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م� م�ی� �� ر م� ال م ی� ر�� م� ال م� الل ی� م�

م� م�ی� ر� یل م� ا مل ی� س� ر� ملی ر� س� ر�ا ر�� ر�ال س� مل� ر� رال

ر� ی� م! م� اج راصحا� �ر م� مل ما ملی ر� �رم� ی� &� م م� ال ی� ر� ملی ما ن' ر�ا ی� ما م� ی� س( ر! م* ر+ ی� ر, �ر

ر�! ی� م م� ��ا ر ر� ال ر� ی� را ر�ا ر. م/ ر ی� ر� م� ی� س( ر! ر, ر0ا یل ر! یج ر�ای��! م, ما

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Contemporary Islamic BankingIntroduction, Analysis and Recommendations (in Brief)

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The Theme

: بن النعمان حنيفة أبو لي قال قال وكيع عن وحكيبمكة: المناسك في أبواب خمسة أخطأتفي ثابت

أحلقرأسي، أن أردت إني وذلك حجام، فعلمنيها : : : له قلت قد وكنت نعم، قلت أنت أعربي لي فقال

: فيه، يشارط ال النسك فقال رأسي تحلق بكملي فأومأ القبلة، عن منحرفا فجلست اجلس،رأسيمن أحلق أن وأردت القبلة، باستقبال

: رأسك، من األيمن شقك أدر فقال األيسر، الجانب : لي فقال ساكت وأنا رأسي يحلق وجعل فأدرته،

: تريد أين فقال قمتألذهب حتى أكبر فجعلت كبر، : : ما: فقلت وامض، ركعتين صلي فقال رحلي قلت

ومعه إال الحجام هذا مثل من هذا يكون أن ينبغي : : فقال به أمرتني رأيتك ما لك أين من فقلت علم،

هذا يفعل رباح أبي بن .رأيتعطاء

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Table of ContentsA Brief Conceptual Introduction of Conventional Banking

A Brief Statistical Analysis of Conventional Banking

The Basic Theme Underlying Contemporary Islamic Banking

A Statistical Analysis of Contemporary Islamic Banking

The Various Productions of Contemporary Islamic Banking• Murabaha Finance• Diminishing Musharakah Finance• Ijarah Finance• Salam Finance• Istisna Finance• Musharakah Finance• Mudarabah Finance and Mudarabah Account

A Brief Introduction and Analysis of Takaful

An overall comment regarding Islamic Banking and Recommended Approach

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Brief Conceptual Introduction of Conventional Banking

0 Nature: Financial Intermediary0 Functioning:

BANKForeign Trade

Agency Services

Economic Development

Loans & Advances• I• F• G

Entrepreneurship

Income Source

Credit Creation

Local Trade

Deposit Generation• Individual (Household)• Business (Firm)• Govt.

Payment Mechanism

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Main ActivityMain Source of Income

Deposit Generation

Interest Paid by Bank

Loans & Advances

Interest Received by Bank

Banking Spread

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Credit Creation100Deposit

• Loan → 75

7Deposit

• Loan → 56.25

5Deposit

• Loan → 42.19

4Deposit

Actual Deposit = Rs.100

Loans given = Rs.173.44

Total deposits shown = Rs.273.44

Credit Created = Rs.173.44

More Purchasing Power!

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Economic Development

More CreditMore

Purchasing Power

More DemandDemand creates its own Supply

(Keynes)

More Supply More Production

More Employment More Incomes

More Purchasing

PowerMore Demand

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Upward Spiral of Growth

Consumer Finance

Corporate Finance

CreditCredit

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“Economic Development” - food for thought

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Conventional Bank

Financial Supermarket

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A Brief Statistical Analysis of Conventional Banking

Banks of Pakistan Rupees in Millions

Assets as at 31 Dec 2010

6,364,506

Profit for the year ended 31 Dec 2010

81,564

Top 1000 Banks of the World

Amount

Assets (2009) $96.4 Trillion

Profits (2009) $115 Billion

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A Brief Statistical Analysis of

Contemporary Islamic Banking

Worldwide

Islamic Banks Worldwide

Amount

Assets (2010) $895 Billion

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Statistical Analysis of Contemporary Islamic Banking in Pakistan (2010)

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Share of Islamic Banks in the Banking Sector of

Pakistan

Assets 5.06%

Profit 0.37%

Loans and Advances 4.3%

Deposits 5.5%

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Growth in Pakistani Islamic Banks

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Basic Theme Underlying Contemporary Islamic BankingThe Basic Theme is based on the following points:

Belief in Divine guidance

Restrictions imposed by Allah should be recognized

Islamic Finance is Asset-Backed

Return on Capital should be PROFIT not INTEREST

Islam is a complete system of life and therefore it has an alternative for almost all products of CONVENTIONAL BANKING

Without a full fledge government supported system, Islamic Banking might not be able to have a discernable impact on society

Something is better than nothing. A change takes place in stages.

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Various Products of Contemporary Islamic Banking

Alternatives ofLOANS AND ADVANCES

AND MUDARABAH & MUSHARAKAH IS USED AS AN ALTERNATIVE FOR DEPOSIT GENERATION

Murabaha

Diminishing Musharakah

Ijarah

Salam

Istisna

Musharakah

Mudarabah

20Prod

uct M

ix O

ffer

ed b

y Is

lam

ic B

anks

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An Analysis of Murabaha Finance

SELLER BUYERDelivery of goods 10 June (Contract date)Payment of Price 10 JulyPrice = Fixed (Not subject to change)Such a deferred price may be in excess of spot price

A kind of sale → “Cost + Profit” concept

Usually offered for short term finance

Procedure of Murabaha-e-Mua’jjal sale

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Procedure of Murabaha Finance(Master Murabaha Arrangement)IB & Client

sign a commitment

to Sell & Purchase

Agency Agreement

Principal IBAgent Client

CLIENTPurchases the

goods from the market &

takes possession as an agent of IB

IB sells the goods to the

client

Client pays the deferred price at the agreement

time

E.g. ① Purchase of Raw Material ② Commodity Murabaha for Placements with Conventional Banks

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Illustration of Commodity Murabaha0 Purpose: Used to park IB’s funds with Conventional

Banks 0 Procedure:

CB needs Rs. 1

Billion for 1

month

IB has excess fund of Rs. 1 Billion for 1

month

A Broker arranges a deal with a person (Mr. A) with a

warehouse having

goods (e.g. DAP) of

Rs. 1 Billion

Representatives of IB and CB reach the warehouse.

ANDIB purchases

the DAP from Mr. A against a

spot payment of Rs. 1 Billion

and takes possession.

IB offers to sell DAP to

CB against a deferred price of

Rs. 1.066 Billion

payable within a month.

CB accepts

the offer and

takes possession of

DAP

CB sells the DAP to Mr. A against

spot payment of Rs. 1 Billion

and hands over the

possession of DAP

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Points to NotePrice cannot be increased after fixing but a charity can be enforced

Bank must have possession of goods (even though that be constructive and for a very short while)

Capacity of parties must be clear at all stages

A security may be furnished against the credit given. The goods may also be such security

Before purchasing the goods, the client promises to buy the goods from IB. This promise is enforceable

This mode of finance is only available for purchasing goods

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Objections and RebuttalObjections Rebuttal

• Legal Device (ل���) to achieve

predetermined results.

• A perfectly valid sale as per the rules of Shariah

• Desire promotion in society (especially the business sector)

• Desires are already there. We are trying to provide Halaal means for their satisfaction

• ش*� ال��ا • is not present as there is no increase ش*� ال��ا

whatsoever on the loan

• Similarity with those who practice interest based transaction. ( ال��ا م2 اہ (,!ا,�ات

(KIBOR etc.)

• The procedure is very different.E.g. (1) Milk seller & wine seller (2) Tasmiyah alal zabiha (3) Nikah vs. Zina

• Client cannot be an agent as well • Agency of a client is valid. Although it is better to avoid

• It’s a means of finance not sale • Valid, nevertheless. No shariah violation

• Promise to purchase is actually future sale which is Haraam

• Its wordings are vey clear that it is a promise to buy and not a future sale

• Benefit is claimed before possession • There is constructive possession

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Issues Raised on the Rebuttal

Substantially the transaction appears to be a future sale, if any at all, as:• Usually takaful is done on the goods and premiums are paid by client on

behalf of the IB, but those premiums are added to the cost and recovered from client.

• The promise to purchase by the client is legally enforceable

Same economic outcome as that of interest based finance

• Essentially debt finance• Excess being charged• Injustice• Explanation of examples (Zabiha, Nikah, etc.)

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An Analysis of Diminishing Musharakah Finance

CONCEPT: Joint ownership of property and then purchase is installments by one joint owner.

OFFERED as finance to obtain property

PROCEDURE

• IB and client participate in the joint ownership of property, equipment or enterprise

• SHARE of IB is divided into small units of equal value• SHARE of IB is purchased by client unit by unit over a period of time until client

becomes sole-owner.

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Creation of Shirkat-ul-Milk

Promise to take IB’s share on rent by client

Promise to purchase units of IB by client

Share of IB given to

Client on Rent

Purchase of Units at different

Stages over time by Client

under a separate

Sale Agreement

Adjustment of Rental according

to remaining Share of IB

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Example: House Finance

0 House Cost = Rs.6,000,0000 IB’s Share = Rs.3,500,0000 Client’s Share = Rs.2,500,0000 Profit Rate = 16% (KIBOR +

x%)0 Tenure = 20

years0 Unit sale price = Rs.14,5830 Monthly Rent/Unit = Rs.194

Divided into 240 units of land/property

Rent for 1st month = Rs.46,667Payment for 1st month = Rs.61,250Total Rent in 20 years = Rs.5,623,461Total Payment in 20 years= Rs.9,123,381

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Points to Note

Contracts should not be conditional

Purchase of each unit must be separately effected by separate offer and acceptance at that date

No penalty for late payment, but charity may be enforced

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Objections and Rebuttal

Objections Rebuttal

• Same economic outcomeUse of KIBOR for Rent calculation (ظل�)

• Perfectly in compliance with the rules of Shariah

• Conditional contracts are not allowed as per Shariah

• These are no conditional contracts as:

a) Neither contract contains any reference of the other

b) If one contract is not fulfilled the other will not be automatically terminated

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Issues Raised on the Rebuttal��ال: ک�ا ش��!ت ص�ف الفاظ کا نا� ہے؟

Same economic outcome as that of conventional Banking

• �ف کا ل ش��ط�! whether written or not ال• If one contract is not fulfilled, the other will not be automatically terminated but will definitely be

terminated by IB

These are Conditional Contracts as:

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An Analysis of Ijarah Finance0 CONCEPT: Renting out of goods having usufrunct0 PROCEDURE:

IB-Client Agency

Ijarah AgreementPromise to

gift/sell by IB

Client purchases commodity and lease

period starts

At the end of lease period IB gifts/sell the commodity to

the client

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Points to Note

Insurance expense is of IB but is recovered from client through incorporation in Rentals

Rent may be changed by mutual consent

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Objections and Rebuttal

Objections Rebuttal

• Conditional Contracts • Same as before

• KIBOR for Rent • Same as before

• Same Economic Outcome • Same as before

• Gift? • Not a bad idea!

• or Future Sale • Not a future sale, only a promise to sell

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Issues Raised on the Rebuttal

Economic substance clearly advocates conditionality

Gift: There is not free lunch in life

Essentially a financing transaction

Economic outcome = ظل�

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An Analysis of Salam FinanceCONCEPT: The seller undertakes to supply specific goods to the buyer at a future date in exchange of price fully paid at the time of the contract.

Price of Salam is usually lower than a spot sale

Salam is an exception to the general rule

Conditions Apply

• Full payment of price at the time of contract• Of ONLY these goods whose quantity and quality can be specified• CANNOT be effected on a particular commodity or on a product of a particular field or

farm

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An Analysis of Salam Finance

All specifications of goods to be agreed upon in advance

The quantity of goods should also be agreed in advance

The exact date of delivery should be agreed in advance

The commodity of Salam should remain in the market right from the day of contract upto the date of delivery or at least at the date of delivery

Since price in Salam is generally lower than the price in spot sale; the difference in the two prices may be a valid profit for the IB

A security may be required

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Procedure0 Terms:

Buyer = Rabb-us-Salam (ب ال�ل��)

Seller = Muslam ilaih (مال�� رل� �,)

Cash price = Ra’as-ul-maal (ال ااس ال �)

Purchased commodity = Muslam fih (رل� ف�� �,)

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Procedure0 Two Methods of Salam Financing:

1) Parallel Salam:

Clientمال��) رل� �,)

IB��ل�) /�ب ال(,�ل� ال��

3rd Party(�ب ال�ل�)

1st Salam 2nd Salam

Larger Period Smaller Period

Lesser Price Relatively Higher Price

Difference

IB’s Profit

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Procedure

2) Salam + Promise to buy from 3rd Party:

Clientمال��) رل� �,)

IB��ل�) (�ب ال 3rd Party

1st SalamPromise

to Buy

Less than spot price

Spot Price

Difference

IB’s Profit

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Objections and Rebuttal

Objections Rebuttal

• Sale is not the objective • All the requirements of a valid Bai’-us-Salam ( ال�ل� (��عare present

• KIBOR tool • Not a problem

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An Analysis of Istisna Finance(ا�/ 0اع)

CONCEPT: The buyer orders to manufacture a specific commodity. If the manufacturer undertakes to manufacture the goods for him with material from manufacturer, the transaction of Istisna comes into existence

Price and specifications of the goods should be fully agreed upon with mutual consent

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An Analysis of Istisna Finance(ا�/ 0اع)

The contract can be cancelled by either party before the manufacturer starts the work. But after he has started the work, the contract can only be cancelled by mutual consent

Price need not be paid in full in advance

It is not necessary to fix delivery date

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Instances of Financing by Istisna

House Finance Installation of Machinery

Building of Bridges,

Flyovers, etc

Buy, Operate and Transfer (BOT)

Agreements

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An Analysis of Musharakah Finance

ش�کۃ

ش�کۃ ال!ق&

ش�کۃ ش�کۃ الا,�الش�کۃ ال�ج�ہالا� ال

ش�کۃ ال ل.

• Partnership

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Points to NoteProfit sharing ratio must be determined in advance

The ratio must be on profit not on capital

Should the profit ratio be equal to capital sharing ratio?• Imam Malik & Imam Shafi’I () Yes• Imam Ahmad () No• Imam Abu Hanifa () The profit sharing ratio need not be equal to the capital

sharing ratio. Except in case of a sleeping partner, his profit sharing ratio cannot be more than his capital ratio

Loss sharing ratio must be equal to capital sharing ratio Consensus

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Uses in Finance

Project Finance

Enterprise Setup

Finance

Import Finance

Working Capital Finance

Many others

PRESENTLY

E.g. Placement of

Conventional Banks

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Objections and Rebuttal

Objections Rebuttal

• Why is it not practiced instead of all the “doubtful” products?

• In a dishonest environment such a product is equivalent to committing financial suicide

• No customer is willing either

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Comment on the Rebuttal

0 What was there to loose?0 Proper measures can be devised. (e.g. JSCs)

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An Analysis of Mudarabah Finance & Mudarabah Account

• One partner gives money to another for investing in a commercial enterprise

CONCEPT:

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Points to Note

Loss is suffered by Rabb-ul-maal (Financing partner) ONLY

Profit sharing ratio must be agreed in advance

The mudarib cannot claim any periodical salary

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Mudarabah Finance Mudarabah AccountIB

�ب ال ال(Rabb-ul-maal)

CLIENT,ضا�ب

(Mudarib)CLIENT

�ب ال ال(Rabb-ul-maal) IB

,ضا�ب(Mudarib)

“DEPOSITS”• Profit given on a Daily Product Basis

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Objections and Rebuttal

Objections Rebuttal

• Daily Product Basis is not a valid tool for appropriating profit

• No problem as per shariah

• The “Business” done by IB is not valid

• It is valid

Mudaraba Finance Same as Musharakah

Mudaraba Account

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A Brief Introduction and Analysis of Takaful

The concept and working of conventional insurance

Reinsurance

Insurance Company

Customers

Premium

Policy

Actuarial Evaluations

Premium Investment &

Return generation

Claims in case of occurrence of insured event.

Problems in Conventional Insurance• Riba Interest م�� �• Qimar Gambling ا� Qم• Gharar Uncertainty غ��

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Concept/Theme of Takaful

The concept of insurance is good but the working is problematic. Hence there should be an Islamic alternative.

Two Alternatives

• Donation Model (ع�� *+)• Waqf Model (فQ�)

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1. Donation Model (ع�� *+)PROCESS:

• A Takaful Company is formed• Three Parties:

Takaful Company Trustee and Administrator

Policy Holder Customer

Pool Formed by the donations of policy holders

• Not owned by Takaful Company ONLY administered.

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1. Donation Model (ع�� *+)Takaful Company invites people to acquire policies and contribute (donate) to the pool

Once the pool is prepared it is used

• For paying the loss of policy holders (if any)• For investing as per Mudarabah Rules

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Thus Four (4) Contracts are Formed

• Policy holders give the Takaful Company their premiums as a trust (actually it’s a gift for other policy holders).

‘Amanat’/Trust Contract

• The Takaful Company is appointed as administrator of the pool.

Contract & Administration

• This is between Takaful Company and the pool.Mudarabah

Contract

• Partnership Contract between all policy holdersShirkat Contract

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Points to Note

The giving of premium is NOT conditional on the future compensation of loss

Agency fees can be charged by the Takaful Company

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2. Waqf Model (فQ�)Shareholders create a Waqf for ‘Qurbat’

Policy holders contribute to this Waqf & become eligible to claims

Only the formation is different

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Objections and RebuttalObjections Rebuttal

• Waqf Ala Nafs • Shareholders have not done this

• Benefits of Waqf for subscribers only (�ق& ,!ا�ض�)

• Benefits not because of “Conditional Donations” but because of condition of Waqf

• More Premium More Benefit ( &ق�(,!ا�ض�

• Benefits not because of “Conditional Donations” but because of condition of Waqf

• Waqf goods can only be given on RENT not on Mudarabah + Rabb-ul-maal & Mudarib is the same person

• Wikalah bil Istismaar (ا� �کالۃ �الا�/ث) is

valid & so is Mudarabah

• Waqf requires exactly the same goods

• Not applicable on money

• Benefit on termination of policy ( &ق�(,!ا�ض�

• As per Waqf terms

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Issues Raised on Rebuttal

�ق& ,!ا�ض�

Economic substance over legal form

Reconsideration needed regarding the validity of the basic theme

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Overall Comments•A correction is needed in the underlying Approach and Ideology

UNTRUE GENERALIZATIONS: 1. Islamic finance is asset-backed2. An Alternative has to be there3. Something is better than nothing and the

gradual approach will work

•Elimination needed of modes which are woefully doubtful

•Concerted effort to establish the Khilafah so that in all spheres of life Islam can rule supreme

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Recommended Approach•Islamic finance is Equity Based

•No consumer finance (exception: severe need)

•Corporate finance based on Musharakah and Mudaraba

(the limited liability concept would not be invoked so its debate is unnecessary)

•Khilafah[the Truth is supposed to be simple]

{ : ثم وفرادى مثنى لله تقوموا أن بواحدة أعظكم إنما قل تعالى وقالشديد { عذاب يدي بين لكم نذير إال هو إن جنة من بصاحبكم ما تتفكروا

: [46سبأ]ق ] شهيد وهو مع الس ألقى أو قلب له كان لمن لذكرى ذلك في إن

(37])( - Yالملك عير الس أصحاب في كنا ما نعقل أو نسمع كنا لو (10وقالوا