Islamic banking operates according to Shariah principles and uses different financial instruments than conventional banking. An Islamic bank acts as an intermediary between surplus and deficit financial units by channeling funds using equity-based and debt-based instruments. As an efficient intermediary, an Islamic bank offers competitive money and capital markets, reduces information and transaction costs, and protects customers from risks through a stable payment system and risk management products. The balance sheet of an Islamic bank includes various financing instruments like trade, home, and auto financing as assets, and investment accounts and capital as liabilities.

1. ISLAMIC
BANKING
OPERATIONS
&
INSTRUMENTS
TOPIC 5

2. ROLE OF ISLAMIC BANK AS AN
EFFICIENT FINANCIAL
INTERMEDIARY
– Financial intermediaries: Channeling funds from the SFUs to the DFUs
where predominantly thru fin. intermediaries:-
– Fin intermediaries: Islamic banks, takaful companies, finance
companies;
– SFUs: spending than what they presently earn;
– DFUs: spending than what they presently own.
– Primary functions of a bank as an intermediary:-
1. Transform assets;
2. Conduct orderly payments;
3. Transform risks.

3. EFFICIENT FINANCIAL
INTERMEDIATION FUNCTIONS
Functions of an
Efficient Financial
Intermediary
To offer competent &
solid money and
capital market
To help in the
reduction of
information &
provisional costs
To be founded upon an
established & secured
payment system
To have a well
developed market for
risk trading to protect
economics agents from
event risks & financial
risks

4. Continue
ISLAMIC CONVENIONAL
Nature of operations &
activities
Shari’ah principles & rulings
Financial regulators
Financial regulators
Contractual relationship Partnership relationship
(profit & loss sharing)
Lender – borrower relationship
(interest-based financing)
Mobilization & use of
funds
1. Equity-based financial
instruments; and
2. Debt-based financial
instruments.
Debt financial instruments
Underlying contracts 1. Exchanged based contracts;
2. Partnership contracts;
3. Security contracts;
4. Agency contracts;
5. Gratuitous contracts;
6. Other supporting contracts
Interest-based contracts

5. BALANCE SHEET OF AN
ISLAMIC BANK
ASSETS LIABILITIES
Trade Financing Demand Deposits
Salam Investment Accounts
Murabahah Special Investment Accounts
Ijarah/ Istisna’ EQUITIES
Mudarabah Capital
Musyarakah Reserves
Services (Ju’alah, Wakalah, Kafalah)

6. Acceptance of Funds Application of funds
SOURCES & USES OF FUNDS OF AN ISLAMIC BANK
• Islamic Deposits Account
• Principal guaranteed (up to
RM250k per depositor for each
banking institution)
• Flexi fund withdrawal
• E.g: Savings, current, term.
• Investment Account
• Return: based on underlying asset
performance
• Maturity & withdrawal: upon pre-
agreed conditions.
• 2 types: Restricted & unrestricted
• Home Financing
• Car Financing
• Personal Financing
• Corporate Financing

7. ISLAMIC VS CONVENTIONAL
DEPOSIT
Islamic Deposit Conventional Deposit
The principal amount is fully guaranteed
(except mudarabah).
Principal + interest are guaranteed &
predetermined.
No interest.
Hibah is offered/ given upon bank’s
discretion (unconditional/ promised upfront)
Interest is fixed at predetermined rate.
Interest is subject to change.
Bank cannot offer any kind of incentives
when it’s structured based on wadiah or
qard.
Bank can offer incentives to attract
depositors.
Accepted deposit will be in the hand of the
bank’s management expertise and skills.
Deposit is a debt/ loan to the bank by
customers.

8. Continue
SAVINGS DEPOSIT CURRENT DEPOSIT TERM DEPOSIT INVESTMENT DEPOSIT
Definition Safe keeping of cash
where -same-
A type of arrangement
where customer’s
deposits are held at a
Bank for a fixed term
A profit/ loss account or an
investment account.
Features Deposits & withdraws
of money at any time -same-
Withdrawal only to be
made at the end of the
term/ predetermined
number of days as notice
Account holders earn more
attractive returns although
there is a risk to bear capital
losses.
Form of
materials
1. Saving book; Bank
statement
2. ATM card
1. Cheque book - Certificate
Underlying
contracts
1. Qard (benevelont
loan);
2. Wadi’ah yad
dhamanah; and
3. Mudarabah
-same-
1. Mudarabah
2. Commodity
murabahah
1. Mudarabah (RIA)
2. Wakalah bi istithmar

9. INVESTMENT FUNDS
Restricted Investment Account Unrestricted Investment Account
Funds are invested into specific assets
according to the investment mandate set by
the customers.
Customers rely on bank’s expertise to
determine a broad investment mandate.
Requires matching between investment
tenure & maturity of the underlying assets.
Bank may combine investment account fund
belong to many customers with similar risk
profiles within a single pool or multiple
URIA pools to be invested in a group of
assets.
Customers are subject to specific
withdrawal conditions agreed upon
inceptions.
Customers are subject to more flexible
withdrawal conditions.

10. Mudarabah Investment Account

11. USES OF FUNDS
1.0 RETAIL FINANCING
• Home Financing
• Automobile Financing
• Personal Financing
• Credit Card
2.0 CORPORATE
FINANCING
• Term Financing
• Working Capital
• Trade

12. 1.0 RETAIL FINANCING
1.1Home Financing

13. Common Models & Structures
1. Bay Bithaman Ajil (BBA) Home Financing
2. Tawarruq Home Financing
3. Musyarakah Mutanaqisah Home Financing
4. Parellel Istisna’ Home Financing

14. BBA Home Financing
– The most common used (Malaysia & Brunei) based on the
concept of deferred payment sale.
– The principal amount, tenure and profit rate determines the
“sale price” and the profit earned by the lender. Like
Conventional financing, payments are deferred over
installments.
– The loan contract for BBA Islamic Financing is known as a
Sale and Buy-Back Agreement.

15. Benefits of BBA Islamic
Financing
– For floating profit rates, profit rates are capped at a maximum.
Conventional floating interest rates have no such cap.
– Late settlement of loans can incur lower charges than Conventional
loans as there is no concept of compounding interest calculation.
However, in practice, other fees and charges may apply that could
offset this benefit.

16. BBA HOME FINANCING STRUCTURE
2. Customer approaches the Bank to finance
the remaining balance. This is done when
the customer sells the house to the Bank at
the financing amount (FA)
4. The Bank then sells the house to the
customer at a marked-up price.
3. Bank pays the
remaining
amount (90%) to
the developer.
1. Customer identifies the
house he wants to buy. He only
enter into a S&P agreement
with the developer and pays
deposit of 10% (Customer is
deemed to have beneficial
ownership of the house).
5. The customer will pay the sale price on an
instalment basis.

17. TAWARRUQ HOME
FINANCING
– Commonly used by Islamic banks as a mode of
financing to facilitate cash transactions.
– The concept still remains controversial since it is
deemed similar to bay al-inah to avoid riba’.
– Refer to text book (page: 334) for home financing
mechanism description.

18. No Local Islamic Banks Contract
1 Affin Islamic Bank Berhad 1. Musyarakah Mutanaqisah
2. Tawarruq
2 Alliance Islamic Bank Bhd BBA
3 AmBank Islamic Bhd Tawarruq
4 Bank Islam (M) Bhd Tawarruq
-Payment Holiday
5 Bank Muamalat (M) Bhd Tawarruq
6 CIMB Islamic Bank Bhd Tawarruq
- Many types
7 Hong Leong Islamic Bank Bhd Tawarruq
8 MBSB Bank Bhd Tawarruq
- Many types
9 Maybank Islamic Bhd Tawarruq
10 Public Islamic Bank Bhd 1. Musyarakah Mutanaqisah
2. Ijarah Mawsufah Fi Al-Zimmah Asset Acquisition Financing-i
A forward lease contract (for property under construction) ending with
ownership by way of gift/sale.
3. BBA
11 RHB Islamic Bank Bhd Musyarakah Mutanaqisah

19. No Foreign Islamic Banks Contract
1 Al-Rajhi Banking & Corporations
(M) Bhd
Tawarruq
3 types
2 HSBC Amanah (M) Bhd Musyarakah Mutanaqisah
3 Kuwait Finance House (M) Bhd 1. Ijarah Muntahia Bi Al-Tamlik Asset Acquisition Financing-i
A leasing contract (for completed property) ending with
ownership by way of gift/sale.
2. Ijarah Mawsufah Fi Al-Zimmah Asset Acquisition Financing-i
A forward lease contract (for property under construction)
ending with ownership by way of gift/sale.
4 OCBC Al-Amin Bank (M)Bhd Ijarah Muntahiah bi Al-Tamlik (IMBT) Home/ Term Financing-i
3 types
5 Standard Chartered Saadiq Bhd Musyarakah Mutanaqisah
2 types

20. Benefits of Islamic Financing over
Conventional Financing
– Fixed monthly repayment to help customers balance their monthly budget.
– Cost of stamp duty lower by 20% for Islamic Loan Agreement documents as part of
the government’s efforts to promote Islamic financing
 Note: In conventional financing, there are only 2 legal documents necessary -
Facility Agreement and Charge documents. But for Islamic financing, there are at
least 3 (for some products 4), which brings up the total legal costs.
– A 100% stamp duty waiver on the existing refinance loan balance. In cases
of refinancing from Conventional to Islamic packages.
 Note: This is not applicable to any amount over and above the existing refinance
loan balance.

21. Benefits of Islamic Financing over
Conventional Financing
– Penalty fee for property disposal within the lock-in period can be potentially lower
than a conventional loan.
 Note: A conventional loan’s penalty fee for early settlement (prepayment) is a
set percentage, whereas the Islamic bank will charge based on the bank’s
prevailing cost of funds. However, the fee differs from one Islamic bank to
another.
– Conventional loans are based on Base Lending Rate (BLR) while Islamic loans are
based on Base Financing Rate (BFR) which the bank can actually adjust based on
prevailing market conditions but not more than the ceiling rate, which is the
maximum profit an Islamic finance provider will earn.

22. Benefits of Conventional Financing
over Islamic Financing
– For Conventional loans, if a borrower alters the terms of the finance (E.g. Increase the
facility amount), the Loan Facility Agreement would only need to be up-stamped. For
Islamic financing, a new Sale And Buy-back Agreement (BBA) needs to be drawn up,
making it more expensive.
– Islamic financing have difficulty in restructuring or refinancing in the case of default.
– Your costs for early settlements, late payments or defaults are more transparent in the
contract as compared to Islamic financing.
– The calculation method adopted by each bank differs significantly. Though the outcome
may not be detrimental to the bank or the consumer, due to the restriction in
procedure, a degree of uncertainty exists for both the bank and the customer.

23. 1.0 RETAIL FINANCING
1.2 Automobile Financing

24. Common Model & Structure
1. Al-Ijarah Thumma Al-Bay (AITAB)
Financing;

25. 5. At the same
time, customer
promises
(undertakes) to
buy the car at the
end of leasing/
financing tenure.
2. Customer applies loan from the Bank -
requires the Bank to buy the specified car.
3. Bank buys
the car on cash
basis & takes
ownership of
the car.
1. Customer
identifies the
car
4. Under the AITAB
contract, the customer
shall leases the car
from the Bank for
an agreed period.

26. Ijarah Automobile Financing
Computation
Danish approaches an IFI and applies for a car loan for the period of 5 years.
The purchase of the price is RM 110,000 and Danish is willing to pay the loan
amount in monthly instalment basis with 10% down payment. The profit rate
of the car is 3%.
Sale Price (SP)/ = CF + (CF * i * n)
Total Lease Amt = RM 99,000 + (RM 99,000 * 3% * 5)
= RM 113,850
Bank’s profit = RM 113,850 – RM 99,000
= RM 14,850

27. 1.0 RETAIL FINANCING
1.3 Personal Financing

28. Common Model & Structure
1. Tawarruq Personal Financing; and
2. Rahn Personal Financing

29. Tawarruq Personal Financing
BROKER A BROKER B
ISLAMIC BANK
CUSTOMER
1 3 5 6
2 4
1. The customer & the Bank enter into an agreement where the customer promises to buy a specified commodity from the
Bank. The customer also appoints the Bank as an agent to sell the said commodity.
2. The Bank buys the specified commodity from Broker A on spot basis.
3. The Bank sells the specified commodity to the customer on a deferred basis at (cost + profit).
4. As an agent, the Bank sells the same commodity to Broker B on a spot basis.
5. The Bank pays the customer the sale proceeds in a lump sum.
6. The customer pays the Bank the purchase price (cost + profit) of the commodity on a deferred installment basis.

30. Rahn Personal Financing
1. Customer approaches the Bank with a valuable item
(jewelry worth RM 10,000)
2. The Bank accepts the pledged asset & grants an
interest free loan to the customer (RM 8,000)
3. Customer pays a custodian fee for the service
rendered in safe-keeping the asset.
4. If the customer is unable to repay the debt, the pawned asset will be sold to
settle the outstanding debt. Surplus will be returned to the customer.

31. 1.0 RETAIL FINANCING
1.4 Credit Cards

32. Islamic vs Conventional Credit Card
ISLAMIC CONVENTIONAL
Interest No interest is charged Interest is variable, depending on the
outstanding amount
Collateral Collateral is required in many cases;
most banks require an underlying
deposit or undated check
No collateral
Type of contracts Lease-based, murabahah, tawarruq Loan based
Transaction restrictions The purchase of alcohol, tobacco,
gambling, pork, and sexually-related
items
No restriction
Profit margin on
deposits
Profit is shared between the bank and
customer and is not compounded
No deposits – no profit
Late payment fees Fixed amount + 3 percent of
outstanding balance; the 3 percent is
typically donated to charity
Variable, compounded

33. Common Model & Structure
1. Tawarruq-based Credit Card;
2. Ujrah-based (Service)Credit Card.
https://www.comparehero.my/blog/guide-
islamic-credit-cards

34. Tawarruq-based Credit Card
1. The customer approaches
the bank to apply for a credit
card.
2. The Bank purchases the
commodity from Broker A
4. The Bank sells the commodity to the
customer for a deferred payment. The
selling price equals to the credit limit and
inclusive of the Bank’s profit.
3. The Broker transfers
the the commodity to
the Bank.
5. The customer sells the
commodity to Broker B.
6. Broker B deposits cash into the
customer’s balance in wadi’ah
account.
8. The purchase price is
transferred to the
merchants.
7. The customer
buys goods from
the merchants
using the
balance in the
wadi’ah account

35. Ujrah-based Credit Card
2. The Bank provides a
credit card account based
on the customer’s credit
worthiness.
3. Using the credit card account
facility, the customer pays the
merchants for goods on spot basis.
The amount will be a qard from the
Bank to the customer.
1. The customer approaches the bank to apply
for a credit card.
4. The customer settles the qard. The customer will be charged a
fixed fee by the Bank, such as, a monthly service fee which is based
on actual cost of managing the transaction and an annual service fee
based on the service rendered by the Bank.
The Bank earns profit from the service fee and commission from the
merchants.

39. BENEFITS GIVEN
– Non compounding charges
– Takaful
– Low rates

40. THANK YOU