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Introduction to Islamic Banking & Finance Abdulazeem Abozaid.

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Presentation on theme: "Introduction to Islamic Banking & Finance Abdulazeem Abozaid."— Presentation transcript:

1 Introduction to Islamic Banking & Finance Abdulazeem Abozaid

2 Basis of IBF Islamic Finance is based on principles that are derived from the Quran and Sunna of the Prophet peace be upon him. The basic principle in Islamic Law is permissibility. Under this principle all commercial and financial transactions are permissible except those that contain prohibited elements.

3 3 How does Islamic Finance differ from conventional finance ? Islamic Modes of Finance & Investment are committed to all Sharia Prohibited Practices Prohibited Practices 1. Riba ( Interest ) 2. Sale of Debt 3. Ghabn (Fraud) 4. Gharar (Uncertainty) 5. Dealing in unlawful properties

4 What is Riba? Literally: Increase. Technically: stipulated increase over the loan which a debtor agrees to pay to his creditor in relation to time. Rationale: Money does not have an intrinsic value. It is a measuring tool, a store of value unit and a medium of exchange, not a commodity that could be bought or sold Lending = renting money

5 Sale of Debt Sale of debt occurs in: Discounting commercial papers Dealing in bonds Sale of Sukuk, shares or fund units when they do not represent tangible assets, usufructs or services

6 Uncertainty (Gharar) Gharar: Uncertainty/Ambiguity in a contract Examples of Gharar: Selling unknown goods - The contents of a sealed box are sold; presumably, the box contains a collection of goods, without specifying the quantity of each. - Buying an a commodity for unknown price; whats in ones wallet/pocket. Gambling The gambler is ignorant of the result of the gamble; the outcome depends on chance and not efforts. Rationale: Uncertainty is likely to lead to dispute between contracting parties.

7 GHABN Deception that leads the seller to underestimate or the buyer to overestimate the price of the good. It can be divided into two kinds: - Slight or minor Ghabn ( الغبن اليسير ). It is tolerated in contracts. - Large, excessive, or major Ghabn ( الغبن الفاحش ). Not tolerated. Examples: - Selling at higher than the market value by means of cheating - Bidding a price without intending purchase, just to increase the price payable by the actual purchaser (Najash). - Covering defects and selling as defect free.

8 Dealing in Unlawful Properties Liquor Intoxicants Lawful properties but used for unlawful purposes

9 SOME allegations of similarities with conventional finance

10 DIFFERENT PRICING FOR CASH AND CREDIT SALES Price in deferred sale is higher than spot sale. The bank purchases goods on cash and sells them on credit. The forward price depends on the repayment period. The longer is the maturity, the higher the price. Such price difference, being dependent upon repayment time, is it similar to the interest charged on conventional loans?

11 Why price should be higher with spot than deferred payment? In fact, price difference is similar to the difference between the price of the same commodity under present and future delivery. Price difference is due to the degree of urgency of benefiting from the direct use of real commodities. Similarly, prices charged with deferred payment should justifiably be higher than with spot payment. The difference is not Riba.

12 Contd The misconception stems from misunderstanding of the prohibition of Riba Modern capitalist theory does not differentiate money and physical commodity – Both are seen as factors of production, money is a form of commodity

13 Contd In Islam, money is differentiated from commodities Money has no intrinsic utility. It cannot be utilized directly. As a means of exchange, money can only be used to: Acquire goods and services. Store some wealth, As a unit of account to measure the monetary value of things.

14 Contd Commodities, on the other hand, have intrinsic utility and can be utilized directly. Because money has no intrinsic utility, present money does not command a higher value than future money when money is exchanged for money. Present money cannot therefore be sold for a higher quantity of future money, as both have no value of their own. Conclusion: Sharia acknowledges time value of money in sale contract, not in loan contracts since money cannot be treated as commodity.

15 Classification of Islamic Banking Products: Deposit (Wadia) products: Current account; based on Loan Saving account; based on Mudaraba Time deposit; based on Mudaraba/wakala (agency in investment)

16 Financing Products Sale-based financing contracts: Murabaha Forward Sale Salam Istisna Ijara Financing Equity-based financing contracts: Mudaraba Musharaka Fee based Financing Wakala

17 PRODUCTS OF ILL REPUTE IN ISLAMIC BANKING

18 Buy-Back Sale (Einah) Einah refers to selling a commodity on a deferred basis then buying it bank on a spot basis at a lower price. Obviously, it is meant for extending interest-based debt. This legal trick cannot be condoned by Shariah. Some applications: Personal Financing Overdraft Facility IPDS: Islamic Private Debt Securities

19 19 EINA SALE INDIVIDUAL SAME SUPPLIER PURCHASE GOODS, DEFERRED PAYMENT INCOLLUSION WITH SUPPLIER IMMEDIATELYAFTER SELL FOR IMMEDIATE CASH WANTS CASH EINA SALE

20 IPDS: Creation of debt (dayn) via Einah Investor (Financier) Issuer Sell Asset X for $100m Cash payment $100m Sell Asset X for $120m Deferred payments $120m Securities issued against the debt and made negotiable

21 Tawarruq Tawarruq refers to purchasing a commodity from one party on credit then selling it immediately to another for cash. Tawarruq shares the same objective of Eina as both are meant for obtaining cash. Some applications: Personal & Corporate Financing Overdraft Facility

22 INSTITUTIONAL TAWARRUQ التورق المؤسسي CUSTOMER LME SELL ON MURABAHA COLLUSION WITH BANK PROMISE TO BUY AGENCY AGREEMENT SELL METAL FOR IMMEDIATE CASH NEEDS CASH BAN K BUY METAL

23 Sale of Debt (Bay al-Dayn) Although sale of debt is prohibited in the Shariah, it has been unlawfully practiced in Islamic finance, like in: Islamic factoring Islamic accepted bills Islamic Debt Securities With these arrangements, the underlying consideration is the permissibility of the sale of debt, by the creditor, at a discount Based it on the assumption that Debt arising from sale of commodities is different from debt arising from a money loan.

24 The Criterion of the Non-Shariah Compliant Transaction When a financing mode is structured in such a way that secures a guaranteed profit to the financier without taking any risks. Or, when the financier acts in reality as a creditor who provides money without being involved in the investment process; i.e. when the substance is interest-bearing debt. This will render the transaction impermissible regardless of its legal form, e.g. sale, lease…. Some banks Sharia boards attempt to validate transactions based on their legal forms.

25 Islamic Finance Products

26 DEPOSIT PRODUCTS

27 INVESTMENTDEPOSITS PROFIT SHARE PAYMENTSERVICES CUSTOMERS ISLAMIC BANKS DEMANDDEPOSITS CASH AS MUDARABA OR WAKALA RESTRICTED WAKALA FEES UNRESTRICTED CASH AS QARD HASSAN checks debit cards ATM Money transfer

28 SIMPLE FINANCING PRODUCTS

29 EQUITYFINANCE,MUSHARAKA ISLAMIC BANK FUND USER F I N A N C E A SHARE IN PROFITS A SHARE IN MANAGEMENT DIMINISHING EXTINGUISH gradually

30 MUDARABA RESTRICTED UNRESTRICTED ISLAMIC BANK FUND USER TRANSPARENCY MONITORING + - DOS DO NOTS

31 Promise to Buy SPOT DELIVERY DEFERRED PAYMENT LUMP- SUM OR INSTALLMENTS Sale Contract ISLAMIC BANK SUPPLIER Buyer SPOT PAYMENT Murabahah contract MURABAHA

32 DEFERRED-PAYMENT SALE CONTRACT SPOT DELIVERY DEFERRED PAYMENT: LUMP-SUM OR INSTALLMENTS ISLAMIC BANK BuyerDEFERREDPAYMENTSALE COMMODITIES OWNS

33 CUSTOMER MANUFACTURER BANK COMMISSION TO MANUFACTURE ISTISNA REQUIRES AN ASSET WITH CERTAIN SPECIFICATIONS ASSET DELIVERY REQUIRES AN ASSET WITH THE SAME SPECIFICATIONS ISTISNA DELIVERY OF ASSET INSTALLMENTS COMMISSION TO MANUFACTURE PARALLEL ISTISNA PAYMENTS IN STAGES

34 IJARAH FINANCING BANK DELIVERY, LEASE STARTS PROMISE TO LEASE USUFRUCT FORWARD LEASE TITLE TRANSFER: ASSET PRICE RENTAL PAYMENTS = USUFRUCT AND PART OF ASSET VALUE PURCHASE CUSTOMER REAL ESTATE OWNER Conditional promise to gift or sell at token price DELIVERY

35 Thank You For Queries


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