BUS426

Introduction to Islamic Banking and Finance

Suzanna El Massah

Lecture (4)

Introduction to Islamic Finance

Source: Kettell, Brian B. Introduction to Islamic
Banking and Finance, John Wiley & Sons, 2011.

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 Continue: Topic #1
Week 1 and 2
The origins and framework of
Islamic Finance and banking
Source: Kettell, Brian B. Introduction to Islamic
Banking and Finance, John Wiley & Sons, 2011.
 Chapter 2 and 3

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 Learning Objectives
Upon the completion of week1 and 2, students
should be able to:

1. Understand the components and operating

structures of the Islamic banking and finance
industry

2. Understand and analyze Riba in Islam

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 What are the products offered by Islamic
Islamic Banking?

 Islamic banking products are financial tools

through which the financial institutions carry out
business
 Shari’ah based vs Shari’ah compliant.

 (Innovation aspect)..Emphasis should be on

developing Sharī‘ah-based
 rather than Sharī‘ah-compliant financial products

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Who/what are the Actors/components
of Islamic Finance Industry

3- Islamic
1- Islamic Capital
2- takaful markets &
operators banks Sukuk
arrangers

Islamic
Islamic crowd
finance
funds funding
education

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Components of Islamic Finance Industry

1. Islamic banking instead of conventional banking

Learning Objective 4
Understand the
components and operating
structures of the Islamic

2. Takaful instead of Insurance banking and finance

industry as well as the
process of development of
Islamic finance products.
3. Islamic capital markets instead of capital
markets

4. Islamic non-bank financial institutions

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 1- Islamic Banking

 What is BANK???
 Financial intermediate from surplus to shortage
 The Islamic banking component:
 Deposit-taking and finance of institutions to meet needs
of Muslim customers and investors
 Provide commercial services complies with Shari’ah
 May be:
- Fully fledged Islamic banks “example: ….
- ‘Windows’ of conventional banks “example: Amana-
Al Baraka.

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National Commercial Bank Islamic Window KSA

Al Rajhi Bank Full Islamic KSA

Bank Maskan Full Islamic Iran

Kuwait Finance House Full Islamic Kuwait

Bank Melli Iran Full Islamic Iran

Amislamic Bank Berhad Full Islamic Malaysia

Maybank Islamic Berhad Full Islamic Malaysia

Dubai Islamic Bank Full Islamic UAE

Bank Kerjasama Rakyat Malaysia Berhad  Full Islamic Malaysia

Bank Saderat Iran Full Islamic Iran

Abu Dhabi Islamic Bank Full Islamic UAE

Qatar Islamic Bank Full Islamic Qatar

Al Baraka Banking Group Full Islamic Bahrain

CIMB Bank Berhad (Islamic) Full Islamic Malaysia

Islamic Development Bank Full Islamic KSA

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 Masraf AL Rayan Full Islamic Qatar

Standard  Chartered  Bank  Malaysia  Berhad  Full Islamic Malaysia

(Saadiq)
Alinma Bank Full Islamic KSA

Bank Aljazira Full Islamic KSA

Bank Sepah Full Islamic Iran

Parsian Bank Full Islamic Iran

Bank Islam Malaysia Berhad Full Islamic Malaysia

Emirates NBD PJSC Full Islamic UAE

Bank Asya Full Islamic Turkey

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 Key Islamic Banking Principles
1- Predetermined payments are prohibited

2- PLS & risk sharing

3- Importance of productivity & feasibility compared to credit-

worthiness

4- Money is not a commodity, human effort/risk is required to

create G&S

5- Gharar is prohibited: perfect knowledge of counter-values

..rationale?
(prevents Asymmetric Information)
6- Only shari’ah –approved contracts are permitted/holiness of
contracts
(prevents Asymmetric Information)

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 What is Asymmetric Information?
 The information that is known to one party in
the transaction but not to the other.

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 Asymmetric Information in Islamic
banking
 PLS content of Islamic banks contracts contains
asymmetric risk.
 Solution from the Bank side:
 Feasibility study
 Monitoring
 Borrowers reputation/history and profession
 Complete disclosure
 Complete contracts
 Solution from the depositors side:
 Gather information about safety, soundness, riskiness
and profitability of the Islamic bank.


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Injecting Islamic moral economy into
finance and banking>>>>Islamic Finance
Moral screening process
Banking and finance needs
– Moral process through
endogenising substance related
issues and also through
consequentialistic approach;
Shariah sources – Definition of policy objectives
– Quran – Developing risk and profit-loss
– Sunnah sharing economy through
embedded financing for the
– Ijma’ (jurist development of economy and social
consensus) Shariah filter capital
– Qiyas
(analogy) Fiqh al-Muamalaat
contracts
– Ijtihad
(reasoning) – Musharaka - Partnership
– Mudaraba - Partnership
– Murabaha - Purchase-resale
Islamic banking and finance
– Ijara - Lease
solutions
– Istisna’ - Manufacturing
•Prohibition of certain contract
investments: – Salam - Forward sale
• Prohibition on: − Sectors (e.g.: alcohol, • Asset- • Credit and
armaments, financial
• Financing solutions
– Interest services, gambling, backed debt aim capacity building
pork, pornography, transacti products and empowerment of
– Speculation tobacco) ons with are not individuals and
– Gambling − Instruments (e.g. no investm encourage society;
forward transactions, ents in d
limited option use, no • Social, human and

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real,
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economic
selling) development
assets
 RIBA

Quantit
Time y
Factor FACTO
R
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 Types of Riba
Riba al Fadl-
Riba al Nasi’ah  the increase is independent of
postponement or maturity of debt.
 The increase due to Rather
postponement.
 It happens when two same things
are exchanged unequally.
The Holy Prophet (PBUH) treating
these commodities as a medium of
exchange like money, issued the
following injunction:"Gold for gold,
silver for silver, wheat for
wheat, barley for barley, date
for date, salt for salt, must be
equal on both sides and hand
to hand. Whoever pays more
or demands more (on either
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side) indulges in Riba ." 19
 Forbidden Contracts in Islamic
Commercial Transactions
Figure 2.2: Classification of Riba

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 Forbidden Contracts in Islamic
Commercial Transactions
Why the Prohibition of Riba?

Riba is forbidden in Islam due to:

- Economic effects, e.g. keeping money idle and unproductive, adding to miseries
of the poor

 Social effects, e.g., cutting ties; creating enmity and hatred between the poor
and rich; spreading corruption

 Psychological and spiritual effects, e.g., arrogance, hard-heartedness and

exploiting needs of the poor

- On the state level, e.g. losing control over resources and natural wealth

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 Learning Objective 2.4
Analyze the main forbidden
contracts in Islamic
commercial transactions

Views of Bank Interest

 Traditional View: Bank Interest constitutes riba as
it resembles riba al-nasi’ah

 Liberal View: Bank interest is not riba. It

represents one’s dividends for depositing money in
bank accounts

 Most Convincing Position: The majority of jurists

and Muslims believe bank interest is equivalent to
riba

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 5 Riba-ban reasons:
Unfair

Demeans
human Corrupti
personalit on
y

Harming
Negativ
property
e growth
rights

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