Islamic Banking

Concept, History, Global & local perspective, Model, Difference and Way forward

Outline

• Evolution of Islamic Banking

• Islamic Banking Global perspective

• Islamic Banking in Pakistan – Historical perspective

• Islamic Banking in Pakistan – Present status

• Steps taken for promotion

• Differentiating points of Islamic banking

• Islamic banking modes and agreements  

ISLAMIC BANKING  

• ISLAMIC BANKING is based on the principles of interest free financing and investments. Its liability side is dominantly based on profit and loss sharing basis, and the assets side earn profit through trading, rent and profit and loss on investments and financing.

History of Modern Islamic Banking Cooperative banks in the sub-continent:

o Cooperatives in Hyderabad Dakan (1940s)o Cooperative bank in Karachi (1950s)

Pilgrimage fund in Malaysia (1950s) full-fledged bank in 1967

Saving bank in Mit Ghamr, Egypt (1963)

Nasr Social Bank, Egypt (l97l), was created as an interest-free commercial bank

Dubai Islamic Bank (1974)

Islamic Development Bank (1974)

Dar-al-mal-al-Islami (DMI), Geneva, established in 1981

Islami Bank Bangladesh Limited (IBBL) the first interest free bank in Southeast Asia was incorporated in 1983

History of Modern Islamic Banking In 80s different initiatives were taken in Pakistan, Iran & Sudan.

In 80s Islamic Mutual funds & Mudarabah companies started to emerge

In 90s AAOIFI, Harvard Islamic Finance Forum, Dow Jones Islamic Index were established

In 2000-10, several Islamic Bonds (sukuks) were issued.

Key infrastructure institutes were established including IFSB, IRA (Islamic Rating Agency), CIBAFI, ARCIFI.

Recognition by IMF, World Bank and Basel Committee

Diploma programs, Graduate/Post graduate & doctorate degrees are being offered in Islamic banking by major academic institutions (CIMA, INCEIF, Durban University, IBA, IIBI-UK and several other universities )

• 500 + Islamic financial institutions

• Total size ~ US $1.2 Trillion*

• 250+ Shariah compliant mutual funds with $ 300bn funds

• Around 700 International Islamic sukuks issued till date

• 133 + Takaful companies; > US$ 8.8 billion in contribution• 2005-08 global CAGR 38%

• Over 35+ Shariah & Accounting Standards for Islamic financial institutions ( by AAOIFI)

• Establishment of Islamic indices (Dow Jones, FTSE, KMI-30 etc.)

• Global IF Hubs (London, Bahrain, Malaysia, UAE)

Islamic Banking – Global Perspective

*Arab News.com

• International Groups

– DMI

– Al Baraka

– Al Rajihi

– Kuwait Finance House

– Noor Financial

– Abu Dhabi Islamic bank

• In Pakistan– Meezan

– Al Barakah

– Dubai Islamic

• Many foreign banks now have Islamic windows.

– Citibank

– ANZ

– RBS

– Goldman Sachs

– Hong Kong Shanghai bank

– Saudi American bank

– Saudi British Bank

– UBS AG

Islamic Banking – Global Perspective

• More than 75 countries have ISLAMIC BANKING Institutions

– Approx. 45 Muslim countries including Kuwait, Dubai, Saudi Arabia, Iran, Malaysia, Brunei and Pakistan

– Approx 30 non-Muslim countries including USA, UK, Canada, Switzerland, Srilanka, South Africa and Australia

Islamic Banking - a Success Story

Islamic Banking - a Success Story

Different types of IFIs have emerged globally

• Islamic Commercial Banks• Islamic Investment Banks• Islamic Units of conventional banks• Islamic Funds• Islamic House Financing Schemes• International Financial Market• International Institutions of Islamic Banking

Islamic Banking - a Success Story

AAOIFI

IFSB

IIRA

CIBAFI

Global Bodies for Islamic banking

A A O I F IAccounting & Auditing Organization

of Islamic Financial Institutions

An Umbrella organization for Islamic banking

 

• Established on 1 Safar, 1410H (26th February 1990).• AAOIFI is headquartered in Bahrain.• Entrusted with the task of developing for IFIs:

- Shariah Standards

- Accounting Standards

- Auditing Standard• Has published standards for all major modes of Islamic

Finance.• In Pakistan, AAOIFI standards are being adapted

through ICAP’s Committee• Total Members are 122 Islamic Financial Institutions

from 29 countries.

AAOIFI – brief Introduction

A host of world renowned Shariah Scholars.

1. Shaikh Muhammad Taqi Usmani/Chairman (Pakistan)2. Shaikh Abdullah Sulaiman Al Manea/D.Chairman (KSA)3. Shaikh AlSiddiq Mohamed Al Darir (Sudan)4. Shaikh Wahba Mustafa Al-Zuhaili (Syria)5. Shaikh Ajeel Jaseim Al-Nashmi (Kuwait)6. Shaikh Abdel-Rahman bin Saleh Al-Atram (KSA)7. Shaikh Mohamad Ali Al Taskhiri (Iran)8. Shaikh Dato Ghazali bin Abdul Rahman (Malaysia)9. Sheikh Dr. Nazih Hammad 10. Sheikh Al Ayashi Al Saddiq Faddad (KSA)11. Shaikh Abdel Sattar Abu Ghuddah (KSA)12. Shaikh Nizam Yaquby (Bahrain) 13. Shaikh Ahmad Ali Abdullah (Sudan)14. Sheikh Dr Muhammad Daud Bakar (Malaysia)15. Shiekh Dr Hussein Hamid Hassan (Dubai/UAE)

AAOIFI – Shariah Board

An international standard-setting organization

• Established in November 2002 • Based in Kuala Lumpur • An international standard-setting body of regulatory and

supervisory agencies • Introduces/adapts existing international standards

consistent with Shari'ah principles• To date, it has issued 12 Standards, Guiding Principles and

Technical Notes for the IFIs

• Areas include Risk Management, Capital Adequacy,

Corporate Governance & Supervisory Review Process

The IFSB

• Various International Fiqh bodies like:

– International Islamic Fiqh Academy – Jeddah – Nadwah al-Barakah

Have declared all sort of banking interest as Riba & prohibited and have approved resolutions on various products of Islamic banking

Islamic Banking – Recognition & Approval

Islamic Banking – in Pakistan

“We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice.

Speech at the opening ceremony of State Bank of Pakistan, Karachi July 1, 1948

1947 Pakistan Resolution

1949 Objectives Resolution

1962 Creation of Council of Islamic Ideology (CII) in 1962

1979 Pakistan adopted a policy of gradual transformation of its banking system

1980 A 15 member committee of CII prepared a report on elimination of banking & commercial interest from Pakistan and outlining the Islamic modes of financing

1980 Introduction of zakat system

1983 Introduction of Ushr system

1985 Introduction of mark-up based financing system in banks

1991 Federal Shariat Court (FSC) Declared mark-up procedure un- Islamic

Islamic Banking – in Pakistan

History

1999 Shariah Appellate Bench of Supreme Court rejected all appeals against the previous and called for the establishment of an interest free financial system

2002 Meezan Bank established as Pakistan’s first Commercial Islamic Bank

2003 Establishment of Islamic Banking Department at SBP

2007 Adapted Accounting Standards for Murabaha

2008 SBP issue Instruction & Guidelines for Shariah Compliance in Islamic banks

2008 Government of Pakistan issue Ijarah based sukuk to finance its needs.

2010 6 Full fledge Islamic banks & 14 Islamic banking windows are operating and have over 5% market share in a very short span of time

Islamic Banking – in Pakistan

• Legal framework in place, licenses available for– Islamic commercial bank– Islamic Subsidiary of a conventional bank– Stand alone Islamic branches of a

conventional bank

Islamic Banking – in Pakistan

CURRENT STATUS

• Shariah Board established at SBP

• Islamic products available to cover 85% of the services offered by conventional banks

• Shariah compliant export refinance scheme launched

• Model agreements for products developed by IBD of SBP

• Shariah Audit/Compliance manuals have been developed

• Various training courses and degree programs at universities

• Tax laws are being rationalized to avoid double taxation of IFIs

Islamic Banking – in Pakistan

Steps Taken for promotion

• Full Fledged Islamic Banks – 5*

Meezan Bank

Al-Baraka Bank Pakistan Limited *

Dubai Islamic Bank

Bank Islami Pakistan

First Dawood Islamic Bank

• Many conventional banks operating Islamic Banking

Branches: Bank of Khyber,MCB, Bank Alfalah, Habib Metro

Bank, Bank Al Habib, Standard Chartered Bank, Soneri, HBL,

UBL, Askari, NBP, Faysal/RBS etc. (13) – as they have

accepted the reality and difference of Islamic banking.

Islamic Banking – in Pakistan

* Due to merger of Al-Baraka and Emirates Global Islamic Bank Announced

• Branch network of IB participants – 654* +

• Asset base of IB – Rs. 371 bln*+

• Deposit base of IB – Rs. 289 bln*+

• Growth rate since inception is around 55%

• Share of IB in the overall Banking system stands at 5.9%

approx.

As of March, 2010; SBP Bulletin

Islamic Banking – in Pakistan

What distinguishes Islamic banking from conventional banking

Objectives of Islamic banking

• Equitable Distribution & Circulation of Wealth in the society

• Avoid all Impermissible transactions

Riba (Riba Al Nase’ah / Riba Al Fadhl)

Maysir / Gambling Gharar (Al Jahalah, Bai Qablal Qubz etc).

Uqood-e-Fasida

• Promote participation based & asset Backed Financing

• Fulfilling halal Customer Needs

• Ensuring Shari’a Compliance in all transactions

We find the differences are on three levels:

1. Conceptual & Socio-religious level

- not money lenders

- cannot deal with interest & non permissible industries

2. Business model & Governing framework

- IB actively participates in trade and production process as a supplier, customer or investor

- Governing framework in terms of Shariah Advisor &/or SSB

Distinguishing Features

3. Product Level Implementation

- usually asset backed & involve trading/renting of

asset & participation on profit & loss basis

- Implementation is not just a mere change of paper

work and terms but it involves

- having the right intention,

- the correct sequence of steps and timing of execution

Without a clear understanding of these differences some people even experts tends to makes a common mistake of equating Islamic banks as just another bank with mere change of name.

Distinguishing Features

Basic Difference between Islamic and Conventional Modes of Finance

Conventional

Bank Client

money

money + money (interest)

Whereas Allah has permitted trading

and forbidden Riba

Basic Difference b/w Islamic and Conventional Modes of Finance

Islamic

Bank ClientGoods & Services

money

Islamic Bank’s Assets Side

Islamic Bank’s Assets or Investable Funds

Equity Based Instruments

Trade Based Instruments

• Musharaka --Permanent --Diminishing• Mudarabah

• Murabaha• Istisna• Salam

Rental Based Instrument

• Ijarah (Leasing)

What Distinguishes Islamic Banking

Islamic banking

• Transactions are asset-based/backed

• It is socially-responsible banking because it operates under Shariah restrictions

• Does not permit financing of prohibited goods / Industries

• Ethics and moral values play a major role in investment decisions. Not a choice but a must

Conventional banking

• Transactions are money lending and Riba based

• Involve in many impermissible transactions like Short selling, Sale of Debt, Speculation, artificial financial transactions, no sanctity for Islamic law of contract.

• Permit financing of prohibited goods / Industries like alcohol, casinos etc.

• A matter of choice

Islamic banking is a globally accepted reality and a viable alternative to interest based banking.

It is ethically & economically better way of banking.

Its objective are inline with the goal of Islamic Economics

Islamic alternates of Banking Products can be very effectively developed for all types of needs

However, there is a need for more focus research and innovative product development.

Ulema, bankers and professionals need to coordinate more frequently to find solutions.

The Way Forward

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