Islamic Banking and Finance

Islamic banking• Islamic banking has been defined as banking in consonance with the ethos

and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Sharia’h”

History of Islamic banks

• First Islamic bank of world is Dubai Islamic Bank, 1975.

• First Islamic bank of Pakistan is Meezan Bank .

Meezan Bank• In 2002: Meezan Bank acquires the Pakistan operations of Societe

General and concurrently Al Meezan Investment Bank converts itself into a full-fledged Islamic commercial bank.

• The first Islamic banking license is issued to the Bank and it is renamed Meezan Bank.

Shariah Compliance Mechanism for Islamic Banking• SBP also crafted a very comprehensive and detailed Shariah Compliance

Mechanism, to ensure that the customers can trust the product`s adherence to Islamic Financial Products, and also make the banks accountable to what they offer their customers as a product or service.

3 Major Pillars of this policy are:• Shariah Board: Which checks and approves all the policies, guidelines

and criteria for Advisors• Shariah Advisors: Each bank must have Shariah Advisors, to provide

Islamic guidance to the banks and give the customers complete peace of mind when dealing with Islamic Services/Products

• Shariah Audit System: SBP crafted 9 agreements and contracts with respect to different Financing guidelines and Shariah Audit guidelines for each bank.

DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKINGIslamic Banking• 1) Functions and operations

are based on Sharia’h principles

• 2) Promote risk-sharing between provider of capital (investor) and user of funds (entrepreneurs)

Conventional Banking• 1)Functions and operations

are based on fully man made principles

• 2) Investor is assured of pre-determined rate of interest

Con…• 3) Aim at maximising profit

but subject to Sharia'h restrictions

• 4) Partners, investor and traders, buyer or seller relationship

• 3) Aim at maximising profit without any restrictions

• 4) Creditor-Debtor relationship

Con…• 5) Encourage asset-based

financing and based on commodity trading

• 6) No right of profit if there is no risk involved. The profit and loss sharing depositor may lose money in case of loss.

• 5) Based on money trading. Money is a medium of exchange and not a commodity, its sale and purchase is prohibited in Islam.

• 6) It is almost risk free banking and depositor has no risk of losing its money because interest is guaranteed.

Core Islamic Banking Departments• Human Resource• Audit• Learning and development• Treasury• Branch Banking• Legal• Compliance• Operations• Credit• Product development and Shariah compliance

ISLAMIC BANKING PRODUCTS AND SERVICES• Currently available Islamic Banking Products and services are

a) Partnership based modes of financing

• Musharaka Finance, Mudaraba Finance,

b) Trade based modes of financing

• Murabaha Finance, Salam finance

c) Rental based modes of financing

• Ijarah Finance, Diminishing Musharaka Finance

Partnership based modes of financing Musharaka (partnership)• This is often perceived to be the preferred Islamic mode of

financing, because it adheres most closely to the principle of profit and loss sharing.

Con… Mudaraba (finance by way of trust)• Mudaraba is a form of partnership in which one partner ( rabb-al-mal)

finances the project, while the other party ( mudarib ) manages it. Although similar to a musharaka , this mode of financing does not require that a company be created; the financial institution provides all of the capital and the customer is responsible for the management of the project.

Trade based modes of financing Murabaha (cost-plus financing)• In a murabaha contract, the bank agrees to buy an asset or goods from a

third party, and then resells the goods to its client with a mark-up.• A major difference between murabaha and interest-based lending is that

the mark-up in murabaha is for the services the bank provides (for example, seeking and purchasing the required goods at the best price) and the mark-up is not stipulated in terms of a time period.

Con… Salam (advance purchase)• Salam is purchase of specified goods for forward payment. • This contract is regularly used for financing agricultural

production.

Rental based modes of financing Ijarah (leasing)• Like a conventional lease, ijarah is the sale of manfa’a (the right to use

goods) for a specific period.• In Muslim countries, leasing originated as a trading activity and later on

became a mode of finance.• Ijarah is a contract under which a bank buys and leases out an asset or

equipment required by its client for a rental fee.