Islamic Banking and finance: Chapter 4
Atul Chatterjee
September 10, 2011
Islamic Banking & Finance In South East Asia
Its Development & Future
By Angelo M Vernados Pub: World Scientific Publishing Co. Pte. Ltd. in 2005
Chapter 4: Islamic Financial Products Page 62 to 92
Islamic banking is envisaged as having a social objective in which ideally the banker is a partner and the relationship is not of creditor – debtor.
Islamic banks have boards to decide whether a project conforms to Shariah. This is because the Shariah is not strictly codified so interpretation is needed.
Emergence of Islamic banks (IBs)
Surprisingly the first banks emerged in Egypt as recently as 1963.
However it was in the decade of the 70s which saw a number of IBs coming into being. This may be linked to the oil bonanza for the oil producing countries in and after 1974. (Atul C: Proper studies are yet to be done regarding this linkage.)
The first bank to be started in a non Islamic nation was the International Islamic Bank of Investment and Development in Luxembourg, 1980.
Financial product rules
Under Islamic law financial assets cannot be sold eg. Accounts receivable cannot be sold to another party, so also debt.
One of the first indexes to bring out an Islamic complaint product used certain filters to eliminate companies from the list.
The company should not trade in alcohol, pork, entertainment and weapons of war.
Exclude companies with a debt-to-total-asset ratio of 33 % or more.
Exclude companies with "impure-plus-non-operating interest
income" to a revenue ratio of 5 % or more, where impure indicates items such as alcohol, pork etc.
Exclude companies with accounts receivable to a total assets ratio of 45 % or more.
FTSE Global Islamic Index Series (GIIS) compiled in 1999 was the first truly Islamic index.
In Islamic law deferred sales are a way of disguising interest. If a customer wants a certain asset and cannot make down payment the bank purchases it adds a markup of profit and the customer pays over a period of time. So this according to Islamic bankers makes it a profit based transaction and not an interest based one.
1 Al-Bai Bithaman Ajil (financing the acquisition of assets
through deferred installment sales)
2 Al-Ijara (financing the use of services of an asset through
leasing)
3 Al-Ujr (fee-based syndication services)
4 Al-Murabaha (letters of credit: deferred lump-sum sales or
cost plus)
5 Al-Murabaha (financing working capital: deferred lumpsum
sales or cost plus)
6 Salam (financing the acquisition of assets in the future: forward
purchase)
One of the basic problems is that under Islam an asset cannot be sold without being received. In other words you cannot sell a harvest of dates without collecting the dates from the date palms. Similarly a merchant cannot accept payment for goods which are still at sea.
(When you read about trade by Arabs in the first millennium they were doing this, i.e. buying and selling goods while those were still at sea.)
Under IB the following activities are carried out, most of them it must be remembered were being carried out earlier. So they have come in another guise.
Leasing
Debt financing
Secondary debt market
Bond issuance
Insurance
(Atul C: Insurance is the most obvious form of covering losses under uncertainty. Gharaar is not permitted under Islam hence there is something called takaful which has been developed, i.e. mutual help in which you cover each other´s losses. )
Companies are required to pay zakat i.e. charity payment to the needy. Note this is not an obligation on an individual alone but also on companies.
(Atul C: It can be likened to CSR of companies in the west wherein a certain amount is allocated to social responsibilities. Here it is generally the board of the company which specifies it, whereas zakat is under Islamic law.)
One of the most outstanding features of takaful is that there is no forfeiture element. In conventional insurance if premiums are not paid up to four years or so the amount is forfeited by the company, with nothing being paid to the premium payer.
The other difference is that the method of calculation of profits and the division of profits is clearly stated.
Another way in which Islamic systems differ is that defaults have to be covered by third party guarantors.
Overall Islamic systems need to develop before they can match western ones. Financial systems and products are primitive. Swaps, options, calls etc have no Islamic counterpart. Even salaam which is a futures product is a convoluted one. Also the quantum of funds held under IB to total funds is still small, not more than 10% in any country.
(Atul C: IB will probably not catch up with western systems. If some products like takaful which appear superior to western ones are developed these will provide competition and occupy a niche for themselves.)
IB, Islamic Banking, sharia, shari´ah, fatwah, fatwa,mudarib,riba,interest,zakat,Islamic law, futures,usury,halah, halal
Its Development & Future
By Angelo M Vernados Pub: World Scientific Publishing Co. Pte. Ltd. in 2005
Chapter 4: Islamic Financial Products Page 62 to 92
Islamic banking is envisaged as having a social objective in which ideally the banker is a partner and the relationship is not of creditor – debtor.
Islamic banks have boards to decide whether a project conforms to Shariah. This is because the Shariah is not strictly codified so interpretation is needed.
Emergence of Islamic banks (IBs)
Surprisingly the first banks emerged in Egypt as recently as 1963.
However it was in the decade of the 70s which saw a number of IBs coming into being. This may be linked to the oil bonanza for the oil producing countries in and after 1974. (Atul C: Proper studies are yet to be done regarding this linkage.)
The first bank to be started in a non Islamic nation was the International Islamic Bank of Investment and Development in Luxembourg, 1980.
Financial product rules
Under Islamic law financial assets cannot be sold eg. Accounts receivable cannot be sold to another party, so also debt.
One of the first indexes to bring out an Islamic complaint product used certain filters to eliminate companies from the list.
The company should not trade in alcohol, pork, entertainment and weapons of war.
Exclude companies with a debt-to-total-asset ratio of 33 % or more.
Exclude companies with "impure-plus-non-operating interest
income" to a revenue ratio of 5 % or more, where impure indicates items such as alcohol, pork etc.
Exclude companies with accounts receivable to a total assets ratio of 45 % or more.
FTSE Global Islamic Index Series (GIIS) compiled in 1999 was the first truly Islamic index.
In Islamic law deferred sales are a way of disguising interest. If a customer wants a certain asset and cannot make down payment the bank purchases it adds a markup of profit and the customer pays over a period of time. So this according to Islamic bankers makes it a profit based transaction and not an interest based one.
1 Al-Bai Bithaman Ajil (financing the acquisition of assets
through deferred installment sales)
2 Al-Ijara (financing the use of services of an asset through
leasing)
3 Al-Ujr (fee-based syndication services)
4 Al-Murabaha (letters of credit: deferred lump-sum sales or
cost plus)
5 Al-Murabaha (financing working capital: deferred lumpsum
sales or cost plus)
6 Salam (financing the acquisition of assets in the future: forward
purchase)
One of the basic problems is that under Islam an asset cannot be sold without being received. In other words you cannot sell a harvest of dates without collecting the dates from the date palms. Similarly a merchant cannot accept payment for goods which are still at sea.
(When you read about trade by Arabs in the first millennium they were doing this, i.e. buying and selling goods while those were still at sea.)
Under IB the following activities are carried out, most of them it must be remembered were being carried out earlier. So they have come in another guise.
Leasing
Debt financing
Secondary debt market
Bond issuance
Insurance
(Atul C: Insurance is the most obvious form of covering losses under uncertainty. Gharaar is not permitted under Islam hence there is something called takaful which has been developed, i.e. mutual help in which you cover each other´s losses. )
Companies are required to pay zakat i.e. charity payment to the needy. Note this is not an obligation on an individual alone but also on companies.
(Atul C: It can be likened to CSR of companies in the west wherein a certain amount is allocated to social responsibilities. Here it is generally the board of the company which specifies it, whereas zakat is under Islamic law.)
One of the most outstanding features of takaful is that there is no forfeiture element. In conventional insurance if premiums are not paid up to four years or so the amount is forfeited by the company, with nothing being paid to the premium payer.
The other difference is that the method of calculation of profits and the division of profits is clearly stated.
Another way in which Islamic systems differ is that defaults have to be covered by third party guarantors.
Overall Islamic systems need to develop before they can match western ones. Financial systems and products are primitive. Swaps, options, calls etc have no Islamic counterpart. Even salaam which is a futures product is a convoluted one. Also the quantum of funds held under IB to total funds is still small, not more than 10% in any country.
(Atul C: IB will probably not catch up with western systems. If some products like takaful which appear superior to western ones are developed these will provide competition and occupy a niche for themselves.)
IB, Islamic Banking, sharia, shari´ah, fatwah, fatwa,mudarib,riba,interest,zakat,Islamic law, futures,usury,halah, halal
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