This document provides an overview of Islamic banking and finance. It begins with defining key concepts in financial systems such as money, credit, and finance. It then describes the structure of Malaysia's financial system and the roles of banks as financial intermediaries. The document outlines the goals and objectives of Islamic banking, and highlights key differences from conventional banking such as the prohibition of riba and emphasis on risk sharing. Some advantages of Islamic banking discussed are justice and fairness, liquidity, and no fixed obligations. The document concludes with challenges facing Islamic banking such as misconceptions, the need for skilled talents, and rising costs for small Islamic banks.

1. ISLAMIC
BANKING AND
FINANCE
Mahyuddin Khalid
emkay@salam.uitm.edu.my
OVERVIEW OF FINANCIAL SYSTEM

2. CONTENT
 OVERVIEW OF FINANCIAL SYSTEM
 FINANCIAL SYSTEM STRUCTURE IN
MALAYSIA
 BANKS AS FINANCIAL INTERMEDIARIES
 ISLAMIC BANKING
 GOALS AND OBJECTIVES OF ISLAMIC
BANKING
 DIFFERENCES BETWEEN ISLAMIC
BANKING AND CONVENTIONAL BANKING
SYSTEM
 ADVANTAGES OF ISLAMIC BANKING
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3. FINANCIAL SYSTEM
 Concept of Financial System
 The collection of accounting processes and
procedures that allow a business to keep
accurate financial records, monitor
accounts, prevent fraud and mistakes, and catch
any discrepancies.
 A financial system allows a company to maintain
accountability for expenditures and
revenues, and to control their finances to
minimize waste and loss.
 A financial system is concerned about
money, credit and finance.
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4. FINANCIAL SYSTEM
 Concept of Money
 Money is anything generally accepted as a means of
paying for goods and services and a measure of value.
 Functions of Money :
 Medium of exchange
 Measure of value
 Temporary store of value
 Concept of Credit/Loan
 An arrangement in which a lender gives money or
property to a borrower, and the borrower agrees to return
the property or repay the money, usually along with
interest, at some future point(s) in time.
 There is a predetermined time for repaying a loan, and
generally the lender has to bear the risk that the borrower
may not repay a loan (though modern capital markets
have developed many ways of managing this risk).
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5. FINANCIAL SYSTEM
 Concept of Finance
 Finance is the procurement (to get, obtain) of
funds and effective (properly planned) utilization
of funds.
 It also deals with profits that adequately
compensate for the cost and risks borne by the
business.
 Finance deals with matters related to money and
the markets.
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6. FINANCIAL SYSTEM STRUCTURE IN
MALAYSIA
Financial Institutions Financial Markets
a) Banking System
 BNM
 Banking Institutions :
- Commercial banks include Islamic banks
- Finance Companies
- Merchant Banks
 Others:
- Discount Houses
- Representatives Offices of Foreign Banks
- Offshore Banks in Labuan IOFC
b) Non-Bank Financial Intermediaries :
• Provident & Pension Funds
• Insurance companies include Takaful
• Saving institutions
• Others:
- Unit Trusts – Pilgrims Fund Board –
Housing Credit Institutions – Cagamas
Berhad –Credit Guarantee Corporation –
Leasing Companies –Factoring Companies
–Venture Capital Companies.
a) Money & Foreign Exchange Markets :
• Money Market
• Foreign Exchange Market
b) Capital Markets:
• Equity markets
• Bond Markets –Public Debt Securities –
Private Debt Securities
c) Derivatives Markets:
• Commodity Futures
• KLSE CI Futures
• KLIBOR Futures
d) Offshore Markets:
• Labuan International Offshore Financial
Centre (IOFC)
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7. BANKS AS FINANCIAL
INTERMEDIARIES
 Financial intermediaries is an entity that acts as the
middleman between two parties in a financial
transaction.
 Financial intermediaries encompass a wide range of
entities in terms of size and scale of operation
ranging from a banks, broker-dealers, investment
advisers and financial planners.
 Roles of banks as financial intermediaries:
1. Promote savings and capital accumulation to finance
projects using various modes of financing.
2. Finance international trade.
3. Mobilize resources for investments for the benefit of
society.
4. Contribute social welfare through Corporate Social
Responsibilities (CSR) and zakat.
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8. PRINCIPLES GOVERNING OF ISLAMIC
BANKING
Islam
Aqidah
(Faith and Belief)
Shariah
(Practices and
Activities)
Ibadat Muamalat
Political
Activities
Economic
Activities
Banking &
Financial
Activities
Social Activities
Akhlak
(Moralities and
Ethics)

9. ISLAMIC BANKING
 Islamic banking is defined as banking system which
is in consonance with the spirit, ethos and value
system of Islam and governed by the principles laid
down by Islamic Shariah.
 Islamic Banking according to Islamic Banking Act
1983:
 “..a company which carries on Islamic banking business
means banking business whose aims and operation do
not involve any element which is not approved by the
religion of Islam…”
 Islamic banking, the more general term, is based not
only to avoid interest-based transactions prohibited
in Islamic Shariah but also to avoid unethical and un-
social practices.
 In practical sense, Islamic Banking is the
transformation of conventional money lending into
transactions based on tangible assets and real
9

10. ISLAMIC BANKING IN MALAYSIA
 The first Islamic bank was established in
Malaysia in 1983 through Bank Islam
Malaysia Berhad.
 Later in March 1993, Bank Negara Malaysia
(BNM) introduced Interest Free Banking
Scheme (now replaced with Islamic banking
scheme (IBS).
 The scheme allowed conventional banking
institutions to offer Islamic banking products
and services using their existing
infrastructure, including staff and branches
10

11. SALIENT FEATURES OF ISLAMIC
BANKING
Main
concern
Ensuring
justice and
equity in
economy
PLS are
major
features
Prohibition
of riba
Financial
transaction

12. PHILOSOPHICAL FOUNDATIONS OF ISLAMIC
BANKING
Huriyyah
Tazkiyah
Al-’adalah
Amanah
Khilafah
Tawhid
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13. 13
GOALS AND OBJECTIVES OF ISLAMIC
BANKING
• The thrust is towards financing on risk- sharing and strict focus
on halal activities
• Focus on offering banking transactions adhering to Shariah
principle and avoiding conventional interest- based banking
transactions.
Offer Financial Services
• Established a direct and close relationship between the bank’s
return on investment and the successful operation of the
business by the entrepreneur.
Economic Development
• Considered to be most profitable, religiously permissible and are
beneficial to the economy.
Optimum Resources Allocation

14. GOALS AND OBJECTIVES OF ISLAMIC
BANKING
• Profit- sharing principle encourages banks to go for projects with long-
term gains instead of short- term gains.
• Banks conduct proper studies before getting into projects. High returns
distributed to shareholder maximize the social benefits and bring
prosperity to the economy.
Optimum Approach
• Ensures equitable distribution of income and resources among the
participation parties, with its profit- sharing approach which is one of a
kind.
Equitable Distribution of Resources
• Islam recognize money as a means of exchange and not as a
commodity.
• Riba- free system leads to stability in the value of money to enable the
medium of exchange.
Facilitate Stability in Money Value
14

15. PRINCIPLES OF ISLAMIC BANKING
 Islamic banking is the conduct of banking
based on SHARIAH principle, subject to
among others:
1. Prohibition of Riba
 Riba is strictly prohibited under Islam and is
considered as haram.
 Islam allows only one kind of loan that is Qardhul
Hassan.
2. Equity participation
 Islam encourages Muslims invest their money and
become partners in order to share profits and risk in
the business instead of becoming creditors.
 In Islam, financing is based on the belief that the
financier and borrower should equally share the risks
of the business venture.
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16. PRINCIPLES OF ISLAMIC BANKING
3. Prohibition of gharar
 Gharar means to undertake a venture blindly without
sufficient knowledge or to undertake excessively
transactions
 An Islamic financial system discourages hoarding and
prohibits transactions featuring extreme gharar.
4. Contractual relationship
 Depends upon the nature of transaction.
 It could be a seller and buyer relationship (Murabaha), a
lessor- lessee relationship (Ijarah), and a partnership
(Musyaraka)
5. Money as Potential Capital
 It is way of defining the value of a thing.
 Should not be allowed to give rise to more money, via
fixed interest payments, simply by being put in a bank or
when lent to someone.
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17. Islamic Banking System Characteristic
s
Conventional Banking
System
•Functions and operating
modes are based on
Shariah law.
•Banks have to ensure that
all business activities are in
compliance with Shariah
requirements.
Business
Framework
•Functions and operating
modes are based on
secular principles and not
based on any religious law
or guidelines.
•Each bank should have a
Shariah Supervisory Board
to ensure that all business
activities are in line with
Shariah requirements.
Shariah
Supervisory
Board
•There is no such
requirement necessary.
DIFFERENCES BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM
17

18. COMPARISON BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM
Islamic Banking System Characteristic
s
Conventional Banking
Promotes risk sharing
between investor and the
bank & the bank and the
entrepreneur : pre-agreed
proportion
Risk sharing Predetermined rate of
interest
Under PLS-return only if
there is a profit
-more concern with
soundness of the project
and managerial
competence of the
entrepreneur.
Emphasis to
product
Credit worthiness
All economic agents have
to work within the Islamic
moral value.
Moral
Dimension
Little attention to the moral
implications of the
activities

19. Islamic Banking System Characteristic
s
Conventional Banking
System
• Financing is not interest –
oriented
• Based on the principle of
buying and selling of assets,
whereby the selling price
include a profit margin
• Fixed from the beginning.
Prohibition of
Riba in
Financing
• Financing is interest –
oriented
• A fixed/floating interest is
charged for the use of
money.
•Islamic banks are restricted
to participate in economic
activities, which are not
Shariah-compliant.
Restrictions •There are no such
restrictions.
Pay zakat as a religious
obligation and tax required
by the government
Zakat
(Religious
Tax)
Don’t pay zakat but only
pay tax as required by the
government
COMPARISON BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM
19

20. 20
ADVANTAGES OF ISLAMIC
BANKING
• The main feature of the Islamic model is that it is based
on a profit-sharing principle, whereby the risk is shared
by the bank and the customer.
• This system of financial intermediation will contribute to
a more equitable distribution of income and wealth.
Justice and Fairness
• Follow the profit and loss-sharing principle to mobilize
resources and are less likely to face any sudden run
on deposits.
• As such, they have a minimum need for maintaining
high liquidity.
Liquidity

21. ADVANTAGES OF ISLAMIC
BANKING
• Financing and deposits are extended under the profit and
loss sharing arrangement. The banks are likely to know their
fund users better in order to ensure that the funds are used
for productive purpose and vice-versa for investors.
• It will develops better relations between the financial
intermediary and the fund providers or consumers.
Better Customer Relations
• Islamic banks do not have fixed obligations such as interest
payments on deposits. Therefore, they are able to allocate
resources to profitable and economically desirable activities.
• Also holds good for Islamic financing, as the payment
obligations of the entrepreneur is associated with the
revenue.
No Fixed Obligations
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22. ADVANTAGES OF ISLAMIC
BANKING
• Transparent to the account holders on the investments made in
different areas and the profits realized from these investments.
The profit is then shared in the pre-agreed ratio.
Transparency
• Strong ethical and moral dimensions of doing business and
selecting business activities to be financed, play an important
role in promoting socially desirable investments and better
individual or corporate behavior.
Ethical and Moral Dimensions
• Although based on Shariah principles to meet the financial
needs of Muslims, it is not restricted to Muslim only and is
available to non-Muslims as well.
Banking for All
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23. CHALLENGES OF ISLAMIC
BANKING
 Misconception about Islamic banking
 Many still has a wrong understanding or
misconception against Islamic Banking which among
the thoughts are:
 Islamic Banking is only for Muslims
 Islamic Banking is not profitable because no interest is
charged
 Islamic Bank is a charitable organization
 Thus better awareness shall be create among the
customers that Islamic Banking is not only an
alternative financial approach but also in some
aspects provides better value propositions to the
consumers.
 Divergence of opinions
 Shariah interpretation versus business practicability/
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24. CHALLENGES OF ISLAMIC
BANKING
 Moving towards equity based financing (Musharakah/
Mudharabah) financing?
 Commercial banks requires a new set of technical and risk
management capabilities i.e. industry experts and know-how
 Market readiness – profit sharing, trade secrets, bank as strategic
business partners (potential conflicting interest).
 Balance sheet size, risk appetite and underwriting capabilities
 Supervisory and prudential regulatory framework.
 Accounting and auditing standards.
 War of talents
 Global shortage of Islamic finance talents at almost all levels
 Inadequate pool of Shariah scholars with the right combination of
knowledge in Shariah and modern finance
 Rising Cost for Small Islamic Banks
 Ballooning operating costs for Islamic banks as opposed to relative
cost stability for the overall banking system - expenditure on IT
infrastructure, expenses for R&D and product innovation and network
expansion and new delivery channels
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25. END OF CHAPTER25