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1
“Banking Operation & Islamic Banking”
On the topic
“Difference Between Islamic Banking and Commercial Banking
& Features...
2
Contents
Conventional Banking ………………………………….. 3
Islamic Banking ………………………………….. 3
Difference bw Conventional and Islamic...
3
Conventional Banking:
A commercial bank (or business bank) is a type of retail bank that provides services,
such as acce...
4
Islamic Bank in Pakistan:
 Bank Islami Pakistan Limited
 Burj Bank
 Dubai Islamic Bank Pakistan Limited
 Meezan Bank...
5
It can charge additional money
(penalty and compounded
interest) in case of defaulters.
Islamic banks have no provision
...
6
mudharabah concept, client have
to share in a loss position.
Its functions and operations follow the
Qur’an and the Sunn...
7
Challenges of Islamic Banking:
 Shariah interpretation versus the
financing commercial viability.
 Legal jurisdictions...
8
Islamic Economic System in Pakistan:
Capitalism, Communism and Mixed Economics system has purely a materialistic
approac...
9
2. Consumption of Wealth:
In Islamic System uses of luxuries are not allowed because it against the concept of
"TAQWA" s...
10
7. Responsibility of the Government:
Responsibility of the Islamic Government are
 Should check un-Islamic activity li...
11
Islamic Banks into Conventional Banking Systems:
Financial products and institutions will impose on the regulated entit...
12
Sources of sharia law:
 Interpretations of the Qur'an
 Interpretations of the Sunnah
 Ijma, consensus amongst schola...
13
organization is to design and disseminate accounting and auditing standards that can be
applied internationally by all ...
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Difference Between Islamic Banking and Commercial Banking & Features of Islamic Economic System in Pakistan

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Difference Between Islamic Banking and Commercial Banking
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Difference Between Islamic Banking and Commercial Banking & Features of Islamic Economic System in Pakistan

  1. 1. 1 “Banking Operation & Islamic Banking” On the topic “Difference Between Islamic Banking and Commercial Banking & Features of Islamic Economic System in Pakistan” Presented To: “Sir Nouman Dar” Presented By: Muhammad Shaban MCE 12169 Yasir Ali MCE 12154 Mutahir Bilal MCE 12147 Nadia Izhar MCE 12170 Class M.Com Semester 4th Evening Superior University Lahore.
  2. 2. 2 Contents Conventional Banking ………………………………….. 3 Islamic Banking ………………………………….. 3 Difference bw Conventional and Islamic Banking……… 4 Challenges of Islamic Banking………………………………….. 7 Islamic concepts of a economy b/w Economics and Law… 10 Islamic Banks into Conventional Banking Systems…….. 11 Shariah Compliance …………………………….…… 11 Legal and Regulatory Adaptations………………………….. 11 Segregation of Funds……………………………….…. 12 Accounting and Auditing Standards ……………….…..... 12
  3. 3. 3 Conventional Banking: A commercial bank (or business bank) is a type of retail bank that provides services, such as accepting deposits, giving business loans and basic investment products. A financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. The traditional commercial bank is a brick and mortar institution with tellers, safe deposit boxes, vaults and ATMs. However, some commercial banks do not have any physical branches and require consumers to complete all transactions by phone or Internet. In exchange, they generally pay higher interest rates on investments and deposits, and charge lower fees. Categories of commercial banks in Pakistan: Commercial banks operating in Pakistan can be divided into four categories:  Nationalized Commercial Banks (NCBs),  Privatized Banks,  Private Banks and  Foreign Banks. Islamic Banking: A banking system that is based on the principles of Islamic law (also known Shariah) and guided by Islamic economics. Two basic principles behind Islamic banking are the sharing of profit and loss and, significantly, the prohibition of the collection and payment of interest. Collecting interest is not permitted under Islamic law. Fundamental of Islamic Banking:  Shariah laws are the tenets of Islamic Banking. As such, the comparison with that of the conventional are not exactly like-to-like.  Conventional banking was build upon the fundamentals of debtor-creditor relationship with interest being the price of credit and reflecting the opportunity cost of money. Hence, money is a commodity somewhat.  Financial relationship in Islam is generally participatory in nature. E.g. the principles of Musharakah and Mudharabah, or contractual transaction. In addition, risk and reward relationship is guided by the socio-economic principles.
  4. 4. 4 Islamic Bank in Pakistan:  Bank Islami Pakistan Limited  Burj Bank  Dubai Islamic Bank Pakistan Limited  Meezan Bank Limited  Al Baraka Bank (Pakistan) Limited  Emirates Global Islamic Bank Basic Differences between Islamic and Conventional Banking: Islamic Banking Conventional Banking The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. The functions and operating modes of conventional banks are based on fully manmade principles (largely capitalism theory). It promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). The investor/lender is guaranteed of a predetermined rate of interest or returns. It also aims at maximizing profit but subject to Shariah restrictions. Unrestricted profit maximisation illustrated by derivatives trading. 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. It does not deal with Zakat. Participation in partnership business is the fundamental function of the Islamic banks. Understanding the venture is therefore essential. Embedded know-your-customer orientation. Lending money and getting it back with compounding interest is the fundamental function of STRICTLY PRIVATE & CONFIDENTIAL Understanding the venture is therefore essential. Embedded know-your-customer orientation. the conventional banks. Money is a commodity and the motivation.
  5. 5. 5 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 except for compensation (typically such proceeds is given to charity). Rebates early settlement at the Bank's discretion. Due importance to the public interest/ maslahah. Its ultimate aim is to ensure growth with equity. Often, lenders/banks interest becoming forefront. It makes no effort to ensure growth with equity. For the Islamic banks, it must be based on a Shariah approved underlying transaction. For interest-based commercial banks, borrowing from the money market is relatively STRICTLY PRIVATE & CONFIDENTIAL easier. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations. Since income from the advances/loans is fixed, it gives little importance to developing expertise in project appraisal and evaluations. Risks are transferable at a price (and sometimes incremental). The conventional banks give greater emphasis on creditworthiness of the clients where credit equals to ‘commodity pricing’. Greater emphasis on the viability of the projects. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller. Relationship is often defined as that of creditor-debtor. 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 A conventional bank has to guarantee all its deposits.
  6. 6. 6 mudharabah concept, client have to share in a loss position. Its functions and operations follow the Qur’an and the Sunnah as much as possible. Its functions and operations are based fully on man-made principles. In its investment product,an Islamic bank promotes the sharing of risk and profit between investor and investment fund manager.There is no fixed profit promised. Division of profit is based on real profit. In its investment product, the investor is promised a fixed rate. In reality, it is a riba based loan activity. Aiming for profit that adheres to Islamic discipline that is limited to that which benefit society. Aiming for profit without religious or moral boundaries. Its retail product utilizes thetrading or renting of an asset,and not the loan contract. The retail loan product applies the system of giving out loans with multiplied interest. Charges compensation for any late payment, but it does not go toward the bank’s earnings.Instead, it is channeled directly to charity. Charging a compounding penalty on a loan if there is late payment. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks. The 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 give for early settlement at the Bank's discretion. It can charge additional money (penalty and compounded interest) in case of defaulters. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity. Very often it results in the bank's own interest becoming prominent. It makes no effort to ensure growth with equity. For the Islamic banks, it must be based on a Shariah approved underlying transaction. For interest-based commercial banks, borrowing from the money market is
  7. 7. 7 Challenges of Islamic Banking:  Shariah interpretation versus the financing commercial viability.  Legal jurisdictions and governing laws.  Transparency, accountability and governance for public and privatesectors.  Tax incentives, pervasive government intervention and controls.  Supervisory and prudential regulatory framework.  Lack in depth capital markets and liquidity funding.  Accounting and auditing standards. relatively easier. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations. Evaluation also stresses on the potential or viability, performance and prospect of the project that is being financed. Evaluation stresses on the ability of the borrower to pay off the loan. Not much attention is given to the progress of the customer’s project. Profit according to the concept of sharing profit-loss; the bank gives more attention on investing in project development. Earn revenue from fixed interest charged to the customer. The bank-customer relationship: seller, buyer or partner. The bank-customer relationship: loan lender and borrower.
  8. 8. 8 Islamic Economic System in Pakistan: Capitalism, Communism and Mixed Economics system has purely a materialistic approach in which human social life has no importance. But in Islamic System, the followers of Islam are required to lead a material life in such way that it becomes a source of happiness and respect of others in this world for making secure himself for next world. Islamic Economic System consist of institutions, organizations and the social values by which natural, human and manmade resources are used to produce, exchange, distribute and consume wealth? Goods and services under the guiding principles of Islam to achieve "FALAH" in this world and also other it. Salient Features of Islamic System: Main characteristics of Economic System of Islam are:  The Concept of Private Property  Consumption of wealth  Production of wealth  Distribution of wealth  The concept of Zakat  Interest free Economy  Economic Growth  Responsibilities of the Government. 1. The Concept of Private Property: Basic Principles in Islam for Consumption or Investment of private property are:  Concept of "HALAL" and "HARAM" for earning or in production and consumption of wealth.  A property cannot be used against public interest.  Show much as you have something.  Real/money Capital cannot be used for gain.  Payment of Zakat is compulsory.
  9. 9. 9 2. Consumption of Wealth: In Islamic System uses of luxuries are not allowed because it against the concept of "TAQWA" should have distinguish between "HALAL" and "HARAM"."BUKHAL" and "ISRAF" are to be avoided. 3. Production of Wealth: Price mechanism plays a key role in carrying out the production process in an Islamic Society. As Price system results in the expectations of workers and consumers the Govt. Interferences with the price mechanism to over come the problem. These things are not allowed in Islamic System.  Production of drugs, gambling, lotery, music, dance etc.  Lending and borrowing on interest  Black marketing, Smuggling etc. 4. Distribution of Wealth: Islamic Economics System favour fair (not equal) distribution of wealth in the sence that it should not be confined to any particular section of the society. For fair distribution of wealth Islam gives following steps:  "BUKHAL" and "ISRAF" are to be avoided.  Payment of Zakat  Interest not allowed  Monopoly of Private firm not allowed  Earning from Black Market. 5. The Concept of Zakat: Zakat is a major source of revenue the government in an Islamic state. It levy on all goods and money or on wealth if have to pay yearly on the month of RAJAB or RAMADAN. 6. Interest free Economy: The whole financial system the bank structure in particular is run on the basis "SHARAKAT" and "MUZARABAT" in Islamic state. Therefore, Islamic economics is an interest free economy.
  10. 10. 10 7. Responsibility of the Government: Responsibility of the Islamic Government are  Should check un-Islamic activity like gambling, smuggling, black marketing etc.  Should secure poor people by giving them necessity of life i.e. food, clothing, health etc.  Should provide equal employment opportunity.  Social and Economic Security is required to guaranteed by the Govt. Islamic concepts of a economy between economics and law: The prevalent doctrine of Islamic economics today can be summarized as follows:  Islam conveys a positive outlook on this life in general and provides a supportive value system for economic activities in particular.  Islamic economic ethics exhibits considerable overlap with Western-Christian perceptions in the field of individual ethics. Great importance is ascribed to personal achievement.  Individuals are expected to earn their living through their own work. A person’s own achievement (physical and intellectual work) is the most important basis for legitimately obtaining material goods and wealth.
  11. 11. 11 Islamic Banks into Conventional Banking Systems: Financial products and institutions will impose on the regulated entities, as well as the potential implications of the interaction between Islamic and conventional banks. This section reviews four areas of paramount importance that practitioners and supervisors need to appreciate in order for Islamic banking to be successfully introduced into a conventional system:  Compliance with the Shariah  Segregation of Islamic and conventional funds  Accounting standards  Legal and regulatory adaptations  Transparency and awareness campaigns. Sources of Financing in Islamic banking There are the following sources of financing.  Murabaha.  Ijarah.  Mushariqah Mutanaqisah  Tawaruq.  Salam  Istisnah Shariah Compliance: Islamic finance in based on the principles established by the Shariah as well as other jurisprudence or rulings, known as fatwa, issued by qualified Muslim scholars. Admittedly, some of the issues covered by these rulings can be quite complex, forcing the institutions involved to often seek the assistance of experts in interpreting them. As a result, it has become a common practice for Islamic banks to appoint their own board of Shariah scholars. Nevertheless, since expertise in these matters is still relatively scarce in some countries, different Islamic banks often share the same scholars. This phenomenon has the beneficial side-effect that it promotes consistency across the services and products offered by these institutions. The fund aimed at drawing funds from the Gulf region. Initially, the fund experienced difficulties in attracting investors, as it lacked a Shariah board, and thus it was viewed with reticence by Gulf investors. After some time, a Shariah board was appointed and the fund took off successfully.
  12. 12. 12 Sources of sharia law:  Interpretations of the Qur'an  Interpretations of the Sunnah  Ijma, consensus amongst scholars ("collective reasoning")  Qiyas/Ijtihah analogical deduction ("individual reasoning") Legal and Regulatory Adaptations: One of the questions that will need to be resolved promptly as Islamic banking emerges within a conventional system is how to embed Islamic activities into the existing juridical framework. To think about this issue, it is useful to adopt a two-tier perspective and address first the legal aspects of Islamic contracts, and second, the regulatory aspects of Islamic financial transactions. Segregation of Funds: An important principle behind Islamic finance is the desire to maintain the moral purity of all transactions. The funds intended for Shariah-compatible investments should therefore not be mixed with those of non-Islamic investments. This requirement is not based on the assumption that the activities of non-Muslims are intrinsically impure. The rationale behind this principle is rather one of prudence, in the sense of taking all the necessary precautions to ensure that Islamic funds do not become mixed with other funds that may be involved with riba, gharar, or haram activities. Therefore, in order to ensure compliance with Islamic principles, conventional banks wishing to offer Islamic products must guarantee and publicize that the funds devoted to conventional activities will not be mixed (commingled) with those destined for Islamic activities. In operational terms, this requires that banks establish different capital funds, accounts, and reporting systems for each type of activity. In this sense then, when a conventional bank opens an Islamic window, to a large degree, it is in fact establishing a separate entity from the rest of the bank. Accounting and Auditing Standards: The rapid expansion of the Islamic financial industry that started in the 1970s was not initially accompanied by the creation of a set of internationally recognized accounting rules. In consequence, Islamic institutions around the globe had to resort to developing their own accounting solutions for their new products, rendering comparisons across institutions difficult, and sometimes even giving the impression of lack of transparency. The need for a body of accounting standards purposely designed to reflect the specificities of Islamic products became even more pressing as new and more complex instruments were being marketed. To close this widening gap, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was created in 1990. One of the main goals of this
  13. 13. 13 organization is to design and disseminate accounting and auditing standards that can be applied internationally by all Islamic institutions.

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