WHAT IS PARTICIPATORY BANKING? Concept, Instruments and Issues AUSAF AHMAD International Conference on Participatory Banking New Delhi Sept 01, 2007

In the name of Allah, the most Beneficent, the Most Merciful.

This presentation includes: What is Participatory banking? Basic function: Financial Intermediation An Introduction to Participatory financing techniques. Observations on some common misconceptions.

Clarification on Nomenclature Participatory 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.

COMMON PARAMETERS BETWEEN PARTICIPATORY AND COMMERCIAL BANKS Same purpose: Financial intermediation. Same Objective: Profit Successful Operation of Participatory banks has shown that financial intermediation is possible even without interest.

FINANCIAL INTERMEDIATION SURPLUS HOUSEHOLDS DEFICIT HOUSEHOLDS [Firms} FINANCIAL INTERMEDIATION Financial Flow FINANCIAL INTERMEDIARIES Financial Flow

FINANCIAL MARKET THE FIRM INDIVIDUALS FINANCIAL INTERMEDIARIES

DIRECT FINANCING Financial Flow Households Businesses Flow of Real goods

Financial Institutions Indirect Financing Return on Investment Return on Investment Business Households Financial Institutions Financial Resources Financial Resources

STRUCTURE OF FINANCIAL MARKETS Supervisory Bodies Indirect Finance Direct Finance Bonds Equities Depository Institutions Contractual Savings Institutions Investment Intermediaries Secondary Markets Commercial Banks Insurance Companies Mutual Funds Primary Markets Saving & Loan Associations Pension Funds Finance Companies Investment Banks Dealers and Brokers Stock Exchanges Over-the-Counter Exchange Cooperatives

Social and Moral Norms Gharar Should not indulge in Riba Should not involve in Should not indulge in fraudulent behavior Should not coerce Should assure fairness to all parties. No coercion. No financing of socially undesirable goods such as alcohol, drugs, pornography. Should not resort to morally reprehensible practices such as cheating, bribing, fraudulent practices.

The View on Bank Interest No distinction is made between usury and interest. No distinction is made between consumption loans and productive loans. No distinction between constant and variable interest rates. No distinction is made between individual and institutional rate of interest.

AVOIDANCE OF GHARAR Definition of Gharar Uncertainty / Ambiguity Ambiguity of Quantity [Gharar fil Miqdar] Ambiguity of Attributes [Gharar fis sifah] such as Ambiguity in time or place of delivery Ambiguity in price etc.

DEBT FINANCE Vs. PARTICIPATORY FINANCE Participatory finance, in comparison, to debt finance is: More just More equitable More efficient More growth oriented.

PRESENT SCENE Participatory Banks in the Government Sector Pakistan, Sudan, Iran Participatory Banks in the Mixed Sector - Malaysia Participatory Banks in the Private Sector Gulf Non Banking Financial Institutions Al Ameen [ Bangalore, India] Participatory Financing by standard Commercial Banks in the Domestic Sector Saudi British, NCB, Saudi American, Misr Bank Participatory financing by Commercial banks in the foreign sector. Islamic Banks established by multinational Banks Citibank, HSBC Amanah Bank,

A TYPICAL BALANCE SHEET Uses of Funds Murabaha Musharakah Mudarabah Ijarah Qard Hasan Sources of Funds Current Account Saving Accounts Investment Acc Special Invest. Acc

Business Practices in Sources of Funds Current Accounts Saving Accounts Investment Accounts General Investment accounts Limited Period Investment accounts Specified Investment accounts

Current Deposits [sources of funds] Very Similar to standard commercial banks No return paid back to depositors Checking facilities Are Current deposits a loan to the bank from depositors ? Are Current deposits a trust by depositors to banks ? Use of Current deposits by the banks on their own risk.

Saving Deposits [Sources of Funds] Saving deposits without authorization to invest Saving deposits with authorization to invest Return to depositors who provide authorization to invest. Saving deposits as a part of trust accounts. Saving deposit as Notice account

Investment Deposits [Sources of Funds] Islamic Banking counterpart of Fixed Deposits. Withdrawal allowed only in special cases Investment deposits as Mudarabah Accounts. Depositor: Rabbal Mal; Bank: Aamil Share profit on agreed basis, bear full loss. Investment pool Distribution of profits on pro rata basis.

Special Investment Deposits [Sources of Funds] Concept of Wakalah The bank acts as a wakeel. Implement\s the instruction of the Mawakkil. Special purpose investment, Specify, purpose, sector, industry, or even project. The bank gets a fee for the services rendered. Full profit or loss goes to the depositor. The bank will share in loss only in case of proven neglect.

USES OF FUNDS MUDARABAH MUSHARAKAH MURABAHAH IJARAH (Leasing) IJARAH WA IQTINA (Lease Purchase) MUSHARAKAH MUTANAQISAH LOAN ON SERVICE CHARGE INTEREST FREE LOANS.

TYPES OF CONTRCTS

TYPES OF CONTRCTS Contracts of Sale / Lease are Muawadat. Gharar is not allowed in such contracts. Mudarabah and Musharakah are contracts of Partnerships. Some amount of gharar may be tolerated in such contracts. Sadaqat and Hadaya are Tabarruat. No objection to Gharar in these type of contracts.

Financing Techniques These techniques were devised in the classical period for the commodity trade Their application to financial sector is an innovation of the modern era. The application of these techniques requires new documentation which was not required in the early period.

MURABAHAH [USES OF FUNDS] - I The word MURABAHA is derived from the word Ribh, meaning profit in Arabic. Sale with a profit. Cost-plus financing. Examples of Murabahah. Two contracts: A contact of intent to conduct a Murabaha Sale and another contact to buy the good ordered in previous contract. Promise is not a legal binding. It introduces an element of risk in the transaction. The element of risk justifies the profit in Murabaha sale : Fiqhi principle : Al Kharaj bi Daman.

MURABAHAH [USES OF FUNDS] - II Applications of Muraqbaha: In domestic trade In foreign trade In financing consumer durables In financing real estaes ABUSES OF MURABAHA MURABAH AND BAY EINA.

MURABAHAH [USES OF FUNDS] - II Applications of Muraqbaha: In domestic trade In foreign trade In financing consumer durables In financing real estaes ABUSES OF MURABAHA MURABAH AND BAY EINA.

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

MUDARABAH [USES OF FUNDS] Mudarabah existing from pre-Islamic times. Permitted on the Cannon of Necessicity. Profit and loss sharing is a wrong translation. Arrangement: Profit is shared on an agreed basis, loss is borne by the Rabbal Mal. Bank: Rabbal Mal, Entrepreneur : Aamil Double tier Mudarabah. Requirements for a successful Mudarabah

Other Financing Techniques Loans on Service Charge Qard Hasan [interest free loans] Service Charge is to be equal to actual administrative expenditure Qard Hasan is limited to social purposes only.

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. Ijarah muntahi bit tamlik

Other Financing Techniques Diminishing Musharakah Loan of Service Charges. Only administrative expenses can be charged. Interest free loans are provided as a social service

Latest Trends in Participatory Financial Markets Derivatives and secondary market Evolution of Financial Instruments and Financial Papers Securitization Musharakah bonds Ijarah bonds

SOME MISCONCEPTIONS PARTICIPATORY BANKING IS RELIGION BASED. PARTICIPATORY BANKING IS FOR A SPECIFIC COMMUNITY PARICIPATORY BANKING REPLOACES INTEREST RATE WITH PROFIT AND THAT IS ALL.