An Introduction

to Islamic Banking and Finance

Presented by: Faisal M. Niyaz Hudawi

One – Day Work Shop

The Central School, Dubai
01-01-2009

Organized By: SKSSF UAE National Committee

Introduction

† Islam the Divine religion

† A Comprehensive way of life
† It is the only religion that forwards
alternative system of economics.
Islamic Economic System
Three Economic Systems that prevails
today

Capitalism
Socialism
Islam
Capitalism
† Absolute right of Private Property
† Wealth concentration in few hands
† Materialist Oriented
Qaroon the Best Example
Socialism
† Totally Denies Private Property
† Thus hinders Human Progress
† Working Class Oriented
Islamic Concept
ۖ ‫ﻦ اﻟﺪﱡ ْﻧﻴَﺎ‬
َ ‫ﻚ ِﻣ‬
َ ‫ﺲ َﻧﺼِﻴ َﺒ‬
َ ‫ﺧ َﺮ َة ۖ َوﻟَﺎ ﺗَﻨ‬ ِ ‫ك اﻟﻠﱠ ُﻪ اﻟﺪﱠا َر اﻟْﺂ‬ َ ‫† وَا ْﺑ َﺘ ِﻎ ﻓِﻴﻤَﺎ ﺁﺗَﺎ‬
‫ن‬
‫ض ۖ ِإ ﱠ‬ِ ‫ﻚ ۖ َوﻟَﺎ َﺗ ْﺒ ِﻎ ا ْﻟ َﻔﺴَﺎ َد ﻓِﻲ ا ْﻟَﺄ ْر‬ َ ‫ﻦ اﻟﻠﱠ ُﻪ ِإَﻟ ْﻴ‬
َ‫ﺴ‬َ‫ﺣ‬ ْ ‫ﺣﺴِﻦ َآﻤَﺎ َأ‬ ْ َ‫وَأ‬
(77‫ﻦ)ﺳﻮرة اﻟﻘﺼﺺ‬ َ ‫ﺴﺪِﻳ‬
ِ ‫ﺤﺐﱡ ا ْﻟ ُﻤ ْﻔ‬ِ ‫اﻟﻠﱠﻪَ ﻟَﺎ ُﻳ‬
† "But seek, with the (wealth) which Allah
has bestowed on thee, the Home of the
Hereafter, nor forget thy portion in this
world: but do thou good, as Allah has been
good to thee, and seek not (occasions for)
mischief in the land: for Allah loves not
those who do mischief." (Al Qasas 77)
Islam

† Property is Amanah (trusteeship) From

Allah the Almighty
† Admits the right of Private Property
but not absolute.
† Decentralization of wealth
† Should not create economical anarchy
† Success in both worlds
Basic Concept of Islamic Economy
† Prohibition of Riba
† Prohibition of Gambling
† Prohibition of Garar
Riba (Interest)

‫ﻄ ُﻪ‬
ُ ‫ﺨ ﱠﺒ‬َ ‫ن ِإﻟﱠﺎ َآﻤَﺎ َﻳﻘُﻮ ُم اﱠﻟﺬِي َﻳ َﺘ‬ َ ‫ن اﻟ ِّﺮﺑَﺎ ﻟَﺎ َﻳﻘُﻮﻣُﻮ‬ َ ‫ﻦ َﻳ ْﺄ ُآﻠُﻮ‬َ ‫† اﱠﻟﺬِﻳ‬
‫ﻞ‬
‫ﺣﱠ‬
َ ‫ﻞ اﻟ ِّﺮ َﺑﺎ ۗ َوَأ‬
ُ ‫ﻚ ِﺑَﺄ ﱠﻧ ُﻬ ْﻢ ﻗَﺎﻟُﻮا ِإ ﱠﻧﻤَﺎ ا ْﻟ َﺒ ْﻴ ُﻊ ِﻣ ْﺜ‬
َ ‫ﺲ ۚ َٰذِﻟ‬
ِّ ‫ﻦ ا ْﻟ َﻤ‬َ ‫ن ِﻣ‬ُ ‫ﺸ ْﻴﻄَﺎ‬ ‫اﻟ ﱠ‬
(275 ‫ﺣ ﱠﺮ َم اﻟ ّﺮِﺑَﺎ )ﺳﻮرة اﻟﺒﻘﺮة‬ َ ‫اﻟﻠﱠ ُﻪ ا ْﻟ َﺒ ْﻴ َﻊ َو‬
† “Those who devour usury will not stand
except as stand one whom the Evil one by
his touch Hath driven to madness. That is
because they say: "Trade is like usury," but
Allah hath permitted trade and forbidden
usury.” (Al Baqara 275)
† All Semitic religions prohibited interest
† In 15th Century Church Approved Usury
Gambling
‫ب وَا ْﻟَﺄ ْزﻟَﺎ ُم‬
ُ ‫ﺴ ُﺮ وَا ْﻟﺄَﻧﺼَﺎ‬ ِ ‫ﺨ ْﻤ ُﺮ وَا ْﻟ َﻤ ْﻴ‬
َ ‫ﻦ ﺁ َﻣﻨُﻮا ِإ ﱠﻧﻤَﺎ ا ْﻟ‬
َ ‫† ﻳَﺎ َأ ﱡﻳﻬَﺎ اﱠﻟﺬِﻳ‬
‫ن‬
َ ‫ﺟﺘَﻨِﺒُﻮ ُﻩ َﻟ َﻌﱠﻠ ُﻜ ْﻢ ُﺗ ْﻔِﻠﺤُﻮ‬ْ ‫ن ﻓَﺎ‬ِ ‫ﺸ ْﻴﻄَﺎ‬ ‫ﻞ اﻟ ﱠ‬ ِ ‫ﻋ َﻤ‬
َ ‫ﻦ‬ْ ‫ﺲ ِّﻣ‬ٌ ‫ﺟ‬ ْ ِ‫ر‬
( 90 ‫)اﻟﻤﺎﺋﺪة‬
† “O ye who believe! Intoxicants and
gambling, (dedication of) stones, and
(divination by) arrows, are an
abomination,- of Satan's handwork:
eschew such (abomination), that ye
may prosper.” (Al Maida 90)
Garar
† Jabir b. Abdullah (Allah be pleased
with them) is reported to have said
that Allah's Messenger (may peace be
upon him) forbade the sale of a
heap of dates the weight of which
is unknown in accordance with
the known weight of dates.
(Bukhari - Book #010, Hadith #3654)
Necessity of Banking

† Banking is a necessity in the present

economy
† Pooling of the fund to provide for the
required
† Saves time and effort
† Trustable institution controlled by
central monitory system
Conventional Banks and Islamic
Banking
† Banking is not alien to Islam, mode of
operation that matters
† Conventional Banks are receiving and
providing money on interest basis
† Islamic Banks are receiving and
providing money on profit and loss
sharing basis
† In conventional banking either the
client or the bank facing injustice
† Islamic banks involves only those
industries accepted by Islamic
Shariha
History of Islamic Banking
† Most see Islamic banking as the
Islamized form of conventional banking
but we find different forms of banking
among early Muslims
† Use of cheques in the period of Omar
(R)
† Zubair Awam used to receive funds
from the people
Medieval Period
† Sayarifa and Jahabiza
† Basara Wall-street of Middle ages
† Central Banking System of Abbasid
state Diwan-e-Jahabiz in AD 929
(H316)
† Dar-al-mal in Egypt by Fatimid State
† Mudaraba in medieval period
† Approval of Usury by Church in 15th
Century
Modern Islamic Banking
† Ahmed Al Najjar in Mith Gamar,
Egypt in 1963 – A Savings Bank
† Islamic Development Bank – 1974 by
OIC
† In 1975, the first Commercial Islamic
Bank – Dubai Islamic Bank
† Faisal Islamic Bank- Egypt & Sudan
(1977)
† Bahrain Islamic Bank – (1979)
Sources of Islamic Banking
† Quran,
† Hadith,
† Ijma,
† Qiyas
† Hanafi, Shaifi, Maliki & Hanbali
Schools of thoughts
† Fiqh –al- Muaamalaat
Islamic Banking tools
† Asset Side – Financing tools

† Liabilities Side – Deposit tools

Financing Tools
† Fund Collection for Business –
Musharaka or Mudaraba
† Purchase of Goods/Services –
Murabaha
† Utilize usufruct of Assets for Certain
period – Ijara
† Production of natural Products -Salam
† Production of Industrial Products -
Istisnaa
Musharka
† Equity – Based
† Shirka – Sharing
† Musharaka means a joint enterprise
formed for conducting some business
in which all partners share the profit
according to a specific ratio while the
loss is shared according to the ratio
of the contribution.
Management of Musharaka
† All Partners are agent of others and
every one has right to participate in
the Management
† They may appoint some of them as
Managers. The right will be delegated
to them to carry entire business
activities
Profit and Loss Sharing
† Profit ratio shall be determined at the time
of Contract
† Profit should be determined in proportion to
the actual profit earned.
† No lump sum amount to be fixed as profit
† An active investor can get more Profit than
a Sleeping Partner
† Loss is distributed exactly according to the
ratio of investment.
Issues in Musharaka
† Liquidity of the Capital
† Mixing of the Capital
† Tenure of Musharaka
† Special Conditions – regarding liquidity
in case of withdrawal one Partner.
† Limited Liability
Application of Musharaka
† Project Financing
† Small & Medium Enterprise Financing
† Import/Export Financing
† Company Formation
† Saving / Investment Accounts
† Investment Certificates
Difference Between
Interest based financing
† 1.A fixed rate of return on a
loan advanced by the financier
is predetermined
irrespective of the profit
earned or loss suffered by the
debtor.
† 2.The financier cannot suffer
loss.
† 3.Results in injustice either to
the creditor or to the debtor.
If the debtor suffers a loss, it
is unjust on the part of the
creditor to claim a fixed rate of
profit. Also if the debtor earns
a very high rate of profit, it is
injustice to the creditor to give
him only small proportion of
the profit leaving the rest for
the debtor.ad
Musharakah
† Musharakah does not envisage
a fixed rate of return. The
return is based on the actual
profit earned by the joint
venture.
† The financier can suffer loss, if
the joint venture fails to
produce fruits.
† The returns of the creditor are
tied up with the actual profits
accrued through the
enterprise. The greater the
profits of the enterprise, the
higher the rate of return to the
creditor. If the enterprise
earns enormous profits, all of
it cannot be secured by the
debtor exclusively but will be
shared by common people e.g.
Depositors in the bank.
Mudaraba
† This is a kind of partnership where one
partner gives money to another for
investing in a commercial enterprise. The
investment comes from the first partner
who is called "Rab-ul-Maal" while the
management and work is an exclusive
responsibility of the other, who is called
"Mudarib" and the profits generated are
shared in a predetermined ratio.
Terminology
† Mudarib : Working Partner (brings
effort)
† Ras-ul-Maal : Investment
† Rab-ul-Maal : Investor (brings
capital)
† Known as Qirad in Books of Fiqh
Types of Mudaraba
† Mudaraba Muqayyada (Restricted
Mudraba)

† Mudarab Mutlaqa (Unrestricted

Mudaraba)
Profit and Loss in Mudaraba
† Profit Share shall be determined at
the time of Contract
† No lump Sum Amount as profit
† No Salary for Mudarib. In case of
Mudaraba fasid only Ujrat-mithl
(ordinary Pay)
† Loss on Investor. Mudarib loses his
administrative effort
Difference Between
Musharaka & Mudaraba
† All partners invest.
† All partners participate in the
management of the business and
can work for it.
† All partners share the loss to the
extent of the ratio of their
investment.
† The liability of the partners is
normally unlimited. If the liabilities
of business exceed its assets and
the business goes in liquidation, all
the exceeding liabilities shall be
borne pro rata by all partners.
† As soon as the partners mix up their
capital in a joint pool, all the assets
become jointly owned by all of them
according to the proportion of their
respective investment.
† All partners benefit from the
appreciation in the value of the
assets even if profit has not accrued
through sales.
† Only Rab-ul-Maal invests.
† Rab-ul-maal has no right to
participate in the management
which is carried out by the
Mudarib only.
† Only Rab-ul-maal suffers loss
because the Mudarib does not
invest anything. However this is
subject to a condition that the
Mudarib has worked with due
diligence.
† The liability of Rab-ul-maal is
limited to his investment unless
he has permitted the Mudarib to
incur debts on his behalf.
† The goods purchased by the
Mudarib are solely owned by
Rab-ul-maal and the Mudarib
can earn his share in the profit
only in case he sells the goods
profitably.
Applications/ Issues
† Just Like Musharakah
† A Case Study of National Bonds
Musharaka Muthanaqqisa
(Diminishing Partnership)
† A Modern Concept
† Combination more than one
transaction
† Mostly Used in House Finance
† Used in Combination with Ijarah
† Joint ownership – Gradually one of
Partner sells his share to the other
and it becomes his Sole Property
Musharaka Muthanaqqisa
(Diminishing Partnership)
† According to this concept, a financier and
his client participate either in the joint
ownership of a property or an equipment,
or in a joint commercial enterprise. The
share of the financier is further divided into
a number of units and it is understood that
the client will purchase the units of the
share of the financier one by one
periodically, thus increasing his own share
until all the units of the financier are
purchased by him so as to make him the
sole owner of the property, or the
commercial enterprise,
House Financing: A Model
† Creates a Joint Ownership in the Property
(Eg. 80% bank - 20% Client)
† Bank Lease his share in the House to his
Client and Charges rent.
† Bank Divides his share of 80% into 8 equal
units.
† Client Purchase each unit monthly
† Rent Reduces as Banks Share reduce
† Finally House becomes Property of the
Client
Mushraka Muthanaqqisa
† Joint Purchase
† Leasing
† Selling different units of Shares
† Different transactions not to tied up
in Single Contract
† Can be used for Auto and Trade
Finance
Murabaha (Cost Plus)
† Widely used in Islamic Banking
† Fixed return as it is a Sale
† It is a Sale where the seller expressly
mentions the cost of sold Commodity
he has incurred and sells it to another
person by adding some profit.
† It is not a loan on interest. But sale of
Commodity
Murabaha (Cost Plus)
† All the rules of Basic Sale applicable
† Bank discloses its Cost and Profit
Margin to the Client.
† The Client Pays on Deferred Payment
basis
† Some criticize it as it technically
replaces the word “interest’ with
profit.
Issues in Murabaha
† Securities against Murabaha
† Penalty of Default
† Compensation or Donation to Charity
† No increment or decrement in price
once the sale contract is executed.
Applications of Murabaha
† Auto Financing
† Equipments
† Import/Export
† House/Land
† Consumer Goods
Salam
† A kind of Forward Sale
† the seller undertakes to supply specific
goods to the buyer at a future date in
exchange of an advanced price fully paid at
spot. The price is in cash but the supply of
purchased goods is deferred.
† To meet the need of farmers who need
money to grow their crops and to meet the
need of traders for import and export
business
Salam - Conditions
† Strict conditions as it is a forward sale
† Spot full payment
† Quality and Quantity to be specified
† Exact date and Place of Delivery to be
specified.
† Not to be effected on a Particular
Commodity
Benefits of Salam
† Profit for Bank from a Parallel Salam
where the bank gets payment in
Advance for the future delivery
† Or Bank can obtain a promise to
purchase from a third party.
Istisnaa
† It is an order to a manufacturer to
manufacture a specific commodity for
the purchaser. The manufacturer uses
his own material to manufacture the
required goods.
Differences between
Istisnaa and Salam
† The subject on which transaction † The subject can be anything that
of Istisna' is based, is always a need manufacturing or not.
thing which needs to be
manufactured. † The price has to be paid in full in
† The price in Istisna' does not advance.
necessarily need to be paid in full
in advance. It is not even
necessary to pay the full price at † The time of delivery is an
delivery. It can be deferred to essential part of the sale.
any time according to the
agreement of the parties. The † The contract cannot be cancelled
payment may also be made in unilaterally.
installments.
† The time of delivery does not
have to be fixed in Istisna'.
† The contract can be cancelled
before the manufacturer starts
the work.
Uses of Istisnaa
† House Financing (Land Provided by
Client)
† Plant/Factory
† Apartments Booking
† BOT of Bridges and Highways
Ijarah (Leasing)
† Transferring of usufruct to another
person for an agreed period for a
specified consideration.
† Ownership remains with the lessor
and all the liabilities of Ownership on
him
† Lessee is liable to compensate for any
harm by misuse or negligence
Ijarah
† Rent should be charged after the
delivery of the leased asset
† After the lease period expired, the
lessor may transfer the ownership to
the lessee either free of charge or for
a nominal price.
† This is called Ijara wa iqthina
† This is also used in House /Equipment
financing.
Liabilities Side
† Deposit
† Current Account is a Qard not
Amanah
† Amana cannot be used by Bank for
Business.
† The bank cannot be held liable in case
of any damage or loss to amanah
† Savings and Investment accounts on
Mudaraba basis
Role of the Bank as Agent (Wakeel)
† Payment /receiving money on behalf
of Customer
† LC opening and acceptance
† Issuance of Cards
† Safe Keeping
† Remittance
† Bank Can Charge Agency Fee for this
Bank as a Guarantor (Kafeel)
† Letter of Guarantee
† No fee to be charged for this
† Only Expenses to be charged
† Advisory Services can be provided on
a charge basis
Islamic Investment funds
† Sukuk Islamic Alternative to Conventional
bonds
† AAOIFI defines Sukuk as being:
“Certificates of equal value representing
after closing subscription, receipt of the
value of the certificates and putting it to
use as planned, common title to shares and
rights in tangible assets, usufructs and
services, or equity of a given project or
equity of a special investment activity”.
Comparison of Sukuk & Bond
† A bond is a contractual debt obligation whereby the
issuer is contractually obliged to pay to bondholders,
on certain specified dates, interest and principal,
whereas, the sukuk holders claims an undivided
beneficial ownership in the underlying assets.
† Consequently, sukuk holders are entitled to share in
the revenues generated by the sukuk assets as well
as being entitled to share in the proceeds of the
realization of the sukuk assets.
† A distinguishing feature of a sukuk is that in instances
where the certificate represents a debt to the holder,
the certificate will not be tradable on the secondary
market and instead is held until maturity or sold at
par
Types Sukuk
† Musharakah Sukuk
† Mudaraba Sukuk
† Ijraha Sukuk
† Salam Sukuk
† Istisnaa Sukuk
† Murabah Sukuk
Takaful- Islamic way of Insurance
† Takaful comes from the Arabic root-
word ‘kafala’ — guarantee.
† Takaful means mutual protection and
joint guarantee.
† Operationally takaful refers to
participants mutually contributing to
a common fund with the purpose of
having mutual indemnity in the case
of peril or loss.
Basic Elements of Takaful
† Mutuality and cooperation.
† Takaful contract pertains to Tabrru’at as against mu’awadat
in case of
† conventional insurance.
† Payments made with the intention of Tabarru (contribution)
† Eliminates the elements of Gharrar, Maisir and Riba.
† Wakalah/Modarabah basis of operations.
† Joint Guarantee / Indemnity amongst participants – shared
responsibility.
† Constitution of separate “Participants’ Takaful Fund”.
† Constitution of “Shariah Supervisory Board.”
† Investments as per Shariah.
Comparison of Insurance & Takaful
Conventional Insurance
† Two parties. Insurer
(company),
† Insured (Policy holders)
† The premium comes in the
† ownership of company.
† Covering of risk is duty of
company
† There is only one contract
i.e.
† Only insurance company is
insurer
† Surplus is not returned to
policy
† holders totally or partially
† Pool of Insurance company
is not alegal identity
† There is one relation in
insurance.
Takaful
† Three parties company, policy
holder,pool
† Takaful company does not
become
owner of premium
† Covering of risk is duty of
company.
† There is a bunch of contracts.
† Takaful company is not insurer
but
† policy Holders are insurers &
insured among themselves.
† 8. Surplus is returned to policy
holders.
† 9. Pool of Takaful Company is a
legal identity
† 10. there are a different
relations at
† different stages in Takaful
Takaful Models
† Mudaraba Model

† Wakala Model

† Wakala-Waqaf Model
Islamic Credit Cards
† No interest
† Monthly Administrative Fee
† Late Payment – Penalty to Charity
Growth of Islamic Banking
† One Institution in one Country (1975)
† More than 300 institutions spread
over 75 countries.(2008)
† Total Sharia- Compliant assets: $639
bn
† Expected - $ 1 Trillion by 2010
† Five Stand Alone Islamic Banks in UK
Europe towards Islamic Finance
† UK Govt. launched Saharia-
Compliant pension Funds.
† UK Considering issue of Islamic Bonds
to fund the building of Athletes village
for London 2012 Olympics
† Gordon Brown Urges “London to be
gateway to Islamic Finance”
West looks towards Islam
† US Treasury Deputy Secretary Rober
Kimmit “The US Govt. is studying the
salient features of Islamic banking to
ascertain how far it could be useful in
fighting the ongoing world economic
crisis”
Challenges Ahead
† Standardisation of rules and
regulations
† Scarcity of enough Scholars.
† Some Survey says there are only
Nearly 260 Islamic scholars world
wide.
† Quality Education and Training
required
Conclusion
† One of Biggest of Muslim Community
in the world is denied of this right –
Indian Muslims

† We have to fill the gap

† Let us work together