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

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

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

4. 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.

5. 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.

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

7. FINANCIAL MARKET
THE FIRM
INDIVIDUALS
FINANCIAL
INTERMEDIARIES

8. DIRECT FINANCING Financial Flow Households Businesses
Flow of Real goods

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

10. 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

11. 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.

12. 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.

13. 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.

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

15. 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,

16. 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

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

18. 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.

19. 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

20. 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.

21. 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.

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

23. TYPES OF CONTRCTS

24. 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.

25. 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.

26. 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.

27. 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.

28. 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.

29. 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

30. 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

31. 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.

32. 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

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

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

35. 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.