DIP – 10. Islamic Banking Lim Sei Kee @ cK

Islamic Banking Islamic banks adhere to the concepts of Islamic law. Islamic banking refers to a system of banking or banking activity that is consistent with Islamic law (shariah) principles and guided by Islamic economics

Principles of Islamic banking Prohibition of riba (interest) Profit sharing (mudharabah) Safekeeping (wadiah) Joint venture (musharakah) Cost plus (murabahab) Leasing (ijarah)

Conventional banking Islamic banking It does not deal with zakat In modern Islamic banking, it has become one of the service oriented function of the Islamic banks to be a zakat collection centre and they also pay out their zakat It can charge additional money in case of defaulters Islamic banks have no provision to charge any extra money from the defaulters Very often it results in the banks own interest becoming prominent. it makes no effort to ensure growth with equity It gives due importance to the public interest, its ultimate aim is to ensure growth with equity Conventional bank has to guarantee all its deposits Islamic bank can only guarantee deposits for deposit account, thus depositors are guaranteed repayment of their funds

Islamic Banking –The Concept Concept  principles  no deception and no riba (interest) It is not new  7th Century Money is a medium of exchange Interest can lead to injustice/exploitation in society  Zulm No real 'lending' as all 'lenders' obtain interests To earn money for banks, they must obtain an equity / ownership Requires banks to participate, share risk  profit varies Profit share is distributed instead of interest earned Leads to more ethical society (Unlike West  you must pay interest) This concept encourages better resource management

Islamic Banking is known by several names: Interest free banking (Iran) PLS Banking (Pakistan) Islamic Banking (Gulf) Special Finance Houses (Turkey) All expressions are used interchangeably. Some people prefer Islamic Finance House instead of Islamic bank. (Beit ul tamweel)

Islamic Modes of Finances Rental-based Ijarah  Lease Partnership-based Musharakah  Partnership  time,$  share profit Risk is shared between 2 person  loss or profit is shared Mudharabah  Partnership one $, other effort If profit, it is shared with the customer; bank takes its fee If loss, customer loses; bank does not take its fee

MUSHARAKAH [USES OF FUNDS] Musharakah is from the word Sharikah. More than one partners: Partnership in capital proportion and project supervision. A partner may waive his right of supervision or delegate it to another partner. Arrangements: Sharing of Profit and loss in accordance with capital proportion agreed proportion. Variant: Share of profit in agreed proportion, share of loss in capital proportion. Applications of Musharakah: i. in Import trade Ii. In Agriculture

The structure of a Musharakah Contract ISLAMIC BANK PARTNER (Customer) MUSHARAKAH 60% Ownership 40% Ownership

MUDHARABAH [USES OF FUNDS] Mudharabah existing from pre-Islamic times. Profit and loss sharing is a wrong translation. Arrangement: Profit is shared on an agreed basis, loss is borne by the Rabbal Mal. (Bank)

Islamic Credit Cards Ujrah Concept  Payment in exchange for services, benefits and privileges offered to the cardholders Mudharabah  Partnership  bank $, customer benefit Minimum age  21, With parents  18 Payable Facility Charges  varies monthly; 0 if full payment paid on or < due date Ta'widh (compensation)  1% of outstanding balance

Periodic proportionate Profits / Return of Capital CLIENT (Mudarib) Investor of Capital ISLAMIC BANK Payment of Mudarabah Capital Mudharabah (Passive Partnership) INVESTMENT / TRADING ACTIVITIES Earning of Profits ISLAMIC BANK Periodic proportionate Profits / Return of Capital CLIENT (Mudarib) Distributor of Profits Earned

The bank provides to the customer (mudarib) all the capital to fund a specified enterprise The customer contributes only entrepreneurship. The customer is responsible for the day to day management of the enterprise and is entitled to deduct its management fee (mudarib fee) from the enterprise’s profits. The mudarib fee could be a fixed fee (to cover management expenses) and a percentage of the profits or a combination of the two. The balance of the profit of the enterprise is payable to the bank If the enterprise makes a loss, the bank (as the fund provider or Rabbul Mal) has to bear all the losses unless the loss has resulted from negligence on the part of the mudarib.

IJARAH [USES OF FUNDS] Ijarah is emerging as a popular technique of financing amongst the Islamic banks Elements of a lease contact: Lessor, Lessee, instrument and period of lease, The asset remains in the ownership of the lessor. Maintenance is the responsibility of the owner.

Ijara Mortgages – Lease to Own Find a house to purchase and agree a sale price Bank will then purchase the property outright You then enter into 2 agreements with the bank Pay back the purchase price  fixed monthly instalments  over 25 years Pay agreed $ as rent each month  bank’s profit Rent is set annually, ↓ yearly in % of payment When fully paid  ownership is transferred to you Borrow  up to 90% of the purchase price Legitimate under Sharia law

The structure of an Ijarah Wa Iqtina Contract Assets leased to customer – title does (not) pass at end of lease term Transfer of title to bank VENDOR ISLAMIC BANK CUSTOMER (Lessee) Payment of purchase price Ijarah Installment

Ijarah The bank buys the asset from the vendor The bank then leases the asset to the customer Periodic rentals are collected by the bank The title of the asset remains with the bank under as operating ijarah Title passes to the customer under a Lease ending with transfer of ownership, either gradually over the period of the contract, at the end.

SOME MISCONCEPTIONS ISLAMIC BANKING IS RELIGION BASED ISLAMIC BANKING IS FOR A SPECIFIC COMMUNITY ISLAMIC BANKING REPLACES INTEREST RATE WITH PROFIT AND THAT IS ALL.

The end of course.

Individual presentation 1. Discuss the importance of the Islamic system in managing a business. 2. Discuss how to make effective decisions to comply with Islam. 3. Describe Islamic banking Musharakah Mudharabah Ijarah Takaful

Important dates 25th Feb: Tutorial 10 Presentation Dates: 28th Feb 4th Mar 7th Mar 11th Mar*** NOTE: MAXIMUM 5 STUDENTS /EACH DATE.