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Islamic Finance November 27, 2014. What is Islam ? - third Abrahamic religion - Word “Islam” means “finding peace with” or “submission to” God - Based.

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Presentation on theme: "Islamic Finance November 27, 2014. What is Islam ? - third Abrahamic religion - Word “Islam” means “finding peace with” or “submission to” God - Based."— Presentation transcript:

1 Islamic Finance November 27, 2014

2 What is Islam ? - third Abrahamic religion - Word “Islam” means “finding peace with” or “submission to” God - Based upon “Five Pillars” - Founded by Prophet Muhammed ( ) - Second largest religion in the world billion followers (often set at 1.3 billion) - Centred around Mecca – spiritual “focus” of Islam - Monotheist - incorporates many of the prophets and beliefs of both Christianity and Judaism. - Islamic calendar begins in 622 – the year of the Hijra

3 Major religious groups as a percentage of the world population in 2005.

4 Five Pillars of Islam 1. Profession of Faith – “Lal illahah al illallah” – There is no god but God and Muhammed is his messenger (shahada) 2. Prayer – 5 times a day facing Mecca - must ablute before prayer (wudu) (salat) 3. Fasting – Generally refers to the month of Ramadan - gives time to reflect on how the poor and hungry feel - fasting refers to any intake of solids or liquids form sunrise to sunset - Pregnant women,sick and travelers exempt (sawm) 4. Hajj – every Muslim must perform the Hajj in Mecca at at least once in his life if financially able 5. Alms or Charity - to the poor - technically 2.5% of earnings (zakat) - additional amounts may be paid voluntarily (sadaqa)

5 What is a bank ? - Takes deposits from account holders - Lends money to borrowers - Makes money on “spread” Eg – Bank has 3,000,000 Kc on deposit – pays 4% 3,000,000 x 4% = 120,000 Manages to lend 90% of the money at 7% 2,700,000 x 7% = 189,000 Profit is “spread” - 189,000 – 120,000 = 69,000

6 So, a bank just makes money on the difference

7 A bank can offer many other services – Czech Banking Act on taking deposits: According to article 5d of the Banking Act (1991) a) acceptance of deposits from the public, d) money transmission services, e) issuing and administering means of payment, g) trading for own account and for account of clients in: 1. money market instruments, 2. foreign exchange, 3. financial futures and options 4. transferable securities, i) advice on capital structure, industrial strategy and related questions and services relating to mergers and the purchase of undertakings, j) money broking, k) portfolio management and advice, l) safekeeping and administration of securities, m) providing banking information, n) safe custody services.

8 According to the same article 5d of the Banking Act (1991) a bank may not only lend but: b) lending, c) financial leasing, f) providing guarantees, h) participation in securities issues and the provision of services related to such issues, i) advice on capital structure, industrial strategy and services relating to mergers

9 Notice that some activities are fee-driven e.g. Custody services, money transmission, consultations While others are more “spread” driven e.g. deposits vs. lending and leasing

10 If we look at a typical balance sheet: Debt to third party Debt to owners

11 Borrowing from third parties (suppliers or banks) is not the same as from shareholders Third parties are normally paid interest – a charge that is almost guaranteed to be paid when possible Shareholders or owners are normally paid from profits (dividends) and this is not necessarily paid, even when possible. Thus, distance is often kept between bank and the borrower. The bank takes guarantees (collateral) to ensure payment of both the principal and the interest. This often can cripple a company in trouble. Often squabbling creditors do more damage to a debtor’s financial well-being as they fight over the assets – this is one of the big failings of the larger banks. They take little risk when they lend money.

12 Banks also ensure the “multiplier effect” -

13 Islamic Concept of Banking Concept of usury (riba) - is related firstly to the fifth pillar of Islam – charitability - when you have income, you must share it with others. - usury was banned in Old & New Testaments - was also frowned on historically (Shakespeare) - is seen as a way to get something by doing nothing for it other than to have a lot of money. It is a form of theft. - in the Koran, it is written that what is taken will be destroyed and wrongdoers will be punished. What is given will be multiplied. - when Muslims started to make serious money from oil, they were not sure about what to do. Definitely, lending profitably would not be well accepted - many states retained Koranic scholars as advisors Money is not an asset, and cannot be used as such to create wealth (more money)– it is just a measure of value

14 How does it work? All lending must be Sharia compliant Bank does not charge interest - shares both profits and losses Profits divided according to capital invested Depositors share profits with bank Depositors choose type of investment they want money put in

15 Some Products Sukuk – Islamic type of bond – Profit sharing Murabaha - Purchase and resale Ijarah – Leasing arrangement Salam – Forward payments for goods delivered later Ististna’a – Like Salam but for manufactured goods

16 Are there any advantages? Bank and borrower have similar objectives Excessive risk-taking is not allowed Bank contact is also expert advisor Predatory activity in downturn not permitted Islamic banks were not affected by Credit Crisis 2008

17 Are there any disadvantages? Bank as partner – loss of control Portion of profit might be quite costly Cannot invest in certain sectors - alcohol, pork, gambling, etc

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