what is participatory banking? concept, instruments and issues ausaf ahmad international conference...
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WHAT IS PARTICIPATORYBANKING?
Concept, Instruments and Issues
AUSAF AHMAD
International Conference on Participatory BankingNew Delhi
Sept 01, 2007
In the name of Allah, the most Beneficent, the Most Merciful.
This presentation includes:
• What is Participatory banking?• Basic function: Financial
Intermediation • An Introduction to Participatory
financing techniques.• Observations on some common
misconceptions.
Clarification on Nomenclature• Participatory Banking is known by
several names:• Interest free banking (Iran)• PLS Banking (Pakistan)• Islamic Banking (Gulf)• Special Finance Houses (Turkey)• All expressions are used
interchangeably.
COMMON PARAMETERS BETWEEN PARTICIPATORY AND COMMERCIAL BANKS
• Same purpose: Financial intermediation.
• Same Objective: Profit• Successful Operation of
Participatory banks has shown that financial intermediation is possible even without interest.
FINANCIAL INTERMEDIATION
SURPLUS HOUSEHOLDS
DEFICIT HOUSEHOLDS[Firms}
FINANCIAL INTERMEDIATION
FINANCIAL INTERMEDIARIES
Financial Flow
Financial Flow
THE FIRM
FINANCIAL MARKET
FINANCIALINTERMEDIARIES
INDIVIDUALS
DIRECT FINANCING
HouseholdsBusinesses
Flow of Real goods
Financial Flow
Indirect Financing
Business
Financial Institutions
Households
Financial Resources
Financial Resources
Return on Investment
Return on Investment
STRUCTURE OF FINANCIAL MARKETS
Supervisory Bodies
Direct Finance Indirect Finance
Bonds Equities
PrimaryMarkets
SecondaryMarkets
InvestmentBanks
Dealers andBrokers
StockExchanges
Over-the-CounterExchange
DepositoryInstitutions
ContractualSavings
Institutions
InvestmentIntermediaries
CommercialBanks
Saving & LoanAssociations
Cooperatives
InsuranceCompanies
Mutual Funds
PensionFunds
FinanceCompanies
Social and Moral Norms
• Gharar Should not indulge in Riba
• Should not involve in • Should not indulge in
fraudulent behavior• Should not coerce• Should assure
fairness to all parties.
• No coercion.
• No financing of socially undesirable goods such as alcohol, drugs, pornography.
• Should not resort to morally reprehensible practices such as cheating, bribing, fraudulent practices.
The View on Bank Interest
• No distinction is made between usury and interest.• No distinction is made between consumption loans
and productive loans.• No distinction between constant and variable
interest rates.• No distinction is made between individual and
institutional rate of interest.
AVOIDANCE OF GHARAR
• Definition of Gharar• Uncertainty / Ambiguity• Ambiguity of Quantity [Gharar fil
Miqdar]• Ambiguity of Attributes [Gharar fis
sifah] such as• Ambiguity in time or place of delivery• Ambiguity in price etc.
DEBT FINANCE Vs.
PARTICIPATORY FINANCE • Participatory finance, in
comparison, to debt finance is:• More just• More equitable• More efficient• More growth oriented.
PRESENT SCENE
• Participatory Banks in the Government Sector• Pakistan, Sudan, Iran
• Participatory Banks in the Mixed Sector• - Malaysia
• Participatory Banks in the Private Sector• Gulf
• Non Banking Financial Institutions• Al Ameen [ Bangalore, India]
• Participatory Financing by standard Commercial Banks in the Domestic Sector• Saudi British, NCB, Saudi American, Misr Bank• Participatory financing by Commercial banks in the foreign sector.
• Islamic Banks established by multinational BanksCitibank, HSBC Amanah Bank,
A TYPICAL BALANCE SHEET
Sources of Funds
Current AccountSaving AccountsInvestment AccSpecial Invest. Acc
Uses of Funds
MurabahaMusharakahMudarabahIjarahQard Hasan
Business Practices in Sources of Funds
• Current Accounts• Saving Accounts• Investment Accounts
• General Investment accounts• Limited Period Investment accounts• Specified Investment accounts
Current Deposits [sources of funds]• Very Similar to standard commercial banks• No return paid back to depositors• Checking facilities• Are Current deposits a loan to the bank from
depositors ? • Are Current deposits a trust by depositors to
banks ?
• Use of Current deposits by the banks on their
own risk.
Saving Deposits[Sources of Funds]
• Saving deposits without authorization to invest
• Saving deposits with authorization to invest• Return to depositors who provide authorization
to invest.• Saving deposits as a part of trust accounts.• Saving deposit as Notice account
Investment Deposits[Sources of Funds]
• Islamic Banking counterpart of Fixed Deposits.• Withdrawal allowed only in special cases• Investment deposits as Mudarabah Accounts.• Depositor: Rabbal Mal; Bank: Aamil• Share profit on agreed basis, bear full loss. • Investment pool• Distribution of profits on pro rata basis.
Special Investment Deposits [Sources of Funds]
• Concept of Wakalah• The bank acts as a wakeel. Implement\s the
instruction of the Mawakkil.• Special purpose investment, Specify, purpose,
sector, industry, or even project.• The bank gets a fee for the services rendered. • Full profit or loss goes to the depositor. The
bank will share in loss only in case of proven neglect.
USES OF FUNDS
• MUDARABAH• MUSHARAKAH• MURABAHAH• IJARAH (Leasing)• IJARAH WA IQTINA (Lease Purchase)• MUSHARAKAH MUTANAQISAH• LOAN ON SERVICE CHARGE• INTEREST FREE LOANS.
TYPES OF CONTRCTS
Contracts
Muawadat Contracts against Payment
Musharakat Contracts of Partnerships
TabarruatContracts of Charity
TYPES OF CONTRCTS
• Contracts of Sale / Lease are Muawadat. Gharar is not allowed in such contracts.
• Mudarabah and Musharakah are contracts of Partnerships. Some amount of gharar may be tolerated in such contracts.
• Sadaqat and Hadaya are Tabarruat. No objection to Gharar in these type of contracts.
Financing Techniques
• These techniques were devised in the classical period for the commodity trade
• Their application to financial sector is an innovation of the modern era.
• The application of these techniques requires new documentation which was not required in the early period.
MURABAHAH [USES OF FUNDS] - I• The word MURABAHA is derived from the word
Ribh, meaning profit in Arabic.• Sale with a profit.• Cost-plus financing. • Examples of Murabahah.• Two contracts: A contact of intent to conduct a
Murabaha Sale and another contact to buy the good ordered in previous contract.
• Promise is not a legal binding. It introduces an element of risk in the transaction.
• The element of risk justifies the profit in Murabaha sale : Fiqhi principle : Al Kharaj bi Daman.
MURABAHAH [USES OF FUNDS] - II• Applications of Muraqbaha:
• In domestic trade• In foreign trade• In financing consumer durables• In financing real estaes
• ABUSES OF MURABAHA• MURABAH AND BAY EINA.
MURABAHAH [USES OF FUNDS] - II• Applications of Muraqbaha:
• In domestic trade• In foreign trade• In financing consumer durables• In financing real estaes
• ABUSES OF MURABAHA• MURABAH AND BAY EINA.
MUSHARAKAH [USESOF FUNDS] • Musharakah is from the word Sharikah.• More than one partners: Partnership in capital
proportion and project supervision.• A partner may waive his right of supervision or delegate
it to another partner.• Arrangements: Sharing of Profit and loss in accordance
with capital proportion agreed proportion.• Variant: Share of profit in agreed proportion, share of
loss in capital proportion.• Applications of Musharakah: • i. in Import trade• Ii. In Agriculture
MUDARABAH [USES OF FUNDS]• Mudarabah existing from pre-Islamic times.• Permitted on the Cannon of Necessicity.• Profit and loss sharing is a wrong translation.• Arrangement: Profit is shared on an agreed
basis, loss is borne by the Rabbal Mal.• Bank: Rabbal Mal, Entrepreneur : Aamil• Double tier Mudarabah. • Requirements for a successful Mudarabah
Other Financing Techniques• Loans on Service Charge• Qard Hasan [interest free loans]• Service Charge is to be equal to actual
administrative expenditure• Qard Hasan is limited to social purposes
only.
IJARAH [USES OF FUNDS]
• Ijarah is emerging as a popular technique of financing amongst the Islamic banks
• Elements of a lease contact: Lessor, Lessee, instrument and period of lease,
• The asset remains in the ownership of the lessor. Maintenance is the responsibility of the owner.
• Ijarah muntahi bit tamlik
Other Financing Techniques
• Diminishing Musharakah• Loan of Service Charges. Only
administrative expenses can be charged.
• Interest free loans are provided as a social service
Latest Trends in Participatory Financial Markets
• Derivatives and secondary market• Evolution of Financial Instruments
and Financial Papers• Securitization• Musharakah bonds• Ijarah bonds
SOME MISCONCEPTIONS
• PARTICIPATORY BANKING IS RELIGION BASED.
• PARTICIPATORY BANKING IS FOR A SPECIFIC COMMUNITY
• PARICIPATORY BANKING REPLOACES INTEREST RATE WITH PROFIT AND THAT IS ALL.