Study on Islamic

Finance

and Products.

Mohammed Saleem .OA

salimvettom@gmail.com

Objective of the Study

Primary objective

To study the Islamic financial system, its

products and merits.

Secondary objective

To study the use these financing techniques

To analyze the feature of Islamic products

with conventional financial products.

Financial System

The system that allows the transfer of

money between savers and borrowers.

Instruments & Institutions to transfer

funds from saving surplus units to

saving deficit units in the most efficient

manner.

It facilitates intermediation between

savers (fund provider) and investors (

fund user)

Financial System Efficiency

Promotion of efficiency is the primary goal of

every Financial System.

It is measured in terms of efficiency achieved in

mobilizing savings from saving surplus units in

the economy and in allocating these funds

among saving deficit units.

Increase in the range of financial assets and

instruments would improve efficiency in

mobilization of funds.

For Improving Allocational

Efficiency it Needs

Less transaction cost

Simplified transaction system

Availability and accuracy of information

Should be a stable system.

Islamic Fianacial System Financial institutions and instruments which are

functioning on the basis of directions and rules in shariah

(a set of rules that governs every aspect of Islamic life)

are known as Islamic financial system.

In conventional finance there is a tug of war between

ethics and efficiency.

In Islamic finance ethics dominate all the concerns.

The Shari'ah specifies, inter alia, rules that relate to the

allocation of resources, property rights, production and

consumption, and the distribution of income and wealth

Shariah Prohibits

Riba: which is taking or giving of interest

Masir : which is involvement in speculative and gambling

transactions

Gharar : which is uncertainity about the terms of contract

or the subject matter, eg. Prohibits selling something

which one does not own.

Investment in business dealing in alcohol, drugs,

gambling, armaments, etc. which are considered unlawful

or undesirable.

• Prohibition of interest is not limited to Islam it is prohibited in Judaism and Christianity

• Key objective is to ensure SOCIAL JUSTICE

• Money is only a medium of exchange, no value in

itself.

• Therefore should not be allowed to give rise to more

money, via fixed interest payments, simply by being

put in a bank or lent to someone else

• Results in concentration of wealth

Interest can leads to injustice and exploitation in

society.

Why Interest/ Riba Prohibited

Principle of Islamic Finance

Freedom to contract

Freedom from Riba

Freedom from Algharar

Freedom from gambling and unearned income

Freedom from price control and manipulation

Mutual cooperation and solidarity

Public Interest

Global Islamic Finance Industry

1963 : Mit Gamir Project, Egypt.

1975 : IDB, Jeddah

1975 : Dubai Islamic Bank

Growth Rate : 10-15%

300 Institutions over 75 countries USD

800 billion under management.

Expected tocontinue with assets growing

USD 1 trillion by 2010.

Islamic Window : ABNAmro, HSBC, City

Bank

Islamic Finance Products

Investment Financing

Trade Financing

Lending

Musharakah ( Joint Venture) Musharaka is similar to a joint venture, whereby two

parties (an Islamic Financial Institution and a Client)

provide capital for a project which both may manage.

Profits are shared in pre-agreed ratios but losses are

borne in proportion to equity participation

Business Venture

Client Bank

Profit / Loss

Mudaraba – Trustee Partnership

Mudaraba is a contract between two

parties: One of them provides finance (

Rab ul maal) & other uses his labour and

expertise (Mudarib).

Profit, if earned, is distributed between the

two parties in accordance with the ratio as

per the agreement. Financial Loss, if

suffered is borne by the investor only.

Client Bank

Business Venture

Profit Loss

Murabaha ( Mark upSales) The client orders an Islamic Bank to purchase

certain goods at a specific cash price

The Bank purchase these goods from the

supplier and sells to the client at a marked – up

price ( Cost + Profit).

The differed price may be paid up on lump sum

or in installment

Client Bank

CostGoods / Ownership

Cost + Profit

Ijara ( Lease)

A contract under which an Islamic bank finances

equipment, building or other facilities for the

client against an agreed rental. The ownership

remains with the lessor bank and can be

transferred on predetermined basis.

Salam ( Forward Selling)

Salam means a contract in which advance

payment is made for goods to be delivered

later on.

The seller undertakes to supply some

specific goods to the buyer at a future date

in exchange of an advance price fully paid

at the time of contract.

Istisna

It is a contractual agreement for

manufacturing goods and commodities,

allowing cash payment in advance and

future delivery or a future payment and

future delivery.

Qard Hassan ( Charitable Loan)

It is an interest free loan.

Only loan permitted by Shariah.

The loans are made from the pooled donations

of the members, Zakat and are generally

granted to those who are facing emergency

personal crisis.

Activity

Client approaches Bank for loan and offers collateral

security.

Bank lends an amount to client.

Client repays amount to Bank (with or without

administrative expenses) in part or in full

TAKAFUL (INSURANCE)

Takaful, the Islamic alternative to

insurance, is based on the concept of

social solidarity, cooperation and mutual

indemnification of losses of members.

It is a deal among a group of persons who

agree to jointly indemnify the loss or

damage that may inflict upon any of them,

out of the fund they donate collectively.

What Distinguishes Islamic Banking

• Transactions are asset-based

• It is socially-responsible banking because it operates under Shariah restrictions

• Does not permit financing of prohibited goods / Industries

• It starves evil out of the society

• Ethics and moral values play a major role in investment decisions. Not a choice but a must

- Conventional banking prices money.

- Islamic banking prices goods and services which creates real wealth in the society leading to economic well-being.

Conventional Banking Islamic Banking

- Is based on fixed return on both Sides of the balance sheet.

- Is based on profitsharing on deposits side,and on profit on assetsside.

Distinguishing Features

- Does not involve itself in trade and business

- Actively participates in trade and production.

Conventional Banking Islamic Banking

- Depositors get a fixed rate regardless of the bank’s profitability, thus insulating them from the bank’s true performance.

- Profit is shared with the depositor, higher the bank’s profit, higher the depositors income.

Distinguishing Features

Basic Difference between Islamic and

Conventional Modes of Finance

Conventional

Bank Client

money

money + money (interest)

Basic Difference between Islamic and

Conventional Modes of Finance

Islamic

Bank ClientGoods &

Services

money

Performance of Islamic Finance In comparison with conventional banking

systems, Islamic bank’s assets and deposits

have grown at GR of 20-22% while those of

conventional banks have grown at a rate of 11%

for the period 2002 – 2005.

Key Isuues

Taxation & Legal Issues

Risk Management

Regulatory Issues

Fragmentation

Conclusion Islamic Finance assures Equitable

distribution of risks and rewards among

the stakeholders

Inculcating market discipline and higher

ethical standards given its emphasis on

non-exploitation and social welfare.

It may be observed that Islamic finance is

far more interesting and complex than

conventional finance as far as financing

techniques are concerned.

it is in the area of assets rather than in

liabilities that the practices of Islamic

banks are more diverse and complex than

those of conventional banks.

it is generally believed that Murabahah is

the most widely used technique and that

the majority of the financing provided by

Islamic banks goes to short-term trade and

the financing of real estate.