Isalmic Banking Vs Conventional Banking

Islamic banking and interest based banking
Table of contents
CHAPTER 1 ............................................................... ERROR! BOOKMARK NOT DEFINED.
1.1 EXECUTIVE SUMMARY ............................................................................................................. 5 1.2 1.3 1.4 SCOPE OF THE STUDY .......................................................................................................... 7 OBJECTIVES OF THE STUDY ................................................................................................. 8 METHODOLOGY ................................................................................................................... 8
CHAPTER 2 ................................................................................................................................... 9
LITERATURE REVIEW .............................................................................................................. 9
2.1 WHAT IS BANK? ................................................................................................................... 9
2.2 HISTORY OF BANKING ............................................................................................................ 9
2.3 ISLAMIC BANKING .......................................................................................................... 11
2.4 INTRODUCTION ..................................................................................................................... 12 2.5 HISTORY OF ISLAMIC BANKING........................................................................................... 13 ISLAMIC BANKING: ORIGIN, SCOPE, AND GROWTH .................................................................. 13 TABLE 1 ....................................................................................................................................... 15 2.6 COUNCIL FOR ISLAMIC IDEOLOGY .......................................................................... 16 2.7 ISLAMIC BANKING GLOBAL SCENARIO ............................................................................. 19
2.8 MODES OF ISLAMIC FINANCE ..................................................................................... 23
MURABAHA.................................................................................................................................. 23 IJARAH .......................................................................................................................................... 23 IJARAH-WAL-IQTINA .................................................................................................................. 23 MUSHARAKAH ............................................................................................................................ 24 MUSAWAMAH.............................................................................................................................. 24 ISTISNA'A ..................................................................................................................................... 25 BAI MUAJJAL................................................................................................................................ 25 MUDARABA.................................................................................................................................. 25 BAI SALAM ................................................................................................................................... 26
2.9 ISLAMIC BANKING ISSUES ........................................................................................... 27
HUMAN RESOURCE FOR SHARIA'H COMPLIANCE ................................................................... 27 UNRESOLVED FIQH ISSUES ........................................................................................................ 28 LEGAL FRAMEWORK.................................................................................................................... 28 EXCESS LIQUIDITY ....................................................................................................................... 28
2.10 INTEREST BASED BANKING ....................................................................................... 29
THE ROLE OF INTEREST BASED BANKS ...................................................................................... 30 2.11 PRODUCTS OF INTEREST BASED BANKING ....................................................................... 31 TRANSACTIONAL ACCOUNT ...................................................................................................... 31 SAVINGS ACCOUNT..................................................................................................................... 32
CERTIFICATE OF DEPOSIT ........................................................................................................... 33 CREDIT CARD ............................................................................................................................... 34 DEBIT CARD ................................................................................................................................. 34 MORTGAGE LOAN ....................................................................................................................... 35 UNSECURED DEBT (PERSONAL LOAN) ....................................................................................... 36 LOAN............................................................................................................................................. 36
2.12 ISLAMIC BANKING VS INTEREST BASED BANKING ........................................ 37
2.13 SIMILARITIES AND DIFFERENCES ...................................................................................... 39 DEPOSITS ..................................................................................................................................... 40 FINANCING AND INVESTMENTS ................................................................................................ 41 OVERDRAFTS / CREDIT CARDS .................................................................................................. 42 SHORT TERM LOANS ................................................................................................................... 43 MEDIUM TO LONG TERM LOANS ............................................................................................... 45 LEASING ....................................................................................................................................... 45 AGRICULTURAL LOANS .............................................................................................................. 46 HOUSE FINANCING ..................................................................................................................... 47 INVESTMENTS .............................................................................................................................. 47 2.14 ISLAMIC BANKING PLAYING ROLE IN THE ECONOMIC DEVELOPMENT OF THE WORLD ....................................................................................................................................................... 49 OPERATIONAL CHALLENGES AND PROSPECTS ....................................................................... 52 THE CHALLENGES FACING INDIVIDUAL ISLAMIC BANKS ........................................................ 53 THE CHALLENGE OF ADOPTING AN ISLAMIC FINANCIAL SYSTEM ........................................ 54
MOTIVATING FACTORS FOR ISLAMIC BANKING .................................................................... 56
CHAPTER 3 ................................................................................................................................. 57
3.1 CONCLUSION .......................................................................................................................... 57 3.2 BIBLIOGRAPHY ....................................................................................................................... 58
CHAPTER 1
1.1 Executive summary
This study is undertaken to understand the concept of Islamic banking and interest based banking, the difference between the two systems and their economic implications for an economy. In general terminologies, a financial institution or a financial
intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets is given the name of bank. The prime source of revenue and cost of funds to conventional banks (interest based banks) is charging interest through lending and accepting deposits for interest respectively. Interest is the major driver of operations of conventional banks although other valuable services including guarantees, funds transfers, safety of wealth, facilitation in international trade etc. also form a substantial part of income of banks. Islamic banking, on the other hand, is a banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and un-social practices. In practical sense, Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic prosperity. The origination of term interest dates back to 17th century with the emergence of banking system at global level. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning/value as that of Riba. Further, it is narrated that the loan that draws interest is Riba. There is consensus among the Muslim scholars of all the fiqhs that interest is Riba in all its forms and manifestations.
Islamic Financial Institutions (IFIs) are operating in the same society where conventional banks are operating and perform all those functions which are expected from a financial institution. IFIs are assisting business world by providing all the services required to run the economy smoothly, however, the philosophy and operations are different. In this study I will analyze the operations and products of IFIs in comparison with traditional conventional banks. Any financial system is expected to assist in running the economy by providing the following services grouped in two headings. First; Savings mobilization from savers to entrepreneurs and Second; Provision of general utility services including transfer of funds, facilitation in international trades, consultancy services, safekeeping of valuables, and any other service for a fee. There is no restriction on provision of such services by IFIs as for the service is not against the Sharia. However there exists difference in mechanism of funds mobilization from savers to entrepreneurs as described following. Savings mobilization consists of two phases i.e. accepting deposits and extending financing an d investments.
1.2 Scope of the Study

The focus of the study will be on: Introduction to Islamic banking and interest based banking Products if Islamic and interest based banking Difference between interests based and islamic banking. Major modes of Islamic banking and finance Practical aspects of Islamic banking and its economy wide implications.
1.3 Objectives of the Study

What are Islamic Banking and its philosophy? What are interests based banking and its philosophy? What are the basic principles of Islamic banking? What is the difference between interests based banking and Islamic banking?
1.4 Methodology
The material of the study will authentically be obtained from secondary sources such as books, research reports, and research articles taken from Internet
Chapter 2 Literature review 2.1 What is bank?

A bank is a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers that have capital deficits to customers with capital surpluses. Due to their critical status within the financial system and the economy generally, banks are highly regulated in most countries. Most banks operate under a system known as fractional reserve banking where they hold only a small reserve of the funds deposited and lend out the rest for profit. They are generally subject to minimum capital requirements which are based on an international set of capital standards, known as the Basel Accords.
2.2 History of banking

The History of Banking begins with the first prototype banks of merchants of the ancient world that made grain loans to farmers and traders carrying goods between cities; recorded as having occurred at about 2000 BC within the areas of Assyria and Babylonia. Later on, in ancient Greece and during the Roman Empire, lenders based in temples made loans and added two important innovations: the accepting of deposits and the changing of money. Archaeology from this period in ancient China and India shows the existence also of money lending activity.
Banking, in the modern sense of the word, can be traced to medieval and early Renaissance Italy, to the rich cities in the north such as Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in 14th century Florence, establishing branches in many other parts of Europe. Perhaps the most famous Italian bank was the Medici bank, established by Giovanni Medici in 1397. The development of banking spread through Europe also and a number of important innovations took place in Amsterdam during the Dutch Republic in the 16th century and in London in the 17th century. During the 20th century, developments in telecommunications and computing resulting in major changes to the way banks operated and allowed them to dramatically increase in size and geographic spread. The Late-2000s financial crisis saw significant number of bank failures, including some of the world's largest banks, and much debate about bank regulation.
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2.3 Islamic banking

Islamic banking is based on the principles of Islamic economics an economic framework in accordance with Islamic law (Sharia'h). There are two types of Islamic economics:
Caliphate , the Islamic form of government representing the political unity and leadership of the Muslim world (Islamic political framework) Assuming the political framework is non-Islamic, therefore, seeking to integrate some prominent Islamic tenets into a secular economic framework
Caliphate is the absolute Islamic rule, thus the economy focuses on distribution of resources in order to meet the basic and luxurious needs of individuals in society, and the state has a clear role in policing, taxation, managing public assets, and ensuring the circulation of wealth. Such a political framework in its true form does not exist in today's world. Assuming non-Islamic political framework simply proposes two main tenets: no interest can be earned on loans and socially responsible investing. This is the way interest based banking is Islamizedthe first step towards an Islamic economic framework. Modern day Islamic scholars and academics have developed various modes of Sharia'h complaint financing that are designed to work within the prevailing capitalist economic framework. In order to achieve this balance numerous concessions have been afforded to financial institutions that would not apply if a
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viable interest free economic system existed. The intention behind making these concessions is to encourage the evolution of this type of alternative system.
2.4 Introduction
Islamic banking refers to a system of banking or banking activity that is consistent with Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection and payment of interest, also commonly called riba. Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered unlawful, or haraam.
Islamic finance has been gaining momentum on a global scale for the last 30 years. Many Islamic Banks have sprung up over the last few years. These changes are occurring both in Muslim and in western countries, and are driven by a global trend amongst Muslims to become more observant of their faith. It might have been the reason why Islamic Banking emerged, however, today Islamic Banking is sought by Muslims and non-Muslims due to the benefits it offers. Industry size is currently estimated at more than $400 billion, with projected growth of 15% per annum.
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Financial institutions around the globe are trying to keep pace with the growing demand for Shariah compliant products and services.
2.5 History of Islamic banking

ISLAMIC BANKING: ORIGIN, SCOPE, AND GROWTH
The first modern experiment with Islamic banking was undertaken in Egypt under cover, for fear of being labeled as a manifestation of Islamic fundamentalism, which was anathema to the government in power. It took the form of a saving bank based on profit-sharing in the town of Mit Ghamr, lasted until 1967, by which time there were nine such banks in the country. These banks neither charged nor paid interest, invested mostly in trade and industry, directly or in partnership with others, and shared profits with depositors. The 1970s heralded the arrival of a new age in Islamic finance witnessing the establishment of the Nasr Social Bank in 1971 (Egypt), Philippine Amanah Bank in 1973, the Dubai Islamic Bank in 1975, the Kuwait Finance House, the Faisal Islamic Bank of Sudan, and the Faisal Islamic Bank of Egypt, all in 1977, the Bahrain Islamic Bank in 1979, and the Qatar Islamic Bank in 1981, to mention a few. By the end of 1996 the number of Islamic banks, IBs, rose to 166 with a total paid-up tier-one capital of $7.3 billion, and total assets of $137 billion. Moreover, if one excludes the Iranian and Pakistani IBs, the countries that operate under the Islamic system of banking (along with Sudan), only 40 percent of the paid-up capital and 30 percent of total assets are commanded by those
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from other countries. These percentages do not tell the whole picture. The 19 Gulf Cooperative Council, GCC, states command 18 percent of the total paid-up capital, and 13 percent of total assets of all IBs. In other words, 10 Iranian, 46 Pakistani, and 19 GCC IBs totaling 75 out of 166, command 78 percent of total paid-up capital and 83 percent of total assets for the IBs. These numbers appear impressive if one ignores the size of a single large commercial bank in many developed economies of the West. Thus, it is quite obvious that IBs are relatively very small and a few of them are not even profitable Table 1 shows the number of IBs by region, their capital, total assets, and capital-to-asset ratios for the year-end 1996. Of the 50 financial institutions in South Asia, 5 are in Bangladesh (total capital of $20.6 million, total assets of $594 million), 1 is in India (total capital of $1.2 million, total assets of $3.5 million), and the remaining 46 are in Pakistan. Of the 35 institutions in Africa, Algeria, Djibouti, Gambia, Guinea, Mauritania, Niger, South Africa, Senegal, and Tunisia have 1 bank each, and the remaining 26 are in Sudan. Total capital of those 9 countries' institutions is $102 million with assets of $376 million representing roughly 48 and 19 percent respectively of those of all Africa. Of the 30 IBs in Southeast Asia, 3 are in Brunei, 4 are in Malaysia, 1 is in the Philippines, and the remaining 22 are in Indonesia. Two Malaysian Banks-Bank Islam Malaysia Berhad and Lembaga Tabung Haji-together account for $3.3 billion of the total assets of $3.8 billion for the entire region. Middle East is defined here as Egypt, Iran, Iraq, Jordan, Lebanon, Turkey and Yemen. Egypt has 4 IBs (total capital of$337 million with assets totaling $4. billion), Iran has 10 (total capital of $32.4 billion with assets totaling $50.2 billion), Iraq has 1 (capital $402 million with assets of $9.9 billion), Jordan has 2 (capital of $23.5 million
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TABLE 1
ISLAMIC BANKS AND FINANCIAL INSTITUTIONS AT YEAR-END 1996 (in $ million) Region # of Capital Total Assets Total Net Capital Net to Asset in % Profit as of Total Assets South Asia Africa Middle East1 GCC2 Europe America Total 166 7,270 137,131 101,163 1,686 5.3 1.2 1 -Middle East includes Egypt, Iran, Iraq, Jordan, Lebanon, Turkey, and Yemen. 2- GCC stands for Gulf Cooperation Council, consisting of Bahrain, Kuwait, Qatar, Saudi Arabia, and United Arab Emirate (UAE). SOURCE: International Association of Islamic Banks, Jeddah, Saudi Arabia, quoted by Timewell (1998). 50 35 24 19 & 8 962 213 136 4,060 1,340 559 45,201 1,951 3,801 67,142 18,084 952 27,042 603 1,572 54,288 16,494 1,164 350 39 184 373 686 54 2.1 10.9 3.6 6 7.4 58.7 0.8 2.0 4.8 0.6 3.8 5.7 %
Banks
Deposits Profit
Southeast Asia 30
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2.6 COUNCIL FOR ISLAMIC IDEOLOGY

In 1980, a think tank by the name Council of Islamic Ideology (C.I.I.), consisting of 15 eminent jurists, scholars, economist and bankers was formed. Their task was to recommend to the Federal Government all possible avenues and amendments to bring the existing laws and practices of the country in conformity with the injunctions of Islam. C.I.I., after several meetings and extensive brain storming, apart from recommendations in lieu of other civil and criminal laws, suggested to the Federal Government that an interest free banking system should be introduced in the country. Their first recommendation was that Interest, referred to as "Riba" in the Holy Quran, based on Verses 278 and 279 of Surah Al Baqarah, is Haram. Allah Almighty and his Messenger (PBUH) have declared war on those who indulge themselves in Riba. C.I.I, recommended that instead of lending money on basis of interest/ Riba, the financing in the shape of Islamic financing Bai Muajjal (deferred sale) should be adopted. In furtherance to the above, the Federal Government adopted the system of mark-up in January, 1981 and repealed Interest Act, 1839. On the basis of the foregoing recommendations of the C.I.I., agreed to by the Federal Government, the State Bank of Pakistan's Banking Control Department, issued Circular Nos.13 and 32, dated 20th June, 1984 and 26th November, 1984, respectively. Through the earlier circular, the intention of the government to shift the interest based banking to Islamic modes of financing was revealed. In
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that circular, the financial institutions/banks were barred from receiving any interest bearing deposits from July 1, 1985. As regards the loaning, it was suggested that the banks should adopt the Islamic mode of financing, mentioned in the 1st Annexure of the circular, i.e. mark-up (Bai Muajjal), Musharika (profit loss sharing), Morabaha (hire purchase, leasing etc). The second circular barred the banks from charging mark-up on mark-up on overdue loans as penalty. The C.I.I., in order to establish interest free/Riba free banking system in Pakistan, proposed amendments in the following laws: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (1) (n) (o) (p) (q) The Interest Act of 1839 The Government Saving Banks Act of 1873 (Section-10) The Negotiable Instrument Act of 1881 (Sections-79, 80, 114 & 117) The Land Acquisition Act, 1894 (concerned provisions) The Code of Civil Procedure, 1908 (concerned provisions) The Cooperative Societies Act, 1925 (concerned provisions) The Cooperative Societies Rules, 1927 (concerned provisions) The Insurance Act, 193 8 (concerned provisions) The State Bank of Pakistan Act, 1956 (Section-22(l) The West Pakistan Money Landers Ordinance, provisions) The West Pakistan Money Lenders Rules, 1965 (concerned provisions) The Punjab Money Lenders Ordinance, 1960 (concerned provisions) The NWFP Money Lenders Ordinance, 1960 (concerned provisions) The Baluchistan Money Lenders Ordinance, 1960 (concerned provisions) The Agricultural Development Banks Rules 1961 (Rule No. 17 (1) (2) & (3) The Banking Companies Ordinance, 1962 (Section 25 (2a&b)) (r) Banking Companies Rules, 1963 (Rule No.9 (2&3) The 1960 (concerned
(m) The Sindh Money Lenders Ordinance, 1960 (concerned provisions)
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(s) (t) (u)
The Banks (Nationalization) Payment of Compensation Rules, 1974 (Rule 9) The Banking Companies (Recovery of Loans) Ordinance, 8(2a&b) The Constitution of Pakistan 1973 (Article No.203 (a) to 203(j) and 270(a) 1979 (Section
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2.7 Islamic Banking Global Scenario

Over the last three decades Islamic banking and finance has developed into a full-fledged system and discipline reportedly growing at the rate of 15percent per annum. Today, Islamic financial institutions, in one form or the other, are working in about 75 countries of the world. Besides individual financial institutions operating in many countries, efforts have been underway to implement Islamic banking on a country wide and comprehensive basis in a number of countries. The instruments used by them, both on assets and liabilities sides, have developed significantly and therefore, they are also participating in the money and capital market transactions. In Malaysia, Bahrain and a few other countries of the Gulf, Islamic banks and financial institutions are working parallel with the interest based system
Bahrain with the largest concentration of Islamic financial institutions in the Middle East region, is hosting 26 Islamic financial institutions dealing in diversified activities including commercial banking, investment banking, offshore banking and funds management. It pursues a dual banking system, where Islamic banks operate in the environment in which Bahrain Monetary Agency (BMA) affords equal opportunities and treatment for Islamic banks as for interest based banks. Bahrain also hosts the newly created Liquidity Management Centre (LMC) and the International Islamic Financial Market (IIFM) to coordinate the operations of Islamic banks in the world. To provide appropriate regulatory set up, the BMA has introduced a comprehensive prudential and reporting framework that is industry-specific to the concept of Islamic banking and finance. Further, the BMA has pioneered a range of innovations designed to broaden the
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depth of Islamic financial markets and to provide Islamic institutions with wider opportunities to manage their liquidity.
Another country that has a visible existence of Islamic banking at comprehensive level is Malaysia where both interest based and Islamic banking systems are working in a competitive environment. The share of Islamic banking operations in Malaysia has grown from a nil in 1983 to above 8 percent of total financial system in 2003. They have a plan to enhance this share to 20 percent by the year 2010. However, there are some conceptual differences in interpretation and Shariah position of various contracts like sale and purchase of debt instruments and grant of gifts on savings and financial papers.
In Sudan, a system of Islamic banking and finance is in operation at national level. Like other Islamic banks around the world the banks in Sudan have been relying in the past on Murabaha financing. However, the share of Musharaka and Mudaraba operations is on increase and presently constitutes about 40 percent of total bank financing. Although the Islamic financial system has taken a good start in Sudan, significant problems still remain to be addressed.
Like Sudan, Iran also switched over to Usury Free Banking at national level in March 1984. However, there are some conceptual differences between Islamic banking in Iran and the mainstream movement of Islamic banking and finance. Owing to the growing amount of capital availability with Islamic banks, the refining of Islamic financing techniques and the huge requirement of infrastructure development in Muslim countries there has been a large number of project finance deals particularly in the Middle East region. Islamic banks now participate in a wide financing domain stretching from simple Shariah-compliant retail products to highly complex structured finance and large-scale project
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lending. These projects, inter alia, include power stations, water plants, roads, bridges and other infrastructure projects. Bahrain is the leading centre for Islamic finance in the Middle East region. The establishment of the Prudential Information and Regulatory Framework for Islamic Banks (PIRI) by the BMA in conjunction with AAOIFI has gone a long way towards establishing a legal and regulatory framework to meet the specific risks inherent in Islamic financing structures. The BMA has quite recently signed MoU with the London Metal Exchange (LME) to pool assets to develop and promote Shariah compliant tradable instruments for Islamic banking industry. The arrangement is seen as a major boost for industrys integration in the global financial system and should set the pace for commodity-trading environment in Bahrain. BMA has also finalized draft guidelines for issuance of Islamic bonds and securities from Bahrain. In May 03, the Liquidity Management Centre (LMC) launched its debut US$ 250 million Sukuk on behalf of the Government of Bahrain.
National Commercial Bank (NCB) of Saudi Arabia has introduced an Advance Card that has all the benefits of a regular credit card. The card does not have a credit line and instead has a prepaid line. As such, it does not incur any interest. Added benefits are purchase protection, travel accident insurance, etc and no interest, no extra fees with any conditions, the card is fully Shariah compliant. It is more secure than cash, easy to load up and has worldwide acceptance. This prepaid card facility is especially attractive to women, youth, self employed and small establishment employees who sometimes do not meet the strict requirements of a regular credit card facility. Saudi Government has also endorsed an Islamic-based law to regulate the kingdom's lucrative Takaful sector and opened it for foreign investors.
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Islamic banks have also built a strong presence in Malaysia, where Standard & Poor's assigned a BBB+ rating to the $600 million Sharia-compliant trust certificates (called Sukuk) issued by Malaysia Global Sukuk Inc. Bank Negara Malaysia (BNM) has announced to issue new Islamic Bank licenses to foreign players. The Financial Sector Master plan maps out the liberalization of Malaysia's banking and insurance industry in three phases during the next decade. It lists incentives to develop the Islamic financial sector and enlarge its market share to 20 percent, from under 10 percent now. A dedicated high court has been set up to handle Islamic banking and finance cases.
In United Kingdom, the Financial Services Authority is in final stages of issuing its first ever Islamic banking license to the proposed Islamic Bank of Britain, which has been sponsored by Gulf and UK investors. The United States of America has appointed Dr. Mahmud El Gamal, an eminent economist/expert on Islamic banking to advise the US Treasury and Government departments on Islamic finance in June 2004.
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2.8 Modes of Islamic Finance

Murabaha
Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance.
Ijarah
Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.
Ijarah-Wal-Iqtina
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A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.
Musharakah
Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.
Musawamah
Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to reveal his cost. Both the parties negotiate on the price. All other
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conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.
Istisna'a
It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Istisna'a can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways.
Bai Muajjal
Literally it means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal. It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.
Mudaraba
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A form of partnership where one party provides the funds while the other provides expertise and management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a pre-agreed basis, while loss is borne only by the provider of the capital.
Bai Salam
Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies. Barring this, Bai Salam covers almost everything, which is capable of being definitely described as to quantity, quality and workmanship
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2.9 Islamic Banking Issues

Human resource for Sharia'h compliance
Users of Islamic financial services assign primary importance to Sharia'h compliance of the services they use. It is understandable that Sharia'h noncompliance entails a serious operational risk and can result in withdrawal of funds from and instability of an Islamic bank, irrespective of its initial financial soundness. Sharia'h compliance is hence a serious matter for an Islamic bank, in addition to its compliance with other regulatory requirements.
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Unresolved Fiqh Issues

Lack of standard financial contracts and products can be a cause of ambiguity and a source of dispute and cost. In addition, without a common understanding of certain basic foundations, further development of banking products is hindered.
Legal framework
An appropriate legal, institutional and tax framework is a basic requirement for establishing sound financial institutions and markets. Islamic jurisprudence offers its own framework for the implementation of commercial and financial contracts and transactions. Nevertheless, commercial, banking and company laws appropriate for the enforcement of Islamic banking and financial contracts do not exist in many countries.
Excess Liquidity
Islamic banks have over 60 % excess liquid funds which cannot be properly utilized due to non-availability of Sharia'h Compliant products and instruments. The competitiveness and soundness of financial institutions depend on the availability of efficient financial products. Islamic banks urgently need Sharia'h compliant products to meet a number of pressing needs.
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2.10 Interest based Banking

Interest based banking is based on the principle that the more you have, the more you can get. In other words, if you have little or nothing, you get nothing. As a result, more than half the population of the world is deprived of the financial services of the interest based banks. Interest based banking is based on collateral. Interest based banks look at what has already been acquired by a person Interest based banks go into punishment mode when a borrower is taking more time in repaying the loan than it was agreed upon. They call these borrowers defaulters. When a client gets into difficulty, interest based banks get
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worried about their money, and makes all efforts to recover the money, including taking over the collateral. In interest based banks charging interest does not stop unless specific exception is made to a particular defaulted loan. Interest charged on a loan can be multiple of the principal, depending on the length of the loan period.
The role of interest based banks

Interest based banks engage in the following activities: Processing of payments by way of telegraphic transfer, internet banking, or other means Issuing bank drafts and bank cheques Accepting money on term deposit Lending money by overdraft, installment loan, or other means Providing documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures Safekeeping of documents and other items in safe deposit boxes Sales, distribution or brokerage, with or without advice, of: insurance, unit trusts and similar financial products as a financial supermarket
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Cash management and treasury merchant banking and private equity financing Traditionally, large interest based banks also underwrite bonds, and make markets in currency, interest rates, and credit-related securities, but today large interest based banks usually have an investment bank arm that is involved in the mentioned activities
2.11 Products of interest based banking

Products offered by mostly interest based banking usually called interest based banking are given below Transactional account Savings account Certificate of deposit Credit card Debit card Mortgage loan Unsecured debt(personal loan) Loan
Transactional account
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A transactional account is a deposit account held at a bank or other financial institution, for the purpose of securely and quickly providing frequent access to funds on demand, through a variety of different channels. Transactional accounts are meant neither for the purpose of earning interest nor for the purpose of savings, but for convenience of the business or personal client; hence do they tend not to bear interest. Instead, a customer can deposit or withdraw any amount of money any number of times, subject to availability of funds.
Savings account
savings accounts are accounts maintained by retail financial institutions that pay interest but cannot be used directly as money in the narrow sense of a medium of exchange (for example, by writing a check). These accounts let customers set aside a portion of their liquid assets while earning a monetary return. For the bank, money in a savings account may not be callable immediately and therefore often does not incur a reserve requirement freeing up cash from the bank's vault to be lent out with interest. Withdrawals from a savings account are occasionally costly, and they are more time-consuming than withdrawals from a demand (current) account. However, most saving accounts do not limit withdrawals, unlike certificates of deposit. In the United States, violations of Regulation D often involve a service charge, or even a downgrade of the account to a checking account. With online accounts, the main penalty is the time required for the Automated Clearing House to
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transfer funds from the online account to a "brick and mortar" bank where it can be easily accessed. During the period between when funds are withdrawn from the online bank and transferred to the local bank, no interest is earned.
Certificate of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually risk free; they are "money in the bank". CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA) for credit unions. They are different from savings accounts in that the CD has a specific, fixed term (often monthly, three months, six months, or one to five years), and, usually, a fixed interest. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. Fixed rates are common, but some institutions offer CDs with various forms of variable rates.
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Credit card
Credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. A credit card is different from a charge card: a charge card requires the balance to be paid in full each month. In contrast, credit cards allow the consumers a continuing balance of debt, subject to interest being charged. A credit card also differs from a cash card, which can be used like currency by the owner of the card. Most credit cards are issued by banks or credit unions, and are the shape and size specified by the ISO/IEC 7810 standard as ID-1. This is defined as 85.60 53.98 mm (33/8 21/8 in) in size.
Debit card
A debit card (also known as a bank card or check card) is a plastic card that provides the cardholder electronic access to his or her bank account(s) at a financial institution. Some cards have a value with which a payment is made, while most relay a message to the cardholder's bank to withdraw funds from a designated account in favor of the payee's designated bank account. The card can be used as an alternative payment method to cash when making purchases. In some cases, the primary account number is assigned exclusively for use on the Internet and there is no physical card.
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In many countries, the use of debit cards has become so widespread that their volume has overtaken or entirely replaced checks and, in some instances, cash transactions. The development of debit cards, unlike credit cards, has generally been country specific resulting in a number of different systems around the world, which were often incompatible. Since the mid 2000s, a number of initiatives have allowed debit cards issued in one country to be used in other countries and allowed their use for internet and phone purchases. Unlike credit cards, the funds paid using a debit card are transferred from the bearer's bank account, instead of having the bearer pay back the money at a later date. Debit cards usually also allow for instant withdrawal of cash, acting as the ATM card for withdrawing cash. Merchants may also offer cash back facilities to customers, where a customer can withdraw cash along with their purchase
Mortgage loan
A mortgage a mortgage loan is a loan secured by real evidences that realty loan. the property through existence through the of the the use of and of in note which the loan
the encumbrance of
granting
mortgage which secures the
However,
word mortgage alone,
everyday usage, is most often used to mean mortgage loan. The word mortgage is a Law French term meaning "death contract," meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure. A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank, either directly or indirectly through intermediaries. Features of mortgage loans such as
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the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably. In many jurisdictions, though not all (Bali, Indonesia being one exception), it is normal for home purchases to be funded by a mortgage loan. Few individuals have enough savings or liquid funds to enable them to purchase property outright. In countries where the demand for home ownership is highest, strong domestic markets have developed.
Unsecured debt (personal loan)

n finance, unsecured debt refers to any type of debt or general obligation that is not collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors. In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower.
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In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent.
2.12 Islamic Banking Vs Interest based banking
The main difference between Islamic and interest based banking is that Islamic teaching says that money itself has no intrinsic value, and forbids people from profiting by lending it, without accepting a level of risk in other words, interest (known as "riba") cannot be charged. To make money from money is prohibited wealth can only be generated through legitimate trade and investment. Any gain relating to this trading is shared between the person providing the capital and the person providing the expertise.
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At Islamic Bank of Britain, we generate all our profit through Shariah compliant trading and investment activities. We then share the profits with our customers at a pre-agreed ratio. In order to share profits you must hold one of our savings or investment accounts There are two major differences between Islamic Banking and Interest based banking: 1. Interest based banking practices are concerned with "elimination of risk" where transaction. 2. When Interest based banks involve in transaction with consumer they do not take the liability only get the benefit from consumer in form of interest whereas Islamic banks bear all the liability when involve in transaction with consumer. Getting out any benefit without bearing its liability is declared Haram in Islam. While the basics of what the business is are the same, the term refers to operating the business within Islamic law. The main thing that affects this business under that law is that Islam prohibits the charging of interest. Certainly a problem in modern banking! However, what is considered to be interest has different definitions by different Islamic scholars...some say it can only be considered on gold and silver...but paying back the same weight as you borrowed (the same weight of paper money for example), is not interest. Like in all religious things, there would seem to be some conflict and differences between followers that may seem strange to outsiders. as Islamic banks "bear the risk" when involve in any
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So basically, modern Islamic banking may take many forms, each of which strives to adhere to it understands of Islamic law.
2.13 Similarities and Differences

Islamic Financial Institutions (IFIs) are operating in the same society where interest based banks are operating and perform all those functions which are expected from a financial institution. IFIs are assisting business world by providing all the services required to run the economy smoothly, however, the philosophy and operations are different. In this section I will analyze the operations and products of IFIs in comparison with traditional Interest based banks. Any financial system is expected to assist in running the economy by providing the following
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Services grouped in two headings. First; Savings mobilization from savers to entrepreneurs and Second; Provision of general utility services including transfer of funds, facilitation in international trades, consultancy services, Safekeeping of valuables, and any other service for a fee. There is no restriction on provision of such services by IFIs as for the service is not against the Sharia. However there exists difference in mechanism of funds mobilization from savers to entrepreneurs as described following. Savings mobilization consists of two phases i.e. Accepting deposits and extending financing and investments.
Deposits
Deposits are collected from savers under both types of institutions for reward irrespective a bank is operating under interest based system or Islamic system. The difference lies in agreement of reward. Under interest based system reward is fixed and predetermined while under Islamic deposits are accepted through Musharaka and Mudaraba where reward is variable. Under interest based banking return is higher on long-term deposits and lower for shortterm deposits. Same is the practice in Islamic banking to share profit with depositors. Higher weight for profit sharing is assigned to long-term deposits being available to bank for investing in longer term projects yielding superior returns and lower weight for short-term deposits which cannot be invested in long term projects. The only difference in interest based and
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Islamic system lies in sharing of risk and reward. Under interest based system total risk is born by the bank and total reward belongs to it after servicing the depositors at fixed rate while under Islamic system risk and reward both are shared with depositors. Reward of depositors is linked with outcomes of investments made by IFIs. Under Islamic financial system only those IFIs will be able to collect deposits who can establish trust in the eyes of masses hence leading to optimal performance by financial industry. So for IFIs workings in Pakistan have succeeded in establishing their credibility in the eyes of savers.
Financing and Investments

The second phase in savings mobilization process is extension of credit facility to business and industry for return. Both types of institutions (Islamic and Interest based) are providing financing to productive channels for reward. The difference lies in financing agreement. Interest based banks are offering loan for a fixed reward while IFIs cannot do that because they cannot charge interest. IFIs can charge profit on investments but not interest on loans. In interest based banking three types of loans are issued to clients including short term loans, overdrafts and long-term loans. Islamic banks cannot issue loans except interest free loans (Qarz e Hasna) for any requirement however they can do business by providing the required asset to client. In following
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paragraphs I present the comparative working of different products (financing scheme) of both systems.
Overdrafts / Credit Cards

Interest based banks offer the facility of overdrawing from account of the customer on interest. One of its form is use of credit card whereby limit of overdrawing for customer is set by the bank. Credit card provides dual facility To customer including financing as well as facility of plastic money whereby customer can meet his requirement without carrying cash. As for facility of financing is concerned that is not offered by Islamic banks except in the form of Murabaha (which means IFI shall deliver the desired commodity and not the cash) however facility to shop/meet requirement is provided through debit card whereby a customer can use his card if his account carries Credit balance. Under interest based banking a customer is charged with interest once the facility availed however under Murabaha only profit is due when the commodity is delivered to the customer. Furthermore in case of default customer is charged with further interest for the extra period under interest based system however extra charging is not allowed under Murabaha.
Third under interest based system customer can avail the opportunity of rescheduling by entering into a new agreement to pay interest for extended period which is not the case under Murabaha. IFIs can claim only the original receivable amount agreed in initial contract. Another practical issue under Murabaha is how to deal with intentional defaulters. Different options are lying with IFIs including to blacklist the defaulter for any further financing
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facility, to stipulate in the contract that in case of default all installments will be due at once, to stipulate in the contract a penalty shall be imposed but the same shall not form income of IFIs rather it will go in charity
Short term loans

Short term and medium term loans are provided to customer to meet working capital requirements of firm by interest based banks. Working capital is required by firms to invest in inventories and accounts receivables and meet the expenses. As for inventory investment is concerned that is provided by Islamic banks through Murabaha. As for meeting of day to day expenses of business is concerned financing is provided through participation term certificates where by profit of a certain period (e.g. quarter, six month, one year) is shared by IFIs on prorate basis. However financing through participation term certificates is not as easy as a short term loan from interest based bank due to risk seeking short-term facility of involved for IFIs in the prove to the transaction. Firm viability of is the no from IFIs has to nonprofit
project/business to the satisfaction of investor. For meeting the working capital requirements organizations date there arrangement under Islamic financial system. Personal consumption loans are also not issued by IFIs how ever any individual of sound financial position can acquire anything for his personal use under Murabaha financing whereby a certain percentage of profit is added on cost by IFIs. Murabaha financing is very useful for short to medium term financial requirements of business/nonprofit organizations and individuals. Murabaha financing is asset based financing and anyone can request to an IFI for provision of an asset generally used for Halal (lawful) purposes. By default under Islamic financial system IFIs cannot lend cash for interest (only exception is Qarz e Hasna
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Charity loan). One of the features of Murabaha is in case of delay in payment by customer IFI cannot ask for extra amount as time value of money like interest based banks. However penalty is imposed on defaulter if stipulated in original contract of Murabaha duly signed by the customer but same cannot be included in the income of IFI. This penalty must be which leads to economic stability and creates linkage between real and financial sector. It is not zero sum game because utility is created through services and products and not by mere building the blocks of wealth through dealing in paper money. Although Murabaha is being used by IFIs successfully and have succeeded in meeting short to medium term requirements of firms by providing a successful replacement of interest based loans yet certain differences exist in both type of financing. First is one cannot get cash under Murabaha. Second asset is purchased by IFI initially then transferred to customer hence IFI participate in risk. Third refinancing facility is not available under Murabaha. Fourth in case of default price of the commodity cannot be enhanced however penalty may be imposed if stipulated in original contract of Murabaha however same cannot be included in income of IFI. Fifth only those assets can be supplied by IFIs under Murabaha whose general and/or intended use is not against the injunctions of Sharia (e.g. supply of a machine to produce liquor) spent for charitable
purposes. Under Murabaha scheme of financing facility is linked with assets
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Medium to long term loans

Medium to long-term loans are provided for purchase or building of fixed assets by firms to expand or replace the existing assets. Under Islamic financial system requirement of firms and individuals are fulfilled through Murabaha, Bai Muajjal and Istasna (discussed in appendix B). Another financing option for long-term financing is profit sharing under Musharaka and Mudaraba (discussed in appendix B). Although financing under Murabaha, Bai Muajjal and Istasna is very much look like interest based loans with the only difference of provision of asset and not cash to client however differences exist in the contracts which alter the nature of risks and returns. Financing under Musharaka and Mudaraba is challenging for IFIs and firms as well. Under Sharia based financing schemes firms have to prove the viability/profitability of the project/business to the satisfaction of IFIs to get the finance because risk of losing the amount is involved.
Leasing
Leasing is relatively recent source of financing whereby usufruct of an asset is transferred to lessee for agreed amounts of rentals. Under leasing ownership may or may not be transferred. Same facility is provided by IFIs under agreement of Ijara. Under Ijara asset is provided to customer for use with out transfer of ownership for a specific period of time in exchange for agreed rentals. Ownership of asset can be transferred to customer through mutual agreement at the completion of lease term. All ownership risks are born by IFIs during Ijara tenure. Certain differences exist in the transaction under both systems. First is rental under
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Ijara
are not
due until asset is
delivered to the
lessee for use. Second
additional rent cannot be demanded in case of default except a penalty (if stipulated in original contract of lease) which is not the income of IFI. Third during period of major repair rent cannot be demanded by IFI. Fourth if asset is lost or destroyed IFI cannot claim further installments hence all risks of ownership are born by IFI.
Agricultural Loans
Agricultural loans include both types of loans short-term as well as long-term. Short-term loans are required by farmers for seeds and fertilizers and longterm loans are required to develop additional lands and purchase of equipments. Normally farmers return these loans after selling the finished crops. Interest based banks are providing credit facility by charging interest. Same facility is provided by IFIs to the farmers under Bai Slam, Bai Murabaha Musharaka and Mudaraba (discussed in appendix B). Under Bai Salam cash is provided to farmers for purchase of seeds and fertilizers however this is not loan rather purchase of finished crops to be delivered by farmers. For purchase of equipments Murabaha facility is used and for development of additional land Musharaka and Mudaraba is used by IFIs. To get finance for land development farmers have to convince the IFIs about profitability of the venture due to risk involved in the transaction.
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House financing
Housing finance/Mortgages is the more secured form of financing for both interest based banks and IFIs. Under interest based system loan is provided for interest while under Islamic financial system facility is provided through diminishing Musharaka. Under diminishing Musharaka house is purchased jointly by IFI and customer. IFI rents out its share in property to customer for an agreed amount of rent. Share of financier is divided in units of small denomination. Customer pays the installments to IFI consist of rentals plus purchase price of a unit. Stake of customer in property is increasing while of IFI is decreasing with payment of every installment. Finally with the payment of last installment stake of IFI reaches to zero and property is transferred in the name of customer. Diminishing Musharaka model can help out in avoiding the real estate crisis (like of 2008) because on when market value of property decreases both IFI and Hanif (2010) have raised certain customer suffers according to their share in property and whole burden is not shifted customer alone. Hijazi, & questions about the existing practice of IFIs working in Pakistan and needs to be addressed by policymakers, Sharia boards and management of IFIs.
Investments
In order to maintain liquidity interest based banks have many avenues including government securities, shorter term loans and money at call and short notices, leasing companies bonds, investment in shares etc. Interestingly mandatory reserve maintenance by interest based banks with central banks is also rewarded in the form of interest. Interest based banks can also create liquidity by issuing the bonds against their receivables. Commercial banks are also protected by central bank by providing liquidity in rainy days for
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interest. Interbank deposits are also rewarded in the form of interest by commercial banks.For IFIs avenues are very limited to create required liquidity at the same time to earn some revenue by investing in short term and liquid securities. IFIs cannot invest in government securities, short term loans, bonds and money at call and short notices because of interest based transactions. Mandatory reserve with central bank is maintained by IFIs but they are not rewarded like interest based banks. Looking towards central bank in rainy days to maintain liquidity is also not as straightforward due to interest demand of central bank. IFIs cannot demand interest on interbank deposits. As for investment in market able securities are concerned again IFIs are not free to invest in any equity security due to two reasons. First Halal business of the underlying firm is required. Second financial operations of underlying firm should be interest free. Keeping in view the dominance of interest based banking and existing business practices one can conclude safely that a very negligible number of firms meet both conditions. The much appreciable job has been done by Almeezan investment management limited (AIML) a subsidiary of leading Islamic bank in Pakistan (Meezan bank) in this regard. A list of Sharia compliant securities is being maintained and updated every six monthly out of which 30 companies are selected for Kse Meezan Index (KMI). KMI was established in June 2008.IFIs can invest only in those securities which are declared Sharia compliant securities through filtering of Sharia compliance criteria.
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2.14 Islamic banking playing role in the economic development of the world
Islamic banking is unique, but by no means anomalous. It is neither at odds with nor incomparable to interest based banking. Is it possible to contrast the two models? I-They are both financial intermediations. A financial intermediary is the institution that acts as a middleman between cash surplus units (savers) and deficit spending units (users of fund). It is quite obvious that the main function of interest based banks is financial intermediation. However, there are those who would like to think that there is no such thing in the Islamic economic system as financial intermediation and that an Islamic bank can only be sufficiently Islamic if it can operate like a trader, one who buys and s ells goods and commodities. The financial intermediary in interest based banking is a borrower-lender institution. Since such institution will not survive unless it at least covers expenses, then an income must be generated from such arrangement. This is where interest appears. An Islamic bank, on the other hand, is based on a multi-tier Mudarabah. A Mudarabah is a partnership in profit where capital and management may joint together to create value. The income accruing to the Islamic financial intermediary is coming out of profit not from interest. The root of such a conception is the fact that Shari'ah doesnt distinguish between a seller being a trader or a final intermediary, unlike positive law where civil law is different from commercial law. In Shari'ah all people stand against one legal code.
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II-A case in mind is Murabaha. There are those who say if an Islamic bank does Murabaha any other form but the traders way of doing things it will not be permissible from Shari'ah point of view, and an Islamic bank would be in their view a dubious interest based bank. They say: since it is never the intention of the bank, to own there assets and hold on to them then, such bank is not sufficiently Islamic. According to this viewpoint, an Islamic bank must have huge warehouses and elegant stores full of goodies for sale. This is not valid and those who think so miss two important points: Intention is of no consequence on the permissibility or otherwise of any exchange contract in Shari'ah. In an authentic Hadith, the Prophet (PBUH) showed one companion how to substitute a usurious transaction by another non usurious to reach the same purpose, He (PBUH) didnt object to the intention nor that he nullified the contract on the basis of intention. Rather he corrected the form of contract. If the anatomy of the contract is in line with Shari'ah requirements, then the transaction is acceptable. Hence, if bank actually buys and then sells, with ownership passing from seller to buyer and that the subject of contract is a good or commodity then the transaction is correct. In interest based banking the subject of contract is money hence any increase is usurious. III-The way interest based banks render financial intermediation is very simple. They borrow money and lend money. Both assets and liabilities are one form of lending. Islamic banking function in a rather elaborate (not perplexing) way. They have to continuously innovate to satisfy the needs of their clients. It
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is because of this we see Murabaha, Musharakah, Mudarabah, Istisnaa, Salam to name just a few Islamic modes of finance. This makes the job of an Islamic banker not all roses, but certainly a more interesting one. IV-A interest based banker is a risk manger. He is concerned with all kind of credit, market, interest rate, legal and other risk factors. An Islamic banker should be just as concerned. However, there is one added risk for the Islamic banker, this is what we may call Shari'ah disobservance risk. Risk analysis refer to the forces that may cause the outcome of investment to be sub optimal. Certainly an Islamic investor earning non-permissible income is an outcome that is most undesireous, and it may cause the value of his investment to be reduced. V-Contrary to popular opinion, being concerned about time value of money is a similarity not a difference between Islamic and interest based banking. There is no basis for the current thinking that Shari'ah doesnt allow the attachment of monetary value to time in the contracts exchange. The contract of Salam and differed-payment sales fly in the face of this argument. It is only in loans that Shari'ah requires that no time value of money is considered (but replaced by great rewards in the hereafter). VI-A major difference, however, remains in the handling of delinquency and default. When a borrower delays payment of debt, interest will accrue on his delayed portion. Unless, such borrower defaults and become incapable of paying back his debt, such interest will compensate the interest based bank for lost business. This cant be done in Islamic banking as this is considered usurious.
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Clearly, this is a disadvantage from two aspects: Firstly, an Islamic bank will not have the opportunity in a Murabaha transaction for example, to be compensated for lost profit. But more importantly, it increases significantly, the Murabaha risks. Since bank clients are rational people who will seize an opportunity when they see one, they will always delay payment. One major Ijtihad of contemporary Shari'ah scholars, is to allow the Islamic bank to impose penalties. Rather than accrue such penalties as income, and hence become usurious, they are disposed off to charity. This way the pressure will mount on the debtor to pay in time, without falling into Shari'ah impressibility.
Operational Challenges and Prospects

Both the theory of Islamic banking and the rapid expansion of Islamic banks recent years have demonstrated the viability and feasibility of non-interest-based operations. This must be surprising to those who believed that banks and financial systems could not operate in a modern economy without reliance on an interest rate mechanism. Indeed, experience has shown that Islamic banks are powerful means of mobilizing resources. Operationally, however, both the Islamic financial systems in the three countries that have adopted it as well as individual Islamic banks face challenges that need to be addressed. The most important among these challenges is the fact that, while it has been relatively easy to create a system in which deposits do not pay interest, the asset portfolios of Islamic banks do not contain sufficiently strong components that are based on profit-sharing. The main reasons for this are: (a) lack of a legal and institutional framework to facilitate appropriate contracts as well as mechanisms
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to enforce them; and/or (b) lack of appropriate menus containing a broad range and a variety of maturity structures of financial instruments. Consequently, a relatively strong risk perception has become associated with profit-sharing methods in particular and Islamic banking in general. This, in turn, has led to concentration d asset portfolios of the Islamic banks in short-term and traderelated assets with inimical effects on investment and economic development. The problem is exacerbated by the fact that Muslim countries, as is the case in much of the developing world, suffer from a lack of deep and efficient capital and money markets that can provide the needed liquidity and safety for existing assets. The absence of suitable long-term instruments to support capital formation is mirrored in the lack of very short-term financial instruments to provide liquidity.
The challenges facing individual Islamic

banks
Impressive as the growth record of individual Islamic banks may be, the fact is that at present, those banks have mostly served as intermediaries between the financial resources of Muslims and major commercial banks in the West. In this context, this has been a one-way relationship, so far. There is still no major Islamic bank that has been able to develop ways and means of intermediating between Western financial resources and the demand for them in Muslim countries. It also appears that individual Islamic banks face difficulties in fund placement because they have had a major bias towards short-term, secured, low-return but liquid investments. The challenge for these institutions stems from motivational and technical factors. Motivationally, their basic aim appears to have been that of demonstrating the viability of Islamic banking without taking too many risks. Admittedly, this is a
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noble and a very important objective, however, although they have succeeded in this effort and have managed to create a market niche for Islamic banking, they do not seem to have achieved the market depth that could ensure long-term profitability and survival. This stems from the fact that they appear to be far behind in technical innovations and financial market developments that in recent years have revolutionized finance and capital markets. There is no evidence that these banks have made any large investment in research and product development, nor is there any evidence that new financial products developed in recent years, particularly in equity derivatives, have been utilized to any significant degree by the major Islamic banks. This is unfortunate because the market opportunities that these banks have been able to develop, to allow funds from Islamic communities to be placed in Islamically permissible portfolios, can and will be exploited by more efficient and innovative Western financial institutions that already have or will discover this market niche. While there is considerable room for competition and expansion in this field, the long-term survivability of individual Islamic banks will depend on how rapidly, aggressively, and effectively they can develop techniques and instruments that would allow them to carry on a two-way intermediation function. They need to find ways and means of developing marketable Shariah-based instruments by which asset portfolios generated in Muslim countries can be marketed in the West as well as marketing Shariah-based Western portfolios in Muslim communities.
The challenge of financial system
adopting
an
Islamic
The most important challenge for Islamic banking is in its system-wide implementation. At present, many Islamic countries suffer from financial disequilibria that frustrate attempts at wholesale adoption of Islamic banking.
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Financial imbalances in the fiscal, monetary and external sector of these economies cannot provide fertile ground for efficient operation of Islamic banking. Major structural adjustments particularly in fiscal and monetary areas are needed to provide Islamic banking with a level playing field. Additionally, adoption of a legal framework of property ownership and Contracts that would clearly specify the domain of private and public property rights as well as stipulation of legally enforceable rights of parties to contract that fully reflect the requirements of the Shariah, are necessary to allow an operational framework conducive to efficient operation of Islamic banking. An Islamic financial system can be said to operate efficiently if, as a result of its adoption, rates of return in the financial sector correspond to those in the real sector. In many Islamic countries fiscal deficits are financed through the banking system. To lower the costs of this financing, the financial system is repressed by artificially maintaining limits on bank rates. Thus, financial repression is a form of taxation that provides governments with substantial revenues. To remove this burden, government expenditures have to be lowered and/or revenues raised. Massive involvement of governments in the economy makes it difficult for them to reduce their expenditures. Raising taxes is politically difficult. Thus, imposing controls on domestic financial markets becomes a relatively easy form of raising revenues. Under the above circumstances, it is understandable why governments would have to impose severe constraints on private financial operations that can provide higher returns to their shareholders and/or depositors. This makes it very difficult for Islamic banks and other financial institutions to realize fully their potential. For example, Mudarabah companies that can provide higher returns than the banking system would end up in direct competition with the banking system for deposits that are used for bank financing of fiscal deficits.
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While Muslim countries may, for legitimate reasons, opt for an Islamic financial system, for the economy as a whole to benefit fully from the operations of such a system, it is necessary that (a) government expenditures are fully rationalized, (b) revenues from taxation, and those derived from property legitimately placed within the government domain by the Shariah, are raised to meet the expenditure needs the government, (c) the financial sector is liberalized so that returns to this sector reflect returns to the real economy, (d) equity markets are developed to allow financing of investment projects outside banking institutions, and, finally, (e) the structure of the banking system should be such as to allow strong banking supervision and prudential regulation commensurate with the risks involved in various transactions.* To accomplish the last objective, the banking structure can be tiered in accordance with principal Islamic financial transactions. It is reasonable to assume that risks involved in Musharakah or Mudarabah financing, are different from those involved in trade-type financing. It follows, therefore, that prudential regulations of these transactions should be different.
Motivating Factors for Islamic Banking

Motivation and renewed interest in Islamic finance industry stems from its strong economic, financial and social considerations, backed by its unique features. Most significant is its appeal to add to financial diversity and innovation being skewed towards:
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(i)
Asset backed and equity based transactions, which promote entrepreneur friendliness and consideration of project viability
(ii)
Equitable distribution of risks and rewards among the stakeholders;
(iii)
Inculcating market discipline and higher ethical standards given its emphasis on non-exploitation and social welfare.
In the wake of high Asian domestic savings rates and build up of the regions foreign exchange reserves as well as oil surpluses of Middle East in the last few years, Islamic finance is now also emerging as a way to wealth management, both of richer nations and high net worth individuals.
Chapter 3
3.1 conclusion
Hence we conclude that the interest based banking is totally dependent upon the interest in every aspect of banking while the Islamic banking is totally against the interest in every aspect of banking so due to the interest the Islamic banking and the interest based banking have very differences which are mainly in product that they are offering just like the interest banks offers credit cards, debit cards, loans on interest ,leasing on interest etc but the Islamic banking offer different products which are totally on the Islamic halal rules Murabaha ,Ijarah ,Ijarah-Wal-
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Iqtina ,Musharakah ,Musawamah ,Istisna'a ,Bai Muajjal etc.so these products are totally different from that of interest based banking
3.2 bibliography
Abdul Gafoor, A.L.M., Interest-Free Commercial Banking, ch.4.1995, available at www.islamic-finance.com. Afzal, 0. "Riba: Usury or Interest or Both", a Conference paper for the Islamic Chamber of Commerce and Industry (ICCI), San Jose, California, November 7-9, 1996. Aggarwal, R.K., and Yousef, T., "Islamic Banks and Investment Financing", Journal of Money, Credit, and Banking, 32, I (February 2000): 93-120. Ahmad, M., Business Ethics in Islam, Academic Dissertations-5, Islamabad, Pakistan, The International Institute of Islamic Thought, 1995. Ali, A.Y., The Holy Qur'an: Text, Translation Commentary, Washington, D.C., The American International Printing Company, 1946. al-Saud, A.M., "Bain al-Faida wa al-Riba," AI-Shuruq al Islami, (April 1985): 18 -20.
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59

Isalmic Banking Vs Conventional Banking

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Islamic banking and interest based banking

CHAPTER 1 ............................................................... ERROR! BOOKMARK NOT DEFINED.

LITERATURE REVIEW .............................................................................................................. 9

2.1 WHAT IS BANK? ................................................................................................................... 9

2.2 HISTORY OF BANKING ............................................................................................................ 9

2.3 ISLAMIC BANKING .......................................................................................................... 11

Islamic banking and interest based banking

2.8 MODES OF ISLAMIC FINANCE ..................................................................................... 23

2.9 ISLAMIC BANKING ISSUES ........................................................................................... 27

2.10 INTEREST BASED BANKING ....................................................................................... 29

Islamic banking and interest based banking

2.12 ISLAMIC BANKING VS INTEREST BASED BANKING ........................................ 37

Islamic banking and interest based banking

MOTIVATING FACTORS FOR ISLAMIC BANKING .................................................................... 56

3.1 CONCLUSION .......................................................................................................................... 57 3.2 BIBLIOGRAPHY ....................................................................................................................... 58

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

1.2 Scope of the Study

Islamic banking and interest based banking

1.3 Objectives of the Study

Islamic banking and interest based banking

Chapter 2 Literature review 2.1 What is bank?

2.2 History of banking

Islamic banking and interest based banking

Islamic banking and interest based banking

2.3 Islamic banking

Islamic banking and interest based banking

Islamic banking and interest based banking

2.5 History of Islamic banking

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

2.6 COUNCIL FOR ISLAMIC IDEOLOGY

Islamic banking and interest based banking

(m) The Sindh Money Lenders Ordinance, 1960 (concerned provisions)

Islamic banking and interest based banking

(s) (t) (u)

Islamic banking and interest based banking

2.7 Islamic Banking Global Scenario

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

2.8 Modes of Islamic Finance

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

2.9 Islamic Banking Issues

Islamic banking and interest based banking

Unresolved Fiqh Issues

Islamic banking and interest based banking

2.10 Interest based Banking

Islamic banking and interest based banking

The role of interest based banks

Islamic banking and interest based banking

2.11 Products of interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

Islamic banking and interest based banking

mortgage which secures the