Muhammad Arif
Islamic Banking in Various jurisdictions
The rapid pace of growth of Muslim population worldwide presents a lucrative window of opportunity for Islamic Banking. However, banks need to examine the key location-specific factors while offering Islamic Banking products and develop targeted offerings based on the unique needs of a region.
Sharia compliance is at the core of the activities for any bank intending to launch Islamic products. The Sharia compliance is ensured or verified by bank’s own Sharia boards with Sharia scholars on them; and/or by Sharia boards of Central banks. However, Sharia scholars are currently spread too thinly across numerous institutions. Compounding the present difficulty of finding scholars is that there is a difference in opinion on Sharia interpretations among Sharia scholars. There are differing opinions of how to apply or interpret Sharia law amongst the different banking regions, notably between the Middle East and Malaysia. Also, currently there are a number of regulatory frameworks within which Islamic banking is developing. These frameworks and rules can often be contradictory and lead to differences in the application compliance.
Islamic banks worldwide traditionally offer four categories of financial contracts: Deposits, Lending, Treasury and Trade Finance. The given sections provide a comparative evaluation of Islamic Banking offerings across geographical regions.
| Form of Deposits in Islamic Banking | ||||
| PRODUCT/PROCESS | MIDDLE EAST/Pakistan | NORTH AFRICA | MALAYSIA | INDONESIA
|
| Savings Account based
on: Wadiah Mudharabah Qard
|
Mudharabah and Qard are standard offering | Mudharabah and Qard are standard offering | Wadiah is more popular than Mudharabah | Mudharabah is most popular, followed by Wadiah |
| Current Account based
on: Wadiah Mudharabah Qard
|
Qard and Mudharabah
are standard offerings
|
Qard and Mudharabah
are standard offerings
|
Only Wadiah is offered to
customers
|
Only Wadiah is offered to
customers
|
| Fixed Deposit based on:
Mudharabah, Commodity Murabaha Wakalah
|
All three are popular
products, especially within GCC countries
|
All three are popular
products |
Mudharabah is the
Standard offering. Commodity Murabaha and Walakah are gradually becoming more popular
|
Only Mudharabah is
being offered to customers
|
| Recurring
Deposits/Saving Plan to increase deposits |
Popular scheme offered
to customers as a “forced saving plan”
|
Popular scheme | Slow take-up as Takaful
unit-linked plan is more attractive to customers
|
Popular scheme to
encourage saving for Hajj and Education
|
| Structured Products | Products are offered to
selected customers |
Products are offered to
selected customers |
Products are offered to
selected customers |
Not offered to public yet
|
| Profit Distribution | Adopt guideline issued by
AAOIFI on Mudharabah based products |
Adopt guideline issued by
AAOIFI on Mudharabah based products |
Adopt guideline issued by
AAOIFI but more refined and complex
|
products
Revenue-based (instead of profit based) but less complex
|
| Liquidity Management | Standard offering when
banks promote their cash management services to commercial and corporate customers
|
Emerging requirements | Same as ME and Africa
|
Emerging requirements in Indonesian market
|
| Fund Management(Allowing banks to create
multiple funds or pools meant for specific target customers)
|
Very popular
arrangement wherein customers can place deposits into various funds based on their risk preferences and expected returns
|
Popular arrangement
wherein customers can place deposits into various funds based on their risk preferences and expected returns
|
Low demand from
Customers. However, non-bank financial institutions (NBFI) and developmental banks are using this capability to manage borrowings or “special allocation” received from banks and government agencies
|
Emerging requirements
but take up from customers is low
|
| FINANCING in Islamic Banking
|
||||
| PRODUCT/PROCESS | MIDDLE EAST/Pakistan | NORTH AFRICA | MALAYSIA | INDONESIA
|
| Monetization Products Cash finance based on
Tawarruq and Salam
|
Salam structure is
preferred as Tawarruq is discouraged by scholars
|
Salam structure is
preferred |
Very popular scheme
based on Tawarruq concept
|
Both Tawarruq and
Salam structures are not approved by scholars |
| Vehicle Financing
(Murabaha and Ijarah) |
Standard offering
|
Standard offering | Standard offering | offering Standard features, some
are managed by multi finance outfits
|
| House Financing
(Murabaha, Ijarah and Diminishing Musharakh)
|
Only Ijarah and
Diminishing Musharakh are popular
|
Only Ijarah and
Diminishing Musharakh are popular
|
Only Ijarah and
Diminishing Musharakh are popular
|
Only Ijarah and
Diminishing Musharakh are popular
|
| Pawn Broking (Al-Rahnu) | Prohibited product | Prohibited product | Popular, as a form of
personal financing with gold as collateral
|
Popular, as a form of
personal financing with gold as collateral
|
| Equipment/Industrial
leasing (Operating/Financial) based on Ijarah concept
|
Operating and financial
leases are popular
|
Operating and financial
leases are popular
|
Mostly financial lease | Mostly financial lease |
| Plant/Construction
financing using Istisna and forward Ijarah
|
Both structures used but
forward Ijarah is popular
|
Forward Ijarah is popular | Istisna and forward
Ijarah are prevalent
|
Istisna structure is more
popular
|
| Project Financing based
on Musharakah and Dim Musharakah and Mudharabah
|
Popular form of financing | Popular form of financing | Banks not keen to offer
as deemed too risky |
Popular form of financing
|
| Working capital financing
based on Tawarruq , Mudharabah or Musharakah
|
Mudharabah and
Musharakah offered but not Tawarruq as it is prohibited
|
Mudharabah and
Musharakah offered but not Tawarruq as it is prohibited
|
Only Tawarruq is being
offered by banks
|
Mudharabah and
Musharakah offered but not Tawarruq as it is prohibited
|
| Syndication origination,
processing and support
|
Basic requirements.
Subscription received under Musharakah and other structures |
Basic requirements.
Subscription received under Musharakah and other structures |
Syndication mimics
arrangement in conventional using Sharia compliant structures
|
Basic requirements.
Subscription received under Musharakah
|
| Rebate processing | Rebates are given at end
of financing or at redemption
|
Rebates are given at end
of financing or at redemption
|
Rebates are given during
or at end of financing
|
Rebates are given at end
of financing or at redemption
|
| Penalty charging | Penalty charged is
always given to charity
|
Penalty charged is
always given to charity
|
Penalty charged is
treated as income, and if above a threshold to be given to charity
|
Penalty charged is
treated as income, and if above a threshold to be given to charity |
| Asset securitization
(Selling of financing assets to other parties)
|
Practice is now emerging | Not Prevalent | This is common practice
in Malaysia wherein a government body buys mortgages from banks to enhance liquidity
|
Requirement is being
discussed but is yet to be approved by the Sharia scholars
|
| Rescheduling and
restructuring
|
Complete flexibility
required, especially for corporates
|
Complete flexibility
required, especially for corporates
|
Complete flexibility
required, especially for corporates and VVIPs
|
Less complex
requirements than ME, Africa and Malaysia
|
| Collection | External collectors and
lawyers are used extensively by banks and they form part of the ecosystem and must be monitored closely
|
External collectors and
lawyers are used extensively by banks and they form part of the ecosystem and must be monitored closely
|
Same as ME and Africa | Collections
are mostly handled by internal collectors
|
| Assets Takeover | Very popular scheme as
this helps reduce complexity and to transfer assets to banks’ books
|
Popular scheme as this
helps reduce complexity and to transfer assets to banks’ books
|
Same as ME and Africa Same as ME and Africa
|
Same as ME and Africa Same as ME and Africa
|
| Origination – Retail
(Ijarah, Istisna, Mudharabah, Musharakah, Murabaha and Tawarruq)
|
Advanced requirements
to address competitive landscape including Doc Mgmt, Credit Scoring and Credit Control before disbursement
|
Advanced requirements
to address competitive landscape including Doc Mgmt, Credit Scoring and Credit Control before disbursement
|
Same as ME and Africa | Requirements are still
Basic. However, future requirements may match that of ME and Africa
|
| Origination – Corporate
(Ijarah, Istisna, Mudharabah, Musharakah, Murabaha and Tawarruq)
|
Advanced origination
features for various business requirements like Project finance, Working capital Financing, Term financing including Financial analysis, workflow definition, Doc Mgmt, Credit Scoring and Credit Control before disbursement
|
Advanced origination
features for various business requirements like Project finance, Working capital Financing, Term financing including Financial analysis, workflow definition, Doc Mgmt, Credit Scoring and Credit Control before disbursement
|
Same as ME and Africa | Requirements are still
Basic. However, future requirements may match that of ME and Africa
|
| TREASURY Functions in Islamic Banking
|
||||
| PRODUCT/PROCESS | MIDDLE EAST/Pakistan | NORTH AFRICA | MALAYSIA | INDONESIA
|
| Forex Standard requirements | Standard requirements Forward deals are not
allowed .
|
Standard requirements Forward deals are not
allowed |
Standard requirements Forward deals are not
allowed |
Standard requirements Forward deals are not
allowed |
| Money Market | Money market is active
but products are less complex due to strict rules imposed by the Sharia scholars
|
Money market is active
but products are less complex due to strict rules imposed by the Sharia scholars
|
Money market is very
active and many unique products based on Mudharabah, Commodity Mudharabah and other structures are offered by central banks and government agencies
|
Standard requirements,
very basic instruments based on Mudharabah are offered. Commodity Mudharabah is yet to be offered in the market
|
| Securities | Government papers and
Sukuk offered by government and large companies are the typical securities traded
|
Government papers and
Sukuk offered by government and large companies are the typical securities traded
|
Active market even
though players buy for investment rather than trading. Active repo market as well
|
Only government papers
are traded. Very limited Sukuk and other instruments
|
| Derivatives | Very limited derivatives
products due to strict ruling by Sharia scholars
|
Not Yet Available | More advanced than
Middle East and Africa. Profit and Currency swap derivatives have been seen in the market
|
No derivative-based
product in the market
|
| Front Office | Standard front-office
functionalities to facilitate dealers in their trading daily, with good support for all instruments available in the market
|
Standard front-office
functionalities to facilitate dealers in their trading daily, with good support for all instruments available in the market
|
Same as ME and Africa | Same as ME and Africa |
| Middle Office | Standard middle office
functionalities to ensure dealing risks are minimized and all limits are properly assigned and controlled |
Standard middle office
functionalities to ensure dealing risks are minimized and all limits are properly assigned and controlled
|
Same as ME and Africa | Same as ME and Africa |
| Back Office | Standard back-office
functionalities to facilitate completion of deals, sending of notices and swift messages to transacting parties and to handle all accounting entries and reporting
|
Standard back-office
functionalities to facilitate completion of deals, sending of notices and swift messages to transacting parties and to handle all accounting entries and reporting
|
Same as ME and Africa | Same as ME and Africa |
| TRADE FINANCE in Islamic Banks
|
||||
| PRODUCT/PROCESS | MIDDLE EAST | NORTH AFRICA | MALAYSIA | INDONESIA
|
| Complete LC Processing
based on Murabaha, Wakalah and Musharakah Concepts
|
Standard requirements
due to UCP practices
|
Standard requirements
due to UCP practices
|
Same as ME and Africa | Same as ME and Africa |
|
Bills |
Standard requirements
due to UCP practices
|
Standard requirements
due to UCP practices
|
Same as ME and Africa | Same as ME and Africa |
| Guarantees | Standard requirements
due to UCP practices
|
Standard requirements
due to UCP practices
|
Same as ME and Africa | Same as ME and Africa |
| Complete LC Processing
based on Murabaha, Wakalah and Musharakah Concepts
|
Standard requirements
due to UCP practices
|
Standard requirements
due to UCP practices
|
Same as ME and Africa | Same as ME and Africa |
Shariah compliant investment funds
The most common forms of Shariah compliant investment funds are equity funds, real estate funds and money market funds. Islamic mutual fund works in a similar manner as a conventional fund except that the Islamic mutual fund only deploys funds in Shariah-compliant investments. The key players in Islamic mutual fund are: Asset Management Company, Trustee, Shariah Advisor & Registrar
These investment funds employ Islamic contracts which ensure that the terms and rights of all parties are safeguarded in conformity with Islamic principles (examples and definitions are given below).
Musharakah: A partnership where profits are shared according to a pre-agreed ratio while losses are shared in proportion to the capital investment of each partner. This equity financing arrangement is widely regarded as the purest form of Islamic financing.
Mudarabah: An investment partnership under which the investor (the “Rab-ul-Mal”) provides capital to the investment manager (the “Mudarib”) in order to undertake a business or an investment activity. While profits are shared on a pre-agreed ratio, losses are borne only by the investor.
Ijarah: An Islamic lease agreement. Instead of lending money and earning interest, Ijarah allows the investor to earn profits by charging rentals on the asset leased to the user.
Murabaha: Purchase and resale of an asset. Instead of lending money, the investor purchases the desired asset from a third party and resells it at a predetermined higher price to the user. By paying this higher price over installments, the user of the asset has effectively obtained credit without paying interest.
The classical equity instruments in Islamic commercial law (musharakah and mudarabah) require partnership and profit sharing. In financial markets, investing in stocks and equity funds is permitted but must conform to certain guidelines.
Conventional interest-based lending or bonds are ruled out in Islamic finance because it relies on interest. Instead, asset-backed financing is encouraged with the risk being shared by the provider and the user of the
UBL Al Ameen Funds (Shariah Compliant Money Market — Annualized return), NAFA Islamic Principal Protected/Preservation Fund (Shariah Compliant Fund of funds – Absolute return), Atlas Islamic Income Fund (Shariah Compliant Income — Annualized return), Dawood Islamic Fund (Shariah Compliant Asset Allocation – Absolute return),Alfalah GHP Balanced Allocation Fund,ABL Islamic Financial Planning Fund and JS Islamic Fund (Shariah Compliant equity — Absolute return) are ome Islamic Mutual funds in Pakistan. Other than these Mezzan Bank and Bank Islami also offer investment schemes under Islamic mode of financing.
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