BANKING AND

FINANCE

OVERVIEW OF FINANCIAL
SYSTEM

CONTENT
2

OVERVIEW OF FINANCIAL
SYSTEM
BANKS AS FINANCIAL
INTERMEDIARIES
ISLAMIC BANKING
GOALS AND OBJECTIVES OF
ISLAMIC BANKING
DIFFERENCES BETWEEN
ISLAMIC BANKING AND
CONVENTIONAL BANKING
SYSTEM
ADVANTAGES OF ISLAMIC
BANKING
CHALLENGES OF ISLAMIC
BANKS

FINANCIAL SYSTEM
3

Concept of Financial System

The collection of accounting

processes and procedures that
allow a business to keep
accurate
financial
records,
monitor accounts, prevent fraud
and mistakes, and catch any
discrepancies.
A financial system allows a
company
to
maintain
accountability for expenditures
and revenues, and to control
their finances to minimize waste
and loss.
A financial system is concerned
about money, credit and finance.

FINANCIAL SYSTEM
4

Concept of Money

Money is anything generally accepted as

a means of paying for goods and services
and a measure of value.
Functions of Money :
Medium

of exchange
Measure of value
Temporary store of value

Concept of Credit/Loan

An arrangement in which a lender gives

money or property to a borrower, and the
borrower agrees to return the property or
repay the money, usually along with
interest, at some future point(s) in time.
There is a predetermined time for
repaying a loan, and generally the lender
has to bear the risk that the borrower
may not repay a loan (though modern
capital markets have developed many
ways of managing this risk).

FINANCIAL SYSTEM
5

Concept of Finance

Finance is the procurement

(to get, obtain) of funds and
effective (properly planned)
utilization of funds.
It also deals with profits that
adequately compensate for
the cost and risks borne by
the business.
Finance deals with matters
related to money and the
markets.

BANKS AS FINANCIAL
INTERMEDIARIES
6

Financial intermediaries is an entity

that acts as the middleman between
two parties in a financial transaction.
Financial intermediaries encompass a
wide range of entities in terms of size
and scale of operation ranging from a
banks,
broker-dealers,
investment
advisers and financial planners.
Roles
of
banks
as
financial
intermediaries:

1.

2.
3.

4.

Promote
savings
and
capital
accumulation to finance projects using
various modes of financing.
Finance international trade.
Mobilize resources for investments for
the benefit of society.
Contribute
social
welfare
through
Corporate Social Responsibilities (CSR)
and zakat.

PRINCIPLES GOVERNING OF
ISLAMIC BANKING

Islam
Aqidah
(Faith and
Belief)

Shariah
(Practices and
Activities)

Akhlak
(Moralities
Ethics)

Ibadat

Muamalat

Political
Activities

Economic
Activities
Banking &
Financial
Activities

S
Ac

ISLAMIC BANKING
8

Islamic banking is defined as banking

system which is in consonance with
the spirit, ethos and value system of
Islam and governed by the principles
laid down by Islamic Shariah.

Islamic Banking according to Islamic

Banking Act 1983:
..a company which carries on
Islamic banking business means
banking business whose aims and
operation do not involve any
element which is not approved by
the religion of Islam

Islamic banking, the more general

term, is based not only to avoid
interest-based transactions prohibited
in Islamic Shariah but also to avoid
unethical and un-social practices.

In practical sense, Islamic Banking is

the transformation of conventional
money lending into transactions based

SALIENT FEATURES OF ISLAMIC

BANKING

GOALS AND OBJECTIVES OF

ISLAMIC BANKING
1
0

Offer Financial Services

The thrust is towards financing on risk- sharin

strict focus on halal activities
Focus on offering banking transactions adher
Shariah principle and avoiding conventional i
based banking transactions.
Economic Development

Established a direct and close relationship be

the banks return on investment and the succ
operation of the business by the entrepreneu
Optimum Resources Allocation

Considered to be most profitable, religiously

permissible and are beneficial to the econom

GOALS AND OBJECTIVES OF

ISLAMIC BANKING
1
1

Optimum Approach

Profit- sharing principle encourages banks to go fo

with long- term gains instead of short- term gains.
Banks conduct proper studies before getting into p
High returns distributed to shareholder maximize
benefits and bring prosperity to the economy.
Equitable Distribution of Resources

Ensures equitable distribution of income and resou

among the participation parties, with its profit- sha
approach which is one of a kind.
Facilitate Stability in Money Value

Islam recognize money as a means of exchange a

a commodity.
Riba- free system leads to stability in the value of
enable the medium of exchange.

PRINCIPLES OF ISLAMIC BANKING

1
2

Islamic banking is the conduct of

banking based on SHARIAH
principle, subject to among
others:
1.

Prohibition of Riba
Riba

is strictly prohibited under Islam

and is considered as haram.
Islam allows only one kind of loan that
is Qardhul Hassan.
2.

Equity participation
Islam

encourages Muslims invest their

money and become partners in order
to share profits and risk in the business
instead of becoming creditors.
In Islam, financing is based on the
belief that the financier and borrower
should equally share the risks of the
business venture.

PRINCIPLES OF ISLAMIC BANKING

1
3

3.

Prohibition of gharar
Gharar

means to undertake a venture

blindly without sufficient knowledge or
to undertake excessively transactions
An Islamic financial system discourages
hoarding and prohibits transactions
featuring extreme gharar.
4.

Contractual relationship
Depends

upon the nature of transaction.

It could be a seller and buyer
relationship (Murabaha), a lessor- lessee
relationship (Ijarah), and a partnership
(Musyaraka)
5.

Money as Potential Capital

It

is way of defining the value of a thing.

Should not be allowed to give rise to
more money, via fixed interest
payments, simply by being put in a bank
or when lent to someone.

DIFFERENCES BETWEEN ISLAMIC

BANKING AND CONVENTIONAL
BANKING SYSTEM
1
4

Islamic Banking
System

Charact Conventional
eristics Banking System

Functions and
operating modes
are based on
Shariah law.
Banks have to
ensure that all
business
activities are in
compliance with
Shariah
requirements.

Busines
s
Framew
ork

Each bank
should have a
Shariah
Supervisory
Board to ensure
that all business
activities are in
line with Shariah
requirements.

Shariah There is no such

Supervi requirement
sory
necessary.
Board

Functions and
operating modes
are based on
secular principles
and not based on
any religious law
or guidelines.

COMPARISON BETWEEN ISLAMIC BANKING

AND CONVENTIONAL BANKING SYSTEM

Islamic Banking Charact Conventional

System
eristics Banking
Promotes risk
sharing
between
investor and
the bank & the
bank and the
entrepreneur :
pre-agreed
proportion

Risk
Predetermined
sharing rate of interest

Under PLSEmphasi Credit

return only if
s to
worthiness
there is a
product
profit
-more concern
with soundness
of the project
and managerial
competence of
the
entrepreneur.
All economic

Moral

Little attention

COMPARISON BETWEEN ISLAMIC

BANKING AND CONVENTIONAL
BANKING SYSTEM
1
6

Islamic Banking
System

Charact Conventional
eristics Banking System

Financing is not Prohibit Financing is

interest
ion of interest
oriented
Riba in oriented
Financi A fixed/floating
Based on the
principle of
ng
interest is
buying and
charged for the
selling of assets,
use of money.
whereby the
selling price
include a profit
margin
Fixed from the
beginning.
Restricti There are no
Islamic banks
are restricted to
ons
such
participate in
restrictions.
economic
activities, which
are not Shariahcompliant.
Pay zakat as a

Zakat

Dont pay zakat

ADVANTAGES OF ISLAMIC
BANKING
1
7

Justice and Fairness

The main feature of the Islamic model

it is based on a profit-sharing principle
whereby the risk is shared by the bank
the customer.
This system of financial intermediation
contribute to a more equitable distribu
income and wealth.
Liquidity

Follow the profit and loss-sharing princ

mobilize resources and are less likely t
any sudden run on deposits.
As such, they have a minimum need fo
maintaining high liquidity.

ADVANTAGES OF ISLAMIC
BANKING
1
8

Better Customer Relations

Financing and deposits are extended unde

profit and loss sharing arrangement. The b
are likely to know their fund users better i
to ensure that the funds are used for prod
purpose and vice-versa for investors.
It will develops better relations between th
financial intermediary and the fund provid
consumers.
No
Fixed Obligations

Islamic banks do not have fixed obligation

as interest payments on deposits. Therefo
are able to allocate resources to profitable
economically desirable activities.
Also holds good for Islamic financing, as th
payment obligations of the entrepreneur is
associated with the revenue.

ADVANTAGES OF ISLAMIC
BANKING
1
9

Transparency

Transparent to the account holders on the inves

made in different areas and the profits realized
these investments. The profit is then shared in
agreed ratio.
Ethical and Moral Dimensions

Strong ethical and moral dimensions of doing b

and selecting business activities to be financed
important role in promoting socially desirable
investments and better individual or corporate
Banking for All

Although based on Shariah principles to meet t

financial needs of Muslims, it is not restricted to
only and is available to non-Muslims as well.

CHALLENGES OF ISLAMIC
BANKING
2
0

Misconception about Islamic banking

Many still has a wrong understanding or

misconception against Islamic Banking
which among the thoughts are:
Islamic

Banking is only for Muslims

Islamic Banking is not profitable because
no interest is charged
Islamic Bank is a charitable organization

Thus better awareness shall be create

among the customers that Islamic
Banking is not only an alternative
financial approach but also in some
aspects provides better value
propositions to the consumers.

Divergence of opinions

Shariah interpretation versus business

practicability/ financing commercial
viability

CHALLENGES OF ISLAMIC
BANKING
2
1

Moving towards equity based financing

(Musharakah/ Mudharabah) financing?

War of talents

Commercial banks requires a new set of technical

and risk management capabilities i.e. industry
experts and know-how
Market readiness profit sharing, trade secrets,
bank as strategic business partners (potential
conflicting interest).
Balance sheet size, risk appetite and underwriting
capabilities
Supervisory and prudential regulatory framework.
Accounting and auditing standards.
Global shortage of Islamic finance talents at almost
all levels
Inadequate pool of Shariah scholars with the right
combination of knowledge in Shariah and modern
finance

Rising Cost for Small Islamic Banks

Ballooning operating costs for Islamic banks as

opposed to relative cost stability for the overall
banking system - expenditure on IT infrastructure,
expenses for R&D and product innovation and
network expansion and new delivery channels

22

END OF CHAPTER