Islamic Corporate Head Islamic Banking Services An Introduction to Islamic Banking and Finance; Principles, Concepts and Philosophy Amer Khalil ur Rehman Islamic Corporate Head Islamic Banking Services Askari Bank Limited 2nd November, 2009 Disclaimer: Views expressed here in a personal capacity

Learning Objectives Increase Awareness about Islamic Banking and Finance Including; The Prohibition of Riba in Major Religions Riba in the Quran and Hadith Main Principles of Islamic Economics Differences between Conventional Vs Islamic Banking Basic Concepts and Philosophy of Islamic Banking; Evolution of Islamic banking; International Institutions dealing with Islamic Banking

Background: Prohibition of Riba

Why Islamic Banking? What is its Market Potential? Interest, Usury, or Riba is forbidden in all major religions e.g. Judaism (Deutronomy 23:19) Christianity (Thou Shall not lend upon usury..) Islam (Religion of over 1/5th of world population) Foreign Banks, RBS (ABN Amro Bank), Citibank, Deutsche Bank, Hong Kong & Shanghai Banking Corporation, Merrill Lynch, Standard Chartered, Union Bank of Switzerland etc, doing Islamic Banking for profit.. and market size potential.. and not (necessarily) for religious reasons.. Vision: Singapore Eateries & Fast Food Chains! (Thou shall not lend upon usury…)

Judeo Christian Tradition “Thou shalt not lend upon usury to thy brother, usury of money, usury of anything that is lent upon usury” (Deutronomy 23:19)

Judeo Christian Tradition “He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniquity, hath executed true judgment between man and man, hath walked in my statutes, and hath kept my judgments, to deal truly; he is just He shall surely live, said the Lord GOD” (Ezekiel 18: 8,9)

Judeo Christian Tradition “He that by usury and unjust gain increaseth his substance, He shall gather it for him that will pity the poor” (Proverbs 28:8)

Judeo Christian Tradition “In thee have they taken gifts to shed blood; thou hast taken usury and increase, and though hast greedily gained of thy neighbours by extortion, and hast forgotten me, said the Lord God.” [Ezekiel 22:12]

Introduction to Islamic Banking

Islam and Shari’ah A balanced approach is required by Islam Our Focus Source: Institute of Policy Studies Our Focus A balanced approach is required by Islam

Sources of Fiq’h in Islam Quran Sunnah Ijama’e Ummah (Consensus of the Ulema) Ijtehad / Qiyas (AAOIFI Shariah Standards: through Ijtama’ee-Ijtehad) Accounting & Auditing Organization for Islamic Financial Institutions’ Shariah Standards Accounting Standards, Auditing Standards & Governance Standards

According to the Quranic verses.. (summary) Taking interest has been equated with rejecting faith.. (Al-Imran) God deprives interest of all blessings.. (2:276) Even [Just] Saying: “Trade is like Interest” is forbidden.. and would attract punishment on the day of judgment… (2:275) O (Muslim) Believers (Not Non-Muslims!!) if indeed you really are Believers and fear God then give up interest.. if not then take notice of war from Allah and his Messenger… (2:278-279) Detailed severe punishments mentioned in Quran for those who make war upon Allah and his Messenger.. (5:33) (Caution: Role of State not Individuals. Additional context 5:32)

Riba in the Quran Third Revelation: “O Believer, take not doubled and redoubled interest [interest on interest], and fear God so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy” (The family of Imran – Sura Al-Imran)

Riba in the Quran “God deprives interest of all blessing, but blesses charity; He loves not the ungrateful sinner” (The Cow – Sura Al-Baqara 2:276)

Riba in the Quran Fourth Revelation: “Those who benefit from interest shall be raised like those who have been driven to madness by the touch of devil; this is [just] BECAUSE THEY SAY: “Trade is like interest” while God has permitted trade and forbidden interest…” (The Cow – Sura Al-Baqara 2:275) ..Hence, those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to God’ but those who revert shall be inhabitants of fire and abide therein forever”

Riba in the Quran Fifth Revelation: “O believers, fear Allah, and give up what is still due to your from the interest (usury), IF [indeed] you are true believers[!!!]. If you do not do so, then take Notice of War from Allah and his Messenger. But, if you repent, you can have your principal. Neither should you commit injustice, nor should you be subjected to it.” (The Cow – Sura Al-Baqara 2:278-9)

Riba in Quran (Related in context to 2:278) “The only reward of those Who make War upon Allah & his Messenger, and strive after corruption in the land, will be that they will be Killed Or, Crucified, Or, have their Hands and Feet on alternate sides Cutoff, Or, will be Expelled out of the land. Such will be their degradation in the world, and in the hereafter, theirs will be an awful doom. (Quran: The Table Spread - Al-Maida Chapter 5: Verse 33-34) Caution: Role of State not Individuals to implement Shariah. See Context 5:32) Save those who repent before ye overpower them. For know that Allah is Forgiving, Merciful.

Important Caution: Duty of the State (Not Individuals) to implement Shari’ah Law.. Taking one life is equal to killing mankind.. “..Whosoever killeth a human being, other than man-slaughter or corruption in the earth, it shall be as if he killed all mankind, and whoso saveth the life of one, it shall be as if he had saved the life of all mankind...” (Quran: The Table Spread - Al-Maida Chapter 5: Verse 32) (i.e. Individuals need to refrain from Vigilantism!!…)

Riba in Hadith “The Prophet cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: “They are all alike (in guilt).” (Sources: Jabir ibn Abdullah, Muslim, Tirmidhi, Musnad Ahmed)

“Even when interest is much, it is bound to end up in paltriness.” The Holy Prophet said: “Even when interest is much, it is bound to end up in paltriness.” (Sources: Ibn Mas`ud, Ibn Majah, Musnad Ahmad)

Muamalat (civil transactions) should be.. Free from Riba (an increase without ‘iwad or equal counter-value) In Compliance with (objectives of i.e. Maqasid - e - ) Shariah Devoid of Gharar (uncertainty, indeterminacy) Free from Qimar (gambling) and Maysir (games of chance) Free from Ghishsh (fraud) and Khilabah (cheating) Entitlement to profit depends on liability for risk Contracts based on free mutual consent “What is not explicitly prohibited is permissible”

Shariah and Maqasid-e-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." Al-Ghazali  

Shariah and Maqasid-e-Shariah "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 al-Qayyim

Human Financial Needs Forms of Contracts Instruments Securities Equity (Capital) Market Debt Market

Islamic Mode Description Bai’ Murabaha Cost Plus Profit Sale Shariah Permissibility Source Quran Sunnah Ijma’a (Consensus) Trade Based (Debt Creating) Modes (Low Risk Category) Bai’ Murabaha Cost Plus Profit Sale Yes Bai’ Istisna`a Sale on Order Bai’ Salam Commodity Sale Semi-Debt Creating Mode (Medium Risk Category) Ijarah Leasing Sharing (Non-Debt) Modes (Full Risk Category) Musharakah Joint Venture Profit Sharing Mudarabah Trustee

Conventional vs Islamic Financing money Bank Client money + money (interest) vs Islamic Financing Basic Difference between Islamic and Conventional Modes of Finance Islamic Banking Goods & Services Client money

Conventional Vs Islamic Economics Difference in Factors of Production Land Labour (+Entrepreneur) Capital Islamic Land Labour (incl. Entrepreneur) Capital Conversion..

Frequently Asked Questions (Some Common Misconceptions…) Form Vs Substance Issue Are Mudarabah & Musharakah “the ideal modes”? Are Fixed Returns possible in Islamic Banking? Can Returns be the same as Conventional? No! Trade Based modes are the ideal modes! [Allah has permitted Trade and Forbidden Riba (2:275)] Yes! Through Fixed Rental Income or Fixed Profit on Sale Transactions Yes! e.g. If Cost of Cow is same!! since US$ / Kilo Haram Meat ≠ US$ / Kilo Halal Meat!!!

Frequently Asked Questions (Some Common Misconceptions…) Impact of Inflation and Time Value of Money Banking is 600 years old, so how can there be Role for Bank in Islam? Islamic Banks share Profits, would they also share losses? Can Islamic Banks get funds from Conventional Banks? if yes, why? Financial Contracts / Transactions existed over 1400 years ago Under lying modes / Financial Contracts form the basic building block Yes! BUT!!!! Only if they actually occur, despite diversification; Since Risk Beta of Banks is closer to the Market Risk Beta!!! Prevent Riba!!! Or Speak against Riba? Or just Consider it wrong?

Is Benchmarking with Conventional permissible? Confusion due to Mixing of Shariah Issues with Pricing Decisions Tiers Conventional Bank Depositor Borrower Interest on Deposits Interest Spread Interest on Borrowing Market Rates 10% 2% 12% Tiers Islamic Bank Depositor Financee Tier 1. Mudaraba I Rab-ul-Mal I Mudarib I Tier 2. Mudaraba II Rab-ul-Mal II Mudarib II “Return” “Profit Spread” “Financial Costs” Unfair to Depositor X X 4% 2% 6% to Financee X 14% X 16% Fair As per IFSB 10% 12% US$ / Kilo Haram Meat ≠ US$ / Kilo Halal Meat Market Based Returns are not just permissible! IFSB prefers / recommends them as they are Fair and Equitable!!

Onus Shifts!! Client Halal Restaurant Owner Halal Abattoir / Butcher Islamic Banking Shariah Advisor Onus Onus

Why reliance on Shariah Advisor and Onus Shift is Essential? Bai’tan fil Bai’…

AAOIFI Accounting & Auditing Organization for Islamic Financial Institutions Shariah Standards Accounting Standards Auditing Standards Governance Standards

Value Addition Offered by Major Islamic Modes.. Islamic Finance Conventional Finance ‘Equivalents’ Intermediated Not intermediated Murabaha None Salam Future Contracts Istisna`a Ijarah Leasing Musharakah Shareholding Venture Capital Mudarabah Value Addition by Major Islamic Modes and their close Conventional Equivalents ICI and Fayzan Manufacturing Mudarabah Interesting Solution to the Privatization Dilemma!!

Bai’ Salam – an illustration Round Trip Commodity Quantity Sold (Sale Price) Purchased(Cost Price) Cash Flows 1. In Madina Rice 10 Kg DH 100 2. Lentils (DH 100) 3. In Damascus DH 200 4. a (DH 50) 4. b 30 Kg (DH 150) 5. DH 300 TOTAL DH 600 (DH 300) ‘Income’ / Positive Cash Flows DH300

Tax Benefit Cash Flows Istisna Istisna Istisna Mode Selection Parallel Istisna Istisna Short Term Murabaha Istisna Tax Benefit Ijarah Istisna Cash Flows D. M.

Seller Buyer Buyer Mode Selection & Istisna Parallel Istisna Istisna Customer Bank Seller Air Bus Buyer Seller Buyer

Islamic Deposit Product Modes Mudarabah Qard Wakalah tul Istismar Musharakah Other Modes Amanah Waddiah

Businesses/Corporates Depositors Askari Islamic Weightage System Pool of Funds Businesses/Corporates Profits Financing Deposits Equity

Askari Islamic Banking Products Liability Side Products Asset Side Products 1. Murabaha 2. Ijarah (Consumer /Corp. Industrial Equipment) 3. Diminishing Musharakah (for Consumer /Corporate) 4. Salam 5. Istisna’ (for Construction/ Machinery/ Manufacturing) Liability Side Products 1. Pak Rupees Chequing Accounts Askari Islamic Current Account Askari Halal Savings and Notice Account (AHSAN) AHSAN MUNAFA AHSAN MASRAFI 2. Foreign Currency Chequing Accounts Askari Halal Foreign Currency Current A/c Askari Halal US Dollar Savings Account 3. Askari Halal Investment Accounts (AHIA) Askari Islamic Investment Certificates (AIIC) Askari Khas Islamic Deposit Account(AKIDA) Askari Islamic Term Quality Deposit(AITQAD) Askari Halal Certificates of Aasaan Monthly Mudarabah (AHCAMM) Askari WAKALAH-TUL-ISTISMAR

(Cost of Being a Muslim) Motivating Factors COBM (Cost of Being a Muslim)

Any Questions? amer.khalil@askaribank.com.pk amerkhalil@consultant.com amerkhalilurrehman@gmail.com

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