Islamic banking system

GOVERNMENT COLLEGE OF SCIENCE WAHDAT ROAD LAHORE

Islamic Banking System Islamic banking refers to a system of banking or banking activity which is consistent with Shariah

(Islamic Law). The Shariah prohibits payment and collection of Interest (Riba).

Definition of Islamic Banking:

“An Islamic bank is a financial institution whose status, rules and procedures

expressly state its commitment to the principle of Islamic Shariah and to the

banning of the receipt and payment of (Riba) on any of its operations”.

Riba means excess, increase or addition and implies any excess compensation without due

consideration. In other words, when money begets money, without exchange for goods and

services it is called Riba.

What is Islamic Banking? (Historical Approach)

Islamic banking refers to a system of banking or banking activity that is consistent with the

principles of the Shari'ah (Islamic rulings) and its practical application through the development

of Islamic economics. The principles which emphasise moral and ethical values in all dealings

have wide universal appeal. Shari'ah prohibits the payment or acceptance of interest charges

(riba) for the lending and accepting of money, as well as carrying out trade and other activities

that provide goods or services considered contrary to its principles. While these principles were

used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that

a number of Islamic banks were formed to provide an alternative basis to Muslims although

Islamic banking is not restricted to Muslims.

Islamic banking has the same purpose

as conventional banking except that it operates in accordance with the rules of Shari’ah, known

as Fiqh al-Muamalat(Islamic rules on transactions). Islamic banking activities must be practiced

consistent with the Shari’ah and its practical application through the development of Islamic

economics. Many of these principles upon which Islamic banking is based are commonly

accepted all over the world, for centuries rather than decades. These principles are not new but

arguably, their original state has been altered over the centuries.

The principle source of the Shari’ah is The Qur’an followed by

the recorded sayings and actions of Prophet Muhammad (pbuh) – the Hadith. Where solutions

to problems cannot be found in these two sources, rulings are made based on the consensus of

a community leaned scholars, independent reasoning of an Islamic scholar and custom, so long

as such rulings to not deviate from the fundamental teachings in The Qur’an.

It is evident that Islamic finance was practiced predominantly in the Muslim world throughout

the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and

Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is

claimed that many concepts, techniques, and instruments of Islamic finance were later adopted

by European financiers and businessmen.

The revival of Islamic banking coincided with the world-wide celebration of the advent of the

15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims

particularly those of the oil producing countries, received a boost due to rationalization of the oil

prices, which had hitherto been under the control of foreign oil Corporations. These events led

Muslims' to strive to model their lives in accordance with the ethics and principles of Islam.

Disenchantment with the value neutral capitalist and socialist financial systems led not only

Muslims but also others to look for ethical values in their financial dealings and in the West some

financial organizations have opted for ethical operations.

Recent Attempts at establishment of Islamic Banking

The Dubai Islamic Bank of U.A.E in 1975

Islamic Bank/Investment Company was established in Bahamas in 1977.

Dar-al-Mal-Islami (DMI), based in Geneva, was established in 1981.

Islami Bank Bangladesh Limited (IBBL) in 1983.

Al-Rajhi Banking Investment Corporation of Saudi Arabia in 1985.

Al-Arafa Islami Bank Bangladesh limited in 1995.

Meezan bank Limited of Pakistan in 2002.

Objectives of Islamic Banking:

The primary objectives of an Islamic Bank should be:

To offer modern financial services in compliance with Shariah.

To contribute towards economic development of the country within the ideology if Islamic

justice.

Best Possible allocation of limited Financial Resources

To Help ensure equitable distribution of wealth.

Islamic Modes of Financing

Trade Related Modes of Financing:

Bai-Muajjal (Mark up Financing)

Leasing(Ijara)

Hire Purchase (Ijara-wa-iqtina)

Buy-back agreement

Investment Auctioning

Development Financing

Bai' Muajjal: (Mark up Financing)

This is a deferred payment sale. A sale in which the parties agree that the payment price shall be

deferred is called a Bai Muajjal. The deferred price maybe more than the cash price, but it must

be fixed at the time of sale. Under this the customer enters in an agreement with the bank

whreby the bank finances the purchase of goods and machinery.

Leasing: (Ijara)

The Islamic word used for leasing is “Ijara”. The lessor is called “Ajir” and the lessee is called

“Mustageer”. In simple words leasing is a contract whereby the lessee uses an asset which is

owned by the lessor. The ownership remain with the lessor and lessee pays monthly or annual

rental for the use of an asset.

Islamic Modes of Financing

Trade Related Modes of Financing

Investment Related Modes of Financing

Hire Purchase: (Ijara-wa-iqtina)

Under hire purchase system, thee bank purchases the required good like equipment, building

and other assets at the request of the client . After the bank deliver those goods to the client

against an agreed rental together with an independent undertaking by the bank or the client that

the ownership of the asset should be transferred to the clients after the completion of the leasing

contract.

Buy-back Agreement :

This mode of financing is to satisfy both short term and long term needs of finance of a client.

The client who is in need of cash sells an immovable or movable property to one bank. The makes

wholly payment in cash. Afterwards the client buys back the same property at a higher price in

future. The client pays for the property either in cash or in installements.

Investment Auctioning:

Under this bank join hands with other financial institutions to form a consortium. This consortium

then works on an industrial project. Afterwards the consortium, places the project for auction.

Bids are invited from bidders and project is sold to highest bidder.

Development Financing:

Under this the bank makes the advances to the client for the development of land or property.

As a result of this the property appreciates in the value. The bank then shares this increase in the

value with the client. This share is called development charges.

Trade Related Modes of Financing:

Mudarbah Murabaha Musharkah Musawamah

Mudarabah

The Mudarabah (Profit Sharing) is a contract, with ONE party providing 100 percent of the capital

and the other party providing its specialized knowledge to invest the capital and manage the

investment project. Profits generated are shared between the parties according to a pre-agreed

ratio. If there is a loss, the first partner "rabb-ul-mal" will lose his capital, and the other party

"mudarib" will lose the time and effort invested in the project the profit is usually shared 50%-

50% or 60%-40% for rabb-ul-mal.

Murabaḥa:

Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the

seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a

financing technique, it involves a request by the client to the bank to purchase certain goods for

him. The bank does that for a definite profit over the cost, The profit in Murahaba can be

determined by mutual consent.

Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by the

seller to either costs or asking price. While the seller may or may not have full knowledge of the

cost of the item being negotiated, they are under no obligation to reveal these costs as part of

the negotiation process. This difference in obligation by the seller is the key distinction between

Murabahah and Musawamah with all other rules as described in Murabahah remaining the same.

Musawamah is the most common type of trading negotiation seen in Islamic commerce.

Other Islamic Services

Hibah (gift)

This is a token given voluntarily by a debtor in return for a loan. Hibah usually arises in practice

when Islamic banks voluntarily pay their customers a 'gift' on savings account balances,

representing a portion of the profit made by using those savings account balances in other

activities.

It is important to note that while it appears similar to interest, and may, in effect, have the same

outcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot

be 'guaranteed'(akin to Dividends earned by Shares, however it is not time bound but is at the

bank's discretion). However, the opportunity of receiving high.

Istisna

Istisna (Manufacturing Finance) is a process where payments are made in stages to facilitate step

wise progress in the Manufacturing / processing / construction works. Istisna enables any

construction company get finance to construct slabs / sections of a building by availing finances

in installments for each slab.

Qard hassan/ Qardul hassan (good loan/benevolent loan)

Qard hassan is a loan extended on a goodwill basis, with the debtor only required to repay the

amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount

beyond the principal amount of the loan (without promising it) as a token of appreciation to the

creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction

is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not

violate the prohibition on 'riba, for it alone is a loan that truly does not compensate the creditor

for the time value of money.

Sukuk (Islamic bonds)

Sukuk is the Arabic name for financial certificates that are the Islamic equivalent of bonds.

However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are

securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit

the charging or paying of interest. Financial assets that comply with the Islamic law can be

classified in accordance with their tradability and non-tradability in the secondary markets.

Takaful (Islamic insurance)

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

to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual

may cease to be uncertain with respect to a very large number of similar individuals. Insurance

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

by the law of large numbers.

Wadiah (safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the

bank and the bank guarantees refund of the entire amount of the deposit, or any part of the

outstanding amount, when the depositor demands it. The depositor, at the bank's discretion,

may be rewarded with Hibah (see above) as a form of appreciation for the use of funds by the

bank.

Wakalah (power of attorney)

This occurs when a person appoints a representative to undertake transactions on his/her behalf,

similar to a power of attorney. Literally Wakalah means protection or remedying on behalf of

others. Legally Wakalah refers to a contract where a person authorizes another to do a certain

well-defined legal action on his behalf.

http://en.wikipedia.org/wiki/Power_of_attorney

Pakistan and Islamic Banking Pakistan was created on the basis of two nation theory. The ultimate desire was to have a

homeland where Muslims could lead their lives according to the eternal and shinning teachings

of Islam. “The Muslims shall be order their lives in the individual and collective sphere in

accordance with the teachings and requirements of Islam as set out in Holy Quran and Sunnah.”

In his speech at the occasion of the inauguration of State Bank of

Pakistan (SBP), Quaid-e-Azam had expressed the desire for evolving an Islamic System of

Banking. The Objective resolution of 1949 further highlighted this matter in a definite way.

By this resolution and other terms of principles of policies of the Constitution it was made

obligatory on the state authorities to devise such an economic and fiscal system which is

characterized by interest free banking.

Constitution of Islamic Republic of Pakistan, 1973 in Article 38(f) Provide that:

“The State Shall… Eliminate Riba as early as possible”

SBP Section related to Islamic Economy:

The first governor of SBP Mr. Zahid Hussain was very keen to

develop a sound and effective modern Islamic banking system. In 1959 the SBP established

Islamic Economic section within the Research Department. This section progressed very quickly

and soon attained the status of fully equipped Division of the bank

Major Islamic Banks in Pakistan

1. Meezan Bank

2. Al Baraka Islamic bank

3. Bank Islami

4. Dubai Islamic Bank

5. Burj Bank

6. Bank Alfalah

7. Askari bank Limited(Islamic Banking branches)

8. Habib Bank Limited (Islamic Banking branches)

9. Bank Al Habib Limited(Islamic Banking branches)

Meezan Bank Meezan Bank Limited, a publicly listed company, is the first and largest Islamic Bank in

Pakistan and one of the fastest growing banks in the history of the banking sector of the Country.

Having the largest branch network and product range, Meezan Bank bears the critical

responsibility of leading the way forward in establishing a stable and dynamic Islamic banking

system replete with dynamic and cutting-edge products and services. Meezan Bank aims to fulfil

its prime objective of providing customers accessibility and convenience, within an atmosphere

and culture of dedicated service and recognition of their needs.

Meezan Bank has developed an extraordinary research and development capability by combining

investment bankers, commercial bankers, Shariah scholars and legal experts to develop

innovative, viable, and competitive value propositions that not only meet the requirements of

today’s complex financial world, but do so with world-class service excellence which our

customers demand; all within the bounds of Shariah.

The Meezan bank is currently providing following banking products and services.

Personal Finance

Car Financing Car Ijara

Home Financing

Corporate Finance

Asset Management

Commercial Finance

Pakistan’s first Shariah complaint Mortgage facility was launched by Meezan bank duly approved

by the Shariah Supervisory Board. This Product enables home purchase , home construction,

renovation as well as replacement of any existing mortgage.

Al Baraka Islamic bank Al Baraka Islamic bank provides it world class services and the products to its customers globally.

With a vision to provide its services according to the Islamic principles its networks are increasing

globally. It has been formed as a merger of the Al Baraka Islamic bank Pakistan, Emirates

Global Islamic Bank Pakistan and the operations of Al Baraka Islamic Bank Bahrain. It’s started

operating globally as on November 1st 2010. It provides a wide range of Islamic financing which

includes Murahaba, Ijarah, Musharakha, and Islamic Export Refinance. It also provides various

deposit schemes according to the basic principles of Islamic banking.

The bank is currently providing following banking products and services.

Islamic Deposit Accounts

Auto Ijara

Rahnuma Travel Services

Sarparast Family Plan

Corporate and investment banking

Bank Islami Bank Islami is the Pakistan’s leading authentic Islamic financial institution. Its products and

services include the consumer banking, retail banking, corporate banking under which it ensures

its customers to provide timely and friendly services. It lends finance to its customers under

MUSKUN home financing, Islamic auto Ijarah new vehicle, Islami auto Ijarah used or imported

vehicles. While it also provides Islamic current account, Islami foreign currency account, Islami

dollar bachat account Islami manaha munafa account and Islami sahulat account.


Consumer Banking

Retail Banking

Bank Islami Takaful

Corporate Banking

Investment Banking

Home Remittances

Dubai Islamic Bank

Dubai Islamic bank is one of the leading financial institutes of the country. It provides Islamic

banking not only to Pakistan but to the whole world. It has its core ethics including morality,

equity, transparency and the diversity. It is one of the fastest growing institutes with its 400

institutions managing a total assists of US $ 1 trillion globally.


Corporate Banking

Consumer Finance

Takaful

Remittances


Burj Bank

Burj Bank which was formerly known as Dawood Islamic bank is operating in Pakistan with its

highly professional team in order to make its customers well satisfies. Its core ethics includes

Purity, integrity, passion, and devotion. Burj bank services are purely based on Islamic principles.



Banca Takaful

Burj carcaaz

Home Musharka

Corporate Financing

SME Financing

Bank Alfalah

Bank Alfalah Islamic banking was established within Bank Alfalah Limited as late as in 2003, which

offers its customers products that are in accordance with the Shariah compliant. This bank invests

in customers believes by introducing Islamic financial solutions, and by fulfilling the promise they

made. Its team consists of highly qualified professional team who is responsible for designing

Islamic financial solutions and ensures that these are in accordance with the Shariah principles

of Islamic banking and finance. Moreover these services areapproved by the Shariah Adviser

at the bank.


Corporate Banking

Consumer Finance

Takaful

Remittances


Corporate Financing

SME Financing

Askari Bank Limited

Askari bank limited also provides its services according to the Shariah complaint; it opens its doors for the Halal

Banking Solutions. It provides economic justice and enhances welfare of society in the accordance with the

Shariah standards. It operates in 32 branches across Pakistan. The Islamic bank services and the products at the

bank are approved by the Shariah advisor at the bank and the Shariah based products of Islamic banking are

managed separately from the conventional banking side. All the transactions under the Islamic banking head

are invested in Halal modes and investments.


Ijara Bi Sayyarah

Home Musharkah

Islamic Deposit Products

Islamic Financing Products

Habib Bank Limited While operating since 1947, Habib Bank has total branches of the 1500 across country which is providing its

best services with the help of its highly professional team and advanced technology. Earlier it was a public

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sector bank however later in 2004 it was privatized through which Aga Khan Fund for Economic Development

acquired its 51% shares. HBL offers a host of Shariah compliant services to the clients. The bank is dedicated to

serve its customers according to their needs in accordance with the law of Islamic banking. The products and

services provided by the bank are licensed by the State bank of Pakistan and which are fit to meet the

requirement of any customer.



HBL Murahaba

HBL Diminishing Musharaka

HBL Ijara

Bank Al Habib Limited Bank Al Habib Limited is on of the well established banks in Pakistan, which has been approved by the state

bank of Pakistan to undertake Islamic banking through its Islamic banking branches. It provides deposit

schemes and Islamic financing to individuals, trader, industries, which are completely in accordance with the

Shariah compliant. These services and the documentation of the Shariah compliant are run by a Shariah advisor

who is responsible for regular monitoring of deposits and financing to ensure the operations are in compatible

with the Shariah.


Murabaha Finance.

Ijarah Finance (Leasing).

Diminishing Musharakah Finance.

Istisna Finance.


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