Glossary of islamic banking

Glossary Of Islamic BankingGlossary Of Islamic Banking

Training Session of BDO’s

Prepared By: Muneeb Waseem Ansari

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Introduction of Islamic Introduction of Islamic BankingBanking

Islamic banking is interest free banking, in which there is no fixed rate of return. Islamic banking is the banking system which is run in accordance with the Islamic laws and the Shari a` board; that guides the institutions. This Shari a` board authorizes the products that whether these are Shari a` compliant or not. Islamic banking is the banking that is guided by Islamic law ( Shari a`) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection and payment of interest,


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also commonly called Riba in Islamic discourse”. Islamic banking also finds its roots in Islamic finance and all type of transactions are interest free and of risk sharing. The interest is prohibited in Islamic ways of banking as it is also obvious from Quran. In Quran, in Sura Al-Imran, Allah said that; “O you who believe! Do not devour Riba multiplying it over and keep your duty to Allah that you may prosper” (3:130). Same kind of prohibition regard fixed interest is also lead in Sura Al-Rum(39) , Al-Nisa(160-161) and Al-Baqarah(275-281) of Quran.


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Riba and Gharar are illegal under Islamic law. Riba refers to fixed rate of interest. Gharar refers to speculation. Islamic banking shows dramatic improvements and developments in Pakistan. Islamic banking is taken as national policy and it is supported but there exist dual banking structure in the Muslim countries. Mostly the banks of conventional system are also opening their separate Islamic banking divisions and branches.


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The expectation of increase in growth of networking of Islamic banking system is increasing. The Islamic banking has increased in terms of branches, deposits, capital funds, sources. The ratio of income to expenses is high which indicates increasing profitability of the sector.


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Riba or InterestRiba or Interest

Riba literally means increase, addition, expansion or growth. It is however not every increase or growth, which is prohibited by Islam. In shariah, Riba technically refers to the premium that must be paid without any consideration.


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Types Of RibaTypes Of Riba

According to jurists of Islam Riba have two types.

Riba Al-NaseahRiba Al-Fadl.


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The organization of term interest dates back to 17th century with the emergence of banking system at global level. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning/ value as that of Riba is defend in the previous question. Further, it is narrated that “ the loan draws interest is Riba”.


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Riba in QuranRiba in Quran

In the Holy Quran, Allah (SWT) says in Sura Al-Baqarah (2-279): “……. And if you repent, yours is your principal”

And what ever Riba you give so that it may increase in the wealth of the people, it does not increase with Allah. ( Sura Al-Rum 30:39)

And because of their charging Riba while they were prohibited from it. ( Sura An-Nisa 4:161)


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Riba in HadithRiba in HadithHazrat Ali Radi-AllahuAnhu reportedly referred that the Holy Prophet said:“ Every Loan that drives a benefit ( to the lender) is Riba. Abu Said al Khudri Radi-AllahuAnhu narrated that Holy Prophet( peace be upon him) said:“ Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt, like for like, payment made hand by hand. If anyone gives more or asks for more, he has dealt in Riba. The receiver and giver are equally guilty.


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Umar b. al-Khattab said, "There are three things. If Allah's Messenger had explained them clearly, it would have been dearer to me than the world and what it contains: (These are) kalala, riba, and khilafa. [Sunan Ibn Majah, Book of Inheritance, Vol. 4, #2727; Ibn Majah adds: "According to al-Zawa'id, the authorities of its isnad are reliable, but it has munqata chain of transmission." p. 113; munqata means an interrupted, broken or discontinuous chain]


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From Usamah ibn Zayd: The Prophet, peace be on him, said: "There is no riba except in nasi'ah [waiting]." [Bukhari, Kitab al-Buyu, Bab Bay al-dinari bi al-dinar nasa'an, #386; also Muslim and Musnad Ahmad]

"There is no riba in hand-to-hand [spot] transactions." [Muslim, Kitab al-Musaqat, Bab bay'i al-ta'ami mithlan bi mithlin; also in Nasa'i].


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Difference between Difference between conventional banking and conventional banking and

Islamic bankingIslamic banking


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Bank Client

money

money + money (interest)

Conventional


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Bank ClientGoods & Services

money

Islamic


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Conventional Banking Islamic Banking

Money is a commodity besides medium of exchange and store of value

Money is not a commodity thought it is used as a medium of exchange and store of value

Time value is the basis for charging interest on capital

Profit on trade of goods for charging on providing service is the basis for earning profit

Interest is charged even in case the organization suffers losses by using bank’s fund

Islamic bank operates on the basis of profit and loss sharing

While disbursing cash finance, running finance or working capital, no agreement for exchange of goods & services is made.

The execution of agreements for the exchange of goods & services is a must while disbursing funds under Murabaha, salam & Istisna contracts

Conventional banks use money as a commodity which leads to inflation

Islamic banking tends to create link with the real sector of the economic system by using trade related activities.


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Conventional banks Islamic Banks

The investor is assured of a pre determined rate of interest

In contract it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur)

Lending money and getting it back with compounding interest is the fundamental functions of the conventional banks

Compounding calculation is strictly prohibited under Islamic banking system

It can charge additional money incase of defaulters

The Islamic banks have no provision to charge any extra money from the defaulters.

Conventional banks invest their deposit in interest based modes

Islamic banking only deals in Halal products and services, all transactions must be in SHARIAH COMPLIANCE

The status of a conventional bank, in relations to its clients, is that of creditors and debtors.

The status of Islamic bank in relation to its clients is that of Partners, Investors, and Trader, Buyer and Seller.

A conventional bank has to guarantee of all its deposits.

Islamic banks cannot guarantee of all its deposits.


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Basic Principles of Islamic Basic Principles of Islamic BankingBanking


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Sanctity of contracts.Risk sharing.No Riba / Interest.Economic purpose / activity.Fairness.No valid subject matter.


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Shariah / Islamic LawShariah / Islamic Law


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Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (peace be upon him) and supplemented by the juristic interpretations by Islamic Scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices.


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Sources of Islamic LawSources of Islamic Law

The Holy Quran

The Sunnah of the Holy Prophet (peace be upon him)

Ijma’ ( consensus of the Ummah)

Qiyas (Analogy)


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Islamic Mode of FinancingIslamic Mode of Financing


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Contracts Mudarabah Murabaha Musawamah Salam Istisna Ijarah Ijarah wa Iqtina ( Ijarah Muntahiyyah Bitamleek)

Sub Contracts Wakalah Kafalah Rahn


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Islamic Banking Fare vis-à-vis Islamic Banking Fare vis-à-vis Conventional BankingConventional Banking

The approach of Islamic banking to satisfy the business needs of the customers is entirely different from that of the approach adopted by conventional banking. Basically Islamic banking satisfies the business needs of the entrepreneurs by the following two methods.

Profit and loss sharing modes

Debt creating modes (financing the purchase of commodities on credit with a mark-up)


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Role of Islamic banking in Role of Islamic banking in Economic Development of the Economic Development of the

CountryCountry


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Islam

Aqidah(Faith and Belief)

Shariah(Practices and Activities)

Akhlaq(Moralities and Ethics)

Principles Governing


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While functioning within the Shariah framework, Islamic banks an perform a crucial task of resource mobilization and efficient allocation using either profit sharing (Musharakah and Mudarabah) or trading & Ijarah based categories of Islamic mode of financing. Profit sharing modes can be used for short, medium and long-term project, financing, import financing, pre-shipment export financing and working capital financing transactions. In order to ensure maximum role of Islamic finance in the development of economy it would be necessary to create an environment which may induce to earmark more funds for Musharakah/Mudarabah based financing.


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Small and medium enterprises (SME) sector has a great potential for expanding production capacity and self-employment opportunities. Enhancing the role of financial sector in development of SME sub-sector could mitigate the serious problems of unemployment and low level of exports.

it can safely be said that Islamic banking has a great potential of playing an effective role in the development of the country.


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Is Islamic Banking ViableIs Islamic Banking Viable


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Islamic banking is still in the stage of evolution. No one can disputes that there is a definite desire amongst Muslims savers to invest their savings in the venues which are permitted by the Shariah. Nevertheless, they must be provides with Halal returns on their investments. Islamic scholars and practical bankers took up this challenge and have made commendable progress in the last few decades in providing a number of such instruments. However, the concepts of Islamic banking and finance are still in their early stages of development and Islamic banking is an evolving reality for continuously testing and refining those concepts.


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Nature of Deposits in Islamic Nature of Deposits in Islamic BanksBanks


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Following are the nature of deposits in Islamic banks.

Deposit Nature

Current Qarz

Saving Mudarabah


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Qarz can be use for own need and amanah can not be used for any purpose, that’s why Islamic banks current accounts are based on Qarz and not in amanah.

Islamic banks offered three types of saving accounts.

Mudarabah Saving AccountMusharakah Saving AccountWakalah Saving Accounts


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ISLAMIC BANKING AS AN ISLAMIC BANKING AS AN ALTERNATIVE APPROACHALTERNATIVE APPROACH


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One might wonder whether Islamic banking and finance is an alternative approach to modern banking. In fact, the banking business is no more than a possible means to satisfy the needs of society according to the prevailing conditions and circumstances. Those needs should always govern the means, not be its subject. The most important development in modern banking is the art of mobilizing funds for investment. It happened to be that the method of both collecting and using of funds was based in the West on interest paid and charged. In contrast, Islamic banking

is a system that provides financing and attracts savings on the basis of profit/loss sharing. One may have to think positively of such a scheme. By waiving the interest factor, we find an alternative vehicle to provide financing on a different basis which should be judged on its own merit.


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For Muslims, this system of profit/loss sharing coincides with their belief in the prohibition of interest, and helps in mobilizing unused funds for investment and creating new job opportunities.

As for non-Muslims, the Islamic banking system does not contradict their faith, while it provides the society with alternative ideas for venture capital and other tools of investment.


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Mudarabah as a contract of participation between the provider of capital and the managing entrepreneur responds to normal human needs. An enterprising engineer living in the West, as an example, would welcome any possibility that enables him to be provided by venture capital to establish a new factory. This could be the case with many individuals of the same spirit. The ultimate test of such alternative is whether it is successful or not. It can be safely said that the idea of Islamic banking has been successful. It is, therefore, not surprising to find several international banking institutions started the establishment of Islamic units or windows for some of their customers. Islamic banking was partially practiced by some of the Western banks and financial institutions in Switzerland, U.K. and the United States.


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The establishment of City Islamic Investment Bank in Bahrain is the latest example for the possible adoption of the Islamic banking system by traditional bankers. Economists have proven that the wider is the freedom ofchoice the higher is the level of social welfare. In addition, wider choice implies greater respect of human rights. When an alternative concept such as Islamic banking is introduced, a new choice is open to the market, with obvious economic and social benefits. Introducing Islamic banking as a new choice has also further benefits related to the advantages it provides to many fund users. Commodity and service producers would certainly appreciate equal opportunities for obtaining capital based on the merits of their businesses


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rather than on their personal creditworthiness alone. Those entrepreneurs who prefer to be self employed need ways to obtain financing other than borrowing. Islamic banking gives those pioneers such an opportunity on the basis of profit/loss sharing. In general, Islamic finance places more weight on the merit

of the business to be financed, rather than the wealth of the fund user. As a result under this new banking alternative, a better distribution of credit may be achieved. Therefore, I would like to recommend strongly to the Western World that all obstacles remaining in the way of establishing Islamic banks in their countries be removed.


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CHALLENGES AND CHALLENGES AND PROSPECTSPROSPECTS


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Last but not least, I would like to conclude with a word about the challenges facing Islamic banks and what prospects they may have. The biggest challenge Islamic banks have faced from their very beginning is how to narrow the gap between the Islamic banking model and its application; in other words, between theory and practice. Difficulties arise in this respect come from being relatively small in a traditional banking environment, having to rely on bankers trained in traditional banking, and attempting to balance the unquenchable enthusiasm on the side of depositors, with a limited supply of investment opportunities.


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Islamic banks have been trying hard to meet those challenges through several means. The first is to work for a better understanding of the concepts upon which their operations are based. This has been a success to the extent that now traditional bankers are mostly cooperative and accommodating. Central bankers have also come forward with new ideas of better methods for supervision and control, to suit the operations of Islamic banks. Another means is to train their staff in this new form of banking and to press for more banking and financial innovations which are necessary for the new modes of finance. Fortunately, financial engineering has come in handy with bold and new ideas in finance which made the Islamic model so much more applicable. Innovations in this regard did not come exclusively from


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Islamic banks. Surprisingly, financial markets produced some useful innovations, perhaps indicating that Islamic banking is an idea whose time has come. Nonetheless, many challenges still remain, not the least to the predominance of Murabaha (sale mode) in the operations of some Islamic banks, as well as the relative scarcity of short-term Islamic financial instruments. The prospects of Islamic banking and finance will depend extensively on the ability of Islamic banks to continue facing challenges with resourcefulness and creativity, in addition to being worthy of trust and understanding. I believe that competition, if allowed and maintained, not only within Islamic banks, but also between all banks whether Islamic or traditional, would insure a promising future for the banking industry as a whole.


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Growth of Islamic Banking in Growth of Islamic Banking in PakistanPakistan


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Focus AreasFocus Areas


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Worldwide StatisticsWorldwide Statistics


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Market PerformanceMarket Performance


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Glossary of islamic banking

Economy & Finance

Transcript of Glossary of islamic banking