In the name of Allah(j.j)Chapter # 5

Interest Free Banking

By Kokab Manzoor

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Contents Definition of interest

Economic importance of prohibition of interest

Islamic banking Definition and need of Islamic banking Supremacy of Islamic banking Bill of exchange & Interest free loans Comparison of conventional & Islamic banking

Insurance Definition, Evolution, importance and Islamic

Concept of insurance

LOGODefinition of Interest

Interest is the price of capital. The Holy Quran uses the word Riba to denote interest which means increase, growth, addition, raise, excess.

Allah deprives interest of all blessing and develops charity [Al-Baqara; 276]

LOGOWhy did Islam forbids

Interest..???

CAPITALIST ECONOMY

Factors Compensation

LAND RENT

LABOR WAGES

CAPITAL INTEREST

ENT PROFIT

ISLAMIC ECO SYSTEM

Factors Compensation

LAND RENT

LABOR WAGES

RISK CAPITAL PROFIT

In Capitalist Economy there are four factors of Production while Islamic Economic system recognizes only three Factors of Production.

LOGOEconomic Importance of Prohibition on Interest

Investment MEC Interest-Rate

100 mn 24 % 18%

200 mn 22 % 18%

300 mn 20 % 18%

400 mn 18 % 18%

1 Interest and investment• Capital investment depends on the one hand on

the rate of interest and on other hand on MEC.• The process of investment in a country will

continue as long as MEC is higher or equivalent to rate of interest, and vice versa…

LOGOCont`d…..

2 Interest and Price

3 Interest and Distribution of Wealth

4 Interest and Trade Cycle

5 Interest and Allocation of Resources

6 Interest and business

7 Interest and Efficiency

8 Interest and Economic Stability

9 Interest and International Loans

LOGOBANK

Bank is an institution which deals in creditFunctions of banks

Accepting deposits Advancing loans Providing agency services Money transfer Safe deposit lockers Investment Credit creation

LOGONeed for Interest Free Banking

Modern banking system gives rise to injustice, oppression, waste of resources and inequitable distribution of resources among nations.

And as modern banking system is based on Riba (interest) and Islam forbids interest. Meanwhile the utility of Banks is acknowledged, so it is necessary to reform the banking system according to the principles of Islam.

LOGOWhat is Islamic Banking ??

Since interest is forbidden by Islam, Shirakah (partnership) and Modarbah will be the only alternative basis of banking in Islamic economy. A bank will be established by two or more individual making investments according to a fixed ratio

Islamic banking has been defined as banking governed by the principles laid down by Islamic Sharia’h

LOGOMECHANISM OF ISLAMIC BANKING

Under Islamic scheme of banking there may two types of depositors.

1 The one who deposit surplus amount and can withdraw at anytime, bank will charge Zakat or service charges for safeguarding.

2 They can not withdraw their money without notice as their amount will be invested in short term projects. The depositors will share in profit and loss.

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Business of the Bank

The business of the Bank may assume three forms,

1 Services on which a charge is made

2 Investment on the basis of Shirakah (partnership) or Modarbah basis

3 Free services

LOGO1 Services on which a charge is made

Like modern banks, the Islamic banks will also receive fee, commission or fixed charges on various services like;

a) Facility of lockers

b) Transfer of Money

c) Receiving and Forwarding of trade Goods

d) Services as financial and legal consultants to business corporations

LOGO2 Investment on the basis of Shirakah or Modarbah basis

The interest free banks will enter into Shirakah or Modarbah transaction with businessmen.

Shirakah A contract between partners on both capital and profit.

Modarbah

A contract between partners in which one provides capital and other provides services.

Note these two will be discussed in detail in next chapter

LOGOIssue of Loans in interest free

Banking system

1. The bank will issue loans without any charge to businessmen for short period.

2. Such loans will be issued by the bank out of “Loan Account”

3. The debtor will provide guarantee

4. Bank have right to invest the available sum in “Loan Account” in profitable venture.

5. Banks shall also be entitled to take charge free loans from Central Bank.

LOGOBill of exchange & interest-free

Loans

Discounting Bills of Exchange would not be permissible; however following procedures may be adopted Instead of bill of Exchange the businessmen

should take loans from Banks on Modaraba basis,

Bank will advance charge free loans The bank will make no deductions, and will

recover the full amount on the date of the maturity of the bill of exchange.

LOGOProcess of Credit Creation in

Islamic banking

Bank will keep 10% as reserve of Loan Account for meeting daily needs

Loan advanced, will be again deposited in bankBank will hold large amount of deposits and rest

will be invested in Modarbah That amount will be deposited in various other

banks, hence bank receives back a large part of the money it lent out or invested.

Hence the process of credit creation is similar to conventional banking but the technique is different

LOGOCOMPARISON

Conventional banking Borrows funds from the

depositors paying interest on the liability side of its balance sheet.

Lends the funds to the borrowers, charging interest on the asset side.

Islamic Banking Partnership (Mudarabah)

or profit and loss sharing arrangement between the bank and the depositors

Profit and loss sharing (Musharaka) or trade and leasing based financing arrangement between the bank and its clients users of funds)

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Conventional banking Between the depositors

and the bank, there is an iron wall.

The interest or the return is predetermined or fixed in advance

Islamic Banking Islamic bank entitles the

depositors--to be informed of what the bank does with their money

--where their money would be invested

The profit or the return is based on the actual investment outcome.

COMPARISON

LOGOCOMPARISON

Conventional banking

Money earning money without real sector business: Transactions are financial asset based

Islamic Banking

Transactions are real asset based as per defined principles of trading or leasing

LOGOSUPERIORITY OF ISLAMIC CONCEPTION OF BANKING

Conventional banking Loan on interest-- chance of unhealthy

investment—leads to depression and ultimately unemployment– also acts criminally if borrower fails to repay.

Islamic banking Interest free loans– banks interested in

investment rather than loan--so healthy investment takes place– reduces unemployment rate--less chance of depression-even if, can easily be countered.

LOGOSummary & Conclusion

1. Riba, usury, Interest are prohibited.

2. Saving is the function of investment not the interest.

3. Islamic banking is based on principles of partnership.

4. Short term and long term financing can be made through system of guarantee.

5. Strong relationship of banks with depositors and entrepreneurs.

6. Islamic banks can contribute better to economic development by performing extra banking activities.

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Islam and Insurance

LOGODefinition of Insurance

Definition “a contract whereby one person, called the

“insurer” undertakes, in return for the agreed consideration, called the “premium”, to pay to another person, called the “assured” a sum of money, on the happening of a specified event.

This specified event must have some element of uncertainty about it.

LOGOImportance of insurance

Risk and uncertainty are part of daily life of human being

Risk is of two types

1 (Risk of loss) In any economic activity a person may gain profit or suffer loss

2 Breakage of crockery, glassware etc, or accidents, injuries, Hazards, sinking of ships etc…

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Importance of insurance

In business the second kind of risk is the greatest target of insurance.

It gives sense of security to businessmen

Improves efficiency

Raise morale to face risk

LOGOEvolution of Insurance

Started to meet risk of traders whose ships were often wrecked by storms

Muslims maritime traders during the Islamic rule in Spain were the pioneers.

Arab traders launched a system of insurance on a Shirakah basis.

LOGOTakaful Islamic concept of insurance

Takaful is an Arabic word that means "guaranteeing each other".

It is a system of Islamic insurance based on the principle that “the risk will be shared collectively by the group Voluntarily”.

This is a pact among a participants who agree to guarantee among themselves against loss or damage to any of them.

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Basic Principle behind Takaful

1.The principle of “fortunate many helping the unfortunate few" is a concept recognized by Islam.

2.The Quran states in Surah Al-Maidah verse # 2:"Help ye one another in righteousness and piety, but

help ye not one another in sin and rancor".

LOGOOperation of Takaful Fund

The contribution collected by company will be further invested on the principle of Al –Modarbah, through which the element of interest (riba) will be replaced.

All premium holders will participate in pofit and loss.

Profit will be shared on agreed ratio.