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DIFFERENCE OF ACCOUNTING SYSTEM BETWEEN ISLAMIC BANKING

AND CONVENTIONAL BANKING

Islamic Banking Conventional Banking


1. Islamic Banks are to follow Quran, 1. Conventional Banking follows the man
Sunnah, Ijma and Kias i.e. Shariah, in all the made practice and rules.
business transactions including Accounting
Entries.
2. They can not engage in any interest 2. They conduct their transactions on interest
transactions basis
3. If any interest is included/entered in the 3. Interest is their main income
operations of the banks, that should be
excluded from the regular income of the
Bank
4. If any income is earned violating Shariah 4. They do not follow shariah rules &
Principles that can not be included in the regulations.
distributable income of the Bank.
5. In Musharaka, Mudaraba, Bai-Salam 5. In Conventional Banking there is no
modes of Investment, Income can not be practice of Musharaka, Mudaraba, Bai-Salam
accounted for on accrual basis. modes of Investment and most of their
income can be recognized on accrual basis.
6. For delay of Payment of Investment by the 6. No such Bai-Muraba and Bai-Muazzal
clients, in case of Bai-Murabaha and Bai- Investment in conventional Banks. They
Muazzal etc. Investment further amount of Charge interest/penal interest for delay in
profit can not be charged. payment /repayment.
7. In case of overdue Investment 7. They charge interest /penal interest on
compensation may be charged if an over due Investment.
independent committee like Review
Committee decides to impose the
Compensation.
8. Islamic Bank is to pay Zakat 2.50% on its 8. They do not pay any Zakat on reserves.
reserves.
Islamic Banking Conventional Banking
9. Islamic Banks are to pay a certain 9. They do not pay a certain amount to the
minimum percentage of Investment Income depositor from their Investment income,
to the Mudaraba Depositors. rather they pay fixed rate of interest
irrespective of Investment Income.
10. Mudaraba Depositors are to share the 10. Their depositors do not share any profit
loss, if any, incurred out of Investment made or bear any loss.
from Mudaraba Deposits.
11. Islamic Banks are to follow Accounting, 11. They only follow International Financial
Auditing and Shariah Standards developed Reporting Standards (IFRS), Bangladesh
by Accounting and Auditing Organization for Bank guidelines, The rules of the Income
Islamic Financial Institutions (AAOIFI) in Tax, The rules of the companies Act, The
addition to International Financial Reporting rules of the SEC.
Standards (IFRS) developed by International
Federation of Accountants, Bangladesh Bank
guidelines, The rules of the Income Tax, The
rules of the companies Act, The rules of the
SEC.

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Reference :
i. The Holy Quran
ii. Accounting, Auditing and Governance Standards for Islamic Financial
Institutions.
iii. The Bank Company Act-1991
iv. The Companies Act-1994
v. The Income Tax Ordinance -1984
vi. SEC Rules.
vii. International Financial Reporting Standards.

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MONETARY AND FISCAL POLICY IN ISLAM

OBJECTIVES OF MONETARY POLICY IN ISLAM :

a) Ensuring optimum supply of money in the economy to facilitate smooth transaction


b) Maintaining stability in the value of money and price level.
c) Economic well-being with full employment and optimum rate of economic growth.
d) Attaining distributive justice.

ENSURING OPTIMUM SUPPLY OF MONEY :

In an Islamic economy Govt. as the solitary authority, has to ensure sufficient amount of
money to enable people in transacting their goods and services. In a capitalist economy the
transaction demand, the precautionary demand and the speculative demand for money is
taken into consideration to determine the amount of money to be supplied. However, in an
Islamic Economy, only the transaction demand, the precautionary demand is entertained.
Speculative demand for money is discouraged by Islam.

STABILITY IN THE VALUE OF MONEY :

In an Islamic economy it is almost mandatory on the central Bank to preserve the value of
money to ensure honesty and fairness in all human dealings to bring socio-economic justice
and general welfare. But, rather than absolute, this objective would mean relative stability in
the general price level. Absolute price stability is neither feasible nor desirable as it may
conflict with the optimum growth and full employment objective of the monetary policy.

ECONOMIC GROWTH AND EMPLOYMENT :

While inflation is incompatible with the goals of an Islamic economy, prolonged recession
and unemployment that cause human sufferings are also unacceptable. Monetary policy has,
therefore, to aim at a high rate of economic growth with full employment and utilization of
productive resources. Islam is in favor of “sustainable development “which means meeting
the needs of the present generation without compromising the needs of future generations.
Economic development and sound environmental management are complementary aspects
of the same agenda. Without adequate environmental protection, development will be
undermined; without development, environmental protection will fail.

DISTRIBUTIVE JUSTICE :

Monetary policy should be used actively to promote the goal of distributive justice and
prevent concentration of wealth and economic power in an Islamic economy. However, too
much concern with distributive justice in formulating and implementing monetary policy may
adversely affect its overall efficiency and effectiveness in attaining the other goals of
monetary policy e.g. growth, employment and development. Reduction in income inequalities
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and necessary redistribution should be and important policy objective of an Islamic state and
hence the domain, mainly, of its fiscal policy. Monetary policy can contribute to this objective.

ROLE OF THE CENTRAL BANK :

Like all central Banks, the central Bank in an Islamic economy should be responsible for the
issue of currency and, in coordination with the government, for its internal and external
stability. Unlike the conventional central bank, it should also bear the responsibility of
preventing the concentration of wealth and power through the financial institutions.
Stabilization of the real value of money should be an important function of the central bank in
order to realize the healthy sustainable growth of the Islamic economy and to ensure socio-
economic justice.

The central bank should be the primary institution responsible for implementing the country’s
monetary policy. Further, since the central bank cannot realize the goal of monetary stability
without cooperation from the government, a harmonious fiscal-budgetary policy would be
indispensable.

SOURCES OF MONETARY EXPANSION :

i) FISCAL DEFICITS : Fiscal deficits can be, and have been, an important source of
excessive monetary expansion. According to one important study “the greater the
dependence of the public sector on the banking system, the harder it is for the central
bank to pursue a consistent monetary policy.

ii) COMMERCIAL BANK CREDIT CREATION : Commercial bank deposits


constitute a significant part of money supply. These deposits may, for the sake of
analysis, be divided into two parts.

a) Primary deposit’, which provide the banking system with the base money
(cash-in tills plus deposits with the central bank)

b) ‘Derivative deposits which, in a proportional reserve system, represent money


created by commercial banks in the process of credit expansion and constitute a
major source of monetary expansion.

Since derivative deposits lead to an increase in money supply in the same manner as
currency issued by the government or the central bank, and since this expansion, just like
government deficits, has the potential of being inflationary in the absence of an offsetting
growth in output, the expansion in derivative deposits must be regulated if the desired
monetary growth is to be achieved. This could be accomplished by regulating the availability
of base money to the commercial banks.

iii) BALANCE OF PAYMENTS SURPLUS: Only a few Muslim countries have


enjoyed a balance of payments surplus in recent years, most of them have experienced
deficits. In the few that did have a surplus, the surplus did not originate in the private
sector and did not lead to an automatic expansion in money supply. It did so only to the
extent government monetized the surplus by spending it domestically and the private
sector balance of payments deficit did not offset this adequately. In the Muslim countries
that have a balance of payment deficit, it is unhealthy monetary expansion along with
public and private sector conspicuous consumption that generate the balance of
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payments disequilibrium through current account deficits and underground capital
outflows. These can not be removed without socio-economic reform at a deeper level and
healthy monetary and fiscal policies in the light of Islamic teachings.

INSTRUMENTS OF MONETARY POLICY:

To realize the objectives of monetary policy in an Islamic framework, the central bank in an
Islamic economy may use the following instruments, jointly or separately, for regulation of
money and credit.

i) TARGET GROWTH IN MONEY SUPPLY : The central bank should


determine annually the growth desired in the money supply (M) in the light of
national economic goals, including the desired but sustainable rate of economic
growth and the stability in the value of money. This target growth in M should be
reviewed quarterly, or as often as necessary, in the light of the performance of the
economy and the trend of important variables. However, the targets should not be
changed frequently but only when justified to accommodate economic shocks,
both domestic and external.

ii) STATUTORY RESERVE REQUIREMENTS : Statutory Reserve


Requirements against the commercial bank’s deposit liabilities usually consist of
two parts : [a] Compulsory Cash Reserve Ratio (CRR), and [b] Liquidity Ratio (LR).
Commercial banks may be required to deposit with the central bank in cash as
CRR a certain proportion, say 5-10 percent, of their total deposits from the public.
In addition, the banks may be required to keep with themselves shortly-maturing
liquid assets, say 10-15 percent; against their deposits. These reserves serve the
twin purpose of security and control of the banks’ capacity to create credit.
Reserve requirements against demand deposits may be higher, while
requirements against savings and Term (Mudaraba) deposits may be lower
because of their equity nature, meant for investment by the banks and not
supposed to be withdrawn frequently. The statutory reserve requirements may be
varied by the central bank according to the dictates of monetary policy.

iii) CREDIT CEILINGS : It may be desirable to fix ceilings on commercial bank


credit to ensure that total credit creation is consistent with monetary targets. Ins
the allocation of this ceiling among individual commercial banks, appropriate care
should be taken to ensure that it does not harm healthy competition among banks.

iv) ALLOCATION OF CREDIT : Since bank credit comes out of funds belonging
to the public, it should be allocated that it helps to realize general social welfare.
The criteria for its allocation, as for other Allah given resources, should be, first, the
realization of the goals of the Islamic society, and, second, the maximization of
private profit. This could be attained by ensuring that (a) credit allocation leads to
an optimum production and distribution of goods and services needed by the
majority of the society, and (b) the benefit of credit goes to an optimum number of
businesses in society.

v) SELECTIVE CREDIT CONTROL : For example, central bank Mudaraba


financing may not be made available except for specific purposes. The Central
bank may also accept a relatively lower profit-sharing ratio, if considered
necessary, for realizing the objective of distributing commercial bank financing to
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an optimum number of businesses for production of the goods and services which
are most needed.

vi) MORAL SUASION : Moral suasion or persuasion should acquire an important


place in Islamic central banking. The central banking. The central bank through its
personal contracts, consultations and meetings with the banks could achieve the
desired goals.

vii) OTHER INSTRUMENTS : For proper functioning of the monetary and credit
system and to secure its objectives and mandate the Islamic central bank may also
use the following instruments to replace the Bank Rate or Discount Rate and
control through regulation of interest rates:

1) Fixing a minimum and / or maximum ratio of profit for Islamic banks in their
joint venture and Mudaraba activities. These ratios may vary for different fields of activity.
2) Designation of various fields for investment and partnership within the
framework of the approved economic policies, and the fixing of a minimum prospective rate
of profit for the various investment and partnership projects. The minimum prospective rate of
profit may vary with respect to different branches of activity.
3) Fixing a minimum and maximum margin of profit, as a proportion to the
cost price of the goods transacted, for banks in installment and hire-purchase transactions.
4) Determination of types and the minimum and maximum accounts of
commissions for banking services.
5) Determination of the types, amounts, minimum and maximum bonuses,
and the establishment of guidelines for advertisements by banks.
6) Determination of the minimum and maximum ratio in joint venture,
Mudaraba investment, hire-purchase, installment transactions, buying or selling on credit,
forward deals with respect to various fields of activity; and also fixing the maximum facility
that can be granted to each customer.

FISCAL POLICY IN ISLAM

OBJECTIVES OF FISCAL POLICY IN ISLAM

a) Collection of sufficient revenue to meet Government revenue and development


expenditures.
b) Ensuring maximum utilization of resources of the country;
c) Economic well-being with full employment and optimum rate of economic growth.
d) Maintaining stability in the value of money and price level.
e) Attaining distributive justice.

INSTRUMENTS OF FISCAL POLICY IN ISLAM

1. Collection of Govt. Revenue


a. Zakat Ushar and other compulsory payment
b. Taxes imposed by the Islamic Govt.
c. Fees, penalties charged under Islamic laws.
2. Govt. Expenditure
a. Revenue Expenditure by the Islamic Govt. and
b. Development Expenditure by the Islamic Govt.
c. Expenditure for eliminating poverty
d. Expenditure for Islamic Dawah
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3. Government Borrowing

Taxation : A comparison between an Islamic and a secular system.


Sl. No. Limitations of Conventional System Superiority of Islamic System
1 Predominance of Indirect Tax Predominance of Direct Tax
2. No control on imposition of taxes by the Govt. Limited and controlled tax by an
Islamic Govt.
3. Huge corruption in the administration of taxes. No question of corruption in the
administration of taxes.
4. Tax evasion is a common phenomenon Tax evasion is a rare phenomenon
5. Payment of tax is not an Ebadah Payment of tax is an Ebadeh

Govt. Expenditure : A comparison between an Islamic and a secular


system

Sl. No. Limitations of Conventional System Superiority of Islamic System


1 Expenditure of the tax revenue is fully under the Expenditure of the tax revenue is not
control of the Govt. fully under the control of the Govt.
2. Exaggeration and corruption in Govt. No scope for exaggeration and
Expenditure corruption in Govt. Expenditure
3. Most of the expenditures are for elite class. Most of the expenditures are for
meeting the basic need of the people.

Govt. Borrowing : A comparison between an Islamic and a secular system

Sl. No. Limitations of Conventional System Superiority of Islamic System


1 Borrowing is based on interest Borrowing is Interest-free
2. Borrowing is a regular policy matter Borrowing is last resort

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ISLAMIC DEVELOPMENT BANK (IDB)

T he Islamic Development Bank is an international financial institution established in pursuance of


the declaration of intent issued by the Conference of Finance Ministers of Muslim Countries held
in Jeddah in Dhul Q’adah 1393H, corresponding to December 1973. The inaugural meeting of the
Board of Governors took place in Rajab 1395H, corresponding to July 1975, and the Bank was
formally opened on 15 Shawwal 1395H coresponding to 20 October 1975. The purpose of the Bank is
to foster the economic development and social progress of member countries and Muslim
communities in non-member countries individually as well as jointly in accordance with the principles
of Shariah i.e. Islamic Law.

The functions of the Bank are to participate in equity capital and to grant loans for productive projects
and enterprises besides providing financial assistance to member countries in other forms for
economic and social development. The Bank is also required to establish and operate special funds for
specific purposes including a fund for assistance to Muslim communities in non-member countreis, in
addition to setting up trust funds. The Bank is authorized to accept deposits and to mobilize financial
resources through Shariah compatible modes. 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; and extending training facilities for personnel engaged in
development activities in member countries to conform to the Shariah.

The persent membership of the Bank consists of 53 countries. The basic condition of membership is
that the prospective member country should be a member of the ‘Organization of the Islamic
Conference’ OIC, pay its contribution to the capital of the Bank and be willing to accept such terms
and conditions as may be decided upon by the IDB Board of Governors. Up to the end of 1412H (June
1992), the authorized capital of the Bank was two billion Islamic Dinars. Since Muharram 1413H
(July 1992). in accordance with a Resolution of the Board of Governors, it became six billion Islamic
Dinars, divided into 600,000 shares having a per value of 10,000 Islamic Dinars payable according to
specific schedules and in freely convertible currency acceptable to the Bank.

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THE OBJECTIVES OF ISLAMIC
ECONOMICS

01. Definition of Economics


Prof. L. Robbins –“Economics is a science which studies human behavior as a relationship
between ends and scarce means which have alternative uses.

02. Definition of Islamic Economics


i) Islamic Economics is that branch of knowledge which helps realise human well-
being through an allocation and distribution of scarce resource that is in conformity
with Islamic teachings without unduly curbing individual freedom or creating
continued macro-economic and ecological imbalances – Omar Chapra.

ii) Islamic Economics aims at the study of human falah achieved by organising the
resources of the earth on the basis of co-operation and participants (Muhammad
Akram Khan).

iii) Islamic Economics is the Muslim thinker’s response to the economic challengers of
their times. In this endeavour they are aided by the Quran and the Sunnah as well
as by reason and experience – M negatullahh Sidddiq.

iv) Islamic Economic is the sciences of how man uses resources and means of
production to study his worldly needs according to a predetermined code given by
Allah (SWT) in order to achieve the greatest equity-Princes Muhammad Al-Faisal
Saud.

v) Islamic Economics is a social which studies the economic problem of the people
imbued with the values of islam. It is a composite social science which studies the
problem of production, distribution and consumption through integrative system of
exchange and transfer overtime and their social through integrative system of
exchange and transfer overtime and their social and moral consequences in the
light of Islamic rationalism. It assumes the presence of Islamic man. M.A. Mannan.

03. Preliminaries :
i) There is a misconception in some sections that establishment of Islamic economy
means establishment of Arab economy as it existed 1400 years back at the time of
the Prophet (SM). This is not correct Islamic economy would be totally upto-date in
its method of organization and use of technology. Only the principles and
framework will be derived from the Quran, the teachings of the Prophet and the
practices of the early days of Islam.
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ii) Similarly, it is wrong to say that Islam does not give an economic system. We
recognize capitalism as an economic system, though its basic characteristics are
only the recognition of the private right of ownership and freedom of economic
activities for the individual. Likewise, socialism is treated as an economic system,
even though its only basic characteristic is the social ownership of means of
production. Islam gives us an much more comprehensive guidance in economic
matters such as prohibition of interest compulsory levy of Zakat, freedom of work
and enterprise, concern of the poor, distinction between the Halal (permissible)
and Harm (prohibited) in income, consumption and production and so no. As such
Islam undoubtedly gives mankind and economic system not found in other
religions. An economic system does not mean only the details of organization,
which are more or less the same in all economic systems.

iii) It is also necessary to bear in mind that an Islamic solution of the same problem
may be more that one. There can be alternative solutions or models for the same
problems or issues. The difference can be quite acute in such sectors as land
reform and role of government is economy. As long as the alternative solutions
proposed by Islamic scholars through Ijtihad had remained within the explicit
framework of the Quran and the Sunnah, the alternatives should be considered
Islamically valid and legitimate.

iv) The Islamic economy which established by the Prophet (SM) and developed by the
Khulafa-i-Rashideen in Medina is the first model of Islamic economy in. so far as
basic principles and values are concerned. This should always remain as a
reference point along with the Quran and the Sunnah. We should remember that
the Prophet freed the pre-Islamic Madinite economy from Jahiliya, or all un-Islamic
practices. As such none can say that what was allowed in Madinite economy, at
that time as not permissible today, or what was not permitted in that economy as
permissible now.

04. The Goals of Islamic Economy :


The goals of an Islamic economy are as under :

(a) Establishment of Adl. (justice), to attain Hasanah (good) and Falah (welfare) in
this life and the life hereafter.

(b) To establish Ihsan (gracious conduct or kindness) in economic affairs.

(c) Establishment of Maroof (proper or good acts practices institutions) in economic


life.

(d) Elimination of Munker (evil, wrong or injurious practices from Economic life).

(e) Freeing humanity from un-wanted burdens and shackles and to make life easier
for them.

(f) Ensure economic efficiency and accelerated rate of growth. Ensure maximum
production & useful production.

(g) Maximize employment to ensure maximum distribution of wealth in Society.

(h) Achieve universal education.

(i) Encourage cooperation in society.

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(j) To ensure full utilization of resources.

(k) Favouring weaker sections to establish them in life.

(l) Bring stability in the value of money & exchange rate.

(m) Ensure broad based economic wellbeing, balanced monetary expansion.

05. Principles of Islamic Economics


Systems :

a. Sole purpose is to obey and please Allah

b. The wealth and asset in all their forms given under trust by Allah.

c. Moral values and guiding factors for all Economic activities.

d. Maximum equitable utilization of human and material resources


given by Allah.

e. Human dignity and respect of Labour.

f. Maximum freedom for economic activity within a just framework.

g. Equitable distribution of wealth and income and disciplined private


ownership.

h. Simplicity economy and austerity in expenditure.

i. Adal and Ihsan (Justice and kindness)

j. Strict prohibition of Riba, Interest and Usury in all forms.

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06. The following Verses of the Holy Quran
clearly point out the aforesaid objectives of
Islamic economy:
i) Allah enjoins on you justice and gracious conduct (Sura Nahl : Ayat-90).
ii) When we give them power on earth, they establish prayer, give Zakat,
enjoin Maroof and Prohibit Munkar (Sura : Hajj : Ayat : 41).
iii) He (the Prophet) enjoins them to follow right things and forbids them
from evil, he makes pure things lawful for them and impure things unlawful,
he relieves them of their burdens and frees them from shackles that bound
them (Sura Araf Ayat : 157).
iv) Our lord, grant us good in this word and in the hereafter (Sura Baqara;
Ayat:20).
v) We desired to show favour into those who were depressed in the earth,
and to make them leaders and to make them inheritors and to establish
them on earth (Sura Qasas, Ayat: (5-6)
vi) Co-operate in acts of piety and virtue and do not co-operate in acts of
sin and transgression (of laws of God) (Sura Al-Maida, Ayat :2).
vii) So that wealth does not circulate only among rich people of you (Sura
Hashr, Ayat :7)

There are many other verses of similar nature in the Holy Quran which clearly
establish the aforementioned goals of Islamic economy.

viii) As regards achieving maximum economic growth, we can point out that
Islam did not allow any owner to keep his agricultural land uncultivated for a
long time. Islam also encouraged cultivation of barren land by any body who
could do so. Hazrat Omar-bin Abdul Aziz directed his governors to lease all
uncultivated state lands to any body who could cultivate against even one-
tenth share of the crop. This indicates Islam’s concern for maximum
utilization of resources for maximum economic growth. (Dr. Yusuf Al-
Qaradawi: Al Halal, Wal Haram).

ix) Islam also encourages maximum distribution of wealth as has been


indicated in the verse of Sura Hashr. Universal education has enjoined by
the Prophet in his famous saying “Education is compulsory on all Muslims,
male or Female”. Education helps gainful employment, which helps in better
distribution of wealth. (S.N.H. Naqvi: Ethics and Economics. An Islamic
Synthesis, First edition, Chapter-5, published by Islamic Foundation, U.K).

07. Basic Characteristics of Islamic Economy

i) Freedom of work and enterprise : Islam has allowed freedom of work


and enterprise. This is evident from the Madinitc model of Islamic economy.
A reading of the chapter of any Hadith collection in respect of agriculture,
gardening, business etc. will establish this. The Quran also clearly states that
“Allah has made business lawful for you (Sura Baqara, Ayat -275)”

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ii) Free Economy : Islam allows economy to cooperate freely according to
the market forces subject to Islamic restrictions and guidelines on
production. Distribution, marketing, investment trade, exchange, wages etc.
The state can also further interfere in this free economy to restore
equilibrium and establish justice and other Islamic objectives as explained
above. In an Islamic economy, there is an “allowability constraint” in every
idle (a terms introduced by Dr. S.N.H Naqvi in his above mentioned book).
An entrepreneur can produce only permitted things, Profit should be normal
in such an economy after giving proper wages to the labourers in
accordance with Islamic principles. Some forms of trade practices,
exchange, investment and land tenancy in agriculture are prohibited in Islam.
It also disallows monopoly and hoarding as social evils. The aforesaid
restrictions make free economy in Islam qualitatively different form
capitalism. Islam can not be said to be capitalistic only because it allows
forces of demand and supply are fundamental economic forces, which were
operational in all ages even before capitalism.

iii)Trusteeship ownership : In Islam God is the true owner of all things.


The Quran says: “To Allah belongs whatever is in the earth”. (Al-Imran).
However, Allah in His mercy allows human beings to inherit wealth, own it
and use it subject to His laws as evident from the following verses :

a) The land belongs to Allah. He allows it to be inherited by won so even


he pleases. ( Sura Araf, Ayat : 128).

b) Do they not see that we have created for them ---- among the things
fashioned by us ---- cattle of which they become owners? (Sura Yasin,
Ayat : 29). Islam, therefore, allows man as Vice-grant, to inherit from
Allah (that is to own) wealth. This is indeed a truss’ for proper use.

iv) Kinds of Ownership : In early Islam there were three kinds of


ownership: Private, communal a state ownership. The books of Hadith are
full of accounts of individual ownership. This was the standard ownership.
Some important things like water, canals pastures and graveyards were
communal properties. The state owned the mines, rivers and large tracts of
land . After the conquest of Syria and Iraq, these lands were made state
lands and were not allowed to go into private ownership. (Tafhimul Quran,
Sura Hashr, Syed Abul Ala Maududi)

v) State Ownership : There is no bar on state ownership of enterprise


in Islam. The basic economic institutions can be or should be brought under
state control, if required to establish social justice or protect the interests of
the community.

vi) Protection of lawful Property : Islam protects lawful property and


is in favour of confiscation of unlawful property. There are many instances of
take over of unlawful property during the period of Hazrat Omar and Hazrat
Omar bin –Abdul Aziz. Lawful property can be taken over by the state only
for valid social reasons after due compensation. During the last Hajj the
Prophet (SM) announced the principle of protection of lawful property. The
Quran says, “ don’t eat each other’s property wrongly” (Sura Nisa, Ayat -29).

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vii) Prohibiting of Interest : Islam prohibits interest. This requires a
total reorganization of the economy, banking, investment, exchange,
business and international trade. A big effort is under way in the Muslim
world in this direction. A body of literature has already come up on this
subject.

viii) Zakat : Islam has made Zakat compulsory on the wealth of rich
Muslims. This is spent for the weaker and distressed sections of the society.
Zakat not only distributes wealth between the rich and the poor of the
society, it also influences investment, savings and allocation of income and
resources. A detailed study has been made in this regard by Dr. Monzer
Kahf in his book “Islamic Economy” American Trust Publications, USA, A
rich body of literature has come up in recent times on Zakat. The Zakat and
Ushr ordinance of Pakistan can be particularly referred to in this connection.

ix) Concern for Poor : This is a special feature of Islam. Zakat is one
institution which testifies to this. In this connection we may refer to ayat 5-6
Sura Qausar as quoted in para 6 above, is particularly significant, where
Allah, the Almighty has expressed this desire to show favour on the
depressed people, Islamic economy shall establish all possible institutions to
carry out this desire of the Almighty.

x) Distribution of inheritance : Islam has not left the distribution of


inheritance on the whoms of a person, In Islam a person can not favour one
over the other of his relations for temporary or subjective reasons as is the
rule in the West. Islam distributes inheritable property among several groups
of people.

a) Children
b) Husband / Wife
c) Parents
d) Brothers and sisters in certain situations.

This distribution has taken care of different groups keeping in view their social role,
requirements proximity of kinship relationships. For those who remain outside the list of
inheritors. Islam has provided for wasiat (will) for all such relations if they are in a distressed
condition. A person can will upto one 3rd of his property for distressed relations or others
outside the inheritors.

Time and again as we were from the clear injunctions of Allah, we hark back discouraged
and crest fallen. Islam provides us the principles of social behavior in our economic life. It is
upto us to develop the technology for the implementation of such principles. Already there is
a resurgence over the Islamic World towards these ends. We pray to Allah for his blessings
and continued guidance. (Summary of speeches given in Islamic Banking course held in
BIBM in January, 1982).

The End
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01. ISLAMIC FINANCIAL SYSTEM (IFS) :

A financial system that is based on Islamic principles and values, which eliminates Riba and
ensure a profit sharing mechanism in the financial system may be called IFS. It may be
characterised by the absence of interest based financial institution & transactions, doubtful
transactions or gharar, Stocks of companies dealing in unlawful activities, unethical or
immoral transactions such as market manipulation, insider trading short-selling etc.

02. DIFFERENCES BETWEEN CFS & IFS

The conventional financial system of two types.

Socialistic financial system and 2) capitalistic financial system both systems have been
proved inefficient to establish economic balance in the society.

Basis of Differences CFS IFS


1. Religious Belief Secular & separates Religion Belief in unity of God &
from other Parts human like. relates this belief to
economic Life of a man.
2. Freedom of Economic In socialism govt enjoys Restrictive freedom is
activity economic freedom but in allowed in the light of Shariah
capitalism Individuals enjoys both by the Govt & /or
freedom. individuals.
3. Ownership of means Socialism-state Ownership Allah is the exclusive owner.
Capitalism-individual Man is the caretaker of the
Ownership property
4. Goals of financial System Socialism-profit of the society Welfare of both here and
Capitalism-Individuals profit. hereafter.
5. Competition Socialism-No Competition Logical Competition And
Capitalism-logical & financial co-operation.
Unethical competition
6. Wealth distribution Socialism equal Capitalism Equitable
Unequal
7. Basis of Economic System Riba or interest Interest free; PLS Zakat &
compensation Based.

Basis of CFS IFS


Differences
8. Sources of the System Intellectuals brain storming of Devine book “Al Quran”&
the economic problems of prophet’s speeches.
men’s life
9. Result Capitalism concentration of Maximum & equitable
income & economic power in Distribution of economic
few hands. Inefficiency opportunities and higher
production in the society.
10. Social & environmental Do not consider the social & Ensure social & environment
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welfare environment welfare welfare
11. Owners exception in Dividend or part of profit in Part of Profit or loss.
respect of investment case of equity financing
12. Lender or Bank’s Interest Profit or loss sharing
expectation in terms of dept
financing.
13. Modes of Investment Loan, Overdraft & Cash Mudarabah, Musharaka,
credit. Murabaha etc.

03. PRINCIPLES OF AN ISLAMIC FINANCIAL SYSTEM

The basic framework for an Islamic financial system is a set of rules and laws, collectively
referred to as shariah, governing economic, social, political and cultural aspects of Islamic
societies. Shariah originates from the rules dictated by the Quran and its practices, and
explanations rendered (more commonly known as Sunnah) by the Prophet Muhammad.
Further elaboration of the rules is provided by scholars in Islamic jurisprudence within the
framework of the Quran and Sunnah. The basic principles of an Islamic financial system can
be summarized as follows :

Prohibition of interest : Prohibition of riba, a term literally meaning “an


excess” and interpreted as “any unjustifiable increase of capital whether in loans or sales” is
the central tenet of the system. More precisely, any positive, fixed, predetermined rate tied to
the maturity and the amount of principal (i.e., guaranteed regardless of the performance of
the investment) is considered riba and is prohibited. The general consensus among Islamic
scholars is that riba covers not only usuary but also the charging of “interest” as widely
practiced.

This prohibition is based on arguments of social justice, equality, and property rights. Islam
encourages the earning of profits but forbids the charging of interest because profits,
determined ex post, symbolize successful entrepreneurship and creation of additional wealth
whereas interest, determined ex ante, is a cost that is accrued irrespective off the outcome of
business operations and may not create wealth if there are business losses. Social justice
demands that borrowers and lenders share rewards s well as losses in an equitable fashion
and that the process of wealth accumulation and distribution in the economy be fair and
representative of true productivity.

Risk sharing. Because interest is prohibited, suppliers of funds become investors


instead of creditors. The provider of financial capital and the entrepreneur share business
risks in return for shares of the profits.

Money as “potential” capital . Money is treated as “Potential” capital –that


is, it becomes actual capital only when it joins hands with other resources to undertake a
productive activity. Islam recognizes the time value of money, but only when it acts as
capital, not when it is “potential” capital.

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Prohibition of speculative behavior . An Islamic financial system
discourages hoarding and prohibits transactions featuring extreme uncertainties, gambling,
and risks.

Sanctity of contracts . Islam upholds contractual obligations and the disclosure


of information as a sacred duty. This feature is intended to reduce the risk of asymmetric
information and moral hazard.

Shariah approved activities . Only those business activities that do not


violate the rules of shariah qualify for investment. For example, any investment in
businesses dealing with alcohol, gambling, and casinos would be prohibited.

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HIRE-PURCHASE & HPSM INVESTMENT –
MEANING, FEATURES, APPRAISAL,
SANCTION, DISBURSEMENT, RECOVERY,
FOLLOW-UP

HIRE PURCHASE

It is a contract two parties, one is lessor & another is Lessee to acquire a rentable asset
by the Lessor and for taking the services of the Asset by the Lessee against rent and
payable the value of the asset to the Lessor at a time for getting the Ownership of the
Asset.

HIRE PURCHASE UNDER SHIRAKATUL MELK (HPSM)

MEANING : HPSM is a synthesis of three contracts i.e. Shirkat, Ijarah &


Sales.

MAIN ELEMENTS : HPSM


a) Wording : Offer & Acceptance
b) Contracting Parties : Lessor & Lessee
c) Subject matter of the contract : Rent & the benefit

STAGES OF HPSM
a) Purchase under Joint Ownership
b) Hire and
c) Sale and/or transfer or Ownership to the other partner lessee

DEFINITION : HPSM is a special type of contract where both the Bank and the Client
supply equity in equal or unequal proportion for purchase of an asset, own the same
jointly, share the benefit as per agreement and bear the loss in proportion to their
respective equity. The share in the asset owned by the Bank is hired out to the Client and
eventually the Bank sells and transfers its ownership to the Client against payment of
price as per agreement.

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SOME FEATURES : HPSM
1. The Bank and the client purchase the asset jointly with specified equity sharing
the ownership under HPSM contract.

2. Though ownership is joint, asset may be registered in the name of any one
mentioning in the HPSM agreement.

3. Rent cannot be considered as price or part of price of the Asset.

4. In the HPSM agreement Hiree does not sell or Hirer does not purchase the
asset but they promise to sell and purchase the same part by part only.

5. The hire contract become effective from the day on which the Hiree transfer the
possession of the asset in good order and assemble condition to the Hirer.

6. As the portion of the Bank is sold and transferred part-by-part the rent will be
reduced proportionally.

7. Under HPSM agreement bank will act as partner, Hiree and at last as a seller
and client will act as partner, as a hirer and lastly as purchaser. The sale and
purchase will be effected by a separate sale contract.

8. Ownership risk will be borne by both the parties proportionally. The Hirer will
maintain the asset with due prudence and shall not be held responsible for the
damage or destruction of the asset without transgression, default or negligence,
otherwise he must be responsible for the same.

9. The Hirer is responsible for keeping the asset in goods condition as a trustee.

10. The Hirer cannot change or remove the property without the permission of the
Hiree.

RULES OF HPSM

• Ownership of the asset of both the Hiree and the Hirer should be recognized as
per law of the land.

• The asset(s) to be hired must not be a fungible one (Perishable or consumable).

• The asset(s) and the benefit/service drived from it is within the category of
‘Halal’ or at least ‘Mobah’ as per Islamic Shariah.

• The Hiree is under obligation to enable the Hirer to the benefit from the asset(s)
by putting the possession of the asset(s) at his disposal in useable condtion at
the commencement of the hire period.

• In a hire contract, the period of hire and the rental to be paid per unit of time be
clearly stated.

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• It is a condition that the rental falls due from the date of handing over of the
asset to Hirer and not from the date of contract or use of the asset.

• It is permissible to advance, defer or install the rental in accordance with the


Agreement.

• The hired assest is a trust in the hands of the Hirer. He will maintain the asset(s)
with due produce and shall not be held responsible for the damage or
destruction of the asset without transression, default or negligence; otherwise
he must be responsible for the same.

• The Hiree/owner bears all the basic costs for repairs & maintenance as per
contract.

• The Hirer bears the cost of ordinary routine maintenance.

• The hire contract is binding and no one party shall unilaterally reseined except
reasons that abrogate binding contract such as damage or destruction.

• If the hired asset is damaged or destructed by the act of Allah and if the Hiree
offers a substitute with the same specifications agreed upon in the hire contract
the contract does not terminate.

• It is also permissible to sell the hired asset by the Hiree to the Hirer during the
tenure of the hire period either part by part or in full at a time.

GESTATION PERIOD

The period from the date of 1st disbursement for acquisition of the asset/property to the
date of handing over of the asset/property to the Hirer in good order and useable condition
to derive the desired service (s)/benefit(s) is called “Gestation/Interim period”.

During the gestation period, the asset remains under construction /installation/making
form, so the asset can not yeild the desired services/benefit(s) and as such no rent should
be charged for that period.

Taking the cost, utility, value addition, market demand for the asset, the sale Price of the
Bank’s share of the asset/property may be fixed at a higher Level to cover the cost/benefit
of the “Gestation Period” or in other words, the Bank may sell its share in the asset at a
higher price with mutual consent of the Bank and the purchaser.

CALCULATION OF MONTHLY INSTALLMENT

Calculation of monthly installment for the Investment allowed under HPSM mode (or
Investment allowed against payment in installment basis).

Total Rent/Profit = (P +Pi)/2 x RR x N + G

Where, P = Amount Disbursed / To be disbursed


Pi = Principal Installment
RR = Rate of Return
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N = Total period of Investment (excluding
gestation period).
G = Un earned Rent / Profit for gestation period.
Monthly Installment = Monthly Principal + Average Monthly Rent

OR
Average monthly rent = ( I x R) / 2400
Where

I = Principal + Monthly Installment


R = Rate of Return

Rent of the gestation period is to be calculated also & spreaded over the whole period of
the investment and to be added up with the monthly installments.

Monthly Installment = Monthly Principal + Average Monthly Rent

• 2400 = 12 months x 2 (reducing balance method) x 100 (Percnetage)


• ** Plus rent of the gestation period considering higher asset value.

Problem :

Suppose an HPSM Investment of Tk. 5,00,000/- was allowed to a client for a period of 5
years excluding gestation period of 1 year at 15% RR.

What will be the monthly installment ?


Calculation :
Principal (P) = Tk. 5,00,000/=
Principal Installment (Pi) = Tk. 5,00,000/- ÷ 60 = 8,333/-
Rate of Return (RR) = 15%
Period of Investment (No. of years) =5
Un Earned Rent/Profit for gestation period (G) = 75,000/-

Total Rent / Profit = (P + Pi)/2xRRxN + G


= (5,00,000+8,333)/2 x 15% x 5 + 75,000
= 2,54,166.50 x 15% x 5 + 75,000
= 2,65,624.87

Monthly rent / Profit = 2,65,624.87 ÷ 60


= 4,427/-

Monthly Installment = Principal + Rent / Profit


= 8,333 + 4,427
= 12,760/-

SHARIAH ISSUES : HPSM

No rent on rent
2. Rent of the gestation period is not recovered during the said
period.
3. Presession of the asset is being handed over to the client.
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It has nothing to do with interest ?
It is the expression of service equaty.

ACCOUNTING PROCEDURE : HPSM

1. Dr. HPSM
Cr. P.O

2. Dr. HPSM Month End/Automatically (Rent)


Cr. Income A/C

3. Dr. HPSM After Gestation Meturity


Cr. Un Earned Income

4. Dr. Un Earned Income At the time of Adjust of Installment


Cr. Income

5. Dr. Client Account


Cr. HPSM

6. Dr. HPSM SS- Above -5 years-12 month -15—


Cr. Profit Suspense A/C 18 below 5 years 9 months 12, 15

7. Dr. Profit Suspense A/C When regular


Cr. Income A/C

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