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Islamic Banking Slides Lehrstuhl für Bankwirtschaft und Finanzdienstleistungen Prof. Dr. Hans-Peter Burghof with Ahmad Abu-Alkheil and Ulli Spankowski Islamic banking & Finance •Introduction •Evolution 2 IslamicBankingandFinance Glossary : IslamicBankingandFinance Term in Arabic Meaning Reba Interest Al-wadiah Safe keeping Bai'muajjal Deferred-payment sale Bai'salam pre-paid purchase Zakat Islamic tax Halal lawful Haram unlawful Ijara leasing Mudaraba profit-sharing Mudarib Entrepreneur-borrower Murabaha Cost-plus or mark-up Musharaka Equity participation Qard hasan Benevolent loan (interest free) Gharar Uncertainty or chance Sukuk Islamic bond Qirad Mudaraba Rabbul-mal Owner of capital Shariah Islamic law Shirka Musharaka 3 Islamic Economics Islamiceconomics: •Is economics in accordance with Islamic law . GoalsofIslamicEconomics: •Broad-based economic well-being with full employment and optimum rate of economic growth. •Stability in the value of money to enable the medium of exchange to be a reliable unit of account and a stable store of value. •A just return is ensured on investment and development projects. •Effective rendering of all services normally expected from the banking system. •Socio-economic justice and equitable distribution of income and wealth 4 IslamicBankingandFinance Rules regardingIslamicfinance: •Any predetermined payment over and above the actual amount of prprincipalincipal is prohibited •The lender must share in the profits or losses arising out of ththee enterprise for which the money was lent •Making money from money is not Islamically acceptable (Asset Based Financing) •Gharar (Uncertainty, Risk or Speculation) is also prohibitprohibiteded •Investments should only support practices or products that are nnotot forbidden 5 IslamicBankingandFinance Islamicbanking: A banking system that is based on the principles of Islamic law (also known as Sharia, and guided by Islamic economics). Islamicbankingdistinguishingfeatures: •Zero interest and capital guarantee (interest-free) •Multi-purpose and not purely commercial •Strongly equity-oriented •Full-reserve banking 6 IslamicBankingandFinance TypesofIslamicfinancing: •Trade financing •Investment financing •Lending • Services UsesOfFunds(FinancingTechniques): •Musharaka (finance by way of partnership --- Joint Venture ) •Mudarabah (Profit Loss Sharing) •Murabahah (cost-plus financing) •Bai'salam ( prepaid purchase) •Bai' muajjal (deferred payment) •Istisnaa (manufacturing). •ijara (Leasing )… 7 IslamicBankingandFinance Musharaka ::: It means partnership. It involves you placing your capital with another person and both sharing the risk and reward. The difference between Musharaka arrangements and normal banking is that you can set any kind of profit sharing ratio, but losses must be proportionate to the amount invested. Typesof Musharaka ::: • DecliningDeclining----BalanceBalance Shared Equity: Commonly used to finance a hhomeome purchase, the declining balance method calls for the bank and the investor to purchase the home jointly, with the institutional investor gradually trantransferringsferring its portion of the equity in the home to the individual homeowner, wwhosehose payments constitute the homeowner's equity. • Permanent Musharaka: In this form of Musharaka an Islamic bank participates in the equity of a project and receives a share of profit on a pro rata basis. The period of contract is not specified. So it can continue so long as the parties concerned wish it to continue. 8 IslamicBankingandFinance Mudaraba : Refers to an investment on your behalf by a more skilled person. It takes the form of a contract between two parties, one who provides the funds and the other who provides the expertise and who agree to the division of any profits made in advance. In other words, Islamic Bank would make Sharia’a compliant investments and share the profits with the customer, in effect charging for the time and effort. If no profit is made, the loss is borne by the customer and Islamic Bank. ADCB 9 IslamicBankingandFinance (MurabahahMurabahah (cost(cost- ---plusfinancing):plusfinancing): Murabaha is a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest. Islamic Bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest. Sayyid Tahir 10 IslamicBankingandFinance Islamicleasing: Leasing or ijara is also frequently practiced by Islamic banks. Under this mode, the banks would buy the equipment or machinery and lease it out to their clients who may opt to buy the items eventually,(HireHire Purchase) in which case the monthly payments will consist of two components, i.e., rental for the use of the equipment and installment towards the purchase price. The description given above, contains thefollowingessential ingredients for outliningthebasicrules under Shari'ah: That there has to be a valuable use of the asset and transferability of that usufruct. That the ownership of the asset is retained by the transferor or lessor throughout the lease period. Consumable cannot be leased. That the risk and liabilities of ownership lie with the lessor. The leased asset shall remain the risk of the lessor throughout the lease period. Any loss or harm caused by factors beyond the control of the lessee shall be borne by the lessor That the risk and liabilities associated with the use of the asset shall be borne by the lessee 11 IslamicBankingandFinance IslamicForwardModes: •Istisnaa (manufacturing) Is a contract to acquire goods on behalf of a third party where the price is paid to the manufacturer in advance and the goods produced and delivered at a later date . •Bai'salam (prepaidpurchase) 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. 12 IslamicBankingandFinance DifferencebetweenIslamic&Conventional Banking SUMMARY: An Islamic bank is a deposit-taking banking institution whose scope of activities includes all currently known banking activities, excluding borrowing and lending on the basis of interest. On the liabilities side, it mobilizes funds on the basis of a Mudarabah or Wakalah (agent) contract. It can also accept demand deposits which are treated as interest-free loans from the clients to the bank. and which are guaranteed. On the assets side, it advances funds on a profit-and–loss sharing or a debt-creating basis, in accordance with the principles of the Sharīah. It plays the role of an investment manager for the owners of time deposits, usually called investment deposits. In addition, equity holding as well as commodity and asset trading constitute an integral part of Islamic banking operations. An Islamic bank shares its net earnings with its depositors in a way that depends on the size and date-to-maturity of each deposit. Depositors must be informed beforehand of the formula used for sharing the net earnings with the bank. 13 Islamic Banking and Finance DifferencebetweenIslamic&Conventional Banking Sayyid Tahir 14 IslamicBankingandFinance CategoriesofAccount : At the deposit end of the scale, Islamic banks normally operate four broad categories of account : •The current account •The savings account •Investment accounts •Special investment accounts 15 IslamicBankingandFinance Islamic Sukuk ( Bonds): Is commonly described as an “Islamic bond”. which representrepresent an undivided beneficial ownership of an underlying asset , Sukuk is a Trust certificate in which investor returnsreturns are derived from legal or beneficial ownership of assets . CertiCertificatesficates of equal value representing proportionate ownership of tangible assets or usufrusufructsucts or services or of the assets of a project or in an investment activity. (AAOIFI) •Kindsof Sukuk ::: • Sukuk representing ownership in tangible assets (mostly(mostly bbasedased on Sale and Lease back or direct lease) • Sukuk representing Usufructs or Services (based on subsub leleasease or sale ofofof services) • Sukuk representing equity share in a particular businessbusiness or investmeninvestmentt portfolio (based on MusharakahMusharakah// MudarabahMudarabah)))) • Sukuk representing receivable or future goods (based on MurabahaMurabaha or Salam ))) IstisnaIstisna’’’’).).).). 16 IslamicBankingandFinance Typical Sukuk StructureforsaleandleasebackStructureforsaleandleaseback… ……… Hamad Rasool 17 IslamicBankingandFinance FlowofFunds ---Acquisition&Rentals Hamad Rasool 18 IslamicBankingandFinance FlowofFunds ---Repayment&Maturity Hamad Rasool 19 IslamicBankingandFinance Sukuk AlAlAl- Al ---IjaraIjara basedModel(Example) Hamad Rasool 20 IslamicBankingandFinance TypicalInternational Sukuk Mechanism – Step bystep… Hamad Rasool 21 IslamicBankingandFinance IslamicinsuranceIslamicinsurance----Takaful Joint guarantee, Islamic alternative to insurance, is based on the concept of social solidarity, cooperation and mutual indemnification of losses of members. It is an accord among a group of persons who agree to jointly indemnify the loss or damage that may be caused, out of the fund they donate collectively. Such a contract usually involves the concepts of MudarabaMudaraba,Mudaraba
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