Islamic Finance An Introduction: Institute of Business Finance and Industry

INSTITUTE OF BUSINESS FINANCE AND INDUSTRY
Islamic Finance An introduction
Conventional system Consumer credit no more confined to poor
No more meeting of excegencies Creation of money Financing of govt. budget deficit Borrowing to repay old debts Roll overs in business finances
PLS or trading Actual assets Economic impact--- development oriented system Better risk sharing system Legal frame work Pakistans experience
Islamic system
Prior 1980 1980s 1990s Relaunch in 2000s Present status
Pakistans experience
Islamic Banking An Overview
ISLAMIC BANKING Emerging as a viable alternative to conventional banking
Strong demand Huge funds New institutions Need time to develop Many questions: Are they really Islamic, can they
sustain?
Comparison of the two systems
CONVENTIONAL BANKING -----FI
Mobilizing Funds (deposits) on the basis of

creditor/ debtor relationship and providing capital to entrepreneurs by way of creditor/ debtor relationship
These modes can be:

Loans and advances of various maturities
Not in accordance with shariah
Risk of default on the asset side and liability side Risk mitigation measures for both Prudential regulations and other policy guidelines No divine restrictions regarding economic performance.
Supervision by the central bank for mitigating risk as well as channeling credits into desired sectors and to fulfill economic objectives. Integration with monetary and fiscal policies.
CONVENTIONAL BANKING
ISLAMIC BANKING-- MAIN FEATURES The Islamic Financial Institutions have to keep in mind the Quranic injunction that all capital belongs to God and is to be used for the good of society
Man as His Vicergent is bound to obey His commandments in entire life including business and economics
ISLAMIC BANKING--UNDERLYING THEME Prohibition of interest in all transactions.
Legitimate and halal profits Capital should be directed into halal channels Hoarding is not permissible in any form Not to create monopoly on the societys resources. Basic need to get rid of the debt ridden society Investments to contribute in the development of
national resources and serve whole community.
ISLAMIC BANKING -THE GUIDING PRINCIPLES
No Interest. Transformation of the debtor-creditor relationship into

some kind of partnership. Profit /loss sharing
Application of Islamic principles in trade and finance.

Trading of assets.
All transactions in accordance with Islamic law. Prohibition of Gharar
ISLAMIC BANKING --FI Mobilizing Funds on the basis of modaraba / Musharika and providing capital to entrepreneurs by way of different modes in accordance with shariah
These modes can be :

Investment modes
Trade related modes

Qarz-e-Hasan
INSTRUMENTS FOR MOBILISING FUNDS
Current accounts/ Trust accounts Savings accounts/ Investment accounts Term Deposits / COIIs, MCs Short term transactions b/w banks/ (in future
for IBs)
Shareholders
INSTRUMENTS FOR UTILISING FUNDS
Musharaka (Investment mode)
Mudaraba Murabaha ljara Salarn Istisna
do
( Trade mode do do do )
Risk of default on the asset side and liability side Risk mitigation measures for both Prudential regulations and other policy guidelines Supervision by the central bank for mitigating risk as
well as channeling credits into desired sectors and to fulfill economics objectives. Integration with monetary and fiscal policies.
ISLAMIC BANKING
Divine restrictions regarding economic performance.
Typical Balance Sheet of a CFI
Assets Loans and advances Lease Financing Investments in Shares
Liabilities& Equity
Deposits-Current,
Saving, Term etc Share Capital
Bonds, PTCs, etc.

FAs.
Reserves
Typical Balance Sheet of an IFI
Assets Modaraba Financing Murabaha Financing Musharaka Financing
Equity & Liabilities

COIIs, Share
MC etc Capital
Reserves
Lease Financing
Investments in Shares Bonds, PTCs, etc..
Typical balance sheet of a business enterprise
ASSETS Land / Building Plant & M/Cs Inventions A/Cs Receivable
Rs. in
Million
200 450 150 50 850
Financed Rs. in Million Through Share Capital 200 Long term loan * 450 Short term 100 loan** Lease Fin. *** 25 Current Liab. 125 850
Typical balance sheet of a business enterprise
ASSETS Land / Building Plant & M/Cs Inventions A/Cs Receivable
Rs. in
Million
200 450 150 50 850
Financed Rs. in Million Through Share Capital 200 Murabha /DM 450 Short term 100 murabaha/mush. Ijarah 25 Current Liab. 125 850
MAIN ISSUES
Supporting Legal Framework Taxation System Education ,Training , Organized Research Govt. Support Paradigm Shift Change management issue Supervision and regulation Market practices: portfolio structure
MAIN ISSUES
PLS vs. FI Why and why not PLS Why and why not FI Practical solution Actual practice What should be the strategy
THREE MAJOR ACHIEVEMENTS

Financing the Halal business only Asset backed financing Better risk Management as compared to conventional banks is possible
Conclusion
Pakistans financial institutions could take a large share
of muslims savings, if they took the initiative of
developing asset and liability products on Islamically

accepted lines.
It has been conservatively estimated that currently about US$ 100 billion are available with muslims wanting to invest in Shariah Compliant instruments.
Conclusion
Islamic banking provides a viable alternative to
interest-based banking
Parallel banking systems for another decade or so. Can be perused without waiting for the whole economy to transform. Its own separate identity is its strength. Supply must follow Demand.

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INSTITUTE OF BUSINESS FINANCE AND INDUSTRY