ISLAMIC BANKING INTRODUCTION, BACKGROUND

AND GLOBAL SCENARIO

HISTORY OF MODERN ISLAMIC BANKING
 Cooperative banks in the sub-continent:
 Cooperatives in Hyderabad Dakan (1940s).
 Cooperative bank in Karachi (1950s).

 Pilgrimage fund in Malaysia (1950s) full-fledged bank in 1967.

 Saving bank in Mit Ghamr, Egypt (1963).

 Nasr Social Bank, Egypt (l97l), was created as an interest-free

commercial bank.

 Dubai Islamic Bank. (1974)

 Islamic Development Bank. (1974)

 Dar-al-mal-al-Islami (DMI), Geneva, established in 1981.

 Islami Bank Bangladesh Limited (IBBL) the first interest free bank in
Southeast Asia was incorporated in 1983.
HISTORY OF MODERN ISLAMIC BANKING
 In 80s different initiatives were taken in Pakistan, Iran & Sudan.

 In 80s Islamic Mutual funds & Mudarabah companies started to emerge.

 In 90s AAOIFI, Harvard Islamic Finance Forum, Dow Jones Islamic Index
were established.

 In 2000-10, several Islamic Bonds (sukuks) were issued.

 Key infrastructure institutes were established including:

 IFSB, IIRA (Islamic Rating Agency), CIBAFI, ARCIFI.AAOIFI.

 Recognition by IMF, World Bank and Basel Committee.

 Diploma programs, Graduate/Post graduate & doctorate degrees are

being offered in Islamic banking by major academic institutions (CIMA,
INCEIF, Durban University, IBA, IIBI-UK and several other universities ).
 ISLAMIC BANKING – GLOBAL PERSPECTIVE

 600+ Islamic financial institutions

 Commercial Banks – 300 above.

 Number of Islamic Funds – 1,065 above.

 Total Islamic Banking Assets ~ USD 1.8 Trillion

 Number of Islamic Mutual Funds – 786 above.

 Global Islamic Mutual Funds – USD 46 billion above.

 Establishment of Islamic indices (Dow Jones, FTSE, KMI-30 etc.).

 Over 40 Shari'ah & Accounting Standards for Islamic financial institutions (by
AAOIFI)

 2009-13 global CAGR 17.6%

 Forecasted CAGR of 19.7% for 2014-18

 Global IF Hubs (London, Bahrain, Malaysia, UAE).

GLOBAL ISLAMIC FUNDS
TRANSITION – OVER THE YEARS
WINDOWS OF ISLAMIC BANKS

Source: Thomson & Reuters

 ISLAMIC BANKING – GLOBAL
PERSPECTIVE
 International Groups  Many foreign banks now
have Islamic windows.
 DMI
 Citibank
 Al Baraka
 ANZ
 Al Rajihi  RBS
 Kuwait Finance House  Goldman Sachs
 Noor Financial  Hong Kong Shanghai
 Abu Dhabi Islamic bank bank
 In Pakistan  Saudi American bank
 Meezan Bank  Saudi British Bank
 Al Barakah  UBS AG
 Dubai Islamic
 Bank Islami
 Burj Bank
 Summit Bank
 DEVELOPMENT IN CAPITAL MARKET:
 UK will become the first non-Muslim country to launch Islamic bonds
called Sukuk, also plans to launch an Islamic index at LSE.

 Dubai, Kuala Lumpur and London are considered as a Hub of Islamic

Finance and are also rapidly growing Islamic financial and capital
markets.

 Sukuk has been recognized globally as a Capital market(secondary

market) financial Instrument .
 ISLAMIC BANKING - A SUCCESS
STORY

 More than 75 countries have ISLAMIC BANKING Institutions

 Approx. 45 Muslim countries including Kuwait, Dubai, Saudi

Arabia, Iran, Malaysia, Brunei and Pakistan.

 Approx 30 non-Muslim countries including USA, UK, Canada,

Switzerland, Srilanka, South Africa and Australia.
 ISLAMIC BANKING - A SUCCESS
STORY

 Different types of IFIs have emerged globally

 Islamic Commercial Banks

 Islamic Investment Banks

 Islamic Units of conventional banks

 Islamic Funds

 Islamic House Financing Schemes

 International Financial Market

 International Institutions of Islamic Banking

 GLOBAL BODIES FOR ISLAMIC
BANKING

AAOIFI

IFSB

IIRA

CIBAFI
 AAOIFI
Accounting & Auditing Organization
of Islamic Financial Institutions

An Umbrella organization for Islamic banking

 AAOIFI – BRIEF INTRODUCTION

 Established on 1 Safar, 1410H (26th February 1990).

 AAOIFI is headquartered in Bahrain.
 Entrusted with the task of developing for IFIs:
- Shariah Standards
- Accounting Standards
- Auditing Standard
 Has published standards for all major modes of Islamic Finance.
 In Pakistan, AAOIFI standards are being adapted through ICAP’s
Committee(IFAS-1,IFAS-2,IFAS-3).
 Total Members are 122 Islamic Financial Institutions from 29 countries.
 AAOIFI – SHARIAH BOARD
A host of world renowned Shariah Scholars.
1. Shaikh Muhammad Taqi Usmani/Chairman (Pakistan)
2. Shaikh Abdullah Sulaiman Al Manea/D.Chairman (KSA)
3. Shaikh Ajeel Jaseim Al-Nashmi (Kuwait)
4. Sheikh Al Ayashi Al Saddiq Faddad (KSA)
5. Shaikh Abdel Sattar Abu Ghuddah (KSA)
6. Shaikh Nizam Yaquby (Bahrain)
7. Shaikh Ahmad Ali Abdullah (Sudan)
8. Shiekh Dr Hussein Hamid Hassan (Dubai/UAE)
9. Sheikh Waleed Bin Hadi. (Qatar )
10. Shaikh Dr. Mohamed Ali Al Qari. (KSA)
11. Shaikh Dr. Esam 'Anezi.( Kuwait)
12. Shaikh Dr. Saleh Abdullah Al-Lihaidan.(KSA)
13. Sheikh Aflah Alkahalili.( Oman)
14. Mr. Abdulla Bin Humood Al Ezzi.(Yemen)
15. Dr. Khaled Al-Fakih.(Bahrain)
16. Sheikh Dr. Abdul Sattar Abu Ghuddah.(KSA)
AN INTERNATIONAL STANDARD-SETTING ORGANIZATION
 The IFSB

 Established in November 2002 .

 Based in Kuala Lumpur.
 An international standard-setting body of regulatory and
supervisory agencies.
 Introduces/adapts existing international standards consistent with
Shari'ah principles.
 To date, it has issued more than 16 Standards, Guiding Principles
and Technical Notes for the IFIs.
 Areas include Risk Management, Capital Adequacy,
 Corporate Governance & Supervisory Review Process.
The Islamic International Rating Agency (IIRA) is the sole rating
agency established to provide capital markets and the banking
sector in predominantly Islamic countries with a rating
spectrum.
 Islamic International Rating Agency

 The Islamic International Rating Agency B.S.C. (IIRA) started

operations in July 2005 to facilitate development of the regional and
national financial markets by delineating relative investment or credit
risk, providing an assessment of the risk profile of entities and
instruments.

 This should be an integral part of the decision process employed by

institutional investors.

IIRA is structured in a way to preserve its independence. It has a

Board of Directors and a completely independent Rating Committee.
The General Council for Islamic Banks And Financial Institution
(CIBAFI) was established in 2001, its founding began by the
Islamic Development Bank on July 10, 1999.
 General Council for Islamic Banks And
Financial Institution

CIBAFI is the official umbrella for all Islamic financial institutions

that comply their services and products with Islamic Shari'ah.

 The aim of CIBAFI is to develop the Islamic financial industry and

protect it in various fields such as training and human resources
development, information and financial analysis, consultancy,
information and awareness.
 ISLAMIC BANKING – RECOGNITION &
APPROVAL

 Various International Fiqh bodies like:

 International Islamic Fiqh Academy – Jeddah .

 Nadwah al-Barakah .

Have declared all sort of banking interest as Riba & prohibited

and have approved resolutions on various products of Islamic
banking.
 ISLAMIC BANKING – IN PAKISTAN

“We must work our destiny in our own way and present to
the world an economic system based on true Islamic
concept of equality of manhood and social justice.

Speech at the opening ceremony of State Bank of Pakistan, Karachi

July 1, 1948
 ISLAMIC BANKING – IN PAKISTAN

History
1947 Pakistan Resolution.
1949 Objectives Resolution.
1962 Creation of Council of Islamic Ideology (CII) in 1962.
1979 Pakistan adopted a policy of gradual transformation of its banking
system.
1980 A 15 member committee of CII prepared a report on elimination of
banking & commercial interest from Pakistan and outlining the
Islamic modes of financing.
1980 Introduction of zakat system.
1983 Introduction of Ushr system.
1985 Introduction of mark-up based financing system in banks.
1991 Federal Shariat Court (FSC) Declared mark-up procedure un-Islamic.
 ISLAMIC BANKING – IN PAKISTAN

1999 Shari'ah Appellate Bench of Supreme Court rejected all appeals against
the previous and called for the establishment of an interest free
financial system.

2002 Meezan Bank established as Pakistan’s first Commercial Islamic

Bank.

2002 Establishment of Islamic Banking Department at SBP.

2007 Adapted Accounting Standards for Murabaha.

2008 SBP issue Instruction & Guidelines for Shari'ah Compliance in Islamic
banks.

2008 Government of Pakistan issue Ijarah based sukuk to finance its needs.

2010 6 Full fledged Islamic banks & 14 Islamic banking windows were
operating and have over 5% market share in a very short span of time

And since then there is no looking back.

 ISLAMIC BANKING - IN PAKISTAN

2011 Introduced landmark changes in the legal framework that

included amendment in the Banking Companies Ordinance,
enactment of Mudarbah companies and Mudarabahs
framework.
2012 Pool management guidelines are issued by SBP(Profit
equalization reserve rules are described and profit Hiba
guidelines are issued by SBP).

2013 IFAS-3 on Profit on loss distribution issued by SECP.

2014 State Bank of Pakistan has launched a Five year strategic

plan………
 ISLAMIC BANKING – IN PAKISTAN

CURRENT STATUS

 Legal framework in place, licenses available for:

 Islamic commercial bank.

 Islamic Subsidiary of a conventional bank.

 Stand alone Islamic branches of a conventional bank.

 Legal framework hybrid of Bahrain and Malaysian model.

 ISLAMIC BANKING – IN PAKISTAN
Steps Taken for promotion
 Shari'ah Board established at SBP and SECP.

 Islamic products available to cover 85% of the services offered by

conventional banks.

 Shari'ah compliant export refinance scheme launched.

 Model agreements for products developed by IBD of SBP.

 Shari'ah Audit/Compliance manuals have been developed.

 Various training courses and degree programs at universities.

 Tax laws are being rationalized to avoid double taxation of IFIs.

 Murabahah (IFAS-1), Ijarah(IFAS-2)and Profit & loss distribution

standards(IFAS-3) are issued by ICAP.

 Strategic Plan by SBP for 2013-2018.

 ISLAMIC BANKING – IN PAKISTAN
Steps Taken for promotion

 Adoption of Key AAOIFI Shari'ah Standards as part of Regulations

 Three New Accounting Entries for Islamic Modes of Financing

 GoP Ijarah Sukuk issued over Rs. 500 Billion

 Specific Pool Management Guidelines for IBIs by SBP

 Work under process for Islamic Discount window, Islamic

benchmark and Islamic LLTF scheme

 ISLAMIC BANKING – IN PAKISTAN
 Full Fledged Islamic Banks

 Meezan Bank .

 Al-Baraka Bank Pakistan Limited .

 Dubai Islamic Bank.

 Bank Islami Pakistan.

 Burj Bank.

 Many conventional banks operating Islamic Banking Branches: Faysal

Bank, Summit Bank, Bank of Khyber, MCB, Bank Alfalah, Habib Metro Bank,
Bank Al Habib, Standard Chartered Bank, Soneri Bank, HBL, UBL, Askari
Bank, Allied Bank, NBP ,Silk Bank, Sindh Bank– as they have accepted the
reality and difference of Islamic banking.
 ISLAMIC BANKING – IN PAKISTAN

 Branch network of IB participants – 1,314

 Asset base of IB – Rs. 1016 billion

 Deposit base of IB – Rs. 872 billion

 Share of assets of IBI in the overall Banking Industry – 9.4%

 Share of deposits of IBI in the overall Banking Industry-10.7%

 Share of IBI in Net Financing & Investment the overall Banking

Industry-7.6%

 Total Islamic Banking Institutions - 20

As of March 2014; SBP Bulletin
What distinguishes Islamic banking
from
conventional banking?
 OBJECTIVES OF ISLAMIC BANKING
 Just and Equitable Distribution & Circulation of Wealth in the
society.
 Avoid all Impermissible transactions:
Riba (Riba Al Nase’ah / Riba Al Fadhl).
Maysir (Gambling) .
Gharar (Uncertainity).
Al Jahalah(Ignorance).
Bai Qablal Qubz etc.
Uqood-e-Fasida.
Bai-ul-kali bil Kali(subject matter and price both deferred).
 Promote participatory based & asset Backed Financing.
 Fulfilling Halal Customer Needs.
 Ensuring Shari’ah Compliance in all transactions.
 To provide an alternate for Interest based banking.
 Stop exploitation of Necessities.
 DISTINGUISHING FEATURES

We find the differences are on three levels:

1. Conceptual & Socio-religious level:

- not money lenders.

- cannot deal with interest & non permissible industries .

2. Business model & Governing framework:

- IBI actively participates in trade and production process as a

supplier, customer or investor.

- Governing framework in terms of Shariah Advisor &/or SSB.

 DISTINGUISHING FEATURES
3. Product Level Implementation

- usually asset backed & involve trading/renting of asset &

participation on profit & loss basis.

- Implementation is not just a mere change of paper work

and terms but it involves.

- having the right intention,

- the correct sequence of steps and timing of execution .

Without a clear understanding of these differences some people

even experts tends to makes a common mistake of equating
Islamic banks as just another bank with mere change of name.
 IFI TARGET MARKET MISCONCEPTIONS:

 The needs of the people are same that’s why Islamic financial
institution products economic reality looks similar to the conventional
counterparts.

 The target market available for Islamic financial institution is same

as conventional counterparts e.g. corporate needs, consumer needs
etc.

 Islamic Banks have the good product range available for the un
tap agriculture industry such as Muzariat etc. Agriculture is the 70% of
the GDP of Pakistan's economy.
 WHAT DISTINGUISHES ISLAMIC
BANKING
Islamic banking Conventional banking
 Transactions are asset-  Transactions are money
based/backed. lending and Riba based.
 It is socially-responsible banking  Involve in many impermissible
because it operates under transactions like Short selling,
Shari’ah restrictions. Sale of Debt, Speculation,
artificial financial transactions,
no sanctity for Islamic law of
contract.
 Does not permit financing of  Permit financing of prohibited
prohibited goods / Industries. goods / Industries like alcohol,
casinos etc.

 Ethics and moral values play a

major role in investment  A matter of choice.
decisions. Not a choice but a
must.
 PROHIBITION OF RIBA IN QURAN

Al Baqarah 275

“Those who devour Riba shall rise up before Allah like men whom Shaitan has
demented by his touch; for they claim that trading is like Riba. But Allah has
permitted trading and forbidden Riba. He that receives an admonition from his
Rabb and mends his ways may keep what he has already earned; his faith is in
the hand of Allah. But he that pays no heed shall be among the people of fire and
shall remain in it forever.”
 PROHIBITION OF RIBA IN AHADITH

Al Baqarah 278 - 279

“O you who believe, Fear Allah and give up what remains of your demand
for Interest, if you are indeed a believer. If you do not, then you are
warned of the declaration of war from Allah and His Messenger; But if you
turn back you shall have your principal: Deal not unjustly and you shall not
be dealt with unjustly.”
 PROHIBITION OF RIBA IN AHADITH

From Hazrat Jabir Ibn-e-Abdullah (RA):

The Prophet, peace be on him, cursed :

 The receiver and the payer of interest,

 The one who records it and,

 The witnesses to the transaction,

and said: "They are all alike [in guilt]."

(Muslim, Tirmidhi and Musnad Ahmad)

BASIC DIFFERENCE BETWEEN ISLAMIC
& CONVENTIONAL MODES OF FINANCE

Conventional System

money
Bank Client
money + money (interest)
Whereas Allah has permitted trading

and forbidden Riba

BASIC DIFFERENCE BETWEEN ISLAMIC
& CONVENTIONAL MODES OF FINANCE

Islamic System

Bank Goods &

Client
Services

Money (Price)
 DEFINITION OF RIBA

Every Debt that pulls any kind of gain is Riba

Masnad ul Haris / Zawaid ul Haithmy Page 500 vol 3

 KEY MISCONCEPTIONS

“Some people claim that there is No concept of banking in

Islam”

 The use of the word banking does not make any

institution halal or haram, rather it is the underlying scope &
nature of activities that are being conducted which makes it
halal or haram.

 Concept of banking based on pooling of excess funds of

depositors and channeling them towards those who require
it for investing activities is not only approved but encouraged by
Islam.

 But the concept of lending and borrowing on the basis of

interest is not allowed in Islam.
 SUBSTANCE OVER FORM:
 When there is a conflict between economic reality and legality
of the transaction the economic reality will prevail.(IASB)

 The economic reality of Islamic banking transaction is trading

rather than lending and the legal form is also Shari’ah compliant.

 Shari’ah Scholars are inclined towards the hiyat (formation)of

the subject matter for example fermentation of fruit pulp at first
stage we get wine(Haram) on second stage we get vinegar(Halal).
 KEY MISCONCEPTIONS

“Islamic banking looks the same as conventional

banking”

 The validity of a transaction does not only depend on the

end result but rather the steps followed in reaching the end.

 A McDonald’s burger in USA and Pakistan looks the same and

has the same taste and smell but the former is haram and the
latter is halal due to its compliance of Islamic guidelines of
slaughtering animals.

 Same is also true for Islamic and Conventional banking. Former

is halal being based on Islamic principles while latter being
based on interest is haram.
 KEY MISCONCEPTIONS

“A fixed rate of return is not permitted under Islamic

Shariah”

Fixed return does not make a transaction halal or haram.

For example:

 Profit on trading.

 Rent on property.
 KEY MISCONCEPTIONS

“Can Interest rate be used as a Benchmark?”

 Using Interest Rate benchmark for determining the profit in

halal transactions does not render the transaction as invalid
or haram.

 The nature of transactions determines the validity of the

transaction.

 For example Liter is the same measure for milk and petrol.
 KEY MISCONCEPTIONS

“Murabaha sale is a border line transaction”

 The Holy Quran says “And Allah has permitted trade”. (2:275)

 It is further mentioned “ But let there be among you traffic and trade by
mutual goodwill”. (4:29)

 According to Imam Shafi in Al-Umm: “If an individual shows another a good

and says: buy this, and I will give you this much profit in it; and then the
second man buys it then the purchase is valid. If the first party said: I will
give you this much profit in it , but I retain an option, then he may conclude
the sale or leave it.”(See Financial Transactions in Islamic Jurisprudence
Vol1 Pg 361)
 KEY MISCONCEPTIONS

“What is the ruling on pledging a security?”

 The contract of pledge is binding on the debtor who provides it, even if the
asset so pledged is not possessed by the creditor.

 Pledges derives their legitimacy from the following Qura’nic verse: “if ye
are on a journey, and cannot find a scribe, a pledge with possession (may
serve the purpose)”.(Bqarah V283)

 And the practice of the prophet (peace be upon him) since it is known that
the prophet (Peace be upon him) died while his shield was still held as
security for a mortgage.(Bukhari 3/1068).

 Moreover a pledge encourages performance and thus prevents the

contract from being breached. And this security also justifies its legitimacy.

(Adapted from AAOIFI Shariah Standards)

 WHY INTEREST/ RIBA PROHIBITED

Imam Al-Ghazali pointed this out 900 years ago in the following
words:
"Riba (interest), is prohibited because it prevents people from undertaking
real economic activities. This is because when a person having money is
allowed to earn more money on the basis of interest, either in spot or in
deferred transactions, it becomes easy for him to earn without bothering
himself to take pains in real economic activities. This leads to hampering the
real interests of the humanity, because the interests of the humanity cannot
be safeguarded without real trade skills, industry and construction.”

Al-Ghazali, Ihya’ul’uloom, as cited by Qal’awi, Al-Masarif-al-

Islamiyyah p. 52, Syria 1998
 WHY INTEREST/ RIBA PROHIBITED

This aspect of interest has been criticized even by many modern

economists. For example, James Robertson writes:

“The pervasive role of interest in the economic system results in the

systematic transfer of money from those who have less to those who have
more. Again, this transfer of resources from poor to rich has been made
shockingly clear by the Third World debt crisis…. When we look at the money
system that way and when we begin to think about how it should be
redesigned to carry out its functions fairly and efficiently as part of an
enabling and conserving economy, the arguments for an interest-free,
inflation-free money system for the twenty-first century seems to be very
strong.”

James Robertson, Future Wealth: A New Economics for the 21st

Century, p. 130, 131, Cassell Publications,
London 1990
 ARTIFICIAL ECONOMY & INFLATION

 Financial derivatives have grown to USD 1,200 trillion by 2012 i.e. 20

times of the world economy.

 How do you imagine a number that big?

You could say that if you laid all those dollar bills end to end, they
would stretch from here to the sun 1,238 times, or to the moon 485,625
times.

 “Too big to Fail strategy” had not worked because AAA rating from
S&P Financial institution are filled for bankruptcy.
 THE WAY FORWARD

 Islamic banking is a globally accepted reality and a viable

alternative to interest based banking.

 It is ethically & economically better way of banking.

 Its objective are inline with the goal of Islamic Economics

 Islamic alternates of Banking Products can be very effectively

developed for all types of needs

 However, there is a need for more focus research and innovative

product development.

 Ulema, bankers and professionals need to coordinate more

frequently to find solutions.
 THE WAY FORWARD:

 IFIs promotes economic activity results in healthy GDP.

 IIBR the benchmark for IFI has been successfully launched in

different Islamic countries.
THANK YOU