ISLAMIC BANKING –AN

INTRODUCTION

Presented by Hajara Pitan14th July 2011

INTRODUCTION TO ISLAMIC BANKING

Islamic banking is a system of banking or banking activity that is consistent with the principles of Islamic law.

Islamic law prohibits the charge of interest on loans (usury called RIBA in Arabic) .

EVOLUTION IF ISLAMIC BANKING

Considerations: - Islamic States were governed such

that the political head was also the religious head.

- It therefore meant that the well being of members of the community rested with him.

- Thus Islamic banks were to act as financial intermediaries and investment institutions.

SERVICES OFFERED BY ISLAMIC BANKS

Similar services to those of conventional banks

Offer chequeing accounts and clearing mechanisms, bank drafts, bills of exchange, travelers’ cheques.

Also offer various types of customer accounts

PRINCIPLES OF ISLAMIC BANKING

Justice, equality and solidarity

Forbidden List (Haram)

Property Rights are key

Fair distribution of wealth

Effort and risk sharing precede gain

ISLAMIC BANKING V. CONVENTIONAL BANKING

Key Points

Forbidden Products & Services

Uncertainty of outcome

Banking Procedure

Charge of Interest

Speculation Discouraged

RULES OF ISLAMIC BANKING Prohibition of predetermined payment above

principal lent

Lender participates in profits or losses of business or use to which money lent was used.

Making money from money- haram

Prohibition of uncertainty, risk or speculation (Gharar in Arabic)

No investment in services or products that are not forbidden or even discouraged by Islam.

• Islamic scholars differ on what would amount to Riba or interest

•Prohibition of ALL forms of Riba

•Interest based transactions pass unjust risks to borrower

•

BASIC FRAMEWORK:PROHIBITION OF RIBA

•Execution of financial dealings in accordance with principles of Shariah

•To support Muslim communities in utilizing and properly allocating financial resources.

•To provide an option of financing for Muslims who want to get same in compliance with Shariah

OBJECTIVES OF ISLAMIC BANKS:

PRIMARY CHARACTERISTICS OF ISLAMIC BANKS

Prohibition of Interest

Consumer Lending discouraged

Profit and Loss Shared

Investment in Real Estate encouraged

Available Deposits

Current Accounts

Investment

Account

Savings Account

MODES OF FINANCING

Investment

Financing

Lending

Trade Financi

ng

Other Financi

al Service

s

Investment financing

Trade financing

lending other financial facilities

loans with a service charge

no cost loan

Over drafts

musharaka (joint venture)

mudarabha (passive partnership)

Mark up trade financing

leasing Hire purchase

Sell and buy back

Letters of credit

MODES OF FINANCING

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ISLAMIC BANK

ISLAMIC BANK

CUSTOMERCUSTOMERVENDORVENDOR

Transfer of title to bank

Transfer of title to customer

Payment of purchase price (P)

Payment of marked up price (P + X)

THE STRUCTURE OF A MUDARABA CONTRACT

MUDARABHA

Bank Buys the asset from the Vendor

The customer buys the asset from the bank at a mark-up price

Mark up price + X is payable at agreed interval.

Time between purchase from the bank and agreed interval is period of financing.

The title moves to customer on purchase from the bank but stays in bank’s custody as collateral until agreed payment is made.

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THE STRUCTURE OF A MUSHARAKA CONTRACT

ISLAMIC BANK

ISLAMIC BANK

PARTNER(Customer)PARTNER(Customer)

MUSHARAKAMUSHARAKA

60% Ownership 40% Ownership

PART II

THE NIGERIAN MODEL

Section 33 (1) (b) Central Bank of Nigeria Act (CBN) Act 2007

Sections 23 (1), 52, 55 (2), 59 (1) (a) and 61 of the Banks and Other Financial Institutions Act 1991 (as amended) provides for: Commercial banks Merchant banks Specialised banks

Non-interest banks Microfinance banks Development banks Mortgage banks

CENTRAL BANK OF NIGERIA GUIDELINES ON ISLAMIC BANKING

Guidelines for the Regulation and Supervision of Non-Interest Financial Institutions released 13th January 2011 Amended 21st June 2011

Thrust of the amendment is that non-interest banking is not limited to Islamic Banking. divided into the provision of financial products

and services based on: 1. principles of Islamic Commercial jurisprudence 2. any other established rules and principles

CBN’S OVERSIGHT FUNCTIONS

The CBN in order to exercise its oversight functions is to have in place an advisory council of experts.

The advisory Council of experts to charged with the responsibility of: ensuring that the financial products offered by the

Islamic Banks meet the minimum requirements of Islamic Commercial jurisprudence.

Advising the CBN on the appropriateness of the relevant financial products to be offered by such institutions.

CBN’S OVERSIGHT FUNCTIONS

PROHIBITION OF DISCRIMINATION: on any grounds in the participation of any institution or person as promoters, depositors, or other party. ?

The CBN is to issue further directives on corporate governance, product compliance, risk management, capital adequacy and operations, based on principles of Islamic Commercial jurisprudence.

CBN’S NEW BANKING MODEL

CBN

COMMERCIAL BANKS

SPECIALISED BANKS

MERCHANT BANKS

NON-INTEREST FINANCIAL

INSTITUTIONS

MICROFINANCE BANKS,

DEV. BANKS, MORT.

INSTITUTIONSISLAMIC FINANCIAL INSTITUTI

ONS

OTHER NIFIs

NON-PERMISSIBLE TRANSACTIONS

Non-permissible transactions for IIFS are transactions relating to:

Gambling Speculation Unjust enrichment Exploitation/unfair trade practices Dealings in pork, alcohol, arms & ammunition, pornography

Products, goods or services which are not compliant with the rules of Islamic commercial jurisprudence; and

Transactions which are uncertain or ambiguous relating to the subject matter, terms and conditions

TYPES OF INSTITUTIONS OFFERING ISLAMIC FINANCIAL

SERVICES (IIFS)

Institutions Offering Islamic Financial Services are not to have the word “Islamic” in their names except with the consent of the Governor of the CBN.

They shall be referred to IIFS on all signage, adverts and promotional materials to facilitate recognition by the general public.

TYPES OF INSTITUTIONS OFFERING ISLAMIC FINANCIAL

SERVICES (IIFS) IIFS may be:

1. full fledged Islamic banks or full fledged Islamic banking subsidiary of a conventional bank

Full-fledged Islamic merchant or full fledged Islamic Banking subsidiary of a conventional merchant bank

A development bank offering Islamic Financial Services

A primary mortgage institution licensed by the CBN to offer Islamic Financial Services…

LICENSING REQUIREMENTS

Technical Agreement executed by the promoters of the proposed institution with an established and reputable Islamic Bank or financial institution.

Technical Agreement must specify the role of the parties must be for a minimum period of 3 years from

the date of commencement of operations.

LICENSING REQUIREMENTS

Terms of license may allow regional or national operation

Regional: must have a presence in at least 6 and maximum of 12 contiguous states of the Federation lying within not more than 2 geo-political zones

National: all the states of the Federation including the Federal Capital Territory

PRUDENTIAL REQUIREMENTS

Capital Adequacy Ratio (CAR): All IIFS shall maintain a minimum capital adequacy ratio as may be prescribed by the CBN

The minimum capital adequacy ratio shall be consistent with the minimum CAR for conventional banks

PRUDENTIAL REQUIREMENTS

Liquidity Management: they must have appropriate policies, strategies and procedures which ensure that they maintain adequate liquidity to fund their operations at all times

They shall not invest their funds in interest bearing securities or activities

PRUDENTIAL REQUIREMENTS

IIFS are expected to comply with other prudential requirements on exposure and concentration limits as may be prescribed by the CBN

They are also to comply with standards of best practices issued by the CBN

ANTI-MONEY LAUNDERING AND COMBATING OF THE FINANCING

OF TERRORISM (AML/CFT)

All IIFS are required to screen shareholders, customers, counterparties, transactions, products and activities against the proceeds of crime, corruption and terrorist financing, using legal and moral filters.

ANTI-MONEY LAUNDERING AND COMBATING OF THE FINANCING

OF TERRORISM (AML/CFT)

They must all have effective AML/CFT policies and procedures and comply with relevant guidelines and statutes for combating money laundering and terrorist financing.

CONCLUSION

The controversy rages on

Islamic banking has been said to aid the development of poor economies

The Nigerian framework under which Islamic banks are to operate is still unfolding

Babalakin & Co. is uniquely positioned to capture the niche market which this new regime offers