Islamic banking in the world - Free Essay Example

Executive summary: Islamic banking is a worldwide phenomenon involving a variety of institutions and Instruments offering Sharia base modes of finance, during the last few decades getting progress and facing challenges. Now most commonly there are three Islamic finance school of thoughts applying into the Islamic world they are Pakistani, Gulf and Malaysian school of thoughts. Islamic finance have a big market but there are some challenges both in secondary and primary market most commonly risk management and liquidity of funds is a big issue but in the Pakistan Islamic banks getting groom over the period of time by introducing unique Islamic mode of finance instruments. The graphical presentation of the different mode of Islamic finance and process. Moreover, all the Islamic Institutes monitor by the State Bank of Pakistan regulatory authority and working over the guidelines for risk management and refining their performance and play a vital role for the growth of country economy. Comparison of existing Islamic institutes and their performance over the period of time and how the banks deals with the overdue amount and how they manage these funds and putting them into the charitable work. Introduction: This report covers the issues of Islamic Banking and how State Bank of Pakistan regulates it according to the Sharia Compliance and enforces the Islamic banking institutions guidelines and principals for risk management. Pakistan holding world second largest Muslim population and having the lot of attraction for the investor dealing in Islamic base business and the report cover the performance of the Islamic institutions as compare with the conventional financial institutions. Moreover, Islamic banks market share their yearly bases performance and growth as compare with the previous years and during the last ten years performance of different banks operating Islamic services in Pakistan and their growth comparison that shows Mezzan Islamic bank performance and how they offer their sharia base service like Ijarah, Mudarbah, Musharkah, Murabaha and Sukuk and their graphical presentation of bank and client process that helpful to understand that how Islamic mode of finance work according to the sharia compliance. In year 2010 the total conventional banking deposits was $78bn and the projected growth rate was 13% p.a. while the share of Islamic banking deposit in Pakistan financial market was $12bn and projected growth rate was 81% p.a. with 440 Islamic operational branches. Need For Islamic Banking: Recent study published in United States stated that the growth rate of world Muslim population is higher than the world non Muslim population and it is believed and projected that it will be the quarter of the world population near 2030. Pakistan, which has seen a rise in radical Islam in current months, will chase Indonesia as the worlds most populous Muslim nation. Majority of the people seeking to invest into the Hala mode of financing and people fad up with the traditional financial system where institutions based on interest. Moreover, Islamic financial system based on the principal of Sharia, which mean they believe and follow the Islamic school of thoughts prohibition on the payment and recipient of interest this is the basic reason that make difference between the Islamic financial institutions and their Western counterparts. Government Regularity: Pakistan was among the three countries in the world that had been trying to implement interest free banking at national level. Islamic Banking is one of the rising field in global financial market and having the potential all around the world. The Islamic Banking is one of the rising field in global financial market and first full flag Islamic Banking Department was established under the supervision of State Bank of Pakistan (SBP) in 2003 and having task to promote or established financial help according to the Sharia Complaint. SBPs Islamic banking polices allow the people to establish their financial relationship with Islamic banks according with their Islamic beliefs. SBP feels the responsibility for the promotion of Islamic Banking and they work on three strategies. Allow the conventional banks to establish their Islamic banking branches throughout the country. Support the private sector to establish Islamic banks. Enforce the existing conventional banks to open stand alone Islamic banking branches. Before commencement of business a reputed sharia advisor has to be appointed according to the given SBP policy. Banks ensure all their document services authorised by their sharia advisors. Banks are required to undertake comprehensive internal audit at least once in a year. Islamic and commercial banks both shell have a separate schedule of charges authorised by their sharia advisors. Risk Management: SBP enforce the Islamic Banking Institutions to follow the guiding principles of risk management established by the Islamic Financial Services Board (IFSB) that helpful to minimize the financial risk and these principals are applied over the six categories of risk they are. Market Risk Credit Risk Operational Risk Liquidity Risk Rate of Return Risk Equity Investment Risk Sharia Compliance Framework: Shariah compliance is the most important feature of Islamic finance. SBP established a comprehensive sharia compliance structure for the credibility of the Islamic Banking Institutions and the structure consists of. Sharia Board at SBP Sharia Advisor Forum Sharia Advisor Model agreement of Islamic mode of financing Guidelines for sharia compliance in IBIs Sharia compliance inspection Industry Progress and Market share: Islamic banks in Pakistan producing amazing results during the time when conventional financial system fully griped even all around the world and having more financial tools than Islamic sector. Under the current policy first Islamic banking licence was granted on in year, 2002. In year 2010 the total conventional banking deposits was $78bn and the projected growth rate was 13% p.a. while the share of Islamic banking deposit in Pakistan financial market was $12bn and projected growth rate was 81% p.a. with 440 Islamic operational branches. It is also important to compare the Pakistani Islamic financial sector with the progress in other countries. Malaysia first Islamic bank was established in 1983 and till 2007 its stand on 13%, Bahrain Islamic Bank stands on 8% during 30 years and Indonesia Islamic banks started their service science 1990s and still it has progress around 1.67% all the above figures shows that the performance of Islamic banking sector in Pakistan comparatively better or satisfactory than other global countries especially east Asian countries. Banking and Finance Shariah Mode of Finance: Islamic finance sector in Pakistan offer a wide range of shariah base service to the investors. Following are the shariah complaint modes of banking and finance. Trading Mode Participatory Modes Debt Based Mode Other Modes zIjarah or Ijarah wa Iqtina Mudaraba Qard Wakalah Murabaha Musharka Assignment of Debt Musawamah Diminishing Musharka Kafalah Salam Equity participation in the form of shares in a corporate entity Istisna Tawarruq Charity Fund: SBP, policy for the income generated by the non-Sharia based resources or the income incurred by the bases of any penalties either its a late payment charges received by the client in default or overdue cases etc are transfer to the charity fund that income utilize for the charitable or social welfare purposes. Banks Offer Services: Following are the year wise entry of Islamic banks in Pakistan economy. Market Share 2003-2007: To analyse the market share its important to check both sides of the balance sheet to discourage the unethical information plays by the account managers and some time auditors play role to help them just for generating accounting profit and get good response from the market. SBP, keep focusing over the accounting performances on both Islamic and Conventional services sector and finally announced yearly bases comparison of the both sectors for encourage the investors. The table below shows the market share performance comparison from 2003-2007. Branch Network Growth: In the Pakistan economy Islamic banking sector performing amazingly and by offering riba free services Islamic banks in overall branch network of the industry has increased over period of time and getting higher pace. All are the major banks in Pakistan now offering Islamic bank services. By 30th June 2008 total asset of Islamic banking industry in Pakistan was over Rs. 225 bn which was the 4.5% of the total banking industry assets. In the four provinces of Pakistan and AJK, more than 330 branches offering Islamic service. SBP, enforce all the conventional and non conventional to open their Islamic branches in all major cities and towns covering all the four provinces of the country and AJK. The table below shows growth in the branches network of Islamic banking industry science 2003-2007. Bank wise Share and Total Assets: Islamic banking system consider the alternative of the existing conventional system and the percentage value of Islamic banking assets growth in Pakistan gradually getting pace during the years 2003-2007 that was 85.2%, 241.8%, 62%, 66.9% and 72.6% respectively. Both IBs Islamic Banks and IBDs Islamic Banking Divisions enjoying growth, but rapid growth seems from year 2004 due to the large network of full fledged Islamic banks over more than 50 cities with the support of conventional bank IBs. The table below shows the assets of Islamic banking industry in Pakistan during the year 2003-2007. The bank wise share of Islamic banking industry Assets is as on 31st December, 2007. It is interesting and noticeable the highest growth that is 32.62% gaining by the fully fledge Pakistan most leading Islamic bank Mezzna Bank Limited (MBL) while the three big commercial bank have not showing the sign of market share they are UBL, NBP and HBL that predict the confidence of people over Islamic banks in Pakistan. Deposit and Bank wise share: Deposits are the key of success for any financial institutes mainly it is important for Islamic banking that target different people from different background during the time when conventional banking having the large share of market but the performance during the years 2003-2007 predict the scope of Islamic banking and its success against the conventional system. Islamic banking divisions and Islamic banks gaining remarkable growth in deposits during the years 2003-2007 that is 65.3%, 259.5%, 65.4%, 67.7% 76.0% respectively. Moreover, rapid progress shown in year 2004 because aggressive banking start from Bank Alfalah Limited and the new entry of Al Barqa bank and after the couple of year Dubai Islamic bank, Emirates Global bank, Bank Islami and Duawood Islamic bank start their full fledge business and contribute to lead the deposit position up to mark during the year 2006 and 2007. Bank share deposits performance during the year 2003-2007 is as under. Financing and Banks Share: Liquidity management play a vital role for the existence of any financial institute. SBP provides a complete range of instructions to all Islamic banks to keep follow them for getting the good results from the market not only provide the policy also provide the a complete sharia compliance cell and sharia advisors for risk management. During the period from 2002-2007 Islamic banks financial performance was amazing that was 97.8% while the respective year growth was 135.1%, 218.4%, 66.4%, 43.4% 63.5%. figures show that Meezan bank capturing almost one third of financing while Bank Alfalh again leads the category of conventional banks having Islamic banking branches with the addition of BankIslami, Emirates Global, Dubai Islamic and Dawood Islamic yearly financing growth rate getting good pace every year. Composition of different mode of Islamic financing that shows saving deposit initially grew at high pace but latterly fixed deposit performance relatively better growing rate. By offering the credible shariah compliance, help to develop the interest of the customers. For the Islamic Banking Institutions ideal modes of financing belong to the low risk share category i.e. those which usually generate a fixed return. Among these Murabaha (cost plus mutually agreed profit margin). Ijara (leasing) are the most attractive and popular modes of financing. However, lately the share of Diminishing Musharaka has also grown at a rapid pace leading towards diversification of the Islamic banks financing portfolio Islamic Mode of Financing: Ijarah: Ijarah is a term of Islamic Fiqh Literally, it means To give something on rent The term Ijarah is used in two situations: It means To employ the services of a person on wages e.g. A hires a porter at the airport to carry his luggage Another type of Ijarah relates to paying rent for use of an asset or property defined as LAND in Islamic Economics Ijarah is an Islamic alternative of Leasing. Leasing backed by an acceptable contract is an acceptable transaction under Shariah. The question of whether or not the transaction of leasing is Shariah compliant depends on the terms and conditions of the contract. Several characteristics of conventional agreements may not conform to Shariah thus making the transaction un-Islamic and thereby invoking a prohibition. Risk and rewards of ownership lies with the owner i.e. any loss to the asset beyond the control of the lessee should be borne by the Lessor. Late payment penalty cannot be charged to the income of the Lessor. Lease and Sale agreement should be separate and non contingent. Bank Ijarah Process: The customer approaches the Bank with the request for financing and enters into a promise to lease agreement. The Bank purchases the item required for leasing and receives title of ownership from the vendor The Bank makes payment to the vendor The Bank leases the asset to the customer after execution of lease agreement. The customer makes periodic rental payments as per the contract At the end of the tenure customer can purchase the asset from the bank with the help of separate Sale agreement. In case of sale, title of property is transferred to Buyer In case of Ijarah, title remain with the Lessor Only the use of the property is transferred to Lessee Murabaha financing: Murabaha is a particular kind of sale and not a financing in its origin. Where the transaction is done on a cost plus profit basis i.e. the seller discloses the cost to the buyer and adds a certain profit to it to arrive at the final selling price. The seller discloses the cost to the buyer and a known profit is added. Payment of Murabaha price may be: At spot In installments. In lump sum after a certain time Some basic rules should be the part of Murabaha base financing, they are Sale price should be determined. Asset to be sold must exist. Sale must be unconditional. Assets to be sold: Should not be used for un-Islamic purpose. Should be in ownership of the seller at the time of sale, physical Step by Step Murabaha Process: Following are the steps that a bank takes during offering Murabah base services. The client and the bank sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. The institution accepts the offer and the sale are concluded whereby ownership as well as risk is transferred to the client. Diminishing Musharakah: Musharkah is the form of Shirakat partnership and following are the types of Musharkah. Shirkat-ul-Milk: Joint ownership of two or more persons in a particular property Shirkat-ul-Aqd: A partnership affected by mutual contract. It can also be translated as a joint commercial enterprise In Diminishing Musharkah the financier and the client have a joint ownership of equipment, property or a commercial enterprise. The share of the financier will be divided into a number of units The client will purchase these units one by one periodically until he is the sole owner of the property Bank and Diminishing Musharkah Process: These are the components that a Bank perform during Diminishing Musharkah contract or agreement. Joint ownership of the Bank and customer Customer as a lessee uses the share of the bank Redemption of the share of the Bank by the customer Istisna: Istisnaa is the second exception to the rules of sale where a sale is allowed without immediate delivery of the goods sold. Istisnaa is a contract of sale of specified items to be manufactured, with an requirement on the part of the manufacturer to deliver them to the Customer upon completion. It is not permissible that the entity of an Istisnaa contract be a tangible existing and identified capital asset. An Istisnaa contract is permitted only for raw materials that can be transformed from their natural state by a manufacturing or construction process involving labor. The time of delivery of goods does not necessarily have to be fixed in Istisnaa however, a maximum time may be agreed upon between the parties. The Istisnaa price can either be paid in advance, or in installments or at the time of delivery of goods. The price of Istisnaa transactions may vary in accordance with variations in the delivery date. Sukuk: For the liquidity management offered sukuk into the Islamic finance money market which is basically the certificate of equal value representing proportionate ownership of tangible assets. This ownership comes in effect after the completion of payment and with the investment of received funds. Sukuk representing equity share in a particular business or investment portfolio (based on Musharakah/ Mudarabah). Sukuk representing receivable or future goods (based on Murabaha or Salam or Istisna). Salam and Murabah base Sukuk are the non tradeable while tradable Sukuk are tangible assets or proportionate ownership of a business or investment portfolio are tradable for instance Ijarah or Musharkah/ Mudarbah base Sukuk. Moreover, Sukuk use for the liquidity need but still it has some objection or restriction during offering into the market. Sukuk holders have the complete ownership rights. Manager cannot lend money when the actual profit is less than the expected. Before offering the sukuk into the market must abide by the Sharia supervisory board. Sukuk should be issue over the new industrial and commercial venture.