UNIVERSITY OF MUMBAI
SHRI CHINAI COLLEGE OF COMMERCE &
ANDHERI (EAST) MUMBAI-69
Prof. NISHIKANT JHA
ROLL NO - 3
T.Y.B.Com (Banking & Insurance)
T.Y.B. COM (BANKING & INSURANCE)
SEMESTER V TH
UNIVERSITY OF MUMBAI
PROF. NISHIKANT JHA
I, Miss. RASHIDA ANSARI, the student Of T.Y.B.Com
(Banking & Insurance), from Shri Chinai College of
Commerce & Economics (semester V
), hereby declare
that I have completed this project on ISLAMIC BANKING,
in the academic year 2007-2008 .The information
submitted is true and original to the best of my knowledge.
Signature of the student
I, Prof. NISHIKANT JHA. hereby certify that Miss.
RASHIDA ANSARI, the student of T.Y.B.Com (Banking &
Insurance), from Shri Chinai College of Commerce &
Economics, (Semester V
) has completed project ISLAMIC
BANKING in the academic year 2007-2008.The
information submitted is true and original to the best of my
Sincere thanks to professor Nishikant Jha for giving me this project. The
project chosen by me was Islamic Banking. It has given me immense
knowledge about Islamic banking i.e. this kind of banking hardly any one of
us are aware of. To my surprise even I didn’t hear about this. I came across
this through internet.
This project contains information about the Islamic banking around the
world. It was developed for the betterment and upliftment of the
Muslim community around the world. There are certain rules and
regulations laid down by the Muslim law board in running a banking
business. This project throws light on the topic such as banking
concepts, banking terms, laws regarding running banking business,
opening an account etc.
The objective behind this project is to give information about ISLAMIC
BANKING. It’s a concept where in very few have ever read about. It’s a
new concept for us as a student as well as for the country of India. It is same
as normal banking but there are certain rules and regulations laid by the
Muslim law. The concept of banking here is on basis of non profit or less
profit motive. This type of banking is mainly for the betterment and
upliftment of the Muslim community.
SR.NO TOPIC PG NO
1) Executive summary 1
2) Introduction 3
3) What is Islamic banking? 4
4) History of Islamic banking 8
5) Interest free banking 11
6) Theoretical basis and business practice 14
7) Sources of funds of Islamic banks 15
8) Uses of funds of Islamic banks 17
9) Basic principles of Islamic banking 22
10) Islamic equity funds 24
11) Islamic laws on trading 25
12) Islamic banking in Malaysia and Bangladesh 26
13) Accounting and Auditing organization 28
14) Islamic banking in non Muslim countries 29
15) Islamic banking in India 31
16) Concepts in Islamic banking 33
17) Case study on Islamic bank 39
18) Annexure 53
19) Survey 54
20) Article on Islamic bank 58
21) Conclusion 60
Islamic banking refers to a system of banking or banking activity that is
consistent with Islamic law (Shariah) principles and guided by Islamic
economics. In particular, Islamic law prohibits usury, the collection and
payment of interest, also commonly called riba in Islamic discourse.
Generally, Islamic law also prohibits trading in financial risk (which is seen
as a form of gambling). In addition, Islamic law prohibits investing in
businesses that are considered unlawful, or haraam (such as businesses that
sell alcohol or pork, or businesses that produce media such as gossip
columns or pornography, which are contrary to Islamic values). In the late
20th century, a number of Islamic banks were created, to cater to this
particular banking market.
Islamic finance is the fastest growing sector in the global finance industry.
From Kuala Lumpur to Dubai, from Los Angeles to London, some 300
Islamic banks and other financial institutions are now operating in some 50
countries, with total assets that top USD300 billion. Products and services
from Islamic current account to multi billion dollar sukuk ("Islamic bond")
are designed based on a set of Syariah principles and supervised by Syariah
scholars. The services are well accepted by Muslim as well as non Muslim
customers and corporations as Islamic values are meant for universal benefit.
Therefore we are monitoring the global development in this special section
This project throws light on the topic such as banking concepts, banking
terms, laws regarding running banking business, opening an account etc.
This project contains information about the Islamic banking around the
world. It was developed for the betterment and upliftment of the Muslim
community around the world. There are certain rules and regulations laid
down by the Muslim law board in running a banking business.
The objective behind this project is to give information about ISLAMIC
BANKING. It’s a concept where in very few have ever read about. It’s a
new concept for us as a student as well as for the country of India. It is same
as normal banking but there are certain rules and regulations laid by the
Muslim law. The concept of banking here is on basis of non profit or less
profit motive. This type of banking is mainly for the betterment and
upliftment of the Muslim community.
The project is very interesting and informative which all can very easily
understand. The data is collected through Internet that is truth in all aspects.
The detail can be easily obtained from the internet. This type of banks is not
found in India but among the Muslim countries. There are no false
information given in this project and can be researched easily on net.
The information collected to complete this project is mainly done through
internet i.e. by search engine google. The sites are wikipedia .com,
banglapedia.com, Muslim law board website and case study taken from
internet conducted on Islamic bank of Bangladesh.
Modern banking system was introduced into the Muslim countries at a time
when they were politically and economically at a low ebb, in the late 19th
century. The main banks in the home countries of the imperial powers
established local branches in the capitals of the subject countries and they
catered mainly to the import export requirements of the foreign businesses.
The banks were generally confined to the capital cities and the local
population remained largely untouched by the banking system. The local
trading community avoided the “foreign” banks both for nationalistic as well
as religious reasons. However, as time went on it became difficult to engage
in trade and other activities without making use of commercial banks. Even
then many confined their involvement to transaction activities such as
current accounts and money transfers. Borrowing from the banks and
depositing their savings with the bank were strictly avoided in order to keep
away from dealing in interest which is prohibited by religion.1
With the passage of time, however, and other socio-economic forces
demanding more involvement in national economic and financial activities,
avoiding the interaction with the banks became impossible. Local banks
were established on the same lines as the interest-based foreign banks for
want of another system and they began to expand within the country
bringing the banking system to more local people. As countries became
independent the need to engage in banking activities became unavoidable
and urgent. Governments, businesses and individuals began to transact
business with the banks, with or without liking it. This state of affairs drew
the attention and concern of Muslim intellectuals. The story of interest-free
or Islamic banking begins here. In the following paragraphs we will trace
this story to date and examine how far and how successfully their concerns
have been addressed.
What is Islamic banking
The introduction of interest-free and equity-based financing by the Islamic
banking system is based on the principles of Islamic economics. The aim of
Islamic economics, as observed by Molla et.al. (1988), is not only the
elimination of interest based transactions and the introduction of the zakah
(contribution to poor) system but also the establishment of just and balanced
social order free from all kinds of exploitation. The Islamic banking system
is highlighted in the World Development report (1989, Box 6.3), as under;
“Islamic banks offer savers risky open-ended mutual fund certificates
instead of fixed-interest deposits. (This is not unlike cooperative banks and
mutual in the west, where deposits earn variable interest and double as
equity.) Difficulties arise on the lending side. Arrangements to share profits
and losses lead to considerable problems of monitoring and control,
especially in lending to small business”.
Ahmed (1994), argues that elimination of interest does not mean zero-return
on capital. Rather, Islam forbids a fixed predetermined return for a certain
factor of production i.e. one party having assured return and the whole risk
of an entrepreneurship to be shared by others. The author also observed that
it is the capital entrepreneurship that shares both the real contribution and
the real profitability. The Islamic bank follows the principle of equity based-
investment. The Islamic banking system also proposes that resources can be
contracted on the basis of venture capital and risk sharing deals. The idea of
equity-based investment banking is not new to the financial market. If we
look into history it may be observed that capital, as loan capital as well as
venture capital played a great role in promoting industrial and economic
development of various countries of the world. For example, during the 19th
and 20th centuries investment banks played a great role in French tradition
while in British model of banking equity- based investment was limited.
Similarly in Germany equity-based investment was being practiced by
commercial banks during that period. Even the banking crisis in the western
world during the great depression in the 30’s or the 80’s proposed two-tire
banking i.e. hundred percent deposit banking and the equity-based
investment banking. Islamic banks appeared on the world scene as active
players over two decades ago. But "many of the principles upon which
Islamic banking is based have been commonly accepted all over the world,
for centuries rather than decades".
The basic principle of Islamic banking is the prohibition of Riba- (Usury - or
interest): "While a basic tenant of Islamic banking - the outlawing of riba, a
term that encompasses not only the concept of usury, but also that of interest
- has seldom been recognized as applicable beyond the Islamic world, many
of its guiding principles have. The majority of these principles are based on
simple morality and common sense, which form the bases of many religions,
"The universal nature of these principles is immediately apparent even at a
cursory glance of non-Muslim literature. Usury was prohibited in both the
Old and New Testaments of the Bible, while Shakespeare and many other
writers, particularly those writing in the 19th century, have attacked the
barbarity of the practice. Much of the morality championed by Victorian
writers such as Dickens - ranging from the equitable distribution of wealth
through to man's fundamental right to work - is clearly present in modern
"Although the western media frequently suggest that Islamic banking in its
present form is a recent phenomenon, in fact, the basic practices and
principles date back to the early part of the seventh century." (Islamic
Finance: A Euro money Publication, 1997)
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 philosophy 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. Islam not only prohibits dealing in interest but
also in liquor, pork, gambling, pornography and anything else, which the
Shariah (Islamic Law) deems Haram (unlawful). Islamic banking is an
instrument for the development of an Islamic economic order. Some of the
salient features of this order may be summed up as:
1. While permitting the individual the right to seek his economic well-
being, Islam makes a clear distinction between what is Halal (lawful)
and what is haram (forbidden) in pursuit of such economic activity. In
broad terms, Islam forbids all forms of economic activity, which are
morally or socially injurious.
2. While acknowledging the individual's right to ownership of wealth
legitimately acquired, Islam makes it obligatory on the individual to
spend his wealth judiciously and not to hoard it, keep it idle or to
3. While allowing an individual to retain any surplus wealth, Islam seeks
to reduce the margin of the surplus for the well-being of the
community as a whole, in particular the destitute and deprived
sections of society by participation in the process of Zakat.
4. While making allowance for the ways of human nature and yet not
yielding to the consequences of its worst propensities, Islam seeks to
prevent the accumulation of wealth in a few hands to the detriment of
society as a whole, by its laws of inheritance.
5. Viewed as a whole, the economic system envisaged by Islam aims at
social justice without inhibiting individual enterprise beyond the point
where it becomes not only collectively injurious but also individually
The Islamic financial system employs the concept of participation in the
enterprise, utilizing the funds at risk on a profit-and- loss-sharing basis. This
by no means implies that investments with financial institutions are
necessarily speculative. This can be excluded by careful investment policy,
diversification of risk and prudent management by Islamic financial
It is possible, that investment in Islamic financial institutions can provide
potential profit in proportion to the risk assumed to satisfy the differing
demands of participants in the contemporary environment and within the
guidelines of the Shariah.
The concept of profit-and-loss sharing, as a basis of financial transactions is
a progressive one as it distinguishes good performance from the bad and the
mediocre. This concept therefore encourages better resource management.
Islamic banks are structured to retain a clearly differentiated status between
shareholders' capital and clients' deposits in order to ensure correct profit-
sharing according to Islamic Law.
It seems that the history of interest-free banking could be divided into two
parts. First, when it still remained an idea; second, when it became a reality
-- by private initiative in some countries and by law in others. We will
discuss the two periods separately. The last decade has seen a marked
decline in the establishment of new Islamic banks and the established banks
seem to have failed to live up to the expectations. The literature of the period
begins with evaluations and ends with attempts at finding ways and means
of correcting and overcoming the problems encountered by the existing
History of modern Islamic banking
Islamic Banking a new type of banking that operates on principles adhering
to the Quranic norms forbidding usury and transactions, including granting
of loans or credits for interest. The economic rationale for eliminating riba
(interest) and establishing the Islamic banking system is based on values of
justice, efficiency, stability and growth. It is assumed that under the system
of Islamic banking, the industrial and/or commercial risk is shared more
equitably between the entrepreneur and the capital owner and the returns on
investment are shared among the investors on the basis of their proportionate
capital. The conventional banks tend to serve the most creditworthy
borrowers, while the Islamic banking system presumably looks for the most
productive and profitable projects. The Islamic banking approach
theoretically opposes the idea of discrimination in offering banking services
to people of different social standings and provides for social cohesion
between different classes.
The origins of Islamic banking can be traced back to the practice of
mudaraba by the Prophet Muhammad (Sm) himself. The Prophet (Sm) was
mudarib (agent) for his wife, who entrusted her capital or merchandise to
him for trading and got back the principal plus an agreed share of the profit.
As a reward for his labor (and entrepreneurship), the Prophet (mudarib)
received his share of the same. The mudarib, however, was not liable for
losses resulting from the exigencies of travel or from an unsuccessful
business venture. This form of partnership is called mudaraba.
There is another form of partnership called musharaka , in which the
musharik (agent) has a contribution to the capital and can therefore, claim a
higher percentage of profit. As early as in the seventh century, the tax
revenue from Iraq was sent across the desert to Medina in the form of a
mudaraba. Caliph Umar is known to have invested orphans' money in
merchant trading between Medina and Iraq. Musharaka partnerships were
practiced in the north-south trade between Egypt and Jeddah during the
eleventh century. As many as 32 mudaraba contracts were practised in the
17th century in the Turkish city of Busra. Mudaraba was in practice in
Tunisia, Indonesia, Arabian Peninsula and India.
Modern Islamic banking concepts came from the historical practice of the
concept of a 'three-tier mudaraba'. On the first tier, there is the individual,
rab-al-mal, who wishes to invest capital. The second tier is the mudarib
(agent), to whom the rab al-mal entrusts his capital by contract and finally,
on the third tier, there is the entrepreneur, with whom the mudarib signs a
contract, and to whom the mudarib passes the capital originally entrusted to
him by the rab-al-mal.
The first attempt to establish an Islamic financial institution took place in
Pakistan in late 1950s with the establishment of a local Islamic bank in a
rural area. Borrowers of the bank did not pay interest on the credit advanced,
but a small charge was levied to cover the bank's operational expenses.
Although the experience was encouraging, two main factors were
responsible for its failure. First, the deposits made in the bank were to be
held for long and the depositors, who were mostly the landlords found that
with increasing number of borrowers the gap between the amount of capital
available and that of the credit demanded had become very large. Secondly,
the depositors showed considerable interest in the way their money was lent
out but the bank staff did not have complete autonomy over the bank's
operations and therefore, could not always satisfy the customers in this
The second experiment with Islamic banking was conducted in Egypt
between 1963 and 1967 through the establishment of the Mit Ghamr Savings
Bank in a rural area of the Nile Delta.
The bank's operations were based on the same Islamic principles of no-
interest to depositors or from the borrowers. Unlike the Pakistani case, the
borrowers made deposits in the bank for credit facilities.
On the basis of success in the experiment more branches were soon opened
in different parts of Egypt to develop a network of local savings banks. The
project suffered a setback due to political unrests in the country but was
revived in 1971 under the name of Nasser Social Bank, which became the
first Islamic bank in the urban setting based in Cairo.
Following the example of Egypt, Islamic banking emerged in Malaysia in
1963 and in Dubai in 1975. A significant development in Islamic banking
was the granting of a license to Islamic bank in Saudi Arabia. This bank was
established by the fifty-year old Al-Rajhi Company, a firm with assets
valuing more than $5 billion and noted for its currency, exchange and
commercial activities. The bank started operations in 1985 under the name
of Al-Rajhi Banking Investment Corporation and later, developed active
relationships with major manufacturing and trading companies in Europe
and several US corporations. The success of Al-Rajhi in operating profitably
in different regions of the world motivated the Saudi government to go for
full-fledged Islamic banking. In 1975, the Muslim countries have founded
Islamic Development Bank as a multinational corporation to support social
and economic development in Muslim nations within an Islamic Framework.
Bangladesh is a member of the Islamic Development Bank. The first modern
experiment with Islamic banking was undertaken in Egypt under cover
without projecting an Islamic image—for fear of being seen as a
manifestation of Islamic fundamentalism that was anathema to the political
regime. The pioneering effort, led by Ahmad El Najjar, took the form of a
savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in
1963. This experiment lasted until 1967 (Ready 1981), by which time there
were nine such banks in the country.
Interest-free banking as an idea
Interest-free banking seems to be of very recent origin. The earliest
references to the reorganisation of banking on the basis of profit sharing
rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi
(1948) and Mahmud Ahmad (1952) in the late forties, followed by a more
elaborate exposition by Mawdudi in 1950 (1961). Muhammad Hamidullah’s
1944, 1955, 1957 and 1962 writings too should be included in this category.
They have all recognised the need for commercial banks and the evil of
interest in that enterprise, and have proposed a banking system based on the
concept of mudarabha- profit and loss sharing.
In the next two decades interest-free banking attracted more attention, partly
because of the political interest it created in Pakistan and partly because of
the emergence of young Muslim economists. Works specifically devoted to
this subject began to appear in this period. The first such work is that of
Muhammad Uzair (1955). Another set of works emerged in the late sixties
and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961,
1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main
Early seventies saw the institutional involvement. Conference of the Finance
Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian
study in 1972, First International Conference on Islamic Economics in
Mecca in 1976, International Economic Conference in London in 1977 were
the result of such involvement. The involvement of institutions and
governments led to the application of theory to practice and resulted in the
establishment of the first interest-free banks. The Islamic Development
Bank, an inter-governmental bank established in 1975, was born of this
The coming into being of interest-free banks
The first private interest-free bank, the Dubai Islamic Bank, was also set up
in 1975 by a group of Muslim businessmen from several countries. Two
more private banks were founded in 1977 under the name of Faisal Islamic
Bank in Egypt and the Sudan. In the same year the Kuwaiti government set
up the Kuwait Finance House.
However, small scale limited scope interest-free banks have been tried
before. One in Malaysia in the mid-forties4
and another in Pakistan in the
late-fifties. Neither survived. In 1962 the Malaysian government set up the
“Pilgrim’s Management Fund” to help prospective pilgrims to save and
profit. The savings bank established in 1963 at Mit-Ghamr in Egypt was
very popular and prospered initially and then closed down for various
reasons. However this experiment led to the creation of the Nasser Social
Bank in 1972. Though the bank is still active, its objectives are more social
In the ten years since the establishment of the first private commercial bank
in Dubai, more than 50 interest-free banks have come into being. Though
nearly all of them are in Muslim countries, there are some in Western
Europe as well: in Denmark, Luxembourg , Switzerland and the UK. Many
banks were established in 1983 (11) and 1984 (13). The numbers have
declined considerably in the following years.
In most countries the establishment of interest-free banking had been by
private initiative and were confined to that bank. In Iran and Pakistan,
however, it was by government initiative and covered all banks in the
country. The governments in both these countries took steps in 1981 to
introduce interest-free banking. In Pakistan, effective 1 January 1981 all
domestic commercial banks were permitted to accept deposits on the basis
of profit-and-loss sharing (PLS). New steps were introduced on 1 January
1985 to formally transform the banking system over the next six months to
one based on no interest. From 1 July 1985 no banks could accept any
interest bearing deposits, and all existing deposits became subject to PLS
rules. Yet some operations were still allowed to continue on the old basis.
In Iran, certain administrative steps were taken in February 1981 to
eliminate interest from banking operations. Interest on all assets was
replaced by a 4 percent maximum service charge and by a 4 to 8 percent
‘profit’ rate depending on the type of economic activity. Interest on deposits
was also converted into a ‘guaranteed minimum profit.’ In August 1983 the
Usury-free Banking Law was introduced and a fourteen-month change over
period began in January 1984. The whole system was converted to an
interest-free one in March 1985.
Generally speaking, all interest-free banks agree on the basic principles.
However, individual banks differ in their application. These differences are
due to several reasons including the laws of the country, objectives of the
different banks, individual bank’s circumstances and experiences, the need
to interact with other interest-based banks, etc.
Theoretical Basis and Business Practice of Islamic
From the viewpoint of Islamic Shariah, in order to be justified Islamically
the banking system has to avoid interest. Consequently, financial
intermediation in Islamic banking between the bank and the client takes
place as a partner rather than a debtor-creditor. The financial activities of
modern conventional banks are based on a creditor-debtor
relationship between depositors and bank on the one hand and between the
borrower and the bank on the other. Interest is regarded by conventional
banks as the price of credit reflecting the opportunity cost of money. As
interest is prohibited in Islam, commercial banking in an Islamic framework
could not be based on the creditor- debtor relationship.
The other aspect of the theoretical basis of Islamic banking is that the
interest free bank is not risk free. This principle is applicable to two main
factors of production, i.e. labor and capital. According to this principle, as no
payment is allowed to labor, unless it is applied to work, no reward for
capital should be allowed, unless it is exposed to business risk. From these
two principles of the theoretical basis of Islamic banking, it may be said that
Islamic financial relationships are of a participatory nature (Ahmad, 1993).
Based on the theoretical background, business practices of Islamic bank,
especially sources and uses of bank’s funds, are characterized by the
following modes or techniques.
Sources of Funds of Islamic Banks
Islamic banks accept deposits from customers on current accounts as
conventional banks do. This account is also
known as ‘Demand Deposit as the deposited amount is payable to customers
on demand without any notice. As
banks use current account deposits on their own risk the depositors of this
type of account are not entitled to any
share in the profit earned by the bank.
Islamic banks accept saving deposits from customers under Al-Wadia and
Al-Mudaraba Sharia Principles. The word Al-Wadia means trusteeship. In
this case banks act as trustee for its customers. In Saving Accounts under the
Al-Wadia principle the bank is given an authorization by depositors to use
the fund at the bank’s own risk. This type of deposit is almost similar to a
‘Current Account’ or Demand Deposit’ except that the bank guarantees
its customer the full return of the deposited fund with any profit voluntarily.
Under the Al-Mudaraba Shariah principle there are two different types of
savings accounts, such as - savings under profit and loss sharing agreement
and -savings under Investment Account.
The word ‘Al-Mudaraba’ originates from the word ‘Mudarib’ and means the
manager of the fund. The bank in this case acts as a manager of customers’
funds. The depositors on the other hand are known as ‘Sahib-Al-Mal’
meaning the owner of the fund. Deposits accepted on savings under the
Profit and Loss sharing agreement is invested by the bank on its own risk.
Customers give authorization to the bank to invest funds and share profit or
loss on agreed proportions. Account holders of this type of account are
required to maintain a minimum balance in the account. Further to the
above, Islamic banks accept deposits from customers under the Investment
Account on a Profit and Loss Sharing basis. The saving account of such a
nature in an interest-free banking system is also known as a participatory
account or a Profit or Loss Sharing (PLS) account.
Depositors of this type of account receive share of profit to the agreed ratio
from their funds invested by the bank. The profit and loss sharing also
depends on the total amount deposited and the length of period the money is
held by the bank. Depositors of an Investment
Account are required to give prior notice to the bank if they withdraw their
invested funds under any special circumstance. In such a case no share of
profit is given for the amount withdrawn. Investment accounts are again
subdivided into the following various categories.
· Joint or General Investment Account
· Limited-Period Investment Deposit
· Unlimited-Period Investment Deposit
· Specified Investment Deposit
Under the ‘Joint or General Investment Account’ the bank pools together
investment deposits of different maturity-ties which are not invested in any
specified project but utilized for different financing operations of the bank.
Depositors of this type of account receive profits at the end of the period,
which is accounted and distributed on apro rata basis. The ‘Investment
Deposits on Limited Period’ basis indicates a type of investment, where the
bank accept deposits from customers for a specified period of time. The
bank refunds the money to depositors after the time is expired. The profit
generated from such funds is distributed at the end of the financial year. The
bank also accepts deposits from its customers under an ‘Unlimited-Period
Investment Deposit’, where investment deposits are automatically renewable
without specifying the period. Depositors of this type of account may
withdraw their funds within three months notice to the bank. Profits are
distributed to depositors at the end of the financial year. Some Islamic banks
accept an ‘Specified Investment Deposit’, where the bank and the customer
agrees to invest this fund to a specific project or trade. Profits accrued from
this type of investment are shared by the bank and the customer. The bank in
this regard, works as an agent for the customer, and may charge an agreed
fee for the investment function or may share the profit at an agreed
Uses of Funds of Islamic Banks
Based on the theoretical viewpoint as discussed earlier two fundamental
techniques or modes of investment advocated by the Islamic Shariah
- Mudaraba (Capital Financing)
- Musharaka (Partnership )
Mudaraba (Capital Financing)
Capital Trust financing is a contract between at least two parties in which
the bank as the investor supplies the entire capital of the business forming a
relationship between the supplier of capital and the user of capital. These
two parties work together and share profits and losses. Under ‘Murabaha’
financing the investor is known as ‘Rab-Al-Mal’ which means the owner of
the property and the entrepreneur is called ‘Mudarab’, meaning the manager
of capital. When the venture ends, the manager of capital i.e. the
entrepreneur returns the entire capital to the bank, along with an agreed
proportion of profit. If there is any loss, it is born by the bank. The main
advantage with this type of partnership is that it combines the efforts of
human beings and their skills with the capital, which contribute greatly
towards the development activities in a society and also assists to solve
unemployment problems by utilizing manpower resources in a productive
The word ‘Musharaka’ means a profit sharing joint venture, designed to
limited production or commercial activities of long duration. In this case the
bank and the customer contribute capital jointly. They also contribute
managerial expertise and other essential services at agreed proportions.
Profit or losses are shared according to the contract agreed upon. An
individual partner does not become liable for the losses caused by others.
In addition to the above two financial arrangements, Islamic Banks currently
in existence are also engaging in or actively considering several other
financial practices usually acceptable in Islamic Law.
· Murabaha (Mark-up or Cost-Plus-based Financing)
· Ijara (Leasing) and
· Quard- E- Hasan (Interest-Free Loan)
Murabaha (Cost plus profit)
The word ‘Murabaha’ means a cost-plus Profit contract. In this system of
financing the bank agrees to purchase for a client who will then reimburse
the bank in a stated time period at an agreed upon profit margin. The mark-
up price that the bank and the buyer agree to is mainly based on the market
price of the commodity. Thus the bank earns a profit without bearing any
The word ‘Ijara’ indicates leasing. The leasing purchase is another technique
followed by Islamic banks in financing customers. This system is almost
similar to the leasing activity provided in traditional banking. Leasing is a
contract between the bank and the customer to use particular assets. In this
case the bank is called lessor and the customer is called lessee who wants to
use the assets and pays rent. Zineldin(1990, p.83), in this regard argues as,
“ The leasing agreement is based on profit sharing in which the bank buys
the movable or immovable property and lease it to one of its client for an
agreed sum by installments and for a limited period of time into a saving
account held with the same bank. These installments are invested in
Mudaraba investment (Venture) for the customer’s account. The
accumulated profit generated from the payments, and the payments
themselves are invested in the bank’s investment ventures over the time
period of lease, contributing to eventual purchase of the leased assets.”
According to the Western leasing system the lessee pays specific rentals and
a fixed rate of interest over a given period for the use of specific assets. But
in the Islamic banking system of leasing the risk related to leasing has to
be shared between the bank and the lessee, in case of any damage to the
leased assets. The contract is called ‘ijara-wa-iqtina’ i.e. leasing purchase,
when the ownership of the assets is transferred to the clients after the
completion of the leasing contract.
Quard E Hasan (Interest free loan)
Quard E Hasan means an interest-free loan given by the Islamic bank to the
needy people in a society. The practice of dealing with this sort of
investment differs from bank to bank. Quard E Hasan is normally given to
needy students, small producers, farmers, entrepreneurs and economically
weaker sections of the society, who are not in a position to obtain loan or
any financial assistance from any other institutional sources.
TYPES OF ACCOUNTS
All the Islamic banks have three kinds of deposit accounts: current, savings
Current or demand deposit accounts are virtually the same as in all
conventional banks. Deposit is guaranteed.
Savings deposit accounts operate in different ways. In some banks, the
depositors allow the banks to use their money but they obtain a guarantee of
getting the full amount back from the bank. Banks adopt several methods of
inducing their clients to deposit with them, but no profit is promised. In
others, savings accounts are treated as investment accounts but with less
stringent conditions as to withdrawals and minimum balance. Capital is not
guaranteed but the banks take care to invest money from such accounts in
relatively risk-free short-term projects. As such lower profit rates are
expected and that too only on a portion of the average minimum balance on
the ground that a high level of reserves needs to be kept at all times to meet
Investment deposits are accepted for a fixed or unlimited period of time and
the investors agree in advance to share the profit (or loss) in a given
proportion with the bank. Capital is not guaranteed.
Modes of financing
Banks adopt several modes of acquiring assets or financing projects. But
they can be broadly categorised into three areas: investment, trade and
This is done in three main ways: a) Musharaka where a bank may join
another entity to set up a joint venture, both parties participating in the
various aspects of the project in varying degrees. Profit and loss are shared
in a pre-arranged fashion. This is not very different from the joint venture
concept. The venture is an independent legal entity and the bank may
withdraw gradually after an initial period. b) Mudarabha where the bank
contributes the finance and the client provides the expertise, management
and labour. Profits are shared by both the partners in a pre-arranged
proportion, but when a loss occurs the total loss is borne by the bank. c)
Financing on the basis of an estimated rate of return. Under this scheme, the
bank estimates the expected rate of return on the specific project it is asked
to finance and provides financing on the understanding that at least that rate
is payable to the bank. (Perhaps this rate is negotiable.) If the project ends up
in a profit more than the estimated rate the excess goes to the client. If the
profit is less than the estimate the bank will accept the lower rate. In case a
loss is suffered the bank will take a share in it.
This is also done in several ways. The main ones are: a) Mark up where the
bank buys an item for a client and the client agrees to repay the bank the
price and an agreed profit later on. b) Leasing where the bank buys an item
for a client and leases it to him for an agreed period and at the end of that
period the lessee pays the balance on the price agreed at the beginning an
becomes the owner of the item. c) Hire purchase where the bank buys an
item for the client and hires it to him for an agreed rent and period, and at
the end of that period the client automatically becomes the owner of the
item. d) sell and buy back where a client sells one of his properties to the
bank for an agreed price payable now on condition that he will buy the
property back after certain time for an agreed price. e) letters of credit where
the bank guarantees the import of an item using its own funds for a client, on
the basis of sharing the profit from the sale of this item or on a mark-up
Main forms of Lending are: a) loans with a service charge where the bank
lends money without interest but they cover their expenses by levying a
service charge. This charge may be subject to a maximum set by the
authorities. b) no cost loans where each bank is expected to set aside a part
of their funds to grant no-cost loans to needy persons such as small farmers,
entrepreneurs, producers, etc. and to needy consumers. c) overdrafts also are
to be provided, subject to a certain maximum, free of charge.
Other banking services such as money transfers, bill collections, trade in
foreign currencies at spot rate etc. where the bank’s own money is not
involved are provided on a commission or charges basis.
Islamic banking has the same purpose as conventional banking except that it
claims to operate in accordance with the rules of Shariah, known as Fiqh al-
Muamalat (Islamic rules on transactions). The basic principle of Islamic
banking is the sharing of profit and loss and the prohibition of riba´
(interest). Amongst the common Islamic concepts used in Islamic banking
are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture
(Musharakah), cost plus (Murabahah), and leasing (Ijarah).
In an Islamic mortgage transaction, instead of loaning the buyer money to
purchase the item, a bank might buy the item itself from the seller, and re-
sell it to the buyer at a profit, while allowing the buyer to pay the bank in
instalments. However, the fact that it is profit cannot be made explicit and
therefore there are no additional penalties for late payment. In order to
protect itself against default, the bank asks for strict collateral. The goods or
land is registered to the name of the buyer from the start of the transaction.
This arrangement is called Murabaha. Another approach is Ijara wa Iqtina,
which is similar to real-estate leasing. Islamic banks handle loans for
vehicles in a similar way (selling the vehicle at a higher-than-market price to
the debtor and then retaining ownership of the vehicle until the loan is paid).
There are several other approaches used in business deals. Islamic banks
lend their money to companies by issuing floating rate interest loans. The
floating rate of interest is pegged to the company's individual rate of return.
Thus the bank's profit on the loan is equal to a certain percentage of the
company's profits. Once the principal amount of the loan is repaid, the
profit-sharing arrangement is concluded. This practice is called Musharaka.
Further, Mudaraba is venture capital funding of an entrepreneur who
provides labor while financing is provided by the bank so that both profit
and risk are shared. Such participatory arrangements between capital and
labor reflect the Islamic view that the borrower must not bear all the
risk/cost of a failure, resulting in a balanced distribution of income and not
allowing lender to monopolize the economy.
And finally, Islamic banking is restricted to Islamically acceptable deals,
which exclude those involving alcohol, pork, gambling, etc. Thus ethical
investing is the only acceptable form of investment, and moral purchasing is
Islamic banks have grown recently in the Muslim world but are a very small
share of the global banking system. Micro-lending institutions such as
Grameen Bank use conventional lending practices, and are popular in some
Muslim nations, but are clearly not Islamic banking.
In theory, Islamic banking should be synonymous with full-reserve banking,
with banks achieving a 100% reserve ratio . However, in practice, this is
rarely the case .
Islamic Equity Funds
Islamic investment equity funds market is one of the fastest-growing sectors
within the Islamic financial system. Currently, there are approximately 100
Islamic equity funds worldwide. The total assets managed through these
funds currently exceed US$5 billion and is growing by 12–15% per annum.
With the continuous interest in the Islamic financial system, there are
positive signs that more funds will be launched. Some Western majors have
just joined the fray or are thinking of launching similar Islamic equity
Despite these successes, this market has seen a record of poor marketing as
emphasis is on products and not on addressing the needs of investors. Over
the last few years, quite a number of funds have closed down. Most of the
funds tend to target high net worth individuals and corporate institutions,
with minimum investments ranging from US$50,000 to as high as US$1
million. Target markets for Islamic funds vary, some cater for their local
markets, e.g., Malaysia and Gulf-based investment funds. Others clearly
target the Middle East and Gulf regions, neglecting local markets and have
been accused of failing to serve Muslim communities.
Since the launch of Islamic equity funds in the early 1990s, there has been
the establishment of credible equity benchmarks by Dow Jones Islamic
market index and the FTSE Global Islamic Index Series. The Web site
failaka.com monitors the performance of Islamic equity funds and provide a
comprehensive list of the Islamic funds worldwide.
Islamic laws on trading
The Quran prohibits gambling (games of chance involving money). The
hadith, in addition to prohibiting gambling (games of chance), also prohibits
bayu al-gharar (trading in risk, where the Arabic word gharar is taken to
The Hanafi madhab (legal school) in Islam defines gharar as "that whose
consequences are hidden." The Shafi legal school defined gharar as "that
whose nature and consequences are hidden" or "that which admits two
possibilities, with the less desirable one being more likely." The Hanbali
school defined it as "that whose consequences are unknown" or "that which
is undeliverable, whether it exists or not." Ibn Hazm of the Zahiri school
wrote "Gharar is where the buyer does not know what he bought, or the
seller does not know what he sold.” The modern scholar of Islam, Professor
Mustafa Al-Zarqa, wrote that "Gharar is the sale of probable items whose
existence or characteristics are not certain, due to the risky nature that makes
the trade similar to gambling." There are a number of hadith who forbid
trading in gharar, often giving specific examples of gharhar transactions
(e.g., selling the birds in the sky or the fish in the water, the catch of the
diver, an unborn calf in its mother’s womb, the sperm and unfertilized eggs
of camels, etc.). Jurists have sought many complete definitions of the term.
They also came up with the concept of yasir (minor risk); a financial
transaction with a minor risk is deemed to be halal (permissible) while
trading in non-minor risk (bayu al-ghasar) is deemed to be haram.
What gharar is, exactly, was never fully decided upon by the Muslim jurists.
This was mainly due to the complication of having to decide what is and is
not a minor risk. Derivatives instruments (such as stock options) have only
become common relatively recently. Some Islamic banks do provide
brokerage services for stock trading and perhaps even for derivatives
Islamic banking in Malaysia
The earliest form of Islamic banking in Malaysia may be traced back to
September 1963 when Perbadanan Wang Simpanan Bakal-Bakal Haji
(PWSBH) was set up. PWSBH was set up as an institution for Muslims to
save for their Hajj (pilgrimage to Makkah) expenses. In 1969, PWSBH
merged with Pejabat Urusan Haji to form Lembaga Urusan dan Tabung Haji
(now known as Lembaga Tabung Haji).
The first Islamic bank in Malaysia was established in 1983. In 1993,
commercial banks, merchant banks and finance companies were allowed to
offer Islamic banking products and services under the Islamic Banking
Scheme (IBS). These institutions however, are required to separate the funds
and activities of Islamic banking transactions from that of the conventional
banking business to ensure that there would not be any co-mingling of
In Malaysia, the National Syariah Advisory Council additionally set up at
Bank Negara Malaysia (BNM) advises BNM on the Shariah aspects of the
operations of these institutions, as well as on their products and services.
In June 2005, Dow Jones and Company of New York and RHB Securities of
Kuala Lumpur, teamed up to launch a new "Islamic Malaysia Index" — a
collection of 45 stocks representing Malaysian companies that comply with
a variety of Sharia-based criteria. Three variables (the total debt of an
indexed company, its total cash plus interest-bearing securities and its
accounts receivables) must each be less than 33% of the trailing 12-month
Islamic banking in Bangladesh
Islamic banking started in Bangladesh through establishment of the ISLAMI
BANK BANGLADESH Ltd. (IBBL), which is considered to be the first interest-
free bank in Southeast Asia. It was incorporated on 13 March 1983 as a
public limited company under the COMPANIES ACT 1913. In December
2001, IBBL had 121 branches, its authorized capital was Taka 1000 million
and paid up capital Taka 640 million. AL BARAKA BANK Ltd, often called
the second Islamic bank of Bangladesh, commenced banking business on 20
May 1997. It is a joint-venture enterprise of Al-Baraka Investment and
Development Company, a renowned financial and business house of Saudi
Arabia, Islamic Development Bank, a group of eminent industrialists of
Bangladesh, and the government of Bangladesh. The authorized capital of
the bank is Taka 600 million and its paid up capital is Taka 259.55 million.
The bank has now 35 branches in different parts of the country.
In addition to extending conventional commercial banking facilities to its
customers, the bank gives substantial financial support to the
implementation of industrial and real estate projects. In 1996, two more
Islamic banks were given clearance to operate under Islamic banking
principles. They were the AL-ARAFAH ISLAMI BANK Ltd. and SOCIAL
INVESTMENT BANK. The fifth Islamic bank of the country is a foreign bank
named the SHAMIL BANK OF BAHRAIN, which was created through merger
of the Faisal Islamic Bank of Bahrain and an Islamic Finance Company.
Accounting and Auditing Organization for Islamic
Financial Institutions. (AAOIFI)
Since 1991, when the Islamic banking and finance industry itself decided
that the existing international standards were inadequate to cater for its
needs, we have come a long way to being recognized as the main standard-
setting organization. We have now issued 56 standards on accounting,
auditing, governance, ethical, and Shari'a standards, including a statement on
capital adequacy. Over the years, AAOIFI has taken significant steps to
encourage the application and enforcement of its standards throughout the
world. We have done so by producing high-quality standards that are
internationally recognized and we have made particular effort to ensure that
our standard setting process constitutes strong cooperation amongst
interested parties. Recently, the General Assembly has approved the increase
of our technical Boards, from 15 to 20 members. This decision will further
boost the adoption and implementation of AAOIFI's standards where they
are either mandatory or used as a guideline by the regulators in jurisdictions
such as Bahrain, Sudan, Jordan, Malaysia, Qatar, Saudi Arabia, Dubai and
Lebanon. Most recently, Syria has signed an agreement to mandate and
adopt AAOIFI's standards.
It is only through international recognition and consistent application of
these standards will the Islamic banking and finance industry realize the full
benefits of accurate and transparent financial reporting, and fulfill its
mission of bringing credible solutions to the masses. As the main avenue for
the interface between market players and regulators, our membership
continues to expand, which now stands at around 140 members from 30
countries. This steady progress is a reflection of the confidence placed on
AAOIFI as the leading representative of the industry.
Apart from developing new standards and encouraging the application of
these standards, AAOIFI continues to organize key Conferences in
regulatory and Shari'a issues, the recent one jointly with the World Bank in
Bahrain, which have now become an essential forum for practitioners,
scholars, academics and regulators to discuss and debate pertinent topics
driving the future of the industry.
Islamic banking in non-Muslim countries
The modern commercial banking system in nearly all countries of the world
is mainly evolved from and modelled on the practices in Europe, especially
that in the United Kingdom. The philosophical roots of this system revolves
around the basic principles of capital certainty for depositors and certainty as
to the rate of return on deposits. In order to enforce these principles for the
sake of the depositors and to ensure the smooth functioning of the banking
system Central Banks have been vested with powers of supervision and
control. All banks have to submit to the Central Bank rules. Islamic banks
which wish to operate in non-Muslim countries have some difficulties in
complying with these rules. We will examine below the salient features.
Certainty of capital and return
While the conventional banks guarantee the capital and rate of return, the
Islamic banking system, working on the principle of profit and loss sharing,
cannot, by definition, guarantee any fixed rate of return on deposits. Many
Islamic banks do not guarantee the capital either, because if there is a loss it
has to be deducted from the capital. Thus the basic difference lies in the very
roots of the two systems. Consequently countries working under
conventional laws are unable to grant permission to institutions which wish
to operate under the PLS scheme to functions as commercial banks. Two
official comments, one from the UK an the other from the USA suffice to
illustrate this. Sir Leigh Pemberton, the Governor of the Bank of England,
told the Arab Bankers’ Association in London that:
It is important not to risk misleading and confusing the general public by
allowing two essentially different banking systems to operate in parallel; A
central feature of the banking system of the United Kingdom as enshrined in
the legal framework is capital certainty for depositors. It is the most
important feature which distinguished the banking sector from the other
segments of the financial system; Islamic banking is a perfectly acceptable
mode of financing but it does not fall within the definition of what
constitutes banking in the UK; The Bank of England is not legally able to
authorise under the Banking Act, an institution which does not take deposits
as defined under that Act;
The Islamic facilities might be provided within other areas of the financial
system without using a banking name.
In the United States, Mr Charles Schotte, the US Treasury Department
specialist in regulatory issues has remarked: There has never been an
application for an Islamic establishment to set up either as a bank or as
anything else. So there is no precedent to guide us. Any institution that
wishes to use the word ‘bank’ in its title has to guarantee at least a zero rate
of interest -- and even that might contravene Islamic laws.
Supervision and control
Besides these, there are other concerns as well. One is the Central Bank
supervision and control. This mainly relates to liquidity requirements and
adequacy of capital. These in turn depend on an assessment of the value of
assets of the Islamic banks. A financial advisor has this to say:
The bank of England, under the 1979 Act, would have great difficulty in
putting a value on the assets of an Islamic institution which wanted to
operate as a bank in the UK. The traditional banking system has much of its
assets in fixed interest instruments and it is comparatively easy to value that.
For example, if they are British Government instruments they will have a
quoted market value; and there are recognised methods for valuing
traditional banking assets when they become non-productive. But it is very
difficult indeed to value an Islamic asset such as a share in a joint venture;
and the Bank of England would have to send a team of experienced
accountants into every Islamic bank operating in the UK as a bank under the
1979 Act, to try to put a proper and cautious value on its assets.
Another important consideration is the tax procedures in non-Muslim
countries. While interest is a ‘passive’ income, profit is an earned income
which is treated differently. In addition, in trade financing there are title
transfers twice -- once from seller to bank and then from bank to buyer --
and therefore twice taxed on this account decreasing the profitability of the
Islamic banking in India: long way to go
Islamic banking as a concept has gained momentum world over and in India
over the past few years. Several foreign banks operating in India, like
Citibank, Standard Chartered Bank, HSBC are operating interest free
windows in several West Asian countries, Europe and USA. There is also a
growing awareness about the concept among Indian banks and it is generally
felt that there is a huge potential market in India for Islamic banking
Islamic banking as a concept has gained momentum world over and in India
over the past few years. Several foreign banks operating in India, like
Citibank, Standard Chartered Bank, HSBC are operating interest free
windows in several West Asian countries, Europe and USA. There is also a
growing awareness about the concept among Indian banks and it is generally
felt that there is a huge potential market in India for Islamic banking
Several banks in the country have shown an inclination to undertake this
form of interest-free banking. However, unless proper regulations are in
place to oversee this form of banking, it will not be possible for scheduled
commercial banks to follow the Islamic rules of banking even in a small
This has led the Reserve Bank of India to set up a committee headed by Mr
Anand Sinha, chief general Manager in-charge, department of banking
operations & development to look into the matter. Islamic organizations like
Jamat-e-Islami are taking an active interest in seeing it through; and its
Maharashtra chapter recently organized a seminar of Islamic scholars and
former bankers on this theme.
TimesofMoney has made a beginning in a small way by offering products &
services that are in compliance with Shariat (Islamic Law) in alliance with
Mashreq Bank, UAE. But this facility is strictly for remittances from the
Gulf to India.
Presently in India, Islamic banking is confined to the co-operative sector.
Only 10-15 Islamic banks with deposits of about Rs 75 cr are operating all
over the country in various states. They are actually non-banking finance
companies (NBFCs), which work on no-profits-no-loss basis. Islamic banks
by and large cater to the needs of local area except a few that operate across
districts or states. Their sources of funds are limited and as a result these
banks have to operate on small scale missing the economies of scale.
Islamic banks in India provide housing loan, on the basis of co-ownership,
venture finance on Mudarabah basis as well as on Musharaka basis and
consumers loans. Some banks finance purchase of automobiles on a hire-
purchase basis. Education finance and skill development finance is also
provided by them. Investments are made in government securities, small
savings schemes or units of mutual funds. These banks also invest in shares
of companies. Hire-purchase and lease finance are other source of
These banks do not function under banking regulations. They are licensed
under Non Banking Finance Companies Reserve Bank Directives 1997 RBI
(Amendment) Act 1997. RBI has also introduced a compulsory registration
system. Within the present system, even if banks are allowed to set up
windows offering this service, they maintain cash reserve and SLR since
these involve interest. This type of banking cannot avail facility of
settlement and clearing system and therefore they cannot issue cheques.
Other constraints are inability to maintain capital adequacy and would be
unable to interact with interest based banks and money market in India.
Consequently, RBI cannot act as the lender of last resort because such
accommodation by the monetary authority is also interest based. Islamic
banks cannot interact with conventional banks based on principles of
Islamic banking concentrates more on short-term and medium-term
operations because long-term lending involves project appraisals and
assessing long term profitability. Most such banks are ill equipped to handle
this responsibility because of the smallness of their operations.
Concepts In Islamic banking
Bai' al-Inah (Sale and Buy Back Agreement)
The financier sells an asset to the customer on a deferred-payment basis, and
then the asset is immediately repurchased by the financier for cash at a
discount. The buying back agreement allows the bank to assume ownership
over the asset in order to protect against default without explicitly charging
interest in the event of late payments or insolvency.
Bai' Bithaman Ajil (Deferred Payment Sale)
This concept refers to the sale of goods on a deferred payment basis at a
price, which includes a profit margin agreed to by both parties. This is
similar to Murabahah, except that the debtor makes only a single installment
on the maturity date of the loan. By the application of a discount rate, an
Islamic bank can collect the market rate of interest.
Literally bai muajjal means a credit sale. Technically, it is a financing
technique adopted by Islamic banks that takes the form of murabaha muajjal.
It is a contract in which the bank earns a profit margin on the purchase price
and allows the buyer to pay the price of the commodity at a future date in a
lump sum or in installments. It has to expressly mention cost of the
commodity and the margin of profit is mutually agreed.
Bai 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. It is necessary that the quality of the commodity intended to
be purchased is fully specified leaving no ambiguity leading to dispute. The
objects of this sale are goods and cannot be gold, silver, or currencies.
Barring this, Bai Salam covers almost everything, which is capable of being
definitely described as to quantity, quality, and workmanship.
This is a token given voluntarily by a debtor to a creditor in return for a loan.
Hibah usually arises in practice when Islamic banks voluntarily pay their
customers interest on savings account balances.
Ijarah is a contract of a known and proposed usufruct against a specified and
lawful return or consideration for the service or return for the benefit
proposed to be taken, or for the effort or work proposed to be expended. In
other words, Ijarah or leasing is the transfer of usufruct for a consideration
that is rent in case of hiring of assets or things and wage in case of hiring of
persons.the literal meaning of usufruct is the right to enjoy the use of
another’s property short of the destruction or waste of its substance.
Ijarah Thumma Al Bai' (Hire Purchase)
These are variations on a theme of purchase and lease back transactions.
There are two contracts involved in this concept. The first contract, an Ijarah
contract (leasing/renting), and the second contract, a Bai contract (purchase)
are undertaken one after the other. For example, in a car financing facility, a
customer enters into the first contract and leases the car from the owner
(bank) at an agreed rental over a specific period. When the lease period
expires, the second contract comes into effect, which enables the customer to
purchase the car at an agreed price.
In effect, the bank sells the product to the debtor, at an above market-price
profit margin, in return for agreeing to receive the payment over a period of
time; the profit margin on the lease is equivalent to interest earned at a fixed
rate of return.
This type of transaction is particularly reminiscent of contractum trinius, a
complicated legal trick used by European bankers and merchants during the
Middle Ages, which involved combining three individually legal contracts in
order to produce a transaction of an interest bearing loan (something that the
Church made illegal).
A contract under which an Islamic bank provides equipment, building, or
other assets to the client against an agreed rental together with a unilateral
undertaking by the bank or the client that at the end of the lease period, the
ownership in the asset would be transferred to the lessee. The undertaking or
the promise does not become an integral part of the lease contract to make it
Istisna'a is a contractual agreement for manufacturing goods and
commodities, allowing cash payment in advance and future delivery or a
future payment, and future delivery. Istisna’a can be used for providing the
facility of financing the manufacture or construction of houses, plants,
projects, and building of bridges, roads, and highways.
Mudarabah (Profit Loss Sharing)
Mudarabah is an arrangement or agreement between a capital provider and
an entrepreneur, whereby the entrepreneur can mobilize funds for its
business activity. The entrepreneur provides expertise and management and
is referred to as the Mudarib. Any profits made will be shared between the
capital provider and the entrepreneur according to an agreed ratio, where
both parties share in profits and only capital provider bears all the losses if
occurred. The profit-sharing continues until the loan is repaid. The bank is
compensated for the time value of its money in the form of a floating interest
rate that is pegged to the debtor's profits.
Murabahah (Cost Plus)
This concept refers to the sale of goods at a price, which includes a profit
margin agreed to by both parties. The purchase and selling price, other costs,
and the profit margin must be clearly stated at the time of the sale
agreement. The bank is compensated for the time value of its money in the
form of the profit margin.
This is a fixed-income loan for the purchase of a real asset (such as real
estate or a vehicle), with a fixed rate of interest determined by the profit
The bank is not compensated for the time value of money outside of the
contracted term (i.e., the bank cannot charge additional interest on late
payments); however, the asset remains in the ownership of the bank until the
loan is paid in full.
This type of transaction is similar to rent-to-own arrangements for furniture
or appliances that are very common in North American stores.
Musawamah is a general and regular kind of sale in which price of the
commodity to be traded is bargained between seller and the buyer without
any reference to the price paid or cost incurred by the former. Thus, it is
different from Murabaha in respect of pricing formula. Unlike Murabaha,
however, the seller in Musawamah is not obliged to reveal his cost. Both the
parties negotiate on the price. All other conditions relevant to Murabaha are
valid for Musawamah as well. Musawamah can be used where the seller is
not in a position to ascertain precisely the costs of commodities that he is
offering to sell.
Musharakah (Joint Venture)
Musharakah is a relationship established under a contract by the mutual
consent of the parties for sharing of profits and losses in the joint business. It
is an agreement under which the Islamic bank provides funds, which are
mixed with the funds of the business enterprise, and others. All providers of
capital are entitled to participate in management, but not necessarily required
to do so. The profit is distributed among the partners in pre-agreed ratios,
while the loss is borne by each partner strictly in proportion to respective
capital contributions. This concept is distinct from fixed-income investing
(i.e. issuance of loans).
Qardul Hassan (Benevolent Loan)
This is a loan extended on a goodwill basis, and the debtor is 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, since it is the one type
of loan that truly does not compensate the creditor for the time value of
Sukuk (Islamic Bonds)
Sukuk is the Arabic name for a financial certificate but can be seen as an
Islamic equivalent of bond. However, fixed-income, interest-bearing bonds
are not permissible in Islam. Hence, Sukuk are securities that comply with
the Islamic law 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
Conservative estimates suggest that over US$ 500 billion of assets are
managed according to Islamic investment principles. Such principles form
part of Shariah, which is often understood to be Islamic law, but it is actually
broader than this in that it also encompasses the general body of spiritual
and moral obligations and duties in Islam.
Takaful (Islamic Insurance)
Takaful is an alternative form of cover that a Muslim can avail himself
against the risk of loss due to misfortunes. The concept of takaful is not a
new concept; in fact, it had been practiced by the Muhajrin of Mecca and the
Ansar of Medina following the hijra of the Prophet over 1,400 years ago.
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
In modern business, one of the ways to reduce the risk of loss due to
misfortunes is through insurance which spreads the risk among many
people. The concept of insurance where resources are pooled to help the
needy does not contradict Shariah. However, conventional insurance
involves the elements of uncertainty (Al-gharar) in the contract of insurance,
gambling (Al-maisir) as the consequences of the presence of uncertainty and
interest (Al-riba) in the investment activities of the conventional insurance
companies that contravene the rules of Shariah. It is generally accepted by
Muslim jurists that the operation of conventional insurance does not
conform to the rules and requirements of Shariah.
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 a hibah (gift) as a form of appreciation for the use of funds by
the bank. In this case, the bank compensates depositors for the time-value of
their money (i.e. pays interest) but refers to it as a gift because it does not
officially guarantee payment of the gift.
This occurs when a person appoints a representative to undertake
transactions on his/her behalf, similar to a power of attorney.
ISLAMIC BANKING IN BANGLADESH:
A CASE STUDY OF IBBL
Mohammed Nurul Alam
International Journal of Islamic Financial Services Vol. 1 No.4
The article undertakes a case study on an Interest-Free Financial Institution
in Bangladesh known as Islamic Bank Bangladesh Limited (IBBL). The aim
of the study was to see how Islamic banking activities differ from a
conventional bank and also to see how Islamic banks may contribute to
render financial services towards small and rural sector. By discussing
various aspects of the IBBL, it is shown in detail how interest-free bank
functions besides many established conventional banks in
the country. Although conventional banks are rendering financial services in
Bangladesh for a long period still, the innovation of interest-free banking
systems, proved its worth in the country’s money market, since IBBL started
rendering banking services without any interest in the nation’s financial
market in recent years. The article mainly consists of two sections. In the
first section, an introduction of Islamic banking systems and various
financing modes or techniques used by Islamic banks, are discussed. The
second section includes a short history of the Islamic Bank Bangladesh
Limited (IBBL) along with an empirical based detailed accounts of its
financial activities in the country since the introduction of this financial
institution in the financial system of Bangladesh.
In the modern financial market an alternate arrangement for participation of
capital and entrepreneurship started with the advent of Islamic banking in
the 70’s. In a number of studies such as IMF, World Bank and IFC, the
Islamic bank activities were discussed in detail. Highlighting Islamic bank’s
principle Khan (1986, p. 19), in the IMF staff Paper, observed as; “Indeed it
is really apparent that the Islamic model of banking based on the principle of
equity participation bears a striking resemblance to proposals made in the
literature on the reform of banking system in many countries.
The Islamic System may well prove to be better suited to adjusting to shocks
that result in banking crises and disruption on the payment mechanism of the
country. In an equity-based system that exclude predetermined interest rate
and does not guarantee the nominal value of deposits, shock to asset position
are immediately absorbed by changes in the values of the share deposits held
by the public in the banks. Therefore, the real value of assets and liabilities
of banks in such a system will be equal at all points in time. In the more
traditional banking system since the nominal value of deposits is fixed, such
shocks can cause a diversion between real assets and liabilities. It is not clear
if this would be correct and how long the process would take.”
A study by OECD of the European countries, Paris, (1983) reveals the fact
that interest-free banking is a novel form of finance and they are not only
trying to give interest another name but that legal instruments within the
framework of Shari’ah exist which permit profitability on a different, albeit
Qoranically acceptable basis. Islamic banks belong to the class of equity-
participation bank. In this regard Ahmad (1994, P. 190) in his study quoted
the idea of Alba’ch as;
“They supply equity in the form of venture capital to investors whose share
is their ingenuity and their labor.
Secondly, they supply equity in the form of equity capital participants in the
type of project, which in general has majority shareholders. They may be
ideally suited to meet the need for equity capital in developing countries
where the business risk is particularly high as well as in the industrialized
countries where the development of new processes and new projects
involves high risk and requires large amount of venture capital”
Scharf (1983, P. 94-95), in his study entitled ‘Arab and Islamic Bank’
conducted by Development center, Organization of Economic Cooperation
and Development (OECD), highlighted the Islamic banking principles and
prospect as follows;
‘Islamic banking is trying to develop the relationship between finance on
one hand and industry and commerce on the other. This new relationship is
the basis of the Islamic economic system being set up.
Though Islamic principles have yet to be put to the test in the competitive of
international finance, the two system are similar in that they both strive for
closer ties between financial intermediation and economic asset creation.
Islamic banks could make a useful contribution to economic growth and
development particularly in a situation of recession, stagflation and low-
growth level because the core of their operation is oriented towards
productive investment All countries both in the North and in the South, need
more venture capital. Loan capital is available, particularly from
industrialized countries but at high interest rates. However, even from
expansion and innovation. This has acted as a brake on productivity and
economic growth in the North. Thus practical and immediate cooperation
possibility exists between Islamic banks and enterprises all over the world.
The intermediation process remains to be fully developed’.
About the possibility of introducing an interest-free financing system
through Islamic banking principle Scharf (1983) also argues that the
establishment Islamic Financial System based on the principle of Shari’ah is
not only feasible but also profitable. Western countries today realize the
truth that interest is an unbearable burden for the developing countries. Due
that, as observed by Ahmad (1994, p. 188), ‘Canada has already waived of
all the interest. Australia has made a similar move. President Mitterrand of
France has officially suggested in the Group-7 meeting that at least 30-35
percent of the present interest element of the debt should be waived off’.
Methodology Used in This Study
Islamic banking systems is a quiet new phenomenon in the money market of
Bangladesh. In order to go deep into this particular area of study and also to
realize the objectives of my research, the methodological approach used in
this study is of a qualitative nature. Regarding a qualitative research
Merriam (1998, p. 5) observes; ‘Qualitative research is an umbrella concept
covering several forms of inquiry that help us understand and explain the
meaning of social phenomena with as little disruption of the natural setting
as possible’. Further to the above, the author with regards to a qualitative
research observes that this method is often used for interchangeably
naturalistic inquiry, interpretative research, field study, participant
observation, inductive research, case study and ethnography.
To understand problems of the Islamic banking activities a case study
method is used in the study about which Yin (1994, p.13) argues that a case
is an empirical inquiry that investigate a contemporary phenomenon within
its real-life content, especially when boundaries between phenomenon and
content are not clearly evident.
The main objective of using case study method is to find how an Islamic
banks functions among other established conventional banks in the country.
Hence, to realize the said objectives, apart from depth interview,
participants’ observation is also used in the study.
Banking Environment in Bangladesh
Bangladesh appeared as a new nation on the world map in the year 1971.
After independence financial institutions, especially banks played a vital role
in re-constructing the war-torn economy of Bangladesh. As reported by BSB
(P. 29, 1993), “the banking system of Bangladesh is a mixed one comprising
nationalized, private and foreign commercial banks. Bangladesh Bank is the
central bank of the country and is in charge of monetary policies of the
Government and controls all commercial banks.” Immediately after
independence the government of Bangladesh nationalized most of the
banking institutions, though, within a short period, due to the failure in
administering them properly, many of them were returned to their owners.
The banking sector is one of the fast growing sectors of economy in
Bangladesh. At present there are 34 banks working in the financial market of
the country, including four Islamic banks and a number of foreign banks.
During the Fiscal Year 1993-94 the banking institutions of Bangladesh
transacted their business through 5,780 branches (BSB, 1994). The deposit
of scheduled banks (excluding inter-bank items) amounted to TK. 309,884
million. The bank deposits during the year 1993-94 were increased by TK.
27,629 million, of which 12.29% was in time deposits and TK. 22,043
million or 25.50% in demand deposits. The total bank credit in the same
year was TK. 240,870 million. Of this, credit to the government sector
recorded a decrease of 55.05% and credit to the private sector expanded by
8.55%. (GB, 1993/94).
The Islamic Bank Bangladesh Limited
Based on Islamic principles and shariah (Islamic law), with an authorized
capital of TK. 500 million (12.5 million US dollars), the Islamic bank in
Bangladesh, called Islamic Bank Bangladesh Limited (IBBL) was
incorporated on March 13, 1983 as a Public Limited Company under the
companies Act of 1913. The bank started its financial activities with effect
from March 30, 1983. This is one of the first interest free banks in South
Asia. The opening of Islamic bank brought a new era in the history of the
country’s financial market. The long cherished desire of many Muslims in
the country was realized. The total number of branches of the bank as on
December 1995 stood at 83. The bank had taken steps to spread its activities
towards the rural areas of Bangladesh. With the implementation of the
expansion program in the year 1997, almost all-important commercial places
of the country would come under the operational activities of the bank.
In Bangladesh, which is the second largest Muslim country of the world,
Islamic Bank Bangladesh Limited (IBBL) started as a joint venture
multinational bank with 63.92% of equity contributed by the Islamic
Development Bank and financial institutions like Al-Raji Company for
Currency Exchange and Commerce of Saudi Arabia, Kuwait Finance House,
Jordan Islamic Bank, Islamic Investment and Exchange Corporation of
Qatar, Bahrain Islamic Bank, Islamic banking System International Holding,
S.A, Dubai Islamic Bank, Kuwait Ministry of Awqaf and Islamic Affairs.
Two eminent personalities of Saudi Arabia namely Fouad Abdul Hameed
Al-Khateeb and Ahmed Salah Jamjoom, are also the sponsors of the Islamic
Bank Bangladesh Limited. (GB 1993/94).
The responsibility for management and formulation policy of the IBBL is
vested in the board of directors. The board consists of 14 local and 9 foreign
directors. As a rule in the Article of Association, a Bangladeshi director is
to be elected as the chairman of the company. A high powered Executive
Committee has been formed to assist the chairman. There are six members
in this committee, nominated by the board of directors. In addition to this
there is a Management Committee consisting of the most senior executives
of the bank. There is also a Shariah Council comprising famous Islamic
scholars, economists and bankers. This Council is responsible for
supervising the day to day affairs of the Islamic bank from the viewpoint of
the Islamic Shariah. (GB, 1995).
Objectives of Islamic Banks Bangladesh Limited
The main object of the Islamic Bank Bangladesh Limited (IBBL) had been
to offer an interest free banking system in the financial market. Apart from
that, the bank started its operation in the country with a view to realizing the
· To establish a partnership relationship with customers and to eliminate the
idea of the debtor-creditor relationship of traditional banks.
· To establish welfare oriented banking system;
· To mobilize savings towards productive sectors;
· To invest on profit and risk sharing basis;
· To invest to those businesses sectors that are found legal from
· the religious point of view.
· To accept deposits on profit and loss sharing basis.
· To create employment opportunities by investing savings towards
prospective economic sectors.
· To extend banking services towards the poor, helpless and low-income
group of people in the society in order to uplift of their standard of living.
· To contribute to establishment of a society by equitable distribution of
· To establish justice in trade and commerce in the country;
· To develop morals among the people and to establish the shariah in the
field of trade and commerce; And;
· To render services for the economic development of the nation.
· To contribute towards establishment of an Islamic Economic System in the
Functions of IBBL
Islamic banks render almost similar services to their customers conventional
banks do. However, differences exist in administering incentives for
deposits and charging for capital investments, in so far as techniques of
the incentive or the cost of the capital is concerned.
Like a conventional bank, the Islamic bank also accepts deposits from
customers and advances loans. The bank invests its funds for short as well as
long term deposits.
The Islamic bank also acts as a custodian of its customers and performs all
foreign transactions on behalf of them. The IBBL perform mainly three
different types of functions
Foreign exchange services
Banking services comprise three regular types of operations related to
acceptance of deposits in the different customers accounts as mentioned
earlier, as well as, different transactional services to the customers, safe-
keeping of personal valuables and securities, collection of bills, agency
The bank lends its funds for the rapid growth and development of industrial
sectors and the promotion of trade and
commerce in the country. The bank also invests its funds in various socio-
economic schemes such as, Rural Investment Scheme, Small Traders
Investment Scheme, Doctors Investment Scheme, Small Transport Scheme,
Small and Cottage Industry Project, Hawker’s Investment Scheme,
Household Durable Scheme and Low Cost Housing Scheme.
The third important function of the bank is to render services to customers
regarding foreign exchange transactions plus services to its customers for
import and export of different industrial, commercial, agricultural and other
Operations of IBBL
This section of the article includes a detailed discussion of various functions
of the Islamic Bank Bangladesh Ltd. (IBBL), since it started its banking
activities such as, acceptance of deposits and investment of funds etc.
Further to that, an attempt has also been made to highlight on the overall
performances of the bank, ever since it started its financial activities in the
money market of Bangladesh.
Acceptance of Deposits
In recent years Islamic Bank Bangladesh limited had succeeded in attracting
increased deposit. The deposit figure rose to Taka 10,418 million in March
1995 from Taka 144.20 million as on March 1983, registering an increase of
Taka. 10,273.8 million.
Year-wise deposit and the growth rate of deposits since 1993
The total deposit figure of the IBBL in the year 1983 was TK: 144.20
million. Since the start of the banking services, the deposit position of the
IBBL showed a favorable tendency every year.
According to data available as of December, 1994, the bank’s deposit figure
increased to Taka 10,226 million from Taka 8,380 million in the year 1993
registering an increase of Taka 1846 million, i.e. 22 per cent as compared to
the national growth rate of 18.47 per cent in the banking sector for that year.
In the year 1994 the total number of depositors rose to 339,600 from
291,000 in the preceding year registering an increase of 17 per cent. (IBBL
Annual Report and GB Financial Report, 1994)
The deposit position of the IBBL as shown by Annual Reports indicate that
in 1984 accumulated deposit figure rose to Taka 635.9 million from Taka
144.20 million year 1983, registering an increase in deposit of Taka 491.7
million i.e. 340% increase in growth rate of deposit within one year. But the
growth rate of deposits decreased from 340% to 145% in 1985. In the year
1986 the total deposits of the bank was Taka. 223o.6 million. If we compare
the rate of growth in 1986 with that of 1985 it can be observed that the
deposit reduced to 42% from 145%, registering a fall of 103% in a one year
period. The bank experienced a drastic fall in deposit growth in the year
1987. The total deposit received in 1987 was TK. 2419.7 and the growth rate
compare to the year 1986 was 08%.
Composition of deposits in the year 1994:
Two shariah principles, viz., AL-Wadia and Mudaraba are followed by the
Islamic bank to mobilize its deposits. The first one is almost similar to
demand account or current account of conventional banks and the other
implies various types of Profit Loss Sharing (PLS) Accounts.
Of these accounts almost 80% to 85% of the total deposit of the Islami Bank
is received under ‘Mudaraba’ Shariah principle. The highest profit so far
paid by the bank on this type of deposit was 15%.
Growth rate of deposits compared to the growth rate of branches of IBBL:
It is assumed that with the proliferation of branches a bank can spread its
activities and attract an increasing number of customers both for accepting
deposits and investing capital. This pattern was not found in case of the
IBBL, since the record shows that in some years, in spite of a growth of a
number of branches, a concomitant growth of deposits did not occur. The
trend of the growth rate of deposits compared to the growth rate of branches
from 1883 to 1995 is shown in figure 4. The IBBL started its operation with
only three branches in the year 1983. In 1995 the number of branches stood
at 53. The growth rate of branches varied from year to year. In 1985 the
number of branches opened was the highest; it decreased again in 1986.
Although there was only a modest decrease of branches in 1986, there was a
drastic reduction in the deposit figure. The deposit growth rate percentage
from 1987 to 1989 is also low compared to the growth of branches.
Profit paid to depositors of IBBL in 1994:
The Annual Report 1994 of IBBL shows that the bank distributed Taka
398.34 million as profit among depositors, which constitute 75% of the
investment income of the concerned financial year. The rate of profit paid to
the depositors is higher than the floor rate fixed by the central bank of the
country. The rate of profit paid to the depositors of various types of deposit
as well as the rate fixed by the central bank.
Investment an Important Means of Using IBBL’S Fund:
The Islamic Bank Bangladesh Limited invests its fund in various projects
under different modes or techniques as discussed earlier. The bank shows a
good progress in investing its funds, since it started its business. From the
record is observed that the total investment of the bank has increased to Taka
9,766 as on March 31, 1995 from Taka 28 Million in the year 1983,
registering an increase of Taka 9738 million since the bank started its
financial activities in the Money Market of Bangladesh.
The Annual Report of 1994 shows that investments of the bank in 1994
increased to Taka 8055.33 million from Taka 5521.35 million in 1993,
registering an increase of Taka 2533.98 million, i.e. 45.89 percent as against
a 6.56 percent growth rate of investment in the banking sector of the
Although the total investment of the bank registered an increase every year,
the rate of growth fluctuated by a wide margin. The record shows that
growth rate of investment from 1987 to 1989 is 28%, 17.8%, and 10.6%
respectively. In the year 1990, a record of a 73.9% growth rate had been
achieved, while it fell in 1991, 1992 and 1993. Further, the growth rate of
investment in 1993 reduced to 7.32% from 20.57% in 1992, registering
reduction of 13% within one year.
Modes of Investment of IBBL:
Islamic Bank Bangladesh Limited follows different modes or techniques
while investing their funds. It has been observed from the past record that
the bank invests its funds mainly under Murabaha, Musharaka, Bai-Muajjal,
Hire Purchase, and Quard E Hasana mode of investments. The Mudaraba
mode has not been used. It is apparent from an analysis of the bank’s mode
of operations that the bank concentrates on the Murabaha mode of
investment. Of the total investment, the bank invested almost 54.13% under
the Murabaha mode and 18.24% under the Bai-Muajjal mode. The Hire
Purchase and the Purchase & Negotiation modes occupy the third and
thefourth positions, registering 11.36% and 8.35% of the total investment
respectively. The bank made its lowest investment in the Musharaka, Quard
E Hasana modes which records only 3.8% and 2.99% of the total investment
since 1983. The investment policy with regard to the duration differs from
one mode of investment to another. The bank makes short, medium and
long-term investments under different modes; the period of investment
mainly depends on the nature of business, item and income cycle.
Musharaka or investment under partnership is one of the most important
financing techniques of the Islamic Bank Bangladesh Limited. This mode of
investment where the bank and the client jointly supplies the capital is also
known as the Equity Participation mode of investment. Profit is distributed
according to a predetermined ratio and loss also shared according to the
capital contributed ratio.
The bank as well as the customer both takes part in the management and
control of the entrepreneurial activities.
The Murabaha is another important mode of investment used by the Islami
Bank Bangladesh Limited. In an average the bank invested more than half of
its capital under this financing technique. The word ‘Murabaha’ means
mark-up sale or sale on profit. In this mode of investment the Islamic Bank
purchases goods at the request of the client and sells the same to him at cost
plus declared profit. The terms and conditions of Murabaha mode of
financing are that there must be three parties to a Mudaraba transaction viz.
The bank, the seller and the buyer. Price of the goods will have to be known
to both the bank and the client.
Mode-wise investment position of IBBL
In the year 1984 the bank made 28.95% of its total investment under the
Musharaka mode which was reduced to 3.54% in 1994. Murabaha
investment on the other hand showed a record increase in 1985, when the
bank made almost 71.98% of its total investment under the Murabaha mode.
In 1989 the figure came down to about 49.6% registering a reduction of
about 30% compared to 1985. Investment under the ‘Bai-Muajjal mode’
increased in the year 1989 to 25.47% but the figure reduced to 15.62% in the
year 1995 registering a fall of 9.85%. The Hire Purchase investment to total
investment decreased to a minimum of 0.44% in the year 1985. The
investment under this mode in comparison to the total investment in-creased
to 13.42% in the year 1989. Since 1989 the investment under the Hire-
Purchase mode showed an upward tendency.
Sector-wise investment of IBBL:
The sector-wise investment position seen in Table 5 indicates that the bank
invested a major portion of their funds in the commercial sector. In the year
1994 the bank invested about Taka 5,002 million in this sector, which is
64,59% of their total investment in the same year. From 1990 to 1994 the
total investment in the commercial sector increased by Taka 3,551 million.
The percentage of investment in the industrial sector did not show any
remarkable progress; rather it diminished gradually since 1990. Record
shows that the percentage of investment in this sector is reduced to 9.35% in
the year 1994 from 28.16% in 1993, registering a reduction of almost 18%
in one year.
Islamic Bank’s Investment in the Industrial Sector
An analysis of Islamic bank’s investments reveals that , the growth rate of
investment in any other sector is not much as compared to the commercial
sector. Investment in the industrial sector increased from 1984 to 1985, and
then started to fall, for example, the percentage in relation to the total
investment decreased in 1987 to 13% from 24% in 1985. Again we can
observe from the record that, the investment growth rate started increasing
from the year 1988. It is seen that, although, the total investment in the
industrial sectors increased to about Taka 892 million in 1994 from 614
million in 1990, yet the percentage of the total investment shows a
decreasing trend. We also observe that, the trend of investment in industrial
sector increased in 1992 and 1993 similar to the increase in 1988
and 1989. In 1994, however, the investment reduced drastically to about
Taka 892 from 1670 million in 1993, registering a decrease in the total
investment from 28% to 9%. By then the flow of investment was channeled
to ‘other sectors’ indicating that the bank is increasingly leaning towards
profit earning projects than development projects. The bank invests a major
portion of its fund in Germinates and textile industries and mostly uses the
Hire-purchase mode of investment. Under the hire-purchase mode a total of
Taka 885, 303, and 502, million was invested in 1990 to 1993 respectively.
Bai-Muajjal was in second position with a total of Taka 41.48 and 68 in
It may be concluded from the above study that the IBBL’s shows an overall
success in both deposits and investment positions since it started its banking
activities. As regards to the deposits side it may be observed that the total
deposits increased over past ten years even though, the average deposit
growth rate from 1988 to 1994 is only 23%. It is also observed that, the bank
did not succeed much in accumulating deposits under various term deposits.
This ultimately results in a reduction of the long-term investment of the
bank, especially investment towards industrial sectors. It is always assigned
that the growth rate of bank branches should increase the savings position of
the bank, which was not the case with the Islamic Bank. This occurred,
despite the fact that, one of the important advantages of opening a PLS
Savings Account with the Islamic Bank is that one can open a Savings
Account with only Taka 100.00 (2.5 US $) where as the initial deposit figure
in any other commercial banks in Bangladesh is not less than Taka 4000 (US
$ 100). Moreover the formalities for opening a Savings Account with
the Islamic Bank are very easy and simple.
As regards the overall investment position of the Islamic Bank Bangladesh it
may be concluded that, since the beginning of banking activities the bank
has not invested any amount in any project on the Mudarab mode of
investment. Although, the Islamic banking theory as regards investment of
funds and acceptance of deposits is based on two fundamental techniques
such as Mudaraba (capital financing) and Musharaka (Partnership), still
these principles are being applied only for collecting deposits and not for the
investment. While answering to a question the chief of the Investment
Department informed me that initially the bank tried to invest funds under
the ‘Mudaraba’ mode but failed to realize expected results. For the time
being they have stopped operating transaction on this mode.
The investment position of the bank since 1983 shows that investment under
the Musharaka mode of investment constitutes a very insignificant
percentage of the total investment. The bank invested a major portion of its
funds under the Murabaha and Bai-Muajjal mode of investment.
In spite of the fact that the bank invests its funds towards various sectors of
the nation’s economy still the sector-wise investment position indicates that
the bank concentrates much in investing towards commercial sectors. The
investment record shows that the percentage of investment towards the
industrial sector is reduced to 9.35% in the year 1994 from 28.16% in 1993,
registering a reduction of almost 18% in one year. This trend in investment
indicates that the IBBL is more interested in investing towards commercial
sectors than other sectors. While interviewing officers in the investment
department it was informed that in order to, make investment under
Musharaka mode of investment honest and sincere entrepreneurs are
required. They experienced a hard time in many cases while introduced
financing under the Musharaka mode. In most cases it was found that
although the entrepreneur is an honest person he lacks in sufficient equity
capital. The bank has not concentrated much in financing small and cottage
industry owners in rural Bangladesh. The bank has not invested yet under
the Mudaraba mode of investment while it is one the main mode of
investment of Islamic banks. It needs a lot of care and the investment under
this mode costs much to administer and supervise the loan. Islamic
Economists and Professionals are carrying on their research to find a proper
means, as to how the Musharaka and Mudarabah modes of investment, may
be made more effective and profitable in financing towards various sectors
of a nation’s economy.
It was observed from the response of a few small-scale industrialists that the
remarkable advantages they get from the bank are easy formalities of
obtaining loan and quick action in processing loan activities. Moreover,
clients of all levels can have free access to the bank and can discuss business
matters with senior officials. Senior officials of the Bank also keep a regular
contact with customers and bank managers frequently visit them in their
places of business. The chief of the Investment Department of the IBBL said
they were experiencing a lot of problems and difficulties in establishing the
idea of an Islamic banking system in the country. But the situation is getting
better than before. A majority of the People in rural and urban areas is aware
of the benefit of this bank, and every year the number of customers is
I had conducted a survey taking a sample size of 100. The survey was
conducted which consisted persons like officers, students, shopkeepers,
housewives, self-employed persons, bank officers, teachers, etc. The
survey was conducted in areas like Andheri, Marol, Sakinaka, Bandra,
Santacruz. The questionnaire is enclosed in the annexure. (Pg –53)
The findings of the survey are shown below with the help of the relevant
Q 1) HAVE YOU HEARD ABOUT ISLAMIC BANK?
Q 2) DO YOU THINK THAT THIS BANK SHOULD BE ESTABLISHED
Q 3) ARE YOU AWARE THAT THIS KIND OF BANKING SYSTEM IS
ESTABLISHED FOR BETTERMENT OF MUSLIM PEOPLE?
Q 4) DO YOU KNOW THAT THIS BANK DOES NOT CHARGE
INTEREST FOR TAKING LOAN?
Q 5) WOULD YOU LIKE TO INVEST IN THIS BANK?
Analysis of the Survey
According to survey conducted on Islamic banking, the results obtained are
1) Out of 100%, 75% of the public said they did not hear about Islamic
bank and the rest 25% of public said they did hear about Islamic bank.
2) In the second question i.e. should this bank be established in India,
18% of the public said Yes. Whereas the rest 82% said No.
3) In the third question i.e. did you know that this Islamic bank is set up
for the betterment of Muslim community, 86% of public said Yes
whereas 14% of the public said No.
4) 5% of the public said they knew that this bank does not charge interest
for taking loan. Whereas 95% of the public did not know that this
bank does not charge interest for taking loan.
5) In the fifth and final question whether one would like to invest in
Islamic bank, 30% of public said Yes and 70% said they would not
invest in Islamic bank.
Article on Islamic bank
`Knowledge of Islamic banking important'
THANJAVUR: Islamic banking is interest-free banking, a concept brought
to life in keeping with the tenets of Islamic religion, said R. Vaidyanathan,
Senior Regional Manager, Indian Overseas Bank, here on Wednesday. He
released a book on Islamic banking, the only such book written in India,
brought out by the Institute of Chartered Financial Analysts of India (ICFAI)
National College. The book was written by V. Subbulakshmi, an
engineering graduate. Mr. Vaidyanathan said Islamic banks don't collect
interest but share the profit with the investors. According to Islamic laws,
paying or receiving interest is a sin. There are 30 such banks in the world. In
the wake of competition triggered by globalisation, people cannot be
confined to the Indian system of banking alone. Students also cannot depend
only on Indian banks for jobs. Hence, knowledge about Islamic banking is
important, Mr. Vaidyanathan said. Indian banking has undergone a sea of
change. Banks are now knocking on the doors of customers, he added. He
appreciated ICFAI National College for bringing out the book. S.
Jagadeesan, Assistant General Manager, State Bank of India, said banks
played an important role in a country's development. After banks were
nationalised in 1969, they reached out to people by opening branches in
rural areas and saw enormous growth.
K. Rajadurai, principal, ICFAI National College, said India was the tenth
largest economy in the world and that it was moving towards becoming the
sixth or seventh position. Mahalingam, Chief Officer of the IOB; Balu,
Manager, Indian Bank; G. Chidambaram, former member of the State
Planning Commission; and Satyanarayana of ICFAI College participated in
Islamic banking is a very young concept. Yet it has already been
implemented as the only system in two Muslim countries; there are Islamic
banks in many Muslim countries, and a few in non-Muslim countries as
well. Despite the successful acceptance there are problems. These problems
are mainly in the area of financing.
With only minor changes in their practices, Islamic banks can get rid of all
their cumbersome, burdensome and sometimes doubtful forms of financing
and offer a clean and efficient interest-free banking. All the necessary
ingredients are already there. The modified system will make use of only
two forms of financing -- loans with a service charge and Mudaraba
participatory financing -- both of which are fully accepted by all Muslim
writers on the subject.
Such a system will offer an effective banking system where Islamic banking
is obligatory and a powerful alternative to conventional banking where both
co-exist. Additionally, such a system will have no problem in obtaining
authorisation to operate in non-Muslim countries.
Participatory financing is a unique feature of Islamic banking, and can offer
responsible financing to socially and economically relevant development
projects. This is an additional service Islamic banks offer over and above the
traditional services provided by conventional commercial banks.
This project is prepared from data found from internet as Islamic banking is
yet to arrive in India.
Ahmad, A. (1983) Evolution of Islamic banking, Institute of Policy Studies,
Ahmad, K. (1994), Elimination of Riba: Concepts and Problems, Response
to the Supreme Court Questionnaire,
Ahsan Fakhrul, A. S. M. (1989), “Islamic banking in Perspective.” Islamic
Bank Bangladesh Limited, Dhaka, Bangladesh
Annual Report (1994), Islamic Bank Bangladesh Limited (IBBL) Annual
Report, IBBL Head Office Dhaka,
Merriam, S. B., (1998), ’Qualitative research and case study application in
education’: Revised and expanded from case study research in education.
Jossey-Boss Inc. Publishers, San Francisco.