Dr Fouad Shakers

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Islamic banking versus commercial banking

Text of Dr Fouad Shakers

  • ISLAMIC BANKING VERSUS COMMERCIAL BANKING:PROSPECTS & OPPORTUNITIESA PRESENTATION BY:Dr. Fouad ShakerSenior Advisor & Partner: First East InvestFormer Secretary General: Union of Arab Banks

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGOUTLINEPrincipals and development of Islamic finance

    Theory and practice of Islamic financial intermediation

    Theoretical & practical differences between Islamic & conventional banking

    Comparison of financial ratios of Islamic and conventional banks

    Future challenges

    Areas for improvement and steps forward

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financePrincipals of Islamic financial system

    Prohibition of Interest (RIBA)An excess Any unjustifiable increase of capital whether are loans or sales in the central tenant of the system.Islamic regulations encourage the earning of profit but forbid the charging of interest. Money as a potential capitalIt joins hands with other resources to undertake a productive activity.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeRisk sharingWhen interest is prohibited, suppliers of fund become investors instead of creditors. Investors & financial intermediary relationship is based on profit & loss sharing principals.

    Prohibition of speculative behaviorDiscouraging hoarding & prohibits transacting featuring extreme uncertainties.

    Sanctity of contractsUpholding contractual obligations & the disclosure as a sacred duty to reduce the risk of asymmetric information & moral hazard.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeSharing-approved activitiesOnly activities that dont violate the rules of shariah qualify for investment.Any business Dealing with alcohol, gambling or casinos is prohibited.

    Social justiceIn Principle , any transaction leads to injustice & exploitation is prohibited.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeDevelopment & growth of Islamic finance

    Development of Islamic financeA rapidly growth part of the financial sector in the world ( >15% annual growth rate).Not only Islamic countries, more than 300 financial institutions in over 50 countries practice some form of Islamic finance.The market current turnover is estimated to be $350 Billion compared with $5 Million in 1985.Islamic finance industry has reached $1.4 Trillion by the end of 2011, expected to be $4 Trillion over medium term.Global conventional banks (HSBC, Citibanketc.) have setups separate windows to offer Islamic banking services.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGPrincipals and development of Islamic financeEmergence & evolution of Islamic institutions in recent historyIn Muslim countries:1963, local saving banks was established in Egypt to practice their work on a none-interest bases to enhance the banking habit.After 1974, many Islamic banks were established in different Muslim countries due to the sharp increase of the oil prices.Sudan, Iran, Pakistan started the Islamization of banking system during 1980s.

    In the western world:In 1983 Islamic finance house started in Luxemburg. recently, besides establishing Islamic banks, Islamic windows in leading banks pursuing this market very aggressively.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationBasic contracts & instruments

    Financing instrumentsUsed to finance obligations arising from the trade and sale of commodities or property and collateralized by the product being financed, such as:MurabahahA bank purchases a product for a customer who doesnt have a capital. Both agree on a profit margin added to the cost, the customer should pay the bank later the whole amount.Bay Al-MuajjilA sale transaction with deferred payment allows the sale of a product on the bases of deferred payment.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationBay Al-SalamThe buyers pays the seller the full price of a product which the seller promises to deliver at a specific future date.IjarahA medium term financial instrument gives something in return for rent, resembles the leasing contract.IstisnahTo facilitate the manufacture of an asset at the request of the buyer. Once the manufacturer undertakes to manufacture the asset for the buyer, the transaction of Istisnah comes into existence.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationInvesting instrumentsVehicles for capital instrument in the form of a partnership.MudarabahA fund management instrument , could be short, medium or long term, whereby an investor entrust capital to an agent to undertake a project.MusharakahAn equity partnership instrument which could be either medium or long term partnership, where two or more persons combine either their capital or their labor to share the profit & losses.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationStructure & components of financial statements for Islamic banks

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationTheoretical Balance Sheet of an Islamic bank based on maturity profile

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationTheoretical Balance Sheet of an Islamic bank based on functionality

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationComposition of an Islamic bank Balance Sheet

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediation

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic financial institutions in practiceEarly forms of Islamic financial institutions were concentrated in commercial banking activities, todays Islamic financial institutions can be divided into the following broad categoriesIslamic banks Could be public or private sector.A hybrid of conventional commercial banks & investment banks, it resembles universal banks.Islamic windowsA setup in a conventional bank that offer Shariah-compliant product.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic investment banks & fundsAiming to capitalize on large investment syndications, market-making and under writing opportunities.Succeeded in developing innovative large-scale transactions in infrastructure finance.Islamic mortgage companiesTargeted at the housing market for Muslim communities in western countries.Four models:Ijarah.Equity partnership (diminishing Musharaka).Murabahah. (sales transaction).Along the lines of corporative societies.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheory & practice of Islamic financial intermediationIslamic insurance companies (Takaful)Takaful means mutual or joint guarantee. The participants agree to share their losses by contributing periodic premiums in the form of investment. They have to redeem the residual value of profits after fulfilling the claims and premiums, which is a critical difference between contemporary insurance and Takaful. Takaful is a given solidarity.Mudaraba companiesSimilar to that of closed-end fund managed by specialized professional management companies. Unlike the Islamic bank, they are not allowed to accept deposits. Funded by equity capital. Two types; Multipurpose (more than one investment purpose) and Specific purpose.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent concepts of borrowing, financing & investment

    Different modes of borrowingAccording to the state banks of Pakistan 2008, conventional banks average for deposits ranged from 2.09% - 2.30% per annum while borrowing rate average ranged from 11.20% - 11.56%. The difference is 7.82%. Islamic banks average rate on PLS deposits ranged from 3.5% to 3.79%. Profit & loss sharing deposits earn more than 1% higher.

    ISLAMIC BANKING VERSES COMMERCIAL BANKING

  • *ISLAMIC BANKING VERSES COMMERCIAL BANKINGTheoretical & practical differences between Islamic & conventional bankingDifferent modes of financingConventional banks high rates of interest on all types of loans. Which may be the cause of the business failure & the default of the loan. Islamic bank provides loans on profit & loss (PLS) bases, and only for production purposes.

    Different modes of investmentConventional banks; 50% in government treasury bills, bonds, term finance certificates for security, they suffer badly in case of stock market crash.Islamic banks