Islamic Banking Theory and Practice Course code MBF 706

InstructorDr. Muhammad Azhar Khan

1. Characteristics of Islamic Financial System

1. Allah is the Sustainer2. God is Real Owner of Everything and Man is Merely a Trustee3. Everything Created for Service and Use of Man4. Concept of Halal and Haram5. System of Sadaqat and Zakat6. Prohibition of Interest7. Ban on Hoarding of Wealth8. Policy of Moderation9. Condemnation of Monasticism and Materialism10. Equity and not Equality

2. Principles of Islamic Financial System

Basic idea of Islamic Financial System is prohibition of receipt and payment of interest. Literature based on the divine guidance about Islamic financial system suggest the following principles.1. Money as potential capital2. Prohibition of Interest3. Risk Sharing4. Sanctity of Contracts

5. Sharia Approved Activities6. Individual Liberty7. Right to Own Property8. Economic Inequality and Charity9. Social Equality10. Circulation of Wealth

2. Principles of Islamic Financial System

3. The existing economic system

Some of the known economic systems are;

• Capitalism

• Socialism

• Communism

• Islamic economic system

1. characteristics of Socialism and communism, such as

their definition, ideas, economic system, social

structure, freedom of choice, ownership of private

property, and means of control etc.

2. A comparison of the major economic systems in the

world, i.e. Capitalism, Socialism, Communism, and

Islamic economic system.

4. Comparison of the Economic Systems

5. Money in Islamic Financial System

• Concept of money, how it evolved from

representative money to fiat money.

• Role of money in the economy and its usage

as a tool to create debt.

• You will also watch an animated documentary

explaining the role of money as debt.

5. Money in Islamic Financial System

Implication of Fiat Money

• Credit Creation

• Inflation

• Unjust wealth appropriation

• Deposit multiplication

6. Factors of Production in Islamic Economic System

• Conventional concept of factors of production,

i.e. land, labor, capital, and entrepreneur.

• Concept of factors of production in Islamic

economic system.

• Role of money as of being a factor of

production.

6. Factors of Production in Islamic Framework

All productive inputs are grouped into two categories;

1. Factor inputs: those inputs that don’t get consumed

in the production process.

2. Consumed inputs: those inputs that are consumed

during the production process and lose their

original nature and shape, e.g. fuel, raw cotton,

plastic, etc.

6. Factors of Production in Islamic Framework

Money as factor of production:• Money is recognized as “consumed input” and

become useful only when converted into consumed input or factor input.

• Money itself is not considered a factor of production but it has the potential to become a factor of production.

7. Money: An Islamic Viewpoint

The Concept and Nature of Money in Conventional system :

1. Money is a commodity and is used to obtain other goods.

2. Widely Marketable as it is highly in demand and valued good.

Thus, it is sure that it can be used anytime and anywhere.

3. It can be transport easily. Money is made to make human life

easier therefore to make sure that convenience is important.

4. Relatively scarce as it is high in demand and high in value,

which means it holds a high value in small quantities

7. Money: An Islamic Viewpoint

Nature of money under Conventional system

5. Money is relatively imperishable. It is durable and can be

used for future purchases.

6. Easy to store.

7. Easily divisible

8. Money lasts forever.

9. All units of money are similar, means that it is easy to

distinguish and estimate the value of the money.

7. Money: An Islamic Viewpoint

Nature of money under Islamic system

1. Islam treats money as unit of account to determine the

relative worth of goods and services.

2. A medium of exchange, and not a store of value.

3. All units of money of the same denomination are 100% equal

to each other.

4. It becomes useful only when it is exchanged into a real asset

or used to buy services.

5. Money cannot be sold or bought on credit.

8. Principles of Islamic Banking

• Governing features of Islamic banking system

1. The prohibition of interest based transactions

2. Avoidance of speculations (gharar)

3. Avoidance of oppression (zulm)

4. Introduction of Islamic tax (zakat)

5. Financing of Sharia Approved activities

• Comparison of Islamic and conventional banking system.

9. Islamic Modes of Financing: Murabaha

After this lecture you should be able to understand

• The concept of Murabaha

• The stages involved in Murabaha transaction

• Practical issues in Murabaha and their resolution

• Murabaha documentation

• Uses of Murabaha as Mode of finance (Local as well as import

Murabaha)

10. Islamic Modes of Financing: Salam and Istisna

1. Salam and parallel Salam

2. Istisna and parallel Istisna

3. And the differences between the Salam and Istisna

modes of financing

11. Islamic Modes of Financing: Musharakah

Musharakah is a form of partnership which is based on profit

and loss sharing.

• Types of Shirkah

a. Shirkah al-Aqad (commercial partnership)

b. Shirkah al-Milk (joint-ownership).

Shirkat al-Aqad refers to partnership with commercial

objective, whereas, Shirkah al-Milk refers to joint-

ownership in a particular asset.

12. Islamic Modes of Financing: Mudarabah

• This is a kind of partnership between the two parties where

one partner contributes capital and the other one contributes

efforts as manager or entrepreneur. The profit of the venture

is share at an agreed ratio while the losses are borne by the

capital provider.

• The investment comes from “Rabb-ul-Maal” (Investor) while

the management and work is an exclusive responsibility of the

working partner, who is called Mudarib.

13. Islamic Modes of Financing: Diminishing Musharakah

• The concept of Diminishing Musharakah

• Features and rules of diminishing Musharakah.

• Uses of diminishing Musharakah particularly in House

Financing for four purposes:

1. Purchase of House

2. Construction of House

3. Renovation of House

4. Balance Transfer Facility (BTF)

14. Islamic Modes of Financing: Ijarah

Ijarah literally means to rent or lease something. In its technical

sense, the term Ijarah has two different connotations as follows:

I. A hire contract to employ the services of a person with wages

given to him/her as a consideration for his/her hired services.

II. A lease contract to transfer the usufruct of a particular property

to another person in exchange for a rent from the client.

15. Applications of Islamic Financing

The concept of Islamic financing regarding its applications

in different areas like. Musharakah, Mudarabah, and

Murabaha is applied in;

1. Project financing

2. Working capital financing

3. Import financing

4. Export financing

16. Islamic Investment Funds

• Principles of Islamic investment funds.• Modes of investment of funds and their

management under Islamic financial system.1. Equity fund2. Ijarah funds3. Commodity funds4. Murabaha funds5. Bai al Dain6. Mixed funds

17. Sukuk

• Sukuk is the Arabic name for a financial certificate.

• Its an Islamic alternative to the conventional interest

bearing bonds.

• Sukuk is a Trust certificate in which investor returns are

derived from legal or beneficial ownership of assets.

• Comparison of Sukuk and Bond

• Controversies/objections in Sukuk

18. Risk Underlying Islamic Financial Modes

After this lecture you will be able to understand

• The basic concept of risk and its classification into

different types.

• Risks faced by the financial institutions.

• Uniqueness of risk in Islamic banks.

• Risks in Islamic Financial instruments.

• How to mitigate in Islamic financial instruments.

19. Takaful (Islamic Insurance)

• Concept of conventional Insurance• Objections against conventional Insurance

system• Difference between Takaful and conventional

insurance• Different models of Takaful like Wakalah

model, Mudarabah model, and the Hybrid model (Wakalah and Mudarabah)

20. Evolution of Islamic Banking in Pakistan

• Social and political background of Pakistan

• History of Islamic banking in Pakistan

• Fact and figures regarding Islamic banking in

Pakistan

Summary of the Lecture

In this lecture we had an introduction of the course.