Islamic Banking & Finance Page 12-07-2019

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Muhammad Arif

Muhammad Arif
Muhammad Arif: Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

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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