Allah will deprive Riba of all blessing, but will give increase for deeds of charity, for He loveth

not creatures ungrateful and wicked. (2:276)

Islamic Financial ISLAMIC FINANCIAL System

SYSTEM

Group Members

Nauraiz Abbas

Mi10MBA030

Waseem Anwer

Mi10MBA042

Yahya Mahmood

Mi10MBA025

Nayyar A. Majeed

Mi10MBA069

Kashif Naeem

Mi10MBA043

Contents
y What is Financial System y Introduction to Islamic Financial System (IFS) y Philosophy behind IFS y Regulation of IFS y Development of IFS in Pakistan y Islamic Modes of Financing y Graphical Representations of IFS
  

Islamic Banking around the World Islamic Banks in Pakistan Financial Highlights IFS

y Comparison Conventional System & Islamic System y Can IFS play any role in economic development of the Country? y Challenges y Conclusion

What is a Financial system ?

y Financial system is the system that allows

the transfer of money between

 

Investors & Borrowers.

y It can operate on a global, regional or firm

specific level.

Introduction Islamic Financial System (IFS)

y Islamic Financial System refers to a system

in which all transactions is consistent with the principles of Islamic law (Shariah)
y Shariah prohibits
o o

Riba (Interest) Gharar (Speculation)

Philosophy behind IFS

y Islamic Shariah forbids interest but it does not prohibit all

gains on capital.
y It is only the increase stipulated over the principal of a loan

or debt that is prohibited.

y Islamic principles simply require that performance of capital

should also be considered while rewarding the capital.

y Islamic financial system is based on
    

Risk-sharing, Owning and handling of physical goods, Involvement in the process of trading, Leasing and Constructing contracts using various Islamic modes of finance

Regulation of IFS
y In Pakistan, the banks are authorized to offer products based on

Islamic modes under the Banking Companies Ordinance, 1962.

y The Shariah Board of State Bank of Pakistan has approved

Essentials of Islamic modes of finance and Model Agreements, which previously issued as guideline to all Islamic banking institutions (IBI) responsible to give approval regarding Shariah compliance of all products of IBIs and issue Shariah rulings. regulations on Islamic banking. In case of any difference of opinion between SBP Shariah Board and Shariah Advisor of an Islamic bank, the ruling of SBP Shariah Board is final.

y Each IBI is required to appoint a Shariah Advisor who is

y The SBP Shariah Board advises State Bank in formulation of

Development of IFS in Pakistan

y The Council of Islamic Ideology (CII) was established in

1962 y 1973 Federal Shariat Court and compressive legislation on Islamic principles was passed, known as the third constitution of Pakistan y 1980 Zakat and Usher Ordinance was passed. Shariah enjoins all Muslims who are sahib-e-nisab to pay, and the State to arrange for the proper collection, disbursement and utilization of Zakat and Usher y 1985 All commercial banking in Pak Rupees was made interest free. As a result total deposits rose from 9.2% at the end of 1981 to 61.6% by end of 1985

Development of IFS in Pakistan (contd)

y In 1991 procedure adopted by banks in 1985 was declared

unislamic by federal shariat court.

y 1999 The shariat appellate bench of supreme court of

Pakistan ordered to cease all laws on interest banking. A high level commission was formed by government to establish and endorse Islamic banking as parallel banking.
y 2001 State bank of Pakistan laid down the standards for

establishment of Islamic commercial banks and stand alone branches by existing commercial banks.

Development of IFS in Pakistan (contd)

y 2002 State bank of Pakistan issued first Islamic banking

license to Meezan bank.

y State bank of Pakistan designed a musharika based export

refinance scheme, in order to provide export finance on the basis of Islamic modes of financing.
y 2004 Islamic banking department (IBD) was established

in state bank of Pakistan.

y 2005 A joint venture of Pak-Kuwait Investment

Company and Malaysian based company named Takaful National launched first takaful business in Pakistan.

Islamic Financial Products

1. Musharakah (Partnership) 2. Mudarabah (Passive Partnership) 3. Ijarah (Leasing) 4. Salam 5. Istisna (Contract of Manufacturing) 6. Wakalah 7. Takaful 8. Sukuk

1. Musharakah (Partnership)

y A joint enterprise in which all the partners share

the profit or loss of the joint venture



Profit of the enterprise can be distributed in any proportion by mutual consent. However, it is not permissible to fix a lump sum profit for anyone. In case of loss, it has to be shared strictly in proportion to the capital contributions.

The liability of all the partners is unlimited.

2. Mudarabah (Passive Partnership)

y This is a contract between two parties :
 

a capital owner (called rabb al-mal) and an investment manager (called mudarib).

y Profit is distributed between the two parties in accordance with the

ratio that they agree upon at the time of the contract. y Financial loss is borne by the capital owner; the loss to the manager being the opportunity cost of his own labor, which failed to generate any income


While the provider of capital can impose certain mutually agreed conditions on the manager, he has no right to interfere in the day-to-day work of the manager. The liability of the rabb al-mal is limited to the extent of his contribution to the capital. The mudarib is not allowed to commit the mudarabah business for any sum greater than the capital contributed by the rabb al-mal.

3. Ijarah (Leasing)
y Ijarah is a contract where the lessee (customer) uses

an asset which is owned by the lessor (Bank)



The ownership remains with the lessor and lessee pays monthly or annual rent for the use of asset Only the assets leased by the lessor can be leased out The commodities like money or fuel which cannot be used without consuming them, cannot be leased out The lessor will be responsible for the insurance of the leased asset

 

4. Salam (Sales Contract)

y Salam is a sales contract in which the price is

paid in advance at the time of contracting, against delivery of the purchased goods/services at a specified future date.
 

The price should be paid in full at the time of the contract. Goods whose quality or quantity cannot be determined by specification cannot be sold through the contract of salam. An example is precious stones. The exact date and place of delivery must also be specified.

5. Istisna (Contract of Manufacturing)

y Istisna is a contract in which a party orders

another to manufacture and provide a commodity , in the contract

   

the description delivery date price and payment date are all set with required details

7. Wakalah
y Wakalah is a contract whereby principal hires

someone else as his agent to act on his behalf for a specific task.


The agent is entitled to receive a predetermined fee irrespective of whether he is able to accomplish the assigned task to the satisfaction of the principal or not. He would be liable to penalties only if it can be proved that he violated the terms of the trust or acted dishonestly.

Takaful (Islamic Insurance)

y An alternative for the contemporary insurance contract. y A group of persons agree to share certain risk by collecting a

specified sum from each. In case of loss to anyone of the group, the loss is met from the collected funds.

y A Takaful company has the following features:



The company is not the one who assumes risks nor the one taking any profit. Rather, it is the participants, the policy holders, who mutually cover each other. All contributions (premiums) are accumulated into a fund. This fund is invested using Islamic modes of investment and the net profit resulting from these investments is credited back to the fund. All claims are paid from this fund. The policy holders, as a group, are the owners of any net profit that remains after paying all the claims. They are also collectively responsible if the claims exceed the balance in the fund.

Sukuk (Islamic Bonds)

y These are basically, certificates of ownership which

are negotiable in secondary markets.



Instruments should represent share in equity, real assets, money or debt or a combination of some or all of these; Instruments representing real physical assets are negotiable at market price Instruments representing debts in their negotiability to the rules of hawalah Instruments representing money are subject to the rules of sarf in their negotiability

Islamic Banking around the World

Source: PressReleasepoint.com

Islamic Banks in Pakistan

Name of Banks
Full-fledged Islamic Scheduled Banks

No. of Branches 2011 87 70 42 64 0 226 489 2010 29 70 42 36 58 168 415

1 2 3 4 5 6

Al-Baraka Bank (Pakistan) Ltd. Bankislami Pakistan Ltd. Dawood Islamic Bank Ltd. Dubai Islamic Bank Ltd. Emirates Global Islamic Bank Ltd.* Meezan Bank Ltd. Total

* Al-Baraka Islamic Bank has been merged with Emirates Global Islamic Bank Ltd and renamed as Al-Baraka Bank (Pakistan) Ltd.
Source: State Bank Annual Report 2011

Islamic Banks in Pakistan

Name Stand-alone Branches of Scheduled Banks
1 2 3 4 5 6 7 8 9 10 11 12 13 Askari Bank Ltd. Bank Alfalah Ltd. Bank Al Habib Ltd. Habib Bank Ltd. Habib Metropolitan Bank Ltd. MCB Bank Ltd. National Bank of Pakistan Soneri Bank Ltd Standard Chartered Bank (Pakistan) The Bank of Khyber The Royal Bank of Scotland * United Bank Ltd. Faysal Bank Ltd. Total

No. of Branches 2011

29 80 10 22 4 14 6 4 12 21 0 5 30 237 29 60 6 4 4 11 6 4 8 18 03 5 10 168

* The Royal Bank of Scotland has been merged with Faysal Bank Ltd

Deposits, Financing and Investments of Islamic Banks

Billion Rs.
Items No. of Accounts Jun 11 Jun 10 YOY Growth %

1,252,020 433.8 51,064 197.7 204.5

1,103,437 314.9 103,294 168.2 62.5

13.47 37.76 -50.56 17.54 227.20

Deposits
Amount No. of Accounts

Financing*
Amount

Investment

Book-value

*Includes advances & bills

Source: State Bank Annual Report 2011

Comparison Between Conventional & Islamic Banking System

Conventional System  Based on man made principle  The investor is assured of a predetermined rate of interest  It aims at maximizing profit without any restriction  It does not deal with Zakat.  compounding interest is the fundamental function of the conventional banks.  The conventional banks give greater emphasis on creditworthiness of the clients. Islamic System  Based on Islamic Shariah  risk sharing between investor and borrower  aims at maximizing profit but subject to Shariah restrictions  Zakat based system  Participation in partnership business is the fundamental function of the Islamic banks.  The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.

Can IFS play any role in economic development of a Country?

y Resource mobilization through Musharaka and Mudaraba

increases employment rate in a country

y Decrease in inflation due to better liquidity option based on

Murabaha techniques
y Market Stability due to Islamic modes of investment y The objective of Islamic Financial System is to raise the living

standard of a society as whole not as a individual

y IFS emphasis on the development of Small and medium

enterprises (SMEs) sector which has a great potential for expanding production capacity and self-employment opportunities in the country

Challenges
y Inadequate legal framework for Islamic banks y Ineffective code of conduct for professionals y

Absence of Shariah audit in Islamic financial institutions

y Lack of research and development in the field of Islamic

finance and economics

y Inadequate Regulatory and Accounting framework for

Islamic banking
y Social and cultural factors y Political Instability y

Lack of public awareness about Islamic economic system

Solutions
y Islamic Laws based society y Islamic code of conduct for professionals y Conducting Shariah audit in financial institutions y Efficient Shariah Supervisory Boards in banks y

Research and development in the field of Islamic financial System

y Political stability y Public awareness through conducting Seminars & training programs

& workshops
y Comprehensive knowledge of Islam & Shariah required for the

development of IFS

Conclusion