BANKING OPERATIONS

ISLAMIC BANKING AND FINANCE

GROUP MEMBERS:

MUHAMMAD BILAL ZIKAR MAKANI

MUHAMMAD ARSALAN PANDHIANI

AHSAN IQBAL BEG

ADRISH ALI HASHMI

DARAKHSAN FATIMA

INTRODUCTION What is Bank and Banking?

Common questions about Islamic Banking?

What is meant by riba? How does an Islamic bank work? What is the difference between Islamic and

conventional banking? What are the main Islamic modes of financing? Is Islamic banking meant for Muslims only? What is the meaning of Takaful? What is the meaning of sukuk?

ISLAMIC BANKING

Islamic Banking is known by several names: Interest free banking Profit and Loss Sharing Banking Islamic Banking Special Finance Houses

• Islamic banking is banking or banking activity that is consistent with the principles of Islamic law (Sharia).

• Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as riba) for loans of money.

• Investing in businesses that provide goods or services considered opposite to Islamic principles is also haraam (forbidden).

KEY DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC BANKING

Conventional Banking Islamic Banking

1. The functions and operating modes of conventional banks are based on fully manmade principles.

1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.

2. The investor is assured of a predetermined rate of interest.

2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).

3. It aims at maximizing profit without any restriction.

3. It also aims at maximizing profit but subject to Shariah restrictions.

4. It does not deal with Zakat. 4. It deals with Zakat.

5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks.

5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well.

6. It can charge additional money (penalty and compounded interest) in case of defaulters.

6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity.

7. Very often it results in the bank's own interest becoming prominent. It makes no effort to ensure growth with equity.

7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

8. For interest-based commercial banks, borrowing from the money market is relatively easier.

8. For the Islamic banks, it must be based on a Shariah approved underlying transaction.

9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.

9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.

10. The conventional banks give greater emphasis on credit-worthiness of the clients.

10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.

11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.

11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.

12. A conventional bank has to guarantee all its deposits.

12. Islamic bank can only guarantee deposits for deposit account.

Sources of Islamic Law

 Various sources of Islamic law are used by Islamic Scholars to explain the Sharia.

The primary sources are: Qur'an: The Qur'an is the holy scripture of Islam. Sunnah: The Sunnah consists of the religious actions and

quotations of the Islamic Prophet Muhammad (P.B.U.H) and narrated through his Companions and Imams.

 Shariah Requirement & Prohibitions

 Shariah aspects of Islamic banking and finance revolve around Shariah requirements which refer to:

Avoidance of prohibitions. Ensuring that the contract have all their essential elements with their

necessary conditions.

The prohibitions are: Producing and trading of impure materials Producing and trading of materials which are of no use Riba Gharar Involvement of gambling

Riba Riba means charging of any interest, meaning money earned

on the lending out of money itself. The prohibition on paying or receiving fixed interest is based

on the Islamic principle that:• Money is only a medium of exchange.• A way of defining the value of a thing; it has no value in

itself.• It should not be allowed to give rise to more money, via fixed

interest payments.• The human effort, initiative, and risk involved in a productive

venture are more important than the money used to finance it.

There are two types of Riba: Riba fadhl: is defined as excess compensation without any consideration

resulting from a sale of homogeneous goods .

Riba nasiah: is defined as excess, which results from predetermined interest (sood) which a lender receives over and above the principle (Rsul Mal).

Gharar Uncertainty in the existence of Subject Matter Uncertainty in the delivery of Subject Matter Un Known

Subject Matter Price Duration Contract

Gambling Gambling is betting or charging something

which depends on the failure of one or more person.

Speculation is not gambling. Some jurists say that speculation is prohibited, but contracts involving speculation are still valid.

Is Islamic Banking for Muslim Only The principles of Islamic Banking, which prohibit

charging of interest rates, are humanistic in nature.

Islamic banking leads towards freedom from economic slavery. The freedom should be not only of Muslims, but of all.

The misunderstanding that Islamic banking is of Muslims only should be changed. It is a democratic banking system. There is not only humaneness and kindness but also productivity in it. It is also a meaningful share-holding.

It is a system in which the one who invests and the one who works for the venture share the profit and loss equally. The field of production will enhance if Islamic finance is properly followed.

SOURCE OF FUNDS

Besides their own capital and equity, Islamic banks rely on two main sources of funds:

Transaction deposits, which are risk free but yield no return. Investment deposits, which carry the risks of capital loss for the promise of

variable.

In all, there are four main types of accounts: Current accounts Savings accounts Investment accounts Special investment accounts

APPLICATION OF FUNDS (TYPES OF FINANCING FACILITIES)

Bai' al 'inah (sale and buy-back agreement) Bai' bithaman ajil (deferred payment sale) Bai' muajjal (credit sale) Musharakah ( joint venture ) Mudarabah Murabahah Musawamah Bai Salam Hibah (gift) Ijarah (leasing/ rental agreement) Ijarah-wal-iqtina Qard hassan/ Qardul hassan (good loan/benevolent loan) Sukuk (Islamic bonds) Takaful (Islamic insurance) Wadiah (safekeeping) Wakalah (power of attorney)

OUR FOCUSED PRODUCTS

Sukuk (Islamic bonds) Sukuk, is the Arabic name for financial certificates that

are the Islamic equivalent of bonds. Fixed-income, interest-bearing bonds are not

permissible in Islam. Sukuk are securities that comply with the Islamic law

(Shariah) and its investment principles, which prohibit the charging or paying of interest.

Conventional Bonds In finance, a bond is a debt security, in which the

authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals (semi annual, annual, sometimes monthly)

History Of Sukuk

In classical period of Islam, Sukuk meant any document representing a contract or conveyance of rights, obligations done in conformity with the Shariah.

Empirical evidence shows that sukuk were a product extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities.

The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetization, the so called securitization.

It is achieved through the process of issuance of sukuk. Its great potential is in transforming an asset’s future cash flow into present cash flow.

Sukuk may be issued on existing as well as specific assets that may become available at a future date.

Types of Sukuk

Murabahah Sukuk

Mudarabah Sukuk

Musharakah Sukuk

Ijarah Sukuk

Salam Sukuk

Istisna’a Sukuk

Benefits of Sukuk

Sukuk have great potential for promoting risk sharing.

Increasing savings mobilization and investment, spurring growth leading to enhanced welfare.

Sukuk is based on an underlying transaction which creates a close link between financial and productive flows.

This contributes to greater stability of the financial system.

Inder the risk-sharing principle required, there is an explicit sharing of risk by the financier and the borrower.

This arrangement will entail the appropriate due diligence and the integration of the risks associated with the real investment activity into the financial transaction.

Controversy

Sukuk are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba.

Conservative scholars do not believe that this is effective, citing the fact that a Sukuk (Islamic bond) effectively requires payment for the time-value of money.

Sukuk offer investors fixed return on their investments which is also similar in appearance to interest in that the investor's return is not necessarily dependent on the risks of that particular venture.

However, banks that issue Sukuk are investing in assets—not currency. The return on such assets takes the form of rent, and is evenly spread over the rental period.

The productivity of the asset forms the basis of the fixed income stream and the return on investment.

Differentiate Sukuk from conventional bonds

Sheik Muhammad Taqi Usmani President of the Shariah Council of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) identified the following three key structuring elements that differentiate Sukuk from conventional bonds.

Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues

Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise

The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested.

In 2011, various statistical and econometrics tests are conducted to check the argument that sukuk securities are merely the same as conventional bond. However, the results on the comparison of yield to maturity of sukuk and that of conventional bonds show that sukuk securities are different from conventional bonds.

TAKAFUL (ISLAMIC INSURANCE)

Takaful is an Arabic word which means guaranteeing each other.

Takaful is an Islamic insurance based on the principle of TA’AWUN (mutual assistance) and TABARRU (donation) where the risk shared collectively by the group voluntarily.

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes.

Insurance by combining the risks of many people enables each individual to enjoy the advantage.

History of Takaful

Muslim jurists acknowledge that the basis of shared responsibility in the system of "Aquila" as practiced between Muslims of Mecca and Medina laid the foundation of mutual insurance. Islamic insurance was established in the early second century of the Islamic era when Muslim Arabs expanding trade into Asia mutually agreed to contribute to a fund to cover anyone in the group that incurred mishaps or robberies along the numerous sea voyages (marine insurance).

Commercial insurance

Commercial insurance is a way to provide security to what is valuable in the event of loss or damage, based on the principal of risk taking and speculation. Commercial insurance is originally Haram as agreed upon by many scholars.

In most non-Islamic countries there are cooperative and mutual insurance companies. There is no harm from the Shari`ah point of view to participate in these services.

But, if a cooperative insurance company is not found one may enter into a contract with a commercial insurance company only by way of necessity.

If a person is forced by law to insurance or by way of need, it is obligatory for him to be content with the minimum proportion of insurance that covers his need.

Commercial insurance is strictly disallowed for Muslims because it contains the following elements:

Al-Gharar (uncertainty) Al-Maisir (gambling) Riba (usury)

Principles of Takaful

The principles of takaful are: Policyholders cooperate among themselves

for their common good. Every policyholder pays his contribution to

help those who need assistance. Losses are divided and liabilities spread

according to the community pooling system. Uncertainty is eliminated with reference to

contribution and compensation. It does not obtain advantage at the cost of

others.

Models of Takaful

There are three models of how takaful can be implemented:

Mudharabah model (profit-sharing) Wakala-Waqf model A combination of both

Types of Takaful in Pakistan

Family Takaful: Family takaful Investment linked takaful Child education takaful Medical & health takaful

General takaful: Home takaful Motor takaful Personal accident takaful

Benefits of Takaful

Through the spirit of cooperation and joint-responsibilities among participants, the act of charity and kindness allows participants the opportunity to obtain two forms of benefit:

First the monetary benefits through the Takaful plan itself.

Secondly the “benefits” in the spiritual sense, through the act of Tabarru’ (donation), participants will receive God’s grace and blessings in life Hereafter.

The Takaful system does not differentiate color or faith; it is meant to benefit all participants, irrespective of their religious beliefs.

PAST AND FUTURE OUTLOOK OF GLOBAL TAKAFUL MARKET

Takaful Companies in Pakistan

Pak Qatar Takaful Pak Kuwait Takaful Takaful Pakistan Limited Dawood Family Takaful Limited

Challenges for Takaful in Pakistan

Education and awareness

Ambiguity in regulatory statutes

Thin margins

Past Performance Of Islamic banking

Islamic finance has been gaining momentum on a global scale for the last 30 years. Many Islamic Banks have sprung up over the last few years.

These changes are occurring both in Muslim and in western countries, and are driven by a global trend amongst Muslims to become more observant of their faith.

Industry size is currently estimated at more than $400 billion, with projected growth of 15% per annum.

Financial institutions around the globe are trying to keep pace with the growing demand for Sharia’h compliant products and services.

Over the last three decades Islamic banking and finance has developed into a full-fledged system.

Today, Islamic financial institutions, in one form or the other, are working in about 75 countries of the world.

Success Of Islamic Banking Industry Of Pakistan

In Pakistan, Islamic Banking was started in 2002 by Meezen Bank Limited.

Currently Meezan Bank is the giant of Islamic Banking Industry of Pakistan with more than 50% of Total industry in Pakistan.

Meezan Bank is grown up by 106% in the year 2011.

Currently there are about 900 branches of Islamic Banking operating in Pakistan; this number is increasing by 100 from last some years.

The Profitability of Islamic Banking Industry has grown up by 58% in the first quarter of year 2012, which is the highest growth rate in the world.

Malaysia is doing Islamic Banking from last 25 years and their Islamic Banking industry holds 12% of total banking industry.

Bahrain is doing Islamic Banking from last 30 years and their Islamic Banking industry holds 8% of total banking industry.

Whereas Pakistan is operating from 10 years and its Islamic Baking industry holds 8% of the total banking industry, which shows the success of Islamic Banking in Pakistan.

Future direction of Islamic Banking Industry of Pakistan

Islamic banking is playing a vital role in the economy as it is attracting a number of unbanked populations towards the banking system.

The potential of Islamic banking is immense in future with tremendous expansion and success of the industry will continue to serve customers and business in Pakistan.

Islamic banking has been emerging overwhelmingly on the surface of earth because of its nature, modes of services and products offered by different banks.

There are a number of investors and account holders shifting speedily towards Islamic banks from conventional banks, which is an encouraging sign for the industry.

Islamic banking industry is expected to double its market share in the next five years.

Islamic banking industry is growing at a fast pace and maintaining an average growth rate of 30 per cent over the past six years.

Challenges to Islamic Banking Industry of Pakistan

The industry is still facing challenges and constraints that need to be addressed to sustain the growth momentum.

Islamic banks need to be more aggressive in increasing their outreach to these areas as more than 70 per cent of their presence is still concentrated in 12 cities.

The development of Sukuk has been instrumental, frequent Sukuk issuance in Pakistan since October 2010 has resulted in improving profits of the industry.

To encourage existing Islamic banking players and incentivizing new entrants, SBP has not only allowed the establishment of full-fledged Islamic microfinance banks and permitted full-fledged Islamic banks and Islamic windows to offer Islamic microfinance services, but has also issued guidelines for Islamic microfinance business.

There is also a need of an Islamic money market, SBP is focused on developing a comprehensive solution that would provide Islamic interbank money market, Islamic Interbank Offered Rate (IIBOR) as benchmark for pricing of various Islamic banking products, development of Shariah Compliant portfolio of SBP to offer placement facility to Islamic banks and the provision of lender of last resort facility, this mechanism can also help the government in bridging its financing need.

7 Tips for BusinessesHow to Increase Profits and Help The Economy

Grow

1. MAKE PROFIT THE SECONDARY AIM

2. BE TRUTHFUL AND HONEST

3. BE OPEN TO SCRUTINY AND CRITICISM

4. BE CLEAN

5. AIM FOR A HIGHER GOAL

6. WORK WITH OTHERS IN YOUR MARKET

7. DO NOT SELL THE HARAM