DOUAE ELEZIZI AZEDDINE BENALI MOHAMED REDA AMAOUN … · World Islamic Banking Master Finance...

D O UA E E L E Z I Z I

A Z E D D I N E B E NA L I

M O H AM E D R E DA A MAO U N

I K R AM O U H A S S I

R A J A E Z A I D I

World Islamic Banking Master Finance Islamic

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Contents

Abstract

Intro

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ction

P

hilo

sop

hy

W

hy Islam

ic B

ank

ing

Ch

allenges &

O

pp

ortu

inities

Conclusion

Introduction

Background of the Topic

Research Problem

Structure of the Research Topic

What is the philosophy of Islamic Banking

Historical Developement of Islamic Banking Industry

Islamic Banking and it principles

Most widly used types of Islamic contratcts today

Why Islamic Banking

Distinction between Conventional and Islamic Banking

Unqiue Risks of Islamic Banking

Islamic Banking a low risk alternative

Challenges & Opportunities for Islamic Banking in the World

Issues & Challenges of Islamic Banking

Opportunities of Islamic Banking


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Abstract

In recent years, a number of Islamic banks have been created to cater the

growing demand, driven by globalization and the vast wealth of some

Muslim states in the Middle East and Southeast Asia.

Islamic finance has moved from a niche position to become a

mainstream component of the global banking system. Islamic banking refers

to a financial system which is consistent with principles of Islamic law (or

‘sharia’) and guided by Islamic ethics.

A large amount of research has been undertaken into this subject. This

research is based on extensive literature review, presents the position of

Islamic Banking in the world...


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Intro

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1- Background of the Topic

Islamic banking and finance is becoming one of the most significant aspects of the modern

global financial system today. In the early of 1970s until now, a fast growing industry that has

developed rapidly within a few years from a niche industry to a global force to be reckoned with in

international arena. The Islamic banking industry has been growing at an average rate of 10-15% in

recent years.

Growth is not confined to Muslim countries. Rapid growth has not, however, come about

without a number of concerns arising, in particular in relation to ethics. Not everyone, it seems, is

embracing Islamic banking in order to benefit from Islamic ethical precepts but for other reasons, such

as to gain access to the petrodollars of Muslim investors. London, for example, adopted Islamic

Finance to enable the financial inclusion of Muslims living in the UK as well as to meet the financing

needs of firms. The global financial crisis of 2007 prompted many countries to search for an

alternative framework to enhance the stability of their financial systems.

The origin of this system lays in the ban on interest for Muslims. The idea of Islamic banking is

to provide an interest free banking system, which includes common values and norms and religious

aspects.

The awareness of ethical banking is increasing as well as the number of ethical funds and banks,

what confirms the willingness of people to use ethical ways of banking, like the Islamic one. Islamic

banking is a financial system conforming to Islamic standards (Shariabords). So is there a chance to

make the economic world better with such a strong banking system? To understand this system of

banking, it is necessary to get deeper into the topic.

2- Research problem

Global financial system runs into trouble in 2007-2008. Subprime mortgage crisis was one

of the starting point. While many western banks defaulted during that period, no major ´´Islamic

Bank´´ default was reported during the crisis.

Introduction


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Intro

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ction

The purpose of this research is to explain the basic principles and ethics of the Islamic

banking in the financial system, and to answer on a very important problematic question: Islamic

Banks less or more risky?.

In order to promote it as an alternative to conventional banking in the world. An alternative of

dealing with financial problems in the future. The objective of the this problematic, is to extend the

research and putting the light on Islamic Banking as a solution of different issues social and financial.

3- Structure of Research

No research can be final and perfect, so is the case with the present study which has its own

limitation.

So the study is spread over 5 sections:

The first chapter a main introduction about the importance of the subject and the goals of

the research that we will discuss later in the presentation.

The second chapter oriented to the historical development of Islamic banking in three

epochs plus a brief overview of Islamic Banking in Morocco, then the principals and

products of Islamic banking.

The third part investigates about distinctions between Islamic Banking and Conventional

Banking, then answering an important question: is it really Islamic Banking less risky

than the conventional.

The fourth part is divided into, two main axes in this research: Challenges and

opportunities of this alternative.

Simplified and clear conclusion, talking about the principal ideas of the subject.

The research about these chapters was gloomy a little bit, but we tried to find maximum of

information and introduce it, in easy way.


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Like all financial systems, Islamic banking is subject to sources of law. The primary sources of

law are Koran, Sunna and Consensus of Legal Scholars, whereas the secondary sources of law are

Conclusion by Analogy, Customary Law and own Approval Certificate, better known as “Fatwa”.

The focus will lay on Sharia, which is the most influencing one. The origin of the term Sharia

lays in the Arabic language and means Islamic moral and religious laws. Sharia, also known as

Islamic law is an accepted law based on the teachings of the Koran and the traditions of the Prophets

Hadith and Sunna. It regulates legal and religious commitment as well as compensatory penalties for

lawbreaking .It covers all religious and legal norms and also evaluation standards for the interpretation

of Islamic norms. This law should help the faithful to live their life in an appropriate way. This Islamic

law gives us the principals of Islamic Banking, that what will discover in this chapter of the topic…

Historical developement of Islamic Finance 1-

It was in the 19th century that Muslims started to realize that the current system of banking and

economy was based on Riba that is interdicted in Islam and is categorically forbidden in all its shapes

whether commercial or non-commercial; and there should be an alternate system where its operations,

products and services conforms to the principles of Shariah (Ali, 2015). For that reason, the Islamic

banks had emerged in the middle of 1970s. Islamic bank have undergone into three phase of

development.

Pre Islamic Islamic Era Medern Islamic

Era

What is the philosophy of Islamic Banking


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Pre Islamic Era

Before the coming of Islam, banking activities has begun in the Arab but its operation has the

element of riba. Meccan of that time used the money either giving it to another party to be traded

through alQirad or mudarabah and the profits is share by both party or lending the money to gain

benefits which consider as riba (Mohammad & et. al, 2013). However, the coming of Islam has

resulted in complete prohibition of all activities that involve riba, and this prohibition did not prevent

the development of trade that took place either nationally or internationally (Sudin, 1996) cited in

(Mohammad & et. al, 2013) and the origin of Islamic finance dates back to the dawn of Islam 1,400

years ago (Ajagbe & Brimah, 2013). 1

Prophet Muhammad before the time of his prophet hood had applied the concept of trust.

Due to his noble conducts such as honesty and integrity, the Arabs of his had appointed him as their

wealth keeper (Hamoud, 1985) cited in (Mohammad & et. al, 2013). Apart from that, during the time

of the Prophet there was also a man by the name al-Zubayr alAwwam who took the role as a bank, and

kept the deposits for other people. However, this form of money keeping was modified by him to

loansAbd Allah bin Al-Zubayr, the son of Al- Zubayr narrated that when people brought their money

to be kept by his father, he will tell that person that the money is being borrowed, instead of being

deposited, as his father was worried that he might lose the money. Al-Zubayr’s action resulted in two

main objectives; the first is by taking the deposit as loans, he has the right to use the money.

Secondly, if the deposit is not used, the owner will experience loss; so if it is regarded as a loan,

it is safer as the borrower is responsible in returning the money (Sudin, 1996) cited in (Mohammad &

et. al, 2013; and Ajagbe & Brimah, 2013). Other than that, there were evidences that the development

of Islamic banking foundation had started since the time of the Prophet.

Among these foundations was the development of Bayt al Mal, which was the central bank

for Islamic countries and played a role in aiding the poor, especially the Muslims (Mohammad & et. al,

2013).

Furthermore, there is clear broad structure of principles practice by Prophet Muhammad (p.b.u.h)

for example contract of mudarabah between Khadijah and Prophet (p.b.u.h), musyarakah whereby Al-

Sa'ib Ibn Abi Al-Sa'ib became a partner of the Prophet before his prophethood, bay’ al-salam was

practiced in the agricultural sector of Madinah during the time of the Prophet (p.b.u.h.) and benevolent

loans (qard hasan) which is another form of financing were also encouraged during that time.

1Ajagbe, T. S., & Brimah, A. N. (2013). Islamic Banking Development and Evolution: Current Issues and Future Prospects. Journal of Research in

International Business and Management,


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Islamic Era

The beginnings of Islamic banking, in its wider sense, date back to the early days of Islam and

the rise of the Islamic Empire. The boom in the internal and external trades in the dawn of Islam led to

the creation of Islamic financial tools such as deposits, money transfers, checks, bills of exchange, and

so forth to cope with these commercial developments. Later, the Europeans adopted these Muslim

practices and continued to evolve them until modern days. (Alharbi, 2015).

In Islamic countries, proceeding of the 4th International Conference on Management and

Muamalah 2017 (ICoMM 2017). Islamic financial practices withered gradually due to the weakening

of the Islamic empire, until these practices were replaced by the Western financial model in the early

16th century. However, Islamic financial practices emerged again in the middle of 19th century. 1

Modern Islamic Era

The late 19th and early 20th century is widely known as the beginning of the era of Islamic

resurgence. Some of those responsible for this resurgence are Muhammad Abduh (1849), Rashid Reda

(1865), Muhammad Iqbal (1975), Abul Aala Maudud (1937), Hasan AlBanna (1939), Hifz Al-Rahman

(1942), Muhammad Hamidullah (1944), Anwar Qureshi (1946), Naiem Siddiqi (1948), Mohammad

Yousuf Al-Dean (1950) and Muhammad Uzair (1955). Their thoughts became the impetus for

Muslims to apply Islamic teachings in all aspects of life including political, social and economic.

Since Islam prohibits riba, it is obvious that elimination of riba from the economic and

banking system became the most popular topic among contemporary Islamic scholars. The first

attempt at Islamic banking system can be seen in Malaysia in the mid 1940s and Pakistan in the late

1950s (Perry & Rehman, 2011; and Ajagbe & Brimah, 2013).The objective of this institution setup by

Malaysia was to invest prospective pilgrim savings in the real estate and plantations in accordance

with Shariah but it was unsuccessful.

While, Pakistan establishment of Local Islamic Bank in the rural area. During that time, the

owners of the land who were obedient to the Islamic teachings deposited their money to the bank,

which was later loaned to other land owners for the purpose of agriculture development .

The borrowers during that time were not charged for lateness in paying back their loans, other

than a small amount for the purpose of bank operation However, the operation of the bank was met

with failure due to a number of factors such as the increase in the number of borrowers compared to

1Alharbi, A. (2015). Development of the Islamic Banking System. Journal of Islamic Banking and Finance, 3(1), 12–25.

http://doi.org/10.15640/jibf.v3n1a2



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the money being kept there, which resulted in vast difference between available capital and credit

demanded, as well as the problem of the bank employees not having autonomous power on the bank

operation. This was because the depositors of that time were hoping to get more benefits as a return for

the money that they lent out (CIFP, 2006) cited in (Mohammad & et. al, 2013) The second attempt was

through setting of banking basic principle and Islamic finance that are to be practiced. The endeavor

took place in Egypt from 1963 until 1967 through the establishment of Mit Ghamr Savings Bank in the

town of Mit Ghamr led by Ahmad El Najjar, in the area of the Nile River Delta, which is 40 kilometers

from Cairo (Ready, 1967) cited in (Mohammad & et. al, 2013). It’s functioned essentially as saving-

investment institutions rather than as commercial banks (Ariff, 1988). Although the services are

considered basic banking services, it was nevertheless sufficient to meet the banking needs of the

surrounding community. However, the existence of the bank was shortlived.

The whole operation of Mit Ghamr Bank was taken over by the National Bank of Egypt and

Egypt Central Bank in mid-1967, which changed the whole bank operation to the riba system.

(Mohammad & et. Al, 2013).

But, the establishment of Mit Ghamr Saving Bank marked a new milestone in the revolution of

the modern Islamic banking system. This bank was considered to be the most innovative and

successful experiment with interest-free banking. At the same time, Malaysia also takes an initiative by

establishing the Muslim Pilgrims Saving Corporation Malaysia in 1963.

Muslim Pilgrims Savings Corporation set up in l963 to help people save for performing hajj

(pilgrimage to Mecca and Medina).

In l969, this body evolved into the Pilgrims Management and Fund Board or the Tabung Haji as

it is now popularly known. The Tabung Haji has been acting as a finance company that invests the

savings of would-be pilgrims in accordance with Shariah, but its role is rather limited, as it is a non-

bank financial institution.

Proceeding of the 4th International Conference on Management and Muamalah 2017 (ICoMM

2017) e-ISBN: 978-967-2122-15-9 507 After Mit Ghamr converted into conventional system, the

Nasir Social Bank was established in Egypt in l97l and declared as an interest-free commercial bank,

although its charter made no reference to Islam or Shariah (Ariff, 1988; and Kamal, Lokesh & Bala,

2008).

In 1974, the finance ministers of all Islamic countries held a convention on the establishment of

the Islamic Development Bank (IDB). IDB was considered to be the first international Islamic bank

that was established with the founding member of 22 Islamic countries. The bank’s principal office

was located in Jeddah, Saudi Arabia and has two regional offices in Rabat, Morocco and Kuala

Lumpur, Malaysia.

The purpose of the bank is to foster the economic development and social progress of member

countries (OIC) and Muslim communities individually as well as jointly in accordance with the

principles of shariah. This was a landmark in the history of Islamic banking (Ali, 2015). The


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establishment of IDB 1974 paved the way for the establishment of other Islamic banks in various

Muslim countries.

Throughout the 1970’s, a number of Islamic banks were founded, mostly in the Arab Middle

East. Immediately after the establishment of IDB in 1974, the Dubai Islamic Bank was incorporated.

In the year 1977, three more Islamic Banks commenced business for example Faisal Islamic

Bank of Egypt, Faisal Islamic Bank of Sudan, Kuwait Finance House and Bahrain Islamic Bank in

year 1979 (Perry & Rehman, 2011).

While throughout the 1980’s, several Islamic Institutions has established for example Qatar

Islamic bank, Islamic bank Bangladesh limited, Bank Islam Malaysia Berhad, Al-Baraka Islamic Bank

of Bahrain, ANZ Global Islamic Finance of UK and among others. Some countries including Pakistan,

Iran, Sudan, Malaysia and Bahrain initiated efforts to implement Islamic banking at larger scales in

their respective countries during 1980s.1

In the next decade some of the conventional banks also introduced Islamic banking products

and services by operating separate Islamic banking units and divisions (Ali, 2015). In the case of

Malaysia, the success of the Tabung Haji provided the main impetus for establishing Bank Islam

Malaysia Berhad (BIMB) which represents a full-fledged Islamic commercial bank in Malaysia. The

Tabung Haji also contributed l2.5 per cent of BIMB's initial capital of M$80 million. BIMB has a

complement of fourteen branches in several parts of the country.

At the same time, some countries attempted to establish full Islamic banking systems and

disconnect themselves from the traditional Western style financial system. Iran, for example, changed

over to Islamic banking in August l983, when they commenced a three-year transition period (Perry &

Rehman, 2011) and Sudan also shown the whole implementation of Islamic banking system.

While some countries practice dual baking system whereby the conventional banking system

operating in parallel with the Islamic banking system for example Bangladesh, Bahrain, Malaysia and

Pakistan.

In the next decade some of the conventional banks also introduced Islamic banking products and

services by operating separate Islamic banking units and divisions (Ali, 2015). In the case of Malaysia,

the success of the Tabung Haji provided the main impetus for establishing Bank Islam Malaysia

Berhad (BIMB) which represents a full-fledged Islamic commercial bank in Malaysia. The Tabung

Haji also contributed l2.5 per cent of BIMB's initial capital of M$80 million. BIMB has a complement

of fourteen branches in several parts of the country.

At the same time, some countries attempted to establish full Islamic banking systems and

disconnect themselves from the traditional Western style financial system. Iran, for example, changed

over to Islamic banking in August l983, when they commenced a three-year transition period (Perry &

Rehman, 2011) and Sudan also shown the whole implementation of Islamic banking system.

1Ariff, M. (1988). Islamic Banking. Asian-Pacific Economic Literature, 2. http://doi.org/10.1111/j.1467-8411.1988.tb00200.x Mohammad, T., & et. al.

(2013). The Historical Development of Modern Islamic Banking: A Study in South-East Asia Counties. African Journal of Business Management, 10(20)


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While some countries practice dual baking system whereby the conventional banking system

operating in parallel with the Islamic banking system for example Bangladesh, Bahrain, Malaysia and

Pakistan

An historical overview of Islamic banking in Morocco

It must be mentioned in this context that Morocco is not new to Islamic banking, yet this sector

has never really taken off. In 2007, Bank al-Maghrib authorized only conventional banks to offer three

Islamic financial products: Ijara leasing products, Murabaha contracts to buy and re-sell underlying

goods and Musharaka – co-ownership financing structures.

The aim of this step was partly to help develop Morocco’s financial industry and partly to lure

investment inflows from Gulf Arab states.1

Dar al-Safa was the first Islamic financial institution in Morocco. The governor of Bank al-

Maghreb approved Dar al-Safa on May 13, 2010 as an Islamic finance company specializing in the

marketing of Islamic finance, but only for personal finance. North Africa and which has been

controlled by the royal family’s investment holding company SNI.

The first four Islamic products which were marketed by Dar al-Safa and made available through

a network of nine branches were based on Murabaha contracts and include: Safa Immo to finance real

estate projects; Safa Auto for vehicle finance; Safa Cons for the purchase of products and services; and

Safa Tajhiz to equip one’s home.2 Despite the fact that Bank al-Maghrib made it possible for

conventional banks to offer Islamic financial products, the Moroccan government imposed higher tax

on Islamic financial products than on conventional banking products.

Therefore, within the conventional regulatory framework, these products were subject to higher

fees and were less competitive. Hence, Islamic financial products met with limited success and failed

to elicit good response from the customers as some of the customers complained that these products

charge higher fees than their conventional counterparts.3

But, the moderate Islamist Justice and Development Party took office after winning the election

in late 2011. As from that point in time, Morocco has intensified its Islamic financial drive. Already

during the electoral campaign, the Justice and Development Party made Islamic banking one of its key

issues, claiming that it would solve the country’s chronic shortage of liquidity, speed up economic

growth, boost GDP growth by at least two percentage points, and establish Casablanca — which has

maintained a relatively stable financial and investment environment on the background of the Arab

Spring — as a regional financial hub known as the Casablanca Finance City with a view to winning

business with other countries in North and West Africa.

1 See on-line at: http://www.stuff.co.nz/business/world/rest-of-world/645995/Morocco-develops-Islamic-financing; 2 See on-line at: http://www.microfinanceacademy.com/2011/02/dar-assafaa-first-islamic-bank-in.html; http://www.theafricareport.com/North-Africa/moroccos-attijariwafa-bank-looks-to-boost-islamic-finance.html; 3 See on-line at: http://www.aawsat.net/2014/01/article55327397; http://www.frontiermarketnetwork.com/article/1671-morocco-opens-door-to-

islamic-finance.

http://www.stuff.co.nz/business/world/rest-of-world/645995/Morocco-develops-Islamic-financing

http://www.frontiermarketnetwork.com/article/1671-morocco-opens-door-to-islamic-finance



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Therefore, for the past two and a half years, the Moroccan Prime Minister, Abdelilah Benkirane,

has been seeking to develop the Islamic banking industry, partly as a way to attract Gulf money and

partly as a way to fund its huge deficit balance.

Morocco’s economy has suffered severely due to the Arab uprisings, the adverse weather

conditions that have taken a toll on the agricultural sector and the euro zone debt crisis. Therefore,

experts from the banking sector think that Islamic banking will generally bring about foreign direct

investment.1

Morocco had been hoping to issue an Islamic bond in 2013 and to develop an Islamic banking

industry after the bill was first put to parliament in April 2012. Those plans were subsequently put on

hold due to the sensitivity of the Moroccan political elite to Islamism and due to disputes over other

issues in the government that eventually led to a cabinet reshuffle in October 2013.2

Still, in January 2013, the Moroccan parliament approved a legislation to issue sovereign sukuks.

This legislation was not part of the Islamic banking draft bill. It was part of a reform of the Morocco’s

securitization law, which was enacted in 2002 and amended in 2010 to broaden the range of eligible

assets and allow institutions other than banks to use securitization.

The Moroccan government submitted to the parliament a new amendment of the securitization

law for the introduction of sukuk at the end of 2012 as part of a broader financial reform aimed at

developing the role of securitization in funding the economy. The law which allows the Moroccan

government and companies to issue sukuk was adopted in January 2013.3

It was another step towards the establishment of full-fledged Islamic banks in Morocco.

Moreover, in June 2013, Dar al-Safa signed an agreement with the education officer’s foundation and

its 350,000 members enabling it to offer the Islamic version of housing loans to the members of the

foundation, most of whom are teachers, who comprise 42 percent of state employees, ahead of the

approval of the Islamic banking regulating draft bill, which will allow Islamic banks, especially from

the Gulf countries, to open full-fledged subsidiaries in Morocco.4

In 2014 ,adoption of law 12.103 on credit institutions and governing acts, the third part was

allocated to participating banks ,the membership of bank al Maghreb to the accounting and auditing of

the participatory financing companies. In 2015 creation of the Higher Council of Ulema of the

legitimate committee for participatory finance, 2016, the finance law includes the taxes requirements

relating to the financing of Murabahah and Ijara, 2017 authorization for the participative banks activity

exp: Umnia Bank.5

1 See on-line at: http://www.internationalfinancemagazine.com/article/Moroccos-Islamic-Finance-Law-Awaits-Parliament-Nod.html;

http://magharebia.com/en_GB/articles/awi/features/2014/01/21/feature-03; http://english.alarabiya.net/en/business

2 see on-line at: http://english.alarabiya.net/en/business/banking-and-finance/2014/01/16/Moroccan-government-adopts-Islamic-finance-law-seeks-

vote-in-parliament.html; http://www.aawsat.net/2014/01/article55327397

3 See on-line at: http://www.thisisafricaonline.com/Business/Morocco-to-enact-sukuk-law?ct=true

4 See on-line at: http://www.theafricareport.com/North-Africa/moroccos-attijariwafa-bank-looks-to-boost-islamic-finance.html

5 https://www.umniabank.ma/fr/banque-participative/financement-participative/historique

http://english.alarabiya.net/en/business

http://www.aawsat.net/2014/01/article55327397

http://www.thisisafricaonline.com/Business/Morocco-to-enact-sukuk-law?ct=true

http://www.theafricareport.com/North-Africa/moroccos-attijariwafa-bank-looks-to-boost-islamic-finance.html

https://www.umniabank.ma/fr/banque-participative/financement-participative/historique


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Islamic Banking and it principles 2-

Riba

The prohibition of Riba is the ban of monetary interest in all forms. This a basic rule in Islam,

which comes from Koran and Sunna. It is the most noticeable difference between conventional

banking and Islamic banking. Islam distinguishes between Riba-al-Nasiah and Riba-al-Fadl. Riba-al-

Nasiah refers to the interest of loan transactions.

In conventional banking systems interests generate profits without real value or operation

behind it, what is prohibited in Islam. However, loan transactions, which are based on amortisation, are

allowed. Riba-al-Fadl corresponds to profits, which are obtained by trade agreements. In Islam people

are only allowed to exchange services and goods of the same quantity and value.

That way, the unjustified enrichment of someone at the expense of another cannot take place.

Consequently, speculations are not possible.1

The purpose of this prohibition is to achieve distributive justice. Thus, the wealth of people

should not be considered in the banking system. The interest-free Islamic banking system requires the

partnership or profit-sharing basis/ loss-sharing basis2 Therefore, the assets and liabilities of Islamic

banks are integrated in the sense that the customers share profits and losses with the banks in a pre-

decided ratio.3

Theoretically, this means that Islamic banks are in a better position than conventional banks

when external shocks occur. This leads also to a strictly selection and a continuously control of their

customers as they are dependent on them. Anyway, conventional banking and Islamic banking are not

1cf. Milena Valeva, Theoretische Grundlegung ethischer Bankbetriebslehre: Die Lehren aus dem Islamic Banking, 1st ed., Gabler Verlag, 2012,

Page 29 et seq. Available at: http://link.springer.com/book/10.1007%2F978-3-8349-3476-5, accessed May 16,2016.

2cf. Bashier, Portfolio Management of Islamic Banks “Certainty Model”. IN: Journal of Banking and Finance 7, 1983, Pages 339 - 354. Available at:

http://ac.els-cdn.com/0378426683900432/1-s2.0-0378426683900432-main.pdf?_tid=e729ce86-e107-11e6-9b25-

00000aab0f6b&acdnat=1485133654_06bd5f1875de259ac61d420a7f6cd381, accessed November 22, 2016

3 cf. Khan, Feisal, How ‘Islamic’ is Islamic Banking? IN: Journal of Economic Behavior & Organization 76 (3), 2010, Pages 805 - 820. Available at:

http://ac.els-cdn.com/S0167268110001940/1-s2.0-S0167268110001940-main.pdf?_tid=9ab173a0-e108-11e6- 92ed-

00000aacb35e&acdnat=1485133955_2ce419326b12432eaf7ae36e81f8b60d, accessed November 22, 2016.

Islamic

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as different as people think.1

This is the reason why they should be treated equally. Therefore, it would make sense to

regulate both by the same institution.

Haram & Halal

Haram and Halal are also two principles of Islamic banking. These terms are often connected

with Islamic food rules. All products, services and economic operations which are considered

unethical, prohibited and impure by Sharia are called Haram. The term Haram includes pork, alcohol,

weaponry, prostitution, tobacco, pornography, monetary interest and enterprises, where economic data

indicates debt overload.2

In conclusion, all other products are considered as Halal and are permitted by Sharia. The

differentiation has to be applied to the complete value-added chain, what means from the first point of

construction to the last point of sale. If every point of the valueadded chain is permitted by Sharia, the

product, service or economic operation is observed Halal. Despite of that principle, many Islamic

banks do not operate in a totally Halal way. This fact could be a reason for the low market share.3

Gharar

Gharar means risk, venture, uncertainty and deception and is generally not forbidden, but it is

said to avoid exceptionally high Gharar. It affects especially the Islamic law of contract. Every

economic transaction with economic disequilibrium is strictly forbidden and void by law. The

subjective interpretation of what is high and low Gharar can lead to disagreements and further negative

impacts between Muslims.4

The risk only refers to the subject-matter of a contract and not to the purchase price. Normally,

the trade with a still not existing or not existing subject-matter of a contract is forbidden by Sharia

because of extremely hight Gharar. Even though, there exist contractual designs, which make this trade

possible. To avoid high risk in an economic operation, every sales contract has to contain clearly and

definitely expressed the characteristics and availability of the subject-matter of the contract to both

contracting parties, the purchase price and the right and duties both contract parties.

The prohibition of Gharar is especially important regarding financial derivatives. This principle

makes bear sales impossible, resulting in a minor product choice for conventional risk-loving

customers.

1cf. Chong, Beng Soon; Liu, Ming-Hua, Islamic banking. Interest-free or interest-based? IN: Pacific-Basin Finance Journal 17 (1), 2009, Pages 125 - 144.

Available at: http://ac.els-cdn.com/S0927538X08000036/1-s2.0-S0927538X08000036- main.pdf?_tid=fb9eea78-e318-11e6-968c-

00000aab0f01&acdnat=1485360892_79ad769a59e8cb6431237d93b6af8347, accessed January 04, 2017.

2cf. Daniel Ecke, Islamic Banking: Grundlagen und Potenzial in Deutschland, Hamburg: Diplomica Verlag, 2012, Page 20 et seq. Available

at: https://www.wiso-net.de/document/DIPL,ADIP__9783842820081100, accessed May 16, 2016.

3& 4ibid.


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Maysir & Qimar

Maysir and Qimar mean game of luck, in which you can easily win something by accident. It is

the situation in a game of luck, when the acquisition of property is constrained to the entrance of a

certain event.

Islamic jurists think that Qimar is a kind of Maysir. Both forms are treated like a type of Gharar,

appear in financial derivatives and are forbidden. Muslims are at issue if capital investments in the

stock market fall under the principle of Maysir and Qimar, but most Islamic jurists determine this type

of capital investment as permitted as long as the activities of the enterprises can be determined as

Halal. The venture with stocks is treated as game of luck, if the stocks are bought as short-term capital

investment. The purchaser decides about the duration of his investment, what makes it difficult to

determine whether it is considered as game of luck or not. Furthermore, it is not possible to tell if

people are committed to this principle or not. 1

Shariaboars

Before working as Islamic financial institution, every bank is engaged to a procedure. The

respective Shariaboard has to examine all products and internal proceedings and certify them as Islam

conformable. If this is not the case, the bank is not allowed to start the business operations. It is

responsible for the continuous control of the operating activities and the examination of new financial

products. The Management of the Islamic bank informs and consults the Shariaboard. The Sharia audit

consists of internal employees with specific expertise. They have to control continuously the operating

activities and inform the Shariaboard about the results. The Islamic Financial Services Board (IFSB),

which is the same as the Basel Committee on Banking Supervision for conventional banks,

recommends an extra external Sharia audit, which takes place once a year.2

The decisions made by the Shariaboard are binding for the Islamic bank and can vary depending

on the members of the board. This makes it difficult to compare different Islamic banks. The decisions

have to be consistent with Islamic law and national laws of the specific country. The size, composition

and establishment of a Shariaboard depends on the articles of association or comparable documents of

the financial institution as well as on the statutory provisions of the country. Members of the

Shariaboards are called Sharia-Scholars and are Islamic jurists.

Risk Sharing

The risks linked to a loan are shared between the bank and the customer .The bank doesn’t work

with interests, it works in a partnership. The principle here is that the lender must share in the profits or

1 cf. Daniel Ecke, Islamic Banking: Grundlagen und Potenzial in Deutschland, Hamburg: Diplomica Verlag, 2012, Page 34 et seq. Available at:

https://www.wiso-net.de/document/DIPL,ADIP__9783842820081100, accessed May 16, 2016.

2 cf. Chong, Beng Soon; Liu, Ming-Hua, Islamic banking. Interest-free or interest-based? IN: Pacific-Basin Finance Journal 17 (1), 2009, Pages 125 - 144.

Available at: http://ac.els-cdn.com/S0927538X08000036/1-s2.0-S0927538X08000036- main.pdf? _tid=fb9eea78-e318-11e6-968c-

00000aab0f01&acdnat=1485360892_79ad769a59e8cb6431237d93b6af8347, accessed January 04, 2017.


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losses arising out of the enterprise for which the money was lent. Islam encourages Muslims to invest

their money and to become partners in order to share profits and risks in a business instead of

becoming creditors. Islamic finance is based on the belief that the provider of capital and the user of

capital should equally share the risk of business ventures, whether those are industries, service

companies or simple trade deals. This is unlike the interest-based commercial banking system, where

all the pressure is on the borrower who must pay back the loan, with the agreed interest, regardless of

the success or failure of his venture. The objective of all this is to encourage investments and thereby

provide a stimulus to the economy and encourages entrepreneurs to maximise their efforts to make

them succeed .1

Ethics

First: When Muslims invest their money in something, it is their religious duty to ensure that

what they invest in is good and wholesome. It is for this reason that Islamic investing includes serious

consideration of the business to be invested in, its policies, the products it produces, the services it

provides, and the impact that these have on society and the environment. In other words, Muslims

must take a close look at the business they are about to become involved in.

In all facets of the financial system, Islam has certain rules, certain regulations as to how

Muslims should go about participating in these activities. For example, in share trading or the

securities market, Islam looks at the activities of the companies, to establish whether or not the

companies are involved in activities which are in line with Sharia.

Second: the objectif isn’t maximisation of profit but concerns moral and social value first. The

Qur'an calls on all its adherents to care for and support the poor and destitute. Islamic financial

institutions are expected to provide special services to those in need. This is not confined to mere

charitable donations but has also been institutionalised in the industry in the form of profit-free loans

or Al Quard Al Hasan. An Islamic bank's business includes certain social projects, as well as charitable

donations. Islamic banks provide profit-free loans. For example, if an individual needs to go to hospital

or wants to go to university, we give what is called Quard Al Hasan. This Quard Hasan is normally

given for a short period of one year and the Islamic bank does not charge anything for that.2

Most widley used contracts in Islamic Banking 3-

Mudarabah

An equity-based contract offered by Islamic banks, which is based on the Islamic Shari’ah. It is a

special kind of partnership, where one partner provides money to another and the latter manages the

money by investing it in commercial projects in order to earn profit which is shared among the two in

a predetermined ratio. The first partner who provides the money to the second is called “rabb al maal

(capital provider)” while the second partner is known as “mudarib (manager)”.

1Copyright 2017 Al Baraka Banking Group

2Kettell B, 2011


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The capital provider may not interfere in the routine transactions of the manager, but may

provide general technical advice, and the manager should provide periodic reports to the capital

provider. The manager also has a choice to add their own capital to what is provided by the capital

provider with their consent, in order to increase profits.

Mudarabah Contracts Profits from the venture are shared between the capital provider and the

manager in a predetermined ratio, while losses are borne solely by the capital provider, provided such

loss is not due to the manager’s negligence or violation of specified conditions. The capital provided

by the rabb al maal is returned by the manager/mudarib when the contract ends or is dissolved. The

contract can be terminated by either of the parties by issuing a notice. Maximum term of the contract

may or may not be specified at the beginning of the contract (there is a difference of opinion in this),

but minimum term cannot be specified. If the contract becomes void due to any reason, the manager’s

status becomes that of an employee which means that he receives no share of profit but gets an

ordinary pay, a salary according to the market value for the work done by the manager; which cannot

exceed the profit share. No fixed amount, whether profit or wage or commission is settled in favor of

either the capital provider or the manager but percentages are specified, which is permitted by the

Shari’ah, as it is linked directly with the performance of the business and does not constitute interest.

Mudarabah contracts are of two types. The first one is a contract in which the capital provider

specifies which projects to invest his/her money in, and the manager is supposed to restrict the

investment to the specified businesses; this type of contract is known as Al Mudarabah al Muqayyadah

(Restricted Mudarabah). The other type is where the capital provider does not specify any project for

investment and the manager has choice; this type of contract is known as Al Mudarabah al Mutlaqah

(Unrestricted Mudarabah). If the manager wants to make an extraordinary investment which is beyond

the normal routine of business, this cannot be done without the express permission of the capital

provider. In Islamic banking, capital provider is the depositor who deposits money under a Mudarabah

contract, while the manager is the bank. The legitimacy of a Mudarabah contract is proven from

Quranic verses and the Sunnah of Prophet Muhammad Peace and Blessings be upon him. Practices of

the companions of the Prophet Peace and Blessings be upon him are also cited for emphasizing the

permissibility of Mudarabah contracts in Sharia.1

Murabahah

Murabahah is another product based on the Islamic Sharee’ah; it refers to the sale of goods at a

price which includes a profit margin, i.e. cost plus. This product is predominantly offered by Islamic

banks in asset financing, property, microfinance and commodity import and export. A Murabahah

contract has an honest declaration of cost and the expenses incurred on the product, along with the

profit mark up being taken by the seller, which is the bank in this case.

The uses of Murabahah include short term, medium term and long term financing for inventory,

raw materials, assets, export, import, vehicle, consumer goods, land and property, education, etc. This

1 Mohamed Waseem, available 2014, http://islamicbanking.info/islamic-banking

http://islamicbanking.info/islamic-banking


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gives an idea on the use of Murabahah in Islamic banks. Murabahah facilitates deferred payments of

which maybe in lump sum or in instalments. If the payment is being made on the spot in cash, there

need not be any mention of the profit that the seller is making; this is known as Bay’ al Mu’ajjal.

In case of deferred payment, which is Bay’ al Muajjal, cost price needs to be expressed; and

here, the price charged can be either equal to, less than or more than the cash price payable in case of

Ba’ al Mu’ajjal. Murabahah, an Islamic Banking Product The justification scholars give for the validity

of contracts where the deferred price is more than the cash price is that the value of the product or the

property is subject to increase during the period of the contract and the seller has the right to claim

such an increase in value. This is contrary to the concept of time value of money; while the value of

products and property increase the value of money remains constant and does not increase or decrease

with time.

Islamic banks have combined the concepts of Bay’ al Muajjal and Bay’ al Murabahah to offer

Murabahah contracts. How the contract works is that the buyer instructs an Islamic bank to purchase a

product or a property on his/her behalf with a promise to purchase the same at an agreed upon profit

margin, by deferring the payment. So, the bank deals with the supplier and once the purchase is

complete, the buyer takes possession of it, while paying in lump sum at a later date or by paying in

instalments.

The basic rules of Murabahah include the existence of the subject (product or property) at the

time of the agreement, the ownership of the subject with the bank while closing the sale, certain and

assured delivery of the subject to the buyer (i.e. having no element of contingency), the express

mention of price including markup, specified time of delivery, payment schedule and the term of

payment.1

It must be noted that the price expresses is not subject to increase in case of any default on part

of the buyer; such an increase would amount to usury, which is strictly prohibited in the Sharee’ah.

It should also be noted that discounting a Murabahah contract is also not permitted for the reason

that it would again amount to usury. A Murabahah contract can’t be rolled over until the contract ends.

The ownership of the sold subject is immediately transferred to the buyer after the sale and the seller

can claim only the amount specified in the contract. There is no scope of entering into another contract

concerning the same subject until the first contract ends. Most Islamic banks offer Murabahah in

different forms and under different sub-categories, but the basic rules remain the same.

Musharakah

Musharakah is a partnership-based contract or an investment product with a partnership structure

for sharing profits and losses, which is based on the Islamic Sharee’ah. It involves investment from all

the partners and an agreement to share profits in a predetermined ratio and to share losses in the ratio

of contribution. Parties to the contract of Musharakah are referred as “musharik” which literally means

partner.



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The common conditions for Musharakah are the existence of partners (Mushariks), capability of

the partners to enter into a contract with free consent, without any misrepresentation and the existence

of commodity.

The special conditions for Musharakah are that the commodity should be capable of agency,

which means each partner should be in a position to manage and take responsibility of the project or

carry on the business; the ratio of profit sharing should be predetermined; and along with the profits,

losses should also be shared in the ratio of contribution towards the contract. However, defining

absolute value or fixed value is not permissible, instead, ratios or percentages must be determined.

Musharakah ContractsThe initial contribution or the capital must be quantified and specified in

terms of currency, value, etc. and the capital invested by various partners need not be mixed and need

not be in liquid form, which means that the capital can wither be in the form of cash or commodity

which meet the conditions specified.

There is a possibility of having a sleeping partner as well in a Musharakah contract. In such case,

they shall be entitled to only the share of profits to the extent of investment partner). Additionally, the

working partners can be predetermined to be allocated higher proportion of profits, with the

justification that the excess received is the compensation for their work. In case of distribution of

losses, it is always distributed on the ratio of investment; no more, no less.

Musharakah stands terminated in case of violation of the conditions of the contract. It can also be

terminated when the purpose of forming the partnership has been achieved. Every partner has the right

to terminate the contract after issuing a notice to the other partners, which could bring an end to the

Musharakah; in such case, the partners may mutually choose to either liquate the assets or distribute

them, in case of dispute concerning this, distribution is preferred.

The Musharakah may also come to an end on the death or insanity of one of the partners. If one

partner wants to terminate the Musharakah while others want to continue the partnership, it is possible.

The duration of the Musharakah should be fixed for such a long term that after the end of the duration,

no other business can be carried out.

However, it can also be for a short term for which the partnership is necessary, during which no

partner can choose to dissolve the partnership. The legitimacy of Musharakah contracts is proven from

a Hadith Qudsi (Hadith with the words of Allah, Glory be to Him). Most major Islamic banks offer

Musharakah as a mode of investment, which the investors can benefit from.17

Ijara

The Arabic term ijara means “providing services and goods temporarily for a wage.” The ijara

contract, as you may guess, involves providing products or services on a lease or rental basis. In the

ijara contract, a person or party is given the right to use the object (the usufruct) for a period of time;

the owner retains the ownership of the assets.



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The ijara contract is similar to a conventional lease in which the owner rents or leases his

property or goods to a lessee for a specified number of periods for a fee.

For example, the lessee is responsible for normal maintenance, and the lessor is responsible for

major maintenance, just as with many conventional lease contracts. However, the following features of

ijara differentiate it from a conventional lease:

The lessor must own the assets for the full lease period.

If the lessee defaults on payments or delays payments, the lessor can’t charge compound interest.

The leased asset’s use is specified in the contract

Three types of ijara arrangements can exist according to sharia principles:

Lease-ending ownership/lease with ownership (ijara wa iqtina/ ijara muntahia bitamleek): In this

ijara contract, the lessee owns the leased asset at the end of the lease period. This lease contract

doesn’t contain any promise to buy or sell the assets, but the bank may offer a (verbal) unilateral

promise of transfer of ownership or offer a purchase schedule for the asset.

The lessee also is allowed to make a (verbal) unilateral promise to purchase the asset. The purchase

price is ultimately decided by the market value of the asset or a negotiated price.

Operating lease (operating ijara): This type of ijara contract doesn’t include the promise to purchase

the asset at the end of the contract. Basically, this setup is a hire arrangement with the lessor.

Forward lease (ijara mawsoofa bil thimma): This contract is a combination of construction finance

(istisna) and a redeemable leasing agreement. Because this lease is executed for a future date, it’s

called forward leasing. The forward leasing contract buys out the project (generally a construction

project) as a whole at its completion or in tranches (portions) of the project.

Many ijara products are on the market with different combinations of contracts. For example,

Malaysian-based Maybank offers car financing with a combination of an ijara contract and a bai

(purchase) contract. ADCB (Abu Dhabi Commercial Bank) offers ijara home financing, as does SABB

(Saudi British Bank) Amanah. 1

Istisna ’a

Istisna’a is an Islamic term meaning “manufacturing” and is applied to construction finance.

With an Istisna’a contract the consumer asks the bank to finance the construction of a house.

The bank engages a builder or the consumer to build, with the bank’s funds, 9 the desired

structure or property that the bank has purchased.

Upon completion of the development, there may be an outright cash sale, a Murabaha sale, an

ljara wa lqtina or a Diminishing Musharakah partnership. (Omar M, 2013)2

1 Islamic finance for Dummies,by Faleel Jamaldeen

2Omar M, (2013). Islamic Banking and finance https://ebookcentral.proquest.com/lib/haaga/reader.action?docID=1336760.


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Based on the findings and results done by many known experts, it can be proven that Islamic

banking performs better than the conventional banking during crisis. This is due to many empirical,

comparative and exploratory studies.

This proves that Islamic banking performs better than the conventional banking in terms of

profit, operation efficiency, liquidity and business growth.

Nowadays, Islamic banking is accepted by not only Muslim countries but also in the western and

other Non-Muslim countries.

Islamic banking services are more humanized and offer more justice to the customers compared

to the conventional banking. One of the best evidences is the interest rate in which the Islamic offers

fixed interest rate while the conventional interest rate can fluctuate according to the economic

situation.

Many customers have suffered loss during the global financial crisis when they took

conventional loans.

As a result, many customers have turned to Islamic banking during the crisis and this has led to

the growth of the Islamic banking business, (Hassan & Dridi, 2010).

Besides the loans, Islamic banking offers many products such as saving and Current accounts

(Wadiah and Mudarabah) which is similar to the conventional banking. But, dividend is given to the

customers instead of interest and profit sharing deposits.

From this short review it anticipated that Islamic banks will sustain, grow and be accepted by

others in the future. 1

1Journal of Islamic and Human Advanced Research, Vol. 3, Issue 1, January 2013, 27-40.

Why Islamic Banking


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1- Distinction between Islamic and conventional Banking:

Conventional bank Islamic Bank

The functions and operating modes of

conventional banks are based on fully manmade

principles.

The functions and operating modes of Islamic

banks are based on the principles of Islamic Shariah.

The investor is assured of a predetermined

rate of interest

Promotes risk sharing between provider of

capital (investor) and the user of funds (entrepreneur).

It aims at maximizing profit without any

restriction.

It also aims at maximizing profit but subject to

Shariah restrictions.

It does not deal with Zakat. In the modern Islamic banking system, it has

become one of the service-oriented functions of the

Islamic banks to be a Zakat Collection Centre and they

also pay out their Zakat.

Lending money and getting it back with

compounding interest is the fundamental

function of the conventional banks.

Participation in partnership business is the

fundamental function of the Islamic banks. The

customers’ business has to be understood.

It can charge additional money (penalty

and compounded interest) in case of defaulters.

Islamic banks have no provision to charge any

extra money from the defaulters. Only small amount of

compensation and these proceeds is given to charity.

Rebates are given for early settlement at the Bank's

discretion.

Very often it results in the bank's own

interest becoming prominent. It makes no effort

to ensure growth with equity.

It gives importance to the public interest. Its

ultimate aim is to ensure growth with equity.

The status of a conventional bank, in

relation to its clients, is that of creditor and

debtors.

The status of Islamic bank in relation to its

clients is that of partners, investors and trader, buyer

and seller.

A conventional bank has to guarantee all

its deposits.

Islamic bank can only guarantee deposits for

deposit account, which is based on the principle of al-

wadiah, thus the depositors are guaranteed repayment

of their funds, however, if the account is based on the

mudarabah concept, clients have to share. A loss if it

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Islamic banking is more humanizing than conventional banking, (Mohammed, Shamsher, Ariff

and Taufiq, 2008). It is noted that Islamic banking provides a more human approach. It had been

proven that many consumers choose Islamic banking rather than conventional. This paper will look

through which banking segment is performing better during the global financial crisis.1

2- Unique Risks of Islamic Banking :

To create value for their participants, senior management and boards of directors at Islamic

financial institutions must take necessary steps to manage their unique risks. Islamic financial

institutions face some risks that conventional financial firms don’t, including equity investment risk,

displaced commercial risk, rate of return risk, and sharia noncompliance risk.

EQUITY INVESTMENT RISK IN ISLAMIC FINANCE:

Islamic financial firms offer instruments based on equity investments. The two contracts

generally used for these instruments are mudaraba (partnership) and musharaka (joint venture

partnership). Equity investment risk arises because of a potential decrease in the fair value of the

equity position held by the Islamic firm.

A firm’s equity participation can range from direct investment in projects or joint venture

businesses to indirect sharia-compliant investment, such as in stocks. If the firm faces a decline in the

value of its equity position, it can lose any potential return on its investments and may even lose its

invested capital. This situation can trigger additional problems, such as credit risk and liquidity risk.

The Islamic firm can try to reduce equity risk by analyzing certain key factors, including the

following, before entering a contract:

The background and business plan of the managing partner or management team

The projected legal and economic environment in which the project will take place

In addition, the firm must continue to monitor the investment after the contract is signed to avoid

information asymmetry with its partner(s). 2

DISPLACED COMMERCIAL RISK

Islamic financial institutions don’t provide fixed returns in exchange for their customers’

deposits or investments. Instead, people who provide funds expect to share profits and losses with the

firm.

1 Journal of Islamic and Human Advanced Research, Vol. 3, Issue 1, January 2013, 27-40.

2 by Faleel Jamaldeen, Islamic Finance for Dummieshttp://www.dummies.com/personal-finance/risks


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Remember: The shared-risk-and-reward scenario is nice in theory, but in practice, investors expect

returns! If they don’t get them, they may move their money to other financial institutions. This

becomes more likely as more Islamic banks and other firms enter the marketplace and sharia-

compliant customers’ options increase.

As a result, Islamic firms face displaced commercial risk; they’re forced to pay returns to fund

providers even if the underlying assets don’t earn profits. The financial institution must smooth out

what may otherwise be a bumpy road for depositors and investors.

Here’s how an Islamic institution can deal with this risk

It gives up a portion of its own profit and/or waives its fee from an investment project or asset so it can

funnel that money into customer returns.

It creates a fund called a profit equalization reserve by setting aside a percentage

Previous years’ profits to use when investment returns dip too low.

It creates another fund called an investment risk reserve (again, funded by a portion of previous years’

profits) that allows the firm to recover investment losses in a given year.

It makes every effort to ensure that its investments are solid and poised to offer maximum returns 1 .

RATE OF RETURN RISK IN ISLAMIC FINANCE

Rate of return risk arises because of unexpected changes in the market rate of return, which

adversely affect a firm’s earnings.

In a conventional financial institution, returns are fixed; both the firm and fund providers know

in advance what their returns will be.

In Islamic firms, returns are uncertain and investors share both profits and losses with the

institution.

Remember Even though investors in Islamic products understand the risks of products that are based

on profit and loss sharing, they may react negatively — and possibly pull out their funds — if a firm’s

returns are lower than market benchmark rates. When market benchmarks increase, an Islamic

institution feels pressure to provide more returns than its asset earnings alone may merit.

If the firm fails to respond to the market rate increase, that failure may lead to liquidity risk

(because customers may withdraw funds too rapidly).

If it responds to the market pressure, it creates displaced commercial risk and must take the steps

outlined in the preceding section.2




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SHARIA NONCOMPLIANCE RISK

Sharia compliance is the reason Islamic financial institutions exist. If a firm isn’t adhering to

sharia principles and guidelines, the impact can be severe. If one or more Islamic scholars indicate that

an Islamic firm is veering away from compliance, its reputation will sink.

Very briefly, here’s what compliance with sharia principles looks like:

Complying with minimum requirements from the start: An Islamic firm must do a few key things to

distinguish itself from a conventional financial institution: avoid interest, gambling, and speculation;

steer clear of investing in prohibited industries; and include a sharia board in its corporate governance

structure.

Keeping transactions and operations in compliance: Even if a firm starts out in compliance, its internal

controls must ensure that transactions and operations are analyzed on an ongoing basis. A sharia

board is responsible for conducting regular sharia audits to look for any possible noncompliance that

may undermine the firm’s reputation.

Developing compliant products: Every product developed by an Islamic financial institution must go

through the institution’s sharia board for approval. When internal approval is secured, the product

goes to outside regulators, who also consider its sharia compliance and may reject it if they have

compliance concerns. The firm’s internal controls must outline this process carefully so that any

.1 product sent to regulators for consideration is, without a doubt, sharia-compliant

Remember: Islamic scholars make their decisions based on their interpretations of source materials,

and interpretations differ. A firm’s internal sharia board may approve a new product only to have

regulators reject it.

Conversely, a firm’s sharia board may reject a product idea that is later approved by another

institution. In these situations, a company’s stakeholders may ask for additional confirmation regarding

a product’s sharia-compliance.

3- Islamic Banking - a low - risk alternative?

The Islamic finance sector has seen rapid growth since the financial crisis. But is it really less risky than conventional banking – and how will new regulations affect the industry?

As the world’s financial system teetered on the brink of disaster, governments stepped in to

shore up the banks and shock waves rippled through the global economy.

Yet the financial crisis did not have a negative impact on all institutions – in fact the failure of

confidence in conventional banks helped to spur on the growth of the Islamic finance industry. In the



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12 months in which the crash occurred, Islamic banks’ worldwide assets grew by 32% compared to

just 13% for conventional banking.

Since then the industry has continued to expand. Its total assets, currently estimated to be in the

region of US$2 trillion, are expected to reach US$3.4 trillion by 2018. Some have even proposed that

Islamic finance, with its focus on ethics and stringent disclosure standards, is the panacea for the

global financial system.

Dr.Mamiza Haq, a finance lecturer at UQ Business School, says Islamic banking is an asset-

based system with some built-in safeguards: “Theoretically, Islamic banks avoid interest at all levels

of financial transactions and promote risk-sharing between the lender and borrower ”. In contrast to

conventional banking, savers are entitled to be informed about what the bank does with their money

and to have a say in where it should be invested.

“The Islamic bank and its customers share any profits in a pre-agreed proportion while any loss

is borne by the lender. Islamic banks can’t create debt without goods and services to back it – such as

physical assets including machinery and equipment.” However, on the negative side, Islamic banks

have fewer options to mitigate risk as they are prevented from using trades such hedging – although

some would argue that this in fact reduces their exposure to losses. In addition, Shariah-compliant

money markets and government securities are underdeveloped in most countries and Islamic banks’

access to lender-of-last-resort facilities operated by central banks are often limited.

The question is, are Islamic banks more risky overall than conventional banks or less so? And

with new standards in the form of Basel III coming into place to force banks to hold higher capital

reserves, how will this affect the sector? Indeed, are such measures even relevant to Islamic banks

given that they operate in a different way?

In a research project by Dr Haq and her colleague Professor Robert Faff, they examined banks in

22 countries during the period from 1998 to 2011 in an attempt to discover what impact the new

standards would have on bank risk in both conventional and Islamic banks.

They found that in general, Islamic banks were less risky and more resilient than their

counterparts in terms of their capital requirement and in attracting deposits from investors. In both

types of banks, a higher level of capital reserves was associated with lower risk, however the impact

was dependent on the type of bank – Islamic or conventional – and other variables.

One interesting finding was that in conventional banks, holding a higher level of reserves

actually increases the risk that they will be unable to meet their short-term liabilities and pay back

deposits – possibly because measuring bank capital focuses on credit risk and ignores the importance

of liquidity.

By contrast Islamic banks do not show a link between the level of capital and liquidity risk.

Dr Haq says: “This suggests that bank capital is of a less concern in that riskiness shoots up less when

capital is low. Perhaps, the conflict between depositors’ and investors’ interests at Islamic banks is less

acute given their financing and lending is tied less to capital.


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“The research also confirms that taking deposits reduces bank insolvency and credit risks. This

is consistent with the traditional banking approach, and in line with the push by regulators worldwide

to encourage banks to reduce their dependency on wholesale funding and increase reliance on deposits

in order to maintain bank safety and soundness.

” While the research relates to the period up to 2011, it suggests that in terms of banking

regulation, one size does not fit all. “While our analysis in general supports the tightening of capital

regulation, it suggests that regulatory reform may not be as simple as imposing a single capital

requirement across all types of banks,” Dr Haq adds.

“Such regulation may also create an uneven playing field, mainly because Islamic banks are

bound by Islamic law and, for instance, have limited access to Shariah-compliant money markets,

government securities, and lender-of-last-resort facilities, severely constraining their ability to raise

funds or increase liquidity quickly. “Formulating policies that are relevant and effective across the

various stages of the business cycle for both conventional and Islamic banks presents a formidable

challenge to policymakers.” 1

1 The business magazine of UQ Business School,August ,2016,https://www.business.uq.edu.au/momentum/islamic-banking-low-risk-alternative


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Challenges and Opportunities of Islamic Banking :

1- Challenges of islamic banking

After explaining unique risks of (I.B). Islamic banking faced big challenges; the

recent one is managing those risks.

Risk management is widely developed in the conventional financial market frameworks.

However, it is underdeveloped in the Islamic financial markets due to limited resources, high cost and

lack of technological machinations to assess and monitor risk in time. Islamic banks face crucial

challenges in improving their risk management strategies as they are exposed to various types of risks.

Conventional risk management techniques and tools are based on interest, gambling and speculation,

which are prohibited by Shariah.

Islamic finance is sorely lacking on product breadth, depth and sophistication. There are still

only few risk hedging instruments and techniques in Islamic finance despite its rapid growth. A

number of risk management techniques are not available due to requirements for Shariah compliance.

In particular, these are credit derivatives, swaps, derivatives for market risk management and money

market instruments (Syed Alwi, 2008).

Hence, the development of prudential regulations and systems related to risk management,

capital adequacy and corporate governance of Islamic banking is all the more pertinent. Financial

engineering is another operational challenge for Islamic banks, which demands standardization of the

process of introducing new products in the market. An Islamic bank currently has its own Shari’ah

board examining and evaluating each new product, without having coordinated efforts with other

banks. This process should be streamlined and standardized to minimize time, effort, cost and

confusion.

Cross border comparison of Islamic banking performances is difficult because the regulatory

frameworks of Islamic banking jurisdictions are not standardized and remain highly divergent, ranging

from frameworks that promote dual banking such as in Malaysia to frameworks that only recognized

Islamic banking system such as in Iran.

Islamic banks may have higher operational risk; greater number of contracts, newer supporting

system, evolving skill sets and lack of consistency of best practice. Islamic banking is perceived to be

more exposed to operational risks associated with the failure of controls, procedures, information

technology systems and analytical models.

Operational risk goes beyond the mathematical models and capital adequacy; and corporate

governance of Islamic banking is all the more pertinent. Financial engineering is another operational

challenge for Islamic banks, which demands standardization of the process of introducing new

products in the market.

An Islamic bank currently has its own Shari’ah board examining and evaluating each new

product, without having coordinated efforts with other banks. This process should be streamlined and


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standardized to minimize time, effort, cost and confusion. Cross border comparison of Islamic banking

performances is difficult because the regulatory frameworks of Islamic banking jurisdictions are not

standardized and remain highly divergent, ranging from frameworks that promote dual banking such as

in Malaysia to frameworks that only recognized Islamic banking system such as in Iran. Islamic banks

may have higher operational risk; greater number of contracts, newer supporting system, evolving skill

sets and lack of consistency of best practice.

Islamic banking is perceived to be more exposed to operational risks associated with the failure

of controls, procedures, information technology systems and analytical models. Operational risk goes

beyond the mathematical models and capital adequacy; a cultural change in the organization regarding

the operational risk is needed in order to develop sound operational risk management practices

(Akkizidis and Kumar, 2008). The issue of capital framework and liquidity standards is central to

adopting the Basel III. The banking institutions are required to raise minimum capital requirements

and hold a capital buffer.

However, Islamic banks are exposed to operational risk arising from compliance to Basel III

requirements. Some of the principles of risk management as proposed in Basel III can be applicable to

the Islamic financial industry with necessary modification and adaptations. Even so, Basel III could

not answer all the risk management issues for Islamic financial institutions; hence there has been a

need for alternative and supportive standards on risk management. Nevertheless, serious and sustained

efforts are needed to find the applicability which is specific to countries and markets. 1

There are different types of challenges that we are facing in this industry. The first challenge

is related to the level of maturity of the industry. Islamic finance is an emerging segment of the

financial services industry that lacks standards and witnesses rapid changes, which puts tremendous

pressure on IT vendors to keep abreast of the sector’s requirements and developments. The second big

challenge is the level of understanding of how different this industry really is from its conventional

counterpart. Most of the people working in this industry come from conventional finance and they

think they can force conventional processes, procedures and IT systems on this segment. This of

course opens the door to any vendor providing conventional banking systems to come and try to

compete in this segment, which brings tremendous number of competitors to a segment that they

simply cannot serve.2

2- Opportunities of islamic banking

Now, as 2018 begins, here is a non-exhaustive list of five trends which may shape and

reshape the contours of the Islamic banking and finance industry. These trends are

opportunities to advance the Islamic Banking Sector. But also these opportunities can return

to challenges.

1 Bessus, J. (2010). Risk Management in Banking. United Kingdom: John Wiley & Sons-Greuning, H. V. & Iqbal, Z. (2008). Risk Analysis for Islamic Banks.

Washington: The World Bank. Akkizidis, I. S. &Khandelwal, S. K. (2008).Financial Risk Management for Islamic Banking and Finance. New York:

2interview with Mohamed Kateb, 2015 https://www.globalbankingandfinance.com/technologies-and-trends-for-islamic-finance-in-2015/

https://www.globalbankingandfinance.com/technologies-and-trends-for-islamic-finance-in-2015/


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Trend 1: Impact of Industry 4.0, fintech and digital banking

“The Fourth Industrial Revolution” (Industry 4.0), title of the book by Prof Klaus Schwab, is the

notion of an industrial revolution that will alter the way we live, work and interact with one another,

including how we utilise and deploy highly disruptive technologies such as artificial intelligence,

robotics and blockchain technologies. This impact is clearly evident in the banking industry. The

banking industry is facing competitive threats from two sets of technology-driven companies that have

arisen from this Industry 4.0; one set consists of large technology companies such as WeChat, Alibaba

Group Holding Ltd and Apple Inc, and the other set comprises new financial technology (fintech)

companies. These large companies have used the loyalty and reputation of their core product offerings

such as smartphones, technological gadgets and social media platforms to penetrate and disrupt the

traditional product offerings of banking institutions. On the other hand, the new, and often startup,

fintech operators are leveraging on their lower operating costs and absence of regulatory burden to

offer differentiated and convenient value propositions to solve traditional financial problems that

would otherwise require lengthy processes and documentations by traditional banks. It is imperative

for banking institutions to decide whether digital investments are meant to be a new source of business

growth, which diversifies sources of income or alternatively, meant to improve cost efficiencies within

the existing business operations. One example of a digital journey is in finding new ways to improve

customer engagement. Establishing an omni-channel platform is one approach of how digitisation can

improve customer origination and engagement.

Digital initiatives may also be driven by a need to improve processes through automation to

enable, say an online paperless account opening by cloud-based documentation management system.

Data cleansing solutions to improve the sophistication of customer analytics to enable mining the

wallet size of the customer is another digital initiative too. These examples, related to customer

engagement, automation and data analytics, may not have an immediate and direct impact to revenue,

but offer long-term capabilities towards strengthening the current business model. On the other hand,

there are also digitisation projects which are primarily revenue-based innovations or entirely new

business lines, such as offering of online transactional banking services, robo-advisors, innovative

mobile payments and other similar value-added products and services. The point is, the range of

digitisation is so diverse, cutting across every market, every product line and every distribution

channel. On that score, the Islamic banking industry has to brace itself to face the unprecedented scale

of onslaught of these digital and fintech disruptions. The challenge for Islamic banks now is to put in

place a flexible and robust business model that is relevant and efficient, while keeping intact the

sanctity of Shariah governance and Shariah compliance within the changing landscape of banking

technologies, and the increasingly loud call out for banks to be more ethical and value-based.1

Trend 2: Value-based Intermediation

That leads to the second trend that will shape the Islamic banking industry in 2018 — value-

based intermediation (VBI). VBI is an attempt to realign the focus of Islamic finance towards creating

1 https://themalaysianreserve.com/2018/01/08/5-trends-will-shape-islamic-finance-2018/,interview with Mohamed Sultan, Jan 2018

https://themalaysianreserve.com/2018/01/08/5-trends-will-shape-islamic-finance-2018/,interview


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greater socioeconomic impact. This is a ground-breaking initiative by Bank Negara Malaysia (BNM),

which produced a strategy paper in July 2017 that proposes several strategies for the Islamic banking

industry to adopt.

BNM governor Tan Sri Muhammad Ibrahim said VBI is “the next frontier, and the major

milestone would be positioning Islamic finance to become more prominent and a leading agent of

positive change for the financial system, built upon shared values of integrity, inclusivity and

sustainability”. The VBI initiative supplements the Sustainable Development Goals, which cover a

wide spectrum of development challenges including poverty, inequality, climate change, sustaining

ecosystem and cities, health and education, among others.

To achieve most of these objectives, finance plays a pivotal role to facilitate and intermediate

capital allocation. For example, to achieve clean water and sanitation or affordable and clean energy,

finance plays the part in designing financial structures such as green bonds or sustainable and

responsible investment funds that allow funds to be mobilised towards funding these sustainability

projects. But following several financial crises over the past decade, including the subprime-lending

into the residential mortgage sector that gave rise to the global financial crisis in 2008 and later in 2012

the London interbank offered rate-rigging scandal, to name a few, doubts have been raised on the

finance sector. The finance sector is blamed to have lost its way, strayed from its stewardship role into

activities totally unrelated to the real economy and its needs. Too many people remain excluded from

the financial system and from access to fair finance. To a certain extent, Islamic finance is not entirely

excluded from this malaise.

It is high time Islamic finance steps up to the plate and become the beacon of light for the

financial industry. Being a financial system that is inspired by the principles of fairness and justice that

balance rewards and risks in an equitable and transparent manner, linking finance with the real

economy, Islamic finance is the most suitable proxy to win back the confidence of the consumers to

the financial sector. Having said that, the pressure will be on Islamic financial institutions to improve

their policies, processes and product offerings to be more proactive in ensuring they create a positive

and sustainable impact to the economy, communities and the environment, towards building a credible

reputation that Islamic banking is ethical and value-based in all ways. The challenge will be in

assessing the cost of all this exercise, while also managing the rising costs within the turbulent global

financial sector, which brings us to the next trend that will shape the Islamic banking industry in 2018 ;

managing costs and yields.1

_Malaysia, the leader in this business (Islamic Banking), and because she´s advance in this sector and a role

model in it, so we decide to give their opportunities and challenges on the future. We hope that Morocco will

follow the same path. To learn from the Malaysian experience.

1 https://themalaysianreserve.com/2018/01/08/5-trends-will-shape-islamic-finance-2018/,interview with Mohamed Sultan, Jan 2018


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Conclusion


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The appearance of Islamic banking and finance on the scene of global financial world and its

rapid growth is an important development of the modern time. It has experienced tremendous growth

not only in the Muslim world but also around the western world showing its viability and

competitiveness as an arrangement of financial intermediation.

The driving force behind the Islamic banking and finance movement was the prohibition of riba

and permissibility of bay (trade) and the spirit of following the shari´ah (Islamic law) principles in

undertaking commercial activities. Its theory was primarily developed on the basis of the PLS (Profit

& Loss Sharing) principles i.e. participatory (Islamically acceptable) financial contracts, namely,

Musharakah, Murabahah, Mudarabah and Ijarah.

The crisis of 2008 gives the real image of the both kind of banks .the traditional failed ,the

islamic bank rise in the financial world and that because of the the prohibition of interest ,the shari´ah

mechanism gives a strong financial building .An ultimate solution for social and economic stability.

However, Islamic banking also has different extra unique risks of her, such as sharia

noncompliance risk, rate of return risk, displaced commercial risk and equity investment risk. So

islamic banks find themselves facing a challenge of managing these risks, besides other challenges, in

the coast there is a lot of opportunities, specially digital ones to develop the sector: using blockchain

for example, in this case there is a deep debate .many innovation in this year can give the main

opportunity to be a bank pole in all the word .

We hope that our country (Morocco) learn from the leaders in this business, to discard poverty

and strengthening the financial sector .


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BIBLIOGRAPHY Ajagbe, T. S., & Brimah, A. N. (2013). Islamic Banking Development and Evolution: Current Issues and Future Prospects. Journal of Research in International Business and Management,

Alharbi, A. (2015). Development of the Islamic Banking System. Journal of Islamic Banking and Finance, 3(1), 12–25.

Ariff, M. (1988). Islamic Banking. Asian-Pacific Economic Literature, 2.

The Historical Development of Modern Islamic Banking: A Study in South-East Asia Counties. African Journal of Business Management, 10(20)

Milena Valeva, Theoretische Grundlegung ethischer Bankbetriebslehre: Die Lehren aus dem Islamic Banking, 1st ed., Gabler Verlag, 2012, Page 29 et seq. Available at: http://link.springer.com/book/10.1007%2F978-3-8349-3476-5, accessed May 16,2016.

Bashier, Portfolio Management of Islamic Banks “Certainty Model”. IN: Journal of Banking and Finance 7, 1983, Pages 339 - 354. Available at:

Khan, Feisal, How ‘Islamic’ is Islamic Banking? IN: Journal of Economic Behavior & Organization 76 (3), 2010, Pages 805 - 820. Available at:.

Chong, Beng Soon; Liu, Ming-Hua, Islamic banking. Interest-free or interest-based? IN: Pacific-Basin Finance Journal 17 (1), 2009, Pages 125 - 144. Available

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Mohamed Waseem, available 2014

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interview with Mohamed Kateb, 2015

Bessus, J. (2010). Risk Management in Banking. United Kingdom: John Wiley & Sons

Greuning, H. V. & Iqbal, Z. (2008). Risk Analysis for Islamic Banks. Washington: The World Bank. Akkizidis, I. S. &Khandelwal, S. K. (2008).Financial Risk Management for Islamic Banking and Finance. New York:

The business magazine of UQ Business School,August ,2016

Faleel Jamaldeen, Islamic Finance for Dummies

Islamic finance for Dummies,by Faleel Jamaldeen

Kettell B, 2011

Copyright 2017 Al Baraka Banking Group


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http://doi.org/10.1111/j.1467-8411.1988.tb00200.x Mohammad, T., & et. al. (2013).

http://www.stuff.co.nz/business/world/rest-of-world/645995/Morocco-develops-Islamic-financing;

http://www.microfinanceacademy.com/2011/02/dar-assafaa-first-islamic-bank-in.html


http://www.aawsat.net/2014/01/article55327397

http://ac.els-cdn.com/0378426683900432/1-s2.0-0378426683900432-main.pdf?_tid=e729ce86-e107-11e6-9b25- 00000aab0f6b&acdnat=1485133654_06bd5f1875de259ac61d420a7f6cd381, accessed November 22, 2016


http://www.internationalfinancemagazine.com/article/Moroccos-Islamic-Finance-Law-Awaits-Parliament-Nod.html

http://magharebia.com/en_GB/articles/awi/features/2014/01/21/feature-03;

http://english.alarabiya.net/en/business/banking-and-finance/2014/01/16/Moroccan-government-adopts-Islamic-finance-law-seeks-vote-in-parliament.html; http://www.aawsat.net/2014/01/article55327397

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http://ac.els-cdn.com/S0927538X08000036/1-s2.0-S0927538X08000036- main.pdf?_tid=fb9eea78-e318-11e6-968c-00000aab0f01&acdnat=1485360892_79ad769a59e8cb6431237d93b6af8347, accessed January 04, 2017.

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https://ebookcentral.proquest.com/lib/haaga/reader.action?docID=1336760.










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Contents Abstract........................................................................................................................................................... 3

Introduction .................................................................................................................................................... 5

Background of topic ................................................................................................................................ 6

Research problem ................................................................................................................................... 7

Structure of research topic ..................................................................................................................... 8

The philosophy of Islamic Banking ................................................................................................................. 9

Historical developement of Islamic Banking .......................................................................................... 9

Islamic Banking and it principles ........................................................................................................... 16

Most widely uesed types of Islamic contracts today ............................................................................ 19

Whey Islamic Banking ................................................................................................................................... 24

Distinction between Conventionnal Bank & Islamic Bank .................................................................... 26

Unique risks of Islamic Banking ............................................................................................................. 27

Islamic Banking a law risk alternative ................................................................................................... 29

Challenges & Opportunities for Islamic Banking in the World ..................................................................... 32

Issues & challenges of Islamic Banking ................................................................................................. 33

Opportunities of Islamic Banking .......................................................................................................... 34

Conclusion .................................................................................................................................................... 37

Bibliography & Webliography ....................................................................................................................... 39

Table of Contents .......................................................................................................................................... 42

World Islamic Banking

Master Finance Islamic

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DOUAE ELEZIZI AZEDDINE BENALI MOHAMED REDA AMAOUN … · World Islamic Banking Master Finance...

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