Transcript Dr. Syed Zulfiqar Shah

Islamic Financial Instruments
MBF 709
By
Dr. Syed Zulfiqar Ali Shah
Ph.D (Finance), ACMA
Ref: Own, Md Noor Ul Islam, Book
Course Contents
Introduction to the Concept of Islamic Finance
Overview of Conventional and Islamic Banking
Islamic Economic System & Major prohibited Elements in Islamic Economy
Islamic Law of Contract & Business Transactions
Islamic Corporate Governance
Overview of Modes of Islamic Finance
Islamic Financial Instruments & institutions
Murabaha & Musharakah
Participatory Modes: Shirkah and its Variants
Salam – A Trade Based Product
Istisna – A Trade Based Product
Ijarah – A Semi Debt based Product
Islamic Asset and Fund Management & Islamic Bond Market – Sukuk
Islamic insurance – Takaful
Risk Management in Islamic Finance & Appraisal of Common Criticism
Plan of Today's Lecture
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Finance in General Perspective
General Decisions in Finance
Fundamental Principles of Islam:
Maqasid Al-Shariah:
The Strategy:
The Islamic World View:
Islamic Financial System(ifs):
Differences Between CFS & IFS
Principles of An Islamic Financial System
The Objectives Islamic Economics and Banking
Principles of Islamic Economics Systems:
Deposit Products of Islamic Bank:
Future of Islamic Banking
Finance
Decision Making
Four types of decisions
• Investment Decision
• Financing Decision
• Asset Management Decision
• Dividend Policy Decision
Investment Decision
• Estimation of Cash Flows
• Required rate of return
• Tools and techniques to evaluate proposal
Financing Decision
Three options of Financing
• Own Money
• Issuance of Equity/ Shares
Common Shares
Preferred Shares
• Debt
Financial Institutions
General public
Asset Management Decision
Assets
•
Current Assets
•
Non Current Assets
Dividend Policy Decision
Why Dividend Policy’
• To avoid expected Risk
• To have money for future investments
Fundamental Principles of Islam
Tawhid (Oneness And Unity of Allah
Allah is One, Unique & Supreme
Khilafah (Vicegerency)
The Concept of Khilafah has a Number of
Implications or Corollaries.
These are:
 Universal Brotherhood
 Resources are a Trust
 Humble Life Style
 Human Freedom
Adalah (Justice)
 Need Fulfillment
 Respectable Source of Earning
 Equitable Distribution of Income & Wealth
 Growth & Stability
Maqasid Al-Shariah:
Maqasid al-Shariah is to promote the welfare of the people by
safeguarding their Faith
 Prosperity (descendant)
 Life & intellect
 Wealth
Maqasid (objectives of) al-Shariah
 There have been efforts by jurists to add to the list of these five requisites
and also to change their sequence, but it seems that these attempts have, in
general, not satisfied most jurists.
 Imam Abu iIhaq-Al-Shatibi (d. 790/1388), writing a little less than three
centuries after Al-Ghazali, put his stamp of approval on his list as well as the
sequence, thereby indicating that both of these are the most preferable in terms
of their harmony with the essence of the Shariah.
The Strategy
 A socially agreed filter mechanism
 A strong motivating system to induce the
individual to render his best in his own
Interest as well as the interest of the society
 Restructuring of the whole economy with the
objective of realizing the maqasid in spite of
scarce resources.
 A positive and strong goal-oriented role for
The government
The Islamic World View
 Inability
of the capitalist & socialist countries as
well as the developing economies to realize
simultaneously the goals of both efficiency & equity
 Social Darwinism, survival of the fittest, class
struggle, maximum want satisfaction, material
condition of life proved unsuccessful.
Maqasid Al-Shariah
Human well-being to be realized by ensuring the enrichment of the following
five ingredients for every individual.
Din
Faith
Nafs
Self
‘Aql
Intellect
Mal
Wealth
Nasl
Posterity
Islamic Financial System
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 characterized 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.
Differences between CFS & IFS
• The conventional financial system is of two types.
1) socialistic financial system and
2) capitalistic financial system
- both systems have been proved inefficient to establish
economic balance in the society.
Islamic Financial System
Basis of Difference
1. Religious Belief
2. Freedom of Economic
Activity
CFS
IFS
Secular & separates Religion
Belief in unity of God & relates
from other Parts human life
this belief to economic Life of a man
In socialism govt. enjoys
Restrictive freedom is allowed in the
economic freedom but in
light of Shariah both by the govt. &/or
capitalism Individuals enjoys
individuals
freedom.
3. Ownership of means
4. Goals of financial System
Socialism-state ownership,
Allah is the exclusive owner. Man is
Capitalism-individual ownership
the caretaker of the property
Socialism-profit of the society
Welfare of both here and hereafter.
Capitalism-Individual’s profit
5. Competition
Socialism-No competition
Logical Competition and financial co-
Capitalism- Logical & unethical
operation
competition
6. Wealth distribution
Socialism-Equal
Capitalism – Unequal
Equitable
Islamic Financial System
Basis of Difference
7. Basis of Economic System
CFS
Riba or Interest
IFS
Interest Free; PLS, Zakat &
Compensation based
Intellects brain storming of the
Devine book “Al-Quran” &
economic problems of men’s life
Prophets(SM) speeches
Capitalism concentration of
Maximum & equitable Distribution of
income & economic power in few
economic opportunities and higher
hands. Inefficiency
production in the society
10. Social & environmental
Do not consider the social &
Ensure social & environmental welfare
welfare
environmental welfare
11. Owners exception in respect
Dividend or part of profit in case
of respect of investment
of equity financing
12. Lender or Bank’s
Interest
Profit or Loss Sharing
Loan, Overdraft & Cash Credit
Mudarabah, Musharaka, Murabahah
8. Sources of the System
9. Result
Part of Profit or Loss
expectation in terms of dept
financing
13. Modes of Investment
etc.
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 usury but also the charging of "interest"
as widely practiced.
Islamic Financial System
• 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.
Islamic Financial System
• 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.
• 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.
Islamic Financial System
The Objectives Islamic Economics and Banking
The Objectives of Shariah
• The very objective of the Shariah is to promote the welfare of the people
which lies in safeguarding their faith, their life, their intellect, their posterity,
and their wealth. Whatever ensures the safeguarding of these five serves
public interest and is desirable. (AI-Ghazali)
• The-basis of the Shariah is wisdom and welfare of the people in this world as
well as the Hereafter. This welfare lies in complete justice, mercy, well being
and wisdom. Anything that departs from justice to oppression, from mercy to
harshness, from welfare to misery and from wisdom to folly, has nothing to do
with the Shariah (Ibn AI-Quayyum).
Definition of Economics
Prof. L. Bobbins -“Economics is a science which studies human behavior as a
relationship between ends end scarce means which have alternative uses.
Islamic Financial System
1.
2.
3.
4.
5.
Definition of Islamic Economics
Islamic Economics is that branch of knowledge which helps realize 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- Oman Chapra.
Islamic Economics aims at the study of human falah achieved by organizing the resources of
the earth on the basis of co-operation and participants (Muhammad Akram Khan).
Islamic Economics is the Muslim thinker's response to the economic challenges of their
times. In this Endeavour they are aided by the Quran and the Sunnah as well as by reason
and experience- M Negatullah Siddiq.
Islamic Economics is the science 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 Soud.
Islamic Economics is a social science 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.
Islamic Financial System
Objectives of Islamic Economics
1. To establish justice in the Economy (5:58) (16:90), Nahal, Nisa)
- Surely Allah enjoins justice and the doing good (to others) (16:90 Al-Nahal)
- Whenever you judge between people, you judge with justice 5:58 (An-Nisa)
2. To protect the interest of the deprived and the oppressed. (28:5) (Kisas)
- And we desired to bestow a favour upon those who were deemed weak in the land, and to
make them the leaders, and to make them the Heirs 28:5 (Al-Qasas)
3. To establish good practices and institutions in the economy and to eliminate bad practice
and bad institutions from Economy (22:41)
- [Well aware of] those who, if we firmly establish them in the land (on earth) will keep up
prayer (remain constant prayer) and give in charity and enjoin good and forbid bad 22:41 (AlHajj)
Islamic Financial System
4. To make life easy and bearable (7:157)
5. To ensure full utilization of resources.
6. Proper of distribution of wealth and Resources.
7. Maximum production of useful production.
8. Bring stability in the value of money and exchange rates
9. Ensure economic efficiency and accelerated rate of growth
10. Ensure broad based economic well being, balanced monetary expansion
and fill employment.
Islamic Financial System
Principles of Islamic Economics Systems:
1. Sole purpose is to obey and please Allah.
2. The wealth and asset in all their forms given under trust by Allah.
3. Moral values and guiding factors for all Economic activities.
4. Maximum equitable utilization of human and material resources given by
Allah
5. Human dignity and respect of Labour.
6. 'Maximum freedom for economic activity within a just framework.
7. Equitable distribution of wealth and income and disciplined private
ownership.
8. Simplicity economy and austerity in expenditure.
9. Adal and Ihsan (Justice and kindness).
10. Strict prohibition of Riba, Interest and Usury in all forms.
Islamic Banking
Modern banking system was introduced into the
Muslim countries at a time when they were
politically and economically at a low ebb, in the late
19th century.
Governance structures are quite different from these
under Islamic banking because the institution must
obey a different set of rules - those of the Holy
Qur'an - and meet the expectations of Muslim
community by providing Islamically-acceptable
financing modes.
The Islamic financial system employs the concept of
participating in Halal business opportunities, utilizing the
funds at risk on a profit-and-loss-sharing basis.
ISLAMIC BANKING MOVEMENT IN THE WORLD
 The objective of Islam injunction is welfare of the whole
humanity. Islamic Banking, based on the Islamic economic
system, is not restricted to Muslims only.
 Malaysia is the first country to issue bonds on Islamic basis.
 In August 1983, the Iranian government had passed the law
for riba free banking
 Islamic Banking and finance started in 1963 when Mit
Ghambr Savings Bank began offering interest free banking
in Egypt.
Principles of Islamic Banking
An Islamic bank is based on the Islamic faith and must stay
within the limits of Islamic Law or the sharia in all of its
actions and deeds. The original meaning of the Arabic word
sharia was 'the way to the source of life' and it is now used
to refer to legal system in keeping with the code of
behaviour called for by the Holly Qur'an (Koran). Four rules
govern investment behaviour:
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the absence of interest-based (riba) transactions;
the avoidance of economic activities involving speculation
(ghirar);
the introduction of an Islamic tax, zakat;
the discouragement of the production of goods and
services which contradict the value pattern of Islamic
(haram)
What is Riba?
• The word "riba" means excess, increase or addition, which
correctly interpreted according to Shariah terminology,
implies any excess compensation without due consideration
(consideration does not include time value of money).
• This definition of riba is derived from the Quran and is
unanimously accepted by all the Islamic scholars. There are
two types of riba, identified to date by these scholars namely
• 'Riba an-Nasiyah' and 'riba al Fadl'.
• 'Riba an-Nasiyah' is defined as excess, which results
From predetermined interest (Sood) which a lender receives
over and above the principle (Ras ul Maal).
• 'Riba al Fadl' is defined as the excess compensation without
any consideration resulting from a sale of goods
Speculation
Another feature condemned by Islamic is
economic transactions involving elements of
speculation. Buying goods or shares at low
and selling them for higher price in the future
is considered to be illicit. Similarly an
immediate sale in order to a void a loss in the
future is condemned. The reason is that
speculators generate their private gains at the
expense of society at large.
Zakat
A mechanism for the redistribution of income and wealth is
inherent is Islam, so that every Muslim is guaranteed a fair
standard of living ,nisab .An Islamic tax ,zakat( a term
derived from the Arabic zaka ,meaning "pure") is the most
important instrument for the redistribution of wealth. This
tax is a compulsory levy, one of the five basic tenets of Islam
and the generally accepted amount of the zakat is one
fortieth (2.5 per cent) of Muslim's annual income in cash or
kind from all forms of assessed wealth exceeding nisab.
Haram
A strict code of 'ethical investment' operates. Hence it is
forbidden for islamic banks to finance activities or
items
forbidden in islam, haram, such as trade of
alcoholic
beverage and pork meat.
Profit-sharing agreements
 Although the restriction against the use of interest
might seem to be a binding constraint upon
expansion, Islamic banks and financial institutions
have in fact grown rapidly.
 As the use of interest rates in financial transactions
is prevented, Islamic banks are expected to
undertake operations only on the basis of Profit
and Loss Sharing( PLS) arrangements or other
acceptable modes of financing .Mudarabah and
musharaka
are
the
two
profit-sharing
arrangements preferred under Islamic law
Sources of funds
Besides their own capital and equity, Islamic
banks rely on two main sources of funds,\
a) transaction deposits, which are risk free
but yield no return and,
b) investment deposits, which carry the risks
of capital loss for the promise of variable. In
all, there are four main types of accounts:
Current accounts
Current accounts are based on the principle of
Al-Wadiah, whereby the depositors are
guaranteed repayment of their funds. At the
same time, the depositor does not receive
remuneration for depositing funds in a current
account, because the guaranteed funds will not
be used for PLS ventures
Savings Accounts
Savings accounts also operate under the alWadiah principle. Savings accounts differ
from current deposits in that they earn the
depositors income: depending upon
financial results, the Islamic bank may
decide to pay a premium ,hiba ,at its
discretion, to the holders of savings
accounts.
Investment accounts
An investment account operates under the
Mudarabah al-Mutlaqa principle, in which the
Mudarib( active partner) must have absolute
freedom in the management of the investment of
the subscribed capital.
Special investment accounts
Special investment accounts also operate under the
Mudarabah principle, and usually are directed
towards larger investors and institutions
The Basic Difference between Capitalist
and Islamic Economy
The basic difference between capitalist and
Islamic economy is that in secular capitalism.
• Capital economy is based on the market
forces.
• Islamic economy based on the Principles of
Qur’an and Sunah.
The Performance of the Islamic Banks
• Islamic banking has become today an
undeniable reality.
• The number of Islamic banks and the financial
institutions is ever increasing.
• New Islamic Banks with huge amount of
capital are being established.
• Conventional banks are opening Islamic
windows or Islamic subsidiaries for the
operations of Islamic banking.
Islamic Financial System
Deposit Products of Islamic Bank:
1.Al-wadeeah Current Deposits
2. Mudarabah Savings Deposits
3.Mudaraba Special Notice Deposits
4.Mudaraba Term Deposits
5.Mudaraba Hajj Savings A/c
6.Mudaraba Savings Bond
7.Mudaraba Special Savings Scheme
8.Mudaraba Monthly Profit Dep. Schemes(MMPDS)
9.MUDARABA MUHOR SAVINGS A/C
10.Mudaraba Waqf Cash Deposit A/C
11.Mudaraba Savings Deposits(RDS)
Islamic Financial System
UNDER CAPITALISM
UNDER ISLAM
1.
Economic Laws are like physical laws
1.
Economic laws are like natural laws
2.
Positivism: Economics is a positive
science as like as biology, physics which
have no value, value neutral
2.
Economics is value oriented. Permissible &
prohibition have to be observed
3.
Motive for More: Pecuniary interest. Man is
rational economic being. Survival of the
fittest, destruction of the poor
3.
Man does not work for only personal
interest. He has to secure the interest of
this world & the world hereafter.
4.
Market Oriented: Market can solve all the
problems. Poor's’ need is not reflected in
the market. Demand is backed by
purchasing power. Result is the mismatch
in resource allocation.
4.
Market can solve major problem but not all.
At least 20% economic problems to be
solved by the government. Communism
prescribes 100% solution by government.
Capitalists leaves it 100% to market.
5.
Little concern for poor humanity
5.
Major concern for poor. Poverty alleviation
by Zakat, Sadaqa & gives emphasis on
economic progress
6.
Nearly 100 corporate of ¾ countries control
the world economy in the name of
globalization.
6.
No concentration of wealth in few hand.
Wide dispersal of wealth & property
7.
18-20% people in Bangladesh live below
poverty line (not getting two meals a day)
7.
None can live below poverty line if Islamic
economic system is established
The Future of Islamic Banking
Islamic banking is here to stay.
financial institutions predict that Islamic
finance will be the world's fastest-growing
banking sector for years.
with a predicted modest estimate of 20
percent annual increase in deposits.
bankers are realizing that Islamic banking is
big business that is only getting bigger
Japan is also planning to start Islamic banking
THANK YOU