with their conventional counterparts EBB 20403 Timur Rustemov Relationship Conventional banking: debtor-creditor relationship between depositor and bank and then the borrower and bank on the other hand. Interest considered being price of credit opportunity cost of money.
Islamic banks: loan has to be given or taken free of charge. With that being said the creditor cannot take advantage of the borrower; when money is lent out on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle underlying for such kind of transactions is deal not unjustly, and ye shall not be dealt with unjustly [2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-creditor relationship. Deposits Irrespective of whether the bank is functioning under the conventional system or Islamic system deposits are collected from depositors for rewards purposes. The difference comes in terms of the agreement of reward. Conventional system: Reward is fixed and pre-determined. Higher return on long-term deposits, and lower on short-term deposits Risk borne by bank and reward to depositor at fixed rate
Islamic Banks: Deposits accepted through Musharakah and Mudarabah where the reward is variable. Same as conventional - Higher weight for profit sharing on long-term deposits, and lower on short-term deposits Share profits with depositors Both risk and rewards shared by depositor Three (3) common Shariah principles used in structuring deposit products are: Mudarabah, Wakalah, and Wadiah Financing/loans Conventional Banking system: Offer loan for a fixed reward 3 types of loans: Short term loans, overdrafts and long-term loans Short & medium term loans are provided to customer to meet working capital requirements Working capital required to invest in inventors and account receivables to meet expenses Islamic Banks: Cannot charge interest but can charge profit on investments but not interest on loans Can only issue interest free loans (Qard al Hassan) Inventory investment provided by Islamic banks through Murabaha Profit of a certain period is shared by IFIs Must prove viability of the project/business No personal consumption loans issued Murabaha financing is very useful for short to medium term financial requirements of business/nonprofit organizations and individuals Leasing provided under agreement of Ijarah Recently IFIs have created an avenue to meet their liquidity requirement in the form of Sukuk (Islamic Bonds) whereby servicing is fixed like conventional bonds however such types of Sukuk can be issued against Ijarah receivables. Contracts: Conventional system: not based off of contract system. Islamic banking system: Must be within the framework of Shariah. A contract only exists once both trading parties have agreed on terms including: asset, price and delivery. A contract is a legally binding agreement or a set of promises between two or more parties either written or oral. Under the common law, the final elements must be met in order for a contract to be valid: Intention/Consideration Certainty of terms no ambiguity Capacity mature and sane parties Informed consent voluntary Legal/Permissible Parties must have ownership of asset that is being sold Parties must be able to deliver Dual Banking System Dual Banking System Existence of dual laws in parallel for the Islamic as well as conventional financial institutions. Both banking systems are equally comprehensive and viable. Malaysia is the best Example
Advantages The Muslims in the countries which have only a conventional system do not have the opportunity to benefit from the facilities of a modern banking system without being involved in Riba. In the case of the conventional plus system (conventional system with a few Islamic banking institutions operating on the fringe of the banking system ex. Saudi Arabia, Bangladesh, and Bahrain): the services they offer are not as comprehensive and as sophisticated as the conventional system. The small scale nature of the operations of the Islamic banking institutions in these countries also make their services less efficient and more costly compared to the conventional institutions. Islamic banks cannot afford to be complacent, since they operate in a competitive and dynamic environment. The level of sophistication in the Islamic banking system will continuously be upgraded. Disadvantages Islamic Banking in dual-banking system is subjected to the same supervision and regulatory regimes of a Central bank than for the conventional one. As IFI have to face competition coming from conventional banks, Islamic bank will have no choice to copy conventional financial products. Conventional banks tend to be leaders Benchmarks have to be similar Customer remains confused Difficult to compete with big conventional banks Displacement risk to Islamic Banks Efforts and initiatives Deployment of human and financial resources to develop Islamic financial instruments. Development of secondary market Strategic alliances have been made between International Financial Exchange and the Bahrain SE: cross-border and trading of Islamic financial products Development of the Islamic Capital Market: ex in Malaysia, Introduction in 2005 of the Citigroup Malaysian Government Securities Index and the DJ RHB Islamic Malaysia Index Al Qard Al Hassan 8/8/2014 11 What is Qard al hassan Qard Al Hassan is a loan which is returned at the end of the agreed period without any interest or share in the profit or loss of the business. Therefore, qard al-hasan is a kind of gratuitous loan given to the needy people for a fixed period without requiring the payment of interest or profit. The receiver of qard al-hasan is only required to repay the original amount of the loan. 8/8/2014 12 Promoting brotherhood Islam emphasizes to make brotherhood among the Muslims. The main principle of brotherhood is to care and share each other. Qard al-hasan being a gratuitous loan can help the fellow Muslim brothers who need money but they do not have. Thus, qard al-hasan enhances brotherhood among the Muslims. 8/8/2014 13 Objectives To help the needy fellow people. To establish better relationship among poor and the rich. The mobilization of wealth among all people in the society. To perform a good deed that is encouraged and appreciated by the Almighty Allah and His messenger. To strengthen the national economy. To facilitate the poor to create new jobs market and business ventures by using their merits, skills and expertise. 8/8/2014 14 Objectives (Contd.) To establish a caring society. To eradicate unemployment problem from the society. It can be also a missionary work for daw'ah activities by giving qard al-hasan to the non- Muslims, who might be attracted by knowing the beauty of Islam. It can remove social and economical discrimination from the society, and Finally, obviously there is a great reward in the Hereafter for giving qard al-hasan.
8/8/2014 15 Banks & Qard al hassan Despite the benefit of the Qard AlHassan on the community, Qard AlHassan is not practice widely in Islamic banks today. Banks aim to maximize their profit and providing Qard AlHassan is incompatible with the banks aim. Qard Al Hassan is zero profit loan which means that the bank will not benefit from the transaction. Moreover, banks dont want to bear the risk from providing Qard because banks act as a trustee of the depositors' money.
8/8/2014 16 Implementation Qard AlHassan can be implemented through Cash Waqaf. In Cash Waqaf, providers of the money will not be depositors but founders where they provide money for no reward. The Waqaf fund and practice should be monitored and audit to insure avoiding any Haram elements.