2. Why Islamic Finance
• About 1,500 Billions (25% of Global
Population) is Muslim
• Riba (Usury & Interest) which is foundation of
modern conventional banking is Prohibited for
Muslims
• There are four sets of verses in Holy Qura’n
about Riba [Ar-Rum 30:39] [An-Nisaa 4:161] [Al-i-'Imran 3:130] [Al-
Baqarah 2:275-281]
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3. Why Islamic Finance
• Conventional Banking led to Financial crisis
due to lack of support from real assets
• Islamic Banking is asset based financing,
hence can serve as hurdle in the way of
financial crisis
• Islamic Banking is equity based financing
which discourage the passive behavior of
Investors
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4. Principles of Islamic Finance
• Prohibition of interest and usury in financial
dealings. Al-Qura’n (30:39, 4:161, 3:130, & 2:275-281).
• Avoidance of Gharar (uncertainty) in a
business transaction (Ayub 2007,page 57; Mansoori 2007, page 179;
Ghazi 2010, page 237).
• Avoidance of Myser and Qimar (speculation)
or any game of chance (Ghazi 2010, Ayub 2007). Myser is
prohibited by Holy Qura’n [ 2: 219 and 5: 90]
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5. Principles of Islamic Finance
• Profit and loss sharing. According to this
principle capitalist demanding profit on capital
should also participate in loss as well (Khan 1989,
page 71; Usmani 2002, page 87; Ghazi 2010, page 386; Khan 2007, page 307 &
Shari’a standard 12).
• Financing for only Halal (permitted) businesses.
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6. Features of Islamic Banking
• The principal activity of customer of Islamic
financial institutions (IFIs) must not be
prohibited by Islamic Shari’a.
• Islamic banks have to follow the principles of
sales and purchase as given by Shari’a
including five khiyars (stipulations).
• Islamic bank cannot claim additional amount
from customer in case of default
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7. Features of Islamic Banking
• Islamic banks cannot service depositors like
conventional banking with a predetermine
return.
• Islamic banks cannot avoid Shari’a compliance
in their operations on the excuse of non
conduciveness of existing legal & business
framework.
• Islamic banks cannot enter into transactions of
futures and forwards; gambling etc.
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8. Features of Islamic Banking
• Under partnership business IFIs cannot limit
their share in profit only also loss in
partnership must be shared according to
equity stake;
• IFIs cannot extend loans except Qarz e Hasna
(charity loans)
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9. Historic Development
• First ever objection on receipt of interest from
banks was raised by Syed Abul Aala Modoodi
• Objective resolution was passed in 1949
(Article 2-A)
• First bank on Islamic Principles was
established in 1963 in Mitghamer (Egypt) and
Tabong Hajji program of Malysia
• Elimination of interest from economy found
place in 1973 Constitution (Aticles 2, 31, 37,227)
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10. Historic Development
• Article 37 dealing with principles of policy
enjoins upon the state to eliminate riba as
early as possible.
• Conference of Foreign Ministers of OIC in 1973
in Jeddah & Establishment of IDB
• Council of Islamic Ideology Issued a
comprehensive report on “Elimination of Riba
from economy”in 1980
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11. Historic Development
• Revolution of Iran 1979 which eliminated interest
from economy
• Interest free banking economy-wide in Pakistan
1985, however optimism failed very badly
• Great research work done by IIU and IPS
• Decision of Federal Shari’a court (Justice Rtd Tanzeel
ur Rehman) in 1991
• AAOIFI 1991 (By Nov 2007, 30 Shari’a standards and by June 2008, 23
accounting standards, 5 auditing standards, 6 governance standards and 2 codes of
ethics were issued).
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12. Historic Development
• Raja Zafar Ul Haq Commission Report in 1997
• Supreme Court decision (1999) [Justice retd
Taqi Usmani & Coaleagues; a land mark]
• Establishment of Islamic Banking Department
in early 2000
• Establishment of Meezan Bank (2003),
BankIslami (2006) Burj Bank; Albaraka;
Emirates Global; Dubai Islamic; HSBC
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13. Industry Overview
• By the end of 2011, Global Volume US $1,289
Billions in more than 50 countries with above
300 Instituions [IFSL-2012]
• Share of Middle East 80% followed by South
and Far East Asia region 15% and balance 5%
from rest of the world [Hanif 2012]
• Islamic Finance shown growth and resilience
during world financial crisis of 2007-08
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16. Industry Overview
• By the end of Sept; 2012, in Pakistan Volume
of Assets is PKR Billions 741; Deposits 627;
Investment & Financing 571 [SBP-2012]
• No of Banks 18 (5+13) with branch network of
977 [SBP-2012]
• Islamic Finance has shown tremendous
growth in Pakistan during last nine years (04-
12) at an average annual rate of 65% (Y-O-Y)
[Hanif -2012]
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19. Comparative Performance
• Hanif et.al 2012
• Study period 2005-09
• Sample includes 22 conventional banks and 05
Islamic banks
• Areas studied profitability, liquidity, credit risk
and solvency
• All figures are based on Industry Averages
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20. Comparative Performance-Profitability
Performance Conventional Banks Islamic Banks Comments
Measure
ROA 1.44% 0.26% Conventional
Banking is
dominating in
ROE 14.26% 1.73% profitability
CSR 52.80% 97.63%
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21. Comparative Performance-Liquidity
Performance Conventional Banks Islamic Banks Comments
Measure
Net Loans/ 53.65% 91.30% Conventional
Assets Ratio
banking is
Liquid Assets/ 96.00% 82.17%
Customer deposits
dominating in
& Short term funds
Ratio
liquidity
Net Loans/ 58.49% 86.84% management
Deposits &
Borrowings
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22. Comparative Performance-Credit Risk
Performance Conventional Banks Islamic Banks Comments
Measure
Comn Equity/ 10.10% 14.81% Islamic
Assets Ratio
Banking is
Total Equity/ 18.72% 16.22%
Net Loans dominating
ImpairedLoans 10.64% 00.65% in credit risk
/ Gross Loans management
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23. Comparative Performance-Solvency
To measure Solvency following model was used
S = 1.5* CA+1.2*EA +3.5* CAR+0.6*NPL+0.3*CI+04*LA
Performance Conventional Banks Islamic Banks Comments
Measure
Solvency 56.36% 91.95% Islamic Banking
Result
is dominating
in Solvency
management
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25. Products-Financing Tools
• Musharaka is a partnership in capital; management by all or any
one of the partner; No salary to a partner; Profit as per agreement,
however share of sleeping cannot be more than active; loss must be
shared according to equity stake; Very fruitful for cash financing to
business and industry [Shari’a Standard 12]
• Mudaraba is a partnership between capital and skill; Profit sharing
as per agreement, however loss is of financier; very fruitful for small
businesses and self employment generation [Shari’a Standard 13]
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26. Products-Financing Tools
• Murabaha is a selling mode of financing where by cost and profit,
both are disclosed to customer; very useful in short term financing
especially overdraft facility [Shari’a Standard 8]
• Salam is a selling based mode of financing especially usefel for
agricultural financing; Cash is provided to farmer in advance as a purchase
price of produce to be delivered to bank later on [Shari’a Standard 10]
• Istisna’a is also selling based mode of finance designed for industrial
financing; cash is provided in advance in return of goods to be delivered at
completion to bank [Shari’a Standard 11]
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27. Products-Financing Tools
• Ijarah is a rental based mode of financing whereby asset is purchased
by bank to deliver to customer on rent; end of Ijarah may be in transfer of
asset from bank to customer; Practically it is used in auto-financing
[Shari’a Standard 9]
• Diminishing Musharaka is a mixture of Musharaka and
Ijarah where by asset is purchased in joint ownership of bank and
customer; Bank rent out his share to customer and receives rent
proportionally; customer purchases share of bank in installments and
finally asset is transferred to customer; Practically it is used for house
financing [Shari’a Standard 12]
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28. Portfolio Make up [July-06 to Sep 10]
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
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29. Capital Market
• Equity Investments Equity shares are Musharaka based
investment Instruments with variable returns, hence allowed under
Islamic financial system, while conventional bonds and Government
securities are interest based with predetermined fixed return and
prohibited [Shari’a Standard 12, 21].
• Skuk is an Islamic bond designed to meet the need of ready market
liquidity instrument; These are different from conventional bonds as
return is not absolutely fixed. [Shari’a Standard 17] According to ISI Emerging
Markets, approximately 2000 issues of Skuk were held with Global volume of
around US $200 Billion by the end of June 2010.
• In addition to corporate Skuk, Sovereign Skuk are also issued by the governments
including Pakistan, Jordan, UAE, Thailand, Malaysia, Turkey, Indonesia, Bahrain,
Qatar, Cayman Islands, Singapore, Germany, Brunei, Gambia and Kuwait.
(www.123 accessed on 5th July, 2010).
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30. Capital Market
• Equity Investments Although investment in equities is allowed,
however in order to invest in shares of a company certain tests (of Shari’a
compliance) must be qualified.
• There are about nine Islamic indexes globally engaged in screening of
companies by applying Shari’a Compliance tests including DJIM, FTSE, S&P,
MSCI, HSBC, Ameri, BID, Azzad and KMI(Derigs & Marzban, 2008).
• In Pakistan KSE-Meezan Index (KMI-30) was launched in 2008. It is revised
semi-annually in May and Nov based on Dec and Jun Positions
• There are above 30 mutual funds working in Pakistan
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31. Capital Market- Screening Criteria KMI-30
• Halal Business of the Investee Company
• Interest Based Financing: Interest based debts to asset ratio should be
less than 40%.
• Shari’a Non-compliant Investments: The ratio of non compliant
investments to total assets should be less than 33%.
• Purification of Shari’a Non-complaint Income: The ratio of Shari’a non-
compliant income to total revenue should be less than 5%.
• Net Liquid Assets to Share Price: The market price per share should be
greater than the net liquid assets per share calculated as: (Total Assets – Illiquid
Assets – Total Liabilities) divided by number of shares.
• Illiquid Assets to Total Assets: The ratio of illiquid assets to total assets
should be at least 20%.
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32. Global Impact of Islamic Finance
• Opportunity of Shari’a compliant financing
• Petro dollars
• Study of Islamic teachings by wider audience
• Promotion of commonalities in Muslim Communities
• Leadership role in global affairs
• Wider participation of masses in financial system
• Stability in financial system if get dominance
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33. Challenges
• Use of Kibor as bench mark for profit
• Use of par value in selling of shares of IFI in House financing
• Use of par value in purchase of skuk at the time of
redemption
• Use of financial penalty in case of default by customer
• Use of independent party guarantee of capital in case of skuk
• Use of time value based computer softwares in calculation of
installments
• Very minor use of profit and loss sharing, salam and Istisna’a
modes of financing
• Non availability of cash financing for day to day operations
except through Musharaka
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34. How to overcome Challenges
Answer is well educated and trained Human Resource
You
Research
2/12/2013 Muhammad Hanif ACMA 34
![Why Islamic Finance
• About 1,500 Billions (25% of Global
Population) is Muslim
• Riba (Usury & Interest) which is foundation of
modern conventional banking is Prohibited for
Muslims
• There are four sets of verses in Holy Qura’n
about Riba [Ar-Rum 30:39] [An-Nisaa 4:161] [Al-i-'Imran 3:130] [Al-
Baqarah 2:275-281]
2/12/2013 Muhammad Hanif ACMA 2](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)