Islamic Banking- FAQ's

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islamic 504 banking 261 banks 234 financial 176 finance 100 financing 96 countries 82 modes 77 debt 71 institutions 68 economic 62 conventional 60 economy 56 foreign 56 funds 56 investment 56 development 50 government 49 profit 49 public 47

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functions the functions of the institute are a to organize and coordinate basic and applied research with a view to developing models and methods for the application of shari ah in the fields of economics finance and banking b to provide for the training and development of professional personnel in islamic economics to meet the needs of research and shari ah observing agencies c to train personnel engages in development activities in the bank s member countries d to establish an information center to collect systematize and disseminate information in fields related to its activities and e to undertake any other activities which may advance it purpose
islamic research and training institute establishment the islamic research and training institute irti was established by the board of executive directors of the islamic development bank idb in h

isbn x the view expressed in this book are not necessarily those of the islamic research and training institute nor of the islamic development bank
C islamic development bank king fahd national library cataloging in publication data jarhi mabid all islamic banking answers to some frequently asked questions jeddah p x cm occasional paper no

policy makers in the monetary and financial sectors of the idb member countries have also often asked the islamic research and training institute irti some basic questions of theoretical and practical importance about the elimination of interest from the national economies of muslim countries and the transformation of the prevailing conventional system to an islamic one
some of these questions reflect a desire to understand the basic concepts of islamic finance while others relate to the creation of an enabling environment through macroeconomic reform and structural adjustments that are needed to establish the islamic financial system and the complications that arise when an effort is made to bring about the transformation without creating such an environment

what is the scope of transactions to which the ban on riba is applicable does the term apply only to the interest charged on consumption loans or does it also cover productive loans advanced by banking and financial institutions q
in the absence of lending at a rate of interest what modes of financing can be used for a trade and industry finance b financing the budget deficit c acquiring foreign loans part islamic banking q

a large number of muslim countries depend heavily on foreign loans from other countries as well as from international financial institutions like the world bank and the imf

in its basic meaning riba can be defined as anything big or small pecuniary or non pecuniary in excess of the principal in a loan that must be paid by the borrower to the lender along with the principal as a condition stipulated or by custom of the loan or for an extension in its maturity

mabid al jarhi and munawar iqbal while trading in any of the six commodities mentioned in a well known authentic hadith abu s a i d al khudri narrated that the apostle of allah peace be upon him said gold for gold silver for silver wheat for wheat barley for barley dates for dates and salt for salt like for like payment being made hand by hand

similarly it makes no difference whether the return is a fixed or a variable percentage of the principal or an absolute amount to be paid in advance or on maturity or received in the form of a gift or prize or a service if stipulated as a condition or expected as a custom in the loan contract or an extension in its maturity

meanwhile it allows the creditor and the debtor to agree on the day of settlement a but not before a to settle the debt in a currency other than the one specified for the debt provided that the rate of exchange applied is the one that prevails on the settlement date

we will limit ourselves here to a very brief review of the basic modes being used by islamic banks emphasizing at the same time that the door is open to devise new forms provided that they conform to the rules of the shari ah

diminishing partnership this is a contract between a financier the bank and a beneficiary in which the two agree to enter into a partnership to own an asset as described above but on the condition that the financier will gradually sell his share to the beneficiary at an agreed price and in accordance with an agreed schedule
murabahah sales contract at a profit markup under this contract the client orders an islamic bank to purchase for him a certain commodity at a specific cash price promising to purchase such commodity from the bank once it has been bought but at a deferred price which includes an agreed upon profit margin called markup in favor of the bank

a lease ending in the purchase of the leased asset leasing that ends in the purchase of the leased asset is a financing contract which is intended to transfer ownership of the leased asset to the lessee at the end of the lease agreement
a l istisna contract of manufacture and al istisna altamwili financing by way of istisna al istisna is a contract in which a party orders another to manufacture and provide a commodity the description of which delivery date price and payment date are all set in the contract

the first is concluded between the beneficiary and the bank in which the price is payable by the purchaser in future in agreed installments and the bank undertakes to deliver the requested manufactured commodity at an agreed time
b the utilisation of islamic modes of financing islamic banks utilize islamic modes of financing on two sides first on the side of liabilities or resource mobilization and second on the side of assets or resource utilization

the bank and the investment deposit holders share the realized profit in accordance with the ratios agreed upon between the parties at the time of contracting
dubai islamic bank faisal islamic bank egypt jordan islamic bank kuwait finance house islam malaysia bank berhad qatar islamic bank simple average weighted average source iqbal munawar et al

in the absence of lending at a rate of interest what modes of financing can be used for a trade and industry finance b financing the budget deficit c acquiring foreign loans as a rule all financial arrangements that the parties agree to use are lawful as long as they do not violate islamic principles
a modes for financing trade and industry murabahah installment sale leasing and salam are particularly suitable for trade while istisna is especially suitable for industry

the government may create an independent legal entity that floats public property certificates and uses the proceeds to purchase those assets and rent them back to the government or any other entity that can use them for productive purposes
c an alternative to foreign loans to provide an alternative to foreign borrowing arrangements could be made to attract foreign as well as domestic funds through two ways

the issue of certificates public as well as private enterprises can issue musharakah partnership and ijarah leasing certificates to finance projects especially development projects in addition to floating stocks
funds can be established either to finance a certain sector for example agriculture industry and infrastructure a particular industry for example textiles household durables etc

what is an islamic bank how different is it from a conventional bank before we define what an islamic bank is like it is better to give a short description of conventional banking

mabid al jarhi and munawar iqbal government level several countries have borrowed billions of dollars used them unproductively for other purposes and ended up with serious debt proble miss banks can ascertain the proper use of loans through monitoring but it is either discouraged by clients or is too costly and hence not commercially feasible

as far as the nature of investment deposits are concerned these could be either general investment deposits that enter into a pool of investment funds or specific investment accounts in which deposits are made for investment in particular projects

financial intermediation enhances the efficiency of the saving investment process by eliminating the mismatches inherent in the requirements and availability of financial resources of savers and entrepreneurs in an economy
with regard to whether we need banks we can divide agents natural as well as legal entities in an economy into two groups one that has the ability to exploit investment opportunities requiring more financial resources than they have

however the concepts of islamic banking and finance are still in their early stages of development and islamic banking is an evolving reality for continuously testing and refining those concepts

another manifestation of the success of islamic banking is the fact that many conventional banks have also started using islamic banking techniques in the conduct of their business particularly in dealing either with muslim clients or in predominantly muslim regions
in order to compare islamic to conventional banking we need first to compare universal to commercial banking and second to see what advantages the use of profit sharing modes may bring to the banking industry

we will first briefly review the advantages of universal banking vis a vis commercial banking and then list some of the advantages of the use of profit sharing modes of finance
in addition by sitting on the firms board of directors banks could influence corporate governance in the whole productive sector leading to general improvements in macroeconomic performance

therefore guaranteeing in advance a fixed return on a loan without taking into consideration the actual results of the operations of the borrowing enterprise would put all business risk on the entrepreneur the contrary however is true and the arrangement would be fair if the financier were to participate in the actual profit or loss of the enterprise as the case may be
those studies have shown that a system which is based on profit sharing is not only viable but also carries with it many advantages which make it superior to an interest based one

since bank assets are created in response to investment opportunities in the real sector of the economy the real factors related to the production of goods and services in contrast with the financial factors become the prime movers of the rates of return to the financial sector
the transformation of an interest based system into one based on profitsharing helps achieve economic growth as this results in increasing the supply of venture or risk capital and consequently encourages new project owners to enter the realm of production as a result of more participation in the risk taking

how many islamic banks are working at present and where islamic banks have spread in all parts of the islamic world alongside conventional banks
mabid al jarhi and munawar iqbal table key financial indicators islamic banks vis a vis conventional banks percentages indicator top ten top ten asian top ten middletop ten world eastern east islamic capital asset ratio

thus the practice of islamic banking at present takes one of the following forms a islamic banks and financial institutions operating within a financial system where all banks are islamised b islamic banks and financial institutions operating alongside other conventional banks c shari ah compliant branches windows and funds established by some conventional banks and financial institutions and d the islamic development bank db in jeddah which is an international financial institution operating in accordance with the rules of the shari ah
table distribution of islamic financial institutions operating in by area area number of ifi s south south east asia gulf cooperation council other countries in the middle east africa europe america australia total source international union of islamic banks directory of islamic banks and financial institutions jeddah

ii the export financing scheme this scheme was established in h under the name of the longer term trade financing scheme lttfs with the aim of expanding the bank s operations in the field of trade financing to facilitate the export of member countries commodities
iii islamic banks portfolio for investment and development in cooperation with other islamic banks the idb established in h an independent fund under the name of islamic banks portfolio for investment and development ibp

the value of the total approved operations of the portfolio from the date of its establishment to the end of h amounted to us million
idb also gives assistance and grants to muslim communities in non member countries as well as assistance from the waqf endowment fund in cases of disaster

governments have also sought to apply islamic banking and finance either partially by allowing islamic banking to operate side by side with conventional banking or by attempting to transform the whole economy to islamic banking and finance

for gradualism to be credible it requires the existence of a well conceived plan and successive or parallel steps that can transform the country from the conventional to the islamic economic system smoothly and with the minimum of transformation costs
for example banking supervision can be modeled to supervise both kinds of banks and financial market rules can be made to provide for the enlisting of islamic financial instruments side by side with conventional ones

due to a lack of knowledge on the part of some banking and government organizations of the details of the new banking system such organizations may carry over their old practices instead of engaging themselves in a conscious effort to apply the new system
islamic banking answers to some frequently asked questions addition proper implementation of an islamic banking system requires organizational legal and human resource frameworks that take time to build

such laws are already in existence in some islamic countries but need to be subjected to a comprehensive review especially with respect to the following aspects aT the scope of banking and financial activities most banking laws tend to restrict the scope of banking to that of commercial banking whereas islamic banking is wider in its scope to match what is known as universal banking

it should by now be clear that the financial system of an economy needs a comprehensive institutional arrangement to cater for the various kinds of needs of the users as well as the providers of funds
these include depository institutions such as commercial banks savings and loan institutions contractual savings institutions such as insurance companies and pension funds and investment intermediaries such as mutual funds unit trusts and finance companies

on the basis of equity participation and profit sharing in addition to debt based modes the soundness of their operations needs a type of control that goes beyond merely ensuring the solvency of debtors which constitutes the main consideration for providing credit
islamic banking answers to some frequently asked questions the central bank should develop rules that ensure the soundness of the financial and operational conditions of islamic banks and financial institutions

the smooth operation of such a system would depend on the existence of these components many of which have been mentioned earlier and on the extent of the adherence to their application
furthermore reform must include balancing the budget and refraining from resorting to excessive deficit financing and following an open door policy with international markets to improve the ability of domestic products to compete in international markets

therefore it is necessary to make available to dealers full and relevant information about the shari ah to subject the transactions involving financial instruments to generally accepted dealing standards and to specify the minimum standards of performance that should be met by enterprises requesting the listing of their instruments on the market
once the role of the central bank in financing the budget deficit regresses the central bank could deposit a part of its issue of money with banks to invest in accordance with the principles of the shari ah

training the application of an islamic banking system depends on the abilities of the central bank the treasury bankers and businessmen to understand the nature of the system and its requirements

accounts deposits and the various banking operations banking law should specify the main categories of each type of deposits and accounts leaving the door open for innovation through the design of new ones within the main categories
regarding investment accounts they can be unrestricted ie intended to enter into the general pool of resources invested by the bank or they can be restricted to specified projects

the accounting standards approved by the accounting and auditing organization for islamic financial institutions in bahrain on the initiative of the islamic development bank islamic banks have established the accounting and auditing organization for islamic financial institutions aaoifi which has issued a number of accounting standards
dealing with bad and delinquent debts the proper approach for solving the problem of non performing debts and delinquent debtors lies in the strict application of financial discipline on both debtors and creditors alike

aT tightening supervisory procedures by the central bank to ascertain the credibility of financing at the time it is extended and the adequacy of the guarantees and the extent of their liquidity if the financing operation is made on the basis of indebtedness
it has been noticed that banks which are privately owned and subject to strict banking controls are less likely to be implicated in the mess of nonperforming debts although they may not be able to escape it altogether

contracts which were concluded under the conventional financial system should be honored even if recourse to the doctrine of necessity has to be made in order to avoid shocks to the local capital markets or to foreign relations

issues pertinent to domestic banks operating on foreign son reciprocity rules under the agreements implemented by the world trade organization wto provide that countries which have their banks operating in a certain foreign country should allow the banks of this certain foreign country to operate on their soil

to achieve this islamic banks in their capacity as members of the system and business organizations with a private stake in its continuity can take the following measures aT public relations provide accurate information explaining the way islamic banks operate and how the public could benefit from their services

therefore the rise of financial service organizations whose functions include the promotion of financial instruments and the creation of a market for them would be of great help and support to islamic banking
mabid al jarhi and munawar iqbal i investment follow up and audit many businessmen refrain from adhering to strict accounting standards thinking that such adherence could lead to subjecting their enterprises to higher tax rates and to the exposure of secret business practices that they do not wish to reveal

how would the role of the central bank and its relationship with the banking system change the elimination of government borrowing would make it inconsistent for the central bank to continue to issue money against treasury bills and government bonds
aT the desired rate of monetary expansion that would be consistent with growth and inflation targets would be equal to the target rate of growth x the elasticity of demand for money plus the target rate of inflation

when higher monetary expansion is desired the central bank would increase the size of central deposits through the purchase of cdcs adding their proceeds to central deposits or directly issuing new money
as the economy wide application of islamic banking and finance requires careful planning what would a prototype plan look like in the following table and passages we present a hypothetical plan whose main features can be used as a guide

table s a hypothetical plan to apply the islamic monetary type of action th two years th two years th two years th t planning design review start apply follow up apply follow up a laws property corporate laws sales commercial law income financial market law r tax tariff laws banking law tax laws zakah law review privatization each year year year review review r govt less subsidies each subsidies

the same phase may also involve the issue of new property laws and corporate laws or adjusting the existing ones accordingly
structural problems may include a large public external as well as domestic debt a large public sector and a weak private sector that is encumbered with many restrictions

it should include the removal of government monopoly on foreign trade the replacement of non tariff restrictions with tariff restrictions the rationalization of the tariff structure in a way that increases revenues and reduces incentives to smuggle and the removal of all restrictions on exports

privatization thanks to private property the management of private enterprises can be distinguished from its counterpart in public enterprises by the fact that it is exposed to the danger of bankruptcy as well as the danger of take over
these were avoided through gradual divestiture of government property the use of open bidding and financial market floating and asset evaluation by specialized consultants in addition to giving priority to domestic investors in the purchase of government assets

in addition to the enactment of such laws the plan envisages an overhaul of the tax collection administration in order to give it the right staff and equipment in addition to proper training and orientation
the reductions in government subsidies envisaged in the above tables so that it would reach percent of its original level within ten years assumes that better targeting as well as the application of zakah would be done as parallel processes

monetary reform during the first phase of the plan structural changes in the monetary system should be made to transform all commercial banks to universal banks while opening the door for the establishment of islamic banks and the gradual transformation of universal banks to islamic banking
public debt in the first phase the country must seek debt relief debt forgiveness as well as rescheduling through active and energetic contacts with donor s foru miss the fact that it is embarking on a serious and rigorous financial and structural adjustment program would go a long way in persuading donors to provide debt relief

ii instruments issued by the central bank aT central deposit certificates cdc s iii instruments issued by banks aT banks can establish trading companies that buy goods and sell them back through murabahah
aT unrestricted investment deposit certificates uidc s whose proceeds would be invested in the general pool of the bank s assets and earn their average rate of return

adopting the operating method of universal banking the economic consequences of eliminating interest at the national level could be anticipated on the basis of considering the nature of the business operations of islamic banks
as previously pointed out islamic banks can undertake financing through partnership modes as well as sales based modes involving fixed returns

we can therefore imagine that those who wish to provide external capital flows on markup bases to an islamic economy would have to wait until the maturity dates of their debt before withdrawal
in a conventional economy debt financing comes in a pyramid shaped chain where foreign banks lend local banks which in turn lend individuals and local enterprises

a dealing with current debt it is important to emphasize at the outset that the shift to the islamic economic system does not mean giving up the settlement of outstanding debt contracted under the conventional system
if interest is totally abolished from the economy of a muslim country how can it deal with foreign countries and foreign financial institutions this question raises three major issues how to deal with current debts the economic effects of borrowing and alternatives to borrowing

islamic banking answers to some frequently asked questions what compounded their problem was the fact that heavily leveraged economies inevitably face two proble miss the first is that business borrowers face disproportionately high risks in relation to the size of equity during periods of slow economic activities as debts have to be repaid regardless of business conditions
the second is that expectations in the debt market are non segmental implying that when debts in one part of the market a sector or a whole country become non performing pessimistic expectations would not be restricted to that part

however should an islamic country exhaust all alternatives to foreign interest based borrowing without succeeding in satisfying financial requirements for meeting the needs of the society could it resort to interest based borrowing the answer to this question is based on the general islamic juridical rule providing that necessity renders legitimate that which is originally illegitimate
aT a leasing fund aT a trade financing fund aT an agricultural investment fund aT an industrial investment fund aT an housing investment financing fund and aT a fund for financing a specific project i i i

the qur anic text providing for the doctrine itself lays down two basic conditions the user must accept the sanctity of the original law implying a return to it as soon as possible and in the meanwhile use the exception to the minimum possible extent

institute of islamic banking and insurance encyclopedia of islamic banking and insurance london institute of islamic banking and insurance
council of islamic ideology pakistan the elimination of interest from the economy of pakistan islamabad council of islamic ideology

globalization and islamic banking and finance challenges and opportunities international seminar on the impact of globalization on the islamic world issues and challenges in the st century institute of diplomacy and foreign relations kuala lumpur june
kamel saleh development of islamic banking idb prize lecture jeddah islamic research and training institute islamic development bank khan m

islamic banking answers to some frequently asked questions nienhaus volker the performance of islamic banks trends and cases in chibli mallat ed
rodrik dan how far will international economic integration go journal of economic perspectives vol

it is also charged with the responsibility of assisting in the promotion of foreign trade especially in capital goods among member countries providing technical assistance to member countries extending training facilities for personnel engaged in development activities and undertaking research for enabling the economic financial and banking activities in muslim countries to conform to the shari ah membership the present membership of the bank consists of countries

in islamic economics he published on the aT he has served as comparative efficiency of interest free and the founding secretary general of the conventional economies in and on the international association of islamic monetary and financial structure of the islamic economic system in in addition to several economics
a c senior research economist pakistan institute aT served as economist institute of national of development economics pide planning cairo director economic and policy islamabad planning ids as well as division chief and dean faculty of social sciences senior economist technical editor of the joint arab economic report secretary general of the international islamic university islamabad

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AlHuda Material\islamic banking

KeyWords

islamic banks banking financial finance investment conventional institutions funds risk financing deposits assets services management international countries equity profit products

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Number of Pages

77

Published Date

2006-12-25 15:24:56

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Islamic Banking- FAQ's

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Top 20 FREQUENT WORDS

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