INTRODUCTION TO

ISLAMIC BANKING AND TAKAFUL

By

Muhammad Ayub
 Today’s Outline
• Introduction
• Finance as a Business!
• Banking & Finance – Institutions & Markets
• Objectives of Business and Finance in Islam
• The concepts of intermediation and Risk
mitigation, basis in the conventional and
Islamic framework;
• History of Islamic banking and takaful
Banking and Non-Banking Institutions
of Finance
• Acquisition and investment of funds; resource
allocation; resource management
• Financial support, Business support
• Banks, Credit institutions; Savings and Loan
Associations: receiving and giving funds at
their own account
• Investment firms
• Risk mitigating institutions
 Financial Complexity
• Complexity in the institutions, customers (private,
corporate, public entities) in the markets (money,
stock exchange, commodity, debt, derivative, foreign
exchange), in the instruments (equity, bonds,
derivatives), as well as in the services rendered
(insurance, underwriting, leasing).
• asset management firms, hedge funds,
• mutual funds, savings banks,
• insurance and re insurance companies Versus
Takaful institutions
 Turning Point in modern finance
• Turning point from traditional banking to
disintermediation and innovative finance occurred in
1971 with the end of the dollar’s convertibility into
gold.
• ...issuance of bonds sold on the capital markets to
individuals and institutional investors.
• banks transferring some of their traditional risks -
such as credit and market risks – to others -innovative
products that generate new sources of income;
• Creating and exchanging risk
Finance as a Business – Islamic Perspective

• Providing finance to facilitate production process

availability throughout the world.

• Finance through real sector activities

• Name the real sector activities?

Beyond Market Perspective:

– Cooperative Risk and Reward sharing
 Banking in Islamic perspective
• Business:
– An occupation, profession or trade - work or job in which
one is engaged for earning means of living;
• Objectives:
• Intermediation ultimately by way of exchange of goods and
services for another or for money in the light of Shariah
principles.
 Basis of of intermediation
• Contract Nature is important for validity of
otherwise:
• Amanah,
• Loan
• Sale / purchase
• Ujrah / Juaalah
• Wakalah
• Shirkah
• Cooperation
 Islamic Banking means
• Sharing of profit and loss on post facto basis arising from:
i. (Deferred) Trading– profit margin for the seller
ii. Rentals on leased assets
iii. PLS in business
iv. Combination of contracts
• Return free (loans)
• Services – fee, Ujrah
• Services mixed with financing – crucial area not yet fully
decided any example?
HISTORY OF ISLAMIC BANKING
 Holy Books
• Riba is prohibited in the Holy Scriptures of several
major religions, including Islam.
• Ethical proscriptions having a significant bearing on
economic and commercial activities and financial
transactions;
• Prohibition in Muslim world taken for granted!
• Riba based banking in Islamic Areas
• Criticism
• Study for alternative
 Preparation to Take of!
• 1890s: - Suez Canal - Cairo branch of Barclays Bank;
• S Scholars’ critique of bank interest
• 1900–1930: Debate in Arab regions, Indian Sub-continent;
• 1930–1950: Economists and socio-political reformers initiated
critique of interest;
• 1950s: Theoretical models of banking and finance based on
Shariah tenets
• 1960s: Experiences of Egypt and Malaysia: rise and fall of
Mitghamr Saving Associations during the 1961–1964;
establishment of Tabung Haji in 1962
• Operational mechanisms for IFS;
• Books ; reading materials on 2-tier system
 First Milestone!
• 1975: DIB, IDB, fiqhi objections to insurance;
• 1970s: Financial murabahah: as the core mechanism for
placement of banks’ funds;
• 1st Int’l Conference on Islamic Economics, held in Makkah in
1976
• 1978: Jeddah Centre for Research in Islamic economics
• 1st Takaful company in 1979 in Sudan,
• CII, Pakistan work in late 1970s – Panel of Economists &
bankers
 Cont’d
• Nation wide effort: Pakistan, Iran and Sudan
• Governors of central banks of OIC States – to jointly
strengthen regulation and supervision of IIFS;
• Mudaraba Companies – 1980
• CII Report, 1980
• Separate Interest-free counters ;Pakistan; Jan 1981
• IRTI: 1981
• Malaysia, Bahrain
• Muslim economists at IMF – Working Papers
• Literature & Ph. D Studies started
• Islamization Commissions in Pakistan
 Pakistan’s declining role as Leader
• 8th Amendment 1985, FSC, SAB of SCP;
• PTCs : June, 1980
• TFC: 1984-85;
• SBP BCD Circular 13 – Islamisation since 1 July, 1985; 12 Modes; 3 categories
• Modes specified in the term "finance" defined in the Tribunals Ordinance.
– Participation in profit and loss
– Mark-up or mark-down
– Hire Purchase
– Leasing
– Rent-Sharing
– Charge or fee of any kind
– Purchase and sale of any property (industrial, intellectual or real) with or
without buyback arrangement by a seller
– Participation Term Certificate.
– Guarantees
 1990s
• AAOIFI,
• FSC Judgment, 14 November, 1991; Govt. Appeal
• Serious notice taken by Western academic circles;
• Dow Jones and Financial Times Islamic indexes
• Effort for regulation, supervision and risk
management
• Legislation to facilitate Islamic banking;
• Business by Commercial event organizers;
• SC Pakistan Judgment, December, 1999
 Policy Change in Pakistan
• Pakistan Govt. Review petition!
• Meeting on September 4, 2001
• Islamic banking in Parallel with conventional;
• Setting Aside the Shariah Courts’ Judgments: June 24,
2002;
• SBP 3-pronged policy; first Islamic commercial
banking license from SBP in January 2002;
• 19 IBIs operating in Pakistan
• Takaful Companies
• Implication of the Policy Change!
 Global Developments
• Sovereign and corporate sukuk
• IFSB,
• IIFM
• GCIBAFI
• Arbitration and Reconciliation Centre for Islamic
Financial Institutions (ARCIFI),
• International Islamic Rating Agency (IIRA)
• Liquidity Management Centre (LMC);
• Tax neutrality measures by some countries
 Sources of Shariah
• Law in the beginning of Islam? -
When only 5 verses
• Juridical work started by the H Prophet himself: Local
customs - Customary law of Makkah –also a source of
law – Blood money to mail relative of deceased; Holy
prophet: in the ratio of inheritance;
• Order of Omar the Great (R ): judges to decide jointly
and consult Ulama / jurists;
• Every knowledgeable has the right in making law_
amount of Dowry – fixing by Omar the Great
 Any points to ponder?

• Every one to express views!

 Shukran
Wa Ma Tawfiqi illa bi Allah!