CHAPTER-2

2.1 Emergence of Islamic Banking For an expending economy, a developed and efficient banking system is indispensable. The tremendous development that the world economy has experienced in the last few decades was contributed by several factors. The role of banking is comparable to what an artery system does in the human body. Despite the outstanding contribution of the conventional banking system (interest-based) several ancient and modern economists are critical about its efficiency level. Specifically, the ineffectiveness of interest rate at a stabilization tool during the period of the great depreciation is a case to note. The world has now been experiencing operation of as many as 250 Islamic banks and financial institutions in more than 50 countries, Muslim and non Muslim. There are religious as well as economic reasons, which have contributed to the emergence of PLS-banking. The basic intention behind establishing Islamic banks was the desire of Muslims to recognize their financial activities in way that do not contradict the principles of Shariah and enable them to conduct their financial transaction without including into Riba (Ahmad 1992).

On this religious ground, proponents of the PLS-system urge the Islamic community to avoid all transaction that interest, instead of increasing wealth, reduce it Further, muslime economists depreciation and stagflation very often found in the capitalist world as an outcome of the financial system based on interest . While religious exigency, call for avoiding any transaction based on interest, economic exigencies, on the other hand , provide anew outlook to the role of banking in promoting investment. 2.2What is Islamic Banking? Islamic banking has been defined in a number of ways. The definition of Islamic banking, as approved by the General Secretariat of the OIC, is stated in the following manner. An Islamic bank is a financial institution whose status, rules and procedures expressly state its commitment of the principal of Islamic Shariah and to the banking of the receipt and payment of interest of any of its operations(Ali& Sarkar 1995 ). It is therefore, natural and indeed, imperative for an Islamic bank to incorporate in its function and practice commercial investment and social activities, as an institution designed to promote the civilized mission of the Islamic economy (Ibid). Ziauddin Ahamed says, Islamic banking is essentially a normative concept and could could defined as conduct of banking in consonance with the ethos of the value system of Islam

2.4 Conventional banking Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank. 2.5 Riba and its basic features The world used by the Quaran concerning interest is Riba its basic characteristics are: Its must be related to loan A prefixed amount of money to be paied when due A time is fixed for the repayment and All these elements for repayment are taken as condition for loan . 2.6 Riba and Profit When money is charged its imposed positive and defines result is Riba on the other hand profit is the gain of uncertain use of trading By definition, Riba is the premium paid by the borrowed of the lender along with principal amount as a condition for the loan. On the other hand profit is the difference between the value of production. Riba cannot be negative, it can at best be very low or zero. But profit cab be positive zero or even negative. From Islanic shariah profit is view, Riba is Haram but profit is Halal.

3.1 Introduction: In August 1974, Bangladesh signed the Charter of Islamic Development Bank and committed itself to reorganize its economic and financial system as per Islamic Shariah. In January 1981, Late President Ziaur Rahman while addressing the 3 rd Islamic Summit Conference held at Makkah and Taif suggested, "The Islamic countries should develop a separate banking system of their own in order to facilitate their and commerce." This statement of Late Ziaur Rahman indicated favourable attitude of the Government of the People's Republic of Bangladesh towards establishing Islamic banks and financial institutions in the country. Earlier in November 1980, Bangladesh Bank, the country's Central Bank, sent a representative to study the working of several. In November 1982, a delegation of IDB visited Bangladesh and showed keen interest to participate in establishing a joint venture Islamic bank in the private sector. They found a lot of work hand already been done and Islamic banking was in a ready form for immediate introduction. Two professional bodies Islamic Economics Research Bureau (IERB) and Bangladesh Islamic Banker's Association (BIBA) made significant contributions towards introduction of Islamic banking in the country. They came forward to provide training on Islamic banking to top bankers and economists to fill-up the vacuum of leadership for the future Islamic banks in Bangladesh. Islamic Bank Bangladesh Led (IBBL) which was incorporated on 13 March 1983 as a Public Company with limited liability under the Companies Act 1913 started functioning with effect from 30 March 1983. IBBL is considered to be the first interest-free bank in South East Asia. It is a joint venture multinational bank with sixty two percent of equity being contributed by the foreign sources. Regarding shareholdings structure of the bank, the local shareholders hold shares in the ratio of thirty-eight to sixty two. In December 1999 the number of its shareholders stood at 6863. Its shares are quoted in the two stock markets of the country namely Dhaka Stock Exchange and Chittagong Stock Exchange. Being in high demand the shares are presently sold at three times higher than the face value. Authorized capital of IBBL in Tk. 500 million as on 31 December, 1999. It has a paid-up capital of Tk. 320.00 million and Reserve Fund of Tk. 930.17 million. The Bank is managed by a 24 member Board of the Directors, among them 8 are foreigners and 16 are local. A9 member Executive Committee formed by the Board of Directors oversees the efficient operation of the Bank. Besides, a Management Committee looks after the affairs of the Bank. IBBL has also a 10-member Shariah Council consisting of prominent Islamic Scholars and jurists, a reputed banker, a renewed lawyer and an eminent economist. The Council gives decision on different issues confronting the Bank on Shariah matters. They also conduct Shariah inspection of branches on selective basis so as to ensure that the Shariah principles are implemented a

complied with meticulously by the branches of the Bank. IBBL through its steady progress and continued success has, by now, earned the reputation of being one of the leading private sector banks of the country. 3.2 Its Mission To establish Islamic banking through the introduction of a welfare oriented banking system and also ensure equity and justice in the filed of all economic activities achieve balanced growth and equitable development through diversified investment operations particularly in the priority sectors and less developed area inn the country.

3.3 Its vision IBBL vision is to always strive achieve superior finance performance be considered a leading Islamic Bank by reputation and performance. IBBL goal is to establish and maintain the modern banking technique. IBBL encourage will try to saving in the form of direct investment. IBBL will also try to encourage investment particularly in project which are more likely to lead to higher employment.

Chapter 5
Investment Mechanism of Islami Bank Bangladesh Limited

Definition of Investment and Investment Mechanism

Investment is the action of deploying funds with the intention and expectation that they will earn a positive return for the owner. The establishment of a factory or the purchase of raw materials and machinery for production purposes are examples in point. The savings of investors in financial assets are invested by the respective company into real assets in the form of the expansion of plant and equipment. When money is deposited with an Islamic Bank, the Bank, in turn, makes investments in different forms approved by the Islamic Shariah with the intent to earn a profit. Not only a Bank, but also an individual or organization can use Islamic modes of investment to earn profits for wealth maximization. In addition to that, the paid up capital of the shareholders also remains with the bank. Basically, Islamic Bank Bangladesh Limited receives these funds on profit-loss sharing basis & deploys the same in the profitable business.

The Major Investment Mechanisms of Islami Bank Bangladesh limited is as under:5.1 Bai-Mechanism 5.2 share- Mechanism 5.3 Isarah-Mechanisms 5.1 Bai-Mechanism 5.1.1 Bai-Muazzal 5.1.2 Bai-Murabaha 5.1.3 Bai-Salam 5.1.4 Bai-Istisna 5.2 share- Mechanism 5.2.1 Mudaraba 5.2.2 Musaraka 5.3 Isarah-Mechanisms 5.3.1 Isarah/ Leasing 5.3.2 Hire purchase 5.3.3 Sirkatul meelk/ Hire purchase under sirkatul meelk.

5.1.1 Bai-Muazzal 5.1.1.1 Meaning of Bai-Muazzal

The term Bai-Muazzal means to sell on credit. If a person the Arabic word Azal means to keep adjourned, to defer or to conduct repayment on a fixed future date. Bank always sells the commodities adding mark up profit with the purchase price thereof. The difference amount between purchase price & sell price is considered as profit.

5.1.1.2 Important features of Bai-Muazzal

1. It is permissible in most cases. 2. It is permissible to make the promise binding upon the client to purchase the goods from the bank. 3. It is permissible to take cash/collateral security to guarantee the implementation of the promise. 4. It is also permissible to document the debt resulting from Bai-Muazzal by a Guarantor. 5. Stock and availability of goods is a basic condition for signing a Baiagreement. Muazzal

6. All goods purchased on behalf of a Bai Muazzal agreement are the responsibility of the bank until they are delivered to the client. 7. The bank must deliver the goods to the client at the time and place specified in the contract. 8. The bank may sell the goods at a higher price then the purchase price to earn profit. 9. The price is fixed at the time of the agreement and cannot be altered.

5.1.1.3 Some observations.

The following steps may be taken to ensure the Bai-Muazzal investment is a good proposition for the bank: 1. The bank may meet with the prospective client regarding his investment needs and business experience. 2. The bank may review the clients past performance and other financing arrangements. 3. The bank may review its current investment policy regarding this type of financing arrangement to ensure the proposal meets bank guidelines.

The following points should receive attention before making any investment decision under Bai-Muazzal.
1. 2. 3. 4. Whether the goods that the client intends to purchase are marketable and have steady demand in the market. Whether the price of the goods is subject to frequent and violent changes. Whether the goods are perishable in short or in long-term duration. Whether the quality and other specifications of goods as desired by the client can be ensured.

5.1.2 Bai-Murabaha 5.1.2.1 Meaning of Bai-Murabaha Murabaha Mutlak: - Bai Murabaha is a sale at a cost plus agreed upon profit.
Under this system goods may be delivered to the client against cash payment or deferred payment. In this system, it is not essential to show the purchase price & mark up profit separately, nor is it required to get the client informed of the mark up profit.

Murabaha Mutlak may be of two types:(a) Ordinary Bai-Murabaha (b) Bai-Murabaha on order and promise 5.1.2.2 Basic Features of Bai-Murabaha:

(1) It is permissible for the client to offer an order to purchase by the bank particular goods (2) It is permissible to make the promise binding upon the client to purchase from the bank. (3) It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify the damage. (4) It also permissible to document the debt resulting from Bai Murabaha by a Guarantor. (5) Stock & availability of goods is a basic condition for signing a Bai Murabaha agreement. (6) The bank must deliver the specified goods to the client on specified date and specified place of delivery as per contract. (7) The price once fixed as per agreement & deferred can not be further increased.

5.1.2.3

Procurement of goods by the bank:

Bai-Murabaha is perfectly a legitimate transaction according to Islamic shariah, provided:-

(a) The goods desired by the client are first purchased by the bank & ownership of the bank on the goods is established, i.e. the bank must transform its money into goods. (b) That after purchase of goods the risk of the same is borne by the bank until the possession of the merchandise has been passed on to the client. (c) That the specification of goods, delivery dates, time and place as well as other terms of contract are ensured.

In such situation, in order to make the Bai-Murabaha transaction Halal the following procedures shall have to be adopted:
(1) Purchase of goods shall be made only after completion of all the documentation formalities. (2) Bai-Murabaha goods may be purchased & the bank may take delivery of the same directly from the market (3) In the case of cash purchase & taking delivery of the goods by the Banks Authorized Official. (4) In the case of purchase of Bai-Murabaha goods by the bank on credit/deferred payment basis, the bank shall execute a Credit Purchase Agreement. (5) In the case of purchase of goods by the agent engaged for the purpose, he will purchase the goods from the genuine producers, sellers or suppliers in the local or outstation market.

5.1.2.4

The conditions of Affecting Bai-Muazzal & BaiMurabaha:

The Islamic scholars have approved the system of Bai-Muazzal & BaiMurabaha subject to following terms & conditions:(1) The ownership as well as possession of the goods must remain with the bank before selling the same to the client. The bank will have to bear the risk of the goods until the same is delivered to the client. (2) After procurement of the goods and acquiring ownership thereon, the bank is required to bear the risk of theft, damage and breakage etc. until the same delivered to the client buyer. (3) At the time of execution of the sale-purchase agreement the nature, specification, quantity and quality of the goods. (4) Once the price is fixed under Bai-Murabaha or Bi-Muazzal mode, then no option will be there to change the same. (5) The process of buying as well as selling in Bai-Murabaha & Bai-Muazzal system is very easy, risk involvement is also comparatively low & good potentiality is there to earn good profit.

5.1.3 Bai-Salam 5.1.3.1 Meaning of Bai-Salam

Bai-Salam is a term used to define a sale in which the buyer makes advance payment, but the delivery is delayed until some time in the future.

The Bai-Salam sales serve the interests of both parties.

(1) The seller receives advance payment in exchange for the obligation to deliver the commodity at some later date. (2) A Bai-Salam agreement allows the purchase to lock in a price, thus protecting him from price fluctuation.

5.1.3.2

Steps if Bai-Salam.

(1) Cash sale or sale on credit (2) Delivery and receipt of the commodity a) The bank may receive the commodity b) The bank may direct the seller to deliver the commodity directly. (3) The sale contract

5.1.3.3

Rules of Bai-Salam/the conditions of affecting Bai-Salam

1) It is a condition that the commodity known by both parties to the agreement. 2) It is a condition that the quality of the commodity be monitored closely, as very little variation from specifications in the contract is allowed. 3) It is a condition that the commodity is delivered on the due date. 4) It is permissible to draw a Salam sale contract for a total to be delivered increments on different specified future dates. 5) Salam is impermissible on land lots and real estates 6) It is a condition that the purchase price in Salam is specified and advanced to the seller. 7) It is a condition in a Salam sale that the due date is known to avoid confusion, which may lead to a dispute. 8) It is a condition that the place of delivery be stated in the contract. 9) It is permissible to take a mortgage on Salam debt to guarantee that the seller satisfies his obligation by delivering the commodity on the due date.

5.1.4 Bai - ISTISNA 5.1.4.1 Definition of Bai Istisna

The bai-istisna is a contract in which the price is paid in advance at the time of the contract and the object of sale is manufactured and delivered later (IDB 1992, P.28). The jurists of the Hanafie School have given various definitions to Istisnas some of which are: That it is a contract with a manufacturer to make something and It is a contract on a commodity on liability with the provision of work. Islamic banks can utilize Istisna in two ways.

1) It is permissible for the bank to buy a commodity on Istisnas contract then sell it after receipt for cash or deferred payment. 2) It is also permissible for the bank to enter into a Istisnas contract in the capacity of seller.

5.1.4.2 Steps of Bai-Istisna. Bai-Istisna Contract: The buyer expresses his desire to buy a commodity and brings
a request to purchase the commodity to the bank.

5.1.4.3 Rules if Bai-Istisna.

1) It is a condition in the Istisna contract to clearly define dimensions and specifications of the product being purchased. 2) The Istisna contract is only used for objects that can be manufactured. 3) The object sold in a Istisna contract is a fixed liability debt. 4) The maker should supply the materials. If they are supplied by the buyer, the contract is Ijara and not Istisna. 5) Once the contract is drawn the ownership of the asset is confirmed to the buyer. 6) It is not a condition in the Istisna contract to advance the price. 7) It is a condition that the time of delivery be specified in the agreement to avoid confusion. 8) It is a condition that the place of delivery be stated in the contract.

5.2 Share-Mechanism 5.2.1 Mudarabah 5.2.1.1 Mudarabah Mechanism:

Mudarabah is considered to have the basic investment mechanism of Islamic banking. Islamic banks mobilize as well as deploy its fund through Mudarabah principle. In Mudarabah investment, Islamic banks provide fund as the Sahibul Maal & the entrepreneur as the Mudarib deploy its labor, time, expertise, skill & management to run the concern. If profit is earned, then the same to be distributed between the both parties as per pre-agreed ratio. As per shariah principle, Islamic banks can not intervene in the activities of the entrepreneur/mudarib, but it deserves the right to supervise the performance of the entrepreneur/mudarib as to whether the same is being accomplished as per agreement. In the case of term Mudarabah investment the duration of the enterprise/concern is fixed & on fulfillment of the term/duration, the agreement expires resulting the termination of the concern as well as distribution of profit as pre-agreed ratio. Entrepreneur/mudarib invests Mudarabah fund in the specific concern/sector/project as per agreement & on fulfillment of the business as well as term the agreement.