Al- Sadiq (A.

S) Institute of Islamic Banking, Finance &

Takaful

By
JAWAID IQBAL
 CONTENTS
 MAJOR ECONOMIC SYSTEMS

 BANKING DEFINED

 BANKING INDUSTRY

 THE GLOBAL BANKING CRISIS

 ISLAMIC BANKING - A SOLUTION

 CONCLUSION
MAJOR ECONOMIC SYSTEMS

 There are the three major Economic Systems:

o Capitalism

o Socialism

o Islamic Economic System

CAPITALISM DEFINED
Capitalism is an economic and social system in which trade
and industry are privately controlled for profit rather than
by the state. The main features of capitalism are:

 Every individual has unconditional and absolute right to

participate in any business to maximize profits

 Market forces will determine the priorities and decide

where to invest resources

 Right to wealth vests with the factors of production

DRAWBACKS OF CAPITALISM
 No moral or regulatory bindings / restrictions while maximizing
profits

 Monopolies and cartels are created that exploit the society

 Government and industrialists may join hands for mutual

benefit and against the interest of the common man

 Imbalance in the distribution of income due to which

concentration of wealth takes place in a few hands
SOCIALISM DEFINED
Socialism is a system in which the means of production and
distribution are controlled by the government and ostensibly is
operated according to the principles of equity and fairness rather
than market forces.

 No individual has the right to participate in any business

independently

 State determines the priorities as per the overall planning

 Government decides where to allocate resources

 Right to wealth is with the government which then distributes it

among the various factors of production as it deems fit
DRAWBACKS OF SOCIALISM

 It violates the basic human right of freedom of the

individual

 Governments are assumed to be angels incapable of

nepotism and favoritism

 It needs a strong and forceful dictatorship to succeed

 It creates a society where there are no incentives therefore

efficiency is compromised
ISLAMIC ECONOMIC SYSTEM

This system accepts the market

forces of demand/supply, the right to
private property as well as the right
to maximize profits. However, all
these rights are not unbridled and
unconditional rather they are limited
by certain restrictions and
prohibitions:
PROHIBITIONS & RESTRICTIONS IN THE
ISLAMIC ECONOMIC SYSTEM
 Divine Prohibitions
o Economic activities like
• Interest
• Gambling
• Hoarding
 Government Intervention
o In cases where exploitation is feared, Government
intervention is allowed
 Moral Restrictions
o Worldly life is a way to get maximum benefit for the life
hereafter therefore, both the means and the end have to
be right.
 COMPARISON OF ECONOMIC SYSTEMS

Socialism Islamic Economic Capitalism

System
Extreme left Middle of the path Extreme right
Man made system System based on Man made
Divine principles system
Imperfect, chances No chance of error Imperfect,
of errors chances of
errors
Based on fear Based on justice and Based on greed
fair play
CONVENTIONAL BANKING
 Banks act as a financial intermediary between the depositor and
the borrower

 It pays fixed rate of interest to the depositor and receives fixed

rate of interest from the borrower

 The difference between the rate paid to the depositor and the
rate received from the borrower is the ‘Gross Profit Margin’ of
the bank

 Lending can be done without any physical asset backing it

ISLAMIC BANKING
 Islamic banking is a banking activity which is consistent with the Islamic law
(Shariah), known as Fiqh e Muamalat (Islamic rules on transactions)

 It does not allow the paying and receiving of Riba’ (interest) and promotes
greater degree of fairness and equity in the conduct of banking business

 Islam not only prohibits Riba but there are also some impermissible businesses
such as
o Liquor
o Pork
o Gambling
o Pornography
o Anything else, which the Shariah (Islamic Law) deems Haram (unlawful)
ISLAMIC BANKING (CONTINUED)
 Financing is primarily done with physical assets backing it

 Relationship between bank and customer may be of these

types:
o Buyer and Seller (Murabaha)
o Lessee and Lessor (Ijarah)
o Agent in Principle (Wakalah)
o Partnership in Business Venture (Musharakah)
 Believer! Be conscious of Allah and give up what
remains of riba if you are indeed believers.

If you do not do so then beware there is a declaration of

war against you by
Allah and his Prophet
Surah Al-Baqarah 278-79

17
 BANKING INDUSTRY

Total Banking Assets (Conventional & Islamic) US $35 Trillion

Total Islamic Banking Assets US $650 Billion

Islamic Banking Assets ( %) 1.87%

GROWTH OF ISLAMIC BANKING
 According to Arab News, it
was reported as of June
2008 that: Islamic Banking
had grown at an annual
rate of 35% worldwide to a
staggering $600 billion

 McKinsey & Co -
Management Consultants
have forecasted the sector
to reach $1 Trillion in
assets by 2010
 (in $ Billions)
Year 2009 2010 2011 2012 2013 2014
Total Asset Size 650 1000 1414 2000 2828 4000
Annual growth (%) - 54% 41% 41% 41% 41%
 The global banking crisis started few years back when in US, a boom in
the housing sector was driving the economy to a new level

 A combination of low interest rates and large inflows of foreign funds

created an easy credit environment for people to take home loans

 The demand for homes increased and fueled the home prices

 The loan agencies widened the loan disbursement and relaxed loan
conditions

 The lending institutions and mortgage firms were giving loans and
ignoring important risk management principles.

 As a result, customers like NINJA (No Income, No Job & Assets) were
also given housing loans
 Most of these types of loan were commonly known as ‘Sub Prime Loans’

 The interest rate charged on Sub Prime Loans were Substantially higher than
the Prime loans

 For lenders, Sub Prime loans were on the surface quite lucrative

 If borrower paid, lender would get good return

 If borrower default, the lender could sell the home at the market price

 Sub Prime loans seemed like a good option when housing market was booming
DERIVATIVES
 Derivatives traders developed a collateralized debt obligations (CDOs) through which a
financial institution combined their assets of various types (for example “prime” mortgages
with “subprime” ones).

 The packaged debt was then sold to a special purpose vehicle, generally registered offshore
in a low tax jurisdiction.

 The new entity then issued its own equity or bonds to resell the debt to other investors,
carving it up into different tranches with different risk ratings using complex mathematical
models.

 Financial derivatives create only money, with no real value, causing inflation and price
rise ,as well as moral decadence, that’s s why economic experts assert that the system of
financial derivatives can not bring about real development. Which is what happened in the
US Housing Industry.
FINANCIAL CRISIS
CURRENT BANKING PROBLEMS
 No moral controls
 Relaxation in regulatory control
 Man made laws which are imperfect & have high chance of
error.
 Systems based on human instincts of fear & greed.
 Major Violations of risk management principles and banking
fundamentals.
 Use of subprime loans & use of derivative instruments
without understanding the risks.
 Bonus culture, people being rewarded for short term
performance rather than long term risk adjusted return on
capital (RAROC)
KARL MARX, DAS CAPITAL, 1867
“Owner of capital will stimulate the working
class to buy more and more of expensive
goods, houses and technology, pushing them
to take more and more expensive credits,
until their debt becomes unbearable. The
unpaid debt will lead to bankruptcy of banks,
which will have to be nationalized, and the
state will have to take the road which will
eventually lead to communism”.
ISLAMIC BANKING- A SOLUTION TO THE
FINANCIAL CRISIS
CRISIS SOLUTION
No moral controls Islamic economic and financial system is based on a set of
values, ideals, and morals, such as honesty, credibility,
transparency, clear evidence, facilitation, co-operation.

Relaxation inIt does not allow any relaxation both in terms of shariah
regulatory control as well regulatory compliance.

Man made lawsIslamic banking does not follow man made principles,
which are imperfectrather it follows the Islamic economic system, which is
& have high chancebased on Divine Principles. Hence, has a low chance of
of error. error.
 CRISIS SOLUTION
Systems based on humanIt is not based on greed as Islamic
instincts of fear & greed. economy promotes participation in profit, loss, and
actual exchanges of money and assets. It does not
allow making money from money which leads to
greed rather promotes risk sharing and
entrepreneurship
Conventional banking usedIn contrast to conventional banks, no Islamic bank
to believe in a freehas failed and has needed government
economy and norecapitalization. As in Islamic Economic System
government interventiongovernment intervention is accepted only up to a
but in the end governmentcertain time.
bailout plans were un
avoidable to save banks
from defaults.
The conventional systemIslamic finance requires that financial dealings must
allows multiple debtbe backed by real assets and be in line with the
creation on a particularIslamic law.
asset without a real
underlying transaction
 CRISIS SOLUTION
Major Violations of riskIslamic system follows the shariah guidelines . It
management principles andbelieves in minimizing the risks and restricts
banking fundamentals transactions with gharar ( uncertainty). It further
allows to adapt to the prevailing rules and
regulations if they are not contradicting to shariah
guidelines.

Conventional banks have toBanks enjoy a built-in stabilizer to help them cope
give fixed rate of interest towith economic downturns, as instead of paying
the depositors, even if theyinterest to depositors, those with investment
are making losses. There ismudaraba accounts share in the banks profits. Thus,
no concept of profit- lossif profitability declines in an economic downturn,
sharing. Hence more Riskdepositors receive lower returns, but if profits rise
involved. they enjoy higher returns. This profit sharing
reduces risk for the banks compared to fixed rate of
interest return on investment.
 CRISIS SOLUTION
Conventional bank doesn’tFinancial dealings in Islamic banking and finance are
believe in equity-basedguided by the ultimate objective of achieving the
financing and hence no riskideals of equitable justice where priority is given to
sharing. The Depositor getsequity-based financing rather than debt-based
fixed rate of interest, wherefinancing.
as the borrower has to payEquity-based financing distributes risk and liability to
fixed rate of interest, henceboth the lenders and borrowers so as to justify the
risk is not equally return to both sides of the transacting parties.
distributed.

Use of fancy derivative In principle, Islamic banking does not allow the use
instruments without of derivative or any other speculative instrument like
understanding the risks forward’s and future’s, rather deals in real assets
 CRISIS SOLUTION
Riba( interest or usury) isFinancial dealings must be free from Riba (interest),
one source of exploitation,Gharar (uncertainty), and maysir (gambling) ensure
especially, as in the case ofthat the elements of exploitation and excessive
sub-prime lending, thespeculation are avoided.
highest rates were charged
to lower earners. SuchIslamic housing finance involves risk sharing between
discriminatory charging bythe bank and the client, rather than transferring all the
conventional banks wasrisk to the latter. Under the most commonly used
justified as being adiminishing musharaka (partnership) contract, the
reflection of the risksbank and the client form a partnership.
involved.
THE RESILIENCE OF ISLAMIC BANKING
 The Conventional banking system collapsed in the financial
crisis. Big banks and Insurance agencies such as Citi group,
RBS & AIG, suffered major losses. One of the Banking
Leader Lehmann brothers had to declare bankruptcy and
lost it’s entity, Major cut downs were done and employees,
even CEO’s were fired.

 On the other hand Islamic banking system has flourished in

this financial crisis and has grown greatly. Instead of firing,
Islamic bank has been hiring people. This financial crisis has
shown a positive shift of people towards Islamic Banking
which can be seen by the growth of Islamic Banking.
 VIEWS OF RENOWNED PERSONALITIES ON
ISLAMIC BANKING

"The ethical principles on which Islamic

finance is based may bring banks closer
to their clients and to the true spirit which
should mark every financial service"

“Western banks could use tools such as the

Islamic bonds, known as sukuk, as
collateral. Sukuk may be used to fund the
car industry or the next Olympic Games
in London”

The Vatican's official newspaper

 The Vatican offered Islamic finance
principles to Western banks as a
solution for worldwide economic crisis.

 The Vatican paper wrote that banks

should look at the rules of Islamic
finance to restore confidence amongst
their clients at a time of global
economic crisis
“They try to patch up here and there with bailouts. But that is
not going to solve anything,”

“So in the process of trying to solve the problem, don’t

dismiss any idea including Islamic banking. Maybe not the
whole Islamic banking, but elements of it can contribute
towards stabilising the banking system of the world.”

Dr Mahathir Mohammad