Lecture Three
Introduction
to
Comparative
Financial System
Brief History of
Islamic Financial System
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In 1963 Interest free savings bank (Mit Ghamr Saving
Bank) was first introduced- invested in trade and industry in
return of share of profits.
During the 1970s and early 80s Egypt Nasr Social Bank,
Dubai Islamic Bank, Faisal Islamic Bank of Sudan and
Islamic Banks in Bahrain, Malaysia, Nigeria Indonesia, and
the Philippines were established
Islamic windows of the conventional banks: As of 2007 20
branches of 10 conventional banks are operating under
Islamic system. Examples- HSBC Amanah fund, ANZ
International Murabhah ltd, Standard Chartered Sadiq
1975 IDB was established through the Conference of
Islamic Finance Ministers in 1973 – Fee and Profit Loss
sharing Basis.
Brief History of
Islamic Financial System in Bangladesh
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Islamic Finance started its journey in Bangladesh in 1980s
with the establishment of the Islami Bank Bangladesh Ltd
(IBBL) on March 13, 1983. It was the first Islamic bank in
South and Southeast Asia. Now the leading private bank in
Bangladesh.
At present there are 7 full fledged Islamic banks operating
in Bangladesh – IBBL-1983, Al-Barakah Islami Bank Ltd 1987 (Now known as ICB Islamic Bank), Al-Arafah Islami
Bank Ltd- 1995, Social Investment Bank Ltd- 1995, Shamil
Bank of Bahrain- 1997, Shahjalal Islami Bank Ltd- 2001,
Exim Bank Ltd- 1999 (Islamic operation from 2004), Bank
Al-Falah- 2007.
Definition of Islamic Finance
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Islamic financial system is a product of Islamic economic
system which is based on the Islamic principles and
philosophy (Shariah). The basic framework for an Islamic
financial system is a set of rules and laws, collectively
referred to as the shariah, governing social, economic,
cultural, and political aspects of the Islamic society. It
differs from the western worldview in the following ways:
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Priority in emphasis on Islam's teaching of Justice and Equity as
demonstrated by the enforcement of distributive justice
A spiritual framework that values human relations above material
possessions
A balance between individual self-interest and the common good
Maximum profit and satisfaction are not the sole objectives, which
in effect minimizes waste
Recognition and protection of private property rights while
encouraging reciprocal responsibilities.
Differences Between Islamic
Finance and Conventional Finance
Bank
Islamic
Goods & Services
Client
Money
Conventional
Money
Bank
Client
Money & Money (Interest)
Differences Between Islamic
Finance and Conventional Finance
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CFS is based on interest where as IFS is based on
profit/loss or rent sharing.
CFS Deals with only the financial assets such as money or
paper, IFS deals with real assets.
CFS is based on predetermined return on both sides of the
balance sheet, IFS is based on profit sharing on deposits
(liability) side and profit/loss on the asset side.
CFS does not involve itself in trade or business- just lend
money in return of payment of interest. IFS actively
participate in legal trade, production, and services through
valid contracts as an investment partner. Similar role like
an investment bank.
Principles of Islamic Financial
System
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The basic principles of the Islamic financial system
are based on the following characteristics
Prohibition of interest (riba)
Risk sharing
Share of the profits
Money as “potential” capital
Prohibition of speculation (Gharar)
Sanctity of contracts
Shariah-approved activities.
Differences between Profit and
Interest
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Profit is related to buying and selling (trading) of goods
and services. Interest is related to purely debt and time.
Profit is the integrated investment of capital, labor and time
spent by the investors. In case of interest, the lender does
not need to invest his labor.
Profit is unidentified and uncertain, interest is predefined
and certain.
Profit is earned once only but interest may be taken
several times.
Profit is subject to having loss, interest has no uncertainty
of loss.
Challenges of Implementing
Islamic Financial System
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The Islamic Financial System requires careful
implementation of the following aspects:
Supportive legal framework
Overall risk management
Ethical values
Shariah body/council
Standard Islamic financial institution
Uniform accounting standard
Major Contracts Used in
Islamic Finance
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Murabahah: Buying and selling of goods based on
cost-plus pricing
Mudhrabah: Profit-sharing partnership
Musharakah: Joint-venture partnership
Ijarah: Leasing
Wakalah: Agency
Bai-al-Salam: Forward sale contract
Istisna’a: Supply contract
Qardul Hasanah: Benevolent loan
Murabahah
(Bai-al-Bithman Ajil)
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It is a type of sale where the seller express the
cost of the sold commodity, and sell it to
another person by adding some profit of markup thereon.
Two aspects are important for this type of
contract:
 Production cost + Mark-up
 Disclosure of actual cost
Basic Features of
Murabahah Contract
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Murabahah is not as loan given on interest, rather it is a
contract of sale of a commodity for a deferred payment
which will include a cost plus added profit.
It must follow the basic Islamic concept of contract (fiqhal-muamalat). Two fundamental concepts are:
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The subject of sale must be present at the time of sale. Example:
selling of inexistent good or service such as unborn calf, crops
before ripe, fish in the pond, etc are prohibited.
The subject of sale must be under the ownership of the seller at
the time of sale. Example: forward contract on short selling is
prohibited.
Basic Features of
Mudarabah Contract
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Mudarabah is a special kind of partnership where one
partner provide money to other partner(s) for investing in
commercial enterprises. The investment comes from the
fund provider who is called “rab-ul-maal” while the
management and work is an exclusive responsibility of the
other, called “mudarib”.
Single-tier and Two-tier Mudarabah: Single tier
mudarabah is a mechanism by which the investor directly
deals with the entrepreneur, where as under the two-tier
mudarabah, investors pull their funds with an intermediary
who subsequently deals with entrepreneurs.
Musharakah
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Musharakah means sharing. In the context of
business it refers to a joint venture in which all
the partners share the profit or loss of the joint
venture. Profit may be shared according to a
previously agreed ratio but losses (if any) has
to be shared according to the proportion of the
contributed capital.
Musharakah
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The basic characteristics of Musharakah contracts
include the followings:
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Each partner is an agent of the other partners in all
aspect of the partnership business
Partners must have-a) free will, b) sound mind and c)
maturity of age
Rate of profit to be shared must be predetermined.
Capital may be invested in any proportion by the
investors
Loss (if any) must be borne according to the share of
capital contribution.
Differences between
Mudarabah and Musharakah
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In case of mudarabah investment is the sole responsibility
of rab-ul-maal, where as under musharakah investment
comes from all the partners.
For mudarabah management is carried out by the
mudarib only, as for musharakah all partners can
participate in the management.
In case of mudarabah any loss incurred is born by the
rab-ul-maal only, where as under musharakah losses are
born by the partners according to their shares of
investment.
For mudarabah there is a limited liability of the investors,
where as for musharakah, the partners have unlimited
liability.
Al-Ijarah (Leasing)
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Ijarah means to give something in exchange for a rent
income. In Islamic term it refers to a contact whereby the
owner of something transfer its utility to another person for
an agreed period, at an agreed consideration.
The bank will lease an item to the customer for a preagreed period and then the customer will pay the balance
of the price for the item and be the owner of the item.
There are two concepts of ijarah:
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The first concept is drawn from Islamic jurisprudence. Here it
refers to employment of the service of a person on wages given to
him as a consideration for his hired services. Example Mr. A has
employed Mr. B in his office as a manager on a monthly basis.
However, in Islamic finance, it refers to the useful rental assets
and properties and not to the services of human beings.
Al-Wakalah
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It refers to the delegation of a duty to another
party for specific purposes and under specific
conditions. Under this concept, the bank act as
an agent in completing a particular transaction
in return of a service charge for the service it
provides.
Istisna’a
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It is an order sale used mainly to finance assets
under construction. This allows the bank to
disburse payments according to the stage of
completion. As a financier, the bank rarely order
the assets for its own use rather for its customers.
Once completed the asset is handed over through
ijarah, murabahah, mudarabah or mushrakah
agreement.
Istisna'a is a technique similar to Bai al Salam and
is used to provide advance funding for construction
and development projects.
Istisnah (cont.)
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The key practical difference to Bai al Salam is that,
instead of buying a finished asset with delivery
deferred, the financier pays an amount to fund the
manufacture, development, assembly, packaging or
construction of an asset to an agreed specification.
On completion, it will typically sell the asset to the
customer or lease it back to the developer under an
Ijara.
The financier's return usually takes the form of a
premium on resale, typically calculated by reference
to a benchmark, such as an inter-bank offer rate
(IBOR), plus a margin.
Bai-al-Salam
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Bai Al-Salam (future delivery) Refers to an
agreement whereby payment is made immediately
while the goods are delivered at a later date. It is
equivalent to an advance payment.
Bai al Salam can be used to provide working
capital. The key difference to Murabaha is that,
while the financier still buys an asset, delivery is
deferred.
Bai-al-Salam (cont.)
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Usually, the financier will receive a discount
for advance payment, typically calculated by
reference to a benchmark, such as IBOR,
plus a margin.
Financier may at the same time enter into a
parallel but separate Bai al Salam with a
third party to resell the asset for an increased
price (also calculated by reference to a
conventional benchmark such as IBOR), or it
may simply sell the asset on delivery.
Qard-al-Hasanah
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Charitable loans free of interest and profitsharing margins, repayment by installments.
A modest service charge is permissible.
Unremunerated deposit products, usually for
charitable purposes.
References
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www.islamic-finance.com
http://www.zawya.com/story.cfm/sidZAWYA2
0071118121758
http://www.sc.com.my/eng/html/icm/Glossary.
html