The evolution beyond the 21st century

Islamic Banking

Objective of this presentation

At the end of this session, you will be able to understand:

1. The concept of Islamic banking, its sources and fundamentals.

2. What & Why Islamic Banking?

3. History of Islamic Banking

4. The differences between Islamic banking and conventional banking

5. Main Islamic banking financial contracts, products & services

6. Future of Islamic Banking

7. Misconceptions of Islamic Banking

Objec

tive

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The concept of Islamic banking, its sources and fundamentals.

The Quran on “Riba”

• Allah SWT has warned those who take / pay Riba, that they would have to go to war with HIM & the Messenger (PBUH)

• Riba - excess or increase , interest. Technically, it means an increase over the principal in a loan transaction

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The Quran on “Riba”

Al Quran 2:275

Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, "Trade is [just] like interest." But Allah has permitted trade and has forbidden interest. So whoever has received an admonition from his Lord and desists may have what is past, and his affair rests with Allah . But whoever returns to [dealing in interest or usury] - those are the companions of the Fire; they will abide eternally therein

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What is Islamic Banking?

It is a system of banking or banking activities that are based on Shari’a rules and principles that amongst others prohibit riba (interest), gharar (uncertainty) and maysir (gambling) and guided by Islamic economics.

These Shari’a rules and principles are derived from the sources of Shari’a which are Al Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shari’a scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad).

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What is Shari’a ?

Shari’a

Aqeedah

Ibadah Muamalah

Legal Affairs

Marriage

Affairs

Financial

Affairs

Takaful

Banking Waqf

Akhlaq

Shari’a is the divine law revealed in the Qur'an and the Sunnah. It is also a “comprehensive system” consisting of Islamic rules and regulations. Simply: The Law of Islam

Main function of Shari’a is “to guide man” to dutifully enjoy freedom and exercise the right to choose between vice and virtue.

AQEEDAH - belief on the oneness of Allah, the angels, all Prophets, holy books, day of judgment & destiny.

IBADAH – relationship of man with Allah e.g. prayers, zakaat, hajj (pilgrimage) etc.

MUAMALAH – relationship of a man with the society

AKHLAQ – Islamic ethics / morals

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Sources of Islamic law

Shari’a sources can be divided into two categories:1. Primary sources (the divine laws); Examples are:

I. Al-Qur’an: Holy book of Islam

II. Al-Sunnah: traditions or known practices of the Prophet Muhammad (PBUH).

III. Ijmaa: the consensus of scholars within the community on a certain issue.

IV. Qiyas: means analogy or reasoning, judges may use Qiyas to decide on a new case law.

Examples: Prohibition of drugs like marijuana Prohibition of smoking

Islamic Banking is developed and operated based on the “Shari’a sources.”

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Sources of Islamic law

2. Secondary sources are used in situations when explicit and specific rulings are not mentioned in the primary sources. These include but not limited to the following:

I. Masalih mursalah (Public interest)

II. Istihsan (Preference)

III. Istishab (Presumption of existence)

IV. Urf (Custom)

V. Ijma’ Ahl madinah (Consensus of people of Madinah).

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Why Islamic Banking?

The primary objectives of Islamic Economic System are:-

Halal way of Banking

Equal Distribution of wealth

Social justice

Ethical way of investment

Peace of mind

Transparency

These objectives can never be achieved in Interest/Riba based economic systems.

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Why Islamic Banking?

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Why Islamic Banking?

Eating just HALAL is not enough !

Did your money for the food come from a HALAL bank ?

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Why Islamic Banking?

&

Bank HALAL

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History of Islamic Banking

History of Islamic Banking

No “BANK” existed in the early history of Islam.

But, principles of Islamic finance have been in practice since the birth of Islam such as: Mudaraba,

Musharakah, Ijarah, Murabahah, Istisna’, Salam

An example of Mudaraba practice is given in the example of Prophet Muhammed (PBUH)’s partnership

with his wife Khadija prior to their marriage.

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History of Islamic Banking

Over 562 Islamic Banks

in 56 countries

around the world with

assets estimated at >1.4 Trillion

USD .

TODAY

HSBC Amanah was

established

1998

Citibank Islamic

window in Bahrain.

1996

Islamic windows for

conventional banks in

Malaysia.

1993

The first commercial

Islamic Bank was Dubai

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1975

Hajj Fund was

established in Malaysia

for Malaysian Muslims to

save and invest their savings for

hajj.

1969

The first attempt to

have a modern Banking

system based on Shari’a principles

goes back to “Mit Gamar“

in Egypt.

1963

NOTE:Amana Bank of Sri Lanka was licensed by CBSL in 2009

40 YEAR

S

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History of conventional banks

Founded in 1865, with over 6,600 offices in over 80 countries

Founded in 1812, with over 4,000 offices in over 36 countries

Founded in 1852, with over 2,500 offices in over 70 countries

150 Years

203 Years

163 Years

Italian bank founded in 1472, with over 3,000 branches

543 Years

Founded in 1690, with it’s presence in over 80 countries

325 Years

Founded in 1765, with it’s presence in over 30 countries

250 Years

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The difference between Islamic banking & conventional banking

Is Islamic Banking only for Muslims?

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Is Islamic Banking only for Muslims?

The primary objectives of Islamic Economic System are:-

Halal way of Banking

Equal Distribution of wealth

Social justice

Ethical way of investment

Peace of mind

Transparency

Applicable to Muslims

Applicable to all

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Spot the difference !

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Islamic Banking Vs. Conventional Banking

Islamic finance distinguishes from Conventional finance in four basic principles:

And Allah permits to trade and forbids Riba

Riba Free

Risk & Reward Sharing

Asset & Service Backing

Contractual Certainty which are free from:

i- Gharar - uncertainty ii- Jahalah – ambiguity iii- Maysir - gambling

Al Quran 2:275

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3 Fundamental Prohibitions in Islamic Finance

Riba

- Interest – any return of money on money, whether it is fixed or floating, simple or compounded and at what ever rate.

Jahalah

- The lack of knowledge about the specifics of an object, event, or action, in-spite of knowledge about its occurrence. For example, The sale of tree with fruits before they ripen is a typical example of Jahalah.

Gharar- Uncertainty and ignorance of the contracting parties over the substance or attributes of the subjects of the contracts.

Maysir (Gambling)

- Betting or charging something that will be forfeited if one fails to obtain greater gain that one hopes for.

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Islamic Banking Vs. Conventional Banking

ISLAMIC BANKING CONVENTIONAL BANKING

1) Functions and operations are based on Shari’a principles Functions and operations are based on fully man made principles

2) Promote risk-sharing between provider of capital (investor) and user of funds (entrepreneurs)

Investor is assured of pre-determined rate of interest

3) Aims at maximising profit but subject to Shari’a restrictions Aim at maximising profit without any restrictions

4) Partners, investor and traders, buyer or seller relationship Creditor-Debtor relationship

5) Encourage asset-based financing and based on commodity trading

Based on money trading. Money is a medium of exchange and not a commodity, its sale and purchase is prohibited in Islam.

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Islamic Banking Vs. Conventional Banking

ISLAMIC BANKING CONVENTIONAL BANKING

6) No right of profit if there is no risk involved. The profit and loss sharing depositor may lose money in case of loss.

It is almost risk free banking and depositor has no risk of losing its money because interest is guaranteed.

7) The Islamic banks, give greater emphasis on the viability of the projects.

The conventional banks give greater emphasis on credit-worthiness of the clients.

8) There extra charges from the defaulters. Only operational costs and these proceeds are given to charity. Rebates are give for early settlement.

It can charge additional money (penalty and compounded interest) in case of defaulters.

9) In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

It does not deal with Zakat.

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Islamic Banking Vs. Conventional Banking

Any clarifications?

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Islamic Banking Financial Contracts, Products & Services

Modes of Financing

a) Partnership based modes of financing (Savings / Fixed deposits)

Musharaka Finance, Mudaraba Finance,

b) Trade based modes of financing (Personal Loans / Auto Loans / Cards)

Murabaha Finance, Salam finance, Tawarruq finance

c) Rental based modes of financing (Housing Loans)

Ijarah Finance, Diminishing Musharaka Finance

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Mudarabah (Deposits)

• A contract or partnership where one provides the capital and the other the entrepreneurship with the profit being shared among them with a predetermined condition

• Partnership in profit whereby one party (rabb al-mal) provides capital and the other party (mudharib) provides labour

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BANK

Murabaha (Auto Finance)

Bank sell it to the Client on Deferred Payment Basis

CLIENT

Bank purchase the Automobileon spot basis

DEALERS

Client owned the Automobile and pay the sale price by installments

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Ijara Finance (Home finance)

This is a lease contract wherein the Bank (lessor) leases the property to the customer (lessee) in return for a rental payment for a specified financing period. The Bank promises to transfer the title of the property to the customer at the end of the financing period, if all payments have been made.

Ijarah is an effective and practical financing tool allowing businesses to acquire their equipment and machinery through leasing, instead of outright purchase, thus reducing the heavy burden of capital expenditure. The leasing period normally ranges from 3-7 years, with the lessee having the right to purchase the leased asset at the end of the Ijarah period.

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Tawarruq / Qard (Credit Cards)

BANK

CLIENT

Sell it to Free Market to get Cash

Bank sell it on behalf of client to Broker B to get Cash

Bank purchase commodities

BROKER ABROKER B

OPTION - 1

OPTION - 2

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Product approval process

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Product Proposal

Review by Shari’a

Department

Fatwa & Shari’a Supervisory

Board

Shari’a Approval

Implementation

Shari’a AuditRectification / Purification

Future Landscape of Islamic Banking

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Highlights

• Sentiment of over 2.2 million customers’ social media posts on their banking experiences with Islamic banks in Saudi Arabia, Bahrain, Kuwait, UAE, Malaysia, Indonesia, Turkey, Qatar and Oman. The results showed that customer satisfaction is mediocre for many Islamic banks.

• International Islamic banking assets with commercial banks exceed US$778b in 2014 in the core markets.

• The global profit pool of Islamic banks is set to triple by 2019. (US$ 10b in 2013 to US$ 37b in 2019)

• Islamic banking assets in six core markets Qatar, Indonesia, Saudi Arabia, Malaysia, UAE, Turkey on course to touch US$1.8t by 2019. (expected CAGR is @ 19%)

• Global Islamic banking assets witnessed a compounded annual growth rate (CAGR) of around 17% from 2009 to 2013. [Global recession]

• Islamic banks in Saudi Arabia, Kuwait and Bahrain represent more than 48.9%, 44.6% and 27.7% market share respectively.

• Positive progress has been made in Indonesia, Turkey and Pakistan, with 43.5%, 18.7% and 22.0% Compound Annual Growth Rate (CAGR) respectively from 2009-2013.

Leading countries on Islamic BankingSource: World Islamic Banking Competitiveness Report 2014-2015

US$ Billion

2014 2015 2016 2017 2018 2019926 1,102 1,311 1,560 1,857 2,209

Leading countries on Islamic BankingSource: World Islamic Banking Competitiveness Report 2014-2015

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For the first ti

me in history in

2013, the

combined profit of Is

lamic banks crossed the

US$10b mark. B

y 2019, collective profits would

touch US$37b as the in

dustry contin

ues its

double-digit annual g

rowth.

Landscape of UAESource: EY World Islamic Banking Competitiveness Report

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UAE is en route to achieve US$263b of Sharia-compliant assets by 2019 (in 2014 it was at US$127b)

UAE is expected to be one of the main markets that drive the future internationalization of the Islamic banking industry

Islamic banking penetration in the UAE currently stands at 21.4%

UAE represents a 14.6% share of the global market

The industry in the UAE is growing at more than twice the rate of conventional banking

Customer feelings were mixed with respect to branch experience, products, online banking and phone banking

The reputations of Islamic banks today will depend on the way banks engage with their customers

Landscape of Dubai

Clearly, Dubai has set an exciting and challenging mandate for its self. Success for Dubai will raise the performance bar across the Islamic finance markets internationally.

Primarily Risk is the quality of execution.

Dubai as an Islamic Financial hub

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World Islamic Banking Competitiveness Report

2014-2015

The future of Islamic Banking

The future aspirations:

a) Digital banking is the future with customers of Participation banks showing tremendous interest. Banking is set to evolve towards technology-based, service-driven value propositions.

b) Customers are increasingly active online and vocal about their experiences.

c) Migration from physical to digital channels requires more attention. Half of the banks surveyed did not have a Twitter account and only 1 in 18 banks offered full customer engagement on social media.

d) Banks should invest in analytics, to build rich insights into customers’ delights and pain points and personalize user experience.

e) 4 out of every 10 Participation banks are not “listening.”

f) Fresh retail banking experience could attract a sizeable majority to switch banks.

g) Customers do not just want their bank to have a digital presence. They want it be tailored to their lifestyle relationships and connections.

h) Have a common Shari’a supervisory board across the region

Misconceptions of Islamic Banking

Islamic Banking !!

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• THEY ARE BOTH THE SAME, ONE CALL IT “INTEREST” AND THE OTHER “PROFIT”

• ISLAMIC BANKING IS MORE EXPENSIVE

• ISLAMIC BANKING DOES NOT “HELP” THE MUSLIMS

• ISLAMIC BANKING HAS A VERY LONG PROCESS

Challenges faced by Islamic Banks

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a) There is no separate legal framework for Islamic banking across the world

b) The lack of a common Shari’a board creates disconnect between product offerings

c) Islamic banking is trying to compete with the traditional conventional banking products with no uniqueness

d) Islamic banks do not have the basic products to offer their customers in some markets (Eg: Amana bank in SL did not have NRFC accounts until recently, does not have a Credit Card proposition, No online banking facilities / In case of international travel there is no global Shari’s complaint travel Takaful solutions)

e) Due to the economies of scale the costs are often higher than the conventional banks

f) Islamic banking products lack innovation and technological solutions due to its complexities

g) Conventional banks do capture this segment by providing similar solutions through a subsidiary Islamic arm

Islamic Banking is About Trust

They say:“Why risking yourself to rob a bank and get jailed”

“Just form a bank, then you can steal from your customer.”

We only have to say:“We are not, this is Islamic Bank”.

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PRESENTED BY: RIZNY ISMAIL

BACK UP SLIDES

Landslide of UAESource: EY World Islamic Banking Competitiveness Report

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The UAE is en route to achieve US$263b of Sharia-compliant assets by 2019 according to EY’s World Islamic Banking Competitiveness (WIBC) report. The industry was estimated to be worth US$127b in 2014, thus making it the third largest Islamic banking market by value, after the Saudi Arabian and Malaysian markets.Ashar Nazim, Global Islamic Finance Leader at EY, says:

“Islamic banks in the UAE, also known as participation banks, are eyeing revenue growth through experience-led transformation of their domestic business. Stronger capital position is also driving their international expansion. Initiatives in mobile payments are likely to cause positive disruption to banks’ traditional operating models. Looking at the positive performance of Islamic banks in the UAE, the country is expected to be one of the main markets that drive the future internationalization of the Islamic banking industry.”Sharia-compliant assets in the UAE crossed the US$100b milestone for the first time. Islamic banking penetration in the UAE currently stands at 21.4% and represents a 14.6% share of the global market. The industry in the UAE is growing at more than twice the rate of conventional banking. Due to high demand, there is increased pressure on efficiency as more Islamic banks attempt to go mainstream.

Islamic banking customers in the UAE happy with customer service

Banking clients were most satisfied with customer service, where positive comments on social media outnumbered negative comments by more than 5%. Half of all the positive sentiments monitored were around customer service levels and complaint handling.

Customer feelings were mixed with respect to branch experience, online banking and phone banking . Out of the sentiments monitored on social media for all the three experiences, there was almost an equal number of positive and negative comments.

The study of social media comments has revealed an improvement opportunity for Sharia-compliant banks with respect to products and services, which were ranked the lowest in terms of customer satisfaction. Half of the overall negative sentiments monitored were about disappointing experiences with regard to product and service offerings.

“The call to action for Islamic banks in the UAE is to build rich insights into customers’ delight and pain points, and break operational silos. The time is right for analytics; banks need to challenge their channel capabilities and push for more customized products and services . Regulatory intervention on product design can help to both attract and protect consumers. The reputations of Islamic banks today will depend on the way banks engage with their customers ,” concludes Ashar.

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