Mohammad Salleh Bin Abdul Saha ISB 300 Centre for Islamic Thought and Understanding University Teknologi MARA Terengganu What is financial system ? The processes and procedures used by an organization management to exercise financial control & accountant ability. These measures include recording , verification, and timely reporting of transactions that affect revenues, expenditures, assets and liabilities. The financial system is concerned about money, credit and finance. (the three terms are intimately related yet are somewhat different from each other) What is money ? Money is anything of value that serves as a generally medium of exchange. Unit of accounting measures. Means to save or store purchasing power. What is credit/loan? An arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point in time. What is finance ? A branch of economics concerned with resource allocation as well as resource management, acquisition and investment. Simply,finance deals with matters related to money and the markets. Financial System Structure in Malaysia Financial Institutions Financial Markets a) Banking System BNM Banking Institutions : - Commercial banks include Islamic banks - Finance Companies - Merchant Banks Others: - Discount Houses - Representatives Offices of Foreign Banks - Offshore Banks in Labuan IOFC a) Money & Foreign Exchange Markets : • Money Market • Foreign Exchange Market b) • • • • Non-Bank Financial Intermediaries : Provident & Pension Funds Insurance companies include Takaful Saving institutions Others: - Unit Trusts – Pilgrims Fund Board – Housing Credit Institutions – Cagamas Berhad –Credit Guarantee Corporation – Leasing Companies –Factoring Companies –Venture Capital Companies. b) Capital Markets: • Equity markets • Bond Markets –Public Debt Securities – Private Debt Securities c) • • • Derivatives Markets: Commodity Futures KLSE CI Futures KLIBOR Futures d) Offshore Markets: • Labuan International Offshore Financial Centre (IOFC) 5 Banks as Financial intermediaries Who is financial intermediaries ? Financial intermediaries may include banks, brokerdealers, investment advisers and financial planners. Roles? Promote savings and capital accumulation to finance projects using various modes of financing. Finance international trade. Mobilize resources for investments for the benefit of society. Contribute social welfare through Corporate Social Responsibilities (CSR) and zakat. Islamic banking What is islamic banking ? • Islamic banking is banking based on Islamic law (Shariah). It follows the Shariah, called fiqh muamalat (Islamic rules on transactions). The rules and practices of fiqh muamalat came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad). Islamic banking in Malaysia ? The first Islamic bank was established in Malaysia in 1983. In 1993, commercial banks, merchant banks and finance companies begun to offer Islamic banking products and services under the Islamic Banking Scheme (IBS banks). The IBS banks have to separate the funds and activities of the Islamic banking transactions from the non You can identify an Islamic bank or an IBS bank from the logo below: ESTABLISHMENT OF ISLAMIC FINANCIAL SYSTEM IN MALAYSIA Banking Industry in Malaysia Section 2 CORPORATE INFORMATION 10 MILESTONES OF ISLAMIC BANKING PRODUCTS 1983-1990 Wadiah Current Account Wadiah Savings Account Mudharabah Financing Ijarah Financing BBA Financing Mudharabah Investment Account Murabahah LC Musharakah LC Wakalah LC Bay Dayn Trade Financing Murabahah Working Capital Financing 1991-2000 Sarf Forex Mudharabah Interbank Investment Musharakah Financing Bay Inah Credit Card Note - This listing is far from being exhaustive. 2001-2005 Bay Dayn, Musharakah, Mudharabah ICDO Wadiah Debit Card Bay Inah Overdraft Bay Inah Commercial Credit Card Bay Inah Personal Financing Bay Inah Negotiable Instrument of Deposit (NID) 2006-2008 Commodity Murabahah Profit Rate Swap Commodity Murabahah Forward Rate Agreement Ijarah Rental Swaps-i BBA Floating Rate Murabahah Floating Rate Istisna’ Floating Rate Ijarah Floating Rate Mudharabah Capital Protected Structured Investment Bay Inah Floating Rate NID Mudharabah Savings Multiplier Deposit Tawarruq Commodity Undertaking 2009 onwards Tawarruq Business Financing Tawarruq Personal Financing Tawarruq Credit Card Murabahah with Novation Agreement Istisna’ convertible to Ijarah Bay and Ijarah (Sale and Lease Back) Musharakah Mutanaqisah Istisna’ with Parallel Istisna’ (April2009,) Philosophical foundations of Islamic Banks Tawhid Khilafah Amanah Al-’adalah Tazkiyah Huriyyah (April2008,April 2009,April 2011) Goals and objectives of Islamic banking • Offer Financial Services The thrust is towards financing on risk- sharing and strict focus on halal activities Focus on offering banking transactions adhering to Syariah principle and avoiding conventional interest- based banking transactions. • Economic Development Established a direct and close relationship between the bank’s return on investment and the successful operation of the business by the entrepreneur. • Optimum Resources Allocation Considered to be most profitable, religiously permissible and are beneficial to the economy. Optimum Approach Profit- sharing principle encourages banks to go for projects with long- term gains instead of short- term gains. Banks conduct proper studies before getting into projects. High returns distributed to shareholder maximize the social benefits and bring prosperity to the economy. Equitable Distribution of Resources Ensures equitable distribution of income and resources among the participation parties, with its profit- sharing approach which is one of a kind. Facilitate Stability in Money Value Islam recognize money as a means of exchange and not as a commodity. Riba- free system leads to stability in the value of money to enable the medium of exchange. (Oct2006,Oct2007,April 2008,April2009, Oct2009,April 2010,April 2011,Sept2011) Principles of Islamic Banking • Islamic banking is the conduct of banking based on Syariah principle • Does not allow the paying and receiving of interest. • The principles for Islamic banking are listed: Prohibition of Riba • • Riba is strictly prohibited under Islam and is considered as haram. Islam allows only one kind of loan that is Qardhul Hassan. Equity participation • Islam encourages muslims invest their money and become partners in order to share profits and risk in the business instead of becoming creditors. • In Islam, financing is based on the belief that the financier and borrower should equally share the risks of the business venture. Prohibition of gharar Gharar means to undertake a venture blindly without sufficient knowledge or to undertake excessively transactions An Islamic financial system discourages hoarding and prohibits transactions featuring extreme gharar. Contractual relationship Depends upon the nature of transaction. It could be a seller and buyer relationship (Murabaha), a lessor- lessee relationship (Ijara), and a partnership (Musyaraka) Money as Potential Capital • It is way of defining the value of a thing. • Should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or when lent to someone. (April2009) Differences between Islamic Banking and Conventional Banking System Business Framework Prohibition of Riba in Financing Syariah Supervisory Board Zakat (Religious Tax) Restrictions Characteristics Islamic Banking System Conventional Banking System (Interest-Based) Business Framework Functions and operating modes are based on secular principles and not based on any religious law or guidelines. Functions and operating modes are based on Syariah law. Banks have to ensure that all business activities are in compliance with Syariah requirements. Syariah Supervisory Board Each bank should have a There is no such Syariah Supervisory Board requirement to ensure that all business necessary. activities are in line with Syariah requirements. Prohibition of Riba in Financing • Financing is not interest – oriented • Financing is interest – oriented • Based on the principle of buying and selling of assets, whereby the selling price include a profit margin • A fixed/floating interest is charged for the use of money. • Fixed from the beginning. Restrictions Islamic banks are restricted to participate in economic activities, which are not Syariah-compliant. There are no such restrictions. Zakat (Religious Tax) E.g. Banks cannot finance Do not deal in Zakat. businesses involving pork, alcohol, etc. In the modern Islamic banking system, it has become one of the functions to collect and distribute zakat. ISSUE 1: SIMILAR TO CONVENTIONAL BANKING? Islamic bank is a “bank” – intermediary in “indirect funding” between depositors and financing customers. The difference is Shariah compliant انما البيع مثل الربا – احل هللا البيع و حرم الربا KEY DIFFERENTIATING FACTOR CONVENTIONAL BANKING ISLAMIC BANKING FUNCTIONS AND OPERATING MODES Based on fully man-made principles Based on the principles of Shariah INTEREST- BASED TRANSACTIONS Most of the activities are interestbased Absence of interest-based (riba) transactions RISK MANAGEMENT Concerned with "elimination of risk" Islamic banks "bear the risk" when involve in any transaction AIMS AT MAXIMIZING PROFIT Without any restriction Subject to Shariah restrictions PENALTY It can charge additional money (penalty and compounded interest) in case of defaulters Charge in the form of ta’widh (compensation) as determined by the Shariah Advisory Council of BNM. BANK-CUSTOMER RELATIONSHIP Creditor and debtors Partners, investors and trader, buyer and seller Advantages of Islamic Banking Justice and Fairness ~ The main feature of the Islamic model is that it is based on a profitsharing principle, whereby the risk is shared by the bank and the customer. ~ This system of financial intermediation will contribute to a more equitable distribution of income and wealth. Liquidity ~ Follow the profit and loss-sharing principle to mobilize resources and are less likely to face any sudden run on deposits. ~ As such, they have a minimum need for maintaining high liquidity. Better Customer Relations ~ Financing and deposits are extended under the profit and loss sharing arrangement. The banks are likely to know their fund users better in order to ensure that the funds are used for productive purpose and vice-versa for investors. ~ It will develops better relations between the financial intermediary and the fund providers or consumers. ~ Also promote productive economic activities and socio-economic justice. No Fixed Obligations ~ Islamic banks do not have fixed obligations such as interest payments on deposits. Therefore, they are able to allocate resources to profitable and economically desirable activities. ~ Also holds good for Islamic financing, as the payment obligations of the entrepreneur is associated with the revenue. Ethical and Moral Dimensions ~ Strong ethical and moral dimensions of doing business and selecting business activities to be financed, play an important role in promoting socially desirable investments and better individual or corporate behavior. Banking for All ~ Although based on Syariah principles to meet the financial needs of Muslims, it is not restricted to Muslim only and is available to non-Muslims as well.