Chapter 1: Overview of financial system

1. Chapter 1: Overview of financial system Mohammad Salleh Bin Abdul Saha ISB 300 Centre for Islamic Thought and Understanding University Teknologi MARA Terengganu

2. What is financial system ? • The processes and procedures used by an organization management to exercise financial control & accountant ability. These measures include recording , verification, and timely reporting of transactions that affect revenues, expenditures, assets and liabilities. • The financial system is concerned about money, credit and finance. (the three terms are intimately related yet are somewhat different from each other)

3. What is money ? • Money is anything of value that serves as a generally medium of exchange. • Unit of accounting measures. • Means to save or store purchasing power. What is credit/loan? • An arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point in time.

4. What is finance ? • A branch of economics concerned with resource allocation as well as resource management, acquisition and investment. Simply,finance deals with matters related to money and the markets.

5. Financial System Structure in Malaysia

6. Banks as Financial intermediaries Who is financial intermediaries ? • Financial intermediaries may include banks, broker-dealers, investment advisers and financial planners. Roles? • Promote savings and capital accumulation to finance projects using various modes of financing.

7. Finance international trade. • Mobilize resources for investments for the benefit of society. • Contribute social welfare through Corporate Social Responsibilities (CSR) and zakat.

8. Islamic banking What is islamic banking ? • Islamic banking is banking based on Islamic law (Shariah). It follows the Shariah, called fiqhmuamalat (Islamic rules on transactions). The rules and practices of fiqhmuamalat came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad).

9. Islamic banking in Malaysia ? • The first Islamic bank was established in Malaysia in 1983. • In 1993, commercial banks, merchant banks and finance companies begun to offer Islamic banking • products and services under the Islamic Banking Scheme (IBS banks). • The IBS banks have to separate the funds and activities of the Islamic banking transactions from the non- • You can identify an Islamic bank or an IBS bank from the logo below:

10. ESTABLISHMENT OF ISLAMIC FINANCIAL SYSTEM IN MALAYSIA Banking Industry in Malaysia Section 2 CORPORATE INFORMATION

11. MILESTONES OF ISLAMIC BANKING PRODUCTS • Wadiah Current Account • Wadiah Savings Account • Mudharabah Financing • Ijarah Financing • BBA Financing • Mudharabah Investment Account • Murabahah LC • Musharakah LC • Wakalah LC • Bay Dayn Trade Financing • Murabahah Working Capital Financing • Sarf Forex • Mudharabah Interbank Investment • Musharakah Financing • Bay Inah Credit Card • Bay Dayn, Musharakah, Mudharabah ICDO • Wadiah Debit Card • Bay Inah Overdraft • Bay Inah Commercial Credit Card • Bay Inah Personal Financing • Bay Inah Negotiable Instrument of Deposit (NID) • Commodity Murabahah Profit Rate Swap • Commodity Murabahah Forward Rate Agreement • Ijarah Rental Swaps-i • BBA Floating Rate • Murabahah Floating Rate • Istisna’ Floating Rate • Ijarah Floating Rate • Mudharabah Capital Protected Structured Investment • Bay Inah Floating Rate NID • Mudharabah Savings Multiplier Deposit • Tawarruq Commodity Undertaking • Tawarruq Business Financing • Tawarruq Personal Financing • Tawarruq Credit Card • Murabahah with Novation Agreement • Istisna’ convertible to Ijarah • Bay and Ijarah (Sale and Lease Back) • Musharakah Mutanaqisah • Istisna’ with Parallel Istisna’ Note - This listing is far from being exhaustive.

12. (April2009,)Philosophical foundations of Islamic Banks

13. (April2008,April 2009,April 2011)Goals and objectives of Islamic banking • Offer Financial Services • The thrust is towards financing on risk- sharing and strict focus on halalactivities • Focus on offering banking transactions adhering to Syariahprinciple and avoiding conventional interest- based banking transactions. • Economic Development • Established a direct and close relationship between the bank’s return on investment and the successful operation of the business by the entrepreneur. • Optimum Resources Allocation • Considered to be most profitable, religiously permissible and are beneficial to the economy.

14. Optimum Approach • Profit- sharing principle encourages banks to go for projects with long- term gains instead of short- term gains. • Banks conduct proper studies before getting into projects. High returns distributed to shareholder maximize the social benefits and bring prosperity to the economy. • Equitable Distribution of Resources • Ensures equitable distribution of income and resources among the participation parties, with its profit- sharing approach which is one of a kind. • Facilitate Stability in Money Value • Islam recognize money as a means of exchange and not as a commodity. • Riba- free system leads to stability in the value of money to enable the medium of exchange.

15. (Oct2006,Oct2007,April 2008,April2009, Oct2009,April 2010,April 2011,Sept2011)Principles of Islamic Banking • Islamic banking is the conduct of banking based on Syariahprinciple • Does not allow the paying and receiving of interest. • The principles for Islamic banking are listed: • Prohibition of Riba • Riba is strictly prohibited under Islam and is considered as haram. • Islam allows only one kind of loan that is Qardhul Hassan. • Equity participation • Islam encourages muslims invest their money and become partners in order to share profits and risk in the business instead of becoming creditors. • In Islam, financing is based on the belief that the financier and borrower should equally share the risks of the business venture.

16. Prohibition of gharar • Ghararmeans to undertake a venture blindly without sufficient knowledge or to undertake excessively transactions • An Islamic financial system discourages hoarding and prohibits transactions featuring extreme gharar. • Contractual relationship • Depends upon the nature of transaction. • It could be a seller and buyer relationship (Murabaha), a lessor- lessee relationship (Ijara), and a partnership (Musyaraka) • Money as Potential Capital • It is way of defining the value of a thing. • Should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or when lent to someone.

17. (April2009)Differences between Islamic Banking and Conventional Banking System

20. ISSUE 1: SIMILAR TO CONVENTIONAL BANKING? • Islamic bank is a “bank” – intermediary in “indirect funding” between depositors and financing customers. • The difference is Shariah compliant • انما البيع مثل الربا – احل الله البيع و حرم الربا

21. Advantages of Islamic Banking • Justice and Fairness ~ The main feature of the Islamic model is that it is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. ~ This system of financial intermediation will contribute to a more equitable distribution of income and wealth. • Liquidity ~ Follow the profit and loss-sharing principle to mobilize resources and are less likely to face any sudden run on deposits. ~ As such, they have a minimum need for maintaining high liquidity.

22. Better Customer Relations ~ Financing and deposits are extended under the profit and loss sharing arrangement. The banks are likely to know their fund users better in order to ensure that the funds are used for productive purpose and vice-versa for investors. ~ It will develops better relations between the financial intermediary and the fund providers or consumers. ~ Also promote productive economic activities and socio-economic justice. • No Fixed Obligations ~ Islamic banks do not have fixed obligations such as interest payments on deposits. Therefore, they are able to allocate resources to profitable and economically desirable activities. ~ Also holds good for Islamic financing, as the payment obligations of the entrepreneur is associated with the revenue.

23. Ethical and Moral Dimensions ~ Strong ethical and moral dimensions of doing business and selecting business activities to be financed, play an important role in promoting socially desirable investments and better individual or corporate behavior. • Banking for All ~ Although based on Syariah principles to meet the financial needs of Muslims, it is not restricted to Muslim only and is available to non-Muslims as well.