What is Islamic Finance?

2. What is Islamic Finance? Abdul Samad Shariah Advisor The Bank of Khyber

3. Why Islamic Finance? • The body which is promoted by Hiram sources is bound to hellfire. • On the Day of Judgment, a person will not be moved from the place where he stand until he is asked about the sources of his income and they way he spent it. • Purifying of the needs of life (food, drink, clothes house etc) is one of the most important reason for the acceptance of prayers by Allah.

4. Rulings In Islam • These 5 primary objectives follow by Shariah can be observed though the Al Ahkam(rulings) upon which Fiqh (Islamic Jurisprudence) rotate around. The rulings are categorized as follows: • a. Wajib (obligatory) • e. Haram (unlawful) • b. Mustahab (recommended) (Sunnat) • c. Mubah (permissible) • d. Makruh (disliked)

5. Rulings • Wajib- An obligatory action or something that shall be performed. Anyone who leave it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. • Haram- An unlawful action or the one that shall not be performed and is strictly prohibited. Anyone who engages in it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. • Mustahab- A recommended action or something that should be performed. • Mubah- A permissible action or something that is neither encouraged nor discouraged. • Makruh- A disliked action or something which is abominable and should be avoided but not in strictly prohibitory terms.

6. Islam and Shariah

7. Human Financial Needs

8. External (Equity & Debt) Financing

9. Most Important Islamic Teaching Related To Business • Elimination of Interest (Raba) • The prohibition of uncertainty (Gharar) • The prohibition of Gambling (Qimar) • The precipitation of games of chance (Maser) • Honesty and Fair Trade (Ghishshand Khilabah) • Spending in the Good Cause • Buy Back • Two Mutually Conditional Contract • Entitlement to profit depends on liability for risk

10. Interest • Interest, Usury, or Riba is forbidden in almost all major religions of the world e.g. • Judaism • Christianity • Islam

11. Riba in Quran • God has permitted trade and forbidden interest….” (The Cow – Sura Al-Baqara 2:275) • Obelievers, fear Allah, and give up what is still due to your from the interest (usury), IF [indeed] you are true believers[!!!]. If you do not do so, then take Notice of War from Allah and his Messenger. • But, if you repent, you can have your principal. Neither should you commit injustice, nor should you be subjected to it.” (The Cow – Sura Al-Baqara 2:278-9)

12. Riba in Quran (Related in context to 2:278) The only reward of those Who make War upon Allah & his Messenger, and strive after corruption in the land, will be that they will be • Killed • Or, Crucified, • Or, have their Hands and Feet on alternate sides Cutoff, • Or, will be Expelled out of the land. • Such will be their degradation in the world, and • in the hereafter, theirs will be an terrible doom.” (Quran: The Table Spread - Al-Maida Chapter 5: Verse 33)

13. Riba in Hadith The Prophet cursed • the receiver and • the payer of interest, • the one who records it and • the witnesses to the transaction • and said: “They are all alike (in guilt).” (Sources: Jabir Ibn Abdullah, Muslim, Tirmidhi, Musnad Ahmed

14. RIBA

15. The prohibition of uncertainty (Gharar) • There are strict rules in Islamic finance against transactions that are highly uncertain or may cause any injustice or dishonesty against any of the parties.  • The concept of Gharar has been broadly defined by the scholars in two ways. • First, Gharar implies uncertainty. • Second, it implies dishonesty.

16. Classical Examples of Gharar • Selling goods that the seller is unable to deliver • Selling known or unknown goods against an unknown price, such as selling the contents of a sealed box   • Selling goods without proper description, such as shop owner selling clothes with unspecified sizes   • Selling goods without specifying the price, such as selling at the 'going price'   • Making a contract conditional on an unknown event, such as when my friend arrives if the time is not specified   • Selling goods on the basis of false description • Selling goods without allowing the buyer the properly examine the goods • The Prophet (pbuh) prohibited the pebble sale and the Gharar sale.

17. Qimar • Qimar includes every form of gain or money, the achievement of which depends purely on luck and chance. • All Lotteries and Prize schemes based purely on luck come under this prohibition. • O ye who believe! Intoxicants and gambling, sacrificing to stones, and (divination by) arrows, are an abomination, of Satan’s handiwork…..:(5:90-91) • He who played Qimar has disobeyed Allah and His Messenger.” (IbnMajah )

18. Honesty and Fair Trade (Ghishshand Khilabah) • Thus Manipulations and Mismanagement like Hoardings • Black marketing • Cheating • Profiteering • Short weighting • Hiding the defective quality of the goods are prohibited in Islamic Financial System. • The prophet (PBUH) said: the truthful honest merchants are with the prophets in the Day of Judgment.

19. Spending in the Good Cause • The Islamic economic approach is one, which is directed towards the achievement and actualization of justice in human relations. • The result of this effort is falah or success and salvation, and hayahtayyibah or good life in this world and the hereafter. • So Islamic banks don’t permute to establish any relation with commodities, services and individuals whose moral practices are doubtful • Some people spend Allah’s wealth (i.e. Muslim’s Wealth) in an unjust manner, such people will be put in the (Hell) fire on the day of resurrection” (Bukhari and Ahmad)

20. Buy Back • The financier sells an asset to the customer on a deferred-payment basis, and then the asset is immediately repurchased by the financier for cash at a discount.

21. Two Mutually Conditional Contract • Two mutually contingent contract have been prohibited by the holy prohibited by the holy Prophet (pbuh). • The sale of two item in such a way that one who intends to purchase good is obliged to purchase the other also at any given price. • One sale transaction with tow prices. • Combining sale and lending in one contract.

22. WHAT IS ISLAMIC BANKING?

23. WHAT IS BANK? • The name bank derives from the Italian word banco "desk/bench. • In practice, the word “Bank” means an institution which borrows money from people and lends money to people for interest or profit and provided other financial services.

24. BANKS ENGAGE IN THE FOLLOWINNNG ACTIVITIES. • Accepting money • Processing of payments by way oftelegraphic transfer, internet banking, or other means; • Issuingbank draftsand bank cheques • Lending money • Providing documentary and standbyletter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures • Safekeeping of documents and other items insafe deposit boxes

25. WHAT IS ISLAMIC BANKING? Islamic banking has been defined as banking in consonancewith the ethos and value system of Islam and governed, in addition to the conventional good governance and rick management rules by the principle laid down by Islamic Shariah.

26. Comparison of the Islamic and Conventional systems Conventional Banking • Conventional Banks take deposit on interest basis and lend on the basis on interest. A part of interest is paid to the depositors and the remaining interest is left for the bank as its income. If this residual is more than its expenses, it will have Net Income otherwise it will have Net loss. Islamic Banking • Islamic Banking accepts deposits on PLS basis and invest in Shariah based modes. Whatever is the profit, it is shared with depositors. If there is a loss it will also be shared.

27. OBJECTIVES OF ISLAMIC BANKING • Shariah compliant banking, to enableMuslimsto do theirbanking transaction– a Halal way. • Achieving the goals and objectives of an Islamic economy.

28. DEPOSITS • A deposit is an account at a bankinginstitution that allows moneyto be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books. • All deposit appears as liability on Balance Sheet of the Bank.

29. CATEGORIES OF DEPOSIT IN ISLMIC BANKING The Shariah option for deposit mobilization can be worked out by respecting two principles: • The aim of the exchange at hand must be recognizes in Shariah. • The modalities to achieve the said must be Shariah Compliant.

30. GENERAL MOODES OF ISLAMIC BANKING USED TO RAISE DEPOSITS Depositors • Deposit can be accepted by islamic bank on basis of: • Amanah • Qarid Investment Accounts • Islamic banks generally use Musharakah and Mudarabah based product for obtaining investment account. • These deposits are based on the Shariah principles of profit and loss sharing, and the banks use them, along with its own funds in businesses which are Shariah compliant. • Wakala model can also be used for Investment Account.

31. Definition of Qard • In Islamic Shariah, loans called Qard have only one concept as far as return thereon is concerned i.e. these are interest–free. • These are repayable in exactly equal amounts in which these are paid.

32. Definition of Amanah • To give any commodity / asset to anybody for the sake of safety is called Amanah. • Anything given as Amanah is considered to be something held in trust, and the same can not be used.

33. Shirkah

34. MEANING OF SHAIRKAT • The literal meaning of Musharakah is sharing. The root of the word "Musharakah" in Arabic is Shirkah, which means being a partner. • Under Islamic jurisprudence, Musharakah means a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution.

35. Types of Shirkah Shirkah Shirkat-ul-Milk (Co- ownership) Shirkat-ul-Aaqd (Contractual Partnership)

36. Shirkat-ul-Milk(Joint ownership) • Joint ownership of two or more persons in a particular property/ asset with out any business intention. • This comes into being as a result of joint purchase, joint acceptance of gift or a bequest and inheritance of joint property etc.

37. Types of Shirkat-ul-Milk • Shirkat-ul-Milk Optional (Ikhtiari) • This comes into operation through the act of parties e.g., purchase of asset with mutual consent. • Shirkat-ul-Milk Compulsory (GhairIkhtiari) • This comes into operation without any action on the part of parties e.g., ownership of heirs on the inherited property.

38. Shirkat-ul-Aqd(Joint venture/partnership). • Shirkat-ul-Aqd or Contract Partnership is an Agreement between two or more parties to combine their assets or to merge their services or obligations and liabilities with the aim of making profit. • It can also be referred to as a joint commercial enterprise or activity

39. Kinds of Shirkat-ul-Aqd Shirkat-ul-Amwal (Investment /Capital Partnership) Shirkat-ul-Aamal (Work Partnership) Shirkat-ul-Wojooh (Credit Partnership)

40. Shirkat-ul-Amwal Where all the partners invest some capital into a commercial enterprise and share its profits according to agreement.

41. Shirkat-ul-Aamal • Where all the partners jointly undertake to render some services for their customers, and the fee charged from them is distributed among them according to an agreed ratio. • For example, if two persons agree to undertake tailoring services for their customers on the condition that the wages so earned will go to a joint pool which shall be distributed between them

42. Shirkat-ul-Wujooh Where the partners have no investment at all, they purchase commodities on deferred price by their goodwill and sell them on spot. Their capital is their credit worthiness and reputation.

43. Types of Shirkat-ul-Aqd All the three are further divided in to two types: Shirkat-ul-Amwal Shirkat-ul-Aamal Shirkat-ul-Wojooh Shirkat-ul-Mufawadah Shirkat-ul-Inan

44. Subdivision of Shirkat-ul-Aqd • 1-Shirkat-ul-Mufawadah: Where capital, profit, loss and management are equal among the partners. • 2-Shirkat-ul-Inan: Partners’ share capital, management, profit and risk are not equal and may differ for each partner. This is common type of partnership.

46. Shirkat-ul-Ammwal Definition: • It is an agreement between two or more persons to invest a sum of money in a business and share its profits according to agreement. The investment of this partnership consists of capital contributed by the partners.

47. SHIRKAT-UL- AMWAL: Capital of Musharakah • It should be known, ascertained and available at the time of contract. • The value should be agreed upon in case of kinds; • Capital paid in different currencies should be valued into the currency of Shirkah; • Capital advanced by the parties. Should be uniform (currency of partnership). • Share capital in a Musharakah can be contributed either in cash or in the form of commodities • In the letter case the market value of the commodities shall determine the share of the partner in the capital.

48. Management of Musharakah • Each partner has right to take part in Musharakah management. • The partner may appoint a managing partner by mutual consent. • One are more of the partners may decide not to work for the Musharakah and work as a sleeping partner. • It is not allowed to specify a fixed remuneration to a partner Musharaka who manages funds or provides some form of other services, such as accounting; • However, it is permissible to give him a greater share of profit than he would receive solely on the basis of his share in the partnership capital;

49. Distribution of Profit • The ratio of profit distribution must be agreed at the time of execution of the contract. • It is not necessary for sharing profit according to proportionate capital contribution; • It is not allowed to defer the determination of profit until realization of profit. • The ratio must be determined as a proportion on the actual profit earned by the enterprise. • Not as percentage of partner’s investment. • Not in lump sum amount. • It is not allowed to defer the determination of profit until realization of profit. • A sleeping partner cannot share in the profit more than the percentage of his capital.

50. Rules of Loss Determination/Distribution • Sharing of Loss: • As a matter of principle the loss has to be shared according to the ratio of capital contribution; • Partners are not allowed to adopt any other mechanism except the mechanism that ensure distribution of loss among partners on pro rata basis; • Any other arrangement, even agreed upon by partners, will be invalid and void. • It is not allowed to hold one partner or group of partners liable for entire loss.