Islamic banking

1. Islamic Banking System
Chapter one
Introduction to Islamic financial system
Mu’amalat: Riba - Gharar - Impermissible (Haram) activities
Sanctity of Contracts
LECTURER:MASLAH ABDULLE.
MASTER OF BANKING MANAGEMENT (MBM).

2. Definitions
Finance is an art of money management and the actual process of acquiring needed
funds.
Financing is an instrument of raising needed funds.
Financial management refers to the efficient and effective management of money
(funds) in such a manner as to accomplish the objectives of the organization.
Financial system refers to a system that facilitates mobilization of fund from
surplus sector and channelization of funds to deficit sector and thereby carrying
decision of households, firms, government, and foreigners.
Components of financial system include:
• Financial institutions
• Financial markets
• Financial instruments, and
• Financial services

3. WHY ISLMIC BANKING.
Before explaining the concept “what
is Islamic Banking” the elaboration of
concept “why Islamic Banking” is
very important.
Islam is a complete code of life that
provides guidance regarding each
aspect of life.

4. WHY ISLAMIC BANKING
The primary objectives of Islamic Banking
System are as under.
Equal Distribution of wealth
Social justice
These objectives can never be achieved in
Interest/Riba based economic systems.

5. What is Islamic Banking?
Definition:
“an Islamic bank is a financial institution whose statutes, rules
and procedures expressly state its commitment to the
principle of Shariah and to the banning of the receipt and
payment of interest on any of its operation…” Organizations of
Islamic Cooperations (OIC)
Moreover, the Malaysian Islamic Banking Act 1983, defines an
Islamic bank as
“… a company which carries on Islamic business. Islamic
business means banking business whose aims and operations
do not involve any element which is not approved by the
religion of Islam…”
Thus, Islamic banking is banking that complies with Shari’ah or
Islamic law.

6. DIFFERENCE BETWEEN ISLAIC AND
CONVENTIOANL BANKING
Islamic Banking
1) Functions and
operations are
based on Sharia’h
principles
Conventional Banking
1)Functions and
operations are
based on fully man
made principles

7. DIFFERENCE BETWEEN ISLAIC AND
CONVENTIOANL BANKING
Islamic Banking
2) Promote risk-
sharing between
provider of capital
(investor) and user
of funds
(entrepreneurs)
Conventional Banking
2) Investor is
assured of pre-
determined rate of
interest

8. DIFFERENCE BETWEEN ISLAIC AND
CONVENTIOANL BANKING
Islamic Banking
3) Aim at
maximising profit
but subject to
Sharia'h
restrictions
Conventional Banking
3) Aim at
maximising profit
without any
restrictions

9. DIFFERENCE BETWEEN ISLAIC AND
CONVENTIOANL BANKING
Islamic Banking
4) Encourage
asset-based
financing and
based on
commodity trading
Conventional Banking
4) Based on money
trading. Money is a
medium of
exchange and not a
commodity, its sale
and purchase is
prohibited in Islam.

10. DIFFERENCE BETWEEN ISLAIC AND
CONVENTIOANL BANKING
Islamic Banking
5) No right of profit
if there is no risk
involved. The profit
and loss sharing
depositor may lose
money in case of
loss.
Conventional Banking
5) It is almost risk
free banking and
depositor has no
risk of losing its
money because
interest is
guaranteed.

11. Key 6 principles of Islamic banking
1. Prohibition of predetermined loan repayments as interest (riba)
2. Profit and loss sharing, which is at the heart of the Islamic
banking system
3. Making money out of money as being unacceptable, with all
financial transactions needing to be asset-backed
4. Prohibition of speculative behavior
5. Only Shariah approved contracts being acceptable
6. The sanctity of contracts
In the News: The Vatican says Islamic Banking May Help Western Banks in
Crisis
“The ethical principles on which Islamic banking is based may bring banks
closer to their clients and to the true spirit which should mark every financial
service,”.

12. Among the norms in Islamic Banking that we want to
elaborate on here are the following three topics:
• 1. The Prohibition of Riba (Interest or Usury) – Money is not
to be exchanged for money with profit. As a result of this
prohibition, alternative solutions are given which encourage
trade and equity participation.
• 2. The Prohibition of Gharar (Uncertainty) – This demands
transparency in contracts as well as in buying and selling.
Prices should be specified, there should be clarity of the
delivery details, quality of goods, quantity of goods etc. The
information should be available to all parties involved and the
outcomes of a contract should be free from ambiguity etc.
• 3. Sanctity of Contract – Contracts should be fair and agreed
upon by both parties. Therefore, the contract should be free
from the elements of Gharar and reach Shari’ah approval in
their content.

13. The performance of Islamic Banking
practices
• Islamic banking and finance is the fastest growing industry in
the financial world.
• It has been experiencing exponential growth in three regions
of the world namely the Middle East, South Asia and
Southeast Asia.
• Each nation appears to have its own opinion on how to
administer certain Islamic financial products. This is
hampering efforts for a globalized system of Islamic banks.

14. The performance of Islamic Banking
practices (cont)
• There are several reasons for these differences.
• The main reason is because the application of the
theoretical aspects of the Islamic banking system differs from
country to country, and under different economic conditions
and social environments.
• Another reason for the differences is due to the different
math-habs (Schools of religious Law). There are four main
math-habs, namely Hanafi, Shafi’i, Maliki and Hanbali. These
math-habs play an important role in developing Islamic
Jurisprudence in countries around the world.

15. An overview of financial system

16. A financial institution (FI) is a company engaged in the
business of dealing with monetary transactions, such
as deposits, loans, investments and currency exchange.
Types of financial institutions
1) Banks
 Central and commercial banks
 Islamic and conventional commercial banks
 Local and foreign commercial banks
 State owned and private owned commercial banks
 Other types of banks include: Specialized banks (banks
that are banking operations that serve a specific type of
economic activity, such as industrial activity or
agriculture),

17. Development banks (national or regional financial
institution designed to provide medium and long-term
capital for productive investment) ,
Investment banks (financial services company that act as an
intermediary in a large and complex financial
transactions. An investment bank is usually involved
when a startup company prepares for its launch of an
initial public offering and corporation merges with a
competitor),
Merchant banks (a bank dealing in commercial loans and
investment), and

18. Saving banks (financial institution whose primary
purpose is accepting saving deposits and paying interest
on those deposits. They were set up by governments or by
social committed groups to encourage low income people
to save money and have access to banking services).

19. 2) Non-bank financial institutions
 Mutual funds (company that pools the money from many
investors and invest the money in securities such as stocks,
bonds, and short term debt)
 Provident funds (investment pools institution that pay for
workers retirements it is called pension fund)
 Insurances
 Real estate financial institutions and Leasing companies
 Remittances
 Brokerage firms
 Micro-finance institutions

20. 2) Non-bank financial institutions (cont..)
 Credit unions and cooperative societies (a non-profit
making institution whose its members can barrow money
from pooled deposits at low interest rates), while
cooperative societies (association of persons united
voluntarily to meet their common economic, social and
cultural needs and aspirations through a jointly owned
enterprise)
 Factoring (is when company buys a debt or receivables
from another company), while and invoice discounting ( is
when a company sells unpaid invoices, against cash by
given in advance)
 Specialized institutions such as Hajj finance companies

21. A financial market is a market in which people trade
financial securities, commodities, and other fungible
items of value at low transaction costs and at prices that
reflect supply and demand. Securities include stocks and
bonds, and commodities include precious metals or
agricultural products.
Types of financial markets
 Money market
 Capital markets
 Other markets such as Derivatives, and Foreign exchange
markets

22. Financial instrument is a document that has a monetary value or represents
a legally enforceable (binding) agreement between two or more parties
regarding a right to payment of money. Financial instruments are monetary
contracts between parties. They can be created, traded, modified and
settled. They can be cash (currency), evidence of an ownership interest in
an entity (share), or a contractual right to receive or deliver cash (bond).
Types of financial instruments
1) Money market instruments
• Treasury bills (are short-term government securities traded on a yield basis.
They represent the short-term debt obligations of a country’s government.
Typical maturities of the treasury bills are three, six and twelve months.
Regular interest payments are not made as in the coupon bonds; interest is
paid by way of issuing at discount and redeeming at par)
• Treasury notes (is a marketable US government debt security with a fixed
interest rate and a maturity between one to 10 years)

23. Commercial papers (promissory note) ( are short-term, unsecured debt
instruments issued by corporations, maturing less than one year).
• Bankers’ acceptance (are short term, discount instruments issued by
companies. They are guaranteed by a bank and are therefore known as
BA).
• Certificate of deposit (is created from a bank deposit and represents a bank-
issued security that documents a deposit and specifies the interest rate and
maturity date)
• Repurchase agreement (repo or buybacks) ( are widely used transactions in
money markets and represents bilateral transactions encompassing the
purchase and resale securities by agreement)

24. 2)Capital market instruments
 Equity market
• Common shares
• Preferred shares
• Unit certificate ( non negotiable certificate issued by company)
• Call warrant (financial instrument that gives the holder the right to buy
underlying shares a specific price on or before a specific date)
 Debt market
• Corporate bond
• Treasury bond (government bond)
• Foreign bond
• Asset-backed securities
3) Derivative and foreign exchange market instruments
• Spot transaction
• Forwards contracts
• Futures contracts
• Option contracts
• Swaps

25. Financial services can be defined as the products and services offered by
institutions like banks of various kinds for the facilitation of various financial
transactions and other related activities in the world of finance like deposits,
loans, insurance, credit cards, investment opportunities and money
management.
Types of financial services
1) Deposits
 Demand deposits (checking accounts, wadiah)
 Time deposits (saving account, mudarabah time deposits)
 Recurring deposits (is a special kind of term deposit offered by banks
which help people with a regular incomes to deposit a fixed amount every

26. 2) Loans
 Short-term, medium-term, and long-term loans (Demand or term loan)
 Cash credit (a short-tem source financing for a company. It enables a company to
withdraw money from a bank account without keeping a credit balance)
 Overdraft/ cashline
 Bills purchased/discounted
 Credit cards
3) Other financial services include: Investments, ATMs, online banking, credit/debit
cards, wire-transfer, Leasing, hire purchase, factoring, issue management, merchant
banking, stock broking, credit rating, auditing, corporate counseling, debt and
capital restructuring, pension funds, mutual funds, insurance and takaful,
underwriting, credit unions, and financing low income societies.

27. • Thank You
• Any Questions?