money, islamic banks and the real economy - … · · 2011-10-05money, islamic banks and the real...
TRANSCRIPT
221
Money, Islamic Banksand
the Real Economy
Abdul Ghafar IsmailProfessor of banking and financial economics
Universiti Kebangsaan Malaysia
CENGAGELearning'
Australia • Brazil • Japan • Korea • Mexico* Singapore* Spain • United Kingdom • United States
Contents i XI
Contents
Par t I : MONEY AND THE ISLAMIC BANKING SYSTEM
CHAPTER 1: AN INTRODUCTION TO MONEY AND THE ISLAMICBANKING SYSTEMThe History of Islamic BankingThe Components of the Islamic Banking SystemThe Principles of Money and Islamic Banking
Principle 1: Money as CapitalPrinciple 2: Rabbul mal and Mudarib RelationshipsPrinciple 3: Risk SharingPrinciple 4: Markets Set Prices and Generate ProfitsPrinciple 5: Islamic Banking StabilityPrinciple 6: Islamic Banks as Agents for Economic Growth
The Organization of This BookSummaryKey Terms and ConceptsQuestions
CHAPTER 2: MONEY AND THE PAYMENT SYSTEMThe Islamic Concept of Money
OwnershipUtilization
The Functions of MoneyThe medium of exchangeThe Store of Value
The Payment SystemCash PaymentsPayments by ChequeGiro PaymentsPlastic CardsCharge CardsCredit CardsDebit Cards
Credit CardsHow does a credit card work in practice?Credit Card AssociationsIssuersAcquirersVisa MembershipIslamic Credit Card
Wholesale Payments System
135778899
1010121313
1517171925252626262627272728282828292930303031
XII • Contents
EFPOSTCHIPSAutomated Clearing House (ACH)
Money Flows in the EconomyBase MoneyBank Money and Bank ReservesThe Transaction Money Supply
SummaryKey Terms and ConceptsQuestions
CHAPTER 3: FINANCIAL INSTRUMENTS, FINANCIAL MARKETS,AND ISLAMIC BANKING INSTITUTIONSLinkages between Financial Instruments, Markets, and
InstitutionsFinancial Instruments
The Creation of Financial ContractsUses of Financial InstrumentsFinancial MarketsThe Role of Financial Markets
The Structure of Financial MarketsMoney MarketCapital MarketForeign Exchange Market
Islamic Banking InstitutionsThe Functions of Islamic Banking InstitutionsThe difference between Islamic Banks and
Conventional BanksBusiness OperationsSocial and Ethical Responsibilities
SummaryKey Terms and ConceptsQuestions
Par t I I : ISLAMIC BANKING OPERATIONS
CHAPTER 4: INTRODUCTION TO BASIC CONTRACTS INISLAMIC BANKINGProhibition of RibaBasic Contracts in Islamic BankingContract of Profit-Sharing
MudarabahDefinitionBasis of MudarabahTypes of MudarabahTerms and Conditions of Mudarabah Contract
31323233333334363737
39
404041424444454546464747
474748495050
51
515355565656575759
1Contents i
Modern Applications of MudarabahMusharakah
DefinitionBasis of MusharakahTypes of MusharakahTerms and Conditions of Musharakah ContractsModern Applications of Musharakah
Contract of SaleIjarah
DefinitionBasis of IjarahTypes of IjarahTerms and Conditions of Ijarah ContractsModern Applications of Ijarah
Ju'alahDefinitionBasis of Ju'alahTerms and Conditions of Ju'alah ContractModern Applications of Ju'alah
Bay'al-MurabahahDefinitionBasis of Bay' al MurabahahTypes of Bay' al-MurabahahTerms and Conditions of Bay' al-Murabahah ContractModern Applications of Bay' al Murabahah
TransactionsBay' Salam
DefinitionBasis of Bay' SalamTypes of Bay' SalamEssential Elements of Bay' Salam ContractModern Applications of Bay' Salam
Istisna'aDefinitionBasis of Istisna'aTerms and Conditions of Istisna'a ContractModern Applications of Istisna'a
Qard ulhasanahDefinitionBasis of Qard ul HasanahTerms and Conditions of Qard ul Hasanah ContractModern Applications of Qard ul Hasanah
Bay' Bithaman AjilDefinitionBasis of Bay' Bithaman AjilEssential Elements of Bay' Bithaman Ajil Contract
xiii |j
596060606061616262626363646565656566666666666767
686868686969707171717172727272737373737474
XIV • Contents
Modern Applications of Bay' Bithaman AjilBay As-Sarf
DefinitionBasis of Bay' As-SarfTerms and Conditions of Bay' As-Sarf ContractModern Applications of Bay' As-Sarf
Contract of DepositsAl Wadi'ah
DefinitionBasis of al-Wadi'ahTypes of Wadi'ahEssential Elements of Wadi'ah ContractModern Applications of Wadi'ah
Contract of WakalahWakalah
DefinitionBasis of al-WakalahTypes of al-WakalahTerms and Conditions of al-Wakalah ContractModern Applications of al-Wakalah
Contract of Gift (Hibah)DefinitionBasis of HibahTerms and Conditions of Hibah ContractsModern Applications of Hibah
Contract of SecurityAI-Kafalah
DefinitionBasis of al-KafalahTypes of al-KafalahTerms and Conditions of al-Kafalah ContractModern Applications of al-Kafalah
Al-HawalahDefinitionBasis of al-HawalahTypes of al-HawalahTerms and Conditions of al-Hiwalah ContractModern Applications of al-Hiwalah
Al-RahnDefinitionBasis of al-RahnEssential Elements of al-Rahn ContractModern Applications of al-Rahn
SummaryKey Terms and ConceptsQuestions
75757575767677777777777878787878797979808080808181828282828383838484848485858585858686878788
CHAPTER 5: SOURCES OF FUNDSThe Balance Sheet of Islamic banksComponents of the Balance SheetDemand Deposits
Wadiah Yad Dhamanah Current Account-iFeaturesMechanismHibah DistributionExample of Hibah Rate
Mudarabah Current Account-iFeaturesMechanismProfit Distribution
Saving DepositsWadiah Yad Dhamanah Saving Account-i,
FeaturesMechanismHibah DistributionExample of Hibah Rate
Mudarabah Saving Account-iFeaturesMechanismProfit Distribution
Wakalah Saving Account-iFeaturesMechanism
Investment DepositsGeneral Investment Accounts-i
FeaturesMechanismProfit DistributionExample of Mudarabah GIA Return
Special Investment Accounts-iFeaturesMechanismProfit Rate DeterminationExample of Indicative Rate of Return
Specific Investment Account-iFeaturesMechanismProfit Distribution
Deposit-Structured AccountsCommodity Murabahah Deposits
FeaturesMechanism
Return
Contents i 1 XV
8 9909293939394959596969697979898989999
100100101101102102102103103103104104105108108109109110111111111111112112112112113
XVI • Contents
CHAPTER 6:
Example of the Rate of Return on Commodity 114Investment-Linked Deposits 114
Features 114Mechanism 115Returns 116
Inter-bank Placement-i 117Profit Equalization Reserve 117Investment Risk Reserve 118Shareholder Funds 119
Paid-up Capital 119Reserves 119
Statutory Reserves 120Financing Loss Reserves 120
Other Capital Accounts 121The Importance of the Sources of Funds Components 121Summary 122Key Terms and Concepts 122Questions 122
USES OF FUNDS 125Cash and Cash Equivalents 126
Vault cash 126Required reserves 126Due to other Islamic Banks 127
Sales Receivables 127Bay'-Bithaman Ajil Financing 128
Features 128Mechanism 128Calculation of Profit Margin for Financing Activities 129Calculation of Interim Profit for Partial Disbursement 131
Working Capital Financing-i 134Features 134Mechanism 134
Salam Financing 136Features 136Mechanism 136
Leasing-i 137Features 137Mechanism 138Rental Payment 139
Hire Purchase-i 140Features 140Mechanism 140Rental Payment 142
Trade Financing 142Letter of Credit-i 142
Contents 4 xvii
CHAPTER 7:
Trust Receipt-iExport Credit Refinancing-iBank Guarantee-i (BG-i)Shipping Guarantee-i (SG-i)Accepted Bills-i
Personal FinancingBay' al-Inah FinancingTawarruq Financing
Equity FinancingDiminishing Musharakah Property Financing-i
FeaturesMechanismIjarah Payment
Mudarabah Project FinancingFeaturesMechanism
Investment in SecuritiesIslamic Inter-bank Cheque Clearing SystemInter-bank Acceptance-iBank Negara Negotiable Notes-iIslamic Negotiable InstrumentsSale and Buy Back Agreement
FeaturesMechanismCalculation of Proceeds
Government Investment IssuesIslamic Treasury BillsCagamas Mudarabah Bonds
Islamic Accepted BillsImports and local purchasesExports and Local sales
Islam Private Debt SecuritiesIslamic Commercial PapersSukuk
FeaturesMechanismReturn
Fixed AssetsInvestment in SubsidiariesThe Importance of the Uses of Funds ComponentsSummaryKey Terms and ConceptsQuestions
INCOME STATEMENTComDonents of Income Statements
143144144145146148148148149150150150151151151152152153154155156156156156158158159159163163163163164164164164165166166166167168168
169170
XVIII ! • Contents
Total Income 172Income from Financing and Investment 172Operating Income 174
Dealing Income 174Fees and Commissions 175
Expenses 176Administrative Expenses 176
Personnel Expenses 177Fixed Asset Expenses 177Other Expenses 178
Allowances 178Objectives of Allowances 178Types of Allowances 179Measurement of Allowances 180
Reserves 180Profit Equalization Reserves 180Investment Risk Reserves 181
Total Distributable Income 181Net Distributable Income 181Income Attributable to the Depositors and Shareholders 184
Profit After Zakat and Taxation 185Zakat 185Taxation 186
Net Profit 187Retained Earnings 187Cash Dividend 187Islamic Bank Profit Model 187Summary 189Key Terms and Concepts 189Questions 189
Par t I I I : ISLAMIC BANKS PERFORMANCE
CHAPTER 8: EVALUATING ISLAMIC BANK PERFORMANCEInternal Performance
Business PlanningStrategic PlanningDistribution ChannelTechnologyPersonal Development
External PerformanceMarket ShareRegulatory ComplianceShariah CompliancePublic Confidence
191
191192192193195196196198198200200201
Contents 4 XIX
Aligning Internal-External Performance Frameworks with MarketValuations 202
Summary 204Key Terms and Concepts 205Questions 205
CHAPTER 9: ANALYZING ISLAMIC BANK PERFORMANCE WITHFINANCIAL RATIOS 207Financial Performance Indicators 209
Profitability and Sustainability Indicators 209Efficiency and Productivity Indicators 210Portfolio Quality Indicators 211Growth and Outreach Indicators 212Financial Structure Indicators 213
Interpreting Performance Indicators - Some Examples 214Earnings Performance Ratios 215
Net Income to Average Assets 215Provision for Financing Losses to Average Assets 215Net Realized Gains or Losses to Average Assets 216Net Income to Average Assets 217
Assets Quality Ratios 217Non-current Financings to Total Financings 217Allowance for Financing and Lease Losses to Non-current
Financings 218Capital Adequacy Ratios 218
Cash Dividends to Net Income 218Tier 1 Capital to Average Assets 218
The Evaluation of Financial Ratios 219Summary 222Key Terms and Concepts 222Questions 223
Part IV: RISK MANAGEMENT 225
CHAPTER 10: UNDERSTANDING RISK 225Unique Features of Islamic Banks 226Defining Risk 227
Market Risk 228Foreign exchange risk 228Profit rate risk 228Equity risk 229
Credit Risk 229Operational Risk 230Liquidity Risks 230Equity Investment Risks 231Displaced Commercial Risks 231
1 XX j 1 • Contents
Compliance RiskInventory Risk
Risk Profiles in an Islamic BankMarket Risk ProfilesCredit Risk ProfilesOperational Risk ProfilesLiquidity Risk ProfilesEquity Investment Risk ProfilesDisplaced Commercial Risk Profiles
SummaryKey Terms and ConceptsQuestions
CHAPTER 11: MANAGING RISKRisk Management AgendaRisk Management Tools
Economic CapitalFormulaHypothetical Example
Expected LossConceptual FrameworkExample
Value-at-RiskEstimating VaRExample
Stress TestingDefinition and ApplicationsTechniques for Stress TestingExample on Macro Test of Islamic Banks
Regulatory RiskSources of Regulatory RisksThe Costs and Consequences of Regulation
Current Practices to Mitigate RisksProfit Equalization ReserveVariable rates of ReturnsProfit RiskSecuritization
Profit Rate SwapSummaryKey Terms and ConceptsQuestions
P a r t V: REGULATORY AND SUPERVISORY ENVIRONMENTS
CHAPTER 12: REGULATIONFrom Law to Regulation
232232232232233234235236237238238239
241242244244245247249249250250251254254255256257259259260261261262262263264265265266
2 6 7
2 6 7268
Contents 4 XXIII I!
Reasons for Regulations 269Safety and Stability 270Promoting Competition and Efficiency through a
Banking Structure 270Public Confidence 271Market Discipline 271Basis for Monetary Policy 272
Policy Issues Related to Regulations 273Regulations on Islamic Bank Activities and
Banking-Commerce Links 273Regulations on Domestic and Foreign Islamic Banks Entry 274Regulations on Capital Adequacy 275Deposit Insurance Design 275Regulations on Easing Private Sector Monitoring of
Islamic Banks 276Government Ownership of Islamic Banks 277
Legal Framework 277The Central Bank Ordinance 1958 277Islamic Banking Act 1983 278Banking and Financial Institutions Act 1989 279Government Investment Act 1983 281
Regulatory Environtments 281Guideline on the Shariah Advisory Council 282Guideline on Corporate Governance 283Guideline on the Presentation of Financial Statements 285Guidelines on Rate of Return 285Guidelines on Total Insured Deposits 285Guidelines on Islamic Banking Products 286
Accepted Bills-i 286Sells and Buys Back Agreement Transactions 287
Summary 288Key Terms and Concepts 288Questions 289
CHAPTER 13: SUPERVISION 291The Philosophy 292The Objectives 293Risk-based Supervision 293
The Approach 294The Framework 296
Stage 1: Full Scope Examination of Islamic Banks 296Stage 2: Impact Assessment of Islamic Banks 296Stage 3: Risk Assessment of Islamic Banks 297Stage 4: Development of a Risk Mitigation Programme 305Stage 5: Evaluation and Validation 306
XXII • Contents
Stage 6: Communicating the Results of the Assessmentand Risk Mitigation Programme to theIslamic Bank 306
Stage 7: Implementation of Risk Mitigation Programme,On-Going Assessment and Response toRisk Escalation 307
The Supervisory Processes 308Off-Site Surveillance 308
Pre Conditions for Effective Off-Site Surveillance 308Off-Site Surveillance Processes 309
On-Site Examination Process 312Examination Planning 312Examination Programme 313Examination Procedures 314
Stress Testing 317Stress Testing Procedure 317Stress-Testing Tools 318
Supervisory Concerns 318Capital Adequacy and Earning Sustainability 318Continuous Surveillance 319
Monitoring System 319Risk Management Tools 322
Supervisory and Enforcement Actions 325Summary 326Key Terms and Concepts 326Questions 327
Par t V I : CAPITAL, LIABILITIES, ASSETS AND OFF-BALANCE SHEETMANAGEMENT 329
CHAPTER 14: CAPITAL MANAGEMENT 329Definition of Islamic Bank Capital 330
Equity 330Reserves 331Capital Hybrid 332
Role of Islamic Bank Capital 333Regulator's View on Capital Adequacy 334Capital Standards 335Capital Base 336
Risk-Adjusted Assets 338Conversion from Off-Balance Sheet 339
Shareholders' Viewpoint on Capital Adequacy 340Capital Structure Decision 340Asset Investment Considerations 341Securitization 343
Contents 4 XXIIIii li
Dividend PolicyCapital Allocation
Fulfilling the Capital RequirementsCapital Adequacy Standard
Basis for Minimum Capital Adequacy RequirementsThe Proposed Minimum Capital Requirements
Shariah Compliant InstrumentsProvisions for Operational RiskAdjustment to the Capital Ratio Denominator
Innovations in Capital InstrumentsExample
SummaryKey Terms and ConceptsQuestions
CHAPTER 15: LIABILITIES MANAGEMENTStructure of Islamic Bank Liabilities
Deposit Sources of FundsDemand DepositsSavings DepositsInvestment DepositsStructured Deposits
Non-Deposit Sources of FundsDeposits and Placements of Islamic Banks and Other
Financial InstitutionsProfit Equalization Reserves
Managing the Net Distributable IncomeLiquidity Management
Factors that Affect LiquidityFinancial Market AccessFinancial ConditionBalance Sheet Structure
Liquidity MeasurementSummaryKey Terms and ConceptsQuestions
CHAPTER 16: ASSETS MANAGEMENTStructure of Islamic Bank AssetsFinancing
Types of FinancingFinancing Business FirmsFinancing for ConsumersFinancing for Real Estate
Financing by ContractsRegulation of Financing
344345345347349349351360362362363364365365
3 6 7368369371371371372373
373374375376377377377377378381382382
3 8 3384386387387392393394395
WIW+Contents
PricingCost-plus PricingPrice-leadership ModelCredit-scoring Systems and Risk-based PricingFirm Profitability Analysis
Investment in SecuritiesInvestment Instruments Held by Islamic BanksFactors Affecting Choice of Investment Securities
Expected Rate of ReturnTax TreatmentMarket RiskDefault RiskLiquidity Risk
Reserve ManagementLegal ReserveShort-term Funds Position Management
Prudent Risk Management Creates Value for Islamic BanksSources of Credit RiskMeasuring Credit Risk
Micro ApproachMacro Approach
SummaryKey Terms and ConceptsQuestions
CHAPTER 17: OFF-BALANCE SHEET MANAGEMENTMotives for Moving Assets Off the Balance SheetFee Income as a Catalyst of Off Balance Sheet ActivitiesOff-Balance Sheet Activities
Financial GuaranteesLetter of GuaranteeStandby Letters of CreditLetter of Comfort and Letter of Awareness
RemittancesStanding InstructionSecurities and Fund Services
Telegraphic TransferTele-bankingTravelers' and Bankers' ChequesCashier's Order /Local Demand Draft
SecuritisationCross Currency SwapSummaryKey Terms and ConceptsQuestions
397398399400401402403405406406407408411413413414415415416416418421422422
4 2 5426427430430430430432432432433435435437437437439441441441
Contents 4 XXV
Part V I I : THE REAL ECONOMY 443
CHAPTER 18: THE ECONOMICS OF THE ISLAMIC BANKINGSYSTEM 443The Role of Islamic Banks 444
Labour-Based Transactions 444Financial-Based Transactions 445Implementing Shariah Law 446Pooling Savings 446Channeling Funds 447Custodian, Payment System Access and Accounting 448
Information Disclosure 449Economic Contribution 450
Extending Contribution to General EconomicDevelopment 451
Benefiting Employees, Customers and Communities 451Islamic Banks - Value Added Wealth 451Summary 453Key Terms and Concepts 454Questions 454
CHAPTER 19: THE CENTRAL BANK 455The History of the Central Bank 456The Role of Bank Negara 458The Objectives of the Central Bank 459
Low and Stable Inflation 459High and Stable Real Growth 460Financial System Stability 461Profit Rate and Exchange-Rate Stability 462
The Organizational Structure of the Central Bank 463The Board of Directors 463The Governor and the Deputy Governors 464The National Shariah Advisory Council 464Organizational Structure 465
Evaluating the Central Bank's Organizational Structure 465Independence from Political Influence 465Decision Making by Committee 467Accountability and Transparency 469
Policy Framework 471Meeting the Challenges: Creating an Islamic Financial Center 472
MIFC 472INCEIF 475
Summary 475Key Terms and Concepts 476Questions 476
• Contents
CHAPTER 20: MONETARY POLICY TRANSMISSION 477The Transmission Mechanism 478
Monetary Policy Transmission Mechanism 478The Impact of Monetary Policy Impulses on the Economy 479
Monetary Policy Tools 482Structure of the Bank Monetary Policy Committee 482The Tools 483
Open Market Operations 483Overnight Policy Rate 485Statutory Reserve Requirements 485
Objectives of Monetary Policy 487The Role of Operating Targets 491Rate versus Quantity Variables as Operating Targets 492The Role of the Monetary Policy Strategy for the
Choice of the Operating Target 494Operating Targets and Monetary Policy Tools 495
The Impact of Monetary Policy Targets on the Bank's BalanceSheet 496
Fiscal Operations and the Central Bank's Balance Sheet 501Summary 504Key Terms and Concepts 505Questions 506
CHAPTER 21: THE ISLAMIC BANKING SYSTEM AND THE REALECONOMY 507Circular Flow 508Understanding of the Exchange Economy 510
The Production Function 510The Demand Curve 513The Supply Curve 516Equilibrium and the Determination of Output
and Inflation 519Money Flow and Balance Sheet in the Exchange Economy 522The Size and Composition of the Balance Sheet as
Intermediate Targets 525Bank Capital 525Bank Liabilities 525Monetary Base 525How does the Monetary Policy Work? 526
Evolving Role of Islamic Financial Institutions 529Summary 530Key Terms and Concepts 530Questions 530