1. College of Business Administration
Jazan University , KSA
Islamic Banking
Course code : FIBA 387
6th Level
JAN 2013

2. Finance & Banking Department
Prepared By
Dr. Omer Ali Babiker Eltahir
Assistant Professor
Finance & Banking Department
Mr. Mohammed Yasin
Lecturer
Mrs. Amreen

3. Islamic Banking
Course Code: FIBA 387 – 6th Level - BBA Finance & Banking
Max .Marks : 100
Term End Exam : 50
Cont. Assessment : 50
COURSE CONTENTS
Unit-I
Islamic Banking: Historical Evolution and Development, Why Islamic Finance? Riba and Gharar: Meaning and Types. Principles of Islamic Banking: Riba (Interest) Free Banking System; Profit-Loss Sharing. Governance in Islamic banking. The Difference Between Islamic Banking and Conventional Banking.
Unit-II
Wadea (Deposit) In Islamic Banking (Domestic Operations)
The Wadea: meaning, types, types of accounts, Operations and journal entries. Teller(Treasury Section), Clearing House.
Unit-III
Finance and Investment in the Islamic Banking (Domestic Operations)
Tools Of Finance And Investment (Permissible Financing Methods): Musharakah (Joint Venture): Meaning, Types. Mudarabah (Partnerships): Meaning. Murabahah (Cost-Plus Sales): Meaning, Types. Ijarah(leasing) Investment In Fixed Assets: Meaning. Bai Salam (Islamic forwards): Meaning. Bay be-Theman Ajel (Credit sales) Meaning.
Unit-IV
ISSUES IN ISLAMIC BANKING
Foreign Operations: Letter of Credit (L/C); Letter of Guarantee ( L/G). Final Accounts (Financial Statements: Income Statement, Balance Sheet). Case study.

4. Unit-I Islamic Banking

5. INTRODUCTION
The term Islamic banking refers to a banking activity or a system of banking that is in consonance with the basic principles of Islamic Shariah(rules and values set by Islam).
In Islamic banking system, a business that offers good interest rates or services is strictly prohibited and it is in fact considered Haraam(forbidden).
Islamic banking offers the same facilities as conventional banking system except that it strictly follows the rules of Shariah or Fiqh al- Muamlat.
Mirza Basheer-ud-Din Mahmood Ahmad was perhaps the first person to discuss Islamic Economics in detail in his books Nizame Nau (1942) and Islam ka Iqtisadi Nizaam (1945). Later work included that of Naeem Siddiqi and Maulana Maududi.
Shariah-compliant assets reached about $400 billion throughout the world in 2009, according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion. 
Iran,  Saudi Arabia  and Malaysia have the biggest shariah-compliant assets.

6. WHAT IS ISLAMIC BANKING
1- “Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Sharia’h”.
2- Islamic banking is also known as interest free banking system as the Shariah disallows the acceptance of “Riba” or interest rate for the accepting and lending of money. ”
2- Banking encompassing Islamic injunctions
To avoid:
Riba –Earning returns from a loan contract or Selling debt contracts at discount
Gharar – Absolute Risk or Excessive uncertainty in contracts, Gambling and chance-based games (Qimar)
General Prohibitions
unethical practices
Shariah Compliance & Prudent Banking
Achieving the goals and objectives of an Islamic economy.

7. EVOLUTION AND DEVELOPMENT OF ISLAMIC BANKING
An early market economy and an early form of mercantilism, sometimes called "Islamic capitalism", were developed between the eighth and twelfth centuries. 
The monetary economy of the period was based on the widely circulated currency the gold dinar, and it tied together regions that were previously economically independent.
A number of economic concepts and techniques were applied in early Islamic banking, including bills of exchange, partnership (mufawada, including limited partnerships, or mudaraba), and forms of capital (al-mal), capital accumulation (nama al-mal), cheques, promissory notes, transactional accounts, loaning, ledgers and assignments. Organizational enterprises independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced during that time. 
Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.

8. origin of Islamic banking
The origin of Islamic banking system can be traced back to the advent of Islam when the Prophet himself carried out trading operations for his wife.
The “Mudarbah” or Islamic partnerships has been widely appreciated by the Muslim business community for centuries but the concept of “Riba” or interest has gained very little diligence in regular or day-to-day transactions.
The first model of Islamic banking system came into picture in 1963 in Egypt. Ahmad Al Najjar was the chief founder of this bank and the key features are profit sharing on the non interest based philosophy of the Islamic Shariah. These banks were actually more than financial institutions rather than commercial banks as they pay or charge interest on transactions.
In 1974, the Organization of Islamic Countries (OIC) had established the first Islamic bank called the Islamic Development Bank or IDB.
The basic business model of this bank was to provide financial assistance and support on profit sharing.
By the end of 1970, several Islamic banking systems have been established throughout the Muslim world, including the first private commercial bank in Dubai(1975), the Faisal Islamic bank of Sudan (1977) and the Bahrain Islamic bank(1979) .
Islamic banking is now one of the world’s fastest-growing economic sectors, comprising over 300 institutions in over 75 countries. They are concentrated in the Middle East and Southeast Asia (with Bahrain and Malaysia being the largest hubs), but are also appearing in Europe and the United States. Total assets worldwide are estimated to exceed $250 billion, and are growing at an estimated 15 percent a year.

9. History of Islamic Banking
Local Islamic banks formed in the 1970s in Muslim countries
Originally emphasized joint-venture structures akin to private equity.
Quickly evolved to provide short-term credit facilities by using the murâbaha structure
With increase in scale, Islamic banks began to branch out to more complex financing schemes, including:
Retail banking, including, deposit taking and consumer lending
Bonds (sukûk)
Medium- and Long-term leases (ijâra)

10. History of Islamic Banking
Impact of 11/9 – Reverse Capital Flight
Perception of hostile climate in many Western jurisdictions, in particular, the United States, led to repatriation of dollars by Arab investors to Middle Eastern banks
Islamic banks, along with conventional banks in the region, benefited from this reverse flight of capital
Increase in Oil Prices Led to Dramatic Increase in Liquidity in the Gulf
Conventional Banks Open “Islamic Windows”
Conventional banks began to respond to requests from Muslim clients to offer products that complied with Islamic law
As the size of the potential market became clear, conventional banks responded with the creation of divisions dedicated to Islamic banking

11. History of Islamic Banking
Conventional International Banks with Islamic Windows:
Citigroup
HSBC
Deutsche Bank
UBS
ABN AMRO
Standard Chartered Bank

12. CONCEPT OF ISLAMIC FINANCE
Although the concept of Islamic finance can be traced back about 1,400 years, its recent history can be dated to the 1970s when Islamic banks in Saudi Arabia and the United Arab Emirates were launched. Bahrain and Malaysia emerged as centres of excellence in the 1990s.
It is now estimated that worldwide around US $1 trillion of assets are managed under the rules of Islamic finance.
Islamic finance rests on the application of Islamic law, or Shariah, whose primary sources are the Qur'an and the sayings of the Prophet Muhammad. Shariah, and very much in the context of Islamic finance, emphasizes justice and partnership.
The main principles of Islamic finance are that:
Wealth must be generated from legitimate trade and asset-based investment. (The use of money for the purposes of making money is expressly forbidden.)
Investment should also have a social and an ethical benefit to wider society beyond pure return.
Risk should be shared.
All harmful activities (haram) should be avoided.

13. RIBA AND GHARAR - MEANING AND TYPES
Riba  means Interest. Riba is forbidden in Islamic economic jurisprudence fiqh and considered as a major sin. Simply, unjust gains in trade or business, generally through exploitation.
There are two types of riba discussed by Islamic jurists:
1- An increase in capital without any services provided and speculation (Maisir), which is prohibited by the Qur'an
2- Commodity exchanges in unequal quantities, also prohibited in the Qur'an.

14. RIBA AND GHARAR - MEANING AND TYPES
refers to any transaction of probable items whose existence or characteristics are not certain, due to lack of information, ignorance of essential elements in the transaction to either party, or uncertainty of the ability of one party to honor the contract.
The Prophet (S.A.W) has forbidden the purchase of the unborn animal in the mother’s womb, the sale of the milk in the udder without measurement, the purchase of spoils of war prior to distribution, the purchase of charities prior to their receipt, and the purchase of the catch of a diver.  
TYPES OF GHARAR
1. Gharar Yaseer (minor or slight)
This type of gharar is tolerated and will not invalidate a contract.
2. Gharar Fahish (major or excessive)
This type of gharar is not tolerated and may result in contract void ability.
All jurists agree that gharar should be avoided in commercial exchange contracts. As Islamic Shari’a forbids riba (interest) because it leads to exploitation and injustice in the society, it also forbids gharar in any transaction to protect the two parties from deceit, ignorance and uncertainty.

15. DIFFERENCES AND SIMILARITIES BETWEEN ISLAMIC AND CONVENTIONAL BANKING
There are two major difference between Islamic Banking and Conventional Banking:
Conventional banking practices are concerned with "elimination of risk" where as Islamic banks "bear the risk" when involve in any transaction.
 When Conventional banks involve in transaction with consumer they do not take the liability only get the benefit from consumer in form of interest whereas Islamic banks bear all the liability when involve in transaction with consumer. Getting out any benefit without bearing its liability is declared Haram in Islam.

16. Major Differences between Islamic and Conventional Banking System
Islamic System
1- Real Asset is a product. Money is just a medium of exchange.
Conventional System
1- Money is a product besides medium of exchange and store of value.
2-Profit on exchange of goods & services is the basis for earning profit
2- Time value is the basis for charging interest on capital
3- Loss is shared when the organization suffers loss
3- Interest is charged even in case, the organization suffers losses

17. Major Differences between Islamic and Conventional Banking System
Islamic System
4- No expansion of money takes place and thus no inflation is created.
Conventional System
4- The expansion of money takes place, which creates inflation.
5- Due to control over inflation, no extra price is charged by the entrepreneur
5- Due to inflation the entrepreneur increases prices of his goods & services
6- Real growth in the wealth of the people of the society takes place, due to multiplier effect and real wealth goes into the ownership of lot of hands.
6- Real growth of wealth does not take place, as the money remains in few hands.

18. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Conventional Banking 1)Functions and operations are based on fully man made principles
Islamic Banking 1) Functions and operations are based on Sharia’h principles

19. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Islamic Banking
2) Promote risk-sharing between provider of capital (investor) and user of funds (entrepreneurs)
Conventional Banking 2) Investor is assured of pre-determined rate of interest

20. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Islamic Banking 3) Aim at maximising profit but subject to Sharia'h restrictions
Conventional Banking 3) Aim at maximising profit without any restrictions

21. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Islamic Banking
4) Partners, investor and traders, buyer or seller relationship
Conventional Banking
4) Creditor-Debtor relationship

22. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Conventional Banking
5) Based on money trading. Money is a medium of exchange and not a commodity, its sale and purchase is prohibited in Islam.
Islamic Banking
5) Encourage asset-based financing and based on commodity trading

23. DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING
Islamic 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.
Conventional Banking
6) It is almost risk free banking and depositor has no risk of losing its money because interest is guaranteed.

24. PRINCIPLES OF ISLAMIC BANKING
a) Prohibition of Interest :
Riba best translated today as the charging of any interest, meaning money earned on the lending out of money itself.
The prohibition on paying or receiving fixed interest is based on the Islamic tenet that money is only a medium of exchange, a way of defining the value of a thing; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else.
The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it.

25. PRINCIPLES OF ISLAMIC BANKING
b) Profit and Loss Sharing :
While Islam employs various practices that do not involve charging or paying interest, the Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilizing the funds at risk on a profit-and- loss- sharing basis.
Such participatory modes used by Islamic banks are known as Musharakah and Mudarabah. This by no means implies that investments with financial institutions are necessarily speculative.
The concept of profit-and-loss sharing in an enterprise, as a basis of financial transactions is a progressive one as it distinguishes good performance from the bad and the mediocre.

26. PRINCIPLES OF ISLAMIC BANKING
c) Sharia’h Approved Activities
Islamic financial system encourages, performing only those business activities which conform to Islamic Sharia’h.
All the activities which do not conform to the Islamic rules and laws are not permissible and dealing in such activities will be dealt with serious consequences.

27. CRITICISM OF ISLAMIC BANKING
Some Islamic banks charge for the time value of money, the common economic definition of interest (riba). These institutions are criticized in some quarters of the Muslim community for their lack of strict adherence to Sharia’h.
The concept of Ijarah is used by some Islamic Banks to apply to the use of money instead of the more accepted application of supplying goods or services using money as a vehicle.
A fixed fee is added to the amount of the loan that must be paid to the bank regardless if the loan generates a return on investment or not.
The reasoning is that if the amount owed does not change over time, it is profit and not interest and therefore acceptable under Shariah.
Islamic banks are also criticized by some for not applying the principle of Mudarabah in an acceptable manner.
Where Mudarabah stresses the sharing of risk, critics point out that these banks are eager to take part in profit-sharing but they have little tolerance for risk.

28. CRITICISM OF ISLAMIC BANKING
The majority of Islamic banking clients are found in the Gulf states and in developed countries.
The majority of financial institutions that offer Islamic banking services are majority owned by Non-Muslims.
With Muslims working within these organizations being employed in the marketing of these services and having little input into the actual day to day management, the veracity of these institutions and their services are viewed with suspicion.

29. SCOPE OF ISLAMIC BANKING
Islamic banking is one of the growing domains of banking which shows promise for the future. Furthermore, it has so far remained undeterred to a larger extent from the current financial crises.
It is about time to develop even more innovative Islamic instruments which can meet the needs of the customers in a religiously viable way.
It is important that these instruments do not defy the laws of Islam and the confidence of the public at large is not shattered.
Islamic banking is one beacon of hope for all the conventional banks that have suffered the crunch due to high speculation and ethical violations of business norms.

30. 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.

31. 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

32. Wadiah (Deposit) In Islamic Banking (Domestic Operations)
Unit-II
Wadiah (Deposit) In Islamic Banking (Domestic Operations)

33. Introduction
There is no doubt that each bank needs financial sources for funding, money bank rate is small relative to the total funds used.
In general Banking Deposits is one of the most important sources of funds in banks , it has been offered through Bank definition that has two ways borrowing from depositors , and lending to borrowers.
Bank Deposits have two types: 1) Deposits of certain things like gold or documents at the bank where placed in safes Pay. 2) Cash deposits, which is that we are talking about. And cash deposits in Islamic banks vary in terms of recovery time.

34. Wadiah Wadiah is a contract ( Aqed ) between
the owner of goods and custodian of the goods.
1- To protect the goods from being stolen,
destroyed etc.
2- To ensure the safe custody of the goods.
3- Operates under the contract of Wadiah Yad Dhamanah (guaranteed custody), The al-wadiah yad Amanh contract says that the bank will provide deposits protection and honor all withdrawals on call provided that it is allowed to use deposits to generate earnings.
4- The bank accepts deposits from its customers looking for safe custody and convenience.
5- The bank requests permission to make use
of the customers’ funds for investment purposes.

35. Wadiah Under the contract of Wadiah:
6- The customers may withdraw their balances
at any time.
7- Profit generated from the use of the customers’ funds belongs to the bank. However, the bank may at its absolute discretion rewards the customers by declaring profits to them.
Under the contract of Wadiah:
1- The custodian i.e. the Bank is not allowed to mention or to promise any reward on the deposit received.
2- The owner/depositors too cannot demand any
rewards or return from their Bank on their savings.
3-Wadiah is purely a contract on safe custody of
goods without any promise on rewards or returns.

36. Types of Bank Deposits in Islamic Banks
Islamic banks provides many types of deposits that meet the needs of the world , and fit all segments of society from individuals and companies, including (Islamic current account - Islamic Savings Account - Islamic Investment Account), and is handled these types according to regulations of Islamic law.

37. Types of Bank Deposits in Islamic Banks
Demand Deposits (Current Accounts)
Current accounts are based on the principle of al-wadiah , and it defines that:
“The current account, a service offered by Islamic banks to customers, and through the customer can keep his money in the bank, with full warranty provided by the bank, and can withdraw it at any time they want without notice and without getting any benefit, or payment or any financial obligation on it - through the bank - at any time, either through issuing checks, or debit balance, or through the bank's branches, or through automated teller machines (ATM), which operates throughout the day, as a customer can pay for purchases through POS machines (POS) deployed in the market”.

38. Demand Deposits (Current Accounts)
1- All Islamic banks operate current accounts on behalf of their clients: individuals and business firms.
2- These accounts are operated for the safe custody of deposits and for the convenience of customers.
3-The bank guarantees the full return of these deposits on demand and the depositor does not gain any share of the profit or any other return in any form.
There are two dominant views about Current Accounts:
1- To treat demand deposits as Amanah. A "Trust Account" instead of a current account.
2- The other view is to treat demand deposits as Qard Hasan (or interest free loan).
According to this view the bank is free to utilize these funds at its own risk without return to, or authorization from, the depositors.

39. Current Accounts
1- Current accounts are based on the principle of al-wadiah , whereby the depositors are guaranteed repayment of their funds.
2- 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 Profit and Loss Sharing (PLS) ventures.
3- Current Accounts can be opened either in domestic currency or foreign currency.
4- Current Accounts holders have the right to draw cheques on their accounts.
5- This account consists of several types, that are: Individual Account, Joint Account, Partnership Account, Government Account , Private Company Account, Company Account, Association Account.

40. Current Deposits In Islamic Banks
-Very Similar to standard commercial banks
- No return paid back to depositors
- Checking facilities
1- Are Current deposits a loan to the bank from depositors ?
2- Are Current deposits a trust by depositors to banks ?
3- Use of Current deposits by the banks on their own risk.

41. Islamic Savings Account
Islamic Savings Account defines as “that combines the advantages of the current account and investment account, where the client can draw from the account whenever he wants, from both branches or through automated teller machines (ATM), or pay for purchases through POS machines (POS), and at the same time the customer can get a return on the remaining balance in the account, according to Mudaraba contract, which includes distribution Ratios between the bank and the client at the beginning of the contract, as a percentage of the profits resulting from customer financing”.

42. Savings Accounts 1- Saving deposits without authorization to invest.
Savings accounts also operate under the al- wadiah 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.
Saving Deposits Operates In Different Ways:
1- Saving deposits without authorization to invest.
In the Islamic Banks the depositors allow the banks to use their money but they obtain a guarantee of getting the full amount back from the bank, but no profits promised from the bank.

43. Saving Deposits 2- Saving deposits with authorization to invest.
In other banks saving accounts are treated as investment accounts , the banks request a permission to use this funds so long as these funds remains with the bank ,but with less stringent conditions as to withdrawals and minimum balance.
Return to depositors who provide authorization to invest.
3- Saving deposits as a part of trust accounts.
4- Saving deposit as Notice account.

44. Investment Accounts Islamic Investment Accounts: is
"money deposited by their owners with Islamic banks in order to obtain a return“.
These accounts subject to “hold speculative legitimacy", where the BID to invest these funds in the areas of work are legitimate.
Distributed profits generated between the bank and the customer, depending on the proportions percentage to be determined when the contract signed.
The bank gets a share of the profits for the effort, and the customer gets a share of the capital return.

45. Investment Accounts
The subject of this investment accounts to base legitimacy “It means participation in the profits and losses, and this does not mean that the client vulnerable to lose part of its capital.
Islamic banks provide funding to customers through Murabaha or participation they get guarantees for the preservation of funds depositors.
Funding is granted to the customer after do feasibility studies that show the success of the project.

46. Investment Deposits
1- Investment accounts identify timed a year - in most cases, and can add profits to the customer's account. 2- Investment account is not entitled to the client withdrawals from the investment account during that period. 3- Investment account in emergency situations, the client can draw with a discount portion of the profits for the amount that has been withdrawn from the account. Investment Account An investment account operates under the mudaraba al-mutlaqa principle, in which the mudarib (active partner) must have absolute freedom in the management of the investment of the subscribed capital.

47. Investment Deposits Islamic Banking counterpart of Fixed Deposits.
Withdrawal allowed only in special cases
Investment deposits as Mudarabah Accounts.
Depositor; Rabbal Mal; Bank: Aamil
Share profit on agreed basis, bear full loss.
Investment pool
Distribution of profits on pro rata basis.
Special investment accounts
Special investment accounts also operate under the mudaraba principle, and usually are directed towards larger investors and institutions.

48. Bank Teller
A Bank Teller
is a member of the staff of a bank who deals directly with the public and handles routine banking transactions like deposits, withdrawals, and so forth. For many people, bank tellers are iconic figures, since they represent the face of the bank to the public.
Employment in this profession is actually shrinking, because some people have turned to Automated Teller Machines (ATMs) and online banking since they find these services more convenient.

49. Bank Teller
The job requirements for becoming a bank teller are fairly minimal.
He or she must have a University Degree, diploma ,high school and exhibit an ability to perform basic math functions.
Bank tellers must also be comfortable with members of the public and with handling large amounts of money.
They are also expected to be extremely attentive and discreet, and in some regions a bank teller may need to pass a law enforcement background check before he or she can be hired.

50. Bank Teller
In a workday, a bank teller might accept cash or checks for deposit, cash checks drawn on his or her bank, issue funds like money orders and traveler's checks, and handle transactions related to savings accounts.
A bank teller also usually promotes services offered by the bank, such as loans, retirement accounts, and insurance; if a customer expresses interest in these services, the teller refers him or her to another bank employee who specializes in these offerings.
A bank teller might also provide access to safe deposit boxes, if a bank offers this service.

51. Development of clearing and settlement arrangements (1)
Clearing House
a place or institution where mutual claims and accounts are settled, as between banks. or
a central institution or agency for the collection, maintenance, and distribution of materials, information, etc.
Development of clearing and settlement arrangements (1)
What banks clear and settle: claims on other banks
Can have banks without having interbank settlement!
Over time, banks increasingly redeemed claims on other banks
Differs according to payment instrument

52. Development of clearing and settlement arrangements (2)
Clearing House
Development of clearing and settlement arrangements (2)
Economic pressures for banks to accept claims on other banks:
Demand from customers – to make bank money more liquid
Accepting bank can issue its own money
Disciplines other banks

53. Development of clearing and settlement arrangements (3)
Clearing House
Development of clearing and settlement arrangements (3)
But costs in accepting claims on other banks;
Credit risk
Clearing the payments
Holding the settlement asset
Transferring the settlement asset

54. Development of clearing and settlement arrangements (4)
Clearing House
Development of clearing and settlement arrangements (4)
But costs in accepting claims on other banks:
Credit risk (frequent settlement rounds)
Clearing the payments (route payments via ‘nodes’)
Holding the settlement asset (netting)
Transferring the settlement asset (exchange paper or book entry claims)

55. Automated Clearing House (ACH)
Nationwide wholesale electronic payments system
Transactions not processed individually
Banks send transactions to ACH operators
Batch processing store-and-forward
Sorted and retransmitted within hours
Banks
Originating Depository Financial Institutions (ODFIs)
Receiving Depository Financial Institutions (RDFIs)
Daily settlement
Posted to receiver’s account within 1-2 business days

56. Automated Clearing House (ACH)
High-volume, small value payment orders between financial institutions
largely recurring payments: payroll, mortgage, car loan, Social Security
Automated Teller Machines (ATM)
Debit-card point-of-sale payments
Telephones or PC bill payments.
Direct deposit (e.g. payroll)
Electronic benefits transfer

57. Automated Clearing House (ACH)
Wholesale Payments
SWIFT (Society for Worldwide Interbank Financial Telecommunications) (non-profit, Brussels).
Financial messaging system, not a payment system, Settlement must occur separately Instructions between financial institutions.
7125 institutions, 193 countries.
1.27 billion messages per year: $5 trillion per day.
2/3 are banks trading for their own accounts.
Settled through transfers in respective currencies (must have accounts in both currencies).
Herstatt risk (pay out one currency before receiving the other -- cascading effect).

58. Unit-III Finance and Investment in the Islamic Banking (Domestic Operations)

59. Permissible Financing Methods
Cost-plus sales (murabaha).
Credit sales (bay‘ bi-thaman-ajil) .
Leasing (’ijarah or ’ıjar).
Partnerships (musharaka and mudaraba).
Islamic forwards (salam and ’istisna‘) .

60. Cost-plus sales (Murabaha)
THE CONCEPT
Murabaha is a contract of sale where the seller discloses to the buyer the actual cost of the item to be sold in addition to the profit margin (mark up) added, to be mutually agreed upon with the buyer.
It is important to note that in classical fiqh, murabaha refers to sale (bay’), with all its implications and prescribed Shari’a conditions pertaining to sale, and has nothing to do with financing in the conventional sense.

61. Cost-plus sales (Murabaha)
Murabaha financing is a widely used contract in contemporary Islamic banking and finance; and it is limited to cases where the customer actually needs to purchase some commodity.
Its used in modern day trade financing
With regard to Islamic banking, Murabaha is an agreement wherein the bank purchases, at the request of a customer, a specified item, and then sells it to him at a mutually agreed marked-up price.

62. Cost-plus sales (Murabaha)
In this sale, the buyer knows the price at which the seller obtained the object to be financed, and agrees to pay a premium over that initial price.
Basic concept: Sale on mutually agreed profit margin on the known cost of goods; payment of sale price is deferred.
Real, tangible goods to be traded and not papers of debt or credit documents.
Murabaha cannot be used as mode in case no commodity is purchased by the client.
Buy-back arrangement: not allowed.
MUAJJAL; Credit price may include margin of mark-up, taking into consideration the deferred payment. As a debt, no return can be charged on the amount of Note/Bill.

63. Cost-plus sales (Murabaha) تذكير الطلاب بحفظ على الاقل اربع فروق
Thus, one may approach an Islamic financial institution and say “purchase this item on my behalf at this price, and I shall give you a profit (’urbihuka) margin of $10”, or “purchase this item on my behalf at this price, and I shall give you a profit (’urbih.uka) margin of 10%”.
The fact that the latter statement may be perceived to make explicit a percentage payment should not be of concern, since it is not Riba if the sale satisfies the conditions of Murabaha.

64. Cost-plus sales (Murabaha)
Notice that in this contract, the Islamic bank or financial institution must own the item at the time the customer buys it from them with the specified profit margin.
Examples of Murabahah
Two contracts:
A contract of intent to conduct a Murabaha Sale.
Another contract to buy the good ordered in previous contract.

65. Cost-plus sales (Murabaha)
The word MURABAHA is derived from the word Ribh, meaning profit in Arabic.
Sale with a profit.
Cost-plus financing.
Promise is not a legal binding. It introduces an element of risk in the transaction.
The element of risk justifies the profit in Murabaha sale : Fiqhi principle : Al Kharaj bi Daman.
Applications of Murabaha:
In domestic trade
In foreign trade
In financing consumer durables
In financing Real Estate

66. Credit sales (bay‘ bi-athamn aajil)
Definition
It is a sale contract in which the payment of the price is deferred and payable at a certain particular time in the future. and receipt the goods immediately.
Installments Sale permissible, even if the deferred price exceeds the spot price.
Deferred prices can vary so long as price not finalised.
Sale cannot take place until the parties agree to a particular price & mode of payment.
Not permissible to fix the spot price on cash basis, then to charge interest expressly tied with different periods.
Commercial papers are lawful types of authentication of a debt by putting it down in writing; - Treated by Shariah near to mandatory.

67. Credit sales (bay‘ bi- athaman ajil)
Very rarely is Murabaha used by Islamic banks with the price paid immediately by the customer.
In such cases, there would be no financing included and the Islamic bank would simply be a middle-man or broker-agent (simsar).

68. Leasing (ijarah or ıjar)
Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct (the right to use the object) for a specified period of time.
The sale of usufruct is permissible in Islam, as evidenced by the verses.
The corpus of the leased asset should exist till the expiry of lease period.
The corpus of the leased asset should remain in the ownership of the lesser during the whole period of lease; in case of Shirkah pro-rata ownership.
The lesser must accept responsibility of any defect in leased asset (without negligence of the lessee) which hinders the intended use of asset.
Sale – Separate and independent contractor

69. Leasing (ijarah or ıjar)
The most important financial difference between Islamic permitted leasing and conventional financial leasing is that the leasing agency must own the leased object for the duration of the lease.
Ijarah is emerging as a popular technique of financing amongst the Islamic banks
Elements of a lease contact: Lesser, Lessee, instrument and period of lease.
The asset remains in the ownership of the lesser. Maintenance is the responsibility of the owner.
Ijarah muntahi bit tamlikالايجار المنتهي بالتملك

70. Partnerships (Musharaka and Mudaraba)

71. MUDARABA Definition of Mudaraba
Mudaraba is a partnership in profit whereby one party provides capital and the other party provides skill and labour.
The provider of capital is called “Sahib al-maal” while the provider of skill and labor is called “Mudarib”.

72. Types of Mudaraba Mudaraba Contracts are generally divided as under:
Unrestricted Mudaraba and
Restricted Mudaraba.
Unrestricted Mudaraba:
Unrestricted Mudaraba may be defined as a contract in which the Sahib al- maal permits the Mudarib to administer the Mudaraba fund without any restriction.

73. Types of Mudaraba Terms and elements of Mudaraba: Restricted Mudaraba
Restricted Mudaraba may be defined as a contract in which the Sahib al-maal restricts the actions of the Mudarib to a specified period or to a particular location or to a particular type of business.
Terms and elements of Mudaraba:
Contracting Parties
There are two contracting parties in Mudaraba:
1. The provider of the capital i.e. ‘Sahib al-maal’ and
2. The Mudarib.

74. Terms and elements of Mudaraba
Capital
Capital is the amount of money given by the provider of funds i.e. Sahib al-maal to the Mudarib with the purpose of investing it in the Mudaraba business.
Profit & Loss
Profit should be for both Sahib al-maal and Mudarib as per agreed ratio. Loss should be borne by the Sahib al-maal.

75. The main features of Mudaraba
a) There should be two parties: Sahib al-maal (financer/Investor) and businessman is Mudarib (Who provides skill and labor).
b) There should be written agreement/contract between the Bank and the businessman which includes nature of business, period/time, sharing of profit etc.
c) Bank will finance and the businessman will run the business by providing his labor & skill.
d) The Bank will not interfere in the business.
e) The businessman will appoint employee(s) and he will run the business independently.
f) The Sahib al-maal /Financier/Investor reserves the right to check/verify the accounts of the business at any time.

76. Definition of Musharaka
Musharaka is a contract of partnership between two or more parties in which all the partners contribute capital, participate in the management, share the profit in proportion to their capital or as per pre-agreed ratio and bear the loss, if any, in proportion to their capital/equity ratio.

77. Types of Musharaka
In the context of Islamic Banking financing, Musharaka may be of two types:
Permanent Musharaka
Diminishing Musharaka
Permanent Musharakah:
partners can sell - as in case of Shares of Joint Stock Companies.
Temporary (Redeemable) Musharaka:
for limited time period, e.g After agreed time period(s),
Diminishing Musharakah:
one partner promises to buy the share of the other partner gradually until the title to the property is completely transferred to him.

78. Permanent Musharaka
Permanent Musharaka may be defined as contract of partnership business between the Islamic Bank and its clients in which the Bank participates in the equity and share the profit at a pre-agreed ratio or bear the loss, if any, in proportion to the ratio of capital/equity where termination period of the contract is not specified.
This is also called continued Musharaka.

79. Diminishing Musharaka
Diminishing Musharaka is a special form of partnership in which one of the partners promises to buy the share of the other partner gradually until the title to the equity is completely transferred to him.
In Diminishing Musharakah:-
Loan of Service Charges. Only administrative expenses can be charged.
Interest free loans are provided as a social service.

80. Musharaka Contracting Parties
There are two or more contracting parties known as partners, It is a condition that all the partners should be competent to give or be given power of attorney.
Capital:
Capital contributed by the partners may be in the equal or unequal and in the form of cash or cash equivalent, goods & commodities, assets or properties etc.
Distribution of Profit:
Profit should be distributed among the partners as per their ratio of capital or as per agreement.

81. Some Important Features of Musharaka
Capital should be specific.
Equal share is not a must.
Nature of capital may be money or valuables.
Active participation of partners.
Ratio of profit prefixed.
Variation in share of profit permissible.
Participation and sharing profit & loss.
Partners retains the ownership and right to management.

82. Musharakah Musharakah is from the word Sharikah.
More than one partners: Partnership in capital proportion and project supervision.
A partner may waive his right of supervision or delegate it to another partner.
Arrangements: Sharing of Profit and loss in accordance with capital proportion agreed proportion.
Variant: Share of profit in agreed proportion, share of loss in capital proportion.
Applications of Musharakah:
i. in Import trade
ii. In Agriculture

83. Difference between Mudaraba and Musharaka

84. Difference between Mudaraba and Musharaka
a)Mudaraba
1. The capital in Mudaraba is the sole responsibility of Sahib al-maal.
2. In Mudaraba, the Saheb al-maal has no right to participate in the management which is carried out by the Mudarib only.
3. In Mudaraba the loss, if any is suffered by the Sahib al-maal only, because the Mudarib does not invest anything, His loss is his labor and skill.

85. Difference between Mudaraba and Musharaka
b) Musharaka
1. In Musharaka it comes from all the partners.
2. In Musharaka, all the partners can participate in the management of the business and can work for it.
3. In Musharaka, all the partners share the loss to the extent of the ratio of their investment.

86. Salam and Parallel Contracts (Future Sale)
Prepayment of price in full for goods to be delivered in future.
Allowed by Holy Prophet (SAW) himself to meet farmers’ money need.
Banks will receive contracted commodities, not money.
Parallel Salam: a bank can sell a commodity purchased through Salam for even the same date of delivery or the quantity;
As long as the two contracts are not made conditional on each other.

87. Purpose of Salam
To meet the need of farmers who need money to grow their crops and to look after their family up to the time of harvest.
To finance someone who is in need to grow something or acquire something for further sale.
To meet the need of traders for import and export business.
The buyer also enjoys a lower purchase price, since he pays in advance.
Acceptance of Time. Value of Money through pricing of goods.

88. Salam Conditions Fungible – homogeneous goods
not where delivery has to be simultaneous, e.g. Gold, silver or currencies.
Date and place of delivery must be specified in the contract.
In case of a number of commodities, the amount and delivery period should be separately fixed.
The bank can sell the Salam Commodity through a parallel contract of Salam for the same date of delivery.
For a parallel Salam, the two contracts should be independent and separately enforceable.
Bank can also obtain a unilateral ‘promise to purchase’ from a third party.
Agency
To sell anywhere in the market

89. Unit-IV ISSUES IN ISLAMIC BANKING

90. The Concept of Letter of Credit in Islamic Banking
It is a facility extended by the banks to the traders and the businessmen.
The purpose of opening letters of credit is to facilitate speedy and simple payment and the transfer of money from one particular spot to one more.
This facility, currently being a lawful support, has to be effectively compensated in terms of Shariah.
If the payment of compensation or remuneration is connected with the quantity of services, the Shariah has no objection.
In this case it will be a kind of service cost which has’ been already thought to be and approved by nearly all the contemporary scholars and learned bodies.
In this situation it will be necessary that the rate of support charge is established maintaining in watch the magnitude of the service, quickness of the payment and the stage of credibility and performance of the lender concerned.

91. Parties in Letters of Credit
Can be summarized as follows:
The Applicant (Demanded opening credit)
Demanded Opening Credit that means the bank's customer (importer), which gives instructions to the bank to open a letter of credit for the supply of certain material for a demanded.
  A Bank that Opens a Letter of Credit
Which is committed to the correspondent bank According to the formula and terms of credit to pay the value when submitted documents which required to be identical to the accreditation requirements. 

92. Parties in Letters of Credit
(The beneficiary) or the so-called (The seller)
The beneficiary of the opening credit (seller) be obliged to create the goods agreed with the buyer (The buyer) within a specified period agreed upon in.
Confirming Bank ) Advance Bank installer)
This installation adds the Bank (reinforcement) on the letter of credit for a commission obtained from (buyer or seller) which in fact gives a true guarantee for the vendor to receive the value of the documents provided by the seller , even if the buyer does not pay for the value of those documents.

93. Types of Letter of Credit
Irrevocable Documentary Credits can be divided into two types :- 1/ Letter of credit is irrevocable and is not installed The so-called (Irrevocable unconfirmed L / C). 2/ Letter of credit is irrevocable (enhanced) installed. 3/ convertible or Transferable L / C. 4/ Revolving credits are called (Revolving L / C) can be divided into two types : a) (Cumulative Revolving). b) (Non Cumulative Revolving) .

94. Types of Letter of Credit
5/ Back to back (L / C).
6/ Agreed Documentary Credits , called (Standby credit) used only in American banks.
7/ Prepayment Credits.
8/ Payment on Credit Allocations
called (deferred payment).
9/ Red Clause Credit.

95. Mechanism to Open Letter of Credit
​​How to open letter of credit can be summarized as follows: A) Demanded letter of credit open a current account to the section that deals with him. B) Financial Balance of the Account is sufficient to cover the value of documents. C) The client requires some special procedures for the purpose of opening a documentary credit. Form open a letter of credit, which includes the following information: - Name of the buyer. - The name of the beneficiary. - Commercial lists. - Shipping documents. - The type of insurance. - Shipping type (single shipment or multiple shipments). - Port forwarding. - Final destination.

96. Letter of Guarantees LETTER OF GUARANTEE
is a written promise issued by a bank to compensate (pay a sum of money) to the beneficiary (third party, local or foreign) in the event that the obligor (customer) fails to honor its obligations in accordance with the terms and conditions of the guarantee / agreement / contract.
A bank guarantee is an undertaking by the bank at the request of a party, whereby the bank – in the event of default by the principal in the fulfillment of his obligations to make payment to the beneficiary within the limits of specified sum of money and within the specified period of time. So, bank guarantees are usually limited with respect to amount and time. As for as the time is concerned - a grace period is usually granted to the beneficiary to claim under the guarantee. This is basically given for the time taken by the beneficiary to present his claim. Letters of Guarantee can be in the form of Bank Guarantees, Performance Bonds, Bid Bonds, Shipping Guarantees or Standby Letter of Credit.

97. Types of Letter of Guarantees
1.Conditional and Unconditional Guarantees. 2.Fixed and Fluctuating Guarantees. 3.Financial Guarantees. 4.Performance / Non-financial guarantees.
Need for a Letter of Guarantee 1.To provide an assurance of the intention of the principal to sign the contract. 2.To safeguard against the principal failing to meet his obligations under such a contract 3.To protect interest of a party awarding the contract (beneficiary) in respect of the repayment of payments and advances made by him in the even of principal not fulfilling the contract terms.

98. Letter of Guarantee Parties and their differs interest
1.The beneficiary: He is the party inviting the tender or He is the party awarding the contract or He is the person who wants to receive a compensatory sum of money incase the tendered fails to perform his obligations or fails to perform the contract in accordance with its terms or to secure repayment of any payment or advances made by him if the principal fails to perform the contract The principal : He is the party tendering the contract or He is the party to whom the contract has been awarded Guarantor : Guarantor is a party who will meet his commitment in terms of the guarantee, without becoming involved in possible disputes between beneficiary and principal The Instructing Party : The new rules recognize the existing widespread practice whereby an instructing party may forward to the guarantor instructions received from or on behalf of the principal and counter-guarantee such instructions.

99. General Aspects of Letter of Guarantees
Benefits to the parties: 1. Benefits to the bank : It gets commission income. 2. Benefits to the principal / Instructing party :
(a) It enables better liquidity by deferring payment and making it contingent on non-performance.
(b) Cheaper than fund-based facilities except where it involves credit substitution. 3. Benefits to the beneficiary : Certainty of payment, in the event of non-performance, guaranteed by the bank.
Important points to be noted before issuing a guarantee : Principal need to indemnify the bank against all losses that the bank may incur in the performance of its obligation to pay.
The bank can obtain further comfort by specifying the place of payment under a guarantee and the governing law.

100. General Aspects of Letter of Guarantees
Date of expiry of the guarantee.
A bank guarantee can be amended.
Bank guarantee expires when the validity period has ended or the BG is returned for cancellation or the entire amount of BG is paid by the bank or the bank is released from its obligations.
Documents required : For grant of Bank guarantee limits Hypothecation / Pledge agreement for collateral security formalities connected with registration charges where necessary.

101. Thank You