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IslamicBanking

System

and

OperationI

Prof.SaifulAzharRosly saiful@incif.org

InternationalCenterForEducationinIslamicFinance(INCEIF)

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1.IntroductiontoIslamicBankingOperations

2.ShariahFramework3.Re ulator Framework

4.LegalFramework

5.FinancialStatementsofIslamicbanks

6.IslamicBanksintheMuslimWorld

7.LessonsfromSubprimeCrisisandFinancialTurmoils

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IslamicFinancialMarket

DirectFinancial

Market

(CapitalMarket)

Sukuk Equity

market

UnitTrust

65%

SCScreening

85%

SCScreening

an

13%

a a u

5% MutualFunds7%

en ure

Capital

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Two

Approaches

1.Shari&TabiGeneralFrameworkofIslamic

Finance

Shariah

Tabi

BusinessPlan

Shariah Framework

RegulatoryFramework

ega + ca

EQUITY

pera ons

Performance

EFFICIENCY

RiskReturn

Performance

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Shariah Regulatory

Fiqh AcademyBasel II

Me a

IslamicFinancial, a ra n

BankNegara

erv ce oar (IFSB)

ar aSupervisoryBoard,

Malaysia

an egaraMalaysia

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Shariah

Aqidah Akhlak Muamalat

ManwithAllahswt Manamong

5Pillars

of

Islam Man

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5

Shariah Principles5

Shariah Principles

1ProhibitionofRiba

1ProhibitionofRiba

2.ApplicationofAlBay

2.ApplicationofAlBay

3.AvoidanceofGharar in

Contracts

3.AvoidanceofGharar in

Contracts

4.ProhibitionofGambling

maisir

4.ProhibitionofGambling

maisir

5.Prohibitionontheproductionand

servicingofprohibited

5.Prohibitionontheproductionand

servicingofprohibited

commo escommo es

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NewParametersinShariahCompliance

ramewor :

ons stency

s

r t ca

AQAD

Principles

LEGAL/CONTRACT

DOCUMENTATIONMAQASIDro ec ono g s

FINANCIAL

REPORTINGAAOIFI/IFSB/IFRS

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BBAHomeFinancin

BayInah

Home

Financing

BayInahPersonalFinancing/Overdraft/creditcard

Tawarukmunazampersonalfinancing

Commodity

murabaha ara ummaa ay

BaibithamanAjilIslamicDebtSecurities(BAIDS)

SukukIjarah

SukukMusharakah

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ChallengingissuesinAQADbasedIslamic

nance

ro ucts

Benchmakingprofitrateagainstinterestrate(LIBOR,KLIBOR). ProfitEqualizationReserve(PER) displacedcommercialrisk Sale

with

condition

to

buyback

at

predetermined

price

betweentwoandthreeparties. ro genera e over ns a men paymen s meva ueo

money

Penalties

on

delayed

payments MusharakahwithPurchaseundertakings fixedprofitto

onepartyonly. I arah Sukuk Sale with re urchase a reement at ar value

andnot

mark

to

market

IjarahSukuk OwnershipofassetbySPV Profitrateswaps speculationorgambling?

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requirementof

AQAD.

1.AgentsofContract

.

3.SubjectMatterofContract

r ce4.OfferandAcceptance

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A ad

Contract

ofContract

Matter

Acceptance

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Sale(AlBay)

Transferof

Buyer&Seller OwnershipfromBuyertoSeller

Property

spot

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Example:Murabaha/BBASale

1. BuyerandSeller

eg. e erowns asse su ec ma er e orema ngsale

2.

Subjectmatter

eg.Malmutaqawim propertywithusurfruct

3. Price

eg.

eton

t e

spot

4. Offer&Acceptance

.

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ofShariah

Toprotecttheinterestofthepublic(society) maslahahalammahby:

.2.Securingofbenefits(tahsil)

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Shariah

Protecting

PublicInterest

Removin the Securin the

Harm

Benefit

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Islamicfinancial roductsasdefinedb A AD

methodology,

should

contain

more

benefits

(masalih)andlessornoharm(madarah).

in

gambling

(maisir)

and

liqour

(qimar),

there

.aregreaterthantheprofits(AlBaqarah:168 .

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in gambling (maisir) and liqour (qimar),there are some sins and some profits. Butthe sins are greater than the profits (Al-Baqarah: 168).

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in Gambling (maisir) and Liqour (qimar),there are some sins and some profits. But

the sins are greater than the profits (Al-

Mudarat Manfaat

Baqarah: 168).

Sins Profits

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Mudarat Manfaat

Riba

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Mudarat Manfaat

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Manfaat

HARAM

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Manfaat

HALAL

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MACRO MICRO

EconomicBubbles Bankruptcy

SubprimeLoans Foreclosure

nanc a urmo nemp oymen

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Theupside(Manfaat) ofCredit

Financing

MACRO MICRO

AllocationofCa ital Wealthcreation

EconomicGrowth Richbecomingricher

,

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empirical)impacts

of

financial

intermediationbasedonaqadbasedShariahcompliantproducts.

1. Efficiencystudies

2. Profitabilitystudies

3. Studies on Consumer welfare and rotection

4. Studieson

Financial

stability

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Aqadbasedproducts(ABP)SHOULDcontainmorebenefitsandlessarm.

Whatif,itwasproventhanthey(ABP)containmoreharmthangood?eg. an onpro ec s cus omercanno ma erecourseaga ns an assellingparty?

DefaultedBBAcustomerarerequiredtomakesettlementbasedonthesellin

rice.

Salewithnotransferofownership.

Givingawaycleaninah personalfinancingathighprofitrates awaytowardssubprimeinah?

ConflictbetweenAqadandMaqasid?

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ProperrecordingoftransactionstoevidentTRUESALE. IFRS Transparent,consistentandcomparable

information BBA bankmustputBBAassetonbalancesheetpriorto

sa e. wee , mont t epen s. Oncesold,itisrecordedasBBAreceivables.

AITABassets

should

be

on

banking

book

as

leasing

assets

utnowtreate as nanc ngan a vances . Externalauditors(PWC,KPMGetc.)arenotrequiredby

theauthoritytoconductShariahaudit.Andtheymaynot.

ConflictbetweenAQADandfinancialreporting?

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Assets Liabilities

Murabaha/BBA WadiahDhamanah

deposits

AITAB ProfitSharingInvestmentAcct

IslamicSecurities/Sukuk Capital

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Assets Liabilities

1st October 2008

FIXEDASSET

1.BBAasset

Assets Liabilities

15 October 2008

CURRENTASSET

2.BBAReceivables ProfitinSuspense

1. 1/9/2008 Bank purchases Property from Vendorfor $200,000

1. 15/9/2008 Bank Sells Property to Customer for

$280,000

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BBAshouldbedocumentedasatruesaleandnotasa

loan.

(Dato

Nik

vs.

BIMB)

Ijarahshouldbedocumentedasoperatingleaseandnot

a

loan

(Tinta

Press

vs.

BIMB) Islamicbankhasnotpracticefairnesscomparedwith

conventionalbank(AffinbankvsZulkifli).

ConflictbetweenAQADanddocumentationofAQAD?

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Hadith (Sahih Bukhari)

High Court Judge Datuk Abdul Wahab Patail says that thesale element in BBA sale is not a bona fide sale

1. SaleandPurchaseAgreement(SPA)

2. PropertyPurchaseAgreement(PPA)

.

4. Deedsofassignment/Charge2. Bank do not have

of property to make a valid sale1. No transfer of title from Customer to Bank

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Basel2,IFSB,AAOIFI,CentralBanking

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Shariah Regulatory

Fiqh AcademyBasel II

Me a

IslamicFinancial

, a ra n

BankNegara

erv ce oar (IFSB)

ar a

SupervisoryBoard,

Malaysia

an egara

Malaysia

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BankingAct

(IBA)1983

BankingAct

(IBA)1983

Islamicbankmeansanycompany whichcarriesonIslamicbankingbusiness andholdsavalidlicense;andalltheoffices

and

branches

of

such

a

bank

shall

be

deemed to be a bank

Islamicbankmeansanycompany whichcarriesonIslamicbankingbusiness andholdsavalidlicense;andalltheoffices

and

branches

of

such

a

bank

shall

be

deemed to be a bank

Islamicbankingbusinessmeansbankingbusinesswhoaimsandoperations donot

theReligion

of

Islam

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ElementwhichisnotallowedbytheReligionofIslam

1Prohibition

1Prohibition

Application

Application

AvoidanceofAvoidanceof ProhibitionProhibition

Prohibitiononthe

production

Prohibitiononthe

productionofRibaofRiba of AlBayofAlBay

Contracts

Contracts

(maisir)

(maisir)andservicingofprohibitedcommodities

andservicingofprohibitedcommodities

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4.Restriction

on

Business4.

Restriction

on

Business 2.

Financial

requirement

and

dutiesofIslamicbanks2.

Financial

requirement

and

dutiesofIslamicbanks

1.Licensing

of

1.

Licensing

of

IslamicbanksIslamicbanks

. ,management

of

Islamic

banks

. ,management

of

Islamic

banks

.

controlover

Islamic

banks

.

controlover

Islamic

banks

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FinancingFinancing DepositDepositAsset Liabilities

Financing

Mortgage

HirePurchase

Personal,enterprise

Saving

Financing Wadiah

DhamanahSavings

,

Leasing PSIA

Operation

alLeasing

PSIA

JV

Venturecapital PrivateEquityStocks

Sukuks Capital

Property

MOREOUTPUTINTHEBANKINGBOOK

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AngloSaxonIslamicBankingWa

etween

commercia

an

investment

an ing

US:Glass SteagallAct1938 Malaysia:BAFIA1992

Financing Deposit

Mortgage Saving

HirePurchase PSIA

Personal

Islamic

Securities

Leasing BrokerageVentureCapital

Property UnitTrustPrivateEquity

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IBA 1983: No Wall between Commercial andInvestment bankingIslamic Banking and BAFIA 1989

sset a ty

Mortgage SavingHirePurchase PSIA

sset a t es

FinancingMortgage

WadiahDhamanah

Personal

Sukuks

Personal

O eration PSIAalLeasing

JV

Sukuks

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UniversalBankin :EconomiesofScaleandSco e

MoreOutputsMoreOutputsLessCostperUnitLessCostperUnit

HigherProfitsHigherProfits

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IBA1983IBA1983

Buyandsellassetsandproperties BBA,

Murabahah,Salam,Istisna

Buyandsellassetsandproperties BBA,

Murabahah,Salam,Istisna

BuyandSellcommonstocksie JointventuresMusyarakah,mudarabah

BuyandSellcommonstocksie JointventuresMusyarakah,mudarabah

Buyassetsandleasingofassets Ijarah

Buyassetsandleasingofassets Ijarah

FeeBasedFinancialServices

FeeBasedFinancialServices FundManagementFundManagement

PrivateEquity PrivateEquity

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Islamic Banking Act 1983 on Shariahadvisory body

that there is in the article of association of the bank concerned, provision for theestablishment of a Syariah advisory body to advise the bank in the operation of its

banking business in order to ensure that they do not involve any element which is not

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To study fatwaspreviously issued

by SSB ofmember banksand how these

To study fatwaspreviously issued

by SSB ofmember banksand how these

Superviseactivities of

member banks toensure they are in

conformity with

Superviseactivities of

member banks toensure they are in

conformity with

Shariah rulings

Shariah rulingsar a ru ngsar a ru ngs

To issue fatwasTo issue fatwas(religious legalopinions) on

financial productsand bankingoperations

(religious legalopinions) on

financial productsand bankingoperations

Settlementoflitigationagainst

Islamicbank?

Settlementoflitigationagainst

Islamicbank?

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--ccoun ng po cy

adopted by banksccoun ng po cy

adopted by banks

sharing ratio between

banks and clients

sharing ratio between

banks and clients

OthersDutiesOthersDuties

Determining thecalculation and payments

Determining thecalculation and payments

Determining the incomedistributed and expensesto be borne b de ositors

Determining the incomedistributed and expensesto be borne b de ositors

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RoleofShariahCommittee(SC)inIslamicbanking

su s ar es w n ows

InterpretationsandenforcementoftheapplicationoftheIslamiclaws,pr nc p esan tra t onsona o t e us nessoperat onso s am c an s.

To

decide

on

the

Shariah

aspect

of

a

new

type

of

transaction

envisaged

and

alsotoexplaintheopiniongiveninlightofIslamicprinciples

,havedischargedtheirobligations.

Toensurethatzakatpaymentiscorrectlycalculatedanddistributed.

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BNM Shariah MuftisBanking

PractisionersAdvisor

Bank Negara

uperv sory oar ShariahScholarsBNM officials

FATWA

Malaysia Islamic

Banking Department Usul-Fiqh

Qawaid

ISLAMIC BANKING DIVISION

Proposals FiqhiyyahFiqh

Muamalat

-

Finance company

Merchant bank

IslamicBanking

Consultants

ShariahCommittee

NewIslamic

Instrument

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TaxNeutralityContract

Documentation

Taxonleasing,,

assets

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IslamicBanking

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BoardofBoardofrec orsrec ors

ShariahAdvisory

Committee

RiskRiskManagementManagement

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BankingFirmBankingFirm

Asset Liability

$20bCapital$20b

NonBankin Firm

Asset Liability

ap ta

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Banking isabusinessbasedonLevera in Itcanborrow8timesitsCa ital1.CAR 8%

1a.BankCapital $20b

. orrow ng m

3.Lending $160@10%

4.Revenue $160mx0.1 = $16b

5.Costofdeposits $160mx0.05= $8b

6. Overhead 3b

7.Provisions $1b

8.Profit $16b ($8b+3B+$1b)=$4b

9.ROE $4b/$20b=20%

10.ROD 5%

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ISLAMIC BANKING

ASSET-BASED FEE-BASEDPROFIT-SHARING

Qirad/Musharaka

Murabaha(deferredsale

Ijara(leasing)

Istisna(saleby order)

Kafalah(guarantee)

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Spot

Deferred (Muajjal)

ost- r ce ar -up Selling Price

Ghurmi

(eg.ownership

risk)

Kasb

(Value-added)

Daman

(Liability)

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Spot (=$100) Discount ($100

$1100

Ghurmi

(eg.ownership risk)Kasb

(Work &Effort)

Daman

(Liability)

1 Al B

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RISK1.Al-Bay

2.Al-I arah

(Ghurmi) ISLAMIC NORMATIVETHEORY OF

PROFIT

3.Salam4.Istisna

5.Mudarabah

6. Musyarakah

IWAD(Equivalent countervalue)

WORK &

EFFORT

(Kasb)

PROFIT=

LIABILITY(Daman)

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Risk

(Ghurmi)

Res onsibilitWork&Effort

(Daman)(Kasb)

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Murabaha

ProfitMar in

CostPrice Profit

rate

x

Facilit xtenor

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ProfitRate

DepositOver ea

Premium

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Interest

a e

DepositOver ea

Premium

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Costof

Deposit

RiskFreerate

TrueTimeValue RiskPremium

of

Money

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TIMEVALUEOFMONEY

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TimePreferenceindicatestheextentofafamilyspreference

forcurrentconsumption overfutureconsumption

.

Moneytodayisworthmorethanmoneytomorrow

2.NegativeTimePreference

Moneytodayisworthlessthanmoneytomorrow

3.NeutralTimePreference

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Positive$1now>

preference

$1future

eutratime

reference

$1now=$1future

Negative$1now

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TimeVa ueoMoney

PositiveTimePreference

(PTVM)

NeutralTimePreference

NegativeTimePreference

Capitalism:IslamicPTVM

interestea sto i a

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Princi le=Presentvalue= 1000

Interest=10%peryear=$100

Tenure=1year

Futurevalue=Presentvalue+interest

$1000

=

$1000

+

$100 FVt =PV0 (1+i)t

i>0;FV>PV i.e.Positivetimepreference

i=0

;

FV

=

PV

i.e.

Neutral

time

preference i

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The

increment

in

lawful

halal

=

hibah

debt(HadithSahih)

his/herdebt,paysmore(HadithSahih)

Theincrementissetordeclaredonmaturit

Theincrement

is

not

contractual

or

fixed

upfront

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Delayinpaymentcanallowsellertoincreaseprice Butincreaseinpricemustbeaccompaniedwithiwadi.e.(an

equivalentcountervalue) Sellermustownassetformakingthesale

Buyerownstheassetaftersaleeventhoughpaymentismadebyinstallment

Sellerholds

no

ri ht

to

ut

the

asset

under

char e.

Undercharge=buyerplacesthepurchasedassetascollateralbutenjoyingtheusurfructatthesametime

Sellercan

sell

the

asset

to

athird

party

even

before

completingpayment.

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Simpleinterest

bearing

loan

i>0

Loan= 10 000

Debt=$11,000

Debt>Loan

=

0 1Year

Ali receives $10,000 Ali repays

$11,000

Total repayment to May an = Principal + interest = P + iP = P (1 +I )

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TotalpaymenttoMaybank=P+iP

0 1Year

Ali receives $10,000 Ali repays

$11,000

Total repayment to May an = Principal + interest = P + iP = P (1 +I )

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Implicit interest rates = 10%

Discount price = $10,000/1.10 = $9091

01Year

Borrower receives 9091

From discount bond

$10,000

IslamicLoan

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=Loan=$10,000;Debt=$10,000

oan= e t

=

0 1Year

Ali receives $10,000 Ali repays

$10,000

Total repayment to May an = Principal + 0 = P + 0P = P (1 +0 )

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increment =

Theincrementissetupfront

Theincrementisdeterminedintheletterofloanoffer

Theincrement

is

contractual

i.e.

legal

action

onborrowerifhefailsto a u .

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T e

Prop et

Mu amma

saw

en o ns

e tor

to

pay

more

butonvoluntarybasisbecausehe(saw)foreseesthe

problem/uncertaintiesfallinguponthecreditorwhohasto

bear:

s o e au t

Riskofinflation

Opportunitycostoftheloan

Sinceacreditorfacestheaboveuncertainties,givenanoptiontospendthemoneytodayorinthefuture,hewillchoosetheformer.Inthisway,heholdspositivetime

preference

(PTP)

outlook.

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ypay

more

on

ar

asan

Tosaythankyou expressing

ones

GRATITUDE OpportunityCost:Thecreditorforegoes

opportunityofearningincomefromthe

moneygivenawayasloan

Inflationrisk:Thecreditorma loseoutwhen

thepayments

holds

lower

purchasing

power

duetoinflation

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Islamicrecognizes

that

1today

tomorrow u compensa on ora s nence snocontractual ienotsetwhentheloancontractis

Compensationisvoluntary

matures

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More?

Gratitude

Inflation

Opportunitycost

LiabilityAsset

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The Banking Business

Profit = (rL1 x L1) (rd1 x D1)

=

Market for DepositMarket for Loan (Financing)

. .

= $2m - $1m = $1 million

rr Sd

SL

rd1

rL1

10%

5%

DdDL

DLoan epositD1L1$20m

$20m

Avera eBalanceSheet:IslamicBankin

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Al-Wadiah Dhamanah

Al-Mudarabah Investments

l-Bai-bithaman Ajil

Al-Murabahah

l-I arahSalam

Istisna

-

Al-Mudarabah

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SavingsAccount

WadiahDhamanah

IslamicNICD Mudarabah

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Autofinancing

AlIjarahThummaAlbay

Bayalinah

Personalfinancing

Tradefinancing

WakalahLC

MurabahahLC

a a a

Islamicacceptedbills.

Ba alinah

Credit

card

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Statutoryreserve

requirement

Statutory iqui ityrequirement

AssetliabilityManagement

RiskManagement

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Asset Liability

Cash WadiahDhamanahCurrent

Account

BBAHome

Financing Wadiah

Dhamanah

Savings

AITABCarFinancing RestrictedMudarabah

Account

aya

na

ersona

nanc ng

EnterpriseFinancingnres r c e

u ara a

Account

GovernmentIslamicSecurities CommodityMurabahah

ofDeposits

Sukuk

FixedAssets ShareholdersCapital

IncomeStatement

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ewar

comesw t

s

IslamicBankingProfitandLossRevenuesCostofFunds $500m$200m

GrossProfit $300mOverheads

ProvisionsforNPF

$80m

$10m

ProfitEqualization

Reserve $5m

ProfitBeforeTaxandZakat $200m

TaxandZakat $60mNetProfit $140m

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Islamic Bank as a Financial Intermediary

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IslamicBankasaFinancialIntermediary1.CAR 8%

.

2.InvestmentDeposit

(Partnership)TransactionDe osit

$160m@expost

3.Financing (Trade) $160@10%

.

.

5.Costofdeposits $160mx0.05= $8b

6.Overhead $3b

7.Provisions $1b

8.Profit $16b

($8b

+3B

+$1b)

=$4b

9.ROE $4b/$20b=20%

10.ROD 5%

Asset Liability

Assetbasedfinancing Transaction Deposit

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f g

Murabahah/BBA

AITAB

Ijarah

p

Salam

Tawaruq

Bayinah

Partnership/ContractFinancing

Musharakah

Mudarabah

InvestmentDeposit

RestrictedPSIA

UnrestrictedPSIA

Feebasedfinancing

Wakalah

CommodityMurabaha

Investment

Sukuks

FixedAssets

Tier1Capital CommonStocks

Tier2

CapitalPreferenceShares

Reserves

Murabaha:1st November2008:BankBuysand

o s sset

8/14/2019 Ibo Iiu2009

94/99

o s

ssetAsset Liability

FixedAsset

Murabahaasset

8/14/2019 Ibo Iiu2009

95/99

RegionalBalanceSheetComparison

8/14/2019 Ibo Iiu2009

96/99

Consolidated Balance Sheets of Islamic Banks in GCC and Malaysia

50

60

30

40

centage

GCC

Malaysia

10

20

Pe

0

sequiva

le

cialin

stitu

'Bitha

man

Ina

am/Istisna

Ijara

a/Muq

ara

usharak

a

es/co

mpa

Others

Cash

andc

Ad

vanc

estootherfina

Murab

aha/Al-Ba Sa

Musara

Investm

entin

securit

8/14/2019 Ibo Iiu2009

97/99

InternationalOutlookforSourcesoffunds

8/14/2019 Ibo Iiu2009

98/99

Sources of funds of Islamic Banks in GCC and Malaysia (combined)

Deposits from other financial

InstitutionsOthers

Shareholders equity

11%

9%

Current Accounts

28%

Investment/Savings accounts

48%

8/14/2019 Ibo Iiu2009

99/99

..

ThankYou