well as work for the firm.

    It can be formed between two or more persons.

    Islamic Economics Project

  • PROFIT SHARING MECHANISM

    In Musharakah, profit sharing ratio has to be agreed atthe start of the Musharakah contract.

    Profit

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