Islamic banking system

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GOVERNMENT COLLEGE OF SCIENCE WAHDAT ROAD LAHORE

Islamic Banking System
Islamic banking refers to a system of banking or banking activity which is consistent with Shariah
(Islamic Law). The Shariah prohibits payment and collection of Interest (Riba).
Definition of Islamic Banking:
“An Islamic bank is a financial institution whose status, rules and procedures
expressly state its commitment to the principle of Islamic Shariah and to the
banning of the receipt and payment of (Riba) on any of its operations”.
Riba means excess, increase or addition and implies any excess compensation without due
consideration. In other words, when money begets money, without exchange for goods and
services it is called Riba.
What is Islamic Banking? (Historical Approach)
Islamic banking refers to a system of banking or banking activity that is consistent with the
principles of the Shari'ah (Islamic rulings) and its practical application through the development
of Islamic economics. The principles which emphasise moral and ethical values in all dealings
have wide universal appeal. Shari'ah prohibits the payment or acceptance of interest charges
(riba) for the lending and accepting of money, as well as carrying out trade and other activities
that provide goods or services considered contrary to its principles. While these principles were
used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that
a number of Islamic banks were formed to provide an alternative basis to Muslims although
Islamic banking is not restricted to Muslims.
Islamic banking has the same purpose
as conventional banking except that it operates in accordance with the rules of Shari’ah, known
as Fiqh al-Muamalat(Islamic rules on transactions). Islamic banking activities must be practiced
consistent with the Shari’ah and its practical application through the development of Islamic
economics. Many of these principles upon which Islamic banking is based are commonly
accepted all over the world, for centuries rather than decades. These principles are not new but
arguably, their original state has been altered over the centuries.
The principle source of the Shari’ah is The Qur’an followed by
the recorded sayings and actions of Prophet Muhammad (pbuh) – the Hadith. Where solutions
to problems cannot be found in these two sources, rulings are made based on the consensus of
a community leaned scholars, independent reasoning of an Islamic scholar and custom, so long
as such rulings to not deviate from the fundamental teachings in The Qur’an.

It is evident that Islamic finance was practiced predominantly in the Muslim world throughout
the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and
Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is
claimed that many concepts, techniques, and instruments of Islamic finance were later adopted
by European financiers and businessmen.
The revival of Islamic banking coincided with the world-wide celebration of the advent of the
15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims
particularly those of the oil producing countries, received a boost due to rationalization of the oil
prices, which had hitherto been under the control of foreign oil Corporations. These events led
Muslims' to strive to model their lives in accordance with the ethics and principles of Islam.
Disenchantment with the value neutral capitalist and socialist financial systems led not only
Muslims but also others to look for ethical values in their financial dealings and in the West some
financial organizations have opted for ethical operations.
Recent Attempts at establishment of Islamic Banking
 The Dubai Islamic Bank of U.A.E in 1975
 Islamic Bank/Investment Company was established in Bahamas in 1977.
 Dar-al-Mal-Islami (DMI), based in Geneva, was established in 1981.
 Islami Bank Bangladesh Limited (IBBL) in 1983.
 Al-Rajhi Banking Investment Corporation of Saudi Arabia in 1985.
 Al-Arafa Islami Bank Bangladesh limited in 1995.
 Meezan bank Limited of Pakistan in 2002.
Objectives of Islamic Banking:
The primary objectives of an Islamic Bank should be:
 To offer modern financial services in compliance with Shariah.
 To contribute towards economic development of the country within the ideology if Islamic
justice.
 Best Possible allocation of limited Financial Resources
 To Help ensure equitable distribution of wealth.

Islamic Modes of Financing
Trade Related Modes of Financing:
 Bai-Muajjal (Mark up Financing)
 Leasing(Ijara)
 Hire Purchase (Ijara-wa-iqtina)
 Buy-back agreement
 Investment Auctioning
 Development Financing
Bai' Muajjal: (Mark up Financing)
This is a deferred payment sale. A sale in which the parties agree that the payment price shall be
deferred is called a Bai Muajjal. The deferred price maybe more than the cash price, but it must
be fixed at the time of sale. Under this the customer enters in an agreement with the bank
whreby the bank finances the purchase of goods and machinery.
Leasing: (Ijara)
The Islamic word used for leasing is “Ijara”. The lessor is called “Ajir” and the lessee is called
“Mustageer”. In simple words leasing is a contract whereby the lessee uses an asset which is
owned by the lessor. The ownership remain with the lessor and lessee pays monthly or annual
rental for the use of an asset.
Islamic Modes of Financing
Trade Related Modes
of Financing
Investment Related
Modes of Financing

Hire Purchase: (Ijara-wa-iqtina)
Under hire purchase system, thee bank purchases the required good like equipment, building
and other assets at the request of the client . After the bank deliver those goods to the client
against an agreed rental together with an independent undertaking by the bank or the client that
the ownership of the asset should be transferred to the clients after the completion of the leasing
contract.
Buy-back Agreement :
This mode of financing is to satisfy both short term and long term needs of finance of a client.
The client who is in need of cash sells an immovable or movable property to one bank. The makes
wholly payment in cash. Afterwards the client buys back the same property at a higher price in
future. The client pays for the property either in cash or in installements.
Investment Auctioning:
Under this bank join hands with other financial institutions to form a consortium. This consortium
then works on an industrial project. Afterwards the consortium, places the project for auction.
Bids are invited from bidders and project is sold to highest bidder.
Development Financing:
Under this the bank makes the advances to the client for the development of land or property.
As a result of this the property appreciates in the value. The bank then shares this increase in the
value with the client. This share is called development charges.
Trade Related Modes of Financing:
 Mudarbah
 Murabaha
 Musharkah
 Musawamah
Mudarabah
The Mudarabah (Profit Sharing) is a contract, with ONE party providing 100 percent of the capital
and the other party providing its specialized knowledge to invest the capital and manage the
investment project. Profits generated are shared between the parties according to a pre-agreed
ratio. If there is a loss, the first partner "rabb-ul-mal" will lose his capital, and the other party
"mudarib" will lose the time and effort invested in the project the profit is usually shared 50%-
50% or 60%-40% for rabb-ul-mal.
Murabaḥa:

Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the
seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a
financing technique, it involves a request by the client to the bank to purchase certain goods for
him. The bank does that for a definite profit over the cost, The profit in Murahaba can be
determined by mutual consent.
Musawamah
Musawamah is the negotiation of a selling price between two parties without reference by the
seller to either costs or asking price. While the seller may or may not have full knowledge of the
cost of the item being negotiated, they are under no obligation to reveal these costs as part of
the negotiation process. This difference in obligation by the seller is the key distinction between
Murabahah and Musawamah with all other rules as described in Murabahah remaining the same.
Musawamah is the most common type of trading negotiation seen in Islamic commerce.
Other Islamic Services
Hibah (gift)
This is a token given voluntarily by a debtor in return for a loan. Hibah usually arises in practice
when Islamic banks voluntarily pay their customers a 'gift' on savings account balances,
representing a portion of the profit made by using those savings account balances in other
activities.
It is important to note that while it appears similar to interest, and may, in effect, have the same
outcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot
be 'guaranteed'(akin to Dividends earned by Shares, however it is not time bound but is at the
bank's discretion). However, the opportunity of receiving high.
Istisna
Istisna (Manufacturing Finance) is a process where payments are made in stages to facilitate step
wise progress in the Manufacturing / processing / construction works. Istisna enables any
construction company get finance to construct slabs / sections of a building by availing finances
in installments for each slab.
Qard hassan/ Qardul hassan (good loan/benevolent loan)
Qard hassan is a loan extended on a goodwill basis, with the debtor only required to repay the
amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount
beyond the principal amount of the loan (without promising it) as a token of appreciation to the
creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction
is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not
violate the prohibition on 'riba, for it alone is a loan that truly does not compensate the creditor
for the time value of money.

Sukuk (Islamic bonds)
Sukuk is the Arabic name for financial certificates that are the Islamic equivalent of bonds.
However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are
securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit
the charging or paying of interest. Financial assets that comply with the Islamic law can be
classified in accordance with their tradability and non-tradability in the secondary markets.
Takaful (Islamic insurance)
Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due
to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual
may cease to be uncertain with respect to a very large number of similar individuals. Insurance
by combining the risks of many people enables each individual to enjoy the advantage provided
by the law of large numbers.
Wadiah (safekeeping)
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the
bank and the bank guarantees refund of the entire amount of the deposit, or any part of the
outstanding amount, when the depositor demands it. The depositor, at the bank's discretion,
may be rewarded with Hibah (see above) as a form of appreciation for the use of funds by the
bank.
Wakalah (power of attorney)
This occurs when a person appoints a representative to undertake transactions on his/her behalf,
similar to a power of attorney. Literally Wakalah means protection or remedying on behalf of
others. Legally Wakalah refers to a contract where a person authorizes another to do a certain
well-defined legal action on his behalf.

Pakistan and Islamic Banking
Pakistan was created on the basis of two nation theory. The ultimate desire was to have a
homeland where Muslims could lead their lives according to the eternal and shinning teachings
of Islam. “The Muslims shall be order their lives in the individual and collective sphere in
accordance with the teachings and requirements of Islam as set out in Holy Quran and Sunnah.”
In his speech at the occasion of the inauguration of State Bank of
Pakistan (SBP), Quaid-e-Azam had expressed the desire for evolving an Islamic System of
Banking. The Objective resolution of 1949 further highlighted this matter in a definite way.
By this resolution and other terms of principles of policies of the Constitution it was made
obligatory on the state authorities to devise such an economic and fiscal system which is
characterized by interest free banking.
Constitution of Islamic Republic of Pakistan, 1973 in Article 38(f) Provide that:
“The State Shall… Eliminate Riba as early as possible”
SBP Section related to Islamic Economy:
The first governor of SBP Mr. Zahid Hussain was very keen to
develop a sound and effective modern Islamic banking system. In 1959 the SBP established
Islamic Economic section within the Research Department. This section progressed very quickly
and soon attained the status of fully equipped Division of the bank

Major Islamic Banks in Pakistan
1. Meezan Bank
2. Al Baraka Islamic bank
3. Bank Islami
4. Dubai Islamic Bank
5. Burj Bank
6. Bank Alfalah
7. Askari bank Limited(Islamic Banking branches)
8. Habib Bank Limited (Islamic Banking branches)
9. Bank Al Habib Limited(Islamic Banking branches)
Meezan Bank
Meezan Bank Limited, a publicly listed company, is the first and largest Islamic Bank in
Pakistan and one of the fastest growing banks in the history of the banking sector of the Country.
Having the largest branch network and product range, Meezan Bank bears the critical
responsibility of leading the way forward in establishing a stable and dynamic Islamic banking
system replete with dynamic and cutting-edge products and services. Meezan Bank aims to fulfil
its prime objective of providing customers accessibility and convenience, within an atmosphere
and culture of dedicated service and recognition of their needs.
Meezan Bank has developed an extraordinary research and development capability by combining
investment bankers, commercial bankers, Shariah scholars and legal experts to develop
innovative, viable, and competitive value propositions that not only meet the requirements of
today’s complex financial world, but do so with world-class service excellence which our
customers demand; all within the bounds of Shariah.
The Meezan bank is currently providing following banking products and services.
 Personal Finance
 Car Financing Car Ijara
 Home Financing
 Corporate Finance

 Asset Management
 Commercial Finance
Pakistan’s first Shariah complaint Mortgage facility was launched by Meezan bank duly approved
by the Shariah Supervisory Board. This Product enables home purchase , home construction,
renovation as well as replacement of any existing mortgage.
Al Baraka Islamic bank
Al Baraka Islamic bank provides it world class services and the products to its customers globally.
With a vision to provide its services according to the Islamic principles its networks are increasing
globally. It has been formed as a merger of the Al Baraka Islamic bank Pakistan, Emirates
Global Islamic Bank Pakistan and the operations of Al Baraka Islamic Bank Bahrain. It’s started
operating globally as on November 1st 2010. It provides a wide range of Islamic financing which
includes Murahaba, Ijarah, Musharakha, and Islamic Export Refinance. It also provides various
deposit schemes according to the basic principles of Islamic banking.
The bank is currently providing following banking products and services.
 Islamic Deposit Accounts
 Auto Ijara
 Rahnuma Travel Services
 Sarparast Family Plan
 Corporate and investment banking
Bank Islami
Bank Islami is the Pakistan’s leading authentic Islamic financial institution. Its products and
services include the consumer banking, retail banking, corporate banking under which it ensures
its customers to provide timely and friendly services. It lends finance to its customers under
MUSKUN home financing, Islamic auto Ijarah new vehicle, Islami auto Ijarah used or imported
vehicles. While it also provides Islamic current account, Islami foreign currency account, Islami
dollar bachat account Islami manaha munafa account and Islami sahulat account.
 Consumer Banking
 Retail Banking
 Bank Islami Takaful

 Corporate Banking
 Investment Banking
 Home Remittances
Dubai Islamic Bank
Dubai Islamic bank is one of the leading financial institutes of the country. It provides Islamic
banking not only to Pakistan but to the whole world. It has its core ethics including morality,
equity, transparency and the diversity. It is one of the fastest growing institutes with its 400
institutions managing a total assists of US $ 1 trillion globally.
 Consumer Finance
 Takaful
 Remittances
Burj Bank
Burj Bank which was formerly known as Dawood Islamic bank is operating in Pakistan with its
highly professional team in order to make its customers well satisfies. Its core ethics includes
Purity, integrity, passion, and devotion. Burj bank services are purely based on Islamic principles.
 Banca Takaful
 Burj carcaaz
 Home Musharka
 Corporate Financing
 SME Financing
Bank Alfalah
Bank Alfalah Islamic banking was established within Bank Alfalah Limited as late as in 2003, which
offers its customers products that are in accordance with the Shariah compliant. This bank invests

in customers believes by introducing Islamic financial solutions, and by fulfilling the promise they
made. Its team consists of highly qualified professional team who is responsible for designing
Islamic financial solutions and ensures that these are in accordance with the Shariah principles
of Islamic banking and finance. Moreover these services areapproved by the Shariah Adviser
at the bank.
 Consumer Finance
 Takaful
 Remittances
 Corporate Financing
 SME Financing
Askari Bank Limited
Askari bank limited also provides its services according to the Shariah complaint; it opens its doors for the Halal
Banking Solutions. It provides economic justice and enhances welfare of society in the accordance with the
Shariah standards. It operates in 32 branches across Pakistan. The Islamic bank services and the products at the
bank are approved by the Shariah advisor at the bank and the Shariah based products of Islamic banking are
managed separately from the conventional banking side. All the transactions under the Islamic banking head
are invested in Halal modes and investments.
 Ijara Bi Sayyarah
 Home Musharkah
 Islamic Deposit Products
 Islamic Financing Products
Habib Bank Limited
While operating since 1947, Habib Bank has total branches of the 1500 across country which is providing its
best services with the help of its highly professional team and advanced technology. Earlier it was a public

sector bank however later in 2004 it was privatized through which Aga Khan Fund for Economic Development
acquired its 51% shares. HBL offers a host of Shariah compliant services to the clients. The bank is dedicated to
serve its customers according to their needs in accordance with the law of Islamic banking. The products and
services provided by the bank are licensed by the State bank of Pakistan and which are fit to meet the
requirement of any customer.
 HBL Murahaba
 HBL Diminishing Musharaka
 HBL Ijara
Bank Al Habib Limited
Bank Al Habib Limited is on of the well established banks in Pakistan, which has been approved by the state
bank of Pakistan to undertake Islamic banking through its Islamic banking branches. It provides deposit
schemes and Islamic financing to individuals, trader, industries, which are completely in accordance with the
Shariah compliant. These services and the documentation of the Shariah compliant are run by a Shariah advisor
who is responsible for regular monitoring of deposits and financing to ensure the operations are in compatible
with the Shariah.
 Murabaha Finance.
 Ijarah Finance (Leasing).
 Diminishing Musharakah Finance.
 Istisna Finance.

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