Islamic Finance

Submitted by Mehnaz

Roll no: 020

MBA 3rd semester

Submitted to Sir Ahmed Shafique

Shaheed Benazir Bhutto University

11th May 2015

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Table of contents

Islamic Finance---------------------------------------------------------------------------------3

Introduction of Islamic Banking------------------------------------------------------------3

Difference between conventional banking and Islamic banking----------------------4

The Principles Of Islamic Finance----------------------------------------------------------5

Basic Principles of Islamic Banking--------------------------------------------------------6 Sanctity of contracts. Risk sharing. No Riba / Interest. Economic purpose / activity. Fairness. No valid subject matter.

Islamic Mode of Financing------------------------------------------------------------------6Financial Instruments------------------------------------------------------------------------6

Mudarabah

Murabaha

Musharkha

Ijarah

History of Islamic Banking and Finance-------------------------------------------7 References---------------------------------------------------------------------------------------------10

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Islamic finance refers to the means by which corporations in the Muslim world, including banks and other lending

institutions, raise capital in accordance with Sharia, or Islamic law. It also refers to the types of

investments that are permissible under this form of law.

Introduction of Islamic BankingThe origin of Islamic banking can be traced back to the advent of Islam when the

Prophet himself carried out trading operations for his wifeIslamic banking is interest free banking, in which there is no fixed rate of return. Islamic

banking is the banking system which is run in accordance with the Islamic laws and the Shari a`

board; that guides the institutions. This Shari a` board authorizes the products that whether these

are Shari a` compliant or not. Islamic banking is the banking that is guided by Islamic law ( Shari

a`) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the

collection and payment of interest, also commonly called Riba in Islamic discourse”. Islamic

banking also finds its roots in Islamic finance and all type of transactions are interest free and of

risk sharing. The interest is prohibited in Islamic ways of banking as it is also obvious from Quran.

In Quran, in Sura Al-Imran, Allah said that; “O you who believe! Do not devour Riba multiplying

it over and keep your duty to Allah that you may prosper” (3:130). Same kind of prohibition regard

fixed interest is also lead in Sura Al-Rum(39) , Al-Nisa(160-161) and Al-Baqarah(275-281) of

Quran. Riba and Gharar are illegal under Islamic law. Riba refers to fixed rate of interest. Gharar

refers to speculation. Islamic banking shows dramatic improvements and developments in

Pakistan. Islamic banking is taken as national policy and it is supported but there exist dual

banking structure in the Muslim countries. Mostly the banks of conventional system are also

opening their separate Islamic banking divisions and branches.

The expectation of increase in growth of networking of Islamic banking system is increasing. The

Islamic banking has increased in terms of branches, deposits, capital funds, sources. The ratio of

income to expenses is high which indicates increasing profitability of the sector.

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Riba in Hadith

"Every loan that derives a benefit (to the creditor) is riba."

This Hadith is reported by  Hazrat Ali Radi-AllahuAnhu

Difference between conventional banking and Islamic banking

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Bank

ClientGoods & Services

money

Islamic Banking System

Conventional Banks Islamic BanksMoney is a commodity besides medium of

exchange and store of value

Money is not a commodity thought it is used as a

medium of exchange and store of value

Time value is the basis for charging interest on

capital

Profit on trade of goods for charging on providing

service is the basis for earning profit

Interest is charged even in case the organization

suffers losses by using bank’s fund

Islamic bank operates on the basis of profit and

loss sharing

While disbursing cash finance, running finance

or working capital, no agreement for exchange

of goods & services is made.

The execution of agreements for the exchange of

goods & services is a must while disbursing funds

under Murabaha, salam & Istisna contracts

Conventional banks use money as a commodity

which leads to inflation

Islamic banking tends to create link with the real

sector of the economic system by using trade

related activities.

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Bank

Client money

money + money (interest)

ConventionalBanking System

The Principles Of Islamic FinanceWealth must be generated from legitimate trade and asset-based investment. (The use of money for

the purposes of making money is expressly forbidden)

Investment should also have a social and an ethical benefit to wider society beyond pure

return.

Risk should be shared.

All harmful activities (haram) should be avoided

Basic Principles of Islamic Banking Sanctity of contracts. Risk sharing. No Riba / Interest. Economic purpose / activity. Fairness. No valid subject matter.

Islamic Mode of Financing

Financial Instruments

The most common forms of Shariah compliant investment funds are equity funds, real estate funds

and money market funds.These investment funds employ Islamic contracts which ensure that the

terms and rights of all parties are safeguarded in conformity with Islamic principles (examples and

definitions are given below).

Mudarabah

Murabaha

Musharkha 6

Ijarah

Mudarabah: An investment partnership under which the investor (the “Rab-ul-Mal”) provides capital to the

investment manager (the “Mudarib”) in order to undertake a business or an investment activity.

While profits are shared on a pre-agreed ratio, losses are borne only by the investor.

MurabahaMurabaha: Purchase and resale of an asset. Instead of lending money, the investor purchases the

desired asset from a third party and resells it at a predetermined higher price to the user. By paying

this higher price over instalments, the user of the asset has effectively obtained credit without

paying interest. The classical equity instruments in Islamic commercial law (musharakah and

mudarabah) require partnership and profit sharing. In financial markets, investing in stocks and

equity funds is permitted but must conform to certain guidelines. Conventional interest-based

lending or bonds are ruled out in Islamic finance because it relies on interest. Instead, asset-backed

financing is encouraged with the risk being shared by the provider and the user of the asset.

Musharkha A partnership where profits are shared according to a pre-agreed ratio while losses are shared in

proportion to the capital investment of each partner. This equity financing arrangement is widely

regarded as the purest form of Islamic financing.

Ijarah: An Islamic lease agreement. Instead of lending money and earning interest, Ijarah allows the

investor to earn profits by charging rentals on the asset leased to the user.

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History of Islamic Banking and FinanceThe history of banking begins with the first prototype banks of merchants of the ancient

world, which made grain loans to farmers and traders who carried goods between cities. This

began around 2000 BC in Assyria and Babylonia. Later, in ancient Greece and during the

Roman Empire, lenders based in temples made loans and added two important innovations:

they accepted deposits and changed money. Archaeology from this period in ancient China

and India also shows evidence of money lending activity.

Banking, in the modern sense of the word, can be traced to medieval and early Renaissance

Italy, to the rich cities in the north such as Florence, Venice and Genoa. The Bardi and

Peruzzi families dominated banking in 14th century Florence, establishing branches in many

other parts of Europe.

Perhaps the most famous Italian bank was the Medici bank, established by Giovanni Medici

in 1397.

The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena, Italy,

which has been operating continuously since 1472.

The development of banking spread from northern Italy throughout the Holy Roman Empire,

and in the 15th and 16th century to northern Europe. This was followed by a number of

important innovations that took place in Amsterdam during the Dutch Republic in the 17th

century, and in London in the 18th century. During the 20th century, developments in

telecommunications and computing caused major changes to banks' operations and let banks

dramatically increase in size and geographic spread. The financial crisis of 2007–2008

caused many bank failures, including some of the world's largest banks, and provoked much

debate about bank regulation.

• Islamic banking and finance (IBF) is relatively new compared to conventional banking and

finance

• Earliest Islamic financial institution can be traced to a savings institution based on profit

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sharing in Mit Ghamr, Egypt in 1963

• Oil boom in the 1970s triggered a rapid growth of Islamic financial institutions

• Establishment of the first Islamic bank (Dubai Islamic Bank in the UAE) in 1975, as well as

the Islamic Development Bank (IDB) in Saudi Arabia

• First attempt in the West to establish Islamic banking was in Luxembourg in 1978.

• Arabic financial and economic system pre-Islam

– Trading based arrangements were common

• Bay’ al-musawamah (bargaining)

• Bay’ al-muzayadah (auctioning)

• Bay’ al-amanah (trust sale)

– Al-murabahah (resale with profit)

– Al-tawliyyah (resale at cost)

–Al-wadiah (resale at loss or below cost)

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References

https://yurizk.com/blog-yurizk/361-pearson-published-new-textbook-on-islamic-finance

http://www.pearsonmiddleeastawe.com/pdfs/SAMPLE-islamic-finance

http://www.academia.edu/4226713/Introduction_to_Islamic_Banking_and_Finance_Principles_and_Practice

Banking and Finance, 3, 36-54.Presley John, & Sessions John, 1994, Islamic Economics: The Emergence of a New Paradigm, The EconomicJournal, 104, 584-596.Pryor Frederic, 1985, The Islamic Economic System, Journal of Comparative Economics, 9, 197-223.Sauer James, 2002, Metaphysics and Economy, the Problem of Interest : a Comparison of the Practice andEthics of Interest in Islamic and Christian Cultures, International Journal of Social Economics, 29, 97-118.Siddiqi Faiz-ul-Aqtab, 1967, Studies in Islamic History, Jamiyatal Publications.Syed Hussain, Ali Jafri, & Lawrence S. Margolis, 1999, The Treatment of Usury in the Holy Scriptures,Thunderbird International Business Review, 41 (4), 371-379.

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